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Month: May

Capital gains : S.55(2)(b) : Sale of shares acquired before 1-4-1981 held as stock in trade up to 1987 — Market value as on 1-4-1981 is cost of acquisition

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II. Reported :

14 Capital gains : Cost of acquisition : S. 55(2)(b) of
Income-tax Act, 1961 : Shares acquired prior to 1-4-1981 and held as stock in
trade up to 2-11-1987 : Sale of shares : Assessee entitled to adopt market value
as on 1-4-1981 as cost of acquisition.

[CIT v. Jannhavi Investments (P) Ltd.; 215 CTR 72 (Bom.)]

The assessee had acquired shares prior to 1-4-1981. Up to
2-11-1987, the shares were held as stock in trade when those were converted into
capital assets. On sale of the shares the assessee claimed the market value of
the shares as on 1-4-1981 as the cost of acquisition relying on the provisions
of S. 55(2)(b) of the Income-tax Act, 1961. The Assessing Officer rejected the
claim, on the ground that the shares were held as stock in trade till 2-11-1987.
Relying on the judgment of the Bombay High Court in the case of Keshavji
Karsondas v. CIT; 207 ITR 737 (Bom.) the Tribunal allowed the assessee’s
claim.

On appeal by the Revenue, the Bombay High Court upheld the
decision of the Tribunal and held :

“(i) On behalf of the Revenue, it was sought to be
contended that the decision in the case of Keshavji Karsondas is
distinguishable in the facts of the present case. He pointed out that by
Finance Act, 1992, w.e.f. 1993, the mode of computation of income chargeable
under head ‘Capital gain’ had changed and the concept of ‘indexed cost of
acquisition’ had been introduced and defined under Explanation III to the 5th
proviso of S. 48. According to him the concept ‘indexed cost of acquisition’
was calculable on the basis of the cost of acquisition for the first year in
which the asset was held or on the first day of April, 1981, whichever was
later. He drew our further attention to S. 55(2)(b) which related to
calculation of ‘any other capital asset’.

(ii) In our view, there is no substance in the contention
of the Revenue. The amendment of 1993 referred to hereinabove does not in any
way nullify or dilute the ratio as laid down in the case of Keshavji Karsondas.
The cost of acquisition can only be the cost on the date of the actual
acquisition. In the present case, there was no acquisition of shares on
2-11-1987 when the same were converted from stock in trade to a capital
asset.”


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Capital gain : Interest on borrowing for investment in shares to be added to cost of acquisition of shares

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15 Capital gains : cost of acquisition : A.Y. 2000-01 :
Interest on capital borrowed for investment in shares is liable to be added to
the cost of acquisition of shares.


[CIT v. Trishul Investments Ltd., 215 CTR 96 (Mad.)]

The assessee company was carrying on business of investment
in shares and securities. In the books of the assessee company, the interest
liability on the borrowed funds was debited. The assessee claimed that the
interest should be included in the cost of acquisition of the shares. The
Assessing Officer rejected the claim. The Tribunal allowed the claim.

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

“(i) The Tribunal correctly held that the interest paid for
acquisition of shares would partake character of cost of share and therefore
the same was rightly capitalised along with the cost of acquisition of shares.
There is no denial regarding the borrowed money for the acquisition of shares
by the assessee. The Tribunal correctly held that the interest payable thereon
should be added to the cost of acquisition of shares. The reasons given by the
Tribunal are based on valid materials and evidence.

(ii) Under these circumstances, we do not find any error or
legal infirmity in the order of the Tribunal so as to warrant interference.”

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Principle of mutuality : Entrance fees, commutation value of subscription for life members received by sports club — Capital Receipt

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A. Unreported :

13 Income/capital receipt : Principle of
mutuality : A.Y. 1992-93 : Assessee is a sports club : Entrance fees : Commuted
value of subscription for life members : Is capital receipt not chargeable to
tax as principle of mutuality applies ?

[CIT v. Willingdon Sports Club (Bom.); ITA No. 121 of
2005; dated 18-3-2008 (Not reported)]

The assessee is a sports club. Its members are described as
gymkhana member, corporate member, short-term member all of whom are entitled to
the advantages or privileges of membership of the club except that of being
present or of voting at the general body meetings of the club or of serving on
the general committee and of proposing or seconding for elections as members of
the club. Apart from these members, there are life/founder/ordinary/super number
members. For the A.Y. 1992-93, the Assessing Officer assessed the total income
at Rs.15,75,900. In appeal, the Commissioner (Appeals) noted the two distinct
kind of members and held that the first category of members who were not allowed
to vote during the general body meeting were also not eligible to participate or
share in the surplus of the club on its winding up, and relying on the judgment
of the Bombay High Court in CIT v. WIAA Club; 136 ITR 569 (Bom.), held
that entrance fees and commutation of fees both have to be taken as revenue
receipts and dismissed the appeal. The Tribunal held that the entrance fees is
capital receipt not chargeable to tax in view of the decision in the case of
CIT v. WIAA Club; 136 ITR 569 (Bom.), which has been followed in CIT v.
Diners Business Services Pvt. Ltd.; 263 ITR 139 (Bom.). Accordingly, the
Tribunal allowed the appeal.

 

In appeal by the Revenue, the following questions were
raised :

“(a) Whether on the facts and in the circumstances of the
case and in law, the Tribunal was right in holding that the entrance fees
received by the assessee is capital receipt not chargeable to tax as the
principle of mutuality applies ?

(b) Whether commuted value of subscription for life members
has to be taxed or treated as capital receipts in the light of the decision of
the Bombay High Court in CIT v. WIAA Club, 136 ITR 569 (Bom.) ?”

 


Following the judgment of the Supreme Court in CIT v.
Bankipur Club; 226 ITR 97 (SC), the Bombay High Court held as under :

“(i) The Revenue it appears have based their submission on
the judgment of this Court in CIT v. WIAA Club; 136 ITR 569. The
membership of the club consisted of ordinary members and life members. The
ordinary members were paying entrance fees and annual subscription. The life
members were paying larger entrance fees without any liability to pay annual
subscription. The club was extending similar facilities both to ordinary and
life members. The issue of mutuality was neither argued nor raised or was on
issue before the learned Bench of this Court. It is on the facts there and
without considering the principle of mutuality that the learned Bench
proceeded to hold that the amount paid by the members had two elements in it.
The part of the amount paid was entrance fees which were paid to the club with
a view to acquiring the right to avail of the services and facilities extended
by the club. The other part was a consolidated commuted payment in lieu of
annual subscription. The Court held that that part of the entrance fees which
was a compounded payment for annual subscription would be income and the
balance would be capital receipt. In our opinion, considering the judgment of
the Supreme Court in Bankipur (supra) and the issue of mutuality which
has been raised in the present appeal, the judgment in WIAA Club (supra)
is clearly distinguishable. Even otherwise, in our opinion, it is doubtful
whether it would be correct law considering the judgment in Bankipur (supra).

(ii) From the principles which have been set out above and
more so in the judgment in Bankipur (supra), even if there be temporary
or honorary members who are not entitled to vote, the assessee would not cease
to be governed by the principle of mutuality. Once the assessee is governed by
the principle of mutuality, its income earned would not be income which would
be assessable to tax.

(iii) For the aforesaid reasons, we are of the view that
there is no infirmity in the judgment and consequently the questions as raised
are devoid of merit and consequently appeal dismissed.”


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Exemption — Income not forming part of the total income — Whether State-controlled Committee/Boards and companies constituted to implement the educational policy of the State should be treated as educational institution eligible for exemption u/s.10(22) o

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7 Exemption — Income not forming part of the total income —
Whether State-controlled Committee/Boards and companies constituted to implement
the educational policy of the State should be treated as educational institution
eligible for exemption u/s.10(22) of the Act — Matter remanded.


[Assam State Text Book Production And Publication Corporation
Ltd. v. CIT, (2009) 319 ITR 317 (SC)]

In the appeals before the Supreme Court, it was concerned
with the A.Ys. 1981-82 to 1996-97, except the A.Y. 1989-90. The question which
arose before the Assessing Officer was whether the Corporation could be termed
as an ‘educational institution’ in terms of S. 10(22) of the 1961 Act ?
According to the Assessing Officer, since the assessee, during the relevant
years, had income exclusively from publication and selling of textbooks to the
students, exemption u/s.10(22) of the Act, as it stood at the material time, was
not admissible. According to the Assessing Officer, the assessee did not exist
solely for educational purposes, particularly in view of clause 21 of the
memorandum of association which provided for distribution of dividends, hence,
its income was not exempt u/s. 10(22) of the Act. This decision of the Assessing
Officer was upheld by the Commissioner of Income-tax (Appeals). In the Tribunal,
there was a difference of opinion between the Member (Judicial) and the Member
(Accountant). By decision of the majority, it was held that the Corporation was
an educational institution and, consequently, the Corporation was entitled to
the benefit of exemption u/s.10(22) of the Act for the relevant assessment years
in question. However, in appeal filed by the Department, the High Court came to
the conclusion that the income of the Corporation, during the relevant
assessment years, was not exempt, particularly in view of the fact that the
assessee did not exist solely for education purposes; that it did not solely
impart education and that its income during the relevant assessment years was
only from publishing and sale of text-books, which according to the High Court,
constituted a profit-earning activity. Against the said decision, the assessee
has come to the Supreme Court by way of civil appeals.

On going through the records, the Supreme Court found that
the High Court had not taken into account the prior history of the case,
particularly in the context of incorporation of the Corporation under the
Companies Act, 1956, as a Government company. Initially, the assessee was a
State-controlled Committee and Board, which was attached to the Office of the
Director of Public Instruction, State of Assam. It was only in the year 1972,
that the Government company got constituted u/s.617 of the Companies Act, 1956;
that, prior to 1972, the entire funding for the working of the Committee/Board
was done by the State of Assam and that even the ownership of the assets
remained vested in the State of Assam, which stood transferred to the
Corporation in 1972, when it got incorporated under the Companies Act, 1956. The
Supreme Court observed that the assessee was a Government company. It was
controlled by the State of Assam. The aim of the said Corporation was to
implement the State’s policy on education; that, clause 21 of the memorandum and
articles of association provided a return on investment to the State of Assam;
that, in the year 1975, in a similar situation, the Central Board of Direct
Taxes (for short, ‘the CBDT’) had granted exemption u/s.10(22) of the Act, vide
letter dated August 19, 1975, to the Tamil Nadu Text Books Society, which
performed activities similar to those of the assessee. The letter dated August
19, 1975, was referred to in the judgment of the Rajasthan High Court in the
case of CIT v. Rajasthan State Text Book Board reported in (2000) 244 ITR
667. A similar question came up for consideration before the Rajasthan High
Court, namely, whether the Rajasthan State Text Book Board was entitled to
exemption u/s.10(22) of the Income-tax Act, 1961 ?

The Rajasthan High Court in its judgment recited that, under
a similar situation, the CBDT had also extended the benefit of exemption under
10(22) of the Act to the Orissa Secondary Board Education, as reported in
Secondary Board of Education v. ITO, (1972) 86 ITR 408 (Orissa). Following
these circulars/letters issued by the CBDT, the Rajasthan High Court had come to
the conclusion that the assessee in that case, namely, Rajasthan State Text Book
Board, was entitled to claim the benefit of exemption u/s.10(22) of the Act.

The Supreme Court, in view of the above, was of the opinion
that the High Court, in its impugned judgment, had not considered the historical
background in which the Corporation came to be constituted; secondly, the High
Court ought to have considered the source of funding, the sharehold-ing pattern
and aspects, such as return on investment; thirdly, it had not considered the
letters issued by the CBDT which are referred to in the judgment of the
Rajasthan High Court granting benefit of exemption to various Board/Societies in
the country u/s.10(22) of the Act; fourthly, it has failed to consider the
judgments mentioned hereinabove; and lastly, it had failed to consider the
letter of the Central Government dated July, 1973, to the effect that all
State-controlled Educational Committee(s)/Board(s) were constituted to implement
the educational policy of the State(s); consequently, they should be treated as
educational institutions.

For the aforesaid reasons, the Supreme Court was of the view
that, instead of remanding the matter to the High Court, it was appropriate that
the matter was remitted to the Assessing Officer to consider it de novo in the
light of the above.

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Embedded leases : The scope under IFRS is much wider (IFRIC 4)

IFRS

Background:


It is not uncommon for enterprises to have contracts with
service providers for providing goods/services on a dedicated basis to these
enterprises. As certain assets may be dedicated for use only for a particular
enterprise, binding procurement commitments may be provided to the service
provider to the extent of entire production capacity of the assets. In certain
other cases, the enterprise may provide minimum procurement guarantee whereby it
pays a fixed price per unit of shortfall in procurements. Through these
arrangements the service provider is assured of compensation for the capital
cost incurred.

An entity may enter into an arrangement, comprising a
transaction or a series of related transactions, that does not take the legal
form of a lease but conveys a right to use an asset (e.g., an item of
property, plant or equipment) in return for a payment or series of payments.
Examples of arrangements in which one entity (the supplier) may convey such a
right to use an asset to another entity (the purchaser), often together with
related services, include :

(1) Outsourcing arrangements, and

(2) take-or-pay and similar contracts in which purchasers
must make specified payments regardless of whether they take delivery of the
contracted products or services (e.g., a take-or-pay contract to
acquire substantially all of the output of a supplier’s power plant).

Embedded leases :

IFRIC 4 provides guidance on determining whether an
arrangement is or contains a lease. The following example illustrates
take-or-pay contracts that would be classified as embedded lease :

An entity has a contract with its supplier (job worker)
whereby the entity is contractually bound to get 100,000 units of goods
manufactured by the supplier. The supplier has installed dedicated machinery to
manufacture and supply the goods only to serve the entity. The supplier has no
other machinery that can manufacture these goods.

Price terms are as under :

  • For first 100,000 units —
    Rs.3 per unit


  • 100,001 onwards — Re.1
    per unit;


  • In case of any shortfall
    as compared to 100,000 units, a penalty of Rs.2 per unit of shortfall shall be
    levied.







In the above case, the assets are deployed for use only for
the entity. Further, irrespective of the actual purchase from the supplier, the
entity is bound to pay a fixed charge in the form of per unit charge and
penalty, if applicable (Rs.200,000 in the above example i.e., even if the
purchaser does not purchase at all, a penalty on 100,000 units would be levied
at Rs.2 per unit). This fixed charge, in substance, is a lease arrangement where
the supplier’s machinery is taken on lease for a lease rent of Rs.200,000.

Determining whether an arrangement is, or contains, a lease :

Guidance in IFRIC 4 helps the entity to assess if
outsourcing/service contract is a simple supply contract or whether in substance
there is actually a lease embedded in the contract. The assessment whether the
above arrangement is or contains a lease is based on whether :

  • the fulfilment of the
    arrangement is dependent on the use of a specific asset or assets; and


  • the arrangement conveys a
    right to use the asset(s).



Arrangement dependent on use of a specific asset or assets :

For classifying an arrangement as a lease, one needs to
assess whether the arrangement is dependent on the use of a specific/identified
asset. For an arrangement to be determined as an embedded lease, there needs to
be reasonable certainty at inception of the contract that the same asset would
be used throughout the term of the contract. In other words, the asset needs to
be a ‘specified asset’.

The asset may be a ‘specified asset’ either explicitly by way
of a contract or could be identified impliedly, based on the facts and
circumstances of the case.

Specified assets explicitly identified in an arrangement :

An asset may be explicitly specified in the contract when,
for instance, the service provider’s plant/ warehouse is mentioned in the
agreement along with the address. Thus it is reasonably certain that the same
plant/warehouse shall be used throughout the contract period.

Although a specific asset may be explicitly identified in an
arrangement, it is not the subject of a lease if fulfilment of the arrangement
is not dependent on the use of the specified asset.

Specified assets implied in an arrangement :

An asset has been implicitly specified if, for instance, the
supplier owns or leases only one asset with which to fulfil the obligation and
it is not economically feasible or practicable for the supplier to perform its
obligation through the use of alternative assets.

The entity will have to use its judgment in determining
whether it is economically feasible or practicable to perform obligations
through use of alternative assets, based on the facts and circumstance in each
case. Assessing whether the use of alternative asset is economically feasible
and practical will not always be straightforward.

Fulfilment of the contract is dependent on the use of
specified asset :

If the supplier is obliged to deliver a specified quantity of
goods or services and has the right and ability to provide those goods or
services using other assets not specified in the arrangement, then fulfilment of
the arrangement is not dependent on the specified asset and the arrangement does
not contain a lease.

The arrangement conveys a right to use the asset :

An arrangement conveys the right to use the asset if the arrangement conveys to the purchaser (lessee) the right to control the use of the underlying asset. The right to control the use of the underlying asset is conveyed if any one of the following conditions is met?:

    a) The purchaser has the ability or right to oper-ate the asset or direct others to operate the asset in a manner it determines.
    b) The purchaser has the ability or right to control physical access to the underlying asset.
    c) Facts and circumstances indicate that it is re-mote that one or more parties (other than the purchaser) will take more than an insignificant amount of the output or other utility that will be produced or generated by the asset during the term of the arrangement, and the price that the purchaser will pay for the output is not contractually fixed per unit of output, nor equal to the current market price per unit of output. In the conditions (a) and (b) above, the lessee obtains the right to operate the asset or restrict the physical access of third parties to the asset by way of an explicit contract. In such cases, the lessee need not take the entire output generated from the asset for an arrangement to be a lease.

In the condition (c) above, a purchaser controls the usage of an asset and a lease exists only when the purchaser is taking substantially all of the output i.e., others cannot obtain the output from the specified asset.

However, an exemption was incorporated in the condition (c), so that arrangements in which the price is either contractually fixed per unit of output or equal to the market price per unit of output at the time of delivery of the output should not be ac-counted for as leases, since the payments in such arrangements are considered as a consideration only for ‘use of an asset’ and not for the ‘availabil-ity of an asset’. This exemption should be applied narrowly and only for arrangements in which a pur-chaser clearly pays for the actual output. Thus, if any variability is introduced to the price per unit, such an arrangement contains a lease. There is a strong presumption that any variability in the price per unit that depends on the output of the asset means that the arrangement conveys the right to use the asset.

If the arrangement is based upon a specific asset, the entity must determine whether the arrange-ment conveys a right to use the asset, based on the above guidance. It is often a challenge to determine whether a right to use the item has been conveyed. Consider the terms ‘fixed price per unit of output’ or‘current market price per unit of output at the time of delivery’. In practice, interpretations of these terms widely vary. Some entities interpret the term ‘fixed price’ as absolutely fixed with no variance per unit, based on costs or volumes. However, other en-tities accept certain adjusted prices as fixed, such as fixed price per unit adjusted for inflation or a fixed percentage increase, etc.

Typical clauses that indicate a lease arrangement:
An illustrative list of contract features that indicate lease arrangement is as under:

    a) a contract whereby the purchaser agrees to buy the entire output of a specified asset and requires the asset to be operated at full capacity, then there is a strong presumption that the purchaser has effective control over the use of assets and therefore the arrangement contains a lease.
    b) If in case of dedicated assets, any variability is introduced to the price per unit, then such an arrangement contains a lease. There is a strong presumption that any variability in the price per unit that depends on the output of the asset means that the arrangement conveys the right to use the asset.

    c) If in case of dedicated assets, pricing arrangements include a minimum procurement guarantee (i.e., the purchaser shall pay a penalty if procurement is lower than minimum guaranteed volumes), the price cannot be termed as current market price. Hence these would be classified as leases.

Assessing or reassessing whether an arrangement is, or contains, a lease:

Initial assessment:

The assessment of whether an arrangement contains a lease shall be made at the inception of the arrangement on the basis of all of the facts and circumstances.

Subsequent reassessment:

A reassessment of whether the arrangement contains a lease after the inception of the arrangement shall be made only if any one of the following conditions is met:

    i) There is a change in the contractual terms, unless the change only renews or extends the arrangement.
    ii) A renewal option is exercised or an extension is agreed to by the parties to the arrangement, unless the term of the renewal or extension had initially been included in the lease term in accordance with paragraph 4 of IAS 17 — Leases.

    iii) There is a change in the determination of whether fulfilment is dependent on a specified asset.

    iv) There is a substantial change to the asset, for example, a substantial physical change to property, plant or equipment.

A reassessment of an arrangement shall be based on the facts and circumstances as of the date of reassessment, including the remaining term of the arrangement. Changes in estimate (for example, the estimated amount of output to be delivered to the purchaser or other potential purchasers) would not trigger a reassessment.

Classification of embedded leases — operating or finance:
If an arrangement contains a lease as per guidance provided under IFRIC 4, the parties to the arrangement shall apply the requirements of IAS 17 — Leas-es to the lease element of the arrangement.

Separation of lease payments from other elements of the contract:
For the purpose of applying the requirements of IAS 17 — Leases, payments and other consideration required by the arrangement shall be separated at the inception of the arrangement (or upon a reassessment of the arrangement) into those for the lease and those for other elements on the basis of their relative fair values.

In some cases, separating the payments for the lease from payments for other elements in the arrangement will require the purchaser to use an estimation technique. For example, a purchaser may estimate the lease payments by reference to a lease agreement for a comparable asset that contains no other elements, or by estimating the payments for the other elements in the arrangement by reference to comparable agreements and then deducting these payments from the total payments under the arrangement to determine the lease component.

For instance, a contract for warehouse management services, whereby the vendor shall manage a warehouse on a dedicated basis for a single customer against a fixed monthly fees. The inputs of the vendor includes warehouse premises, assets deployed therein and warehouse labour. Thus, the arrangement may contain a lease of warehouse and warehouse assets. The overall consideration shall be separated into lease rentals for warehouse, lease rentals for warehouse assets and consideration for warehouse management (labour). In practice separation of individual components pose significant challenges to entities.

Impracticality in separation of lease components: If a purchaser concludes that it is impracticable to separate the payments reliably, it shall:

    a) in the case of a finance lease, recognise an asset and a liability at an amount equal to the fair value of the specified asset under the lease. Subsequently the liability shall be reduced as payments are made and an imputed finance charge on the liability recognised using the purchaser’s incremental borrowing rate of interest

    b) in the case of an operating lease, treat all payments under the arrangement as lease payments for the purposes of complying with the disclosure requirements (i.e., applicable to disclosures only) of IAS 17 — Leases, but
    i) disclose those payments separately from minimum lease payments of other arrangements that do not include payments for non-lease elements, and

    ii) state that the disclosed payments also include payments for non-lease elements in the arrangement.

Terms of arrangements:

Cancellation clause in embedded lease:

If an arrangement qualifies for recognition as an embedded lease and the arrangement is cancellable, the assets under such arrangement shall be accounted as taken on a cancellable operating lease. Hence the payments made need to be separated between lease payments and other elements of the contract for recognition purposes.

However, as the arrangement is cancellable, the entity need not provide disclosures in relation to the lease.

Absence of binding contract:

If the entity neither contractually require the job worker to use the asset exclusively for the company, neither does it contractually restrict the access of third parties to the asset, nor has obtained any contractual right to operate the asset, such arrangement shall not be classified as a lease. This would be a normal purchase of goods/services.

Thus, it is essential that there should be contractual arrangement that provides the right to use a specified asset. If there is only a mutual understanding between the two contracting parties relating to minimum guarantee commitments or adjustment to price based on level of output, without a binding contract, then it would not be classified as an embedded lease.

Financial statement impact:

Once, an arrangement is covered under IFRIC 4, an entity needs to determine whether the underlying embedded lease is an operating lease or a finance lease in accordance with IAS 17 — Leases and apply the accounting principles as set out in that standard.

    a) Accounting by lessee — Finance lease:

Initial recognition and measurement:

If the arrangement is or contains a finance lease, the lessee shall recognise finance lease as assets and li-abilities in their statements of financial position at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease.

Subsequent measurement:

As mentioned above, the total lease component shall be separated from the non-lease component.

The lease component in case of finance lease would be further separated into payments towards the lease obligation and interest on lease obligation.

The leased asset is depreciated over the asset’s useful life or over the lease period whichever is shorter.

The payments made would be adjusted against the lease obligation and interest thereon.

Impact on Indian companies on adoption of IFRS?: Indian GAAP does not have specific guidance on embedded leases. Thus, the contract payments are recognised, in most cases, as revenue expen-diture (say, job work expenses) on accrual basis. On adoption of IFRS by the Indian companies, such arrangements may be classified as embedded finance leases. Thus the charge to the income statement would be in the form of depreciation on assets taken on finance lease, interest expense on finance lease obligation and job worker charges; instead of the entire amount being treated as job work charges. This may impact the asset base (as the assets are capitalised) and income statement classification of the lessee.


    b) Accounting by lessor — Finance lease:

Initial recognition and measurement:

Lessor shall derecognise assets given under an em-bedded finance lease in their balance sheet and present them as a receivable at an amount equal to the net investment in the lease.

Subsequent measurement:

As mentioned above, the total lease component shall be separated from the non-lease component. The lease component in case of finance lease would be further separated into payments towards the lease receivable and interest on lease receivable.

The recognition of finance income on lease receivable shall be based on a pattern reflecting a con-stant periodic rate of return on the lessor’s net in-vestment in the finance lease.

The receipts from the lessee would be adjusted against the lease receivable and interest thereon.

Impact on Indian companies on adoption of IFRS?: Indian GAAP does not have specific guidance on em-bedded leases. Thus, the actual contract receipts are recognised, in most cases, as revenue (say, job work income) on accrual basis. On adoption of IFRS by the Indian companies, such arrangements may be classified as embedded finance leases.

Thus, such transactions will be treated as sale of as-set with a corresponding debit to lease receivable asset. Unlike Indian GAAP, there will be no impact on the income statement on account of deprecia-tion on fixed assets as they were never recognised. The receipts out of the lease component received from the lessee shall be adjusted against the lease receivable to the extent of the principal and interest income.

This may significantly impact the fixed asset base (as the fixed assets are not recognised), the timing of revenue recognition and the EBIT (on account of in-terest income on lease receivable) of the lessor.

    c) Accounting by lessee and lessor — Operating lease:

Recognition and measurement:

As mentioned above, the lease component would be recognised separately from the non-lease component. Thus, the lessor and lessee shall recognise lease income/expense separately from other revenue/expense, respectively.

Impact on Indian companies on adoption of IFRS: The lessor shall present lease income separately within revenue from non-lease revenue. Similar presentation would be required by the lessee for its payments. However, this would impact only the in-come statement presentation.

The operating lease payments would be required to be recognised on a straight-line basis. This may lead to additional impact on the profits for the year on account of adoption of IFRS.

First-time adoption of IFRS:

IFRIC 4 shall have to apply retrospectively to all agreements existing as on the date of transition. Hence, entities shall have to assess all agreements existing as on the date of transition, irrespective of the year in which the same has been entered into i.e., either before or after the date of applicability of IFRIC 4.

Conclusion:

An entity can expect significant changes to its balance sheet and income statement due to application of IFRIC 4 and it is thus essential for an entity to carefully evaluate its implications at the time of entering into arrangements with dedicated vendors.

Financial Instruments — Indian corporates need to gear up for significant changes in the accounting landscape

IFRS

In recent times, a lot has been written and discussed in the
various forums regarding the role played by financial instruments-related
accounting standards and the contribution of ‘fair value’ accounting to the
current global liquidity crisis.

Accounting for financial instruments in general and fair
value accounting in particular is a highly complex and judgmental area, and
requires a very high degree of understanding and experience to implement and
interpret the guiding principles as envisaged in those standards.

Accounting for Financial Instruments is a complex exercise in
view of the varied kinds of instruments that are emerging in the market in the
recent past. International Financial Reporting Standards (IFRS) encompassing
IAS-32, IAS-39 and IFRS-7 deal with the principles involved in recognition,
measurement, disclosures and presentation of financial instruments. The
Institute of Chartered Accountants of India (ICAI) has also published Accounting
Standards (AS), viz., AS-30 on ‘Financial Instruments — Recognition and
Measurement’ and AS-31 on ‘Financial Instruments — Presentation’ which has been
pronounced and is made recommendatory from 01.04.2009 and mandatory from
01.04.2011. Further, AS-32 Exposure draft on ‘Financial
instruments — Disclosures’ has also been published in December 2007 issue of the
Chartered Accountant Journal. These are largely similar to their IFRS
counterparts. Thus, whether India converges to IFRS from 2011 or not, accounting
for financial instruments will largely be in accordance with the principles of
IAS-39 and IAS-32 from 1 April 2011.

The use of these standards ushers in the concept of fair
valuation, which records financial instruments at fair value and changes thereon
in reported earnings or within shareholders funds, depending on the nature of
the financial instrument. The impact of these standards shall cover a large
number of captions in a corporate financial statement including receivables,
payables, borrowings, loans and advances given, security deposits, investments
and even certain types of ‘equity’ instruments, thereby having a significant
impact on accounting for routine transactions entered into by companies in the
normal course of business. These impacts necessitate careful consideration by
corporates and their impact is not restricted to finance companies and banks.

Definition and classifications

Under IFRS, a financial instrument has been defined as a contract that gives rise to a financial asset in one entity with a corresponding liability or equity in another entity. Most monetary items will get covered by this definition such as trade receivables/payables, investments in shares/debentures, retention money, trade deposits, derivatives, financial guarantees, and loans and advances.

    Under the present Indian GAAP, Accounting Standard (‘AS’) 13 classifies an investment into long-term and current investment. Long-term investments are required to be recorded at cost, less any permanent diminution. Current investments are recorded at lower of cost or market. Detailed classification exists for banks as per RBI guidelines. Loans and receivables are stated at cost. Interest income on loans is recognised based on time-proportion basis as per the rates mentioned in the underlying loan agreement.

    On the other hand under IFRS, all financial assets are required to be initially classified into four categories, comprising (i) fair value through profit or loss (FVTPL), (ii) held-to-maturity (HTM), (iii) loans and receivables, and (iv) available-for-sale (AFS). All financial assets will have to be recorded at respective fair values at the time of initial recognition.

    Further, IAS-39 requires FVTPL and AFS assets to be measured at fair values at each subsequent reporting period. In case of FVTPL assets, the unrealised gain/loss is recognised in the profit and loss account whereas for AFS investments, it is recognised in equity until actually realised, whereupon it is transferred to the income statement. HTM and loans and receivable assets are reflected at amortised cost using effective interest method. However, the rules for classification of an investment as HTM are extremely stringent and any subsequent decision to sell these investments would result in adverse consequences, whereby all other existing HTM investments would need to be fair valued and there would be restrictions on future classifications.

    Financial liability is classified into two categories, viz., (i) financial liability at fair value through profit or loss (ii) residual category. The initial measurement is at cost, being the fair value of a consideration received, less transaction costs. Financial liabilities at fair value through profit or loss (including trading) liabilities are measured at fair value, and the change is recognised in the income statement for the period. All other (non-trading) liabilities are carried at amortised cost. Entities may elect to classify certain liabilities as ‘fair value through profit and loss’ if the liabilities are incurred to hedge certain related financial assets which are required to be recorded at fair value. In such a case, a fair value designation for the liabilities can be used to set off the fair value changes in the assets — a form of economic hedge accounting, without following the complex hedge accounting designation and effectiveness testing rules.

Derivatives

    The current Accounting Standards in India do not have any specific standard providing guidance on the recognition and valuation of derivatives. Accounting for certain plain vanilla foreign exchange forward contracts is based on AS-11. Certain exchange traded futures and options are accounted as per ‘Guidance Note on Accounting for Equity Index and Equity Stock Futures and Options’. As per this Guidance Note, mark-to-market losses are recognised but gains are ignored. Further, some derivative instruments may be required to be accounted as per the March 2008 announcement of the ICAI, whereby derivative instruments are to be mark to market with the resulting losses required to be recognised in the income statement based on the principles of prudence. Effective 1 April 2011, the treatment for the aforesaid transactions will need to comply with AS-30 issued by the ICAI. As stated earlier, the guidance in AS-30 is consistent with the requirements of IAS-39.

    IAS-39 deals with derivative instruments in a very comprehensive manner. A derivative is defined as a financial instrument or other contract with the following three characteristics, namely,

1) its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called the ‘underlying’);

2) it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and

3) it is settled at a future date. Further all derivatives are recorded on balance sheet at fair value with changes in fair value being recognised in income statement unless it satisfies the hedge accounting criteria. This often results in significant volatility in reported income, which is not seen under the current Indian Accounting Standards.

Apart from stand-alone derivatives,  IAS-39 requires derivatives embedded or  contained in other contracts to be separated and accounted separately. For example, for convertible  bonds an investor will have to account for the equity option component separately  from the host debt contract. The value of the equity option component would be initially credited to equity. The resultant discount on the debt host would be amortised over the period of the debt to reflect the real cost of the debt instrument (based on market rates for non-convertible debt). Similarly, if an Indian entity has a contract for supply of goods/services denominated in Euros, with a counterparty based in a non-Euro zone country (for example, the U.S.), then there is an embedded rupee-Euro forward currency derivative, which will need to be separated from the host contract of supply of goods/ services and valued separately. The requirements for embedded derivatives will significantly enhance the valuation and measurement complexity of such instruments from current practice.
 
Hedge  accounting

As seen above, IAS-39 uses a measurement model that sometimes requires the measurement of assets and liabilities on different basis. This results in an accounting mismatch in profit or loss account, which results in volatility in reported results (and does not reflect the true performance of the Company in the income statement). Consequently the standard permits an entity to selectively measure assets, liabilities, firm commitments and certain forecast transactions on a basis different from that prescribed, or to defer /match the recognition of gains or losses on derivatives using hedge accounting.

The hedge accounting rules under IFRS are quite stringent and narrowly defined. Hedge accounting is permitted if at the inception of the hedge and on an ongoing basis, the expectation is that the hedge will be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged  risk during  the period  for which  the of hedge  is designated  and ‘actual’ results  are within the 80-125% range. If the changes  don’t  fall within this  band,  then  the  hedge  is  ineffective and, therefore,  fair value  gains/losses   on the hedging contract   will  have  to be  taken  to  the  income statement. Hedges need to be on specifically identified items as against portfolios and should hedge-specific risks and characteristics identified and documented upfront. Stringent documentation criteria prescribed shall also have to be followed.

Hedge  accounting  is voluntary  and the decision to apply  hedge  accounting   should  be  made  on  a transaction  by transaction  basis. The correct use of hedge accounting  (for example,  designating  foreign currency  forward  contracts  as cash flow hedges  of forecasted  foreign  currency  sales) can ensure  that gains  and  losses  relating  to the  derivatives   are recorded   to reflect  the  economic   rationale   for undertaking  the transaction.  In the absence of hedge accounting,  gains and losses on derivatives  would be recorded  in periods  that may be different  from the periods in which the underlying  transactions  are recorded.

Substance over form

Under Indian GAAP, a financial instrument is v classified as either liability or equity, depending on form  rather  than  substance.

Redeemable preference shares are treated as capital under Schedule VI of the Companies Act,1956, even though in substance it may be a liability. However, under IAS-32, they will get classified as debt in the balance sheet of the issuers, since they meet the characteristic of a liability, i.e., redemption after a fixed period and dividend at a fixed rate. This would result in profit after tax numbers being lower, as preference dividend would be reflected as interest cost. Further, premium on redemption of preference shares will no longer be able to be adjusted in the securities premium account but will have to be recognised as an interest expense in the income statement.

Another significant area of impact would be the accounting for Foreign Currency Convertible Bonds (‘FCCB’). FCCBs are bonds that can be converted into equity by the investors before a certain date, or are repaid at an agreed premium at the end of the tenure. FCCBs (and other debt instruments) may be issued with a structure that allows the borrower to pay the entire interest on the instrument (along with the principal) to the investor only when the bond matures, in the form of a ‘redemption premium’. The Companies Act, 1956, Section 78, permits companies to adjust the redemption premium on debentures just as in equity shares, through the share premium account. This accounting treatment is currently fairly common amongst many Indian companies. This accounting treatment would not be permitted under IFRS, as all cost of issuing an instrument (including the redemption premium) would need to be recorded as interest cost over the life of the debt using the effective interest yield method.

Further, under IFRS, FCCBs will be subjected to split accounting. In accordance with the guidance in IAS-39 on the basis of which the conversion option is separated from the host contract i.e., the debt liability depends on the characteristic of the conversion option. If the conversion option meets the definition of equity, then the fair value of the liability without the conversion option is first determined and the residual amount of proceeds is then allocated to equity. If the conversion option is a derivative (i.e., if the conversion price is determined in a currency other than the functional currency of the Company), the fair value of the derivative is first determined with the residual allocated to the debt amount and the derivative portion is fair valued at every reporting date.

Impairment

In the case of banks, the existing provisions on non-performing assets are based on guidelines laid down by the Reserve Bank of India. IFRS prescribes an impairment model that requires case-by-case (for significant exposures) assessment of the facts and circumstances surrounding the recoverability and timing of the future cash flows relating to the credit exposure. An expectation that all contractual cash flows would not be recovered (or recovered without full future interest applications) will lead to an account being classified as impaired and impairment shall be measured on present value basis using the effective interest rate of the exposure as the discount rate. For groups of loans that share homogenous characteristics (such as mortgage and credit card receivables), impairment can be assessed on a collective basis. General provisions are permissible only to extent that they relate to a specified risk that can be measured reliably and for incurred losses. No provisions are permitted for future or expected losses. Provisioning for standard assets will not be permitted under IFRS.

For investments, a similar analysis is conducted, the key difference being that the fair value of the investment is also considered as an input in addition to the financial! credit standing of the issuer. The application of IAS-39 would also change accounting for items such as financial guarantees. It will affect key ratios and performance indicators for most banks and financial institutions, including capital adequacy ratios.

De-recognition

Under IFRS, de-recognition of financial assets is a complex, multi-layered area with the de-recognition decision dependent largely on whether there has been a transfer of risks and rewards. If the assessment of the transfer of risks and rewards is not conclusive, an assessment of control and the extent of continuing involvement are required to be performed.

Securitisation transactions shall be the most impacted area since most Indian securitisation vehicles are currently structured to meet Indian GAAP de-recognition norms stated under the Guidance Note on Accounting for Securitisation issued byfhe ICAL Substantially, all those securitisation vehicles would collapse into the transferor’s balance sheet and assets would fail the de-recognition test under IFRS. For example, securitisation transactions where credit collaterals are provided/guarantee is provided to cover credit losses in excess of the losses inherent in the portfolio of assets securitised, may not meet the de-recognition principles enunciated in IAS-39. This would lead to more instances of transfers failing the de-recognition criteria, thereby resulting in large balance sheets and capital adequacy requirements, lower return on assets and deferral of gains/losses on such securitisation transactions.

Disclosures

IFRS 7 requires entities to provide detailed disclosures in their financial statements that enable users to evaluate:

a) the significance of financial instruments for the entity’s financial position and performance; and

b) the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks. On 5 March 2009, the IASB has issued Improving Disclosures about Financial Instruments (Amendments to IFRS 7). The amendments require enhanced disclosures about fair value measurements and liquidity risk.

The disclosures required under IFRS 7 include quantitative as well as qualitative information. There is a significant amendment in IT/reporting systems which shall be required as there is no accounting standard in India corresponding to IFRS 7 requiring such extensive disclosures. The Announcement on ‘Disclosure regarding Derivative Instruments’, issued by the ICAI, requires the following disclosures to be made in the financial statements:

a) categorywise quantitative data about derivative instruments that are outstanding at the balance . sheet date,

b) the purpose, i.e., hedging or speculation, for which such derivative instruments have been acquired, and

c) the foreign currency exposures that are not hedged by a derivative instrument or otherwise.

Netting assets and liabilities will also be less common as the rules will require more conditions to be met before assets and liabilities can be offset. A mere right to set off will not be adequate and needs to be supplemented with a right and an intention to settle on a net basis the assets and liabilities under consideration.

To conclude, the advent of IFRS shall thus represent a significant challenge to preparers, auditors, accountants, regulators and analysts. As the complexity of accounting increases, focus on need for increased education and training on areas relating to the valuation and accounting for financial instruments increases. Accounting for financial instruments will not only lead to a major impact on measurement of results, but also impact the existing functionalities of the IT systems and processes of companies.

Expenditure : Capital or revenue : S. 37 of I. T. Act 1961 : A. Y. 2002-03 : Amount spent on computer software is revenue expenditure.

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  1. Expenditure : Capital or revenue : S. 37 of I. T. Act
    1961 : A. Y. 2002-03 : Amount spent on computer software is revenue
    expenditure.



 


[CIT vs. Varinder Agro Chemicals Ltd.; 309 ITR 272
(P&H)].

For the A. Y. 2002-03, the Assessing Officer disallowed the
claim of the appellant for deduction of the expenditure on acquisition of
computer software holding that it is capital in nature on the ground that
enduring advantage was derived by the assessee by incurring such expenditure.
The Tribunal allowed the assessee’s claim.

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

“There is nothing to show that the software used by the
assessee was of enduring nature and will not become outdated. Since
technology is fast changing and day by day systems are being developed in a
new way, software may be needed like raw material. The view taken by the
Tribunal is certainly a possible view.”

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Assessment : Extension of period of limitation : S. 150 of I. T. Act, 1961 : A. Y. 1993-94 : Grant of probate to assessee would not extend the period.

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Assessment : Extension of period of limitation : S. 150
of I. T. Act, 1961 : A. Y. 1993-94 : Grant of probate to assessee would not
extend the period.


Reported :

 

[CIT vs. Smt. Shobha Rani Shah : 309 ITR 263 (P &
H)]

The assessee had received the probate of her mother on
30.11.2000. On the basis of the probate the Assessing Officer issued notice
u/s. 148 of the Income-tax Act, 1961, on 31.03.2005 for the A. Y. 1993-94. The
Assessing Officer held that the period of limitation would not be applicable
in view of the provisions of Section 150 of the Act. The Commissioner
(Appeals) held that the effective date for invoking Section 150(1) was the
date of probate of the mother and consequently held that the notice u/s. 148
was beyond the period of limitation. The Tribunal dismissed the appeal filed
by the Revenue holding as follows :

” . . . . once I have held that no finding or direction
was given by the Hon’ble Judge in his order, the issue of notice u/s. 148 is
to be regulated by Section 149 of the Income-tax Act as in the order passed
by the Hon’ble Judge there is no finding or direction to be basis for a
notice within the extended period u/s. 150(1).”

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

“In the present case, the Tribunal has rightly held that
the grant of probate by the Additional District Judge, Rohtak, had no
consequence to the assessment and that the order dated 30.11.2000, would not
cause the limitation to extend u/s. 150 of the Act.”

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Interest on borrowed funds : Deduction u/s.36(1)(iii) of I. T. Act, 1961: A. Y. 1997-98 : Borrowed funds used for purchase of shares held partly as investment and partly as stock in trade : Shares purchased for acquiring controlling interest in company :

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Interest on borrowed funds : Deduction u/s.36(1)(iii) of
I. T. Act, 1961: A. Y. 1997-98 : Borrowed funds used for purchase of shares
held partly as investment and partly as stock in trade : Shares purchased for
acquiring controlling interest in company : Interest on borrowed funds
allowable as deduction u/s. 36(1)(iii).


 



[CIT vs. Srishti Securities Pvt. Ltd. (Bom); ITA No.
71 of 2006: Dated 22.01.2009].

The assessee had purchased shares out of borrowed funds.
The shares were held partly as investment and partly as stock in trade. The
assessee’s claim for deduction of interest was rejected by the Assessing
Officer on the ground that the primary object of acquiring shares was not to
earn dividend but to acquire controlling interest in the company. The CIT(A)
bifurcated interest on pro rata basis between investment and stock in
trade and allowed the interest attributable to stock in trade. The Tribunal
allowed the assessee’s claim, holding that the interest is allowable u/s.
36(1)(iii).

On appeal by Revenue, the Bombay High Court followed the
judgment in the case of CIT vs. Lokhandwala Construction Industries Ltd.
260 ITR 579 (Bom), concurred with the judgment of the Calcutta High Court
in CIT vs. Rajeeva Lohana Kanoria 208 ITR 616 (Cal) and upheld the
decision of the Tribunal. The High Court held that the interest which was
disallowed to the extent of investment will have to be allowed as held by the
Tribunal.

Editor’s Note :

This related to an assessment year prior to insertion of
S.14A.


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Cash credit : Undisclosed income : S. 68 of I. T. Act, 1961 : Disclosure of diamonds in declaration under VDIS : Subsequent sale of diamonds and receipt of consideration by cheque : Receipts shown in books of account is not undisclosed income.

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Cash credit : Undisclosed income : S. 68 of I. T. Act,
1961 : Disclosure of diamonds in declaration under VDIS : Subsequent sale of
diamonds and receipt of consideration by cheque : Receipts shown in books of
account is not undisclosed income.



 


[CIT vs. Inder V. Nankani (Bom); ITA No. 128 of
2009 : Dated 24.02.2009].

The assessee had disclosed diamonds in a declaration under
VDIS. He subsequently sold the said diamonds and received consideration by
cheque. The amount received was shown in the books of account. The Assessing
Officer treated the sale consideration as undisclosed income and made addition
of the said amount to the total income of the assessee. The Assessing Officer
held that the assessee was unable to prove that he was actually in possession
and ownership of the diamonds. It is the case of the Revenue that these were
hawala transactions which were unearthed on the raid being conducted on the
two chartered accountants. The Tribunal deleted the addition.

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

“i) The entire submission on behalf of the Revenue is
that the first purchaser has in fact sold the diamonds to the second
purchaser whose whereabouts could not be traced and as such, the sale was
fictitious. The question is whether the order of the CIT(A) and ITAT suffers
from any error of law.

ii) In the instant case, admittedly the diamonds were
declared. The declaration was accepted by the Revenue and thereafter, the
assessee had paid the tax. The assessee thereafter had sold the said
diamonds and received consideration which is also disclosed in the books of
account. In these circumstances, the finding recorded by the Tribunal cannot
be faulted, namely, that the assessee had proved the possession of the
jewellery or diamonds at the time of declaration.

iii) In the instant case, the Assessing Officer was given
an opportunity to produce any material in his possession to hold to the
contrary. The Assessing Officer failed to comply with the said direction. In
these circumstances, CIT(A) proceeded to pass the order which order came to
be subsequently affirmed by the ITAT.

iv) The Tribunal in the instant case has held that the
assessee had disclosed the diamonds in his possession at the time of VDIS
declaration which was accepted. Once that be the case and the consideration
received from the purchaser which has not been doubted, the fact that there
is doubt about the second sale, cannot result in making addition in the
hands of the assessee.

v) In our opinion, considering the findings of facts in
the case, this is not a fit case where question of law would arise.”

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Export profit : Deduction u/s. 80HHC of I. T. Act, 1961 : Export turnover and total turnover : Export sale price to be modified as per the approval by the RBI for including in the export turnover.

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Export profit : Deduction u/s. 80HHC of I. T. Act, 1961
: Export turnover and total turnover : Export sale price to be modified as per
the approval by the RBI for including in the export turnover.



 


[CIT vs. M/s. Polycot Corporation (Bom); ITA No.
1241 of 2008: Dated 23.01.2009.]

In the appeal filed by the Revenue against the order of the
Tribunal, the Department had raised the following question :

“Whether on the facts and in the circumstances of the
case and law, is the Hon’ble ITAT right in directing the A.O. to compute the
deduction u/s. 80HHC of the Act after the books of account having been
closed/made up with the total export turnover ascertained, holding that the
reduction in the invoice amount having been approved by the RBI, the
original sales price stands modified to this extent and such modified price
only should be included as part of export turnover ?”

The Bombay High Court held as under :

“i) To avail of the benefit of Section 80HHC the proceeds
have to be brought into India within the time prescribed i.e., six
months or such extended period as may be allowed. In the instant case the
RBI granted time up to 30th June, 2001. The proceeds were brought into India
on 30 June, 2001.

ii) Here we may set out the areas of disagreement between
the Revenue and the assessee. It is the contention of the assessee that
while working out total turnover what will have to be considered is the
revenue which has been brought in during the course of that financial year
and if any moneys in respect of export proceeds have come subsequent to the
order of assessment, they will have to be considered in the said financial
year.

iii) The other factual aspect of the matter is that the
buyer proposed deduction in the export price, the respondents agreed to the
same after taking approval of the RBI to the extent of 30%. The respondents
are a totally export oriented unit. Moneys, therefore, in terms of the
approval granted by the RBI were brought in during the period as extended.

iv) The Tribunal in its order observed that once the RBI
has agreed to deduction in the invoice amount, the original sales price
stands modified and such modified price only should be taken as actual
export value. It is further observed that such adjusted export value should
only be included in the export turnover and the total turnover.

v) The contention of the Revenue was that, that should be
excluded from the export turnover.

vi) In our opinion, considering the facts and the
provisions of Section 80HHC, we cannot find fault with the conclusion
arrived at by the learned Tribunal.”

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Business expenditure : Deduction u/s. 37(1) of I. T. Act, 1961 : A. Ys. 1996-97 and 2001-02 : Expenditure on production of films for advertisement of products manufactured by assessee : Is business expenditure allowable u/s. 37(1) ?

New Page 1

Business expenditure : Deduction u/s. 37(1) of I. T.
Act, 1961 : A. Ys. 1996-97 and 2001-02 : Expenditure on production of films
for advertisement of products manufactured by assessee : Is business
expenditure allowable u/s. 37(1) ?



 


[CIT vs. Geoffrey Manners & Co. Ltd. (Bom); ITA No.
789 of 2008: Dated 09.02.2009].

The assessee incurred expenditure on production of films
for the purpose of advertisement for marketing the products manufactured by
it. The Assessing Officer disallowed the claim for deduction of the
expenditure, holding that it is capital in nature. The Tribunal allowed the
claim.

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

“i) A similar issue had come up for consideration before
the Punjab & Haryana High Court in CIT vs. Liberty Group Marketing
Division, 2008 (8) DTR Judgments 28. In that case the assessee had
claimed expenditure incurred on glow signboards, as also T. V. Films. The
expendi-ture was held to be revenue in nature.

ii) In our opinion the correct test to be applied in such
a case would be that if the expenditure is in respect of an ongoing business
of the assessee and there is no enduring benefit, it can be treated as
revenue expenditure. However, if it is in respect of business which is yet
to commence, then the same cannot be treated as revenue expenditure, as
expenditure is on a product yet to be marketed.

iii) The Tribunal on the facts of this case was clearly
within its jurisdiction in holding that the expenditure was by way of
revenue expenditure, as it was in respect of promoting ongoing products of
the assessee herein.”

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Bad debt : Deduction u/s. 36(1)(vii) of I. T. Act, 1961 : After amendment w.e.f. 01.04.1989 it is not obligatory on the part of the assessee to prove that the debt written off is indeed a bad debt for the purpose of deduction u/s. 36(1)(vii).

New Page 1

Unreported :

  1. Bad debt : Deduction u/s.
    36(1)(vii) of I. T. Act, 1961 : After amendment w.e.f. 01.04.1989 it is not
    obligatory on the part of the assessee to prove that the debt written off is
    indeed a bad debt for the purpose of deduction u/s. 36(1)(vii).

 

[DI vs. M/s. Oman International Bank, SAOG (Bom);
ITA No. 114 of 2009; Dated 09.02.2009.]

At the instance of the Revenue the following question was
raised before the Bombay High Court :

“Whether as per the existing provisions even after the
amendment w.e.f. 01.04.1989, is it obligatory on the part of the
assessee to prove that the debt written off by him is indeed a Bad Debt for
the purpose of allowance u/s. 36(1)(vii) ?”

The Bombay High Court answered the question as under :

“The question as framed will have to be answered by
holding that after the amendment it is neither obligatory nor is it a burden
on the assessee to prove that the debt written off by him is indeed a bad
debt as long as it is bona fide and based on commercial wisdom or
expediency.”

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Settlement of cases : Abatement : Ss. 2(45), 245C and 245D(2A) & (2D) of I. T. Act, 1961 : Tax on total income means tax on total income after set-off of carried forward loss : Assessee paid tax correctly : No abatement u/s.245D(2) : Application to be pro

New Page 1

Settlement of cases : Abatement : Ss. 2(45), 245C and
245D(2A) & (2D) of I. T. Act, 1961 : Tax on total income means tax on total
income after set-off of carried forward loss : Assessee paid tax correctly :
No abatement u/s.245D(2) : Application to be proceeded with.


 


[Govind Builders and Developers vs. ITSC : 309 ITR
167 (Bom)].

On 14.09.2006, the assessee made an application to the
Settlement Commission u/s. 245C of the Income-tax Act, 1961 for settlement of
its case for the A. Y. 2004-05. The returned income for that year was a loss
of Rs. 93,112. The assessee had offered an additional income of Rs.53,57,375
in the settlement application. The assessee was also entitled to carried
forward loss of Rs.93,193 of the A. Y. 2003-04. For the purpose of tax payable
u/s. 245D(2A) the assessee arrived at the aggregate total income of
Rs.51,70,820 after reducing from Rs.53,57,375 the returned loss of Rs.93,112
for the relevant year and the carried forward loss of Rs.93,193 of the A. Y.
2003-04. Accordingly it computed the additional tax payable at Rs.18,55,032
and paid Rs.25,59,932 together with interest on 26.05.2007. This payment was
made in compliance with the provisions of Section 245D(2A) of the Act wherein
the last date for payment was 31.07.2007. The Settlement Commission held that
the carried forward loss was wrongly set off and accordingly there was no
compliance of the provisions of Section 245D(2A) of the Act and therefore
declared that the proceedings abated in accordance with the provisions of
Section 245D(2D) of the Act. On 13.11.2007 the assessee paid the difference as
per the decision of the Settlement Commission.

On a writ petition filed by the assessee challenging the
decision of the Settlement Commission, the Bombay High Court held as under :

“i) Section 245D(2A) is mandatory and the additional tax
had to be paid on or before 31.07.2007. The Commission could not condone the
delay or accept the additional amount after 31.07.2007, as the application
itself would stand rejected by operation of law. Once there was no power
with the Commission itself, it was not possible for the Court to act under
the extraordinary jurisdiction under Article 226 read with Article 227 of
the Constitution of India also.

ii) The Settlement Commission, while considering whether
the tax has been paid as contemplated by Section 245D(2A), has to examine
whether that tax is on the total income as disclosed. The tax payable would
be on the income as set out in Section 2(45) of the Act. The assessee was
entitled to carry forward the loss of Rs.92,370. Therefore, the assessee had
correctly paid the tax. Since the assessee could carry forward the loss of
the preceding assessment year, the finding of the Commission that the tax
was not paid was an error of law apparent on the face of the record.
Therefore the finding that the application has abated had to be set aside
and the application had to be proceeded with.”

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Depreciation : S. 32 of I. T. Act, 1961 : A. Y. 1992-93 : Condition precedent : User of machinery : Machinery installed but found defective : Amounts to user of machi-nery : Assessee entitled to depreciation.

New Page 1

  1. Depreciation : S. 32 of I. T. Act, 1961 : A. Y. 1992-93
    : Condition precedent : User of machinery : Machinery installed but found
    defective : Amounts to user of machi-nery : Assessee entitled to depreciation.



 


[CIT vs. Chamundeshwari Sugar Ltd; 309 ITR 326
(Karn)].

The assessee company was running a sugar factory. For the
A. Y. 1992-93, the assessee company installed pollution control machinery as
per the mandate of the Pollution Control Board. The assessee claimed
depreciation to the extent of the value of the machinery installed. The
Assessing Officer found that the machinery that was installed was found to be
defective during the trial runs, and therefore, held that the machinery was
not used for the purpose of business as required u/s. 32 of the Income-tax
Act, 1961. Accordingly, the Assessing Officer disallowed the claim for
depreciation. The Tribunal allowed the claim of the assessee and held that the
assessee was entitled to depreciation because the machinery was installed and
merely because it did not effectively function that was not a ground to reject
depreciation.

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

“i) The interpretation of ‘used for the purpose of
business’ by the Supreme Court in Liquidator of Pursa Ltd. vs. CIT
(1954) 25 ITR 265 lays down that machinery should be installed. The purport
and object of law relating to depreciation as envisaged u/s. 32 of the
Income-tax Act, 1961, has to be meaningfully interpreted, consistent with
the object. When the assessee bona fide installs any machinery but it
becomes defective and non-functional, it cannot be said that it is not put
to use for the purpose of business.

ii) The assessee was entitled to depreciation on the
pollution control machinery.”

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Capital gains : Exemption u/s. 54 of I. T. Act, 1961 : A. Y. 1996-97 : Purchase of two flats and combined to make one residential unit : Exemption u/s. 54 available

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Capital gains : Exemption u/s. 54 of I. T. Act, 1961 :
A. Y. 1996-97 : Purchase of two flats and combined to make one residential
unit : Exemption u/s. 54 available



 


[CIT vs. D. Ananda Basappa; 309 ITR 329 (Karn).]

In October 1995 the assessee sold a residential house for
Rs.2,12,50,000 resulting in long-term capital gain. The assessee purchased two
residential flats adjacent to each other executing two separate registered
sale deeds in respect of two flats situated side by side, on the same day. The
two flats were modified to make it one residential apartment. The assessee
claimed exemption u/s. 54 in respect of investment in the two flats. It was
found by the inspector that the two flats were in the occupation of two
different tenants. The Assessing Officer held that Section 54(1) does not
permit exemption for the purchase of more than one residential premises and
therefore allowed exemption to the extent of purchase of one residential flat.
The Tribunal allowed the assessee’s claim in full.

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

“i) A plain reading of the provisions of section 54(1) of
the Income-tax Act, 1961, discloses that when an individual or Hindu
undivided family sells a residential building or land appurtenant, he can
invest the capital gains for purchase of a residential building to seek
exemption of the capital gains tax. Section 13 of the General Clauses Act,
1897, declares that whenever a singular is used for a word, it is
permissible to include the plural. The expression ‘a’ residential house
should be understood in a sense that the building should be residential in
nature and ‘a’ should not be understood to indicate a singular number.

ii) It was shown by the assessee that the apartments were
situated side by side. The builder had also stated that he had effected
modifications of the flats to make them one unit by opening the door in
between the two apartments. The fact that at the time when the Inspector
inspected the premises, the flats were occupied by two different tenants was
not a ground to hold that the apartment was not one residential unit. The
fact that the assessee could have purchased both the flats in one single
sale deed or could have narrated the purchase of two premises as one unit in
the sale deed was not a ground to hold that the assessee had no intention to
purchase two flats as one unit. The assessee was entitled to the exemption
u/s. 54.”

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Disclosures regarding provisions for liabilities (as per AS-29)

2. Nestle India Ltd. — (31-12-2009)

From Notes to Accounts :
The Company has created a contingency provision of Rs.457,181 thousands (previous year Rs.325,882 thousands) for various contingencies resulting mainly from matters, which are under litigation/dispute and other uncertainties requiring management judgment. The Company has also reversed/utilised contingency provision of Rs.133,980 thousands (previous year Rs.20,966 thousands) due to the satisfactory settlement of certain disputes for which provision was no longer required. The details of classwise provisions are given below :

Notes:
(a) `Litigations and related disputes — represents estimates made mainly for probable claims arising out of litigations/disputes pending with authorities under various statutes (i.e., Income Tax, Excise Duty, Service Tax, Sales and Purchase Tax, etc.). The provability and the timing of the outflow with regard to these matters depend on the ultimate settlement/conclusion with the relevant authorities.

(b) Others — include estimates made for products sold by the Company which are covered under free replacement warranty on becoming unfit for human consumption during the prescribed shelf life, investments held by the employee benefit trusts and other uncertainties requiring management judgment. The timing and probability of outflow with regard to these matters will depend on the external environment and the consequent decision/conclusion by the management.

3. Fulford India Ltd. — (31-12-2009)

From Notes to Accounts :

Provisions, Contingent Liabilities and Contingent Assets Disclosure for the year December 31, 2009 :

The Company has an understanding with trade associations, based on prevailing trade practices, for the replacement of its date-expired and damaged products upon return of such products subject to certain terms and conditions. With effect from the current financial year; the Company has also opted to replace such products by way of credit notes issued. Provision for replacement of such products of the Company is made, based on the best estimates of the management taking into consideration the type of products sold, the likely returns and the costs required to be incurred for such replacements.

The movement in the provision for such costs is as under :


4. Pfizer Ltd. — (30-11-2009)

From Notes to Accounts :

Personnel-related provisions :

Personnel-related provision at the beginning of the year have been settled based on completion of negotiations and execution of the new contract.

The Company has made provision for pending   assessment in respect of duties and other levies, the outflow of which would depend on the outcome of the respective events.

The movement in the above provisions are summarised as under :

Section B : Assurance Statement for Sustainability Reporting : Infosys Technologies Ltd.

Compiler’s Note :

    Sustainability Reporting is a global development which is fast gaining importance and momentum in India. Infosys Technologies Ltd. has published its first Sustainability Report for 2007-08 which presents an account of economic performance, innovations in solutions, services and products, environmental initiatives, people engagement, and social responsibility in accordance with the Global Reporting Initiative (GRI) framework. An Assurance Statement on the same was also obtained by the company. The same is reproduced below. (Names of the firm/s giving the report have been omitted).

Introduction

    XYZ has been commissioned by the management of Infosys Technologies Limited (‘Infosys’) to carry out an assurance engagement on the Infosys Sustainability Report, 2007-08 (‘the Report’).

    Infosys is responsible for the collection, analysis, aggregation and presentation of information within the Report. Our responsibility in performing this work is to the management of Infosys only and in accordance with terms of reference agreed with the Company. XYZ disclaims any liability or responsibility to a third party for decisions, whether investment or otherwise, based upon this assurance statement.

Scope of Assurance :

    The scope of work agreed upon with Infosys includes the following :

  • The full Report as well as references made in the Report to the annual report and corporate website;

  •  Review of the Report against Global Reporting Initiative (GRI) Sustainability Reporting Guidelines, 2006 and confirmation of the application level;

  •  Reporting boundary as set out in the Report;

  • Visits to the Infosys head-office in Bangalore and two development centres in India.

    The verification was carried out between April and July 2008.

Independence

    XYZ did not provide any services to Infosys during 2007-08 that could conflict with the independence of our work. XYZ was not involved in the preparation of any statements or data included in the Report except for this Assurance Statement.

Verification Methodology

    Our assurance engagement was planned and carried out in accordance with the XYZ Protocol for Verification of Sustainability Reporting, which is based both on the GRI Guidelines and the AA1000 Assurance Standard. XYZ took a risk-based approach throughout the assurance engagement, concentrating on the issues that we believe are most material for both Infosys and its stakeholders.

    As part of the verification we have :

  •  Challenged the sustainability-related statements and claims made in the Report and assessed the robustness of the data management system, information flow and controls;

  • Examined and reviewed documents, data and other information made available to XYZ by Infosys;

  • Visited the head-office and two development centres located in Banagalore and Chennai;

  • Conducted interview with 42 representatives (including data owners and decision-makers from different divisions and functions) of Infosys;

  • Performed sample-based audits of the mechanisms for implementing the Company’s own sustainability-related policies, as described in the Report;

  • Performed sample-based review of processes for determining material issues to be included in the Report.

  • Performed sample-based audits of the processes for generating, gathering and managing the quantitative and qualitative data included in the Report;

  •  Reviewed the process of acquiring information and economic/financial data from the company’s 2007-08 certified consolidated Balance Sheet.

Conclusions

    In XYZ’s opinion, the Infosys Sustainability Report 2007-08 provides a fair representation of the Company’s policies, strategies, management systems, initiatives and projects. The Report meets the general content and quality requirements of the GRI Sustainability Reporting Guidelines, 2006, and XYZ confirms that the GRI requirements for application Level ‘A+’ have been met.

Materiality : Infosys has demonstrated a formal approach to assessing material aspects and indicators for reporting. XYZ recommends that Infosys identifies more indicators, other than GRI indicators, representing material issues for the Information Technology (IT) sector, and that they are incorporated in the future sustainability strategy.

 Completeness : Within the reporting boundary defined by Infosys, we do not believe that the Report omits relevant information that would influence stakeholder assessments of decisions or that reflect significant economic, environmental and social impacts.

Accuracy : XYZ has not found material inaccuracies in the data verified or instances where data is presented in a way which significantly affects the comparability of data.

Neutrality : XYZ considers that the information contained in the Report is balanced. The emphasis on various topics in the Report is proportionate to their relative materiality.

 Comparability : XYZ recognises that this is the first Sustainability Report published by Infosys, and we commend the Company for its commitment to reporting accurate and comparable data. The Report clearly states that for many indicators, especially the Environment Health and Safety (EHS) indicators, the reported information will be the baseline.

Responsiveness : Infosys demonstrates an active commitment to dialogue on sustainability issues with stakeholders. The expectations expressed by stakeholders through different engagement channels have generally been addressed in the Report.

Opportunities for Improvement

The following is an excerpt from the observations and opportunities reported back to the management of Infosys. However, these do not affect our conclusions on the Report, and they are indeed generally consistent with the management objectives already in place.

(b) An internal verification mechanism should be developed to further improve the reliability of data as well as help improve internal communication on sustainability reporting.

(b) Systems and processes should be strengthened to better facilitate reporting on global operations.

(b) The materiality assessment approach should be further developed and refined to identify appropriate indicators for all material issued identified.

Extracts from Certificate on Corporate Governance

New Page 1Section B :
Miscellaneous

Extracts from Certificate on Corporate Governance

Based on such a review and to the best of our information and
according to the explanations given to us, in our opinion, the Company has
complied with the conditions of Corporate Governance as stipulated in Clause 49
of the Listing Agreement of the Stock Exchange of India, except the following :

I. The Company has not applied certain Accounting Standards
as referred to Para 3(d) of our Audit Report dated 31st July 2007;

II. Two complaints of shareholders could not be resolved by
the Company within a reasonable time period of 1 month.


Since the relevant records were not made available to us, we
are unable to comment on the disclosure of all the pecuniary relationships and
transactions of the Company with the Directors.


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Substantial question of law — Whether the assessee was entitled to deduction u/s.80-IA of the Act on the amount of entire eligible income without reducing the amount of export incentives from the same.

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6 Substantial question of law — Whether the assessee was
entitled to deduction u/s.80-IA of the Act on the amount of entire eligible
income without reducing the amount of export incentives from the same.


[ACIT v. Neo Sack P. Ltd., (2009) 319 ITR 124 (SC)]

The High Court dismissed the appeal on the aforesaid question
holding that it did not arise from the order of the Tribunal and therefore could
not be made a subject matter of appeal u/s.260A of the Act. On appeal, the
Supreme Court was of the view that the question raised was an important question
of law arising for interpretation of S. 80-IA of the Act. The said question was
neither answered by the Tribunal nor by the High Court. The Supreme Court
therefore granted liberty to the Department to move to the High Court and raise
the issue specifically and in case the High Court found that the answer to the
above question needed factual finding(s), it may remit the case to the Tribunal
for disposal on merits in accordance with law.

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Supreme Court — Special Leave Petition — Order passed by the High Court should be a speaking order — Matter remanded.

New Page 1

5 Supreme Court — Special Leave Petition — Order passed by
the High Court should be a speaking order — Matter remanded.


[Speed Lines P. Ltd. v. CIT, (2009) 316 ITR 102 (SC)]

The High Court had dismissed an appeal filed u/s. 260A of the
Act holding that no substantial question of law arose for its consideration. On
a special leave to the Supreme Court, the order of the High Court was set aside
by the Supreme Court since the order of the High Court was a non-speaking. The
matter was remitted to the High Court for fresh consideration on merits.

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Penalty — Concealment of income — Matter remanded to the High Court since it had relied upon its earlier decision which, though approved by the Supreme Court in some other matter, was later held to not lay down the correct law by Larger Bench of the Supre

New Page 1

4 Penalty — Concealment of income — Matter remanded to the
High Court since it had relied upon its earlier decision which, though approved
by the Supreme Court in some other matter, was later held to not lay down the
correct law by Larger Bench of the Supreme Court.


[CIT v. Atul Mohan Bindal, (2009) 317 ITR 1 (sc)]

Atul Mohan Bindal, the assessee, filed return of his income
for the A.Y. 2002-03, declaring his total income at Rs.1,98,50,021. In the
assessment proceedings u/s.143, a notice along with questionnaire was issued to
him by the Assessing Officer. Pursuant thereto, the assessee attended the
assessment proceedings and furnished the requisite details. During the
assessment proceedings, it transpired that the assessee worked with M/s. DHL
International(S) Pte. Ltd., Singapore, during the previous year and was paid
salary in Singapore amounting to US $ 36,680.79 equivalent to Rs. 17,81,952. The
assessee explained that an amount of US $ 8199.87 (Rs.3,98,350) was deducted as
tax from the aforesaid salary income and having paid tax on salary income earned
in Singapore, he was of the view that the said income was not liable to be
included in the total income in India. He, however, offered salary income of
Rs.17,81,952 to be included in his total income. The assessee was also found to
have received an amount of Rs. 5,00,000 from his erstwhile employer M/s.
Honey-well International (India) Pvt. Ltd. in the previous year. His explanation
was that the said amount was exempted u/s.10(10B) of the Act being retrenchment
compensation. According to the Assessing Officer, that amount could not be
exempted u/s.10(10B), as the assessee was not a workman. The assessee also
earned interest income of Rs.22,812 from Bank of India, which was not included
by him in the total income but he offered for tax the said amount. The AO,
accordingly, added Rs.17,81,952, Rs.5,00,000 and Rs. 22,812 to the income
declared by the assessee in the return and assessed the total income of the
assessee at Rs.2,21,54,785. Penalty proceeding u/s. 271(1)(c) were initiated
separately and penalty of Rs.7,75,211 was imposed.

The assessee accepted the order of assessment but challenged
the order of penalty in appeal before the Commissioner of Income-tax (Appeals).

The Commissioner of Income-tax (Appeals) allowed the appeal
and set aside the order of penalty. The Commissioner of Income-tax (Appeals)
held that the assessee has neither concealed the particulars of his income, nor
furnished any inaccurate particulars thereof.

The Tribunal upheld the order of the Commissioner of
Income-tax (Appeals).

The Delhi High Court considered the question whether the
Assessing Officer had recorded a valid satisfaction for initiating penalty
proceedings u/s.271(1)(c) of the Act. Inter alia, relying upon a decision of
that Court in CIT v. Ram Commercial Enterprises Ltd., (2000) 246 ITR 568 (Delhi)
and noticing that Ram Commercial Enterprises had been approved by the Supreme
Court in Dilip N. Shroff v. Joint CIT, (2007) 291 ITR 519 (SC) and T. Ashok Pai
v. CIT, (2007) 292 ITR 11, held that from the reading of the assessment order,
it was not discernible as to why the AO chose to initiate proceedings against
the assessee and under which part of S. 271(1)(c). The High Court, therefore,
accepted the view of the Tribunal and the Commissioner of Income-tax (Appeals)
and dismissed the appeal of the Revenue with cost of Rs.5,000.

On an appeal, the Supreme Court held that a close look at S.
271(1)(c) and Explanation 1 appended thereto would show that in the course of
any proceedings under the Act, inter alia, if the Assessing Officer is satisfied
that a person has concealed the particulars of his income or furnished
inaccurate particulars of such income, such person may be directed to pay
penalty. The quantum of penalty is prescribed in clause (iii). Explanation 1,
appended to S. 271(1) provides that if that person fails to offer an explanation
or the explanation offered by such person is found to be false or the
explanation offered by him is not substantiated and he fails to prove that such
explanation is bona fide and that all the facts relating to the same and
material to the computation of his total income have been disclosed by him, for
the purposes of S. 271(1)(c), the amount added or disallowed in computing the
total income is deemed to represent the concealed income. The penalty spoken of
in S. 271(1)(c) is neither criminal nor quasi-criminal but a civil liability;
albeit a strict liability. Such liability being civil in nature, mens rea is not
essential.

The Supreme Court further held that insofar as the present
case was concerned, as noticed above, the High Court had relied upon its earlier
decision in Ram Commercial Enterprises Ltd. (2000) 246 ITR 568 (Delhi) which is
said to have been approved by the Supreme Court in Dilip N. Shroff (2007) 291
ITR 519. However, Dilip N. Shroff (2007) 291 ITR 519 was held to be not laying
down good law in Dharamendra Textile (2008) 306 ITR 277 (SC) and Dharmendra
Textile was explained by the Supreme Court in Rajasthan Spinning and Weaving
Mills (2009) 8 Scale 231. According to the Supreme Court the matter therefore
needed to be reconsidered by the High Court in the light of its decisions in
Dharmendra Textile (2008) 306 ITR 277 (SC) and Rajasthan Spinning and Weaving
Mills (2009) 8 Scale 231.

The Supreme Court therefore allowed the appeal and the
judgment of the High Court of Delhi was set aside. The matter was remitted back
to the High Court for fresh consideration and decision as indicated above.



Notes :

(i) The assessee had chosen not
to appear.

(ii) Also see judgment in the
case of Reliance Petroproducts Pvt. Ltd. (322 ITR 1 — SC) analysed in ‘Closements’.


levitra

Kar Vivad Samadhan Scheme, 1998 — What is conclusive is the order passed U/ss.(1) of S. 90 of the Scheme determining the sum payable under the Scheme and the terms ‘direct tax enactment’ or ‘indirect tax enactment’ or ‘any other law for the time being in

New Page 1

6. Kar Vivad Samadhan Scheme, 1998 — What is
conclusive is the order passed U/ss.(1) of S. 90 of the Scheme determining the
sum payable under the Scheme and the terms ‘direct tax enactment’ or ‘indirect
tax enactment’ or ‘any other law for the time being in force’ refer only to
those statutes under which the order had been passed. Immunity is only in
respect of institution of any proceeding for prosecution of any offence under
direct tax enactment or indirect tax enactment or from imposition of penalty
under any of such enactments.


[ Master Cables P. Ltd. v. State of Kerala and
Anr., (2008) 296 ITR 8 (SC)]

The appellant was engaged in the business of manufacture and
sale of insulated electrical cable. It was registered under the Kerala General
Sales Tax Act, 1963 (for short, ‘the Act’). Assessment proceedings in respect of
the A.Ys. 1995-96 and 1996-97 were completed relying upon or on the basis of the
books of account maintained by it. An inspection, however, was carried out in
the premises of the appellant. A certain amount of unaccounted production and
sale of goods was found. The appellant admittedly took recourse to the
provisions of the Kar Vivad Samadhan Scheme. Declaration made by it thereunder
was accepted. By an order dated January 14, 2003, the earlier assessment order
was set aside. The appellant filed an appeal before the Kerala Sales Tax
Appellate Tribunal. The matter was remitted to the Deputy Commissioner for its
re-examination. By an order dated May 20, 2003, the assessment in respect of the
A.Y. 1996-97 was set aside. The said authority directed reassessment for the
year 1995-96 by an order dated November 7, 2003. Questioning the said orders,
appeals were filed by the appellant before the Tribunal, which by reason of a
common judgment dated December 21, 2005, were dismissed. Two sales tax revisions
were filed thereagainst before the High Court, which by reason of the impugned
judgment had been dismissed. Before the Supreme Court it was contended by the
appellant that having regard to the provisions of Ss.(3) of S. 90 of the Scheme,
the term ‘any other law for the time being in force’ must be given a wide
meaning, so as to cover not only the direct tax or indirect tax envisaged
thereunder, but also the sales tax laws of the State in the light of the
provisions of clause (3) of Article 286 of the Constitution of India and
sub-clauses (c) and (d) of clause (29A) of Article 366 thereof. After
considering the provision of S. 90(3) and S. 91 of the Kar Vivad Samadhan
Scheme, the Supreme Court held that what is conclusive is the order passed U/ss.(1)
of S. 90 of the Scheme determining the sum payable under the Scheme. The terms
‘direct tax enactment’ or ‘indirect tax enactment’ or ‘any other law for the
time being in force’ refer only to those statutes under which the order had been
passed. Immunity is in respect of institution of any proceeding for prosecution
of any offence under direct tax enactment or indirect tax enactment or from
imposition of penalty under any of such enactments. The terms ‘direct tax
enactment’ and ‘indirect tax enactment’ have been defined u/s.87(h) and 87(j) of
the Scheme. Admittedly, the case of the appellant did not come within the
purview thereof. The amplitude of the provisions of the Scheme having been
extended only to the enactments made by Parliament, having regard to the
constitutional scheme contained in Article 246 of Constitution of India, the
same cannot be extended to assessment of sales tax under a State legislation.
The legislative field to enact a law relating to sales tax is within the
exclusive domain of a State Legislature in terms of entry 54, List II of the
Seventh Schedule to the Constitution of India. The Supreme Court held that once
it is found that a statutory authority had the jurisdiction to reopen a
proceeding or set aside the order of the assessing authority, only the higher
authorities can interfere therewith. Only because the appellant had taken
recourse to the Scheme, the same would not attract either Ss.(3) of S. 90 of the
Scheme or S. 91 thereof, so as to cover a subject which is within an exclusive
domain of the State Legislature. The appeal was therefore dismissed.

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Charitable purpose — Charitable Institution — Statutory body established for the predominant purpose of development of minor ports the management of which is with the State Government and where there is no profit motive covered within the meaning of the w

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5 Charitable purpose — Charitable Institution
— Statutory body established for the predominant purpose of development of minor
ports the management of which is with the State Government and where there is no
profit motive covered within the meaning of the words any other object of
general public utility in S. 2(15) of the Act and is entitled to registration
u/s.12A


[ CIT v. Gujarat Maritime Board, (2007) 295
ITR 561 (SC)]

The Gujarat Maritime Board is a statutory authority
constituted u/s.3(2) of the Gujarat Maritime Board Act, 1981. The Board was
registered as ‘local authority’ in terms of definition u/s.3(31) of the General
Clauses Act, 1897, and was availing of exemption as local authority u/s.10(20)
of the 1961 Act. By the Finance Act, 2002, an Explanation was added in S. 10(20)
of the Income-tax Act, by which ‘local authority’ was defined. It gave a
restricted meaning to the words ‘local authority’. By reason of the said
Explanation, the expression ‘local authority’ was confined to panchayats,
municipality, municipal committee, district board and cantonment board. Thus,
the Maritime Board did not come within the definition of the expression ‘local
authority’. Under the circumstances, the Gujarat Maritime Board made an
application to the Commissioner for registering it (Board) as a ‘charitable
institution’ as defined u/s.2(15) of the Income-tax Act, 1961. Accordingly, they
claimed exemption as charitable institution in respect of income derived from
their profit/business u/s.11 of the 1961 Act. This has been denied by the
Department. One of the objections raised on behalf of the Department was that
the Gujarat Maritime Board was not entitled to the benefit of S. 11 of the 1961
Act, as the said Board was not a trust under the Public Trusts Act and,
therefore, it was not entitled to claim registration u/s.12A of the 1961 Act.
The Department’s case was that the Maritime Board was a statutory authority. It
was the case of the Department that the Board was performing statutory
functions. Development of minor ports in the State of Gujarat cannot be termed
as the work undertaken for charitable purposes and in the circumstances the
Commissioner rejected the Board’s application u/s.12A of the 1961 Act. On an
appeal, after perusal of number of decisions which have interpreted the words in
S. 2(15), namely, ‘any other object of general public utility’, the Supreme
Court held that the said expression is of the widest connotation. The word
‘general’ in the said expression means pertaining to a whole class. Therefore,
advancement of any object of benefit to the public or a section of the public as
distinguished from benefit to an individual or a group of individuals would be
charitable purpose. The said expression would prima facie include all
objects which promote the welfare of the general public. It cannot be said that
a purpose would cease to be charitable even if public welfare is intended to be
served. If the primary purpose and the predominant object are to promote the
welfare of the general public, the purpose would be charitable. When an object
is to promote or protect the interest of a particular trade or industry, that
object becomes an object of public utility, but not so if it seeks to promote
the interest of those who conduct the said trade or industry. If the primary or
predominant object of an institution is charitable, any other object which might
not be charitable, but which is ancillary or incidental to the dominant purpose,
would not prevent the institution from being a valid charity. According to the
Supreme Court, the present case was squarely covered by its judgment in the case
of CIT v. Andhra Pradesh State Road Transport Corporation, (1986) 159 ITR
1 (SC), in which it has been held that since the Corporation was established for
the purpose of providing efficient transport system, having no profit motive,
through it earns income in the process, it is not liable to Income-tax. The
Supreme Court further observed that under the scheme of S. 11(1) of the 1961
Act, the source of income must be held under trust or under other legal
obligation. Applying the said test, it was clear that the Gujarat Maritime Board
was under legal obligation to apply the income which arose directly and
substantially from the business held under trust for the development of minor
ports in the State of Gujarat. Therefore, they were entitled to be registered as
‘charitable trust’ u/s.12A of the 1961 Act.

levitra

ACC LTD. — (31-12-2007)

New Page 1ACC LTD. — (31-12-2007)

From Notes to Accounts :

There are no Micro, Small and Medium Enterprises, as defined
in the Micro, Small and Medium Enterprises Development Act, 2006 to whom the
Company owes dues on account of principal amount together with interest and
accordingly no additional disclosures have been made.

The above information regarding Micro, Small and Medium
Enterprises has been determined to the extent such parties have been identified
on the basis of information available with the Company. This has been relied
upon by the auditors.


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FULFORD (INDIA) LTD. — (31-12-2007)

New Page 1FULFORD (INDIA) LTD. — (31-12-2007)

From Notes to Accounts :

The Company has not received any intimation from the
suppliers regarding status under the Micro, Small and Medium Enterprises
Development Act, 2006 (the act) and hence disclosure regarding :

(a) Amount due and outstanding to suppliers as at the end
of accounting year;

(b) Interest paid during the year;

(c) Interest payable at the end of the accounting year, and

(d) Interest accrued and unpaid at the end of the
accounting year, has not been provided.


The Company is making efforts to get the confirmations from
the suppliers as regards their status under the Act.


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Honeywell Automation India Ltd. — (31-12-2007)

New Page 1HONEYWELL AUTOMATION INDIA LTD. — (31-12-2007)

From Notes to Accounts :

Disclosure in accordance with Section 22 of the Micro, Small
and Medium Enterprises Development Act, 2006 :

Particulars

Amount (Rs.
‘000)

(a) Principal amount remaining unpaid and

206,945

Interest due
thereon

—

(b) Interest
paid in terms of Section 16

—

(c) Interest due and payable for the period of delay in
payment

—

(d) Interest accrued and remaining unpaid

—

(e) Interest due and payable even in succeeding years

—

The Company has compiled the above information based on
verbal confirmations from suppliers. As at the year end, no supplier has
intimated the Company about its status as a Micro or Small Enterprise or its
registration under the Micro, Small and Medium Enterprises Development Act,
2006.

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MRF LTD. — (30-9-2007)

New Page 1MRF LTD. — (30-9-2007)

From
Schedules :

A. Current
Liabilities :

Rs. crore

Rs. crore

Sundry Creditors :

Outstanding dues of Micro Enterprises & Small Enterprises
(Note 5)

3.30

1.50

Outstanding dues of creditors other than Micro
Enterprises & Small Enterprises

411.68

370.73


From Notes to Accounts :




8. There are no delays in the payment of dues to micro,
small and medium enterprises, to the extent such parties have been identified
on the basis of information available with the Group. Previous year’s figures
stated in Schedule 8 represent amounts due to small-scale industrial
undertakings.



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HINDUSTAN UNILEVER LTD.

New Page 1HINDUSTAN UNILEVER LTD.

— (31-12-2007)

From Schedule :

Sundry Creditors (Refer Note 21)

From Notes to Accounts :

There are no Micro and Small Enterprises, to whom the Company
owes dues, which are outstanding for more than 45 days as at 31st December,
2007. This information as required to be disclosed under the Micro, Small and
Medium Enterprises Development Act, 2006 has been determined to the extent such
parties have been identified on the basis of information available with the
Company.

&

HONEYWELL AUTOMATION INDIA LTD. — (31-12-2007)


From Notes to Accounts :

Disclosure in accordance with Section 22 of the Micro, Small
and Medium Enterprises Development Act, 2006 :

Particulars

Amount (Rs.
‘000)

(a) Principal amount remaining unpaid and

206,945

Interest due
thereon

—

(b) Interest
paid in terms of Section 16

—

(c) Interest due and payable for the period of delay in
payment

—

(d) Interest accrued and remaining unpaid

—

(e) Interest due and payable even in succeeding years

—

The Company has compiled the above information based on
verbal confirmations from suppliers. As at the year end, no supplier has
intimated the Company about its status as a Micro or Small Enterprise or its
registration under the Micro, Small and Medium Enterprises Development Act,
2006.

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S & S Power Switchgear Ltd.

New Page 1S & S POWER SWITCHGEAR LTD.

— (30-9-2007)

From Notes to Accounts :

7. The Company is in the process of identifying the
small-scale units and Micro, Small and Medium Enterprises and hence :

(a) Interest, if any, payable as per Interest on Delayed
Payment to Small Scale and Ancillary Industrial Undertakings Ordinance, 1993
and the Micro, Small and Medium Enterprises Development Act, 2006 is not
ascertainable, and

(b) Amount payable to small-scale units is not
ascertainable.


From Auditors’ Report :



(g) Subject to the foregoing, in our opinion and to the
best of our information and according to the explanations given to us, the
said financial statements read along with the notes thereon, subject to the
dues to the small-scale industry units (Refer Note 7 of Schedule 15), give
the information required by the Companies Act, 1956, in the manner so required
and give a true and fair view in conformity with the accounting principle
generally accepted in India.



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Abbott India Ltd. — (30-11-2007)

New Page 1ABBOTT INDIA LTD. — (30-11-2007)

From Schedules :

A. Current Liabilities :

 
Rupees in millions
As at 30-11-2006 Rupees in millions

Sundry Creditors :

Due to Micro & Small Enterprises (Refer Note B 27 —
Schedule 16)

—
 —

Others†
308.4
286.6

† Previous year includes an amount of Rs.36.7 million due to
small-scale industrial undertakings.



From Notes to Accounts :




(a) An amount of Rs.4.4 million and Nil was due and
outstanding to suppliers as at the end of the accounting year on account of
Principal and Interest, respectively.

(b) No interest was paid during the year.

(c) No interest is payable at the end of the year other
than interest under the Micro, Small and Medium Enterprises Development Act,
2006.

(d) No amount of interest was accrued and unpaid at the end
of the accounting year.

The above information and that given in Schedule 10 —
‘Current Liabilities and Provisions’ regarding Micro, Small and Medium
Enterprises has been determined to the extent such parties have been
identified on the basis of information available with the Company. This has
been relied upon by the auditors.



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Income from undisclosed sources — Should be taxed in the year of receipt — Matter remanded for fresh adjudication.

New Page 1

Glimpses of Supreme Court Rulings

Kishor Karia
Chartered Accountant
Atul Jasani
Advocate

8 Income from undisclosed sources — Should be taxed in the
year of receipt — Matter remanded for fresh adjudication.

[Fifth Avenue v. CIT, (2009) 319 ITR 132 (SC)]

The appellant, a registered partnership firm consisted of 15
partners. The firm was being managed by three partners by name, Irfan Razak, K.
Rahman Khan and Sadath Ali Khan. The firm constructed a commercial complex known
as ‘Fifth Avenue’ consisting of ground + three floors. The building consisted of
82 commercial shops. The building was under construction till the end of
January, 1993. Different shops were sold by the firm under different sale deeds
to several buyers. On January 5, 1993, exercising the powers u/s.132 of the
Income-tax Act, M/s. India Builders Corporation (which was also a partnership
firm) was searched. During the search, a document pertaining to the
appellant-firm was seized. Based on the documents seized during the search
conducted in the premises of one of the partners of the appellant-firm, the
proceedings were initiated. According to the Revenue, while selling different
portions of the building apart from the sale consideration shown in the sale
deeds, the firm had also received additional sale consideration by cash which
had not been accounted and the consideration shown in the sale deeds were
received by the firm through cheques. An enquiry was conducted and the Assessing
Officer held that the unaccounted income of the assessee-firm had to be brought
to tax. Accordingly, the appellant-firm was called upon to pay tax
Rs.1,52,49,240 and also ordered for separate penalty proceedings u/s.271(1)(c)
of the Act challenging the order passed by the Assessing Officer. The appellant-assessee
filed an appeal before the Commissioner of Income-tax (Appeals). The
Commissioner of Income-tax (Appeals) after hearing the parties allowed the
appeal on the ground that the document seized was not while conducting a search
on the premises of the assessee and there was nothing to show that unaccounted
money was received by the firm and that the computer printout could not be
linked with the transaction pertaining to the appellant. Therefore, the appeal
filed by the assessee was allowed by the Commissioner of Income-tax (Appeals),
against which, the Revenue took up the matter in appeal before the Tribunal,
Bangalore Bench. The Tribunal, Bangalore Bench, after examining the legality and
the correctness of the order passed by the Assessing Officer and so also the
order passed by the Commissioner of Income-tax (Appeals) came to the conclusion
that even though the document was seized from the premises of a partner of the
appellant-firm — India Builders Corporation, as the document was pertaining to
the appellant-firm and that the seizure of the document from the premises of
India Builders Corporation had not been denied by the appellant-firm,
considering the provisions of S. 3(18) of the General Clauses Act and also the
presumption attached u/s.132(4A) of the Income-tax Act, held that the partners
of the appellant-firm have received unaccounted money in cash and the same had
to be brought into assessment. According to the Tribunal, the statement of Mr.
Ziaulla Sheriff disclosed that he was a partner of 10% share and his son, Yunuz
Zia, was also a partner of 10% share and Irfan Razack was the main partner
managing the affair of the firm and that Irfan Razak was examined on February
24, 1993. In his evidence he had denied the receipt of cash on behalf of the
appellant-firm, but he had admitted the contents of the seized printout
material. Relying upon the evidence of Irfan Razak, the Tribunal came to the
conclusion that the partners of the firm accepted the contents of the printout
taken from the computer in respect of the appellant-firm from India Builders
Corporation and, therefore, came to the conclusion that the Commissioner of
Income-tax (Appeals) has committed an error in allowing the appeal. Accordingly,
the order passed by the Commissioner of Income-tax (Appeals) was set aside and
the order passed by the Assessing Officer was restored.

The Karnataka High Court in the appeal filed before it held
that even though the appellant-firm’s premises was not searched, when an
important document was seized by the authorities from the premises of the
partners of the appellant-firm, it was for the appellant to show that the
appellant or any of its partners did not receive such money by way of cash which
had not been disclosed in the return filed by the appellant. When the appellant
was contending that it had not received cash from the purchasers and that the
sale consideration shown in the sale deeds alone was paid to the appellant, the
onus was on the appellant to examine its partners to dispel such contentions.
When the appellant had admitted the seizure of the documents in question from
the premises of its partners, Ziaulla Sheriff and Yunus Zia, it was for them to
explain that this particular document was not pertaining to the partnership
concern of the appellant and it is also for them to show under that
circumstances the said document was in possession of its partners and similarly
it was for them to show the said document had nothing to do with the business
activities of the appellant. It was held that the Tribunal was justified in
reversing the finding of the Commissioner of Income-tax (Appeals).

The High Court however noted that the Tribunal while
considering the matter pertaining to penalty proceedings initiated u/s.272(1)(c)
of the Income-tax Act had remanded the matter to the Assessing Officer to
ascertain and give a finding whether the entire unaccounted money of
Rs.2,32,28,173 was received in the A.Y. 1993-94 and whether the same was
received by the partners of the appellant-firm on different dates and that the
amount so received had to be spread over based on the actual receipt of the
money in different assessment years. Relying upon the order of the Tribunal
rendered in penalty proceedings, it was contended before the High Court that
even in quantum appeal, the matter had to be reconsidered by the Assessing
Officer in order to ascertain whether the amount of Rs.2,32,28,173 was received
by the partners of the firm during the A.Y. 1993-94 or not.

The High Court observed that the search material showed that
payments were made on different dates. The High Court found that the entire
unaccounted money had been brought into tax for the A.Y. 1993-94, which in fact
was not fully correct. The High Court was therefore, of the view that the order
passed by the Assessing Officer had to be set aside and the matter had to be
remanded to the Assessing Officer to find out whether Rs.2,32,28,173 was
received by the partners of the appellant-firm during the A.Y. 1993-94 or not,
and based on such finding, the assessment had to be completed. The High Court
held that it was for the appellant and his partners to explain and produce
relevant documents before the Assessing Officer to show that when and how the
aforesaid amount of Rs.2,32,28,173 was received by them. If the partners of the
appellant-firm were unable to produce any material evidence, then it was for the
Assessing Officer to complete the assessment, treating that the amount had been
received by the partners of the appellant-firm during the A.Y. 1993-94 only. The High Court further held that in view of the assessment being set aside,
at the request of the assessee, the assessee would not raise any question of
limitation.

In an
appeal before the Supreme Court it was con-tended by the appellant that the
High Court had failed to answer the question as to whether the amount allegedly
paid by the purchasers on different dates to the managing partners of the firm
could be brought to tax in the hands of the appellant firm. The Supreme Court
found merit in the contention of the appellant, but as the other question was
remanded by the High Court to the Assessing Officer, the Supreme Court also
remanded the issue to the Assessing Officer for fresh consideration in accordance
with law.

Estate duty — Valuation of goodwill — Super Profits method — There is no hard and fast rule regarding multiplier to be applied for evaluating goodwill — Value would depend on the nature of business and prevailing market conditions — Property passing on de

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10 Estate duty — Valuation of goodwill — Super Profits method
— There is no hard and fast rule regarding multiplier to be applied for
evaluating goodwill — Value would depend on the nature of business and
prevailing market conditions — Property passing on death — Claim pending
adjudication on date of death — Not a property available at the time of death.


[Controller of Estate Deputy v. Nalini V. Saraf, (2009) 319
ITR 303 (SC)]

One V. G. Saraf passed away on October 18, 1984. He was a
partner in M/s. Saraf Trading Corporation, a partnership firm carrying on
business as commission agents and exporters of tea. It exported tea to U.S.S.R.
The firm was constituted under deed of partnership dated November 27, 1963. The
firm had three partners. The deceased had fifty per cent share in profit and
loss. On September 16, 1981, the firm was reconstituted with the admission of
one more partner and a minor. The Assistant Controller of Estate Duty, inter
alia, held that for determining the value of goodwill, there were two methods of
valuation, namely, super profits method and total capitalisation method. The
Assistant Controller
preferred the super profits method. Applying the super profits method, the
Assistant Controller applied the multiplier of three years’ purchase, whereas
the assessee-respondent contended that 3X was excessive. The Assistant
Controller further held that refund of income-tax, which became due after the
demise of V. G. Saraf, constituted property of the deceased, which was also
disputed by the legal representatives of the deceased.

On the facts, the Tribunal found that at the relevant time,
the market conditions in the U.S.S.R. were not congenial; that there was huge
volatility in the tea export business even otherwise; and in the circumstances,
the Tribunal applied the multiplier of one year’s purchase instead of three
years’ purchase. This finding was upheld by the High Court.

The Supreme Court noted that in this case, the method was not
in dispute. The Supreme Court held that there was no hard and fast rule
regarding the multiplier to be applied for evaluating the goodwill of the firm.
It all depended on the nature of the business and the prevailing market
conditions. Hence, the Supreme Court was of the view that this aspect was a pure
question of fact and did not call for interference by the Supreme Court.

On the question as to whether the refund in question, which became payable
after the death, the Tribunal and the High Court concurrently held that the
refund had not become due (crystallised) on October 18, 1984, when V. G. Saraf
passed away. In fact, on that day, the claim for refund under the Act was
pending adjudication. Such refund stood determined only after the deceased.
Hence, the Supreme Court held that such refund could not be considered to be a
property available at the time of the death.

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Rectification of mistake — Whether power subsidy received by an assessee is revenue receipt or capital receipt has to be decided on the facts of each case after examining the scheme of subsidy and therefore cannot be a subject matter of rectification on t

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9 Rectification of mistake — Whether power subsidy received
by an assessee is revenue receipt or capital receipt has to be decided on the
facts of each case after examining the scheme of subsidy and therefore cannot be
a subject matter of rectification on the basis of some subsequent decision of
the Supreme Court.


[Mepco Industries Ltd. v. CIT, (2009) 319 ITR 208 (SC)]

The appellant, engaged in the business of manufacture of
potassium chlorates, had its factory in the Union Territory of Pondicherry. The
appellant received power subsidy for two years, which it initially offered as
revenue receipt in its return of income. In the petition filed u/s.264 of the
Act, the assessee pleaded that the subsidy amount was a capital receipt, hence
not liable to be taxed, and accordingly, it sought revision of the assessment
orders for the A.Ys. 1993-94 and 1994-95. In the revision petitions, the
appellant had pleaded that the subsidy amount was a capital receipt, and for
that purpose, it relied upon the judgment of the Supreme Court in the case of
CIT v. P. J. Chemicals Ltd. reported in (1994) 210 ITR 830. The revision
petitions filed by the appellant u/s.264 of the Act stood allowed by the
Commissioner of Income-tax by order dated April 30, 1997. Subsequent to the said
order, on September 19, 1997, the Supreme Court in the case of Sahney Steel and
Press Works Ltd. (1997) 228 ITR 253 held that incentive subsidy admissible to
Sahney Steel and Press Works Limited was a revenue receipt, and hence, it was
liable to taxed u/s.28 of the Act. This decision was based on a detailed
examination of the subsidy scheme formulated by the Government of Andhra
Pradesh. It stated that incentives would not be available unless and until
production had commenced. In that matter, the Supreme Court found that
incentives were given by refund of sales tax and by subsidy on power consumed
for production. In short, on the facts and circumstances of that case, the
Supreme Court had come to the conclusion that the incentives were production
incentives in the sense that the assessee was entitled to incentives only after
entering into production. It was also clarified that the scheme was not to make
any payment directly or indirectly for setting up the industries.

Following the said judgment of the Supreme Court in the case
of Sahney Steel and Press Works Ltd. (1997) 228 ITR 253, delivered on September
19, 1997, the Commissioner of Income-tax passed an order of rectification dated
March 30, 1998. The only ground on which the rectification was sought to be made
by the Commissioner of Income-tax was that power tariff subsidy given to the
appellant herein was admissible only after commencement of production.
Consequently, according to the Commissioner of Income-tax, power tariff subsidy
constituted operational subsidies, they were not capital subsidies, and in the
circumstances, applying the ratio of judgment of this Court in the case of
Sahney Steel and Press Works Ltd. (1997) 228 ITR 253, the Commissioner of
Income-tax sought to rectify its earlier order dated April 30, 1997, by invoking
S. 154 of the Act. Aggrieved by the said order, the appellant filed writ
petitions before the Madras High Court, which took the view that, in view of the
subsequent decision of this Court, in the case of Sahney Steel and Press Works
Ltd. (1997) 228 ITR 253, the Department was entitled to invoke S. 154 of the Act
and that the Commissioner was right in treating the receipt of subsidies as a
revenue receipt. This decision of the learned single Judge was affirmed by the
Division Bench of the Madras High Court.

On appeal by special leave, the Supreme Court held that on
the facts of the present case, it was of the view that the present case involved
change of opinion. The Supreme Court observed that the Government grants
different types of subsidies to the entrepreneurs. The subsidy in Sahney Steel
and Press Works Ltd. (1997) 228 ITR 253 (SC) was an incentive subsidy linked to
production. In fact, in Sahney Steel and Press Works Ltd. (1997) 228 ITR 253
(SC) (at page 257), the Court categorically stated that the scheme in hand was
an incentive scheme and it was not a scheme for setting up the industries. In
the said case, the salient features of the scheme were examined and it was
noticed that the scheme formulated by the Government of Andhra Pradesh was
admissible only after the commencement of production. The Supreme Court held
that in income-tax matters, one has to examine the nature of the item in
question, which would depend on the facts of each case. In the present case, it
was concerned with power subsidy, whereas in the case of CIT v. Ponni Sugars
and Chemicals Ltd. reported in (2008) 306 ITR 392, the subsidy given by the
Government was for repaying loans. Therefore, in each case, one has to examine
the nature of subsidy. This exercise cannot be undertaken u/s.154 of the Act.
There is one more reason why S. 154 in the present case was not invokable by the
Department. Originally, the Commissioner of Income-tax, while passing orders
u/s.264 of the Act on April 30, 1997, had taken the view that the subsidy in
question was a capital receipt not taxable under the Act. After the judgment of
the Supreme Court in Sahney Steel and Press Works Ltd. (1997) 228 ITR 253, the
Commissioner of Income-tax took the view that the subsidy in question was a
revenue receipt. Therefore, according to the Supreme Court, the case before it
was a classic illustration of change of opinion.

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Companies — MAT — Provision for bad and doubtful debts is not for meeting liability and cannot be added back in computing ‘book profits’ under Section 115JA(2)(c).

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10.  Companies — MAT — Provision for bad and doubtful
debts is not for meeting liability and cannot be added back in computing ‘book
profits’ under Section 115JA(2)(c).


 

[CIT vs. HCL Comnet Systems and Services Ltd.,
(2008) 305 ITR 409 (SC)].

The assessee-company was engaged in trading in data
communication equipment and satellite communication services. During the
course of assessment proceedings, the Assessing Officer found that the
assessee had debited an amount of Rs.92,15,187 on account of bad debts to the
profit and loss account. However, on the ground that it was a provision for
bad and doubtful debts, the Assessing Officer added the aforestated amount to
the book profits as per Explanation (c) to Section 115JA of the Act.

On appeal, the Commissioner of Income-tax (Appeals) allowed
the assessee’s appeal. That decision of the Commissioner of Income-tax
(Appeals) stood affirmed by the Tribunal and also by the High Court.

On further appeal by the Revenue, the Supreme Court held
that the Assessing Officer does not have the jurisdiction to go beyond the net
profit shown in the profit and loss account except to the extent provided in
the Explanation. The Assessing Officer has to make adjustment permissible
under the Explanation given in Section 115JA of the 1961 Act.

The said Explanation has provided six items, viz.,
item Nos. (a) to (f), which if debited to the profit and loss account can be
added back to the net profit for computing the book profit.

Item (c) deals with amount(s) set aside as provision made
for meeting liabilities, other than ascertained liabilities. The assessee’s
case would, therefore, fall within the ambit of item (c) only if the amount is
set aside as provision; the provision is made for meeting a liability; and the
provision should be for other than an ascertained liability, i.e., it
should be for an unascertained liability. The Supreme Court observed that
there are two types of ‘debt’. A debt payable by the assessee is different
from a debt receivable by the assessee. A debt is payable by the assessee
where the assessee has to pay the amount to others, whereas the debt
receivable by the assessee is an amount which the assessee has to receive from
others. In the present case, the ‘debt’ under consideration was a ‘debt
receivable’ by the assessee. The provision for bad and doubtful debt,
therefore, is made to cover up the probable diminution in the value of the
asset, i.e., debt which is an amount receivable by the assessee.
Therefore, such a provision cannot be said to be a provision for a liability,
because even if a debt is not recoverable, no liability could be fastened upon
the assessee. In the present case, the debt is the amount receivable by the
assessee and not any liability payable by the assessee and, therefore, any
provision made towards irrecoverability of the debt cannot be said to be a
provision for liability. The Supreme Court therefore was of the view that item
(c) of the Explanation was not attracted to the facts of the present case. In
the circumstances, the Assessing Officer was not justified in adding back the
provision for doubtful debts of Rs.92,15,187 under clause (c) of the
Explanation to Section 115JA of the 1961 Act.

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Export Business — Deduction U/s. 80 HHC — For the Assessment Year 1990-91, Section 80 HHC(3) statutorily fixes the quantum of deduction on the basis of proportion of business profits under the head ‘Profits and gains of business or profession’, irrespecti

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9.  Export Business — Deduction U/s. 80 HHC — For the
Assessment Year 1990-91, Section 80 HHC(3) statutorily fixes the quantum of
deduction on the basis of proportion of business profits under the head ‘Profits
and gains of business or profession’, irrespective of what could strictly be
described as profits derived from export of goods out of India.


 

[Modyset P. Ltd. vs. CIT (2008) 305 ITR 276 (SC)].

The asessee, a limited company, purchased 105 computers for
Rs.90,91,063. It exported them and realised export sales of Rs.90,91,063.
There was no export profit during the relevant assessment year 1990-91. The
Income-tax Officer allowed the claim of deduction under Section 80HHC at
Rs.15,81,389 as the total business income of the assessee stood at
Rs.55,31,941 by applying the ratio in terms of Section 80HH(3)(b) as follows :

Export Profits = 90,91,063 x 55,31,941

3,18,01,941

The Commissioner of Income-tax revised the aforesaid
assessment order in exercise of his powers under Section 263 denying the
deduction under Section 80 HHC, holding that Section 80 HHC confers the
benefit only on those assessees who have not only carried on the export
business, but who have also derived profits on such business. On an appeal,
the Tribunal allowed the assessee’s appeal following the decision of its Delhi
Special Bench in International Research Park Laboratories Ltd. vs. Asst.
CIT [(1995) 212 ITR (AT) 1], in which it was held that profits need not be
earned in the export business alone to claim special deduction under Section
80 HHC. On a reference by the Revenue, the Karnataka High Court following the
decision of the Supreme Court in Ipca Laboratory Ltd. vs. Dy CIT
[(2004) 266 ITR 521] held that since the assessee had not earned profits from
export sales during the year in question, the assessee was not entitled for
deduction under Section 80 HHC. On an appeal to the Supreme Court by the
assessee, it was held that the eligibility for deduction is contemplated by
Section 80 HHC(1), whereas the quantum of deduction is determined under
Section 80 HHC(3). In the matter of determining the quantum of deduction, the
‘principle of proportionality’ applied. There are two situations which are
covered by Section 80HHC (3), namely, turnover only from export sales and
secondly turnover from composite sales (domestic and export business). In both
cases the formula applied as under :

Section 80 HHC concession = export profit =

Profits of business x Export turnover

Total turnover

The Supreme Court on facts held that the calculation had
been correctly done by the Income-tax Officer. The Supreme Court further held
that the High Court had erred in relying upon the judgment in case of Ipaca
Laboratories Ltd., inasmuch as the provisions as applicable in that case were
for the assessment year 1996-97 which were different from the provisions for
the assessment year 1990-91 with which it was concerned and that for the
relevant assessment year the CBDT Circular No. 564 indicated that Section
80HHC (3) statutorily fixes the quantum of deduction on the basis of a
proportion of business profits under the head ‘Profits and gains of business
or profession’, irrespective of what could strictly be described as profits
derived from export of goods out of India. According to the Supreme Court, the
Circular supported its above reasoning. The Supreme Court however, clarified
that the above reasoning was strictly applicable to the law as it stood during
the relevant assessment year.

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Rectification — Mistake apparent from record — Failure to apply judgment of jurisdictional High Court is a mistake apparent from record.

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8. Rectification — Mistake apparent from record — Failure
to apply judgment of jurisdictional High Court is a mistake apparent from
record.


    [ACIT vs. Saurashtra Kutch Stock Exchange Ltd., (2008) 305 ITR 227 (SC)].

    The assessee, Saurashtra Kutch Stock Exchange Ltd., a company registered under Section 25 of the Act made an application on 10-02-1992 for registration under Section 12A of the Act. The assessee filed its return of income for the assessment year 1996-97, declaring nil income claiming exemption u/s. 11 of the Act, though it had not been registered u/s. 12A of the Act. The return was processed u/s. 143(1)(a) of the Act. On 07-11-1997 a notice was issued to the assessee u/s. 154 to show cause why the exemption granted u/s. 11 should not be withdrawn. In reply it was stated that as it had made an application for registration it was entitled to exemption u/s.11 of the Act. Meanwhile, the CIT on 20-02-1998 granted registration to the assessee on condition that the eligibility regarding exemption u/s. 11 of the Act would be examined by the A. O. for the each assessment year. In an order dated 03-12-1999 passed u/s. 143(3) of the Act, the A. O. rejected the claim of exemption u/s. 11 of the Act. The CIT(A) rejected the appeal of the assessee. The Tribunal also dismissed the appeal of the assessee. The assessee filed a miscellaneous application u/s. 254(2) of the Act to rectify the error committed by the Tribunal in the decision rendered by it in appeal. The Tribunal allowed the miscellaneous application and recalled its earlier order passed in appeal. For allowing the application, the Tribunal relied upon the decision of the jurisdictional High Court.

    Dissatisfied with the order passed by the Tribunal in miscellaneous application, the Revenue filed a writ petition which was dismissed by the High Court. On an appeal, the Supreme Court first considered as to what is a mistake apparent from record. After noting the precedent, the Supreme Court held that a patent, manifest and self-evident error which does not require elaborate discussion of evidence or argument to establish it, can be said to be an error apparent on the face of the record and can be corrected while exercising certiorari jurisdiction. An error cannot be said to be apparent on the face of the record if one has to travel beyond the record to see whether the judgment is correct or not. An error apparent on the face of the record means an error which strikes on mere looking and does not need a long drawn out process of reasoning on points where there may conceivably be two opinions. Such error should not require any extraneous matter to show its incorrectness. To put it differently, it should be so manifest and clear that no Court would permit it to remain on record. If the view accepted by the Court in the original judgment is one of possible views, the case cannot be said to be covered by an error apparent on the face of the record.

    The Supreme Court thereafter considered as to whether non-consideration of a decision of a jurisdictional Court or of the Supreme Court can be said to be a mistake apparent from record.

    The Supreme Court held that it was well settled that a judicial decision acts retrospectively. Accordingly to Blackstonian theory, it is not the function of the Court to pronounce a ‘new rule’, but to maintain and expound the ‘old one’. In other words, Judges do not make law, they only discover or find the correct law. The law has always been the same. If a subsequent decision alters the earlier one, it (the latest decision) does not make new law. It only discovers the correct principle of law which has to be applied retrospectively. To put it differently, even where an earlier decision of the Court operated for quite some time, the decision rendered later on would have retrospective effect clarifying the legal position which was earlier not correctly understood.

    The Supreme Court held that in the present case, according to the assessee, the Tribunal decided the matter on October 27, 2000. Hiralal Bhagwati was decided a few months prior to that decision by the jurisdictional High Court, in which it was held that a trust could claim exemption under Section 11, but it was not brought to the attention of the Tribunal. In the circumstances, the Tribunal had not committed any error of law or of jurisdiction in exercising power under sub-Section (2) of Section 254 of the Act and in rectifying the ‘mistake apparent from the record’. Since no error was committed by the Tribunal in rectifying the mistake, the High Court was not wrong in confirming the said order. Both the orders, therefore, in the opinion of the Supreme Court, were strictly in consonance with law and no interference was called for.

Money Makes the world go round

Editorial

The last month has witnessed some big-ticket entertainment,
coming not only from a cricket league but also from the spectacle of a Union
Minister and a powerful cricket czar exchanging public blows in relation to the
affairs of the league, resulting in the revelation of various alleged
malpractices being indulged in the organisation of the tournament. Various other
public personalities and organizations have also been dragged into the fight,
with their actions also coming under the public scanner. The last month also
witnessed the arrest of a senior income tax official at Thane, while in the
process of collecting bribes; the official seeking to implicate her senior. What
is the connection between the two events?

Both these happenings are evidence of the fact that the urge
to make money at any cost has permeated all spheres of our society and resulted
in the debasement of the functioning of various organisations and institutions.
The IPL has generated tons of money for the organisation (and others?), and, in
the bargain, seems to have attracted all sorts of malpractices to generate
further funds. The allegations indicate that the IPL seems to have been run as a
closed club to generate unimaginable sums of money for those who were fortunate
enough to be close to the organisers. The fight seems to have been caused by the
desire on the part of the organisers to keep gatecrashers out of the party.

Over the years, unfortunately, one has seen politics becoming
a highly profitable business, just as organised crime has always been highly
profitable. The unimaginable amounts that a politician—the son of a labourer—had
earned during his short stint as Chief Minister of a mineral-rich state, would
put most businessmen to shame, and would probably suffice to meet the needs of
quite a few generations. The mind-boggling amounts which some bureaucrats and
tax officials are rumoured to demand and earn in a year far exceed an entire
lifetime’s earnings of most people. Entertainment and sports are now big money
spinners, and the combination of the two, which the IPL represents, is a highly
potent mixture. No wonder IPL has attracted the attention of businessmen,
politicians and, as rumoured, perhaps even the underworld.

As the old song goes, “Money makes the World go Round”. It is
true that money greases the wheels of business and commerce. Nobody disputes
that everybody requires a certain amount of money to lead a decent life. Making
money is fine, so long as it is not at the cost of throwing values to the winds.
The problem really arises when the greed for money overtakes all other human
emotions and values and the pursuit of money is seen as an end in itself, and
not as a means to achieve the end of leading a quality life.

Unfortunately, in India, the general values of life seem to
be taking a backseat more and more to the business of making money at any cost.
Corruption is just one offshoot of this trend. Power is seen to be associated
with money. A person with money power believes that the law can be manipulated
to his advantage to serve his own ends. While the common man is invariably
harassed for minor transgressions of the law, even major violations are swept
under the carpet if the right influence is exercised. Are we therefore
unfortunately metamorphing into an unequal society, with different rules for the
haves and the have-nots? This has the potential to create unrest and
dissatisfaction, which could create difficulties for the entire country.

For truly sustainable progress and development, it is
essential that every person has equal opportunity, and is treated equally under
the law. For proper functioning of civilised society, enforcement of laws has to
be evenhanded and firm—having laws which are selectively enforced is a sureshot
recipe for chaos. Only a society which rewards merit and innovation can progress
in the long run.

A related question is whether we, as a generation, are guilty
of not doing enough to impart true education to our succeeding generations,
thereby increasing the potential for chaos? With children more and more exposed
to the outside world, the influence of parents (or grandparents) over children
is not as much as it used to be in the past. Extra efforts are required to
counteract stronger negative external influences. Our education system, being
based on secular ideals, does not make any attempt to inculcate human values in
our children. These values are to be found in all religions—respect for others’
lives, property, etc. In running down religion in the name of secularism, are we
doing ourselves a disservice? The products of our education system may be
wizards at making money—but have they been brought up with values conducive to
being members of a civilised and peaceful society, where everybody can live in
harmony?

Each one of us needs to take some time out to think—are we
merely enjoying the fruits of our forefathers’ efforts, or are we making efforts
to contribute to a value-based society, so that our successors too will be able
to live in a better world? In what way can each of us contribute to restoring a
sense of values in society collectively?

Gautam Nayak

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TDS Compliance

Editorial

The best way to ensure
statutory compliance is to make the process as simple as possible, so that the
person who has to comply with the law, finds it less burdensome to comply with,
rather than undergoing penalty for non-compliance. Unfortunately, as witnessed
by the recent amendments in tax deduction at source (TDS) procedures, the CBDT
is seeking to make compliance so cumbersome that it makes the compliance
extremely onerous, if not impossible for most tax deductors.

All these years, the CBDT has
failed miserably in its attempts to ensure that there was proper compliance with
TDS provisions, and that tax collection by way of TDS matched with tax credit
given for TDS. This was on account of the complicated and ambiguous provisions,
which made the law difficult for most tax deductors to understand, and the
manner in which the law was administered, with many tax officers not fully
conversant with the correct provisions of law. Poor tax administration caused
revenue leakages in the system.

Realising that it was unable to
set its own house in order, the CBDT now seems to be going to the other extreme
of casting the entire burden of creating the data, on the tax deductors. This is
acceptable to some extent, given the benefits of computerisation that would flow
to tax deductors and deductees. But the extent of compliance being cast now
makes it so onerous, that it would require almost every business to hire
additional people to comply with such requirements, the total number of people
required probably exceeding the size of the entire Income Tax Department.

The requirements of Form 24C
seem to reveal a mindset of the CBDT, that businesses are in existence only to
comply with the requirements of the tax authorities. It would be almost
impossible to compile the monthly data in the manner sought. Just to give an
example, details of total payments to contractors during the month have to be
given, including those from which taxes have not been deducted. Payments to
contractors may be debited to printing & stationery, travel & conveyance,
advertisement, staff welfare and dozens of other accounts. To identify and
compute the monthly value of such payments and others every quarter would
involve more work than that required for filing the return of income !

Is this a financial stimulus
package being thought up of by the CBDT to create employment ? It will certainly
have the opposite effect, as businesses already suffering from eroded
profitability will not be able to bear the burden. Maybe taxes could be reduced
on businesses to ease the burden, by reduction of the size of the Income Tax
Department, given the extent to which its functions are being outsourced.

The increasing scope of
mandatory e-payments and e-filing also makes one wonder whether the CBDT is
aware of the ground realities in this country, where most places do not even
have continuous electric power to run their computers, or where internet
connectivity is often irregular. Outside Mumbai, one often hears narratives of
how all details were filled in and payment or uploading was about to be done,
when there was a power or internet or website failure, necessitating initiation
of the entire process again after power or connectivity was restored.

Only 30 banks permit e-payment
of taxes. What about those deductors who have their accounts with other banks ?
Many people prefer not to have internet banking, on account of their fear of
fraud.

Under such circumstances, it
would perhaps have been far better to make e-payments and e-filing optional
rather than mandatory. The least that one would expect is to keep such e-payment
or e-filing as simple as possible, so that it is easy to comply with, given the
constraints that we suffer from.

The worst part of the
amendments is the new rule 37BA providing that credit for TDS would be granted
on the basis of the returns filed by tax deductors and reflected in the TIN
system, instead of on the basis of TDS certificates. Today, it is well-known
that on account of various flaws in the system, the credit appearing in the TIN
system rarely reflects more than 50% of the TDS deducted from a taxpayer as
evidenced by TDS certificates. The major culprits for such failure are
nationalised banks and Government Departments, which do not comply with the
requirements or do so incorrectly. There is no provision for a taxpayer to
penalise or force a tax deductor to file his TDS returns correctly. When the tax
authorities, with their powers to penalise and prosecute, have not been able to
enforce proper TDS compliance, how can a mere taxpayer without any powers ensure
this ?

Such a provision amounts to
cheating a taxpayer of the legitimate taxes contributed by him, for no fault of
his. It amounts to expropriation of taxpayers’ money by the Government over and
above the taxes that it has recovered. One understands that even today, a
sizeable amount of taxes paid to the Government has not been credited to
accounts of taxpayers but is lying in suspense, on account of incorrect PAN,
other details, etc., mentioned by tax deductors or banks. The CBDT cannot escape
its responsibility to come out with a better scheme to ensure that every
taxpayer gets credit for all taxes deducted from his income, besides all taxes
paid by him.

Gautam Nayak

 

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E-filing, e-payment and e-TDS — Successful ?

Editorial

The Income Tax Department does not seem to believe in the
proverb ‘Act in haste, repent at leisure’. All its recent actions show that it
believes in introducing new procedures in a hurry without creating the necessary
infrastructure for it, without learning from its past mistakes, and without
regard to the enormous difficulties to taxpayers. It believes that keeping quiet
about the problems caused by premature introduction of such initiatives can
enable it to claim its initiatives to have been a success — forget about
taxpayers who suffer the brunt of such problems !


The new PAN numbers were introduced without the necessary
infrastructure in place, resulting in non-allotment of PAN, mismatched PAN cards
and allotment of multiple PAN numbers.

When e-filing of TDS returns was introduced, along with the
Tax Information Network (TIN), we were informed that all data relating to TDS
and payment of taxes would be captured by the system, doing away with the need
for issue of physical TDS certificates and the need for filing challans along
with the returns of income. The reality, as many taxpayers have found to their
dismay, is that the TIN displays only a part of the tax deducted at source from
their receipts, and that correction of data captured by TIN is an extremely
difficult task. To top it all, their legitimate refunds are held up on account
of such system problems, due to the CBDT insisting that credit for TDS should be
granted only on the basis of the TIN figures, and not on the basis of physical
TDS certificates, as provided by law. Many taxpayers were slapped with huge
demands, instead of the large refunds due to them. A few taxpayers were
fortunate to receive their refunds after approaching the Ombudsman (one such
order is reproduced on page 163).

With e-filing of returns, we were told that this would speed
up the processing of returns and issue of refunds. The reality we find is that
the processing of returns filed for assessment year 2007-08 has barely begun,
though by now, the processing of such returns should have been completed.

We now have a situation where taxpayers who want to file
their TDS returns are told that such returns will not be accepted unless the
returns contain a minimum percentage of PANs of deductees. No groundwork has
been done to ensure that all deductees necessarily obtain and furnish their PANs,
no provisions have been made to enable deductors to force deductees to obtain
and furnish PANs, and yet deductors are prevented from complying with their
statutory obligations ! All this, merely by issue of a press release ! To top it
all, it is highly likely that penalties would be levied on such deductors who
are unable to file their TDS returns for no fault of their own.

As if this were not enough, we now have mandatory e-payment
of taxes for certain categories of taxpayers from 1st April 2008, for corporates,
and individuals and partnership firms who were liable to tax audit in the
earlier year. Banks are still unprepared for such large e-payments. It takes at
least 20 days to activate this e-payment facility with most of the banks. Many
banks refuse to open an account if such account is merely intended to be used
for e-payment of taxes. This would in effect force taxpayers to change their
longstanding bankers, though they may be fully satisfied with their services.

One individual taxpayer, who pays advance tax of about Rs.50
lakhs in each instalment, and who approached one of the nationalised banks which
is authorised for such e-payments, was flabbergasted to discover that the bank
would accept e-payment of a maximum amount of Rs 5 lakhs in a day. He is still
trying to figure out how he can make his advance tax payments !

The Society has made a representation regarding the
difficulties being faced by taxpayers in complying with e-payment at such short
notice (reproduced on page 245), but does the Income Tax Department ever heed
any advice or take into account the difficulties of taxpayers? In this
consumer-centric age, should not the voice of taxpayers be heard and respected
by the Income Tax Department, which depends upon taxpayers for all its
revenues ?

One thought that payment of taxes and filing of tax returns
were sacrosanct duties of taxpayers. It however appears that the Income Tax
Department, which is resorting to such initiatives to conceal its own internal
deficiencies and problems, is putting hurdles in the way of taxpayers who wish
to comply with their obligations. A strange situation indeed !

Let us hope that the Income Tax Department realises the need to consult
taxpayers and their representatives, take into account the various difficulties
being faced, provide the necessary infrastructure and enabling legislation, and
then undertake new initiatives. This alone will lead to real success of such
initiatives !

Gautam Nayak

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The issuance of IFRS standards in India

Accounting Standards

The International Financial Reporting Standards (IFRS)
roadmap issued by the Ministry of Corporate Affairs (MCA) stated that the IFRS
standards would be submitted to the MCA by 30 April 2010. It is widely believed
that The Institute of Chartered Accountants of India (ICAI) would facilitate the
notification of the IFRS standards in the Companies Accounting Standard Rules
through the National Advisory Committee on Accounting Standards (NACAS).

As per the roadmap issued by the MCA, there shall be two
separate sets of accounting standards u/s.211(3C) of the Companies Act, 1956.
The first set shall comprise the Indian Accounting Standards which are converged
with the IFRS and apply to the specified class of companies. The second set
shall comprise the existing Indian Accounting Standards and apply only to the
companies not covered in any of the phases of the roadmap or till the date of
applicability of IFRS for companies covered in
later phases.

Under IFRS, there are 29 International Accounting Standards (IAS)
and 9 IFRS, 11 Standing Interpretations Committee (SIC) interpretations and 16
International Financial Reporting Interpretations Committee (IFRIC)
interpretations, a total of 65. At the end of March, more than 40 of these
promulgations were not yet issued by the Institute of Chartered Accountants of
India.

Under the circumstances, corporate entities have raised
questions on how the commitment made in the roadmap can be achieved. More
importantly, entities do not know if they should start preparing for IFRS as
issued by the International Accounting Standards Board (IASB) or there will be
certain changes/exceptions to those standards. If there are changes, what will
those changes be ? Particularly, what is not clear is, whether Indian companies
will be able to use all the options allowed under IFRS or ICAI/MCA shall remove
certain options while adopting IFRS in India. For example, under IFRS, IAS-19
provides a number of alternatives to account for actuarial gains and losses,
such as the corridor approach, full recognition to income statement, full
recognition to reserves instead of the income statement. In India, it may be
possible that some of these alternatives may not be allowed.

The author is not in agreement that the alternative
accounting available under IFRS should be eliminated. This would not provide a
level playing field to Indian entities vis-à-vis international companies which
will have this benefit. It may be noted that Australia introduced IFRS
initially by eliminating multiple alternatives under IFRS. However, at a later
date they realised that this was not workable and reverted back to a full IFRS
providing all the options available under IFRS to Australian companies.

Considering the number of pending standards, there is a clear
need to significantly accelerate the process of issuing the IFRS standards. Any
time provided for public exposure will further delay the issuance of these
standards. Currently issuance and notification of standards happens on a
standard by standard basis. This process, if followed for IFRS, will take a long
time and there is no way that the 30 April deadline would be met. To smoothen
the process, the ICAI/NACAS should expose and notify all standards at one go.


For companies covered by the convergence roadmap, we may mention that it is
more of an operational issue and the ICAI/NACAS/MCA will resolve the  same
in due course. The Indian Government is committed to achieve convergence with
IFRS in  India. Thus, entities should not slow down their conversion
efforts.

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Gaps in GAAP Amendment to AS-11

The Central Government, vide Notification dated 31 March 2009, has amended Accounting Standard (AS) 11 The Effects of Changes in Foreign Exchange Rates, notified under the Companies (Accounting Standard) Rules, 2006. Pursuant to the amendment, a new paragraph has been inserted in AS-11 to allow amortisation/capitalisation of foreign exchange differences arising on long-term monetary items. The amendment has far-reaching consequences, than is apparent on a plain reading.

The option permitted is not in accordance with IAS-21 Effect of Changes in Foreign Exchange Rates. The Institute of Chartered Accountants of India (ICAI) and The Ministry of Corporate Affairs (MCA) have committed to adopt IFRS with effect from April 1, 2011. Availability of the option only till March 31, 2011 clearly reinforces ICAI and MCA commitment towards adopting IFRS by 2011. Companies should take serious note of this, and start preparing for IFRS, given that the IFRS conversion process is a lengthy process.

In Annexure 1, through a simple example, the author has tried to explain the practical application of the amendment when a loan is taken for working capital purposes with regards to (a) retrospective application of the standard, (b) write-off of unamortised balance at 31 March 2011 and (c) the method of amortisation. In Annexure 2, the example remains the same, except that the loan is taken for acquiring fixed assets.

The key salient features are :

1. Exchange differences on monetary items under AS-11 are required to be recognised in the P&L Account. The amendment to AS-11 allows an alternative treatment of amortising/capitalising exchange differences on long-term monetary items.

2. If a company avails the option given in the Notification, it needs to be adopted for all long-term foreign currency monetary items. In other words, cherry picking of monetary items is not permitted.

3. The alternative treatment is optional and has to be exercised in the first reporting period after the date of the Notification. The option once exercised is irrevocable.

4. The alternative treatment applies to exchange differences, i.e., both exchange gains and losses.

5. The Notification is issued by The Ministry of Corporate Affairs (MCA) as per the authority granted under the Companies Act, 1956 which is applicable to companies. For non-corporate entities, such as partnership firms, trusts and HUFs, the ICAI has clarified that the AS-11 amendment would not apply.

6. The exchange differences to the extent falling within paragraph 4(e) of AS-16 would continue to be governed by the said requirements since these do not fall within the purview of AS-11. The option given in the Notification is available only in respect of exchange differences to the extent these are governed under AS-11.

7. If the long-term foreign currency monetary item relates to other than an acquisition of a depreciable capital asset, exchange differences should be accumulated in the ‘Foreign Currency Monetary Item Translation Difference Account’ and amortised over the life of the monetary item but not beyond 31 March 2011. If the monetary item is settled, then exchange differences cannot be carried forward and will need to be recognised immediately.

8. If the long-term foreign currency monetary item relates to acquisition of a depreciable capital asset, exchange differences arising on such monetary items should be added to or deducted from the cost of the asset.

9. Capitalisation of exchange differences as cost of depreciable asset and accumulation of exchange differences in the ‘Foreign Currency Monetary Item Translation Difference Account’ are not two separate options. Thus, if a company decides to capitalise exchange differences on foreign currency loan taken for acquisition of a depreciable capital asset, it would also need to defer the exchange differences to the ‘Foreign Currency Monetary Item Translation Difference Account’ on the foreign currency loan taken for working capital.

10. Schedule VI has been amended to remove the requirement with regard to capitalisation of exchange differences. Henceforth, the requirement with regard to capitalisation of exchange difference will be dealt with only under Accounting Standards notified in the Companies (Accounting Standards) Rules.

11. Unlike pre-revised Schedule VI, the amendment does not make any distinction in respect of fixed assets acquired from outside India or otherwise. Hence the optional treatment in the Notification would have to be applied in respect of all depreciable assets, whether acquired from within or outside India.

12. A company cannot apply this amendment with prospective effect or to accounting periods commencing before 7 December 2006. The Notification is applicable to all accounting periods commencing on or after 7 December 2006. If a company follows financial year, then the Notification would apply to all long-term monetary items that existed on 1 April, 2007 and thereafter. If a company follows calendar year, then the Notification would apply to all long-term monetary items that existed on 1 January, 2007 and thereafter.

13. To the extent the adjustment relates to earlier years (for example 1-4-2007 to 31-03-2008), the same has to be effected through the general reserve account.

14. Companies need to carefully evaluate the impact of current taxes, deferred taxes and impairment. With regards to the retrospective adjustment through the general reserve (effect of earlier years), deferred tax on that component will be adjusted to (a) in the case of a ‘Foreign Currency Monetary Item Translation Difference Account’ to a reserve account, (b) in the case of capitalisation to fixed asset it is less clear, whether the same should be adjusted to the P&L account, reserve account or ignore it as a permanent difference.

15. Networth of company will increase if exchange loss is capitalised in fixed assets and vice-versa. Exchange differences on long-term monetary assets and liabilities accumulated in ‘Foreign Currency Monetary Item Translation Difference Account’ will have no effect on networth of the company when compared to the existing AS-11 requirements.

It may be noted that AS-ll does not deal with derivatives in general, other than forward exchange contractswhich are entered into to hedge assets and liabilities on the balance sheet. AS-l1 also does not cover forward contracts that are entered into to hedge highly probable transactions and firm commitments. The AS-l1 amendment applies to monetary items.Derivatives are not monetary items within the definition of AS-l1. Therefore AS-11 amendment does not apply to derivative accounting; however, because the derivatives are entered into for hedging monetary items, the amendment has significant impact in the way such derivatives are accounted for.

The existing requirements relating to (a)A5-11with regards to forward exchange contracts, (b) Announcement of the ICAI with regards to derivatives in general, (c) AS-30 Financial Instruments: Recognition and Measurement (applicable from 1-4-2009 on recommendatory basis and 1-4-2011on mandatory basis), (d) the fact that AS-30 has not yet been notified in the Companies (Accounting Standards) Rules, and (e) the current amendment to AS-l1 creates a permutation and combination of numerous situations and complexities for which there may be no answer in current Indian GAAP literature other than by conjecture. It is possible that numerous practices would emerge. This was clearly visible in the implementation by companies of the Announcement on Derivatives issued by the ICAL This amendment will only further add to that confusion.

Consider the following situation. Company has entered into an option contract to hedge foreign currency loan liability of USD 100 taken for operations. As per the amendment, exchange difference on long-term loan liability for working capital purpose should be accumulated in Foreign Currency Monetary Item Difference Account. The following accounting treatments are theoretically possible for the option contract:

a) Account for mark-to-market losses on the option contract in the profit and loss account disregarding accounting for exchange differences on the underlying hedged item. Gains, if any, may be ignored.

b) Alternatively, gains on the option contracts may be recognised if the company can demonstrate that it is complying with AS-30 principles, to the extent possible.

c) If option is an effective hedge, adjust mark-to-market changes on option contract with exchange difference on underlying loan and account for net exchange difference on loans in Foreign Currency Monetary Item Difference Account. If there is net MTM gain, then it may be ignored.

d) The treatment in (c) above could also be used for an ineffective hedge, provided it is reasonably an economic hedge.

e) The same as scenario (c), but company may recognise net MTM gains on option contract in Reserve account if the company is following principles of AS-30 for derivative contracts.

Annexure  1

How are exchange differences accumulated in the ‘Foreign Currency Monetary Item Translation Difference Account’ amortised? Consider the following scenario:

i) FXLimited’s financial year ends on 31 March.

ii) On 1 April 2006,FXhas taken foreign currency loan amounting to Euro 300,000,for use in the working capital.

iii) The loan is repayable after 6 years, i.e., on 31 March 2012.

iv) Given in a table at the top of the next column, is the amount of exchange gain/ loss arising on the loan at each reporting date

v) FX has decided to amortise exchange differences as per the option given in the Notification.

Response

In respect of exchange differences arising on restatement of long-term monetary items not pertaining to acquisition of depreciable capital assets, the Notification provides that the same should be accumulated in the ‘Foreign Currency Monetary Item Translation DifferenceAccount’ and amortised over the remaining lifeof the loan but not beyond 31 March 2011.As per the Notification, the amendment is applicable retrospectively in respect of accounting periods commencing on or after 7 December 2006. Thus, the company would adopt the following treatment:

i) Exchange difference arising during the year ended 31 March 2007 continues to be recognised in the P&L. No retrospective adjustment is allowed for these differences.

ii) FXneeds to retrospectively adjust the amount of exchange loss recognised in the year ended 31 March 2008. The amount of retrospective’ adjustment is computed as below:

iii) FX would determine amount to be amortised in each of subsequent years as shown in the table appearing at top on the following page.

The amortisation is based on the remaining life of the loan and period to 31 March 2011, whichever is earlier. In this case,31March2011 is earlier; thus amortisation is one-third, one-half and one for years ending 31 March 2009, 31 March 2010 and 31 March 2011, respectively.

iv) No exchange differences can be carried beyond 31 March 2011 and exchange differences arising in the year ended 31 March 2012 need to be recognised immediately. In any case, FX should have adopted IFRS from 1 April 2011 and application of IAS-21 would also require exchange differences on monetary items to be recognised immediately.

An interesting observation is that since the amendment has a retrospective effect, previous exchange differences that were recognised in profit or loss would be transferred to the ‘Foreign Currency Monetary Item Translation Difference Account’ through general reserve. As this account is amortised to profit or loss of FX, there would be a double recording of the exchange difference in the profit or loss; once in previous years’ profit or loss and once going ahead by way of amortisation in future profit or loss.

Note 1

There can be various methods of determining amortisation. For example, one may argue on the following possible methods of amortisation:

i) The loan repayment is after 5 years from the date of retrospective application, i.e., 1 April 2007. Thus, amortisation for the year ended 31 March 200S is 1/ 5th of the exchange differences for the year. Since the Notification does not allow carry forward beyond 31 March 2011, any amount remaining at 31 March 2011 is written off at the said date.

ii) Year ended 31 March 200S is the 2nd year of the loan and the total period of the loan is 6 years. Thus, appropriate amortisation for the year is 2/ 6th of exchange differences for the year ended 31 March 200S.

iii) Year ended 31 March 200S is the 2nd year of the loan and the Notification allows carry forward only up to 31 March 2011. Thus, appropriate amortisation for the year is 2/5th of exchange differences for the year ended 31 March 200S.

iv) As per the Notification, FX can apply the amendment from 1 April 2007 and it is allowed to amortise exchange differences arising on the loan up to 31 March 2011. Thus, maximum deferral period for exchange differences arising and accumulated on the loan during the year ended 31 March 200S is 4 years. Accordingly, 1/4th of exchange differences is appropriate amortisation for the exchange differences.

The author is of the view that method (iv) is the most appropriate method for amortising exchange differences. Thus, the calculation is based on this method.

Annexure    2

Capitalisation of Exchange Difference

Consider the following scenario:

i) FX Limited’s  financial  year ends  on 31 March.

ii) On 1 April 2006, FX has taken foreign currency loan amounting to Euro 300,000, for acquiring plant. At the date of loan, exchange rate was Euro 1 = INR 60.

iii) FX purchased the plant amounting to INR lS,OOO,OOOusing loan amount.

iv) The useful life of the plant is 10 years and depreciation is based on the straight-line method. The loan is repayable after 6 years, i.e., on 31 March 2012.

v) Given at top on the next page in a table is the amount of exchange gain/ loss arising on the loan at each reporting date

vi) FX has decided to capitalise exchange differences as per the option given in the Notification.

Response
In respect of exchange differences arising on restatement of long-term monetary items pertaining to acquisition of depreciable capital assets, the Notification provides that the same should be adjusted to the cost of the asset and should be depreciated over the balance life of the asset (as against the life of the loan). As per the Notification, the amendment is applicable retrospectively in respect of accounting periods commencing on or after 7 December 2006. Thus, the company would adopt the following treatment:

(i) Exchange difference arising during the year ended 31 March 2007 continues to be recognised. No retrospective adjustment is required/ allowed for these differences.

(ii) FXneeds to retrospectively adjust the amount of exchange loss recognised in the year ended 31 March 2008. For exchange differences capitalised in a year, it is assumed that the same arises evenly during the year. Accordingly, the company charges 50% depreciation on such addition. On this basis, the amount to be capitalised for previous periods is determined as shown in the table alongside.

(iii) FX passes the following entry to apply the option retrospectively (at 1 April 2008)

Debit Plant INR…………….. 850,000
Credit General Reserve……………. INR 850,000

(iv) For subsequent years, FX determines capitalisation and depreciation as shown in the table below:

(v) Exchange differences arising in the year ended 31 March 2012 need to be recognised as income/ expense immediately and cannot be capitalised. In any case, FX should have adopted IFRS from 1 April 2011 and application of IAS-21 would also require exchange differences on monetary items to be recognised immediately. Also, carrying amount of plant would be determined based on IAS-16/ IFRS 1 principles.

Straight-lining of Lease

Business Combinations under IFRS

New Page 1As mergers and
acquisitions are fairly common nowadays and accounting implications significant,
there has been considerable focus and debate on how business combinations are
accounted for. Theoretically there are two methods, the pooling method and the
purchase method. The pooling method is applied when two business equals combine
into a new entity, with no acquirer being clearly identified. The purchase
method is applied when an acquirer is clearly identified in a business
combination. It may be noted that pooling is allowed only if certain conditions
indicating the merger of equals is fulfilled.

Under the pooling method the excess of consideration for
acquisition over the book value of the assets acquired is adjusted against
reserves, since the underlying transaction is a get-together of two enterprises
and consequently there is no goodwill to be recorded as an asset. Whereas under
the purchase method the consideration paid over and above the fair value of the
net assets acquired is captured as goodwill, which going forward is
tested for impairment. Under the purchase method, all identifiable assets
and liabilities are fair valued, irrespective of whether those
assets/liabilities were recorded or not in the books of the acquiree.

IFRS 3 — Business Combinations now prohibits pooling
method, since permitting two methods vitiated comparability and created
incentives for structuring business combinations to qualify for pooling, and
achieve the desired accounting objective, given that the two methods produced
quite different results. Besides in the real world it is improbable that there
would be combination of business equals with the acquirer not being
identifiable. Therefore, IFRS 3 now allows only the purchase method. With the
abolition of pooling method, there is no more incentive under IFRS to structure
deals, so as to qualify for the pooling method.


Fair value accounting under IFRS 3 reflects the true
value of an acquisition and the premium paid, i.e., goodwill. Going ahead
it would also result in an appropriate depreciation/amortisation of assets
acquired, since the fair value rather than book value of the assets would be
depreciated. It results in greater transparency and management responsibility
for the acquisition and the price paid to acquire the business. Any future
impairment of acquisition goodwill will put to question the appropriateness of
management’s decision to acquire the business.

Considerable judgment will be called for in applying IFRS 3,
including the identification and valuation of intangible assets and contingent
liabilities. Unfortunately, IFRS 3 provides limited guidance on determining fair
value of assets and liabilities acquired. There exists some guidance that
valuation report should be taken.

An interesting point to note is that IFRS 3
prohibits amortisation of goodwill and requires goodwill to be
tested only for impairment. Amortisation of goodwill results in an
even spread of charge to the income statement over several years; contrarily, a
huge one-off impairment charge on impairment of goodwill, as required by IFRS 3,
will bring in substantial volatility to the income statement.

Under Indian GAAP, there is no comprehensive standard dealing
with business combinations. In fact there are as many as six standards that deal
with various types of business combinations and accounting for goodwill. Many of
these requirements are disparate and inconsistent, for example, goodwill
resulting from an amalgamation has to be compulsorily amortised over not more
than 5 years, whereas there is no compulsion to amortise goodwill on acquisition
of a subsidiary. Another example is that acquisition accounting in the case of
acquisition of a subsidiary or an associate is based on book values, whereas
amalgamation other than which fulfil pooling conditions, can be accounted either
using book values or fair values of net assets acquired.

As stated above, acquisition accounting of sub-sidiaries,
associates and joint ventures under Indian GAAP is based on book values rather
than fair values. Unlike Indian GAAP, IFRS 3 requires assets and liabilities
acquired, including contingent liabilities, to be recorded at fair value.
Contingent liabilities are not recorded as liabilities under Indian GAAP.
Contingent liabilities are fair valued and recorded under IFRS in an
acquisition, since the consideration paid for a business by an acquirer is also
influenced by the nature and quantum of contingent liabilities of the acquiree.
For reasons mentioned above, goodwill determined under Indian GAAP is a plug-in
number, unrealistic and of little use in analysing the business combination.

IFRS 3 requires all Business Combinations (excludes common
control transactions) within its scope to be accounted as per purchase method
and prohibits pooling method. Indian GAAP permits both purchase method and
pooling of interest method, in the case of amalgamations. Pooling of interest
method is allowed only if the amalgamation satisfies certain specified
conditions.

In IFRS 3, acquisition accounting is based on substance.
Reverse acquisition under IFRS is accounted assuming the legal acquirer is the
acquiree. For example, a big private limited company to seek quick listing may
be legally acquired by a small listed company. Under IFRS, the private company
would be treated as an acquirer though legally it was acquired by the listed
company. In Indian GAAP, acquisition accounting is based on legal
form and in the above example the listed company would be treated as an
acquirer.

Business combination accounting under Indian GAAP is outdated
and does not reflect the underlying substance and the true premium paid for an
acquisition. Because of the inconsistent and disparate requirements across
various standards, it provides incentives for deal structuring. It is high time
that IFRS 3 is adopted in India without waiting for 2011.

levitra

Tax Deduction at Source u/s.195

Controversies

1. Issue for consideration :


1.1 S. 195 of the Income-tax Act provides for tax deduction
at source from payment of interest or any other sum chargeable under the
provisions of the Income-tax Act (other than salaries or dividend specified in
S190) to a non-resident or a foreign company at the prescribed time at the rates
in force.

1.2 U/s.195(2), where the payer considers that the whole of
such sum so payable to a non-resident would not be income chargeable of the
recipient, he can make an application to the Assessing Officer to determine the
appropriate proportion of such sum chargeable to tax, and thereupon shall deduct
tax u/s.195(1) only on that proportion of the sum chargeable to tax. Similarly,
sections 195(3) and 197 provide for the payee making an application to the
Assessing Officer for issue of a certificate that income-tax may be deducted at
lower rates of tax or not deducted on payment to be received by him, where such
lower rate or non-deduction is justified.

1.3 The issue has arisen before the courts as to whether, in
a case where the payment to the non-resident or a foreign company does not
comprise any income chargeable to tax in India at all (for example, in case of
payment for purchase of goods imported from the non-resident), whether the payer
has necessarily to apply to the tax authorities for a certificate u/s.195(2) or
whether the payment can be made to such non-resident or foreign company without
any deduction of tax at source, and without obtaining any such certificate
u/s.195(2) or u/s.195(3) or u/s.197.

1.4 While the Karnataka High Court has taken the view that it
is mandatory to obtain such a certificate from the tax authorities, the Delhi
High Court has taken a contrary view that in such cases, the payer can make the
payment without the need for such certificate.

2. Samsung Electronics’ case :


2.1 The issue came up before the Karnataka High Court in the
case of CIT v. Samsung Electronics Co. Ltd., 320 ITR 209. Various other appeals
of different resident payers were also decided vide this judgment.

2.2 In this case, the assessee payer was a branch of a Korean
company engaged in the development, manufacture and export of software for use
by its parent company. The software developed by it was for in-house use by the
parent company. During the relevant years, the assessee imported ready-made
software products from US and French companies for its own use. It did not
deduct tax at source from payments made to the US and French companies on the
ground that the payment to the foreign companies was for purchase of products,
and was not in the nature of royalty, and was not chargeable to tax in India.

2.3 The Assessing Officer held that the payment was in the
nature of royalty, that the assessee was bound to deduct tax at source on the
payments, and accordingly treated the assessee as an assessee in default
u/s.201(1), and also levied interest u/s.201(1A). The Commissioner (Appeals)
dismissed the assessee’s appeals against this order.

2.4 The Tribunal held that the payment was not in the nature
of royalty in terms of the relevant provisions of the Double Taxation Avoidance
Agreements. It also held that it was not incumbent on the assessee to deduct any
amount u/s.195.

2.5 Before the Karnataka High Court, it was argued on behalf
of the Department that the payment was in the nature of royalty on which tax was
required to be deducted at source u/s.195. It was argued that the transaction
was a licence and was therefore in the nature of royalty. It was further claimed
that the assessee was bound to deduct tax u/s.195 and that it could not contend
that it was not the income of the recipient. Reliance was placed on the decision
of the Supreme Court in the case of Transmission Corporation of A.P. Ltd. v.
CIT, 239 ITR 587.

2.6 It was argued by the assessee that the nature of payment
was not royalty even u/s.9(1)(vi), on account of the fact that the non-resident
supplier had merely sold a copyrighted article and not the copyright itself,
relying on the decision of the Supreme Court in the case of Tata Consultancy
Services v. State of Andhra Pradesh, 271 ITR 401. It was therefore claimed that
the payment was for purchase of articles/goods in connection with the business
carried on by the assessee. It was further claimed that under the Double
Taxation Avoidance Agreements, since the non-resident recipients had no
permanent establishments in India, the entire income of the non-residents
attributable to the payments was not taxable in India. It was therefore claimed
that there was no obligation on the part of the payer to deduct any amount.

2.7 It was also contended by the other assessees that there
was no obligation on their part to deduct any amount from the payments, as they
were fully and bona fide satisfied that the amount was not taxable in the hands
of the non-resident in India. They had therefore not chosen to apply for any
relief or concession in terms of S. 195(2) and (3). It was further argued that
the words used in S. 195 are ‘chargeable to tax’ and hence a person deducting
tax u/s.195 would have to necessarily first see whether the same was chargeable
to tax and then only, if it was so chargeable, he was to deduct tax. It was
contended that if a person was not liable to be charged to tax, then the payer
could not be held to be a person in default u/s.201.

2.8 The Karnataka High Court considered the decision of the
Supreme Court in Transmission Corporation of AP’s case (supra) and of the
Calcutta High Court in P. C. Ray & Co. (India) Private Limited v. ITO, 36 ITR
365, wherein the Calcutta High Court had held that if the term ‘chargeable under
the provisions of this Act’ means actually liable to be assessed to tax, in
other words, if the sum contemplated was taxable income, a difficulty is
undoubtedly created as to complying with the provisions of the Section.’ The
High Court in that case had held that what was contemplated was not merely
amounts, the whole of which were taxable without deduction, but amounts of a
mixed composition, a part of which only might turn out to be taxable income as
well; and the disbursements, which were of the nature of gross revenue receipts,
were yet sums chargeable under the provisions of the Income-tax Act and came
within the ambit of the Section.

2.9 The Karnataka High Court therefore rejected the arguments
of the assessees that the expression ‘any other sum chargeable under the
provisions of this Act’ would not include cases where any sum payable to
non-resident was trading receipts, which may or may not include ‘pure income’.
According to the Karnataka High Court, the language of S. 195(1) was clear and
unambiguous and cast an obligation to deduct appropriate tax at the rates in
force.

2.10 The Karnataka High Court observed that S. 195 was not a charging Section, nor a Section providing for determination of the tax liability of the non-resident receiving the payments from the resident. The amount deducted by the resident was only a provisional tentative amount, which was kept as a buffer for adjusting this amount against the possible tax liability of the non-resident. Deduction of the amount u/s.195 was not the same as determination of the liability of the non-resident, who may be or may not be liable to pay any tax. Determination of tax liability could only be on the basis of the return of income filed by the non-resident. According to the Karnataka High Court, the only scope and manner of reducing the obligation for deduction imposed on a resident payer in terms of S. 195(1) was by the method of invoking the procedure u/s.195(2) of making an application to the Assessing Officer to determine by general or special order the appropriate proportion of such sum so chargeable, and upon such determination alone, being allowed the liberty of deducting the proportionate sum so chargeable to tax to fulfil the obligations u/s.195(1).

2.11 The Karnataka High Court therefore held that in the absence of an application u/s.195(2), the payer was obliged to deduct tax at source u/s. 195(1), even though the payment did not contain any element of income of the non-resident chargeable to tax in India.

    Van Oord’s case :

3.1 The issue again recently came up before the Delhi High Court in the case of Van Oord ACZ India (P) Ltd. v. CIT, (unreported — ITA No. 439 of 2008 dated 15th March 2010, available on www.itatonline.org).

3.2 In this case, the assessee was an Indian subsidiary of a Netherlands company, and was engaged in the business of dredging, contracting, reclamation and marine activities. During the relevant year, the assessee reimbursed mobilisation and demo-bilisation cost to its parent company. This cost related essentially to transportation of dredger, survey equipment and other plant and machinery from countries outside India to the site in India and the transportation of such plant and machinery on com-pletion of the contract, including fuel cost incurred on transportation. These services were contacted by the parent company and were provided by vari-ous non-resident entities. The assessee reimbursed such cost to the parent company on the basis of invoices received by the parent company from the non-resident entities.

3.3 The assessee filed an application to the As-sessing Officer for issue of nil tax withholding certificate in respect of reimbursement of various costs to the parent company. The Assessing Officer issued a certificate of deduction of tax at source at 11%, and the assessee deducted tax at source accordingly on Rs.6.98 crore. In the course of assessment proceedings, the Assessing Officer disallowed payments of Rs.8.66 crore made to the parent company u/s.40(a) (i), on the ground that the assessee had defaulted in deducting tax at source u/s.195.

3.4 The Commissioner (Appeals) upheld the disal-lowance made by the Assessing Officer. The Tribu-nal confirmed the addition, stating that the asses-see was mandatorily liable to deduct tax at source u/s.195, and that it was not necessary to determine whether such payment was chargeable to tax in In-dia in the hands of the non-resident. The Tribunal further held that the assessee was a dependent agent permanent establishment of the parent foreign company and therefore the reimbursement of expenses to the foreign parent company was to be subjected to tax.

3.5 Before the Delhi High Court, it was argued on behalf of the assessee that the amount reimbursed to the parent company was not chargeable to tax in India in the hands of the parent company, and that the assessee was consequently not liable to deduct tax at source u/s.195. It was argued that the obligation to deduct tax at source u/s.195 was predicated on the condition that tax was payable by the non-resident on the payments received by it, and once it was established that no such tax was payable by the non-resident, the assessee could not be treated to be in breach of its obligations.

3.6 It was pointed out that the reason for fastening the obligation to deduct tax at source of the payment to non-resident only in a situation where such payment was chargeable to tax in India was that it was not the intention of the law to fasten an absolute liability on the remitter to deduct tax at source from the payment to the non-resident, and then subject the non-resident to the rigorous process of filing return and seeking refund and assessment on the basis of such return. Where the remitter was of the opinion that some part of the income may be chargeable to tax in India, the remitter could approach the Assessing Officer to determine the ap-propriate portion of the income that would be sub-ject to tax in India and the rate on which tax was to be deducted at source. Reliance was placed on the observations of the Supreme Court in the case of Transmission Corporation of AP Ltd. (supra) and various other cases for the proposition that the obligation to deduct tax at source is triggered only when the payment to be made to the non-resident is chargeable to tax in India in the hands of the non-resident recipient.

3.7 On behalf of the Department, it was argued that S. 195 only determines the proportion of liability and presupposes the existence of liability. It was pointed out that the assessee itself had applied for determination of extent of liability. The statutory obligation of the assessee with regard to deduct tax at source was fully crystallised, and therefore there was no justification on the part of the assessee not to deduct tax at source, particularly when the order passed u/s.195(2) had attained finality.

3.8 The Delhi High Court noted that the issue before the Supreme Court in the case of Transmission Corporation of AP (supra) was whether tax at source was to be deducted by the payee on the entire amount paid by it to the recipient or whether it was to be deducted only on the component of pure income profits. It was therefore in the context of whether tax deductible was to be on the gross sum of trading receipts paid to non-residents or whether only on the income component. It was in that context that the Supreme Court held that “any other sum chargeable under the provision of this Act” would include the entire amount paid by the assessee to non-residents. The observations of the Supreme Court therefore needed to be read in that context. The Delhi High Court noted that the Su-preme Court was not concerned in that case with a situation where no tax in the hands of the recipient was payable at all. The Delhi High Court noted that certain observations in the judgment clearly depicted the mind of the Supreme Court that liability to deduct tax at source arose only when the sum paid to the non-resident was chargeable to tax. Once that is chargeable to tax, it was not for the assessee to find out how much of the amount of the receipts was chargeable to tax, but it was its obligation to deduct tax at source on the entire sum paid by the assessee to the recipient.

3.9 The Delhi High Court relied on certain other decisions of the High Courts, including that of the Delhi High Court in the case of CIT v. Estel Communications (P) Ltd., 217 CTR 102 and the Karnataka High Court in the case of Jindal Thermal Power Company Limited v. Dy. CIT, 182 Taxman 252, where Courts had taken the view that there was no obligation to deduct tax at source since there was no tax liabil-ity of the non-resident in India. The Delhi High Court noted the decision of the Karnataka High Court in the case of Samsung Electronic Co. Ltd. (supra), and observed that the context in that case was different. The Delhi High Court expressed its disagreement with some of the observations made in that judgment of the Karnataka High Court.

3.10 The Delhi High Court therefore held that the obligation to deduct tax at source arises only when the payment was chargeable under the provisions of the Income-tax Act. The Delhi High Court noted that in the case before it, the income-tax authorities had accepted that the foreign company was not liable to pay any tax in India by accepting the foreign company’s tax return u/s.143(1) and refunding the tax deducted at source. Therefore, the assessee could not be regarded as having defaulted in deduction of TDS u/s.195.

    Observations :

4.1 This issue was also again very recently considered by the Special Bench of the Income-tax Appellate Tribunal at Chennai, in the case of ITO v. Prasad Production Ltd., (ITA No. 663/Mds/2003, dated 9th April 2010 — unreported, available on www.itatonline.org).

4.2 The Tribunal in this case considered the decision of the Karnataka High Court in Samsung’s case (supra) as well as that of the Supreme Court in the case of Transmission Corporation of AP (supra). The Tribunal noted that both the Department as well as the assessee were relying upon the Supreme Court decision in the case of Transmission Corporation of AP. It therefore focussed on the observations in that judgment. It noted the provisions of the follow-ing paragraph on page 588 :

“The consideration would be — whether payment of the sum to the non-resident is chargeable to tax under the provisions of the Act or not ? That sum may be income or income hidden or otherwise embedded therein. If so, tax is required to be deducted on the said sum, what would be the income is to be computed on the basis of various provisions of the Act including provisions for computation of the business income, if the payment is a trade receipt. However, what is to be deducted is income-tax pay-able thereon at the rates in force. Under the Act, total income for the previous year would become chargeable to tax u/s.4. Ss.(2) of S. 4, inter alia, provides that in respect of income chargeable U/ss.(1), income-tax shall be deducted at source where it is so deductible under any provision of the Act. If the sum that is to be paid to the non-resident is charge-able to tax, tax is required to be deducted.”

4.3 The Tribunal also noted the observations of the Supreme Court in the case of Eli Lilly & Co., 312 ITR 225, as under :

“To answer the contention herein we need to examine briefly the scheme of the 1961 Act. S. 4 is the charging Section. U/s.4(1), total income for the previous year is chargeable to tax. S. 4(2), inter alia, provides that in respect of income chargeable U/ss.(1), income-tax shall be deducted at source whether it is so deductible under any provision of the 1961 Act which, inter alia, brings in the TDS provisions contained in Chapter XVII-B. In fact, if a particular income falls outside S. 4(1), then the TDS provisions cannot come in.”

4.4 From these two decisions of the Supreme Court, the Tribunal concluded that it was abundantly clear that the charging provisions could not be divorced from the TDS provisions, and that S. 195 would be applicable only if the payment made to the non-resident was chargeable to tax.

4.5 The Tribunal also noted the material difference between the provisions of Ss.(2) and Ss.(3) of S. 195. U/ss.(2), the payer made the application for deduction of tax at lower rates. U/ss.(3), the payee could make an application for deduction of tax at lower rate or without deduction of tax. According to the Tribunal, the reason for such difference was that where the payer had a bona fide belief that no part of the payment bore income character, S. 195(1) itself would be inapplicable and hence there would be no question of going into the procedure prescribed in S. 195(2). Ss.(3) deals with a situation where the payer wants to deduct tax from the payment, but the payee believed that he was not chargeable to tax in respect of that payment. Hence the payee was given an opportunity to seek approv-al of the Assessing Officer to receive the payment without deduction of tax.

4.6 The Tribunal interestingly observed that by deciding whether the payment bore any income character or not, the payer was not determining the tax liability of the total income of the payee, but merely considering the chargeability in respect of the payment that he was making to the payee.

4.7 The tribunal also considered the fact that for the purposes of remittances to non-residents, a chartered accountant’s certificate was prescribed as an alternative to the procedure u/s.195(2). This was evident from the CBDT Circular 767, dated 22-5-1998. It noted that the certification covered all types of payment, whether purely capital or revenue in nature, but exempt either under the act or the relevant Double Taxation Avoidance Agreement or payments bearing pure income character. The Tribunal held that the new format of the CA certificate clearly established the legal position of S. 195 that the payer need not undergo the procedure of S. 195 at all if he was of the bona fide belief that no part of the payment was chargeable to tax in India.

4.8 The Tribunal therefore held that if the asses-see had not applied to the Assessing Officer u/s. 195(2) for deduction of tax at a lower or nil rate of tax under a bona fide belief that no part of the payment made to the non-resident was chargeable to tax, then he was not under any statutory obligation to deduct tax at source on any part of the payment.

4.9 When one looks at the provisions of S. 195(1), the language is clear that it applies only to income chargeable to tax, and not to other items at all. As analysed by the Special Bench of the Tribunal, the Karnataka High Court seems to have misapplied the ratio of the decision of the Supreme Court in Transmission Corporation of AP. The better view seems to be that of the Delhi High Court and that of the Special Bench of the Tribunal that if the income is not chargeable to tax in India in the hands of the non-resident recipient, the payer need not obtain a certificate u/s.195(2) for not deducting tax at source.

4.10 In any case, an appeal to the Supreme Court against the decision of the Karnataka High Court has been admitted by the Supreme Court and has been fixed for hearing on 18th August 2010, on which date one hopes that this controversy will ultimately be laid to rest.

PF Payments u/s.43B —Retrospectivity of Amendment

1. Issue for Consideration :

    1.1 S.43B of the Income-tax Act provides that certain expenditures, which would otherwise have been allowable as deductions in computing the total income under the Income-tax Act, shall be allowed as deduction only in the year of actual payment of such items by the assessee notwithstanding the method of accounting followed by the assessee. These expenditures are listed in clauses (a) to (f) of the said Section Clause (b) of the said Section refers to the sums payable by an employer by way of contribution to any Provident Fund, Superannuation Fund, Gratuity Fund, or any other fund for the welfare of employees (‘welfare dues’). Accordingly, the deduction of welfare dues is allowed only where payment of such expenditure is actually made.

    1.2 Till assessment year 2003-04, the second proviso to S.43B provided that no deduction of welfare dues covered by the said clause (b) would be allowed unless such sum had actually been paid on or before the due date as defined in the Explanation to S.36(1)(va), i.e., the due date for payment of such welfare dues under the relevant applicable law. From assessment year 2004-05, the second proviso to S.43B has been omitted, and welfare dues covered by clause (b) were brought into the purview of the first proviso, which provides that the disallowance would not operate if the sums are paid on or before the due date of filing of the Income-tax return of the year in which the liability to pay such sum was incurred, and proof of such payment was furnished along with the return.

    1.3 A dispute has arisen as to whether this amendment was applicable to all pending matters, and therefore applied retrospectively, or whether it applied prospectively from assessment year 2004-05 onwards. While the Bombay High Court has held that the amendment would apply prospectively, the Delhi and Madras High Courts have taken the view that the amendment applied retrospectively.

2. Godaveri (Mannar) Sahakari Sakhar Karkhana’s case :

    2.1 The issue came up before the Bombay High Court in the case of CIT vs. Godaveri (Mannar) Sahakari Sakhar Karkhana Ltd. 298 ITR 149.

    2.2 In this case, pertaining to assessment years 1991-92 and 1994-95, the assessee had made payments of provident fund dues before the due date of filing of its return of income, but beyond the due date stipulated under the Provident Fund Act. The amounts had been disallowed by the Assessing Officer, but the assessee’s appeal against such disallowance had been allowed by the Commissioner (Appeals). The Tribunal had also upheld the order of the Commissioner (Appeals).

    2.3 Before the Bombay High Court, it was argued on behalf of the Revenue that the deletion of the second proviso to S.43B with effect from 1st April 2004 only meant that the relaxation in S.43B, insofar as employer’s contribution was concerned, would be governed by the first proviso to S.43B from 1st April 2004 only.

    2.4 On behalf of the assessee, it was submitted that the amendment was curative and was resorted to for the purpose of removing the hardship caused by the second proviso. A similar amendment had been made in relation to clause (a) relating to tax, duty, cess and fees earlier, and in relation to such amendment, the Supreme Court, in the case of Allied Motors (P) Ltd. vs. CIT 224 ITR 677, had held the amendment to be curative and retrospective. It was argued that the proviso which was inserted to remedy the unintended consequences and to make the provision workable, the proviso which supplied an obvious omission in the Section and was required to be read into the Section to give the Section a reasonable interpretation, was required to be treated as retrospective in operation, so that a reasonable interpretation could be given to the Section as a whole.

    2.5 The Bombay High Court went through the history of S.43B and the amendments carried out to it from time to time. It analysed the decision of the Supreme Court in Allied Motors case. It noted that when the two provisos to S.43 B were added, payments under clause (b) and payments under other clauses of S.43B were treated as two different classes. The Finance Act, 1989 substituted the second proviso, noting certain hardships that were being occasioned by the operation of that proviso. The Bombay High Court noted that, in its wisdom, the Parliament chose not to delete the second proviso but substituted it, and therefore intended that S.43B(b) should be treated as a class by itself distinct from the other sub-Sections. The second proviso was omitted based on the recommendations of the Kelkar Committee Report, which responded to representation by trade and industry that the delayed payment of statutory liability related to labour should be accorded the same treatment as the delayed payment of taxes and interest.

    2.6 The Bombay High Court noted the decision of the Madras High Court in CIT vs. Synergy Financial Exchange Ltd., 288 ITR 366, where the Madras High Court held that the amendment was not retrospective, on the basis that fiscal legislation imposing liability is generally governed by normal presumption that it is not retrospective and that in interpreting the statute, the Courts, in the first instance, have to consider the plain written language of the statute. If on so reading, it is not possible to give effect to the intent of the Parliament, then the Courts resort to purposeful interpretation to give effect to that intent. The Bombay High Court also (inadvertently) noted the decision of the Assam High Court in George Williamson (Assam) Ltd. vs. CIT, 284 ITR 619 as rejecting the contention that the amendment should be read as retrospective, though the Assam High Court in that case upheld the contention of the assessee for allowing deduction for the payments on or before the due date of filing of the return of income.

2.7 The Bombay High Court noted that the amendment was made applicable from the assessment year 2004-05. It observed that in interpreting statutory provisions, the Court also considered the mischief rule, namely, what was the state of law before the act or the amendment, and what was the mischief that the Act or the amendment sought to avoid. From the normal aids to construction, the Court observed that the only mischief that the amendment if at all sought to obviate was the need to eliminate the procedural complexities, reduce paperwork, simplify tax administration and to enhance efficiency and also integrate such tax proposals as the system could at present absorb, and acceptance of the representations made by trade and industry that they should not be denied the benefit of deductions on account of delayed payment of taxes and interest.

2.8 According to the Bombay High Court, the law as it stood earlier was that in relation to the employer’s contribution to provident fund, if it was not paid within the due date, was not eligible for deduction. According to the High Court, this position had been remedied, and the remedial measure had been made applicable from assessment year 2004-05. The Bombay High Court therefore took the view that it could not be said that the amendment was retrospective.

2.9 Subsequent to this decision of the Bombay High Court, the decision of the Assam High Court in George Williamson’s case went up to the Supreme Court in a special leave petition as CIT vs. Vinay Cement Ltd. 213 CTR 268. In a short five-line order, the Supreme Court noted that they were concerned with the law as it stood prior to the amendment of Section 43 B, that in the circumstances the assessee was entitled to claim the benefit under Section 43 B for that period, particularly in view of the fact that he had contributed to Provident Fund before filing of the return, and dismissed the special leave petition.

2.10 Subsequent to this decision of the Supreme Court, the matter again came up before the Bombay High Court in the case of CIT vs. Pamwi Tissues Ltd. 215 CTR 150, relating to assessment year 1990-91.In this case, when the attention of the Bombay High Court was drawn to the dismissal of the special leave petition by the Supreme Court in Vinay Cement’s case, it observed that the dismissal of the special leave petition by the Supreme Court cannot be said to be the law decided. According to the Bombay High Court, for a judgment to be a precedent, it must contain the three basic postulates – a finding of material facts, direct and inferential, statements of the principles of law applicable to the legal problems disclosed by the facts, and judgment based on the individual effect of the above. The Bombay High Court therefore followed its earlier decision in the case of Godaveri (Mannar) Sahakari Sakhar Karkhana, holding that Provident Fund payment made after the due date under the PF Act but before the due date of filing of the return of income, were not allowable.

3. Nexus Computer’s    case:

3.1 The issue again recently came up before the Madras High Court in the case of CIT vs. Nexus Computer (P) Ltd., 177 Taxman 202.

3.2 In this case pertaining to assessment year 2000-01, the attention of the Madras High Court was drawn by the Revenue to its earlier decision in the case of Synergy Financial Exchange (Supra), wherein it had held that the amendment was not retrospective, and by the assessee, to the decision of the Assam High Court in George Williamson’s case and the dismissal of the special leave petition by the Supreme Court in Vinay Cement’s case.

3.3 The Madras High  Court in that  case (Nexus Computers)noted that the order of the Supreme Court in Vinay Cement’s case was a speaking order, which gave reasons for rejecting the special leave petition, and that the reasoning given in the dismissal of the special leave petition in that case would be binding on it as the law declared by the Apex Court under article 141 of the Constitution. Therefore, the Madras High Court held that the Provident Fund payments would be allowable under Section 43 B.

3.4 The issue also came up before the Delhi High Court in the case of CIT vs. Dharmendra Sharma, 297 ITR 320, in relation to assessment year 2001-02, and in CIT vs. P.M. Electronics Ltd., 177 Taxman 1. The Delhi High Court took note of the decisions of the Madras High Court in Synergy Financial Exchange, the Bombay High Court in Pamwi Tissues, the Supreme Court in dismissing the special leave petition in Vinay Cement’s case, and the Madras High Court in Nexus Computer’s case. The Delhi High Court also observed that judicial discipline required it to follow the view of the Supreme Court in Vinay Cement’s case, and hold the amendment to be retrospective. The Delhi High Court therefore disagreed with the approach adopted by the Bombay High Court in Pamwi Tissues case.

4. Observations:

4.1 The issue of whether the amendment is retrospective in operation or not can be for the time being concluded on examination of the true effect of the Supreme Court order in Vinay Cement’s case, delivered while dismissing the special leave petition. As observed by the Bombay High Court, the question is whether it was a dismissal on merits, laying down a binding precedent. If the decision of the Supreme Court is held to have been delivered on merits, it would be the law of the land and be binding on the Courts; if not, the Courts would be empowered to examine the issue independently.

4.2 As observed by the Supreme Court in the case of Kunhayammed vs. State of Kerala, 119 STC 505 :

“If the order refusing leave to appeal is a speaking order, i.e., gives reasons for refusing the grant of leave, then the order has two implications. Firstly, the statement of law contained in the order is a declaration of law by the Supreme Court within the meaning of article 141 of the Constitution. Secondly, other than a declaration of law, whatever is stated in the order are the findings recorded by the Supreme Court which would bind the parties thereto and also the Court, Tribunal or authority in any proceeding subsequent thereto by way of judicial discipline, the Supreme Court being the Apex Court of the country. But, this does not amount to saying that the order of the Court, Tribunal or authority below has stood merged in the order of the Supreme Court rejecting special leave petition or that the order of the Supreme Court is the only order binding as res judicata in subsequent proceedings between the parties.”

4.3 Reading the order of the Supreme Court in Vinay Cement’s case certainly gives the impression that though the order is short, the Supreme Court has applied its mind to the issue at stake while dismissing the petition, and dismissed it on merits, and not merely on technical grounds or as not maintainable. The order therefore seems to set a binding precedent, which all High Courts ought to have followed.

4.4 Further, it is no doubt true that the operation of the proviso gave rise to absurd situations where large amounts were disallowed on account of trivial delays of a few days, even when there was reasonable cause for making delayed payments of labour welfare dues. It does seem rather harsh to take the view that such disallowance was always intended by the Legislature.

4.5 The better view of the matter is therefore the view of the Delhi and Madras High Courts that the omission of the second proviso to S.43Bis retrospective in operation, and applied to all pending matters as on the date of the amendment.

Capital Gains Account Scheme — Due Date for Deposit

Controversies

1. Issue for consideration :


1.1 An assessee is entitled to exemption for long-term
capital gains arising on transfer of any asset u/s.54F, if he purchases or
constructs a residential house within the stipulated period (one year before or
two years after the date of transfer for purchase, and three years after the
date of transfer for construction). The exemption available is of such amount of
capital gain in the ratio of the cost of the new house to the net sale
consideration on transfer of the assets.

1.2 Ss.(4) of S. 54F provides that the amount of net
consideration, which is not appropriated by the assessee towards the purchase of
the new asset within one year before the date of transfer of the original asset,
or which is not utilised by him for the purchase or construction of the new
asset before the date of furnishing the return of income u/s.139, shall be
deposited by him before furnishing such return into an account with a bank under
the Capital Gains Account Scheme, and utilised in accordance with such scheme.
If this is done, the amount actually utilised by the assessee for the purchase
or construction of the new asset together with the amount so deposited is deemed
to be the cost of the new asset for computing the exemption u/s.54F. In other
words, pending actual utilisation for purchase or construction of the new house,
the amount has to be deposited in the Capital Gains Account Scheme. The amount
deposited under the scheme can be utilised only for the purpose of making
payment for purchase or construction of the new house.

1.3 At times, it may so happen that the assessee fails to
deposit the amount under the Capital Gains Account Scheme before the due date
for filing the return of income u/s.139(1), but actually purchases or constructs
a new residential house before the due date for filing belated return of income
u/s.139(4), i.e., within the stipulated time period of two/three years.
The question that arises in such a case is whether the benefit of the exemption
u/s.54F can yet be availed of by the assessee in spite of such failure.

1.4 While the Delhi Bench of the Tribunal has held that the
assessee is not entitled to the exemption in such a case, the Bangalore Bench of
the Tribunal has held that the assessee can still avail of the benefit of the
exemption if such utilisation is before the due date for filing belated return
of income u/s.139(4).

2. Taranbir Singh Sawhney’s case :


2.1 The issue first came up before the Delhi Bench of the
Tribunal in the case of Taranbir Singh Sawhney v. Dy. CIT, 5 SOT 417.

2.2 In this case, the assessee sold certain shares on 25th
June 1996, and deposited the sale proceeds in his bank account on 3rd August
1996. He purchased a residential house on 1st December 1997, without depositing
any amount under the Capital Gains Account Scheme. Thereafter, the assessee
filed his return of income on 13th November 1998, claiming exemption u/s.54F of
the capital gains on sale of shares on account of property purchased on 1st
December 1997.

2.3 The Assessing Officer denied the claim for exemption
u/s.54F, on the ground that the conditions specified in that Section were not
fulfilled by the assessee, since the assessee did not deposit such consideration
in an account under the Capital Gains Account Scheme pending purchase of a
residential house. According to the Assessing Officer, the date of acquisition
of the new residential property was 1st December 1997, which was after the due
date applicable to the assessee of furnishing his return of income u/s.139(1),
i.e., 30th June 1997. According to the Assessing Officer, the net
consideration was neither appropriated towards the purchase of residential
property before the due date, nor was it deposited in the account under the
Capital Gains Account Scheme before that date, resulting in non-fulfilment of
the conditions prescribed u/s.54F. The AO therefore denied the exemption
u/s.54F.

2.4 Before the Commissioner (Appeals), the assessee submitted
that he had opened an independent bank account for depositing the sale proceeds
for onward investment in a residential property, that the entire sale proceeds
so deposited in his bank ac-count were ultimately used for acquiring residential
property, that this account was only used for the purchase of property, and
therefore, in sum and in substance, he had complied with the provisions of S.
54F. the assessee claimed that not maintaining a bank account under the Capital
Gains Account Scheme was a technical breach, the conditions specified in S. 54 F
having been substantially complied with. The Commissioner (Appeals) rejected the
assessee’s contentions and dismissed the appeal.

2.5 Before the Tribunal, it was argued that the denial of
exemption was done on a mere technical lapse. It was claimed that the sale
proceeds of shares were utilised only for the purpose of investment in the new
house property and not for any other purpose. Though the sale proceeds were not
deposited in a bank account under the Capital Gains Account Scheme 1988, they
were kept in a separate bank account and utilised only for the purpose of
investment in the house property. Accordingly, the assessee had substantially
complied with the conditions specified in S. 54F. It was submitted that the
exemption provisions should be construed liberally, as held by the Supreme Court
in the case of Bajaj Tempo Ltd. v. CIT, 196 ITR 188, and that the
provisions of S. 54F should be construed in the manner to further its objectives
and not to restrain it.

2.6 The Tribunal noted the fact that the appropriation of net
consideration in the house property was not made before the due date of filing
of the return as specified u/s.139(1), and that therefore the net consideration
ought to have been deposited in a bank account under the Capital Gains Account
Scheme, 1988. Since this had not been done, according to the Tribunal, it
disentitled the assessee from exemption. According to the Tribunal, the plea of
the assessee that it was a mere technical breach was not a relevant criterion to
decide the eligibility of the assessee for exemption. The Tribunal also held
that the plea of the assessee that the provisions be construed liberally so as
to further its objectives was not tenable having regard to the clear provisions
of law. The Tribunal therefore rejected the assessee’s claim for exemption
u/s.54F.

3. Nipun Mehrotra’s case :


3.1 The issue again recently came up before the Bangalore
Bench of the Tribunal in the case of Nipun Mehrotra v. ACIT, 110 ITD 520.

3.2 In this case, the assessee sold shares for a total net sale consideration of Rs.11,10,833, out of which Rs.9,00,000 was paid as part consideration for acquisition of a new flat between February 2000 and June 2000. The assessee had earlier paid an amount of Rs.22lakhs to the builder for purchase of the flat between February 1999 and October 1999.A further sum of Rs.4 lakhs was paid on 4th September 2000 and Rs.3,98,000 was paid after September 2000 till March 2001. The assessee accordingly claimed exemption u/ s.54F of the entire capital gains.

3.3 The Assessing Officer considered only the payments made after the sale of shares, and since the assessee had made payments of only Rs.9 lakhs before the due date of filing of the return of income, denied exemption u/ s.54F in respect of net sale consideration of Rs.2,10,833, on the ground that the assessee should have invested this amount in the Capital Gains Account Scheme before the due date of filing the return of income for assessment year 2000-01, i.e., before 31st July 2000.

3.4 The Commissioner (Appeals) confirmed the order of the Assessing Officer, holding that the language of the statute was clear and unambiguous and that, in the name of liberal interpretation, the provisions could not be circumvented.

3.5 Before the Tribunal, the Department argued that the assessee had not placed any evidence on record to suggest that the sale consideration received from the sale of shares were utilised for the purchase of the new asset, as a sum of Rs.22 lakhs was paid before the shares were sold. According to the Department, the investment of Rs.22 lakhs could not be considered for the purpose of allowing exemption u/ s.54F.

3.6 The tribunal considered the provisions of S. 54F(4). It noted that the assessee had to utilise the amount for the purchase or construction of the new asset before the date of furnishing the return of income u/s.139. Since there was no mention of any sub-section of S. 139, according to the Tribunal, one could not interpret that S. 139 mentioned therein should be read as S. 139(1). Following the decision of the Gauhati High Court in the case of CIT v. Rajesh Kumar [alan, 286 ITR 274 in the context of S. 54(2), the Tribunal was of the view that S. 139 mentioned in S. 54F included not only S. 139(1),but all sub-sections of S. 139.

3.7 According to the Tribunal, the intention behind the insertion of Ss.(4) in S. 54F was to dispense with the rectification of assessments in case the taxpayer failed to acquire the corresponding new asset. Therefore, if the new asset was acquired before the date of filing of the return u/s.139, then the assessee could file such return and there would be no need of rectification. The Tribunal noted that the decision of the Gauhati High Court was not available to the Delhi Bench of the Tribunal in the case of Taranbir Singh Sawhney (supra).

3.8 The Tribunal therefore held that the assessee was entitled to the exemption of the entire amount of Rs.11,10,833 u/s.54F.

4. Observations:

4.1 It is true that the Bangalore Bench has not noted the fact that the subsequent part of S. 54F(4) expressly refers to S. 139(4) – “Such deposit being made in any case not later than the due date applicable in the case of the assesee for furnishing the return of income under Ss.(l) of S. 139 in an account….. “

4.2 However, it is essential to understand the background behind the introduction of the requirement of depositing the amount in the Capital Gains Account Scheme. Prior to introduction of this requirement, it was noticed that assessees would claim the exemption u/ s.54F, by stating their intention to invest in a residential house within the prescribed time period. There was no mechanism for the Assessing Officer to verify whether such investment was made within the prescribed time, and it was felt that many assessees obtained the exemption without any actual investment in a residential house. Hence, this requirement was introduced to ensure that the exemption was not obtained under a false statement that the investment would be made within the prescribed period.

4.3 From that perspective, so long as the investment is made before the date of filing of the income tax return, whether u/s.139(1) or u/s.139(4), the purpose of introduction of the Capital Gains Account Scheme is achieved, namely, ensuring that the investment has actually been made before the return is filed.

4.4 As held by the Gauhati  High Court in the case of Rajesh Kumar [alan (supra), in construing a beneficial enactment, the view that advances the object of the enactment and serves the purpose must be preferred to the one which obstructs the object and paralyses the purpose of the beneficial enactment. Therefore, even if the investment in the house property has been made before the date of filing of the belated return, the purpose of the legislature is achieved, and it is not appropriate to deny the exemption on the ground that there has been a delay in investment, and accordingly a failure to invest in a bank account under the Capital Gains Account Scheme.

4.5 The requirement to invest in a bank account under the Capital Gains Account Scheme is therefore really a procedural requirement to ensure that investment is made in a residential house as claimed in the return of income, where such investment has already not been made. To deny the exemption when there has been substantial compliance by actual investment in a house, on the ground that investment has not been made in the Capital Gains Account Scheme within the prescribed time limit, appears to be unjustified. The time limit therefore needs to be read down as including the time limit for filing of a belated return of income, as held by the Gauhati High Court.

4.6 Therefore,  the view  taken  by the Bangalore Bench of the Tribunal  appears  to be a better view of the matter, as compared  to the view taken by the Delhi Bench.

Auditors should try old-fashioned auditing

Getting back to basic checks may be the only way for accounting firms to avoid flawed audits — says Emile Woolf, forensic and litigation consultant.
    One of the defining features of the economic crisis is disclosure of high-level fraud on a breathtaking scale. Although the auditors’ traditional mantra —‘It is not the purpose of audits to detect fraud’ —is repeated at every opportunity, somehow those who rely on audits as a safeguard do not get the message.

    The battle against public expectation has been waged since the beginning of auditing. Various attempts have been made to ‘educate’ investors on what they should expect, but none has succeeded in persuading the public or the courts that the profession’s perception of audit scope is sustainable whenever a higher level of effectiveness is warranted. Routinely bland, mechanical expressions in audit reports carrying more hope than conviction, fill pages, but are read only by insomniacs seeking a cure. Much of that nonessential tidbit in the audit report is now being trimmed.

    It is true that by no means all expectations of audit effectiveness are justified. In the midst of the BCCI debacle Emile Woolf received a box of golf balls with the (then) PriceWaterhouse logo after Emile Woolf wrote an article highlighting the absurdity of seeking to pin the Bank of England’s supervisory failures on BCCI’s auditors. Similarly unwarranted expectations were voiced when Equitable Life’s auditors, Ernst & Young, were misguidedly sued for not anticipating potential consequences of a dispute on guaranteed annuities that was resolved only when it finished up in the House of Lords.

‘Auditability’ Pressures

    Informed opinion is sensitive to the distinction between baseless exploitation of auditors as deep-pocket scapegoats, and auditing that is indefensibly substandard. But with the expansion of global markets, the ‘auditability’ of major enterprises becomes inversely proportional to the scale of their operations, and short-circuiting basic procedures by auditors inevitably follows.

    Currently in the news is the fraud at Satyam, India’s outsourcing giant. Its founder and chairman has confessed publicly to orchestrating a scam over several years resulting in massive cash overstatements. How ironic that last September Satyam was given the Golden Peacock award by the World Council on Corporate Governance, and in 2007 its crooked chairman was named Ernst & Young Entrepreneur of the Year ! It is too early to comment on the Satyam audits, but following these admissions, PriceWaterhouse, the Indian arm of PwC, formally withdrew audit opinions previously issued. In a letter to Satyam, released by the Mumbai Stock Exchange, the auditors stated that they had ‘placed reliance on management controls over financial reporting’ when signing off the accounts. Whether or not this means they did not, independently, confirm bank balances inflated by some $1 bn (£0.7bn), is not known.

    Either way, history shows that no matter how plausibly firms re-invent technical justifications for relying on the work of others, their neglect to perform the most obvious procedures lands them in trouble — over and over again.

Missing the Obvious

    In one of many examples from my case-book, had the auditors merely opened the company’s ‘private cash-book’ they would have seen columns blatantly recording the finance director’s substantial personal expenditure and illicit ‘loans’ to finance department personnel (mainly the FD’s relatives). Instead they relied on ‘high-level IT systems reviews’ in which the FD obligingly collaborated.

    Executives of another cash-strapped company conspired to sit on millions of pounds of receipts from debtors instead of remitting them to the finance company that had discounted related invoices months earlier. The breach could have been discovered by comparing one of the balances listed on the finance company’s month-end reconciliation with the corresponding sales ledger balance. Instead, the auditors relied on analytical procedures framed on unchecked representations of one of the conspirators.

    There is a common thread that threatens to mire the reputations of some major firms if a systemic flaw, now embedded in their auditing culture, is not rooted out. Relying on high-level ‘management controls’, unsupported by basic transactional checks on company records, has never been justified. It is time to resurrect that thing called good, old-fashioned auditing.

    Source : Accountancy, March 2009.

Security alert

Accountant AbroadLately there
have been quite a few reported cases of lost customer data both in the
government or public sector domain as well as in private corporate sector. This
is forcing information security up the corporate agenda.

It seems as though with every new day comes a fresh
revelation of an organisation that has lost some customer data. First there was
the loss by Revenue & Customs Department of two discs containing details of 25
million child benefit recipients. Then the Ministry of Defence admitted that
details of 600,000 applicants to the armed forces were stolen from a laptop in
the boot of a naval officer’s car. Those were just the two largest such
revelations in the UK. There have been many others, such as the loss by the
vehicle registrar in Northern Ireland of the personal details of more than 6,000
car owners.

It is not only government bodies that are failing to protect
customer data. Private businesses are also struggling. To give just two examples
in insurance industry, Norwich Union has lost £3m of customer money through
identity fraud, and Nationwide lost a laptop containing 11m customers’ details.
There are signs that cases such as these are finally driving the issue of data
security up the corporate agenda, forcing senior executives to consider the many
ways in which sensitive data can go astray.

Perhaps the most obvious way to lose data is through the
physical loss of a storage device such as a laptop, a disc or an external hard
drive. According to recent research, business travellers in the UK lose a
staggering 8,500 laptops and other mobile devices in UK airports every year.
Stockport Primary Care Trust recently revealed that it lost the personal medical
records of 4,000 NHS patients on a USB stick.

Helen Hart, a senior associate at law firm Stevens & Bolton
LLP, says : “Data should only be able to be copied over to portable storage
devices with the consent of the company and with such data being passworded. As
passwords can be cracked quite easily by experienced hackers, data should be
encrypted if possible. Organisations that already encrypt information should use
the most up-to-date technology as older methods are easier to hack.”

According to Jim Fulton, vice-president of marketing at
Digital Persona, more and more companies are beginning to use fingerprint
biometric technology. He says : ‘The technology has evolved and is now more
reliable and durable, as well as more affordable and practical. Fingerprint
readers are being embedded into an increasing number of mobile devices like
phones, PDAs, laptops and even USB memory sticks.’

However, for most data it is not necessary to go this far.
Secure encryption is by and large very simple and affordable. In fact, as Jim
Selby, European product manager for Kingston Technology, points out : “The most
shocking aspect of the loss of 25m records by the Revenue, the data on the two
discs could easily have been stored on an inexpensive and easy to use encrypted
two gigabyte USB drive costing just about £ 65.”

Last year, US clothing retailer TJX, had 45m records stolen
in what is perhaps the largest corporate data theft on record. The thieves
managed this by simply parking outside one of the company’s shops and accessing
its wireless Internet system. As Mario Zini, business development director at
Claranet, says : ‘Companies are making ever greater use of the Internet, and
this is exposing their data to ever greater risk.’

Most corporates are now well used to fending off hackers.
Patrick Walsh, director of product management and marketing for eSoft, outlines
the extent of the attacks : “If you put a computer on the public Internet, it
will be scanned by hackers within minutes. If a service such as a Secure Shell
server is publicly available, it is likely to be a matter of minutes before
hackers attempt common username and password combinations at fast rates. An
unpatched Windows machine on the public Internet without a firewall will be
compromised in under 10 minutes.”

He goes on to outline the following steps that companies can
take to protect their systems : “Antivirus scanning must happen for all files
that come into an organisation, not just those that arrive as email attachments.
Websites known to host phishing attacks, malware, and exploits should be
blocked. This list must be updated in real time. Peer-to-peer and instant
messaging applications should be strictly controlled. Email with phishing
attacks should be blocked before it reaches the end user. All confidential data
between home offices, branch offices, and headquarters should be encrypted and
sent over a virtual private network.”

While those technical enhancements will go a long way towards
protecting a company’s customer data, on their own they are not sufficient.
Martha Bennett, research director at Datamonitor, says : “Information security
is much like physical security. Whatever sophisticated alarm systems a home
owner puts in place, burglars will always find a way in if they try hard
enough.” Any business that wants to protect its customer data needs to go beyond
a purely technical solution to implement proper processes and training.

David Cole, security consultant at risk management
specialists DNV IT Global Services, says : “One of the main areas where
organisations fall down in securing information is lack of employee training.
Many have focussed on installing the latest technology to protect their data
while not addressing the weakest link in any organisation — employees
themselves. Good training can bring the threat of data theft alive for
employees, to help them understand and advocate information security policy.”

Providing  this  training  is far  from  simple.  The threats  change  on an almost  daily basis, and few people are sufficiently enthused  by data security to maintain   a focus  on  it.  Joe  Fantuzi,   CEO  of Workshare, describes how one of his products  can help:  “The  key is continual  reinforcement.   Our Workshare Protect scans all documents  leaving the system  to check for any sensitive  data,  and  then asks the user if he or she actually wants  to send it out. Google recently sent out a Power Point presention that  contained  confidential  information  on projected financials in the speaker notes. If they’d used our system they would probably have been spared this embarrassment.”

Clearly, there is much to be done. William McKinney, marketing director of Sterling Commerce, stresses the importance of building a strategy. “Companies tend to be reactive,” he says “Don’t just leap on the latest threat in the media. – Take time to look at your business and work out where the threats lie. Where are your points of weakness? Which is the most sensitive data ?”

Devising and implementing this strategy is a long-term project that will require most businesses to invest significant quantities of time and money. However, a growing number of businesses are sufficiently concerned by the threats of not only fines from regulators, but also negative media coverage that they are starting to act. It is not before time.

Better  data  security  in seven  steps:

    1. Classify your data according to its sensitivity and confidentiality to ensure that the security measures are appropriate to the risk.

    2. Perform a formal risk assessment to identify security vulnerabilities and to ensure appropriate risk mitigation.

    3. Embed formal accountability for data security in job descriptions.

    4. Employ appropriate tools such as encryption and biometrics where sensitivity or confidentiality is a key issue.

    5. Ensure the corporate audit committee has information security as a key item on its agenda.

    6. Encourage the board to recognise its final accountability for security. It needs to ask the right questions and allocate appropriate resources.

    7. Provide all staff with repeated education and reminders about their responsibility for security.

(Source:    accountancymagazine.com/March2008)

Precedent : Conflicting judgments of Co-ordinate Benches : Court to consider judgment which in its opinion is better in point of law : Constitution of India, Art.141 :

9. Precedent : Conflicting judgments of Co-ordinate Benches : Court to consider judgment which in its opinion is better in point of law : Constitution of India, Art.141 :

    The petitioner was the widow of Gopaldas Kanhyalal Gujarati. The late Gopaldas Kanhyalal Gujarati had participated in the Indian Independence Movement and was receiving Freedom Fighter’s Pension from the Government of Maharashtra. He had applied for Freedom Fighter’s Pension from the Central Government. The same was rejected. A fresh application was submitted alongwith required documents. In the meantime, the husband of the petitioner expired. After that, the petitioner pursued the matter and submitted all required documents. In spite of receiving of the application, the Central Government has neither granted pension nor communicated anything to the petitioner. Under these circumstances, the present petition had been filed.

    The Hon’ble Court observed that on the issue there were conflicting decisions of Co-ordinate Benches of the Supreme Court. Under such circumstances it was open to the Court to consider the judgment which in its opinion is the better in point of law, irrespective of when the judgments were pronounced. The Supreme Court noted that the judgment in Surja & Ors vs. UOI, 1992 SC 777 was rendered on the peculiar facts of that case and then declared the position of law, that an applicant must have actually suffered a minimum imprisonment of six months less the remission period of one month. Therefore, it was not possible to take a view different than the view taken in the case of Surja (Supra) which was binding under Art. 141 of the Constitution.

    [Gulabbai w/o. Gopaldas Gujrati vs. Union of India & ors. Writ Petition No. 1299 of 2008 Dated 9/7/2008 AIR (2009) (NOC) 763 (Bom) (2008) (6) AIR Bom R 857]

Condonation of delay : High Court has no power to condone the delay in filing the reference application under unamended Sec.35H(1) of Central Excise Act, 1944.

8. Condonation of delay : High Court has no power to condone the delay in filing the reference application under unamended Sec.35H(1) of Central Excise Act, 1944.

    The question for consideration was whether the High Court has power to condone the delay in presentation of the reference application under unamended Section 35 H(1) of the Central Excise Act, 1944 beyond the prescribed period by applying Section 5 of the Limitation Act, 1963. Unamended Section 35G speaks about appeal to the High Court. Sub-Section 2(a) enables the aggrieved person to file an appeal to the High Court within 180 days from the date on which the order appealed against is received by the Commissioner of Central Excise or the other party. There is no provision to condone the delay in filing the appeal beyond the prescribed period of 180 days.

    Unamended Section 35H speaks about reference application to the High Court. As per sub-section (1), the Commissioner of Central Excise or other party within a period of 180 days of the date upon which he is served with notice of an order under Section 35C direct the Tribunal to refer to the High Court any question of law arising from such order of the Tribunal. Here again as per sub-section (1), application for reference is to be made to the High Court within 180 days and there is no provision to extend the period of limitation for filing the application to the High Court beyond the said period and to condone the delay.

    In this matter the Court was concerned with ‘reference application’ made to the High Court under Section 35H (1) of the Act before amendment of the Central Excise Act by Act 49/2005 (w.e.f. 28.12.2005) by which several provisions of the Act were omitted including Section 35H.

    The Hon’ble Court observed that except providing a period of 180 days for filing reference application to the High Court, there is no other clause for condoning the delay if reference is made beyond the said prescribed period. In the case of appeal to the Commissioner, Section 35 provides 60 days time and in addition to the same, the Commissioner has power to condone the delay up to 30 days if sufficient cause is shown. Likewise, Section 35B provides 90 days time for filing appeal to the Appellate Tribunal and sub-section (5) therein enables the Appellate Tribunal to condone the delay irrespective of the number of days if sufficient cause is shown. Likewise, Section 35EE which provides 90 days time for filing revision by the Central Government and, proviso to the same enables the revisional authority to condone the delay for a further period of 90 days if sufficient cause is shown, whereas in the case of appeal to the High Court under Section 35G and reference to the High Court under Section 35H of the Act, total period of 180 days has been provided for availing the remedy of appeal and the reference. However, there is no further clause empowering the High Court to condone the delay after the period of 180 days. Chapter VIA of the Act provides appeals and revisions to various authorities. Though the Parliament has specifically provided an additional period of 30 days in the case of appeal to the Commissioner, it is silent about the number of days if there is sufficient cause in the case of an appeal to Appellate Tribunal. Also an additional period of 90 days in the case of revision by Central Government has been provided. However, in the case of an appeal to the High Court under Section 35G and reference application to the High Court under Section 35H, the Parliament has provided only 180 days and no further period for filing an appeal and making reference to the High Court is mentioned in the Act.

    As pointed out earlier, the language used in Sections 35, 35B, 35EE, 35G and 35H makes the position clear that an appeal and reference to the High Court should be made within 180 days only, from the date of communication of the decision or order. In other words, the language used in other provisions makes the position clear that the Legislature intended the Appellate Authority to entertain the appeal by condoning the delay only up to 30 days after expiry of 60 days, which is the preliminary limitation period for preferring an appeal. In the absence of any clause condoning the delay by showing sufficient cause after the prescribed period, there is complete exclusion of Section 5 of the Limitation Act. The High Court was, therefore, justified in holding that there was no power to condone the delay after expiry of the prescribed period of 180 days. Even otherwise, for filing an appeal to the Commissioner, and to the Appellate Tribunal as well as revision to the Central Government, the Legislature has provided 60 days and 90 days, respectively, on the other hand, for filing an appeal and reference to the High Court larger period of 180 days has been provided with to enable the Commissioner and the other party to avail the same. In view of the above, the Court held that the Legislature provided sufficient time, namely, 180 days for filing reference to the High Court which is more than the period prescribed for an appeal and revision and the High Court has no power to condone delay.

    [Commissioner of Customs and Central Excise vs. M/s. Hongo India (P) Ltd & Anr., Supreme Court dt. 27/3/2009 (Full Bench). (Source: itatonline.org)]

A company is entitled to invoke the provision of Sec.630 of Companies Act so as to retrieve its property being withheld wrongfully by legal representatives of the employee: Companies Act, 1956.

7. A company is entitled to invoke the provision of Sec.630 of Companies Act so as to retrieve its property being withheld wrongfully by legal representatives of the employee: Companies Act, 1956.
    2. The issue that arises for consideration in the present appeal is with regard to the scope of and ambit of the provisions of Section 630 of the Companies Act, 1956, more specifically, as to whether the proceedings under the said provisions would cover within its purview only an employee of the company or also persons claiming a right through him or under him.

    One Mr. Chandra Bhushan Saran, father of appellant No. 1 and maternal grandfather of appellant no. 2 was allotted third floor residential premises of the building ‘Devonshire House’. Since he was appointed as a Director and Technical Advisor of one M/s. Automobile Products of India Ltd. (‘API Ltd.’). The suit premises was owned by Her Highness Vijaya Raje Scindia Maharani of Gwalior and was taken on lease by API Ltd. for residential needs of its employee.

    Subsequent to Mr. C. B. Saran’s resignation he was appointed as the Managing Director of XLO Ltd., respondent No. 1 herein. Mr. C. B. Saran was entitled to rent-free accommodation and for the sake of convenience, the API Ltd. executed a licence agreement in respect of the suit premises in favour of respondent no. 1. Accordingly, Mr. C. B. Saran along with his family, which consisted of his wife, son and daughter, continued to occupy the said premises.

    Mr. C. B. Saran expired in Germany and on his demise his son Mr. Sanjay Saran, by virtue of his employment with respondent No. 1, the suit premises was allotted in his favour.

    It is pertinent to mention here that in the year 1976, API Ltd. filed a suit before the Small Causes Court against the respondent no. 1 and Mr. C. B. Saran disputing the tenancy right in relation to the suit property. After the demise of Mr. C. B. Saran his legal heirs were substituted in the said suit.

    The respondent no. 1 instituted a proceeding under Section 630 of the Act against the present appellants. The Additional Chief Metropolitan Magistrate vide order dated 26.06.2007 found the appellants guilty under Section 630 of the Act. The appellants were directed to vacate the suit premises within 4 months from the date of the said order and in default to suffer simple imprisonment for 4 months.

    The appellants filed a criminal appeal before the Sessions Judge which was dismissed. Against the said dismissal, the two appellants preferred a criminal revision application before the High Court of Bombay, which was also dismissed. It is against the said order that the appellants have approached the Apex Court.

    The Hon’ble Court observed that the main purpose to make action an offence under Section 630 is to provide a speedy and summary procedure for retrieving the property of the company where it has been wrongly obtained by an employee or officer of the company or where the property has been lawfully obtained but unlawfully retained after termination of the employment of the employee or the officer. Sub-section (1) is in two parts. Clauses (a) and (b) of sub-section (1) create two different and separate offences. Clause (a) contemplates a situation wherein an officer or employee of the company wrongfully obtains possession of any property of the company during the course of his employment to which he is not entitled, whereas clause (b) contemplates a case where an officer or employee of the company having any property of the company in his possession, wrongfully withholds it or knowingly applies it to purposes other than those expressed or directed in the articles and authorised by the company. Under this provision, it may be that an officer or an employee may have lawfully obtained possession of any property during the course of his employment, still it is an offence if he wrongfully withholds it after termination of his employment. Clause (b) also makes it an offence, if any officer or employee of the company having any property of the company in his possession knowingly applies it to purposes other than those expressed or directed in the articles and authorised by the Act. In terms of sub-section (2), the Court is empowered to impose a fine on the officer or employee of the company if found in breach of the provision of Section 630 of the Companies Act and further to issue direction if the Court feels it just and appropriate for delivery of the possession of the property of the company.

    The capacity, right to possession and the duration of occupation are all features which are integrally blended with the employment. Once the right of the employee or the officer to retain the possession of the property gets extinguished either on account of termination of services, retirement, resignation or death, they (persons in occupation) are under an obligation to return the property back to the company and on their failure to do so, they render themselves liable to be dealt with under Section 630 of the Act for retrieval of the possession of the property.

Service Concession Arrangements — IFRIC 12/SIC-29

Article

Introduction :


Service concession arrangements apply to public-private
partnerships for execution of infrastructure projects for i.e., roads, bridges,
tunnels, etc. This interpretation will impact infrastructure companies in India
once they converge their financial statements from April 1, 2011. This
interpretation deals with accounting treatment to be followed by operator. This
article will deal with the concept enshrined in this interpretation as well as
accounting and disclosure norms to be followed by the operator. Considering
increasing thrust given by the Government for Public-Private-Partnerships (PPP)
for execution of infrastructure projects, this
interpretation will govern accounting by operators in future.

Service concession arrangements typically involve two
parties, grantor (government or public sector entity) and operator (private
sector entity). The operator constructs, upgrades, operates and maintains
infrastructure for a specified period of time. The operator is paid for its
services over the period of arrangement. Such arrangements are also known as
Build-Operate- Transfer (BOT) projects, a rehabilitate-operate-transfer or a
public-private concession arrangement.

This interpretation applies only if the following two
conditions are satisfied as provided in para 5 of this interpretation :

  • The grantor controls or regulates what services the
    operator must provide with the infrastructure, to whom it must provide them
    and at what price.

and

  • The grantor controls — through ownership, beneficial
    entitlement or otherwise — any significant residual interest in the
    infrastructure at the end of the term of the arrangement.

Accounting treatment :


  • Revenue recognition :



The operator shall account for revenue and costs relating
to construction services and upgrade services in accordance with IAS 11 :
Construction Contracts. The operator shall account for operation services in
accordance with IAS 18 : Revenue Recognition. The contract revenue is measured
at the fair value of the consideration receivable.

  • Operator’s rights over the infrastructure :



The arrangement does not convey the right to control the
use of public infrastructure and therefore infrastructure cannot be recognised
as plant property and equipment as per IAS 16. The operator has only access to
operate the infrastructure in accordance with the terms of contract on behalf
of the grantor. The assets provided by the grantor if form part of the
consideration payable by the grantor, then the same will be recognised as
plant property and equipment, measured at fair value at initial recognition.
In this case, the operator shall also recognise a liability in respect of
unfulfilled obligations it has assumed in exchange for assets.





  • Consideration
    receivable — Intangible asset or financial asset ?



This is one of the important accounting issues which has to
be dealt with by the operator for consideration received or receivable for the
performance of construction or upgrade services. This consideration received
or receivable shall have to be recognised at fair value. However, the
consideration may be rights to :

3 Financial Asset

3 Intangible Asset

Financial Asset :

The operator shall recognise a financial asset when it has an
unconditional right to receive cash or other financial asset from or at the
discretion of the grantor. The operator is said to have an unconditional right
when the grantor guarantees determinable amount or meets shortfall, if any,
between amounts received from users of public service and guaranteed
determinable amount even if the payment is contingent on the operator, ensuring
that the infrastructure meets specified quality or efficiency requirements (Para
16 of IFRIC 12).

The operator shall classify the financial asset either as a
loan or receivable, an available-for-sale financial asset or fair value through
profit and loss account (Para 24 and 25 of IFRIC 12). Generally, the entity
would classify the financial asset as a loan or receivable considering lesser
complexity involved and measure the same at amortised cost using effective
interest method in the profit or loss account.

Intangible Asset :

The operator shall recognise an intangible asset to the
extent it receives a right (a licence) to charge the users of public service.
The assets need to be recorded as per fair value of consideration receivable in
accordance with IAS 38 : Intangible Assets. The operator has a licence to charge
users of the public service and therefore meets the definition of an intangible
asset. In this case, the revenue is conditional and bears demand risk, unlike a
financial asset where operator is insulated from demand risk and guaranteed a
sum of money (Para 17 of IFRIC 12).

In case the operator is paid for construction services partly
by a financial asset and partly by an intangible asset, it will be necessary to
account for each separately and recognise the consideration received/receivable
at fair value. This situation may arise if the government partly finances the
project cost.




  • Resurfacing
    obligations :     The operator’s resurfacing obligation arises as a consequence of use of the road during the operating phase. It is recognised and measured in accordance with IAS 37 : Provisions, Contingent Liabilities and Contingent Assets i.e., at the best estimate of the expenditure required to settle the present obligation at the end of the reporting period (Para IE 19 of IFRIC 12).


    •     Borrowing costs :


    The operator generally requires huge capital commitment and has recourse to debt funds for execution of infrastructure projects. IAS 23 : Borrowing Costs permits borrowing costs to be capitalised as part of cost of qualifying asset to the extent they are directly attributable to its acquisition, construction or production until the asset is ready for intended use or sale. The intangible asset meets the definition of qualifying asset as licence to charge public for use of infrastructure takes a substantial time for construction and up-gradation. A financial asset does not meet the definition of qualifying asset and hence the borrowing costs are not capitalised and the same are expensed as and when incurred (Para 22 of IFRIC 12).

    •     Amortisation of Intangible asset :


    The operator requires to account for an intangible asset in accordance with IAS 38 : Intangible Assets. IAS 38 provides for number of amortisation methods i.e., straight-line method, the diminishing balance method and the unit of production method. The method selected should reflect expected pattern of consumption of the expected future economic benefits embodied in the asset and the same should be applied consistently from period to period, unless there is a change in the expected pattern of consumption of those economic benefits.

        Disclosure norms :

    SIC-29 governs disclosure norms for operator companies and specifies appropriate disclosure that needs to be provided in the notes.

    All aspects of a service concession arrangement shall be considered in determining the appropriate disclosures in the notes. An operator and a grantor shall disclose the following in each period (Para 6 and 6A of SIC-29) :

    •     a description of the arrangement;
    •     significant terms of the arrangement that may affect the amount, timing and certainty of future cash flows (e.g., the period of the concession, re-pricing dates and the basis upon which re-pricing or re-negotiation is determined);


    •     the nature and extent (e.g., quantity, time period or amount as appropriate) of :


    •     rights to use specified assets;


    •     obligations to provide or rights to expect provision of services;


    •     obligations to acquire or build items of property, plant and equipment;


    •     obligations to deliver or rights to receive specified assets at the end of the concession period;


    •     renewal and termination options; and


    •     other rights and obligations (e.g., major overhauls);


    1.    changes in the arrangement occurring during the period; and

     2.   how the service arrangement has been classified.

     3.   An operator shall disclose the amount of revenue and profits or losses recognised in the period on exchanging construction services for a financial asset or an intangible asset.

    Relevant extract from published accounts : Illustrative Notes to Account from Consolidated Financials of Noida Toll Bridge Company Limited (NT-BCL) where they applied the interpretation of IFRIC 12 : Service Concession Arrangements for the year ended 2009. The Company has prepared their finan-cial statements in accordance with International Financial Reporting Standards (IFRS).

    Service Concession Arrangement entered into between X & Co, NTBCL and Grantor :
    A Concession Agreement entered into between the NTBCL, X & Co Limited and the New Okhla Industrial Development Authority, Government of Uttar Pradesh, conferred the right to the Company to implement the project and recover the project cost, through the levy of fees/toll revenue, with a designated rate of return over a period of 30 years concession period commencing from 30th December 1998 i.e., the date of Certificate of Commencement, or till such time the designated return is recovered, whichever is earlier. The Concession Agreement further provides that in the event the project cost with the designated return is not recovered at the end of 30 years, the concession period shall be extended by 2 years at a time until the project cost and the return thereon is recovered. The rate of return is computed with reference to the project costs, cost of major repairs and the shortfall in the recovery of the designated returns in earlier years. As per the certification by the independent auditors, the total recoverable amount comprises project cost and 20% designated return. NTBCL shall transfer the Project Assets to the New Okhla Industrial Development Authority in accordance with the Concession Agreement upon the full recovery of the total cost of project and the returns thereon.

    Revenue recognition — Operation services :                                                           Revenue is recognised to the extent that it is probable that the economic benefits will flow to the Group and the revenue can be reliably measured. Revenue comprises :

    Toll revenue :
    Toll revenue is recognised in respect of toll collect-ed at the Delhi-Noida Toll Bridge and the attributed share revenue from prepaid cards.

    Licence fee :
    Licence fee income from advertisement hoardings and office premises is recognised on an accruals basis in accordance with contractual obligations.

    Service charges :
    Service charges are recognised on accrual basis in respect of revenue recovered for the various business auxiliary services provided to the parties.

    Recognition of Concession Agreement as an Intangible Asset :

    Basis of accounting for the service concession :
    The Group has determined that IFRIC 12 Service Concession Arrangement is applicable to the Concession Agreement and hence has applied it in accounting for the concession.

    The directors have determined that the intangible asset model in IFRIC 12 Service Concession Arrangements is applicable to the concession. In particular, they note that users pay tolls directly so the grantor does not have the primary responsibility to pay the operator.

    In order to facilitate the recovery of the project cost and 20% designated returns through collection of toll and development rights, the grantor has guaranteed extensions to the terms of the Concession, initially set at 30 years.

    The Group has received an ‘in-principle’ approval for development rights from the grantor. However the Group has not yet entered into any agreement with the grantor which would constitute an assurance from the grantor to facilitate the recovery of shortfalls. Management recognises that the development right agreement when executed will give rise to intangible assets in their own right.

    Disclosures for Service Concession Arrangement as prescribed under SIC-29 Service Concession Ar-rangements — Disclosure have been incorporated into the financial statements.

    Significant assumptions in accounting for the intangible asset :

    On completion of construction of the Delhi -Noida Toll Bridge (6th February 2001), the rights under the Concession Agreement have been recognised as an intangible asset, received in exchange for the construction services provided. Construction costs include besides others, expenditure incurred and provisions for outstanding capital commitments on the Ashram Flyover, which was significantly completed on the date of recognition of the in-tangible asset. This section of the bridge was commissioned on 30th October 2001. The intangible asset received has been measured at fair value of the construction services as of Rs. 5,338,586,459 as on the date of commissioning. The Group has recognised a profit of Rs.1,548,095,840, which is the difference between the cost of construction services rendered (the cost of the project asset of Rs.3,790,490,619) and the fair value of the construction services.

    The Directors have concluded that as operators of the bridge, they have provided construction services to NOIDA, the grantor, in exchange for an intangible asset, i.e., the right to collect toll from road-users during the Concession year.

    Accordingly, the Group has measured the intangible asset at cost, i.e., the fair value of the construction services as at 6th February 2001, the date of completion of construction and commissioning of the asset.

    Key assumptions used in establishing the cost of the intangible asset are as follows :

    •     Construction of the DND Flyway commenced in 1998 and was completed on 6th February 2001. The exchange of construction services for an intangible asset is regarded as a trans-action that generates revenue and costs, which have been recognised by reference to the stage of completion of the construction. Contract revenue has been measured at the fair value of the consideration receivable. Hence in each of the years of construction, construction revenue has been calculated at cost plus 17.5% and the corresponding construction profit has been recognised through retained earnings.


    •     Management has capitalised qualifying finance expenses until the completion of construction.
    •     The intangible asset is assumed to be received only upon completion of construction. Until then, management has recognised a receivable for its construction services. The fair value of construction services have been estimated to be equal to the construction costs plus margin of 17.5% and the effective interest rate of 13.5% for lending by the grantor. The construction industry margins range between 15-20% and management has determined that a margin of 17.5% is both conservative and appropriate. The effective interest rate used on the receivable during construction is the normal interest rate which grantor would have paid on delayed payments.


    •     The intangible asset has been recognised on the completion of construction, i.e., 6th February 2001.
    •     The management considers that they will not be able to earn the designated return under the Concession Agreement over 30 years. The Company has an assured extension of the concession as required to achieve project cost and designated returns. An independent engineer had earlier certified the useful life of the Delhi- Noida Toll Bridge as 70 years. The intangible asset was being amortised over the same years on straight-line basis. Based on the independent professional experts’ advice obtained during the current year, the Company has reestimated the life of the bridge to be of 100 years. The method of amortization of the intangible asset has also been changed during the current year from straight-line to unit of usage method.

    Maintenance obligations :
    Contractual obligations to maintain, replace or restore the infrastructure (principally resurfacing costs and major repairs and unscheduled maintenance which are required to maintain the Bridge in operational condition except for any enhancement element) are recognised and measured at the best estimate of the expenditure required to settle the present obligation at the balance sheet date. The provision is discounted to its present value at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. Development rights will be accounted for as and when exercised.

    Conclusion :
    Infrastructure companies were following different practices as regards accounting for service concession arrangements. However this interpretation will bring out uniformity in accounting practices to be followed by infrastructure companies. The key issues to be addressed are determination of fair value of consideration for construction services rendered, which requires proper valuation and income tax consequences.

Is rotation of auditors an answer to Satyam episode

Background

    The question whether there should be a system of rotation of statutory auditors introduced to avoid repetition of Satyam episode has been raised in some quarters. In the past, the Government had tried to introduce this system by proposing amendments in the Companies Act on two occasions. However, these amendments could not be implemented as the Parliamentary Committees which examined these proposal rejected them in view of the strong protests from our members and the Institute. Investigations about the role of auditors in the Satyam episode are in progress. The reasons for the audit failure are not ascertained and, therefore, it would be premature to make this episode as illustrative. No definite conclusions can be drawn at this stage and it cannot be said that such episode will not be repeated if we introduce the system of rotation of statutory auditors through any legislation. It is reported that no developed country in the world has introduced this system.

Concept of rotation of statutory auditors

    The question of rotation of auditors has been considered in the past. In 1972, it was proposed to add clause (1B) in Section 224 of the Companies Act by the Companies (Amendment) Bill, 1972. This clause sought to introduce the concept of ‘rotation of auditors’. This was proposed with a view to bringing out disassociation of auditors from groups of companies, so that they may not have any temptation to shield shortcomings of the management from shareholders. It was also stated that this would achieve a more equitable distribution of audit work among younger members of the profession.

    There was lot of resistance from members when this proposal was sought to be introduced by amendment of the Companies Act. It was felt that such a proposal would put out of gear complete machinery in respect of audit of corporate sector by members of the accounting profession. It was also felt that this provision would not achieve the proposed objective. As a compromise, it was decided to represent to the Government that if ceiling on audits per member/partner is fixed, it would achieve the objective of wider dispersal of audit.

    The Joint Committee of Parliament appreciated the submissions made by the Institute. The Joint Committee took the view that a ceiling on audits would sufficiently serve to break the evil of continued association of auditors with groups of companies. It was decided to fix the ceiling at 20 as such groups generally consisted of more than 20 companies. It was also decided that out of these 20 companies, not more than ten companies should be having paid-up share capital of Rs.25 lacs or more. In the case of a firm of auditors the ceiling applied was on the basis of each partner in whole-time practice. On the above basis, the Companies (Amendment) Act, 1974, amended Section 224 of the Companies Act to provide for ceiling on company audits on the above basis.

Companies Bill, 1997

    The above provision worked with satisfaction for more than 20 years. Even in the Companies Bill, 1993 the concept of ceiling on audits was accepted. However, the Companies Bill, 1997 once again proposed to provide rotation of auditors in clause 180 (2). Under this clause, it was proposed to increase the ceiling on audits to 25 companies and also provide for rotation of auditors in such a manner that no company would be able to appoint or reappoint an auditor for more than five consecutive years.

    The Council of our Institute strongly opposed the concept of rotation of audit when the above Bill was under consideration. After an in-depth consideration of the matter at various forums in the profession all over the country, the Council came to the conclusion that the proposal relating to rotation of auditors was neither in the interest of the shareholders nor would it lead to better corporate governance and, therefore, it was not in the national interest. The Council, therefore, suggested dropping of the proposal on the following grounds.

    “The legislation in almost all developed countries does not contain any provision regarding rotation of auditors. On the contrary, the concept is that the position of the auditors should be strengthened and the option of the management to change them should be limited to the very minimum. This seems to be the concept behind the spirit of various provisions of the Companies Act in India, which provide for certain special proceedings if an auditor is to be removed or he is not to be reappointed at a general meeting.

    “The system of rotation can be evaded easily and will only result in practices like tie-up arrangements between auditing firms and splitting of existing firms. It would indeed be impossible to implement it in a manner that its perceived advantages are realised.

    “Rotation does not improve the independence of auditors. This is because the management plays one auditor against the other. It considerably reduces the chance of a strict and upright auditor to be appointed after his term, since the management (having been exposed to different auditors) would tend to opt for the ones who are considered more convenient.

    “Rotation of auditors will inevitably result in higher cost since new auditors will have to spend extra time in familiarising themselves with the nuances of the activities of a company. As a matter of fact, research has shown that modern business operations are becoming so complex that an auditor takes at least two years to really understand the intricacies of the input-output relationships and the economic realities behind the financial transactions. It is well known that audit failures are more in the first or second year of an audit. In more advanced countries, certain audit firms have actually developed special expertise in specific industries. The quality of audit will therefore definitely suffer if there is rotation of auditors.

    “The Council of the Institute is fully supportive of all initiatives meant to enhance the independence of the auditors. It genuinely believes that rotation of auditors will be a retrograde step unlike some of other initiatives in the Companies Bill, 1997, e.g. tightening up of provisions regarding disqualification of auditors and constitution of audit committees. The Council has in fact been constantly debating and enforcing a number of steps to improve the qualify of audit. A few initiatives being taken by the Council are (a) working out a system of peer reviews, (b) enforcing audit standards more stringently, and (c) ensuring that an auditor does not have interest in the organisation under audit.

The above Bill was referred to the Parliamentary Standing Committee for its consideration. In its report dated 27th July, 2000, the Committee has considered the suggestions received from the Institute and others and recommended that clause 180 (2) of the above Bill, relating to rotation of auditors, for giving stability to the appointment of auditors, be dropped.

That Committee, has, however, accepted the alternative suggestion made by the Institute that the system of appointment of joint auditors be introduced. The Committee has observed that with the acceptance of this suggestion, the effect will be that the Companies Act will be introducing, for the first time, the concept of joint auditors, which is prevailing in some of the advanced countries. This will ensure that the continuity in audit is not broken. It may be noted that the Companies Bill, 1997, ultimately lapsed and could not be passed.

Naresh  Chandra Committee  report

The Government of India appointed a Committee under the Chairmanship of Shri Naresh Chandra in August, 2002 to examine various issues relating to Corporate Governance. One of the. terms of reference related to examination of measures required to ensure that managements and auditors actually present a true and fair statement of affairs of companies. The whole effort of the Government was to improve corporate functioning and to improve corporate financial reporting. The Committee submitted its report in November, 2002. Besides considering the corporate governance issues, the Committee also considered the issues relating to statutory auditor – company relationship, steps to be taken to preserve independence of auditors, rotation of auditors, measures to improve corporate financial reporting, composition of board of directors, role of independent directors, strengthening the statutory provisions governing Chartered Accountants and other related matters.

On the question  of good corporate  governance,  the Committee observed that two corporate instruments that improve corporate governance are financial and non-financial disclosures and (ii) independent oversight of management. It was observed that independent oversight of management comprises two aspects. The first relates to the role of independent statutory auditors and the second relates to the role of independent directors.

The Committee observed that shareholders appoint auditors who are required to report whether the audited financial statements present a ‘true and fair’ view of the financial health of the auditee. Therefore, the quality and independence of
statutory auditors was fundamental to corporate oversight. While it was the job of the management to prepare the accounts, it was the responsibility of the statutory auditors to scrutinise the same and give an independent report on the same. Auditors have the skills to scrutinise complex accounts of today’s multi-divisional and multi-segmental corporations, but these skills will come to naught if the auditing firm did not have a strict arm’s length independent relationship with the management of the corporate body.

In order that auditors are able to preserve their independence, the Committee suggested that auditors should maintain arm’s length relationship with the management. The suggestions of the committee that the auditor should not (i) have financial interest in audit client, (ii) have business or personal relationship with the audit client, (iii) have undue dependence on the audit client, (iv) accept loans or guarantees from audit client, (v) have key management position within two years prior to his appointment and (vi) render certain non-audit services, were incorporated in the Companies Amendment Bill, 2003. Unfortunately, this Bill could not be passed by the Parliament.

The Committee considered the question of rotation of auditors and after detailed discussion with various bodies, came to the conclusion that there was no need to provide for rotation of auditors. It was stated that the Committee had not found sufficient international evidence favouring compulsory rotation of audit firms. Various independent accounting studies made available to the Committee indicated no discernible benefit from rotation. In fact, these studies universally indicated the opposite – that rotation tends to enhance the risk of audit ‘failures in the last year of the tenure of the outgoing auditor and the first two years of the new auditor. Even in the USA the Sarbanes-Oxley Act, 2002 (SOX Act) does not provide for rotation of auditors.

Given the international practice, the Naresh Bombay Chartered Accountant Journal, May 2009 Chandra Committee observed that there was no conclusive proof of the gains while there was sufficient evidence of the risks if the concept of rotation of auditors was accepted. However, the Committee was in favour of compulsory rotation of audit partners as provided in SOX Act in the USA.

According to the Committee, the partners and at least 50% of the engagement team (excluding the articled clerks and trainees) responsible for the audit of either listed companies or companies whose paid up capital and free reserves exceed Rs.10 Crores, or companies whose turnover exceeds Rs.50 crores, should be rotated every five years. Persons who are rotated in this manner can be allowed to return, if need be, after a break-up of three years.

Having emphasised the need for keeping arm’s length relationship with the management, the Committee considered the vexed question of who will audit the auditors? It is true, the auditor performs a critical role in informing the shareholders of the true and fair picture of the state of financial and operational affairs of a company. However, the ability to play this role will depend on the auditor’s knowledge, skills, independence, professional skepticism and integrity. For this purpose, there is a great need to regulate auditors effectively to ensure that they properly discharge their fiduciary responsibilities.

In India the Institute of Chartered Accountants of India (ICAI) has been set up under the Chartered Accountants Act, 1949 to examine and regulate the profession of Chartered Accountancy. The ICAI has set up a system of Peer Review of audit firms. The Committee considered the Peer Review Statement issued by ICAI and observed that this system was indeed a good one. However, the Committee felt that it was time to think of a very indigenous and refined arrangement to ensure the quality of attestation services performed by Chartered Accountants in relation to the technical standards prescribed for them. Although the Committee was satisfied with the above peer review statement which was a self-contained document and which addressed most of the issues regarding ‘who audits the auditors’, the Committee recommended establishment of a ‘Quality Review Board’ as an independent body outside the Council of the Institute. It may be noted that under Sections 28 A to 28 D of the Chartered Accountants Act, as amended in 2006, a Quality Review Board consisting of 5 members nominated by the Government and 5 members nominated by the Council of ICAI has been appointed.

The Companies Bill, 2008


The Companies Bill, 2008, has been introduced in the Lok Sabha on 23.10.2008 to replace the existing Companies Act, 1956. There is no proposal about rotation of statutory auditors in the Bill. However, some of the provisions are proposed to ensure that the independence of statutory auditors is not impaired. In brief, these provisions are as under:

“Special Resolution will be required if an auditor other than retiring auditor is proposed to be appointed.

“An auditor who has direct financial interest in the company or who receives any loans or guarantee from the company or who has any business relationship (other than an auditor) with the company cannot be appointed as auditor.

“A person whose relative is in employment of the company as a director or Key managerial personnel cannot be appointed as auditor.

“If a firm is appointed as auditors, only the partner of the firm, as authorised by the firm, can sign the audit report on behalf of the firm.

“An auditor cannot accept any other assignment from the company like accounting, book keeping, internal audit, design and implementation of any financial information system, actuarial services, investment advisory services, investment banking services, financial services and management services.

“Audit report shall state whether the financial statements comply with the accounting standards and auditing standards. It may be noted that the National Advisory Committee appointed by the Government will now be required to advise the Government about Accounting Standards as well as Auditing Standards. In other words, the auditors will have to comply with Auditing Standards laid down by the Government on the advice of the National Advisory Committee.

“Auditor shall have a right to attend every Annual General Meeting and shall have a right to be heard at such meeting on any part of the business conducted at the meeting.

“If the auditor makes default in complying with the provisions relating to reporting on the financial statements, provisions prohibiting rendering on other services, and allowing any person other than an authorised person to sign audit report, he shall be liable to pay fine of Rs.25,000 which may extend to Rs.5 lacs. If it is found that the auditor has knowingly or willfully contravened any of the above provisions, he shall be punishable with impairment for a term up to one year or with fine of Rs.1 lac which may extend to Rs.25 lacs or with both. It is also provided that in such cases, the auditor will have to refund the fees and also pay for damages to the company or to any other persons for loss arising out of incorrect or misleading statements of particulars made in the audit report.”

From the above provisions proposed in the Companies Bill, 2008, it will be noticed that these provisions are more stringent and are being introduced with a view to achieve the goal to improve/ strengthen the independence of statutory auditors and quality of audit. It must be recognised that the Government is keen to ensure that the independence of statutory auditors is not affected by any weakness in the corporate governance.

To sum up


Our Institute is a regulatory body and its function is to regulate training of articled trainees, conduct examinations, regulate and develop the profession. All our members are taught the importance of independence, integrity, objectivity, confidentiality, technical standards, professional behaviour and technical competence. Therefore, there is a strong presumption that our members are independent and will not succumb to any pressure. One of the reasons advanced in favour of rotation of statutory auditors is that statutory auditors will tend to lose their independence if they are associated with a particular company in that capacity for a long duration. There is no reason to doubt the competence of the Council of ICAI to ensure the virtues of independence, integrity, objectivity, etc. in the members of our profession. If a person qualifies our examination after completing the practical training without imbibing the above virtues, the Council should consider some other measures to improve the quality of education and training. If a member is independent by virtue of his training and qualification in the first three or five years of audit assignment of a company, he will always remain independent irrespective of his continued association with that company. If he has not imbibed the virtues of independence, integrity, etc. during his education and training period, he cannot remain independent even in the first year of his audit assignment even if rotation of statutory auditors is made mandatory.

Another probable argument by those who favour rotation of statutory auditors is that the younger members will get audits of large companies. This argument is also not valid, because the Institute’s representation before the Parliamentary Committee which was considering this amendment proposed in the Companies Bill, 1997, clearly states “the system of rotation can be evaded easily and will only result in practices like tie-up arrangements between auditing firms and splitting of existing firms”. The Institute has also observed in the above representation that “rotation does not improve the independence of auditors”. As stated above, several reasons are given by the Institute and it is possible that our members may adopt unethical means to secure assignments if compulsory rotation is introduced.

Our Institute has grown from strength to strength over 60 years. The reforms introduced in the field of education, training, CPE Programmes, Quality Review process, etc. have moulded our members to withstand pressures from outside. Therefore, the thinking that independence of members will be affected while discharging the attest function because of a long association with a particular client is not all justified.

From the above discussion it becomes evident that rotation of statutory auditors is not an answer to ensure independence of auditors and quality of audits. The steps taken to strengthen the education and training, ceiling on number of audits per partner, CPE Programmes, Peer Review, etc. are adequate at present. Further, the system of putting additional responsibilities on audit committee and independent directors will go a long way in ensuring independence of auditors and improving corporate governance. As suggested by various committees as well as the Council of the Institute, the system of joint auditors, rotation of partners and audit team of the audit firm can definitely improve the present position. It is also possible to introduce a system by which each audit firm should declare, while accepting the audit, as to under which partner the audit assignment is accepted. An audit firm cannot accept more than the specified number of audits per partner as permitted by the Companies Act. The audit firm should ensure that the audit report is signed only by that partner under whom the audit is accepted. In exceptional cases the audit firm can be allowed to make a change and assign the audit to another partner, subject to the specified number, after making disclosure for the same. In this manner it can be ensured that the system of appointing ‘Signing Partners’, which is in vogue in certain audit firms, at present, will be abolished. This system will ensure that each practising member of the Institute undertakes audit assignment of such number of audits, per partner, as permitted by the provisions of the Companies Act. This will improve the quality of audit.

Disallowances u/s.14A of Income-tax Act

Article

1. Background :


1.1 S. 14A has been inserted in Chapter IV of the Income tax
Act by the Finance Act, 2001, with retrospective effect from 1-4-1962. This
Section provides for disallowance of expenditure incurred in relation to income
which is not included in the total income of the assessee (i.e. exempt
income). The operative part of this Section reads as under :

“For the purposes of computing the total income under this
chapter, no deduction shall be allowed in respect of expenditure incurred by
the assessee in relation to income which does not form part of the total
income under this Act.”

1.2 Proviso to the Section was added by the Finance Act, 2002
w.e.f. 11-5-2001. It provides that the A.O. cannot reopen the assessment u/s.147
for any assessment year prior to A.Y. 2001-02 for this purpose or pass any
rectification order u/s.154 for prior years to disallow any such expenditure.

1.3 In the case of CIT v. Indian Bank Ltd., (56 ITR
77), Supreme Court had decided in 1964 that the condition for deductibility of
an expenditure does not depend upon its quality of directly or indirectly
producing taxable income and, therefore, there was no warrant for disallowing a
proportionate part of the interest referable to moneys borrowed for the purchase
of tax free securities. This principle was reiterated in the case of CIT v.
Maharashtra Sugar Mills Ltd., (82 ITR 452). In this case it was held that no
part of managing agency commission can be disallowed on the ground that it
partly relates to managing sugarcane cultivation, the income from which was
exempt from tax. Again, in the case of Rajasthan State Warehousing
Corporation v. CIT, (242 ITR 450) the above principle was once again
reiterated by the Supreme Court. In this case, it was held that if business is
one and indivisible, the expenditure cannot be apportioned and disallowed to the
extent it may relate to income which is exempt from income tax.

1.4 It may be noted that the explanatory memorandum issued
with the Finance Bill, 2001, gives the purpose for which the amendment is made.
This reads as under :

“Certain incomes are not includible while computing the
total income as these are exempt under various provisions of the Act. There
have been cases where deductions have been claimed in respect of such exempt
income. This in effect means that the tax incentive given by way of exemptions
to certain categories of income is being used to reduce also the tax payable
on the non-exempt income by debiting the expenses incurred to earn the exempt
income against taxable income. This is against the basic principles of
taxation whereby only the net income, i.e., gross income minus the
expenditure, is taxed. On the analogy, the exemption is also in respect of the
net income. Expenses incurred can be allowed only to the extent they are
relatable to the earning of taxable income.

It is proposed to insert a new S. 14A so as to clarify the
intention of the legislature since the inception of the Income-tax Act, 1961,
that no deduction shall be made in respect of any expenditure incurred by the
assessee in relation to income which does not form part of the total income
under the Income-tax Act.”


1.5 From the above, it appears that only direct expenses
incurred for earning the income which is exempt will be covered by S. 14A. Even
in the decisions of the Supreme Court referred to above there is nothing to
infer that direct expenses incurred for earning exempt income is allowable.
Therefore, even in the absence of a provision contained in the new S. 14A law
was well settled. There is nothing in this Section to suggest that indirect
expenses will be disallowed.

1.6 In actual implementation of this provision, the
Income-tax Department has been taking the view that all items of income
(including dividend on shares and units of Mutual Funds etc. on which Dividend
Distribution Tax is paid) stated in S. 10 of the Income-tax Act are governed by
S. 14A. The intention of this legislation was to disallow only direct expenses
incurred for earning exempt income. In almost all cases even indirect expenses
are also being disallowed on proportionate basis. In order to ensure uniform
approach, S. 14A was amended by the Finance Act, 2006, w.e.f. 1-4-2007 (A.Y.
2007-08). By this amendment Ss.(2) and Ss.(3) were added in S. 14A to provide
that AO shall determine the amount of expenditure incurred in relation to the
exempt income in accordance with such method as may be prescribed by Rules. The
reasons for making this amendment in S. 14A are explained in Paras 11.1 to 11.3
of CBDT Circular No. 14/2006 of 28-12-2006.

2. New Rule 8D :


2.1 In exercise of the powers given in S. 14A(2) C.B.D.T. has
issued a Notification No. S.O. 547(E) on 24-3-2008 (299 ITR (ST) 88). This
notification amends the Income-tax Rules by insertion of a new Rule 8D providing
for a “Method for determining amount of expenditure in relation to income not
includible in total income”. Reading this Rule it is evident that the Rule
provides for disallowance of not only direct expenditure incurred for earning
the exempt income but also for disallowance of proportionate indirect
expenditure. This is clearly contrary to the main objective with which S. 14A
was enacted.

2.2 Broadly stated, the new Rule 8D provides as under :

(i) The method prescribed in the Rule is to be applied only if the AO is not satisfied with :

(a) The correctness of the claim of expenditure incurred for earning the exempt income made by the assessee or

(b) The claim made by the assessee that no expenditure has been incurred for earning exempt income.

(ii) The method prescribed in the Rule states that the expenditure in relation to income which does not form part of the total income shall be the aggregate of the following amounts :

(a) The amount of expenditure directly relating to income which does not form part of total income.

(b)In the case of interest on borrowed funds which is not directly attributable to any particular income or receipt, the amount computed in accordance with this following formula:

A*B/C

A = Amount of interest, other than the amount of interest which is directly attributable to the exempt income stated in (a) above.

B = The average of value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the relevant accounting year.

C = The average of total assets as appearing in the balance sheet of the assessee, on the first day and the last day of the relevant accounting year. The term ‘Total Assets’ means total assets as appearing in the balance sheet excluding the increase on account of revaluation of assets but including the decrease on account of revaluation
of assets.

c) An amount equal to 1h % of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the relevant accounting year.

2.3 From the above Rule, it will be noticed that CBDT has, instead of prescribing a simple method, prescribed a complicated formula. By applying this formula, in most cases, expenditure which has no connection with earning the exempt income will get disallowed. Some of the issues relating to this New Rule require consideration:

    i) As stated in para 2.2(ii)(b) above, interest which is directly attributed to borrowed funds used for the purpose of earning taxable income or receipts will not be considered for disallowahce of proportionate interest u/s.14 A. Therefore, interest on term loan taken for purchase of Plant & Machinery, Motor car loan, amount borrowed for acquiring factory or office building or any other business asset will not be considered for such disallowance.

    ii) It is not mentioned that interest which is disallowable u/s.43B or u/s.36(1)(iii) will also be excluded. But it can be assumed that only such expenditure, which is otherwise allowable in the computation of total income, will be considered for disallowance u/s.14A.

    iii) In the above formula in para 2.2(ii)(b) above while explaining the terms ‘B’ and ‘C’ there is a reference to the average value of investments and total assets as per the Balance Sheet of the assessee. It is not clear as to what figures shall be adopted in the cases of non-corporate assessees, such as Individuals and HUFs who do no maintain books of accounts.

    iv) In explanation to the term ’12’ it is stated that for considering average value of Investments, we have to consider “Investment, income from which does not or shall not form part of the total income”. This will mean that even if there is no income from some or all of the investments, the average value of these investments will enter the formula for disallowance of proportionate interest. This will mean that in some cases where there is no income from such investments and no exemption from tax is claimed on any income, proportionate interest will be disallowed. In some cases, if income from some investments is say only Rs.1lac on which exemption is claimed, but disallowance of proportionate interest under the formula may work out to Rs.2 lacs.

v) While explaining the term ‘C’ it is stated that average of Total Assets as per Balance sheet should be taken. It can be assumed that items like (a) Preliminary Expenses not written off, (b) Deferred Revenue expenses, (c) Deferred Tax Assets, (d) Debit Balance of Profit & Loss AI c. etc., which do not represent any tangible or intangible asset, appearing in the Balance sheet of the assessee will be excluded from Total Assets.

    vi) Similarly, current liabilities which are to be deducted from current assets in the case of the company can be added while working out the amount of Total Assets.

    vii) The formula given in para 2.2.(ii)(c) above, states that amount equal to 1/2% of the average value of investments, income from which is exempt from tax, should also be disallowed ul s.14A. This provision is not at all equitable. Such disallowance is to be made with reference to average value of such investments from which exempt income is received or not. This disallowance has no relation to either the exempt income or to the expenditure claimed by the assessee. In many cases the amount worked out may exceed the exempt income or may exceed even the total expenditure (for taxable as well as exempt income) incurred by the assessee. If we take the illustration of a closely held Investment company it is common knowledge that the administrative expenses are nominal as compared to the value of the investments. In such cases, the amount to be disallowed under the formula will far exceed the total expenses. It is suggested that a very strong representation should be made for deletion of this part of the New Rule. In any event, it should be represented that the total disallowance under the formula should not exceed 5% of the income for which exemption is claimed.

 The validity of the New Rule 8D can be challenged on the ground that S. 14A authorises CBDT to prescribe the method for determination of expenditure incurred in relation earning the exempt income, but the method prescribed by this Rule only determines the notional cost for holding investments which mayor may not yield an exempt income. Such notional cost for holding the investment has no relationship with the actual expenditure incurred and claimed by the assessee. There-fore, the New Rule goes beyond the authority given to CBDT by S. 14A

2.4 As stated earlier, the above amendment giving power to CBDT to prescribe the method for determination of expenditure to be disallowed u/ s.14A was made by the Finance Act, 2006 w.e.f. AY. 2007-08. Therefore, the above method, as now pre-scribed by New Rule 8D, should apply to computation of income for AY. 2007-08 and onwards. However, there are certain judicial pronouncements which suggest that amendment made in S. 14A(2) and (3) made by Finance Act, 2006, is a procedural provision and, therefore, the method for computation of disallowable expenditure, whenever pre-scribed, will be applicable to all pending assessments for earlier years also. Reference in this connection  may be made  to the following  decisions:

(i) ACIT v. Citicorp Finance (India) Ltd., 108 ITD 457 (Mum.)

(ii) Kalpataru Construction Overseas (P) Ltd. v. DCIT, 13 SOT 194 (Mum.)

(iii) DCIT v. Seksaria Biswar Sugar Factory Ltd., 14 SOT 66 (Mum.)

(iv) Prakash Heat Treatment & Industries (P) Ltd. v. ITO, 14 SOT 348 (Mum.)

(v) DCIT v. Smita Conductors Ltd., 16 SOT 251 (Mum.)

(vi) Narotamdas Bhau v. ACIT,  15 SOT 629 (Mum.)

(vii) Conwood Agencies (P) Ltd. v. ITO, 15 SOT 308 (Mum.)

Contrary view has been taken in the case of Vidyut Investments Ltd. v. ITO, 10 SOT 284 (Delhi) where it is held that S. 14A(2) and (3) will only apply w.e.f. AY. 2007-08 and onwards.

In case of expatriate, seconded to Indian Company, liability of TDS on ‘Home Salary’ paid by the Foreign Company outside India — Sec. 192

Introduction

1.1 A person responsible for making certain payments [Payer] to a resident or a non-resident (Payee) is required to deduct tax (TDS) as provided in various provisions contained in Chapter XVIIB of the Income-Tax Act, 1961 (the Act). In the last few years, the net of TDS is substantially widened from time to time by the Government and large number of payments are now covered within those provisions. A large portion of direct tax collection is made by the Government through TDS provisions.

1.2 Out of the collections made by the Government by way of TDS, a major portion of the collection represents the TDS from salary income. Sec.192(1) provides that any person responsible for paying (Employer) any income chargeable under the head ‘Salaries’ [hereinafter referred to as Salary Income], at the time of payment, is required to deduct tax on the estimated Salary Income of the assessee (Employee) for relevant financial year as provided in the Section. Such Employee could be resident or non-resident. The only criterion is taxability of Salary Income under the Act. Such tax is required to be deducted at an average rate of Income-tax as provided in the Section. Sec.192(2) further provides that if the assessee (Employee) is employed simultaneously under more than one employer during the financial year, etc., he may furnish to the Employer referred to in Sec.192(1) such details of his Salary Income from the other employer or employers in the prescribed form (Form No.12B) and in that event, such Employer is under an obligation to take into account such details for the purpose of making deduction under Sec.192(1). The provisions contained in Sec.192(2) are regarded as optional for the assessee (Employee).

1.3 When a non-resident (say, a Foreign Company) makes payment outside India to any resident (or to non-resident in certain cases) falling within any of the provisions contained in Chapter XVIIB, then in such a case, whether such a non-resident also is required to deduct tax or not is a matter which is currently under debate on the ground as to whether such machinery provisions of the Act can be applied beyond the territories of India [i.e., on the ground of extra-territorial jurisdiction]. The Department holds the view that in such an event, even such a non-resident making payment outside India is required to deduct tax and comply with the provisions of the Act with regard to TDS. This view of the Department is also reflected in some of the Circulars issued by the CBDT [e.g., Circular No.726, dated 18.4.1995, under which certain exceptions for TDS are provided for payments made by non-residents to resident Payees, being lawyers, chartered accountants, etc.].

1.4 In many cases, a Foreign Company enters into joint venture with an Indian partner in respect of some business activities for which a company is incorporated in India jointly with the resident joint venture partner [J. V. Company or Indian Company]. Similarly, many a time, a Foreign Company incorporates a subsidiary company in India for carrying out certain business activities [Indian Company]. In such cases, many a time, such Foreign Company deputes its employees on secondment basis to such Indian Company and the expatriates so seconded remain in India for a specified period in the employment of the Indian Company (generally such expatriates also become resident in India under the Act during such a period). In such cases, the Indian Company makes payment of salary, etc. and deducts tax under Sec.192(1) in respect of such payments. At the same time, in many such cases, such expatriates seconded by the Foreign Company to the Indian Company retain their lien on their job with the Foreign Company and also continue to remain on the rolls of the Foreign Company, and, apart from the salary, etc. received from the Indian Company, they also receive the agreed remuneration outside India in foreign currency from such Foreign Company (Home Salary). In such cases, no reimbursement is made by the Indian Company in respect of such Home Salary received by the expatriates and the same is also not claimed as deduction in computing the taxable income of the Indian Company. In such cases, the issue with regard to taxability of such Home Salary in India is under debate, which has to be decided on the basis of facts and circumstances of each case. In cases where such Home Salary is related to the services rendered by such expatriates in India, the same is generally treated as taxable income in India and in such an event, further issue with regard to liability of TDS in respect of such Home Salary is also under debate. In many cases, the Department has taken a stand that since such Home Salary relates to services rendered in India, the same is deemed to have accrued or arisen in India under Sec.9(1)(ii) and accordingly, the Indian Company is liable to deduct tax under Sec.192(1), as no work is performed by such expatriates for the Foreign Company during such periods.

1.5 Recently, the Apex Court had occasion to consider the issues referred to hereinbefore in the case of Eli Lilly & Co. India Pvt. Ltd. [Civil Appeal No.5114/2007] and other cases. Therefore, the judgment of the Apex Court in this batch of cases is of great importance and hence, it is thought fit to consider the same in this column.

Eli Lilly & Co. India Pvt. Ltd. and Others —178 Taxmann 505 (SC).

2.1 In the above cases (taken up by the Apex Court together), the Home Salary was paid by a Foreign Company to its employees seconded to the Indian Company [which was also not reimbursed by’ the Indian Companies 1, no tax was deducted on such payments. The Indian Companies had deducted tax under Sec.192 in respect of Salary Income paid by them to such seconded expatriates. In some cases, the employees had filed their returns of income in India and paid taxes on the Home Salary. In some cases, it seems, initially, a stand was taken that Home Salary is not taxable in India, but it appears that subsequently such stand was given up and taxes were paid. Since a large number of cases were involved, the detailed facts in respect of each one of those cases are not available except for one case to which reference is made hereinafter. Primarily, it seems that in all cases, the Indian Companies were treated as ‘assessee-in-default’ under Sec.201 and interest was charged under Sec.201(lA) and in some cases, penalty under Sec.271C was also levied for non-deduction of tax. It seems that in all cases, the High Court had decided these issues in favour of the Indian Companies.

2.2 In the case of Mis. Eli Lilly & Co. India Pvt. Ltd. (Indian Company), the brief facts were: The Company was engaged in manufacturing and selling pharmaceutical products during the Financial Years 1992-93 to 1999-2000. The Company was a J. V. Company between Messrs. Eli Lilly Inc., Netherlands (Foreign Company) and its Indian Partner, Mis. Ranbaxy Ltd. The Foreign Company had seconded four expatriates to the Indian Company (i.e., J. V. Company) and the appointment was routed through a J. V. Board consisting of Indian Partner and the Foreign Company. Only a part of their aggregate remuneration was paid in India by the Indian Company on which tax was deducted under Sec.192(1). These expatriates, who were seconded by the Foreign Company to the J. V. Company in India, also continued to be on the rolls of the Foreign Company and they received Home Salary outside India in foreign currency from the said Foreign Company, on which no tax was deducted. A survey under Sec.133(A) was carried out and in the course of such survey, these facts were noticed. The post-survey operations revealed that those expatriates who were employed by the Indian Company (on being seconded by the Foreign Company), no work was performed by them for the Foreign Company. Based on these facts, the Assessing Officer (A.a.) found that total remuneration paid to them was only on account of services rendered in India and therefore, the same is taxable in India in terms of Sec.9(1)(ii), and accordingly subject to tax deduction under Sec.192(1) of the Act. It was the contention of the Indian Company that the Home Salary is paid by the Foreign Company to expatriates outside India, de hors the contract of employment in India. The A.a. treated the Indian Company as ‘assessee-in-default’ under Sec.201 in respect of Home Salary paid by the Foreign Company outside India and levied interest under Sec.201(lA). In the Appellate proceedings, the Tribunal and the High Court took a view that the Indian Company was not under statutory obligation to deduct tax under Sec.192 on the Home Salary paid by the Foreign Company, as it was not paid by the Indian Company and hence it is not an ‘assessee-in-default’. At the instance of the Department, the matter came up before the Apex Court and the Apex Court decided to dispose of this case as well as other cases involving similar issues together.

2.3    On behalf of the Revenue, it was submitted that Sec.192 comprises the following four elements:

i) It imposes an obligation of ‘deducting’ tax on ‘any person’ responsible for paying any income chargeable under the head ‘salary’,

ii) Clarifies that this obligation attaches itself ‘at the time of payment’, which is the temporal time-frame,

iii) The rate is to be determined on the basis of the average rate of Income-tax for the financial year, and

iv) Most importantly, the rate is to be applied ‘on the estimated income of the assessee under this head for that financial year’, i.e., for the totality of the assessable salary income of the assessee-employee.

2.3.1 On behalf of the Department, it was, inter alia, further contended that the expression ‘any person’ in Sec.192 would include any person responsible for making salary payment to an employee, whether such employee is in India or outside India or whether such payment is made in india or outside India. The only requirement is that the assessee employee must be paid in respect of services rendered in India. A reference was also made in Sec.192(2) to draw a distinction between the expressions, ‘making the payment’ and ‘making the deduction’. With this distinction, it was contended that the very fact that Sec.192(2) authorises the employee to choose one of the several persons ‘making the payment’ and not ‘making the deduction’ is an indication that the obligation under Sec.192(1) attaches to ‘any’ person, who is responsible for making payment of Salary Income and is not limited to a person, who is under an obligation to deduct tax at source. It was finally contended that Sec.192 imposes a joint and several obligation on all the persons, who are responsible for paying any Salary Income to employees in India. In the alternative, it was contended that if it is held that it is only Indian Employer who is obliged to deduct tax at source and not the foreign employer (who is directly paying to the foreign account of the employee outside India), the obligation of the Indian employer has to be interpreted co-extensively and in respect of the entire Salary Income of the employees, so long as such Salary Income of the employee arises or accrues in India or is in respect of ‘services rendered in India’.

2.3.2 With regard to the issue relating to penalty under Sec.271C, on behalf of the Department it was contended that such penalty is in the nature of civil liability. The burden of bringing the case within the exception provided in Sec.273B, namely, showing ‘reasonable cause’, is squarely on the assessee. It was pointed out that in these appeals, the assessee has pleaded bona fide misunderstanding of law, which explanation does not satisfy the test of ‘reasonable cause’ and therefore, merits rejection.

2.4 The counsel appearing on behalf of Mis. Eli Lilly & Co. India Pvt. Ltd. [i.e., an Indian Company] raised various contentions. The Indian Company (which is Employer in India) was under no obligation to deduct tax under Sec.192(1) from the Home Salary, which was admittedly not paid by it. Sec.192(1) obliges the Employer to deduct tax out of the esti-mated salary income at the time of making payment thereof. Such TDS is required on estimated income for the reason that Salary Income is liable to change during the year on account of various reasons, such as increment, pay revision, payment of bonus, D.A., valua-tion of perquisites in kind, etc. Unlike most of the other provisions, TDS is required under Sec.192(1) at the time of payment of salary, the obligation of Employer is to deduct tax qua the amount actually paid by the Employer or paid on his behalf or on his account. Sec.192(2) specifically provides that when the employee is simultaneously in employment of more than one employer, the employee has an option to file with one employer (the chosen employer), a declaration of salary earned by him in Form No.12B and in that event, such chosen em-ployer is under an obligation to deduct tax on aggregate Salary Income of the employee. In the absence of exercise of option under Sec.192(2), the obligation of each employer is confined to the amount of salary actually paid by him and there is no statutory obligation on one employer to take into account the salary paid by other employer for the purpose of TDS. The TDS provisions are in the nature of machinery provisions, which enable easy col-lection and recovery of tax and the same are independent of charging provisions which are applicable to the recipients of income, whereas the IDS provisions are applicable to the Payer of income. The obligation of IDS on the Payer is independent of assessment of income in the hands of all the expatriate employees and hence the employer is obliged to deduct tax at source only from the payment made by him or payment made on his behalf or on his account. Each employer is required to comply with the TDS obligations in respect of Salary Income paid by him and the obligation does not extend to deduct tax out of Salary Income paid by other persons, when it is not on account of or on behalf of such employer, notwithstanding the fact that such salaries may have nexus with the service of the employee with the employer (Indian Company) and may be assessable to tax in India in the hands of the recipient employee. The payment of Home Salary by the Foreign Company in Netherlands was not on behalf of or on account of the Indian Company and consequently, the Indian Company was not under a statutory obligation to deduct tax from the entire Salary Income of the expatri-ate including Home Salary, particularly when the expatriates did not exercise an option under Sec.192(2) requiring the Indian Company to deduct tax from their aggregate Salary Income. It was also pointed out that each of the expatriate employees had paid directly the tax due on the Home Salary by way of advance taxi self-assessment tax from time to time and they had also filed their returns of income in India. In view of this, there is no loss to the Revenue of the alleged default of not deducting tax on the entire Salary Income as on account of short deduction of tax and hence, even if the Indian Company is regarded as ‘assessee-in-default’ in terms of Sec.201 of the Act, the tax alleged to be in default cannot be once again recovered from the Indian Company.

2.4.1 The counsel appearing on behalf of another Indian Company [M/ s. Erection Communica-tions Pvt. Ltd.] raised various contentions.

These include contentions with regard to the issue that such TDS provisions have no extra-territorial operations. In this regard it was, inter alia, submitted: there is no provision in the Act that TDS provisions shall apply to payment made abroad by a person who is located outside India, breach of such provisions results in severe penal and criminal action and therefore, penal and criminal liability imposition by a statute on foreigners in respect of their acts and omissions committed outside India should not be inferred unless there is a clear-cut provision in the Act to that effect, applicability of TDS provisions to payment made abroad has nothing to do with the taxability of such amount in India, there are various instances where the amounts paid outside India by a foreigner are taxable in India, but such payments are not subject to TDS provisions, etc. Dealing with the provisions of Sec.192(1), it was contended that the same can be divided into two distinct parts. First part creates a legal liability to deduct tax and the second part provides for computation of the amount of tax to be deducted. On a plain and correct reading of the provisions creating liability to deduct tax, the tax is deductible only from the amount paid or payable by the Payer and he is not at all required to deduct tax in respect of the amount paid by any other person. The second part of the provision also refers to only estimated Salary Income of the employee for the whole financial year on the basis of payment made by the Payer (Employer). Other contentions raised were similar to those raised by the earlier counsel.

2.4.2 Another counsel appearing on behalf of M/ s. Mitsui & Co. Ltd. also raised similar contentions. However, his main thrust was with regard to penalty imposed under Sec.271C. It was contended that the retention/continuation payment made to expatriates in Japan by Head Office (H.O.) of the Company was not taxable in India and/ or TDS provisions are not applicable to such payments. It was further stated that the Company had presented its case before the Department to this effect. However, after consultation with CBDT, it was agreed to pay the tax and accordingly the amount of tax and interest was deposited on the understanding that there will not be any penalty proceeding. Accordingly, both in law and on facts, the Department had erred in imposing penalty. To support his legal stand with regard to non-taxability of the amount also, various contentions were raised with reference to the provisions contained in Sec.9(1)(ii) as well as the Explanation introduced by the Finance Act, 1983 (w.ef 1.4.1979) and another Explanation introduced by the Finance Act, 1999 (w.ef 1.4.2000), to ultimately contend that despite the amendment made by the Finance Act, 1983, a salary paid for ‘off-period’ was not covered in the provisions and hence another amendment was made, which is prospective in nature. In effect, it seems that an attempt was made to show that taxability of such amount was debatable. The difference between the Branch (Branch Office) on the one hand and H.O. on the other hand recognised for the purpose of implementing TDS provisions was also brought out as, in this case, the expatriates were working at the Project Office in India and were getting salary for rendering services in India and at the same time, they were also getting continuation/retention payments (Home Salary) from the H.O. in Japan.

2.4.3 The Court also noted that the other counsels appearing for various other assessees have adopted the arguments taken up by the earlier counsels.   

[To be Concluded]

Concealment Penalty — Whether Disallowed Claim For Expenditure Amounts to “Furnishing Inaccurate ‘Particulars’ ”

Closements

Introduction :


1.1 Under the Income-tax Act (the Act), to safeguard the
interest of the Revenue against non-disclosure of correct income in the return
of income furnished by the assessee, various provisions are made including the
provisions for imposition of penalty for concealment of income. A penalty
u/s.271(1) c) of the Act (‘Concealment Penalty’) can be imposed in cases where
the assessee has concealed the particulars of his income (‘Concealed Income’) or
furnished inaccurate particulars of his income (‘Furnishing Inaccurate
Particulars of Income’). The action of imposition of penalty should clearly
bring out whether the penalty is imposed on account of concealed income or for
furnishing inaccurate particulars of income.

1.2 Explanation 1 to S. 271(1) provides legal fiction
whereunder any addition or disallowance is deemed to represent the concealed
income for the purpose of levy of concealment penalty once the condition
provided in the Explanation are satisfied (hereinafter this Explanation 1 is
regarded to as the said Explanation). The said Explanation shifts the burden of
proof from the Department to the assessee as regards the concealed income. In
substance, the said Explanation provides for a deeming fiction whereunder any
addition or disallowance made to the total income is regarded as concealed
income for the purpose of levy of concealment penalty under the circumstances
mentioned therein. The said
Explanation has undergone change from time to time and the same was last
substituted by the Taxation Laws (Amendment) Act, 1975 and the same was
subsequently amended by the Taxation Laws (Amendment and Miscellaneous
Provisions) Act, 1986 w.e.f. 10-9-1986. It may also be noted that it is a
settled law that the issue of concealment of income for the purpose of imposing
concealment penalty is to be decided on the basis of the law in force at the
time of furnishing return of income.

1.3 In the context of the levy of concealment penalty,
various issues are under debate. By and large, in practice, once any claim of
expenditure made in the return of income is disallowed [or any addition is made
to the returned income], the assessing authority initiates proceedings for
imposition of concealment penalty. In most such cases, once such
disallowance/addition is confirmed by the First Appellate Authority, generally
the assessing authority imposes concealment penalty, though it is a settled
position in law that mere disallowance of expenditure or addition to income by
itself does not give rise to concealed income.

1.4 In the context of imposition of concealment penalty,
various issues are under debate. One such issue is : whether disallowance of
claim of expenditure treating the same as incorrect amounts to furnishing
inaccurate particulars of income, attracting provisions relating to concealment
penalty.

1.5 Earlier, the Apex Court in the case of Dilip N. Shroff
(291 ITR 519), inter alia, held that the order imposing such penalty is
quasi-criminal in nature and the concealment of income and furnishing inaccurate
particulars of Income, both, referred to deliberate act on the part of the
assessee. In substance, the Court expressed the view that mens rea is essential
ingredient for invoking provisions relating to concealment penalty. The Apex
Court, in this case, also made various other important observations with regard
to provisions relating to concealment penalty.

1.6 Subsequently, another Division Bench of the Apex Court,
in the context of similar provisions relating to the levy of penalty under
Central Excise Act, 1944 and the rules made thereunder (the Excise Act), had to
consider some of the views expressed in the above referred judgment of Dilip N.
Shroff (Dilip N. Shroff’s case). At the instance of this Division Bench of the
Apex Court, the relevant issue was referred to a Larger Bench (consisting of
three Judges) and that is how the Larger Bench in the case of Dharmendra
Textiles Processors (306 ITR 277) considered the effect of the judgment of the
Apex Court in the case of Dilip N. Shroff (supra). Primarily, the latter
judgment was concerned with the levy of penalty under the Excise Act. The Larger
Bench in this case (Dharmendra Textile’s case), did not agree with the view
taken in Dilip N. Shroff’s case. We have analysed this judgment in this column
in the December, 2008 issue of the Journal. In our write-up, we have expressed
the view that the judgment in Dharmendra Textile’s case overrules the judgment
of Dilip N. Shroff’s case only to the extent it holds that deliberate act on the
part of the assessee will have to be proved for the levy of concealment penalty
(i.e., mens rea is essential ingredient of the provisions) and the order
imposing such penalty is quasi-criminal in nature, but the other observations
made in Dilip N. Shroff’s case in the context of concealment penalty
u/s.271(1)(c) should continue to hold good, as the Apex Court in the case of
Dharmendra Textile’s case was neither specifically concerned with those
observations, nor with the provisions of S. 271(1) (and the Explanation thereto)
of the Act.

1.6.1 Unfortunately, subsequent to the judgment in the case
of Dharmendra Textile’s case, by and large in most cases, the Department appears
to have taken a view that once the disallowance/addition is confirmed at the
Appellate level and the final total income is higher than the returned income,
provisions relating to levy of concealment penalty get attracted.

1.6.2 In various decisions of the Tribunal, the effect of the
judgment in Dharmendra Textile’s case came up for consideration under different
circumstances and on different set of facts. In most such cases, by and large,
the different Benches of the Tribunal have not accepted the extreme stand taken
by the Department on the effect of the judgment in Dharmendra Textile’s case and
in those decisions, the effect of the said judgment is explained under different
circumstances [Ref. Gem Granite — 18 DTR 358 (Chennai), Mrs. Najma Kanchwalla —
24 DTR 369 (Mumbai), Glorious Reality (P) Ltd. — 29 SOT 292 (Mumbai), Veejay
Service Station — 22 DTR 527 (Delhi), V.I.P. Industries Ltd. — 21 DTR 153
(Mumbai), etc.]. Apart from this, the Delhi High Court in the case of Escorts
Finance Ltd. (ITA No. 1005 of 2008) also explained the effect of Dharmendra
Textile’s case. After considering the said judgment of the Apex Court, the
Punjab and Haryana High Court in the case of Haryana Warehousing Corporation
also took the view that no concealment penalty can be levied where the assessee
has made a bona fide claim of exemption by making proper and adequate disclosure
in the return of income even if the claim of such exemption is not accepted.
Even the Apex Court in the case of Rajasthan Spinning & Weaving Mills considered
the judgment in the case of Dharmaneda Textile and did not agree with the
extreme view of the Department, though in the context of the provisions under
the Excise Act.

1.6.3 A very detailed and well-reasoned decision explaining the effect of the judgment in Dharmendra Textile’s case is found in the case of Kanbay Software India [P] Ltd. — 22 DTR 481 (Pune). In this decision, various aspects of concealment penalty have been considered in detail.

1.7 Notwithstanding the above, the controversy with regard to the effect of Dharmendra Textile’s case continued. In spite of various decisions of the Apex Court and the High Courts explaining the provisions relating to concealment penalty, by and large, the Department is invoking these provisions in most cases where any disallowance of expenditure/claim of deduction or addition to income is confirmed at the Appellate level. In this scenario, the judgment of the Apex Court in Dharmendra Textile’s case gave a fillip to the existing practice, adding fuel to the fire, and the problem got aggravated, notwithstanding the subsequent development on the issue referred to hereinbefore. The Department continued to hold a view that the judgment in Dilip N. Shroff’s case is no longer a good law. On the other hand, the view held in the profession, by and large, was that the Larger Bench in the Dharmendra Textile’s case overrules the judgment in Dilip N. Shroff’s case only to the extent it holds that mens rea is essential ingredient of the provisions relating to concealment penalty and the provisions are quasicriminal in na-ture and except for this, the judgment in Dilip N. Shroff’s case is still a good law.

1.8 Recently, the Apex Court in the case of Reliance Petroproducts Pvt. Ltd. had an occasion to consider the issue referred to in para 1.7 above and hence the judgment of the Apex Court in that case becomes relevant and important in relation to the matters concerning concealment penalty. Therefore, it is thought fit to consider the same in this column.

CIT v. Reliance Petroproducts Pvt. Ltd.
— 322 ITR 158 (SC) :

2.1 The above case relates to A.Y. 2001-02. The brief facts of the said case were : The assessee had furnished return of income showing a loss of Rs.26,54,554. The assessee had claimed deduction of expenditure by way of interest (Rs.28,77,242) on borrowing for the purpose of purchase of shares of IPL by way of its business policy. The assessee did not earn any income from those shares and the Assessing Officer (AO) disallowed the claim of the said interest expenditure by invoking provision of S. 14A. Accordingly, the income was assessed at Rs.2,22,688.

2.2 In response of show-cause notice regarding concealment penalty, the assessee, inter alia, contended that all the details given in the return of income were correct and it was neither a case of concealment of income, nor a case of furnishing any inaccurate particulars of such income. It was also pointed out that the disallowance is made in the as-sessment solely on account of different view taken on the same set of facts and hence, at the most, the same could be termed as difference of opinion and not a case of concealed income or a case of furnishing inaccurate particulars of income as contemplated in provisions relating to concealment penalty. It was also pointed out that the assessee is an invest-ment company and in the earlier A.Y. (i.e., 2000-01) similar disallowance is deleted by the First Appellate Authority and that view has also been confirmed by the Appellate Tribunal. The AO did not accept the contentions of the assessee and imposed a penalty of Rs.11,37,949. The First Appellate Authority deleted the penalty and the appeal of the Department before the Appellate Tribunal also did not succeed. The High Court also confirmed the order of Appellate Tribunal. Under these circumstances, the issue with regard to the said penalty came-up before the Apex Court at the instance of the Department.

2.3 On behalf of the Department, it was, inter alia contended that the claim of interest expenditure was totally without any legal basis and was made with mala fide intentions and the claim was also not accepted by the First Appellate Authority and hence it was obvious that such claim did not have any basis. It was also pointed out that the issue of deductibility of such expenditure in the earlier year is pending before the High Court. It was further contended that otherwise also, the expenditure of interest is not eligible for deduction u/s.36(1)(iii) of the Act as under the said provision, only the amount of interest paid on capital borrowed for the purpose of business/profession could be claimed and the present case was not in respect of the capital borrowed for such purposes. Attention was also drawn to the provisions of S. 10(33) to show that expenditure incurred in relation to exempt income is not deductible. In short, the contention was that the assessee had made a claim, which was totally unacceptable in law and thereby had invited the provisions relating to concealment penalty and had exposed itself to such provisions.

2.4 On behalf of the assessee, it was, inter alia, contended that the language of the provision of concealment penalty had to be strictly construed, this being part of a taxing statute and more particularly the one providing for penalty. Accordingly, unless the wording directly covered the assessee and the factual situation therein, there could not be any penalty under the Act. It was also pointed out that there was no case of concealed income or the case of furnishing inaccurate particulars of income in the return furnished by the assessee.

2.5 After considering the contentions of both the sides, the Court proceeded to consider the issue further and after referring to the relevant provisions of the Act, the Court noted that the provisions suggest that for imposing concealment penalty, there has to be concealed income or furnishing inaccurate particulars of income. The Court then noted that the present case is not the case of concealed income and that is not the case of the Department either. On behalf of the Department, it was suggested that by making incorrect claim for the expenditure of interest, the assessee has furnished inaccurate particulars of income. Dealing with this contention, after referring to the dictionary meaning of the word ‘particulars’, the Court stated that the same used in S. 271(1)(c), would embrace the meaning of the de-tails of claim made. It is an admitted position that in the present case no information given in the return was found to be incorrect or inaccurate. It is not, as if, any statement made or any details supplied were found to be factually incorrect. Therefore, at least, prima facie, the assessee cannot be made guilty of furnishing inaccurate particulars of income. While dealing with the interpretation of the Department that ‘submitting an incorrect claim in law for the expenditure on interest would amount to giving inaccurate particulars of such income’, the Court stated that such cannot be the interpretation of the concerned words. According to the Court, the words are plain and simple and in order to expose the assessee to concealment penalty, unless the case is strictly covered by the provision, the penalty provision cannot be invoked. According to the Court, by any stretch of imagination, making an incorrect claim in law cannot tantamount to furnishing inaccurate particulars of income. The Court also referred to the judgment of the Apex Court in the case of Atul Mohan Bindal (317 ITR 1), in which the Court considered the same provisions. After referring to judgment in Dharmendra Textile’s case, as also to the judgment in the case of Rajasthan Spinning and Weaving Mills (supra), the Court in that case reiterated on page 13 of the judgment that : ‘It goes without saying that for applicability of S. 271(1)(c), conditions stated therein must exist’.

2.6 After mentioning the above position in law, the Court referred to the Dilip N. Shroff’s case and stated as under (pages 164-165) :

“Therefore, it is obvious that it must be shown that the conditions u/s.271(1)(c) must exist before the penalty is imposed. There can be no dispute that everything would depend upon the return filed because that is the only document where the assessee can furnish the particulars of his in-come. When such particulars are found to be inaccurate, the liability would arise. In Dilip N. Shroff v. Joint CIT, (2007) 6 SCC 329, this Court explained the terms ‘concealment of income’ and ‘furnishing inaccurate particulars’. The Court went on to hold therein that in order to attract the penalty u/s.271(1) (c), mens rea was necessary, as according to the Court, the word ‘inaccurate’ signified a deliberate act or omission on behalf of the assessee. It went on to hold that clause (iii) of S. 271(1)(c) provided for a discretionary jurisdiction upon the assessing authority, inasmuch as the amount of penalty could not be less than the amount of tax sought to be evaded by reason of such concealment of particulars of income, but it may not exceed three times thereof. It was pointed out that the term ‘inaccurate particulars’ was not defined anywhere in the Act and, therefore, it was held that furnishing of an assessment of the value of the property may not by itself be furnishing inaccurate particulars. It was further held that the Assessing Officer must be found to have failed to prove that his explanation is not only not bona fide but all the facts relating to the same and material to the computation of his income were not disclosed by him. It was then held that the explanation must be preceded by a finding as to how and in what manner, the assessee had furnished the particulars of his income. The Court ultimately went on to hold that the element of mens rea was essential. It was only on the point of mens rea that the judgment in Dilip N. Shroff v. Joint CIT was upset”.

2.7 The Court then dealt with the judgment of Dharmendra Textile’s case and the effect thereof on Dilip N. Shroff’s case and explained as under (page

165) :

“. . . . . . The basic reason why the decision in Dilip N. Shroff v. Joint CIT was overruled by this Court in Union of India v. Dharmendra Textiles Processors, was that according to this Court the effect and dif-ference between S. 271(1)(c) and S. 276C of the Act was lost sight of in the case of Dilip N. Shroff v. Joint CIT. However, it must be pointed out that in Union of India v. Dharmendra Textile Processors, no fault was found with the reasoning in the decision in Dilip N. Shroff v. Joint CIT, where the Court explained the meaning of the terms ‘conceal’ and ‘inaccurate’. It was only the ultimate inference in Dilip N. Shroff v. Joint CIT to the effect that mens rea was an essential ingredient for the penalty u/s. 271(1)(c) that the decision in Dilip N. Shroff v. Joint CIT was overruled.”

2.8 The Court then noted that in the present case, it is not concerned with mens rea and also stated that it has seen the meaning of the word ‘particu-lars’ earlier. The Court then stated as under (pages165-166) :

“. . . . . . Reading the words in conjunction, they must mean the details supplied in the return, which are not accurate, not exact or correct, not according to truth or erroneous. We must hasten to add here that in this case, there is no finding that any details supplied by the assessee in its return were found to be incorrect or false. Such not being the case, there would be no question of inviting the penalty u/s.271(1)(c) of the Act. A mere making of the claim, which is not sustainable in law, by itself, will not amount to furnishing inaccurate particulars regarding the income of the assessee. Such claim made in the return cannot amount to the inaccurate particulars.”

2.9 The Court then referred to the argument based on S. 14A of the Act and the points raised and reiterated that such claim of excessive deductions, knowing that they are incorrect, amounted to concealed income. Further, the Court noted that it was tried to be argued that the falsehood in accounts can take either of two forms : (i) an item of receipt will be suppressed fraudulently or (ii) an item of expenditure may be falsely (or in an exaggerated amount) claimed. According to the Department, both types of items are to reduce the taxable income and therefore, amount to concealed income as well as furnishing of inaccurate particulars of income. Rejecting these contentions, the Court stated as under (page 166) :

“We do not agree, as the assessee had furnished all the details of its expenditure as well as income in its return, which details, in themselves, were not found to be inaccurate, nor could be viewed as the concealment of income on its part. It was up to the authorities to accept its claim in the return or not. Merely because the assessee had claimed the expenditure, which claim was not accepted or was not acceptable to the Revenue, that by itself would not, in our opinion, attract the penalty u/s. 271(1)(c). If we accept the contention of the Revenue, then in case of every return where the claim made is not accepted by the Assessing Officer for any reason, the assessee will invite penalty u/s.271(1)(c). That is clearly not the intendment of the Legislature.”

2.10 The Court then also referred to the judgment of the Apex Court in the case of Sree Krishna Electricals (27 VST 249) rendered under the Tamil Nadu General Sales Tax Act in connection with the penalty proceedings wherein the authorities had found that there were some incorrect statements made in the return, though the said transactions were reflected in the accounts of the assessee. The Court then quoted the following observations from the judgment in that case (page 167) :

“So far as the question of penalty is concerned, the items which were not included in the turnover were found incorporated in the appellant’s account books. Where certain items which are not included in the turnover are disclosed in the dealer’s own account books and the assessing authorities include these items in the dealer’s turnover disallowing the exemption, penalty cannot be imposed. The penalty levied stands set aside.”

2.10.1 Referring to the above-referred observations in the context of penalty proceedings under the Sales Tax Act of Tamil Nadu, the Court stated that the situation in the present case is still better as no fault has been found with the particulars submitted by the assessee in his return. Accordingly, the Court held that the First Appellate Authority, the Tribunal and the High Court have correctly reached the conclusion and accordingly, dismissed the appeal filed by the Department as without merit.

Conclusion :
3.1 In view of the above judgment of the Apex Court, the settled position is again reiterated that mere disallowance of claim for expenditure by itself would not tantamount to furnishing inaccurate particulars of income and accordingly, in such cases no concealment penalty can be levied on that basis, notwithstanding the judgment of the Apex Court in Dharmendra Textile’s case. We hope that this principle reiterated by the Apex Court will be followed by the Department in spirit. We also hope that the Department will not initiate proceedings for the levy of concealment penalty in such cases.

3.2 From the above judgment of the Apex Court, it is now clear that the judgment of the Apex Court in Dilip No. Shroff’s case is overruled by the judgment in Dharmendra Textile’s case only to the extent it holds that the element of mens rea is essential for levy of concealment penalty and the other observations in Dilip N. Shroff’s case will continue to hold good, except perhaps the observations with regard to nature of concealment penalty.

Copyright : A joint owner of a copyright, without the consent of the other joint owner cannot grant licence or interest in the copyright : Copyright Act, 1957.

6. Copyright : A joint owner of a copyright, without the consent of the other joint owner cannot grant licence or interest in the copyright : Copyright Act, 1957.

    The petitioner sought injunction restraining the respondents from transferring, licensing or sub- licensing any rights in the copyright of the film ‘Victoria No. 203’ to any third party.

    The facts giving rise to the controversy between the parties are that the petitioner is the producer and first owner of copyright in the film ‘Victoria No. 203’. By an agreement dated 26th July 2007, the petitioner assigned to the respondent alongwith him joint ownership in the ratio of 50 : 50 of the rights in the negative of the film. There was some dispute between the parties as to whether copyright in the film or only in the negatives of the film are assigned. That would be decided by the Arbitral Tribunal. Clause No. 8(d) of the agreement provides that the respondents shall be entitled to enter into an agreement in respect of his rights (under the agreement) by making the petitioner the confirming party to the agreement. The agreement provides that all disputes and differences arising between the parties in connection with the agreement shall be resolved by mutual consent, failing which the disputes shall be referred to arbitration. Pending constitution of the Arbitral Tribunal and reference, the petitioner has claimed interim injunction.

    The Hon’ble Court observed that the petitioner was the producer and original holder of the copyright in the film. Perusal of clause No.8 of the agreement prima facie showed that the petitioner had made the respondents joint owners of the copyright to the extent of 50%, the petitioner had further given the right to the respondents to exploit the said copyright by entering into an agreement with others, but subject to petitioner being made the confirming party to the agreement. According to the petitioner, the respondents have negotiated with a third party for exhibiting of the film abroad without the consent of the petitioner.

    Placing reliance on the decision of the Supreme Court in M/s. Power Control Appliances vs. Sumeet Machines P. Ltd., (1994) Vol. 2 SCC 448, it was held that in respect of joint ownership of a copyright, the use of the copyright must be made jointly by the co- owners and individual use by any one of the co- owners is not permissible.

    A joint owner of a copyright cannot, without the consent of the other joint owner, grant a licence or interest in the copyright. The respondents cannot exploit the copyright singly or individually. The exploitation of the copyright must be jointly made by the petitioner and respondents, as they are the joint owners. The respondents are not entitled to grant licence for exploitation of the film ‘Victoria No. 203’ without the concurrence of the petitioner. In view of above, the petitioner was entitled to an injunction pending the arbitration.

    [Angath Arts P. Ltd. vs. Century Communications Ltd. & Anr. AIR 2009 Bom. 26.]

Tenancy : Tenant can be evicted if subletting is done without the consent in writing of the landlord

New Page 1

10 Tenancy : Tenant can be evicted if
subletting is done without the consent in writing of the landlord.

The appellant No. 1 was inducted as a tenant in the year 1956
by the erstwhile owners of the suit shop. He was all along in continuous
possession of the suit shop and was conducting the business from the same along
with his brother, under the name and style of M/s. Mitra Book Depot. The rent
receipts issued by the landlord were in the name of M/s. Mitra Book Depot as
tenant.

Subsequently, a business was started in a portion of the suit
shop in the name of M/s. Mitra Stores and M/s. Lucky Confectioners being
appellants 2 to 4. In the year 2000, the owners sold the suit shop to one Anil
Anand. However, the rent of the suit shop was continued to be paid to erstwhile
owners by the appellant. Mr. Anil Anand sold the suit shop to the respondent by
a registered deed of sale in year 2000. However, the appellant No. 1 went on
depositing the rent in the name of the original landlord. Finally, in February,
2002, the respondent filed an eviction petition before the Rent Controller,
Delhi u/s.14(1)(b) of the Act on the ground of subletting by the appellant No.
1. The Rent controller passed the order of eviction by holding, inter alia,
that the case of subletting was duly proved as from the evidence on record, both
oral and documentary, it was clear that an independent business was run by the
appellants and that they were in exclusive possession of a portion of the suit
shop.

The appellants filed a writ petition before the High Court of
Delhi and the High Court dismissed the same.


 S. 14(1)(b) of the Act, reads as under :

“That the tenant has, on or after the 9th day of June,
1952, sublet, assigned or otherwise parted with the possession of the whole or
any part of the premises without obtaining the consent in writing of the
landlord.”

On further appeal the Supreme Court observed that if a tenant
had sublet or assigned or otherwise parted with the possession of the whole or
any part of the premises without obtaining the consent in writing of the
landlord, he would be liable to be evicted from the said premises as per S.
14(1). That is to say, the following ingredients must be satisfied before an
order of eviction can be passed on the ground of subletting :


(1) the tenant has sublet or assigned or parted with the
possession of the whole or any part of the premises;

(2) Such subletting or assigning or parting with the
possession has been done without obtaining the consent in writing of the
landlord.

 


In Kailasbhai Shukaram Tiwari v. Jostna Laxmidas Pujara
and Anr., Manu/SC/2529/2005, while dealing with a case of subletting under
the Bombay Rules, Hotel and Lodging House Rates Control Act, 1947 (57 of 1947),
the Apex Court observed that the question as to whether a person is a member of
the family of the tenant must be decided on the facts and circumstances of the
case. It observed in paragraph 14 as follows :

“Apart from the parents, spouse, brothers, sisters, sons
and daughters, if any other relative claims to be a member of the tenant’s
family, some more evidence is necessary to prove that they have always resided
together as members of one family over a period of time. The mere fact that a
relative has chosen to reside with the tenant for the sake of convenience,
will not make him a member of the family of the tenant in the context of rent
control legislation.”

 


In the facts of the case, the appellant No. 1 had parted with
the exclusive possession of a part of the suit premises in favour of the
appellant Nos. 2 to 4 without obtaining the consent in writing, either of the
erstwhile landlord or the purchaser respondent, nor the appellant could prove
that appellant nos. 2 to 4 being the family members were assisting him it the
business, hence the appeal was dismissed.

[Vaishakhi Ram & Ors. v. Sanjeev Kumar Bhatiani, Civil Appeal No. 1559
of 2008, dated 25-2-2008, Supreme Court of India.]

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Stamp duty : Cousins not being members of the family do not fall with definition of word ‘family’ under Stamp Act : S. 45(a).

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9 Stamp duty : Cousins not being members of
the family do not fall with definition of word ‘family’ under Stamp Act : S.
45(a).


The respondents herein are the sons of two brothers. They
entered into a deed of partition in respect of certain properties and presented
the same for registration. The respondents paid the fixed stamp duty as per
Article 45(a) of the Act. The District Registrar did not agree with the stamp
duty and held the said document as a pending document.

 

On appeal for release of documents, the Madras High Court
observed that the document presented for registration though titled as partition
deed was not actually a partition deed between two blood brothers. The
respondents were first cousins and the document was one falling under Article
45(b) of the Act. The word ‘family’ means as defined under Article 58 and reads
as under :

“Father, mother, husband, wife, son, daughter, grandchild.
In the case of any one whose personal law permits adoption, ‘father’ shall
include an adoptive father, ‘mother’ an adoptive mother, ‘son’ an adopted son
and ‘daughter’ an adopted daughter.”

 


Thus, it is seen that the word, ‘family’ is given a
restrictive meaning in its application to Article 58 and the same meaning is
imported to the word ‘family’ appearing in Article 45 of the Act. Consequently,
the respondents would be entitled to claim the benefit of concessional rate of
stamp duty under Article 45(a) only if both of them are members of a family,
within the meaning of the definition of the word, ‘family’ under Article 45(a).
Therefore, prima facie, the objection raised by the appellants i.e.,
District Registrar with regard to the nature of the document is well founded.
Under such circumstances, it was not possible to order the release of the
documents.

[ District Registrar, Tindivanam and Anr. v. V.
Ranganathan & Anr., AIR 2008 Mad 73.]

 


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Deficiency in services by airline

New Page 1

7 Deficiency in services by airline :

Consumer Protection Act. 2(1)(g).

The airline unilaterally cancelled the ticket without
intimating to the passenger prior to cancellation of tickets of onward journey.
Notice on ticket stipulated that passenger if breaks journey for more than 72
hours had to reconfirm the onward reservation. Telephones of the airline were
busy when passengers tried to reconfirm, nor emails of passenger were replied.

 

In these circumstances it was held that as the telephone
system was not functioning, the clause mentioned on ticket cannot be applied.
The airline was held deficient in its services.

[ Air India v. Prakash Singh & Anr., AIR 2008 (NOC)
666 (NCC)]

 


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Maintenance : Mother can claim maintenance against her son : S. 125 of Cr. P.C.

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8 Maintenance : Mother can claim maintenance
against her son : S. 125 of Cr. P.C.


The respondent herein is the mother of the present applicant
Rafiuddin. The respondent was divorced in the year 1973. She had no source of
income and nobody was ready to maintain her. Therefore she claimed maintenance
from the present applicant i.e., son.

The Court relying on the decision in case of Mahendrakumar
Ramrao Gaikwad v. Golbhai Ramrao Gaikwad and Anr., 2000(2) Mh. L. J. 378 (Bom.)
held that the son cannot be absolved from his responsibility to maintain his
mother; even though the husband may be alive, son is one of those persons from
whom a woman can claim maintenance u/s. 125 of Cr. P.C.

 

The mother would be entitled to claim maintenance from the
son u/s.125 of Cr. P.C., irrespective of the fact that the husband is alive.

[ Rafiddin v. Smt. Salecha Khatoon, AIR 2008 NOC 776
(Bom.)]

 


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Co-operative Housing Society : A member of tenant co-partnership housing society is not a tenant of the society : Rent Act 1947, S. 5(11) and Maharashtra Co-operative Societies Act, 1961, S. 29.

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6 Co-operative Housing Society : A member of
tenant co-partnership housing society is not a tenant of the society : Rent Act
1947, S. 5(11) and Maharashtra Co-operative Societies Act, 1961, S. 29.


The respondent No. 1 Belfer Co-op. Housing Society Ltd. was a
tenant co-partnership housing society which held both land and flats constructed
thereon and Dr. Gopal Mahadevo Dhadphale respondent No. 2 was admitted as member
of the society. The said respondent No. 2 inducted M/s. Anita Enterprises and
M/s. Anita Medical Systems P. Ltd. being appellants no. 1 and 2 in Room No. 1
and 2 of the said premises on monthly rent. Both the appellants were put in
possession of the aforesaid premises. Thereafter certain dispute arose between
respondent No. 2 and the appellants. The appellants filed two separate suits for
a declaration that they were tenants with regard to the aforesaid premises. The
suit was dismissed by Trial Court.

 

Meanwhile the society raised a dispute before the
Co-operative Court u/s.91 of the Maharashtra Co-op. Societies Act, 1960 for
evicting the appellants from the premises. The Co-op. Court decided the dispute
in favour of the society and passed eviction order against the appellant. The
Division Bench of the High Court upheld the orders of the Co-op Court.

 

S. 12 of the Maharashtra Co-op. Societies Act lays down that
the Registrar shall classify all societies into one or other of the classes of
societies defined in S. 2 and also into such subclasses thereof, as may be
prescribed. Rule 10 prescribes such classification of the societies and under
Rule 10(1)(5) three types of housing societies have been enumerated.


Class

Sub-class

Examples of societies falling in the class or subclass,
as the case may be

1. 2. 3
Housing society (a) Tenant ownership
housing society		 Housing societies
where land is held either on leasehold or freehold basis by societies and
houses are owned or are to be owned by members.
(b) Tenant
Co-partnership housing society.		 Housing societies
which hold both land and buildings either on leasehold or freehold basis and
allot them to their members.
(c) Other housing
societies.		 House mortgage
societies and House construction societies.

 

In the case of tenant co-partnership housing society, it is
clear from the rules that the ownership of the land and building both remains
with the society and a member cannot be said to be co-owner, but in the case of
tenant ownership housing society, the ownership of the land remains with the
society, but ownership of the building/flat vests in the member. So far as
tenant within the meaning of S. 5(11) of the Rent Act is concerned, he has a
mere right to occupy. He is entitled to the protection of the statute so long as
grounds for eviction are not made out and can be evicted only by instituting a
suit in a Court enumerated u/s.28 of the Rent Act.

 

The concept of tenant co-partnership housing society was
considered by the Apex Court in the case of Sanwarmal Kejriwal v. Vishwa
Co-operative Housing Society Ltd., (1990) 2 SCC 288, wherein it was noticed
that the title to the property, i.e., the land and building/flat both,
vests in the society.

 

The status of a member in a tenant co-partnership housing society is very peculiar. The ownership of the land and building both vests in the society and the member has, for all practical purposes, right of occupation in perpetuity after the full value of the land and building and interest accrued thereon have been paid by him. Although dejure, he is not owner of the flat allotted to him, but, in fact, he enjoys almost all the rights which an owner enjoys, which includes right to transfer in case he fulfils the two pre-conditions, namely, he occupies the property for a period of one year and the transfer is made in favour of a person who is already a mem-ber or a person whose application for membership has been accepted by the society or whose appeal u/ s.23 of the Societies Act has been allowed by the Registrar or to a person who is deemed to be a member U/ss.(IA) of S. 23 of the Societies Act. In case any of these two conditions is not fulfilled, a member cannot be said to have any right of transfer. Thus, the law laid down by the Apex Court in the case of Sanwarmal (supra) is that a member has more than a mere right to occupy the flat, meaning thereby higher than tenant, which is not so in the case of a tenant within the meaning of S. 5(11) of the Rent Act. Therefore the status of a member in the case of tenant co-partnership housing society cannot be said to be that of a tenant within the meaning of S. 5(11) of the Rent Act, as such there was no relationship of landlord and tenant between the society and the member. Thus the appellants were not entitled to protection of the Rent Act. In view of the above, the appeals were dismissed.

[M/s. Anita Enterprises & Anr. v. Belfer Co-op. Hsg. Society Ltd. & Ors., AIR 2008 SC 746]

News report

Cancerous Corruption

Top service tax officer arrested for attempt to extort Rs.2 lakh


A Service Tax Superintendent, who attempted to extort Rs.2
lakh from a city transporter by threatening him of penal action for alleged
Service Tax evasion, was arrested by the CBI on Friday
night. A person who acted as facilitator on behalf of the tax official has also
been arrested.

According to CBI sources, Service Tax Superintendent, S. G.
Desai, 45, and his accomplice Neerav Mayekar, were arrested from a hotel
opposite Vile Parle railway station when they accepted the bribe of Rs.1 lakh,
being the first instalment of Rs.5 lakh bribe demanded by the tax official.

The complainant runs a ‘packers & movers’ service in Goregaon.
Desai whose office scrutinises Service Tax payment by business establishments
had sent a notice to the complainant saying he had
paid Service Tax at the rate of 3.65 per cent, though he was supposed to file it
at the rate of 12.63 per cent.

When the complainant objected, Desai asked him to furnish
accounts for the past five years and later allegedly demanded Rs.5 lakh to
settle the matter. The amount was finally settled at Rs.2 lakh, of which Rs.1
lakh was to be paid on Friday night. The CBI laid a trap and arrested the duo
while accepting the money.

(Source : Mumbai Mirror Bureau)

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Technology news this week

In spite of the current downtrend, the investment and development in newer technology continues unabated. This month, I have pieced together some of the latest developments in the Information Technology industry to gain some insight about the recent developments.

Pirate Bay verdict and file-sharing

    The internet has always been a symbol for knowledge sharing. Among other things, countless users have been sharing much more than just knowledge i.e., personal information, music, movies, etc. Sharing music and movies first began hurting the entertainment industry at large, that’s when law enforcement agencies started cracking down on such sites. Pirate Bay was one such file-sharing sites and is the latest casualty of the cause. The verdict against the founders of The Pirate Bay is being hailed by many as a triumphant win against illegal file-sharing. The four men involved in the BitTorrent tracking site were found guilty of being accessories to violating copyright law. A Swedish Court sentenced each of them to a year in jail and a collective fine of $3.6 million. In the long run, though, the verdict may not be as significant as some suggest, when it comes to the battle against online file-sharing. Other players have opined this because, just like Napster, The Pirate Bay doesn’t actually host copyrighted files — it simply allows users to post links to material hosted on third-party servers. That’s why, incidentally, prosecutors ended up dropping the initial charge of ‘assisting copyright infringement’ and pursuing only a ‘assisting making available copyrighted material’ charge instead.” The Court said even if you are distributed, you are nevertheless encouraging your customers to violate copyright, and we’ll hold you accountable.

Stealthy Rootkit

    Countless websites have been rigged to deliver a powerful piece of malicious software that many security products may be unprepared to handle. The malicious software is a new variant of Mebroot, a program known as a ‘rootkit’ for the stealthy way it hides deep in the Windows operating system. An earlier version of Mebroot first appeared around December 2007 and used a well-known technique to stay hidden.

    Since Mebroot appeared, security vendors have refined their software to detect it. But the latest version uses much more sophisticated techniques to stay hidden. The new variant inserts program hooks into various functions of the kernel, or the operating system’s core code. Once it has taken hold, the malware then makes it appear that the Master Boot Record (MBR) hasn’t been tampered with. The rootkit infects the computer’s MBR, as a result it’s the first code a computer looks for when booting the operating system after the BIOS runs. If the MBR is under a hacker’s control, so is the entire computer and any data that’s on it or transmitted via the Internet. Then, each time the computer is booted, Mebroot injects itself into a Windows process in memory, such as svc.host. Since it’s in memory, it means that nothing is written to the hard disk, another evasive technique. Mebroot can then steal any information it likes and send it to a remote server via HTTP.

    The infection mechanism is known as a drive-by download. It occurs when a person visits a legitimate website that’s been hacked. Once on the site, an invisible iframe is loaded with an exploit framework that begins testing to see if the browser has a vulnerability. If so, Mebroot is delivered, and a user notices nothing.

Nokia’s new E75 phone

    Nokia has unveiled a new addition to its E-series range, the Nokia E75 with Nokia Messaging Service which provides e-mail solutions on Nokia devices with the pre-installed Nokia Messaging push e-mail service. According to a press release the E75 is the first device from Nokia that offers complete integration of e-mail and messaging services and provides an easy process for instant e-mail set-up and supports up to 16 e-mail accounts. Among other things, the Nokia E75 boasts of full desktop e-mail functionality along with both standard keypad and QWERTY keypad. It is also touted to be capable of supporting all features of Nokia Messaging Service — a number of third party e-mail solutions, namely, Gmail, Yahoo, Rediffmail, Sify, Indiatimes, Net4, Hotmail and In.com amongst others.

    Of course the Nokia E75 comes with the usual stuff i.e., an intelligent input feature with auto-completion and correction, a 3.2 megapixel camera, autofocus, flash, and comes integrated with a music player, media player, FM and internet radio, an integrated A-GPS and pre-loaded maps on the memory card and last but not the least, the device includes a built-in mobile VPN for intranet access. In case you are wondering . . . . it also comes with a price tag of approx 27K.

The most vulnerable browser

    Firefox fans take note : News reports circulating on the net suggest that Firefox is far more vulnerable than Opera, Safari, and Internet Explorer — and by a wide margin. In 2008, it had nearly four times as many vulnerabilities as each of those browsers. The rumours suggest that Firefox had 115 vulnerabilities reported in 2008, compared to 30 for Opera, 31 for Internet Explorer, and 32 for Safari. That doesn’t mean, though, that Internet Explorer is off the hook for security concerns. Far from it. ActiveX remains the browser plug-in or add-on with the most number of vulnerabilities.

New iPhone 3.0 Beta software

Apple has released a third beta build of the iPhone 3.0 software, taking developers one step closer to the final release in June. One of the most significant additions to the latest beta of the iPhone 3.0 software is the way individual apps will be able to notify users of updates or additional content. At the moment, individual apps flag users only in iTunes of new events, but with the 3.0 build, they will be able to do so right on the phone via badge, text or sound notifications. Spotlight (phone-wide search) will now let users save the last search they made, and can set restrictions for inside-application purchases and location data. An interesting fact about the third beta of the iPhone 3.0 software is that the Skype app no longer works on 3G. With previous builds, Skype allowed 3.0 beta software users to place calls via 3G, unlike the same app on the current 2.2 platform, which can make calls only over Wi-Fi. Apple seems to have fixed this ‘bug’, so no more wishful thinking for cheap VolP in the 3.0 final release. This third beta of the iPhone 3.0 software indicates the imminent arrival of a final 3.0 software in June, just like Apple promised. However, the question remains whether we will get some new iPhone hardware as well, especially as rumors intensified over the last weeks, detailing hardware components and features.

That’s all for this month, I hope to have more interesting developments next month.

Open document format

Computer Interface

History :


Documentation became a part of our culture ever since the
written word was invented. Documentation as we all know, is the simplest method
of allowing understanding and referencing. The methods of documentation have of
course evolved over the years along with the formats in which the data
was stored. So also, data formats have been around for as long as
computing. They reflected the varying capabilities and functions of different
computing systems and have evolved as these computing systems have evolved. In
the decades since, a wide range of formats (TXT, PDF, HTML, and DOC, just to
name a few) became popular because they meet specific user needs and tap into
new computing capabilities as they evolved. Then came the increasing
expectations and demands and technology met them by changing at a scorching
pace. Advances were being made in the field literally on a day-to-day basis, to
the extent that redundancy actually became an inbuilt attribute.

With such advances and the passage of time, the ones who
don’t match the pace, fade away in the dark corners of technological redundancy.
Many of us have experienced disappearance of older formats. For instance : Punch
cards were once commonplace, but you wouldn’t think of using them today.
WordStar was once what everyone used as their word processor; now, even filters
to read the format are less and less common. (More closer to heart Tally 4.5 to
Tally 9, Windows 3.11 to Vista and so on so forth). Luckily, WordStar format is
similar to ASCII and is thus mostly recoverable. But there are times when I
can’t read some important PowerPoint 4 files in today’s PowerPoint, only 7 years
later. This has come to a point that a file you created in a software less than
half a decade ago is no longer usable. This because the software/application no
longer accepts (supports) it.

Today




  •  When you buy a music CD you know it will fit in your CD player.



  •  When you buy canned food, you know it will work with your can opener.



  •  When you buy a toaster, you know it will work with the power plugs in your
    house.



  • When you visit a website, do you need to know what software that website runs
    to create the web page ?



  •  When you send an email, do you need to know what email client your friend
    has ?



Then why should it be different for your documents ? You
should be able to send your documents to your customers without knowing what
office software they run and be confident that it would work. Have you ever had
trouble opening a document that someone sent you ? Have you ever bought a copy
of an application software that you didn’t want because you have to read
documents that only work with that version of an application software ? Have you
ever wondered why there is so little choice in office software ?


  •  What if you could send a file to anyone and know that they can read it ?



  •  What if you could buy any product you want and know that you can still
    communicate with your customers ?



This is where the OpenDocument Format (ODF), an open,
XML1-based file format for office documents comes into the picture.
OpenDocuments include text documents, spreadsheets, drawings, presentations and
more. An OpenDocument is freely available for any software maker to use and
implement and does not favour any vendor over all the others. The creation of
XML-based document formats continues this evolution, and even within this
category a number of formats are being developed, including ODF2, Open XML3 and
UOF4. We should expect the creation of new formats in the future as the
technology evolves, and, as has always been the case, users should be able to
choose the formats that work best for them.

Recent developments :

One objective of open formats like OpenDocument is to
guarantee long-term access to data without legal or technical barriers, and some
governments have come to view open formats as a public policy issue.
OpenDocument is intended to be an alternative to proprietary formats,
including the commonly used DOC, XLS, and PPT formats used by
Microsoft Office and other applications. Up until Feb. 15th 2008, these
latter formats did not have documentation available for download, and were only
obtainable by writing directly to Microsoft Corporation and signing a
restrictive non-disclosure agreement. As of Feb. 15th 2008, Microsoft
offers documents for download claiming to accurately specify the aforementioned
document formats (although this claim hasn’t been independently verified yet).
Microsoft is supporting the creation of a plug-in for Office to allow it to use
OpenDocument. The OpenDocument Foundation, Inc. has created a similar
plug-in that will allow continued use of Microsoft Office.

The OpenDocument format (ODF, ISO/IEC 26300, full name :
OASIS Open Document Format for Office Applications) is a free and open file
format for electronic office documents, such as spreadsheets, charts,
presentations and word processing documents. While the specifications were
originally developed by Sun, the standard was developed by the Open Office XML
technical committee of the Organisation for the Advancement of Structured
Information Standards (OASIS) consortium and based on the XML format originally
created and implemented by the OpenOffice.org office suite (see OpenOffice.org
XML).

Case for the Governments to adopt open document formats:

Case for the Governments to adopt open document formats:
In all humility, with whatever limited knowledge I have about technology and of the trends that are taking shape, I am now getting paranoid about the whole e filing process and the initiatives adopted by the Government.

Although the process was in bits and pieces (fits and start is more like it), the process adopted by the Government has been rather haphazard. Instead of learning from each other’s experience, every department has tried to do their “own thing”.
 
For instance : the e-filing process was kicked off by the Government in 2004. At the time text files were in vogue (still is with the etds process), then came the PDF- (MCA 21 and ITRs for Corp orates in AY 06-07). The last year it was Excel and XML and the story will go on.

This year the Government is pushing for efiling not only for Income Tax, but also for Service Tax, VAT . and other laws. Even here, there is no uniformity. The Income-tax Department is using XML format, VAT authorities seem to be following suit, but the Excise & Service Tax authorities are still depending on an HTML format (EASIEST), the MCA relies on the PDF format.

The concern stems from the fact that governments don’t create office documents, so that they can be tossed in the shredder. They often have to be accessible decades (or centuries) later, and many of them – have to be accessible to any citizen, regardless of what equipment they use or will use. Having said this, the question that needs to be answered is has the Government given a serious thought to the fact that although, PDF is a very useful display format, it has a different purpose – while it’s great at preserving formatting, it doesn’t let you edit the data meaningfully. HTML is great for web pages, or short, but it’s just not capable enough for data mining and data retrieval. Both HTML and PDF will continue to be used, but they cannot be used as a complete replacement.

The writing on the wall suggests that the taxpayer, along with dealing with the many intricacies in law, will now be saddled with the additional burden of dealing with multiple data formats. Nobody knows what will happen 5-7 years down the line when presumably better formats are in vogue. Unless the Government realises the pitfalls and makes conscientious efforts in developing/adopting standardised/ open standard software, we will all have to save our old software packages and the files generated thru them, on floppies/CDs/DVD, etc. and pray that they still work when the sleeping giant wakes up.

Daughter’s Right In Coparcenary

My article on ‘Daughter’s right in coparcenary’ (BCAJ-January 2009, Page 509) has evinced considerable interest amongst the practising chartered accountants. I have been flooded with number of inquiries and questions. Some of the inquiries have raised interesting supplemental questions, which justify an additional article on broader aspects on the same subject.

As is well known, the Hindu Succession Act, 1956 (‘the Act’) was amended by the Hindu Succession (Amendment) Act, 2005 (‘the Amendment Act’) with effect from 9th September, 2005. S. 6 of the Act, which was substituted by the Amendment Act to the extent it is relevant to this Article reads as under :

    “6. Devolution of interest in coparcenary property. — (1) On and from the commencement of the Hindu Succession (Amendment) Act, 2005, in a joint Hindu family governed by the Mitakshara law, the daughter of a coparcener shall, —

    (a) by birth become a coparcener in her own right in the same manner as the son;

    (b) have the same rights in the coparcenary property as she would have had if she had been a son;

    (c) be subject to the same liabilities in respect of the said coparcenary property as that of a son, and any reference to a Hindu Mitakshara coparcener shall be deemed to include a reference to a daughter of a coparcener :

Provided that nothing contained in this sub-section shall affect or invalidate any disposition or alienation including any partition or testamentary disposition of property which had taken place before the 20th day of December, 2004.

(2) to (5) x x x

Explanation. — x x x”

S. 6 of the Act (as amended by the Amendment Act) inter alia provides that on and from the commencement of the Amendment Act, in a joint Hindu family governed by Mitakshara law, the daughter of a coparcener by birth becomes a coparcener in her own right in the same manner as the son. The Section further provides that any property to which a female Hindu becomes entitled by virtue of the provision shall be held by her with the incidents of coparcenary ownership and shall be regarded as property capable of being disposed of by her by testamentary disposition.

One interesting issue which arises for consideration is as to what happens in case of a daughter of a deceased coparcener of an HUF. The brief facts on which such question can arise could be :

    (a) there is an existing HUF consisting of father A (Karta) and his two sons B and C. Therefore, the HUF would consist of three coparceners, namely, A, B and C.

    (b) A dies before September, 2005 leaving his will whereby he bequeaths his undivided one-third share in the HUF assets to his HUF, so that the HUF continues with two coparceners B and C.

    (c) At the time of the death of A he has left no wife, but two daughters D and E.

    (d) The question is whether after passing of the Amendment Act, D and E get any right in the properties and assets of the HUF.

S. 6 of the Act as it stood at the time of the death of A (i.e., prior to the amendment) reads as under :

“6. Devolution of interest of coparcenary property : When a male Hindu dies after the commencement of this Act, having at the time of his death an interest in a Mitakshara coparcenary property, his interest in the property shall devolve by survivorship upon the surviving members of the coparcenary and not in accordance with this Act :

Provided that, if the deceased had left him surviving a female relative specified in Class I of the Schedule or a male relative specified in that class who claims through such female relative, the interest of the deceased in the Mitakshara coparcenary property shall devolve by testamentary or intestate succession, as the case may be, under this Act and not by survivorship.

Explanation 1 : For the purposes of this Section, the interest of a Hindu Mitakshara coparcener shall be deemed to be the share in the property that would have been allotted to him if a partition of the property had taken place immediately before his death, irrespective of whether he was entitled to claim partition or not.

Explanation 2 : Nothing contained in the proviso to this Section shall be construed as enabling a person who has separated himself from the coparcenary before the death of the deceased or any of his heirs to claim on intestacy a share in the interest referred to therein.

Based on the provisions of S. 6 of the Act as at the time of death of A read with Explanation 1 to the said Section, the share of a deceased coparcener of the HUF is to be determined as if a partition of the property has taken place immediately before his death. Accordingly, in the example given above, there being three coparceners of the HUF A had one-third undivided share in the HUF property, which devolved upon the HUF as per his will.

It is significant to note that S. 6 of the Act (as amended) prescribes that on and from the commencement of the Amendment Act, the daughter of a ‘coparcener’ by birth becomes a coparcener in her own right in the same manner as the son and gets the same rights in the coparcenary property as she would have had if she had been a son. However, on the date of commencement of the Amendment Act i.e., 9th September, 2005, A was no longer one of the coparceners. The two brothers B and C were the only coparceners of the HUF. It, therefore, follows that the two sisters D and E do not fall in the category of being the ‘daughters of a coparcener’ to qualify for any right under S. 6 of the Act as amended. Accordingly, it is submitted that in such a case the daughters would not be entitled to any right in the HUF property and assets.

The conclusion arrived at above is also supported by some court decisions.

The Supreme Court in the case of Sheela Devi and Ors. v. Lal Chand and Anr., [2007(1) MLJ 797] has clearly observed that the Amendment Act would have no application in a case where the succession was opened in 1989 when the father passed away.

In the case of Smt. Bhagirathi and Others v. S. Manivanan and Anr., (AIR 2008 Madras 250), the Madras High Court has held as under :

    “13. A careful reading of S. 6(1) read with 6(3) of the Hindu Succession (Amendment) Act clearly indicates that a daughter can be considered as a coparcener only if her father was a coparcener at the time of coming into force of the amended provision. It is of course true that for the purpose of considering whether the father is a coparcener or not, the restricted meaning of the expression ‘partition’ as given in the explanation is to be attributed.

        In the present case, admittedly the father of the present petitioners had expired in 1975. S. 6(1) of the Act is prospective in the sense that a daughter is being treated as coparcener on and from the commencement of the Hindu Succession (Amendment) Act, 2005. If such provision is read along with S. 6(3), it becomes clear that if a Hindu dies after commence-ment of the Hindu Succession (Amendment) Act, 2005, his interest in the property shall devolve not by survivorship but by intestate succession as contemplated in the Act.

        In the present case, the death of the father having taken place in 1975, succession itself opened in the year 1975 in accordance with the existing provisions contained in S. 6. If the contention of the petitioners is accepted, it would amount to giving retrospective ef-fect to the provisions of S. 6 as amended in 2005. On the death of the father in 1975, the property had already vested with Class-I heirs including the daughters as contemplated in the unamended S. 6 of the Act. Even though the intention of the amended provision is to confer better rights on the daughters, it cannot be stressed to the extent of holding that the succession which had opened prior to coming into force of the amended Act are also required to be re-opened. In this connection, we are also inclined to refer to the decision of M. Srinivasan, J., as His Lordship then was, reported in 1991(2) MLJ 199 (Sundarambal and Others v. Deivanaayagam and Others). While interpreting almost a similar provision, as contained in S. 29-A of the Hindu Succession

    Act, as introduced by the Tamil Nadu Amendment Act 1 of 199, the learned single Judge had made the following observations :

    “14.    Under sub-clause (1), the daughter of a coparcener shall become a coparcener in her own right by birth, thus enabling all daughters of the coparcener who were born even prior to 25th March, 1989 to become coparceners. In other words, if a male Hindu has a daughter born on any date prior to 25th March, 1989, she would also be a coparcener with him in the joint family when the amendment came into force. But the necessary requisite is, the male Hindu should have been alive on the date of the coming into force of the Amended Act. The Section only makes a daughter a coparce-ner and not a sister. If a male Hindu had died before 25th March, 1989 leaving coparcenary property, then his daughter cannot claim to be a coparcener in the same manner as a son, as, on the date on which the Act came into force, her father was not alive. She had the status only as a sister-a-vis her brother and not a daughter on the date of the coming into force of the Amendment Act . . . . . .”.

    It is submitted that the sentence “But the necessary requisite is, the male Hindu should have been alive on the date of the coming into force of the Amend-ment Act” quoted by the Madras High Court in the said judgment is from the same Court’s earlier judgment in Sundarambal’s case, is quite significant and throws light on the hypothetical question raised in this article.

    There is one more court decision on the effect of the Amendment Act, again from the Madras High Court. In the case of Valliammal v. Muniyappan, [2008 (4) CTC 773], the Madras High Court has observed as under :

    “6.    In the plaint, it is stated that the father of the plaintiffs died about thirty years prior to the filing of the suit. The second plaintiff as P.W.1 has deposed that their father died in the year 1968. The Amendment Act 39 of 2005 amend-ing S. 6 of the Hindu Succession Act, 1956 came into force on 9-9-2005 and it conferred right upon female heirs in relation to the joint family property. The contention put forth by the learned Counsel for the appellant is that the said Amendment came into force pending disposal of the suit and hence the plaintiffs are entitled to the benefits conferred by the Amending Act. The Amending Act declared that the daughter of the coparcener shall have the same rights in the coparcenary property as she would have had if she had been a son. In other words, the daughter of a coparcener in her own right has become a coparcener in the same manner as the son insofar as the rights in the coparcenary property are concerned. The question is as to when the succession opened insofar as the present suit properties are concerned. As already seen, the father of the Plaintiffs died in the year 1968 and on the date of his death, the succession had opened to the properties in question. In fact, the Supreme Court in a recent deci-sion in Sheela Devi and Ors. v. Lal Chand and Anr., 2007 (1) MLJ 797 (SC) considered the above question and has laid down the law as follows :

      19.  The Act indisputably would prevail over the old Hindu Law. We may notice that the Parliament, with a view to confer the right upon the female heirs, even in relation to the joint family property, enacted the Hindu Succession Act, 2005. Such a provision was enacted as far back in 1987 by the State of Andhra Pradesh. The succession having opened in 1989, evidently, the provisions of Amendment Act, 2005 would have no application.

    In view of the above statement of law by the Apex Court, the contention of the appellant is devoid of merit. The succession having opened in the year 1968, the Amendment Act 39 of 2005 would have no application to the facts of the present case.”

    Based on the above and other supporting decisions, the Madras High Court has in the recently decided case of S. Seshachalam v. S. Deenadayalan and Ors., (MANU/TN/1956/2000) taken a similar view rejecting the claim of daughters of a coparcener, who had died in 1965.

    Therefore, it is clear that a daughter would get benefit of the Amendment Act only if her father is alive at the time of coming into force of the Amendment Act. Going back to the hypothetical question raised in this article, the two sisters D and E would not be entitled to any right under S. 6 of the Act as amended.

Worldwide tax review — Limitation of Benefits Provisions in Income Tax Treaties

Article

Based on recent news reports, it appears that the Indian
Government is in the process of renegotiating the India-Cyprus Income Tax Treaty
and would like to hold talks to renegotiate the India-Mauritius Income Tax
Treaty. A key change that the Indian Govt. may push for during the course of
renegotiation is to add a Limitation on Benefits (‘LOB’) provision in the tax
treaties.

An LOB provision is an anti-abuse provision that sets out
which residents of the Contracting States are entitled to the treaty’s benefits.
The purpose of an LOB provision is to limit the ability of third country
residents to obtain benefits under the said treaty. This type of use of the
treaty, where third country residents establish companies in a Contracting State
with the principal purpose to obtain the benefits of the treaty between the
Contracting States, is commonly referred to as ‘treaty shopping’.

The introduction of LOB provisions in recent Indian treaties
is indicative of a policy to discourage treaty shopping. Recently, India
renegotiated the India-Singapore Income Tax Treaty (Singapore Treaty) and the
India-UAE Income Tax Treaty (UAE Treaty) through separate Protocols that add LOB
provisions in each, effective in 2005 and 2008, respectively. Although it is too
early to tell how extensive this shift in policy will become, for now India
seems to be following a similar path taken by the United States starting in the
early 1980s when it began renegotiating its income tax treaties and insisting
that treaty partners agree to having LOB provisions in the renegotiated
treaties. For the U.S., it believes that such provisions are effective in
stopping aggressive international tax planning that uses its treaties for the
benefit of third country residents.

A look at the LOB Provisions in the

India-Singapore and India-UAE Treaties :

The recent LOB provision added to the Singapore Treaty is
illustrative of India’s new direction. The India-Singapore Comprehensive
Economic Co-operation Agreement (‘CECA’) was signed on June 29, 2005. As part of
the CECA, Singapore and India agreed on a Protocol and the tax treaty was
amended. The amendments introduced by this Protocol came into force from August
1, 2005.

The Protocol provides that capital gains arising to a
resident of a Contracting State from the sale of property and shares (other than
immovable property or property forming part of a permanent establishment) in the
other Contracting State would be taxed only in the Contracting State where the
alienator is resident.

In other words, when the Singapore company divests its
interest in the Indian company, it will be exempt from Indian capital gains tax.
However, to prevent third country residents from misusing the capital gains
exemption by establishing a holding company in Singapore, an LOB provision was
also added to the treaty.

The LOB provision is very limited in scope, in that it only
impacts capital gains tax and not other benefits provided by the treaty. Under
the LOB provision, a resident company of Singapore will not be entitled to the
capital gains exemption if the primary purpose for the company’s establishment
was to obtain the capital gains exemption. In addition to this test that looks
at a taxpayer’s motive for its holding structure, the provision includes a
second test which provides that companies (referred to as ‘shell’ companies)
that have no or negligible business operations, or with no real or continuous
business activities in Singapore, would not qualify for the capital gains
exemption under the treaty. Under a safe harbour rule, a Singapore company would
not be a shell if : (1) it was listed on recognised stock exchanges of India or
Singapore, or (2) its total annual expenditure on operations in its state of
residence is equal to or more than S$ 200,000 or Rs.50,00,000, as the case may
be, in the 24 months immediately before the date its capital gains arise. It is
not entirely clear whether the Singaporean company still has to satisfy the
motive test even if it passes the safe harbour rule.

In contrast to the Singapore Treaty, the LOB provision added
to the UAE Treaty is broader in scope in that it applies to all benefits
under the treaty. The LOB provision provides that a company would not be
entitled to treaty benefits if “the main purpose or one of the main purposes of
the creation of such entity was to obtain the benefits . . .” of the treaty.
Once again the intention behind the provision is to curb the use of holding
companies that do not have bona fide business activities in India/UAE
from being granted treaty benefits. However, unlike the Singapore Treaty, the
UAE Treaty does not give any guidelines on what is required to prove that a
company has sufficient business activities to obtain treaty benefits. As a
result, this LOB provision will surely create unnecessary uncertainty as to the
application of the treaty. The treaty partners may need to provide some guidance
on this at some point.

From a policy standpoint it appears that India will continue
to request some form of an LOB provision to be added in its treaties in future
treaty negotiations, including renegotiations of existing treaties (such as
Cyprus and Mauritius) where it perceives misuses taking place, making
tax-efficient inbound investment planning for foreign companies more
challenging.

Overview of LOB Provisions in U.S. Treaties :

With the growth of Indian companies, more and more such
companies are seeking to expand overseas and in this regard the United States is
the largest market for expansion. The United States is a high-tax jurisdiction
and has one of the most complex tax systems in the world. As a consequence, an
Indian company expanding into the United States should understand the U.S. tax
system and the tax costs to a foreign investor.

A foreign investor in a U.S. company will generally receive
return on his investment in the form of capital gains from the divestment of the
U.S. business, or the receipt of dividends, interest, royalties and other types
of investment income. As the United States does not tax capital gains on the
sale of capital assets, such as stock in a company (unless the company has
certain U.S. real property assets), foreign investors will not generally have to
concern themselves with U.S. capital gains tax issues on divestment of U.S.
stock.

On the other hand, dividends, interest, and royalties and
other types of investment income would be subject to a relatively high 30% U.S.
withholding tax. Thus, an Indian company would have to focus on how to reduce or
eliminate the 30% U.S. withholding tax on such U.S. investment income.

Finding ways to reduce or eliminate this tax cost is challenging from a U.S. perspective. The best way of lowering the 30% U.S. withholding tax is to access the benefits of a U.S. income tax treaty, which can provide reduced rates from 0% to 25%, depending on the treaty. In this regard, the U.S. has gone through many challenges over the years as a result of foreign investors creating elaborate schemes designed to lower this tax by accessing one of its many income tax treaties by treaty shopping. To counter treaty shopping, the U.S. has negotiated to have LOB provisions included in its treaties including the US-India Income Tax Treaty-(‘India Treaty’). The LOB provisions limit the treaty residents who may be granted treaty benefits. Importantly, the United States has also made changes to its domestic tax laws that complement the measures taken with its income tax treaties, such as, promulgating anti-conduit regulations, and interest earning stripping rules, and through a rich history of case law and rulings have developed substance over form, economic substance and business purpose doctrines that serve to curb tax transactions that are viewed as abusive. For purposes of this discussion, we will focus only on the U.S Treaty LOB provisions.

1. U.S. LOB provisions:

Broadly, the LOB provisions of most U.S. income tax treaties provide that resident companies of the two Contracting States are entitled to treaty benefits (such as reduction or elimination of the 30% US withholding tax rate on investment income) only if they satisfy one of the tests under the LOB provision of the treaty in question. Although each treaty is unique, there are generally at least three objective tests found in most U.S. income tax treaties, namely: (1)the Publicly Traded Company Test, (2) Ownership /Base-erosion Test, and (3) the Active Trade or Business Test. Further, the LOB provisions will typically have a clause providing that benefits may also be granted if the competent authority of the Contracting State from which benefits are claimed determines that it is appropriate to provide treaty benefits in that case. This little used clause gives the Competent Authority of the Contracting State involved discretion to grant treaty benefits in cases where even though the treaty resident cannot satisfy any of the objective tests, it should nonetheless be granted treaty benefits.

We have seen that without the benefit of a U.S. income tax treaty, an Indian investor would be subject to a 30% U.S. withholding tax on its U.S. sourced investment income. Fortunately, the tax treaty with India (‘India Treaty’) provides relief by reducing the 30% U.S. withholding tax rate for dividends, interest and royalties to 15%, 15% and 15/ 10%, respectively. There are also other U.S. income tax treaties that provide even better benefits, such as the UK Treaty, which can provide zero withholding tax on these three types of income if certain other requirements are met. The key to obtaining these reduced rates though is qualifying for treaty benefits under the respective LOB provision.

 2. The U.S.-India Treaty LOB Provision – Article 24 :

The current tax treaty with India (‘India Treaty’) entered into force in December 1990. As with its other treaties, the United States wants to ensure that under the ‘India Treaty’, only ‘qualified residents’ of either treaty country obtain treaty benefits. The paragraphs of Article 24 (LOB) that relate to companies are intended to guarantee that only Indian or U.S. resident companies that have substantial substance and strong business connections or activities in India or the United States may be entitled to use the treaty.

In this regard, Article 24, paragraph 1, provides an Ownership /Base-erosion Test that is a two-prong test, both of which must be satisfied. Under the first prong of the test, more than 50% of each class of an Indian company’s shares must be owned, directly or indirectly, by individual residents who are subject to tax in either India or the United States, or by the government or government bodies of either Contracting State. Under the second prong of the test, the Indian company’s gross income must not be used in ‘substantial’ part, directly or indirectly, to meet liabilities (such as interest or royalties liabilities) in the form of deductible payments to persons, other than persons who are residents, U.S. citizens or the government or government bodies of either Contracting State. The term ‘substantial’ is not defined under the treaty, however, deductible payments that are less than 50% of the company’s gross income will generally not be considered substantial. This provision is generally focussed on stopping situations where third country lenders or licensors use the treaty to obtain the reduced 15% and 15/10% U.S. withholding tax rate for interest and royalty payments, respectively.

Paragraph 2 of Article 24 provides that an Indian company will qualify for treaty benefits, regardless of its ownership (as is required under the Owner-ship/Base-erosion Test), if it is engaged in an active trade or business in India and the item of income for which treaty benefit is being claimed is connected with or incidental to such trade or business. A company in the business of managing investments for its own account will not be treated as carrying on an active trade or business, unless it’s in the banking or insurance business. This treaty does not define the term ‘active trade or business’, but as discussed below, some guidance is available in the U.S. Treasury Technical Explanation to the ‘U.K. Treaty’ (which is the official guide to the U’K, Treaty by the United States) which provides a definition that the U.s. would likely apply consistently to all its treaties. This test is applied separately to each item of income of the Indian company, compared to the Ownership/Base-erosion Test and the Publicly Traded Company Test (discussed below), where if these tests are satisfied, then all the income of the treaty resident is entitled to all treaty benefits.

The third test under Article 24 is the Publicly Traded Company Test under paragraph 3. Under this test, a publicly traded Indian corporation can qualify for treaty benefits if its principal class of shares is sub-stantially and regularly traded on a recognised stock exchange (e.g., the NASDAQ or New York Stock Exchange in the United States or the National Stock Exchange in India).

3. The U.S.-U.K. Treaty LOB Provision – Article 23 :

The current tax treaty with U.K. (‘UK Treaty’) entered into force in March 2003. It is illustrative of the United States’ more recent policy towards its income tax treaties, which is to extend significant tax breaks to its treaty partners. In this regard, the UK Treaty can provide zero withholding tax on dividends (0%, 5%, or 15%), interest (0%) and royalty (0%) payments if certain requirements are met. These reduced rates generally make it a very desirable treaty to access. Under its LOB provision, however, the U.S. has ensured that only certain categories of residents are granted these treaty benefits. The LOB provision is more extensive than the ‘India Treaty’; providing more tests under which a resident may qualify for treaty benefits, but in all cases it provides a high bar requiring that only those companies with significant substance and business activities or connections in the United Kingdom qualify.

Under paragraphs 2(c), 2(f),and 4 of Article 23, there is a Publicly Traded Company Test, an Ownership / Base-erosion Test, and an Active Trade or Business Test, respectively.

Although these LOB tests are similar to the LOB tests under the ‘India Treaty’, there are some important differences under the Publicly Traded Company Test. Under this Publicly Traded Company Test, a publicly traded company includes companies whose principal class of stock is listed on a ‘recognised stock exchange’, just like under the ‘India Treaty’. However, the recognised stock exchanges under this Publicly Traded Company Test include not only exchanges in the Contracting States, but also the stock exchanges of Ireland, Switzerland, Amsterdam, Brussels, Frankfurt, Hamburg, Johannesburg, Madrid, Milan, Paris, Stockholm, Sydney, Tokyo, Toronto and Vienna. In addition, this Publicly Traded Company Test includes a subsection that allows certain subsidiaries of a publicly traded company to qualify for the ‘U.K. Treaty’ benefits. Under this part of the test, a company resident in one of the Contracting States that is at least 50% held by vote and value by five or fewer publicly traded companies that qualify for treaty benefits under the Publicly Trade Company Test may also qualify for ‘U.K. Treaty’ benefits (e.g., a wholly-owned U.K. subsidiary of a Ll.K, publicly traded company whose shares are regularly traded on the London Stock Exchange). Thus, the Publicly Traded Company Test allows more publicly traded companies and their subsidiaries that are residents of either Contracting State to qualify for UK Treaty Benefits than those under the ‘India Treaty’.

The Active Trade or Business Test in both treaties is substantially the same. However, unlike the ‘India Treaty’, the U.S. Treasury Technical Explanation to the ‘u.K. Treaty’ does provide a definition of an active ‘trade or business’ for purposes of qualifying for treaty benefits under this test. In this regard, from a U.S. perspective, a U.K. company will be treated as carrying on an active trade or business if it carries on a ‘specific unified group of activities that constitute an independent economic enterprise carried on for profit.’ In addition, ‘a corporation will be considered to carryon a trade or business only if the officers and employees of the corporation conduct substantial managerial and operational activities.’ Further, any company whose function is to make or manage investments for its own account will not be treated as carrying on an active trade or business (unless it’s in the banking, insurance or securities business). The Technical Explanation makes clear that headquarters operations are considered in the business of managing investments, and therefore, the United States will not treat such companies as qualifying for treaty benefits under this test.

In addition to the tests above, the ‘U.K. Treaty’ also has Derivatives Benefits Test that is not found in the ‘India Treaty’. This test expands the types of resident companies that may qualify for ‘U’K. Treaty’ benefits. It allows a resident company that cannot satisfy one of the other tests to qualify for treaty benefits if it is owned by third country residents that meet certain requirements. Under this test, a resident company will be entitled to treaty benefits with respect to an item of income, profit or gain if: (1) at least 95% of vote and value of the company is owned, directly or indirectly, by 7 or fewer persons who are ‘equivalent beneficiaries’; and (2) less than 50% of the company’s gross income for the taxable period in which the item of income, profit or gain arises is paid or accrued, directly or indirectly, to persons who are not equivalent beneficiaries, in the form of deductible payments. The treaty defines an ‘equivalent beneficiary’ as a resident of an EU country or of a European Economic Area state (e.g., France, Ireland, Germany, or the Netherlands, etc.) or NAFTA states (Canada and Mexico). The equivalent beneficiary must also be entitled to all the benefits of a tax treaty between an EU country, a European Economic Area state or NAFTA state and the Contracting State from which the ‘U.K. Treaty’ benefits are claimed (the ‘Third Country Treaty’). Further, with respect to claiming treaty benefits for dividends, interest, or royalties, the equivalent beneficiary must be entitled under the Third Country Treaty to a rate of tax on the income for tvhich benefits are being claimed that is at least as low as the rate applicable under the ‘U.K. Treaty’.

The Derivatives Benefits Test can be illustrated with the following example. A U.K. resident company owns a U’.S. subsidiary and is owned 100% by a publicly traded company in France. The U.S. subsidiary pays a dividend to the U.K. resident company. Under the ‘U.K. Treaty’, the u.K. resident company does not satisfy any of the other LOB tests. Its French parent, however, does qualify for benefits under the U.S.-France Income Tax Treaty, which provides a 5% withholding tax rate on dividend payments. Thus, the U.K. resident company will be entitled to the ‘U.K. Treaty’ benefits for dividend payments it receives from the U.S. subsidiary. The treaty rate will be limited to 5% and not the 0% the ‘Ll.K. Treaty’ provides, because that is the lowest rate its French parent would be granted under the U.S.-France Income Tax Treaty.

4. How to Structure Investments into the United States:

Because of LOB provisions it may be that, the most tax-efficient way for an Indian company to reduce the U.S. tax on dividends, interest, royalties and other investment income is to hold its U.S. investment directly and to try and qualify for benefits under the ‘India Treaty’. However, if the company has extensive operations in another country that has a treaty with the United States which gives better treaty benefits than the ‘India Treaty’, then it may be worthwhile considering using that treaty. The ‘UK Treaty’ is the best example of such a treaty.

Planning    Example:

An Indian corporation in the pharmaceutical business owns 100% of an existing U.K. subsidiary that in turn owns 100% of a U.S. subsidiary. The U.K. subsidiary owns a factory in the United Kingdom that produces a variety of products that are marketed and distributed in a number of European countries by third parties and in the United States by the U.S. subsidiary. The Ll.S, subsidiary regularly makes dividend distributions to the U.K. subsidiary, which it uses to expand in its U.K. manufacturing operations. Assuming certain requirements are satisfied under Article 10 (Dividends), the U.K. subsidiary should be able to qualify for treaty benefits under the Active Trade or Business Test to reduce the U.S. withholding tax on dividends from 30% to zero. This is a better withholding tax result than if the Indian corporation had directly invested in the U.S. subsidiary and obtained a 15% U.S. withholding tax rate on dividend distributions from the U.S.

Conclusion:

The tax environment in India is very challenging from an inbound and outbound perspective today. India is keen to receive its share of the tax revenues available in cross-border transactions. To this end it seems to be heading on a policy path similarly taken by the U.S. years ago to allow only a clearly identified group of persons access to its income tax treaties and the tax benefits they provide. The use of LOB provisions in Indian income tax treaties will be something to take into consideration by foreign investors to avoid being treated as treaty shopping. For Indian companies expanding into the U.S., they will have to take a closer look at its tax treaties and the challenging requirements set out by the LOB provisions within them to effectuate tax-efficient structures for their overseas business operations.

Disciplinary Mechanism of ICAI

1 Introduction

    1.1 We are currently in the diamond jubilee year of our Republic as well as of our Institute. The motto of our nation is Satyameva Jayate (Truth alone triumphs). We can only dream of poetic justice of truth winning over untruth. In this Kaliyug, real life events often shatter this fond belief. The recent episode of ‘Satyam Computers’ has evoked a storm in our profession as well. The motto of our Institute of Chartered Accountants of India is ‘Ya esha Supteshu Jagarti’ (He who is awake when others are asleep.) This was actually spoken about the ‘Soul’ — the ‘Atman’ in the Upanishadas. It implies that our conscience should always be awake. Unfortunately, the overall scenario is such that not only others but our own professionals have started losing faith in the profession. The situation calls for a good degree of introspection and self-criticism.

    1.2 In recent years, there was a spate of complaints against our professional brothers for alleged misconduct. I had occasion to handle quite a few such cases which gave me some insight in the field. It is not only torturous for the respondents whom I represented, but even more stressful to me. I have, therefore, taken it as a mission to spread awareness of this subject and caution our fellow-members, since prevention is always better than cure.

    1.3 The topic is too vast. The experiences which I wish to share are often frightening and depressing. But unless all of us develop positive attitude, assertive approach and collective action, the future seems to be very gloomy. Not much can be expected from our leaders. It is the same state of affairs as in our Indian democracy. Our own indifference and inaction will put us into deeper trouble. Time has come to really wake up and get out of our slumber.

    The purpose of this article is to make readers conscious of the grave reality. I have consciously avoided technicalities and focussed on practical aspects.

2 Some glaring statistics

    2.1 When the Chartered Accountants’ Act was originally passed in the year 1949, the ‘Disciplinary Committee’ consisted of 5 persons. viz. President, Vice-President, two other elected members of Central Council and one Government Nominee. This Committee was supposed to hear the cases all over India. Today our membership is nearing 1,50,000 and till 2007, the same committee was discharging this function.

    2.2 Times have changed. General tolerance level of people has gone down. People have not only become aware of nuisance value, but have started using it. In the first 30 to 40 years of our Institute’s existence, there might have been about 300 to 400 complaints; whereas now the rate is about 500 to 600 hundred per year.

    2.3 Due to various scams, mass scale complaints are received by the Council or initiated suo moto based on ‘Information’. Such scams add 100 to 200 cases in one stroke.

    2.4 A complaint can be filed within 10 years from the occurrence of the event complained against — Regulation 14 of the ICAI Regulations, 1988. Unfortunately, there is no time-limit prescribed for disposal. For example, even today, a few cases filed in the year 1996 in respect of accounts for the year 1987-88 might have remained undecided.

    After the passage of CA Amendment Act, 2006, the new procedure seeks to cut short the time by introducing a procedure for summary disposal.

    2.5 A survey carried out in the USA revealed that 95% of the complaints against professionals (doctors) are filed out of ego problems —mainly due to improper communication by the professionals.

3 Certain fundamental principles

    3.1 A complaint once filed could not be withdrawn under the old system. Under the new system, it can be withdrawn subject to the permission of Director Discipline and Board of Discipline.

    3.2 For holding a member guilty, the following points are considered absolutely inconsequential —

    (a) Whether the complainant or anybody is aggrieved or not.

    (b) Whether the complainant, although aggrieved, wants to pardon a respondent.

    (c) Whether the complainant has approached the Council with clean hands or whether the complainant himself is a confirmed criminal or has committed contributory negligence.

    (d) Whether the respondent has compensated the complainant for the loss that was incurred by him due to negligence of the respondent.

    (e) Whether the complainant backs out and remains absent during the hearing.

    3.3 Nevertheless, the basic duty of adducing evidence against the respondent does lie on the complainant. These are quasi-criminal proceedings and the Disciplinary Committee has the powers of the Civil Court.

    3.4 The basic objective of the Council is to examine whether the respondent is fit to continue as a member. This is as per a Calcutta High Court decision. The Council does not have jurisdiction to examine the conduct of the complainant or a non-member. It is primarily concerned with safeguarding the credibility and image of the profession. A clear message should go to the public at large that an unscrupulous member is severely punished; and that the Code of Ethics is religiously and rigorously enforced.

    3.5 A general feeling in the society is that complaints are not processed expeditiously. There are delays and members are treated leniently. The Society expects that the Code of Ethics should be strictly implemented.

4. Reasons for delays

    4.1 Many a time, complaints are filed even after 6 to 7 years of the occurrence of alleged misconduct. The permissible time is 10 years as per Regulation 14.

    4.2 Sometimes, the complaints remain unattended at the Council for a number of years — may be due to administrative pressures or due to sudden shifts in priorities.

4.3 After a complaint is received by the Council, it is forwarded to the respondent asking him to file an explanation (written statement). That written statement is forwarded to the complainant with a request to send a rejoinder. To that rejoinder again, the respondent is asked to give his comments. Thus, both the parties get two innings. This was under old regime.

In the amended system, the last limb (comments on the rejoinder by respondent) has been eliminated. This is in respect of complaints filed on or after 28th day of February 2007. However, the Disciplinary Directorate may seek further information from the concerned parties, if required.

4.4 After this preliminary data, the Director Discipline forms a prima jacie opinion as to whether the Respondent is ‘prima facie’ guilty. Under the old system, this decision rested with the Council of 30 members. One can imagine the delay inherent in the old system.

4.5 The instant reaction of any person on receiving a complaint against him is either total nervousness; or a serious anger against the complainant. Both these extremes result in loss of objectivity. The respondent on some pretext or the other seeks extension of time to write a reply.

4.6 Normally, a member tries to hide this from his friends and colleagues; and approaches some lawyer. Lawyers can seldom appreciate the substance of the complaint in the context of our profession. If it requires knowledge of accounting standards and audit technicalities, lawyers may have serious limitations. They usually write a legalistic reply which is often in the nature of counter-attack on the complainant. As stated earlier, the Council is not much concerned with the conduct of the complainant. Thus, the reply becomes either verbose or irrelevant, in the context of our Council’s perception. It is necessary to write a concise and objective reply, by briefly describing the background. In most of the cases, a member is made a scapegoat, as an arm-twisting pressure tactic, in the dispute of the complainant with some other party. (for interesting instances, see para 6)

When a person is found ‘prima facie’ guilty, the disciplinary proceedings are deemed to have commenced. The disqualification or ineligibilities for allotment of bank audits, C & AG Audits, etc. become applicable from this point of time. It should be noted that these ineligibilities are as per the norms of the appointing authorities and not of the ICAI.

4.8 Hearing of cases under the new system is just commencing. At present, the old cases are still pending. The Disciplinary Committee (DC) has its sittings for one or two days each at various important cities in the country. In Mumbai, for example, it might visit on 4 to 5 occasions in a year.

4.9 Duration of a hearing may range from half-an-hour to 8 to 10 hours. Once or twice, a case may be adjourned at the request of the parties. During the hearing, there are witnesses summoned, examined and cross-examined, evidences adduced, submissions made, and complainants as well as respondents are interrogated. Proceedings are tape-recorded and verbatim report (minutes) are made available to the parties. There is a high degree of transparency. Sometimes, submissions are so voluminous that they may run into a couple of thousand pages.

4.10 After the hearing is concluded, it takes normally not less than 10 to 12 months to receive a report. Basically, the DC members are themselves very busy professionals.

They are on tours off and on and have many other issues to deal with. Sitting in judgment against fellow-members is a very delicate task, far from pleasant. Ordinarily, out of five members, only three of them actually sit for hearing. Either the President or the Vice-President presides over the proceedings.

4.11 The report of the DC is basically in the nature of fact finding. It is not conclusive. Under the old system, the DC report is considered by the entire Council. Members of the DC who had sat for the actual hearing at DC cannot sit in the Council while their report is considered. So also, a few other members may be disqualified. In the Council again, both the parties are represented and heard.

Before the DC, a lawyer or any member of ICAI could represent; but before the Council, only a member can represent.

4.12 After the hearing, the Council takes the decision immediately, usually by a majority vote. The Council may take any of the following decisions :

a) Send back the matter to the DC for reconsideration.

b) In case of misconduct specified in schedule I, decide whether a member is guilty and if yes, to award punishment. Since, for Schedule I, the Council’s decision is as good as final, the Council gives one more hearing to the respondent before awarding punishment – Sec. 21(4) of CA Act, 1949.

c) In respect of offences in the second Schedule, the Council has only a power to recommend to the High Court – both the aspects – viz. Whether the Respondent is guilty and if yes, what is the punishment.

For First Schedule, in case the punishment recommended is suspension of membership for a period exceeding 5 years or for life, then also, the Council has to refer it to the High Court.

4.13 Readers may be aware that the High Court in turn may take a few more years. It is thus possible that the decision may become final (unless contested in the Supreme Court) after about 15 to 20 years from the occurrence of the alleged misconduct.

5 Types  of punishment

Under the old system, there were only two types of punishment-

For First Schedule-

i) reprimand  or

ii) suspension of membership for not exceeding five years.

For Second  Schedule-

i) reprimand  or

ii) suspension of membership for any length of time.

6 Interesting (and alarming) instances

6.1 As mentioned earlier, the chartered accountant has become a very soft target. The role of a CA, especially as an auditor, is very vulnerable. There is an increasing tendency to make him a victim of disputes between two parties. The CA is totally unconnected with the dispute.

6.2 I am not trying to say that the work of the CAs in these instances was flawless. There were lacunae; but by no stretch of imagination there was any serious lapse or negligence or mala fide intention or misbehaviour. It was sheer misfortune that brought them into trouble. One very important lesson one should learn is ‘not to do anything in good faith’.

6.3 So far, I have had occasion to handle quite a few cases. The following live instances can really be eye-openers-

6.3.1 For co-operative  Societies, there is a system  that  after  consecutive   two years, the auditor should be changed. Audits are in individual name. There was a couple, both CAs. The wife did a particular audit for 2 years; followed by the husband doing it. Unfortunately, there was a legal separation proceeding between the two; and the wife lodged a complaint that the husband accepted the audit without communicating with the previous auditor.

6.3.2 A private limited company, only two shareholders – brothers; and both were directors. A reputed CA firm doing audit for more than 15 years. In one particular year, since the younger brother was busy in visa formalities since both were to travel together -auditor signed the accounts when only one – elder brother – who was MD with 60% holding – signed the accounts.

Income-tax return was filed thereafter, younger brother refused to sign and filed a complaint that the auditor signed without signature of two directors – Sec. 215 of the Companies Act.

At this juncture, let me point out that in terms of Sec. 215, it is not enough that two directors have signed. What is more important is the approval of accounts in a Board Meeting. This aspect is often overlooked. I would advise that the auditor should retain at least one copy of accounts signed by not only two, but all directors or partners as the case may be.

Interestingly, the reason behind this complaint was that the auditor had declined the complainant’s personal request to accommodate his daughter as a ‘dummy article’.

6.3.3 Mr. A – held Certificate of Practice. – but never pursued it. He was always into a business with Mr. B – Both promoters and co-directors. B’s son completed articleship under A. Unfortunately, there was a dispute between A and B. B’s son files a complaint that A was engaged in a business without obtaining the Council’s permission.

6.3.4 Situation  is all the more vulnerable in co-operative housing  societies. Invariably, there are internal quarrels. A co-operative housing society received a large sum on sale of FSI five years ago. There was no issue with the Income Tax. Due to the disputes among members and also the managing committee, one member files a case that as an honest citizen, he will approach the LT. authorities to issue notice u/s 148, make the society pay the tax and recover from auditor since he did not give proper advice! The purpose was to exert pressure on the other party by threatening the auditor.

6.3.5 A fraudulent lady entered into an ‘arrangement’ with the proprietor of 100% export business. The auditor who was basically a tax practitioner, used to do the audit basically for Sec. 44AB and 80HHC of the Income Tax Act. There was total exemption under Income Tax as well as Sales Tax. The lady in collusion with the businessman and CMD of a nationalised bank, fraudulently got a huge loan disbursed. She herself took away the money. All the three (the lady, the businessman and CMD of bank) were chargesheeted by CBI. And the lady files a complaint that she was misguided bv the audited figures. It could be r roved beyond doubt that the auditor and the accounts had no role to play in the entire deed.

Nevertheless, certain shortcomings which are inherent in any accounts were exposed and the otherwise innocent chartered accountant had to face disciplinary proceedings.

6.3.6 One proprietor CA signed the tax audit report of a medium-scale CA firm – all the partners of which were his close friends. The total collection of the firm about 10 years ago was nearing Rs. two crores.

Unfortunately, in the scrutiny assessment of the firm, it was found that on one particular day, there was a negative cash balance of a few hundred rupees. The Assessing Officer intimated this to the ICAI as a misconduct.

I repeat that in none of the cases one could say that there was no mistake at all. However, the courts have held that the charge in terms of Clause (7) of Part I of Second Schedule is that of ‘gross negligence’ and not of ‘inefficiency’. Every mistake is not a gross negligence. I am sure, these stories are representative of the present scenario.

Our fellow members will be well-advised to proceed with utmost care and caution.

What is essential is a positive perception and conviction that the Code of Ethics is for our protection. It is not a burden, but a shield.

I wish all the readers a trouble-free practice and good luck.

6.3.7 In a deal of immovable properties between Mr. A & Mr. B, Mr. C – a CA was representing Mr. B. In the course of documentation, there were certain differences. C’s presence was felt inconvenient by A and his lawyer. Hence, a complaint was filed against C that he was rendering services of ‘legal drafting’ which is not permissible for a CA.

Under the amended law, there are three types of punishments prescribed.

For First Schedule

i) reprimand

ii) suspension of membership for not exceeding 3 months; or

iii) fine not exceeding Rs. one lakh.

For Second  Schedule

i) reprimand

ii) suspension of membership for any length of time.
    
iii) fine  not  exceeding Rs. five lakhs.

Further, under the new system, the Council’s function is now entrusted to an Appellate Tribunal of five constituents.

Note: After the amendment in the year 2006, the procedure has undergone a radical change. The same will be dealt with in a separate article. At present, a number of old cases are still pending and readers need to know the real position in its perspective.

Changing of law through issuance of circulars ! ! !

Introduction :

    Till today the law on the subject of repairing and maintenance of roads and other infrastructural facilities was clear in the minds of all stakeholders (barring a few service tax commissionerates).

    There was this discussion that maintenance and/or repairing of roads may be a taxable activity, but a conclusive view came across from most corners that no such taxing is possible because the law itself was clear enough.

    This view was based on a sound principle of law which says that if a service activity is specifically excluded from the purview of taxation from one service category, it cannot be included in some other category unless and until specific inclusion thereof is provided for it in that Section.

    The Central Board of Excise and Customs (CBEC) has now come up with a Circular No. 110/2009, dated 23.02.2009 clarifying the doubts in respect of levy of service tax on repair/renovation/widening of roads.

    The Circular has tried to give extra-judicial meaning to 2 sections involved :

    1. Commercial or industrial construction service [Section 65(105) (zzq)]

    2. Management, maintenance or repair service [Section 65(105) (zzg)].

Legislative Background :

I. Commercial or Industrial Construction Service :

As per Section 65(25b) of the Finance Act, 1994 (Act), ‘Commercial or industrial construction service’ means —

(a) construction of a new building or a civil structure or a part thereof; or

(b) construction of pipeline or conduit; or

(c) completion and finishing services such as glazing, plastering, painting, floor and wall tiling, wall covering and wall papering, wood and metal joinery and carpentry, fencing and railing, construction of swimming pools, acoustic applications or fittings and other similar services, in relation to building or civil structure; or

(d) repair, alteration, renovation or restoration of, or similar services in relation to, building or civil structure, pipeline or conduit,

which is —

(i) used, or to be used, primarily for; or

(ii) occupied, or to be occupied, primarily with; or

(iii) engaged, or to be engaged, primarily in,

commerce or industry, or work intended for commerce or industry, but does not include such services provided in respect of roads, airports, railways, transport terminals, bridges, tunnels and dams;

    The above defining Section clearly spells out that all kinds of repairing, alteration, renovation, restoration or similar services provided in relation to any infrastructural facilities including roads is completely non-taxable. Therefore it can be safely said that there was and still exists a specific exclusion from charging of service tax on repairing and related services in respect of roads.

II. Management, Maintenance or Repair Service :

    As per section 65 (64) of the Act,

    “management, maintenance or repair service means any service provided by —

    (i) any person under a contract or an agreement; or

    (ii) a manufacturer or any person authorised by him,

    in relation to,

    (a) management of properties, whether immovable or not;

    (b) maintenance or repair of properties, whether immovable or not; or

    (c) maintenance or repair including reconditioning or restoration, or servicing of any goods, excluding a motor vehicle.

    [Explanation : For the removal of doubts, it is hereby declared that for the purposes of this clause, —

    (a) ‘goods’ includes computer software;

    (b) ‘properties’ includes information technology software;]

    This section puts in place a charge on management, maintenance or repair services in relation to all movable and immovable goods and properties. This Section was first amended w.e.f. 16.06.2005 to include maintenance services in respect of immovable properties and it was further amended from 1.05.2006 to include repairing services therein also.

    Legal Importance of circular :

    It is an accepted rule of law that an Act passed by the Parliament is supreme in authority and its provisions cannot be re-defined by issuance of Circulars. Circulars can only be guides to law and law cannot be re-defined by these instruments. Many Circulars have been struck down by Courts. In the case of Commissioner of Sales Tax vs. Indra Industries, (2001) 248 ITR 338 (SC), the apex court has opined that,

    “A Circular by tax authorities is not binding on the Courts. It is not binding on the assessee.”

    Hence Circulars at best are instruments in the hands of administrators to clear doubts where they exist, but unfortunately these are being used to create doubts where none exist.

    Defining the Circular

    Circular no. 110 is issued in response to clarification sought by the Nashik Commissionerate on the issue. The Circular has tried to clarify 2 issues —

    a. Whether management, maintenance or repairs of roads is taxable under similar service head or not.

    b. Segregation of activities in relation to roads into 2 distinct heads as under :

    i. Maintenance & repair activities

    1. Resurfacing

    2. Renovation

    3. Strengthening

    4. Relaying

    5. Filling of potholes

    ii. Construction Activities

    1. Laying of a new road

    2. Widening of narrow road to broader road (such as conversion of a two-lane road to a four-lane road)

    3. Changing road surface (gravelled road to metalled road/metalled road to black-topped/blacktopped to concrete, etc.).

In simple language, as per this Circular all activities of management, maintenance or repairing in respect of roads will be taxable with retrospective effect at least from 1.05.2006 if not earlier. It has tried to define what activities are classifiable as Maintenance or Repair services and what can be defined as Construction. As there is no legal standing of the Circulars, its impact cannot be retrospective in nature.

If we believe this Circular to be sacrosanct, then at least from 1.05.2006 all jobs of resurfacing, renovation, strengthening, relaying or filling of potholes in respect of roads will become taxable.

This can be stretched to mean that if a road is constructed once – all relaying work done on it for as many years to come – would be a taxable activity given that the quality of surface of the road is not changed from gravelled road to metalled road/metalled road to blacktopped/blacktopped to concrete, etc.

Mistake of Omission:

The Circular fails to recognise one important sub-clause of section 65 (25b) of the Act.

As explained earlier, this Section defines the words “Commercial or Industrial Construction” – wherein sub-clause (d) of Section 65 (25b) clearly includes all kinds of repair, alteration, renovation, restoration or similar services. Thereby meaning that repairs is also a sort of Construction.

The definition further has an the exclusion clause which says that,

“but does not include such services provided in respect of roads, airports, railways, transport terminals, bridges, tunnels and dams.]”

The words “Such services” – refer to sub-clause 65 (25b) (a) to (d) – which means that all repairing, renovation, etc., jobs in relation to roads are NOT TAXABLE at all.

Why was this clause not referred to before issuance of the impugned Circular is a question that only the Board can answer. It is clear that they have not considered this sub-clause and this mistake of omission would give birth to serious litigation issues for the infrastructure sector as a whole.

Conclusion:

As far as repairing jobs of roads, etc., is concerned there was no iota of doubt in the legislative intent, because infrastructure is the need of the day and upkeep of the infrastructural facilities is a core area in which the Government is working hard. Unfortunately this Circular may undo all the good intentions of law.

It is not as if the law is silent on the issue. On the contrary, the law is crystal clear and specifically excludes all kinds of repair jobs done in respect of all infrastructural facilities like roads, airports, railways, transport terminals, bridges, tunnels and dams as explained above.

This Circular must be withdrawn with immediate effect and all efforts must be taken by all stake-holders to force the Central Government into withdrawing it. The Circular, in any case according to me, is Void-ab-initio and will not stand the scrutiny of Tribunals and courts in the long run. But till that happens, it would have played the mischief it is intended to. The litigation-creating potential of this Circular is immense and immediate.

This Circular would  proverbially open a Pandora’s box for the maintenance and repairing of infrastructural facilities sector as a whole, because the logic of this circular, if accepted, would mean that similar services in relation to infrastructural facilities other that roads -like airports, tunnels, dams, etc., – will also be taxable and that too retrospectively.

This Circular has all the right ingredients to do all the wrong things !

Accounting for financial instruments and derivatives

In Parts One and Two, we discussed definition, recognition, classification and measurement principles of financial assets and financial liabilities. In this part, we will discuss the definition and accounting for derivatives including principles of hedge definition, recognition and accounting.

Derivatives

    A derivative is a financial instrument or other contract which has all the following 3 characteristics (para 8.1 of AS-30) :

    · Its value changes in response to changes in an underlying (the underlying could be a specified interest rate, a financial instrument, a commodity, a currency, an index, a credit rating or index, or other variable).

    · It requires no or small initial net investment (than the investment that would be required if an entity were to enter into other contracts that would be expected to have a similar response to changes in the price of the underlying).

    · It is settled at a future date.

    Common examples of derivatives are forwards, futures, calls, puts and swaps. Derivatives may be exchanged, traded or over-the-counter contracts. If the underlying is a non-financial variable, the standard specifies that the variable should not be specific to a party to the contract. Derivative contracts may be net settled or gross settled. The definition and accounting of a derivative does not depend upon the method of settlement. In both settlement systems, the accounting remains the same.

    If a company buys crude oil futures on a commodity exchange, it typically pays a small initial margin that may range from 5 to 20%. The company is exposed to risk arising from movements in the price of crude oil, which will impact prices of crude oil futures resulting in gains or losses. The contract will be settled at a future date. In practice, most futures contracts are net settled. If the company bought futures at a price of $ 41 per barrel and on the date of expiry the price of spot and futures (which will converge on expiry) is $ 47, the company would have gained $ 6 per barrel, which would be paid to the company on expiry in a net settlement framework. In a gross settlement framework, the company would pay $ 41 and receive delivery of crude oil.

Recognition and Measurement

    A derivative instrument is by default classified as a financial asset or a financial liability held for trading. Derivatives which are financial guarantees or designated as hedging instruments are exceptions. Assets and liabilities held for trading fall under the broader category ‘Financial Assets and Li-abilities held at fair value through Profit and Loss’.

    Accordingly, derivatives (other than exceptions above) are initially recognised at fair value on the date of acquisition or issue (para 47 of AS-30). Transaction costs are recognised as expenses. Subsequently, they continue to be carried at fair value without deduction for transaction costs that may be incurred on sale or disposal (para 51 and 52 of AS-30).

    As a consequence of continuous fair valuation of derivative positions, corporates will be exposed to earnings volatility. Derivative fair values are known to fluctuate substantially and a high exposure to derivatives which do not qualify for hedge accounting treatment is a major challenge that corporates need to manage well.

Example of a Forward Contract

    The accounting community will be familiar with recognition and measurement of forward dollar contracts under the AS-11 framework. The principles of AS-30 are quite different and it may be useful to compare the two methodologies.

    Corporate XYZ Ltd. buys a three-month forward dollar contract for $ 1 on May 1, 2009 at a forward rate of Rs. 50.25. The spot rate on that day was Rs. 49.65 and the premium paid on the forward was Rs. 0.60. The contract was entered into to hedge an import payment that is due three months later.

    Let us assume that the spot rate on June 30, 2009 was Rs. 51 and the forward rate of a one month forward on June 30, 2009 was Rs. 51.12.

AS 11 Framework

    The premium of Rs. 0.60 will be amortised over three months. The June quarter financials will therefore recognise an expense of Rs. 0.40 (two months proportionate amortisation). On June 30, 2009, the forward contract will be revalued to spot Rs. 51.00. However, the underlying payable will also be revalued to Rs. 51.00. The impact of revaluing the underlying payable and the long forward will offset each other so that the impact on the profit would be zero.

AS-30 Framework

    There is no concept of amortisation of forward premium. The derivative contract would be recognised at fair value on the date of inception. A typical on-market forward would have a fair value of zero on the date of inception. In other words, if the corporate were to turn around and square up the contract immediately after inception, it would be able to do so at the same forward rate as it contracted.

    At quarter end, the derivative contract will be fair valued. If the contracted forward rate was Rs. 50.25 and the forward rate on June 30, 2009 was Rs. 51.12, the corporate has generated a gain of Rs. 0.87. This will be present valued (discounted) as there is one month left for expiry. Suppose the present value comes to Rs. 0.86. This is the fair value of the derivative to be recognised as an Asset in the Balance Sheet as at June 30, 2009. Please note that the spot rate of the dollar on June 30, 2009 is not relevant for fair valuing the forward contract, but would be relevant for revaluing the underlying payable.

    The second effect of this fair valuation could either be recorded as a gain in the Profit and Loss account or could be carried to Hedging Reserves, depending upon whether the derivative contract qualifies as a hedge and the type of hedge definition.

Hedge  Accounting

Hedge Accounting is a choice of accounting policy which corporates mayor may not exercise. Hedge accounting allows the corporate to offset the volatility which earnings are exposed to as a consequence of derivative fair valuation at the end of every reporting period. It allows the corporate to either recognise an offsetting gain or loss in the profit and loss itself (and thus negate the derivatives impact) or to recognise the derivative gains or losses
directly in reserves. While it is common to hedge using derivative instruments, it is possible to use regular financial non-derivative instruments for hedging.

The AS-30 framework envisages primarily two types of hedged risks:

(a) those arising from changes in fair values of existing assets, existing liabilities or unrecognised firm commitments (Fair Value Hedging), and

(b) those arising from changes in future cash flows (which could emanate from existing assets, existing liabilities, as well as from highly probable forecasted transactions) (Cash Flow Hedging).

Both risks should affect profit and loss of the entity in order to qualify for hedge accounting treatment. Some examples of underlyings, risks, classification for the purpose of hedging and type of hedge are provided below. The type of hedge indicated here is the one most commonly designated, but it is possible to argue that a cash flow hedge also exposes a corporate to a fair value risk and vice versa and hence such designations need to be effected with care.

Hedge Definitions and Effectiveness

Each hedge should be formally documented in an elaborate manner. The documentation will include a formal risk management policy, the hedging instrument, the hedged item, the hedged risk, effectiveness testing methodology to be adopted by the corporate and approval processes. This area needs involvement of non-accounting managers from the corporate, including the top management, operations and treasury.

Effectiveness testing is required on a prospective basis to establish that the hedge is expected to be effective in managing the risk which it seeks to mitigate. At each reporting period end, the hedge needs to be retrospectively tested to establish whether it was de facto effective in its stated objective. The standard specifies that the change in the fair value of the hedging instrument should retrospectively fall between 80% to 125% of the change in the value of the hedged item attributable to the hedged risk. If the hedge is not effective, hedge accounting principles cannot be applied.

Accounting for Fair Value Hedges

In fair value hedges, gains and losses arising from both instruments, viz., the hedged item and the hedging instrument are recognised in the statement of profit and loss, thus creating an offset such that the net gains or losses impact the reported profit. In more formal terms, the following treatment is adopted:

  •     Gain or loss arising from re-measuring the hedging instrument at fair value is recognised in the statement of profit and loss.
  •     Gain or loss arising from the hedged item attributable to the hedged risk is recognised in the statement of profit and loss.

Example –    Export Receivables

Corporate XYZ has exported merchandise for $ 100,000 recognised at spot rate of Rs. 50 on the day of export. The corporate sold 3-month forward dollars at Rs. 50.60 on the same day. At the quarter end, the spot rate was Rs. 50.75 and forward rate (of an equivalent tenor as that outstanding on that forward) was Rs. 51.02.

The corporate needs to designate the risk sought to be hedged in a precise manner. This risk can be defined in two ways (a) risk of the volatility of the spot dollar (b) risk of the volatility of the forward dollar. Each designation will lead to difference in hedge accounting measurements as well as effectiveness.

Risk of Spot Volatility

The spot has moved by Rs. 0.75 while the forward has moved by Rs. 0.42 between the date of export and the period end. The forward would be discounted to present value as the realisability of the forward is expected only on its final settlement. Let us assume the present value of the forward gain is Rs. 0.41. Hedge effectiveness percentage would come to 55% and the hedge would fail. The derivative fair value will be charged to the profit and loss statement while the receivable would be revalued under AS-l1 and the restatement gain taken to the profit and loss statement.

Risk of Forward Volatility


The forward element of the receivable has hypothetically moved by Rs. 0.41 (when fair valued) and the forward contract has also moved by Rs. 0.41 (when fair valued). Thus the hedge is effective. This loss on the forward would be recognised in the statement of profit and loss, while the movement in the spot would be recognised under AS-II in the profit and loss.

The final impact on the net profit is the same in this illustration, irrespective of whether the hedge is effective or otherwise. However, the line item classification within the statement of profit and loss may differ. Hedged items related gains and losses are commonly classified along with the underlying transactions while gains and losses on ineffective hedges are classified as derivative losses, which, if material, would merit a separate line item disclosure in the statement of profit and loss.

Cash Flow Hedge Accounting

Gains and losses on hedging instruments designated as cash flow hedges, if effective, are recognised directly in equity (generally in Hedging Reserves). These gains and losses are recycled into the statement of profit and loss when the underlying transaction impacts the statement of profit and loss.

Example – Forecasted Revenue


Corporate ABC forecasts dollar revenues of $ 10mio for the year to end March 2010. These sales relate to the month of January 2010. It faces a risk of dollar volatility and has sold forward dollars for each month in this financial year so as to hedge itself at Rs. 51.27 today, when the spot dollar was Rs. 50. At the end of the June quarter, spot dollar was Rs. 50.65 while the forward dollar of equivalent tenor was Rs. 51.75.

The corporate needs to designate the hedged risk in a precise manner. In particular, the hedged risk may be defined as (a) the risk of volatility in the spot or (b) the risk of volatility in the forward.

If the spot risk is designated, hedge effectiveness will be tested as under. Change in the value of the hedging instrument (based on forward dollar) is Rs 0.48, while the change in the value of the hedged item (i.e., forecasted revenues based on spot dollar) is Rs. 0.65. The hedge effectiveness ratio will work out to 74% and the hedge will be considered ineffective. Please note that the forward dollar will need to be present valued to arrive at the fair value, but that process will make the hedge further ineffective.

The loss on the forward will be recognised in the statement of profit and loss as the hedge is ineffective.

If the forward risk is designated, hedge effectiveness will be computed at 100% (as both the hedging instrument and the hedged item will change by the same amount of the present value of Rs. 0.48). The loss on the forward will therefore be recognised in equity. This accounting process will shield the present earnings from derivative volatility.

In the quarter in which the revenue forecasted actually happens (in our example the Jan.-March 2010 quarter), the cumulative gains or losses parked in reserves will be recycled into the statement of
profit and loss.

Conclusion
Derivative accounting and hedge accounting are complex areas which need a deep understanding of economic hedging, derivative instruments, risk management concepts as well as the accounting standard requirements. Systemic challenges around hedge definitions and accounting are stringent and corporates need to plan in advance to establish these systems well. In many cases, a committed involvement of operational managers as well as information technology is required to implement hedge accounting successfully.

Simplicity and complexity

Article

“How much money you need to make a charity of Rs.100 ?” This
is the question asked of a group of people. The answer may vary depending upon
the nature of the group. For example, a group of people aspiring for admission
to a management course may ask a counter question : How much is the financial
requirement of the donor to meet his normal needs ? Will he be left, after he
had made the charity, with sufficient funds to meet his requirements ? A group
of financial experts, or aspiring experts, will ask about the time when the
charity is to be made, for a charity of Rs.100 to be made now has a different
time value of money from a charity to be made a year hence. They will think that
if the charity is to be made a year hence, then the donor needs roughly Rs.91
today if the rate of discount is 10%.


Do you find anything strange in these answers ? Yes, what you
find strange is that no group is able to see the question straight. Each
believes it is a complex question, and each, while trying to answer it, adds its
own bit of complexity to the question. The management group wants to look at the
question from the management angle, and the financial experts bring in the time
value of money. Nobody seems to think that to make a charity of Rs.100 all that
you need is Rs.100. The question does not require hypothesizing anything.

Why can’t we think straight ? Because we have lost simplicity
in our thinking. We have started believing that anything that is simple is too
true to be accepted, and anything that is good has to be complex, or anything
that is complex has to be good. We equate complexity with beauty and simplism
with being simpleton.

Let us look around and see how much complexity we are
surrounded with. You see an advertisement on TV in which a monkey snatches an
undergarment from a clothesline and makes a peculiar noise. He wears it, jumps
and finally leaves the garment hanging on the tree. I have often tried to figure
out what is the advertisement all about. Does it promote sale of garments or is
it an advertisement made by an animal protection group ? It is too complex. May
be the creator of the advertisement thinks that anything that is complex is
beautiful. Let us take one more example. Newspapers recently reported a
statement made by a legal expert in the context of a crime where the convicts
were handed over death punishment, which read, “The act was diabolic of the
superlative degree in conception and cruel in execution and does not fall within
any comprehension of the basic humanness which indicates the mindset which
cannot be said to be amenable for any reformation.” It was too complex. All that
the statement meant was that a heinous crime was committed and the culprits were
beyond the scope of reformation. People usually go gaga over complex things and
associate complexity with intelligence, whereas, the fact of the matter is that
more often than not complexity reflects ignorance and lack of grip of the person
over the subject. What is really difficult is to make things simple. Only one
who is truly well versed in a subject can present the subject in a manner that
is simple and intelligible to a layman.

In all these complex cases you are as perplexed as others.
Others do not speak up. You too fear that if you admitted that you did not
understand, you would be regarded as a moron. You keep mum.


Jack Trout, a management consultant, has written a book
titled ‘The Power of Simplicity’1.
He advocates simplicity in every field by showing how simple things succeed in
life and how much more effective they can be. While giving a few more examples
of so-called experts who make things complex, he says that when an expert on
environment may say that he is doing environmental scanning what he really may
be meaning is that he is looking out of the window.


Why can’t we be simple ? There are psychological reasons.
Basically it is our fear that keeps us from admitting what we believe. Jack
Trout lists the following fears :

1. Fear of failure

2. Fear of self defence

3. Fear of trusting others

4. Fear of thinking

5. Fear of speaking

6. Fear of being alone


According to Jack Trout complexity can be attributed to the
fear of thinking. He believes that we fear thinking and therefore look to others
for solutions. Thus, we end up accepting solutions offered by others and that
too only if the solutions are complex.

Why are we discussing the topic of simplicity and
complexity ? Because it concerns us finally as chartered accountants. Let us
take a few more examples of complexity around us in our own profession. The
first one that comes to my mind is the provisions of S. 80HHC of the Income-tax
Act, 1961 (the I.T. Act). The provisions, as they were, were already complex and
as though this complexity were not enough, we, the taxpayer and, I must state
with due respect, the judiciary, made them more complex. Then there are the
provisions relating to Fringe Benefit Tax. Here also, as though the Government
thought that the provisions were not complex enough that the CBDT issued the
Circular which hardly anybody can claim to have fully understood. Then there are
a number of accounting standards (AS) full of complexities. AS-15 relating to
Employees’ Cost, AS-30 relating to Financial Investments and AS-31 relating to
Financial Instruments, to name a few, are some such complex standards.
Professionals in private admit that few of them have been able to fully grasp
these standards. This is not to suggest that there are no chartered accountants
who have not grasped the standards; there are. But these chartered accountants
have used their valuable energy on something that is not as valuable, at least
to the society, as it ostensibly appears.

Another reason why we have developed complex-ity around us is that we harbour a false notion that if we are complex in our expression we look more professional. However, we have paid a heavy price by being or trying to appear professional.

If we do not wake up in time, we may observe most complex rules, regulations and ASs in breach and will secretly hold them in contempt. Once we hold ASs in contempt and ostensibly present accounts hardly intelligible to the public, we will be removed from the public also, and may eventually lose their esteem. We perhaps created complexity to tell the world that our job is difficult, and thereby, to earn esteem. But that very thing which was devised to earn us esteem will destroy the little esteem the public holds us in. I am reminded of a dialogue between two doctors in Bernard Shaw’s play “Doctor’s Dilemma”, which though is uttered in the context of the doctor’s profession may as well apply to us. The dialogue runs like this:

Ridgeon: “We’re not a profession: we’re a conspiracy.”

Sir Patrick: “All professions are conspiracies against the laity.”

I recommend all to read Jack Trout’s book – “The Power of Simplicity” and to contribute to make life simpler and better.

A. P. (DIR Series) Circular No. 116 dated 1st April, 2014

Advance Remittance for Import of Rough Diamonds

Presently, RBI had notified the names of 9 mining companies to whom an importer (other than a Public Sector Company (PSC) or a Department/Undertaking of the Government of India/State Government) could make advance remittance without any limit and without bank guarantee or stand by letter of credit for import of rough diamonds into India.

This circular provides that henceforth RBI will not notify the names of mining companies to whom an importer (other than a Public Sector Company (PSC) or a Department/Undertaking of the Government of India/State Government) could make advance remittance without any limit and without bank guarantee or stand by letter of credit for import of rough diamonds into India.

Henceforth, banks can decide, subject to certain conditions, on overseas mining companies to whom an importer (other than PSC or Department/Undertaking of Government of India/State Government) can make advance payments, without any limit / bank guarantee/stand-by letter of Credit for import of rough diamonds into India.

In case of an importer entity in the Public Sector or a Department/Undertaking of the Government of India/State Government/s, banks can permit advance remittance subject to satisfaction of the applicable conditions and a specific waiver of bank guarantee from the Ministry of Finance, Government of India, where the advance payments is equivalent to or exceeds US $ 100,000.

Banks have to submit a report of all advance remittances made without a bank guarantee or standby letter of credit, where the amount of advance payment is equivalent to or exceeds US $ 5,000,000, to the concerned Regional Office of Reserve Bank of India, in the format annexed to this circular, within 15 calendar days of the close of each half year.