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Chit fund: (i) Method of accounting — Change in method of accounting from mercantile system of accounting to completed contract method — Profits accounted for chit discount on completed contract method — Result revenue neutral — Assessee’s method of computing justified; (ii) Business expenditure — Advertisement expenditure — Expenses incurred not on particular series of chit alone but for promotion and running of business — Allowable as revenue expenditure in year in which expenses incurred

9 Shriram Chits and Investments (P.) Ltd. vs. ACIT [2022] 442 ITR 54 (Mad) A.Ys.: 1987-88 to 1995-96 and 1999-2000  Date of order: 30th August, 2012 Ss. 37 and 145 of ITA, 1961

Chit fund: (i) Method of accounting — Change in method of accounting from mercantile system of accounting to completed contract method — Profits accounted for chit discount on completed contract method — Result revenue neutral — Assessee’s method of computing justified; (ii) Business expenditure — Advertisement expenditure — Expenses incurred not on particular series of chit alone but for promotion and running of business — Allowable as revenue expenditure in year in which expenses incurred

The assessee was in chit business. Till 31st December, 1985, in respect of the method of accounting u/s 145 of the Income-tax Act, 1961, the assessee followed the mercantile accounting system regarding the commission earned by it in its capacity as foreman, conducting the chit activity. However, thereafter, the assessee changed the method to the completed contract method of accounting, and the commission earned was accounted for on the completion of each series of chits. The Department did not accept the change of the accounting method on the ground that on the date the auction was conducted, the right of the assessee to receive the commission in the capacity as foreman accrued, and consequently, the assessee was not entitled to wait for the completion of each chit period, as there was no accrual of income at the end of each term.

The Commissioner (Appeals) upheld the order of the assessing authority. The Tribunal held that the remuneration or commission of the foreman accrued at the end of chit draw and that, therefore, the assessee’s commission had to be related to and determined based on every auction and not to be postponed to the completion period and dismissed the assessee’s appeal.

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

“i) A reading of the rights of the subscribers and responsibilities of the chit fund as foreman in the provisions of the Chit Funds Act, 1982 shows that the duty is cast on the foreman to conduct the chit to a duration assured and in the event of any default of payment of any one of the instalments, the foreman has the responsibility to make good that loss. At the end of the chit period, the subscriber is assured of the amount for which he participated in the scheme. In the background of the provisions of sections 21 to 28 of the 1982 Act read in the context of the definition of “discount” and “dividend”, on every auction, the discount that is arrived at is taken for the purpose of meeting the expenses of running the chit. The expenses normally include all expenses apart from the commission payable to the foreman, and the dividends that are payable to the subscribers, are normally carried to the end of the chit period. Every chit is an independent transaction containing a series of activities to be undertaken during the course of the transaction. Even though the discount and commission are recognised with the conduct of auction every month, yet, with all the load mounted on the discount, the uncertainties in the payment of subscriptions and the commitments that the assessee has to discharge under the 1982 Act, the revenue recognition, as a business proposition becomes determinable only at the end of the particular chit transaction.

ii) While in the proportionate completion method, revenue is recognised proportionately by referring to the performance of each act, the possibility of revenue recognition in the proportionate completion method being a fairly determinable one, in the completed services contract method, the difficulty in determining the revenue arises by reason of the significant nature of the services yet to be performed in relation to the transaction that normally, the revenue recognition is taken to the end of the performance. Therefore, even while adopting the proportionate completion method, where there is every possibility of identifying the revenue vis-a-vis the extent of services completed, there is a line of caution stated that when there is a better method available to assess the better performance, it may be adopted to the straight line basis for ascertaining the income. However, when the services yet to be performed are so significant in relation to the transaction, difficulty arises in recognising the revenue in the performed services. Therefore, in contrast to the proportionate completion method, necessarily, revenue recognition is postponed till the completion of the services of the contract. Under clause 9, “Basis for revenue recognition”, it is stated that so long as there is uncertainty on the ultimate collection, revenue is not normally recognised along with rendering of services. Even though payment may be made in instalments, when the consideration is not determinable within reasonable limits, recognition of revenue is postponed. Accounting Standards 9 and 7 both speak in one voice at least as regards the proportionate completion method, the completion contract method and both these methods aim at the methodology for arriving at the revenue recognition with a certain degree of certainty, taking into consideration, the significance of the services performed and to be performed in relation to the particular transaction.

iii) Section 21(1)(b) of the 1982 Act provides for entitlement to receive commission, remuneration or for meeting the expenditure of running the chit at a rate not more than 5 per cent. Therefore, at a given point of time, a foreman cannot, with any certainty, assert that his commission be paid irrespective of the expenses that he may have to incur for the conduct of the transaction. In the computation of income on the completed contract basis, the exercise would be seen as revenue neutral. Under the 1982 Act, the discount is the sum of money which is set apart under the chit agreement to meet the expenses of running the chit. This also has to take note of the default among the different classes of subscribers.

iv) While there may be a certainty as to the dividend received every month for purpose of assessment on accrual basis, as far as a company running the chit business is concerned, the dividend and the discount can properly be ascertained only at the completion of the transaction and not in the midway. Given the significant nature of the services yet to be performed in relation to the chit series, till the series come to an end, it is difficult to assess with any certainty, the amount that would be properly called as income for the purpose of assessment. “Discount” as defined under section 2(g) of the 1982 Act means the money set apart under the chit agreement to meet the expenses of running the chit or for distribution among the subscribers or for both. Dividend is the share of the subscriber in the amount of discount available for reasonable distribution among the subscribers at each instalment of the chit.

v) Given the rights of the subscriber, when section 21 of the 1982 Act provides for 5 per cent of the chit amount to be given to the assessee as foreman which was stated therein as commission, remuneration or for meeting the expenses of running the chits, and when the dividend to the assessee as foreman had to come only from out of the discount, the Department was not justified in contending that the assessee could not adopt the completed contract method for income recognition. The assessee was justified in adopting the completed contract method to arrive at the real income.

vi) The assessee’s expenditure was related both to the administrative costs and to the advertisement costs. The expenses could not be viewed as relatable to the particular series alone, but as relating to the running of the business and were revenue expenditure of the relevant assessment year in which it was incurred. The fact that the advertisement referred to the beginning of a new series, per se, would not mean that it was relatable to the conduct of the business of the assessee in general. The advertisement was more in the nature of information as to the business of the assessee and for its promotion.

vii) The plea of the Department that the change in the method of accounting was not bona fide was taken without any material. Except for the issue on mutuality relating to the A. Ys. 1988-89 to 1995-96 and 1999-2000 the findings of the Tribunal to the extent regarding the method of accounting were set aside.”

CERTIFICATION ENGAGEMENTS

INTRODUCTION
Chartered accountants in practice are requested to certify and attest multiple documents. These can be a net-worth certificate, turnover certificate, an ITR (Income Tax Return) certificate, ODI (Overseas Direct Investment) certificate, certificate required by banks for loan/renewal/compliance purposes, and certifications for tender purposes as for local inputs or statutory compliance certificates.
Considering the importance of these certificates and the need to bring uniformity in reporting, the ICAI issued a Guidance Note on Reports or Certificates for Special Purposes (Revised 2016) (GN). The purpose of this GN is to guide on engagements requiring a practitioner to issue reports other than those issued in audits/reviews of historical financial information. Guidance Notes assist professional accountants in implementing the Engagement Standards and the Standards on Quality Control issued by the AASB under the authority of the Council of ICAI.
As per the GN, a report or certificate issued by a practitioner can provide either a reasonable or a limited level of assurance depending upon the nature, timing and extent of procedures to be performed based on the facts and circumstances of the case. Therefore, when a practitioner is required to give a certificate or a report for special purpose, a careful evaluation of the scope of the engagement needs to be undertaken, i.e., whether the practitioner would be able to provide an opinion (in a reasonable assurance engagement) or a conclusion (in a limited assurance engagement) on the subject matter.

Reasonable assurance
engagement

Limited assurance engagement

• An
assurance engagement in which the practitioner reduces engagement risk to an
acceptably low level in the circumstances of the engagement, as the basis for
the practitioner’s opinion.

 

• The
practitioner gives a report in the form of positive assurance (direct) and
nature timing and extent of procedures are more extensive.

• An
assurance engagement in which the practitioner reduces engagement risk to a
level that is acceptable in the circumstances of the engagement but where
that risk is greater than for a reasonable assurance engagement.

 

• The
practitioner gives a

 

(continued)

 

report
in the form of negative assurance (indirect) and nature timing and extent of
procedures are moderate.

Examples – Certificates Based on Reasonable Assurance

ü Certification of Turnover for past
years

ü Certification of Net worth of
entity

ü Certification of Derivative Exposures

ü Certification of compliance with Buyback
Regulations

ü Annual Performance Report (APR)
Certificate

ü Overseas Direct Investment (ODI)
Certificate

Examples – Certificates Based on Limited Assurance

ü Certification of Non-financial
information
required for Tender

ü Certificate on Accounting treatment
in conformity with Accounting standards

ü Certificate issued by a Professional Accountant
other than auditor

 

This article aims to highlight the key aspects relating to issuance/challenges of certificates that the auditor/professional accountant should consider.

ENGAGEMENT ACCEPTANCE PROCEDURES
The practitioner should consider relevant ethical and independence requirements while accepting or continuing an engagement. The practitioner should agree in writing the terms, i.e. objective, scope, responsibilities of practitioner and responsibilities of the engaging party, fees, type of assurance in detail and limitations on use based on the eventual use in the engagement letter. Any change in engagement scope should not be agreed to unless there is a reasonable justification. In case of limitation on scope imposed, the practitioner should not accept the assignment where he will end up disclaiming his opinion.
WHEN ASSURANCE REPORT/CERTIFICATE IS PRESCRIBED BY LAW OR REGULATION
Sometimes, the applicable law and regulation or a contractual arrangement that an entity might have entered into prescribes the layout or wording of reports or certificates. These wordings generally contain the words such as ‘Certify’ or ‘True and Correct’. These words, i.e., ‘True and Correct’ indicate absolute assurance. Absolute assurance indicates that the documents certified are 100% free from misstatements, and the auditor’s engagement risk has been reduced to zero. The practitioner should refrain from using words that indicate absolute assurance and clarify that only a reasonable or limited assurance is provided.

Points to consider when the format/layout is prescribed by law:

•    Certificate is to be prepared as per the format specified by the regulatory authority (e.g. APR certificate).
•    Enclose a statement containing essential elements of the assurance report to the certificate.
•    A separate line stating “to be read with the enclosed statement of even date” shall be inserted towards the end of the certificate and above the signature. Such statement shall be enclosed with the certificate.
•    Underlying management statement/annexure, duly attested, on which auditor will issue the certificate.
•    To evaluate whether intended users might misunderstand the assurance conclusion and whether additional explanation in the assurance report can mitigate possible misunderstanding.

Example1
RBI had alleged wrong certification of a Company by a CA Firm (Respondent) which did not meet dual principle business criteria (Income & Asset Criteria) as required in terms of the Non-Banking Financial (Non Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015. Further, respondent failed to issue exception report to RBI.
Findings
The respondents are held guilty of gross negligence and professional misconduct  falling within the meaning of Clause (7) of Part I of Second Schedule of Chartered Accountant Act,1949 for violation of “Non-Banking Financial Companies Auditor’s Report (Reserve Bank) Directions, 2013”.

 

1   Report/Orders issued by ICAI
disciplinary Committee on Non Compliances in issuing Certificate/Report.

WHEN ASSURANCE REPORT/CERTIFICATE IS TO BE GIVEN WHILE ISSUING/CERTIFYING PROVISIONAL/PROJECTED STATEMENTS
Usually, clients approach banks for new loans/renewal/enhancement of loans. Many bankers ask such clients to produce three years of audited financials/provisional/projected financials and get them signed. It is pertinent to note there is no circular by RBI requesting such underlying documents. The Chartered Accountants Act, 1949 (Clause 3 of Part I of the Second Schedule) deems a CA in practice guilty of professional misconduct if he permits his/firm’s name to be used in connection with an estimate of earnings contingent upon future transactions in a manner which may lead to the belief that he vouches for the accuracy of the forecast. This means that a practitioner cannot certify whether a business will achieve a future result or not as per the projected financial statements. However, the projections can be examined by a Chartered Accountant under SAE 3400-The Examination of Prospective Financial Statement (PFI). PFI could be in the form of a forecast, a projection or a combination of both, for example, a one year forecast plus a five-year projection. We must note PFI contains projections/forecasts involving uncertainty, and therefore adequate care must be taken on the type of assurance given. PFI is highly subjective, and it requires the exercise of considerable judgment. The practitioner needs to assess the source and reliability of the evidence supporting management’s assumptions/estimates and, where hypothetical assumptions are used, whether all significant implications of such assumptions are considered. The auditor should document important matters in providing evidence to support his report on the examination of prospective financial information and evidence that such examination was carried out in accordance with the SAE. The auditor can provide only a moderate level of assurance on the reasonableness of management’s assumptions used and reasonable assurance (opinion) on the PFI’s proper preparation based on the assumptions, and its presentation in accordance with the relevant financial reporting framework.

Similarly, for the certification of ITR, members are advised not to certify ITR as a true copy as per FAQs on UDIN-issued by ICAI. However, they can make an opinion/ certificate/ report about ITR based on its source, location and authenticity of data from which it is being prepared, and UDIN is required.

ICAI has also issued a Guidance Note on Reports in Company Prospectuses (Revised 2019). This Guidance Note guides compliance with the Companies Act, 2013 and the SEBI  (Issue of Capital and Disclosure Requirements) Regulations, 2018 relating to the reports required to be issued by CAs in prospectus issued by companies for Indian offerings. Underwriters and lead managers usually undertake a due diligence process on the information contained in the prospectus. As a part of that process, they also seek to obtain an added level of comfort from the auditors on various aspects of the prospectus (in the form of a comfort letter), in addition to the auditors’ report already contained in the prospectus. The auditor should agree with the lead manager on the scope and limitation of the issuance of a comfort letter.

MATTERS REQUIRING ATTENTION WHILE ISSUING CERTIFICATE/REPORT

Disclosures   
It is generally seen that practitioners cannot provide complete disclosures such as disclosure of responsibilities of the parties involved, the subject matter, and disclosure of the intended purpose of the certificate. Disclosures provide clarity and help avoid misunderstandings of the objective, scope, responsibilities, subject matter, and applicable criteria. Issuers should make it a practice to provide detailed disclosures in their certificates and reports that will leave little to the imagination of the user. In case where a format is prescribed, or a certificate is to be issued in a specific format, there is always a challenge to detail the disclosures/qualifications etc. Also, where there are specific formats/certification over portals-Fixed formats, there is no specific place for mentioning/inserting UDIN, and this adds as a limitation while issuing a certificate.
Certification of non-financial information

While a client applies for tenders, many documents are required to be certified by the CA. Sometimes non-financial documents are also requested to be certified by a CA. The auditor may use the work of an expert for non-financial information after considering its competency, capability and objectivity.
Key Performance Indicators-SEBI Disclosures
In its consultation paper, SEBI has planned tougher pricing norms for startup IPOs. SEBI believes the disclosures made under the ‘Basis of Issue Price’ section in an offer document need to be ‘supplemented with non-traditional parameters’ and other Key Performance Indicators (KPIs). For example a technology or app-based startup, the KPIs could be figures like the number of downloads or average time spent on a platform. Further, it is not always possible to correlate KPIs with the issue price. KPIs can be dynamic, evolve with time, and can be volatile due to technology changes depending on the management’s strategies and learnings from previous quarters. KPIs would be further required to be certified by a statutory auditor/independent CA. It would be challenging for an auditor, and it will have to be seen if giving such a certificate is feasible since the auditor will not have the required skills for non-financial KPI’s. SEBI should provide guidelines on how KPIs need to be disclosed. For example, the guidelines could specify that the following information should be accompanied with the disclosure of KPIs:
• a clear definition of the metric, and
• how it’s calculated.
For example, when disclosing ‘acquisition of new customers’, it should define whether the numbers indicate the basis on which a new customer is identified. For example, it is a new customer because it has downloaded the App for a subsequent time, or it is a new customer because it has placed the first order in a particular period, or it is a new customer because it has logged in from a new device.
When report is issued based on Agreed Upon Procedures Engagement
In an Engagement to Perform Agreed-upon Procedures regarding Financial Information-SRS (Standard on Related Services) 4400, the client requires the auditor to issue a report of factual findings based on specified procedures performed on the specified subject matter of specified elements, accounts or items of a financial statement.
Example – An ongoing arbitration engagement – where the dispute pertains to revenue realisation/valuation from a real estate project, the client has requested the auditor to perform agreed-upon procedures concerning individual items of financial data, say, revenue and accounts receivable, and has provided books of accounts, supporting documents from buyers and valuation reports by independent valuers.
The procedures performed will not constitute an audit or a review. Accordingly, no assurance will be expressed, whereas in the issuance of a report/certificate (reasonable/limited assurance), an opinion is given.
Sources and Methodology
A practitioner will be better off stating the sources of his information. It will be better to state where the data/audit evidence is obtained. This will safeguard the practitioner and clarify the sources to the reader. Where the underlying data is relied upon by the practitioner, he may state so in his report. Often copies are provided by the client via scan on emails. The practitioner may consider evaluating the genuineness or otherwise of such documents. A practitioner may mention the methodology adopted by him in undertaking the assurance activity.
Example2 – The CA (Respondent) issued a certificate to a Bank for account opening without verifying the underlying documents and ensuring its genuineness. The board findings stated that the certificate is a written confirmation of the facts stated therein. When a Chartered Accountant issues a certificate, it is believed to be ‘True and Correct’. The respondent ought to have exercised due professional scepticism to see that the correct facts as to the existence of the necessary documents.
Findings – The respondent is guilty of ‘Other Misconduct’ falling within the meaning of item (2) of Part IV of First Schedule to the Chartered Accountants Act 1949 read with section 22 of the said act.
Representations and Documentation
Adequate guidance is available on obtaining management representations. A practitioner may be cautious when relying on representation as primary evidence. Considering the limited nature of assurance or reasonable assurance engagements, a practitioner should obtain adequate management representations to correlate these with other evidence. When representations are not provided, or clients disagree to do so, the practitioner may treat this as a red flag. A practitioner should maintain adequate documentation that forms the basis of his report / certificate and reference it appropriately.

 

2   Report/Orders issued by ICAI
disciplinary Committee on Non Compliances in issuing Certificate/Report.

Title, Content and Structure
The GN provides for the content, flow and structure of the report. It is observed that many practitioners continue to provide certificates like before without following the format prescribed. This especially involved obtaining UDIN and affixing the UDIN to the signature panel. One may refer to the recent FAQ on UDIN (January 2022) for various aspects relating to UDIN covering numerous situations. Addressing the report to the proper party is very important. The format also prescribes an opinion para, which requires clear and complete articulation of what is being reported.
Restriction on use
It is important to state that a certificate is issued for a specific purpose and therefore should only be used for that purpose and not for any other purposes. Often a certificate is issued for FEMA or specific banks, and the practitioner may state the purpose and/or user.
Issuance of incorrect certificates for taking benefit of license/scheme/tax benefits/subsidy
A practitioner should ensure utmost care while issuing a certificate after verifying all underlying documents and diligently performing necessary audit procedures. It is seen that authorities have held professionals guilty if the certificate is incorrectly issued based on significant errors/frauds in books of accounts which the practitioner ignored. In a few cases where certificates are to be issued to tax authorities, it is seen that figures are manipulated to take undue advantage of license/scheme/tax benefit/subsidy.
Example3 – The respondent had issued bogus certificates of past exports based on which the concerned importers were able to obtain advance licenses and DEEC Book for duty-free imports. This resulted in evasion of duty to the government to the extent of Rs. 1crore.
Findings – The respondent is guilty of ‘Other Misconduct’ falling within the meaning of Section 22 read with section 21 of the Chartered Accountant Act, 1949. The respondent is separately prosecuted under the Customs Act, and a penalty is imposed on him.

 

3   Report/Orders issued by ICAI
disciplinary Committee on Non Compliances in issuing Certificate/Report.

Other Points
Materiality – Materiality must be considered in the context of qualitative factors, and when applicable, quantitative factors. When considering materiality in particular engagements, the importance of both the factors is a matter of professional judgment.
Internal Audit Report and Internal Control – Where the practitioner plans to use the internal audit functions’ work, he should evaluate its competence, objectivity and quality control and whether its work is relevant for the engagement. The practitioner should obtain an understanding of internal controls and needs to evaluate its inherent limitations.
BOTTOM LINE
Considering the various challenges, there is a lot of risk and exposure for the auditor while issuing such certificates. The auditor may be called upon by various regulators if there is an issue related to the certificate/report. The auditor must ensure that he has obtained and preserved sufficient and appropriate audit evidence and apply professional scepticism and professional judgment while arriving at the opinion. Certificates serve numerous purposes, and as CAs, it is our responsibility to issue them with due care and diligence. There is an increasing requirement for the auditor to issue certificates in the statutory format. Considering the same, ICAI may consider looking at its Guidance Note to avoid rejection of such certificates.  

THE FINANCE ACT, 2022

1. BACKGROUND
Finance
Minister Smt. Nirmala Sitharaman presented her fourth regular Budget in
Parliament on 1st February,2022. In her Budget speech, she emphasised
four priorities, namely (i) PM Gatishakti, (ii) inclusive development,
(iii) productivity enhancement & investment, sunrise opportunities,
energy transition and climate action and (iv) financing of investments.
The Finance Minister has given a detailed explanation of the measures
that the Government proposes to take in the coming years.

The Finance Minister has also introduced the Finance Bill, 2022, containing 84 sections amending various sections of the Income-tax Act. Before the passage of the Bill, 39 amendments to the Bill were
introduced in Parliament. The Parliament passed the Bill with the
amendments on 29th March, 2022. The Finance Act, 2022, has received the
assent of the President on 30th March, 2022. By this Act, several
amendments are made to the Income-tax Act, increasing the burden of
compliance for tax payers. However, there are some amendments which will
give some relief to taxpayers. Contrary to the Government’s declared
policy , there are some amendments that will have retrospective effect.
In this article, some of the important amendments in the Income tax-Act
(Act) are discussed.

2. RATES OF TAXES FOR A.Y. 2023-24

2.1
There are no changes in the slabs and the rates for an Individual, HUF,
AOP and BOI. The tax rates remain unchanged in the case of a Firm
(including LLP), Co-operative Society and Local Authority. In the case
of a Domestic Company, the tax rate remains the same at 25% if a
company’s total turnover or gross receipts for F.Y. 2020-21 was less
than R400 Crore. In the case of other larger companies, the tax rate
will be 30%. The rate of 4% of the tax for ‘Health and Education Cess’
will continue for all assessees. Apart from what is stated in Para 2.2,
the rates of surcharge are the same as in earlier years.

2.2 It
may be noted that some relief in rates of surcharge is given in A.Y.
2023-24 (F.Y. 2022-23). The revised rates of surcharge are as under:

(i) Individual, HUF, AOP / BOI
There
is no change in the surcharge rates on slab rates in A.Y. 2023-24.
However, the surcharge on income taxable under sections 111A, 112, and
112A and dividend income will not exceed 15%.

(ii) AOP (having corporate members only)
In
the case of AOP having only corporate members, the rate of surcharge
will be 7% if the income exceeds R1 crore but does not exceed R10
crores. The rate of surcharge will be 12% if the income exceeds R10
crores.

(iii) Co-operative Societies
The rate of
surcharge is reduced for A.Y. 2023-24 to 7% if the income is more than
R1 crore, but less than R10 crore. In respect of income exceeding R10
crore, the rate of surcharge is unchanged at 12%.

2.3. Alternate Minimum Tax
In
the case of co-operative societies, the Alternate Minimum Tax (AMT)
payable u/s 115JC is reduced from 18.5% to 15% from A.Y. 2023-24 (F.Y.
2022-23).

3. TAX DEDUCTION AND COLLECTION AT SOURCE (TDS AND TCS)

3.1 Section 194-IA:
This section is amended w.e.f. 1st April, 2022 – tax at 1% is to be
deducted on higher of stamp duty value or the transaction value. When
the consideration and stamp duty valuation is less than R50 Lakhs, no
tax is required to be deducted.

3.2 Section 194R: (i) This new section comes into force from 1st April, 2022.
It provides that tax shall be deducted at source at 10% of the value of
the benefit or perquisite arising from business or profession if the
value of such benefit or perquisite in a financial year exceeds R20,000.

(ii) The provisions of this section are not applicable to an
Individual or HUF whose sales, gross receipts or turnover does not
exceed R1 crore in the case of business or R50 Lakhs in the case of
profession during the immediately preceding financial year.

(iii)
The section also provides that if the benefit or perquisite is wholly
in kind or partly in kind and partly in cash, and the cash portion is
not sufficient to meet the TDS amount, then the person providing such
benefit or perquisite shall ensure that tax is paid in respect of the
value of the benefit or perquisite before releasing such benefit or
perquisite.

(iv) In the Memorandum explaining the provisions of
the Finance Bill, 2022, it is clarified that section 194R is added to
cover cases where the value of any benefit or perquisite arising from
any business or profession is chargeable to tax u/s 28(iv). Therefore,
this new TDS provision will apply only when the value of the benefit or
perquisite is chargeable to tax in the hands of the person engaged in
the business or profession u/s 28(iv). It is also provided that the
Central Government shall issue guidelines to remove any difficulty that
may arise in implementing this section.

3.3 Section 194-S: (i) This is a new section which will come into force on 1st July, 2022
– which provides that any person paying to a resident consideration for
transfer of any Virtual Digital Asset (VDA) shall deduct tax at 1% of
such sum. In a case where the consideration for transfer of VDA is (a)
wholly in kind or in exchange of another VDA, where there is no payment
in cash or (b) partly in cash and partly in kind but the part in cash is
not sufficient to meet the liability of TDS in respect of the whole of
such transfer, the payer shall ensure that tax is paid in respect of
such consideration before releasing the consideration. However, this TDS
provision does not apply if such consideration does not exceed R10,000
in the financial year.

(ii) Section 194-S defines the term
‘Specified Person’ to mean a person being an Individual or a HUF, whose
total sales, gross receipts or turnover from business or profession does
not exceed R1 crore in case of business or R50 Lakhs in the case of
profession, during the financial year immediately preceding year in
which such VDA is transferred or being Individual or a HUF who does not
have income under the head ‘Profits and Gains of Business or
Profession’. In the case of a Specified Person –

(a) The
provisions of section 203A relating to Tax Deduction and Collection
Account Number and section 206AB relating to special provision for TDS
for non-filers of Income-tax returns will not apply.

(b) If the
value or the aggregate value of such consideration for VDA does not
exceed Rs. 50,000 during the financial year, no tax is required to be
deducted.

(iii) In the case of a transaction to which sections
194-O and 194-S are applicable, then tax is to be deducted u/s 194-S and
not u/s 194-O.

3.4 Sections 206AB and 206CCA: These
sections deal with a higher rate of TDS and TCS in cases where the payee
has not filed his Income-tax returns for two preceding years and in
whose case aggregate TDS/TCS exceeds R50,000. At present, section 206AB
is not applicable in respect of TDS under sections 192, 192A, 194B,
194BB, 194BL and 194N. By amendment, effective from 1st April, 2022,
it is now provided that TDS/TCS at higher rates in such cases will not
apply u/s 194IA, 194IB and 194M where the payer is not required to
obtain TAN. Further, the test of non-filing the Income-tax returns under
sections 206AB/206CCA has been now reduced from two preceding years to
one preceding year.

4. DEDUCTIONS

4.1 Section 80CCD: At
present, the deduction for employer’s contribution to National Pension
Scheme (NPS) is allowed to the extent of 14% of the salary in the case
of Central Government employees. For others, the deduction is restricted
to 10% of the salary. In order to give benefit to State Government
employees, section 80CCD(2) is amended with retrospective effect from A.Y. 2020-21 (F.Y. 2019-20).
By this amendment, the State Government employees will now get a
deduction for employer’s contribution to NPS to the extent of 14% with
retrospective effect.

4.2 Section 80DD: At present, a
deduction is allowed in respect of the contribution to a prescribed
scheme for maintenance of a dependent disabled person if such scheme
provides for payment of the annuity or lump sum to such dependent person
in the event of death of the assessee contributing to the scheme, i.e.
the parent or guardian. This section is amended effective from A.Y. 2023-24 (F.Y. 2022-23)
to allow a deduction for such contribution even where the scheme
provides for payment of annuity or lump sum to the disabled dependent
when the assessee contributor has attained the age of 60 years or more
and the deposit to such scheme has been discontinued. It is also
provided by the amendment that such receipt of annuity or lump sum by
the disabled dependent shall not result in the contribution made by the
assessee to the scheme taxable.

4.3 Section 80-IAC: At
present, an eligible start-up incorporated on or after 1st April, 2016
but before 1st April, 2022, is entitled to claim an exemption of profits
for three consecutive assessment years out of ten years from the year
of incorporation. For this purpose, the conditions laid down in this
section should be complied. This section is now amended to provide that
the above benefit will be available to a start-up company incorporated
on or before 31st March, 2023.

4.4 Section 80LA: This
section provides for specified deduction in respect of income arising
from the transfer of an ‘aircraft’ leased by a unit in International
Financial Services Centre (IFSC) if the unit has commenced operation on
or before 31st March, 2024. The amendment of this section has extended
this benefit to a ‘ship’ effective A.Y. 2023-24 (F.Y. 2022-23).

5. CHARITABLE TRUSTS AND INSTITUTIONS
Significant
amendments were made in the procedural provisions relating to
Charitable Trusts and Institutions in sections 10(23C), 12A and 12AA of
the Income-tax Act by Finance Acts 2020 and 2021. A new section 12AB was
added to the Income-tax Act. This year, far-reaching amendments are
made in sections 10(23C), 11 and 13 dealing with Specified Universities,
Educational Institutions, Hospital etc. (herein referred to as
‘Institutions’) and Charitable and Religious Trusts (herein referred to
as ‘Charitable Trusts’). These amendments are as under:

5.1 Institutions Claiming Exemptions u/s 10(23C)
Section
10(23C) of the Act provides for exemption to a Specified University,
Educational Institutions, Hospitals etc., (Institutions). This section
is amended as under:

(i)  Section 10(23C)(v) grants exemption to
an approved Public Charitable or Religious Trusts. It is now provided
that if any such Trust includes any temple, mosque, gurudwara, church or
other notified place and the Trust has received any voluntary
contribution for the purpose of renovation or repair of these places of
worship, the Trust will have option to treat such contribution as part
of the Corpus of the Trust. It is also provided that this Corpus amount
shall be used only for this specified purpose and the amount not
utilized shall be invested in specified investments listed in section
11(5) of the Act. It is also provided that if any of the above
conditions are violated, the amount will be considered as income of the
Trust for the year in which such violation takes place. This provision
will come into force from A.Y. 2021-22 (F.Y. 2020-21).

It may be noted that a similar provision is added, effective A.Y. 2021-22 (F.Y. 2020-21), in section 11 in respect of Charitable or Religious Trusts claiming exemption u/s 11.

(ii)
At present, an Institution claiming exemption u/ 10(23C) must utilise
85% of its income every year. If this is not possible, it can accumulate
the unutilised income within 5 years. However, there is no provision
for any procedure to be followed for such accumulation. The amendment to
section 10(23C), effective from A.Y. 2023-24 (F.Y. 2022-23),
now provides that the Institution should apply to the Assessing Officer
(AO) in the prescribed form before the due date for filing the return
of income for accumulation of unutilised income within 5 years. The
Institution must state the purpose for which the income is being
accumulated. By this amendment, the provisions of section 10(23c) are
brought in line with section 11 of the Act.

(iii) At present,
section 10(23C) provides for an audit of accounts of the Institution. By
amendment, it is now provided that, effective from A.Y. 2023-24 (F.Y. 2022-23),
the Institution shall maintain its accounts in such manner and at such
place as may be prescribed by the Rules. Such accounts will have to be
audited by a CA, and a report in the prescribed form will have to be
given by him.

(iv) Section 10(23C) is also amended by replacing
the existing proviso XV to give very wide powers to the Principal CIT to
cancel approval or provisional approval given to the Institution for
claiming exemption. If the Principal CIT comes to know about specified
violations by the Institution, he can conduct an inquiry, and after
giving an opportunity to the Institution, cancel the approval or
provisional approval. The term ‘specified violations” is defined in this
amendment.

(v) By another amendment to section 10 (23C), effective from A.Y. 2023-24 (F.Y. 2022-23), it is provided that the Institution shall file their returns of income by the due date specified in section 139(4C).

(vi)
A new Proviso XXI is added in section 10(23C) to provide that if any
benefit is given to persons mentioned in section 13(3), i.e., author of
the Institution, Trustees or their related persons, such benefit shall
be deemed to be the income of the Institution. This will mean that if a
relative of a trustee is given free education in the educational
Institution, the value of such benefit will be considered as income of
the Institution. In this case, the tax will be charged at 30% plus
applicable surcharge and cess u/s 115BBI.

(vii) It may be noted that section 56(2)(x) has been amended from A.Y. 2023-24 (F.Y. 2022-23)
to provide that if the Author, Trustees or their related persons as
mentioned in section 13(3) receive any unreasonable benefit from the
Institution or Charitable Trust exempt under sections 10(23C) or 11, the
value of such benefit will be taxable as ‘Income from Other Sources’.

(viii)
At present, the provisions of section 115TD apply to a Charitable or
Religious Trust registered u/s 12AA or 12AB. Now, effective from A.Y. 2023-24 (F.Y. 2022-23), the
provisions of section 115TD will apply to any University, Educational
Institution, Hospital etc., claiming exemption u/s 10(23C) also. Section
115TD provides that if the Institution loses exemption u/s 10(23C) due
to cancellation of its approval or due to conversion into a
non-charitable organization or other reasons, the market value of all
its assets, after deduction of liabilities, will be liable to tax at 30%
plus applicable surcharge and cess.

5.2 Charitable Trusts claiming exemption u/s 11

Sections
11, 12 and 13 of the Act provide exemption to Charitable Trusts
(Including Religious Trusts), registered u/s 12A, 12AA or 12AB. Some
amendments are made in these and other sections as stated below:

(i)
As stated above, if a Charitable Trust owns any temple, mosque,
gurudwara, church etc., it can treat any contribution received for
repairs or renovation of such place of worship as corpus donation. This
amount should be used for the specified purpose. The unutilized amount
should be invested as provided in section 11(5). This provision will
come into force from A.Y. 2021-22 (F.Y. 2020-21).

(ii)
At present, if a Charitable Trust is not able to utilise 85% of its
income in a particular year, it can apply to the AO for permission for
the accumulation of such income for 5 Years. If any amount out of such
accumulated income is not utilised for the objects of the Trust up to
the end of the 6th year, it is taxable as income in the sixth year. This
provision has now been amended, effective from A.Y. 2023-24 (F.Y. 2022-23),
to provide that if the entire amount of the accumulated income is not
utilised up to the end of the 5th Year, the unutilised amount will be
considered as income of the fifth year and will become taxable in that
year.

(iii) If a Charitable Trust is maintaining accounts on an accrual basis of accounting, it is now provided that any
part of the income which is applied to the objects of the Trust, the
same will be considered as application for the objects of the Trust only
if it is actually paid in that year.
If paid in a subsequent year,
it will be considered as application of income in the subsequent year.
This amendment will come into force from A.Y. 2022-23 (F.Y. 2021-22).

(iv)
Section 13 deals with the circumstances in which exemption under
section 11 can be denied to Charitable Trusts. At present, if any income
or property of the Trust is utilised for the benefit of the Author,
trustee or related persons stated in section 13(3), the exemption is
denied to the Trust. Now, effective from A.Y. 2023-24 (F.Y. 2022-23),
this section is amended to provide that only that part of the income
which is relatable to the unreasonable benefit allowed to the related
person will be subjected to tax in the hands of the Charitable Trust.
This tax will be payable at 30% plus applicable surcharge and cess.

(v)
At present, section 13(1)(d) provides that if any funds of the
Charitable Trust are not invested in the manner provided in section
11(5), the Trust will not get exemption u/s 11. This section is now
amended, effective from A.Y. 2023-24 (F.Y. 2022-23), to
provide that the exemption will be denied only in respect of the income
from such prohibited investments. Tax on such income will be chargeable
at 30% plus applicable surcharge and cess.

(vi) Section 12A has been amended, effective from A.Y. 2023-24 (F.Y. 2022-23),
to provide that the Charitable Trust shall maintain its accounts in the
manner as may be prescribed by Rules. These accounts will have to be
audited by a Chartered Accountant.

(vii) In line with the
amendment in section 10(23c) proviso XV, very wide powers are now given,
by amending section 12AB (4), to the Principal CIT to cancel
registration given to a Charitable Trust for claiming exemption. If the
Principal CIT comes to know about specified violations by the Charitable
Trust, he can conduct an inquiry and after giving opportunity to the
Trust, cancel its registration. The term ‘Specified Violations’ is
defined by this amendment.

5.3 Special Rate of Tax
A new section 115BBI has been added, effective from A.Y. 2023-24 (F.Y. 2022-23),
for charging tax at 30% plus applicable surcharge and cess. This rate
of tax will apply to registered Charitable Trusts, Religious Trusts,
Educational Institutions, Hospitals etc., in respect of the following
specified income:

(i) Income accumulated in excess of 15% of the income where such accumulation is not allowed.

(ii)
Where the income accumulated by the Charitable Trust or Institution is
not utilised within the permitted period and is deemed to be the income
of the year when such period expires.

(iii) Income which is not
exempt u/s 10(23c) or section 11 by virtue of the provisions of section
13(1)(d). This will include the value of benefit given to related
persons, income from Investments made otherwise then what is provided in
section 11(5) etc.

(iv) Income which is not excluded from the
total income of a Charitable Trust u/s 13(1) (c). This refers to the
value of benefits given to related persons.

(v) Income which is
not excluded from the total income of a Charitable Trust u/s 11(1) (c).
This refers to income of the Trust applied to objects of the Trust
outside India.

5.4 New Provisions for Levy of Penalty

New
section 271 AAE is added in the Income-tax Act for levy of penalty on
Charitable Trusts and Institutions claiming exemption under sections
10(23C) or 11. This penalty relates to benefits given by the Charitable
Trusts or Institutions to related persons. The new section provides that
If an Institution claiming exemption u/s 10(23C) or a Charitable Trust
claiming exemption u/s 11 gives an unreasonable benefit to the Author of
the Trust, Trustee or other related persons in violation of proviso XXI
of section 10(23C) or section 13(1) (c), the AO can levy penalty on the
Trust or Institution as under:

(i) 100% of the aggregate amount
of income applied for the benefit of the related persons where the
violation is noticed for the first time.

(ii) 200% of the aggregate amount of such income where the violation is noticed again in the subsequent year.

6. INCOME FROM BUSINESS OR PROFESSION

6.1 Section 14A:
At present, expenditure incurred in relation to exempt income is not
allowed as a deduction. There was a controversy as to whether section
14A would apply when there was no income from a particular investment.
This section is now amended effective from A.Y. 2022-23 (F.Y. 2021-22)
to clarify that the disallowance under this section can be made even in
a case where no exempt income had accrued or was received, and
expenditure was incurred. It is also clarified that the provisions of
section 14A will apply notwithstanding anything to the contrary
contained in the Income-tax Act.

6.2 Section 35 (1A):
Section 35 allows deduction of expenditure on scientific research. Under
section 35(1A), such deduction is denied under certain circumstances.
This section is now amended effective from A.Y. 2021-22 (F.Y. 2020-21) to
provide that the donor will not be allowed a deduction in respect of
the donation for research u/s 35 if the donee has not filed a statement
of donations before the specified authorities.

6.3 Section 17: This section is amended effective from A.Y. 2020-21 (F.Y. 2019-20) to
provide that any sum paid by the employer in respect of any expenditure
actually incurred by the employee on medical treatment of the employee
or any of his family members for treatment relating to COVID-19 shall
not be regarded as taxable perquisite. This will be subject to such
conditions as may be notified by the Central Government.

6.4 Section 37(1): At
present, Explanation 1 to section 37(1) provides that any expenditure
incurred for any purpose which is an offence or which is prohibited by
law shall not be allowed as a deduction while computing income under the
head ‘Profits and Gains of Business or Profession’. Now Explanation – 3
is added from A.Y. 2022-23 (F.Y. 2021-22) to clarify that the following types of expenses shall not be allowed while computing the business income of the assessee:

(i)
Expenditure incurred for any purpose which is an offence under, or
which is prohibited by, any law in India or outside India, or

(ii)
Any benefit or perquisite provided to a person, whether or not for
carrying on business or profession, where its acceptance is in violation
of any law or rule or regulation or guidelines governing the conduct of
such person, or

(iii) Expenditure incurred to compound an
offence under any law, in India or outside India. It may be noted that
this amendment may affect the benefits or perquisites provided by
pharmaceutical companies to medical professionals. If any benefit or
perquisite is received by a medical professional from a pharmaceutical
company, the same is taxable as the income of the medical professional
u/s 28 (iv). This will now suffer TDS at 10% of the value of such
benefit or perquisite under new section 194R. Further, it will be
difficult to find out whether a particular benefit is prohibited by law
in a foreign country.

6.5  Section 40(a) (ii): (i) Tax
levied on ‘Profits and Gains of Business or Profession’ is not allowed
as a deduction under this section. In the case of Sesa Goa Ltd vs. JCIT 117 taxmann.com 96,
the Bombay High Court held that the term ‘tax’ will not include ‘cess’
levied on tax. A similar view was taken by the Rajasthan High Court.
This section is now amended retrospectively effective from A.Y. 2005-06 (F.Y. 2004-05),
and it is now provided that the term ‘tax’ shall include any surcharge
or cess on such tax. Thus, no deduction will be allowable for ‘cess’ on
the basis of the above High Court decisions.

(ii) It may be noted
that section 155 has been amended from 1st April, 2022 to provide for
the amendment of the computation of income/loss in a case where
surcharge or cess has been claimed and allowed as a deduction in
computing total income. This amendment is as under:

(a) If the
assessee has claimed the deduction for surcharge or cess as business
expenditure, the AO can rectify the computation of income or loss u/s
154. He can also treat this deduction as under-reported income u/s
270A(3) and levy a penalty under that section. For this purpose, the
limitation period of 4 years u/s 154 shall be counted from 31st March
2022. This will mean that such a rectification order can be passed on or
before 31st March, 2026.

(b) However, if the
assessee makes an application to the AO in the prescribed form and
within the prescribed time, requesting for recomputation of the income
by excluding the above claim for deduction of surcharge or cess and pays
the amount due thereon within the specified time, no penalty under
section 270A will be levied. It appears that interest will also be
payable with the tax.

(iii) This is a retrospective legislation.
The claim for deduction of surcharge or cess may have been made by some
assessees in view of the High Court decision. To levy a penalty u/s 270A
for such a claim made in earlier years is a very harsh provision.

6.6 Section 43B:
This section provides that interest payable on an existing loan or
borrowing from Financial Institutions shall be allowed only in the year
of actual payment. The Supreme Court, in the case of M.M. Aqua Technologies Ltd. vs. CIT reported in 436 ITR 582
held that the interest payable in such a case can be considered to have
been actually paid if the liability to pay interest is converted into
debentures. The Explanation 3C, 3CA and 3CD of section 43B have been
amended from A.Y. 2023-24 (F.Y. 2022-23) to provide that
if such interest payable is converted into debenture or any other
instrument, by which the liability to pay is deferred to a future date,
it shall not be considered as actual payment.

6.7 Section 50: This section was amended by the Finance Act, 2021, from A.Y. 2021-22 (F.Y. 2020-21). Now, an explanation is added from A.Y. 2021-22 to
clarify that reduction of the amount of goodwill of a business or
profession from the ‘block of assets’ as provided in section 43(6) (c)
(ii) (B) shall be deemed to be transfer of goodwill.

6.8 Section 79A:
At present, there is no restriction on the set-off of any loss or
unabsorbed depreciation against undisclosed income detected during a
search or survey proceedings under sections 132, 132A or 133A (other
than 133A (2A)). Now, a new section 79A is added from the A.Y. 2022-23 (F.Y. 2021-22)
to provide that any loss, either of the current year or brought forward
loss or unabsorbed depreciation, cannot be adjusted against the
undisclosed income, which is defined as under:

(i) Any income of
the relevant year or any entry in the books of accounts or other
documents or transactions detected during a search, requisition or
survey, which has not been recorded in the books of accounts or has not
been disclosed to the Principal Chief CIT, Chief CIT, Principal CIT or
CIT before the date of search, requisition or survey, or

(ii) Any
expenditure recorded in the books of accounts or other documents are
found to be false and would not have been detected but for the search,
requisition or survey.

7. TAXATION OF VIRTUAL DIGITAL ASSETS
In
this year’s Budget, no ban has been imposed on dealing in
cryptocurrencies or other similar digital currencies. In para III of the
budget speech, the Finance Minister has stated that “Introduction of
Central Bank Digital Currency (CBDC) will give a big boost to digital
economy. Digital Currency will also lead to a more efficient and cheaper
management system. It is, therefore, proposed to introduce Digital
Rupee, using blockchain and other technologies, to be issued by the
Reserve Bank of India starting 2022-23”.

Further, in Para 131 of
the Budget Speech, the Finance Minister has stated that “There has been a
phenomenal increase in transactions in virtual digital assets. The
magnitude and frequency of these transactions have made it imperative to
provide for a specific tax regime. Accordingly, for taxation of virtual
digital assets, I propose to provide that any income from transfer of
any virtual digital assets shall be taxed at the rate of 30 per cent”.

To implement this decision the following amendments are made in various sections of the Income-tax Act effective A.Y. 2023-24 (F.Y. 2022-23).

7.1 Section 2(47A): This
is a new section which defines the term ‘Virtual Digital Asset’ (VDA)
to mean any information or code or number or token (other than an Indian
currency or a foreign currency) generated through cryptographic means
in or otherwise, by whatever name called, providing a digital
representation of value exchanged with or without consideration with the
promise or representation of having inherent value, or functions as a
store of value or a unit of account including its use in any financial
transaction or investment, but not limited to investment scheme, and can
be transferred, stored or traded electronically. This definition also
includes non-fungible tokens or any other token of a similar nature. It
also includes any other digital asset that may be notified by the
Central Government. This definition comes into force from 1st April,
2022.

7.2 Section 115BBH: This is a new section which comes into force from A.Y. 2023-24. It provides as under:

(i)
Where the total income of an assessee includes any income from transfer
of VDA, income tax on such income is payable at 30% plus a surcharge
and cess. It may be noted that in this provision, no distinction is made
between income from transfer VDA in the course of trading or VDA held
as a capital asset. However, it is clarified that the definition of the
term ‘transfer’ in section 2(47) shall apply whether VDA is a capital
asset or not.

(ii) No deduction in respect of any expenditure
(other than the cost of acquisition) or allowance or set-off of any loss
shall be allowed to the assessee under any provision of the Income-tax
Act in computing income from transfer of such VDA.

(iii) No
set-off of loss from the transfer of the VDA shall be allowed against
income computed under any provision of the Income-tax Act, and such loss
shall not be allowed to be carried forward.

7.3 Section 56(2)(x): Gift
of VDA received by a non-relative will be taxable u/s 56(2) (x) as
‘Income from Other Sources’. If a person receives a gift of VDA of the
aggregate market value exceeding R50,000 or VDA is transferred to him
for a consideration where the difference between the consideration paid
and its market value is more than R50,000, tax will be payable by him as
provided in section 56(2) (x). Amendment in section 56(2) (x) provides
that the expression ‘property’ includes ‘VDA’. The CBDT will have to
frame rules for the determination of market value of VDA for the
purposes of section 56(2) (x).

7.4 Section 194-S: This is a
new section which provides for deduction of TDS @1% from the
consideration for VDA. The provisions of this section are discussed in
Para 3.3 above. This provision comes into force on 1st July, 2022.

7.5 General: In
the Memorandum explaining the provisions of the Finance Bill, 2022, it
is stated that “Virtual digital assets have gained tremendous popularity
in recent times and the volumes of trading in such digital assets has
increased substantially. Further, a market is emerging where payment for
transfer of virtual digital assets can be made through another such
asset. Accordingly, a new scheme to provide for taxation of such virtual
digital assets has been proposed in the Bill”.

Reading the above amendments, some issues arise for consideration.

(i)
The new provisions do not clarify as to under which head the income
from transfer of VDA will be taxable i.e. whether it is ‘Income from
Business’ or ‘Capital Gains’ or ‘Income from Other Sources’.

(ii)
A transfer of VDA in exchange for another VDA is liable to tax. It is
not clear how the market value of the VDA received in exchange will be
determined. The Central Government will have to frame Rules for this
purpose.

(iii) VDA is defined u/s 2(47 A) and this definition
comes into force on 1st April, 2022. A question will arise as to whether
income from transfer of similar VDA prior to 1st April, 2022 will be
taxable and if so whether it will be considered as a ‘Capital Asset’ as
defined in section 2(14). Under this definition, ‘Capital Asset’ means
“property of any kind held by an assessee, whether or not connected with
his business or profession”.

(iv) If income arising from
transfer VDA before 1st April, 2022 is considered taxable, a question
will arise whether the loss in such transactions will be allowed to be
adjusted against other income and carried forward loss will be allowed
to be adjusted against income in subsequent years.

We will have to wait for some clarification from CBDT on all the above issues.

8. CAPITAL GAINS

8.1 Section 2(42C): This
section defines ‘slump sale’. Finance Act, 2021, had widened this
definition to cover a case of transfer of an undertaking ‘by any means’,
which till then was restricted to a case of transfer ‘as a result of
the sale’. There was some doubt about the interpretation of this
provision. Therefore, this definition is now amended from A.Y. 2021-22 (F.Y. 2020-21)
to substitute the word ‘sales’ by the word ‘transfer’. Thus, the
definition now covers a case of transfer of any undertaking by means of a
lump sum consideration without assigning individual values to assets
and liabilities for such transfer.

8.2 Surcharge on Capital Gains: As
stated in Para 2.2 above, a surcharge on tax on long-term capital gains
u/s 111A, 112 and 112 A in the case of Individual, HUF, AOP, BOI etc.
will not exceed 15% of tax from the A.Y. 2023-24 (F.Y. 2022-23).

9. INCOME FROM OTHER SOURCES

9.1 Section 56(2)(x): According
to the Government’s declared policy, amount received by a person for
medical treatment of COVID -19 illness should not be made liable to any
tax. Therefore, section 56(2) (x) has been amended to provide as under:

(i)
Any sum of money received by an Individual from any person in respect
of the medical treatment of himself or any member of his family for any
illness related to COVID -19, to the extent of the expenditure actually
incurred will not be taxable.

(ii) Any amount received by a
member of the family of a deceased person from the employer of the
deceased person will not be taxable.

(iii) An amount up to R10
lakhs received from any person by a member of the family of the deceased
person, whether the cause of death of such person was illness related
to COVID -19 will not be taxable. However, such amount should be
received within 12 months of the date of the death, and such other
conditions as may be notified by the Central Government are satisfied.

It
may be noted that for the purpose of (ii) and (iii), the word ‘family’
is given the meaning as defined in section 10(5). This word will,
therefore, mean (a) the spouse, (b) children of the individual and (c)
parents, brothers and sisters of the Individual or any of them who is
wholly or mainly dependent on the Individual.

The above amendments are made from A.Y. 2020-21 (F.Y. 2019-20)

9.2 Section 68: This
section provides that any sum credited in the books of the assessee
shall be considered as income if the assessee does not offer an
explanation about the nature and source of such sum. Even if the
explanation is offered by the assessee, but the AO is of the opinion
that the explanation offered by the assessee is not to his satisfaction,
the AO can treat such sum as income of the assessee. This section is
amended from A.Y. 2023-24 (F.Y. 2022-23). The amendment
now provides that where the amount received by the assessee consists of
loan or borrowing or otherwise, by whatever name called, the assessee
will have to give a satisfactory explanation to the AO about the source
from which the person in whose name the amount is credited obtained the
money. In other words, the assessee will now have to prove the source of
funds in the hands of the lender. However, this provision will not
apply if the amount is credited in the name of a Venture Capital Company
or a Venture Capital Fund.

It may be noted that this new
provision will create many practical difficulties for the assessee. If
the lender does not co-operate and share the details of the source of
his funds, the assessee borrower will suffer. Further, it is not clear
whether this new provision will apply to borrowings made on or after 1st
April, 2022 or to old borrowing also. There is also no clarity on
whether the assessee will have to prove the source of funds borrowed
from a Financial Institution, Banks or Co-operative Societies etc.

9.3 Dividend from Foreign Company:
At present, dividend income earned by an Indian Company from a Foreign
Company in which it holds 26% or more of the equity share capital is
taxed at the concessional rate of 15%. This provision is contained in
section 115BBD. By amendment of this section from A.Y. 2023-24 (F.Y. 2022-23),
this concession is withdrawn from 1st April, 2022. Thus, such dividends
will be taxed at the normal rate of 30%. However, the Indian Company
will be able to take benefit of deduction u/s 80M if it declares a
dividend out of such dividend from the Foreign Company.

10. ASSESSMENT AND REASSESSMENT OF INCOME

10.1 In the Finance Act, 2021, new
provisions were made for the procedure to be followed for assessment or
reassessment of income including that in the case of a search or
requisition. Sections 147, 148 and 149 were substituted and a new
section 148A was added from 1st April, 2021. The following amendments
are made in these provisions from A.Y. 2022-23 (F.Y. 2021-22):

10.2 Section 132 and 132B
dealing with search and requisition are amended to include reference to
the assessment, reassessment or re-computation under sections 14(3),
144 or 147 in addition to assessment under section 153A.

10.3 Explanation 1
to Section 148 lists items considered as information about income
escaping assessment. Following changes are made in this list:

(i)
One of the item relates to the final objection raised by C&AG. Now
the requirement is that if any ‘Audit Objection’ states that the
assessment for a particular year is not made in accordance with the
provisions of the Income-tax Act, it will become information, and the AO
can issue notice based on such information.

(ii) The scope of the ‘information’ is now extended to the following items:

(a) Any information received under an agreement referred to in section 90 or 90A.

(b)
Any information made available to the AO under the scheme notified u/s
135A, providing for the collection of information in a faceless manner.

(c) Any information which requires action in consequence of the order of a Tribunal or a Court.

10.4 Explanation 2 to
section 148 deals with information with the AO about escapement of
income in cases of search, survey etc. The following changes are made in
these provisions:

(i) Information about any function, ceremony
or event obtained in a survey u/s 133A (5) can now be used for reopening
an assessment u/s 148. This will include any marriage or similar
function.

(ii) The deeming fiction that Explanation 2 to section
148 was applicable for 3 assessment years immediately preceding the
relevant year has been removed.

10.5 The requirement of obtaining approval of any Specified Authority by the AO is modified as under:

(i)
If the AO has passed the order u/s 148A(d) to the effect that it is a
fit case for the issue of notice u/s 148, he is not required to take the
approval of the Specified Authority before issuing a notice u/s 148.

(ii) For serving a show-cause notice on the assessee u/s 148A(b), no approval of the Specified Authority is required.

(iii)
A new section 148B is inserted, providing that the AO below the rank of
Joint Commissioner is required to take the approval of Additional
Commissioner, Additional Director, Joint Commissioner or Joint Director
before passing an order of assessment or reassessment or re-computation
in respect of an assessment year to which Explanation 2 to section 148
applies.

10.6 Section 149(1)(b): This section provides for
extended time limit of 10 years for issuance of notice u/s 148. This
extended time limit applies where the AO has in his possession books of
accounts, documents or evidence to reveal that income represented in the
form of asset which has escaped assessment is of R50 Lakhs or more.
This provision is now amended to provide that the income escaping
assessment should be represented in the form of (a) an asset, (b)
expenditure in respect of a transaction or in relation to an event or
occasion or (c) An entry or entries in the books of account.

Further,
the words ‘for that year’ has been omitted. Thus, the threshold limit
of R50 Lakhs or more need not be satisfied for each assessment year for
which notice u/s 148 is to be issued.

10.7 Section 149(1A):
A new sub-section (IA) is added in section 149 to provide that, in case
investment in such asset or expenditure in relation to such event or
occasion has been made or incurred in more than one year within the 10
years period, a notice u/s 148 can be issued for every such assessment
year.

10.8 Section 148A: It is now provided that the
procedure for issue of a notice under this section will not apply where
the AO has received any information under the scheme notified u/s 135A.

10.9 It is now provided, effective from 1st April, 2021, that restriction in section 149(1) for issuance of a notice u/s 148 for A.Y. 2021-22 or
any earlier year, if such notice could not have been issued at that
time on account of being beyond the time limit as specified in section
149(1)(b) as it stood before 1st April, 2021, shall also apply to notice
under sections 153A or 153C.

10.10 Section 153: This section, dealing with the time limit for completing an assessment, has been amended from 1st April, 2021.
It is now provided that the assessment for the A.Y. 2020-21 (F.Y.
2019-20) should be completed by 30th September, 2022 (within 18 months
of the end of the assessment year).

10.11 Section 153A:
Explanation 1 to this section provides for excluding the period to be
excluded for limitation. This section is now amended from 1st April, 2021
to provide for the exclusion of the period (not exceeding 180 days)
commencing from the date on which search is initiated u/s 132 or
requisition is made u/s 132A to the date on which the books of account,
documents, money, bullion, jewellery or other valuable articles seized
or requisitioned are handed over to AO having jurisdiction over the
assessee. A similar amendment is made in section 153B.

10.12 Section 153B: The time limit for completing assessment u/s 153A relating to search cases have now been removed from 1st April, 2021. In all cases where a search is made on or after 1st April, 2021,
the assessment will be made under sections 143, 144 or 147. Time limit
provided for such assessments will apply. However, in a case where the
last authorization for search or requisition u/s 132/132A was executed
in F.Y. 2020-21, or books/documents/assets seized were handed over to
the AO in F.Y. 2020-21, the assessment in such case for the A.Y. 2021-22
can be made on or before 30th September, 2022.

10.13 Section 271 AAB: This
section provides for the levy of penalty at a lower rate in search
cases if the specified conditions are complied. One of the conditions is
that the assessee should have paid tax on undisclosed income and filed
the return of income declaring the undisclosed income before the
specified date. The definition of ‘specified date’ is now amended from 1st April, 2021 to include the date on which the period specified in the notice u/s 148 expires.

11. FACELESS ASSESSMENTS SCHEME

11.1
Section 92CA deals with the provisions for reference to the Transfer
Pricing Officer. Section 144C deals with reference to Dispute Resolution
Panel. Section 253 deals with the procedure for filing appeals before
ITA Tribunal. Under these sections, power is given to notify a scheme
for faceless procedure for assessments and appeals before 31st March,
2022. Similarly, u/s 255 dealing with the procedure for disposal of
appeals before the ITA Tribunal, the notification for a faceless hearing
can be issued before 31st March, 2023. In all these sections,
amendments are made, and the above time limit for issue of notification
for faceless procedure is now extended up to 31st March, 2024.

11.2 Section 144B dealing with the procedure for faceless assessments has been amended from 1st April, 2022.
The faceless assessment scheme has come into force on 1st April, 2021.
Some amendments are made in section 144B, modifying the procedure under
the scheme. In brief, these amendments are as under:

(i) At
present, the scheme applies to assessments under sections 143(2) and
144. Now, it will also apply to assessments, reassessments and
recomputation u/s 147.

(ii) At present, the time limit for a
reply to a notice u/s 143(2) is 15 days from the receipt of notice. This
time limit is removed. Now, the time limit will be stated in the notice
u/s 143(2).

(iii) The concept of Regional Faceless Assessment Centre is done away with.

(iv)
It is now specified that the Assessment Unit can seek the assistance of
the Technical Unit for (a) determination of Arm’s Length Price, (b)
valuation of property, (c) withdrawal of registration and (d) approval,
exemption or any other matter.

(v) The procedure for Assessment
Unit (AU) preparing the draft assessment order and revising the same on
getting comments has been done away with. Now, AU has to state in
writing if no variations are proposed to the returned income. If
variations are proposed a show-cause notice is to be issued to the
assessee. On receipt of the response from the assessee, the National
Assessment Centre shall direct the AU to prepare a draft order, or it
can assign the matter to the Review Unit.

(vi) After receiving
the suggestions from the Review Unit, the National Assessment Centre has
to assign the case to the same AU which had prepared the draft order.
In the old scheme, the case had to be assigned to another AU. To this
extent, the new provision that the matter goes back to the original AU
which made the draft order is a welcome change.

(vii) In the old
scheme, there was no provision for referring the case for special audit
u/s 142(2A). Now, it is provided that if AU is of the opinion that
considering the complexity of the case, it is necessary to get special
audit done, it can refer the matter to the National Assessment Centre.

(viii)
Under the old scheme, a request for a personal hearing through video
conferencing could be granted only if the Chief Commissioner or Director
General approved the same. This provision is now amended and it is
provided that if the request for personal hearing is made by the
assessee, the Income tax Authority of the concerned Unit has to allow
the same through video conferencing. This is a welcome provision.

(ix)
At present, section 144B(9) provides that the assessment shall be
considered non-est if the same is not made in accordance with the
procedure laid down u/s 144B. This provision is now deleted with retrospective effect from 1st April, 2021. This is very unfair. It removes the safeguard, which ensured that the department would follow the procedure u/s 144B.

(x)
At present, section 144B(10) provides that the function of the
verification unit can be assigned to another verification unit. This
sub-section is now deleted from 1st April, 2022.

12. TO SUM UP

12.1
Contrary to the declared policy of the present government, there are
more than a dozen amendments in the Income-tax Act which have
retrospective effect. In particular, the amendment to disallow surcharge
and cess while computing business income is retrospective and applies
from A.Y. 2005-06. Further, such a claim made by an assessee based on
the High Court decision will be subject to a levy of penalty if the
assessee does not recompute the total income for that year and pay the
tax within the specified time. It is not clear whether interest on the
tax due will be payable. The AO is given time up to 31st March, 2026 to
pass the rectification order u/s 154 and levy penalty u/s 270A. Such
type of retrospective amendment is very harsh and may not stand judicial
scrutiny.

12.2 It is true that there is no increase in the rates
of taxes, and some relief is given to specific entities in the matter
of rates of surcharge. The only new tax levied is on Virtual Digital
Assets (VDA). This is a new type of asset, and some issues will arise
while computing the income from transactions relating to VDAs. The CBDT
will have to clarify issues relating to the valuation and reporting of
transactions.

12.3 Significant amendments were made in the
Finance Act 2020 and 2021 in the provisions relating to Charitable
Trusts and Institutions claiming exemption u/s 10(23c) and 11. This
year, some further amendments are made to these provisions. Some of
these amendments are beneficial to Charitable Trusts and Institutions.
However, the manner in which the amendments are worded creates a lot of
confusion. It is necessary that a separate chapter is devoted in the
Income-tax Act, and all provisions of sections 10(23c), 11, 12, 12A,
12AA, 12AB, 13 etc., dealing with exemption to these Trusts and
Institutions are put under one heading. This chapter should deal with
rate of tax, interest, penalty etc., payable by such Trusts and
Institutions. This will enable the person dealing with Public Trusts and
Institutions to know their rights and obligations.

12.4 The
scope for deduction of tax at source (TDS) has been extended to two more
items. New section 194-R has been added, and TDS provisions will now
apply to the value of benefit or perquisite given to a person engaged in
business or profession. Further, under the new section 194-S, the TDS
provisions apply to the transfer of VDA. These provisions will increase
the compliance burden of assessees.

12.5 Significant amendments
are made in the provisions relating to computation of ‘Income from
Business or Profession’. Now, expenditure incurred in relation to exempt
income will be disallowed even if no exempt income is received.
Further, the value of any benefit or perquisite provided to a person
where acceptance of such benefit or perquisite is prohibited by any law,
rule or guidelines governing the conduct of such person will be
disallowed. This will affect most of the pharmaceutical and other
companies providing such benefits or perquisites to their agents or
dealers.

12.6 Another damaging provision introduced by new
section 79A relates to denial of adjustment of current years or carried
forward loss or unabsorbed depreciation against specified undisclosed
income. This provision comes into force from A.Y. 2022-23 (F.Y.
2021-22).

12.7 The amendment to section 68, putting the burden of
proving the source of the money in the hands of the person from whom
funds are borrowed is another amendment that will increase the
compliance burden of the assessees. Now assessees will have to maintain
evidence about the source of funds in the hands of the lender. This is
going to be difficult.

12.8 A new provision is made in section
139 (8A), allowing the assessee to file a belated return of income
within 24 months after the end of the specified time limit for filing a
revised return. There are several conditions attached to this provision.
Further, interest, fees for late filing, and additional tax is payable.
Reading these conditions, it is evident that such belated return cannot
be filed to claim any relief in tax. Thus, very few persons will be
able to take advantage of this provision.

12.9 Taking an overall
view of the amendments made in the Income-tax Act this year, one can
take the view that it is a mixed bag. There are some retrospective
amendments which are very harsh. There are some amendments which are
with a view to give some relief to assessees but they are attached with
several conditions. In this effort, the Income-tax Act has become more
complex, and the Government’ declared objective to simplify the tax laws
is not achieved.

(This article summarises key direct tax
provisions. Because of the extensive amendments, provisions related to
updated returns, penalties and prosecution, IFSC, appeals and revisions,
and certain other amendments are excluded due to space constraints –
Editor)

THE OTHER 5 TRILLION MARK

In our 75th year of independence, we Indians revisit our collective and individual dreams. As a civilisational nation – the last surviving civilisation – we have to talk honestly about our problems if we want to face them head-on. I thought of calling them the ‘other 5 trillion’, which we need to overcome. One may not be able to quantify accurately but these problems are old, deep rooted, and rancid. The list is not exhaustive and yet it is a drag on the 5 trillion economy dream.

1.    Infinite compliances: India is obsessed, almost drunk on compliance. British rule continues through these compliances. Look at Schedule III – which requires converting numbers in thousands, lacs and crores. But GST returns, XBRL, or ITRs require exact numbers filled. Duplication, laws without timelines, discretion, the list is infinite. Charity Commissioner of Maharashtra: One lady sits on a tall bench and ‘passes’ an order if you wish to add a Trustee to a Trust. It’s not her money in the trust, the trust doesn’t even take public funds, it’s a family trust to do Charity, has no immovable property, but she can bully you and ‘take rent’ for approving something as basic as appointing a Trustee. PM has also talked about these matters to Babudom, but nothing much has happened. ‘Government is not a team. It is a loose confederation of warring tribes.’ – Sir Humphrey Appleby.

2.    Corruption: It persists. Try and take a refund of CIT(A) order when you have to see a AO.  At places where discretion exists, delay and bribe thrive. After taxes and inflation this eats into your earnings and savings every second.

3.    Appeasement based on segregation: For votes, politicians do anything. Today, 70-80-90% reservation either persists or is sought. Caste-based, religion-based, social strata based reservation is a form of wholesale manufacturing of vote banks. The idea is to form a group that can bully and cast votes en masse for or against. Merit is secondary or even disregarded.

4.    Supremely Slow Court: Broadband speeds have increased, car speeds have increased, but courts? Recently a HC said R10-12 crore fraud amount is not very big (after granting a hearing in 24 hours). Postman Umakant Mishra, after 29 years, was cleared of stealing $ 1 after being suspended for that long. The SC recently said every sinner has a future in case of a rapist-murderer of a four-year-old. Court doors open at odd hours for some when 73,000 cases are pending outside the same door. And to one wealthy lawyer, it charged R1 for contempt of court. Its suo motu notice sense has no parallel. One doesn’t know whether to be aghast, amused or ashamed at the behaviour of this broken pillar of the State.

5.    Logic Defying Phenomena: We have towns/stations that glorify murderers – to reach Nalanda, you go to Bhaktyarpur Jn., named after Bhaktyar, who destroyed Nalanda. We have tomb tourism like Humayun and Lodhi tombs around Delhi and elsewhere. We have more taxes than transaction prices on essential things like fuel. We have ‘leaders’ who are lawmakers but do not pay government rents or electricity for years, whereas taxpayers get treatment in accordance with the law. State legalises encroachment to millions with impunity. We have recognised political parties that remember Stalin each year, who killed 9.5 million of his own people. The language of our oppressors is the bridge language for the nation. Even today Income Tax Department asks for address page in foreign passports when most don’t have address page for issuing PAN.

Ease of living and ease of doing business are closer to being a cruel joke than a reality. As we come close to the 75th anniversary called Amrit Mahotsav, we need solutions to survive and thrive. We have come a long way yet the road to be covered is longer. We must aim to surmount this other five trillion mark before we can meaningfully achieve the five trillion dream.

 
Raman Jokhakar
Editor    

Section 23 – Annual Letting Value of house property is to be determined on the basis of municipal rateable value

4 Anand J. Jain vs. DCIT Amarjit Singh (J.M.) and Manoj Kumar Aggarwal (A.M.) ITA No.: 6716/Mum/2018 A.Y.: 2015-16 Date of order: 18th January, 2021 Counsel for Assessee / Revenue: Anuj Kishnadwala / Michael Jerald

Section 23 – Annual Letting Value of house property is to be determined on the basis of municipal rateable value

FACTS
During the previous year relevant to the assessment year under consideration, the assessee owned 19 flats at Central Garden Complex out of which seven were lying vacant whereas the remaining were let out. The assessee, in his return of income, offered an aggregate income of Rs. 1.26 lakhs on the basis of municipal rateable value (MRV). The A.O., applying the provisions of section 23(1)(a), opined that the annual letting value (ALV) shall be deemed to be the sum for which the property might reasonably be expected to be let out from year to year. Therefore, the municipal value was not to be taken as the ALV of the property. He applied the average rate per square metre at which the other 12 flats were let out by the assessee and worked out the ALV at Rs. 64.57 lakhs; after reducing municipal taxes and statutory deductions, he added a differential sum of Rs. 42.57 lakhs to the total income of the assessee.

Aggrieved, the assessee preferred an appeal to the CIT(A) where it relied upon a favourable decision of the Bombay High Court in the case of CIT vs. Tip Top Typography (48 taxmann.com 191) and also on the favourable orders of the Tribunal in its own case for A.Ys. 2009-10 and 2010-11 wherein the A.O. was directed to adopt the municipal rateable value as the ALV of the vacant flats held by the assessee. It was also mentioned that the predecessor CIT(A) has taken a similar view for A.Ys. 2012-13 to 2014-15. The CIT(A) distinguished the facts of the year under consideration by noticing that out of 19 flats, 12 were actually let out and that in the earlier years the A.O. did not make proper inquiry to estimate the rental income, but since this year 12 flats were actually let out, the same would give a clear indication of the rate at which the property might reasonably be expected to be let out. He confirmed the estimation made by the A.O.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD
The Tribunal noticed that the issue of determination of ALV was a subject matter of cross-appeals for A.Ys. 2013-14 and 2014-15 before the Tribunal in the assessee’s own case vide ITA No. 6836/Mum/2017 & Others, order dated 27th February, 2019 wherein the bench took note of the earlier decision of the Tribunal in A.Y. 2012-13 in ITA Nos. 3887 & 3665/Mum/2017. In the decision for A.Y. 2012-13, the co-ordinate bench after considering the relevant provisions of the Act and also following the decision of the Bombay High Court in Tip Top Typography [(2014) 368 ITR 330] and also Moni Kumar Subba [(2011) 333 ITR 38], upheld the determination of ALV on the basis of the municipal rateable value.

The Tribunal observed that it is the consistent view of the Tribunal in all the earlier years that municipal rateable value was to be taken as the annual rental value. There is nothing on record to show that any of the aforesaid adjudications has been reversed in any manner. The Tribunal held that the distinction of facts as made by the CIT(A) was not to be accepted. Following the consistent view of the Tribunal in earlier years in the assessee’s own case, the Tribunal directed the A.O. to adopt the municipal rateable value as the annual letting value. This ground of appeal filed by the assessee was allowed.

Sections 45, 48 – Extinguishment of assessee’s right in flat in a proposed building is actually extinguishment of any right in relation to capital assets and accordingly compensation received upon extinguishment of rights falls under the head ‘capital gain’

3 Shailendra Bhandari vs. ACIT Rajesh Kumar (A.M.) and Amarjit Singh (J.M.) ITA No.: 6528/Mum/2018 A.Y.: 2015-16 Date of order: 21st January, 2021 Counsel for Assessee / Revenue: Porus Kaka / T.S. Khalsa

Sections 45, 48 – Extinguishment of assessee’s right in flat in a proposed building is actually extinguishment of any right in relation to capital assets and accordingly compensation received upon extinguishment of rights falls under the head ‘capital gain’

FACTS
During the year under consideration the assessee cancelled an agreement entered into for purchase of a flat and received Rs. 2,50,00,000 as compensation along with refund of money already paid towards purchase of the flat amounting to Rs. 10,75,99,999. The said flat was booked by the assessee, as confirmed by the builder, vide a letter of intent dated 9th February, 2010 wherein the terms and conditions for the purchase of the property were duly mentioned. The letter of intent had to be cancelled as the sellers were not allowed to raise the building height up to the level on which the flats were to be constructed. The assessee, after giving various reminders and legal notices to the builders, succeeded in getting a compensation of Rs. 2,50,00,000 along with refund of money already paid, as evidenced by a letter dated 29th March, 2014.

These rights were transferred to the assessee by three persons, viz., Ms Vibha Hemant Mehta, Mrs. Anuja Badal Mittal and Mr. Sunny Ramesh Bijlani, who were shareholders in Kunal Corporation Pvt. Ltd. which was the owner of the plot and was to construct the building after obtaining necessary permissions from the Government authorities.

The A.O. held that the asset for which the letter of intent was issued in favour of the assessee did not exist on the date 9th February, 2010 when the letter of intent was issued by the assessee. The assessee has merely made a deposit with the developers which is refundable to the assessee along with compensation subject to certain terms and conditions. The A.O. also held that when an asset does not exist it is not a capital asset and therefore the assessee is not entitled to claim capital gain on the same. He rejected the claim of the assessee.

Instead of the long-term capital loss of Rs. 3,37,09,596 claimed by the assessee, the A.O. taxed Rs. 2,50,00,000 as income from other sources by holding that the said receipt is not from transfer of capital assets.

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

The aggrieved assessee preferred an appeal to the Tribunal where on behalf of the Revenue it was contended that the letter of intent issued by the builder for the purpose of allotment of flat, which was not in existence on the date of execution of the letter of intent as well as on the date of execution of the letter of intent and also not on the date of cancellation of the said letter of intent, is not an agreement. Since the seller has not followed the provisions of MOFA which are applicable in the state of Maharashtra, the letter of intent cannot be treated as having created any interest, right, or title in a capital asset in favour of the assessee.

HELD

The Tribunal held that the provisions of MOFA cannot regulate the taxability of any income in the form of long-term capital gain / loss which may arise from the cancellation of any letter of intent / agreement which is not registered. The Tribunal held that the assessee has rightly calculated the long-term capital loss upon cancellation of the letter of intent dated 9th February, 2010. It observed that the case of the assessee finds support from the decision of the jurisdictional High Court in the case of CIT vs. Vijay Flexible Containers [(1980) 48 taxman 86 (Bom)] and it is also squarely covered by the decision of the co-ordinate bench of the Tribunal in the case of ACIT vs. Ashwin S. Bhalekar ITA No. 6822/M/2016 A.Y. 2012-13 wherein the Tribunal has held that the extinguishment of the assessee’s right in a flat in a proposed building is actually extinguishment of any right in relation to capital assets and accordingly held that the compensation received upon extinguishment of a right which was held for more than three years falls under the head ‘capital gain’ u/s 45. Following these decisions, the Tribunal set aside the order of the CIT(A) and directed the A.O. to allow the claim of the assessee on account of long-term capital loss.

Extension for conducting special audit u/s 142(2A) cannot be granted by CIT, only the A.O. can grant such extension – Assessment concluded after such extended limitation period shall be considered as void ab initio

15 [2020] 82 ITR (Trib) 399 (Del) ACIT vs. Soul Space Projects Ltd. ITA Nos.: 193 & 1849/Del/2015 A.Ys.: 2007-08 & 2008-09 Date of order: 3rd June, 2020

Extension for conducting special audit u/s 142(2A) cannot be granted by CIT, only the A.O. can grant such extension – Assessment concluded after such extended limitation period shall be considered as void ab initio

FACTS
During assessment proceedings, the A.O. arrived at the conclusion that it was necessary to conduct a special audit u/s 142(2A) of the books of accounts of the assessee. The assessee raised objections to the proposed special audit and the A.O., after rejecting the objections and with the approval of the CIT, ordered a special audit in accordance with the provisions of section 142(2A). Thereafter, the Special Auditor requested for extension of time period and the A.O. forwarded this request to the CIT. The CIT granted extension of time. The assessments were completed after limitation period on account of the extension granted for special audit.

The assessment orders were challenged before the CIT(A) which provided relief to the assessee on merits. The orders of the CIT(A) were challenged by the Revenue before the Tribunal and the assessee filed cross-objections raising the issue of limitation in completing the assessment.

Before the Tribunal, the assessee argued that as per the proviso to section 142(2A) it was only the A.O. who had the power to extend the time period for conducting the audit; hence, the extension granted by the CIT was legally invalid. It was argued that the exercise of the statutory power of an authority at the discretion of another authority vitiates the proceedings.

On the other hand, the Department contended that the A.O. had applied his mind and was satisfied that the matter required extension; however, the extension application was forwarded only for the administrative approval of the CIT; even otherwise, since the CIT was the approving authority for special audit, therefore his involvement for extension of time as per the proviso was inherent. The Revenue argued that since on a substantial basis the requirement of the proviso to section 142(2A) was met, just on account of administrative approval of the CIT for sanctioning the extension, it should not vitiate the extension of time for the special audit.

HELD
The issue before the Tribunal was whether or not the action of the CIT in granting an extension for a further period u/s 142(2A) was legally valid.

The Tribunal held that the proviso to section 142(2A) clearly provides that the A.O. shall extend the said time period if the conditions as mentioned in the said proviso are satisfied. While the initial direction is to be given with the approval of the CCIT / CIT, however, for extension it is only the A.O. who has to take a decision for extension, the sole power to extend vests only with him.

There was no need for the higher authorities to be involved in the issue of extension. It may be an administrative phenomenon to inform the CIT about the extension, but statutorily that power is vested with the A.O.

The Tribunal held that the statutory powers vested with one specified authority cannot be exercised by another authority unless and until the statute provides for the same. The statute has accorded implementation of various provisions to specified authorities which cannot be interchanged. A power which has been given to a specified authority has to be discharged only by him and substitution of that authority by any other officer, even of higher rank, cannot legalise the said order / action.

Accordingly, it was held that the extension given by the CIT was beyond the powers vested as per the statute and therefore the assessment completed after the due date was void ab initio.

Section 147 – Reopening of assessment – A.O. to provide complete reasons as recorded by him to the assessee and not merely an extract of reasons

14 [2020] 82 ITR(T) 235 (Del) Wimco Seedlings Ltd. vs. Joint CIT ITA Nos.: 2755 to 2757 (Delhi) of 2002 A.Ys.: 1989-90 to 1991-92 Date of order: 22nd June, 2020

Section 147 – Reopening of assessment – A.O. to provide complete reasons as recorded by him to the assessee and not merely an extract of reasons

FACTS
The assessee was a company engaged in the business of providing consultancy services in the field of agricultural forestry plants by undertaking research and development (R&D) activities. The A.O. had initiated reassessment proceedings u/s 147 for A.Ys. 1989-90 to 1991-92 and passed the order u/s 143(3) r.w.s. 147. These orders were challenged by the assessee and the matter went up to the Delhi High Court which remanded the appeals to the ITAT for a fresh adjudication on all issues, including on the aspect of reassessment.

In the remanded appeals, the assessee had challenged the reopening of the assessment proceedings u/s 147 for A.Ys. 1989-90 to 1991-92 on various grounds wherein the first ground of appeal was that the reasons provided by the A.O. in the course of reassessment proceedings and the reasons filed by the Department before the Delhi High Court were different.

HELD
One of the disputes arising in this case was whether while initiating reassessment proceedings the A.O. is supposed to provide complete details of reasons recorded and not merely a few extracts of the said reasons so that the assessee can prepare its defence effectively against the proposed reopening of the assessment. It was held that in all circumstances the A.O. is supposed to provide the complete reasons recorded for reopening of the assessment to facilitate the assessee to raise appropriate objections to the reopening. It cannot be the case of the Revenue that it gives a few extracts of the reasons to the assessee to defend it and when cornered before the higher authorities, the Revenue comes out with the detailed reasons recorded by the A.O. The reasons produced before the High Court were quite different from the reasons provided to the assessee and hence the ITAT held the reassessment proceedings to be invalid and quashed the assessment orders.

Section 56(2)(vii) r.w.s. 2(14) – The term ‘property’ has been defined to mean capital asset, namely, immovable property being land or building or both and hence where immovable property does not fall in the definition of capital asset, it will not be subject to the provisions of section 56(2)(vii)

13 [2020] 82 ITR (T) 522 (Jai) Prem Chand Jain vs. Asst. CIT ITA No.: 98 (JP) of 2019 A.Y.: 2014-15 Date of order: 8th June, 2020

Section 56(2)(vii) r.w.s. 2(14) – The term ‘property’ has been defined to mean capital asset, namely, immovable property being land or building or both and hence where immovable property does not fall in the definition of capital asset, it will not be subject to the provisions of section 56(2)(vii)

FACTS


The assessee had purchased two plots of land during the year claiming these to be agricultural land. The sale consideration as per the respective sale deeds was Rs. 5,50,000 and their stamp duty value [SDV] as determined by the Stamp Duty Authority amounted to Rs. 8,53,636;  therefore, there was a difference to the tune of Rs. 3,03,636. The A.O. invoked the provisions of section 56(2)(vii)(b) and held that agricultural land falls within the definition of property and, thus, added the differential amount under the head other sources. The CIT(A) upheld the addition. Consequently, the assessee filed an appeal before the ITAT.

HELD
The dispute in this case was whether agricultural land was to be included in the definition of immovable property and whether it was covered by the provisions of section 56(2)(vii)(b). It was the contention of the Department that there was no express exclusion provided for agricultural land from the operation of section 56(2)(vii). But it was submitted on behalf of the assessee that vide the Finance Act, 2010 in clause (d) in the Explanation, in the opening portion, for the word ‘means—‘ the words ‘means the following capital asset of the assessee, namely:—’ were substituted with retrospective effect from 1st October, 2009. It was further submitted that the substitution of the words ‘means’ for the words ‘means the following capital asset of the assessee, namely’ made the intention of the Legislature very clear, that henceforth the deeming provision of 56(2)(vii)(b) would apply in case of those nine specified assets, if and only if they were capital assets.

The ITAT referred to the provisions of clause (d) of the Explanation to section 56(2)(vii) where the term ‘property’ was defined to mean capital asset of the assessee, namely, immovable property being land or building or both. Hence, the ITAT held that if the agricultural land purchased by the assessee did not fall in the definition of capital asset u/s 2(14), they cannot be considered as property for the purpose of section 56(2)(vii)(b). The ITAT remanded the matter to the A.O. to determine whether or not the agriculture land so acquired falls in the definition of capital asset. It was further concluded that where it is determined by the A.O. that the agricultural land so acquired doesn’t fall in the definition of capital asset, the difference in the SDV and the sales consideration cannot be brought to tax under the provisions of section 56(2)(vii)(b) and relief should be granted to the assessee.

Further, it was also held that where the assessee had objected to the adoption of SDV as against the sale consideration, the matter should be referred by the A.O. to the Departmental Valuation Officer [DVO] for determination of fair market value.

Editorial Note:
In ITO vs. Trilok Chand Sain [2019] 101 taxmann.com 391/174 ITD 729 (Jaipur-Trib), the Tribunal had upheld the applicability of section 56(2)(vii) to the purchase of agricultural land. The decision in Trilok Chand Sain was not referred to by the ITAT in the above case. However, in another decision in Yogesh Maheshwari vs. DCIT [2021] 125 taxmann.com 273 (Jaipur-Trib), the ITAT, after considering the decision of co-ordinate benches at Pune in Mubarak Gafur Korabu vs. ITO [2020] 117 taxmann.com 828 (Pune-Trib) and at Jaipur in ITO vs. Trilok Chand Sain (Supra) and this decision held that if the agricultural land purchased by the assessee is not a capital asset, the provisions of section 56(2)(vii)(b) are not applicable.

Section 56(2)(viib) – Issue of shares at face value to shareholders of amalgamating company, in pursuance of scheme is outside the ambit of section 56(2)(viib)

12 126 taxmann.com 192 DCIT Circle 3(1) vs. Ozone India Ltd. IT Appeal No. 2081 (Ahd) of 2018 A.Y.: 2013-14 Date of order: 27th January, 2021

Section 56(2)(viib) – Issue of shares at face value to shareholders of amalgamating company, in pursuance of scheme is outside the ambit of section 56(2)(viib)

FACTS
The assessee company was amalgamated with another company (KEPL) and in the process all the assets (except land) and all the liabilities of KEPL were taken in the books of the assessee at book value. Land parcels were taken at revalued price. The excess value of net assets vis-à-vis corresponding value of shares issued towards consideration for amalgamation was thus credited in the books of the assessee company as ‘capital reserve’.

The A.O. observed that the assessee received assets worth Rs. 60.26 crores and liabilities worth Rs. 6.05 crores of the amalgamating company, i.e., KEPL. Thus, the assessee received net assets worth Rs. 54.21 crores against the corresponding issue of shares having face value of Rs. 15 crores to the shareholders of KEPL. The A.O. taxed the excess net assets worth Rs. 39.21 crores received on account of amalgamation and credited as capital reserve of the amalgamated company, as being excess consideration for issue of its shares under the provisions of section 56(2)(viib). On appeal to the CIT(A), he held that the provisions of section 56(2)(viib) were not applicable and reversed the additions made by the A.O. Aggrieved, the Revenue preferred an appeal with the Tribunal.

HELD
The issue of shares at ‘face value’ by the amalgamated company (assessee) to the shareholders of the amalgamating company in pursuance of the scheme of amalgamation legally recognised in the Court of Law is outside the ambit of section 56(2)(viib). Section 56(2)(viib) creates a deeming fiction to imagine and fictionally convert a capital receipt into revenue income and its application should be restricted to the underlying purpose. Further, section 56(2)(viib), when read in conjunction with the Memorandum of Explanation to the Finance Bill, 2012 and CBDT Circular No. 3/2012 dated 12th June, 2012, is to be seen as a measure to tax hefty or excessive share premium received by private companies on issue of shares without carrying underlying value to support such premium.

Thus, the provisions of section 56(viib) would not be applicable where the assessee company has admittedly not charged any premium at all and the shares were issued at face value.

Section 28 – Loss arising on capital reduction by a subsidiary company in whose shares investment was made for purpose of business of assessee, for setting up supply chain system and manufacturing units in global market, is a business loss

11 TS-189 ITAT-2021 (Ahd) DCIT vs. GHCL ITA Nos.: 1120/Ahd/2017 & CO 29/Ahd/2018 A.Y.: 2012-13 Date of order: 5th March, 2021

Section 28 – Loss arising on capital reduction by a subsidiary company in whose shares investment was made for purpose of business of assessee, for setting up supply chain system and manufacturing units in global market, is a business loss

FACTS
The assessee invested in the share capital of its subsidiary, namely, Indian Britain BV consisting of 2,285 shares @ Euro 100 each in A.Y. 2006-07. During the year under consideration, the said subsidiary reduced its share capital due to heavy losses. Consequently, the number of shares of the assessee company was reduced to 1,85,644 from 2,21,586 shares acquired in A.Y. 2006-07. Due to the aforesaid capital reduction, the assessee company incurred a loss of Rs. 99.89 crores on investment made in the equity shares of Indian Britain BV. The assessee claimed long-term capital loss of Rs. 157,97,38,428. In the course of assessment proceedings, it revised its claim of loss to Rs. 99,89,96,245 and claimed that loss on account of capital reduction be allowed as a business loss while computing income chargeable to tax under the head ‘profits and gains from business and profession’ on the ground that investment in the subsidiary was made for the purpose of business of the assessee company for setting up of a supply chain system and manufacturing units in the global market, i.e., overseas.

The assessee submitted that it was incorporated in 1983 and started its soda ash manufacturing in Gujarat in 1988. It entered the textile business in 2001. The entire investment in the wholly-owned subsidiary Indian Britain BV was made by the assessee acquiring global units of a soda ash manufacturing and textile business chain as a measure of commercial expediency to further its business objective. In its desire for expansion in the overseas market, the assessee looked for various acquisitions of home textile businesses in the U.S. and retail chains in the U.K. In this effort at expansion, after setting up of the Vapi home textile plant it showed that Indian products can be sold in the U.S. and the U.K. and, as such, India could become the processing hub for home furnishing textile items.

The A.O. rejected the claim made by the assessee in the course of the assessment proceedings by relying on the decision of the Supreme Court in Goetze (India) Ltd. vs. CIT (157 taxman 1).

Aggrieved, the assessee preferred an appeal to the CIT(A) who adjudicated the issue in favour of the assessee.

HELD
The Tribunal observed that it has adjudicated the issue determining the nature of transaction relating to business loss of acquiring of Rosebys Retail chain in the appeal of the Revenue vide ITA No. 976/Ahd/2014 for A.Y. 2009-10 wherein business loss allowed by the DRP in favour of the assessee was sustained on the ground that the assessee had acquired Rosebys Operation Ltd. to expand its textile business operation globally based on a study carried out by KSA Tech Pak, a renowned global consultant.

The Tribunal observed that:

(i) it is an undisputed fact that the assessee acquired S.C. Bega UPSAM (renamed as GHCL UPSAM Ltd.) in Romania for soda ash manufacturing and similarly acquired Rosebys U.K. Ltd. in the U.K. and Ban River Inc. in the U.S. to expand its home textile business as the company was having plants for textile manufacturing at Madurai and Vapi. The purpose of investment in the subsidiaries was to expand its business globally. After such acquisition, the sales and export shot up substantially and international concerns started taking the company’s products even after reduction in shares and liquidation of the subsidiary Indian Britain B.V. The assessee had explained its business expansion by making investment in a subsidiary company in Netherland from a commercial angle;

(ii) before the CIT(A), the assessee made a detailed submission demonstrating that loss claimed on account of investment in shares of the wholly-owned subsidiary company was a business loss. The assessee gave a detailed submission pointing out that there was recession in Europe and the U.S. Due to continued financial difficulty and other diverse factors, its subsidiaries incurred huge losses and became sick units. The assessee submitted to the CIT(A) that due to huge loss, its subsidiary company, Indian Britain BV passed a resolution to reduce its share capital of Euro 1,85,64,400 (1,85,644 shares) to 1,85,45,835.60 (1,85,644 shares) out of 2,21,586 shares so that such amount can be set off against the accumulated deposit. This resulted in loss amounting to Rs. 99,89,96,245 due to reduction in the value of the share of its subsidiary company.

The Tribunal held that the assessee has made investments in the subsidiary company for business development out of commercial expediency and thus on reduction of capital of the said subsidiary the loss incurred in the value of shares was in the nature of business loss. In the light of the facts and findings reported in the decision of the CIT(A), the Tribunal did not find any infirmity in the decision of the CIT(A) in allowing the losses on reduction in value of shares on investment in the subsidiary company as business losses in the hand of the assessee company. This ground of the appeal of the Revenue was dismissed.

Section 115JB – Provision made for Corporate Social Responsibility, in accordance with the guidelines issued by the Department of Public Enterprises, constitutes an unascertained liability and needs to be added back while computing ‘book profits’ when how the amount is to be spent has neither been determined nor specified by the assessee

10 TS-205 ITAT-2021 Delhi Pawan Hans Ltd. vs. DCIT A.Y.: 2014-15 Date of order: 18th March, 2021

Section 115JB – Provision made for Corporate Social Responsibility, in accordance with the guidelines issued by the Department of Public Enterprises, constitutes an unascertained liability and needs to be added back while computing ‘book profits’ when how the amount is to be spent has neither been determined nor specified by the assessee

FACTS
The assessee, a public sector undertaking, filed its return of income for A.Y. 2014-15 declaring its total income to be a loss of Rs. 1,89,90,55,165 and paying taxes u/s 115JB on a declared book profit of Rs. 66,18,51,561. In the course of assessment proceedings, the A.O. noticed that the assessee has created a provision for Corporate Social Responsibility (CSR) in its books of accounts. The A.O. held that the said provision was an unascertained liability as the assessee had only created the provision but where the amount was to be spent was unascertained. He rejected the assessee’s contention that the provision had been created on the basis of the guidelines issued by the Department of Public Enterprises (DPE) which the assessee was bound to follow. The A.O. disallowed the sum of Rs. 35,09,480 being provision of CSR u/s 115JB considering it as an unascertained liability.

Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the action of the A.O. who, while holding the disallowance to be justified, noted that the guidelines issued by the DPE were not the determinative factor to decide the allowability of the provisions.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD
The essential question before the Tribunal was whether or not the provision for CSR as made by the assessee amounting to Rs. 35,09,480 can be considered as an ascertained liability. The Tribunal noted that the assessee has made the impugned provision in terms of the calculation provided as per the DPE guidelines. However, although the amount to be provided towards meeting the liability of the CSR expenditure has been quantified in accordance with the said guidelines, how the amount is to be spent has neither been determined nor specified by the assessee. Considering the meaning of the word ‘ascertained’ as explained by dictionaries, the Tribunal held that, at best, it is just an amount which has been set aside for being spent towards CSR but without any further certainty of its end-use. Thus, it cannot be said that the liability is an ascertained liability. The decisions relied upon on behalf of the assessee were held to be distinguishable on facts as in those cases the nature / mode of expenditure ear-marked for CSR spending was very much determined and specified, i.e., the nature / mode of expenditure was ‘ascertained’. The Tribunal dismissed the ground of appeal filed by the assessee.

Section 263 – A non est order cannot be erroneous and prejudicial to the interest of the Revenue – Assessment order passed without jurisdiction is bad in law and needs to be quashed – Order passed u/s 263 revising such an order is also bad in law

9 2021 (3) TMI 1008-ITAT Delhi Shahi Exports Pvt. Ltd. vs. PCIT ITA Nos.: 2170/Del/2017 & 2171/Del/2017 A.Y.: 2008-09 Date of order: 24th March, 2021

Section 263 – A non est order cannot be erroneous and prejudicial to the interest of the Revenue – Assessment order passed without jurisdiction is bad in law and needs to be quashed – Order passed u/s 263 revising such an order is also bad in law

FACTS
In both the appeals filed by the assessee, it raised an additional ground challenging the jurisdiction of the PCIT to review and revise the order passed by the A.O. u/s 153C which assessment order itself was illegal and bad in law due to invalid assumption of jurisdiction as contemplated u/s 153A/153C.

For A.Y. 2008-09, the A.O. on 30th March, 2015 framed an order u/s 153A read with sections 153C and 143(3) wherein the additions made while assessing the total income u/s 143(3) were repeated and consequently the total income assessed was the same as that assessed earlier in an order passed u/s 143(3).

The PCIT invoked provisions of section 263 and set aside the assessment order dated 30th March, 2015 on the ground that after the merger of Sarla Fabrics Pvt. Ltd. with Shahi Exports Pvt. Ltd. whatever additions were made in the hands of Sarla Fabrics Pvt. Ltd. were to be assessed in the hands of Shahi Exports Pvt. Ltd.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD
The Tribunal noted that since the income assessed in an assessment framed u/s 153A read with sections 153C and 143(3) was the same as that assessed earlier in an order passed u/s 143(3), the additions made had no link with incriminating material found at the time of the search. The Tribunal noted the ratio of the decision of the Delhi High Court in the case of CIT vs. Kabul Chawla in 380 ITR 573. In view of the ratio of the decision of the Apex Court in the case of Singhad Technical Educational Society (397 ITR 344) holding that in the absence of any incriminating material no jurisdiction can be assumed by the A.O. u/s 153C, the Tribunal quashed the assessment framed u/s 153C by holding it to be without jurisdiction and, therefore, bad in law.

In view of the decision of the Supreme Court in the case of Kiran Singh & others vs. Chaman Paswan & Ors. [(1955) 1 SCR 117] holding that the decree passed by a Court without jurisdiction is a nullity, the Tribunal held that the assumption of jurisdiction u/s 263 in respect of an assessment which is non est is also bad in law as a non est order cannot be erroneous and prejudicial to the interest of the Revenue.

The Tribunal quashed the order framed u/s 263 on the principle of sublato fundamento cadit opus, meaning that in case the foundation is removed, the super structure falls. In this case, since the foundation, i.e., the order u/s 153C has been removed, the super structure, i.e., the order u/s 263, must fall.

Section 68 – Once the total turnover of the assessee is much more than the total cash deposit in the bank account, no addition is called for on account of unexplained cash deposit in said account

8. 2021 (3) TMI 1012-ITAT Delhi Virendra Kumar vs. ITO ITA No.: 9901/Del/2019
A.Y.: 2011-12 Date of order: 24th March, 2021

Section 68 – Once the total turnover of the assessee is much more than the total cash deposit in the bank account, no addition is called for on account of unexplained cash deposit in said account

FACTS
The assessee is an individual who derives his income from wholesale business. The assessment for A.Y. 2011-12 was reopened on the basis of information that he had deposited Rs. 12,07,200 in cash in his savings bank account with ICICI Bank Ltd. during the F.Y. 2010-11. In response to the said notice u/s 148, the assessee furnished his return of income on 16th October, 2018 declaring the total income at Rs. 1,57,440. In the course of reassessment proceedings, the A.O. asked the assessee to explain the source of deposit. He observed that cash from different places like Delhi, Jaipur and Narnaul was deposited in the account. In the absence of any satisfactory explanation, the A.O. held that the assessee has no valid and genuine explanation with regard to the cash deposit of Rs. 8,57,200 after giving benefit of Rs. 3,50,000.

Aggrieved, the assessee preferred an appeal to the CIT(A) where it was contended that full details were given before the A.O., stating that most of the cash deposit was from sale receipts and an amount of Rs. 3,50,000 was taken from his brother. The complete break-up of the cash deposit in the account was filed before the A.O. and, therefore, the addition made by the A.O. was not justified. The CIT(A), after considering the remand report of the A.O. and the rejoinder of the assessee to the remand report, sustained an addition of Rs. 3,62,000 being cash deposit of Rs. 3,16,000 at Jaipur, Rs. 15,000 at Jamnagar and Rs. 36,000 at Delhi, holding the same to be not out of regular sale.

The aggrieved assessee then preferred an appeal to the Tribunal where it was contended that he has declared gross receipt of Rs. 19,25,140 and has offered income u/s 44AD by applying the net profit rate of 8.16%. Therefore, once the gross receipts are accepted and not disputed and such gross receipt is much more than the total deposits in the bank accounts, no addition is called for merely by stating that the deposits are not out of sale proceeds.

HELD
The Tribunal noted that:
(i) The A.O. accepted an amount of Rs. 3,50,000 received by the assessee as gift from his brother and made an addition of Rs. 8,57,200 on the ground that the assessee could not successfully discharge his onus by providing evidence in support of the cash deposits;
(ii) Of the addition of Rs. 8,57,200 made by the CIT(A), it has already given relief to the extent of Rs. 4,90,200 and the Revenue is not in appeal before the Tribunal;
(iii) The CIT(A) sustained the addition of Rs. 3,67,000 on the ground that the assessee could not substantiate with evidence of sales the cash deposits made at Jamnagar, Delhi and Jaipur;
(iv) The assessee did furnish explanations about the deposits made at Jamnagar and Jaipur.

The Tribunal held that once the total turnover of the assessee is much more than the total cash deposit in the bank account (in this case sales is 227% of the cash deposit), no addition is called for on account of unexplained cash deposit in the bank account. The explanation of the assessee appears to be reasonable. The Tribunal held that the CIT(A) is not justified in sustaining the addition of Rs. 3,67,000, it set aside the order of the CIT(A) and directed the A.O. to delete the addition.

YOUTUBE – HOW TO USE IT AS A BRANDING TOOL

HOW YOUTUBE CAN BECOME YOUR DIGITAL BRAND

Since its launch in 2005, YouTube has emerged as a powerhouse of reach and search engine optimisation (SEO). With more than two billion users and 30 million visits a day, YouTube has moved branding from video over static content. Gone are the days when a Facebook post, a tweet or newsletters to clients would suffice. Today, YouTube is no longer regarded as an entertainment site but a portal for self-education and branding.

Let us take a simple example – Your client calls and asks for simple steps to file his GST return. You prepare a four-page document spending a full day writing the same and share it with your client. The client now has to read the document and follow the steps in it and then visit the GST portal and try them out for himself to understand each step.

Alternatively, what can be far more valuable both to you and to the client is a screen recording the steps on the GST portal, making a video and sharing it with the client. You would have spent just ten minutes on it and the client would be more comfortable watching the video.

It is a well-known fact that visuals work better than text for both the consumer and the creator. Taking advantage of the visuals, professionals can build a brand for themselves that will have global reach. And if you are still not convinced that YouTube is ‘the next thing’ that you should choose for branding your firm, the following pointers may help convince you:

* YouTube is great in improving your SEO: The YouTube channel works as a second site and offers room for you to describe yourself. Additionally, you may also describe each video with tags to optimise search results and reach maximum people. Tagging videos for SEO purposes gives an advantage of being found in general.
* Global Audience: YouTube is analogous to Google or Bing where users visit to find useful tutorials, explanation videos, product reviews and so on.
* Posting on YouTube will help people find you on Google, which ultimately does the branding for you without you using any of the pull modes.
* Videos build a brand for you: Videos help humanise your brand. They bring it to life, taking your message from flat and static to dynamic and engaging. Videos help your brand build trust and authority in a unique way. If brands really want to connect with people, videos simply have to be a part of their digital marketing plans because videos capture our attention better than text and images.

Now that we have convinced you how important it is to have a YouTube channel for your brand, let us help you get started with some tips on launching your YouTube channel.

SETTING UP A BUSINESS YOUTUBE ACCOUNT
While almost all social media requires users to create an account to access their content, YouTube does not have any such requirement. A user can view its contents without having an account, but to upload your content you need an account. Membership is only required to view videos flagged as adult content. You can follow these steps to create your business YouTube account:

(i) Sign in to your company’s Google account.
(ii) Click on your Google account’s avatar (profile picture). You’ll find this in the top right corner. It’s a small circle containing your profile picture.
(iii) Click on ‘Your channel.’ It’s the top option in the first batch of icons.
(iv) Choose ‘Use a business or other name.’ You’ll need to select this option to get started with a business YouTube account. You can then enter your company’s name.
(v) Click ‘Create’ – and you have a business YouTube account!

In the top right-hand corner of the page, there are four buttons. The first one is an icon of a video camera that directs you to the page where you upload a video. The next icon is for YouTube apps. After that there is an icon for notifications and messages; it notifies you of your account activity, such as a new like or comment. The one closest to the right-hand side, which is an icon of your profile picture, will direct you to your account information pulled from Google.

CUSTOMISING YOUR YOUTUBE PROFILE AND VERIFYING YOUR CHANNEL
Once you’ve signed up for YouTube, you’ll need to customise your profile with your business’s information. Every user is assigned a channel according to the username and you will be given a specific URL so that other people can find your channel through a direct link – but you will need to do more than the basics to stand out from the competition.

A. Customise your channel
1. Add channel art;
2. Fill in your business info;
3. Create a channel trailer: While optional, a channel trailer (a brief video that introduces viewers to the content they’ll find on your YouTube channel) is an excellent customisation option to increase YouTube viewer engagement. Once you add this trailer, it will appear on your account’s homepage when viewers visit, helping to reel them in and acquaint them with your brand.

B. Interacting with others on YouTube
There are several ways to interact with other YouTube users:
(a) Comments and replies to the comments,
(b) Likes: If the channel likes are public, it works as a playlist for the channel,
(c) Subscription: The best way to get users,
(d) Playlists: You can organise related content together using the site’s playlist feature. If you choose to publicise your playlists, they will appear on your channel’s page below your uploaded content.
(e) Sharing: The site’s social widget allows users to share videos on other social media networks such as Twitter, Facebook, Google Plus, Blogger, Reddit, Tumblr, Pinterest and LinkedIn.

C. Verifying your YouTube channel
How will you know if a channel is verified or not? There will be a small checkbox which indicates a verification badge next to the channel’s name. To apply for verification, your channel must have 100,000 subscribers.

D. YouTube Live
Just like Facebook Live, YouTube has its own live-streaming feature. Broadcasts are usually oriented around news or sports but now many speakers have started taking their sessions on YouTube Live. And, many apps like Zoom allow internal integration where you can simply do a zoom meeting and live-stream it on YouTube.

STRATEGIES FOR BRANDING ON YOUTUBE
YouTube, like almost any other social media, is a lot about how many views you generate and how active is your audience. YouTube promotes channels and videos through its own unique Machine Learning Algorithm. There are no direct hacks available to achieve that but as always there is some smart work and a few tips which you can try to generate more views and create a successful channel.

Share videos on other social media platforms:
Link back to your videos whenever possible on your website and other social media networks. But don’t stop at direct video links. Link back to your channel so that your audience can see what it looks like and have the chance to subscribe.

Just uploading a video and sharing it on social media is not enough. You should have a proper video strategy on how you want to target your audience. For example, a video explaining GST3B around the due date will give you more views than on normal days.

Use relevant keywords in a video’s title, tags and description:
Experiment with different titles and descriptions. Selecting relevant keywords to increase hits is a common SEO strategy of marketers on any social networking site. It helps audiences find content that interests them. A quick exercise would be to watch one of your company’s videos from the beginning and to create a list of relevant words and phrases as you watch it.

Engage with similar content uploaded by other users:
Like and comment on videos uploaded by other users. Not only might those users stumble upon your videos and channel, but anyone else who sees that comment or like might do so as well. Do this with videos that have a similar topic, interest or theme as yours to attract new viewers.

Display content uploaded by other users:

In addition to liking and commenting on other users’ videos, you can highlight featured channels and your liked videos on your own account. In doing so, you show that you’re active in your industry’s YouTube community and direct traffic – a much-needed internet commodity – to other YouTube users in your realm. Be sure to highlight videos that are relevant to your viewer base and not uploads from your direct competitors.

Curate playlist:
If any of your videos follow a consistent theme, organise them together. Perhaps you upload a video every Friday morning; you could compile all those videos into a ‘Friday series’ playlist. Your playlists will appear on your channel’s page, right below your uploaded videos.

Upload content regularly – MOST IMPORTANT:
Especially if you’ve developed a decent pool of subscribers, viewers will be counting on you to create, edit and upload new content. This adds relevance to your brand. This also applies to any other website where users can follow and engage with your content.

Use clickable links to reference other content:
At the end of videos, you’ll notice that many videos reference previous, relevant or even newer content with a clickable link inside the video. You can add these while editing your video in the site’s video manager. This feature can also link to any pages or sites your video covers.

Use YouTube stories:
YouTube recently created YouTube stories, which are similar to Snapchat or Instagram stories. A ‘story’ is a collection of short videos that can remain visible for a day or until they’re deleted. It gives good visibility.

PERSONAL (FIRM) BRANDING ON YOUTUBE
Creating a brand for yourself and your firm is what you should primarily look at when going to YouTube and not to get clients or monetise. In the craving for more reach and gaining clients (which at first shouldn’t be the intent), the essence of branding should not be lost. However, there are still ways in which you may have a personal brand on YouTube.

Stick to your niche:
At first, find people you want to create your brand within. Your content should definitely be curated accordingly. For example, if you wish to showcase yourself as a GST expert, it is very important to regularly post videos on that topic. Diverging topics for the sake of gaining followers will not help in any way. The audience should be relevant and engaging and not more.

Call to action:
The Code of Ethics doesn’t allow us to mention contact or personal details in the educational video. However, the video description section is something that you may use to let people know how to reach you in case they have any queries. You may also use your profile to have contact details and email id or links to your professional social media profiles. This will make it easier for the viewer to reach out to you.

Start and end page:

Having a really good start and end page is as important as the content of the video. This is your chance to brand for yourself. For the end page, you may consider giving references to other videos which makes it convenient for the viewers to know where they will find their answers.

CONCLUSION
If used with correct strategies and efforts (which we have tried and put together in this article), YouTube can do branding for you and your firm (without, of course, in any way violating the Code of Ethics). However, it is also important to note that we do not violate any of the clauses in the COE. [For example, as per Clause 2.14.1.6(iv) – Q, the educational video should not make any reference to the CA firm and should not contain contact details or website in the video. However, your channel page may have such details in the description.]

CHANGES IN PARTNERSHIP TAXATION IN CASE OF CAPITAL GAIN BY FINANCE ACT, 2021

A. INTRODUCTION
In the case of partnership, there may be transfer of capital asset by a partner to a firm or vice versa. Section 45(3) deals with transfer of a capital asset by a partner to a firm; before its substitution by the Finance Act, 2021, section 45(4) dealt with transfer by way of distribution of a capital asset by a firm to a partner on dissolution or otherwise. These provisions were inserted with effect from 1st April, 1988 to provide for full value of consideration in respect of the aforesaid transfer of capital assets between firm and partner.

While the aforesaid sections apply to even AOPs and BOIs, for the purpose of this article reference is made only to firm and partners.

When a partner’s account is settled on retirement or dissolution, he may be given one or more of the following;

(a) Cash, (b) Capital asset, (c) Stocks.

The aforesaid provisions dealt with transfer of capital asset in the limited circumstances provided thereunder.These sections generated a lot of controversies and have given rise to a number of court rulings. A prominent issue is, when a partner upon retirement or dissolution takes home more cash than his capital account balance at the time of retirement, whether he or the firm is liable to pay any tax. The courts are almost unanimous in holding that mere payment of cash would not give rise to any taxable capital gains either in the hands of the firm or in the hands of the partner. It has been held that what he gets is in settlement of his account and nothing more.

B. FINANCE ACT, 2021
The changes proposed in the Finance Bill, 2021 by way of substitution of section 45(4) and insertion of section 45(4A) were not carried through. The Finance Act, 2021 discarded the proposed changes but seeks to change the scheme of taxation of capital gain in the following manner:

(a) Existing section 45(3) is retained,
(b) Existing section 45(4) is replaced by a new sub-section,
(c) New section 9B is introduced,
(d) New clause (iii) is added to section 48.

The new scheme, through the combination of sections 45(4) and 9B, provides for taxation in the hands of the firm in the case of receipt of capital asset or stock-in-trade or cash (or a combination of two or more of them) by the partner on reconstitution or dissolution of the firm. Section 48(iii) seeks to mitigate the impact of double taxation.

Sections 9B and 45(4) apply to receipts by partner from the firm on or after 1st April, 2020 in connection with dissolution / reconstitution. A question arises as to whether these sections apply to such receipts in connection with dissolution / reconstitution which took place prior to 1st April, 2020. The literal interpretation suggests that the date of receipt being critical, the date of dissolution / reconstitution is immaterial as long as the  receipt is in connection with dissolution / reconstitution. One possible counter to this interpretation is that the erstwhile section 45(4) dealt with distribution of capital asset on dissolution or otherwise of the firm and it held the field till 31st March, 2020. Section 9B deals with receipt in connection with reconstitution or dissolution, while substituted section 45(4) deals with receipt in connection with reconstitution. One could notice some overlap between erstwhile section 45(4) and section 9B insofar as receipt of capital asset on dissolution is concerned.

On the basis of this reasoning, it is not unreasonable to expect that new provisions should be considered as applicable only when both the dissolution / reconstitution and receipt have taken place on or after 1st April, 2021. One more reason for this interpretation could be that once dissolution / reconstitution has taken place prior to 1st April, 2021, respective rights arising from such dissolution / reconstitution crystallised on the date of such dissolution / reconstitution. Any receipt thereafter is only in relation to such rights which crystallised before the effective date of the new provisions.

C. SECTION 9B

The Finance Bill, 2021 did not propose section 9B. It rather proposed a substitution of existing section 45(4) and insertion of new section 45(4A). However, while enacting the Finance Act, 2021, section 9B is introduced.

Explanation (ii) to section 9B defines ‘specified entity’ as a firm or other association of persons or body of individuals (not being a company or a co-operative society). Explanation (iii) defines ‘specified person’ as a person who is a partner of a firm or member of other association of persons or body of individuals (not being a company or a co-operative society) in any previous year. For the sake of convenience, in this article, specified entity is referred to as a firm and specified person is referred to as a partner.

Section 9B(1) provides that where a partner receives, during the previous year, any capital asset or stock-in-trade or both from a firm in connection with the dissolution or reconstitution of such firm, the firm shall be deemed to have transferred such capital asset or stock-in-trade, or both, as the case may be, to the partner in the year in which such capital asset or stock-in-trade or both are received by the partner.

Section 9B(2) provides that any profits and gains arising from such deemed transfer of capital asset or stock-in-trade, or both, as the case may be, by the firm shall be deemed to be the income of such firm of the previous year in which such capital asset or stock-in-trade or both were received by the partner. Such income shall be chargeable to income-tax as income of such firm under the head ‘Profits and gains of business or profession’ or under the head ‘Capital gains’ in accordance with the provisions of this Act.

As per section 9B(3), fair market value of the capital asset or stock-in-trade, or both, on the date of its receipt by the partner shall be deemed to be the full value of the consideration received or accruing as a result of such deemed transfer of the capital asset or stock-in-trade, or both, by the firm.

As per Explanation (i), reconstitution of the firm means, where
(a) one or more of its partners of firm ceases to be partners; or
(b) one or more new partners are admitted in such firm in such circumstances that one or more of the persons who were partners of the firm, before the change, continue as partner or partners after the change; or
(c) all the partners, as the case may be, of such firm continue with a change in their respective share or in the shares of some of them.

D. SALIENT FEATURES OF SECTION 9B

The purpose of placing section 9B outside the heads of income appears to be to avoid replication of charging and computation provisions under both heads of income, i.e., profits and gains from business or profession, and capital gains.

Section 9B would apply when a partner receives during the previous year any capital asset / stock-in-trade or both from a firm in connection with dissolution or reconstitution of firm.

Upon such receipt, the firm shall be deemed to have transferred such capital asset / stock-in-trade or both to the partner in the year of receipt of the same by the partner.

The business profits or capital gains arising from aforesaid deemed transfer shall be chargeable under the respective heads of income. Fair market value (FMV) of capital asset / stock-in-trade or both on the date of receipt shall be deemed to be the full value consideration (FVC) for determination of the business profits / capital gain.

Reconstitution would include the case of admission / retirement / change in profit-sharing ratio.

E. CERTAIN ISSUES ASSOCIATED WITH SECTION 9B
Section 9B(2) deems the profits and gains on deemed transfer of capital asset or stock-in-trade as the income of the firm in the year of receipt of asset by the partner. If receipts by one or more partners spread over to more than one year, the taxability thereof on the firm follows suit.

In the case of dissolved firm, it is interesting to note how the above fiction works when the partners receive the assets in the years subsequent to the year of dissolution. While there is a fiction to deem such receipt as a transfer by firm, there is no fiction to deem that the firm is not dissolved. In such a situation, whether the machinery provision of section 189(1) which permits the A.O. to proceed to assess the firm as if it is not dissolved, applies or not is a debatable issue.

The fair market value of the allotted asset shall be deemed to be the full value of consideration. For this purpose, the balance in the capital account of the partner is not relevant.

Section 9B does not as such provide for prescription of the rules for determination of the FMV. Therefore, recourse has to be had to section 2(22B) which defines FMV. Special provisions like sections 43CA and 50C do not apply in a case covered by section 9B.

The business profit arising u/s 9B, though chargeable under the head ‘profits and gains from business or profession’, does not fall u/s 28. Therefore, section 29 which provides that ‘the income referred to in section 28 shall be computed in accordance with the provisions contained in sections 30 to 43D’ may not apply. This is for the reason that section 29 refers only to income referred to in section 28. Therefore, business profits may have to be computed on commercial principles, without recourse to the aforesaid provisions providing any allowance or disallowance.

Unlike in the case of section 29 which refers only to section 28, section 48 refers to the head ‘capital gains’. Therefore, capital gains arising from section 9B will have to be computed after considering section 48. Therefore, the cost of acquisition, cost of improvement, their indexation and incidental transfer expenditure will be available as deduction.

While section 45 is saved by sections 54 to 54GB, there is no such saving provision in section 9B. Therefore, whether a firm is eligible for exemption u/s 54EC, etc., in respect of capital gains arising u/s 9B is an open question. While on a stricter note such exemption is not available, on a liberal note one may contend that exemption should be available if related conditions are fulfilled. Proponents of a stricter interpretation may argue that exemption u/s 54EC is inconceivable as there is no inflow in terms of actual consideration for satisfying the requirement of rollover. The proponents of a liberal interpretation may counter such contention by pointing out that deeming fiction requires logical extension and rollover sections do not require rupee-to-rupee mapping. If the liberal theory is accepted, the date of receipt being deemed to be the date of transfer, is relevant for reckoning the time limit irrespective of the date of change in constitution or dissolution.

F. SECTION 45(4)
Section 45(4) as it stood before substitution by Finance Act, 2021 read as follows:
‘(4) The profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or other association of persons or body of individuals (not being a company or a co-operative society) or otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place and, for the purposes of section 48, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer.’

The substituted section 45(4) by the Finance Act, 2021 reads as follows:
‘(4) Notwithstanding anything contained in sub-section (1), where a specified person receives during the previous year any money or capital asset or both from a specified entity in connection with the reconstitution of such specified entity, then any profits or gains arising from receipt of such money by the specified person shall be chargeable to income-tax as income of such specified entity under the head “capital gains” and shall be deemed to be the income of such specified entity of the previous year in which such money or capital asset or both were received by the specified person, and notwithstanding anything to the contrary contained in this Act, such profits or gains shall be determined in accordance with the following formula, namely:…’

The following table depicts some key differences between the two provisions:

Earlier
section 45(4)

Substituted
section 45(4)

It would apply to transfer of capital asset by a partner on
the dissolution of a firm

It would apply upon receipt of capital asset or money or both by
a partner in connection with reconstitution of a firm

Profits and gains arising from transfer are chargeable to tax as
the income of firm

Profits and gains arising from such receipt by partner are
chargeable to tax as income of the firm

Chargeable to tax in the PY in which the transfer took place

Such profits and gains chargeable to tax as income is deemed to
be the income of the firm in the PY in which money or capital asset or both
is received by partner

Capital gains are computed
u/s 48

Capital gains are computed as per the formula provided therein
notwithstanding anything to the contrary contained in the Act

FMV of the asset on the date of transfer shall be deemed to be
the FVC

Formula does not provide for any full value of consideration

 

However, aggregate of amount of money received and fair market
value of capital asset received on the date of receipt constitutes
consideration

Cost of acquisition, cost of improvement and incidental
expenditure upon transfer are reduced from FVC

Amount of capital account balance of partner in the books of
firm at the time of reconstitution is reduced from the above aggregate amount

Benefit of indexation is available

There is no element of cost of acquisition and cost of
improvement, hence no indexation

G. SALIENT FEATURES OF SECTION 45(4)
Section 45(4) would apply when a partner receives during the previous year any money or capital asset or both from a firm in connection with the reconstitution of a firm.

Any profits and gains arising from such receipt shall be chargeable in the hands of the firm under the head ‘capital gains’.

Such capital gain shall be deemed to be chargeable to tax in the previous year of receipt of such money or capital or both by the partner.

Reconstitution is defined in the same manner as is defined u/s 9B.

H. COMPUTATION OF CAPITAL GAIN U/S 45(4)
Capital gain shall be computed u/s 45(4) as per the formula provided therein, i.e., A=B+C-D.

The capital gain is computed by considering the following components:
B = Amount of cash received by the partner,
C = Amount of FMV of capital asset received by the partner,
D = Amount of capital account balance of a partner in the books of the firm at the time of its reconstitution.

The difference between capital account balance on the date of receipt and aggregate of cash received and FMV of capital asset received constitutes capital gains in the hands of the firm.

I. CORRIGENDUM TO SECTION 45(4)
On 22nd March, 2021, the Finance Ministry sent a notice of amendments to the Lok Sabha, wherein section 45(4) as proposed in the Bill was substituted completely by a new section 45(4). The newly-proposed section 45(4) had the words ‘…any profits or gains arising from receipt of such money by the specified person…’

On 23rd March, 2021, the Lok Sabha approved the Bill as amended by notice of amendments dated 22nd March, 2021. The Presidential Assent to the Bill was given on 28th March, 2021. The Finance (No. 13) Act, of 2021 was notified on 28th March, 2021. The Notified Finance (No. 13) Act, of 2021 carried Section 45(4) with the aforesaid words.

Two corrigenda were issued on 6th April, 2021 and 15th April, 2021. In the first corrigendum, for the words ‘…from receipt of such money by’, the words ‘…from such receipt by…’ were substituted. While it is not known as to the exact content of section 45(4) as approved by the Lok Sabha, on the basis of Notified Finance (No. 13) Act, of 2021 it can be inferred that the Lok Sabha has approved the Bill which carried section 45(4) as stated in the notice of amendments dated 22nd March, 2021.

The aforesaid substitution is not just correcting a clerical error, but it has substantial implications. The originally introduced words would have confined the scope of section 45(4) only to receipt of money, whereas the substituted words would extend it not only to receipt of money but also to receipt of capital asset.

Unless an Amendment Act is enacted, substituted words by a corrigendum having the effect of amending a law passed by the Parliament may be open to challenge on the ground of overreach by the executive.

J. COMPARISON BETWEEN SECTION 9B AND SECTION 45(4)
The following table compares above two provisions;

Section
9B

Section
45(4)

It would apply upon receipt of capital asset or stock-in-trade
or both by a partner from the firm on the dissolution or reconstitution of a
firm

It would apply upon receipt of capital asset or cash or both by
a partner from the firm in connection with reconstitution of the firm

Allotment of stock-in-trade is covered

Allotment of stock-in-trade is not covered

For the purpose of computation u/s 9B, FMV is deemed to be FVC
and computation would be in accordance with Chapter IV-C or D, i.e., ‘Profits
and gains of business or profession’ or ‘Capital gains’

Computation mechanism is given u/s 45(4) in the form of formula

The following table summarises the applicability of the above two sections:

  

 

Section
9B

Section
45(4)

Reconstitution

Yes

Yes

Dissolution

Yes

No

Cash to partner

No

Yes

Capital asset to partner

Yes

Yes

Stock-in-trade to partner

Yes

No

K. DOUBLE TAXATION AND ITS MITIGATION
As may be seen from a close reading of sections 9B and 45(4), in the event of receipt of capital asset by a partner from a firm in connection with its reconstitution, the firm is liable to tax under both section 9B and section 45(4).

Explanation 2 to section 45(4) clarifies that when a capital asset is received by a partner from a firm in connection with the reconstitution of such firm, the provisions of section 45(4) shall operate in addition to the provisions of section 9B and the taxation under the said provisions thereof shall be worked out independently.

Therefore, it is a clear case where double taxation is explicitly intended or provided for. Where Parliament in its wisdom chooses to explicitly provide for double taxation, it has a plenary power to do so.

In this regard, reliance is placed on the following decisions:

  •     Jain Bros vs. Union of India [1970] 77 ITR 107 (SC);
  •     Laxmipat Singhania vs. CIT [1969] 72 ITR 291 (SC);
  •     CIT vs. Manilal Dhanji [1962] 44 ITR 876 (SC);
  •     Escorts Limited vs. UOI [1993] 199 ITR 43 (SC); and
  •     Mahaveer Kumar Jain vs. CIT [2018] 404 ITR 738  (SC).

Thus, while double taxation cannot be inferred or implied, the same can be explicitly provided for.

Thus, it is a clear case of Parliament wanting to apply both sections in case of receipt of capital asset by a partner in connection with the reconstitution of a firm.

Section 48 is also amended by Finance Act, 2021 where Clause (iii) is inserted which reads as follows:
‘(iii) in case of value of any money or capital asset received by a specified person from a specified entity referred to in sub-section (4) of section 45, the amount chargeable to income-tax as income of such specified entity under that sub-section which is attributable to the capital asset being transferred by the specified entity, calculated in the prescribed manner:’

Section 48(iii) provides that the amount chargeable to tax u/s 45(4) to the extent attributable to the capital asset being transferred by a firm shall be reduced from the FVC of a capital asset being transferred by a firm. Such reduction, however, needs to be calculated in the prescribed manner. The rules in this regard are awaited. These provisions are applicable for PY 2020-21 and the rules were not out as on 1st April, 2021. Therefore, such rules when notified will have to be made retrospective so as to be applicable to PY 2020-21. If the retrospective application of rules causes prejudice to the taxpayer, the same may be open to challenge in terms of section 295(4).

As noted earlier, section 45(4) applies when a partner receives capital asset or money or both from a firm in connection with its reconstitution. If a partner receives capital asset with or without money, capital gain attributable to such receipt of capital asset will not be available for relief u/s 48(iii). This is for the obvious reason that the subject capital asset having already been given to a partner, could not be subsequently transferred by the firm to any other person. Upon allotment to a partner, the capital asset concerned ceases to exist with the firm.

However, if a firm is liable to tax on transfer of money with or without capital asset to the partner in connection with reconstitution of a firm, the capital gain on such transfer of money chargeable u/s 45(4) would be available for relief u/s 48(iii). This relief is given on the premise that when cash is paid to the retiring partner on reconstitution, the same may be attributed wholly or partly to the revaluation of one or more capital assets which are retained by the firm. Subsequently, when a firm transfers such revalued capital asset, it would be liable to pay tax on capital gain. In such a case, capital gain may include the revalued portion on which the firm would have discharged tax u/s 45(4). This will result in double taxation. In order to mitigate such double taxation, it is provided that capital gains already charged to tax u/s 45(4) to the extent attributable to the capital asset that is being transferred by a firm would be allowed as deduction u/s 48(iii).

It is interesting to note that section 48(iii) may also apply in a situation where both sections 9B and 45(4) are applied simultaneously in the same previous year.

As stated earlier, section 8 applies not only to capital gain chargeable u/s 45, but to any capital gains chargeable under the head ‘capital gain’. As section 9B provides for capital gains to be chargeable to tax under the head ‘capital gain’, section 48 is applicable to the capital gain covered u/s 9B as well.

While computing the capital gain chargeable u/s 9B read with section 48, capital gain chargeable u/s 45(4) to the extent attributable to the capital asset dealt with by section 9B would be reduced from the FVC determined u/s 9B(3). Section 48 does not provide for determination of the FVC. It only provides for deductions from the same. Therefore, there is no disharmony between section 9B(3) and deduction u/s 48(iii).

L. CERTAIN OTHER ISSUES OF SECTION 45(4)

What is the meaning of receipt of money? Whether receipt of money includes constructive receipt by way of credit to account? A mere credit to the account of the partner cannot be equated with the receipt of money. Upon reconstitution, certain sum may be credited to a partner’s account which is allowed to remain in the firm. In such case, it cannot be said that he received money from the firm upon a mere credit. However, when the amount so credited is withdrawn by him, section 45(4) is attracted. The answer could be different if the ratio of Raghav Reddy in 44 ITR 760 SC is applied to such credit unless such ratio is distinguished on the basis of Toshiku in 125 ITR 525 SC.

Whether receipt of rural agricultural land covered: As rural agricultural land is not a capital asset, section 45(4) is not attracted.

Receipt by legal heirs of deceased partner: Section 45(4) would apply to receipt by a partner from the firm. A receipt by the legal heir of the deceased partner cannot be regarded as receipt by the partner. Therefore, section 45(4) is not applicable.

Would capital balance include balances in current account and loan of partners: While the balance in current account could be appropriately called as part of capital balance, the same may not be so in the case of loan by partners.

Is proportionate share of reserves to be considered as part of capital: Credit balance in the profit and loss account or balances in the reserves should be credited to partners’ accounts before dissolution / reconstitution. In any case, payment from such credit / reserves cannot be regarded as payment in connection with dissolution / reconstitution.

How to compute if there is negative capital balance: A negative balance in the capital account represents money due by the partner to the firm. If such balance is not made good by him on dissolution / reconstitution, it amounts to a waiver which may in turn amount to payment of cash in the light of the ratio in Mahindra and Mahindra 404 ITR 1 SC.

M. WHEN GOODWILL IS TRANSFERRED
If goodwill, being a capital asset, is transferred to a partner, sections 45(4) and 9B as discussed earlier would apply. This is so irrespective of whether the goodwill is self-generated or acquired.

If goodwill is self-generated, in terms of section 55(2)(a) and section 55(1)(a) the cost of acquisition and cost of improvement shall be deemed to be nil.

If goodwill is purchased for a consideration, newly-introduced proviso to section 55(2)(a) would apply. This proviso provides that the actual cost of goodwill shall be reduced by the depreciation allowed up to A.Y. 2020-21.

Provisions of section 50 along with the newly-introduced proviso to section 50(2) may not apply in view of the fact that sections 45(4) and 9B are special provisions.

Additionally, upon such transfer, if no consideration is received or is accrued, provisions of section 50 may not operate unless the fiction of section 9B(3) is read into section 50. In any case, section 45(4) does not have any such fiction.

ACKNOWLEDGEMENTS: The author acknowledges the inputs from Mr. S. Ramasubramanian and Mr. H. Padam Chand Khincha and the support of Mrs. Sushma Ravindra for the purposes of this analysis.

PERSONAL BRANDING FOR CAs

It is always thought that being the best wins at anything. That might be true for sports but not for life and our profession. When it comes to sports, there is only one place to be – at the top. And to ace the game, you have to be the best. But when it comes to career progression and self-development, it’s different. Instead of being the best, you must strive for competency, credibility, differentiation in a unique and specialised niche.

In their book The Blue Ocean Strategy, authors W. Chan Kim and Renée Mauborgne write that ‘Blue ocean strategy challenges companies to break out of the red ocean of bloody competition by creating uncontested market space that makes the competition irrelevant instead of dividing up existing – and often shrinking – demand and benchmarking competitors. Blue ocean strategy is about growing demand and breaking away from the competition.’

The authors may be talking about businesses, although this thought if applied on a personal level makes one think, ‘But how do I break away from the competition?’ The answer is, Be different. Don’t just ask yourself, ‘What am I better at?’ Ask also, ‘How am I different?’

Anyone who tries can be different in their area of work by developing themselves, not just professionally but by getting better at one or more of the following skills:

  •  Writing – We’re all writers.
  •  Public speaking – Getting over the mental block most of us face. It helps you be a better leader.
  •  Selling – Develop a personal brand. We all have something to sell – our products, services, our ideas or even ourselves. To be able to create the right influence and impact gives an edge. Persuasion and negotiation skills matter.

What is branding? Simply put, your brand is your promise to your customer. It tells him what he can expect from your products and services, and it differentiates your offering from that of your competitors. Your brand is derived from who you are, who you want to be and who people perceive you to be. Similarly, personal branding is the practice of marketing people and their careers as brands. It is an on-going process of developing and maintaining a reputation and impression of an individual, group, or organisation. Your personal brand is how you promote yourself. It is the unique combination of skills, experience and personality that you want your followers to see. It is the telling of your story and the impression people gain from your online reputation.

PRINCIPLES FOR PERSONAL BRANDING
1. Credibility: The foundation for building credibility is trust. To boost credibility, you need to be honest. Keeping your communication open and honest not only sets an example for your co-workers but also shows others that they can trust you.
2. Competence: Building and polishing your core competence is imperative to establish yourself.
3. Values: Values help you establish a sense of purpose and direction for your personal brand. They act as guideposts that assist you in evaluating choices in your life. Values change as you change; they reflect what’s important to you at any given moment.

Strategy to build your brand through a five-step process
1. Brand clarity and strategy. To genuinely make a difference by being helpful, useful and relevant at all times with trust.
2. A website that wows. Updated at all times and within the guidelines of what the Institute regulations permit.
3. Authentic social media engagement that attracts, engages and compels people to do business with visibility and trust by sharing insightful views, dishing out wisdom or perspectives to benefit one and all.
4. Captivating and engaging content that converts, a communication plan that is purposeful and creative based on unique strengths. Communicate not to sell but to serve. Communicate not to advertise but to create meaningful conversations that enrich and enlighten.
5. Marketing to serve people with honesty, encouragement, generosity, compassion, kindness and respect, influence with integrity and transparency.

A Chartered Accountant is bound by his Code of Conduct & Ethics and cannot advertise or solicit for work. Hence, personal branding for a CA has to be done within the framework of this Code. Some guidelines prescribed by the Institute:

1. Website
Ensure that the website is on pull mode and not push mode. The details in the website should be so designed that they do not amount to soliciting clients or professional work. Be aware of the information that can be displayed on your website.

2. Publications
It is not permissible for a member to mention in a book or an article published by him, or a presentation made by him, any professional attainment(s) whether of the member or the firm of chartered accountants with which he is associated. However, he may indicate in a book, article or presentation the designation ‘Chartered Accountant’ as well as the name of the firm.

3. Public interviews
While giving interviews or otherwise furnishing details about themselves or their firms in public interviews or to the press or at any forum, the members should ensure that it should not result in publicity. Due care should be taken to ensure that such interviews or details about the members or their firms are not given in a manner highlighting their professional attainments.

4. Issue of greeting cards / invites
Issue of greeting cards or personal invitations by members indicating their professional designation, status and qualifications, etc., is not allowed. However, the designation ‘Chartered Accountant’ as well as the name of the firm may be used in greeting cards, invitations for marriages and religious ceremonies, etc., provided they are sent only to clients, relatives and friends of the members concerned.

5. Educational videos
While videos of an educational nature may be uploaded on the internet by members, no reference should be made to the chartered accountants’ firm wherein the member is a partner / proprietor. Further, it should not contain any contact details or website address.

6. Use of logo / monogram
The use of logo / monogram of any kind / form / style / design / colour, etc., whatsoever by a CA is prohibited. Members may use the common logo created for the CA profession.

A brand is a simple but complex perception in the minds of the beholder. Brands are built not by accident but by design. A great positioning statement is an opener for any conversation about your business. Know who you are, what you do, what is different about what you do and for whom you do it and how you are a good fit. It is not the client’s job to remember you. It is your job that they do not forget you. You have many options but select the one that works best for you. This is similar to a client having many options but he selects you.

* Don’t create a design without strategy – Strategise
* Don’t try to do everything on your own – Outsource
* Don’t wait for the perfect moment – Speed and agility matters with flexibility.

Have a tagline or a brand manifesto formula in three words you want to be spoken for you
* What action are you doing? Verb
* Which audience are you serving? Noun
* What are you bringing to the table, uniquely, differentiated, unlike anybody else? Noun – Verb (competition has failed to address).

Some questions you should introspect before you start building your brand

* The key messaging, positioning, unique promise or value offered by my competition;
* The gaps seen or the category that can be created or value added that is unique;
* Carving a niche, building, strengthening and dominating it to be out of bounds of competition;
* Top three mistakes / weaknesses of competition that can be leveraged to create exceptional value to be at a different level;
* Perspectives offered that are unique and radically distinct from other industry leaders;
* Key distinguishing factors in personal brand management at a global level.

Social media as a medium for personal branding

Amidst the global lockdowns as a result of the pandemic, we have found a lot more time on our hands. Many of us have actively started building an online presence. It may be the best time to do it – while the global economy is taking a massive hit which will have long-reaching implications, digital platforms are seeing higher engagement rates than ever, with more and more people looking for information and entertainment online and focusing their attention on social platforms and other apps. This could provide an opportunity to get your thoughts out there and to build your profile with a captive audience.

Using LinkedIn effectively
LinkedIn is the older, more responsible sibling of Facebook. The benefits of LinkedIn are endless. With a few clicks, you can find your dream job or your dream client. LinkedIn not only makes it easier for you to find people but also for others to discover you.

A few tips to get you started

  •  Be active on social media.
  •  Tap into your network. Networking is the key.
  • Write a simple but engaging LinkedIn summary or headline – the short, one-line description which readers will first see along with your name.
  1.  Keep your profile updated with skillsets possessed, experience, recommendations, etc.
  •  Post original content.
  •  Network not to sell and market blatantly but develop connects for creating mutual win-wins and helping each other grow and develop as better human beings. The business conducted as a result of the trust and the bonding developed is purely incidental.

A BLUEPRINT TO BUILD A PERSONAL BRAND
1. Serious soul-searching, introspection and brainstorming to find purpose, vision, to get clarity on What am I doing, why am I doing it and for whom?
2. Understanding the competitive landscape to grab opportunities in the external eco-system at play.
3. Thinking like a thought leader to focus outside in, to enrich and add value with personal mastery which no one else is doing.
4. Create your Brand Universe (Strategy) – Thought Leadership Capital – Repurposing and targeting your message to your audience. The new way of thinking is to claim and dominate your niche. Personify your topic so that no one dares to try it.
5. Define and own your Brand Intellectual Property as there is no dearth of copycats or thieves. Ring-fence and protect your idea by all means. You are the brand ambassador of your IP.
6. Define your target audience and what value you give them.
7. Building your network blueprint around those to whom you can add value. It doesn’t matter whom you know but what matters is who knows you and your personal brand. Expand your visibility across three degrees of network.
8. Design a content strategy. Your brand is as good as your content. Context is relevant for your content; know where your audience stays or is visible; have a signature style of expression.
9. Launch your brand – strategise the timing of making your completed profile public and then creating a complimentary engagement strategy to keep the brand vibrant and relevant.
10. Build your speaker brand. Craft a ‘rockstar’ speech with signature topics. Position and craft stellar speeches by presenting them brilliantly. Be awesome, full of energy and enthusiasm, don’t be boring.
11. Build your author brand. Write a book on your niche that showcases your knowledge and is useful to your target audience and helps effectively in solving their pain-points. Don’t just be visible but also relevant.
12. Build a tribe of like-minded professionals who can give quality feedback to fast-track your speed and development whilst earning their trust and love.

Branding takes time. Start now. Massive learnings happen on the way. Integrity, Transparency, Authenticity, Originality, Competency and Credibility matter. Be consistent to leave a legacy that far outlives your physical life. Stay Branded – Stay Blessed – and Serve the World.

Credit share: My Branding Guru – Tanvi Bhatt / My CA colleague – Cynora Lemos.

STRATEGY: THE HEART OF BUSINESS – PART II

Strategy is the heart of running and changing a winning business, as we saw in Part I (BCAJ, March, 2021). Crafting a good strategy is critical for an enterprise to realise its growth and value creation aspirations. This is a capability which successful organisations have in abundance, otherwise they use external experts (aka consultants). What is equally important is Strategy Deployment, i.e. executing the strategy effectively. In many contexts I would say that a higher weightage can be accorded to smart execution. Even a first mover of a strategy may lose out over time if execution does not keep pace. Ford Motor Company, for example, invented cars, but Japanese cars rule the roost in the automobile world now. In this Part II, I will share some aspects about successful execution which I have experienced over the years in running businesses.

The Vision, Mission and Values set, an enterprise typically aspires for a Strategic Target to be achieved in a defined time frame. Towards this goal, a Strategy Map is drawn out which clarifies the strategic objectives and initiatives to be deployed. We have seen how a Strategy Deployment Matrix1 is a great tool to align and integrate individual, team, department and functional goals with that of the enterprise. Now on to some detail on deployment.

LEAD AND LAG

An individual or a Function planning activities by setting goals can use two types – Lead and Lag actions or goals. A Lead action or activity is one which can be executed or influenced and which will result in an outcome or achievement in the desired direction. Lag goals are the ones which are the targeted or intended results. A typical example is the case of a person who wishes to get fitter or become healthier. A Lag goal s/he can have is to lose say five kilograms of weight. The Lead actions or goals which will result in delivering this Lag goal can be (i) eat right, say 2,000 calories per day, and (ii) be active, say walk 10,000 steps daily. The Lag measure is thus the outcome driven by the Lead measure or actions driving the process as indicated in Figure 1 below:

Therefore it is essential to have a healthy mix of Lead and Lag goals while crafting the plan for the year. The goals chosen should be spread over the four perspectives to make a Balanced Scorecard2. With this structure, it lends itself to constructive periodic reviews on how the actions are progressing towards the set goals. This is pictorially depicted in Figure 2 hereunder.

ALIGNMENT AND INTEGRATION
The goals thus planned to be executed in any organisation have to be aligned with the enterprise objectives, at every level and person all the way down. While this will be a vertical flow, it is also important that these are integrated well across functions or departments to make a synergistic impact pulling in the same direction. In all this, robust communication at every level individually or in groups is absolutely critical for the team to comprehend the collective goals and develop a collaborative and committed mind-set. This is outlined in Figure 3.



TOOLS FOR EXECUTION

Having structured and deployed the goals meaningfully, I have utilised a number of effective tools to drive and monitor execution. The purpose is to ensure a discipline in the desired actions being performed as well as to have a structured process in place to review progress. The idea is that attention is given and focused on the exceptions and escalation happens to the appropriate level in time for interventions to help delivery. These are based on two fundamental tenets:

Let us examine some tools which are helpful for the purpose.

ORGANISATIONAL REVIEWS
The strategic target broken down into executable actions on the lines mentioned above will need to be monitored for performance. A broader framework on integrating the review fora and the areas to be covered was touched upon earlier3. This can be detailed out into a review framework as illustrated in Figure 4. The purpose of structuring the review discipline across the organisation is to ensure that not only the right areas are reviewed at the appropriate levels, but also to avoid overlap and superfluous efforts. This process also clarifies the periodicity of each review, the timing, topics as well as the attendance. The team is thus clear on the forum available and the expectation of right feedback.

In these review meetings the agenda being set, it is expected that the concerned will circulate pre-read papers so that the participants can come into the discussion with preparation. That way time is not frittered away in sharing fundamental data and base information. Furthermore, the areas and items which require decision-making in the forum are highlighted. The bulk of the time is therefore focused on decision-making and the team collectively addressing exceptions or areas which record tardy progress.

Performance Review Structure

Review
Forum

Key
Measures / Objectives

Frequency

Probable
date and duration

Participation

Agenda

Board

Strategy
and Operational, Performance Measures

5 times a year

 

Board members, MD & CEO

Policies & Capabilities, Changing Org. Needs, Adherence to
strategic goals

Executive
Committee

Scorecard achievement,
Corporate, Projects, Major issues

Monthly

1st and 2nd week, 3 hrs.

Executive Committee members, MD & CEO, Invitee for specific
session

Performance, capabilities, Comp.,
Performance, Changing Org. needs, LT / ST plans, innovation

ORM (Operational review meeting)

Execution of actions planned, Decision on issues

Monthly

2nd week, full day

MD & CEO, COO, EVP Finance, VP Mfg, EVP-TBD, VP-DS, VP-IBD,
VP-HR, GMs, Mkt Heads, Identified, Functional heads, Other Invitees

Operational performance, EPM measure, KPI, real contribution,
working capital, Customer Feedback / Supplier’s Inputs, People Issues,
Environment Innovation.

Cross Functional Teams reviews     

Result of cross functional Initiatives

Monthly

3rd week, 2-3 hrs.

MD & CEO, COO, EVP-Finance, Cross Functional Team members,
Special Invitees

Operational performance, status of projects,
improvement initiatives, Capital projects, Supply chain, Fund Management

Functional review meetings (Factory / Zones)

Operational performance review

Monthly

1st week, full day

Chiefs, Factory heads, Zonal managers, Other department heads,
Special Invitee

Divisional performance, Project status,
Market / Customer Issues, Finance Issues, Safety & Env.

Dept. Review

Achievement against
projected performance

Weekly / Monthly

Specified day, 2-3 hrs

Dept. Heads & Dept. Staff as required, Cross Functional Team
members

Unit Performance, Capabilities, SHE related
Issues, Initiatives, Supply chain

COLOUR CODE TRACKING VISION (CCTV)
The CCTV is a simple yet powerful mechanism to visually comprehend the problem areas in any project or goal delivery. Equally, it also provides comfort at a glance on the projects or areas which are going well. Thus, it does not require intervention at any senior level and can be left to the person / team responsible to deliver as intended. Such a visual representation as portrayed in Figure 5 is quite helpful in any review meeting for the team to quickly pick up and focus on the areas which deserve collective attention.

As can be seen, the CCTV highlights in the traffic signal colours over a period of time the health of the various interventions. Remarks on sluggish progress where applicable are given along with the suggested actions. Discussion can be forthwith focused on the points highlighted in red as well as yellow items with the result that the meetings conclude with specific actions agreed to get the laggard items back on track.

CCTV (colour code tracking vision)

Project/
Initiative

Original
Target
Date

Status
as of

Remarks

Action
required

01-
Jan
-21

08-
Jan
-21

15-
Jan
-21

22-
Jan
-21

29-
Jan
-21

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ORGANISATIONAL RESPONSIVENESS
In times of uncertainty and volatility, responsiveness in organisations has to be real-time. Often, delayed responses which occur due to blindness in information lead to lost opportunities and may even result in longer-term adverse impact, such as loss of market share. This is being experienced by entities and has been telling since early 2020 due to disruptions from the Covid pandemic.

Businesses can witness significant volatility in terms of cost escalations, supply bottlenecks, changing terms of business, disruption in external environment, etc. This necessitates a change in the way of making business decisions.

An effective way I have experienced in the past is to form a cross-functional team consisting of all key operational departments (vide Figure 6). This team keeps a weekly (even daily) track of changes in the environment and decides appropriate actions to address the changes. For example, the team could introduce a concept of pricing that is based on replacement cost. Based on inputs from the procurement department, the finance team circulates the replacement cost to all the departments, which is used for frequently reviewing pricing decisions in the organisation. This will result in protection from margin erosions in a highly volatile environment. It will also help in timely sourcing of the key materials to cater to the emerging business opportunities.

Cross-functional Action team:
A Weekly feature

Forum for discussion on changing scenario and taking appropriate actions



DRIVING EXECUTION: AGILITY INDEX

It is common to find organisational review fora having a system of making minutes of the meeting. I have found that in doing so some simple tweaks can bring in greater efficiency:
(i) at the end of the meeting, every participant shares the takeaway of his / her actions. Not only does this clarify what each person / team has understood but also instils ownership in delivering actions;
(ii) the secretary of the meeting ensures that the minutes are circulated within 24 hours of the close of the meeting; and
(iii) measuring the speed of execution in terms of ‘Agility Index’.

A score of 9 is assigned to completed actions (Colour Code: Green).
A score of 3 is assigned to actions that are yet to be completed but are in progress (Colour Code: Yellow).
And a score of 1 is assigned to actions that have not been initiated (Colour Code: Red).

The Agility Index (Figure 7) is computed by summing up the item-wise score expressed as a percentage to the total possible, which is the sum of all items times 9 which indicates completion. This, at a glance gives the efficiency of implementation of the agreed actions in an objective manner. This index can also be used to track the action implementation efficiency of Board Meetings as well.

 Agility Index

Action
Agreed

Responsibility
/Owner

Timeline

Status

Tracker
points

 

 

 

 

 

1.  xxx

ABC

15-Apr

 

9

 

 

 

 

 

2.  yyy

PQR

18-Apr

 

3

 

 

 

 

 

3.  zzz

XYZ

21-Apr

 

1

DIGITAL ENABLERS
Digital age now has pervaded all aspects of life at work and in personal domain. Digital technologies such as Cloud, Mobility, Internet of Things, Artificial Intelligence and Virtual Reality are enabling organisations to reimagine and transform businesses. A plethora of tools and information is available through the digital platform greatly enhancing execution capability. In agriculture, for example, gone are those bad old days like the protagonist in Do Bigha Zameen physically labouring away. In advanced agriculture economies such as USA and Brazil, farmers control the entire farming through electronic and mechanical processes using drones, hi-tech machines4, etc. to make the right decisions based on soil and environmental insights and practice precision farming. All this sitting in a control room away from the field! AI and predictive technologies have enabled to customise practices with understanding of future weather and pest changes. Manufacturing operations are guided today by Computer-aided Design, Big Data, Machine Learning, Robotics, etc. which significantly improve productivity and quality. All this, however, has led to an explosion of information available and it is crucial to design internal systems to process and focus these for effective execution.

EXECUTION: A DISCIPLINE
Authors Larry Bossidy and Ram Charan wrote in their remarkable book5 that ‘execution is a specific set of behaviours and techniques that companies need to master in order to have competitive advantage’. Execution is therefore a discipline which ensures that the strategy to achieve the strategic goals of the enterprise is duly deployed and implemented to have sustained competitive advantage. Therefore, we can conclude that Performance is Strategy plus EXECUTION.

This is the last article in this series by Mr. V. Shankar. For the previous five articles, please refer to the BCAJ issues of January 2020, March 2020, June 2020, August 2020 and March 2021

References
1.    Strategy: The Heart of Business – Part I, BCAJ, March, 2021, Page 13
2.     ‘The Balanced Scorecard: Translating Strategy into Action’ by David P. Norton and Robert S. Kaplan
3.     Governance & Internal Controls: The Touchstone of Sustainable Business – Part II, BCAJ, June, 2020, Page 15
4.     https://youtu.be/FNn5DB1Zen4
5.   ‘Execution: The Discipline of Getting Things Done’ by Larry Bossidy and Ram Charan

JDA STRUCTURING: A 360-DEGREE VIEW

“When a subject is multidimensional, a different approach is necessary. Instead of a series of standalone articles on the topic, a single article covering important aspects of the subject (JDA here) and have domain experts comment on each aspect of the subject was deemed worthwhile. The uniqueness of the article is in its subject coverage from the standpoint of each of the four perspectives: accounting, direct and indirect taxes and general and property law at once. This has resulted in an integrated piece where each facet is at once analysed from each of the four perspectives. Sunil Gabhawalla, CA, conceptualised the content and format of this article and shared the outline with three other domain experts. Through the medium of video calls, each one of them shared his perspectives on a number of touch-points outlined by Sunil. These were eventually compiled into this article. Ameet Hariani, advocate and solicitor, covered the Legal side; Pradip Kapasi, CA, covered the Direct tax aspects; Sudhir Soni, CA, covered Accounting aspects; and Sunil took on the Indirect taxation aspects. Thus, the article is a ‘joint development’ by all of them! – Editor”  

Joint development of real estate – A win-win for both landowner and developer?

In today’s scenario, joint development is the preferred mode of development of urban land. A joint development agreement (JDA) is beneficial for both the landowner as well as the developer. It is a win-win situation for both. Conceptually, the resources and the efforts of the landowner and the developer are combined together so as to bring out the maximum productive result post-construction.

What are the possible risk factors?

Having said so, real estate development is spread over quite a few years and is fraught with risks as diverse as price risk (the expected market price of the developed property at the end of the project not commensurate with the expectations), regulatory risk (frequent changes in development regulations at the local level), tax risk (significant lack of clarity on the tax implications of the present law as well as the risk of possible amendments therein before the project completion), business risk (inability of the landowner / developer to fulfil the commitments resulting in either substantial losses or disputes), financial risk (inability to match the regular cash outflows till the time the project becomes self-sustaining) and so on. Like many other businesses, there are risks involved in real estate development in general and joint development projects in particular.

Why this article?

It is not only the diversity of the risks but also the interplay of these risks which makes the entire subject complex and also results in varying models or transaction structures between the landowner and the developer for the joint development of the real estate project. This article attempts to draw upon the experiences of the respective domain experts to apprise the readers of the complex interplay of the risk factors which go into the structuring of the joint development agreements and provide a holistic view of this complex topic. It aims to introduce the nuances and niceties across multiple domains but is not intended to be an exhaustive treatise on the topic.

What are the possible transaction structures?
Well, there are choices galore. Each joint development agreement is customised to suit the specific needs of the stakeholders. While in most of these structures the landowner would pool in the development rights in the property already held by him, the developer would undertake development obligations and compensate the landowner either in the form of money or developed area (either fixed or variable, again either upfront or in instalments). Within this broad conceptual definition of the ‘deliverables’ by the respective stakeholders, a multitude of factors and a complex interplay between them will determine the ‘terms and conditions’ and, therefore, the essence of the joint development agreement. Without diluting the specificity of each joint development agreement, one may compartmentalise the scenarios into a few baskets as listed below:

1. Outright sale of land / grant of development rights by the landowner to the developer against a fixed monetary consideration either paid upfront or in deferred instalments over the project period.
2. Grant of development rights by the landowner to the developer against sharing of gross revenue earned by the developer from the sale of the project.
3. Grant of development rights by the landowner to the developer against sharing of net profits earned by the developer from the project.
4. Grant of development rights by the landowner to the developer against sharing of area developed by the developer in a pre-determined ratio.

How does one choose an appropriate structure?

Well, this is the million-dollar question. The experts spent a considerable amount of time brainstorming this question and identifying various parameters which will help in choosing an appropriate structure.

From the landowners’ perspective, the structure could be determined based on the fine balancing of the timing of the transfer of legal title in the property from the landowner and the timing of the flow of consideration to him. Throw in the subjective metrics of the risk-taking ability of the stakeholders and the level of comfort that the landowner and the developer have with each other in terms of the extent of trust and / or mistrust, and the entire equation starts becoming fuzzy. To add to the fizz, compliance obligations under regulations like RERA and restrictions under FEMA could also act as show-stoppers.

Ameet Hariani says, ‘For example, under RERA it is the promoter’s obligation to obtain title insurance of the real estate project. The relevant section of RERA, among other things, requires a promoter to obtain all such insurances as may be notified by the appropriate Government, including in respect of the title of the land and building forming the real estate project and in respect of the construction of the said project. Since both the landowner as well as the developer will be classified as promoters, it would be prudent for parties entering into a JDA to specify which party (among the “promoters”) will be responsible for obtaining the title insurance for the project.’

In some transaction structures, tax obligations (both direct tax as well as indirect tax – GST and, not to forget, stamp duty) could act as the final nail in the coffin. For example, the upfront exposure towards payment of stamp duty and income-tax coupled with the ab initio parting of the title may rule out the possibility of an outright sale of land by the landowner against deferred consideration from the developer. As stated by Ameet Hariani, ‘From a legal perspective, legal rights should be retained by the landowner till the performance by the developer of the developer’s obligations. Only then should legal rights be transferred.’

While stamp duty is a duty on the execution of the document and could be paid by either of the parties, Ameet Hariani has this to say, ‘So far as stamp duty implications are concerned, normally these are borne by the developer. All documents relating to immovable property should be registered and consequently the quantum of stamp duty is an important determinant to be worked out.’

The above factors are relevant from the developer’s perspective as well. However, many more aspects become relevant. While the landowner would like to protect and retain his title in the property to the last possible milestone, for the developer a restricted right in the land could present significant constraints in financing the project, especially if he is dependent on funding from banks. Ameet Hariani has a word of advice, ‘Legally speaking, agreements for development rights are significantly different from those for sale of land. Courts have held that some types of development agreements cannot be specifically enforced. The key is to ensure that the development agreements that are executed should be capable of being specifically enforced.’ More importantly, the marketability of the project to the end customer / investor depends significantly on the buyer taking a loan from the bank. Therefore, the customer’s and the customer’s lending institution’s perception of the transaction structure and the clarity of the title of land become very important factors.

Hence, Ameet Hariani warns, ‘Financial institutions normally will not give finance in respect of the development agreement unless there is a specific clause in the development agreement entitling the developer to raise finance on the property; and the developer must also have the right to also mortgage the developer’s proportionate share in the land. This often makes the landowner extremely uncomfortable, especially because the landowner’s contribution, i.e., the land comes into the “hotchpotch” almost immediately. This is a matter that is often debated strongly while financing the development agreement’. The local development regulations and restrictions may also play an important part. ‘Is the plot size economically viable? Is there some arbitrage available due to an adjacent plot of land also available for development? Does the development fit within the overall vision of the developer?’ These are some questions which occupy the mind-space of the developer.

Is there one dominant parameter determining the transaction structure?

With such a high level of subjectivity and associated complexity, the discussion amongst the panel of experts tried to focus on identifying whether there was one dominant factor for determining the transaction structure. ‘Cash, Cash and Cash’ was the vocal emphasis factor from the experts. Let’s see what Ameet Hariani has to say: ‘The essential part of the transaction is the cash flow requirement of the landowners. Based on this, all the other issues can be structured.’

Sudhir Soni concurs: ‘The commercial considerations are largely dependent on the cash flow requirements of the developer and the landowner. Grant of development rights against sharing of revenue or developed area are the more prevalent JDA structures and there is not much difference in the business context. Grant of development rights against share of net profits is rare. The commercial considerations for a landowner to select between an area share or revenue share arrangement also depend on the cash flow requirements and taxation implications.’

There is a financial facet other than cash which is equally important – the timing of revenue recognition. Says Ameet Hariani, ‘So far as the developer’s requirements are concerned, since revenues can now only be recognised effectively upon the Occupation Certificate being obtained, and keeping the RERA perspective in mind, the speed of completion of the project is of paramount importance. This is especially true so far as listed developers are concerned.’

Practically, joint development arrangements have specific performance clauses for both the parties and will not allow a mid-way exit to either party. However, the future is uncertain. What if a developer runs out of cash mid-way and needs to exit and bring in another developer? Ameet Hariani opines, ‘Normally, a landowner would be uncomfortable to have a provision whereby development rights can be transferred / assigned without the landowner’s consent. It will be a very rare case where such right is allowed to the developer. There is a high likelihood of litigation where there is a transfer of rights proposed to a third party developer by the current developer’.

The litigation risk is not only at the developer’s end but also at the landowner’s end. Ameet Hariani continues, ‘Also, in the event the landowner wants the developer to exit and wants to appoint a new developer, once again there is a high likelihood of litigation.’ But Ameet Hariani has a golden piece of advice suggesting the incorporation of an arbitration clause in the agreement. ‘Earlier, there was a debate as to whether developer agreements could be made subject to arbitration or not. Recent judgments read with the amendments to the Specific Relief Act and the Arbitration Act have now clarified the position significantly and a well-drafted arbitration clause would be key to ensure protection for both the parties’, he says.

But new transaction structures are emerging

While the discussion was around the traditional options of transaction structuring, the experts did agree that the scenario is fluid and specific situations may suggest the evolution of new transaction structures. While income-tax and stamp duty outflows act as a deterrent to the transaction structure of an outright sale of land, the grant of development rights could possibly be a subject matter of GST. There appears to be a notification which obliges the developer to pay GST on acquisition of development rights (under reverse charge) and another notification which obliges him to also pay GST on the area allotted to the landowner (under forward charge). Much to the chagrin of the developer, the valuation of such a barter transaction is far away from business reality and input tax credits (ITC) are also not allowed. Perhaps the only sigh of relief is that the substantial cash outflow on this account is deferred till the date of receipt of the completion certificate.

But wait! Weren’t transactions in immovable property expected to be outside the purview of GST? ‘Though there is a strong case to argue that such transactions should not be subjected to GST, there are conflicting interpretations on this front and the lower judicial forums are divided. One therefore has to wait for the Supreme Court to provide a final stand on this aspect,’ says Sunil Gabhawalla. Unluckily, businesses can’t wait and the stakes involved are phenomenal. The industry therefore tries to adapt and innovate newer transaction structures which are perhaps more tax-efficient.

Welcome the new concept of ‘Development Management Agreement’ wherein the developer acts as a project manager or a consultant to the landowner in developing the identified real estate. Suitable clauses are inserted to ensure that the developer and the landowner appropriate the profits of the venture in the manner desired. Essentially, this concept turns the entire relationship topsy-turvy and the key challenge is to ensure that the developer has a suitable title in the property while under development. ‘Safeguarding the developer’s rights and title in the property being developed becomes the most important aspect in this structure. Further, the brand value of the developer and past experience of other landowners with the developer is crucial for the landowner to make a choice as to which developer the landowner will go with,’ says Ameet Hariani.

It’s not really new for a tax aspect to be an important determinant for deciding a transaction structure. In case of corporate-owned properties put up for redevelopment, it is not uncommon to explore the route of demerger or slump sale and seek the associated benefits under the income-tax law. Pradip Kapasi says, ‘In case of demerger, the transfer of land by the demerged company to the resulting company would be tax-neutral provided the provisions of section 2(19AA) and sections 47(vib) and 47(vic) are complied with. No tax on transfer would be payable by the company or the shareholders. The cost of the land in the hands of the resulting company would be the same as was its cost in the hands of the demerged company’. Sunil Gabhawalla supports this approach, ‘GST is not payable on a transaction of transfer of business under a scheme of demerger’.

Well, the devil lies in the details. The provisions referred to above effectively require continuity of shareholding to the extent of at least 75%. This may not be possible in all cases. There comes up another option, of slump sale. Pradip Kapasi suggests, ‘The provisions of section 2(42C) r/w/s 2(19AA) and section 50B would apply on transfer of land as a part of the undertaking. No separate gains will be computed in respect of land. The company, however, would be taxed on the gains arising on transfer of the business undertaking in a slump sale. The amendments of 2021 in sections 2(42C) and 50B would have to be considered in computing the capital gains in the hands of the assignor company’. Effectively, income-tax becomes due on slump sale. What happens to GST? Sunil Gabhawalla opines, ‘There is an exemption from payment of GST.’

While such exotic products and arrangements may exist and appeal to many, there would always be takers for the plain vanilla example. The essential business case is that of the landowner and the developer coming together to jointly develop the property. A simple transaction structure could be to recognise the same as a joint venture, as an unincorporated association of persons. In fact, this is a risk parameter always at the back of the mind of any tax consultant. A less litigative route would be to grant such concept a legal recognition by entering into a partnership. To limit the liability of the stakeholders, the LLP / private limited company route can be considered. What could be the tax consequences of introduction of land into the entity?

Pradip Kapasi has this to say, ‘In such an event, of introduction in the partnership firm or LLP, provisions of section 45(3) of the Income-tax Act would be attracted and the landlord’s income under the head capital gains would be computed as per section 45(3) read with or without applying the provisions of section 50C. The profit / loss on subsequent development by the SPV would be computed under the head profits and gains of business and profession. In computing the income of the SPV, a deduction for the cost of land would be allowed on adoption of the value at which the account of the partner introducing the land is credited’. Would such introduction of land into the partnership have any GST implications? ‘Apparently, no, since such transactions are structured as in the nature of supply of land per se’, says Sunil Gabhawalla. He further comments, ‘If the transaction is structured as an introduction of a development right in the partnership firm, things can be different and reverse charge mechanism as explained earlier could be triggered’.

The next steps

Having dabbled with the possible transaction structures with an overall understanding of the complex factors at play in determining the possible transaction structures, we now proceed to dive into the accounting and tax issues in some of these specific structures. Since the landowner and the developer would be distinct legal entities, the discussion can be undertaken from both the perspectives separately.

Landowner’s perspective


Fundamentally different direct tax outcomes arise depending on whether the land or the development rights are contributed by the landowner as an investor or as a business venture.

Landowner as an investor
Essentially, in case the immovable property is held as an investor, it would be treated as a capital asset and the transfer of the capital asset or any rights therein would attract income-tax in the year of transfer itself under the head ‘capital gains’. While a concessional long-term capital gains tax rate and the benefits of reinvestment may be available, in order to curb the menace of tax evasion the Government prescribes that the value of consideration will be at least equivalent to the stamp duty valuation. This provision can become a spoilsport especially in situations where the ready reckoner values prescribed by the Government are not in alignment with the ground-level reality. However, Pradip Kapasi offers some consolation. While the said provisions would apply with full force to transactions of outright sale of land, the application of section 50C to grant of development rights transferred could be a matter of debate. But is the minor tax advantage (if at all) so derived really worth it? Remember the jigsaw puzzle of GST discussed above. But again, someone said that GST applies only on supplies
made in the course or furtherance of business. Did we not start this paragraph with the assumption that the landowner is an investor and is not undertaking a business venture?

Sunil Gabhawalla agrees with this thought process but at the same time cautions that the term ‘business’ is defined differently under the GST law and the income-tax law. He adds, ‘The valuation based on ready reckoner may be prescribed under income-tax law, but the same does not apply to GST where either the transaction value or equivalent market value become the key criteria’. Sudhir Soni endorses this thought from the accounting perspective as well, ‘The ready reckoner value will not necessarily be the fair value for accounting. The valuation for accounting purposes will be either based on the fair value of the entire land parcel received by the developer [or] based on the standalone selling price of constructed property given by the developer’.

In many cases, both the developer as well as the landowner wish to share the risks and rewards of the price fluctuations and also align cash flows. Accordingly, the consideration for the grant of development is both deferred as well as variable – either by way of share of gross revenue or share of profits, or sharing of area being developed. In cases where the landowner does not receive the money upfront and is keen on deferring the taxation to a future point of time, is it possible? The views of Pradip Kapasi are very clear, ‘Provision in agreement or deed for deferred payment or even possession may not help in deferring the year of taxation’. In the case of sharing of gross revenue, he further cautions that the fact of uncertainty of the quantum of ‘full value of consideration’ and its time of realisation may be impending factors but may not be conclusive for computation of capital gains, unless ‘arising’ of profits and gains on transfer itself is questioned. There could be debatable issues about the year of taxation of overflow or the underflow of consideration.

How does one really question or defer the timing of ‘arising’ of profits and gains on transfer? Without committing to the conclusiveness of the end position, which would be based on multiplicity of factors, Pradip Kapasi has a ray of hope to offer. In his words, ‘The cases where either the profit or developed area is shared could be differentiated on the ground that the landlord here has agreed to share the net profits of a business and therefore has actively joined hands to carry on a business activity for sharing of profits of such business. In such circumstances, his “share of profits” could arise as and when it accrues to the business’.

But tax law is full of caveats and provisos. Pradip Kapasi further warns, ‘There is a possibility that the landowner’s association with the developer here could be viewed as constituting an AOP and his action or treatment could activate the provisions of section 45(2) dealing with conversion of capital asset into stock-in-trade and / or the provisions of section 45(3) for introduction of capital asset into an AOP. In case of application of section 45(2) and / or 45(3), there would arise capital gains in the hands of the landlord and would be subjected to tax as per the respective provisions. The surplus, if any, could be the business profits; however, where the transactions are viewed as constituting an AOP, he would be receiving a share in the net profits of the AOP and the share of profit received from the AOP would be computed as per provisions of sections 67B, 86 and 110 of the Income-tax Act’.

Phew, that’s a barrage of cryptic sections to talk about! Let’s keep our fingers crossed and assume that the landlord survives this allegation of the transaction being treated as an AOP. The battle is then nearly won. Pradip Kapasi continues, ‘Where no profits and gains are brought to tax in the year of grant of development rights under the head “capital gains”, the capital gains can be held to have arisen in the year of receipt of the ready flats, where the gains would be computed by reducing the COA (cost of acquisition) of land from the SDV (stamp duty value) of the flats received. Further, if the transaction is structured such that no capital gains tax is levied in the year of receipt of ready flats, the capital gains may be taxed in the year of sale of the flats allotted by the developer’. He further warns about some practical difficulties in this stand being taken; ‘where the landlord on receipt of flats does not sell them but lets them out, difficulties may arise for bringing to tax the notional gains in the hands of the landlord’.

In case all this mumbo-jumbo has dumbed your senses, a landlord who is an individual or HUF may consider the possibility of entering into a ‘specified agreement’ prescribed u/s 45(5A) that involves the payment of consideration in kind, with or without cash consideration in part, for grant of development rights. Under the circumstances, the capital gains on execution of the development agreement shall stand deferred to the year of issue of the completion certificate of the project or part thereof where the full value of consideration for the purpose of computation of capital gains would be taken as the aggregate of the cash consideration and the stamp duty value of his share of area in the project in kind on the date of the issue of the completion certificate. This assumed concession is made available on compliance of the strict conditions including ensuring that the landlord does not transfer his share in the project prior to the date of issue of the completion certificate. Subsequent sale of the premises received under the agreement would be governed as per the provisions of section 45 r/w/s 48.

That’s too much of income-tax. Let’s divert our attention to GST. As a welcome change, Sunil Gabhawalla has a bit of advice for the landowners entering into joint development agreements after 1st April, 2019, ‘Sit back and relax. As stated earlier, the burden of paying the tax on supply of development rights has been transferred to the developer’. What happens when the landowner resells the developed area allotted to him under the area-sharing agreement? Sunil Gabhawalla adds, ‘If the developed area is sold after the receipt of the completion certificate, there is no tax. If the developed area is sold while the property is under construction, the landowner can argue that he is not constructing any area and therefore he is not liable for payment of GST. Remember, the GST on the area allotted to the landowner would also be paid by the developer’.

But life in GST cannot be so simple, right? Nestled in the by-lanes of a condition to a Rate Notification disentitling a developer from claiming input tax credit (ITC) for residential projects is an innocent-looking sentence which permits the landowner to claim ITC on units resold by him if he pays at least equivalent output tax on the units so resold. Sunil Gabhawalla says, ‘Well, the legal tenability of such a position can be questioned. But in tax laws, with the risk of litigation and retrospective amendments, the writing on the wall is that the boss is always right. If the landowner opts to fall in line, he would require a registration and would be paying additional GST on the difference between the tax charged to him and that which he charges to the end buyer. While this also brings commercial parity vis-à-vis the buyers for landowner’s inventory and the developer’s inventory, it could also result in some cash flow issue if not structured appropriately.’

In a nutshell, therefore, the key tax issue bothering the landowner in case of joint development agreements is not really GST but the upfront liability towards a substantial capital gains tax irrespective of actual cash realisation.

Landowner as a businessman

Will things change if the land is held as stock-in-trade? Actually, yes, and substantially. As a businessman, the landowner forfeits his entitlement of concessional long-term capital gains tax rate. But that pain comes with commensurate gain – the tax is attracted not when the transfer takes place but at a point of time when the income accrues in relation to such land. Says Pradip Kapasi, ‘The point of accrual of income is likely to arise on acquisition of an enforceable right to receive the income with reasonable certainty of realisation. The method of accounting and sections 145 and 28 may also play a vital role here. Provisions of ICDS and Guidance Note, where applicable, would apply’. Welcome to the wonderland of accounting and its impact on taxation!

Sudhir Soni says, ‘There may be alternatives. If it is treated as a capital gain, the amounts received as revenue share will be accumulated as advance and recognised at the end of the project, on giving possession. If it is treated as a business, at each reporting date apply percentage of completion to the extent of its share’. But is it really that simple? Well, the situation is fluid and the conflict is nicely summarised by Pradip Kapasi, ‘The fact that there was a “transfer” would not be a material factor in deciding the year of taxation. At the same time, the deferment of receipt may not be the sole factor for delaying the taxation where the enforceability of realisation is reasonably certain’.

Pradip Kapasi further cautions, ‘The provisions of section 43CA may play a spoilsport by introducing a deeming fiction for quantifying the revenue receipts.’ He has an additional word of advice. He suggests the preference of variable consideration models like gross revenue sharing, profit sharing or area sharing over the fixed consideration model. To quote him, ‘The case of the landlord here to defer the year of taxation could be better unless an income can be said to have accrued as per section 28 r/w/s 145, ICDS, where applicable, and Guidance Note of 2012’.

As usual, he has a few words of caution: firstly, ‘There is a possibility that the development rights held by the landlord are considered as a capital asset within the meaning of section 2(14) by treating such rights as a sub-specie of the land owned by him. In such case, a challenge may arise on the income-tax front where transfer of such
rights to the developer is subjected to taxation in the year of transfer itself. This possibility, however remote, could not be ignored though the better view is that even this sub-specie is a part of this stock-in–trade’; and secondly, ‘The possibility of treating the association with the developer as an AOP is not altogether ruled out especially in view of the amendment of 2002 for insertion of Explanation of section 2(31) dealing with the definition of “person” w.e.f. 1st April, 2002. In such an event, though remote, issues can arise in application of the provisions of section 45 to 55, particularly of sections 45(2), 45(3), 50C and 50D.’ Again, a plethora of sections to study and analyse. Well, that’s for the homework of the readers.

What happens on the GST front if the landowner is a businessman? Sunil Gabhawalla reiterates, ‘Sit back and relax if the development agreement is entered into after 1st April, 2019’. But what happens in cases where the development agreement is prior to that date? ‘I’m afraid, definitive answers are elusive. Whether transfer of development rights is liable for GST or not is itself a subject matter of debate. The issues of valuation and the timing of payment of tax are also not settled. We may need a separate article to deal with this,’ he adds.

Is Development Management Agreement a panacea for the landowner?
The concept of Development Management Agreement (DMA) has already been explained earlier. A quick sum and substance recap of the transaction structure would help us appreciate that the appointment of a development manager by the landowner vide a DMA would tantamount to the landowner donning the hat of a real estate developer and the development manager acting as a mere service provider. It will effectively mean that the landowner is the real estate developer who is developing a real estate project in his own land parcel. While this model offers significant respite in the GST outflow on development rights and also avoids the stretched interpretation of barter and consequent GST on free units allotted to existing members for self-consumption (remember, a redevelopment agreement entered into by a co-operative society is a sub-specie of a development agreement), it also helps the landowner in deferring the income-tax liability to a subsequent stage due to his becoming a businessman.

In the words of Pradip Kapasi, ‘In this case, the appointment of a Development Consultant under a DMA would itself be treated as a business decision in most of the cases. The appointment would signal the undertaking of an enterprise by the landlord on a systematic and continuous basis, constituting a business. Such an appointment would not be regarded as a “transfer” of capital asset and no capital gains tax would be payable on account of such an appointment. The first effect of such a decision would be to invite the application of section 45(2) providing for conversion or treatment of a capital asset into stock-in-trade and as a consequence lead to computation of capital gains that would be chargeable in the year of transfer of the stock-in-trade being developed. The market value of the land on such happening would be treated as the cost of the stock-in-trade and the rest would be governed by the computation of Profits and Gains of Business and Profession r/w/s 145, ICDS and Guidance Note’.

But is all hunky-dory as far as GST is concerned? Sunil Gabhawalla cautions, ‘While there is a respite in taxation for the landowner, it may be important to note that the developer relegates himself to the position of a contractor rather than a developer. This would disentitle him from claiming the concessional tax rate of 5% for developers and instead he would be liable for the general tax rate of 18% on the value of the services provided by him. However, this higher rate of tax comes with the eligibility towards claiming input tax credit.’

Developer’s perspective
Well, that was a lot of discussion from the point of view of the landowner. What happens at the developer’s end? Pradip Kapasi has a very simple and affirmative answer on this front. ‘The payment agreed to be made towards the development rights / land acquisition to the landowner would constitute a business expenditure that will be allowed to be deducted against the sale proceeds of the developed area, and if not sold by the yearend, would form the stock-in-trade and would be reflected in the books of accounts as its carrying cost’.

But what happens if the payment towards the development rights is deferred like in gross revenue sharing arrangements? ‘The net receipts subject to his method of accounting would be taxed in respective years of sale and / or realisation. The carrying cost of the stock would be represented by the amount of direct expenditure incurred by him excluding the notional cost of acquiring DR. In the alternative, the payment to be made to the landlord would constitute a business expenditure that will be allowed to be deducted against the gross sale proceeds, and if remaining to be sold by the yearend, would form part of the stock-in-trade and would be reflected in the books of accounts as its carrying cost’, says Pradip Kapasi.

In case of profit-sharing arrangements, however, he cautions about the risk of constitution of an AOP and the associated perils of sections 67B, 86 and 110. He is also afraid that the land cost may not be available as a deduction to the AOP. How does one deal with area-sharing agreements? Pradip Kapasi responds, ‘The net receipts of the balance area coming to the share of the developer would be taxed in respective years of sale and / or realisation where the cost of construction of all the flats would be allowed to be deducted as business expenditure. The carrying cost of the stock could be represented by the amount of direct expenditure incurred by him excluding the notional cost of acquiring DR. In the alternative, the payment to be made to the landlord in kind would constitute a business expenditure that will be allowed to be deducted against the gross sale proceeds, and if remaining unsold by the yearend, would form a part of the stock-in-trade and would be reflected in the books of accounts as its carrying cost.’

The clear essence of the above discussion is that the accounting treatment is important. But depending on certain criteria, enterprises are required to follow either IGAAP or Ind AS. Let us check out what Sudhir Soni has to say. ‘While there is very limited guidance available under IGAAP for accounting of joint development agreements, the cost that is incurred by the developer towards construction of the entire project is treated as cost towards earning the revenue from sale to the developer’s customers. Accordingly, in case of area share for landowner there is no separate accounting and in case of revenue share to landowner it is accounted through the balance sheet. Elaborate guidance is, however, available under Ind AS 115’.

He adds, ‘The JDA is a contract for specific performance and does not have a cancellation clause. For projects executed through joint development arrangements, it is evaluated that the arrangement with land owners are contracts with customers. The transaction is treated as if the developer is buying land from the landowner and selling the constructed area to the landowner. This results in a “grossing” of revenue and land cost, which is a difference from the accounting under Indian GAAP.’ Whether such a difference in accounting treatment will have any ramifications under the income-tax or GST law, only time will tell.

 

Having treated the transaction as a barter, there comes the issue of accounting for such a transaction. Sudhir Soni says, ‘For real estate projects executed through JDA not being jointly controlled operations, wherein the landowner provides land and the developer undertakes the development work on such land and agrees to transfer certain percentage of constructed area / revenue proceeds to the landowner, the revenue from the development and transfer of agreed share of constructed area / revenue proceeds in exchange of such development rights / land is accounted on gross basis. Revenue is recognised over time (JDA being specific performance arrangements) using input method, on the basis of the inputs to the satisfaction of a performance obligation relative to the total expected inputs to the satisfaction of that performance obligation. The gross accounting at fair value for asset in form of land inventory (subsequently recognised as land cost over time basis stage of project completion) and the corresponding liability to the landowner (subsequently recognised as revenue over time basis stage of project completion) may be accounted on signing of JDA, but in practice the accounting is done on the launch of the project, considering the time gap between the signing of the JDA and the actual launch of the project. The developer’s commitments under the JDA, which is executed and pending completion of its performance obligation, are disclosed in the financial statements.’

Further, ‘For real estate projects executed through a JDA being jointly controlled operations, which provide for joint control to the contracting parties for the relevant activities, the respective parties would be required to account for the assets, liabilities, revenues and expenses relating to their interest in such jointly controlled JDA.’

Now comes the next accounting issue of measurement of fair value for such a barter. Sudhir Soni says, ‘The fair value for the gross accounting of JDA is the market value of land received by the developer or based on the standalone selling price of the share of constructed property given by the developer. In case the same cannot be obtained reliably, the fair value is then measured at the fair value of construction services provided by the developer to the landowner’. Well, but the valuation provisions under GST are different. Sunil Gabhawalla agrees and says that each domain will have to be independently respected.

The bottom line, it seems, is that the direct tax consequences for the developer will closely follow the generally accepted accounting principles for determination of net profit for a year. But are things equally simple in GST? Not really. Sunil Gabhawalla shares his inputs. ‘Unless the developer in essence constitutes a contractor, all new residential projects attract 5% GST on the sale proceeds of the units sold while under construction. Even area allotted to the landowner attracts this 5% GST on the equivalent market value of the units allotted to the landowner. Affordable housing projects enjoy a concessional tax rate of 1%. However, no input tax credit is available to the developer’.

But wait a minute! This is not all. A plethora of reverse charge mechanism Notifications require the developer to pay tax on the expenses incurred by him. For example, the proportionate value of the development rights acquired by him from the landowner is liable to GST in the hands of the developer at the time of receipt of the occupation certificate. As Sunil Gabhawalla adds, ‘It may make sense for the developer to procure goods and services from registered dealers only since another Notification requires the developer to pay GST on reverse charge if the procurement from unregistered dealers exceeds 20%. Notably, no tolerance limit has been provided for procurement of cement, where reverse charge mechanism triggers from the first rupee of procurement from unregistered dealers.’

Summing up
This article was an attempt to apprise the readers of the nuances of this complex topic. All experts agreed that the tax efficiencies of each structure over the other would be determined largely by the available circumstances and the needs of the parties. No structure, in such an understanding, is superior to other structures, nor inferior to any.

 

PAYMENT GATEWAYS

A Payment Gateway is a service that provides a payment transaction interface between a customer and the supplier. It can be used for direct payments in-store or for e-businesses or online commercial transactions. Earlier, banks were the primary payment gateway service providers. However, today specialised Fintech organisations are the preferred providers of this service.

When a customer makes a payment using a Payment Gateway, the following tasks are performed to complete the transaction:

1. Typically, the credit / debit card number is entered online, or a credit / debit card is swiped or scanned using a contactless card-reading device. In the case of online transactions, the CVV and the name on the card is also requested.
2. The card number is encrypted as soon as it is entered and transmitted to the Card Association (Master / Visa / Amex) through the Acquiring Bank.
3. The Card Association then routes the transaction to the appropriate Card Issuing Bank.
4. The Card Issuing Bank verifies the debit or credit available on the card concerned and sends a response back to the Acquiring Bank and subsequently to the Payment Gateway with a response code, i.e., whether approved or denied.
5. The Payment Gateway then conveys the response back to the device or website from which the transaction originated.
6. The merchant will then process the transaction for goods or services based on his own internal guidelines.
7. The entire process will take not more than five to ten seconds!
8. At the end of the day, or at periodic intervals, the Issuing Bank will settle the aggregate of transactions to the Acquiring Bank after deducting its commission on the same.
9. The Acquiring Bank will pay the Payment Gateway service provider who will in turn settle all amounts received on behalf of the merchant after deducting its charges for the same.

Many payment gateways also provide tools to automatically screen orders for fraud, blocked card lookups, velocity pattern analysis, ‘black-list’ lookups, IP address lookups, etc.

Points to be considered by a seller of goods and services while choosing a good Payment Gateway:

(i) The Payment Gateway needs to be fast and secure. Speed and security are the main considerations, since without either of them the Payment Gateway would be unsuitable for use.
(ii) A good Payment Gateway also needs to provide a variety of payment options to the user. Apart from Credit Cards and Debit Cards, many Payment Gateways in India also allow use of e-wallets, Online Banking and Virtual Cards. This gives total flexibility to the client and ensures that the client can complete the transaction, irrespective of his preferred mode of payment.
(iii) If your business is global, multi-currency options would be a great advantage.
(iv) Many Payment Gateways make it extremely easy to integrate them in your website or other software platforms, which can get you up and running immediately.
(v) The settlement cycle may vary from a day to a week which will depend on the number and value of transactions.
(vi) Earlier, there used to be one-time setup charges being levied by Payment Gateways – nowadays, the one-time setup charge is waived by many providers.
(vii) The per transaction fees may vary for each Payment Gateway and for each type of transaction. This is negotiable with the Payment Gateway service. The higher the value and volume of transactions, the lower will be
the per transaction fee. Typical transaction costs may have a fixed component and a variable component. The variable component may range from 0.25% to 3% of the value of the transaction.

PayPal is one of the pioneers in the field. It has an international presence and handles a variety of currencies. It is different in the way it handles payments. You have to enter your credit card information only once and create a user-id and password. PayPal will then handle all your payments going through its gateway. The merchant never gets to access your credit card information at all, hence it is completely safe.

Amazon Pay is designed for Amazon merchants and shoppers. It facilitates easy payment through its wallet which needs to be refilled from time to time.

Square is a Payment Gateway which also has its own hardware, making it very easy to acquire payments. The hardware may be in the form of a POS terminal, contactless slide-in, magstripe squares connected to your mobile or in-Stand form.

Among the Indian Payment Gateways, the most popular are Razorpay, CCAvenue, PayUBiz, Instamojo, PayTm and Atom. Each of them has similar features with ease of use and a variety of payment options. PayTm is easiest to deploy – both for the customer and the seller for offline and online transactions. However, Razorpay and Instamojo are the easiest to integrate
into your website. A detailed comparison between the 15 popular Payment Gateway providers is available at http://bit.ly/pgcomparison.

As for the risk factors, all Payment Gateways are regulated by Reserve Bank of India and have strict reporting norms. Transactions are encrypted with 128 bit (or higher) security protocol and are therefore extremely safe and reliable. Breaches, if any, are to be instantly reported and monitored. Hence, most of the popular Payment Gateways are safe and reliable on all counts. RBI Guidelines on Regulation of Payment Aggregators and Payment Gateways are available at https://bit.ly/3tpmCwm.

In these days of growing online transactions, a Payment Gateway for your website is a must-have tool, not only for selling goods and services but also for easy and smooth collection of payments!

SAT SETS ASIDE INSIDER TRADING ORDERS

As discussed several times earlier in this column, SEBI has been investigating stock market frauds, insider trading, etc., by tracking the use of social media / messaging applications. About a year back, we also discussed certain SEBI orders where it was held that some persons shared unpublished price-sensitive information through the popular chat application WhatsApp. Stiff penalties were levied on such persons under the Insider Trading Regulations. Those who were penalised appealed to the Securities Appellate Tribunal (‘SAT’) which has now reversed those orders. SAT has held that, on the facts, there was no violation of the SEBI Regulations on insider trading.

This decision of SAT has several interesting aspects. Has SAT made any significant interpretation of the law that has far-reaching implications as suggested by some reports? When can a person, who shares unpublished price-sensitive information (‘UPSI’), be held to have violated the Regulations? Is it necessary that a link be established between the person having the UPSI and the source within a company who had leaked such information? There are also lessons generally for persons using social media applications. Let us consider this decision (Shruti Vora vs. SEBI, dated 22nd March, 2021) in greater detail.

BROAD SCHEME OF SEBI (PROHIBITION OF INSIDER TRADING) REGULATIONS, 2015 AS RELEVANT HERE
The Regulations seek to prohibit and punish insider trading. They prohibit what is commonly understood as insider trading – that is, trading by an insider who is in possession of, or has access to, UPSI. However, they also prohibit several other things like communication of UPSI except where permitted under the Regulations. The Regulations also have further requirements of disclosure of holdings and dealings by certain insiders, prohibition of trading during periods when the trading window is required to be closed, etc.

In the present case, the relevant provision is related to the sharing of UPSI. Insiders are prohibited from sharing UPSI. The reason for this prohibition is obvious. Sharing such information may result in the recipient dealing and profiting out of it. However, such recipient may also further pass on such information to others. Such sharing is also covered by the offence of ‘insider trading’.

However, as this case shows, three interesting questions arise: Is it required to show that a person who shared UPSI had received it from a particular person within the company? Is it required that he should know that such information was UPSI? Would the offence of insider trading also cover sharing of UPSI by a person who is not aware that it is UPSI?

The first question has been answered by a deeming provision in the Regulations itself. It is provided that a person would be deemed to be an insider even if he is in mere possession of UPSI. Thus, it is not required that his source of such information be traced within the company (a little more on this later). He is deemed to be an insider. If he then deals in the securities, or shares such UPSI, he would be deemed to have committed the offence of insider trading.

The second question is interesting and indeed became, as we will see, the core issue in this case. Should a person know that the information in his possession is UPSI? The Regulations have not made an express provision on this. SAT has held that a person should be aware that such information is UPSI and it is only in such a case that the person would be deemed to be an insider. However, the equally critical question is how does one establish whether a person knows that the information he possesses is UPSI? This can be tricky as this would be something in the person’s mind. This aspect will be discussed further while analysing the decision.

The third question would be answered by implication from the answer to the second question although, again, the Regulations have no express provision about it. If a person does not know that the information he possesses is UPSI, then sharing of such information would not make him guilty of the offence of insider trading.

With this brief background, let us consider the case and then discuss what SAT has held.

FACTS OF THE CASE AND SEBI’S ORDER
It appears that SEBI was alerted especially by media reports that financial results of reputed companies were being leaked and shared in advance on social media through chat applications like WhatsApp. It conducted investigations and amongst its findings was some data relating to two appellants in the present case. It was found that they worked in the industry and had forwarded financial results through WhatsApp to many persons, including clients. The financial results forwarded were eerily accurate and very closely matched the actual results published soon after. However, SEBI could not trace who had sent this information to such persons. Even the companies concerned could not find any leak that could have happened internally from within the companies themselves.

SEBI, however, held that the law was clear. Possession of UPSI made the person an insider. The law also prohibited insiders from sharing UPSI with others. Since these persons did share the UPSI, they committed the offence of insider trading. It levied stiff penalties on such persons. Since similar orders were passed separately for sharing of results for each company, the penalties cumulatively rose to an even larger amount.

The parties had argued that not only these messages but several others were also forwarded in the same manner. And these messages were forwarded to groups of numerous persons. The messages were sent almost as soon as they were received. The other messages had information which was not UPSI and in any case often did not even match with the actual financial results in those other cases. However, SEBI stuck to its position and held that they had indulged in insider trading and levied penalties.

APPEAL BEFORE SAT
In the appeal before SAT, the appellants made several arguments. It was pointed out that they were not aware that what they had was UPSI. They had received numerous such messages and those were also forwarded along with the ones under question. They had no means to verify the authenticity of any of the information. The messages / information so received could be compared to ‘heard in the street’ columns common in media and while such pieces are read by many, it was accepted that their authenticity was not assured. Indeed, some could be just rumours or informed guesses. The appellants also pointed out that the specific messages that were of concern were not differently coded while being forwarded. So the recipients could not distinguish those messages from the others.

DECISION OF SAT
SAT accepted the arguments of the appellants and set aside the orders of SEBI levying penalties. It also made some important points about the interpretation of the law.

At the outset, SAT confirmed that possession of UPSI did make a person an insider under law and sharing of such UPSI by such person would be an offence under the Regulations. SEBI did show that the person was in possession of the UPSI and hence it may appear that one part was fulfilled. The information was shared, too.

However, and this was the crucial point, did such person know the information received and shared was UPSI? And, if not, would the information still be UPSI qua such person? The law is silent on this point. However, this did matter because it is from the perspective of the person accused of insider trading. If such person did not know it was UPSI, then that person cannot be held to be in possession of UPSI and hence is not an insider. And if this was so, his sharing of the information was not insider trading.

It was apparent from the record itself that the persons had received numerous bits of information and had forwarded the same to many other persons. Neither the persons sending them nor the persons receiving them could have had any way of knowing that the information was authentic and hence UPSI. SAT observed, ‘The above definitions of the “unpublished price sensitive information” and “insider” would show that a generally available information would not be an unpublished price sensitive information… The information can be branded as an unpublished price sensitive information only when the person getting the information had a knowledge that it was unpublished price sensitive information’. Thus, the information was not UPSI. One could take the example of the numerous WhatsApp forwards many of us receive. We have become used to examine them with so much scepticism that we generally have stopped even reading most of them.

While it is true that possession of UPSI was sufficient to make a person an insider, there were sufficient circumstances to doubt that it was UPSI and thus the onus shifted back to SEBI. It was now up to SEBI to prove, even with a reasonably low benchmark of proof or of the preponderance of probability, that the persons knew it was UPSI. SEBI could not and it did not so prove.

SAT also noted that SEBI has not connected the information to any source within the companies and even the companies did not have any such findings of leakage.

The order was thus set aside.

CONCLUSION
The important legal point thus is that UPSI is from the perspective of the person who is in possession of the same. If I have a pile of stones with me and I do not know that a couple of the ‘stones’ are really diamonds, I may give the same to someone else for a low value. And even he may do the same with them.

That said, this does not mean one should be lax with the law. The law provides for serious consequences for insider traders and the benchmark of proof remains relatively low. In this particular case, the facts were peculiar and hence did not allow any wider generalisation. One should remain ever vigilant while forwarding information. The law has sufficient deeming provisions. Chartered Accountants are typically and even otherwise deemed to be insiders as auditors, advisers, CFOs, etc. They are also expected to know the importance of figures and it is even possible that information shared by them may be given more weightage by the recipient, and thereby also by SEBI while deciding guilt. Thus, this case should induce even more caution.

OCI: A FEW CHANGES, BUT LOTS OF CONFUSION

INTRODUCTION
The Overseas Citizen of India or OCI was a modified form of dual citizenship introduced by the Indian Government in 2005 for the benefit of Non-Resident Indians (NRIs) and Persons of Indian Origins (PIOs) resident abroad. India currently does not permit dual citizenship, i.e., a person cannot be the citizen of both India and a foreign country, say the USA. He must select any one. An OCI cardholder is not a full-fledged citizen but he has certain benefits at par with a citizen. As of 2020, there were over six million OCIs abroad.

This scheme has seen certain regulatory and legal developments which have caused a great deal of confusion and anxiety amongst the OCI cardholders resident abroad. The University of WhatsApp (sic!) has played a stellar role in fuelling this fire. The intent of this article is to discuss those forwards and dispel some myths.

WHAT IS REGULATORY FRAMEWORK?
An OCI card is granted by the Government of India to a person under the aegis of the Citizenship Act, 1955. Section 7A of this Act provides for the registration of OCIs. At the cost of repetition, an OCI is not a full-fledged Indian citizen under the Citizenship Act but he is only registered as an OCI. Section 7A allows the Government to register the following individuals as OCIs on an application made by them:

(a) Any person who currently is a foreign citizen but was an Indian citizen at the time of commencement of the Constitution of India, i.e., in 1950;
(b) Any person who currently is a foreign citizen but was eligible to be an Indian citizen at the time of commencement of the Constitution of India, i.e., in 1950;
(c) Any person who currently is a foreign citizen but belonged to a territory that became part of India after Independence;
(d) Any person who is a child or a grandchild of the above persons;
(e) A minor child of a person mentioned in the clause above;
(f) A minor child both of whose parents are citizens of India or one of whose parents is a citizen of India;
(g) Spouse of a citizen of India or spouse of an Overseas Citizen of India cardholder;
(h) Spouse of a person of Indian origin who is a citizen of another country and whose marriage has been registered and subsisted for a continuous period of not less than two years immediately preceding the presentation of the application under this section.

Thus, all of the above persons are eligible to be registered as OCIs. Interestingly, even a person of non-Indian origin can be registered as an OCI if he marries a citizen / an OCI cardholder. For example, a Caucasian American man marries an Indian OCI woman residing in the USA. He, too, would be eligible to be registered as an OCI along with their children. The Act further provides that the OCI card granted u/s 7A to a spouse is liable to be cancelled upon dissolution of marriage by the competent court. The special privileges can then be withdrawn.

The Bombay High Court in Lee Anne Arunoday Singh vs. Ministry of Home Affairs, WP 3443/2020 has held that the provisions of section 7 of the Act cast a duty on the Government to take necessary steps regarding cancellation of the OCI card issued on spouse basis, if the marriage is dissolved by a competent court of law.

The Government of India has recently made a submission in a similar case before the Delhi High Court that a foreigner registered as an OCI on the strength of marriage to an Indian citizen loses that status when the marriage is dissolved. Such foreigners are no longer eligible to be registered as OCIs under the Citizenship Act. Such a person could, however, continue to visit India by applying for an ordinary / long-term visa. A PIL (public interest litigation) has also been filed before the Delhi High Court in Jerome Nicholas Georges Cousin vs. Union of India, W.P. (C) 8398/2018 by a French national against this provision. In his plea he states that he would have to close down his business and go back to France since he would now not have permission to run a business in India.

WHAT ARE THE BENEFITS AVAILABLE TO AN OCI?
The OCI card is a life-long visa granted to these foreign citizens. While their passport is the primary document to enter India, the OCI card is an additional document that they receive. They can visit India as many times as they want and stay as long as they wish. They can even permanently reside in India and work and study here. Non-OCI cardholders need to get registered with the Foreigners Regional Registration Office if they want to stay for more than six months in India. These procedures are not applicable to OCIs.

Earlier, there was a concept of a Person of Indian Origin (PIO) card which was also a long-term visa. However, issuance of new PIO cards has been discontinued and all PIO cardholders are being encouraged to migrate to the OCI card.

The Government has made some changes in the benefits available to OCIs by a Notification issued in March, 2021. This Notification has caused a lot of confusion amongst the Indian diaspora. The revised list of benefits available to OCIs is as follows:

(1) It grants a multiple entry life-long visa for visiting India for any purpose. The revised Notification has added that for undertaking the following activities, the OCI cardholder shall be required to obtain a special permission or a Special Permit, as the case may be, from the competent authority or the Foreigners Regional Registration Officer or the Indian Mission concerned, namely:
(i)  to undertake research;
(ii) to undertake any missionary or tabligh or mountaineering or journalistic activities. This amendment is to overrule the Delhi High Court’s decision in the case of Dr. Christo Thomas Philip vs. Union of India, W.P. (C) 1775/2018 where an OCI card was cancelled on the ground that the person was involved in missionary activities in India. The Court held that there is no law which prevents missionary activities by an OCI and hence the cancellation was invalid. The Court had held that prima facie the rights under Article 14 (equality before law) and 19 (freedom of speech and expression) of the Constitution of India which are guaranteed to the citizen of India, also appear to be extended to an OCI card-holder;
(iii) to undertake internship in any foreign Diplomatic Missions or foreign Government organisations in India or to take up employment in any foreign Diplomatic Missions in India;
(iv) to visit any place which falls within the Protected or Restricted or prohibited areas as notified by the Central Government or competent authority.
    
(2) Exemption from registration with the Foreigners Regional Registration Officer or Foreigners Registration Officer for any length of stay in India. The revised Notification has added that the OCI cardholders who are normally resident in India shall intimate the jurisdictional Foreigners Regional Registration Officer or the Foreigners Registration Officer by email whenever there is a change in permanent residential address and in their occupation.

(3) It provides parity with NRIs in the matter of
(i)  inter-country adoption of Indian;
(ii) appearing for the all-India entrance tests to make them eligible for admission against any NRI seat. However, the OCI cardholder shall not be eligible for admission against any seat reserved exclusively for Indian citizens. This overrules the decision of the Karnataka High Court in the case of Pranav Bajpe vs. The State of Karnataka, WP 27761/2019 which held that when the parity between the OCI cardholder and Non-Resident Indians is removed, the concept of OCI cardholder cannot be given a restricted meaning as Non-Resident Indian so as to restrict such admission only to Non-Resident Indian quota in the State quota of seats and not in the institutional quota or Government quota of seats under the NEET Scheme. It had concluded that the minor children of Indian citizens born overseas must have the same status, rights and duties as Indian citizens, who are minors;
(iii) purchase or sale of immovable properties other than agricultural land or farmhouse or plantation property; and
(iv) pursuing the following professions in India as per the provisions contained in the applicable relevant statutes or Acts as the case may be, namely, doctors, dentists, nurses and pharmacists; advocates; architects; chartered accountants.

(4) In respect of all other economic, financial and educational fields not specified in this Notification or the rights and privileges not covered by the Notifications made by the Reserve Bank of India under the Foreign Exchange Management Act, 1999, the OCI cardholder shall have the same rights and privileges as a foreigner. This is a new addition by the March, 2021 Notification. Thus, if any benefit is not specifically conferred either under the Citizenship Act or under the FEMA, 1999, then the OCI would only be entitled to such privileges as are available to a foreigner.

An OCI is not entitled to vote in India, whether for a Legislative Assembly or Legislative Council, or for Parliament, and cannot hold Constitutional posts such as those of President, Vice-President, Judge of the Supreme Court or the High Courts, etc., and he / she cannot normally hold employment in the Government.

CAN AN OCI BUY PROPERTY IN INDIA?
One of the benefits of being an OCI is that such a person can buy immovable property in India other than agricultural land. The Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 deal with this aspect. Rule 21 permits an OCI to purchase any immovable property in India other than agricultural land or farmhouse or plantation property. An OCI is also allowed to get a gift of such a property from an Indian resident / NRI / OCI who is a relative as per the definition under the Companies Act, 2013. Citizens of certain countries, such as Pakistan, Bangladesh, Sri Lanka, Afghanistan, China, Iran, Nepal, Bhutan, Hong Kong or Macau, or the Democratic People’s Republic of Korea (DPRK), cannot purchase immovable property in India without permission from the RBI but even this prohibition is not applicable to OCI cardholders. It may be noted that the above relaxations under the FEMA Rules are only for OCI cardholders and not for all persons of Indian origin. If a foreign citizen of Indian origin does not have an OCI card, then he cannot buy immovable property in India without prior permission of the RBI. This is one of the biggest benefits of having an OCI card.

In this respect, misunderstanding of a Supreme Court decision in Asha John Divianathan vs. Vikram Malhotra, CA 9546/2010 Order dated 26th February, 2021 has created great heartburn amongst the OCI community. This was a decision rendered under the erstwhile Foreign Exchange Regulation Act, 1973 (which has been superseded by the FEMA in 1999). Section 31 of the erstwhile law provided that any foreign citizen desirous of buying immovable property in India required the prior approval of the RBI. The Court held that entering into any such transaction without RBI approval was treated as an unenforceable act and prohibited by law. It further held that when penalty was imposed by law for the purpose of preventing something on the ground of public policy, the thing prohibited, if done, would be treated as void, even though the penalty if imposed was not enforceable. It is important to note that this decision is not applicable in the light of the current provisions of the FEMA Regulations. As explained above, the law now, by virtue of Rule 21 of the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 expressly provides that an OCI can purchase any immovable property in India other than agricultural land or farmhouse or plantation property.

WHAT DOES FEMA PROVIDE IN RESPECT OF OCIs?
The provisions relating to OCIs have been dealt with in great detail under the FEMA Regulations and it would be difficult to elaborate on all of them here. However, a few examples are explained here. At most places under the FEMA Regulations, the provisions available to persons of Indian origin have been replaced with OCIs. Thus, it is mandatory for the PIOs to have an OCI card. For instance, the facility of investment on a non-repatriable basis under Schedule IV of the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 is allowed only to Non-Resident Indians and OCI cardholders. Persons of Indian origin who do not have OCI cards cannot avail of this facility.

Similarly, under the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 an Indian bank is allowed to lend in Indian rupees only to an NRI or an OCI cardholder.

However, in a few Regulations under FEMA, it is not mandatory to have an OCI card. For example, a Non-Resident External (NRE) Bank Account or a Non-Resident Ordinary (NRO) Bank Account can be opened by any Person of Indian origin. It is not necessary that such a person has an OCI card. Similarly, the Foreign Exchange Management (Remittance of Assets) Regulations, 2016 allows a PIO to remit up to US $1 million every year out of balances held in the NRO account and from the sales proceeds of assets.

IS THE DEEMED RESIDENCY PROVISION APPLICABLE?
Under section 6 of the Income-tax Act, any Indian citizen having total Indian income exceeding Rs. 15 lakhs during the previous year is deemed to be an Indian tax resident in that year, if he is not liable to tax in any other country or territory by reason of his domicile or residence or any other criteria of similar nature. This provision is applicable only to an Indian citizen, i.e., a person holding an Indian passport. An OCI does not have an Indian passport and so he would be out of the deemed taxation net.

CONCLUSION
The law relating to OCIs is dynamic in nature. In respect of all other economic fields not expressly specified or not covered by the Notifications under the FEMA, 1999, the OCI cardholder is equated with the same rights and privileges as a foreigner. Thus, it becomes very important to understand what are the benefits and provisions for an OCI cardholder.

GSTN COMMON PORTAL: E-GOVERNANCE

Digitisation of tax administration has been a progressive step of the Government in the recent past. Understandably, the primary thrust for it came from increasing tax complexities and allegedly evasive measures adopted by business enterprises. This warranted Governments to arrest such activities through real-time and non-erasable trails of events. Now, tax administrations are increasingly harnessing the benefits of digitisation by instant identification, examination and conclusion of tax challenges.

Therefore, a robust IT infrastructure was the key to the success of the implementation of a ‘self-policing’ GST in India. The need for such infrastructure led to the birth of the GST Network (GSTN) which was entrusted with the responsibility of setting up, operating and the maintenance of IT systems. GSTN was established as a special purpose vehicle by the Ministry of Finance to provide common IT infrastructure, systems and services to the Central and State Governments, taxpayers and other stakeholders for supporting the implementation and administration of the GST in India.

Much like the GST scheme, the GST Network has also been subjected to critiques. Firstly, the structure and functioning of the GSTN with the possibility of interference by non-governmental bodies, and secondly, the privacy concerns emerging from such large-scale collection of data. That apart, the GSTN has been entrusted to operate the GST common portal under the domain and boundaries of the GST law.

LEGAL BACKGROUND
Section 146 of the CGST / SGST Act, 2017 empowers the Government to notify a common electronic portal for facilitating registration, tax payments, furnishing of returns, computation / settlement of integrated tax, electronic way-bill and such other functions as may be necessary. Notification No. 4/2017-CT dated 19th June, 2017 notified www.gst.gov.in (the website managed by GSTN) as the common portal for the purpose of facilitating ‘registration, payment of tax, furnishing of returns and computation and settlement of integrated tax’. On the GST portal, the website states that the said portal includes all its sub-domains, internal and external services serviced by the domain and mobile applications of the GST portal. Similarly, Notification No. 9/2018-CT dated 23rd January, 2018 has notified www.ewaybillgst.gov.in as the Common Goods and Services Tax Electronic Portal for furnishing of electronic way-bill.

Recently, Notification No. 69/2019-CT dated 13th December, 2019 notified www.einvoice1-10.gov.in as the portal for e-invoice preparation. Parallel Notifications were issued by States for recognising the said web-portal(s) for specific purposes. Through such provisions, legal sanctity was sought to be provided to the said portal(s) but only for limited functions as specified in the Notifications. Interestingly, transition returns, refund applications and appeals do not find mention in the enabling Notifications notifying the common portal for specific purposes and one may resort to this as a legal contention in the days to come.

LEGAL QUESTIONS
Some critical questions arising from the e-governance initiatives of the Government are:
(a) What is the scope of the common portal in administration of the law?
(b) Whether the Notification issued under the CGST / SGST on the common portal would apply to the IGST Act even though a Notification has not been issued for this purpose?
(c) Whether the frameworks / contents, conditions, restrictions in the portal are backed by legal provisions? Is the Government imposing its view of the law on the taxpayer? Are there any remedies left to the taxpayer where the GST portal does not permit one to apply the law in a particular manner?
(d) What are the consequences of a failure in the GSTN systems, especially on down-time, lack of proper response, etc.? Whether the ‘proper officer’ can cite helplessness in matters of substantive rights where the portals restrict functionalities? What is the legal sanctity of the response / lack of response of GSTN helpdesks?

SETTLED PRINCIPLES
Before going into details, it may be important to assimilate the critical concepts of law which would govern the above questions. The first one is the well-settled provision that delegated authorities would have to operate within the framework of law and the legislations or actions are subject to the vires of the governing statute. This reminds one of the decision of the Supreme Court in St. Johns Teachers Training Institute vs. Regional Director, NCTE (2003) 3 SCC 321 at page 331 which held that regulations and rules are directed towards ‘supplementing’ the law rather than ‘supplanting’ the law. The Court stated as follows: ‘What is permitted is the delegation of ancillary or subordinate legislative functions, or, what is fictionally called, a power to fill up details.’

The other principle is that ‘forms / returns’ forming part of a statute cannot drive its interpretation1. The Supreme Court in the context of adjustment of MAT credit referred to the forms and held in CIT vs. Tulsyan NEC Ltd. (330 ITR 226) as follows: ‘It is immaterial that the relevant form prescribed under the Income-tax Rules, at the relevant time (i.e., before 1st April, 2007), provided for set-off of MAT credit balance against the amount of tax plus interest, i.e., after the computation of interest under section 234-B. This was directly contrary to a plain reading of section 115-JAA(4). Further, a form prescribed under the Rules can never have any effect on the interpretation or operation of the parent statute.’

And finally, procedural laws are meant to further the object of the substantive provisions and not restrict their scope [CCE vs. Home Ashok Leyland (2007) 4 SCC 51].

RELATIONSHIP BETWEEN GSTN AND GOVERNMENT OF INDIA
GSTN was incorporated on 28th March, 2013 for the purpose of implanting e-governance and technology initiatives for the efficient rollout of the GST law. As per media reports, it can be inferred that work on the creation of the IT infrastructure commenced much before the passage of the Constitution (One Hundred and First Amendment) Act, 2016. It was during the 4th GST meeting on 3rd-4th November, 2016 that GSTN made a presentation about the status of the web development and the services being offered by GSTN on this front.

_____________________________________
1 LIC vs. Escorts Ltd. (1986) 1 SCC 264
Interestingly, the statute does not enlist the criteria for selection, operation and regulation of an IT service provider (whether Government-owned or otherwise). The GST Council in its minutes also does not formally identify / appoint the GSTN as the sole service provider for this massive task. This question is important because the 11th meeting had specifically approved a proposal of appointing GSTN for the development of the e-way bill IT infrastructure but the appointment of GSTN for the basic GST portal seems to be missing in the minutes. The legal sanctity of entrusting / delegating the IT infrastructure to GSTN through the Government of India is unclear from public domain documents and requires immediate attention.

ANALYSIS
Compliance under the erstwhile laws under Excise, Service Tax, VAT, Entry Tax was largely performed electronically. It was thus expected that the reporting and compliance under the GST law would also continue to be driven by technology. However, the level of technological complexities was relatively lower under those laws. The electronic forms under the erstwhile laws had limited functionalities and were meant for the limited purpose of capturing data. The administration then utilised the data collected at the back-end for risk management purposes.

However, the GST portal ushered in a much higher level of legal control at the data entry point itself by the taxpayers and in many instances hindered the decision-making of the taxpayer. Although the insertion of legal control might have been intended to assist taxpayers in accurate data capture, in certain cases it appears to have breached the legal framework. For a start, we should read this disclaimer of the GSTN portal for its users:

‘Though all efforts have been made to ensure the accuracy and currency of the content on this website, the same should not be construed as a statement of law or used for any legal purposes or otherwise. GSTN hereby expressly disowns and repudiates any claims or liabilities (including but not limited to any third party claim or liability, of any nature, whatsoever) in relation to the accuracy, completeness, usefulness and real-time of any information and contents available at this website, and against any intended purposes (of any kind whatsoever) by use thereof, by the user/s (whether used by user/s directly or indirectly). Users are advised to verify / check any information and contents, with the relevant Government department(s) and / or other source(s) and to obtain any appropriate professional advice before acting thereon as may be provided, from time to time, in the website.’

Thus, the GSTN portal clearly disclaims its responsibility over administering the law and states that the web functionality does not represent the interpretation of law. In fact, the portal also does not claim responsibility over the accuracy of the contents which are uploaded on it and has directed taxpayers to either approach Government officials or seek professional advice.

DAWN OF THE PORTAL
The e-governance initiative under GST commenced with the migration of registration(s) of erstwhile taxpayers into the GST regime. This involved the filling of Form REG-26 which contained checks and balances in terms of back-end validation of PAN numbers, legacy registration numbers, bank accounts, etc. This is usually done to sanitise the data at the entry point so that redundancies can be avoided. As time passed, additional functionalities were introduced on the GSTN portal. The most critically discussed of these were related to the returns in GSTR1, GSTR2, GSTR3 and their ancillary forms. Though these forms were notified in law, due to various reasons including lack of technical preparedness of the GSTN, the alternative summary form in GSTR3B was introduced. Subsequently, additional modules on transition returns, refunds, input tax credit (ITC), etc., were introduced in a phased manner. The transition module has been widely debated in legal forums since it directly impacted the eligibility of taxpayers to claim the said credit. Technical glitches in the form, lack of clarity in the transition module, coupled with the complexity of the user tabs, made the form difficult to comprehend for taxpayers resulting in non-availment of credit.

In September, 2019 the refund module was launched envisaging electronic processing of refund from application to disbursement. There have been instances where taxpayer refunds have been delayed due to internal technical glitches in the refund disbursement process and its interaction with other external databases (such as PFMS). Recently, the portal has enabled the functionality of appeals (including advance rulings) in respect of refunds, registrations, etc. The portal is progressively digitising the inter-face between the administration and taxpayers.

In the effort to digitise the process, internal controls / checkpoints have been placed at the point of data entry itself which may hinder even genuine cases. The GSTN assumes that taxpayers have uploaded accurate data at all entry points in the manner expected by the portal. Taxpayers in many cases have failed to understand the data expectations due to lack of technical guidance material or ineffective helpdesk support from the GSTN, thus resulting in incorrect data entry. Moreover, the portal has been developed based on the administration’s perspective / interpretation of law which may or may not be accurate. In an era of self-assessment (in contradistinction to officer-assessment), taxpayers should be granted the liberty to apply the law as per their own understanding without any technical hindrances. The vires of taxing statutes have been tested multiple times in higher forums and reading down or striking down of legal provisions is not unknown. With several technical restrictions (enlisted below), taxpayers have been thrust with the administration’s view of law.

The ensuing paragraphs are an attempt to list the technical challenges in the portal which appear to be either contradictory to law or hamper a taxpayer’s right to perform a self-assessment of his taxes based on his interpretation. The important pointers under each module are herewith tabulated2:

Return module

Table
Ref.

Functionality

Comments

GSTR1: Aggregate turnover

Data filed auto-populated used for various
threshold limits such as E-invoice, etc.

The functionalities use turnover for
enabling facilities of e-invoicing, etc. This causes issues where taxpayers
might have reported an incorrect turnover in the previous year(s) which may
have been rectified in annual returns / left unrectified. The system merely
aggregates the turnover and adopts this as the basis for enabling / disabling
features

GSTR1: Date of invoice and invoice No.

Date of invoice cannot be before date of
registration

A taxable person who has availed GST
registration belatedly is barred from reporting the original tax invoice even
though taxes may have been charged / paid in the said invoice to the
recipient

GSTR1: B2C and B2B

Amendment from B2C to B2B

One may view section 39(7) as being a time
limit only to rectify any particulars which have an impact on the tax liability. In cases where the particulars do not
have any tax liability such as this, the time limit provisions should not
apply, but the portal restricts such revisions

GSTR1 : SEZ

SEZ supplies liable for
CGST / SGST

Certain advance rulings have stated that
restaurant services are liable to CGST / SGST and not IGST. Return
functionalities do not permit CGST / SGST for SEZ invoices

GSTR1 : B2CL

Amendment in B2CL invoices

B2C large invoices (in excess of Rs. 2.5
lakhs) are entered at an invoice level but amendment tables in GSTR1 do not
provide any functionality to update the GSTIN of these invoices and shift
them to the B2B section – taxpayers are forced to raise credit notes to the
B2CL data and upload fresh invoices in the B2B section

GSTR1 – DNs / CNs

Linking DNs / CNs with multiple invoices

Until recently, DNs / CNs were mandatorily
required to be linked to a single invoice. The law has been amended making
the linking an open-ended feature. The GSTN portal has only recently opened
this feature by de-linking the mapping of DNs / CNs with a single invoice.
Till now, taxpayer(s) were unable to upload this data

GSTR1 – Export details

Alterations in type of exports

Alteration in invoices from ‘with payment’
to ‘without payment’ is not permissible which causes disabilities in other
refund functionalities

GSTR3B: Taxable turnover

Negative turnover is not permissible

In cases where the credit note raised in a
tax period exceeds the output turnover, the data field does not permit negative
values. CBEC Circular / Helpdesk suggest that the unadjusted credit notes are
to be reported in subsequent months. Moreover, due to zero-values being
reported in GSTR3B, there arises a variance between GSTR1 and GSTR3B and
disables certain other functionalities in other modules (such as refunds,
etc.)

GSTR3B – ITC

ITC order of set-off

GSTR3B mandatorily requires the ITC to be
utilised prior to making cash payments or performing inter-head set-offs.
Taxpayers may choose to avail ITC and refrain from utilising the same on the
grounds of ambiguity. But the utilisation is thrust upon them, consequently
opening the scope for incorrect utilisation

GSTR9 – Table 9

Details of tax paid

Annual return auto-populates details of
taxes paid in a non-editable format in GSTR9. Taxpayers who have paid taxes

GSTR9 – Table 9

 

(continued)

Details of tax paid

through DRC 03, etc., and have

included the turnover in annual return
would not be able to record this tax payment, resulting in glaring
discrepancies

GSTR9 – Table 6

Details of input tax availed

Annual return permits reversal of ITC and
accordingly directs filing of DRC 03 for such reversals but the reverse is
not permissible. Taxpayers are not permitted to avail ITC through the annual
return. In the absence of a clear GSTR1, 2 and 3 and a stop-gap GSTR3B,
taxpayers have looked at GSTR9 as the only
final return to report the tax credits / liabilities. The law neither
specifies the document of availing credit nor bars claim of credit through
GSTR9. Yet, the functionality in the tax portal does not permit availing of
such ITC in the electronic credit ledger through GSTR9

GSTR9

Table 8 – GSTR2A

Details auto-populated in Table 8
representing input invoices uploaded by suppliers does not reconcile with the
taxpayers’ GSTR2A. Until 2018-19, the taxpayers were not provided with
item-wise listing of such auto-population and in many cases taxpayers were
forced to file
the document as it was auto-populated

GSTR9

Table 9 – Auto population

Form GSTR9 keeps the data fields for this
table open to alteration by the taxpayer but the portal freezes the tax
payment details through ITC and / or cash

GSTR1/9

Exempt supplies / HSN tables

The exempt supplies / HSN tables are static
and not open to alteration. Without the functionality, the taxpayers would be
faced with questioning on classification even though it may not be admittance
by taxpayer in its strict sense

GSTR1/3B/9

Unfructified supplies

Taxpayers may have situations where
supplies are rejected
by the recipient at the doorstep. Though the law provides for cancellation of
invoice, once
the invoice is uploaded on the GSTR1 the portal does not have any feature to
mark a particular invoice as cancelled, forcing the taxpayer to raise credit
notes which is itself not permissible under law

GSTR2A & 2B module

Table
Ref.

Functionality

Comments

GSTR2B

ITC not available summary

The form provides an ‘advisory’ that
invoices which do not meet the conditions of section 16(4), or the place of
supply is different from the location of the recipient, should not be
eligible for credit. The criterion of place of supply does not seem to emerge
from any specific provision

GSTR2A / 2B time limit

Delayed reporting of invoice by
counter-party

GSTR2A/ 2B mark credit which is belatedly
reported as ineligible even though the supplier would have reported taxes
appropriately and complied with section 16 in its entirety, e.g., alteration
of an invoice from B2C table to B2B table involving updation of GSTINs

GSTR2A / 2B

DTA clearance by SEZ

Bill of entry filed by DTA on procurement
of goods by an SEZ does not appear in the GSTR2B. This throws up red flags
while filing GSTR3B as this data is not auto-populated in the said form

__________________________________________________________
2 The tables are illustrative and not exhaustive – over the period GSTN has gradually addressed many such challenges

Adjudication modules

Table
Ref.

Functionality

Comments

GST APL-01

Disputed tax

Taxes which are reported through DRC 03
challan are reported as ‘admitted tax’ even though the tax payments are made
under protest to avoid the interest / penal consequences. While filing the
appeal, the online module directs an additional 10% to be paid as pre-deposit
towards disputed liability. Effectively, the taxpayers are required to pay
110% of the tax demanded for filing the appeal online

Job work module

Table
Ref.

Functionality

Comments

ITC-04

Unit of measurement (UOM)

The form raised red flags where the UOM of
outward movement towards job work is different from inward movement from job
worker. The form does not appreciate that job work activity can result in
complete transformation of inputs resulting in difference in UOMs. The portal
attempts to map the outward dispatches with inward receipts at the same UOM

Refund modules

Table
Ref.

Functionality

Comments

RFD-01

Sequential filing

RFD-01 are mandatorily required to be filed
sequentially forcing the taxpayer to file Nil refund applications even though
he / she may want to come back and file a refund for past period (of course
within the time limit)

RFD-01

Export turnover

Incorrect reporting of export turnover in
other tables (such as B2B, etc.) of GSTR3B / GSTR1 is not reflected in the
refund form resulting in incorrect application of refund formula

RFD-01

Lower of three figures

RFD-01 restricts refunds to the lower of
(a) input tax credit at the end of the tax period; (b) refund as on date of
application; and (c) input tax credit as per formula. The refund module is
not reflective of the law as it restricts refund of ITC based on the balance
as at the end of the tax period. Taxpayers who have accumulated ITC after the
relevant tax period would still be restricted to the ITC as at the end of the
tax period

RFD-01

Input tax credit

Taxpayers may have reversed ITC pertaining
to past periods while filing GSTR3B. Though prior period reversals are not
relevant for refund computations, the online form auto-populates the net
figure from GSTR3B, causing a deviation from the statutory formula

E-way bill modules

Table
Ref.

Functionality

Comments

EWB-01

Validity of E-way bill

The E-way bill portal calculates the
validity automatically based on the PIN codes specified by the taxpayer. It
is quite possible that transporters adopt a route of their choice depending
on accessibility, convenience, etc. To freeze the validity based on pin codes
from external third party data is not specified under law

EWB-01

Back-end validation of vehicle numbers

E-way bill portal performs a back-end
validation of the vehicle numbers with the government-approved ‘vaahan’
website. Inefficiencies in those websites also creep into the GST system as
the E-way bill portal raises red flags for a vehicle number not visible in
the ‘vaahan’ website

JUDICIAL PRECEDENCE UNDER GST

The prominence of law over forms and procedures has been the hallmark of even recent decisions under GST. The Delhi High Court in Bharti Airtel Limited vs. UOI [2020 (5) TMI 169] examined the plea of the taxpayer who was restricted from rectifying the returns for a particular tax period and was directed by a CBEC Circular to rectify only in subsequent tax periods. The Court examined the limitations of the GSTN portal and held that the taxpayer had a right to rectify the very same return and claim refund of the excess taxes paid for the tax period under consideration. The Madras High Court in Sun Dyechem vs. CST 2020 TIOL-1858-HC-MAD-GST held that incorrect reporting of tax type by the supplier cannot be left unamended as it would hamper the tax credits at the customer’s end. The Court directed the jurisdictional officer to make amendments in supplier’s GSTR1 so that the correct tax type is reflected in the customer portal, thus undermining the influence of the portal over equity and law.

In another case, the Delhi High Court in Brand Equity Treaties Limited vs. UOI [2020 (5) TMI 171] recognised that technical glitches should be granted a wider scope to include even challenges faced at the taxpayer’s end (such as lack of internet connectivity, IT infrastructure, etc.). In the context of Transition Credit, Courts in many instances (such as Tara Exports [2020 (7) TMI 443]) have permitted manual filing of Tran-1 forms to avail the tax credit as an alternative to filing the same on the online portal. These decisions affirm the settled proposition that procedural laws are meant to further the substantive rights acquired under law.

However, one must also not lose sight of the decision of NELCO vs. UOI [2020 (3) TMI 1087] wherein the Bombay High Court upheld the vires of the rule defining technical glitches as being those arising at the GSTN end and cannot be interpreted to cover those difficulties prevailing at the taxpayer’s end. The Madhya Pradesh High Court in Shri Shyam Baba Edible Oils vs. CC 2020-VIL-567-MP held that the procedure prescribed in law should be strictly followed. Where the law prescribes SCNs, orders, etc., which are to be communicated through the common portal, they should necessarily be communicated only through the common portal. These decisions uphold the importance of the common portal and imply that taxpayers should take necessary steps to equip themselves with the technological upgradations warranted under the new law.

Let us now take up the question whether the GSTN portal can be described as a portal to report the numbers of the taxpayer or can be it designed to administer the law by placing checks and balances at the data entry point itself, thereby curbing the right of the taxpayer to self-assess its taxes. Going by the propositions laid down above, the portal cannot place fetters on the taxpayer’s right to fill up data as per its computation and should not be driven by pre-filled data points contained in the GST portal. Moreover, even where the data is auto-populated, the taxpayers should be granted the right to alter the auto-population and place their self-assessed values. The tax administration can without doubt examine the data at the back-end and seek clarifications to the alteration of the data plugged into the form, but that should be performed through a due process of adjudication or assessment. A website-driven automated assessment is not warranted under the GST law. Therefore, the GSTN portal should refrain from being a legislative or administrative tool and rather restrict itself to being a repository of information of all taxpayers.

A second question is to examine whether the enabling Notifications under the CGST / SGST Act of identifying the GSTN portal as a common portal would apply to the IGST Act as well. Whether separate Notifications are required to be issued under the IGST Act empowering the GSTN portal to operate as a common portal for all purposes of the IGST Act? Going by the implication of the phrase mutatis mutandis3 in section 20 of the IGST Act which links it to the CGST Act, the rules, notifications, including the prescription of the common portal, would apply equally to the IGST Act as well. The entire chapter of ‘Miscellaneous provisions’ under the CGST Act has been made applicable to the IGST Act and consequently the common portal notified in terms of section 146 of the CGST Act falling under this chapter would be operative for the IGST Act as well.

A third question, on the vires of the restrictions / controls placed in the GSTN portal, has been discussed above. The forms are aimed at capturing the self-assessed data of the taxpayers and not to regulate the taxpayer itself. The restrictions are questionable and even where the common portal is the primary forum for making necessary applications, the Court has devised an alternative approach of manual filing of the applications. The taxpayer ought to have a fit case for seeking this alternative remedy of filing manual applications. The taxpayers could face hurdles subsequently in enabling the functionalities of refund, reflection in electronic credit ledgers, etc., and hence should use this as a measure of last resort only.

_________________________________________________
3 (1983) 2 SCC 82 Ashok Service Centre vs. State of Orissa
Coming to a fourth, crucial question, proper officers have been the ‘go-to persons’ for taxpayers in case of technical difficulties. But the situation here is such that proper officers are neither equipped with legal nor technological powers and therefore claim helplessness. Taxpayers run from pillar to post between the GSTN helpdesk and the proper officer. In many cases the helpdesk directs taxpayers to reach out to the proper officer for technical snags. Without any specific direction from the Board, taxpayers are unable to enforce their right to receive a resolution to their technical problems from the proper officer. In certain cases, helpdesks also provide solutions without legal backing (for example, in one case a helpdesk directed the taxpayer to apply for cancellation and seek fresh registration due to a technical snag). The helpdesks are not proper officers under law and have no authority to decide on legal matters and it is imperative for the administration to issue binding guidelines to the field formations to accept the technical queries, seek speedy resolution at the back-end from the helpdesk and respond to the taxpayer with a solution. Until then, the taxpayers would be left on their own to comply with the law and then offer extensive explanations at the time of audits / assessments on what had transpired at the time of filing the applications on the portal and the reason for plugging the numbers as it stood therein.

In conclusion, the helpdesk does not have any legal authority to resolve taxpayer grievances and the proper officers should be directed through appropriate administrative instructions to take up these matters.

The authority to design, operate and regulate the IT infrastructure is open to questioning as the Legislature has not empowered the Government(s) or their Boards to direct the creation or regulation of the website. The involvement of GSTN as a separate entity appears to be on a questionable foundation and open to examination. Until then, taxpayers should make earnest efforts to reconcile themselves to the portal requirements and record the deviations from the data expectations suitably to enforce their legal rights of a self-assessment rather than a portal-assessment at higher forums.

IMPLEMENTATION OF Ind AS 116 ‘LEASES’ USING FULL RETROSPECTIVE APPROACH

Compiler’s Note
The Ministry of Company Affairs, on 30th March, 2019, notified Ind AS 116 ‘Leases’. Under Ind AS 116 lessees have to recognise a lease liability reflecting future lease payments and a ‘right-of-use asset’ for all material lease contracts. Almost all companies that adopted Ind AS 116 applied the standard using the modified retrospective approach, with the cumulative effect of initially applying the standard, recognised on the date of initial application. Accordingly, there was no restatement of comparative information; instead, the cumulative effect of initially applying this standard was recognised as an adjustment to the opening balance of retained earnings on the date of initial application (refer to this column in the BCAJ of July, 2020 for illustrative disclosures on the modified retrospective approach).

Given below is an illustration of a company that has adopted the full retrospective approach by restating of previous years’ figures to make them comparable.

NESTLE INDIA LTD. (31ST DECEMBER, 2020)

From Notes forming part of Financial Statements
Leases
Effective 1st January, 2020, the Company has applied Ind AS 116 ‘Leases’ using full retrospective approach recognising the cumulative effect of adopting Ind AS 116 as an adjustment to the retained earnings as on the transition date, i.e., 1st January, 2019. Accordingly, previous year figures have been restated to make them comparable. Ind AS 116 has replaced the existing leases standard, Ind AS 17 ‘Leases’.

The Company assesses whether a contract is or contains a lease at inception of a contract. A contract is or contains a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

At the date of commencement of the lease, the Company recognises a right-of-use asset (‘ROU’) and a corresponding lease liability for all lease arrangements in which it is a lessee.

The right-of-use assets are initially recognised at cost, which comprises the initial amount of the lease liability adjusted for any lease payments made at or prior to the commencement date of the lease plus any initial direct costs less any lease incentives. They are subsequently measured at cost less accumulated depreciation and impairment losses, if any. Right-of-use assets are depreciated from the commencement date on a straight-line basis over the shorter of the lease term or useful life of the underlying asset.

The lease liability is initially measured at the present value of the future lease payments. The lease payments are discounted using the interest rate implicit in the lease or, if not readily determinable, using the incremental borrowing rates. The lease liability is subsequently remeasured by increasing the carrying amount to reflect interest on the lease liability, reducing the carrying amount to reflect the lease payments made. A lease liability is remeasured upon the occurrence of certain events such as a change in the lease term or a change in an index or rate used to determine lease payments with a corresponding adjustment to the carrying value of right-of-use assets.

Lease liability and right-of-use assets have been separately presented in the Balance Sheet and lease payments have been classified as financing cash flows.

The Company’s leases mainly comprise of land, buildings and vehicles. The Company leases land and buildings primarily for offices, manufacturing facilities and warehouses.

The Company recognises lease payments as operating expense on a straight-line basis over the period of lease for certain short-term (one month or below) or low value arrangements.

From Notes forming part of Financial Statements
First time adoption, Ind AS 116 ‘Leases’
(i) The Company has adopted Ind AS 116 ‘Leases’ effective 1st January, 2020 using the full retrospective method with a transition date of 1st January, 2019. The impact of the Ind AS 116 adoption on the Balance Sheet as at 31st December, 2019 and 1st January, 2019 is as under:

As at 1st January, 2019
(Rs. in million)

Particulars

Pre-implementation
of Ind AS 116

Implementation
adjustments

Post-implementation
of Ind AS 116

Property, Plant & Equipment

24,006.2

(1,192.1)

22,814.1

Right of use assets

2,429.4

2,429.4

Others

56,874.6

56,874.6

Total assets

80,880.8

1,237.3

82,118.1

Other equity

35,773.2

(122.8)

35,650.4

Others

964.2

964.2

Total equity

36,737.4

(122.8)

36,614.6

Non-current lease liabilities

960.4

960.4

Current lease liabilities

440.9

440.9

Deferred tax liabilities (net)

588.2

(41.2)

547.0

Trade payables

12,403.7

12,403.7

Others

31,151.5

31,151.5

Total equity and liabilities

80,880.8

1,237.3

82,118.1

As of 1st December, 2019
(Rs. in million)

Particulars

Pre-implementation
of Ind AS 116

Implementation
adjustments

Post-implementation
of Ind AS 116

Property, Plant and Equipment

22,267.1

(1,179.0)

21,088.1

Right of use assets

2,326.4

2,326.4

Others

48,314.9

48,314.9

Total assets

70,582.0

1,147.4

71,729.4

Other equity

18,358.4

(133.9)

18,224.5

Others

964.2

964.2

Total equity

19,322.6

(133.9)

19,188.7

Non-current lease liabilities

896.0

896.0

Current lease liabilities

462.0

462.0

Deferred tax liabilities

179.5

(45.1)

134.4

Trade payables

14,946.9

(31.6)

14,915.3

Others

36,133.0

36,133.0

Total equity and liabilities

70,582.0

1,147.4

71,729.4

(i) The cumulative impact of application of the standard net of deferred taxes has been adjusted through opening equity (1st January, 2019) and previous year’s equity has been restated. Reconciliation of equity as previously reported versus the restated equity is as under:

Particulars

As
at 31st December, 2019

As
at 1st January, 2019

Equity reported in accordance with Ind AS 17

19,322.6

36,737.4

a) Recognition of ROU assets

1,147.4

1,237.3

b) Recognition of short-term and long-term lease liabilities

(1,326.4)

(1,401.3)

c) Deferred tax impact

45.1

41.2

Restated equity in accordance with Ind AS 116

19,188.7

36,614.6

(ii) Reconciliation of profit reported for 2019 to restated profit after adoption of Ind AS 116 ‘Leases’ is as under:

Particulars

Pre-implementation
of
Ind AS 116

Implementation
adjustments

Post-implementation
of Ind AS 116

Revenue of operations

123,689.0

123,689.0

Total income

126,157.8

126,157.8

Finance costs (including interest cost on
employee benefit plans)

1,198.3

92.9

1,291.2

Depreciation and amortisation

3,163.6

537.9

3,701.5

Employee benefit expenses

12,629.5

(47.8)

12,581.7

Other expenses

29,545.4

(568.0)

28,977.4

Others

52,871.1

52,871.1

Total expenses

99,407.9

15.0

99,422.9

Profit before tax

26,749.9

(15.0)

26,734.9

Tax expenses

7,054.4

(3.9)

7,050.5

Profit after tax

19,695.5

(11.1)

19,684.4

Other comprehensive income

(1,547.7)

(1,547.7)

Total comprehensive income

18,147.8

(11.1)

18,136.7

Profit from operations

25,862.5

77.9

25,940.4

(iii) Effect on the statement of cash flows for the year ended 31st December, 2019 is as under:

Particulars

Pre-implementation
of Ind AS 116

Implementation
adjustments

Post-implementation
of Ind AS 116

Profit before tax

26,749.9

(15.0)

26,734.9

Depreciation & amortisation

3,163.6

537.9

3,701.5

Interest on lease liabilities

92.9

92.9

Others

(7,576.8)

(7,576.8)

Net cash generated from operating activities

22,336.7

615.8

22,952.5

Net cash generated from investing activities

829.9

829.9

Interest on lease liabilities

(92.9)

(92.9)

Principal payment on lease liabilities

(522.9)

(522.9)

Others

(35,399.5)

(35,399.5)

Net cash used in financing activities

(35,399.5)

(615.8)

(36,015.3)

Net decrease in cash and cash equivalents

12,232.9

12,232.9

Total cash and cash equivalents at the
beginning of the year

35,239.0

35,239.0

Total cash and cash equivalents at the end of
the year

23,006.1

23,006.1

(iv) Impact of restatement on earnings per share (EPS) for the year ended 31st December, 2019 is not significant.

ACCOUNTING OF COMPLEX CONVERTIBLE BONDS WITH A CALL OPTION

A convertible bond instrument may have additional derivatives, such as a call or a put option. The accounting of such instruments can get very complex with regard to determining the values of and thereafter accounting for the host instrument, the equity element and the call option. The example in this article explains the concept in a very simplified manner.

EXAMPLE – MULTIPLE DERIVATIVES

Facts

• A Ltd. has issued Optionally Convertible Debentures (OCD) amounting to INR 300 crores to B Ltd. on the following terms:

  •  Tenure: 4 years
  •  Coupon: Nil
  • IRR: 15% p.a.

    
• During the tenure of the OCDs, A Ltd. can call the OCD and redeem it with the stated IRR.
• The market rate for similar debt without conversion feature is 17% p.a.
• B Ltd. can also ask for conversion at any time before maturity based on the following formula:

  •  No. of equity shares = (Investment amount + applicable IRR) divided by (Face value of equity share; i.e.,

INR 10)
• If redemption or conversion doesn’t happen before maturity, then the OCDs will be redeemed mandatorily at maturity.

How is this instrument accounted for in the books of A Ltd. in the following two scenarios?
Scenario A – If B Ltd. opts for conversion before maturity at end of year 1.
Scenario B – B doesn’t opt for conversion and OCDs are redeemed at maturity.

Response

Let us first consider the relevant provisions under the Standards before we attempt to solve the problem.

Ind AS 32 Financial Instruments: Presentation

19. If an entity does not have an unconditional right to avoid delivering cash or another financial asset to settle a contractual obligation, the obligation meets the definition of a financial liability, except …………….

29. An entity recognises separately the components of a financial instrument that (a) creates a financial liability of the entity and (b) grants an option to the holder of the instrument to convert it into an equity instrument of the entity. For example, a bond or similar instrument convertible by the holder into a fixed number of ordinary shares of the entity is a compound financial instrument. From the perspective of the entity, such an instrument comprises two components: a financial liability (a contractual arrangement to deliver cash or another financial asset) and an equity instrument (a call option granting the holder the right, for a specified period of time, to convert it into a fixed number of ordinary shares of the entity). The economic effect of issuing such an instrument is substantially the same as issuing simultaneously a debt instrument with an early settlement provision and warrants to purchase ordinary shares, or issuing a debt instrument with detachable share purchase warrants. Accordingly, in all cases, the entity presents the liability and equity components separately in its balance sheet.

32. Under the approach described in paragraph 31, the issuer of a bond convertible into ordinary shares first determines the carrying amount of the liability component by measuring the fair value of a similar liability (including any embedded non-equity derivative features) that does not have an associated equity component. The carrying amount of the equity instrument represented by the option to convert the instrument into ordinary shares is then determined by deducting the fair value of the financial liability from the fair value of the compound financial instrument as a whole.

Ind AS 109 Financial Instruments

B 4.3.5 (e) A call, put, or prepayment option embedded in a host debt contract or host insurance contract is not closely related to the host contract unless:

i. the option’s exercise price is approximately equal on each exercise date to the amortised cost of the host debt instrument or the carrying amount of the host insurance contract; or

ii. ………..

The assessment of whether the call or put option is closely related to the host debt contract is made before separating the equity element of a convertible debt instrument in accordance with Ind AS 32.

DAY 1 ACCOUNTING

Compound financial instrument (see paragraphs 19, 29 and 32 of Ind AS 32)
• The OCD issued by A Ltd. is a compound financial instrument. The host instrument will be classified as liability, since there is contractual obligation to pay cash toward interest (i.e., guaranteed IRR of 15% p.a.) and principal repayment that issuer A Ltd. cannot avoid. The equity conversion option is accounted as equity.
• The equity conversion option can’t be considered as closely related to the host instrument, because an equity conversion option is not a normal feature of a typical debt instrument, so it needs to be separated. The usual treatment for an instrument with these terms is to conclude that the ‘fixed for fixed’ criterion is met. This is because the number of shares is predetermined at the outset and the only variable is the passage of time. Accordingly, conversion option is classified as equity on Day 1.
• During the life of the host bond, expectations about early conversion should not be taken into account when estimating the cash flows used to apply the effective interest rate. The early conversion option is a characteristic of the equity component (the conversion option) and not of the host liability. The estimated cash flows used to apply the effective interest rate method are, therefore, the contractual cash flows based on the contractual final maturity of the host liability. The Effective Interest Rate (EIR) is 17% p.a.

Early call option to redeem OCD [see paragraph B4.3.5(e) of Ind AS 109]
• The call option’s exercise price is set at par value of OCD plus stated IRR till the date of exercise of call option. Therefore, at each exercise date the option’s exercise price is likely to be approximately equal to the amortised carrying amount of the OCDs plus the equity conversion option. Therefore, the call option is closely related to the host debt instrument. As a result, the call option is not separately accounted for but it remains part of the liability component. The assessment of whether the call option is closely related to the host debt contract is made before separating the equity element of a convertible debt instrument in accordance with Ind AS 32.

Date

Particulars

Amount
(rounded off in crores)

Day 1

Bank

300

 

 

To Equity (balancing figure representing residual interest)

 

20

 

To Debenture (future cash flows discounted at 17%)

 

280

 

(Initial recognition of the financial instrument
in the nature of a compound instrument comprising of elements of debt and
equity)

 

 

     
Subsequent accounting

Date

Particulars

Amount
(rounded off in crores)

End of Year 1

Interest on Debentures

48

 

 

To Debenture (classified under ‘Liability component of compound financial
instrument’)

 

48

 

(Interest recognised in P&L at EIR of 17%;
i.e. 280*17%)

 

 

Scenario A – If B Ltd. opts for conversion at end of Year 1
If B Ltd. opts for conversion before maturity – Since conversion was allowed under the original terms of instrument, the entity should determine the amortised cost of liability component using the original EIR till the conversion date. It will derecognise the liability component and recognise it as equity. There is no gain or loss on early conversion.    

Date

Particulars

Amount
(rounded off in crores)

End of Year 1

Debenture [280+48]

328

 

 

To Equity share capital

 

328

 

(Conversion of OCD into equity shares of the
company)

 

 

Scenario B – If B doesn’t opt for conversion and OCDs are redeemed at maturity

Date

Particulars

Amount
(rounded off in crores)

Year 1-4

Interest on debentures (cumulative interest for 4 years)

245

 

 

To Debenture

 

245

 

(Interest recognised in P&L at EIR of 17%)

 

 

 

 

 

 

End of Year 4

Debenture [280+245]

525

 

 

To Bank

 

525

 

(Being debentures redeemed)

 

 

KEY TAKEAWAYS:

  •  In the case of a compound financial instrument, the instrument has to be separated for the liability and equity component;
  • The instrument may have additional derivatives, such as a put or a call option. The accounting of such derivatives will depend upon whether those are closely related to the liability component. If the option is closely related to the liability component it is not separated from the liability component. On the other hand, if the option is not closely related to the liability component, it is separately accounted for and marked to market at each reporting date, till such time as it is finally settled;
  • On settlement of the compound financial instrument, the equity element (INR 20) recognised initially, may be transferred to retained earnings.

 

ISSUES IN TAXATION OF DIVIDEND INCOME, Part – 2

In the first of this two-part article published in April, 2021, we had analysed the various facets of the taxation of dividends from a domestic tax perspective as well as the construct of the dividend Article in the DTAAs. In this second part, we analyse some specific international tax issues related to dividends, such as applicability of DTAA to the erstwhile dividend distribution tax (‘DDT’) regime, application of the Most Favoured Nation clause in a few DTAAs, some issues relating to beneficial ownership, application of the Multilateral Instrument to dividends and some issues relating to underlying tax credit.

1. APPLICATION OF DTAA TO THE ERSTWHILE DDT REGIME
From A.Y. 2004-05 to A.Y. 2020-21, India followed the DDT system of taxation of dividends. Under that regime, the company declaring the dividends was liable to pay DDT on the dividends declared. One of the issues in the DDT regime was whether the DTAAs would restrict the application of the DDT. While this issue may no longer be relevant for future payments of dividends, with the Finance Act, 2020 reintroducing the classical system of taxation of dividends, this may be relevant for dividends paid in the past.

This controversy has gained significance because of a recent decision of the Delhi ITAT in the case of Giesecke & Devrient (India) (P) Ltd. vs. Add. CIT [2020] (120 taxmann.com 338). However, before considering the above decision, it would be important to analyse two decisions of the Supreme Court which, while not specifically on the issue, would provide some guidance in analysing the issue at hand.

The first Supreme Court decision is that of Godrej & Boyce Manufacturing Company Limited vs. DCIT (2017) (394 ITR 449) wherein the question before the Court was whether section 14A applied in the case of dividend income (under the erstwhile DDT regime). The issue to be addressed was whether dividend income was income which does not form part of the total income under the Act. In the said case, the assessee argued that DDT was tax on the dividends and, therefore, dividends being subject to tax in the form of DDT, could not be considered as an income which does not form part of the total income of the shareholder. The Supreme Court did not accept this argument and held that the provisions of section 115-O are clear in that the tax on dividends is payable by the company and not by the shareholders and by virtue of section 10(34) the dividend income received by the shareholder is not taxable. Therefore, the Apex Court held that the provisions of section 14A would apply even for dividend income in the hands of the shareholders.

Interestingly, in the case of Union of India & Ors. vs. Tata Tea Co. Ltd. & Anr. (2017) (398 ITR 260), the Supreme Court was asked to adjudicate on the constitutional validity of DDT paid by tea companies as the Constitution of India prohibits taxation of profits on agricultural income. In this case the Court held that DDT is not a tax on the profits of the company but on the dividends and therefore upheld the constitutional validity of DDT.

Now the question arises, how does one read both the above decisions of the Supreme Court, delivered in different contexts, to give effect to both the orders in respect of DDT. One of the interpretations of the application of DDT, keeping in mind the above decisions of the Supreme Court, is that while DDT is not a tax on the shareholders but the company distributing dividends, it is a tax on the dividends and not on the profits of the company distributing dividends.

One would need to evaluate whether the above principle emanating from both the above judgments could be applied in the context of a DTAA. Article 10 of the UN Model Convention reads as under:

‘(1) Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.
(2) However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed:…..’ (emphasis supplied).

Therefore, the UN Model Convention as well as the DTAAs which India has entered into provide for taxation of the stream of income and do not refer to the person in whose hands such income is to be taxed. Accordingly, one may be able to take a view that a DTAA restricts the right of taxation of the country of source on dividend income and this restriction would apply irrespective of the person liable for payment of tax on the said dividend income. In other words, one may be able to argue that DTAA would restrict the application of DDT to the rates specified in the DTAA.

Interestingly, the Protocol to the India-Hungary DTAA provides as under,

‘When the company paying the dividends is a resident of India the tax on distributed profits shall be deemed to be taxed in the hands of the shareholders and it shall not exceed 10 per cent of the gross amount of dividend.’

In other words, the Protocol deems the DDT to be a tax on the shareholders and therefore restricted the DDT to 10%.

Further, as Hungary is an OECD member and the DTAA between India and Hungary was signed in 2003, one could also have applied the Most Favoured Nation clause in the Protocols in India’s DTAAs with Netherlands, France and Sweden to apply the above restriction on shareholders resident in those countries.

The Delhi ITAT in the case of Giesecke & Devrient (India) Pvt. Ltd. (Supra) also held that the DDT would be restricted to the tax rates as prescribed under the relevant DTAA. The argument that the Delhi ITAT has considered while applying the tax treaty rate for dividends is that the introduction of the DDT was a form of overriding the treaty provisions, which is not in accordance with the Vienna Convention of the Law of Treaties, 1969 and hence the DTAA rate should override the DDT rate.

Now, the question is whether one can claim a refund of the DDT paid in excess of the DTAA rate applying the above judicial precedents and, if so, which entity should claim the refund – the company which has paid the dividends or the shareholder? In respect of the second part of the question, the Supreme Court in the case of Godrej & Boyce (Supra) is clear that DDT is a tax on the company declaring the dividends and not on the shareholders. Therefore, the claim of refund, if any, for DDT paid in excess of the DTAA rates should be made by the company which has paid the dividends and not by the shareholders.

In order to evaluate whether one can claim refund of the excess DDT paid, it is important to analyse two scenarios – where the case of the taxpayer company is before the A.O. or an appellate authority, and where there is no outstanding scrutiny or appeal pending for the taxpayer company.

In the first scenario, where the taxpayer is undergoing assessment proceedings or is in appeal before an appellate authority, such a refund may be claimed by making such a claim before the A.O. or the relevant appellate authority. While the A.O. may apply the principle of the Supreme Court in the case of Goetze (India) Ltd. vs. CIT (2006) (284 ITR 323), the appellate authorities are empowered to consider such a claim even if not claimed in the return of income following various judicial precedents, including the Bombay High Court in the case of CIT vs. Pruthvi Brokers & Shareholders (P) Ltd. (2012) (349 ITR 336).

In the second scenario, the options are limited. One may evaluate whether following certain judicial precedents this could be considered as a mistake apparent from record requiring rectification u/s 154 or whether one can obtain an order from the CBDT u/s 119.

In the view of the authors, if the taxpayer falls in the category as mentioned in the first scenario, one should definitely consider filing a claim before the A.O. or the appellate authority as even if such claim is rejected or subsequently the Supreme Court rules against the taxpayer on this issue, given that the DDT has already been paid by the taxpayer company, there may not be any penal consequences.

2. ISSUE IN APPLICATION OF MFN CLAUSE IN SOME TREATIES

Another recent issue is the application of the MFN clause to lower the rate of taxation of dividends. While application of the MFN clause is not a new concept, this issue has been exacerbated with the reintroduction of the classical system of taxation.
Article 10(2) of the India-Netherlands DTAA provides for a 10% tax in the country of source. Paragraph IV(2) of the Protocol to the India-Netherlands DTAA provides as follows,

‘If after the signature of this Convention under any Convention or Agreement between India and a third State which is a member of the OECD, India should limit its taxation at source on dividends, interests, royalties, fees for technical services or payments for the use of equipment to a rate lower or a scope more restricted than the rate or scope provided for in this Convention on the said items of income, then as from the date on which the relevant Indian Convention or Agreement enters into force the same rate or scope as provided for in that Convention or Agreement on the said items of income shall also apply under this Convention’ (emphasis supplied).

The India-Netherlands DTAA was signed on 13th July, 1988. Pursuant to this, India entered into a DTAA with Slovenia on 13th January, 2003. Article 10(2) of the India-Slovenia DTAA provides for a lower rate of tax at 5% in case the beneficial owner is a company which holds at least 10% of the capital of the company paying the dividends.

While the DTAA between India and Slovenia was signed in 2003, Slovenia became a member of the OECD only in 2010. In other words, while the Slovenia DTAA was signed after the India-Netherlands DTAA, Slovenia became a member of the OECD after the DTAA was signed.

Therefore, the question arises whether one can apply the MFN clause in the Protocol of the India-Netherlands DTAA to restrict India from taxing dividends at a rate not exceeding 5%.

In this context, the Delhi High Court in a recent decision, Concentrix Services Netherlands BV vs. ITO (TDS) (2021) [TS-286-HC-2021(Del)] has held that one could apply the rates as provided under the India-Slovenia DTAA by applying the MFN clause in the India-Netherlands DTAA. In this case, the assessee sought to obtain a lower deduction certificate from the tax authorities u/s 197 by applying the rates under the India-Slovenia DTAA. However, the tax authorities issued the lower deduction certificate with 10% as the tax rate. Following the writ petition filed by the taxpayer, the Delhi High Court upheld the view of the taxpayer. The Delhi High Court relied on the word ‘is’ in the India-Netherlands DTAA in the term ‘….which is a
member of the OECD…’ of the Protocol. The High Court held that the said word describes a state of affairs that should exist not necessarily at the time when the subject DTAA was executed but when the DTAA provisions are to be applied.

Interestingly, the High Court also referred to the contents of the decree issued by the Netherlands in this respect wherein the India-Slovenia DTAA was made applicable to the India-Netherlands DTAA on account of the Protocol. In this regard, the Court followed the principle of ‘common interpretation’ while applying the interpretation of the issue in the treaty partner’s jurisdiction to the interpretation of the issue in India.

Therefore, one may be able to apply the lower rates under the India-Slovenia DTAA (or even the India-Colombia DTAA or India-Lithuania DTAA which also provide for a 5% rate) to the India-Netherlands DTAA by virtue of the MFN clause in the latter.

Similarly, India’s DTAAs with Sweden and France also contain a similar MFN clause and both the DTAAs are also signed before the India-Slovenia DTAA. Therefore, one can apply a similar principle even in such DTAAs.

However, it is important to consider the practical aspects such as how should one disclose the same in Form 15CB or in the TDS return filed by the payer as the TDS Centralised Processing Centre may process the TDS returns with the actual DTAA rate without considering the Protocol.

3. SOME ISSUES RELATING TO BENEFICIAL OWNER

In the first part of this article, we analysed the meaning of the term ‘beneficial owner’ in the context of DTAAs. This article seeks to identify some other peculiar issues around beneficial owner in DTAAs.

Firstly, it is important to understand that the term ‘beneficial owner’ is used in relation to ownership of income and not of the asset. Therefore, in respect of dividends one would need to evaluate whether the recipient is the beneficial owner of the income. The fact that the recipient of the dividends is a subsidiary of another company may not have any influence on the interpretation of the term. If, however, the recipient is contractually obligated to pass on the dividends received to its holding company, it may not be considered as the beneficial owner of the income.

Article 10 relating to dividends in most of India’s DTAAs requires the recipient of the dividends to be a beneficial owner of the income. For example, Article 10(2) of the India-Singapore DTAA provides as follows,

‘However, such dividends may also be taxed in the Contracting State …… but if the recipient is the beneficial owner of the dividends, the tax so charged shall not exceed….’ (emphasis supplied).

On the other hand, some of India’s DTAAs require the beneficial owner to be a resident of the Contracting State as against the recipient being the beneficial owner. For example, Article 10(2) of the India-Belgium DTAA provides as follows,

‘However, such dividends may also be taxed in the Contracting State ….. but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed….’ (emphasis supplied).
 
Now, the question arises whether the difference in the above languages would have any impact. In order to understand the same, let us consider an example wherein I Co pays dividends to A Co which is a resident of State A and A Co is obligated to transfer the dividends received to its holding company HoldCo, which is also a resident of State A. In other words, the recipient of the income is A Co and the beneficial owner of the income is HoldCo, and both are tax residents of State A.

In case the DTAA between India and State A is similar to that of the India-Singapore DTAA, the benefit of the lower rate of tax under the DTAA may not be available as the lower rate applies only if the recipient is the beneficial owner of the dividends, and in this case the recipient, i.e., A Co, is not the beneficial owner of the dividends.

On the other hand, if the DTAA between India and State A is similar to that of the India-Belgium DTAA, the benefit of the lower rate of tax under the DTAA would be available as the beneficial owner of the dividends, i.e., HoldCo, is a resident of State A. Therefore, one should also carefully consider the language in a particular DTAA before applying the same.

Another peculiar issue in respect of beneficial owner is the consequences of the recipient not being considered as the beneficial owner. The issue is further explained by way of an example.

Let us consider a situation where I Co, a resident of India, pays dividend to A Co, a resident of State A, and A Co is obligated to transfer the dividends received to its holding company B Co, a resident of State B.

In this scenario, the benefit of the DTAA between India and State A would not be available as the beneficial owner is not a resident of State A. This would be the case irrespective of whether the language is similar to the India-Singapore DTAA or the India-Belgium DTAA. Now the question is whether one can apply the DTAA between India and State B as the beneficial owner, B Co, is a resident of State B. While B Co is the beneficial owner of the income, the dividend is not ‘paid’ to B Co. Therefore, the Article on dividend of the DTAA between India and State B would not apply. Moreover, in the Indian context, the entity in whose hands the income would be subject to tax would be A Co and therefore evaluating the application of the DTAA between India and State B, wherein A Co is not a resident of either, would not be possible. Accordingly, in the view of the authors, in this scenario the benefit of the lower rate of tax on dividends in both the DTAAs would not be available.

4. APPLICATION OF THE MULTILATERAL INSTRUMENT (‘MLI’)
Pursuant to the Base Erosion and Profit Shifting Project of the OECD, India is a signatory to the MLI. The MLI modifies the existing DTAAs entered into by India. Some of the Indian DTAAs are already modified, with the MLI being effective from 1st April, 2020. We have briefly evaluated the relevant articles of the MLI which may apply in the context of dividends.

(a) Principal Purpose Test (‘PPT’) – Article 7 of the MLI
Article 7 of the MLI provides that the benefit of a Covered Tax Agreement (‘CTA’), i.e., DTAA as modified by the MLI, would not be granted if it is reasonable to conclude that obtaining the benefit of the said DTAA was one of the principal purposes of any arrangement or transaction, unless it is established that granting the benefit is in accordance with the object and purpose of the relevant provisions of the said DTAA.

In respect of dividends, therefore, the benefit under a DTAA may be denied in case it is reasonable to conclude that the transaction or arrangement was structured in a particular manner with one of the principal purposes being to obtain a benefit of that DTAA.

For example, US Co, a company resident in the US, wishes to invest in I Co, an Indian company. However, as the tax rate on dividends in the India-US DTAA is 15%, it interposes an intermediate holding company in the Netherlands, NL Co, with an objective to apply the India-Netherlands DTAA to obtain a lower rate of tax on dividends (5% after applying the MFN clause and the India-Slovenia DTAA as discussed above). In such a scenario, the tax authorities in India may deny the benefit of the dividend article in the India-Netherlands DTAA as one of the principal purposes of investment through the Netherlands was to obtain the benefit of the DTAA.

The PPT is wider in application than the General Anti-Avoidance Rules (‘GAAR’). Further, as it is a subjective test, there are various issues and challenges in the interpretation and the application of the PPT.

(b) Dividend transfer transactions – Article 8 of the MLI

Article 10(2) of some of the DTAAs India has entered into provide two rates of taxes as the maximum amount taxable in the country of source, with a lower rate applicable in case a certain holding threshold is met. For example, Article 10(2) of the India-Singapore DTAA provides for the following rates of tax as a threshold beyond which the country of source cannot tax:
(i) 10% of the gross amount of dividends in case the beneficial owner is a company which owns at least 25% of the shares of the company paying dividends; and
(ii) 15% in all other cases.

Such DTAAs provide a participation exemption by providing a lower rate of tax in case a certain holding threshold is met.

Article 8 of the MLI provides that the participation exemption which provides for a lower rate of tax in case a holding threshold is met would not apply unless the required number of shares for the threshold are held for at least 365 days, including the date of payment.

Therefore, in case of an Indian company paying dividends to its Singapore shareholder which holds more than 25% of the shares of the Indian company, the tax rate of 10% would be available only in case the Singapore company has held the shares of the Indian company for a period of at least 365 days.

One of the issues in the interpretation of Article 8 of the MLI is that the Article does not specify the manner of computing the period of holding – whether the period of 365 days should be considered for the period immediately preceding the date of payment of dividends, or can one consider the period after the dividend has been paid as well. While one may be able to take a view that as the Article does not require the holding period to be met on the date of the payment of the dividend, the period of holding after the payment of dividend may also be considered. However, there may be practical challenges, especially while undertaking withholding tax compliances for payment of such dividend.

5. ISSUES RELATED TO TAX CREDIT ON DIVIDENDS RECEIVED
Having analysed various aspects in the taxation of dividends in the country of source, we have also analysed some specific issues arising in respect of dividends in the country of residence. India follows the credit system of relieving double taxation.

One of the issues in respect of tax credit is that of conflict of interpretation between both the Contracting States. Let us take an example; F Co, a resident of State A, pays dividend on compulsorily preference shares to I Co, an Indian company. Assume that under the domestic tax law of State A such a payment is considered as interest. Assume also that the tax rate for interest and dividends is 15% and 10%, respectively, under the DTAA between India and State A.

In this scenario, State A would withhold tax at the rate of 15%. Now the question is whether India would provide a credit of 15% or would the tax credit be restricted to 10% as India considers such payment as dividends? The Commentary on Article 23 of the OECD Model Convention provides that in the case of a conflict of interpretation, the country of residence should permit credit for the tax withheld in the country of source even if the country of residence would treat this income differently. The only exception to this rule provided by the Commentary is when the country of residence believes that the country of source has not applied the provisions of a DTAA correctly, would the country of residence deny such higher tax credit.

In the present case, one may be able to contend that the country of source, State A, has correctly applied the DTAA in accordance with its domestic tax law and therefore India would need to provide tax credit of 15% subject to other rules relating to foreign tax credit.

Another peculiar aspect in respect of tax credit for dividends received from a foreign jurisdiction is that of the underlying tax credit. Some of the DTAAs India has entered into provide for an underlying tax credit.

For example, Article 25(2) of the India-Singapore DTAA, dealing with tax credit, provides as under,

‘Where a resident of India derives income which, in accordance with the provisions of this Agreement, may be taxed in Singapore, India shall allow as a deduction from the tax on the income of that resident an amount equal to the Singapore tax paid, whether directly or by deduction. Where the income is a dividend paid by a company which is a resident of Singapore to a company which is a resident of India and which owns directly or indirectly not less than 25 per cent of the share capital of the company paying the dividend, the deduction shall take into account the Singapore tax paid in respect of the profits out of which the dividend is paid.’

Therefore, tax credit would include the corporate tax paid by the company which has declared the dividend. This is explained by way of an example. Let us consider that I Co, an Indian company, is a 50% shareholder in Sing Co, a tax resident of Singapore. Assuming that Sing Co has profits (before tax) of 100 which are distributed (after payment of taxes) as dividend to the shareholders, the tax credit calculation in the hands of I Co would be as follows:
 

 

Particulars

Amount

A

Profit of Sing Co

100

B

(-) Corporate tax of 17% in Singapore

(17)

C

Dividend payable (A-B)

83

D

Dividend paid to I Co (50% of C)

41.5

E

(-) Tax on dividends in Singapore

(0)

F

Net amount received by I Co (D-E)

41.5

G

Tax in India u/s 115BBD (15% of F)

6.2

H

(-) Tax credit for taxes paid in Singapore (=E)

0

I

(-) Underlying tax credit for taxes paid by Sing Co (50% of B)

(8.5)

J

Actual tax credit [(H + I ) subject to maximum to G]

(6.2)

K

Tax payable in India (G – J)

0

L

Net amount received in India (net of taxes) (F –
K)

41.5

6. CONCLUSION

Each DTAA may have certain peculiarities. For example, the India-Greece DTAA provides for an exclusive right of taxation of dividends to the country of source, and the country of residence is not permitted to tax the dividends. With the reintroduction of the classical system of taxation of dividends, therefore, it is important to understand and evaluate the DTAA in detail in cross-border payment of dividends.

It is also important to evaluate the tax credit article in respect of dividends received from foreign companies in order to examine whether one can apply underlying tax credit as well.

PREMIUM RECEIVED BY LANDLORD ON TRANSFER OF TENANCY RIGHTS – CAPITAL OR REVENUE?

ISSUE FOR DISCUSSION

A person acquiring the right to use an immovable property on a month-to-month basis without acquiring the ownership right is known as the tenant and the person continuing to be the owner of the property is known as the landlord. The monthly compensation paid for the use of the property is known as the rent. Various States in India have tenancy laws, whereby tenants are protected from eviction by the landlord from premises in which they are tenants. The rights so acquired by the person to use the property are known as tenancy rights. These rights may be acquired for a consideration known as salami or premium, though many States prohibit payment of such consideration.

On the other hand, many States permit the transfer of tenancy rights by the tenant for a consideration with the consent of the landlord, who may consent to the transfer on receipt of a payment or even without it. These tenancy rights are recognised by the tax laws as capital assets of the tenant and accordingly the gains if any on their transfer are taxed under the head capital gains. Section 55 provides that the cost of acquisition of the tenancy is to be taken as Nil unless paid for, in which case the cost would be the one that is paid for acquiring the tenancy. Tenancy rights when acquired for a fixed period under a written instrument are known as leasehold rights. Acquisition of a license to use the property, although similar to lease or tenancy, is not the same.

An interesting issue has arisen as to the manner of taxation of the receipt by the landlord for consenting to such transfer of tenancy – whether it is capital in nature and therefore not taxable or taxable as capital gains, or whether it is revenue in nature and taxable as income. There have been conflicting decisions of the Mumbai Bench of the Tribunal on this issue. The taxation of such receipt under the provisions of section 56(2)(x) is another aspect that requires consideration.

THE VINOD V. CHHAPIA CASE
The issue came up before the Mumbai Bench of the Tribunal in the case of Vinod V. Chhapia vs. ITO (2013) 31 taxmann.com 415.

In this case, the assessee was a HUF which owned an immovable property. Part of the property was let out to a tenant since 1962 and part of the property was occupied by the members of the HUF. The tenant expired in 1986 and the tenancy rights were inherited by her daughter.

A tripartite agreement was entered into between the daughter, new tenants and the landlord for surrender of tenancy by the daughter and grant of tenancy by the landlord in favour of the new tenants. The daughter surrendered her tenancy rights in favour of the landlord to facilitate renting of the property to the new tenants. The incoming tenants paid an amount of Rs. 14.74 lakhs to the daughter and an amount of Rs. 7.26 lakhs to the assessee-landlord simultaneously. The assessee accepted the surrender of tenancy rights and possession of the property and received the amount from the new tenants as consideration for granting the new tenants monthly tenancy of the flat.

The assessee invested the amount of Rs. 7.26 lakhs in bonds issued by NABARD, treated the amount received from the new tenants as capital gains and claimed exemption u/s 54EC.

During assessment proceedings, the assessee claimed that the amount was received towards surrender of a right, which was part of the bundle of rights owned by the assessee in respect of the property. The assessee claimed that the receipt of the consideration of Rs. 7.26 lakhs was for the extinguishment of the rights and therefore was capital gains eligible for exemption u/s 54EC. Various decisions were cited by the assessee in support of the proposition that the amount received on surrender of tenancy rights was a capital receipt, which was taxable under the head ‘capital gains’.

But the A.O. brought out the distinction between transfer of tenancy rights vis-à-vis surrender of tenancy rights. According to him, the receipt by the landlord was for consenting to a transfer of the right of residence by the existing tenant to the new tenants. He sought to support this view by the fact of payment of consideration by the new tenants to both the original tenant and the landlord. The A.O. distinguished the judgments cited before him, since all of those related to surrender of tenancy rights.

According to the A.O., the outgoing tenant (the daughter) surrendered (transferred) the tenancy rights in favour of the new tenants and not to the assessee-landlord. He held that the amount of Rs. 7.26 lakhs was received by him from the new tenants for consenting to the transfer of tenancy to the new tenants, and not for surrender of tenancy, and was therefore not a capital receipt. The A.O. therefore taxed the amount of Rs. 7.26 lakhs as income of the assessee under the head ‘income from other sources’, rejecting the claim of exemption u/s 54EC.

Before the Commissioner (Appeals), the assessee submitted that consent of the landlord was mandatory for the new tenants to enjoy the right of residence. Thus, by consenting, the assessee gave up (transferred) some of the rights out of the bundle of rights attached to the said property, a capital asset. Reliance was placed on the Supreme Court decision in the case of CIT vs. D.P. Sandu Bros. Chembur (P) Ltd. 273 ITR 1 and on the Bombay High Court decision in the case of Cadell Weaving Mill Co. (P) Limited vs. CIT 249 ITR 265, for the proposition that the amount received on surrender of tenancy rights is a capital receipt taxable under the head ‘capital gains’, and not ‘income from other sources’.

The Commissioner (Appeals) rejected the appeal, confirming the order of the A.O. and held that the assessee continued to hold the ownership rights even after the new tenants entered the house and that the outgoing tenant transferred the tenancy rights to the new tenants. The assessee merely gave its consent for such transfer, for which it received the sum of Rs. 7.26 lakhs which could not be termed as a receipt for surrender of tenancy rights. Had it amounted to a surrender of tenancy rights in favour of the landlord, the consideration would have been paid by the landlord to the outgoing tenant. Therefore, it was a case of encashment of the power of consent for transfer of the tenancy rights to the new tenants. The Commissioner (Appeals) next observed that if the new tenants further transferred the property to some other tenant, the assessee would be entitled to receive a similar amount and the ownership rights of the property would continue to vest with the assessee.

Before the Tribunal, on behalf of the assessee it was submitted that the rights attached to an immovable property constituted a bundle of rights. Exploitation of these rights gives rise to capital gains. Without the surrender of tenancy rights by the original tenant to the assessee, the assessee could not have consented to the transfer of residence in favour of the new tenant. Therefore the consideration received by the assessee was for surrender of tenancy rights, which was a capital receipt, taxable as capital gains.

Attention was drawn by the assessee to the tripartite agreement between the assessee, the original tenant and the new tenants, which mentioned that the original tenant was the sole owner of the tenancy rights and she surrendered the flat to the landlord including the tenancy rights.

On behalf of the Revenue it was argued that normally in the case of surrender of tenancy rights the tenant would receive the consideration from the landlord for surrender of the same. In the case before the Tribunal, the landlord did not pay the consideration to the original tenant, but it was the new tenants who paid the consideration to the original tenant. Further, the assessee continued to hold the right of ownership of the property and tenancy rights were transferred from the old tenant to the new tenants. It was therefore submitted that the amount was rightly taxed as ‘income from other sources.’

The Tribunal noted that all the decisions cited before it, whether by the assessee or by the Revenue, were in the context of undisputed surrender of tenancy rights and were therefore distinguishable on facts. Analysing the facts of the case, the Tribunal was of the view that the consideration paid by the new tenants was for consent of the landlord for the transfer of tenancy rights between the new and old tenants and the amount of Rs. 7.26 lakhs was the consideration for consent. According to the Tribunal, generally in matters of tenancy rights disputes it is the tenant who gets the financial benefit, which flows from the pockets of the landlord in lieu of surrender of the tenancy rights by the tenant, and the landlord does not receive any amount. Therefore, according to the Tribunal, the settled law relating to taxation of a receipt on surrender of tenancy rights would not apply in the case before it.

The Tribunal also examined whether the assessee actually received all the rights over the property, including the tenancy rights. It noted the clause in the agreement which indicated that the existing tenant surrendered the tenancy rights along with the property to the assessee. It questioned the need for the existing tenant to be a signatory to the agreement giving the property on monthly rent to the new tenants and the need for a tripartite agreement. According to the Tribunal, letting of the property to the new tenant was a matter of agreement between the landlord and the new tenant.

Noting that the monthly rental and rental advance were nominal, the Tribunal was of the view that the sum of Rs. 7.26 lakhs paid to the landlord by the new tenant was consideration for the consent. As per the Tribunal, the receipt was for the consent for transfer by the old tenant to the new tenants, for a consideration of Rs. 14.48 lakhs and there was a need for the consent of the landlord. The Tribunal accordingly held that there was no transfer of any capital asset by the landlord to the new tenants and that the sum of Rs. 7.26 lakhs was neither a capital receipt nor a rental receipt.

The Tribunal also noted that there was no time gap between the vacation of the property by the old tenant and grant of rental rights to the new tenants. There was continuity of renting of the property and there was no evidence to infer that the house was in the vacant possession of the assessee even after the alleged end of the tenancy of the old tenant. Therefore, the assessee never got the property in vacant condition. Hence the Tribunal held that the amount received was consideration for consent, it did not involve any transfer of capital rights attached to the property, and it constituted a windfall gain to the assessee, which was taxable under the head ‘income from other sources’.

NEW PIECE GOODS BAZAR CO. LTD. CASE

The issue again came up before the Mumbai Bench of the Tribunal in the case of Jt. CIT vs. New Piece Goods Bazar Co. Ltd., ITA No. 6983/Mum/2012 dated 25th May, 2016.

In this case, the assessee was the owner of several shops in the cloth market which were given on rent to different tenants. Every year, some tenants transferred the possession of shops to new tenants, with the consent of the assessee, who was the owner of the shops. In consideration of giving its consent to the transfer of possession of the shops from old tenants to the new tenants, the assessee was receiving a certain premium from the old tenants.

Earlier, the receipt of premium by the assessee was shown as income under the head ‘capital gains’. During the relevant year also, certain old tenants transferred their possessory rights of the rental shops to the new tenants with the consent of the assessee. In consideration of giving consent for such transfer of possessory rights, the assessee received a premium of Rs. 1,15,50,000 from the old tenants. The assessee treated such amount as income from ‘capital gains’ and claimed exemption from taxation of a part thereof u/s 54EC.

The A.O. held that the assessee was the owner of the shops, the old tenants had transferred the tenancy rights in favour of the new tenants along with rights of possession and the assessee remained the owner of the shops as before. Consequently, there was no transfer of the capital assets, being shops, as even after the transfer of tenancy rights the assessee continued to remain the owner of the shops. According to the A.O., while the transfer of tenancy rights indisputably resulted in capital gains, such capital gains would be taxable in the hands of the outgoing tenants and could not be taxed as the capital gains of the assessee. The A.O. therefore held that the amount received by the assessee as premium was taxable in the hands of the assessee as ‘income from other sources’ and not as ‘capital gains’, and that the assessee was therefore not entitled to exemption u/s 54EC.

In an appeal before the Commissioner (Appeals), the assessee submitted that in earlier and subsequent years also, a similar amount was offered to tax as capital gains and was accepted by the Income-tax Department. It was further argued that tenancy rights was undoubtedly a capital asset under the law and therefore any gains arising from the transfer of such rights had to be assessed under the head ‘capital gains’.

The Commissioner (Appeals) noted that a right was a bundle of benefits embedded in some asset or independent thereof. Capital asset meant property of any kind held by an assessee. Therefore, a right, whether or not attached to any asset, was also a property. The old tenant could transfer the possessory rights of the shops only with the consent of the landlord. According to the Commissioner (Appeals), such right of consent was a property in the hands of the assessee. Since that right or property was connected to the capital asset, i.e., shops, therefore such a right of consent was also a capital asset in the hands of the assessee which was more or less similar to a tenancy right, which was also a capital asset.

The Commissioner (Appeals) therefore held that on giving consent to change in the possession of rented premises from an old tenant to a new tenant, there was a transfer of capital asset. He, therefore, held that such receipt was liable to tax as capital gains and the assessee was entitled to exemption u/s 54EC.

On appeal by the Revenue, the Tribunal expressed its agreement with the observations of the Commissioner (Appeals) that the assessee acquired a bundle of rights (ownership) with respect to the shops. These rights included, inter alia, the right of grant of tenancy. The term ‘capital asset’ was defined in the widest possible manner in section 2(14) and had been curtailed only to the extent of exclusions given in the said section, including stock-in-trade and personal effects. The asset under consideration clearly did not fall within the above exclusions. The bundle of rights acquired by the assessee was undoubtedly valuable in terms of money.

On the above reasoning, the Tribunal held that the tenancy rights formed part of a capital asset in the hands of the assessee and therefore any gains arising therefrom would be assessable under the head ‘capital gains’, eligible for deduction u/s 54EC.

In Sujaysingh P. Bobade (HUF) vs. ITO (2016) 158 ITD 125 (Mum) a similar view was taken that the amount received by the landlord was a capital receipt, subject to tax as capital gains. However, in that case the appeal was against an order of revision passed u/s 263 and the landlord had received the amount from the new tenants for allotment of tenancy rights under tenancy agreements.

A similar view has also been taken by the Tribunal in the case of ITO vs. Dr. Vasant J. Rath Trust, ITA No. 844/Mum/2014 dated 29th February, 2016 wherein the old tenants had surrendered their tenancy rights to the landlord without receiving any consideration and the landlord directly entered into tenancy agreements with the six new tenants on receipt of consideration for grant of tenancy rights.

OBSERVATIONS

Any property, especially immovable property, comprises of a bundle of rights where each such right is a capital asset capable of being transferred by the owner for an independent consideration to different persons. Ownership of the land and / or building is the classic case of owning such a bundle of rights. The right to grant tenancy flows from such a bundle. The Supreme Court in the case of A.R. Krishnamurthy, 176 ITR 417, in the context of the ownership of a mine, held that the mining rights were a part of the mine and were capable of being held as an independent asset and therefore of being transferred independent of the ownership of the mine. It held that the grant of the lease to mine the asset or the mining rights resulted in the transfer of a capital asset, negating the case of the assessee that there was no transfer of capital asset on grant of the mining rights where the ownership of the mine continued with the assessee. The court also rejected the contention that there was no cost of acquisition of such rights or the cost could not be attributed to such rights.

Receipt of a salami or premium by a landlord from a tenant for grant of tenancy rights in an immovable property owned by him is a capital receipt and not a revenue receipt [Durga Das Khanna vs. CIT 72 ITR 796 followed by the Bombay and the Calcutta High Courts in CIT vs. Ratilal Tarachand Mehta 110 ITR 71 and CIT vs. Anderson Wright & Co. 200 ITR 596, respectively]. The Courts held that unless such a receipt is proved to be in the nature of rent or advance rent, it could not be taxed under the Act as revenue income.

The Supreme Court, in the case of CIT vs. Panbari Tea Co. Ltd. 57 ITR 422 held that a premium received on parting with the lessor’s interest was a capital receipt and the rent receipt was revenue in nature:

‘When the interest of the lessor is parted with for a price, the price paid is premium or salami. But the periodical payments made for the continuous enjoyment of the benefits under the lease are in the nature of rent. The former is a capital income and the latter a revenue receipt. There may be circumstances where the parties may camouflage the real nature of the transaction by using clever phraseology. In some cases, the so-called premium is in fact advance rent and in others rent is deferred price. It is not the form but the substance of the transaction that matters. The nomenclature used may not be decisive or conclusive but it helps the court, having regard to the other circumstances, to ascertain the intention of the parties.’

The amount received for giving consent is certainly not an advance rent. Can the giving of a consent in relation to user of a capital asset amount to a revenue receipt, even where it is assumed, though not right, that there is no transfer of the capital asset itself (in this case, tenancy rights) by the landlord? The character of a receipt depends upon its relation with the capital asset. For a receipt to be considered as income, it should be a receipt that is of revenue in nature. Normally, the amount received for use of an asset, such as rent, is revenue in nature and is income. However, that logic may not apply to all receipts in relation to a capital asset. Again, for a receipt to be a capital receipt it is not necessary that there should be a transfer of a capital asset or a diminution in value of a capital asset. Transfer of a capital asset is only necessary in order to subject a capital receipt to tax as capital gains.

When a landlord gives his consent for transfer of a tenancy, in substance, he is consenting to grant of the possessory rights to a new tenant. Therefore, he is giving up his possessory rights over the premises in favour of a new tenant. This can be viewed as a right in respect of the premises being agreed to be foregone for the future as well.

Another way of examining the matter is whether the receipt is in relation to a capital asset. The right to consent to a new tenant is also a right associated with the ownership of the immovable property. It is therefore part of the bundle of rights which constitute the immovable property. The exercise of such right in favour of the incoming tenant amounts to exercise of a capital right, the compensation for which would necessarily be capital in nature.

Therefore, the better view of the matter is that the premium received by the landlord for according his consent to transfer of tenancy rights is a capital receipt, subject at best to capital gains tax, and is not a revenue income.

The connected important issue is whether there is any cost of acquiring / holding such a right in the hands of the landlord. Can a part of the cost of acquiring the immovable property be attributed to the cost of the tenancy rights and be claimed and allowed as deduction in computing the capital gains? In our considered opinion, yes, such cost though difficult to ascertain is not an impossible task and should be determined on commercial consideration and be allowed in computing the capital gains arising on grant of the consent to transfer the tenancy rights or for creation of such rights.

Once it is held that the receipt is in the nature of a capital receipt that is liable to tax in the hands of the landlord under the head capital gains, the question of applicability of section 56(2)(x) should not arise. In any case, the receipt, in our opinion, is for a lawful consideration and cannot be subjected to the provisions of this provision that should not have had any place in the Income-tax Act.

Vivad se Vishwas sections 2(1)(o) and 9(a)(ii) – Prosecution – Pending prosecution for assessment year in question on an issue unrelated to tax arrears – Holding that an assessee would not be eligible to file a declaration would defeat very purport and object of Vivad se Vishwas Act – Question No. 73 vide Circular No. 21/2020 dated 4th December, 2020 is not in consonance with section 9(a)(ii) of Vivad se Vishwas Act

3 Macrotech Developers Ltd. vs. Pr. Commissioner of Income Tax [Writ Appeal No. 79 of 2021, date of order: 25th March, 2021 (Bombay High Court)]

Vivad se Vishwas sections 2(1)(o) and 9(a)(ii) – Prosecution – Pending prosecution for assessment year in question on an issue unrelated to tax arrears – Holding that an assessee would not be eligible to file a declaration would defeat very purport and object of Vivad se Vishwas Act – Question No. 73 vide Circular No. 21/2020 dated 4th December, 2020 is not in consonance with section 9(a)(ii) of Vivad se Vishwas Act

The assessee is a public limited company engaged in the business of land development and construction of real estate properties. Initially, Shreeniwas Cotton Mills Private Limited (‘Cotton Mills’ for short) was a subsidiary of the assessee company. Subsequently, it was merged with the assessee company on the strength of the amalgamation scheme sanctioned vide order dated 7th June, 2019 passed by the National Company Law Tribunal, Mumbai Bench. The merger had taken place with effect from 1st April, 2018. However, the pending tax demand against the cotton mills under the Act continued in the name of the cotton mills since migration of the permanent account number of the cotton mills to the permanent account number of the assessee company had not taken place. Therefore, it is pleaded that the tax demand of the cotton mills should be construed to be that of the assessee company and reference to the assessee company would mean and include the assessee company as well as the cotton mills.

For the A.Y. 2015-16, the assessee had filed return of income u/s 139(1) disclosing total income of Rs. 2,05,71,01,650. The self-assessment income tax payable on the returned income as per section 115JB was Rs. 69,92,08,851. At the time of filing of the return, an amount of Rs. 27,34,77,755 was shown to have been paid by way of tax deducted at source. The balance of the self-assessment tax of Rs. 42,57,31,096 (Rs.69,92,08,851 less Rs. 27,34,77,755) with interest thereon under sections 234A, 234B and 234C aggregating to Rs. 12,36,74,855 (totalling Rs. 54,94,05,951) was paid by the assessee after the due date for filing of the return.

The Pr. CIT issued notice to the assessee on 19th September, 2017 to show cause as to why prosecution should not be initiated against it u/s 276-C(2) for alleged wilful attempt to evade tax on account of delayed payment of the balance amount of the self-assessment tax. The assessee in its reply denying the allegations, made a request to the Pr. CIT to withdraw the show cause notice. The assessee did not apply for compounding u/s 279(2).

In the meanwhile, on 17th December, 2017, the A.O. passed the assessment order for the A.Y. 2015-16 u/s 143(3). In this order, he disallowed certain expenses claimed by the assessee towards workmen’s compensation and other related expenses. After disallowing such claim, the A.O. computed the tax liability of the assessee at Rs. 61.75 crores, inclusive of interest.

When the aforesaid assessment order was challenged by the assessee, the Commissioner (Appeals) dismissed it and upheld the assessment order vide order dated 27th December, 2018.

Aggrieved by this order, the assessee preferred further appeal before the ITAT which is pending before the Tribunal for final hearing.

While the appeal of the assessee was pending before the Tribunal, the Central Government enacted the Direct Tax Vivad se Vishwas Act, 2020 which came into force on and from 17th March, 2020. The primary objective of this Act is to reduce pending tax litigations pertaining to direct taxes and in the process grant considerable relief to the eligible declarants while at the same time generating substantial revenue for the Government.

Circular No. 9 of 2020 dated 22nd April, 2020 was issued whereby certain clarifications were given in the form of questions and answers. The Central Government vide a Notification dated 18th March, 2020 has made the Vivad se Vishwas Rules.

With a view to settling the pending tax demand, the assessee submitted a declaration in terms of the Vivad se Vishwas Act on 23rd September, 2020 in the name of the cotton mills in respect of the tax dues for the A.Y. 2015-16 which is the subject matter of the appeal pending before the Tribunal.

While the assessee’s declaration dated 23rd September, 2020 was pending, it came to know that the Pr. CIT had passed an order on 3rd May, 2019 authorising the Joint Commissioner of Tax (OSD) to initiate criminal prosecution against the cotton mills and its directors by filing a complaint before the competent magistrate in respect of the delayed payment of self-assessment tax for the A.Y. 2015-16. On the basis of such sanction, the Income-tax Department filed a criminal complaint under section 276-C(2) r/w/s 278B before the 38th Metropolitan Magistrate’s Court at Ballard Pier. However, no progress has taken place in the said criminal case.

The impugned Circular No. 21/2020 dated 4th December, 2020 was issued giving further clarifications in respect of the Vivad se Vishwas Act. Question No. 73 contained therein is: when in the case of a taxpayer prosecution has been initiated for the A.Y. 2012-13 with respect to an issue which is not in appeal, would he be eligible to file declaration for issues which are in appeal for the said assessment year and in respect of which prosecution has not been launched? The answer given to this is that ineligibility to file declaration relates to an assessment year in respect of which prosecution has been instituted on or before the date of declaration. Since for the A.Y. 2012-13 prosecution has already been instituted, the taxpayer would not be eligible to file a declaration for the said assessment year even on issues not relating to prosecution.

It is the grievance of the assessee company that on the basis of the answer given to Question No. 73 its declaration would be rejected since the declaration pertains to the A.Y. 2015-16 and prosecution has been launched against it for delayed payment of self-assessment tax for the A.Y. 2015-16. It is in this context that the assessee approached the High Court by a writ petition seeking the reliefs as indicated above.

The High Court held that the exclusion referred to in section 9(a)(ii) is in respect of tax arrears relating to an assessment year in respect of which prosecution has been instituted on or before the date of filing of declaration. Thus, what section 9(a)(ii) postulates is that the provisions of the Vivad se Vishwas Act would not apply in respect of tax arrears relating to an assessment year in respect of which prosecution has been instituted on or before the date of filing of declaration. Therefore, the prosecution must be in respect of tax arrears relating to an A.Y. The Court was of the view that there is no ambiguity insofar as the intent of the provision is concerned and a statute must be construed according to the intention of the Legislature and that the Courts should act upon the true intention of the Legislature while applying and interpreting the law. Therefore, what section 9(a)(ii) stipulates is that the provisions of the Vivad se Vishwas Act shall not apply in the case of a declarant in whose case a prosecution has been instituted in respect of tax arrears relating to an assessment year on or before the date of filing of declaration. The prosecution has to be in respect of tax arrears which naturally is relatable to an assessment year.

The Court observed that a look at clauses (b) to (e) of section (9) shows that there is a clear demarcation in section 9 of the Act inasmuch as the exclusions provided under clause (a) are in respect of tax arrears, whereas in clauses (b) to (e) the thrust is on the person who is either in detention or facing prosecution under the special enactments mentioned therein. Therefore, if we read clauses (b) to (e) of section 9, it would be apparent that such categories of persons would not be eligible to file a declaration under the Vivad se Vishwas Act in view of their exclusion in terms of section 9(b) to (e).

Apart from this, the Court observed that under the scheme of the Act and the purpose of the Rules as a whole, the basic thrust is on settlement in respect of tax arrears. Under section 9 certain categories of assessees are excluded from availing the benefit of the Vivad se Vishwas Act. While those persons who are facing prosecution under serious charges or those who are in detention as mentioned in clauses (b) to (e) are excluded, the exclusion under clause (a) is in respect of tax arrears which is further circumscribed by sub-clause (ii) to the extent that if prosecution has been instituted in respect of tax arrears of the declarant relating to an A.Y. on or before the date of filing of declaration, he would not be entitled to apply under the Vivad se Vishwas Act. Now, tax arrears has a definite connotation under the Vivad se Vishwas Act in terms of section 2(1)(o) which has to be read together with sections 2(f) to 2(j).

Further, the High Court held that to say that the ineligibility u/s 9(a)(ii) relates to an assessment year and if for that assessment year a prosecution has been instituted, then the taxpayer would not be eligible to file declaration for the said A.Y. even on issues not relating to prosecution, would not only be illogical and irrational but would be in complete deviation from section 9(a)(ii) of the Act. Such an interpretation would do violence to the plain language of the statute and, therefore, cannot be accepted. On a literal interpretation or by adopting a purposive interpretation of section 9(a)(ii), the only exclusion visualised under the said provision is pendency of a prosecution in respect of tax arrears relatable to an assessment year as on the date of filing of declaration and not pendency of a prosecution in respect of an A.Y. on any issue. The debarment must be in respect of the tax arrears as defined u/s 2(1)(o) of the Vivad se Vishwas Act. Therefore, to hold that an assessee would not be eligible to file a declaration because there is a pending prosecution for the A.Y. in question on an issue unrelated to tax arrears would defeat the very purport and object of the Act. Such an interpretation which abridges the scope of settlement as contemplated under the Act cannot, therefore, be accepted.

Insofar as the prosecution against the petitioner is concerned, the same has been initiated u/s 276C(2) because of the delayed payment of the balance amount of the self-assessment tax. Such delayed payment cannot be construed to be a tax arrear within the meaning of section 2(1)(o). Therefore, such a prosecution cannot be said to be in respect of tax arrears. Since such a prosecution is pending which is relatable to the A.Y, 2015-16, it would be in complete defiance of logic to debar the petitioner from filing a declaration for settlement of tax arrears for the said A.Y. which is pending in appeal before the Tribunal.

Considering the above, the clarification given by way of answer to Question No. 73 vide Circular No. 21/2020 dated 4th December, 2020 is not in consonance with section 9(a)(ii) of the Vivad se Vishwas Act and, therefore, the same would stand to be set aside and quashed. The declaration of the petitioner dated 23rd September, 2020 was directed to be decided by the Pr. CIT in conformity with the provisions of the Vivad se Vishwas Act dehors the answer given to Question No. 73 which was set aside and quashed. The writ petition was allowed.

 

POLITICAL RESPONSE

The devastation wrought by the virus over the last few weeks has been unnerving, both psychologically and physically, for everyone. Each one of us would know or have someone in the family who has suffered or died in this wave.

However, as we are painfully aware, accountability is NOT the strength of Government, be it Central or State, or as an institution. In the time of this medical calamity wrecking death and distress, the verbal response of the political leadership has been typical – below par. Here is a succinct articulation of the tone, tenor, nature, classification, propensity and quality of responses from the political class in general and which is accentuated during this time:

1. Deflect: Not answer honestly and directly. A direct question seeks a straightforward and not just a smart, cheeky answer (the difference between and  ). But when a Cabinet Minister was asked that by attending election rallies, weren’t you spreading infection, he replied, ‘Check me now!’

2. Collecting and sharing data: Many data points are not calculated, or not calculated properly, or not made available. Data is critical. What gets measured gets changed. Someonewrote:(The numbers show that the situation is bad, the situation shows that the numbers are incomplete.)

3. Cherry-pick: A commonly shared social media (SM) post compares India with the US and China in the number of doses administered. Yes, delightful and praiseworthy, but not PACEWORTHY as India has five times the population compared to at least the US and the percentage of the total inoculated is the real KPI. What is not stated, especially by the Health Minister (HM), is the number of days it will take to inoculate the 70 to 80 crore eligible / target population. As I write this on 1st May, 2021, I referred to the Twitter timeline of the Minister, when the surge is at its all-time peak of 4,00,000 plus new cases per day: But there is no reference to this daily indicator in the last 48 hours. Posts are about vaccination, WHO meeting, condolences for well-known persons… but nothing that can be said to be challenges – deaths, positivity rate, the task ahead, etc. One wonders whether the data shared is to ‘build a narrative’ or to also share important ‘facts’. If a government believes that the entire nation is with them and they are with the people, they would share facts without hesitation. The Lancet1 Editorial called this out as ‘perpetuating a too positive spin in government communication’.

4. Congress did it – After seven years, as someone pointed out, the Central Government still thinks that Congress rule is continuing. While there are legacy issues, as soon as a challenge appears, this is the one common point in the responses. Does it implicitly suggest to 130 crore people – you all need to wait for the next 70 years!

5. Credit without debit – Single entry accounting. All credit belongs to the Government or its leader, and debits are unaccounted for. Ministers ‘hailing’ the PM each day during the crisis and communication on SM is talking about how the PM was involved, instrumental, etc. Constant self-congratulatory behaviour seems out of place when people are scrambling for oxygen to stay alive in the national capital and in the States.

6. Victory before even the battle is over: The Government constantly seeks another moment to bask in the glory. I wonder if this is due to insecurity or lack of confidence. The HM said we are in the endgame of Covid on 15th March. Announcing victory when not even 1% of the population is vaccinated with two doses and we were at least 140 crore doses away! Generally, Mantri (ministers), Tantri (administrator), Santri (yes-men, wah-wahkaars and the media) displayed posters with leaders on them, subliminally saying things are nearing an end without the critical caveat that we have a long way ahead and that it’s NOT OVER till it is OVER.

_____________________________________________________________________
1     https://www.thelancet.com/journals/lancet/article/PIIS0140-6736(20)32001-8/fulltext
7. Respond in the future tense: When the question is of the immediate past or the present, the answer is about the future – how we have started doing some grand things.

8. State subject: A federation must work together and if States are underperforming or need help, they need to be pulled up or pushed and / or guided. States blame the Centre and vice versa. Democracy or Blamocracy?

9. Politicising: Sad to see politicising even in dire times. Action and words seem to have some added political motive.

10. Denial: This is the most ‘effective’ response. One very vocal CM said in April that we are fully equipped and there is no problem. In a week, he was calling for help.

(The above list of verbal responses excludes justification, excuse morphed as an explanation, wordplay, making grand announcements, conspiracy theories and other forms of responses. After observing these attributes of political response, I feel these could be a chapter of a book titled Manual for Politicians – say, Chapter 2021 on ‘Responding to Accountability Questions’!)

Government has all powers and resources at its disposal. It is Government’s job to be able to FORESEE what is coming based on data. In spite of the early March report by the national supermodel committee, which said that the second wave had already set in, the Governments didn’t do enough.

India had the maximum benefit of hindsight from all over the world. Many Governments didn’t learn the lesson of what can go wrong and what response may be required.

Take the example of vaccines: Knowing that there are no vaccines, an announcement for the 3rd age group is made for 1st May. In Mumbai, people are running from pillar to post since two weeks for a second dose. The US booked 400 million doses in August, 2020, the EU 800 million by November, 2020. India’s first order of vaccines was in January, 2021. States were not sure about how this will pan out till April. And this is despite a $30 billion pharma industry in the country with the finest minds! Now the Supreme Court is telling the administration to license vaccine-making to generate enough. Same for oxygen plants and the rest: Delhi had eight plants approved with funds from the PM Cares Fund. But it managed only one plant till April. If the planned 162 plants had been set up around the country, they could have produced 80,500 litres of medical oxygen per minute2. This translates approximately to one ton of liquid oxygen per day per plant. So, it’s not a crisis of ‘lack of funds’ or ‘lack of talent’, it’s a crisis of ‘lack of execution’, ‘lack of intent’ and ‘lack of vision’. In the words of our Rashtra Kavi Dinkarji:

Someone said, what you see now is not the crumbling of infrastructure but what was already there. Everything is exposed – from logistics to coordination, to the greed of hospitals, black marketing, wrong medication, careless disregard and casual behaviour of citizens about appropriate behaviour. The point is we have to see the difference between taking credit vs. receiving compliments from people; making claims vs. taking questions about people’s claims; complacency vs. accountability; and arrogance vs. compassion.

Please take a moment to say a mantra, a chant, a prayer every day for those in pain and those who departed in pain and / or send good vibes. Many of you would have made a tangible contribution (monetary, help, blood, etc.) towards those that need it. The crisis has taught us one thing – that we are on our own and people have to support each other.

But, we can’t ignore the many remarkable things happening. Someone sold his car to provide oxygen cylinders, or someone driving overnight 1,200 km. Delhi-Bokaro-Delhi bringing oxygen for his friend – ordinary people doing extraordinary things! Let’s take a moment to send strength and gratefulness to those who have helped, to those who will help, to those who are helping tirelessly – the medical and frontline workers, the real unsung heroes whose photographs should be on Covid vaccine certificates for taking on this unending disaster for 14 long months. They deserve our deepest respect.
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2     The New Indian Express, 27th April, 2021, Article by S. Gurumurthy

 

Raman Jokhakar
Editor

DUAL RESIDENT ENTITIES – ARTICLE 4 OF MLI

(This is the second article in the MLI series of articles started in April, 2021)

1. INTRODUCTION
Section 90(1) of the Income-tax Act, 1961 (the Act) read with Article 253 of the Constitution enables the Central Government to enter into Tax Treaties. Accordingly, India has entered into Tax Treaties with over 90 countries. The overarching preamble to a Tax Treaty is to eliminate double taxation and, vide the Multilateral Instruments (MLI), the same is also extended to prevent double non-taxation, or treaty abuse, or treaty-shopping arrangements.

The Tax Treaty does not impose taxes but distributes taxing rights. It provides substantive rights but relies on the domestic tax law to provide for the rules and procedures to levy tax. As per section 90(2), the beneficial provisions of the Tax Treaty shall override the specific provisions of the Act, subject to the domestic General Anti-Avoidance Rules (GAAR) and issue of Tax Resident Certificate from the tax officer in the foreign country. Thus, it is imperative to understand the treaty entitlement issues.

The taxpayer would certainly apply the Tax Treaty when its income is taxable in its resident state as well as in the source state. In other words, when it is the recipient of income taxable in more than one jurisdiction. Once applicable, its application is dependent on the following:

Scope of Application

Rules of Application

‘Taxpayer’ in Article 1

Preamble to Tax Treaty

‘Taxes’ in Article 2

Principal Purpose Tests

‘Residence’ in Article 4

Limitation of benefit clause, etc.

While the above relates to treaty entitlement, this article is focused on Article 4 of the MLI on Dual Resident Entities (non-individuals) that are usually referred to in Article 4(3) of the relevant Tax Treaty. As a pre-cursor, a Dual Resident Entity (DRE) is defined as such when an entity is deemed to be a resident of more than one jurisdiction under the domestic provisions. For example, when a  UK-incorporated entity is a tax resident of UK as per its domestic tax law (say, because of its incorporation under the UK tax law) and is also deemed to be a resident of India as per the Indian domestic tax law (say, because of the POEM rule under the Income-tax Act, 1961). The present Tax Treaty, without the effect of MLI, dealt with the conflict of dual resident entities and contained a tie-breaker rule for determination of the effective treaty residence.

2. ARTICLE 4(3) OF THE TAX TREATY
In accordance with Article 1(1) of the OECD Model Tax Convention, the Tax Treaty shall apply to persons who are residents of one or both of the Contracting States. Article 2 defines ‘persons’ to include an individual, a company and any other body of persons and defines ‘company’ to mean a body corporate or an entity that is treated as a body corporate for tax purposes, whereas Article 4 defines ‘residence’ for treaty purposes. In relevance, the Tax Treaty allocates or distributes taxing rights on the basis of the treaty residence.

The term ‘residence’ in Article 4(1) of the relevant Tax Treaty refers to the domestic definition of the residence, which, for Indian purposes, is section 6 of the Act. However, for resolving the issue of dual residency for non-individuals, the Tax Treaty refers to its own rule specified in Article 4(3) of the relevant Tax Treaty, i.e., Place of Effective Management (POEM). The OECD does not impose any restrictions or criteria for determination of residence in Article 4(1). In the case of dual residency for non-individuals, Article 4(3) refers to the POEM criterion as a single tie-breaker rule to determine ‘treaty residence’.

The term POEM is not defined in the OECD Model Tax Convention or in the relevant Tax Treaty. An analogy is drawn from the OECD Commentary which in itself does not provide sufficient and reliable guidance on its key determinants. Dual resident non-individuals are known to have abused this guidance gap. The tax authorities, as a last resort, have determined POEM on the basis of their domestic tax law vide Article 3(2) of the OECD Model Tax Convention. Under the Act, section 6 deems a foreign company to be a resident of India if it has its POEM in India. The CBDT Circular 6/2017 further provides guidance on how to determine POEM on the basis of various parameters for active business outside India and in India.

3. MULTILATERAL INSTRUMENTS
In order to curb tax abuse or evasion, article 4(1) of the Multilateral Instruments (MLI) amends the existing article 4(3) of the relevant Tax Treaty for resolving dual residency. It provides that the resolution of dual residence shall be through mutual agreement between the Contracting Jurisdictions concerned. It departs from the current treaty practice1, insofar as the POEM may no longer be the main rule to resolve the dual residence; and that the competent authorities will have the freedom to consider a number of factors to be taken into account while determining treaty residence of Dual Resident Entities (DRE). Article 4(1) of MLI also provides that the benefit of the Tax Treaty shall not be available until and unless the mutual agreement is concluded.

While Article 4(2) of MLI elucidates the manner in which the existing text of the Tax Treaty will change or modify, Article 4(3) of MLI provides an option to the Contracting States to make reservations. Article 4(4) of MLI elucidates the manner in which a Contracting Jurisdiction shall notify its partner Contracting Jurisdiction and thereby the Tax Treaty agreements to be covered under MLI.

4. DUAL RESIDENT ENTITIES – ARTICLE 4 OF MULTILATERAL INSTRUMENTS
4.1 Paragraph 1 of Article 4 of MLI states the following:
Paragraph 1. Where by reason of the provisions of a Covered Tax Agreement a person other than an individual is a resident of more than one Contracting Jurisdiction, the competent authorities of the Contracting Jurisdictions shall endeavour to determine by mutual agreement the Contracting Jurisdiction of which such person shall be deemed to be a resident for the purposes of the Covered Tax Agreement, having regard to its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors. In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by the Covered Tax Agreement except to the extent and in such manner as may be agreed upon by the competent authorities of the Contracting Jurisdictions.

 

1   United Nations’ Manual for the Negotiation of
Bilateral Tax Treaties between Developed and Developing Countries 2019, page 61

The key phrases for discussion are given below:

  • ‘A person other than an individual is a resident of more than one Contracting Jurisdiction.’
  • ‘shall endeavour to determine by mutual agreement.’
  • ‘having regard to its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors.’
  • ‘shall not be entitled to any relief or exemption from tax.’
  • ‘except to the extent and in such manner as may be agreed upon by the competent authorities of the Contracting Jurisdictions.’

MLI provides for a shift in the initial determination of treaty residence, from the taxpayer / tax authority (determination using POEM) to now the Competent Authority of the Contracting Jurisdiction concerned (determination by mutual agreement).

Until its final determination by mutual agreement, the DRE is not entitled to any relief or exemption from tax under the Tax Treaty to which MLI applies. However, the last sentence also contemplates a discretionary power in the hands of the Competent Authority to grant some relief under the relevant Tax Treaty. From the perspective of the Act, with no access to the Tax Treaty, a foreign company shall be deemed to be a domestic resident if its POEM (as per domestic guidance) is in India. A foreign limited liability partnership (being a body corporate) shall be deemed to be a resident in India where the control and management of its affairs is situated wholly or partly in India. Paragraph 52 of the Explanatory Statement to MLI provides the following:

‘Existing “tie-breaker” provisions addressing the residence of persons other than individuals take a variety of forms. For example, some [such as Article 4(3) of the UN Model Tax Convention, and of the OECD Model Tax Convention prior to the BEPS Project] break the tie in favour of the place of effective management, some focus on the place of organisation, and others call for determination by mutual agreement but do not explicitly deny benefits in the absence of such a determination.’

It must be noted that the POEM, being one of the various determinants, is in itself an anti-avoidance measure. It applies the substance-over-form approach in order to determine the location where ‘key management and commercial decisions’ were made. It seems that POEM is the key criterion for Competent Authorities to determine treaty residence and thereby entitlement to the relevant Tax Treaty. MLI or its Explanatory Statement does not provide any guidance on how to determine treaty residence and how to determine POEM or which aspect to consider for ‘any other relevant factor’. It seems that the domestic guidance on determination of POEM may not be relevant for determination of treaty residence as the purpose of section 6(3) is to make a foreign company a resident in India and thereby enabling dual residency, whereas the purpose of Article 4(1) of the MLI is to resolve the conflict of dual residency.

With high discretion in the hands of the Competent Authority, there is no obligation on the Competent Authority to reach a mutually acceptable agreement. Further, the DRE may not have any say in the matter and may not have any right to appeal or arbitrate a negative decision on treaty residence.

Lastly, the CBDT has in Rule 44G of the Income-tax Rules, 1962 provided for the manner in which an Indian resident can apply to the Competent Authority in India for initiation of MAP. It also provides for a suggestive timeline (not mandatory) of 24 months for arriving at a mutually agreeable resolution of the tax dispute. However, a foreign entity is not allowed to apply to the Competent Authority in India.

4.2 Paragraph 2 of Article 4 of MLI states the following:
Paragraph 1 shall apply in place of or in the absence of provisions of a Covered Tax Agreement that provide rules for determining whether a person other than an individual shall be treated as a resident of one of the Contracting Jurisdictions in cases in which that person would otherwise be treated as a resident of more than one Contracting Jurisdiction. Paragraph 1 shall not apply, however, to provisions of a Covered Tax Agreement specifically addressing the residence of companies participating in dual-listed company arrangements.

The key phrases for discussion are given below:

  • ‘in place of or in the absence of.’
  • ‘companies participating in dual-listed company arrangements.’

This Paragraph is the compatibility clause that describes the interaction between Article 4(1) of the MLI and the existing Article 4(3) of the relevant Tax Treaty (also known as the Covered Tax Agreement). The effect of ‘in place of or in the absence of’ is as provided below:

 

4.3 Paragraph 3 to Article 4 of MLI states the following:
A party may reserve the right:
a) for the entirety of this Article not to apply to its Covered Tax Agreements;
b) for the entirety of this Article not to apply to its Covered Tax Agreements that already address cases where a person other than an individual is a resident of more than one Contracting Jurisdiction by requiring the competent authorities of the Contracting Jurisdictions to endeavour to reach mutual agreement on a single Contracting Jurisdiction of residence;
c) for the entirety of this Article not to apply to its Covered Tax Agreements that already address cases where a person other than an individual is a resident of more than one Contracting Jurisdiction by denying treaty benefits without requiring the competent authorities of the Contracting Jurisdictions to endeavour to reach mutual agreement on a single Contracting Jurisdiction of residence;
d) for the entirety of this Article not to apply to its Covered Tax Agreements that already address cases where a person other than an individual is a resident of more than one Contracting Jurisdiction by requiring the competent authorities of the Contracting Jurisdictions to endeavour to reach mutual agreement on a single Contracting Jurisdiction of residence, and that set out the treatment of that person under the Covered Tax Agreement where such an agreement cannot be reached;
e) to replace the last sentence of paragraph 1 with the following text for the purposes of its Covered Tax Agreements: ‘In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by the Covered Tax Agreement’;
f) for the entirety of this Article not to apply to its Covered Tax Agreements with parties that have made the reservation described in sub-paragraph e).

This Paragraph relates to the reservation which can be entirely, partially or in a modified format. The signatories are free to express their reservation and restrict the extent of the application of Article 4 of MLI. It may opt out of Article 4 of MLI in the manner stated above and continue with the existing provisions of the Tax Treaty, without giving effect of MLI.

For example, in the India-Austria Tax Treaty, Austria has reserved the right for the entirety of Article 4 of MLI not to apply to its Covered Tax Treaty. India has notified India-Austria Tax Treaty and has not provided any reservation. Accordingly, Article 4 would not apply.

Likewise, in the India-Australia Tax Treaty, Australia has reserved the right to deny treaty benefits in absence of mutual agreement in accordance with Article 4(3)(e) of MLI above. Both India and Australia have notified the relevant article in the India-Australia Tax Treaty. India has not provided any reservation [including reservation as per Article 4(3)(f)]. Accordingly, Article 4(1) of MLI shall replace the existing Article 4(3) of the India-Australia Tax Treaty, with the last sentence of Article 4(1) of MLI to be modified by Article 4(3)(e) of the MLI.

The signatory party to the MLI that has not made a reservation of this article is required to notify the Depository of its Covered Tax Treaty purported to be covered or already covered in its existing treaty. The procedure is discussed in Article 4(4) of the MLI discussed below.

4.4 Paragraph 4 to Article 4 of MLI states the following:
Each party that has not made a reservation described in sub-paragraph a) of paragraph 3 shall notify the Depository of whether each of its Covered Tax Agreements contains a provision described in Paragraph 2 that is not subject to a reservation under sub-paragraphs b) through d) of Paragraph 3, and if so, the article and paragraph number of each such provision. Where all Contracting Jurisdictions have made such a notification with respect to a provision of a Covered Tax Agreement, that provision shall be replaced by the provisions of Paragraph 1. In other cases, Paragraph 1 shall supersede the provisions of the Covered Tax Agreement only to the extent that those provisions are incompatible with Paragraph 1.

This Paragraph complements the application of Article 4(2) of MLI. Refer to the diagram illustrated in Paragraph 2 above, wherein each party has to notify the Depository of whether each of its Covered Tax Agreements contains an existing provision that is not subject to a reservation under Paragraph 3(b) through (d). Such a provision would be replaced by the provisions of Article 4(1) of MLI where all parties to the Covered Tax Agreement have made such a notification. In all other cases, 4(1) of MLI would supersede the existing provisions of the Covered Tax Agreement only to the extent that those provisions are incompatible with Article 4(1) of MLI.

Paragraph 52 of the Explanatory Statement to MLI provides that ‘Where a single provision of a Covered Tax Agreement provides for a tie-breaker rule applicable to both individuals and persons other than individuals, Paragraph 1 would apply in place of that provision only to the extent that it relates to a person other than an individual.’

5. EXCEPTION
Paragraph 2 of Article 4 of MLI provides an exception to this Article, i.e., ‘Paragraph 1 shall not apply, however, to provisions of a Covered Tax Agreement specifically addressing the residence of companies participating in dual-listed company arrangements.’

The above clause has a restricted effect from the Indian perspective as it refers to the existing treaty clause addressing the residence of companies participating in dual-listed company arrangements, e.g., the UK-Netherlands Tax Treaty. In the dual-listed company arrangement, like merger, two listed companies operating in two different countries enter into an alliance in which these companies are allowed to retain their separate legal identities and continue to be listed and traded on the stock exchanges of the two countries. It is a process that allows a company to be listed on the stock exchanges of two different countries. In a typical merger or acquisition, the merging companies become a single legal entity, with one business buying the other. However, ‘a dual-listed company arrangement’ is a corporate structure in which two corporations function as a single operating business through a legal equalisation agreement but retain separate legal identities and stock exchange listings2. The arrangement reflects a commonality of management, operations, shareholders’ rights, purpose and mission through an agreement or a series of agreements between two parent companies, operating as one business.

 

2   http://www.legalservicesindia.com/article/1580/Dual-Listing-of-Companies.html
and Explanatory Statement in respect of Article 4(2) of MLI

 

6. WAY FORWARD
MLI is seeking to replace / supersede the existing framework of the Tax Treaty. While MAP was a well-known measure present in the Tax Treaty to resolve tax conflicts, Article 4 of MLI purports to use this measure for determining the Treaty Entitlement, more particularly the issue on treaty residence. Until the coming into force of Article 4(1) of MLI, the treaty entitlement was never doubted in the existing Article 4 of the relevant Tax Treaty [except in rare cases like in article 4(3) of the Indo-USA DTAA]. However, post-amendment through MLI, the DRE would be entitled to Tax Treaty only on conclusion of MAP, the outcome of which is uncertain. The MAP pursuant to Article 4(3) of MLI should not be confused with the MAP pursuant to Article 25 of the OECD Model Tax Convention.

For example, Article 27 of the India-UK Tax Treaty provides that ‘Where a resident of a Contracting State considers that the actions of one or both of the Contracting States result or will result for him in taxation not in accordance with this Convention, he may, notwithstanding the remedies provided by the national laws of those States, present his case to the competent authority of the Contracting State of which he is a resident.’

Whereas Paragraph 58 of the Explanatory Statement to MLI states that where Article 4(1) of MLI denies the benefits of the Covered Tax Agreement, in the absence of the concluded MAP for treaty residence, such denial cannot be viewed as ‘taxation that is not in accordance’ with the provisions of the Covered Tax Agreement.

Accordingly, Article 27 of the India-UK Tax Treaty would not apply for two reasons: (a) by referring to ‘resident of a contracting state’, it is referring to treaty residence and not domestic residence. Since treaty residence is not yet determined, the said clause is not applicable; (b) by referring to taxation that is ‘not in accordance with this Convention’, the said clause is not applicable when Paragraph 58 of the Explanatory Statement is read along with this clause.

Furthermore, MAP concluded under one Tax Treaty (e.g. UK-India Tax Treaty) would not have any precedence when contemplating another Tax Treaty (e.g. Netherlands-India Tax Treaty) and would be time-consuming and exhaustive for the DRE, especially when the MAP discussion fails under one Tax Treaty and it might be late for the DRE to initiate MAP for past years under another Tax Treaty.

Secondly, there is no obligation on the competent authorities to actually reach an agreement. The wording used in Article 4(1) of MLI is ‘shall endeavour’ to agree in MAP, pending which the taxpayer’s treaty entitlement is at stake. The discretion afforded to the Competent Authorities under Article 4 of MLI is wider in scope than the domestic General Anti-Avoidance Rule. Possibly, it was intentional to curtail treaty abuse and provide powers in the hands of the contracting state. Further, if POEM is the key determinant for the Competent Authority, it should be based on a regulated guidance, not at the free discretion of the respective Competent Authorities who may give different relevance to a particular factor. Howsoever it may be, the lifting of corporate veil under a cross-border scenario should be avoided in genuine cases and should be used only as a tool to prevent tax abuse or tax evasion. The form and governance of DRE should be respected to the extent it is appropriate and reasonable.

Thirdly, the DRE would not be entitled to the Tax Treaty, in the absence of mutual agreement, even if MAP discussion is ongoing, where the last sentence of Article 4(1) of MLI is replaced by the specific sentence in Article 4(3)(e) of MLI, or where the DRE would not be entitled to the Tax Treaty except to the extent the Competent Authorities grant some relief to it [assuming Article 4(3)(e) is not applicable]. In the absence of guidelines, the questions that may arise are: That once the MAP is concluded, whether the outcome shall apply to the DRE retrospectively or prospectively? Whether the person who is responsible for payment (payer) to DRE is obliged to withhold taxes without considering the benefit from Tax Treaty, considering that it may not be privy to the MAP or tax conflict? Whether the right to deny treaty entitlement is for the DRE and not for the payer who is obliged to withhold taxes at the applicable Tax Treaty rate or the Act rate, whichever is more beneficial? As a way forward, in order to reduce the hardship, the Competent Authorities should suspend or defer the collection of taxes while MAP discussions are ongoing and provide rules for the taxpayer to comply with withholding tax issues in these scenarios.

Lastly, the DRE should have a right to contest the conclusions drawn under the MAP in an international court or in its resident Contracting Jurisdiction, or under a multilateral arbitration. At present, MLI assumes that the MAP would be concluded in the right manner with right determinants, giving full discretionary power to the Competent Authorities to decide which determinants would be key to determine treaty residence, as against the guidance given in the OECD Commentary for, say, POEM, wherein it has discussed various determinants with examples. As a way forward, the Contracting Jurisdictions that participated in MAP should permit DRE a legal remedy to contest MAP in its domestic forum and, if successful, to allow the court decision to become an addendum to the concluded MAP. Further, if the MAP is not concluded, the DRE is not entitled to the Tax Treaty. DRE should not suffer from permanent fracture for the rigidness of the Competent Authorities. DRE should be provided with legal remedy to resolve the impending dispute.

VIRTUAL HEARING

The other day I visited the office of a senior Chartered Accountant (hereinafter ‘the senior’) unannounced after a long time. He is indeed very ‘senior’, not less than 80, but still in practice. Age is just a number for him; he is both energetic and active. Before I entered the chamber, his driver Jaya told me, ‘Sir is about to begin a virtual hearing’. But as soon as I knocked on the door, I heard him shout, ‘Get out, Tommy!’

Tommy, for your information, is his pet dog. The senior operates from his four-bedroom flat, with the hall converted into his office. And believe me, Tommy ran out as soon as I opened the door, brushing against my leg. I was caught unawares and got scared. The senior was scanning the papers littered on his table, maybe making last-minute preparations. As he heard the sound of my footsteps, he looked up, squinted at me and hurriedly waved to me to sit down. I slowly lowered myself into the chair in front of him.

‘Herambh, you! What a pleasure!’ he greeted me, as if he had been waiting for me.

‘Sir, just a courtesy call, nothing more.’

‘Herambh, you know, today is the first-ever virtual hearing of my life,’ he stated.

‘Sir, Jaya told me that when I was entering your cabin,’ I said.

‘Jaya told you? Okay, no problem.’ But the senior seemed to be nervous, his nervousness conspicuous on his face. I thought it would be better to leave.

‘Sir, I could come some other day,’ I said politely.

‘No, no, Herambh, I have no problem, you stay till the end of the hearing; look, I am not computer-savvy and this new technology, internet blah blah… you would be a great help to me,’ he said.

‘I can understand your concern, Sir, when I began to learn computers long back, I was afraid of pressing a button on the keyboard thinking something would go wrong!’

‘Are you scaring me, Herambh?’ he asked.

‘No, Sir, not at all! I was just telling you my experience from my initial days,’ I hastily clarified.

‘Look, I have learnt the ABC of computers from my grandsons Bunty and Babli who are in the 7th and 8th standards; very smart chaps. Let me call them.’ The senior got up, went to the balcony and shouted ‘Bunty-Babli, come up immediately!’

Bunty and Babli replied in chorus ‘Yes, Grandpa, coming! Last ball!’

After a while the door behind me cracked open and Bunty with a bat and Babli with the ball, both with cricket caps on their heads, entered the hall-turned-office.

‘Relax, Bunty-Babli, relax! Sit by my side, drink a glass of water.’ I observed that two chairs were arranged for Bunty and Babli on either side of the senior’s chair. They settled down and wiped their faces that were full of sweat and dust. The senior was looking at them with great pride and hope [hope, maybe, for a successful hearing]. Then he brought out two medium-size chocolate bars from a drawer and gave these to them. I was watching the scene silently, seeing the grandpa and his love and affection for his grandsons.

‘Well, Herambh, because of on-line education, Bunty and Babli are well versed with this internet technology, they will guide me in this “virtual hearing”, the first ever in my life, you know,’ confessed the senior without being asked.

‘Hello Bunty, Babli,’ I greeted them.

They somehow managed to say ‘Hi, Uncle’, in chorus, still munching on the chocolate bars.

As soon as they finished them, they took charge of all the computer apparatus on the table – keyboard, mouse, headphone, etc.

‘Grandpa, let’s start; Babli, switch on,’ Bunty ordered.

‘Yes, Dadu,’ Babli got up and switched on the main supply.

As the computer turned on, Bunty and Babli glued their eyes to the screen, searching for the internet connection.

‘Yes! Grandpa, we got the internet connection,’ shouted Bunty. Both the senior and I became alert. Following Bunty’s declaration, the senior wore his spectacles and started to locate the hearing notice which had the log-in details.

‘Bunty beta, these are the log-in details,’ the senior handed over the paper to Bunty, looking at him with great hope and placing one hand on his shoulder. On the other side, Babli was fidgeting in his chair, waiting to contribute his bit.

‘Grandpa, you are not allowing me to do anything; only Bunty beta do this, Bunty beta do that,’ complained Babli.

‘Calm down, Babli, you find my pen and mobile,’ the senior said.

Babli moved swiftly to look for the two articles in the heap of papers and files littered on the table. He somehow succeeded in his search, messing up the papers and files even further. And he handed over the mobile and the pen to the senior.

‘Good boy, God bless you.’ the Senior said, looking at Babli.

As the time of hearing was approaching, he told Bunty to log in. Doing as told, Bunty logged in and declared, ‘Grandpa, put on your specs and headphone, we are about to start the virtual hearing session.’

Fortunately, the case was before a single-member bench. At the scheduled time, there was some movement on the screen and the Member appeared.

‘Speak, grandpa, speak,’ advised Bunty and Babli in hushed tones.

‘Good morning, Sir,’ greeted the senior.

‘How are you, Bhishmacharya?’ asked the Member. Being the senior-most in Tribunal practice, the senior was addressed as ‘Bhishmacharya’ with reverence.

‘I’m fine,’ replied the senior. Having exchanged initial pleasantries, the case references were brought on record. However, the departmental representative was still not in the loop.

On the other hand, the senior was very eager to begin his first-ever experience of a ‘virtual hearing.’ But all of a sudden, the screen went blank.

‘Bunty-Babli, see what happened,’ shouted the senior.

‘Grandpa, wait, the internet may be down on the other side,’ advised Bunty.

After a while, the Member appeared on the screen. ‘Internet trouble, connectivity dropped, I wonder the learned DR is still not on air,’ said the Member.

‘Your Honour, I emailed my paper book for your ready reference well in advance, it must have reached the learned DR also,’ said the senior.

There was a pause. The senior could hear the Member’s mobile ringing. The Member picked up his phone and the senior overheard the conversation, ‘What happened? Not possible… why… power outage plus no connectivity… Oh my God!… No alternative… adjourn… next date… wait, I will call you back…”

‘Sorry, Counsel, we will have to adjourn the hearing; the learned DR says no power, no connectivity… Counsel can we make it to 1st April, is it suitable to you?’ the Member asked.

‘No problem, Your Honour, make it to 1st April,’ said the senior with a heavy heart. The Member logged off instantly. Bunty did the same. The senior took a long breath and removed the headphone. Bunty and Babli ran away to complete their interrupted cricket match. I, too, got up and consoled the senior.

‘Better luck next time, Sir; don’t be nervous, it happens very often, you are not an exception,’ and moved towards the door. And Tommy ran in to meet his master.

Thus, the first-ever virtual hearing ended with the first-ever virtual adjournment!

TDS – Payments to contractors – Section 194C – Assessee, Department of State Government – Government directing assessee to appoint agency for construction of college buildings providing percentage of project cost for each building as service charges – Payments to agencies for construction of college buildings – Appellate authorities on facts holding that assessee not liable to deduct tax – Concurrent findings based on facts not shown to be perverse – Order need not be interfered with

19 CIT vs. Director of Technical Education [2021] 432 ITR 110 (Karn) A.Y.: 2011-12 Date of order: 10th February, 2021

TDS – Payments to contractors – Section 194C – Assessee, Department of State Government – Government directing assessee to appoint agency for construction of college buildings providing percentage of project cost for each building as service charges – Payments to agencies for construction of college buildings – Appellate authorities on facts holding that assessee not liable to deduct tax – Concurrent findings based on facts not shown to be perverse – Order need not be interfered with

The assessee was a Department of the Government of Karnataka and was in charge of the academic and administrative functions of controlling technical education in the State of Karnataka. As part of its activities, the assessee entrusted the construction of engineering and polytechnic college buildings under construction agreements to KHB and RITES. The Deputy Commissioner treated the assessee as an assessee-in-default and passed an order u/s 201(1) on the ground that the assessee had failed to deduct the tax as required u/s 194C on the payments made under the contracts with KHB and RITES. Accordingly, a demand notice was also issued.

The Commissioner (Appeals), inter alia, held that the Government of Karnataka directed the assessee to appoint a particular agency like KHB or RITES for every new building on remuneration by providing a specific percentage of the project cost for each building in the form of service charges and that the provisions of section 194C were not applicable. The Tribunal upheld the order of the Commissioner (Appeals).

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

‘The Tribunal was right in holding that the assessee was not liable to deduct tax u/s 194C on payments made to KHB and RITES for rendering of services in connection with the construction of engineering and polytechnic college buildings in the State of Karnataka. The Commissioner (Appeals) had gone into the details of the memorandum of understanding entered into with KHB and RITES and had held that the provisions of section 194C were not applicable to the assessee. The concurrent findings of fact by the appellate authorities need not be interfered with in the absence of any perversity being shown.’

TDS – Commission – Scope of section 194H – Transactions between banks for benefit of credit card holders – Transactions on principal-to-principal basis – Section 194H not applicable

18 CIT vs. Corporation Bank [2021] 431 ITR 554 (Karn) A.Y.: 2011-12 Date of order: 23rd November, 2020
    
TDS – Commission – Scope of section 194H – Transactions between banks for benefit of credit card holders – Transactions on principal-to-principal basis – Section 194H not applicable

The assessee is a nationalised bank. For the A.Y. 2011-12, the A.O. made disallowance u/s 40(a)(ia) of service charges paid to National Financial Switch (NFS) on the ground that tax was not deducted at source u/s 194H.

The Commissioner of Income-tax (Appeals) and the Tribunal allowed the assessee’s claim.

On appeal by the Revenue, the following question was farmed:

‘Whether, on the facts and in the circumstances of the case, the Tribunal erred in holding that on the payment made towards the service charges rendered by M/s NFS is neither commission nor brokerage which does not attract tax deduction at source u/s 194H of the Income-tax Act?’

The Karnataka High Court upheld the decision of the Tribunal and held as under:

‘i) In case the credit card issued by the assessee was used on the swiping machine of another bank, the customer whose credit card was used to get access to the internet gateway of acquiring bank resulting in realisation of the payment. Subsequently, the acquiring banks realise and recover the payment from the bank which had issued the credit card. The relationship between the assessee and any other bank is not of an agency but that of two independents on principal-to-principal basis. Even assuming that the transaction was being routed to National Financial Switch and Cash Tree, even then it is pertinent to mention here that the same is a consortium of banks and no commission or brokerage is paid to it. It does not act as an agent for collecting charges. Therefore, we concur with the view taken by the High Court of Delhi in CIT vs. JDS Apparels (P) Ltd. [2015] 370 ITR 454 (Delhi) and hold that the provisions of section 194H of the Act are not attracted to the fact situation of the case.

ii) In the result, the substantial question of law is answered against the Revenue and in favour of the assessee.’

Settlement of cases – Sections 245D, 245F and 245H – Powers of Settlement Commission – Application for settlement of case following search operations and notice u/s 153A – Order of penalty thereafter as consequence of search – Assessment and penalty part of same proceedings – Order of penalty not valid

17 Tahiliani Design Pvt. Ltd. vs. JCIT [2021] 432 ITR 134 (Del) A.Y.: 2018-19 Date of order: 19th January, 2021

Settlement of cases – Sections 245D, 245F and 245H – Powers of Settlement Commission – Application for settlement of case following search operations and notice u/s 153A – Order of penalty thereafter as consequence of search – Assessment and penalty part of same proceedings – Order of penalty not valid

A search and seizure operation u/s 132 as well as a survey u/s 133A were carried out on 29th May, 2018 in the case of the assessee. Thereafter, the Investigation Wing referred the case to the A.O. The Range Head of the A.O. of the assessee, after going through the seized material, presumed that the assessee had violated the provisions of section 269ST and issued a notice to it for the A.Ys. 2018-19 and 2019-20 to show cause why penalty u/s 271DA for violating the provisions of section 269ST should not be imposed on it. Meanwhile, in pursuance of the search and seizure operation, notices u/s 153A were issued to the assessee for the A.Ys. 2013-14 to 2018-19. The assessee applied for settlement of the case on 1st November, 2019 for the A.Ys. 2012-13 and 2013-14 to 2019-20 and in accordance with the provisions of the Act on 1st November, 2019 itself also informed the A.O. about the filing of the application before the Settlement Commission. The A.O., however, proceeded to pass a penalty order dated 4th November, 2019.

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

‘i) Though section 245A(b) while defining “case” refers to a proceeding for assessment pending before an A.O. only and therefrom it can follow that penalties and prosecutions referred to in sections 245F and 245H are with respect to assessment of undisclosed income only, (i) section 245F vests exclusive jurisdiction in the Settlement Commission to exercise the powers and perform the functions “of an Income-tax authority under this Act in relation to the case”; and (ii) section 245H vests the Settlement Commission with the power to grant immunity from “imposition of any penalty under this Act with respect to the case covered by the settlement”. The words, “of an Income-tax authority under this Act in relation to the case” and “immunity from imposition of any penalty under this Act with respect to the case covered by the settlement”, are without any limitation of imposition of penalty and immunity with respect thereto only in the matter of undisclosed income. They would also cover penalties under other provisions of the Act, detection whereof has the same origin as the origin of undisclosed income. Not only this, the words “in relation to the case” and “with respect to the case” used in these provisions are words of wide amplitude and in the nature of a deeming provision and are intended to enlarge the meaning of a particular word or to include matters which otherwise may or may not fall within the main provisions.

ii) Both the notices u/s 153A as well as u/s 271DA for violation of section 269ST had their origin in the search, seizure and survey conducted qua the assessee as evident from a bare reading of the notice u/s 271DA. Both were part of the same case. The proceedings for violation of section 269ST according to the notice dated 30th September, 2019 were a result of what was found in the search and survey qua the assessee and were capable of being treated as part and parcel of the case taken by the assessee by way of application to the Settlement Commission.

iii) The Settlement Commission had exclusive jurisdiction to deal with the matter relating to violation of section 269ST also and the A.O., on 4th November, 2019, did not have the jurisdiction to impose penalty for violation of section 269ST on the assessee. His order was without jurisdiction and liable to be set aside and quashed.’

New industrial undertaking in free trade zone – Export-oriented undertaking – Exemption under sections 10A and 10B – Shifting of undertaking to another place with approval of authorities – Not a case of splitting up or reconstruction of business – Assessee entitled to exemption

16 CIT vs. S.R.A. Systems Ltd. [2021] 431 ITR 294 (Mad) A.Ys.: 2000-01 to 2002-03 Date of order: 19th January, 2021

New industrial undertaking in free trade zone – Export-oriented undertaking – Exemption under sections 10A and 10B – Shifting of undertaking to another place with approval of authorities – Not a case of splitting up or reconstruction of business – Assessee entitled to exemption

While completing the assessment u/s 143(3) read with section 147 for the A.Ys. 2000-01 and 2001-02, the A.O. disallowed the claim of deduction made by the assessee under sections 10A and 10B on the ground that an undertaking was formed by splitting up / reconstruction of the business already in existence. While completing the assessment u/s 143(3) read with section 263(3) for the A.Y. 2002-03, the A.O. disallowed the claim u/s 10A on the ground that an undertaking was formed by splitting up / reconstruction of the business already in existence among others.

The Commissioner of Income-tax (Appeals) allowed the appeals for the A.Ys. 2000-01 and 2001-02 by following the order of the Tribunal. The Department filed appeals before the Income-tax Appellate Tribunal and the Tribunal confirmed the order of the Commissioner of Income-tax (Appeals). The Tribunal held that this was not a case of setting up of a new business but only of transfer of existing business to a new place located in a software technology park area and, thereafter, getting the approval from the authorities.

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

‘On the facts and in the circumstances of the case, the assessee was entitled to deduction u/s 10A/10B.’

Deduction u/s 80-IA – Electricity undertaking – Expenditure on renovation and modernisation of existing lines – Condition precedent for deduction u/s 80-IA(4) – Work of renovation need not be completed – Expenditure need not be capitalised in accounts – Expenditure need not result in increase in value of assets – Assessee undertaking renovation and modernisation of existing lines more than 50% of book value of assets as on 1st April, 2004 – Assessee entitled to deduction u/s 80-IA(4)

15 Bangalore Electricity Supply Company Ltd. vs. Dy. CIT [2021] 431 ITR 606 (Karn) A.Y.: 2005-06 Date of order: 27th January, 2021

Deduction u/s 80-IA – Electricity undertaking – Expenditure on renovation and modernisation of existing lines – Condition precedent for deduction u/s 80-IA(4) – Work of renovation need not be completed – Expenditure need not be capitalised in accounts – Expenditure need not result in increase in value of assets – Assessee undertaking renovation and modernisation of existing lines more than 50% of book value of assets as on 1st April, 2004 – Assessee entitled to deduction u/s 80-IA(4)

The assessee was a public limited company which was wholly owned by the Government of Karnataka and was engaged in the activity of distribution of electricity. For the A.Y. 2005-06, it claimed deduction of Rs. 141,84,44,170 u/s 80-IA(4)(iv)(c), but the A.O. disallowed the claim. This was upheld both by the Commissioner (Appeals) and the Tribunal.

In its appeal to the High Court, the assessee submitted that its case fell within the third category of undertakings and, therefore, the amount undertaken towards renovation and modernisation had to be considered. Alternatively, it submitted that capital work-in-progress was to be included and should not be restricted only to those amounts which were capitalised in the books and substantial renovation and modernisation could be at any time during the period beginning on 1st April, 2004 and ending 31st March, 2006. It contended that it had undertaken substantial renovation and modernisation of existing lines which was more than 50% of the book value of assets as on 1st April, 2004 under the Explanation to section 80-IA(4)(iv)(c).

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

‘i) From a perusal of section 80-IA(4) it is evident that there are three types of undertakings which are considered by the Legislature eligible for deduction u/s 80-IA, viz., an undertaking which is (i) set up for generation or generation and distribution of power, (ii) starts transmission or distribution by laying network of new transmission or distribution lines, (iii) undertakes substantial renovation and modernisation of the existing network of transmission or distribution lines. Thus, for each type of undertaking the Legislature has used different expressions, viz., “set up”, “starts” and “undertakes”. These words have different meanings. The expression “undertake” has not been defined under the Act. Therefore, its common parlance meaning has to be taken into account. The meaning of the word “undertake” used in section 80-IA(4)(iv)(c) cannot be equated with the word “completion”.

ii) The Circular dated 15th July, 2005 [(2005) 276 ITR (St.) 151] issued by the CBDT clearly states that the tax benefit under the section has been extended to undertakings which undertake substantial renovation and modernisation of an existing network of transmission or distribution lines during the period beginning from 1st April, 2004 and ending on 31st March, 2006. The provisions of section 80-IA(4)(iv)(c) use the expression “any time” during the period beginning from 1st April, 2004 and ending on 31st March, 2006 and do not use the word “previous year”. Wherever the Legislature has intended to use the expression “previous year”, it has consciously done so, viz., in section 35AB, section 35ABB, section 35AC and section 35AD as well as in 77 other sections of the Act.

iii) There is no requirement of capitalisation of the amount in the books of accounts mentioned in section 80-IA(4)(iv)(c) which does not mandate that there has to be an increase in the value of plant and machinery in the books of accounts. Therefore, such a requirement which is not prescribed in the language of the provision cannot be read into it.

iv) The assessee had undertaken substantial renovation and modernisation of existing lines which was more than 50% of the book value of the assets as on 1st April, 2004 under the Explanation to section 80-IA(4)(iv)(c). Thus, it could safely be inferred that the assessee had undertaken the work towards renovation and modernisation of existing transmission or distribution lines. The assessee was entitled to deduction u/s 80-IA(4).’

Appeal to High Court – Court quashing order and remanding matter to Tribunal – Effect – Search and seizure – Appeal arising out of block assessment – Assessee entitled to raise question of limitation in remand proceedings – Tribunal refusing to adjudicate issue of limitation holding it was not subject matter of remand – Not sustainable – Matter remanded to Tribunal

14 Karnataka Financial Services Ltd. vs. ACIT [2021] 432 ITR 187 (Karn) A.Ys.: 1986-87 to 1996-97 Date of order: 8th February, 2021

Appeal to High Court – Court quashing order and remanding matter to Tribunal – Effect – Search and seizure – Appeal arising out of block assessment – Assessee entitled to raise question of limitation in remand proceedings – Tribunal refusing to adjudicate issue of limitation holding it was not subject matter of remand – Not sustainable – Matter remanded to Tribunal

The assessee carried on the business of equipment leasing. Pursuant to a search, a notice was issued to it u/s 158BC for the block period 1986-87 to 1996-97 and the assessee filed its return of income. The A.O. held that the assessee had purchased the assets from one PLF at a higher value with a view to claim depreciation on the enhanced value as against the actual written down value in the books of accounts of PLF and restricted the depreciation to assets of value Rs. 1 crore. The Tribunal deleted the disallowance of depreciation and held in favour of the assessee.

The Department filed an appeal before the High Court against the order of the Tribunal. During the pendency of the appeal, the Court by an order directed the assessee to be wound up and appointed the official liquidator to take charge of its assets. The Court set aside the order of the Tribunal and remitted the matter to the Tribunal for fresh adjudication considering the amended provisions of section 158BB. The Tribunal thereupon passed an order with respect to the question of depreciation but did not adjudicate the ground raised by the assessee with regard to limitation on the ground that it was not the subject matter of the order of remand of the Court.

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

‘i) The order passed by the Tribunal had been set aside in its entirety by this Court. Therefore, it was open to the assessee to raise the plea of limitation.

ii) Since the Tribunal had not adjudicated the issue with regard to limitation, the order passed by the Tribunal insofar as it pertained to the finding with regard to the issue of limitation was quashed and the Tribunal was directed to decide the issue of limitation with regard to the order of assessment passed by the A.O. for the block period 1986-87 to 1996-97. It would be open to the parties to raise all contentions before the Tribunal on this issue.’

Appeal to High Court – Sections 92CA and 260A – Powers to disturb findings of fact recorded by Tribunal – Only upon specific question being raised as to their being perverse – Transfer pricing – Exclusion of comparables and depreciation on goodwill – High Court cannot go into facts

13 Principal CIT vs. Samsung R&D Institute Bangalore Pvt. Ltd. [2021] 431 ITR 615 (Karn) A.Y.: 2009-10 Date of order: 30th November, 2020

Appeal to High Court – Sections 92CA and 260A – Powers to disturb findings of fact recorded by Tribunal – Only upon specific question being raised as to their being perverse – Transfer pricing – Exclusion of comparables and depreciation on goodwill – High Court cannot go into facts

The assessee was a wholly-owned subsidiary of SECL and rendered software development services to its associate enterprises. In the A.Y. 2009-10 the assessee realised a net profit margin of 15.45% in respect of the international transactions with its associate enterprises. The Transfer Pricing Officer made a transfer pricing adjustment in respect of software development services and passed an order u/s 92CA which was incorporated by the A.O. in his order.

Before the Commissioner (Appeals) the assessee challenged the selection of the entity IL as comparable. The Commissioner (Appeals) excluded IL on account of its enormous size and bulk and partly allowed the appeal. The Tribunal directed the Transfer Pricing Officer to exclude certain companies from the list of comparables on the basis of functional dissimilarity. The Tribunal also held that the assessee was entitled to depreciation on goodwill.

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

‘i) The Tribunal is the final fact-finding authority and a decision of the Tribunal on the facts can be gone into by the High Court only if a question has been referred to it which says that the finding of the Tribunal is perverse.

ii) The issue whether the entity IL was comparable to the assessee and was functionally dissimilar was a finding of fact. The Commissioner (Appeals) had dealt with the findings recorded by the Transfer Pricing Officer and had been approved by the Tribunal by assigning cogent reasons. The findings were findings of fact.

iii) Even in the substantial questions of law, no element of perversity had either been pleaded or demonstrated. The Tribunal was justified in removing certain companies from the list of comparables on the basis of functional dissimilarity and in holding that the assessee was entitled to depreciation on goodwill.’

Appeal to Appellate Tribunal – Powers of Tribunal – Sections 253 and 254 and Rule 24 – No power to dismiss appeal on ground of non-prosecution – Duty to dispose of appeal on merits – Tribunal to restore appeal and afford opportunity of hearing to both parties

12 Rabindra Kumar Mohanty vs. Registrar ITAT [2021] 432 ITR 158 (Ori) A.Y.: 2009-10 Date of order: 18th March, 2020

Appeal to Appellate Tribunal – Powers of Tribunal – Sections 253 and 254 and Rule 24 – No power to dismiss appeal on ground of non-prosecution – Duty to dispose of appeal on merits – Tribunal to restore appeal and afford opportunity of hearing to both parties

The Income-tax Appellate Tribunal issued notice for hearing of the appeal filed by the assessee on 6th July, 2017. On that date, the authorised representative of the assessee filed an adjournment application and the case was placed for hearing on 30th August, 2017. However, on that date neither the assessee nor his authorised representative or his counsel was present. The Tribunal, therefore, dismissed the appeal for want of prosecution.

On a writ petition filed by the assessee the Orissa High Court held as under:

‘i) The Income-tax Act, 1961 enjoins upon the Appellate Tribunal to pass an order in an appeal as it thinks fit after giving both the parties an opportunity of being heard. It does not give any power to the Appellate Tribunal to dismiss the appeal for default or for want of prosecution in case the appellant is not present when the appeal is taken up for hearing.

ii) Article 265 of the Constitution of India mandates that no tax can be collected except by authority of law. Appellate proceedings are also laws in the strict sense of the term, which are required to be followed before tax can legally be collected. Similarly, the provisions of law are required to be followed even if the taxpayer does not participate in the proceedings. No assessing authority can refuse to assess the tax fairly and legally merely because the taxpayer is not participating in the proceedings. Hence, dismissal of appeals by the Income-tax Appellate Tribunal for non-prosecution is illegal and unjustified.

iii) Merely because a person is not availing of his right of natural justice it cannot be a ground for the Tribunal to refuse to perform its statutory duty of deciding the appeal. An appellate authority is required to afford an opportunity to be heard to the appellant.

iv) The Tribunal could not have dismissed the appeal filed by the assessee for want of prosecution and it ought to have decided the appeal on merits even if the assessee or its counsel was not present when the appeal was taken up for hearing. The Tribunal was to restore the appeal and decide it on the merits after giving both the parties an opportunity of being heard.’

Appeal to Appellate Tribunal – Powers of Tribunal – Sections 253 and 254 and Rule 24 – No power to dismiss appeal on ground of non-prosecution – Duty to dispose of appeal on merits – Appeals restored before Tribunal

11 Daryapur Shetkari Sahakari Ginning and Pressing Factory vs. ACIT [2021] 432 ITR 130 (Bom) A.Ys.: 2002-03 to 2004-05 Date of order: 24th November, 2020

Appeal to Appellate Tribunal – Powers of Tribunal – Sections 253 and 254 and Rule 24 – No power to dismiss appeal on ground of non-prosecution – Duty to dispose of appeal on merits – Appeals restored before Tribunal

For the A.Ys. 2002-03, 2003-04 and 2004-05, against the orders of the Commissioner (Appeals), the assessee had filed appeals before the Tribunal. The Tribunal dismissed all three appeals by a common order on the ground that none appeared on behalf of the assessee which meant that the assessee was not interested in prosecuting those appeals.

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

‘i) Rule 24 of the Income-tax (Appellate Tribunal) Rules, 1963 mandates that when an appeal is called for hearing and the appellant does not appear, the Tribunal is required to dispose of the appeal on merits after hearing the respondent.

ii) The order passed by the Tribunal dismissing the appeals in limine for non-appearance of the appellant-assessee holding that the assessee was not interested in prosecuting the appeals was unsustainable. The Tribunal was duty-bound to decide the appeals on the merits after hearing the respondent and the Department according to the mandate under Rule 24 of the 1963 Rules and in terms of the ratio laid down by the Supreme Court.

iii) The order of the Tribunal being contrary to Rule 24 of the 1963 Rules was quashed and set aside. The respective appeals were restored for adjudication on the merits before the Tribunal.’

Appeal to Appellate Tribunal – Section 254 of ITA, 1961 and Rule 24 of ITAT Rules, 1963 – (i) Application for recall of order – Tribunal dismissing appeal for non-prosecution – Duty of Tribunal to decide appeal on merits; (ii) Application for recall of order – Limitation – Amendment in law – First application for restoration of appeal dismissed for non-prosecution within period of limitation – Tribunal dismissing second application invoking amendment to section 254(2) – Erroneous

10 Pradeep Kumar Jindal vs. Principal CIT [2021] 432 ITR 48 (Del) A.Y.: 2008-09 Date of order: 19th February, 2021

Appeal to Appellate Tribunal – Section 254 of ITA, 1961 and Rule 24 of ITAT Rules, 1963 – (i) Application for recall of order – Tribunal dismissing appeal for non-prosecution – Duty of Tribunal to decide appeal on merits; (ii) Application for recall of order – Limitation – Amendment in law – First application for restoration of appeal dismissed for non-prosecution within period of limitation – Tribunal dismissing second application invoking amendment to section 254(2) – Erroneous

The assessee filed an application in March, 2017 before the Tribunal for recall of the order dated 10th December, 2015 dismissing its appeal for non-prosecution. The application was dismissed by the Tribunal in limine by an order dated 7th February, 2018. The Tribunal dismissed the assessee’s contention that between 8th and 10th December, 2015 he was ill and hence could not appear when the appeal was heard on 10th December, 2015, and held that u/s 254(2) as amended with effect from 1st June, 2016, any miscellaneous application had to be filed within six months from the date of the order and that, therefore, the application for restoration of the appeal dismissed on 10th December, 2015 was barred by limitation. Thereafter, the assessee filed another application on 26th February, 2018 for recall of the order dated 7th February, 2018 which was also dismissed by an order dated 23rd December, 2020 on the ground that a second application was not maintainable.

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

‘i) There was no adjudication by the Tribunal of the appeal on merits. Its order dated 10th December, 2015 dismissing the assessee’s appeal was for non-prosecution and not on merits, as it was required to do notwithstanding the non-appearance of the assessee when the appeal was called for hearing, was violative of Rule 24 of the Income-tax (Appellate Tribunal) Rules, 1963 and thus was void. The action of the Tribunal, of dismissing the appeal for non-prosecution instead of on merits and of refusal to restore the appeal notwithstanding the applications of the assessee, was not merely an irregularity. The Tribunal had erred in dismissing the first application of the assessee filed in March, 2017 for restoration of the appeal invoking the amendment to section 254(2) requiring application thereunder to be filed within six months and in not going into the sufficiency of the reasons given by the assessee for non-appearance.

ii) The application filed by the assessee in March, 2017 invoking Rule 24 of the 1963 Rules was within time and could not have been dismissed applying the provisions of limitation applicable to section 254(2).

iii) In view of the aforesaid, the petition is allowed. I.T.A. No. 3844/Del/2013 preferred by the petitioner before the Income-tax Appellate Tribunal is ordered to be restored to its original position, as immediately before 10th December, 2015, and the Tribunal is requested to take up the same for hearing on 15th March, 2021 or on any other date which may be convenient to the Income-tax Appellate Tribunal.’

Section 195 read with section 40(a)(i) – A payment may be treated as reimbursement, and consequently not be subject to TDS u/s 195, if it satisfies twin tests of: (a) one-to-one correlation between outflow and inflow of recipient; and (b) receipt and payment being of identical amount

2 TS-203 ITAT-2021 (Pune) BYK Asia Pacific Pte. Limited vs. ACIT ITA No: 2110/Pun/2019 Date of order: 24th March, 2021

Section 195 read with section 40(a)(i) – A payment may be treated as reimbursement, and consequently not be subject to TDS u/s 195, if it satisfies twin tests of: (a) one-to-one correlation between outflow and inflow of recipient; and (b) receipt and payment being of identical amount

FACTS
The assessee was the branch in India of a Singapore Company (Singapore HO). The Singapore HO was a subsidiary of a German parent company. The assessee was engaged in providing technical support services and testing facility to Asia-Pacific customers of the German parent – although it appears that such services were pursuant to an understanding with the Singapore HO. The assessee operated on cost-plus basis and recovered all its costs (including reimbursement) with a mark-up of 10%. The assessee was treated as a PE of the Singapore HO and was charged to tax on mark-up.

The assessee had made certain payments to Singapore HO which the HO had defrayed towards seminar, IT, training, printing expenses and staff welfare expenses for the assessee branch and which were claimed as deductions from income. Further, the branch had not deducted tax from the said payments on the ground that said payments were reimbursement of expenses. The A.O. disallowed payments u/s 40(a)(i). The DRP upheld the order of the A.O.

The aggrieved assessee appealed before the Tribunal.

HELD

  •  Section 195 applies only if amount is chargeable to tax in the hands of recipient. Chargeability presupposes some profit element. If the recipient merely recovers the amount spent by it, without any profit element, such recovery is reimbursement and not a sum chargeable to tax.
  •  Two conditions should co-exist to fall within reimbursement. First, one-to-one direct correlation between the outgo of the payment and inflow of the receipt must be established. Second, receipt and payment should be of identical amount.
  •  The first condition is satisfied when at the time of incurring the amount is directly identifiable as payment made for the benefit of the other.
  •  The second condition is satisfied when repayment of the amount originally spent is made without any mark-up.
  •  The assessee had provided back-to-back invoices of identical amounts in respect of payments made towards seminar, training and printing expenses. Accordingly, such payments were in the nature of reimbursement of expenses. Consequently, the assessee was not required to deduct tax from the same u/s 195.
  •  As regards IT expenses, it was observed that payments were made on monthly basis. The assessee had contended that payments were apportionment of head office expenditure to the assessee at cost. While the burden of proving ‘reimbursement’ is on the assessee, the assessee had not placed any agreement or evidence on record in support of its contention. Hence, the payments could not be said to be in the nature of reimbursement of expenses. Therefore, the matter was remanded to the A.O. for examining the true nature of the payment.

Note – It is not clear why ‘make available’ argument was not advocated in respect of monthly reimbursements.

 

Sections 22, 56 – Since the nature of services provided by the assessee to the tenants / lessees was linked to the premises and was in the nature of the auxiliary services which were directly linked to the leasing of the property, gross receipts on account of amenities / services provided by the assessee to its tenants are chargeable to tax under the head ‘Income from House Property’ and not ‘Income from Other Sources’

5 ACIT vs. XTP Design Furniture Ltd. Pramod Kumar (V.P.) and Saktijit Dey (J.M.) ITA No. 2424/Mum/2019 A.Y.: 2013-14 Date of order: 19th January, 2021 Counsel for Assessee / Revenue: None / T.S. Khalsa

Sections 22, 56 – Since the nature of services provided by the assessee to the tenants / lessees was linked to the premises and was in the nature of the auxiliary services which were directly linked to the leasing of the property, gross receipts on account of amenities / services provided by the assessee to its tenants are chargeable to tax under the head ‘Income from House Property’ and not ‘Income from Other Sources’

FACTS
The assessee had leased its office premises at Unit Nos. 201, 301 and 401 in Peninsula Chambers to Group Media Pvt. Ltd. and Hindustan Thompson Associates Ltd. The assessee had given the lessees additional common facilities like lift, security, fire-fighting system, common area facilities, car parking, terrace use, water supply, etc. The assessee charged license fees and also amenities fees. Both these amounts were offered by the assessee for taxation under the head ‘Income from House Property’. The A.O. taxed the license fees under the head ‘Income from House Property’, whereas the amenities fees were taxed by him as ‘Income from Other Sources’.

Aggrieved, the assessee preferred an appeal to the CIT(A) who, following the decision of the Tribunal in the assessee’s own case for A.Ys. 2009-10 and 2010-11, decided the appeal in favour of the assessee.

Aggrieved, the Revenue preferred an appeal to the Tribunal.

HELD
The Revenue fairly accepted that the issue under consideration is clearly covered by the decision of the Tribunal, in the assessee’s own case, for A.Ys. 2009-10 and 2010-11 in favour of the assessee. The Tribunal noted that the CIT(A) has decided the issue by following these decisions of the Tribunal wherein for the A.Y. 2009-10 the Tribunal has held as under:

‘We find that the nature of services provided by the assessee to the tenants / lessees were linked to the premises and were in the nature of the auxiliary services which were directly linked to the leasing of the property. Since there is a direct nexus between the amenities and leased premises, the CIT(A) has rightly directed the A.O. to treat the income from amenities under the head, “Income from House Property”’.

The Tribunal while deciding the appeal for A.Y. 2010-11, has in its order dated 9th February, 2016, concurred with the above view by holding that ‘the income of Rs. 4,38,61,486 received by the assessee company from amenities shall be chargeable to tax under the head “Income from House Property”.’

The Tribunal held that it found no reason to take any other view of the matter than the view taken by the co-ordinate bench. It held that there is no infirmity in the order of the CIT(A) in deciding the issue in favour of the assessee in consonance with the decision of the co-ordinate bench.

‘YATHECHCHHASI TATHA KURU’ | DO AS YOU WISH

‘YATHECHCHHASI TATHA KURU’ | DO AS YOU WISH
Giving advice is an integral part of our profession. For that matter, every person, whether a professional or not, has to act as a consultant in some way or other. As a brother, sister, parent, friend, teacher, elderly person, colleague and so on, everyone gives some kind of advice to others.

The ‘title’ above is picked from the greatest advice ever given by anybody in human history – the Shreemad Bhagawad Geeta. As you know, the Bhagawad Geeta is the advice given by Lord Shreekrishna to his favourite and most intelligent disciple, Arjun. It contains 700 shlokas (rhymes) full of philosophy and guidance useful for day-to-day life. Its supremacy in philosophical literature has been recognised by renowned scholars of all countries and religions. It is our true Indian philosophy not restricted to any religion as such.

What is the implication of this – ‘Do as you wish’? This is the 63rd shloka from the concluding, 18th Chapter of the Geeta. Bhagwaan says:

‘(Arjun), thus, I have narrated to you the full knowledge which is the secret of all secrets (deepest knowledge). After listening to all this and thinking over it, Do as you wish!’

Friends, this apparently simple sentence has a great message and teaching for all of us – not only for CAs but for everyone. In fact, this has been the guiding principle for me in not only the 40 years of my professional life, but in my personal life as well. It is capable of giving great peace of mind to us.

What is so great about it? Remember, it has been said by none other than Bhagwaan Shreekrishna whose preachings are considered to be impeccable and irrefutable. The philosophy is told on a battle-field. It symbolises our life which is a constant battle – between two thoughts, good versus evil. Yet, Bhagwaan is not over-insistent on what HE advised. He has no ego. He does not make it a prestige issue. He doesn’t sit on Arjun’s head and say that he should act only according to His advice. In fact, the greater the insistence, the more the resistance. He leaves it to Arjun’s discretion.

As against this, many of us are very possessive about our views. We feel that what we think is the only ultimate truth and that it is the only correct view.

Be it in a family, in office, in institutions or in social groups, everybody puts across his views vehemently on practically every subject ranging from politics, economics, cricket, Covid, interpretation of laws, etc., to social issues… I have seen CAs trying to prevail on their clients and imposing their advice on them.

This is one of the main reasons for disputes and misgivings. One has to understand one’s role. If one is an adviser or consultant and not the decision maker, one needs to stop at a certain stage. Try to express one’s honest views, explain with examples, put them in writing, wherever required, argue with an open mind, explain the consequences if one’s views are not accepted, point out that the advice is in the listener’s interest, but leave the decision to the other person. Just say, ‘I have explained my views. Now it is up to you to decide and act. If anything goes wrong, please don’t blame me’ and then see the results. This has a better impact!

Needless to say, when you know that the other person is weak, or not competent to decide, or dependent on you and you yourself have to face the consequences, the approach could be different. You have to use your discretion and adopt the appropriate strategy.

This ‘Do as you wish’ approach may also develop the decision-making ability of the person concerned, making him aware that the ultimate responsibility is his own. Further, our spiritual thought preaches ‘detachment’ or ‘absence of attachment’.

‘Do as you wish’ is a classic example of not being attached to your views.

Friends, these are my views. And after reading these, Do as you wish!

Section 244A – Refunds – Interest on – Where assessee, a contractor, followed project completion method of accounting and during A.Y.s. 2003-04 to 2005-06 it had received certain payments after deduction of tax at source and in the return of income filed for A.Y. 2005-06 it had disclosed payments received during three A.Y.s., 2003-04 to 2005-06 and AO passed assessment order and granted refund to assessee, on such refund, interest in terms of section 244A would be payable from respective assessment years

Principal CIT vs. Kumagai Skanska HCC ITOCHU Group; [2019] 102 taxmann.com 416 (Bom): Date of order: 29th January, 2019 A.Y.s..: 2003-04 to 2005-06

Section 244A – Refunds – Interest on – Where assessee, a contractor, followed project completion method of accounting and during A.Y.s. 2003-04 to 2005-06 it had received certain payments after deduction of tax at source and in the return of income filed for A.Y. 2005-06 it had disclosed payments received during three A.Y.s., 2003-04 to 2005-06 and AO passed assessment order and granted refund to assessee, on such refund, interest in terms of section 244A would be payable from respective assessment years

The assessee was engaged in the business of civil construction. It followed the project completion method of accounting to offer its income to tax. During the A.Y.s. 2003-04, 2004-05 and 2005-06, it had received certain payments as a contractor on which the payer had deducted tax at source. In the return of income filed for A.Y. 2005-06, it had declared a certain loss. In the said return, it had claimed the income relatable to the payments made during the said year as well as during the earlier two A.Y.s. 2003-04 and 2004-05.

The assessment order passed by the Assessing Officer gave rise to refund. The assessee contended before the Assessing Officer that on such refund interest in terms of section 244A would be payable from the respective assessment years. The Assessing Officer held that the income in relation to the payments on which tax was deducted at source was returned by the assessee in the A.Y. 2005-06 and, therefore, interest could not be   paid on the refund for any period prior to the said assessment year.

The Tribunal held in favour of the assessee.

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

“i)  Section 244A pertains to interest on refunds. In the instant case, the assessee’s case falls under clause (a) of sub-section (1) of section 244A. Clause (a) of sub-section (1) of section 244A covers situations where the refund is out of any tax collected at source or paid by way of advance tax or treated as paid u/s. 199. This reference to treat tax as paid u/s. 199 would clearly cover the tax deducted at source. In the instant case, the assessee had suffered deduction of tax at source at the time of payments. In that view of the matter, the case of the assessee would clearly be covered under clause  (a) to sub-section (1) of section 244. In such a situation, this clause provides that interest shall be calculated at the rate of 1/2 per cent for every month or part thereof, comprising a period from the 1st day of April of the assessment year to the date on which the refund is granted, provided the return is filed before the due date, specified in sub-section (1) of section 139.

ii)  Here the reference ‘from the 1st day of April of the assessment year’, which is the starting point for computing the interest payable, must be to the assessment year in which the tax was deducted at source. This expression has to be read along with the main body of clause (a) which refers to the refund arising out of,  inter alia, the tax treated to have been paid as per section 199. Any other view would be held untenable, since the Revenue which has received the tax deducted at source from the payments to be made to the assessee and appropriated the same would refund the same but the interest would be accounted much later when the return giving rise to the refund is filed.

iii)  In view of the aforesaid, the Tribunal had not committed any error. The appeal filed by the Revenue deserved to be dismissed.”

Section 54F – Even after amendment w.e.f. A.Y. 2015-16, investment of long-term capital gain in two bungalows located adjacent to each other and used as one residential unit qualifies for exemption u/s 54F – Benefit of exemption could not have been denied on reasoning that there were two different registries of buildings / properties as both properties purchased by assessee were a single property located in same geographical area

7. [2020] 114 taxmann.com 508 (Ahd.)(Trib.)

Mohammadanif Sultanali Pradhan vs. DCIT

ITA No. 1797/Ahd/2018

A.Y.: 2015-16

Date of order: 6th January, 2020

 

Section 54F – Even after amendment w.e.f. A.Y. 2015-16,
investment of long-term capital gain in two bungalows located adjacent to each
other and used as one residential unit qualifies for exemption u/s 54F –
Benefit of exemption could not have been denied on reasoning that there were
two different registries of buildings / properties as both properties purchased
by assessee were a single property located in same geographical area

 

FACTS

During the previous year relevant to the A.Y. 2015-16, the
assessee in his return of income declared income under the head capital gain at
Rs. 23,84,101 after claiming exemption u/s 54F for Rs. 1,08,00,000. In support
of the exemption claimed, the assessee contended that he has made investment in
two bungalows which are adjacent to each other, bearing Nos. 18 and 19 located
at survey No. 606/2, TPS No. 92, Sarkhej – Makarba – Okaf – Fatewadi of Mouje
Sarkhej, taluka Vejalpur, district Ahmedabad.

 

The A.O. was of the view that the assessee can claim
exemption u/s 54F with respect to the investment in one bungalow only.
Accordingly, he computed the exemption with respect to one bungalow only
amounting to Rs. 43,77,118 and thus disallowed the excess claim u/s 54F of Rs.
64,22,882.

 

Aggrieved, the assessee preferred an appeal to the CIT(A) and
submitted that both the bungalows are in the same society, adjacent to each
other. As such both the bungalows are one unit for residential purposes.
Therefore, he claimed that he is entitled to deduction / exemption for both the
bungalows u/s 54F.

 

The CIT(A) rejected the claim of the assessee on the ground
that there is an amendment under the provisions of section 54F of the Act where
the expression previously used, ‘a residential house’, has been substituted
with ‘one residential house’. Such amendment is effective with effect from A.Y.
2015-16, i.e., the year under consideration.

 

Aggrieved, the assessee preferred an appeal to the Tribunal.

 

HELD

The Tribunal observed that:

(i) the
issue relates to whether the assessee is eligible for exemption u/s 54F of the
Act against the long-term capital gain for the investment made in the two
properties which are adjacent to each other and used as one residential unit.
It noted that indeed, the provision of the law requires that the exemption will
be available to the assessee u/s 54F for the investment in one residential
unit;

 

(ii) under
the provisions of section 54F, there is no definition / clarification provided
about the area of the residential property. It means that one assessee can buy
a huge bungalow / property of, say, one thousand square metres and can claim
the deduction subject to conditions. Similarly, another assessee acquired two
different residential properties adjacent to each other but both the properties
put together were only two hundred square metres – but he will be extended the
benefit of the exemption with respect to one unit only because there are two
different properties based on registry documents;

 

(iii) there can be a situation that the family of the assessee is quite
large, comprising of several members, and therefore he needs two properties
adjacent to each other to accommodate them. So from the point of view of the
assessee it is a single property but he got two different properties registered
as per the requirement of the builder;

 

(iv) the
assessee cannot be deprived of the benefit conferred under the statute merely
on the reasoning that there were two different registries of the buildings /
properties;

 

(v) it
is also not a case of the Revenue / assessee that both the properties purchased
by the assessee were located in different geographical areas. In such a
situation the law amended u/s 54F appears to be applicable where the assessee
buys two properties in two different areas;

 

(vi) the
principles laid down by the courts cannot be just brushed aside on the aspect
of defining one residential unit. It noted the observations of the Hon’ble High
Court of Karnataka in the case of CIT vs. D. Ananda Basappa [(2009) 309
ITR 329]
.

 

The Tribunal held that the assessee
is entitled to claim exemption u/s 54F in respect of investment made in two
adjacent bungalows used as one residential unit. The Tribunal deleted the
addition made by the A.O. and confirmed by the CIT(A).

 

This ground of appeal filed by the assessee was
allowed.

INTERPLAY BETWEEN DEEMING FICTIONS OF SECTIONS 45(3) AND 50C

ISSUE FOR
CONSIDERATION

Section
45(3) of the Act provides for taxation of the capital gains on transfer of a capital
asset by a person to a firm in which he is or becomes a partner, by way of
capital contribution or otherwise, in the year of transfer and further provides
that the amount recorded in the books of accounts of the firm shall be deemed
to be the full value of the consideration received or accruing as a result of
such transfer of the capital asset for the purposes of section 48. Section 50C
of the Act provides that the value adopted or assessed or assessable by the
stamp valuation authority for the purpose of payment of stamp duty in respect
of transfer of a capital asset, being land or building or both, shall for the
purposes of section 48 be deemed to be the full value of the consideration
received or accruing as a result of such transfer if it is higher than its
actual consideration.

 

Whether both
the aforesaid provisions of the Act can be made applicable in a case where the
capital asset transferred by a partner to his firm by way of his capital
contribution is land or building or both is the issue that is sought to be
examined here. Whether for the purposes of section 48 the full value of
consideration should be the amount as recorded in the books of the firm in
accordance with the provisions of section 45(3), or whether it should be the
value as adopted or assessed or assessable by the stamp valuation authority in
accordance with the provisions of section 50C? Whether in computing the capital
gains, the higher of the two is to be adopted or not?

 

The Lucknow
bench of the Tribunal has held that the provisions of section 50C shall prevail
over the provisions of section 45(3) in a case where the stamp duty value was
higher than the value recorded in the books of the firm. As against this, the
Mumbai, Kolkata, Hyderabad and Chennai benches of the Tribunal have held that
the provisions of section 45(3), ignoring the provisions of section 50C, alone
can apply in a case where land or building has been introduced by a partner by
way of his capital contribution.


THE CARLTON HOTEL
(P) LTD. CASE

The issue
first came up for consideration of the Lucknow bench of the Tribunal in the
case of Carlton Hotel (P) Ltd. vs. ACIT 35 SOT 26 (Lucknow) (URO).
In this case, during the previous year relevant to A.Y. 2004-05 the assessee
company entered into a partnership with two other persons. The assessee company
contributed 2,40,000 sq. ft. of land as its capital contribution which was
valued at Rs. 7,81,96,735 and was so recorded in the books of the partnership
firm. The assessee was given 5% share in the partnership firm, whereas the
other two partners were given 95% share.

 

For the
purposes of computing capital gains in the hands of the partner assessee on
transfer of the land to the partnership firm, the A.O. invoked the provisions
of section 50C and applied circle rates for the purpose of calculating the
consideration for transfer. He valued the consideration at Rs. 29,75,46,468
instead of Rs. 7,81,96,735 and on that basis he calculated the long-term
capital gains. The A.O. inter alia doubted the genuineness of the
introduction of land and noted that the assessee has contributed 88% of capital
in lieu of only 5% share in profits which was beyond the normal business
prudence and the transfer of the land to the firm was as good as a sale. For
the purpose of holding so, he referred to the clauses of the partnership deed
and observed that the assessee had little role to play in the partnership
business, the assessee was not a managing partner in the firm, construction on
the plot was to be carried out by another partner of the firm, the assessee was
not having any civil, criminal or financial liability, the business of the
partnership was to be exclusively carried out by other partners of the firm,
the bank account could be independently operated only by the other two
partners, whereas the assessee could operate only with joint signatures of the
other two partners; it was only the other partners who had been empowered to
introduce new partners, the assessee did not have any right over the goodwill
of the firm, was not authorised to make any change in the composition of the
board which had controlling interest in its share capital, etc.

 

Thus, the A.O. alleged that the
assessee had adopted a device to evade capital gains tax by showing lower value
of sale consideration in the books of the firm, whereas the actual market value
of the land was much higher as reflected from the circle rate. He relied on the
decisions of the Supreme Court in the case of McDowell & Co. Ltd. vs.
CTO 154 ITR 148
for the proposition that if an assessee adopts a tax
avoidance scheme, then the form can be ignored. Thus, by taking the substance
of the transaction into consideration, the market value of the land transferred
to the firm as capital contribution was adopted by invoking section 50C,
contending that mere reliance on section 45(3) in isolation would defeat the
intent and purpose of the taxing statute.

 

Importantly, the A.O. also took a
view that section 50C was applicable even in a situation covered by section
45(3). The A.O., ignoring the facts that the transfer of land as capital
contribution was not through a registered document and that the provisions of
section 50C were amended only thereafter to rope in even the transfer of
immovable property otherwise than through a registered document, applied the provisions
of section 50C.

 

Upon further appeal, the CIT(A)
confirmed the order of the A.O. confirming that the value adopted by the
assessee for transferring the land to the firm was a collusive one and that the
provision of section 50C being a specific provision was applicable even where
provisions of section 45(3) had been invoked.

 

Upon further appeal to the
Tribunal, it was contended on behalf of the assessee that the provisions of
section 45(3) and section 50C were mutually exclusive; where section 45(3) was
applicable, section 50C would not be applicable and vice versa. It was
further submitted that section 45(3) created a deeming fiction whereby the
consideration recorded by the firm in its books was deemed to be the full value
of consideration for the purpose of computing capital gains. Section 50C was
another deeming section which empowered the A.O. to substitute the valuation
done by the stamp valuation authority as sale consideration in place of
consideration shown by the parties to the transaction. Once one deeming section
was invoked, another deeming section could not be made to nullify the effect of
the earlier deeming section. The application of section 50C in such a situation
would render section 45(3) otiose. Regarding the allegation that the assessee
had entered into a collusive transaction and accordingly had shown lower value
of consideration in the books of the firm, it was submitted that the firm would
be paying tax upon its further sale by adopting the value of land as recorded
in the books and, hence, there would not be any revenue loss.

 

On the other hand, the Revenue
supported the order of the A.O. and the CIT(A) and claimed that the form of the
transaction had to be ignored and its substance had to be considered, since the
assessee had entered into a collusive transaction.

 

The Tribunal
for the reasons recorded in the order rejected one of the contentions of the
Revenue that since section 50C required adoption of the circle rates for the
purpose of levy of the stamp duty which rates, once declared, could be
‘adopted’ for the purpose of substituting the full value of consideration for
section 48 and it was not necessary that the document for transfer of asset was
actually registered before invoking section 50C.

 

On the issue under consideration,
however, the Tribunal held that the provisions of section 50C could be invoked
even though the case was otherwise covered under section 45(3); section 50C
would override section 45(3). Section 45(3) was a general provision, while
section 50C was a special provision which would override section 45(3). In the
final analysis, however, the Tribunal rejected the action of the A.O. in
applying the provisions of section 50C on the ground of non-registration and
non-payment of the stamp duty.

 

It may be noted for the record
that the Revenue had filed a further appeal before the Allahabad High Court
against the decision of the Tribunal mainly for pleading that the transaction
was a colourable transaction executed with the intention to evade the tax
liability. And the High Court upholding the contention held that there existed all
the facts and circumstances to show prima facie that the entire
transaction of contribution to partnership was a sham and fictitious
transaction and an attempt to devise a method to avoid tax and remanded the
matter back to the Tribunal to look into this aspect of the matter, which was
an issue directly raised by the Revenue right from the stage of assessment. No
findings have been given by the High Court with respect to the issue of
applicability of section 50C to the transaction of introduction of capital
asset by the partner in the firm which is otherwise covered by section 45(3).


AMARTARA PVT. LTD.
CASE

Thereafter,
the issue came up for consideration of the Mumbai bench of the Tribunal in DCIT
vs. Amartara Pvt. Ltd. 78 ITR (Trib.)(S.N.) 46 (Mum).

 

In this
case, during the previous year relevant to A.Y. 2012-13 the assessee entered
into a limited liability partnership with the object of developing,
constructing and operating resorts, hotels and apartment hotels and / or for
carrying out such other hospitality businesses. The assessee transferred an
immovable property, being a plot of land admeasuring 6,869.959 metres situated
at Powai, Mumbai, as its capital contribution to the newly-created LLP vide
a supplementary agreement dated 29th December, 2011.

 

The said
plot of land was valued at Rs. 5.60 crores on the basis of the valuation report
obtained and it was recorded at that value in the books of the LLP. The
assessee, while computing capital gains on transfer of land into the
partnership firm in accordance with the provisions of section 45(3), had taken
the value as recorded in the books of the firm, i.e., Rs. 5.60 crores, as the
full value of the consideration deemed to have been received or accrued as a
result of transfer of capital asset to the partnership firm. The supplementary
agreement through which the said plot of land was introduced by the assessee
into the LLP was registered on 24th April, 2012 and the stamp duty
authority had determined the market value of the property for the purpose of
payment of stamp duty at Rs. 9,41,78,500.

 

The A.O.
invoked the provisions of section 50C and adopted the amount of Rs.
9,41,78,500, being the value determined by the stamp valuation authority at the
time of registration of the supplementary partnership deed, as the full value
of consideration for the purpose of computing capital gains. He observed that
the provisions of section 45(3) did not begin with a non-obstante clause
and, therefore, there was no specific mention of non-applicability of section
50C in the cases covered by section 45(3). He also relied upon the Lucknow
Tribunal decision in the case of Carlton Hotel (P) Ltd. (Supra)
for the proposition that section 50C, being a specific provision, would
override the provisions of section 45(3). The CIT(A) confirmed the order of the
A.O. by following the said decision in the case of Carlton Hotel (P) Ltd.
(Supra).

 

On further
appeal before the Tribunal, the assessee contended that sections 45(3) and
45(4) were special provisions for computation of capital gains on transfer of
capital assets between the partnership firm and the partners and that both the
provisions were deeming fictions created for the purpose of taxation of
transfers of capital assets in such special cases; importing another deeming
fiction to determine the full value of consideration in such special cases was
incorrect in view of the decision of the Hon’ble Supreme Court in the case of CIT
vs. Moon Mills Ltd. 59 ITR 574.
It was submitted that the decision
rendered by the Lucknow bench of the Tribunal was per incuriam, in the
light of the decision of the Hon’ble Supreme Court in the case of CIT vs.
Moon Mills Ltd. (Supra),
as per which a deeming fiction could not be
extended by importing another deeming fiction for the purpose of determination of
the full value of consideration.

 

It was also
contended on behalf of the assessee that section 50C of the Act had no
application where no consideration was received or accrued, and hence,
computing full value of consideration by applying the provisions of section 50C
in a case where there was a transfer between partners and the partnership firm
without there being any actual consideration received or accrued, was
incorrect.

 

In reply,
the Revenue heavily relied upon the said decision of the Lucknow bench of the
Tribunal in the case of Carlton Hotel (P) Ltd. (Supra) and
contended that section 50C overrode the provisions of section 45(3) once the
document of transfer was registered as per the provisions of the Registration
Act, 1908 and the stamp duty was paid for the registration of such document.

 

The Tribunal held that the
purpose of insertion of section 45(3) was to deal with cases of transfer
between a partnership firm and partners and in such cases the Act provided for
the computation mechanism of capital gains and also provides for consideration
to be adopted for the purpose of determination of full value of consideration.
Since the Act itself provided for deeming consideration to be adopted for the
purpose of section 48 of the Act, another deeming fiction provided by way of
section 50C could not be extended to compute the deemed full value of
consideration as a result of transfer of capital asset. It held that the
Lucknow bench had simply observed that the provisions of section 50C overrode
the provisions of section 45(3) but had not given a categorical finding.
Accordingly, the addition made towards the long-term capital gain by invoking
the provisions of section 50C
was deleted.

 

This decision of the Mumbai bench
of the Tribunal has been subsequently followed by the Tribunal in the cases of ACIT
vs. Moti Ramanand Sagar (ITA No. 2049/Mum/2017); ACIT vs. Kethireddy Venkata
Mohan Reddy (ITA No. 259/Hyd/2019); and ITO vs. Sheila Sen (ITA No.
554/Kol/2016).

 

OBSERVATIONS

The issue
under consideration arises due to two conflicting provisions of the Act which
can be invoked for a given transaction wherein the capital asset transferred by
a partner to his firm, as a capital contribution or otherwise, is land or
building. Section 45(3) provides for the amount recorded in the books of
accounts of the firm as deemed consideration. Section 50C provides for the
value adopted, assessed or assessable by stamp valuation authorities as deemed
consideration, if it exceeds the consideration received or accruing. Thus, both
the provisions deal with the determination of the full value of consideration
for the purpose of computation of capital gains by creating a deeming fiction.
Apart from considering the legislative intent behind both the provisions in
order to resolve the conflict between these two provisions, there are various
other aspects which are also required to be considered, like whether two
deeming fictions can operate simultaneously with respect to the same component
of the computation; whether one of these two provisions can be considered as a
general provision and the other one as a special provision whereby it can
override the general one; and which one will prevail if both the provisions are
required to be considered as special provisions.

 

Sub-section (3) was inserted in
section 45 by the Finance Act, 1987 with effect from A.Y. 1988-89. Prior to the
insertion of sub-section (3), the issue of taxability of the transfer of
capital asset by a partner to his firm was decided by the Supreme Court in the
case of Sunil Siddharthbhai vs. CIT 156 ITR 509. In this case,
the Supreme Court held that when the assessee brought his personal assets into
the partnership firm as his contribution to the capital, there was a transfer
of a capital asset within the meaning of the terms of section 45. This was
because the asset which was, till the date of such bringing in as firm’s
capital, an individual asset, after bringing it in became a shared asset. The
Supreme Court further held that the transfer of asset by the partner to the
firm as capital contribution would not necessarily result in receipt of any
consideration by the assessee so as to attract section 45 and the credit entry
made in the partner’s capital account in the books of the partnership firm did
not represent the true value of consideration. It was a notional value only,
intended to be taken into account at the time of determining the value of the
partner’s share in the net partnership assets on the date of dissolution or on
his retirement.

Therefore,
according to the Supreme Court, it was not correct to hold that the
consideration which a partner acquires on making over his personal asset to the
partnership firm as his contribution to its capital can fall within the
provisions of section 48. Since section 48 was fundamental to the computation
machinery incorporated in the scheme relating to determination of charge
provided in section 45, the Supreme Court held that such a case must be
regarded as falling outside the scope of capital gains taxation altogether.

 

It was in
this background that the legislature had introduced a specific provision so as
to bring the transfer of the capital asset by a partner to his firm to tax, as
is evident from Circular No. 495 dated 22nd September, 1987, the
extract from which is reproduced below:

 

Capital
gains on transfer of firms’ assets to partners and
vice versa and by way of compulsory acquisition

24.1 One of
the devices used by assessees to evade tax on capital gains is to convert an
asset held individually into an asset of the firm in which the individual is a
partner. The decision of the Supreme Court in
Kartikeya V. Sarabhai vs. CIT [1985] 156 ITR 509 has set at rest the controversy as to whether such a conversion amounts
to transfer. The Court held that such conversion fell outside the scope of
capital gains taxation. The rationale advanced by the Court is that the
consideration for the transfer of the personal asset is indeterminate, being
the right which arises or accrues to the partner during the subsistence of the
partnership to get his share of the profits from time to time and on
dissolution of the partnership to get the value of his share from the net
partnership assets.

 

24.2 With a
view to blocking this escape route for avoiding capital gains tax, the Finance
Act, 1987 has inserted new sub-section (3) in section 45. The effect of this
amendment is that profits and gains arising from the transfer of a capital
asset by a partner to a firm shall be chargeable as the partner’s income of the
previous year in which the transfer took place. For purposes of computing the
capital gains, the value of the asset recorded in the books of the firm on the
date of the transfer shall be deemed to be the full value of the consideration
received or accrued as a result of the transfer of the capital asset.

 

In view of
the above, it is clear that but for the specific provision of section 45(3),
the transfer of any capital asset by a partner to his firm could not have been
charged to tax under the head capital gains. In addition to providing for the
chargeability, section 45(3) also addresses the lacuna of the inability of
section 48 to cover such transfer within its ambit which was noticed by the Supreme
Court in the case of Sunil Siddharthbhai (Supra), by deeming the
amount recorded in the books of accounts of the firm as the full value of
consideration received or accruing as a result of such transfer.

 

Therefore,
it is obvious that section 45(3) needs to be invoked in order to charge the
capital gains tax in respect of transfer of a capital asset by a partner to his
firm. Having invoked the provisions of section 45(3) for the purpose of
chargeability, it needs to be applied in full and the alteration in the
computation mechanism as provided in that section also needs to be considered.
It would not be possible to invoke the provisions of section 45(3) only for the
purpose of creating a charge and, then, compute the capital gain in accordance
with the other provision, i.e., section 50C, by ignoring the computational
aspect of section 45(3) altogether.

 

The Mumbai
bench of the Tribunal in the case of ACIT vs. Prem Sagar (ITA No.
7442/Mum/2016)
has held that both the limbs of section 45(3), i.e.,
charging provision and deeming fiction providing for the full value of
consideration, go hand in hand for facilitating quantification of the capital
gains tax. In case the quantification of the capital gains tax as envisaged in
section 45(3) is substituted by section 50C, then the charging to tax of the
transaction under consideration would in itself stand jeopardised and the
section would be rendered inoperative.

 

Having said
that the computation of capital gains needs to be made in accordance with the
provisions of section 45(3), the question may arise as to whether the amount of
consideration as decided in accordance with it can then be amended by invoking
the provisions of section 50C, in a case where the valuation adopted, assessed
or assessable by the stamp valuation authority is found to be higher than the
amount recorded in the books of the firm. For the purpose of section 50C the
comparison is required to be made between the consideration received or
accruing as a result of the transfer of the capital asset and the value
adopted, assessed or assessable by the stamp valuation authority for the
purpose of payment of stamp duty in respect of such transfer. Here, the
consideration received or accruing should be the real consideration received or
accruing, and not the consideration which is deemed to have been received or
accrued. This is because the expression ‘the consideration received or accruing
as a result of the transfer’ cannot be construed to include the consideration
deemed to have been received or accrued.

Wherever
required, the legislature has included a specific reference to something which
has been deemed to be so, in addition to the reference of the same thing in
simple terms. For example, section 9 provides for incomes which shall be deemed
to accrue or arise in India under certain circumstances. For the purpose of
including such income which is deemed to accrue or arise in India within the
scope of total income, clause (b) of section 5(1) makes specific reference to
it in addition to referring to the income which accrues or arises (in real and
not on deemed basis). The relevant clause is reproduced below:

 

(b) accrues
or arises or is deemed to accrue or arise to him in India during such year

 

There was no
need to make such a specific reference to the income which is deemed to accrue
or arise in India, if a view is taken that the income which accrues or arises
in India will in any case include the income which is deemed to accrue or arise
in India. As a corollary, the expression ‘the consideration received or
accruing as a result of the transfer’ as used in section 50C cannot include the
consideration deemed to be received or accrued in terms of the provisions of
section 45(3).

 

Further,
section 45(3) deems the amount recorded in the books of accounts of the firm as
a consideration only for the purpose of section 48. Therefore, the deeming
fiction created in section 45(3) has limited applicability and it cannot be
extended to section 50C, to deem the amount so recorded in the books of
accounts of the firm as consideration received or accruing for the purpose of
making its comparison with the valuation adopted, assessed or assessable by the
stamp valuation authorities. As a result, the provisions of section 50C cannot
be made applicable to the transfer of a capital asset by a partner to his firm
for which the true value of consideration received or accruing cannot be
determined, as held by the Supreme Court in the case of Sunil
Siddharthbhai (Supra).

 

The Supreme
Court in the case of CIT vs. Moon Mills Ltd. 59 ITR 574 has held
that one fiction cannot be imported within another fiction. Two different
provisions of the Act are providing for a fiction by deeming certain amounts as
the full value of consideration for the purpose of computation of capital gains
as per section 48. Section 45(3) deems the amount recorded in the books of the
firm as the full value of consideration and section 50C deems the value
adopted, assessed or assessable by the stamp valuation authority as the full
value of consideration. If section 50C has been made applicable over the amount
deemed to be the full value of consideration in terms of section 45(3), then it
will amount to superimposing a fiction upon a fiction – which would be contrary
to the decision of the Supreme Court.

 

In the case
of ITO vs. United Marine Academy 130 ITD 113 (Mum)(SB), a special
bench of the Tribunal has dealt with the interplay of deeming fictions as
provided in sections 50 and 50C and has observed as under:

 

For the
reasons given above and on interpretation of the relevant provisions of
sections 48, 50 and 50C, we are of the view that there are two deeming fictions
created in section 50 and section 50C. The first deeming fiction modifies the
term ‘cost of acquisition’ used in section 48 for the purpose of computing the
capital gains arising from transfer of depreciable assets, whereas the deeming
fiction created in section 50C modifies the term ‘full value of the
consideration received or accruing as a result of transfer of the capital
asset’ used in section 48 for the purpose of computing the capital gains
arising from the transfer of capital asset being land or building or both. The
deeming fiction created in section 50C thus operates in a specific field which
is different from the field in which section 50 is applicable. It is thus not a
case where any supposition has been sought to be imposed on any other
supposition of law. On the other hand, there are two different fictions created
into two different provisions, and going by the legislative intentions to create
the said fictions, the same operate in different fields. The harmonious
interpretation of the relevant provisions makes it clear that there is no
exclusion of applicability of one fiction in a case where another fiction is
applicable. As a matter of fact, there is no conflict between these two legal
fictions which operate in different fields and their application in a given
case simultaneously does not result in imposition of one supposition on another
supposition of law.

 

Thus,
insofar as transfer of an asset forming part of a block is concerned, the
Tribunal has held that both the provisions of the Act, i.e. sections 50 and
50C, can operate simultaneously. This is primarily for the reason that they
operate in different fields of the computation of capital gains. It was
categorically observed by the Tribunal that it was not a case where any
supposition has been sought to be imposed on another supposition of law.
Therefore, the inference which can be drawn indirectly on the basis of these
observations of the special bench is that two deeming fictions cannot operate
simultaneously if they operate in the same field like in the issue under
consideration.

 

It is also a
settled principle of interpretation that if a special provision is made on a
certain matter, the matter is excluded from the general provisions. This
principle is expressed in the maxims Generalia specialibus non derogant
(general things do not derogate from special things) and Generalibus
specialia derogant
(special things derogate from general things).

 

However, it won’t be correct to
claim here that either of the two sections is a special one and, hence, it
overrides the other. Section 45(3) is a special provision insofar as
computation of capital gains resulting from capital contribution made by a
partner to the firm is concerned, and section 50C is a special provision
insofar as transfer of immovable property is concerned. Therefore, the issue
can better be resolved having regard to the other considerations as discussed
instead of merely relying upon these principles of interpretation.

 

In Canora
Resources Ltd., In Re 180 Taxman 220
, the AAR was dealing with a case
where the transfer pricing provisions contained in sections 92 to 92F were also
becoming applicable to the transaction of the type which was covered by section
45(3). In this case, the AAR rejected the contention of the assessee that
section 45(3) being a special provision shall prevail over the general
provisions of sections 92 to 92F with regard to the transfer pricing.
Considering the purpose for which the transfer pricing provisions have been
made, the AAR held that section 45(3) would not apply to international
transactions and they should be dealt with in accordance with the transfer
pricing provisions. Insofar as such purposive interpretation is concerned with
respect to the issue under consideration, recently, the Chennai bench of the
Tribunal in the case of Shri Sarrangan Ashok vs. ITO (ITA No.
544/Chny/2019)
has held that had it been the intention of the
legislature to make section 50C applicable even to the transaction of the
contribution of immovable property by a partner into the firm, the Parliament
could have repealed section 45(3) while introducing the provisions of section
50C. However, the fact that Parliament in its wisdom had retained section 45(3)
shows that Parliament intended to apply only the provisions of section 45(3) to
such transfer of capital assets by the partner to his firm.

 

The better view in our considered opinion, therefore,
is that the provisions of section 50C cannot be made applicable to a
transaction which falls within the scope of the provisions of section 45(3).

Domestic Tax Considerations Due To Covid-19

Background

The intensifying Covid-19
pandemic and the looming uncertainty on future business outlook have put the
emergency brakes on India Inc. Sudden lockdown, supply side disruption, adverse
foreign exchange rate, travel restriction as also uncertainty on vaccine to
cure the misery have added to the uncertainty, pushing Captains of India Inc.
into rescue mode. Clearly, while the immediate focus is to save the ship from
sinking, tax considerations also require due consideration in time to come.
This article focuses on some of the direct tax issues which are likely to be
faced by Indian taxpayers.

 

Deduction
of expenses incurred on Covid 19

As the pandemic increased its
spread into the country, India Inc. rose to the occasion and started supporting
various noble causes of the society in terms of supplying food, medical
supplies, setting up of quarantine centres, etc. Most of the corporates joined
hands in the national interest and contributed to PM CARES and CM Covid-19
Funds to support frontline workers and assist in the medical war. MCA, with a
noble intention, amended Schedule VII of the Companies Act, 2013 (‘Cos Act’) to
include Covid-19 expenditure as eligible CSR expenditure in compliance with CSR
law.

 

Explanation 2 to section 37(1) of
the Income-tax Act, 1961 (‘the Act’) provides that any expenditure incurred by
an assessee on the activities relating to corporate social responsibility referred
to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed
to be an expenditure incurred by the assessee for the purpose of the business
or profession.

 

The amendment to Schedule VII of
the Companies Act read with the Explanation 2 to section 37(1) of the Act
raises the following issues:

 

a)   Whether the expenditure on Covid-19 is tax deductible for an
assessee not required to comply with CSR regulations of the Companies Act,
2013?

b)   Can an assessee claim business expenditure for
Covid -19 related expenditure which he does not claim to be CSR for the purpose
of compliance with section 135 of Cos Act?

It is possible to take a view
that Explanation 2 to section 37(1) of the Act is applicable only to those
assessees who are covered by section 135 of the Companies Act. Thus, if an
assessee is not covered by the said regulation, the limitation of Explanation 2
to section 37 is not applicable. Courts have held that factors like meeting
social obligation, impact on goodwill on contribution to society, etc. meet the
test of commercial expediency and deduction has been granted1. Thus,
onus will be on the assessee to prove nexus of the expenditure with the
business and the positive impact on business to perfect the claim of deduction.
Branding of company on distribution of food and essential requirements, images
of employees wearing company branded shirts and supporting larger cause, media
reports, posting on social websites will all support the claim for deduction.

 

The issue arises in the second
category i.e. an assessee who is otherwise covered by section 135 of Companies
Act who does not claim Covid-19 related expenditure for compliance with CSR
laws. The difficulty arises as Explanation 2 to section 37(1) disallows
expenditure ‘referred to in section 135’. Referred to would mean ‘mentioned’ in
section 135 of the Companies Act. Explanation 2 to section 37(1) fictionally
deems such expenditure as not being for business purpose. Whilst argument in
favour of deduction seems a better view of the matter, it is recommended that
assessee should take fact-specific legal advise before claiming deduction.

 

Impact on lease rental

Lockdown and
social distancing are likely to have significant impact on lease rentals. The
impact may be deep for let-out properties in shopping malls and hotels.
Further, the sudden lockdown may have resulted in economic disruption of
business of the lessee, impairing its ability to pay rent. Following situations
are likely to arise:

 

a)   Lessee does not pay rent for lockdown period by invoking force
majeure
, which is accepted by the lessor;

b)   Lessee invokes force majeure which is not accepted by the
lessor;

c)   Lessor and lessee defer rent for a mutually
agreed period;

d)   Lessee is unable to pay rent and vacates the
premises;

e)   Lessor is subsequently unable to find a
lessee for the property either on account of lockdown or lower rental yield;

 

In case of situation a), act of force
majeure
goes to the root of the contract making the contract unworkable. On
account of the said event, a view could be taken that the property ceases to be
a let-out property. Accordingly, it may be possible for the lessor to seek
benefit of vacancy allowance u/s 23(1)(c). The said provision states that in
case actual rent received or receivable is less than deemed Annual Let out
Value (ALV) on account of vacancy then, actual rent received or receivable will
be deemed to be ALV. In this case, vacancy arises contractually. In other
words, even though goods or assets of lessee may continue to be lying in said
property but still it has to be treated as not let out, absolving the  lessee from the liability to pay rent.
Vacancy in the context in which it is used in section 23(1)(c) will need to be
interpreted as the antithesis of let out.

 

Situation b) is tricky as there
is a rent dispute during the lockdown period. Section 23(1)(b) provides that
when actual rent received or receivable is higher than ALV, then said amount
will be treated as ALV. ‘Receivable’ postulates concept of accrual. As per one
option, lessor may treat same amount as unrealised rent and offer the same in
the year of receipt u/s 25A. However, if it is required to keep rent as
receivable in books of accounts to succeed under the Contract Act, then in such
an event, tax liability will arise.

 

Situation c) involves mere
deferment of payment of rent and accordingly lessor will be required to pay tax
on rent component as it fulfils the test of receivable u/s 23(1)(b). 

 

Situation d) is a case comparable
to unrealised rent. Explanation to section 23 read with Rule 4 provides for
exclusion of such rent if the conditions prescribed in Rule 4 are complied
with.

 

Issue in case of situation e)
arises as section 23(3) permits only two houses to be treated as self-occupied.
Situation narrated in e) needs to be distinguished from a situation wherein
assessee in past years has offered income from more than two houses under the
head Income from house property. Conclusion does not change for such assessee.
Situation e) deals with a situation wherein assessee desires to actually let
out his house but could not find a tenant. In such situations, the Tribunal2  has held that even if the house remains
vacant for the entire year despite the best attempts of the assessee, then
benefit of vacancy allowance u/s 23(1)(c) should be granted to the assessee and
accordingly ALV for such property would be Nil. Against this proposition, there
is also an adverse decision in the case of Susham Singla [2016] 76
taxmann.com 349 (Punjab & Haryana)
3. Perhaps a
distinguishing feature could be that in cases where vacancy allowance was
granted by the Tribunal, the assessee was able to demonstrate efforts made to
let out property.

 

Impact on business income


Revenue
recognition

Revenue recognition for computing
income under the head ?profits and gains of business or profession’ is governed
by the principles of accrual enshrined in section 4 as also ICDS IV dealing
with revenue recognition. ICDS IV permits revenue recognition in respect of
sale of goods only if the following criteria are met:

 

  •     Whether significant risks and rewards of ownership have been
    transferred to the buyer and the seller retains no effective control
  •     Evaluate reasonable certainty of its ultimate collection

 

These criteria are relevant for
revenue recognition for F.Y. 2019-20. On account of lockdown and logistics
issues, it is possible that goods dispatched could not reach the customer.
Contractually, even though the transaction may have been concluded, the seller
was obliged to deliver goods to the buyer. In such a case, because of lockdown,
goods may be in transit or in the seller’s warehouse. In such a situation,
significant risk and reward of ownership continues to be with the seller.
Accordingly, the seller may not be required to offer the said amount to tax.
Further, economic stress may change the credit profile of the customer, raising
a question on the realisability of sale proceeds of the goods sold even
pre-Covid-19 outbreak. In such a case, even though the test of accrual would be
met, since there is uncertainty in ultimate collection, the assessee may not
recognise such revenue. This criterion is also important as the customer may
invoke force majeure clause or material adverse clause and turn back
from its commitment. 

 

Section 43CB of the Act read with
ICDS IV requires the service industry to apply Percentage of Completion Method
(POCM). If duration of service is less than 90 days, the assessee can apply
Project Completion Method (PCM) and offer revenue to tax on completion of the
project. Disruption caused due to pandemic and work from home is likely to
impact numerous service contracts. Assessee will have to determine stage of
completion of contract on 31st March 2020 for each open contract at
year end to determine its chargeable income. It is equally possible that a
contract which was estimated to be completed in less than 90 days may take more
time and accordingly move from PCM to POCM basis of recognition. Thus, it is
possible that an income which was estimated to be offered to tax in F.Y.
2020-21 may partially be required to be taxed in F.Y. 2019-20, changing the
assumptions at the time of computing advance tax. An issue which judiciary is
likely to face is whether the 90 days period should be read as a rigid test or
exceptional events like Covid-19 can be excluded for computing the 90 days’
periods. 

 

Provision
for onerous contract

Ind AS 37 requires recognition of
provision for onerous contract. An onerous contract is a contract in which the
unavoidable costs of meeting the obligations under the contract exceed the
economic benefits expected to be received under it. If an entity has a contract
that is onerous, the present obligation under the contract shall be recognised
and measured as a provision.

 

Section 36(1)(xviii) of the Act
provides that mark to market (M2M) loss or other expected loss shall be
computed in accordance with ICDS. Section 40A(13) of the Act provides that no
deduction or allowance shall be allowed in respect of any M2M loss or expected
loss except as allowable u/s 36(1)(xviii). ICDS 1 provides that expected loss
shall not be recognised unless the same is in accordance with other ICDS. ICDS
X provides that no provision shall be recognised for costs that need to be
incurred to operate in the future. On co-joint reading of aforesaid law, no
deduction shall be allowed for onerous contract under normal provisions.
However, for MAT purposes, such provision will be deductible as it cannot be said
that such provision is for unascertained liability. This treatment will require
an assessee to accurately track expenses incurred on such contract in future
years and claim it as deduction in year of incurrence.

 

Liquidated
damages

Disruption in the supply chain
may result in claims or counter claims as it is possible that the assessee
would not be in a position to meet its contractual obligations. The contract
may provide for payment of liquidated damages. Courts have held that such
payment is tax deductible4.

 

Remeasurement
of provision

Lockdown and social distancing
have resulted in India Inc. rethinking on extension of warranty and service
period in respect of goods sold prior to Covid-19. This is likely to result in
change in warranty provision. Provision for warranty is tax deductible if
otherwise the requirements of ICDS X are met. Practically for companies
following Ind AS, warranty provisions are discounted to fair value. However,
ICDS X expressly prohibits deduction based on discounting to net present value
basis. This mismatch will require an assessee to accurately reconcile claims
made in the past ignoring NPV basis, revise the provision and ignore NPV
discounting for claiming deduction. This is much easier said than done.

 

Further, companies following Ind
AS are required to make provision for debtors based on Expected Credit Loss
(ECL) method. This method requires consideration of not only the historic data
but also of the future credit risk profile of debtor. In turbulent times like
these, making an estimate of the future profile of a customer is likely to be
challenging since the business outlook is uncertain. Further, the impact of
lockdown on each customer, its ability to raise finances and stay afloat
involves significant assumptions and customer-specific data. Normative
mathematical models cannot be relied upon. It is possible that ECL provision
may increase for F.Y. 2019-20. Such provision may not be tax deductible under
normal computation provisions [Explanation 1 to section 36(1)(vii)]. As regards
MAT, the issue is debatable. Gujarat High Court’s Full Bench in case of CIT
vs. Vodafone Essar Gujarat Ltd
5  has held that if the provision is accounted
as reduction from debtor / asset side and not reflected separately in
liabilities side then, in such case said provision is not hit by any limitation
of Explanation 1 to section 115JB and is tax deductible.

 

Inventory
valuation

ICDS 2 permits valuation of
inventory at cost or Net Realisable Value (NRV) whichever is lower. It is
possible that on account of prolonged shutdown, disruption in supply chain,
overhaul of non-essential commodities, some of the inventory which may be lying
in warehouse or stuck in transport may no longer be marketable e.g perishable
goods, inventory with short shelf life (food products) may be required to be
disposed of. In such case, it should be possible to recognise NRV at Nil. Care
should be taken to obtain corroborative 
evidence in terms of internal technical reports, subsequent measures to
dispose of, etc. to substantiate Nil realisable value.

Fixed
Asset

The spread of Covid-19 has had a
differing impact on various nations. It is possible that some of the fixed assets
acquired could not be installed on account of cross border travel prohibitions
not only in India but across the globe. In such a case, such assets which were
earlier contemplated to start active use in F.Y. 2019-20 will miss the
deadline. In absence of satisfaction of the user test, no depreciation can be
claimed in F.Y. 2019-20. Further in terms of ICDS V – tangible fixed assets,
cost attributable to such fixed asset may also be required to be capitalised.
Further, if such asset is purchased out of borrowed funds, interest expenditure
will be required to be capitalised. Unlike Ind AS 23, ICDS IX does not suspend
capitalisation when active development is suspended. This mismatch will require
the assessee to accurately determine interest cost which is expensed for books
purpose and capitalise it as part of borrowing for tax purposes. It is equally
possible that unexpected delay may impact advance tax projections made for F.Y.
2019-20.

 

Shares and securities

The Act provides special
anti-abuse provisions in respect of dealing in shares and securities. Sections
50CB and  56(2)(x) regulate transactions
where actual consideration is less than fair market value. Rule 11UA provides a
computation yardstick to compute fair market value. The economic downturn may force
some promoters to sell their shares at less than Rule 11UA value to genuine
investors either to repay debts borrowed on pledge of shares or to raise
capital for future survival. Provisions of sections 50CB and 56(2)(x), if
invoked, may result in additional tax burden. Fortunately, Mumbai Tribunal in ACIT
vs. Subhodh Menon
  relying on the
Supreme Court decision in the case of K P Varghese  read down the provision to apply only in
abusive situations.

 

Further, the pandemic may require
promoters to pump in capital into the company. Section 56(2)(viib) regulates
share infusion by a resident shareholder. The provision proposes to tax
infusion of share capital above the fair market value as computed by a merchant
banker. DCF is a commonly accepted methodology to value business. DCF requires
reasonable assumption of future cash flows, risk premium, perpetuity factor
etc. Considering that the present situation is exceptional, it may involve
significant assumptions by the valuer as also the company. Further, there will
be an element of uncertainty, especially when the business outlook is not
clear. It is possible that the actual business achievements may be at material
variance with genuine assumptions.

 

In contrast, the existing
situation may have an impact on capital infused in the past, say 2-3 years,
which were justified considering the valuation report availed from the Merchant
Banker at the said time. Tax authorities may now rely upon actual figures and question
the valuation variables used by the Merchant Banker. Tax authorities may
attempt to recompute fair value considering actual figures. In such a
situation, the onus will be on the assessee to demonstrate impact of Covid-19
on valuation assumptions made in the past. Evidence such as loss of major
customer, shutdown in major geographies, increased cost of borrowing, capacity
underutilisation will support the case of the assessee to justify valuation
done before Covid-19 breakout. 

 

Conclusion

One hopes normalcy returns soon.
Aforesaid are some of the issues which, in view of the authors, are only the
tip of the iceberg. If the pandemic deepens its curve, it is likely to result
in significant business disruption. Every impact on business has definite tax
consequences and tax professionals have a special role to play.   

 

________________________________________________

1   CIT vs. Madras Refineries Ltd., (2004) 266 ITR 170 (Mad);
Orissa Forest Development Corporation Ltd. vs. JCIT, (2002) 80 ITD 300
(Cuttack); Surat Electricity Co. Ltd. vs. ACIT, (2010) 5 ITR(Trib) 280 (Ahd)

2   Sachin R. Tendulkar vs.
DCIT [2018] 96 taxmann.com 253 (Mumbai – Trib.); Empire Capital (P.) Ltd vs.
DCIT [2018] 96 taxmann.com 253 (Mumbai – Trib.);
Ms. Priyananki Singh Sood vs. ACIT [2019] 101 taxmann.com 45 (Delhi –
Trib.)

3   SLP dismissed by Supreme Court [2017] 81 taxmann.com 167 (SC)

4    PCIT vs. Green
Delhi BQS Ltd [2019] 417 ITR 162 (Delhi); CIT
vs. Rambal
(P.) Ltd [2018] 96 taxmann.com 170 (Madras); PCIT
vs. Mazda Ltd
[2017] 250 Taxman 510 (Gujarat) ; Haji Aziz and Abdul Shakoor Bros [1961] 41
ITR 350 (SC)

5    [2017] 397 ITR 55 (Gujarat)

6    [2019] 103 taxmann.com 15 (Mumbai)

7    [1981] 131 ITR 597 (SC)

Always Clean the Light

When we
are no longer able to change a situation, we are challenged to change
ourselves. – Viktor E. Frankl

 

As we have
progressed economically, we have started measuring our joy with what we
possess. External objects and experiences are ‘the cause’ of our happiness. We
also justify this approach as ‘normal’ and ‘obvious’. Therefore, when the
situation doesn’t measure up to our past expectation and experience, we feel on
edge. We feel our goals and dreams have blurred and even shattered by
uncertainty. The challenge of the downturn is both real and psychological.
The real challenges include matters such as cash crunch, difficulties in
getting things done, people backing out on commitments, disruption, and the
like. Such problems have actual consequences. These challenges require actual
resolution through skills, persuasion and patience.

 

On the other side, there are psychological
challenges which are the ‘real’ challenges (pun intended). They accentuate real
challenges with a sticky layer of fear and anger that smear our thinking. The
psychological challenges are constructed by thoughts, but since they are inside
us and are impulsive, they have more power over us.

 

Take the example of uncertainty relating to the
reduction of fees, loss of clients, clients folding up, looking for
alternatives, or loss of profit. These by themselves are actual real challenges
as they could result in cash flow issues. However, the ‘obvious’ anxiety about
it is like putting slimy dirt on a wound which makes it harder to cure.

 

The following pages carry nine wonderful articles
on the impact of Covid-19. So this longer editorial is dedicated to some
principles and practices to face challenging times with understanding and
resolve and make the most out of it:

 

1. Freedom
of Response

Viktor Frankl
spent three years in four Nazi concentration camps including Auschwitz. His
father, mother and brother were killed during that time. He saw people taken to
gas chambers knowing he could be next.

Viktor
survived to write one of the most influential books of our times – Man’s
Search for Meaning
– where he wrote some of the most exceptional thoughts ever
expressed.

 

We who lived in concentration camps can remember
the men who walked through the huts comforting others, giving away their last
piece of bread. They may have been few in number, but they offer sufficient
proof that everything can be taken from a man but one thing: the last of the
human freedoms
to choose
one’s attitude in any given set of circumstances, to choose one’s own way.

 

If we think
about it, we can’t change circumstances every time; however, we can choose our
response to them. The quality of our response can change our experience
completely. Viktor calls this the last of human freedoms. Most of us
would have seen this in the movie Life is Beautiful. Lives of the great
ones such as Mandela demonstrated it when he was in prison in a seven square
foot cell for 18 years with the floor as his bed and a bucket for a toilet.

 

Viktor wrote:
Life is never made unbearable by circumstances, but only by lack of meaning
and purpose.

 

2.
Gratitude

If you are
reading this, you are undoubtedly better off than millions of others who are in
a much worse situation than you are. Vala Afshar of Salesforce wrote: If you
have a family that loves you, a few good friends, good health, food on your
table and roof over your head, you are richer than you think.

 

If one were
to sit down and think of the blessings one has – caring people, events,
moments, things we have in varying measures deserve an appropriate response of
gratitude. What we take for granted or even disregard, is nothing short of a
blessing if we know how to value it. The feeling of gratitude is also
associated with a beneficial chemical effect – it activates a neurotransmitter
and hormone called dopamine which has a massive influence on both body and
brain.

 

3.
Acceptance

What is
can only be accepted. Just as one cannot deny the existence of a tree outside
the window, we cannot deny what is. Once we look at things this way and accept
them as they are – not how we feel about them or how we would want them to be –
a miracle unfolds. One comes out of psychological clutches. And acceptance does
not mean turning off effort. It means being in the right spot before the effort
to change the situation.

 

4. Cycle
of Impermanence 

What we see
is there, but not forever. We have heard that change is permanent. The likeable
and resentful is temporary. Almost everything you have experienced or possessed
– age, people, time, health, money, people, objects – are subject to
impermanence.

 

Joy or sorrow
fades with time – be it a new house, a new car or new phone or a nasty notice
from the tax office. Transitory nature of things has a positive side, ?this too
shall pass keeps us going’ wrote a Chartered Accountant recently. All
unpleasant situations are more likely to pass, as movement is the nature of the
universe.

 

5.
Learning

My teacher
had once told me: If you keep learning, you will always remain young. Being
young means growing, fresh, curious and full of energy. Learning means staying
away from stagnation, in touch with the context and ever ready to face
challenges.

 

No one will
deny that this has been the best time to learn. Just look at the webinars
taking place on all topics all over the world. Look at the quiet time we have
at our disposal due to slow client response. Learning develops a learning
mindset, not just skills.

 

This is the most durable shield we have. The
lowest 20-30% of skills that are available for a charge today will vanish due
to low demand or technology takeover. Our existing saleable skill sets can
vanish too. Imagine Google with your permission throwing up a simple bank
summary or tax return based on reading what is there in your inbox. So we need
to learn the skills of the future to stay relevant.

 

We better up-skill
ourselves even if it is outside our existing area of interest or expertise.
Let’s broaden our spectrum and come out of that ‘specialised’ area and learn
about digital technologies, law, management, and new areas of practice. A great
idea is where we can blend two or three different areas.

6. Take
care of yourself

a. Meditate:
Just sit comfortably for 20-60 minutes with back upright, close your eyes and
do nothing. If thoughts come, watch them. If you need to hold on to something,
focus on the breath.

 

b. Exercise:
Take care of the body with three different types of exercises (health
permitting) – aerobic training (increase heart rate depending on age and body
parameters), strength training (work muscles, especially doable at home) and
flexibility training (yoga asanas).

 

c. Read:
Reading opens the mind to the perspectives and wisdom of others. Today we don’t
even have to read. The technology reads most written material, or we can see a
video of that subject. All of this for free or little cost. Find the most
encouraging authors and catch up with all that you wanted to read or listen to.

 

d. Thoughts
and Words: Watch the narrative inside the mind. Choose the track that is
uplifting and gives strength. Best way to find strength is to give comfort to others.
Use those that you would like to hear – words of strength, appreciation, and
care.

 

7. Act

It’s not
what you know, but what you do with what you know that counts.
There is so
much one can do today without going anywhere, without spending money and with
little effort.

 

I have been
reading Naval Ravikant who writes: Doing something is better than doing
nothing. Doing something focused is even better. Doing something focused and
unique is even better. (Paraphrased)

 

We can do a
lot – master a subject, learn a health hack, update processes and policies,
take training, learn better communication, take on to writing and start a blog
or a YouTube channel, take online long duration courses, build something with
technology, overcome a bad habit, develop healthy new habits, check-in with
people and see how they are doing. And of course, the routine work.

 

8. Always
clean the light first

I heard an
African American tell her story. Since the age of twelve, she worked after schools
hours, cleaning homes and banks. On her way back from cleaning jobs, she would
talk to older women who did similar jobs at the bus stop. She asked them about
how to clean, what to clean, what were the best ways to clean.

One woman never took part in the conversation. But one day
she spoke: ‘Girl, always clean the light first. Always take care of the lights.
Every house when you go in has a big chandelier that nobody has cleaned. Get a
ladder, climb up to the light, take your solution and clean each crystal, each
bulb. Make sure you clean the light because nobody cleans the light, and if
you take care of the light, everything shines
‘.

The young girl did exactly that on her next cleaning visit.
That day the woman of the house came out and asked: ‘What did you do?
Everything looks amazing in here!’ The husband came in the evening and said
whoever this girl is, get her back here and make sure you pay her extra.

That little girl, who is now a doctor, was telling her story
on a video, concluded: ‘There is a light inside each one of us that must be
nurtured. That must be cared for, that must shine brightly. That light hasn’t
been addressed, it hasn’t been talked to. We are given this time to take care
of this light.’

She is spot on! This inner light changes everything –
not on the outside, but the way we see it, and the way we feel. The reality is
‘shaped’ by this light within each one of us.

BEYOND NATIONALISM

Thousands
of years ago, many different tribes lived along the Yellow River (the river
Huang He), which was their source of survival and sustenance. But they also
suffered from occasional floods and periods of drought. Individually they were
powerless against the fury of nature, but collectively they could perhaps tame
the mighty river. So they came together to build dams and canals to regulate
the river and mitigate the ravages of floods and droughts. Then, in a long and
complicated process over many decades, the tribes coalesced together to form
the Chinese nation which controlled the entire Yellow River and raised the
level of prosperity and safety for everybody.

 

From
clans to tribes to nation states, homo sapiens has evolved. Perhaps it
is time for him to take the next collective leap and come together as one
humanity.

 

The
problems faced by the world today require global, collaborative solutions. Yet,
paradoxically, we are leaning towards extreme nationalism. US President Donald
Trump announced that he is not a ‘globalist’ but a ‘nationalist’. He said,
‘…globalist is a person that wants the globe to do well, frankly, not caring
about our country so much, and you know what? We can’t have that’.

 

Rabindranath
Tagore and Mahatma Gandhi had some deeply philosophical discussions on the
perils of nationalism. World War I showed the havoc that extreme nationalism
can create and Tagore urged nationalists to rise from ‘Self-interest’ and
instead work for ‘Welfare of the world’. From now onward, he said, ‘Any nation
which takes an isolated view of its own country will run counter to the spirit
of the New Age and know no peace’.

 

In stark
contrast to the sentiments expressed by Trump, H.G. Wells said, ‘Our true
nationality is (and should be) mankind’.

 

The need
of the hour is to encourage people to be loyal to humankind and to planet Earth
in addition to their own countries. We can have deep affinity to our family,
our village, our profession, our country and also to the whole human species.
Occasionally, there may be conflicts in maintaining this balance; but there is
no contradiction. In fact, provoking the sentiment of ‘othering’ or ‘we’
against ‘them’ can be dangerously destabilising.

Sometimes
we put work before family, sometimes family before work. Similarly, sometimes
we need to put the national interest first, but there are occasions when we
need to privilege the global interests of humankind. Loyalty to one’s country
and to the world are not mutually exclusive sentiments.

 

Like the
tribes along the Yellow River, humanity is now living alongside the cyber ocean
which no single nation can regulate by itself. Climate change, technological
disruption, bioengineering and the most recent Covid-19 pandemic are all global
problems that make a mockery of all national borders and cry out for global
co-operation.

 

Take just
one example of the impact of genetic engineering on humanity. Assume that the
US chooses to outlaw all genetic experiments in humans on ethical grounds, but
if North Korea continues to pursue that agenda, the US will very quickly have
to re-evaluate its priorities. If even one country follows this high-risk
experiment, the other countries will be under tremendous pressure to follow suit
as no country can afford to be left behind in this dangerous race.

 

We take tremendous pride in our
countries, forgetting that large nations appeared in the history of mankind
only in the last few thousand years – just yesterday morning in the time
scale of evolution. As Tagore put it, ‘There is only one history – the history
of man. All national histories are merely chapters in the larger one’. Indeed,
nation states developed to deal with large-scale problems that small tribes
could not solve by themselves.

 

Now, in
the 21st century, we face problems that even large nations cannot
solve by themselves. It may have been the Yellow River then and the cyber ocean
now that require taming through global co-operation. So let’s heed the words of
Tagore, ‘Nationalism cannot be our final spiritual shelter; my refuge is
humanity’.

 

A true
patriot is equally a global citizen.

 

Note: A lot of thoughts,
including the analogy of the Yellow River, have been taken from the books of
Yuval Noah Harari and a recent interview with him

Section 64 – Entire loss arising to wife of assessee in the business of Futures and Options (F&O) which business was started by her during the previous year with contribution from assessee in shape of gifts, was liable to be clubbed in hands of assessee in terms of Explanation 3 read in conjunction with section 64(1)(iv) – Assessee was entitled to club full loss from business of F&O in his personal income

8. [2020] 113 taxmann.com 378 (Pune)(Trib.)

Uday Gopal Bhaskarwar vs. ACIT

ITA No. 502/Pune/2019

A.Y.: 2014-15

Date of order: 20th January, 2020

 

Section 64 – Entire loss arising to wife of assessee in the
business of Futures and Options (F&O) which business was started by her
during the previous year with contribution from assessee in shape of gifts, was
liable to be clubbed in hands of assessee in terms of Explanation 3 read in
conjunction with section 64(1)(iv) – Assessee was entitled to club full loss
from business of F&O in his personal income

 

FACTS

The assessee, in the return of
income filed by him, clubbed the loss from the business of his spouse amounting
to Rs. 31,56,429 in view of the provisions of section 64. In the course of
assessment proceedings, on being called upon to justify such a claim, the
assessee submitted that during the year under consideration he gifted a sum of
Rs. 94.50 lakhs to Mrs. Priti Bhaskarwar, his wife, who started a business of
Futures and Options (F&O) on 18th September, 2013. The assessee
claimed that she incurred a loss of Rs. 31,56,429 in the business which was
clubbed in his hands.

 

The A.O. accepted the primary claim
of the assessee of his wife having incurred a loss of Rs. 31.56 lakhs in the
business of F&O, which was set up on 18th September, 2013, and further that
the loss from such business was eligible for set-off against the income of the
assessee in terms of section 64(1)(iv) read with Explanation 3 thereto. He,
however, did not accept the assessee’s contention that the entire loss of Rs.
31.56 lakhs be set off against his (the assessee’s) income. Considering the
mandate of Explanation 3 to section 64(1), the A.O. held that only that part of
the business loss incurred by the assessee’s wife could be set off against the
assessee’s income which bears the proportion of amount of investment out of the
gift on the first day of the previous year to the total investment in the
business as on the first day of the previous year.

 

He, therefore, computed the amount
of loss eligible for set-off against the assessee’s income at Rs. 9,72,563 by
multiplying Rs. 31,56,429 (loss incurred by wife in the business) with Rs.
25.00 lakhs (gifts made by the assessee to his wife up to 18th
September, 2013) as divided by Rs. 81,13,648 (opening capital as on 1st April,
2013 as increased by the gift of Rs. 25.00 lakhs given by the assessee up to 18th
September, 2013).

 

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

 

Still aggrieved, the assessee
preferred an appeal to the Tribunal.

 

HELD

The Tribunal noted that the core of
controversy is the computation of eligible amount of loss incurred by the
assessee’s wife which is eligible for set-off against the assessee’s income.

 

On going through the mandate of
section 64(1)(vi) of the Act in juxtaposition with Explanation 3 to the
sub-section, it transpires that there can be two possible situations of
utilisation of the assets transferred by husband to wife triggering the
clubbing provision. The first situation can be where the amount of assets
received by the wife is exclusively invested in an asset and further there is
no investment by the wife in such a new asset. The full income resulting from
such an exclusive investment is liable to be clubbed with the total income of
the husband. An example of such a situation can be a wife making a fixed
deposit with a bank, etc. out of the gift of money received from her husband.
The full amount of interest income arising on such FDR is liable to be clubbed
with the income of the husband.

 

The second situation can be where
the amount of assets received by the wife as a gift from her husband is not the
exclusive investment in the business carried on by her. Rather, she has also
made separate investment in the said business. In such a situation of a common
pool of unidentifiable investments in the business, there arises difficulty in
precisely attributing the income of such a business to the investments made out
of the gift received from the husband attracting clubbing and to investments
made out of funds other than the gift received from the husband not attracting
the clubbing provision. It is in such a scenario that the prescription of
Explanation 3 comes into play by providing that the amount of income from the
combined business as relatable to the assets transferred by the husband should
be computed by taking the income from such business earned during the year as
multiplied with the amount of assets received by the wife from her husband as
invested in the business and divided by her total investment in the business,
including the amount of assets received from the husband.

 

In a nutshell, there are three
components in this formula. The first component is the income of the business,
which is to be considered for the year. The second is the amount of assets
received by the wife from her husband as invested in the business, and the
third is the total investment in the business including the amount of assets
received from the husband. The latter two figures are required to be taken as
on the first day of the previous year. Section 3 defines ‘Previous year’ to
mean ‘the financial year immediately preceding the assessment year.’ The proviso
to section 3 states that, in the case of a business newly set up in a financial
year, the previous year shall be the period beginning with the date of the
setting up of the business and ending with the said financial year. Since the
wife of the assessee started the new business of F&O on 18th
September, 2013, the extant case is, ergo, covered by the proviso
to section 3.

 

Having examined the factual position
in detail, the Tribunal held that the entire amount of loss resulting from the
business of F&O started by Mrs. Priti Bhaskarwar with the gifts received
from the assessee is liable to be clubbed in the hands of the assessee.

 

This ground of appeal filed by the assessee was
decided in favour of the assessee.

COVID-19 IMPACT ON INDIAN ECONOMY AND THE FINANCIAL MARKETS

INTRODUCTION:
THE ECONOMIC IMPACT

It was mid-January when we
started to hear stories about a virus in China which had locked down the entire
Wuhan city, the epicentre of the virus. Its effect had also spread to other
Asian countries and by 30th January, 20201 India reported
its first Covid-19 case. After two and a half months of the first reported
case, India is now in the second phase of lockdown. India took early calls to
go for a complete lockdown and implemented strict guidelines due to the
experience of other countries, the rate of transmission of the virus from one
person to another and also the strain which this virus could cause on the
healthcare system of the country.

 

Observers state that the lockdown
slowed the growth rate of the virus by 6th April to a rate of
doubling every six days, from a rate of doubling every three days earlier. The
metric called R-Naught or R-Zero, estimates that the infection rates in India
have fallen to 1.55 on 11th April from 1.83 on 6th April,
further indicating that lockdowns could be helping2.

 

This article seeks to explore the
consequences and impact of the current health crisis on the overall Indian
economy and the Indian financial markets.

 

Looking back to the situation
till a couple of years ago, India was going through its own economic slowdown:

(i) The primary reasons were the ‘shocks’ of demonetisation in 2016 and
the introduction of the Goods and Services Tax (GST) in 2017.

(ii) India recorded the lowest quarterly GDP growth rate in the last
decade of 4.7% in Q3FY203 and the growth outlook (pre-Covid-19) for
FY21 was upwards of 5%.

(iii) The economy had started to show some signs of recovery when the
index of industrial production (IIP) grew by 2% on a y-o-y basis in January,
2020. The manufacturing index also improved by 1.5%.

 

(iv) To boost the economy, the Finance Minister reduced the base
corporate tax rate to 22% (effectively ~ 25%) for companies which do not seek
to take certain exemption benefits. This led to earnings recovery for many
companies and a boost to the stock markets as well.

 

What impact will the current
crisis have on the GDP growth rate?3

(a) It has been estimated by various rating agencies that the advanced
economies will contract by 0.5% to 3% in 2020 as against a global growth of
1.7% in 2019.

(b) China is estimated to grow ~ 3% in 2020, while India’s growth
forecast for FY21 has been revised downwards and is estimated to be between
1.8% and 2.5% from more than 5% estimated before the lockdown was announced.

(c) Having said that, even a 2% growth rate is still good news for
India. Due to the low base rate, the expected GDP growth in FY22 is expected to
be upwards of 7%.

 

With what is now happening across
the world (post the Covid-19 outbreak), including India, a slowdown in each and
every economy is imminent. The extent of impact in different geographies will
vary based on the severity of the virus, the stimulus packages by the
governments to revive the economy and how fast a nation is able to commence its
economic activities.

 

MEASURES
TAKEN SO FAR BY THE GOVERNMENT OF INDIA

Though India has been very slow
in announcing economic packages for industry, there have been three major
announcements – two by the RBI (monetary policy) and one by the Finance
Ministry (fiscal policy).

 

(1) On 26th March, Finance Minister Nirmala Sitharaman
announced a Rs. 1.7 lakh-crore fiscal package for the poor, including cash
transfers, free food grains and free cooking gas.

(2) On 27th March, the RBI announced a 75-basis points cut in
the policy rate and a 100-bps cut in the cash reserve ratio for banks to inject
liquidity in the system and provide moratoriums for loan repayments for three
months (March to May, 2020).

(3) On 17th April, RBI freed up more capital for banks to
lend, announced a fresh Rs. 50,000-crore targeted long-term repo operation to
address the liquidity stress of NBFCs and microfinance institutions and hinted
at the possibility of further rate cuts going forward. RBI also announced a Rs.
50,000-crore special finance facility to NABARD, SIDBI and NHB for onward
lending to NBFCs in the space. The RBI Governor also announced that India would
do ‘whatever it takes’.

 

To sum up, the government has
first prioritised the containment of the virus and providing relief to the
poorest sections of society. In the days to come, it will dole out sector- and
industry-specific packages as well.

 

IMPACT ON VARIOUS INDUSTRIES

It
goes without saying that the lockdowns will certainly have an impact on each
and every industry in
varying degrees.

S.No.

Industry

Impact

Likely nature of effect

1

Auto and auto components

High

  • Weak PV and CV demand due to
    liquidity shortage with NBFCs, economic uncertainties, weaker consumer
    purchasing power, likely NPAs in the sector
  •  Stuck with inventories of
    unsold BS-IV vehicles with the original deadline of selling
    them before 31st March, 2020

2

Aviation and tourism

High

  • Uncertainty over travel
    restrictions which can extend or remain restricted for a longer period of
    time, borders might remain closed
  • Loss of jobs and pay cuts
  • 102 of 137 airports managed
    by AAI have recorded losses to the tune of Rs. 1.6 billion
  • Estimated to render more than 50% of tourism industry workforce
    jobless in hospitality industry4

3

Agriculture

Low

  • Since agriculture is the
    backbone of the country and part of government-announced essential category,
    the impact is likely to be low on both primary agricultural production and
    usage of
    agri-inputs like seeds, pesticides and fertilisers
  • Agro-chemicals: Companies
    that depend on exports for finished goods sale and imports of raw ingredients
    will be impacted

  • Food exports: Major
    destinations like the U.S., Europe expected to grapple with Covid-19
    for the next few months and Indian export-based companies will be impacted
    due to low consumer demand and port hurdles
  • The economic packages likely
    to be announced will provide relief to farmers and the allied sectors and,
    hence, the overall impact on agriculture will be low

4

Chemicals and petrochemicals

Medium

  • Weakening in crude oil
    prices and cascading impact on petrochemicals, coupled with uncertain
    domestic and global demand; petrochemicals prices are likely to remain low
  • Uncertain demand outlook and weak prices are
    expected to lead to weak market
    sentiments and delayed investments in the sector

5

Consumer, retail & internet business

Low to medium

Essential commodities:

  • Growth seen for essential
    commodities players, with possible margin improvements, unless there is price
    control by government
  • There will be increased
    pressure on supply chain for deliveries of products amidst the lockdown

Non-essential commodities:

  • Markets likely to crash due to low discretionary
    demand. Overdependence on imports
    could pose a threat
  • Industries facing severe challenges: Apparel, durables, restaurants and other on-premise services like gyms / salons, etc.

6

Banking and NBFC’s

Medium to high

  • Banking sector to be under
    pressure due to reduced off-take of loans in expected recessionary market
    conditions and cautious lending
  • Possibility of increased delinquencies post the
    moratorium period, and may also result in depressed NIMs in a low interest
    rate regime
  • Drop in transaction fee-based income due to lower cross-border
    trade

  • Affordable housing, two-wheeler financing,
    micro-finance and gold loans
    exposures to be adversely impacted

7

Insurance

Low

  • Fresh demand for health insurance and life
    insurance witnessed a surge in the current scenario
  • Renewals may get delayed due
    to shortage of money in the hands of policyholders
  • Usage of AI / ML / technology can assist in
    reduction of operating costs, increasing customer satisfaction and policy
    management

8

MSMEs

High

  • Many MSMEs to face closure of business if the
    lockdown continues for more than eight weeks due to heavy leverage costs and
    no production output for more than eight weeks

  • More than 114 million people
    are likely to get affected, with a dent in
    their contribution to GDP (~ 30-35% of GDP)

9

Transport and logistics

Medium to high

  •  Crude price reduction is
    likely to positively impact the
    transportation costs in the short term
  • Freight traffic volume is expected to slow down

  • Post-monsoon, the demand is
    anticipated to spike on account of accrued consumer
    savings as well as onset of festive season
  •  Lower utilisation of ports
    infra, road and rail infra, storage infra due to reduced cargo traffic in
    short to medium term

10

Healthcare and pharmaceuticals

Low to medium

  • Generic drugs are most impacted – reliance is high on imports (~
    70%) from China

  • Non-availability of labour,
    transport of ingredients and supply side issues
    could impact production volume

  • High exports demand for
    certain products over the short term – as developed countries
    (U.S., EU, etc.) look to stockpile medicines
  • Probable price controls of essential drugs
  • Online pharmacies – medicine
    delivery has been affected due to non-availability of delivery staff

11

Construction and real estate

High

  • The housing sector is
    expected to see muted demand with significant reduction in new launches

  • The existing demand for
    commercial real estate may either get curtailed or
    postponed till H2 of the current year
  • One of the largest employment generators in the
    country, it will have a multiplier
    effect on around 250 allied industries
  • There is a likelihood of the
    government providing relief to the sector in terms of relaxation for project
    delays in residential housing sector, easing financial stress by extending
    loan repayment, etc.

12

Overall imports and exports

High

  •  India’s merchandise exports
    slumped by a record 34.6% in March, 2020 while imports declined 28.7% as
    countries sealed their borders to combat the Covid-19 outbreak5
  • Business Process
    Outsourcing, one of the India’s largest exports, will be severely affected as
    lockdown measures, both in origin and destination countries, have forced
    offices to close. It will be further accelerated with the cost-cutting
    measures by the destination countries
  • However, it is likely that India’s balance of
    payments position may improve. Weak domestic demand, low oil prices and
    Covid-19-related disruptions are expected to narrow the current account deficit
    to 0.2% in FY21 and to keep it low in the following years

Source: KPMG report, news articles

 

 

Some general and overarching
impacts on the overall economy could be:

(i) Unemployment – The unemployment in
India has shot up from 7% to 23% in the last two weeks of March, 20206

(ii) Poverty – As per the estimates of the Indian Labour
Organisation, more than 400 million people in India are at the risk of sinking
back below the poverty line.

 

While the current lockdown will
be ending on 3rd May and some relaxations have been offered post 20th
April, if the number of infections surges, there could be further lockdowns.
This could further affect the businesses and the economy and we should be
prepared for the same.

 

 

THE IMPACT ON THE FINANCIAL MARKET

Let us now look at how the Indian
financial markets have been impacted in the past during various crises – from
the Harshad Mehta and Ketan Parekh scams to the Global Financial Crisis (GFC)
and the recent China-US trade wars. Table 2 (next page) denotes the time
required for the market (Nifty) to bottom out from its peak and then the time
taken to reach back to its peak:

 

Peak

Trough (Bottom)

Peak to Trough

Recovery Month and  Value

Months to

Recovery

Month

Value

Month

Value

Months

Extent (%)

Month

Value

Mar-92

1262

Apr-93

622

13

-50.7

Feb-94

1,349

23M

Feb-94

1349

Nov-96

830

33

-38.5

Aug-99

1,412

66M

July-97

1222

Nov-98

818

16

-33.1

July-99

1,310

24M

Feb-00

1655

Sept-01

914

19

-44.8

Dec-03

1,880

46M

Dec-03

1880

May-04

1,484

5

-21.1

Nov-04

1,959

11M

Dec-07

6139

Nov-08

2,755

11

-55.1

Dec-10

6,135

36M

Dec-10

6135

Dec-11

4,624

12

-24.6

Oct-13

6,299

34M

Feb-15

8902

Feb-16

6,987

12

-21.5

Mar-17

9,174

25M

Aug-18

11681

Aug-19

10,793

6

-7.6

Apr-19

11,748

8M

Jan-20

12362

23-Mar-20

7,610

2

-38.4

??

??

??

Source: Nifty historical data

 

 

The Indian equities reached the
trough (bottom) on 23rd March, 2020. The current down-turn is still underway
and has shown the trough as on 23rd March, 2020.

 

What has happened to the Indian
financial markets since the start of the crisis?7

  • The valuations have corrected significantly
    on a trailing PE basis – from a high of 29.9 a few months back to ~ 16-17 now.
    During the GFC, the Nifty PE had touched a low of ~ 11-12 trailing PE.
  • The long-term EPS growth has been 13%
    year-on-year and in the quarter ended December, 2019 the EPS growth was ~ 15%.
    This was mainly due to the tax cuts which led to recovery in Q3 FY20.
  • The long-term average of Nifty Earnings has
    been ~ 12.5% while in the last five years the average has fallen to ~ 3-4%.
    There was a marginal recovery in the last financial year but now the recovery
    has been deferred to FY22.
  • The benchmark indices – Nifty50 and the
    Sensex – have fallen ~ 25% year-to-date (YTD), 2020.
  • Within the large-cap, mid-cap and small-cap
    space, the fall has been as under:

    small
cap has fallen ~ 33%

    followed
by mid-cap at ~ 26% and

    large
cap at ~ 19% on a YTD, 2020 basis.

  • Nifty Bank has fallen the most during this
    crisis, plunging almost 50% and certain NBFCs falling more than 50% as well.
    The markets recovered somewhat in the first two weeks of April, 2020 and today
    the Nifty Bank is sitting at a 40% discount to its peak valuation.
  • While Nifty Bank has fallen significantly,
    Nifty Pharma has been the biggest beneficiary and is the only index with a
    positive YTD return of ~ 16%. The rest of the indices (sectors) have seen
    negative returns, the least negative being Nifty FMCG at ~ (-)5%.
  • In the credit scenario the investment grade
    ratings have fallen from 40% earlier to ~ 30% now. The downgrades are much higher
    in value – ~ Rs. 1,990 billion worth papers have been downgraded.
  • On the global front, the US Dow Jones has
    fallen by ~ 20% on YTD, 2020 basis, while most of the European markets have
    fallen upwards of 20% on YTD, 2020 basis. The China market has been the most
    resilient and has fallen only ~ 8% on YTD, 2020 basis.

 

Before the Covid-19 crisis, the
banking and financial services were facing massive problems with the collapse
of IL&FS and DHFL and the Yes Bank fiasco. In the current market scenario,

  • NPAs are likely to increase as the private
    banks, NBFCs and even micro-finance institutions have aggressively built their
    retail loan book and there will likely be massive layoffs
  • Further, these loans are majorly unsecured
    and there can be a slew of defaults, especially on the MFI side, and can also
    bring the mid and smaller NBFCs to the brink of collapse
  • Some of the new-age digital financial
    startups which simply opened the liquidity tap to trap the young earners with
    huge interest rates, may be forced to shut shop
  • However, the liquidity and moratoriums
    provided by RBI will come to the rescue
  • More clarity in this regard will emerge only
    after three to six months when the economic activity resumes
  • Meanwhile, credit off-take can be low for
    the next couple of quarters as companies rework on their capex plans due to
    weak demand and the uncertain global environment.

 

ANY
SILVER LINING IN THE MIDST OF THIS CRISIS?

While all of the above sounds
quite alarming, there are many positives in India’s current state of affairs:

 

  • Forex reserves: India has forex reserves to
    the tune of USD 476.5 billion as on 10th April, 2020 and in a
    worst-case scenario this will take care of 11.8 months of India’s import bills8.

  • Crude prices: The crude prices have fallen
    to record lows, lower than $10 per barrel as on 20th April, 2020. If India can
    import and store additional crude at this level, it will save huge import bills
    once normalcy kicks in and crude prices rise. Since 80% of India’s oil
    requirement is met through imports, a fall in crude oil prices can save USD 45
    billion on crude oil imports9.
  • MSCI Index re-jig: Indian stocks are
    expected to see an inflow of more than USD 7 billion on account of a likely
    increase in their weight on the MSCI Index. FIIs have been net sellers and they
    have sold more than Rs. 30,000 crores in the last four weeks. Therefore, a
    re-jig of the MSCI index will bring in fresh FII inflows10.
  • Low inflation: The food inflation is on a
    declining trajectory and has eased ~ 160 basis points from its peak in January,
    2020. The CPI inflation as on 19th March, 2020 was 5.9% and the RBI is
    confident of bringing it below 4% by the second half of 2020.
  • Normal monsoons: The Indian Meteorological
    Department has forecast a normal monsoon in 2020. This will benefit agriculture
    which is the backbone of the Indian economy.
  • Shift from China to other geographies: Many
    countries are envisaging a shift of dependency from China and also to shift
    their manufacturing bases from China to either their home country or to find a
    suitable alternative. Japan has announced packages for its companies bringing
    back manufacturing home. India can benefit a lot if some of this shift happens
    from China to India. It will significantly improve FDI flows into India.


FOOD FOR THOUGHT

The way the economy will recover
or fall will depend on how the pandemic plays out. No doubt a vaccine is the
need of the hour, but that will take a minimum of nine months to a year to
develop and then to be distributed to every human being on the planet. While
there may be some medicinal cure which could be developed, there will be
uncertainties in the interim. During these times, the following possibilities
could emerge:

 

  • Will there be de-globalisation? Will
    countries close borders – partially or completely?
  • Will India gain a lot of market share with
    a shift in manufacturing base to India?
  • Will there be a V-shaped, U-shaped,
    W-shaped or L-shaped recovery of the Indian and global financial markets?
  • Will there be disruption in existing
    industries – Will Information Technology be the new king? Will the pharma
    sector be the best performer index in the market?

 

We are fighting with an ‘unknown
unknown’ phenomenon and only over time will we be able to get the answers to
the above questions.

 

I would like
to conclude with a quote from Joel Osteen – ‘Quit worrying about how
everything is going to turn out. Live one day at a time’
. This, too, shall
pass and we will emerge as a stronger and better economy in the end.
 

 

Disclaimer: The views, thoughts and opinions expressed
in this article belong solely to the author; the data has been gathered from
various secondary sources which the reader needs to independently verify before
relying on it. The information contained herein is not intended to be a source
of advice or credit analysis with respect to the material presented, and does
not constitute investment advice

________________________________________________________

1   Ministry of Health, https://www.mohfw.gov.in/, News Articles

2   https://theprint.in/science/r0-data-shows-indias-coronavirus-infection-rate-has-slowed-gives-lockdown-a-thumbs-up/399734/

3   IMF estimates,
Various rating agencies
4   https://economictimes.indiatimes.com/news/economy/indicators/indias-tourism-sector-may-lose-rs-5-lakh-cr-4-5-cr-jobs-could-be-cut-due-to-covid-19/articleshow/74968781.cms?from=mdr

5   https://www.livemint.com/news/india/india-s-trade-deficit-narrows-to-9-8-bn-in-march-exports-dip-34-6-11586955282193.html

6   CMIE
database,
https://www.cmie.com/kommon/bin/sr.php?kall=warticle&dt=2020-04-07%2008:26:04&msec=770

7   Newspaper Articles, Nifty50 Returns

9   https://www.energylivenews.com/2020/03/24/india-to-save-45bn-on-crude-oil-imports-next-financial-year/

10  https://www.bloombergquint.com/markets/morgan-stanley-sees-71-
billion-inflows-into-india-on-msci-rejig

 

SOME REFLECTIONS ON COVID-19 AND THE ECONOMY: RESET TIME

I am presenting a few thoughts on
the reasons for the pandemic, how to stop future pandemics, its impact on the
economy and steps for its revival, the oil shock and its domino effect and
other related issues.

 

PANDEMIC REASON – VIRUS AND STRESS IN
ANIMALS

I have seen
a video on the reasons for pandemics published by the Nutrition Facts Organisation
of the USA in 2010. Dr. Michael Greger, M.D., FACLM, explains that (i)
this is a zoonotic disease and the virus which is present in animals infects
mankind, (ii) most viruses are completely neutralised within 30 minutes under
direct sunlight; however, in dark, damp and shaded conditions they can survive
for weeks, (iii) viruses which have existed for thousands of years innocuously
have now become deadly.

 

Why is this so? Clearly, the stress
and the pain suffered by animals results in even an innocent virus turning
into a deadly one.
When these stressed animals / birds are eaten by men,
they get infected. If we don’t stop industrial animal farming for food, then we
should be prepared for a pandemic of deadly proportions equivalent to the
Indonesian tsunami of 2004 simultaneously hitting all the major cities around
the world.
In case a pandemic hits the USA, it may be necessary to lockdown
the whole country for 90 days. This prediction was made in the year 2010. (See
the video: https://nutritionfacts.org/video/pandemics-history-prevention/)

 

In short, extreme cruelty by
mankind on animals and birds has caused this pandemic. And all nations are
responsible for this cruelty. Industrial farming of pigs and chicken, of cows
for milk, etc., several such cruel practices were started in the capitalist western
countries and this is the chief cause of this virus.

 

According to me, in the same way,
globally, half the human population lives in stress because of poverty and wars
inflicted by greedy lobbies and nations. This stress also affects world peace
and welfare. It is time we take notice of this fact.


PREVENTING FUTURE VIRAL PANDEMICS

To prevent such pandemics, one
should not only turn vegetarian, one should turn vegan. It is a simple
philosophy. Love your animals as you love your family. Love your employees as
your own family. Love is a great strength. The absence of love or callousness
has immeasurable negative power. Philosophy includes the principles of how to
live happily in society and the world. In Hindi it is called:
In English, it’s ‘The
relationship amongst: Individuals, Universe and God’.

 

A useless plastic straw that we
throw away travels a few thousand miles through the ocean and hurts a tortoise.
The tortoise is in stress. Its stress affects world peace. We do not give
cognition to the stress suffered by billions of lives around the world. It is
high time that we recognise the philosophy that the stress caused in the
tiniest of lives will one day come back to haunt us. We have ignored the
warnings of numerous environmentalists. Let us now hear this warning by Mother
Nature or
This is the time to RESET
everything and challenge all our assumptions
. The virus has proved that we
have to live as one family,
The solution to this virus and many other
problems may be found by the world in co-operation and not in competition. All
national boundaries are man-made and artificial. The ultimate truth is – We Are
All One,

 

If someone
had said before seeing the above video, ‘Don’t be cruel with animals’, the mass
commercialised industrialist as well as the consumer would not have listened to
him. The government would not interfere considering ‘philosophy and ethics as a
matter of personal choice’. But after seeing the video anyone who believes in prevention
of pandemics
and other mass tragedies may want to practice and spread the
message of Universal Love and Truth.

 

A reader may ask, ‘Okay. I have
understood that the cause of the current pandemic is human cruelty to animals
and birds. But as an individual, what can I do?’ The answer to that is,
‘One individual cannot change the world. He cannot stop industrialised animal
farming. But he can stop eating animals and consuming dairy products.’ When
many individuals stop buying any product which involves cruelty, businesses
will have to change their practices. If we do not reset our business practices
and our personal lives, nature may (or may not) give us another warning.

 

PANDEMIC’S IMPACT ON ECONOMY

Both the Indian and the global
economies have suffered a serious setback due to the current pandemic.
How serious is it? How long will it take to recover? As recently stated by Mr.
Sanjiv Mehta, CA, Chairman of Hindustan Unilever, no one can provide a proper
answer to these questions. Economics is a social subject. Unlike the laws of
physics, the results of actions in economics cannot be predicted. They depend
upon society’s psychology, culture, readiness to put in hard work and so on.

 

To explain the issue in simple
terms, one can use the analogy of a person who has suffered a heart attack.
He knows the reasons of the attack: Lack of exercise, an over-indulgent
lifestyle, and so on. ‘Can he or will he recover? How good will be the
recovery?’ The answer to these questions is, ‘Of course he will recover.’ ‘How
well he will recover depends upon whether he has learnt his lesson. Will he
change his over-indulgent lifestyle? Will he start exercises? And does he have
the will power to return to a healthy life? Is he a positive thinker? Does his
positivity translate into action?’

 

This analogy can be applied not
only to individuals hit by disease, but also to nations hit by disasters.

 

The current pandemic has already
caused serious damage to economies. And the damage will continue for some time.
Nations and the world are not going to die. We will all recover. How well do we
recover is the issue. The quality of recovery depends upon how well we reset
our businesses and our personal lives.

 

Supply chains have been broken
and damaged. The demand for many goods and capital assets has evaporated. When
both supply and demand go down, there is necessarily a contraction of the
economy. There is no alignment between reduction in supply and demand. In other
words, the supply of goods A, B and C has stopped. The demand for goods C, Y
and Z has evaporated. Hence the contraction in the economy can be even worse.

 

In agriculture, tea gardens and
mango and grape orchards, vegetables and so on are adversely affected.
Agriculture has been exempted from the lockdown. But then a lot of migrant
workers have gone back to their native places. Transport is affected. Even the
manufacture of medicines is seriously affected.

 

Where does a nation start with relief
and recovery actions?
The Government of India (GOI) and the RBI have
already announced different packages of financial relief – all together
amounting to Rs. 5 trillions. (One trillion is a short term for one lakh
crores.) Food Security is provided to 80 crores of Indians. The
GOI has started with ensuring that the poor daily wage-earners do not stay
hungry. They are being provided food and fuel in different ways. It is my
personal knowledge that, at least in Gujarat, the GOI is reaching the poor.

 

Having discussed stress and the
pain in animals, let us turn to the stress and the pain in human beings.
Let us take an example. The Covid-19 virus has spread in the Dharavi slum.
Hundreds of people are infected. This has raised fears of community spread. The
Central and the State Governments are worried. They do not see any practical
solution. They are frustrated. Imagine an invisible tiny virus frustrating the
Government of India. Why has this situation arisen?

 

In Mumbai, some flats are sold at
a price of Rs. 1,00,000 per square foot, or even more. In the same city,
several million people live in slums, on footpaths and in chawls. Many
people just do not have a roof over their heads.

 

Why is there such a wide
difference in incomes and wealth?

 

We do not ask this question.
Society in general doesn’t care. The government has excellent schemes for slum
development.
Market forces will make it practical to give decent homes to
many slum-dwellers. And instead of spending money on slum redevelopment, the
government will get revenue. And yet, the Dharavi redevelopment scheme has not
taken off for so many years. Why? Because of corruption and greed.

 

Imagine a poor person living in
Dharavi. Most people there do not have toilets and bathrooms within their tiny
homes. They use common facilities. Imagine their fear of viral infection. They
can’t leave Dharavi due to the lockdown. And they can’t live in Dharavi because
of the abysmal living conditions. What amount of fear and stress are the people
living in Dharavi suffering from right now? Won’t that stress affect us and our
governments? Nature has already provided the answer. It will affect all of us.

There are many individuals and
NGOs who question the current pitiable condition of the poor. They work on the
ground in helping the poor. Many of them have achieved good success. May their
tribe grow; may their enthusiasm to help the poor infect society and
governments. May we see a day when every family in India has a home. One
such dreamer is
Prime Minister Narendra Modi. He has already planned a
scheme for this purpose. I remember saying in my presentation at the BCAS
Economics Study Circle in 2015: ‘If all the welfare schemes planned by Mr. Modi
are executed in reality (not just on paper), then India can have 12% GDP growth
for the next 20 years.’ This is the solution and the answer to the question,
’How will the economy be affected by the present pandemic?’

 

India has a huge unsatisfied
need. And India has sufficient natural resources to provide food, clothing and
homes to every individual in the country. But the market system will not permit
it. Under a capitalist market system, farmers, teachers and doctors earn less
than share market speculators and tax consultants. A producer of goods and
services earns less than a film star and a sportsman. This market system has
to be reset
.

 

GDP

GDP is a
misleading statistical figure that has become popular to such an extent that it
has become harmful. When a jungle is destroyed and factories are set up, GDP
goes up. But there is no consideration for the damage to the environment, the
loss of life of animals, the huge difficulties to tribals and so on. If the
Indian rupee rises to Rs. 36 per dollar, our GDP will jump from $2.8 trillion
to $5.6 trillion. This shows that the exchange conversion market is an
illusion. When liquor and cigarette production goes up, the GDP goes up. Share
market speculators speculate and GDP goes up with zero contribution to the real
economy. I am not worried if the GDP falls, but the people would be free from
pollution and the resultant diseases.

 

There is none and there will be
no direct relationship between welfare and GDP.

 

THE
CORONA SHOCK: NEGATIVE OIL PRICE

On Monday, 20thApril,
and also on Thursday, 23rd April, 2020, the price for a barrel of
crude oil on the New York Commodity Exchange dropped to negative $38. What is a
negative oil price? Why did it happen? And what can be the consequences?

 

This has happened because of
excess supply of crude oil and lack of storage capacity for the excess. Global
production (extraction from oil wells) is 100 million barrels per day (MBD).
With the almost global lockdown, the entire transport system and factories have
stopped. Now only domestic and agricultural consumption of power continues. As
per oil experts’ opinion, the demand has gone down by at least 25%. However,
production of crude oil continues at the same pace. Saudi Arabia, Russia and
the USA have agreed to cut down production by about 10.3 MBD. This cut will be
effective from 1st May, 2020. But the surplus of supply over
consumption will continue. Global storage tanks are almost full. In the USA,
people holding a ‘Buy’ contract have no storage space. Assume that a buyer has
already paid the full price. Now, either he has to lift the oil, or pay $38 per
barrel to cancel the contract. A negative price reflects the cost of storage
for an indefinite period. However, these negative prices will not last. It is
estimated that in the short term the price may settle around $20/barrel.

 

Crude oil is the most important
component of energy today. Hence, the USA has used it as an instrument in its currency
war.
Its government insists that all global trade must happen in US
Dollars. Some nations refused. They were ready to sell their oil in Euros.
Hence the attacks on Iraq, Lebanon and Libya and the sanctions on Venezuela and
Iran. This is a classic illustration of a currency war using commodities as
weapons. When the opponents do not succumb to sanctions, the USA starts a
weapons war. [See a clip of the news on CNN dated 23rd April, 2020:
New York (CNN Business) 22nd April, 2020.]

 

The report said, ‘The Trump
administration ordered Chevron to halt oil production in Venezuela
, dealing
another blow to the nation. The directive is part of President Donald Trump’s
effort to pressure the regime of Venezuelan President Nicolas Maduro by starving
it of cash. Despite having more oil reserves than any other country on earth,
Venezuela’s production has imploded because of tough sanctions imposed by the
United States and other reasons.’

 

But there are other factors to be
considered. When oil was sold at $100 per barrel, the USA started shale oil
production on such a scale that it became free from imports of crude oil. The
average cost of production of shale oil is estimated to be $40 per barrel
(estimates vary). When the oil price was high, shale gas producers took huge
loans on small capitals and did business. Now, with the oil price being less
than $40 per barrel, most of them are making losses. Because of the viral
pandemic, the global economy has slowed down. The demand for oil may remain low
in the short term. Hence prices may remain under $40 for many months. Some
shale oil producers may even go insolvent.

 

Domino Effect: When an
oil producer goes insolvent, the following people also suffer losses:
Speculators in oil prices, speculators in shares of oil companies, banks and
institutions that lent to the oil producers, speculators in bank shares;
employees of all of the above entities suffer and ultimately the government
loses tax revenues.
When these loss-making companies are bailed out, the common man, the taxpayer,
suffers. Thus, one loss has a domino effect.

 

We have seen this oil industry
projection at some length. There are many other enterprises that are also
highly leveraged. The airline industry is a capital intensive, high
revenue cost industry with widely fluctuating profit margins. The lockdown may
have caused huge losses for all airline companies. Some may go insolvent. Many
other enterprises will also go insolvent. That means huge losses for banks
and the financial system. Will it result in banks going insolvent? Will central
bankers around the world be able to save the banking system?

 

In Maharashtra, mango and
grape orchard
owners can’t export their fruits. All over the country, many
farmers cannot sell their products even within India. Most of their products
are perishable. They will suffer huge losses. Who will bear these losses? The
list can go on.

 

Suddenly, the force majeure
clause is being invoked by parties for not fulfilling their part of the
performance. Everyone looks at themselves. As if the ship is sinking! If this
happens on a very large scale, then the economy can come crashing down. The
economy is really like a giant machine with several wheels within wheels.
All these wheels are connected by bearings, gears and chains. Some wheels
stopping or slowing down may disrupt the machine. But if several wheels stop
functioning, then the bearings can break down and the machine stop. We need to
identify all the wheels, bearings, gears and chains in the economic machine.
Observe them, help them, and ensure that almost all parts function.

 

SOLUTION: ECONOMIC ACTION

Confidence at the highest level
is crucial. The US and European economies have been built over a few hundred
years. The Indian and Chinese economies and societies have been built over a
few thousand years.
How can these economies be destroyed if a pandemic
disturbs them for a few months? Only when an economy has its fundamentals
seriously wrong can it be damaged. Probably, all countries, including communist
countries, are working on Capitalist Market Economics. These need to be RESET.
In other words, extreme disparities in income, wealth and welfare have to be
reduced. Every producer of goods and services must get at least a living wage.
There should be no or minimum stress caused by unfair economics at the human
level. Poor people constitute the base of the economic pyramid. When the base
is strong, the structure will be steady. And it can come up fast. If the poor
at the base die due to starvation, the whole economy will be badly affected And
it cannot recover fast enough.

 

The Government of India has
effected a large financial relief package. And the Prime Minister has
his heart in the right place. First priority is being given to the poor, daily
wage earners, hawkers and others. Cooked and uncooked food is reaching the poor
in villages through the government machinery. There are corners where the government
may not reach. These are being reached by NGOs. Cash is reaching the poor under
‘Direct Benefit Scheme’. Tax refunds are being expedited. Banks are asked to
release more loans. Provident fund claims are being released quickly. Through
all practical measures the government is ensuring that cash flow in the nation
must continue. Cash in the society is like blood in the body. It must remain
circulating. Otherwise the body parts will get numb. And even the smallest part
going numb will affect the whole body.

 

One big relief this time is from
the tax departments. Every year, from January to March, Income-tax and
GST officers get into overdrive to collect tax revenues, whether departmental
claims were right or wrong. Big refund claims, howsoever legitimate, are
withheld for the 4th quarter. That pressure is off this year. And revenue
targets have naturally gone for a toss.

 

Will this huge expenditure of Rs.
5 trillion cause a budgetary deficit? Yes, certainly the budgetary
deficit will increase. Will it cause inflation? May be, maybe not. The
Food Corporation of India (FCI) has over 70 million tonnes of food stocks.
Every year, substantial quantities of food rot and have to be disposed of. If
this stock of food is used, the market demand-supply equations will not be
affected. There need not be any inflation in the price of food. There are some
other items whose demand has fallen. In the case of some other items, it is the
supply that has fallen. All together, as a combined figure, there may be a
minor inflation. (Any guess for the future is to be taken with a pinch of
salt.) But in times of recession, it will help the economy rather than damage
it.

 

ON TOP OF THE ECONOMIC CHAIN

Man is at the top of the food
chain
. No other animal eats man. Man eats almost every animal and plant.
Man contributes little to the nature, but he exploits nature to the maximum
extent. Similarly, there are many people within mankind who are on top of the
economic chain. They contribute little to the economy / society and yet earn
disproportionately large incomes. It is for governments to identify the
enterprises on the top of the economic chain. Do not spend a single rupee
and a single minute on these people. They will manage.

 

BAILOUT PACKAGES

All nations
have announced huge bailout packages. Most of the funds for these packages will
come simply by ‘printing money’. How long can money supply influence and when
does it become useless or even counter-productive? To understand this point,
consider an extreme hypothesis: Indian GDP is Rs. 190 trillion. Can we
say, ‘Just print Rs. 190 trillion and no one has to do any work? They can relax
and enjoy.’ We cannot do that. People have to work and produce goods and
services. A currency note that cannot buy anything has no value. Having
ruled out the extreme hypothesis, one needs to work out the right balance.
Every enterprise that breaks down due to the pandemic will be a wheel that
stops functioning. Save that wheel. Lend it sufficient cash to make it turn
again. Once it starts running, stop lending. Slowly take back the loans. On the
other hand, the daily wage earner can be given food free as long as the
lockdown runs. Probably, for one more week. Then stop all free doles. His
hunger will make him hunt for work. And those millions of wheels will start
functioning once again. Bailout packages is a huge subject by itself. But I
will not go into that right now.

 

There should be no central
command in the sense of planning from top-down. A central command will make
mistakes and commit blunders. Let everyone find their own way. Ensure
continuity of infrastructure. Those who need help should be helped. Give
priority to very small enterprises, then to small and medium, and finally to
large. Let individual spirits find individual solutions. Open up the market
with safety. Planning by every individual and every enterprise, with the
government supporting them, is the best approach.

 

Note: This
article was written on 24th April. Before it gets published in our
journal, I had the opportunity to listen to the Economic Wizard – Mr. Mohandas
Pai on BCAS Webinar on 9th May. I am adding a few more notes.

 

i)  When India works for full year, it generates
GDP of say Rs. 200 Trillions. It is clear that Indian economy will not work for
at least two months due to Covid 19 Pandemic. As simple arithmetics, GDP should
fall by 17%. There are many variables. Some things continued even during lock
down. Some things will not work even after the lock down is lifted. On the
whole, Indian GDP for the financial year 2020-21 can fall by 20%. From an
estimated growth rate of 5% if there is a fall of 20%, our GDP may fall by 15%.
This can cause massive repercussions. As discussed earlier, Government, RBI
& peoples’ job is to ensure that the wheels within wheels work with minimum
damage. Otherwise the domino effect can cause far more losses.

ii) Long term stability lies in
Indian economy being an independent economy. Neither based on exports, nor
based on imports. In still longer terms, when we all – Government to people are
sensitive to the weakest of the lives; and when we ensure welfare of all lives;
we can have a truly satisfied, peaceful India.

 

CONCLUSION

India
and the world have suffered huge personal and economic losses. All this because
of a tiny, invisible organism which probably does not even have life. This is a
warning that Mother Nature has given to Mankind. If we learn the lesson, if we
reset our lifestyle and our capitalist market economics, we can prevent future
pandemics. If we ensure that every individual and every fit enterprise survives
this pandemic, then the human spirit will ensure that in the short term the
economy will be functioning well. Ignore the share market indices and GDP
statistics. Focus on welfare of all – ‘Unto The Last’. Adopt Gandhiji’s and
Vinobaji’s concept of SARVODAYA.

IMPACT OF COVID-19 ON CORPORATE AND ALLIED LAWS

Prior to the manifestation of the
Covid-19 pandemic, most of us would have heard about a disaster recovery plan
or business continuity plan as part of the risk management plans. Such disaster
recovery plans would seldom have envisaged a situation of countrywide, or even
global, lockdowns which most of the world is currently experiencing. Therefore,
it is unwise to expect that such a well-thought-out disaster recovery or
continuity plan would have been prepared for a country as a whole. No doubt,
there are certain legislations like the Disaster Management Act, 2005 and the
Epidemic Diseases Act, 1897 which have come handy to the government in this
unprecedented calamity.

 

Coming to the specific subject of
the impact of Covid-19 on the Corporate and Allied Laws, we need to briefly
touch base with the typical limitations that all of us are suffering from. The
current situation of countrywide lockdown and social distancing norms is making
most of us feel handicapped at not being able to attend office as we would
generally do, have free access to the enabling office environment of accessing
computers, the internet, physical records, printing and scanning documents, DSCs
and all other tools that create a smooth working environment and enable the
ease of working. For most of our working lives easy availability of such basic
office infrastructure has been taken for granted and we did not pause and think
even for a minute what would happen if the easy availability of such office
infrastructure is interrupted for any length of time.

 

These aspects are highlighted to
pinpoint the limitations which business enterprises are facing today as far as
operational aspects are concerned. Apart from these operational limitations or
micro issues, there are many substantive effects or macro issues which Covid-19
has triggered globally. Therefore, in the context of Corporate and Allied Laws
we would need to dissect the Covid-19 impact from two broad perspectives, viz.,
(1) Operational or micro issues; and (2) Substantive or macro issues.

 

Various operational or micro
issues are more to do with operational difficulties currently faced by
corporates causing hindrances in timely and adequate compliances for the short
time span during the ongoing lockdown. On the other hand, the substantive or
macro issues would require a much deeper understanding of certain provisions of
the Corporate and Allied Laws in the context of the unique environment created
by Covid-19 and its possible effects, which would have a long-lasting impact on
Indian corporates in the medium to long term, say over a period of six to 18
months.

 

Many relaxations announced
address the operational or micro issues under the Companies Act, 2013, FDI
norms to check opportunistic takeovers of Indian companies and reducing the
post buyback period for raising further capital from 12 months to six months
under SEBI Regulations amongst others. Therefore, as the Indian corporates
battle the disruptions caused by Covid-19 and endeavour to revive and
streamline business operations post relaxations of the lockdown measures, there
would be a greater need to evaluate the Corporate and Allied Laws provisions
which could create hindrances or pose substantive or macro limitations to
effective recovery and announce enabling relaxations to provide a free runway
for a smooth take-off.

 

Most of us would be aware about
these relaxations by now given the quick spread of such updates on social media
platforms (even faster than coronavirus). Therefore, without getting into the
details, I would like to briefly summarise most of the relaxations as a quick
refresher for ease of reference.

 

I.   Companies Act, 2013 and related rules

 

1. Board meeting permitted through video conferencing or other
audio-visual means
in respect of certain matters for which mandatory
physical meeting is otherwise required, which includes approval of financial
statements, Board’s report, prospectus and matters relating to mergers,
amalgamations, demergers, acquisitions and takeovers – up to 30th
June, 2020
.

 

2. Maximum time gap between two consecutive Board meetings
relaxed from the existing 120 days to 180 days for the next two quarters, i.e. till
30th September, 2020.

 

3. Non-holding of at least one meeting of Independent Directors in
a financial year
without the attendance of Non-Independent Directors will
not be treated as violation for F.Y. 2019-20.

 

4. Non-compliance of residency in India for a minimum period
of 182 days by at least one director of every company will not be treated as
violation for F.Y. 2019-20
.

 

5. Implementation of reporting by auditors as per the Companies
(Auditor’s Report) Order, 2020 deferred by one year to F.Y. 2020-21.

 

6. The time limit for (i) creating Deposit Repayment Reserve of
20% of deposits
maturing during F.Y. 2020-21; and (ii) making specified
investment or deposit of at least 15% of the amount of debentures maturing during
F.Y. 2020-21 extended from 30th April to 30th June,
2020.

 

7. The time limit for filing of declaration for commencement of
business
by newly-incorporated companies extended from 180 days to 360
days
.

8. Contribution to newly-formed PM CARES Fund covered
under CSR spending of corporates and FAQs released in relation to CSR
spending in view of the peculiar situation of the Covid-19 pandemic.

 

9. Conduct of Extraordinary General Meetings through video
conferencing or other audio-visual means permitted till 30th June,
2020
in unavoidable cases, subject to certain safeguards and protective
mechanisms as detailed in MCA Circular No. 14/2020 dated 8th April,
2020 as further clarified by MCA Circular No. 17/2020 dated 13th
April, 2020.

 

10. Extension of due date of AGM to 30th September, 2020
for companies whose financial year has ended on 31st December,
2019
, i.e. time limit extended from six months from the end of the
financial year to nine months.

 

11. Companies Fresh Start Scheme, 2020 (CFSS) has been announced
in order to enable certain eligible defaulting companies to regularise their
filings without payment of additional fees and granting immunity from launching
prosecution or proceedings for imposition of penalty on account of delay
associated with certain filings. The detailed guidelines and operational
procedures have been laid out in MCA Circular No. 12/2020 dated 30th March,
2020.

 

12. LLP Settlement Scheme, 2020 (LSS) which was announced through
MCA Circular No. 06/2020 dated 4th March, 2020 has been modified vide MCA
Circular No. 13/2020 dated 30th March, 2020
keeping in mind the
prevalent situation.

 

II.  Securities and Exchange Board of India (SEBI)
Regulations applicable to listed companies

 

A. SEBI (Listing Obligations and Disclosure Requirements) Regulations,
2015 (‘LODR’)

1. The following relaxations, in the form of extension of timeline
for certain compliance requirements / filings by entities whose equity
shares are listed
, have been announced (Refer Table A).

Further, vide a separate
circular1, SEBI has granted similar relaxations to issuers who have
listed their debt securities, non-convertible redeemable preference shares and
commercial papers, and to issuers of municipal debt securities.

 

2. As per Regulations 17(2) and 18(2)(a), the Board of directors and
the audit committee need to meet at least four times a year, with a maximum
time gap of 120 days between two meetings. The listed entities are exempted
from observing this maximum time gap for the meetings held / proposed to be
held between 1st December, 2019 and 30th June, 2020.
However, listed entities need to ensure that there are at least four Board and
audit committee meetings conducted in a year.

 

3. The effective date of operation of the new SEBI circular on
Standard Operating Procedure (SOP)
dated 22nd January, 2020 in
relation to imposition of fines and other enforcement actions for
non-compliance with provisions of the LODR, has been extended to compliance
periods ending on or after 30th June, 2020 instead of 31st
March, 2020. Thus, the existing SEBI SOP Circular dated 3rd May,
2018 would be applicable till such date.

 

4. Publication of newspaper advertisements for certain
information such as notice of Board meetings, financial results, etc. as
required under Regulations 47 and 52(8) has been exempted for all events
scheduled till 15th May, 2020
.

Table A

No.

Regulation
No.

Compliance
requirement / filings

Relaxations
w.r.t. quarter / F.Y. ending
31st March, 2020

 

 

 

Due date

Extended date

1.

7(3)

Half-yearly compliance certificate on share
transfer facility

30th April, 2020

31st May, 2020

2.

13(3)

Quarterly statement of investor complaints

21st April, 2020

15th May, 2020

3.

24A

Annual secretarial compliance report

30th May, 2020

30th June, 2020

4.

27(2)

Quarterly corporate governance report

15th April, 2020

15th May, 2020

5.

31

Quarterly shareholding pattern

21st April, 2020

15th May, 2020

6.

33

Quarterly financial results

15th May, 2020

30th June, 2020

Annual financial results

30th May, 2020

30th June, 2020

7.

40(9)

Half-yearly certificate from practicing CS on
timely issue of share certificates

30th April, 2020

31st May, 2020

8.

44(5)

Holding of AGM by top 100 listed entities by
market capitalisation

31st August, 2020

30th September, 2020

9.

19(3A), 20(3A) and 21(3A)

Nomination and Remuneration Committee, Stakeholders
Relationship Committee and Risk Management Committee need to meet at least
once in a year

31st March, 2020

30th June, 2020

10.

Circular issued in terms of Regulation 101(2)

Disclosure requirement by large corporates

 

 

Initial disclosure

30th April, 2020

30th June, 2020

Annual disclosure

15th May, 2020

30th June, 2020



5. Regulation 29(2) specifies that listed entities should give prior
intimation to stock exchanges about Board meeting
(i) at least five days
before the meeting wherein financial results are to be considered, and
(ii) two working days for all other matters. This requirement of prior
intimation has been reduced to two days in all cases for Board meetings
to be held till 31st July, 2020.

 

6. Any delay in submission of information to stock exchanges
regarding loss of share certificates and issue of duplicate share certificates
within two days of receiving such information as required under Regulation
39(3) will not attract penal provisions for intimations to be made between 1st
March, 2020 and 31st May, 2020.

 

7. In line with the relaxations announced by the MCA for allowing
companies whose financial year ended on
31st December, 2019
to hold their AGM till 30th
September, 2020, SEBI has granted similar relaxation to top 100 listed
entities, whose financial year ended on 31st December, 2019,
for holding their AGM within a period of nine months instead of within a period
of five months from the year-end.

 

8. SEBI has further clarified that authentication / certification of
any filing / submission made to the stock exchanges under LODR may be done
using digital signature certificate (DSC) until 30th June, 2020.

 

Suggested relaxations: Apart from the above
relaxations proactively given by SEBI, the following further relaxations may be
considered by it:

 

1. There were a few amendments made to the LODR based on the
recommendations of the Kotak Committee which came into effect from 1st
April, 2020, mostly relating to Board of directors and its meetings. These
include (i) requirement of having at least one Independent woman director by
the top 1,000 listed entities [Reg. 17(1)(a)]; (ii) requirement of having at
least six directors on the Board by top 2,000 listed entities [Reg. 17(1)(c)]
and (iii) a person shall not be a director in more than seven listed entities
(Reg. 17A). While most of these provisions were introduced well before time for
listed entities to be compliant beforehand, the current situation warrants
reconsideration in extending the effective date of these provisions.

2. Regulation 25(3) of LODR requires Independent directors to hold at
least one meeting in a year without the presence of Non-Independent directors
and members of management. Here, too, relaxation should be granted by extending
the due date to 30th June, 2020 as done for compliance of
Regulations 19(3A), 20(3A) and 21(3A) in respect of committee meetings. It is
worthwhile to recall that the MCA has waived the similar requirements under the
Companies Act as stated above.

 

B.  SEBI (Substantial Acquisition of Shares and Takeovers) Regulations,
2011 (‘SAST’)

The time limit for filing annual
disclosures under Regulations 30(1) and 30(2) by persons holding 25% or more
shares / voting rights in a listed company and by promoters (including persons
acting in concert), respectively, regarding aggregate shareholding and voting
rights held in the listed company, have been extended till 1st June,
2020 instead of seven working days from the end of the financial year. Further,
a similar time limit extension has been granted for disclosure to be made by
promoters under Regulation 31(4) regarding non-encumbrance of shares held by
them, other than those already disclosed during the financial year.

 

C.  SEBI (Issue of Capital and Disclosure Requirements) Regulations,
2018 (‘ICDR’)

1. Rights Issues: SEBI has proactively announced certain
much-needed relaxations to listed entities in order to create an enabling
environment for fund-raising through rights issues that open on or before 31st
March, 2021. SEBI, vide a Circular2 , has granted relaxations
from strict application of certain provisions relating to rights issues, which
broadly include the following:

 

a) Eligibility conditions relating to Fast Track Rights Issues:
Certain eligibility conditions have been relaxed, inter alia, in the
form of reduction of certain time periods and monetary caps so that companies
can find it easy to comply with such conditions and come out with Fast Track
Rights Issues for quick fund raising.

b) Relaxation with respect to minimum subscription amount: The
requirement of receipt of minimum subscription amount in a rights issue has
been relaxed from the existing 90% to 75%, provided that such companies
need to ensure that at least 75% of the issue size is utilised for the objects
of the issue other than general corporate purpose.

c) Relaxation with respect to minimum threshold required for
non-filing of draft offer document with SEBI for its observations:
The
listed entities with a rights issue size of up to Rs. 25 crores (instead of Rs.
10 crores as earlier applicable) need not file draft letter of offer with SEBI
and can directly proceed to issue letter of offer to shareholders.

 

2. Validity of Observations issued by SEBI: As per the
existing provisions, a public issue / rights issue may be opened within a
period of 12 months from the date of issuance of Observations by SEBI. This has
been relaxed vide a SEBI Circular3  which provides that the validity of the SEBI
Observations, where the same have expired / will expire between 1st March,
2020 and 30th September, 2020 has been extended by six months from
the date of expiry of such Observations, subject to a requisite undertaking
from the lead manager to the issue.

 

3. Relaxation from fresh filing of offer document with SEBI in
case of increase / decrease in fresh issue size:
As per the existing
provisions, fresh filing of the draft offer document along with fees is
required in case of any increase or decrease beyond 20% in the estimated fresh
issue size. This has been relaxed vide a SEBI Circular3
whereby issuers have been permitted to increase or decrease the fresh issue
size by up to 50% of the estimated fresh issue size without the requirement to
file a fresh draft offer document with SEBI subject to fulfilment of certain
conditions. This relaxation is applicable for issues (IPO / Rights Issues /
FPO) opening before 31st December, 2020.

 

D. SEBI (Buy-back of Securities) Regulations,
2018 (‘Buy-back Regulations’)

Regulation 24(i)(f) of the
Buy-back Regulations imposes a restriction that companies shall not raise
further capital for a period of one year from the expiry of the buy-back
period, except in discharge of their subsisting obligations. Vide a SEBI
Circular4, this restrictive timeframe of one year has been reduced
to six months in line with the provisions of section 68(8) of the Companies
Act, 2013. This relaxation is applicable till 31st December, 2020.
This is a welcome relaxation, much needed in the current scenario where many
companies had announced buy-back prior to the outbreak of Covid-19 and may now
need capital to survive these difficult times.

 

III. Insolvency and Bankruptcy Code, 2016 (‘IBC’)

The provisions of the IBC can
play a crucial role to make or break an entity in this turbulent business
environment. It is obvious that many businesses would find it difficult to
honour their financial obligations on time due to loss of business, revenue and
profit, as well as due to lack of liquidity in the market. In this regard, the
government has already announced its intention to put in place requisite
safeguards so that business entities are not dragged to insolvency proceedings
to further worsen the ongoing business crisis. The following few key decisions
/ announcements have already been made or are at an advanced stage of
consideration:

 

1.    
The threshold limit of debt default for invoking the Corporate
Insolvency Resolution Process (CIRP) has been increased to Rs. 1 crore from Rs.
1 lakh.

 

2. An amendment has been made to the IBBI CIRP Regulations to provide
that the period of lockdown imposed by the Central Government due to Covid-19
shall not be counted for the purposes of the time-line for any activity that
could not be completed due to such lockdown in relation to a CIRP.

 

3. As per a news article, the provisions of
sections 7, 9 and 10 relating to initiation of CIRP is proposed to be suspended
for a period of six months which can be extended up to one year through
promulgation of an ordinance.


To conclude,
we must acknowledge the proactive relief measures announced by the government
and Regulators as far as Corporate and Allied Laws compliances are concerned,
which would provide a much-needed breather to India Inc. to successfully sail
through these difficult times. It would be imperative to continuously evaluate
and announce further substantive reliefs that should be provided till business
normalcy is achieved.

 

Let
me recall the words of Swami Vivekananda, ‘To think positively and
masterfully, with faith and confidence, life becomes more secure, richer in
achievement and experience’
in the hope that all of us would imbibe this
thought in these difficult times; and once we overcome this situation, we will
cherish this novel experience for the rest of our lives.


___________________________________________________

1   SEBI Circular No. SEBI/HO/DDHS/ON/P/2020/41 dated 23rd March,
2020

2     SEBI Circular No.
SEBI/HO/CFD/CIR/CFD/DIL/67/2020 dated 21st April, 2020

3     SEBI Circular No.
SEBI/HO/CFD/DIL1/CIR/P/2020/66 dated 21st April, 2020

4     SEBI Circular No.
SEBI/HO/CFD/DCR2/CIR/P/2020/69 dated 23rd April, 2020


FINANCIAL REPORTING AND AUDITING CONSIDERATIONS ON ACCOUNT OF COVID-19

Most countries, businesses and
companies are expected to be impacted by the Covid-19 pandemic and the
increased economic uncertainty may have major financial reporting consequences.
Supply-chains,distribution-chains, cash-flows, demand, price variations,
facility access, workforce availability, debt obligations, contract
cancellations, are experiencing turbulence. 
Such a holistic and cumulative impact on different spheres of business
operations carries a definite, and acute consequence on the financial reporting
by the entity.

 

The role of preparers of
financial statements, audit committees, auditors and regulators become critical
in this situation. Distilling the impact through the requirements of existing
accounting and auditing requirements frameworks and communicating it
effectively will enable financial markets to base their decisions on such
robust and dependable inputs.

 

Auditors’ role will require
special attention in relation to appropriate treatment of the financial impacts
and disclosures thereof. The Institute of Chartered Accountants of India has
issued an ‘Accounting & Auditing Advisory on Impact of Coronavirus on
Financial Reporting and the Auditors Consideration’
to help its members in
effectively discharging their obligations.

 

There will be issues to consider
for this year’s reporting as well as in future years. Every entity would need
to consider the financial impact on itself and the areas of the financial
statements that will be affected along with determining the required
disclosures. Financial reporting areas that are likely to require close
consideration include the following:

 

(1)  Impairment of assets

Impairment of assets becomes the
foremost financial reporting consideration, given that testing of impairment is
predominantly based on the earnings realisation from a group of assets.

 

The assumptions such as
the fall in demand, impact of lockdown, fall in commodity prices, decrease in
market interest rates, manufacturing plant shutdowns, shop closures, reduced
selling prices for goods and services, cost of capital, etc. may have a
meaningful impact on the impairment testing performed by entities. Whilst most
entities would perform impairment testing on an annual basis, the current
Covid-19 situation would qualify for being an ‘indicator’, thereby requiring
entities to test for impairment even in the interim.

 

(2)  Going concern

Financial statements are prepared
on a going concern basis unless management intends either to liquidate the
entity or to cease trading, or has no realistic alternative but to do so.

 

With business models being
challenged especially in the travel, hospitality, leisure and entertainment
segments, companies may need to consider the implications on the assessment of
going concern and whether these circumstances will result in prolonged
operational disruption which will significantly erode the financial position of
the entity or otherwise result in failure.

 

It is the
responsibility of management to make an assessment as to whether the entity is
a going concern or otherwise. The unprecedented and uncertain nature of the
pandemic makes it imperative for an entity to evaluate various scenarios that
are possible and assess their impact on the assumption of going concern.
Inability to satisfy the assumptions of going concern would lead to deviation
from historical cost-based accounting and other impacts.

 

Management should also expect an informed
and sometimes contrarian dialogue with auditors on the aspect of going concern.

 

(3)  Valuation of inventory

With social distancing norms in
place, entities may not have been able to carry out their annual physical
inventory count fully or even partially on the cut off date. Due to the
lockdowns, auditors and companies may need to rely on additional alternate
procedures to gain comfort on the position and valuation as on 31st March,
2020.

Companies would need to assess
whether, on their reporting date, an adjustment is required to the carrying
value of their inventory to bring them to their net realisable value in
accordance with the principles of Ind AS 2 –Inventories and AS 2 – Valuation
of Inventories
.

 

Given the pandemic, net
realisable value calculation will likely require more detailed methods and
assumptions, e.g. write-down of stock due to lesser expected price realisation,
reduced movement in inventory, expiry of perishable products, lower commodity
prices, or inventory obsolescence. The usability of raw materials and work in
progress may also require close consideration.

 

A typical question arises in
relation to allocation of overheads to the valuation of inventory. If an entity
ceases production or reduces production for a period of time, significant
portions of unallocated fixed production overheads (e.g., rent, depreciation of
assets, some fixed labour, etc.) will need to be expensed rather than
capitalised, even if some reduced quantity of inventory continues to be
produced.

 

(4)  Lease and onerous contracts

The implications of force
majeure
provisions on contracts and leases remain to be tested. It is
possible that there may be changes in the terms of lease arrangements or
lessors may grant concession to lessees with respect to lease payments,
rent-free holidays, additional days in subsequent period, etc. Such revised
terms or concessions shall be considered while accounting for leases which may
lead to the application of accounting relating to the modification of leases.
However, generally anticipated revisions are not taken into account.

 

Some entities may encounter
situations wherein certain contracts may become onerous to perform. Ind AS 27
defines an onerous contract as a contract in which the unavoidable costs of
meeting the obligations under the contract exceed the economic benefits
expected to be received under it. Price erosions, long-term commitment, salvage
discount, commitment of additional performance are certain triggers to evaluate
whether a contract has turned onerous. As soon as a contract is assessed to be
onerous, a company applying Ind AS 37 records a provision in its financial
statements for the loss it expects to make on the contract.

 

(5)  Expected credit loss (ECL)

ECL is an expectation-based
probability weighted amount determined by evaluating a range of possible
outcomes. It enables entities to make adequate provisions for non-realisation
of financial assets including trade receivables.

 

Ind AS 109 – Financial
Instruments
requires an entity, amongst other matters, to also evaluate the
likelihood of the occurrence of an event if this would significantly affect the
estimation of expected losses of financial assets. In assessing the expected
credit loss, management should consider reasonable and supportable information
at the reporting date. Covid-19 impact would require to be factored in the ECL
probability model of entities.

 

Expected credit losses may
increase due to an increase in the probability of default for financial assets.
Additionally, the effects of the coronavirus may trigger a significant increase
in credit risk, and therefore the recognition of a lifetime ECL provision on
many financial assets.

 

Event-based provisioning in
relation to specific instances, like a customer turning insolvent or a specific
financial investment getting affected, would continue to be factored in
irrespective of the ECL.

 

(6)  Revenue recognition and borrowing costs

Ind AS 15 – Revenue from
Contracts with Customers
often requires a company to make estimates and
judgements determining the timing and amount of revenue to be recognised.
Covid-19 may result in a likely increase in sales returns, decrease in volume
discounts, higher price discounts, etc. Entities may need to account for
returns and refund liabilities towards the customers whilst recognising the
revenue.

 

Ind AS 115 requires an entity to
defer a component of revenue to be recognised when the contract includes
variable consideration. This may result in some entities recognising a contract
liability rather than revenue, if significant uncertainty exists surrounding
whether the entity will realise the entire consideration.

 

Separately, the guidance on
borrowing costs requires an entity to suspend the capitalisation of borrowing
costs to an asset under construction for such extended periods that the actual
construction of the asset is suspended.

 

(7)  Government grant

Governments may support entities
with monetary and non-monetary measures, but such benefits may be one-time
events or spread over time.

 

Entities may need to establish an
accounting policy regarding government assistance which needs to be appropriate
and in line with the requirements of Ind AS 20 – Accounting for Government
Grants and Disclosure of Government Assistance
. It is essential to distinguish
between government assistance and government grants and ensure that grants are
recognised only when the recognition criterion in Ind AS 20 is met. Some of the
government assistance may involve deferral of tax payments or other tax
allowances. The accounting treatment of tax allowances may need to be accounted
for under Ind AS 12 –  Income Taxes
rather than Ind AS 20.

 

The current relaxation by the
Reserve Bank of India allowing a moratorium on loan instalments may not qualify
as a government grant.

 

(8)  Deferred tax

Ind AS 12 – Income Taxes
requires that the measurement of deferred tax liabilities and deferred tax
assets shall reflect the tax consequences that would follow from the manner in
which the entity expects, at the end of the reporting period, to recover or
settle the carrying amount of its assets and liabilities.

 

Covid-19 could affect future
profits and / or may also reduce the amount of deferred tax assets or create
additional deductible temporary differences due to various factors (e.g. asset
impairment, non-utilisation of available losses, change in projections).
Entities having deferred tax assets on account of accumulated tax losses would
need to reassess their measurement with a newer set of business projections.

 

Entities may have considered the
assumption of ‘indefinite reinvestment’ and not recognised deferred tax on
accumulated undistributed earnings of subsidiaries. Such assumptions may need
to be revisited to determine if they remain appropriate given the entity’s
current cash flow projections.

 

(9)  Fair value and hedge accounting

Ind AS 113 – Fair Value
Measurement
recognises the fact that observable inputs being considered for
deriving fair value may be either of (i) observable market price (quoted price
in an active market – Level 1) or (ii) application of valuation techniques
(Level 2 and Level 3).

 

With 1,500 companies trading at
their 52-week low on the Bombay Stock Exchange, the fair value measurement
considered by entities may need a re-look across all three methods of observable
inputs.

While volatility in the financial
markets may suggest that the prices are aberrations and do not reflect fair
value, it would not be appropriate for an entity to disregard market prices at
the measurement date, unless those prices are from transactions that are not
orderly.

 

The financial assumptions in a
valuation model like discounting rate, weighted average cost of capital, etc.
that are considered in a Level-3 valuation would need a reassessment.

 

Hedge effectiveness assessment is
required to be performed at the inception and on an on-going basis at each
reporting date or in case of a significant change in circumstances, whichever
occurs first. The current volatility in the markets may result in an entity
requiring to either re-balance the hedge where applicable, or discontinuing
hedge accounting if an economic relationship no longer exists, or the
relationship is dominated by credit risk. Certain opportunistic and speculative
transactions may also take place.

 

When a hedging relationship is
discontinued because a forecast transaction is no longer highly probable, a
company needs to determine whether the transaction is still expected to occur.
If the transaction is:

(i) still expected to occur, then gains or losses on the hedging
instrument previously accumulated in the cash flow reserve would generally
remain there until the future cash flows occur; or

(ii) no longer expected to occur, then the accumulated gains or losses
on the hedging instrument need to be immediately reclassified to profit or
loss.

 

(10) Disclosures and management guidance

Transparent disclosures should be
made on the effects and risks of this outbreak on the entity. The Securities
and Exchange Commission instructed publicly traded companies to provide
‘robust’ disclosures on the impact of Covid-19 on their operations and results.
Entities would need to disclose the impact of Covid-19 on their performance,
including qualitative aspects of the business.

 

Difficult times also warrant
accuracy in guidance; in an uncommon move, leading Indian bell-wether companies
like Wipro and Infosys have refrained from giving any annual guidance to
their shareholders for F.Y. 2020-21, citing the uncertain impact of Covid-19.

 

The relevance of an audit effort
on the financial statements is further emphasised in uncertain times like
these. Some of the common questions that auditors could encounter would
include:

 

(A) Have the risk considerations relevant to an entity changed, thereby
requiring an amendment to the audit approach?

Standards on auditing require an
auditor to identify and assess the risk of material misstatements and
materiality in planning and performing an audit. This assessment may have been
made during the earlier half of the financial year 2019-20 and the audit
procedures tailored on the basis of such earlier assessment. Due to Covid-19
and its far-reaching implications, the risk considerations relevant to an
entity may change significantly, thereby requiring an auditor to revisit the
audit plan, materiality and the approach to testing.

 

The perfect storm that Covid-19
offers has the potential to usurp good and healthy business models and push
profitable companies into a survival challenge. It would be important for
auditors to revisit the audit plan and the risk considerations once again given
the exposure an entity would have to Covid-19.

 

(B) Have the audit procedures been compromised on account of
restrictions, lockdowns and social distancing?

Auditors may face a challenge in
performing routine audit procedures during times of lockdown, social
distancing, travel restrictions, lesser access to management teams, etc.
Typically, audit procedures that have either a physical work-stream or
dependency on a third party are likely to get impacted. These could include
physical verification of inventory, cash on hand reviews, seeking external
balance confirmations, requiring comfort from component auditors, etc.

 

SA 501 requires the auditor to
observe some physical inventory counts on an alternative date if the attendance
of physical counting cannot be performed at the year-end date, or perform
alternative audit procedures where attendance of physical inventory counts is
impracticable. The standard also requires an auditor to perform roll-back procedures
to derive the desired comfort on inventory level on a reporting date.

 

Audit procedures should be
simulated to understand the potential impacts on such procedures to be
performed and alternate procedures identified to supplement or otherwise replace
such an audit procedure.


(C) How does an auditor provide comfort on the operating effectiveness
of internal financial controls given the altered way of working, such as work
from home, no wet signatures, cloud dependency, etc.?

Standards on auditing require an
auditor to assess the design and implementation along with the operating
effectiveness of internal controls over financial reporting. The sudden impact
of Covid-19 and the precautionary measures taken by governments across the
world have resulted in newer work models of work from home, no wet signatures,
cloud dependency, etc.

 

Auditors would need to evaluate
the impact of such differentiated working models on the internal control
framework and the desired reliance by the auditor on their operating
effectiveness. If the level of expected controls reliance changes, it is
important to document this and any other resulting changes to the planned audit
response.

 

(D) Is Covid-19 an adjusting event or a non-adjusting event?

According to Ind AS 10 – Events
after the reporting date
, events occurring after the reporting period are
categorised into two, viz. (a) Adjusting events, i.e. those that require
adjustments to the amounts recognised in the financial statements for the
reporting period, and (b) Non-adjusting events, i.e. those that do not require
adjustments to the amounts recognised in the financial statements for the
reporting period.

 

Entities and auditors would need
to ascertain the impact of Covid-19 as either an adjusting or non-adjusting
event given the peculiarity that the effects of Covid-19 and lockdown were
prevalent in March, 2020 itself. Entities impacted by the Covid-19 pandemic
will need to assess how these events have, and may in future impact their
operations. Managements will need to consider the facts and apply critical
judgement in assessing what specific events and, more importantly, the timing
of those events, provide evidence of conditions that existed at the end of the
reporting period in order to determine if an adjustment is required. If it is
concluded as non-adjusting, the entity will need to determine if disclosure of
the event is required.

 

(E) Does Covid-19 require added consideration to emphasis of matter and
in relation to going concern uncertainty?

If the auditor considers it
necessary to draw users’ attention to a matter presented or disclosed in the
financial statements that in the auditor’s judgement is of such importance that
it is fundamental to users’ understanding of the financial statements, the
auditor shall include an ‘Emphasis of Matter’ paragraph in the Auditor’s
Report. SA 706 also cites instances that may warrant an emphasis of matter
observation by the auditor. One such instance is ‘A major catastrophe
that has had, or continues to have, a significant effect on the entity’s
financial position.
’ Depending on the circumstances of the entity, the
auditor may consider appropriate reporting as emphasis of matter.

 

When
preparing financial statements, management is required to make an assessment of
an entity’s ability to continue as a going concern. In line with SA 570
(Revised), the auditor’s responsibilities are to obtain sufficient appropriate
audit evidence regarding, and conclude on, the appropriateness of management’s
use of the going concern basis of accounting in the preparation of the
financial statements, and to conclude, based on the audit evidence obtained,
whether a material uncertainty exists about the entity’s ability to continue as
a going concern.

 

Depending
on the circumstances, the auditor would need to consider whether to include a
separate section ‘Material Uncertainty Related to Going Concern’ in the
auditor’s report.

 

COVID AND FAIR VALUE MEASUREMENT

Fair value measurements are
required or permitted under Ind AS for many financial instruments and
non-financial assets and liabilities. They are required for quoted and unquoted
investments in shares, bonds, receivables, payables, derivatives, etc. As also
in certain situations for non-financial items, such as in determining
impairment of property, plant, equipment or goodwill. This article attempts to
discuss whether the current markets post the Covid outbreak can be considered
as not being orderly and therefore ignored for determining the fair values for
the year ending 31st March, 2020 financial statements.

 

Before we attempt to address the
moot question, whether markets as on 31st March, 2020 were orderly
or not, let us first look at the various provisions of Ind AS 113 Fair Value
Measurement.

(i)
Paragraph 2 of Ind AS 113 states that ‘Fair value is a market-based
measurement, not an entity-specific measurement. For some assets and
liabilities, observable market transactions or market information might be
available. For other assets and liabilities, observable market transactions and
market information might not be available. However, the objective of a fair
value measurement in both cases is the same – to estimate the price at which an
orderly transaction to sell the asset or to transfer the liability would take place
between market participants at the measurement date under current market
conditions
(i.e., an exit price at the measurement date from the
perspective of a market participant that holds the asset or owes the
liability).’

(ii) Paragraph 3 of Ind AS 113
states that ‘When a price for an identical asset or liability is not
observable, an entity measures fair value using another valuation technique
that maximises the use of relevant observable inputs and minimises the use of
unobservable inputs. Because fair value is a market-based measurement, it is
measured using the assumptions that market participants would use when pricing
the asset or liability, including assumptions about risk. As a result, an
entity’s intention to hold an asset or to settle or otherwise fulfil a
liability is not relevant when measuring fair value.’

(iii) Paragraph 61 of Ind AS 113
states as follows ‘An entity shall use valuation techniques that are
appropriate in the circumstances and for which sufficient data are available to
measure fair value, maximising the use of relevant observable inputs and
minimising the use of unobservable inputs.

(iv) Ind AS 113 defines orderly
transaction as ‘A transaction that assumes exposure to the market for a
period before the measurement date to allow for marketing activities that are
usual and customary for transactions involving such assets or liabilities; it
is not a forced transaction (e.g. a forced liquidation or distress sale.).’

 

IDENTIFYING TRANSACTIONS THAT ARE NOT
ORDERLY

Ind AS 113.B38 states that ‘If
an entity concludes that there has been a significant decrease in the volume or
level of activity for the asset or liability in relation to normal market
activity for the asset or liability (or similar assets or liabilities), further
analysis of the transactions or quoted prices is needed. A decrease in the
volume or level of activity on its own may not indicate that a transaction
price or quoted price does not represent fair value or that a transaction in
that market is not orderly.’

 

Ind AS 113.B43 provides guidance
for determination of whether a transaction is orderly (or is not orderly).
Whether there has been a significant decrease in the volume or level of
activity requires comparison to normal market activity level. B43 lists down
the following circumstances that may indicate that a transaction is not
orderly:

(a) There was not adequate
exposure to the market for a period before the measurement date to allow for
marketing activities that are usual and customary for transactions involving
such assets or liabilities under current market conditions.

(b) There was a usual and
customary marketing period, but the seller marketed the asset or liability to a
single market participant.

(c) The seller is in or near
bankruptcy or receivership (i.e., the seller is distressed).

(d) The seller was required to
sell to meet regulatory or legal requirements (i.e., the seller was forced).

(e) The transaction price is an
outlier when compared with other recent transactions for the same or a similar
asset or liability.

 

OBSERVATIONS AND CONCLUSIONS

Fair value is a measurement of a
date-specific exit price estimate based on assumptions (including those about
risks) that market participants would make under current market conditions.
The fair value measurement objective is to determine an exit price at the
measurement date from the perspective of a market participant. Fair value of
the asset or liability reflects conditions as of the measurement date and not
a future date
. It would not be appropriate for an entity to disregard
market prices at the measurement date, unless those prices are from
transactions that are not orderly. The concept of an orderly transaction is
intended to distinguish a fair value measurement from the price in a distressed
sale or forced liquidation.
The intent is to convey the current value of
the asset or liability at the measurement date, not its potential value at a
future date.

 

The current situation may make it
challenging to estimate the price that would be obtained due to highly volatile
markets and / or a lack of an active market existing for certain instruments
(e.g. derivatives that are not traded on an exchange). However, the objective
of ‘fair value’ will continue to be to determine a price at which an orderly transaction
would take place between market participants under conditions that existed at
the measurement date. It would not be appropriate to adjust or disregard
observable transactions unless those transactions are determined to be not
orderly. There is a high bar to conclude that a transaction price is not
orderly under Ind AS 113.B43, which provides a list of factors to consider if a
transaction is not orderly. The author believes that there is an implicit
rebuttable presumption that observable transactions between unrelated parties
are orderly. In almost all instances, such transactions are considered orderly.
Therefore, the evidence necessary to conclude an observable transaction between
unrelated parties is not orderly should be incontrovertible. Accordingly,
the fair value of an investment in an active market (e.g. BSE, NSE, etc.) would
continue to be calculated as the product of the quoted price for the individual
instrument times the quantity held (commonly referred to as ‘P times Q’), even
in times of significant market volatility.
Volatility may raise questions
as to whether current pricing is reflective of fair value. However, the
standard does not permit current market evidence to be dismissed on the basis
of volatility alone.

 

Some may argue that in the
current environment there is an element of forced selling and that fair value
measurement is not intended to reflect prices in a forced or distressed sale.
Nevertheless, the presence of distressed or forced sellers in a market may
influence the price that could be obtained by a non-distressed seller in an
orderly transaction.

 

Fair value measurement would
consider how the Covid outbreak and any actions taken by governments at the
reporting date would have impacted market participants’ valuation assumptions.
Current market conditions may appear to be a ‘distress sale’, however, if such
conditions exist broadly in the market, then those factors should be
incorporated into a fair value measurement. It would be incorrect to adjust a
measure for expected ‘rebounds’ in value. For financial instruments with level
1 prices (those that are quoted on an active market), even if there is a
significant decline in activity on that market, this does not mean that the
price has become unobservable or that it was 
under a distress sale or a forced liquidation.

 

Whilst determining a valuation
for other than level 1 category of instruments (i.e., those that are quoted in
an active market), preparers of financial statements may have to use valuation
techniques. This may be the case for several unquoted shares or derivatives or
bonds, etc. Preparers using valuation techniques may have to consider the
impact of Covid-19 on various assumptions including discount rates,
credit-spread / counter-party credit risk, etc.
In doing so, the aim will
be to maximise observable inputs and minimise unobservable inputs. The
observable inputs will reflect current market conditions at the balance sheet
date and should not be ignored.

 

The
ICAI guidance ‘Impact of Corona Virus on Financial Reporting and the
Auditors Consideration’
states that ‘It may not be always appropriate to
conclude that all transactions in such a market are not orderly. Preparers
should be guided by the application guidance in Ind AS 113 that indicates
circumstances in which the transaction is not considered an orderly
transaction.’
Though the ICAI guidance does not provide any detailed
guidance, it makes no exception to complying with the requirements of the
Standards. For Indian GAAP, similar considerations will apply in respect of
financial assets within the scope of AS 13 Accounting for Investments.

Section 69C – Unexplained expenditure – Bogus purchases – Mere reliance by the A.O. on information obtained from the Sales Tax Department, or the statements of two persons made before the Sales Tax Department, would not be sufficient to treat the purchases as bogus

5. Pr. CIT-13 vs. Vaman International Pvt. Ltd. [Income tax Appeal
No. 1940 of 2017]

Date of order: 29th January, 2020

ACIT vs. Vaman International Pvt.
Ltd. [ITA No. 794/Mum/2015; Date of order: 16th November, 2016;
A.Y.: 2010-11; Bench ‘F’]

 

Section 69C – Unexplained
expenditure – Bogus purchases – Mere reliance by the A.O. on information
obtained from the Sales Tax Department, or the statements of two persons made
before the Sales Tax Department, would not be sufficient to treat the purchases
as bogus

 

The assessee is a company engaged
in the business of trading and sale of furniture and allied items on wholesale
basis. The A.O. doubted the expenditure of Rs. 4,75,42,385 stated to be on
account of purchases from two parties, viz., Impex Trading Co. (for an amount
of Rs. 2,90,80,292) and Victor Intertrade Pvt. Ltd. (Rs. 1,84,62,093). The A.O.
acted on the basis of information received from the office of the
Director-General of Income Tax (Investigation), Mumbai and from the Sales Tax
Department that in the list of bogus sales parties the names of the two
aforesaid parties were included which rendered the purchase transaction
doubtful.

 

The A.O. observed that the
assessee did not produce lorry receipts and other related documents to reflect
the movement of goods sold and purchased which were crucial for determining the
genuineness of the purchase transaction. In the absence thereof, the A.O. added
the said amounts to the total income of the assessee u/s 69C by treating the
expenditure as bogus purchases.

 

The first appellate authority
held that such addition by the A.O. could not be sustained. Accordingly, he deleted
the addition of Rs. 4,75,42,385. The Tribunal, by an order dated 16th
November, 2016, upheld the order of the first appellate authority and dismissed
the appeal of the Revenue.

 

On further appeal, the Hon. High
Court observed that section 69C deals with unexplained expenditure. But it also
contains a deeming provision which states that if an assessee incurs any
expenditure in the relevant previous year but offers no explanation about the
source of such expenditure or part thereof, or if the explanation provided is
not satisfactory to the A.O., then the amount covered by such expenditure or
part thereof shall be deemed to be the income of the assessee; and once it is
so deemed, the same shall not be allowed as a deduction under any head of
income.

 

The Court relied on the Gujarat
High Court decision in Krishna Textiles vs. CIT, 310 ITR 227  wherein it has been held that u/s 69C the
onus is on the Revenue to prove that the income really belongs to the assessee.

 

The Hon. Court observed that the
A.O. did not doubt the sales and stock records maintained by the assessee. By
submitting confirmation letters, copies of invoices, bank statements, payment
orders, payment by account payee cheques, etc., the assessee had proved that
the sales and purchases had taken place. By highlighting the fact that all the
payments against the purchases were made through banking channels by way of
account payee cheques, the first appellate authority held that the source of
expenditure was fully established by the assessee beyond any doubt. He had
further recorded that during the appellate proceedings the assessee had
furnished complete quantitative details of the items of goods purchased during
the year under consideration and their corresponding sales. Mere reliance by
the A.O. on information obtained from the Sales Tax Department, or the
statements of two persons made before the Sales Tax Department, would not be
sufficient to treat the purchases as bogus and thereafter to make the addition
u/s 69C.

 

The Tribunal also held that if
the A.O. had doubted the genuineness of the purchases, it was incumbent upon
him to have caused further inquiries in the matter to ascertain the genuineness
or otherwise of the transactions and to have given an opportunity to the
assessee to examine / cross-examine those two parties vis-a-vis the
statements made by them before the Sales Tax Department. Without causing such
further inquiries in respect of the purchases, it was not open to the A.O. to
make the addition u/s 69C of the Act. 


_____________________________________________________________________________________________________

 

 

Errata

IN THE HIGH COURTS, March 2020 

 

We regret to point out a typographical error
on Page 51 of the caption issue in respect of the following decision:

The Pr CIT -1 v/s M/s. Ami Industries (India)
P Ltd [ Income tax Appeal no 1231 of 2017 dt : 29/01/2020
(Bombay HighCourt)].

where “Addition is
not justified “ should be replaced in place of “Addition is justified” and be
read accordingly.

Condonation of delay – 458 days – Belated appeal against section 263 order before ITAT – Appeal filed after consequential assessment order and dismissal of appeal – Delay condoned on payment of costs

4. Procter & Gamble Hygiene and Healthcare Ltd. vs.
Commissioner of Income Tax-8 [Income tax Appeal No. 1210 of 2017]

Date of order: 4th February, 2020

 

Procter & Gamble Hygiene
& Healthcare Ltd. vs. CIT, Range-8 [ITA No. 4866/Mum/2015; Date of order:
30th November, 2016; A.Y.: 2008-09; Bench ‘H’ Mum.]

 

Condonation of delay – 458 days –
Belated appeal against section 263 order before ITAT – Appeal filed after
consequential assessment order and dismissal of appeal – Delay condoned on
payment of costs

 

The issue involved in the appeal
is condonation of delay in filing of the appeal u/s 254 of the Act by the
appellant before the Tribunal. The A.O. passed the assessment order on 1st
February, 2012 in which certain deductions were allowed u/s 80IC. The
CIT-8, Mumbai was of the view that the A.O. had wrongly allowed deduction u/s
80IC. He was of the further view that the assessment order so made was
erroneous and prejudicial to the interest of the Revenue. Accordingly, he
invoked jurisdiction u/s 263 and vide an order dated 31st
March, 2014 set aside the assessment order by directing the A.O. to pass a
fresh assessment order by taxing the interest income earned by the petitioner
on the amount covered by the deduction sought for u/s 80IC under the head
‘income from other sources’. The A.O. passed the consequential assessment order
dated 9th June, 2014. It was against this assessment order that the
assessee preferred an appeal before the CIT(A)-17.

 

However, by
the appellate order dated 28th August, 2015 the first appellate
authority dismissed the appeal of the assessee, holding that it was not
maintainable as the A.O. had only given effect to the directions given to him
by the CIT, relying on the decision in Herdillia Chemicals Ltd. vs. CIT
[1997] 90 Taxman 314 (Bom.)
. Aggrieved by this, the petitioner
preferred an appeal before the Tribunal which was registered as ITA No.
5096/Mum/2015. In the meanwhile, the assessee, having realised that the order
passed by the jurisdictional administrative commissioner u/s 263 of the Act had
remained unchallenged, belatedly filed an appeal before the Tribunal which was
registered as ITA No. 4866/Mum/2015. In the process there was a delay of 450
days. The assessee filed an application before the Tribunal for condonation of
delay in filing ITA No. 4866/Mum/2015 and in support thereof also filed an
affidavit dated 12th September, 2016 explaining the delay. The
assessee stated in its affidavit that the appellant did not prefer an appeal as
the Learned CIT had set aside the assessment so that the issues involved would
be agitated before the A.O. or the appellate authorities, i.e., against the
order of the A.O.

 

Both the appeals were heard
together and by a common order dated 30th November, 2016 both the
appeals were dismissed. The appeal ITA No. 5096/Mum/2015 was dismissed on the
ground that there was no question of any consequential assessment as per the
revision order. The assessee’s appeal was rightly dismissed by the CIT(A).

 

Insofar as
ITA No. 4866/Mum/2015 was concerned, the same was dismissed as being
time-barred as the delay in filing the appeal was not condoned. The ITAT
observed that the assessee had clearly, and presumably only on the basis of a
legal opinion, taken a conscious decision not to appeal against the revision
order. No reasonable, much less sufficient, cause had been advanced for
condonation of delay. It also stated that there was no basis for the said bona
fide
belief which is stated as the reason for the assessee having not
preferred an appeal against the revision order.

 

The
Hon. High Court observed that when the Tribunal had entertained the appeal
arising out of the consequential assessment, it was not justified on the part
of the Tribunal to have rejected the appeal filed by the appellant against the
order passed by the jurisdictional administrative commissioner u/s 263 of the
Act because that was the very foundation of the subsequent assessment
proceedings. Therefore, in the interest of justice the delay in filing appeal
was condoned and the said appeal was directed to be heard on merit by the
Tribunal. The appellant was directed to pay costs of Rs. 25,000 to the
Maharashtra State Legal Services Authority.

Complaint filed u/s 276C (1) of the Act – Wilful attempt to evade tax – Appeal pending before CIT(A) – Criminal proceedings kept in abeyance

3. M/s Beaver Estates Pvt.
Ltd vs. The Assistant Commissioner of Income Tax Corporate Circle 1(1);
OP(Crl.) No. 400 of 2019

Date of order: 23rd
October, 2019

(Kerala High Court)

 

[Complaint filed CC No. 65/2015
of Additional Chief Judicial Magistrate (E&O), Ernakulam]

 

Complaint filed u/s 276C (1) of
the Act – Wilful attempt to evade tax – Appeal pending before CIT(A) – Criminal
proceedings kept in abeyance

 

In the instant case, the
prosecution was launched u/s 276C(1) of the Act for wilful attempt to evade tax
before the Additional Chief Judicial Magistrate’s Court (Economic Offences),
Ernakulam. The first petitioner is a company and the second petitioner is the
Managing Director of the said company.

 

The plea of the petitioners was
that they have filed an appeal before the statutory authority challenging the
assessment and that the decision in the appeal has got a bearing on the
prosecution against them; therefore, the criminal proceedings pending against
them may be kept in abeyance till the disposal of the appeal. The petitioners
contended that if the statutory appeal filed by them under the Act is allowed,
it would knock down the very basis of the prosecution against them and,
therefore, the criminal proceedings may be ordered to be kept in abeyance.

 

The Hon. Court noticed that
section 276C provides the punishment for wilful attempt to evade tax, penalty
or interest. Section 278B provides for offences by companies. In the instant
case, the prosecution is u/s 276C(1) for wilful attempt to evade tax. The
decision of the statutory appellate authority regarding the assessment and
computation of tax would have a bearing on the prosecution against the
petitioners.

 

The Court relied on the decision
of the Apex Court in the case of K.C. Builders vs. Assistant Commissioner
of Income Tax (2004) 2 SCC 731
wherein it held that the levy of
penalties and prosecution u/s 276C are simultaneous and, hence, once the penalties
are cancelled on the ground that there is no concealment, the quashing of
prosecution u/s 276C is automatic. In the instant case, the prosecution is u/s
276C(1) for wilful attempt to evade tax. The decision of the statutory
appellate authority regarding the assessment and computation of tax would have
a bearing on the prosecution against the petitioners.

 

Similarly, in Commissioner
of Income Tax vs. Bhupen Champak Lal Dalal AIR 2001 SC 1096
, the Court
had observed that the prosecution in criminal law and proceedings arising under
the Act are undoubtedly independent proceedings and, therefore, there is no
impediment in law for the criminal proceedings to proceed even during the
pendency of the proceedings under the Act. However, a wholesome rule will
have to be adopted in matters of this nature where courts have taken the view
that when the conclusions arrived at by the appellate authorities have a
relevance and bearing upon the conclusions to be reached in the case,
necessarily one authority will have to await the outcome of the other
authority.

 

The Department relied on the
decision of the Apex Court in Sasi Enterprises vs. Assistant Commissioner
of Income Tax (2014) 5 SCC 139
. The Court held that the decision in Sasi
Enterprises (Supra)
has got no application to the present case because
the prosecution against the petitioners is for committing the offence u/s 276C
and not for the offence u/s 276CC.


The
Court held that the decision of the statutory appellate authority regarding the
assessment and computation of tax would have a bearing on the prosecution
against the petitioners for wilful attempt to evade tax. Therefore, the
Additional Chief Judicial Magistrate (Economic Offences), Ernakulam was
directed to keep in abeyance all further proceedings against the petitioners in
the criminal case till the disposal of the appeal filed before the Commissioner
of Income Tax (Appeals), Kochi.

Search and seizure (presumption u/s 132[4A]) – Section 132(4A) of ITA, 1961 – No addition could be made on account of undisclosed income only on basis of presumptions u/s 132(4A) without recording any findings as to how loose sheets found during search were linked to assessee – In absence of corroborative evidence, Tribunal was not justified in reversing finding of CIT(A)

18. Ajay Gupta vs. CIT

[2020] 114 taxmann.com 577 (All.)

Date of order: 13th November, 2019

 

Search and seizure (presumption u/s 132[4A]) – Section 132(4A) of ITA, 1961 – No addition could be made on account of undisclosed income only on basis of presumptions u/s 132(4A) without recording any findings as to how loose sheets found during search were linked to assessee – In absence of corroborative evidence, Tribunal was not justified in reversing finding of CIT(A)

 

The residential premises of the assessee were searched u/s 132 of the Income-tax Act, 1961 on 28th February, 2000. Pursuant to a notice u/s 158BC, the assessee filed return of income declaring NIL undisclosed income. The A.O. assessed the undisclosed income at Rs. 65,33,302.

 

The CIT (Appeals) partly allowed the appeal of the assessee. The CIT (Appeals) deleted the addition of Rs. 5,58,870 made by the A.O. on account of papers found during the search. The Tribunal reversed the order of the CIT (Appeals) and restored that of the A.O. The appeal by the assessee was admitted on the following questions of law:

 

‘1. Whether the presumption u/s 132(4A) of the Income-tax Act can be raised in the assessment proceedings?

 

2. Whether, apart from section 132(4A) of the Act, the burden to explain the documents seized from the possession of the assessee during search is upon him, and if it is so, then has he discharged the burden?’

 

The Allahabad High Court allowed the appeal and held as under:

 

‘i) It is not in dispute that two loose papers were found during search from the premises of assessee, however, during block assessment proceedings, the assessee had denied the documents and statement was recorded by Deputy Director of Investigation; he had submitted that he had no concern with the said documents so seized. Further, the A.O. while passing the assessment order, had only on basis of the loose papers found during search made addition to the undisclosed income of the assessee while the entries of said papers remained uncorroborated.

 

ii) This Court, in the case of CIT vs. Shadiram Ganga Prasad, 2010 UPTC 840, has held that the loose parchas found during search at the most could lead to a presumption, but the Department cannot draw inference unless the entries made in the documents so found are corroborated by evidence.

 

iii) As section 132(4A) of the Act provides that any books of accounts, documents, money, bullion, jewellery or other valuable articles or things found in possession of, or in control of any person in course of search may be presumed to be belonging to such person, and further, if the contents of such books of accounts and documents are true. But this presumption is not provided in absolute terms and the word used is “may” and not “shall”, as such the Revenue has to corroborate the entries made in the seized documents before presuming that transactions so entered were made by the assessee. Presumption so provided is not in absolute terms but is subject to corroborative evidence.

 

iv) In the present case, the Tribunal only on basis of presumption u/s 132 (4A) of the Act, reversed the finding of CIT (Appeals) without recording any finding as to how the loose sheets which were recovered during search were linked with the assessee. In the absence of corroborative evidence, the Tribunal was not justified in reversing the finding by the CIT (Appeals).

 

v) In view of the above, we are of the considered view that the order passed by the Tribunal reversing the finding of CIT (Appeals) in regard to deletion of the addition made of Rs. 5,58,870 and restoring the order of the A.O. on mere presumption is unsustainable. The order dated 12th March, 2010 is set aside to that extent and the matter is remitted back to the Tribunal to decide afresh as far as addition of Rs. 5,58,870 is concerned, within a period of three months from today.’

Revision – Business loss – Allowable (as share trading) – Section 28(i) r.w.s. 263 of ITA, 1961 – Assessee company, engaged in business of financing and trading in shares – During assessment, A.O. before accepting assessee’s claim of operational loss in share trading, verified demat accounts, sale, purchase and closing stocks of assessee company and inquired about said loss – Show cause notice u/s 263 for revising assessment could not be issued on the basis that said accounts were to be examined

17. Principal CIT vs. Cartier Leaflin (P) Ltd.

[2019] 112 taxmann.com 63 (Bom.)

[2020] 268 Taxman 222 (Bom.)

Date of order: 15th October, 2019

A.Y.: 2011-12


Revision – Business loss – Allowable (as share trading) – Section 28(i) r.w.s. 263 of ITA, 1961 – Assessee company, engaged in business of financing and trading in shares – During assessment, A.O. before accepting assessee’s claim of operational loss in share trading, verified demat accounts, sale, purchase and closing stocks of assessee company and inquired about said loss – Show cause notice u/s 263 for revising assessment could not be issued on the basis that said accounts were to be examined

 

The assessee was engaged in the business of financing and trading in shares. In its return of income, the assessee declared a total loss of Rs. 11.29 crores. In assessment, the A.O. made a few additions / disallowances which resulted in the assessee’s taxable income reaching Rs. 35.50 crores. Subsequently, the Principal Commissioner opined that the amount of Rs. 8.79 crores shown under ‘other operating losses’ seemed to be a trading loss incurred by the assessee company out of its business of financial and capital market activities, which was its main business activity. He opined that on perusal of the assessment records, it was noticed that no examination of the books of accounts, transaction accounts of the share trading activity carried out by the assessee company vis-a-vis the demat accounts was carried out by the A.O. and that the entire operating loss as mentioned was accepted without any verification or proper application of mind. He, thus, held that the assessment order passed by the A.O. appeared to be erroneous and prejudicial to the interest of Revenue. Notice u/s 263 of the Income-tax Act, 1961 was issued by the Principal Commissioner.

 

On the assessee’s appeal, the Tribunal noted that from the records available it was evident that complete details in support of the claim of operating loss of Rs. 8.79 crores were made available by the assessee company to the A.O. In fact, the manner in which the operating loss was arrived at was submitted in a tabulated form along with item-wise details of all transactions during the assessment proceedings. Thus, the Tribunal concluded that the show cause notice u/s 263 by the Principal Commissioner was issued without examining the assessment records and the view taken by the A.O. after examination of exhaustive details and evidence was a possible view. The Tribunal held that the notice u/s 263 is not valid.

 

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

‘i) The finding of fact in the order of the Tribunal is that the proceedings u/s 263, on the face of it, have been initiated without examination of records before the A.O. is not shown to be perverse. It is clear that the show cause notice proceeds on the basis that the books of accounts, transaction accounts of share trading carried out by the assessee vis-a-vis demat accounts have not been examined by the A.O. during the course of assessment proceedings. However, in the assessment order dated 28th March, 2014 itself, the A.O. had recorded that he examined the demat account in order to verify the share trading activities claimed by the assessee. Moreover, before passing the assessment order, sale, purchase and closing stocks were also examined by the A.O.

 

ii) Thus, the basis to invoke section 263 factually did not exist as there was due inquiry by the A.O. during the assessment proceedings leading to the assessment order. Thus, it is amply clear that the A.O. had applied his mind while accepting the claim of the assessee of operating loss of Rs. 8.79 crores making the proceedings u/s 263 bad in law. In any event, the view taken on facts by the A.O. is a possible view and the same is not shown to be bad.

 

iii) In the above view, the question as proposed does not give rise to any substantial question of law. Thus, not entertained. And appeal is, therefore, dismissed.’

I – Section 115JB – Provision for leave encashment is not to be added back to the book profit for computation u/s 115JB as it is an ascertained liability determined on actuarial basis II – Provision for wealth tax was not to be reduced from book profit to be computed u/s 115JB

6. [2020] 114 taxmann.com 538 (Mum.)(Trib.)

Caprihans India Ltd. vs. DCIT

ITA No. 4252/Mum/2011

A.Y.: 2005-06

Date of order: 23rd December, 2019

 

I – Section 115JB – Provision for leave encashment is not to
be added back to the book profit for computation u/s 115JB as it is an
ascertained liability determined on actuarial basis

 

II – Provision for wealth tax was not to be reduced from
book profit to be computed u/s 115JB

 

FACTS I

While assessing the total income of the assessee u/s 153C
r.w.s. 143(3) of the Act, the A.O. for the purpose of computing book profits
added the amount of provision for leave encashment of Rs. 15,30,070 on the
ground that it was an unascertained liability. He held that the liabilities
pertaining to leave encashment were not ascertained by the end of the financial
year, therefore the assessee had made a provision for the same.

 

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

 

The assessee then preferred an appeal to the Tribunal where,
relying on the ratio of the decision of the Punjab & Haryana High
Court in the case of CIT vs. National Hydro Electric Power Corporation
Ltd. [2010] 45 DTR 117 (P&H)
it was contended that the provision
for leave encashment was made in the books on actuarial basis, therefore the
same could not be held to be in the nature of a provision for an unascertained
liability.

 

HELD I

The Tribunal held that if a business liability had definitely
arisen in the accounting year, the deduction should be allowed although the
liability may have to be quantified and discharged at a future date.

 

It observed that this view is fortified by the judgment of
the Hon’ble Supreme Court in the case of Bharat Earth Movers vs. CIT
[2000] 245 ITR 428 (SC).
In the said case, it was observed by the
Hon’ble Apex Court that what should be certain is the incurring of the
liability and the fact that the same is capable of being estimated with
reasonable certainty, although the actual quantification may not be possible.
The Apex Court had observed that the provision for meeting the liability for
encashment of earned leave by the employees is not a contingent liability and
is admissible as a deduction.

 

In view of the above, the Tribunal held that as the provision
for leave encashment had been made by the assessee on actuarial basis,
therefore the same being in the nature of an ascertained liability could not
have been added by the A.O. for the purpose of determining the ‘book profit’
u/s 115JB. This ground of appeal of the assessee was allowed.

 

FACTS II

The assessee, while computing the ‘book profit’ u/s 115JB had
added back the amount of the wealth tax provision. On appeal, the assessee by
way of a specific ground had assailed the addition of the provision for wealth
tax while computing the ‘book profit’ u/s 115JB. However, the CIT(A) declined
to accept the aforesaid claim. Observing that the said provision was covered
u/s 115JB, the CIT(A) had upheld the view taken by the A.O.

 

Aggrieved, the assessee preferred an appeal to the Tribunal
where it was contended that as the provision for wealth tax does not fall
within any of the items of the ‘Explanation’ to section 115JB, the same could
not be added back while computing the ‘book profit’ under the said statutory
provision. In support of the aforesaid contention, reliance was placed on the
order of the ITAT, Kolkata, Special Bench in the case of JCIT vs. Usha
Martin Industries Ltd. [2007] 104 ITD 249 (SB).

 

HELD II

The Tribunal observed that an addition to the
‘book profit’ which during the period relevant to the year under consideration
was computed as per Part II of Schedule VI of the Companies Act, 1956 could be
made only if the same was permissible as per Item No. (a) to (k)
of the Explanation to section 115JB. As contemplated in clause (a) of
the ‘Explanation’ to this section, ‘the amount of Income-tax paid or payable,
and the provision therefor’
was liable to be added for computing the ‘book
profit’ u/s 115JB. However, as there was no such provision for making the
addition with regard to wealth tax, the A.O. could not have added the same for
computing the ‘book profit’ of the assessee company u/s 115JB. It observed that
its view is fortified by the order of the ITAT, Kolkata, Special Bench in the
case of JCIT vs. Usha Martin Industries Ltd. [2007] 104 ITD 249 (SB).
The Tribunal directed the A.O. to rework the ‘book profit’ u/s 115JB after
deleting the provision for wealth tax. This ground of appeal of the assessee
was allowed.

Return of income – Filing of, in electronic form (set-off and carry-forward of losses) – Section 139D r.w.s. 72 of ITA, 1961 and Rule 12 of ITR, 1962 – Procedure of filing electronic return as per section 139D r.w. Rule 12 cannot bar assessee from making claim which he was entitled to – Assessee was directed to make representation before CBDT where he was not able to reflect set-off available in terms of section 72 in prescribed return of income in electronic form

16. Samir Narain Bhojwani
vs. Dy.CIT

[2020] 115 taxmann.com 70
(Bom.)

Date of order: 22nd
October, 2019

A.Y.: 2019-20

 

Return of income – Filing of, in
electronic form (set-off and carry-forward of losses) – Section 139D r.w.s. 72
of ITA, 1961 and Rule 12 of ITR, 1962 – Procedure of filing electronic return
as per section 139D r.w. Rule 12 cannot bar assessee from making claim which he
was entitled to – Assessee was directed to make representation before CBDT
where he was not able to reflect set-off available in terms of section 72 in
prescribed return of income in electronic form

 

The assessee was obliged u/s 139D
of the Income-tax Act, 1961 read with Rule 12 of the Income-tax Rules, 1962 to
file his return of income electronically with his digital signature. However,
he was not able to reflect in the prescribed return of income in electronic
form the set-off available in terms of section 72, i.e., setting off of current
year’s business income against the carry-forward loss from the earlier years.
This was because the return which was filed electronically required certain
columns to be filled in by the petitioner while the other columns were
self-populated. The assessee was thus unable to change the figures and make a
claim for set-off u/s 72 in the present facts. This resulted in excess income
being declared, resulting in an obligation to pay more tax on income which in
terms of section 72 was allowed to be set off against carried-forward losses of
earlier years.

 

Therefore, the assessee filed a
writ petition under Article 226 of the Constitution of India and sought a
direction from the High Court to the Respondent No. 1, the A.O., and Respondent
No. 2, the CBDT, to accept the petitioner’s return of income for A.Y. 2019-20
in paper form u/s 139(1) of the Act and the same be taken up for assessment in
accordance with the Act.

 

The Bombay High Court allowed the
writ petition and held as under:

 

‘i) The claim sought to be urged by the assessee,
viz., set-off of business profits of this year offered to tax under the head
“capital gain” being set off against carried-forward loss is prima facie
supported by the decisions of the Tribunal in the case of M.K. Creations
vs. ITO [IT Appeal No. 3885 (Mum.) of 2014, dated 7th April, 2017]
and in ITO vs. Smart Sensors & Transducers Ltd. [2019] 104 taxmann.com
129/176 ITD 104 (Mum.–Trib.)
. It is also not disputed by the Revenue
that the return of income in electronic form is self–populated, i.e., on
filling in some entries, the other entries in the return are indicated by the
system itself. Thus, the petitioner is unable to make a claim which according
to him he is entitled to in law. In case the petitioner is compelled to file in
the prescribed electronic form, it could be declared by the A.O. as defective
(if all entries are not filled), or raise a demand for tax on the basis of the
declared income u/s 143(1), or if the assessment is taken to scrutiny u/s
143(3), then the petitioner will not be entitled to raise a claim of set-off
u/s 72 during the assessment proceedings. This, in view of the decision of the
Hon’ble Supreme Court in the case of Goetze (India) Ltd. vs. CIT [2006]
157 Taxman 1/284 ITR 323
wherein it has been held that if a claim is
not made by the assessee in its return of income, then the A.O. would have no
power to entertain a claim otherwise than by way of revised return of income.
The revised return of income, if the petitioner attempts to file it, would
result in the petitioner not being able to make the claim for which the revised
return is filed as the revised return of income would also have to be filed in
the prescribed electronic form which does not provide for such an eventuality.
Thus, for the purposes of the subject assessment year if the return of income
is filed electronically, it (the assessee) would have given up, at least before
the A.O., his claim to benefit of section 72; this, whether the return of
income is processed u/s 143(1) or undergoes scrutiny u/s 143(3).

 

ii) The purpose and object of e-filing of return is simplicity and
uniformity in procedure. However, the above object cannot in its implementation
result in an assessee not being entitled to make a claim of set-off which he
feels he is entitled to in accordance with the provisions of the Act. The
allowability or disallowability of the claim is a subject matter to be
considered by the A.O. However, the procedure of filing the return of income
cannot bar an assessee from making a claim under the Act to which he feels he
is entitled.

 

iii) It is true that in terms of Rule 12 of the Rules the returns are
to be filed by the petitioner only electronically and he is bound by the Act
and the Rules, thus (the Department) cannot accept the paper return. However,
in terms of section 139D, it is for the CBDT to make rules providing for filing
of returns of income in electronic form. This power has been exercised by the
CBDT in terms of Rule 12 of the Rules. However, the form as prescribed does not
provide for (the) eventuality that has arisen in the present case and may also
arise in other cases. Thus, this is an issue to be brought to the notice of the
CBDT, which would in case it finds merit in this submission, issue necessary
directions to cover this gap.

 

iv) In the normal course, the petitioner would have been directed to
file representation with the CBDT making a demand for justice, before
considering issuing of a writ of mandamus. However, in the peculiar
facts of this case, the petitioner is required to file return of income by 31st
October, 2019. It is only when the petitioner was in the process of
filing his return electronically that he realised that he is unable to make a
claim of set-off u/s 72, even though the claim itself is prima facie
allowable in view of the decisions of the Tribunal in M.K. Creation
(Supra) and Smart Sensors & Transducers Ltd. (Supra)
. In the
absence of the petitioner filing its return of income on or before 31st
October, 2019, the petitioner is likely to face penal consequences. The issue
raised is a fundamental issue, which needs to be addressed by the CBDT.

 

v) Therefore, it would be appropriate that the petitioner make a
representation on the above issue to the CBDT, who would then consider it in
the context of the facts involved in the instant case and issue necessary
guidelines for the benefit of the entire body of assessees if the petitioner is
right in his claim that the prescribed return of income to be filed
electronically prohibits an assessee from making its claim. However, in the
meantime, the petitioner, without prejudice to his rights and contentions, would
file the return of income in electronic form on the system before the last
date. Besides, (he would) also file his return of income for the subject
assessment year in paper form with the A.O. before the last date. This return
of income in paper form would be accepted by the A.O. without prejudice to the
Revenue’s contention that such a return cannot be filed.

 

vi) In the meantime, till such time as the
CBDT takes a decision on the petitioner’s representation, the Revenue would not
act upon the electronically filed return of income so as to initiate any
coercive recovery proceedings.’

Recovery of tax – Stay of demand pending first appeal – Section 220(6) of ITA, 1961 and CBDT Circular No. 530 dated 6th March, 1989 – The Circular stating that a stay of demand be granted if there are conflicting views of High Court can be extended to conflicting views of different Benches of Tribunal as well

15. General Insurance
Corporation of India vs. ACIT

[2019] 111 taxmann.com 412
(Bom.)

[2019] 267 Taxman 596 (Bom.)

Date of order: 14th
October, 2019

A.Y.: 2017-18

 

Recovery of tax – Stay of demand
pending first appeal – Section 220(6) of ITA, 1961 and CBDT Circular No. 530
dated 6th March, 1989 – The Circular stating that a stay of demand
be granted if there are conflicting views of High Court can be extended to
conflicting views of different Benches of Tribunal as well

 

For the A.Y. 2017-18, the
assessee filed an appeal against the assessment order. The assessee also filed
an application for stay of demand u/s 220(6) of the Income-tax Act, 1961. The
assessee was directed to deposit 20% of tax demand during pendency of appellate
proceedings.

 

The assessee filed a writ
petition challenging the order and claimed that the assessee is entitled to
unconditional stay till disposal of appellate proceedings in view of the fact
that there were conflicting decisions of co-ordinate Benches of the Tribunal so
far as the merit of the assessee’s case was concerned. The Bombay High Court
allowed the writ petition and held as under:

 

‘i) The CBDT Circular No. 530 dated 6th March, 1989 states that stay
of demand be granted where there are conflicting decisions of the High Court.
This principle can be extended to the conflicting decisions of the different
Benches of the Tribunal. Thus, in the above facts a complete stay of the demand
on the above head, i.e., Item No. 1 of the above chart, was warranted in the
petitioner’s favour.

ii) Therefore, unconditional stay was to be granted to assessee till
disposal of appellate proceedings.’

Reassessment – Sections 147, 148 and 151 of ITA, 1961 – Where A.O. issued reassessment notice on basis of sanction granted by Chief Commissioner – Since Chief Commissioner was not specified officer u/s 151(2) to grant such sanction, impugned notice was to be quashed

14. Miranda Tools (P) Ltd.
vs. ITO

[2020] 114 taxmann.com 584
(Bom.)

Date of order: 14th
November, 2019

A.Y.: 2014-15

 

Reassessment – Sections 147, 148
and 151 of ITA, 1961 – Where A.O. issued reassessment notice on basis of
sanction granted by Chief Commissioner – Since Chief Commissioner was not
specified officer u/s 151(2) to grant such sanction, impugned notice was to be
quashed

 

The petitioner is a company
engaged in the business of manufacture and marketing of fabrics. The petitioner
filed its return of income for the A.Y. 2014-15 on 22nd September,
2014 declaring NIL income. The assessment was completed u/s 143(3) of the
Income-tax Act, 1961 by an order dated 1st September, 2016.
Thereafter, on 26th February, 2019, the A.O. issued a notice u/s 148
of the Act on the ground that he has reason to believe that the income
chargeable to tax in respect of share application money for the relevant
assessment year has escaped assessment. The petitioner submitted its
objections. The A.O. rejected the objections.

 

The assessee filed a writ
petition and challenged the reopening of the assessment. The Bombay High Court
allowed the writ petition and held as under:

 

‘i) As per the provisions of section 151(2) of the Act, a sanction to
issue notice for reopening u/s 148 of the Act has to be given by the Joint
Commissioner of Income Tax in case the reassessment is sought to be done before
(or within) four years. Under section 2(28C) of the Act, a Joint
Commissioner also means Additional Commissioner of Income Tax. In the present
case, the A.O. submitted a proposal to the Principal Chief Commissioner of Income
Tax for reopening the assessment u/s 148 on 6th February, 2019.

 

ii) The question arises whether the sanction granted by the Chief
Commissioner of Income Tax would fulfil the requirement of section 151. It has
long been settled that when the statute mandates the satisfaction of a
particular authority for the exercise of power, then it has to be done in that
manner only. Adopting this principle, the Division Benches of this Court in the
cases of Ghanshyam K. Khabrani vs. Asstt. CIT [2012] 20 taxmann.com
716/210 Taxman 75 (Mag.)/346 ITR 443
and CIT vs. Aquatic Remedies
(P) Ltd. [2018] 96 taxmann.com 609/258 Taxman 357/406 ITR 545
have held
that sanction for issuance of reopening notice has to be obtained from the
authority mentioned in section 151 and not from any other officer, including a
superior officer. In the present case the Chief Commissioner of Income tax is
not the officer specified in section 151 of the Act. There is thus a breach of
requirement of section 151(2) of the Act regarding sanction for issuance of
notice u/s 148 of the Act. Consequently, the impugned notice and the impugned
order cannot be sustained in law. The petitioner, therefore, is entitled to
succeed.

 

iii) Accordingly, the impugned notice dated
26th February, 2019 and the impugned order dated 15th
July, 2019 are quashed and set aside.’

Principal Officer (condition precedent) – Section 2(35) of ITA, 1961 – Where neither service of notice nor hearing of petitioner before treating petitioner as a Principal Officer was involved, and connection of petitioner with management and administration of company was also not established, A.O. could not have named petitioner as Principal Officer

13. A. Harish Bhat vs. ACIT (TDS)

[2019] 111 taxmann.com 210 (Karn.)

Date of order: 17th October, 2019

F.Ys.: 2009-10 to 2012-13

 

Principal Officer (condition
precedent) – Section 2(35) of ITA, 1961 – Where neither service of notice nor
hearing of petitioner before treating petitioner as a Principal Officer was
involved, and connection of petitioner with management and administration of
company was also not established, A.O. could not have named petitioner as
Principal Officer

 

The petitioner was treated as a
Principal Officer of the company Kingfisher Airlines for the F.Ys. 2009-10 to
2012-13 u/s 2(35) of the Income-tax Act, 1961. The petitioner filed a writ
petition and challenged the order.

 

He contended
that to come within the ambit of key management personnel, the petitioner had
to be either Managing Director or the Chief Executive Officer, whole-time
director / company secretary / chief financial officer / or in any way be
connected with the management or administration of the company. The Revenue, on
the other hand, justifying the said order, submitted that the petitioner was
the treasurer of the U.B. Group of Companies during the relevant financial
years and hence he was treated as Principal Officer. Further, neither a
personal hearing nor an order was necessary to treat the person as a Principal
Officer. It was sufficient if a notice of the intention of the A.O. of treating
any person as Principal Officer was issued. The petitioner assailed the order
of the Commissioner on the ground that the objections submitted by the
petitioner to the notice had not been duly considered and hence sought to set
aside the said order.

 

The Karnataka High Court allowed
the writ petition and held as under:

‘i) The impugned order deserves to be set aside for the reason that a
Principal Officer, as contemplated u/s 2(35), used with reference to a local
authority or a company or any other public body or any association of persons
or any body of individuals, means the secretary, treasurer, manager or agent of
the authority, company, association or body, or any person connected with the
management or administration of the local authority, company, association or
body upon whom the A.O. has served a notice of his intention of treating him as
the Principal Officer thereof.

 

ii) It is clear that to treat any person as a Principal Officer, such
person should be connected with the management or administration of the local
authority / company or association or body. Such connection with the management
or administration is the basis for treating any person as a Principal Officer.
Such connection has to be established or to be supported with substantial
material to decide the connection of any person with the management or
administration. Without disclosing the basis, no person can be treated as a
“Principal Officer” of the company recognising him as the Key Management Personnel
of the company. The details of such information on the basis of which the Key
Management Personnel tag is made, have to be explicitly expressed in the notice
of the intention of treating any person as a Principal Officer by the A.O.
Neither in the show cause notice nor in the order impugned was such a
connection of the petitioner with the management or administration of the
company Kingfisher Airlines Limited established. The phrase “Key Management
Personnel” of the company has a wide connotation and the same has to be
supported with certain material; unless such connection is established, no
notice served on the petitioner would empower the respondent authority to treat
the petitioner as a “Principal Officer”.

 

iii) In the instant case, the question inasmuch as
(sic) neither service of notice nor hearing of the petitioner before
treating the petitioner as a Principal Officer is involved. The fulcrum of
dispute revolves around the aspect whether the petitioner is the person
connected with the management or administration of the company. Such finding
has to be supported by substantial material and has to be reflected in the
notice issued u/s 2(35) to treat a person as a Principal Officer of the company
which will have wider consequences. The said aspect is lacking in the present
order impugned. Merely on surmises and conjectures, no person shall be treated
as a Principal Officer.

 

iv) The writ petition is to be allowed. The
impugned order is to be quashed.’

OECD’S ‘GloBE’ PROPOSAL – PILLAR TWO (Tax Challenges of the Digitalisation of the Economy – Part II)

The current international tax
architecture is being exploited with the help of digitalised business models by
the Multinational Enterprises (MNEs) to save / avoid tax through BEPS. To
counter this, the existing tax rules require reconsideration and updation on
the lines of the digitalised economy. Many countries have introduced unilateral
measures to tackle the challenges in taxation arising from digitalisation which
restricted global trade and economy.

 

Now, OECD has set the deadline of
end-2020 to come out with a consensus-based solution to taxation of
cross-border transactions driven by digitalisation. For this, OECD has
published two public consultation documents, namely (i) ‘Unified Approach under
Pillar One’ dealing with Re-allocation of profit and revised nexus rules, and
(ii) ‘Global Anti-Base Erosion Proposal (GloBE) – Pillar Two’. It is important
to understand these documents because once modified, accepted and implemented
by various jurisdictions, they will change the global landscape of international
taxation in respect of the digitalised economy.

 

Part I of this article on ‘Pillar
One’ appeared in the January, 2020 issue of the BCAJ. This, the second
article, offers a discussion on the document dealing with GloBE under ‘Pillar
Two’.

 

1.0 BACKGROUND

Thanks to advances in technology,
the way businesses were hitherto conducted is being transformed rapidly. In
this era of E-commerce, revenue authorities are facing a lot of challenges to
tax Multinational Enterprises (MNEs) who are part of the digital economy. To
address various tax challenges of the digitalisation of the economy, OECD in
its BEPS Action Plan 1 in 2015 had identified many such challenges as one of
the important areas to focus upon. Since there could not be any consensus on
the methodology for taxation, the Action Plan recommended a consensus-based
solution to counter these challenges. OECD has targeted to develop such a
solution by the end of 2020 after taking into account suggestions from the
various stakeholders. Meanwhile, on the premise of the options as examined by
the Task Force on the Digital Economy (TFDE), the BEPS Action Plan 1 suggested
three options to counter the challenges of taxation of the digitalised economy
which could be incorporated in the domestic laws of the countries. It is
provided that the measures to tackle the challenges of taxing digitalised
economy shall not be incompatible with any obligation under any tax treaty or
any bilateral treaty. They shall be complementary to the current international
legal commitments.

 

OECD issued an interim report in
March, 2018 which examines the new business framework as per the current
digitalised economy and its impact on the international tax system. In January,
2019 the Inclusive Framework group came up with a policy note to address the
issues of taxation of digitalised economy into two complementary ‘pillars’ as
mentioned below:

 

Pillar 1 – Re-allocation of
Profits and the Revised Nexus Rules

Pillar 2 – Global Anti-Base
Erosion Mechanism

 

The three proposals suggested under
Pillar 1 are as follows:

(i) New Nexus Rules – Allocation based on sales rather than physical
presence in market / user jurisdiction;

(ii) New Profit Allocation Rules – Attribution of profits based on
sales even in case of unrelated distributors (in other words, allocation of
profits beyond arm’s length pricing, which may continue concurrently between
two associated enterprises);

(iii) Tax certainty via a three-tier mechanism for profit allocation:

(a) Amount A: Profit allocated to market jurisdiction in absence of
physical presence.

(b) Amount B: Fixed returns varying by industry or region for certain
‘baseline’ or ‘routine’ marketing and distributing activities taking place (by
a PE or a subsidiary) in a market jurisdiction.

(c) Amount C: Profit in excess of fixed return contemplated under
Amount B, which is attributable to marketing and distribution activities taking
place in marketing jurisdiction or any other activities. Example: Expenses on
brand building or advertising, marketing and promotions (beyond routine in
nature).

 

Thus, it highlights potential
solutions to determine where the tax should be paid and the basis on which it
should be paid.

 

Let us look at the proposals
under Pillar Two in more detail.

 

2.0 PILLAR TWO – GLOBAL
ANTI-BASE EROSION PROPOSAL (‘GloBE’)

The public consultation document
has recognised the need to evolve new taxing rules to stop base erosion and
profit shifting into low / no tax jurisdictions through virtual business
structures in a digitalised economy. According to the document, ‘This Pillar
seeks to comprehensively address remaining BEPS challenges by ensuring that the
profits of internationally operating businesses are subject to a minimum rate
of tax. A minimum tax rate on all income reduces the incentive for taxpayers to
engage in profit shifting and establishes a floor for tax competition among
jurisdictions.’

 

The harmful race to the bottom on
corporate taxes and uncoordinated and unilateral efforts to protect the tax
base has led to the increased risk of BEPS, leading to a lose-lose situation
for all jurisdictions in totality. Therefore, the GloBE proposal is an attempt
to shield the tax base of jurisdictions and lessen the risk of BEPS.

 

Broadly, the GloBE proposal aims
to have a solution based on the following key features:

 

(i) Anti-Base Erosion and Profit Shifting

It not only aims to eliminate
BEPS, but also addresses peripheral issues relating to design simplicity,
minimise compliance and administration costs and avoiding the risk of double
taxation. Taxing the entities subject to a minimum tax rate globally will seek
to comprehensively address the issue of BEPS. Such a proposal under Pillar Two
will cover the downside risk of the tax revenue of the MNEs globally by
charging a minimum tax rate, which otherwise would lead to a lose-lose
situation for various jurisdictions.

(ii) New taxing rules through four component parts of the GloBE proposal

The four component parts of the
GloBE proposal, proposed to be incorporated by way of changes into the domestic
laws and tax treaties, are as follows:

 

(a) Income inclusion rule

Under this rule, the income of a
foreign branch or a controlled entity if that income was subject to tax at an
effective rate that is below a minimum rate, will be included and taxed in the
group’s total income.

 

For example, the profits of the
overseas branch in UAE of a Hong Kong1  (HK) company will be included in the taxable
income in HK, as the UAE branch is not subjected to tax at the minimum rate,
say 15%. But for this rule, profits of the overseas branch of an HK company
would not have been taxed in HK. Of course, HK may have to amend its domestic
law to provide for such taxability.

 

Example 1 – Accelerated taxable
income (as given in the public consultation document).
In our
opinion, this example throws light on the income inclusion rule.

 

Application of income inclusion
rule

Example 1

Year 1

Year 2

Inclusion rule (Book)

Inclusion rule (Book)

Country B (Tax)

Inclusion rule (Book)

Country

B (Tax)

Income

50

100

50

0

Expenses

(10)

(20)

(10)

(0)

Net income

40

80

40

(0)

Tax paid

(16)

(16)

0

0

Minimum tax (15% x net income)

(6)

 

(6)

 

Excess tax (= Tax paid – Minimum tax)

10

 

0

 

Tentative inclusion rule tax

 

6

 

Excess tax carry-forward
used

 

(6)

 

Inclusion rule tax

 

0

 

Remaining excess tax
carry-forward

10

 

4

 

 

(b) Undertaxed payments rule

It would operate by way of denial
of a deduction or imposition of source-based taxation (including withholding tax)
for a payment to a related party, if that payment was not subject to tax at or
above a minimum rate.

(c) Switch-over rule

It is to be introduced into tax
treaties such that it would permit a residence jurisdiction to switch from an
exemption to a credit method where the profits attributable to a Permanent
Establishment (PE) or derived from immovable property (which is not part of a
PE) are subject to an effective rate below the minimum rate.

(d) Subject to tax rule

It would complement the
under-taxed payment rule by subjecting a payment to withholding or other taxes
at source and adjusting eligibility for treaty benefits on certain items of
income where the payment is not subject to tax at a minimum rate.

 

The GloBE proposal recognises the
need for amendment of the domestic tax laws and tax treaties to implement the
above four rules. However, it also cautions for coordinated efforts amongst
countries to avoid double taxation.

 

3.0  DETERMINATION OF TAX
BASE

The first step towards applying a
minimum tax rate on MNEs is to determine the tax base on which it can be
applied. It emphasises the use of financial accounts as a starting point for
the tax base determination, as well as different mechanisms to address timing
differences.

 

3.1 Importance of consistent tax base

One of the simple methods to
start determining the tax base is to start with the financial accounting rules
of the MNE subject to certain agreed adjustments as necessary. The choice of
accounting standards to be applied will be subject to the GloBe proposal. The
first choice to be made is between the accounting standards applicable to the
parent entity or the subsidiary’s local GAAP. The next choice is which of the
accounting standards will be acceptable for the purposes of the GloBE proposal.

 

As per the public document, it is
suggested to determine the tax base as per the CFC Rules or, in absence of CFC
rules, as per the Corporate Income Tax Rules of the MNE’s jurisdiction. Such an
approach will overcome the limitation of the inclusion of only certain narrow
types of passive income. However, it would mean that all entities of an MNE
will need to recalculate their income and tax base each year in accordance with
the rules and regulations of the ultimate parent entity’s jurisdiction. There
can be differences in accounting standards between the subsidiary’s
jurisdiction and the ultimate parent entity’s jurisdiction, and to address the
same the public document recommends that the MNE groups shall prepare the
consolidated financial statements and compute the income of their subsidiaries
using the financial accounting standards applicable to the ultimate parent
entity of the group as part of the consolidation process.

 

Accounting standards which are
accepted globally can serve as a starting point for determining the GloBE tax
base.

 

3.2 Adjustments

Financial accounting takes into
account all the income and expenses of an enterprise, whereas accounting for
tax purposes can be different. Relying on the unadjusted figures in accounts
could mean that an entity’s net profits may be overstated or understated when
compared to the amount reported for tax purposes. Most of the differences among
the accounting standards will be timing differences and some of the differences
may be permanent differences or temporary differences that require further
consideration, and some of the timing differences may be so significant that
they warrant the same consideration as permanent differences.

 

3.2.1  Permanent differences

Permanent differences are
differences in the annual income computation under financial accounting and tax
rules that will not reverse in the future. Permanent differences arise for a
variety of reasons. The need to adjust the tax base may depend upon the level
of blending ultimately adopted in the GloBE proposal. Inclusions and exclusions
of certain types of income and expenses in domestic tax policy may lead to
permanent differences. Thus, consideration for such differences is of utmost
importance while determining the tax base.

 

Examples of permanent differences

Dividends received from foreign
corporations and gains on sale of corporate stocks may be excluded from income
to eliminate potential double taxation. Under the worldwide blending approach,
the consolidated financial statements should eliminate dividends and stock
gains in respect of entities of the consolidated group. However, under a
jurisdictional or entity blending approach, the financial accounts of the group
entities in different jurisdictions would be prepared on a separate company
basis and dividends received from a ‘separate’ corporation would be included in
the shareholder’s financial accounting income.

Permanent difference also arises
due to disallowance of certain deductions under the domestic tax laws of a
particular jurisdiction, such as entertainment expenses, payment of bribes and
fines, etc.

 

3.2.2  Temporary differences

Temporary differences are
differences in the time for taking into account income and expenses that are
expected to reverse in the future. It can lead to a low cash effective tax rate
at the beginning of a period and high cash effective tax rate at the end of a
period, or vice versa. A separate blending approach may lead to
difference volatility in the ETR from one period to another. Temporary
differences are very important in determination of the tax base and also affect
the choice of blending.

 

Approaches to addressing
temporary differences

The public consultation document
on Pillar Two lists three basic approaches to addressing the problem of
temporary differences, namely,

(i) carry-forward of excess taxes and tax attributes,

(ii) deferred tax accounting, and

(iii) a multi-year average effective tax rate.

 

It also provides that these basic
approaches could be tailored and elements of the different approaches could be
combined to better or more efficiently address specific problems.

 

4.0 BLENDING OF HIGH-TAX
AND LOW-TAX INCOME FROM ALL SOURCES

According to the public
consultation document, ‘Because the GloBE proposal is based on an effective
tax rate (“ETR”) test it must include rules that stipulate the extent to which
the taxpayer can mix low-tax and high-tax income within the same entity or
across different entities within the same group. The Programme of Work refers
to this mixing of income from different sources as “blending.”’

 

Blending means the process of mixing
of the high-tax and low-tax income of an MNE from all the sources of all the
entities in the group. Blending will help to calculate the ETR on which the
GloBE proposal is based. It can be done on a limited basis or a comprehensive
basis, from a complete prohibition on blending to all-inclusive blending.
Limited basis will lead to no or less blending (mixing) of income and taxes of
all different entities and jurisdictions. This would restrict the ability of an
MNE to reduce charge of tax applied on all entities across all jurisdictions
through mixing the high-tax and low-tax income.

 

It is suggested to apply the
GloBE proposal (minimum tax rate rule) in the following manner:

First Step: Determine
the tax base of an MNE and then calculate the Effective (blended) Tax Rate
[ETR] of the MNE on the basis of tax paid.

Second Step: Compare
the ETR with the Minimum Tax Rate prescribed according to the relevant blending
approach.

Third and the final Step: Use any
of the four components as specified in the GloBE proposal to the income which
is taxed below the minimum tax rate prescribed. [The four components as
discussed above are: (i) Income inclusion rule, (ii) Under-taxed payments rule,
(iii) Switch-over rule and (iv) Subject to tax rule].

 

Determining the Effective
(blended) Tax Rate [ETR] of the MNEs forms the second step in applying a
minimum tax rate rule. It throws light on the level of blending under the GloBE
proposal, i.e., the extent to which an MNE can combine high-tax and low-tax
income from different sources taking into account the relevant taxes on such
income in determining the ETR on such income.

 

There are three approaches to
blending:

4.1   Worldwide blending approach

4.2   Jurisdictional blending approach

4.3   Entity blending approach.

 

The above three different
blending approaches are explained in brief below:

4.1 Worldwide blending approach

In this case, total foreign
income from all jurisdictions and tax charged on it are mixed. An MNE will be
taxed under such an approach if the total tax charged on such foreign income of
an MNE is below a prescribed minimum rate. The additional tax charged on such
income will be the liability of an MNE to bring the total tax charged to the
prescribed minimum rate of tax.

4.2 Jurisdictional blending approach

In this case, blending of foreign
income and tax charged on such income will be done jurisdiction-wise. The
liability of additional tax would arise when the income earned from all the
entities in a particular jurisdiction is below the minimum rate, i.e., if an
MNE has been charged lower tax on the income from a particular jurisdiction
than the minimum rate of tax. The sum of the additional taxes of all the
jurisdictions will be the tax liability of an MNE.

4.3 Entity blending approach

Under this approach blending is
done of income from all sources and tax charged on such income in respect of
each entity in the group. Additional tax will be levied on an MNE whenever any
foreign entity in a group is charged with tax below the minimum tax rate
prescribed for that foreign entity.

 

All three approaches have the
goal congruence of charging MNEs a minimum rate of tax globally with different
policy choices.

 

In addition, in respect of
blending, the public consultation document on Pillar Two also explains in
detail the following:

(1)   Effect of blending on volatility

(2)   Use of consolidated financial accounting information

(3)   Allocating income between branch and head office

(4)   Allocating income of a tax-transparent entity

(5)   Crediting taxes that arise in another jurisdiction

(6)   Treatment of dividends and other distributions.

 

5.0 CARVE-OUTS

Implementation of the GloBE
proposal is fraught with many challenges and therefore, to reduce the
complexity and restrict the application, the Programme of Work2,
through its public consultation document, calls for the exploration of possible
carve-outs as well as thresholds and exclusions. These carve-outs / thresholds
/ exclusions will ensure that small MNEs are not burdened with global
compliances. They would also provide relief to specific sectors / industries.

 

The Programme of Work calls for
the exploration of carve-outs, including for:

(a) Regimes compliant with the standards of BEPS Action 5 on harmful tax
practices and other substance-based carve-outs, noting, however, that such
carve-outs would undermine the policy intent and effectiveness of the proposal.

(b) A return on tangible assets.

(c) Controlled corporations with related party transactions below a
certain threshold.

 

The Programme of Work also calls
for the exploration of options and issues in connection with the design of
thresholds and carve-outs to restrict application of the rules under the GloBE
proposal, including:

(i)   Thresholds based on the turnover or other indications of the size
of the group.

(ii) De minimis thresholds to exclude transactions or entities
with small amounts of profit or related party transactions.

(iii) The appropriateness of carve-outs for specific sectors or industries.

 

6.0 OPEN ISSUES

There are several open issues in
the proposed document, some of which are listed below:

 

6.1 Appropriate Accounting Standards

Determination of tax base is the
starting point to apply measures given in the GloBE proposal. Thus, the use of
financial accounting is the basis to determine the tax base. Hence, the issue
could be, which of the accounting standards would be appropriate and
recommended for determining the tax base across various jurisdictions?

 

6.2 Non-preparation of consolidated accounts by smaller MNEs

There can be some instances when
smaller MNEs are not required to prepare consolidated accounts by the statute
for any purpose. In such a case where the information is not consolidated, how
will the tax base be determined?

 

6.3 Compliance cost and economic effects

The blending process,
irrespective of the policy approach, will have a lot of compliance costs which
may even exceed the economic benefit out of the process. How does the GloBE
proposal deal with this?

 

6.4 Changes in ETR due to tax assessments in subsequent years

MNEs operate in different
jurisdictions and each jurisdiction may have different tax years, assessment
procedures and so on. It is very likely that tax determined for a particular
year based on self-assessment may undergo significant change post-assessment or
audit by tax authorities. This may change the very basis for benchmarking of
ETR with a minimum tax rate. There should be a mechanism to make adjustments
beyond a tolerable limit of variance.

 

7.0 CONCLUSION

OECD had asked for public
comments on its document on GloBE not later than 2nd December, 2020.
However, there are several areas yet to be addressed which are ambiguous and to
find solutions to them within a short span of time till December, 2020 is
indeed a daunting task. However, it is also a fact that in the absence of
consensus and delay in a universally acceptable solution, more and more
countries are resorting to unilateral measures to tax MNEs sourcing income from
their jurisdictions.

 

In this context, it is important
to note that vide Finance Act, 2016 India introduced a unilateral
measure of taxing certain specified digitalised transactions by way of
Equalisation Levy (EL) @ 6%. The scope of EL is expanded significantly by the
Finance Act, 2020 by providing that E-commerce operators, including
facilitators, shall be liable to pay EL @ 2% on the consideration received
towards supply of goods and services.

 

Determination
of a tax base globally on the basis of consolidated profits is a very complex
process. To give effect to all the permanent and temporary differences while
determining the tax base along with blending of income from different sources
from all jurisdictions will be a challenging task for the MNEs. It is to be seen
how effectively the four components of the GloBE proposal, individually and in
totality, will be practically implemented. The success of the GloBE proposal
also depends upon the required changes in the domestic tax laws by the
countries concerned. The cost of compliance and uncertainty may also need to be
addressed. A higher threshold of revenue could take care of affordability of
cost of compliance by MNEs, whereas clear and objective rules may take care of
uncertainty.

 

All
in all, we are heading for a very complex global tax scenario.

COVID-19 AND TRANSFER PRICING – TOP 5 IMPACT AREAS

Starting December, 2019, the
world has witnessed the once-in-a-generation pandemic. Multinational
Enterprises will have to consider the effect of COVID 19 on their transfer
pricing policies due to large scale economic disruption. It will be imperative,
especially in this economic environment, to adhere to and demonstrate arms
length behaviour. Many MNEs have started revisiting transfer pricing policies,
inter company agreements, and documentation standards.

 

This article highlights the top
five transfer pricing impact areas arising out of Covid-19:

 

  • Supply chain restructuring
  • Renegotiation of pricing and other terms
  • Cash optimisation
  • Balancing business uncertainty with tax
    certainty
  • Benchmarking

 

Towards the end of the article,
some recommendations have also been outlined for consideration of the
government authorities to make it easier for taxpayers to demonstrate
compliance with arm’s length principles.

 

1.  Supply chain restructuring

MNE groups with geographically
diverse supply chains are affected severely due to the pandemic. Any disruption
to any part of the supply chain tends to impact the entire group, though the
extent of the impact depends on the importance of the part of the supply chain
which has been disrupted and the availability of alternatives.

 

Many MNE groups have discovered
the fragility in their value chains as a result of the disruption caused by the
pandemic. They are faced with one or more of the following situations:

  • Longer than needed supply chain involving
    various countries
  • Overdependence on a particular supplier /
    set of suppliers / region / country for materials / services / manufacturing /
    market
  • Affiliate(s) finding it difficult to sustain
    their businesses owing to disruption caused by the pandemic
  • Unviable non-core businesses.

 

MNE groups could consider this as
an opportunity to revisit their existing supply chains and also potentially
restructure the supply chain to achieve one or more of the following:

  • Shorter supply chains involving lesser
    number of geographical locations
  • Creation of alternate sourcing destinations
    for materials and services
  • Setting up of manufacturing / service
    facilities in alternate destinations
  • Closure and / or monetisation of non-core
    businesses / entities.

 

These restructuring transactions
could raise multiple transfer pricing issues, including:

  • Exit charges for that affiliate which will
    be eliminated from the supply chain / will get reduced business because of
    creation of an alternate destination
  • New transfer pricing agreements, policies
    and benchmarks to be developed in case of setting up of affiliates in new /
    alternate jurisdictions
  • Valuation issues in case non-core assets are
    transferred to affiliates
  • Issues relating to bearing of closure costs
    in case some group entities or part of their businesses face insolvency /
    closure
  • Issues around identification and valuation
    of intangibles involved in the restructuring exercise
  • Appropriate articulation of restructuring
    transactions in the local files of the entities concerned and the Master File
    of the group.

 

2.  Renegotiation of pricing and other terms

In arm’s length dealings,
businesses are in fact renegotiating prices as well as other terms, mainly with
their vendors.

 

In the case
of many MNEs it would be perfectly arm’s length behaviour for different
entities within the group to start discussions and re-negotiations regarding
prices and other terms of their inter-company transactions. In fact, in many
cases it might be non-arm’s length for companies to not renegotiate with their
affiliates. In almost all cases, it would be arm’s length behaviour to have
inter-company agreements which mirror agreements that would have been entered
into between third parties.

 

Renegotiations of existing
arrangements / agreements could be of at least the following types:

 

2.1. Compensation for limited
risk entities in the group

Many MNEs
have entities which operate as limited risk entities, such as captive service
providers, contract manufacturers, limited risk distributors, etc. As a general
rule, these limited risk entities are eligible for a stable income, all
residual profits or losses being attributed to the Principal affiliate.
However, in today’s dynamic business environment, no-risk entities do not exist
and limited risk entities also bear some risks. For example, limited risks
captive service providers or contract manufacturers have a significant single
customer risk; therefore any adverse disruption to that single customer will
adversely impact the captive as well.

 

In times of disruption like this,
exceptions to the general rule may be warranted and compensation for limited
risk activities may need to be revisited, depending, inter alia, on the
type of activity performed, type of disruption faced and the control and decision-making
capabilities of each of the parties involved.

 

In third party situations the
service provider would be better off to agree to reduced income (or even losses
in the short term) from the Principal, especially if the Principal itself is
facing challenges relating to its own survival. Accordingly, on a case-to-case
basis, certain MNEs may have the ability / necessity to revisit their
arrangements with their captive entities for the short to medium term. The
revision in the inter-company agreements could take several forms. For
instance, such revised agreements may provide for compensation for only costs
(without a mark-up), reduced mark-up, compensation for only ‘normal’ costs
(with or without mark-up), etc.

 

2.2.  Renegotiations of other terms

It is common for entities in an
MNE group to negotiate prices of their inter-company transactions from time to
time in line with the prevailing business dynamics. However, in emergencies
like these certain other terms of the agreements between affiliates may also
need to be renegotiated. For example, the commitment relating to quantities
which a manufacturer will purchase from the related raw material supplier may
undergo a significant renegotiation. Given the non-recovery of fixed costs due
to the resulting idle capacity, the raw material cost per unit may increase
which the supplier may want to pass on to the manufacturer. A higher per unit
cost, on the other hand, may make the related supplier uneconomical for the
manufacturer. In the interest of the long-term commercial relationship, the
parties may agree to an in-between pricing mechanism, as is likely to be the
case in third-party dealings. Which party would bear which types of costs would
depend on the characterisation of the parties, the decision-making evidenced
through capabilities of the persons involved, and the options realistically
available to the parties involved.

 

3. Cash optimisation

Cash optimisation is currently
one of the most important considerations of businesses across the world.

 

Many MNE groups facing a cash
crunch have started looking at the cash position with different group entities
and trying to optimise the cash available with them. This could lead to some
new funding-related transactions and benchmarking issues such as those relating
to interest and guarantee fees transactions between affiliates.

 

In some situations, taxpayers
that have borrowed funds from their affiliates and are not in a position to
honour their interest / principal repayment commitments could approach their
affiliate lenders to negotiate for a reduction in interest rate / interest
waiver / moratorium at least for some period of time. On the other hand, the
lender affiliate may want to balance the moratorium with a revision in the
interest rate. Significant movements in exchange rates of currencies primarily
attributable to the pandemic could make this negotiation even more dynamic. Any
kind of negotiation should take into account the perspectives of both parties
and options realistically available to them.

 

Similarly, payment terms for
goods or services purchased from or sold to AEs or other inter-company
transactions, such as royalties, could also be renegotiated at least for the
short term, to enable different entities within the MNE group to manage their
working capital cycle more efficiently.

 

4. Balancing business uncertainty with tax certainty

4.1. Advance Pricing Agreements (APAs)

Globally, APAs have been an
effective tool for taxpayers and tax authorities to achieve tax certainty.
However, in times like these businesses go through unprecedented levels of
uncertainty. Therefore, many taxpayers may find it against their interest to be
bound by the terms of the APAs, especially where these provide for a minimum
level of tax profits to be reported by the taxpayer.

 

If their circumstances warrant
it, taxpayers who have already entered into an APA may consider applying for
revision of the same. The law provides that an APA may be revised if, inter
alia
, there is a change in the underlying critical assumptions1.  Most Indian APAs have a critical assumption
of the business environment being normal through the term of the APA. In times
like these, a request for revision may be warranted if the business environment
for the taxpayer is considered to be abnormal based on the specific facts and
circumstances of its case and the impact of the uncertainty on the transaction
under consideration.

 

If the taxpayer and the
authorities do not agree to the revision, the taxpayer may potentially also
request for cancellation of the agreement2. On the other hand, in
case the tax authorities believe that cancellation of the agreement is
warranted due to failure on the part of the taxpayer to comply with its terms,
the taxpayer should utilise the opportunity provided to it to explain the
pandemic-related impact on the APA and the related reason for its failure to
comply with the terms of the agreement.

 

For taxpayers who are in the
process of negotiating for their APAs, and for whom the business impact is very
uncertain right now, it may be prudent to wait to get some more clarity
regarding the full impact of the pandemic on their business before actually
concluding the APA.

 

Alternatively,
taxpayers should request for an APA for a shorter term, say a period of up to
Financial Year (F.Y.) 2019-20, even if it means entering into the APA for, say
three or four years. Another APA could then be applied for, starting F.Y.
2021-22, based on the scenario prevailing then.

 

4.2. Safe harbours

The government has not yet
pronounced the safe harbours for the F.Y. 2019-20. Once these are pronounced,
depending on their industry, extent of business disruption, expected loss of
business / margins and the safe harbours provided for F.Y. 2019-20 and onwards,
taxpayers should evaluate whether or not to opt for safe harbours at least for
the F.Y.s 2019-20 and 2020-21.

5. Benchmarking

The current economic situation is
likely to create some unique benchmarking issues which should be borne in mind.
While some of these issues are common to taxpayers globally, a few issues are
specific to India given the specific language of the Indian transfer pricing
regulations.

 

5.1. Justification of losses / low margins

Taxpayers are facing several
business challenges including cost escalations / revenue reductions which are
not related to their transactions with affiliates. Taxpayers in several sectors
have recorded sharp declines in revenues due to lockdowns in various parts of
the world, including India. Some taxpayers are faced with the double whammy of
escalated costs even in times of reduced revenues. Escalated costs could
include, for example, additional costs relating to factory personnel who are
provided daily meals and other essentials, additional transportation costs
incurred to arrange special transport for essentials owing to most fleet
operators not plying, etc.

 

It is pertinent for taxpayers to
identify and record these expenses separately from the expenses incurred in the
regular course of business (preferably using separate accounting codes in the
accounting system). Depending on the transfer pricing method and comparables
selected, taxpayers should explore the possibility of presenting their
profitability statements excluding the impact of these additional costs /
reduced revenues.

 

Another alternative available to
taxpayers is to justify their transfer prices considering alternative profit
level indicators (PLIs).

 

In any case, given the fact that
a lot of information about comparable benchmarks is not available in the public
domain currently, business plans, industry reports, business estimates, etc.,
prepared / approved by the management of the organisation should be maintained in
the documentation file and presented to the transfer pricing authorities if
called for.

 

5.2.  Loss-Making Comparables

During times of emergency like
these, for many businesses the focus shifts from growth / profitability to
survival. Therefore, many businesses could try operating at marginal costing
levels to recover committed costs / utilise idle capacity. Therefore, businesses
operating at net operating losses could be a normal event at least in times
like these. Secondly, even the taxpayer could have been pushed into losses
because of completely commercial reasons and even such losses could be arm’s
length and commercially justifiable.

 

From the
perspective of transfer pricing benchmarking, persistently loss-making
companies are typically rejected as comparables mainly because they do not
represent the normal economic assumption that businesses operate to make
profits. However, in times when business losses are normal events, benchmarking
a loss-making taxpayer with only profit-making comparables would lead to
artificial benchmarks and, potentially, unwarranted transfer pricing additions
in the hands of taxpayers.

 

In case loss-making comparables
are indeed rejected, it could be more prudent to reject companies making losses
at a gross level.

 

5.3.  Unintended comparables

The current
focus of many businesses is survival. Businesses which have created capacities
to cater to their affiliates may find it difficult to sustain if the impact of
the pandemic lasts longer than a few months. For example, consider the case of
an Indian manufacturer whose manufacturing capacities are created based on
demand projections and confirmed orders from its affiliates. Since the
capacities are completely used up in catering to demand from its affiliates,
the manufacturer does not cater to unrelated parties. In case there is a
disruption in the demand from such affiliates expected in the medium term, in
order to sustain in the short to medium term, the Indian manufacturer could
start using its manufacturing set-up for other potential (unrelated) customers
also. While this appears to be a purely rational business decision by the
Indian manufacturer, a question arises whether such third-party dealings will
be considered as comparable transactions for dealings with affiliates. The
Indian manufacturer in this case would need to be able to document the business
justification for entering into these transactions with unrelated parties and
whether these are economically and commercially different from the routine
related party transactions. Similar issues could arise in respect of other
transactions such as temporary local procurement, local funding, etc.


5.4.  Mismatch in years and adjustments

The Indian transfer pricing
regulations provide for the use of three years’ data of comparables to iron out
the impact of cyclical events from the benchmarking analysis. However, data of
the last two years may not be representative of the conditions prevailing in
the current year (in this context, current year could be F.Y. 2019-20 as well
as 2020-21, both years being impacted to different extents due to the
pandemic).

 

Since the financial data of a lot
of comparables is not available up to the due date of transfer pricing
compliance, this mismatch may lead to a situation where normal business years
of comparables are compared with the pandemic-affected years of taxpayers – a
situation which is very likely to give skewed results.

 

Adjustments are regularly made to
minimise the impact of certain differences between a tested party (say,
taxpayer) and the comparable benchmarks. Depending on the industry in which the
taxpayer operates and the manner in which its affiliates are impacted,
taxpayers may need to make adjustments, including some unique adjustments, to
more aptly reflect the arm’s length nature of inter-company prices.

 

However, in the Indian context
the law does not provide for the making 
of adjustments to the tested party and the adjustments are to be
necessarily made to comparable data3. Given the lack of reliable
data for making adjustments, the reliability of the adjustments themselves may
be questioned.

 

It must be borne in mind that the
principle which necessitates downward adjustments to comparables’ margins
currently being made to normal years will also require upward adjustments to
comparables’ margins in respect of pandemic-affected years going forward. This
situation is simplistically illustrated in Table 1 below. For the purpose of
the illustration, it is assumed that:

 

  • F.Y. 2017-18 and 2018-19 are considered as
    normal business years
  • F.Y. 2019-20 is impacted by the pandemic,
    but to a lesser degree
  • F.Y. 2020-21 is impacted severely by the
    pandemic
  • F.Y. 2021-22 is a normal business year
  • At the time of conducting the benchmarking
    analysis, comparables’ data is available for only the last two years.

 

 

Table 1 – Year-wise comparability4
and adjustments5

 

Tested
Financial Year

Comparable
Financial Years

Adjustments
Required (say, adjustments to margins)

Remarks

2019-20

2018-19, 2017-18

Downward

Downward adjustment due to loss of business
compared to normal years (2018-19, 2017-18)

2020-21

2019-20, 2018-19

Downward

Downward adjustment due to loss of business
compared to normal / less impacted years (2019-20, 2018-19)

2021-22

2020-21, 2019-20

Upward

Upward adjustment due to normal business compared
to impacted years (2020-21, 2019-20)

 

 

6.  Recommendations to government authorities

Government authorities could
consider the following recommendations by way of amendments to the law to relax
adherence to transfer pricing regulations for taxpayers, especially for F.Y.s
2019-20 and 2020-21, i.e., the impacted years:

 

  • Expansion of arm’s length range
    Since different industries and different companies in the same industry will
    respond to the pandemic in different ways, the margins of comparables over the
    next two years could be extremely varied. Therefore, for the impacted years the
    arm’s length range may be expanded from the current 35th to 65th
    percentile to a full range, or inter-quartile range (25th to 75th
    percentile), as is used globally. Similarly, the applicable tolerance band
    could be appropriately increased from the current 1% / 3%.
  • Extending compliance deadline – In
    case the deadline for companies to file their financial statements for F.Y.
    2019-20 with the Registrar of Companies (RoC) is extended, the deadline for
    transfer pricing compliance should also be extended, to give the taxpayers
    their best chance to use comparable data for F.Y. 2019-20.
  • Extending deadlines for Master File
    compliance
    – It is expected that companies will take time to be able to
    fully assess the impact of the pandemic on their business models, value chains,
    profit drivers, etc., and then appropriately document the same in their Master
    File. Therefore, the due date for Master File compliances may be extended at
    least for F.Y. 2019-20.
  • Adjustment to taxpayer data – At
    least for the impacted years, the law could be amended to provide an option to
    the taxpayer to adjust its own financial data since the taxpayer will have a
    better level of information regarding its own financial indicators.
  • Multiple year tested party data – As
    discussed earlier, the Indian transfer pricing regulations currently provide
    for using multiple year data of the comparables as benchmarks for current year
    data of the tested party. For F.Y.s 2019-20 and 2020-21, use of multiple year
    data could be allowed even for the tested party to average out the impact of
    the pandemic to a certain extent.
  • Safe harbours relaxation – Safe
    harbours for F.Y. starting 2019-20 are currently pending announcement. The
    authorities could use this opportunity to rationalise these safe harbours to
    levels representative of the current business realities and reduce the safe
    harbour margins expected of Indian taxpayers. Safe harbours which are
    representative of the current business scenario will be very helpful to
    taxpayers potentially facing benchmarking issues discussed earlier in the
    article.
  • Relaxation in time period for
    repatriation of excess money (secondary adjustment)
    – Given the cash crunch
    being faced by MNEs worldwide, the time period for repatriation of excess money6  could be extended from the current period of
    only 90 days7.

 

CLOSING REMARKS

While the pandemic has impacted
almost every business in some way or the other in the short term and in many
inconceivable ways in the long term, just this claim alone will not be enough
from a transfer pricing perspective. Taxpayers will need to analyse the exact
impact of the pandemic on their entire supply chain and to the extent possible
also quantify the impact for their specific business. The impact of the
pandemic, steps taken by the management to mitigate the adverse impact,
negotiations / renegotiation (with third parties as well as affiliates),
business plans and business strategies, government policies and interventions
are some of the key factors which will together determine the transfer pricing
impact of the pandemic on the taxpayer.

 

The pandemic has brought to the
fore the importance of having robust agreements. While the current discussion
revolves mostly around force majeure clauses in third-party agreements,
inter-company agreements are equally important in the context of transfer
prices between the entities of an MNE group. Going forward, for new
transactions with affiliates or at the time of renewal of agreements relating
to existing transactions, care should be taken to draft / revise inter-company
agreements specifically outlining emergency-like situations and the
relationship between the parties in such times. Which party will be responsible
for which functions and would bear what type of risks and costs should be
clarified in detail. Agreements could potentially also include appropriate
price adjustment clauses. MNEs could consider entering into shorter term
agreements till the time the impact of the pandemic is reasonably clear. Having
said that, even if the agreement permits price adjustments, any pricing / price
adjustment decisions taken should also consider the economic situation and the
implication of such decisions under other applicable laws, including transfer
pricing laws of the other country/ies impacted by such decisions.

 

 

These times require businesses to
act fast and address several aspects of their business, and often, to keep the
business floating in the near term. Needless to say, taxpayers should
adequately document the commercial considerations dictating these decisions on
a real time basis and be able to present the same to transfer pricing
authorities in case of a transfer pricing scrutiny. Further, in the Master File
taxpayers should include a detailed industry analysis and a description of
business strategies as well as the corporate philosophy in combating the
financial impact of Covid-19, including the relationships with employees,
suppliers, customers / clients and lenders.

 

Governments and
inter-governmental organisations around the world are closely monitoring the
economic situation caused by the pandemic. Organisations such as OECD are also
monitoring various tax and non-tax measures taken by government authorities to
combat the impact of Covid-198. Taxpayers would do well to
continuously monitor the developments (including issuance of specific transfer
pricing guidelines relevant to this pandemic) at the level of organisations
such as OECD and UN, and also look out for guidance from the government
authorities.  

____________________________________________________________

 

1   Refer Rule 10Q of Income Tax Rules, 1962

2   Refer Rule 10Q of
Income Tax Rules, 1962

3   Refer Rule 10B of Income Tax Rules, 1962

4   Refer Rule 10CA of Income Tax Rules, 1962

5   Refer Rule 10B of
Income Tax Rules, 1962

6   Refer section 92CE of Income-tax Act, 1961

7   Refer Rule 10CB of Income-tax Rules, 1962

8   For instance, the OECD has recently published a report on tax and
fiscal policy in response to the coronavirus crisis. The OECD has also compiled
and published data relating to country-wise tax policy measures. Both, the
report as well as the country-wise data, can be accessed at www.oecd.org/tax

THE IMPACT OF COVID-19 ON INTERNATIONAL TAXATION

The rapid
outbreak of Covid-19 has had a significant commercial impact globally. As
globalisation has led to the world becoming one market (reducing borders and
increasing economic interdependence), the virus knows no borders and the impact
is being experienced by all of us.

 

Nearly 162 countries and their
governments are enforcing lockdowns and travel restrictions and taking other
measures to control further spread of the virus. The business community across
the world is operating in fear of an impending collapse of the global financial
markets and recession. This situation, clubbed with sluggish economic growth in
the previous year, especially in a developing country like India, is leading to
extremely volatile market conditions. In fact, 94% of the Fortune 1000
companies are already seeing Covid-19 disruptions1.

 

Amongst many tax issues (covered
separately in this Journal), this article focuses on cross-border elements in
the new equations. Such cross-border elements include unintended Permanent
Establishment exposure, incidental (and / or accidental) tax residency,
taxation issues relating to cross-border workers and so on. Transfer Pricing
issues have been covered separately in this Journal. In such a background, this
article attempts to throw some light on the impact of the Covid-19 outbreak on
these aspects.

 

IMPACT
ON CREATION OF PERMANENT ESTABLISHMENT

As the work scenario has changed
across the world due to Covid-19, with most employees working from their homes
while others may have got stuck in foreign countries because of the lockdown,
it has created several questions for companies as to the existence of their
Permanent Establishments in such countries.

 

The various treaties provide for
several types of PEs such as Fixed Place PE, Agency PE, Construction PE and
Service PE.

Fixed Permanent Establishment
(‘Fixed Place PE’)

 

 

A Permanent Establishment is ‘a
fixed place of business through which the business of an enterprise is wholly
or partly carried on’. This is commonly referred to as ‘basic rule of PE’, or
fixed place PE. A fixed place PE exists if the business of the enterprise is
carried out at a fixed place within a jurisdiction, typically for a substantial
period depicting permanence.

 

For a home office to be
considered the PE of an enterprise, the home office must be used on a
continuous basis for carrying on its business and the enterprise must require
the individual to use that location to carry on the said business.

 

It is worthwhile to note that the
Hon’ble Apex Court recently in the case of E-funds IT Solutions Inc2
which also relied on the ruling in the case of Formula One3,
held that ‘a Fixed Place PE can be created only if all the tests for the
constitution of a Fixed Place PE are satisfied, i.e., there is a “fixed place
at the disposal of the foreign enterprise”, with some “degree of permanence”,
from which the “business is carried on”’
.

 

The OECD in its Secretariat
Analysis of Tax Treaties and the Impact of the Covid-19 Crisis4  in paragraphs 5, 8 and 9 provides that under existing
treaty principles it is unlikely that a business will be considered to have a
fixed place PE in a jurisdiction as a result of the temporary presence of its
employees during the Covid-19 crisis. It has stated that ‘individuals who
stay at home to work remotely are typically doing so as a result of government
directives; it is
force majeure, not an enterprise’s requirement.
Therefore, considering the extraordinary nature of the Covid-19 crisis, and to
the extent that it does not become the new norm over time, teleworking from
home (i.e., the home office) would not create a PE for the business / employer,
either because such activity lacks a sufficient degree of permanency or
continuity, or because, except through that one employee, the enterprise has no
access or control over the home office’.

 

A typical
remote work from home scenario in the present crisis is a result of force
majeure
, i.e., government travel restrictions or work from home directives
which have been imposed during the pandemic and as such should not result in
the creation of a Fixed Place PE in a foreign jurisdiction. However, time is of
the essence to show how courts and tax authorities interpret Fixed Place PEs
under Covid-19.

 

Agency Permanent Establishment

The concept of PE has taken birth
in the context of two tax principles, i.e. the residence and source principles
of taxation. As per the source principle, if a tax resident of a particular
country earns income through another person (a separate legal entity) in
another country and where such other person can conclude contracts, then such
person creates an Agency PE in the latter country. The issue which needs to be
addressed is whether the activities of an individual temporarily working from
home for a non-resident employer during the present pandemic could give rise to
a dependent Agent PE.

 

In the case
of Reuters Limited vs. Deputy Commissioner of Income Tax (ITA No. 7895/Mum/2011)
the concept of Agency PE was discussed in detail wherein it was held that ‘A
qualified character of an agency is providing authorisation to act on behalf of
somebody else as to conclude the contracts’.
This means that the presence
which an enterprise maintains in a country should be more than merely
transitory if the enterprise is to be regarded as maintaining a PE, and thus a
taxable presence, in that country.

 

OECD in its Secretariat Analysis
of Tax Treaties and the Impact of the Covid-19 Crisis has stated that ‘an
employee’s or agent’s activity in a State is unlikely to be regarded as
habitual if he or she is only working at home in that State for a short period
because of
force majeure and / or government directives extraordinarily
impacting his or her normal routine’.

 

Construction Permanent
Establishment

The concept of Construction PE
provides that profits generated from construction works will be taxed in the
country in which the permanent establishment (construction site) is placed or located.

 

In general, a construction site
will constitute a PE if it lasts more than 12 months under the OECD Model, or
more than six months under the UN Model. However, the threshold may vary in
different tax treaties. It appears that many activities on construction sites
are being temporarily interrupted by the Covid-19 crisis.

 

In this regard, it has been seen
that the Indian tax authorities do not assume that interruptions of works at
site are to be excluded from the project period. OECD in its Secretariat
Analysis of Tax Treaties and the Impact of the Covid-19 Crisis has stated that ‘it
appears that many activities on construction sites are being temporarily
interrupted by the Covid-19 crisis. The duration of such an interruption of
activities should however be included in determining the life of a site and
therefore will affect the determination, whether a construction site
constitutes a PE. Paragraph 55 of the Commentary on Article 5(3) of the OECD
Model explains that a site should not be regarded as ceasing to exist when work
is temporarily discontinued (temporary interruptions should be included in
determining the duration of a site).

 

However, it is questionable
whether this case can be applied to the current pandemic situation which was
simply unpredictable. It is a natural event, but not seasonal. It is not even
predictable with a sufficient probability, as in bad weather. It is simply not
calculable; it is a classic force majeure scenario.

 

Service Permanent Establishment

Globalisation has led Multinational
Enterprises (MNEs) to increase cross-border secondment of technical, managerial
and other employees to their subsidiaries located in low-cost jurisdictions
such as India. The rationale behind seconding such employees is sometimes to
help the subsidiaries avail the benefit of the skill and expertise of the
seconded employees in their respective fields, and sometimes to exercise
control.

 

Secondment of employees has
become a really significant area, given that some bank staff or companies’
staff on assignments or secondments may be trapped in their non-native country
due to the travel restrictions, while others may have come back earlier than
expected; such situations might create a Service Permanent Establishment
(Service PE) for the companies.

 

Forced quarantine may delay the
intended secondment of an employee abroad or make a person employed on a
foreign contract decide to return to India due to reasons beyond control. In
this case, work for a foreign employer will be performed from India. This may
result in the creation of taxability of the employee’s income in India and in
some cases may even create risk of a permanent establishment. It is pertinent
to note, of course, that each case should be analysed on its own merits.

 

The concept of PE has been
defined extensively in various places but the interpretation of the same
continues to be complex and subjective. The distinct nature of each transaction
makes the interpretation of the law and the judicial precedents worth noting.
There can be no thumb rule which can be inferred from the jurisprudence or OECD
guidelines at present to the current crisis. Whether the virus-induced duration
of interruption would be included in the deadline in individual cases will
depend upon the specific circumstances.

 

We have
experienced in the recent past that India has been the frontrunner in
implementing the recommendations of OECD G-20 nations which are being discussed
under the initiative of BEPS Action Plans. Examples of this are introduction of
the concept of Significant Economic Presence (SEP) and Equalisation Levy (EL)
in the statute. However, it is important to see whether the same enthusiasm is
shown while implementing the recommendations on Covid-19-related aspects.

 

IMPACT
ON RESIDENTIAL STATUS OF A COMPANY (PLACE OF EFFECTIVE MANAGEMENT)

A company is generally tax
resident in the country where it is incorporated or where it has its ‘Place of
Effective Management’ (‘POEM’). The residential status of a company dictates
where a company will be taxed on its worldwide profits.

 

The OECD MC has defined POEM as ‘the
place where key management and commercial decisions that are necessary for the
conduct of the business as a whole are in substance made and that all relevant
facts must be examined to determine POEM’
.

 

In India,
POEM has been recognised by amendment in section 6(3) of the Income-tax Act,
1961 under the Finance Act, 2015 which states that a company is said to be
resident in India in any previous year, if it is an Indian company, or its
place of effective management in that year is in India. The Explanation to
section 6(3) provides that POEM means a place where key management and
commercial decisions that are necessary for the conduct of the business of an
entity as a whole are, in substance, made. POEM is also an internationally
recognised residency concept and adopted in the tie-breaker rule in many Indian
treaties for corporate dual residents and is also adopted in many jurisdictions
in their domestic tax laws.

 

Due to Covid-19, management
personnel / CEO may not be able to travel to the habitual workplace on account
of restrictions and may have to attend Board meetings via telephone or video
conferencing which will create a concern as to the place / jurisdiction from
which decisions are being taken.

 

It is pertinent
to note that the Central Board of Direct Taxes (‘CBDT’) had issued POEM
guidelines vide Circular No. 06 dated 24th January, 2017. In
the context of cases where the company is not engaged in active business
outside India, the Guidelines state that the location of the company’s head
office is one of the key determinant factors.

 

In this connection, CBDT has
considered a situation where senior management participates in meetings via
telephone or video-conferencing. In such a situation, CBDT states that the head
office would normally be the location where the highest level of management
(e.g., the Managing Director / Financial Director) and their direct support
staff are located.

 

OECD in its Secretariat Analysis
of Tax Treaties and the Impact of Covid-19 states that ‘it is unlikely that
the Covid-19 situation will create any changes to an entity’s residence status
under a tax treaty. A temporary change in location of the Chief Executive
Officers and other senior executives is an extraordinary and temporary
situation due to the Covid-19 crisis and such change of location should not
trigger a change in residency, especially once the tie breaker rule contained
in tax treaties is applied’.

 

Although the OECD Guidance
provides relief in this respect, however, taxpayers should be mindful of the
specific clarifications issued by respective tax jurisdictions on this aspect.
Recently, the US IRS has announced5 cross-border tax guidance
related to travel disruptions arising from the Covid-19 emergency. In the
guidance, IRS stated that ‘U.S. business activities conducted by a
non-resident alien or foreign corporation will not be counted for up to 60
consecutive calendar days in determining whether the individual or entity is
engaged in a U.S. trade or business or has a U.S. permanent establishment, but
only if those activities would not have been conducted in the United States but
for travel disruptions arising from the Covid-19 emergency’.

 

 

Similarly, jurisdictions such as
Ireland, UK and Jersey, Australia have issued guidance providing various
relaxations to foreign companies in view of Covid-19.

 

While the OECD Secretariat has
done an analysis on treaty impact, it may be worthwhile exploring a
multilateral instrument (on the lines of MLI) for avoiding conflict of
positions while granting treaty benefit to the taxpayers.

 

IMPACT ON RESIDENTIAL STATUS OF AN
INDIVIDUAL

Generally, number of days
presence is considered as a threshold (the total number of days that an
individual is present in a particular jurisdiction) for determining individual
tax residency. An exception to this principle is where citizens are taxed
irrespective of their presence.

 

Due to the Covid-19 outbreak,
travel is restricted, which gives rise to two main situations:

i. A
person is temporarily away from his home (perhaps on holiday, perhaps to work
for a few weeks) and gets stranded in the host country because of the Covid-19
crisis and attains domestic law residence there.

ii. A person/s is working in a country (the ‘current home country’)
and has acquired residence status there, but they temporarily return to their
‘previous home country’ or are unable to return to their current home country
because of the Covid-19 situation.

 

According to
the OECD, in the first scenario it is unlikely that the person would acquire
residence status in the country where he is temporarily staying because of
extraordinary circumstances. There are, however, rules in domestic legislation
considering a person to be a resident if he or she is present in the country
for a certain number of days. But even if the person becomes a resident under
such rules, if a tax treaty is applicable, the person would not be a resident
of that country for purposes of the tax treaty. Such a temporary dislocation
should therefore have no tax implications.

 

In the second scenario, it is
again unlikely that the person would regain residence status for being
temporarily and exceptionally in the previous home country. But even if the
person is or becomes a resident under such rules, if a tax treaty is
applicable, the person would not become a resident of that country under the
tax treaty due to such temporary dislocation.

However, in litigious countries
like India, and in the context of recent legislative amendments where NRIs have
been targeted for ?managing’ their period of stay in India, the very thought of
having to substantiate to the authorities that as per any tie-breaker test, a
person is non-resident in India is daunting.

 

With a view to remove genuine
hardships to individuals, CBDT has issued a clarification through Circular No.
11 of 2020 dated 8th May, 2020 in respect of determination of
residency u/s 6 due to Covid-19. The circular is applicable to individuals who
came on visit to India on or before 22nd March, 2020 and have
continued to be in India in different scenarios. This circular applies only for
determination of residency for FY 2019-2020.

 

Accordingly, in case of
individuals who have come on a visit to India on or before 22nd
March, 2020 and are falling under the following categories, relaxation will be
provided while determining their number of days’ presence in India for the
purpose of section 6 for FY 2019-20, as explained hereunder:

 

a. Scenario 1: where an
individual (who is on a visit to India) is unable to leave India before 31st
March, 2020 – the period of stay between 22nd and 31st
March, 2020 (both inclusive) shall not be counted for determining presence in
India.

 

b. Scenario 2: where an individual
has been quarantined in India on account of Covid-19 on or after 1st
March, 2020 and such individual has departed on an evacuation flight before 31st
March, 2020 or is unable to depart – the period starting from the start
of the quarantine period up to 31st March, 2020 or date of actual
departure shall not be counted for determining presence in India.

 

c. Scenario 3: where an
individual (who is on a visit to India) has departed on an evacuation flight
before 31st March, 2020 – the period of stay between 22nd
March, 2020 and date of his departure shall not be counted for determining
presence in India.

 

It has also
been stated that another circular will be issued in due course for determining
residency for FY 2020-2021. These pro-active clarifications bring relief to
many individuals facing difficulties in determining their residential status
amidst the measures taken by various governments to contain the impact of
Covid-19. It should be noted that this circular provides relief only from the
residence test u/s 6 of the Act. The issue of an individual’s forced stay in
India playing a role in constituting residence for a foreign company, HUF,
etc.; or determination of a business connection or Permanent Establishment of a
non-resident in India; and other such implications are not covered in the
circular. The US has recently issued a clarification which states that up to 60
consecutive calendar days of presence in the USA that are presumed to arise from
travel disruption caused by Covid-19 will not be counted for purposes of
determining US tax residency.

 

IMPACT ON CROSS-BORDER WORKERS

Cross-border
workers are persons who commute to work in one state but live in another state
where they are resident.

 

As per the
Income from Employment Article of the DTAAs, income from employment is taxable
only in a person’s state of residence unless the ‘employment is exercised’ in
the other state. However, there are certain conditions for not taxing
employment income in a state where employment is exercised (presence of employee
in that state not exceeding 183 days; and remuneration is paid by an employer
who is not a tax resident of that state; and such remuneration is not borne by
the employer’s PE in that state).

 

The issue which will come up here
is the taxation of wages and salaries received by such cross-border workers in
cases where they cross the threshold of 183 days due to travel restrictions.

OECD in the Secretariat Analysis
of Tax Treaties and the Impact of Covid-19 has stated that income should be
attributable to the state where they used to work before the crisis.

 

THE WAY FORWARD

The issues discussed above are
some of the common issues on which clarification / guidance should be issued by
the respective tax jurisdictions in order to protect taxpayers from unnecessary
hardship. We expect that CBDT will also consider these issues and come out with
relevant relief measures. Though the OECD guidelines have a persuasive value,
they are not binding in any manner, especially to non-OECD member countries. In
fact, taxpayers may have certain other issues on which they may need
clarifications; therefore, a mechanism should be put in place where they can
describe the facts and get redressal from the tax authorities. It is
recommended that companies / individuals must maintain robust documentation
capturing the sequence of facts and circumstances of the relevant presence
inside or outside of India during the Covid-19 crisis to substantiate the bona
fides
of their case before the tax authorities if and when they arise in
future.

 

‘Presume not that I am the thing
I was’
– Shakespeare‘Come what come may, time and the hour run
through the roughest day’
– Shakespeare  



____________________________________________

1   https://fortune.com/2020/02/21/fortune-1000-coronavirus-china-supply-chain-impact/
dated 21st February, 2020

2   ADIT vs. E-funds IT Solution Inc. (Civil Appeal No. 6802 of 2015
SC)

3   Formula One World Championship Ltd. vs. CIT (IT) [2016] 76
taxmann.com 6/390 ITR 199 (Delhi)(SC)

4   https://read.oecd-ilibrary.org/view/?ref=127_127237-vsdagpp2t3&title=OECD-Secretariat-analysis-of-tax-treaties-and-the-impact-of-the-COVID-19-Crisis

5   https://www.irs.gov/newsroom/treasury-irs-announce-cross-border-tax-guidance-related-to-travel-disruptions-arising-from-the-covid-19-emergency

INTERPLAY OF GST & EMPLOYMENT REGULATIONS

INTRODUCTION
– SERVICE BY EMPLOYEES EXCLUDED FROM GST

GST is a tax on all supplies of
goods or services, or both, made in the course or furtherance of business.
However, Schedule III, Entry 1 treats services by an employee to the employer
in the course of or in relation to his employment as neither a supply of goods
nor a supply of services, effectively resulting in the situation that such
services are excluded from the purview of GST.

 

HOW TO
DETERMINE EMPLOYER-EMPLOYEE RELATIONSHIP

It,
therefore, becomes important to analyse the scope of the abovementioned entry.
Since the exact tests of determination of employment contract are not
specifically listed in the GST law, it will be important to understand the said
tests from legal precedents under the general law including various labour
legislations. To begin this journey it may be worthwhile to refer to the
decision of the larger Bench of the Supreme Court in the case of Balwant
Rai Saluja & others vs. Air India Limited & others [Civil Appeal No.
10264-10266 of 2013].
In this case, the Court laid down the following
tests which are required to be satisfied to demonstrate the existence of an
employer-employee relationship:

 

(i)   Who appoints the workers?

(ii)   Who pays the salary / remuneration?

(iii) Who has the authority to dismiss?

(iv) Who can take disciplinary action?

(v) Whether there is continuity of service?

(vi) What is the extent of control and supervision?

 

Various legislations have been
enacted to safeguard the interest of employees employed by employers. Some of
the key legislations are the Factories Act, 1948, the Industrial Employment
Act, 1946, the Industrial Disputes Act, 1947, the Contract Labour Regulation
Act, 1970, the Workmen’s Compensation Act, 1923, and so on. Each of these
legislations has defined the term employee, identified as worker, workmen, etc.
However, it is important to note that the definition of employee referred
to in one legislation is restricted only to that legislation and merely because
a person is an employee under one legislation he does not become an employee in
general of the employer.
The Supreme Court in the above decision has
held that for matters which are not related to the specific legislations, one
needs to satisfy the above test to establish the existence of an
employer-employee relationship.

 

WHAT IS THE SCOPE OF THE ENTRY?

The next point that needs to be
analysed is what all will be included within the scope of the consideration /
remuneration paid to an employee. Generally, the consideration paid to an
employee carries two components, one being the monetary component which would
cover payouts like salary, wages, allowances, etc., and the other being
non-monetary components such as perquisites, rent-free accommodation, etc.,
which are made available to employees under the terms of the employment
contract. Some components may be mandated by the legislature and some may be
part of the employment policy of the employer.

 

The legislations referred to
above also deal with the meaning of ‘consideration’. For example, section 2
(rr) of the Industrial Disputes Act, 1947 defines the term ‘wages’ to mean all
the remuneration capable of being expressed in terms of money and payable to a
workman in respect of his employment or work done in such employment, and also
includes (a) allowances that the workman is entitled to, (b) the value of the
house accommodation or of the supply of light, water, medical attendance or
other amenities, or of any service, or of any concessional supply of food
grains or other articles, (c) any travelling concession, and (d) any commission
payable on the promotion of sales or business, or both. However, it also
excludes certain items such as (i) any bonus, (ii) any contribution paid /
payable by the employer to any pension fund / provident fund / for the benefit
of the workman under any law for the time being in force, and (iii) any
gratuity payable on the termination of service.

Similarly, section 2(v) of the
Payment of Wages Act, 1932 defines the term ‘wages’ as all the remuneration
(whether by way of salary, allowances or otherwise) expressed in terms of
money, or capable of being so expressed, which would be payable to a person
employed in respect of his employment, or of work done in such employment and
includes (a) any remuneration payable under any award or settlement between the
parties or order of a Court, (b) overtime remuneration, (c) additional
remuneration payable under the terms of employment, (d) any amount due on
termination of employment, and (e) any sum which the employee is entitled to
under any scheme framed under any law for the time being in force, excluding
any bonus, value of benefits, such as house accommodation, electricity or water
supply, medical attendance or other amenity, or of any service excluded from
the computation of wages by a general or special order of the appropriate
government, any contribution paid by the employer to any pension or provident
fund and the interest accrued thereon, any travelling allowance or the value of
any travelling concession and any sum paid to the employed person to defray
special expenses entitled to him by the nature of work.

 

The above two definitions in the
context of specific legislations clearly point towards what shall constitute
‘consideration’ and it generally intends to include within its scope all
payments made to the employees, except for specific items which are also
excluded only for the purpose of the specific legislations. But the general
principle laid down in the said legislations indicates that all payments made
or facilities extended to the employees as a part of employment contracts would
be treated as a part of the consideration to the employee. This principle was
laid down by the Supreme Court in the case of Gestetner Duplicators
(Private) Limited vs. CIT [1979 AIR 607 = 1979 SCR (2) 788]
wherein the
Court held as under:

 

It is thus clear that if under
the terms of the contract of employment, remuneration or recompense for the
services rendered by the employee is determined at a fixed percentage of
turnover achieved by him, then such remuneration or recompense will partake of
the character of salary, the percentage basis being the measure of the salary
and therefore such remuneration or recompense must fall within the expression
‘salary’ as defined in Rule 2(h) of Part A of the Fourth Schedule to the Act.
In the instant case before us, admittedly, under their contracts of employment
the assessee has been paying and did pay during the previous years relevant to
the three assessment years to its salesmen, in addition to the fixed monthly
salary, commission at a fixed percentage of the turnover achieved by each
salesman, the rate of percentage varying according to the class of article sold
and the category to which each salesman belonged. The instant case is,
therefore, an instance where the remuneration so recompense payable for the
services rendered by the salesmen is determined partly by reference to the time
spent in the service and partly by reference to the volume of work done. But it
is clear that the entire remuneration so determined on both the basis clearly
partakes of the character of salary.

 

In fact, while determining what
shall and what shall not constitute consideration, one should refer to the
principle of dominant intention theory, as laid down by the Supreme Court in Bharat
Sanchar Nigam Limited vs. UoI [2006 (2) STR 161 (SC)].
The Court in the
said decision held that one needs to look into the substance of the transaction
in order to determine how the same would get covered. Once it is established
that any payment made to an employee or any benefit / facility made available
to him is in the course of an employment contract, irrespective of whether the
same is a mandatory requirement or not, it gets covered within the purview of
that contract and cannot be distinguished from it.

 

Employer and employees are
related persons – Does this impact the tax treatment of the facilities /
benefits provided to employees?

 

Section 15 provides that an
employer and his employee shall be deemed to be related persons. Further, Entry
2 of Schedule I deems certain activities to be supplies even if the same are
without consideration. The entry reads as under:

 

Supply of goods or services or
both between related persons or between distinct persons as specified in
section 25, when made in the course or furtherance of business:

 

Provided that gifts not exceeding
fifty thousand rupees in value in a financial year by an employer to an
employee shall not be treated as supply of goods or services or both.

 

In the normal course, various
facilities / benefits are provided by the employer to his employees. Let us
first analyse whether or not the same constitute a supply under GST (without
considering the scope of entries under Schedule I and Schedule III). It is
imperative to note that generally when an employer makes available any
facilities / benefits to the employee, it is not mandatory in nature. For
example, commutation facility extended by the employer may not be availed of by
employees who prefer to travel on their own. It is upon the employee to decide
whether he intends to avail of the facility. Similarly, it is not necessary
that all employees might avail the canteen facility. Rather, they might want to
make arrangements on their own. It is only as a part of the employer’s HR
policy / statutory requirement that the employer makes available the facilities
/ benefits.

 

However, once it becomes part of
the employment policy, which the employee would have accepted, it becomes part
of the employment contract, i.e., the employer has made available the
facilities / benefits in pursuance to the services supplied by the employee to
the employer. However, there is no contrary service supplied by the employer.
The employer has merely undertaken the activity of incurring the cost to make
available the benefits / facilities to its employees. However, merely because a
cost is incurred does not necessarily mean that the employer has supplied the
service. In Kumar Beheray Rathi vs. Commissioner of Central Excise, Pune
[2014 (34) STR 139],
the Tribunal held that the assessee was acting
merely as a trustee or a pure agent as it was not engaged in providing any
service but only paying on behalf of various flat-buyers to various service
providers. In this particular case, even though there was recovery of cost, the
Tribunal has held that there was no provision of service. The argument would therefore
get stronger in a case where consideration is not involved. Similarly, in the
case of Reliance ADAG Private Limited vs. CST, Mumbai [2016 (43) STR 372
(Tri.)(Mum.)],
the Tribunal has held that merely incurring expenses on
behalf of group companies and recovering them would not amount to provision of
service. The principles laid down in the said case should also apply to the
current case.

 

Another aspect to be noted is
that in certain cases, such as telephone facilities / insurance services, there
is a legal impediment to the employer providing such service since they are
regulated services and only those people who are authorised by the Department
of Telecommunication (DOT) or the Insurance Regulatory Development Authority of
India (IRDAI) can provide such a service. Therefore, this is one more basis to
say that by merely making available the facilities / benefits the employer has
not made a supply to his employees, but rather it is a cost incurred by him in
the course of receiving services from his employee and, therefore, is nothing
but just an employment cost for him. This aspect has also been discussed in our
previous article ‘Decoding GST: Inter-Mingling of Income tax and GST’ (BCAJ,
April, 2020).

 

Therefore, once a view is taken
that making available benefits / facilities does not constitute supply, Entry 2
of Schedule I which deems an activity of supply of goods or services between a
distinct person / related person as supply, even if made without consideration,
would not be applicable. This would be because Entry 2 pre-necessitates that
the activity has to be treated as supply u/s 7.

 

Another point to be noted is that
if a view is taken that by incurring the above expenses / making available the
benefits to the employees, there is a supply made by the employer, it could
result in additional unwarranted compliances on the part of the employer. Let’s
take an example of insurance facilities / benefits extended to the employee. If
a view is taken that the employer has indeed provided these services, then they
would be in violation of the IRDAI guidelines since they would be engaged in
providing insurance services without necessary approvals. Similar would be the
situation in case of telecommunication facilities made available to the
employees where one needs to obtain approval from DOT, or in the canteen
facilities from FSSAI. Further, in some cases such an interpretation would
result in an absurd application from other aspects also. For example, in case
of rent-free accommodation provided by the employer to the employee, if a view
is taken that the same is a supply of service in view of Entry 2 of Schedule I,
while there would be no tax liability on the outward side since the services of
renting of residential accommodation is exempted from tax, correspondingly, the
Department might take a view that the employer is engaged in providing exempt
services, thus triggering the applicability of the provisions of sections 17(2)
and 17(3) of the Central Goods & Services Tax Act, 2017 requiring
compliances under Rules 42 and 43 of the Central Goods & Service Tax Rules,
2017.

 

Therefore,
it is apparent that whether or not any amount is recovered from the employee
for any facilities / benefits made available to him, it would be wrong to treat
the same as a supply itself under GST. In fact, the next proposition would be
important, which is to say that the facilities / benefits which are made
available to the employees is nothing but a part of the employee cost incurred
in the course of receiving the services of the employee in pursuance of the
employment contract. This view finds support from the decision of the Andhra
Pradesh High Court in the case of Bhimas Hotels Private Limited vs. Union
of India [2017 (3) GSTL 30 (AP)]
wherein, in the context of canteen
recoveries, the Court held that such recoveries have to be seen as part of any
pay package that workers have negotiated with employers and therefore cannot be
construed as service falling within the definition of ‘service’ u/s 65B(44) of
the Finance Act, 1994. The logic behind the above conclusion was that under
service tax the definition of service excluded any service provided by the
employee to the employer in the course of employment from its purview. Since
the recoveries were made in pursuance of the employment contract, they were
excluded from the scope of the definition of service. It is imperative to note
that even under GST, Entry 1 of Schedule III provides that services provided by
an employee to the employer in the course of the employment contract shall be
treated neither as supply of goods nor as supply of services. Therefore, it can
be said that under GST,

 

(a) Any facilities / benefits made available to the employees would not
be liable to GST as they do not amount to supply of service itself

(b) The facilities / benefits made available to the employees even if
not a statutory requirement but part of the employment policy, should be
treated as covered under Entry 1 of Schedule III and therefore excluded from the
scope of supply itself

(c) Even if any amounts are recovered from the employees, the same would
also be covered under Entry 1 of Schedule III in view of the decision in the
Bhimas Hotels case (Supra)
and should be treated as nothing short of
reduction in the employee cost.

 

Readers might also take note of
the contrary AARs under GST on this subject. In the case of Caltech
Polymers Private Limited [2018 (18) GSTL 350 (AAR)]
and upheld by the
Appellate Authority in [2018 (18) GSTL 373 (AAR)], the Authority
has held that the employer is liable to pay GST on amounts recovered from
employees for the canteen facilities extended to them. However, in the context
of recovery of insurance premia from employees, the authority has held that as
the same do not constitute an activity incidental or ancillary to their
business activity, they cannot be treated as supply of service. One may refer
to the ruling in the case of Jotun India Private Limited 2019 (29) GSTL
778 (AAR).

 

Eligibility
of Input Tax Credit on employee-related costs

 

There are
specific provisions which restrict claim of Input Tax Credit u/s 17(5) as
under:

(b) the following supply of goods or services or
both:

(i) food
and beverages, outdoor catering, beauty treatment, health services, cosmetic
and plastic surgery, leasing, renting or hiring of motor vehicles, vessels or
aircraft referred to in clause (a) or clause (aa), except when used for the
purposes specified therein, life insurance and health insurance:

Provided
that the input tax credit in respect of such goods or services or both shall be
available where an inward supply of such goods or services or both is used by a
registered person for making an outward taxable supply of the same category of
goods or services or both or as an element of a taxable composite or mixed
supply;

(ii) membership of a club, health and fitness
centre; and

(iii) travel benefits extended to employees on
vacation such as leave or home travel concession:

Provided
that the input tax credit in respect of such goods or services or both shall be
available, where it is obligatory for an employer to provide the same to its
employees under any law for the time being in force.

(g) goods
or services or both used for personal consumption;

 

Building on
the above discussion, it is important to note that while making available the
various benefits / facilities to their employees, the employers incur various
costs on which GST would have been charged by their suppliers. Therefore, the
question that needs consideration is whether or not credit shall be available
on such expenses incurred.

 

The
specific reason for this query is that section 17(5) lists items on which
credit shall not be allowed. These are termed as blocked credits. For various
expenses while there is a restriction on claim of credit, an exception has been
provided when the expense is incurred as a statutory requirement. For example,
while in general ITC on food and beverages is not allowed, however, vide
an exception it has been provided that if it is a statutory requirement to
provide such facilities, Input Tax Credit shall be available. For instance,
under the Factory Act, 1948 every factory employing more than 250 employees is
required to maintain a canteen for them. As discussed earlier, for the purpose
of this Act the employees also include those who are not on the payroll of the
employer, i.e., while in general, an employer-employee relationship does not
exist, for the purposes of the Factory Act, 1948 they are treated as employees
and therefore the question that needs consideration is whether the eligibility
to claim credit will apply for such an outsourced workforce also. This would be
specifically important in cases such as construction contracts where generally
the labour is outsourced.

The same
applies to rent-a-cab services, insurance services, etc., as well. However, at
times there are inward supplies received which facilitate the making available
of benefits / facilities to employees. For example, equipment / crockery
purchased for a canteen. There is no specific restriction on the claim of
credit on such items. The restriction applies only to food and beverages and
these do not constitute food and beverages. Therefore, credit on such items
could be claimed.

 

Another
area that would need deliberation is clause (g) of section 17(5) which
restricts claim of credit on goods or services or both used for personal
consumption. The scope of this entry has seen substantial confusion as to
whether it would apply to goods or services used for employee consumption. For instance,
the company organises a picnic for its staff. Will this get covered under this
entry or not? To understand this, one needs to analyse the scope of the term
‘personal consumption’. However, before proceeding further it would be relevant
to refer to the similar entry in CENVAT Credit wherein Rule 2 (l) states that
specific services which were meant for ‘personal consumption of any employee’
shall not constitute input service. It is imperative to note that while the CCR
specified whose personal consumption, the same is apparently silent under GST.
This would indicate that in the absence of a specification, a view can be taken
that the term ‘personal consumption’ is to be seen in the context of the
taxable person and not the employees and, therefore, subject to other clauses
of section 17(5), credit would be available even if they were meant for
consumption of the employees.

 

However,
the answers would change in the above case where the cost of making available
the benefits / facilities, whether wholly or partly, is recovered from the
employees. In such a case, it would result in a reduction of cost for the
employer and therefore, to that extent, the employer would not be entitled to
claim credit. However, there are instances where employers take a view that in
a case where credit is allowable and the corresponding costs are recovered from
the employees, GST should be paid on the recovery amount to avoid complicating
ITC calculations. However, one should take a view that paying GST on the
recovery would mean that the employer has accepted liability under Entry 2 of
Schedule I and there might be challenges on the valuation of the supply claimed
to be made by the employer to his employees because section 15 of the Central
Goods & Services Tax Act, 2017 requires such a transaction to be valued as
per the Valuation Rules.

 

Applicability of GST on payments made to
directors of a company

 

Entry 6 of
Notification 13/2017 – CGST Rate requires that the GST in case of service
supplied by a director of a company or a body corporate to the said company /
body corporate shall be paid by the service receiver, i.e., the company in case
the service provider is a director / body corporate. However, this particular
aspect of the GST law has seen its share of controversy, with conflicting
decisions under the Service Tax regime as well as a ruling issued by the
Authority for Advance Ruling.

 

However, before proceeding further, it would be
necessary to go through the background of the concept of directors. Directors
are individuals who are appointed on the Board of a company to protect the
interests of the shareholders and manage the affairs of the company. Generally,
there are two types of directors: executive directors who are involved in the
day-to-day activities of the business, and non-executive directors, also known
as independent directors, whose role is mainly to ensure that the interest of
the shareholders and other stakeholders is largely protected. The maximum
remuneration that can be paid to each class of directors is also regulated.
However, when determining whether the directors satisfy the test of an
employer-employee relationship, there would be a different outcome which is
evident from the following:

Condition

Executive Director

Non-Executive / Independent Director

Who appoints the workers?

Shareholders, on the recommendation of Board, or Board, to be
subsequently ratified by the shareholders

Who pays the salary / remuneration?

Company

Company

Who has the authority to dismiss?

Shareholders

Who can take disciplinary action?

Shareholders

Whether there is continuity of service?

Generally, appointed till end of next general meeting

What is the extent of control and supervision?

Full control and supervision by shareholders

No control / supervision

As is apparent from the above, in
the case of Executive Directors, the test of employer-employee relationship
laid down by the Supreme Court in Balwant Rai Saluja (Supra) is
satisfied. However, it is not so in the case of Independent directors as the
key element of existence and control and supervision is missing. It is
therefore sufficient to say that while Executive Directors satisfy the test of
the employer-employee relationship, the same is not so in the case of
Non-executive / Independent directors. Therefore, in case of directors, while
admittedly notification 13/2017 – CT (Rate) imposes a liability on the company
to pay tax on reverse charge, the issue that remains is whether the payment
made to directors who are in an employer-employee relationship will get covered
within this entry or will it be excluded from the purview of Entry 1 of
Schedule III.

 

Therefore,
since Schedule III itself excludes transactions where an employer-employee
relationship exists from the purview of supply itself, notification 13/2017 –
CT (Rate) imposing the liability to pay tax on the service recipient is ultra
vires
of the provisions of the Act and, therefore, not maintainable. This
aspect has already been considered by the Gujarat High Court in the recent
decision in
Mohit Minerals Private Limited vs. UoI & others [2020 VIL 36
Guj.].

 

In fact, it
is imperative to note that a similar entry requiring payment of tax under RCM
was applicable even under the Service Tax regime where there were two
conflicting decisions. The Division Bench of the Mumbai Tribunal in the case of
Allied Blenders & Distillers Private Limited vs. CCE & ST,
Aurangabad [2019 (24) GSTL 207 (Tri.)(Mum.)]
held that directors’
salary would be excluded from the purview of service tax and therefore no tax
would be liable to be paid under Reverse Charge. However, the Kolkata Tribunal
(SMB) has, in the case of Brahm Alloy Limited vs. Commissioner [2019 (24)
GSTL 616 (Tri.)(Kol.)]
held otherwise and confirmed the liability to
pay tax on directors’ remuneration, described as salary by concluding that an
employer-employee relationship didn’t exist on account of two reasons; firstly,
the resolution of the company confirming the appointment of the directors did
not cover the terms of appointment / hiring of services and also the action to
be taken for non-performance of specified duties without which it cannot be
construed as to whether an individual was appointed as Promoter-Director or an
employee director; and secondly, payments made in a quarterly and not monthly
manner. It is apparent that the decision in the case of Brahm Alloy
Limited
is contrary to the established principles and might not survive
if appealed before a higher authority.

 

It is also
important to note that under the GST regime, the AAR has, in the case of Clay
Craft India Private Limited [Raj/AAR/2019-20/33]
also held to the
contrary, that tax is payable under Reverse Charge. The Authority has concluded
that the services rendered by the director to the company are not covered under
Entry 1 of Schedule III as the directors are not employees of the company.

 

The next
issue relating to directors is the applicability of reverse charge in case of
directors deputed on behalf of investing companies, in which case the
remuneration is paid to the company and not to the representative directors.
The issue revolves around whether such transactions would be covered under
notification 13/2017 – CT (Rate) or not? It is imperative to note that in this
transaction structure, the transaction is between two different companies /
body corporates wherein one body corporate has deputed a person as a director
on the Board of the other company. In other words, both the supplier and the
recipient of service are a body corporate / company. The notification requires
that the service provider must be an individual, being a director of the
company. However, that is not so in the case of the current set of
transactions. In other words, Entry 6 does not get triggered at all and,
therefore, no reverse charge would be applicable on such transactions.

 

Is GST applicable on notice period
recoveries / claw-back of payments to employees?

 

Before
looking into the tax implications of notice period recovery / claw-back, let us
understand the background of these transactions.

 

Notice
period recovery: Generally, the employment contracts have a clause that if an
employee intends to leave the organisation or an employer intends to
discontinue the services of an employee, each party will be required to give a
notice to the other of their intention to do so, and once the notice is served,
the party giving the notice will be required to serve a notice period, i.e., if
the employee is serving notice, he will be required to continue in employment
for a pre-decided period to enable the employer to make alternate arrangements.
Similarly, if the employer has served notice to the employee, he will have to
allow the employee to continue in employment for a pre-decided period to enable
the employee to find new employment, or prepare for transition. This is
generally treated as serving notice period. However, there are times when the
party giving the notice does not intend to honour the commitment in which case
they are required to compensate the other person monetarily. In case the
employee refuses to serve the notice period, he would be required to pay
compensation to the employer, which would be either adjusted from his full and
final settlement or recovered from him, and vice versa; if the employer
abstains from honouring the notice period clause, he would monetarily reimburse
the employee.

 

Similarly,
claw-back refers to recovering the amounts already paid to the employees. In
case of senior management employees, there are generally clauses in the
agreement which provide that in case of non-satisfaction of certain conditions
of the employment contract, the payments made to the employees shall be
recovered back from them. For example, if a top level employee is joining a
company from another company, in order to lure him to accept the employment he
is offered ‘joining bonus / incentive’ with the condition that if he does not
continue the employment for a specified period, the same would be liable to be
recovered from him. Similarly, even in case of incentives / bonus, there are
clauses for claw-back of the bonus if there is some action on the part of the
employee which is detrimental to the employer.

 

The issue
that needs consideration is whether recoveries such as the above would
constitute a supply and therefore liable for GST? It is imperative for the
readers to note that the applicability of GST on notice period recoveries has
been a burning issue right from the service tax regime wherein the following
service was declared to be a deemed service u/s 66E: agreeing to the
obligation to refrain from an act, or to tolerate an act or a situation, or to
do an act;…

 

A similar
entry has continued even under the GST regime with Entry 5(e) of Schedule II of
the Central Goods & Services Tax Act, 2017 which declares the above to be
treated as supply of service under the GST regime as well, thus keeping the
issue alive. Let us analyse the same.

 

Whether such recoveries would be covered under Entry 1 of Schedule III?

However,
what needs to be noted is that the above recoveries emanate from a contract of
employment which is covered under Schedule III as neither being supply of goods
nor supply of services. A contract is the logical starting point for any
transaction. In any contractual obligation, the contracting parties are under
an onus to perform the contract. The contracting terms determine the
responsibility and enforce the performance on each contracting party. In case
of non-performance by any party, resort has to be taken to the contractual
relationship to determine the scope of recovery, if any. Hence, the contract is
in toto the binding force in any relationship.

A Latin
maxim, Nemo aliquam partem recte intelligere potest antequam totum perlegit,
says that no one can properly understand a part until he has read the whole.
Hence, it is important to analyse the entire transaction matrix, the
contractual relationship between the employer and the employee, the relevant
contracts / documents before diving into a discussion on the applicability of
service tax. An employment contract is a written legal document that lays out
binding terms and conditions of an employment relationship between an employee
and an employer. An employment contract generally covers an overview of job
responsibilities, reporting relationships, salary, benefits, paid holidays,
leave encashment benefits, details of employment termination and also provides
that in case an employee wants to quit, the employee should provide one month’s
notice before resigning or compensation in lieu of notice period.

 

The
employment contracts are long-term contracts with the employees. The
understanding and expectations from the employer are that the employee should
provide his services on a continuous basis. The employees are working on
important client projects or certain functions important for the operation of
the business; if any employee resigns in between, that impacts the progression
of the project adversely. To avoid such a situation and give sufficient time to
the employer to make alternative arrangements, the mandatory notice period is
prescribed under the employment contract. However, if the employee wishes to
leave without serving the notice period, the contract provides for recovery of
a certain amount which is generally deducted from the amounts due to the
leaving employee earned in the course of employment.

 

The ‘notice
period recovery’ is a provision for an eventuality that may arise as per
mutually-agreed terms of the employment contract. Notice period recovery is a
condition of the employment contract agreed mutually and hence is intricately
linked with the employer-employee relationship and arises out of an employment
contract only.

 

In the case
of Lakshmi Devi Mills Limited vs. UP Government [AIR 1954 All. 705, 714]
it has been held that ‘terms and conditions of service’ not only include the
recruitment or appointment but also all aspects like disciplinary matters,
removal from service, dismissal, etc. Therefore, termination or quitting the
organisation on notice or notice period recovery in lieu thereof is an
integral part of the employment contract. Thus, notice period recovery is just
another condition of the contractual relationship of an employer and employee
just like other terms of the same employment agreement. Hence, the notice
period recovery in lieu of not adhering to the notice period emanating
from the employment contract should get covered under Entry 1 of Schedule III
and therefore excluded from the scope of supply itself.

 

Is there
any service provided by the employer?

Another
point to be noted is that merely because there is recovery would not convert
the same into consideration. In permitting the employee to leave the
organisation, there is nothing that the employer has done to qualify as
service. For treating something as service, there has to be an activity which
requires doing something for another person. In case of notice period
recoveries, there is no rendition of service from the employer in the case of
permitting the employee to leave the organisation before the completion of the
notice period. The events which precede the employee leaving the organisation
are:

 

(a) The decision to leave is that of the
employee

(b) The request for termination is made by
the employee

(c) The employer has no choice to retain the
employee if he really wants to leave

(d) If the employer decides not to insist on
the notice period, even then he cannot insist on the recovery of the notice pay
if the employee wants to serve the notice period; he will be required to
continue the employment till that period

(e) Therefore, the employer has no choice to
decide on whether the employee should stay back for the notice period or
whether he should leave early against recovery of notice pay. This choice is
also made by the employee.

 

From the
above it is evident that all the activities and decisions are actually carried
out by the employee. And the employer does nothing. He neither decides nor is
in a position to decide. Hence, there is no provision of service by the
employer. Merely because the employee is permitted to leave by the employer
does not by any stretch of the imagination get covered by ‘activity performed
for the employee’.

 

Would mere recovery of amounts characterise it as consideration?

Another
aspect which would need deliberation is whether or not the amounts recovered on
account of notice period recovery / claw-back clauses can be treated as
consideration? Merely because money is received would not give it the
characteristic of consideration. In the case of Cricket Club of India vs.
Commissioner of Service Tax, Mumbai [2015 (40) STR 973]
it was held
that mere money flow from one person to another cannot be considered as
consideration for a service. The relevant observations of the Tribunal in this
regard are extracted below:

 

‘11.
…Consideration is, undoubtedly, an essential ingredient of all economic
transactions and it is certainly consideration that forms the basis for
computation of service tax. However, existence of consideration cannot be
presumed in every money flow. The factual matrix of the existence of a monetary
flow combined with convergence of two entities for such flow cannot be moulded
by tax authorities into a taxable event without identifying the specific
activity that links the provider to the recipient.

12. …Unless
the existence of provision of a service can be established, the question of
taxing an attendant monetary transaction will not arise.’

 

Even in the celebrated case of UoI
vs. Intercontinental Consultants and Technocrats Pvt. Limited
[2018-TIOL-76-SC-ST],
the Apex Court upheld the decision of the Delhi
High Court that observed that ‘…and the valuation of tax service cannot be
anything more or less than the consideration paid as quid pro quo for
rendering such a service’.

 

In the case of HCL Learning
Limited vs. Commissioner of CGST, Noida [2019-TIOL-3545-CESTAT-All.],

the Hon’ble Tribunal of Allahabad has categorically held as under:

 

‘1… From
the record, we note that the term of contract between the appellant and his
employee are that employee shall be paid salary and the term of employment is a
fixed term and if the employee leaves the job before the term is over then
certain amount already paid as salary is recovered by the appellant from his
employee. This part of the recovery is treated by Revenue as consideration for
charging service tax… terms of contract between the appellant and his
employee are that employee shall be paid salary and the term of employment is a
fixed term and if the employee leaves the job before the term is over then
certain amount already paid as salary is recovered by the appellant from his
employee. This part of the recovery is treated by Revenue as consideration for
charging service tax.

 

2. We hold
that the said recovery is out of the salary already paid and we also note that
salary is not covered by the provisions of service tax. Therefore, we set aside
the impugned order and allow the appeal.’

Therefore,
whether recovery is from salary due / retained or salary already paid, the fact
remains that salary is excluded from service tax and such recovery cannot be
termed as consideration.

 

Will notice period recovery be covered under Entry 5(e) of Schedule II
to treat the same as supply of service?

The
decision to quit the organisation by the employee is a unilateral decision. The
same is forced upon the employer and he has to accept it. The employer cannot
make any employee work without his consent. Article 23(1) of the Indian
Constitution prohibits forced labour in any form. In other words, statutorily
no employee can be forced to work against his wish. In case the employee wishes
not to serve the notice period and opt to leave the organisation before
completion of the notice period, in such a situation the employer can only
recover the notice period dues.

 

Further,
the employer would not be tolerating any act in such a case. If the employer
has the option to tolerate or not to tolerate, then it can be said to be a
conscious decision. In such cases, in view of the above discussion, the decision
to quit is thrust upon the employer without any option. Therefore, it cannot be
said that the employer has agreed to tolerate the said act of the employee.

 

A breach of
contract cannot be said to be ‘tolerated’ and that is why an amount is imposed
to deter breach in contracts. The contract of employment is for receipt of
services from the employee and not for the breach. The Court of Appeal (UK) in
the case of Vehicle Control Services Limited [(2013) EWCA Civ 186],
has noted that payment in the form of damages / penalty for parking in wrong
places / wrong manner is not a consideration for service as the same arises out
of breach of contract with the parking manager.

          

The Madras
HC has critically analysed the levy of service tax on notice period recoveries
in the case of GE T&D India Limited vs. Deputy Commissioner of
Central Excise, Large Tax Payer Unit, Chennai [2020-VIL-39-Mad-ST]
wherein
the OIO had confirmed the demand treating the recoveries as consideration for
providing declared service u/s 66E. In this case, the Court held as under:

 

‘11. The
definition in clause (e) of section 66E as extracted above is not attracted to
the scenario before me as, in my considered view, the employer has not “tolerated”
any act of the employee but has permitted a sudden exit upon being compensated
by the employee in this regard.

12. Though
normally a contract of employment
qua an employer and employee has to be read as a whole, there are
situations within a contract that constitute rendition of service such as
breach of a stipulation of non-compete. Notice pay,
in lieu of sudden termination, however, does not give rise to the
rendition of service either by the employer or the employee.’

 

The above
judgment clearly lays down the principle that notice period recovery cannot be
treated as ‘service’ by an employer, more so a ‘declared service’. Some
monetary recovery by an employer from an employee on account of breach of
contract cannot be said to be consideration for any different service. Breach
of contract leading to recovery does not lead to the creation of a new contract
of tolerating any act of the employee. The notice period recovery, at best,
represents nothing but reduction in salary payable which is due to the employee
which emanates only from the employment agreement. To draw an analogy, for
breach of contracts, certain companies recover liquidated damages from the
amounts due to the opposite party who fails to execute his duties as stipulated
under the contract. In case of notice period recoveries, the employer recovers
notice period recovery from the employee for breach of contract conditions as
stipulated in the employment agreement. The Tribunal has in the case of Reliance
Life Insurance Company Limited [2018-TIOL-1308-CESTAT-Mumbai = 2018 (19) GSTL
J66 (Tri.)(Bom.)]
held that the surrender / discontinuance charges
represent penalty or liquidated damages and cannot be considered as a
consideration for any services. On a similar footing, in another case of Gondwana
Club vs. Commissioner of Customs & Central Excise, Nagpur
[2016-TIOL-661-CESTAT-Mum.]
the club had recovered certain charges from
the employees for the accommodation provided to them. In this case also, the
Tribunal held as under:

 

‘7… The
contractual privileges of an employer-employee relationship are outside the
purview of service tax and this activity of the appellant does not come within
the definition of the taxable service of “renting of immovable property” sought
to be saddled on the appellant in the impugned order. Accordingly, the demand
under the head “renting of immovable property service” does not sustain.’

 

In a very
recent decision, the Hon’ble High Court of Bombay had the opportunity to
analyse the concept of ‘supply’ in relation to violation of legal right and
claim of compensation / damages in the context of the Central Goods &
Services Tax Act, 2017. The Hon’ble High Court in the case of Bai Mamubai
Trust & Ors vs. Suchitra Wd/O. Sadhu Koraga Shetty & Ors
[2019-VIL-454-Bom.]
observed as under:

 

56. I am in
agreement with the submissions of the Learned
Amicus Curiae that where a dispute concerns price / payment for a
taxable supply, any amount paid under a court’s order / decree is taxable if,
and to the extent that, it is consideration for the said supply or a payment
that partakes that character. In such cases, the happening of the taxable event
of ‘supply’ is not disputed, but the dispute may be in regard to payment for
supplies already made. This could be, for example, where the defendant denies
the liability to pay the price forming consideration for the supply. The order
/ decree of the court links the payment to the taxable supply and the requisite
element of reciprocity between supply and consideration is present.

 

57.
However, where no reciprocal relationship exists, and the plaintiff alleges
violation of a legal right and seeks damages or compensation from a Court to
make good the said violation (in closest possible monetary terms), it cannot be
said that a ‘supply’ has taken place.

 

58. The
Learned
Amicus Curiae correctly submits that
enforceable reciprocal obligations are essential to a supply. The supply
doctrine does not contemplate or encompass a wrongful unilateral act or any
resulting payment of damages. For example, in a money suit where the plaintiff
seeks a money decree for unpaid consideration for letting out the premises to
the defendant, the reciprocity of the enforceable obligations is present. The
plaintiff in such a situation has permitted the defendant to occupy the premises
for consideration which is not paid. The monies are payable as consideration
towards an earlier taxable supply. However, in a suit, where the cause of
action involves illegal occupation of immovable property or trespass (either by
a party who was never authorised to occupy the premises or by a party whose
authorisation to occupy the premises is determined) the plaintiff’s claim is
one in damages.

 

The above
judgment of the Hon’ble High Court clearly explains that a contractual
obligation forced out of a contract for legal violation cannot be said to be an
activity on which tax is applicable. Although the context is under the Goods
& Services Tax law, but the same can be very well correlated with the
Service Tax laws. Violation of contractual terms by way of monetary
compensation does not result into a ‘contract’ between the parties on which tax
is payable. Reciprocal relationship is a must, which is missing in the case of
notice period recovery as succinctly explained in the grounds above.

 

Based on the
above judgments, analogies and justification as to why notice period recovery
cannot be said to be a ‘declared service’, it is apparent that the recoveries
made from employees on account of non-serving of notice period / claw-back
clauses should not be liable to GST.

 

INTERPLAY WITH PROFESSION TAX ACT

Each
business having a presence in a particular state and employing a specified
number of employees is required to deduct Profession Tax from the salary
payable to the employees and deposit it with the respective State Profession
Tax Authorities of the branch where the employees are based.

 

In the
pre-GST regime, entities engaged in providing services in multiple states had
an option to take single registration and, therefore, had limited exposure to
the state authorities. In many cases, it was observed that the Profession Tax
deducted from employee’s salary was deposited in only one state though the
employee was based in a branch in a different state. While under the pre-GST
regime the state had no overview over such cases, with the introduction of GST
such entities are under the radar of the authorities of multiple states and
issues such as non-registration under Profession Tax, non-payment of profession
tax in the correct state and so on might start coming to the fore. In case of
non-compliance, there might be repercussions which might need to be taken care
of.

 

CONCLUSION

In view of the specific exclusion for services
rendered by employees to employers, it may be important to ensure that the said
exclusion is interpreted in the context of the precedents set under other
legislations
.

OPERATIONAL IMPACT OF CORONAVIRUS OUTBREAK ON GST

India has been in lockdown mode
in response to the coronavirus pandemic since 24th March, 2020. It
all started on 30th January when Kerala confirmed the first case of
the disease. In most of the states a semi-lockdown situation started on 12th
March with the closure of schools, colleges and cinema halls, malls, night
clubs, marriages and conferences as a precautionary measure. In Maharashtra,
the provisions of the Epidemic Diseases Act, 1897 were invoked on 13th March.
The impact on business houses started when the State Government ordered private
offices to operate with less than 50% of total attendance and allow the rest to
work from home. The orders were given on 17th March and the
restrictions further tightened on 20th with the announcement of the
closure of all workplaces excluding essential services.

 

And on the 24th of
March, 2020, the Government of India issued a nationwide lockdown order for
containment of the Covid-19 epidemic to be effective for 21 days from the 25th
of March. This lockdown was further extended up to 3rd May. It is
thus seen that the lockdown started affecting trade and business operations in
most of the states from 15th March, a period which coincided with
the compliance period (GST payments and filing of returns) under GST for the
month of February, 2020.

 

It will not be incorrect to state
that in a country like India, considering the present tax rate structure, tax
collection is one of the indicators of the economic growth of trade and
commerce. The indirect tax, which is a tax imposed on consumption, reflects
directly on the economic health of trade and commerce. With the introduction of
the Goods and Services Tax from July, 2017, the tax rate structures of various
commodities and services have been rationalised multiple times to ensure steady
growth in revenue collection. Over the past few months, the GST has been
contributing over Rs. 1 lakh crores in the indirect tax receipts of the Centre
and the states. However, in March, 2020 the GST collections slipped below the
said psychological mark – a fall that may partially be attributable to the
Covid-19 situation (the government announcement extending the due dates for
making payment of GST for the said month came very late). It is, however,
important to note that the GST collections for March, 2020 are at Rs. 97,597
crores and are still higher as compared to the numbers for September and
October of 2019. Considering the economic lockdown in the entire month of
April, 2020, the collection for this month is certainly going to be a
challenge.

 

The Hon’ble Finance Minister has
announced various tax compliance-related reliefs / measures for the next few months
to enable the trade and businesses to effectively address this unprecedented
situation while managing their tax compliances and cash flow. Some of the
important relaxations made are given below:

 

(i) Extension of time limit for filing of GSTR3B for the months of
February, March and April to 30th June, 2020 for assessees having a
turnover of less than Rs. 5 crores.

(ii) For assesses with a turnover more than Rs. 5 crores (large
assessees), the rate of interest for delayed payment of tax has been conditionally
reduced from 18% to 9% p.a. from 15 days after the due date. However, there is
no extension of the due date. No late fee / penalty shall be charged for delay
relating to this period.

(iii) Time limits for notices, notifications, approval orders, sanction
orders, filing of appeals, furnishing applications, reporting any other
document, etc., or for any other compliance (barring a few exceptions) expiring
between 20th March and 29th June are extended to 30th
June, 2020.

(iv) 24/7 clearance at all customs stations till 30th
June, 2020 to address any congestion, delay or surge on account of the
prevailing conditions.

(v) RBI extended the time period for realisation and repatriation of
export proceeds for export of goods or software made up to or on 31st
July to 15 months (from the existing nine months) from the date of export.

(vi) (For a detailed note on GST amendments refer to Recent
Developments in GST
in the BCAJ issue dated April, 2020).

 

The extension in payment of GST
for the months of February to April, 2020 is certainly a big relief to the
taxpayers. However, it is strongly felt that it would have been more
appropriate for the government to completely waive off the interest for those
making the payments for the months of February to May on or before 31st
July, 2020. As per the said extension, for assessees having a turnover of more
than Rs. 5 crores no interest will be charged if they make the payment on or
before 4th May. Considering that the lockdown has been extended from
the earlier 14th April to 3rd May, a further 15 days’
extension in the said date is the least that trade and commerce can expect.

 

The lockdown was implemented
without any advance announcement, as a result of which a lot of practical
problems have arisen.

 

(a) The problem of Invoice / E-way bill
generation and printing:
As we all know, under GST the movement of goods is
allowed only with proper supporting documents such as Invoice / E-way bills,
etc. Any goods not accompanied by proper documentation are liable to be seized
and attract a heavy penalty. During the lockdown period and the related mandate
to work from home, many have experienced difficulties in printing invoices /
generating E-way bills due to the lack of a printing set-up at home. In a few
cases, as a temporary measure the transportation was done without adequate
documentation based only on oral information about Invoice No. and E-way bill
Nos. provided by the supplier to the transporter.

 

(b) Possibility of clandestine movement of goods: There is
a high risk of clandestine movement of goods by certain anti-social tax evaders
during the lockdown period, especially since the tax authorities may not be in
a position to keep a check on in-transit movements of goods due to scaling down
in the mobile squad staff during this period. The government, perhaps in
anticipation of this issue, has not relaxed the requirement of generating E-way
bills and issuing invoices.

 

(c) Preparation of manual invoices: Many organisations did not
have sufficient IT infrastructure in place to enable access to their accounting
/ invoicing software from home. Therefore, in many cases invoices were prepared
manually (i.e., outside the regular systems), resulting in various control
lapses such as no consecutive system-generated invoice number, the challenge as
to the proper accounting thereof, etc. Further, it’s not unlikely that instead
of paying interest, the large assessees may consider filing of GSTR3B on an ad
hoc
basis and prefer to reconcile the amounts later whenever the GSTR1
returns are filed, increasing the compliance burden due to added
reconciliation.

 

(d) Digital signature: Use of digital signature is a
must for carrying out many important compliances under GST, for example, filing
of GST Returns, making payment of GST using DRC-03, refund applications, etc.
As the duration of the lockdown period and gravity of the situation were
unknown, many employees / consultants working with the GST compliance team did
not carry the digital signature home with them which added to their compliance
hindrances during the lockdown period. To address this issue, as a temporary
measure the GSTIN has permitted filing of returns without digital signature and
only on the basis of EVC code.

 

(e) Transitional consignments: Many consignments were in
transit during the lockdown period. Since many states sealed their borders from
12th March onwards, a huge volume of consignments was immobilised.
The problem relating to the expiry of the E-way bill was partially addressed by
the subsequent relief measures extending the validity of the E-way bills
expiring between 20th March and 15th April up to 30th
April, 2020. However, most of the consignments, perishable in nature, resulted
in spoilage of goods. The GST law requires a reversal of Input Tax Credit on
goods lost due to damage / spoilage etc. Unfortunately, no relief has so far
been given in respect thereof. Besides, delays in delivery resulted in many
such orders being cancelled, the tax on which was already paid, adding to the
working capital woes of the trade. In cases involving stock transfers between
different registered units of the same entity, the supplying unit ended up
paying taxes, whereas the receiving unit could not avail the ITC due to
non-receipt of goods.

 

(f) Cancellation of services: The hospitality, tourism and
airline industries suffered a major setback due to the cancellation of their
services during the lockdown. In many cases, the advance was refunded with some
cancellation charges. The issue as to the applicability of the rate of
cancellation charges is still unsettled and hence is likely to remain in focus
during assessments dealing with the said period.

 

(g) Delays in processing refunds: Since the
tax department is functioning with limited staff during the lockdown period,
various refund applications are pending processing, thus adding to the
cash-flow problems of the assessees. This has also impacted various other
administrative processes, such as matters dealing with the restoration of GST
registrations, the release of bank account attachment / blockage of electronic
credit ledger, etc.

(h) Goods supplied free under CSR initiative: During
the lockdown period many entities have been involved in CSR initiatives by
donating masks, gloves, sanitizers, food packets, etc. The eligibility of ITC
on such donations is also doubtful in the light of the provisions of section
17(5)(h) of the CGST Act and no tax incentive has been provided for the same.

 

As part of an administrative
relief package, the time limits for notices, notifications, approval orders,
sanction orders, filing of appeals, furnishing applications, reporting any
other document, etc., as also the time limit for any other compliance expiring
between 20th March and 29th June is extended to 30th
June, 2020. However, certain provisions have been excluded from the purview of
such relaxations. For example, no relaxation was given for time limit stated in
section 31 for issue of invoices. Hence, in cases involving continuous supply
of services, if the event obligating the payment falls during the lockdown
period, then the issue of invoice is mandatory and shifting of liability is not
permissible.

 

Similarly, if during the lockdown
period the turnover of any person exceeds the threshold limit provided for
obtaining GST registration, then such person shall be required to obtain the
registration within 30 days thereof as no relaxation from the same has been
provided. And in cases where the assessee could not make the previous
compliances before the due dates on account of various reasons and the default
continued owing to inability to take any corrective action during the lockdown
period, the imposition of late fees and interest for the lockdown period will
continue. In this background, it would be interesting to see whether an
assessee can exclude the lockdown period from the limitation period citing force
majeure
or impossibility of performance?

 

Unfortunately, in many states
such notifications were not issued by the State VAT / Commercial Tax Departments
as regards pre-GST matters. In an attempt to prevent the spread of coronavirus,
the Maharashtra State Goods and Services Tax Department issued detailed
guidelines to its officers and staff discouraging personal appearances of
assessees / their representatives and completing the time-barring assessments
by obtaining the details through emails and to pass manual orders. However, no
extension of the time limit was given for cases that were getting time-barred
in March, 2020. This may have far-reaching implications, especially where the
orders are passed ex parte and because the Maharashtra VAT Act contains
no provision for cancellation of assessment order and an appeal is not admitted
without depositing 10% of the disputed tax liability by way of pre-deposit.

 

It also appears that the decision
of the department in not extending the statutory due date is in direct
contravention of the order of the Hon’ble Supreme Court in the suo motu
WP (Civil) No. 3/2020 vide order dated 23rd March, 2020,
wherein the Apex Court in the exercise of its powers under Article 141 of the
Constitution (binding on all Courts / Tribunals and authorities), has ordered
that the period of limitation in all proceedings, irrespective of the
limitation prescribed under the general law or special law whether condonable
or not, shall be extended with effect from 15th March, 2020 till
further orders. The service tax audits / inquiries under the pre-GST laws also
continued during the lockdown period (admittedly not on a full scale)
increasing the risk of best-judgment SCNs due to the inability of the assessee
to produce proper data during the said period. In some cases, the authorities
issued notices for conducting personal hearing through video conferencing.

 

The
economic impact of coronavirus on GST is directly linked to the economic health
of trade, commerce and industry during the said period and will become clearer
in the days to come and could even become permanent. However, the operational
impact and practical difficulties explained above are temporary in nature and
are expected to have a short life. Hopefully, with the re-opening of the
economy these things will come back on track and certain cases of fait
acompli
experienced during the said period will be addressed wherever
possible by appropriate administrative orders. The whispers seeking more relief
are getting louder and there is a possibility that the government is likely to
announce further relaxations if the lockdown period is further extended. One only
hopes that this happens sooner rather than later.

Section 9(1)(vii)(b) of Act – On facts, since payments made by assessee to foreign attorneys for registration of IPs abroad were not for services utilised in profession carried on outside India, or for making or earning any income from any source outside India, FTS was sourced in India and not covered by exception carved out in section 9(1)(vii)

7. [2020] TS-117-ITAT-(Kol.)

ACIT vs. Sri Subhatosh Majumder

ITA No. 2006/Kol/2017

A.Y.: 2011-12

Date of order: 26th February, 2020

 

Section 9(1)(vii)(b) of Act – On facts, since payments made
by assessee to foreign attorneys for registration of IPs abroad were not for
services utilised in profession carried on outside India, or for making or
earning any income from any source outside India, FTS was sourced in India and
not covered by exception carved out in section 9(1)(vii)

 

FACTS

The assessee (resident in
India) was a patent attorney who provided IP registration services to its
clients in India. For registration of the IP of his clients abroad, the
assessee had made payments to foreign lawyers and attorneys. According to the
assessee, services were performed abroad and hence the payments were not
chargeable to tax in India. Therefore, the assessee did not withhold tax from
these payments.

 

But according to the A.O.,
the assessee had obtained technical information or consultancy services from
foreign attorneys. And although services were rendered outside India, they were
essentially connected with the profession carried on by the assessee in India.
Therefore, the payments were in the nature of FTS in terms of section
9(1)(vii), read with Explanation 2 thereto. Accordingly, the A.O. disallowed
the expenses u/s 40(a)(i).

 

On an appeal, following the
earlier years’ order in the assessee’s case5, the CIT(A) deleted the
addition by the A.O.

 

Being aggrieved, the tax
authority appealed before the Tribunal.

 

HELD

(1) Foreign attorneys were appointed for
registration of IP under patent laws of foreign countries where products were
sold. They had specialised knowledge and experience of foreign IP laws and
procedures for IPR registrations. Only because of the advice of foreign
attorneys the assessee and / or his clients could prepare the requisite,
technically intricate documentation necessary for preparing IP rights
registration applications in foreign countries. Foreign attorneys also
represented the clients of the assessee before the IP authorities abroad and
provided clarifications and explanations necessary for registrations.

(2) The following facts did not
support the contention of the assessee that he had merely acted as a
pass-through facilitating the payment to foreign attorneys or as an agent:

(a) Perusal of the documents furnished by the assessee did not show the
existence of direct and proximate nexus or direct contact between clients and
foreign attorneys.

(b) Clients had not issued any letters which showed that the appointment
of the foreign attorneys was made by the assessee on their specific
instructions or request.

(c) Perusal of the engagement letter issued by a client showed that it
had engaged the services of the assessee for registration of trade marks in
several foreign countries. It nowhere suggested engaging the services of, or
coordinating with, any particular foreign attorney. The manner of performance
was also left to the sole discretion of the assessee. The contractual terms did
not mention reimbursement of costs by the client.

(d) Copies of invoices raised by foreign attorneys showed that privity
of work was between the assessee and the foreign attorneys who performed their
work in terms of the appointment made by the assessee.

 

(3) Thus,
the foreign attorneys were engaged by the assessee. Payments to them were also
made by him. Such engagement was in the performance of professional services by
the assessee in India. The source of income of the assessee was solely located
in India. The assessee had engaged the services of foreign attorneys for
earning income from sources in India. Accordingly, the services rendered by the
foreign attorneys were in the nature of FTS in terms of section 9(1)(vii)(b)
and were not covered in the exception carved out therein.

_______________________________________________________________

5              Said
order pertained to years prior to amendment made vide Finance Act, 2010

Section 9(1)(i) of Act – As appearance of non-resident celebrity for promotional event outside India was for the benefit of the business in India, there was significant business connection in India and hence appearance fee paid was taxable in India

6. [2020] 115 taxmann.com 386 (Mum.)(Trib.)

Volkswagen Finance (P) Ltd. vs. ITO

ITA No. 2195/Mum/2017

A.Y.: 2015-16

Date of order: 19th March, 2020

 

Section 9(1)(i) of Act –
As appearance of non-resident celebrity for promotional event outside India was
for the benefit of the business in India, there was significant business
connection in India and hence appearance fee paid was taxable in India

 

FACTS

The assessee was an Indian
member-company of a global automobile group. It organised a promotion event in
Dubai jointly with another Indian member-company of the group for the launch of
a car in India. For this purpose, the assessee paid appearance fees to a
non-resident (NR) international celebrity outside India. In consideration, the
assessee and its group company had full rights to use all the event footage /
material / films / stills / interviews, etc. (event material) for its business
promotion.

The assessee contended before the A.O. that the event took place in
Dubai; the NR made his appearance in Dubai; the NR or his agent had not
undertaken any activity in India in relation to the appearance fee; and hence,
appearance fee could not be treated as accruing or arising in India, or deemed
to be accruing or arising in India. Therefore, the income was not taxable under
the Act. Consequently, no tax was required to be withheld. Accordingly, there
was no question of claiming any DTAA benefit.

 

But the A.O. held that the
payment was in the nature of royalty u/s 9(1)(vi) and further, Article 12 of
the India-USA DTAA also did not provide any relief. Hence, the assessee was
liable to withhold tax.

 

On appeal, the CIT(A)
confirmed the conclusion of the A.O. and further held that the sole purpose of
organising the event in Dubai was to avoid attracting section 9(1)(i) relating
to Business Connection in India. Being aggrieved, the assessee filed an appeal
before the Tribunal.

 

HELD

(i) The Tribunal relied upon the Supreme Court’s observations in the
R.D. Agarwal case4  to hold
that business connection is not only a tangible thing (like people, businesses,
etc.), but also a relationship. From the following facts it was apparent that
the event in Dubai and the business of the assessee in India had a
relationship.

 

(a) The event was India-centric and the benefits thereof were to accrue
to the assessee and its group company in India because the target audience was
in India.

(b) The assessee and its group company were permitted non-exclusive use
of the event material.

(c) Both the assessee and its group company had business operations only
in India.

(d) The claim of entire expenses of the event by the assessee and its
group company showed that they had treated the same as ‘wholly and
exclusively for the purposes of business’
.

 

(ii) As a consequence of the relationship between the event in Dubai and
the business of the assessee in India, income had accrued to the NR. In this
case, the business connection was intangible since it was a ‘relationship’ and
not an object. However, it was a significant business connection without which
the appearance fee would not have been paid.

Accordingly, the NR had
business connection in India. Hence, the payment made to the NR was taxable in
India. Consequently, the assessee was required to withhold tax.

 

______________________________

3   Decision
does not mention particulars of circumstantial evidence provided by the
assessee for proving residency

4   (1965)
56 ITR 20 (SC)

Article 15(1) of India-Austria DTAA – Sections 6(1), 90(4) of the Act – Notwithstanding section 90(4), submission of TRC is not mandatory to claim DTAA benefit if assessee otherwise provides sufficient circumstantial evidence

5. [2020] TS-15 -ITAT-(Hyd.)

Sreenivasa Reddy
Cheemalamarri vs. ITO

ITA No. 1463/Hyd/2018

A.Y.: 2014-15

Date of order: 5th
March. 2020

 

Article 15(1) of
India-Austria DTAA – Sections 6(1), 90(4) of the Act – Notwithstanding section
90(4), submission of TRC is not mandatory to claim DTAA benefit if assessee
otherwise provides sufficient circumstantial evidence

 

FACTS

The assessee was deputed by
his employer in India to Austria. He was paid certain foreign allowance outside
India on which the employer had deducted tax in India. The assessee contended
that since he was in India for less than 60 days, he was a non-resident (NR).
Further, he was a tax resident of Austria. Hence, in terms of Article 15(1) of
the India-Austria DTAA, the salary earned by a tax resident of Austria was
taxable only in Austria. Accordingly, he filed a NIL return as an NR in India.
The assessee also expressed his inability to furnish the Tax Residency
Certificate (TRC) on the ground that the issuance of a TRC was dependent upon
the Austrian tax authority.

  

Therefore, relying on section
90(4)1  of the Act, the A.O.
denied DTAA benefit on the ground that the assessee could not furnish the TRC.
The assessee preferred an appeal before the CIT(A). Agreeing with the view of
the A.O., the CIT(A) dismissed the appeal. The assessee then filed an appeal before
the Tribunal.

 

HELD

(i) If, in spite of his best possible efforts, the assessee could not
procure the TRC from the country of residence, the situation may be treated as
impossibility of performance2. In such circumstances, the assessee
cannot be obligated to do an impossible task and be penalised for the same.

 

(ii) If the assessee provides sufficient circumstantial3 evidence
for proving residency, the requirement of section 90(4) ought to be relaxed.

 

(iii) In case of conflict between the DTAA and the Act, DTAA would prevail
over the Act. In terms of the DTAA, the assessee was liable to tax in Austria
for services rendered in Austria. Therefore, notwithstanding the Act requiring
a TRC for proving residency, not providing the same to the tax authorities
cannot be the only reason for denial of DTAA benefit to the assessee.

 

Note: In the absence of
any such specific mention, it is not clear whether the Tribunal read down
section 90(4) of the Act, impliedly treating it as a case of ‘treaty override’.

____________________________________________________________________________________________

1   Section
90(4) provides that an NR assessee will be entitled to claim relief under DTAA
only if he has obtained a TRC from the government of that country

2      Decision does not mention particulars of
‘best possible efforts’ of assessee or basis on which ITAT considered the
situation to be that of ‘impossibility of performance’. Decision merely
mentions that ‘normally it is a herculean task to obtain certificates from
alien countries for compliance of domestic statutory obligations’

Section 199/205 – Assessee cannot be made to suffer because of non-deposit of tax deducted with the government by the deductor – Under section 205, the assessee / deductee cannot be called upon to pay the tax – Credit for the tax deducted at source has to be allowed in the hands of the deductee irrespective of whether or not the same has been deposited by the deductor to the credit of the Central government

4. Aricent
Technologies Holdings Ltd. vs. Addl. CIT (Delhi)

Sushma
Chawla (J.M.) and Dr. B.R.R. Kumar (A.M.)

ITA. No.
5708/Del/2019

A.Y.:
2015-16

Date of
order: 23rd December, 2019

Counsel
for Assessee / Revenue: Ajay Vohra, Neeraj Jain and Anshul Sachar / Sanjay I.
Bara

 

Section 199/205 – Assessee cannot be
made to suffer because of non-deposit of tax deducted with the government by
the deductor – Under section 205, the assessee / deductee cannot be called upon
to pay the tax – Credit for the tax deducted at source has to be allowed in the
hands of the deductee irrespective of whether or not the same has been
deposited by the deductor to the credit of the Central government

 

FACTS

The assessee in its
return of income had claimed credit to the extent of Rs. 18,79,68,945. The
A.O., upon completion of the assessment u/s 144 r.w.s. 143(3), allowed the
credit of TDS of Rs. 16,57,18,029. Thus, credit for TDS was short-granted to
the extent of Rs. 2,22,50,916.

 

The assessee had, along with the
return of income, furnished complete details including the names of the
parties, the amount paid by them and the tax deducted at source in respect of
the TDS of Rs. 18.79 crores.

 

HELD

The Tribunal observed that the issue
which has arisen in the present ground of appeal is against the short credit of
tax deducted at source. It noted that the assessee had furnished the party-wise
details of the amounts aggregating to Rs. 18.79 crores deducted out of payments
due to the assessee, which are also furnished as part of the Paper Book.

 

It also noted that the grievance of
the assessee is two-fold. First of all, it was pointed out that in case
subsequent to the processing of the assessment order, if changes are made in
the Form No. 26AS by the parties who had deducted tax at source out of the
payment made to the assessee, then the credit of the same should be allowed to
the assessee. The Tribunal held that it found merit in the plea of the assessee
though the AR for the assessee has not filed any evidence in this regard. But
in case necessary evidence is available, then it is the duty of the A.O. to
allow the claim as per Revised Form No. 26AS.

 

As regards the next stand of the
assessee, that in case the deductor deducts tax at source, i.e. withholds tax
out of payments due / paid to the assessee but does not deposit the tax
withheld by it, then why should the assessee suffer? The Tribunal held that

(i) Under
section 199(1) it is provided that if tax has been deducted at source in
accordance with the provisions of Chapter XVII and paid to the Central
government, the same shall be treated as payment of tax on behalf of the person
from whose income the deduction was made; and

(ii) Under
section 205 it is further provided that where the tax has been deducted at
source by the deductor out of the payments due to the deductee, then such
deductee cannot be held liable for payment of such tax which was deducted at
source by the deductor.

 

Once tax has been deducted then the
deductor is liable to deposit the same into the credit of the Central
government. Such amount which is withheld by the deductor out of the amount due
to the deductee, i.e., the person to whom the payments are made, then the said
deduction shall be treated as payment of tax on behalf of the person from whom
such deduction was made as per the provisions of section 199(1).

 

It also observed that there are
provisions under the Act dealing with the recovery of tax at source from the
person who has withheld the same. In terms of section 205 of the Act, the
assessee / deductee cannot be called upon to pay tax to the extent to which tax
had been deducted from the payments due.

 

Consequently, it follows that credit
for such tax deducted at source, which is deducted from the account of the
deductee by the deductor, is to be allowed as taxes paid in the hands of the
deductee irrespective of the fact whether or not the same has been deposited by
the deductor to the credit of the Central government.

 

The
deductee in such circumstances cannot be denied credit of tax deducted at
source on its behalf. It held that where the assessee is able to furnish the
necessary details with regard to tax deduction at source out of the amounts due
to it, then the action which follows is allowing the credit of such tax
deducted at source to the account of the deductee.

 

In
case where the deductor deposits the tax deducted at source to the credit of
the Central government and the deduction reflects in Form No. 26AS, may be on a
later date, then it is incumbent upon the assessee to produce the necessary
evidence in this regard and it is also the duty of the A.O. to allow such
credit of tax deducted at source as taxes paid in the hands of the deductee
assessee.

 

It observed that its view is
supported by the ratio laid down by the Bombay High Court in Yashpal
Sahani vs. Rekha Hajarnavis, Assistant Commissioner of Income-tax [(2007) 165
taxman 144 (Bom.)]
and the Gujarat High Court in the case of Sumit
Devendra Rajani vs. Assistant Commissioner of Income-tax [(2014) 49 taxmann.com
31 (Gujarat)].

 

Applying the same parity of reasoning
in the decision of the Bombay High Court in Pushkar Prabhat Chandra Jain
vs. Union of India [(2019) 103 taxmann.com 106 (Bombay)],
the Tribunal
directed the A.O. to allow the credit of tax deducted at source in the hands of
the assessee where the assessee produces the primary evidence of the same being
deducted tax at source out of the amount due to it.

 

This ground of appeal filed by the assessee was allowed.

Income from undisclosed sources – Section 69 of ITA, 1961 – Addition on basis of statement made by partner of assessee u/s 108 of Customs Act, 1962 – No other corroborative evidence – Addition not justified

12. Principal CIT vs. Nageshwar Enterprises

 [2020] 421 ITR 388 (Guj.)

Date of order: 3rd February, 2020

A.Y.: 2007-08

 

Income from undisclosed sources –
Section 69 of ITA, 1961 – Addition on basis of statement made by partner of
assessee u/s 108 of Customs Act, 1962 – No other corroborative evidence –
Addition not justified

 

In the course of a search
conducted by the Customs Department, a partner of the assessee in his statement
recorded on oath admitted before the Directorate of Revenue Intelligence the
undervaluation of goods, part of which pertained to A.Y. 2007-08, the year of
search. He admitted that the undervalued amount was paid in cash to the sellers
which were foreign companies. During the assessment the A.O. rejected the
submissions of the assessee and made additions on account of unaccounted
investment and unaccounted purchases.

 

The
Commissioner (Appeals) found that the A.O. did not make further inquiries and
that the only evidence with him was in the form of a confessional statement of
the partner of the assessee recorded on oath u/s 108 of the Customs Act, 1962
and that in the absence of any corroborative evidence or finding, no addition
could be made merely on the basis of the admission statement. The Tribunal
found that the addition was made based on the show cause notice issued by the
Revenue Intelligence, that the statement was retracted by the partner and that
the Customs Excise and Service Tax Appellate Tribunal had dropped the
proceedings initiated against the assessee. The Tribunal held that in the
absence of any documentary evidence no addition could be made on the action of
a third party, i.e., the Directorate of Revenue Intelligence.

 

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

‘i) The Tribunal was correct in holding that no addition could be made
on the basis of the action of the third party, i.e., the Directorate of Revenue
Intelligence. The Department could not start with the confessional statement of
the assessee. The confessional statement had to be corroborated with other
material on record.

 

ii) The appellate authorities had
concurrently recorded a finding that except the statement of the partner
recorded u/s 108 of the Customs Act, 1962, there was no other evidence. No
question of law arose.’

Income – Exemption u/s 10(24) of ITA, 1961 – Registered trade union – Amount received on settlement of dispute between company and its workers disbursed to workers – Amount not assessable in hands of trade union

11. Gujarat Rajya Kamdar Sabha Union Machiwadi vs. ITO

[2020] 421 ITR 341 (Guj.)

Date of order: 7th January, 2020

A.Y.: 2009-10

 

Income – Exemption u/s 10(24) of
ITA, 1961 – Registered trade union – Amount received on settlement of dispute
between company and its workers disbursed to workers – Amount not assessable in
hands of trade union

 

The assessee was a registered
trade union. Its managing committee passed a unanimous resolution that as a
result of a compromise arrived at between the assessee and a company in the
Labour Court, whatever amount was received from the company would be fully
distributed to the workers of the company. In such circumstances a settlement
was arrived at on 15th May, 2008, which was reduced into writing in
the form of a memorandum of settlement between the company, i.e, the employer,
and the assessee. In view of the settlement, the assessee received payment of
Rs. 60,96,818. The amount was assessed in the hands of the assessee as income
for the A.Y. 2009-10.

 

The Tribunal upheld the
assessment and the addition.

 

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

 

‘i) Once the factum of settlement was not disputed coupled with
the factum of receipt of a particular amount from the company, and the
amount had been distributed amongst the employees, the case would squarely
stand covered u/s 10(24) of the Income-tax Act, 1961. Though the contribution
from the employer was received as per the settlement agreement, it was only
incidental to the activities of the services of the assessee in resolving the
dispute between the member workers and the employer with the intention of
advancement of welfare of the members.

 

ii) The amount was not assessable as income of the assessee.’

Income – Accrual of (time of accrual of income) – Section 5 of ITA, 1961 – Where assessee sold a land during relevant assessment year and as per MOU part of sale consideration was payable by purchaser on completion of assessee’s obligation under MOU – Assessee having not met conditions of MOU during relevant year, such amount was not taxable in relevant assessment year

10. Principal CIT vs. Rohan
Projects

[2020] 113 taxmann.com 339
(Bom.)

Date of order: 18th
November, 2019

A.Y.: 2012-13

 

Income – Accrual of (time of
accrual of income) – Section 5 of ITA, 1961 – Where assessee sold a land during
relevant assessment year and as per MOU part of sale consideration was payable
by purchaser on completion of assessee’s obligation under MOU – Assessee having
not met conditions of MOU during relevant year, such amount was not taxable in
relevant assessment year

 

The assessee
is engaged in the business termed Promoter and Developer. It had sold land to
M/s Symboisis which transaction took place in the previous year relevant to the
A.Y. 2012-13. The land was sold under  a
Memorandum of Understanding (MOU) dated 2nd February, 2012 for a
total consideration of Rs. 120 crores. However, the assessee offered only a sum
of Rs. 100 crores for tax in the return for the A.Y. 2012-13. This was because
the MOU provided that a sum of Rs. 20 crores would be paid by the purchaser
(M/s Symboisis) on execution of the sale deed after getting the plan sanctioned
and on inclusion of the name of the purchaser in the 7/12 extract. However, as
the assessee was not able to meet the conditions of the MOU during the subject
assessment year, the sum of Rs. 20 crores, according to the assessee, could not
be recognised as income for the subject assessment year. The A.O. did not accept
this and held that the entire sum of Rs. 120 crores is taxable in the subject
assessment year.

 

The Tribunal, after recording the
above facts and relying upon the decision of the Supreme Court in Morvi
Industries Ltd. vs. CIT [1971] 82 ITR 835
, held that the income accrues
only when it becomes due, i.e., it must also be accompanied by corresponding
liability of the other party to pay the amount. On facts it was found that the
amount of Rs. 20 crores was not payable in the previous year relevant to the subject
assessment year as the assessee had not completed its obligation under the MOU
entirely. Moreover, it also found that Rs. 20 crores was offered to tax in the
subsequent assessment year and also taxed. Thus, the Tribunal allowed the
assessee’s appeal.

 

On appeal by the Revenue, the
following question of law was raised:

‘Whether on the facts and in the
circumstances of the case and in law, the Tribunal was justified in holding
that a sum of Rs. 20 crores is not taxable in the subject assessment year?’

 

The Bombay High Court upheld the
decision of the Tribunal and held as under:

 

‘i) We note that the finding of fact arrived at by the Tribunal that
the respondent was not able to comply (with) its obligations under the MOU in
the previous year relevant to the subject assessment year so as to be entitled
to receive Rs. 20 crores is not shown to be perverse. In fact, the issue is
covered by the decision of the Apex Court in the case of CIT vs. Shoorji
Vallabdas & Co. [1962] 46 ITR 144
wherein it is held that “Income
tax is a levy on income. No doubt, the Income-tax Act takes into account two
points of time at which the liability to tax is attracted, viz., the accrual of
the income or its receipt; but the substance of the matter is the income; if
income does not result at all, there cannot be a tax ” So also in Morvi
Industries Ltd. (Supra)
, the Supreme Court has held that income accrues
when there is a corresponding liability on the other party. In the present
facts, in terms of the MOU there is no liability on the other party to pay the
amounts.

 

ii) In any event, the amount of Rs. 20 crores has been offered to tax
in the subsequent assessment year and also taxed. This Court, in the case of CIT
vs. Nagri Mills Co. Ltd. [1958] 33 ITR 681 (Bom.)
has observed as
follows:

 

“3. We have often wondered why
the Income-tax authorities, in a matter such as this where the deduction is
obviously a permissible deduction under the Income-tax Act, raise disputes as
to the year in which the deduction should be allowed. The question as to the
year in which a deduction is allowable may be material when the rate of tax
chargeable on the assessee in two different years is different; but in the case
of income of a company, tax is attracted at a uniform rate, and whether the
deduction in respect of bonus was granted in the assessment year 1952-53 or in
the assessment year corresponding to the accounting year 1952, that is, in the
assessment year 1953-54, should be a matter of no consequence to the
Department; and one should have thought that the Department would not fritter
away its energies in fighting matters of this kind. But, obviously, judging
from the references that come up to us every now and then, the Department
appears to delight in raising points of this character which do not affect the
taxability of the assessee or the tax that the Department is likely to collect
from him whether in one year or the other.”

 

Nothing has been shown to us as
to why the above observation will not apply to the present facts.

 

iii) In the aforesaid circumstances, the
view taken by the Tribunal on facts is a possible view and calls for no
interference. In any event the tax on the amount of Rs. 20 crores has been paid
in the next year. Therefore, the proposed question does not give rise to any
substantial question of law. Hence, not entertained. The appeal is, therefore,
dismissed.’

BCAJ SURVEY ON IMPACT OF COVID-19 ON CHARTERED ACCOUNTANT FIRMS

The BCAJ carried out a
dipstick survey in April, 2020 to identify the challenges faced by
professionals and firms. Respondents were asked to share their perspectives,
challenges and how they are responding. 

 

Attributes of the respondents:

 

A>  Location and Presence

52% respondents had presence in
Non-Metros and about 48% in both Metros and Non-Metros.

 

B>  Nature of Respondents

48% respondents were proprietors,
37% were firms having up to 4 partners, 10% were firms having 5-9 partners and
5% were firms having more than 10 partners.

 

SURVEY QUESTIONS AND RESPONSES

 

1.  Have you made a systematic assessment of probable impact on the
firm?

 

 

2.  Time frame you have considered in the above assessment for impact
of lockdown / slowdown?

 

 

 

 

3.  Is downsizing of staff on the horizon or under consideration during
the next 6 months?

 

 

4.  Increments for FY 2020-21

 

 

5.  Bonuses for FY 19-20 to staff

 

 

 

6.  Partner and Senior Staff pay and payouts: What is the most likely
scenario?

 

 

7.  Have you considered or are already in the process of renegotiating
rent or other contracted expenses?

 

 

8.  Based on the Type of Work and Nature of Clients and assuming
lockdown and gradual lifting – do you see your firm’s cash flow:

 

 

 

9.  To manage Working Capital, you are likely to

 

 

10.   Do you expect some clients seeking fees reduction?

 

HOW TO RESTART THE ENGINE AFTER THE LOCKDOWN

As India is
slowly MOVES towards a step by step removal of national lockdown imposed due to
the Covid-19 pandemic, there have been wide-ranging discussions in government
circles on what should be India’s strategy for an exit scenario. The Ministry
of Home Affairs from time to time has issued various guidelines for managing
with the Covid 19 impacts; Aarogya Setu App, state guidelines,mandatory wearing
of mask, social distancing amongst other 
elements in the fight against Covid-19.

 

With the
restarting of economy and life on the governments’ agenda,  various guidelines on ‘restarting’ India and
among these the most important one is to create Standard Operating Procedures
(SOPs) to ensure that preventive measures are executed  in a systematic manner post–lockdown;  the other guiding principles are as follows:

  • Guidance
    from Central Government, State Government 
    and WHO
  • Protection
    of personnel and visitors
  • Social
    distancing in travel to and from workplace and during interaction with
    suppliers and those in the distribution chain
  • Business
    protection and continuity
  • Implementing
    best practices for safety and prevention
  • Introducing
    audit procedures to monitor and ensure that safe practices are implemented and
  • Action
    plan in the event of persons feeling unwell at the workplace.

 

PROCESS FOR IMPLEMENTATION
OF SOPS

  • The
    organisation should begin with forming an internal team of Covid-19 fighters

The Covid-19
team should comprise of a factory / warehouse / shop / office in-charge, human
resource manager, business supervisor or head of business, administration /
utility in charge, medical expert on site (or identify the nearest medical
expert and security personnel). In case of local market or mandi
operators, the same can be managed by the market / trade association or local mandi
operator.

 

  • Prepare
    the SOP and plan for its deployment

Ground Zero: Online involvement of staff, if possible online training, to fight the
disease and restrict / minimal onsite interactions

Week 1: Framing the SOP; the company should get the SOP verified by the local
authorities or an internal / external expert

Week 2: Start operation as per government regulations; however, only staff who
have observed clear 14 days’ quarantine should attend the office; and only
necessary staff should attend in person, the support staff can operate from
home

Week 3: Organisations in manufacturing / trading or service should try and
achieve minimum capacity utilisation

Week 4: Entering this stage, and if all things go well and no additional
positive patients are identified in the organisation, then the capacity
utilisation can be increased by 20% per week moving forward, subject to
government guidelines.

 

The broader
framework of the SOP should cover at least the following:

 

1.   Identify the risk area

a.  Entrance

b.  Office meeting room

c.  Change room

d.  Canteen

e.  Shopfloor

f.   Restrooms

g.  Warehouse / storage areas, etc.

 

2.   Identify / implement the
mitigating measures

 

3.  Define the processes to be
implemented to prevent / report for Covid-19 occurrences based on severity

a.  If the locality is Covid-free,
then business as usual

b.  If the locality is in the
vicinity of an impacted locality, then business as usual with close monitoring

c.  Locality impacted and declared as
hotspot: severe impact

d.  Locality declared as containment
zone: highly severe impact

 

4.  Identify the person responsible for
implementation of measures

5.  Reporting to local health authorities /
municipal corporation or others

6.  Mandatory checklist for business continuity
plan post-lockdown to be implemented

7.  Regular monitoring, review and update of the
protocols.

(* Sector-specific
SOPs are recommended)

 

SUGGESTED ELEMENTS OF SOPS FOR SERVICE INDUSTRY

Client-facing
operations such as banking, insurance, other professional services, etc. should
consider continuing online / mobile servicing of clients where possible. Office
workers to include bare minimum staff required to run back-end operations. As
the risk and rate of infection drops in an area, officer attendance can slowly
be increased.

 

(A) Delivery of office supplies

  • All
    office supplies should be properly sanitised for each material movement (in /
    out / transport)

 

(B) Labour / employee

  • Social
    distancing norms to be defined and maintained
  • Mandatory
    wearing of face masks at all times
  • Disposable
    facemasks not to be  re-used, cloth masks
    to be encouraged
  • All
    washrooms to be sanitised, at least twice daily
  • Each
    employee’s temperature to be checked on entry
  • Staff
    showing any symptoms, even a mild cough or low-grade fever, to stay at home
  • Employees
    should maintain hygiene during transport from home to workspace / client’s
    place
  • Avoid
    in-person meetings to the extent possible.

 

(C) Office setup

  • Reduce
    staff movements onsite
  • Work
    From Home options to be made available to staff
  • Regular
    sanitisation of entire facility, including meeting rooms, offices, canteens,
    equipment, washrooms, machine touch points, operating panels, tissue boxes,
    hand sanitizers, seats and covers requiring human touch to be sanitized twice a
    shift
  • Social
    distancing during lunch break, batch-wise option or similar
  • Display
    posters promoting and instructing about respiratory hygiene
  • Workshop
    / guidance on maintaining occupational health and safety
  • Arrange
    seats so that employees / participants are at least one  metre apart
  • Maintain
    log of names and contact details of all participants of meetings for at least
    one month
  • Identify
    a room or area where someone who is feeling unwell or has symptoms can be
    safely isolated
  • Create
    follow-up protocol for a situation where a meeting participant / staff member /
    service provider tests positive for Covid-19 during or just after the meeting
    in conjunction with partner healthcare provider or local health department.

 

(D) Travel / business trip

  • Each
    employee to be tested before business trips
  • Avoid
    sending employees who may be at higher risk of serious illness or where
    Covid-19 is spreading
  • Employees
    should comply with any local restrictions on travel, movement or large
    gatherings
  • Employees
    who have returned from an area where Covid-19 is spreading should monitor their
    temperature and other symptoms for 14 days.

 

(E) Dealing with clients and partners

  • Social
    distancing norms to be followed
  • Promote
    video meetings as much as possible
  • Carry
    / ensure sufficient hygiene equipment such as hand sanitizer for all meeting
    participants
  • Visit
    only those client offices who have complied with the necessary requirements of
    Covid-19 prevention measures
  • Self-declaration
    at the gate and maintaining traceability and screening of persons entering the
    office premises.

 

(F) Dealing with bank / financial
institutions

  • Make
    effective use of online banking options

 

(G)
Infrastructure for safety of staff / labour

  • Surfaces
    (e.g. desks and tables) and objects (telephones, keyboards) need to be wiped
    with disinfectant regularly
  • Hygiene
    and social distancing to be encouraged for canteens and accommodation usage
  • Refrain
    from usage of ACs as much as possible.

 

The above is
an illustrative list and not exhaustive; additionally, industry / sector-wise
specific SOPs are recommended.

 

IMPLEMENT, REVIEW
AND IMPROVE

There still remains significant uncertainty about the
potential for more widespread transmission of Covid-19, hence organisations
should incorporate these practices as part of their Business Continuity Plan
and all the employees and people associated with the business should be trained
to deal with such situations in future. The implementation of the SOP and
checklist should be audited by the organisations as well as local authorities.

MAKING A WILL WHEN UNDER LOCKDOWN

INTRODUCTION

We are currently living in times
of uncertainty due to Covid-19. Hopefully, by the time this issue reaches you
India’s lockdown would have eased. However, it could also be extended or
re-enforced at any time. It is in times such as these that we realise that life
is so fragile and fleeting. This lockdown has also forced several of us to
consider making a Will. During these past 30 days, the author has drafted
several Wills for people who are concerned about what would happen if they
contracted the virus. Through this month’s feature, let us look at the unique
issues and challenges which one faces when drafting a Will during a lockdown.

 

DECODING
THE JARGON

Wills are usually associated with
a whole lot of jargon which make them appear very complex to the man on the
street. However, most of these legal words are used by legal professionals and
a person making a Will can avoid using them. However, it is beneficial to
understand the meaning of these words in order to understand various other
things. All or some of the following terms are normally involved in a Will:

 

(a) Testator / testatrix: A person who makes the Will. He
/ she is the person whose property is to be disposed of after his / her death
in accordance with the directions in the Will.

(b) Beneficiary / legatee: The person to whom the
property will pass under the Will. He is the person to whom the property of the
testator would be bequeathed under the Will.

(c) Estate: The property of the testator remaining after his
death. It consists of the sum total of such assets as are existing on the date
of the testator’s death. The estate may also increase or decrease after the
testator’s death due to the actions carried out by the executors. For example,
the executors may carry on the business previously run by the deceased in the
name of the estate.

(d) Executor / executrix: The person who would
administer the estate of the testator after his death in accordance with the
provisions of the Will. The executor is normally named in the Will itself. An
individual, limited company, partnership firm, etc., may be appointed as an
executor. In many cases, a bank is appointed as the executor of a Will. For all
legal and practical purposes, the executor acts as the legal representative of
the estate of the deceased. On the death of the testator, the property cannot
remain in a vacuum and hence the property immediately vests in the executor
till the time the directions contained in the Will are carried out and the
property is distributed to the beneficiaries.

(e) Bequest: The property / benefits which flow under the
Will from the testator’s estate to the beneficiary.

(f) Bequeath: The act of making a bequest.

(g) Witnesses: The persons who witnesses the signing
of the Will by the testator.

 

BACK
TO BASICS

First things first, making a Will
involves certain basics which one needs to remember. Any adult, owning some
sort of property or assets can and should make a Will. If a Will is not made,
then the personal succession law as applicable would take over. For instance, Hindus
would be governed by the Hindu Succession Act, 1956. Only adults of sane mind
can make a Will. Thus, anyone who is insane or is a lunatic, or has lost
control over his mental faculties cannot make a Will.

 

A Will is a document which
contains the last wishes of a person as regards the manner and mode of
disposition of his property. A person expresses his will as regards the
disposition of his property. The Indian Succession Act, 1925 (which governs the
making of Wills in India) defines a Will to mean ‘the legal declaration
of the intention of the testator with respect to his property which he desires
to be carried into effect after his death’. However, the intention manifests
only after the testator’s death, i.e., posthumous disposition of his property.
Till the testator is alive, the Will has no validity. He can dispose of all his
properties in a manner contrary to that stated in the Will and such action
would be totally valid.

For example, ‘A’ makes a lockdown
Will bequeathing all his properties to his brother. However, post the lockdown
he, during his lifetime itself, transfers all his properties to his son with
the effect that at the time of his death he is left with no assets. Such action
of the testator cannot be challenged by his brother on the ground that ‘A’ was
bound to follow the Will since the Will would take effect only after the death
of the testator. In this case, as the property bequeathed would not be in
existence, the bequest would fail. The Will can be revoked at any time by the
testator in his lifetime. Hence, it is advisable to at least make a basic Will.
It can always be revised once things improve.

 

The testamentary capacity of the
testator is paramount in case of a Will. If it is proved that he was of unsound
mind, then the Will would be treated as invalid. What is a ‘sound mind’ is a
question of fact and needs to be ascertained in each case. Hence, if a person
has been so impacted by the Covid-19 that his mental faculties are arrested,
then he cannot make a valid Will.

 

The most important element of a
Will is its date! The last Will of a deceased survives and hence the date
should be clearly mentioned on the Will.

 

LOCKDOWN
ISSUES

Let us now consider the singular
situations which arise in making a Will during a lockdown. People making a Will
may experience some or all of these in these testing times:

(a) Format: There is no particular format for making a Will.
Several persons have expressed apprehension that during the lockdown they are
unable to obtain a stamp paper, unable to print a document or unable to get
ledger paper, etc. A Will can be handwritten (provided it is legible
handwriting); it could be on a plain paper and it need not be on a stamp paper.

Thus, there should not be any problems from a format perspective.

 

(b) Witness: Section 63 of the Indian
Succession Act, 1925 requires that the Will should be attested by two or more
witnesses, each of whom has:

(i) seen the testator sign the Will or affix his mark; or

(ii) received from the testator a personal acknowledgement of his
signature or of the signature of such other person.

 

Each of the witnesses must sign
the Will in the presence of the testator. No particular form of attestation is
prescribed. It is important to note that the attesting witnesses need not
know the contents of the Will. All that they attest is the testator’s signature
and nothing more.

 

A problem which many people could
face is getting two Witnesses to witness the Will. Neighbours may be requested
to help out. However, what if the neighbours are reluctant to do so due to
social distancing issues, or in the case of persons living in bungalows? In
such cases, one’s domestic servants, maids, watchmen may be asked to act as
witnesses. They must, as witnesses, either write their name or at least affix
their thumb impression – left thumb for males and right thumb for females.

 

However, what can people do if
there are no servants also? In such a case, the adult family members of the
testator may be approached. However, a question which arises is that if such
members are beneficiaries under the Will, can they act as witnesses, too?
Generally speaking, No. The Indian Succession Act states that any bequest
(gift) to a witness of a Will is void. Thus, he who certifies the signing of
the Will should not be getting a bequest from the testator. However, there is a
twist to the above provision. This provision does not apply to Wills made by
Hindus, Sikhs, Jains and Buddhists and, hence, bequests made under their Wills
to attesting witnesses would be valid. Wills by Muslims are governed by their
Shariyat Law. Thus, the prohibition on gifts to witnesses applies only to Wills
made by Christians, Parsis, Jews, etc. Accordingly, any Will by a Hindu can
have a witness as a beneficiary.

 

A related question would be, can
an executor be a witness under the Will? Thus, if a person names his wife as
the executor, can she also be an attesting witness? The answer is, Yes. An
executor is the person who sets the Will in motion. It is the executor through
whom the deceased’s Will works. There is no bar for a person to be both an
executor of a Will and a witness of the very same Will. In fact, the Indian
Succession Act, 1925 expressly provides for the same. Accordingly, people of
all religions can have the executor as the witness.

 

To sum up, in the case of Hindus,
Sikhs, Jains and Buddhists, the witness can be a beneficiary and an executor.
However, in the case of Wills made by Christians, Parsis, Jews, etc., the
witness can be an executor but not a beneficiary.

 

Can witnesses practice social
distancing and yet witness the signing of the Will? Some English cases throw
some light on this issue. In Casson vs. Dade (1781) 28 ER 1010 a
testatrix signed her Will in her lawyer’s office and went to sit in her horse
carriage before the witnesses signed it. Since she could, through the
carriage’s window and the office’s window, see the witnesses signing, it was
held that the Will was valid.

 

This case is an example of where
the circumstances were enough to meet the witnessing requirements. This case
was followed by the UK Court of Protection in Re Clarke in
September, 2011
when a lasting power of attorney in the UK was held to
have been validly executed where the donor was in one room and the witnesses in
another, separated by a glass door. Even though the witness was sitting in the
adjacent room, there were clear glass doors with ‘Georgian bars’ between the
two rooms and it was held that the witness had a clear line of sight through
those glass doors. It was held that the donor would also have been able to see
the witness by means of the same line of sight through the glass doors.

 

As the Indian law stands today, a
witness cannot witness the execution of a will by Zoom or Skype. Scotland is
one of the places where this is possible. To deal with the witness issue, the
Law Society of Scotland has amended its guidance on witnessing the signing of a
Will. It allows the lawyer to arrange a video link with the client. If this can
be done, the solicitor can witness the client signing each page. The lawyer
should assess the capacity of the client and using his professional judgement,
consider whether any undue influence is being exerted on the client.

 

The signed Will can then be
returned to the solicitor by post. The lawyer can then sign as witness on the
receipt of the signed Will. This is a truly revolutionary step!

 

(c) Doctor’s Certificate: Quite
often, a doctor’s certificate as to the mental fitness of the deceased is
attached to a Will. This is especially so in the case of very old persons so as
to show that the Will is valid. The doctor would certify that the testator is a
person who is alert and able to understand what he is doing. A question which
now arises is how to obtain a doctor’s certificate if the testator cannot visit
the doctor? One option to consider if the doctor is being regularly consulted
is that a video conference could be arranged and if the doctor can issue the
certificate on that basis, then that would suffice. Of course, the doctor’s
certificate may not physically reach the testator but the same could be
collected once the lockdown eases and attached to the Will. It is advisable in
the case of very old / feeble persons that the certificate is obtained from a
neurophysician or a psychiatrist.

An alternative to this would be
to obtain a video recording of the Will execution process with the testator
reading out the entire Will. This helps show that he understands what he is
doing and is useful for very old persons who cannot obtain a medical
certificate.

 

(d) Enumerating all assets: It is generally preferable
that the Will be specific and enumerate all assets of the testator along with
account numbers, etc. so that it would help the beneficiaries in identifying
the assets. However, in a lockdown it may happen that such details are in the
office or in a bank locker and the testator is unable to access them and write
the details in the Will. In such a case, as many details as possible may be
given, or the Will may make a general bequest of the entire estate of the
testator as on the date of his death. On a separate note, it is always a good
idea to keep a complete inventory of assets along with details of nominations,
account numbers, addresses, etc., both at office and at home.

 

While bequests can be general or
specific, they cannot be so generic that the meaning itself is unascertainable.
For instance, a Will may state ‘I leave all my money to my wife’. This is a
generic bequest which is valid since it is possible to quantify what is
bequeathed. However, if the same Will states ‘I leave money to my wife’ then it
is not possible to ascertain how much money is bequeathed. In such an event,
the entire Will is void.

 

The Will must also create a
repertoire of digital assets which should enumerate all important passwords,
online accounts, e.g., emails, social media accounts, bank accounts, etc.

 

(e) Registration: Registration of
Wills is out of the question in a lockdown. However, registration is not
compulsory.
Again, a video Will can act as an alternative.

 

(f) Bequest to minors : In the
case of nuclear families, there is a tendency to leave everything to one’s
spouse and in case of death of the spouse before the death of the testator, to
the children. However, in the case of minor children it is not advisable to
bequeath assets directly to them. In such situations, a trust is advisable. In
times such as these setting up a trust is not possible since it would not be
feasible to obtain a PAN, open a bank account / demat account, etc. What, then,
can one do? A trust under a Will may be considered, in which case the trust
comes into effect only when the Will is executed and no trust is set up at the
time of making the Will. Thus, the act of settling the assets into the trust is
pushed till when the Will is executed. This trust could own all the assets to
be bequeathed to the minors.

 

If at all assets are to be bequeathed
directly to minors, then a guardian should be appointed under the Will. In this
case, the Hindu Minority and Guardianship Act, 1956 lays down the
law relating to guardianship of Hindus and the powers and duties of the
guardians. A Hindu father who can act as the natural guardian of his legitimate
children can appoint a guardian by his Will. Such a guardian could be for the
minor and / or for his property. Such an appointment would be invalid if the
father dies before the mother, because in such a case the mother would take
over as the natural guardian. However, once the mother dies, and if she dies
without appointing a person as the guardian under her Will, then the father’s
testamentary guardian would be revived. The testamentary guardian is subjected to
a dual set of restrictions. Firstly, those specified in the Will appointing
him, and secondly, those contained in this Act which apply to natural
guardians. Thus, the testamentary guardian is subjected to the restrictions on
sale of immovable property just as a natural guardian would be. The rights of
the testamentary guardian would be the same as those of a natural guardian. In
case the minor is a girl, then the rights of the testamentary guardian would
end on her marriage.

 

(g) Living Will: A living Will is not recognised
in India. However, as per the Supreme Court’s decision in Common Cause
vs. UOI, WP (Civil) 215/2005 (SC),
an Advanced Medical Directive is
possible. This can state as to when medical treatment may be withdrawn, or if
specific medical treatment that will have the effect of delaying the process of
death should be given. However, one of the stringent requirements of such a
document is the requirement of two independent witnesses and the directive
should be countersigned by a Jurisdictional Judicial Magistrate, First Class
(JMFC), so designated by the district judge concerned. This requirement would
not be possible in the case of a lockdown and hence, having an Advanced Medical
Directive is not possible till such time as normalcy returns.

 

(h) Hospital bed Wills: What happens in case a
person is unfortunate to contract the virus and is placed in a hospital
quarantine? Can such a person make a Will? The above peculiar issues would
apply to him also. As always, the biggest challenge would be getting two
witnesses. He could request the doctors / nurses treating him to help out. That
is the only way out for a patient in the isolation ward.

    

CONCLUSION

It is evident that a Will under
lockdown would throw up several unique issues. However, as explained above, a
solution exists for even the strangest of problems. An overarching question is,
should one adopt a DIY (Do It Yourself) approach or consult a professional for
preparing the Will? At the risk of sounding biased, I would always suggest consulting
a professional, especially when the Will is being executed during a lockdown.

 

While
legal planning does not prevent a healthcare crisis, it can and would ensure
that you control who makes decisions. It also prevents your loved ones from
being left with a stressful legal situation to fix in a short time. Getting
one’s legal affairs in order today would give you the peace of mind that you
have taken tangible steps to truly be prepared for an uncertain future. Till
then, stay safe and don’t forgot to wash your hands!

SEBI’S BROAD ORDER ON ENCUMBERED SHARES – REPERCUSSIONS FOR PROMOTERS

In the ongoing Covid-19 crisis,
where the world is reeling and stock markets are crashing three times and then
recovering once, a recent SEBI order on disclosure of encumbered shares could
have widespread repercussions on promoters. Increasingly, over the years, the
regulatory outlook of SEBI has been one of disclosures and self-education
rather than close monitoring and micro-management. Material events relating to
a company should be disclosed at the earliest so that the public can educate
itself and take an informed decision. In this context, an order levying a
fairly stiff penalty in a complex case of encumbrance of shares held by a
promoter company makes interesting reading (Adjudication Order in respect of
two entities in the matter of Yes Bank Ltd. Ref No.: EAD-2/SS/SK/89/252-253
/2019-20, dated 31st March, 2020).

 

BRIEF
BACKGROUND

Disclosure of holding of shares
in listed companies by promoters and certain other persons (substantial
shareholders, etc.), is an important feature of the securities laws in India.
Promoters typically have large holdings of shares, they control the company and
their continued involvement in it as substantial shareholders is an aspect
considered by the public as relevant in investment decision-making. Being
insiders with control of the company, their dealings in shares are also closely
monitored. Thus, movements in shareholding of shares are required to be
disclosed by several provisions of the securities laws. These disclosures are
event-based and also periodical. Quarterly / annual disclosures are mandated.
So are disclosures based on certain types of transactions or crossing of
certain values / quantities / percentage of movement in the shares held.

 

Interestingly, and this is the
topic of this article, disclosure of encumbrance in the shares of promoters and
their release is also a requirement under the provisions of SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011 (‘the Takeover
Regulations’). Regulation 31 of the Takeover Regulations requires disclosure by
the promoters of the creation, release or invocation of any encumbrance on
their shares.

 

The definition of what constitutes
‘encumbrance’ has undergone changes over the years and the present case relates
to a matter before the recent amendment made in July, 2019, though the
principle would apply even now. The earlier definition was short – ‘“encumbrance”
shall include a pledge, lien or any such transaction, by whatever name called’
.

 

It is of particular interest to
shareholders whether and to what extent the shareholding of promoters is
encumbered. The Satyam case is often referred to in this regard.

 

COMPLEXITY
OF ENCUMBRANCES

Pledging and hypothecation of
shares are the classic and most familiar of encumbrances on shares. A
shareholder may, for example, transfer his shares to a lender who would hold
them till the loan is repaid. If there is a default, the lender may simply sell
the shares in the market and realise his dues. But now that shares are held
digitally in demat accounts, a special process has been made to enable pledge /
hypothecation of shares. The shares are not transferred to the lender but a
record is made of the pledge / hypothecation in the demat account.

 

However, encumbrance, as the
definition shows, is a wider term rather than mere pledge / hypothecation. The
definition is inclusive and also has a residuary clause that says such
transactions ‘by whatever name called’ are also covered. As we will see later,
the parties in the present case, however, claimed that encumbrances should be
limited to pledge / hypothecation.

 

A question arises whether
restrictions placed on the disposal or other transactions in respect of shares
amounts to encumbrance as so envisaged. The classic case is of giving a
Non-Disposal Undertaking, popularly referred to as an NDU, in respect of the
shares. This means an undertaking is given that the shares held shall not be
disposed of till certain conditions (say, loans / interest are repaid) are met.
Even if a plain vanilla NDU is held to be an encumbrance, there are actually
many variants of an NDU or similar encumbrances as the present case shows. The
question is whether the definition should be treated as a generic catch-all
definition or whether it should be given a restrictive meaning. This has been
the core question addressed in this decision. Let us consider the specific
facts.

 

FACTS
OF THE CASE

The matter concerns two promoter
companies of Yes Bank Limited. Broadly summarised, the essential facts (though
there is some variation in details) are as follows: Both took loans by way of
differently structured non-convertible debentures from entities. The total
amount of loans taken was Rs. 1,580 crores. The shares held and which were the
subject matter of the alleged encumbrance, constituted 6.30% of the share
capital of Yes Bank. The debenture documents / terms placed certain
restrictions on the promoter entities. They were required to maintain a certain
cover ratio / borrowing cap. If such limits were violated, there were certain
consequences, principally that the promoter entity could be held to have
defaulted. There was, however, some flexibility. The promoter entities could
make certain variations after the approval of debenture holders in a specified
manner or after complying with certain conditions.

 

SEBI’S
ALLEGATION

SEBI held that the cover ratio /
borrowing cap effectively amounted to an encumbrance on the shares and thus
required disclosures under the Takeover Regulations. It alleged that the
entities would effectively face a restriction on the sale of their shares
because if they sold the shares, the ratios / caps would get exceeded and hence
the terms of the debentures could get violated. It was an admitted fact that no
disclosure of this alleged encumbrance was made as required under the
Regulations. Thus, there was a violation of the Regulations and SEBI issued a
show cause notice as to why penalty should not be levied.

 

CONTENTIONS
OF THE PROMOTER ENTITIES

The promoters gave several
detailed technical and substantive arguments to support their view that there
was no violation and hence no penalty could be levied. Technical arguments like
inordinate delay in initiating the proceedings were given. It was also argued
that since then the structure had undergone substantial changes, and
particularly on revision of terms, disclosure was required and was duly made.

 

It was argued that the definition
of encumbrance effectively limited it to things like pledge, hypothecation,
etc. The principle of ejusdem generis applied for the words used ‘by any
other name called’ considering that they were preceded by the words ‘such
transaction’.

 

Some of the other major arguments
were as follows: It was argued that the structure and terms of debentures did
not amount to encumbrance as understood in law. The caps on borrowings, etc.
were of financial prudence. There were many alternatives for the entities to
sell the shares if they wanted to do so within the terms of the debentures
themselves. References were made to FAQs and press releases where some
clarifications were given about encumbrances. It was argued that examples were
given of the type of encumbrances that were envisaged to be given and the
present facts did not fit those examples.

 

Incidentally, the parties had
earlier applied for settlement of the alleged violations but the application
was returned due to expiry of the stipulated time under the relevant settlement
regulations.

 

REPLY
AND DECISION OF SEBI

SEBI rejected all the arguments.
The debenture documents were made in late 2017 / early 2018 and thus SEBI held
that there was no inordinate delay in initiating the proceedings. The mere fact
that the structure was changed later and the disclosures duly made did not
affect the fact that no disclosure was made originally when the alleged
encumbrance was made.

 

It also rejected the core
argument that ‘encumbrance’ should be given a limited meaning more or less
restricting it to cases like pledge and hypothecation or the like. SEBI pointed
out that the definition was inclusive and even more descriptive than limiting.
The use of the words ‘by any other name called’ could not be restricted to
examples given of pledge / hypothecation. The principle of ejusdem generis
did not apply.

 

SEBI also traced the history of
the regulations and explained the dilemma that was faced regarding identifying
the many types of encumbrances. It was accepted that encumbrances on shares of
promoters needed disclosure in the interest of the securities markets.
Considering the varied and often sophisticated nature of encumbrances, the
definition was made descriptive / inclusive and not exhaustive. It was well
settled, SEBI argued, that securities laws being welfare regulations, needed
wider beneficial interpretation.

 

Although the definition was
modified recently whereby some specific instances were further added, it did
not mean that the earlier definition should be construed narrowly.

 

SEBI noted that the effect of the
conditions regarding limits was that the shares of the entities could not be
sold. This amounted to an encumbrance on shares and hence non-disclosure
amounted to violation of the Regulations.

 

SEBI thus levied a penalty of Rs.
50 lakhs on each of the two entities.

 

CONCLUSION

It goes without saying that
disclosure of encumbrances matters at any stage. Indeed, SEBI has required,
over a period, more and more information relating to encumbrances including,
most recently, the purpose for which the encumbrances were made.

 

However, their effect would be
seen particularly when the encumbrances end up being given effect to with
shares being sold in the market on invoking of the encumbrances, to take an
example. This may particularly happen when the price of the shares goes down
sharply, resulting in a vicious circle. The coverage / margin required by the
encumbrance documents gets violated and there is need to provide more shares as
encumbrance or sale of shares (and) which results in further lowering of price.
This would again affect the interests of shareholders. We are seeing now a huge
crash in share prices. It is possible that there may be many such similar
encumbrances and they may come to light because of the impact of share sale or
other transactions. There may be more cases in which SEBI may have to act.

 

This decision is relevant even
under the amended regulations. It lays down the principles and intent of the
regulations relating to encumbrances. Thus, unless reversed on appeal, it would
matter particularly (if and) for any fresh encumbrance as understood in a broad
manner in the SEBI order is undertaken. Such encumbrances then would advisably
be disclosed duly in accordance within the time limits and manner prescribed.

 

There
may be entities that have not disclosed the encumbrances till now, taking a
stand similar to that taken by the entities in the present case. They may need
to revisit their stand and documents and see whether due disclosures need to be
made, even if belatedly, but voluntarily. Better late than never.

REVIEW OF FOREIGN DIRECT INVESTMENT POLICY DUE TO COVID-19 PANDEMIC

(A)   BACKGROUND – FDI Regulations pre-October, 2019

Under the erstwhile FEMA regulations
governing Foreign Direct Investment into India (‘FDI’), i.e., FEM 20(R),
Foreign Exchange Management (Transfer of Issue of Security by a Person Resident
outside India) Regulations, 2017 (‘FDI Regulations’) dated 7th November, 2017,
the RBI had powers to govern FDI which included equity investments into India.

 

The above regulations were issued
after superseding the earlier regulation dealing with FDI, i.e., the Foreign
Exchange Management (Transfer or issue of Security by a Person Resident outside
India) Regulations, 2000 which were issued by RBI on 3rd May, 2000 (‘Old FDI
Regulations’).

 

Thus, under the FDI regulations, RBI
had powers to regulate FDI into India. At the same time, the Government of
India used to issue a consolidated FDI Policy which contained a broad policy
framework governing FDI into India. The last such consolidated FDI Policy (‘FDI
Policy’) was issued on 28th August, 2017 by the Department of
Industrial Policy and Promotion, Government of India. However, as only the RBI
had the powers to govern FDI, Para 1.1.2 of the FDI Policy stated that any
changes in it made by the Government of India will need to be notified by the
RBI as amendments to the FDI regulations. Further, it was specifically
clarified that if there was any conflict between changes made in the FDI Policy
through issuance of Press Notes / Press Releases and FDI Regulations, the FDI
Regulations issued by RBI will prevail. Further, the FDI Policy defined FDI in
Para 2.1.14 as under:

 

‘FDI’ means investment by
non-resident entity / person resident outside India in the capital of an Indian
company under Schedule I of Foreign Exchange Management (Transfer or Issue of
Security by a Person Resident Outside India) Regulations, 2000
.

Schedule I of the Old FDI
Regulations dealt with investment by person resident outside India in the
equity / preference / convertible debentures / convertible preference shares of
an Indian company.

 

Hence, under the earlier FEMA regime
FDI was governed by the RBI through FDI Regulations and the policy framework
was given by the Government through issuance of an annual FDI Policy and
amendments by issuance of Press Notes / Press Circulars as and when required.

 

(B)   BACKGROUND – FDI Regulations post-October, 2019

However, the above position
governing FDI was completely overhauled with effect from October, 2019. From 15th
October, 2019 the Government of India assumed power from the RBI to regulate
non-debt capital account transactions. Subsequently, vide 16th
October, 2019, the Central Government notified the following list of instruments
which would qualify as non-debt instruments:

 

List of instruments notified
as non-debt instruments

(a) all
investments in equity instruments in incorporated entities: public, private,
listed and unlisted;

(b) capital
participation in LLPs;

(c) all
instruments of investment recognised in the FDI Policy notified from time to
time;

(d) investment
in units of Alternative Investment Funds (AIFs), Real Estate Investment Trusts
(REITs) and Infrastructure Investment Trusts (InvIts);

(e) investment
in units of mutual funds or Exchange-Traded Funds (ETFs) which invest more than
fifty per cent in equity;

(f)   junior-most
layer (i.e. equity tranche) of the securitisation structure;

(g) acquisition,
sale or dealing directly in immovable property;

(h) contribution
to trusts; and

(i)   depository
receipts issued against equity instruments.

Thus, all investments in equity
shares, preference shares and convertible debentures and preference shares were
classified as non-debt and came to be regulated by the Central Government
instead of by the RBI.

 

Thereafter, on 17th
October, 2019 the Central Government issued the Foreign Exchange Management
(Non-Debt Instruments) Rules, 2019 (‘Non-Debt Rules’) for governing Non-Debt
transactions.

 

Hence, upon issuance of the above Non-Debt
Rules, the power to regulate FDI into India was taken over by the Central
Government from the RBI. Accordingly, the FDI Policy effectively became
redundant as it governed FDI as defined under the erstwhile FDI Regulations
which was superseded by the Non-Debt Regulations with effect from 17th
October, 2019.

 

(C) Amendments to FDI Policy by issuance of Press Note No. 3 (2020)
dated 17th April, 2020

The existing FDI Policy, vide
Para 3.1.1, provided that a non-resident entity could invest in India under the
automatic route subject to the FDI Policy. However, investments by an entity or
an individual based in Bangladesh and Pakistan was allowed only under the
Government route.

 

In view of the Covid pandemic, the
Government of India has amended the FDI Policy by issuing the above Press Note
No. 3 (2020) dated 17th April, 2020 under which the FDI Policy is
now amended to provide that if any investment is made by an entity, citizen or
beneficial owner who is a resident of a country with whom India shares its land
border, will be under the Government route. Further, any transfer of ownership
of existing or future FDI in an Indian entity to a person resident of the above
countries would also require Government approval.

 

Additionally, it has also been
provided that the above amendment in the FDI Policy will take effect from the
date of the FEMA notification.

 

Subsequently, the Government of
India has issued a notification dated 22nd April, 2020 (‘FEMA
Notification’) to amend Rule 6(a) of the Non-Debt Rules which deals with FDI
for giving effect to the above Press Note No. 3.

 

(D) Implication of above amendment to Non-Debt Rules

(i)   Restrictions on investment from neighbouring countries

As on date, India shares its land
boundary with the following seven countries: Pakistan, Bangladesh, China,
Nepal, Myanmar, Bhutan and Afghanistan.

 

As per the pre-amended Rule 6(a) of
the Non-Debt Rules, a person resident outside India could make investment
subject to the terms and conditions specified in Schedule I which dealt with
FDI in Indian companies. However, there was a proviso which specified
that investment from the following persons / entities was under the Government
route:

 

  • An entity incorporated in Bangladesh or
    Pakistan;
  • A person who is a citizen of Bangladesh or
    Pakistan.

 

As per the amendment made on 22nd
April, 2020, the above provision has been amended to provide that investment
from the following persons / entities will be under the Government route:

  • An entity incorporated in any of seven
    neighbouring countries mentioned above;
  • If the beneficial owner is situated in any
    of the above seven neighbouring countries;
  • The beneficial owner is a citizen of any of
    the above seven neighbouring countries.

 

Further, transfer of ownership of
any existing or future FDI in an Indian entity to the above persons will also
be under the Government route.

 

Accordingly, for example, if earlier
a company based in China wanted to undertake FDI in any Indian company, the
same was allowed under the automatic route subject to sectoral caps, if any,
applicable to the industry in which the Indian company was operating. However,
post-22nd April, 2020 a Chinese company which has made investment in
an Indian company which is engaged in a sector where FDI is permissible up to
100% without any restrictions, would neither be allowed to undertake any fresh
investment in such Indian company nor acquire shares in any existing Indian
company under the FDI route without Government approval.

 

The above restriction has come in
the wake of news reports that the People’s Bank of China has acquired more than
1% stake in HDFC. The Government’s intention is to ensure that when the
valuation of Indian companies is low due to the impact of Covid-19, Indian
companies are not taken over by Chinese companies. However, the above
restriction is not directed only at China but covers investment from all the
seven countries mentioned above.

(ii) Meaning of beneficial ownership

It is interesting to note that the
term ‘beneficial owner’ has not been defined under FEMA. Rule 2(s) of the
Non-Debt Rules, 2019 while defining the term ‘foreign investment’ clarifies
that where, in respect of investment made by a person resident in India, if a
declaration is made under the Companies Act, 2013 that the beneficial interest
in the said investment is to be held outside India, such investment even though
made by a person resident in India, will be considered as foreign investment.
Thus, the Non-Debt Rules, 2019 refer to the provisions of the Companies Act,
2013 (‘Cos Act’) for determining whether a beneficial interest exists or not.

 

Section 89(10) of the Cos Act
defines beneficial interest in a share to include directly or indirectly,
through any contract, arrangement or otherwise, the right or entitlement of a
person alone or together with any other person to –

(a) exercise
or cause to be exercised any or all of the rights attached to such share;

(b) receive
or participate in any dividend or other distribution in respect of such share.

 

Hence,
based on the above provision of the Cos Act, it can be concluded that ‘beneficial
interest’ means a person who has the right to exercise all the rights attached
to the shares and also receive dividend in respect of such shares.

 

Further, section 90 of the Cos Act
read with Rule 2(e) of the Companies (Significant Beneficial Owners) Rules,
2018 specifies that if an individual, either directly or indirectly, is holding
10% or more of shares or voting rights in a company, such individual will be
considered to be a significant beneficial owner of shares and will be required
to report the same in the prescribed format.

 

Additionally, Rule 9(3) of the
Prevention of Money Laundering (Maintenance of Records) Rules, 2005 (‘PMLA Rule
9’) defines beneficial owner as a natural person holding in excess of the
following thresholds:

 

Nature of entity

Threshold limit

Company

25% of shares or capital or profits

Partnership firm

15% of capital or profits

Unincorporated body or body of individuals

15% of property or capital or profits

Trust

15% interest in trust

 

Further, the above-referred PMLA
Rule 9 also provides that in case any controlling interest in the form of
shares or interest in an Indian company is owned by any company listed in India
or overseas or through any subsidiaries of such listed company, it is not
necessary to identify the beneficial owner. Thus, in case of shares or
interest-held listed companies, beneficial ownership is not to be determined.

 

The above PMLA Rule 9 is followed by
SEBI for the purposes of determining beneficial ownership in any listed Indian
company.

 

Hence, we have a situation where the
Cos Act determines a significant beneficial owner as a natural person holding
10% or more directly or indirectly in the share capital, whereas SEBI, for the
purposes of a listed company, considers a threshold of shareholding exceeding
25% to determine beneficial ownership.

 

Additionally, the OECD Beneficial
Ownership Implementation Toolkit, March, 2019 states that beneficial owners are
always natural persons who ultimately own or control a legal entity or
arrangement, such as a company, a trust, a foundation, etc. Accordingly, where
an individual through one or more different companies controls the investment,
all intermediate controlling companies will be ignored and the individual would
be considered to be the beneficial owner of the ultimate investment.

 

However, in the absence of any
clarity given under the FEMA notification or by the Press Note regarding the
percentage beyond which an individual would be considered to be having
beneficial interest in the investment, one may take a conservative view of
considering shareholding of 10% or more as beneficial interest for the purposes
of FEMA. The same is explained by the example below:

 

Example

An Indian company is engaged in the
IT sector in which 100% FDI is permitted under the automatic route having the
following shareholding pattern:

In the above fact pattern, where the
Chinese Co. or a Chinese individual are holding 10% or more beneficial interest
either directly or indirectly through one or more entities in an Indian
company, the same will be covered under the restriction imposed by the FEMA
notification. Accordingly, any future investment of the Mauritius Co. into the
Indian Co. will be subject to Government approval.

 

Further, any change in shareholding
at any level which will transfer beneficial interest from a non-Chinese company
/ individual to a Chinese company or Chinese individual, will also be subject
to Government approval.

 

(iii) Meaning of FDI

Rule 6(a) of the Non-Debt Rules
provides that a person resident outside India can make investment subject to
the terms and conditions specified in Schedule I which deals with FDI in Indian
companies. FDI is defined to include the following investments:

  • Investment in capital instruments of an
    unlisted Indian company; and
  • Investment amounting to 10% or more of
    fully diluted paid-up capital of a listed Indian company.

 

Capital instruments means equity
shares, fully, compulsorily and mandatorily convertible debentures, fully,
compulsorily and mandatorily convertible preference shares and share warrants.

 

As per the amendment made on 22nd
April, 2020 the above Rule 6(a) has been amended to provide that
investment from entities or a beneficial owner located in the above seven
neighbouring countries will be under the automatic route.

 

Any investment of less than 10% in a
listed Indian company is considered as Foreign Portfolio Investment and is
covered by Schedule II of the Non-Debt Rules.

 

Further, the following schedules of Non-Debt
Rules cover different types of investments into India:

Schedule reference

Nature of investment

Schedule II

Investment by Foreign Portfolio Investment

Schedule III

Investment by NRIs or OCIs on repatriation basis

Schedule IV

Investment by NRIs or OCIs on
non-repatriation basis

Schedule V

Investment by other non-resident investors like sovereign
wealth funds, pension funds, foreign central banks, etc.

Schedule VI

Investment in LLPs

Schedule VII

Investment by Foreign Venture Capital investors

Schedule VIII

Investment in an Indian investment vehicle

Schedule IX

Investment in depository receipts

Schedule X

Issue of Indian depository receipts

As the amendment is made only in
Rule 6(a) which deals with FDI in India covered under Schedule I, investment
covered by the above-mentioned Schedules II to X (excluding investment in LLP
covered by Schedule VI) will not be subject to the above restrictions placed on
investors from China and other neighbouring countries.

 

For example, any investment of less
than 10% in a listed Indian company will be considered to be Foreign Portfolio
Investment and, accordingly, will not be subject to the above restrictions
placed on investors from China and other neighbouring countries.

 

With regard to investment in LLPs,
the same is covered by Schedule VI of the Non-Debt Rules. Clause (a) of
Schedule VI provides that a person resident outside India, not being Foreign
Portfolio Investor (FPI) or Foreign Venture Capital Investor (FVCI), can
contribute to the capital of an LLP which is operating in sectors wherein FDI
up to 100% is permitted under the automatic route and there are no FDI-linked
performance conditions.

 

Accordingly, post-22nd April,
2020, as FDI by person / entities based in neighbouring countries will fall
under the approval route they will not be eligible to make investment in any
LLP, irrespective of the sector in which it operates. Thus, persons / entities
based in neighbouring countries will neither be able to undertake fresh
investment in an existing LLP where they are already holding partner’s share,
or incorporate new LLPs or buy stakes in any existing LLP even under the
Government route.

 

Thus, unlike investment in companies
which will be allowed with the prior approval of the Government, investment in
LLPs will no longer be permissible either under the automatic route or the
approval route irrespective of the business of the LLP. Similarly, a company
having FDI with investors who belong to the neighbouring countries will not be
allowed to be converted into an LLP.

 

Meaning of transfer of
existing or future FDI

The amended provision says
Government approval is required before transfer of existing or future FDI in an
Indian entity to persons / entities based in the neighbouring countries. Hence,
transfer of existing FDI in an Indian entity as well as transfer of any FDI
which is made in future to persons / entities based in the neighbouring
countries will require Government approval.

 

Restriction
on issuance of shares against pre-incorporation expenses

Under the existing provisions, a WOS
set up by a non-resident entity operating in a sector where 100% FDI is
permitted under the automatic route, is permitted to issue shares against
pre-incorporation expenses incurred by its parent entity subject to certain
limits.

 

Going forward, as investment by
neighbouring countries will now fall under the Government route, a WOS set up
by a parent entity which is based in the neighbouring countries will not be
permitted to issue shares against pre-incorporation expenses incurred by the
parent entity.

 

Convertible instruments

FDI includes equity shares, fully,
compulsorily and mandatorily convertible debentures, fully, compulsorily and
mandatorily convertible preference shares, and share warrants. Accordingly, any
issuance or transfer of convertible instruments to persons / entities of
neighbouring countries will now be subject to Government approval irrespective
of the fact that convertible instruments have not yet been converted into equity.

 

However, determining beneficial
ownership in case of convertible instruments will be challenging. The case may
be more complicated where overseas investors in an Indian company have issued
optionally convertible instruments.

 

In this regard, one may place
reliance on the definition of FDI under Rule 2(r) which requires FDI to be
computed based on the post-issue paid-up equity capital of an Indian company on
fully diluted basis. Hence, a similar analogy could also be applied for
computing beneficial ownership of residents / entities of neighbouring
countries on the assumption that the entire convertible instruments have been
converted into equity.

 

(iv) Indirect foreign investment – Downstream
investment

Indirect foreign investment is
defined to mean downstream investment received by an Indian entity from:

(a) another
Indian entity (IE) which has received foreign investment and (i) the IE is not
owned and not controlled by resident Indian citizens or (ii) is owned or
controlled by persons resident outside India; or

(b) an
investment vehicle whose sponsor or manager or investment manager (i) is not
owned and not controlled by resident Indian citizens or (ii) is owned or
controlled by persons resident outside India.

 

The above amendment will also affect
downstream investment made by an existing Indian company which is owned or
controlled by persons resident outside India. Hence, if persons / entities of
neighbouring countries have beneficial interest in such an Indian company which
is owned or controlled by persons resident outside India, any downstream
investment made by such a company would also be under Government route.

 

The above can be illustrated as
follows:

 

 

Thus, in the instant case, as Indian Co. is owned or
controlled by persons resident outside India, any investment made by Indian Co.
will be considered to be downstream investment and will be required to comply
with the applicable sectoral caps. Hence, if persons / entities of neighbouring
countries hold beneficial interest in Indian Co., any subsequent investment
made by Indian Co. will require Government approval. Further, any downstream
investment made by WOS would also need prior Government approval.

 

Additionally, downstream investment by an LLP which is owned
or controlled by persons resident outside India and having beneficial ownership
of persons / residents of neighbouring countries will not be allowed in any
Indian company, irrespective of the sector.

 

(v) Effective date of changes made in FDI Policy

It is interesting to note that the Government had decided to
make changes in the FDI Policy by issuing a Press Note. Further, the Press Note
has itself stated that the above changes will come into effect from the date of
issuance of the relevant notification under FEMA. The relevant FEMA
Notification has been issued on 22nd April, 2020 and hence the above
changes will be effective from that date.

 

(vi) Status of FDI from Hong Kong

Hong Kong is one of the major contributors to FDI in India.
As per Government of India records, FDI from Hong Kong is almost double that
from China and hence it is essential to evaluate whether Hong Kong will be
considered separate from China to determine whether it will be covered under
the new restrictions imposed by Press Note No. 3. It is interesting to note
that Hong Kong is governed separately as Hong Kong Special Administrative
Region of China but it forms part of China. However, for the purpose of
reporting FDI, Hong Kong is classified as a separate country by the Government
of India. Similarly, the Indian Government has entered into a separate tax
treaty with Hong Kong in addition to China for avoidance of double taxation.
Additionally, Hong Kong has separately signed the Multilateral Convention in
addition to China as part of OECD’s BEPS Action Plans.

 

Based on the above, it appears that the Government is taking
the view that Hong Kong is separate from China; and if such is indeed the case,
then it is possible to take the view that the above restrictions imposed by Press
Note No. 3 will not affect FDI from Hong Kong and the same should be covered
under the automatic route as hitherto applicable. However, it is advisable that
the Government issue an appropriate clarification on the same.

 

SUMMARY

Based on the above discussions, the amendment in
the FDI regime by putting investment from neighbouring countries under the
Government route has given rise to several issues. It is expected that the
Government will quickly issue necessary clarifications in this regard.

Sections 2(47), 45 – A cancellation of shares consequent to reduction of capital constitutes a ‘transfer’ – Loss arising from the cancellation of shares is entitled to indexation and is allowable as a long-term capital loss – The fact that the percentage of shareholding remains unchanged even after the reduction is irrelevant

3. Carestream Health Inc. vs. DCIT (Mumbai)

M. Balaganesh (A.M.) and Amarjit Singh (J.M.)

ITA No.: 826/Mum/2016

A.Y.: 2011-12

Date of order: 6th February, 2020

Counsel for Assessee / Revenue: Nitesh Joshi / Padmapani Bora

 

Sections 2(47), 45 – A cancellation of shares consequent to
reduction of capital constitutes a ‘transfer’ – Loss arising from the
cancellation of shares is entitled to indexation and is allowable as a
long-term capital loss – The fact that the percentage of shareholding remains
unchanged even after the reduction is irrelevant

 

FACT

The assessee was a company
incorporated in and a tax resident of the United States of America. It made
investments to the extent of 6,47,69,142 equity shares of the face value of Rs.
10 each in Carestream Health India Private Limited (CHIPL), its wholly-owned
Indian subsidiary. During the previous year relevant to the assessment year
under consideration, viz. A.Y. 2011-12, CHIPL undertook a capital reduction of
its share capital pursuant to a scheme approved by the Bombay High Court. Under
the capital reduction scheme, 2,91,33,280 shares (out of the total holding of
6,47,69,142 shares) held by the assessee were cancelled and a total
consideration amounting to Rs. 39,99,99,934 was received by the assessee towards
such cancellation / capital reduction. This consideration sum of Rs.
39,99,99,934 worked out to Rs. 13.73 for every share cancelled by CHIPL. This
was also supported by an independent share valuation report.

 

As per the provisions of section
2(22)(d), out of the total consideration of Rs 39,99,99,934, the consideration
to the extent of accumulated profits of CHIPL, i.e., Rs. 10,33,11,000 was
considered as deemed dividend in the hands of the assessee. Accordingly,
Dividend Distribution Tax (DDT) on such deemed dividend @ 16.609% amounting to
Rs. 1,71,58,924 (10,33,11,000 * 16.609%) was paid by CHIPL. Since the aforesaid
sum of Rs. 10,33,11,000 suffered DDT u/s 115-O, the assessee claimed the same
as exempt u/s 10(34) in the return of income. The balance consideration of Rs.
29,66,88,934 was appropriated towards sale consideration of the shares and
capital loss was accordingly determined by the assessee as prescribed in Rule
115A to Rs. 3,64,84,092 and a return was filed claiming such long-term capital loss.
Thus, the assessee had claimed long-term capital loss of Rs. 3,64,84,092 upon
cancellation of the shares held by it in CHIPL pursuant to reduction of capital
in the return of income for the year under consideration.

 

The A.O. held that there was no transfer
within the meaning of section 2(47) in the instant case. He observed that the
assessee was holding 100% shares of its subsidiary company and during the year
it had reduced its capital. The assessee company had 100% shares in the
subsidiary company and after the scheme of reduction of capital also, the
assessee was holding 100% of the shares. According to the A.O., this clearly
establishes that by way of reduction of capital by cancellation of the shares,
the rights of the assessee do not get extinguished. The assessee, both before
and after the scheme, was having full control over its 100% subsidiary. The
conditions of transfer, therefore, were not satisfied. Further, the shares have
been cancelled and are not maintained by the recipient of the shares.

 

Before the A.O. the assessee also
made an alternative argument of treating the same as a buyback. The A.O.
observed in this regard that since the assessee had taken approval from the
High Court for reduction of capital, the same cannot be treated as a buyback.
He, therefore, disallowed the claim of long-term capital loss in the sum of Rs.
3,64,84,092 due to indexation and also did not allow it to be carried forward.

 

The assessee filed objections before
the DRP against this denial of capital loss. The DRP disposed of the objections
of the assessee by holding that the issue in dispute is covered by the decision
of the Special Bench of the Mumbai Tribunal in the case of Bennett
Coleman & Co. Ltd.
reported in 133 ITD 1. Applying
the ratio laid down in the said decision, the DRP observed that the
share of the assessee in the total share capital of the company as well as the
net worth of the company would remain the same even after capital reduction /
cancellation of shares. Thus, there is no change in the intrinsic value of the
shares and the rights of the shareholder vis-a-vis the other
shareholders as well as the company. Thus, there is no loss that can be said to
have actually accrued to the shareholder as a result of the capital reduction.

 

Pursuant to this direction of the
DRP, the A.O. passed the final assessment order on 23rd December,
2015 disallowing the long-term capital loss of Rs. 3,64,84,092 claimed by the
assessee in the return of income.

 

Aggrieved, the assessee preferred an
appeal to the Tribunal.

 

HELD

At the outset, the Tribunal noted
that the assessee had incurred capital loss only due to claim of indexation
benefit and not otherwise. The benefit of indexation is provided by the statute
and hence there cannot be any mala fide intention that could be
attributed to the assessee in claiming the long-term capital loss in the said
transaction.

 

As regards the contention of the A.O.
that there is no transfer pursuant to reduction of capital, the Tribunal
observed that –

i) it
is a fact that the assessee had indeed received a sale consideration of Rs.
39.99 crores towards reduction of capital. This sale consideration was not
sought to be taxed by the A.O. under any other head of income. The Tribunal
held that this goes to prove that the A.O. had indeed accepted this to be the
sale consideration received on reduction of capital under the head ‘capital
gains’ only, as admittedly the same was received only for the capital asset,
i.e., the shares. The Tribunal held that the existence of a capital asset is proved
beyond doubt. The capital gains is also capable of getting computed in the
instant case as the cost of acquisition of the shares of CHIPL and the sale
consideration received thereon are available. The Tribunal held that the
dispute is, how is the A.O. justified in holding that the subject mentioned
transaction does not tantamount to ‘transfer’ u/s 2(47).

 

ii) there
is a lot of force in the argument advanced by the A.R. viz. that merely because
the transaction resulted in loss due to indexation, the A.O. had ignored the
same. Had it been profit or surplus even after indexation, the A.O. could have
very well taxed it as capital gains.

 

The ratio that could be
derived from the decision of the Hon’ble Supreme Court in CIT vs. G.
Narasimhan
reported in [236 ITR 327 (SC)], is that
reduction of capital amounts to transfer u/s 2(47). Even though the shareholder
remains a shareholder after the capital reduction, the first right as a holder
of those shares stands reduced with the reduction in the share capital.

 

The Tribunal observed that it is not
in dispute that in the instant case the assessee had indeed received
consideration of Rs. 39.99 crores towards reduction of capital and whereas in
the facts of the case before the Mumbai Special Bench reported in 133 ITD
1
relied upon by the DR, there was no receipt of consideration at all.
Out of the total consideration of Rs. 39.99 crores arrived @ Rs. 13.73 per
share cancelled in accordance with the valuation report obtained separately, a
sum of Rs. 10.31 crores has been considered by the assessee as dividend to the
extent of accumulated profits possessed by CHIPL as per the provisions of
section 2(22)(d) and the same has been duly subjected to dividend distribution
tax. The remaining sum of Rs. 29.67 crores has been considered as sale
consideration for the purpose of computing capital gain / loss pursuant to
reduction of capital.

 

The most crucial point of distinction
between the facts of the assessee and the facts before the Special Bench of the
Mumbai Tribunal was that in the facts before the Special Bench, the Special
Bench was concerned with a case of substitution of one kind of share with
another kind of share, which has been received by the assessee because of its
rights to the original shares on the reduction of capital. The assessee got the
new shares on the strength of its rights with the old shares and, therefore,
the same would not amount to transfer. For this purpose reference has been made
to section 55(2)(v). According to the Special Bench, the assessee therein will
take the cost of acquisition of the original shares as the cost of substituted
shares when capital gains are to be computed for the new shares.

 

In the present case section 55(2)(v)
has no application. The cost of acquisition of 2,91,33,280 shares shall be of
no relevance in the assessee’s case at any later stage. In paragraph 23 at page
13 of the decision of the Special Bench, it has been observed that though under
the concept of joint stock company the joint stock company is having an
independent legal entity, but for all practical purposes the company is always
owned by the shareholders. The effective share of the assessee in the assets of
the company would remain the same immediately before and after reduction of
such capital. It has thus been observed that the loss suffered by the company
would belong to the company and that cannot be allowed to be set off in the
hands of the assessee.

 

The law is now well settled by the
decision of the Hon’ble Supreme Court in the case of Vodafone
International Holdings B.V [341 ITR 1]
wherein it was held that the
company and its shareholders are two distinct legal persons and a holding
company does not own the assets of the subsidiary company. Hence, it could be
safely concluded that the decision relied upon by the DR on the Special Bench
of the Mumbai Tribunal in 133 ITD 1 is factually distinguishable
and does not come to the rescue of the Revenue.

 

The Tribunal held that the loss arising to the
assessee for cancellation of its shares in CHIPL pursuant to reduction of
capital in the sum of Rs. 3,64,84,092 should be allowed as long-term capital
loss eligible to be carried forward to subsequent years. The ground of appeal
filed by the assessee was allowed.

Business expenditure – Section 37(1) of ITA, 1961 – Where assessee company engaged in business of development of real estate had, in ordinary course of business, made certain advance for purchase of land to construct commercial complex but same was forfeited as assessee could not make payment of balance amount – Forfeiture of advance would be allowed as business expenditure

9. Principal CIT vs.
Frontiner Land Development P. Ltd.

[2020] 114 taxmann.com 688
(Delhi)

Date of order: 25th
November, 2019

A.Y: 2012-13

 

Business expenditure – Section
37(1) of ITA, 1961 – Where assessee company engaged in business of development
of real estate had, in ordinary course of business, made certain advance for
purchase of land to construct commercial complex but same was forfeited as
assessee could not make payment of balance amount – Forfeiture of advance would
be allowed as business expenditure

 

The assessee, a company engaged
in the business of real estate development, had entered into a contract with
HDIL for purchase of land to construct a commercial complex in 2004 and had
paid an advance of Rs. 3.50 crores. However, it could not pay the balance
amount and, therefore, HDIL forfeited the advanced amount in 2011. In the
relevant year, i.e., A.Y. 2012-13, the entire capital gain and interest income
of the assessee company was offset with the amount so forfeited. The A.O. held
that forfeiture of advance was a colourable device to adjust capital gains. He
characterised the forfeiture as capital expenditure and made an addition.

 

The Commissioner (Appeals)
allowed the assessee’s appeal and deleted the addition of Rs. 3.5 crores. The
Tribunal upheld the decision of the Commissioner (Appeals).

 

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

 

‘i)   From the facts narrated in the impugned order, it emanates that
the transaction between the assessee and HDIL is not disputed. The transaction,
in fact, has also been accepted by the A.O. while treating the write-off as
capital expenditure. Thus, the only question that arises for consideration is
whether such a transaction could be categorised as “colourable device”
and the forfeiture of Rs. 3.50 crores could be treated as capital expenditure.
Since the genuineness of the transaction is not disputed, we are unable to find
any cogent ground or reason for the same to be considered as colourable device.
In fact, the assessee had produced several documents in support of the
forfeiture, such as the copy of the agreement to sell dated 12th
October, 2004; letter requesting for extension of agreement; letters granting
extension from HDIL; letter granting final opportunity; and letter of
forfeiture of advance, which in fact has been extracted in the impugned order.

 

ii) In order to claim deduction, the assessee has
to satisfy the requirements of section 37(1) of the Act which lays down several
conditions, such as, the expenditure should not be in the nature described
under sections 30 to 36; it should not be in the nature of capital expenditure;
it should be incurred in the previous year; it should be in respect of business
carried out by the assessee; and be expended wholly and exclusively for the
purpose of such business.

 

iii) The assessee is a company which is engaged in the business of real
estate. The main object of the business of the company is development of real
estate. It made a payment of Rs. 3.50 crores as advance to HDIL for purchase of
land to construct a commercial complex for the development of real estate.
Since it did not make the payment of the balance amount, for whatever reason,
the advance given was forfeited. In this view of the matter, the advance given
in the ordinary course of business has been rightly treated as loss incurred by
the company.

 

iv) We are unable to find any material on
record to suggest to the contrary. In view of the aforesaid factual findings,
the treatment given to the forfeiture of advance of Rs. 3.50 crores could not
be categorised as capital expenditure. Therefore, the question of law urged by
the appellant does not arise for consideration as the issue is factual. The
appeal is, accordingly, dismissed.’

TEAM PERFORMANCE REVIEW IN PROFESSIONAL SERVICE FIRMS

People in professional service firms are
their greatest asset. In that context, we need to ask:

 

(1) Are we doing everything we can to
provide our teams the best of career and personal growth opportunities that
they deserve? (2) Do we spend the necessary time on reviewing our team’s
performance, giving feedback and offering it the mind space and focus that is
necessary?

 

This article is a take on how professional
service firms should review performance, encourage team members to perform
better and reward them for the performance that they deliver for the firm.

 

The Context

Professionals at every stage of their career
are normally inquisitive about their next phase of growth. Sometimes, even
without spending sufficient time on thinking through the roadmap for their
practice area development. It is important for partners to take the onus of
providing leadership, mentorship, guidance and a roadmap to the professionals
in their team so that they are not left scampering without a direction. It is
the obligation of partners and firm leaders to provide a high-quality
environment in which merit and performance are rewarded, apart from offering
experience and seniority. It is binding on the partners to ensure that they
work with the millennials in understanding how they think and work and, through
that understanding, to develop a framework that enables individual development
and provides a career roadmap to the persons involved.

 

GOAL – SETTING


The first step in the process of a
performance review is to ask the question: What do we measure the
performance against?

 

The objective of performance assessment is
served only when team members have clarity of thought and vision. Hence, each
individual in the firm should be provided with written, clear and specific
goals for the upcoming year, clearly highlighting where and how each individual
is supposed to perform. Key performance indicators should also be highlighted.
Effectively, one is developing a scorecard for an individual, relative to the
individual’s capacity and capability to execute and develop on a
mutually-agreed set of goals.

 

So, how does one really set achievable and
measurable goals? Here are five steps that one can consider:

 

  •    The first step in the
    process is to look at the past twelve months and analyse: How did the
    individual perform?
  •    The second is to identify
    the individual’s core strengths and where he/she needs improvement;
  •    The third step is to agree
    upon a process and timeline to streamline those areas which need improvement by
    making actionable plans and which should be discussed with the team members
    threadbare;
  •    Next, the partners must
    identify the roles a team member can play in areas which are relevant and
    critical for the practice in the coming year and incorporate them in the
    scorecard;
  •    The final step is to hold a
    discussion with team members and agree upon mutually acceptable goals and close
    it with documentation.

 

PERFORMANCE REVIEW MECHANISM


Once the goals are set, it is important that
these goals are actually pursued and they get reflected in individual and
team performances.
For this purpose the firm must establish a proper
performance review mechanism. It is not enough to just hold an annual review at
the end of the year – by then, the damage could already have been done. Quarterly
reviews
ensure a gradual step towards improving performance by quicker
admission and follow-up on the areas which need improvement.

 

But how should one go about assessing
employee performance? The process of assessment can be divided into two parts:

    Facilitating self-evaluation, and

    360-degree feedback.

 

The employee must first exercise his own
judgement and rate his performance on the parameters and goals previously set.
He must question himself: Have I worked on my weaknesses? Have I met my
performance targets? What was my contribution to the firm? The employee must
appreciate and be able to see areas that need improvement.

 

External feedback is also necessary to
assess actual performance. The firm’s seniors and reporting managers must
comment on the improvement seen with respect to the pre-decided,
mutually-agreed goals.  At the same time,
feedback should be obtained from the entire eco-system in which the employee is
working. The employer should seek feedback from other team members, juniors and
clients to know how an employee has performed on various fronts. With
concurrent, self, upward, downward and external feedback, the employer now gets
a 360-degree review of the actual performance of the employee. The employer can
now discuss his observations with the employee and jointly decide the areas
which need further improvement.

 

ATTRIBUTES AND MOTIVATION


The key attributes which a leader must focus
on while reviewing performance are integrity, team spirit, attitude, the
individual’s orientation to the firm’s goals and performance management.

 

The attitude of the employees is a very
critical factor driving the performance of the firm. The partner must ensure
that all the employees feel good about what they do and that they perceive the
firm’s growth to be in consonance with their personal development. Such
motivation should also be seen at the team level by having a team-first
attitude.

 

FEEDBACK


Communication is the key to any process. The
way the employer conveys feedback influences the way the feedback would be
perceived.

 

Firstly, the
firm must create a culture where giving and receiving feedback (both positive
and constructive) is the norm. Secondly, acknowledging the importance of the
manner of delivering feedback; the partners must attempt to deliver even
negative feedback in a constructive way. Simple experiences can help us to
learn how to deliver constructive feedback. For instance, recall an experience
in which you were given constructive feedback. Now delve into the reasons why
the experience was positive or negative. What did the giver say or do that made
the experience positive or negative? Work on the areas which made the
experience negative and imbibe the qualities which made the experience
positive. This way, one can provide at least reasonably well-communicated
feedback.

 

Being emphatic and understanding while
providing feedback will ensure greater acceptance and improvement.

 

A PLAN FOR NEXT YEAR


An integral part of the performance review
process is to develop a plan for an individual. Let’s call it an Individual
Development Plan
(IDP). This plan should ensure that the scorecard, the
individual development sheets, and the KPIs, along with the goals, are
documented after a joint discussion between the team member and the partner.
This annual plan will serve as the guiding plan for the next year’s evaluation.

 

The key aspect in completing the IDP and
planning for the season ahead is that the team member’s SWOT analysis should be
conducted and a joint IDP should emerge from it.

 

HAPPY TEAM MEMBER


The process of a performance review is meant
to enhance employee morale and give the firm a chance to evaluate the team
member. It is essential for the partners to understand how the employees
perceive the review process because it will make all the difference.
A
performance review should be thought of as constructive feedback for individual
and organisational development. At the end of the process, the employee
should feel that the review actually contributed to his individual and team
learning.
The best outcome of the review should be that the individual
comes out as a happy team member. Happiness stems from the fact that he/she has
a clear set of goals and a roadmap in mind which is directly in consonance with
his goals and needs.

 

ASPIRATIONAL TEAM MEMBER


Team members should be encouraged by
partners to achieve the highest standards of performance and integrity that
will help them to grow individually and also as a team. Aspirational team
members wish to see themselves ahead from where they were before. They need to
believe they are headed somewhere in life and have a purpose. A performance
review should, therefore, aim at a convergence 
of individual development goals with the organisational goals to provide
value to each individual.

 

MEANINGFUL OUTCOMES


The ultimate objective of a performance
review is to get meaningful outcomes.
Outcomes
don’t just mean improvement in the firm’s revenue and operations. The clear
identification of each team member’s strengths and weaknesses, improvement in
employee efficiency and alignment of the practice goals with the employee goals
is effectively the right step in the right direction. These outcomes are what
constitute a well-rounded and comprehensive performance review mechanism.
Professionals must strive to achieve this consistently.

 

Performance review is a process to help team
members evaluate: How did the year go by? What could he/she have done
differently? What are the learnings carried forward to the next year? While
executing this process, there will be emotional and professional upheavals
which a team member should accept with dignity and grace. Therein lies true
learning for a professional.

 

While all of the above may sound daunting,
is it worth the effort? Totally. 
 

 

Coping with Compliances

Laws are meant to serve a number of
purposes: Establishing standards, maintaining order, resolving disputes, and
protecting liberties and rights, etc. Indian laws often fail to achieve these
purposes and even produce opposite outcomes! Often Rule of Law does not bring
intended results when laws are not equally applicable (say between State and
citizens or amongst groups of people), not equally enforced, not adjudicated
fairly and lacks a timely and cost-effective justice delivery system. In the
Indian context people avoid or dodge laws due to many reasons such as:

 

a.  Following rules does not necessarily lead to
intended / expected outcomes (low standard of service to a tax-payer or bad
quality of service delivery from State or administrative underperformance).

b. Laws are larger than the purpose they serve
(disproportionate compliance, corruption, red tape, treating the tax-payer as
evader, arbitrariness, lack of accountability).

c.  Justice delivery and adjudication process is
so convoluted and takes so much longer than it should even for routine matters.

 

The above can only be remedied by government
empathy and innovation so that citizens are encouraged to abide by the spirit
of the law and don’t get worn out by burden of doing business which is more
akin to doing compliances. It is said: Tax evasion is reprehensible; it is
social injustice by the evader to his fellow citizens. Arbitrary or excessive
taxation is equally reprehensible; it is social injustice by the government to
the people.
In today’s context excessive, reactive, and irrelevant laws
constitute reprehensible acts of social injustice by government on its own
people. Constant tweaking, amending, notifying, not notifying for months and
years1, changing schema, dysfunctional compliance portals (take GST
and PT) and the list is unending.

 

Let’s take the example of Digital Signatures
Certificates (DSC) in case of non-resident directors. They require Apostille /
Notary every two years. Add KYC process by MCA to this (aka duplication). Such
authentication costs Rs. 8,000 to 14,000 per document in many countries. While
authentication is a valid aim, its feasibility (cost, benefit, time, risk) in a
given context (say a non-operational or non-public interest entity) requires
balance. On top of this, banks ask for their own KYC. That is not all. New
changes require a video of the person (perhaps to check he is alive) before he
can get a DSC! Additionally, MCA has brought out new forms that necessitate
giving a photograph of the Director and latitude and longitude to keep the
company ‘active’! Moreover, the requirement for a full-time company secretary
is a cost burden due to a threshold / basis that is not reflective of the
actual need for having one. In a connected world, numerous disconnected laws
translate into a barrage of futile compliances that give a false sense of
conformity especially for mid-sized businesses.

 

Take obsolete laws! Inter-state change of registered
office requires that creditors give NOC. In a recent case, creditors gave their
no objection on email through scanned letters. After uploading them, the MCA
asked for proof of calling for the confirmations. Well, there was no choice but
to post those letters to creditors, enrich the postal department and upload
proof of sending by ‘Registered AD’. And yes that ‘compliance’ met the legal
requirements and the registered office shifting got approved.

 

Every form and procedure necessitates
periodic evaluation by an independent questioning group and a survey from users
– to ensure that these forms and procedures remain effective, smooth, and
meaningful. This is especially necessary for a compliance averse society like
ours. New compliances coming out every few months seem like surgical strike –
but on the wrong side – numbing the already low and overburdened base.

 

________________________________________

1   In 643 days of GST (known as Good and Simple
Tax) at the beginning of April 2019: 1 Amendment Act, 31 amendments in CGST
Rules, 364 Notifications, 224 Circulars and Orders. That is 620 changes in CGST
and IGST alone or nearly 1 per day and SGST changes are disregarded.



 

Raman Jokhakar

Editor

PUNARJANMA (REBIRTH)

Indian thinkers believe firmly in the theory
of ‘rebirth.’ It is considered as an integral part of ‘Hindu’ culture.
Many modernists and atheists discard ‘rebirth’ as a ‘mythand
a meaningless concept
. Life after death is indeed a mystery and the desire
to unravel it is probably universal. Despite this belief even in India, there
were atheists like Charvak and there are many even today who ridiculed the
concept of ‘rebirth’
by questioning as to how a body which is burnt can be
reborn. However, most religions believe in the concept of ‘judgement day
when the soul will rise to receive ‘judgement’.

 

The answer to this perennial question is: It
is a fact that the body does not return – what returns is the soul (Atma)
in another body. Soul is an observer, what actually comes along with soul is
our sub-conscious which carries the past. As there is still research on this
subject, the purpose of this article is to see: How the western world is
responding to and looking at ‘rebirth’.

 

There are departments in several
universities doing research on ‘Soul and Rebirth’. Henry Ford, the
acclaimed industrialist, realised at the age of 26 the truth of
rebirth
. Ford believed that the skills a person has are ‘the legacy of many
prior births.’ Henry Ford dedicated his wealth to this research and Dr.
Stevenson carried out the research for 4 decades.

 

Friedrich Nietzsche, the German philosopher,
says that rebirth is the turning point of human existence. He adds, whatever
you do, rebirth is imminent! Corroborating this, Stuart Cheshire, an
American thinker, states wise people don’t need evidence; and there is no
use giving evidence to ‘extra-wise’ people’.

 

Kahlil Gibran believed in rebirth and so did
Socrates, and Leo Tolstoy. Even a politician, Benjamin Franklin, believed in
‘rebirth’. There are many surgeons who have written that they have actually
experienced the existence of the soul while performing ‘surgery’. A few
of their patients have related their ‘near death experience’.

 

We ourselves have observed and experienced
that some children have phenomenal ‘in-born’ knowledge and skills. This
establishes that the soul has brought with it the knowledge from its last life.

 

Scientists
and psychiatrists have also developed the technique of ‘Past Life Regression
which helps in diagnosing many chronic and psychological disorders. This also
establishes that ‘life’ is a cycle that rarely ends. Hence, all
religions motivate people to do righteous acts or ‘satkarma’ and deter them
from doing wrong things (dushkarma) because it is an inherent belief
that ‘rebirth’ carries with it our acts of the past life.



The concept of ‘karma’ is based on
‘rebirth’
. – ‘as you sow, so shall you reap’.

 

There is another interesting observation
made by researchers. They say the journey of the soul from one body to another
may not be a one-time event! It may be a slow process and ‘rebirth’ happens in
a phased manner and even after some time after death. Some also believe ‘soul
can enter even a living body resulting in a change in behaviour’
. The
scientists have observed that one suddenly acquires the skills or abilities
which one never possessed!

 

Several books have chronicled where a young
child remembers his / her past life and have visited their abode in previous
births and have met their families.

 

Hence there is ‘rebirth’. The lesson is: Let us live our life according to our simple
belief of ‘being good and doing good’
so that what the soul carries with it
to the next birth is nothing but goodness – Rebirth is a fact and let us
accept it.

Section 37 and Insurance Act, 1938– Business expenditure – Disallowance – Payments prohibited by law – Effect of Explanation 1 to section 37 – Reinsurance payments to non-residents – Not prohibited by law – Deduction allowable

8. Cholamandalam
MS General Insurance Co. Ltd. vs. Dy. IT; 411 ITR 386 (Mad):
Date
of order: 12th December, 2018 A.Y.:
2009-10

 

Section
37 and Insurance Act, 1938– Business expenditure – Disallowance – Payments
prohibited by law – Effect of Explanation 1 to section 37 – Reinsurance
payments to non-residents – Not prohibited by law – Deduction allowable

 

The legal
issue in this appeal before the High Court relates to disallowance of
reinsurance premium ceded to non-resident reinsurers. The assessee has raised
the following substantial questions of law for consideration:

 

“i)   Whether the ITAT erred in deciding the
validity of reinsurance ceded to the non-resident reinsurers when such issue
was not even raised before it by either the Department or the appellant?

ii)   Whether the ITAT erred in holding that the
IRDA (General Insurance-Reinsurance) Regulation, 2000 is contrary to section
101A of the Insurance Act, 1938 when it does not have the power to decide the
validity of regulations made by the IRDA?

iii)   Whether the ITAT erred in holding that
reinsurance payments to non-residents are prohibited by law and therefore hit
by Explanation 1 to section 37 of the Income-tax Act, 1961?”

 

The Madras
High Court held in favour of the assessee and held as under:

“i)   The Tribunal has no jurisdiction to declare a
transaction to be either prohibited or illegal occurring under a different
statute over which it has no control.

ii)   The Insurance Act, 1938 stood amended w.e.f.
01.04.1961. It inserted section 101A. Section 2(16B) of the Act defines
‘reinsurance’ to mean the insurance of all or part of one insurer’s risk by
another insurer who accepts the risk for a mutually-acceptable premium. There
is no distinction drawn between an Indian reinsurer and a foreign reinsurer. On
and after the introduction of section 101A to the Insurance Act, 1938 there is
a mandatory requirement for other insurer to reinsure with Indian reinsurers
and such percentage is put to a maximum of 30%. The language of section 101A
nowhere prohibits the reinsurance with foreign reinsurance companies above the
percentage specified by the authority with previous approval by the Central
government.

iii)   A reading of the Insurance Regulatory and
Development Authority (General Insurance-Reinsurance) Regulations, 2000 also
clearly shows that there is absolutely no prohibition for reinsurance with a
foreign reinsurance company.

iv)  A reading of Circular No. 38(XXXIII-7), dated
03.10.1956 would clearly reveal that at no point of time has the Income-tax
Department taken a stand that the reinsurance business with a foreign
reinsurance company was a prohibited business.

v)   A reading of the order passed by the Tribunal
showed that the decision of the Tribunal on the effect of certain provisions of
the Insurance Act, 1938, whether reinsurance was permissible with foreign
entities and whether it was prohibited or valid in law, were all queries which
were raised by the Tribunal suo motu when the appeals were heard.

vi)  The sum and substance of the conclusion of the
Tribunal was that the entire reinsurance arrangement of the assessee company
was in violation and contrary to the provisions of section 2(9) of the
Insurance Act and, therefore, the entire reinsurance premium had to be
disallowed u/s. 37 of the Act. The Tribunal held that there was a clear
prohibition for payment of reinsurance premium to non-resident reinsurance companies.
The Tribunal held that an Indian insurer could not have any reinsurance
arrangement with a reinsurance company other than the insurer, as defined in
section 2(9) of the Insurance Act. The Tribunal was of the view that unless and
until a branch was opened by the foreign reinsurance company, the question of
conducting reinsurance business in India could not be done. This conclusion of
the Tribunal was not sustainable. Such a finding was without noticing the
reinsurance regulations, which had been provided by the Insurance Regulatory
Authority of India.

vii)  The Tribunal erred in drawing a presumption
regarding prohibition of reinsurance with foreign reinsurance companies. This
presumption was erroneous for the simple reason that the statement of objects
of the Insurance Act itself clearly stipulated wherever there was a
prohibition.

viii) The Tribunal had no jurisdiction to declare any
provisions of the regulations to be inconsistent with the provisions of the
Insurance Act. This was wholly outside the purview of the Tribunal.

ix)  The Tribunal did not consider the correctness
of the order passed by the Assessing Officer or that of the Commissioner
(Appeals). Therefore, the Tribunal could not have held that the Assessing
Officer rightly disallowed the insurance premium u/s. 40(a)(i).”

Section 48 – Legal and professional expenditure incurred by assessee, a foreign company, for sale of shares of its Indian subsidiary is an expenditure incurred wholly and exclusively in connection with transfer and is allowable as deduction while computing capital gains

5. [2019] 103
taxmann.com 297 (Mum)
AIG Offshore
Systems Services Inc. vs. ACIT ITA No.:
6715/Mum/2014
A.Y.: 2010-11 Dated:  18th January, 2019

 

Section 48 – Legal
and professional expenditure incurred by assessee, a foreign company, for sale
of shares of its Indian subsidiary is an expenditure incurred wholly and
exclusively in connection with transfer and is allowable as deduction while
computing capital gains

 

FACTS


During the previous
year relevant to the assessment year in dispute, the assessee, a foreign
company, carrying on activities as a Foreign Institutional Investor, sold
shares held by it in its Indian subsidiary and offered long-term capital gains
arising from sale of shares of the Indian subsidiary.

 

During the course
of assessment proceedings, the Assessing Officer (AO) observed that the
assessee had claimed deduction of expenditure incurred towards transfer of
shares. The assessee submitted that the said expenditure represented legal /
professional fees paid to lawyers / accounting firms for assisting in transfer
of shares. The AO, however, held that:

 

(i)   the expenditure claimed by the assessee was
not of such nature that without incurring those expenses sale of shares could
not have been done;

(ii)   the objective behind incurring the expenses
was to optimise the economic value of the business and not for the purpose of
transfer of shares; and

(iii)  the documentary evidences relied upon by the
assessee also did not mention the name of the buyer.

 

The AO disallowed
the assessee’s claim for deduction of expenditure while computing capital
gains.

Aggrieved, the
assessee preferred an appeal to the CIT(A) who upheld the disallowance by
holding that the expenditure incurred is in the nature of business expenditure.

 

Still feeling
aggrieved, the assessee preferred an appeal to the Tribunal.

 

HELD


The Tribunal,
relying on various decisions, held that expenditure which is intrinsically
connected to the transfer of a capital asset is allowable as deduction u/s.
48(i) of the Act. On a perusal of the documents filed by the assessee, the
Tribunal observed that the expenses were towards advice on sale of entire
shareholding, preparation of share / sale / purchase agreement, preparation of
closing documents including board resolution, share transfer forms, etc., and
were therefore for the transfer of shares. The Tribunal held that it was clear
from the scope of the work that the services rendered by the legal /
professional firm was intrinsically related to transfer of shares of the Indian
subsidiary and therefore the expenditure qualified for deduction u/s. 48(i).
The Tribunal also held that non-mentioning of the name of the buyer did not, in
any way, militate against the fact that the expenditure incurred by the
assessee on account of legal and professional fees was in connection with the
transfer of shares.

 

The appeal of the
assessee was allowed by the Tribunal.

Section 37(1) – Business expenditure – Allowability of (Consultancy charges) – Assessee made payments to one ‘S’, a consultant, and claimed deduction of same as business expenditure – AO, on the basis of a statement of ‘S’ recorded during search operations, held that ‘S’ had not rendered any service to assessee so as to receive such payments and disallowed expenditure – Appellate Authorities allowed payments made to ‘S’ holding that there was sufficient evidence justifying payments made to ‘S’ and AO, other than relying upon statement of ‘S’ recorded in search, had no independent material to make disallowance – Allowance of payments made to ‘S’ was justified

7. CIT
vs. Reliance Industries Ltd.; [2019] 102 taxmann.com 372 (Bom):
Date
of order: 30th January, 2019

 

Section
37(1) – Business expenditure – Allowability of (Consultancy charges) – Assessee
made payments to one ‘S’, a consultant, and claimed deduction of same as
business expenditure – AO, on the basis of a statement of ‘S’ recorded during
search operations, held that ‘S’ had not rendered any service to assessee so as
to receive such payments and disallowed expenditure – Appellate Authorities
allowed payments made to ‘S’ holding that there was sufficient evidence
justifying payments made to ‘S’ and AO, other than relying upon statement of
‘S’ recorded in search, had no independent material to make disallowance –
Allowance of payments made to ‘S’ was justified

 

The
assessee made payments to one ‘S’, a consultant, and claimed deduction of same
as business expenditure. The Assessing Officer on the basis of a statement of
‘S’ recorded during search operations held that the said person had not
rendered any service to the assessee so as to receive such payments. He
accordingly disallowed the payments made to ‘S’.

 

The
Commissioner (Appeals) allowed the payments made to ‘S’ holding that ‘S’ had
retracted the statement recorded during search, the assessee had pointed out
the range of services provided by ‘S’, and the Assessing Officer had no other
material to disallow the expenditure. The Tribunal confirmed the view of the
Commissioner (Appeals). It held that ‘S’ retracted his statement within a short
time by filing an affidavit. Subsequently, his father’s statement was recorded
in which he also reiterated the stand taken in the affidavit.

 

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

“The
entire issue is based on the appreciation of materials on record. The
Commissioner (Appeals) and the Tribunal concurrently held that there was
sufficient evidence justifying the payments made to ‘S’, a consultant, and the
Assessing Officer other than relying upon the statement of ‘S’ recorded in
search had no independent material to make the disallowance. No question of law
arises.”

Articles 12 and 14 of India-Uganda DTAA – Where services provided by non-resident individuals outside India were covered under Article 14 (which is specific in nature), Article 12 (which is general in nature) could not apply; hence, the payments were not chargeable to tax in India

7. TS-177-ITAT-2019 (Bang) Wifi Networks P. Ltd. vs. DCIT ITA No.: 943/Bang/2017 A.Y.: 2011-12 Dated: 5th April, 2019

 

Articles 12 and 14 of India-Uganda DTAA –
Where services provided by non-resident individuals outside India were covered
under Article 14 (which is specific in nature), Article 12 (which is general in
nature) could not apply; hence, the payments were not chargeable to tax in
India

 

FACTS


The assessee, an Indian company, had engaged
certain non-resident individuals for providing certain technical services
outside India. The assessee had made payments to them without withholding tax
from such payments.



The AO held that the payments were in the
nature of Fee for Technical Services (FTS) under the Act. Since the assessee
had not withheld tax u/s. 195, the AO disallowed the payments u/s. 40(a)(i) of
the Act.

 

Aggrieved, the assessee appealed before the
CIT(A) who upheld the order of the AO on the ground that the payments qualified
as FTS under the Act as well as DTAA, and hence, tax should have been withheld
from the payments. Thus, CIT(A) upheld the order of the AO.

 

Aggrieved, the assessee appealed before the
Tribunal.

 

HELD


  •     Perusal of the order of
    CIT(A) shows that his conclusion is based only on Article 12 of the
    India-Uganda DTAA and section 9(1)(vii) of the Act. He had not considered
    Article 14 of the India-Uganda DTAA.
  •     Article 14 applies in case
    of professional services performed by independent individuals. Article 12(3)(b)
    of the India-Uganda DTAA specifically excludes from its ambit payments made for
    services mentioned in Articles 14 and 15. Reliance was placed on the decision
    of Poddar Pigments Ltd. vs. ACIT (ITA Nos. 5083 to 5086/Del (2014) dated
    23.08.2018)
    wherein it was held that specific or special provisions in DTAA
    should prevail over the general ones. Hence, Article 12 which is broader in
    scope and general in nature, will be overridden by Article 14 which
    specifically applies to professional services provided by individuals.
  •     As per the terms of the
    agreement between the assessee and the payees, and considering the scope of
    their services, the services rendered by the payees were professional services
    covered under Article 14. Professional services covered under Article 14 could
    be technical in nature but merely because they were technical in nature it
    cannot be said that Article 14 was not applicable.
  •    
    Further, having regard to specific exclusion in Article 12(3)(b) in respect of
    services covered in Article 14, the payments made by the assessee would be
    covered by Article 14 and on non-satisfaction of conditions specified therein,
    such income was taxable only in Uganda. Hence, tax was not required to be
    withheld from such payments. 

 

 

 

Sub-sections 9(1)(vii), 40(a)(i) of the Act – payments made to foreign agent for services rendered outside India, which assessee was contractually required to perform, were not covered within section 9(1)(vii); hence, payments were not subject to tax withholding; payment for market survey, being for managerial, technical or consultancy services, was subject to tax withholding

6. TS-183-ITAT-2019 (Ahd) Jogendra L. Bhati vs. DCIT ITA No.: 2136/Ahd/2017 A.Y.s.: 2013-14 Dated: 5th April, 2019

 

Sub-sections 9(1)(vii), 40(a)(i) of the Act
– payments made to foreign agent for services rendered outside India, which
assessee was contractually required to perform, were not covered within section
9(1)(vii); hence, payments were not subject to tax withholding; payment for
market survey, being for managerial, technical or consultancy services, was
subject to tax withholding

 

FACTS


The assessee had a sole proprietary business
of trading and export of medicines. The assessee had procured an order from the
Government of Ecuador for supply of medicines to 300 hospitals in Ecuador.

 

The assessee had hired a local agency of
Ecuador (FCo) to undertake various activities to fulfil the conditions of the
order. Such activities included liaising with the local authorities,
registration of products at Ecuador, export of goods to Ecuador, clearing of
goods from customs authorities, storage in warehouse, and physical delivery of
goods to various hospitals across the country; the assessee did not withhold
taxes on such payments.

 

Further, the assessee also made certain
payments towards market survey for new products or territory to other non-resident
entities (FCo1). However, it did not withhold tax while making payments for
such services.

 

According to the AO, since the services
rendered by FCo were specialised services in the field of pharmaceuticals, they
were covered within the expression “management technical or consultancy
services” used in Explanation 2 to section 9(1)(vii) of the Act. Since
the assessee had not withheld tax from such payments, the AO disallowed the
expenditure u/s. 40(a)(i) of the Act.

 

However, the assessee contended that payments
made to FCo and FCo1 did not accrue or arise in India and hence were not taxable in India. Aggrieved, the assessee appealed before
the CIT(A) who upheld the order of the AO.

 

Aggrieved, the assessee appealed before the
Tribunal.

 

HELD

  •     Section 9 of the Act
    defines FTS as any consideration for rendering of any ‘managerial, technical or
    consultancy services’, but does not include the consideration for any
    construction, assembly, etc.
  •     ‘Managerial’ service means
    managing the affairs by laying down certain policies, standards and procedures
    and then evaluating the actual performance in the light of the procedure so
    laid down. The ‘managerial’ services contemplate not only execution but also
    planning of the activity. If one merely follows directions of the other for
    executing a job in a particular manner without planning, it could not be said
    that the former is ‘managing’. Similarly, for ‘consultancy’ some consideration
    should be given to rendering of advice, opinion, etc.
  •     The activities of FCo included
    liaison with local authorities, registration of products in Ecuador, clearing
    of goods from customs, storage in warehouse and physical delivery of the goods
    to various hospitals across the country. The assessee necessarily had to carry
    out these activities to fulfil its obligation under the agreement with the
    Government of Ecuador. The assessee had appointed FCo to render these services
    and incur the expenses. The assessee had also not debited any other expenditure
    separately for these activities.
  •     Thus, the payments made to
    FCo were simplicitor reimbursement of actual expenditure as well as
    commission to FCo for performing the activities that the assessee was obligated
    to perform. All the services were rendered in Ecuador.
  •     Section 195 would apply if payment
    has an element of income. If there is no element of income, tax is not required
    to be withheld.
  •     In several decisions, High
    Courts as well as ITAT have held that the nature of services of foreign agents
    should be determined on the basis of the agreement. If they are services simplicitor
    for procurement of a contract and fulfilment of certain obligations like
    logistics, warehousing, etc., then such services could not be classified as
    technical, managerial or consultancy services.

 

However, as the expenses incurred by the
assessee towards market survey for new products or territory would provide the
assessee with information which would be used by the assessee for exploring new
business opportunity, provision of such information would thus qualify as
managerial, technical or consultancy services. Hence, the assessee was required
to withhold tax from payment made to FCo1.

 

Articles 4, 16 of India-USA DTAA; section 6 of the Act – in case of dual residency, residential status shall be determined by applying tie-breaker test under the DTAA

5. (2019) 104 taxmann.com 183 (Bangalore –
Trib)
DCIT vs. Shri Kumar Sanjeev Ranjan ITA No.: 1665 (Bang.) of 2017 A.Y.: 2013-14 Dated: 15th March, 2019

 

Articles 4, 16 of India-USA DTAA; section 6
of the Act – in case of dual residency, residential status shall be determined
by applying tie-breaker test under the DTAA

 

FACTS

The assessee, a US citizen,  was working in the USA since 1986. His spouse
and two children were all US citizens. The assessee was deputed to India by his
employer from June, 2006 to August, 2012. Upon completion of his assignment in
India, the assessee left India on 10.08.2012 and resumed his employment in the
USA. Since then he was residing with his family in the USA.

 

Prior to 1986, the assessee had lived in
India for 21 years. He relocated to the USA in 1986 and became a permanent
resident in 1992. After marriage, his spouse was also residing in the USA.
Their two children were born there. When he was on assignment to India, the
assessee was taking his vacations in the USA.

 

The assessee had a house in India as well as
in the USA. He had let out his house in the USA while he was on assignment to
India.

 

On the basis of his physical presence in
India, the assessee was a tax resident of India for FY 2012-13. The assessee
also qualified as a tax resident of the USA for FY 2012-13. During the period
11.08.2012 to 31.03.2013 the assessee earned a salary in the USA. According to
the AO, since the assessee was a tax resident in India during the relevant AY,
his entire global income, including salary earned in the USA, was liable to tax
in India. Hence, the AO sought to tax his salary in the USA for the period
11.08.2012 to 31.03 2013.

 

The assessee
contended before the AO that he should be considered a tax resident of the USA
under the tie-breaker rule of the India-USA DTAA on the basis that the assessee
furnished detailed particulars on different aspects[1]  to establish that his ‘centre of vital
interests’ was closer to the USA than to India. And to establish that his
habitual abode was in the USA, the assessee highlighted two aspects, namely,
time spent and intent of settling down in the USA on completion of the
assignment.

 

The AO, however, noted that:

 

  •     personal and economic
    relations refer to a long and continuous relation that an individual nurtures
    with a State;
  •     it could not be broken so
    casually into bits and pieces by claiming that on one day the assessee has an
    economic and personal relationship with State A and after a few days with State
    B;
  •     the concept of economic and
    personal relationship is a qualitative one which has to be analysed in a
    holistic manner rather than being compartmentalised;
  •     merely by moving to the USA
    for an assignment from 11.08.2012 to 31.03 2013, the assessee could not claim
    that his economic and personal relationships were suddenly closer to the USA
    than to India, particularly when during the preceding entire AY the assessee
    was present in India.

 

The AO, accordingly, did not accept the
contention of the assessee that his ‘centre of vital interests’ was in the USA.
He further rejected the concept of dual (or split) residency on the ground that
the Act or the India-USA DTAA did not recognise it. The assessee had claimed
exemption under Article 16 of the India-USA DTAA. The AO also rejected this
claim since the assessee had not furnished tax residency certificate.

 

On appeal before CIT(A), the assessee
furnished the tax residency certificate. The CIT(A) noted that the tax
residency certificate furnished by the assessee showed that he was also a tax
resident of the USA. Further, since the assessee had a permanent home in India
as well as in the USA, the CIT(A) applied the test of closer personal and
economic relations (‘centre of vital interests’) and concluded that the ‘centre
of vital interests’ of the assessee was closer to the USA than to India.
Accordingly, the CIT(A) held that the Assessee qualified for exemption under
Article 16 of the India-USA DTAA. Therefore, the AO could not tax the salary
income of the assessee earned in the USA in India.

 

HELD

  •     Article 4 of the India-USA
    DTAA determines the tax residential status of a person. Where a person is a tax
    resident of both the States, Article 4 provides certain tie-breaker tests:
  •     The first test pertains to
    the availability of a permanent home: The assessee had a house in India as well
    as in the USA. However, since he had let out his house in the USA, it was
    deemed to be ‘unavailable for use’. Hence, he did not satisfy the first test.
  •     The second test is about
    ‘centre of vital interests’. After examining various aspects, the CIT(A) had
    found that the ‘centre of vital interests’ of the assessee was closer to the
    USA than to India. The conclusion of the CIT(A) arrived at based on facts
    cannot be faulted.


[1] These were: (i)
where dependent members resided; (ii) where assessee had his personal
belongings such as house, car, personal effects, etc.; (iii) where assessee
exercised his voting rights; (iv) driving licence and vehicle tax payments; (v)
which country was ordinarily his country of residence; (vi) in which State the
assessee had better social ties; (vii) in which State the assessee

had
substantial investments, savings, etc.; (viii) in which State the assessee ultimately
intended to settle down; and (ix) in which State the assessee was contributing
to social security.

Section 45(4) read with section 2(14) – Receipt of money equivalent to share in enhanced portion of the assets re-valued by the Retiring Partners do not give rise to capital gain u/s. 45(4) read with section 2(14)

4. D.S. Corporation vs. Income Tax Officer
(Mum)
Members: P.M. Jagtap (V.P.) – Third Member I.T.A. Nos.: 3526 & 3527/MUM/2012 A.Y.s: 2006-2007 and 2007-2008 Dated: 10th January, 2019 Counsel for Assessee / Revenue: Dr. K.
Shivaram and Rahul Hakani / Ajay Kumar

 

Section 45(4) read with section 2(14) –
Receipt of money equivalent to share in enhanced portion of the assets
re-valued by the Retiring Partners do not give rise to capital gain u/s. 45(4)
read with section 2(14)

 

FACTS


The assessee, a partnership firm, was
originally constituted vide the deed of partnership entered into on 01.08.2005
with the object to carry on the business of real estate development and
construction. The firm was reconstituted from time to time. On 23.09.2005, the
assessee firm purchased a property at a suburb in Mumbai for a consideration of
Rs. 6.5 crore. After arriving at a settlement with most of the tenants
occupying the said property and obtaining permission of the competent authority
concerned for construction of a five-star hotel, the said property was revalued
at Rs. 193.91 crore as per the valuation report of the registered valuer. The
resultant revaluation surplus was credited to the capital accounts of the
partners in their profit sharing ratio. Two of the five partners retired from
the partnership firm, on 27.03.2006 and on 22.05.2006. On their retirement,
both these partners were paid the amounts standing to the credit of their
capital accounts in the partnership firm including the amount of Rs. 30.88 crore
credited on account of revaluation surplus.

 

According to the AO, there was transfer of
capital asset by way of distribution by the assessee firm to the retiring
partners in terms of section 45(4) of the Act and the assessee firm was liable
to tax on the capital gain arising from such transfer. According to the CIT(A)
there was no dissolution of partnership firm at the time of retirement, there
was only reconstitution of the partnership firm with change of partners.
Therefore, he held that the provisions of section 45 (4) were not attracted.

 

On appeal before the Tribunal, there was a
difference of opinion between the Accountant Member and the Judicial Member.
The Accountant Member relied on the decision of the Supreme Court in the case
of Tribhuvan G. Patel vs. CIT (236 ITR 515), wherein it was held that
even where a partner retires and some amount is paid to him towards his share
in the assets, it should be treated as falling under clause (ii) of section 47
of the Act. Accordingly, the Accountant Member held that payment of amount to
the retiring partner towards his share in the assets of the partnership firm
amounted to distribution of capital asset on retirement and the same falls
within the ambit of section 45(4). He held that use of the word “otherwise”
in section 45(4) takes within its ambit not only the case of transfer of
capital asset by way of distribution of capital asset on dissolution of the
firm, but also on retirement.

 

Further relying on the decision of the
Supreme Court in the case of CIT vs. Bankey Lal Vaidya (79 ITR 594) and
the decision of the Bombay High Court in the case of CIT vs. A.N. Naik
Associates (265 ITR 346)
, he upheld the addition made by the AO on account
of capital gain to the total income of the assessee firm by application of section
45(4), but only to the extent of surplus arising out of revaluation of property
which stood distributed by way of money equivalent to the retiring partners.
According to him, the balance addition made by the AO on account of capital
gain in the hands of the assessee firm on account of revaluation surplus
credited to the capital of the other partners, who continued and did not retire
during the years under consideration, could not be sustained as there was no
transfer or distribution of capital asset to those non-retiring partners.

 

According to the Judicial Member, however,
the cases relied upon by the Accountant Member were rendered on altogether
different facts and the ratio of the same, therefore, was not applicable to the
facts of the assessee. In the case of the assessee, except payment of money
standing to the credit of the partners’ capital account in the partnership,
there was no physical transfer of any asset by the partnership firm so as to
attract the provisions of section 45(4). He also relied on the decisions of the
Karnataka High Court in the case of CIT vs. Dynamic Enterprises [359 ITR 83]
and the Mumbai Tribunal in the cases of Keshav & Co. vs. ITO [161 lTD
798]
and Mahul Construction Corporation vs. ITO (ITA No. 2784/MUM/2017
dated 24.11.2017)
.

 

On account of the difference in opinion
between the members, the matter was referred to the Third Member, i.e., in
these facts and circumstances of the case, whether the money equivalent to
enhanced portion of the assets revalued constitutes capital asset and whether
there was any transfer of such capital asset on dissolution of the firm or
otherwise within the meaning of section 45(4) read with section 2(14).

 

Before the Third Member, the Revenue
contended that the assessee’s case was a clear case of transfer of right in the
land by the retiring partners to the continuing / incoming partners giving rise
to the capital gain. According to it, the decision of the Bombay High Court in
the case of A.N. Naik Associates and the decision of the Supreme Court in the
case of Bankey Lal Vaidya relied upon by the Accountant Member are relevant and
the same squarely cover the issue in favour of the Revenue.

 

HELD


According to the Third Member, the
partnership firm in the present case continued to exist even after the
retirement of two partners from the partnership. There was only a
reconstitution of partnership firm on their retirement without there being any
dissolution and the land property acquired by the partnership firm continued to
be owned by the said firm even after reconstitution without any extinguishment
of rights in favour of the retiring partners. The retiring partners did not
acquire any right in the said property and what they got on retirement was only
the money equivalent to their share of revaluation surplus (enhanced portion of
the asset revalued) which was credited to their capital accounts. There was
thus no transfer of capital asset by way of distribution of capital asset
either on dissolution or otherwise within the meaning of section 45(4) read
with section 2(14) of the Act.

 

According to him, the money equivalent to
enhanced portion of the assets re-valued does not constitute capital asset
within the meaning of section 2(14) and the payment of the said money by the
assessee firm to the retiring partners cannot give rise to capital gain u/s.
45(4) read with section 2(14). Accordingly, the Third Member agreed with the
view of the Judicial Member and answered both the questions referred to him in
favour of the assessee.

 

Section 251 – Power of enhancement conferred on CIT(A) can be exercised only on the issue which is the subject matter of the assessment. The CIT (Appeals), even while exercising its power for enhancement u/s. 251, cannot bring a new source of income which was not subject matter of assessment

12. (2019) 69 ITR (Trib) 261 (Jaipur) Zuberi Engineering Company vs. DCIT ITA Nos.: 977-979/JPR/2018 A.Y.s: 2012-13 to 2014-15 Dated: 21st December, 2018

 

Section 251 – Power of enhancement
conferred on CIT(A) can be exercised only on the issue which is the subject
matter of the assessment. The CIT (Appeals), even while exercising its power
for enhancement u/s. 251, cannot bring a new source of income which was not
subject matter of assessment

 

FACTS


The assessee was a
partnership firm and a contractor engaged in erection and fabrication work. The
assessment was completed making disallowances of various expenses claimed by
the assessee. On appeal, the Commissioner (Appeals) enhanced the assessment by
rejecting books of accounts and estimating higher net profit. On further appeal
to the Tribunal, the Tribunal allowed the assessee’s appeal and held as under.

 

HELD


The power of
Commissioner (Appeals) to enhance an assessment exists in section 251. However,
this power can be exercised only on the issue which is a subject matter of the
assessment. In the instant case, the issue of not accepting the books of
accounts was never taken up by the Assessing Officer in the scrutiny
proceedings. Therefore, the same did not constitute the subject matter of the
assessment. Consequently, it is beyond the scope of the power of enhancement
available with Commissioner (Appeals).

 

It is a settled proposition of law that the
Commissioner (Appeals), even while exercising the power for enhancement u/s.
251, cannot bring a new source of income which was not a subject matter of the
assessment. An issue or claim discussed / taken up in the course of assessment
proceedings becomes the subject matter of assessment but all the probable
issues that are capable of being taken up for scrutiny but are not so taken up
can at most collectively constitute scope of assessment, for which Commissioner
(Appeals) cannot exercise power of enhancement.

 

However, the
Commissioner can exercise revisionary powers in respect of the same subject to
fulfilment of conditions specified u/s. 263. Thus, in the instant case, since
the issue of rejection of books of accounts was not the subject matter of
assessment, the Tribunal set aside the order of the Commissioner (Appeals) qua
the issue of the power of the Commissioner (Appeals) to reject the books of
accounts.

Even in a limited scrutiny case there is no bar on the AO as regards adjudication of issues raised by the assessee

11. (2019) 69 ITR (Trib) 79 (Amritsar) Thakur Raj Kumar vs. DCIT ITA No.: 766/Asr/2017 A.Y.: 2014-2015 Dated: 29th November, 2018

 

Even in a limited scrutiny case there is no
bar on the AO as regards adjudication of issues raised by the assessee

 

FACTS


The assessee’s case was selected for complete scrutiny under
Computer-Assisted Scrutiny Selection. However, later, it was converted to
limited scrutiny to examine an issue pertaining to capital gains on securities.
The assessee had sold an agricultural land and offered relevant capital gains
to tax. However, in the course of assessment proceedings, the assessee made a
fresh claim to substitute the cost of acquisition of the land claimed by him in
return of income, for another value. The AO denied his claim citing that the
scrutiny being a limited one, he had no jurisdiction to discuss and pass
judgment on issues not covered within the reasons of scrutiny and the only
recourse available to the assessee was to file a revised return. On appeal to
Commissioner (Appeals), the issue was decided against the assessee. The
assessee therefore preferred an appeal to the Tribunal.

 

HELD


The Tribunal held
that though the AO has no jurisdiction to touch upon issues which are not a
subject matter of limited scrutiny, however, there is no bar to adjudicate the
issues raised by the assessee. This is because an AO is obliged to make correct
assessment in accordance with provisions of the law. Further, in terms of
Circular No. 14 dated 11.04.1955, the department cannot take advantage of
ignorance of the assessee to collect more tax than what is legitimately due.

 

The matter was,
thus, remanded to the file of the Assessing Officer to adjudicate the
assessee’s claim. Though the decision in Goetz (India) Limited vs. CIT
(2006) 284 ITR 323(SC)
was relied on by the D.R., the same does not seem to
be discussed by the Tribunal.

 

Section 54 – An assessee is entitled to claim deduction u/s. 54 if he purchases a new house property one year before or two years after the date of transfer of the original asset, irrespective of the fact whether money invested in purchase of new house property is out of sale consideration received from the transfer of original asset or not

10. (2019) 198 TTJ (Mum) 370 Hansa Shah vs. ITO ITA No.: 607/Mum/2018 A.Y.: 2011-12 Dated : 5th October, 2018

 

Section 54 – An assessee is entitled to
claim deduction u/s. 54 if he purchases a new house property one year before or
two years after the date of transfer of the original asset, irrespective of the
fact whether money invested in purchase of new house property is out of sale consideration
received from the transfer of original asset or not

 

FACTS


During the year,
the assessee had sold a flat jointly held with others and declared her share of
capital gain at Rs. 55,82,426. However, she claimed deduction of the capital
gain u/s. 54 of the Act towards investment made of Rs. 98,90,358 in purchase of
a new flat. The AO noted that the investment of Rs. 98,90,358 included housing
loan of Rs. 50 lakh availed from Citibank. The assessee submitted that the
housing loan was not utilised for the purchase of the new house. The assessee
had produced the loan sanction letter of the bank as well as bank statement to
demonstrate that the housing loan was disbursed much after the purchase of the
new house by the assessee. In fact, the assessee had also explained the source
of funds utilised in the purchase of the new house. However, the AO rejected
the claim of the assessee and reduced the housing loan from the cost of the new
house and allowed the balance amount of Rs. 48,93,358 towards deduction u/s. 54
of the Act. Accordingly, he made an addition of Rs. 6,92,068 towards long-term
capital gain.

 

Aggrieved by the
assessment order, the assessee preferred an appeal to the CIT(A). The CIT(A)
sustained the addition made by the AO.

 

HELD


The Tribunal held that even assuming that the housing loan was utilised
for the purpose of purchase of new house property, it needed to be examined
whether by the reason of utilisation of housing loan in purchase of new house
property, the assessee would not be eligible to claim deduction u/s. 54 of the
Act. For this purpose, it was necessary to look into the provisions of section
54. On a careful reading of the aforesaid provision as a whole and more
particularly sub-section (1) of section 54 of the Act, it became clear that the
only condition which required to be fulfilled was, one year before or two years
after the date of transfer of the original asset the assessee must have
purchased the new house property.

 

In case the logic of the department that for availing deduction the
consideration received by the assessee from the sale of the original asset had
to be utilised for investment in the new house property was accepted, the
provision of section 54(1) would become redundant because such a situation
would never arise in case assessee purchased the new house property one year
before the date of transfer of new asset.

 

Thus, on a plain
interpretation of section 54(1) of the Act, it had to be concluded that if the
assessee purchased a new house property one year before or two years after the
date of transfer of the original asset, he was entitled to claim deduction u/s.
54 of the Act irrespective of the fact whether money invested in the purchase
of the new house property was out of the sale consideration received from transfer
of original asset or not. In the present case, the assessee had purchased the
new house property within the stipulated period of two years from the date of
transfer of the original asset. That being the case, the assessee was eligible
to avail deduction u/s. 54 of the Act.

Section 12A read with section 11 and 12 – Where return of income had been filed in response to notice u/s. 148, requirement u/s. 12A filing of return of income stood fulfilled

9. [2019] 198 TTJ (Chd) 498 Genius Education Society vs. ACIT ITA No.: 238/Chd/2018 A.Y.: 
2012-13 Dated: 20th August, 2018

     

Section 12A read with section 11 and 12 –
Where return of income had been filed in response to notice u/s. 148,
requirement u/s. 12A filing of return of income stood fulfilled


FACTS


The assessee applied for registration u/s. 10(23C)(vi) which was denied
by the Chief Commissioner. The assessee had also applied for registration as a
charitable society u/s. 12AA on the same day which was granted by the Principal
Commissioner, with effect from 01.04.2012 effective from assessment year
2013-14. Subsequently, the Assessing Officer (AO) noticed that for the impugned
assessment year, no return of income had been filed by the assessee and the
assessee’s application for approval u/s. 10(23C)(vi) had been rejected.
Consequently, reopening proceedings were initiated by issuing notice under section
148. In response to the same, the assessee filed Nil return of income. During
assessment proceedings, the assessee contended that having been granted
registration u/s. 12AA effective from assessment year 2013-14, the benefit of
the same was available to it in the impugned year also by virtue of the first
proviso to section 12A(2).

 

Aggrieved, the
assessee preferred an appeal to the CIT(A). The CIT(A) upheld the order of the
AO, holding that benefit of second proviso was not available to the assessee since
in the present case the assessee was ineligible to claim exemption not on
account of absence of registration u/s. 12A, but because of the fact that
assessee had failed to file its return of income and report of audit, as
required under the provisions of section 12A(b).

 

HELD


The Tribunal held
that it was not the case of the Revenue that the reopening was valid on the
ground of absence of registration u/s. 12A for the impugned year, therefore
making its income taxable. In fact, the CIT(A) had accepted that reopening
could not have been resorted to on account of absence of registration u/s.12A
for the impugned year on account of the second proviso to section 12A(2).
Therefore, the contention of the assessee on this count was accepted by the
Revenue. But the argument of the Revenue was that because the assessee failed
to comply with the conditions of section 12A(1)(b) which was necessary for
claiming exemption u/s. 11 and 12, its income for the impugned year was
taxable, which had thus escaped assessment and, therefore, the reopening was
valid. The said conditions, as pointed out by the CIT(A), were the filing of
return of income accompanied with the report of an auditor in the prescribed
form.

 

The requirement of filing of return of income and the report of audit
have been specified for being eligible for claiming exemption u/s. 11 and 12
along with the grant of registration u/s. 12AA. The section nowhere prescribed
the filing of return by any due date, therefore the findings of the CIT(A) that
the assessee having not filed its return within the prescribed time it had
failed to comply with the requirement prescribed, was not tenable. As for the
requirement of filing report of audit in the prescribed form, the said
condition has been held by courts to be merely procedural and, therefore,
directory in nature and not mandatory for the purpose of claiming exemption
u/s. 11 and 12.

 

Therefore, in view
of the above, no merit was found in the argument of the Revenue that the
assessee was not eligible for exemption u/s. 11 and 12 on account of not having
complied with the requirements of section 12A(1)(b). Since this was the sole
basis for upholding the validity of the reassessment proceedings, it was noted
that the reassessment in the present case was invalid, on account of the second
proviso to section 12A(2) which specially debarred resort to the same in view
of registration having been granted from the immediately succeeding assessment
year. The reassessment framed was therefore set aside and the addition made was
deleted.

 

Sections 10(37), 45 – Interest on enhanced compensation received from government on compulsory acquisition of agricultural land is exempt u/s. 10(37) of the Income-tax Act, 1961 and consequently TDS deducted on account of enhanced compensation was liable to be refunded

8. [2019] 104 taxmann.com 99 (Del) Baldev Singh vs. ITO ITA No.: 2970/Del./2015 A.Y.: 2011-12 Dated: 8th March, 2019

 

Sections 10(37), 45 – Interest on enhanced
compensation received from government on compulsory acquisition of agricultural
land is exempt u/s. 10(37) of the Income-tax Act, 1961 and consequently TDS
deducted on account of enhanced compensation was liable to be refunded

 

FACTS

The assessee, in
the return of income filed by him, claimed exemption u/s. 10(37) of the Act in
respect of enhanced compensation of Rs. 4,69,20,146, received by him during the
previous year in respect of agricultural land inherited by him from his
parents.

 

During the course
of assessment proceedings, the Assessing Officer (AO) observed that the said
compensation of Rs. 4,69,20,146 comprised of Rs. 2,70,33,074 as principal and
balance Rs. 1,98,85,972 as interest and TDS amounting to Rs. 93,84,030 was
deducted, out of which Rs. 74,45,433 was refunded to the assessee and credited
to his account.

 

The AO, based on
the amendments made in sections 56(2), 145A(b) and 57(iv) of the Act which were
applicable with effect from 1.04.2010 held that interest on enhanced
compensation was liable to be taxed as income in the year in which it was
received, irrespective of the method of accounting followed and accordingly
taxed Rs. 99,42,986 being the interest received after allowing 50% deduction.

 

Aggrieved, the
assessee preferred an appeal to the CIT(A). In the appellate proceedings before
CIT(A) it was contended that the Supreme Court has in CIT vs. Ghanshyam Dass
(HUF) [2009] 315 ITR 1
held interest on enhanced compensation to be a part
of compensation and therefore the same is exempt u/s. 10(37) of the Act. This
decision of the Supreme Court in CIT vs. Ghanshyam Dass (HUF) (supra)
has been followed in the case of CIT vs. Gobind Bhai Mamaiya [2014] 367 ITR
498 (SC)]
. The CIT(A) upheld the action of the AO and observed that the
decision of the Supreme Court in the case of Gobind Bhai Mamaiya (supra)
did not deal with exemption u/s. 10(37) of the Act but held that interest u/s.
28 of the Land Acquisition Act is interest on enhanced compensation and is to
be treated as an accretion to the value and part of compensation. He held that
the decision of the SC in Gobind Bhai Mamaiya (supra) is not applicable
to the facts of the case.

 

Aggrieved, the
assessee preferred an appeal to the Tribunal.

 

HELD

The Supreme Court
has, in Union of India vs. Hari Singh [(2018) 254 Taxman 126 (SC)]
relied by the assessee, set aside the matter to the AO and specifically directed
the AO to examine the facts of the case and apply the law as contained in the
Act. The SC also directed the AO to find out whether the land was agricultural
land and if that be the case then the tax deposited with the Income-tax
Department shall be refunded to the assessee.

 

The Tribunal
observed that the CIT(A), in his order, did not state that an amount shall be
brought to tax u/s. 45(5) without applying provisions of section 10(37) of the
Act which exempts receipts from being taxed. The Tribunal held that section
45(5) did not make reference to the nature of property acquired but dealt with
the category of cases which fell within the description of “capital assets”.
However, section 10(37) specifically exempted income chargeable under the head
capital gains arising from transfer of agricultural land. It was therefore
clear that the Supreme Court specifically directed the AO to examine if the
compensation received was in respect of the agricultural land, (and if so) the
tax deposited with the Income-tax Department shall be refunded to the
depositors.

 

The Tribunal,
therefore, following ratio laid down by the Supreme Court in the case of CIT
vs. Ghanshyam Dass (supra) and Union of India vs. Hari Singh (supra)
directed the AO to refund the TDS amount deducted on account of enhanced
compensation.

 

The Tribunal
allowed the appeal filed by the assessee.