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Critical Analysis

A recent decision of the Supreme Court in All India Haj Umrah Tour Organizer Association Mumbai vs. UOI¹ (‘AIHUTO’ case) did not prima-facie seem to unsettle legal positions framed over the history of indirect tax legislation. Probably, the limited macro scope failed to generate enough traction for the decision to be scrutinised further. Yet, a more critical analysis of the decision would suggest a missed opportunity to decide on certain basic tax principles which could have resolved fundamental issues of the law. To appreciate this viewpoint, we may delve into the details and respectfully examine the missed pointers.

BACKGROUND

The issue cropped up on account of a tax exemption being granted to Haj pilgrims who availed services through the ‘State Run Haj committees’ and hence having a visible saving compared to the services being offered by Private Tour Operators (HGOs/PTOs). The simple grievance of the PTOs was that they are being discriminated against despite all the services provided by Haj Committees and PTOs being identical. The PTOs approached the Courts on this matter and were rightly directed to the GST council for making appropriate representations on such policy matters, which was rejected by the GST council based on the recommendation of the Fitment committee. Petitions were filed by PTOs before the Apex Court challenging the said decision.

CASE SUMMARY

PTOs render Haj package services to pilgrims, which involve (a) return air ticket booking; (b) hotel accommodation at Saudi Arabia; (c) catering activity during the Haj; (d) ancillary services such as foreign exchange, local travel, etc. India and Saudi Arabia, through a bilateral agreement, agreed to regulate the Haj pilgrimage for smooth conduct of the Haj by Indian pilgrims. A limited quota of families is permitted to perform the Haj on a yearly basis based on the bilateral arrangement. Internally, India has enacted the Haj Committee Act, 2002 and set up the Haj Committee to allocate the seats to the Haj and assign licenses to PTOs to render private tour operator services based on their allotted quota. Haj Committee itself provides Tour operator services on a nonprofit basis to pilgrims through a lottery system, thereby enabling pilgrims to perform their Haj. The only difference between the tour operator services provided by Haj Committee and PTOs is that while the former is a non-profit organisation, the latter conducts business with the profit motive.

1. 2022-VIL-39-SC

CONCLUSION

The Court held as follows:

– Question of whether the service is extra-territorial cannot be examined as the matter is pending before another Bench;

– The list of decisions on the beneficial or strict interpretation of exemptions need not be examined since there is no ambiguity on the scope of the exemption. The exemption is limited to either (a) religious ceremonies or (b) a specified list of organisations; Tour operator services do not fall into either of the above;

– Exemptions being a matter of policy, the exclusion of other organisations (PTOs in this case) from the exemption list does not make the law discriminatory; and

– Tour operator services are not ‘event-based/ performance-based services’, and the place of supply is based on the default rule of ‘ordinary residence of recipient’, and hence a domestic service.

OUR ANALYSIS

The decision could be analysed under four heads (a) Extra-territoriality, (b) Place of Supply, (c) Discrimination, and (d) Scope of exemption. Detailed arguments under each of these heads have been documented below. The relevant legal provisions are extracted for ready reference:

GST exemption entry² under contention was as follows:

Heading
9963;

9972;
9995;

Services
by a person by way of- (a) conduct of any religious
ceremony ………..

Heading
9991

Services
by a specified organisation in
respect of a religious pilgrimage facilitated by the Government of India,
under bilateral arrangement.

Place of Supply (‘POS’) Entry – The relevant POS entries before the Court:

Default Rule – (2) The place of supply of services, except the services specified in sub-sections (3) to (14), …………. shall be the location of the recipient

Event Based Rule – (7) The place of supply of services provided by way of,—

(a) organisation of a cultural, artistic, sporting, scientific, educational or entertainment event including supply of services in relation to a conference, fair, exhibition, celebration or similar events; or

(b) services ancillary to organisation of any of the events or services referred to in clause (a), or assigning of sponsorship to such events:
…………
(ii) to a person other than a registered person, shall be the place where the event is actually held and if the event is held outside India, the place of supply shall be the location of the recipient.

Passenger Transportation Service – (9) The place of supply of passenger transportation service to, ………..

(b) a person other than a registered person, shall be the place where the passenger embarks on the conveyance for a continuous journey

2. Service Tax exemption entry in Notification 25/2012-ST dt. 20.06.2012 is pari materia with GST exemption entry except to the extent of SAC numbering and inter-relation with the SAC schedule.

Extra-territoriality

The taxpayer contended that Haj Pilgrimage commences from India; involves organising the activity of the Haj at an overseas location; is substantially performed outside India, and hence extra-territorial in nature. The Bench declined to consider this argument since a similar issue was pending before another Bench.

One may perceive that the Court could have addressed this submission to a certain extent since this would have formed the foundation of the entire decision. Alternatively, the Court could have kept the matter pending until the referred Bench resolved the territoriality issue. A tax levy can be crystallised only after crossing the jurisdictional threshold. The Court has ventured into ‘place of supply’ provisions oriented towards ascertainment of India’s tax jurisdiction. Deciding on the place of supply after settling the territoriality subject may have induced some more robustness into the decision.

We know that Article 269 provides levy and collection of taxes on goods or services supplied in the course of inter-state trade or commerce, including the importation into India. Parliament has been empowered to formulate the principles for ascertainment of supply which takes place in inter-state trade or commerce. One could interpret the provisions of sections 7 to 13 to ascertain the place of supply (i.e. legal situs) for ascertainment of India’s taxing jurisdiction. The overall fabric of the provisions indicates that the taxes would be payable depending on the likely consumption of goods or services. Time and again, Courts³ and Government FAQs have stated that GST/ service tax is intended to be a ‘destination-based consumption tax’ – implying that the attempt should be to reach the destination of consumption of the economic activity proposed to be taxed.

3. AIFTP vs. UOI 2007 (7) S.T.R. 625 (S.C.); AL&FS vs. UOI 2010 (20) S.T.R. 417 (S.C.)

In the present facts, the Court could have considered applying this principle to tour operators whose services are conducted across jurisdictions. The special feature of a tour operator service is that while the service could be agreed upon in India, the actual performance and benefit of the service taxes place both in and outside India. Thus, such services have the possibility of multiple situs for each element (e.g. boarding/ catering outside India, overseas travel, etc.).

The Act has already adopted the attribution mechanism in certain cases. Special provisions have been made for attribution of value of Government advertisement contracts to each state to which the advertisement relates. The IGST Rules have attempted to closely approximate the consumption based on certain public information – e.g. advertisement through internet has been guided by TRAI⁴ published information of internet subscribers in concerned states; television has been guided by BARC⁴ published subscriber base; and train advertisements are apportioned based on distance travelled in each state and published by Indian Railways. The target consumers in each state have been adopted as the basis of likely consumption in a State. Moreover, the GST council, in its 47th meeting, made changes in the rate notification by acknowledging that tour operators rendering services to foreign tourists are liable to be taxed only on the appropriate portion of the tour conducted in India.

Thus, there was reasonable guidance within the law to apportion the consumption of a single service into various jurisdictions based on reasonable parameters. While the law has provided similar parameters for a limited category of services (such as immovable property, event-related and some performance-based services), the provisions do not address the entire gamut, especially the services which are governed by the default rule (i.e. place of recipient).

The taxpayer’s expectation from the Court is whether a direction could have been made to the Council to develop logical parameters or alternatively mandate the taxpayer to provide a reasonable parameter for examination, subject to approval by the Revenue. This would have formed a precedent of approximating the value of service rendered at multiple locations and limiting the powers of a state to tax activities only within its geographical jurisdiction. Other sectors would have benefitted from an established principle and taken a cue to adopt reasonable parameters to affix the place of supply of such multi-locational services.

The extra-territoriality issue could also have been addressed based on the decision in the recent Mohit Mineral’s case⁵. In that case, the Court adopted the presence of ultimate beneficiary of ocean freight service and/or destination of import goods as having sufficient nexus with India to extend its tax net. The Court went on to state that the recipient of service should be understood in the backdrop of the location of consumption of the goods/ services and not by strict application of contractual understanding of the recipient. The Court implied that economic consumption of a service should be identified based on location of the person who benefits from the service rather than the person who has demanded the service (which could be different persons). Thus, the Apex Court itself enforced the consumption principle through a nexus theory and diluted the literal definition of ‘recipient’ under law.

4. Telecom Regulatory Authority of India; Broadcast Audience Research Council
5. 2022 (61) G.S.T.L. 257 (S.C.) UOI vs. Mohit minerals Pvt. Ltd.

In the current case, the Court could have relied upon the said theory and ascertained whether the transaction between Indian residents (Tour operator and pilgrim) for services/ events occurring substantially outside India is liable to tax ‘entirely’ in India. Though section 12 of the Act applied to such transaction, the fact of rendition of service outside India (e.g. lodging, catering, local travel) could have had a bearing on the consumption of the service. Applying the analogy from Mohit Mineral’s case, the interpretation of the recipient and its locational benefit across multiple jurisdictions could have been taken up with the Court. The perspective of cross-border dual taxation on account of foreign jurisdiction taxing them as per local laws could have also been examined (refer to subsequent discussions under POS). Either way, the taxpayers would have rejoiced with answers to these issues for application in their respective sectors.

Place of Supply

This issue is a fall-out from the extra-territorial subject, and its analysis would have two facets – (i) Whether the Court could have elaborated on the ‘location of recipient’ and ‘POS rule’; and (ii) Whether certain important concepts could have been addressed prior to applying the POS rule.

The taxpayer contended that substantial activities in respect of the Haj were performed outside India. Since the event was for unregistered persons, the location of the recipient ought to be ascertained at the time of performance of the Haj, which is outside India. The recipient’s location at the time of consumption of the service plays an important role in fixing the location and assess the territoriality of the subject. The literal wording of the definition of ‘location of recipient’ fixes the situs to the ‘usual residence’ of the person. Section 12 does not address cases where supplier and recipient contract to render/ receive a service at a foreign location. It merely fixes the location of both parties and assumes that in all cases that the service is rendered at the usual place of residence in India. Similarly, section 13(6) artificially taxes the entire services in India despite a minuscule proportion of the service being rendered in India and a substantial portion being outside India.

The Counsel may have persuaded the Court to assess the provisions in the context of the type of service being rendered. Consumption of certain one-time services (such as catering, foreign travel, etc.) at foreign location would be misconstrued by mere literal application of wordings. The preceding rules of location of service recipient and provider attempt to identify the location in multi-locational entities to the establishment which is consuming the service (directly concerned). If this is the case, then in a hierarchical provision, the residual rule ought to have also been interpreted in the same light. The Court could have been persuaded to look through the literal wordings to address the consumption principle underlying the law.

The Counsel probably hinted at the larger impact of such a literal application. Foreign jurisdictions would apply the consumption principle and tax those services in their jurisdiction, while India would simultaneously tax the same on the residence principle. While direct tax laws applied the source/ residence principle, they were protected through the double taxation agreements, which minimised dual taxation; VAT laws across nations are not governed by such bilateral arrangements. It is therefore even more imperative to be guided strictly by source / consumption rules so that tax economies do not trespass each other’s territories. These critical concepts (on economic double taxation, fixation of situs, etc.) could have formed part of the reasoning of the Court.

On certain other arguments, the Court rejected the application of the event-based rule on the ground that ‘religious events’ are not specified in the list therein. The Court stated that even by application of the rule of ejusdem generis, the performance of Haj is not an ‘event’ and hence not falling within the domain of event-based rule. The default rule would be applicable since the individual is a resident of India, and the location of such service recipient would necessarily be in India. The taxpayers cannot dissect each step or service task and claim that the location of the recipient during the Haj is outside India and the place of supply is outside India.

The rule of ejusdem generis is applicable when a term is not specified in the series of terms but is intended to be encompassed in a more generic term. It attempts to identify a common thread in a series of terms under a common family. An event (sports, cultural, etc.) is generally a congregation of persons with a common purpose. Haj is a religious event when Muslims across the world visit the holy place, offering their prayers at the said location. Respectfully, the Court could have made a liberal conclusion to the generic term under this rule. However, it turned out that the Court stated that ‘religious events’ are not specified in the provision, and hence the rule of event-based activities cannot be applied to such Haj ceremonies.

While one may be critical of the Court rejecting the event-based rule to religious events, the end conclusion seems to be correct in the overall scheme. The appropriate rationale of the Court could have been that the provisions of event-based services are applicable only to ‘Event organisers’ and not to associated persons who provide services to the participants. PTOs are neither organisers of the event nor render services to the organisers of the event. They render services only to the participants of the events. Eventually, the rule would be held inapplicable but with a different analogy. Going by the current analogy, Revenue may contend even in cases of ‘Event organisers’ of religious events, that they are entirely out of the said event-based rule and hence liable to tax under the residence rule.

The intriguing concept which could have been placed before the Court was the interplay of composite supply with the POS provisions. The Court relied on the default rule and the passenger transportation rule for ascertainment of the POS for the tour operator service. Now section 8 of CGST law r.w.s.20(ii) of the IGST Act clearly directs the tax liability to be ascertained based on the concept of composite/ mixed supply (i.e. either principal supply or highest taxed rate supply, respectively). Tour operator services are classifiable as an individual supply under HSN 99855 though it involves elements of travel, accommodation and other ancillary services. The POS provisions are not strictly aligned with the HSN scheme of classification and adopt a more descriptive approach to services.

Therefore, two contrasting theories could exist while interplaying the POS and composite supply provision (A) one theory could be that composite supply principles are applicable for the entire enactment and once the principal supply has been identified, all legal consequences including POS would follow the principal supply with other ancillary supplies being irrelevant – applying this analogy, the Court rightly applied the default rule of location of recipient since tour operator services are not specifically mentioned in the subsequent rules; (B) the other theory could be that composite supply principles are independent of POS, the POS should be examined independently for identifiable elements (i.e. travel, accommodation, etc.) and the transaction should be segregated for each of these elements. While this dissection would certainly create some chaos on valuation, taxability and other procedural challenges, it would represent an accurate application of the consumption theory. The Counsel pursued this argument, but the Court rejected any kind of dissection of the tour package.

There appears to be a simultaneous application of both theories in the decision. The Court, after application of the residence rule, also went ahead with applying the POS rule for passenger transportation services. It conveys that both theories could be applied simultaneously for ascertaining the POS of services, i.e. once as a Tour operator under the default rule and another as passenger transportation activity (being an ancillary element of the tour operator activity). This gives the reader an impression that elements of a service could be dissected, and POS provisions could be applied independently to them. The Court could have addressed this concept with some more detail to assist the entire trade on this critical subject.

Discrimination

This has probably been the most vehemently argued point of the taxpayer. The exemption was applicable only to tours conducted by Haj Committee, being the ‘specified organisation’ under the entry. Consequently, PTOs which also operated under the same enactment were denied this exemption since they did not feature in the specified list. The PTO’s main contention was that all the tour activities organised by them and the Haj Committee in respect of Haj pilgrims are identical, except to certain minor features such as pricing, catering and proximity of boarding to the Haj. These activities not being significant in the whole scheme of the tour and by themselves do not disentitle them from the exemption. The points of similarity recorded in the decision were:

a. The tours were conducted by both organisations under the Bilateral arrangement with Saudi Arabia.

b. 70% quota was allotted to be organised by Haj Committee, and the balance 30% was allotted to PTOs.

c. All sub-activities of the Haj are identical (i.e. travel, accommodation, tour planning, etc.).

d. Haj ceremony was common under the Holy Quran, and both organisations were to abide by the entire procedure.

Thus, being an indirect tax legislation, the object of the entry is to provide cost-effective travel to the Haj Muslims and this object would be defeated if exemption is limited only to Haj Committees and not extended to PTOs. Hence, the said exemption entry was violative of Article 14 of the Constitution.

The Court provided a very thorough reasoning to refute this line of argument. The Court examined the Haj Act and the roles / responsibilities assigned to the Haj Committee under the enactment. It was acknowledged that the said committee operated with a democratic set-up with the objective of a smooth Haj operation under the bilateral arrangement and overall welfare of the pilgrims. Though Haj Committee operated as tour operators, other responsibilities were entrusted upon them, and the funds generated from such tour operations were to be used for the very same purpose. PTOs, on the other hand, operated as a commercial venture as against Haj Committees, which were non-profit organisation under the control and supervision of the Government. Thus, the Government was justified in limiting the exemption only to specified service providers rather than giving a blanket exemption. There was clearly an intelligible differentia in classifying the Haj committee under a separate basket and limiting the exemptions only to Government controlled entities or instrumentalities. The GST council’s deliberation established a rational basis of differential treatment and could not be found fault with. The legislature and/ or the Government have wider latitude on economic matters, and the ‘sufficiency of the satisfaction’ of the Government in granting exemption in the public interest is not the domain of Courts and is a policy matter left best to the Government to decide.

The question of discrimination is a constitutional issue and could have multiple facets. For tax laws, benefits could be extended by law on account of nature/composition of activity, the status of supplier/ recipient, location of the supply, end use etc. Each benefit could be touching upon a particular facet of the service. In the subject exemption entry, the taxpayer vehemently argued that the taxation being on the service activity, discrimination based on the class of service provider is not permissible and amounts to treating equals as unequal. The Counsel probably implied that supply being the core subject matter, differential treatment based on other parameters such as status of the supplier, etc. would be discriminatory treatment.

The Court rightly stated that the Government has the prerogative to decide the organisation to which the exemption is granted, especially if there is an intelligible differentia and reasonable classification has been attributed to the said decision. In the context of Haj committees, the Court relied upon a decision of the Customs law which upheld the exemptions to State Trading houses and denied the same to other importers. The Court upheld that PTOs and the Haj Committee as separate classes since the latter were Government controlled organisations with a non-profit motive and aimed at furthering the cause of the statute under which they were constituted.

Another discriminatory point which could have been placed before the Court was whether an Indian resident availing services through an operator for hotel accommodation by making a booking from India vis-à-vis the very same Indian resident availing the accommodation services at the hotel counter, be treated differently. This differentiation will be applicable to all overseas services which are booked from India. The service provider, nature of service and location of the service are identical in both scenarios. Yet, the mode of booking makes the former taxable and the latter nontaxable in India. Similarly, the GST council has recently proposed the introduction of a mechanism to assess the tax only on a portion of the tour of foreign tourists conducted in India. This apportionment has not been extended to converse scenarios where an Indian tourist makes a foreign tour which is naturally conducted outside India. Couldn’t this be a point of discrimination to an Indian tourist who conducts a tour outside India and yet taxed on the entire overseas leg?

One may note that while taxpayers can raise these as grievances of discrimination, the Court has been sceptical on this subject. Ideally, a ruling considering the overall economic and legal impact may have paved for some clarity on this principle. The takeaway has been that Article 14 cannot be adopted in a straitjacket manner, and persistent inclination to argue discrimination should be cautiously adopted in tax legislations.

Scope of Exemption

The taxpayer argued that the exemption should be interpreted to state that Haj is a religious ceremony and hence the consumer should not bear the burden of tax. It was also submitted that Supreme Court’s decision in Dilip Kumar’s case⁶ was placed in the right perspective in the latter decision in Mother Superior Adoration Convent⁷. The Supreme Court in Dilip Kumar’s case, did not just state that exemption entries are an exception and hence should be interpreted strictly. The Court also acknowledged that the beneficial purpose should not be lost sight of while interpreting such entries. The taxpayer argued that the entire activity was being conducted with the ultimate objective of performing a ‘religious ceremony’. Since all the services are directed towards this religious ceremony, the exemption entry should be accordingly extended to preparatory activities including Haj tours. A tax impost would be passed on to Haj pilgrims; therefore, the object of granting exemption and reducing the financial burden on religious pilgrimage, would not be fulfilled. Beneficial exemptions are to be interpreted to further achieve the beneficial object of performing the religious ceremony. Thus, the exemption should be granted to PTOs who were assisting in the entire Haj tour.

6. 2018 (9) SCC 1 – 2018-VIL-23-SC-CU-CB

7. 2021 (5) SCC 602 – 2021-VIL-43-SC

The Court subtly acknowledged that beneficial exemption entries should be examined from the perspective of the beneficial object. But this approach should be adopted only when the exemption entry is ambiguous, leading to alternative interpretations. Where the exemption entry itself is restrictive, it would be impermissible for the Court to expand the said entry. In the current case, the exemption entry is crystal clear that the same would be limited to ‘specified organisations’. If the intention and object were to provide an exemption to services provided by PTOs in respect of religious pilgrimage, the notification would have specifically provided so. Moreover, the exemption as regards ‘religious ceremony’ has been confined only to persons conducting the ceremony, and PTOs are not rendering the service of ‘conducting religious ceremony’. They are assisting in making a travel package and completing the Haj but are not themselves conducting the religious ceremony. Thus, the exemption entry was targeted to a particular ‘service provider’ rendering a ‘specific service’. Both conditions were essential ingredients of the exemption, and the Court rightly rejected any attempt to dilute the former condition. There did not exist any ambiguity in the exemption entry for one to seek applying the beneficial object principle cited in earlier decisions of the Court.

CONCLUSION/ WAY FORWARD

To reiterate, the outcome of the decision may have been commensurate with the overall position in law. Courts are burdened with a huge pendency, and matters reach finality only after certain decades. In this scenario, taxpayers expect legal clarity rather than falling victim to ambiguity. The never-ending dilemma of applying literal wordings or legal intent has haunted taxpayers and professionals. With such a background, it is generally expected that any opportunity of clarifying the law should not be missed and a decisive verdict be rendered so that Courts/ businesses are not further burdened with litigation on tax demands.

shailesh.kwebmaker

S. 148A(d) – Reopening of assessment – Impugned SCN as well as the impugned order u/s 148A(d) of the Act are based on distinct and separate grounds – Information referred in SCN not provided to Assessee

11 Best Buildwell Private Limited vs. Income Tax Officer, Circle 4 (2), Delhi & Anr.
W.P.(C) 11338/2022
Date of order: 1st August, 2022
Delhi High Court

S. 148A(d) – Reopening of assessment – Impugned SCN as well as the impugned order u/s 148A(d) of the Act are based on distinct and separate grounds – Information referred in SCN not provided to Assessee

The petitioner challenged the order dated 30th March, 2022 passed u/s 148A(d) and notice dated 31st March, 2022 issued u/s 148 as well as show cause notice (SCN) dated 16th March, 2022 issued u/s 148A(b) for A.Y. 2018-19.

The petitioner states that the petitioner had filed its return of income for A.Y. 2018-19 declaring an income of Rs. 6,32,45,180 and a loss of Rs. 74,36,185. He states that the case of the petitioner was picked up for scrutiny, and after examination of all the submissions of the petitioner, an assessment order dated 27th April, 2021 u/s 143(3) r.w.s 144B was passed assessing the income of the petitioner at Rs. 6,41,76,500. He points out that one of the points for selecting the petitioner’s case for scrutiny was ‘Business Purchases’, and after analysing the documents submitted by the petitioner, no additions were made by the Assessing Officer on account of business purchases.

The petitioner states that the impugned SCN dated 16th March, 2022 issued u/s 148A(b) did not provide any information and/or details regarding the income that has been alleged to have escaped assessment. He states that the petitioner filed a response to the impugned SCN dated 16th March, 2022, specifically requesting the respondent to provide the details of the transaction and vendors from whom the petitioner had made purchases and raised invoices which respondent No.1 considered bogus. He further states that respondent No.1 failed to consider the fact that the petitioner had made purchases from vendors who were registered under GST and had claimed an input tax credit of GST on the purchases made from them as per statement 2A reflected on the GST portal based on the invoices raised by the vendors. He points out that the credit claimed by the petitioner has not been rejected.

The petitioner states that the impugned order dated 30th March, 2022 u/s 148A(d) merely relies on an alleged report prepared against the assessee company. He emphasises that no such report was ever furnished to the petitioner.

On behalf of the respondents, it was stated that notice u/s 148A(b) had been issued in the present instance as the petitioner’s ITR and GST Data did not reconcile. He also states that the analysis of GST information of third parties reveals substantial routing of funds by way of bogus purchases.

In rejoinder, the petitioner states that the impugned order passed u/s 148A(d) does not refer to any lack of reconciliation between the ITR and GST data of the petitioner. He also states that no GST information showing substantial routing of funds was ever furnished to the petitioner.

The Court observed that the impugned SCN, as well as the impugned order u/s 148A(d), are based on distinct and separate grounds.

The SCN primarily states that “it is seen that the petitioner has made purchases from certain non-filers”. However, no details or any information about these entities was provided to the petitioner. It is not understood as to how the petitioner was to know which of the entities it dealt with were filers or non-filers!

Further, the impugned order states that a report was prepared against the petitioner-company, which concludes that the assessee had shown bogus purchases from bogus entities to suppress the profit of the company and reduce the tax liability from 2015-16 to 2020-21. However, no such report which forms the basis for the ‘information’ on which the assessment was proposed to be reopened had been provided to the petitioner. In fact, there are no specific allegations in the SCN to which the petitioner could file a reply.

Keeping in view the aforesaid, the impugned order dated 30th March, 2022 passed u/s 148A(d) and notice dated 31st March, 2022 issued u/s 148 are quashed, and the respondents are given liberty to furnish additional materials in support of the allegations made in the SCN dated 16th March, 2022 within three weeks including reports, if any. Thereafter, the AO shall decide the matter in accordance with the law. The writ petition was disposed.

shailesh.kwebmaker

S. 148A r.w.s. 149 – Reopening of assessment – A.Y. 2014-15 – Effect of SC Judgement in case of Ashish Agarwal dated 4th May, 2022 and Board’s Circular dated 11th May, 2022 – Where the income of an assessee escaping assessment to tax is less than Rs. 50,00,000 – Reopening not justified

10 Ajay Bhandari vs. Union of India & 3 Ors.
Writ Tax No. 347 of 2022
Date of order: 17th May, 2022
Allahabad High Court

S. 148A r.w.s. 149 – Reopening of assessment – A.Y. 2014-15 – Effect of SC Judgement in case of Ashish Agarwal dated 4th May, 2022 and Board’s Circular dated 11th May, 2022 – Where the income of an assessee escaping assessment to tax is less than Rs. 50,00,000 – Reopening not justified

The impugned notice u/s 148 of the Income Tax Act, 1961, for A.Y. 2014-15 was issued to the petitioner by respondent no. 3 on 1st April, 2021. The “reasons to believe” recorded by respondent no. 3 for issuing the impugned notice, read as under:

“I have reason to believe that an income to the tune of Rs. 2,63,324 has escaped assessment for the aforesaid year”.

The reassessment order dated 31st March, 2022 has been passed by respondent no. 4, i.e. National Faceless Assessment Centre, Delhi u/s 147 r.w.s.144B.

The Additional Solicitor General (ASG) of India relied on the judgement of Hon’ble Supreme Court under Article 142 of the Constitution of India in Civil Appeal No. 3005 of 2022 (Union of India and others vs. Ashish Agarwal) decided on 4th May, 2022 and reported in 2022 SCC OnLine SC 543 and submitted that the notices issued after 1st April, 2021 u/s 148 are liable to be treated as notices u/s 148A of the Act, 1961 as substituted by the Finance Act, 2021.

He further relied on Instruction being F.No 279/Misc./M-51/2022-ITJ, Ministry of Finance, Department of Revenue, CBDT, ITJ Section dated 11th May, 2022, paragraph 7.1 of the aforesaid instruction and stated that the notices u/s 148 relating to A.Ys. 2013-14, 2014-15 and 2015-16 shall not attract the judgement of Hon’ble Supreme Court in the case of Ashish Agarwal (supra). Lastly, the ASG submitted that since the notice was issued on 1st April, 2021 for A.Y. 2014-15, therefore, it shall be covered by a Division Bench’s judgement of this Court in the case of Daujee Abhushan Bhandar Pvt. Ltd. vs. Union of India and 2 others (Writ Tax No. 78 of 2022) decided on 10th March, 2022.

The petitioner referring to paragraphs 23 and 25 of the judgement of the Hon’ble Supreme Court in the case of Ashish Agarwal (supra) submitted that the impugned notice u/s 148 issued by respondent no. 3 is wholly without jurisdiction inasmuch as jurisdiction cannot be assumed after the expiry of the limitation period. He further submits that conferment of jurisdiction is essentially an act of the legislature, and the jurisdiction cannot be conferred by any circular or even by Court orders. He submits that even under the amended provisions, which have no application on facts of the present case, impugned notice u/s 148 would be without jurisdiction and barred by limitation inasmuch as for A.Y. 2014-15, the limitation under the amended provisions of sections 148A and 149 had expired on 31st March, 2018 inasmuch as the allegation of evaded income is Rs. 2,63,324 which has been provided to be read as Rs. 26,33,324 by notice dated 17th March, 2022 u/s 142(1), which is much below Rs. 50 Lacs.

The Hon. Court observed the judgment of Hon’ble Supreme Court in the case of Ashish Agarwal (supra) and Circular F.No 279/Misc./M-51/2022-ITJ, dated 11th May, 2022 issued by the Ministry of Finance, Department of Revenue, CBDT, ITJ Section, New Delhi. Section 147, as it existed till 31st March, 2021, empowers the Assessing Officer to assess or reassess or recompute loss or depreciation allowance or any other allowance, as the case may be, for the concerned assessment year in the case of an assessee if he has reason to believe that income chargeable to tax has escaped assessment, subject to the provisions of sections 148 to 153. A pre-condition to initiate proceedings u/s 147 is the issuance of notice u/s 148. Thus, notice u/s 148 is a jurisdictional notice. Section 149 provides a time limit for issuance of notice u/s 148. The time limit is provided under the unamended provisions (existed till 31st March, 2021) and the amended provisions (effective from 1st April, 2021) as amended by the Finance Act, 2021.

The judgment of Hon’ble Supreme Court under Article 142 of the Constitution of India, in the case of Ashish Agarwal (supra) has been explained for implementation/clarified by Instruction No.01/2022 being F.No 279/Misc./M-51/2022-ITJ, dated 11th May, 2022 issued by the Ministry of Finance, Department of Revenue, CBDT, ITJ Section, New Delhi, in exercise of powers u/s 119.

The ASG has made a statement before the Court, that as per Clause-7.1 of the Board’s circular dated 11th May, 2022, the notices u/s 148 relating to A.Ys. 2013-14, 2014-15 and 2015-16, shall not attract the judgment of Hon’ble Supreme Court in the case of Ashish Agarwal (supra) and the impugned notice u/s 148 issued on 1st April, 2021 for A.Y 2014-15 is, therefore, clearly barred by limitation and consequently without jurisdiction. Therefore, in view of the admission made by the learned ASG on behalf of the respondents, all other questions, including the question of conferment of jurisdiction etc., are left open and not dealt with by the Hon. Court.

The Court further observed that as per clauses 6.2 and 7.1 of the Board’s Circular dated 11th May, 2022, if a case does not fall under clause (b) of sub-section (i) of section 149 for the A.Ys. 2013-14, 2014-15 and 2015-16 (where the income of an assessee escaping assessment to tax is less than Rs. 50,00,000) and notice has not been issued within limitation under the unamended provisions of section 149, then proceedings under the amended provisions cannot be initiated.

The impugned notice u/s 148 of the Act, 1961 issued on 1st April, 2021 for A.Y. 2014-15 and the impugned notice dated 13th January, 2022 u/s 144 and the reassessment order dated 13th January, 2022 u/s 147 r.w.s 144B for A.Y. 2014-15 passed were quashed. The writ petition was allowed.

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Transfer of case — Notice — Both assessee and firm wherein assessee was partner assessed in Mumbai — Pending of case before additional chief metropolitan magistrate in Bengaluru could not be reason for transfer of assessee’s assessment from Mumbai — Order transferring case quashed and set aside

41 Divesh Prakashchand Jain vs. Principal CIT
[2022] 445 ITR 496 (Bom.)
Date of order: 1st December, 2021
S.127(2) of ITA, 1961

Transfer of case — Notice — Both assessee and firm wherein assessee was partner assessed in Mumbai — Pending of case before additional chief metropolitan magistrate in Bengaluru could not be reason for transfer of assessee’s assessment from Mumbai — Order transferring case quashed and set aside

The assessee was a partner in a firm, SSJ, which manufactured and sold gold ornaments having its principal place of business in Mumbai. The firm had a branch in Bengaluru. The assessee stated that he had sent samples of jewellery to Bengaluru to be displayed to customers and two of his employees were intercepted by the Bengaluru police and gold jewellery belonging to the firm was found on them and investigations commenced and a case before the Additional Chief Metropolitan Magistrate, Bengaluru was pending. The Deputy Director of Income-tax (Investigation) Bengaluru was a respondent in the pending case. The Principal Commissioner issued a show-cause notice u/s 127(2) of the Income-tax Act, 1961 and transferred the assessee’s case to Bengaluru for completing the assessment proceedings.

The Bombay High Court allowed the writ petition filed by the assessee challenging the order of transfer and held as under:

“i) The pendency of a case before the Additional Chief Metropolitan Magistrate could not be accepted as reason for transfer of the assessee’s assessment from Mumbai to Bengaluru. Though the assessee was given a show-cause notice u/s. 127(2) and personal hearing was granted before passing the order for transfer of the case the reasons recorded in the order were subject to judicial scrutiny and must be reasonable.

ii) The assessee was assessed in Mumbai and the firm of which the assessee was a partner was also assessed in Mumbai. In the order, the Principal Commissioner had only narrated the facts but had not given any reasons why in the facts and circumstances, the assessee’s case had to be transferred to Bengaluru. The order of transfer was quashed and set aside.

iii) The assessee was to fully co-operate with the authorities in Bengaluru, provide all the required documents for the purpose of investigation or assessment and also appear for recording his statement in Bengaluru or Mumbai as and when called for (subject to giving a reasonable notice in advance of the date and time to be present) and co-operate in every possible way with the Bengaluru Office of the Department.”

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Accounting of Production-Linked Incentives (PLI)

INTRODUCTION

To incentivise and promote production, growth and capital investment in the country, the Indian government introduced PLI schemes for various industries. Under the scheme, a cash incentive is given each year for a certain number of years (e.g., five years in the case of the white goods industry), basis fulfilment of specific conditions and the incentive amounts are determined as a percentage of incremental sales. There are several conditions, but the two most important conditions relate to cumulative investment and incremental sales (over the base year).

The qualifying investments include plant and machinery and capital investment in research and development but exclude, for example, land. Incremental sales are determined basis consolidated financial statements, including global sales; however, the capital investment and production should occur in India.

The grant is provided each year, provided the conditions relating to cumulative investment and incremental sales are met for that year. In the case of white goods, if the grant for Year 1 is earned because the entity fulfilled the cumulative investment and incremental sales condition in that year, but the entity subsequently exits from the scheme, the grant earned in earlier years is clawed back. However, in the case of pharmaceutical sector, the requirements are not free from doubt. For example, consider the following FAQ regarding the PLI scheme, which applies to pharmaceutical companies.

Q – “What if part assets are purchased initially and then later after two years these were sold by the company (reason could be new technology, new equipment with better capacity is available)

A – Gross Investment value of the said sold assets would be deducted from the Cumulative Investment for that year in which sale is made.”

While the above FAQ suggests that if part assets are sold subsequently, it will not result in a clawback of grant earned in earlier years, there is no clarity on what happens if the entire cumulative investment is disposed of.

In the analysis below, both scenarios have been covered, i.e., grants earned in earlier years may or may not be clawed back if the cumulative investment is subsequently disposed of or the entity exits from the PLI scheme. Additionally, the analysis below will equally apply to whether the investment is entirely front-loaded or staggered over time.

QUESTIONS

Assuming for simplicity, the entity avails the PLI grant by making the qualifying investment in plant and machinery for manufacturing eligible products, the following questions arise:

1. Is the PLI grant a capital (fixed asset) or revenue-related grant?

2. The conditions related to cumulative investment and incremental sales are tested on an annual basis. How is the grant recognised each quarter?

TECHNICAL REFERENCES

Ind AS 20, Accounting for Government Grants and Disclosure of Government Assistance

Paragraph 3

Grants related to assets are government grants whose primary condition is that an entity qualifying for them should purchase, construct or otherwise acquire long-term assets. Subsidiary conditions may also be attached restricting the type or location of the assets or the periods during which they are to be acquired or held.

Grants related to income are government grants other than those related to assets.

Paragraph 12

Government grants shall be recognised in profit or loss on a systematic basis over the periods in which the entity recognises as expenses the related costs for which the grants are intended to compensate.

Paragraph 19

Grants are sometimes received as part of a package of financial or fiscal aids to which a number of conditions are attached. In such cases, care is needed in identifying the conditions giving rise to costs and expenses which determine the periods over which the grant will be earned. It may be appropriate to allocate part of a grant on one basis and part on another.

Paragraph 7

Government grants, including non-monetary grants at fair value, shall not be recognised until there is reasonable assurance that:

(a) the entity will comply with the conditions attaching to them; and

(b) the grants will be received.

Illustrative Examples for IAS 34, Interim Financial Reporting

Paragraph B23

Volume rebates or discounts and other contractual changes in the prices of raw materials, labour, or other purchased goods and services are anticipated in interim periods, by both the payer and the recipient, if it is probable that they have been earned or will take effect. Thus, contractual rebates and discounts are anticipated but discretionary rebates and discounts are not anticipated because the resulting asset or liability would not satisfy the conditions in the Conceptual Framework that an asset must be a resource controlled by the entity as a result of a past event and that a liability must be a present obligation whose settlement is expected to result in an outflow of resources.

ANALYSIS

Is the PLI grant a capital (fixed asset) related grant or revenue related grant?

The equivalent international standard to Ind AS 20, namely, IAS 20, Accounting for Government Grants and Disclosure of Government Assistance, was adopted in April, 2001. The standard is archaic and does not deal with complex grants presently given across the globe. Therefore, applying the standard is not a straightforward exercise, particularly when there are multiple conditions that need capital investment as well as production and sales to take place. With regards to the PLI scheme, whether the grant is a capital or revenue grant, there could be multiple views, which are discussed below:

View A – PLI is a capital (fixed asset) grant

One may argue that the PLI grant is a capital grant, basis the following arguments:

Without the acquisition of the plant and machinery, the grant would not have been available. The condition relating to incremental sales is only incidental, as the acquisition of plant and machinery would ensure that there would be production and incremental sales that logically follows the capital investment. Only an irrational entity would acquire plant and machinery and not use them for the production of goods.

Paragraph 3 of Ind AS 20 states that grants related to assets are government grants whose primary condition is that an entity qualifying for them should purchase, construct or otherwise acquire long-term assets. Subsidiary conditions may also be attached, restricting the type or location of the assets or the periods during which they are to be acquired or held. One may argue that the starting point is the acquisition of the plant and machinery, and therefore that is a primary condition. The requirement relating to incremental sales is merely a subsidiary condition; therefore the grant qualifies as a capital grant, basis the definition in paragraph 3.

Paragraph 12 of Ind AS 20 states that government grants shall be recognised in profit or loss on a systematic basis over the periods in which the entity recognises as expenses the related costs for which the grants are intended to compensate. Since the grant is production-linked, it could be assumed that the grant compensates for the depreciation incurred on the plant and machinery.

In some PLI schemes, for example, in the white goods industry, the grant is clawed back if the entity exits the scheme. Therefore, it is necessary not only to acquire the plant and machinery but also to use and hold it for a certain number of years.

The counterargument to the above is as follows:

There is no requirement in some of the PLI schemes to hold on to the plant and machinery for the entire period of the grant. Additionally, if the capital investment is sold or disposed of in subsequent years, the grant relating to earlier years is not clawed back. For example, subsequent disposal of part assets in the case of pharmaceutical companies does not result in a clawback of grants earned in earlier years. Consequently, it may be argued that the grant is not a capital grant.

Though the standard defines what a primary condition is, from the PLI scheme, it is not clear whether the asset acquisition is indeed the primary condition. Therefore, it would not be appropriate to conclude that acquisition of the plant and machinery is the primary condition, and incremental sales is a subsidiary condition.

The grant is not specifically meant to subsidise depreciation. The grant conditions require conditions to be fulfilled each year and are not a straightforward grant provided for the acquisition of an asset. The grant conditions require the plant to operate and the manufactured goods to be sold at a certain level, fuelling economic buoyancy.

View B – PLI is a revenue grant

One may offer the following arguments to support the view that the grant is a revenue grant.

Very often, the acquisition and use of plant and machinery may not translate into incremental sales because the demand for the underlying products may have diminished, or a catastrophe such as Covid may restrict economic activity. Hence it is not appropriate to trivialise the condition relating to incremental sales, and one may argue that incremental sales is the primary condition. In other words, incremental sales could be a very constraining condition and hence could be treated as a primary condition.

Each year, the grant is received only if the entity is able to achieve incremental sales. The grant amount is determined as a percentage of incremental sales, thereby suggesting that incremental sales are a very important condition for determining the grant amount and qualifying for the grant. Because prominence is given to incremental sales for earning the grant each year, the grant is treated as a revenue grant.

Each year is treated as a separate unit for the purposes of determining and receiving the grant amount. For example, in the case of the pharmaceutical industry, the grant received each year is not clawed back in subsequent years if the conditions in those years are not met or the investment already made is partly sold or disposed of. Because the grant is meant to operate for each year, the most appropriate accounting would be to record the grant for each year if the eligibility conditions for those years are fulfilled.

The counterargument for this view is the same arguments provided in support of View A.

View C – PLI is a combination of capital and revenue grant

The grant seems to be a mixture of both capital and revenue conditions, and hence in accordance with paragraph 19, the same would be allocated between capital and revenue grant. However, the counterargument for this view is that there is no clear basis for allocating the grant between capital and revenue grant, and any forced allocation may be arbitrary and highly subjective.

HOW IS THE GRANT RECOGNISED EACH QUARTER?

At each quarter end, the entity will not know whether it would fulfil all the conditions relating to the grant by the end of the year or over the grant period, unless the conditions are all met by that quarter end. Applying Paragraph B23 of IAS 34, the entity will have to anticipate each quarter end, whether it would achieve all the grant-related conditions by the end of the year or over the grant period. Though Illustrative Examples are not included in Ind AS 34, the example in IAS 34 can be treated as authoritative literature in the absence of any contrary requirement under Ind AS. Applying Paragraph 7 of Ind AS 20 and Paragraph B 23 of IAS 34, the entity would recognise the grant in each quarter, provided there is reasonable assurance and probability that the grant would be received and would not have to be reversed in a subsequent quarter/year.

CONCLUSION

For arguments already provided above, the author believes that on the first question, View C is not advisable. In the absence of clear guidance in the standard, there could be a choice between View A and View B. In making such an evaluation, the entity needs to carefully evaluate all the conditions relating to the grant, as well as its ability to fulfil all the conditions, particularly where non-fulfilment of such conditions may result in a clawback of the grant earned in earlier years. Additionally, different considerations may apply when the cumulative investment is made in other than plant and machinery, for example, in research and development.

The entity should recognise the grant at each quarter end, provided the probability criterion is met. The entity should be careful while recognising the grant at each quarter end and ensure that the grant recognised in a quarter does not have to be reversed in a subsequent quarter or a subsequent year because the conditions that were anticipated to be fulfilled are not eventually fulfilled or the entity decides to exit the scheme, resulting in a clawback of grant earned in earlier years.

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Disallowance u/s 14A Where No Exempt Income and Effect of Explanation

ISSUE FOR CONSIDERATION

S.14A, introduced by the Finance Act, 2001, provides for disallowance with retrospective effect from 1st April, 1962 of an expenditure incurred in relation to income which does not form part of the total income under the Income-Tax Act. The expenditure to be disallowed is required to be determined in accordance with Rule 8D of the Income-Tax Rules provided the AO, having regard to the accounts, is not satisfied with the correctness of the claim of the assessee, including the claim that no expenditure has been incurred in relation to an exempt income.

The provision of s.14A r.w. Rule 8D has been the subject matter of unabated litigation since its introduction, which continues despite various amendments made thereafter. The subjects of litigation involve a variety of reasons and many of them have reached the Apex Court. One such subject is about the possibility of disallowance in a case where the assessee has not earned any exempt income during the year for which expenditure is incurred.

Applying the law prior to the recent insertion of the Explanation and the non-obstante clause in s. 14A, the Delhi High Court in the case of Cheminvest Ltd., 61 taxmann.com 118, ruled that no disallowance could be made u/s 14A if no exempt income had been earned during the year. The Supreme Court has dismissed the SLP against the Madras High Court ruling that s.14A could not be invoked where no exempt income was earned by the assessee in the relevant assessment year. Chettinad Logistics (P) Ltd., 95 taxmann.com 250 (SC).

The legislature, for undoing the impact of the law laid down by the Supreme Court, has introduced an Explanation to s.14A by the Finance Act, 2022, w.e.f 1st April, 2022. The said Explanation reads as under: “Explanation-For the removal of doubts, it is hereby clarified that notwithstanding anything to the contrary contained in this Act, the provisions of this section shall apply and shall be deemed to have always applied in a case where the income, not forming part of the total income under this Act, has not accrued or arisen or has not been received during the previous year relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such income not forming part of the total income.”

The Explanatory Memorandum to the Finance Bill, 2022, relevant parts, reads as:

“4. In order to make the intention of the legislation clear and to make it free from any misinterpretation, it is proposed to insert an Explanation to section 14A of the Act to clarify that notwithstanding anything to the contrary contained in this Act, the provisions of this section shall apply and shall be deemed to have always applied in a case where exempt income has not accrued or arisen or has not been received during the previous year relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such exempt income.

5. This amendment will take effect from 1st April, 2022.”

Simultaneously a non-obstante clause is introduced in s. 14A(1) which reads as: Notwithstanding anything contained to the contrary in the Act, for the purposes of ………………” The Explanatory Memorandum, relevant parts, read as:

“6. It is also proposed to amend sub-section (1) of the said section, so as to include a non-obstante clause in respect of other provisions of the Income-tax Act and provide that no deduction shall be allowed in relation to exempt income, notwithstanding anything to the contrary contained in this Act.

7. This amendment will take effect from 1st April, 2022 and will accordingly apply in relation to the assessment year 2022-23 and subsequent assessment years”.

Ironically, an amendment made to settle a raging controversy has itself become the cause of another fresh controversy. An issue has arisen whether the Explanation now inserted, is prospective in its nature and therefore would apply to A.Y. 2022-23 onwards or would apply retrospectively to cover at least the pending assessments and appeals. While the Mumbai Bench of the Tribunal, has held the Explanation to be prospective in its application, the Guwahati Bench of the Tribunal has held the same to be retrospective in nature and has applied the same in adjudicating an appeal before it for A.Y. 2009-10 and onwards. The Delhi High Court, however, has in a cryptic order recently held the Explanation to be prospective. The Guwahati Bench has passed a detailed order for holding the Explanation to be retrospective for a variety of reasons which are required to be noted and may require examination by the Courts to arrive at a final conclusion on the subject.

BAJAJ CAPITAL VENTURES (P) LTD.’S CASE

The issue first came up for consideration of the Mumbai bench of the ITAT in the case of ACIT vs. Bajaj Capital Ventures (P.) Ltd. 140 taxmann.com 1. In the cross appeals filed, one of the grounds raised by the assessee company was “On the facts and in the circumstances of the case and in law, the respondent prays that no disallowance ought to be made in absence of earning of any exempt income.”

During the course of the scrutiny assessment proceedings, it was noticed that the assessee was holding investments in shares, which were for the purpose of earning dividend income, but no disallowance was made u/s 14A for expenses incurred to earn this tax exempt income. The AO disallowed an amount of Rs. 11,87,85,293 under rule 8D r.w. Section 14A. Aggrieved, the assessee carried the matter in appeal before the CIT(A), who restricted the disallowance to Rs. 9,87,978, as was claimed by the assessee, with observations, inter alia, as follows:

6.2 I have considered the assessment order and the submission of the appellant. The issue regarding applicability of section 14A read with rules 8D of the Income Tax Rules,1962 has been the subject matter of incessant litigation on almost every issue, involved, i.e. whether a disallowance can be made when no exempt income has been earned during the year, whether the satisfaction has been correctly recorded by the AO regarding the correctness of the claim and in respect of such expenditure incurred in relation to exempt income, whether share application money is to be considered as investment, whether investment in subsidiary company or joint ventures can be said to be made with a view of earn exempt income etc. In the present case the admitted fact is that no dividend income or any other exempt income has been earned during the year under consideration. The present legal position established by the Delhi High Court in the case of Cheminvest Ltd. (61 taxmann.com 118), which has also been relied upon by the appellant, is that no disallowance can be made if no exempt income has been earned during the year. Recently, in the case of Commissioner of Income Tax, (Central) 1 v. Chettined Logistics (P) Ltd. [(2018) 95 taxmann 250 (SC)1, the Hon’ble Supreme Court have dismissed the SLP against High Court ruling that section 14A cannot be invoked where no exempt income was earned by assessee in relevant assessment year. The ITAT Mumbai [jurisdictional ITAT] has recently in the case of ACIT v. Essel Utilities Distribution re affirmed the same.”

On further appeals by the assessee and the revenue, to the Tribunal, the bench on due consideration of the rival contentions and facts, passed the following order in light of the applicable legal position;

“7. We find that there is no dispute about the fact that the assessee did not have any tax exempt income during the relevant previous year and that the period before us pertains to the period prior to insertion of Explanation to section 14A. In this view of the matter, and in the light of consistent stand by co-ordinate benches, following Hon’ble Delhi High Court’s judgment in the case of Cheminvest Ltd v. CIT [(2015) 61 taxmann.com 118 (Del)], we uphold the plea of the assessee that no disallowance under section 14A was and in the circumstances of the case. The plea of the Assessing Officer is thus rejected. As regards the disallowance of Rs. 9,87,978/- it is sustained on the basis of computation given in the alternative plea of the assessee, but given the fact that the basic plea of non-disallowance itself was to be upheld, there was no occasion to consider the computation given in the alternative plea. This disallowance of Rs. 9,87,978/- must also be deleted.

8. In view of the above discussions, we hold that no disallowance under section 14A was justified on the facts, and the remaining disallowance of Rs. 9,87,978/- must be deleted. Ordered, accordingly.

9. In the result, appeal of the Assessing Officer is dismissed and appeal of the assessee is allowed. Pronounced in the open court today on the 29th day of June, 2022.”

It is clear from the reading of the order that the bench did notice that the period involved in appeal pertained to a period for which the Explanation inserted by the Finance Act, 2022 was not applicable and in view of the same had thought it fit to not to invoke application of the Explanation on the understanding that the said Explanation had no retrospective application, though this part has not been expressly noted in the body of the order.

The catch words by Taxmann read as: “The assessee did not have any tax exempt income during the relevant previous year (P.Y. 2016-17/A.Y. 2017-18) which pertains to the period prior to insertion of Explanation to section 14A (by Finance Act, 2022 w.e.f. 1st April,). As the new Explanation applies with effect from A.Y. 2022-23 and does not even have limited retrospective effect even to proceedings for past assessment years pending on 1st April, 2022, no disallowance u/s 14A shall apply in the absence of any tax-free income in the relevant assessment year prior to A.Y. 2022-23.”

WILLIAMSON FINANCIAL SERVICES LTD.’S CASE

Back to back, the issue came up again in the case of ACIT vs. Williamson Financial Services Ltd. 140 taxmann.com 164 (Guwahati – Trib.) relating to the A.Ys. 2009-10 and 2012-13 to 2014-15. In assessing the income for A.Y 2013-14, the AO noted that the assessee during the year had earned an exempt dividend income of Rs. 3,70,80,750 on the investments made by the company. He also noticed that the own funds of the company were not sufficient to meet the investments in question and therefore, applied the provisions of s.14A read with Rule 8D and computed the expenditure relatable to the exempt dividend income at Rs. 10,62,10,110. Since the assessee in its computation of income had suo moto disallowed an amount of Rs. 2,25,48,285 on account of expenditure relatable to the tax exempt dividend income earned by it, the AO disallowed the balance amount of Rs. 8,36,61,625 and added back the same to the income and computed the taxable income accordingly.

Being aggrieved by the same, the company filed an appeal before the CIT(A) who, relying upon the decision in the case of Moderate Leasing and Capital Services Private Limited ITA 102/(2018) dated 31/01/2018, held that the disallowance u/s 14A could not exceed the total tax exempt income earned during the year. He accordingly restricted the disallowance to the extent of exempt income earned by the company.

Being aggrieved by the above action of the CIT(A), the revenue has appealed to the ITAT. The Revenue contested the decision of the CIT (Appeals) on the ground that he was not justified in facts as well as in law in restricting the disallowance u/s 14A to the extent of income claimed exempt for the assessment year under consideration.

The Revenue invited the attention to the newly inserted Explanation to s. 14A to submit that it had now been clarified that notwithstanding anything to the contrary contained in the Act, the provisions of s.14A should apply and be deemed to have always applied in a case where the income, not forming part of the total income had not accrued or arisen or had not been received during the year and the expenditure had been incurred during the year in relation to such income. It was contended that the Explanation was declaratory and clarificatory in nature, therefore, the same would apply with retrospective effect, and that the action of the CIT(A) in restricting the disallowance to the extent of exempt income earned by the assessee was not as per the mandate of the amended law.

The Revenue supported its contentions with the following submissions:

The CBDT Circular No. 5/2014 dated 11th February, 2014, had clarified that disallowance of the expenditure would take place even where the taxpayer in a particular year had not earned any exempt income.

Ignoring the circular, the Courts had held that where there was no exempt income during the year, no disallowance u/s 14A of the Act could be made. Such an interpretation by the Courts, ignoring the expressed intent stated in the circular, in the opinion of the legislature was not in line with its intent and defeated the legislative intent of s.14A of the Act.

In order to make the intention of the legislation clear and to make it free from misinterpretation and to give effect to the CBDT’s Circular No. S/2014 dated 11th February, 2014, the Legislature had made two changes to s. 14A through the Finance Act, 2022, which are (a). Insertion of non-obstante clause by way of substitution and, (b). Insertion of an Explanation to reinforce, by way of clarification, the intents of the CBDT’s Circular No.05/2014 dated 11th February, 2014.

The main objective to insert a non-obstante clause in sub-section (1) of s.14A which read as “Notwithstanding anything to the contrary contained in this Act, for the purpose of…” was to overcome the observations made in the case of Redington (India) Ltd vs. Addl.CIT, 392 ITR 633, 640 (Mad), wherein it was observed that an assessment in terms of the Act was specific to an assessment year and related previous year as per s.4 r.w.s. 5 of the Act. The Madras High Court in that case had further held that any contrary intention, if there was, would have been expressly stated in s.14A and in its absence, the language of s. 14A should be read in the context such that it advanced the scheme of the Act rather than distort it. Such interpretation of the Court had made the Circular No.05/2014 dated 11th February, 2014 infructuous. To address the misunderstanding, the legislature had inserted the Explanation to clarify its intentions.

The Explanation inserted contained another non-obstante clause, to overcome the past judicial observations and it was clarified the intention of the legislature that the Explanation should always be deemed to have been in s.14A for disallowance of any claim for deduction against expenditure incurred to earn an exempt income, irrespective of the fact whether or not any income was earned in the same financial year.

Further, in general parlance, whenever a clarificatory amendment with the use of words such as “for the removal of doubts”, and “shall be deemed always to have meant” etc. was made, the amendment was to have a retrospective effect, even if it was made effective prospectively.

Circular No 5/2014 dated 11th February, 2014 was still in force, and for invoking disallowance u/s 14A of the Act, it was not material that the assessee should have earned such exempt income during the financial year under consideration.

The decision of the CIT(A) holding that the disallowance u/s 14A read with Rule 8D could not exceed the income claimed exempt appeared to be perverse.

In reply, on behalf of the assesse, it was submitted that the Explanation to s. 14A introduced vide the Finance Act 2022, was prospective in nature and could not be applied to the pending appeals, and that the law settled prior to the insertion of the Explanation, holding that the disallowance of expenditure u/s 14A could not exceed the exempt income earned by the assessee during the year, alone should apply. It was further contended that:

Even after the issue of the CBDT Circular No. 5/2014 dated 11th February, 2014, the Courts held that when there was no exempt income, then disallowance u/s 14A was unwarranted, following a simple rule that when there was no exempt income, there was no necessity to disallow the expenditure. CIT vs. Corrtech Energy Pvt. Ltd., 223 Taxman 130 (Guj); CIT vs. Holcim India Pvt. Ltd., 57 taxmann.com 28 (Del); Marg Ltd vs. CIT,120 taxmann.com 84 (Madras).

The Delhi High Court, in the case of CIT vs. Moderate Leasing and Capital Services Pvt. Ltd in ITA 102/2018 order dated 31/01/2018 had held that disallowance u/s 14A should not exceed the exempt income itself. The SLP filed by the Revenue was dismissed by the Supreme Court of India Special Leave Petition (Civil) Diary No(s). 38584/2018 dated 19/11/2018.

The Guwahati bench of the ITAT, in deciding the issues in favour of the Revenue on due consideration of the contentions of the opposite parties, observed as under:

In determining the effective date of the application of an amendment, prospective or retrospective, the date from which the amendment was made operative did not conclusively decide the question of its effective date of application.

The Court had to examine the scheme of the statute prior to the amendment and subsequent to the amendment to determine whether an amendment was clarificatory or substantive.

An amendment which was clarificatory was regarded by the Courts as being retrospective in nature and its application would date back to the date of introduction of the original statutory provision which it sought to amend. Clarificatory amendment was an expression of intent which the Legislature had always intended to hold the field with retrospective effect.

A clarificatory amendment might be introduced in certain cases to set at rest divergent views expressed in decided cases on the true effect of a statutory provision.

Where the Legislature expressed its intent, by declaring the law as clarificatory, it was regarded as being declaratory of the law as it always stood and was therefore, construed to be retrospective.

A perusal of the Explanation revealed that it started with the words “For the removal of doubts, it is hereby clarified ……”. Then the wording in the body of the provision expressly stated: “…..the provisions of this section shall apply and shall be deemed to have always applied……”

The opening words of the Explanation revealed in an unambiguous manner that the said provision was clarificatory and had been inserted for removal of doubts. Further, as provided in the Memorandum explaining the provision, the Explanation had been inserted to make the intention clear and to make it free from any misinterpretation.

The said Explanation being clarificatory in nature was inserted for the purpose of removal of doubts and to make the intention of the legislature clear and free from misinterpretation and thus the same, obviously, would operate retrospectively.

Any contrary interpretation holding that the said Explanation shall operate prospectively would render the words “shall apply and shall be deemed to have always applied” as redundant and meaningless, which was not the intention of the legislature.

The Explanation did not propose to levy any new taxes upon the assessee but it only purported to clarify the intention of the legislature that actual earning or not earning of the exempt income was not the condition precedent for making the disallowance of the expenditure incurred to earn an exempt income.

The legal position was declared by the Supreme Court in the case of Walfort Share & Stock Brokers Pvt. Ltd., 326 ITR 1 (SC), that the expenses allowed could only be those incurred for earning the taxable income; that the basic principle of the taxation was to tax the net income and on the same analogy, the exemption was also in respect of net income.

The Supreme Court in the case of CIT vs. Rajendra Prasad Moody 115 ITR 519 had held that even if there was no income, the expenditure was allowable. Income included loss, as was held by the Supreme Court in the case of CIT vs. Harprasad & Co. P Ltd. 99 ITR 118, and as such only the net income was taxable, i.e. gross income minus expenditure, and as such the net income might be a loss also.

Since the earning of positive net income was not a condition precedent for claiming deduction of expenditure, on the same analogy, the earning of exempt income was also not a condition precedent for attracting a disallowance of expenditure incurred to earn exempt income. This position had only been reiterated and clarified by the Explanation to s.14A, so as to remove the doubts and to make clear the intention of the legislature and to make the provision of s. 14A free from any other interpretation. Therefore, it could not be said that the Explanation proposed or saddled any fresh liability on the assessee.

The contention of the assessee that the Explanation applied only to those cases where no exempt income had been earned at all and that the said Explanation was not applicable to cases where the assessee had earned some exempt income was not acceptable; such a proposition might place different assessees in inequitable position. In such a scenario, in a case where an assessee did not earn any exempt income, he might suffer disallowance as per the formula prescribed under Rule 8D, whereas, in a case where an assessee earned some meagre exempt income, the disallowance in his case would be restricted to such meagre exempt income and the assessee having no exempt income, would have to suffer more disallowance than the assessee having meagre exempt income. Even otherwise, the Explanation sought to clarify the position that the disallowance of expenditure relatable to exempt income was not dependent upon actual earning of any exempt income.

The legal position that the AO must first record satisfaction as to the correctness of the claim of the assessee in respect of expenditure incurred in relation to exempt income before invoking rule 8D for disallowance of expenditure u/s 14A continued to apply and should still be adhered to and the aforesaid Explanation introduced vide Finance Act 2022 did not in any manner change that position. There was no change of the legal position even after introduction of the Explanation.

The Guwahati bench of the tribunal in conclusion held that the:

Explanation to s. 14A, inserted by Finance Act, 2022 w.e.f. 1st April, 2022, shall apply retrospectively even for periods prior to 1st April, 2022.

Disallowance of expenditure incurred in relation to exempt income shall apply in terms of the Explanation even in those cases where assessee has earned no exempt income during the relevant assessment year.

Application of the amendment shall not be restricted to those cases where assessee had earned some exempt income which was less than expenditure incurred in relation to exempt income.

The disallowance could not be limited to the amount of exempt income of an year.

The decision of the Mumbai bench of the Tribunal in the case of ACIT vs. Bajaj Capital Ventures (P.) Ltd. (supra), holding a contrary view that the Explanation to s.14A inserted w.e.f. 1st April, 2022 has no retrospective applicability, was not expressly considered by the bench as the same might not have been cited by the assessee.

OBSERVATIONS

Section 14A of the Act was introduced in 2001, with retrospective effect from the year 1962, to state that no deduction shall be granted towards an expenditure incurred in relation to an income which does not form part of the Total Income. The method for identifying the expenditure incurred is prescribed under Rule 8D of the Income-tax Rules,1962. Further, by the Finance Act, 2006, sub-sections (2) and (3) have been inserted w.e.f. 1st April, 2007.

A Proviso was inserted earlier by the Finance Act of 2002 with retrospective effect from 11th May, 2001. It reads: “Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001”.

The CBDT has issued a Circular No. 5 dated 11th February, 2014, clarifying that Rule 8D r.w.s. 14A provides for disallowance of the expenditure even where taxpayer in a particular year has not earned any exempt income. The circular noted that still some Courts had taken a view that if there was no exempt income during a year, no disallowance u/s 14A could be made for that year. The Circular had stated that such an interpretation by the Courts was not in line with the intention of the legislature.

Over the years, disputes have arisen in respect of the issue whether disallowance u/s 14A can be made in cases where no exempt income has accrued, arisen or received by the assessee during an assessment year. From its inception, the applicability of this provision has always been a subject matter of litigation and one such point that has been oft-debated is regarding the disallowance of expenditure in the absence of exempt income. In 2009, a Delhi Special Bench of the Tribunal in Cheminvest Ltd. vs. CIT, 121 ITD 318, took a view that when an expenditure is incurred in relation to an exempt income, irrespective of the fact whether any exempt income was earned by the assessee or not, disallowance should be made, a position that has not been found acceptable to the Courts, including the Apex Court.

An interesting part is noticed on reading of the Explanatory Memorandum to the Finance Bill, 2022 which clarifies that the Explanation has been inserted in s. 14A w.e.f. 1st April, 2022, while the non-obstante clause in sub- section (1) of s. 14A has been inserted w.e.f A.Y. 2022-23. This inconsistent approach has led one to wonder whether the insertion of the Explanation is prospective and is applicable to A.Y. 2022-23 and onwards, while the amendment in s.14A(1) made applicable w.e.f. 1st April, 2022 has a retrospective applicability to pending proceedings on 1st April, 2022.

The amendment, by insertion of non-obstante clause in sub-section (1), is expressly made effective from 1st April, 2022; whereas in respect of the Explanation, as noted vide paragraph 5 of the Memorandum, it is written that the amendment will take effect on 1st April, 2022 and will accordingly apply in relation to A.Y. 2022-23 and subsequent assessment years.

The Explanation inserted in the section is worded as: ‘Section 14A shall apply and shall be deemed to have always applied in a case where exempt income has not accrued or arisen or has not been received during the financial year and the expenditure has been incurred in relation to such exempt income.’ The provision seems to apply to past transactions as well, but the Memorandum makes it effective from A.Y. 2022-23 only.

Whether the provisions of s. 14A will have a retroactive application? Will the Explanation apply retrospectively even where the same has been expressly made affective from A.Y. 2022-23? Can the Explanatory Memorandum override the language of the law amended? Can there be a mistake in the Memorandum and if yes, can it be overlooked? Can it be said that the amendment in s. 14A by the Finance Act, 2022 by inserting an Explanation to s. 14A alters the position of law adversely for the assessee and hence, such an amendment cannot be held to be retrospective in nature? These are the questions that have arisen in a short span that have a serious impact on the adjudication of the assessments and appeals, and may lead to rectification, revision and reopening of the completed assessments.

The Delhi High Court, in the case of Moderate Leasing and Capital Services Pvt. Ltd in ITA 102/2018 dated 31/01/2018 held that disallowance u/s 14A should not exceed the exempt income itself; the SLP filed by the Revenue against this judgment was dismissed by the Supreme Court of India Special Leave Petition (Civil) Diary No(s). 38584/2018 dated 19/11/2018. Can such a finality be disturbed and reversed by the Explanation now inserted, even where the Explanation is not introduced with retrospective effect?

A proviso to s.14A inserted by the Finance Act, 2002, with retrospective effect from 11th May, 2001, prohibits an AO from reassessing an income u/s 147 or passing an order enhancing the assessment or reducing the refund u/s 154 for any assessment year up to 2001-02. No such express prohibition is provided for in respect of the application of the Explanation in question.

The CBDT vide Circular No. No. 5/2014, dated 11th February, 2014, had clarified the stand of the Government of India that the expenditure, where claimed, would be liable for disallowance even where the assessee has not earned any taxable income for the year. The Courts, in deciding the issue, have not followed the mandate of the Circular.

The incidental issue that has come up is about the application of Explanation to cases where some exempt income is earned during the year. It is argued that the Explanation would have no application in such cases in as much as the Explanation can apply only to cases where no exempt income has accrued or arisen or been received during the year.

It is important to appreciate the true nature of the Explanation; does it supply an obvious omission or does it clear up the doubts as to the meaning of the previous law. If yes, it could be considered as declaratory or curative and its retrospective operation is generally intended. Venkateshwara Hatcheries Ltd., 237 ITR 174 (SC). The other aspect that has to be considered in deciding the effective date of application is to determine whether the amendment levies a tax with retrospective effect; if yes, it’s retrospective application should be given only if the amendment is made expressly retrospective and not otherwise. Retrospectivity, in such a case, cannot be presumed. Thirdly, an amendment which divests an assessee of a vested right should be applied retrospectively with great discretion even where such an amendment is made expressly retrospective.

An explanatory, declaratory, curative or clarificatory amendment is considered by Courts to be retrospective. Allied Motors, 224 ITR 677 (SC). This is true so far as there prevailed a doubt or ambiguity and the amendment is made to remove the ambiguity and provide clarity. However, an amendment could not be retrospective even where it is labeled as clarificatory and for removal of doubts where there is otherwise no ambiguity or doubt. Vatika Township P. Ltd., 367 ITR 490 (SC). In provisions that are procedural in nature, it is not difficult to presume retrospective application. Even in such case the retrospectivity would be limited to the express intention. National Agricultural, 260 ITR 548 (SC).

Article 20 of the Constitution imposes two limitations on the retrospective applicability. Firstly, an act cannot be declared to be an offence for the first time with retrospective effect, and secondly, a higher penalty cannot be inflicted with retrospective effect.

A declaratory act is intended to remove doubts regarding the law; the purpose usually is to remove a doubt as to the meaning of an existing law or to correct a construction by Courts considered erroneous by the legislature. Insertion of an Explanation where intended to supply an obvious omission or clear up doubts as to the true meaning of the Act is usually retrospective. However, in the absence of the clear words indicating that the amendment is declaratory it would not be so construed when the pre-amended provision was clear and unambiguous. A curative amendment is generally considered to be retrospective in its operation. Lastly, the substance of the amendment is more important than its form. Agriculture Market Committee, 337 ITR 299 (AP) and Brij Mohan, 120 ITR 1 (SC).

The sum and substance emerging from the above discussion is that an amendment in law is retrospective when it is so provided and it is prospective when it is not so provided in express terms. Even a declaratory or a clarificatory amendment requires an express intention to make it retrospective. In other words, there is no presumption for an amendment to be considered as retrospective in nature, unless the amendment is procedural in nature.

The power of the legislature to make a retrospective amendment is not in question here. It is a settled position that an amendment can be made by the legislature with retrospective effect and when so made, it would always be presumed to have been made w.e.f. the date specified in the amendment, and would be enforced by the authorities in applying the law as amended. In many cases of amendments, it may be necessary to examine the scheme of the Income-Tax Act prevailing prior to the amendment and also subsequent to the amendments. Vijayawada Bottling Co. Ltd., 356 ITR 625 (AP).

The issue under consideration as noted is more complex or different; the Explanation inserted in s.14A is expressly made to be effective from 1st April, 2022 and is intended to apply to A.Y. 2022-23, onwards. Under the circumstances, on a first blush it would be correct to concur with the decisions of the Mumbai Bench and of the Delhi High Court, but for the fact that these decisions have not considered the intention of the legislature behind the amendment in detail, which is expressed in so many words in the Explanatory Memorandum. Importantly, they have not considered the express language of the Explanation, which reads as ‘the provisions of this section shall apply and shall be deemed to have always applied’.

The challenge here is to resolve the conflict that is posed on account of two contrasting expressions and terms used in the Explanation and in the Explanatory Memorandum. The Explanation in clear words provides for a retrospective application, while the Explanatory Memorandum applies the amendment prospectively. In such circumstances, the issue for consideration is whether the effect should be given to the express language of the Explanation or to the Explanatory Memorandum for determining the date of its application. The Guwahati Bench, is of the view that in such circumstances the Court should examine the true legislative intent instead of simply being swayed by the express mention of the effective date and assessment year in the Explanatory Memorandum. For this, the Bench has relied upon the decision in the case of Godrej & Boyce, Mfg. Co. Ltd., 328 ITR 81 (Bom.). The view that is canvased is that the mention of the date or the year in the Explanatory Memorandum is not sacrosanct or conclusive of the retrospective nature or otherwise of the amendment.

The Bombay High Court, in the case of Godrej & Boyce, Mfg. Co. Ltd., (supra.), relying on several decisions of the Supreme Court, had held that in determining the effective date of applying an amendment, the date from which the amendment was made operative did not conclusively decide the question and the Court has to examine the scheme of the statute prevailing prior to and subsequent to the amendment to determine whether an amendment was clarificatory or substantive and further, if it was clarificatory, it could be given a retrospective effect, and if it was substantive, it should be prospectively applied.

It further held that a clarificatory amendment was an expression of intent which the legislature had always intended to hold the field; such an amendment might be introduced in certain cases to set at rest divergent views expressed in decided cases on the true effect of a statutory provision. The Court accordingly held a legislative intent when clarified was to be regarded as declaratory of the law as it always stood and therefore be construed as retrospective provided the amendment did not bring about a substantive change in legal rights and obligations of the parties.

The Guwahati Bench of the Tribunal, taking a leaf from the above referred decision in the case of Godrej & Boyce, Mfg. Co. Ltd., 328 ITR 81 (Bom.), held that simply because the Explanatory Memorandum provided that the Explanation would apply from A.Y. 2022-23, the Explanation did not become prospective in nature and the adjudicating authorities were required to examine the true legislative intent for deciding the effective date of application of an amendment.

The Delhi High Court however, in the case of Pr CIT vs. ERA Infrastructure (India). Ltd. 327 CTR (Del) 489, has, in a cryptic order, recently held the Explanation to be prospective, holding that the amendment cannot be held to be retrospective if it changes the law as it earlier stood.

In our considered opinion, the effective date of application specified by the Explanatory Memorandum may not be taken as sacrosanct and final in all cases, unless the amendment has the effect of adversely disturbing the rights and obligations of the parties with retrospective effect. In other words, an attempt should be made by the Courts to determine independently the effective date of application where the law has been amended for removal of doubts or is expressly provided to be declaratory or clarificatory. In the case of the Explanation, on a bare reading of the language thereof, it is gathered that in express language it is provided that the amendment should always be read as if the same was always there by use of words ”the provisions of this section shall apply and shall be deemed to have always applied”. It is therefore, very respectfully noted that the Courts were required to examine whether the Explanation in question was retrospective or not without being summarily swayed by the effective date specified in the Explanatory Memorandum for holding that the amendment was prospective in nature and would not apply to assessment years up to A.Y. 2021-22. Having said that, it is fair to await the final view of the highest Court that is obtained on due consideration of the views expressed here. The situation is unique and demands discretion for conclusive views of the Apex Court.

shailesh.kwebmaker

TDS — Compensation received on acquisition of land for public project under an agreement — Provisions of s. 96 of Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 providing that no income-tax or duty shall be levied on any award or agreement made under Act except u/s 46 — Assessee not specific person u/s 46 — Compensation received by assessee not liable to deduction of tax at source — Deductor to file correction statement of tax deducted — Department to process statement — Tax deducted at source to be refunded accordingly

40 Seema Jagdish Patil vs. National Hi-Speed Rail Corporation Ltd. and Ors
[2022] 445 ITR 382 (Bom.)
Date of order: 9th June, 2022
Ss. 139, 194-IC, 194L, 200(3) proviso, 200A(d) and 237 of ITA, 1961 and ss. 46, 96 of Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013

TDS — Compensation received on acquisition of land for public project under an agreement — Provisions of s. 96 of Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 providing that no income-tax or duty shall be levied on any award or agreement made under Act except u/s 46 — Assessee not specific person u/s 46 — Compensation received by assessee not liable to deduction of tax at source — Deductor to file correction statement of tax deducted — Department to process statement — Tax deducted at source to be refunded accordingly

NHRCL acquired the land of the assessee purportedly under an agreement and deducted tax at source from the compensation paid. Thereafter, a supplementary deed was entered into between the assessee, and NHRCL under which some additional amount was paid to the assessee and tax was deducted from that part of the compensation also. The assessee requested NHRCL to reverse the tax deducted on the ground that no tax was deductible. NHRCL replied that tax exemption did not apply to the compensation on the land acquired from the assessee and that the tax deducted from the payment made to the assessee was duly deposited with the Department. According to the assessee, her income was exempted from tax, and she could not fill Schedule TDS-2 and hence could not make an application u/s 199 of the Income-tax Act, 1961 read with rule 37BA(3)(i)
of the Income-tax Rules, 1962 whereas according to NHRCL the assessee had to file a return and claim the refund.

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

“i) The CBDT under Circular No. 36 of 2016, dated October 25, 2016 ([2016] 388 ITR (St.) 48) has clarified that “the matter has been examined by the Board and it is hereafter clarified that compensation received in respect of award or agreement which has been exempted from levy of Income-tax by section 96 of the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 shall not be taxable under the provisions of the Income-tax Act, 1961”. It also recognizes acquisition by award or agreement. Section 96 of the 2013 Act unequivocally provides that no Income-tax or duty shall be levied on any award or agreement made under the Act except u/s. 46 of the 2013 Act which applies to the specified persons. Specified person includes any person other than (i) appropriate Government (ii) Government company (iii) association of persons or trust or society as registered under the Societies Registration Act, wholly or partially aided by the appropriate Government or controlled by the appropriate Government.

ii) The proviso to section 200(3) of the 1961 Act provides that the person may also deliver to the prescribed authority the correction statement for rectification of any mistake in the statement delivered under the sub-section in such form and verified in such manner as may be verified by the authority. Clause (d) of sub-section (1) of section 200A of the 1961 Act, inter alia, provides for determination of the sum payable by or the amount of refund due to the deductor.

iii) The income received by the assessee on account of the property acquired by NHRCL by private negotiations and sale deed was exempted from tax. According to the public notice issued for acquisition of land through direct purchase and private negotiations by the office of the Sub-Divisional Officer for implementing the project, while purchasing the land directly for the project the compensation would be fixed by giving 25 per cent. enhanced amount of the total compensation being calculated for the land concerned in terms of the provisions of sections 26 to 33 and Schedule I to the 2013 Act. Undisputedly, the land was acquired for a public project. A policy decision had been taken by the State Government under its Government Resolution dated May 12, 2015 for acquiring the property by private negotiations and purchases for implementation of public project. The methodology was also provided. The computation of compensation had to be under the provisions of the 2013 Act which was introduced to expedite the acquisition for the implementation of the project. If the parties would not agree with the negotiations and direct purchase, then compulsory acquisition under the provisions of the 2013 Act had to be resorted to. The 2013 Act also recognised the acquisition through an agreement. NHRCL was not a specified person within the meaning of section 46 of the 2013 Act and the provisions of the section would not be attracted. Therefore, since the exemption u/s. 96 of the 2013 Act would apply and no tax can be levied on the amount of compensation NHRCL should not have deducted tax from the amount of compensation paid to the assessee.

iv) It was not possible for the court to arrive at a conclusion as to whether the assessee was required to file return or not. NHRCL had already deducted tax which it ought not to have been deducted. Therefore, (i) NHRCL should file a correction statement as provided under the proviso to sub-section (3) of section 200 of the 1961 Act to the effect that the tax deducted by it was not liable to be deducted, (ii) the Department shall process the statement including the correction statement that might be filed u/s. 200A more particularly clause (d) thereof and (iii) the parties should thereafter take steps for refund of the amount in accordance with the provisions of the 1961 Act and the 1962 Rules.”

shailesh.kwebmaker

Survey — Impounding of documents — Retention of such documents — Effect of s. 131 — Retention beyond fifteen days only after approval of higher authority named in provision — Decision should be communicated to assessee

39 Muthukoya T. vs CIT
[2022] 445 ITR 450 (Ker.)
A.Ys.: 2007-08 to 2011-12
Date of order: 18th May, 2022
S. 131 of ITA, 1961

Survey — Impounding of documents — Retention of such documents — Effect of s. 131 — Retention beyond fifteen days only after approval of higher authority named in provision — Decision should be communicated to assessee

As part of Income-tax survey operations, the petitioner’s premises was inspected on 17th February, 2010, and on issuing summons to him to produce books of account and other original documents, the petitioner produced various documents which were impounded u/s 131(3) of the Income-tax Act, 1961. Subsequently, the petitioner filed his returns and cleared the entire Income-tax dues in 2010 itself. However, the authorities did not return the original documents impounded by them. The petitioner, therefore, filed a writ petition requesting a direction for returning the documents. It was pleaded that despite the request for the return of the original document of title, the respondents have, under one pretext or the other, delayed returning the document. The petitioner also asserted that the respondents had informed that they misplaced the documents and that the same would be returned after tracing it out. According to the petitioner, the respondents cannot hold on to the documents indefinitely and that such an action is illegal and contrary to the principles of equality enshrined under article 14 of the Constitution of India.

The Kerala High Court allowed the writ petition and held as under:

“i) U/s. 131(3) of the Income-tax Act, 1961, the documents impounded can be retained in the custody of the Income-tax Department beyond 15 days only after obtaining the approval of the Principal Chief Commissioner or other officers named in the sub-section. Apart from obtaining orders of approval from the officers to retain the documents, there is an added obligation upon the Department to communicate the orders to the assessee to enable retention of documents beyond the period specified in the said sub-section.

ii) Documents impounded u/s. 131 had been retained beyond the period of fifteen days. No approval had been obtained by the Department from any of the officers mentioned in section 131(3) of the Act. Therefore, the respondents could not under any circumstances retain the documents of title of the assessee.

iii) In view of the above, the respondents have acted illegally and with material irregularity in retaining the documents of title belonging to the petitioner. Accordingly, the respondents are directed to return the original sale deed bearing No. 3561 of 2008 executed before the Sub-Registrar’s office, Ernakulam to the petitioner within an outer period of 30 days from the date of receipt of a copy of this judgment.”

shailesh.kwebmaker

Reassessment — Notice u/s 148 — Limitation — Law applicable — Constitutional validity of provisions — Effect of enactment of s. 148A with effect from 01/04/2021 — Notifications extending time limit for notices u/s 148 up to 30/06/2021 — Notifications not valid — Notice u/s 148 issued on 30/06/2021 — Not valid

38 Mohammed Mustafa vs. ITO
[2022] 445 ITR 608 (Kar.)
A.Y.: 2016-17
Date of order: 18th April, 2022
Ss. 148 and 148A of ITA,1961

Reassessment — Notice u/s 148 — Limitation — Law applicable — Constitutional validity of provisions — Effect of enactment of s. 148A with effect from 01/04/2021 — Notifications extending time limit for notices u/s 148 up to 30/06/2021 — Notifications not valid — Notice u/s 148 issued on 30/06/2021 — Not valid

The petitioner filed the return of income for A.Y. 2016-17 on 30th July, 2016 and declared a total income of Rs. 7,84,730. The petitioner thereafter received a notice dated 30th June, 2021 u/s 148 of the Income-tax Act, 1961 for A.Y. 2016-17.

The petitioner assessee filed a writ petition and challenged the validity of the notice. The Karnataka High Court allowed the writ petition and held as under:

“i) It is a cardinal principle of law that the law which has to be applied is the law in force in the assessment year unless otherwise provided expressly or by necessary implication. When the statute vests certain power in an authority to be exercised in a particular manner, the authority is required to exercise such power only in the manner provided therein.

ii) Substitution of a provision results in repeal of the earlier provision and its replacement by the new provision. Substitution thus combines repeal and fresh enactment. Therefore, the amended provisions of section 148A of the Income-tax Act, 1961 would apply in respect of notices issued with effect from April 1, 2021 and the erstwhile provisions of sections 147 to 151 of the Act, cannot be resorted to as, they have been repealed by the amending Act, viz., the 2020 Act. Even otherwise, no saving clause has been provided in the Act for saving the erstwhile provisions of sections 147 to 151 of the Act.

iii) The CBDT issued Notification No. 20 of 2021 dated March 31, 2021 ([2021] 432 ITR (St.) 141) and extended the time limit for issue of notice u/s. 148 of the Act from March 31, 2021 to April 30, 2021. Another Notification No. 38 of 2021 dated April 27, 2021 ([2021] 434 ITR (St.) 11) was issued u/s. 3(1) of the Act by the Central Government, by which time limit for issuance of notice u/s. 148 of the 1961 Act was further extended from April 30, 2021 to June 30, 2021.

iv) The notifications dated March 30, 2021 and April 27, 2021, are clearly beyond the authority delegated to the Central Government under the 2020 Act to issue notifications extending time limits for various actions and compliances. By means of the Explanations, the Central Government extended the operation of sections 148, 149 and 151 prior to their amendment by the Finance Act, 2021 and sought to revive the non-existent provisions which is clearly beyond its authority. Therefore, the Explanations contained in the notifications dated March 30, 2021 and April 27, 2021 are liable to be struck down as ultra vires the 2020 Act.

v) The validity of a notice has to be adjudged on the basis of law as existing on the date of notice. The notice u/s. 148 dated June 30, 2021 was invalid and had to be struck down. The notice was not valid.”

shailesh.kwebmaker

Offences and prosecution — Wilful attempt to evade tax — Presumption of culpable mental state u/s 278E — Self-assessment return filed — Delay in paying tax — Tax and interest thereon paid before complaint filed — Prosecution malicious and invalid

37 Mrs. Noorjahan and Ors. vs. Dy. CIT
[2022] 445 ITR 17 (Mad.)
A.Y.: 2017-18
Date of order: 26th April, 2022
Ss. 276C and 278E of ITA, 1961

Offences and prosecution — Wilful attempt to evade tax — Presumption of culpable mental state u/s 278E — Self-assessment return filed — Delay in paying tax — Tax and interest thereon paid before complaint filed — Prosecution malicious and invalid

M/s. AMK Solutions Pvt. Limited is the assessee. For A.Y. 2017-18, the assessee company filed a return of income on 31st October, 2017. However, the tax admitted to be payable was not remitted by the assessee along with the return, which is the requirement of the law u/s 140A of the Income-tax Act, 1961. Thereafter, after a delay of 4½ months, the assessee remitted a sum of Rs. 6,85,462 towards the tax and interest payable. However, the Income-tax Department filed complaints against the assessee company and the directors for prosecution for offences u/s 276C(2), alleging that the petitioners have wilfully attempted to evade payment of Income-tax for A.Y. 2017-18.

The assessee company and the directors filed criminal writ petitions challenging the validity of complaints and requesting discharge. It was pointed out that the tax payable by the petitioners for A.Y. 2017-18 was paid well before the issuance of show-cause notice, and the same was intimated to the authorities. Without applying mind and not considering the payment of tax with interest, sanction to prosecute was granted, and the private complaint came to be filed suppressing the factum of tax payment much prior to sanction to prosecute. That, there is a lack of ingredients to prosecute the petitioners u/s 276C(2), besides suppression of fact and non-application of mind. The Madras High Court allowed the writ petitions and held as under:

“i) Wilful attempt to evade any tax, penalty or interest chargeable or imposable u/s. 276C of the Income-tax Act, 1961, is a positive act on the part of the assessee which is required to be proved to bring home the charge against the assessee. A “culpable mental state” which can be presumed u/s. 278E of the Act would come into play only in a prosecution for any offence which requires a culpable mental state on the part of the assessee. Section 278E of the Act is really a rule of evidence regarding existence of mens rea by drawing a presumption though rebuttable. That does not mean that the presumption would apply even in a case wherein the basic requirements constituting the offence are not disclosed. More particularly, when the tax is paid much before the process for prosecution is set into motion. The presumption can be applied only when the basic ingredients which would constitute any offence under the Act are disclosed. Then alone would the rule of evidence u/s. 278E of the Act regarding rebuttable presumption as to existence of culpable mental state on the part of accused come into play.

ii) There was no concealment of any source of income or taxable item, inclusion of a circumstance aimed to evade tax or furnishing of inaccurate particulars regarding any assessment or payment of tax. What was involved was only a failure on the part of the assessee to pay the tax in time, which was later on paid after 4½ months along with interest payable. So, it would not fall under the mischief of section 276C of the Act, which requires an attempt to evade tax and such attempt must be wilful. If the intention (culpable mental state) of the assessees was to evade tax or attempt to evade tax, they would not have filed the returns in time disclosing the income and the tax liable to be paid. They would not have remitted the tax payable with interest without waiting for the authorities to make demand or notice for prosecution. Thus, except a delay of 4½ months in payment of tax, there was no tax evasion or attempt to evade the payment of tax.

iii) To invoke the deeming provision, there should be a default in payment of tax in true sense. The Principal Commissioner who had accorded sanction on March 14, 2019 had not considered the payment of tax with interest by the assessee on February 15, 2018. Further the Principal Commissioner had conspicuously omitted to record the fact of payment of tax with interest except to record that the tax was not paid within time. Thus, the suppression of material facts, intentional suggestion of falsehood and non-application of mind went to show that this was a malicious prosecution initiated by the Income-tax authorities by abusing the power. When the mala fides were patently manifested, the assessees need not be forced to undergo the ordeal of trial. The complaint was quashed.”

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Income from other sources — Deductions — Scope of s. 57(iii) — Not necessary that expenses should have resulted in income — Sufficient if nexus is established between expenses and income

36 West Palm Developments LLP vs. ACIT
[2022] 445 ITR 511 (Kar.)
A.Y.: 2009-10
Date of order: 19th November, 2021
S. 57(iii) of ITA, 1961

Income from other sources — Deductions — Scope of s. 57(iii) — Not necessary that expenses should have resulted in income — Sufficient if nexus is established between expenses and income

The assessee was engaged in development and purchased, sold, constructed and leased properties. The assessee was sanctioned a loan on 26th September, 2008 for a sum of Rs. 35 crores from the Union Bank of India. The assessee paid a sum of Rs. 33,50,00,000 to P as an advance towards the purchase of properties by cheques dated 30th September, 2008 and 13th October, 2008. However, because of adverse market conditions, the assessee withdrew from the transaction and requested P to refund the earnest money. P refunded the earnest money by cheques dated 23rd October, 2008 and 29th October, 2008. The assessee thereafter lent money to other shareholders and made inter-corporate deposits to the tune of Rs. 35,62,450 for which total interest earned was to the extent of Rs. 2,02,52,131 as against the interest of Rs. 2,84,47,557 paid on loans. The assessee filed the return of income for A.Y. 2009-10, declaring income of Rs. 5,34,23,338 after claiming a loss of Rs. 81,95,426 under the head “Income from other sources”, which was arrived at after reducing the interest payable on the loan of Rs. 2,84,47,557 against the interest income of Rs. 2,02,52,131 earned from inter-corporate deposits and loans to shareholders u/s 57(iii) of the Act. The Assessing Officer disallowed the claim for deduction/set-off of the loss of Rs. 81,95,426.

The Commissioner (Appeals) upheld the order. The Tribunal dismissed the assessee’s appeal.

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

“i) Section 57(iii) of the Income-tax Act, 1961, mandates that income chargeable under the head “Income from other sources” shall be computed after making a deduction of any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income. Section 57(iii) of the Act does not require that the expenditure incurred is deductible only if the expenditure has resulted in actual income. As long as the purpose of incurring expenditure is to earn income, the expenditure would have to be allowed as a deduction u/s. 57(iii) of the Act. U/s. 57(iii) of the Act a nexus between the expenditure and income has to be established.

ii) On the facts and circumstances of the case, the assessee was entitled to deduction u/s. 57(iii) of the Act. In any case, the Tribunal exceeded its jurisdiction in disallowing the entire interest expenditure as the power of the Tribunal was limited to passing an order in respect of subject matter of the appeal.”

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Capital gains — Transfer — Law applicable — Effect of amendment of Transfer of Property Act in 2001 — Agreement for sale of property which is not registered — No transfer of property within meaning of s. 2(47) of Income-tax Act — No liability to pay capital gains tax

35 Principal CIT vs. Shelter Project Ltd.
[2022] 445 ITR 291 (Cal.)
A.Y.: 2009-10
Date of order: 4th February, 2022
S. 2(47) of ITA, 1961 and s. 53A of Transfer of Property Act, 1882

Capital gains — Transfer — Law applicable — Effect of amendment of Transfer of Property Act in 2001 — Agreement for sale of property which is not registered — No transfer of property within meaning of s. 2(47) of Income-tax Act — No liability to pay capital gains tax

Pursuant to an unregistered agreement, possession of the property was handed over by the assessee to a company engaged in developing housing projects wholly owned by the State of West Bengal. The question before the Assessing Officer (AO) was as to whether this amounted to transfer u/s 2(47)(v) of the Income-tax Act, 1961 and whether capital gain tax was attracted? The AO held that the transaction amounted to transfer and assessed capital gains to tax.

The Tribunal took note of the factual position and, more particularly, that the case arose much after the amendment to section 53A of the Transfer of Property Act which was amended by the Amendment Act, 2001, which stipulates that if an agreement like a joint development agreement is not registered, then it shall have no effect in law for the purposes of section 53A of the Transfer of Property Act. Accordingly, the assessee’s appeal was allowed, and the addition was deleted.

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

“i) The Transfer of Property Act, 1882 was amended by the Registration and Other Related Laws (Amendment) Act, 2001 which stipulates that if an agreement such as a joint development agreement is not registered, it shall have no effect in law for the purposes of section 53A of the 1882 Act. The Supreme Court in CIT vs. BALBIR SINGH MAINI [2017] 398 ITR 531 (SC), held that in order to qualify as a “transfer” of a capital asset u/s. 2(47)(v) of the Income-tax Act, 1961 there must be a ”contract” which can be enforced in law u/s. 53A of the 1882 Act. The expression “of the nature referred to in section 53A” in section 2(47)(v) was used by the Legislature ever since sub-clause (v) was inserted by the Finance Act of 1987, with effect from April 1, 1988. All that is meant by this expression is to refer to the ingredients of applicability of section 53A to the contracts mentioned therein. This expression cannot be stretched to refer to an amendment that was made years later in 2001, so as to then say that though registration of a contract is required by the 2001 Act, yet the aforesaid expression “of the nature referred to in section 53A” would somehow refer only to the nature of contract mentioned in section 53A, which would then in turn not require registration. There is no contract in the eye of law in force u/s. 53A after 2001 unless the contract is registered.

ii) Since the development agreement was not registered, it would have no effect in law for the purposes of section 53A which bodily stood incorporated in section 2(47)(v) of the Income-tax Act, 1961. Thus, the Tribunal was right in allowing the assessee’s appeal and granting the relief sought for, namely deletion of the addition to income of the consideration received on transfer of land for development.”

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Late payment charges and service tax do not attract TDS and consequently payment of these amounts without deduction of tax at source does not attract provisions of s.40(a)(ia).

27 Prithvi Outdoor Publicity LLP vs. CIT(A)
ITA No. 1013/Ahd./2019 (Ahd.-Trib.)
A.Y.: 2013-14
Date of order: 29th June, 2022
Section: 40(a)(ia)

Late payment charges and service tax do not attract TDS and consequently payment of these amounts without deduction of tax at source does not attract provisions of s.40(a)(ia).

FACTS
The Assessee incurred advertisement expenditure and made a payment of Rs. 2,27,56,222 to Andhra Pradesh Road Transport Corporation (APRTC). Out of Rs. 2,27,56,222, the Assessee deducted TDS on Rs. 2,17,08,097 and balance Rs. 10,48,125 was paid without deduction of tax. Payment of Rs. 10,48,125 on which no tax was deducted comprised Rs. 9,77,429 paid towards late fees and the balance of Rs. 1,16,155 towards service tax. The Assessee contended that since there is no provision to deduct tax on late fees and service tax, the said amount could not be disallowed u/s 40(a)(ia). Further, since the amount was penal in nature, no tax could be deducted on the same. Lastly, the Assessee contended that the recipient, i.e. APRTC, had included the said payment of Rs. 10,48,125 in its income and offered the same for tax; no disallowance could be made u/s 40(a)(ia).

The Assessing Officer, however, invoked the provisions of s.40(a)(ia) with respect to the payment of Rs. 10,48,125 made without deduction of tax at source.

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

Aggrieved, the Assessee preferred an appeal to the Tribunal.

HELD
The Tribunal held that the TDS provisions did not apply to late fees and service tax, and therefore disallowance u/s 40(a)(ia) could not be made.

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Conditions imposed by CIT, at the time of registration, with respect to conduct of the trust and circumstances in which registration can be cancelled, vacated by the Tribunal on the ground that the scheme of law does not visualise these conditions being part of the scheme of registration being granted to the applicant trust.

26 Bai Navajbai Tata Zoroastrian Girls School vs. CIT(E)
[2022] 141 taxmann.com 62 (Mum.-Trib.)
A.Ys.: 2022-23 to 2026-27
Date of order: 29th July, 2022
Section: 12A

Conditions imposed by CIT, at the time of registration, with respect to conduct of the trust and circumstances in which registration can be cancelled, vacated by the Tribunal on the ground that the scheme of law does not visualise these conditions being part of the scheme of registration being granted to the applicant trust.

FACTS
The Assessee is a charitable trust who had applied for registration u/s 12A of the Income-tax Act, 1961 (“the Act”). The CIT granted registration to the Assessee u/s 12A subject to certain conditions. That is, while passing the order granting registration to the Assessee, the CIT imposed certain conditions, which, inter alia, are as follows:

The Trust/Institution should quote the PAN in all its communications with the Department.

The registration does not automatically confer any right on the donors to claim deduction u/s 80G.

No change in the terms of Trust Deed/Memorandum of Association shall be effected without the due procedure of law, and its intimation shall be given immediately to the Office of the Jurisdictional Commissioner of Income Tax. The registering authority reserves the right to consider whether any such alteration in objects would be consistent with the definition of “charitable purpose” under the Act and in conformity with the requirement of continuity of registration.

The Trust/ Society/Non-Profit Company shall maintain accounts regularly and get these accounts audited in accordance with the provisions of s.12A(1)(b) of the Act.

Separate accounts in respect of profits and gains of business incidental to attainment of objects shall be maintained in compliance with s.11(4A) of the Act.

All public money received including for Corpus or any contribution shall be routed through a bank account whose number shall be communicated to the Office of the Jurisdictional Commissioner of Income Tax.

The Assessee observed that all the conditions imposed in the order granting registration were the conditions which formed the reasons for which registration of the trusts is cancelled, and therefore the conditions were not valid. The Assessee challenged the said order of the Commissioner on the ground that the provisions of the Act do not provide for conditional registration u/s 12A, and in the absence of such provision under the Act, the Commissioner was not justified in imposing conditions upon the Assessee.

HELD

On appeal, the Tribunal held as follows:

The finding regarding the objects of the trust and the genuineness of the trust’s activities cannot be conditional.

The expression “compliance of the requirements under item (B), of sub-clause (i) (i.e. the compliance of such requirements of any other law for the time being in force by the trust or institution as are material for the purpose of achieving its objects)” is applicable to conditions precedent, say for example obtaining under FCRA which is under process, the Commissioner may grant registration subject to FCRA registration being obtained by the Assessee.

The conditions which the Commissioner imposed had the sanction of the law. That is, irrespective of such conditions being imposed by the Commissioner, the conditions found place in the law and the conditions imposed by the Commissioner could not be said to have the force of the law.

The Commissioner has a limited role, and can call for documents or information or make inquiries. The Commissioner cannot decide how and for what reasons the registration has to be cancelled, that too at the time of registration. The Commissioner, therefore, could not have supplemented the conditions by laying down conditions at the time of granting the registration.

Conditions attached to registration must be tested on the scheme of law, and the conditions imposed by the Commissioner did not find the force of law.

The observations of the Commissioner regarding the conduct of the Assessee trust could not be construed as legally binding in the sense that non-compliance with such guidance will not have any consequence beyond what is stated under the provisions of the Act. Further, the Tribunal also held that the implications of not doing what is set out in the conditions imposed by the Commissioner would not remain confined to the cancellation of registration when the law stipulates much harsher consequences.

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Revised Code of Ethics

INTRODUCTION AND OVERALL STRUCTURE OF THE REVISED CODE OF ETHICS

ICAI recently issued the 12th edition of the Code of Ethics, in convergence with the changes to the International Ethics Standards Board for Accountants (IESBA) Code of Ethics. In this article, we shall discuss certain significant changes in the revised Code of Ethics and their relevance in the contemporary professional world.

For the first time, the Code of Ethics has been segregated into different volumes, i.e. I, II and III. These volumes became applicable with effect from 1st July, 2020.

Volume–I of the Code of Ethics (12th edition) is the revised Counterpart of Part-A of Code of Ethics, 2009. It is based on International Ethics Standards Board for Accountants (IESBA) Code of Ethics, 2018 edition.

Volume–II of the Code of Ethics is the revised counterpart of Part-B of the Code of Ethics, 2009. It is based on domestic provisions.

Volume–III of the Code of Ethics contains Case Laws segregated and updated from the Clauses under Part-B of Code of Ethics, 2009.

The Code of Ethics, 2009, and the revised Code of Ethics are a convergence (and not an adoption) of the provisions of the International Federation of Accountants (IFAC) IESBA Code of Ethics.

It is a well-known maxim that “Ignorance of Law is No Excuse”. The revised Code of Ethics (Volume–I) has been issued as a Guideline of the Council. Further, there is change from “should” to “shall”, and requirements are clearly demarcated. As a result, the non-compliance with provisions of the Code will be deemed as a violation of Clause (1) of Part-II of the Second Schedule of the CA Act, 1949-

A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional misconduct, if he-

(1) contravenes any of the provisions of this Act or the regulations made thereunder or any guidelines issued by the Council.

Thus, the revised Code of Ethics, 2019, is mandatory to be followed.

VOLUME-I – STRUCTURE

Volume-I of the Code of Ethics is based on the IESBA Code of Ethics and is structured as follows:

Part 1- which applies to all Professional Accountants, is Complying with the Code, Fundamental Principles and Conceptual Framework.

Part 2- pertains to provisions applicable to Professional Accountants in Service.

Part 3- pertains to provisions applicable to Professional Accountants in Public Practice.

The Code further contains International Independence Standards (Parts 4A and 4B):

• Part 4A- Independence for Audits & Reviews (Sections 400 to 899)

• Part 4B- Independence for Other Assurance Engagements (Sections 900 to 999).

The Code also contains a Glossary of terms used in the Code of Ethics applicable to all Professional Accountants, whether in practice or service.

DEFERRED PROVISIONS OF VOLUME I

There are certain provisions of Volume-I of the Code of Ethics deferred till further notification:

(a) The provision relating to Non-Compliance of Laws and Regulations, popularly called NOCLAR is the new provision in Volume-I. It was not there in the Code of Ethics, 2009. It has been made applicable to members in practice and service both.

(b) Fees- Relative Size- These deal with the restriction of fees from any single client.

(c) Taxation Services to Audit Clients- the earlier edition of the Code had no prohibition on Taxation Services to Audit Clients. However, the revised Code has certain restrictions on taxation services provided to audit clients.

CERTAIN SIGNIFICANT CHANGES IN THE REVISED CODE OF ETHICS

(a) Independence Standards- While the 2009 edition of the Code has Section 290, i.e., “Independence – Assurance Engagements”, Volume–I of the Revised Code, based on the 2018 IESBA Code, has “Independence Standards” in the form of Parts- 4A and 4B as mentioned above.

All members are expected to comply with these Independence Standards while conducting various professional assignments.

The segregation of the existing Section 290 into Parts- 4A and 4B represents the bulkiest change. Most provisions/compliances are common to both Parts 4A and 4B but are given separately in the Code under both parts.

(b) Breaches of the Code- This is regarding the Accountant’s duty in case of breach of Independence Standards, where nobody, except the member knows that there has been breach on his part. There was no such corresponding provision in the earlier Code of Ethics.

This may be said to be a mechanism of self-correction prescribed in the Code in case the Chartered Accountant on his own discovers an unintentional violation.

Examples

A Chartered Accountant who identifies a breach of any other provision of the Code shall evaluate the significance of the breach and its impact on the chartered accountant’s ability to comply with the fundamental principles. The chartered accountant shall also: (a) take whatever actions might be available, as soon as possible, to address the consequences of the breach satisfactorily; and (b) determine whether to report the breach to the relevant parties.

(c) Firm Rotation Requirements- The 2009 edition of the Code of Ethics contained requirements relating to partner rotation. It does not contain Firm rotation requirements.

However, in line with the Companies Act, 2013, the Code being the immediately subsequent edition after coming into force of Companies Act, 2013, Section 550 on Firm rotation has been incorporated in Volume-I over and above the provisions of partner rotation appearing in the IESBA Code.

Accordingly, it is clarified in the Code that partner rotation will co-exist along with Audit Firm rotation (wherever prescribed by a statute).

The 2019 Code (i.e., Volume-I) incorporates Firm rotation requirements to make the guidance comprehensive for members.

(d) Introduction of Key Audit Partner and changes in Rules of Partner Rotation- Key Audit Partner was not defined in the earlier Code of Ethics. In Volume-I of the revised Code of Ethics, Key Audit Partner has been defined as “The Engagement partner, the individual responsible for the engagement quality control review, and other audit partners, if any, on the engagement team who make key decisions or judgments on significant matters with respect to the audit of the financial statements on which the firm will express an opinion. Depending upon the circumstances and the role of the individuals on the audit, “other audit partners” might include, for example, audit partners responsible for significant subsidiaries or divisions.”

The time or period of partners in the Firm remains the same, i.e., 7 years.

However, there is a change with regard to the difference in cooling-off periods. As against the cooling-off period of 2 years, now there will be a cooling-off period of:

5 years for Engagement Partners;

3 years for Engagement Quality Control Review; and

2 years for all other Key Audit Partners of the Firm.

This change is important, as it makes stricter rules on partner rotation.

Further, there are certain restrictions on Activities During Cooling-off w.r.t partner rotation as contained in Section 540 of Volume-I of the Code of Ethics.

The Chartered Accountant will have to maintain the relevant documentation regarding the Key Audit Partner, Cooling-off provisions etc.

(e) Changes in Professional Appointments- The Council of ICAI approved the KYC Norms, which are mandatory in nature and shall apply in all assignments pertaining to attest functions. These became mandatory with effect from 1st January, 2017.

In the revised Code, in paragraph R320.8, the incoming auditor shall request the retiring auditor to provide known information regarding any facts or other information of which, in the retiring auditor’s opinion, the incoming auditor needs to be aware before deciding whether to accept the engagement. There was no such corresponding duty in the earlier Code.

(f) Periodical Review with respect to Recurring Client Engagements- As per Volume-I of the Code of Ethics, for a recurring client engagement, a professional accountant shall periodically review whether to continue with the engagement.

In view of the same, potential threats to compliance with the fundamental principles might be created after acceptance which, had they been known earlier, would have caused the professional accountant to decline the engagement.

(g) Introduction of the term “Public Interest Entity”- The Revised Code 2019 edition contains a new term, “Public Interest Entity” (PIE). It had not been used in the Code of Ethics, 2009.

PIE is defined as-

(i) A listed entity; or

(ii) An entity-

Defined by regulation or legislation as a public interest entity; or

For which the audit is required by regulation or legislation to be conducted in compliance with the same independence requirements that apply to the audit of listed entities. Such regulation might be promulgated by any relevant regulator, including an audit regulator.

For the purpose of this definition, it may be noted that Banks and Insurance Companies are to be considered Public Interest Entities.

Other entities might also be considered by the Firms to be public interest entities, as set out in paragraph 400.8.

There are enhanced independence requirements for PIE clients in the new Code.

(h) Management Responsibilities- The provisions on Management Responsibilities occur for the first time in the ICAI Code of Ethics and appear in Sections 607 – 608.

The feature did not find mention in the Code of Ethics, 2009. In Volume-I, there is a new section dealing with ‘Management Responsibilities’. As per the same, the Firm shall not assume management responsibility for an audit client.

Determining whether an activity is a management responsibility depends on the circumstances and requires the exercise of professional judgment. Examples of activities that would be considered management responsibility include:

Setting policies and strategic direction.

Hiring or dismissing employees.

Directing and taking responsibility for the actions of employees in relation to the employees’ work for the entity.

However, providing advice and recommendations to assist the management of an audit client in discharging its responsibilities is not assuming a management responsibility.

Providing administrative services to an audit client does not usually create a threat. Examples of administrative services include:

Word processing services.

Preparing administrative or statutory forms for client approval.

Submitting such forms as instructed by the client.

Monitoring statutory filing dates and advising an audit client of those dates.

Members may note another term known as “Management Services” as appearing in Section 144 of Companies Act, 2013. These are not defined in the Companies Act or the Rules framed thereunder. Since these will be defined by Government, there is no finality of views on the Management Services being or not being at par with Management Responsibilities as appearing in Volume-I of the Code.

(i) Documentation Requirements- The 2009 Code required Firms to document their conclusions regarding compliance with independence requirements.

In the 2019 Code, the requirements of documentation have been given in greater detail. NOCLAR requires all steps in responding with NOCLAR to be documented.

The Chartered Accountant is encouraged to document:

The facts.

The accounting principles or other relevant professional standards involved.

The communications and parties with whom matters were discussed.

The courses of action considered.

How the accountant attempted to address the matter(s).

Requirements for NOCLAR have to be sufficient to enable an understanding of significant matters arising during the audit, the conclusions reached, and significant professional judgments made in reaching those conclusions. Thus, documentation is of critical importance in manifesting compliance with NOCLAR.

CONCLUSION
The Code of Ethics has been developed to ensure ethical behaviour for members while retaining the long-cherished ideals of ‘excellence, independence, integrity’, protecting the dignity and interests of members and leading our profession to newer heights.

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Major Changes in Overseas Investment Regulations under FEMA

INTRODUCTION

A revamp of the Overseas Direct Investment regulations of the Foreign Exchange Management Act, 1999 (FEMA) was under process for quite some time. Draft Overseas Investment Rules and Overseas Investment Regulations were also in the public domain for consultation. The Finance Ministry, in consultation with RBI, has now finalised the Rules and Regulations, overhauling the outward investment provisions substantially. The new rules supersede the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004, and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015.

This article highlights the significant changes in Overseas Direct Investment provisions in a simplified manner. While there are open issues due to the language adopted in the rules and regulations, such analysis of issues is beyond the scope of this article.

1. WHAT ARE THE MAJOR CHANGES BROUGHT ABOUT BY THE NEW PROVISIONS?

The new provisions have liberalised a few important areas concerning overseas investments and, more importantly, clarified quite a few aspects regarding the older provisions. Some of the significant changes brought about by the new rules and regulations are summarised below:

(i) The new provisions provide enhanced clarity to various terms, including:

Bonafide business activity

Foreign entity

Overseas Direct Investment (ODI)

Overseas Portfolio Investment (OPI)

Strategic Sector

Subsidiary or Step-down subsidiary (SDS),

Financial services activity

Revised pricing guidelines

(ii) The provisions also dispense with approval for:

Deferred payment of consideration.

Investment/disinvestment by a person resident in India under investigation by any investigative agency/regulatory body if conditions are met.

Issuance of corporate guarantees to or on behalf of Second or subsequent level Step Down Subsidiary (SDS).

Write-off on account of disinvestment.

Round-tripped investment if conditions are met, etc.

The provisions have also brought in revised set of compliances and ‘Late Submission Fee’ (LSF) for reporting delays.

2. HOW WOULD THE REVISED OVERSEAS INVESTMENT RULES OPERATE?

In line with amendment to Section 6 of FEMA in 2015, the changes are brought about both by the Government and RBI in the following manner on 22nd August, 2022:

Title	Content	Notified by
FEM (Overseas Investment) Rules, 2022	Dealing with Non-Debt Instruments	Central Government [Notification No. G.S.R. 646(E).]
FEM (Overseas Investment) Regulations, 2022	Dealing with Debt Instruments	RBI [Notification No. FEMA 400/2022-RB.]
FEM (Overseas Investment) Directions, 2022	Directions to be followed by Authorised Dealer-Banks	RBI [Annexed to AP DIR Circular No. 12.]

Title

Content

Notified by

FEM (Overseas Investment) Rules,
2022

Dealing with Non-Debt
Instruments

Central Government [Notification
No. G.S.R. 646(E).]

FEM (Overseas Investment) Regulations,
2022

Dealing with Debt
Instruments

RBI [Notification No.
FEMA 400/2022-RB.]

FEM (Overseas Investment) Directions,
2022

Directions to be
followed by Authorised Dealer-Banks

RBI [Annexed to AP DIR
Circular No. 12.]

Consequential amendments have also been made to the Master Direction on Reporting under FEMA and the Master Direction on Liberalised Remittance Scheme (LRS).

3. WHAT IS COVERED BY OVERSEAS INVESTMENT?

Overseas Investment (“OI”) means Financial Commitment (“FC”) and Overseas Portfolio Investment (“OPI”) by a person resident in India.

FC, in turn, means the aggregate amount of investment made by a person resident in India by way of:

– Overseas Direct Investment (“ODI”),

– Debt (other than OPI) in a foreign entity or entities in which ODI is made, and

– Non-fund-based facilities to or on behalf of such foreign entity or entities.

The total FC made by an Indian entity in all the foreign entities taken together at the time of undertaking such commitment cannot exceed 400% of its net worth as on the date of the last audited balance sheet or as directed by RBI.

It should be noted that the erstwhile regulations allowed unexhausted limit of holding as well as subsidiary for reckoning the limit of 400% of the net worth of the ‘Indian Party’. Now, only the net worth of the investor entity (Indian Entity) is to be
considered.

Corporate guarantees by specified group companies are allowed. However, they will be counted towards the utilisation of such group companies’ financial commitment.

4. WHAT DOES ODI COVER?

Rule 2(1)(q) of the OI Rules defines ‘Overseas Direct Investment’. Accordingly, ODI means investment by way of:

a. Acquisition of unlisted equity capital of a foreign entity, or

b. Subscription as a part of the Memorandum of Association of a foreign entity, or

c. Investment in 10% or more of the paid-up equity capital of a listed foreign entity, or

d. Investment with control, where investment is less than 10% of the paid-up equity capital of a listed foreign entity.

Control and Equity Capital are important terms, explained later in this article.

Further, once an investment is classified as ODI, the investment shall continue to be treated as ODI even if the investment falls below 10% of the paid-up equity capital of the foreign entity or if the investor loses control of the foreign entity.

5. WHAT ARE THE CHANGES IN ODI RULES AS COMPARED TO EARLIER?

The erstwhile regulations referred to ODI as Direct investment outside India by an Indian Party in a Joint Venture (JV) and Wholly Owned Subsidiary (WOS). All these terms have undergone a change.

JV/WOS is substituted under the new regime with the concept of ‘foreign entity’, which means an entity formed or registered or incorporated outside India with limited liability. By implication, investment cannot be made in any foreign entity with unlimited liability. It includes an entity in an International Financial Services Centre (IFSC) in India.

The concept of Indian Party (IP), where all the investors from India in a foreign entity were together considered as IP, has been substituted under the new regime with the concept of ‘Indian entity’, which shall mean a Company or a Limited Liability Partnership or a Partnership Firm or a Body Corporate incorporated under any law for the time being in force. Each investor entity shall be separately considered an Indian entity.

Further, there was lack of clarity between ODI and portfolio investment under the erstwhile regulations. ODI and OPI have now been demarcated into distinct baskets of investments which is explained below.

6. WHAT IS THE CRITERIA TO DETERMINE AN ODI INVESTMENT VIS-À-VIS LISTED AND UNLISTED ENTITIES?

One of the major clarifications emerging in the new rules is that any investment (even one share) in an unlisted entity would be considered as ODI. This was not clear in the erstwhile regime, and each AD Bank was applying different criteria for the same.

Further, an investment in a listed entity of over 10% will now be considered as ODI even if there is no control, while an investment of any limit in a listed entity which provides control would be considered as ODI.

The following flow-chart depicts the difference between ODI and OPI in the case of investment in equity capital:

Control has become a key factor in determining whether an investment is ODI. ‘Control’ has been defined to mean:

– the right to appoint a majority of the directors, or

– to control management or policy decisions exercisable by a person or persons, acting individually or in concert, directly or indirectly,

– including by virtue of their shareholding or management rights or shareholders’ agreements or voting agreements that entitle them to 10% or more of voting rights or in any other manner in the entity.

The above wording makes it clear that ‘Control’ should be looked at in substance and not on a technical basis.

As per the new rules, ODI covers investment in ‘Equity Capital’ which is defined to mean equity shares or perpetual capital; or instruments that are irredeemable; or contribution to non-debt capital of a foreign entity in the nature of fully and compulsorily convertible instruments. What is meant by perpetual capital is not clarified – but it seems to suggest that equity capital would be capital which is for the long term and not a specific period as it would be in the case of redeemable instruments.

7. WHAT ARE THE IMPORTANT CHANGES AS FAR AS STRUCTURING OF OVERSEAS INVESTMENTS GO?

One of the important changes brought about relates to subsidiary or step-down subsidiary (SDS) of the foreign entity. Subsidiary means a first-level subsidiary of a foreign entity. SDS means second and further level subsidiaries beneath the first level subsidiary. Subsidiary or SDS of a foreign entity is defined as an entity in which the foreign entity has ‘Control’. It should be noted that ‘Control’ is the only criterion for determining whether an entity is a subsidiary/ SDS of the foreign entity. Hence, where the foreign entity does not have ‘Control’, it will not be treated as SDS. The rules provide that in such a case, even no reporting is required.

However, it has been provided that the subsidiary and SDS shall comply with the structural requirements of the foreign entity, i.e., it should have limited liability. At the same time, it has been provided that only ‘subsidiaries and SDS’ are required to comply with the structural requirements of the foreign entity. Hence, it can be inferred that the foreign entity may invest in an entity with unlimited liability if the entity does not fall within the definition of subsidiary/ SDS, i.e., the foreign entity does not have control over such underlying entity.

Another important change is the introduction of ‘strategic sector’. The above requirement of limited liability for a subsidiary / SDS has been exempted for a foreign entity hiving its core activity in a ‘strategic sector’ which shall include energy and natural resources sectors such as Oil, Gas, Coal, Mineral Ores, submarine cable system and start-ups and any other sector or sub-sector as deemed fit by the Central Government. ODI in these sectors can also be made in unincorporated entities as well as part of consortiums (in the case of the submarine cable systems sector).

As can be noticed above, strategic sectors include startup sector. However, any ODI in startups shall not be made out of funds borrowed from others in accordance with Rule 19(2) of OI Rules.

8. WHAT DOES OPI MEAN?

OPI means investment in foreign securities other than ODI. It does not include investment in any unlisted debt instruments, or any security issued by a person resident in India (except for those in an IFSC).

More importantly, FC does not include OPI investment; hence the overall limit of 400% of net worth does not apply to OPI investments.

Thus, any investment less than 10% in a listed entity without control would be outside the ambit of FC and its limits. However, there are caps on OPI investments which are given below:

An Indian entity can invest only 50% of its net worth as on the date of its last audited balance sheet under the OPI route. A resident individual can invest up to the limit as per LRS, i.e., $ 250,000 per financial year.

OPI by a resident in India in the equity capital of a listed entity, even after its delisting, shall continue to be treated as OPI until any further investment is made in the entity.

Minimum qualifications shares, or shares or interest acquired by resident individuals by way of sweat equity shares or under Employee Stock Ownership Plan or Employee Benefits Scheme up to 10% of the equity capital of a foreign entity, whether listed or unlisted and without control shall be considered as OPI.

Any investment made overseas under Schedule IV of the OI Rules in securities as stipulated by SEBI, Mutual Funds (MFs), Venture Capital Funds (VCFs) and Alternative Investment Funds (AIFs) registered with SEBI shall also be considered as OPI.

9. WHAT CHANGES HAVE COME IN FOR INVESTMENTS THAT CAN BE MADE IN FOREIGN ENTITIES UNDERTAKING FINANCIAL SERVICES ACTIVITIES?

For an Indian entity engaged in financial services activity in India, there are no significant changes. Such an entity can make ODI in a foreign entity which is directly or indirectly engaged in financial services activity subject to the erstwhile conditions of a) a 3-year profit track record; b) being registered or regulated by a financial services regulator in India and c) having obtained the required approval for the activity from the regulators both in India and the host country. However, as per the new rules, in the case of an ODI made in an IFSC, such approval would have to be provided within 45 days from the date of application; else, it would be considered that such approval has been granted. Banks and NBFIs regulated by RBI are not included in these regulations and would need to follow the conditions laid down by RBI in this regard.

Further, until now, only Indian entities in the financial services sector were allowed to invest in foreign entities engaged in financial services. As per new ODI Rules, Indian entities which are not involved in financial services activities are also permitted to invest in foreign entities engaged in financial services (except banking and insurance) subject to only one condition – that such entities have earned net profits during the last three financial years.

This single condition also has been removed for Indian entities that invest in an entity in an IFSC engaged in financial services activity.

Even Resident Individuals (RI) are allowed to make ODI in a foreign entity in an IFSC, including in an entity engaged in financial services activity (except for banking and insurance). However, in such a case, where the RI controls the foreign entity, such entity cannot have a subsidiary or SDS outside the IFSC.

Further, what activities would constitute ‘Financial services activity’ was not clear in the erstwhile regulations as the term was not defined. However, the new rules provide that a foreign entity shall be considered to be engaged in the business of financial services activity if it undertakes an activity which, if it were carried out by an entity in India, would require registration with or is regulated by a financial sector regulator in India.

10. CAN A GIFT OF OVERSEAS SHARES BE RECEIVED OR MADE BY A RESIDENT INDIVIDUAL?

Foreign securities can be acquired by a Resident Individual (RI) as a gift from another person resident in India who is a relative as per clause (77) of section 2 of the Companies Act. Gift of shares can also be received from a person resident outside India, but only in accordance with provisions of the Foreign Contribution (Regulation) Act, 2010 (FCRA) and the rules and regulations made thereunder.

At the same time, RIs are not allowed to gift an overseas investment to a person resident outside India.

11. WHAT ARE THE CHANGES FOR OVERSEAS INVESTMENT BY A RESIDENT INDIVIDUAL?

Apart from changes in acquiring shares by way of gift and in a foreign entity in an IFSC as explained above, the following are the other main changes for overseas investment by a RI:

a. Step-down subsidiary (SDS) in case of ODI

Under FEMA 120, individuals investing under the ODI Route were not allowed to invest in a structure which would have a subsidiary or an SDS. Under the new regulations, a subsidiary or SDS of a foreign entity is allowed where RI does not have control of the foreign entity.

Moreover, in case of acquisition by way of inheritance or sweat equity shares or qualification shares or shares or interest under ESOP or Employee Benefits Scheme, ODI can be in a foreign entity engaged in financial services activity or can also have a subsidiary or SDS even if RI has control in such foreign entity.

b. Certain investments deemed to be OPI

Acquisition of sweat equity shares or qualification shares or shares or interest under ESOP or Employee Benefits Scheme, amounting to less than 10% of equity capital of a foreign entity without control, will be classified as OPI even if such entity is unlisted.

Similarly, a contribution by an RI to an investment fund or vehicle set up in an IFSC would be considered an OPI.

c. Inheritance of foreign securities under the ODI route is also now expressly provided.

12. IS ROUND TRIPPING ALLOWED UNDER THE NEW RULES?

Round tripping was not allowed earlier without prior approval of the RBI. It was not considered a bona fide business activity by RBI, which was the prerequisite for an ODI investment. While this condition continues, bona fide business activity has now been exhaustively defined under the new rules. It simply means an activity permissible under any law in force in India and in the host jurisdiction.

Rule 19(3) now prohibits investment back into India in cases where the resultant structure has more than two layers of subsidiaries.

The combined reading of the definition of bona fide business activity and limitation in restriction under Rule 19(3) above suggests that round tripping is now allowed. However, it has not been expressly provided for in the Rules.

13. ARE THERE ANY CHANGES IN THE ACQUISITION OF IMMOVABLE PROPERTY OUTSIDE INDIA?

While the rules for the acquisition of Immovable Property (IP) outside India have remained largely the same, the following changes need to be noted as per Rule 21 of the OI Rules read along with amendments in the LRS Master Direction:

a. IP can be purchased under the LRS Scheme as earlier. Further, funds can also be consolidated in respect of relatives as earlier. However, the requirement for such relatives to be co-owners has been removed now.

b. A person resident in India can acquire IP now out of income or sale proceeds of assets (other than ODI) acquired overseas as per the provisions of the FEMA.

c. Earlier only a company having an office outside India could acquire IP outside India for the business and residential purposes of its staff. This has now been allowed for an Indian Entity which has a wider meaning now, as explained earlier.

d. In the erstwhile regulations for buying IP outside India, it was permitted to acquire property jointly with a relative who is a PROI, given that there should be no remittance from India. This condition (of no remittance) seems to have now been removed.

14. WHAT ABOUT INVESTMENTS MADE UNDER THE ERSTWHILE REGULATIONS?

Rule 6 prescribes that any investment or financial commitment outside India made in accordance with the Act or the Rules or Regulations made thereunder and held as on the date of publication of these new rules shall be deemed to have been made under the new Rules and Regulations.

Conversely, it has been provided that if any investment was in violation of the earlier regulations it will remain a violation and may attract consequences as if the old rules are still applicable.

15. WHAT ARE THE CHANGES MADE FOR INVESTMENT IN IFSC?

There are several relaxations made under the new OI Rules in respect of investment in an IFSC. Fundamentally a foreign entity is defined to include an entity set up in an IFSC. Thus, investment into an entity in an IFSC would be considered ODI. At the same time, overseas investment by a financial institution in an IFSC is outside the ambit of the OI Rules.

Specific relaxations have also been made for investment by an Indian entity and RI in an entity engaged in financial services activity in an IFSC, as explained in reply to query 9 above. Such an investment is now allowed by an Indian entity not engaged in financial services activity within India without any attendant conditions.

16. ARE THERE ANY CHANGES IN THE PRICING GUIDELINES?

Earlier the pricing guidelines stated that investment in a JV/WOS outside India could happen at the value arrived at as prescribed by FEMA 120 or even at a value lower than that. Also, the transfer of investment in a JV/WOS could happen at the fair valuation as per FEMA 120 or even at a value higher than that. However, the new OI Rules prescribe that the pricing for investment as well as transfer shall be subject to a price arrived at on an arm’s length basis, taking into consideration the valuation as per any internationally accepted pricing methodology. Further, AD Banks are required to put in a board-approved policy with respect to the documents that need to be taken by them with respect to the pricing and also provide for scenarios where such valuation may not be insisted upon.

17. WHAT ARE THE MODES AVAILABLE FOR FINANCIAL COMMITMENT BY AN INDIAN ENTITY OTHER THAN BY WAY OF EQUITY CAPITAL?

Separate Regulations have been issued by RBI (OI Regulations) for investment in Debt Instruments issued by a foreign entity or to extend non-fund-based commitment to or on behalf of a foreign entity, including the overseas step-down subsidiaries of such Indian entity, subject to the following conditions:

i) The Indian entity is eligible to make ODI,

ii) Such an entity has made ODI in the foreign entity,

iii) The Indian entity has acquired control in such a foreign entity at the time of making such FC.

FC by an Indian entity by way of debt, guarantee, pledge or charge and by way of enabling deferred payment are covered in Regulations 4, 5, 6 and 7 of the OI Regulations. Further, FC under all these regulations would be considered part of the overall limit for FC as stipulated by the OI Rules.

18. IS DEFERRED PAYMENT ALLOWED NOW? WILL IT ALSO COVER CONDITIONAL PAYMENT?

Regulation 7 of OI Regulations now allows acquisition or transfer through deferred payment. This was earlier under the approval route. The deferred consideration shall be treated as part of non-fund-based commitment till the final payment is made. It is provided that payment of consideration may be deferred provided:

i) Deferment is for a definite period,

ii) Deferment should be provided for in the agreement,

iii) Equivalent amount of foreign securities shall be transferred or issued upfront, and

iv) Full consideration shall be paid finally as per applicable pricing guidelines.

Under conditional payment, the amount of payment may vary, or payment may not be made at all. Whereas the above-mentioned conditions for deferred payment require upfront transfer/issue and valuation and also eventual payment of full consideration as per pricing guidelines. Hence, conditional payment may not be allowed as part of deferred payment.

19. OTHER CHANGES

Apart from the above changes, the new OI Rules have also brought in changes with respect to the following:

a. Requirement of a NOC as per Rule 10 of the OI Rules by an Indian entity under investigation or having an account termed as NPA or classified as a willful defaulter.

b. Restructuring of the Balance Sheet of the foreign entity has been allowed subject to conditions as provided in Rule 18 of the OI Rules.

c. Reporting for OI has been changed, and new forms have been issued – ODI has to be reported in Form FC, while OPI has to be reported in Form OPI by a person resident in India other than individuals.

One must keep in mind the above changes before entering into a Financial Commitment in respect of a foreign entity. As mentioned earlier, there are certain issues with regard to the new regulations and an analysis of all such issues is beyond the scope of this article.

shailesh.kwebmaker

PMLA – Magna Carta – Part 1

BACKGROUND
On 27th July, 2022, the Supreme Court of India gave a landmark ruling in the case of Vijay Madanlal Choudhary vs. Union of India [2022] 140 taxmann.com 610 (SC) on various aspects and concepts involving dicey provisions of The Prevention of Money Laundering Act, 2002 (“PMLA”). This decision put to rest raging controversies on various issues agitated in a huge batch of petitions, appeals and cases.

DICEY ISSUES
The issues agitated before and examined by the Supreme Court covered as many as twenty significant aspects of PMLA. Some of these had arisen from decisions of various High Courts rendered a long time ago and were pending the final decision of the Apex Court. Few crucial aspects related to parameters of the concept of money-laundering, punishment for money-laundering, confirmation of provisional attachment, search and seizure, arrest, the burden of proof, bail, powers of authorities regarding summons, production of evidence and Special Courts.

These aspects were agitated before the Supreme Court in as many as over 240 civil and criminal writ petitions, appeals and special leave petitions (SLPs) including transferred petitions and cases.

APPROACH OF THE SUPREME COURT
The Supreme Court was seized of various civil and criminal writ petitions, appeals, SLPs, transferred petitions and transferred cases raising various questions of law. Such questions pertained to constitutional validity and interpretation of certain provisions of the other statutes, including the Customs Act, the Central Goods and Services Tax Act, the Companies Act, the Prevention of Corruption Act, the Indian Penal Code and the Code of Criminal Procedure (CrPC). However, the Apex Court decided to focus primarily on the challenge to the validity of certain important provisions of PMLA and their interpretation.

In addition to ‘challenge to constitutional validity’ and ‘interpretation of provisions of PMLA’, there were SLPs filed against various orders of High Courts and subordinate Courts all over the country. In all such SLPs, prayer for grant of bail or quashing or discharge was rejected by the Supreme Court. The government of India, too, had filed appeals and SLPs. There were also a few transfer petitions filed before the Supreme Court under Article 139A(1) of the Constitution of India.

Instead of dealing with facts and issues in each case, the Supreme Court confined itself to examining the challenge to the relevant provisions of PMLA, being a question of law raised by parties.

The question as to whether some of the amendments to the PMLA could not have been enacted by the Parliament by way of a Finance Act was not examined by the Supreme Court. The same was left open for being examined along with the decision of the Larger Bench (seven Judges) of the Supreme Court in Rojer Mathew (2020) 6 SCC 1.

Consistent with the approach of the Supreme Court, the author, too, has decided merely to give here the gist of the conclusions reached by the Supreme Court on crucial aspects, as follows.

DEFINITIONS
Certain substantive aspects of the following important definitions in PMLA were examined by the Supreme Court.

“investigation”

“proceeds of crime”

As regards the definition of “investigation”, it was concluded that the term “proceedings” [section 2(1)(na) of PMLA] is contextual and is required to be given expansive meaning to include the inquiry procedure followed by the Authorities of Enforcement Directorate (ED), the Adjudicating Authority, and the Special Court.

Likewise, it has been held that the term “investigation” does not limit itself to the matter of investigation concerning the offence under PMLA and is interchangeable with the function of “inquiry” to be undertaken by the Authorities under PMLA.

As regards the definition of “proceeds of crime”, it was held that the Explanation inserted w.e.f. 1st August, 2019 does not travel beyond the main provision predicating tracking and reaching up to the property derived or obtained directly or indirectly as a result of criminal activity relating to a scheduled offence.

OFFENCE OF MONEY-LAUNDERING
The concept of “money-laundering” is pivotal to all other provisions of PMLA. This concept was rationalised by inserting an Explanation w.e.f. 1st August, 2019. The Supreme Court examined all nuances of “money-laundering” and held that “money-laundering” has a wider reach so as to capture every process and activity, direct or indirect, in dealing with the proceeds of crime and is not limited to the happening of the final act of integration of tainted property in the formal economy. The Supreme Court opined that the Explanation does not expand the purport of Section 3 (Offence of money-laundering) but is only clarificatory in nature.

The Supreme Court clarified that the word “and” preceding the expression “projecting or claiming” occurring in Section 3 must be construed as “or”, to give full play to the said provision so as to include “every” process or activity indulged into by anyone. According to the Supreme Court, “projecting or claiming the property as untainted property” would constitute an offence of money-laundering on a stand-alone basis, being an independent process or activity. Being a clarificatory amendment, it would make no difference even if the Explanation was introduced by Finance Act or otherwise.

The Supreme Court very aptly rejected the interpretation suggested by the petitioners, that only upon projecting or claiming the property in question as untainted property that the offence of money-laundering would be complete. According to the Supreme Court, after insertion of the Explanation to section 3, this suggestion was not tenable. Indeed, it was explained that the offence of money-laundering is dependent on the illegal gain of property as a result of criminal activity relating to a scheduled offence. This proposition was elaborated by the Supreme Court with the observation that the Authorities under PMLA cannot prosecute any person on a notional basis or on the assumption that a scheduled offence has been committed unless it is so registered with the jurisdictional police and/or pending enquiry/trial including by way of criminal complaint before the competent forum. In view of the Supreme Court, if the person is finally discharged/acquitted of the scheduled offence or where the criminal case against him is quashed by the Court of competent jurisdiction, there can be no offence of money-laundering against him or anyone claiming such property being the property linked to the stated scheduled offence through him.

CONFIRMATION OF PROVISIONAL ATTACHMENT
In various appeals and petitions, the constitutional validity of section 5 of PMLA authorising provisional attachment was challenged. After examining the relevant legal position, it was held by the Supreme Court that section 5 is constitutionally valid. According to the Supreme Court, provisional attachment provides for a balancing arrangement to secure the interests of the person and also ensures that the proceeds of crime remain available to be dealt with in the manner provided by PMLA. Elaborating this, it was observed by the Supreme Court that the procedural safeguards as envisaged by law are effective measures to protect the interests of the person concerned.

The challenge to the validity of section 8(4) of PMLA authorising seizure of property attachment which is confirmed, was also rejected by the Supreme Court subject to Section 8 being invoked and operated in accordance with the meaning assigned to it.

SEARCH AND SEIZURE
In several petitions, PMLA authorities’ powers of search and seizure were challenged as unconstitutional to the extent of deletion of the Proviso to section 17 which dispensed with report or complaint to the Magistrate. This challenge was also rejected by the Supreme Court on the ground that there are stringent safeguards provided in section 17 and the rules framed thereunder.

A similar challenge to the deletion of Proviso to section 18(1) dealing with the search of persons was also rejected on the ground that there are similar safeguards provided in section 18. Accordingly, it was held that the amended provision does not suffer from the vice of arbitrariness.

ARREST
The challenge to the constitutional validity of section 19 providing powers to arrest was rejected on the ground that there are stringent safeguards provided in section 19. Accordingly, the Supreme Court held that section 19 does not suffer from the vice of arbitrariness.

BURDEN OF PROOF
Section 24 of PMLA mandates a reverse burden of proof. In respect to the challenge to the validity of this provision, the Supreme Court held that section 24 has reasonable nexus with the purposes and objects sought to be achieved by PMLA and cannot be regarded as manifestly arbitrary or unconstitutional.

SPECIAL COURTS TO TRY OFFENCE OF MONEY-LAUNDERING
Section 44 of PMLA provides for trial of the offence of money-laundering and scheduled offence by Special Courts.

As regards the challenge to the validity of section 44, the Supreme Court did not find merit in such a challenge (that was based on the premise that section 44 was arbitrary or unconstitutional). However, it observed that the eventualities referred to in section 44 shall be dealt with by the Court concerned and by the Authority concerned in accordance with the interpretation given in this judgement.

OFFENCES TO BE COGNISABLE AND NON-BAILABLE
Section 45 of PMLA deals with this aspect. Earlier, in Nikesh Tarachand Shah vs. UoI (2018) 11SCC 1, the Supreme Court had declared the twin conditions in section 45(1) of PMLA, as it stood at the relevant time, as unconstitutional. However, now the Supreme Court has held that the said decision did not obliterate section 45 from the statute book; and that it was open to the Parliament to cure the defect noted by the Supreme Court in the earlier decision to revive the same provision in the existing form.

To elaborate this, the Supreme Court observed that it does not agree with the observations in Nikesh Tarachand Shah distinguishing the ratio of the Constitution Bench decision in Kartar Singh, and other observations suggestive of doubting the perception of Parliament in regard to the seriousness of the offence of money-laundering including about it posing a serious threat to the sovereignty and integrity of the country. It was further elaborated by the Supreme Court that section 45, as applicable post-2019 amendment, is reasonable and has direct nexus with the purposes and objects to be achieved by PMLA and does not suffer from the vice of arbitrariness or unreasonableness.

As regards the prayer for grant of bail, it was explained by the Supreme Court that irrespective of the nature of proceedings, including those under section 438 of CrPC or even upon invoking the jurisdiction of Constitutional Courts, the underlying principles and rigours of section 45 may apply.

It was also explained that the beneficial provision of section 436A of CrPC (which provides a maximum period for which an undertrial can be detained) could be invoked by the accused arrested for an offence punishable under PMLA.

POWERS OF AUTHORITIES REGARDING SUMMONS AND PRODUCTION OF DOCUMENTS AND EVIDENCE

Section 50 of PMLA deals with the powers of authorities regarding summons, compelling production of records, etc.

In this connection, the Supreme Court held that the process envisaged by section 50 is in the nature of an inquiry against the proceeds of crime and is not an “investigation” in the strict sense of the term for initiating prosecution; and the authorities under PMLA referred to in section 48 are not police officers as such.

It was explained by the Supreme Court that the statements recorded by the Authorities under PMLA are not hit by Article 20(3) (no person accused of any offence shall be compelled to be a witness against himself) or Article 21 of the Constitution of India (Protection of life and personal liberty).

ENFORCEMENT CASE INFORMATION REPORT (ECIR)

In respect of the plea that a copy of ECIR should be supplied to the arrested person, the Supreme Court held that in view of the special mechanism envisaged by PMLA, ECIR cannot be equated with an FIR under CrPC. It was explained that ECIR is an internal document of the ED and the fact that an FIR in respect of a a scheduled offence has not been recorded does not come in the way of the authorities referred to in section 48 to commence inquiry/investigation for initiating “civil action” of provisional attachment of property being proceeds of crime.

It was held that the supply of a copy of ECIR in every case to the arrested person is not mandatory and it is sufficient that at the time of arrest, ED discloses the grounds of such arrest.

Indeed, the Supreme Court observed that, when the arrested person is produced before the Special Court, it is open to the Special Court to look into the relevant records presented by the authorised representative of ED for answering the issue of the need for his/her continued detention in connection with the offence of money-laundering.

On this issue, it was suggested by the Supreme Court that even though the ED manual is not to be published, being an internal departmental document issued for the guidance of the ED officials, the department ought to explore the desirability of placing information on its website which may broadly outline the scope of the authority of the functionaries under the Act and measures to be adopted by them as also the options and remedies available to the person concerned before the Authority and the Special Court.

PUNISHMENT
As regards the plea about the proportionality of punishment with reference to the nature of the scheduled offence, it was held by the Supreme Court that such plea is wholly unfounded and stands rejected.

WAY FORWARD
What next after the pronouncement of the Supreme Court ruling?

Indeed, in terms of Article 141 of the Constitution, the propositions affirmed by the Supreme Court are now binding on all courts in India.

That calls for clear direction for the way forward. The way forward post 27th July, 2022 is outlined by the Supreme Court by way of following interim measures for four weeks from 27th July, 2022.

The private parties in the transferred petitions are at liberty to pursue the proceedings pending before the High Court. The contentions other than those dealt with in this judgement, regarding validity and interpretation of the concerned PMLA provision, are kept open, to be decided in those proceedings on their own merits.

Writ petitions which involve issues relating to Finance Bill/Money Bill are to be heard along with the Rojer Mathew case.

In the writ petitions in which further relief of bail, discharge or quashing was prayed, the private parties are at liberty to pursue further reliefs before the appropriate forums, leaving all contentions in that regard open, to be decided on its own merits.

The writ petitions in which validity and interpretation of other statutes (such as Indian Penal Code, CrPC, Customs Act, Prevention of Corruption Act, Companies Act, 2013, CGST Act) were challenged, were directed to be placed before appropriate Bench “group-wise or Act-wise”.

The parties are at liberty to mention for early listing of the concerned case including for continuation/vacation of the interim relief.

[Some of the interesting questions and answers arising from reading of this judgment will be dealt with by the Author in the next issue of the BCAJ]

References:

[Readers are advised to read the following two articles published in the BCAJ in 2021 written by Dr. Dilip K. Sheth about PMLA for more insight. The said articles can be accessed on bcajonline.org]

1. OFFENCE OF MONEY-LAUNDERING: FAR-EACHING IMPLICATIONS OF RECENT AMENDMENT – Published in January, 2021.

2. ‘PROCEEDS OF CRIME’ – PMLA DEFINITION UNDERGOES RETROSPECTIVE SEA CHANGE – Published in February, 2021.

Editor’s Note: At the time of going to press, the Supreme Court, on 26th August 2022, stated that two aspects of its 27th July 2022 judgement required reconsideration (i.e. (i) the finding that ECIR is not FIR and hence no mandatory need to provide it to the accused; and (ii) the negation of the cardinal principle of “presumption of innocence”).

shailesh.kwebmaker

Digitalisation of Form 10F – New Barrier To Claim Tax Treaty?

BACKGROUND
The Income-tax Act 1961 (‘Act’) grants an option to a Non-Resident (‘NR’) to be
governed by the provisions of the Act or the Double Tax Avoidance Agreement
(DTAA), whichever is beneficial. Section 90(4) mandates non-residents to obtain
a Tax Residency Certificate (TRC) from the country of residence to take benefit
of the DTAA by virtue of section 90 of the Act. In addition, section 90(5)
requires non-residents to furnish information in Form 10F. In practice, NRs
used to furnish TRC and Form 10F either in physical form or an electronic copy
to the payer of income to avail of DTAA benefits at the time of withholding.
Now, Notification No. 3/2022 dated 16th July, 2022 (‘Notification’), requires
Form 10F to be furnished electronically and verified in the manner prescribed.
This article deals with nuances and implications arising from this
Notification.

PROCESS OF OBTAINING FORM 10F IN DIGITALISED FORM
The Notification came into effect on 16th July, 2022. Form 10F in digitalized
form can be generated from the income tax e-filing portal by logging into the
assessee’s account for the Financial Year (F.Y.) 2021-22 and F.Y. 2022-23.
Thereafter, the NR is required to fill in information prescribed in Form 10F,
upload a copy of TRC and verify the same by affixing the digital signature
(DSC) of the person authorized to e-verify Form 10F.

Incidentally, when logging in, the portal states, “This Form is applicable
to an assessee who is a citizen of India living in another country and earning
foreign Income”. It is submitted that this statement is incorrect. In any
case, instruction on the portal has no statutory force.

CONSEQUENCES OF DIGITALISED FORM 10F
Obtaining Form 10F in the digitalised form will require a NR to obtain PAN in
India, as without PAN, Form 10F in digitised form is not accepted. In addition,
the authorized signatory must register his DSC in the NR tax login. It is
possible that such an authorized signatory may be a non-resident. Consequently,
the authorized signatory will also be required to submit KYC documents to
procure DSC.

This requirement can be complied with by NR assessees, generally Associated
Enterprises (AEs) who receive taxable income in India and regularly file a tax
return in India or report international transactions in Form 3CEB. These AEs,
irrespective of technical reading of Rule 21AB(2), are likely to comply with
new norms¹. However, there are numerous business payments made to NR
which are not recurring in nature and are not chargeable to tax in India
pursuant to a favorable tax treaty. NR vendors are not comfortable obtaining
PAN and therefore undertake submission of 10-F electronically. Section 195
creates parallel liability on the deductor to withhold tax. The Notification is
expected to give rise to uncertainty in the following illustrative situations:

Payment for technical services which does not fulfil
the requirement of make available condition in India-US DTAA.

Software license payments which are not taxable
pursuant to royalty article in DTAA read with Supreme Court decision in
case of Engineering Analysis Centre of Excellence (P.) Ltd vs. CIT².

Import of goods in India may result in Significant
Economic Presence under Explanation 2A to section 9(1)(i). Since SEP
provisions are subject to DTAA, importers obtain TRC and Form 10F from
NRs.

Interest payment on rupee-denominated loans which are
not entitled to concessional tax rate u/s 194LC or section 194LD / where
payer wishes to obtain TRC and Form 10F on the conservative basis (should
the benefit of section 194LC or section 194LC is denied by tax authority).

Equipment rental payment to Netherland NR and payment
for aircraft leasing to Ireland NR.

Transfer of shares of an Indian Company by NR seller
being tax resident of Mauritius, Singapore entitled to capital gain
exemption³.

Indirect transfer of shares of an overseas company
deriving substantial value from India taxable under Explanation 4 and
Explanation 5 to section 9(1)(i).

This Notification is effective from 16th July, 2022. No prior intimation or
time gap is given to the assessee to comply with the law. It is likely to
impact ongoing contracts where Indian payers based on a bonafide understanding
of the law would have agreed to bear tax liability under the net of tax
contract on the premise that NR will provide TRC, Form 10F (either in physical
or an electronic copy), and other usual declarations. The Notification may
result in a change in the law that was not envisaged at the time of entering
into the contract. Equally, NR may not agree to obtain PAN and furnish Form 10F
digitally. They may continue the present practice of giving Form 10F in
physical or an electronic copy. In such cases, if the Law is read literally, it
may mean that Form 10F is not furnished by NR in the prescribed manner and
accordingly condition of section 90(5) of the Act is not complied with.
Consequently, tax may be required to be deducted in accordance with Act. This
is likely to create friction between the deductor and the NR vendor. In cases
where the contract is on the net of tax basis, the deductor will be responsible
for paying tax which will escalate the cost of services.

Considering the aforesaid, it is necessary to evaluate whether the Notification
which requires digitalization of Form 10F is valid and is likely to stand the
test of law. This needs to be evaluated considering the propositions which are
discussed hereunder.

1. Non-corporate FPIs do not need DSC for signing tax
returns. Non-corporate entities can electronically transmit the ITR and
subsequently submit the physically-signed acknowledgment copy with CPC. Using a
DSC only for electronically furnishing Form 10F is likely to create a practical
challenge.
2. [2021] 125 taxmann.com 42 (SC)
3. Article 13(3A) of India-Mauritius DTAA; Article 13(4A) of India-Singapore
DTAA subject to satisfaction of specified conditions in DTAA.

FORM 10F – WHETHER REQUIRED IN ALL
CIRCUMSTANCES?
Section 90(4) provides that NR shall not be entitled to the benefit of DTAA
unless TRC is obtained. Section 90(5) provides that NR referred to in
subsection (4) shall provide other information as may be prescribed. This
linkage gives the inference that subsection (5) needs to be read as an integral
part of sub-section (4), and noncompliance of same can result in denial of DTAA
benefit.

Rule 21AB(1) of the Income-tax Rules, 1961 (“the Rules”) (prescribed u/s 90(5))
requires NR to furnish the following information in Form 10F:

(i) Status (individual, company, firm, etc.) of the assessee;

(ii) Nationality (in case of an individual) or country or specified territory
of incorporation or registration (in case of others);

(iii) Assessee’s tax identification number in the country or specified
territory of residence and in case there is no such number, then, a unique
number based on which the person is identified by the Government of the country
or the specified territory of which the assessee claims to be a resident;

(iv) Period for which the residential status, as mentioned in the certificate
referred to in subsection (4) of section 90 or sub-section (4) of section 90A,
is applicable; and

(v) Address of the assessee in the country or specified territory outside
India, during the period for which the certificate, as mentioned in (iv) above,
is applicable.

The information prescribed in item number (i) above should be read “as
applicable” even though such words are not found in Rule 21AB(1). This is
because the status of the assessee is a concept under Indian law. Section 2(31)
ascribes status to a person, which may not be a concept in overseas countries.
Further, the tax identification number may not be issued by the country to a
tax-exempt entity (e.g. Abu Dhabi Investment Authority or pension trust).

The Notification requires NR to fill in aforesaid information in its tax login
account and verify the same using the DSC of the person authorized to sign the
income-tax return. Rule 21AB(2) creates carve out to sub-rule (1). It reads as
under:

“The assessee may not be required to provide the information or any part
thereof referred to in sub-rule (1) if the information or the part thereof, as
the case may be, is contained in the certificate referred to in sub-section
(4) of section 90 or sub-section (4) of section 90A.”

The exception carved out in Rule 21AB(2) is important. It states that Form 10F
is not required if all information in Rule 21AB(1) is already forming part of
TRC. In the view of the authors, typically, TRC issued by major treaty partners
(e.g. Germany, Netherlands, Singapore, Japan, Mauritius, Australia, France
etc.) reveals that it contains all the information as stipulated in Rule
21AB(1). Accordingly, Rule 21AB(1) and consequently section 90(5) is not
applicable in so far as TRC issued by such countries are concerned. Thus, NRs
resident of such countries are not impacted by the Notification requiring Form
10F to be issued digitally.

However, TRC issued by countries like Hong Kong, Ireland, etc., does not
contain information such as addresses. Thus, the safe harbour of Rule 21AB(2)
does not apply in such cases. Accordingly, NR from such treaty countries will
be required to submit Form 10F in digitalized form.

PROVISIONS IN ACT AND RULE GOVERNING THE APPLICATION OF PAN
Section 139A(1) and Rule 114 requires the assessee to obtain PAN if his income
is chargeable to tax in India. Rule 114B has prescribed such transactions where
PAN is required to be obtained. Transactions listed in Rule 114B are in nature
of investment in shares, debentures, etc., above a particular threshold. None
of the provisions requires NR to obtain PAN in India, where income is exempt
from tax pursuant to favourable DTAA. In fact, section 206AA and Rule 37BC
(dealt subsequently) give further force to this argument.

The Notification is issued in exercise of powers conferred in sub-rule (1) and
sub-rule (2) of Rule 131 of the Income-tax Rules, 1962. Rule 131 was, in turn,
inserted by the Income-tax (first twenty-first Amendment) Rules, 2021, w.e.f.
29th July, 2021 (21st Amendment). The 21st Amendment, in turn, was in the
exercise of powers conferred in section 295 of the Act. The process of
obtaining Form 10F in digitalised form requires the NR assessee to obtain PAN
in India. Thus, indirectly, the Notification is inconsistent with section
139A(1) / Rule 114. It is trite law that subordinate legislation must conform
to the parent statute and any subordinate legislation inconsistent with the
provisions of the parent statute is liable to be set aside. It is equally well
settled that circulars being executive / administrative in character cannot
supersede or override the Act and the statutory rules⁴. In Godrej
& Boyce Mfg. Co. Ltd. vs. State of Maharashtra⁵, the
Apex Court held that circulars are administrative in nature and cannot alter the
provisions of a statute, nor can they impose additional conditions.

4. Federation of Indian Airlines vs.
Union of India (WP (C) No. 8004/2010); In Additional District Magistrate
(Rev.), Delhi Administration vs. Shri Ram AIR 2000 SC 2143; In B.K. Garad vs.
Nasik Merchants Co-op. Bank Ltd, AIR 1984 SC 192.
5. (2009) 5 SCC 24

NOTIFICATION – WHETHER OVERRIDES TAX TREATY?
This issue will arise in a situation where a non-resident who is otherwise
entitled to beneficial treatment under DTAA is denied treaty benefit as Form
10F is not furnished in a digitalised format. This is primarily because NR does
not have a PAN in India, or his authorized signatory does not have a DSC. The
following arguments support Notification indirectly overrides tax treaty which
is not permissible:

Article 31 of the Vienna Convention provides that a
treaty is to be interpreted “in good faith in accordance with the ordinary
meaning to be given to the terms of the treaty in their context and in the
light of its object and purpose. Every treaty in force is binding on the
parties to it and must be performed by them in good faith”. What it
implies is that whatever the provisions of the treaties, these provisions
are to be given effect in good faith. Therefore, no matter how desirable
or expedient it may be from the perspective of the tax administration when
a tax jurisdiction is allowed to amend the settled position with respect
to a treaty provision by an amendment in the domestic law and admittedly
to nullify the judicial rulings, it cannot be treated as the performance of
treaties in good faith. That is, in effect, a unilateral treaty over-ride
which is contrary to the scheme of Article 26 of Vienna Convention on Law
of Treaties⁶.

6. DIT vs. New Skies Satellite BV
[2016] 382 ITR 114 (Mad); ACIT vs. Reliance Jio Infocomm Ltd [2019] 111
taxmann.com 371 (Mumbai – Trib.).

The Andhra Pradesh High Court in Sanofi Pasteur
Holding SA cautioned against the use of legislative power to
unilaterally amend domestic law in the following words:

“Treaty-making power is integral to the exercise of sovereign legislative or
executive will according to the relevant constitutional scheme, in all
jurisdictions. Once the power is exercised by the authorized agency (the
legislature or the executive, as the case may be) and a treaty entered into,
provisions of the such treaty must receive a good faith interpretation by every
authorized interpreter, whether an executive agency, a quasi-judicial authority
or the judicial branch. The supremacy of tax treaty provisions duly
operationalised within a contracting State [which may (theoretically) be
disempowered only by explicit and appropriately authorized legislative
exertions], cannot be eclipsed by the employment of an interpretive stratagem,
on the misconceived and ambiguous assumption of revenue interests of one of the
contracting States.”

Failure on part of NR to obtain Form 10F in digitalised
form impairs the right of NR to claim treaty benefit. The information
prescribed under Rule 21AB(1) obtained in a physical or an electronic copy
does not become invalid merely because it is not furnished in electronic
form through the income tax e-filing portal. The Notification, to this
extent, has the vice of treaty override, which may not be permissible. The
requirement of obtaining Form 10F is under domestic law and is not forming
part of the treaty. Accordingly, section 90(5), as also the impugned
Notification may be considered a treaty override.

As per section 90(2), the provisions of DTAA to the
extent more beneficial to the assessee shall prevail over the Domestic Law
and if the legislature wants to make any provision of Domestic Law to
override the Treaty, a specific provision is required to be made in the
Statute to that effect as made in sub-section (2A) of section 90 to give
overriding effect to GAAR provisions. A proposition that treaty benefit
can be denied for non-digitalised Form 10F seems untenable as there is no
corresponding amendment in section 90 to permit treaty override or in
section 139A to obtain PAN by specified class of assessee. In fact,
Notification is inserted pursuant to Rule 131, which was inserted vide
21st amendment to the Rules in exercise of power u/s 295.

In the context of section 90(4), which requires an
assessee to obtain TRC, Tribunal⁷ has held that an eligible
assessee cannot be denied the treaty protection u/s 90(2) on the ground
that the said assessee has not been able to furnish a TRC in the
prescribed form. The Tribunal⁸ read section 90(4) as resulting
in treaty override and did not accept Revenue’s contention of the
superiority of section 90(4) over section 90(2). The ratio of these
decisions should equally apply in the present context.

7. Skaps Industries India (P.) Ltd
vs. ITO [2018] 94 taxmann.com 448 (Ahmedabad – Trib.); Ranjit Kumar Vuppu vs.
ITO [2021] 127 taxmann.com 105 (Hyderabad – Trib.)
8. Supra

SECTION 206AA – LEGISLATIVE HISTORY
Section 206AA provides for withholding of tax at 20% if PAN is not furnished by
the recipient of income. In the context of DTAA, the question arose whether
section 206AA overrides the treaty rate where NR does not have PAN in India.

In under noted decisions⁹, the supremacy of tax treaty was upheld.
This view is based on the premise that the purpose of the DTAA provision will
get defeated if tax is withheld at a higher rate in the absence of PAN which
subsequently needs to be refunded by the filing of the tax return in India. The
Delhi High Court in Danisco India (P.) Ltd. vs. Union of India¹⁰
read down the provision of section 206AA in the following words:

“Having regard to the position of law explained in Azadi Bachao Andolan
(supra) and later followed in numerous decisions that a Double Taxation
Avoidance Agreement acquires primacy in such cases, where reciprocating states
mutually agree upon acceptable principles for tax treatment, the provision in
Section 206AA (as it existed) has to be read down to mean that where the
deductee i.e. the overseas resident business concern conducts its operation from
a territory, whose Government has entered into a Double Taxation Avoidance
Agreement with India, the rate of taxation would be as dictated by the
provisions of the treaty.”

9. Infosys Ltd. vs. DCIT [2022] 140
taxmann.com 600 (Bangalore – Trib.); Nagarjuna Fertilizers & Chemicals Ltd.
vs. Asstt. CIT [2017] 78 taxmann.com 264 (Hyd.);
10. [2018] 90 taxmann.com 295/253 Taxman 500/404 ITR 539

Parliament amended law by introducing sub-section (7) to section 206AA, making law
inapplicable to non-residents for interest, dividend, royalty, fees for
technical service income who furnishes information prescribed in Rule 37BC.

Rule 37BC(2) makes section 206AA inapplicable to non-residents who furnish the
following information:

i) name, e-mail id, contact number;

ii) address in the country or specified territory outside
India of which the deductee is a resident;

iii) a certificate of his being resident in any country or
specified territory outside India from the Government of that country or
specified territory if the law of that country or specified territory provides
for the issuance of such certificate;

iv) Tax Identification Number of the deductee in the country
or specified territory of his residence and in case no such number is
available, then a unique number based on which the deductee is identified by
the Government of that country or the specified territory of which he claims to
be a resident.

The aforesaid information is identical to information contained in Form 10F. It
can be contended that information under self-declaration can be considered
valid for the purpose of Rule 37BC; it cannot be considered invalid for the
purposes of Form 10F merely because it is not submitted in the electronic form
on the income tax e-filing portal.

Since the information in Rule 37BC is akin to Form 10F, the Notification can be
viewed as contrary to or overriding Rule 37BC. The Notification will result in
denial of treaty benefit even though the condition of Rule 37BC has complied.
If by Notification, the Act itself stands affected, the Notification may be
struck down¹¹.

11. Kerala Samsthana Chethu
Thozhilali Union vs. State of Kerala, (2006) 4 SCC 327

CONCLUDING REMARKS
The Notification has an impact on cross-border payments for F.Y. 2021-22
compliance as well as on ongoing transactions. Payer will have to factor in
this Notification while entering into new / renewal of existing business
contract, especially when payment is on a net of tax basis. Law regarding Form
10F was settled and well understood by non-residents dealing with India. In
practice, it is unlikely that vendors will obtain PAN in India and furnish Form
10F in electronic form on the income tax e-filing portal. This will require the
industry to take decisions on merits.

shailesh.kwebmaker

GLoBE Rules: Determination of Effective Tax Rate (ETR) and Top-Up Tax (TUT) – Part 2

1. TO REFRESH ON THE FIRST PART

1.1 In the first part of this article (“Pillar 2: An Introduction To Global Minimum Taxation”, August, 2022 BCAJ), we discussed the evolution and policy objectives of GloBE Rules. The article also discussed different inter-locking mechanisms of GloBE Rules, which ensure that a large MNE Group (turnover as per CFS is = € 750 mn in 2 out of 4 preceding fiscal years) pays at least 15% tax on profits earned in each jurisdiction where it has a presence (in the form of a subsidiary or a permanent establishment (PE)). This is achieved by the imposition of a “top-up tax” (TUT), wherever the effective tax rate (ETR) computed at a jurisdictional level for all subsidiaries/PEs in a jurisdiction is below 15%. For this purpose, each subsidiary or PE is referred to as a “constituent entity” (CE) of the MNE Group.

As a first priority, such TUT can be imposed by the same jurisdiction whose ETR is < 15%. If such jurisdiction fails to impose TUT, it can be imposed by the jurisdiction of the ultimate parent entity (UPE) of the MNE Group or, failing that, by the jurisdiction of the lower tier intermediate parent entities of the MNE Group.

Assuming none of the aforesaid mechanisms can collect TUT, as a last resort, it can be imposed by other jurisdictions where the MNE Group has a presence (in the form of a subsidiary or a PE) which have implemented GloBE Rules.

While the above is to broadly recap different inter-locking mechanisms of GloBE Rules, which are discussed more elaborately in the first part, in this second part, we shall discuss the calculation of ETR. It is computed at a jurisdictional level as a factor of tax expense (numerator) upon GloBE income (denominator) of all CEs in a single jurisdiction. For this purpose, chapters 3 and 4 of GloBE Rules specify detailed rules to compute the numerator and denominator, which are explained in this article. An attempt has also been made to contextualise the provisions as if an overseas MNE Group is computing the TUT liability for a CE in India. However, the discussion may equally apply to computing TUT liability in respect of Indian in-scope MNE having a CE abroad. Of specific attention to readers are those situations where, surprisingly, even a high-tax jurisdiction such as India, can trigger TUT liability under GloBE Rules.

2. START POINT FOR ETR – ‘FIT FOR CONSOLIDATION’ ACCOUNTS

The UPE prepares consolidated financial statements (CFS) by calling for ‘data pack’ or ‘fit for consolidation’ accounts of each CE. Such ‘fit for consolidation’ accounts are based on accounting standards applicable to the CFS of the UPE, which may differ from accounting standards applicable to local statutory accounts of the CE. These ‘fit for consolidation’ accounts may also include profit/loss on account of intra-group transactions, which are subsequently eliminated in preparing CFS.

In the GloBE Rules, the start point for computing the numerator and denominator of jurisdictional ETR formula is tax expense and profit after tax as per ‘fit for consolidation’ accounts of each CE. As the numerator and denominator is initially computed for each CE, profit/loss on intra-group transactions (both domestic and cross-border) is factored in the start point. To address certain policy issues and to take care of specific considerations, GloBE Rules have introduced certain adjustments to the start point. Some adjustments are mandatory, while others are optional. Once the tax expense and book profit for each CE is adjusted for GloBE, both these parameters are aggregated for all CEs in a jurisdiction. The ETR is determined by dividing aggregate adjusted tax expense upon aggregate adjusted book profit. In this article, the numerator is termed “adjusted covered tax” and the denominator “GloBE income”.

3. COMPUTATION OF DENOMINATOR OF ETR – GLoBE INCOME

Assuming, instead of adjusted book profit, ETR would have been determined by adopting taxable income (for local tax purposes) as the denominator, which could have reflected the impact of all tax incentives (such as those available under the Indian Income-tax Act – IFSC, s.80-IA, s.10AA, agricultural income or weighted deductions such as s.80JJAA), it would not have achieved the GloBE Rules objective. As a result, the denominator is reckoned w.r.t. adjusted book profit.

Some adjustments in computing GloBE income, as enumerated below, are clearly on account of policy considerations such as disallowing payments on account of bribes or penalties. As against that, exclusion in respect of dividend and capital gains on equity shares in computing the GloBE income is primarily to ensure that the rules remain restricted to operating profits of a CE while dividend and capital gains are a derivative reflection of operating profits of the underlying CE. In addition, some adjustments are made to ensure that intra-group cross-border transactions are at ALP, and certain other adjustments are in the form of a SAAR to target abusive arrangements, such as disallowing intra-group finance expenditure, which may have the impact of reducing GloBE liability.

4. ILLUSTRATIVE MANDATORY ADJUSTMENTS

The mandatory adjustments to profit after tax include:

(a) Add back provision for current tax and deferred tax expense¹.

(b) Add back fines and penalties (only if amount = € 50,000 per CE), and bribes and illegal expenses².

(d) Adjustments to align transaction value in respect of intra-group cross-border transactions with ALP adopted for local tax purposes, if book treatment is at variance from such ALP (discussed further below)⁴.

(e) Exclude dividend or capital gain/loss on equity interests (discussed further below).

(f) Include effect of prior period errors or change in accounting policy, which is otherwise routed directly through the balance sheet (these are considered only if the amounts pertain to periods after applicability of GloBE Rules)⁵.

(g) Expenses attributable to intragroup financing arrangement (discussed further below).

(h) Exclusion for income from international shipping and qualifying ancillary activities (discussed further below).

1. Article 3.2.1(a)
2. Article 3.2.1(g)
3. Article 3.2.1(i)
4. Article 3.2.3
5. Article 3.2.1(h) – however, where prior period expense results in tax refund of > € 1 mn, GloBE requires reworking of prior year’s ETR by adopting reduced tax expense in numerator and such prior period expense in denominator.

5. ILLUSTRATIVE ELECTIVE ADJUSTMENTS

Some adjustments are at the option of the taxpayer. These are:

(a) Deduct Employee Stock Option Plan (ESOP) cost as per local tax rules instead of as per books⁶.

(b) Ignore fair valuation/impairment gain/loss and consider such gain/loss only on actual realisation⁷.

6. Article 3.2.2
7. Article 3.2.5 – if realisation method is elected, such option applies qua jurisdiction (cannot pick and choose for one of the CE) – also, such option can be exercised either qua all assets or only qua all tangible assets.

6. EXCLUSION OF DIVIDEND AND CAPITAL GAIN/LOSS ON EQUITY INTERESTS⁸

6.1. As indicated above, one of the adjustments to arrive at GloBE income is exclusion in respect of dividend and gain/loss on sale of equity shares. The rationale behind such exclusion is:

a. Dividend is generally paid out of retained earnings that have already been subject to corporate tax or GloBE TUT in the hands of the company⁹.

b. Similarly, gain on equity shares represents retained earnings which may have already been subject to corporate tax or GloBE TUT in the investee company’s jurisdiction and/or represents unrealised gains in assets held by the investor company which may be subject to corporate tax or GloBE TUT in future as these gains are realised¹⁰.

8. Article 3.2.1(b) and (c)
9. Para 179 to 189 of Blueprint
10. Para 190 to 196 of Blueprint

6.2. The exclusion ensures that no TUT is levied on such income which is exempt across most jurisdictions (while not in India). The following are excluded in computing GloBE income of corporate shareholder:

Classification in CFS	What is excluded	Conditions for exclusion
Subsidiary, joint venture, associate	• Dividend • Capital gain/loss (includes fair valuation gain/loss) • Gain/loss recognised as per equity method	N/A
Any other entity, where MNE holds = 10% ownership interest as on date of distribution or disposition	• Dividend • Capital gain/loss (includes fair valuation gain/loss)	N/A
Any other entity, where MNE holds < 10% ownership interest	• Dividend	Holding should be long-term i.e. held for at least a year as on the date of distribution

Classification
in CFS

What is
excluded

Conditions for
exclusion

Subsidiary, joint venture, associate

• Dividend

• Capital gain/loss (includes fair
valuation gain/loss)

• Gain/loss recognised as per equity method

N/A

Any other entity, where MNE holds = 10%
ownership interest as on date of distribution or disposition

• Dividend

• Capital gain/loss (includes fair
valuation gain/loss)

N/A

Any other entity, where MNE holds < 10%
ownership interest

• Dividend

Holding should be long-term i.e. held for
at least a year as on the date of distribution

From the discussion hereabove, in respect of the last category above, where MNE holds < 10% ownership interest, only dividend is excluded, and that too, only if such holding is long-term, whereas capital gain/loss is subject to TUT liability.

Separately, although local tax rules typically disallow deductions for expenses associated with income excluded from taxable income, for simplicity, while dividend is excluded from GloBE income, there is no specific requirement to disallow expenses related to such dividend¹¹.

11. Para 45 of commentary

While dividend and capital gain/loss are excluded in computing GloBE income, there is no such exclusion in computing taxable income or book profit for the purposes of s.115JB. This can have an interesting interplay as illustrated here in the context of ICo, which is owned by an overseas MNE Group:

ICo enjoys 100% tax holiday on operating profits u/s. 10AA, and hence does not have any normal tax liability. However, ICo is subject to MAT at ~15%.

During the year in question, particulars of ICo’s income are as below:

Operating profit eligible for S.10AA deduction is 1,00,000.
Loss on sale of shares of associate is 60,000.

Accordingly, book profit for MAT is 40,000 and tax liability @ 15% as per MAT provisions is 6,000.

In computing ETR of ICo under GloBE, gain/loss on sale of shares of an associate (and related tax effects) are excluded. Thus, denominator is 1,00,000 and numerator is 6,000. ETR is 6,000/1,00,000 = 6%, resulting in shortfall of 9% as compared to 15%.

TUT liability in respect of ICo = 9,000 namely 9% on operating profits of 1,00,000 (subject to reduction on account of substance-based carve out).

7. ALP ADJUSTMENTS IN COMPUTING GLoBE INCOME

7.1. Article 3.2.3 provides that, in computing GloBE income, any intra-group cross-border transaction recognised at a value that is not consistent with ALP as adopted for local tax purposes must be adjusted to be consistent with such ALP.

7.2. As per commentary, it is “generally expected” that an intra-group cross-border transaction is recognised at ALP in books. In the absence of any bilateral/unilateral TP adjustment for local tax purposes, Article 3.2.3 is not triggered, and the value recognised in the books is accepted to be ALP.

7.3. Impact of bilateral TP adjustment – For bilateral TP adjustment, where the taxable income of both transacting CEs is at variance from book income, the impact of such TP adjustment should also be considered in computing GloBE income.

Article 3.2.3 makes no distinction based on the point of time that such ALP is determined, namely whether the bilateral TP adjustment is made before or after GloBE returns are filed. Article 3.2.3 can apply irrespective of whether ALP is determined as part of self-assessment or pursuant to assessment by tax authorities. It can apply pursuant to bilateral APA or MAP.

Assuming information regarding bilateral TP adjustment is available at the time of filing GloBE return (i.e. return for self-assessment of GloBE tax liability), it is possible to give effect to Article 3.2.3 at the time of filing such GloBE return itself. However, questions may arise when bilateral TP adjustment is finalised many years after filing GloBE return. To illustrate,

Assume ICo of India (subject to a local tax rate of 25%) has received services in Year 1 from FCo (which is in a zero-tax jurisdiction).

FCo has raised an invoice of 1,000 on ICo.

Bilateral APA is concluded after 5 years where ALP for the transaction is computed at 800.

Giving effect to such ALP increases ICo’s GloBE income by 200, whereas FCo’s GloBE income decreases by 200.

If such adjustment is given effect retrospectively by revising GloBE return of Year 1, TUT liability in respect of FCo reduces by 30 (200 x 15%), resulting in a refund of previously paid GloBE TUT¹². As per commentary, article 3.2.3 adjustment cannot result in the refund of previously paid GloBE tax, and in this example, the impact of article 3.2.3 should be given in GloBE return of year 5 and not of year 1. As a result, FCo’s GloBE income for year 5 decreases by 200 in respect of the transaction concluded in year 1, resulting in an increase in ETR for year 5.

12. ICo, being in HTJ, may not trigger any GloBE TUT liability as a result of ALP adjustment.

While article 3.2.3 cannot result in a refund of GloBE tax paid for a past year, article 3.2.3 can result in additional demand of GloBE tax for a past year. In this example, assuming FCo procured services from ICo at 1,000 in year 1 whose ALP is determined at 800 in year 5 pursuant to bilateral APA, FCo’s GloBE income can be retrospectively increased by 200, such that, in year 5, the taxpayer can be exposed to an additional demand of GloBE tax in respect of transaction concluded in year 1. To clarify, in this scenario, ETR of year 1 is recomputed to give effect to ALP adjustment, although resultant TUT liability may be collected in year 5. This may be contrasted with the earlier scenario above, where the ETR of year 5 itself was impacted.

7.4. Impact of unilateral TP adjustment – As aforesaid, for bilateral TP adjustment, the GloBE income of both transacting CEs needs to be adjusted to align with the taxable income mandatorily. However, for unilateral TP adjustment (affecting the taxable income of only one of the transacting CEs), special rules are provided to compute GloBE income based on whether unilateral TP adjustment is triggered in a high-tax jurisdiction (HTJ) vs. under-taxed jurisdiction (UTJ). The concepts of HTJ and UTJ are explained in later paras.

At a conceptual level, when unilateral TP adjustment is initiated in HTJ, an adjustment must be made in computing the GloBE income of both transacting CEs, regardless of whether the counterparty is in HTJ or UTJ.

When unilateral TP adjustment is initiated in UTJ, no adjustment is needed in computing GloBE income of both transacting CEs – and book value is respected for such computation of both transacting CEs.

This can be explained with help of the following example:

Assume ICo of India (subject to a local tax rate of 25%) has received services from FCo (which is in a zero-tax jurisdiction).

FCo has raised an invoice of 1,000 on ICo.

While ICo is unlikely to trigger TUT under GloBE, FCo may trigger TUT of 150 based on invoice value (15% of 1,000).

If, based on TP documentation, ICo determines ALP at 800 and makes voluntary TP adjustment while filing local tax return, ICo’s local tax liability increases by 50 (i.e. 200 x 25%).

As per commentary, if FCo’s GloBE income is not adjusted to 800, there is not only an increase in ICo’s local tax liability (by 50 as aforesaid) but also an increase in the GloBE tax liability in respect of FCo – because GloBE income of 200 would be doubly counted in India as also in FCo’s jurisdiction. As a result, the commentary requires a downward adjustment to FCo’s GloBE income to the extent of 200.

Accordingly, GloBE TUT liability in respect of FCo is 120 (15% of 800). The commentary justifies this to avoid “double taxation”.

While the above illustrates a simple scenario, difficult questions may arise where unilateral TP adjustment may happen many years after GloBE returns are filed. Unlike the guidance for bilateral TP adjustment, there is no guidance for unilateral TP adjustment. In this example, assuming the transaction between ICo and FCo pertains to year 1 while unilateral TP adjustment attains finality with the conclusion of the assessment of ICo in year 5, questions will arise as to how FCo may be able to get its GloBE income corrected in terms of Article 3.2.3 and the basis on which it may effectively enjoy refund/reduction of GloBE TUT paid in earlier years as may arise on account of downward adjustment to FCo’s GloBE income.

Coming to the concepts of HTJ and UTJ for Article 3.2.3, the following alternate conditions are prescribed to determine whether or not a jurisdiction is UTJ:

a. Nominal tax rate of the jurisdiction is < 15%, (or)

b. GloBE ETR of the jurisdiction in each of the 2 preceding fiscal years is < 15%.

As the above are alternative conditions, it is possible that even a country like India may become UTJ for a given MNE Group, though the applicable headline tax rate may be > 15%.

7.5. Also, it is unclear how Article 3.2.3 will be applied where unilateral TP adjustment is made in computing taxable income of both transacting CEs, resulting in each CE adopting a different ALP for the same transaction. The commentary acknowledges that the GloBE implementation framework will give further consideration to appropriate adjustments when tax authorities in different jurisdictions disagree on ALP determination.

7.6. While the above rules apply to intra-group cross-border transactions, there is limited applicability of ALP mandate for intra-group domestic transactions. Article 3.2.3 states that loss on account of sale/other transfer of an asset to another CE of the same jurisdiction is to be recognised at ALP – only if such loss is otherwise cognisable in computing GloBE income (i.e. such loss has been debited to P&L). As per the commentary, this is a tax avoidant measure to prevent manufacturing loss through intra-group asset transfers. Additionally, for cross-border and domestic transactions, Article 3.2.3 requires both transacting CEs to record a transaction in the same amount in computing GloBE income¹³.

13. As per para 109 of commentary, this result is anyways expected if a common accounting standard is applied to both transacting CEs.

8. INTRA-GROUP FINANCING

8.1. Article 3.2.7 provides that, in computing GloBE income of a CE in a low-tax jurisdiction (namely low-tax entity), the expense attributable to intra-group financing availed directly or indirectly from another CE in a high-tax jurisdiction (namely high-tax entity) shall be disallowed, if:

a. in the absence of Article 3.2.7, such expense would have reduced GloBE income of the low tax entity,

b. without resulting in a commensurate increase in “taxable income” (as per domestic tax laws) of high tax entity.

For the purpose of Article 3.2.7¹⁴, a jurisdiction is LTJ if the jurisdiction’s effective tax rate (as per GloBE Rules, ignoring the impact of Article 3.2.7) is < 15% (and vice versa for HTJ).

14. Guidance in Article 3.2.3 to determine whether a jurisdiction is UTJ is not relevant for article 3.2.7.

To illustrate, assume ICo of India (in HTJ) provides an interest-free loan of 10,000 to FCo in zero tax jurisdiction. In fit for consolidation accounts (as per IndAS/IFRS), the lender (ICo) records a loan receivable of 10,000 at the net present value (NPV) of 6,000 by discounting at the prevalent interest rate. Over the life of the loan, ICo recognises notional interest income by credit to P&L and a debit to loan receivable. Likewise, the borrower (FCo) recognises corresponding and matching notional interest expenditure.

In terms of Article 3.2.7, intra-group finance expenditure debited to P&L of FCo is disallowed in computing GloBE income of the borrower (FCo) in LTJ if there is no corresponding increase in “taxable income” (as per domestic tax laws) in the hands of the lender (ICo) in HTJ.

In the present case, notional interest income is not includible in the taxable income of the lender (ICo) in HTJ. Hence, Article 3.2.7 requires disallowance of notional interest expense in computing the GloBE income of the borrower (FCo) in LTJ.

Article 3.2.7 may not have applied in the hands of FCo if, in this example:

a. the loan was provided at prevalent market rate, as ICo would have included actual interest income in taxable income and paid local tax thereon; or

b. ICo was subject to MAT provisions and notional interest income has been included in book profit (namely taxable income computed as per MAT provisions); or

c. ICo was subject to TP adjustment in respect of interest free loan, resulting in imputing notional interest income while determining taxable income of ICo.

The scope of intra-group financing arrangement is not confined to loans. It can apply where there is any credit or investment made, and the other conditions are satisfied. In the above example, it can apply where ICo provides capital infusion as Redeemable Preference Shares (RPS) in FCo which is accounted under IndAS/IFRS as a loan, in a manner as specified above.

8.2. Additionally, for Article 3.2.7 to apply, all conditions (namely borrower is in LTJ, the lender is in HTJ, borrower debiting financing expense in P&L, no commensurate increase in taxable income of lender) should be reasonably anticipated to be fulfilled, over the expected duration of such intra-group financing arrangement.

8.3. Article 3.2.7 has strict conditions to determine whether there is an increase in the taxable income of the lender in HTJ. For example, if such lender is able to immediately set off interest income against brought forward loss or unabsorbed interest expenditure – which is not expected to be used otherwise – it is deemed that there is no increase in the taxable income of such lender, and therefore, the limitation of Article 3.2.7 applies while computing GloBE income of the borrower.

9. INTERNATIONAL SHIPPING SECTOR EXCLUSION

9.1. In terms of sector exclusion, net income from international shipping activities and qualifying ancillary activities are excluded from GloBE income. This is because special features of the shipping sector (such as capital-intensive nature, level of profitability and long economic life cycle) have led to special tax rules across jurisdictions (such as tonnage tax), often operating outside the scope of corporate income tax.

9.2. While detailed rules for shipping sector exclusion are not covered in this article, there is one important aspect that deserves to be highlighted. As per Article 3.3.6, in order to qualify for the exclusion of international shipping income, the CE must demonstrate that the strategic or commercial management of all ships concerned is effectively carried on from within the jurisdiction where the CE is located. As per the commentary, the location of strategic or commercial management is determined basis facts and circumstances. The commentary further provides the following indicators for determining the place of strategic or commercial management:

a. Strategic management includes making decisions on significant capital expenditure and asset disposals (e.g. purchase/sale of ships), award of major contracts, agreements on strategic alliances and vessel pooling and direction of foreign establishments.

b. Commercial management includes route planning, taking bookings, insurance, financing, personnel management, provisioning and training.

It is possible that ships are owned by ACo of Country A but are managed by BCo of Country B. ACo and BCo are CEs of the same MNE Group. The ownership is retained in Country A for commercial reasons such as creditor protection. The management is from Country B for commercial reasons such as efficiency, quality/safety, service level, and related factors. Since the location of strategic or commercial management is different from the location of the CE that owns these ships, income earned from these ships may not qualify for exclusion from GloBE income. In this regard, representations are made to provide more clarity on Article 3.3.6.

10. ADJUSTMENT TO BE MADE TO BOOK PROFIT, ONLY IF SPECIFIED BY GLOBE RULES

10.1. Since the calculation of GloBE income is linked to ‘fit for consolidation’ accounts, any item which is either debited or credited to the P&L account cannot be excluded unless there is a specific adjustment warranted by GloBE Rules. To illustrate, no adjustment may be needed in respect of charity donations or CSR expenses which may have been debited to the P&L account irrespective of its deductibility for local tax purposes.

10.2. Similar to expenditure, the amounts credited to the P&L account cannot be excluded from GloBE income unless specifically provided. Dividend and capital gains in respect of equity shares of subsidiary/joint venture/associate need to be excluded from GloBE income, irrespective of whether the jurisdiction of the CE (like India) has a participation exemption regime. Since dividend may trigger local tax in India at a rate higher than the minimum tax rate of 15%, a CE in India may desire that such dividend as also local tax thereon is considered to be a part of ETR calculation for India. However, no such option is available with MNE Group and such dividend and local tax thereon need exclusion while calculating ETR.

10.3. Separately, a significant impact may arise when the entity, pursuant to a settlement of liabilities under IBC or bankruptcy code, gets a significant haircut which in terms of applicable accounting standards may be required to be credited to the P&L account. In the Indian context, while MAT provisions have become academic for entities opting for s.115BAA, in respect of such credits to P&L account, which is accepted to be non-taxable, there could be TUT liability if the haircut is significant as compared to operating profits which MNE Group may earn from Indian entities.

11. DETERMINATION OF DENOMINATOR OF ETR – ADJUSTED COVERED TAX

11.1. As each jurisdiction may have its own corporate tax system, GloBE Rules define “covered tax”, which refers to types of tax that can be included in the numerator. For example, indirect tax or stamp duty cannot be considered as covered tax. At a broad level, covered tax is defined as any tax w.r.t. an entity’s income or profits. The commentary gives additional guidance in determining the scope of the covered tax. Generally, the concept of covered tax is likely to align with conditions to determine if a tax is income-tax as per Ind AS/IFRS.

11.2. To recollect, income tax expense as per ‘fit for consolidation’ accounts is the start point for the numerator of ETR. Once there are adjustments made to book profit in computing GloBE income to ensure that numerator (namely covered tax) represents tax paid in respect of profits forming part of the denominator, certain correlative adjustments are warranted even to calculate the numerator.

11.3. At a policy level, in blueprint, the proposal was to adopt only current tax expense in the numerator and not to recognise deferred tax expense. This certainly was not acceptable to stakeholders and multiple representations were made to impress upon the OECD that ETR calculation will be skewed and will not represent the real picture if book-to-tax timing differences as dealt with by deferred tax adjustments are not taken into account. Consequently, in GloBE Rules, deferred tax elements are also considered, albeit with multiple safeguards/limitations. To illustrate, while DTL is reckoned in the numerator, to ensure the integrity of calculation is maintained such that DTL provided at a higher tax rate in books is not sheltering other tax incentives, GloBE Rules require calibration of DTL at 15% tax rate. Likewise, there are provisions to ensure that DTL, which is not actually paid within 5 years is recaptured (subject to certain exceptions). As discussed further, the DTA mechanism is also used by GloBE Rules for ensuring that loss incurred in earlier years is set off while computing TUT liability in future years.

To a tax professional, recollecting an understanding of DTA/DTL is crucial for understanding the adjustments of ETR calculation. While we claim no accounting expertise, we have broadly summarized DTA/DTL as relevant for IndAS/IFRS to the extent found pertinent.

11.4. CONCEPT OF DEFERRED TAX EXPENSE – AN ACCOUNTANT’S PERSPECTIVE

The timing of recognising incomes/expenses in books can be different compared to tax. To ensure a true and fair view and to adhere to the matching principle, accounting standard requires that “tax effects” of incomes and expenses should be recognised in the same period in which incomes and expenses are recognised. The tax expense is the aggregate of current tax and deferred tax. While current tax reflects actual tax payable as per tax return, deferred tax reflects the impact of temporary differences.¹⁵

^{15. Under IGAAP, DT is recognised for the timing difference between book profit and taxable income [this concept is also explained in the Supreme Court decision of J. K. Industries vs. UOI [2007] 165 Taxman 323 (SC)]. Under Ind AS, a balance sheet approach is followed, where DT is recognised for the temporary difference between book base and tax base of assets/liabilities. Ind AS does not make the distinction between timing difference and permanent difference – e.g., under Ind AS, DT is recognised even for the difference between book base and tax base on account of revaluation.}

A provision for deferred tax liability is recognised when the future tax liability is higher because:

Income is recognised in books, and tax is payable only in future (e.g., percentage of completion method is followed to record revenue in books, but project completion method is followed for tax purposes), or

Deduction is claimed in the tax return, but the expense is recognised in books only in future (e.g., capital R&D expenditure is fully claimed u/s. 35(1)(iv) of ITA whilst the capital asset is depreciated in books over a period).

Contrarily, a deferred tax asset is recognised when a tax benefit is to arise in future (e.g., s.43B deduction allowable in tax return on actual payment).

Such deferred tax liability or asset is reversed when the temporary difference is reversed in future i.e.

Provision for DTL is reversed as tax liability is actually discharged in future, or

DTA is reversed as tax deduction is actually claimed in future.

11.5. For calculating ETR, generation of DTA lowers ETR, while reversal of DTA enhances ETR. Likewise, generation of DTL results in enhancing ETR, while reversal of DTL lowers ETR.

Assume, on account of s.35AD deduction, ICo’s local tax liability is nil – but ICo recognises DTL provision reflecting tax payable in future years. For calculating ETR under GloBE, as the DTL provision is included in the numerator, investment-linked incentives such as s.35AD is protected from TUT liability under GloBE.

11.6 ILLUSTRATIVE ADJUSTMENTS TO CURRENT TAX AND DEFERRED TAX, TO ARRIVE AT “ADJUSTED COVERED TAX”

11.6.1. Corelative adjustment: To ensure parity, GloBE requires exclusion from the numerator of current tax and deferred tax that relates to income excluded from the denominator¹⁶. For example, since dividend and capital gains on equity interests is typically excluded from the denominator (as discussed above at para 6), the tax effects of such income are also excluded from the numerator.

11.6.2. Recast DTA/DTL to 15% tax rate if recognised at tax rate > 15%: In books, DTA/DTL are measured at tax rates that are enacted or substantively enacted as of the balance sheet date. If such tax rate is > 15%, specifically for computing ETR under GloBE, the DTA/DTL is recast to 15% tax rate¹⁷. For example, if ICo (subject to corporate tax rate of 25%) claims accelerated depreciation of 1,00,000 in tax return over and above book depreciation, ICo recognises DTL provision of 25,000 @ 25%. For computing ETR, such DTL provision is recast to 15% tax rate i.e. 15,000.

16. Article 4.1.3(a) and 4.4.1(a)
17. Article 4.4.1

This recast ensures that DTL provision in excess of 15% tax rate in respect of a taxable business is not used to shield TUT liability in respect of income of another business that enjoys 100% tax holiday, or other tax incentives that are enjoyed in the jurisdiction.

In a high-tax jurisdiction such as India, assume ICo opting for s.115BAA has a book profit of 1,00,000 but taxable income of nil due to excess of accelerated depreciation over book depreciation of 80,000 and weighted deduction u/s 80JJAA of 20,000. The DTL provision in the books on account of accelerated depreciation is recognised at 20,000 (80,000 x 25%) while in GloBE calculations, this is capped to 12,000 (15% tax rate). ETR of ICo is 12,000/1,00,000 = 12%. As ETR is < 15%, ICo can trigger TUT liability @ 3% – which reflects impact of weighted deduction u/s 80JJAA. This shows that even in high-tax jurisdictions such as India or UK, where taxable income can be significantly impacted by a combination of timing differences and weighted deductions, weighted deductions can result in TUT liability because DTL on account of timing differences is capped to 15% tax rate.

11.6.3. DTL recapture: If DTL provision is included in the numerator in year 1, GloBE Rules require such DTL to reverse within the next 5 years namely actual tax payment should happen within the next 5 years. If this condition is not met, GloBE Rules require such DTL to be re-captured in year 6, which means that, in year 6, ETR of year 1 is recomputed on a retrospective basis after ignoring such DTL – resultant TUT liability of year 1 (based on recomputed ETR of year 1) is payable in year 6. This is in addition to the normal top-up tax (if any) of year 6. It may be noted that the GloBE return of year 1 is not revised in year 6, but there is a separate column in GloBE return of year 6 to recompute ETR of year 1 and pay the resultant TUT liability in year 6¹⁸. Furthermore, if the actual tax payment of such DTL happens in, say, year 8, the same can be added to covered tax in the the ETR computation of year 8.

However, where the DTL provision is covered by specified exceptions¹⁹, there is no recapture. Specified exceptions comprise, for example: DTL due to accelerated depreciation on tangible assets (e.g., s.35AD), DTL due to 100% tax deduction of capital R&D expenditure (e.g., s.35(1)(iv), DTL due to fair valuation gains, etc.)²⁰ The policy rationale behind these exceptions is that: DTL is typically tied to substantive activities in a jurisdiction; (or) DTL is not prone to assessee manipulation; (or) DTL is certain to reverse over time.

18. If, at the time of filing GloBE return of year 1, the entity expects that DTL provision recognised in year 1 is unlikely to reverse in next 5 years, such entity can, in terms of Article 4.4.1(b) r. w. 4.4.7, elect to ignore or disclaim such DTL provision while filing GloBE return of year 1 itself – so as to avoid recapture of such DTL provision in year 6. Such actual tax payment will then form part of the numerator on actual payment basis.
19. Article 4.4.5
20. Under I-GAAP AS-22, DTL was not recognised w.r.t. fair valuation gains, as that represented a permanent difference between book profit and taxable income. Under IndAS, a balance sheet approach is adopted requiring comparison of book base and tax base, which results in recognising DTL on account of fair valuation gains in books.

It may be noted that the exceptions include only accelerated depreciation in respect of tangible assets and not in respect of intangible assets. For an entity focussed on acquiring intangibles with a huge IP base (e.g., a pharma or software company), IP having indefinite life is not amortised in books, but can be amortised for local tax purposes. This can result in recognising DTL provision every year, as the tax base of IP goes on reducing while the book base of IP remains constant. If such IP is sold in future, capital gains tax liability is computed w.r.t. WDV as reduced by accumulated depreciation. This future tax liability is recognised in the form of DTL provision every year as IP is amortised for local tax purposes. DTL provision reverses only on the sale of IP in future. Where DTL provision recognised in books in year 1 does not reverse until year 6 (because IP is not sold until year 6), there can be recapture. As a result, in year 6, ETR of year 1 needs to be recomputed by excluding (or ignoring) DTL provision in respect of IP amortisation. This exclusion of DTL provision from numerator can cause ETR of year 1 (as recomputed) to be < 15%, and trigger GloBE liability in year 6.

11.6.4. DTA in relation to tax credits is ignored: Under IndAS/IFRS, the concept of deferred tax accounting is not restricted to temporary differences between accounting income and taxable income. It also extends to tax credits/losses. It requires creating DTA when tax credits are made available in current year, which is reversed as tax credits are absorbed or offset in future years.

In respect of MAT credit, IndAS/IFRS requires recognising DTA in the year of generation of MAT credit – such DTA is reversed as MAT credit is utilised in future years. In the year of generation of MAT credit, the current tax provision is equivalent to MAT payable for that year, while a corresponding deferred tax asset is recognised of the very same amount, representing MAT credit entitlement. In the outer column of P&L A/c for this year, the net tax expense is zero²¹. In the year of generation of MAT credit, whether ETR should be computed after reducing DTA on account of MAT credit?

GloBE Rules state that, in computing ETR, DTA with respect to the generation and use of tax credits should be ignored or excluded²². The commentary suggests that the scope of this entry is wide and is not restricted to tax credits which are provided as tax incentives (for example, R&D tax credit, where a percentage of the capital cost of eligible R&D expenditure is set off against tax liability). Hence, in this case, in computing ETR, creation and reversal of DTA on account of generation and utilisation of MAT credit should be ignored. In the year of generation of MAT credit, the numerator should be based on actual MAT payable, ignoring the DTA represented by potential advantage on account of MAT credit entitlement.

11.6.5. Use of DTA to ensure set off for loss-making entities: Ordinarily, taxable income is determined after set off of past loss, and no tax may be payable if profits are insufficient to absorb past loss. As stated at para 2 above, the start point for the denominator is profit after tax as per P&L of the current year, while loss of earlier years is not captured therein. GloBE Rules grant set off of loss of earlier years by making use of DTA. To recollect, under IndAS/IFRS, a DTA is recognised in year of generation of loss, in anticipation of future tax benefit in form of set off of loss while computing taxable income. This DTA is reversed in the year of actual set off. Generation of DTA results in lowering ETR, while reversal of DTA results in enhancing ETR.

For example, assume that an entity (liable to corporate tax rate of 25%, and not enjoying any tax incentives) incurs loss of 1,00,000 in year 1 and earns profit of 1,00,000 in year 2. In books, in year 1, the entity creates DTA of 25,000 (@ 25%). In year 1, there is no GloBE liability because denominator of ETR formula is negative. In books, in year 2 namely generation of profit, DTA of 25,000 is reversed in books. For GloBE, such DTA of 25,000 is recast to 15,000 (@ 15%)²³ in terms of discussion at para 11.6.2 above. As a result, ETR for year 2 is 15%, and there is no GloBE liability for year 2.

21. In a future year, when MAT credit is utilised, such DTA pertaining to MAT credit entitlement is reversed.
22. Article 4.4.1(e)
23. Article 4.4.1

It is possible that, under IndAS/IFRS, the entity may not recognise any DTA in books in respect of loss generated in year 1, if there is no reasonable certainty of future taxable profits as of year 1. To ensure that past loss is effectively set off even in this scenario where there is no DTA recognised in books, GloBE Rules provide that the impact of accounting recognition adjustment should be ignored²⁴. The commentary²⁵ explains that, in reckoning DTA/DTL for GloBE purposes, the requirement of reasonable certainty of future taxable profits (which is a pre-condition for recognising DTA in books) is discarded. As a result, despite non-recognition of DTA in books, it is possible to recognise DTA for GloBE purposes in the year of generation of tax loss and use such DTA for enhancing ETR when such tax loss is set off under domestic tax laws.

For jurisdictions having corporate tax rate < 15%: Assume the same numbers given earlier, except that, the entity is liable to corporate tax rate of 10% instead of 25%. The entity would recognise DTA of only 10,000 in books, and ETR for year 2 would be 10% (namely DTA reversal of 10,000 divided by profit of 1,00,000), which would trigger TUT liability @ 5% (considering shortfall as compared to minimum tax rate of 15%) in year 2, despite the entity effectively not having made any profits. To avoid such results, DTA recognised in books at 10% tax rate can be recast upwards to 15% tax rate, such that DTA for GloBE purposes is considered at 15,000 as against 10,000. This ensures that ETR for year 2 is 15%, and there is no TUT liability in year 2. To claim this benefit, the entity needs to prove that the loss of 1,00,000 pertains to items forming part of GloBE income in the denominator of ETR. For example, if such loss is on account of sale of shares of an associate which is excluded while computing GloBE income, DTA for such loss needs to be excluded from the numerator (on the ground of corelative adjustment).

The discussion in the preceding paras is equally relevant to the loss incurred before applicability of GloBE Rules²⁶.

For zero tax jurisdictions: Where the entity is in a jurisdiction which does not levy any corporate tax (and as a result, there is no potential of recognising DTA in the books) (e.g., Bermuda), GloBE Rules provide an option to the entity to recognise DTA outside the books @ 15% of GloBE loss (i.e. after making all upward/downward adjustments to arrive at the denominator of ETR)²⁷. Such DTA can be utilised in future years to enhance ETR when denominator turns positive. Such option can be exercised only at the jurisdictional level, and only in the first GloBE return filed for that jurisdiction (and not in a later year).

24. Article 4.4.1 (c)
25. Refer para 76 and 77 at page 102.
26. Article 9.1
27. Article 4.5

Importantly, such an option can facilitate recognition of DTA outside the books only for loss incurred after the applicability of GloBE Rules. It does not apply for loss incurred before the applicability of GloBE Rules²⁸. To illustrate, assume the same numbers given earlier, except that, the entity is liable to corporate tax rate of 0% instead of 25%. If year 1 is a pre-GloBE year (i.e. GloBE Rules are inapplicable in year 1), DTA outside the books cannot be recognised for loss of year 1, and TUT liability for year 2 is triggered of 15,000. However, if year 1 is a post GloBE year, TUT liability for both years is nil.

While the aforesaid option can also be exercised for high-tax jurisdictions, as a fallout of exercising such option, DTA/DTL in books is fully ignored in ETR, and only DTA for GloBE loss can be considered in addition to current tax provision in ETR.

11.7. Post filing adjustments²⁹: If, in the current year, there is a change in tax provision for earlier year/s (can be increase or decrease of tax liability for earlier year/s), the impact of such change is always factored in computing ETR of the current year. The earlier year/s ETR is not reworked. Such changes can happen on account of completion of assessment or filing of revised return for earlier years.

As an exception to the above, in the following cases, refund/decrease of tax liability for an earlier year which gets admitted (or recognised in the books) in the current year is given effect to by recomputing earlier year’s ETR (any TUT liability due to such re-computation is recovered separately in current year):

a. Where quantum of refund/decrease of earlier year’s tax liability is > €1 million at jurisdiction level.

b. Where quantum of refund/decrease of earlier year’s tax liability is < € 1 million at jurisdiction level, and the assessee chooses to give effect by recomputing earlier year’s ETR (such being an annual choice).

11.8. Cross-border allocation rules³⁰: GloBE Rules are built on the general principle that tax expense relating to a given income should be allocated to the jurisdiction where the underlying income is considered in GloBE calculations. To illustrate, if withholding tax is paid in source jurisdiction (say, India) in respect of royalty income which belongs to a subsidiary in residence jurisdiction (say, Netherlands), withholding tax paid in India as also tax paid in Netherlands will be included in numerator of Netherlands, while computing the ETR of Netherlands³¹.

28. Para 8.4 of UK consultation document on Pillar 2, OECD Secretariat’s clarification in virtual public consultation meeting held on 25th April, 2022.
29. Article 4.6.1
30. Article 4.3

31. Like withholding tax, if STTR is also recovered, STTR will also be attributed to the CE whose income suffers STTR.

Similarly,

• Taxes paid in respect of a PE (which is considered as a separate CE for GloBE Rules; and adjusted covered tax and GloBE income of such PE are computed separately from the HO owning such PE) in the PE jurisdiction as well as the HO jurisdiction are considered in the ETR calculation of the PE³².

• CFC tax paid in the jurisdiction of the ultimate parent is allocated to jurisdiction where CFC is located. This is despite CFC being many layers below the ultimate parent³³.

In respect of dividend, tax paid on intra-group dividend (namely dividend declared by one CE to another CE) is allocated to the jurisdiction of the CE that has distributed the dividend³⁴. To recollect, for computing ETR of shareholder’s jurisdiction, dividend is excluded from GloBE income, and tax on such dividend is also excluded from adjusted covered tax. But, on the logic that tax follows income, where one CE receives dividend from another CE, tax on such dividend can be allocated to the jurisdiction of the CE which has distributed the dividend. To clarify, tax on dividend borne by entities outside the MNE Group (which are not CEs) is not allocated to the CE which distributes dividend.

32. GloBE Rules have a specific definition of PE and also provide special provisions to deal with such cases. Accordingly, the impact of PE under GloBE Rules requires independent evaluation.
33. Article 4.3.2(c) r.w. 4.3.3
34. Article 4.3.2(e)

Assume a case where, ICo is the ultimate parent of an MNE Group, which holds 100% shares in MauCo, a CE having operations in Mauritius. MauCo pays no corporate tax in Mauritius. If MauCo declares its entire profits as dividend in the same year such profits are earned, dividend tax paid by ICo in India @ 25% is allocated to Mauritius (namely jurisdiction of CE that distributed such dividend) in determining ETR of Mauritius. As a result, although no corporate tax is paid in Mauritius, because of allocation of dividend tax from India to Mauritius, ETR of Mauritius is > 15%. However, assuming no occasion arises for ICo to pay dividend tax (because MauCo does not declare dividend, or because ICo claims deduction u/s 80M), nothing is allocated to Mauritius, and ETR of Mauritius is 0%, resulting in TUT liability @ 15% of profits earned in Mauritius. Dividend tax paid by individuals who are promoters of ICo cannot be allocated to Mauritius, as individuals are not a part of MNE Group under the GloBE Rules.

Let us tweak the facts to assume that ICo holds 100% shares of MauCo indirectly through another holding company namely SingCo of Singapore. The entire profits of MauCo are upstreamed to SingCo, and thereafter to ICo. ICo pays dividend tax @ 25% under ITA. As per GloBE Rules, dividend tax paid by ICo in India is allocated to the jurisdiction of the company that distributed such dividends (namely Singapore) and not to the jurisdiction of the underlying company which earned the profits (namely Mauritius). As a result, the ETR of Mauritius is 0%, and TUT liability in respect of MauCo profits is triggered @ 15%, despite payment of dividend tax in India on such profits. As per the commentary, where there is an intermediate holding company, dividend tax paid by the upper-tier parent (namely ICo) is not allocated to MauCo, considering the inconvenience of tracking and tracing distributions through the ownership chain.

12. COMING UP

This article discussed the charging provisions, recovery mechanism, determination of ETR (including illustrating some India-specific fact-patterns). In this backdrop, the last article of this series will, inter alia, dwell upon special tax rules for business reorganisations and compliance/administrative aspects.

[The authors are thankful to CA Geeta D. Jani, CA Shaptama Biswas and CA Dolly Sharma for their support.]

shailesh.kwebmaker

BCAS Foundation’s Tree Plantation and Eye Camp Drive- 2022

BCAS Foundation is a registered Public Charitable Trust whose principal activities are to undertake various public charitable purposes such as relief of the poor, education and other objects of general public utility.

Last month, the HRD Committee of BCAS, under the aegis of the BCAS Foundation, undertook Tree Plantations and Eye Donation Camps at Pindval and Vansda, respectively. It is heartening to note that such noble activities started in 2011 and have completed 11 years. BCAS Foundation has been instrumental in planting more than 1,00,000 trees in and around Dharampur and conducting more than 1,000 cataract operations for tribals in and around Vansda, Gujarat. Thanks to coordinators CA Meena Shah, CA Utsav Shah, CA Darshan Nathwani and the young brigade of Articled Students and CAs who participated over these years.

This year, being India’s 76th Independence Day, the project visit was specifically planned for 13th and 14th August 2022 to commemorate and celebrate ‘Azadi ka Amrit Mahotsav’ with noble causes of contributing toward Greener India and giving a better vision to the underprivileged tribals of people in and around Vansda. We thank our esteemed BCAS Donors with whose support we could contribute a sum of Rs. 4,80,000 for these noble causes. A Group of 23 enthusiastic volunteers representing BCAS and donors planted trees and witnessed Cataract Eye Camp at the Sant Ranchoddas Eye Hospital in Vansda. The Group visited three different NGOs engaged in many noble activities.

SARVODAYA PARIVAR TRUST (SPT): The Group reached Pindval, Dharampur, to visit the SPT centre. SPT runs two Ashram Schools in Pindval and Khadaki. The trust is an initiative of founders who carried on the vision of Archarya Vinoba Bhave of unconditional service to tribals. SPT works in the areas of Environment, Education, and Water Conservation and follows a holistic approach to poverty alleviation based on Gandhian principles. The Group, and a team of local farmers planted saplings of mango and bamboo trees. The Team had the privilege of Flag hoisting with Farmers and Tribal Children on the field. BCAS contributed to the plantation of about 10,000 trees (@ Rs. 30 per tree, amounting to Rs. 3,00,000). SPT has a nursery wherein they prepare saplings of various fruits and non-fruits bearing trees throughout the year and distribute them to farmers during the monsoon season. The captive plantation ensures a higher survival rate of more than 60%.

Trustee, Shri CA Virendra Shah led the project and briefed about the outcome of the activities that have positively impacted the lives of several people in the hilly region.

DHANVANTRI TRUST (DT): Late Dr. Kanubhai Vaidya founded Sant Ranchoddas Eye Hospital, Vansda, which provides free cataract operations and other eye care facilities for needy people. Trustee, Shri Ghanshyambhai briefed about the facilities and Eye Treatment provided at the 100-bed Hospital. With the kind support of doctors and volunteers, till now they have conducted over 85,000 cataract surgeries. The Group got an idea about how ignorance and extreme poverty result in blindness amongst the poor. This year BCAS donated Rs. 1,85,000 sponsoring 185 cataract operations @ Rs. 1,000 per operation.

SHRIMAD RAJCHANDRA ASHRAM, DHARAMPUR (SRMD): SRMD is a spiritual mission for inner transformation through wisdom, meditation, and selfless service. Founded by Pujya Gurudev Shri Rakeshji, the organisation works through 196 centres in five continents. The Group visited the Ashram, the temple of Bhagwan Mahavir Swami and got an idea about various humanitarian activities undertaken by the Mission in the form of Schools, Colleges, Animal hospitals, etc. It was an enriching and enlightening experience witnessing devotion and selfless services by the Mission to upliftt tribals and poor people.

The visit ended with fond memories of the noble organisations and comradeship amongst team members. The visit not only contributes to the environment but also empowers and sensitised youngsters to undertake noble activities in life.

shailesh.kwebmaker

Intricate Issues in Tax Audit

INTRODUCTION
Since the provision for audit u/s 44AB of the Income-tax Act was introduced in 1984, it has occupied centre stage of activity for many CAs in practice. Popularly, it is referred to as Tax Audit. After nearly four decades, while the original provisions and forms may look simple, the task of conducting a tax audit has always been complex. While in earlier years, the complexities revolved around getting the client to prepare proper financial statements from manually maintained accounting records, today, the challenge is getting the client to compile the voluminous details before auditing and reporting these in the complex online utilities.

Before we get into some of the issues one has to tackle while forming a view and reporting on the same; it is important to understand the objective behind the introduction of Tax Audit. The scope and effect of section 44AB were explained by the CBDT in Circular No. 387, dated 6th July, 1984 [(1985) 152 ITR St. 11] in para 17, as under:

“17.2 A proper audit for tax purposes would ensure that the books of accounts and other records are properly maintained, that they faithfully reflect the income of the taxpayer and claims of deduction are correctly made by him. Such audit would also help in checking fraudulent practices. It can also facilitate the administration of tax laws by a proper presentation of the accounts before the tax authorities and considerably saving the time of assessing officers in carrying out routine verifications, like checking correctness of totals and verifying whether purchases and sales are properly vouched or not. The time of the assessing officers thus saved could be utilised for attending to more important investigational aspects of a case.”

The reporting complexities have been continuously increasing over the years, and it is evident from the fact that after the introduction of the forms in 1984, the first major change in reporting happened in 1999, after almost 15 years. The changes in the law and forms have become more frequent thereafter. At times, the reporting requirements travel beyond mere furnishing of particulars. The most glaring example is clause 30C(a), which requires the auditor to report on whether the assessee has entered into an impermissible avoidance arrangement.

The Institute of Chartered Accountants’ of India has been providing guidance to the members in the form of Guidance Notes and other pronouncements from time to time. The 2022 revised edition of The Guidance Note on Tax Audit under section 44AB of the Income-tax Act, 1961 – A.Y. 2022-23 (the GN) has been recently published.

We may turn our attention to some of the important matters when it comes to reporting in Form Nos. 3CA / 3CB / 3CD.

REPORTING CONSIDERATIONS
As per section 145, an assessee has an option to follow cash or mercantile system of accounting. Under clause 13(a) of Form 3CD, the assessee has to state the method of accounting it follows. As stated in para 11.6 of the GN, Accounting Standards (AS) also apply to financial statements audited u/s 44AB, and members should examine compliance with mandatory Accounting Standards when conducting such audits. Further, as per para 13.9 of the GN, normal Audit Procedures will also apply to a person who is not required by or under any other law to get his accounts audited. Where in the case of an assessee, the law does not prescribe any specific format or requirements for the preparation and presentation of financial statements, the ICAI has recently published ‘Technical Guide on Financial Statements of Non-Corporate Entities’ and ‘Technical Guide on Financial Statements of Limited Liability Partnerships’.

The following matters need to be kept in mind while furnishing an audit report, especially under Form No. 3CB:

(a) Assessee’s responsibility and Tax Auditor’s responsibility paragraphs have to be included at appropriate places in both Form No. 3CA and Form No. 3CB, as the case may be. The illustrations of the same are given in para 13.11 of the GN.

(b) If an assessee follows the cash system of accounting in accordance with section 145, then the said fact must be mentioned in Form No. 3CB while drawing attention to the notes included in the financial statements, if any.

(c) In case the financial statements of an assessee are otherwise not required to be prepared or presented in any particular format by any law, and if the ‘Technical Guide on Financial Statements of Non-Corporate Entities’ or ‘Technical Guide on Financial Statements of Limited Liability Partnerships’, as applicable, is not followed, then the said fact should be included as an observation.

PAYMENT OR RECEIPT LESS THAN 5% IN CASH IN CASE OF ELIGIBLE ASSESSEE COVERED BY SECTION 44AD
With effect from A.Y. 2020-21, a proviso was inserted to section 44AB(a), whereby a relaxation from getting accounts audited was provided to certain assessees. Thus, an assessee, having sales, turnover or gross receipts below Rs. 10 crores, whose aggregate of all receipts or payments in cash (including non account-payee cheques / bank drafts) does not exceed five per cent of the sales, turnover or gross receipts, is not required to get its accounts audited u/s 44AB(a).

U/s 44AD(4) if an eligible assessee, who has declared profit for any earlier year in accordance with section 44AD, chooses to declare profit less than that prescribed in section 44AD(1) in any of the succeeding 5 years and his income exceeds the maximum amount which is not chargeable to tax, then he is liable to get his accounts audited u/s 44AB(e) r.w.s. 44AD(5).

The issue that arises for consideration is whether the benefit provided in the proviso to section 44AB(a) would also apply to assessees covered u/s 44AB(e). The objective of increasing the said limit, as stated, was to reduce the compliance burden on small and medium enterprises. Even the Finance Minister, in her speech, had said – “In order to reduce the compliance burden on small retailers, traders, shopkeepers who comprise the MSME sector, I propose to raise by five times (in Finance Act raised to Rs. 10 crores) the turnover threshold for audit ….”.

However, the stated object of the amendment and law ultimately introduced in this regard are at variance. It does not appear to encompass eligible assessees covered u/s 44AD by not extending the said proviso to section 44AB(e). Thus, reference to small retailers, traders, and shopkeepers in the Finance Minister’s speech is rendered meaningless, as they are the ones who are actually covered as eligible assessees u/s 44AD.

TURNOVER FROM SPECULATIVE TRANSACTIONS AND DERIVATIVES, FUTURES & OPTIONS
Determination of turnover or gross receipts from Speculative Transactions as well as from Derivatives, Futures & Options has been a subject matter of many lengthy discussions. The GN has dealt with the subject and provided the following guidance in paras 5.14(a) and (b) for determination of turnover for applicability of section 44AB. In either case, the determination would be as under:

(a) Speculative Transactions: These are transactions in respect of commodities, shares or stocks etc., that are ultimately settled otherwise than by actual delivery. In such cases, transactions are recognised in the books of account on net basis of difference earned or loss incurred. According to the GN, the sum total of such differences earned or loss incurred, i.e. total of both the positives and negatives has to be taken into consideration for determination of turnover.

(b) Derivatives, Futures & Options: These transactions are also settled, on or before the strike date, without actual delivery of the stocks or commodities involved. In such cases, the total of all favourable and unfavourable outcomes should be taken into consideration for determining turnover along with the premium received on the sale of options (unless included in determining net profit from transaction). The GN also states that differences on reverse trades would also form part of the turnover.

INTEREST AND REMUNERATION RECEIVED BY A PARTNER IN A FIRM
The applicability of provisions of section 44AB to receipt of interest and remuneration by a partner in a firm has been a matter of some litigation in the context of levy of penalty u/s 271B. There have been judgements of the ITAT both in favour and against. This issue came up before the Hon. Bombay High Court recently in Perizad Zorabian Irani vs. Principal CIT [(2022) 139 taxmann.com 164 (Bombay)] wherein it is held that:

“Where assessee was only a partner in a partnership firm and was not carrying on any business independently, remuneration received by assessee from said partnership firm could not be treated as gross receipts of assessee and, accordingly, assessee was justified in not getting her accounts audited under section 44AB with respect to such remuneration.”

In coming to the above conclusion, the High Court relied on the judgement of Hon. Madras High Court in Anandkumar vs. ACIT [(2021) 430 ITR 391 (Mad)]. The case before the Madras High Court was of an assessee who had declared presumptive income u/s 44AD at 8% of the remuneration and interest earned from the partnership firm. The Assessing Officer had disallowed the claim of benefit u/s 44AD while holding that the assessee was not carrying on business independently but as a partner in the firm, and receipts on account of remuneration and interest from firms cannot be construed as gross receipts as mentioned in section 44AD.

Thus, two important points emerge from the above discussion:

(a) Remuneration and Interest in excess of Rs. 1 crore would not make a partner of a firm liable to tax audit u/s 44AB, and

(b) Benefit of section 44AD is not available in respect of remuneration and interest received by a partner from a partnership firm.

INCOME COMPUTATION AND DISCLOSURE STANDARDS (ICDS)
Reporting under this clause assumes great significance as, most of the time, assessees are not fully aware of the said standards. Two important matters to note from an auditor’s perspective are:

(i) If financial statements are prepared and presented by following the Accounting Standards, as discussed in Reporting Considerations herein before, then there might be some items of adjustments under ICDS and accordingly need reporting under clause 13 of Form No. 3CD, and

(ii) If the ICDS are followed in the preparation and presentation of financial statements, especially in the case of non-corporate assessees or LLPs, then there would be a need for qualifications in Form No. 3CB, where the Accounting Standards are not followed.

Generally, one will have to take into consideration the following important items, amongst others, in respect of the following ICDS:

ICDS	Subject	Matters for consideration
ICDS – I	Accounting Policies	• Impact of changes in accounting policies • Marked to market profit / losses
ICDS – II	Valuation of Inventories	• Inclusive vs. Exclusive • Borrowing Costs • Time value of money • Clause 14(b)
ICDS – IV	Revenue Recognition	• Performance Obligations • Provision for sales returns
ICDS – V	Tangible Fixed Assets	• Borrowing Cost • Forex gain / loss treatment • Clause 18
ICDS – VI	Effects of Changes in Foreign Exchange Rates	• Cash flow hedges • Marked to market profit / losses
ICDS – VIII	Securities	• Average cost vs. Bucket Approach
ICDS – IX	Borrowing Costs	• Inventories • Fixed Assets

ICDS

Subject

Matters for consideration

ICDS – I

Accounting Policies

• Impact of changes in accounting policies

• Marked to market profit / losses

ICDS – II

Valuation of Inventories

• Inclusive vs. Exclusive

• Borrowing Costs

• Time value of money

• Clause 14(b)

ICDS – IV

Revenue Recognition

• Performance Obligations

• Provision for sales returns

ICDS – V

Tangible Fixed Assets

• Borrowing Cost

• Forex gain / loss treatment

• Clause 18

ICDS – VI

Effects of Changes in Foreign Exchange
Rates

• Cash flow hedges

• Marked to market profit / losses

ICDS – VIII

Securities

• Average cost vs. Bucket Approach

ICDS – IX

Borrowing Costs

• Inventories

• Fixed Assets

Some of the above matters are covered for reporting under other clauses also. At times such multiple reporting results in further adjustments in the intimations received u/s 143(1).

1. Certain adjustments in respect of inventories relating to taxes, duties etc., are reported, as per ICDS II, under clause 13(e), as well as in clause 14(b) for reporting deviation from section 145A. When intimation u/s 143(1) is received, it is noticed that there are double additions made if the same item is reported in two different clauses as per the reporting requirements. It is difficult to prescribe any particular method of reporting in such a matter. However, one may take a practical view and report such adjustments in clause 14(b) as it is directly arising from the provision of law rather than under clause 13(e), which comes from the requirement of delegated legislation in the form of ICDS. Of course, whatever manner of reporting is adopted by the assessee, it would be prudent to disclose the same in para 3 of Form No. 3CA or para 5 of the Form No. 3CB, as the case may be.

2. In cases of proprietary concerns, along with business affairs, many times other personal details are also reported in the financial statements. If the proprietor is following the mercantile system of accounting and is also earning some other incomes, which are credited directly to the capital account, then clause 13(d) is attracted. It may be remembered that ICDS also apply to the computation of income under the head ‘Income from Other Sources’. Clause 13(d) is attracted if any adjustments are required to be made to the profit or loss for complying with ICDS. The scope of ICDS also extends to the recognition of revenue arising from the use by others of the person’s resources yielding interest, royalties or dividends. Similarly, under clause 16, amounts not credited to the profit and loss account are required to be reported. Under clause (d) of the said clause, ‘any other item of income’ is to be reported.

This particular reporting has been causing some problems again in intimations received where the said amount, though declared as income from other sources, is added to business income.

To deal with such a problem, the correct course of action would be to segregate personal financial affairs from business affairs. However, where such segregation is not possible for some good reasons, then probably the assessee may have to make a choice of reporting or not reporting the same. The auditor, in turn, would have to disclose such fact as a qualification under clause 5 of Form No. 3CB if not reported. If reported, then probably, an explanation would need to be included at the appropriate place, probably along with other documents that are uploaded along with the financial statements.

One may face such situations in respect of other items also. As an auditor, it may be a good practice to disclose such fact/s in clause 3 of Form No. 3CA or clause 5 of Form No. 3CB, as the case may be. Such disclosure may simply be an observation or a qualification, also at times depending on the facts and circumstances of a given case.

CHANGES IN PARTNERSHIP
In clause 9(b), in respect of Partnership Firms or Association of Persons, changes in the partnership or members or in their profit-sharing ratio are required to be reported. There has been a major change in provisions of section 45(4) w.e.f. 1st April, 2021. Any profits or gains arising from receipt of money or capital asset by a partner because of reconstitution of partnership firm is chargeable to tax, and such tax has to be paid by the firm.

While there is no separate reporting required in Form 3CD of such gains, one will have to take the above into account to ensure that due payment or provision for tax is made in the books of account. In such cases, the assessee may have taken legal opinions on some of the issues. If reliance is placed on the same, then necessary audit procedures as also disclosure, if additionally required, may be discussed with the assessee. One would also need to examine the valuation reports in respect of some of the assets that may have been obtained for the determination of amounts payable to any partner on account of reconstitution. Also, the assessee needs to obtain Form No. 5C, where applicable, to determine the nature of capital gains and carried forward cost of assets retained by the firm.

IMPERMISSIBLE AVOIDANCE ARRANGEMENT (IAA)
Clause 30C requires reporting of impermissible avoidance arrangement entered into by the assessee during the previous year under consideration. Reporting under this clause was deferred to 1st April, 2022.

Chapter X-A deals with provisions of General Anti-Avoidance Rules (GAAR) contained in sections 95 to 102. The intent, as per the Explanatory Memorandum of provisions of GAAR is to target the camouflaged transactions and determine tax by determining transactions on the basis of substance rather than form. GAAR applies to transactions entered into after 1st April, 2017. There are elaborate procedures for a transaction to be declared an IAA. For an arrangement to be declared as IAA, its main purpose should be to obtain a tax benefit and should satisfy one or more conditions of section 96, which are as under:

it creates rights / obligations which are not ordinarily created between persons dealing at arm’s length,

it results, directly or indirectly, in misuse or abuse of the provisions of the Act,

it lacks commercial substance or is deemed to lack commercial substance, by virtue of fiction created by section 97, or

is entered into or is carried out, by means, or in a manner, which may not be ordinarily employed for bona fide purposes.

There are elaborate steps laid down where a matter travels from Assessing Officer to the CIT or PCIT and to the Approving Panel. The CIT or the PCIT may declare the transaction as IAA if the assessee does not respond to show cause notice. In case the assessee objects to such a treatment, then the matter is referred to the Approving Panel, which may or may not hold the transaction to be IAA.

As per Rule 10U, GAAR is not applicable in certain specified cases thereunder.

Thus, there are various complexities involved in determining whether a transaction is an IAA. It involves determining parties who are to be treated as one and the same person, calculation of tax benefit obtained and if the same is more than Rs. 3 crores and access to records of some or all of the connected parties. This will involve substantial uncertainty, impossibility of computing overall tax effect and involvement of substantial subjectivity. The very fact that, even for administrative purposes, such an elaborate system from AO to Approving Panel is put in place, is a pointer to the difficulties involved. It is well-nigh impossible for a Tax Auditor to come to a conclusion on such a matter. In any case, the first step of furnishing the details under this clause rests on the assessee. Thus, in view of the difficulties arising on account of uncertainty and subjectivity, an auditor would hardly ever be able to come to a true and correct view of the matter. Accordingly, a Tax Auditor should include a disclaimer in respect of reporting under this clause as per para 56.14 of the GN with necessary modification.

The GN also suggests inquiring about pending matters relating to IAA or declaration of any transaction as IAA in respect of any of the earlier years and reporting the facts relating to the same.

THE BREAK-UP OF TOTAL EXPENDITURE AND GST
Clause 44, in pursuance of the information exchange collaboration initiated between CBIC and CBDT, was inserted on 20th July, 2018, but kept in abeyance for reporting prior to 1st April, 2022. While the ultimate objective of this clause is not clear, it appears to be in the nature of data collation for the purposes of GST. It requires reporting of the break-up of expenditure of entities registered or not registered under GST in the following manner:

1. Total amount of expenditure incurred during the year (Column 2)

2. Expenditure in respect of entities registered under GST:

a. Relating to goods or services exempt from GST (Column 3)

b. Relating to entities falling under composition scheme (Column 4)

c. Relating to other registered entities (Column 5)

d. Total payment to registered entities (Column 6)

3. Expenditure relating to entities not registered under GST (Column 7)

The first question that arises for the purpose of reporting under this clause is what is the ambit or scope of the term “expenditure”? Oxford dictionary defines it as “the act of spending or using money; an amount of money spent”. It appears that all the expenditures as reported in the Profit and Loss Statement may have to be bifurcated for the purpose of reporting at clause 44. However, there might be certain exclusions or inclusions that may have to be taken care of:

1. Provisions and allowances (e.g., provisions for doubtful debts) are not expenditure and therefore, will have to be excluded.

2. Depreciation and amortisation, not being in the nature of expenditure, will also have to be excluded.

3. Capital Expenditure shall also be treated as expenditure and requires to be reported.

4. Prepaid expenditure incurred in the current year but forming part of the expenditure of the subsequent year will have to be added and conversely, prepaid expenditure of previous year forming part of the expenditure of current year will have to be reduced.

Once the total expenditure incurred during the year is derived under column 2, this requires bifurcation into expenditure in respect of entities registered under GST and those not registered under GST. The expenditure in respect of registered entities requires further bifurcation into exempt goods or services, relating to entities under the composition scheme and those relating to other registered entities.

As per section 2(47) of CGST Act, 2017, exempt supply means “supply of any goods or services or both which attracts nil rate of tax or which may be wholly exempt and includes non-taxable supply”. Exempt supplies shall include the supply of goods or services that have been exempted by way of notification (e.g., interest) or subjected to a nil rate of tax by way of notification. It shall also include supplies which are currently outside the levy of GST, such as petrol, diesel and liquor.

Activities or transactions that are treated as neither supply of goods nor a supply of services under Schedule III do not fall within the ambit of exempt supplies. Thus, expenditure in respect of such activities may have to be reported under the residuary category at column 5, in case of registered entities, or column 7 in case of unregistered entities. However, Para 82.3 of GN states that such activities need not be reported under this clause.

The details of expenses under the reverse charge mechanism (i.e., RCM where the recipient is liable to pay tax) are also required to be reported. In the case of RCM expenses from registered entities, these shall form part of expenditure relating to other registered dealers under column 5. In the case of RCM expenses from unregistered dealers, it shall be reportable under expenditure relating to entities not registered in column 7.

The critical issue here is what should be the source of such details required to be reported under this clause, as currently, there is no return or form in GST that requires mandatory reporting with respect to all expenditures. The reporting in respect of supplies from entities under the composition scheme in Table 16 of Form GSTR-9 (Annual Return) is currently optional up to F.Y. 2021-22. Table 14 of Form GSTR-9C (Reconciliation Statement), which requires expenditure head-wise reporting of Input Tax credit availed, is also optional up to F.Y. 2021-22. Reporting in respect of inward supplies from composition entities and exempt inward supplies is also required in Table 5 of GSTR-3B. However, most taxpayers are not able to report it on a monthly basis.

An inward supplies register, if available, consisting of all the expenditures incurred for the year could be considered as the basis for compiling vendor-wise expense details. Additionally, internal data for vendor master may have to be analysed to obtain details of entities registered under the composition scheme, registered entities, and unregistered entities. All the entries not charged with GST may be analysed to obtain details pertaining to exempt supplies, those pertaining to composition entities and those pertaining to unregistered entities.

The reporting is not required head-wise or vendor-wise. However, it is advisable to separately report revenue and capital expenditure. It is also advisable to maintain detailed head-wise and vendor-wise details as, typically, it may expected to be called for during scrutiny.

GSTR-2A (a statement containing details of inward supplies) may also be considered for reporting details in respect of registered entities. Owing to the dynamic nature of the statement and further requirement of reconciling the same with the books, it may not give desired and accurate details. The details in respect of composition entities and unregistered entities will also have to be separately compiled as these shall not be available from GSTR-2A.

Reporting under clause 44 involves an elaborate exercise, and all the details may not be available in most of the cases. In most cases, it may not be true and correct as required for the purpose of reporting. Therefore, it may be necessary to consider adequate disclosures along with notes, partial disclaimers, and in an appropriate circumstance, a complete disclaimer on reporting in this clause.

CONCLUSION
In this article, some intricate contemporary matters have been touched upon. However, there are some evergreen issues that keep on springing some surprises during the conduct of the audit and teach us something new. While many things have become easy on account of technology, there are matters which also add to our difficulties in terms of submission of data, maintenance and preserving of audit records and, of course, not the least, the challenges posed by the portal at times.

Two things that one has come to realise about tax audit, after practicing for some decades:

Assessees and Tax Auditors adapt to reporting on many intricate issues and settle with the same in a couple of years, and

When the issues are settled, the law comes up with something new and more complex requirements to be reported.

The tax audit reporting is, therefore, never finally settled, adding to the woes of taxpayers and tax auditors.

shailesh.kwebmaker

TALE OF TWO CLIMATES

Climate change is wreaking havoc in the world. Today we find that many countries, including India, are experiencing torrential rains, resulting in floods in many areas and thereby causing loss of lives, vegetation, and properties. At the same time, Europe and many Western countries are experiencing unprecedented heat and drought. Many rivers have dried up or are on the verge of drying up, resulting in an energy crisis and adversely impacting the global supply chain.

Many forests have caught fire, and millions of hectares of land and vegetation have been destroyed. On 24th August, 2022, Reuters reported that extreme fires have swallowed up vast swathes of land, destroyed homes, and threatened livelihoods worldwide in the first half of 2022. It further reports that wildfires have destroyed over 3.3 million acres of land across the Globe in 2022 alone. This shows the magnitude of the problem.

The Middle East has been disturbed for many years, with continuing fights in Syria, Iraq, and other countries. The war between Ukraine and Russia has been going on for more than six months now, without any end. A large amount of carbon emission due to the use of high-tech weapons in these wars has further aggravated the climatic conditions worldwide. The world is passing through a turbulent time with no immediate relief in sight. The geopolitical situation is very fragile, with increasing tension between China and Taiwan on one side and Russia and NATO on the other. The tension in the Asia Pacific region is also growing, with Indonesia asserting its right in the South China Sea and other Southeast Asian countries.

Under the current scenario, India has a major role to play. However, as stated earlier, not only the natural climatic conditions, but the economic and regulatory climate in India is also changing. India has made notable progress in the recent past and has successfully come out of the economic ill effects of the pandemic. Today, India is poised for a great leap on the economic front. Even the World Bank has predicted impressive growth for India. Under the circumstances, it is imperative that India plays its cards carefully.

Many companies have decided to shift their operations from China, and one of the choicest countries in Asia is India. If India were to gain from these geopolitical developments and touch a five trillion-dollar economy by 2024, then the regulatory requirements should be simple, business-friendly, and with fair administration. There cannot be two views that the country’s revenue base should be protected, and every taxpayer should pay legitimate tax. However, if the regulations are clear and fairly administered, then they will ensure tax certainty and avoid litigations.

Let’s turn our attention to another climatic change in India, i.e., in the area of Tax Audits. Recent amendments under the Tax Audit regime deserve attention. The reporting requirements are such that a Tax Auditor is virtually carrying out the assessment of his client. Tax Audit was introduced with a laudable object of facilitating tax administration by a proper presentation of the accounts such that the time of Assessing Officers could be utilised for attending to more investigational aspects. However, if one were to read the requirements of reporting under Clause 30C, one finds that the Auditor is supposed to do an investigation and report any transaction which is in the nature of an “Impermissible Avoidance Arrangement (IAA)”. Essentially, it requires an Auditor to examine every transaction and report whether it is in the nature of IAA as referred to in section 96 of the Act and quantify the amount of tax benefit resulting from IAA. It requires judgment by an auditor as to whether a particular transaction is impermissible or not. While the Auditor has to certify whether the transaction is in the nature of IAA, it cannot be held so unless a detailed procedure is followed under the Act, and finally, the Approving Panel of experts declares it so after a detailed examination. It also has a danger for the Tax Auditor. What if the transaction was reported by him as IAA and challenged by the taxpayer in higher forums, which ultimately turns out to be a non-IAA? And what happens in the reverse scenario? Is he not in trouble either way?

In a lighter vein, it reminds me of a joke where a student is asking his parents how they expect him to learn all subjects (all by himself), which one teacher cannot teach. Tax Audit, thus, casts onerous responsibility on a Tax Auditor. Ideally, Tax Audit should have provided for merely reporting a transaction without the Auditor’s opinion and/or certification on whether it is an IAA. This Clause, along with Clauses 30A and 30B, requires Tax Auditors to be well versed with Transfer Pricing Regulations and International Taxation (for Interest Deductibility u/s 94B).

Another onerous requirement made applicable from A.Y. 2022-23 is reporting under Clause 44 about the “Break-up of the total expenditure of entities registered or not registered under GST”. It will not only require more time and effort for an Auditor to comply with this requirement but would also need a good amount of knowledge of GST, as is evident from the Guidance Note by the ICAI.

In 38 years of its existence, a tax audit is today as comprehensive as complex.

It requires experts from different fields to do justice. The silver linings are the ability of Chartered Accountants to rise to every occasion, thanks to their rigorous training and faith of the judiciary and revenue department in the profession. The Hon’ble Supreme Court in T.D. Venkata Rao vs. Union of India [1999] 237 ITR 315 (SC) made the following significant observations: “Chartered Accountants, by reason of their training, have special aptitude in the matter of audits. It is reasonable that they, who form a class by themselves, should be required to audit the accounts of businesses whose income (sic: turnover) exceeds Rs.40 lakhs* and professionals whose income (sic: gross receipts) exceeds Rs.10 lakhs* in any given year”.

As rightly observed by the Apex Court, Chartered Accountants are a class by themselves. We are distinct, diligent, dependable, and determined. While new regulations and requirements open new opportunities for practice and growth, we should be mindful of their risks. We should also be mindful of work-life balance in today’s hectic world. Everything comes with a price tag. At the end of the day, we should ask ourselves one question, is it worth?

shailesh.kwebmaker

GOPICHANDAN

We offer Namaskaars to God as part of our worship. It is a mark of our respect and devotion towards Him. I am referring to the Gods of all religions – be it a Hindu God or Allah or Jesus or any form of the Almighty.

A question often asked is why our God does not shower His blessings on us even if we worship Him sincerely and regularly.

The answer is that we do not have blind faith in Him. Our devotion is not uncompromising. We carry doubts and questions about the very existence of God and His powers!

Gopikas of Lord Shrikrishna is the ultimate example of true devotion. Once a Guru told the Gopis that they can even walk on the water and cross the river with true devotion. Gopis did achieve it, but the Guru got drowned!

Chandan means sandalwood. It gives complete coolness to our body if mixed with water and applied. But what is Gopichandan? It is nothing but mud – soil (mitti) mixed with water. It also gives coolness. Gandhiji used to apply it to his forehead. The story behind Gopichandan is beautiful. Once Shrikrishna pretended to have an acute headache. All Gods and others in heaven were extremely worried. No remedy was working! So, they surrendered and asked Him what the real remedy was. The Lord said – please get me the soil (mitti) under the feet of my true devotee from the earth. The task was given to Narad Muni.

He met many sages and rishis and requested them for the soil beneath their feet – to apply to Shrikrishna’s forehead. They got furious. They said they were praying for years to see and fall on Krishna’s feet; and how dare Narad ask for the mitti under their feet to be applied to His forehead? They said it would take them to hell!

Then Narad approached other second-rank sages and disciples who were busy performing ‘yagyas’. At Narad’s request, they also said that if senior sages feared going to hell, how did Narad expect that they would agree? So, they refused.

Finally, Narad reached Vrindavan, where Gopikas were rejoicing in Krishna’s sweet memories. They greeted Narad. They were pained to learn from him that their beloved Kanha was not well! They instantly agreed to give Narad whatever he wanted. Narad cautioned them by telling what senior sages had told him, i.e. going to hell!

Gopis said we are not afraid of going to hell or doing anything for the well-being of their Krishna. They said no matter what happens to us; we cannot digest the idea of Kanha being in trouble! For Him, they were willing to stay permanently in hell; but praying to Him!

Narad took the mitti under their feet, asked them to mix it in water and crush it by their feet, and carried the ‘mud’ to Shrikrishna. Needless to say that Krishna got relief from his headache!

Similar stories may be there in all religions. God loves only true devotees. God will surely bless us when we offer our Namaskaar with this mindset!

Our patriots and martyrs treated our motherland as their God. They were willing to sacrifice anything and everything for her independence and progress. That is why they deserve our Namaskaars.

shailesh.kwebmaker

SOME INTERESTING FREE WINDOWS 10 APPS & DOWNLOADS

We have all been using Windows 10 for many years now. However, there are some hidden, little-known apps and some free third-party apps which can make our productivity soar in multiple ways. Here are a few of them which you can use in your day-to-day work life.

STICKY NOTES
We have all used Sticky Notes some time or other at the workplace. Windows 10 offers you digital Sticky Notes right on your desktop. Just press the Windows Key and type Sticky Notes and you will be presented with the Sticky Notes app. You may create as many Sticky Notes as you desire and paste them at your desired locations on your desktop. You can format the Sticky Notes, add pictures, create bulleted lists and assign some basic colours to your Sticky Notes based on your preferences and categorisation of each or a group of Notes.

If you are using a Microsoft Launcher on your Android phone, you will be able to sync the Notes to your phone automatically and effortlessly.

This is a very simple tool to boost your productivity and comes in-built with Windows 10. Try it and use it – it is free, right on your desktop.

NIGHT LIGHT SETTINGS
All computer monitors emanate light which hits our eyes all the time. Prolonged usage could tire our eyes. Besides, after sunset, the blue light emanating from the monitor could even affect our eyes adversely. Windows 10 allows us to change our display settings to reduce the strain on our eyes.

On any blank area of the desktop, right-click with your mouse and then select Display Settings. In the Find a Setting box on the top left, just type Night Light and select the item displayed for Night Light. The Night Light Settings will be displayed. Here, you can turn Night Light on or off manually. You may also select the strength or intensity of the light when the Night Light is on, based on your comfort level.

If you wish to automate the process, you could set the time when Night Light comes on and when it would be turned off. Further, if you switch on your location settings for Windows, the system will automatically turn it on at Sunset and turn it off at Sunrise.

Pretty cool and comfy!

EVERYTHING
This is a very simple and extremely fast utility which allows you to search all areas on your computer in a jiffy.

Very often, we just remember the name of the file, but just can’t remember where it is buried in the plethora of folders and multiple sub-folders on our hard disk. For all you know, it may be lying on the external drive of our computer or even on a data card, inserted into our computer. Sometimes, we may not even remember the file name accurately, but we may just remember that it is a document file or an image file.

Windows 10 provides native search across the entire ecosystem. But if you have ever tried it, it can be very tardy and time-consuming, especially if you have a large hard disk with multiple levels of folders.

This is where Everything steps in. Once you download and install it, just enter the name or part name of the file you are searching and you will be amazed at the speed of the results. You can even search for part of the file name or for a type of file in combination with its name. The Advanced Search option allows you to specify matching case, any or all words in the file name and much more.

From the list of files displayed, you may double-click any file to open it.

You can download Everything from https://www.voidtools.com/. Try it once, you will never use Windows Search ever again.

FILE-CONVERTER
There are loads of file converters available online. Zamzar.com is one of the popular options which allows you to convert files from one format to another. For using the online file converter, you must upload your file to their servers and then specify to which format you wish to convert the file. It takes a few seconds to perform the conversion and you can then download the file back to your computer when it is ready. Since this involves uploading your file to their server, many times users are worried about the privacy of their data.

Enter File-Converter – a very simple and light utility that will change the way you convert files on a day-to-day basis. Just head to https://file-converter.org and download and install the file converter. Don’t worry if you don’t see anything on your screen yet. Once installed, go to any folder and right-click on the file which you wish to convert. You will see the File-Converter option in your context menu. When you hover over it, you will be able to see the types of files to which you can convert your original file. For example, if you right-click on a pdf file, it will show you the option to convert it to a png file! Just click on your option and the conversion begins. It’s as simple as that. No need to upload any files or install any more programmes.

You also have the option to configure the pre-sets and set your choices, and the conversions are instant and free. You may choose to convert multiple files at once and either retain or delete the original files after conversion.

You may find some limitations in case of certain types of files or files which have very complex formatting, but for a major part of daily usage, this is a very sleek, swift and light utility.

So now, open up Windows and let your productivity soar by using these tips on a daily basis. Good luck!

shailesh.kwebmaker

ACCREDITED INVESTORS – A NEW AVENUE FOR RAISING FINANCE

SEBI has, at its Board meeting of 29th June, 2021, taken some baby steps to introduce and recognise a new category of investors – the Accredited Investors (‘AIs’) who are persons of high net worth / income. This has been followed up by amendments to the respective SEBI regulations on 3rd August, 2021. These changes should open up a new and wide channel of raising finance from informed and capable investors, particularly in areas where the present regulations are too restrictive.

This is not a new concept internationally. Many countries such as the USA, Canada, Singapore and even China have provisions for such a category of persons who are deemed to be well aware, if not sophisticated, and also having sufficient net worth so as to be able to bear losses in risky investments. Many rules are relaxed for such persons and issuers / intermediaries are able to issue complex, high risk / high return products to such persons at terms that are mutually agreed rather than statutorily prescribed. Thus, on the one hand, entities that cannot otherwise raise finance without crossing many hurdles can now raise finance more easily from such persons, on the other hand, such persons have wider avenues of investments to aim for higher returns at risks which they understand and can even manage.

In other words, AIs are expected to be sophisticated high net worth investors who do not need elaborate hand-holding by the regulator. They can evaluate complex, high risk / high return products / services and negotiate terms flexibly to protect their interests.

COMPLEX SEBI REGULATIONS AIMED AT THE NAÏVE AND UNSOPHISTICATED INVESTOR
SEBI’s regulations generally are models of micro-management. Having seen small investors repeatedly suffering in their investments, and perhaps also considering the reality of Indian markets, the rules in capital markets tend to bend towards elaborate controls. Parties generally cannot, even by mutual agreement, waive the many requirements of law enacted for the protection of investors.

A portfolio manager, for example, cannot accept a client with less than Rs. 50 lakhs of investment even if the client is well informed / capable. He also cannot invest more than 25% of the portfolio in unlisted securities under discretionary management, even if the client is agreeable to this. Similarly, Alternative Investment Funds have restrictions which cannot be avoided. Investment Advisers, too, face a very elaborate set of rules which govern almost every aspect of their business, including even the fees that they can charge. Thus, even if an informed client is willing to pay higher fees to get expert advice, the investment adviser is limited by the regulations.

The result of all this is that needy issuers are starved of funds and well-informed investors deprived of avenues with the potential of higher returns.

CONSULTATION PAPER ISSUED IN FEBRUARY, 2021
SEBI had initiated this process in February, 2021 by issuing a consultation paper proposing a framework for AIs and seeking public comments. This has now been finalised and amendments accordingly made to the regulations relating to Alternative Investment Funds, Portfolio Managers and Investment Advisers.

Who would be recognised as Accredited Investors?
As per the new framework, a person can obtain a certificate as an AI on the basis of net worth / assets or income, or a combination of the two. For example, an individual / HUF / family trust can be an AI if its annual income is at least Rs. 2 crores or net worth is at least Rs. 7.50 crores, with at least half of it in financial assets. Or it can be a combination of at least Rs. 1 crore annual income and net worth of Rs. 5 crores (with at least half in financial assets).

For other trusts, a net asset worth of at least Rs. 50 crores can qualify them as AIs. For corporates, too, a net worth of Rs. 50 crores is necessary. A partnership firm would be eligible if each partner is individually eligible. Similar parameters are provided for non-residents such as non-resident Indians, family trusts / other trusts, corporates, etc. Government departments, development agencies and Qualified Institutional Buyers, etc., would be AIs without any such minimum requirements.

Interestingly, a further category of AIs has been specified, viz., Large Value Accredited Investors. This would apply in case of Portfolio Managers and would be persons who have agreed to invest at least Rs. 10 crores.

A strange aspect is that, unlike some countries in the West, SEBI has not permitted educated / experienced investors to qualify as AIs. Indeed, having qualification or experience is not deemed to be even relevant! Thus, for example, Chartered Accountants or even CFAs, though trained to be well-versed with finance, cannot only by virtue of the fact of being qualified and competent, be recognised as AIs. They can act as advisers to AIs, but not be AIs themselves, unless they have the minimum size of assets / income.

Further, again unlike many western countries, merely having a minimum income / net worth is not enough. A formal certification as an AI is needed from certain bodies recognised for this purpose. A fee would have to be paid to them for grant of such a certificate. Curiously, although the details have not been notified, it appears from the Consultation Paper that the certificate is likely to be valid only for one year at a time and will have to be renewed annually.

The Consultation Paper had proposed yet another strange condition. Persons who desire to provide financial products / advice to AIs would not only need to obtain a copy of such a certificate from the AIs, but will also need to additionally approach the certifying agency and reconfirm with them. This would be a needless additional hurdle. Hopefully, the process may actually end up being simpler with such confirmation being quickly provided online on an automated basis after due verification by the certifying agency. However, it would be best that this requirement is not mandated when the further details are notified.

Nature of relaxations from regulations available for transactions with AIs
While ideally, an informed and capable investor should not face any hurdles in his decision-making power for making investments, even if the provisions are meant for protection, there will not be total relaxation. Instead, perhaps with the intention of testing the waters and going in gradually, SEBI has given partial relaxation from the regulations. In fact, the relaxations as proposed are few and far between. The minimum investment required, the terms on which contracts of providing services can be made, the fees that can be charged, the extent to which investments in unlisted securities can be made, etc., are some relaxations proposed.

The amendments are primarily made in the SEBI regulations governing Alternative Investment Funds, Portfolio Managers and Investment Advisers. The Consultation Paper / SEBI Board meeting has talked of amendments to other regulations, too, and it is possible that more changes may be made in the near future.

BENEFITS OF THE NEW CONCEPT
The new scheme can be expected to benefit intermediaries, investors and indeed the market. They would have more freedom to enter into arrangements and investments with risks and complexities that they are comfortable with. It should also result in availability of far more funds, from many more persons and by many more issuers. Today, many such investments simply cannot take place because of protective legal requirements. There would also be more flexibility for the parties involved. The amendments also create a sub-category of AIs called Large Value Accredited Investors, as also a separate category of fund called Large Value Fund for Accredited Investors. These would enable further flexibility to larger investors who expectedly can undertake more informed risks.

Can an AI opt out of the scheme either generally or on a case-to-case basis?
There are a few other concerns. Even if a person is an AI, he may not always want to waive the regulatory protection. He may have more than the prescribed size of net worth, etc. However, in certain cases, he may prefer not to invest as an AI. It seems that there is no bar on him from opting out.

However, care would have to be taken in the paperwork / agreements to ensure that there is no inadvertent waiver. It is common, however, that investors end up signing on the dotted line on long documents containing fine print. This is even more important considering that the benchmark for being an AI is only financial and not knowledge / qualifications.

An interesting issue would still remain as to whether, in case of disputes, his being an AI could be used against him and he be assumed to be an informed and sophisticated investor.

Whether SEBI would be available as arbiter in case of disputes / malpractices?

The intention clearly is that parties should be able to negotiate their own terms and formulate such structures, even if complex and high risk, as they are comfortable with. The regulations that otherwise provide for mandatory detailed terms would not apply. The question then would be what would be the role of SEBI in case of disputes between AIs and issuers / intermediaries? In particular, whether SEBI would still be available as arbiter in case of malpractices? Or will the parties have to approach civil courts which are expensive and time-consuming? One hopes that at least in case of frauds, manipulations, gross negligence and the like, recourse to SEBI would still be available as SEBI continues to be an expert and generally swift-footed regulator.

CONCLUSION

Despite some concerns, the amendments are still a major reform in the capital markets. Considering that the relaxations are generally partial, the level of complexity may actually increase. One can now only wait and see how the experience turns out to be over the years and how SEBI deals with the issues that would arise.
(You can also refer to the Article on Accredited Investors on Page 31 of BCAJ, August, 2021)

shailesh.kwebmaker

CRYPTOCURRENCIES: TRAPPED IN A LEGAL LABYRINTH (Part – 3)

Over the last two months, this Feature has examined the legal background surrounding cryptocurrencies and FEMA provisions in relation to Virtual Currencies (VCs). In this, the concluding part, we take up the tax issues pertaining to this exciting new asset class

LEGALITY STILL IN DOUBT
The legality of VCs in India continues to be a question mark. As recently as on 10th August, 2021, the Minister of State for Finance gave a written reply in the Rajya Sabha stating that the Government does not consider cryptocurrencies legal tender or coin and will take all measures to eliminate use of these crypto-assets in financing illegitimate activities or as part of the payment system. The Government will also explore the use of blockchain technology proactively for ushering in a digital economy. He added that a high-level Inter-Ministerial Committee (IMC) constituted under the Chairmanship of the Secretary (Economic Affairs) to study the issues related to VCs and propose specific actions to be taken, had recommended in its report that all private cryptocurrencies, except any cryptocurrency issued by the State, be prohibited in India. The Government would take a decision on the recommendations of the IMC and the legislative proposal, if any, would be introduced in the Parliament.

Coupled with this is the action taken by the Enforcement Directorate against a crypto exchange in India on the grounds of money-laundering. The accusation was that the exchange was facilitating some Chinese betting apps which converted their Indian earnings into VCs and then transferred the same to digital wallets based in the Cayman Islands.

In spite of the above regulatory heat, the popularity of VCs and crypto exchanges is growing by the day and a crypto exchange has now even entered the Unicorn club!

However, in the midst of the regulatory hullabaloo and the hype over VCs, one must not lose sight of the fact that at the end of the day tax must be paid on all earnings from VCs. The Income-tax Act is not concerned with the legality of a trade. In CIT vs. S.C. Kothari [1972] 4 SCC 402 it was observed that: ‘…If the business is illegal, neither the profits earned nor the losses incurred would be enforceable in law. But that does not take the profits out of the taxing statute.’

Again, in CIT vs. K. Thangamani [2009] 309 ITR 15 (Mad), the Madras High Court held that the income-tax authorities are not concerned about the manner or means of acquiring income. The income might have been earned illegally or by resorting to unlawful means. But any illegality associated with the earning has no bearing on its taxability. The assessee, having acquired income by unethical means or by resorting to acts forbidden by law, cannot be heard to say that the State cannot be a party to such sharing of ill-gotten wealth. Allowing such income to escape the tax net would be nothing but a premium or reward to a person for doing an illegal trade. In the event of taxing the income of only those who had acquired the same in a legal manner, the tendency of those who acquire income by illegal means would increase. It is not possible for the Income-tax authorities to act like the police to prevent the commission of unlawful acts, but it is possible for the tax machinery to tax such income.

The Finance Ministry in reply to a question raised in the Rajya Sabha has stated that irrespective of the nature of business, the extant statutory provisions on the scope of total income for taxation as per section 5 of the Income-tax Act, 1961 envisage that total income shall include all income from whatever source derived, the legality of income thus being of no consequence. The gains arising from the transfer of cryptocurrencies / assets is liable to tax under a head of income, depending upon the nature of holding of the same. It further stated that no data is maintained on cryptocurrency earnings of Indians as there is no provision in the Income-tax return to capture data on earnings arising from cryptocurrencies / assets.

Accordingly, irrespective of whether a crypto trade is legal or illegal, we need to examine its taxability. Let us briefly analyse the same. At the outset, it may be noted that since this is an evolving subject, there is no settled view and hence an attempt has been made to present all the possible views.

TAXABILITY OF TRADERS IN VCs
Whether a particular asset is a capital asset or a stock-in-trade has been one of the burning issues under the Income-tax Act. Section 2(14) defines the term ‘capital asset’ to mean property of any kind held by an assessee, whether or not connected with his business or profession, but it does not include any stock-in-trade. Hence, a stock-in-trade of any nature, whether securities, land or VCs, would be outside the purview of a capital asset.

People who trade in VCs, i.e., frequently buy and sell cryptos, are as much traders in VCs as a person dealing in shares and securities. The usual tests laid down to distinguish a trader from an investor would apply even in the case of VCs. Hence, tests such as intention at the time of purchase, frequency of trades, quantum, regularity, accounting treatment, amount of stock held on hand, whether purchase and sale take place in quick succession, whether borrowed funds have been used for the purchase, etc., are all relevant tests to help determine whether a person is a dealer / trader in VCs or an investor. The ratio laid down by the Supreme Court in CIT vs. Associated Industrial Development Company (P) Ltd. 82 ITR 586 (SC) in the context of securities would be equally relevant even in the case of VCs. The Court held that whether a particular holding is by way of investment or forms part of the stock-in-trade is a matter which is within the knowledge of the assessee who holds the asset and it should, in normal circumstances, be in a position to produce evidence from its records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which are held by way of investment.

The CBDT Circular No. 4/2007, dated 15th June, 2007 and Circular No. 6/2016 dated 29th February, 2016, issued in the context of taxability of gains on sale of securities would assist in determining the issue even for VCs.

If a person is a trader in VCs, then any gain made by him would be taxable as business income. The purchase price of the VCs would be allowed as a deduction even if the Government / RBI takes a stand that trading in VCs is illegal.

One school of thought also suggests that since there is no actual delivery involved in the case of VCs, transactions in VCs should be treated as a speculative transaction u/s 43(5). But it would be incorrect to say that delivery is not given in case of VCs because they are credited to a digital wallet. Delivery need not always be physical and could even be constructive or symbolic and should be seen in the context of the goods in question. However, this could become a litigious issue. For example, shares in dematerialised format are credited to a demat account and not physically delivered. Similarly, mutual fund units only appear in a statement.

Section 43(5) states that any commodity in which a contract for the purchase / sale is settled otherwise than by an actual delivery or transfer of the commodity, would be treated as a speculative transaction. The decision of the Supreme Court in the case of Internet and Mobile Association of India vs. Reserve Bank of India, WP(C) No. 528/2018, order dated 4th March, 2020 (SC) has held that it was not possible to accept the contention that VCs were just goods / commodities and could never be regarded as real money! Thus, while the Court has not come to a definite conclusion, the fact that VCs are commodities has been upheld by the Apex Court. In such a scenario, could the trading in VCs be treated as a speculative business? If so, then the losses from this business can only be set off against speculative gains u/s 73 of the Act, and the losses to the extent not set off can be carried forward only for four assessment years. Yet another school of thought suggests that the profits from trading in VCs should be taxed as Income from Other Sources.

TAXABILITY OF INVESTORS IN VCs
For investors in VCs, the gains would be taxable as capital gains. Depending upon whether the VC in question has been held for a period of more than or less than three years, the VCs would be treated as long-term capital assets or short-term capital assets. Long-term capital gains would be eligible for indexation and would be taxed @ 20% + surcharge + cess. Short-term capital gains, on the other hand, would be taxed as per the regular slab rate applicable to the investor. It must be pointed out that the special concessional tax rates of 10% with grandfathering of the cost for long-term gains in case of listed shares and 15% in the case of short-term gains on listed shares, do not apply to gains on VCs. Any long-term capital gain made on the sale of VCs can be saved by an Individual / HUF by reinvesting the net sale consideration in the purchase / construction of a new house property u/s 54F.

Receiving VCs as payment for goods / services
If a business receives payment for the goods / services sold by it in the form of VCs, then it would be treated as a barter exchange and the fair market value of the VCs received would be treated as the consideration received for the sale / supply. The cost of goods sold / services rendered would be deducted from this consideration and the gains would be taxable as business income.

Payment for mining
One buzzword associated with VCs is ‘mining’. A ‘VC miner’ is like the miner in the coal / gold / ore mine who, through his arduous labour, comes up with a prized catch. A Bitcoin miner is one who solves complex, cryptic math puzzles on the Bitcoin network and makes the network secure by validating the transactions which take place on it. While it is difficult to explain this concept, suffice it to say that miners help in improving the transaction network of VCs. And a miner receives payment in the form of VCs! Now how would this transaction be taxed is the question.

A good way to look at this would be that the miner is actually providing a service by carrying out the mining. Hence, the income from the same should be taxed as his business income. The cost of power, depreciation on IT equipment, maintenance, etc., would all be deductible expenses incurred to earn this income. The fair market value of the VCs received by the miner would be treated as the consideration for the service and the difference would be taxed as his business income. The Central Board of Indirect Taxes and Customs is also considering levying GST on mining activities on the ground that these constitute a service. Alternatively, if it is not a business income, it may be taxed as Income from Other Sources.

A more aggressive view is that income from mining consists of capital gains arising from a self-generated asset. This could be used for amateurs who are into VC mining as opposed to miners who carry on the activity as an occupation. Here, applying the principle laid down by the Supreme Court in CIT vs. B.C. Srinivasa Shetty [1981] 128 ITR 294 (SC), a view is taken that since the cost of acquisition of such a self-generated capital asset cannot be determined and that since section 55(2) has not prescribed the cost of acquisition / improvement of the same to be Nil, the income cannot be taxed. It is likely that the Tax Department would contest this view.

Gift of VCs
What would be the tax treatment if a person gifts VCs to another person? A gift of specified property is taxable u/s 56(2)(x) in the hands of the recipient except in the exempt cases. However, the gift must be of property as defined in the Explanation to section 56(2)(x). Property is defined to mean any sum of money, immovable property, shares and securities, jewellery / bullion, art / sculptures and archaeological collections. The Government of India has constantly taken a stand (as explained above) that VCs are not money / legal currency in India. And that VCs are not shares and securities. Thus, VCs are not property as understood u/s 56(2)(x). Accordingly, it stands to reason that the provisions of section 56(2)(x) cannot apply in the hands of a donee who gets a gift of VCs.

Disclosure in Income-tax returns
Any individual / HUF who has annual total income exceeding Rs. 50 lakhs needs to file Schedule AL on Assets and Liabilities in his Income-tax return.

The assets required to be reported in this Schedule include immovable assets (land and building), financial assets, viz., bank deposits, shares and securities, insurance policies, loans and advances given, cash in hand, movable assets, viz., jewellery, bullion, vehicles, yachts, boats, aircraft, etc. Hence, it is an inclusive definition of the term assets. If a person owns VCs, it stands to reason that the same should also be included in the asset disclosures under Schedule AL. The cost price of the VC needs to be disclosed under this Schedule. For a resident who holds VCs credited to an overseas digital wallet / held with a foreign crypto exchange during the previous year, even if he has duly reported them in Schedule FA (foreign assets), he is required to report such foreign assets again in Schedule AL, if applicable.

However, for a non-resident or ‘resident but not ordinarily resident’, only the details of VCs located in India are to be mentioned. It would be interesting to note in the case of VCs how the situs of the asset would be determined.

Another Schedule to be considered is Schedule FA on foreign assets. A resident in India is required to furnish details of any foreign asset held by him in Schedule FA. This Schedule need not be filled up by a ‘not ordinarily resident’ or a ‘non-resident’. The details of all foreign assets or accounts in respect of which a resident is a beneficial owner, a beneficiary or the legal owner, is required to be mandatorily disclosed in the Schedule FA. Tables A1 to G of Schedule FA deal with the disclosures of various foreign assets and comprise of foreign depository accounts – foreign custodian accounts, foreign equity and debt interest, foreign cash value insurance contract or annuity contract, financial interest in any entity outside India, any immovable property outside India, any other capital assets outside India, any other account located outside India in which the resident is a signing authority, etc. The CBDT has not offered any guidance on how foreign VCs should be disclosed. However, in the absence of any clarity the same may be disclosed under either of the following two Tables of Schedule FA:

• Table D – Any other capital assets outside India
• Table E – Any other account located outside India in which the resident assessee is a signing authority (which is not reported in Tables A1 to D).

In Table D, the value of total investment at cost of any other capital asset held at any time during the accounting period and the nature and amount of income derived from the capital asset during the accounting period is required to be disclosed after converting the same into Indian currency. Further, the amount of income which is chargeable to tax in India, out of the foreign source income, should also be specified at column (9). The relevant Schedule of the ITR where income has been offered to tax should be mentioned at columns (10) and (11). The instructions state that for the purposes of disclosure in Table D, capital assets include any other financial asset which is not reported in Table B, but shall not include stock-in-trade and business assets which are included in the balance sheet. Hence, VCs held as stock-in-trade by traders would not be included in this Table.

In Table E, the value of peak balance or total investment at cost, in respect of the accounts in which the assessee has a signing authority, during the accounting period is required to be disclosed after converting the same into Indian currency. Only those foreign accounts which have not been reported in Table A1 to Table D of the Schedule should be reported in Table E.

One school of thought tends to suggest that in the absence of any specific guidance on disclosure under Schedule FA, VCs need not be disclosed. This would be playing with fire. The Black Money (Undisclosed Foreign Income and Assets) Act, 2015 levies a penalty of Rs. 10 lakhs for non- / improper disclosures in Schedule FA. Hence, it would be better to err on the safe side and disclose the foreign VCs held.

It should be remembered that even though there is a question mark under FEMA over whether the Liberalised Remittance Scheme can be used for buying foreign VCs, disclosures under Schedule FA should nevertheless be made. Income-tax disclosures and taxation are not dependent upon the permissibility or otherwise of a transaction!

CONCLUSION
The world of cryptocurrencies is of high reward but carries high regulatory risk. This is due to the fact that there are a lot of uncertainties and unknown factors coupled with the apparently hostile attitude of the RBI and the Government towards VCs. People transacting in them should do so with full knowledge of the underlying issues that could arise. The famous Latin maxim ‘Caveat Emptor’ or ‘Buyer Beware’ squarely applies to all transactions involving virtual currencies!

(Concluded)

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CURRENT VS. NON-CURRENT CLASSIFICATION WHEN LOAN IS RESCHEDULED OR REFINANCED

This article deals with current vs. non-current classification where a loan is refinanced or the loan repayment is rescheduled subsequent to the reporting date but before the financial statements are approved for issue.

QUERY

Entity Ze has a five-year bank loan that was outstanding at 31st March, 20X1, the reporting date. At the reporting date, the loan had already completed a term of four years and six months. Therefore, at 31st March, 20X1, the loan was repayable before 30th September, 20X1. On 30th June, 20X1, Entity Ze approved the financial statements for issue. However, after 31st March, 20X1 but before 30th June, 20X1, it signed an agreement with the bank to refinance the loan for another five years. The entity did not have discretion to refinance the loan at the reporting date. It was agreed between the bank and the entity post-31st March, 20X1 but before the financial statements were approved for issue. Entity Ze wants to classify this as a non-current liability. Is that an acceptable position?

RESPONSE

No. This is not an acceptable position. At 31st March, 20X1, Entity Ze should present the loan as current liability instead of as non-current liability.

References of the Standard

The following paragraphs of Ind AS 1 Presentation of Financial Statements are relevant:

69 An entity shall classify a liability as current when:

(a) it expects to settle the liability in its normal operating cycle;

(b) it holds the liability primarily for the purpose of trading;

(d) it does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period (see paragraph 73). Terms of a liability that could, at the option of the counter-party, result in its settlement by the issue of equity instruments do not affect its classification.

An entity shall classify all other liabilities as non-current.

72 An entity classifies its financial liabilities as current when they are due to be settled within twelve months after the reporting period, even if:

a. the original term was for a period longer than twelve months, and

b. an agreement to refinance, or to reschedule payments, on a long-term basis is completed after the reporting period and before the financial statements are approved for issue.

73 If an entity expects, and has the discretion, to refinance or roll over an obligation for at least twelve months after the reporting period under an existing loan facility, it classifies the obligation as non-current, even if it would otherwise be due within a shorter period. However, when refinancing or rolling over the obligation is not at the discretion of the entity (for example, there is no arrangement for refinancing), the entity does not consider the potential to refinance the obligation and classifies the obligation as current.

74 Where there is a breach of a material provision of a long-term loan arrangement on or before the end of the reporting period with the effect that the liability becomes payable on demand on the reporting date, the entity does not classify the liability as current, if the lender agreed, after the reporting period and before the approval of the financial statements for issue, not to demand payment as a consequence of the breach.

75 However, an entity classifies the liability as non-current if the lender agreed by the end of the reporting period to provide a period of grace ending at least twelve months after the reporting period, within which the entity can rectify the breach and during which the lender cannot demand immediate repayment.

ANALYSIS

Paragraph 69 contains provisions relating to when a financial liability is presented as current. Paragraph 74 contains more of an exception to paragraph 69.

Paragraphs 74 and 75 of Ind AS 1 contain provisions relating to curing of a breach of a material provision of a loan. As per paragraph 74, a loan is presented as non-current if a breach of a material provision relating to a loan is cured after the end of the reporting period, but before the financial statements are approved for issue, such that the loan is no longer current.

As per paragraph 75, if the lender provides a grace period ending at least twelve months after the reporting period, within which a breach can be rectified, the loan is treated as non-current.

The fact pattern that is being dealt with is not relating to the curing of a breach. It is related to extension of the loan term that is otherwise current at the reporting date. With regard to this fact pattern, it is paragraphs 72 and 73 that apply rather than paragraphs 74 and 75. As per paragraph 72, the entity classifies its financial liabilities as current when they are due to be settled within twelve months after the reporting period, even if the original term was for a period longer than twelve months, and an agreement to refinance the loan on a long-term basis is completed after the reporting period and before the financial statements are approved for issue. Paragraph 73 confirms that if an entity did not have the refinancing or rescheduling rights prior to the reporting date, any refinancing or rescheduling agreement on a long-term basis post the reporting date but before the financial statements are approved for issue, the loan would not qualify as a non-current liability at the reporting date.

CONCLUSION

On the basis of the above, at 31st March, 20X1, Entity Ze should present the loan as current liability instead of as non-current liability. Post the reporting period, and after the loan is rescheduled or refinanced on a long-term basis, Entity Ze would present them as non-current.

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Revision u/s 263 – Inquiry conducted by the A.O. – Inadequacy in conduct of inquiry – Revision bad in law

10 Principal Commissioner of Income Tax vs. M/s Brahma Centre Development Pvt. Ltd. [Income Tax Appeal No. 116 & 118 of 2021; Date of order: 5th July, 2021 (Delhi High Court)] [Arising from ITA Nos. 4341/Del/2019 and 4342/Del/2019; A.Ys.: 2012-2013 and 2013-2014]

Revision u/s 263 – Inquiry conducted by the A.O. – Inadequacy in conduct of inquiry – Revision bad in law

The PCIT vide his orders dated 28th March, 2019, interfered with the assessment orders dated 31st January, 2017 and 27th September, 2017 passed by the A.O. concerning the respondent / assessee pertaining to A.Ys. 2012-13 and 2013-14, respectively.

The PCIT had interfered with the original assessment orders because of a view held by him that interest earned by the assessee against fixed deposits was adjusted, i.e., deducted from the value of the inventory and not credited to the Profit & Loss account. The PCIT noted that the tax auditor, in the report filed in Form 3CD, had observed that interest earned on fixed deposits pertained to ‘other income’ and had not been credited to the P&L account. The interest earned on fixed deposits in A.Y. 2012-13 was Rs. 9,47,04,585, whereas in A.Y. 2013-14 it was Rs. 4,32,91,517.

Consequently, after the PCIT had issued two separate show cause notices to the assessee concerning the aforementioned A.Ys. dated 20th February, 2019 and had received replies against the same, he proceeded to pass two separate orders of even date, i.e., 28th March, 2019 concerning A.Ys. 2012-13 and 2013-14. The PCIT interfered with the orders of assessment on the ground that they had been passed without making any inquiries as to whether the interest earned by the assessee had any nexus with the real estate project the construction of which was undertaken by the assessee. Thus, according to the PCIT, the assessment orders were ‘erroneous’ insofar as they were prejudicial to the interests of the Revenue. In the appeals preferred before the Tribunal by the assessee, the view held by the PCIT was reversed. Thus, the Revenue approached the High Court by way of the instant appeals.

The High Court observed that it is not in dispute that the assessee was engaged, inter alia, in the business of promotion, construction and development of commercial projects. It is also not in dispute that the assessee had undertaken construction / development of a project allotted to it by the Haryana State Industrial and Infrastructure Development Corporation (‘HSIIDC’). It was observed that on 11th August, 2016, the Chartered Accountants of the assessee, i.e., BSR and Co. LLP, filed their response to certain queries raised by the A.O. at a hearing held before him on 9th August, 2016 concerning A.Y. 2013-14. One of the queries raised concerned the exclusion of interest received on fixed deposits from the category / head ‘income from other sources’. Likewise, in response to a notice dated 14th September, 2017 issued by the A.O. under sections 154 and 155 in respect of A.Y. 2012-13, a reply was submitted by the assessee on 12th October, 2017. In the notice dated 14th September, 2017, inter alia, it was brought to the attention of the assessee that audit scrutiny had, amongst others, raised objections regarding the interest earned on fixed deposits in A.Y. 2012-13 which was not credited to the P&L account and had been deducted from the value of inventory. The assessee had filed an appropriate reply.

The Court observed that having regard to the aforesaid documents, it cannot be said that the inquiry or verification was not carried out by the A.O. The Tribunal has recorded findings of fact concerning the inquiry made by the A.O.

The fact that the A.O. has not given reasons in the assessment order is not indicative, always, of whether or not he has applied his mind. Therefore, scrutiny of the record is necessary and while scrutinising the record the Court has to keep in mind the difference between lack of inquiry and perceived inadequacy in inquiry. Inadequacy in conduct of inquiry cannot be the reason based on which powers u/s 263 can be invoked to interdict an assessment order. If an Income-tax Officer acting in accordance with law makes a certain assessment, the same cannot be branded as erroneous by the Commissioner simply because, according to him, the order should have been written more elaborately.

The Income-tax Officer had made inquiries in regard to the nature of the expenditure incurred by the assessee. The assessee had given a detailed explanation in that regard by a letter in writing. All these are part of the record of the case. Evidently, the claim was allowed by the Income-tax Officer on being satisfied with the explanation of the assessee. Such decision of the Income-tax Officer cannot be held to be ‘erroneous’ simply because in his order he did not offer an elaborate discussion in that regard. The A.O., having received a response to his query about the adjustment of interest in the A.Y.s concerned, against inventory, concluded that there was a nexus between the receipt of funds from investors located abroad and the real estate project, which upon being invested generated interest. Thus, it cannot be said that the conclusion arrived at by the A.O., that such adjustment was permissible in law, was erroneous.

The Court observed that in the instant cases, it was not as if the funds were surplus and therefore invested in a fixed deposit. The funds were received for the real estate project and while awaiting their deployment, they were invested in a fixed deposit which generated interest.

Furthermore, the Court observed that it need not examine whether Clauses (a) and (b) of Explanation 2 appended to section 263 could have been applied to the A.Y.s in question since, on facts, it has been found by the Tribunal that an inquiry was, indeed, conducted by the A.O.

Thus, for the reasons stated, the Revenue appeals are dismissed.

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Direct tax Vivad se Vishwas – Appellant – Communication of assessment order – Order must be served in accordance with section 282 of the Act – Time limit to file appeal had not expired as petitioner had not received the assessment order

9 Ashok G. Jhaveri vs. Union of India & Others [Writ petition No. 722 of 2021; Date of order: 28th July, 2021 (Bombay High Court)]

Direct tax Vivad se Vishwas – Appellant – Communication of assessment order – Order must be served in accordance with section 282 of the Act – Time limit to file appeal had not expired as petitioner had not received the assessment order

The petitioner had filed a return of income for A.Y. 2012-13 in March, 2013, declaring a total income of Rs. 7,02,170. The respondent issued a notice u/s 148 reopening the assessment for the said A.Y. 2012-13 in March, 2019.

According to the petitioner, he received a notice u/s 274 r/w/s 271 (1)(c) on 25th December, 2019 via e-mail and the said notice was also uploaded on his e-filing portal account. He had responded to the same through the e-filing portal on 23rd January, 2020, pointing out that he had not received the assessment order u/s 143(3) r/w/s 147, nor had the same been uploaded on the e-filing portal and therefore he was unable to reply to the show cause notice.

The petitioner had requested the respondent to send the assessment order to the address mentioned in his letter dated 29th January, 2020 filed on 3rd February, 2020. The petitioner was issued a letter by respondent No. 4, referring to the outstanding demand and directed to pay 20% of the outstanding demand amount. The petitioner once again, by an on-line response dated 8th February, 2020, communicated that the assessment order has not been received at his end; neither was the order uploaded on the e-filing portal nor was it served with the Notice of Demand u/s 156.

In the meantime, the Direct Tax Vivad se Vishwas Act, 2020 (‘DTVSV Act, 2020’) came into force under a Notification dated 17th March, 2020 to help settle matters in respect of disputed tax. The petitioner once again approached the respondents to issue the assessment order. He received the assessment order on 15th December, 2020 – which had been passed on 22nd December, 2019.

Now, u/s 2(1)(a)(ii) of the DTVSV Act, the term ‘appellant’ is defined as being an assessee in whose case the assessment order is passed by the A.O. and the time limit to file an appeal against such order has not expired on 31st January, 2020. The petitioner had opted for the DTVSV scheme by filing an application on 23rd December, 2020 in Forms 1 and 2 of the DTVSV Act and Rules thereunder. However, the status of the application filed by him under the DTVSV scheme showed that the application had been rejected for the reason that he had not filed any appeal against the order in respect of which he wished to avail benefit (an assessee has to file an appeal on or before 31st January, 2020) and since the appeal had not been filed, it did not fulfil the criteria prescribed under the DTVSV Act.

According to the petitioner, while the time limit to file appeal is 30 days from the date of communication of notice of demand u/s 249(2)(b), the benefit of the scheme under the DTVSV Act, 2020 would be available to him as the time limit to file an appeal had not expired because he had not received the assessment order despite repeated requests.

The respondents contended that the petitioner had been given an intimation letter through the e-proceedings on 22nd December, 2019 and, thus, it has to be presumed that the assessment order has been issued and served. It was submitted that the petitioner’s claim of non-receipt of assessment order through the on-line filing portal is difficult to be appreciated as there is no such grievance by any other assessee. Ordinarily, the assessment order is sent alongside. As such, non-receipt of assessment order through on-line filing portal is not probable; therefore, it cannot be said that the order was not issued to the assessee.

On verification, the respondents informed the Court that it does not appear that attachment of assessment order had accompanied the intimation.

In this context, the Court referred to section 282 which refers to service of notice. On perusal of the same, the Court observed that it is clear that the service of an order ought to have been made by delivering or transmitting a copy thereof in the manner contained in section 282, which admittedly had not been done until 15th December, 2020.

The Court observed that this was a peculiar case where the assessment order of 22nd December, 2019 had not been served upon the petitioner till he obtained a copy on 15th December, 2020 and as can be seen from the aforesaid discussion, the petitioner was handicapped from lodging an appeal before the specified date, i.e., 31st January, 2020 for no fault of his. In the circumstances, it would emerge that the petitioner would be able to avail benefit of the term ‘appellant’ under section 2(1)(a)(ii) of the DTVSV Act.

The Court also noted that in Circular No. 9 of 2020 dated 22nd April, 2020 in its reply to Question Nos. 1 and 23, it has been stated that where any order has been passed under the Act and the time limit to file an appeal has not expired on 31st January, 2020, then the assessee can very well opt for the said scheme. The purpose and object behind bringing in the DTVSV Act is to provide resolution of disputed tax matters and to put an end to litigation and unlock revenue detained under litigation.

The respondents were directed to consider the petitioner’s application in accordance with the provisions of the DTVSV Act and Rules. The petition was allowed.

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Writ – Notice u/s 148 – Writ petition against notice – Court holding notice invalid – Directions could not be issued once reassessment held to be without jurisdiction

50 T. Stanes and Company Ltd. vs. Dy. CIT [2021] 435 ITR 539 (Mad) A.Ys.: 2010-11, 2011-12; Date of order: 9th October, 2020 Ss. 147, 148 of ITA, 1961; and Art. 226 of Constitution of India

Writ – Notice u/s 148 – Writ petition against notice – Court holding notice invalid – Directions could not be issued once reassessment held to be without jurisdiction

Writ petitions were filed by the assessee contending that the notices issued u/s 148 to reopen the assessment u/s 147 for the A.Ys. 2010-11 and 2011-12 were without jurisdiction being based on change of opinion. The single judge held that the reassessment was without jurisdiction but observed that the A.O. could proceed on other grounds.

The Division Bench of the Madras High Court allowed the appeals filed by the assessee and held as under:

‘The findings rendered by the single judge and his order to the extent of holding that the reassessment proceedings u/s 147 were without jurisdiction, were to be confirmed but his directions / observations were set aside. Having held that the reassessment proceedings were without jurisdiction, to make any further observation / direction was not sustainable.’

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Special deduction u/s 80JJAA – Employment of new employees – Return of income – Delay in filing revised return claiming benefit u/s 80JJAA – Submission of audit report along with return – Substantive benefit cannot be denied on ground of procedural formality – Assessee entitled to benefit u/s 80JJAA

49 Craftsman Automation P. Ltd. vs. CIT [2021] 435 ITR 558 (Mad) A.Y.: 2004-05; Date of order: 6th February, 2020 Ss. 80JJAA, 139(5), 264 of ITA, 1961

Special deduction u/s 80JJAA – Employment of new employees – Return of income – Delay in filing revised return claiming benefit u/s 80JJAA – Submission of audit report along with return – Substantive benefit cannot be denied on ground of procedural formality – Assessee entitled to benefit u/s 80JJAA

The assessee was entitled to deduction u/s 80JJAA. For the A.Y. 2004-05, the assessee had not claimed deduction u/s 80JJAA in the return of income. The assessee filed a revised return making a claim for deduction u/s 80JJAA and claimed refund. The A.O. refused to act on the revised return.

The Commissioner rejected the revision application u/s 264 on the grounds that according to sub-section (2) of section 80JJAA, deduction could not be allowed unless the assessee furnished with the return of income the report of the accountant, as defined in the Explanation below sub-section (2) of section 288 giving such particulars, and that the revised return was filed beyond the period of limitation prescribed u/s 139(5). The assessee filed this writ petition and challenged the order u/s 264. The Madras High Court allowed the writ petition and held as under:

‘i) If an assessee is entitled to a benefit, a technical failure on the part of the assessee to claim the benefit in time should not come in the way of grant of the substantial benefit that was otherwise available under the Income-tax Act, 1961 but for such technical failure. The legislative intent is not to whittle down or deny benefits which are legitimately available to an assessee. The A.O. is duty-bound to extend substantive benefits which are available and arrive at just tax to be paid.

ii) The failure to file a return within the period u/s 139 for the purpose of claiming benefit of deduction u/s 80JJAA was a procedural formality. The assessee was entitled to benefit u/s 80JJAA.

iii) Denial of substantive benefit could not be justified. It was precisely for dealing with such situations that powers had been vested with superior officers like the Commissioner u/s 264. The Commissioner ought to have allowed the revision application filed by the assessee u/s 264 and the assessee was entitled to partial relief.

Accordingly, the order of the Commissioner was set aside and the Assistant Commissioner directed to pass appropriate orders on the merits ignoring the delay on the part of the assessee in filing the revised return u/s 139(5) and failure to furnish the audit report.’

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GOVERNMENT INFRASTRUCTURE PROJECTS

INTRODUCTION

Infrastructure development is one of the stated priorities of the Government. While it is primarily the responsibility of the Government to ensure speedy infrastructure development and provide access to such infrastructure to the citizens at minimal possible cost, over a period of time participation of the private sector has been solicited through the Public Private Partnership (PPP) model.

For example, under the Build Operate & Transfer (BOT) model, the Government or its designated agencies and the successful bidder enter into an agreement termed as ‘Concession Agreement’ wherein the Government / its designated agency agree to grant a concession to private sector infrastructure companies who in legal parlance are known as ‘concessionaires’. The grant of such a concession permits the concessionaire to build the infrastructure (as may be agreed), operate it over a period of time and ultimately transfer it back to the Government. There is a nominal fee which is generally payable by the infrastructure company for such a right granted by the Government / its designated agency. This charging of fee by the Government / its designated agency indicates that the concessionaire is the service recipient in the current case and the Government / its designated agency assumes the role of a service provider.

Under this model, the revenue for the infrastructure company could be in different forms. The most common method of revenue generation for it is the grant of the right to collect usage charges. This right is granted to the infrastructure company for the contract period. The second model which is also very common is the annuity model wherein the Government / its designated agencies agree to make a fixed periodic payment to the concessionaire, while the collection of usage charges is done by the Government / designated agency themselves. There is also a third revenue model, commonly known as the hybrid annuity model, where collection of usage charges for a certain period is with the concessionaire and after that period the Government / designated agencies collect the usage charges themselves and pay a lump sum annuity to the concessionaire.

The above models of infrastructure development are in stark contrast with other traditional models in which the private sector contractor is expected to construct the infrastructure as a contractor and receives a pre-defined consideration.

Such different models result in diverse GST consequences both on the levy of tax on the development efforts as well as the claim of input tax credit (ITC). Further, the receipt of usage charges during the O&M period also has different GST consequences. This article deals with some of the GST issues arising in such infrastructure development projects.

GST IMPLICATIONS ON BOT PROJECTS

While analysing the GST implications on a Government project, the first step is to understand the nature of the project. Let us see this with the help of a standard project under the BOT model where the infrastructure company enters into a ‘concession agreement’ with the Government / designated agency. Generally, the agreements are worded in such a manner as to state that the Government / designated agency has agreed to ‘grant a concession’ to the concessionaire, i.e., the infrastructure company, for which the latter has to pay a nominal consideration (generally, Rs. 1). In such cases, it is apparent that it is the infrastructure company which receives the supply and the Government / designated agency which actually makes the supply. While the tax implications would be immaterial in view of the nominal consideration, the legal issues could be identified as under:

• Whether the supply by Government / designated agency would qualify as supply of goods or services?
While an intangible property is treated as goods, in view of the decision in the case of Tata Consultancy Services vs. State of AP [2004 (178) ELT 22 (SC)], it needs to satisfy the tests of utility, capability of being bought and sold and, lastly, capability of being transmitted, transferred, delivered, stored, possessed, etc. While undoubtedly in the current case the rights would have been granted to the concessionaire, such rights would be lacking the characteristics referred to in the TCS case. In such a situation, it would be more appropriate to treat the rights granted as service rather than goods.

• If supply of services, whether the recipient would be liable to pay GST under RCM?
Once it is concluded that the supply is that of service and the service provider is the Government / designated agency, the provisions of reverse charge would get triggered and there would be a liability to pay GST under reverse charge mechanism. Of course, the recipient can claim exemption if the value of service does not exceed Rs. 5,000 as provided for vide Entry 9 of Notification No. 12/2017-CT (Rate) dated 28th June, 2017.

GST implications on core revenue
Let us now discuss the GST implications on the core revenue, i.e., usage charges collected by the concessionaire. Under the BOT model, there are different ways in which the concessionaire receives the said revenue, namely:
• Standard Model – Collection of usage charges,
• Annuity Model – Periodic payment from the Government / designated agencies,
• Hybrid Model – Collection of usage charges plus periodic annuity payment from the Government / designated agencies.

The tax implication on the first model is very simple as one merely needs to analyse the tax implications on the collection charges, which may vary depending on the nature of the collection charges. For example,
• collection of usage charges in respect of access to road is exempted by Entry 23 of Notification No. 12/2017-CT (Rate);
• services provided by way of transportation of passengers through rail (other than first class / an air-conditioned coach), including metro rails, is exempted vide Entry 17;
• services provided by way of transportation of passengers through rail by way of first class / an air-conditioned coach is liable to GST @ 5%;
• services of transportation of goods by rail is liable to GST @ 12% except in case where Indian Railways itself undertakes the transportation, in which case the same is liable to GST @ 5%;
• in case of ports (air / sea), there is no exemption and therefore charges collected from such users are liable to GST @ 18%.

The controversy revolves around the annuity model for roads. An annuity is a periodic payment made by the Government / designated agency to the concessionaire. Under this model, the collection of toll / usage charges is undertaken by the Government / designated agency and the concessionaire has no role to play in the same. There is a controversy around taxability of such annuity payments. This is because in case of such agreements the transaction structure takes a shift and even the concessionaire becomes a service provider, to the extent that he has constructed the infrastructure for which he has received the annuity payments from the Government / designated agencies. In that context, the annuity payments become liable to GST @ 12%. This has also been clarified by the recent CBIC Circular 150/06/2021-GST dated 7th June, 2021 wherein the Board has clarified that the said exemption will not apply to annuity paid for construction of roads. However, the said Circular apparently makes Entry 23A of Notification No. 12/2017-CT (Rate) which exempts service by way of access to a road or a bridge on payment of annuity, irrelevant. The said exemption Entry was introduced after discussions at the GST Council meeting held on 13th October, 2017 which read as under:

‘Agenda item 13(iv): Issue of Annuity being given in Place of Toll Charges to Developers of Public Infrastructure – exemption thereon
61. Introducing this Agenda item, the Joint Secretary (TRU-II), C.B.E. & C. stated that while toll is a payment made by the users of road to concessionaires for usage of roads, annuity is an amount paid by the National Highways Authority of India (NHAI) to concessionaires for construction of roads in order that the concessionaire did not charge toll for access to a road or a bridge. In other words, annuity is a consideration for the service provided by concessionaires to NHAI. He stated that construction of roads was now subject to tax at the rate of 12% and due to this, there was free flow of input tax credit from EPC (Engineering, Procurement and Construction) contractor to the concessionaires and thereafter to NHAI. He stated that as a result, tax at the rate of 12% leviable on the service of road construction provided by concessionaire to NHAI would be paid partly from the input tax credit available with them. He stated that the Council may take a view for grant of exemption to annuity paid by NHAI / State Highways Construction Authority to concessionaires during construction of roads. He added that access to a road or bridge on payment of toll was already exempt from tax. The Hon’ble Minister from Haryana suggested to also cover under this provision annuity paid by State-owned Corporations. After discussion, the Council decided to treat annuity at par with toll and to exempt from tax, service by way of access to a road or bridge on payment of annuity.’

Interestingly, before the above clarification from the CBIC, the issue was dealt with by the AAAR in the case of Nagaur Mukundgarh Highways Private Limited [2019 (23) GSTL 214 (AAAR-GST)]. In this case, the AAAR held that annuity paid during the construction phase would be liable to GST under SAC 9954, while annuity paid during the O&M phase would be exempted under SAC 9967. However, the said ruling seems to be on a weak footing mainly because there is nothing in the concession agreements which states that the annuity paid post completion of work is towards the O&M phase only and not towards the construction activity. Therefore, appropriating annuity paid during the O&M phase towards the toll charges seems to be improper.

A proper clarification on this issue would certainly be forthcoming since the amounts mentioned in such contracts are generally inclusive of GST and if ultimately it is held that GST is indeed payable on the annuity component, the entire financials for the project would be impacted since it would have a 12% GST impact, of course with corresponding benefit. But it should be kept in mind that in case of long-term projects, if a position has been initially taken that the annuity was not liable for GST, corresponding ITC would not have been taken and the same would now be time-barred. Therefore, the GST credit may be available only prospectively and the benefit may not be substantial to that effect.

INPUT TAX CREDIT IMPLICATIONS
This now takes us to the next aspect of ITC. To understand the ITC-related implications, it may be important to put down the chronology of events:
• The concessionaire receives services from the Government / designated agency;
• The concessionaire undertakes the development of infrastructure activity, which entails paying GST on various inward supplies;
• The revenue is earned by collecting usage charges from the users.

It is imperative to note that in most of the cases, the infrastructure so developed is an immovable property, such as roads, airports, seaports, metro rail, etc. Therefore, the issue remains whether ITC can at all be claimed in view of section 17(5)(c)/(d) of the CGST Act, 2017 which restricts claim of ITC on account of goods or services (including works contract services) received for construction of an immovable property on own account. Of course, the said restriction applies only if the cost incurred towards the same is capitalised in the books of accounts.

This opens up an important dimension from the accounting perspective. It should be noted that the concessionaire is not the owner of the infrastructure project and therefore the amounts are not capitalised in the books of accounts as Fixed Assets, but rather treated as intangible asset / Financial Asset, which is amortised over a period of time as per the guidelines laid down by the relevant Ind AS. If one takes an aggressive view, the restriction u/s 17(5) may be circumvented and make such concessionaire eligible for ITC.

Secondly, in the case of Safari Retreats Private Limited vs. CC of GST [2019 (25) GSTL 341 (Ori)], the provisions of section 17(5)(d) have been ultra vires the provisions of the object of the Act and it has been held that ITC should be allowed on receipt of goods or services used in the construction of an immovable property which is used for providing an output service. However, it needs to be kept in mind that the Revenue appeal against this order is currently pending before the Supreme Court.

The above discussion would be relevant only in case of projects for airport / seaport where the usage charges to be collected from the users are taxable. However, in case of road projects / metro rail projects there is an exemption from tax on collection of charges and, therefore, even otherwise the claim of credit would be hit by section 17(2) of the CGST Act, 2017 and therefore ITC may not be eligible.

GST IMPLICATIONS ON OTHER GOVERNMENT PROJECTS
In case of projects not under the PPP model, where the contract is given to the infrastructure company for a fixed consideration, the GST implications would be of a different level. This is because Entry 3 of Notification No. 11/2017-CT (Rate) prescribes a lower effective GST rate of 5% / 12% on specific services. However, the said concession is subject to satisfaction of conditions such as:

To whom have the services been supplied?
The entries require that the service should be provided either to the Central Government, State Government, Union Territory, Local Authority, Government Authority or Government Entity.

What constitutes Government Authority / Government Entity has been defined in the Notification itself as under:

Government Authority	Government Entity
[(ix) ‘Governmental Authority’ means an authority or a board or any other body, – (i) set up by an Act of Parliament or a State Legislature; or (ii) established by any Government, with 90% or more participation by way of equity or control, to carry out any function entrusted to a Municipality under Article 243W of the Constitution or to a Panchayat under Article 243G of the Constitution	(x) ‘Government Entity’ means an authority or a board or any other body including a society, trust, corporation, (i) set up by an Act of Parliament or State Legislature; or (ii) established by any Government, with 90% or more participation by way of equity or control, to carry out a function entrusted by the Central Government, State Government, Union Territory or a Local Authority.]

Government
Authority

Government
Entity

[(ix) ‘Governmental Authority’ means an
authority or a board or any other body, –

(i) set up by an Act of Parliament or a
State Legislature; or

(ii) established by any Government,

with 90% or more participation by way of
equity or control, to carry out any function entrusted to a Municipality
under Article 243W of the Constitution or to a Panchayat under Article 243G
of the Constitution

(x) ‘Government Entity’ means an authority
or a board or any other body including a society, trust, corporation,

(i) set up by an Act of Parliament or State
Legislature; or

(ii) established by any Government,

with 90% or more participation by way of
equity or control, to carry out a function entrusted by the Central
Government, State Government, Union Territory or a Local Authority.]

From the above, it is apparent that the only distinction between Government Authority and Government Entity is that the former carries out functions entrusted to any Municipality under Article 243W or a Panchayat under Article 243G, while the later carries out any function entrusted to it by the Government.

Nature of service
The next aspect that needs to be looked into is the nature of supply being made. Clauses (iii) and (vi) provide that composite supply of works contract supplied to Central Government, State Government, Union Territory, a Local Authority, a Governmental Authority or a Government Entity by way of construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration of, should be considered as eligible for the lower tax rate.

The above highlighted portion is relevant. It requires that the supply should be a composite supply of works contract. This indicates that the supply has to be in relation to an immovable property, owing to the fact that the definition of the term ‘works contract’ applies specifically to immovable property under GST. This aspect was recently dealt with by the AAR in the case of Nexustar Lighting Project Private Limited [2021 (47) GSTL 272] wherein the Authority held that a contract for installation of streetlights did not qualify as a works contract and therefore benefit of lower tax rate was not available.

Service in relation to
The next aspect that needs analysis is whether or not the services are provided in relation to the following:

Under Entry 3 (iii)
(a) a historical monument, archaeological site or remains of national importance, archaeological excavation, or antiquity specified under the Ancient Monuments and Archaeological Sites and Remains Act, 1958 (24 of 1958);
(b) canal, dam or other irrigation works;
(c) pipeline, conduit or plant for (i) water supply, (ii) water treatment, or (iii) sewerage treatment or disposal.

Under Entry 3 (vi)
(a) a civil structure or any other original works meant predominantly for use other than for commerce, industry, or any other business or profession;
(b) a structure meant predominantly for use as (i) an educational, (ii) a clinical, or (iii) an art or cultural establishment; or
(c) a residential complex predominantly meant for self-use or the use of their employees or other persons specified in paragraph 3 of the Schedule-III of the Central Goods and Services Tax Act, 2017.
[Explanation. – For the purposes of this item, the term ‘business’ shall not include any activity or transaction undertaken by the Central Government, a State Government or any Local Authority in which they are engaged as public authorities.]

Under Entry 3 (vii):
Composite supply of works contract involving predominantly earth work, that is constituting 75% of the value of works contract.

Care should be taken specifically while dealing with Entry 3 (vi)(a) where the interpretation of the phrase ‘for use other than for commerce, industry, or any other business or profession’ has created substantial confusion. For example, in the context of works contract services provided in relation to electricity generation plants, the AAR has on multiple occasions held that the activities carried out by electricity generating / distribution companies cannot be treated as ‘for use other than for commerce, industry, or any other business or profession’. One may refer to the recent decisions of the AAAR in the cases of R.S. Development & Constructions Private Limited [2021 (48) GSTL 162 (AAAR – Kar)], Manipal Energy & Infratech Private Limited [2020 (40) GSLT 237 (AAAR – Kar)], etc.

Entry (vii) provides for levy of GST @ 5%. However, the condition is that the service involved should be a composite supply of works contract involving predominantly earth work that is constituting 75% of the value of the works contract. While the term ‘earth work’ has not been defined under the GST law, the same was analysed by the AAAR in the case of Soma Mohite Joint Venture [2020 (041) GSTL 0667 (AAAR – GST – Mah)] wherein the Appellate Authority held that earth work includes both excavation and fortification. Therefore, so long as earth work constitutes more than 75% of the value of a works contract, the benefit of a lower tax rate should be available. However, for such benefit care should be taken to ensure that the contract specifically mentions the consideration for such activity separately. If the break-up is not available, the benefit of the lower rate may be denied.

Common condition
A common condition for Entries (iii) and (vi) when the services are provided to a Government Entity is that the said Government Entity should have procured the said services in relation to a work entrusted to it by the Central Government, State Government, Union Territory or Local Authority, as the case may be.

In Shri Hari Engineers & Contractors [2020 (38) GSTL 396 (AAR – GST – Guj)], the AAR had denied the benefit of lower tax rate for the reason that the Railtel Corporation of India Limited, which had issued the contract, was not entrusted to carry out the said activity by the Central Government / State Government / Union Territory or Local Authority.

Therefore, while concluding classification under Entry 3 (iii) or Entry 3 (vi), fulfilment of this condition should be looked into and documentary evidence to support the same should be obtained.

Extension of benefit to sub-contractors
Vide Entries 3 (ix) and 3 (x), the benefit of lower tax rate is also extended to sub-contractors who make composite supply of works contract to the main contractor. However, it is imperative to note that this benefit applies only for works contract services and not stand-alone services and the same would be liable to GST @ 18%.

Exemption
In addition to lower effective tax rate, certain services supplied to Government have been exempted vide Notification No. 12/2017-CT (Rate). The same is tabulated in the following Table:

*Entry*	Nature of supply	Supply relating to	Service provided to
3	Pure services (excluding works contract services or other composite supplies involving supply of any goods)	Any activity in relation to a function entrusted to a Panchayat under Article 243G / to a Municipality under Article 243W of the Constitution	Central Government, State Government, Union Territory, Local Authority, a Governmental Authority or a Government Entity
3A	Composite supply of goods or services (goods not being more than 25% of the value of the composite supply)	Any activity in relation to a function entrusted to a Panchayat under Article 243G / to a Municipality under Article 243W of the Constitution	Central Government, State Government, Union Territory, Local Authority, a Governmental Authority or a Government Entity

Entry

Nature
of supply

Supply
relating to

Service
provided to

Pure services (excluding works contract
services or other composite supplies involving supply of any goods)

Any activity in relation to a function
entrusted to a Panchayat under Article 243G / to a Municipality under
Article 243W of the Constitution

Central Government, State Government, Union
Territory, Local Authority, a Governmental Authority or a Government Entity

Composite supply of goods or services
(goods not being more than 25% of the value of the composite supply)

Any activity in relation to a function
entrusted to a Panchayat under Article 243G / to a Municipality under
Article 243W of the Constitution

Central Government, State Government, Union
Territory, Local Authority, a Governmental Authority or a Government Entity

What constitutes ‘pure services’ has not been defined under GST. However, by nomenclature, it seems that supply which does not have any element of supply of goods involved in it would be treated as pure service, for example, consultancy service. This view finds support from the decision of the AAR in the case of R.R. Enterprises [2021 (47) GSTL 309 (AAR – GST – Har)] wherein the Authority held that since only manpower supply services were to be provided by the applicant and since no supply of goods is involved, such services qualify as pure services.

The important aspect which needs to be looked into while dealing with exemption entries is that the services provided should be in relation to a function which has been entrusted to a Municipality under Article 243W or Panchayat under Article 243G. However, the service need not be provided directly to the Municipality or Panchayat. It may be provided to the Central Government / State Government / Government Authority / Government Entity.

The only caveat is that the service should be provided in relation to an activity specified in Article 243W / Article 243G. Whether a particular activity is covered under Article 243G / 243W or not has been dealt with by the AAR on multiple occasions.

In the case of Lokenath Builders [2021 (46) GSTL 205 (AAR – GST – WB)], it was held that waste disposal services by engaging garbage-lifting vehicles and other cleaning equipment without any supply of goods would be a pure service and an activity covered under Entry 6 of the 12th Schedule and therefore eligible for exemption.

In MSV International Inc. [2021 (49) GSTL 171 (AAR – GST – Har)], while the Authority held that the services provided in relation to construction of State / district highways was a pure service, the same would still not be eligible for exemption benefit since the construction of State / district highways was not an activity entrusted to a Municipality under Article 243W / Panchayat under Article 243G of the Constitution.

Similarly, the exemption benefit was denied by the AAR for services provided to National Institute of Technology, an institute of higher education, which was not covered under Article 243W / 243G of the Constitution. (Refer National Institute of Technology [2021 (47) GSTL 314 (AAR – GST – Har)].

In Janaki Suhshikshit Berojgar Nagrik Seva Sansthan Amravati [2021 (46) GSTL 277 (AAR – GST – MH)], the AAR denied the benefit of exemption to service of supply of manpower to Government Medical College. The conclusion of the Authority was that supply of manpower was not covered under either the 11th or the 12th Schedule.

In the view of the authors, the above ruling does not represent the correct position of law. Entry 6 of the 12th Schedule, public health, is the responsibility of the Municipality and therefore it is bound to make necessary arrangements to deliver the same to the citizens. Any service provided by a vendor towards the said activity can therefore be said to be in relation to a function entrusted to the Municipality under Article 243W of the Constitution and therefore eligible for exemption.

There are some other examples of service which can also be eligible for the exemption, such as:
• advertisements placed in the newspapers creating awareness by the Municipal Corporation would be eligible for exemption since activities in relation to public health awareness are among the activities entrusted to the Municipality under Article 243W;
• services provided in relation to collection of parking charges on behalf of the Municipality are covered under Entry 17 of the 12th Schedule of the Constitution and therefore should be eligible for exemption.

The above discussion clearly brings out the need to analyse the tax position of any project at the tendering stage itself. This is because in case of Government projects usually the contract value is treated as inclusive of GST and the contractor has to bill accordingly. If during the tendering process the company bids assuming eligibility for exemption / lower GST rate and ultimately it turns out that the supply was taxable at the normal rate, the implications would be catastrophic.

ARBITRATION CLAIMS
An important part of Government projects (which is also present in private transactions) are the arbitration clauses in the agreements. At times, due to contractual disputes, the parties to a contract may opt for arbitration and reconciliation and there can be flow of money (both ways) depending on the outcome of the project.

While determining taxability of arbitration claims, a detailed reading of the arbitration award is very relevant. For example, in the case of BOT arrangements discussed above, there is a clause for payment of grant to the concessionaire. If there is a delay in payment of grants, the concessionaire may seek compensation and can go for arbitration on the said issue. If the arbitration award is on account of such a dispute, it may not be taxable since the grant itself was not taxable in the first place.

However, if the arbitration award is for a contractual dispute, for example, the contractor lodges a claim of Rs. 2 crores on the client for work done, while the client approves the claim only to the extent of Rs. 1.75 crores – in such cases, the contractor has an option to resort to arbitration for the disputed amount and if the arbitration is in his favour, he would be entitled to receive the differential amount along with costs as may be granted by the arbitration award. In such a case, a more appropriate position would be to say that the differential amount received is towards a supply and therefore liable to GST.

Arbitration claims – rollover from pre-GST regime
In the case of arbitration awards, it has to be kept in mind that the outcome period of the dispute under arbitration is very long. It is possible that arbitration claims for work done during the pre-GST regime get concluded under the GST regime. This will lead to substantial challenges for the contractors for the following reasons, especially in cases where the dispute is on account of quantification of work done:
• Under the pre-GST regime, services to Government were exempted or were taxable at a substantially lower rate (post abatement). Similarly, even under the VAT regime, the applicable tax rate for works contract was on the lower side, say 5% / 8%.
• The work for the said service would have been completed under the pre-GST regime. However, it is seen that the tax on the said amount is not discharged as the claim is not approved by the client and it has been an industry practice to pay tax on such amounts only when the matter reaches finality.
• The issue that arises is whether the tax on such arbitration awards would be payable under the pre-GST laws, i.e., VAT / Service tax, or as per the provisions of the CGST / SGST Acts? The answer to this question would be relevant since under the pre-GST regime the effective tax rate would have been lower as compared to the effective GST rate which is 12% for supplies to Government.

To deal with the above situation, let us refer to section 142(11) of the CGST Act, 2017 which provides that to the extent tax was leviable under the erstwhile VAT Acts or under Chapter V of the Finance Act, 1994, no tax would be leviable under the CGST Act, 2017. It is imperative to note that in case of such roll-over arbitration disputes, the work is already completed before the claim is lodged. It is mere quantification of the work which takes place upon resolution of the dispute and, therefore, it can be said that the tax was actually leviable under the VAT Acts / Finance Act, 1994 itself when the activity was actually carried out and hence a view can be taken that no GST is leviable on such arbitration awards.

Arbitration claims – in the nature of liquidated damages
The next point of discussion would be arbitration claims where the award is in the nature of liquidated damages. Liquidated damages are dealt with under the Indian Contract Act, 1872 within sections 73 and 74. Section 73 states that ‘when a contract has been broken, the aggrieved party is entitled to get compensation or any loss or damages which has been inflicted to him / her naturally during the usual course of breach of contract or about which the parties to the contract had prior knowledge when they entered the contract.’

Similarly, section 74 states that ‘when a contract has been broken, and if a sum is named in the contract as the amount to be paid for such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for’.

Therefore, when an arbitration award is on account of breach of contractual terms, which results in grant of damages to either party, the same would not constitute consideration under the Contract Law and therefore there cannot be any liability towards GST on the same.

TDS DEDUCTION & ASSOCIATED CHALLENGES
Section 51 of the CGST Act, 2017 obligates Government / designated agencies to deduct TDS on payments made for taxable supply of goods or services, or both, received by them.

Unfortunately, as a universal rule TDS is deducted on all payments, including on grants, arbitration awards, etc., without actually analysing whether or not the said payment is towards receipt of taxable supply of goods or services, or both. This results in difficulty for the concessionaire / contractor. This is because if they would have taken a position that they have not made any supply / the supply made by them is exempt, the TDS provisions would not have got triggered. If in such cases also TDS is deducted and if they accept the same, it is likely that the Department may challenge their claim stating that their clients themselves treat the supply as taxable supply, leaving such concessionaires / contractors in a Catch-22 situation.

Of late, it has also been seen that the tax authorities have been issuing notices based on mismatch between the credits reported in GSTR7 by the tax deductors vis-a-vis the liability reported by the contractors. It is imperative to note that there will generally be a time gap between disclosure of liability by the supplier and deduction of tax by the deductor. This is because the supplier would pay the tax when he issues the invoice to the deductor-client. However, such invoice goes through the approval
process which generally consumes time and before the invoice is accounted by the deductor-client and TDS is deducted.

It is therefore advisable that before any TDS credit is claimed, the same be reconciled with the month in which the corresponding liability was discharged and, preferably, if the client has deducted TDS in advance (on provisional basis), such credit should be kept deferred and claimed only when the actual invoice is issued by the contractor and the corresponding liability discharged.

CONCLUSION
The general perception in the industry is that doing business with the Government is a profitable venture. But there are many complications and confusions which make such businesses quite risky. It is always advisable for taxpayers to be very careful while taking a position on a transaction with Government as the tax would generally have to be paid out of one’s own pocket, thus having a severe impact on the overall profitability of the venture.

shailesh.kwebmaker

Recovery of tax – Set-off of refund – Stay of demand – Pending appeal against assessment order for A.Y. 2013-14 – Set-off of demand of A.Y. 2013-14 against refund of A.Ys. 2014-15 to 2016-17 – Effect of circulars, instructions and guidelines issued by CBDT – Excess amount recovered over and above according to such circulars, instructions and guidelines to be refunded with interest – A.O. restrained from recovering balance tax due till disposal of pending appeal

48 Vrinda Sharad Bal vs. ITO [2021] 435 ITR 129 (Bom) A.Ys.: 2012-13 to 2019-20; Date of order: 25th March, 2021 Ss. 220(6), 237, 244A, 245 of ITA, 1961

Recovery of tax – Set-off of refund – Stay of demand – Pending appeal against assessment order for A.Y. 2013-14 – Set-off of demand of A.Y. 2013-14 against refund of A.Ys. 2014-15 to 2016-17 – Effect of circulars, instructions and guidelines issued by CBDT – Excess amount recovered over and above according to such circulars, instructions and guidelines to be refunded with interest – A.O. restrained from recovering balance tax due till disposal of pending appeal

The assessee was a developer. For the A.Y. 2013-14, a demand notice was issued, that during the pendency of his appeal against the assessment order an amount of Rs. 1,38,34,925 was collected by the Department adjusting the refunds pertaining to the A.Ys. 2014-15, 2015-16 and 2016-17. On an application for stay of recovery of demand, the A.O. passed an order of stay for the recovery of balance of tax due for the A.Y. 2013-14, reserving the right to adjust the refund that arose against the demand.

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

‘i) The Centralised Processing of Return of Income Scheme, 2011 was introduced under Notification dated 4th January, 2012 ([2012] 340 ITR (St.) 45] in exercise of the powers u/s 143(1A) with a view to process a return of income expeditiously. Clause 10 of the scheme states that set-off of refund arising from the processing of return against tax remaining payable will be done by using details of the outstanding demand as uploaded on to the system by the A.O. Sub-section 143(1B) provides that for the purpose of giving effect to the scheme made under sub-section (1A), a notification with respect to application or non-application of any provisions relating to processing of the return may be issued. Having regard to the context of sections 143(1A) and 143(1B), it does not appear that clause 10 under the scheme is intended to be read out of the context isolatedly (sic). The scheme pursuant to section 143(1A) will have to be taken into account along with the other provisions of the Act and would take within its fold instructions issued by the CBDT from time to time. It does not appear that the clause is in derogation of operation of the provisions and instructions or would render the provisions and the instructions insignificant and redundant. Clause 10 will have to be read in the context of the provisions in the Act governing refund and orders, circulars, instructions issued from time to time.

ii) Set-off of refund under the clause is to be done by using details of the Income-tax demand against the person uploaded on to the system. The exercise of power to have set-off or adjustment of refund is regulated by legislative provisions and instructions. The details referred to in the clause would have to correspond to the provisions and instructions operating. Function under the clause would be circumscribed by them and it would be incongruous to consider that uploading referred to in clause 10 would mean all refunds arising are liable to be adjusted against the tax demands irrespective of orders thereon by the authorities and / or subsisting instructions and the provisions applicable.

iii) The amount recovered from the assessee over and above the amount as per instructions, memoranda, circulars towards demand of tax for the A.Y. 2013-14 pending in appeal would be returned to the assessee with interest and the refund of amounts over and above the amount as per circulars, instructions and guidelines issued by the CBDT may not be adjusted towards tax demand for the A.Y. 2013-14 till disposal of the appeal. Having regard to the instructions, circulars and memoranda issued from time to time, which were not disputed by the Department, it would be expedient that the A.O. refrained from recovering tax dues demanded for the A.Y. 2013-14 and a restraint was called for.’

shailesh.kwebmaker

Penalty – Concealment of income or furnishing of inaccurate particulars – Method of accounting – Claim of deduction in return filed in response to notice u/s 153A in accordance with change in accounting method and prevailing law – New claim made because of change in accounting policy – Not a case of concealment of income or furnishing of inaccurate particulars – Findings of fact – Tribunal justified in upholding order of Commissioner (Appeals) that penalty was not imposable

47 Principal CIT vs. Taneja Developers and Infrastructure Ltd. [2021] 435 ITR 122 (Del) A.Y.: 2007-08; Date of order: 24th March, 2021 Ss. 132, 145, 153A, 271(1)(c) of ITA, 1961

Penalty – Concealment of income or furnishing of inaccurate particulars – Method of accounting – Claim of deduction in return filed in response to notice u/s 153A in accordance with change in accounting method and prevailing law – New claim made because of change in accounting policy – Not a case of concealment of income or furnishing of inaccurate particulars – Findings of fact – Tribunal justified in upholding order of Commissioner (Appeals) that penalty was not imposable

The search in the TP group led to the proceedings u/s 153A against the assessee for the A.Y. 2007-08. The assessee filed a fresh return in which a cumulative expenditure comprising interest paid on borrowings, brokerage and other expenses was claimed on an accrual basis. The A.O. found that such expenses were not claimed in the original return filed by the assessee u/s 139 and disallowed the claim in his order u/s 153A / 143(3). The Commissioner (Appeals) sustained the addition made by the A.O. Thereafter, the A.O. initiated penalty proceedings and levied penalty u/s 271(1)(c). Before the Tribunal, the assessee gave up its challenge to the disallowance of its claimed expenses by the A.O. and accordingly, the disallowance of the expenses ordered by the A.O. and sustained by the Commissioner (Appeals) remained.

The Commissioner (Appeals) set aside the penalty order passed by the A.O. The Tribunal held that the assessee had made a fresh claim in its return filed u/s 153A of the proportionate expenditure, which was originally claimed, partly in the original return and the balance in the return u/s 153A, that such balance was already shown in the project expenditure for that year at the close of the year which was carried forward in the next year as opening project work-in-progress, that therefore, in the subsequent year it was also claimed as expenditure and that there was no infirmity in the order of the A.O. with respect to that finding. However, the Tribunal rejected the Department’s appeal with respect to the levy of penalty.

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

‘i) Where the basic facts were disclosed or where a new claim was made because of a change in the accounting policy, albeit in a fresh return, and given up because the law, as declared, did not permit such a claim, in such circumstances initiation of penalty proceedings u/s 271(1)(c) against the assessee was not mandated in law. The assessee had brought about a change in the accounting policy vis-a-vis borrowings, brokerage and other expenses in line with Accounting Standard 7 which permitted the assessee to make a new claim for deduction of such expenses, on an accrual basis, in the A.Y. 2007-08. However, the assessee had, in its original return, claimed deduction of a portion of such expenses based on an accounting policy (i. e., a percentage of completion method) which was prevalent at that point in time. Those facts were in the knowledge of the Department and such expenses which were sought to be claimed, on an accrual basis, constituted a fresh claim which was embedded in the fresh return filed u/s 153A.

ii) In the quantum appeal, the assessee had given up its claim of the expenses, for the reason that it was a new claim which was sought to be incorporated in the fresh return, which was made on an accrual basis as the assessment was completed and the fresh return filed by the assessee, pursuant to the proceedings taken out u/s 132 read with section 153A, did not give the assessee the leeway to sustain such claim, since no incriminating material was found during the search. The assessment for the A.Y. 2007-08 stood completed before the search. The assessee had neither concealed the particulars of its income nor furnished inaccurate particulars of income which were the prerequisites for imposition of penalty.

The conclusion reached by the Tribunal that the penalty imposed by the A.O. was correctly cancelled by the Commissioner (Appeals) need not be interfered with. No question of law arose.’

shailesh.kwebmaker

Export – Exemption u/s 10B – Scope – Meaning of ‘computer software’ – Engineering and design included in computer software – Assessee engaged in export of customised electronic data relating to engineering and design – Entitled to exemption u/s 10B

46 Marmon Food and Beverage Technologies India (P) Ltd. vs. ITO [2021] 435 ITR 327 (Karn) A.Y.: 2009-10; Date of order: 9th April, 2021 S. 10B of ITA, 1961

Export – Exemption u/s 10B – Scope – Meaning of ‘computer software’ – Engineering and design included in computer software – Assessee engaged in export of customised electronic data relating to engineering and design – Entitled to exemption u/s 10B

The assesse (appellant) is a 100% export-oriented undertaking engaged in the business of export of customised electronic data according to the requirements of its customers. The requirement is received in electronic format and it is again delivered in electronic format pertaining to various activities in the field of engineering and design. For the A.Y. 2009-10 the assessee filed its return of income declaring ‘Nil’ income after claiming deduction of Rs. 1,80,27,563 u/s 10B. The A.O. denied the claim for deduction u/s10B.

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

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

‘i) Under section 10B, newly-established 100% export-oriented undertakings are entitled to 100% deduction of export profits. Prior to its substitution, section 10B has been operative from 1st April, 1989. With a view to enlarging the scope of the tax holiday to 100% export-oriented undertakings approved by the prescribed authority, an Explanation for the term “produce” had been inserted in section 10B to include production of computer programmes by the Finance Act, 1994.

ii) A tax holiday was given to certain assessees importing and exporting electronic data and as it was a new subject under the Act, the Central Board of Direct Taxes (CBDT) was empowered to notify certain services of customised electronic data or any products or services to mean “computer software” eligible for deduction. The CBDT, in exercise of powers conferred under Explanation 2(i)(b) to section 10B, has notified certain information technology-enabled products or services by Notification dated 26th September, 2000 ([2000] 245 ITR (St.) 102]. The Notification… is a clarificatory Circular and it has been issued in exercise of the powers conferred under Explanation 2(i)(b) to section 10B of the Income-tax Act. The CBDT has notified certain services of customised electronic data or products or services to mean the computer software eligible for deduction. The intention of the Notification was not to constrain or restrict, but to enable the Board to include several services or products within the ambit of the provisions of section 10B and this is precisely what has been done by the Board.

iii) The term “computer software” means: (a) a set of instructions expressed in words, codes, schemes or in any other form capable of causing a computer to perform a particular task or achieve a particular result; (b) a sequence of instructions written to perform a specified task for a computer. The same programme in its human-readable source code form, from which executable programmes are derived, enables a programmer to study and develop its algorithms; (c) a set of ordered instructions that enable a computer to carry out a specific task; (d) written programmes or procedures or rules and associated documentation pertaining to the operation of a computer system. Engineering and design finds place in the CBDT Notification dated 26th September, 2000. The Act nowhere provides for a definition of “engineering and design” and the requirement for availing of the benefit of deduction as reflected from section 10B read with the Notification… is fulfilled when the assessee has finally developed a computer programme only. Under section 10B no certificate is required under any regulatory authority.

It is a settled proposition of law that a co-ordinate bench of the Tribunal is required to follow the earlier decisions and in case there is a difference of opinion, the matter may be referred to a larger bench.

From the documents on record, it could be safely gathered that the assessee was engaged in the activity of engineering designs, redesigns, testing, modifying, prototyping and validation of concept. The assessee was also engaged in the activity of providing manufacturing support and computer-aided design support to its group companies. The assessee captured the resultant research of the activity in a customised data both in computer-aided design and other software platforms and for the purposes of carrying (out) these activities, the assessee employed engineers and other technical staff for various research projects undertaken by them. The assessee exported the software data. The activities carried out by the assessee like analysing or duplicating the reported problems, developing and building, testing products, carrying out tests, design and development had to be treated as falling within the scope of section 10B with or without the aid of section 10BB. Thus, the assessee was certainly eligible for deduction u/s 10B.

Another important aspect of the case was that in respect of the eligibility of claim of deduction u/s 10B, in respect of the same assessee it had been accepted by the Department for the A.Ys. 2006-07 to 2008-09. The assessee was entitled to the deduction u/s 10B for the A.Y. 2009-10.’

shailesh.kwebmaker

Business expenditure – Clearing and forwarding business – Payment of speed money to port labourers through gang leaders to expedite completion of work – Acceptance of books of accounts and payments supported by documentary evidence – Payment of speed money accepted as trade practice – Restriction of disallowance on the ground vouchers for cash payments were self-made – Unjustified

45 Ganesh Shipping Agency vs. ACIT [2021] 435 ITR 143 (Karn) A.Ys.: 2007-08 to 2009-10; Date of order: 6th February, 2021 S. 37 of ITA, 1961

Business expenditure – Clearing and forwarding business – Payment of speed money to port labourers through gang leaders to expedite completion of work – Acceptance of books of accounts and payments supported by documentary evidence – Payment of speed money accepted as trade practice – Restriction of disallowance on the ground vouchers for cash payments were self-made – Unjustified

The assessee was a firm which carried on business as a clearing and forwarding and steamer agent. For the A.Ys. 2007-08, 2008-09 and 2009-10, the A.O. disallowed, u/s 37, 20% of the expenses incurred by the assessee as speed money which was paid to the workers for speedy completion of their work on the grounds that (a) the assessee produced self-made cash vouchers for the cash payments to each gang leader, (b) the identity of the gang leader was not verifiable, and (c) the recipients were not the assessee’s employees.

The Commissioner (Appeals) restricted the disallowance to 10% which was confirmed by the Tribunal.

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

‘i) The authorities had accepted the books of accounts produced by the assessee. The A.O., in his order, had admitted that the payment of speed money was a trade practice which was followed by the assessee and similar business concerns functioning for speedy completion of their work. However, the disallowance of 20% of the expenses was made solely on the ground that the assessee had produced self-made cash vouchers and the finding had been affirmed by the Commissioner (Appeals) and the Tribunal.

ii) However, the books of accounts had not been doubted by any of the authorities. The Tribunal was not justified in sustaining the disallowance of expenses at 10% of the expenses paid to port workers as incentive by the assessee in relation to the A.Ys. 2007-08, 2008-09 and 2009-10.

iii) In the result, the impugned order of the Tribunal dated 29th May, 2015 insofar as it contains the findings to the extent of disallowance of 10% of the expenses incurred by the assessee in relation to the A.Ys. 2007-08, 2008-09 and 2009-10 is hereby quashed. Accordingly, the appeal is allowed.’

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Assessment – Limitation – Computation of period of limitation – Exclusion of time taken to comply with direction of Court – Meaning of ‘direction’ in section 153(3) – Court remitting matter to A.O. asking him to give assessee opportunity to be heard – Not a direction within meaning of section 153(3) – No exclusion of any time in computing limitation

44 Principal CIT vs. Tally India Pvt. Ltd. [2021] 434 ITR 137 (Karn) A.Y.: 2008-09; Date of order: 6th April, 2021 S. 153 of ITA, 1961

Assessment – Limitation – Computation of period of limitation – Exclusion of time taken to comply with direction of Court – Meaning of ‘direction’ in section 153(3) – Court remitting matter to A.O. asking him to give assessee opportunity to be heard – Not a direction within meaning of section 153(3) – No exclusion of any time in computing limitation

For the A.Y. 2008-09, the case of the assessee was referred to the Transfer Pricing Officer (TPO) for computation of the arm’s length price u/s 92C. The Court by an order restrained the TPO from proceeding to pass a draft assessment order for a period up to 7th March, 2012, i.e., approximately three months. The writ petition was disposed of by the Court by order dated 7th March, 2012 remitting the matter to the A.O. and directing the assessee to appear before the A.O. on 21st March, 2012. The TPO, by an order dated 13th June, 2012 after affording an opportunity to the assessee, passed a draft order of assessment on 5th July, 2012 and forwarded it to the assessee on 11th July, 2012. The assessee filed objections before the Dispute Resolution Panel which passed an order on 22nd April, 2013. The A.O. passed a final order on 31st May, 2013.

The Tribunal held that the draft assessment was completed by the A.O. on 5th July, 2012, beyond the period of limitation.

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

‘i) Section 153 lays down the period of limitation for assessment. Section 153(3) states that in computing the period of limitation, the time taken to comply with a direction of the court is to be excluded. Section 153(3)(ii) applies to cases where any direction is issued either by the appellate authority, revisional authority or any other authority to decide an issue. The Supreme Court in Rajinder Nath vs. CIT and ITO vs. Murlidhar Bhagwan Das has held that a finding given in an appeal, revision or reference arising out of an assessment must be a finding necessary for disposal of a particular case. Similarly, a direction must be an expressed direction necessary for disposal of the case before the authority or court and must also be a direction which the authority or court is empowered to give while deciding a case before it. A direction issued to remit the matter and asking the assessee to appear before the A.O. on a particular date does not amount to either issuing a direction or finding within the meaning of section 153(3)(ii).

ii) It was evident that the order dated 7th March, 2012 passed by the Court neither contained any finding nor any direction. The Tribunal was right in holding that the draft assessment was completed by the A.O. on 5th July, 2012, which was beyond the period of limitation.’

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Appeal to Appellate Tribunal – Appeal to Commissioner (A) – Powers of Commissioner (A) – Commissioner (A) can call for and examine fresh material – Power of Tribunal to remand matter – Power must be exercised judiciously – A.O. rejecting claim for deduction – Commissioner (A) considering fresh documents and allowing deduction – Tribunal not justified in remanding matter to A.O.

43 International Tractors Ltd. vs. Dy. CIT(LTU) [2021] 435 ITR 85 (Del) A.Y.: 2007-08; Date of order: 7th April, 2021 Ss. 80JJAA, 250(4) of ITA, 1961

Appeal to Appellate Tribunal – Appeal to Commissioner (A) – Powers of Commissioner (A) – Commissioner (A) can call for and examine fresh material – Power of Tribunal to remand matter – Power must be exercised judiciously – A.O. rejecting claim for deduction – Commissioner (A) considering fresh documents and allowing deduction – Tribunal not justified in remanding matter to A.O.

In the return filed for the A.Y. 2007-08, the assessee had failed to claim the deductions both u/s 80JJAA and qua prior period expenses. The deduction u/s 80JJAA was at Rs. 1,07,33,164 and the prior period expenses were quantified at Rs. 51,21,024. These deductions were claimed by the assessee before the A.O. by way of a communication dated 14th December, 2009 filed with him. This statement, admittedly, was accompanied by a Chartered Accountant’s report in the prescribed form (i.e., form 10DA). Furthermore, the details concerning prior period expenses were also provided by the assessee. The A.O., however, declined to entertain the two deductions claimed by the assessee.

The Commissioner (Appeals) allowed the appeal of the assessee. The Tribunal remanded the matter to the A.O.

On appeal by the assessee, the Delhi High Court set aside the order of the Tribunal and held as under:

‘If a claim is otherwise sustainable in law, the appellate authorities are empowered to entertain it. The Commissioner (Appeals) in the exercise of his powers u/s 250(4) is entitled to call for production of documents or material to satisfy himself as to whether or not the deductions claimed were sustainable and viable in law.

Insofar as the deduction claimed u/s 80JJAA was concerned, the Commissioner (Appeals) not only had before him the Chartered Accountant’s report in the prescribed form, i.e., form 10DA, but also examined the details concerning the new regular workmen, numbering 543, produced before him. In this context, the Commissioner (Appeals) examined the details concerning the dates when the workmen had joined the service, the period during which they had worked, relatable to the assessment year at issue, as also the details concerning the bank accounts in which remuneration was remitted. Based on this material, the Commissioner (Appeals) concluded that the deduction u/s 80JJAA was correctly claimed by the assessee. Likewise, insofar as prior period expenses were concerned, out of a total amount of Rs. 51,21,024 claimed by the assessee, a sum of Rs. 24,78,391 was not allowed for the reason that withholding tax had not been deducted by the assessee. The assessee had disclosed the same in its communication dated 14th December, 2009 placed before the A.O.

All that the Tribunal was required to examine was whether the Commissioner (Appeals) had scrupulously verified the material placed before him before allowing the deductions claimed by the assessee. The Tribunal, however, instead of examining this aspect of the matter, observed, incorrectly, that because an opportunity was not given to the A.O. to examine the material, the matter needed to be remanded to the A.O. for a fresh verification. The judgment of the Tribunal deserved to be set aside. The fresh claims made by the assessee, as allowed by the Commissioner (Appeals), were to be sustained.’

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Article 4 of India-Mauritius DTAA – Re-domiciliation of company by itself cannot lead to denial of treaty in the country of re-domiciliation

5 ADIT vs. Asia Today Limited [(2021) 127 taxmann.com 774 (Mum-Trib)] ITA Nos.: 4628-4629/Mum/2006 A.Ys.: 2000-01 and 2001-02; Date of order: 30th July, 2021

Article 4 of India-Mauritius DTAA – Re-domiciliation of company by itself cannot lead to denial of treaty in the country of re-domiciliation

FACTS
The assessee was a company incorporated in 1991 as an international business company in the British Virgin Islands (BVI). It re-domiciled to Mauritius on 29th June, 1998 when the Registrar of Companies issued a Certificate of Incorporation stating that ‘…on and from 29th day of June, 1998, incorporated by continuation as a private company limited by shares’ and that ‘this certificate will be effective from the date of de-registration in BVI’. Simultaneously, the BVI issued a certificate stating ‘The Registrar of Companies of the British Virgin Islands hereby certifies that ________, an international business company incorporated under section 3 of the International Business Companies Act of the law of British Virgin Islands, has discontinued its operations in the British Virgin Islands on 30th June, 1998’.

For the first time, the tax authority contended before the Tribunal that since the assessee was a BVI company, it did not qualify for benefit under the India-Mauritius DTAA. The assessee objected to this contention of the tax authorities.

HELD
On re-domiciliation

Corporate re-domiciliation is a process through which a corporate entity moves its domicile (or place of incorporation) from one jurisdiction to another while at the same time retaining its legal identity.

On re-domiciliation, a corporate entity is de-registered from one jurisdiction and ceases to exist there but simultaneously comes into existence in another jurisdiction.

In the offshore world re-domiciliation of a corporate entity is a fact of life.

While re-domiciliation of a corporate entity may trigger detailed examination per se, DTAA benefits cannot be denied merely because of re-domiciliation.

On facts of the case
The assessee had re-domiciled more than two decades ago. During this period, the tax authority had granted benefit under the India-Mauritius DTAA without raising any question. Hence, the issue was merely academic in nature.

Note: The decision primarily dealt with adjudication of the PE in India of the assessee and attribution of profit to dependent agent. The issue of denial of DTAA benefit on the issue of re-domiciliation was agitated by the tax authority for the first time before the Tribunal. However, only this issue is compiled because it was agitated by tax authority for the first time.

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Provisions of section 68 would not apply in case where shares are allotted in lieu of self-generated goodwill wherein there is no movement of actual sum of money

39 ITO vs. Zexus Air Services (P) Ltd. [(2021) 88 ITR(T) 1 (Del-Trib)] IT Appeal No. 2608 (Del) of 2018 A.Y.: 2014-15; Date of order: 23rd April, 2021

Provisions of section 68 would not apply in case where shares are allotted in lieu of self-generated goodwill wherein there is no movement of actual sum of money

FACTS
The assessee company wanted to establish itself in the aviation industry for which an aviation license from the Ministry of Civil Aviation was required. A precondition for procuring this license was that the company must have authorised share capital of at least Rs. 20 crores. One of the directors of the assessee company who had expertise and experience of the industry, helped it to procure the said aviation license. The assessee company allotted shares of Rs. 20 crores to this director by recognising the efforts made by him in the form of ‘goodwill’. Accordingly, Rs. 20 crores was credited to the share capital and a corresponding debit entry was made in the form of self-generated ‘goodwill’. There was no actual flow of money and this was merely a book entry. Documents filed by the assessee company before the ROC in relation to increase in the authorised capital also mentioned that the said shares were allotted in lieu of the ‘blessings and efforts’ of the said director.

But the A.O. held that the assessee company could not substantiate the basis or provide any evidence to justify the value of the goodwill. It was contended that the company had adopted a colourable device to evade taxes. Accordingly, an addition of Rs. 20 crores u/s 68 was made.

The assessee company argued that the provisions of section 68 would not apply in the present facts of the case because there was no actual movement of money and hence it was a tax-neutral transaction. Reliance was placed on the decision of the Delhi High Court in the case of Maruti Insurance Distribution Services Ltd. vs. CIT [2014] 47 taxmann.com 140 (Delhi) wherein it was held that it was the decision of the businessmen to decide and value its goodwill. Concurring with this contention, the CIT(A) deleted the addition made u/s 68.

HELD
It was an undisputed fact that there was no actual receipt of any money by the assessee company; and when the cash did not pass at any stage and when the respective parties did not receive cash nor did they pay any cash, there was no real credit of cash in the cash book and, therefore, the provisions of section 68 would not be attracted. Reliance was placed on the following decisions:

a) ITO vs. V.R. Global Energy (P) Ltd. [2020] 407 ITR 145 (Madras High Court), and
b) ACIT vs. Suren Goel [ITA No. 1767 (Delhi) of 2011].

Reference was also made to the decision in the case of ACIT vs. Mahendra Kumar Agrawal [2012] 23 taxmann.com 285 (Jaipur-Trib) wherein it was held that the term ‘any sum’ used in section 68 cannot be taken as parallel to ‘any entry’.

An identical matter had come up before the Kolkata Tribunal in the case of ITO vs. Anand Enterprises Ltd. [ITA No. 1614 (Kol) of 2016] wherein, referring to the decision of the Supreme Court in the case of Shri H.H. Rama Varma vs. CIT 187 ITR 308 (SC), the Tribunal held that the term ‘any sum’ means ‘sum of money’; accordingly, in the absence of any cash / monetary inflow, addition u/s 68 cannot be made.

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Section 2(47) r/w/s 50C – If there is a gap between the date of execution of sale agreement and the sale deed and if the guidance value changes, the guidance value as on the date of agreement has to be considered as the full consideration

38 Prakash Chand Bethala vs. Dy. CIT [(2021) 88 ITR(T) 290 (Bang-Trib)] IT Appeal No. 999 (Bang) of 2019 A.Y.: 2007-08; Date of order: 28th January, 2021

Section 2(47) r/w/s 50C – If there is a gap between the date of execution of sale agreement and the sale deed and if the guidance value changes, the guidance value as on the date of agreement has to be considered as the full consideration

FACTS
The assessee was an HUF that had acquired a property by participating in a BDA auction. The agreement for acquisition of the property took place on 24th July, 1984 and the assessee had acquired possession on 29th August, 1984.

One R.K. Sipani (RKS) acquired the aforesaid property from the assessee through M/s K. Prakashchand Bethala Properties Pvt. Ltd. (KPCBBL) through an oral agreement in the month of September, 1989 for the consideration of Rs. 9.80 lakhs. The assessee gave the possession of the property to RKS on 24th October, 1989. Thereafter, on 8th March, 1993, an unregistered sale agreement was made between the assessee and RKS to bring clarity on the aforementioned transaction. Then, on 9th March, 2007, a sale deed was executed in which the aforesaid site was sold to M/s Suraj Properties (a proprietary concern of RKS’s wife) for the consideration of Rs. 9.80 lakhs.

The A.O. noticed that the guidance value of the property as per the executed sale deed on 9th March, 2007 was Rs. 2.77 crores and the sale consideration was less than the guidance value; thus, the provisions of section 50C were attracted. On appeal, the CIT(A) also confirmed the action of the A.O. Aggrieved by the order, the assessee filed an appeal before the Tribunal.

HELD
The question before the Tribunal was what could be the full value of such consideration, i.e., whether the value on which the stamp duty was paid at the time of the sale deed or the value declared in the sale agreement.

The Tribunal observed that the assessee had entered into the sale agreement on 8th March, 1993 and a major portion of the agreed consideration had been received by the assessee through account payee cheque and possession of the property was also handed over to RKS on 24th October, 1989. There is no dispute regarding these facts. The only action pending was actual registration of the sale deed.

The Tribunal observed that section 50C(1) provides that if there is a gap between the date of execution of the sale agreement and the sale deed and if the guidance value changes, the guidance value as on the date of the agreement has to be considered as the full consideration of the capital asset. In the present case,
1) the enforceable agreement was entered into on 8th March, 1993 by payment of a major portion of the sale consideration,
2) the possession of the property had already been handed over on 24th October, 1989,
3) only the formal sale deed was executed on 9th March, 2007.

Therefore, the Tribunal held that the transfer had taken place vide the sale agreement dated 8th March, 1993 and full value of consideration for the purpose of computing long-term capital gain in the hands of the assessee has to be adopted only on the basis of the guidance value of the property as on the date of the sale agreement, i.e., 8th March, 1993, and not on the date of the sale deed of 9th March, 2007. Accordingly, there was no applicability of section 50C in the year 2007-08.

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Business income – Proviso to S. 43CA(1) and the subsequent amendment thereto relates back to the date on which the said section was made effective, i.e., 1st April, 2014

37 Stalwart Impex Pvt. Ltd. vs. ITO [(2021) TS-615-ITAT-2021 (Mum)] A.Y.: 2016-17; Date of order: 2nd July, 2021 Section 43CA

Business income – Proviso to S. 43CA(1) and the subsequent amendment thereto relates back to the date on which the said section was made effective, i.e., 1st April, 2014

FACTS
During the previous year relevant to the assessment year under consideration, the assessee, engaged in the construction of commercial and residential housing projects, sold flats to various buyers. In respect of three flats the A.O. held that the stamp duty value (SDV) is more than their agreement value. The total agreement value of the said three flats was Rs. 97,11,500 whereas their SDV was Rs. 1,09,83,000. Upon an objection being raised by the assessee, the A.O. made a reference to the Department Valuation Officer (DVO) for determining the market value of the said flats. The DVO determined the market value of the three flats to be Rs. 1,03,93,000. However, before receipt of the report of the DVO, the A.O. made the addition of the difference between the SDV and the agreement value of the said three flats, i.e., Rs. 12,71,500, u/s 43CA.

Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the action of the A.O. The assessee then preferred an appeal to the Tribunal.

HELD
The Tribunal observed that the difference between the agreement value and the value determined by the DVO is approximately 7%. On behalf of the assessee it was contended that since the difference is less than 10%, no addition should be made. The Tribunal noted that a similar issue had come up before the Tribunal in the case of Radhika Sales Corporation vs. Addl. CIT [ITA No. 1474/Pune/2016, A.Y. 2011-12, order dated 16th November, 2018 and the Tribunal while deciding the issue deleted the addition made and observed that ‘since difference between the value declared by the assessee and the value determined by the DVO is less than 10%, no addition in respect of long-term capital gain is warranted.’ The Tribunal observed that while the said decision was rendered in the context of section 50C and the addition in the instant case is u/s 43CA, both the provisions are pari materia and therefore the decision rendered u/s 50C would hold good for interpreting section 43CA as well. The Tribunal held that where the difference between the sale consideration declared by the assessee and the SDV of an asset (other than capital asset), being land or building, or both, is less than 10%, no addition u/s 43CA is warranted.

The Tribunal observed that the Finance Act, 2018 inserted a proviso to section 43CA(1) providing 5% tolerance limit in variation between declared sale consideration vis-à-vis SDV for making no addition. A similar proviso was inserted by the Finance Act, 2018 to section 50C(1). The said tolerance band was enhanced from 5% to 10% by the Finance Act, 2020 w.e.f. 1st April, 2021. The Tribunal in the case of Maria Fernandes Cheryl vs. ITO (International Taxation) 123 taxmann.com 252 (Mum) after considering various decisions and the CBDT Circular No. 8 of 2018 dated 26th December, 2018 held that the amendment is retrospective in nature and relates back to the date of insertion of the statutory section to the Act.

The Tribunal held that both sections are similarly worded except that both the sections have application on different sets of assessees. The proviso has been inserted and subsequently the tolerance band limit has been enhanced to mitigate the hardship of genuine transactions in the real estate sector. Considering the reasoning given for insertion of the proviso and exposition by the Tribunal for retrospective application of the same, the Tribunal held that the proviso to section 43CA(1) and the subsequent amendment thereto relates back to the date on which the said section was made effective, i.e., 1st April, 2014.

The Tribunal allowed the appeal filed by the assessee.

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Business Expenditure – Swap charges paid to convert a floating rate loan to a fixed rate loan are allowable as deduction – Since interest was allowed when loan carried floating rate the character of transaction does not change by swapping from floating to fixed rate

36 Owens-Corning (India) Pvt. Ltd. vs. ITO [(2021) TS-517_ITAT-2021 (Mum)] A.Y.: 2003-04; Date of order: 25th June, 2021 Section 37

Business Expenditure – Swap charges paid to convert a floating rate loan to a fixed rate loan are allowable as deduction – Since interest was allowed when loan carried floating rate the character of transaction does not change by swapping from floating to fixed rate

FACTS
The assessee company availed a loan from a US bank on floating rate of interest. During the previous year relevant to the assessment year under consideration, the assessee chose to convert the said loan carrying floating rate of interest into fixed rate of interest. The assessee was asked to pay certain swap charges for the said conversion from floating to fixed rate. The swap charges liability had been duly incurred by the assessee during the year. The assessee characterised the swap charges as being in the nature of interest.

But the A.O. while assessing the total income disallowed the swap charges claimed on the ground that the said expenditure is capital in nature.

Aggrieved, the assessee preferred an appeal to the CIT(A) who held that the assessee converting the loan from floating rate of interest to fixed rate of interest has derived enduring benefit and hence the expenditure incurred by the assessee falls in the capital field warranting capitalisation thereon and hence cannot be allowed u/s 37(1).

HELD
The Tribunal noted the calculation of swap charges and observed that the swap charges incurred by the assessee for conversion from floating to fixed rate of interest would necessarily partake the character of interest. The interest paid by the assessee when the loan was in floating rate was duly allowed by the A.O. Hence, the character of the transaction does not change pursuant to this swap from floating to fixed rate. The utilisation of the loan for the purposes of business has not been disputed, hence there is no question of disallowance of any interest whatever the nomenclature, interest or swap charges. The nomenclature of the transaction is absolutely irrelevant to the substance of the transaction.

The Tribunal, following the decision of the Jurisdictional High Court in the case of CIT vs. D. Chetan & Co. 390 ITR 36 (Bom) held that the assessee is entitled to deduction of swap charges. This ground of appeal filed by the assessee was allowed.

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DEDUCTION OF MAINTENANCE CHARGES IN COMPUTING INCOME FROM HOUSE PROPERTY

ISSUE FOR CONSIDERATION
Section 22 of the Income-tax Act creates a charge over the annual value of the house property being a building or lands appurtenant to the building of which the assessee is the owner and which has not been used for the purpose of any business or profession carried on by the assessee. The annual value of the house property is required to be computed in the manner laid down in section 23. It deems the sum for which the property might reasonably be expected to be let from year to year as its annual value subject to the exception where the property is let, in which case the amount of rent received or receivable is considered to be its annual value if it is higher. Section 24 provides for the deductions which can be claimed in computing the Income from House Property, namely, (i) a sum equal to 30% of the annual value (referred to as ‘standard deduction’), and (ii) interest payable on capital borrowed for acquisition, construction, repairs, etc., of the property subject to further conditions as provided in clause (b).

Quite often, an issue arises as to whether the assessee can claim a deduction of expenses like maintenance charges, etc., which it had to incur in relation to the property which is let out while computing its annual value for the purposes of section 23. The fact that the annual value is required to be computed on the basis of rent received or receivable in case of let-out property and no specific deduction has been provided for any expenses other than interest u/s 24, makes the issue more complex. Numerous decisions are available dealing with this issue in the context of different kind of expenses, such as maintenance charges, brokerage, non-occupancy charges, etc. For the purpose of this article, we have analysed two decisions of the Mumbai bench of the Tribunal taking contrary views in relation to deductibility of maintenance charges while computing annual value u/s 23.

SHARMILA TAGORE’S CASE
The issue had earlier come up for consideration of the Mumbai bench of the Tribunal in the case of Sharmila Tagore vs. JCIT (2005) 93 TTJ 483.

In this case, for the assessment year 1997-98, the assessee had claimed deduction for the maintenance charges of Rs. 48,785 and non-occupancy charges of Rs. 1,17,832 levied by the society from the total rent received of Rs. 3,95,000 while computing her income under the head Income from House Property. The A.O. disallowed the claim for deduction of both the payments on the ground that the expenses were not listed for allowance in section 24. On appeal, the disallowance made by the A.O. was confirmed by the Commissioner (Appeals).

The Tribunal, on appeal by the assessee, held that the maintenance charges have to be deducted while determining the annual letting value of the property u/s 23 following the ratio of the decisions in the cases of –
• Bombay Oil Industries Ltd. vs. Dy. CIT [2002] 82 ITD 626 (Mum),
• Neelam Cables Mfg. Co. vs. Asstt. CIT [1997] 63 ITD 1 (Del),
• Lekh Raj Channa vs. ITO [1990] 37 TTJ (Del) 297,
• Blue Mellow Investment & Finance (P) Ltd. [IT Appeal No. 1757 (Bom), dated 6th May, 1993].

The claim of the assessee for the deduction of maintenance charges while computing the annual value on the basis of rent received was upheld by the Tribunal. As regards the non-occupancy charges, the Tribunal noted that the expenditure had to be incurred for letting out the property. Therefore, while estimating the annual letting value of the property, which was the sum for which the property might reasonably be expected to be let from year to year, the non-occupancy charges could not be ignored and should be deducted from the annual value. Thus, the Tribunal directed the A.O. to re-compute the annual value after reducing the maintenance charges as well as non-occupancy charges from the rent received.

In the case of Neelam Cables Mfg. Co. (Supra), the assessee had claimed deduction for building repairs and security service charges. Insofar as building repair charges were concerned, the Tribunal held that no separate deduction could be allowed in respect of repairs as the assessee was already allowed the deduction of 1/6th for repairs as provided in section 24 (as it was prevailing at that time). However, in respect of security service charges, the Tribunal held that the charges would be deductible while computing the annual value u/s 23, though no such deduction was specifically provided for in section 24. Since the gross rent received by the assessee should be considered as inclusive of security service charges, the Tribunal held that such charges which were paid in respect of letting out of the property should be deducted while determining the annual value.

In the case of Lekh Raj Channa (Supra), the Tribunal allowed the deduction of salaries paid to persons for the maintenance of the building, security of the building and attending to the requirements of the tenants while computing the annual letting value.

The Tribunal in the case of Bombay Oil Industries Ltd. (Supra), following the above referred decisions of the Delhi bench and in the case of Blue Mellow Investment & Finance (P) Ltd. (Supra), had held that the expenditure by way of municipal taxes, maintenance of the building, security, common electricity charges, upkeep of lifts, water pump, fire-fighting equipment, staff salary and wages, etc., should be taken into account while arriving at the annual letting value u/s 23.

A similar view has been taken in the following cases about deductibility of expenses, mainly maintenance charges, while arriving at the annual letting value of the let-out property –
• Realty Finance & Leasing (P) Ltd. vs. ITO [2006] 5 SOT 348 (Mum),
• J.B. Patel & Co. vs. DCIT [2009] 118 ITD 556 (Ahm),
• ITO vs. Farouque D. Vevania [2008] 26 SOT 556 (Mum),
• ACIT vs. Sunil Kumar Agarwal (2011) 139 TTJ 49 (UO),
• Asha Ashar vs. ITO [2017] 81 taxmann.com 441 (Mum-Trib),
• Neela Exports Pvt. Ltd. vs. ITO (ITA No. 2829/Mum/2011 dated 27th February, 2013),
• Krishna N. Bhojwani vs. ACIT (ITA No. 1463/Mum/2012 dated 3rd July, 2017),
• Saif Ali Khan vs. CIT (ITA No. 1653/Mum/2009 dated 23rd June, 2011).

ROCKCASTLE PROPERTY (P) LTD.’S CASE
The issue again came up for consideration recently before the Mumbai bench of the Tribunal in the case of Rockcastle Property (P) Ltd. vs. ITO [2021] 127 taxmann.com 381.

In this case, for the assessment year 2012-13, the assessee had earned rental income from a commercial property which was situated in a condominium. The assessee credited an amount of Rs. 91.42 lakhs as rental income in its Profit & Loss account as against gross receipts of Rs. 93.65 lakhs after deducting Rs. 2.23 lakhs paid towards the ‘society maintenance charges’. The A.O. held that the charges were not allowable as a deduction since the assessee was already allowed deduction of 30% u/s 24(a). The CIT(A) confirmed the disallowance by relying upon several decisions, including the decisions of the Delhi High Court in the case of H.G. Gupta & Sons, 149 ITR 253 and of the Punjab & Haryana High Court in Aravali Engineers P. Ltd. 200 Taxman 81.

On appeal to the Tribunal, it was contended on behalf of the assessee that under the terms of letting out, the assessee was required to bear the expenses on society maintenance and the gross rent received by the assessee included the society maintenance charges that were paid by the assessee. Therefore, in computing the annual value, the amount of rent which actually came to the hands of the owner should alone be taken into consideration in view of the provisions of section 23(1)(b) that provide for adoption of the ‘actual rent received or receivable by the owner’. Reliance was also placed on various decisions of the Tribunal taking a view that such maintenance charges should be deducted while computing the annual letting value of the let-out property. As against this, the Revenue submitted that the assessee’s claim was not admissible as per the statutory provisions.

The Tribunal perused the Leave & License agreement and noted that the payment of municipal taxes and other outgoings was the liability of the assessee. Any increase was also to be borne by the assessee. The licensee was required to pay a fixed monthly lump sum to the assessee as license fees irrespective of the assessee’s outgoings. On the above findings, the Tribunal noted that it was incorrect for the assessee to plead that the actual rent received by the assessee was net of ‘society maintenance charges’ as per the terms of the agreement.

The Tribunal further noted that section 23 provided for deduction of only specified items, i.e., taxes paid to the local authority and the amount of rent which could not be realised by the assessee, from the ‘actual rent received or receivable’. No other deductions were permissible. Allowing any other deduction would amount to distortion of the statutory provisions and such a view could not be countenanced. It observed that accepting the plea that the rent which actually went into the hands of the assessee was only to be considered, would enable the assessee to claim any expenditure from rent actually received or receivable which was not the intention of the Legislature.

As far as the decision of the co-ordinate bench in the case of Sharmila Tagore (Supra) was concerned, the Tribunal relied upon its earlier decision in the case of Township Real Estate Developers (India) (P) Ltd. vs. ACIT [2012] 21 taxmann.com 63 (Mum) wherein it was held that –
• the decision of the Delhi High Court in the case of H.G. Gupta & Sons (Supra) had not been considered in the Sharmila Tagore case;
• the decision of the Punjab & Haryana High Court in the case of Aravali Engineers (P) Ltd. (Supra) was the latest decision on the subject that held that the deduction was not allowable.

Apart from the cases of Rockcastle Property (P) Ltd. (Supra) and Township Real Estate Developers (India) (P) Ltd. (Supra), a similar view has been taken in the following cases whereby the expenses in the nature of maintenance of the property have not been allowed to be reduced from the gross amount of the rent for the purpose of determining the annual value of the property –
• Sterling & Wilson Property Developers Pvt. Ltd. vs. ITO (ITA No. 1085/Mum/2015 dated 11th November, 2016),
• Ranjeet D. Vaswani vs. ACIT [2017] 81 taxmann.com 259 (Mum-Trib), and
• ITO vs. Barodawala Properties Ltd. (2002) 83 ITD 467 (Mum).

OBSERVATIONS
What is chargeable to tax in the case of house property is its ‘annual value’ after reducing the same by the deductions allowed u/s 24. The annual value is required to be determined in accordance with the provisions of section 23. Sub-section (1) of section 23 which is relevant for the purpose of the subject matter of controversy reads as under –

For the purposes of section 22, the annual value of any property shall be deemed to be –
(a) the sum for which the property might reasonably be expected to let from year to year; or
(b) where the property or any part of the property is let and the actual rent received or receivable by the owner in respect thereof is in excess of the sum referred to in clause (a), the amount so received or receivable; or
(c) where the property or any part of the property is let and was vacant during the whole or any part of the previous year and owing to such vacancy the actual rent received or receivable by the owner in respect thereof is less than the sum referred to in clause (a), the amount so received or receivable:
Provided that the taxes levied by any local authority in respect of the property shall be deducted (irrespective of the previous year in which the liability to pay such taxes was incurred by the owner according to the method of accounting regularly employed by him) in determining the annual value of the property of that previous year in which such taxes are actually paid by him.
Explanation. – For the purposes of clause (b) or clause (c) of this sub-section, the amount of actual rent received or receivable by the owner shall not include, subject to such rules as may be made in this behalf, the amount of rent which the owner cannot realise.

The limited issue for consideration, where the property is let, is whether ‘the actual rent received or receivable’ referred to in clause (b) in respect of letting of the property or part thereof can be said to have included the cost of maintaining that property and, if so, whether the actual rent received or receivable can be reduced, by the amount of the cost of maintaining the property, for the purposes of clause (b) of section 23(1).

One possible view of the matter is that the ‘actual rent received or receivable’ should be the amount of consideration which the tenant has agreed to pay for usage of the property and merely because the owner of the property has to incur some expenses in relation to that property, the amount of ‘actual rent received or receivable’ cannot be altered on that basis; the proviso to section 23(1) permits the deduction for taxes levied by the local authority, which is also the obligation of the owner of the property, is indicative of the intent of the Legislature that no other obligations of the owner of the property can be reduced from the amount of actual rent received or receivable; any payment or other than the taxes so specified shall not be deductible from the annual value; section 24 limits the deduction to those payments that have been expressly listed in the said section and any deduction outside the list is not allowable, as has been explained in the Circular No. 14/2001 dated 9th November, 2001 explaining the objective of the amendment of 2001 in section 24 to substitute some eight deductions like cost of repairs, collection charges, insurance premium, annual charge, ground rent, interest, land revenue, etc., with only two, namely, standard deduction and interest; any deduction other than the ones specified by the proviso to section 23(1) and section 24, i.e., municipal taxes, interest and standard deduction, is not permissible.

The other equally possible view is that the amount of ‘actual rent received or receivable’ is dependent on the fact that the let-out property in question necessarily requires the owner to bear the expenses in relation to the property as a condition for letting, expressly or otherwise, and considering this correlation, the amount of ‘actual rent received or receivable’ should be adjusted taking into consideration the cost of maintaining the property or any other such expenses in relation to the property which the owner is required to incur; the express permission to deduct the municipal taxes under the proviso should not be a bar from claiming such other payments and expenses which have the effect of reducing the net annual rent in the hands of the owner and should be allowed to be reduced form the annual value as long as there is no express prohibition in the law to do so; section 24 lists the permissible deductions in computing the income under the head ‘income from house property’ and is unrelated to the determination of annual value and should not have any role in determination thereof; the expenses that go to reduce the annual value should nonetheless be allowed as they remain unaffected by the provisions of section 24.

The obligation of the owner to incur the expenses in question is directly linked to the earning of the income and has the effect of determining the fair rental value. The value shall stand reduced where such obligations are not assumed by the owner. Needless to say, an express agreement by the parties for passing on the obligation to pay such expenses to the tenant and reducing the rent payable would achieve the desired objective without any litigation; this in itself should indicate that the fair rental value is directly linked to the assuming of the obligations by the owner to pay the expenses in question and that such expenses should be reduced from the annual value. The case for deduction is well supported on the principle of diversion of obligation by overriding covenant. The concept has been well explained by the Supreme Court in the case of CIT vs. Sitaldas Tirathdas [(1961) 41 ITR 367] the relevant extract from which is reproduced below –

In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assesse as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation, cannot be said to be a part of the income of the assesse. Where by the obligation income is diverted before it reaches the assesse, it is deductible; but where the income is required to be applied to discharge an obligation after the income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one’s own income, which has been received and is since applied. The first is a case where income never reaches the assessee, who even if he were to collect it does so, not as part of his income, but for and on behalf of the person to whom it is payable.

Further reference can also be made to the case of CIT vs. Sunil J. Kinariwala [2003] 259 ITR 10 wherein the Supreme Court has, after referring to various precedents on the subject, explained the concept of diversion of income by overriding title in the following manner:

When a third person becomes entitled to receive the amount under an obligation of an assessee even before he could lay a claim to receive it as his income, there would be diversion of income by overriding title; but when after receipt of the income by the assessee, the same is passed on to a third person in discharge of the obligation of the assessee, it will be a case of application of income by the assessee and not of diversion of income by overriding title.

It is possible to canvass two views when the issue under consideration is examined in light of this principle; it can be said that there is no diversion of income by the owner of the property when he incurs the expenses for maintenance of the property, or it can be held that there is a diversion. The better view is to favour an interpretation that permits the reduction than the one that defeats the claim. It is also possible to support the claim for reduction from annual value on the basis of real income theory.

In the cases of Sharmila Tagore and others, the Tribunal has taken a view that allowed the reduction of maintenance charges from the annual value on the basis that to that extent the amount of rent never reached the owner or the owner was not benefited to that extent.

shailesh.kwebmaker

Capital Gains – Amount received on sale of additional benefit derived by the assessee by way of getting vested with additional FSI on the land and building owned by the assessee is only a windfall gain by operation of law and which had not cost the assessee any money is a capital receipt Book Profits – A particular receipt which is in the capital field cannot be brought to tax u/s 115JB merely on the ground that the assessee has voluntarily offered it in the return of income

35 Batliboi Ltd. vs. ITO [(2021) TS-410-ITAT-2021 (Mum)] A.Y.: 2013-14; Date of order: 21st May, 2021 Sections 4, 45, 115JB

Capital Gains – Amount received on sale of additional benefit derived by the assessee by way of getting vested with additional FSI on the land and building owned by the assessee is only a windfall gain by operation of law and which had not cost the assessee any money is a capital receipt

Book Profits – A particular receipt which is in the capital field cannot be brought to tax u/s 115JB merely on the ground that the assessee has voluntarily offered it in the return of income

FACTS
The assessee company owned land along with super structure which was acquired by it vide a sale deed dated 15th April, 1967. During the financial year relevant to the assessment year under consideration, the assessee company proposed to sell the said land along with its super structure. In the course of negotiations it became aware that post acquisition of land and constructed building, the Development Control Regulations (DCR) in the city of Coimbatore had undergone a change resulting in the company obtaining an additional benefit by way of additional FSI of 0.8.

The company sold the said land along with super structure vide a deed of sale on 23rd January, 2013 for a consideration of Rs. 11,14,00,000. Taking the help of the valuer, Rs. 4,76,25,000 out of this composite consideration was attributed to the additional FSI obtained as a result of the amendment in the DCR. In the return of income filed, the assessee regarded the sum of Rs. 4,76,25,000 received towards additional FSI as a capital receipt. However, while computing the book profit u/s 115JB, the said sum of Rs. 4,76,25,000 was included in the book profit.

The A.O. brought this sum of Rs. 4,76,25,000 to tax as long-term capital gains. This amount was also treated as part of book profits u/s 115JB since it was already offered to tax voluntarily by the assessee.

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

The aggrieved assessee preferred an appeal to the Tribunal where it also raised an additional ground, viz., that the sum of Rs. 4,76,25,000 being a capital receipt is not part of the operating results of the assessee and therefore is not includible in computing its book profits u/s 115JB.

HELD
The Tribunal observed that the total sale consideration of Rs. 11,14,00,000 has not been doubted by the Revenue. The break-up of consideration, as done by the assessee, by relying on the independent valuer’s report was also not doubted by the Revenue. The only dispute was whether the said sum of Rs. 4,76,25,000 could be treated as a capital receipt thereby making it non-exigible to tax both under normal provisions as well as in the computation of book profits u/s 115JB.

The Tribunal held that the assessee could not have pre-empted any change in the DCR in the city of Coimbatore at the time of purchase or before sale. Admittedly, no cost was incurred by the assessee for getting such benefit by way of additional FSI. Hence, it could be safely concluded that the additional benefit derived by the assessee by way of additional FSI on the land and building owned by him is only a windfall gain by operation of law and which had not cost him any money. The Tribunal found that the entire issue in dispute is squarely covered by the decision of the Jurisdictional High Court in the case of Kailash Jyoti No. 2 CHS Ltd. and others dated 24th April, 2015. Following this decision, the Tribunal held that the sum of Rs. 4,76,25,000 received by the assessee on the sale of additional FSI is not exigible for long-term capital gains. It directed that the same be excluded under the normal provisions of the Act.

While deciding the additional ground, the Tribunal observed that there is absolutely no dispute that the receipt of Rs. 4,76,25,000 is indeed a capital receipt and the same does not form part of the operational working results of the assessee company. Even according to the Revenue, the said receipt is only inseparable from the land and building and accordingly it only partakes the character of a capital receipt. The Tribunal held that merely because a particular receipt, which is in the capital field, has been offered to tax by the assessee voluntarily in the return of income while computing book profits u/s 115JB it cannot be brought to tax merely on that ground. It is very well settled that there is no estoppel against the statute. It noted that the dispute is covered by the Tribunal in the assessee’s own case in ITA No. 5428/Mum/2015 for A.Y. 2011-12, order dated 17th December, 2021.

Following this decision, the Tribunal held that the sum of Rs. 4,76,25,000 being a capital receipt from its inception is to be excluded while computing book profits u/s 115JB and also on the ground that it does not form part of the operational working results of the company.

The Tribunal allowed both the grounds of appeal filed by the assessee.

shailesh.kwebmaker

Alleged on-money received cannot be taxed in the hands of assessee, a power of attorney holder – Assessee being power of attorney holder, cannot be treated as rightful owner of the income which has arisen on sale of a particular property as his action was only in a representative capacityAlleged on-money received cannot be taxed in the hands of assessee, a power of attorney holder – Assessee being power of attorney holder, cannot be treated as rightful owner of the income which has arisen on sale of a particular property as his action was only in a representative capacity

34 Bankimbhai D. Patel vs. ITO [(2021) TS-403-ITAT-2021 (Ahd)] A.Ys.: 2003-04 and 2004-05; Date of order: 19th May, 2021 Section 4

Alleged on-money received cannot be taxed in the hands of assessee, a power of attorney holder – Assessee being power of attorney holder, cannot be treated as rightful owner of the income which has arisen on sale of a particular property as his action was only in a representative capacity

FACTS
In this case, the original assessment for A.Y. 2003-04 was completed u/s 143(3) r/w/s 147 assessing total income at Rs. 29,86,640 against a returned income of Rs. 47,120. The case of the A.O. was that the assessee was a power of attorney (PoA) holder of certain pieces of land on which construction was done and these were sold. He received on-money and that on-money has not been accounted for by the assessee. The A.O. recorded the statement of one Rasikbhai Patel who confessed that he paid Rs. 8,71,695 but documents were executed only for Rs. 1,32,500. On the basis of this statement, the A.O. harboured the belief that the difference of these two amounts, i.e., Rs. 7,39,195, was collected by way of on-money. He applied this rate to all the plots sold during the year and believed that the assessee has retained on-money which deserves to be assessed in the hands of the assessee. A similar exercise was done for the A.Y. 2004-05.

When the matter reached the Tribunal, it restored the matter back to the file of the A.O. with a direction to find out as to what was the arrangement between the landowners and the PoA holder and who has received the sale consideration; and whether the recipient of sale consideration has offered capital gains; after examining all these aspects and also after finding out what has happened in the hands of the owners, the A.O. should decide the issue afresh and pass necessary orders.

In the set-aside proceedings from which this appeal has arisen, the A.O. made reference to evidence collected in the first round of the assessment proceedings and added the undisclosed and unrecorded income by way of on-money to the total income of the assessee on the ground that the landowners have not filed their return of income for A.Y. 2003-04.

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

HELD
The Tribunal observed that both the authorities have failed to analytically examine the issue as per the direction of the ITAT in the first round. The A.O. was specifically directed to examine the understanding between the landowners and the assessee; whether it has been agreed that the landowners would receive only the amount mentioned in the sale deed. It noted that the A.O. has not recorded the statement of any of the landowners though he was given all the details. He recorded the statement of one of the purchasers in the first round but that is not a relevant evidence as that evidence can be taken for determination of quantum but cannot be used to determine who received that quantum. The Tribunal found the action of the A.O. in holding that since the landowners have not paid capital gains, on-money is to be taxed as income of the assessee to be illogical.

The Tribunal held that the law contemplates that the A.O. has to first determine in whose hand the income has to be assessed and who is the rightful owner. The assessee being a PoA holder, cannot be treated as the rightful owner of the income which has arisen on the sale of a particular property. His action was only in a representative capacity. It observed that it could have appreciated the stand of the A.O. if he had been able to bring on record the terms of agreement between the assessee as well as landowners specifying the distribution of amount between the assessee in his capacity as PoA holder vis-à-vis the actual owner. No such steps were taken in spite of the specific direction of the Tribunal in the first round. Considering all these aspects, the Tribunal held that there is no justification for sustaining addition in both the assessment years in the hands of the assessee. The appeal filed by the assessee was allowed.

shailesh.kwebmaker

INDIA’S MACRO-ECONOMIC & FINANCIAL PROBLEMS AND SOME MACRO-LEVEL SOLUTIONS

India’s leadership wishes that India be recognised as an economic superpower.

But there is one catch in fulfilling this intent. Can we become an economy that comes in the first five in GDP rankings (although due to our large population, per capita we may still be very low) if we do not really ‘own’ our businesses in financial structures and do not supposedly pay our due share of taxes?

How can there be an entrepreneurial push to an economy when so much of quality time is spent not on expanding business and exploiting opportunities, but on creating ‘suitable business, financial and tax structures’?

Why are Indians considered a model minority culturally overseas when within the country we see examples of businesses defaulting on loans and interest payments with the term ‘wilful defaulter’ being specially coined for them and being accused of ‘tax evasion’?

[Please refer link (as example) – https://wap.business-standard.com/article/companies/around-rs-10-52-trn-corporate-debt-may-default-over-3-years-india-ratings-120030200388_1.html.]

‘Wilful defaulter’ is someone who has the ability to pay but is organising his business with the intent not to pay.

There are two macro-economic and financial problems that India is facing today:
(I) High debt capital gearing, and
(II) Intent of tax evasion (direct and indirect).

(I) High debt capital gearing
A classic case of high capital gearing and borrowings to fund business outcome comes from a major
telecom service provider (source – ‘moneycontrol.com’, standalone financials).

Between the years 2016-17 and 2020-21, this telecom company had these important events:
i)   Increase in equity capital – Rs. 25,130.07 crores;
ii)   Increase in tangible & intangible assets – Rs. 86,637.52 crores;
iii)   Increase in long-term borrowings – Rs. 105,777.67 crores;
iv)   Increase in short-term borrowings – Rs. 39.35 crores;
v)   Losses incurred in this period – Rs. 86,561.43 crores.

One can see that the increase in share capital to fund losses and increase in tangible and intangible assets is much lower than the increase in borrowings. The company has also used operating creditors to fund its business.

In the case of a large Indian entity whose major business is in oil and gas, between the years 2016-17 and 2020-21, the increase in reserves and surplus due to undistributed profits is Rs. 182,980 crores, while the increase in long-term and short-term borrowings is Rs. 92,447 crores. Clearly, there is a good match between increased borrowings and increased profits after tax for the period under review.

‘High Capital Gearing’ in Indian corporates is resulting in a skewed debt to equity ratio. This high debt when not serviced by payments on due dates of interest and principal instalment due, results in the corporate being ultimately called a ‘Non-Performing Asset’ (by bankers as lenders) and the process of recovery of dues starts.

NPAs pose a serious problem for the financial viability of India’s financial lending sector.

(Please see link – https://www.business-standard.com/article/finance/banks-gross-npas-may-rise-to-13-5-by-sept-financial-stability-report-121011200076_1.html.)

NPAs are unfair to the savings class of citizens because they destroy the net worth of banks – very unfairly, the insurance for the individual saving and keeping money in banks is restricted to Rs. 5 lakhs per bank. How this figure of Rs. 5 lakhs has come about is not known. Anybody who has studied Indian middle class savings patterns knows that a very large part of their savings corpus is in bank deposits. More than the borrower being impacted by action against him, the bank customer is hit hard, again very unfairly. Why has the RBI as regulator not thought of protecting the bank depositor by insisting that all deposits should be fully insured for bank default is not known. If the DICGC (Credit Insurance and Credit Guarantee Corporation) which is a 100% subsidiary of RBI does not have the financial muscle to carry the entire risk liability, one can always bring in Indian and overseas insurers for providing the default risk cover.

The issue that needs attention is why do corporates accumulate such high debt (mainly from the banking sector)? The reality is that once the banking sector was opened to private players and long-term funding got opened in foreign exchanges, both the then Development Finance Institutions, ICICI Ltd. and IDBI Ltd., chose to become commercial / retail banks.

As the push for infrastructure came from the Government of India, commercial bankers became financiers of long-term debt (instead of just working capital funding). Bankers who were working capital funding entities started moving into long-term capital funding without truly understanding the implications. The intent of this article is not to comment on fraudulent behaviour or political intervention in sanctioning of loans. That is a different matter and proving of criminal conduct and punishment thereof is outside the scope of this article.

Corporate promoter groups in multiple business types saw an opportunity to draw large debt (facilitated by the financial markets meltdown in 2008 and 2009) and exploited the situation. The absence of the ‘skin in the game’ philosophy resulted in debt being incurred on unmerited and unviable business expansion / extension or new business proposals. In the hope of keeping the engines of growth firing, the banking sector funding went into undependable and unviable projects. Why did banks and financial institutions continue their funding despite ‘High Capital Gearing’ being visible is the question to be asked. The ease of getting borrowings has compounded the problem. Ultimately, the borrower is facilitated and the depositor is ruined!

To be fair, there is no doubt that in many over-leveraged business segments like the realty sector during Covid-19, the business entities have worked towards reducing debt by sale of business, liquidation of assets, etc.

SOLUTION
One part of the solution to avoid ‘High Capital Gearing’ and funding thereof is to have a much better overview of lending proposals and their appraisal at the lenders’ end (banks and financial institutions).

The other part which is systemic in nature is to remove the Income tax shield advantage of interest cost. Any entity has two sources of funds:
1) Shareholders capital – This funding is less popular because returns to shareholders come after corporate or business Income tax.
2) Borrowings – This funding is more popular because interest paid on debt funds is an eligible item of deductible expense, thereby reducing their cost impact for the business.

If a business wishes to give a shareholder dividend of Rs. 1,000 at a corporate income tax rate of 30%, it needs to earn Rs. 1,400+. However, Rs. 1,000 paid as interest on borrowings being eligible for income tax deduction as expense, actually costs Rs. 700 to the business (tax shield Rs. 300).

This business structuring and Income tax differential treatment of interest payment and returns to shareholders post tax, has moved the pendulum unswervingly towards debt from shareholders’ funds. Also, Indian corporate and business management is still very much dependent on family-based promoter groups who clearly would like to keep their exposure to risk at the lowest level. The principle of ‘as little skin in the game’ is followed.

Owing to this family / promoter development in Indian corporates, and maybe because the law is not facilitative enough, we do not have aggressive ‘business control’ wars and that has closed off the option of takeover by a rival if the business is languishing or going down. The IBC comes in much later at the point where insolvency is declared.

This is why in India the promoters’ exposure when business goes down is very low, thanks further to low capital invested. The high risk exposure is taken by the unsecured creditors and debt holders who are the ones taking the ‘haircut’. Hence, we are seeing the way the existing promoter is fighting to retain control of the entity in the Insolvency and Bankruptcy proceedings. Companies languish but don’t die.

(Please see link – https://m.economictimes.com/news/company/corporate-trends/view-india-is-no-country-for-dying-companies/articleshow/85552085.cms.)

Our laws and our infrastructure to ensure timely implementation of laws are often not in sync with one another. This is fully exploited by a defaulting promoter. As the late Mr. Arun Jaitley said, ‘There are sick defaulting companies, but no poor promoters’!

Business Income tax should be based on profit before interest and tax, thereby removing the tax shield that is provided by interest. To compensate for this additional tax outgo, the rate on business income tax should be brought down by about 300 to 500 basis points (3 to 5%). By putting both sources of funds, at the same tax treatment level, the incentive to move towards debt and reduce equity contribution should diminish.

(II) Intent of tax evasion (direct and indirect)
There is no point in repeating ad nauseam that as per Finance Ministry Officials Indians evade both direct and indirect tax. Of course, nobody talks of the fact that agricultural income does not come under Income tax and therefore all international comparisons of percentage of direct taxpayers and percentage of total direct tax collection to total tax collected from individual assessees gets terribly vitiated.

GST has tightened indirect tax compliance to a great extent, but it could still do better on compliance matters. It is one thing to keep saying that Indians are tax-evaders and another to create an environment where tax evasion is not contemplated because it gives very marginal advantage.

SOLUTION
The solution is evident from the problem. There is a need to break the Chinese wall separating the Direct Tax Administration from the Indirect Tax Administration. GST has an issue because it is borne by the end customer who gets no credit on tax and it becomes a cost to him. That is why we have the sales without invoice, the unverified composition dealer sales, etc. Where the income tax payer can take GST credit (CGST, SGST, IGST) totally, he will be quite pleased.

The author is not aware whether fungibility between direct and indirect tax is available in other economies. All economies do have direct and indirect tax payment by the ultimate consumer. However, the Indian situation is different. We need to incentivise the ultimate taxpayer so that tax revenues are buoyant.

Amend the tax laws such that a direct tax payer is permitted GST paid on his personal purchases funded by income (taxable) as a credit. The moment this is done, the customer will insist on getting a proper ‘GST Invoice’. Of course, this GST invoice must have the assessee’s name and PAN #or Aadhaar #. Once the GST invoice is made, the details of a GST dealer will be available. A direct tax payer for the sake of taking GST credits on direct tax liability payable, will file his income tax return, thereby increasing the numbers of income tax returns filers.

Increased GST Returns filings will benefit state governments also in SGST and share of IGST.

It is preferred that agriculture income also comes within the income tax net, although this may have serious political consequences and may need to wait for implementation. Farmers buying agriculture equipment, seeds, fertilisers will be benefited.

In fact, if after full GST deduction the income tax assessee has a tax refund, 40% of that should be given / paid to him as incentive and the other 60% stand cancelled.

Our tax authorities (both direct and indirect) will need to do some original tax thinking. Just stating that Indians evade tax is insulting and does not improve tax compliance. Let them think of a solution that is not very convoluted and cumbersome.

The taxpayer must feel advantaged in filing the direct tax return, The authorities have to integrate direct and indirect tax, since the end customer is paying for the same and is the same person.

The answer to both the above serious problems lies in making the final individual taxpayer the centre of Government and regulatory authorities’ policies. The solution is available, it has to be accepted and implemented.

Of course, there will be serious resistance to the above proposals from the Revenue Ministry and from businesses, for being ‘impractical and unviable’. However, both proposals are of benefit to the individual – whether as bank depositor, shareholder of over-leveraged entities or as taxpayer (direct and indirect tax). The time has come to be different in thinking and implementing policies.

(The author is grateful for the usage of news links which have collaborated his point of view)

shailesh.kwebmaker

IMPLICATIONS OF KEY AMENDMENTS TO COMPANIES ACT, 2013 ON MANAGEMENT AND AUDITORS

The effect of laws and regulations on financial statements varies considerably. Non-compliance with the same may result in fines, litigation or other consequences for the entity that may have a material effect on the financial statements. It is the responsibility of management, with the oversight of those charged with governance, to ensure that operations are conducted in accordance with the provisions of various laws and regulations, including those that determine the reported amounts and disclosures in an entity’s financial statements.

Standards on Auditing (SA) 250, Consideration of Laws and Regulations in an Audit of Financial Statements, deals with the auditor’s responsibility to consider laws and regulations when performing an audit of financial statements. The provisions of some laws or regulations have a direct effect on the financial statements in that they determine the reported amounts and disclosures in an entity’s financial statements, e.g., the Companies Act, 2013 (‘2013 Act’). Other laws and regulations that do not have a direct effect on the determination of the amounts and disclosures in the financial statements, but compliance with which may be fundamental to the operating aspects of the business, to an entity’s ability to continue its business, or to avoid material penalties (e.g., compliance with the terms of an operating license, compliance with regulatory solvency requirements, or compliance with environmental regulations), non-compliance with such laws and regulations may therefore have a material effect on the financial statements. The Code of Ethics issued by the ICAI also includes specific sections on Responding to Non-Compliance of Laws and Regulations (NOCLAR)1 for listed companies. However, the auditor is not responsible for preventing non-compliance and cannot be expected to detect non-compliance with all laws and regulations.

The MCA has issued various amendments to the Companies Act, 2013, including an amendment to Schedule III of the Companies Act, 2013 to increase transparency and to provide additional disclosures in the financial statements, and CARO 2020 to enhance the reporting requirements for auditors. The MCA has also amended the provisions of Rule 11 of the Companies (Audit and Auditors) Rules, 2014 to include additional matters in the Auditor’s Report w.e.f. 1st April, 2021 (except the requirement related to audit trail which is applicable w.e.f. 1st April, 2022).

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1 The ICAI issued an announcement dated 26th July, 2021 and deferred the applicability date of these provisions to 1st April, 2022

This article attempts to provide an overview of the key amendments relating to the definition of listed company, Corporate Social Responsibility and managerial remuneration and related challenges emanating from these amendments and the enhanced role of management and auditors.

I. AMENDMENT TO DEFINITION OF LISTED COMPANY
Section 2(52) of the 2013 Act provides the definition of a listed company. Listed companies under this Act are required to adhere to stricter compliance norms when it comes to filing of annual returns, maintenance of records, appointment of auditors, appointment of independent directors and woman directors, constitution of board committees, etc. This may dis-incentivise (or demotivate) private companies / unlisted public companies from seeking listing of their debt securities even though doing so might be in the interest of the company. Effective 1st April, 20212, the MCA amended section 2(52) of the 2013 Act and Companies (Specification of Definitions Details) Rules, 2014 to exclude the following class of companies from the definition of a listed company:

Public companies which have not listed their equity shares on a recognised stock exchange but have listed:

– Non-convertible debt securities, or
– Non-convertible redeemable preference shares, or
– Both the above categories
issued on private placement basis in terms of the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 / SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013, respectively.

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2 The MCA issued Notification No. G.S.R. 123(E) dated 19th February, 2021 on the
Companies (Specification of Definitions, Details) Second Amendment Rules, 2021

Private companies which have listed their non-convertible debt securities on private placement basis on a recognised stock exchange in terms of the SEBI (Issue and Listing of Debt Securities) Regulations, 2008.

Public companies which have not listed their equity shares on a recognised stock exchange but whose equity shares are listed on a stock exchange in a permissible foreign jurisdiction as specified in the sub-section of section 23(3)3 of the 2013 Act.

It may be noted that SEBI has not modified the definition of a listed company. Accordingly, the implications are limited to the provisions prescribed under the 2013 Act. Some of these considerations are discussed below:

Relaxation for companies from compliances under 2013 Act
Listed companies are required to comply with additional stringent requirements under the 2013 Act, e.g., at least 1/3rd of the total number of directors to be independent directors, appointment of one woman director on the board, appointment of an internal auditor and compliance with auditor’s rotation norms. Companies which no longer qualify as listed companies pursuant to the above amendment would not be required to comply with such stringent requirements.

Besides, it is interesting to note that though the intent of the amendment is to provide relaxations for private / public companies, there might be some unintended consequences as well. One such unintended consequence is the debenture redemption norms. Section 71(4) of the 2013 Act read with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 prescribes the quantum of debenture redemption reserve and the investment or deposit of sum in respect of debentures maturing during the year ending on the 31st day of March of the next year, unless specifically exempted. It may be noted that in accordance with Rule 18(7)(b)(iii)(B), debenture redemption reserve is not required to be created by listed companies having privately-placed debentures. Pursuant to the amendment, these exemptions may no longer be available; creation of the debenture redemption reserve and investment of sums in respect of debentures might become applicable for listed companies having privately-placed debentures. However, this will be subject to clarification by the MCA or the ICAI.

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3 Such class of public companies may issue such class of securities for the purposes of listing on permitted stock exchanges in permissible foreign jurisdictions or such other jurisdictions, as may be prescribed

Preparation of financial statements under Ind AS by the company
One of the criteria for applicability of Ind AS prescribed under the Companies (Indian Accounting Standards) Rules, 2015 is that companies whose ‘equity or debt securities are listed’ or are in the process of being listed on any stock exchange in India (except for listing on the SME exchange or Innovators Growth Platform), or outside India would be required to prepare financial statements as per Ind AS. Further, these Rules provide that once a company starts following Ind AS, it would be required to follow these for all the subsequent financial statements even if any of the prescribed criteria do not subsequently apply to it. Accordingly, companies which no longer qualify as listed companies but have prepared financial statements under Ind AS, would continue to prepare financial statements in accordance with Ind AS.

Private / public companies listing non-convertible debt securities and / or non-convertible redeemable preference shares on a private placement basis are excluded from the definition of ‘Listed company’ as per the amended definition. One may argue that Ind AS applies to all listed companies. Since these companies are not listed companies as defined under the 2013 Act, such companies would not be required to comply with Ind AS (unless other thresholds are met). A closer look at the aforesaid Rules indicates that Ind AS applies to companies whose ‘equity or debt securities are listed’ – instead of ‘listed company’. Hence, strictly speaking, the other possible view is that private / public companies having listed non-convertible debt securities / non-convertible redeemable preference shares on a private placement basis would need to comply with Ind AS. These companies need to consider GAAP applicable to them and their auditors, while issuing an opinion on true and fair view and compliance with accounting standards u/s 133 of the Act, will need to consider this amendment.

Auditors reporting on Key Audit Matters (KAM)
Auditors are required to report Key Audit Matters in the audit report of a listed entity which has prepared a complete set of general purpose financial statements as required by SA 701, Communicating Key Audit Matters in the Independent Auditor’s Report. KAMs are those matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial statements of the current period. The Standard on Quality Control – 1 and SA 220, Quality Control for an Audit of Financial Statements, define a listed entity as an entity whose shares, stock or debt are quoted or listed on a recognised stock exchange, or are traded under the regulations of a recognised stock exchange or other equivalent body.

Different definitions of ‘Listed company’ under the 2013 Act and SA 220 may raise an applicability issue. One may argue that auditing standards are prescribed u/s 143(10) of the 2013 Act. Accordingly, the question is whether a listed company should be understood uniformly for all purposes under the 2013 Act, including while reporting on KAMs, or the definition of SA 220 be applied while auditing and reporting on the company’s financial statements. The definitions under the 2013 Act are for compliance with the legal requirements under the 2013 Act and do not apply to accounting and auditing matters. Since auditors are responsible to conduct audit in accordance with the SA, the auditor should follow the definition of a listed entity as envisaged in the SAs while reporting on KAMs. Hence, one may argue that auditors of all listed companies (even those not considered as listed companies under the 2013 Act) would continue to report on KAMs as required by SA 701. The MCA and the ICAI may consider clarifying this aspect.

Auditor’s reporting on CARO 2020
The Central Government, in exercise of the powers conferred on it under sub-section (11) of section 143 of the Companies Act, 2013 (hereinafter referred to as ‘the Act’), issued the Companies (Auditor’s Report) Order, 2020 on 25th February, 2020. Called CARO 2020 for short, it is applicable for the financial years commencing on or after 1st April, 2021 to a prescribed class of entities including listed companies, public companies and private companies meeting the prescribed thresholds.

One may take a view that CARO 2020 does not prescribe the listing of securities by any company (including a private company) as a criterion for applicability. Hence the change in definition of a listed company may not impact the applicability of CARO. The MCA and the ICAI may consider clarifying this issue. However, reporting on CARO 2020 would continue to apply to all public companies (listed or unlisted).

II. AMENDMENT TO CORPORATE SOCIAL RESPONSIBILITY (CSR) PROVISIONS
Section 135 of the 2013 Act and the Companies (Corporate Social Responsibility Policy) Rules, 2014 (‘CSR Rules’) prescribe the norms relating to CSR. The MCA has recently overhauled the norms and brought significant changes in implementation of CSR initiatives, introduced new concepts like mandatory impact assessment, and prescribed the manner of dealing with unspent CSR amounts. These amendments were notified on 22nd January, 2021. CARO 2020 has also introduced specific additional reporting requirements for the auditors related to unspent amount under sections 135(5) and 135(6) of the 2013 Act. The revised Schedule III under the 2013 Act has added specific disclosures to be made by companies in respect of CSR spend.

The requirement of audit of CSR activities has not been made mandatory under the 2013 Act. However, various provisions of the Companies (Company Social Responsibilities Policy) Rules, 2014 require the monitoring and reporting mechanism for CSR activities.

Auditor’s responsibilities
Wherever an eligible company undertakes CSR activity itself, the key responsibilities of the auditor are summarised below:
• Auditors should check compliance with section 135 of the 2013 Act and check whether the expenditure has been incurred as per the CSR policy formulated by the company;
• The auditor is also required to check whether the activity / project undertaken is within the purview of Schedule VII of the Act;
• If mere contribution / donation is given for a specified purpose, then whether it is specifically allowed as per Schedule VII of the Act;
• The auditor, while opining on the financial statements, will also be required to check whether separate
disclosure of expenditure on CSR activities has been made as per Schedule III applicable for the financial
year ending 31st March, 2021 and additional disclosures as per revised Schedule III have been made by the company for the financial year commencing on or after 1st April 2021;
• The auditor to check whether the company has recorded a provision as at the balance sheet date to the extent considered necessary in accordance with the provisions of AS 29 / Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets, in respect of the unspent amount;
• To check compliance with relevant Standards on Auditing for audit of CSR spend including:
– SA 250 – Consideration of Laws and Regulations in an Audit of Financial Statements;
– SA 720 (Revised) – The Auditor’s Responsibilities Relating to Other Information.

Eligible CSR activities in the context of Covid-19
The MCA has issued a Circular dated 30th July, 2021 clarifying that spending of CSR funds for Covid-19 vaccination for persons other than the employees and their families is an eligible CSR activity under Schedule VII of the Companies Act, 2013. Management would need to establish necessary internal controls to track that the spend is made to benefit persons other than employees and their families.

Increased focus on impact creation
The amendments require every company with an average CSR obligation of INR 10 crores or more (in the three immediately preceding F.Y.s) to undertake an impact assessment of their CSR projects having an outlay of INR 1 crore or more and has been completed not less than one year before undertaking the impact study. The assessment should be carried out through an independent agency and the impact assessment reports should be placed before the board and should be annexed to the annual report on CSR.

Enhanced monitoring mechanism
The amendments significantly enhance the monitoring mechanism and require the CSR committee to formulate and recommend an annual action plan in pursuance of its CSR policy to the board of directors. The action plan should include the prescribed matters such as the manner of execution of such projects or programmes, modalities of utilisation of funds and implementation schedules, and the monitoring and reporting mechanism for the projects or programmes.

The board of the company is required to satisfy itself that the funds disbursed have been utilised for the CSR purposes and in the manner as approved by it. It should be certified by the Chief Financial Officer or the person responsible for the financial management of the company.

The amendments have introduced a new format for the annual report on CSR activities to be included in the board’s report of a company for the F.Y. commencing on or after 1st April, 2020. Some of the new disclosures to be made by companies in the annual report include details of impact assessment of CSR projects (if applicable) along with the report and amount spent on impact assessment, details of the amount available for set-off and details of unspent CSR amount for the preceding three F.Y.s, including amount transferred to unspent CSR account and fund specified in Schedule VII of the 2013 Act. In case of creation or acquisition of a capital asset, additional disclosures are prescribed.

The auditor will also be required to read the information included in the annual report as required by SA 720, The Auditor’s Responsibilities Relating to Other Information.

Unspent CSR amount – Reporting in CARO 2020
Section 135 prescribes a mandatory spending of 2% of the average net profits made by the company during the three immediately preceding financial years on CSR activities. Earlier, section 135 followed a ‘comply or explain approach’, i.e., the board of directors was required to explain in the Board Report the reason for not spending the minimum CSR amount. Accordingly, no provision for unspent amount was required to be made before the amendment.

The MCA observed that a tenable reason does not expel or extinguish the obligation to spend the stipulated CSR amount4. With this objective in mind, section 135 and the CSR Rules were amended and the ‘comply or explain’ approach was replaced with a ‘comply or pay penalty’ approach. The amended provisions now require the following in respect of ‘unspent amounts’:

• On-going CSR projects [Section 135(6)]: In this case, the company should transfer the unspent amount to a special bank account within a period of 30 days from the end of the financial year. The company should spend such amount within a period of three F.Y.s from the date of such transfer as per its obligation towards the CSR policy. In case it fails to do so, it would be required to transfer the same to a fund specified in Schedule VII of the 2013 Act within a period of 30 days from the date of completion of the third financial year.

Other than on-going projects [Section 135(5)]: When there is no on-going project, the unspent amount should be transferred to a fund specified in Schedule VII of the 2013 Act within a period of six months from the end of the financial year.

Additional reporting requirements for CSR have been introduced in CARO 2020 which require the auditor to report on the above two aspects.

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4 Report of the High-Level Committee on Corporate Social Responsibility, 2018

Subsequent to the amendment, the revised Technical Guide on CSR issued by the ICAI provides that an obligation to transfer the unspent amount to a separate bank account within 30 days of the end of the financial year and eventually any unspent amount out of that to a specified fund, indicates that a provision for liability for the amount representing the extent to which the amount is to be transferred within 30 days of the end of the financial year needs to be recognised in the financial statements.

Implementation challenges
The following implementation challenges will need to be considered and evaluated by both the company and the auditor in this regard:

• The CSR amendments do not link the applicability of the amendments to any financial year. It may be noted that the applicability of this amendment is prospective and therefore provision may be required for shortfall for the F.Y. 2020-21 and onwards.

• Assessment of presentation of unspent amount in the CSR bank account in the financial statements may be critical as such amounts would not be available for any other purpose. Ind AS 7 / AS 3 on Cash Flow Statement requires companies to disclose, together with a commentary by management, the amount of significant cash and cash equivalent balances held by the entity that are not available for use by the entity. Thus, the amounts in the unspent CSR bank account should be disclosed as restricted cash with adequate commentary by the management in the financial statements.

• While preparing quarterly financial information, an issue may arise whether provision for CSR obligation for the entire year should be recognised in the first quarter or the provision for unspent amount should be made at the end of the year. In this regard, the ICAI has clarified that for the unspent amount a legal obligation arises to transfer to specified accounts depending upon the fact whether or not such unspent amount relates to on-going projects. Therefore, liability needs to be recognised for such unspent amount as at the end of the financial year. However, the amount spent during the interim period needs to be charged as expense for the same interim period. It cannot be deferred to the remaining interim periods of the financial year.

The amendments have also prescribed significant penalties, e.g., in case of non-compliance with provisions relating to unspent amount a penalty twice the default amount would be imposed on the company subject to a maximum of INR 1 crore. The auditor will need to evaluate the implications on the audit report in case of non-compliance with the mandatory and stringent CSR provisions.

III. MANAGERIAL REMUNERATION
Section 149(9) of the 2013 Act provides that an independent director may receive remuneration by way of profit-related commission as may be approved by the members. In case of no / inadequate profit, section 197 of the 2013 Act permitted payment of remuneration only to its executive directors or managers.

The MCA has extended the model followed for remuneration to executive directors to non-executive directors (including independent directors) by amending section 149 and section 197, and Schedule V to the 2013 Act. Schedule V now prescribes the following limits for payment of remuneration to each non-executive director (including independent directors):

Where the effective capital is	Limit of yearly remuneration payable shall not exceed (INR) in case of other director (i.e., other than managerial person)
Negative or less than INR 5 crores	12 lakhs
INR 5 crores and above but less than INR 100 crores	17 lakhs
INR 100 crores and above but less than INR 250 crores	24 lakhs
INR 250 crores and above	24 lakhs plus 0.01% of the effective capital in excess of INR 250 crores

Remuneration in excess of the above limits may be paid if the resolution passed by the shareholders is a special resolution.

While Schedule V has been amended to include the limits for non-executive directors, Explanation II which provides for computation of effective capital for a managerial person has not been amended. It provides as below:
• Where the appointment of the managerial person is made in the year in which the company has been incorporated, the effective capital shall be calculated as on the date of such appointment;

• In any other case the effective capital shall be calculated as on the last date of the financial year preceding the financial year in which the appointment of the managerial person is made.

In the absence of a specific amendment, one may take the view that similar provisions should be applied for other directors also, i.e., for a non-executive director. The MCA may issue a clarification in this regard.

The above amendment is effective from 18th March, 2021. This means that companies would need to comply with the amended provisions in F.Y. 2020-21 and onwards.

Amendment to remuneration policy
The earlier remuneration policies of the company would not have the flexibility of payment of remuneration in case of no / inadequate profits as payment of remuneration to non-executive directors (including independent directors). Since the amendments now permit payment of remuneration in case of loss / inadequate profits, the remuneration policy of the company would need to be updated so as to comply with these requirements.

Auditor’s reporting
Auditor’s reporting on director’s remuneration in its audit report (under ‘Report on Other Legal and Regulatory Requirement’) will encompass remuneration paid to non-executive directors as well. Since remuneration would be paid to non-executive directors (including independent directors) in case of no / inadequate profits, the auditors would need to verify compliance in this regard.

BOTTOMLINE
The overhaul of the CSR provisions, amendments to the definition of listed company and managerial remuneration highlights the intent of the MCA aimed towards developing a robust and coherent regulatory and policy framework and underlying ecosystem. The primary responsibility of effective implementation of these amendments lies with the management by ensuring their compliance in a timely manner. However, the reporting responsibilities and issuing a true and fair view on the financial statements of the company lies with the auditor. The auditor should keep track of these fast-changing regulations and their consequential implications on the audit report, especially in case there is any non-compliance.

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SPECIAL PURPOSE ACQUISITION COMPANIES – ACCOUNTING AND TAX ISSUES

Special Purpose Acquisition Companies (SPACs) have become a rage in the United States and some other countries over the past few months. SPACs have a number of unique features – they have a limited shelf-life as they are in business only for a few years, they have no object other than acquiring a target company and they do not have too much in common with other corporates in terms of assets, liabilities, employees, etc. SEBI is considering issuing guidelines on how SPACs should operate in India. This article summarises the accounting and tax issues that SPACs could encounter here.

INTRODUCTION
SPACs. The word does not sound very exciting but it is a phenomenon that is taking stock markets (at least in the USA) by storm. The abbreviation expands as Special Purpose Acquisition Companies but a more street-sounding name is ‘blank cheque companies’. These are companies that are set up with next to nothing and list on the stock exchanges only for the purpose of raising capital for acquisitions. In India, SEBI is planning to come out with a framework on SPACs ostensibly to facilitate Startups to list on the exchanges. SPACs are usually formed by private equity funds or financial institutions, with expertise in a particular industry or business sector, with investment for initial working capital and issue-related expenses.

Private companies would benefit from SPACs as they go on to become listed entities without going through the rigours of an Initial Public Offering (IPO). It is not that SPACs is a new phenomenon – the concept of reverse mergers resembles a SPAC in many respects. SPACs are different from normal companies in that they have only one object – to list on the exchanges with the sole intention of acquiring a target company. One of the main advantages of a SPAC is the fact that it can use forward-looking information in the prospectus – this may not be permitted in a usual IPO.

In case the SPAC is not able to identify and acquire a target company within the set time frame it winds up and the funds are returned to the investors. In case the SPAC identifies a target company and enters into a Business Combination, the shareholders of the SPAC will have the opportunity to redeem their shares and, in many cases, vote on the initial Business Combination transaction. Each SPAC shareholder can either remain a shareholder of the company after the initial Business Combination or redeem and receive its pro rata amount of the funds held in the escrow account.

Investors in a SPAC put in a small amount of money for a stake in the company (usually around 20%). They get allotted shares with a lock-in period of up to a year. They have the option of exiting once the lock-in period is over. SPACs would also have similarities with Cat-1 alternate investment funds (AIF’s) – an angel fund listing on the SME platform.

THREE STAGES
Usually, a SPAC will have three phases with different time frames:

*Stage*	*Activity*	*Indicative time frame*
1	IPO	3 months
2	Search for target company	18 months
3	Close transaction	3 months

Ind AS accounting standards
Since all SPACs have to list on some stock exchange, they would have to follow Ind AS accounting standards as it is mandatory for all listed entities.

Stage 1
In Stage 1, SPACs normally issue different types of financial instruments to the founders / investors such as equity shares, convertible shares or share warrants. Investors would be keen to invest in these instruments since the warrants give them an opportunity to get some more shares in case a target company has been identified. Usually, the IPO price is fixed at par (say Rs. 10) while the exercise price of the warrants is fixed about 15% higher. SPACs are forced to invest at least 85% of their IPO proceeds in an escrow account. Accounting for these instruments would be driven by Ind AS 32 / Ind AS 109. Since the SPAC would not be undertaking any commercial activities at this stage, very few Ind AS standards other than Ind AS 32/109 would need to be applied. Typically, at this stage SPACs do not own too many assets. The nature of the financial instruments issued to the investors would determine the accounting. These instruments could be equity instruments, share warrants that are exercisable, convertible shares or bonds and other instruments that are entirely equity in nature. The type of the instrument would determine whether it would be accounted for as equity share capital, under other equity, or as a separate line item ‘instruments that are entirely equity in nature’.

Stage 2
Once a target company has been identified and the acquisition is formalised, Ind AS 103 Business Combinations would have to be applied. There are seven steps in Business Combination accounting:

1.   Is it an acquisition
2.   Identify the acquirer
3.   Ascertain acquisition date
4.   Recognising and measuring assets acquired, liabilities assumed, and NCI
5.   Measuring consideration
6.   Recognising and measuring Intangible Assets
7.   Post-acquisition measurement and accounting

First step – Is it an acquisition?
An amendment to Ind AS 103 has made the distinction between an asset acquisition and a Business Combination clearer. The main pointers are:

1.   Business must include inputs and substantive processes applied to those inputs which have ability to create output / contribute to ability to create output.
2.   Change in definition of ‘output’ – it now focuses on goods and services provided to customers.
3.   Omission of ability to substitute the missing inputs and processes by the market participants.
4.   Addition of ‘Optional Concentration Test’.

Remaining steps
Once the transaction meets the definition of a Business Combination, the other six steps would need to be followed. These would invariably be: identifying the acquirer, determining the acquisition date, measuring acquisition date fair values, measuring the consideration to be paid, recognising goodwill and deciding on post-combination accounting. Business Combination Accounting permits the recognition of previously unrecognised Intangible Assets – this clause would be important for SPACs since they would invariably look at technology companies that have some Intangible Assets for an acquisition.

GOING CONCERN?
Most SPACS have a limited shelf-life of about two to three years. One of the fundamental principles on which the Framework to Ind AS Standards has been formulated is the principle of Going Concern. An interesting question that arises is whether the management will need to comment on the going concern concept since it is clear that the SPAC will not be a going concern in a few years from the date of listing. Usually, SPACs provide a disclosure on their status in the financial statements. The disclosure given below is from the Form 10K (annual report) of Churchill Capital Corp IV for the year ended 31st December, 2020:

‘Our amended and restated certificate of incorporation provides that we will have until 3rd August, 2022, the date that is 24 months from the closing of the IPO, to complete our initial business combination (the period from the closing of the IPO until 3rd August, 2022, the “completion window”). If we are unable to complete our initial business combination within such period, we will: (1) cease all operations except for the purpose of winding up; (2) as promptly as reasonably possible, but not more than ten business days thereafter, redeem the public shares at a per share price, payable in cash, equal to the aggregate amount then on deposit in the trust account, including interest (net of permitted withdrawals and up to $100,000 of interest to pay dissolution expenses), divided by the number of then outstanding public shares, which redemption will completely extinguish public stockholders’ rights as stockholders (including the right to receive further liquidating distributions, if any), subject to applicable law; and (3) as promptly as reasonably possible following such redemption, subject to the approval of our remaining stockholders and our board of directors, dissolve and liquidate, subject in each case to our obligations under Delaware law to provide for claims of creditors and the requirements of other applicable law. There will be no redemption rights or liquidating distributions with respect to our warrants, which will expire worthless if we fail to complete our initial business combination within the completion window.’

It would appear that a disclosure on the above lines would suffice to satisfy the ability of the entity to continue as a going concern during the limited period of its existence.

CONTINGENT CONSIDERATION
A SPAC merger agreement may include a provision for additional consideration to be transferred to the shareholders of the target company in the future if certain events occur or conditions arise. This additional consideration, commonly referred to as an ‘earn-out’ payment, may be in the form of additional equity interests in the combined company, cash or other assets. If the SPAC is identified as the accounting acquirer and the target company is a business, the earn-out payment may represent contingent consideration in connection with a Business Combination. While such payments may be negotiated as part of the merger, the terms of the arrangement need to be evaluated to determine whether the payment is part of or separate from the Business Combination. In making this evaluation, the SPAC should consider the nature of the arrangement, the reasons for entering into the arrangement and which party receives the primary benefits from the transaction.

If the arrangement is entered into primarily for the benefit of the SPAC or the combined company rather than primarily for the benefit of the target or its former shareholders, the arrangement is likely a separate transaction that should be accounted for separately from the Business Combination. For example, payments are sometimes made to shareholders of the target company who will remain as employees of the combined company after the merger. In this case, the SPAC must carefully evaluate whether the substance of the arrangement is to compensate the former shareholders for future services rather than to provide additional consideration in exchange for the acquired business. If the SPAC determines that an earn-out provision represents consideration transferred for the acquired business, the contingent consideration is recognised at acquisition-date fair value under Ind AS 103. However, earn-out arrangements that represent separate transactions are accounted for under other applicable Ind AS. For example, payments made to former shareholders of the target company that are determined to be compensatory are accounted for as compensation expense for services provided in the post-merger period.

TAX IMPACT
Shareholders
At the time of the Business Combination, shares are usually issued. For shareholders under the Indian Income-tax Act, 1961, issue of shares in any form results in a ‘transfer’ of shares held by the existing shareholders of the Indian target entity. The consideration is received in the form of SPAC shares. Capital gains tax may emerge on the sale / swap of shares of the Indian target company against the shares of SPAC. The taxable capital gains would be the excess of the fair market value over the cost of acquisition in the hands of the selling shareholders. Tax rates vary from 10% to 40% under the Indian tax laws, plus applicable surcharge and cess. Tax rates shall primarily depend upon various factors – inter alia, the mode of transfer, i.e., share swap vs. merger, residential status of shareholders, availability of treaty benefits and the period of holding of the shares.

SPAC
A SPAC is required to comply with the applicable withholding tax obligation at the time of discharge of consideration to non-residents, i.e., whether on account of a merger or swap of shares.

If an Indian target company has unabsorbed tax losses and its shareholder voting rights change by more than 49%, then the unabsorbed tax losses would lapse and it shall not be eligible to carry forward its past tax losses.

Once the shares of the SPAC are listed, it is possible that the tax implications of the indirect transfer rules outlined in section 9(1)(i) would need to be considered. However, this would apply only if the SPAC is a foreign company. [Will SPAC be an Indian or a foreign company?] If it is an Indian company, then its shares are actually located in India only. Where is the question of applying indirect transfer rules? For example, a tax liability would arise if a SPAC derives its substantial value from India (more than 50%) under the Indian indirect transfer rules. Shareholders who hold less than 5% of the voting power or the SPAC’s capital are not subject to Indian indirect transfer implications, provided certain conditions are met. For other shareholders, any transfer of SPAC shares results in Indian indirect transfer implications.

SPONSORS
Typically, a SPAC sponsor converts its Class B shares into Class A shares upon successfully acquiring a target company. Depending upon the date and timing of the Business Combination and the conversion of Class B shares into Class A shares, tax implications under the Indian indirect transfer rules need to be evaluated for the SPAC sponsor.

SPACs would also need to consider the implications of Notification No. 77/2021 dated 7th July, 2021 issued by the Central Board of Direct Taxes which clarifies that where the value of net goodwill removed from the block is in excess of the opening written down value as on 1st April, 2020, such excess will now be offered to tax as short-term capital gain.

WOULD SPACs BE A SUCCESS IN INDIA?
The answer to this question would obviously depend on the guidance that SEBI comes up with on SPACs. The Primary Market Advisory Committee of SEBI is deliberating on whether a framework for SPACs should be introduced. The Committee is also looking into any safeguards that should be built into the framework being proposed. From the information available now, SPACs are being set up by hedge funds and private equity investors who plan for a quick exit from their investments in a couple of years. The success of SPACs depends on the existence of companies that are available for a Business Combination. Traditional Indian companies may not be interested in the SPAC route as many would feel that it is too short-term in nature – they are in for the long term. Startups could provide a good source of companies that are SPAC-eligible. India has a large number of Startups but how many of them are worthy of listing remains to be seen. In addition, Indian companies do not have a history of issuing complicated financial instruments which is one of the basic requirements of a SPAC. As things stand today, it would be reasonable to conclude that there will be a few SPAC transactions in India but the concept of SPAC is not going to overly excite everyone at Dalal Street!

shailesh.kwebmaker

MLI SERIES ANALYSIS OF ARTICLES 3, 5 & 11 OF THE MLI

A. ARTICLE 3 – Hybrid mismatch arrangement

Instances of entities treated differently by countries for taxation are commonplace. A partnership is a taxable person under the Indian Income-tax Act, 1961, while in the United Kingdom a partnership has a pass-through status for tax purposes, with its partners being taxed instead. The problems caused by such asymmetric treatment of entities as opaque or transparent for taxation by the Contracting States is well-documented. There have been attempts to regulate the treatment of such entities, notably the 1999 OECD Report on Partnerships and changes made to the Commentary on Article 1 of the OECD Model in 2003. One common problem where Contracting States to a tax treaty treat an entity differently for tax purposes is double non-taxation. Let us take the following example, which illustrates double non-taxation of an entity’s income:

Example 1: T is an entity established in State P. A and B are members of T residing in State R. State P and State S treat the entity as transparent, but State R treats it as a taxable entity. T derives business profits from State S that are not attributable to a permanent establishment in State S.

Figure 1

State S treats entity T as fiscally transparent and recognises the business profits as belonging to members A and B, who are residents of State R. Applying the State R-S Treaty, State S is barred from taxing the business profits without a PE. On the other hand, State R does not flow through the partnership’s income to its partners. Accordingly, State R treats entity T as a non-resident and does not tax the income or tax its partners A and B. The double non-taxation arises because both State R and State S treat the entity differently for taxation. Another problem is that an entity established in State P could have partners / members belonging to third countries (as in Figure 1 above), encouraging treaty shopping.

1.1 Income derived by or through fiscally transparent entities [MLI Article 3(1)]
The Action 2 Report of the Base Erosion and Profit Shifting (BEPS) Project on Hybrid mismatch arrangements (‘Action 2 Report’) deals with applying tax treaties to hybrid entities, i.e., entities that are not treated as taxpayers by either or both States that have entered into a tax treaty. Common examples of such hybrid entities are partnerships and trusts. The OECD Commentary on Article 1 of the Model (before its 2017 Update) contained several paragraphs describing the treatment given to income derived from fiscally transparent partnerships based on the 1999 Partnership Report.

As per the recommendation in the Action 2 Report, Article 3(1) of the Multilateral Instrument (‘MLI’) inserts a new provision in the Covered Tax Agreements (‘CTA’) which is to ensure that treaties grant benefits only in appropriate cases to the income derived through these entities and further to ensure that these benefits are not granted where neither State treats, under its domestic law, the income of such entities as the income of one of its residents. A similar text has also been inserted as Article 1(2) in the OECD Model (2017 Update).

Article 3(1) reads as under:
For the purposes of a Covered Tax Agreement, income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either Contracting Jurisdiction shall be considered to be income of a resident of a Contracting Jurisdiction but only to the extent that the income is treated, for purposes of taxation by that Contracting Jurisdiction, as the income of a resident of that Contracting Jurisdiction.

The impact of Article 3(1) on a double tax avoidance agreement can be illustrated in the facts of Example 1 above. Unless State R ‘flows through’ the income of the entity T to its partners for taxation and tax the income sourced in State S as income of its residents, State S is not required to exempt or limit its taxation as a Source State while applying the R-S Treaty. State S will also not apply the P-S Treaty since the income belongs to the partners of entity T who are not residents of State P. The Source State is expected to give treaty benefits only to the extent the entity’s income is treated for taxation by the Residence State as the income of its residents. The following example illustrates this:

Example 2: A and B are entity T’s members residing in State P and R, respectively. States R and P treat the entity as transparent, but State S treats it as a taxable entity. A derives interest arising in State S. There is no treaty between State R and State S.

Figure 2

In this example, State S will limit its taxation of interest arising in that State under the P-S Treaty to the extent of the share of A in the profits of P. The income derived from the entity by the other member B will not be considered by State S to belong to a resident of State P and it will not extend the P-S treaty to that portion of income. Since there is no R-S treaty, State S will tax the income derived by member B from the entity as per its domestic law.

The OECD Commentary
As per paragraph 7 of the Commentary on Article 1 in the OECD Model (2017 Update), any income earned by or through an entity or arrangement which is treated as fiscally transparent by either Contracting States will be covered within the scope of Article 1(2) [which is identical to Article 3(1) of the MLI] regardless of the view taken by each Contracting State as to who derives that income for domestic tax purposes, and regardless of whether or not that entity or arrangement has a legal personality or constitutes a person as defined in Article 3(1) of the Convention. It also does not matter where the entity or arrangement is established: the paragraph applies to an entity established in a third State to the extent that, under the domestic tax law of one of the Contracting States, the entity is treated as wholly or partly fiscally transparent, and income of that entity is attributed to a resident of that State. State S is required to limit application of its DTAA only to the extent the other State (State R or State P, as the case may be) would regard the income as belonging to its resident. Thus, when we look at the facts in Example 2 above, the outcome will not change even if the entity T is established in State R (or a third state which has a treaty with State S) so long as that State flows through the income of the entity to a member resident in that State.

In other words, State S applies the P-S Treaty because A is a resident of State P and is taxed on his share of income from entity T and not because the entity is established in that State. Similarly, if a treaty exists between State R and State S, State S shall apply that treaty only to the extent of income which State R regards as income of its resident (B in this case).

However, India has expressed its disagreement with the interpretation contained in paragraph 7 of the Commentary. It considers that Article 1(2) covers within its scope only such income derived by or through entities that are resident of one or both Contracting States. Article 4(1)(b) of the India-USA DTAA (which is not a CTA) is on the lines of Article 3(1) of the MLI. On the other hand, Article 1 of the India-China Treaty (which was amended vide a Protocol in 2018 and not through the MLI) requires the entity or arrangement to be established in either State and to be treated as wholly fiscally transparent under the tax laws of either State for the rule on fiscally transparent entities to apply.

Impact on India’s treaties
India has reserved the application of the entirety of Article 3 of the MLI relating to transparent entities from applying to its CTAs, which means that this Article will not apply to India’s treaties. A probable reason could be that India finds it preferable to bilaterally agree on any enhancement of scope of the provisions relating to transparent partnerships to other fiscally transparent entities only after an examination of its impact bilaterally rather than accept Article 3(1) in the MLI, which would have applied across the board to all its CTAs.

1.2 Income derived from fiscally transparent entities – Elimination of double taxation [MLI Article 3(2)]
Action 6 Report of the BEPS Project on Preventing the Granting of Treaty Benefits in Inappropriate Circumstances (‘Action 6 Report’) recommends changes to the provisions relating to the elimination of double taxation. Article 3(2) of the MLI is intended to modify the application of the provisions related to methods for eliminating double taxation, such as those found in Articles 23A and 23B of the OECD and UN Model Tax Conventions. Often, such situations arise in respect of income derived from fiscally transparent entities. For this reason, this provision has been inserted in Article 3 of the MLI which deals with transparent entities. Article 3(2) of the MLI reads as follows:

Provisions of a Covered Tax Agreement that require a Contracting Jurisdiction to exempt from income tax or provide a deduction or credit equal to the income tax paid with respect to income derived by a resident of that Contracting Jurisdiction which may be taxed in the other Contracting Jurisdiction according to the provisions of the Covered Tax Agreement shall not apply to the extent that such provisions allow taxation by that other Contracting Jurisdiction solely because the income is also income derived by a resident of that other Contracting Jurisdiction. [emphasis supplied]

The article on eliminating double taxation in a tax treaty obliges the Contracting States to provide relief of double taxation either under exemption or credit method where the other State taxes the income of a resident of the first State in accordance with that treaty. However, there may be cases where each Contracting State taxes the same income as income of one of its residents and where relief of double taxation will necessarily be with respect to tax paid by a different person. For example, an entity is taxed as a resident by one State while it is treated as fiscally transparent, and its members are taxed instead, in the other State, with some members taxed as residents of that other State. Thus, any relief of double taxation will need to take into account the tax that is paid by different taxpayers in the two States.

Action 6 Report notes that, as a matter of principle, Articles 23A and 23B of the OECD Model require a Contracting State to relieve double taxation of its residents only when the other State taxed the relevant income as the Source State or as a State where there is a permanent establishment to which that income is attributable. The Residence State need not relieve any double taxation arising out of taxation imposed by the other State in accordance with the provisions of the relevant Convention solely because the income is also income derived by a resident of that State. In other words, the obligation to extend relief lies only with that State which taxes an income of a person solely because of his residence in that State. Other State which may tax such income because of both source and residence need not extend relief. This will obviate cases of double taxation relief resulting in double non taxation.

The OECD Commentary gives some examples to illustrate the scope of this provision. Some of these examples are discussed here in the context of the India-France DTAA for the reader to relate to them more easily.

Example 3: The partnership P is an Indian resident under Article 4 of the India-France DTAA. In France, the partnership is fiscally transparent and France taxes both partners A and B as they are its residents.

Figure 3

The only reason France may tax P’s profits in accordance with the provisions of the Treaty is that the partners of P are its residents and not because the income arises in France. In this example, France is taxing income of A and B solely on residence whereas India is taxing income of P on both residence and source. Thus, India is not obliged to give credit to P for the French taxes paid by the partners on their share of profit of P. On the other hand, France will be required to provide relief under Articles 23 with respect to the entire income of P as India may tax that income in accordance with the provisions of Article 7. This is even though India taxes the income of P, which is its resident. The Indian taxes paid by P will have to be considered for exemption under Article 23 against French taxes payable by the partners in France.

Example 4: Income from immovable property situated in other State

Figure 4

The facts are the same as in Example 3 except that P earns rent from immovable property in France. In this example, France is taxing income of A and B on residence and source whereas India is taxing income of P solely on residence. Thus, India is obliged to give credit for French taxes paid, which is in accordance with Article 6 of the India-France Treaty even though France taxes the income derived by the partners who are French residents. On the other hand, France is not obliged to give credit for Indian taxes, which are paid only because P is resident in India and not because income is sourced in India. However, both India and France have to give credit to tax paid in third State as per their respective DTAAs with the third State. If there is no DTAA with the third State, credit may be given as per the respective domestic law [viz., section 91 of IT Act]. Both India and France giving FTC is not an aberration as both would have included income from third State in taxing their residents.

Example 5: Interest from a third state

Figure 5

Here, the facts are the same as in Example 3 except that P earns interest arising in a third State. France taxes the interest income in the hands of the partners only because they are French residents. Consequently, India is not obliged to grant credit for French taxes paid by the partners in France. In this case, India is not obliged to give credit for French taxes paid in accordance with the India-France Treaty only because the interest is derived by the partners who are French residents. Also, France is not obliged to give credit for Indian taxes paid in accordance with the Treaty only because P is resident in India and not because income is sourced in India.

The above discussion is also relevant for countries that have opted for the credit method in Option C through Article 5(6) of the MLI since that Option contains text similar to that contained in Article 3(2).

1.3 Right to tax residents preserved for fiscally transparent entities [MLI Article 3(3)]
It is commonly understood that tax treaties are designed to avoid juridical double taxation. However, treaties have been interpreted in a manner to restrict the Resident State from taxing its residents. Article 11 of the MLI contains the so-called ‘savings clause’ whereby a Contracting State shall not be prevented by any treaty provision from taxing its residents. Article 3(3) of the MLI provides for a similar provision for fiscally transparent entities. The saving clause, as introduced by Article 11, is discussed in greater detail elsewhere in this article.

Impact on India’s treaties
Since India has reserved the entirety of Article 3 of the MLI, paragraphs 2 and 3 also do not apply to modify any of India’s CTAs.

B. ARTICLE 5 – Methods of elimination of double taxation
Double non-taxation arises when the Residence State eliminates double taxation through an exemption method with respect to items of income that are not taxed in the Source State. Article 5 of the MLI provides three options that a Contracting Jurisdiction could choose from to prevent double non-taxation, which is one of the main objectives of the BEPS project. These are described below:

2.1 Option A
Article 23A of the OECD Model Convention provides for the exemption method for relieving double taxation. There have been instances of income going untaxed in both States due to the Source State exempting that income by applying the provisions of a tax treaty, while the Resident State also exempts the same. Paragraph 4 of Article 23A of the OECD Model addresses this problem by permitting the Residence State to switch from the exemption method to the credit method where the other State has not taxed that income in accordance with the provisions of the treaty between them.

As explained in the OECD Model (2017) Commentary on Article 23A (paragraph 56.1), the purpose of Article 23A(4) is to avoid double non-taxation as a result of disagreements between the Residence State and the Source State on the facts of a case or the interpretation of the provisions of the Convention. An instance of such double non-taxation could be where the Source State interprets the facts of a case or the provisions of a treaty in such a way that a treaty provision eliminates its right to tax an item of income. At the same time, the Residence State considers that the item may be taxed in the Source State ‘in accordance with the Convention’ which obliges it to exempt such income from tax.

The BEPS Action 2 Report on Hybrid Arrangements recommends that States which apply the exemption method should, at the minimum, include the ‘defensive rule’ contained in Article 23A(4) in the tax treaties where such provisions are absent. As per Option A, the Residence State will not exempt such income but switch to the credit method to relieve double taxation of its residents [MLI-A 5(3)]. For example, Austria and the Netherlands, both of whom adopt the exemption method to relieve double taxation of their residents, have chosen Option A and have notified the relevant article eliminating double taxation present in the respective CTAs with India. The deduction from tax in the Residence State shall be an ordinary credit not exceeding the tax attributable to the income or capital which may be taxed in the other State.

2.2 Option B
One of the instances of base erosion is commonly found under a hybrid mismatch arrangement where payments are deductible under the rules of the payer jurisdiction but not included in the ordinary income of the payee or a related investor in the other jurisdiction. The Action 2 Report recommends introducing domestic rules targeting deduction / no inclusion outcomes (‘D/NI outcomes’). Under this recommended rule, a dividend exemption provided for relief against economic double taxation should not be granted under domestic law to the extent the dividend payment is deductible by the payer.

In a cross-border scenario, several treaties provide an exemption for dividends received from foreign companies with substantial shareholding. To counter D/NI outcome from such treatment, insertion of a provision akin to Article 23A(4) (described above under Option A) provides only a partial solution. Option B found in Article 5(4) of the MLI permits the Residence State of the person receiving the dividend to apply the credit method instead of the exemption method generally followed by it for dividends deductible in the payer State. None of India’s treaty partners has chosen this Option.

2.3 Option C
Action 2 Report also recommends States to not include the exemption method but opt for the credit method in their treaties as a more general solution to the problems of non-taxation resulting from potential abuses of the exemption method. Option C implements this approach wherein the credit method would apply in place of the exemption method provided for in tax treaties. The deduction from tax in the Residence State shall be an ordinary credit not exceeding the tax attributable to the income or capital which may be taxed in the other State.

The text of Option C contains the words in parenthesis, ‘except to the extent that these provisions allow taxation by that other Contracting Jurisdiction solely because the income is also income derived by a resident of that other Contracting Jurisdiction’. These words are similar to the MLI provision in Article 3(2) relating to fiscally transparent entities. The reader can refer to the discussion under Article 3(2) above, which describes the import of these words, which have also been added in Article 23A-Exemption Method and Article 23B-Credit Method in the OECD Model (2017). As per paragraph 11.1 of the Commentary on Articles 23A and 23B, this rule is merely clarificatory. Even in the absence of the phrase, the rule applies based on the current wording of Articles 23A and 23B.

2.4 Asymmetric application
Article 5 of the MLI permits an asymmetric application with the options chosen by each State applying with respect to its residents. For example, India has chosen Option C which applies to the provisions for eliminating double taxation to be followed by India in its treaties for its residents. The provisions in a treaty to eliminate double taxation by the other State are not affected by India’s choice of Option. Similarly, the other State’s choice also does not affect the provision relating to India. For example, the Netherlands has opted for Option A, while the Elimination article in the treaty for India will not get modified as India has not notified the CTA provision.

2.5 Impact of India’s treaties
India’s treaties generally follow the ordinary credit method to eliminate double taxation of its residents barring a few countries where it adopts the exemption method. India has opted for Option C, which will apply in place of the exemption method in the CTAs, where it follows the exemption method. Accordingly, India has notified its CTAs with Bulgaria, Egypt, Greece and the Slovak Republic. Greece and Bulgaria have reserved the application of Article 5 of the MLI, due to which their CTAs with India are not modified. Both India and the Slovak Republic have chosen Option C and both countries have moved from the exemption method in their CTA to the credit method. As for its CTA with Egypt, India’s Option C applies for its residents while Egypt has not selected any option and the exemption method in the CTA continues to apply to its residents. By opting for Option C with the Slovak Republic and Egypt, India has impliedly applied MLI 3(2) which it has otherwise reserved in entirety.

Of the other countries which apply the exemption method to relieve double taxation of their residents in India’s treaties, Austria and the Netherlands have opted for Option A and notified the CTA provisions. Estonia and Luxembourg, too, follow the exemption method for their residents in their CTA with India. Yet, though they have opted for Option A, they have not notified the relevant provisions and the CTAs shall remain unmodified. Presumably, since the India-Luxembourg DTAA already contains provisions of the nature contained in Option A, and under the India-Estonia treaty, Estonia exempts only that income from taxation taxed in India, these jurisdictions have chosen not to avail of the defensive rule provided in the MLI.

C. ARTICLE 11 – Saving of a State’s right to tax its own residents
3.1 Rationale
A double tax treaty is entered into with the object of relieving juridical double taxation. The double taxation is relieved, either by allocating the taxing rights to one of the contracting States to that treaty, or eliminated by the relief provisions through an exemption or credit method. However, treaties have sometimes been interpreted to restrict the Resident State from taxing its residents in some instances.

One example would be to interpret the phrase ‘may be taxed in the source State’ as ‘shall only be taxed in the source State’, thereby denuding the right of the Residence State to tax its resident. Another example is a partnership that is resident of State P with one partner resident of State R. State P taxes the partnership while State R treats the partnership as transparent and taxes the partners.

Figure 6

The partnership P is resident of State P and is entitled to the P-R Treaty, similar to the OECD Model. If the partnership earns royalty income arising in State R, State R is not entitled to tax the same as per Article 12(1) of the OECD Model which allocates the taxing right only to the residence state, State P. Thus, the partner resident in State R could argue, based on the language of Article 12(1), that State R does not have the right to tax him on his share of the royalty income earned by the partnership since the P-R treaty restricts the taxing right of State R.

However, many countries disagree with this interpretation. Article 12 applies to royalties arising in one State and paid to a resident of the other State. When taxing partner B, State R is taxing its resident on income arising in its territory. To clarify that State R is not prevented from taxing its residents, paragraph 6.1 was inserted to the Commentary on Article 1 of the OECD Model, which reads as under:

‘Where a partnership is treated as a resident of a Contracting State, the provisions of the Convention that restrict the other Contracting State’s right to tax the partnership on its income do not apply to restrict that other State’s right to tax the partners who are its own residents on their share of the income of the partnership. Some states may wish to include in their conventions a provision that expressly confirms a Contracting State’s right to tax resident partners on their share of the income of a partnership that is treated as a resident of the other State.’

The BEPS Report on Action 6 – Preventing Treaty Abuse concluded that the above principle reflected in paragraph 6.1 of the Commentary on Article 1 should be more generally applied to prevent interpretations intended to circumvent the application of a Contracting State’s domestic anti-abuse rules. The report recommends that the principle that treaties do not restrict a State’s right to tax its residents (subject to certain exceptions) should be expressly recognised by introducing a new treaty provision. The new provision is based on the so-called ‘saving clause’ usually found in US tax treaties. The object of such a clause is to ‘save’ the right of a Contracting State to tax its residents. In contrast to the savings clause in the US treaties that apply to residents and citizens, the savings clause inserted into the covered tax agreements by Article 11 of the MLI applies only to residents. The savings clause inserted by Article 11 of the MLI plays merely a clarifying role, unlike the substantial role of the US savings clause due to its more extensive scope.

Article 11 of the MLI is aimed at the Residence State and its tax treatment of its residents. This provision does not impact the source taxation of non-residents. There are several exceptions to this principle listed in Article 11 of the MLI where the rights of the Resident State to tax its residents are intended to be restricted:

a) A correlative or a corresponding adjustment [a provision similar to Article 7(3) or 9(2) of the OECD Model] to be granted to a resident of a Contracting State following an initial adjustment made by the other Contracting State in accordance with the relevant treaty on the profits of a permanent establishment of that enterprise or an associated enterprise;
b) Article 19, which may affect how a Contracting State taxes an individual who is resident of that State if that individual derives income in respect of services rendered to the other Contracting State or a political subdivision or local authority thereof;
c) Article 18 which may provide that pensions or other payments made under the social security legislation of the other Contracting State shall be taxable only in that other State;
d) Article 18 which may provide that pensions and similar payments, annuities, alimony payments, or other maintenance payments arising in the other Contracting State shall be taxable only in that other State;
e) Article 20, which may affect how a Contracting State taxes an individual who is a resident of that State if that individual is also a student who meets the conditions of that Article;
f) Article 23, which requires a Contracting State to provide relief of double taxation to its residents with respect to the income that the other State may tax in accordance with the Convention (including profits that are attributable to a permanent establishment situated in the other Contracting State in accordance with paragraph 2 of Article 7);
g) Article 24, which protects residents of a Contracting State against certain discriminatory taxation practices by that State (such as rules that discriminate between two persons based on their nationality);
h) Article 25, which allows residents of a Contracting State to request that the competent authority of that State consider cases of taxation not in accordance with the Convention;
i) Article 28, which may affect how a Contracting State taxes an individual who is resident of that State when that individual is a member of the diplomatic mission or consular post of the other Contracting State;
j) Any provision in a treaty which otherwise expressly limits a Contracting State’s right to tax its residents or provides expressly that the Contracting State in which an item of income arises has the exclusive right to tax that item of income.

The last item [at serial (j) above] is a residuary provision that refers to the distributive rules granting the Source State the sole right to tax an item of income. For example, Article 7(1) of the India-Bangladesh DTAA provides that the State where a PE is situated has the sole right to tax the profits attributable to that PE and is not impacted by the savings clause. Treaty provisions expressly limiting the tax rate imposable by a Contracting State on its residents are also covered by the exception to the savings clause. An example of such a provision is contained in Article 12(1) of the Israel-Singapore Treaty which states: ‘Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. However, the tax so charged in the other Contracting State shall not exceed 20 per cent of the amount of such royalties.’

3.2 Dual-resident situations
The saving clause in Article 11 of the MLI applies to taxation by a Contracting State of its residents. The meaning of residents flows from Article 4 (dealing with Residence) of the tax treaties and not from the domestic tax law. Thus, where a person is resident in both Contracting States within the meaning of Article 4 of the treaty, the tie-breaker rule in Article 4(2) or (3) will determine the State where that person is resident, and the saving clause shall apply accordingly. The State that loses in the tie-breaker does not benefit from the savings clause to retain taxing right over that person even though he is its resident as per its domestic tax law.

3.3 Application of domestic anti-abuse rules
A savings clause also achieves another objective of preserving anti-abuse provisions by the Resident State like the ‘controlled foreign companies’ (‘CFC’) rules. In a CFC regime, the Resident State taxes its residents on income attributable to their participation in certain foreign entities. It has sometimes been argued, based on a possible interpretation of provisions of the Convention such as paragraph 1 of Article 7 and paragraph 5 of Article 10, that this common feature of CFC legislation conflicted with these provisions. The OECD Model Commentary (2017 Update) on Article 1 in paragraph 81 states that Article 1(3) of the Model (containing the saving clause) confirms that any legislation like the CFC rule that results in a State taxing its residents does not conflict with tax conventions.

3.4 India’s position and impact on India’s treaties
India has not made any reservation for the application of Article 11. Forty-one countries have reserved their application leaving 16 CTAs to be modified by inserting the savings clause. Article 11 of the MLI will have only a limited effect on India’s treaties as India does not have domestic CFC rules and treats partnerships as fiscally opaque. However, it is possible that the interpretation of the courts of the distributive rule ‘may be taxed’ in the Source State as ‘shall be taxed only’ in the Source State, thus preventing the taxation by India of such income of its residents could be impacted.

In CIT vs. R.M. Muthaiah [1993] 202 ITR 508 (Kar), the High Court, interpreting the words ‘may be taxed’ in the context of the India-Malaysia Treaty, held that ‘when a power is specifically recognised as vesting in one, exercise of such a power by other, is to be read, as not available; such a recognition of power with the Malaysian Government would take away the said power from the Indian Government; the Agreement thus operates as a bar on the power of the Indian Government in the instant case.’ The High Court concluded that India could not tax its residents on such income. Article 11 of the MLI could undo the decision to enable India to tax its residents, notwithstanding the said ruling. On the other hand, an alternative interpretation could be that ‘may be taxed’ or ‘shall only be taxed’ are distributive rules in treaties that expressly allocate taxing rights to one or both the Contracting States and are covered by the exception listed in Article 11(1)(j) reproduced above. The saving clause is not targeted at them.

shailesh.kwebmaker

DIGITAL WORKPLACE – WHEN ALL ROADS LEAD TO ROME…

In the previous article we spoke briefly about the ‘Digital Workplace’, its advantages, limitations and so on. ‘Digital Workplaces’ are evolving very quickly; while there are many who feel that these will replace existing physical offices completely, others believe that these will go out of fashion as soon as ‘normalcy’ returns. However, we believe that just like every other technological change, starting from computers to mobile phones, the ‘Digital Workplace’ will not replace the existing way of working but it will co-exist with the existing office environment; however, we will see a digital transformation in the way we work.

Digital transformation is a journey that every firm will have to undertake in its own way with multiple connected intermediary goals, striving, in the end, towards ubiquitous optimisation across processes… and the business ecosystem of a hyper-connected age between people, teams, technologies, various players in ecosystems, etc., is the key to success.

Before talking about the alternatives, we are sure everyone reading this article is aware that a Traditional Office was the basic or primary way that an office existed. A professional wanting to start a business or practice would first look for an ‘Office Place’.

The ‘Office’ had its own advantages and limitations but it was the only way we used to work. Many employees complained about having to get to the office daily, or getting half a day’s wages cut for punching in five minutes late and spending so much critical time travelling to the office. A study by MoveInSync1 found that Indians spend 7% of their day getting to their offices. However, with the outbreak of the pandemic, everything has changed, starting from the perception of individuals to realistic circumstances. Since travelling has not been permitted for the major portions of the years 2020 and 2021, businesses have been left with no option but to switch to digitalisation and to a digital office. In India we call this ‘jugaad’. But the ‘jugaad’ worked! Almost everyone adjusted to the new normal and somehow survived the toughest of times. After the two ‘waves’ that have come and gone and the threat of a third wave looming large, some of the businesses have already restarted and switched back to the traditional office concept. People are taking precautions to the extent possible and are resigned to their fate, but feeling that they do not have any other option, offices are resuming normal work.

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1 https://economictimes.indiatimes.com/jobs/indians-spend-7-of-their-day-getting-totheir- office/articleshow/70954228.cms

But is it true that we do not have any option other than to just move back to our physical offices despite all the inherent dangers? Or can we have better alternatives and take maximum benefit of the learnings from the past and, with the help of technology, find a perfect mixture of physical and digital workplaces to ensure that we do not lose the advantages of a physical office and maximise the available technologies at our disposal?

There are three big limitations of physical or traditional offices:

1. Cost of real estate – Rent, lease, etc.: With the constant rise in the price of real estate and limited supply, the rent in the P&L account is always a significant amount for Indian companies. And some of the well-established businesses which have saved on rent by purchasing office space are now realising that their significant capital is stuck in real estate which is not growing at the same rate as their business. So it is not always wise to invest limited capital in real estate and block it for a long time when as a businessman you can put it to work harder. We have spoken to various professionals from India and received information that the total cost of real estate investment / rent could be between 20 and 40% of the total revenue a firm can generate.

2. Commuting for employees: As stated earlier, in India people spend nearly two hours to reach the office and if that is not already bad, the situation of overcrowded public transport, bad infrastructure and roads, and unrealistic traffic wastes a lot of valuable time of employees in travelling. More often than not, employees going out for a crucial meeting will prefer to leave an hour early instead of risking getting late. However, this leaving early may be good for creating an impression, but the time that it costs can be huge for the overall business. On an average an Indian spent as much as 9% of his time in commuting2 in the pre-lockdown era. Now, due to the lockdown, this cost is only going to be higher.

3. Limitation in hiring: The traditional office works within the four walls of the premise, so many times a company from Chennai or Delhi cannot hire talent from Mumbai or Bangalore unless the employee is willing to relocate; in many cases, companies have to spend extra on relocation expenses, etc.

There are arguments that the above limitations have always existed and these, coupled with other limitations, were always part of the game; companies had come to accept the limitations and functioned without much ado.

So what has changed now? It’s the pandemic which is working either like a blessing in disguise or a ‘rude awakening’ for businesses. Traditional offices may not suddenly go out of fashion, but a shift towards digitalisation which started gradually has taken a huge leap of faith and the pandemic has allowed everyone to adopt the trial and error method as they were assessing the limitations that their businesses were facing due to the ‘Work From Home’ culture. However, while many were struggling during this period, some started thriving and excelled in this new culture. The businesses that understood how technology worked and the best way to utilise the alternatives are now setting the standards for others to follow.

___________________________________________________________

2 https://www.dnaindia.com/mumbai/report-mmrda-you-spend-84-of-your-income-oncommute- 2715777

What are the alternatives to traditional offices?

While the traditional offices may not go out of fashion completely, businesses are finding different ways to mix and match them with the new alternatives available to maximise the work culture vis a vis the cost. There are many different types of offices that are being set up currently. Let us look at some examples:

1. Shared Offices
2. Work From Home
3. Flexi Offices
4. Co-working Spaces
5. Virtual Office (only for registration)

Shared Offices:
XYZ Associates, a CA firm, has 50 employees. Most of them are on audit and mostly never visit the office. XYZ Ltd. had purchased a large office space earlier. Now, realising that it does not need such a big sitting capacity and that it has already spent so much on infrastructure that it is not feasible to change office, it has decided to share its office spaces in a strategic manner so that the total cost is divided. This used to be the practice earlier, especially with brokers at the BSE or at other places where the cost was too high; but now many professionals have started utilising extra space in their offices with clear demarcations and sub-let it to other businesses to improve the return on the capital invested in their bigger office. If need be, in future they may stop sharing the office space.

Honestly, the shared office concept was there even prior to the pandemic but it was very limited and mostly seen as a way to save on rent; but the way shared offices were used was more in the manner of a traditional office where, after sharing the space, the business will occupy its own space and operate just as a traditional office. Now, with technology the concept of shared offices is evolving where businesses are realising that their need for office space may not be constant and, accordingly, the ‘shared office space’ concept has made a comeback where the same old concept is used in a modern way. But the principle is the same.

Work From Home:
Since the onset of the pandemic, XYZ Associates has been left with only one option – Work From Home. It facilitates employees with all necessary hardware and software (readers may refer to our previous article). The work is done, the client is satisfied and the lockdown rules are also not violated. What else do we need?

One of the most used expressions of 2020 has to be ‘Work From Home’ (WFH). Almost all offices have shifted to this culture. People enjoyed working from home till it lasted as the new dressing sense arrived, attending meetings via mobile phone and computer started saving a lot of time and they started getting more time to spend with family; these have helped many people, but after a point of time many got tired as it was merely a makeshift arrangement. However, some companies do prepare well and have utilised the opportunity diligently to ensure that they shift part of their workforce to WFH at a reduced pay; with the kind of savings employees manage on cost of travelling to having to buy or rent a house in a premium location to avoid travelling, many employees have willingly accepted the offer as it has offered a net advantage to them. WFH, if established well in an organisation with a proper digital workplace with impeccable communications, regular flow of information and processes, can help iron out a lot of limitations in businesses.

Flexi Offices:
XYZ Associates earlier had an office with a seating capacity of 100. During the pandemic it realised that a traditional office is a must for multiple purposes (having a registered address for compliances, holding client meetings and important team meets), but everyone need not visit it daily. The cost of such an office is also too high. So it decided to shift to a smaller space with 30 seats and flexi timings. Now the employees can plan and ‘book’ the office for meetings or visits. This has indeed solved many problems for the firm.

This is a new concept in offices that has been growing in recent years. Offices will have the capacity for a limited number of employees and while it will be used as an office, not everyone would be accommodated at the same time. So while most of the employees can continue to work from home, the ‘Flexi Office’ system permits some of the employees to travel to the office in a predetermined way (by appointment!). It can be used for important meetings or discussions which cannot be done via the online mode or when employees are not able to work from home owing to temporary limitations. Organisations will use different methods to regulate who can travel to office, from making an early ‘booking’ to rotating the staff on fixed days to allow them to access the office. In this system, the organisation does not have fixed desks or places for employees – instead, a desk space / seating area is shared and generally allocated on a FIFO basis. The concept of a ‘Flexi Office’ gives the optimum benefits of the traditional office and also an option for organisations to take advantage of technology to save costs as well as hire talent without geographical limitations.

Co-working Spaces:
Mr. A stays on the outskirts of Mumbai and has a downtown office. In an ideal situation, he would love to work from home to save on travel time and cost. But he has various limitations at home: a small home which may not be ideal for attending calls, it would be difficult to ignore guests that may visit during office hours, as also multiple people working from the same home. Mr. A can’t work from home, but also wants to save on travel time and cost.

On the other hand, the firm XYZ Associates where he works wants to save on office infrastructure cost but is not comfortable with employees working from home. They have seen employees’ family members disturbing them during WFH calls or have experienced wi-fi connections getting lost.

Both XYZ Associates and Mr. A agree to opt for Co-working spaces. They find such a space in an area nearest to the employee which offers a desk, electricity, infrastructure and unlimited high speed wi-fi. This will solve everyone’s problem. While Mr. X will take only ten minutes and spend Rs. 20 daily to travel to such a Co-working space, XYZ Associates will save on office infrastructure. Also, when the company offers Co-working to employees in locations like Bandra-Kurla Complex or Nariman Point in Mumbai, it may cost them as much as Rs. 30,000 to Rs. 50,000 per seat but on the outskirts it may go down to Rs. 5,000 to Rs. 10,000 annually.

Co-working spaces are growing in popularity in India and companies like Innov8, WeWork, Springboard, etc. are already investing big time to provide Co-working spaces. Co-working is basically like a shared office but instead of an organisation deciding rules and managing costs, it is managed by a team of professionals who share their space for a fee. For example, just as we pay rent to a hotel to avail all facilities, Co-working is a ‘hotel’ for our business where we can focus just on work and all the formalities from cleaning the space, arranging for coffee, to collecting your courier, etc., is taken care of by the service provider. Plus, Co-working provides no distraction working along with a virtually office-like experience for employees who are working from home. Many Startups that are offering WFH have also started offering incentives to employees if they prefer to work from any of the Co-working spaces near by. And especially in cities like Mumbai where the houses are small and it’s not possible for all employees to manage working from home without distractions, businesses are benefiting from this new option. Co-working charges a minimum monthly or daily fee and lets individuals work without worrying about the other basic necessities like Internet access or arranging for administrative responsibilities.

One can use Co-working spaces by booking a desk for a single day, a week or a month.

Virtual Office (only for registration):
XYZ Limited started its business asking all employees to work from home. Now, since their turnover has crossed the minimum limit for GST registration they are in trouble as to how to do it without an official place of business. So they have been looking for Virtual Offices that charge a minimum amount and let them rent the office only for documentation purposes. XYZ Limited will now have a registered place of business while the employees can still continue working from home.

Virtual Office as a concept is growing in popularity in India owing to regulatory requirements wherein we still need a physical office address to start a business. A Virtual Office is basically a service in which a business owner can show a place as its address for communication and compliance purposes at minimal cost. This becomes useful in cases where a person wants to work from home but does not have all the documents for office premises, or does not want to show the residential address for business correspondence.

CONCLUSION
Growth is optional, but change is constant. There are many examples in the past when companies which have moved along with the shift in technology have gained significant ground vs. the companies that resisted change. The giants of the retail business have fallen because they did not adapt to eCommerce, while newbies of the market like Flipkart and Zomato are becoming far more valuable as they have shown adaptability.

Through this article we are not saying that traditional offices will be out of fashion immediately but now the time has come when, as things have started moving, the one who is ready to adapt to change will thrive. The Digital Workplace is the future and the only thing that is still not clear is the extent to which it will change our lives. Like the computer revolution of the 1980s or mobile phones earlier in this century, every one of us knew it would be a game-changer but ‘how’ was not clear back then. Similarly, the Digital Workplace is going to be the modern way of working and we can either resist the change and delay it, or accept it with open arms and get ready for the future.

shailesh.kwebmaker

WHY INDIA SHOULDN’T JUST AIM TO BE A $5 T ECONOMY

Indians succeed MUCH more in every country compared to India! They are, in fact, a model minority – highly educated, do not seek state support, have the lowest police arrests, blend well culturally and rise to the highest positions in business and profession.

Indians in the US have a per capita income of $55,000 (and average household income of $120,000 surpassing all ethnic groups, including white Americans1). If the same group were in India, the GNP of India will be more than $70 trillion!

India was about 25% of the world’s economy till 18202 when the British arrived. And 130 years later, when they left in 1947, India’s share was 3% (wiping off 2,000 years of growth in one century)! Yet, India was the largest economy in Asia in 1947.

On the other hand, today India’s share of global population is 18% and its share of global economy 7%3, or still 3% in absolute value out of about $100 trillion global GDP. India’s share in global exports was 1.71% in 2019. All of this doesn’t add up and we need to think: What should be India’s share of global economy and exports?

We have to ask: why do Indians not succeed in their own country? How come India is 20% of China when they were both the same in 1980 ($180 bn GDP)? China has more than five times the global trade as India ($800 bn vs. $4.5 tr). India was known for its fabrics for centuries; today Bangladesh has overtaken us in the garment sector and per capita GDP (remember, India had freed Bangladesh just 50 years back). India is the cultural source of nine-tenths of South-East Asian countries, but ASEAN countries have a larger GDP than that of India. Why have countries with bigger disadvantages overtaken India? What is the reason for such a large and long gap between potential and performance when Indians are perhaps as intelligent as anyone else?4

1 Economic Times, 29^th
January, 2021

2 Read Angus Maddison

3 PPP adjusted

4 Attributed to Kishore
Mehbubani’s talk

I think today India is at its historic best opportunity: absence of Nehruvian economics (from 1950 to 1980 we grew at 3.5% per year; global growth was 4.5%; our population grew at 2.5%; hatred for business reached its peak; per capita income grew at 1%; and by 1980 India was the poorest in Asia). Today, youth is power (34% population between 15 and 24 years of age) and hundred other reasons. Therefore, the next ten years are crucial for the speedy growth of India.

Recent data suggests encouraging trends: UPI (3.2 billion transactions, Rs. 5 tr in transactions in March, 2021 compared to Rs. 2 tr in March, 2019); FastTag (192 m transactions since inception, saving fuel and revenue leakage); 55,000 Startups and expected to reach 100,000 by 2025; 58 Unicorns (employ 1.2 m people); Population (fertility is 2% whereas replacement rate is 2.3%); GST (last nine out of ten months generated more than Rs. 1 lakh crores each month); Software exports ($160 bn); Outsourcing (60% of global outsourcing comes to India); the IT Industry is $210 bn. Just imagine, if a food delivery company can add Rs. 100,000 crores to the market cap what can the index do if 20 such IPOs hit the markets! And this at a time when only about 3.4% people invest in stocks (against 50% in the US and 7% in China).

This is perhaps our best window in time before our population starts ageing in about ten years. Why should we not let the Indian tiger out of the cage – not into the zoo or a circus, but into the wide, wild world of competition. India doesn’t deserve to be JUST a $5 tr economy but much more!

Raman Jokhakar
Editor

shailesh.kwebmaker

AS YOU SOW…

One fine morning during the lockdown days, we happened to be listening to a talk which referred to the ‘Karma Account’. As accountancy professionals, we registered the summary as follows:

The rule is Debit for sin and Credit for good deeds. There is also the concept of brought forward of balance in the form of ‘sanskars’ from the previous birth to this one and carry forward from this birth to the next.

Most of us would distinctly recall our elders referring to ‘pichale janam ke sanskar’ (impressions of an earlier life) / ‘pichale janam ka karz’ (debts of an earlier life), etc.

The talk also elucidated the brought forward ‘sanskars’ by referring to child prodigies who, though without training, were manifesting the ‘sanskars’ of their previous birth. In fact, we are always puzzled when we see a scoundrel or a lazy or stupid person rolling in wealth. ‘How can it be?’ is the question that we ask.

A beautiful analogy was provided as an answer to a seemingly difficult riddle. Have you ever been to a flour mill? Sometimes, you see pulses being poured into the hopper at the top but see wheat flour being turned out at the end of the process. And you wonder how this happens, without realising that the wheat that was poured in earlier is now coming out as the white wheat flour. The ground pulses shall appear later. It is only a matter of time.

If this is so, this account of ‘sanskars’ should be kept pure. What will happen if this account is carried forward with inappropriate entries and manipulated transactions resulting from an incorrect living? What will happen in the next birth? Everyone should take care to pass correct entries as a reflection of right knowledge, right faith and right conduct in their present lives so that the balance is either zero (state of bliss) or the balance carried forward is of the nature of credit strengthening our lives in the next birth.

A cursory appraisal of the Brihadaranyaka Upanishad (7th Century BC) at 4.4.5–6 gives us the following:

Now as a man is like this or like that,
according as he acts and according as he behaves, so will he be;
a man of good acts will become good, a man of bad acts, bad;
he becomes pure by pure deeds, bad by bad deeds;

And here they say that a person consists of desires,
and as is his desire, so is his will;
and as is his will, so is his deed;
and whatever deed he does, that he will reap.

The Jain philosophy elaborately provides for the nature and working of Karma as also the pathway to be free of the Karmic Account – released of worldly affairs and into the perfect blissful state, i.e., moksha.

To conclude, we cannot but help recall Kabir who said

Kabir so dhan sanchiye, jo aage ko hoye
sees charaye potli, le jaat na dekhya koye

Kabir, accumulate the wealth that is for the beyond
None has been seen to depart carrying a bag of material wealth.

shailesh.kwebmaker

WHO CONTROVERSY: LACK OF GLOBAL LEADERSHIP IN CORONA CRISIS

INTRODUCTION

When the metaphorical ship of a growing,
prosperous world hit the figurative iceberg of Covid-19, it sank and it sank
like no ship had ever sunk before. While all of this happened, the WHO behaved
very much like the band in the movie ‘Titanic’ that continued to play songs
while lives were lost and the ship sank.

The World Health Organization (WHO) was
established on 7^th April, 1948 and was entrusted with the responsibility
of creating a better, healthier future for people all over the world. It was
assigned the role of providing leadership on matters critical to health,
shaping the research agenda and stimulating the generation, translation and
dissemination of valuable knowledge. However, when D-Day beckoned, the WHO
failed and it failed gloriously. Just when the world was looking up to this
multinational body, it failed with repercussions that will perhaps only get
worse in the course of time.

Covid-19 has fallen like a clutch of bombs
on the world. As of today, the number of coronavirus cases stands at a
bewildering figure of 1,71,51,191 and has claimed 6,69,435 innocent lives. It
is truly astonishing that despite technical advancements, life-changing inventions
and incredible leaps in the field of medicine, we are still in such a situation
that things are worsening day after day, every day. There is perhaps nothing
better to showcase the gruesomeness of our reality. This is the question
uppermost in the minds of everyone, whether a daily wage labourer in a small
village in Uttar Pradesh, or a migrant worker desperately trying to go back
home from Mumbai to Bihar. The world today asks the same question and does so
in bewilderment when a prestigious and well-funded global watchdog for health,
the WHO, appears to have fallen flat on its face.

Let us look at the attitude that the
international health body has displayed. Look at the statements of some of its
members, such as Prof. Dieder Houssin, who is also a member of the Review
Committee, International Health Regulations. On 23^rd January he
said, ‘Now is not the time. That’s a bit too early to consider that this
event is a public health emergency of international concern’.

These comments were made on the exact day
when the lockdown commenced in the city of Wuhan where it all started. It is
perhaps because of the sluggishness and negligence of such massive proportions
that we face a time where there is little hope for those who have to choose
between food on the table and contracting the deadly virus. The world today is
paying the cost for the blunders committed by the WHO. Its leadership has
proved to be ineffective and is likely to adversely affect the lives of
billions who now confront a prolonged tragedy worsened by an economic slowdown
of gigantic proportions.

Through this paper I attempt to draw the
reader’s attention to the shortcomings of and the blunders committed by the WHO
which have led us to where we are today.

BACK IN TIME

The SARS epidemic of 2002-03 had let loose
fear, concern and death in a similar manner. Even then, China was slow to
acknowledge the epidemic domestically and failed to inform the global community
about its possible spread.

During the SARS epidemic, WHO was quick to
recommend travel restrictions and criticise China for delaying the submission
of vital information that would have limited its global spread. Even after
eradication of SARS, WHO warned that the world would not remain free from other
novel forms of the coronavirus. The then Director-General of WHO, Dr Gro Harlem
Brundtland, implored the international community to investigate possible animal
reservoirs that could be a source for future outbreaks and better study the
movement of the virus to humans.

China’s wet markets were specifically
identified as a likely environment for the virus to incubate and jump from
animals to humans. The mutable nature of the virus, coupled with China’s rapid
urbanisation, proximity to exotic animals and refusal to tackle illegal
wildlife trade and commerce, were together termed a ‘time bomb’ by a research
paper in 2007.

As late as December, 2015 the coronavirus
family of diseases was selected to be included in a list of priorities
requiring urgent research and development. It was earmarked as a primary
contender for emerging diseases likely to cause a major pandemic.

JUMP TO PRESENT

Here is a list of mistakes that the WHO
committed. Had these been avoided, it could have changed the history of the
world as we know it today.

Mistake 1: Sluggish reaction

China informed WHO on 31^st
December, 2019, while it was first public on news channels on 8^th
January, 2020. Surprisingly, when a pneumonia-like virus was detected in Wuhan
in late December, 2019, the WHO reacted sluggishly. Dr. Tedros Adhanom,
Director-General of WHO, applauded China’s ‘commitment to transparency’ in the
early days of the epidemic in January.

Mistake 2: Denied human-to-human
transmission

The WHO denied evidence of human-to-human
transmission on 14^th January, 2020 which has now become a famous
tweet by the WHO.

WHO refused to acknowledge the
human-to-human transmission of the virus despite several cases already showing
transmission. WHO also castigated countries like the USA and India who started
restricting flights to and from China or issued travel advisories.

Mistake
3: Ignored Taiwan which had critical information

One country that got their advice was
Taiwan, which also warned the WHO that it suspected the virus was spreading
through human-to-human transmission. Taiwan, which has one of the lowest rates
of known Covid-19 infections per capita among countries impacted by the virus,
was prevented from joining the WHO as a member country in 2015 by China which
refuses to acknowledge its independence. A newspaper headline of 3^rd
April, 2020, said famously, ‘The WHO Ignores Taiwan. The World Pays the
Price’.

In late March, WHO Epidemiologist Bruce
Aylward declined to answer a Hong Kong reporter’s question about Taiwan, or
even acknowledge its existence.

As Taiwan was distributing facemasks to its
citizens, the WHO was advising the rest of the world that they were doing so
unnecessarily while initially the CDC and the US Surgeon-General followed its
lead; but health experts pointed out as to how mounting evidence that masks can
help slow the spread of respiratory diseases by about 50%, especially among
asymptomatic carriers in a population, and what the WHO maintained was
virtually non-existent despite mounting evidence to the contrary in
mid-February.

A CNN Health news article said, ‘Infected
people without symptoms might be driving the spread of coronavirus more than we
realised”

While Beijing informed the WHO on 31^st
December, there are expert estimates that the virus had spread to humans as far
back as October.

Mistake 4: Delayed response

Even after being told, the WHO showed no
urgency to send an investigative team, careful not to displease the Chinese
government. A joint WHO-Chinese team went to Wuhan only in mid-February and
wrote a report with decidedly Chinese characteristics misleading the entire
world of the then situation.

A South China Morning Post article said, ‘Coronavirus: China’s first confirmed Covid-19
case traced back to November 17’.

Mistake 5: Misled the world

Covid-19 continued to exhibit
characteristics of a pandemic, spreading rapidly around the world. But not only
did Dr. Tedros Adhanom and his team fail to declare a public health emergency,
they also urged the international community to not spread fear and stigma by
imposing travel restrictions.

The global health body even criticised early
travel restrictions by the US as being excessive and unnecessary. It declared
Covid-19 as a pandemic only on 11^th March.

Mistake 6: Criticised preventive measures

Following the WHO’s advice, the European
Centre for Disease Prevention and Control (ECDC) suggested that the probability
of the virus infecting the EU was low, likely delaying more robust border
controls by European states.

As the virus continued spreading across
Europe and reached America, WHO recommended that the travel industry maintain
the status quo. Dr. Tedros said on 3^rd February: ‘There is
no reason for measures that unnecessarily interfere with international travel
and trade.’

Mistake 7: Didn’t learn from mistakes

Indeed, the WHO’s response to Ebola was
similarly criticised by the international community. This is not a first in
WHO’s history. In the 1950s and 60s, WHO found itself manoeuvring between the
Soviet-led Communist bloc and the US.

Mistake 8: Colluding with China

The first cases of the Wuhan virus were seen
as early as November but the Chinese government silenced the whistleblowers and
downplayed the threat. Dr. Lee Wenliang is one of those whistleblowers who died
as a hero trying to sound the alarm of coronavirus weeks before he contracted
the illness himself and died. The CNN news headline on 11^th February
was: ‘China’s hero doctor was punished for telling truth about coronavirus.’

During such testing times, the WHO only
continued to please the authoritarian government of China. It praised China for
releasing the virus’s genome while neglecting to mention that it took them at
least 17 days to do so.

China also did not report human-to-human
transmission until late January, even though Chinese doctors suspected the same
at least a month earlier. WHO scientists weren’t allowed into Wuhan until three
weeks after the outbreak first came to light. While all of this happened, Dr.
Tedros continued to glorify the all-powerful regime by saying, ‘We would have
seen many more cases outside China by now if it were not for the government’s
efforts to protect their own people and the people of the world. The Chinese
government is to be congratulated for the extraordinary measures it has taken
to contain the outbreak’.

There is nothing hidden about China’s
efforts at undermining international organisations. Its growing clout in
international organisations is creating new fault lines in global politics and
the WHO has been an early victim. Remember, the WHO, led by Margret Chan in
2013 was one of the first international institutions to have signed an MoU with
China to advance health priorities under the Belt and Road Initiative.

China has not only attempted to censor all
official accounts of its early failings but has also employed an overt global
disinformation campaign, trying to pinpoint the source of the outbreak as the
US or Europe.

It is an irony of our times that the world’s
most potent authoritarian state (China) heads over a quarter of all specialised
agencies in the UN, ostensibly the centrepiece of the international liberal
order.

Mistake 9: Personal interest

Dr. Tedros, an Ethiopian politician, was
also seen as a China-backed candidate in 2017 for the Director-General’s
election. The ex-Health Minister of Ethiopia has favoured China in innumerable
ways which may be due to China having made a lot of investments in Ethiopia
under the One Belt One Road initiative and because Ethiopia does not want to
anger the red dragon. Dr. Tedros could also be favouring China because of these
reasons. In late January, he visited China and on 28^th January he
met with President Xi Jinping in Beijing. Following the meeting, he commended
China for ‘setting a new standard for outbreak control’ and praised the
country’s top leadership for its ‘openness to sharing information’ with the WHO
and other countries.

Dr. Tedros said on 5^th February
that ‘China took action massively at the epicentre and that helped in
preventing cases from being exported’.

Mistake 10: Political background

Dr. Tedros’ inaction stands in stark
contrast to the WHO’s actions during the 2003 SARS outbreak in China.

The then WHO Director-General, Dr. Gro
Harlem Brundtland, who had been the Prime Minister of Norway twice, made
history by declaring the WHO’s first travel advisory in 55 years which
recommended against travel to and from the disease epicentre in southern China.
Dr. Brundtland also criticised China for endangering global health by
attempting to cover up the outbreak through its usual playbook of arresting
whistleblowers and censoring the media. It is said that Dr. Tedros is not from
a political background, hence he is unable to face China bluntly and blame it
for the coronavirus.

Mistake 11: Funding

WHO has
required voluntary budgetary contributions to meet its broad mandate. In recent
years, it has grown more reliant upon these funds to address its budget
deficits.

This dependence on voluntary contributions
leaves WHO highly susceptible to the influence of individual countries or
organisations. China’s WHO contributions have grown by 52% since 2014 to
approximately $86 million.

CONCLUSION

It is an open secret among international
diplomats and public health experts that WHO is ‘not fit for its mission’,
riddled as it is with politics and bureaucracy. Given its previous failures and
the warning that was SARS, its leadership has no excuse for reacting in such a
sluggish and indifferent manner.

A global
pandemic does not occur every time a novel infectious pathogen emerges. It does
when there is an absence of accurate information about the pathogen and a
failure of basic public services – in this case, the failure to regulate food
and marketplaces to prevent the transmission of pathogens and the failure to
shut down transportation and control movement once it spreads. When authorities
regulate public health, share information about a pathogen and co-operate to
control its movement, diseases are contained and pandemics are unlikely to
occur.

The collateral price that the world has paid
for this lesson is perhaps too exorbitant. Hopefully, we will take a leaf from
this book and have better, more accountable and robust structures in place for
such pathogens that threaten all life on our planet.

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https://www.usnews.com/news/world/articles/2020-02-03/who-chief-says-widespread-travel-bans-not-needed-to-beat-china-virus

11.
https://www.cnn.com/asia/live-news/coronavirus-outbreak-02-04-20/index.html

12.
https://www.bbc.com/news/world-asia-china-51409801

* The above article was chosen as the
best article from over 50 entries submitted at
‘Tarang 2020’, the 13^th Jal Erach CA Students’ Annual Day organised
by the BCAS. One of the features of this year’s event was ‘Writopedia’.

Indian Firm made the world’s first cruelty free soap;
got Rabindranath THakur to model for it

The first rule of every manufacturing company is to
keep its process a secret. But Godrej brothers did the opposite and distributed
pamphlets in Gujarati that explained the process of making soaps from vegetable
oils. Did it establish trust and appealed a larger audience? You bet.

Rabindranath Thakur sits in his quintessential calm
position in a photo, hands obediently placed on his laps as he stares into the
abyss. Next to his portrait is a quote that reads, “I know of no foreign soaps
better than Godrej’s and I will make a point of using it.”

Yes, as hard as it may seem to believe, the Nobel
Laureate had agreed to endorse a toilet soap in the early 1920s. Not just him,
other freedom fighters like Annie Besant and C. Rajagopalachari also followed
suit and marketed the ‘Godrej No. 1’ soap.

The aim was to promote the first made-in-India and
cruelty-free soap and further strengthen India’s freedom struggle movement, and
the leaders made their political statements by requesting people to cripple the
economy of colonisers by boycotting foreign goods and instead opting for
something that is ‘for Indians, and by Indians’.

Ardeshir Godrej, a businessman by profession and patriot
at heart, is the man behind starting this humble swadeshi brand in 1897. His
younger brother Pirojsha also joined the business and together they came to be
known as the Godrej Brothers.

Fast forward to 2020, a 122-year-old consumer-goods
giant, the Godrej Group controls $4.7 billion revenue. It comprises five major
companies with interests in real estate, FMCG, agriculture, chemicals and
gourmet retail.

Godrej has not only been an undying witness to India’s
rapid development but has also paved way for many ‘firsts’ in India including
springless lock, Prima typewriter, ballot box and refrigerators.

(Better India, August 7, 2020)

shailesh.kwebmaker

SOME USEFUL APPS

In this month’s edition we
look at some apps which are useful to us professionally.

McKINSEY INSIGHTS

The McKinsey Insights
app offers business insights and analysis on the biggest issues facing senior
executives today – from leadership and corporate strategy to the future of work
and AI’s impact on business and society. In addition, explore new articles on
digitisation, marketing and analytics across industries such as consumer goods,
financial services and tech. In fresh content updated daily, McKinsey
consultants and contributing experts look at the latest in climate change,
diversity and inclusion in the workplace, organisational restructuring,
bringing data to bear on business strategy and more. Content includes articles
from McKinsey Quarterly, reports from the McKinsey Global Institute, podcasts
and videos.

This app allows you to
view recent and most popular content, save articles for offline reading and
register to personalise your app experience.

The best part is that all
content is free. Go ahead, get insights into your business and professional
world today!

Android: https://bit.ly/2Q1Un4TiOS:
https://apple.co/3l2fylN

LINKEDIN – SLIDESHARE

LinkedIn SlideShare is the world’s largest community for sharing
presentations and professional content, with 60 million unique visitors a month
and more than 15 million uploads. It is much more than just slides. Find
infographics, videos, how-to guides, data and analytics reports, industry
research, thought-leadership articles, Q&As, DIY instructions, visual
guides and more. You can follow companies and organisations like Dell, Ogilvy,
the White House, Netflix, NASA and more, who share their expertise on
SlideShare.

Students can use
SlideShare for academic research, professionals can deepen their industry
knowledge and everyone can explore interesting topics to learn something new.

You can save your
favourites to read later (even offline) on your phone or Android tablet. And
now you can even clip the best content on SlideShare and organise your research
into Clipboards, all in one place.

Android: http://bit.ly/2GpTq1PiOS:
https://apple.co/2Z3fjet

LAYOUT FROM INSTAGRAM: COLLAGE

This is a simple app which
allows you to stitch up to nine images together and load them onto Instagram.
Instagram allows you to add only one image at a time. However, sometimes you
may wish to combine multiple similar selfies or landscape shots to fit into one
collage picture. This app lets you do just that.

It also helps you tweak many
parameters for each photo, including the size, border width or zoom. You are
the editor, so feel free to experiment and get creative – tell a story, show
off an outfit, or just splice, dice and change the look of your regular photos
to convey a mood or theme.

The app also has three
handy buttons at the bottom to replace an image, mirror it or flip it upside
down. The final product can be quite neat and impressive. It can be further
enhanced by using Instagram’s native filters.

Android:
http://bit.ly/2L5glDI iOS: https://apple.co/2L5ljAl

TICKTICK

TickTick is a simple and effective to-do list and task manager
app which helps you make schedules, manage time, remind about deadlines and
organise life at work, home and everywhere else. It is very easy to get started
with its intuitive design and personalised features. Add tasks and reminders in
mere seconds and then focus on important work. The app syncs across devices, so
you are always up to date.

You can add your tasks by
voice input or by typing. With Smart Date Parsing, the date info you enter into the new field will be automatically set as due date for task reminder with an
alarm. You can set multiple notifications for important tasks and notes to
never miss any deadline.

You can even get easy
access to your tasks and notes by adding a checklist widget to your home
screen. That is pretty neat.

Android: http://bit.ly/2KF9uAG iOS:
https://apple.co/2N9Tp7R

INSTAPAPER

Instapaper is the simplest way to save and store articles for
reading: offline, on-the-go, anytime, anywhere, perfectly formatted. It
provides a mobile and tablet-optimised text view that makes reading Internet
content a clean and uncluttered experience. Read offline, even on airplanes,
subways, on elevators, or on Wi-Fi-only devices away from Internet connections.
It saves most web pages as text-only, stripping away the full-sized layout to
optimise for tablet and phone screens with adjustable fonts, text sizes, line
spacing and margins.

You
have the option to sort and search downloadable files for easy access. You can
download up to 500 articles on your phone or tablet and store unlimited
articles on the Instapaper website. Dictionary and Wikipedia lookups, tilt
scrolling, page-flipping, preview links in the built-in browser without leaving
the app are all available, just like in Kindle.

A great app to consume
content at your own time and space.

Android:
http://bit.ly/2FxujtG iOS: https://apple.co/2FAjrv5

I hope you will be able to use these apps
effectively to become more productive in your professional life.

shailesh.kwebmaker

TAXABILITY OF A PROJECT OFFICE OR BRANCH OFFICE OF A FOREIGN ENTERPRISE IN INDIA

In our last article
published in the August, 2020 issue of the BCAJ, we discussed various
aspects relating to taxability of a Liaison Office (LO) in India, including the
recent decision of the Supreme Court in the case of the U.A.E. Exchange Centre.

In addition to a Liaison
Office (LO), Project Offices (PO) and Branch Offices (BO) of foreign
enterprises have also been important modes of doing business in India for many
foreign entities.

Issues have arisen for
quite some time as to under what circumstances a PO / BO has to be considered
as a Permanent Establishment (PE) of a foreign enterprise in India and then be
subjected to tax here.

In this article, we
discuss various aspects relating to taxability of a PO / BO in India, including
the recent decision of the Supreme Court in the case of Samsung Heavy
Industries Ltd.

BACKGROUND

The determination of tax
liability of a foreign enterprise has been a contentious subject in the Indian
tax regime for a very long time. And whether a foreign enterprise has a PE in
India has been a highly debatable issue, though it is very fact-intensive. The
ITAT and the courts have been taking different views based on the facts of each
case.

A Project Office means a
place of business in India to represent the interests of the foreign company
executing a project in India but excludes a Liaison Office. A Site Office means a
sub-office of the Project Office established at the site of a project but does
not include a Liaison Office.

A foreign company may open
project office(s) in India provided it has secured from an Indian company a
contract to execute a project in India, and (i) the project is funded directly
by inward remittance from abroad; or (ii) the project is funded by a bilateral
or multilateral international financing agency; or (iii) the project has been
cleared by an appropriate authority; or (iv) a company or entity in India
awarding the contract has been granted term loan by a public financial
institution or a bank in India for the project.

A Branch Office in
relation to a company means any establishment described as such by the company.

As per Schedule I read
with Regulation 4(b) of the FEM (Establishment in India of a Branch Office or a
Liaison Office or a Project Office or any Other Place of Business) Regulations,
2016 [(FEMA 22(R)], a BO in India of a person resident outside India is
permitted to carry out the following activities:

(i) Export / import of goods.

(ii) Rendering
professional or consultancy services.

(iii) Carrying out
research work in which the parent company is engaged.

(iv) Promoting technical
or financial collaborations between Indian companies and parent or overseas
group company.

(v) Representing the
parent company in India and acting as buying / selling agent in India.

(vi) Rendering services in
Information Technology and development of software in India.

(vii) Rendering technical
support to the products supplied by parent / group companies.

(viii) Representing a
foreign airline / shipping company.

Normally, a branch office
should be engaged in the same activity as the parent company. There is a
difference between the PO / BO and LO, both in terms of their models and, more
importantly, their permitted activities. As per the FEMA 22(R), an LO is
permitted to carry out very limited activities and can only act as a
communication channel between the source state and the Head Office; whereas a
PO / BO is permitted to carry out commercial activities, but only those
specified activities as per the RBI Regulations.

Thus, under FEMA 22(R) a PO
is allowed to play a larger role as compared to an LO in India. Further, the
scope of permitted activities of a BO provided in Schedule I of FEMA 22(R) is
much larger than the scope of permitted activities of an LO provided in
Schedule II of FEMA 22(R).

In National
Petroleum Construction Company vs. DIT (IT) [2016] 66 taxmann.com 16 (Delhi),
the Delhi High Court, after referring to the definitions of LO and PO in the
Foreign Exchange Management (Establishment in India of Branch or Office or
Other Place of Business) Regulations, 2000, held that ‘It is apparent from
the plain reading of the aforesaid definitions that whereas a liaison office
can act as a channel of communication between the principal place of business
and the entities in India and cannot undertake any commercial trading or
industrial activity, a project office can play a much wider role. Regulation (6)(ii)
of the aforesaid regulations mandates that a “project office” shall not
undertake or carry on any other activity other than the “activity relating
and incidental to execution of the project”. Thus, a project office can
undertake all activities that relate to the execution of the project and its
function is not limited only to act as a channel of communication.’

WHETHER A PO / BO CONSTITUTES A PE IN INDIA?

As mentioned above, as per
the prevailing FEMA regulations a PO / BO can carry out activities which may
not be limited to acting as a communication channel between the parent company
and Indian companies.

An issue that arises for
consideration is whether just because the scope of the permitted activities of
a PO / BO is much wider as compared to an LO under FEMA 22(R), would that be an
important consideration in determining the existence of a PE of a foreign
enterprise in India?

Due to the difference in
scope of activities to be carried out by an LO and a PO / BO, the assessing
officers many a times take a stand that the PO / BO is a PE of a foreign
enterprise as they are permitted to carry out commercial activities as compared
to an LO. This perception leads to the conclusion of a PO / BO being a PE in
India.

In order to decide whether
a PO / BO constitutes a PE in the source state, the actual activities carried
out by them in India need to be minutely analysed irrespective of the fact
whether such activities were carried out in violation of FEMA regulations and
RBI approval.

RELEVANT
PROVISIONS OF THE INCOME-TAX ACT, 1961 (the ITA) and the (DTAAs) relating to
PEs

Definition
under the ITA

Section 92F(iiia) defines
a PE as follows: ‘permanent establishment’, referred to in clause (iii),
includes a fixed place of business through which the business of the
enterprise is wholly or partly carried on.’

Section 94B defines a PE
as a ‘permanent establishment’ and includes a fixed place of business
through which the business of the enterprise is wholly or partly carried on.

Similarly, Explanation (b)
to section 9(1)(v), Explanation (c) to sections 44DA, 94A(6)(ii) and 286(9)(i)
defines a PE by referring to the definition given in section 92F(iiia).

It is important to note
that under the ITA a PE is defined in an inclusive manner. It has two limbs,
i.e. (a) it has to be a fixed place of business, and (b) through such fixed
place the business of the enterprise is wholly or partly carried on.

Definition of
Fixed Place PE and exceptions under the OECD Model Conventions

Since the publication of
the first ambulatory version of the OECD Model Convention in 1992, the Model
Convention was updated ten times. The last such update which was adopted in
2017 included a large number of changes resulting from the OECD / G20 Base
Erosion and Profit Shifting (BEPS) Project and, in particular, from the final
reports on Actions 2 (Neutralising the Effects of Hybrid Mismatch
Arrangements), 6 (Preventing the Granting of Treaty Benefits in
Inappropriate Circumstances), 7 (Preventing the Artificial Avoidance
of Permanent Establishment Status), and 14 (Making Dispute
Resolution Mechanisms More Effective), produced as part of that project.

Article 5(1) of the OECD
Model Convention 2017 update defines the term ‘permanent establishment’ as
follows:

‘1. For the purposes of
this Convention, the term ‘‘permanent establishment’’ means a fixed
place of business through which the business of an enterprise is wholly
or partly carried on.

Article 5(2) of the OECD
Model Convention 2017 provides that the term ‘permanent establishment’
includes, especially, (a) a place of management; (b) a branch; (c) an
office; (d) a factory; (e) a workshop; and (f) a mine, an oil or gas well,
a quarry or any other place of extraction of natural resources.

Thus, on a plain reading
of Articles 5(1) and 5(2), a branch or an office is normally considered as a PE
under a DTAA.

The updated Article 5(4)
provides that the term PE shall be deemed not to include:

(a) the use of facilities
solely for the purpose of storage, display or delivery of goods or
merchandise belonging to the enterprise;

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

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

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

(e) the maintenance of a
fixed place of business solely for the purpose of carrying on, for the
enterprise, any other activity;

(f) the maintenance of a
fixed place of business solely for any combination of activities mentioned
in sub-paragraphs (a) to (e), provided that such activity or, in the
case of sub-paragraph (f), the overall activity of the fixed place of
business is of a preparatory or auxiliary character.

Paragraph 4.1 of Article 5
provides for exception to paragraph 4 as under:

‘4.1 Paragraph 4 shall not
apply to a fixed place of business that is used or maintained by an
enterprise if the same enterprise or a closely related enterprise
carries on business activities at the same place or at another place in
the same Contracting State, and

(A) that place or other
place constitutes a permanent establishment for the enterprise or the
closely related enterprise under the provisions of this Article, or

(B) the overall
activity resulting from the combination of the activities carried on by the
two enterprises at the same place, or by the same enterprise or closely related
enterprises at the two places, is not of a preparatory or auxiliary
character, provided that the business activities carried on by the two
enterprises at the same place, or by the same enterprise or closely related
enterprises at the two places, constitute complementary functions that are
part of a cohesive business operation.’

It is important to note
that the UN Model Convention 2017 contains a modified version of Article 5 to
prevent the avoidance of PE status which is on the same lines as Articles 5(4)
and 5(4.1) of the OECD MC mentioned above, except that in Articles 5(4)(a) and
5(4)(b) of the UN MC 2017, the word ‘delivery’ is missing. This is due to the
fact that the UN MC does not consider activity of ‘delivery’ of goods as of
preparatory or auxiliary character.

Determination
of existence of PE in cases of non-carrying on of ‘business’ or ‘core business’
of the assessee

On a proper reading and
analysis of Article 5(1), it would be observed that it contains two limbs and
to fall within the definition of a fixed place PE both the limbs have to be
satisfied. Therefore, in case of a PO / BO, normally the first limb is
satisfied, i.e., there is a ‘fixed place of business’ in India but if the second
limb ‘through which the business of an enterprise is wholly or partly
carried on’ is not satisfied, then a fixed place PE cannot be said to be in
existence.

The Tribunal and courts
have, based on the facts of each case, often held that if the actual activities
of a PO / BO did not tantamount to carrying on the business of an enterprise
wholly or partly, then a fixed place PE cannot be said to have come into
existence.

Recently, the Supreme
Court in the case of DIT vs. Samsung Heavy Industries Limited (SHIL)
[2020] 117 taxmann.com 870 (SC) after in-depth analysis of the facts
held that the Mumbai Project Office of SHIL cannot be said to be a fixed place
of business through which the ‘core business’ of the assessee was wholly or
partly carried on. Relying on a number of judicial precedents of the Supreme
Court in the cases of CIT vs. Hyundai Heavy Industries Co. Ltd., [2007] 7
SCC 422; DIT (IT) vs. Morgan Stanley & Co. Inc., [2007] 7 SCC 1;
Ishikawajima-Harima Heavy Industries Ltd. vs. DIT, [2007] 3 SCC 481;
and ADIT vs. E-Funds IT Solution Inc. [2018] 13 SCC 294, the
Court in paragraphs 23 and 28 held as follows:

‘23. A reading of the aforesaid judgments makes it clear that
when it comes to “fixed place” permanent establishments under double
taxation avoidance treaties, the condition precedent for applicability of
Article 5(1) of the double taxation treaty and the ascertainment of a
“permanent establishment” is that it should be an establishment
“through which the business of an enterprise” is wholly or partly
carried on. Further, the profits of the foreign enterprise are taxable only where the said enterprise carries on its core
business through a permanent establishment. What is equally clear is
that the maintenance of a fixed place of business which is of a preparatory or
auxiliary character in the trade or business of the enterprise would not be
considered to be a permanent establishment under Article 5. Also, it is
only so much of the profits of the enterprise that may be taxed in the other
State as is attributable to that permanent establishment.

28. Though it was pointed out to the ITAT that there were
only two persons working in the Mumbai office, neither of whom was qualified to
perform any core activity of the assessee, the ITAT chose to ignore the
same. This being the case, it is clear, therefore, that no permanent
establishment has been set up within the meaning of Article 5(1) of the DTAA, as
the Mumbai Project Office cannot be said to be a fixed place of business
through which the core business of the assessee was wholly or partly carried
on. Also, as correctly argued by Shri Ganesh, the Mumbai Project Office,
on the facts of the present case, would fall within Article 5(4)(e) of the
DTAA, inasmuch as the office is solely an auxiliary office, meant to act as a
liaison office between the assessee and ONGC. This being the case, it is
not necessary to go into any of the other questions that have been argued
before us.’

In the context of a fixed
place PE, in the SHIL case the Supreme Court mentioned and summarised the
aforesaid aspect in the decision in the case of Morgan Stanley & Co.
Inc. (Supra) as under:

‘17. Some of the judgments of this Court have dealt with
similar double taxation avoidance treaty provisions and therefore need to be
mentioned at this juncture. In Morgan Stanley & Co. Inc. (Supra),
the Double Taxation Avoidance Agreement (1990) between India and the United
States of America was construed. …..Tackling the question as to whether a
“fixed place” permanent establishment existed on the facts of that
case under Article 5 of the India-US treaty – which is similar to Article 5 of
the present DTAA – this Court held:

“10. In our view, the second requirement of Article 5(1) of DTAA is not
satisfied as regards back office functions. We have examined the
terms of the Agreement along with the advance ruling application made by MSCo
inviting AAR to give its ruling. It is clear from reading of the above
Agreement / application that MSAS in India would be engaged in supporting the
front office functions of MSCo in fixed income and equity research and in
providing IT-enabled services such as data processing support centre and
technical services, as also reconciliation of accounts. In order to
decide whether a PE stood constituted one has to undertake what is called as a
functional and factual analysis of each of the activities to be undertaken by
an establishment. It is from that point of view we are in agreement with the
ruling of AAR that in the present case Article 5(1) is not applicable as the
said MSAS would be performing in India only back office operations. Therefore
to the extent of the above back office functions the second part of Article
5(1) is not attracted.”

14. There is one more
aspect which needs to be discussed, namely, exclusion of PE under Article 5(3).
Under Article 5(3)(e) activities which are preparatory or auxiliary in
character which are carried out at a fixed place of business will not
constitute a PE. Article 5(3) commences with a non obstante clause. It states that notwithstanding what is stated in
Article 5(1) or
under Article 5(2) the term PE shall not include maintenance of a fixed place
of business solely for advertisement, scientific research or for activities
which are preparatory or auxiliary in character. In the present case we are
of the view that the abovementioned back office functions proposed to be
performed by MSAS in India falls under Article 5(3)(e) of the DTAA. Therefore,
in our view in the present case MSAS would not constitute a fixed place PE
under Article 5(1) of the DTAA as regards its back office operations.’

The Supreme Court further
mentioned about the decision in the case of E-Funds IT Solution Inc. (Supra)
as follows:

‘22. Dealing with “support services” rendered by an Indian
Company to American Companies, it was held that the outsourcing of such
services to India would not amount to a fixed place permanent establishment
under Article 5 of the aforesaid treaty, as follows:

“22. This report
would show that no part of the main business
and revenue-earning activity of the two American companies is carried on
through a fixed business place in India which has been put at their
disposal. It is clear from the above that the Indian company only renders
support services which enable the assessees in turn to render services to their
clients abroad. This outsourcing of work to India would not give rise to a
fixed place PE and the High Court judgment is, therefore, correct on this
score.”’

In view of above
discussion, to constitute a fixed place PE it is particularly important to
determine what constitutes the ‘Business’, ‘Core Business’ or the ‘Main
business’, as referred to by the Supreme Court, of the assessee foreign
enterprise. This determination is going to be purely based on the facts and
hence an in-depth functional and factual analysis of the activities being
actually performed by the PO / BO would be required to be carried out in each
case.

The term ‘business’ is
defined in an inclusive manner in section 2(13) of the ITA as follows:
‘Business’ includes any trade, commerce, manufacture or any adventure or
concern in the nature of trade, commerce or manufacture.

Article 3(1)(h) of the
OECD MC provides that the term ‘business’ includes the performance of
professional services and of other activities of an independent character.

From
an overall analysis of the decisions, it appears that if the activities of the
PO / BO are purely in the nature of back office activities or support services
which enables the assessee foreign enterprise in turn to render services to
their clients abroad or performing mere coordination and executing delivery of
documents, etc., then the same would not be considered as the core or main
business of the assessee, and accordingly a PO / BO performing such activities
would not constitute a fixed place PE in India.

It is not quite clear as
to whether to constitute Core or Main business of the assessee foreign
enterprise there has to be revenue-earning activity in India, i.e., having
customers or clients in India to whom goods are sold or for whom services are
rendered, invoiced and revenue generated in India, is necessary for the same to
be constituting a fixed place PE in India and consequently be taxable in India.

RELIANCE OF RELEVANT DOCUMENTS

Since the determination of
a fixed place PE is predominantly an in-depth fact-based exercise, the ITAT and
the courts have to rely on various relevant documents.

It has been observed that
in the application to the Reserve Bank of India (RBI) for obtaining approval of
PO / BO, the relevant Board resolution of the foreign enterprise to open a PO /
BO, the approval given by the RBI, the accounts maintained by the PO / BO in
India, etc., are very relevant for arriving at the determination of the
existence of a PE in India.

The ITAT in SHIL vs.
ADIT IT [2011] 13 taxmann.com 14 (Delhi), largely relied upon (a)
SHIL’s application to RBI for opening the PO; (b) SHIL’s Board Resolution for
opening the PO; and (c) RBI’s approval for opening the PO. In respect of the
Board Resolution, the ITAT focused on its first paragraph alone and in
paragraph 71 of the order observed as follows:

‘71. There is a force in the contention of Learned DR that
the words “That the Company hereby open one project office in Mumbai,
India for co-ordination and execution of Vasai East Development Project for Oil
and Natural Gas Corporation Limited (ONGC), India” used by the assessee company
in its resolution of Board of Directors meeting dated 3-4-2006 makes it
amply clear that the project office was opened for coordination and execution
of the impugned project. In the absence of any restriction put by the assessee
in the application moved by it to the RBI, in the resolutions passed by the
assessee company for the opening of the project office at Mumbai and the
permission given by RBI, it cannot be said that Mumbai project office was not a
fixed place of business of the assessee in India to carry out wholly or partly
the impugned contract in India within the meaning of Article 5.1 of DTAA.
These documents make it clear that all the activities to be carried out in
respect of impugned contract will be routed through the project office only.’

All these gave a prima
facie impression that the PO was opened for coordination and execution of
the entire project and was thus involved in the core business activity of SHIL
in India.

However, the Supreme Court
delved deeper and looked at various other factors which the ITAT had ignored or
dismissed. In paragraphs 27 and 28, the Court, relying on the second paragraph
of the Board Resolution which clarified that the PO was established for
coordinating and executing delivery of certain documents, and not for the
entire project, the fact that the accounts of the PO showed no expenditure
incurred in relation to execution of the contract and that the only two people
employed in the PO were not qualified to carry out any core activity of SHIL,
concluded that no fixed place PE has been set up within the meaning of Article
5(1) read with Article 5(4)(e) of the India-Korea DTAA.

The
above indicates that the determination of the existence of a fixed place PE of
a foreign enterprise in India requires a deep factual and functional analysis
and the same cannot be determined on mere prima facie satisfaction.

Even in the case of Union
of India vs. U.A.E. Exchange Centre [2020] 116 taxmann.com 379 (SC)
dealing with the question relating to a Liaison Office being considered as a
fixed place PE in India, the Court relied on the approval letter given by the
RBI. In paragraph 9 of the judgment. the Supreme Court mentioned that ‘keeping
in mind the limited permission and the onerous stipulations specified by the
RBI, it could be safely concluded, as opined by the High Court, that the
activities in question of the liaison office(s) of the respondent in India are
circumscribed by the permission given by the RBI and are in the nature of
preparatory or auxiliary character. That finding reached by the High Court is
unexceptionable.’

In Hitachi High
Technologies Singapore Pte Ltd. vs. DCIT [2020] 113 taxmann.com 327
(Delhi-Trib.) the ITAT held that whether the assessee violated the
conditions of RBI or FEMA is not relevant in determining the LO as a PE under
the I.T. Act.

It appears
that there is an increasing reliance by the ITAT and courts, inter alia, on the application and related documents
and the approval of the RBI in considering whether an LO / PO / BO can
constitute a fixed place PE in India.

INITIAL ONUS REGARDING EXISTENCE OF A FIXED PLACE PE IN
INDIA

An important question
arises as to whether the onus is on the assessee or the tax authorities to
first show that a PO / BO is a fixed place PE in India.

The ITAT in the SHIL
case (Supra) held that the initial onus was on the assessee and not the
Revenue. However, the Supreme Court in the SHIL case reiterated the fact
that the initial onus lies on the Indian Revenue, and not the assessee, to
prove that there is a PE of the foreign enterprise in India before moving
further to determine the Indian tax liability of that enterprise. While
reversing the finding of the ITAT, the Supreme Court stated that ‘Equally
the finding that the onus is on the Assessee and not on the Tax Authorities to
first show that the project office at Mumbai is a permanent establishment is
again in the teeth of our judgment in E-Funds IT Solution Inc. (Supra).’

The Supreme Court in E-Funds
IT Solution Inc. (Supra) stated that the burden of proving the fact
that a foreign assessee has a PE in India and must, therefore, suffer tax from
the business generated from such PE, is initially on the Revenue. The
Court observed as follows:

‘16. The Income-tax Act,
in particular Section 90 thereof, does not speak of the concept of a PE. This
is a creation only of the DTAA. By virtue of Article 7(1) of the DTAA, the
business income of companies which are incorporated in the US will be taxable
only in the US, unless it is found that they were PEs in India, in which event
their business income, to the extent to which it is attributable to such PEs,
would be taxable in India. Article 5 of the DTAA set out hereinabove provides
for three distinct types of PEs with which we are concerned in the present
case: fixed place of business PE under Articles 5(1) and 5(2)(a) to 5(2)(k);
service PE under Article 5(2)(l) and agency PE under Article 5(4). Specific and
detailed criteria are set out in the aforesaid provisions in order to fulfil
the conditions of these PEs existing in India. The burden of proving the
fact that a foreign assessee has a PE in India and must, therefore, suffer tax
from the business generated from such PE is initially on the Revenue. With
these prefatory remarks, let us analyse whether the respondents can be brought
within any of the sub-clauses of Article 5.’

In view of above referred
two Supreme Court decisions, it can be said that the initial onus is on the
Revenue and not on the assessee.

PREPARATORY OR AUXILIARY ACTIVITIES TEST

As mentioned above,
Article 5(4) of the OECD MC provides exclusionary clauses in respect of a fixed
place PE provided the activities of a PE, or in case of a combination of
activities the overall activities, are of a preparatory or auxiliary
character. In this connection, the readers may refer to extracts of the
OECD Commentary in this regard discussed in paragraph 4 of the article
published in the BCAJ of August, 2020 in respect of Taxability of the
Liaison Office of a Foreign Enterprise in India.

Further, in the context of
activities of an ‘auxiliary’ character, in National Petroleum
Construction Company vs. DIT (IT) (Supra) the Delhi High Court in paragraph
28 explained as follows:

‘28. The Black’s Law Dictionary defines the word “auxiliary”
to mean as “aiding or supporting, subsidiary”. The word “auxiliary”
owes its origin to the Latin word “auxiliarius” (from auxilium meaning help).
The Oxford Dictionary defines the word auxiliary to mean “providing
supplementary or additional help and support”. In the context of Article
5(3)(e) of the DTAA, the expression would necessarily mean carrying on
activities, other than the main business functions, that aid and support the
Assessee. In the context of the contracts in question, where the main
business is fabrication and installation of platforms, acting as a
communication channel would clearly qualify as an activity of auxiliary
character – an activity which aids and supports the Assessee in carrying on its
main business.’

BEPS Report on Action 7 – Preventing
the Artificial Avoidance of Permanent Establishment Status

When the exceptions to the
definition of PE that are found in Article 5(4) of the OECD Model Tax
Convention were first introduced, the activities covered by these exceptions
were generally considered to be of a preparatory or auxiliary nature.

Since the introduction of
these exceptions, however, there have been dramatic changes in the way that
business is conducted. Many such challenges of a digitalised economy are
outlined in detail in the Report on Action 1, Addressing the Tax Challenges
of the Digital Economy. Depending on the circumstances, activities
previously considered to be merely preparatory or auxiliary in nature may nowadays
correspond to core business activities. In order to ensure that profits derived
from core activities performed in a country can be taxed in that country,
Article 5(4) is modified to ensure that each of the exceptions included therein
is restricted to activities that are otherwise of a ‘preparatory or auxiliary’
character.

BEPS concerns related to
Article 5(4) also arose from what is typically referred to as the
‘fragmentation of activities’. Given the ease with which multinational
enterprises may alter their structures to obtain tax advantages, it was
important to clarify that it is not possible to avoid PE status by fragmenting
a cohesive operating business into several small operations in order to argue
that each part is merely engaged in preparatory or auxiliary activities that
benefit from the exceptions of Article 5(4).

Article 13 of
Multilateral Instrument (MLI) – Artificial avoidance of Permanent Establishment
status through the Specific Activity Exemptions

MLI has become effective
in India from 1^st April, 2020 and it will affect many Indian DTAAs
post MLI because, wherever applicable, MLI will impact the covered tax
agreements. Article 13 of MLI deals with the artificial avoidance of PE through
specific activity exemptions, i.e., activities which are preparatory or
auxiliary in nature, and provides two options, i.e. ‘Option A’ and ‘Option B’.

India
has opted for ‘Option A’, which continues with the existing list of exempted
activities from (a) to (e) in Article 5(4), but has added one more sub-clause
(f) which states that the maintenance of a fixed place of business solely for
any combination of activities mentioned in sub-paragraphs (a) to (e) is covered
in the exempt activities, provided all the activities mentioned in sub-clauses
(a) to (e) or a combination of these activities must be preparatory or
auxiliary in nature. Therefore, as per modified Article 5(4), in order to be
exempt from fixed place PE, each activity on a standalone basis as well as a
combination of activities should qualify as preparatory or auxiliary activity
test.

INDIAN JUDICIAL PRECEDENTS

On the issue of whether a
PO / BO constitutes a fixed place PE in India, there are mixed judicial
precedents, primarily based on the facts of each case. In addition to various Supreme
Court cases mentioned and discussed above, there are many other judicial
precedents in this regard.

BO Cases

In a few cases, based on
the peculiar facts of each case, the Tribunals and courts have held that a BO
does not constitute a fixed place PE in India. In this regard, useful reference
can be made to the following case: Whirlpool India Holdings Ltd. vs. DDIT
IT [2011] 10 taxmann.com 31 (Delhi).

However, in the following
case it has been held that a BO constitutes a fixed place PE in India: Hitachi
High Technologies Singapore Pte Ltd. vs. DCIT [2020] 113 taxmann.com 327
(Delhi-Trib.).

In the case of Wellinx
Inc. vs. ADIT IT [2013] 35 taxmann.com 420 (Hyderabad-Trib.), where it
was contended by the assessee that the income of the BO is not taxable in
India, the ITAT held that services performed by a branch office are on account
of outsourcing of commercial activities by its head office, and income arising
out of such services rendered would be taxable under article 7(3) of the
India-USA DTAA.

PO Cases

Similarly, in the case of
POs, based on the factual matrix the following cases have been decided in
favour of assessees as well as the Revenue:

In favour of the
assessees:

Sumitomo
Corporation vs. DCIT [2014] 43 taxmann.com 2 (Delhi-Trib.);

National
Petroleum Construction Company vs. DIT (IT) [2016] 66 taxmann.com 16 (Delhi);

HITT Holland
Institute of Traffic Technology B.V. vs. DDIT (IT) [2017] 78 taxmann.com 101
(Kolkata-Trib.).

In favour of the Revenue:

Voith Paper
GmbH vs. DDIT [2020] 116 taxmann.com 127 (Delhi-Trib.);

Orpak Systems
Ltd. vs. ADIT (IT) [2017] 85 taxmann.com 235 (Mumbai-Trib.).

KEY POINTS OF JUDGMENT OF THE SUPREME COURT IN SHIL

The Supreme Court in this
case has clearly established that facts are important in deciding about the
existence of a fixed place PE in India, while principles of interpretations
more or less remain constant. It is imperative that one must minutely look into
the facts and actual activities to decide existence of a fixed place PE in case
of a PO / BO.

The key points of this
judgment can be summarised as under:

In deciding whether a
project office constitutes a fixed place PE, the entire set of documentation
including the relevant Board resolutions, application to RBI and approval of
the RBI, should be read minutely and understood in their entirety.

The detailed factual and
functional analysis of the actual activities and role of PO / BO in India is
crucial in determining a PE. It would be necessary to determine whether the PO
/ BO carries on business / core business or the main business of the foreign
enterprise in India.

The nature of expenses
debited in the accounts of the PO / BO throws light and cannot be brushed aside
on the ground that the accounts are entirely in the hands of the assessee. They
do have relevance in determining the issue in totality.

It reiterates that the
initial onus is on the Revenue to prove the existence of a fixed placed PE in
India.

Even post-MLI, the Supreme
Court ruling in SHIL’s case should help in interpretation on a fixed place PE
issue.

CONCLUSION

The issue of existence of
a fixed place PE in case of a PO / BO has been a subject matter of debate
before the ITAT and courts for long. The ruling of the Supreme Court in SHIL’s case
endorses the settled principles on fixed place PE in the context of a PO of a
turnkey project. The Supreme Court reiterated that a fixed place PE emerges
only when ‘core business’ activities are carried on in India. The Court brings
forth more clarity on the existence of a fixed place PE or otherwise in case of
a PO / BO and should instil confidence in multinationals to do business in
India and bring much needed certainty in this regard.

shailesh.kwebmaker

COPARCENARY RIGHT OF A DAUGHTER IN FATHER’S HUF: FINAL TWIST IN THE TALE?

INTRODUCTION

The Hindu Succession
(Amendment) Act, 2005 (‘2005 Amendment Act’) which was made operative from 9^th
September, 2005, was a path-breaking Act which placed Hindu daughters on an
equal footing with Hindu sons in their father’s Hindu Undivided Family by
amending the age-old Hindu Succession Act, 1956 (‘the Act’). However, while it
ushered in great reforms it also left several unanswered questions and
ambiguities. Key amongst them was to which class of daughters did the 2005
Amendment Act apply? The Supreme Court by two important decisions had answered
some of these questions and helped clear a great deal of confusion. However,
just when one thought that things had been settled, a larger bench of the Apex
Court has turned the decision on its head and come out with a more liberal
interpretation of the law. Let us analyse the Amendment and the old and the new
decisions to understand the situation in greater detail.

THE 2005 AMENDMENT ACT

First, let us understand
the Amendment to put the issue in perspective. The Hindu Succession (Amendment)
Act, 2005 amended the Hindu Succession Act, 1956 which is one of the few
codified statutes under Hindu Law. It applies to all cases of intestate succession
by Hindus. The Act applies to Hindus, Jains, Sikhs, Buddhists and to any person
who is not a Muslim, a Christian, a Parsi or a Jew. Any person who becomes a
Hindu by conversion is also covered by the Act. The Act overrides all Hindu
customs, traditions and usages and specifies the heirs entitled to such
property and the order or preference among them. The Act also deals with some
important aspects pertaining to an HUF.

By the 2005 Amendment Act,
Parliament amended section 6 of the Hindu Succession Act, 1956 and the amended
section was made operative from 9^th September, 2005. Section 6 of
the Hindu Succession Act, 1956 was totally revamped. The relevant portion of
the amended section 6 is as follows:

‘6. Devolution of interest
in coparcenary property.?(1) On and from the commencement of the Hindu
Succession (Amendment) Act, 2005 (39 of 2005), in a Joint Hindu family governed
by the Mitakshara law, the daughter of a coparcener shall,?

(a) by birth become a
coparcener in her own right in the same manner as the son;

(b) have the same rights
in the coparcenary property as she would have had if she had been a son;

(c) be subject to the same
liabilities in respect of the said coparcenary property as that of a son, and
any reference to a Hindu Mitakshara coparcener shall be deemed to include a
reference to a daughter of a coparcener:

Provided that nothing
contained in this sub-section shall affect or invalidate any disposition or
alienation including any partition or testamentary disposition of property
which had taken place before the 20^th day of December, 2004.’

Thus, the amended section
provides that a daughter of a coparcener shall become by birth a coparcener in
her own right in the same manner as the son and, further, she shall have the
same rights in the coparcenary property as she would have had if she had been a
son. It also provides that she shall be subject to the same liabilities in
respect of the coparcenary property as a son. Accordingly, the amendment
equated all daughters with sons and they would now become coparceners in their
father’s HUF by virtue of being born in that family. She has all rights and
obligations in respect of the coparcenary property, including testamentary
disposition. Not only would she become a coparcener in her father’s HUF, but
she could also make a will for the same.

One issue which remained
unresolved was whether the application of the amended section 6 was prospective
or retrospective?

Section 1(2) of the Hindu
Succession (Amendment) Act, 2005, stated that it came into force from the date
it was notified by the Government in the Gazette, i.e., 9^th
September, 2005. Thus, the amended section 6 was operative from that date.
However, did this mean that the amended section applied to:

(a) daughters born after
that date,

(b) daughters married
after that date, or

There was no clarity under
the Act on this point.

PROSPECTIVE APPLICATION UPHELD

The Supreme Court, albeit
in a different context, clarified that the 2005 Amendment Act did not seek to
reopen vesting of a right where succession has already taken place. According
to the Supreme Court, ‘the operation of the Statute is no doubt prospective
in nature… the 2005 Act is not retrospective, its application is prospective” –
G. Sekar vs. Geetha (2009) 6 SCC 99.

The Supreme Court has held
in Sheela Devi vs. Lal Chand, (2007) 1 MLJ 797 (SC) that if the
succession was opened prior to the Hindu Succession (Amendment) Act, 2005, the
provisions of the 2005 Amendment Act would have no application.

FATHER-DAUGHTER COMBINATION IS A MUST

Finally, the matter was
settled by a two-Judge Bench of the Apex Court in its decision in the case of Prakash
vs. Phulavati, (2016) 2 SCC 36. The Supreme Court examined the issue in
detail and held that the amendment was prospective and not retrospective. It
further held that the rights under the Hindu Succession Act Amendment were
applicable to living daughters of living coparceners (fathers) as on 9^th
September, 2005 irrespective of when such daughters were born. It further held
that any disposition or alienation including a partition of the HUF which may
have taken place before 20^th December, 2004 (the cut-off date
provided under the 2005 Amendment Act) as per law applicable prior to the said
date, would remain unaffected. Thus, as per the above Supreme Court decision,
in order to claim benefit what was required was that the daughter should be
alive and her father should also be alive on the date of the amendment, i.e., 9^th
September, 2005. Once this condition was met, it was immaterial whether the
daughter was married or unmarried. The Court had also clarified that it was
immaterial when the daughter was born.

DAUGHTER BORN BEFORE THE ACT

In Danamma @ Suman
Surpur & Anr. vs. Amar & Ors., (2018) 3 SCC 343, another
two-Judge Bench of the Supreme Court took off from the Prakash case
(Supra) and agreed with it. It held that the Amendment used the words ‘in
the same manner as the son’. It was therefore apparent that both the sons
and the daughters of a coparcener had been conferred the right of becoming
coparceners by birth. It was the very factum of birth in a coparcenary that
created the coparcenary, therefore the sons and daughters of a coparcener
became coparceners by virtue of birth. The net effect of the amendment
according to the Court was that it applied to living daughters of living
coparceners as on 9^th September, 2005. It did not matter whether the
daughters were married or unmarried. It did not matter when the daughters were
born. They might be born even prior to the enactment of the 1956 Act, i.e., 17^th
June, 1956.

THREE-JUDGE VERDICT LAYS DOWN A NEW LAW

A three-Judge Bench of the
Supreme Court in the case of Vineeta Sharma vs. Rakesh Sharma, CA 32601
/2018, Order dated 11^th August, 2020 considered a bunch of
SLPs before it on the issue of the 2005 Amendment Act. The Court by a very
detailed verdict considered the entire genesis of the HUF Law. It held that in
the Mitakshara School of Hindu law (applicable to most parts of India), in a coparcenary
there is unobstructed heritage, i.e., right is created by birth. When right is
created by birth it is called unobstructed heritage. At the same time, the
birthright is acquired in the property of the father, grandfather, or great
grandfather. In case a coparcener dies without leaving a son, right is acquired
not by birth, but by virtue of there being no male issue and is called
obstructed heritage. It is called obstructed because the accrual of right to it
is obstructed by the owner’s existence. It is only on his death that obstructed
heritage takes place. It held that property inherited by a Hindu from his
father, father’s father, or father’s grandfather (but not from his maternal
grandfather) is unobstructed heritage as regards his own male issues, i.e., his
son, grandson, and great-grandson. His male issues acquire an interest in it
from the moment of their birth. Their right to it arises from the mere fact of
their birth in the family, and they become coparceners with their paternal
ancestor in such property immediately on their birth, and in such cases
ancestral property is unobstructed heritage.

Further, any property, the
right to which accrues not by birth but on the death of the last owner without
leaving a male issue, is called obstructed heritage. It is called obstructed
because the accrual of right to it is obstructed by the existence of the owner.
Consequently, property which devolves on parents, brothers, nephews, uncles,
etc. upon the death of the last owner is obstructed heritage. These relations
do not have a vested interest in the property by birth. Their right to it
arises for the first time on the death of the owner. Until then, they have a
mere spes successionis, or a bare chance of succession to the property,
contingent upon their surviving the owner. Accordingly, the Apex Court held
that unobstructed heritage took place by birth and obstructed heritage took
place after the death of the owner.

The Apex Court laid down a
very vital principle that coparcenary right, under section 6 (including
after Amendment), is given by birth which is called unobstructed heritage.
It is not a case of obstructed heritage depending upon the owner’s death. Thus,
the Supreme Court concluded that a coparcener’s father need not be alive
on 9^th September, 2005, i.e., the date of the Amendment.

The Court observed that
the Amendment was a gender bender inasmuch as it sought to achieve removing ‘gender
discrimination to a daughter who always remains a loving daughter’. It
further held that though the rights could be claimed, w.e.f. 9^th
September, 2005, the provisions were of a retroactive application, i.e., they
conferred benefits based on the antecedent event and the Mitakshara coparcenary
law should be deemed to include a reference to a daughter as a coparcener.
Under the amended section 6, since the right was given by birth, i.e., an
antecedent event, the provisions concerning claiming rights operated on and
from the date of the Amendment Act. Thus, it is not at all necessary that the
father of the daughter should be living as on the date of the Amendment, as she
has not been conferred the rights of a coparcener by obstructed heritage. The
effect of the amendment is that a daughter is made coparcener with effect from
the date of the amendment and she can claim partition also, which is a
necessary concomitant of the coparcenary. Section 6(1) recognises a joint Hindu
family governed by Mitakshara Law. The coparcenary must exist on 9^th
September, 2005 to enable the daughter of a coparcener to enjoy rights
conferred on her. As the right is by birth and not by dint of inheritance, it
is irrelevant whether a coparcener whose daughter is conferred with the rights
is alive or not. Conferral is not based on the death of a father or other
coparcener.

The Court also held that
the daughter should be living on 9^th September, 2005. In the
substituted section 6, the expression ‘daughter of a living coparcener’ has not
been used. One corollary to this explanation would mean that if the daughter
has died before this date, then her children cannot become coparceners in their
maternal grandfather’s HUF. However, if she dies on or after this date, then
her children can become coparceners in their maternal grandfather’s HUF.

The Court explained one of
the implications of becoming a coparcener was that a daughter has now become
entitled to claim partition of coparcenary w.e.f. 9^th September,
2005, which was a vital change brought about by the statute. Accordingly, the
Supreme Court in Vineeta Sharma vs. Rakesh Sharma, CA 32601/2018, Order
dated 11^th August, 2020 expressly overturned its earlier
verdict in Prakash vs. Phulavati, (2016) 2 SCC 36 and those
portions of Danamma @ Suman Surpur & Anr. vs. Amar & Ors., (2018)
3 SCC 343 which approved of the decision in Prakash vs. Phulavati.

EXCEPTION TO THE RULE

Section 6(5) of the Act
provides that the Amendment will not apply to an HUF whose partition has been
effected before 20^th December, 2004. For this purpose, the partition
should be by way of a registered partition deed / a partition brought out by a
Court Decree. In the Amendment Bill even oral partitions, supported by
documentary evidence, were allowed. However, this was dropped at the final
stage since the intention was to avoid any sham or bogus transactions in order
to defeat the rights of coparcener conferred upon daughters by the 2005
Amendment Act.

It was argued before the
Court that the requirement of a registered deed was only directory and not
mandatory. But the Court negated this argument. It held that the intent of the
provisions was not to jeopardise the interest of the daughter but to take care
of sham or frivolous transactions set up in defence unjustly to deprive the
daughter of her right as coparcener. In view of the clear provisions of section
6(5), the intent of the Legislature was clear and a plea of oral partition was
not to be readily accepted. However, in exceptional cases where the plea of
oral partition was supported by public documents and partition was finally
evinced in the same manner as if it had been effected by a decree of a court,
it may be accepted. A plea of partition based on oral evidence alone could not
be accepted and had to be rejected outright.

CONCLUSION

The conclusion arrived at
by the Supreme Court in Vineeta Sharma’s case (Supra) undoubtedly
appears to be correct as compared to the earlier decisions on the point. A
beneficial Amendment was sought to be made restrictive and the same has now
been set right. However, consider the turmoil and the legal complications which
this decision would now create. Several disputes in HUFs were created by the
2005 Amendment and those raging fires were settled by the decision in Prakash
vs. Phulavati (Supra). It has been almost five years since this
decision was rendered. Now comes a decision which overrules the settled law.
One can expect a great deal of litigation on this issue now that the
restrictive parameters set down have been removed. In respect of cases pending
before different High Courts and subordinate courts, the Supreme Court in Vineeta
Sharma’s case (Supra) has held that daughters cannot be deprived of
their equal right and hence it requested that all the pending matters be
decided, as far as possible, within six months. However, what happens to cases
where matters are settled? Would they be reignited again?

One wonders
how Parliament can enact such a path-breaking enactment and not pay heed to a
simple matter of its date of applicability. Could this issue not have been
envisaged at the drafting stage? This is a classic case of a very advantageous
and laudable Amendment suffering from inadequate drafting! Is it not strange
that while the language of some of our pre-Independence Acts (such as the
Contract Act 1872, Transfer of Property Act 1882, Indian Succession Act 1925,
etc.) have stood strong for over a century, some of our recent statutes have
suffered on the drafting front. Ultimately, matters have to travel to the
Supreme Court leading to a lot of wastage of time and money. One can only hope
that this issue of the coparcenary right of a daughter in her father’s
HUF is settled once and for all. Or are there going to be some more
twists in this tale?

If you disrupt yourself, you
will be able to manage and even thrive through disruption.

—
Whitney Johnson, Executive Coach and Author

shailesh.kwebmaker

DISGORGEMENT OF ILL-GOTTEN GAINS – A US SUPREME COURT JUDGMENT AND A SEBI COMMITTEE REPORT

BACKGROUND

One of the
important enforcement tools that SEBI has against wrong-doers in capital
markets is disgorging their ill-gotten gains. This means taking away by SEBI
those gains that such persons have made from their wrong-doings. For example,
an insider may trade based on unpublished price-sensitive information and make
profits. SEBI would take away, i.e., disgorge, such profits and deposit them in
the Investors’ Protection and Education Fund. There can be numerous other
similar cases of ill-gotten gains such as through price manipulation, excessive
remuneration, fraudulent schemes of issue of securities, etc.

Disgorgement is
not a punitive action and thus is limited to the gains made. Penalty and other
actions may be over and above such disgorgement. The idea of disgorgement is
that a wrong-doer should not retain the profits from his wrong-doing.

While this power
is expressly available to SEBI under law (thanks to a curiously worded
‘Explanation’ to section 11B), there are many areas on which there is ambiguity
and lack of clarity. Recently, however, there have been two developments that
finally have highlighted these areas of concern in relation to disgorgement.
The first is a judgment of the Supreme Court of the USA (in Charles C.
Liu et al vs. SEC, Supreme Court dated 22^nd June 2020, No. 18-501
– referred to here as Liu), and the second is the report of the
high-level committee under the Chairmanship of Justice A.R. Dave (Retired
Judge, Supreme Court of India) dated 16^th June, 2020 (‘the Report’).

The US judgment
in Liu has highlighted three qualifications to the absolute power
of disgorgement of the Securities and Exchange Commission (SEC) in the context
of the prevailing law. The Report, on the other hand, makes recommendations for
amendments in these areas, although to some extent different from what the US
judgment in Liu has held. These developments need discussion
because disgorgement happening at present in India (and even in the US) is
often ad hoc, arbitrary and even unfair.

For example, the
Securities Appellate Tribunal in Karvy Stock Broking Ltd. vs. SEBI
[(2008) 84 SCL 208] pointed out the arbitrary manner in which
disgorgement was ordered by the Securities and Exchange Board of India. Persons
who rendered services, and thus were part of the alleged scam, were required to
disgorge the entire illegal gains. Similar orders of disgorgement were,
however, not made against others in the same matter who had made the major
gains.

There are no
legal or judicial guidelines regarding the manner of disgorgement except some
generic remarks in SEBI orders or SAT decisions. Some of the issues raised in Liu
and the Report can be strongly raised before SEBI and appellate authorities in
the hope that they would be ruled on, thus creating clarity and precedents. In
some or all areas, the law itself could be amended, thus creating a strong, transparent
and comprehensive base that SEBI and parties can rely on.

PRESENT PROVISIONS RELATING TO
DISGORGEMENT IN INDIA UNDER THE SEBI ACT, 1992

SEBI has ordered
disgorgement of ill-gotten gains in numerous cases over the years. While
disgorgement is accepted as an inherent power based on equity, the basis in
terms of specific legal provisions in the Act is almost a belated
after-thought. It is in the form of an ‘Explanation’ to section 11B of the SEBI
Act inserted in 2013. The Explanation declares that SEBI has the power to
disgorge any profit made / loss avoided by any transaction or activity in
contravention of the Act or Regulations made thereunder. Such ‘wrongful gain
made or loss averted’ can be disgorged. No further guidance or details are
given in the provision or in any Rules / Regulations / Circulars.

Thus, while
power has been granted in the law, many aspects remain unclear and thus result
in arbitrary actions in many cases that have now been highlighted, particularly
through the US judgment and the Report.

Who should be
made to disgorge the profits? Should every person who has contravened the law
be made to disgorge the full profits, or should each person be made to disgorge
the profits that he has made? In particular, can a wrong-doer be made to pay
even the profits earned by another wrong-doer in the same wrong but who cannot
or does not pay the amount? In short, should the liability be joint and
several? If yes, are all wrong-doers to be subject to such joint and several
liability, or only certain specific categories of such wrong-doers should be so
subject?

Should the gross
gains earned by a wrong-doer be fully disgorged or only his net gains
that have gone into his pocket? In other words, should any deductions be
allowed for expenses, taxes, etc. incurred while earning such profits?

Should any
account be taken of losses incurred by the victims or should the disgorgement
be only of the gains made?

Who should keep
such disgorged profits? Should they be paid to those who incurred the losses,
or can SEBI / Government keep them? Can an employer disgorge profits earned by
an employee through violations of Securities Laws?

THE DECISION OF THE US SUPREME COURT IN
LIU

Summarised and simplified, these were the
facts: A married couple formulated a scheme to defraud foreign nationals,
inviting them to invest in certain commercial enterprises. This, it was
promised, would enable them to obtain permanent residence in the USA. It turned
out that this was allegedly a scam and only a small part of such amounts raised
(about $27 million) were invested for such purposes. A substantial portion of
the rest was diverted to personal accounts. Such acts were found to be in
violation of the relevant laws and SEC ordered disgorgement.

SEC, for the
purpose of disgorgement, applied a provision that enabled grant of ‘equitable
relief that may be appropriate or necessary for the benefit of investors’. The
core question before the Court was whether such disgorgement satisfied this
condition of ensuring equitable relief.

The Court
upheld the right of SEC to disgorge the ill-gotten gains. However, three
conditions were placed: First, joint and several liability cannot be placed on
all the guilty persons, except in cases where the parties are partners in the
wrong-doing. Second, the condition that it is for the benefit of investors
should be satisfied. In the ordinary course, if the disgorged proceeds are used
to compensate the loss caused to investors, the condition would be satisfied.
In other cases, compliance of this condition would have to be demonstrated.
Third, it was held that it would not be correct to disgorge all the profits
without giving appropriate deductions. While monies that go into the pocket of
the wrong-doer cannot be allowed as deductions, fair deductions on legitimate
expenses related to the activity that was in violation of law could be allowed.

Indian
Securities Laws do have parallels with those in the USA and thus judicial
developments there are considered by SEBI and Courts here. The judgment is not
only on certain general legal principles but also lays down issues that have
relevance even in the Indian context. However, the language of the law in India
is specifically different in some respects and hence it cannot be directly
applied to India in all aspects. For example, there is no condition in the
Explanation to section 11B that the disgorged amount should be for the benefit
of investors. It is also specifically stated in section 11(5) that the amount
disgorged should be credited to the IPEF fund, the uses of which have been
prescribed in the regulations. Thus, the decision in Liu, while
raising interesting questions, would have to be applied after considering the
niceties of specific and different provisions in India.

REPORT OF JUSTICE A.R. DAVE COMMITTEE

The Report is
fairly detailed and covers suggestions for reforms in certain major areas. In
one of the sections, where suggestions have been given relating to
quantification of penalties and the like, the subject of disgorgement has been
discussed in some detail. Notably, the Report was released before the decision
in Liu was rendered. Nevertheless, the issues that came up in Liu
have also been discussed to an extent.

The Report notes
the language of the Explanation and its possible interpretations. A literal
view could be that a wrong-doer could be held liable to disgorge only the gains
that have gone into his pocket and he would not be made to pay what other
wrong-doers gained. However, the Report opines that the better view is that the
gains made by all wrong-doers can be recovered from each person. The Committee,
however, suggests that the language should be made more clear and specific to provide
for joint and several liability of all persons who indulged in such
wrong-doing.

It also opines that disgorgement should be
of net gains and not of gross gains. It suggests detailed guidance on what
deductions should be allowed from the gains, so that only the net gains are
disgorged. Interestingly, income-tax is allowed as a deduction where it has
been incurred on gains from certain insider trading but not, say, where there
are identifiable investors who have lost money.

The Report also
notes that SEBI has no powers of compensating investors by helping them recover
their losses from the wrong-doers. For recovering their losses, the victims
have to approach civil courts. It also notes that it is the gains made that can
be disgorged and not the losses caused to others. Such losses can, however, be
taken into account for levy of penalty.

The Report makes
detailed and specific amendments to the law. It has been released for public
comments after which SEBI may implement it by amending the law.

CONCLUSION

Wrong-doings in
securities laws usually have a motive of financial gain. If the gains are
disgorged consistently, the motive is frustrated and wrong-doers lose their
incentive. That, coupled with penalty and other enforcement and even prosecution,
should help curb the ills in our securities markets.

The law relating
to disgorgement, however, continues to remain vague and opaque, leading to
arbitrary actions. The absence of guidelines also leads to inconsistent
actions. Appellate authorities also face the same problem of absence of a base
in law in terms of clear provisions.

Even the
decision in Liu is general in nature though broad guidelines are
given. Fortunately, we have the detailed and scholarly report of Justice Dave
and one hopes that it is quickly implemented after due consideration.

shailesh.kwebmaker

Part A Service Tax

I. HIGH COURT

25. [2020-TIOL-1285-HC-AHM-ST] M/s. Linde Engineering India Pvt. Ltd. vs.
Union of India Date of order: 16^th January, 2020

Services rendered by a
company located in India to its holding company outside India not being
establishments of distinct persons, are considered as export of service

FACTS

The petitioner is engaged
in providing services in India and outside India. Service is provided to their
holding company located outside India. A show cause notice was issued alleging
that the services provided to the holding company being merely an establishment
of a distinct person, cannot be considered as export of service and would fall
within the definition of exempted service, and therefore Rule 6(3) of the
CENVAT Credit Rules, 2004 is applicable and hence a demand is raised for
reversal of credit.

HELD

The Court noted that the
demand is raised on mere misinterpretation of the provisions of the law. The
petitioner and its parent company can by no stretch of the imagination be
considered as the same entity. The petitioner is an establishment in India
which is a taxable territory and its 100% holding company, which is the other
company in the non-taxable territory, cannot be considered as establishment so
as to treat them as distinct persons for the purpose of rendering services.
Thus, services provided to its holding company are considered as export of
service as per Rule 6A of the Service Tax Rules, 1994.

II. TRIBUNAL

26. [2020-TIOL-1178-CESTAT-ALL] M/s Encardio-Rite Electronics Pvt. Ltd. vs.
Commissioner of Appeals, Central Excise and Service Tax Date of order: 25^th November, 2019

Even though the
sub-contractor and the main contractor are located in the taxable territory,
since the service is consumed in the state of Jammu and Kashmir the service is
not taxable

FACTS

The appellants are sub-contractors
engaged in laying of tracks for the Indian Railways and work associated with the construction of dams. The entire activity is performed in the state of
Jammu and Kashmir. The Revenue argues that since both the sub-contractor and
the main contractor are located in the taxable territory in view of Rule 6 of
the Taxation of Services (Provided from Outside and Received in India) Rules
2006 as well as Rule 8 of the Place of Provision of Service Rules, 2012, the service is taxable and therefore tax is leviable.

HELD

The Tribunal primarily
noted that the services were provided and consumed in the state of Jammu and
Kashmir. It was held that the provisions of the rule cannot override provisions
of the sections provided in the Act. Section 64 clearly lays down that provisions
of Chapter V of the Finance Act, 1994 which deals with service tax are not
applicable in the state of Jammu and Kashmir. Accordingly, since the service is
consumed in a non-taxable territory, the demand of service tax is not
sustainable.

27. [2020-TIOL-1167-CESTAT-CHD] State Bank of India vs. Commissioner
(Appeals) of CGST, Ludhiana Date of order: 27^th February, 2019

Refund cannot be rejected
on technical grounds that the payment of tax sought to be refunded was made in
a wrong service code

FACTS

The appellant is a banking
company providing banking and financial services. They received services from a
contractor and discharged service tax under reverse charge on works contract
service. However, while making the payment the same was made under the category
of banking and financial services. Since they were not required to pay service
tax under reverse charge, they filed a refund claim. The claim was rejected on
the ground that they have failed to show that the payment was made under works contract
service.

HELD

The Tribunal noted that
whatever service tax was payable by the appellant has been paid under banking
and financial services. They have also produced a certificate issued by the
chartered accountant showing that the service tax of which the refund claim is
filed is none other than the works contract service. The Tribunal accordingly
held that the refund claim cannot be rejected on technical grounds and the
appeal was allowed.

28. [2020-TIOL-1166-CESTAT-CHD] M/s Hitachi Metals India Pvt. Ltd. vs.
Commissioner of Central Excise and Service Tax Date of order: 3^rd April, 2019

The provisions of section
11B are not applicable when tax is not required to be paid

FACTS

The appellant entered into
an agreement with a foreign company for promotion of products in India by way
of customer identification and contact, communication to or from, inquiries
relating to business, co-operate with and represent companies in its
promotional efforts, etc. Due to confusion and lack of clarity, the appellant
paid service tax during the period from April, 2006 to February, 2008 for the
services provided to their foreign-based service recipient for the payment
received against the services in convertible foreign exchange. A refund claim
was filed which was rejected on the ground that the same is filed beyond the
time limit prescribed u/s 11B of the Central Excise Act, 1944. Accordingly, the
present appeal is filed.

HELD

The
Tribunal relying on the decision in the case of National Institute of
Public Finance and Policy vs. Commissioner of Service Tax
[2018-TIOL-1746-HC-DEL-ST] held that since the appellant was not liable
to pay service tax, the time limit prescribed u/s 11B of the Central Excise
Act, 1944 for filing of refund claim is not applicable.

shailesh.kwebmaker

TAXATION OF RECEIPT BY RETIRING PARTNER

ISSUE FOR CONSIDERATION

On retirement of a
partner from a partnership firm, at times the outgoing partner may be paid an amount
which is in excess of his capital, current account and loan balances with the
firm. Such amount paid to the outgoing partner is often determined on the basis
of an informal valuation of the net assets of the firm, or of the business of
the firm.

Taxation of such
receipts by a partner on retirement from a partnership firm has been an issue
which has been the subject matter of disputes for several decades. As far back
as in September, 1979, the Supreme Court in the case of Malabar Fisheries
Co. vs. CIT 120 ITR 49, held that dissolution of a firm did not amount
to extinguishment of rights in partnership assets and was thus not a ‘transfer’
within the meaning of section 2(47). In 1987, the Supreme Court, in a short
decision in Addl. CIT vs. Mohanbhai Pamabhai 165 ITR 166,
affirmed the view taken by the Gujarat High Court in 1973 in the case of CIT
vs. Mohanbhai Pamabhai 91 ITR 393. In that case, the Gujarat High Court
had held that when a partner retires from a partnership and the amount of his
share in the net partnership assets after deduction of liabilities and prior
charges is determined on taking accounts on footing of notional sale of
partnership assets and given to him, what he receives is his share in the
partnership and not any consideration for transfer of his interest in
partnership to the continuing partners. Therefore, charge of capital gains tax
would not apply on such retirement.

The law is amended
by the Finance Act, 1987 with effect from Assessment Year 1988-89 by insertion
of section 45(4) and simultaneous deletion of section 47(ii). Section 47(ii)
earlier provided that distribution of assets on dissolution of a firm would not
be regarded as a transfer. Section 45(4) now provides as under:

‘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.’

Section 45(4), with
its introduction, so far as the firm is concerned, provides for taxing the firm
on distribution of its assets on dissolution or otherwise. However, even
subsequent to these amendments, the taxability of the excess amounts received
by the partner on retirement from the firm, in his hands, has continued to be a
matter of dispute before the Tribunals and the High Courts. While the Pune,
Hyderabad, Mumbai and Bangalore benches have taken the view that such excess
amounts are chargeable to tax as capital gains in the hands of the partner, the
Mumbai, Chennai, Bangalore and Hyderabad benches have taken the view that such
amounts are not taxable in the hands of the retiring partner. Further, while
the Bombay, Andhra Pradesh and Madras High Courts have taken the view that such
amount is not taxable in the hands of the partner, the Delhi High Court has
taken the view that it is taxable in the hands of the partner as capital gains.

THE HEMLATA S. SHETTY CASE

The issue came up
before the Mumbai bench of the Tribunal in the case of Hemlata S. Shetty
vs. ACIT [ITA Nos. 1514/Mum/2010 and 6513/Mum/2011 dated 1st December, 2015].

In this case,
relating to A.Y. 2006-07, the assessee was a partner in a partnership firm of
D.S. Corporation where she had a 20% profit share. The partnership firm had
acquired a plot of land in September, 2005 for Rs. 6.50 crores. At that time,
the original capital contributions of the partners was Rs. 3.20 crores, the
partners being the assessee’s husband (Sudhakar M. Shetty) and another person.
The assessee became a partner in the partnership firm on 16^th
September, 2005, contributing a capital of Rs. 52.50 lakhs. On 26^th
September, 2005 three more partners were admitted to the partnership firm. Most
of the tenants occupying the land were vacated by paying them compensation, and
the Ministry of Tourism’s approval was received for setting up a five-star
hotel on the plot of land.

On 27^th
March, 2006 the assessee and her husband retired from the partnership firm, at
which point of time the land was revalued at Rs. 193.91 crores and the surplus
on revaluation was credited to the partners’ capital accounts. The assessee and
her husband each received an amount of Rs. 30.88 crores on their retirement
from the partnership firm, over and above their capital account balances.

The A.O. noted that
the revaluation of land resulted in a notional profit of Rs. 154.40 crores for
the firm and 20% share therein of the assessee and her husband at Rs. 30.88
crores each was credited to their accounts. No tax was paid on such revalued
profits on the plea that those amounts were exempt u/s 10(2A). The A.O. held
that the excess amount received on retirement from the partnership firm was
liable to tax as short-term capital gains as there was a transfer within the
meaning of section 2(47) on retirement of the partner.

The Commissioner
(Appeals), on appeal, confirmed the order of the A.O.

Before the
Tribunal, on behalf of the assessee, reliance was placed on a decision of the
Bombay High Court in the case of Prashant S. Joshi vs. ITO 324 ITR 154,
where the Bombay High Court had quashed the reassessment proceedings initiated
to tax such excess amount received on retirement of a partner from the
partnership firm, on the ground that the amount was a capital receipt not
chargeable to tax and the reopening of the case was not maintainable.

It was argued on
behalf of the Department that the Tribunal had decided the issue against the
assessee in the case of the assessee’s husband, Sudhakar M. Shetty vs.
ACIT 130 ITD 197, on 9^th September, 2010. In that case, the
Tribunal had referred to the observations of the Bombay High Court in the case
of CIT vs. Tribhuvandas G. Patel 115 ITR 95, where the Court had
held that there were two modes of retirement of a partner from a partnership
firm; in one case, a retiring partner, while going out, might assign his
interest by a deed; and in the other case, he might, instead of assigning his
interest, take the amount due to him from the firm and give a receipt for the
money and acknowledge that he had no more claim on his co-partners. In that
case, the Bombay High Court held that where, instead of quantifying his share
by taking accounts on the footing of a notional sale, the parties agreed to pay
a lump sum in consideration of the retiring partner assigning or relinquishing
his share or right in the partnership and its assets in favour of the
continuing partners, the transaction would amount to transfer within the
meaning of section 2(47). This view was followed by the Bombay High Court in
subsequent decisions in the cases of CIT vs. H.R. Aslot 115 ITR 255
and N.A.Mody vs. CIT 162 ITR 420, and the Delhi High Court in the
case of Bishan Lal Kanodia vs. CIT 257 ITR 449.

In the case of Sudhakar
Shetty (Supra), the Tribunal observed that in deciding the case of Prashant
S. Joshi (Supra), the Bombay High Court had not considered its earlier
decisions in the cases of N.A. Mody (Supra) and H.R. Aslot
(Supra) and the said decision was rendered by the Court in the context
of the validity of the notice u/s 148, and therefore the ratio of the
decision in that case did not apply to the facts of the case before it in the Sudhakar
Shetty case.

On behalf of the
assessee, Hemlata Shetty, it was pointed out to the Tribunal that, after the
Tribunal’s decision in Sudhakar Shetty’s case, the Department had
reopened the assessment of the firm where the assessee and her husband were
partners and assessed the notional profits as income in the hands of the firm
u/s 45(4). It was argued that the Department had realised the mistake that it
could not have assessed the partners on account of receipt on retirement u/s
45(4). It was therefore pointed out that due to subsequent developments, the
facts and circumstances had changed from those prevalent when the Tribunal had
decided the case of Sudhakar Shetty.

It was further
argued on behalf of the assessee that after the judgment in the Sudhakar
Shetty case on 9^thSeptember, 2010, a similar matter had
been decided by the Mumbai bench of the Tribunal in the case of R.F.
Nangrani HUF vs. DCIT [ITA No. 6124/Mum/2012] on 10^th
December, 2014, where the decision in Sudhakar Shetty’s case was
also referred to. The issue in that case was similar to the issue in the case
of Hemlata Shetty. In R.F. Nangrani HUF’s case, the
Tribunal had followed the decision of the Supreme Court in the case of CIT
vs. R. Lingamallu Rajkumar 247 ITR 801, where it had held that the
amount received on retirement by a partner was not liable to capital gains tax,
and the Tribunal in that case had also considered the decision of the Hyderabad
bench in ACIT vs. N. Prasad 153 ITD 257, which had taken a
similar view. It was argued on behalf of the assessee that when there were
conflicting decisions delivered by a bench of equal strength, the later
judgment should be followed, especially when the earlier judgment was referred
to while deciding the matter in the later judgment.

The Tribunal noted
that in the case of CIT vs. Riyaz A. Shaikh 221 Taxman 118, the
Bombay High Court referred to the fact that the Tribunal in that case had
followed the Bombay High Court decision in Prashant S. Joshi’s
case, while noting that Tribuvandas G. Patel’s case, which had
been followed in N.A. Mody’s case, had been reversed by the
Supreme Court. The Bombay High Court further noted in Riyaz Shaikh’s
case that Prashant Joshi’s case had also noted this fact of
reversal, and that it had followed the decision of the Supreme Court in R.
Lingamallu Rajkumar’s case 247 ITR 801.

The Tribunal
therefore followed the decision of the jurisdictional High Court in Riyaz
Shaikh’s case and held that the amount received by the assessee on
retirement from the partnership firm was not taxable under the head ‘Capital
Gains’.

This decision of
the Tribunal in Hemlata Shetty’s case has been approved by the
Bombay High Court in Principal CIT vs. Hemlata S. Shetty 262 Taxman 324.
R.F. Nangrani HUF’s Tribunal decision has also been approved by the
Bombay High Court in Principal CIT vs. R.F. Nangrani HUF 93 taxmann.com
302. A similar view has also been taken by the Andhra Pradesh High
Court in the case of CIT vs. P.H. Patel 171 ITR 128, though this
related to A.Y. 1973-74, a period prior to the deletion of clause (ii) of
section 47. Further, in the case of CIT vs. Legal Representative of N.
Paliniappa Goundar (Decd.) 143 ITR 343, the Madras High Court also
accepted the Gujarat High Court’s view in the case of Mohanbhai Pamabhai
(Supra) and disagreed with the view of the Bombay High Court in the
case of Tribhuvandas G. Patel (Supra), holding that excess amount
received by a partner on retirement was not taxable.

A similar view has
also been taken by the Mumbai bench of the Tribunal in the case of James
P. D’Silva vs. DCIT 175 ITD 533, following the Bombay High Court
decisions in Prashant S. Joshi and Riyaz A. Shaikh’s
cases and by the Bangalore bench in the case of Prabhuraj B. Appa, 6 SOT
419 and by the Chennai bench in the case of P. Sivakumar (HUF),
63 SOT 91.

SAVITRI KADUR’S CASE

The issue again
came up before the Bangalore bench of the Tribunal recently in the case of Savitri
Kadur vs. DCIT 177 ITD 259.

In this case, the
assessee and another person had formed a partnership with effect from 1^st
April, 2004. Yet another person was admitted as a partner with effect from 1^st
April, 2007, and simultaneously the assessee retired from the firm with effect
from that date. The assessee had a capital balance of Rs. 1.64 crores as on 1^st
April, 2006 and her share in the profit for the year of Rs. 46 lakhs was
credited to her account. The land and building held by the firm was revalued
and her share of Rs. 62.51 lakhs in the surplus on revaluation was credited to
her account. Interest on capital of Rs. 18.12 lakhs was also credited to her
account which, after deducting drawings, showed a balance of Rs. 2.78 crores as
on the date of her retirement. The assessee was paid a sum of Rs. 3.40 crores
on her retirement. The assessee had invested an amount of Rs. 50 lakhs in
capital gains bonds.

The difference of
Rs. 62 lakhs between Rs. 3.40 crores and Rs. 2.78 crores was taxed as capital
gains by the A.O. in her hands. According to the A.O., such amount was nothing
but a payment for her giving up her right in the existing goodwill of the firm,
that there was a transfer u/s 2(47) on her retirement, which was therefore
liable to capital gains tax.

The Commissioner
(Appeals) upheld the order of the A.O., placing reliance on the decision of the
Bombay High Court in the case of CIT vs. A.N. Naik Associates 265 ITR 346,
where the High Court had held that there was a charge to capital gains tax u/s
45(4) when the assets of the partnership were distributed even on retirement of
a partner, and the scope of section 45(4) was not restricted to the case of
dissolution of the firm alone.

On appeal, the
Tribunal observed that it was necessary to appreciate how the act of the
formation, introduction, retirement and dissolution of partnership was used by
assessees as a device to evade tax on capital gains; first by converting an
asset held individually into an asset of the firm and later on retiring from
the firm; and likewise by conversion of capital assets of the firm into assets
of the partners by effecting dissolution or retirement. In that direction, the
Tribunal analysed the background and tax implications behind conversion of
individual assets into assets of partnership, distribution of assets on
dissolution, reconstitution of the firm with the firm continuing whereby a
partner retired and the retiring partner was allotted a capital asset of the
firm for relinquishing all his rights and interests in the partnership firm as
partner, and continuation of the firm after reconstitution whereby a partner
retired and the retiring partner was paid a consideration for relinquishing all
his rights and interests in the partnership firm as partner in any of the
following manner:

(a) on the basis of
amount lying in his / her capital account, or

(b) on the basis of
amount lying in his / her capital account plus amount over and above the sum
lying in his / her capital account, or

The Tribunal
thereafter held that the case of the appellant, on the basis of the facts
before it, was a situation falling under (b) above, meaning that the assessee
on her retirement from the firm was paid on the basis of the amount lying in
her capital account plus an amount over and above the sum lying in her capital
account.

The Tribunal
observed that:

(i) there was no
dispute that there could not be any incidence of tax in situation (a) above on
account of the Supreme Court decision in the case of Additional CIT vs.
Mohanbhai Pamabhai (Supra);

(ii) so far as
situations (b) and (c) were concerned, they had been the subject matter of
consideration in several cases, and there had been conflict of opinion between
courts on whether there would be incidence of tax or not;

(iii) the fact that
there was revaluation of assets of the firm with a resultant enhancement of the
capital accounts of the partners was not relevant.

The Tribunal
further observed that:

(1) the share or
interest of a partner in the partnership and its assets would be property and,
therefore, a capital asset within the meaning of the aforesaid definition. To
this extent, there could be no doubt;

(2) the question
was whether it could be said that there was a transfer of capital asset by the
retiring partner in favour of the firm and its continuing partners so as to
attract a charge u/s 45;

(3) the share or
interest of a partner in the partnership and its assets would be property and,
therefore, a capital asset within the meaning of the aforesaid definition. The
next question was whether it could be said that there was a transfer of capital
asset by the retiring partner in favour of the firm and its continuing partners
so as to attract a charge u/s 45;

(4) the question
whether there would be incidence of tax on capital gains on retirement of a
partner from the partnership firm would depend upon the mode in which
retirement was effected. Therefore, taxability in such a situation would depend
on several factors like the intention, as was evidenced by the various clauses
of the instrument evincing retirement or dissolution, the manner in which the
accounts had been settled and whether the same included any amount in excess of
the share of the partner on the revaluation of assets and other relevant
factors which would throw light on the entire scheme of retirement /
reconstitution;

(5) for the
purposes of computation, what was to be seen was the credit in the capital
account of the partner alone.

The Tribunal,
referring to the observations of the Bombay High Court in the case of Tribhuvandas
G. Patel (Supra), held that the terms of the deed of retirement had to
be seen as to whether they constituted a release of any assets of the firm in
favour of the continuing partners; where on retirement an account was taken and
the partner was paid the amount standing to the credit of his capital account,
there would be no transfer and no tax was exigible; however, where the partner
was paid a lump sum consideration for transferring or releasing his interest in
the partnership’s assets to the continuing partners, there would be a transfer,
liable to tax. The Tribunal noted that the Supreme Court, in appeal in that
case, had held that there was no incidence of tax on capital gains on the
transaction only because of the provisions of section 47(ii), which exempted
the distribution of capital assets on dissolution, even though the facts in the
case in appeal before the Supreme Court were concerning the case of a retiring
partner giving up his rights over the properties of the firm.

The Tribunal
referred to the cases of the Pune bench in the case of Shevantibhai C.
Mehta 4 SOT 94 and the Mumbai bench of the Tribunal in the case of Sudhakar
M. Shetty (Supra) and held that the facts in the case before it were
almost identical to the facts in the case of Sudhakar M. Shetty.

It distinguished
the other cases cited before it on behalf of the assessee on the grounds that
some of those cases related to a period prior to the amendment of the law made
effective from A.Y. 1988-89, or were cases where the issue involved was whether
the reassessment proceedings were valid, or were cases involving the
partnership firm and not the partner, or were cases where the retiring partner
was paid a share in the goodwill of the firm. In short, the Tribunal held that
those cases were not applicable to the facts of the assessee’s case.

The Tribunal
finally upheld the action of the A.O. in taxing the excess paid to the retiring
partner over and above the sum standing to the credit of her capital account as
capital gains. However, it modified the computation of the capital gains by
treating the amount lying to the credit of the partner’s account, including the
amount credited towards goodwill in the partner’s capital account, as a cost
and allowing the deduction thereof. It also held the gains to be long-term
capital gains and allowed exemption u/s 54EC to the extent of investment in
capital gains bonds.

A similar view has
been taken by the other benches of the Tribunal in the cases of Shevantibhai
C. Mehta (Supra), Sudhakar M. Shetty (Supra) and Smt. Girija
Reddy vs. ITO 52 SOT 113 (Hyd)(URO). The Delhi High Court also, in a
case relating to A.Y. 1975-76 (before the amendment), Bishan Lal Kanodia
vs. CIT 257 ITR 449, followed the decision of the Bombay High Court in Tribhuvandas
G. Patel (Supra) to hold that the receipt on retirement was liable to
capital gains tax.

OBSERVATIONS

To understand the
root of the controversy, one would have to go back to the decision of the
Gujarat High Court in the case of CIT vs. Mohanbhai Pamabhai 91 ITR 393,
which was affirmed by the Supreme Court, 165 ITR 166, holding
that there was no transfer of capital assets by a partner on his retirement. In
that case, on retirement, the assessee received a certain amount in respect of
his share in the partnership which was worked out by taking the proportionate
value of a share in the partnership assets, after deduction of liabilities and
prior charges, including an amount representing his proportionate share in the
value of the goodwill. It was this proportionate share in the goodwill which
was sought to be taxed as capital gains by the authorities.

In that case, the
Gujarat High Court held that:

(i) what the
retiring partner was entitled to get was not merely a share in the partnership
assets, he has also to bear his share of the debts and liabilities, and it was
only his share in the net partnership assets, after satisfying the debts and
liabilities, that he was entitled to get on retirement;

(ii) Since it was only in the surplus that the
retiring partner was entitled to claim a share, it was not possible to predicate
that a particular amount was received by the retiring partner in respect of his
share in a particular partnership asset, or that a particular amount
represented a consideration received by the retiring partner for extinguishment
of his interest in a particular partnership asset;

(iii) when the
assessee retired from the firm, there was no transfer of interest of the
assessee in the goodwill or any other asset of the firm;

(iv) no
consideration received or accrued as a result of such transfer of such interest
even if there was a transfer; and

(v) no part of the amount received by the assessee
was assessable to capital gains tax u/s 45.

The Gujarat High
Court relied on its earlier decision in the case of CIT vs. R.M. Amin 82
ITR 194, for the proposition that where transfer consisted in
extinguishment of a right in a capital asset, unless there was an element of
consideration for such extinguishment, the transfer would not be liable to
capital gains tax.

It may be noted
that in Mohanbhai Pamabhai, the document pursuant to which
retirement was effected stated that the amount had been decided as payable to
the retiring partners in lieu of all their rights, interest and share in
the partnership firm, and each of them voluntarily gave up their right, title
and interest in the partnership firm. The goodwill had not been recorded or
credited to the capital accounts of the partners, and therefore it was a (b)
type of situation classified by the Bangalore Tribunal. The Bangalore bench of
the Tribunal therefore does not seem to have been justified in stating that
only cases where only balance standing to credit of the capital account is paid
to the retiring partner [situation (a) cases] are not transfers as was held by
the Supreme Court in Mohanbhai Pamabhai. In other words, the
facts of the Mohanbhai Pamabhai case classified with situation
(b) and the Tribunal overlooked this fact; had it done so by appreciating that
the facts in the case before the Supreme Court were akin to situation (b), the
decision could have been different.

The Supreme Court
approved the Gujarat High Court decision on the footing that there was no
transfer within the meaning of section 2(47) on retirement of a partner from a
partnership firm. By implication, the Supreme Court held that such cases of
retirement, where a partner was paid a sum over and above the balance due as
per the books of accounts, was not chargeable to capital gains tax.
Interestingly, in deciding the case the Supreme Court, while holding that the
receipts in question were not taxable, did not distinguish between different
modes of retirement, as some of the Tribunals and High Courts have sought to
do, for taxing some and exempting others.

The Tribhuvandas
G. Patel case (Supra) was one where the retiring partner was paid his
share in the goodwill of the firm and was also paid his share of appreciation
in the assets of the firm. Here, relying on the Commentary of Lindley on
Partnership, the Bombay High Court observed as under:

‘Further, under
section 32, which occurs in Chapter V, retirement of a partner may take any
form as may be agreed upon between the partners and can occur in three
situations contemplated by clauses (a), (b) and (c) of sub-section (1) of
section 32. It may be that upon retirement of a partner his share in the net
partnership assets after deduction of liabilities and prior charges may be
determined on taking accounts on the footing of notional sale of partnership
assets and be paid to him, but the determination and payment of his share may
not invariably be done in that manner and it is quite conceivable that, without
taking accounts on the footing of notional sale, by mutual agreement, a
retiring partner may receive an agreed lump sum for going out as and by way of
consideration for transferring or releasing or assigning or relinquishing his
interest in the partnership assets to the continuing partners and if the
retirement takes this form and the deed in that behalf is executed, it will be
difficult to say that there would be no element of “transfer”
involved in the transaction. In our view, it will depend upon the manner in
which the retirement takes place. What usually happens when a partner retires
from a firm has been clearly stated in the following statement of law, which
occurs in Lindley on Partnership, 13^thedition, at page 474:

“24.
Assignment of share, etc., by retiring partner.—When a partner retires or dies,
and he or his executors are paid what is due in respect of his share, it is
customary for him or them formally to assign and release his interest in the
partnership, and for the continuing or surviving partners to take upon
themselves the payment of the outstanding debts of the firm, and to indemnify
their late partner or his estate from all such debts, and it is useful for the
partnership agreement specifically so to provide.”

At page 475,
under the sub-heading “stamp on assignment by outgoing partner”, the
following statement of law occurs:

“An
assignment by a partner of his share and interest in the firm to his
co-partners, in consideration of the payment by them of what is due to him from
the firm, is regarded as a sale of property within the meaning of the Stamp
Acts; and consequently the deed of assignment, or the agreement for the
assignment, requires an ad valorem stamp. But if
the retiring partner, instead of assigning his interest, takes the amount due
to him from the firm, gives a receipt for the money, and acknowledges that he
has no more claims on his co-partners, they will practically obtain all they
want; but such a transaction, even if carried out by deed, could hardly be held
to amount to a sale; and no ad valorem stamp, it is apprehended, would
be payable.”

A couple of
things emerge clearly from the aforesaid passages. In the first place, a
retiring partner while going out and while receiving what is due to him in
respect of his share, may assign his interest by a deed or he may, instead of
assigning his interest, take the amount due to him from the firm and give a
receipt for the money and acknowledge that he has no more claim on his
co-partners. The former type of transactions will be regarded as sale or
release or assignment of his interest by a deed attracting stamp duty, while
the latter type of transaction would not. In other words, it is clear, the
retirement of a partner can take either of two forms, and apart from the
question of stamp duty, with which we are not concerned, the question whether
the transaction would amount to an assignment or release of his interest in
favour of the continuing partners or not would depend upon what particular mode
of retirement is employed and as indicated earlier, if instead of quantifying
his share by taking accounts on the footing of notional sale, parties agree to
pay a lump sum in consideration of the retiring partner assigning or
relinquishing his share or right in the partnership and its assets in favour of
the continuing partners, the transaction would amount to a transfer within the
meaning of section 2(47) of the Income-tax Act.’

Based on the
language of the Deed of Retirement, the Bombay High Court took the view that
since there was an assignment by the outgoing partner of his share in the
assets of the firm in favour of the continuing partners, there was a transfer
and the gains made on such transfer were exigible to tax.

In the context of
taxation, the Bombay High Court observed:

‘It may be
stated that the Gujarat decision in Mohanbhai
Pamabhai’s case [1973] 91 ITR 393 is the only
decision directly on the point at issue before us but the question is whether
the position of a retiring partner could be equated with that of a partner upon
the general dissolution for capital gains tax purposes? The equating of the two
done by the Supreme Court in Addanki
Narayanappa’s case, AIR 1966 SC 1300, was not
for capital gains tax purposes but for considering the question whether the
instrument executed on such occasion between the partners inter se required registration and could be admitted in evidence
for want of registration. For capital gains tax purposes the question assumes
significance in view of the fact that under section 47(ii) any distribution of
assets upon dissolution of a firm has been expressly excepted from the purview
of section 45 while the case of a retirement of a partner from a firm is not so
excepted and hence the question arises whether the retirement of a partner
stands on the same footing as that upon a dissolution of the firm. In our view,
a clear distinction exists between the two concepts, inasmuch as the
consequences flowing from each are entirely different. In the case of
retirement of a partner from the firm it is only that partner who goes out of
the firm and the remaining partners continue to carry on the business of the
partnership as a firm, while in the latter case the firm as such no more exists
and the dissolution is between all the partners of the firm. In the Indian
Partnership Act the two concepts are separately dealt with.’

This distinction between the dissolution and the retirement, made by
the High Court for taxing the receipt was overruled by the Supreme Court by
holding that the two are the same for the purposes of section 47(ii) of the
Act.

It was therefore
that the Bombay High Court first held that there was a transfer and later that
the receipt of consideration on transfer was not exempt from tax u/s 47(ii) of
the Act. The Supreme Court, however, overruled the Bombay High Court decision,
holding that retirement was also covered by dissolution referred to in section
47(ii), and that such retirement would therefore not be chargeable to capital
gains. It may also be noted that the Bombay High Court’s decision was rendered
prior to the Supreme Court decision in the case of Mohanbhai Pamabhai
(Supra).

Surprisingly, the
Delhi High Court, while deciding the case of Bishanlal Kanodia (Supra),
relied upon the decision of the Bombay High Court in Tribuhuvandas G.
Patel (Supra), overlooking the implications of the decisions of the
Supreme Court in the cases of Mohanbhai Pamabhai and Tribhuvandas
G. Patel wherein the ratio of the decision of the Bombay High
Court was rendered inapplicable. The Delhi High Court sought to distinguish
between dissolution and retirement, even though the Supreme Court had held that
the term ‘dissolution’ for the purpose of section 47(ii) included retirement up
to A.Y. 1987-88; the case before the Delhi High Court concerned itself with
A.Y. 1975-76.

Further, though the
decision of the Madras High Court in the case of the Legal Representatives of
N. Paliniappa Goundar (Supra) was relied upon by the assessee in the
case of Savitri Kadur (Supra), it was not considered by the
Bangalore bench of the Tribunal. The Madras High Court in that case, for A.Y.
1962-63, considering the provisions of section 12B of the 1922 Act, had dealt
with the decisions of the Gujarat High Court in the case of Mohanbhai
Pamabhai and of the Bombay High Court in the case of Tribhuvandas
G. Patel, which had not yet been decided by the Supreme Court. While
disagreeing with the view of the Bombay High Court, the Madras High Court
observed as under:

With respect, we
cannot see why a retirement of a partner from a firm should be treated as
having different kinds of attributes according to the mode of settlement of the
retiring partner’s accounts in the partnership. In our view, whether the
retiring partner receives a lump sum consideration or whether the amount is
paid to him after a general taking of accounts and after ascertainment of his
share in the net assets of the partnership as on the date of retirement, the
result, in terms of the legal character of the payment as well as the
consequences thereof, is precisely the same. For, as observed by the Gujarat
High Court in Mohanbhai‘s case when a partner retires from the firm and receives an amount
in respect of his share in the partnership, what he receives is his own share
in the partnership, and it is that which is worked out and realised. Whatever
he receives cannot be regarded as representing some kind of consideration
received by him as a result of transfer of assignment or extinguishment or
relinquishment of his share in favour of the other partners.

We hold that
even in a case where some kind of a lump sum is received by the retiring
partner, it must be regarded as referable only to the share of the retiring
partner. This being so, no relinquishment at all is involved. What he receives
is what he has already put in by way of his share capital or by way of his
exertions as a partner. In a true sense, therefore, whether it is a dissolution
or a retirement, and whether in the latter case the retirement is on the basis
of a general taking of accounts or on the basis of an ad hoc payment to the retiring partner, what the partner obtains
is nothing more and nothing less than his own share in the partnership. A
transaction of this kind is more fittingly described as a mutual release or a
mutual relinquishment. In the very case dealt by the Bombay High Court, the
particular amount paid by the remaining partners in favour of the retiring
partner was only a payment in consideration of which there was a mutual
release, a release by the retiring partner in favour of the remaining partners
and a release by the remaining partners in favour of the retiring partner. The
idea of mutual release is appropriate to a partnership, because a retired
partner will have no hold over the future profits of the firm and the partners
who remain in the partnership release the retired partner from all future
obligations towards the liabilities of the firm.

We, therefore,
unqualifiedly accept the decision of the Gujarat High Court as based on a
correct view of the law and the legal relations which result on the retirement
of a partner from the partnership. With respect, we do not subscribe to the distinction
sought to be drawn by the learned Judges of the Bombay High Court between an ad hoc payment to a retiring partner and a payment to him after
ascertaining his net share in the partnership.

The Andhra Pradesh High Court in the case of CIT vs. L. Raghu
Kumar 141 ITR 674, also had an occasion to consider this issue for the
A.Y. 1971-72. In this case, the retiring partner received an amount in excess
of the balance lying to the credit of his capital account and his share of
profits. The Andhra Pradesh High Court considered the decisions of the Bombay
High Court in the case of Tribhuvandas G. Patel (Supra) and CIT
vs. H.R. Aslot 115 ITR 255, where the Bombay High Court had held that
whether there was a transfer or not would depend upon the terms of the retirement
deed – whether there is an assignment by the outgoing partner in favour of the
continuing partners, or whether the retiring partner merely receives an amount
for which he acknowledges receipt.

The Andhra Pradesh
High Court observed as under:

‘It is no doubt
true as submitted by the learned counsel for the revenue that the Bombay High
Court did not accept the principle in the Mohanbhai case, that there is no distinction between a case of a retirement
of the partner and dissolution of the partnership firm and that there can never
be a transfer of a capital asset in the case of a retirement of a partner as
there is no relinquishment of a capital asset or extinguishment of rights
therein. With great respect, we are unable to agree with the view of the Bombay
High Court. The rights of a partner are governed by the provisions of the
Partnership Act. Otherwise by a mere description, the nature of the transaction
can be altered. Further, the Gujarat High Court in Mohanbhai’s case (Supra) followed the
decision of the Supreme Court in Narayanappa
(Supra) which laid down the proposition of law
unequivocally.’

This decision of
the Andhra Pradesh High Court has been affirmed by the Supreme Court in CIT
vs. R. Lingmallu Raghukumar 247 ITR 801. Therefore, effectively, the
Supreme Court has approved of the approach taken by the Andhra Pradesh High
Court, to the effect that there can never be a transfer of a capital asset in
the case of retirement of a partner as there is no relinquishment of a capital
asset or extinguishment of rights therein, and that the nature of the
transaction cannot be altered by a mere description, but is governed by the
provisions of the Partnership Act. It is only logical that a transfer cannot
arise merely because a retiring partner is paid an amount in excess of his
capital, or because the retirement deed wording is different.

This fact of law
laid down by the Supreme Court and the overruling of the law laid down by the
Bombay High Court, has been recognised by the Bombay High Court in its later
decision in the case of Prashant S. Joshi (Supra), clearly and
succinctly, where the Bombay High Court observed:

‘The Gujarat
High Court held that there is, in such a situation, no transfer of interest in
the assets of the partnership within the meaning of section 2(47). When a
partner retires from a partnership, what the partner receives is his share in
the partnership which is worked out by taking accounts and this does not amount
to a consideration for the transfer of his interest to the continuing partners.
The rationale for this is explained as follows in the judgment of the Gujarat
High Court (in the Mohanbhai Pamabhai case):

“…What
the retiring partner is entitled to get is not merely a share in the
partnership assets; he has also to bear his share of the debts and liabilities
and it is only his share in the net partnership assets after satisfying the
debts and liabilities that he is entitled to get on retirement. The debts and
liabilities have to be deducted from the value of the partnership assets and it
is only in the surplus that the retiring partner is entitled to claim a share.
It is, therefore, not possible to predicate that a particular amount is
received by the retiring partner in respect of his share in a particular
partnership asset or that a particular amount represents consideration received
by the retiring partner for extinguishment of his interest in a particular
asset.”

14. The appeal
against the judgment of the Gujarat High Court was dismissed by a Bench of
three learned Judges of the Supreme Court in Addl.
CIT vs. Mohanbhai Pamabhai [1987] 165 ITR 166.
The Supreme Court relied upon its judgment in Sunil
Siddharthbhai vs. CIT [1985] 156 ITR 509. The
Supreme Court reiterated the same principle by relying upon the judgment in Addanki Narayanappa vs. Bhaskara Krishnappa AIR 1966 SC 1300. The Supreme Court held that what is envisaged on the retirement of
a partner is merely his right to realise his interest and to receive its value.
What is realised is the interest which the partner enjoys in the assets during
the subsistence of the partnership by virtue of his status as a partner and in
terms of the partnership agreement. Consequently, what the partner gets upon
dissolution or upon retirement is the realisation of a pre-existing right or
interest.

The Supreme
Court held that there was nothing strange in the law that a right or interest
should exist in praesenti but its realisation or
exercise should be postponed. The Supreme Court inter alia cited with
approval the judgment of the Gujarat High Court in Mohanbhai Pamabhai’s
case (Supra) and held that there is no transfer upon the retirement of a
partner upon the distribution of his share in the net assets of the firm. In CIT
vs. R. Lingmallu Raghukumar [2001] 247 ITR 801, the Supreme Court held,
while affirming the principle laid down in Mohanbhai Pamabhai
that when a partner retires from a partnership and the amount of his share in
the net partnership assets after deduction of liabilities and prior charges is
determined on taking accounts, there is no element of transfer of interest in
the partnership assets by the retired partner to the continuing partners.

15. At this
stage, it may be noted that in CIT vs.
Tribhuvandas G. Patel [1978] 115 ITR 95 (Bom.),
which was decided by a Division Bench of this Court, under a deed of
partnership, the assessee retired from the partnership firm and was inter alia paid an amount of Rs. 4,77,941 as his share in the
remaining assets of the firm. The Division Bench of this Court had held that
the transaction would have to be regarded as amounting to a transfer within the
meaning of section 2(47) inasmuch as the assessee had assigned, released and
relinquished his share in the partnership and its assets in favour of the
continuing partners. This part of the judgment was reversed in appeal by the
Supreme Court in Tribhuvandas G. Patel vs. CIT [1999] 236 ITR 515.

Following the
judgment of the Supreme Court in Sunil
Siddharthbhai’s case (Supra), the Supreme Court
held that even when 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. Therefore, the question was answered in favour of the assessee and
against the revenue. Section 47(ii) which held the field at the material time
provided that nothing contained in section 45 was applicable to certain
transactions specified therein and one of the transactions specified in clause
(ii) was distribution of the capital assets on a dissolution of a firm. Section
47(ii) was subsequently omitted by the Finance Act of 1987 with effect from 1^st
April, 1988. Simultaneously, sub-section (4) of section 45 came to be inserted
by the same Finance Act. Sub-section (4) of section 45 provides that 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.

The fair market
value of the assets 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 for
the purpose of section 48. Ex facie sub-section
(4) of section 45 deals with a situation where there is a transfer of a capital
asset by way of a distribution of capital assets on the dissolution of a firm
or otherwise. Evidently, on the admitted position before the Court, there is no
transfer of a capital asset by way of a distribution of the capital assets on a
dissolution of the firm or otherwise in the facts of this case. What is to be
noted is that even in a situation where sub-section (4) of section 45 applies,
profits or gains arising from the transfer are chargeable to tax as income of
the firm.’

The Bombay High
Court in Prashant Joshi’s case (Supra) also considered the fact
that section 45(4) was brought in simultaneously with the deletion of section
47(ii), providing for taxation in the hands of the firm, in a situation of
transfer of a capital asset on distribution of capital assets on the
dissolution of a firm or otherwise. Clearly, therefore, the intention was to
tax only the firm and that too only in a situation where there was a
distribution of capital assets of a firm on dissolution or otherwise, which
situation would include retirement of a partner as held by the Bombay High
Court in the case of CIT vs. A.N. Naik Associates 265 ITR 346.
This understanding of the law has clearly been brought out by the Bombay High
Court in Hemlata Shetty’s case (Supra), where the Bombay High
Court has observed that amount received by a partner on his retirement from the
partnership firm is not subject to tax in the retiring partners’ hands in view
of section 45(4), and the liability, if any, for tax is on the partnership
firm.

Had the intention
been to also tax a partner on his retirement on the excess amount received over
and above his capital balance in the books of the firm, an amendment would have
been made to cover such a situation involving the receipt of capital asset by a
partner on distribution by the firm simultaneously with the deletion of section
47(ii).

The Bombay High
Court’s decision in the case of Riyaz A. Shaikh (Supra) is a
decision rendered in the context of A.Y. 2002-03, i.e., post-amendment. It was
not a case of a writ petition filed against any reassessment but was an appeal
from the decision of the Tribunal. The Court in that case has considered all
the relevant decisions – the Bombay High Court’s decisions in the cases of Prashant
S. Joshi, N.A. Mody and Tribhuvandas G. Patel, besides
the Supreme Court decisions in the cases of Tribhuvandas G. Patel
and R. Lingamallu Rajkumar – while arriving at the view that the
amounts received on retirement by a partner are not liable to capital gains
tax.

Similarly, Hemlata
Shetty’s case pertained to the post-amendment period and the Court
therein has considered the earlier decisions of the Bombay High Court in the Prashant
S. Joshi and Riyaz A. Sheikh cases and has also
considered the impact of section 45(4). It is indeed baffling that the Bombay
High Court decision delivered on 5^th March, 2019 and the earlier
decision of the Tribunal in the same case have not been considered by the
Bangalore bench of the Tribunal in Savitri Kadur’s case, decided
on 3^rd May, 2019, which chose to follow the decision of Sudhakar
M. Shetty (Supra), where the matter was still pending before the Bombay
High Court, rather than a decision of the Bombay High Court in his wife’s case
on identical facts (retirement from the same partnership firm) for the
immediately preceding assessment year, where the matter had already been
decided on 5^th March, 2019. We are sure that the decision of the
Tribunal could have been different if the development had been in its
knowledge.

One may note that
the Legislature, realising that the receipt in question was not taxable under
the present regime of the Income-tax Act, 1961, had introduced a specific
provision for taxing such receipt in the hands of the partner under the
proposed Direct Tax Code which has yet to see the light of the day.

The better view of
the matter therefore is that retirement of a partner from a partnership firm is
not subject to capital gains tax, irrespective of the mode of retirement of the
partner, as rightly held by the Bombay High Court in various decisions, and the
Mumbai bench of the Tribunal in the cases of Hemlata Shetty and James
P. D’Silva (Supra). It is rather unfortunate that this issue has been
continuing to torture assessees for the last so many decades, even after
several Supreme Court judgments. One hopes that this matter will finally be
laid to rest either through a clarification by the CBDT or by a decision of the
Supreme Court.

The beauty of doing nothing is that you can do it
perfectly. Only when you do something is it almost impossible to do it without
mistakes. Therefore people who are contributing nothing to society, except
their constant criticisms, can feel both intellectually and morally superior.

—
Thomas Sowell

shailesh.kwebmaker

Article 11(3)(c) of the India-Mauritius DTAA – Interest income earned from India by a Mauritian company engaged in the banking business is exempt under Article 11(3)(c) of the India-Mauritius DTAA; in terms of Circular No 789, TRC issued by Mauritius tax authority is valid proof of residence as well as beneficial ownership

18. [2020] 117 taxmann.com 750 (Mumbai-Trib.) DCIT vs. HSBC Bank
(Mauritius) Ltd. ITA No: 1320/ Mum/2019 A.Y.: 2015-16 Date of order: 8^th
July, 2020

Article 11(3)(c) of the India-Mauritius DTAA
– Interest income earned from India by a Mauritian company engaged in the
banking business is exempt under Article 11(3)(c) of the India-Mauritius DTAA;
in terms of Circular No 789, TRC issued by Mauritius tax authority is valid
proof of residence as well as beneficial ownership

FACTS

The assessee, a resident of Mauritius, carried on banking business as a
licensed bank in Mauritius. The assessee was also registered as an FII with
SEBI. Article 11(3)(c) of the India-Mauritius DTAA exempts interest income from
tax in India if: (i) the interest is derived and beneficially owned by the
assessee; and (ii) the assessee is a bank carrying on bona fide banking
business in Mauritius. The assessee had received interest income from
securities and loans to Indian tax residents. According to the assessee, being
a tax resident of Mauritius, it qualified for exemption under Article 11(3)(c)
of the DTAA and hence, interest earned by it was not chargeable to tax in
India. To support its beneficial ownership and residential status, the assessee
placed reliance on the Certificate of Residency (TRC) issued by Mauritius tax
authorities and also Circular No 789⁶.

The A.O., however, did not grant exemption on the ground that the banking
activities carried out by the assessee in Mauritius were minuscule and were
only for namesake purpose. Further, Circular No. 789 dealt with taxation of
dividends and capital gains under the India-Mauritius DTAA and did not apply in
case of interest. Accordingly, the A.O. charged tax on interest @ 5% u/s 115AD
of the Act, read with section 194LD.

On appeal, relying upon the orders of the Tribunal in favour of the
assessee in earlier years⁷, the CIT(A) concluded in favour of the
assessee.

Being aggrieved, the Tax Department filed an appeal before the Tribunal
where it contended that the earlier years’ orders did not deal with the Tax
Department’s objection that the assessee was not a beneficial owner of the
interest and was a conduit company.

HELD

The following observations from the orders of earlier years⁸
in the case of the assessee are relevant:

As per Circular 789, wherever a Certificate of Residency is issued by
the Mauritius tax authority, such Certificate will constitute sufficient
evidence for accepting residential status as well as beneficial ownership for
application of the India-Mauritius DTAA.

Circular 789 equally applies to taxability of interest in terms of
Article 11(3)(c) of the DTAA.

Thus, having regard to the Tax Residency Certificate issued by the
Mauritius tax authority, the assessee is ‘beneficial owner’ of interest income.

Accordingly, interest earned by the assessee is exempt in terms of
Article 11(3)(c) of the India-Mauritius treaty.

Note: The decision is in the context of the India-Mauritius DTAA prior
to its amendment with effect from 1^st April, 2017. Post-amendment,
Article 11(3A) reads as follows:

‘Interest arising in a Contracting State shall be exempt from tax in
that State provided it is derived and beneficially owned by any bank resident
of the other Contracting State carrying on bona fide
banking business. However, this exemption shall apply only if such interest
arises from debt-claims existing on or before 31^st March, 2017.’

_________________________________________________________________________________________________

6 Circular No 789 provides that TRC will
constitute sufficient evidence in respect of tax residence as well as
beneficial ownership for application of DTAA

7 A.Y. 2009-10 (ITA No. 1086/Mum/2018), A.Y.
2010-11 (ITA No. 1087/Mum/2018) and A.Y. 2011-12 (ITA No. 1708/Mum/2016)

8 A.Y. 2014-15 (ITA No. 1319/Mum/2019)

shailesh.kwebmaker

Article12 of the India-Ireland DTAA – Consideration received by the assessee for supply / distribution of its copyrighted software products was not chargeable to tax in India as royalty under Article 12 of India-Ireland DTAA

17. [2020] 117 taxmann.com 983 (Delhi – Trib.) Mentor Graphics Ireland
Ltd. vs. ACIT ITA No. 3966/Del/2017 A.Y.: 2014-15 Date of order: 9^th
July, 2020

Article12 of the India-Ireland DTAA – Consideration received by the
assessee for supply / distribution of its copyrighted software products was not
chargeable to tax in India as royalty under Article 12 of India-Ireland DTAA

FACTS

The assessee, an Ireland resident company, received consideration for
sale of software and provision of support services. According to the assessee,
it had received consideration for sale of copyrighted product and not for sale
of copyright and hence, in terms of Article 12 of the India-Ireland DTAA, such
consideration was not chargeable to tax in India. However, it offered income
from support services to tax.

Relying upon the Karnataka High Court decisions in the case of Samsung
Electronics Company Ltd² and Synopsis International
Old Ltd.³, the A.O. and the DRP held that the consideration
received by the assessee for supply / distribution of copyrighted software
products was for grant of ‘right to use’ of the copyright in the software and
hence it qualified as ‘royalty’.

Being aggrieved, the assessee appealed before the Tribunal.

HELD

In
earlier years, on an identical issue in the assessee’s case⁴,
the Tribunal had ruled in favour of the assessee.

Further,
in DIT vs. Infrasoft Ltd.⁵ , the jurisdictional
High Court had held that receipt from sale of software by the assessee in
that case was not royalty under Article 12 of the India-Ireland DTAA.

Accordingly,
income from sale of software was not in the nature of ‘royalty’ under
Article 12 of the India-Ireland DTAA and was not taxable in India.

———————————————————————-

2
345 ITR 494 (Kar)

3 212 Taxman 454 (Kar)

4 ITA No. 6693/Del/2016 relating to Assessment
Year 2013-14

5 [2013] 220 Taxman 273 (Del.)

shailesh.kwebmaker

Article 12 of India-Singapore DTAA; Section 9 of the Act – Provision for IT infrastructure management and mailbox / website hosting services were not in nature of royalty, whether under the Act or Article 12 of DTAA; fees for management services (such as sales support, financial advisory and human resources assistance) and fees for referral services did not satisfy the requirement of ‘make available’ under Article 12 of DTAA

16. [2020] 118
taxmann.com 2 (Mumbai-Trib.) Edenred (P) Ltd.
vs. DDIT ITA Nos.
1718/Mum/2014; 254/Mum/2015 A.Ys.: 2010-11 to
2012-13 Date of order: 20^th
July, 2020

Article 12 of
India-Singapore DTAA; Section 9 of the Act – Provision for IT infrastructure
management and mailbox / website hosting services were not in nature of
royalty, whether under the Act or Article 12 of DTAA; fees for management
services (such as sales support, financial advisory and human resources
assistance) and fees for referral services did not satisfy the requirement of
‘make available’ under Article 12 of DTAA

FACTS

The assessee was a
Singapore tax resident company. It entered into certain agreements with its
group companies in India for rendering the following services:

Infrastructure Data Centre (IDC) services

Management services

Referral services

Administration and supervision of central infrastructure

Mailbox hosting services

Website hosting services

Sales support activities

Legal services

Financial advisory services

Human resource assistance

Support services¹ to serve clients in India that
were referred by assessee

Relying upon
Article 12 of the India-Singapore DTAA, the assessee contended that income
received from the aforesaid agreements was not taxable in India. The A.O. as
well as the DRP rejected this contention of the assessee. The following is a
summary of the conclusions of the A.O. and of the DRP:

Services

Draft A.O. order

Draft DRP direction

Final assessment order

IDC charges

Taxable as royalty under Act and DTAA

Management services

Taxable as FTS under Act and DTAA

Referral fees

Taxable as royalty under Act and DTAA

Taxable as royalty and FTS under Act and DTAA

Being aggrieved,
the assessee appealed to the Tribunal.

HELD

IDC Charges

Facts pertaining
to IDC agreement are as follows:

The assessee
had an infrastructure data centre and not an information centre in Singapore.

The Indian
group companies did not access or use the CPU of the assessee; the IDC
agreement did not permit such use / access to group companies of the assessee
nor had the assessee provided any system which enabled group companies such use
/ access.

The assessee
did not maintain any centralised data; IDC did not have any capability in
respect of information analytics, data management.

The assessee
provided IDC service using its own hardware / security devices / personnel;
Indian group companies received standard IDC services without use of any
software; the assessee had used bandwidth and networking infrastructure for
rendering IDC services; Indian companies only received output generated by the
assessee using bandwidth and network but not the use of underlying
infrastructure.

Consideration
paid by group companies was for IDC services and not for any specific
programme. Besides, the assessee had not developed any embedded / secret
software which was used by group companies.

Having regard to
the case law relied upon by the assessee and the Tax Department, since the
assessee had merely provided IDC services, such as administration and
supervision of central infrastructure, mailbox hosting services and website
hosting services, income from IDC services was not in the nature of ‘royalty’,
whether under the Act or under the DTAA.

Management
Services

The assessee had
provided management services to support Indian group companies in carrying on
their business efficiently and running the business in line with the business
model, policies and best practices uniformly followed by companies of the
assessee group.

Services did not
‘make available’ any technical knowledge, skill, know-how or processes to
Indian group companies.

Hence,
consideration received by the assessee for management services was not in the
nature of ‘fees for technical services’ under the DTAA.

Referral Fees

The fees
received by the assessee in consideration for referral services did not ‘make
available’ any technical knowledge, skill, know-how or processes to Indian
group companies because there was no transmission of the technical knowledge,
experience, skill, etc. by the assessee to the group company or its clients.

Hence, the
consideration received by the assessee for referral services was not in the
nature of ‘fees for technical services’, whether under the Act or under the
DTAA.

__________________________________

1
Decision does not describe nature of services in detail

shailesh.kwebmaker

Section 28: Share of profits paid to co-developer based on oral understanding not disallowable as the recipient had offered it to tax and there was no revenue loss and the transaction was tax-neutral

14. HP Associates vs. ITO (Mumbai) Vikas Awasthy (J.M.) and G. Manjunatha (A.M.) ITA No. 5929/Mum/2018 A.Y.: 2011-12 Date of order: 12^th June, 2020 Counsel for Assessee / Revenue: Haridas Bhatt / R. Kavitha

Section 28:
Share of profits paid to co-developer based on oral understanding not
disallowable as the recipient had offered it to tax and there was no revenue
loss and the transaction was tax-neutral

FACTS

The A.O.
disallowed a sum of Rs. 61,800 being share of profit transferred by the
assessee to Lakshmi Construction Co. The disallowance was made on the ground
that there was no formal written agreement to share profit in an equal ratio.

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

Aggrieved, the assessee preferred an appeal to the
Tribunal where it was contended that the assessee had jointly developed a
project with Lakshmi Construction Co. for which there was a joint development
agreement. Though there was no formal written agreement between the co-developers
for sharing profits in equal ratio, there was, however, an oral understanding
between the parties that the profits will be shared in equal ratio. The
transfer of share of profits by the assessee has not resulted in any loss of
revenue as the recipient has offered the same to tax and paid taxes thereon.

HELD

The Tribunal observed that the contention on
behalf of the assessee that there was no revenue loss has been substantiated by
placing on record the income-tax return of M/s Lakshmi Construction Co. It also
noted that both the firms are assessed at the same marginal rate of tax.
Therefore, the transaction is tax-neutral and no loss is caused to the
Government exchequer. The Tribunal deleted the addition of Rs. 61,800 made by
the A.O. and confirmed by the CIT(A).

shailesh.kwebmaker

Section 35(1)(ii): Deduction claimed by an assessee in respect of donation given by acting upon a valid registration / approval granted to an institution cannot be disallowed if at a later point of time such registration is cancelled with retrospective effect

13. Span Realtors vs. ITO (Mumbai) G. Manjunatha (A.M.) and Ravish Sood (J.M.) ITA No. 6399/Mum/2019 A.Y.: 2014-15 Date of order: 9^th June, 2020 Counsel for Assessee / Revenue: Rashmikant Modi and Ketki Rajeshirke
/ V. Vinod Kumar

Section
35(1)(ii): Deduction claimed by an assessee in respect of donation given by
acting upon a valid registration / approval granted to an institution cannot be
disallowed if at a later point of time such registration is cancelled with
retrospective effect

FACTS

The assessee
firm, engaged in the business of real estate, had made a donation of Rs. 1
crore to a Kolkata-based institution, viz. ‘School of Human Genetics and
Population Health’ (SHG&PH) and claimed deduction of Rs. 1.75 crores u/s
35(1)(ii) @ 175% on Rs. 1 crore. The A.O. called upon the assessee to
substantiate the claim of such deduction. The assessee submitted all the
evidences which were required to substantiate the claim of deduction.

However, the A.O. was not persuaded to subscribe
to the genuineness of the aforesaid claim of deduction by the assessee. He
observed that a survey operation conducted u/s 133A of the Act on 27^th
January, 2015 in the case of SHG&PH had revealed that the said research
institution had indulged in providing accommodation entries of bogus donations
to the donors through a network of brokers. The A.O. gathered that the
secretary had admitted in her statement that was recorded in the course of
survey proceedings u/s 131(1) of the Act that the said institution, in lieu of commission, was
providing accommodation entries of bogus donations through a network of market
brokers. Besides, the accountant of SHG&PH, in the course of survey
proceedings, was found to be in possession of a number of messages from brokers
regarding bogus donations and bogus billings. He also observed that as per the
information shared by DDIT (Inv.), Kolkata, the said institution had filed a
petition before the Settlement Commission, Kolkata Bench, wherein it had
admitted that in consideration of service charge they had indulged in providing
accommodation entries of bogus donations.

Moreover, the
Ministry of Finance vide a Notification dated 15^th September,
2016, had withdrawn its earlier Notification dated 28^th January,
2010. Hence, the A.O. disallowed the claim of deduction of Rs. 1.75 crores.

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

Still
aggrieved, the assessee preferred an appeal to the Tribunal.

HELD

The Tribunal observed that as on the date of
giving of donation, SHG&PH was having a valid approval granted under the
Act. Having regard to the language of the Explanation to section 35(1)(ii), the
Tribunal was of the view that it can safely be gathered that a subsequent
withdrawal of such approval cannot form a reason to deny the deduction claimed
by the donor. By way of analogy, the Tribunal observed that the Supreme Court in
the case of CIT vs. Chotatingrai Tea [(2003) 126 Taxman 399 (SC)]
while dealing with section 35CCA of the Act, had concluded that a retrospective
withdrawal of an approval granted by a prescribed authority would not
invalidate the assessee’s claim of deduction. The Tribunal also observed that
on a similar footing the Bombay High Court has in the case of National
Leather Cloth Mfg. Co. vs. Indian Council of Agricultural Research [(2000) 100
Taxman 511 (Bom.)] observed that such retrospective cancellation of
registration will have no effect upon the deduction claimed by the donor since
such donation was given acting upon the registration when it was valid and
operative.

The Tribunal
held that if the assessee acting upon a valid registration / approval granted
to an institution had donated the amount for which deduction is claimed, such
deduction cannot be disallowed if at a later point of time such registration is
cancelled with retrospective effect. It also observed that the co-ordinate
Mumbai bench of the Tribunal in Pooja Hardware Pvt. Ltd. vs. ACIT [ITA
No. 3712/Mum/2016 dated 28^th October, 2019] has, after
relying on the earlier orders of the co-ordinate benches of the Tribunal on the
issue pertaining to the allowability of deduction u/s 35(1)(ii) of the Act in
respect of a donation given to SHG&PH by the assessee, vacated the
disallowance of the assessee’s claim for deduction u/s 35(1)(ii) of the Act.
The Tribunal observed that the issue is squarely covered by the orders of the
co-ordinate benches of the Tribunal, and therefore it has no justifiable reason
to take a different view. Following the same, the Tribunal set aside the order
of the CIT(A) and vacated the disallowance of the assessee’s claim for
deduction u/s 35(1)(ii) of Rs. 1.75 crores.

shailesh.kwebmaker

Section 254: Non-consideration of decision of jurisdictional High Court, though not cited before the Tribunal at the time of hearing of appeal, constitutes a mistake apparent on record

12. Tata Power Company vs. ACIT (Mumbai) Shamim Yahya (A.M.) and Saktijit Dey (J.M.) M.A. No. 596/Mum/2019 arising out of ITA No. 3036/Mum/2009 A.Y.: 2003-04 Date of order: 22^nd May, 2020 Counsel for Assessee / Revenue: Nitesh Joshi / Micheal Jerald

Section 254:
Non-consideration of decision of jurisdictional High Court, though not cited
before the Tribunal at the time of hearing of appeal, constitutes a mistake
apparent on record

FACTS

In ground No.
3 of ITA No. 3036/Mum/2009, the Revenue challenged the decision of the CIT(A)
in deleting the surplus on buyback on Euro Notes issued by the assessee
earlier. It was the claim of the assessee that since Euro Notes were issued by
the assessee for capital expenditure, the income derived as a surplus on
buyback of Euro Notes would be capital receipt and hence not taxable. Although,
the A.O. treated it as the income of the assessee, the CIT(A), relying upon the
decision of the Tribunal in the assessee’s own case for the assessment year
2000-01, allowed the assessee’s claim and deleted the addition.

Before the
Tribunal, the assessee, apart from relying upon the decision of the Tribunal in
its own case, also relied upon the decision of the Hon’ble Supreme Court in CIT
vs. Mahindra & Mahindra Ltd. [(2018) 302 CTR 201 (SC)] to contend
that foreign exchange fluctuation gain on buyback of Euro Notes cannot be
treated as income chargeable to tax as Euro Notes were raised for incurring
capital expenditure. The Tribunal restored the issue to the A.O. for fresh
adjudication after applying the ratio laid down in Mahindra &
Mahindra Ltd. (Supra).

In the course
of hearing of the Miscellaneous Application, it was submitted that after taking
note of the decisions of the Supreme Court in Mahindra & Mahindra
Ltd. (Supra) and in CIT vs. T.V. Sundaram Iyengar & Sons
[(1996) 222 ITR 344 (SC)], the Jurisdictional High Court has reiterated
the view expressed by the Supreme Court in Mahindra & Mahindra Ltd.
(Supra) and consequently the issue stands settled in favour of the
assessee. Therefore, there is no need for restoring the issue to the A.O.

HELD

The Tribunal
observed that the Jurisdictional High Court in Reliance Industries Ltd.
(ITA No. 993 of 2016, dated 15^th January, 2019), after
taking note of the decisions of the Supreme Court in Mahindra &
Mahindra Ltd. (Supra) and T.V. Sundaram Iyengar & Sons
(Supra) has upheld the decision of the Tribunal in holding that the
gain derived from buyback of foreign currency bonds issued by the assessee
cannot be treated as revenue receipt.

The Tribunal
held that though it may be a fact that the aforesaid decision was not cited
before the Tribunal at the time of hearing of appeal, however, as held by the
Supreme Court in Saurashtra Kutch Stock Exchange Ltd. [(2008) 305 ITR 227
(SC)], non-consideration of a decision of the Supreme Court or the
Jurisdictional High Court, even rendered post disposal of appeal, would
constitute a mistake apparent on the face of record. It held that since the
aforesaid decision of the Hon’ble Jurisdictional High Court will have a crucial
bearing on the disputed issue, non-consideration of the said decision certainly
constitutes a mistake apparent on the face of record as envisaged u/s 254(2) of
the Act.

The Tribunal
recalled the order dated 21^st May, 2019 passed in ITA No.
3036/Mum/2009 and restored the appeal to its original position.

shailesh.kwebmaker

Sections 2(47), 28(i), 45 – Gains arising on transfer of development rights held as a business asset are chargeable to tax as ‘business income’ – Only that part of the consideration which accrued, as per terms of the agreement, would be taxable in the year of receipt

22. [117 taxmann.com 637 (Del.)(Trib.)] ITO vs. Abdul Kayum Ahmed Mohd. Tamboli ITA No. 1408/Del/2011 A.Y.: 2006-07 Date of order: 6^th July, 2020

Sections 2(47), 28(i), 45 – Gains arising
on transfer of development rights held as a business asset are chargeable to
tax as ‘business income’ – Only that part of the consideration which accrued,
as per terms of the agreement, would be taxable in the year of receipt

FACTS

The assessment of the assessee was re-opened because the consideration
received for transfer of development rights was not offered for taxation. Since
the assessee had handed over possession of the land and also transferred the
development rights, the A.O. in the course of reassessment proceedings taxed
the amount received by the assessee on transfer of development rights as
business income. The assessee submitted that under the contract with the
developer, he was to perform work on the basis of receipt of funds from the
developer. Accordingly, the assessee had offered only a part of the receipts as
income to the extent that receipts had accrued. The balance, according to him,
were conditional receipts. The developer, in response to a notice sent u/s
133(6), confirmed the position as stated by the assessee.

But the A.O. opined that the said accounting treatment was not in
consonance with the mercantile system of accounting followed by the assessee. Besides, since the transfer had been
completed, the consideration would be taxable in the year of receipt as
business income.

Aggrieved, the assessee preferred an appeal to the CIT(A) and contended
that the balance amount be considered as capital receipts. The CIT(A)
adjudicated in the assessee’s favour and held that only the part of the amount
accrued as per the agreement would be taxable in the year of receipt. He
estimated an amount of 10% of the gross receipts to be taxable in the year of
receipt. The provisions pertaining to capital gains were also held to be
inapplicable as the development rights were business assets.

Aggrieved, the Revenue filed an appeal to the Tribunal.

HELD

It was evident from
the terms of the joint venture agreement that only part income accrued to the assessee on execution of the project agreement. The balance consideration was a
conditional receipt and was to accrue only in the event of the assessee
performing certain obligations under the agreement. Since the development
rights constituted the business assets of the assessee, the provisions of
capital gains would not be applicable. The order of the CIT(A) taxing 10% of
the gross receipts was justified. The Tribunal upheld the decision of the
CIT(A) and held that only part of the receipts as estimated accrued to the
assessee were taxable.

shailesh.kwebmaker

Sections 28, 36(1)(iii) – In a case where since the date of incorporation the assessee has carried on substantial business activities such as raising loans, purchase of land, which was reflected as stock-in-trade in the books of accounts, and entering into development agreement, the assessee can be said to have not only set up but also commenced the business. Consequently, interest on loan taken from bank for purchase of land which was held as stock-in-trade is allowable as a deduction

21. [117 taxmann.com 419 (Del.)(Trib.)] Jindal Realty (P) Ltd. vs. ACIT ITA No. 1408/Del/2011 A.Y.: 2006-07 Date of order: 22^nd June, 2020

Sections 28, 36(1)(iii) – In a case where
since the date of incorporation the assessee has carried on substantial
business activities such as raising loans, purchase of land, which was
reflected as stock-in-trade in the books of accounts, and entering into
development agreement, the assessee can be said to have not only set up but
also commenced the business. Consequently, interest on loan taken from bank for
purchase of land which was held as stock-in-trade is allowable as a deduction

FACTS

During the previous
year relevant to the assessment year under consideration, the assessee, engaged
in real estate business, borrowed monies from banks and utilised the same to
purchase land for township projects and also for giving as advance to other
associate parties for purchase of land by them. The interest on such monies
borrowed was claimed by the assessee as deduction u/s 36(1)(iii), and the
return of income was filed for the previous year declaring a loss.

The A.O. disallowed
the claim of deduction of interest on the ground that the assessee had not
commenced any business activity and held the same to be pre-operative in
nature.

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

Still aggrieved,
the assessee preferred an appeal to the Tribunal.

HELD

The Tribunal held
that since the date of incorporation, the assessee carried on substantial
business activities such as raising loans, purchase of land which was reflected
as stock-in-trade in the books of accounts and entering into development
agreements. The Tribunal relied on the decision of the Delhi High Court in the
case of CIT vs. Arcane Developers (P) Ltd. 368 ITR 627 (Del.)
wherein it is held that in case of real estate business, the setting up of
business was complete when the first steps were taken by the
respondent-assessee to look around and negotiate with parties.

Thus, the assessee
had not only set up the business but also commenced the business in the
previous year and therefore was eligible to claim deduction of interest
expenditure u/s 36(1)(iii).

The appeal filed by
the assessee was allowed.

shailesh.kwebmaker

Section 50B read with sections 2(19), 2(42C) and 50 – Windmills of an assessee, engaged in the business of aqua culture, export of frozen shrimp, sale of hatchery seed and wind-power generation, along with all the assets and liabilities, constitute an ‘undertaking’ for the purpose of slump sale

20. [117
taxmann.com 440 (Vish.)(Trib.)] ACIT vs. Devi Sea
Foods Ltd. ITA No.
497/Vish./2019 A.Y.: 2013-2014 Date of order: 19^th
June, 2020

Section 50B read
with sections 2(19), 2(42C) and 50 – Windmills of an assessee, engaged in the
business of aqua culture, export of frozen shrimp, sale of hatchery seed and
wind-power generation, along with all the assets and liabilities, constitute an
‘undertaking’ for the purpose of slump sale

FACTS

The assessee sold
three windmills, declared the gains arising on such sale as a slump sale and
computed the long-term capital gains as per section 50B. The assessee had not
furnished separate financial statements for the windmill business activity;
however, it was claiming deduction u/s 80-IA on the income from the windmill as
a separate business which was allowed by the A.O. from A.Y. 2009-10 onwards.
But at the time of the sale, the A.O. denied the applicability of the
provisions related to slump sale by stating that the windmills did not
constitute an ‘undertaking’ and charged the income as short-term capital gains.

Aggrieved, the
assessee preferred an appeal to the CIT(A) who held that each windmill is a
unit of the undertaking and is covered by the definition of slump sale. He also
noted that though the assessee had shown windmills as part of the block of
assets, depreciation claim could not be a factor to deny benefit of slump sale.
He directed the A.O. to compute long-term capital gains u/s 50B.

Aggrieved, the
Revenue filed an appeal to the Tribunal.

HELD

The Tribunal observed that the windmills were part of the assessee’s
business, for which the assessee was claiming deduction since A.Y. 2009-10. The
A.O. had not made any adverse remarks in respect of deduction claimed u/s
80-IA. Though separate books of accounts had not been maintained, the assessee
had demonstrated separate ledger account belonging to the windmill operation,
and income from such activity was independently ascertainable. Further, there
is no requirement in the Act that all assets sold under slump sale should be
together. The Tribunal held that the real test for considering any sale of an asset
as non-slump sale would be any independent asset or liability not forming part
of the business operations. It held that the windmills satisfied all conditions
for being considered as an ‘undertaking’ and the provisions of slump sale would
be applicable.

shailesh.kwebmaker

Reopening – Capital gains arising on conversion of the land into stock-in-trade – Closing stock has to be valued at cost or market price whichever is lower – No reason to believe income had escaped assessment – Reopening bad in law: Sections 45(2) and 147 of the Act

9. M/s. J.S. & M.F. Builders vs. A.K. Chauhan and others [Writ Petition
No. 788 of 2001 A.Ys.: 1992-93, 1993-94, 1994-95 and 1995-96 Date of order: 12^th
June, 2020 (Bombay High Court)

Reopening – Capital gains arising on conversion of the land into
stock-in-trade – Closing stock has to be valued at cost or market price
whichever is lower – No reason to believe income had escaped assessment –
Reopening bad in law: Sections 45(2) and 147 of the Act

The petitioner had challenged the legality and validity of the four
impugned notices, all dated 25^th February, 2000 issued u/s 148 of
the Act, proposing to re-assess the income of the petitioner for the A.Ys.
1992-93, 1993-94, 1994-95 and 1995-96 on the ground that income chargeable to
tax for the said assessment years had escaped assessment.

The case of the petitioner is that it is a partnership firm constituted by
a deed of partnership dated 21^st October, 1977. The object of the
firm is to carry out business as builders and developers.

An agreement was entered into on 8^th November, 1977 between one
Mr. Krishnadas Kalyanji Dasani and the petitioner whereby and whereunder Mr.
Dasani agreed to sell, and the petitioner agreed to purchase, a property
situated at Borivali admeasuring approximately 6,173.20 square metres. The
property consisted of seven structures and two garages. The property was
mortgaged and all the tenements were let out. The aggregate consideration for
the purchase was Rs. 3,00,000 and a further expenditure of Rs. 44,087 was
incurred by way of stamp duty and registration charges. The said property was
purchased subject to all encumbrances. The purchased property was reflected in
the balance sheets of the petitioner drawn up thereafter as a fixed asset. For
almost a decade after purchase, the petitioner entered into various agreements
with the tenants to get the property vacated. In the process, they incurred a
further cost of Rs. 9,92,427.

In the balance sheet as on 30^th September, 1987 the Borivali
property was shown as a fixed asset the value of which was disclosed at Rs.
13,36,514; a detailed break-up of it was furnished. With effect from 1^st
October, 1987, the petitioner converted a portion of the property into
stock-in-trade and continued to retain that part of the property which still
remained tenanted as a fixed asset. The market value of the entire Borivali
property as on 1^st October, 1987 was arrived at Rs. 69,38,000 out of
which the value of the property that was converted into stock-in-trade was
determined at Rs. 66,29,365.

The petitioner thereafter demolished the vacant structures and commenced
construction of a multi-storied building. In the balance sheet as on 31^st
March, 1989, the petitioner reflected the tenanted property as a fixed asset at
a cost of Rs. 2,86,740 and the stock-in-trade at a value of Rs. 66,29,365.. A
revaluation reserve of Rs. 55,58,759 was also credited. In the Note
accompanying the computation of income it was clearly mentioned that the
conversion of a part of the Borivali property was made into stock-in-trade and
the liability to tax u/s 45(2) of the Act would arise as and when the flats
were sold. During the previous year relevant to the A.Y. 1992-93, the
petitioner had entered into 14 agreements for sale of 14 flats, the total area
of which admeasured 10,960 square feet (sq. ft.).

For the A.Y. 1992-93 the petitioner declared income chargeable under the
head ‘profits and gains of business or profession’ at Rs. 9,37,385 and the
income chargeable under the head ‘capital gains’ at Rs. 8,10,993. The ‘capital
gains’ was arrived at by determining the difference between the market value of
the land converted into stock-in-trade as on 1^st October, 1987 and
the cost incurred by the petitioner which came to a figure of Rs. 55,87,591.
Having regard to the total built-up area of 37,411 sq. ft., the ‘capital gains’
per sq. ft. was computed at Rs. 149.36 on a pro-rata basis. Accordingly,
having regard to the area of 10,960 sq. ft. sold, the ‘capital gains’ was
determined at Rs. 16,36,986. Along with the return of income, a computation of
income as well as an audit report in terms of section 44AB of the Act were also
filed. The A.O. completed the assessment u/s 143(3) of the Act assessing the
petitioner at the income of Rs. 17,85,560.

For the A.Y. 1993-94, as in the previous A.Y., income was computed both
under the head ‘profits and gains of business or profession’ as well as under
the head ‘capital gains’ for 12 flats sold during the relevant previous year.
The return was accompanied by the tax audit report as well as the profit and
loss account and balance sheet. The A.O. completed the assessment u/s 143(3)
assessing the petitioner at an income of Rs. 17,30,230. It is stated that in
the assessment order the A.O. specifically noted that income from ‘long-term
capital gains’ was declared in terms of section 45(2) of the Act.

The petitioner’s return of income for the A.Y. 1994-95 was processed u/s
143(1)(a) of the Act and an intimation was issued on 30^th March,
1995.

For the A.Y. 1995-96, the petitioner filed its return declaring income
under both heads, i.e., ‘income from business’ and ‘capital gains’. The income
of the petitioner was computed in a similar manner as in the earlier years with
similar disclosures in the tax audit report, profit and loss account and
balance sheet furnished along with the return. In the course of the assessment
proceedings, the petitioner furnished details of flats sold as well as the
manner of computing profit in terms of section 45(2). The assessment for the
A.Y. 1995-96 was completed u/s 143(3) of the Act determining the taxable income
at Rs. 1,32,930.

According to the petitioner, it received on 8^th March, 2000 four notices, all dated 25^th
February, 2000, issued u/s 148 of the Act for the four assessment years, i.e.,
1992-93 to 1995-96.

The reasons recorded for each of the assessment
years were identical save and except the assessment details and figures. The
A.O. broadly gave four reasons to justify initiation of re-assessment
proceedings. Firstly, the petitioner was not justified in assuming that the
market value of the stock adopted as on 1^st October, 1987 would
continue to remain static in the subsequent years. In other words, the closing
stock of the land should have been valued at the market price as on the date of
closing of accounts for the year concerned. This resulted in undervaluation of
closing stock and consequent reduction of profit.

Secondly, even though the petitioner might have entered into agreements and
sold certain flats, the ownership of the land continued to remain with the
petitioner. The whole of the land under the ownership of the petitioner
constituted its stock-in-trade and it should have been valued at the market
price as on the date of closing of accounts for the year concerned. Thus, the
assessee had suppressed the market price of the closing stock, thereby reducing
the profit.

Thirdly, for the purpose of computing the ‘capital gains’ in terms of
section 45(2) of the Act, the petitioner was not justified in taking the cost
of the entire land; rather, the petitioner ought to have taken only a fraction
of the original cost of Rs. 3,00,000. Thus, there was inflation of cost.
Lastly, in terms of section 45(2), the ‘capital gains’ arising on conversion of
the land into stock-in trade ought to have been assessed only in the year in
which the land was sold or otherwise transferred. As the land was not conveyed
to the co-operative society, the petitioner was not justified in offering to
tax the ‘capital gains’ in terms of section 45(2) of the Act on the basis of
the flats sold during each of the previous years relevant to the four A.Y.s
under consideration.

The Court admitted the writ petition for final hearing.

The petitioner submitted that it had fully complied with the requirement of
section 45(2) of the Act and the capital gains arising on the conversion of the
land into stock-in-trade was offered and rightly assessed to tax in the years
in which the flats were sold on the footing that on the sale of the flat there
was also a proportionate sale of the land. This methodology adopted by the
petitioner is in accordance with law. It was also submitted that it is not
correct to think that any profit arises out of the valuation of the closing
stock. In this connection, reliance was placed on a decision of the Supreme
Court in Chainrup Sampatram vs. CIT, 24 ITR 481.

The Petitioner also referred to a decision of this Court in CIT vs.
Piroja C. Patel, 242 ITR 582 to contend that the expenditure incurred
for having the land vacated would certainly amount to cost of improvement which
is an allowable expenditure.

The case of the Revenue was that the A.O. after recording the sequence of
events from acquiring the property vide the deed of conveyance dated 23^rdApril, 1980 noted that the assessee had converted part of the property
into stock-in-trade on 1^st October, 1987 with a view to construct
flats. On the date of conversion into stock-in-trade, the value thereof was
determined at Rs. 66,29,365. Up to A.Y.1991-92 there was no construction. After
the building was constructed, the constructed flats were sold to various
customers. On the sale of flats, the assessee reduced the proportionate market
value of the land as on 31^st March, 1989, in the same ratio as the
area of the flat sold bore to the total constructed area. However, the assessee
valued the closing stock at market price prevailing as on 1^st
October, 1987. According to the A.O., the closing stock should have been valued
at the market price on the close of each accounting year. This resulted in
undervaluation of closing stock and consequent reduction of profit.

Secondly, land as an asset is separate and distinct from the building. The
building was shown as a work in progress in the profit and loss account
prepared by the assessee and filed with the return. Even after construction of
the building and sale of flats, the stock, i.e., the land was still under the
ownership of the assessee. Ownership of land was not transferred. As the land
continued under the ownership of the assessee, its value could not be reduced
on the plea that a flat was sold. The whole of the land under ownership of the
assessee constituted its stock-in-trade and it should have been valued at the
market price as on the date of closing of the accounts for the year under
consideration. Therefore, the A.O. alleged that the assessee had suppressed the
market price of the closing stock, thus reducing the profit.

The third ground given was regarding computation of ‘capital gains’
furnished with the return of income. The A.O. noted that the total capital
gains as on 1^st October, 1987 was arrived at by deducting the cost
of the land as on 1^st October, 1987, i.e., Rs. 10,41,774, from the
fair market value of the land, i.e., Rs. 66,29,365, which came to Rs.
55,87,591. According to the A.O., the assessee made deduction of the cost
incurred for the entire land whereas only a fraction of the said land was
converted into stock-in-trade where construction was done.

The A.O. worked out that the cost of the converted piece of land was only
Rs. 13,260. He arrived at this figure by deducting Rs. 2,86,740, which was the
value of the tenanted property from the cost of the property, i.e., Rs.
3,00,000. Thus, he alleged that there was inflation of cost by Rs. 10,28,514
(Rs. 10,41,774 – Rs.13,260).

The last ground given by the A.O. was regarding offering of long-term
capital gain by the assessee. He noted that for the purpose of computation of
long-term capital gain, the assessee estimated the fair market value of the
land converted to stock as on 1^stOctober, 1987 at Rs. 66,29,365
which was reduced by the cost incurred as on 1^st October, 1987,
i.e., Rs. 10,74,774. However, the A.O. also noted that the method of
computation of cost was not clear in view of the fact that the whole of the
land with tenanted structures was purchased for Rs. 3,00,000. The A.O. further
noted the methodology adopted by the assessee for computation of long-term
capital gain. According to him, the assessee had worked out the difference
between the fair market value of the land converted to stock and the cost and
thereafter divided it by the total permissible built-up area. The quotient was
identified by the assessee as capital gains per sq. ft. The assessee thereafter
multiplied the built-up area of individual flats sold with such quotient and
claimed it to be the ‘capital gains’ for the year under consideration. By
adopting such a computation, the assessee was claiming sale of land in
different years in the same ratio as the area of flat sold bore to the total
permissible FSI area. But this calculation was not accepted by the A.O.
primarily on the ground that land as a stock was different from the flats.
Selling of flats did not amount to selling of proportionate quantity of land.

The Court held that u/s 45(2) of the Act, ‘capital gains’ for land should
be considered in the year when land was sold or otherwise transferred by the
assessee. Though flats were sold, ownership of the land continued to remain
with the assessee. ‘Capital gains’ would be chargeable to tax only in the year
when the land was sold or transferred to the co-operative society formed by the
flat purchasers and not in the year when individual flats were sold.

The Court accepted the contention of the petitioner that the A.O. proceeded
on the erroneous presumption that stock-in-trade had to be valued at the
present market value. In Chainrup Sampatram (Supra), the Supreme
Court had held that it would be wrong to assume that the valuation of the
closing stock at market rate has for its object the bringing into charge any
appreciation in the value of such stock. The true purpose of crediting the
value of unsold stock is to balance the cost of those goods entered on the
other side of the account so that the cancelling out of the entries relating to
the same stock from both sides of the account would leave only the transactions
on which there had been actual sales in the course of the year showing the
profit or loss actually realised on the year’s trading. While anticipated loss
is taken into account, anticipated profit in the shape of appreciated value of
the closing stock is not brought into the account as no prudent trader would
care to show increased profit before its actual realisation. This is the theory
underlying the rule that the closing stock has to be valued at cost or market
price whichever is lower and it is now generally accepted as an established
rule of commercial practice and accountancy. In such circumstances, taking the
view that profits for income tax purposes are to be computed in conformity with
the ordinary principles of commercial accounting unless such principles have
been superseded or modified by legislative enactments, the Supreme Court held
that it would be a misconception to think that any profit arises out of
valuation of the closing stock.

With regard to the third ground, i.e., computation of ‘capital gains’, the
Court held that the cost incurred included not only the sale price of the land,
i.e., Rs. 3,00,000, but also the expenditure incurred by way of stamp duty and
registration charges amounting to Rs. 44,087. That apart, the assessee had
incurred a further sum of Rs. 9,92,427 in getting the entire property vacated.
The contention of the A.O. that there was inflation of cost is not correct.
Thus, for computing the income under the head ‘capital gains’, the full value
of consideration received as a result of transfer of the capital asset shall be
deducted by the expenditure incurred in connection with such transfer, cost of
acquisition of the asset and the cost incurred in improvement of the asset. The
expression ‘the full value of the consideration’ would mean the fair market
value of the asset on the date of such conversion. The meaning of the
expressions ‘cost of improvement’ and ‘cost of acquisition’ are explained in
sections 55(1) and 55(2) of the Act, respectively.

The expression ‘capital asset’ occurring in sub-section (1) of section 45
is defined in sub-section (14) of section 2. ‘Capital asset’ means property of
any kind held by an assessee whether or not connected with his business or
profession as well as any securities held by a foreign institutional investor,
but does not include any stock-in-trade, consumable stores or raw materials,
personal effects, etc.

Again, the word ‘transfer’ occurring in sub-section (1) of section 45 has
been defined in section 2(47) of the Act. As per this definition, ‘transfer’ in
relation to a capital asset includes sale, exchange or relinquishment of the
asset or the extinguishment of any rights therein, or compulsory acquisition of
the asset, or in case of conversion of the asset by the owner into
stock-in-trade of the business carried on by him, such conversion or any
transaction involving the allowing of possession of any immovable property to
be taken or retained in part performance of a contract, or any transaction
whether by way of becoming a member of or acquiring shares in a co-operative
society, etc. which has the effect of transferring or enabling the enjoyment of
any immovable property.

In the case of Miss Piroja C. Patel (Supra), the court held
that on eviction of the hutment dwellers from the land in question, the value
of the land increases and therefore the expenditure incurred for having the
land vacated would certainly amount to cost of improvement.

Thus, the cost incurred on stamp duty, etc., together with the cost
incurred in carrying out eviction of the hutment dwellers would certainly add
to the value of the asset and thus amount to cost of improvement which is an
allowable deduction from the full value of consideration received as a result of
the transfer of the capital asset for computing the income under the head
‘capital gains’.

Insofar as the fourth ground is concerned, the A.O. has taken the view that
long-term capital gains arising out of sale or transfer of land would be
assessed to tax only in the year in which the land is sold or otherwise
transferred by the assessee. Opining that land as a stock is a different item
of asset than a flat, the A.O. held that ownership of land continued to remain
with the assessee notwithstanding the sale of flats. Therefore, he was of the view
that ‘capital gains’ would be chargeable to tax only in the year when the land
is sold or otherwise transferred to the co-operative society formed by owners
of the flats and not in the year when individual flats are sold.

According to the A.O., the assessee had erred in
offering to tax ‘capital gains’ in the year when the individual flats were
sold, whereas such ‘capital gains’ could be assessed to tax only when the land
was transferred to the co-operative society formed by the flat purchasers. If
the assessee had offered to tax as ‘capital gains’ in the assessment years
under consideration that which should have been offered to tax in the
subsequent years, it is beyond comprehension as to how a belief can be formed
that income chargeable to tax for the assessment year under consideration had
escaped assessment. That apart, the flat purchasers by purchasing the flats had
certainly acquired a right or interest in the proportionate share of the land
but its realisation is deferred till the formation of the
co-operative society by the owners of the flats and eventual transfer of the
entire property to the co-operative society.

The Court also referred to various other decisions, namely, Prashant
S. Joshi [324 ITR 154 (Bom)], Additional CIT vs. Mohanbhai Pamabhai, 165 ITR
166 (SC), Sunil Siddharthbhai vs. CIT, 156 ITR 509 (SC) and
Addanki Narayanappa vs. Bhaskara Krishnappa, AIR 1966 SC 1300, wherein
the Court held that what is envisaged on the retirement of a partner is merely
his right to realise his interest and to receive its value. What is realised is
the interest which the partner enjoys in the assets during the subsistence of
the partnership by virtue of his status as a partner and in terms of the
partnership agreement. Therefore, what the partner gets upon dissolution of the
partnership or upon retirement from the partnership is the realisation of a
pre-existing right or interest. The Court held that there was nothing strange
in the law that a right or interest should exist in praesenti but
its realisation or exercise should be postponed. Applying the above principle,
the Court held that upon purchase of the flat, the purchaser certainly acquires
a right or interest in the proportionate share of the land but its realisation
is deferred till formation of the co-operative society by the flat owners and
transfer of the entire property to the co-operative society.

Thus, on an overall consideration of the entire matter, the Court held
that there was no basis or justification for the A.O. to form a belief that any
income of the assessee chargeable to tax for the A.Y.s under consideration had
escaped assessment within the meaning of section 147 of the Act. The reasons
rendered could not have led to formation of any belief that income had escaped
assessment within the meaning of the aforesaid provision.

Therefore, in the facts and circumstances of the case, the impugned
notices issued u/s 148 of the Act dated 25^th February, 2000 were set
aside and quashed.

shailesh.kwebmaker

Settlement of cases – Chapter XIX-A of ITA, 1961 – Powers of Settlement Commission – Application for settlement of case – Settlement Commission cannot consider merits of case at that stage; A.Ys. 2015-16 to 2018-19

51. Hitachi Power Europe GMBH vs. IT Settlement Commission [2020] 423 ITR
472 (Mad.) Date of order: 17^th February, 2020 A.Ys.: 2015-16 to
2018-19

Settlement of cases – Chapter XIX-A of ITA, 1961 – Powers of Settlement
Commission – Application for settlement of case – Settlement Commission cannot
consider merits of case at that stage; A.Ys. 2015-16 to 2018-19

In June, 2010, the National Thermal Power Corporation had invited bids
under international competitive bidding for the supply and installation of
eleven 660-megawatt steam generators at five locations in India. A bid was
successfully submitted by B, a company incorporated in India and engaged in
providing turnkey solutions for coal-based thermal power plants. B
sub-contracted a portion of the scope of work under three contracts to its
joint venture company, which in turn sub-contracted a portion thereof to the
assessee. One of the contentions raised by the assessee on the merits was that
the scope of work under each of the contracts was separate and distinct in all
respects including the delineation of the work itself, the modes of execution
of the contract and the payments therefor.

For this reason, the assessee took the stand that the income from offshore
supplies would not be liable to tax in India. For the A.Ys. 2015-16 to 2018-19
the assessee filed returns of income offering to tax the income from onshore
supply and services only. While assessment proceedings were pending, the
assessee applied for settlement of the case. The Settlement Commission held
that the contract was composite and indivisible and hence the applicant, i. e.,
the assessee, had failed to make a full and true disclosure of income.

On a writ petition against the order, the Madras High Court held as under:

‘i) The scheme of Chapter XIX-A of the Income-tax Act, 1961 is to provide a
holistic resolution of issues that arise from an assessment in the case of an assessee that has approached the
Commission. The question of full and true disclosure and the discharge of tax
liability at all stages prior to final hearing should be seen only in the
context of the issues offered for settlement and the remittances of additional
tax thereupon. Issues decided by the Commission and the liability arising
therefrom will be payable only at the stage of such determination, which is the
stage of final hearing u/s 245D(4) of the Act.

ii) The assessee had just applied for settlement of the case. The Commission,
however, in considering the “validity” or otherwise of the application,
proceeded to delve into the merits of the matter even at that stage. The order
of the Settlement Commission was beyond the scope of section 245D(2C) having
been passed on the merits of the issue raised and set aside the same. This writ
petition is allowed.’

shailesh.kwebmaker

DEFINITION OF A BUSINESS (AMENDMENTS TO Ind AS 103)

The definition of business
has been amended (vide MCA notification dated 24^thJuly,
2020) and continues to be intended to assist entities to determine whether a
transaction should be accounted for as ‘a business combination’ or as ‘an asset
acquisition’.

The accounting for the
acquisition of an asset and for the acquisition of a business are very different,
hence the classification is very critical. The amendments are applicable to
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after 1^st
April, 2020 and to asset acquisitions that occur on or after the beginning of
that period. In a nutshell, the amendments have made the following broad
changes:

(i) the definition of a
business and the definition of outputs is made narrow.

(ii) clarify the minimum
features that the acquired set of activities and assets must have in order to
be considered a business.

(iii) the evaluation of
whether market participants are able to replace missing inputs or processes and
continue to produce outputs is removed.

(iv) an optional concentration
test that allows a simplified assessment of whether an acquired set of
activities and assets is not a business has been introduced.

The amendments replace the
wording in the definition of a business as follows:

Old Definition

New Definition

‘An integrated set of activities and assets
that is capable of being conducted and managed for the purpose of providing a
return in the form of dividends, lower costs or other economic benefits
directly to investors or other owners, members or participants’

‘An integrated set of activities and assets
that is capable of being conducted and managed for the purpose of providing
goods or services to customers, generating investment income (such as
dividends or interest) or generating other income from ordinary activities’

The changed definition
focuses on providing goods and services to customers, removes the emphasis from
providing a return to shareholders as well as to ‘lower costs or other
economics benefits’, because many asset acquisitions are made with the motive
of lowering costs but may not involve acquiring a substantive process.

Under the revised
standard, the following steps are required to determine whether the acquired
set of activities and assets is a business:

Step 1

Consider whether
to apply the concentration test

Does the entity want to apply the
concentration test?

If yes go to Step 2, if no go to Step 4

Step 2

Consider what
assets have been acquired

Has a single identifiable asset or a group
of similar identifiable assets been acquired?

If yes go to Step 3, if no go to Step 4

Step 3

Consider how the
fair value of gross assets acquired is concentrated

Is substantially all of the fair value of
the gross assets acquired concentrated in a single identifiable asset or a
group of similar identifiable assets?

If yes, the concentration test has passed,
transaction is not a business, if no go to step 4

Step 4

Consider whether
the acquired set of activities and assets has outputs

Does the acquired set of activities and
assets have outputs?

Go to step 5

Step 5

Consider if the
acquired process is substantive

If there are no outputs, in what
circumstances is the acquired process considered substantive?

If there are outputs, in what circumstances
is the acquired process considered substantive?

If acquired process is substantive,
transaction is a business; if acquired process is not substantive,
transaction is an asset acquisition

OPTIONAL CONCENTRATION TEST

The optional concentration
test allows the acquirer to carry out a simple evaluation to determine whether
the acquired set of activities and assets is not a business. The optional
concentration test is not an accounting policy choice; therefore, it may be
used for one acquisition and not for another. If the test passes, then the
acquired set of activities and assets is not a business and no further
evaluation is required. If the test fails or the entity chooses not to apply
the test, then the entity needs to assess whether or not the acquired set of
assets and activities meets the definition of a business by making a detailed
assessment.

The amended standard does
not prohibit an entity from carrying out the detailed assessment if the entity
has carried out the concentration test and concluded that the acquired set of
activities and assets is not a business. The standard-setter decided that such
a prohibition was unnecessary, because if an entity intended to disregard the
outcome of the concentration test, it could have elected not to apply it.

In theory, the
concentration test might sometimes identify a transaction as an asset
acquisition when the detailed assessment would identify it as a business
combination. That outcome would be a false positive. The standard-setter
designed the concentration test to minimise the risk that a false positive
could deprive users of financial statements of useful information. The
concentration test might not identify an asset acquisition that would be
identified by the detailed assessment. That outcome would be a false negative.
An entity is required to carry out the detailed assessment in such a case and
is expected to reach the same conclusion as if it had not applied the
concentration test. Thus, a false negative has no accounting consequences.

What is a
single identifiable asset?

A single identifiable
asset includes any asset or group of assets that would be recognised and
measured as a single identifiable asset in a business combination. This will
include assets that are attached or cannot be removed from other assets without
incurring significant cost or loss of value of either asset. Examples of single
identifiable asset include land and buildings, customer lists, trademarks,
outsourcing contracts, plant and machinery, intangible asset (for example, a
coal mine), etc. Land and buildings cannot be removed from each other without
incurring significant cost or loss of value to either of them, unless the
building is inconsequential or very insignificant in value.

What is a
group of similar identifiable assets?

Assets are grouped when
they have a similar nature and have similar risk characteristics (i.e., the
risks associated with managing and creating outputs from the assets). The
following are examples of groupings which are not considered to be similar
assets:

(a) a tangible asset and
an intangible asset.

(b) different classes of
tangible assets under Ind AS 16, for example, equipment and building (unless
the equipment is embedded in the building and cannot be removed without
incurring significant cost or loss of value to either the building or the
equipment).

(c) tangible assets that
are recognised under different Standards (e.g. Ind AS 2 ‘Inventories’ and Ind
AS 16 ‘Property, Plant and Equipment’).

(d) a financial asset and
a non-financial asset.

(e) different classes of
financial assets under Ind AS 109 ‘Financial Instruments’ (e.g receivables,
equity investments, etc.).

(f) different classes of
intangibles (e.g. brand, mineral rights, etc.)

(g) assets belonging to
the same class but have significantly different risk characteristics, for
example, different types of mines.

In applying the
concentration test, one test is to evaluate whether substantially all of the
fair value of the gross assets acquired is concentrated in a single
identifiable asset or a group of similar identifiable assets? How is the fair
value determined?

The fair value of the
gross assets acquired shall include any consideration transferred (plus the
fair value of any NCI and the fair value of any previously held interest) in
excess of the fair value of net identifiable assets acquired. The fair value of
the gross assets acquired may normally be determined as the total obtained by
adding the fair value of the consideration transferred (plus the fair value of
any NCI and the fair value of any previously held interest) to the fair value
of the liabilities assumed (other than deferred tax liabilities), and then
excluding cash and cash equivalents, deferred tax assets and goodwill resulting
from the effects of deferred tax liabilities.

The
standard-setter concluded that whether a set of activities and assets includes
a substantive process does not depend on how the set is financed. Consequently,
the concentration test is based on the gross assets acquired, not on net
assets. Thus, the existence of debt (for example, a mortgage loan financing a
building) or other liabilities does not alter the conclusion on whether an acquisition is a business combination. In addition, the gross assets
considered in the concentration test exclude cash and cash equivalents
acquired, deferred tax assets, and goodwill resulting from the effects of
deferred tax liabilities. These exclusions were made because cash acquired, and
the tax base of the assets and liabilities acquired, are independent of whether
the acquired set of activities and assets includes a substantive process.

Example – Establishing the
fair value of the gross assets acquired

Ze Co holds a 30% interest
in Ox Co. A few years later, Ze acquires control of Ox by acquiring an
additional 45% interest in Ox for INR 270. Ox’s assets and liabilities on the
acquisition date are the following:

a building with a fair
value of INR 720

an identifiable
intangible asset with a fair value of INR 420

cash and cash
equivalents with a fair value of INR 180

deferred tax assets of
INR 120

financial liabilities
with a fair value of INR 900

deferred tax liabilities
of INR 240 arising from temporary differences associated with the building and
the intangible asset.

Ze determines that at the
acquisition date the fair value of Ox is INR 600, that the fair value of the
NCI in Ox is INR 150 (25% x INR 600) and that the fair value of the previously
held interest is INR 180 (30% x INR 600).

Analysis

When performing the
optional concentration test, Ze needs to determine the fair value of the gross
assets acquired. Ze determines that the fair value of the gross assets acquired
is INR 1,200, calculated as follows:

the total (INR 1,500)
obtained by adding:

– the consideration paid
(INR 270), plus the fair value of the NCI (INR 150) plus the fair value of the
previously held interest (INR 180); to

– the fair value of the
liabilities assumed (other than deferred tax liabilities) (INR 900); less

the cash and cash
equivalents acquired (INR 180); less

deferred tax assets
acquired (INR 120).

Alternatively, the fair
value of the gross assets acquired (INR 1,200) is also determined by:

the fair value of the
building (INR 720); plus

the fair value of the
identifiable intangible asset (INR 420); plus

the excess (INR 60) of:

– the sum (INR 600) of the
consideration transferred (INR 270), plus the fair value of the NCI (INR 150),
plus the fair value of the previously held interest (INR 180); over

– the fair value of the
net identifiable assets acquired (INR 540 = INR 720 + INR 420 + INR 180 + INR
120 – INR 900).

MINIMUM REQUIREMENTS TO QUALIFY AS BUSINESS

What are the
minimum requirements to meet the definition of a business?

Elements
of a business

Explanation

Examples

Inputs

An
economic resource that creates outputs or has the ability to contribute to
the creation of outputs when one or more processes are applied to it

tangible assets

•
right-of-use assets

•
intangible assets

•
intellectual property

•
employees

•
ability to obtain necessary material or rights

Processes

A
system, standard, protocol, convention or rule that when applied to an input
or inputs, creates outputs or has the ability to contribute to the creation
of outputs. These processes typically are documented, but the intellectual
capacity of an organised workforce having the necessary skills and experience
following rules and conventions may provide the necessary processes that are
capable of being applied to inputs to create outputs. (Accounting, billing,
payroll and other administrative systems typically are not processes used to
create outputs.)

•
strategic management processes

•
operational processes

•
resource management processes

Outputs

The
result of inputs and processes applied to those inputs that provide goods or
services to customers, generate investment income (such as dividends or
interest) or generate other income from ordinary activities

•
revenue

To qualify as a business,
the acquired set of activities and assets must have inputs and substantive
processes that together enable the entity to contribute to the creation of
outputs. However, the standard clarifies that outputs are not necessary for an
integrated set of assets and activities to qualify as a business. A business
need not include all of the inputs or processes that the seller used in
operating that business. However, to be considered a business, an integrated
set of activities and assets must include, at a minimum, an input and a
substantive process that together enable the entity to contribute to the
creation of outputs.

According to the
standard-setters, the reference in the old definition to lower costs and other
economic benefits provided directly to investors did not help to distinguish
between an asset and a business. For example, many asset acquisitions may be
made with the motive of lowering costs but may not involve acquiring a
substantive process. Therefore, this wording was excluded from the definition
of outputs and the definition of a business.

Ind AS 103 adopts a market
participant’s perspective in determining whether an acquired set of activities
and assets is a business. This means that it is irrelevant whether the seller
operated the set as a business or whether the acquirer intends to operate the
set as a business. An assessment made from a market participant’s perspective
and driven by facts that indicate the current state and condition of what has
been acquired (rather than the acquirer’s intentions) helps to prevent similar
transactions being accounted for differently. Moreover, bringing more subjective
elements into the determination would most likely have increased diversity in
practice.

When is an acquired process considered to be substantive?

The amended Standard
requires entities to assess whether the acquired process is substantive. The evaluation
of whether an acquired process is substantive depends on whether the acquired
set of activities and assets has outputs or not. For example, an early-stage
entity may not have any outputs / revenue, and is therefore subjected to a
different analysis of whether the acquired process along with the acquisition
of the development stage entity is substantive or not. Moreover, if an acquired
set of activities and assets was generating revenue at the acquisition date, it
is considered to have outputs at that date, even if subsequently it will no
longer generate revenue from external customers, for example because it will be
integrated by the acquirer.

For activities and assets
that do not have outputs at the acquisition date, the acquired process is substantive
only if:

(i) it is critical to the
ability to develop or convert an acquired input or inputs into outputs; and

(ii) the inputs acquired
include both an organised workforce that has the necessary skills, knowledge,
or experience to perform that process (or group of processes) and other inputs
that the organised workforce could develop or convert into outputs. Those other
inputs could include:

(a) intellectual
property that could be used to develop a good or service;

(b) other
economic resources that could be developed to create outputs; or

Examples of the inputs
include technology, in-process research and development projects, real estate
and mineral interests.

As can be seen from the
above discussion, for an acquired set of activities and assets to be considered
a business, if the set has no outputs, the set should include not only a
substantive process but also both an organised workforce and other inputs that
the acquired organised workforce could develop or convert into outputs.
Entities will need to evaluate the nature of those inputs to assess whether
that process is substantive.

For activities and assets
that have outputs at the acquisition date, the acquired process is substantive
if, when applied to an acquired input or inputs:

(1) it is critical to the
ability to continue producing outputs, and the inputs acquired include an
organised workforce with the necessary skills, knowledge, or experience to
perform that process (or group of processes); or

(2) significantly
contributes to the ability to continue producing outputs and is considered
unique or scarce; or cannot be replaced without significant cost, effort, or delay
in the ability to continue producing outputs.

The following additional
points support the above:

(A) an acquired contract
is an input and not a substantive process. Nevertheless, an acquired contract,
for example, a contract for outsourced property management or outsourced asset
management, may give access to an organised workforce. An entity shall assess
whether an organised workforce accessed through such a contract performs a
substantive process that the entity controls, and thus has acquired. Factors to
be considered in making that assessment include the duration of the contract
and its renewal terms.

(B) difficulties in
replacing an acquired organised workforce may indicate that the acquired
organised workforce performs a process that is critical to the ability to
create outputs.

(C) a process (or group of
processes) is not critical if, for example, it is ancillary or minor within the
context of all the processes required to create outputs.

As can be seen from the
above discussions, more persuasive evidence is required in determining whether
an acquired process is substantive, when there are no outputs, because the
existence of outputs already provides some evidence that the acquired set of
activities and assets is a business. The presence of an organised workforce
(although itself an input) is an indicator of a substantive process. This is
because the ‘intellectual capacity’ of an organised workforce having the
necessary skills and experience following rules and conventions may provide the
necessary processes (even if not documented) that are capable of being applied
to inputs to create outputs.

The standard-setter
concluded that although an organised workforce is an input to a business, it is
not in itself a business. To conclude otherwise would mean that hiring a
skilled employee without acquiring any other inputs could be considered to be
acquiring a business. The standard-setter decided that such an outcome would be
inconsistent with the definition of a business.

Prior to the amendments,
Ind AS 103 stated that a business need not include all of the inputs or
processes that the seller used in operating that business, ‘if market
participants are capable of acquiring the business and continuing to produce
outputs, for example, by integrating the business with their own inputs and
processes’. The standard-setter, however, decided to base the assessment on
what has been acquired in its current state and condition, rather than on
whether market participants are capable of replacing any missing elements, for
example, by integrating the acquired activities and assets. Therefore, the
reference to such integration was deleted from Ind AS 103. Instead, the
amendments focus on whether acquired inputs and acquired substantive processes
together significantly contribute to the ability to create outputs.

Illustrative
examples

Example
–Acquisition of real estate

Base facts

Ze
Co purchases a portfolio of 8 single-family homes along with in-place lease
contracts for each of them. The fair value of the consideration paid is equal
to the aggregate fair value of the 8 single-family homes acquired. Each
single-family home includes the land, building and lease-hold improvements.
Each home is of a different carpet size and interiors. The 8 single-family
homes are in the same area and the class of customers (e.g., tenants) are
similar. The risks in relation to the homes acquired and leasing them out are
largely similar. No employees, other assets, processes or other activities are
received in this transaction.

Scenario 1 – Application of optional concentration test

Analysis

Ze elects to apply the
optional concentration test set and concludes that:

each single-family home
is considered a single identifiable asset because:

the building and
lease-hold improvements are attached to the land and cannot be removed without
incurring significant cost; and

the building and the
associated leases are considered a single identifiable asset, because they
would be recognised and measured as a single identifiable asset in a business
combination.

the group of 8
single-family homes is a group of similar identifiable assets because they are
all single-family homes, are similar in nature and the risks associated with
operations and creating outputs are not significantly different. This is
consistent with the fact that the types of homes and classes of customers are
not significantly different.

Ze concludes that the
acquired set of activities and assets is not a business because substantially
all of the fair value of the gross assets acquired is concentrated in a group
of similar identifiable assets.

Scenario 2 –Corporate
office park

Facts

Assume the same base case,
except that Ze also purchases a multi-tenant corporate office park with four
15-storey office buildings with in-place leases. The additional set of
activities and assets acquired includes the land, buildings, leases and
contracts for outsourced cleaning, security and maintenance. However, no
employees, other assets, other processes or other activities are transferred.
The aggregate fair value associated with the office park is similar to the
aggregate fair value associated with the 8 single-family homes. The processes
performed through the contracts for outsourced cleaning and security are minor
within the context of all the processes required to create outputs.

Analysis

Ze elects to apply the
optional concentration test and concludes that the single-family homes and the
office park are not similar identifiable assets, because the risks associated
with operating the assets, obtaining tenants and managing tenants are
significantly different. This is consistent with the fact that the two classes
of customers are significantly different. As a result, the concentration test
fails because the fair value of the corporate office park and the 8
single-family homes is similar. Thus, Ze proceeds to evaluate whether the
acquisition is a business in the normal way.

The set of activities and
assets has outputs because it generates revenue through the in-place leases. Ze
needs to evaluate if there is an acquired process that is substantive. For
activities and assets that have outputs at the acquisition date, the acquired
process is substantive if, when applied to an acquired input or inputs:

it is critical to the
ability to continue producing outputs, and the inputs acquired include an
organised workforce with the necessary skills, knowledge, or experience to
perform that process (or group of processes); or

significantly
contributes to the ability to continue producing outputs and is considered
unique or scarce; or cannot be replaced without significant cost, effort, or
delay in the ability to continue producing outputs.

Ze concludes that the
above criterion is not met because:

the set does not include
an organised workforce;

the only processes
acquired (processes performed by the outsourced cleaning, security and
maintenance personnel) are ancillary or minor and, therefore, are not critical
to the ability to continue producing outputs.

the processes do not
significantly contribute to the ability to continue producing outputs.

the processes are not
unique or scarce and can be replaced without significant cost, effort, or delay
in the ability to continue producing outputs.

Consequently, Ze concludes
that the acquired set of activities and assets is not a business. Rather, it is
an asset acquisition.

Scenario 3 –Corporate
office park

Facts

Consider the same facts as
in Scenario 2, except that the acquired set of activities and assets also
includes the employees responsible for leasing, tenant management, and managing
and supervising all operational processes.

Analysis

Ze elects not to apply the
optional concentration test and proceeds to evaluate whether there is a
business in the normal way. The acquired set of activities and assets has
outputs because it generates revenue through the in-place leases. Consequently,
Ze carries out the same analysis as in Scenario 2.

The acquired set includes
an organised workforce with the necessary skills, knowledge or experience to
perform processes (i.e. leasing, tenant management, and managing and
supervising the operational processes) that are substantive because they are
critical to the ability to continue producing outputs when applied to the
acquired inputs (i.e. the land, buildings and in-place leases). Additionally,
those substantive processes and inputs together significantly contribute to the
ability to create output. Therefore, Ze concludes that the acquired set of
activities and assets is a business.

In the author’s view,
these amendments may result in more acquisitions being accounted for as asset
acquisitions as the definition of business has narrowed. Further, the
accounting for disposal transactions will also be impacted as Ind AS 110 Consolidated
Financial Statements will be applicable in case of the recognition of
proceeds from the sale of a business, while Ind AS 115 Revenue from
Contracts with Customers will be applied for the recognition of proceeds
from the sale of an asset.

shailesh.kwebmaker

REPORT: ROLE OF THE PROFESSIONAL IN A CHANGING TAX LANDSCAPE

HITESH D. GAJARIA
Chartered Accountant

(BCAS
Lecture Meeting, 8^thJuly, 2020)

A
report by CA Riddhi Lalan

Hitesh D. Gajaria, a respected member of the BCAS family since 1985, delivered a remarkable speech at the BCAS Lecture Meeting on 8^thJuly, 2020. We are publishing this summary just when the profession is at the threshold of change, a trending theme of 2020-21: Tradition, Transition and Transformation, adopted by the BCAS. A summary cannot convey the full import of his talk but we hope it will enable the professionals to get an eagle-eye view of the landscape of the tax profession, both near and far. We would recommend that you also watch the captivating talk on the BCAS YouTube channel.

The tax world is in a state of rapid flux. Earlier, the tax profession was all about filing returns, assessments, filing appeals and litigating matters. From simple and straight-forward days, where the most common tax concerns were additions on account of lower GP Ratio, deductions u/s 37 and revenue expenditure vs. capital expenditure for the Income-tax and the lack of C-Forms in the Sales Tax Assessments, the tax profession today has morphed into a complex, multi-dimensional arena requiring unique and varied skills from the tax professionals.

In light of this background, the learned speaker sought to dwell upon the most gripping questions for the tax professionals today – What are the current global and local trends? What factors have caused the changes? And as a result, how is the tax world different today? Is tax planning still possible? What is the future of the tax profession? What can be done by a tax professional to stay relevant and on top of the changes?

THE CURRENT TRENDS

Global

Increased reporting obligations in a number of tax jurisdictions.

Increased collaborations between tax authorities of different jurisdictions and robust exchange of information mechanisms.

Tightened rules to combat profit shifting with reference to concepts like transfer pricing, which India adopted only in 2002, but the US had since the mid-1960s.

Increasing tendency to focus on ‘formula-based approaches’ to profit attribution.

Strong anti-abuse rules to target treaty shopping and other abusive arrangements.

No consensus on tackling the tax challenge arising from digitisation of the global economy. Even if a consensus is reached, it may result in re-thinking of the way taxation of income is approached and highly sophisticated and complex rules which a tax professional will have to master.

Increased blurring of direct and indirect taxes, with a shift towards transaction type tax levies invading the domain of direct taxes.

Local

Protectionism and increased unilateral measures, triggered by the revival of nationalistic politics in various nations, developed as well as developing, and partially by the slow pace of multilateral reform in tax.

At the same time, countries still want to attract investments (both domestic and foreign) by way of large headline rate cuts for businesses to flourish in a jurisdiction. While this may trigger another round of tax competition, there will be greater need for not only tax competition but also tax co-operation. Tax war is an extreme situation which no country can afford today; however, tax competition shall always sustain.

Proliferation of preferential regimes (e.g., patent box regimes).

Many countries have combated preferential regimes by way of disallowance provisions for foreign related party transactions.

Uncertainty over tariffs and potential trade wars has ripened the entire area of customs and indirect taxes for rethinking and overhaul.

Unilateral measures to tax the digital sector have been introduced by many countries including India.

In many countries, including India, huge compliance burden has been embedded at the stage of business transactions taking place, leading to huge burden on businesses.

Closer home, an oncoming storm of tax assessments, audits, recoveries and tax enforcement measures is on the anvil because the government needs to start recovering taxes to make up for the increasing fiscal deficit and to fund more social welfare programmes if the needs of the lowest strata of society have to be met.

WHAT FACTORS HAVE CAUSED THESE CHANGES?

The changes in the tax trends began after the global financial crisis of 2008 which put huge fiscal pressure on governments worldwide. Improving tax compliance and increasing tax enforcement were seen as better routes rather than increasing tax rates, leading to increased global political interest in tax issues and driving the agenda for tax reforms. There has been a greater public focus and media scrutiny on taxpayer behaviour (Apple, Starbucks, Amazon, Panama papers leak, etc.). While there has been an increased alignment of interests between nations with exceptions, tax simplification, rationalisation and reforms have led to even more burdensome compliance for taxpayers. Covid-19 could be yet another turning point for unknown reforms in the tax world.

HOW IS THE TAX WORLD DIFFERENT TODAY?

THEN	NOW
Tax liability depended on the strict letter of the law Remedies to correct abuse lay with the legislature to amend the tax laws	Tax ‘morality’ has gained significance Factors such as substance, purpose and the acceptability of the outcome are extremely relevant for both taxpayers and advisers
Secrecy and confidentiality was generally maintained	There has been a rise in publicising tax outcomes, naming and shaming of tax defaulters Increasing data leaks have proved that the so-called tax havens have been mirages in some sense Information asymmetries between countries have been largely plugged through exchange of information mechanisms
Tax matters involved only the government and the taxpayer assisted by tax advisers	List of stakeholders has expanded to include the media, NGOs and even consumers
Compliance was a labour-intensive and assured source of regular work	Compliance functions are being radically overhauled through use of technology tools
Clear distinction between tax avoidance and tax evasion Tax avoidance was thought to be a goal	The term ‘tax avoidance’ is under a cloud The new standard is ‘tax morality’

IS TAX PLANNING STILL POSSIBLE?

The days of tax planning in the form of reduction of tax liability with little or no impact on economic circumstances and ascertaining and implementing the most tax efficient way of achieving legitimate business objectives are over. That type of tax planning which disregards commercial realities no longer exists but it has evolved. Tax planning, in the traditional sense, will no longer work in an era where international measures such as CFC, MLI and domestic measures such as General Anti-Avoidance Rules are in place. However, planning for real business transactions is still possible.

A professional, who is fully grounded in understanding and mastering the law and able to guide businesses about what is permissible and what is not, will sustain. However, any planning will now involve a much higher risk of scrutiny at assessment and judicial levels. Higher threshold for acceptability and higher risk of scrutiny of the transactions from a large number of stakeholders would be inevitable. There is heightened risk of such transactions being reported on the front pages of newspapers due to increased information availability; a professional must measure himself by these standards. Extremely robust documentation and robust proof of commercial substance will be critical.

WHAT IS THE FUTURE OF THE TAX PROFESSION?

The entire platform of tax services will rest on three main pillars which will broadly define how tax professionals may need to specialise their skillsets and garner focused experience:

(1) Technology-enabled tax compliance:

Technology has ruthlessly changed the landscape and has been eagerly embraced by tax authorities; this, perhaps, has been a big revelation!

It is the need of the hour to completely adapt and master technology to stay ahead.

Competition would not only be limited to the tax professionals but also more disruptors, say non-professional technology firms, who enable compliance at a fraction of the cost, will now enter the arena.

Technology using Artificial Intelligence (AI) and Machine Learning (ML) must take over a number of repetitive tasks.

Technology has raised a question as to ‘Whether professionals, going forward, would even be engaged for compliance?’

Compliance would not be dead for a professional, but will need adaptability and agility.

Additional challenges of data safety, security and protection need to be addressed.

By embracing mass compliance and processing data in larger volumes, a tax professional can gain leverage from the data available which will open a whole new vista predicting tax outcomes to better serve clients.

While drafting and research has been taken over by AI, there are two ways to look at it – (i) threat to routine compliance, and therefore, accept technology; (ii) opportunity for value addition due to increasing uncertainty.

Technology has merits but with the overload of the digital world there is also digital distraction. Tax professionals need to engage in deep work, detox periodically from technologies and opt for in-depth and consistent reading. Advisory services flowing from such detailed reading and connecting theory to practice in how that impacts a client is now more valuable.

Technology cannot substitute experience and deep knowledge. Here lies the true value of a tax professional.

By using algorithms and data mining, the Department is in a position to point out anomalies. Tax professionals need to be better prepared to address such anomalies. To walk the path of technology, assistance from data scientists may be required.

(2) High end advisory:

Global convergence of tax methodologies, the drive against base erosion with accompanying changes in domestic and international laws and the emergence of and seeping in of transaction tax type levies, gives rise to fresh challenges for a professional to overcome.

Today, with the convergence of accounting and tax principles, giving clear preference to the doctrine of substance over form and new and ever-changing corporate law, foreign exchange and SEBI regulations, we are in the middle of a perfect storm with attendant opportunities.

There is a perceived need for professionals who have experience in more than just one or two core areas and also for those professionals who can collaboratively work together with other professionals in different disciplines to evolve solutions which overcome complex problems, while simultaneously not falling foul of any regulations.

A longer-term strategy to develop and nurture appropriate talent needs to be undertaken because, in this arena, too, sister professions are nibbling away at pieces of work that Chartered Accountants traditionally did.

(3) Litigation:

Complexities and uncertainties shall lead to an explosion of tax litigation.

The tax professional has only witnessed the implementation aspects of GST; audits are yet to commence.

There was no reduction in number of tax officers due to digitisation of the GSTN. These officers would be trained to do tax assessments more intelligently. The Income-tax Department, also, has sharply climbed up the learning curve. Even judges in Tribunals and Courts are keeping abreast with latest trends.

Conflict between the needs of the government to garner more revenue and that of businesses to conserve more revenue will result in a sharp increase in litigation.

At the same time, it needs to be understood that not all litigation is good. Hand-holding and guidance to clients would gain relevance to decide which litigation to pursue and which not to, having regard to the alternate forums of dispute resolution available under domestic laws as well as under international tax laws.

Government is also realising the futility of litigations and therefore a scheme like VSVS is an attempt to clear such backlogs.

The tax professional needs to be nuanced in how to assist clients to shape their litigation strategies. Jurisprudence is not static as more case laws are available online nationally and internationally.

Mandatory disclosure regulations in case of aggressive tax positions require a balance in audit, assurance and litigation.

These three pillars are not independent compartments. A strong professional may have competency either in all or in more than one of these.

Certification assignments should be taken up only if capabilities and professional competency are available before pitching for such assignments. The Department is now equipped with algorithms to intelligently search all the reports and ferret out anomalies. Therefore, there is no easy way, either to discharge the certification function correctly or refrain from accepting – there is just no other option.

Tax risk in the corporate world: Barring a few exceptions, there is polarisation in the way the market is valuing companies having clear, transparent, ethical policies. Effective tax rate is not to be viewed in an absolute sense; it needs to be looked at on a comparative basis, based on a bench-marking analysis and tax policies and decided accordingly. The tone and culture of the corporate decides whether tax risk is a subject of discussion in the Board Room. Adverse tax consequences with attendant negative publicity is already tinged with social stigma, at least in the minds of independent directors whether the corporates believe in it or not. Therefore, tax risk is, increasingly, forming a part of the Board Room discussions.

HOW TO STAY RELEVANT?

Maximum advantage available with the younger professionals having agility, ability, keenness, inquisitiveness and willingness to change.

Develop a willingness to adapt to changed circumstances.

Ability to manage tax risks without overpaying taxes.

Adherence to ethical standards is not old-fashioned; it is expected and demanded today.

An analogy may be drawn from the letter ‘T’. The vertical line is the depth and core. Develop that depth, that core, own it, invest in it and nurture it. But do not forget the horizontal line which is the adjacent line. It is now, more than ever, important to read commercial news, develop good communication skills, understand cultural differences, learn personal etiquette, etc. Both lines need to be worked upon simultaneously.

SME firms and bigger firms need to come together and collaborate, especially after the Covid-19 pandemic.

Develop cutting-edge technical skills and become comfortable with a fast-paced legal and regulatory environment.

We find ourselves at the crossroads to reinvent ourselves and today is the day to start. When nothing is certain, the maximum opportunity lies ahead – just re-trim your masts to catch that wind.

shailesh.kwebmaker

THE FINANCE ACT, 2020

1. BACKGROUND

1.1 Ms Nirmala Sitharaman, the Finance Minister, presented her second
Budget to the Parliament on 1^stFebruary, 2020. The Finance Bill, 2020, presented along with the Budget
with certain amendments suggested by the Finance Minister on the basis of
discussions with the stakeholders, was passed by the Parliament without any
discussion on 23^rd March, 2020. It received the assent of the
President on 27^th March, 2020. The Finance Act, 2020 was passed by
both the Houses of Parliament without any discussion in view of the recent
lockdown due to the coronavirus pandemic which has affected India and the whole
world.

1.2 Some of the
important proposals in the Budget, relating to the Direct Taxes, can be
summarised as under:

(i) In line with
the reduction in rates of Income-tax for certain domestic companies which forgo
certain deductions and tax incentives introduced last year, the Finance Act,
2020 provides for revised slabs of Income-tax rates for Individuals and HUFs
who do not claim certain deductions and tax incentives.

(ii) Dividend
Distribution Tax, hitherto payable by companies and Mutual Funds and consequent
exemption on dividend received by shareholders and unitholders, has been
discontinued effective from 1^st April, 2020. Consequently, the
exemption in respect of dividend receipt enjoyed by the shareholders and
unitholders of Mutual Funds has been withdrawn.

(iii) The
compliance burden of Charitable Trusts and Institutions has been increased.

(iv) The Finance
Minister has recognised the need for a ‘Taxpayer’s Charter’. A new section 119A
has been inserted in the Income-tax Act effective from 1^st April,
2020 to provide that CBDT shall adopt and declare the Taxpayer’s Charter. CBDT
will issue guidelines for ensuring that this Charter is honoured by the
Officers of the Tax Department.

(v) One important
measure announced by the Finance Minister this year relates to the Disputed
Income-tax Settlement Scheme. ‘The Direct Tax Vivad Se Vishwas Bill,
2020’ was introduced by her and was passed by Parliament on 13^th
March, 2020. This Scheme has been introduced with a view to reduce litigation.
It is stated that about 4,83,000 Direct Tax cases are pending before various
appellate authorities. The assessees can avail the benefit of this Scheme by
paying the disputed tax and getting waiver of penalty, interest and fee.

1.3 This Article discusses some of the important
amendments made in the Income-tax Act by the Finance Act, 2020.

2. RATES OF TAXES

2.1 The slab rates
in the case of Individuals, HUFs, AOP, etc., for A.Y. 2021-22 (F.Y. 2020-21)
are the same as in A.Y. 2020-21 (F.Y. 2019-20). Similarly, the tax rates for
firms, LLPs, co-operative societies and local authorities for A.Y. 2021-22 are
the same as in A.Y. 2020-21. In the case of a domestic company, the rate of tax
is the same for A.Y. 2021-22 as in A.Y. 2020-21. However, the rate of 25% is
applicable in A.Y. 2021-22 to a domestic company having total turnover or gross
receipts of less than Rs. 400 crores in F.Y. 2018-19. In A.Y. 2020-21, this
requirement was with reference to total turnover or gross receipts relating to
F.Y. 2017-18.

2.2 The rates for Surcharge on tax applicable in A.Y. 2020-21 will
continue in A.Y. 2021-22. It may be noted that dividend declared and received
on or after 1^st April, 2020 is now taxable in the hands of the
shareholder. Earlier, the company was required to pay Dividend Distribution Tax
(DDT) and the shareholder was not liable to pay any tax. Therefore, dividend
income for F.Y. 2020-21 (A.Y. 2021-22) will be liable to tax in the hands of
the shareholder. In order to provide relief in the rate of Surcharge to
Individual, HUF, AOP, etc. having total income exceeding Rs. 2 crores, it is
provided that the rate of Surcharge will be 15% on the Income-tax on dividend income
included in the total income.

2.3 The Health and
Education Cess of 4% of Income-tax and Surcharge shall continue as in the
earlier year.

3. REDUCTION IN TAX RATES FOR INDIVIDUALS AND HUFs

3.1 Last year, the
Income-tax Act was amended by insertion of new sections 115BAA and 115BAB to
reduce the tax rates of a domestic company to 22% if the company does not claim
certain deductions and tax incentives. In respect of newly-formed manufacturing
companies, registered on or after 1^st January, 2019, the tax rate
was reduced to 15% if certain deductions and tax incentives were not claimed.

3.2 In the Finance Act, 2020 a new section 115BAC has been inserted
in the Income-tax Act with effect from A.Y. 2021-22 (F.Y. 2020-21) to reduce
the tax rates for Individuals and HUFs if the assessee does not claim certain
deductions and tax incentives. For claiming this concession in tax rates, the
assessee will have to exercise the option in the prescribed manner. The reduced
tax rates are as under:

Income (Rupees in lakhs)

Existing rate

Reduced rate (section 115BAC)

2.50 L

Nil

2.50 to 5.00 L

5.00 to 7.50 L

20%

10%

7.50 to 10.00 L

20%

15%

10.00 to 12.50 L

30%

20%

12.50 to 15.00 L

30%

25%

Above 15.00 L

30%

Surcharge and Cess
at the specified rates will be chargeable. It may be noted that there is no
separate higher threshold for senior and very senior citizens in the above
concessional tax rate scheme.

3.3 For claiming
the benefit of the above concession in tax rates, the assessee will have to
forgo the deductions under sections, (i) 10(5) – Leave Travel Concession, (ii)
10(13A) – House Rent Allowance, (iii) 10(14) – Dealing with special allowances
granted to employees other than conveyance and transport allowance under Rule
2BB(1)(a), (b), (c) and Sr. No. 11 of Table under Rule 2BB(2) as notified by
CBDT Notification dated 26^th June, 2020.

Out of the above,
some of the allowances as may be prescribed will be allowed, (iv) 10(17) –
Allowances to MPs and MLAs, (v) 10(32) – Deduction of clubbed income of minor
up to Rs. 1,500, (vi) 10AA – Deduction of income of SEZ unit, (vii) 16 –
Standard deduction of Rs. 50,000, deduction for entertainment expenses in
specified cases, deduction for professional tax, etc., available to salaried
employees, (viii) 24(b) – Interest on borrowing for self-occupied property,
(ix) 32(1)(iia) – Additional depreciation, (x) 32AD – Investment in new plant
and machinery in notified areas in certain states, (xi) 33AB – Deposits in tea,
coffee and rubber development account, (xii) 35(1)(ii), (iia), (iii) and (2AA)
– Specified deduction for donations or expenses for Scientific Research, (xiv)
35AD – Deduction of capital expenditure for specified business, (xv) 35CCC –
Weighted deduction for specified expenditure on Agricultural Extension Project,
(xvi) 57(iia) – Standard deduction for Family Pension, (xvii) Chapter VIA – All
deductions under Chapter VIA – excluding deduction u/s 80CCD(2) – Employee’s
contribution in notified Pension Scheme, section 80JJAA – Expenditure on
employment of new employees and section 80LA(1A) dealing with deduction in
respect of certain income of International Financial Services Centre.

This will mean that deductions under sections 80C (investment in PPF
A/c, LIP payments or investments in other savings instruments up to Rs. 1.50
lakhs), 80D (medical insurance), 80TTA/80TTB (deduction for interest on bank
deposits), 80G (donations to charitable trusts, etc.) cannot be claimed,
(xviii) Section 71 – Set-off of carried-forward loss from house property
against income from other heads, (ixx) Section 32 – Depreciation u/s 32 [other
than section 32(1)(iia)] shall be allowed in the prescribed manner, (xx) No
exemption or deduction for allowances or perquisites allowable under any other
law can be claimed, (xxi) provisions of Alternate Minimum Tax and credit under
sections 115JC/115JD will not be available.

3.4 As stated
above, the assessee will have to exercise the option in the prescribed manner
where an Individual or HUF has no business income, this option can be exercised
for A.Y. 2021-22 or any subsequent year along with the filing of the return of
income u/s 139(1). In other words, the option can be exercised every year in
the prescribed manner.

3.5 If the
Individual or HUF has income from business or profession, the option can be
exercised for A.Y. 2021-22 or any subsequent year before the due date for
filing the return of income for that year u/s 139(1). The option once exercised
shall apply to that year and all subsequent years. Such an assessee can
withdraw the option at any time in a subsequent year and, thereafter, it will
not be possible to exercise the option at any time so long as the said assessee
has income from business or profession.

3.6 It may be
noted that the above option for concession in tax rates will not be available
to AOP, BOI, etc. The existing slab rates will continue to apply to them.
Further, the provisions of sections 115JC and 115JD relating to Alternative
Minimum Tax and credit for such tax will not apply to the person exercising
option u/s 115BAC.

3.7 Considering
the above conditions, it is possible that very few assessees will exercise this
option for lower tax rates. If deductions for PPF contribution, LIP, etc., u/s
80C, donation u/s 80G, Mediclaim Insurance u/s 80D, Standard Deduction from
Salary income u/s 16, travel and other allowances under sections 10(5), 10(13A)
and 10(14), and similar other deductions are not to be allowed, this concession
in tax rates to Individuals and HUFs will not be attractive.

4. TAXATION OF DIVIDENDS

4.1 Up to 31^st
March, 2020, domestic companies declaring / distributing dividend to
shareholders were required to pay DDT u/s 115-O of the Income-tax Act at the
rate of 15% plus applicable Surcharge and Cess. Similarly, section 115-R
provided for payment of tax by a Mutual Fund while distributing income on its
units at varying rates. Consequently, sections 10(34) and 10(35) provided that
the shareholder receiving dividend from a domestic company or a unitholder
receiving income from an M.F. will not be required to pay any tax on such
dividend income and income received from an M.F. in respect of the units of the
M.F. However, from A.Y. 2017-18 (F.Y. 2016-17), dividend from a domestic
company received by an assessee, other than a domestic company and Public
Trusts, was made taxable u/s 115BBDA at the rate of 10% plus applicable
Surcharge and Cess if the total dividend income was more than Rs. 10 lakhs.

4.2 Now, after
about two decades, the system of levying tax on dividends has been changed
effective from 1^st April, 2020. Sections 115-O and 115-R levying DDT
on domestic companies / M.F.s are now made inoperative. Sections 10(34), 10(35)
and 115BBDA are also not operative from 1^st April, 2020.

4.3 In view of the above, any dividend declared by
a domestic company or income distributed by an M.F., on or after 1^st
April, 2020 will be taxable in the hands of the shareholder / unitholder at the
rate applicable to the assessee. In the case of a non-resident assessee it will
be possible to claim benefits of applicable tax treaties which will include
limit on tax rate for dividend income and tax credit in home country as
provided in the applicable tax treaty.

4.4 Section 57 has
been amended to provide that expenditure by way of interest paid on monies
borrowed for investment in shares and units of M.F.s will be allowed to be
deducted from Dividend Income or Income from units of M.F.s. This deduction
will be restricted to 20% of Dividend Income or Income from units of M.F.s. No
other deduction will be allowed from such income.

4.5 A new section,
80M, has been inserted in the Income-tax Act effective from A.Y. 2021-22 (F.Y.
2020-21). This section provides for deduction in the case of a domestic company
whose gross total income includes dividend from any other (i) domestic company,
(ii) foreign company, or (iii) a business trust. The deduction under this
section will be allowed to the extent of dividend distributed by such company
on or before the due date. For this purpose ‘Due Date’ means the date one month
prior to the due date for filing the return of income u/s 139(1). In other
words, if a domestic company has received dividend of Rs. 1 crore from another
domestic company, Rs. 50 lakhs from a foreign company and Rs. 25 lakhs from a
business trust during the year ending 31^st March, 2021, it will be
entitled to claim deduction from this total dividend income of Rs. 1.75 crores,
amount of dividend of say Rs. 1.60 crores declared on or before 31^st
August, 2021 if the last date for filing its return of income u/s 139(1) is 30^th
September, 2021. It may be noted that the benefit u/s 80M will not be available
in respect of income from units of M.F.s.

4.6 In order to
provide some relief to Individuals, HUFs, AOP, BOI, etc., a concession in the
rate of Surcharge has been provided in respect of dividend income. In case of
such assessees, the rate of Surcharge on income between Rs. 2 crores and Rs. 5
crores is 25% and the rate of Surcharge on income above Rs. 5 crores is 37.5%.
It is now provided that if the income of such assessee exceeds Rs. 2 crores,
the rate of Surcharge shall not exceed 15% on Income-tax computed in respect of
the Dividend Income included in the total income. From the wording of this
concession given to Dividend Income, it appears that this concession will not
apply to the income from units of M.F.s received by the assessee.

4.7 Since the
income from dividend on shares is now taxable, section 194 has been amended to
provide that tax at the rate of 10% of the dividend paid to the resident
shareholder will be deducted at source. In the case of a non-resident
shareholder, the TDS will be at the rate of 20%. Similarly, new section 194K now
provides that an M.F. shall deduct tax at source at 10% of income distributed
to a resident unitholder. In the case of a non-resident unitholder, the rate of
TDS is 20% as provided in section 196A.

4.8 It may be
noted that u/s 193 it is provided that tax is not required to be deducted at
source from interest paid by a quoted company to its debenture-holders if the
said debentures are held in demat form. This concession is not given under
sections 194 or 194K in respect of quoted shares or units of M.F.s held in
demat form. Therefore, the provisions for TDS will apply in respect of shares
or units of M.F.s held in demat form.

5. TAX DEDUCTION AND COLLECTION AT SOURCE

5.1 Sections
191 and 192: Both these sections are amended effective from A.Y. 2021-22
(F.Y. 2020-21). At present, section 17(2)(vi) of the Income-tax Act provides
for taxation of the value of any specified securities or sweat equity shares
(ESOP) allotted to any employee by the employer as a perquisite. The value of
ESOP is the fair market value on the date on which the option is exercised as
reduced by the actual payment made by the employee. When the shares are
subsequently sold, any gain on such sale is taxable as capital gain. The
employer has to deduct tax at source on such perquisite at the time of exercise
of such option u/s 192.

In order to ease
the burden of startups, the amendments in these two sections provide that a
company which is an eligible startup u/s 80IAC will have to deduct tax at
source on such income within 14 days (i) after the expiry of 48 months from the end of the relevant assessment year, or (ii) from
the date of sale of such ESOP shares by the employee, or (iii) from the date on which the employee who
received the ESOP benefit ceases to be an employee of the company, whichever is
earlier. For this purpose, the tax rates in force in the financial year in
which the said shares (ESOP) were allotted or transferred are to be considered.
By this amendment, the liability of the employee to pay tax on such perquisite
and deduction of tax on the same is deferred as stated above. Consequential
amendments are also made in sections 140A (self-assessment tax) and 156 (notice
of demand).

5.2 Sections
194, 194K and 194LBA: Sections 194 and 194LBA are amended and a new section
194K is inserted effective from 1^st April, 2020. These sections now
provide as under:

(i) Section 194
provides that if the dividend paid to a resident shareholder by a company
exceeds Rs. 5,000 in any financial year, tax at the rate of 10% shall be
deducted at source. In the case of a non-resident shareholder, the rate for TDS
is 20% as provided in section 195.

(ii) New section 194K provides that if any income is
distributed by an M.F. to a resident unitholder and such income distributed
exceeds Rs. 5,000 in a financial year, tax at the rate of 10% shall the
deducted at source by the M.F. In the case of a non-resident unitholder, the
rate of TDS is 20% u/s 196A.

(iii) Section 194LBA has been amended to provide that
in respect of income distributed by a Business Trust to a resident unitholder,
being dividend received or receivable from a Special Purpose Vehicle, the tax
shall be deducted at source at the rate of 10%. In respect of a non-resident
unitholder, the rate for TDS is 20% on dividend income.

5.3 Section 196C:
Section 196C dealing with TDS from income by way of interest or dividends in
respect of Bonds or GDRs purchased by a non-resident in foreign currency has
been amended from 1^st April, 2020. Under the amended section, TDS at
10% is now deductible from the dividend paid to the non-resident.

5.4 Section
196D: This section deals with TDS from income in respect of securities held
by an FII. Amendment of this section from 1^st April, 2020 now
provides that dividend paid to an FII or FPI will be subject to TDS at the rate
of 20%.

5.5 Section
194A: This section deals with TDS from interest income. This section is
amended effective from 1^st April, 2020. At present, a co-operative
society is not required to deduct tax at source on interest payment in the
following cases:

(i) Interest
payment by a co-operative society (other than a Co-operative Bank) to its
members.

(ii) Interest
payment by a co-operative society to any other co-operative society.

(iii) Interest
payment on deposits with a Primary Agricultural Credit Society or Primary
Credit Society or a Co-operative Land Mortgage Bank.

(iv) Interest
payment on deposits (other than time deposits) with a co-operative society
(other than societies mentioned in iii above) engaged in the business of
banking.

Under the
amendments made in section 194A effective from 1^st April, 2020, the
above exemptions have been modified and a co-operative society shall be
required to deduct tax at source in all the above cases at the rates in force,
if the following conditions are satisfied:

(a) The total
sales, gross receipts or turnover of the co-operative society exceeds Rs. 50
crores during the immediately preceding financial year, and

(b) The amount of
interest, or the aggregate of the amounts of such interest payment during the
financial year, is more than Rs. 50,000 in case the payee is a senior citizen
(aged 60 years or more) or more than Rs. 40,000 in other cases.

5.6 Section 194C: This section is amended effective from 1^st
April, 2020. At present the term ‘Work’ is defined in the section to include
manufacturing or supplying a product according to the requirement or
specification of a customer by using material purchased from such customer.
Now, this term ‘Work’ will also include material purchased from the associate
of such customer. For this purpose, the ‘associate’ means a person specified
u/s 40A(2)(b).

5.7 Section
194J: This section is amended effective from 1^st April, 2020.
The rate of TDS has been reduced to 2% from 10% in respect of TDS from fees for
technical services. The rate of TDS from professional fees will continue at 10%
of such fees.

5.8 Section
194LC: This section is amended effective from 1^st April, 2020.
The eligibility of borrowing under the loan agreement or by issue of long-term
bonds for concessional rate of TDS under this section has now been extended
from 30^th June, 2020 to 30^th June, 2023. Further, section
194LC(2) has now been amended to include interest on monies borrowed by an
Indian company from a source outside India by issue of long-term Bonds or
Rupee-Denominated Bonds between 1^st April, 2020 and 30^th
June, 2023, which are listed on a recognised stock exchange in any
International Financial Services Centre. In such a case, the rate of TDS will
be 4% (as against 5% in other cases).

5.9 Section
194LD: This section is amended effective from 1^st April, 2020.
This amendment is made to cover interest payable from 1^st June, 2013
to 30^th June, 2023 by a person to an FII or a Qualified Foreign
Investor on Rupee-Denominated Bonds of an Indian company or Government security
u/s 194LD. Further, now interest at specified rate on Municipal Debt Securities
issued between 1^st April, 2020 and 30^th June, 2023 will
also be covered under the provisions of this section. The rate for TDS is 5% in
such cases.

5.10 Section
194N: Section 194N was inserted effective from 1^st September,
2019 by the Finance (No. 2) Act, 2019. It provided that a banking company,
co-operative bank or a Post Office shall deduct tax at source at 2% in respect
of cash withdrawn by any account holder from one or more accounts with such
bank / Post Office in excess of Rs. 1 crore in a financial year. This limit of
Rs. 1 crore applied to all accounts of the person in any bank, co-operative
bank or Post Office. Hence, if a person has accounts in different branches of
the bank, total cash withdrawals in all these accounts will be considered for
this purpose. This TDS provision applied to all persons, i.e., Individuals,
HUFs, AOP, firms, LLPs, companies, etc., engaged in business or profession, as
also to all persons maintaining bank accounts for personal purposes. Under this
section there will be no TDS on cash withdrawn up to Rs. 1 crore in a financial
year. The TDS provision will apply on cash withdrawal in excess of Rs. 1 crore.

Now, the above
section has been replaced by a new section 194N effective from 1^st
July, 2020. This new section provides as under:

(i) The provision
relating to TDS at 2% on cash withdrawals exceeding Rs. 1 crore as stated above
is continued. However, w.e.f. 1^st July, 2020, if the account holder
in the bank / Post Office has not filed the returns of income for all the three
assessment years relevant to the three previous years, for which the time for
filing such return of income u/s 139(1) has expired, the rate of TDS will be as
under:

(a) 2% of cash withdrawal from all accounts with a bank or Post
Office in excess of Rs. 20 lakhs but not exceeding Rs. 1 crore in a financial
year.

(b) 5% of cash withdrawal from all accounts with a bank or Post
Office in excess of Rs. 1 crore in a financial year.

(ii) The Central
Government has been authorised to notify, in consultation with RBI, that in the
case of any account holder the above provisions may not apply or tax may be
deducted at a reduced rate if the account holder satisfies the conditions
specified in the Notification.

(iii) This section
does not apply to cash withdrawals by any Government, bank, co-operative bank, Post
Office, banking correspondent, white label ATM operators and such other persons
as may be notified by the Central Government in consultation with RBI if such
person satisfies the conditions specified in the Notification. Such
Notification may provide that the TDS rate may be at reduced rates or at Nil
rate.

(iv) This
provision is made in order to discourage cash withdrawals from banks and
promote digital economy. It may be noted that u/s 198 it is provided that the
tax deducted u/s 194N will not be treated as income of the assessee. If the
amount of this TDS is not treated as income of the assessee, credit for tax
deducted at source u/s 194N will not be available to the assessee u/s 199 read
with Rule 37BA. If such credit is not given, this will be an additional tax
burden on the assessee.

5.11 Section
194-O and 206AA: New section 194-O has been inserted effective from 1^st
April, 2020. Existing section 206AA has been amended from the same date.
Section 194-O provides that the TDS provisions will apply to E-commerce
operators. The effect of this provision is as under:

(i) The two terms
used in the section are defined to mean (a) ‘E-commerce operator’ is a person
who owns, operates or manages digital or electronic facility or platform for
electronic commerce, and (b) ‘E-commerce participant’ is a person resident in
India selling goods or providing services or both, including digital products,
through digital or electronic facility or platform for electronic commerce. For
this purpose the services will include fees for professional services and fees
for technical services.

(ii) An E-commerce
operator facilitating sale of goods or provision of services of an E-commerce
participant, through its digital electronic facility or platform, is now
required to deduct tax at source at the rate of 1% of the payment of gross
amount of sales or services or both to the E-commerce participant. Such TDS is
to be deducted from the amount paid by the purchaser of goods or recipient of
services directly to the E-commerce participant / E-commerce operator.

(iii) No tax is
required to be deducted if the payment is made to an E-commerce participant who
is an Individual or HUF if the payment during the financial year is less than
Rs. 5 lakhs and the E-commerce participant has furnished PAN or Aadhaar Card
Number.

(iv) Further, in
the case of an E-commerce operator who is required to deduct tax at source as
stated in (ii) above or in a case stated in (iii) above, there will be no
obligation to deduct tax under any provisions of Chapter XVII-B in respect of
the above transactions. However, this exemption will not apply to any amount
received by an E-commerce operator for hosting advertisements or providing any
other services which are not in connection with sale of goods or services.

(v) If the
E-commerce participant does not furnish PAN or Aadhaar Card Number, the rate
for TDS u/s 206AA will be 5% instead of 1%. This is provided in the amended
section 206AA.

(vi) It is also
provided that CBDT, with the approval of the Central Government, may issue
guidelines for the purpose of removing any difficulty that may arise in giving
effect to provisions of section 194-O.

5.12 Section 206C: This section dealing with collection of tax at
source (TCS) has been amended effective from 1^st October, 2020.
Hitherto, this provision for TCS applied in respect of specified businesses.
Under this provision a seller is required to collect tax from the buyer of
certain goods at the specified rates. The amendment of this section effective
from 1^st October, 2020 extends the net of TCS u/s 206C (1G) and (1H)
to other transactions as under:

(i) An authorised
dealer, who is authorised by RBI to deal in foreign exchange or foreign
security, receiving Rs. 7 lakhs or more from any person in a financial year for
remittance out of India under the Liberalised Remittance Scheme (LRS) of RBI,
is liable to collect TCS at 5% from the person remitting such amount. Thus, LRS
remittance up to Rs. 7 lakhs in a financial year will not be liable for this
TCS. If the remitter does not provide PAN or Aadhaar Card Number, the rate of
TCS will be 10% u/s 206CC.

(ii) In the above
case, if the remittance in excess of Rs. 7 lakhs is by a person who is
remitting the foreign exchange out of education loan obtained from a financial
institution, as defined in section 80E, the rate of TCS will be 0.5%. If the
remitter does not furnish PAN or Aadhaar Card Number, the rate of TCS will be
5% u/s 206CC.

(iii) The seller of an overseas tour programme
package, who receives any amount from a buyer of such package, is liable to
collect TCS at 5% from such buyer. It may be noted that the TCS provision will
apply in this case even if the amount is less than Rs. 7 lakhs. If the buyer
does not provide PAN or Aadhaar Card Number, the rate for TCS will be 10% u/s
206CC.

(iv) It may be
noted that the above provisions for TCS do not apply in the following cases:

(a) An amount in
respect of which the sum has been collected by the seller.

(b) If the buyer
is liable to deduct tax at source under the provisions of the Act. This will
mean that for remittance for professional fees, commission, fees for technical
services, etc. from which tax is to be deducted at source, this section will
not apply.

(c) If the
remitter is the Central Government, State Government, an Embassy, High
Commission, a Legation, a Commission, a Consulate, the Trade Representation of
a Foreign State, a Local Authority or any person in respect of whom the Central
Government has issued a Notification.

(v) Section
206C(1H) which comes into force on 1^st October, 2020 provides that a
seller of goods is liable to collect TCS at the rate of 0.1% on receipt of
consideration from the buyer of goods, other than goods covered by section
206C(1), (1F) or (1G). This TCS provision will apply only in respect of the
consideration in excess of Rs. 50 lakhs in the financial year. If the buyer
does not provide PAN or Aadhaar Card Number, the rate of TCS will be 1%. If the
buyer is liable to deduct tax at source from the seller on the goods purchased and
made such deduction, this provision for TCS will not apply.

(vi) It may be
noted that the above section 206C(1H) does not apply in the following cases:

(a) If the buyer
is the Central Government, State Government, an Embassy, a High Commission,
Legation, Commission, Consulate, the Trade Representation of a Foreign State, a
Local Authority, a person importing goods into India or any other person as the
Central Government may notify.

(b) If the seller
is a person whose sales, turnover or gross receipts from the business in the
preceding financial year does not exceed Rs. 10 crores.

(vii) The CBDT,
with the approval of the Central Government, may issue guidelines for removing
any difficulty that may arise in giving effect to the above provisions.

5.13 Obligation
to Deduct Tax at Source: Hitherto, the obligation to comply with the
provisions of sections 194A, 194C, 194H, 194-I, 194-J or 206C for TDS was on
Individuals or HUFs whose total sales or gross receipts or turnover from
business or profession exceeded the monetary limits specified in section 44AB
during the immediately preceding financial year. The above sections are now
amended, effective from 1^stApril, 2020, to provide that the above
TDS provisions will apply to an individual or HUF whose total sales or gross
receipts or turnover from business or profession exceeds Rs. 1 crore in the
case of business or Rs. 50 lakhs in the case of profession. Thus, every
Individual or HUF carrying on business will have to comply with the above TDS
provisions even if he is not liable to get his accounts audited u/s 44AB.

5.14 General:

(i) From the above
amendments it is evident that the net for TDS and TCS has now been widened and
even transactions which do not result in income are now covered under these
provisions. Individuals and HUFs carrying on business and not covered by Tax
Audit u/s 44AB will now be covered by the TDS and TCS provision. In particular,
persons remitting foreign exchange exceeding Rs. 7 lakhs under LRS of RBI will
have to pay tax u/s 206C. This tax will be considered as payment of tax by the
remitter u/s 206C(4) and he can claim credit for such tax u/s 206C(4) read with
Rule 37-1.

(ii) It may be
noted that the Government has issued a Press Note on 13^th May, 2020
giving certain relief during the Covid-19 pandemic. By this Press Note it is
announced that TDS / TCS under sections 193 to 194-O and 206C will be reduced
by 25% during the period 14^th May, 2020 to 31^st March,
2021. This reduction is given only in respect of TDS / TCS from payments or receipts
from residents. This concession is not in respect of TDS from salaries or TDS
from non-residents and TDS / TCS under sections 260AA or 206CC.

6. EXEMPTIONS AND DEDUCTIONS

6.1 Section 10(23FE): This is a new clause providing for
exemption of income from dividend, interest or long-term capital gain arising
from investment made in India by a specified person during the period 1^st
April, 2020 to 31^st March, 2024. The investment may be in the form
of a debt, share capital or unit. For this purpose the specified person means a
wholly-owned subsidiary of Abu Dhabi Investment Authority which complies with
the various conditions of the Explanation given in the section. For claiming
the above exemption the specified person has to hold the investment for at least
three years. Further, the investment should be in (a) a Business Trust, (b) an
Infrastructure Company as defined in section 80-IA, (c) such other company as
may be notified by the Central Government, or (d) a Category I or Category II
Alternative Investment Fund regulated by SEBI and having 100% investment in one
or more companies as referred to in (a), (b) or (c) above.

If exemption under
this section is granted in any year, the same shall be withdrawn in any
subsequent year when the specified person violates any of the conditions of the
section in a subsequent year. It is also provided in the section that if any
difficulty arises about interpretation or implementation of this section, CBDT,
with the approval of the Central Government, may issue guidelines for removing
the difficulty.

6.2 Section
10(48C): This a new clause inserted from 1^st April, 2020. It
provides for exemption in respect of any income of Indian Strategic Petroleum
Reserves Ltd., as a result of arrangement for replenishment of crude oil stored
in its storage facility in pursuance of directions of the Central Government.

6.3 Section
80EEA: This section was added by the Finance (No. 2) Act, 2019 to provide
for deduction of interest payable up to Rs. 1,50,000 on loan taken by an
Individual from a Financial Institution for acquiring a residential house. One
of the conditions in the section is that the loan should be sanctioned during
the period 1^st April, 2019 to 31^st March, 2020. This
period is now extended to 31^st March, 2021.

6.4 Section
80GGA: This section deals with certain donations for Scientific Research or
Rural Development. Till now, this deduction was allowed even if amounts up to
Rs. 10,000 were paid in cash. Now this section is amended, effective from 1^st
June, 2020 and the above limit of Rs. 10,000 is reduced to Rs. 2,000.

6.5 Section
80-IAC: This section deals with deduction in case of startup entities
engaged in specified businesses. The section is amended from A.Y. 2021-22 (F.Y.
2020-21). At present, the deduction under this section can be claimed for three
consecutive assessment years out of seven years from the year of incorporation.
By amendment of this section, the outer limit of seven years has been increased
to ten years.

In the Explanation
defining ‘Eligible Startup’, at present it is provided that the total turnover
of the business of the startup claiming deduction under this section should not
exceed Rs. 25 crores. This limit is now increased to Rs. 100 crores.

6.6 Section
80-IBA: This section deals with deduction in respect of income from
specified housing projects. At present, for claiming deduction under this
section one of the conditions is that the housing project should be approved by
the Competent Authority during the period from 1^st June, 2016 to 31^st
March, 2020. This period is now extended up to 31^st March, 2021.

6.7 Filing Tax
Audit Report: At present sections 80-IA, 80-IB and 80JJAA provide that for
claiming deduction under these sections the assessee has to file the Tax Audit
Report u/s 44AB along with the return of income. These sections are now
amended, effective from 1^st April, 2020 to provide that the Tax
Audit Report shall be filed one month before the due date for filing return of
income u/s 139(1). This will mean that in all such cases the Tax Audit Report
will have to be finalised one month before the due date for filing the return
of income u/s 139(1).

7. CHARITABLE TRUSTS

At present, a
University, Educational Institution, Hospital or other Medical Institution
claiming exemption u/s 10(23C) of the Income-tax Act is required to get
approval from the designated authority (Principal Commissioner or a
Commissioner of Income-tax). The procedure for this is provided in section
10(23C). The approval once granted is operative until cancelled by the
designated authority. For other Charitable Trusts the procedure for
registration is provided in section 12AA. Registration, once granted, continues
until it is cancelled by the designated authority. The Charitable Trusts and
other Institutions are entitled to get approval u/s 80G from the designated
authority. This approval is valid until cancelled by the Designated Authority.
On the strength of this certificate u/s 80G the donor to the Charitable Trust
or other Institutions can claim deduction in the computation of his income for
the whole or 50% of the donations as provided in section 80G. The Finance Act,
2020 has amended sections 10(23C), 11, 12A, 12AA and 80G and inserted section
12AB to completely change the procedure for registration of Trusts. These
provisions are discussed below.

7.1. New
procedure for registration:

(i) A new section
12AB is inserted effective from 1^st October, 2020 which specifies
the new procedure for registration of Charitable Trusts. Similarly, section
10(23C) is also amended and a similar procedure, as stated in section 12AB, has
been provided. All the existing Charitable Trusts and other Institutions
registered under sections 10(23C) and 12AA will have to apply for fresh
registration under the new provisions of section 10(23C)/12AB within three
months, i.e., on or before 31st December, 2020. The fresh registration will be
granted for a period of five years. Therefore, all Trusts / Institutions
claiming exemption under sections 10(23C)/11 will have to apply for renewal of
registration every five years.

(ii) Existing
Charitable Trusts, Educational Institutions, Hospitals, etc., will have to
apply for fresh registration u/s 12AB or 10(23C) within three months, i.e. ,on
or before 31^stDecember, 2020. The designated authority will grant
registration under section 12AB or 10(23C) for a period of five years. This
order shall be passed within three months from the end of the month in which
the application is made. Six months before the expiry of the above period of five
years, the Trusts / Institutions will have to again apply to the designated
authority for renewal of registration which will be granted for a period of
five years. This order has to be passed by the designated authority within six
months from the end of the month when the application for renewal is made.

(iii) For new
Charitable Trusts, Educational Institutions, Hospitals, etc., the following
procedure is to be followed:

(a) The
application for registration in the prescribed form should be made to the designated
authority at least one month prior to the commencement of the previous year
relevant to the assessment year for which the registration is sought.

(b) In such a
case, the designated authority will grant provisional registration for a period
of three assessment years. The order for provisional registration is to be
passed by the designated authority within one month from the last date of the
month in which the application for registration is made.

(c) Where such
provisional registration is granted for three years, the Trust / Institutions
will have to apply for renewal of registration at least six months prior to
expiry of the period of the provisional registration or within six months of
commencement of its activities, whichever is earlier. In this case, the
designated authority has to pass the order within six months from the end of
the month in which the application is made. In such a case, renewal of
registration will be granted for five years.

(iv) Section 11(7)
is amended to provide that the registration of the Trust u/s 12A/12AA will
become inoperative from the date on which the Trust is approved u/s
10(23C)/10(46), or on 1^st October, 2020, whichever is later. In such
a case the Trust can apply for registration u/s 12AB. For this purpose the application
for registration u/s 12AB will have to be made at least six months prior to the
commencement of the assessment year for which the registration is sought. The
designated authority will have to pass the order within six months from the end
of the month in which the application is made.

(v) Where a Trust
or Institution has made modifications in its objects and such modifications do
not conform with the conditions of registration, application should be made to
the designated authority within 30 days from the date of such modifications.

(vi) Where the
application for registration, renewal of registration is made as stated above,
the designated authority has power to call for such documents or information
from the Trust / Institutions or make such inquiry in order to satisfy itself
about (a) the genuineness of the Trust / Institutions, and (b) the compliance
with requirements of any other applicable law for achieving the objects of the
Trust or Institution. After satisfying himself, the designated authority will
grant registration for five years or reject the application for registration
after giving a hearing to the trustees. If the application is rejected, the
Trust or Institutions can file an appeal before the ITA Tribunal within 60
days. The designated authority also has power to cancel the registration of any
Trust or Institutions u/s 12AB on the same lines as provided in the existing
section 12AA. All applications for registration pending before the designated
authority as on 1^st October, 2020 will be considered as applications
made under the new provisions of section 10(23C)/12AB.

7.2. Corpus
donation:

(i) Hitherto, a
corpus donation given by an Educational Institution, Hospital, etc. claiming
exemption u/s 10(23C) to a similar institution claiming exemption under that
section, was not considered as application of income under that section. By
amendment of section 10(23C), effective from 1^st April, 2020, a
corpus donation given by such an Institution to a Charitable Trust registered
u/s 12AA also will not be considered as application of income u/s 10(23C).
Similarly, section 11 at present provides that a corpus donation given by a
Charitable Trust to another Charitable Trust registered u/s 12AA is not
application of income. This section is also amended, effective from 1^stApril,
2020, to provide that a corpus donation given by a Charitable Trust to a
Charitable Trust registered u/s 12AA and to Educational Institutions or a
Hospital registered u/s 10(23C) will not be considered as application of income.

(ii) Section 10(23C) is amended, effective from 1^st
April, 2020, to provide that any corpus donation received by an Educational
Institution or a Hospital claiming exemption under that section will not be
considered as its income. At present, this provision exists in section 12 and
Charitable Trusts claiming exemption u/s 11 are getting benefit of this
provision.

7.3. Section
80G(5)(vi):

A proviso
to section 80G(5)(vi) is added from 1^st October, 2020. At present, a
certificate granted u/s 80G is valid until it is cancelled. Now, this provision
is deleted and a new procedure is introduced. Briefly stated, this procedure is
as under:

(i) Where the
Trust / Institution holds a certificate u/s 80G it will have to make a fresh
application in the prescribed form for a new certificate under that section
within three months, i.e. on or before 31^st December, 2020. In such
a case the designated authority will give a fresh certificate which will be
valid for five years. The designated authority has to pass the order within
three months from the last date of the month in which the application is made.

(ii) For renewal
of the above certificate, an application will have to be made at least six
months before the date of expiry of the said certificate. The designated authority
has to pass the order within six months from the last date of the month in
which the application is made.

(iii) In a new
case, the application for certificate u/s 80G will be required to be filed at
least one month prior to the commencement of the previous year relevant to the
assessment year for which the approval is sought. In such a case, the
designated authority will give provisional approval for three years. The
designated authority has to pass the order within one month from the last date
of the month in which the application is made.

(iv) In a case
where provisional approval is given, application for renewal will have to be
made at least six months prior to the expiry of the period of provisional
approval, or within six months of the commencement of the activities by the
Trust / Institution, whichever is earlier. In this case the designated
authority has to pass the order within six months from the last date of the
month in which the application is made.

In cases of
renewal of approval as stated in (ii) and (iv) above, the designated authority
shall call for such documents or information or make such inquiries as he
thinks necessary in order to satisfy himself that the activities of the Trust /
Institution are genuine and that all conditions specified at the time of grant
of registration earlier have been complied with. After it is satisfied it shall
renew the certificate u/s 80G. If it is not so satisfied, it can reject the
application after giving a hearing to the Trustees. The Trust / Institution can
file an appeal to the ITAT within 60 days if the approval u/s 80G is rejected.

7.4. Sections
80G(5)(viii) and (ix): Clauses (viii) and (ix) are added in section 80G(5)
from 1^st October, 2020 to provide that every Trust / Institution
holding a section 80G certificate will be required to file with the prescribed
Income-tax Authority particulars of all donors in the prescribed form within
the prescribed time. The Trust / Institution has also to issue a certificate in
the prescribed form to the donor about the donations received by it. The donor
will get deduction u/s 80G only if the Trust / Institution has filed the
required statement with the Income-tax Authority and issued the above
certificate to the donor. In the event of failure to file the above statement
or issue the above certificate to the donor within the prescribed time, the
Trust / Institution will be liable to pay a fee of Rs. 200 per day for the
period of delay under the new section 234G. This fee shall not exceed the
amount in respect of which the failure has occurred. Further, a penalty of Rs.
10,000 (minimum) which may extend to Rs. 1 lakh (maximum) may also be levied
for the failure to file details of donors or issue certificate to donors under
the new section 271K.

It may be noted
that the above provisions for filing particulars of donors and issue of
certificate to donors will apply to donations for Scientific Research to an
association or company u/s 35(1)(ii)(iia) or (iii). These sections are also
amended. Provisions for levy of fee or penalty for failure to comply with these
provisions will also apply to the donee company or association which received
donations u/s 35. As stated earlier, the donor will not get deduction for
donations as provided in section 80GG if the donee company or association has
not filed the particulars of donors or not issued the certificate for donation.

Further, there is
no provision for filing appeal before the CIT(A) or ITATl against the levy of
fee u/s 234G.

7.5. Filing of
Audit Report: Sections 12A and 10(23C) are amended, effective from 1^st
April, 2020 to provide that the audit reports in Forms 10B and 10BB for A.Y.
2020-21 (F.Y. 2019-20) and subsequent years shall be filed with the tax
authorities one month before the due date for filing the return of income.

7.6 General:
The existing provisions relating to Charitable Trusts and Institutions are
complex. By the above amendments they are made more complex. The effect of
these amendments will be that there will be no ease of doing charities. In
particular, smaller Charitable Trusts will find it difficult to comply with
these procedural requirements. The compliance burden for them will increase. If
the Trusts are not able to comply with the requirement of filing details of
donors with the Tax Authorities or giving certificates to donors, they will
have to pay late filing fees as well as penalty. Again, the requirement of
getting fresh registration for all Trusts and Institutions and renewing the
same every five years under sections 10(23C), 12AB and 80G will be a
time-consuming process. Those dealing with Trust matters know how difficult it
is to get any such certificate or registration from the Income-tax Department.
In order to reduce the compliance burden, the requirements of filing details
about donors should have been confined to information relating to donations
exceeding Rs. 50,000 received from a donor during the year. Trustees of the
Charitable Trusts are rendering honorary service. To put such an onerous
responsibility on such persons is not at all justified. Under the new
provisions the donors will not get deduction for the donations made by them if
the trustees of the Trust do not file the prescribed particulars relating to
donors every year. Therefore, smaller Trusts will find it difficult to get
donations as donors will have apprehension that the donee trust may not file
the required details with the Income-tax Department in time.

8. RESIDENTIAL STATUS

The provisions
relating to residential status of an assessee are contained in section 6 of the
Income-tax Act. Significant changes are made by amendments in section 6 so far
as the residential status of an individual is concerned. In brief, these
amendments are as under:

(i) An individual
is resident in India in an accounting year if, (a) his stay in India is for 182
days or more in that year, or (b) his stay in India is for 365 days or more in
four years preceding that year and he is in India for a period of 60 days or
more in the accounting year.

(ii) At present,
in the case of a citizen of India or a Person of Indian Origin who is outside
India and comes on a visit to India in the accounting year, the threshold of 60
days stated in (i) above is relaxed to 182 days. By amendment of this provision
from A.Y. 2021-22 (F.Y. 2020-21), it is provided that in the case of a citizen
of India or a Person of Indian Origin who is outside India having total income
other than the specified foreign income, exceeding Rs. 15 lakhs during the
relevant accounting year, comes on a visit to India for 120 days or more in the
accounting year, will be considered as a resident in India.

(iii) It may be noted that the existing provision
applicable to a citizen of India who leaves India in any accounting year as a
member of the crew of an Indian ship or for the purpose of employment outside
India remains unchanged.

(iv) New sub-section (1A) is added in section 6 to
provide that if a citizen of India, having total income other than the
specified foreign income in the accounting year exceeding Rs. 15 lakhs, shall
be deemed to be a resident for 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
criterion of similar nature.

(v) Section 6(6) defines a person who is deemed to
be a ‘Resident but not Ordinary Resident’ (‘R but not OR’). By amendment of
this section, it is provided that the following persons shall also be
considered as ‘R but not OR’.

(a) A citizen of India, or a Person of Indian Origin, having total
income other than specified Foreign income exceeding Rs.15 lakhs during the
accounting year and who has been in India for a period of 120 days or more but
less than 182 days in that year.

(b) A citizen of India, who is deemed to be a resident in India, as
stated in (iv) above, will be considered as ‘R but not OR’.

(vi) For the above purpose the ‘specified foreign
income’ is defined to mean income which accrues or arises outside India, except
income derived from a business controlled in India or a profession set up in
India.

(vii) It may be
noted that under the Income-tax Act, an ‘R and OR’ is liable to pay tax on his
world income and a non-resident or an ‘R but not OR’ has to pay tax on income
accruing, arising or received in India. Therefore, individuals who are citizens
of India or Persons of Indian Origin will have to be careful about their stay
in India and abroad and determine their residential status on the basis of this
amended law.

9. SALARY INCOME

(i) At present, the contribution by an employer (a)
to the account of an employee in a recognised Provident Fund exceeding 12% of
the salary, (b) Contribution to superannuation fund in excess of Rs. 1,50,000,
and (c) contribution in National Pension Scheme is fully taxable in the hands
of an employee. However, deduction provided in section 80CCD(2) can be claimed
by the employee. There is no combined upper limit for the purpose of deduction
of amount of contribution made by the employer.

(ii) Section 17(2) has been amended, effective from
A.Y. 2021-22 (F.Y. 2020-21), to provide that the aggregate contribution made by
the employer to the account of the employee by way of PF, superannuation fund,
NPS exceeding Rs. 7,50,000 in an accounting year will be taxable as perquisite
in the hands of the employee. Further, any annual accretion by way of interest,
dividend or any other amount of similar nature during the year to the balance
at the credit of the fund or scheme, will be treated as perquisite to the
extent it relates to the employer’s taxable contribution. The amount of such
perquisite will be calculated in such manner as may be prescribed by the Rules.

10. BUSINESS INCOME

10.1 Section
35: Expenditure on scientific research

Section 35(1)
provides for weighted deduction for expenditure on Scientific Research by a
Research Association, University, College or other Institution or a Specified
Company (herein referred to as Research Bodies). The existing section provides
that these Research Bodies have to obtain approval of the prescribed authority.
Now this section is amended, effective from 1^st October, 2020, to
provide as under:

(i) The approval
granted to such Research Bodies on or before 1^st October, 2020 shall
stand withdrawn unless a fresh application for approval in the prescribed form
is made to the prescribed authority within three months, i.e., on or before 31^st
December, 2020. The notification issued by the prescribed authority shall be
valid for five consecutive assessment years beginning from A.Y. 2021-22.

(ii) It is also
stated that the Notification issued by the Central Government in respect of the
Research Bodies after 31^st December, 2020 shall, at any one time,
have effect for such assessment years not exceeding five assessment years as
may be specified in the Notification.

(iii) The
amendment in the section also provides that the above Research Bodies shall be
entitled to the deduction under the section only if the following conditions
are satisfied:

(a) They have to
prepare such statement about donations for such period as may be prescribed and
deliver these to the specified Income-tax Authority.

(b) They should
furnish to the donor a certificate specifying the amount of the donation in the
prescribed form.

(iv) It may be noted that if the statement in the
prescribed form is not filed in time or the certificate to the donor is not
given in time as stated above, the Research Body will be liable to pay a fine
of Rs. 200 per day of default u/s 234G. Further, penalty of Rs. 10,000
(minimum) which may extend to Rs. 1 lakh (maximum) may also be levied u/s 271K.

(v) The donor will not get deduction for the
donation if the above statement is not filed and the certificate in the
prescribed form is not issued by the Research Body.

10.2 Section
35AD: At present, section 35AD(1) provides for 100% deduction of Capital
Expenditure (other than expenditure on Land, Goodwill and Financial Assets)
incurred by any specified business. Further, section 35AD(4) provides that no
deduction is allowable under any other section in respect of which 100%
deduction is allowed u/s 35AD(1).

The section is now
amended, effective from A.Y. 2020-21 (F.Y. 2019-20), giving option to the
assessee either to claim deduction under the section or not do so. If such
option is exercised and the assessee has not claimed deduction u/s 35AD(1),
deductions u/s 32 can be claimed.

10.3 Section
43CA: This section provides that if the consideration for transfer of land
/ building, which is held as stock-in-trade, is less than 105% of the stamp
duty valuation, the stamp duty valuation (SDV) will be deemed to be the
consideration. This provision is now amended, effective from A.Y. 2021-22 (F.Y.
2020-21), to provide that if the consideration is less than 110% of the SDV,
then the SDV shall be deemed to be the consideration. Thus, further concession
of 5% is given in this transaction.

10.4 Section
72AA: At present, this section deals with carry-forward and set-off of
accumulated losses and unabsorbed depreciation on amalgamation of Banks. This
section is amended, effective from A.Y. 2020-21 (F.Y. 2019-20). By this
amendment, the benefit of carry-forward and set-off losses and unabsorbed
losses which was given on amalgamation of Banks has been extended to the
following entities.

(a) Amalgamation of one or more Banks with another
Bank under a scheme framed by the Central Government under the Banking
Companies (Acquisition and Transfer of Undertakings) Act, 1970 or the similar
Act of 1980.

(b) Amalgamation of one or more Government
companies with another Government company under a scheme sanctioned by the
Central Government under the General Insurance Business (Nationalisation) Act,
1972.

11. CAPITAL GAINS

11.1 Sections
49 and 2(42A): Section 49 provides for cost of acquisition for capital
assets which became the property of the assessee under specified circumstances.
Further, section 2(42A) provides for the period of holding of a capital asset
by an assessee for being considered as a short-term capital asset. These two
sections are amended, effective from A.Y. 2020-21 (F.Y. 2019-20). Briefly
stated, these amendments are as under:

(a) In the event
of downgrade in credit rating of debt and money market instruments in M.F.
schemes, SEBI has permitted the Asset Management Companies an option to
segregate the portfolio of such Schemes. In the event of such segregation, all
existing investors are allotted equal number of units in the segregated
portfolio held in the main portfolio. It is now provided that in determining
the period of holding of such segregated portfolio, the period for which the
original units in the main portfolio were held will be included.

(b) Further, the
cost of acquisition of such units in the segregated folio shall be the cost of
acquisition of the units held by the assessee in the total portfolio in
proportion to the NAV of the asset transferred to the segregated portfolio out
of the NAV of the total portfolio before the date of segregation. The cost of
acquisition of the original units in the main portfolio will be suitably
reduced by the amount derived as cost of units in the segregated portfolio.
These provisions are similar to those applicable for allocation of cost of
shares on demerger of a company.

11.2 Sections
50C and 56(2)(X): Section 50C provides that if the consideration for
transfer of a capital asset (land or building or both) is less than 105% of the
Stamp Duty Valuation (SDV), the SDV will be deemed to be the consideration.
This provision is now amended, effective from A.Y. 2021-22 (F.Y. 2020-21) to
provide that if the consideration is less than 110% of the SDV, the SDV will be
deemed to be the consideration. Thus, further concession of 5% is given for
such transactions.

On the same basis,
section 56(2)(X) is also amended. Under this section if land / building is
received by an assessee from a non-relative for a consideration which is less
than 105% of the SDV, the difference between the SDV and consideration is
treated as income from other sources. This section is also amended on the same
line as section 50C and further concession of 5% is given for such a
transaction.

11.3 Section
55: At present, this section provides that if the capital asset became the
property of the assessee before 1^st April, 2001, the assessee has
the option to adopt the fair market value of the asset transferred as on 1^st
April, 2001 for its cost of acquisition. This section is now amended, effective
from A.Y. 2021-22 (F.Y. 2020-21), to provide that if the capital asset is land
/ building, the fair market value on 1^st April, 2001 which the
assessee wants to adopt, shall not be more than the SDV on 1^st
April, 2001.

12. FILING OF RETURN OF INCOME

12.1 Section
139(1): At present, a person (including a company) who is required to get
his accounts audited is required to file his return of income on or before 30^th
September every year. By amendment of this section from A.Y. 2020-21 (F.Y.
2019-20), such a person will have to file his return of income on or before 31^st
October of the year. Further, at present a working partner of a firm or LLP
which is required to get its accounts audited is covered by this provision.
Now, any partner, including a working partner of a firm or LLP which is
required to get its accounts audited can file his return of income on or before
31^st October of that year. It may be noted that for A.Y. 2020-21,
the due date for filing return of income is extended up to 30^th
November, 2020 under CBDT Notification No. 35/2020 dated 24^th June,
2020.

12.2 Ordinance
dated 31^st March, 2020: By Taxation and Other Laws (Relaxation
of certain Provisions) Ordinance dated 31^st March, 2020 and CBDT
order u/s 119 dated 31^st March, 2020 and CBDT Notification dated 24^th
June, 2020 extends the time limit for filing return of income for A.Y. 2019-20
(F.Y. 2018-19) u/s 139(4) and revised return u/s 139(5), has been extended up
to 30^th September, 2020. This concession is due to Covid-19 and
consequential lockdown from 25^th March, 2020 onwards in the country.

12.3 Section
140: Under this section, at present the return of income has to be signed
in the case of a company by a Managing Director or Director and in the case of
an LLP by a Designated Partner or Partner. By amendment of this section from
A.Y. 2020-21 (F.Y. 2019-20), it is provided that in such cases the return of
income can be signed by such person as may be prescribed by the Rules.

13. TAX AUDIT REPORTS

13.1 Section 44AB: By amendment of this section, effective from
A.Y. 2020-21 (F.Y. 2019-20), it is provided that in the case of a person
carrying on business if the aggregate of all amounts received including for
sales, turnover or gross receipts and the aggregate amount of all payments
(including expenditure incurred) in cash during the accounting year does not
exceed 5% of the sales, turnover or gross receipts and 5% of the total
payments, Tax Audit u/s 44AB will be required only if the sales, turnover or
gross receipts exceed Rs. 5 crores in that accounting year. It may be noted
that this provision will apply to a company, firm, LLP, individual, AOP, HUF,
etc.

In other cases,
the existing turnover limit of Rs. 1 crore will apply. The above concession is
not applicable in the case of a person carrying on profession where the limit
with reference to gross receipts is Rs. 50 lakhs.

13.2 From the
wording of the amendment in section 44AB it appears that the limit of 5% of
cash receipts and payments applies with reference to all receipts from sales,
turnover or gross receipts, receipts from debtors, receipts from capital
account transactions, receipts of interest on loans and deposits, etc., and to
all payments for expenses for business or other purposes, payments to
creditors, payments of taxes, repayment of loans, payments for capital account
transactions, payments relating to transactions other than business, etc. In
other words, the above concession is not applicable if 5% or more of total
receipts as well as 5% or more of total payments are in cash.

13.3 At present,
the Tax Audit Report u/s 44AB is required to be filed along with the return of
income. This provision is now amended from the A.Y. 2020-21 (F.Y. 2019-20) to
provide that the Tax Audit Report should be filed with the tax authorities one
month before the due date for filing the return of income. Therefore, if the
due date for filing the return of income is 31^st October, then the
Tax Audit Report should be filed on or before 30^th September of that
year. In the case where Transfer Pricing Audit Report is to be obtained, the
due date for filing the return of income remains 30^th November. In
such cases, the Audit Report u/s 92F will have to be filed on or before 31^st
October.

13.4 It may be
noted that there are other sections under the Income-tax Act which require
different types of audit reports in the prescribed forms to be filed with the
return of income. These sections relate to charitable trusts, transfer pricing,
book profits, etc. Therefore, sections 10(23C), 10A, 12A, 32AB, 33AB, 33ABA,
35D, 35E, 44DA, 50B, 80-IA, 80-IB, 80JJAA, 92F, 115JB, 115JC and 155VW are
suitably amended from A.Y. 2020-21 (F.Y. 2019-20). In all these cases, the Tax
Audit Report will be required to be filed one month before the due date for
filing the Income-tax return of income.

13.5 In the
Memorandum explaining the provisions of the Finance Bill, 2020, it is stated
that to enable pre-filing of returns in case of the assessee having income from
business or profession, it is required that the Tax Audit Report may be
furnished by the said assessee at least one month prior to the date of filing
of the return of income. All the above sections are amended for this purpose
from A.Y. 2020-21.

14. APPEALS

14.1 Section
250: At present, an appeal before the CIT(A) is to be filed through
electronic mode. Thereafter, the assessee or his counsel has to attend before
the CIT(A) and argue the matter. In order to reduce human interface from the
system, section 250 has been amended from 1^st April, 2020 to provide
for a new E-appeal Scheme on lines similar to the E-assessment Scheme. This amendment
is as under:

(i) The Central
Government is given power to notify an E-appeal Scheme for disposal of appeal
so as to impart greater efficiency, transparency and accountability.

(ii) Interface
between CIT(A) and the appellant in the course of appellate proceedings will be
eliminated to the extent technologically feasible.

(iii) Utilisation
of resources through economies of scale and functional specialisation will be
optimised.

(iv) An appellate system with dynamic jurisdiction
in which an appeal shall be disposed of by one or more CIT(A)s will be
introduced.

Further, the
Central Government may direct for exception, modification and adaptation as may
be specified in the Notification. The above directions are to be issued before
31^st March, 2022.

14.2 Section
254: Under this section, the ITAT has been given power to grant stay of
disputed demand on an application filed by the assessee. At present, the
Tribunal is not required to impose any condition for deposit of any amount out
of the disputed demand while granting such stay.

This section is
amended from 1^st April, 2020 to provide that the ITAT can pass a
stay order subject to the condition that the assessee shall deposit at least
20% of the disputed tax, interest, fee, penalty, etc., or furnish security of
equal amount of such disputed tax.

Further, ITAT can
grant extension of stay only if the assessee has complied with the condition of
depositing the amount of disputed tax or furnishing of security for the amount
as stated above. The ITAT has to decide the appeal, where stay of demand is
granted, within 365 days of granting of the stay. Thus, the stay of demand
granted by the Tribunal cannot exceed 365 days.

15. PENALTIES

15.1 Section
271AAD: This is a new section inserted in the Act which will have
far-reaching implications. This section will take effect from 1^st
April, 2020. It provides that if, during any proceedings under the Act, either
a false entry or an omission of an entry, which is relevant for computation of
total income of such person is found in the books of accounts maintained by any
person with a view to evade tax liability, the A.O. can levy penalty of 100% of
the aggregate amount of such entry or omission of entry. Since this is a penal
provision, it is possible to take the view that this provision will apply to
any false entry or omission of entry found in the books for the accounting year
2020-21 and onwards.

The term ’false
entry’ for this purpose is defined in the Explanation to the section. It
includes use or intention to use:

(i) Forged or falsified documents such as false
invoice or, in general, a false piece of documentary evidence, or

(ii) Invoice in respect of supply or receipt of goods
or services or both issued by the person or any other person without actual
supply or receipt of such goods or services or both, or

(iii) Invoice in respect of supply or receipt of
goods or services or both to or from a person who does not exist.

15.2 Section
271K: This is a new section which comes into force on 1^st June,
2020. Under this section the A.O. is given power to levy penalty of Rs. 10,000
(minimum) which may extend to Rs. 1 lakh (maximum) for non-compliance of
requirements to (i) file required statements in time, or (ii) furnish
certificate to the donors as required under sections 35(1)(ii)(iia), or (iii),
35(1A)(ii), 80G(5)(viii) or (ix).

15.3 Section
274: This section has been amended from 1^st April, 2020 to
provide for a scheme for conducting penalty proceedings on lines similar to the
E-assessment Scheme. By this amendment, the Central Government is authorised to
notify a scheme for the purpose of imposing penalty so as to impart greater
efficiency, transparency and accountability. This scheme will provide for:

(i) Elimination of
interface between the A.O. and the assessee in the course of proceedings to the
extent technologically feasible,

(ii) Optimisation
of utilisation of resources through economies of scale and functional
specialisation,

(iii) Introduction
of mechanism of imposing penalty with dynamic jurisdiction in which penalty
shall be imposed by one or more Income-tax authorities.

Further, the
Central Government is also empowered to issue Notification directing that any
of the provisions of the Act relating to jurisdiction and procedure for
imposing penalty shall not apply or shall apply with such exceptions,
modifications or adaptations as may be specified in the Notification. Such
Notification can be issued on or before 31^st March, 2022.

16. OTHER AMENDMENTS

16.1 Section
115UA: This section deals with taxation of income of unit holders of
Business Trust. Section 115UA(3) is amended from A.Y. 2021-22 (F.Y. 2020-21) to
provide that the distributed income in the nature of interest, dividends and
rent shall be deemed to be income of the unit holder and shall be charged to
tax. Consequential amendments are made in section 194LBA to provide for
deduction of tax at source on such distributed income.

16.2 Section
133A: At present, the power to survey u/s 133A(1) can be exercised with the
approval of Joint Commissioner or Joint Director. This section is amended from
1^st April, 2020 and it is provided as under:

(i) Where the
information is received from the authority to be prescribed by the Rules, the
survey shall not be undertaken by Assistant Director, Deputy Director,
Assessing Officer, T.R.O. or an Inspector without obtaining approval of the
Joint Commissioner or Joint Director.

(ii) In any other
case, no survey can be conducted by the Joint Director, Joint Commissioner,
Assistant Director, Deputy Director, Assessing Officer, T.R.O. or Inspector
without the approval of the Director or Commissioner of Income-tax.

16.3 Section
143: Sections 143(3A) and (3B) deal with the E-Assessment Scheme for
assessment u/s 143(3). By amendment of this section from 1^st April,
2020 it is now provided that the E-Assessment Scheme shall also apply to ex
parte assessment u/s 144. Further, the time limit for issue of any
notification giving direction that any of the provisions of the Income-tax Act
relating to assessment of total income or loss shall not apply or shall apply
with such exceptions, modifications or adaptations as may be specified, has
been extended from 31^st March, 2020 to 31^st March, 2022.

16.4 Section
144C: This section deals with the Dispute Resolution Panel (DRP). At
present, the provision for sending draft assessment order by the A.O. to the
assessee applied only if the A.O. proposed variation in the income or loss
returned by the assessee. By amendment of this provision from 1^st
April, 2020 it is now provided that the A.O. will have to send the draft
assessment order to the assessee even if the A.O. proposes to make any
variation which is prejudicial to the interest of the assessee. Further, at
present the provisions of this section apply in the case of (i) an assessee in
whose case transfer pricing adjustments are proposed by an order passed by
T.P.O. and (ii) a foreign company. With effect from 1^st April, 2020,
this section will also apply in cases of all non-residents.

16.5 Section
234G: This is a new section inserted in the Income-tax Act from 1^st
June, 2020. It provides for levy of a fee for failure under sections (a)
35(1)(ii), (iia) or (iii), (b) 35(1A)(ii), (c) 80G(5)(viii), and (d) 80G(5)(ix)
to file statements or issue certificates to donors under these sections. This
fee is Rs. 200 per day during which the failure continues. However, such fine
shall not exceed the amount in respect of which the above failure has occurred.
This fee is payable before filing the statement or issuing the certificate
required under the above sections after the due date. As stated earlier, these
statements relate to particulars of donors to be filed with the tax authorities
and the certificates to be issued to donors. It may be noted that no appeal is
provided against the levy of this fee if the delay in filing statements or
issue of certificates is for reasonable cause.

16.6 Sections
203AA and 285BB: Section 203AA required the Income-tax authority to prepare
and deliver to the assessee a statement in Form 26AS giving details of TDS, TCS
and taxes paid. This section is deleted from 1^st June, 2020 and a
new section 285BB is inserted in the Act from the said date. This new section
provides that the prescribed Income-tax authority shall upload in the
registered account of the assessee an Annual Information Statement in the
prescribed form and within the prescribed time. This statement will include
information about taxes paid, TDS, TCS, sale / purchase transactions of
immovable properties, share transactions, etc., which are reported to the tax
authorities under various provisions.

16.7 Section
288: This section gives a list of persons who can appear before the
Income-tax authorities and Appellate Authorities as authorised representatives.
This section is amended from 1^st April, 2020 to authorise CBDT to
prescribe, by Rules, any other person who can appear as an authorised
representative.

17. TAXPAYER’S CHARTER

At present there is no provision under the Income-tax Act providing for
declaration of a Taxpayer’s Charter. A new section 119A has been inserted in
the Act from 1^st April, 2020 which provides that CBDT shall adopt
and declare a Taxpayer’s Charter and issue such orders, instructions, directions
and guidelines to the Income-tax Authorities for administration of such
Charter. This Charter may explain the Rights and Duties of taxpayers. Let us
hope that the Income-tax Authorities respect the rights of taxpayers in the
true spirit in which the Charter is to be issued by CBDT.

18. ‘VIVAD SE VISHWAS’ SCHEME

Parliament passed
‘The Direct Tax Vivad Se Vishwas Act, 2020’ in March, 2020. Certain
amendments are made in the Act by ‘The Taxation and Other Laws (Relaxation of
Certain Provisions) Ordinance, 2020’ promulgated by the President on 31^st
March, 2020. This Scheme has been introduced with a view to reduce litigation
in Direct Tax cases pending before various appellate authorities. The assessees
can avail the benefit of this Scheme by paying the disputed tax and getting
waiver of penalty, interest and late filing fee.

19. TO SUM UP

(i) From the above
analysis of the provisions of the Finance Act, 2020, the existing complex
Income-tax Act has been made more complex. Many provisions are added in the Act
which have increased the compliance burden of the taxpayers. The assessees and
their tax advisers will have to be more vigilant to ensure compliance with
these provisions and to meet the time limits provided for their compliance.

(ii) In last year’s
Budget, rates of Income-tax for certain domestic companies were reduced on the
condition that they forgo certain deductions and tax incentives. The scope of
deductions to be forgone has been widened and such companies will not be able
to claim deductions under all sections of chapter VIA, excluding sections
80JJAA and 80M. Similar benefit is now given to Individuals, HUFs and
Co-operative Societies who will pay lower tax if they opt to forgo various
deductions and tax incentives. Considering the list of deductions and
incentives to be forgone, it is possible that very few assessees will exercise
the option for lower rate of tax.

(iii) Dividend
Distribution Tax, hitherto levied on companies for over two decades, has now
been removed. Now, dividend on shares and income distribution on units of
Mutual Funds will be taxed in the hands of the share / unit holders. This is
one of the major steps taken in this Budget. This change will bring many
persons within the tax net as the exemption enjoyed by them so far has been
withdrawn.

(iv) By several
amendments made in the provisions relating to exemption granted to Charitable
Trusts, Educational Institutions and Hospitals, the compliance burden of such
institutions will increase. These amendments made in the Income-tax Act are
unfair.
When the Government is propagating for ease of doing business and ease of
living, it has made the life of Trustees of such Trusts more difficult. With
these new provisions, there will no ease of doing charities. In particular,
these provisions will make the life of Trustees of small trusts difficult. The
provisions for renewing registration of trusts every five years, renewing
section 80G
certificates every five years, filing particulars of donors every year and
issuing certificates to donors are time-consuming. Further, any delay in
compliance with these provisions will invite late filing fees and penalty. If
the Government wanted to keep track of the activities of such trusts, these
provisions could have been made applicable to Trusts having net worth exceeding
Rs. 5 crores or those who receive donations of more than Rs. 1 crore every
year.

(v) Several
amendments are made in the provisions relating to Tax Deduction and Tax
Collection at Source. Now, tax is required to be collected from persons
remitting foreign exchange under the LRS Scheme. The scope of the provisions
for TDS / TCS is now widened and, in some cases, tax will be collected at
source even on items which do not constitute income of the deductee.

(vi) Amendments
relating to residential status will bring some of the persons who could avoid
tax by planning their visits to India every year under the tax net. Now, many
persons will find it difficult to avoid tax liability in India.

(vii) The new
section 271AAD providing for 100% penalty for an alleged false entry or
omission of any entry is a harsh provision. This will raise many issues of
interpretation. This will create hardship to the assessees where arbitrary
addition is made by the tax authorities and penalties are levied under this
section. An incidental question arises whether this provision is retrospective
or applies to accounting entries relating to transactions entered into on or
after 1^st April, 2020.

(viii) One welcome feature of this year’s Budget is statutory
recognition of a ‘Taxpayer’s Charter”. CBDT has to prescribe the Rules for this
Charter which will declare the rights and duties of a taxpayer. Let us hope
that CBDT provides a comprehensive document when this Chapter is announced and
that the Income-tax Authorities respect the rights of taxpayers in the letter
and spirit of this document.

(ix) Another
welcome feature of this year’s Budget is the enactment of the Direct Tax Vivad
Se Vishwas Act. The objective of this Act is to reduce Direct Tax
litigation pending before the Appellate Authorities. Considering the liberal
provisions of this Act, it is possible that many assessees will avail the
benefit of this scheme for settlement of many pending tax disputes.

(x) This year’s
Finance Bill was introduced in both the Houses of Parliament on 1^st
February, 2020. The various provisions of the Bill were not discussed in Parliament.
More than 125 amendments to the original Bill were moved by the Finance
Minister on 23^rd March, 2020 and the Bill with the amendments was
passed by both Houses of the Parliament without any
discussion due to Covid-2019 which affected India and the entire world. Some of
the harsh provisions in the Finance Act, 2020, as pointed out above, have not
undergone legislative scrutiny. It is possible that these harsh provisions are
removed or suitably modified in the days to come.

(Like many
committed authors of the BCA Journal, Shri P.N. Shah has been authoring
an article on the Finance Act for as long as I can remember. This year due to
Covid-19 and non-availability of staff, we have received it much later than we
would have liked. The article summarises key direct tax provisions [except
co-operative societies, rate reduction of specified companies, taxation of
non-residents and provisions relating to DTAA and transfer pricing which we
couldn’t carry due to space constraints] and serves as a summary analysis of
the key changes – Editor)

shailesh.kwebmaker

Glimpses Of Supreme Court Ruilings

14. Yum! Restaurants (Marketing) Private Limited vs.
Commissioner of Income Tax, Delhi

Date of order: 24^th April, 2020

Doctrine of mutuality – Applicability of – The
receipt of money from an outside entity without affording it the right to have
a share in the surplus does not only subjugate the first test of common
identity, but also contravenes the other two conditions for the existence of
mutuality, i.e., impossibility of profits and obedience to the mandate – There
is a fine line of distinction between absence of obligation and presence of
overriding discretion – An arrangement wherein one member is subjected to the
absolute discretion of another, in such a manner that the entire liability may
fall upon one whereas benefits are reaped by all, is antithetical to the mutual
character in the eyes of law – The raison d’être behind the refund of
surplus to the contributors or mandatory utilisation of the same in the
subsequent assessment year is to reduce their burden of contribution in the
next year proportionate to the surplus remaining from the previous year –
Non-fulfilment of this condition is antithetical to the test of mutuality

The
appellant company Yum! Restaurants (Marketing) Private Limited (‘YRMPL’ or
‘assessee company’ or ‘assessee’) was incorporated by Yum! Restaurants (India)
Pvt. Ltd. (‘YRIPL’), formerly known as Tricon Restaurants India Pvt. Ltd., as
its fully-owned subsidiary for undertaking the activities relating to
advertising, marketing and promotion (‘AMP activities’) for and on behalf of
YRIPL and its franchisees after having obtained approval from the Secretariat
for Industrial Assistance (‘SIA’) for the purpose of economisation of the cost
of advertising and promotion of the franchisees as per their needs. The
approval was granted subject to certain conditions as regards the functioning
of the assessee whereby it was obligated to operate on a non-profit basis on
the principles of mutuality.

In
furtherance of the approval, the assessee entered into a tripartite operating
agreement (the ‘tripartite agreement’) with YRIPL and its franchisees, wherein
the assessee company received fixed contributions to the extent of 5% of gross
sales for the proper conduct of the AMP activities for the mutual benefit of
the parent company and the franchisees.

For the
assessment year 2001-02, the assessee filed its return stating the income to be
Nil under the pretext of the mutual character of the company. The same was not accepted by the A.O.
who observed that the assessee company along with the franchisees was to
contribute a fixed percentage of its revenue to YRMPL. However, as per the
tripartite agreement submitted by YRMPL, YRIPL had the sole absolute discretion
to pay to YRMPL any amount as it may deem appropriate and that YRIPL had no
obligation to pay any amount if it chooses not to do so. YRIPL was under no
legal obligation to pay any amount of contribution as per its own version
reflected from the tripartite agreement. The A.O. determined the total income
at Rs. 44,44,002, being the excess of income over expenditure for A.Y. 2001-02.

The
imposition of liability by the A.O. was upheld by the CIT(A) on the ground of taint
of commerciality in the activities undertaken by the assessee company.

The
liability was further confirmed by the Tribunal, wherein the essential
ingredients of the doctrine of mutuality were found to be missing. The Tribunal
inter alia found that apart from others, contributions were also
received from M/s Pepsi Foods Ltd. and YRIPL. Pepsi Foods Ltd. was neither a
franchisee nor a beneficiary. Similarly, some contribution was also received
from YRIPL who was not under any obligation to pay. Thus, the essential
requirement, that the contributors to the common fund are either to participate
in the surplus or they are beneficiaries of the contribution, was missing.
Through the common AMP activities no benefit accrued to Pepsi Foods Ltd. or
YRIPL. Accordingly, the principles of mutuality could not be applied.

The
consistent line of opinion recorded by the aforementioned three forums was
further approved in appeal by the High Court.

According
to the Supreme Court, the following questions of law arose in the present case:

(i)
Whether the assessee company would qualify as a mutual concern in the eyes of
law, thereby exempting subject transactions from tax liability?

(ii)
Whether the excess of income over expenditure in the hands of the assessee
company is not taxable?

The
assessee had contended before the Supreme Court that the sole objective of the
assessee company was to carry on the earmarked activities on a no-profit basis
and to operate strictly for the benefit of the contributors to the mutual
concern. It was further contended that the assessee company levied no charge on
the franchisees for carrying out the operations. While assailing the
observations made in the impugned judgment, holding that Pepsi Foods Ltd. and
YRIPL were not beneficiaries of the concern, the assessee company had urged
that YRIPL was the parent company of the assessee and earned a fixed percentage
from the franchisees by way of royalty. Therefore, it benefited directly from
enhanced sales as increased sales would translate into increased royalties. A
similar argument had been advanced as regards Pepsi Foods Ltd. It was stated
that under a marketing agreement the franchisees were bound to serve Pepsi
drinks at their outlets and, thus, an increase in the sales at KFC and Pizza
Hut outlets as a result of AMP activities would lead to a corresponding
increase in the sales of Pepsi. It was pointed out that Pepsi was also
advertised by the franchisees in their advertising and promotional material,
along with Pizza Hut and KFC.

As
regards the doctrine of mutuality, it was urged by the assessee company that
the doctrine merely requires an identity between the contributors and
beneficiaries and it does not contemplate that each member should contribute to
the common fund or that the benefits must be derived by the beneficiaries in
the same manner or to the same extent. Reliance had been placed by the
appellant upon reported decisions to draw a parallel between the functioning of
the assessee company and clubs to support the presence of mutuality.

The
Revenue / respondent had countered the submissions made by the assessee company
by submitting that the moment a non-member joins the common pool of funds created
for the benefit of the contributors, the taint of commerciality begins and
mutuality ceases to exist in the eyes of law. It had been submitted that the
assessee company operated in contravention of the SIA approval as contributions
were received from Pepsi, despite it not being a member of the brand fund. It
was urged that once the basic purpose of benefiting the actual contributors was
lost, mutuality stands wiped out.

The
Supreme Court held that it was undisputed that Pepsi Foods Ltd. was a contributor
to the common pool of funds. However, it did not enjoy any right of
participation in the surplus or any right to receive back the surplus which was
a mandatory ingredient to sustain the principle of mutuality.

The
assessee company was realising money both from the members as well as
non-members in the course of the same activity carried on by it. The Supreme
Court noted that in Royal Western India Turf Club Ltd., AIR 1954 SC 85
it has categorically held such operations to be antithetical to mutuality.
Besides, the dictum in Bankipur Club (1997) 5 SCC 394 was apposite.

According
to the Supreme Court, the contention of the assessee company that Pepsi Foods
Ltd., in fact, did benefit from the mutual operations by virtue of its
exclusive contracts with the franchisees was tenuous, as the very basis of
mutuality was missing. Even if any remote or indirect benefit is being reaped
by Pepsi Foods Ltd., the same could not be said to be in lieu of
it being a member of the purported mutual concern and, therefore, could not be
used to fill the missing links in the chain of mutuality. The surplus of a
mutual operation was meant to be utilised by the members of the mutual concern
as members enjoy a proximate connection with the mutual operation. Non-members,
including Pepsi Foods Ltd., stood on a different footing and had no proximate
connection with the affairs of the mutual concern. The exclusive contract
between the franchisees and Pepsi Foods Ltd. stood on an independent footing
and YRIPL as well as the assessee company were not responsible for
implementation of the contract. As a result, the first limb of the
three-pronged test stood severed.

The
Supreme Court held that the receipt of money from an outside entity without
affording it the right to have a share in the surplus did not only subjugate
the first test of common identity, but also contravened the other two
conditions for the existence of mutuality, i.e., impossibility of profits and
obedience to the mandate. The mandate of the assessee company was laid down in
the SIA approval wherein the twin conditions of mutuality and non-profiteering
were envisioned as the sine qua non for the functioning of the assessee
company. The contributions made by Pepsi Foods Ltd. tainted the operations of
the assessee company with commerciality and concomitantly contravened the
prerequisites of mutuality and non-profiteering.

The
Court further held that YRIPL and the franchisees stand on two substantially
different footings. For, the franchisees are obligated to contribute a fixed
percentage for the conduct of AMP activities, whereas YRIPL is under no such
obligation in utter violation of the terms of the SIA approval. Moreover, even
upon request for the grant of funds by the assessee company, YRIPL is not bound
to accede to the request and enjoys a ‘sole and absolute’ discretion to decide
against such request. An arrangement wherein one member is subjected to the
absolute discretion of another, in such a manner that the entire liability may
fall upon one whereas benefits are reaped by all, is the antithesis to the
mutual character in the eyes of law.

According
to the Supreme Court, the contention advanced by the appellant that it is not
mandatory for every member of the mutual concern to contribute to the common
pool failed to advance the case of the appellant. The Court held that there is
a fine line of distinction between absence of obligation and presence of
overriding discretion. In the present case, YRIPL enjoyed the latter to the
detriment of the franchisees of the purported undertaking, both in matters of
contribution and of management. In a mutual concern, it is no doubt true that
an obligation to pay may or may not be there, but in the same breath it is
equally true that an overriding discretion of one member over others cannot be
sustained in order to preserve the real essence of mutuality wherein members
contribute for the mutual benefit of all and not of one at the cost of others.

The
Court observed that the settled legal position is that in order to qualify as a
mutual concern, the contributors to the common fund either acquire a right to
participate in the surplus or an entitlement to get back the remaining
proportion of their respective contributions. Contrary to the above stated
legal position, as per clause 8.4 the franchisees did not enjoy any
‘entitlement’ or ‘right’ on the surplus remaining after the operations were
carried out for a given assessment year. As per the aforesaid clause the
assessee company may refund the surplus subject to the approval of its Board of
Directors. It implied that the franchisees / contributors could not claim a
refund of their remaining amount as a matter of right. According to the Supreme
Court, the raison d’être behind the refund of surplus to the
contributors or mandatory utilisation of the same in the subsequent assessment
year is to reduce their burden of contribution in the next year proportionate
to the surplus remaining from the previous year. Thus, the fulfilment of this
condition is essential. In the present case, even if any surplus is remaining
in a given assessment year, it would not reduce the liability of the
franchisees in the following year as their liability to the extent of 5% was
fixed and non-negotiable, irrespective of whether any funds were surplus in the
previous year. The only entity that could derive any benefit from the surplus
funds was YRIPL, i.e., the parent company. This was antithetical to the test of
mutuality.

It was
observed that the dispensation predicated in the tripartite agreement may
result in a situation where YRIPL would not contribute even a single paisa to
the common pool and yet be able to derive profits in the form of royalties out
of the purported mutual operations, created from the fixed 5% contribution made
by the franchisees. This would be nothing short of derivation of gains /
profits out of inputs supplied by others. According to the Supreme Court, the
doctrine of mutuality, in principle, entails that there should not be any
profit-earning motive, either directly or indirectly. One of the tests of
mutuality requires that the purported mutual operations must be marked by an
impossibility of profits and this crucial test was also not fulfilled in the
present case.

The
Supreme Court further observed that the exemption granted to a mutual concern
is premised on the assumption that the concern is being run for the mutual
benefit of the contributors and the contributions made by the members ought to
be directed accordingly. Contrary to this fundamental tenet, the tripartite
agreement relieves the assessee company from any specific obligation of
spending the amounts received by way of contributions for the benefit of the contributors.
It explicates that the assessee company does not hold such amount under any
implied trust for the franchisees.

According
to the Supreme Court, the assessee company had acted in contravention of the
terms of approval.

The
appellant had urged before the Supreme Court that no fixed percentage of
contribution could be imputed upon YRIPL as it did not operate any restaurant
directly and, thus, the actual volume of sales could not be determined.
According to the Court this argument was not tenable as YRIPL received a fixed
percentage of royalty from the franchisees on the sales. If the franchisees
could be obligated with a fixed percentage of contribution, 5% in the present
case, there was no reason as to why the same obligation ought not to apply to
YRIPL.

The
Court further noted that the text of the tripartite agreement pointed towards
the true intent of the formation of the assessee company as a step-down subsidiary.
It was established to manage the retail restaurant business, the advertising,
media and promotion at the regional and national level of KFC, Pizza Hut and
other brands currently owned or to be acquired in future. In its true form, it
was not contemplated as a non-business concern because operations integral to
the functioning of a business were entrusted to it.

The
Supreme Court held that the doctrine of mutuality bestows a special status to
qualify for exemption from tax liability. The appellant having failed to fulfil
the stipulations and to prove the existence of mutuality, the question of
extending exemption from tax liability to the appellant, that, too at the cost
of the public exchequer, did not arise.

The
assessee company had relied upon reported decisions before the Supreme Court to
establish a parallel between the operations carried out by it and clubs.
According to the Supreme Court, all the members of the club not only have a
common identity in the concern but also stand on an equal footing in terms of
their rights and liabilities towards the club or the mutual undertaking. Such
clubs are a means of social intercourse and are not formed for the facilitation
of any commercial activity. On the contrary, the purported mutual concern in
the present case undertook a commercial venture wherein contributions were
accepted both from the members as well as from non-members. Moreover, one
member was vested with a myriad set of powers to control the functioning and
interests of other members (franchisees), even to their detriment. Such
assimilation could not be termed as a case of ordinary social intercourse
devoid of commerciality.

The
Supreme Court was of the view that once it had conclusively determined that the
assessee company had not operated as a mutual concern, there was no question of
extending exemption from tax liability.

To
support an alternative claim for exemption, the assessee company took a plea in
the written submissions that it was acting under a trust for the contributors
and was under an overriding obligation to spend the amounts received for
advertising, marketing and promotional activities. It urged that once the
incoming amount is earmarked for an obligation, it does not become ‘income’ in
the hands of the assessee as no occasion for the application of such income
arises.

The
Supreme Court left the question of diversion by overriding title open as the
same was neither framed nor agitated in the appeal memo before the High Court
or before it (except a brief mention in the written submissions), coupled with
the fact that neither the Tribunal nor the High Court had dealt with that plea
and that the rectification application raising that ground was pending before
the Tribunal.

15. Basir Ahmed
Sisodiya vs. The Income Tax Officer Date of order: 24^th
April, 2020

Cash credits – The
appellant / assessee, despite being given sufficient opportunity, failed to
prove the correctness and genuineness of his claim in respect of purchase of
marble from unregistered dealers to the extent of Rs. 2,26,000 and resultantly,
the said transactions were assumed as bogus entries (standing to the credit of
named dealers who were non-existent creditors of the assessee) – The appellant
/ assessee, however, in penalty proceedings had offered explanation and caused
to produce affidavits and record statements of the unregistered dealers
concerned and establish their credentials and that explanation having been
accepted by the CIT(A) who concluded that the materials on record would clearly
suggest that the unregistered dealers concerned had sold marble slabs on credit
to the appellant / assessee, as claimed – That being the indisputable position,
the Supreme Court deleted the addition of amount of Rs. 2,26,000

The appellant / assessee was served with a notice u/s
143(2) of the Income-tax Act, 1961 (the ‘1961 Act’) by the A.O. for the A.Y.
1998-99, pursuant to which an assessment order was passed on 30^th
November, 2000. The A.O., while relying on the balance sheet and the books of
accounts, inter alia took note of the credits amounting to Rs. 2,26,000.
He treated that amount as ‘cash credits’ u/s 68 of the 1961 Act and added the
same in the declared income of the assessee (the ‘second addition’). According
to the A.O., the credits of Rs. 2,26,000 shown in the names of 15 persons were
not correct and any correct proof / evidence had not been produced by the
assessee with respect to the income of the creditors and source of income. He
also made other additions to the returned income.

Aggrieved, the assessee preferred an appeal before the
Commissioner of Income Tax (Appeals), Jodhpur. The appeal was partly allowed vide
order dated 9^th January, 2003. However, as regards the trading
account and credits in question, the CIT(A) upheld the assessment order.

The
assessee then preferred a further appeal to the ITAT. Having noted the issues
and objections raised by the Department and the assessee, the ITAT partly
allowed the appeal vide order dated 4^th November, 2004.
However, the order relating to the second addition regarding the credits of Rs.
2,26,000 came to be upheld.

The
assessee then filed an appeal before the High Court u/s 260A of the 1961 Act.
The appeal was admitted on 27^th April, 2006 on the following
substantial question of law:

‘Whether
claim to purchase of goods by the assessee could be dealt with u/s 68 of the
Income-tax Act as a cash credit, by placing burden upon the assessee to explain
that the purchase price does not represent his income from the disclosed
sources?’

The High
Court dismissed the appeal vide impugned judgment and order dated 21^st
August, 2008 as being devoid of merits. The High Court opined that the amount
shown to be standing to the credit of the persons which had been added to the
income of the assessee, was clearly a bogus entry in the sense that it was only
purportedly shown to be the amount standing to the credit of the fifteen
persons, purportedly on account of the assessee having purchased goods on
credit from them, while since no goods were purchased, the amount did represent
income of the assessee from undisclosed sources which the assessee had only
brought on record (books of accounts), by showing to be the amount belonging to
the purported sellers and as the liability of the assessee. That being the
position, the contention about impermissibility of making addition under this
head, in view of addition of Rs. 10,000 having been made in trading account,
rejecting the books of accounts for the purpose of assessing the gross profit,
could not be accepted. The gross profit shown in the books had not been
accepted on the ground that the assessee had not maintained day-to-day stock
registers, nor had he produced or maintained other necessary vouchers, but
then, if those books of accounts did disclose certain other assets which were
wrongly shown to be liabilities, and for acquisition of which the assessee did
not show the source, it could not be said that the A.O. was not entitled to use
the books of accounts for this purpose.

The
assessee in the civil appeal before the Supreme Court reiterated the argument
that the A.O., having made the addition u/s 144 of the 1961 Act being ‘best
judgment assessment’, had invoked powers under sub-section (3) of section 145.
For, assessment u/s 144 is done only if the books are rejected. In that case,
the same books could not be relied upon to impose subsequent additions as had
been done in this case u/s 68.

The
assessee filed an I.A. No. 57442/2011 before the Supreme Court for permission
to bring on record subsequent events. By this application, the assessee placed
on record an order passed by the CIT(A) dated 13^th January, 2011
which considered the challenge to the order passed by the Income-Tax Officer
(ITO) u/s 271(1)(c) dated 17^th November, 2006 qua the
assessee for the self-same assessment year 1998-99. The ITO had passed the said
order as a consequence of the conclusion reached in the assessment order which
had by then become final up to the stage of ITAT vide order dated 27^thApril, 2006 – to the effect that the stated purchases by the assessee
from unregistered dealers were bogus entries effected by him. As a result,
penalty proceedings u/s 271 were initiated by the ITO. That order was set aside
by the appellate authority [CIT(A)] in the appeal preferred by the assessee, vide
order dated 13^th January, 2011 with a finding that the assessee
had not made any concealment of income or furnished inaccurate particulars of
income for the assessment year concerned. As a consequence of this decision of
the appellate authority, even the criminal proceedings initiated against the
assessee were dropped / terminated and the assessee stood acquitted of the
charges u/s 276(C)(D)(1)(2) of the 1961 Act vide judgment and order
dated 6^th June, 2011 passed by the Court of Additional Chief City
Magistrate (Economic Offence), Jodhpur City in proceedings No. 262/2005.

The
Supreme Court noted that during the course of appellate proceedings, the
appellant filed an application under Rule 46A vide letter dated 16^th
October, 2008 and the same was sent to the ITO, Ward-1, Makrana vide
this office letter dated 28^th January, 2009 and 1^st
December, 2010 to submit remand report after examination of additional
evidences. Along with the application under Rules 46A, the appellant filed
affidavits from 13 creditors, the Sales Tax Order for the Financial Year
1997-98 showing purchases from unregistered dealers to the tune of Rs.
2,28,900, cash vouchers duly signed on revenue stamp for receipt of payment by
the unregistered dealers and copy of ration card / Voter ID Card to show the
identity of the unregistered dealers. The A.O. recorded statements of 12
unregistered dealers out of 13. In the report dated 22^nd December,
2010, he mentioned that statements of the above 12 persons were recorded on 15^th
/ 16^th December, 2010 and in respect of identify the unregistered
dealers filed photo copies of their voter identity cards and all of them had
admitted that they had sold marble on credit basis to Basir Ahmed Sisodiya, the
appellant, during F.Y. 1997-98 and received payments after two or three years.
However, he observed that none of them had produced any evidence in support of
their statement since all were petty, unregistered dealers of marble and doing
small business and therefore no books of accounts were maintained. Some of them
had stated that they were maintaining small dairies at the relevant period of
time but they could not preserve the old dairies. Some of them had stated that
they had put their signature on the vouchers on the date of the transactions.

The
Supreme Court further noted that the CIT(A) had observed that in respect of the
addition of Rs. 2,26,000 there had been no denial of purchase of marble slabs
worth Rs. 4,78,900 and sale of goods worth Rs. 3,57,463 and disclosure of
closing stock of Rs. 2,92,490 in the trading account for the year ended on 31^st
March, 1998. Without purchases of marble, there could not have been sale and
disclosure of closing stock in the trading account which suggested that the
appellant must have purchased marble slabs from unregistered dealers. The
CIT(A) had found that the explanation given by the appellant in respect of
purchases from unregistered dealers and their genuineness were substantiated by
filing of affidavits and producing these before the A.O. in the course of
remand report, and the A.O. did not find anything objectionable in respect of
the identity of the unregistered dealers and claims made for the sale of marble
slabs to the appellant in the F.Y. relevant to A.Y. 1998-99.

The
Supreme Court observed that considering the findings and conclusions recorded
by the A.O. and which were commended to the appellate authority as well as the
High Court, it must follow that the assessee despite being given sufficient
opportunity, failed to prove the correctness and genuineness of his claim in
respect of purchase of marble from unregistered dealers to the extent of Rs.
2,26,000. As a result, the said transactions were assumed as bogus entries
(standing to the credit of named dealers who were non-existent creditors of the
assessee).

According
to the Supreme Court, the assessee, however, in penalty proceedings had offered
explanation and caused to produce affidavits and record statements of the
unregistered dealers concerned and establish their credentials and that
explanation having been accepted by the CIT(A) who concluded that the materials
on record would clearly suggest that the unregistered dealers concerned had
sold marble slabs on credit to the assessee, as claimed.

The
Supreme Court was therefore of the view that the factual basis on which the
A.O. formed his opinion in the assessment order dated 30^th November,
2000 (for A.Y. 1998-99) in regard to the addition of Rs. 2,26,000, stood
dispelled by the affidavits and statements of the unregistered dealers
concerned in penalty proceedings. That evidence fully supported the claim of
the assessee. The appellate authority vide order dated 13^th
January, 2011, had not only accepted the explanation offered but also recorded
a clear finding of fact that there was no concealment of income or furnishing
of any inaccurate particulars of income by the appellant / assessee for the
A.Y. 1998-99. That now being the indisputable position, it must necessarily
follow that the addition of the amount of Rs. 2,26,000 could not be justified,
much less maintained.

The
Supreme Court, therefore, allowed the appeal.

16. Union of India (UOI) and Ors. vs. U.A.E.
Exchange Centre Date of order: 24^th
April, 2020

India-UAE DTAA – Merely
having a fixed place of business through which the business of the assessee is
being wholly or partly carried on is not conclusive unless the assessee has a
PE situated in India, so as to attract Article 7 dealing with business profits
to become taxable in India, to the extent attributable to the PE of the
assessee in India – As per Article 5, which deals with and defines the
‘Permanent Establishment (PE)’, a fixed place of business through which the
business of an enterprise is wholly or partly carried on is to be regarded as a
PE and would include the specified places referred to in Clause 2 of Article 5,
but Article 5(3) of the DTAA which starts with a non obstante clause and
also contains a deeming provision predicates that notwithstanding the preceding
provisions of the Article concerned, which would mean clauses 1 and 2 of
Article 5, it would still not be a PE if any of the clauses in Article 5(3) are
applicable – No income as specified in section 2(24) of the 1961 Act was earned
by the liaison office of the respondent in India because the liaison office was
not a PE in terms of Article 5 of DTAA as it was only carrying on activity of a
preparatory or auxiliary character

The
respondent, a limited company incorporated in the United Arab Emirates (UAE)
was engaged in offering, among other things, remittance services for
transferring amounts from UAE to various places in India. It had applied for
permission u/s 29(1)(a) of the Foreign Exchange Regulation Act, 1973 (‘the 1973
Act’), pursuant to which approval was granted by the Reserve Bank of India (the
RBI) vide letter dated 24^th September, 1996.

The
respondent set up its first liaison office in Cochin, Kerala in January, 1997
and thereafter in Chennai, New Delhi, Mumbai and Jalandhar. The activities carried on by the respondent
from the said liaison offices were stated to be in conformity with the terms
and conditions prescribed by the RBI in its letter dated 24^th
September, 1996. The entire expenses of the liaison offices in India were met
exclusively out of funds received from the UAE through normal banking channels.
Its liaison offices undertook no activity of trading, commercial or industrial,
as the case may be. The respondent had no immovable property in India otherwise
than by way of lease for operating the liaison offices. No fee / commission was
charged or received in India by any of the liaison offices for services
rendered in India. It was claimed that no income accrued or arose or was deemed
to have accrued or arisen, directly or indirectly, through or from any source
in India from liaison offices within the meaning of section 5 or section 9 of
the Income-tax Act, 1961 (the 1961 Act). According to the respondent, the
remittance services were offered by it to non-resident Indians (NRIs) in the
UAE. The contract pursuant to which the funds were handed over by the NRI to
the respondent in the UAE was entered into between the respondent and the NRI
remitter in the UAE. The funds were collected from the remitter by charging a
one-time fee of Dirhams 15. After collecting the funds from the NRI remitter,
the respondent made an electronic remittance of the funds on behalf of its
customer in one of two ways:

(i) By telegraphic transfer through bank
channels; or

(ii) On
the request of the NRI remitter, the respondent sent an instrument / cheque
through its liaison offices to the beneficiaries designated by the NRI
remitter.

In
compliance with section 139 of the ITA, 1961, the respondent had been filing
its returns of income from the A.Y. 1998-99 and until 2003-04, showing Nil
income, as according to the respondent no income had accrued or was deemed to
have accrued to it in India, both under the 1961 Act as well as the agreement
entered into between the Government of the Republic of India and the Government
of the UAE, which is known as the Double Taxation Avoidance Agreement (‘DTAA’).
This agreement (DTAA) had been entered into between the two sovereign countries
in exercise of powers u/s 90 of the 1961 Act for the purpose of avoidance of
double taxation and prevention of fiscal evasion with respect to taxes and
income on capital. The DTAA had been notified vide notification No. GSR
No. 710(E) dated 18^th November, 1993. The returns were filed on a
regular basis by the respondent and were accepted by the Department without any
demur.

However,
as some doubt was entertained, the respondent filed an application u/s 245Q(1)
before the Authority for Advance Rulings (Income Tax), New Delhi, which was
numbered as AAR No. 608/2003 and sought ruling of the Authority on the
following question:

‘Whether
any income is accrued / deemed to be accrued in India from the activities
carried out by the Company in India?’

The
Authority vide its ruling dated 26^th May, 2004 answered the
question in the affirmative, saying, ‘Income shall be deemed to accrue in India
from the activity carried out by the liaison offices of the applicant in
India.’ In so holding, the Authority opined that in view of the deeming
provision in sections 2(24), 4 and 5 read with section 9 of the 1961 Act, the
respondent-assessee would be liable to pay tax under the 1961 Act as it had
carried on business in India through a ‘permanent establishment’ (PE) situated
in India and the profits of the enterprise needed to be taxed in India, but
only that proportion that was attributable to the liaison offices in India (the
PE).

The
Authority held that the applicant had liaison offices in India which attended
to the complaints of the clients in cases where remittances were sent directly
to banks in India from the UAE. In addition, in cases where the applicant had
to remit the amounts to the beneficiaries in India as per the directions of the
NRIs, the liaison offices downloaded the information from the internet, printed
cheques / drafts in the name of the beneficiaries in India and sent them
through couriers to various places in India. Without the latter activity, the
transaction of remittance of the amounts in terms of the contract with the NRIs
would not be complete. The commission which the applicant received for
remitting the amount covered not only the business activities carried on in the
UAE but also the activity of remittance of the amount to the beneficiary in
India by cheques / drafts through courier which was being attended to by the
liaison offices.

There
was, therefore, a real relation between the business carried on by the
applicant for which it received commission in the UAE and the activities of the
liaison offices (downloading of information, printing and preparation of
cheques / drafts and sending the same to the beneficiaries in India), which
contributed directly or indirectly to the earning of income by the applicant by
way of commission. There was also continuity between the business of the
applicant in the UAE and the activities carried on by the liaison offices in
India. Therefore, it followed that income had deemed to have accrued / arisen
to the applicant in the UAE from ‘business connection’ in India.

The
Authority further held that insofar as the amount was remitted telegraphically
by transferring directly from the UAE through bank channels to various places
in India and in such remittances the liaison offices had no role to play except
attending to the complaints, if any, in India regarding the remittances in
cases of fraud etc., it could be said to be auxiliary in character. However,
downloading the data, preparing cheques for remitting the amount and
dispatching the same through courier by the liaison offices was an important
part of the main work itself because without remitting the amount to the
beneficiaries as desired by the NRIs, performance of the contract would not be
complete. It was a significant part of the main work of the UAE establishment.
It, therefore, followed that the liaison offices of the applicant in India for
the purposes of this mode of remittance were a ‘permanent establishment’ within
the meaning of the expression in the DTAA.

Following
the impugned ruling of the Authority, dated 26^th May, 2004, the
Department issued four notices of even date, i.e., 19^th July, 2004
u/s 148 of the 1961 Act addressed to the respondent and pertaining to A.Y.s
2000-01, 2001-02, 2002-03 and 2003-04, respectively. The respondent approached
the Delhi High Court by way of Writ Petition No. 14869/2004, inter alia
for quashing of the ruling of the Authority dated 26^th May, 2004,
quashing of the stated notices and for a direction to the appellants not to tax
the respondent in India because no income had accrued to it or was deemed to
have accrued to it in India from the activities of its liaison offices in
India.

The High
Court was of the opinion that the Authority proceeded on a wrong premise by
first examining the efficacy of section 5(2)(b) and section 9(1)(i) of the 1961
Act instead of applying the provisions in Articles 5 and 7 of the DTAA for
ascertaining the respondent’s liability to tax. Further, the nature of
activities carried on by the respondent-assessee in the liaison offices being
only of a preparatory and auxiliary character, were clearly excluded by virtue
of the deeming provision. The High Court distinguished the decisions relied
upon by the Authority in Anglo-French Textile Co. Ltd., by
agents, M/s. Best & Company Ltd., Madras vs. Commissioner of Income
Tax, Madras AIR 1953 SC 105 and R.D. Aggarwal & Company
(Supra). The ratio in these decisions, according to the High
Court, was that the non-resident entity could be taxed only if there was a
business connection between the business carried on by a non-resident which
yields profits or gains and some activity in the taxable territory which
contributes directly or indirectly to the earning of those profits or gains.

The High
Court then concluded that the activity carried on by the liaison offices of the
respondent in India did not in any manner contribute directly or indirectly to the
earning of profits or gains by the respondent in the UAE and every aspect of
the transaction was concluded in the UAE, whereas the activity performed by the
liaison offices in India was only supportive of the transaction carried on in
the UAE. The High Court also took note of Explanation 2 to section 9(1)(i) and
observed that the same reinforces the fact that in order to have a business
connection in respect of a business activity carried on by a non-resident
through a person situated in India, it should involve more than what is
supportive or subsidiary to the main function referred to in clauses (a) to
(c). The High Court eventually quashed the impugned ruling of the Authority and
also the notices issued by the Department u/s 148 of the 1961 Act, since the
notices were based on the ruling which was being set aside. The High Court,
however, gave liberty to the appellants to proceed against the respondent on
any other ground as may be permissible in law.

Feeling
aggrieved, the Department filed a Special Leave Petition before the Supreme
Court.

According
to the Supreme Court, the core issue that was required to be answered in the
appeal was whether the stated activities of the respondent-assessee would
qualify the expression ‘of preparatory or auxiliary character’?

The
Supreme Court observed that having regard to the nature of the activities
carried on by the respondent-assessee, as held by the Authority, it would
appear that the respondent was engaged in ‘business’ and had ‘business
connections’ for which, by virtue of the deeming provision and the sweep of
sections 2(24), 4 and 5 read with section 9 of the 1961 Act, including the
exposition in Anglo-French Textile Co. Ltd. (Supra) and R.D.
Aggarwal & Company (Supra), it would be a case of income deemed to
accrue or arise in India to the respondent. However, in the present case, the
matter in issue would have to be answered on the basis of the stipulations in
the DTAA notified in exercise of the powers conferred u/s 90 of the 1961 Act.

Keeping
in view the finding recorded by the High Court, the Supreme Court proceeded on
the basis that the respondent-assessee had a fixed place of business through
which its business was being wholly or partly carried on. That, however, would
not be conclusive until a further finding is recorded that the respondent had a
PE situated in India so as to attract Article 7 dealing with business profits
to become taxable in India, to the extent attributable to the PE of the
respondent in India. For that, one has to revert back to Article 5 which deals
with and defines the ‘Permanent Establishment (PE)’. A fixed place of business
through which the business of an enterprise is wholly or partly carried on is
regarded as a PE. The term ‘Permanent Establishment (PE)’ would include the specified
places referred to in clause 2 of Article 5. According to the Supreme Court, it
was not in dispute that the place from where the activities were carried on by
the respondent in India was a liaison office and would, therefore, be covered
by the term PE in Article 5(2). However, Article 5(3) of the DTAA opens with a non
obstante clause and also contains a deeming provision. It predicates that
notwithstanding the preceding provisions of the Article concerned, which would
mean clauses 1 and 2 of Article 5, it would still not be a PE if any of the
clauses in Article 5(3) are applicable. For that, the functional test regarding
the activity in question would be essential. The High Court had opined that the
respondent was carrying on stated activities in the fixed place of business in
India of a preparatory or auxiliary character.

The
Supreme Court, after noting the meaning of the expression ‘business’ in section
2(13) of the 1961 Act, discerning the meaning of the expressions ‘business
connection’ and ‘business activity’ from section 9(1) of the 1961 Act and the
dictionary meaning of the expressions ‘preparatory’ and ‘auxiliary’, concluded
that since the stated activities of the liaison offices of the respondent in
India were of preparatory or auxiliary character, the same would fall within
the excepted category under Article 5(3)(e) of the DTAA. As a result, it could
not be regarded as a PE within the sweep of Article 7 of the DTAA.

According
to the Supreme Court, while answering the question as to whether the activity
in question could be termed as other than that ‘of preparatory or auxiliary
character’, it was to be noted that the RBI had given limited permission to the
respondent u/s 29(1)(a) of the 1973 Act on 24^th September, 1996.
From paragraph 2 of the stated permission it was evident that the RBI had
agreed for establishing a liaison office of the respondent at Cochin, initially
for a period of three years, to enable the respondent to (i) respond quickly
and economically to inquiries from correspondent banks with regard to suspected
fraudulent drafts; (ii) undertake reconciliation of bank accounts held in
India; (iii) act as a communication centre receiving computer (via modem)
advices of mail transfer T.T. stop payments messages, payment details, etc.,
originating from the respondent’s several branches in the UAE and transmitting
to its Indian correspondent banks; (iv) printing Indian Rupee drafts with a
facsimile signature from the Head Office and counter signature by the
authorised signatory of the office at Cochin; and (v) following up with the
Indian correspondent banks. These were the limited activities which the
respondent had been permitted to carry on within India. This permission did not
allow the respondent-assessee to enter into a contract with anyone in India but
only to provide service of delivery of cheques / drafts drawn on the banks in
India.

The
permitted activities were required to be carried out by the respondent subject
to conditions specified in Clause 3 of the permission, which included not to
render any consultancy or any other service, directly or indirectly, with or
without any consideration and further that the liaison office in India shall
not borrow or lend any money from or to any person in India without prior
permission of the RBI. The conditions made it amply clear that the office in
India would not undertake any other activity of trading, commercial or
industrial, nor shall it enter into any business contracts in its own name
without prior permission of the RBI. The liaison office of the respondent in
India could not even charge commission / fee or receive any remuneration or
income in respect of the activities undertaken by it in India. From the onerous
stipulations specified by the RBI, it could be safely concluded, as opined by
the High Court, that the activities in question of the liaison office(s) of the
respondent in India were circumscribed by the permission given by the RBI and
were in the nature of preparatory or auxiliary character. That finding reached
by the High Court was unexceptionable.

The
Supreme Court concluded that the respondent was not carrying on any business
activity in India as such, but only dispensing with the remittances by
downloading information from the main server of the respondent in the UAE and
printing cheques / drafts drawn on the banks in India as per the instructions
given by the NRI remitters in the UAE. The transaction(s) had been completed
with the remitters in the UAE, and no charges towards fee / commission could be
collected by the liaison office in India in that regard. To put it differently,
no income as specified in section 2(24) of the 1961 Act was earned by the
liaison office in India and more so because the liaison office was not a PE in
terms of Article 5 of the DTAA (as it was only carrying on activity of a
preparatory or auxiliary character).

The
concomitant was that no tax could be levied or collected from the liaison
office of the respondent in India in respect of the primary business activities
consummated by the respondent in the UAE. The activities carried on by the
liaison office in India as permitted by the RBI clearly demonstrated that the
respondent must steer away from engaging in any primary business activity and
in establishing any business connection as such. It could carry on activities
of preparatory or auxiliary nature only. In that case, the deeming provisions
in sections 5 and 9 of the 1961 Act could have no bearing whatsoever.

The Supreme
Court dismissed the appeal with no order as to costs.

shailesh.kwebmaker

Settlement of cases – Sections 245C(1) and 245D(4) of ITA, 1961 – Powers and duties of Settlement Commission – Application for settlement – Duty of Commission either to reject or proceed with application filed by assessee – Settlement Commission relegating assessee to A.O. – Not proper; A.Ys. 2008-09 to 2014-15

50. Samdariya Builders Pvt. Ltd. vs. IT Settlement Commission [2020] 423
ITR 203 (MP) Date of order: 7^th May, 2019 A.Ys.: 2008-09 to 2014-15

Settlement of cases – Sections 245C(1) and 245D(4) of ITA, 1961 – Powers
and duties of Settlement Commission – Application for settlement – Duty of Commission
either to reject or proceed with application filed by assessee – Settlement
Commission relegating assessee to A.O. – Not proper; A.Ys. 2008-09 to 2014-15

The assessee was a part of a group of companies. Search and survey
operations under sections 132 and 133A of the Income-tax Act, 1961 were
conducted in the residential and business premises of the group, including
those of the assessee and some brokers. No incriminating material was found
against the assessee during the operations, but nine loose sheets of paper,
purportedly relating to the assessee, were seized from a broker. In compliance
with notices issued u/s 153A for the A.Ys. 2008-09 to 2013-14 and section
142(1) for the A.Y. 2014-15, the assessee filed returns of income. During the
assessment proceedings, the assessee filed an application u/s 245C(1) before
the Settlement Commission for settlement and the application was admitted u/s
245D(1) and was proceeded with by the Settlement Commission u/s 245D(2C).
Thereafter, the Principal Commissioner filed a report under Rule 9 of the
Income-tax Rules, 1962. The Settlement Commissioner, by his order u/s 245D(4)
relegated the assessee to the A.O. Hence, the A.O. issued a notice to the
assessee to comply with the earlier notice issued u/s 142(1).

The assessee filed a writ petition and challenged the order. The Madhya
Pradesh High Court allowed the writ petition and held as under:

‘i) The Settlement Commission’s power of settlement has to be exercised in
accordance with the provisions of the Income-tax Act, 1961. Though the
Commission has sufficient powers in assessing the income of the assessee, it
cannot make any order with a term of settlement which would be in conflict with
the mandatory provisions of the Act, such as in the quantum and payment of tax
and the interest. The object of the Legislature in introducing section 245C of
the Income-tax Act, 1961 is to see that protracted proceedings before the
authorities or in courts are avoided by resorting to settlement of cases.

ii) The Settlement Commission could have either rejected the application or
allowed it to be proceeded with further. If the Settlement Commission was of
the opinion that the matter required further inquiry, it could have directed
the Principal Commissioner or the Commissioner to inquire and submit the report
to the Commission to take a decision. The Commission could not get around the
application for settlement. When a duty was cast on the Commission, it is
expected that the Commission would perform the duty in the manner laid down in
the Act, especially when no further remedy is provided in the Act against the
order of the Settlement Commission. The order of the Settlement Commission
relegating the assessee to the A.O. was to be set aside.’

shailesh.kwebmaker

Offences and prosecution – Sections 271(1)(c), 276C(2), 278B(3) of ITA, 1961 and Section 391 of Cr.P.C., 1973 – Wilful default in payment of penalty for concealment of income – Conviction of managing director and executive director of assessee by judicial magistrate – Appeal – Evidence – Documents to prove there was no wilful default left out to be marked due to inefficiency and inadvertence – Interest of justice – Appellate court has power to allow documents to be let in as additional evidence; A.Y. 2012-13

49. Gangothri Textiles Ltd. vs. ACIT [2020] 423 ITR 382 (Mad.) Date of
order: 20^th November, 2019 A.Y.: 2012-13

Offences
and prosecution – Sections 271(1)(c), 276C(2), 278B(3) of ITA, 1961 and Section
391 of Cr.P.C., 1973 – Wilful default in payment of penalty for concealment of
income – Conviction of managing director and executive director of assessee by
judicial magistrate – Appeal – Evidence – Documents to prove there was no
wilful default left out to be marked due to inefficiency and inadvertence –
Interest of justice – Appellate court has power to allow documents to be let in
as additional evidence; A.Y. 2012-13

The assessee company was a textile manufacturer. It
was represented by its managing director and executive director. The Assistant
Commissioner of Income-tax filed a complaint before the Judicial Magistrate u/s
200 and 190(1) of the Code of Criminal Procedure, 1973 against the petitioners
for offences u/s 276C(2) read with section 278B(3) of the Income-tax Act, 1961
for the A.Y. 2012-13 for wilful default in payment of penalty levied u/s
271(1)(c) of the IT Act.

The petitioners filed revision petitions and
contended that the trial court had failed to take into consideration the
necessity and requirement for marking the documents adduced by way of
additional evidence. The Madras High Court allowed the revision petition and
held as under:

‘i) Where documents of evidence are left out to be
marked due to carelessness and ignorance, they can be allowed to be marked for
elucidation of truth, in the interests of justice, by exercising powers u/s 391
of the Code of Criminal Procedure, 1973. The intention of section 391 of the
Code is to empower the appellate court to see that justice is done between the
prosecutor and the prosecuted in the interests of justice.

ii) According to section 391
of the Code, if the appellate court opined that additional evidence was
necessary, it shall record its reasons and take such evidence itself. The
petitioners had been charged u/s 276C(2) read with section 278B(3) of the Act
for having wilfully failed to pay the penalty and having deliberately failed to
admit the capital gains that arose from the sale transactions done by the
assessee. The criminal revision petition u/s 391 of the Code had been filed by
the petitioners even at the time of presentation of the appeal. The documents
sought to be marked as additional evidence were not new documents and they were
documents relating to filing of returns with the Department in respect of the
earlier assessment years, copies of which were also available with the
Department. By marking these documents, the nature or course of the case would
not be altered. The documents had not been produced before the trial court due
to inefficiency or inadvertence of the person who had conducted the case. Where
documents were left out to be marked due to carelessness and ignorance, they
could be allowed to be marked for elucidation of truth, in the interest of
justice, by exercising powers u/s 391 of the Code.

iii) The petitioners should be allowed to let in
additional evidence subject to the provisions of Chapter XXIII of the Code in
the presence of the complainant and his counsel.’

shailesh.kwebmaker

Income – Accrual of income – Mercantile system of accounting – Business of distribution of electricity to consumers – Surcharge levied on delayed payment of bills – Assessee liable to tax on receipt of such surcharge; A.Y. 2005-06

48. Principal CIT vs. Dakshin Haryana Bijli Vitran Nigam
Ltd. [2020] 423 ITR 402 (P&H) Date of order: 29^th November, 2018 A.Y.: 2005-06

Income – Accrual of income – Mercantile system of accounting – Business of
distribution of electricity to consumers – Surcharge levied on delayed payment
of bills – Assessee liable to tax on receipt of such surcharge; A.Y. 2005-06

The assessee distributed electricity. For the A.Y.
2005-06 the assessment was completed u/s 143(3). Subsequently, proceedings for
reassessment were initiated on the ground that the assessee had charged
surcharge on delayed payment of bill and this was charged as part of the single
bill along with the electricity charges. The assessee did not account for the
surcharge as part of its income on the ground that its recovery was not
definite. The A.O. made an addition on account of the surcharge levied but not
realised since the assessee followed the mercantile system of accounting.

The Commissioner (Appeals) deleted the addition
following his earlier orders. The Tribunal affirmed his order.

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

‘i) As and when the assessee received payment of
surcharge, it would be obliged to pay tax on such amount. There was no
illegality or perversity in the findings recorded by the appellate authorities
which warranted interference.

ii) No question of law arose.’

shailesh.kwebmaker

Fringe benefits tax – Charge of tax – Section 115WA of ITA, 1961 – Condition precedent – Relationship of employer and employee – Free samples distributed to doctors by pharmaceutical company – Not fringe benefit – Amount spent not liable to fringe benefits tax; A.Y. 2006-07

47. Principal CIT vs. Aristo Pharmaceuticals P. Ltd. [2020] 423 ITR 295 (Bom.) Date of order: 23^rd January, 2020 A.Y.: 2006-07

Fringe benefits tax – Charge of tax – Section 115WA of ITA, 1961 –
Condition precedent – Relationship of employer and employee – Free samples
distributed to doctors by pharmaceutical company – Not fringe benefit – Amount
spent not liable to fringe benefits tax; A.Y. 2006-07

The
following questions were raised in the appeal filed by the Revenue before the
Bombay High Court:

‘i)
Whether on the facts and in the circumstances of the case and in law, the
Tribunal was right in setting aside the action of the A.O. without appreciating
the fact that the fringe benefit assessment was framed after duly considering
the CBDT Circular No. 8 of 2005 ([2005] 277 ITR (St.) 20] and the Explanatory
Notes to the Finance Act, 2005 on the provisions relating to fringe benefit
tax?

ii)
Whether on the facts and in the circumstances of the case and in law, the
Tribunal was right in ignoring the fact that the Tribunal has explained
considering the case of Eskayef vs. CIT [2000] 245 ITR 116 (SC),
of the Supreme Court that free medical samples distributed to doctors is in the
nature of sales promotion and, similarly, any expenditure on free samples of
other products distributed to trade or consumers would be liable to fringe
benefit tax?’

The
Bombay High Court held as under:

‘i) From
a bare reading of section 115WA of the Income-tax Act, 1961 it is evident that
for the levy of fringe benefits tax it is essential that there must be a
relationship of employer and employee and the fringe benefit has to be provided
or deemed to be provided by the employer to his employees. The relationship of
employer and employee is the sine qua non and the fringe benefits have
to be provided by the employer to the employees in the course of such
relationship.

ii) The
assessee was a pharmaceutical company. Since there was no employer-employee
relationship between the assessee on the one hand and the doctors on the other
hand to whom the free samples were provided, the expenditure incurred for them
could not be construed as fringe benefits to be brought within the additional
tax net by levy of fringe benefit tax.’

shailesh.kwebmaker

Deemed income – Section 41(1) of ITA, 1961 – Remission or cessation of trading liability – Condition precedent for application of section 41(1) – Deduction must have been claimed for the liability – Gains on repurchase of debenture bonds – Not assessable u/s 41(1)

46. CIT vs. Reliance Industries Ltd. [2020] 423 ITR 236 (Bom.) Date of order: 15^th January, 2019

Deemed income – Section 41(1) of ITA, 1961 – Remission or cessation of
trading liability – Condition precedent for application of section 41(1) –
Deduction must have been claimed for the liability – Gains on repurchase of
debenture bonds – Not assessable u/s 41(1)

The
assessee had issued foreign currency bonds in the years 1996 and 1997 carrying
a coupon rate of interest ranging between 10 and 11% and having a maturity
period of 30 to 100 years. The interest was payable half-yearly. According to
the assessee, on account of the attack on the World Trade Centre in the USA on
11^th September, 2001, the financial market collapsed and the
investors of debentures and bonds started selling them which, in turn, brought
down the market price of such bonds and debentures which were traded in the
market at less than the face value. The assessee, therefore, purchased such
bonds and debentures from the market and extinguished them. In the process of
buyback, the assessee gained a sum of Rs. 38.80 crores. The A.O. treated this
as assessable to tax in terms of section 41(1) and made addition accordingly.

The
Commissioner (Appeals) deleted the addition. The Tribunal confirmed the
decision of the Commissioner (Appeals).

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

‘i) For
applicability of section 41(1), it is a sine qua non that there should
be an allowance or deduction claimed by the assessee in any assessment year in
respect of loss, expenditure or trading liability incurred. Then, subsequently,
during any previous year, if the creditor remits or waives any such liability,
the assessee is liable to pay tax u/s 41(1).

ii) It
was not the case of the Revenue that in the process of issuing the bonds the
assessee had claimed deduction of any trading liability in any year. Any
extinguishment of such liability would not give rise to applicability of
sub-section (1) of section 41.’

shailesh.kwebmaker

Capital gains – Transfer of bonus shares – Bonus shares in respect of shares held as stock-in-trade – No presumption that bonus shares constituted stock-in-trade – Tribunal justified in treating bonus shares as investments; A.Ys. 2006-07 to 2009-10

45. Principal CIT vs. Ashok Apparels (P.) Ltd. [2020] 423 ITR 412 (Bom.) Date of order: 8^th April, 2019 A.Ys.: 2006-07 to 2009-10

Capital gains – Transfer of bonus shares – Bonus shares in respect of
shares held as stock-in-trade – No presumption that bonus shares constituted stock-in-trade
– Tribunal justified in treating bonus shares as investments; A.Ys. 2006-07 to
2009-10

In the
appeal by the Revenue against the order of the Tribunal, the following question
was raised before the Bombay High Court.

‘Whether
on the facts and in the circumstances of the case and in law, the Income-tax
Appellate Tribunal was justified in treating the bonus shares as investments
with a cost of acquisition of Rs. Nil for the year under consideration,
ignoring the fact that the original shares, for which bonus shares were
allotted, were present in the trading stock itself for the year under
consideration, thus the bonus shares allotted against the same were also
required to be treated as a part of trading stock itself?’

The
Bombay High Court upheld the decision of the Tribunal and held as under:

‘i) In CIT
vs. Madan Gopal Radhey Lal [1969] 73 ITR 652 (SC) the Supreme Court
observed that bonus shares would normally be deemed to be distributed by the
company as capital and the shareholder receives the shares as capital. The
bonus shares are accretions to the shares in respect of which they are issued,
but on that account those shares do not become stock-in-trade of the business
of the shareholder. A trader may acquire a commodity in which he is dealing for
his own purposes and hold it apart from the stock-in-trade of his business.
There is no presumption that every acquisition by a dealer in a particular
commodity is acquisition for the purpose of his business; in each case the
question is one of intention to be gathered from the evidence of conduct and
dealings by the acquirer with the commodity.

ii) The
A.O. had merely proceeded on the basis that the origin of the bonus shares
being the shares held by the assessee by way of stock-in-trade, necessarily the
bonus shares would also partake of the same character. The Tribunal was
justified in the facts and circumstances of the case in treating the bonus
shares as investments.’

shailesh.kwebmaker

Capital gains – Exemption u/s 54 of ITA, 1961 – Sale of residential house and purchase or construction of new residential house within stipulated time – Construction of new residential house need not begin after sale of original house; A.Y. 2012-13

44. Principal CIT vs. Akshay Sobti [2020] 423 ITR 321 (Del.) Date of order: 19^th December, 2019 A.Y.: 2012-13

Capital gains – Exemption u/s 54 of ITA, 1961 – Sale of residential house
and purchase or construction of new residential house within stipulated time –
Construction of new residential house need not begin after sale of original
house; A.Y. 2012-13

For the
A.Y. 2012-13 the assessee had claimed deduction u/s 54 in respect of capital
gains from the sale of residential house. The A.O. disallowed the deduction u/s
54 on the ground that the assessee had entered into an agreement dated 10^th
February, 2006 and the date of the agreement was to be treated as the date of
acquisition, which fell beyond the one year period provided u/s 54 and was also
prior to the date of transfer.

The
Commissioner (Appeals) held that the assessee had booked a semi-finished flat
and was to make payments in instalments and the builder was to construct the
unfinished bare shell of a flat. Under these circumstances, the Commissioner
(Appeals) considered the agreement to be a case of construction of new
residential house and not purchase of a flat. He observed that since the
construction has been completed within three years of the sale of the original
asset, the assessee was entitled to relief u/s 54. 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)
Section 54 of the Income-tax Act, 1961 requires an assessee to purchase a
residential house property either one year before or within two years after the
date of transfer of a long-term capital asset, or construct a residential
house. It is not stipulated or indicated in the section that the construction
must begin after the date of sale of the original or old asset.

ii) The
assessee had fulfilled the conditions laid down in section 54 and was entitled
to the benefit under it.’

shailesh.kwebmaker

Business expenditure – Deduction u/s 42(1)(a) of ITA, 1961 – Exploration and extraction of oil – Conditions precedent for deduction – Expenditure should be infructuous or abortive exploration expenses, and area should be surrendered prior to commencement of commercial production – Meaning of expression ‘surrender’ – Does not always connote voluntary surrender – Assessee entering into production sharing contract with Government of India and requesting for extension at end of contract period – Government refusing extension – Assessee entitled to deduction u/s 42(1)(a); A.Y. 2008-09

43. Principal CIT vs. Hindustan Oil Exploration Co. Ltd. [2020] 423 ITR 465 (Bom.) Date of order: 25^th March, 2019 A.Y.: 2008-09

Business expenditure – Deduction u/s 42(1)(a) of ITA, 1961 – Exploration
and extraction of oil – Conditions precedent for deduction – Expenditure should
be infructuous or abortive exploration expenses, and area should be surrendered
prior to commencement of commercial production – Meaning of expression
‘surrender’ – Does not always connote voluntary surrender – Assessee entering
into production sharing contract with Government of India and requesting for
extension at end of contract period – Government refusing extension – Assessee
entitled to deduction u/s 42(1)(a); A.Y. 2008-09

The assessee was engaged in the business of exploration and extraction of
mineral oil. It entered into a production-sharing contract with the Government
of India on 8^th October, 2001 for the purposes of oil exploration.
According to the contract, a licence was issued to a consortium of three
companies, which included the assessee, to carry out the exploration initially
for a period of three years and the entire exploration was to be completed
within a period of seven years in three phases. At the end of the period,
extension was denied by the Government of India. In its Nil return of income
filed for the A.Y. 2008-09, the assessee claimed deduction u/s 42(1)(a) of the
Income-tax Act, 1961 on the expenditure on oil exploration on the ground that
the block was surrendered on 15^th March, 2008. The A.O. was of the
opinion that it had not surrendered the right to carry on oil exploration since
the assessee was interested in extension of time which was denied by the
Government of India and disallowed the claim.

The Commissioner (Appeals) allowed the appeal. The Tribunal found that
according to article 14 of the contract, relinquishment and termination of
agreement were two different concepts and that by a letter dated 28^th
March, 2007 the assessee was informed that its contract stood relinquished. The
Tribunal held that the assessee was covered by the deduction provision
contained in section 42, that such expenditure was not amortised or was not
being allowed partially year after year and it had to be allowed in full, and
therefore there was no justification to deny the benefit of deduction to the
assessee.

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

‘i) As long as the commercial production had not begun and the expenditure
was abortive or infructuous exploration expenditure, the deduction would be
allowed. The term “surrender” itself was a flexible one and did not always
connote the meaning of voluntary surrender. The surrender could also take place
under compulsion. The assessee had no choice but to surrender the oil blocks
because the Government of India had refused to extend the validity period of
the contract. Admittedly, commercial production of oil had not commenced. The
act of the assessee to hand over the oil blocks before the commencement of
commercial production was covered within the expression “any area surrendered
prior to the beginning of commercial production by the assessee”.

ii) The
provisions of section 42 recognised the risks of the business of exploration
which activity was capital-intensive and high in risk of the entire expenditure
not yielding any fruitful result and provided for special deduction. The
purpose of the enactment would be destroyed if interpreted rigidly. For
applicability of section 42(1)(a) the elements vital were that the expenditure
should be infructuous or abortive exploration expenses and that the area should
be surrendered prior to the beginning of commercial production by the assessee.
As long as these two requirements were satisfied, the expenditure in question
would be recognised as a deduction. The term “surrender” had to be appreciated
in the light of these essential requirements of the deduction clause. It was
not the contention of the Department that the expenditure was infructuous or
abortive exploration expenditure.

iii) The interpretation of section 42(1)(a) by the Tribunal and its order
holding the assessee eligible for deduction thereunder were not erroneous.’

shailesh.kwebmaker

i) Business expenditure – Disallowance – Sections 14A and 36(1)(iii) of ITA, 1961 – Interest on borrowed capital – Finding that investment from interest-free funds available with assessee – Presumption that advances made out of interest-free funds available with assessee – Deletion of addition made u/s 14A justified (ii) Unexplained expenditure – Section 69C of ITA, 1961 – Suspicion that certain purchases were bogus based on information from sales tax authority – Neither independent inquiry conducted by A.O. nor due opportunity given to assessee – Deletion of addition by appellate authorities justified; A.Y. 2010-11

42. Principal CIT vs.
Shapoorji Pallonji and Co. Ltd. [2020] 423 ITR 220
(Bom.) Date of order: 4^th
March, 2020 A.Y.: 2010-11

(i) Business expenditure –
Disallowance – Sections 14A and 36(1)(iii) of ITA, 1961 – Interest on borrowed
capital – Finding that investment from interest-free funds available with
assessee – Presumption that advances made out of interest-free funds available
with assessee – Deletion of addition made u/s 14A justified

(ii) Unexplained
expenditure – Section 69C of ITA, 1961 – Suspicion that certain purchases were
bogus based on information from sales tax authority – Neither independent
inquiry conducted by A.O. nor due opportunity given to assessee – Deletion of
addition by appellate authorities justified; A.Y. 2010-11

For the
A.Y. 2010-11, the A.O. held that the purchases made by the assessee from two
sellers were bogus; according to information received from the Sales Tax
Department, Government of Maharashtra, those two sellers had not actually sold
any material to the assessee. Accordingly, he issued a show cause notice in
response to which the assessee furnished copies of the bills and entries made
in its books of accounts in respect of such purchases. However, the A.O. in his
order made addition u/s 69C of the Income-tax Act, 1961. He also made
disallowances under sections 14A and 36(1)(iii) of the Act.

The
Commissioner (Appeals) deleted the disallowances. The Tribunal upheld the
decision of the Commissioner (Appeals). According to the Tribunal, the A.O. had
merely relied upon the information received from the Sales Tax Department but
had not carried out any independent inquiry. The Tribunal recorded a finding
that the A.O. failed to show that the purchased materials were bogus, whereas
the assessee produced materials to show the genuineness of the purchases and
held that there was no justification to doubt the genuineness of the purchases
made by the assessee.

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

‘i) On
the facts as found by the Commissioner (Appeals) and as affirmed by the
Tribunal, the presumption that if there were funds available with the assessee,
both interest-free and overdraft or loans, the investments were out of the
interest-free funds generated or available with the assessee was established.
The Tribunal had affirmed the order of the Commissioner (Appeals) deleting the
addition made by the A.O. u/s 14A on the ground that the interest-free funds
available with the assessee were far in excess of the advance given. The
principle of apportionment under Rule 8D of the Income-tax Rules, 1962 did not
arise as the jurisdictional facts had not been pleaded by the Department.

ii) The
finding of the Commissioner (Appeals) as affirmed by the Tribunal was that the
assessee had not utilised interest-bearing borrowed funds for making
interest-free advances but had its own interest-free fund far in excess of
interest-free advance. No question of law in respect of the deletion of the
disallowance made by the A.O. u/s 36(1)(iii) arose.

iii) The Tribunal was justified in deleting the addition
made u/s 69C on the ground of bogus purchases. Merely on suspicion based on the
information received from another authority, the A.O. ought not to have made
the additions without carrying out independent inquiry and without affording
due opportunity to the assessee to controvert the statements made by the
sellers before the other authority.’

shailesh.kwebmaker

DATA-DRIVEN INTERNAL AUDIT – II PRACTICAL CASE STUDIES

BACKGROUND

Internal auditors are effective in their
delivery of professional services only by conducting value-added services.
Important value drivers for management are:

– cost savings / optimisation,

– prevention or detection of frauds,

– compliance with procedures and regulations.

These can only be achieved in today’s day and
age by adoption of technology for all stages in the life-cycle of the internal
audit. It may necessitate getting the data from multiple sources, analysing
huge quanta of data, comprehensively quantifying the findings and presentation
of data in intelligent form to various stakeholders for action to be taken for
improvement/s.

Let’s add the fact that we are moving to
remote auditing, again a necessity in today’s circumstances and which would
most probably become the new normal in times to come. Remote auditing is
already being practised by many organisations where internal auditors carry out
internal auditing for global, geographically-spread entities from their
internal audit teams based out of India.

In our earlier article (Pages 11-13; BCAJ,
August, 2020), we have discussed the necessity of adopting a data-driven
internal audit approach for efficient and effective internal audit, basically
explaining ‘why’. Now, we are offering the methodology to be adopted for making
it happen, in other words, ‘how’ to do it.

STAGES IN DATA-DRIVEN INTERNAL AUDIT

Using what you know

(1) DETERMINE WHETHER DATA ANALYTICS IS APPROPRIATE
FOR THE AUDIT

The potential benefits of using Data
Analytics can be judged from the audit objectives and the expected problems, as
well as from the data volume, the number of records and the number of fields.
Special consideration should be given to the usefulness of additional analysis
over what is currently provided by the system and whether any special factors
apply, such as fraud detection and investigation, Value for Money audits (in
obtaining performance statistics) and special projects.

(2) CONSIDER AUDIT OBJECTIVES AND WHERE DATA
ANALYTICS CAN BE USED

Data Analytics can be used in different areas
with different goals and objectives. Data Analytics is generally used to
validate the accuracy and the integrity of data, to display data in different
ways and to generate analysis that would otherwise not be available. It can
also be helpful in identifying unusual or strange items, testing the validity
of items by cross-checking them against other information, or re-performing
calculations.

Although Data Analytics allows you to
increase your coverage by investigating a large number of items and potentially covering 100% of transactions, you may still want to extract
and analyse a portion of the database by using the sampling tasks within. You
could examine a subset of the population (a sample), to predict the financial
result of errors, or to assess how frequently a particular event or attribute occurs
in the population as a whole.

The quality of the data, your knowledge of
the database and your experience will contribute to the success of Data
Analytics processes. With time you will be able to increase or widen the scope
of investigations (for example, conducting tests which cannot be done manually)
to produce complex and useful analyses, or to find anomalies that you never thought
were feasible.

It is also not unusual that far more
exceptional items and queries are identified when using Data Analytics than other methods and that these may require follow-up time. However, the use
of Data Analytics may replace other tests and save time overall. Clearly, the
cost of using the Data Analytics Tool must be balanced against the benefits.

Case Study 1 – General Ledger – What is our
Audit Objective?

Management override and posting of fictitious
journals to the General Ledger is a common way of committing fraud; and one of
the key audit procedures is to test the appropriateness of journal entries
recorded in the General Ledger.

The objectives may include testing for risk
or unusual transactions such as:

Journals with no description,

Journals not balancing,

Journals containing keywords,

Journals posted by unauthorised users,

Journals posted just below approval limits,

Journals posted to suspense or contra
accounts.

Case Study 2 – Accounts Receivable – What is
our Audit Objective?

Accounts Receivable is one of the largest
assets of a business; therefore, there is a need to audit and gain assurance
that the amounts stated are accurate and reasonable.

The objectives may include:

Identify large and / or unusual credit
notes raised in the review period,
Capture customers with significant write-offs
during the year,

Isolate customers with balances over their
credit limit,

Filter out related party transactions
and balances,

Generate duplicates and gaps in the
sales invoice numbers,

Match after-date collections to year-end
open items / balances.

Preparing data for analysis

(3) DETERMINE DATA REQUIRED AND ARRANGE DOWNLOAD
WITH PREPARATION

Data download is the most technical stage in the
process, often requiring assistance and co-operation from Information
Technology (IT). Before downloading or analysing the data, it is necessary to
identify the required data. Data may be required from more than one file or
database. It is important at this stage that the user understands the
availability and the details of the databases. You may also have to examine the
data dictionary to determine the file structure and the relationships between
databases and tables.

In determining what data is required, it may
be easier to request and import all fields. However, in some cases this may
result in large file sizes and it may be time-consuming to define all the
fields while importing the files. Therefore, it may be better to be selective,
ignoring blank fields, long descriptive fields and information that is not
needed. At the same time, key information should not be omitted.

Case Study 1 – General Ledger – Planning –
What Data is Required?

The Auditor needs to obtain a full General
Ledger transactions history for the audit year after all the year-end
(period-end) postings have been completed by the client. To carry out a
completeness test on the General Ledger transactions, the ‘Final’ Closing Trial
Balances at the current and previous year-ends are required. Where possible,
obtain a system-generated report as a PDF file, or observe the export of the
Trial Balance, this will give assurance over the integrity and completeness of
the Trial Balance figures from the Accounting Software or ERP system.

General ledger initial check for preparing
the data

Field Statistics can be used to verify the
completeness and accuracy of data like incorrect totals, unusual trends,
missing values and incorrect date periods in the General Ledger. This pre-check
in the data preparation stage allows the Auditor a greater chance of
identifying any issues that will cause invalid test results. Comparing
difference in totals obtained from the client for the Transaction Totals in the
General Ledger with the Field Statistics should be clarified with the client
before proceeding further with the Analytic tests.

Case Study 2 – Accounts Receivable – Planning
– What Data is Required?

The Auditor should requisition the ‘AR
Customer-wise open items at the year-end’ data. This data provides more details
than a simple list of balances because often an Auditor wants to test a sample
of unpaid invoices rather than testing the whole customer balance. Further, the
Auditor should obtain the ‘Accounts Receivable Transactions’ during the year to
analyse customer receipts in the year, to test for likely recoverability. Apart
from this, more detailed Data Analytics can be performed on the sales invoices
and credit notes, as well as cut-off analysis.

Accounts receivable initial check for
preparing the data

Field Statistics can be used to verify the completeness and accuracy of
data like incorrect totals, unusual trends, missing values and incorrect date
periods in the Accounts Receivable (AR) ledger. This pre-check in the data
preparation stage offers the Auditor a better chance of identifying any issues
that could cause invalid test results. Comparing difference in totals obtained
from the client for the AR Debit Credit Totals with the Field Statistics should
be clarified with the client before proceeding further with the Analytic tests.

Validating data

(4) USE ANALYTIC TASKS

Case Study 1 – General Ledger – Highlighting
Key Words within Journal Entry Descriptions

Objective – To isolate and extract any manual journal entries using key words or
unusual journal descriptions. These can include, but not be limited to,
‘adjustment, cancel, missing, suspense’.

Technique – Apply a search command on the manual journal entries which have been
posted with the defined unusual descriptions by using a text search command.

Interpretation of Results – Records shown when using the above
criteria would display records which have description narratives that include
key terms such as ‘adjustment’, ‘cancel’, ‘suspense’ and ‘missing’, and may
require further investigation.

When determining which manual journal entries
to select for testing, and also what description should be tested, it is
helpful to know that financial statements can be misstated through a variety of
fraudulent journal entries and adjustments, including:

Writing off liabilities to income,
Adjustments to reserves and allowances
(understated or overstated),

False sales reversed after year-end and
out-of-period revenue recorded to inflate revenue.

Therefore, when defining the narratives to
search for, you will need to tailor the said search to the type of manual
journal entry that the Auditor is aiming to test.

Case Study 2 – Accounts Receivable –
Detecting suppression of Sales

Objective – To test for gaps in invoicing sequences which may indicate unrecorded
sales and / or deleted invoices.

Technique – Gap Detection is used to detect gaps in data. These could be gaps
within purely numeric or alpha-numeric sequential reference numbers, or these
could be gaps within a sequence of dates. Perform a Gap Detection on the field
‘Invoice Number’.

Interpretation of Results – Any gaps in invoicing sequences require
further investigation to ensure that revenue has been correctly allocated, as
well as to check for improper revenue recognition which can be accomplished by
manipulating income records, causing material misstatement.

Discovering patterns, outliers, trends using
pre-built analytic intelligence

The Discover task provides insights through
patterns, duplicates, trends and outliers by mapping data to high-risk elements
using the Data Analytical Tool’s predefined Analytic Intelligence.

Identify trends, patterns, segmental
performance and outliers automatically.

Intuitive auto-generation of dashboards that
can then be further refined with IDEA’s inbuilt Analytic Intelligence.

(5) REVIEW AND HOUSEKEEPING

As with any software application, all work
done in Data Analytic Tools must be reviewed. Review procedures are often
compliance-based, verifying that the documentation is complete and that
reconciliations have been carried out. The actual history logs from each analytical
activity should also be reviewed.

Backup of all the project folders must be
done meticulously and regularly.

Clear operating instructions with full
details on how to obtain files, convert them and download them should be
documented for each project and kept easily accessible for the Audit Teams who
will take up the project in the ensuing review period. If necessary, logic
diagrams with appropriate explanatory comments should be placed in the Audit
working-paper file so that a different auditor could pick up the project in the
following year.

CONCLUSION

By embedding data analytics in every stage of the audit process and
mining the vast (and growing) repositories of data available (both internal and
external), Auditors can deliver unprecedented real-time insight, as well as
enhanced levels of assurance to management and audit committees.

Businesses are faced with unprecedented
complexity, volatility and uncertainty. Key stakeholders can’t wait for
Auditor’s analysis of historical data. They must be alerted to issues at once
and be assured of repetitive monitoring of key risks. Data Analytics empowers
Audit to deliver, as well as to serve the business more proactively in audit
planning, scoping and risk assessments, and by monitoring key risk indicators
closely and concurrently. Auditor’s use of data analytics in every phase of the
audit can help management and the audit committee make the right decision at
the right time.

shailesh.kwebmaker

TAXPAYER SERVICES: MESSAGE, MEANING AND MEANS – 1/n

A taxpayer is that rare citizen who creates value, earns income and parts
with a portion of it as tax for nation-building. Just as it is the ‘legal’
obligation to pay tax, there is a much ‘higher moral social’ obligation upon
the government to ensure that the taxpayer is treated as a valued patron and
ensure that his taxes give him a bang for his buck.

Faceless Assessment and the Taxpayer’s Charter (TC) is an awakening and
realisation of the above understanding. This move is what a wise government and
sincere taxpayer would want. PM Modi spoke candidly about making the tax system
‘seamless, painless and faceless’ and assuring the honest taxpayer of ‘fair,
courteous and rational behaviour’.

Over the last few years, calibrated sequential changes were undertaken –
the black money act, DeMo, post-DeMo amnesty scheme (GKY), the Benami Act,
reduction of rates for corporates and individuals, increasing the threshold for
the Department to litigate, dispute resolution Vivad se Vishwas scheme,
E-assessments, etc.

Since its first appearance in, I think, 1998, the TC has got its rightful
place from posters in hallways to the statute book. The directional change is
worthy of appreciation for what otherwise to many of us was a no-brainer. However,
this can only be a start in the direction of developing a real taxpayer rights
and services charter. We have harsh provisions against the taxpayer who
deviates, but none against the tax assessor if he deviates from his role. There
is a fundamental issue of power without adequate transparency and
accountability.

Here are some thoughts on how this process can be made real and robust.

Define tax overreach: We have
serious consequence of penalties and prosecution defined and applied on
taxpayers. For a law to be fair, we need equivalent definitions and
descriptions of tax ‘extortion’, ‘extraction’ and ‘jehadism’ (all for lack of a
vocabulary which needs to be evolved) on the Tax Department depending on the
intensity of their actions that eventually get turned down at subsequent levels
of appeal.

Accountability: Tax officers
must be held accountable monetarily and otherwise. An assessee should be
compensated for the hassle that she has to go through. Considering that the
success rate of the Tax Department is 15 to 20% at all levels combined, it is
clear that there is large-scale illegal collection of taxes that are
subsequently reversed with interest cost being suffered by the exchequer.
Another example is of prosecution, which if proved excessive or overruled, the
ITO must face the music for irresponsible behaviour that resulted in agony,
cost and loss of reputation. No exercise of power should be permitted
without accountability.

Create grounds for the taxpayer: The taxpayer should be able to take grounds of calling the order
‘perverse’, ‘excessive’, or ‘illegal’ (all for lack of a vocabulary which needs
to be evolved) and should be able to claim reverse penalty on the Department if
he wins. Grounds such as the above should be evolved and defined under the law,
and that would give the taxpayer equal ‘power’ to call the bluff of the ITO.

Ban on Targets: Setting
targets should be made illegal. The vocabulary, mentality and methods that
follow a ‘target regime’ create bias against a fair, respectful and reasonable
assessment.

The TC is perhaps one of the best news of the year. The change deserves our
support, encouragement and positivity. At the same time, as the title of this
Editorial says, it is 1/n, a process. I welcome and solicit your ideas and
suggestions on what should change in small simple measures, how a reform can
take form, a translation of fourteen points into actionable, doable measures.
Do write to journal@bcasonline.org.

Raman
Jokhakar

Editor

shailesh.kwebmaker

EXTINCT PROFESSION

This is an article that ‘appeared’ in the
daily ‘Futurology’ in the year 2050. The title of the article was
‘Extinct Profession’. It was to mark the Silver Jubilee of the death of a
dignified (?) profession. It is from a small island called ‘Overlaw’ in an
unknown ocean. The following are some excerpts from the said article:

There has always been a policy in the
business that the big players get some work done by small players by offering them a seemingly lucrative business volume. Small players get
excited, especially if they are new entrants in the business. Their costing is
fully monitored by the big players. After a couple of years of a smooth
relationship, the big start delaying the payments. The poor small ones don’t
mind it initially. The big ones place larger orders with some small advances.

Again, they withhold the payments. They
paint a rosy future before the small players. The poor fellows have no choice.

The small go to a banker and raise funds on
the ‘merit’ that they have orders from large corporates. The bankers oblige.
Their meters of interest and EMI start ticking. But the small ones cannot
function smoothly.

Gradually, the small players see the death
of their own businesses. The big ones are scratch-free. They have a hundred
reasons for not paying – from ‘quality defects’ to ‘belated deliveries’.

And then, the big find some new small ones!
The cycle continues forever… Government makes laws against such tactics but
there is a provision in fine print, in every beneficial law, that the lawmaker
is not responsible for its implementation.

Here is a story where an entire profession
in the country had to be closed down 25 years ago. Had the profession survived,
it would have celebrated its centenary year in the current year 2050.

The profession was basically rendering a
very specialised service to businessmen and many government / private
organisations. Under the law then prevailing, it was mandatory for many
organisations to avail their professional services.

The persons belonging to that profession
were under the impression that the profession was important and indispensable.
But the reality was that had it not been legally incumbent, nobody would have
willingly gone for their services. The payment to those professionals was
always considered as unproductive and was at the bottom of the list of priorities
with the users of their services. It was common that the fees of these
professionals were kept unpaid for up to three or even four years.

But all of a sudden, the ‘Governors’ of the
profession, with a laudable objective to protect the profession, declared that
if your fees are unpaid for two consecutive years by a client, you should
discontinue your services to that client.

The ‘Governors’ said it would be unethical
to render service to that client who owes you so much. There was a big hue and
cry against this decision. But the ‘Governors’ said the client cannot escape
because no other service provider can accept his work unless the previous
person’s fees are paid.

So, the
previous professional lost the work. He could not get any other work since all
the clients had avoided payments to their respective professionals. The
mandatory service could not be rendered by anybody to anybody!

All clients became defaulters under the laws
concerned. They became disqualified to run their business. So, the businesses
were closed.

The government
realised the gravity of the situation, so it brought an amnesty scheme. The
mandatory compliance was waived. Clients found it more economical to pay the
money under amnesty rather than paying fees to the professionals.

The ‘Governors’ of the profession kept on
introducing newer and newer rules and regulations thrust by other countries.
That was done under the garb of ‘Ethics’.

The professionals started spending more time
on learning and more money on books and study courses. Since most of the
clients’ work was discontinued, they had a lot of idle time.

This continued for a few years and in the
year 2025 the government realised that the mandatory compliance was not
required at all. The so-called specialised services rendered by the profession
became redundant. Everybody realised that it had made no difference whatsoever
to anyone even in the absence of those services.

One fine morning, the profession was
declared to be no longer relevant and all the laws were changed accordingly.

That was the end of the profession.

The students as well as the existing
professionals heaved a big sigh of relief that there was no longer any need to
study too many laws and regulations!

shailesh.kwebmaker

COLLABORATE TO CONSOLIDATE’ – A GROWTH MODEL FOR PROFESSIONAL SERVICES FIRMS

In today’s times,
when the market is seeking lower cost alternatives in every spend and the
otherwise not-to-be touched area of audit fees or tax fees of a CA firm is
increasingly being questioned by CFOs and business owners, with ever-increasing
need for specialist advice, the refrain is to come together with like-minded
professionals.

Consolidation of
professional services firms is a prerequisite for professions to grow. It is a
huge challenge and an uphill task for a lot of firms to grow as disaggregated
practices. Covid-19 has actually altered the course and changed the rules of
the game and advanced the time for these discussions. If you are not growing
consistently, there is a case for a relook. If you haven’t thought through
succession planning for your firm, now is the time to do so.

This article is an
attempt to provide some ideas and suggest a framework to proprietorship firms
and partnership firms providing professional services such as chartered
accountancy firms, law firms and other professional services firms to come
together, collaborate and work together for their common growth.

Consolidation of
accounting firms requires a fair bit of thought, analysis and a sustained
positive outlook. The mindset of growth has to be foremost for any
consolidation to be productive and value accretive. And to start this process,
collaborating with like-minded firms may be a good way to proceed.

(I) PREREQUISITES OF CONSOLIDATION

(i) Mindset

It is of paramount
importance that the mindset to collaborate, consolidate and grow is clear and
positive. Having a positive, open mindset means that one is willing to work
together under a conducive framework;

(ii) What can one consolidate?

Consolidation
doesn’t only have to be by merger. One can consolidate mindsets, expertise,
people, teams, functions, technology, markets, HR, brand building, finance and
accounts, administration and various other aspects which can make the
professional services firms nimble-footed and adaptable to change and growth.

(II) GETTING STARTED

It is also not lost
on any of us that coming together for a common client or referred client may be
a good way to get started.

For example:

When there is a
referred client, where a professional refers some matter to another
professional, although the other professional will be the primary service
provider, the referring professional should contribute actively by providing
the background knowledge on the basis of his / her experience and the
relationship aspects of dealing with the client, so that the other professional
can benefit from the referring partner’s experience and expertise.

If this is
addressed in a manner which is sufficiently engaging, powerful, organised and
delivered in a properly thought through manner, then you have the right
prerequisites for a successful consolidation.

The thesis is that
enthusiastic collaboration is a vital ingredient and a prerequisite for
sustained, organised growth. I have no doubt that professional services firms
will pursue the above with a lot of enthusiasm and momentum once a road-map is
given and a framework is created.

(III) MODELS OF CONSOLIDATION

(A) Referral
model

This is a simple,
‘start with’ model. ABC & Co has a client to whom it is providing audit and
tax services. The client needs MIS services. Given that ABC & Co is an
auditor, it may not be able to provide MIS services as then the firm may no
longer be independent. So, ABC contacts XYZ & Co and refers the client’s
MIS work. XYZ delivers and invoices fees.

XYZ will in turn
ensure that it will not pitch for any other services to the client. If the
client comes for any other work, it will get referred back to ABC. This is an
unwritten code that is based on trust.

If this is done
well, trust develops and this lays the ground for both firms to collaborate. If
XYZ ever crosses the line, ABC will not work with XYZ in the future. That
itself is a good deterrent in this model.

The code of conduct
and rules of professional engagement may prohibit payment of referral fees and
this needs to be respected.

(B) Preferred
partner model

This is an
extension of the referral model, where ABC and XYZ consider each other as
preferred firms to collaborate with. If ever there is work coming to ABC which
it cannot deliver, ABC will refer it to XYZ as the firm of first choice.

Conversely, XYZ
will refer work to ABC for any engagement where it needs help / support. In
this model again, it is a very clear way of supporting each other in such a way
that the sanctity of the preferred firm model is maintained.

There could be
exceptions where XYZ is not able to service a client of ABC, in which case ABC
is obviously free to choose any other firm.

An associate firm by definition is a form of membership where
like-minded firms agree to come together under a common association and agree
to abide by the principles and rules of working under a larger umbrella. The
associate firm continues to work under its own brand and will not need to
change its constitution nor its key areas of work.

The associate firm
agrees to collaborate with other member firms in a manner that encompasses the
referral model and the preferred partner model with more formalised meetings,
exchange of knowledge, use of resources, common marketing collaterals and a
greater speed of response and alignment.

The associate firm
model has been in existence for many years and has proved to be a very credible
alternative to the member firm model and the network model. The biggest
difference is that members are free to continue their own brands and they have
far more independence in what they choose to do or not to do, including the
choice of work, business areas, office locations, client servicing and choice
of sharing of information.

Effectively, there
are no compulsions and there are no territorial restrictions. Each firm is free
to expand into any territory and is free to conduct or practice any service
area without any pre-approval or without worrying about a centrally
administered bureaucratic process.

The main
disadvantage of an associate model is that it may not always be tightly
integrated and associate firms can choose not to fall in line citing whatever
compulsions they face and there is very little that other firms can do.

(D) Network
model

A network model is
one of the best ways to grow professional practices. Each firm is a member of a
global network or a national or regional network, using a common brand, using
common tools and having signed a member firm agreement which binds them with
the central leadership, a common partner pool and, most importantly, a common
identity.

Indeed, over a
century it has been proven that the network model has the ability to grow the
fastest and to become the largest amongst all prevalent models of
collaborations amongst professional services firms.

In a network, the
biggest consideration is giving up one’s brand where the professional services
firm agrees to use the international brand or the national or regional brand
and accepts that its own brand will play second fiddle. All marketing
collaterals and service delivery are under the common brand; except where
regulations may not permit a foreign brand. In such cases, the network pushes
for alternate options and finds a way to co-exist within the rules.

In a network model,
member firms are often guided by common rules of engagement. Conduct of shared
work, sharing of knowledge, territorial restrictions, respect for an office,
its location and its territorial boundaries, firm-wide dissemination of
developments and a governance structure where partners align with the central
leadership form the daily core of network firms’ activities.

Whilst there are
several perceived disadvantages such as loss of one’s own brand, the associated
loss of identity and integration into common practices which one may take some
time to evolve, understand and add up to, the network model has stood the test
of time. It has proven and validated the concept of ‘collaborate to grow
manifold’ and critics have accepted the formal network models.

(E) Merger model

In a merger model,
the referral firms, the associate firms, the preferred partner firms and the
network firms effectively amalgamate into a single firm with a single bank
account. Effectively, one is ‘all in’. That means it is truly a ‘one firm,
firm’ and partners can grow or not grow driven by the collective performance of
the larger firm. There are no real silos, there are no individual mindsets, nor
any individual practices.

Each partner works
for the larger collective firm under the belief that as long as one is
contributing to his or her best abilities, the larger collective will grow. As a
partner, I am benefiting from the expertise and the common delivery processes
of the firm.

In a merger
situation, the rules of the game are very different and may appear overwhelming
to start with. One should get into a merger only after detailed due diligence
and after a few years of working together with one of the above models. It is
like a marriage; there are sacrifices to be made, there are positions to be
gone away from and yet there’s the harmony and beauty of the collective.

A partner may not
need to be spending time on areas outside of his or her core focus. What it
does is provide partners with adequate time to build, consolidate and grow.
Focus on service areas, with administrative or functional work percolating down
to the teams, is a positive outcome.

(IV) Road-map for consolidation

Having looked at
the various models of consolidation, it is now time to look at the execution
road-map for consolidation:

(i) Each firm
should identify its own skill sets, expertise, specialisation and the firm’s
USP. Clarity of expertise and USP is critical.

(ii) The objective of the collaboration should be
very well defined. What are we trying to achieve? Is it growth of revenue,
growth of profitability, growth of skill sets, working with the best minds,
professional growth, sharing of knowledge, newer geographies, recognition of
the changing market place and demands of the client? Clarity on the objective
is very critical. Often, in the haste of coming together, the main objective is
forgotten. That’s to be avoided at all costs.

(iii) Once the firm
is clear on who is best at practising a particular area, the automatic next
step will be to have one or two partners from each of the firms to collaborate
intensely and with the purpose of achieving a target of identifying a few
like-minded yet unique firms to integrate with. These one or two partners have
the responsibility of ensuring that the objectives of the collaboration are
fulfilled.

(iv) One of the
better ways to start is by working together on actual projects. That normally
provides a good way to get an insight into the other firms. It also provides an
easy and operational way to get to know the practices and processes of other
firms. Taking the first baby steps is important.

(v) Once some early success is seen, the
foremost assumption that all partners are aligned for collective growth will be
tested. It will be hard for partners to sit on the fence. Thus the acceptance
of a preferred firm model or even an associate firm model will not be too
challenging. Keep moving forward to a point where trust is created and
enhanced. Each model should be given adequate chance to work and succeed. At
some point, an associate firm model can give way to a network firm model.

(vi) The partners
leading this initiative for their firms have to be at it. It’s a constant
effort. Take small steps but keep moving forward. It won’t get done overnight.
But achieving small successes will pave the way for larger integration. If all
cylinders are aligned, the practices will see merit in a merger and move
towards a one firm, firm model.

CONCLUSION

It is no longer
okay to continue the status quo. During Covid-19, survival itself is
akin to growth. But, what next? Perhaps, it is time to understand and
introspect. It is time to move forward from working as disaggregated practices.
It is time to work together. It is time to consolidate.

shailesh.kwebmaker

NEED FOR IMMUNITY AND SPIRITUALITY IN PANDEMIC

How can I emerge stronger through this
devastating pandemic and become a real winner in a new and changed world? This
is a question that must have certainly agitated everyone’s mind in these last
few months.

So much has been written and discussed about
the current situation. The actions that you take now and in the weeks ahead
will without a doubt define you and your attitude towards life. And while the
impact of this crisis will vary across regions, it will be no exaggeration to
say that this time around the burden of destiny is real.

What is emerging from the competing demands
and chaotic conditions is the paramount importance of being positive and doing
the right thing at the right time. After all, anxiety and fear adversely affect
the physiological systems that protect individuals from infection.

Let’s begin with immunity, the most desired
condition that everyone wishes for. In today’s technical world the primary role
of immunity is to recognise viruses and to obliterate them. Many good measures
have been discussed and prescribed for improving immunity. These include a
healthy diet, ample sleep, optimum hydration, regular exercise, minimising stress,
meditation, yoga and pranayama, avoiding smoking and alcohol, etc. The
most favoured therapy in vogue is the use of immunity-boosting supplements and
foods.

If and when one gets infected, timely
treatment is of paramount importance. However, healing involves not just
flushing out viruses but simultaneously enhancing the body’s immunity system.
The same principle applies to our spiritual healing, too.

The Bhagavad Gita says that we should
not fan our likes and our dislikes. If such thoughts develop in our minds, we
should simply ignore them. But this is easier said than done.

We do strive to have a spiritual immune
system. In general, such a system refers to our reactions to thoughts,
attitudes, feelings and motivations. Our subconscious mind instinctively
responds to harshly spoken words, expressions and physical gestures. But if we
can control such reactions, we will not only emerge sharper but also as better,
happier and more contented individuals.

I believe that despite the real world’s
annoyances and influences, a skilled spiritual level can support our resolve to
overlook a negative reaction, thus ensuring a higher state of mind. On the
physical level it is a well-established fact that our mental attitude does
impinge on health! It is surely much easier for those who have deeply instilled
these factors in their subconscious / spiritual level.

It is only by following what is dharma
for our body and for our mind that we can strengthen our immune system to fight
against adverse circumstances. A proper diet, a clean lifestyle, a supportive
attitude and spiritual endeavours will certainly boost our immune system. Our
scriptures say that Dharma, grounding, withdrawal from materialistic
activities and practices of Japa and Daan are internal preventive
means.

While modern medicine does provide quick
relief, debates continue about the side-effects and probable long-term harms of
the same. But alternate medicine and cure undoubtedly educate us on how to keep
the environment and ourselves naturally clean.

The spiritual immune system and the physical
immune system are deeply interrelated. It is hard to separate one from the
other and I believe that best results are obtained by working on health at both
levels. We cannot possibly ignore all negative influences from the world, but
we must develop the strength to handle them.

Even as the battle against the existing
pandemic is being fought primarily by our healthcare workers, we can do our bit
by limiting our exposure to the virus by staying indoors, maintaining required
social distancing and following basic hygiene protocols to improve both
physical and social immunity levels.

shailesh.kwebmaker

Income – Accrual of income – Difference between accrual and receipt – Specified amount retained under contract to ensure there are no defects in execution of contract – Amount retained did not accrue to assessee Business loss – Bank guarantee for satisfactory execution of contract – Contract cancelled and bank guarantee encashed – Loss due to encashment of bank guarantee was deductible

42. CIT vs. Chandragiri
Construction Co.; [2019] 415 ITR 63 (Ker.) Date of order: 13^th
March, 2019; A.Ys.: 2002-03 to 2005-06; and 2007-08

Income – Accrual of income – Difference between accrual and receipt –
Specified amount retained under contract to ensure there are no defects in
execution of contract – Amount retained did not accrue to assessee

Business loss – Bank guarantee for satisfactory execution of contract –
Contract cancelled and bank guarantee encashed – Loss due to encashment of bank
guarantee was deductible

The assessee entered into a contract and furnished
a guarantee for satisfactory execution of the contract. There was a defect
liability period reckoned from the date of completion of the contract for which
period the awarder retained certain amounts for the purpose of ensuring that
there arose no defects in the work executed by the assessee. The assessee
claimed that the amount retained did not accrue to it. This claim was rejected
by the AO. The contract was cancelled by the awarder and the bank guarantee was
encashed. An arbitration proceeding was pending between the awarder and the
awardee. The assessee claimed the bank guarantee amount as business loss. The
AO disallowed the claim holding that till the arbitration proceedings were
concluded the assessee could not claim the amount as business loss.

The Tribunal allowed both the claims of the assessee.

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

‘i) Accrual
and receipt are two independent incidents and their matching or correspondence
in time in a given case, if so occurring, is purely a matter of coincidence,
both immaterial and irrelevant for the purpose of determining the fact of
accrual, which has to be on its own terms.

ii) By the specific terms of the contract itself, the awarder was
entitled to retain the amount so as to rectify any defects arising in the
period in which as per the terms of the contract the amount was retained. There
could be no accrual found on the completion of contract, since the assessee’s
right to such amount would depend on there being no defects arising in the
subsequent period during which the awarder was enabled retention of such
amounts.

iii) The
assessee did not have the amounts with it and the bank guarantee had been
encashed and it was a loss which occurred in the A.Y. 2007-08. It was
deductible.’

shailesh.kwebmaker

Section 55A of ITA 1961 – Capital gain – Cost of acquisition – Reference to Valuation Officer – Refusal by AO to make reference to Valuation Officer not proper – Matter remanded to AO for reference to Valuation Officer

41. C.V. Sunny vs. CIT; [2019] 415 ITR 127 (Ker.) Date of order: 19^th
March, 2019;

Section 55A of ITA 1961 – Capital gain – Cost of acquisition – Reference
to Valuation Officer – Refusal by AO to make reference to Valuation Officer not
proper – Matter remanded to AO for reference to Valuation Officer

The assessee, his son and
wife purchased land comprised in the same survey number for the same price on
the same day in 1975. The assessee and his son sold the land on 19^th
January, 2006 at the same price. The assessee showed the cost of acquisition of
the land as on 1^stApril, 1981 at Rs. 1,15,385 per cent, which was
later revised to Rs. 94,132 per cent. The AO did not accept this. He held that
since the cost of acquisition of land owned and sold by the assessee’s son as
on 1^st April, 1981 was fixed at Rs. 1,000 per cent, the cost of
acquisition of the land owned and sold by the assessee should also be fixed at
the same rate.

The Commissioner (Appeals) dismissed the appeal
filed by the assessee. The Tribunal found that the cost of acquisition
determined in respect of the land owned by the assessee’s son had been approved
by the court in the case filed by him. It held that there existed no
circumstances to make a reference u/s 55A of the Income-tax Act, 1961 as
contended by the assessee and that there was no illegality committed by the AO
and the Commissioner (Appeals) in adopting the same value as the cost of
acquisition in respect of the land owned and sold by the assessee.

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

‘i) The AO
should have made a reference to the Valuation Officer u/s 55A in respect of the
cost of acquisition of the land sold by the assessee.

ii) The AO
had taken it for granted that since the assessee and his son had purchased the
property in the same survey number on the same day at the same rate, the cost
of acquisition would not be different in respect of the two lands and therefore
it was not necessary to make a reference u/s 55A.

iii) In the
assessee’s son’s judgement the court had not approved or disapproved the
valuation of the capital asset made by the AO in respect of the land owned and
sold by the son of the assessee who did not seek any reference u/s 55A at the
first Appellate stage but raised such contention only before the Tribunal for
which reason the court did not interfere with the valuation of the land made by
the AO. Therefore, the authorities were not justified in holding that the court
had approved the cost of acquisition of the land owned and sold by the son of
the assessee as Rs. 1,000 per cent. Even before the AO, the assessee had
produced the report of a registered valuer and the assessee had based his claim
on the estimate made by the registered valuer. The AO had not shown any reason
whatsoever to have rejected the valuation made by the registered valuer.

iv) The
assessment order passed by the AO and the revised order as confirmed by the
Appellate authorities are set aside. The matter is remitted to the AO to make a
reference u/s 55A to the Valuation Officer.’

shailesh.kwebmaker

Sections 2(47) and 45(4) of ITA 1961 – Capital gains – Firm – Retirement of partners – Consequential allotment of their shares in assets in firm – Not transfer of capital assets – Provisions of section 45(4) not attracted – No taxable capital gain arises

40. National Co. vs. ACIT; [2019]
415 ITR 5 (Mad.) Date of order: 8^th April, 2019;A.Y.: 2004-05

Sections 2(47) and 45(4) of ITA 1961 – Capital gains – Firm – Retirement
of partners – Consequential allotment of their shares in assets in firm – Not
transfer of capital assets – Provisions of section 45(4) not attracted – No
taxable capital gain arises

The assessee was a partnership firm with four
partners. Two of the partners agreed to retire from the partnership business
and the remaining two partners, with their son being admitted as another
partner, continued the business. At the time of retirement of the two partners,
the assets and liabilities of the firm were valued and the retiring partners
were allotted their share in the assets in the firm. The AO made an addition on
account of capital gains u/s 45 of the Income-tax Act, 1961 on the ground that the long-term capital gains arose out of transfer of immovable
properties by the assessee to the retiring partners.

The Commissioner (Appeals) held that the reconstitution
of the partnership would not attract the provisions of section 45(4) and
deleted the addition made on account of long-term capital gains. The Tribunal
allowed the appeal filed by the Department and held that section 45(4) applied
to the assessee and that there was transfer of assets within the meaning of
section 2(47)(vi) of the Act.

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

‘i) When a
partner retires from a partnership he receives his share in the partnership and
this does not represent consideration received by him in lieu of relinquishment
of his interest in the partnership asset. There is in this transaction no
element of transfer of interest in the partnership assets by the retiring
partner to the continuing partner.

ii) The
provisions of section 45(4) would not be attracted on the retirement of the two
partners and consequential allotment of their share in the assets in the
assessee firm. There was only reconstitution of the firm on the retirement of
the two partners and admission of another partner. The partnership continued.
There was only a division of the assets in accordance with their entitlement to
their shares in the partnership, on the retirement of the partners. There was
no element of transfer of interest u/s 2(47) in the partnership assets by the
retiring partners to the continuing partners in this transaction.

iii) We
therefore answer the substantial question of law in favour of the assessee and
against the Revenue. The appeals of the assessee are allowed.’

shailesh.kwebmaker

Section 37 of ITA 1961 – Business loss –Embezzlement of cash by director of assessee – Recovery of amount or outcome of pending criminal prosecution against director before Magistrate Court – Not relevant – Deduction allowable

39. Principal CIT vs. Saravana
Selvarathnam Trading and Manufacturing Pvt. Ltd.; [2019] 415 ITR 146 (Mad.)
Date of order: 14^th March, 2019; A.Y.: 2012-13

Section 37 of ITA 1961 – Business loss –Embezzlement of cash by director
of assessee – Recovery of amount or outcome of pending criminal prosecution
against director before Magistrate Court – Not relevant – Deduction allowable

For the accounting year 2012-13, the assessee claimed as bad debt u/s 36
of the Income-tax Act, 1961 the amount embezzled by a director who dealt with
the day-to-day business activities. Upon the embezzlement being found out
during the internal audit, the director was removed from the board of
directors. A criminal prosecution against him was still pending before the
Metropolitan Magistrate. The Assessing Officer disallowed the claim for
deduction.

The Tribunal held that the conditions prescribed u/s 36(2) were not
complied with and therefore deduction of the embezzled amount could not be
allowed as bad debt but the embezzled amount claimed was allowable as a
business loss suffered by the assessee in the course of its business activity.

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

‘i) The embezzlement by one
of the directors or an employee of the business of the assessee during the
ordinary course of business would be a business loss irrespective of the
criminal prosecution of the director or employee. The final outcome of the
criminal proceedings or recovery of the amount in question would not determine
the claim of the assessee in the A.Y. 2012-13 when it was written off as a
business loss.

ii) The Tribunal had
rightly held it to be a business loss as it was treated to be only pilferage of
the assessee company’s funds by a director on the board of the company. No
question of law arose.’

shailesh.kwebmaker

IS GSTR3B A RETURN?

INTRODUCTION

Recently, the Gujarat High Court had occasion
to examine an interesting issue of whether GSTR3B is a return as envisaged u/s
16(4) of the CGST Act, 2017. In a detailed judgement, the Court held that the
press release dated 18^th October, 2018 could be said to be illegal
to the extent that it clarifies that the last date for availing input tax
credit relating to the invoices issued during the period from July, 2017 to
March, 2018 is the last date for the filing of returns in Form GSTR3B for the
month of September, 2018. The decision brings to the fore the risks of changing
tax compliance processes without supporting amendments in the legislative
framework.

GUJARAT HIGH COURT DECISION

The pivot of the entire debate revolved
around the time limit for claiming input tax credit as prescribed u/s 16(4) of
the Act. The said provision is reproduced below for ready reference:

A registered person
shall not be entitled to take input tax credit in respect of any invoice or
debit note for supply of goods or services or both after the due date of
furnishing of the return under section 39 for the month of September following
the end of financial year to which such invoice or invoice relating to such
debit note pertains or furnishing of the relevant annual return, whichever is
earlier,

¹Provided that the registered person shall be
entitled to take input tax credit after the due date of furnishing of the
return under section 39 for the month of September, 2018 till the due date of furnishing of the return under the
said section for the month of March, 2019 in respect of any invoice or invoice
relating to such debit note for supply of goods or services or both made during
the financial year 2017-18, the details of which have been uploaded by the supplier
under sub-section (1) of section 37 till the due date for furnishing the
details under sub-section (1) of said section for the month of March, 2019.

Since section 16(4) of the Act refers to a
return to be filed u/s 39, the Court directed itself to the provisions of
section 39(1) of the CGST Act which reads as under:

Every registered
person, other than an Input Service Distributor or a non-resident taxable
person or a person paying tax under the provisions of section 10 or section 51
or section 52 shall, for every calendar month or part thereof, furnish, in such
form and manner as may be prescribed, a return, electronically, of inward and
outward supplies of goods or services or both, input tax credit availed, tax
paid and such other particulars as may be prescribed, on or before the
twentieth day of the month succeeding such calendar month or part thereof.

The search for the correct return format then
led towards Rule 61(1) which prescribes GSTR-3 to be the form in which the
monthly return specified u/s 39(1) should be filed. The said Rule reads as
under:

Every registered
person other than a person referred to in section 14 of the Integrated Goods
and Services Tax Act, 2017 or an Input Service Distributor or a non-resident
taxable person or a person paying tax under section 10 or section 51 or, as the
case may be, under section 52, shall furnish a return specified under
sub-section (1) of section 39 in Form GSTR-3, electronically, through the
common portal either directly or through a facilitation centre notified by the
Commissioner.

The provisions of section 16(4), section
39(1), Rule 61(1) and many other provisions were drafted considering the
original workflow of a two-way transaction level matching through the processes
of filing GSTR-1 followed by auto population of credit in GSTR2A and matching
and self-claim in GSTR-2, resulting in the return in form GSTR-3. However, due
to various reasons, the compliance process was sought to be simplified through
the introduction of form GSTR3B. The same was done not though any amendment in
the Act, but through the introduction of Rule 61(5). The initial verbiage of
Rule 61(5) was as under:

Where the time limit
for furnishing of details in FORM GSTR-1 under section 37 and in form GSTR-2
under section 38 has been extended and the circumstances so warrant, return in
form GSTR3B, in lieu of form
GSTR-3, may be furnished in such manner and subject to such conditions as may
be notified by the Commissioner.

The said verbiage suggested that form GSTR3B
was a substitute for the filing of return in GSTR-3. However, the said verbiage
was substituted with retrospective effect with the following words:

Where the time limit
for furnishing of details in form GSTR-1 under section 37 and in form GSTR-2
under section 38 has been extended and the circumstances so warrant, the
Commissioner may, by notification, specify that return shall be furnished in
form GSTR3B electronically through the common portal, either directly or
through a facilitation centre notified by the Commissioner.

Based on the above, the Gujarat High Court
observed that the Notification No. 10/2017 Central Tax dated 28^th
June, 2017 which introduced mandatory filing of the return in form GSTR3B
stated that it is a return in lieu of form GSTR-3. However, the Government, on
realising its mistake that the return in form GSTR3B is not intended to be in
lieu of form GSTR-3, rectified its mistake retrospectively vide
Notification No. 17/2017 Central Tax dated 27^th July, 2017 and
omitted the reference to return in form GSTR3B being return in lieu of Form
GSTR-3.

The observations of the Gujarat High Court
treating GSTR3B not as a substitute of GSTR-3 but merely as an additional
compliance requirement have widespread ramifications and some of those aspects
are discussed in this article.

IS THERE A DUE DATE FOR CLAIMING INPUT TAX
CREDIT?

While the Gujarat High Court does lay down
that the press release clarifying that the due date of filing the GSTR3B for
the month of September, 2018 to be the due date for claiming input tax credit
is illegal, it does not define any specific date by which the input tax credit
has to be claimed. With the understanding that the return referred to in
section 16(4) is GSTR-3 and not GSTR3B, it may be relevant to once again read
the provisions of section 16(4) to decipher the due date.

It is evident that the provision prescribes
the earlier of two events as the last date for claiming input tax credit:

(i) Due date of furnishing GSTR-3 for
September, 2018 – which has been extended ad infinitum;

(ii) Due date of furnishing the relevant
annual return – to be filed in GSTR-9 as per the provisions of section 44 read
with Rule 80.

Therefore, in general cases, the input tax
credit has to be claimed before the due date of furnishing the annual return in
GSTR-9. However, it may be important to note that fresh input tax credit cannot
be claimed in annual return but has to be claimed in GSTR3B (in interim) and
the GSTR-2 (in finality, as and when it is operationalised). Therefore, it will
be important to claim the input tax credit in any GSTR3B filed before the due
date of the filing of the GSTR-9.

WHAT IS THE IMPACT OF ROD ORDER EXTENDING THE
TIME UP TO MARCH?

Through CGST (Second Removal of Difficulties)
Order, 2018, the Government inserted a proviso to section 16(4) and purportedly
sought to extend the September deadline to March. However, the decision of the
Gujarat High Court and the verbiage of the said proviso suggests a different
interpretation. Let us look at the proviso once again:

Provided that the
registered person shall be entitled to take input tax credit after the due date
of furnishing of the return under section 39 for the month of September, 2018
till the due date of furnishing of the return under the said section for the
month of March, 2019 in respect of any invoice or invoice relating to such
debit note for supply of goods or services or both made during the financial
year 2017-18, the details of which have been uploaded by the supplier under
sub-section (1) of section 37 till the due date for furnishing the details
under sub-section (1) of said section for the month of March, 2019.

On a fresh reading of the said proviso, one
would notice that the reference to annual return is missing in the proviso. It
merely refers to the return in section 39 (which as per the Gujarat High Court
decision is GSTR-3 and not GSTR3B) and specifies that the credit can be claimed
till the due date of furnishing the return in GSTR-3 of March, 2019. This
absence of any reference to annual return in this proviso effectively means
that the input tax credit can be claimed at any point of time till the
Government notifies the due date for GSTR-3. However, it may be noted that the
proviso is restrictive in nature and covers only cases where the invoices have
been uploaded by the supplier in form GSTR-1 by the due date of filing GSTR-1
for March, 2019.

AMENDMENTS TO GSTR-1

Section 37(3) of the CGST Act, 2017 permits
rectification of any error or omission of the details furnished in GSTR-1. However,
such rectifications are not permitted after the date of furnishing the return
u/s 39 (GSTR-3, as per the High Court interpretation) for the month of
September or furnishing of the annual return, whichever is earlier.

Applying the above observations relating to
input tax credit, the date of furnishing the annual return would be the outer
date before which the amendments to GSTR-1 can be carried out. It may be noted
that unlike section 16(4) which uses the phrase ‘due date’ of return, section
37(3) uses the phrase ‘date’ of furnishing the return.

WHAT IS THE DUE DATE OF PAYMENT OF TAX?

Section 39(7) prescribes the due date for
payment of tax. The said due date of payment of tax is linked to the date of
filing the return (GSTR-3, as per the decision of the High Court). Due to the
introduction of an interim return in GSTR3B, a proviso was inserted in section
39(7) to provide as under:

Provided that the Government may, on the
recommendations of the Council, notify certain classes of registered persons
who shall pay to the Government the tax due or part thereof as per the return
on or before the last date on which he is required to furnish such return,
subject to such conditions and safeguards as may be specified therein.

Apart from this, Rule 61(6) was inserted in
the CGST Rules, 2017 to provide as under:

Where a return in
form GSTR3B has been furnished, after the due date for furnishing of details in
form GSTR-2,

(a) Part A of the return in form GSTR-3 shall be
electronically generated on the basis of information furnished through form
GSTR-1, form GSTR-2 and based on other liabilities of preceding tax periods and
Part B of the said return shall be electronically generated on the basis of the
return in form GSTR3B furnished in respect of the tax period;

(b) the registered
person shall modify Part B of the return in form GSTR-3 based on the
discrepancies, if any, between the return in form GSTR3B and the return in form
GSTR-3 and discharge his tax and other liabilities, if any;

(c) where the amount
of input tax credit in form GSTR-3 exceeds the amount of input tax credit in
terms of form GSTR3B, the additional amount shall be credited to the electronic
credit ledger of the registered person.

The above provisions have to be read along
with Notification 23/2017 prescribing return in form GSTR3B. Para 2 of the said
Notification lays down the condition requiring the discharge of the tax payable
under the Act. The phrase ‘tax payable under the Act’ is defined under clause
(ii) of the Explanation to mean the difference between the tax payable as
detailed in the return furnished in form GSTR3B and the amount of input tax
credit entitled to for the month.

Having reconciled to the position that GSTR3B
is an additional compliance return and not a substitute for GSTR-3, the
following propositions emerge:

(1) GSTR3B is an additional ad hoc
compliance requirement (akin to advance tax requirement under income tax);

(2) As and when the process of GSTR-2 and
GSTR-3 is operationalised, the difference between the tax payable as per GSTR3B
and GSTR-3 shall be payable under Rule 61(6)(b). There is no reference to any
interest payable on such difference and since the due date of the said payment
is not notified, it is not evident whether there is a delay in the said
payment;

(3) Similarly, Rule 61(6)(c) would also
permit the differential input tax credit to be credited to the electronic
credit ledger at that point of time.

THE WAY FORWARD

The Gujarat High Court decision clearly
demonstrates the perils of administering the law through notifications and
bringing about fundamental amendments to processes and compliances without
corresponding legislative amendments. It is important for the Government to
look at this decision as a wake-up call and review comprehensively all such
disconnects in law and practice and propose suitable amendments in the
legislative framework so that the law is aligned to the practices expected of
the taxpayers.

shailesh.kwebmaker

INTEREST U/S 201(1A) WHERE PAYEE IS INCURRING LOSSES

ISSUE FOR CONSIDERATION

Section 201(1) of the Income-tax Act, 1961
provides that where any person, who is required to deduct any sum in accordance
with the provisions of the Act, does not deduct, or does not pay, or after so
deducting fails to pay the whole or any part of the tax as required under the
Act, then he is deemed to be an assessee in default in respect of such tax. The
proviso to this section, inserted with effect from 1^st July, 2012,
provides that such a person shall not be regarded as an assessee in default if
the payee has furnished his return of income u/s 139, has taken into account
the relevant sum (on which tax was deductible or was deducted) for computing
his income in such return of income, and has paid the tax due on the income
declared by him in such return of income and has furnished a certificate to
this effect from an accountant in form 26A prescribed under rule 31ACB. An
amendment by the Finance Act (No. 2) 2019, not relevant for our discussion, has
been made to apply the proviso to the case of a payee, irrespective of his
residential status.

Sub-section (1A) of section 201, without
prejudice to section 201(1), provides for payment of interest at the prescribed
rate for the prescribed period by the person who has been deemed to be in
default; however, in case of a person who has been saved under the proviso as
aforesaid with effect from 1^st July, 2012 such interest shall be
paid from the date on which such tax was deductible by him to the date of
furnishing of the return of income by the payee.

A question has arisen before the High Courts
as to whether any interest u/s 201(1A) is payable by the payer on failure to
deduct tax at source, in a case where the payee has filed a return of income
declaring a loss. While the Madras, Gujarat and Punjab and Haryana High Courts
have taken the view that interest is payable even in such cases, the Allahabad
High Court has taken a contrary view, that no interest is payable in such a
case.

DECISION IN SAHARA INDIA COMMERCIAL CORPN.
LTD. CASE

The issue came up before the Allahabad High
Court in the cases of CIT (TDS) vs. Sahara India Commercial Corporation
Ltd. (ITA Nos. 58, 60, 63, 68 and 69 of 2015 dated 18^th January,
2017).

In those cases pertaining to the period
prior to the amendment of 2012, the assessee had made payments to a sister
concern, Sahara Airlines Ltd., without deducting the tax at source, which had
suffered loss in all the relevant years. While interest u/s 201(1A) had been
levied by the AO, the Tribunal had held that if the recipient payee had filed
all its returns for those years declaring loss in all the relevant assessment
years, interest u/s 201(1A) could not be charged on the payer assessee.
According to the Tribunal, the fact that the loss declared by the recipient in
its return on assessment turned into a positive income, would not make a
difference inasmuch as the tax demand was on account of difference between the
returned income and assessed income and not because of non-deduction of tax by
the assessee payer, and hence it would not alter the situation and no interest
was payable by the payer.

Since no evidence was placed before the
Tribunal regarding the claim of incurring of losses by the recipient, it
restored the matter to the AO for verification that the recipient had filed all
its returns for those years declaring loss in all the relevant assessment years
and there was no tax liability on the receipts at any point of time. The
Tribunal had held that if it was established that the recipient had filed all
its returns for those years declaring loss in all the relevant assessment
years, interest u/s 201(1A) could not be charged on the assessee payer.

On an appeal by the Revenue, the Allahabad
High Court noted that the question about liability of interest u/s 201(1A) had
also been considered by the same court in Writ Tax No. 870 of 2006 in
Ghaziabad Development Authority vs. Union of India and others, wherein
it had been held that the nature of interest charged u/s 201(1) was
compensatory and if the recipient had already paid tax or was not liable to pay
any tax whatsoever, no interest u/s 201(1A) could have been recovered from the
assessee for the reason that interest could have been charged for the period
from when tax was due to be deducted till the date the actual amount of tax was
paid by the recipient; if there was no liability for payment of tax by the
recipient, the question of deduction of tax by the assessee payer would not
arise and the interest also could not have been charged.

The Allahabad High Court following its own
decision approved and confirmed the view taken by the Tribunal, that no
interest u/s 201(1A) was chargeable in a case where the payee had filed a
return of loss.

A similar view, that no interest was
chargeable u/s 201(1A) in cases where the recipient had returned losses, has
been taken by the Income Tax Appellate Tribunal in the cases of Allahabad
Bank vs. ITO 152 ITD 383 (Agra), National Highway Authority of India vs. ACIT
152 ITD 348 (Jab.), Haldia Petrochemicals Ltd. vs. DCIT 72 taxmann.com 338
(Kol.), and Reliance Communications Ltd. vs. ACIT 69 taxmann.com
307 (Mum.).

THE PUNJAB INFRASTRUCTURE DEVELOPMENT BOARD
DECISION

The issue had also come up before the Punjab
and Haryana High Court in CIT vs. Punjab Infrastructure Development Board 394
ITR 195.

In that case, the assessee entered into
contracts with concessionaires for achieving its objects under various models
such as the ‘Build Operate and Transfer’, ‘Design Build Operate and Transfer’
and ‘Operation and Management’ models. Under those contracts, payments were made
to various concessionaires without deduction of tax at source. The AO had held
that the assessee was liable to deduct tax at source on such payments u/s 194C
and, having failed to do so, levied interest u/s 201(1A).

The Commissioner (Appeals) allowed the
assessee’s appeals, holding that no tax was deductible u/s 194C. Since the
assessee was not liable to deduct tax at source at all, the Commissioner
(Appeals) deleted the interest charged u/s 201(1A).

The Income Tax Appellate Tribunal dismissed
the appeals of the Revenue, accepting the assessee’s alternative argument that
the assessee was not liable to interest u/s 201(1A) on account of the fact that
the payees had filed their returns, which were nil returns or returns showing a
loss, and the sums paid were included in such return of income. The Punjab and
Haryana High Court, on appeals by the Revenue, analysed the provisions of
section 201. Though these appeals pertained to assessment year 2007-08, the
High Court thought fit to analyse the amendment of 2012 by way of insertion of
the provisos to sub-section (1) and sub-section (1A), since it was contended
that these amendments were clarificatory in nature and therefore had
retrospective effect. The High Court observed that even if the proviso to
sub-section (1) was held to be not retrospective, it would make no difference
to the assessee’s case in view of the judgement of the Supreme Court in the
case of Hindustan Coca-Cola Beverage (P) Ltd. vs. CIT 293 ITR 226,
where the Supreme Court held as follows:

‘10. Be that as it may, circular No.
275/201/95-IT (B) dated 29.1.1997 issued by the Central Board of Direct Taxes,
in our considered opinion, should put an end to the controversy. The circular
declares “no demand visualised under section 201(1) of the Income Tax Act
should be enforced after the tax deductor has satisfied the officer in charge
of TDS, that taxes have been paid by the deductee assessee.” However, this
will not alter the liability to charge interest under section 201(1A) of the
Act till the date of payment of taxes by the deductee assessee or the liability
for penalty under section 271C of the Income Tax Act.’

According to the Punjab and Haryana High
Court, the last sentence made it clear that even if the deductee had paid the
tax dues, it would not alter the liability of the payer of the sum to pay
interest u/s 201(1A) till the date of payment of taxes by the deductee. Thus,
according to the High Court, even prior to the amendment on 1^st
July, 2012, the liability to pay interest u/s 201(1A) was there even in cases
where the deductee had paid the tax dues.

The Court observed that the language of
section 201 was clear and unqualified; it did not permit an assessee to decide
for itself what the liability of the deductee was or was likely to be; that it
was a matter for the AO who assessed the returns of the deductee; and it was in
fact not even possible for him to do so inasmuch as he could not have
ascertained with any degree of certainty about the financial position of the
deductee. According to the High Court, a view to the contrary would enable an
assessee to prolong the matter indefinitely and, if accepted, it might even
entitle the assessee to contend that the adjudication of the issue be deferred
till the finalisation of the assessment of the deductee; that such could never
have been contemplated by the legislature; and that the language of section 201
did not even suggest such an intention.

The Punjab and Haryana High Court also
referred with approval to the decisions of the Madras High Court in the cases
of CIT vs. Ramesh Enterprises 250 ITR 464 and CIT vs.
Chennai Metropolitan Water Supply and Sewerage Board 348 ITR 530. The
Court agreed with the view that the terminal point for computation of interest
had to be taken as a date on which the deductee had paid taxes and filed
returns, even before the amendment. The Court also observed that section 197
militated against the deductor unilaterally not paying or paying an amount less
than the specified amount of TDS, by itself deciding the deductee’s liability
to pay tax or otherwise.

In conclusion the Court held that interest
u/s 201(1A) was chargeable even if the deductee had incurred a loss, though it
remanded the matter back to the Tribunal for deciding on the applicability of
section 194C.

The Gujarat High Court, in the case of CIT
vs. Labh Construction & Ind. Ltd. 235 Taxman 102, has taken a
similar view that interest was payable in such a case, though holding that the
liability to pay interest would end on the date on which the assessment of the
deductee was made.

OBSERVATIONS

The purpose of charging the interest in
question is to ensure that the Revenue is compensated for late payment of the
tax from the period when it was due till the time it was recovered. Where no
tax is due, the question of payment of any compensatory interest should not
arise at all unless it is penal in nature. In ascertaining the fact of payment
of taxes, due credit should be given for the taxes paid by the payee and also
to the fact that the payee was otherwise not liable to tax. The Gujarat High
Court, in the case of CIT vs. Rishikesh Apartments Co-op. Housing Society
Ltd. 253 ITR 310, has observed:

‘From the legal provisions discussed
hereinabove, it is crystal clear that in the instant case, Ravi Builder, on
whose behalf the tax was to be paid by the assessee, had duly paid its tax and
was not required to pay any tax to the Revenue in respect of the income earned
by it from the assessee. If the tax was duly paid and that too at the time when
it had become due, it would not be proper on the part of the Revenue to levy
any interest under section 201(1A) of the Act, especially when the builder had
paid more amount of tax by way of advance tax than what was payable by it. As
the amount of tax payable by the contractor had already been paid by it and
that too in excess of the amount which was payable by way of advance tax, in
our opinion, the Tribunal was absolutely right in holding that the tax paid by
the contractor in its own case, by way of advance tax and self-assessment tax,
should be deducted from the gross tax that the assessee should have deducted
under section 194C while computing interest chargeable under section 201(1A) of
the Act. If the Revenue is permitted to levy interest under the provisions of
section 201(1A) of the Act, even in the case where the person liable to be
taxed has paid the tax on the due date for the payment of the tax, the Revenue
would derive undue benefit or advantage by getting interest on the amount of
tax which had already been paid on the due date. Such a position, in our
opinion, cannot be permitted.’

A similar view has been taken by the Bombay
High Court in the case of Bennett Coleman & Co. Ltd. vs. ITO 157 ITR
812, that interest is compensatory interest in nature and it seeks to
compensate the Revenue for delay in realisation of taxes. Interest should be
charged only where tax is due and if
found to be due, for the period ending with the payment of such tax. In a case
where the payee has a loss, there is no question of payment of any tax by the
payee, and therefore the question of payment of interest by the payer also
should not arise.

The deductor
cannot be held to be an assessee in default if tax has been paid by the
deductee. Once this non-payment of taxes by the recipient is held as a
condition precedent to invoking section 201(1), the onus is then on the AO to
demonstrate that the condition is satisfied. It is for the AO to ascertain
whether or not the taxes have been paid by the recipient of income – Hindustan
Coca-Cola Beverages (Supra).The question of making good the loss
of Revenue by way of charging of interest arises only when there is indeed a
loss of revenue, and loss of revenue can be there only when the recipient has a
liability to tax and has yet not paid the tax. It is also necessary for the AO
to find that the deductee has also failed to pay such tax directly before
treating the payer as an assessee in default. In Jagran Prakashan Ltd.
vs. Dy. CIT, 345 ITR 288:

‘…The issue on hand, of charge of
interest u/s 201(1A), cannot be adjudicated in cases where the payee has filed
a return of loss, by relying on the non-contextual observation or an obiter dicta of the decision in the case of Hindustan
Coca-Cola Beverage (P) Ltd. vs. CIT 293 ITR 226. In that case, the issue
was about the treatment of the assessee in default or not where the payee had
otherwise paid taxes and the apex court held that the payer was not to be
deemed to be an assessee in default. The issue of interest u/s 201(1A) was not
before the Court. The Court, applying the circular of 1997, held that the payer
was not an assessee in default and stated, though not being called to do so,
that the decision had no implication on the liability to pay interest u/s
201(1A) for the period up to the date of payment by the payee. It is
respectfully stated that a part of the observations of the decision should not
be used to apply to the facts that are materially different and not in the
context…’

The better view therefore seems to be that
of the Allahabad High Court that no interest is chargeable u/s 201(1A) in a
case where the deductee has incurred losses during the relevant assessment year
and has no income chargeable to tax and no tax was payable by the payee and
that there was no loss to the Revenue.

It is relevant
to note that the decisions referred to and analysed here are in respect of the
period before 1^st July, 2012
with effect from which date provisos have been inserted in section
201(1) and (1A). The first amendment in section 201(1) provides that an
assessee shall not be deemed to be in default in cases where the conditions
prescribed are satisfied, the main condition being the payment of taxes by the
payee. It can therefore be safely stated that the amendment in sub-section (1)
is providing the legislative consent to the law laid down by the courts and
discussed here, and to that extent there is no disagreement between the
taxpayers and the tax gatherers.

Whether the same can be said of the second
amendment in section 201(1A) by way of insertion of the proviso therein which
has the effect of providing for payment of interest by the payer, for the
period up to the date of filing the return of income? Can it be said that
interest under sub-section (1A) shall be payable in cases governed by the
proviso to section 201(1A) for the period up to the date of filing of return by
the payee now that an express charge has been created for such payment? In our
considered opinion, no interest shall be payable by the payer in a case where
the payee has filed a return of loss or where he has paid taxes on its income
before the year-end, for the following reasons:

(i) Sub-section (1A) creates a charge for
payment of interest without prejudice to the fact that the payer is not treated
as an assessee in default. In other words, the charge is expected to
stick even where the payer is not treated as an assessee in default. It is
possible to seriously contend that an independent charge for levy of interest
is not sustainable where the assessee is not held to be in default and there
otherwise is no loss of revenue. In the circumstances, for the Revenue to
demand compensation may not hold water;

(ii) The courts, as noted above, without the
benefit of the amendments, have held that no interest u/s 201(1) was chargeable
in the facts and circumstances discussed here. The ratio of these decisions
should help the assessee to successfully plead that no interest is payable by
the payer where no tax is found to be payable by the payee even after the
amendment of section 201(1A);

(iii) With insertion of the proviso to
sub-section (1), it is clear that the legislature intends to exempt the payers
who ensure the compliance of the prescribed conditions. This intention should
be extended to interest under sub-section (1A) as well;

(iv) A proviso to the main section should be
applied only in cases where the main section is otherwise found to be
applicable; in cases where there is no ‘failure’ on the part of the payer, the
question of applying the proviso should not arise. The proviso here has the
effect of limiting the liability and not expanding it. In that view of the
matter, the insertion of the proviso should not be read to have created an
independent charge for levy of interest. In other words, the understanding
prevailing before the insertion w.e.f. 1^stJuly, 2012 has not
changed at all qua the levy of interest;

(v) For the charge of interest under
sub-section (1A) to succeed, it is essential to establish the failure to deduct
tax or pay tax; such failure has to be determined w.r.t. the liability to
deduct and / or pay which in turn is linked to the liability of the payee to
taxation. In cases where the payee is not otherwise liable to pay any taxes, it
may be very difficult to establish failure on the part of the payer;

(vi) Cases where the payee has filed the
return of loss or where it has paid taxes before the year-end, have a much
better case for exemption from interest.

shailesh.kwebmaker

71ST ANNUAL GENERAL MEETING 9TH JULY, 2019

The 71^st
Annual General Meeting of the BCAS was held at the Yogi Sabhagruha, Dadar, on
Tuesday, 9^thJuly, 2019.

The President,
Mr. Sunil Gabhawalla, took the chair and called the meeting to order. All
business as per the agenda contained in the notice was conducted, including
adoption of accounts and appointment of auditors.

Mr. Mihir
Sheth, Hon. Joint Secretary, announced the results of the election of the
President, Vice-President, two Secretaries, Treasurer and eight members of the
Managing Committee for the year 2019-20.

OFFICE-BEARERS

President Mr.
Manish Sampat

Vice-President Mr.
Suhas Paranjpe

Joint Secretary Mr.
Mihir Sheth

Joint Secretary Mr.
Samir Kapadia

COMMITTEE MEMBERS

Anil Doshi Chirag
Doshi

Bhavesh Gandhi Divya
Jokhakar

Jagdish Punjabi Rutvik
Sanghvi

Kinjal Shah Mandar
Telang

CO-OPTED MEMBERS

Anand Bathiya Zubin
Billimoria

Vaibhav Manek Hardik
Mehta

Ganesh Rajagopalan Shreyas
Shah

EX-OFFICIO

(Outgoing President) Sunil Gabhawalla

Member (Publisher) Raman
H. Jokhakar

The ‘Jal Erach
Dastur Awards’ for the features and articles appearing in the BCAS Journal
during the year 2018-19 were presented to CA Dolphy D’Souza (Best Feature) and
Ms Priya Sawant (Best Article).

The book,
‘Input Tax Credit Under GST’, authored by CA Darshan Ranavat, was officially
released on the occasion.

Before the
conclusion of the AGM, members, including Past Presidents of the BCAS, were
invited to share their views and observations about the Society.

The Founding Day
lecture was delivered at the end of the formal proceedings of the AGM. It was
an outstanding oration by Mr. Pinakin Desai, the well-known professional who
spoke on the ‘Finance Bill’ before a capacity audience that heard him in
pin-drop silence.

OUTGOING PRESIDENT’S
REPORT

Sunil
Gabhawalla: As I rise
before you for the last time as the President of this esteemed Society, I have
mixed emotions of fulfilment and joy – Fulfilment at having lived a year full
of purpose and the joy of handing over the baton to a worthy Incoming
President, Manish, who also has become a very dear friend during the BCAS
journey.

In my
acceptance speech I had presented the annual plan for BCAS year 2018-19
focussing on the expectations of the common man, which we had identified to be
broadly in four distinct sets – “Re-engineer myProfession”, “Re-kindle
myPassion”, “Re-store myPride” and “Re-juvenate myBCAS”. In alignment with this
annual plan, the Managing Committee and the nine Sub-Committees delivered
around 233 events, 19 publications, 12 editions of the BCAJ, 12 digital assets,
24 representations and countless interactions both in person and online, easily
resulting in an average touch-point of more than one on each working day and
clocking a little over 180,000 hours of education. Before moving ahead, there
is one honest confession to make. At the start of the year, when I gazed
through the crystal ball, I had never imagined that we would achieve this
volume and quality, but the stupendous work undertaken by numerous volunteers
made this possible. My heart is filled with gratitude to each one of them.

Full credit is
due to the Chairmen and Co-Chairmen of the Committees. Totalling 11 in all,
they constituted the Dream World Cup Team which could easily win any match. I
am a strong believer of
the BCAS policy of having a Past President as a Chairman of the Committee. In
my view, it is the key differentiator of the Society as compared to other
organisations. During the year, I have witnessed each of the Chairmen spending
considerable time and energy in the cause of the Society – not only by sharing
the experience and providing balanced perspective, but also through actual
execution. It was not uncommon for a Chairman to even sit down and draft an
announcement. In fact, the eye for minute detail and the commitment of these
personalities brings soul to each event and publication and provides that
impeccable quality, event after event, publication after publication. I request
you all to join hands in acknowledging their role towards the growth of the
Society.

It is now time
to recognise the selfless efforts of the other members of the Core Group – the
Conveners, Course Coordinators and Committee Members. Each of the 43 Committee
/ Sub Committee meetings was full of excitement, ideas and enthusiasm. When the
springboard itself is so strong and the execution thereafter is also flawless,
it is not a surprise that, year after year, the Society, despite stiff
competition and a structural defect of no CPE Credit, surpasses the
achievements of the previous year.

The vision
statement of the Society starts by emphasising that it shall be a
learning-oriented organisation. Content therefore is the key ingredient to such
learning. The faculties, authors, brains trustees, panellists constitute the
nucleus around which the other substance is woven. We need to thank them for
selflessly sparing time out from their busy schedule towards the noble cause of
the Society.

Let me take a
small pause in my thanksgiving endeavour and bring my attention back to the
annual plan. Befitting the theme, we did try to concentrate our energies on the
common man and his four expectations. The sheer volume of the events indicated
earlier presents an impediment in showcasing each one of them. While each of
the events was a precious gem, some initiatives stood out distinctly and it
would not be out of place to revisit some fond memories of such events.

You would all
agree that the profession is passing through very interesting times and needs
re-engineering. The Society continuously held lecture meetings on innovative
topics like ‘the impact of technology on the role of auditors’”, ‘making
internal audit count’, ‘changing risk landscape for audit profession’, ‘AI, ML
and future of internal audit’, etc., where eminent personalities like P.R.
Ramesh, T.N. Manoharan, N.P. Sarda and Shailesh Haribhakti challenged the status
quo and presented their impression of how the profession would evolve in
the future. While these events dealt with the future of the profession, many
lecture meetings catered to the immediate needs of the members on a real-time
basis. Be it understanding the GST Returns or Audit Reports or the
newly-introduced ‘Banning of Unregulated Deposit Scheme’, the Society was
always at the forefront in organising such events. We had the occasion to
invite the CEO of GSTN Prakash Kumar to share his experiences on the GSTN
Portal, whereas senior Department officials addressed us on the TDS and VAT
Amnesty Scheme. We also requested seniors and subject experts from our Core
Group to speak on varied topics ranging from filing of income tax returns to
CSR, Important Amendments relevant to Audit, Important Direct Tax Decisions and
so on.

With a view to
keep the knowledge delivery crisp, relevant and participative, the panel
discussion format was introduced in many events – Corporate Law NRRC and
Internal Audit Conclave being a few examples. Panel discussion as a format was
also found popular and effective in RRCs – be it the General RRC or the ITF or
the GST RRC. We had events like the Real Estate Seminar, Tech Summit, etc.,
designed totally on the format of panel discussion. We also conducted many
industry-specific events like the workshops on NBFCs, Charitable Trusts and
Real Estate.

Taking the cue
from the successful long-duration courses on topics like DTAA, FEMA and
Advanced Transfer Pricing conducted since many years, a new long-duration
course on GST was successfully conducted during the current year. Over and
above these courses, many curtain-raiser courses covering the fundamentals of
the domain were also organised – Internal Audit 101 Series and GAAR Workshop
being examples.

The year saw an
increased focus on the use of technology. Be it Courseplay, Youtube and the
other social media or the digital video initiative of ‘Tax GuruCool’, members
were no longer constrained due to geographical limitations. A series of
workshops around effectively using proprietory software like SAP, Power BI,
IDEA, etc. were organised to equip the members to scale up their offerings. The
Tech Summit was an excellent event which showcased the endless possibilities
offered by technology solutions to our members. A few interesting concepts of
sponsorships and exhibition stalls were tried for the first time at the Society
and they were well received by the participants.

The five
residential courses of the Society were very popular and successful. We tried
many new concepts in the General RRC held at Agra, including a full day devoted
to practice management-related topics. The Society regularly conducted joint
events with other organisations like DTPA, JCAG, IIA, IMC, CTC, GSTPAM, AIFTP,
MCTC, FFE, etc. While some of these provided a geographical penetration, some
provided the Society an exposure to a different target audience.

In order to
re-inculcate the reading habit, the nine study circles were rejuvenated and
made more participative. Structured section-wise reading of the GST Law was
also attempted by a select group of invited faculties through the Intensive
Study Group concept in order to develop interpretation skills in this nascent
law.

Students
constitute the future of the profession. The triangle of graduation studies, CA
curriculum and article training leaves little time for recreation and
self-reflection. It’s indeed events like Tarang which bring out their
latent skill sets and give them the much-needed break from the monotony. The
Students’ Study Circle was also reactivated and found a lot of interest due to
the choice of relevant topics and faculties.

The Society,
jointly with the BCAS Foundation, undertook various social causes like tree
plantation, blood donation camps, heritage walk, etc. It also undertook the
task of providing relief to the victims of the Kerala floods.

The Journal
Committee celebrated the 50^th year of the BCAJ by
commemorating feature writers who have written for more than five years. I
would like to place on record special appreciation for the Editor Raman
Jokhakar who led the year from the front. The Golden Year glowed even more
bright under your able leadership.

During the
year, the Society made a series of representations to the government
authorities on varied topics. Most of these representations received keen
interest from the policy makers and the Society was frequently invited to
present its views on various proposed legislations. A substantial portion of
the simplified GST Audit Report finds its roots in the recommendations and
efforts of the Society. The recent interpretation on the role of the GST
Auditor was being canvassed by the BCAS right from day one and it is satisfying
to find the said interpretation being revalidated by the government. The
Society also connected with other professional organisations in jointly
representing various other issues before the government. This effort also
received good media coverage and made the government act upon some of the
representations.

It’s time to
revert back to the thanksgiving. It’s now the turn of the office-bearers –
Manish, as an able Vice-President, provided the vital back-end support
throughout the year and also acted as a wise sounding board for any new
adventures or misadventures that came to my mind. With Suhas ably handling the
Treasury, I did not have to worry about finance and accounts. Mihir was the
go-to person for all Information Technology-related initiatives and issues,
whereas Abhay was the strong support for the events, including the Committee
meetings. I just cannot thank them enough. Together, we could divide activities
based on our strengths and generate synergies which helped us achieve what we
had dreamt of. My thanks are also due to their spouses – Poonam, Nita, Nipa and
Awani.

How can I miss
thanking my spouse? Thank you Jayashree for supporting me throughout the year
with your perspectives and also taking good care of Prakruti and Hriday.

Not coming from
a large firm background, there was always an anxiety about whether the BCAS
commitment would impact the professional practice. I am really blessed that my
partners and my team at SBGCO took on the baton really well and managed my
practice so that I could concentrate on fulfilling my obligations at BCAS. My
special thanks to Parth, Yash, Darshan and everyone at team SBGCO for walking
the extra mile. At a young age, you have set an example for many others to
emulate. The year came with lots of pressure on my time and helped me discover
my priorities. This discovery will go a long way in moulding my future – my gym
instructor is waiting for more regular visits from my side and so is the couch
in my library. After a year-long sabbatical, it is now time to accept speaking
assignments as also fulfil the promises made to family and friends.

My best wishes
and congratulations to the new team at the BCAS; I would like to wish Manish
all the best for an illustrious year ahead. Having interacted with him closely,
I am fully confident that he will take the Society to even greater heights
during his tenure.

Thank you.

INCOMING PRESIDENT’S
SPEECH

Manish
Sampat: I take this
opportunity to congratulate my predecessor Sunil for a fabulous and memorable
year at the helm of our Society, which comes to an end today. During the last
one year he has led by example and has ensured that the quality of service to
all the members is taken to greater heights. Now this has made my life much
more difficult, because the bar of expectation has risen so much that I will
have to do a tremendous effort just to equal it. As I embark on my journey as
President of this prestigious Society, I am both humbled and honoured and would
like to thank all of you and in particular the Past Presidents of the Society
for bestowing this honour on me, showing confidence in my capabilities and
considering me worthy of this position.

It is a matter
of great satisfaction, sense of achievement and pride for me, both personally
and professionally. I am also aware that along with position come greater
responsibility, dedication and commitment. I assure you of my best efforts and
promise you that I will strive to deliver to the best of my ability. I look
forward to the same love, support, encouragement and understanding that you
have been showing to all our Presidents in the past.

Our Society was
formed in 1949 and as we celebrate 70 years of our existence today and of our
service to our members… 70 years is no small achievement and I salute the founders
who had the vision to form this Society seven decades ago… and the
contributions of all the Past Presidents to bring this Society to its current
position. The Society has always offered mentorship, nurtured leadership and
given several highly successful torch-bearers to the profession.

Today I am in
front of you because of two reasons. One is that I am a chartered accountant
and the second is that I am associated with this Society. Before I share my
annual plan with you, I want to share with you a very short story. A story of a
typical South Bombay attitude boy, happy-go-lucky boy who was never bothered in
life, never serious about anything, who also used to do DJ-ing in his college
days, and immediately joined his father’s business during his college days.
After completing his graduation, he had only two wishes, one was to take the
family business forward, and second, was to get married. In fact, he had also
told his parents to find a suitable girl for him. But, in fact, life had
something else in store for him and his destiny was to take him somewhere else.

His father,
Pratap Sampat, was the only person who wanted him to be a CA, but since he
could not convince him, he took him to his family friend, Pravinchandra N.
Shah, who was a chartered accountant and also a family friend and he convinced
him (the boy) to become a chartered accountant. So he started his articles and
that’s how the story began, that’s where the seeds were sown. He started
enjoying what he was doing during his internship. All throughout, his pillar of
strength and inspiration was naturally his mother, Rohini Sampat.

When he started
his CA and during his exams, when he used to get up at 3 or 4 o’clock in the
morning to study, his mother used to give him coffee and sit across the table
just looking at him, as if he is the only person in the world doing his CA.
Even today, she remains a very comforting factor and a pillar of strength.

While doing his
articles, that boy met this pretty girl Poonam and things happened and she
would go on to become his wife and she would give him two lovely children,
Daksh and Kanishka.

Friends, the
rest is history, that naughty boy, that happy-go-lucky chap, that person who
was never serious in life, is today in front of you. Today, I want to thank my
Mom and Dad for shaping my destiny. I mean, they are the real reason why I am
there, and had they not been there, I don’t know where I would have been.
That’s one part of my journey.

The second part
of my journey is that after becoming a CA, even before my results came out, I
immediately plunged into practice. At my very first client meeting I met this
gentleman, he told me in his style, ‘Betaji, do you know about BCAS? Are you a
member of BCAS?’ I said no, but I will become a member. ‘Narang Sahib, thank
you for introducing me to this lovely Society.’

Soon after
that, I met this man Shariq Contractor. I do not have words to describe him. He
has been a friend, a mentor, a philosopher, a father-figure, an elder brother,
and he is always available for me whenever I require him. Even today, I can
discuss any matter with him, be it personal or otherwise. In fact, on my
membership card, I have been fortunate to have as proposer and seconder, Narang
Sahib and Shariq Contractor. After that, whenever I have filed a nomination
form at the BCAS, Shariqbhai and Gautambhai (Gautam Nayak) have always been my
proposer and seconder.

The story
doesn’t end there. After starting my practice, once, coincidentally, while at
the Tardeo Income tax office, I met this gentleman; after I greeted him, he
walks away and then comes back and says, are you a member of the BCAS? I said, yes, I am. He asked,
are you a part of the core group? My reply was ‘No’, I don’t know what is core
group. He said, why don’t you become a part of a core group? ‘We are just
forming a new committee, the HRD Committee, why don’t you become part of the
HRD Committee?’ I don’t think Amitbhai (Ameet Patel) will remember, but I had
asked, what would I have to do? He said, ‘you don’t have to do anything. Our
Chairman is so good that he does all the good work and you just sit and enjoy’.
That’s how my journey in the core group began, and I remember I started as a
course coordinator of the public speaking class which used to take place at
BCAS’s old office – Churchgate Mansion and I used to attend on Saturdays and
that’s where my first extended family of BCAS, my gang, was formed.

Similarly,
Pradeepbhai (Pradeep Shah) has been a great inspiration for me and the lessons
that he has taught me have really benefited me. In fact, in my annual plan, one
arm of the plan is what I have learned from him. I remember he always joked
with me. Once, I was going with him in his car as we used to stay close to each
other. His car broke down and I had to push his car. And till the very last, he would pull my leg
and tell people that he used to harass
me a lot and made me push his car! But I am sure, Pradeepbhai, wherever you
are, you are looking at us and blessing us all. One more thing about him. On
many occasions he used to tell me, ‘Manish, if you want to become President of
the BCAS, either you change your name to Rajesh or you join CNK’. I couldn’t
change my name, so I joined CNK.

My journey as
an office-bearer… In 2015-16, Raman (Raman Jokhakar) invited me to be a part
of the Office-Bearers and I don’t know whether it was by choice or by
compulsion, that he couldn’t find anyone. But yes, I agreed. And, rather than
being the Secretary, I volunteered to be the Treasurer. But between his and
Chetan’s (Chetan Shah) year, they made me sign so many cheques that I felt like
the second richest person in India after Mukesh Ambani! In those two years as
Treasurer I got a full control, a grip of the accounts, the financials and the
operations of the BCAS. That’s what helped me.

After him,
Narayan (Narayan Pasari) pushed me out of my comfort zone and made me take up
Secretary ship. What I learned from him was an eye for detail. He had such an
eye for detail that he could pick a needle from a haystack. Actually it was in
this year that I got more involved, I got more engaged with BCAS and got into
the groove. I started thinking about the direction in which I wanted to take
the Society and how I could contribute to it.

Next came Sunil
(Sunil Gabhawalla). What can I say about this leader… par excellence? The
name Sunil itself has Su-Nil, which means good, dark blue, which means that it
represents Lord Krishna. Actually, Sunil has been a stern and strict but
understanding leader, who would accept no nonsense, and an intellectual leader.
Whatever I say about him will be insufficient. On many occasions I got a chance
to talk to him and I remember that in
one of the conversations he told me, ‘Manish, I have two big dream projects in
my year. One, I want my RRC to be remembered. I want a fabulous RRC, and the
second thing is the Tech Summit’. Friends, you have seen how the RRC has gone,
he has led by example, the multi-disciplinary panel discussion in that RRC was
so well accepted that there were repeated requests to have this from various
organisations. He not only moderated it, but was totally involved in drafting
the case studies. One full day on practice management was also his brainchild.
Coming to the Tech Summit, to be quite frank, when he discussed the matter with
all of us, I remember all of us were so sceptical about what Sunil had in mind.
The super success that the Tech Summit has achieved has made it a flagship
event and we will be repeating it year on year. Sunil, your year has gone and
we have become the best of friends.

Before deciding
on my annual plan I did a little bit of introspection, what should it be, what
should it include, what should be its points? But before that I had to do a
little bit of thinking, that what does BCAS stand for? No doubt today BCAS is
considered the leading organisation of volunteers which is known because of its
ethical systems, because of the quality of its events, the quality of its
programmes and the initiatives that it takes. It is also known because of its
Journal. Whenever you go out, and say that you are representing the BCAS, you
get a response that they already know about the Journal. Before the BCAS’s
reach the Journal has already reached there. Finally, BCAS is also known for
its innovativeness and it has many firsts to its credit that others copy. This
is the strength of BCAS.

However, there
are challenges and the challenges, I think, can be broadly classified into two
parts. One is the challenges from other organisations, because other
organisations have also upped their mantle, giving similar programmes with
similar quality; and the second one is the dynamic, changing stratosphere or
the demands of the members. The members’ age profile has changed, their
preferences have changed and so BCAS needs to be relevant and it has to think
out of the box. It has to be constantly adapting to changes and open to
changes, new ideas and innovations.

Coming to
the annual plan, after
doing this introspection and understanding the background, I asked myself, what should be my priorities?
What should be my annual plan? I listed down the pointers and priorities. When I looked back to
compare it to the last two or three years’ plans, the points were more or less
the same. There was nothing different. So from that day onwards I decided, if
I can’t do anything different, I will do things differently. This is going
to be my theme for the year that we will be doing things differently.

Annual plans
are usually for one year. Every President brings in his own thought process and
priorities. What we, the leadership at BCAS, have decided is that now the plans
should be medium to long-term plans as we march to our 75^thyear. We
took the common man’s theme from last year as base. The common man means the
9,000 plus members of the BCAS, who are predominantly either two or three
partners or sole proprietors. After identifying them, what does a member of
BCAS want?

Naturally today
they are all looking at growth. We decided that our annual plan for the coming
year would be concentrated on and around growth. What does growth mean? It
means increase in size, in prosperity, in enhancement of your skills, etc. We
have identified five distinct areas of growth which is indicative of 5G.
5G as we all know is the fifth generation network for cellular phones and it
represents Speed, Efficiency, Supremacy, Competitiveness and Technology
Advancement.

The five areas
of growth that we have identified for the annual plan for the current year are Inclusive
Growth, Sustainable Growth, Economic Growth, Dynamic Growth and EQ Growth.

What does Inclusive
Growth mean? It means making life better for everyone. I believe in the
theory … (what I learned from Pradeepbhai), theory of abundance, that there
is enough work in the universe for all the people. So if you want to grow, you
don’t necessarily have to put your foot on somebody else’s shoulder to go up.
There is abundance, there are equal opportunities and we will try to create
equal opportunities for all our members, for all our chartered accountants.
Along with this comes the point that you look at the fraternity first and then
at your own self-growth. Making life better for everyone is inclusive growth
and this indicates building the profession.

The second plan
is Sustainable Growth. Look at long-term plans and don’t go for
short-term targets or temporary gains. Look at long-term gains. How can this
happen? This can happen only and only by inculcating ethics, not only in our
professional but also in our personal lives. A strong value system and ethics
is what will sustain over a long period of time. Secondly what is needed is
what Narang Saheb, Shariqbhai, Amitbhai
did… they caught people who were actually young and they saw their place to
leadership. We will aim to identify future leaders and groom them for future
leadership, because the newer ideas are naturally going to come from them. This
indicates building capacities and capabilities.

What are all of
us interested in? Ultimately, everything boils down to financial benefits. Economic
Growth comes as financial benefits. I believe, this can happen in two ways,
first by upgrading your technical knowledge and skills, and having new and
emerging areas of practice, so whenever we plan any programmes, RRCs, events,
we will have this in mind… and that’s the reason why we have a new Committee
this year (Internal Audit). Secondly, opportunities for networks and
consolidation of firms is the need of the hour. We will try to encourage this
and create opportunities for networking and consolidation of practices. Many
members have shown interest in this and this inspired me to have this growth
area. Of course, all of us know that in mergers and consolidations, two and two
always adds up to five.

Dynamic
Growth means making
the members more competitive by making them future ready. Use of technology in
practice, use of technology, digitisation and automation all at a reasonable
price indicates building the future of
the profession.

And last, the
most important focus area, an area that is very close to me. We may have
technology upgradation, all types of skills and other attributes, but
everything is useless if you don’t honour human relationships, human emotions
and human capital. That, I believe, is the fifth avenue of growth, which is Emotional
Growth.

So what we have
thought is that rather than just having suggestions, I have put concrete points
and I have asked all the Committees to work on at least one or two new events
or initiatives during the year. I have listed them out, so not only do they act
as our targets that we have to achieve, but also, at the end of the year, act
as an indicator whereby we will be able to measure our performance. I’m not
scared of failure. I have put in actionables for each Committee. Even if I
don’t succeed, I will at least go back happily, that at least I tried.

Starting with
the Accounting and Auditing Committee, naturally, this is my karmabhumi.
It is headed by our Himanshu Kishnadwala. This Committee does not have a
long-duration course. Therefore, one target for this Committee is to have a
long-duration course. We will figure out whether we want to have it on IGAAP,
Ind AS or on the Standards of Accounting. The second most important thing is that
this Committee is celebrating a milestone by way of its residential course on
Ind AS, the tenth edition of its residential study course. We have planned it
in a different way this year.

The next is the
Corporate and Allied Law Committee, which is headed by Chetan Shah. This
Committee, again, is more suited to fit into our aim of increasing the reach of
BCAS to its members. It will be initiating a lot of programmes with sister
organisations CTC, IMC and so on. We have also planned a lot of joint programmes
with regulators which will come out from this Committee. The third important
pointer in this Committee is that we will do programmes on emerging areas like
valuation, which has not been done since a long time.

The HR
Committee is headed by Rajesh Muni and KK. I call this Committee my janmabhumi,
because I was born in this Committee in the BCAS. It is doing admirable work;
there are many laudable projects, but I have identified two main items that we
would like to do. One is reviving the Professionals Accountancy Course which
was beneficial to those people who had not been able to complete their CA. The
second thing is that the 150^th year of Mahatma Gandhi’s birth is
coming up, so we need to do something for that. We will plan some celebration
around this.

The next is the
Indirect Tax Committee and two stalwarts, Deepak Shah and Sunil Gabhawalla, are
heading it this year. Indirect tax and GST is the flavour of the season and
this Committee is doing great work. We aim to bring out a GST Audit Manual by
the next year’s audit season and this Committee’s long-duration courses and
intensive study courses will be raised to even higher standards.

The new kid on
the block committee is headed by Uday Sathaye and Nandita Parekh. This fits
into my annual plan, emerging area of practice. Internal Audit will find a
place in this year’s RRC. This Committee will do a lot of work in the area of
taking BCAS outside the city of Bombay. We also plan an Internal Audit RRC.

The
International Tax Committee headed by Mayur Nayak is a rock-solid performer and
always a winner. The Journal Committee is the vintage wine of our Society.
Raman Jokhakar heads this Committee and they do only two things, they improve
and innovate, they improve and innovate. They set higher standards for themselves
and the only agenda for this Committee is the digitalisation of the journals on
the net.

Seminar, Public
Relations and Membership Development Committee is headed by Narayan Pasari and
Pradip Thanawala. This Committee has a lot of work to be done. Public Relations
have been included purposely in the name this year with an intention. We will
look out for benefits for our members, like insurance at a discounted price and
other such services. RRC will improve upon its own performance last year and this
Committee will also work on taking the BCAS programmes outside the city.

The Taxation
Committee has been the most tech-savvy Committee headed by Ameet Patel. They
have pioneered the Tax-Gurukool, which has been adopted by other Committees.
They have something in store but I don’t want to disclose it right now. One
target for them is bring out the Tax Audit publication in time, before the tax
audit season.

Finally, the
Technology Committee, headed by Nitin Shingala. Only two items on the agenda
for them, develop a mobile app for the BCAS which is integrated with the back
office and seek the Committee’s support for streamlining our back office
infrastructure.

We have other
stakeholders also, and they are our staff. I have worked with them for the past
so many years and I know that they don’t have one boss, they have to reply to
250 bosses and they have to get adjusted to their style of functioning. I know
a lot needs to be done, we need to trim the excess fat and we will work in that
direction.

Before I
conclude, I would just like to say that BCAS is an organisation that is on
self-driven mode. We don’t have to do anything, it is a collective organisation
which is taken care of by itself, and only one person gets a chance to lead it
for one year. Friends, I can’t do anything alone without your support and it
will be a team effort. My success is in your hands.

I am not an
ardent fan of any poetry, I don’t read much of poetry but this is the poem I
learned in school and I still remember these lines. The poet is going through a
forest and he reaches a sweet spot where the weather is soothing, the scenery
is bewitching, making him want to stay for a while, but unfortunately, he
cannot enjoy, he has to move on to fulfil his promises. He says,

The woods
are lonely, dark and deep,

But I have
promises to keep

And miles to
go before I sleep

And miles to
go before I sleep.

Thank you.

shailesh.kwebmaker

GURU

Gurus are the fairest flowers of mankind,

they are the oceans of mercy without any motive

—Swami
Vivekananda

Why do we need a Guru? What does a Guru do?

We are ignorant and ignorance is a curse.
The Guru removes ignorance and grants knowledge. He makes us realise the power
of knowledge and the use of knowledge.

Is there only one Guru one has in life?

Have
we ever asked ourselves why we read a newspaper? We do so because we want to
know what is happening – –to gain knowledge about what is happening in the
world around us. In that sense, is the newspaper a Guru?

Again,
whilst being educated in school or college, we are taught by several teachers
and each teacher teaches us a different subject. Are all these teachers our
Gurus?

When
we join a business or profession we have a mentor(s) who teaches us how to act.
Are these mentors our Gurus?

Again,
every book we read and gather and absorb some thoughts from, in that sense – is
the author our Guru?

The answer to all these is in the
affirmative. Hence, in my view one has several Gurus and each one contributes
to removing our ignorance or adds to our knowledge.

I have personally learnt from my seniors, my
peers and my juniors. They were big contributors to my knowledge.
Mistakes made by juniors and others made me think how to deal with the mistakes
and their suggestions added to my knowledge. Both thinking and knowledge remove
ignorance.

Who needs a Guru?

The answer is, everyone – let us not
forget mother is the first Guru – she brings awareness in the child.
Napoleon says ‘The first university is the mother’s cradle’. Let us remember
that even realised souls need a Guru.

A few examples:

Adi
Shankaracharya, an evolved soul, searched for a Guru and when Govindacharya
asked ‘Who are you?’ he recited the Nirvan Shatakam – so a person who
had realised and was aware of the nature of self still needed a Guru to
complete his journey.

Paramhans
Ramakrishna, who is said to have had the darshan of Mother Kali and is said to
have exhibited in his body Buddha, Krishna, Christ and Mohammed, realised the
ultimate only when he met Totapuri.

Arjun,
when in a quandary in the Mahabharata, sought Krishna as Guru.

Ramana Maharishi says ‘Even a Guru is
ever a disciple’.

What does a Guru do!

Guru empties the seeker’s mind by removing
irrelevant thoughts and guiding him with knowledge of self and God.
He is a friend, a brother and burden bearer and shows the way. Guru is an
anchor. He is a man of peace. Guru guides the seeker to a higher state of
being.

Sadhguru Jaggi rightly says: ‘Guru is not
a crutch but a bridge’.

By God’s grace a moment comes when we ask
ourselves a simple question:

What is the purpose of life? And we seek
a mentor – we seek wisdom.

Blessed is the person who meets such a
person. My Guru’s teaching is simple ‘See God in yourself and everyone and
serve other human beings as you serve yourself. Service without expectation’.

However, there are mentors – Gurus – who go
beyond this simple spiritual teaching and who guide us even in
non-spiritual issues – the mundane demands of life. In my view one needs such a
Guru – one who guides not only when one is alive but also beyond this life. I
would conclude by quoting Osho:

‘The
more you become surrendered to the Guru,

the
more you feel that you have freedom
you never had before.’

In short we have two genres of guides –
teachers who mentor us on ‘how to live – knowledge of life’ – and Gurus
who bestow on us the wisdom of life and death.

Blessed are
those who have only one Guru who does both.

shailesh.kwebmaker

GROWING CONCERNS ABOUT GOING CONCERNS

The Indian economy is going through a
tumultuous time. Rs. 1 trillion¹
were wiped out of the markets due to various causes. A more distinctive
feature is that several pillars of the economy are in the news for the wrong
reasons. From NBFC²s, Reserve Bank of India³, SEBI⁴,
Credit Rating Agencies⁵, to Stock Exchanges, bankers⁶,
National Clearing Corporation, NSDL⁷ and auditors.

However, the reports on audits and auditors
are most distressing. The central banker banned a top audit firm; criminal
charge sheets lodged against two other top firms and partners in the IL&FS
case; MCA seeking a five-year ban; reports of an auditor leaking
price-sensitive information; MCA approving the removal of an audit firm;
auditor resignations; blaming the auditors for the stock price fall, and more.

Before we look more deeply at the audit
framework in India, auditors have been implicated in many other parts of the
world and much of this seems symptomatic. An FRC (UK) report⁸ has dealt with a number of aspects of the
audit market, including audit quality and audit failures. Notable reasons given
by the report are: a. Failure to exercise sufficient professional
scepticism or challenging the management, b. Failure to obtain
sufficient appropriate evidence, and c. Loss of independence. The FRC
report also points out perils of the precarious audit market structure with
‘too few to fail’ firms which make up the audit market (97% and 99% in the UK
and the US securities markets are audited by only four auditors). India hasn’t
reached there yet but it seems like it is on its way, ignoring structural problems
and treating symptoms superficially. The report also states that each of the
top four ‘audit’ firms reported three-fourths of their revenue from ‘non-audit’
services and faster growth in ‘non-audit’ revenue. The ‘auditors’ are actually
doing more ‘non-audit’ work and suspected of getting audit work in order to get
more lucrative ‘non-audit’ work. Coming back to India, the MCA should have done
much more and much better in presenting data on the above lines rather than
bringing out a rather hasty and flawed report⁹last year.

The root causes within the auditing
framework need examination. The problems and surrounding questions are many and
complex but not impossible to overcome if dealt with in right earnest. The
problems are written on the wall – i. Appointment of auditors (mostly by
a common management and ownership), ii. increasing concentration in the
audit market (oligopolistic audit market where market leaders begin to convey a
sense that they are the market – too big and too few to fail types), iii.
multiple regulators (SEBI, MCA, NFRA, ICAI, RBI, etc.), iv.
misunderstanding about audit (what it can do and what it cannot do), v. conflict
of interest and independence issues (audit firms are connected with group
entities looking for non-audit work), and vi. a misty reporting framework
(changing and difficult to fathom) to name a few.

The expectation and delivery gaps are
widening and blurred. Auditors, regulators and the public do not understand
them in the same sense. It seems that an auditor today is neither a watchdog
nor a bloodhound, but rather a sniffer dog. So long as an auditor has done what
the auditing standards ask of him, he cannot be sent to a doghouse. All the
same we have more questions than answers, and we need to flip that fast –
before it’s too late.

___________________________________________________________________________

1 Bloomberg Quint report published June 23, 2019
– Eleven Stocks, $14 billion erased

2 IL&FS, DHFL etc.

3 It was expected to keep an eye on systemically
important NBFC, SFIO pointing out that it should have acted faster

4 Reported to be the most powerful market
regulator in the world who could have done more in ‘algo’ scam

5 Giving credit ratings that turned out to be
worthless, ICRA CEO and MD asked to go on leave

6 PSB NPAs at Rs. 806,412 crores in March, 2019
or Rs. 8.1 billion (per PIB release of 24^thJune,.2019)

7 Allegations of shares moving out of pool
account of a broker in allied matter

8 Statutory
Audit Services Market Study, 18^th April, 2019

9 Findings and Recommendations on Regulating
Audit Firms, October, 2018

Raman Jokhakar

Editor

shailesh.kwebmaker

FINANCE (NO. 2) ACT, 2019 – ANALYSIS OF BUY-BACK TAX ON LISTED SHARES

BACKGROUND

A company
having distributable profits and reserves may choose one of two ways to return
profit to its shareholders – declare a dividend or buy-back its own shares. In
the former case, the company is liable to dividend distribution tax (DDT) u/s
115-O of the Income-tax Act, 1961 (IT Act), while in the latter case, the
taxability is in the hands of the shareholder on the capital gains as per
section 46A of the IT Act. Such capital gain on unlisted shares had been either
tax-free on account of the application of beneficial tax treaty provisions, or
the taxable amount used to be lower because of special tax treatment accorded
to capital gains under the IT Act (such as indexation benefit).

Unlisted
companies used to be under the spotlight as they opted for the buy-back route
instead of dividend declaration to avoid DDT liability and in such cases the
capital gains tax was lower than DDT due to the above-mentioned reasons. To
counter this practice, the Finance Act, 2013 introduced section 115QA in the IT
Act. This section created a charge on unlisted companies to pay additional
income tax at the rate of 20% on buy-back of shares from a shareholder. In such
cases, exemption was provided to income arising to the shareholder u/s 10(34A)
of the IT Act.

AMENDMENT BY
FINANCE (No. 2) ACT, 2019

The Memorandum
to the Finance Bill noted the instances of tax arbitrage even in case of listed
shares wherein companies resorted to buy-back of shares instead of payment of
dividend. The buy-back option was considered attractive on account of the
following:

(i) Taxability
in case of buy-back: The company did not have any liability and capital gain in
the hands of the shareholder was exempt u/s 10(38) of the IT Act. After
abolition of this exemption, section 112A of the IT Act caused a levy of 10%
tax on capital gain with effect from A.Y. 2019-20;

(ii) Taxability
in case of dividend declaration: The company was liable to DDT but the dividend
was exempt in the hands of the shareholder (except if it exceeded Rs. 10 lakhs
which was taxable at 10% as per section 115BBDA of the IT Act).

In the backdrop
of companies (including major IT companies) implementing buy-back schemes worth
Rs. 1.43 trillion in the past three years to return cash to shareholders, the
Finance Bill presented on 5^th July, 2019 introduced an
anti-avoidance measure. Section 115QA of the IT Act – tax on distributed income
to shareholders that was hitherto applicable only to buy-back of shares not
listed on a recognised stock exchange – has been made applicable to all
buy-back of shares, including of listed shares.

By a parallel
amendment, exemption is provided in section 10(34A) of the IT Act for income
arising to the shareholder on account of such buy-back of shares.

The amendments
are effective from 5^th July, 2019.

ANALYSIS

Calculation of buy-back tax

The company
shall be liable to additional income-tax (in addition to tax on its total
income – whether payable or not) at the rate of 20% on distributed income. As
per clause (ii) of Explanation to section 115QA(1) of the IT Act, the
distributed income means consideration paid on buy-back of shares, less amount
received by it for the issue of shares, determined as prescribed in Rule 40BB
of the Income tax Rules. The Rule describes various situations and
circumstances for determination of the amount received by the company. This
includes subscription-based issue, bonus issue, shares issued on conversion of
preference shares or debentures, shares issued as part of amalgamation,
demerger, etc.

For issue of
shares not covered by any of the specific methods prescribed in the Rule, the
face value of the share is deemed to be the amount received by the company as
per Rule 40BB(13). Applying this mechanism, if a shareholder has acquired
shares (face value Rs. 10) from an earlier shareholder at Rs. 100 and the
buy-back price is Rs. 500; the buy-back tax liability for the company will be
computed as Rs. 490 (500 less 10) and not on the gain of Rs. 400 (500 less 100)
in the hands of the shareholder.

In case of
buy-back of listed shares, provisions of Rule 40BB(12) will come into the
picture. This states that where the share being bought back is held in dematerialised
form and the same cannot be distinctly identified, the amount received by the
company in respect of such share shall be the amount received for the issue of
share determined in accordance with this rule on the basis of the
first-in-first-out method. If the shares have been dematerialised in different
tranches and in different orders, practical challenges will be faced in
computing buy-back tax.

Dividend or buy-back – what is more beneficial?

After this
amendment, a question arises as to whether a company is better off declaring
dividend rather than repurchasing its own shares? The pure comparison of the
rates of tax u/s 115-O of the IT Act: DDT at 20.56%, and u/s 115QA of the IT
Act: buy-back tax at 23.29%, suggest so. However, if one adds the taxation of
dividend income in the hands of the shareholder at the rate of 10% for dividend
in excess of Rs. 10 lakhs as per section 115BBDA of the IT Act, higher
surcharge of 25% / 37% on tax to the DDT tax liability, the overall outcome for
the company and the shareholder taken together gives a different perspective.
This is reflected in the following table:

The comparison
of total tax impact column shows tax arbitrage in case of the buy-back option.

Section 14A disallowance

As per section
14A of the IT Act, expenses incurred in relation to income that does not form
part of total income is not allowed as deduction. In the year of buy-back where
additional tax is paid by the company and exempt income is claimed by the
shareholder, section 14A of the IT Act may be triggered to make a disallowance
in the hands of the shareholder. One may draw reference to the Supreme Court
decision in the case of Godrej & Boyce Manufacturing Company Ltd.
(394 ITR 449). In the context of disallowance u/s 14A of the IT Act on
tax-free dividend income that was subjected to DDT u/s 115-O, the Supreme Court
had ruled in favour of making a disallowance. The underlying principle of the
decision may be extended to cases covered by section 10(34A) of the IT Act as
well in the year of buy-back to contend that although buy-back has suffered
additional tax in the hands of the company, the applicability of section 14A of
the IT Act persists in the hands of the shareholder.

Whether loss in the hands of the shareholder will be
available for set off?

If buy-back
price (say 500) is lower than the price at which the shareholder acquired the
shares from the secondary market (say 700), the shareholder will record a loss
of Rs. 200. Section 10(34A) of the IT Act provides that any ‘income’ arising to
a shareholder on account of buy-back as referred to in section 115QA of the IT
Act will not be included in total income. Therefore, whether ‘income’ will also
include loss of Rs. 200, and as such this amount is to be ignored and not
considered for carry forward and set off purposes.

The Kolkata
Tribunal in the case of United Investments [TS-379-ITAT-2019(Kol.)]
examined whether when gain derived from the sale of long-term listed shares was
exempt u/s 10(38) of the IT Act, as a corollary loss incurred therefrom was to
be ignored. The Tribunal opined that in a case where the source of income is
otherwise chargeable to tax but only a specific specie of income derived from
such source is granted exemption, then in such case the proposition that the
term ‘income’ includes loss will not be applicable. It remarked that it cannot
be said that the source, namely, transfer of long-term capital asset being
equity shares by itself is exempt from tax so as to say that any ‘income’ from
such source shall include ‘loss’ as well. The legislature could grant exemption
only where there was positive income and not where there was negative income.
Referring to CBDT Circular No. 7/2013 on section 10A, the Tribunal noted that
exemption was allowable where the income of an undertaking was positive; and
the Circular also provided that in case the undertaking incurs a loss, such
loss is not to be ignored but could be set off and / or carried forward.
Accepting the reliance on the Calcutta High Court ruling in Royal
Calcutta Turf Club (144 ITR 709), the Mumbai Tribunal in Raptakos
Brett & Co. Ltd. (69 SOT 383), allowed benefit of carry forward of
losses.

Applying the
principles of the above decision, it can be said that transfer of listed shares
in a buy-back scheme is a taxable event per se and it is only a positive
income arising to the shareholder on buy-back effected as referred to in
section 115QA of the IT Act that has been granted exemption by the legislature.
In case of loss resulting from the buy-back price being lower than the
acquisition cost, it may be considered for carry forward and set off provisions
as per the relevant provisions of the IT Act. However, litigation on this
aspect cannot be ruled out.

Re-characterisation still possible?

In the past and
now in the recent case of Cognizant Technology Solutions, the tax authorities
have sought to disregard the buy-back scheme and treat it as distribution of
dividend. The General Anti-Avoidance Rules (GAAR) effective from 1^st
April, 2017 has empowered the tax department to disregard and re-characterise
arrangements if the main purpose is to obtain tax benefit and other conditions
are satisfied.

Now that
distribution out of profits by way of dividend declaration and buy-back of
shares is chargeable to tax in the hands of the company as additional income,
will the income tax department still question the choice and manner chosen by
the company under the GAAR provisions remains to be seen. If such an attempt is
made, it would seek to ignore the very form of the transaction. The taxpayers
have recourse to CBDT Circular No. 7/2017 wherein it was clarified that GAAR
will not interplay with the right of the taxpayer to select or choose the
method of implementing a transaction.

A buy-back
scheme undertaken by a company compliant with the provisions of the Companies
Act and other regulatory frameworks may be alleged as a colourable device to
evade payment of DDT and tax on dividend income in the hands of the recipient.
The action of the tax authorities can be refuted by placing reliance on the
decision of the Mumbai Tribunal in the case of Goldman Sachs (India)
Securities (P) Ltd. (70 taxmann.com 46) which laid down that merely
because a buy-back deal results in lesser payment of taxes it cannot be termed
as a colourable device.

CONCLUDING
REMARKS

With the
immediate applicability of buy-back tax from 5^th July, 2019 and
considering that it is an additional tax outflow for the company, the buy-back
price offered by companies and the return on investment will be affected. To
save the tax, companies may use surplus funds for additional investments or
deploy them back again in business rather than distribution to shareholders.

One will have
to wait and see if the grandfathering clause is considered by the Finance
Minister to protect and safeguard listed companies whose buy-back was already
underway as on budget day i.e. 5^th July, 2019. Besides, the current
buy-back rules may need to be revisited to provide for situations that are
relevant to shares of listed companies. The rules ought to factor in a
situation where shares are acquired on a stock exchange at a higher price than
the issue price received by the company. If the acquisition price is considered
in such an instance, the buy-back tax will essentially be computed on the gain
in the hands of the shareholder (buy-back price less acquisition price).

shailesh.kwebmaker

RERA, A CRITICAL ANALYSIS

RERA (or Real Estate Regularity Authority),
introduced as a remedy against the rampant malpractices of builders and to
safeguard the interests of homebuyers by ensuring the sale of plots, apartments
or buildings in an efficient, fair and transparent manner, has had more than
two years of operation and it is time to look back and assess the strengths and
weaknesses of the legislation in its present form and application. As with any
regulatory measure at the nascent stage, particularly in an area like the real
estate sector, there were inevitably certain teething problems to be addressed
and the effectiveness lies in the way such problems have been dealt with.

NOT OPERATIONAL IN ALL STATES

The Central legislation, applicable
throughout the country (except the then state of Jammu & Kashmir), did not
find an equally enthusiastic response from several states and Union territories
which failed to act within the prescribed time in matters of framing rules,
setting up the Authorities, creating the website and establishing the Appellate
Tribunals in their respective jurisdictions.

It is a matter of common knowledge that
barring Maharashtra and a few other states, the governments did not abide by
the mandate of the Act in framing the Rules in the prescribed time. As conveyed
recently by the Centre to the Supreme Court, the process to notify the Rules in
Arunachal Pradesh, Meghalaya, Nagaland and Sikkim is still under way. Twenty
nine states / UTs have so far set up the Authority and only 22 the Appellate
Tribunal. The inaction on the part of several states for a considerably long
period of time not only distorted the pan-India nature of the Act, but also
deprived the people of those states of the intended benefits, creating unjust
differentiation.

The Centre needs to be more active in
ensuring enforcement of the Act and its timely implementation in the true
spirit of the legislation by constant monitoring.

LACK OF HARMONY BETWEEN THE ACT AND RULES

RERA, the Central Act, is not uniformly
implemented in various states because the rule-making power is vested in the
states which have framed rules of varying nature, some even inconsistent with
the substantive provisions of the Act.

Section 84 of RERA provided for the state
governments to make rules for carrying out the provisions of the Act by
notification within a period of six months of the commencement of the Act.
Although the power to frame rules was vested in the states, it was expected
that the Rules would be within the framework of the Act and as such would not
be different in substance beyond a reasonable limit.

But is it fair for certain states to go
beyond the authority to suit their own understanding of how the provisions
should be? For instance, the provision of section 4(2)(l)(D) requires 70% of
the amounts realised from time to time from the allottees to be deposited in a
separate bank account to cover the cost of construction and the land cost which
can be withdrawn from the account to cover the cost of the project, in
proportion to the percentage of completion of the project. The idea in broad
terms was to have free funds equal to the profit component embedded in the
receipts (estimated at 30% of the receipts) and to keep the balance amount
separate from other funds to be used exclusively for the cost of the
construction and the land. The withdrawal, as per the Act, is restricted to the
amount proportionate to the percentage completion of the project.

Certain states
have prescribed rules for determining the withdrawable amount which are not
consistent with the provisions of the Act. Maharashtra, for instance, permits
withdrawal of the entire land cost and the entire cost incurred up to the date
of withdrawal, leaving, in a large number of cases, hardly any amount to be
utilised for further construction. Further damage to the concept is done by the
executive order giving artificial meaning to the land cost which is a notional
cost higher than the actual land cost envisaged in the Act. The Maha-RERA, for
instance, permits withdrawal of the notional indexed cost in line with the
computation of cost of acquisition for purposes of capital gain under the
Income-tax Act which results in withdrawal of an amount several times more than
the actual land cost (Circular No. 7/2017 dated 4^thJuly, 2017).

There are other areas where such digression
is visible. Notable among these is the area of conveyancing. Section 11(4)(f)
provides for executing a registered conveyance deed of the apartment, plot or
building in favour of the allottee and the undivided proportionate title in the
common areas to the Association of Allottees or the Competent Authority. The
Rules of several states are at variance with this provision as they have chosen
to go by the prevailing / prevalent local laws, even if they are inconsistent
with the provisions of the Act. Maharashtra, for instance, goes by the pattern
laid down in MOFA and provides for conveyance of the building not to the
allottees but to the association of allottees / society / company. In case of
buildings in layouts, the structure of the building (excluding basements and
podium) is to be conveyed to the respective societies and the undivided and the
inseparable land along with basements and podiums are to be conveyed to the
apex body or Federation of all the societies formed for the purpose [Rule
9(2)]. Tamil Nadu follows its local law, i.e., The Tamil Nadu Apartment
Ownership Act,1994 and provides for conveyance of undivided share of land,
including proportionate share in the common area, directly to the respective
allottees [Rule 9(3) of Tamil Nadu Rules]. Karnataka follows Tamil Nadu and
provides for conveyance of apartment along with proportionate share in common
areas to the respective allottees.

One can hold a view that such rules are more
reasonable and pragmatic, providing for consistency in the practice so far
observed, without in any way harming the cause of the allottees. The solution
in such cases appears to be a review of the Act instead of allowing such
variance to continue. Rules being subordinate legislation are to be in
conformity with the law. Another possible solution can be to make the
provisions applicable in the absence of local laws, as has been done in section
17 which lays down the time within which the conveyance is to be made.

UNWORKABLE
OR DIFFICULT DIRECTIONS

There is one area of concern to the
promoters. In an agreement where the landowner gets his land developed by the
builder in consideration of allotment of certain units in the developed
building free of cost, both the landowner as well as the builder are regarded
as the promoters under the Act.

In such a case, is it fair to insist on both
of them to open separate bank accounts for depositing 70% of the receipt from
the allottees, creating a situation where the landowner who though not required
to incur any cost of construction, is forced to keep 70% of sale proceeds of
his share of units in the bank account till the entire project is completed? If
we examine the provision closely, it requires opening of a separate account for
the project and not for individual promoters. If the project is one in which
there are two promoters, then there should be a requirement of opening one bank
account only. Is it fair in such circumstances to ask the landowner to deposit
70% of sale proceeds in a separate bank account?

It will take a substantially long time for
contentious issues to be settled in judicial forums. In case a high-level body
is established at the Centre with the authority to issue clarifications by way
of circulars binding on all the Authorities, much of the hardship and
litigation can be avoided.

INTERPRETATIONS INCOMPATIBLE WITH THE SPIRIT
OF LAW

RERA has been introduced to safeguard the
interests of the home-buyers. The object and the purpose of the legislation is
material in the understanding of any provision which, unless contrary to any
specific provision, is to be interpreted in a manner so as to subserve the
purpose of the Act.

In view of such
an accepted canon of interpretation particularly in respect of a legislation
which is remedial in nature, meant to address the problems faced by the class
of people having no accessible remedy for the harm done to them by the class of
powerful persons, is it fair for the authorities to go by the rigidity and technicality
of words and expressions disregarding the objects and purposes of the
legislation? The decision not to entertain complaints for delayed possession
after the promoter has offered to give possession; the decision exempting the
promoter from the requirement of registration if the completion certificate is
issued within three months from the commencement of the Act; the decision not
to entertain complaints if the project is not registered; the decision not to
consider a project as ongoing even if a part-occupancy certificate is issued
before 1^stMay, 2017; these are some of the decisions which appear
to go against the avowed purpose of the legislation depriving the affected
persons of the remedy to which they are entitled for no fault of theirs.

DECISION-MAKING PROCESS

Even though the Authority is constituted of
a Chairman and two members, the decision on complaints filed by the aggrieved
allottees is taken by a single member, resulting in the same Authority taking
different views on the same issue. This introduces subjectivity in judicial
decision-making which should ideally be avoided.

One finds instances of a differing approach
in decisions by different members of the same Authority. On the basic issue,
for instance, whether RERA has application in respect of projects which are not
registered or which are exempted from registration, different decisions have
come from different members. One member has taken a decision that registration
is one of the obligations cast on the promoter, non-performance of which visits
with penal consequences under the Act. The registration is not the essential
pre-requisite for entertaining a complaint under RERA. A different view is
taken by the other member who declines to entertain the complaint of the
aggrieved person if it relates to an unregistered project. The issue has been
considered and adjudicated by the Appellate Tribunal and the jurisdictional
High Court, yet the
problem persists.

As a matter of sound judicial process, it is
advisable to introduce the Bench system of deciding judicial matters. Once a
different view is proposed to be taken by another Bench on the matter of
interpretation, the Chairman should constitute a larger Bench to decide the
matter.

PUBLICATION OF CASES DECIDED BY DIFFERENT
JUDICIAL AUTHORITIES

RERA being a
Central Act, the views taken by any Tribunal / High Court on any issue should
be a source of guidance to all the Authorities in the country. For this it is
necessary to have agencies like those bringing out AIR, Taxmann, etc., for
publishing important decisions on points of law given by different Tribunals,
High Courts and the Supreme Court so that the doctrine of precedent and Stare Decisis may be applied in relation to RERA cases also.

CONCLUSION

Overall, RERA has provided substantial relief to the
hitherto unprotected home-buyers. It has succeeded in instilling a sense of
confidence and providing an assurance that things will go as promised. In this regard,
certain states including Maharashtra have played a commendable role. With this
undeniable truth, the need is for the initial enthusiasm to continue unabated
in providing speedy resolution of disputes in the true spirit of the
legislation. The discussion above is meant to focus on certain aspects, a
meaningful consideration of which may go a long way in making RERA serve its
purpose even better.

shailesh.kwebmaker

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