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Month: September

Sections 45, 48 – The cost of construction incurred by the Builder cannot be the consideration for exchange of land in the scheme of Joint Development. It is the FMV, based on the value of the Sub-Registrar, on the date of JDA, which needs to be taken as full value of consideration

16.  Y. S. Mythily vs. ITO
(Bangalore)

Members : Inturi Rama Rao (AM) and Lalit
Kumar (JM)

ITA No. 235/Bang./2016

A.Y.: 2006-07.                                                                    
Date of Order: 9th June, 2017.

Counsel for assessee / revenue: H. Guruswamy / Swapna Das

FACTS  

The assessee owned vacant site in respect of which she
entered into a Joint Development Agreement (JDA) with M/s Sai Dwarka Builders
and Developers. As per the terms of JDA entered into by the assessee, the
assessee agreed to transfer to the developer 55% of the undivided portion of
the land measuring 3153 sq. ft. (sic mts) out of total 5733 sq. ft. (sic mts)
and the remaining undivided portion of 2580 sq. mts was retained by the
assessee. The proposed built up area to be constructed was about 19,836 sq. ft.
out of which the assessee was entitled to 45% of the built-up area measuring
8735 sq. ft. in exchange of 3153 sq. ft of undivided portion of land and
developer was entitled to 55% of the built-up area measuring 11000 sq. ft.

In the course of assessment proceedings, the Assessing
Officer (AO) proposed to adopt cost of construction incurred by the Builder as
consideration for exchange of 55% of the undivided portion of land measuring
3153 sq. ft. According to the AO, the cost of construction, as provided by the
Builder to the AO, was Rs. 1238 per sq. ft. The AO accordingly, determined the
consideration to be Rs. 1,08,13,930 in respect of 55% of undivided portion of
land transferred by the assessee in favor of the Builder. The assessee, relying
on the ratio of the decision of Karnataka High Court in the case of Sri. Ved
Prakash Rakhra (2015) 370 ITR 762 (Kar.) submitted that the cost of
construction incurred by the Builder cannot be the consideration for exchange
of land in the scheme of Joint Development. The AO did not accept the
contentions of the assessee.

Aggrieved, the assessee preferred an appeal to the CIT(A) who
dismissed the appeal on the ground that the decision of the Karnataka High
Court in the case of Sri. Ved Prakash Rakhra (supra) is distinguishable
in as much as in the case of the assessee the agreement does not mention the
price of land transferred by the assessee.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD 

The Tribunal upon going through the relevant clauses of the
JDA observed that neither the AO nor the CIT(A) had adjudicated as to the date
of transfer i.e. as to when the property would be transferred in terms of JDA.
In the opinion of the Tribunal, prima facie, the property would not be
transferred to the assessee during the assessment year under consideration in
terms of JDA. However, since this was not urged before the Tribunal, it did not
adjudicate this issue on merit.

The Tribunal held that for the purposes of
determining the cost of construction, in identical facts and circumstances of
the case, the Hon’ble jurisdictional High Court has in the case of Ved Prakash
Rakhra (supra) held that the date of entering into the JDA would be “the
date” for the purposes of arriving at the cost of transfer i.e. cost of
structure as on the date of agreement would be the cost of transfer instead of
cost of actual construction in terms of JDA. Following the decision of the High
Court, the Tribunal allowed the appeal filed by the assessee.

Sections 43(5), 271(1)(c) – Penalty cannot be levied in a case where set off of loss against normal business income was not allowed because the AO assessed the loss to be speculative loss as against normal business loss claimed by the assessee in its return of income. Such a change amounts to change in sub-head of loss and not furnishing of inaccurate particulars of income invoking penal provisions.

18.  [2017] 84
taxmann.com 63 (Kolkata – Trib.)

DCIT vs. Shree Ram Electrocast (P.) Ltd.

A.Y.: 2009-10                                                                     
Date of Order: 2nd June, 2017

FACTS 

The assessee in its return of income for AY 2009-10 claimed
deduction of Rs. 51,00,000. This sum represented amount paid by the assessee as
damages to Global Alloys Pvt. Ltd. with whom assessee had entered into a
contract on 9.7.2008 for purchase of 200 MT of “Silicon Magnum” and 50MT of
“Ferro Silicon” at the rate of Rs. 78,000/MT and Rs. 86,000/MT respectively.
The contract was valid till 28.2.2009. The contract interalia provided
that in case of failure on the part of the assessee to lift the material on the
date fixed for performance of the agreement, the assessee would pay damages to
seller. Similar was the provision in case the supplier failed to supply the
material. The quantification of damages was with reference to market price on
the date of failure.

The Assessing Officer (AO) held that –

(i)   the agreement read as a whole showed that the
loss in question was speculative in nature;

(ii)  the element of speculation was embedded in
clauses 7 and 8 of the agreement;

(iii)  non-delivery of material was contemplated in
the contract itself and the payment of Rs. 51 lakh was emanating directly from
the settlement of the contract rather than on account of any arbitration award
on account of any separate suit filed by counter party for breach of the
contract;

(iv) non-delivery of material was never a breach of
the contract but was a part of the contract under clauses of the contract and
either assessee or the seller could lose or gain depending upon whether price
of the material decreases or increases in future.

The AO rejected the contention of the assessee that the
amount paid was damages and damages paid for breach of contract was not to be
regarded as speculative loss was not accepted by the AO.

As a result of the AO treating the loss to be speculative in
nature, there was a consequent addition to the total income of the assessee.
Further, the AO initiated penalty proceedings u/s. 271(1)(c) for furnishing
inaccurate particulars and concealing particulars of income. He levied penalty
u/s. 271(1)(c) of the Act.

Aggrieved, the assessee preferred an appeal to the CIT(A) who
held that a loss declared in the income was treated as a speculative loss and
consequently not allowed to be set off against the normal business income would
only be a change of the sub-head of the loss and it could not be said that
there was furnishing of inaccurate particulars. He decided the appeal in favour
of the assessee.

Aggrieved, the revenue preferred an appeal to the Tribunal.

HELD

The Tribunal noted that in the quantum proceedings, the
Tribunal has vide order dated 22.3.2013 confirmed the action of the CIT(A) that
the loss under consideration is a speculation loss and cannot be set off
against income of a non-speculative nature. It observed that the question that
requires consideration and decision is whether the disallowance of the
assessee’s claim for set off of share trading loss against other income by
treating the same as speculation loss will attract penalty u/s. 271(1)(c). It
observed that the issue is covered in favour of the assessee by the following
judicial pronouncements –

(i)   CIT vs. SPK Steels (P.) Ltd. [2004]
270 ITR 156 (MP);

(ii)  CIT vs. Auric Investment & Securities
Ltd. [2009] 310 ITR 121 (Delhi)

(iii)  CIT vs. Bhartesh Jain [2010] 323 ITR
358 (Delhi).

The Tribunal noted that the Delhi High Court in the case of
Auric Investment & Securities Ltd. (supra) has held that penalty
imposed by the AO u/s. 271(1)(c) was not sustainable as mere treatment of
business loss as speculation loss by the AO did not automatically warrant
inference of concealment of income and there was nothing on record to show that
in furnishing return of income, the assessee has concealed its income or had
furnished any inaccurate particulars of income.

The Tribunal upheld the action of the CIT(A) in deleting the
penalty levied by the AO.

The Tribunal dismissed the appeal filed by the
revenue.

Section 5: Where foreign employer directly credited the salary, for services rendered outside India, into the NRE bank account of the non-resident seafarer in India, same cannot be brought to tax in India u/s. 5.

17.  [2017] 82
taxmann.com 209 (Kolkata – Trib.)

Shyamal Gopal Chattopadhyay 
vs. DDIT

A.Y.: 2011-12                                                                                  
Date of Order: 2nd June, 2017

FACTS 

The assessee, a Marine Engineer, engaged with Wallem Ship
Management Ltd., in capacity as a Master was paid USD 74271.36 on different
dates, convertible into Indian Rupees of Rs. 33,47,312. The amount was received
in USD outside India and on request of the assessee, was remitted to the
Savings Bank NRE Account maintained by the assessee with HSBC in India. The
above income was not offered for taxation on the ground that it has been
received from outside India in foreign currency.

In the course of assessment proceedings, the Assessing
Officer (AO) issued asked the assessee to show cause why remuneration received
in India should not be brought to tax in terms of section 5(2)(a) of the Act.

The AO rejected the assessee’s contention that the payments
were received outside India and at the request of the assessee, were remitted
to his savings bank NRE account maintained in India. The AO charged to tax the
sum of Rs. 33,47,112 as income chargeable to tax in India. For this
proposition, he placed reliance on the Third Member decision of Mumbai Tribunal
in the case of Capt. A. L. Fernandes vs. ITO [2002] 81 ITD 203, wherein
it has been held that salary received by the assessee in India is taxable u/s.
5(2)(a) of the Act.

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
where it contended that its case is squarely covered by the following decisions
–

(i) DIT
(Int Tax) vs. Prahlad Vijendra Rao [2011] 198 Taxman 551 (Kar.)

(ii) CIT
vs. Avtar Singh Wadhwan [2001] 247 ITR 260 (Bom.)

It was also submitted that the issue is now squarely covered
in favour of the assessee by CBDT Circular No. 13/2017 dated 11.4.2017 wherein
it has been categorically clarified by CBDT that the subject mentioned receipt
is not taxable as income u/s. 5(2)(a) of the Act.

HELD 

The Tribunal observed that the decision in the case of Tapas
Kumar Bandhopadhya vs. DDIT (Int. Tax) [2016] 159 ITD 309 (Kol.-Trib.),
relied upon by the ld. DR, was rendered by placing reliance on the Third Member
decision of Mumbai Tribunal in case of Capt. A. L. Fernandes (supra).
This decision clearly lays down that the receipt in India of salary for
services rendered on board a ship outside the territorial waters of any country
would be sufficient to give the country where it is received the right to tax
the said income on receipt basis. Such a provision is found in section 5(2)(a)
of the Act which was applied in the aforesaid decision. It is trite that
decision of a Third Member would be equivalent to a decision of a Special Bench
and thereby would become a binding precedent on the division bench. However, we
find that the impugned issue has been duly addressed by the CBDT Circular No.
13/2017 dated 11.4.2017 as rightly relied upon by the ld AR.

A perusal of the Circular referred to above, shows that
salary accrued to a non-resident seafarer for services rendered outside India
on a foreign going ship (with Indian flag or foreign flag) shall not be
included in the total income merely because the said salary has been credited
in the NRE account maintained with an Indian bank by the seafarer. Remittances
of salary into NRE Account maintained with an Indian Bank by a seafarer could
be of two types: (i) Employer directly crediting salary to the NRE Account
maintained with an Indian Bank by the seafarer; 
(ii) Employer directly crediting salary to the account maintained
outside India by the seafarer and the seafarer transferring such money to NRE
account maintained by him in India. The latter remittance would be outside the
purview of provisions of section 5(2)(a) of the Act, as what is remitted is not
“salary income” but a mere transfer of assessee’s fund from one bank
account to another which does not give rise to “Income”. It is not
clear as to whether the expression “merely because” used in the
Circular refers to the former type of remittance or the latter. To this extent,
the Circular is vague.

In the instant case, the employer has directly
credited the salary, for services rendered outside India, into the NRE bank
account of the seafarer in India. In our considered opinion, the aforesaid
Circular is vague inasmuch as it does not specify as to whether the Circular
covers either of the situations or both the situations contemplated above.
Hence, we deem it fit to give the benefit of doubt to the assessee by holding
that the Circular covers both the situations referred to above. The result of
such interpretation of the Circular would be that the provisions of sec.5(2)(a)
of the Act are rendered redundant. Be that as it may, it is well settled that
the Circulars issued by CBDT are binding on the revenue authorities. This
position has been confirmed by the Hon’ble Apex Court in the case of Commissioner
of Customs vs. Indian Oil Corpn. Ltd. [2004] 267 ITR 272, wherein their Lordships
examined the earlier decisions of the Apex Court with regard to binding nature
of the Circulars and laid down that when a Circular issued by the Board remains
in operation then the revenue is bound by it and cannot be allowed to plead
that it is not valid or that it is contrary to the terms of the statute.
Accordingly, the grounds raised by the assessee are allowed.

Sections 23, 198, 199 – Credit has to be granted even in respect of TDS on the part of annual value which has been claimed as unrealised rent.

16.  [2017] 82 taxmann.com 456 (Mumbai- Trib.)

Shree Ranji Realties (P.) Ltd. vs. ITO

A.Y.: 2010-11                                                                     
Date of Order: 9th June, 2017

FACTS 

The assessment of total income of the assessee company having
investment in shares, mutual funds and immovable properties, etc. was
completed u/s. 143(3) of the Act. 
Subsequent to completion of assessment, the Assessing Officer (AO)
noticed that the assessee had offered income under the head `Income from House
Property’ after deducting amount of unrealised rent under Rule 4 of the
Income-tax Rules, 1962 (“Rules”) and had claimed credit of TDS on both,
realized as well as unrealised rent.  The
AO, in an order passed u/s. 154 of the Act restricted the credit of TDS to the
extent of actual amount of rent received.

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
where relying on the decision of the Apex Court in the case of T. S.
Balaram, ITO vs. Volkart Bros. [1971] 82 ITR 50 (SC), it was contended that
the issue is highly debatable and cannot be rectified u/s. 154 of the Act. 

HELD  

The Tribunal observed that –

(i)   the facts are not in dispute that the
assessee has disclosed rental income but claimed deduction of unrealised rent
u/s. 23(1) read with rule 4 of the Rules;

(ii)  the Unrealised rent is duly offered to tax by
the assessee at the first instance, and then the same is claimed as deduction from
Rental Income u/s. 23(1) of the Act r.w. Rule 4 of the rules;

(iii)  the assessee duly fulfils all the conditions
as laid down in section 198 r.ws. 199 read with Rule 37A of the Act. 

(iv) TDS had been deducted and paid to the Central
Government by the deductee and Payment / Credit of Rent Income has been
included in the accounts of the assessee;

(v)  the deductor had duly filed requisite TDS
returns as per Rules and also issued TDS certificate to the assessee and the
same was furnished to the AO;

(vi) amount of TDS claimed, corresponding to claim
of unrealised rent, is duly offered to tax as income of the assessee, in view
of section 198 of the Act and also assessed by the AO. 

It held that the Unrealised rent is deduction which is
claimed u/s. 23(1) of the Act, read with Rule 4 of the Rules, from the total
rental income offered during the year. The unrealised rent is not an exempt
income. As the total rental income (including unrealised rent) is duly offered
to tax under the head ‘Income from House Property’, corresponding TDS credit
needs to be allowed. The Tribunal observed that there are similar instances,
where although the deduction is allowed with respect to total income offered
during the year, still the claim of TDS with respect to such deduction is duly
allowable under the Act i.e. TDS credit is allowed on deduction of Income u/s.
8OIA, 8OIB, 80IC of the Act, etc. and also TDS credit is allowed on bad
debts claimed u/s. 36(1)(vii) of the Act.  

Further, the issue is covered by the decision of co-ordinate
bench of this Tribunal in the case of Chander Shekhar Aggarwal (2006) 157 ITD
626 (Delhi).

The Tribunal held that the assessee’s action is in accordance
with provisions of section 199 of the Act and the assessee is eligible for seeking credit of the TDS amount. 

The Tribunal set aside the order of the authorities below and
decided the issue in favour of the assessee. It also held that this issue is
highly debatable and cannot be acted upon by the revenue.

The Tribunal allowed the appeal filed by the
assessee.

10. Capital Gain – purchase and sale of shares and mutual funds – Whether chargeable to tax under the head ‘capital gains’ or as business income

CIT, vs. Mohan Vallabhdas Bhatiya. [ Income tax Appeal no
1201 of 2014 dt : 24/01/2017 (Bombay High Court)].

[ACIT , vs. Mohan Vallabhdas Bhatiya., [dated 31/01/2014;
A Y: 2005-06. Mum.ITAT]

The assessee carries on business as a trader in shares. He
also has investments, consequently he holds two portfolios one an investment
portfolio showing the capital assets and the other is trading portfolio. The
assessee was consistently showing gains on account of his investment portfolio
and offering them to tax under the head ‘capital gains’. In fact, right from
the AY : 2003-04 till AY: 200-10, the Revenue has consistently accepted the claim
of the assessee with regard to the gain made on its investment portfolio is
taxable under the head Capital gain except for the subject AY, the Revenue is
seeking to take a different view. The grievance of the Revenue is that in the
subject Assessment Year, there were borrowed funds. Thus, the gains claimed to
have been made on investments are in fact trading gains.

So far as borrowed funds are concerned, the Tribunal records
the fact that a small amount of loan was taken from the relatives and it did
not bear any interest. Moreover, the use of borrowed funds is not necessarily
attributable to the investments made, as there is no such finding given by the
authorities below.

The Hon. High Court dismissed the Revenue’s appeal upholding
the stand of the Assessee that the income earned on account of purchase and
sale of shares and mutual funds were chargeable to tax under the head ‘capital
gains’ and not as business income.

The High Court observed that even before the Tribunal, the
Revenue did not point out any variation in the facts and circumstances of the
case for the subject Assessment Year from those of the earlier and subsequent
years on account of income earned on investment. Moreover, the loan which has
been taken from relatives were for a small amount and further the use of these
borrowed funds were not established to be for purchase of shares for investment
by the authorities.

Therefore, in view of the fact that the Revenue
has been consistently taking a view that the income earned on investments is
taxable under the head capital gains no difference in facts and /or in law has
been pointed out to take a different view for the subject AY. Moreover, both
the CIT(A) as well as the Tribunal have concurrently come to a finding of fact
that the income earned on the investment portfolio is chargeable under the head
capital gains and not under the head ‘profits from trading of shares’ which is
not shown to be perverse. In the above view, the revenue’s Appeal was
dismissed. 

9. TDS – Payments made for hiring of cranes – the crane owner responsible for day-to-day maintenance and operating costs – liable for TDS u/s. 194C of the Act – not u/s. 194I of the Act.

CIT (TDS) vs. M/s. UB Engineering Ltd. [ Income tax Appeal
no 1312 of 2014 With 1313 of 2014, dt : 23/01/2017 (Bombay High Court)].

[ITO , (TDS – 3), vs. M/s. UB Engineering Ltd. [ ITA NO.
2025 & 2026/PN/2012; Bench : A ; dated 30/09/2013 ; A Y:2007-08 &
2008-09. Pune. ITAT ]

The assessee is engaged in the business of erection and
commissioning of Industrial Plants and also in A.Ys. 2008-09 & 2009-10
undertakes maintenance of operational plants. The assessee undertakes such work
on contractual basis. Amongst the machinery deployed, it includes ‘cranes’
which are mobilised for movement of heavy machinery. Apart from the deployment
of machinery, assessee also allocated specific activities to labour
contractors. In the case of such activities, assessee incurred expenditure of
Rs.1,21,14,506/- for mobilisation of cranes. The assessee company deducted tax
at source on such payments treating the same to be contractual payments and
applying the provisions of section 194C of the Act. Accordingly, the assessee
deducted tax at source u/s. 194C @ 1% whereas as per the AO the tax was liable
to be deducted in terms of the provisions of section 194I of the Act @ 10% plus
surcharge, treating the payments as rental payments. For the said reason, the
AO treated the assessee as an assessee in default in terms of section 201(1) of
the Act for short deduction of tax to the extent of Rs.12,39,043/- and also
held the assessee liable for the payment of interest on such short deduction in
terms of section 201(1A) amounting to Rs.4,46,055/-.

The CIT(A) considered the facts of the case and concluded
that assessee had correctly applied the provisions of section 194C of the Act
while deducting the tax at source on the impugned payments. The CIT(A) has
noticed that assessee hired services of cranes for which entire maintenance,
repairs, drivers’ salaries etc. was borne by the supplier. The CIT(A) relied
upon the decision of the Pune Tribunal in the case of Wings Travels, ITA No.
1136/PN/2009 and also the judgement of the Hon’ble Gujarat High Court in the
case of Swayam Shipping Services (P) Ltd., 339 ITR 647 (Gujarat) and concluded
that the AO was not justified in invoking the provisions of section 194I of the
Act in respect of the ‘crane hire charges’.

The Tribunal observed that factually, it is not in dispute
that the crane owner not only provides the services of a crane but is also
responsible to provide the operator and incur maintenance & repairs costs, etc.
The Hon’ble Gujarat High Court in the case of Swayam Shipping Services (P) Ltd.
(supra) held that the payments for hiring cranes and Trailers were
liable for deduction of tax at source in terms of section 194C of the Act and
not in terms of section 194I of the Act. The Tribunal also relied on decision,
of the Pune Bench decision in the case of Wings Travels (ITA
No.1136/PN/2009, dated 30th August, 2011 and Bharat Forge Ltd.
vs. Addl. CIT vide ITA No.1357/PN/2010, wherein a similar view to the
effect that in cases where the crane owner provides the operator as also is
responsible for day-to-day maintenance and operating costs, the payments made
for hiring of cranes would be liable for deduction of tax at source u/s. 194C
of the Act and not u/s. 194I of the Act, as contended by the Revenue. Accordingly,
the order of the CIT(A) was affirmed.

Being aggrieved, the Revenue carried the issue in appeal to
the High Court. The High Court observed that the impugned order dismissed the
Revenue’s  appeal before it by inter
alia placing reliance upon the decision of the  coordinate 
bench in the case of  Wings
Travels (Supra). In the affidavit dated 13th January, 2017, Mr.
Rajesh Gawali,  Deputy Commissioner of
Income Tax (TDS) stated that the 
decision of the coordinate  bench
of the Tribunal in  Wings Travels  (supra) has been accepted by the Income
Tax Department in view of an  earlier
view taken in the case of  Accenture
Services (P) Ltd. (ITAT  No.5920,
5921 and 5922/Mum/2009).

In the above view, Revenue Appeal was dismissed.

8. Advance received for exports – shown in the accounts as a liability for a period of more than 10 years – no addition of the amount shown as a liability u/s. 41(1)

CIT vs. M/s. Aasia Business Ventures Pvt.Ltd. [ Income tax
Appeal no 1010 of 2014, dt : 24/01/2017 (Bombay High Court)].

[M/s. Aasia Business Ventures Pvt. Ltd. vs. ITO. [ITA
No.430/MUM/2011 ; Bench : A ; date:08/11/2013 ; A Y: 2007- 2008. MUM. ITAT ]

The assessee is engaged in giving advisory services and
traded in shares. Earlier, the assessee was a trader in SKO Superior Kerosene
Oil. It imported SKO and was selling the same in domestic market. During the
course of assessment, the AO noticed that an amount of Rs.3.04 crore was
reflected under the head “current liabilities” (being advance against exports)
in its balance sheet for the year ending 31st March, 2007. On
inquiry, the AO found that the advance had been received as far back as on 24th
January, 1997 from one Amas Mauritius Ltd. in order to export goods.
However, the exports could not be made till date and the balance is still due
and payable to  Amas Mauritius Ltd. in
the books of assessee. The AO in the above view held that the transaction of
advance from Amas Mauritius Ltd. was not a genuine transaction and it was not
to be repaid. Therefore, an addition of Rs.3.04 crore was made on application
of section 41(1) of the Act as cessation of liability.

The CIT(A) upheld the order of AO. Being aggrieved by the
order of the CIT(A), the assessee filed an appeal to the Tribunal. The assessee
pointed out that it had approached the Reserve Bank of India for permission to
return the amount of Rs.3.04 crore shown as an advance against export to Amas
Mauritius Ltd. However, the approval of RBI had not yet been received. The
Tribunal allowed the assessee’s appeal by following the decisions of this Court
in Commissioner of Income Tax vs. Chase Bright Steel Ltd. 177 ITR 128 to
hold that where an amount is shown as an advance in the balance sheet by the
assessee, it amounts to acknowledgment of liability and it does not cease to
exist. So far as the genuineness of the transaction as well as creditworthiness
of the creditor is concerned, the impugned order holds that the same was appearing
in the books of account for all the earlier assessment years and the same was
accepted by the Revenue as genuine. Further, the ITAT placed reliance upon a
decision of its Co-ordinate bench in Jayram Holdings Pvt. Ltd. (ITA
No.6914/Mum/2010) rendered on 4th July, 2012 wherein in almost identical fact
situation, advance received for exports was also shown in the accounts as a
liability for a period of more than 10 years, the Tribunal took a view that
there can be no addition of the amount shown as a liability either u/s. 41(1)
and/or u/s. 28(iv) of the Act. This is so as long as the liability exists.

Before the High Court, the grievance of the Revenue was that
the above transaction is not genuine. This particularly in view of the fact
that Amas Mauritius Ltd. is a 40% shareholder in the assessee company. Thus
related.

Therefore, the impugned order of the Tribunal requires
consideration by this Court to determine its correctness.

The High Court observed that the issue as arising herein was
also a subject matter of consideration before the Tribunal in the case of M/s.
Jayram Holdings Pvt. Ltd. (supra) and it is relied upon in the impugned
order to conclude that section 41(1) of the Act cannot be applied in the
present facts. The Court noticed that in the above case also, the assessee
therein had received from its sister concern an advance for export and shown in
its books over a period of 10 years as a liability.

However, the Tribunal held that section 41(1) of the Act
cannot be applied so long as the liability is acknowledged. The Court held that
the liability does not cease, so long as the party acknowledges its liability.
The order of the Tribunal in Jayram Holdings Pvt. Ltd. (supra) has been
accepted by the revenue. No distinguishing features in the present case have
been indicated during the course of the hearing.

Moreover, it was stated that on obtaining the
permission from Reserve Bank of India on 21st April, 2014, the
amounts have been repatriated to  Amas
Mauritius Ltd. on 16th May, 2014. Thereafter, this amount is not now
shown as a liability. In the above view, the appeal was dismissed.

41. Revision- Section 264 – A. Y. 2013-14- Power of Commissioner – Intimation u/s. 143(1) whether can be considered in revision – Assessee filing revised return and seeking interference by Commissioner – Commissioner to consider revision application

Agarwal Yuva Mandal (Kerala) vs. UOI; 395 ITR 502 (Ker):

For the A. Y. 2013-14, the assessee society filed return of
income claiming certain deductions. The assessee received an intimation u/s.
143(1) disallowing certain expenses on the ground that it was not registered
u/s. 12A of the Act, 1961. The assessee was assessed to a liability of Rs.
2,85,190-. The assessee later revised its return, but no action was taken by
the Department based on the revised return. The assessee thereafter received a
reminder for payment of the outstanding amount of Rs. 2,85,190. The assessee
sent a reply requesting consideration of its revised return. Since there was no
response, the assessee filed a revision petition u/s. 264 of the Act. The
Principal Commissioner declined to exercise the revisional authority holding
that the intimation u/s. 143(1) was not an order of assessment for the purpose
of section 264, whereas it was deemed to be a notice of demand u/s. 156 of the
Act. The assessee filed a writ petition against the order of the Principal
Commissioner.

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

“i)  Section 143 had undergone certain changes
w.e.f. 01/06/1999. The statute uses the word intimation and not order. It was
in the light of the change in the statutory provision that one had to consider
the scope and effect of the revisional powers u/s. 264.

ii)  Though not as a challenge to section 143(1)
notice, when the assessee filed a revised return and sought for interference by
the Commissioner, necessarily a claim had to be considered in accordance with
law. The Commissioner would be justified in considering the claim to deduction
by the assessee in accordance with law u/s. 264 of the Act. The Commissioner is
directed to consider the matter.”

40. TDS – Rent – Section 194-I – A. Y. 2010-11 – Meaning of “rent”- Passenger service fees collected by airline operators – Use of land and building incidental – Tax not deductible at source on such fees

CIT(TDS) vs. Jet Airways (India) Ltd.; 395 ITR 230 (Bom):

The assessee was engaged in the business of transportation by
aircraft and for that purpose used and occupied airports run by airport
operators. In the course of its business the assessee collected on behalf of
the airport operators, a passenger service fees and handed it over to the
airport operators.

However, as no tax was deducted at source while handing over
the passenger service fees to the airport operator, a notice u/s.
201(1)(1a)  of the Act, 1961 was issued
calling for the assessee’s explanation. The basis of the notice was that the
passenger service fees paid over to the airport operator was “rent” falling
within the scope of section 194-I of the Act. The assessee contended that the
passenger service fees collected by it from its passengers and handed over to
the airport operator is not in the nature of rent. That it consisted of two
components, i.e., security component and facilitation component.

However, the Assistant Commissioner (TDS) did not accept the
assessee’s submission and held the assessee liable to deduct and pay the amount
of tax at source and the interest thereon u/s. 201(1) and (1A). The Tribunal
held that the payment could not be considered to be rent and allowed the
assessee’s claim.

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

“i)  The
assessee collected passenger service fees only from its embarking passengers
for and on behalf of the airport operator. The payment of passenger service
fees was for use of secured building and furniture. Therefore, the use of land
or building in this case was only incidental. As the substance of the passenger
service fees was not for use of land or building, but for providing security
service and facilities to the embarking passengers, the payment could not be
considered to be rent within the meaning of section 194-I.

ii)  Tax
was not deductible at source on the payment. Proposed question of law does not
give rise to any substantial question of law and thus not entertained.”

39. Search and seizure – Assessment u/s. 153A – A. Ys. 2003-04, 2006-07 to 2008-09 – Assessee can claim deduction in return u/s. 153A or first time before appellate authorities

CIT vs. B. G. Shirke Construction Technology P. Ltd.; 395
ITR 371 (Bom):

The assessee was engaged in the execution of construction
contracts. On 18/12/2008, there was a search and seizure action u/s. 132 of the
Income-tax Act, 1961 upon the assessee. Pursuant thereto, notices u/s. 153A
were issued for the A. Ys. 2003-04, 2006-07 to 2008-09. As the assessment for
the A. Ys. 2007-08 and 2008-09 were pending before the Assessing Officer, they
stood abated in view of the second proviso to section 153A(1) of the Act.
Consequently, the assessee filed the returns of income for the subject
assessment years u/s. 153A read with section 139(1) of the Act. In its returns
of income, the assessee had offered the income on account of execution of
contracts but had not excluded the amounts retained by its customers till the
completion of the defect liability period after completion of the contract.
This amount could not be quantified in a short time available to file the
returns of income. Therefore, the assessee had filed a note along with its
returns of income pointing out the aforesaid facts and its seeking appropriate deduction
when completing the assessments. The note also pointed out that the said amount
had inadvertently not been claimed as a deduction in its original returns of
income. During the assessment proceedings, the assessee quantified its claim
year wise placing reliance on relevant clause of the contract with its
customers, so as to claim deduction to the extent the customers have retained
(5–10%). The Assessing Officer quantified the claim amount but did not allow
the claim holding that he does not have power to allow the claim in view of the
judgment of the Supreme Court in Goetze (India) Ltd. vs. CIT 284 ITR 323
(SC). The Tribunal held that although it is undisputed that the computation of
income did not reflect the actual quantification of the amount of retention
money held by the customers which cannot be subject to tax, but the note filed
along with the return of income indicated the claim in principle. The
quantification was explained during the assessment proceedings along with the
relevant clauses of each contract with its customers. The Tribunal held that
the decision of Supreme Court in Goetze (India) Ltd., will not apply to the
present facts as in this case the claim for deduction on account of retention
money had been made along with the return of income, only the quantification of
the amount was made during the assessment proceedings.

The Tribunal held that the claim for deduction was to be
allowed. The Tribunal further held that even if the quantification made during
the assessment proceedings was considered to be a fresh claim and could not
have been entertained by the Assessing Officer, there was no bar/impediment in
raising the claim before the appellate authorities for consideration.
Accordingly, the Tribunal allowed the assessee’s claim for deduction. 

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

“i)  The consequence of notice u/s. 153A(1) of the
Income-tax Act, 1961 is that the assessee is required to furnish a fresh return
of income for each of the six of the assessment years in regard to which a
notice has been issued. Section 153A(1) itself provides that on filing of the
return consequent to notice, the provisions of the Act will apply to the return
of income so filed. Consequently, the return filed u/s. 153A(1) of the Act is a
return furnished u/s. 139 of the Act. Therefore, the provisions of the Act
would be otherwise applicable in the case of a return filed in the regular
course u/s. 139(1) of the Act would also continue to apply in the case of a
return filed u/s. 153A of the Act.

ii)  In
the return of income filed u/s. 139(1) of the Act, an assessee is entitled to
raise a fresh claim before the appellate authorities, even if it was not raised
before the Assessing Officer at the time of filing of the return of income or
filing of revised return. The restriction in the power of the Assessing Officer
will not affect the power of the Appellate Tribunal to entertain a fresh claim.
There is no substantial question of law. Appeal is dismissed.”

35. Charitable purpose – Exemption u/s. 11 – A. Ys. 2006-07 and 2009-10 – Education main activity of assessee – Publishing and printing books and selling them at subsidised rates or distributing them at free of cost – Profit earned thereby utilised for education – Denial of exemption erroneous-

Delhi Bureau of Text Books vs. DIT(Exemption); 394 ITR 387
(Del):

The assessee was registered as a charitable institution u/s.
12A(a) of the Act, 1961. It printed and published text books for Government
schools and sold them at subsidised rates with nominal profits. It also
distributed free books, reading material and school bags to needy students. Its
income was exempt from tax u/s. 11 of the Act, during the A. Ys. 1971-72 to
2005-06. It was denied the benefit of exemption for the A. Ys. 1975-76 and
1976-77, but the Commissioner (Appeals) restored the exemption and the same was
confirmed by the Tribunal. For the A. Ys. 2006-07 to 2009-10, the Assessing
Officer denied the exemption and the same was confirmed by the Appellate
Tribunal. The Tribunal held that the asessee’s activities were in the nature of
business, that compliance with the requirement of section 11 could be examined
in every assessment year, that in its earlier order for the A. Ys. 1975-76 and
1976-77, it had not considered the assessee’s income and expenditure statements
or other relevant evidence, that the assessee had not maintained separate books
of account for its activities of sale and purchase of books thereby violating
the provisions of section 11(4A), and that the assessee had made accumulation
in excess and ”without specifying any purpose” and “was not wholly for
charitable purposes”.

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

“i)  The preparation and distribution of text books
contribute to the process of training and development of the mind and the
character of students. There does not have to be a physical school for an
institution to be eligible for exemption. What is important is the activity. It
has to be intrinsically connected to “education”.

ii)  The Appellate Tribunal was incorrect in
denying exemption to the assessee u/ss 11 and 12 of the Act. It erred in
holding that the activities carried out by the assessee fell under the fourth
limb of section 2(15), “the advancement of any other object of general public
utility” and that its activities were not solely for the purpose of advancement
of education. It came to the erroneous conclusion merely because the assessee
had generated profits out of the activity of publishing and selling text books
that it had ceased to carry on the activity of “education”.

iii)  It failed to consider the issue in the
background of the setting up of the assessee, its control and management and
the sources of its income and the pattern of its expenditure and that its
surplus amount was again utilised in its main activity of “education”. The
assessee contributed to the training and development of the knowledge, skill,
mind and character of the students.

iv) The exemption had been granted to the assessee
u/s. 11 and 12 from the A. Ys. 1971-72 to 2005-06 consistently for 34 years.
For the A. Ys. 1975-76 and 1976-77, grant of exemption had been restored by the
Appellate Tribunal which was not contested by the Department. Apart from the
fact that the assessee had earned more profits from its essential activity of
education, there was no change in the circumstances concerning its activity of
publishing and selling books during the A. Ys. 2005-06 to 2009-10. There was no
justification to warrant a different approach. Appeals are allowed.”

34. Capital gains- Exemption u/s. 54F – A. Y. 2012-13 – Assessee getting more than one residential house in several blocks – All flats product of one development agreement on same piece of land – Flats located in same address – Assessee is entitled to benefit of exemption u/s. 54F

CIT vs. Gumanmal Jain; 394 ITR 666 (Mad):

The assessee and his two sons owned certain contiguous
extents of land. The assessee along with his two sons entered into a joint
development agreement with a builder to develop the land by constructing 16
flats therein with a total built up area of 56,945 sq. ft. The assessee and two
sons on the one hand and the builder on the other hand agreed to share in 70:30
ratio between them. The land was developed, 16 flats with separate kitchens and
37 car parks were put up. In lieu of the 70:30 ratio set out in the builder’s
agreement, the assessee got 9 flats and the sons got 3 flats each. For the A.
Y. 2012-13, the Assessing Officer rejected the assessee’s claim for exemption
u/s. 54F of the Act, 1961 on the ground that the assessee owned more than one
residential house and assessed the long term capital gain of Rs. 2,31,56,430 to
tax. The Commissioner (Appeals) allowed the assessee’s claim for exemption and
the same was upheld by the Tribunal.

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

“i)  The assessee having got flats along with his
two sons would not disentitle him from getting the benefit u/s. 54F of the Act
only on the ground that all the flats were not in the same block, particularly
in the light of the admitted factual position that all the flats were located
at the same address. As long as all the flats were in the same address, even if
they were located in separate blocks or towers it would not alter the position.

ii)  After all, all the flats were a product of one
development agreement of the same piece of land. Therefore, the assessee was
entitled to get the benefit of section 54F of the Act.”

33. Business expenditure – Exempt income- Disallowance u/s. 14A- A. Y. 2011-12 – If no exempt income is earned in the assessment year in question, there can be no disallowance of expenditure in terms of section 14A read with Rule 8D even if tax auditor has indicated in his tax audit report that there ought to be such a disallowance

Principal CIT vs. IL & FS Energy Development Company
Ltd.; [2017] 84 taxmann.com 186 (Delhi)

Assessee is a company engaged in provision of consultancy
services. On 26th September 2011, the Assessee filed its return at a
loss of Rs. 2,42,63,176/- for the A. Y. 2011-12. The Assessee had not earned
any exempt income in the relevant year. The assessee had not made any
disallowance u/s. 14A of the Act, 1961. The Assessing Officer computed the
disallowable amount u/r. 8D and made disallowance. The Tribunal held that since
the assessee had not earned any exempt income in the relevant year there can be
no disallowance u/s. 14A of the Act and allowed the assessee’s claim.

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

“i)  The key question in the present case is
whether the disallowance of the expenditure will be made even where the
investment has not resulted in any exempt income during the AY in question but
where potential exists for exempt income being earned in later AYs.

ii)  Section 14A does not particularly clarify
whether the disallowance of the expenditure would apply even where no exempt
income is earned in the AY in question from investments made, not in that AY,
but earlier AYs.

iii)  The words “in relation to income which
does not form part of the total income under the Act for such previous year”
in the above Rule 8D(1) indicates a correlation between the exempt income
earned in the AY and the expenditure incurred to earn it. In other words, the
expenditure as claimed by the Assessee has to be in relation to the income
earned in ‘such previous year‘.

iv) This
implies that if there is no exempt income earned in the AY in question, the
question of disallowance of the expenditure incurred to earn exempt income in
terms of section 14A read with Rule 8D would not arise.

v)  The mere fact that in the audit report for the
AY in question, the auditors may have suggested that there should be a
disallowance cannot be determinative of the legal position. That would not
preclude the assessee from taking a stand that no disallowance u/s. 14A of the
Act was called for in the AY in question because no exempt income was earned.”

32. ALP – Computation- Sections 92 and 92C – A. Y. 2011-12 – Determination of operating costs- Agreement between parties – Reimbursement of costs received from AEs – Finding that reimbursement of cost of infrastructure was without a mark up- Claim of assessee to exclude cost of infrastructure to be allowed

Principal CIT vs. CPA Global Services Pvt. Ltd.; 394 ITR
473 (Del):

The assessee is a wholly owned subsidiary of CPA Mauritius
Ltd., which in turn is a subsidiary of CPA Jersey. It offers a range of legal
support services to its associated enterprises (AEs) as well as to independent
third party customers. During the A. Y. 2011-12, the assessee received an
amount from its associated enterprises as “cost recharge on account of spare
capacity” which was not reflected in its profit and loss account. The Transfer
Pricing Officer (TPO) was of the view that the assessee had not produced any
evidence in support of its claim that the expenditure was towards maintenance
of spare capacity at the instance of the AEs.

The Dispute Resolution Panel (DRP) held that the arm’s length
price (ALP) of the receipts from the AEs included all the costs and that the
assessee did not give sufficient reasons to exclude certain costs for the
purposes of computing the ALP. While the application filed by the assessee u/s.
154 of the Income-tax Act, (hereinafter for the sake of brevity referred to as
the “Act”) 1961 was pending before the DRP, a draft assessment order
was passed by the Assessing Officer based on the decision of the DRP. Before
the Appellate Tribunal, the assessee referred to the agreement with its AEs and
submitted that the reimbursement towards the cost of service with a mark up had
been accounted for in working out the ALP in the transfer pricing study and the
other reimbursement it sought to exclude from the operating costs was towards
the cost of infrastructure on which there was no mark up. The Appellate
Tribunal held that the reimbursement cost should be excluded as they did not
involve any functions to be performed so as to consider it for profitability
purposes and directed the TPO to exclude the reimbursement costs while working
out the operating costs.

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

“i)  The Appellate Tribunal after examining the
agreement between the assessee, and its AEs had agreed with the assessee that
the reimbursement of the infrastructure cost had no mark up. Unless there was a
specific plea by the Department to the effect that such a factual finding was
perverse, on a general plea of perversity, the appeal could not be entertained.
Also, it should be accompanied by a reference to the relevant document which
formed part of the record of the case before the Appellate Tribunal.

ii)   No
substantial question of law arises from the order of the Tribunal. Appeal is
dismissed.”

Applicability of Section 14A – Interest To Partners

Issue for Consideration

Section 14A(1) of the Income-tax Act, 1961 provides that for
the purposes of computing the total income, under the chapter (Chapter IV –
Computation of Total Income), no deduction shall be allowed in respect of an
expenditure incurred by the assessee in relation to the income which does not
form part of the total income under the Act.

Under the scheme of taxation of partnership firms, a
partnership firm is entitled to deduction of interest paid to partners, and
such interest paid is taxable in the hands of the partners, under the head
‘profits and gains of business and profession, vide section 28(v) of the Act. The
deduction of such interest to partners, in the hands of the firm, is governed
by the restrictions contained in section 40(b)(iv), which section provides that
payment of interest to any partner, which is authorised by, and is in
accordance with, the terms of the partnership deed and relates to any period
falling after the date of such partnership deed in so far as such amount
exceeds the amount calculated at the rate of 12% simple interest per annum,
shall not be allowed as deduction.

A question has arisen before the Tribunal in various cases as
to whether interest paid to partners, which is allowable as a deduction to the
partnership firm, can be regarded as an ‘expenditure incurred’ by the assessee
firm, and can therefore form part of the disallowance u/s.14A, to the extent
that it has been incurred in relation to the income arising on investment made
out of the funds received from the partners and on which interest is paid by
the firm, which income does not form part of the total income of the partnership
firm.

While the Ahmedabad and Mumbai benches of the Income Tax
Appellate Tribunal have held that such interest, in the hands of the firm,
would be regarded as an expenditure subject to disallowance u/s. 14A, the Pune
bench of the Tribunal has taken a contrary view holding that interest paid by a
partnership firm on its partners’ capital cannot be regarded as an expenditure amenable to section 14A.

Shankar Chemical Works’ case

The issue first came up before the Ahmedabad bench of the
Tribunal in the case of Shankar Chemical Works vs. Dy CIT 47 SOT 121.

In this case, relating to assessment year 2004-05, the
assessee was a partnership firm carrying on the business of manufacturing of
chemicals. It had invested in various financial assets, such as debentures,
bonds, mutual funds and shares to the extent of Rs. 1.93 crore, the income from
some of which investments was exempt from tax to the extent of Rs. 43.48 lakh.
The assessing officer noted that the assessee had borrowings to the extent of
Rs. 15.57 lakh, on which an interest of Rs. 1.54 lakh had been paid. Besides,
the firm had paid interest on partners’ capital. The assessing officer
concluded that investments in all these mutual funds, shares and securities had
been made out of the funds of the firm, which were either out of the partners’
capital or from borrowings from others. The interest payment on these funds
were made either to partners or to the persons from whom borrowings were made.
He therefore disallowed an amount of Rs. 17.04 lakh out of the total interest expenses of Rs. 23.23 lakh u/s. 14A.

On appeal before the Commissioner(Appeals), the disallowance
of interest u/s. 14A was upheld. The Commissioner(Appeals) held that the
capital was employed for the purpose of investment in mutual funds, shares and
debentures and bonds, and not for the business of the assessee firm for which
the partnership was formed. He also held that the provisions of section 40(b)
were not applicable, and the funds were utilised for the purpose of investment
rather than the business. He upheld the working of the disallowance of interest
made by the assessing officer in proportion to the amount of investment and
total funds employed, and held that the partners of the firm were entitled to
relief under the explanation to section 10(2A) in respect of the that part of
interest of the firm which was not allowed as a deduction to the firm.

Before the Income Tax Appellate Tribunal, on behalf of the
assessee, it was argued that no nexus had been established between the interest
payment and the earning of the exempt income. It was further argued that as per
section 28(v), interest paid to a partner of a firm was chargeable to tax in
the hands of the firm. Therefore, disallowance of such interest u/s. 14A, in
the hands of the firm, would amount to a double taxation. It was further argued that the
firm and the partners were not different entities.

Reliance was placed on paragraph 48 of the CBDT Circular No.
636 dated 31st August 1992, where the provisions of the Finance act,
1992, regarding assessment of the firm were explained. In the circular, it was
stated that share of a partner in the profits of the firm would not be included
in computing, his total income u/s. 10(2A). However, interest, salary, bonus,
commission or any other remuneration paid by the firm to the partner would be
liable to tax as business income in the partner’s hands. An explanation has
been added to section 10(2A) to make it clear that the remuneration or
interest, which was disallowed in the hands of the firm, would not suffer
taxation in the hands of the partner. It was further pointed out that in the
case of the assessee, the partners to whom interest was paid were taxable at
the maximum rate.

It was further argued on behalf of the assessee that the
amendment to the scheme of assessment of a firm had been made to avoid double
taxation of the income. Interest paid to partners was distribution of profit
allocated to the partners in the form of interest and as such it could be taxed
once either in the hands of the firm or in the partners’ hands, but could not
be taxed in both places. Since the partners had paid tax on interest received
from the firm, and all the conditions laid down in section 40(b) had been
fulfilled, no portion of interest paid to partners could be disallowed, and if
it was disallowed it would amount to double taxation.

On behalf of the revenue, it was contended that no interest
free funds were available to the assessee, and therefore disallowance had
rightly been made. The investments were made from capital of the partners, on
which interest at the rate of 10.5% per annum was paid.

The Tribunal rejected the contention of the assessee that
there was no nexus between the exempt income and partners’ capital, since no
interest-free funds were available with the firm. Importantly, in respect of
the assessee’s argument that any disallowance of interest u/s. 14A would amount
to double disallowance, the Tribunal noted that as per the provisions contained
in section 14A(1), an expenditure incurred for earning exempt income was not to
be considered for computing total income under chapter IV. This implied that
such expenditure was to be allowed as deduction while working out the exempt
income under chapter III. In case of expenditure which was incurred for earning
exempt income, a specific treatment was to be given, that such expenses should
be disregarded for computing total income under chapter IV and should be
reduced from exempt income under chapter III. Hence, according to the Tribunal,
there was no double addition or double disallowance.

The Tribunal observed that partners had a share in all the
incomes of the firm. As per the above treatment in the hands of the firm,
regarding expenses incurred for earning exempt income, taxable income of the firm
would increase and exempt income of the firm would go down by the same amount,
total of both remaining the same. The total share of profit of the partner in
the income of the firm would also remain the same, but his share in income
which was exempt in the hands of the firm would be less, and his share in
income which Is taxable in the hands of the firm would be more. However, the
entire share of profit receivable by a partner from a firm was exempt, and
hence there was no impact in the hands of a partner. According to the Tribunal,
since there was no disallowance as such in the hands of the firm, but the
expenditure incurred for earning exempt income was not allowed to be reduced
from taxable income, and instead was to be reduced from exempt income, there
was no effective disallowance in the hands of the firm of the expenses incurred
for earning exempt income, and hence there was no question of any double
allowance or double disallowance.

It also noted that under the proviso to section 28(v), where
there was a disallowance of interest in the hands of the firm due to the
provisions of section 40(b), then and only then the income in the hands of the
partner had to be adjusted to the extent of the amount not so allowed to be
deducted in the hands of the firm. Hence, the proviso to section 28(v) would
come into play only if there was some disallowance in the hands of the firm
u/s. 40(b). According to the Tribunal, in the case before it, the disallowance
was u/s. 14A, and not u/s. 40(b), and therefore, the proviso to section 28(v)
was not applicable and therefore, the partner of the firm was not entitled to
any relief under the said proviso. In any case, since the appellant before the
Tribunal was the firm, and not the partners, the Tribunal did not give any direction
on this aspect of taxability of the partners.

Examining section 10(2A) and the explanation thereto, the
Tribunal rejected the assessee’s argument that if any interest was disallowed
in the hands of the firm, the same could not form part of the total income in
the hands of the partner. According to the Tribunal, the explanation to section
10(2A) did not support such a contention, as the total income of the firm, as
assessed, should alone be considered, and the share of the concerned partner in
such assessed income should be worked out as per the profit sharing ratio as
specified in the partnership deed, and it was such share of the relevant
partner, which only would be considered as exempt u/s. 10(2A).

The Tribunal next addressed the assessee’s argument that
interest paid to partners was distribution of profits allocated to the partners
in the form of interest and hence interest to partners could be taxed once,
either in the hands of the firm or in the hands of the partner, and could not
be taxed in both hands. It also considered the argument of the assessee that
since the partners had paid tax on interest received by them from the firm, no
portion of interest paid to partners could be disallowed, and if disallowed, it
would amount to double taxation. According to the tribunal, such arguments were
devoid of any merit, because interest paid to partners by the firm was not
distribution of profit by the firm, since interest was payable to the partners
as was prescribed in the partnership deed, even if there was no profits in the
hands of the firm. If a firm had a loss and paid interest to the partners, the
loss of the firm would increase to that extent, which would be allowed to be
carried forward in the hands of the firm. Therefore, according to the Tribunal,
interest, to partners was not a distribution of profits by the firm to the
partners and there was no double taxation.

Addressing the assessee’s argument that interest paid to
partners was not an expenditure at all, but was a special deduction allowed to
the firm u/s. 40(b), the tribunal observed that there was no deduction allowed
under section 40(b). According to the Tribunal, section 40(b) was a restricting
section for various deductions allowable under sections 30 to 38. Analysing the
provisions of section 40(b), the Tribunal was of the view that this section was
really restricting and regulating deduction allowable to the firm on account of
payment of interest to partners, and was not an allowing section. According to
the Tribunal, the section allowing the deduction of interest remained section
36(1)(iii), and therefore payment of the interest to partners was also an
expenditure, which was hit by the provisions of section 14A, if it was incurred
for earning exempt income.

The Tribunal accordingly rejected the assessee’s appeal, and
thereby upheld the disallowance of interest to partners u/s. 14A.

This decision of the Tribunal was followed by the Mumbai
bench of the Tribunal in the case of ACIT vs. Pahilajrai Jaikishin 157 ITD
1187, where the Tribunal held that such interest paid to partners on their
capital was an expenditure subject to disallowance u/s. 14A, if it was incurred
in relation to exempt income.

Quality Industries’ case

The issue again came up for consideration before the Pune
bench of the Tribunal in the case of Quality Industries vs. Jt CIT 161 ITD
217.

In this case, relating to assessment year 2010-11, the
assessee firm was engaged in the business of manufacture of chemicals, and had
earned tax-free income of Rs. 24.64 lakh from investment in mutual funds of Rs.
4.42 crore. The assessee had claimed deduction for interest of Rs. 75.64 lakh,
consisting of interest to partners of Rs. 74.88 lakh and interest on bank loans
of Rs. 0.76 lakh.

The assessing Officer, observing that investment in mutual
funds was made out of interest-bearing funds, which included interest-bearing
partners capital, was of the view that the assessee had incurred expenditure,
including interest expenses, which was attributable to earning income from
investment in mutual funds, which was exempt. He, therefore, disallowed
estimated expenditure incurred in relation to such income from mutual funds in
terms of the formula under rule 8D amounting to Rs. 29.25 lakh, including
interest of Rs. 27.85 lakh.

The Commissioner(Appeals) observed that the main source of
investment in mutual funds was partners’ capital, which bore interest at 12%
per annum. According to the Commissioner(Appeals), such interest was relatable
to income from mutual funds, which did not form part of the total income.
Therefore, the Commissioner(Appeals) upheld the disallowance made by the
assessing officer observing that the provisions of section 14A were attracted
to such expenditure.

Before the Tribunal, it was argued on behalf of the assesse,
that the assessee had fixed capital of Rs. 6.24 crore, received from the
partners, on which interest at the rate of 12% per annum had been charged to
the partnership firm. The firm also had current capital from partners that was
received from time to time, which amounted to Rs. 1.14 crore at the end of the
year, on which no interest was paid. It was argued that interest payable on
fixed capital from partners did not bear the characteristic of expenditure per
se as contemplated u/s. 14A. It was pointed out that as per the scheme of
taxation of firms, the payment to the credit of partners in the form of
interest and salary was chargeable to tax in the respective hands as business
income by operation of law.

Reliance was placed on behalf of the assessee on the decision
of the Supreme Court in the case of CIT vs. R M Chidambaram Pillai 106 ITR
292 for the proposition that payment of salary represented special share of
profits, and was therefore taxable as business income. On the same footing, it
was argued that interest on partners’ capital was a return of share of profit
by the firm to the partners. Both interest and salary to partners were not
subjected to TDS, and both fell for allowance under section 40. It was argued
that section 40(b) was not just a limiting section, notwithstanding the fact
that some fetters on the rate of interest had been put thereunder. Salary to
partners and interest paid on partners’ capital was made allowable in the hands
of the firm only from assessment year 1993-94, subject to limits and
restrictions placed u/s. 40(b), and was not allowable prior thereto and
supported the view that section 40(b) was not merely meant for limiting the
deduction, as had that been the case, interest would have been allowable in the
hands of the partnership firm since the birth of the income tax law.

It was further submitted that section 14A was applicable only
where an expenditure was incurred, and not in respect of any and every
deduction or allowance. It was argued that an expenditure was needed to be
incurred by the party, which was absent in view of the mutuality present in a
partnership firm between the firm and its partners. The firm had no separate
existence from its partners, and it was a separate assessable entity only for
the purposes of the Income-tax Act. The Partnership Act, 1932 did not recognise
the firm as a separate entity.

It was further argued on behalf of the assessee that any
disallowance of interest of capital would lead to double disallowance of the
same expenditure, as the partners were already subjected to tax on interest on
capital in their respective personal returns.

The Tribunal analysed the nuances of the scheme of taxation
of partnership firms. It noted that prior to assessment year 1993-94, the
interest charged on partners’ capital was not allowed in the hands of the partnership
firm, while it was simultaneously taxable in the hands of the respective
partners. The amendment by the Finance Act, 1992 by insertion of section 40(b)
was to enable the firm to claim deduction of interest outgo payable to partners
on the respective capital subject to some upper limits. Therefore, according to
the tribunal, as per the present scheme of taxation, the interest payment on
partners’ capital in a sense was not treated as an allowable business
expenditure, except for the deduction available u/s. 40(b).

The Tribunal noted that partnership firms, on complying with
the statutory requirements, were allowed deduction in respect of interest to
partners, subject to the limits and conditions specified in section 40(b), and
in turn those items would be taxed in the hands of the partners as business
income u/s. 28(v). Share of partners in the income of the firm was exempt from
tax u/s. 10(2A). Therefore, the share of income from a firm was on a different
footing from the interest income, which was taxable as business income.

The Tribunal also noted that interest and salary received by
the partners were treated on a different footing by the Act, from the ordinary
sense of the terms. Section 28(v) treated interest as also salary received by a
partner of the firm as a business receipt, unlike different treatment given to
similar receipts in the hands of entities other than partners. It also noted
that under the proviso to section 28(v), the disallowance of such interest was
only with reference to section 40(b), and not with reference to section 36 or
section 37. According to the tribunal, it gave a clue that deduction towards
interest to partners was regulated only u/s. 40(b), and that the deduction of
such interest was out of the purview of sections 36 or 37.

The Tribunal observed that there was no amendment to the
general law provided under the Partnership Act, 1932. The amendment to section
40(b) had only altered the mode of taxation. The partnership firm continued not
to be a separate legal entity under the Partnership Act, and it was not within
the purview of the Income-tax Act to change or alter the basic law governing
partnership. Therefore, interest or salary paid to partners remained the
distribution of business income. The tribunal referred to the decision of the
Supreme Court in the case of R. M. Chidambaram Pillai (supra) for this
proposition. The tribunal also referred to the decision of the Supreme Court in
the case of CIT vs. Ramniklal Kothari 74 ITR 57, for the proposition
that the business of the firm was business of the partners of the firm. Hence,
salary, interest and profits received by the partner from the firm was business
income, and therefore expenses incurred by the partner for the purpose of
earning this income from the firm was admissible as deduction from such share
of income from the form in which he was a partner. Thus, even for taxation
purposes, the partnership firm and partners have been seen collectively, and
the distinction between the two was blurred in the judicial precedents.

Since the firm and partners of the firm were not separate
persons under the Partnership Act, though they were a separate unit of
assessment for tax purposes, according to the Tribunal, there could not be a
relationship inferred between the partner and firm as that of lender of funds
(capital) and borrowal of capital from the partners. Therefore, section
36(1)(iii) was not applicable at all. According to the Tribunal, section 40(b)
was the only section governing deduction towards interest to partners. In view
of section 40(b), according to the Tribunal, the assessing officer had no
jurisdiction to apply the test laid down under section 36, to find out whether
the capital was borrowed for the purposes of business or not. Thus, the
question of allowability or otherwise of the deduction did not arise, except
for section 40(b).

According to the Tribunal, the interest paid to partners
simultaneously getting subjected to tax in the hands of the partners was merely
in the nature of contra items in the hands of the firm and partners.
Consequently, interest paid to partners could not be treated at par with the
other interest payable to outside parties. Thus, in substance, the revenue was
not adversely affected at all by the claim of interest on capital employed with
the firm by the partnership firm and partners put together. Capital diverted to
mutual funds to generate alleged tax-free income did not lead to any loss in
revenue due to the action of the assessee. In view of the inherent mutuality,
as per the Tribunal, when the partnership firm and its partners were seen
holistically and in a combined manner, with interests paid to partners
eliminated in contra, the investment in mutual funds, generating tax-free
income bore the characteristic of an expenditure that was attributable to its own capital, where no disallowance
u/s. 14A read with rule 8D was warranted.

The Tribunal therefore held that the provisions of section
14A read with rule 8D were not applicable to interest paid to partners, but
applied only to interest payable to parties other than partners.

Observations

The logic of the Pune bench of the Tribunal, that the amount
introduced by the partners into the partnership firm is not a borrowing of
capital by the partnership firm but is an introduction of capital by the
partners for constituting the partnership firm and carrying on its business,
does seem fairly attractive at first sight.

The scheme of taxation of the partnership firm and its
partners under tax laws is also relevant. It is only by an artificial provision
that the entire income of the partnership firm is divided into two components
for convenience of taxation – one component taxable in the hands of the firm,
and the second component taxable in the hands of the partners. Section 40(b) read
with the proviso to section 28(v) clearly brings out this intent that what is
taxable in the hands of the firm, is not taxable in the hands of the partners,
while what is taxable in the hands of the partners is not taxable in the hands
of the firm. Therefore, viewed from that perspective, the view of the Pune
Tribunal that the interest to partners was not an expenditure, but was a mere apportionment of the income of the firm, also seems attractive.

This view is also supported by the fact that though salaries
and interest are subjected to tax deduction at source, remuneration and
interest to partners are not so subject to the provisions of tax deduction at
source. In a sense, the tax laws now recognise the fact that such remuneration
and interest to partners stands on a different footing from the normal
expenditure of salaries and interest.

However, to a great extent, the answer to this question is to
be found in the decision of the Supreme Court in the case of Munjal Sales
Corpn vs. CIT 298 ITR 298. In this case, relating to assessment years
1993-94 to 1997-98, the Supreme Court was considering a situation where
interest free loans had been granted to sister concerns in August/September
1991, and interest paid had been disallowed u/s. 36(1)(iii) by the Assessing
Officer. The Tribunal had deleted the disallowance for assessment years 1992-93
and 1993-94, holding that interest free loans had been given out of the
assessee’s own funds. The disallowances for assessment years 1994-95 to 1996-97
were however upheld by the Tribunal.

Before the Supreme Court, the assessee contended that section
40(b) was a standalone section having no connection with the provisions of
section 36(1)(iii), and that section 36(1)(iii) did not apply, as it was a case
of payment of interest to a partner on his capital contribution, which could
not be equated to monies borrowed by the firm from third parties.

In this case, while holding that since the loans were
advanced for business purposes, the interest on such loans would not be subject
to any disallowance under section 36(1)(iii) read with section 40(b)(iv), the
Supreme Court observed as under:

“Prior to the Finance Act,
1992, payment of interest to the partner was an item of business disallowance.
However, after the Finance Act, 1992, the said section 40(b) puts limitations
on the deductions under sections 30 to 38 from which it follows that section 40
is not a stand-alone section. Section 40, before and after the Finance Act,
1992, has remained the same in the sense that it begins with a non obstante clause.
It starts with the words ‘Notwithstanding anything to the contrary in sections
30 to 38’ which shows that even if an expenditure or allowance comes within the
purview of sections 30 to 38, the assessee could lose the benefit of deduction
if the case falls under section 40. In other words, every assessee, including a
firm, has to establish, in the first instance, its right to claim deduction
under one of the sections between sections 30 to 38 and in the case of the
firm, if it claims special deduction, it has also to prove that it is not
disentitled to claim deduction by reason of applicability of section 40(b)(iv).
Therefore, in the instant case, the assessee was required to establish in the
first instance that it was entitled to claim deduction under section 36(1)(iii
), and that it was not disentitled to claim such deduction on account of
applicability of section 40(b)(iv). It is important to note that section 36(1)
refers to other deductions, whereas section 40 comes under the heading ‘Amounts
not deductible’. Therefore, sections 30 to 38 are other deductions, whereas
section 40 is a limitation on those deductions. Therefore, even if an assessee
is entitled to deduction under section 36(1)(iii), the assessee-firm will not
be entitled to claim deduction for interest payment exceeding 18/12 per cent
per se. This is because section 40(b)(iv) puts a limitation on the amount of
deduction under section 36(1)(iii). 

It was vehemently urged on
behalf of the assessee that the partner’s capital is not a loan or borrowing in
the hands of a firm. According to the assessee, section 40(b)(iv) applies to
partner’s capital, whereas section 36(1)(iii) applies to loan/borrowing.
Conceptually, the position may be correct, but in the instant case, the scheme
of Chapter IV-D was in question. After the enactment of the Finance Act, 1992,
section 40(b)(iv) was brought to the statute book not only to avoid double
taxation, but also to bring on par different assessees in the matter of
assessment. Therefore, the assessee-firm, in the instant case, was required to
prove that it was entitled to claim deduction for payment of interest on
capital borrowed under section 36(1)(iii), and that it was not disentitled
under section 40(b)(iv). There was one more way of answering the above contention.
Section 36(1)(iii) and section 40(b)(iv) both deal with payment of interest by
the firm for which deduction can be claimed. Therefore, keeping in mind the
scheme of Chapter IV-D, every assessee, who claims deduction under sections 30
to 38, is also required to establish that it is not disentitled under section
40. The object of section 40 is to put limitation on the amount of deduction which the assessee is entitled to under sections 30 to 38. Section 40
is a corollary to sections 30 to 38 and, therefore, section 40 is not a
stand-alone section.”

The Supreme Court has therefore held that
interest on partner’s capitals is primarily to be considered for allowance u/s.
36(1)(iii), and that section 40(b) puts a restriction on the quantum of interest
so allowable. That being the view taken by the Supreme Court, the view taken by
the Ahmedabad and Mumbai benches of the Tribunal seems to be the better view,
that interest on capitals to partners would be an expenditure, which would also
need to be considered for the purposes of disallowance u/s. 14A.

September 2017: Like-No-Other

September is a busy month for us.
But for September 2017, calling it ‘busy’ will be a ‘material misstatement’.
Every alternate day is a regulatory deadline under some law. While deadlines
have grown exponentially, September 2017 will be – like-no-other – a record of
sorts. Audit closure, tax returns, advance tax payments, AGMs, Tax Audits,
limited reviews, and GST dateline every 5 days all through the month makes this
a marathon month – like no other. While people will put pressure on your time
and attention, know when to insert a full stop, a comma or a semicolon.

A Chartered Accountant plays a
vital role in facilitating compliance for their clients. CA still evokes trust
which few handful professions carry today. It is another matter that some who
call themselves CAs would be better off showing their income under the head
business rather than profession. However, CAs still remain the first port of
call as trusted advisors to help clients tide over difficult times with
multiple timelines and complex issues. This is the hallmark of a professional:
to put client need above personal interest. For that very reason, Chartered
Accountants are not the ones who count, but those on whom clients can count on.  

Presumptive Punishment – If suspicion was evidence

Recently, it was reported that
MCA gave information about ‘shell companies’ to SEBI. While the words ‘shell’
company is not defined under the statute, let alone Companies Act, 2013, the
SEBI went ahead and issued an ‘administrative’ order to put a ban and have
stock exchanges initiate proceedings against the companies. Without going into
the validity of whether these companies have committed any default, the basis
on which SEBI went ahead and put strictures on ‘presumptive basis’ is alarming.
SEBI even challenged the jurisdiction of SAT to entertain an appeal against its
order, calling it ‘administrative’, even when the order had ‘serious civil
consequence’ and ‘prejudicially impaired the rights and obligations’ of the companies.
Such actions by MCA and SEBI, even if they contained substance, brings to fore
the approach based on ‘suspicion’, abruptness and disregard to natural justice.
The SAT rightly pointed out – “We are prima facie of the opinion that
the impugned communication issued by SEBI on the basis that the appellants are
‘suspected shell companies’ deserves to be stayed1”. While every
unlawful activity deserves right action, overstepping the boundaries and
violating the rights is more dangerous. Thomas Jefferson said this about
rightful liberty: “Rightful liberty is unobstructed action according to our
will within limits drawn around us by the equal rights of others. I do not add
‘within the limits of the law’ because law is often but the tyrant’s will, and
always so when it violates the rights of the individual.”

Amendments Galore: Notification, Clarification, Corrigendum

Recently, we have seen some
pieces of clarification, exemptions and relaxations which make the
process<purpose! Professionals often seek solace in the adage – better late
than never. Take the example of ICOFR, made applicable to all companies without
reasonable exceptions. The Companies Act, 2013 had a bias to address corporate
frauds, and so it brought out ‘one size fits all’ approach. Recent announcements
by the Ministry of Corporate Affairs have cleared impediments thrust upon
non-public interest entities. Specifically, the notification, corrigendum and
circular dated 13th June, 13th July and 25th
July respectively have eliminated the need to report on ICOFR by the auditors
in respect of certain companies.

A long pending proposal to amend
the Companies Act was passed by Lok Sabha on 27th July 2017 through
the Companies (Amendment) Bill, 2017. The changes are yet to be notified.
Auditor ratification (S. 139) has been done away with. S. 185 (on loans) is
replaced. The move to bring back layers of subsidiaries is still in limbo since
the proviso to S. 2 (87) remains to be notified. Let’s hope that finally the
layers are not brought back and vested interests do not succeed in creating
circular ownership loops. Declaration of dividend out of unrealized/notional/
revaluation gains due to fair value is specifically barred (S. 123). This is
especially relevant considering that many fair valuations have boosted annual
and Q1/2017 results of Ind-AS compliant companies. While garnishing of profit
and loss account through fair valuation makes the results look better, prudence
should hinder distribution of unrealized gains. Amendments made in Companies
Act, 2013 should strengthen the application of law in substance and we can hope
that there is better congruence amongst the family of laws applicable to
companies. 

Reporting under Tax Audit has
changed as well. While carrying out the audits u/s. 44AB of the Income Tax Act,
professionals will have to pay special attention to amended clause 13 relating
to ICDS and clause 31 in relation to sections 269SS and 269T. Special attention
must also be paid to cash balances in respect of non-corporate assessees. So
far as companies are concerned, there is a reporting about SBN in the financial
statements, however, in case of other assessees, one will have to be especially
cautious. As if this was not enough, few days ago Form 29B was changed to
address Ind AS companies under MAT. 

Paying a tribute

We celebrated 70 years of our
nationhood. A simple, silent yet an all pervasive achievement has been in the
area of payments. It sounds too familiar to be of any consequence. However, one
of the silent institutions of India, National Payments Corporation of India has
been at work to bring about game changing innovations. I recently was at a talk
by the former CEO of NPCI. He recollected how we issued cheques, the cheques
went for ‘collection’ and took up to 21 days when they were ‘outstation’
cheques. Cheques physically moved to a location for ‘clearing’. Millions of
cheques ‘cleared’ daily. Old men and women walked for miles to collect their
pension and other dues from designated banks! All this was not too long ago.
Today, we have come far from all that and financial inclusion has spread all
the way to grass roots level. RTGS, NEFT, IMPS, RuPay Card, BHIM, *99# have
largely replaced cheques, clearing, and passing. Payment technologies, such as
IMPS, were pioneered by India. 24X7 payments through IMPS is one such
innovation which allows one to pay and receive money on a real time basis. We
all have paid hefty bank charges for issuance of demand draft, while today many
banks charge Rs. 5 for transfer up to Rs. 1,00,000 and NIL up to Rs. 1,000.
That is certainly a big payout from financial technologies at work!  

Finally, I hope we all sail
through September as we have in the past! Despite the respite given by CBDT on
31st August, remember to take care of yourself. In the words of Jim
Rohn: Take care of your body. It’s the only place you have to live.

Raman
Jokhakar

Editor

Untitled

As I prepared to write
this piece, a flurry of thoughts were racing through my mind. In an attempt to
fish some of these thoughts and put them into words before they vanish into
oblivion, I popped open my word editor and launched a new document. The file
name on top displayed “Untitled”.

I struggled for a good 20
minutes in an attempt to assign a good title to this piece. I needed to know
how it would look like when I have finished writing it, and what will be the
exact picture? Alas, it was all in vain. I negotiated with myself to begin
writing, explore the work in progress and perhaps discover a title enroute.

Don’t we often fall into
the trap of assigning a title to our lives? When we breed the desire to begin a
new venture, we are flooded with thoughts such as – “where will I be years down
the line” or “will this end up well for me?” or “I still haven’t figured out
exactly how I will go about it!” Very often, these thoughts clutter us so
successfully, that we fail to even begin writing our story. How often do we
give ourselves the opportunity to start with something, explore the work in
progress and then assign a title to our story?

Daymond John, founder of
the apparel retail chain FUBU, waited tables at a restaurant when he had
a desire to create an apparel brand for young men. As he struggled to see how
far and fast his brand would grow, he was selling self-sewn hats for some extra
money. He got an order from America’s leading retailer for $400,000 worth of
products. However, there was a challenge – he had no inventory! Daymond
accepted the order and then began to explore exactly HOW he was going to fulfil
it. Today, FUBU has sold more than $6 Billion worth of products. What
would have happened if he had not begun at all because he did not have a final
picture or a goal or an exact plan in mind?

We often become
disillusioned by “begin with the EXACT goal in mind”. How often do we have an
exact goal before we begin something? How many of us are exactly where we
planned to be 10 years ago? Goals are not stagnant and firm, but like breathing
organisms which keep moving forward as we keep moving towards them. It is more
important to have a direction in which we wish to succeed and begin taking
action along that direction. We can begin to explore, discover a goal and form
the title of our story on the way.

There is a famous story
when a man was passing through a jungle where he found many arrows having hit
the bulls eye on trees. He looked around and found a boy with a bow and arrows.

He congratulated him, “You
are a great archer. All your arrows have hit the bulls eye. Can you show me how
you do it?” The boy blushed and said, “I hit the arrow first and make the
circle later.” Many great people have hit the arrow first, and figured out
their bulls eye later.

Are we struggling to start
something new because we are confused about a final goal? It is ok to flag off
without a map but just with a compass in hand. It is ok to be confused and
begin with nothing but a will to take action. It is ok to begin a new journey
while still being ‘untitled’.

Insider Trading – A Recent Comprehensive Case

There are some provisions of
Securities Laws that need a regular refresh for the reason that they are found
to be frequently violated and entail penalties etc. Insider Trading is
one such provision which one can say is regularly violated. Senior management
and even professionals who ought to know better are found to be on the wrong
side of the law. A recent order of the Securities and Exchange Board of India
(SEBI) is worth considering. It reviews the law relating to Insider Trading.
The case deals with the law prior to amendment of 2015. However, the principles
remain the same even under the amended law. The case covers several types of
acts that are treated to be violative of the SEBI (Prohibition of Insider
Trading) Regulations 1992 (the 1992 Regulations were replaced by the 2015
Regulations). The case is in the matter of CR Rajesh Nair – Managing
Director of Sigrun Holdings Limited (Adjudication Order number AK/AO-14/2017
dated 16th June 2017).


Broad facts of the case

The facts of the case are
interesting and also contentious since SEBI had to arrive at findings that were
against what the party claimed the facts were. The facts and conclusions as
reported in the SEBI Order are summarised here.

 

The party against whom the order
was passed was Managing Director of Sigrun Holdings Limited, a listed company.
It was alleged that he carried out several acts in violation of the
Regulations. He sold shares during a time when there was unpublished price
sensitive information (“UPSI”) that he had access to. The Regulations
prohibit an insider having access to or in possession of UPSI to deal in the
shares of the company. The obvious reason for such prohibition is that a person
in possession of unpublished price sensitive information (UPSI) has an edge
over the shareholders/public generally and would unfairly profit from the same.
He is entrusted with such information in good faith and it will be a betrayal
of `good’ faith if he seeks to profit from it. Hence, he is banned from dealing
in the shares in such circumstances.

 

As proving insider trading is a
comparatively difficult task, the regulations have provided for a blanket ban
over making opposite trades by an insider during the next six months. In other
words if an insider makes a purchase or sale of shares of the company, he is
debarred from making a sale or purchase for the next six months. SEBI, through
detailed investigation including the questioning of the broker, established
that :

 

–  shares were sold within six months of purchase

–  shares were sold on the basis of UPSI

–  shares were sold just before the declaration
of operational results which exhibited substantial reduction resulting in
decline of share price

–  shares were sold during the period when
trading window was closed

–  shares were sold without obtaining
pre-clearance of the Compliance Officer.

 

Hence, there were multiple
violations of the regulations.

 

SEBI then computed in detail the
losses he avoided by selling shares earlier by comparing the sale price on the
date of sale with the sale price at the end of six months period.

 

Investigation, response of MD/broker and
confirmation of findings

SEBI pursued the MD and the broker
concerned to obtain detailed information regarding the trades. The defense put
forth in respect of certain sales was that the MD had not really sold the
shares voluntarily but sales were made by the broker to meet certain “mark to
market” losses incurred by him. Thus, the effective contention was that there
was no violation of the Regulations since this was not within the control of
the MD. However, SEBI examined the facts of the case, the need for margin
money, etc. and found that this contention was not correct and
underlying facts did not match with such contention. Hence, this submission was
rejected and a finding given that the MD had sold the shares within six months
in violation of the regulations.

 

Ascertainment of profiting from insider
trading

Insider Trading, by definition, is
an attempt to profit from UPSI that gives an edge to an insider. The profits
made are usually demonstrated by actual movement of the price on release of the
UPSI.

 

However, it has been accepted that
it is not necessary, to conclude that Insider Trading has taken place, that the
market price should have actually moved in the expected direction. Violation of
the Regulations takes place as soon as the insider deals whilst in possession
of the UPSI.

 

Having said that, the penalty for
insider trading is also related to the profits made – higher the profits made,
higher is the penalty. For this purpose, losses avoided are treated as profits
made. However, there is a stiff penalty of upto Rs. 25 crore where profits
cannot be computed directly.

 

In the present case, SEBI worked
out in detail the losses avoided. There were two types of trades. One set of
trades while there was sale when trading window was closed. The losses avoided
by sale of the shares by working out the price at which the shares were sold
and the price after release of the UPSI was calculated. The other set of trades
were sales made within six months of purchase. In this case, the sale price for
each lot sold within such six months period was compared with the sale price
immediately at the end of the six month period. The losses so avoided were
calculated.

 

As a side note, there is an
interesting aspect here. The rule that reverse trades shall not be carried out
for the following six months has an intention, it appears, of ensuring that
insiders do not quickly deal in the shares as this would help control Insider
Trading to some extent. An insider, thus, who buys 1,000 shares on 1st
January should not sell these shares till 1st July. The rule is
absolute. If one buys even 1 share, he cannot sell any number of shares till
six months. This is probably not wholly consistent with what appears to be the
intention. In the present case too, the MD had bought 1,00,000 shares on 5th
February 2010. However, in the following six months he sold 8,81,307 shares. In
the normal course, the ban should apply only to 1,00,000 shares that he
purchased and not to his entire shareholding. To put in other words, the ban
should apply only to the first 1,00,000 shares he sells and not to any further
sale of shares. However, the law, as literally read, applies to all of his
shareholding and hence any quantity of shares sold would attract this ban, and,
hence, the disgorgement of profits. Thus, profit on sale of all 8,81,307 shares have thus been ordered to be disgorged.

 

Levy of penalty

It is reiterated that the following
violations were held to have been made:-

1.  Dealing while in
possession of UPSI

2.  Sale of shares within six
months of purchase

3.  Sale of shares without
taking pre-clearance of the Compliance Officer.

 

The losses avoided through sale of
shares in violation of the Regulations were just about Rs. 2 crore.

 

SEBI noted that a Managing Director
has grave and higher responsibility of complying with such Regulations and
violation of it should deserve a higher penalty. It relied on the following
observation of the Securities Appellate Tribunal (in Harish K. Vaid vs.
SEBI, order dated 3rd October 2012):-

“It was then argued by the learned counsel for the appellants that
keeping in view the quantum of shares purchased, the penalty imposed by the
Board is excessive. The appellant has not derived any benefit as there was no
sale of shares based on UPSI. The adjudicating officer, while imposing the penalty,
although noted provisions of section 15J of the Act regarding factors to be
taken into account while adjudging the quantum of penalty, he has not applied
them correctly to the facts of the case. We have given our thoughtful
consideration to this aspect and are unable to accept the argument of the
learned counsel for the appellant. The evil of insider trading is well
recognized. The purpose of the insider trading regulations is to prohibit
trading to which an insider gets advantage by virtue of his access to price
sensitive information. The appellant is the Company Secretary and Compliance
Officer of the company who was involved in the finalization of quarterly
financial results and was fully aware of the regulatory framework and code of
conduct of the company. Under such circumstances, when there is a total
prohibition on an insider to deal in the shares of the company while in
possession of UPSI, the quantity of shares traded by him becomes immaterial.
Section 15G of the Act prescribes the penalty of twenty-five crore rupees or
three times the amount of profit made out of the insider trading, whichever is
higher. Section 15HB of the Act prescribes a penalty which may extend to one
crore rupees. However, the adjudicating officer has imposed a penalty of Rs. 10
lakh only on each of the violators. In the facts and circumstances of the case,
we are not inclined to interfere even with the quantum of penalty imposed.”

 

Accordingly,
penalties aggregating to Rs. 6.08 crore were levied on the Managing Director.

 

Conclusion

This Order is a good case study on
how meticulous investigation is made by SEBI particularly in the face of, no
response from the party and incorrect replies from the broker. The contentions
were systematically refuted and it was established that there were violations.
The actual calculation of the losses that were avoided was also made in detail.
The working adopted and principles applied, though simple and logical, are also
relevant and illustrate the methods and principles involved.

 

The intent of the Regulations which
deal with multiple ways of preventing and deeming acts of Insider Trading are
clarified in this order. As stated earlier, the ban on reverse trade within six
months, need for pre-clearance from Compliance officer and ban on trade when
trading window is closed, are examples of in-built checks and balances.

 

The case also demonstrates how the
UPSI benefit is to be determined in terms of worsening performance of a company
which was made public only after the sale of shares.

 

In
conclusion, the case also demonstrates levy of stiff and deterrent penalty
which sets an example for would-be violators.

RERA: Some Issues

Introduction

After an Overview of the Real Estate (Regulation and Development) Act, 2016 (“the Act”) in last month’s Feature, let us examine some critical issues under the same as applicable in the State of Maharashtra. It may be noted that the RERA is a State Regulator and hence, each State and each State’s RERA is empowered to issue their own Rules and Regulations respectively. This Article restricts itself to the State of Maharashtra.

At the outset, it must be confessed, that the Act is an evolving statute and at this stage, there may be more questions than answers. Having said that, the RERA in the State of Maharashtra (“MahaRERA”) is quite proactive and has been issuing clarifications on several issues.

Promoter: Land Owners also covered

The Act requires a Promoter to register a real estate project with the RERA. As on the deadline of 31st July, 2017, over 10,000 projects were registered with the MahaRERA.

The Act defines a Promoter in an exhaustive manner by giving a very far reaching definition. It covers any person who acts (himself) as a builder, coloniser, contractor, developer, estate developer or who claims to be acting as the holder of a power of attorney from the owner of the land on which the building or apartment is constructed or plot is developed for sale.

An interesting issue arises as to what would be the position of a land owner who enters into a joint development agreement with a developer for say, a share in the revenue from the sale of flats or a share in the area to be developed? For instance, a landowner executes a development rights agreement with a developer and in lieu of the same would receive a 40% share of the revenues ( to be)  received from the Project. Alternatively, he agrees to  receive 40% of the built-up area in the project. Would such a land owner also be treated as a Promoter? The answer to this is Yes! The MahaRERA in its Order has coined the definition of the term “Co-Promoter” and defined it to mean and includes any person(s) or organisation(s) who, under any agreement or arrangement with the Promoter of a Real Estate Project is allotted or entitled to a share of the total revenue generated from the sale of apartments or share of the total area developed in the real estate project. Thus, every land owner who receives an area / revenue share would be treated as a Promoter of the real estate project. It would be permissible for the liabilities of such Co-Promoters to be as per the joint development agreement with the developer. However, for withdrawal from the RERA Account, they shall be at par with the Promoter of the Real Estate Project. The land owner would be required to give an undertaking to the RERA, including an undertaking relating to the title to land and the date of completion of the project. Consequently and most vitally, the Order holds that the cost of land payable to land owners by the Promoter cannot be regarded as cost of Project and cannot be withdrawn from the RERA Account and that such land owners must open a separate bank account for deposit of 70% of the sale proceeds from the allottees! An intriguing part about this Order is its interplay with the Act. Section 4 of the Act mandates that 70% of the realisations from flat allottees shall be deposited in a separate designated account which would be used only to cover the cost of construction and the land cost. In a joint development agreement, the share payable to a land owner by a developer is the developer’s land cost. However, the MahaRERA’s Order expressly prohibits payment of this land cost from the separate designated account!

Recently, some land owners have approached the Bombay High Court challenging this Order of the MahaRERA. The final outcome of this case would be eagerly awaited by several land owners.

After the advanced capital gains tax liability on a land owner (started by the decision of the Bombay High Court in Chaturbhuj Dwarkadas Kapadia, 260 ITR 491 (Bom)) and indirect taxes (GST/VAT/service tax as on a works contract) for the portion constructed by the developer for the land owner, this would be the final straw which breaks the proverbial camel’s back! Of course, the newly introduced section 45(5A) of the Income-tax Act seeks to provide some solace to land owners who are individuals and HUFs by postponing the capital gains tax liability. However, for a great majority of land owners they would be staring at a scenario, where on the one hand, they are asked to pay capital gains tax on the execution of a development agreement once the conditions specified in Chaturbhuj Dwarkadas Kapadia, 260 ITR 491 (Bom) are triggered and on the other hand, they cannot withdraw the money received from the flat allottees!! It may be noted that this is a restriction imposed by the MahaRERA and hence, only applies in the State of Maharashtra and not in other States (unless the Authorities in other States also issue a similar Order). Further, this Order only applies when the consideration for the land owner is in the form of a revenue / area share. If the transaction is one of an outright sale / conveyance, then this restriction is not applicable and the developer can easily use the sale proceeds to pay off the land owner. Having said that, finding a developer, in the current real estate market, willing to buy a land on an outright basis is akin to finding a needle in several haystacks. Something which even google.com would find very difficult to search. If a land owner does find such a developer, then he kills 3 birds with one stone – he can pay tax (since he has the funds), there would not be any GST liability (since there is no works contract component) and he would not be classified as a Promoter under the RERA Order. Truly an Utopian scenario!

Promoters: Contractors
A question arises whether a building contractor is required to be registered as a Promoter? The definition includes a contractor or person by any name who acts as the holder of a power of attorney from the land owner on which the building / apartment is constructed. However, the overarching requirement for registration is that the Promoter must sell one or some of the apartments. Section 3 which mandates registration makes it clear that no Promoter shall sell or offer for sale any apartment or building without prior registration. Hence, if there is no sale or offer for sale, then there should not be any requirement for registration as a Promoter. Section 3 similarly provides that any renovation, repair or redevelopment which does not involve marketing, sale or new allotment of any apartments would not require registration. Hence, a building redevelopment which does not have any free sale component would be outside the purview of registration. The FAQs issued by the MahaRERA also support this view where the answer given states that if there are 16 apartments in a society redevelopment project, registration would be required provided there are some apartments which are for sale. Hence, it stands to reason that if there is no sale component, then there would not be any requirement for registration. 

Promoters: Financiers and Private Equity Funds
A similar predicament as that of the land owners may also be experienced by lenders / private equity funds who have contributed funds to the real estate project. In most cases, such financiers have step-in rights, i.e., in the event that the developer is unable to complete the project, then they would step-in to his shoes and complete the project.  In addition, financiers more often than not, have strong investor protection rights which enable them to participate in the control and management of the developer’s entity.  The definition of the term Promoter is extremely wide. Hence, it is a moot point whether such financiers may also be roped in within the definition of a Promoter / Co-Promoter? This may even hamper any exit to be provided by the developer to the financier since payments to Promoters do not fall within the permissible uses from a designated bank account. It may be possible to contend that mere presence of such rights may not make a lender to be treated as a Promoter till they are actually exercised.

This may force financiers to utilise secured debt structures in which only the project is mortgaged in their favour without any exotic rights. In such an event, the financier would not be treated as a Promoter and the designated bank account can be used to repay the lender. In any case, the obligations would be attracted once the mortgage is foreclosed and the financier proceeds with the incomplete tasks.

Designated Account to be maintained

The Act requires that the Promoter must maintain a separate designated bank account. 70% of all realisations from flat allottees must be deposited in this account to cover the cost of construction and the land cost and must be utilised for that purpose only. The balance 30% may be withdrawn without routing the same to the designated account. For making withdrawals from this account, 3 Certificates are required. The provisions applicable in the State of Maharashtra in this respect are spread over the Central Act, the Rules (framed by the Maharashtra State Government), the Regulations  (framed by the Maharashtra RERA), the Forms (issued by the Maharashtra RERA) and the Clarifications (issued by the Maharashtra RERA). All these diverse provisions have been harmonised and analysed below for the ease of ready reference:

(a)   Designated Bank Account – 70% of all amounts realised for the real estate project from the allottees, shall be deposited in a separate bank account to cover the cost of construction and the land cost and shall be used only for that purpose. These deposits may include advances received against allotment.

(b)   Procedure for Withdrawals – The Promoter is entitled to withdraw amounts from the designated bank account, to cover the cost of the project (land and construction and borrowing), in proportion to the percentage of completion of the project. Withdrawal is permissible only after it is backed by 3 certificates stating that the withdrawal is in proportion to % completion of the project. The Promoter is required to submit the following 3 certificates to the bank operating the designated account:

–   Firstly, a certificate in Form 1 from the project Architect certifying the % completion of construction work of each of the buildings/wings of the project;

–   Secondly, a certificate in Form 2 from the Engineer for the actual cost incurred on the construction work of each of the buildings/wings of the project; and

–   Thirdly, a certificate in Form 3 from a practicing Chartered Accountant, for the cost incurred on construction and the land . The practicing Chartered Accountant shall also certify the proportion of the cost incurred on construction and land to the total estimated cost of the project. The total estimated cost of the project multiplied by such proportion shall determine the maximum amount which can be withdrawn by the Promoter from the separate account.

The Promoter is required to follow the above at the time of every withdrawal from the separate account till Occupancy Certificate in respect of the project is obtained. On receipt of the Completion Certificate in respect of the project, the entire balance amount lying in the separate account can be withdrawn by the Promoter.

However, as a concession, MahaRERA has allowed a Promoter to do away with the practice of submitting 3 certificates for every withdrawal from the designated bank account. He may obtain the same and retain them on record and furnish them to the auditor at the time of the annual audit. The Promoter would have to submit a self-declaration to the bank once every quarter and this would suffice for the withdrawals.

(c)   Contents of CA’s Certificate: Form 3 requires the CA to certify the following:

–   Total Estimated Cost (Land Cost + Construction Cost) of the project based on the Form 2 issued by the engineer.

–   Total Cost Incurred (Land Cost + Construction Cost) of the Real Estate Project based on an actual verification of the books of account by the CA.

–   % completion of Construction Work (as per the Architect’s Certificate in Form 1). However, the MahaRERA has clarified that this need not be filled in by the CA for all ongoing certificates and should be filled in only in the final certificate issued after 100% of the construction work has been completed.

–   Proportion of the Cost incurred on Land Cost and Construction Cost to the Total Estimated Cost. (Total Cost Incurred / Total Estimated Cost).

–   Amount which can be withdrawn from the Designated Account (Total Estimated Cost * Total Cost Incurred / Total Estimated Cost)

     Less: Amount withdrawn till date of this certificate as per the Books of Accounts and Bank Statements

–   Resulting figure is the Net Amount which can be withdrawn from the Designated Bank Account

The CA certifying Form 3 should be different than the statutory auditor of the Promoter’s enterprise.

(d)   Components of Form 3:

(A)  Land Cost includes all costs incurred by the Promoter for acquisition of ownership and title of the land, including premium payment; Premium for TDR/ FSI; stamp duty, transfer charges, etc.

In cases, where the Promoter, due to inheritance, gift or otherwise, is not required to incur any cost for the land, then his cost is determined on the basis of the Stamp Duty Ready Reckoner value of the land prevailing on the date of registration of the real estate project with the MahaRERA.

In respect of the land cost, the MahaRERA has clarified that the fair market value of the acquisition cost shall be the indexed cost of acquisition of the land computed as per the Income-tax Act provisions. One wonders how should this indexation be applied while issuing a certificate because the term “fair market value of the indexed cost” is not to be found in Form 3. A suitable clarification on this would be appreciated.

Further, it has been clarified that interest specifically done for land acquisition should be added. Interest for construction of rehab component in a project is also treated as land cost. Costs incurred for slum rehab, relocation of tenants in a redevelopment project, etc., are all includible in land cost.

(B) The Cost of Construction includes all costs, incurred by the Promoter, towards the on-site and off-site expenditure for the development of the Real Estate project, including payment to any Authority and the Principal sum and interest, paid to certain lenders.

     In respect of the Cost of Construction, the MahaRERA has clarified that:

(i)  The term “incurred” means products or services received creating a debt in favour of the supplier or received against a payment made. It is a moot point whether payment of advances towards cost is permissible? A suitable clarification on this would be appreciated.

(ii) The development / construction cost should not include marketing, brokerage expenses incurred for the sale of flats. These, though part of the project cost, should not be met out of the designated account but should be met from the other accounts / funds of the Promoter.

(iii) While principal sum should be shown in brackets it must not be treated as a part of the construction cost.

(iv)Income-tax payable by the Promoter is not a part of the construction cost.

(v) Cancellation amounts paid to allottees who cancel their bookings can be treated as a part of the construction cost and can be withdrawn from the designated account.

(e)   Annual Audit; The Promoter must get his accounts audited by 30th September of every financial year and must produce a statement of accounts duly certified and signed by auditor to the MahaRERA. The Annual Report on statement of accounts must be in Form 5.

Form 5 requires the auditor to certify that the amounts collected for a particular project have been utilised for that project alone and that the withdrawal from the designated bank account has been in accordance with the proportion to the percentage of completion of the project. If not, then the Form must specify the amount withdrawn in excess of the eligible amount or any other exceptions. MahaRERA has clarified that auditor must certify that 70% of the realisations have been used for the project (the balance 30% could be used for any purpose).

(f)   Mismatch  in  Certificates and  Audit: The Regulations contain a very important provision. They state that  if the  Form 5 issued by the auditor reveals that any Certificate issued by the project architect (Form 1), engineer (Form 2) or the chartered accountant
(Form 3):

–   Has false or incorrect information and

–   the amounts collected for a particular project have not been utilised for the project and

–   the withdrawal has not been in compliance with the proportion to the percentage of completion of the project,

then the MahaRERA, in addition to taking penal actions as contemplated in the Act and the Rules, shall also take up the matter with the concerned regulatory body of the said professionals of the architect, engineer or chartered accountant, for necessary penal action against them, including dismemberment.

Thus, while % of completion of work needs to be mentioned in ongoing Form 3 issued by a CA (as per the relaxations given by the MahaRERA), the withdrawals must be in sync with the proportion to the percentage of completion of the project. In fact, the Auditor is required to specifically report on this issue and if it is found that this condition has been violated, then the RERA may even complain to the ICAI against the CA issuing Form 3. Thus, there is a unique scenario where the CA need not report on % completion but he must ensure withdrawal is in compliance with % completion. Hence, it would be in the interest of the CA to always ensure that his certificate clearly specifies whether the withdrawal is in proportion with the percentage of completion of the project.

The abovementioned rules will have to be followed by the co-promoter as well, to the extent applicable.

Conclusion

The Act is a major reform in India’s real estate sector and as is the case with any transformation, there are bound to be teething problems and unsolved queries. As the sector progresses on the learning curve, lessons will be learnt and issues may get resolved.
 
At this stage, it would be worthwhile to alert CAs issuing certificates under the Act, to remember Shakespeare’s quote “Discretion is the Better Part of Valour!” Thus, they should exercise due care and caution while certifying and in cases of doubt or ambiguity, consider asking the Promoter to obtain a legal opinion. Avoid acting in haste and repenting in leisure!!

Threats to RTI

Those who wish to proclaim the great impact of Right to
Information say that it is responsible for creating the culture of transparency
in the government. The widespread usage of RTI is proof of this. This claim is
reasonable and is obvious in the empowerment of citizens and the scams it has
exposed. There is a strong feeling that corruption is unacceptable and there is
a great resolve to curb it. This is in line with the declaration in the
preamble of the constitution.

However, accountability and transparency have not yet
become embedded in the DNA of those with power, and this is a change that is
being resisted. There are signs that we may have reached a point of
stagnation, which could lead to RTI’s regression. This cannot be good for the
citizens and democracy. Many techniques have been developed by the officers to
stall RTI queries. At times, absurdly high charges in tens of thousands are
sought as costs for gathering the information. Another way is to offer piles of
files for inspection without indexing and pagination. I once asked a government
department about a list of transfers of senior officers in violation of Act 21
of 2006; they sent it to over 30 different offices. One more technique is to
transfer the application multiple times. All these are against the letter and
spirit of the law.

First let us analyse the reasons for RTI’s success and wide
proliferation. The main reason was the fact that it was reasonably well crafted
because of active civil society intervention and participation. There were
people’s movements like Mazdoor Kisan Shakti Sangathan which had championed
this law. The teeth of the act were the penalty provisions which for the
first time provided for a financial penalty up to Rs. 25000 to be paid by a
public information officer, if he/she did not provide information without
reasonable cause. This for the first time recognized the sovereignty of the
individual citizen.

Civil society organizations and individuals very
enthusiastically took upon themselves the job of educating people. Citizens
took ownership of this law. Government officials feared the Information
Commissions and felt they would have a difficult time if the matters went to
courts in writs. Among the first few cases which went to courts, various high
courts acknowledged that this was a fundamental right of citizens which had
been earlier defined in various Supreme Court judgements, such as those in Raj
Narain case, R. Rajagopal, SP Gupta, ADR-PUCL and others.

However, after the first few years of this honeymoon, the resistance
to RTI began building up within the establishment. The establishment soon
realized that it had unleashed a genie, which curbs its powers for
arbitrariness and corruption. In less than a year, the government decided to
amend the act to dilute its effectiveness. There were intense protests across
the country by citizens and the government had to retract. After that there
were at least two more efforts to dilute the Act but these too failed. The last
time was when the Central Information Commission ruled that six major political
parties were ‘public authorities’ as defined by the law and hence would have to
give information in RTI. The parties ganged up together so that they could
carry on with their opaque operations with black money, undemocratic working
and in contravention of their constitutions. Citizen opposition managed to
again stop this. But political parties have jointly decided to defy the
orders of the Commission to display their pompous arrogance. They have refused
to appoint Public Information Officers or give any information in RTI. They are
disregarding the orders of the Commission without even a fig leaf of getting a
stay from a Court.

Most state and central governments are showing great
reluctance to follow the RTI Act. They have developed techniques to wear out
the applicant. The lackadaisical ways of the Information Commissions have
helped and emboldened them. It has been noticed that most Information
Commissions impose penalties in the rarest of cases, as if they are imposing a
death penalty. Governments often do not appoint Commissioners.

Amongst the few times that the former PM spoke he had
mentioned his distress at what he called ‘frivolous and vexatious’ RTI
applications and the time taken up in these. A RTI query about this revealed
that it was a casual observation based on his perception and irritation with
pestering RTI queries by the powerless citizen. There was no evidence. The
present PMO refused to even provide information about the visitors to the PM!
Why should this be so? The PM works round the clock in the service of people
and such reluctance appears suspicious. Will revealing those names reveal
some dark secrets?

The governments appear to be institutionalizing mechanisms
whereby citizens know only what the government wants them to know. It is
absurd that citizens who are mature enough to elect those who should govern the
nation are not considered mature enough to be trusted about information on
those who represent them. This claim is made by those who are in power, and who
do not understand and subscribe to democratic working. After getting power,
people’s mindset undergoes a transformation. It is a matter of deep distress
that even the present CM of Delhi Arvind Kejriwal, who became nationally famous
for his work in the RTI campaign, has not brought about any significant change
in his government towards transparency.

Information Commissioners are mainly selected as an act of
political patronage. Many of them have no predilection for transparency,
though they may pay lip service to it. The lack of effective working,
accountability and transparency at most of the commissions is heart wrenching.
Many commissioners do not understand the law, nor the basic rationale for
transparency or democracy.  Apart from
this the lazy way in which many work has built up mounting pendencies, and it
appears that they will be largely responsible for frustrating RTI.

It is unfortunate that the last few years have seen decisions
by most quasi-judicial and judicial bodies expanding the interpretations of the
exemptions and constricting the citizen’s right. Former Supreme Court judge,
Justice Markandey Katju has said “I therefore submit that an amendment be made
to the RTI Act by providing that an RTI query should be first examined
carefully by the RTI officer, and only if he is prima facie satisfied on
merits, for reasons to be recorded in writing that the query has some substance
that he should call upon the authority concerned to reply. Frivolous and
vexatious queries should be rejected forthwith and heavy costs should be
imposed on the person making them.” A former Chief Justice of India said in
April 2012, “The RTI Act is a good law but there has to be a limit to it.”
At this rate and logic, we may be asked to justify why we wish to speak or express
ourselves! A study of all the Supreme Court judgements by this writer
appears to show that the Right to Information is being constructed by gross
misinterpretation. Government departments get stays from Courts to many
progressive orders of the Information Commissions. Citizens do not have the
wherewithal to fight protracted legal battles. While parliament’s attempts to
dilute the RTI Act were thwarted by the sovereign citizens, its emasculation by
adjudicators is happening at a brisk pace. Many decisions are blunting the law
of its power to curb corruption.

 One of the most
problematic statements by the Supreme Court in a RTI case is quoted in many
places: “Indiscriminate and impractical demands or directions under RTI Act
for disclosure of all and sundry information (unrelated to transparency and
accountability in the functioning of public authorities and eradication of
corruption) would be counter-productive as it will adversely affect the
efficiency of the administration and result in the executive getting bogged
down with the non-productive work of collecting and furnishing information. The
Act should not be allowed to be misused or abused, to become a tool to obstruct
the national development and integration, or to destroy the peace, tranquillity
and harmony among its citizens. Nor should it be converted into a tool of
oppression or intimidation of honest officials striving to do their duty. The
nation does not want a scenario where 75% of the staff of public authorities
spends 75% of their time in collecting and furnishing information to applicants
instead of discharging their regular duties. “

This needs to be contested. The statement “should not be
allowed to be misused or abused, to become a tool to obstruct the national
development and integration, or to destroy the peace, tranquillity and harmony
among its citizens” would be appropriate for terrorists, not citizens using
their fundamental right to information. There is no evidence of RTI damaging
the nation. As for the accusation of RTI taking up 75% of time, I did the
following calculation: By all accounts, the total number of RTI applications in
India is less than 10 million annually. The total number of all government
employees is over 20 million. Assuming a 6-hour working day for all employees
for 250 working days, it would be seen that there are 30,000 million working
hours. Even if an average of 3 hours is spent per RTI application (the average
is likely to be less than two hours) 10 million applications would require 30
million hours, which is 0.1% of the total working hours. This means it would
require 3.2% staff working for 3.2% of their time in furnishing information to
citizens. This too could be reduced drastically if computerised working and
automatic updating of information was done as specified in section 4 of the RTI
Act. It is unfortunate that the apex court has not thought it fit to castigate
public authorities for their brazen flouting of their obligations u/s. 4, but
upbraided the sovereign citizens using their fundamental right.

I would submit that the powerful find RTI upsetting their
arrogance and hence try to discredit it by often talking about its misuse.
There are many eminent persons in the country, who berate RTI and say there
should be some limit to it. It is accepted widely that freedom of speech is
often used to abuse or defame people. It is also used by small papers to resort
to blackmail. The concept of paid news has been too well recorded. Despite all
these there is never a demand to constrict freedom of speech. But there is a
growing tendency from those with power to misinterpret the RTI Act almost to a
point where it does not really represent what the law says. There is widespread
acceptance of the idea that statements, books and works of literature and art
are covered by Article 19 (1) (a) of the constitution, and any attempt to curb
it meets with very stiff resistance. However, there is no murmur when users of
RTI are being labelled deprecatingly, though it is covered by the same article
of the constitution. Everyone with power appears to say: “I would risk my
life for your right to express your views, but damn you if you use RTI to seek
information which would expose my arbitrary or illegal actions.” An
information seeker can only seek information on records.


I would also submit that such frivolous attitude
towards our fundamental right is leading to an impression that RTI needs to be
curbed and its activists maybe deprecated, attacked or murdered. The citizen’s
fundamental right to information is now facing strong challenges, owing to its
great success and the fact that it has changed the discourse and paradigm of
power. Our democracy is at a crossroads. The next decade could result in
increasing the scope of transparency to result in a true democracy. However, if
the forces opposing transparency gain over the demos, a regression can
take place. If this happens, those in power must note that the citizen will not
stand for it. Citizen groups must take active measures to defend their right,
including demanding a transparent process of selecting commissioners and making
the political leadership aware that they will resist any dilution of the law. RTI
must be saved and allowed to flower. At this juncture as the nation celebrates
70 years of independence it must hold samvads (dialogues) across the nation to
restore RTI to its pristine glory. Parliament with citizen inputs made a law
which ranks amongst the top five in the world in terms of its provisions.
However, we rank at a poor 66 in terms of implementation. It is our duty to
create adequate public opinion to safeguard our Right to Information.

Insolvency and Bankruptcy Code 2016 – Challenges and Opportunities

The enactment of the ‘The Insolvency and Bankruptcy Code
2016’ (IBC) on May 26, 2016 is perhaps one of the biggest reforms along with
GST undertaken by India in recent times. The Code unifies and streamlines the
laws relating to recovery of debts and insolvency for both corporate and
non-corporate persons, including individuals.

The preamble to the Act introduces the Act as

–   An Act to consolidate and amend the laws
relating to reorganisation and insolvency resolution of corporate persons,
partnership firms and individuals

–   To fix time periods for execution of the law
in a time bound manner

–   To maximise the value of assets of interested
persons

–   To promote entrepreneurship

–   To increase availability of credit

–   Balance the interests of all stakeholders
including alteration in the order of priority of Government dues.

The vision of the new law is to encourage entrepreneurship
and innovation. Some business ventures will always fail but they will be
handled rapidly and swiftly. Entrepreneurs and lenders will be able to move on
instead of being bogged down with decisions taken in the past.

The Code repeals or overrides around 11 laws and promises to
bring a sea change in how debt recovery and insolvency are handled in India,
drawing from the success of such law in other countries.

Insolvency, Bankruptcy and Liquidation

Bankruptcy and Liquidation share in common the concept of
‘Insolvency’. This means that it takes a person or a company becoming
‘Insolvent’ to trigger a Bankruptcy or Liquidation.

Having said that, not all Liquidation occurs as a result of
Insolvency (i.e., Members Voluntary Liquidations occurs when the shareholders
of a solvent company elect to liquidate the company, simply because that
company has achieved its purpose).

To address the question directly, Insolvency is the common
link to Bankruptcy and Liquidation. Let me unpack these concepts.

Applicability of the Code

The provisions of the Code shall apply for insolvency,
liquidation, voluntary liquidation or bankruptcy of the following entities:

1.  Any company incorporated under the Companies
Act 2013, or under any previous law

2.  Any other company governed by any special act
for the time being in force, except insofar as the said provision is
inconsistent with the provisions of such Special Act

3.  Any Limited Liability Partnership under the
LLP Act 2008

4.  Any other body incorporated under any law for
the time being in force, as the Central Government may by notification specify
in this behalf

5.  Partnership firms and individuals.

There is an exception to the applicability of the Code that
it shall not apply to corporate persons who are regulated financial service
providers like Banks, Financial Institutions and Insurance companies.

Institutional set up under
the code

With a view to improve Ease of doing business in India, the
code provides for a time bound process for speedy disposal and also the manner
for maximisation of value of assets. It will create a win-win situation not
only for the creditor and debtor companies, but it will also benefit the
overall economy.

The IBC provides an institutional set-up comprising of the
following five pillars:

I.   Insolvency Professionals (‘IP’) –To
conduct the corporate insolvency resolution process and includes an interim
resolution professional; the role of the IP encompasses a wide range of
functions, which includes adhering to procedure of the law, as well as accounting
and finance functions.

II.  Insolvency Professional Agencies (‘IPA’)
–To enroll and regulate insolvency professional as its member in accordance
with the Insolvency and Bankruptcy Code 2016 and read with regulations.

III.  Information Utilities – to collect,
collate and disseminate financial information to facilitate insolvency
resolution.

IV. Insolvency and Bankruptcy Board of India
(‘IBBI’) – A Regulator who will oversee these entities and to perform
legislative, executive and quasi-judicial functions with respect to the
Insolvency Professionals, Insolvency Professional Agencies and Information
Utilities.

V. Adjudicating Authority – The National
Company Law Tribunal (NCLT), established under the Companies Act, 2013 would
function as an adjudicator on insolvency matters under the Code.

The implementation of any system does not only depend on the
law, but also on the institutions involved in administration and execution of
the same. It depends on the effective functioning of all the institutions but
the Insolvency Professionals have a vital role to play in the insolvency and
bankruptcy resolution process.

Distinguishing Features of the IBC

The Code provides a comprehensive and time bound mechanism to
either put a distressed person on a firm revival path or timely liquidation of
assets. The interests of all stakeholders have been taken care of. Some of the
salient features of the code are as follows:-

1.    Dedicated Adjudicating and Appellant
Authority:

       The adjudicating authority for Corporates
shall be National Company Law Tribunal (NCLT) and for others shall be Debt
Recovery Tribunal (DRT).The first appeal shall lie with NCLAT and DRAT
respectively and the final appeal shall lie with the Supreme Court. No other
Court shall have any jurisdiction to grant any stay or injunction in respect of
matters within the domain of NCLT, DRT, NCLAT and DRAT. This would provide a
specialised mechanism to resolve stressed accounts problem.

       Further, a separate regulator i.e. the
IBBI is set up to regulate various matters under the Code.

2.    Time Bound Process: The Code provides that
the insolvency resolution shall have to be completed within 180 days (maximum
one extension of 90 days allowed) from the date of admission of application for
insolvency resolution. If no resolution is reached in the above time frame, the
Code provides for automatic liquidation. Hence, once default happens and
insolvency resolution application is filed by any stakeholder, financial
creditors would be forced to make intelligible choices so as to maximise
economic value of business or face liquidation. At the same time, promoters
should get sensitive about managing cash flows as default would straight lead
to loss of control over business. 

3.    Preserving Value of Business: Once the
application for insolvency resolution is admitted, there shall be complete
moratorium till completion of insolvency proceedings. Board of Directors shall
remain suspended and affairs of the company shall come under the control of the
Resolution Professional. Though the entity shall remain a going concern.
Creditors shall be precluded from taking any action against the Company
including enforcement of security under SARFAESI Act during this period. Even a
lessor cannot take possession of leased assets back during the moratorium
period. Thus it shall provide an opportunity for the creditors to discuss
sensible restructuring that can provide a better value than straight
liquidation even while business and its assets are preserved during this
period.

4.    Failure to Pay is the new Trigger: Existing
mechanisms under SICA and Companies Act are tuned to provide for interjection
when the borrower’s ability to pay is demonstrably impaired. Whereas under the
Code, a creditor can trigger insolvency resolution process just on default.
Thus a defaulter can be dragged into insolvency resolution process without
waiting for its net-worth to get eroded or for the account to be classified as
NPA. This would be a big deterrent for able debtors to arm-twist small
creditors.

     Therefore, the Code will have an effect
of early identification of distress. It will instill discipline among promoters
or else they will risk losing management control and also face liquidation.

5.    Professionalisation of Insolvency
Management:

       The Insolvency Professionals shall be
regulated and licensed professionals and will have a critical role in the
process. During the process of Insolvency Resolution, the management of the
borrower shall be taken over by the Insolvency Resolution Professional. This
will help preserve the value of business and assets of the debtor during the
insolvency resolution process. Lenders will no longer be worried about
mismanagement by promoters of distressed corporates. As of now, the only option
lenders had was to convert debt into equity and take over the management for
which they may not be having the requisite competency.

6.    New Priority Order of Payment: A welcome
change brought in by the Code is that the statutory dues are relegated to the 5th
position in the priority of payment from the current 1st
position. Herein, even unsecured financial creditors shall be paid before
clearance of dues of the Central and State Governments. This provision is
likely to boost corporate bond market as well as debt funding of SMEs and
startups.

7.    All Creditors empowered to trigger
Insolvency: All creditors whether domestic or foreign, whether secured or
unsecured and whether financial or operational can apply for insolvency
resolution. The defaulting debtor himself may also apply. Thus for the first
time, structured mechanism for redressal of defaults is being provided to
operational creditors such as suppliers, employees etc. Similarly, the
foreign lenders and unsecured lenders shall find a mechanism to enforce their
debts in a fair and transparent process. This no doubt will deepen the credit
markets in India.

8.    Enforcement of Personal Guarantees: If any
corporate debt is secured by means of personal guarantee, then the bankruptcy
of the personal guarantor shall be dealt with by same NCLT rather than DRT.
Thus, there will be a common forum for a creditor to enforce debt from both
borrower and guarantor.

9.    Information Utilities: There is an enabling
provision to facilitate creation of Information Utilities which will house
comprehensive credit data relating to debtors, their creditors and securities
created. This will improve transparency and better decision making at all
levels.

10.  Fresh Start: A non-corporate debtor on finding
himself unable to pay his debts may apply for a fresh start by discharge from
certain debts, provided he satisfies the following conditions:-

–   Gross annual income of the debtor is not
exceeding Rs 60,00/-

–   Aggregate value of debtor is not exceeding
Rs. 20,000/-

–   Aggregate value of debts is not exceeding Rs.
35,000/-

–   Debtor is not undercharged bankrupt

–   Debtor does not own a dwelling unit
(encumbered or not )

    No Fresh Start Order in the last 12 months
prior to the date of application.

Brief Overview of Corporates Insolvency Resolution Process

In the following flowchart, we can see an overview of the
Corporate Insolvency Resolution Process.

Who can become an Insolvency Professional?

Category I – Any Chartered Accountant, Company Secretary,
Cost Accountant and Advocate who has passed the Limited Insolvency Examination
and has 10 years of experience and enrolled as a member of the respective
Institute/Bar Council; or a Graduate who has passed the Limited Insolvency
Examination and has 15 years of experience in management, after he received a
Bachelor’s degree from a University established or recognised by law.

The IBBI has notified the syllabus for the Limited Insolvency
Examination. For syllabus, enrollment process for the examination, etc.,
kindly visit: http://www.ibbi.gov.in/limited-insolvency.html or www.iiipicai.in

The ICAI has also set up a section 8 company and its website
contains an interesting E Learning platform covering the entire gamut of IBC
including mock tests. (www.iiipicai.in)

Category II – Any other individual on passing the
National Insolvency Examination.

The IBBI is yet to notify the syllabus for the National
Insolvency Examination.

The IPs are regulated by the code set out by the IBBI.
Section 208 (2) sets out code that needs to be followed by every insolvency
professional.

Further, the duties of the IP are laid out in the Model Bye
Laws [IBBI – (Model Bye-Laws and Governing Board of Insolvency Professional
Agencies) Regulations 2016, Clause VII of Schedule – Regulation 13].

Opportunities for Chartered Accountants (CAs)

The passage of the Insolvency and Bankruptcy Code, 2016 has
thrown up a tremendous set of new opportunities for CAs.  On an analysis of the major responsibilities
of the IPs to the Debtors and Creditors, the IPs should be well versed with
aspects of Company Law, Taxation, Banking and Finance, Stakeholder Management,
Valuation/Sale of assets, Cash flow management and Commercial and business
acumen.

Considering the onerous responsibilities on the IP, it would
be very difficult for an individual to possess such multiple skills and hence
the IBC has brought in a concept of Insolvency Professional Entities (IPEs)
which can be registered as partnerships, limited liability partnerships and
corporate entities.

Such IPEs can be expected to have the capacity to offer the
diverse skill sets on a single platform to facilitate the Insolvency and
Bankruptcy practice.

IPE presents opportunities to CAs to team up their
counterparts, Company Secretaries, Cost Accountants and Lawyers and present a
complete solution to their clients. 

Based on precedents of the last 6 months, and a view of this
author, in case of insolvency cases filed by Financial creditors, IPs can earn
between Rs. 2 lakh to Rs. 4 lakh per month and in case of cases filed by
creditors or by the corporates, IPs can earn between Rs. 50,000 to Rs. 2 lakh
per month depending upon the size of business and complexity of each case.

With the recent push by the Reserve Bank of India (‘RBI’) to
the Banks to file for Insolvency on the top 500 defaulters/NPAs under the new
IBC, banks have moved fast and started the process in the right earnest and the
process is expected to pick up speed. Further, with large scale media coverage
on the IBC, the creditors have also filed numerous cases for Insolvency on
Debtors and have received favourable closures in a short span of time. Both
these would throw up numerous and multiple opportunities for Professionals in a
short span of time and the first mover advantage will always help in quickly
building up the credentials in this space.

As on date, approximately 800-1,000 IPs have been
registered with IBBI and there is an estimate of more than 1 lakh cases of
defaulters/NPA pending only with Banks at various stages. Hence, there exists a
significant gap between the potential demand of IPs expected in the near future
versus the supply of IPs.

Problem Areas under IBC

As the Indian corporate sector and business community get
more aware of the IBC due to push by the Government to the banks to file for
insolvency and widespread media coverage, financial creditors (primarily
unsecured lenders) and operational creditors are using the IBC as a pressure
tactic on the Corporate Debtor to pay their due sums. During the last few
months, there have been numerous cases filed by operational creditors with NCLT
under the IBC, however, many such cases filed by operational creditors have not
been admitted by NCLT due to various reasons. However, at the same time, under
the fear of IBC, many cases of operational creditors have been settled by the
Corporate Debtor to avoid being referred to NCLT under the IBC. Hence, as we
get more judicial precedence of cases not being admitted by NCLT, sense should
prevail and only genuine cases would be filed under IBC. Further, business
practices amongst the Indian corporate sector and business community especially
with respect to operational creditors should definitely see a significant
improvement in the years to come.

Conclusion

This Code is currently in early stages of
implementation and is focused on revival of business and putting idle resources
of the economy to use, this can bring a huge change in lives, livelihoods and
prospects of both creditors, debtors and professionals. It is one of the most
challenging and equally rewarding career options. In this era of major reforms
in uncharted territories, it throws up a big opportunity to work as an
Insolvency Professional and get an early mover advantage.

Ingredients for Crafting a Model Policy On Dealing With Related Party Transactions

Introduction

Related Party Transactions (RPTs) have been a contentious
issue since the advent of Companies. Separation of ownership and control
combined with diffused ownership in companies provides a fertile ground for the
unscrupulous elements to unjustly enrich themselves. More than 200 years ago,
Lord Cranworth in the landmark case of York Building Company vs. McKenzie
highlighted the reason for RPTs invoking distrust. In 1795, he noted

‘No man can serve two masters.
He that is entrusted with the interest of others, cannot be allowed to make the
business an object of interest to himself; because from the frailty of nature,
one who has the power, will be too readily seized with the inclination to use
the opportunity for serving his own interest at the expense of those for whom
he is entrusted.’

A critical strand in the history of corporate law is the
evolution of regulations dealing with RPT, for mal-governance often manifests
itself through RPTs. Despite its role in hampering good governance, RPTs are
not banned anywhere in the world, as this ‘cure’ is more harmful than the
‘disease’ itself.

Given the interdependence, a key element of good governance
is evidenced in the way in which RPTs are regulated. While legal compliance is
the minimum expected of any corporate citizen, good governance practices go
beyond the minimum and set higher standards to inspire shareholders’ and
stakeholders’ confidence in building a profitable and sustainable business.

Regulating RPTs has three critical parts, namely Formulating
a Policy for Dealing with RPTs, Implementing the Policy that is formulated, and
Disclosure of RPTs to their shareholders. This article attempts to provide
insights into crafting a model ‘Policy on Dealing with Related Party
Transactions’ by drawing on the history of regulating RPTs, analysing the
Indian statutes and learning from the practices of the Nifty 50 companies.

A Brief History of Regulating RPTs

One of the earliest recorded RPT disputes involves the East
India Company and Robert Clive. Following the Battle of Plassey, Robert Clive
privately negotiated for himself an annual income of £30,000 for installing Mir
Jaffar as the Nawab of Bengal. In 1765, Laurence Sulivan, the Chairman of East
India Company, who wanted to weed out corruption in the company, initiated the
move to cancel this annual payment as unjustified, resulting in a fight for the
control of East India Company. As it looks, this does not seem to be the first
disputed RPT as joint stock companies were in existence from the 16th century.
However, fighting for the control of the company seemed to be the only method
available to shareholders for redressing their grievances. As RPTs became
avenues for fraud, regulators had to move in to regulate them. Even in events
as recent as 2004, when the US-SEC initiated proceedings against Parmalat of
Italy on what it called ‘the largest financial fraud in history’, RPTs had a
role, revealing a close nexus between frauds and RPTs  

After 1844 AD, when companies could be registered under
specific laws, RPT regulations has evolved rapidly. A major factor prodding on
this evolution is the conflicting economic theories that viewed RPTs from
different perspective. While the Conflict of Interest Theory viewed it
negatively, the Efficient Transaction Theory viewed RPTs positively. Their
difference was in what they viewed as primary to the transaction. In the
Conflict Theory, relationship between Directors and Shareholders in creating
shareholder value was considered of paramount importance, however in the
Efficient Transaction Theory, the business and the business outcome was placed
in the centre stage.

Between the two extremes, corporate law has evolved to
regulate RPTs rather than ban them altogether. Occasionally, on the backdrop of
a large corporate scandal, given the damage they have inflicted on business
confidence, proposals to ban RPTs are mooted and debated at length. However, in
almost all cases, with the passage of time these proposals get diluted as the
ease of doing business assumes importance, resulting in higher disclosures and
more stringent approval processes mandated to prevent misuse of RPTs.

Table 1: Evolution of Regulations for Dealing with Related
Party Transactions

Stage

Year / Country

Status of RPT

Basis

Content

1

1845

UK

Directors disqualified on
entering into RPT but the Act silent on the
effect of  RPTs enforceability

Companies Clauses
Consolidation Act, 1845

As per Section 86, a
Director who held an office of profit or profited from any work done for the
company would cease from voting or acting as a Director.

2

1855

UK

RPTs void Ab-initio

Aberdeen Railway Co. vs.
Blaikie Bros.

‘The ground on which the
disability or disqualification rests, is no other than the principle which
dictates that a person can be both judge and party.’

3

1856

UK

RPT permitted if not
invalidated by the Articles of Association

The Companies Act, 1856

In this Act, a clause was
introduced in the model Articles of Association (which is optional for
companies to adopt) that made Directors with RPTs vacate their office. Many
companies which were incorporated during this period chose to delete this
clause thereby permitting RPTs.

4

1913

India

Board to approve RPT after
the Director declares their interest

The Companies Act, 1913

Section 91 A requires a
Director to provide disclosure of interest in any contract or arrangement
entered into by or on behalf of the company.

5

1936

India

Disinterested Board to
approve RPT with disclosure to shareholders

The Companies (Amendment)
Act, 1936

Section 91 B prohibited an
interested director from voting on any contract or arrangement in which he is
directly or indirectly concerned or interested.

6

1956

India

Central Government to
approve RPTs in certain companies

The Companies Act, 1956

Section 297 required
companies with share capital of Rs.1 crore and above to get Central
Government’s approval for RPTs.

7

2013

India

Disinterested shareholders
to approve RPT with disclosures to 
shareholders

The Companies Act, 2013

Section 188 of the Act,
introduced the concept of interested shareholders.

RPT Regulations in India

The Companies Act, 2013 regulates RPTs for all companies in India. Further
listed entities are also required to comply with the SEBI’s (Listing
Obligations and Disclosure Requirements) Regulations, 2015. Taken together, the
two regulations provide a comprehensive framework for dealing with RPTs.

The Companies Act, 2013 that defines a related party, which in addition
to relatives of Directors & Key Managerial Personnel and body corporates
controlled by them and their companies has a distinct category in clause (vii)
of section 2 (76). This clause includes ‘any person on whose advice, directions
or instructions a director or manager is accustomed to act’. Explanatory
statement to this clause specifically excludes professionals who advice the
directors or managers. Given this exclusion, the persons covered by this clause
can be colloquially categorized as ‘friends, philosophers and guides’. In
practice, this clause may come into effect in financial transactions with
former promoters, Chairman and Chief Executives who acting as unofficial
advisors and mentors could be wielding soft-power over the current decision
makers.

In line with the globally established practice of regulating RPTs and
not banning them, the Companies Act, 2013 too regulates RPTs through section
177 and section 188. Section 188 requires the Board of Directors to approve all
RPTs in both public and private companies. Contrary to the popular
perception, all provisions regulating RPTs specified in the Companies Act, 2013
apply to both the public and the private limited companies equally. The
only concession provided to the private company is vide a notification issued
on June 5, 2015, where the related party in a RPT is permitted to vote on their
transactions in both the Board and Shareholder meetings.

The Act for approving RPTs uses the lens of ‘Ordinary Course of
Business’ and ‘At arm’s length’ basis. As these two terms are not defined in
the Act or by SEBI, a working definition is attempted here. A transaction in
the ordinary course of business would have many other comparable transactions
with multiple unrelated parties thereby making RPTs comparable. Likewise, a
transaction at arm’s length is one in which all the economic benefits and
rewards are embedded in the transaction itself and thereby stand the test of
market place.

Given its comparability and market based pricing, a transaction that is
in the ordinary course of business and at arm’s length basis requires only the
audit committee’s prior approval (section 177). Extending this principle
further, the Audit committee can provide a blanket approval for repetitive
transactions that have a valid reason necessitating prior approval.

Where a transaction does not meet either one of the two
criteria-ordinary course of business or at arm’s length basis, approval of the
Board of Directors is required in a duly conveyed meeting. Hence, this approval
cannot be given by them passing a Circular Resolution. Further, where the
transaction size exceeds defined threshold levels, approval of the Shareholders
is required either in a physical meeting or through the postal ballot.  Rule 15 of the Company (Meeting of the Board
and its Powers) Rules 2014 details these thresholds, which is quite elaborate,
capturing different types of transactions like sales and purchase of goods,
availing or rendering services, buying, selling or leasing of property, with
specific absolute and relative limits for each one of them.

The provisions of the Companies Act, 2013 as detailed above are quite
technical and require considerable analysis to identify the approval process
required. Good governance requires transparency and clarity. Probably taking
this cue, Regulation 23 of the SEBI’s LODR Regulation 2015 provides for the
formulation of a Policy on Materiality of RPTs and on dealing with RPTs to help
decision makers interpret the law and provide operational guidelines for
implementing it. Further, Regulation 46 requires this policy to be displayed on
the Company’s website inviting public scrutiny. Considering its availability,
we have reviewed all the policies that were displayed in the month of May 2017
by Nifty 50 companies to arrive a model policy. 

Lessons from the Practices of Nifty 50 Companies in Drafting
their Policy for Dealing with RPTs

Our review of the Policies on dealing with RPTs of the Nifty 50
companies revealed five critical clauses that define the quality of their policy,
namely:

1.  Objective of the policy,

2.  Basis for giving Omnibus Approvals,

3.  Effect of RPTs not approved,

4.  Criteria for Granting Approvals to RPTs, and

5.  Disclosures required of RPTs.

For each of these clauses, we have picked out one of the exemplary
extracts from the Nifty 50 companies as possible role model for adoption.

I.       Objective of
the Policy

To effectively deal with RPTs, the policy objectives need to be clearly
articulated as illustrated in the example given by highlighting it in bold. 

Reliance Industries Limited.

“Reliance Industries Limited (the “Company” or “RIL”) recognises that
related party transactions can present potential or actual conflicts of
interest and may raise questions about whether such transactions are consistent
with the Company’s and its stakeholders’ best interests.”

II.      Omnibus
Approval

The clarity and specificity of conditions attached to granting omnibus
approval and its subsequent reporting should be unambiguous of what is expected
from the Audit Committee and the management team of the company as seen in the
example given here.

Bosch Ltd.

“In the case  of frequent /
regular / repetitive transactions which are in the normal course of business
of the Company, the Audit Committee may grant standing pre-approval / omnibus
approval. While granting the approval, the Audit Committee shall satisfy
itself of the need for the omnibus approval and that the same is in the
interest of the Company. The omnibus approval shall specify the following:

a.  Name of the related
party.

b.  Nature of the
transaction.

c.  Period of the
transaction.

d.  Maximum amount of the
transactions that can be entered into.

e.  Indicative base price
/ current contracted price and formula for variation in price, if any.

f.   Such other
conditions as the Audit Committee may deem fit.

Such transactions will be deemed to be pre-approved and may not
require any further approval of the Audit Committee for each specific
transaction. The thresholds and limitations set forth by the Committee would
have to be strictly complied with, and any variation thereto including to
the price, value or material terms of the contract or arrangement shall require
the prior approval of the Audit Committee.

Further, where the need of the related party transaction cannot be
foreseen and all prescribed details (as aforementioned) are not available, the
Audit Committee may grant omnibus approval subject to the value per transaction
not exceeding Rs.1,00,00,000/- (Rupees One Crore only). The details of such
transaction shall be reported at the next meeting of the Audit Committee for
ratification.

Further, the Audit Committee shall, on a quarterly basis, review and
assess such transactions including the limits to ensure that they are in
compliance with this Policy. The omnibus approval shall be valid for a
period of one year and fresh approval shall be obtained after the expiry of one
year.” 

III.     Effect of  RPT
not approved

The options available to the Audit Committee on dealing with a RPT needs
to be explicitly spelt out. This could include seeking the related parties to
pay compensation for loss suffered in addition to examining the reasons for this lapse in reporting and suggesting measures to rectify it.

Tata Motors Ltd., Tata Steel Ltd., Tata Power Ltd.

“In the event the Company becomes aware of a
transaction with a related party that has not been approved in accordance with
this Policy prior to its consummation, the matter shall be reviewed by the
Audit Committee. The Audit Committee shall consider all of the relevant
facts and circumstances regarding the related party transaction, and shall
evaluate all options available to the Company, including ratification, revision
or termination of the related party transaction. The Audit Committee shall also
examine the facts and circumstances pertaining to the failure of reporting such
related party transaction to the Audit Committee under this Policy and failure
of the internal control systems, and shall take any such action it deems
appropriate.

In any case, where the Audit Committee determines not to ratify a
related party transaction that has been commenced without approval, the
Audit Committee, as appropriate, may direct additional actions including, but
not limited to, discontinuation of the transaction or seeking the approval of
the shareholders, payment of compensation for the loss suffered by the related
party etc. In connection with any review/approval of a related party
transaction, the Audit Committee has authority to modify or waive any
procedural requirements of this Policy.”

IV.     Criteria for
approval

The criteria captured for approval here is a brief and succinct summary
of the complex legal provisions.   

Axis Bank

“All Material Related Party Transactions shall
require approval of the shareholders through ordinary resolution and the
Related Parties shall abstain from voting on such resolutions. The approval
policy framework is given below:

–  Audit Committee- All Related Party Transactions

–  Board Approval- All Related Party Transactions referred by
Audit Committee for approval of the Board to be considered and Related Part
Transactions as required by the statute

–  Shareholders’ Approval- Approval by Ordinary Resolution
for:

i.   Material Related
Party Transaction

ii.  Related Party
Transactions not in Ordinary Course of Business or not on Arm’s Length basis
and crosses threshold limit as prescribed under the statute.

Related Party
Transactions will be referred to the Audit Committee for review and prior
approval. Any member of the Committee who has a potential interest in any
Related Party Transaction will recuse himself or herself and abstain from
discussion and voting on the approval of the Related Party Transaction.

In determining whether to approve, ratify, disapprove or reject a
Related Party Transaction, the Audit Committee, shall take into account all the
factors it deems appropriate.

To review a Related Party Transaction, the Audit Committee is provided
with all relevant material information of the Related Party Transaction,
including the terms of the transaction, the business purpose of the
transaction, the benefits to the Bank and to the Related Party, and any
other relevant matters.”

V.      Disclosures

The scope and extent of disclosures of RPTs needs to be captured
comprehensively by including all employees concerned with implementation.

Aurobindo Pharma Ltd.

“The particulars of contracts or arrangement with Related Parties
referred to in section 188(1) shall be disclosed in the Board’s report for the
financial year commencing on or after April 1, 2014 in Form AOC-2
enclosed as Annexure-I and the form shall be signed by the persons who have
signed the Board’s report.

Further the particulars of contracts or arrangement with Related Parties
shall also be entered in the Register of Contracts as per the provisions
of section 189 of the Act and the Rules made there under.

All Material RPTs that are entered into with effect from October 1,
2014, shall be disclosed quarterly along with the compliance report on
corporate governance.

The Company shall disclose this Policy on its website and also a web
link thereto shall be provided in in its annual report. The Policy shall also
be communicated to all operational employees and other concerned persons of
the Company.”

Conclusion     

In today’s world, there is no company that can eliminate RPTs totally,
as they are an integral part of the commercial world. Given that all RPTs do
not dilute shareholder value or reflect mal-governance or fraud, it is
important to have a transparent and clear policy in dealing with them. While
compliance with law is the minimum that is expected of any corporate citizen,
good governance practices should go beyond the minimum and set new standards.
In the context of dealing with RPTs, this can begin with investing time and
effort in crafting a clear, comprehensive and concise policy that will enrich
shareholder value creation for the company in addition to significantly
enhancing its sustainability.

Goodwill In Common Control Transactions Under Ind AS ­ Whether Capital Reserve Can Be Negative?

Background

White
Goods Ltd. (WGL) and Electronic Items Ltd. (EIL) are companies under common
control. WGL is in phase 1 of Ind AS. Its transition date (TD) is 1st
April, 2015, comparative year is 2015-16, and first year of Ind AS is 2016-17.
The last statutory accounts under Indian GAAP was 2015-16; which will be a
comparative year under Ind AS.

In the last year of Indian GAAP
and comparative year of Ind-AS; i.e., 2015-16, WGL acquired through a slump
sale the business of EIL and paid a cash consideration. The acquisition was by
way of a slump sale and did not require any court approval.

WGL applied AS 10 Accounting
for Fixed Assets to record for the slump sale under Indian GAAP.
Consequently, the excess of consideration over the fair value of assets and
liabilities taken over was recorded as goodwill. For simplicity, let’s assume,
the fair value of the net assets was equal to the book value of the net assets
taken over.

For purposes of Ind AS, WGL
chooses to restate the business combination in accordance with Ind AS 103.
Appendix C, Business Combinations of Entities under Common Control of Ind AS
103, Business Combinations would apply. In accordance with the said
standard, this would be accounted as a business combination under common
control and consequently WGL would record the assets and liabilities at their
book values and will not record any goodwill.

Issue

Paragraph 12 of Appendix C
(referred to above), requires the following treatment to account for difference
between the consideration amount and the book value of the net assets taken
over.

“The
identity of the reserves shall be preserved and shall appear in the financial
statements of the transferee in the same form in which they appeared in the
financial statements of the transferor. Thus, for example, the General Reserve
of the transferor entity becomes the General Reserve of the transferee, the
Capital Reserve of the transferor becomes the Capital Reserve of the transferee
and the Revaluation Reserve of the transferor becomes the Revaluation Reserve
of the transferee. As a result of preserving the identity, reserves which are
available for distribution as dividend before the business combination would
also be available for distribution as dividend after the business combination.
The difference, if any, between the amounts recorded as share capital issued
plus any additional consideration in the form of cash or other assets and the
amount of share capital of the transferor shall be transferred to capital
reserve and should be presented separately from other capital reserves with
disclosure of its nature and purpose in the notes.”

In Ind AS financial statements,
can the goodwill recognised under Indian GAAP be adjusted against retained
earnings/other equity or whether the goodwill has to be presented as a negative
capital reserve?

The above question becomes very
important because of section 115JB (2C). In accordance with section 115JB (2C),
the book profits of the year of convergence and each of the following four
previous years, shall be further increased or decreased, as the case may be, by
one-fifth of the transition amount adjustments. Explanation (iii) defines
“transition amount” as the amount or the aggregate of the amounts adjusted in
the other equity (excluding capital reserve and securities premium reserve) on
the convergence date. Consequently, Ind AS transitional adjustments in retained
earnings/other equity are included in book profit for determining MAT liability
equally over 5 years beginning from the year of Ind AS adoption. Transitional
adjustments to capital reserve and securities premium are excluded from book
profit.

Author’s View

The following two assumptions
appear implicit in Paragraph 12 referred to above.

–   Paragraph 12
envisages a situation where two companies are merging, and in order to preserve
the identity of the reserves, the difference between the share capital issued
plus other consideration and the share capital of the transferor is recorded as
an adjustment to capital reserves.

–   Paragraph 12
envisages a situation where the consideration is lower than the book value of
the acquired assets and consequently it results in a capital reserve, which is
a positive amount.

In the fact pattern under
discussion, neither of the above two assumptions apply. Consequently the amount
recorded as goodwill under Indian GAAP, can only be eliminated as an adjustment
to retained earnings/other equity under Ind-AS, rather than presented as a
negative capital reserve amount. In the author ‘s view, any reserve under the
standards can only be a positive number. Therefore, it would be more
appropriate to eliminate the goodwill against retained earnings/other equity.

The above treatment will have a
positive income-tax implication. The goodwill debited to retained
earnings/other equity under Ind AS will provide a five year straight line
deduction for the determination of book profits for MAT purposes. This
deduction is not available if the goodwill was debited to capital reserves.
Further, since the goodwill was recorded under Indian GAAP statutory accounts,
the benefit of depreciation going forward would be available for purposes of
normal income tax computations, subject to fulfilment of other conditions.

If the Company had continued to be
in the Indian GAAP regime, it would have amortised goodwill and have lower book
profits for MAT purposes. The Company would also receive the benefit of normal
income tax deduction on account of goodwill depreciation.

Since the Ind AS outcome is the
same as would have been the case if the Company would have continued under
Indian GAAP, it does not provide any undue tax advantage to the Company.

Conclusion

Capital reserve cannot be a
negative number. Consequently, goodwill will be eliminated against retained
earnings/other equity. This could be an acceptable view and will ensure income
tax neutrality between Indian GAAP and Ind AS treatment of goodwill.

Proposed Amendment

The MAT Committee has recommended
an amendment to 115JB [2A]. If the section is amended, it will change the way
book profits are determined under Ind AS on a go forward basis (not
transitional amounts). As per this amendment, items debited or credited to
other equity will be included in determination of book profits barring certain
exceptions. One of the exceptions is capital reserve in respect of business
combination of entities under common control.

In the author’s opinion, capital reserve cannot
be a negative number. Therefore, in a slump sale if the consideration paid is
greater than net assets, the excess will be debited to retained earnings. Since
the amount is not debited to capital reserves, it will not be covered by the
above exception, and should be allowed as a deduction of book profits for the
purposes of MAT in that year.

Sections 9, 44BB of the Act; Article 5(5) of India-Singapore DTAA – Where drilling rig was brought into India for fabrication and upgradation to make it ready for drilling activities, the number of days for which such fabrication and upgradation was being carried out was to be included to determine whether aggregate days exceeded the threshold.

23.  [2017] 83
taxmann.com 174 (Mumbai – Trib.)

DCIT vs. Deep Drilling (1) Pte. Ltd.

A.Y.: 2011-12, Date of Order: 19th April, 2017

Facts

The Taxpayer was a non-resident company, incorporated in
Singapore. It was engaged in the business of providing jack-up drilling unit
and platform well operations services.

The Government of India had awarded an exploration contract
to an Indian company (“I Co”) for exploration in offshore areas of India.
During the year under consideration, the Taxpayer entered into an agreement
with an I Co for providing jack-up drilling unit and platform well operations
for exploration and earned income from the said agreement.

Under the agreement with
I Co, the Taxpayer was required to provide rig as per stipulated
specifications. The Taxpayer brought rig into India for necessary fabrication,
upgradation and positioning to meet requirements of I Co. Actual drilling
operations commenced after such modifications and were undertaken for 119 days.
The Taxpayer did not offer any income to tax in India on the ground that number
of days for which drilling operations were carried on in India were less than
the threshold period of 183 days for constitution of exploration PE in India
under India-Singapore DTAA and in absence of a PE in India, income from its
activities was not taxable in India.

However, the AO observed that the drilling rig was brought
into India in April 2010. Since the rig was in India for more than 183 days, it
constituted exploration PE of the Taxpayer under India-Singapore DTAA.
Therefore, income of the Taxpayer was taxable u/s. 44BB of the Act.

Aggrieved by the order of AO, Taxpayer appealed before
CIT(A). The CIT (A) decided the issue in favour of
The Taxpayer.

Held

–   Under article 5(5) of India-Singapore DTAA,
an enterprise shall be deemed to have an exploration PE in a contracting state,
if it provides services or facilities in that state for a period of more than
183 days in connection with exploration, exploitation or extraction of minerals
oils in that state.

–   The Taxpayer brought the drilling rig into
India on 26th April 2010. For rendering the services to I Co, the
rig was required to undergo necessary fabrication, upgradation and positioning
as per the requirements of I Co before commencing the drilling activity.

–   The operation on the rig to upgrade it, to
prepare it, and to enable it to perform the drilling activity cannot be
considered in isolation from the actual drilling activity for determining
whether the Taxpayer was having a PE in connection with exploration,
exploitation or extraction of mineral oil in India.

–  Thus, the Taxpayer had an
exploration PE in India from the day it commenced fabrication, etc. in
India to perform the drilling activity. Since the number of days for which the
rig was deployed (including those for fabrication, etc.) was more than
183 days, the Taxpayer had an exploration PE in India.

Section 92C, the Act – No royalty could be said to have accrued to the Taxpayer since there was no agreement between AEs and the Taxpayer to charge royalty during the year and since the Taxpayer had not provided any technical or other support to the AEs.

21.  [2017] 83
taxmann.com 305 (Delhi – Trib.)

Dabur India Ltd. vs. ACIT

A.Y.: 2006-07, Date of Order: 12th April, 2017

Facts       

The Taxpayer was engaged in manufacturing and trading of
health care, personal care, cosmetics and veterinary products. It entered into
the following arrangement with two of its subsidiaries based in UAE (“UAE Co”)
and Nepal
(“Nepal Co”).

–   UAE Co:     

     UAE Co had entered into an agreement with
the Taxpayer prior to becoming subsidiary of the Taxpayer for the use of the
technical know-how and R&D support of the Taxpayer in manufacturing
Ayurvedic products in UAE. The Taxpayer had permitted UAE Co to use its brand
name. In return, UAE Co had paid royalty @3% of FOB sale. Further, UAE Co also
manufactured other products without the technical know-how and R&D support
of the Taxpayer. In respect of such products UAE Co was allowed to use the
trademark of the Taxpayer for which a royalty of 1% of FOB sales was paid by
UAE Co to the Taxpayer.

     Subsequently, UAE Co found that Ayurvedic
products of the Taxpayer were not selling in UAE. Hence, it began to
manufacture and market FMCG products with its own technology and hence, paid
royalty @1% to the Taxpayer.

–   Nepal Co:   

     The Taxpayer had entered into agreement
with Nepal Co for payment of royalty @ 7.5% of FOB sale price and as per the
terms of the agreement, the Taxpayer was required to bear the cost of marketing
expenses. However, Nepal Co had to incur substantial expenditure to penetrate
the market and hence, the agreement was amended and the royalty was reduced to
3%. However, in the relevant assessment year, Nepal Co did not pay any royalty.
Further, the Taxpayer had contended that 80% of production of Nepal Co was
purchased by the Taxpayer. Hence, even if the Taxpayer charged royalty, it
would have increased the cost and the Taxpayer would have paid higher price.

     The TPO noted low/non-receipt of royalty
from AEs during the current year. Hence, he asked the Taxpayer to furnish the
reasons for the same.

     The Taxpayer submitted that there was no
agreement for payment of royalty during the year under consideration. Hence,
right to receive the royalty was absent. Further, UAE Co had also refused the
payment of royalty on the ground that it had incurred huge expenditure on
promotion of bands of the Taxpayer.

     The TPO observed that in the absence of
evidence of termination of agreement between the Taxpayer and its AE, as well
as in absence of corroborative evidence like non-use of brand name or non-use
of technical know-how by the AE, the Taxpayer had permitted UAE Co and Nepal Co
use of its intellectual property without any royalty payment and hence, he made
an adjustment in the hands of the Taxpayer considering royalty @ 4% of sales in
case of UAE Co and @ 7.5% of sales in case of Nepal Co.

     Aggrieved by the order of AO, Taxpayer made
appeal before CIT(A). CIT (A) held that international transaction of permitting
use of brand name by AEs was same in both cases. Therefore, there was no reason
to assign higher royalty in one case than the other. Accordingly, he held
royalty @ 2% of FOB sales as arm’s length price in both cases.

Held

Royalty from UAE Co

–   When the agreement was in existence, the
Taxpayer provided technical know-how and R&D support for manufacturing of
products to the Taxpayer. Further, UAE Co had paid royalty @ 1% in accordance
with the agreement even when no product was manufactured with the help and
support of the Taxpayer since it was using the trademark of the Taxpayer.

–   The agreement was not renewed on completion.
Therefore, it had ceased to exist with effect from financial year 2005-06.
Thus, for the year under consideration, no royalty was payable. Further, the
products manufactured, as well as raw material used, by UAE Co were totally
different from those in India. The AO had not brought anything on record to
substantiate that the Taxpayer had provided technical know-how and R&D
support for manufacture of such products.

–   UAE Co had incurred huge expenses on
marketing and advertising the brand of the Taxpayer. Moreover, the AO had also
not brought on record that:

•    the Taxpayer had incurred expenses for
marketing the products of UAE Co; or

•    the Taxpayer made any efforts or contributed
any money for establishing its name in UAE; or

•    the products manufactured by UAE Co were not
different from the products manufactured in India by the Taxpayer; or

•    the claim of the Taxpayer that the products
manufactured, and materials used, in UAE were totally different from those in
India had not been rebutted. 

–   Under section 92C of the Act, read with rules
10B and 10C of the Rules, ALP should be determined on the basis of similar
payments received by similarly situated and comparable independent entities. In
the present case, no comparable case was brought on record by the TPO or CIT
(A).

–   Since the Taxpayer is not providing any
support to UAE Co, it will be fair and reasonable to charge royalty @ 0.75%.

Royalty
from Nepal Co

–   For the year under consideration, Nepal Co
had not paid royalty to the Taxpayer since it had to incur market penetration
expenses.

–   The contention of the Taxpayer that 80% of
production of Nepal Co was purchased by the Taxpayer had not been rebutted. It
is undisputed that royalty was payable in earlier year on sales. Therefore, it
is unbelievable that the Taxpayer charged the royalty on the purchases made by
it from Nepal Co to increase the cost of its own purchases. Even if it is
presumed that the Taxpayer should have charged the royalty, the same amount
would have been added in the purchase price paid by the Taxpayer. Thus, it
would have been revenue neutral.

–   There was no agreement in existence between
the Taxpayer and Nepal Co. Also, nothing was brought on record to substantiate
that the Taxpayer incurred any expenditure which benefited Nepal Co in any
manner. Having regard to all the facts, charging of royalty was not justified
and addition made is deleted.

Section 92C, the Act – Location savings and advantages are very much relevant in cross-border transaction but only for limited purpose of examination and investigation of transaction and not as a basis for determination of ALP and consequential adjustment.

20.  [2017] 84
taxmann.com 15 (Bangalore – Trib.)

Parexel International Clinical Research (P.) Ltd. vs. DCIT

A.Ys.: 2011-12 & 2012-13,

Date of Order: 16th June, 2017

Facts

The Taxpayer was a subsidiary of a dutch company (“F Co”) and
was engaged in providing clinical research services in India. Certain AEs of
the Taxpayer had outsourced the work of clinical trial and research services to
The Taxpayer in India. For its services, the Taxpayer was paid cost plus 15%
markup.

To benchmark its international transactions, the Taxpayer
selected 17 comparable companies having average PLI of 18.05%. Since operating
profit margin of the Taxpayer was within the tolerance range of +/- 5%, it
claimed that its international transactions were at arm’s length.

The Transfer Pricing Officer (“TPO”) observed that compared
to developed countries, regulatory, compliance and investigatory costs were
significantly lower in India, Hence, conducting trial in India through the
Taxpayer had resulted in location saving for the AE. Since benchmarking against
local comparables did not take this into account. Accordingly, the TPO applied
the profit split on account of location saving. Consequently, the location
savings in relation to the total cost of conducting clinical trials was
allocated in the ratio of 50:50 between the Taxpayer and the AE.

Aggrieved by the order of TPO, the Taxpayer appealed before
the Dispute Resolution Panel (DRP). However, DRP concurred with the view of the
TPO. Aggrieved, the Taxpayer appealed before the Tribunal. 

Held

–   Location savings is one of the primary
factors of any cross-border trade. However, such location savings are available
to all parties irrespective of whether the transaction is between the related
party or unrelated party.

–   Location savings’ advantage is universally
accepted in cross-border trade so far as the transactions are not entered into
solely for the purpose of avoiding taxes. On the other hand, BEPS is relevant
only if the sole purpose of the transaction is to shift profit to no tax or low
tax jurisdiction and treaty shopping.

–  Transfer pricing provisions for
determination of ALP are inserted to deal with such transactions between
related parties. While location saving can be a relevant factor for conducting
a proper enquiry for determination of ALP, if the comparable uncontrolled price
is available, location saving cannot be the basis for determination of ALP and
consequential adjustment.

Foreign Tax Credit Rules

One of the pillars of the Double Tax Avoidance Agreement
(DTAA) is Article on “Methods for Elimination of Double Taxation”. Various
methods are prescribed for elimination of double taxation. However, elimination
of double taxation through a foreign tax credit route was fraught with several
issues such as at what rate of exchange credit for taxes are to be computed,
what documents are required to prove payment of overseas taxes, what about
mismatch of taxable years in the country of source and country of residence,
what about increase or decrease in taxes due to assessment in the foreign
country and so on. In order to address all these issues and some more, last
year CBDT had issued a Notification No. S.O.2213(E) dated 27th June
2016 providing Foreign Tax Credit Rules (FTCR), which came into effect from 1st
April 2017.
This article besides explaining various methods for elimination of double
taxation, deals with salient features of the FTCR.

1.0    Introduction

          The objective of a DTAA (also known as
“tax treaty”) is to distribute tax revenue between the two Contracting States
(CS). Articles 6 to 22 in a typical tax treaty contain distributive rules to
this effect. The methods for elimination of double taxation have been dealt
with by Article 23 of the UN Model Tax Convention (UNMC) and the OECD MC.
Article 24 provides for provisions of Mutual Agreement Procedure which can be
invoked by the tax payer, if the CS fails to eliminate double taxation or
apply/interpret the treaty provisions not in accordance with its intent and
purpose. 

          Usually, State of Residence (SR) taxes
global income of a tax payer including income from the State of Source (SS).
Therefore, SR will give credit for taxes paid in the SS.

          Double taxation is eliminated in two
ways, namely, Exemption of Income or Credit of taxes paid. Various methods for
elimination of double taxation can be summarised as follows:

 

          Before we dwell into foreign tax
credit rules, let us glance through the above methods for appreciating
applicability of FTCR in an Indian scenario.

2.0    Exemption Method

2.1     Full Exemption

          In this case, the income taxed in the
SS is fully exempt in the SR.

2.2     Exemption with Progression

          Under this method, SR considers the
income taxed in the SS only for the purpose of determining the effective tax
rate.

          Let us understand the above two
methods with the help of an example.

          Tax slabs and tax incidence in the SR
are as follows:

Income

Tax Rate

Tax on

Rs. 1500

Tax on

Rs. 1000

First Rs. 200 Exempt

 0

0

0

From Rs. 201 to Rs. 500

10%

30

30

From Rs. 501 to Rs. 1000

20%

100

100

Above Rs. 1000

30%

150

—-

Total Rs.

 

280

130

 

Sr. No.

Particulars

Amount INR

1

Income in the SR

1000

2

Income in the SS

500

3

Total income taxable in SR (1+2)

1500

4

Tax
liability in the SR without 
considering Exemption (Tax on a slab basis)

280

5

Total
Income considering full exemption in the SR (income of SS is ignored totally)

1000

6

Tax
liability based in the SR considering full exemption (On a slab basis only on
income from SR i.e. Rs.1000)

 

130

7

Effective
Tax Rate in SR considering income from SS (4/3)

18.6%

8

Tax
in SR considering Exemption

with
Progression (Tax on Rs.1000 @ 18.6%)

 

186

 

 

 

              

3.0    Credit Methods

          Under the credit method, SR will tax
income of its resident on a global basis and then grant credit of taxes paid in
the SS.

          In simple words, when any income of
the person is taxed on source basis in one country and on the basis of his
residence in other country, the country of residence shall compute tax on
overall global income of such person and while doing so, it shall grant to such
a person a credit of the taxes already paid by it on the income taxable at
source in such other country.

          There are two types of credit methods,
namely, Unilateral and Bilateral.

3.1
   Unilateral Tax Credit

          Section 91 of the Income tax Act deals
with the unilateral tax credit. Sub-section (1) of the section 91 provides that
“If any person who is resident in India in any previous year proves that, in
respect of his income which accrued or arose during that previous year outside
India (and which is not deemed to accrue or arise in India), he has paid in any
country with which there is no agreement under section 90 for the relief or
avoidance of double taxation, income-tax, by deduction or otherwise,
under the law in force in that country, he shall be entitled to the deduction
from the Indian income-tax payable by him of a sum calculated on such
doubly taxed income at the Indian rate of tax or the rate of tax of the said
country, whichever is the lower, or at the Indian rate of tax if both the rates
are equal”. (Emphasis supplied)

          From the above, it is clear that the
amount of credit in India will be restricted to the lower of the proportionate
tax in India on the foreign sourced income or taxes paid in the source country.

3.1.1 Issues

          A
question arose as to whether a tax payer can avail unilateral credit in respect
of income from a country with which India has signed a limited tax treaty?
India had a limited tax treaty with Kuwait till 2008 which covered only income
from International Air Transport. (With effect from 1st April 2008,
a new and comprehensive tax treaty with Kuwait has become operative in India).
In case of JCIT vs. Petroleum India International (26 SOT 105), the
Mumbai Tribunal granted benefit of the unilateral tax credit u/s. 91(1) when
only limited DTAA was in operation. Thus, one may conclude that unilateral tax
relief may be available to a tax payer in respect of income which is not
covered by the limited tax treaty.

3.1.2 Some other issues u/s. 91 addressed by the
Judiciary  are tabulated herein below:

Sr. No.

Issue

Decision

Case Law

1

What
if part of foreign income is taxable in India?

Proportionate
credit is available only in respect of income doubly taxed.

CIT
v. O.VR.SV.VR. Arunachalam Chettiar (49 ITR 574) and Manpreet Singh Gambhir
v. DCIT

(26
SOT 208)

 

2

Whether
relief u/s 91 is available against MAT liability u/s 115JB or 115JC of the
Act in India?

If
the foreign sourced income is included in computation of book profits in
India, then relief u/s. 91 is available against MAT liability.

Hindustan
Construction Co. Ltd. v. DCIT

(25
SOT 359)

Proviso
to section 115JAA and 115JD read with Rule 128(7)

 

3

Whether
the relief u/s. 91 is available qua each country of source or one needs to
aggregate income from all foreign sources, which may have an impact of
setting off loss from one country against income from the other.

Expl.
(iii) to Section 91 defines “rate of tax of the said country” to mean
income-tax paid in the other country as per its tax laws. Therefore, relief
u/s. 91 has to be granted in respect of each source country separately.

Bombay
Burmah Trading Corporation Ltd. (126 Taxman 403)

3.2    Bilateral Tax Credit Methods

          There are four bilateral tax credit
methods, namely, (i) Full Credit Method, (ii) Ordinary Credit Method, (iii)
Underlying Tax Credit Method and (iv) Tax Sparing. Let us understand each of
them with illustrations.

3.2.1 Full Credit Method

          Under this method, total tax paid by
the person on his income in the country of source is allowed as a credit
against his total tax liability in the country of residence. The credit is
irrespective of his tax liability in the country of residence. Thus, a person
may be able to get proportionately more credit than the incidence of tax on his
foreign sourced income in the country of residence. This is known as full
credit method. India does not allow full credit of foreign tax to its residents
except under India-Namibia DTAA, which grants full credit in India of taxes paid
in Namibia.

3.2.2 Ordinary Credit Method

          The credit available under this method
shall be lower of the proportionate tax payable on the foreign sourced income
in the country of residence or the actual tax paid in country of source. As a
result, in this case, if the tax on the foreign sourced income is higher in the
country of residence than in the country of source, the taxpayer shall be
liable to pay the balance amount. However, if it is the other way round, i.e.
if tax paid in the source country is higher than the residence country, then
excess shall not be refunded. As stated earlier, tax treaties are distribution
of taxing rights and sharing of revenue between two contracting states and
therefore, any excess tax paid in one country is usually not refunded by the
other country. However, some countries do provide for carry forward of such
excess credit. As far as India is concerned, such excess amount is ignored.

          Majority of Indian tax treaties follow
Ordinary Tax Credit Method, which is not detrimental to the interest of the
country of residence of the tax payer and at the same time, it eliminates
double taxation of income.

          Let
us understand both these methods with the help of a Case Study. Facts of the
case are same as described in paragraph 2.2 herein above with the only change
of assumption of 20% rate of tax in the SS. SR is assumed to be India and SS as
Canada.

Sr.

No.

Particulars

Without DTAA Relief
Rs.

Full Credit Method
Rs.

Ordinary Credit Method Rs.

A.

Taxable
Income in India (1000+500)

1500

1500

1500

B.

Taxable
Income in Canada

500

500

500

C.

Tax
payable in India (on a slab basis)

280

280

280

D.

Tax
Payable in Canada (B*20%)

100

100

100

E.

Effective
Tax Rate in India (C/A)

18.67%

18.67%

18.67%

F

Foreign Tax Credit

NIL

100

(Full Credit)

93

(18.67% of 500)

G

Tax Paid in India net of FTC (C-F)

280

180

187

H

Total
Tax Liability (G+D)

380

280

287

3.2.3 Underlying Tax Credit Method (UTC)

          Under this method, SR gives credit for
taxes paid on profits out of which dividend is declared by the company located
in the SS. This method attempts to eliminate/reduce economic double taxation as
dividend income is taxed twice, once by way of profits in the hands of the
company and secondly by way of dividends in the hands of the shareholders.

          A few Indian tax treaties which
contain UTC provisions are treaties with Australia, China, Ireland, Japan,
Malaysia, Mauritius, Mexico, Singapore, Spain, the UK, and the USA.

          However, it is interesting to note
that most of UTC provisions in Indian tax treaties are with respect to the
residents of treaty partner country and not Indian residents. Only treaties
with Mauritius and Singapore give benefit of UTC to Indian residents.
India-Singapore DTAA provides for minimum shareholding of 25 per cent in order
to avail UTC benefit. India-Mauritius DTAA provides for minimum shareholding of
10 per cent in order to avail UTC benefit.

          An UTC clause of India-Mauritius DTAA
reads as follows:

          “In the case of a dividend paid by
a company which is a resident of Mauritius to a company which is a resident of
India and which owns at least 10 per cent of the shares of the company paying
the dividend, the credit shall take into account [in addition to any Mauritius
tax for which credit may be allowed under the provisions of sub-paragraph (a)
of this paragraph] the Mauritius tax payable by the company in respect of the
profits out of which such dividend is paid.”

          Illustration of the Underlying Tax
Credit

–   Indian company holds 100% shareholding of a
Singapore Company

–   Profits before tax of the Singapore Company
is Rs. 1,00,000/-

–   Tax rates in Singapore:

     Business Income @ 20%

     Withholding Tax on Dividends 5%

–   Tax rate on foreign dividends in India 30%

–   Assume that 100 per cent of profits are
distributed as dividends

Sr.No.

Particulars

Amount in Rs.

A

PBT
in Singapore

1,00,000

B

Tax
on Business Profits @ 20%

20,000

C

Balance
Profits declared as Dividends

80,000

D

Withholding
tax on Dividends @5%

4,000

In the hands of the Indian Company

E

Dividend
Income

80,000

F

Tax
on Dividends @ 30%

24,000

G

Underlying
Tax Credit (@ 100% of B)

20,000

H

Foreign
Tax Credit for Dividends

(Full
credit available as tax rate

in
India is higher than Singapore)

4,000

I

Total
Tax incidence in India

NIL

3.2.4 Tax Sparing

          Under this method, credit is given by
the state of residence in respect of deemed tax paid in the state of source.
Many a times, developing countries give many tax based incentives to attract
capital and technology from the developed nations. (For e.g. section 10
exemptions in India). However, income which may be exempt in India if taxed in
the other country, then the tax spared by the Indian government would go to the
other government rather than the company/entity concerned. Therefore, the
concept of tax sparing has come into being. Usually, provisions concerning tax
sparing cover specific sections of the domestic tax laws.

          However, sometimes, a general
reference is made to apply tax sparing provisions in respect of incentives
offered by a country for the promotion of economic development. [E.g.
India-Japan DTAA]  

          To illustrate, section 10(15)(iv)(fa)
of the Act provides that interest payable by a scheduled bank to a non-resident
depositor on a deposit placed in foreign currency is exempt from tax in India.
If an NRI depositor from Japan earns interest income from India, which is
exempt under this section but taxable in Japan, then the Japanese Government
will give a credit of tax which he would have otherwise paid in India, but for
this exemption.

Illustration

Sr. No.

Particulars

Amount in Rs.

A

Interest
Income received by an

NRI
in Japan on deposit placed

with
SBI in Yen.

1,00,000

B

Tax
paid in Japan @ 30%

30,000

C

Tax
Payable as per India-Japan Tax Treaty @ 10% {Actual tax

paid
is NIL either under DTAA

 or under the Act –

[exempt
u/s. 10(15)(iv)(fa)]}

10,000

D

Tax
Sparing Credit in Japan

10,000

E

Actual
Tax payable in Japan (B-D)

20,000

4.0    Foreign Tax Credit
Rules

          India by and large, follows ordinary
credit method and therefore, a lot of issues were arising for claiming credit.
There was no guidance as to at what rate taxes paid in the foreign country has
to be converted for claiming credit in India, what documents to be submitted,
what about timing mismatch and so on. In order to address these and other
issues, CBDT notified FTCR on 27th June 2016 and were made
applicable w.e.f. 1st April 2017. Let us study these provisions in
detail.

          Income Tax Rule 128 deals with the
provisions of FTC which are summarised as follows:

Sub Rule No.

Particulars

1

Credit of foreign tax to be allowed in
India in the year in

which the corresponding income is
offered to tax or

assessed in India. If income is offered
in more than one

year, then the credit for foreign tax
shall be allowed

in the same proportion in which such
income is offered

to tax or assessed in India.

(This provision takes care of timing
mismatch. If an

Indian resident receives income from
USA, where it was

taxed on a calendar year basis, then he
can offer the

proportionate income in India on
financial year basis. The

rule now clearly provides proportionate
credit of taxes if the income is offered for tax in two financial years)

 2

Meaning of foreign tax

Tax
referred to in a DTAA or as referred to in clause (iv)

of
the Explanation to section 91.

(It
means credit for state taxes or any other tax other

than
specifically covered by a bilateral tax treaty will

not
be available)

3

It
is clarified that FTC will be available against the tax,

surcharge
and cess payable under the Act but not

against
interest, fee or penalty.

4

FTC
will not be available in respect of disputed amount

of
foreign tax. (See Note 1)

5

This sub rule provides certain important
provisions:

(i)
FTC shall be computed vis-a-vis each source of

income
arising in a particular country;

(ii)
The credit shall be lower of the tax payable under

the
Act on such income and the foreign tax paid on

such
income; (See Note 2)

(iii)
As the tax in foreign country would be paid or deducted in the currency of the
respective country, the same needs to be converted into equivalent Indian
rupees. The rule provides that foreign tax should be converted at the
Telegraphic Transfer (TT) Buying Rate of the State Bank of India (SBI) on the
last day of the month

immediately
preceding the month in which such tax has

been
paid or deducted. (See Note 3)

6

Provision
allowing credit of FTC against MAT liability

u/s
115JB or 115JC

7

Excess
of FTC compared to MAT liability u/s 115JB or 115JC to be ignored

8

Documents to be submitted for claiming
FTC

(i)  Form
No. 67 containing details of foreign income and

     Tax
paid/deducted thereon.

(ii) Certificate or statement specifying
the nature of income and the amount of
tax deducted there from or paid by the assessee,—

(a)  from
the tax authority of the country or the specified territory outside India; or

(b)  from
the person responsible for deduction of such tax; or

(c)   signed
by the assessee along with an acknowledgement of online payment or bank
counter foil or challan for payment of tax or proof of tax deducted at
source, as the case may be.

9

The
above form and documents referred to in rule 8

have
to be filed on or before the due date of furnishing

income
tax return u/s. 139 of the Act.

10

Requirement
for submission of Form No. 67 in a case where The carry backward of loss of
the current year results in refund of foreign tax for which credit has been
claimed in any earlier year or years.

 

(Many
countries allow losses to be carried backward and

set
off against profits of the earlier year/s. In such a

situation,
the taxes paid earlier may be refunded to the

tax
payer. In order to avoid unjust enrichment, the

rules
provide for reversal of the FTC in India in respect

of
taxes which are subsequently refunded in the

foreign
jurisdiction)

Note1:Proviso
to sub rule 4 provides that foreign tax credit shall be allowed for the year in
which such income is offered to tax or assessed to tax in India if the assessee
within six months from the end of the month in which the dispute is finally
settled, furnishes evidence of settlement of dispute and an evidence to the
effect that the liability for payment of such foreign tax has been discharged
by him and furnishes an undertaking that no refund in respect of such amount
has directly or indirectly been claimed or shall be claimed.

Note 2:Proviso to sub rule 5 (i) provides that
where the foreign tax paid exceeds the amount of tax payable in accordance with
the provisions of the agreement for relief or avoidance of double taxation,
such excess shall be ignored for the purposes of this clause.

Illustration:

          An Indian company is taxed @ 20% on
royalty income in a foreign country X as per its domestic tax laws. However,
the DTAA between India and country X provides for the tax rate of 10% on such
royalty income, then notwithstanding, actual payment of 20%, the FTC in India
will be restricted to 10% only.

Note 3:Illustration
on conversion of FTC in Indian currency

          Mr. Patel, a resident in India has
received professional fees of USD 10,000/- on 1st February 2017 from
his UK client. His UK client deducted tax @ 20% (i.e. GBP 2000) under the UK
tax laws and paid the same to the UK government on 7th February
2017. India-UK DTAA provides the rate on FTS as 10%.

          He also earned capital gains on sale
of shares on London Stock exchange on 15th March 2017 amounting to
GBP 5000/- on which he paid tax of GBP 500 in UK on 31st March 2017.

          Consider
following rate of exchange of UK Pound vis-a-vis Indian Rupee:

Sr. No.

Date

Rate of Exchange

1 GBP = INR

1

31st
January 2017

84

2

1st
February 2017

85

3

7th
February 2017

83

4

28th
February 2017

82

5

15th
March 2017

80

6

31st
March 2017

81

 

          Rule 115 of the Act provides for the
mechanism to apply the exchange rate for conversion of foreign income to Indian
rupees.

          In the above case, applying provisions
of Rule 115 and sub-rule 5 of Rule 128, foreign income and FTC in India would
be computed as follows:

          FTC for Fees For Technical Services

          Income 10,000 @ Rs. 81/- = Rs.
8,10,000/-

          [Exchange rate as on the last date of
the previous year i.e. as on 31st March 2017 as per Rule 115(2)(c)
of the Act]

          Indian income tax @ 30% = Rs. 2,43,000/-

          FTC on 1000 @ Rs. 84/- = Rs. 84,000/-

          [Exchange rate as on the last date of
the previous month i.e. as on 31st January 2017 as per Rule 128(5)]

[Notes:

(i)       FTC restricted to the tax rate prescribed
in the India-UK DTAA and not the actual payment of GBP 2000;

(ii)      FTC is given at the exchange rate prevalent
on the last date of the preceding month in which the tax has been paid]

          FTC for Capital Gains

          Capital gains of 5000 @ Rs. 82/-    = Rs. 4,10,000/-

          [Exchange rate as on the last date of
the previous month i.e. as on 28th February 2017 as per Rule 115(f)]

          Indian Income tax @ 20%              (assumed)                                =
Rs. 88,000/-

          FTC on 500 @ Rs. 82/-                                                     =
Rs. 41,000/-

          [Exchange rate as on the last date of
the previous month i.e. as on 28th February 2017 as per Rule 128(5)]

5.0    Summation

FTCR has resolved many issues such as the rate
of exchange of FTC, the timing mismatch of two jurisdictions, credit in respect
of disputed foreign tax, loss situation etc. This will help in better
administration, clarity in claiming FTC and reduction in litigation.

Construction Contract Vis-À-Vis Repair Contract

Introduction

Under Maharashtra Value Added Tax
Act, 2002 (MVAT Act), the Works Contracts were taxable by different methods.
There was one normal method by way of deduction u/r 58 of MVAT Rules and in
alternative there were certain composition schemes.

Under Composition Schemes there
were two alternatives, like 5% composition scheme for construction contracts
and 8% composition scheme for other contracts. 

The 5% composition was applicable
to only notified contracts. The Government has issued notification dated 30.11.2006,
notifying the said ‘construction contracts’. The notification is reproduced
below for ready reference.

“FINANCE DEPARTMENT

Mantralaya, Mumbai 400 032, dated the 30th November
2006 

NOTIFICATION – The Maharashtra Value Added Tax Act, 2002.

No. VAT.1506/CR-134/Taxation-1– In
exercise of the powers conferred by clause (i) of the Explanation to
sub-section (3) of section 42 of the Maharashtra Value Added Tax Act, 2002
[Mah. IX of 2005], the Government of Maharashtra hereby notifies the following
works contracts to be the ‘Construction Contracts’ for the purposes of the said
sub-section, namely:-

 

(A) Contracts for construction of,–

(1) Buildings,

(2) Roads,

(3) Runways,

(4) Bridges, Railway over
bridges,

(5) Dams,

(6)    Tunnels,

(7)    Canals,

(8)    Barrages,

(9)    Diversions,

(10)  Rail tracks,

(11)  Causeways, Subways,
Spillways,

(12)  Water supply schemes,

(13)  Sewerage works,

(14)  Drainage,

(15)  Swimming pools,

(16)  Water Purification
plants and

(17)  Jettys

 

(B) Any works
contract incidental or ancillary to the contracts mentioned in paragraph (A)
above, if such work contracts are awarded and executed before the completion of
the said contracts.

 By order and in the name of the Governor of
Maharashtra.”

Controversy

In relation to the above
notification, there was a controversy about the scope of the notified items.
Particularly, in relation to contracts for construction of building, there was
a dispute as to whether only new construction can be covered or repair of existing
building can also be covered. If the contract was for repair of the existing
building, then the view of the department was that it cannot be covered under
the above notification.

Bombay
High Court Ruling 

One of the matters, having such
dispute, went to the Hon. Bombay High Court by way of appeal under MVAT Act.
The matter is in case of Painterior (India) (Maharashtra VAT Appeal No. 22
of 2017 dated 25.7.2017)(Bom). 

The Hon. High Court has narrated
the facts as under:

“Background of the Appeal:

3. The Appellant is a
registered partnership firm registered under the MVAT Act. The Appellant is in
the business of repairs/reconstruction of buildings. Application dated 14th
June 2010, was filed by the Appellant before the Commissioner of Sales
Tax, Maharashtra State (for short, “The Commissioner”) u/s. 56 of the
MVAT Act, for determination of the rate of tax applicable to a contract for
repairs of a building, as the repairs/reconstruction contracts are covered by
the expression “construction contracts”, which is used in section 42(3)
of the MVAT Act read with Notification No.VAT.1506/CR134/Taxation/1 dated 30th
November 2006. The rate of tax applicable thereto, would be 5% as notified
under the Act. The Appellant had forwarded along with the Application to the
Commissioner such type of contract with the Sangam Bhavan Building.

 

4. The Appellant also prayed
for the direction that the determination of the Commissioner should not affect
the liability of the Appellant under the Act in respect of any sale affected
prior to the determination. The Commissioner by order dated 25th
July 2014, rejected the contention of the Appellant and made a determination
that the contract is not a “Construction Contract”, thus attracting the
rate of tax at 8%. Being aggrieved by the order passed by the Commissioner, the
Appellant approached the Maharashtra Sales Tax Tribunal (for short, “the
Tribunal”) in Appeal. The Tribunal by Judgment and order dated 15th December
2016, confirmed the order passed by the Commissioner. Hence, the Appeal.”

The Hon. High Court referred to the
provisions of the Act as well as earlier circulars under Works Contract Tax
Act. Under Works Contract Tax Act, for the amnesty scheme, the Commissioner of
Sales Tax has clarified that repair contracts are also Construction contracts.
Having this interpretation long back, the Hon. High Court held that there is no
reason to change the interpretation. The observations of the Hon. High Court
are as under:

“13. It is necessary to note that
under the WC Act, referring to section 6A(1) a similar notification dated 8
March 2000 was in existence, referring to the contract for construction of
“building”. Similar clause (B) of notification under MVAT Act dated 30th
November 2006 was in existence under Section 42(3) Explanation. The Trade
circular was in existence about the repair, reconstruction and maintenance to
buildings, dams, bridges, canals and barrages would be covered under the
expression of “Construction Contract”, though it was for the purpose of amnesty
scheme. This undisputed position on record shows the consistent stand and
interpretation even of the Department that the “Construction Contract” includes
the repair and reconstruction and maintenance of building. There is no contra
circular and/or material available placed on record in this regard. The
circulars and the practice so adopted by the Department, since long, ought not
to have been overruled while rejecting the case/claim of the Appellant.

14. Therefore, considering the
scheme and purpose of section 42(3)(i) and notification dated 30th
November 2006 under the MVAT Act, we are of the view that the ‘Works Contract’
in question, would be the ‘Construction Contract’. The contract for
construction of buildings includes the repairing, reconstruction and maintenance
of building etc. This is also for the reason that there is no
distinguishing feature and definitions and/or intention reflected in any
provisions about the nature of buildings, whether it is new building or old
building. The word “new” or “old” so observed in the impugned order as not
specifically defined or explained anywhere, cannot be added by giving such
restrictive interpretation to the provisions and the notification in question.
The term “Building” cannot be restricted only to the new building specifically
when, as per the practice and the explanation so given in similarly placed
provisions under the WC Act and the notification explaining the term so
referred above. In spite of the earlier provisions and the interpretation so
given, there is no reason to overlook the same specifically when, there is no
further clarification and/or provisions brought on record to supersede and/or
take away the clarification so issued by the Commissioner at the relevant time.
The repairing and/or reconstruction, if part of Construction Contract, which in
normal parlance and/or understanding cannot be read to mean that the
construction contract refers under these provisions only for the new building.
It is unacceptable and there is no rational and/or justification for want of
specific provisions of such interpretation.”

Conclusion     

Thus,
the Hon. High Court has decided on this highly disputed issue which will bring
the controversy to end. Further, it also becomes clear that the circular
interpretation remains binding even if it is in a different situation.
Consistency in interpretation is getting impliedly confirmed by the Hon. High
Court. We hope that such a trend will always be kept in mind by the revenue
authorities for simplification of law.

Is Schedule Ii To The Central GST Act, 2017 & Other State GST Acts Unconstitutional As Regards Certain Services?

Introduction

The Goods and Services Tax legislations have become a reality
now and are in operation. The start was through a Constitutional (101st)
Amendment Act, 2016 which came into effect from September 2016 itself. In that
Act, the Constitution was amended to insert, modify and delete several articles
to pave the way for introduction of GST. In doing so, however, Article 366(29a)
was left untouched. This article would analyse the effect of having this clause
remaining in the Constitution.

Goods and Services Tax

The term “goods” is defined in Article 366(12) to include all
materials, commodities and articles. As per Article 366(26A), “services” is
defined to mean anything other than goods. Article 366(12A) defines “goods and
services tax” to mean any tax on supply of goods or services or both except
taxes on the supply of the alcoholic liquor for human consumption.” Therefore,
it stands to reason that the goods and services tax is a tax on supply of goods
or services.

Tax on sale or purchase of goods

However, in Article 366(29a), which was inserted by
Constitution (46th Amendment) Act, 1982, the definition of tax on
the sale or purchase of goods was introduced. The reason for its introduction
was several transactions which could not be taxed by the States because of
interpretation placed by the Courts was sought to be overcome. Now let us take
a look at the said definition which is set out hereunder (emphasis supplied):

“[(29A) “tax on the sale or purchase of goods” includes –

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

(b)  a tax on the transfer of property in
goods (whether as goods or in some other form) involved in the execution of a
works contract;

(c)  a tax on the delivery of goods on
hire-purchase or any system of payment by instalments;

(d)  a tax on the transfer of the right to
use any goods for any purpose (whether or not for a specified period) for cash,
deferred payment or other valuable consideration;

(e)  a tax on the supply of goods by any
unincorporated association or body of persons to a member thereof for cash,
deferred payment or other valuable consideration;

(f)   a tax on the supply, by way of or as
part of any service or in any other manner whatsoever, of goods, being food or
any other article for human consumption or any drink (whether or not
intoxicating), where such supply or service, is for cash, deferred payment or
other valuable consideration,

and such transfer, delivery or supply of any goods
shall be deemed to be a sale of those goods by the person making the transfer,
delivery or supply and a purchase of those goods by the person to whom such
transfer, delivery or supply is made;”

In BSNL Ltd vs. UOI 2006 (2) STR 161, the Supreme
Court succinctly brought out reasons for its introduction which is set out
hereunder:

39. Clause (a) covers a situation where the
consensual element is lacking. This normally takes place in an involuntary
sale. Clause (b) covers cases relating to works contracts. This was the
particular fact situation which the Court was faced with in Gannon Dunkerley
and which the Court had held was not a sale. The effect in law of a transfer of
property in goods involved in the execution of the works contract was by this
amendment deemed to be a sale. To that extent the decision in Gannon Dunkerley
was directly overcome. Clause (c) deals with hire purchase where the title to
the goods is not transferred. Yet by fiction of law, it is treated as a sale.
Similarly the title to the goods under Clause (d) remains with the transferor
who only transfers the right to use the goods to the purchaser. In other words,
contrary to A.V. Meiyappan’s decision a lease of a negative print of a picture
would be a sale. Clause (e) covers cases which in law may not have amounted to
sale because the member of an incorporated association would have in a sense
begun both the supplier and the recipient of the supply of goods. Now such
transactions are deemed sales. Clause (f) pertains to contracts which had been
held not to amount to sale in State of Punjab vs. M/s. Associated Hotels of India
Ltd. (supra). That decision has by this clause been effectively legislatively
invalidated.

40. All the clauses of Article 366(29A)
serve to bring transactions where one or more of the essential ingredients of a
sale as defined in the Sale of Goods Act, 1930 are absent, within the ambit of
purchase and sales for the purposes of levy of sales tax. To this extent only
is the principle enunciated in Gannon Dunkerly limited. The amendment
especially allows specific composite contracts viz. works contracts [Clause
(b)], hire purchase contracts [Clause (c)], catering contracts [Clause (e)] by
legal fiction to be divisible contracts where the sale element could be
isolated and be subjected to sales tax.

It is clear from the above definition and analysis, that the
following goals get achieved through the amendment:

i.   The definition talks of a tax on sale or
purchase of goods to include several things listed therein;

ii.  There are three clauses dealing with tax on
transfer (clauses a, b and d), one clause dealing with tax on delivery (clause
d) and two clauses dealing with tax on supply;

iii.  All the clauses deal with goods only;

iv. Further, the clause states that such transfer,
delivery and supply shall be deemed to be a sale or purchase of goods.

GST scenario

In the GST scenario, there are two principal legislations
dealing with tax on supply of goods or services – the Central GST Act, 2017 and
the State GST Act, 2017. It would be noted that the IGST Act, 2017 deals with
interstate supplies and imports. We take the CGST 2017 for analysis for the
sake of convenience and as this has been replicated by all states, it will hold
equally valid. Supply is defined in section 7 to include all forms of supply
of goods or services or both such as sale, transfer, barter, exchange, licence,
rental, lease or disposal made for a consideration in the course or furtherance
of business. Thus, the terminology supply includes sale of goods.

If we look further into section 7(1)(d), supply includes
activities to be treated as supply of goods or supply of services as referred
to in Schedule II. Schedule II attempts to classify what would be termed as
supply of goods and what is termed supply of services.

A close look at Schedule II would reveal the general theme
that transfer of title in goods will be classified as supply of goods and
transfer of other rights in goods would be classified as supply of services.
Further, transactions covered by clauses (b), (c), (d), and (f) of Article
366(29a) are classified as services while transactions covered by clause (e) is
covered as supply of goods. In effect therefore, works contract, hire
purchase transactions and transfer of right to use goods apart from goods
supplied in restaurant/hotels are classified now as supply of services and not
supply of goods.

Does this conflict with Article 366(29a)?

There are no two opinions about this that tax on works
contract, hire purchase and transfer of right to use goods apart from food
supplied in restaurants were and are treated as sale and purchase of goods by
virtue of the deeming fiction appearing in Article 366(29a) of the
Constitution. Therefore, to this extent the transactions being covered by
Schedule II are termed as services are seemingly in direct conflict with the
above constitutional provisions. Therefore, one has to find whether we can
harmonise Article 366(26A) which deals with tax on goods and services vis-a-vis
Article 366(29a) which deals with tax on sale or purchase of goods and deeming
certain transactions to be sale or purchase of goods.

Whether harmonising possible?

If we look at the constitutional provisions, there is no
definition of what is supply. But when we look at the statute, the term supply
is defined to have a wider meaning than the term sale as the latter is included
in the former. Therefore, sale is only a sub-sect of supply which includes
several other things. Can a statute be used to interpret the meaning of the
terms in the Constitution? Is such recourse possible? One argument is that the
term “sale” appearing in the Constitution was so interpreted by the Supreme
Court to be what was being used under a legislation. The summary of this
discussion is found in BSNL case supra which is reproduced hereunder:

To answer the questions formulated by us, it is necessary
to delve briefly into the legal history of Art. 366(29A). Prior to the 46th
Amendment, composite contracts such as works contracts, hire-purchase contacts
and catering contracts were not assessable as contracts for sale of goods. The
locus classicus holding the field was State of Madras vs. Gannon Dunkerley
& Co. – IX STC 353 (SC). There this Court held that the words “sale of
goods” in Entry 48 of List II, Schedule VII to the Government of India Act,
1935 did not cover the sale sought to be taxed by the State Government under
the Madras General Sales Tax Act, 1939. The classical concept of sale was held
to apply to the entry in the legislative list in that there had to be three
essential components to constitute a transaction of sale – namely, (i) an
agreement to transfer title, (ii) supported by consideration, and (iii) an
actual transfer of title in the goods. In the absence of any one of these
elements it was held that there was no sale. Therefore, a contract under which
a contractor agreed to set up a building would not be a contract for sale. It
was one contract, entire and indivisible and there was no separate agreement
for sale of goods justifying the levy of sales tax by the provincial
legislatures. “Under the law, therefore, there cannot be an agreement relating
to one kind of property and a sale as regards another”. Parties could have
provided for two independent agreements, one relating to the labour and work
involved in the execution of the work and erection of the building and the
second relating to the sale of the material used in the building in which case
the latter would be an agreement to sell and the supply of materials
thereunder, a sale. Where there was no such separation, the contract was a
composite one. It was not classifiable as a sale. The Court accepted the
submission of the assessee that the expression “sale of goods” was, at the time
when the Government of India Act, 1935 was enacted, a term of well recognized
legal import in the general law relating to sale of goods and must be
interpreted in Entry 48 in List II of Schedule VII of the 1935 Act as having
the same meaning as in the Sale of Goods Act, 1930. According to this decision
if the words “sale of goods” have to be interpreted in their legal sense, that
sense can only be what it has in the law relating to sale of goods. To use the
language of the Court :

“To sum up, the expression “sale of goods” in Entry 48 is
a nomen juris, its essential ingredients being an agreement to sell movables
for a price and property passing therein pursuant to that agreement. In a
building contract which is, as in the present case, one, entire and indivisible
– and that is its norm, there is no sale of goods, and it is not within the
competence of the Provincial Legislature under Entry 48 to impose a tax on the
supply of the materials used in such a contract treating it as a sale”.

34. Following the ratio in Gannon Dunkerley,
that “sale” in Entry 48 must be construed as having the same meaning which it
has in the Sale of Goods Act, 1930, this Court as well as the High Courts held
that several composite transactions in which there was an element of sale were
not liable to sales tax.

One could also view that actually the Gannon Dunkerly
decision to treat sale in the context of how the Government of India Act, 1935
had viewed it and as our Lists in VII Schedule were more or less reproductions,
it was to be interpreted keeping in mind what was the meaning in the earlier
legislation which was parallel to our constitutional provisions and therefore,
the Supreme Court has actually not subordinated the Constitution to the
statute. However, the BSNL’s case (supra) does not follow this argument
as also other Courts and have consistently interpreted the Gannon Dunkerly
judgement that the terms used in the constitution have been interpreted keeping
in mind the legislation present at that time.

If this argument be accepted, then clearly, the CGST Act 2017
can be used to refer to the meaning of the term supply which is conspicuous by
its absence in the Constitution. So read, sale is a sub-sect of supply as
supply will include other forms like transfer, barter, lease, rental, etc.
apart from sale. Therefore, Article 366(29a) is now a sub-sect of Article
366(26A) which seems to be plausible but flawed in one clear sense – the
sub-sect was introduced before the sect itself. But we assume here that the
makers wanted to so do as they were introducing a tax on a wider system of
supply than the narrow system of sale. If we do not treat the same as a sub
sect, then the two clauses are independent and the GST legislations will
clearly suffer from the vice of unconstitutionality in that respect.

Harmonising will still not save

Assuming for a moment that the clause is a sub-sect of
supply, still the challenge to the provisions contained in schedule II will
hold good because to the extent those clauses treat the transactions as supply
of services, they are still in conflict with the express provisions of Article 366(29a).

One other argument which can be thought of is that Article
366(29a) was retained in the Constitution for a specific reason that those
transactions which were entered into prior to 1.7.2017 when the GST
legislations were brought into force would still be protected for realisations
made after 1.7.2017. To put it simply, suppose you entered into a lease
transaction before 1.7.2017 which amounted to a transfer of right to use goods
and was treated as supply of goods earlier, the instalments that are realised
after 1.7.2017 could still be collected as the Constitutional mechanism is
still intact. However, this would lead us to a very paradoxical position. If
those transactions are covered still as tax on sale or purchase of goods, the
new levy of GST cannot be applied at all. In fact, that is clearly the
situation. For example, if I entered into a car lease on 1.4.2017, the
transaction would have been taxed as a sale of goods under the respective VAT
legislations and VAT has to be discharged every time the lease rentals are
invoiced. Similar would be cases of transfer of rights to use other goods like
machinery. Come 1.7.2017, the car lease rentals are described as services and
taxed at a rate of 43% or other transfers of right to use are now taxed under
GST as services. Can the recovery of instalments be taxed under GST where the
delivery or transfer of right to use is already complete prior to 1.7.2017 when
GST was introduced? The answer is a clear no and therefore, to charge GST on
such transactions may be beyond the statute itself, leave alone the
constitution. This is because, there is no supply under GST and the transfer of
right to use or delivery of goods has already occurred before the GST
legislation came into force. Even section 142(10) of the CGST Act, 2017 will
apply where in a continuing contract the supply is made after 1.7.2017.

That would mean that those collections have to be done under
the old VAT laws which now stand repealed. By virtue of section 174 of the CGST
Act, 2017 or section 173/174 of the Karnataka GST Act 2017 read with section 6
of the General Clauses Act, 1897 can it be said that the previous liability
will still continue under such Acts, in which case, till those transactions
conclude, the respective liability continues. However, it can be equally argued
that liability to pay tax occurs every month on lease rentals and unless the
legislation is in force, there is no liability to pay at all and my previous
liabilities are completely discharged.

Conclusion

Therefore, it appears that the provisions
relating to schedule II of the CGST Act, 2017 or the respective state
legislations trying to tax certain transactions as supply of services are in
direct conflict with the constitutional provisions. There seems to be a further
dilemma that certain completed transactions cannot be brought to tax under the
new GST regime. This is an area which is likely to be explored by the discerning
professionals.

Input Tax Credit – Some Emerging Issues

1.    Fundamentals and basic rules

1.1.    At the heart of an efficient indirect tax is a flawless Input Tax Credit (“ITC”) mechanism, that allows a business to claim offset of taxes paid on expenses at the time of discharging liability of taxes collected from customers. If the tax offset, also known as ITC is not allowed freely to the businesses, it results in tax inefficiencies in the form of tax on tax. In fact, one of the most important justifications for introduction of GST has been the seamless flow of credit.

1.2.    The GST law in general allows registered businesses to avail ITC of taxes paid on inputs / input services / capital goods which are used or intended to be used in the course or furtherance of business, subject to certain restrictions and conditions.

1.3.    This article primarily covers the aspect relating to ITC entitlement, conditions for claim of credit, conditions and restrictions imposed for claim of credit and some teething issues towards credit claim. Chapter V of the CGST Act, 2017 as well as Chapter V of the CGST Rules, 2017 deal with the provisions relating to ITC.

2.    ITC Entitlement – General Conditions

2.1.    Section 16 (1) of the CGST Act, 2017 provides that every registered person shall be entitled to take credit of input tax charged on supply of goods or services or both, which are used / intended to be used in the course or furtherance of his business and the said amount shall be credited to the electronic credit ledger of such person. Section 16(2) stipulates further conditions which need to be satisfied for the claim of credit and the same are listed below:
–    The registered person should be in possession of tax invoice / debit note issued by registered supplier or other tax paying documents
–    The registered person should have received goods / services
–    The tax charged on the invoice should have been actually paid to the Government
–    The recipient should have furnished his return
–    The recipient should have paid the supplier of goods / services the amount due towards the supply received (including taxes) within 180 days
–    The credit should not be blocked under Section 17(5).

2.2.    As can be seen from above, there are various conditions prescribed under GST for claiming ITC, and they revolve around different pillars of compliances, from the view point of recipient (being a registered person, should have received the supply), compliances by both the parties (pre & post supply in the form of payment of taxes by the supplier, making correct disclosures relating to the supply by the supplier, filing the return by the recipient, intended use of the supply – business vs. non-business, etc.) and nature of supply (restricted credit vs. unrestricted credits).

2.3.    Each of the above aspects are discussed in the subsequent paras.

3.    Identifying Recipient of supply

3.1.    As discussed above, one of the important conditions for claiming the ITC is that the registered person should have received the goods or services. In many cases, the payment for a supply may be made by one person but the economic benefit of the supply can be received by another person. Take the case of a Customs House Agent (CHA) paying for the warehousing charges at the Container Freight Station (CFS). Can it be said that the CHA has received the service and is therefore entitled for input tax credit?

3.2.    In the above background, it becomes essential to define what is meant by the phrase “recipient of supply”. Section 2 (93) defines the term “recipient of supply” in the context of goods / services / both as:

    (93) “recipient” of supply of goods or services or both, means—
    (a) where a consideration is payable for the supply of goods or services or both, the person who is liable to pay that consideration;
    (b) where no consideration is payable for the supply of goods, the person to whom the goods are delivered or made available, or to whom possession or use of the goods is given or made available; and
    (c) where no consideration is payable for the supply of a service, the person to whom the service is rendered,    and any reference to a person to whom a supply is made shall be construed as a reference to the recipient of the supply and shall include an agent acting as such on behalf of the recipient in relation to the goods or services or both supplied;

3.3.    The CHA operates out of customs port and facilitates number of activities pertaining to import / export of goods, such as dealing with the shipping line, CFS, loading / unloading of goods in to the vessel, paying port charges, etc. The key to the entire analysis would be whether the CHA is liable to pay the consideration to the underlying vendor. The actual fact of paying the consideration may not be relevant. Therefore, it may be important to look at the contracts. In many cases, the contracts may be verbal or implied. In such a scenario, the invoice can be the best indicator of the contracting relationship.
 
3.4.    Practically, the vendors may enter into contracts/issue the invoices in the following manner:

a.    Contracts entered into with/ Invoices issued in the name of the Importer / Exporter. In such a scenario, the CHA merely acts as an agent. However, payment to the vendors is done by the CHA which is subsequently recovered from importer / exporter.

    In this scenario, the vendors have recognised the importer / exporter as the recipient of supply and hence they will have to be treated as the recipient and the credit can be claimed only by the importer / exporter and not by the CHA.

b.    Contracts entered into with / Invoices issued in the name of CHA. In this scenario, since the person liable to pay the consideration to the underlying vendor is the CHA, the +CHA can be considered as a recipient of supply. It may be important to note that the definition of recipient also includes an agent acting on behalf of the recipient. In this scenario, the vendors have treated the CHA as the person liable for payment of consideration, i.e., recipient of supply. The CHA can claim the credit of the taxes which have been posted into their Electronic Credit Ledger by the respective vendors. It is however, important to note that in such cases, the CHA will not be able to claim the amount as reimbursement of expenditure and he should treat the expenditure incurred by him as inward supplies for providing the outward supply to the importer / exporter.

c.    Issued in the name of CHA who claims the reimbursement of expenses from client as pure agent

    In the above scenario, if the CHA chooses to claim the benefit of reimbursement of expenses and consequent exclusion from valuation of taxable services, in view of the Mumbai High Court decision in the case of Ultratech Cement Limited 2010 (20) S.T.R. 577 (Bom.), the CHA will not be eligible for the claim of credit.

    In fact this will result in an incremental cost for the importer / exporter with no actual benefit flowing in to either the CHA / importer / exporter by way of tax credits.

4.    Denial of credit for non-possession of original tax invoices

–    Section 16 (2) (a) provides that the person claiming the ITC should be in possession of tax invoice / debit note issued by the supplier for claiming the credit.

–    The question that arises is whether the receiver should be in possession of the original tax invoice for claiming credit or photo-copy or scanned copy of the invoice shall also suffice.
–    In this context, it would be important to refer to the provisions of section 145 of the Act, wherein it has been provided that a micro film of a document or the reproduction of the image or images embodied in such micro film (whether enlarged or not); or a facsimile copy of a document; or a statement contained in a document and included in a printed material produced by a computer, subject to such conditions as may be prescribed; or any information stored electronically in any device or media, including any hard copies made of such information, shall be deemed to be a document for the purposes of this Act and the rules made thereunder and shall be admissible in any proceedings thereunder, without further proof or production of the original, as evidence of any contents of the original or of any fact stated therein of which direct evidence would be admissible.

5.    Failure to make payment to vendor for the supply received including taxes

–    Second proviso to section 16 (2) provides that in case where a receiver of supply fails to make the payment to the supplier for the value of supply (incl. GST charged) within 180 days of the date of invoice, he shall be liable to reverse the ITC claimed initially along with the interest thereon.

–    Similarly, the third proviso to section 16 (2) provides that when the receiver of supply makes payment to the vendor post reversal of credit in accordance with the provision of second proviso, he shall be entitled to re-claim the credit of the tax reversed in terms of second proviso.

–    One important issue that arises is whether credit reversal would be required in case of part payments made to suppliers, and if yes, whether to the extent of entire supply or only to the extent payment is not made? It is imperative to note that the proviso to section 16 (2) referred above is silent in this regard. The proviso only requires for reversal of ITC, but is silent as to what extent the reversal shall be necessitated?

–    While there is no clarification for these issue, either from the CBEC / State Authorities, under the erstwhile service tax regime, in the context of Rule 4 (7) of the CENVAT Credit Rules, 2004, (which is a similar provision as the proviso to section 16 (2)), the Board had clarified1 as under:
_____________________________________________________________
1 Circular No. 122/3/2010-S.T., dated 30-4-2010

    (b) In the cases where the receiver of service reduces the amount mentioned in the invoice/bill/challan and makes discounted payment, then it should be taken as final payment towards the provision of service. The mere fact that finally settled amount is less than the amount shown in the invoice does not alter the fact that service charges have been paid and thus the service receiver is entitled to take credit provided he has also paid the amount of service tax, (whether proportionately reduced or the original amount) to the service provider. The invoice would in fact stand amended to that extent. The credit taken would be equivalent to the amount that is paid as service tax. However, in case of subsequent refund or extra payment of service tax, the credit would also be altered accordingly.

–    Similar issue is also faced by the Infrastructure Sector, especially contractors / sub-contractors where there is a concept of retention money, i.e., amount reduced from invoices raised by the suppliers by terming them as “retention money” and subsequent payment as per contractual terms. It is obvious that the amount is contractually due after more than 180 days and hence the payment would actually be made after the period of more than 180 days. Will the requirement of reversal of credit trigger in such situations? It may be fruitful to reproduce the exact provision requiring the reversal of credit

    Provided further that where a recipient fails to pay to the supplier of goods or services or both, other than the supplies on which tax is payable on reverse charge basis, the amount towards the value of supply along with tax payable thereon within a period of one hundred and eighty days from the date of issue of invoice by the supplier, an amount equal to the input tax credit availed by the recipient shall be added to his output tax liability, along with interest thereon, in such manner as may be prescribed

–    It is important to note that the provision obligating the reversal of credit gets triggered when the recipient fails to pay. The phrase “fails to pay” is a specific incident and gets triggered only in situations when there is an obligation to pay. Since the recipient is not obligated to pay the retention money within a period of 180 days, it cannot be said that he has failed to pay the retention money and hence the proviso is not triggered.

6.    Process for claiming Input Tax Credit

6.1.    Section 16 (1) provides that every registered person shall be entitled to take ITC of inward supplies received for use / intended use in the course or furtherance of business, the same comes with the caveat “subject to conditions and restrictions as may be prescribed”.

6.2.    Out of this pool of input tax credit, there are various restrictions imposed on the taxable persons from claiming the input tax credit. It may be important to note that even under the Service Tax / VAT regime, Rule 6 of the CENVAT Credit Rules (including Rule 2 (a), (k) & (l)) as well as Rule 53/ 54 of the Maharashtra Value Added Tax Rules provided for similar conditions / restrictions on the claim of input tax credit.

6.3.    Similar conditions and restrictions are contained under CGST Act, 2017 in the provisions of Section 17 read with Rule 43 of the CGST Rules, 2017. The ITC attributable to total inward supplies received by a registered person, on which ITC has been charged by the supplier as well as transactions where the ITC is applicable under reverse charge mechanism has been classified as “T” for the purpose of determining eligibility.

6.4.    The total ITC is subsequently segregated into multiple baskets, as is evident from the following chart and discussed in detail in subsequent paras:

6.5.    Credit pertaining exclusively to non-business / exempt activities

6.5.1.The first two baskets of segregation of “T” deals with situation wherein inputs / input services are used partly for the purpose of business and partly for other purposes OR partly for affecting taxable supplies and partly for exempt supplies and the amount of credit shall be restricted to so much of input tax as is attributable to business purpose OR is attributable to taxable supplies. To the extent the ITC is attributable to non-business purpose, the same is classified as T1 and to the extent the ITC is attributable to exempt supplies, the same is classified as T2.

6.6.    Restricted Credits

6.6.1.    In addition to above, section 17 (5) provides that ITC shall not be allowed in respect of various expenditure incurred. The inward supplies which are covered u/s. 17 (5) are classified as “T3”. A quick summary of such inward supplies where ITC is restricted include ITC in respect of:

–    Motor vehicles & other conveyances
–    Specified inward supplies, such as:

a.    Food and beverages, outdoor catering, beauty treatment, health services, cosmetic and plastic surgery except where an inward supply of goods or services or both of a particular category is used by a registered person for making an outward taxable supply of the same category of goods or services or both or as an element of a taxable composite or mixed supply;
b.    membership of a club, health and fitness centre;

c.    rent-a-cab, life insurance and health insurance except where ––

    (A) the Government notifies the services which are obligatory for an employer to provide to its employees under any law for the time being in force; or
    (B) such inward supply of goods or services or both of a particular category is used by a registered person for making an outward taxable supply of the same category of goods or services or both or as part of a taxable composite or mixed
supply; and

d.    travel benefits extended to employees on vacation such as leave or home travel concession;

–    Works contract services when supplied for construction of an immovable property (other than plant and machinery) except where it is an input service for further supply of works contract service;
–    Goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account including when such goods or services or both are used in the course or furtherance of business.
–    Goods or services or both on which tax has been paid u/s. 10, i.e., composition scheme.
–    Goods or services or both received by a non-resident taxable person except on goods imported by him;
–    Goods or services or both used for personal consumption;
–    Goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples; and
–    Any tax paid in accordance with the provisions of sections 74, 129 and 130.

6.7.    Identified Credits

6.7.1.    The fourth basket of segregation is pertaining to inward supplies, which are exclusively used for making taxable supplies, including zero rated supplies. Such ITC is tagged as “T4”. A supplier shall be eligible for full input tax credit to the extent the inward supply is tagged under this basket

6.8.    Common Credits

6.8.1.    The balance ITC is the quantum of common inward supplies which are used for making both, taxable as well as exempted supplies on which a ratio needs to be applied on a monthly basis. Such ITC is tagged as “C2”. From C2, the amount of ITC attributable towards exempt supplies (“D1”) is identified using the following ratio,

           Aggregate value of exempt
           supplies during the tax period (E)   
    ____________________________    *    C2   
           Total turnover of the state of the
           registered person during the tax period (F)   

6.8.2.    The term “exempt supplies” has been defined to mean supply of any goods or services or both which attracts nil rate of tax or which may be wholly exempt from tax u/s. 11, or u/s. 6 of the Integrated Goods and Service Tax Act, and includes non-taxable supply (i.e., supply of goods or services or both which is not leviable to tax under this Act or under Integrated Goods and Service Tax Act).

6.8.3.    Value of Exempt Supply shall include the following:
–    Transaction Value of all the exempt supplies
–    Transaction Value of services on which tax is payable under RCM
–    Sale of Land/ Completed Buildings
–    Sale of Securities – 1% of sale value is presumed to be the value of exempted supply.

6.8.4.    A banking company or a financial institution including a non-banking financial company has been given an option to either comply with the ratio requirement or avail only 50% of the eligible ITC on inputs, capital goods and input services in that month. However, such companies shall be required to exercise the option every year and once the option is exercised, the same cannot be withdrawn during the remaining part of the financial year. Further, the 50% credit claim option is not applicable for internal supplies within the company on which tax is payable.

6.8.5.While under the erstwhile Service Tax Regime, the ratio for reversal of credit was to be determined as per the financials of the previous year, to be applied throughout the year and subsequently, requiring a final ratio to be determined based on the financials of the concluded year by the 30th June, the method has been changed to some extent under the GST regime. Under GST, the ratio shall be required to be determined & applied on a monthly basis and subsequently, at the end of the year, a final ratio shall be determined and applied on or before 30th September of the next financial year.

6.9.    Additional 5% adhoc reversal for common input tax credits

6.9.1.    Further, an additional reversal of 5% is proposed from C2 in cases where common inputs / input services are used for business as well as non-business purposes, and the same is denoted as D2 for the purpose of ITC calculations. It is important to note that the additional 5% reversal is required only in cases where a registered taxable person uses some inputs / input services for both, business as well as non-business purposes and not in cases where it is used for purely business purposes.

6.9.2.Therefore, the question that arises is whether this clause is meant to be applicable for all categories of taxable persons or only for specified categories? Perhaps, this entry is meant to cover situations of sole-proprietary / partnership firms / HUF where there is always an element of personal expenditure incurred by the sole proprietor / partners / members being claimed as expenditure. While in the case of a company, while such instances cannot be ruled out, it is important to note that the Statutory Auditors are required to compulsorily disclose the personal expenditure of specified persons booked in the books of the company? So, the question that arises is what shall be the basis for determining the amount for D2 purpose. Has it to be the Income Tax Assessment Order making disallowance u/s. 37 for personal expenditure or has it to be the report of statutory auditor making such disclosures or is it something that has to be at the mercy of GST officer?

6.10.    Credit in case of capital goods identified as being used for effecting taxable supplies is allowed immediately which is a departure from the earlier tax regime wherein credit of capital goods was to be claimed in two equal installments in the first two years. However, more complex provisions for reversal of ITC on capital goods have been prescribed. It has been provided that the claim of ITC on capital goods shall be distributed over a period of 60 months and credit should be availed every year basis the ratio determined on a monthly basis for a period of 60 months.

7.    Credit Claim – Some controversies

7.1.    Credit of ITC in respect of motor vehicles & conveyances

–    As stated earlier, section 17(5), inter alia, does not permit the claim of credit in respect of motor vehicles. In this context, a question which arises is whether taxes paid on repairs and insurance of motor vehicles are eligible for input credit. Is the denial of credit only for procurement of motor vehicles as such or does the denial extend to all goods and services surrounding the effective consumption of the motor vehicle?

–    In this context, it would be important to refer to the decision of the Hon’ble Supreme Court in the case of State of Madras vs. Swastik Tobacco Factory (1966) 3 SCR 79 (SC) wherein it was held that the expression “in respect of the goods” in r. 5(1)(i) means only on the goods, and cannot take in the raw material out of which the goods were made.

–    Taking cue from the said decision, a view can be taken that the restriction for claim of credit is only restricted to receipt of motor vehicles and not other goods or services surrounding the motor vehicles. Therefore, a view can be taken that motor car insurance and repairs shall be eligible for credit under the GST Regime.
7.2.    Distinction between rent-a-cab and leasing of vehicles and eligibility to claim credit thereof

–    While the term rent-a-cab has not been defined under GST, the term cab has generally been perceived as a vehicle used for hiring purposes and is accordingly registered with the Transport Authorities as well. But the same cannot be said for leasing transactions, where the motor car given on lease is actually not registered with the Transport Authorities as a commercial vehicle and hence, the leasing of such vehicles, which in itself might be a commercial activity, cannot be classified as rent-a-cab.

–    It may also be important to note that services of transportation of passengers attract GST at a rate of 5% / 18% while the leasing of goods attract the rate applicable on supply of such GST including the compensation cess thereof. The fact that there is a distinction of rate between the services of transportation of passengers in a cab, which is covered under rent-a-cab category and leasing of vehicles clearly reinforce the view that the credit of tax paid on leasing of vehicles can be claimed as the same is not equivalent to rent-a-cab.

7.3.    Employee reimbursements – Credit Eligibility

7.3.1.An employee, as an agent of the company, who apart from working for the company and making various supplies on behalf of the company, also receives various supplies on behalf of the company in the course of his employment. Such supplies received might be in the nature of supplies meant for personal consumption of the employee or for the business purposes.

7.3.2.For example, an engineer visits a site and purchases various consumable items for use in provision of service to the client. The question that arises is whether the company shall be entitled to claim credit of such taxes, that would have been paid to the vendors?

7.3.3.It is more than evident that such consumable items are procured by the engineer for the company. The immediate consumption and use of such items is by the company and not by the engineer. Therefore the credit should be available to the company. However, it would be important that the invoice be issued in the name of the company and the credit is uploaded by the vendor in the company’s electronic credit ledger.

8.    Conclusion:

8.1.    The industry would have hoped that the ITC provisions under the GST regime would be less complicated as compared to the provisions under the erstwhile tax regime. However, the expectations have not materialised and the above complex provisions, if not complied in an organised manner, might result in future litigation as well as probable loss of credit for businesses. Therefore, businesses will have to be very careful while filing their monthly compliances relating to inward supplies register, tagging the inward supplies as either T1-T4 and C2 as well as calculating the ratios.

Section 2 (22)(e) – Amount contributed by a company, in which assessee is substantially interested, towards capital contribution in a firm in which such company and the assessee is a partner, cannot be regarded as dividend in the hands of the assessee, though the capital contribution by the company was disproportionate to its profit sharing ratio.

17.  Lala Mohan
Ramchand vs. ITO (Mumbai)

Members : G. S. Pannu (AM) and Ravish Sood (JM)

ITA No. 5778/Mum/2012

A.Y.: 2006-07.                                                                    
Date of Order: 14th June, 2017.

Counsel for assessee / revenue: Hiro Rai / Durga Dutt

FACTS 

The assessee was holding 25.5% of share capital of M/s Elite
Housing Development Pvt. Ltd. (EHDPL) and was also a partner in M/s Elite
Corporation with 37.5% share in profits. EHDPL was also a partner in M/s Elite
Corporation (“the firm”) and was having 5% share in profits of the firm.

In the course of reassessment proceedings, the Assessing
Officer (AO) observed that EHDPL was having accumulated profit of Rs.
1,07,11,103 had made an investment of Rs. 73,75,221 in the firm, which
investment according to him was substantially excessive as compared to the
share of profits of EHDPL in the firm. Since the assessee had 37.5% share in
profits of the firm, the firm was characterised by the AO as an eligible
‘concern’ u/s. 2(22)(e) of the Act. The AO had a strong conviction that EHDPL
in the garb of `capital contribution’ had made available its accumulated
profits to the firm and he therefore called upon the assessee to show cause as
to why the investment of Rs. 73,75,221 made by EHDPL in the firm, of which
investment of Rs. 3,00,000 was made during the year under consideration, may
not be assessed as `deemed dividend’ in his hands. The assessee submitted that
EHDPL in its status as a partner of the said firm, had invested an amount of
Rs. 3 lakh on 1.4.2005 by way of its capital contribution and had neither given
any loan or advance to the firm nor the said amount was paid on behalf of the
individual benefit of the assessee, and therefore the provisions of section
2(22)(e) were not applicable. The AO rejected the submissions of the assessee
and assessed the sum of Rs. 3 lakh invested by EHDPL with the said firm as
deemed dividend in the hands of the assessee.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD 

The Tribunal observed that now when it is alleged by the
revenue that the `capital contribution’ by EHDPL as a partner with M/s Elite
Corporation is a farce, then it is for the revenue to establish on the basis of
irrebuttable material that what is apparent is not real and thus dislodge and
disprove the claim of the assessee by proving to the contrary.

The Tribunal concurred with the submissions made on behalf of
the assessee viz. that there is no provision in the Indian Partnership Act,
1932, which therein contemplates that the partners’ `capital contributions’ in
the firm is required to be in proportion of their profit sharing ratios. It
held that in the absence of any such embargo on the capital contributions by
the partners having been placed on the statute, it was not persuaded to
subscribe to the adverse inferences drawn by lower authorities, who the
Tribunal found had observed that the substantial contribution by EHDPL as a
partner in the said firm when pitted against the latter’s meagre 5% share in
profit of the said firm was not found to be justifiable. It found merit in the
reasons furnished on behalf of the assessee as to why the capital contribution
by the partners in the firm was mentioned in clause 6 of the partnership deed
at Rs. 25 lakh. It held that it would be absolutely illogical and rather
impossible to expect that EHDPL could have managed to freeze its capital in the
firm at Rs. 25 lakh or any other figure, even if it would have resolved not to
introduce any fresh capital in the firm or withdraw any part of the same. The
Tribunal held that `capital contribution’ by a partner in a firm is differently
placed as against a loan or an advance to the firm. Loans and advances given by
a partner to the firm are substantially different from their `capital
contributions’. It observed that a perusal of section 48 of the Indian
Partnership Act, 1932 which contemplates the mode of settlement of the accounts
of the partners in the case of dissolution of a firm, in itself categorises the
same under different clauses. The Tribunal held that in the backdrop of
substantial turnover and income offered for tax by the firm, viz. Elite
Corporation, it would be incorrect to hold that the same was a dummy concern
which had been brought into existence with the intent to bypass the deeming
provisions contemplated u/s. 2(22)(e) of the Act. It observed that the funds
introduced by EHDPL by way of its capital contribution were utilised by the
firm in the normal course of its business and were not utilised for the
personal benefit of the assessee. It held that this fact supplements and
supports its view that the capital introduced by EHDPL as a partner in the said
firm cannot be characterised as `deemed dividend’ in the hands of the assessee.
The Tribunal set aside the order of CIT(A).

The appeal filed by the assessee was allowed.

Assessment – Disallowance/addition on the basis of statement of third party – Reliance on statements of third party without giving the assessee the right of cross-examination results in breach of principles of natural justice

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M/s. R. W. Promotions P. Ltd. vs. ACIT (Bom), ITA No. 1489 of 2013 dated 13/07/2015 -www.itatonline.org:

The
assessee was engaged in the business of advertisement, market research
and business promotions for its clients. In the A. Y. 2007-08, the
assessee had engaged services of M/s. Inorbit Advertising and Marketing
Services P. Ltd. (Inorbit) and M/s. Nupur Management Consultancy P. Ltd.
(Nupur) to enable them to carry out promotional and advertisement
activities. The amount of Rs. 1.15 crore paid to them was claimed as
expenditure. The Assessing Officer reopened the assessment to disallow
the claim on the basis of the statements of representatives of Inorbit
and Nupur. The assessee requested for the copies of the statements and
also requested for an opportunity of cross examining the deponents. The
Assessing Officer completed the assessment disallowing the expenditure
of Rs. 1.15 crore without giving the opportunity to cross examine the
deponents.

The Tribunal upheld the disallowance. The Tribunal
held that it is a final fact finding authority and it could direct cross
examination in case it felt that material relied upon by the Assessing
Officer to disallow expenses was required to be subject to the cross
examination. It held that denial of cross examination of the
representatives of Inorbit and Nupur had not led to breach of the
principle of natural justice.

On appeal by the assessee, the Bombay High Court held as under:
“i)
We find that there has been breach of principle of natural justice in
as much as the Assessing Officer has in his order placed reliance upon
the statements of representatives of Inorbit and Nupur to come to the
conclusion that the claim for expenditure made by the appallent is not
genuine. Thus, the appellant was entitled to cross examine them before
any reliance could be placed upon them to the extent it is adverse to
the appellant. This right to cross examine is a part of “audi altrem
partem” principle and the same can be denied only on strong reason to be
recorded and communicated.

ii) The impugned order holding that
it would have directed cross examination if it felt it was necessary, is
hardly a reason in support of coming to the conclusion that no cross
examination was called for in the present facts. This reason itself
makes the impugned order vulnerable.

iii) Moreover, in the
present facts, the appellant had also filed affidavits of the
representatives of Inorbit and Nupur which indicates that they had
received payments from the appellant for rendering services to the
appellant. These affidavits also have not been taken into account by any
authority including the Tribunal while upholding the disallowance of
the expenditure.

iv) Thus, the appellant was not given an
opportunity to cross examine the witnesses whose statement is relied
upon by the revenue and the evidence led by the appellant has not been
considered. Therefore, clearly a breach of principle of natural justice.
In view of the above, we set aside the order of the Tribunal and
restore the issue to the Assessing Officer for fresh disposal after
following the principles of natural justice and in accordance with law.”

levitra

Settlement of cases – Provision for abatement of proceedings – The Supreme Court agreed with the High Court which read down the provision of section 245HA(1)(iv) to mean that only in the event the application could not be disposed of for any reason attributable on the part of the applicant who has made an application u/s. 245C by cut-off date the proceeding would abate

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UOI vs. Star Television News Ltd. (2015) 373 ITR 528 (SC)

In all
the special leave petitions filed by the Union of India, before the
Supreme Court, the correctness of judgment dated 07.08.2009 rendered by
the Bombay High Court in a batch of writ petitions was questioned. In
those writ petitions filed by various assessees, the validity of
Sections 245 HA(1)(iv) and 245HA(3) of the Income-tax Act, 1961, as
amended by Finance Act, 2007 was challenged. The High Court, by a
detailed judgment, found the aforesaid provisions to be violative of
Article 14, etc., but at the same time, it did not invalidate these
provisions as the High Court was of the opinion that it was possible to
read down the provisions of Section 245HA(1)(iv) in particular to avoid
holding the provisions as unconstitutional. The conclusion so arrived at
was summed up in paragraph 54 of the impugned judgment, which read as
under:

“54. From the above discussion having arrived at a
conclusion that fixing the cut-off date as 31st March, 2008 was
arbitrary the provisions of Section 245HA(1)(iv) to that extent will be
also arbitrary. We have also held that it is possible to read down the
provisions of Section 245HA(1)(iv) in the manner set out earlier. This
recourse has been taken in order to avoid holding the provisions as
unconstitutional. Having so read, we would have to read section
245HA(1)(iv) to mean that in the event the application could not be
disposed of for any reasons attributable on the part of the applicant
who has made an application u/s. 245C. Consequently only such
proceedings would abate u/s. 245HA(1)(iv). Considering the above, the
Settlement Commission to consider whether the proceedings had been
delayed on account of any reasons attributable on the part of the
Applicant. If it comes to the conclusion that it was not so, then to
proceed with the application as if not abated. Respondent No.1 if
desirous of early disposal of the pending applications, to consider the
appointment of more Benches of the Settlement Commission, more so as the
Benches where there is heavy pendency like Delhi and Mumbai.”

The
Supreme Court was of the opinion that a well-considered judgment of the
High Court did not call for any interference. All these special leave
petitions and the appeals were accordingly dismissed by the Supreme
Court.

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Reassessment – Notice – There is no question of change of opinion when the return is accepted u/s. 143(1) inasmuch as while accepting the return as aforesaid no opinion is formed.

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DCIT vs. Zuari Estate Development and Investment Co. Ltd. (2015) 373 ITR 661 (SC)

The income-tax return filed by the respondent-assessee for the assessment year 1991-92 was accepted u/s. 143(1) of the Income-tax Act, 1961. After sometime, the Assessing Officer came to know that there was a sale agreement dated June 19,1984, entered into between the respondent and Bank of Maharashtra to sell a building for Rs.85,40,800 on the condition that the sale would be completed only after the five years of the agreement but before the expiration of the sixth year at the option of the purchaser and the purchaser can rescind the same at certain consideration. After the bank had paid to the assessee-company on June 20, 1984, the sum of Rs.84,47,111 being 90 % of the consideration agreed upon, the assessee put and handed over possession in part performance of the agreement of sale to the bank on June 20, 1984, itself. By letter dated June 12, 1990, in terms of clause 5 of the agreement of sale dated June 19, 1984, the bank called upon the assessee to complete the transactions and convey the property to the bank by June 18, 1990. By a letter dated June 16, 1993, the assessee confirmed that the assessee-company had put the premises in possession of the bank and that the assessee company would take all necessary steps for transfer of the said premises on or before September 30, 1993. Even after the said date, the assessee was unable to complete the transaction on the pretext that certain dispute had arisen owing to which the assessee did not complete the transaction. The assessee’s accounts for the year 1991 had disclosed the amount of Rs.84,47,112 by it as a current liability under the heading “advance against deferred sale of building”. In the course of assessment proceedings for the assessment year 1994- 95, the Assessing Officer raised a query as to why the capital gains arising on the sale of the premises should not be taxed in the assessment year 1991-92. On this basis, notice dated December 4, 1996, u/s. 143 read with section 147 of the Income-tax Act was served upon the assessee on the ground that the assessee had escaped tax chargeable on its income in the assessment year 1991-92. Challenging the validity of this notice, the respondent preferred a writ petition in the High Court of Bombay. The High Court had allowed the writ petition:

On appeal by the Revenue, the Supreme Court after going through the detailed order passed by the High Court found that the main issue which was involved in this case was not at all addressed by the High Court. A contention was taken by the appellant-Department to the effect that since the assessee’s return was accepted u/s. 143(1) of the Income-tax Act, there was no question of “change of opinion” inasmuch as while accepting the return under the aforesaid provision no opinion was formed and, therefore, on this basis, the notice issued was valid. According to the Supreme Court, this aspect was squarely covered by its judgment in Asst. CIT vs. Rajesh Jhaveri Stock Brokers Private Ltd.[2007] 291 ITR 500 (SC).

The Supreme Court thus held that the judgment of the High Court was erroneous. The Supreme Court allowed the appeal setting aside the impugned judgment of the High Court.

The Supreme Court further found that pursuant to the notice issued u/s. 143 of the Income-tax Act, the Assessing Officer had computed the income by passing the assessment order on the merits and rejecting the contention of the respondent that the aforesaid transaction did not amount to a sale in the assessment year in question. Against the assessment order, the respondent had preferred the appeal before the Commissioner of Income-tax (Appeals) which was also dismissed. Further appeal was preferred before the Income-tax Appellate Tribunal. This appeal, however, had been allowed by the Tribunal, vide order dated January 29, 2004, simply following the impugned judgment of the High Court, whereby the assessment proceedings itself were quashed. Since the Supreme Court had set aside the judgment of the High Court, as a result, the order dated January 29, 2004, passed by the Income-tax Appellate Tribunal also was set aside. The Supreme Court remitted the matter back to the Income-tax Appellate Tribunal to decide the appeal of the respondent on the merits.

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Export – Special Deduction – To avail benefit of section 80HHC, there has to be positive income from export business – section 80HHC

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Jeyar Consultant and Investment Pvt. Ltd. vs. CIT (2015) 373 ITR 87 (SC).

The appellant company was engaged in the business of export of marine products and also financial consultancy and trading in equity shares. Its total business did not consist purely of exports but included business within the country.

The Assessing Officer, while dealing with the assessment of the appellant in respect of the assessment year 1989- 90 took the view that the deduction was not allowable on the ground that there was no relationship between the assessee-company and the processors. The appellant carried the said order in appeal. The appeal against the assessment order was dismissed by the Commissioner of Income-tax (Appeals). The Appellant filed an appeal before the Income-tax Appellate Tribunal. The Appellate Tribunal set aside the order of the Assessing Officer and came to a conclusion that the appellant was entitled to full relief u/s. 80HHC and directed the Assessing Officer to grant relief to the assessee.

On remand, the Assessing Officer passed a fresh order giving effect to the orders of the Income-tax Appellate Tribunal. While giving the effect, the Assessing Officer found that the appellate had not earned any profits from the export of marine products and in fact, from the said export business, it had suffered a loss. Therefore, according to the Assessing Officer, as per section 80AB, the deduction u/s. 80HHC could not exceed the amount of income included in the total income. He found that as the income from export of marine products business was in the negative, i.e. there was a loss, the deduction u/s. 80HHC would be nil, even when the assessee was entitled to deduction under the said provision. With this order, the second round of litigation started. The assessee challenged the order passed by the Assessing Officer before the Commissioner (Appeals) contending that the formula which was applied by the Assessing Officer was different from the formula prescribed u/s. 80HHC of the Act and it was also in direct violation of the Central Board of Direct Taxes Circular dated July 5, 1990. The Commissioner (Appeals), however, dismissed the appeal of the assessee principally on the ground that u/s. 246 of the Income-tax Act, an order of the Assessing Officer giving effect to the order of the Incometax Appellate Tribunal is not an appealable order. The assessee approached the Income-tax Appellate Tribunal questioning the validity of the orders passed by the Assessing Officer and the Commissioner (Appeals). The Income-tax Appellate Tribunal also dismissed the appeal of the assessee, and upheld the order of the Assessing Officer. Challenging the order of the Income-tax Appellate Tribunal, the assessee approached the High Court u/s. 256(2) of the Act seeking reference to it. The High Court directed the Income-tax Appellate Tribunal to frame the reference and place the same before the High Court. On this direction of the High Court, the Income-tax Appellate Tribunal referred the following question to the High Court:

“Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the deduction admissible to the assessee u/s. 80HHC is nil?”

The High Court answered this question against the assessee holding that the assessee admittedly had not earned any profits from the export of the marine products. On the other hand, it had suffered a loss. The deduction permissible u/s. 80HHC is only a deduction of the profits of the assessee from the export of the goods or merchandise. By the very terms of section 80HHC, it was clear that the assessee was not entitled to any benefit thereunder in the absence of any profits.

On further appeal by the appellant, the Supreme Court observed that there were two facets of this case which needed to be looked into. In the first instance, it had to consider as to whether the view of the High Court that the deduction was permissible u/s. 80HHC only when there are profits from the exports of the goods or merchandise was correct or it would be open to the assessee to club the income from export business as well as domestic business and even if there were losses in the export business but after setting off those against the income/ profits from the business in India, still there was net profit of the business, the benefit u/s. 80HHC would be available? The second question that would arise was as to whether the formula applied by the fora below was correct? In other words, while applying the formula, what would comprise “total turnover”?

The Supreme Court after considering its decisions in IPCA Laboratories Ltd. vs. DCIT [(2004) 260 ITR 521 (SC)] and A.M. Moosa vs. CIT [(2007) 294 ITR 1 (SC)] held that it stood settled, on the co-joint reading of the above judgments, that where there are losses in the export of one type of good (for example, self-manufactured goods) and profits from the export of other type of goods (for example trading goods) then both are to be clubbed together to arrive at net profits or losses for the purpose of applying the provisions of section 80HHC of the Act. If the net result was loss from the export business, then the deduction under the aforesaid Act is not permissible. As a fortiori, if there is net profit from the export business, after adjusting the losses from one type of export business from other type of export business, the benefit of the said provision would be granted.

The Supreme Court however noted that in both the aforesaid cases, namely, IPCA and A.M. Moosa, the Court was concerned with two business activities, both of which related to export, one from export of self manufactured goods and other in respect of trading goods, i.e., those which are manufactured by others. In other words, the court was concerned only with the income from exports.

The Supreme Court observed that in the present case, however, the fact situation was somewhat different. Here, in so far as the export business was concerned, there were losses. However, the appellate-assessee relied upon section 80HHC(3)(b), as existed at the relevant time, to contend that the profits of the business as a whole, i.e., including profits earned from the goods or merchandise within India should also be taken into consideration. In this manner, even if there were losses in the export business, but profits of indigenous business outweigh those losses and the net result was that there was profit of the business, then the deduction u/s. 80HHC should be given. The Supreme Court held that having regard to the law laid down in IPCA and A.M. Moosa, it could not agree with the appellant. From the scheme of section 80HHC, it was clear that deduction was to be provided under subsection (1) thereof which was “in respect of profits retained for export business”. Therefore, in the first instance, it had to be satisfied that there were profits from the export business. That was the prerequisite as held in IPCA and A.M. Moosa as well. S/s. (3) came into the picture only for the purpose of computation of deduction. For such an eventuality, while computing the “total turnover”, one may apply the formula stated in clause (b) of sub-section (3) of section 80HHC. However, that would not mean that even if there were losses in the export business but the profits in respect of business carried out within India were more than the export losses the benefit u/s. 80HHC would still be available. In the present case, since there were losses in the export business, the question of providing deduction u/s. 80HHC did not arise and as a consequence, there was no question of computation of any such deduction in the manner provided under s/s. (3). The Supreme Court therefore held that the view taken by the High Court was correct on the facts of this case.

With this, according to the Supreme Court there was no need to answer the second facet of the problem as the questi

Special Leave Petition – Supreme Court refused to entertain the appeal, since the tax effect was nominal and the matter was very old.

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CIT vs. Central Bank of India (2015) 373 ITR 524 (SC);
CIT vs. Dhanalakshmi Bank Ltd.(2015) 373 ITR 526 (SC);
CIT vs. Navodaya(2015) 373 ITR 637 (SC); and
CIT vs. Om Prakash Bagadia (HUF)(2015) 373 ITR 670 (SC)

The
Supreme Court refused to entertain the appeals having regard to the
fact that the tax effect was minimal leaving the question of law open.

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Interest from undisclosed sources – In case there has been a double taxation, relief must be accorded to the assessee

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Ashish Plastic Industries vs. ACIT [2015] 373 ITR 45(SC)

During the course of survey operation on the assessee, a manufacturer of PVC, excess stock of Rs.13,92,000 was found. On this basis, an addition was made in the assessment order. Before the Commissioner of Incometax (Appeals), the assessee sought to explain this difference by pointing out that sales of 32,809 kgs. of finished products made by one of the sister concerns, namely, Ashish Agro Plast P. Ltd. was wrongly shown as to be that of the assessee. On remand it was found that sales of finished product of 32,809 kgs. as shown is sales register of the sister concern tallied with impounded stock register and that the sister concern had received sales proceeds of the same through the bank accounts prior to the date of survey. It was however further found that sale of 33,682 kgs. of finished goods was nothing but unaccounted sales out of which 32,809 kgs. was made to the aforesaid sister concern. Taking this into consideration, the Commissioner of Income-tax (Appeals) upheld the addition. This order was upheld by the Tribunal and the High Court. The Supreme Court issued a notice on a Special Leave Petition being filed by the assessee limiting to the question as to whether in respect of sales of 32,809 kgs. which were shown in the stock register of Ashish Agro Plast P. Ltd., there had been double taxation. The Supreme Court remanded the case back to the Assessing Officer authority for enabling the assessee to demonstrate as to whether the sister concern had already paid tax on the aforesaid income from the aforesaid sales and directing that, if that was shown, to the extent of tax that was paid, benefit should be accorded to the assessee.

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Wealth-Tax – Company – Exemption – Building used by the assessee as factory for the purpose of its business – Not only the building must be used by the assessee but it must also be for the purpose of its business – Section 40(3)(vi) of the Finance Act, 1983

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Kapri International (P) Ltd. vs.CWT [2015] 373 ITR 50(SC)

The assessee company manufactured bed sheets on a property situated at Plot No.39, Site IV, Sahibabad. It’s own subsidiary company, namely, M/s. Dior International Pvt. Ltd., a company under the same management was doing processing work, namely, dyeing, for the assesseecompany in a part of the factory building situated at the aforesaid property. M/s Dior International Pvt. Ltd. installed its own machinery for the said job work of dyeing and that the assessee charged a sum of Rs.20,000 per month as licence fee from M/s. Dior International Pvt. Ltd. The said sum of Rs.20,000 per month charged as licence fee had been claimed by the assessee to be business income. Further, the job work undertaken by M/s. Dior International Pvt. Ltd., though done wholly for the assessee, was nonetheless charged to the assessee’s account and paid for by the assessee. The question that arose on the facts in this case was whether u/s. 40(3)(vi) of the Finance Act, 1983, “the building” was used by the assessee as a factory for the purpose of its business.

The assessing authority for the assessment year 1984- 85 held that the part of the building given to M/s. Dior International Pvt. Ltd., on licence was not being used for the assessee’s own business and, therefore, the assessee was not entitled to exemption in respect of the said part of the Sahibabad building property. On an appeal to the Commissioner of Income Tax (Appeals), agreed with the assessing authority and dismissed the appeal. In a further appeal to the Income-tax Appellate Tribunal, the Tribunal agreed with the view of the authorities below and dismissed the appeal. The High Court of Delhi agreed with the reasoning of the Tribunal.

On further appeal, the Supreme Court held that not only the property must be used by the assessee but it must also be “for the purpose of its business”. According to the Supreme Court on the property, it was clear on the facts that the assessee and M/s. Dior International Pvt. Ltd. were doing their own business and were separately assessed as such. The charging of Rs.20,000 per month as licence fee by the assessee from M/s. Dior International Pvt. Ltd. changed the complexion of the case. Once this was done, the two companies, though under the same management, were treating each other as separate entities. Also, for the job work done by M/s. Dior International Pvt. Ltd., M/s. Dior International Pvt. Ltd. was charging the assessee company and this again established that two companies preserved their individual corporate personalities so far as the present transaction was concerned. The Supreme Court dismissed the appeal, agreeing with the reasoning of the Tribunal, which had found favour with the High Court.

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Glen Williams vs. Assistant Commissioner of Income Tax ITAT “A” Bench : Bangalore Before N. V. Vasudevan (J.M.) and Jason P. Boaz (A. M.) ITA No. 1078/Bang/2014 Assessment Year 2009-10. Decided on 07.08.2015 Counsel for Revenue / Assessee: T. V. Subramanya Bhat / P. Dhivahar

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Section 41(1) and 68 – Old liability of sundry creditors remaining unpaid – Since not arising from current year’s transaction not taxable u/s. 68 – Also nothing on record to show remission or cessation of liability hence, not taxable u/s. 41(1)

Facts:
The assessee who is a dealer in sale of bakery and confectionary products, filed his return of income declaring an income of Rs.29.07 lakh. In the course of assessment proceedings, the AO called for confirmations and names and addresses of sundry creditors totalling to Rs.68.59 lakh. The assessee could furnish the names & addresses of 12 creditors out of total 22 creditors. The letters sent u/s. 133(6) to these creditors returned with the endorsement “no such person”, except in the case of one creditor. The assessee explained that the creditors were old creditors and the addresses given were the address available in the records of the assessee and therefore the assessee was not in a position to confirm whether those creditors were residing in that address. The AO was not satisfied with this reply and made an addition of Rs.65.67 lakh. On appeal by the assessee, the CIT(A) confirmed the order of the AO.

Held:
The Tribunal noted that neither the order of the AO nor that of the CIT(A) was clear as to whether the impugned addition made was u/s. 68 or 41(1) of the Act. According to it, the provisions of section 68 will not apply as the balances shown in the creditors’ account did not arise out of any transaction during the previous year relevant to AY 2009-10. As regards the applicability of section 41(1) is concerned, according to it, in the case of the assessee it has to be examined whether by not paying the creditors for a period of four years, the assessee had obtained some benefit in respect of the trading liability allowed in the earlier years. It further observed that the words “remission” and “cessation” are legal terms and have to be interpreted accordingly. Referring to the observations of the Supreme court referred to by the Delhi High Court in CIT vs. Sri Vardhaman Overseas Ltd.(343 ITR 408) viz. “a unilateral action cannot bring about a cessation or remission of the liability because a remission can be granted only by the creditor and a cessation of the liability can only occur either by reason of operation of law or the debtor unequivocally declaring his intention not to honour his liability when payment is demanded by the creditor, or by a contract between the parties, or by discharge of the debt”, the tribunal noted that there was nothing on record or in the order of the AO or the CIT(A) to show that there was either remission or cessation of liability of the assessee. Accordingly, it held that the provisions of section 41(1) of the Act could not be invoked by the Revenue. Therefore, the appeal filed by the assessee was allowed.

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[2015] 69 SOT 25 (Chennai) DCIT vs. Sucram Pharmaceuticals ITA Nos. 804 & 806 (Mds)of 2014 Assessment Years: 2010-11 and 2011-12. Date of Order: 18th August 2014

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Sections 80AC, 80IC – For AY 2010-11, where a manual return was furnished before due date while electronic return was filed after due date, provision of section 80AC, so as to claim deduction u/s. 80IC was complied with.

Where without a plausible reason, return of income was not filed before due date, assessee would not be entitled to claim deduction u/s. 80IC.

Facts:
The assessee company filed its return of income, for AY 2010-11, manually in a physical form, on 9th September, 2010. Subsequently, on January 25, 2011 an electronic return was furnished. The assessee had claimed deduction u/s. 80IC of the Act. The Assessing Officer (AO) disallowed Rs. 61,93,667 claimed by the assessee as deduction u/s. 80IC of the Act on the ground that the assessee had failed to file the return of income in electronic mode within due date specified u/s. 139(1) of the Act.

For assessment year 2011-12, the assessee filed its return of income electronically on 12th December, 2011. The assessee had claimed deduction u/s. 80IC. The Assessing Officer disallowed the claim of deduction u/s. 80IC on the ground that the assessee had failed to file the return of income within due date specified u/s. 139(1) of the Act.

Aggrieved, the assessee preferred appeals to CIT(A) who allowed the appeals on the ground that the fault was only technical which was beyond the control of the assessee.

Aggrieved, the revenue preferred an appeal to the Tribunal.

HELD
Since Rule 12(3)(ab) requiring the assessee to file return of income electronically was amended with effect from AY 2010-11, the Tribunal accepted the contention of the assessee that the accountants/tax consultants of the assessee, due to oversight, missed the amendment in the Rules. The Tribunal noted that, however, the manual return was filed before due date specified in section 139(1) of the Act. Accordingly, the Tribunal held that the assessee is entitled to claim deduction u/s. 80IC if otherwise it has complied with the conditions laid down in section 80IC of the Act. Since the AO had not examined the genuineness of the claim of the assessee u/s. 80IC, it remitted the file back to the AO to consider the claim of the assessee u/s. 80IC and allow the same, if the assessee has complied with the conditions required to be satisfied.

However, for assessment year 2011-12, the assessee contended that the tax consultants of the assessee were not fully aware of the fact that the return has to be filed before 30th September of every year. The Tribunal noted that no manual return was filed as in assessment year 2010-11 and also no plausible reason was given by the assessee for furnishing return after the elapse of due date. It observed that since assessment year 2010-11 was the first year in which, furnishing of return electronically under digital signature was made mandatory there were chances that the tax consultants may not be aware of the amended provisions. The benefit of ignorance of the tax consultants was given to the assessee in assessment year 2010-11. After committing the mistake once, if the same mistake is committed again in the next assessment year, it is unpardonable. The Tribunal was of the opinion that the assessee does not deserve any clemency. It held that the assessee had not complied with the provisions of section 80AC and is thus not eligible to claim deduction u/s. 80IC.

The appeal filed by the revenue were allowed.

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[2015] 68 SOT 338 (Agra)(SMC) ACIT vs. Krafts Palace ITA No. 2 & 60 of 2015 CO Nos. 3 & 4 (Agra) of 2015 Assessment Year: 2003-04. Date of Order: 31st March 2015

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Section 255(3) – Power of Single Member Bench to hear a case does not depend upon the quantum of addition or disallowances impugned in appeal but on the total income assessed by the AO being upto Rs. Five lakh.

Facts:
The assessee filed its return of income declaring gross total income/business income of Rs. 8,55,068. However, the Assessing Officer (AO) assessed the gross total income of the assessee, before set off of brought forward business loss at Rs.31,41,645. The total income assessed after set off of brought forward business loss was Rs. 4,83,017 and thus well under Rs.5,00,000 threshold limit of assessed income as specified in section 255(3). However, the dispute involved involved in the appeal and the cross objections involved much higher amounts, in excess of that limit.

In view of the above mentioned facts, a question arose as to whether the matter could be heard by Single Member Bench or should it be referred to a Division Bench.

Held:
In terms of section 255(3) the criterion, so far as class of matters which can be heard by SMC Bench, is concerned is only with respect to the assessed income, i.e., total income as computed by the Assessing Officer (AO). The Single Member Bench has the powers to hear any case, which is otherwise in the jurisdiction of this Bench, pertaining to an assessee whose total income as computed by the AO does not exceed Rs.5,00,000 irrespective of the quantum of the additions or disallowances impugned in the appeal.

Once SMC Bench has the powers to hear such an appeal, it is only a corollary to these powers that the Bench has a duty to hear such appeals as well. The reason is simple. All the powers of someone holding a public office are powers held in trust for the good of public at large.

There is, therefore, no question of discretion to use or not to use these powers. It is for the reason that when a public authority has the powers to do something, he has a corresponding duty to exercise these powers when circumstances so warrant or justify.

Having held that a SMC Bench has the power, as indeed the corresponding duty, to decide appeals arising out of an assessment in which income assessed by the AO does not exceed Rs.5,00,000 it may be added that ideally the decision to decide as to which matter should be heard by a Division Bench should be determined on the basis of, if it is to be based on a monetary limit, the amount of tax effect or the subject matter of dispute in appeal rather than the quantum of assessed income.

There seems to be little justification, except relative inertia of the tax administration in disturbing status quo in the policy matters, for the assessed income as a threshold limit to decide whether the appeal should be heard by the SMC Bench or the Division Bench, particularly when, for example because of the brought forward losses, underneath that modest assessed income at the surface level, there may be bigger ice bergs lurking in the dark representing high value tax disputes, adjudication on which may benefit from the collective wisdom and checks and balances inherent in a Division Bench.

However, as the law stands its assessed income which matters and not the tax effect or the quantum of disallowances or additions, impugned in the appeal. All that is relevant to decide the jurisdiction of the SMC Bench is thus the assessed income and nothing other than that.

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[2015] 153 ITD 153 (Chennai) DDIT (Exemptions) vs. Sri Vekkaliamman Educational & Charitable Trust A.Y. 2009 – 10 Date of Order – 27th September 2013.

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Section 13 read with section 11 – Provisions of section 13(1)(c) and
13(2)(c), are not violated when contract for construction is awarded by
the assessee trust on basis of open bid to a firm belonging to managing
trustee as the said firm quoted the lowest rates. Further, the sum
advanced by the assessee to the said firm for ongoing construction work
in normal course of business activity are business advances and the said
advances would not come within the ambit of advances u/s. 13(1)(d).

FACTS
The assessee was registered as a charitable trust u/s. 12AA. It declared nil income and claimed deduction u/s. 11.

The
assessee had given, a contract of building construction, to the firm of
the managing trustee for which the assessee had advanced certain sum to
the said firm. The AO held that the aforesaid advances come within the
ambit of section 13(1)(d) and thus disentitles the assessee to claim
exemption u/s. 11 of the Act.

Also it was admitted fact that the
said firm had earned a benefit of Rs. 17.30 lakh from the said
contract. The AO therefore held that the Managing Trustee enjoyed
benefits out of the income derived by the trust which is against the
provisions of section 13(1)(c) and thereby disallowed the exemption
claimed by the assessee u/s. 11 of the Act.

The CIT(A) after
considering the submissions of both the sides, held that there is no
violation of provisions of section 13(1)(c) or (d) and allowed exemption
u/s. 11.

On appeal by the Revenue before the Tribunal.

HELD THAT
It is an admitted fact that the firm of the managing trustee had carried out the construction of building of the trust.

A
perusal of section 13(1)(c) would show that the Act puts restriction on
the use of income or any property of the trust directly or indirectly
for the benefit of any person referred to in sub-section(3) of section
13.

A reading of Clause (cc) of sub-section (3) of section 13
would show that it includes any trustee of the trust or manager. The
Assessing Officer declined to grant benefit of section 11, as in the
present case construction of building has been carried out by the firm
of a Managing Trustee and thus, derived direct benefit from the
assessee-trust.

A further perusal of clause(c) of sub-section(2)
of section 13 would show that without prejudice to the generality of
the provisions of clause-(c) and clause-(d) of subsection( 1) of section
13, the income or property of the trust or any part of such income or
property shall be deemed to have been used or applied for the benefit of
the person referred to in s/s. (3), if any amount is paid by way of
salary, allowance or otherwise during the previous year to any person
referred to in s/s. (3) out of the resources of the trust or institution
for services rendered and the amount so paid is in excess of what may
be reasonably paid for such services. In the present case, the Assessing
Officer has out rightly held that the assessee is not entitled to the
benefit of section 11 without ascertaining the reasonableness of the
amount paid for the services rendered.

The construction contract
has been awarded to the firm on the basis of open bid. Since the firm
quoted lowest rates, the contract was awarded to the firm. The
Commissioner (A) has categorically given a finding that in cases of
civil construction contracts, especially were no proper books are
maintained the Act recognises normal profit margins at the rate of 8 %.
The firm has earned a profit of 5.8 % which is very reasonable.

Since
the contract was awarded on competitive basis and the profit earned is
reasonable, hence it is held that the provisions of section 13(2)(c) are
not violated.

The CIT(A) has given a well reasoned finding
that certain sum was advanced by the assessee to the firm of Managing
Trustee for the on-going construction work in the normal course of
business activity and thus it was business advance. The aforesaid advances thus do not come within the ambit of advances u/s. 13(1)(d) of the Act.
The appeal of the Revenue is dismissed.

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[2015] 152 ITD 850 (Cochin) Muthoot Finance Ltd. vs. Additional CIT A.Y. 2009-10 Date of Order – 25th July 2014.

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Section 40(a)(i) – Where assessee does not claim the payment made to
nonresident as expenditure but capitalises the same and claims only
depreciation thereon, no disallowance can be made u/s. 40(a)(i).

FACTS
The
assessee, a non-banking financial company, was engaged in providing
gold loans and other allied investment activities. It made payment to
non-resident for providing engineering site services but did not deduct
tax at the time of payment.

The AO disallowed the entire payment made by the assessee u/s. 40(a)(ia) on account of nondeduction of tax at source

The
assessee submitted that it had not claimed said payment made to
non-resident as expenditure but capitalised same and claimed only
depreciation. He submitted that the disallowance could be considered
only in case the assessee claimed deduction while computing the income
chargeable to tax and it had not claimed any deduction.

On appeal, the CIT-(A) upheld the order of the AO.

On
second appeal before the Tribunal, a query was also raised by the bench
whether the disallowance was to be made u/s. 40(a)(ia) or 40(a)(i). In
response to which the representative of the assessee clarified that the
disallowance was made by the lower authority u/s. 40(a) (ia) and section
40(a)(i) was not taken into consideration.

Regarding the merits of the case

HELD THAT
The
payment made to non-resident for technical services provided to the
assessee is admittedly taxable in India, therefore, the assessee is
bound to deduct tax. The assessee can claim the same as expenditure only
if the assessee deducts the tax at the time of payment.

The
language of section 40 clearly says that the amount paid to
non-resident on which tax was not deducted shall not be deducted while
computing the income chargeable to tax. Therefore, if the assessee
has not claimed the amount on which no tax has been deducted, as
expenditure while computing the chargeable income, there is no necessity
for further disallowance. In other words, if the assessee has not
claimed the payment to non-resident as expenditure and not deducted
while computing the income chargeable to tax, there is no question of
further disallowance by the authorities.

Since no material is
available on record to verify whether the amount paid to the
non-resident was deducted or not, while computing the income chargeable
to tax, the issue is remitted back to the AO to decide the same in
accordance with law after giving reasonable opportunity to the assessee.

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TDS – Income deemed to accrue or arise in India – Sections 9(1)(vii)(b) and 195 – A. Ys. 1998- 99 to 2000-01 – Wet-leasing aircraft to foreign company – Operational activities were abroad – Expenses towards maintenance and repairs were for purpose of earning abroad – Payments falling within the purview of exclusionary clause of section 9(1)(vii)(b) – Not chargeable to tax and not liable for TDS

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DIT vs. Lufthansa Cargo India; 375 ITR 85(Del):

The assessee acquired four old aircrafts from a nonresident company outside India and wet-leased them to a foreign company. “Wet-leasing” means the leasing of an aircraft along with the crew in flying condition to a charterer for a specified period. As the assessee was obliged to keep the aircraft in flying condition, it had to maintain them in accordance with the DGCA guidelines to possess a valid airworthiness certificate as a pre-condition for its business. The assessee entered into an agreement with the overhaul service provider, T. T carried out maintenance repairs without providing technical assistance by way of advisory or managerial services.

The Assessing Officer noticed that no tax was deducted at source on payments to T and no application u/s. 195(2) was filed. He held that the payments were in the nature of “fees for technical services” defined in Explanation 2 to section 9(1)(vii)(b) and were, therefore, chargeable to tax and tax should have been deducted at source u/s. 195(1). He passed order u/s. 201 deeming the assesee to be assessee in default for the F. Ys. 1997-98 to 1999- 2000 and levied tax as well as interest u/s. 201(1A). The Tribunal held that the payments made to T and other foreign companies for maintenance repairs were not in the nature of fees for technical services as defined in Explanation 2 to section 9(1)(vii)(b) and that in any event these payments were not taxable for the reason that they had been made for earning income from sources outside India and, therefore, fall within the exclusionary clause of section 9(1)(vii)(b).

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

“i) The level of technical expertise and ability required in such cases is not only exacting but specific, in that, the aircraft supplied by the manufacturer has to be serviced and its components maintained, serviced and overhauled by the designated centers. International and national regulatory authorities mandate that certification of such component safety is a condition precedent for their airworthiness. The exclusive nature of these services could not but lead to the inference that they are technical services within the meaning of section 9(1)(vii).

ii) However, the overwhelming or predominant nature of the assessee’s activity was to wet-lease the aircraft to a foreign company. The operations were abroad and the expenses towards maintenance and repairs payments were for the purpose of earning abroad. Therefore, the payments made by the assessee fell within the purview of the exclusionary clause of section 9(1)(vii)(b) and were not chargeable to tax at source.

iii) The question of law is answered in favour of the assessee and against the revenue.”

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TDS – Chit Fund – Interest – Section 194A – A. Ys. 2004-05 to 2006-07 – Amount paid by Chit Fund to its subscribers – Not interest – Tax not deductible at source on such interest

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CIT vs. Avenue Super Chits P. Ltd.; 375 ITR 76 (Karn)

The assessee ran a chit fund. The assessee had several chit groups which were formed by having 25 to 40 customers to make one chit group. The customers subscribed an equal amount, which depended upon the value of chits. There were two types of chits. One was the lottery system and the other was the auction system. In the lottery system the lucky winner got the chit amount and in the auction system the highest bidder got the chit amount. Under the scheme the unsuccessful members in the auction chit would earn dividend and the successful bidders would be entitled to retain the face value till the stipulated period under the scheme. The Revenue took the view that when the successful bidder in an auction took the face value or the prize money earlier to the period to which he was entitled, he was liable to pay an amount to others who contributed to the prize money which was termed as interest and that this interest amount, which had been paid by the assessee to its members was liable for deduction of tax u/s. 2(28A) and section 194A of the Income-tax Act, 1961. The Commissioner (Appeals) held that the amount paid by way of dividend under the chit scheme by the assessee to the members of the chit could not be construed as interest under the Act and, therefore, there was no liability on the part of the assessee to deduct tax at source. This was upheld by the Tribunal.

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

“In the first place the amount paid by way of dividend could not be treated as interest. Further, section 194A of the Act had no application to such dividends and, therefore, there was no obligation on the part of the assessee to make any deduction u/s. 194A of the Act before such dividend was paid to its subscribers of the chit.”

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Penalty – Concealment – Section 271(1)(c): A. Y. 2003-04 – The rigors of penalty provisions cannot be diluted only because a small number of cases are picked up for scrutiny – No penalty can be levied unless assessee’s conduct is “dishonest, malafide and amounting to concealment of facts” – The AO must render the “conclusive finding” that there was “active concealment” or “deliberate furnishing of inaccurate particulars”

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CIT vs. M/s. Dalmia Dyechem Industries Ltd. (Bom); I. T. A. No. 1396 of 2013 dated 06/07/2015: www. itatonline.org.

For the A. Y. 2003-04, the Assessing Officer disallowed the proportionate interest out ofthe interest paid for the interest free advances given to the sister concern, holding that the assessee had borrowed funds of which interest liability had been incurred. The Assessing Officer also levied penalty holding that the assessee concealed it’s income by furnishing inaccurate particulars. The Commissioner (Appeals) allowed the appeal and cancelled the penalty. The Commissioner came to the conclusion that merely because the claim made by an Assessee was disallowed, penalty cannot be levied, unless it is demonstrated that the Assessee had any malafide intention. The Tribunal accepted the reasoning of the Commissioner (Appeals) that the penalty cannot be levied merely because the claim of the Assessee is found to be incorrect. The Commissioner and the Tribunal relied upon the decision of the Apex Court in the case of CIT vs. Reliance Petroproducts Pvt. Ltd. [2010] 322 ITR 158 (SC):

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

“i) Section 271(1)(c) of the Act lays down that the penalty can be imposed if the authority is satisfied that any person has concealed particulars of his income or furnished inaccurate particulars of such income. The Apex Court in CIT vs. Reliance Petroproducts Pvt. Ltd. [2010] 322 ITR 158 (SC) applied the test of strict interpretation. It held that the plain language of the provision shows that, in order to be covered by this provision there has to be concealment and that the assessee must have furnished inaccurate particulars. The Apex Court held that by no stretch of imagination making an incorrect claim in law, would amount to furnishing inaccurate particulars.

ii) Thus, conditions u/s. 271(1)(c) must exist before the penalty can be imposed. Mr. Chhotaray tried to widen the scope of the appeal by submitting that the decision of the Apex Court should be interpreted in such a manner that there is no scope of misuse especially since a miniscule number of cases are picked up for scrutiny. Because small number of cases are picked up for scrutiny does not mean that rigors of the provision are diluted. Whether a particular person has concealed income or has deliberately furnished inaccurate particulars, would depend on the facts of each case. In the present case, we are concerned only with the finding that there has been no concealment and furnishing of incorrect particulars by the present assessee.

iii) Though the assessee had given interest free advances to it’s sister concerns and that it was disallowed by the Assessing Officer, the assessee had challenged the same by instituting the proceedings which were taken up to the Tribunal. The Tribunal had set aside the order of the Assessing Officer and restored the same back to the Assessing Officer. Therefore, the interpretation placed by Assessee on the provisions of law, while taking the actions in question, cannot be considered to be dishonest, malafide and amounting to concealment of facts. Even the Assessing Officer in the order imposing penalty has noted that commercial expediency was not proved beyond doubt. The Assessing Officer while imposing penalty has not rendered a conclusive finding that there was an active concealment or deliberate furnishing of inaccurate particulars. These parameters had to be fulfilled before imposing penalty on the Assessee.”

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DIPP – Press Note No. 8 (2015 Series) dated July 30, 2015 Introduction of Composite Caps for Simplification of Foreign Direct Investment (FDI) policy to attract foreign investments

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This Press Note has made the following amendments
to the Consolidated FDI Policy issued on May 12, 2015, with immediate
effect: –

2. Para 3.6.2 (vi) of the Consolidated FDI Policy Circular of 2015, is amended to read as under:

3.6.2
(vi) It is also clarified that Foreign investment shall include all
types of foreign investments, direct and indirect, regardless of whether
the said investments have been made under Schedule 1 (FDI), 2 (FII), 2A
(FPI), 3 (NRI), 6 (FVCI), 8 (QFI), 9 (LLPs) and 10 (DRs) of FEMA
(Transfer or Issue of Security by Persons Resident Outside India)
Regulations. FCCBs and DRs having underlying of instruments which can be
issued under Schedule 5, being in the nature of debt, shall not be
treated as foreign investment. However, any equity holding by a person
resident outside India resulting from conversion of any debt instrument
under any arrangement shall be reckoned as foreign investment.

3. Para 4.1.2 of the Consolidated FDI Policy Circular of 2015, is amended to read as under:

4.1.2
For the purpose of computation of indirect foreign investment, foreign
investment in an Indian company shall include all types of foreign
investments regardless of whether the said investments have been made
under Schedule 1 (FDI), 2 (FII holding as on March 31), 2A (FPI holding
as on March 31), 3 (NRI), 6 (FVCI), 8 (QFI holding as on March 31), 9
(LLPs) and 10 (DRs) of FEMA (Transfer or Issue of Security by Persons
Resident Outside India) Regulations. FCCBs and DRs having underlying of
instruments which can be issued under Schedule 5, being in the nature of
debt, shall not be treated as foreign investment. However, any equity
holding by a person resident outside India resulting from conversion of
any debt instrument under any arrangement shall be reckoned as foreign
investment.

4. Para 3.1.4 (i) of the Consolidated FDI Policy Circular of 2015, is amended to read as under:

3.1.4
(i) An FII/FPI/QFI (Schedule 2, 2A and 8 of FEMA (Transfer or Issue of
Security by Persons Resident Outside India) Regulations, as the case may
be) may invest in the capital of an Indian company under the Portfolio
Investment Scheme which limits the individual holding of an FII/FPI/QFI
below 10% of the capital of the company and the aggregate limit for
HI/FPI/OR investment to 24% of the capital of the company. This
aggregate limit of 24% can be increased to the sectoral cap/statutory
ceiling, as applicable, by the Indian company concerned through a
resolution by its Board of Directors followed by a special resolution to
that effect by its General Body and subject to prior intimation to RBI.
The aggregate FII/FPI/ QFI investment, individually or in conjunction
with other kinds of foreign investment, will not exceed
sectoral/statutory cap.

5. Para 6.2 of the Consolidated FDI Policy Circular of 2015 is amended to read as under:

a)
In the sectors/activities as per Annexure, foreign investment up to the
limit indicated against each sector/activity is allowed, subject to the
conditions of the extant policy on specified sectors and applicable
laws/regulations; security and other conditionalities. In
sectors/activities not listed therein, foreign investment is permitted
up to 100% on the automatic route, subject to applicable
laws/regulations; security and other conditionalities. Wherever there is
a requirement of minimum capitalization, it shall include share premium
received along with the face value of the share, only when it is
received by the company upon issue of the shares to the non-resident
investor. Amount paid by the transferee during post-issue transfer of
shares beyond the issue price of the share, cannot be taken into account
while calculating minimum capitalization requirement.

b)
Sectoral cap i.e. the maximum amount which can be invested by foreign
investors in an entity, unless provided otherwise, is composite and
includes all types of foreign investments, direct and indirect,
regardless of whether the said investments have been made under Schedule
1 (FDI), 2 (FII), 2A (FPI), 3 (NRI), 6 (FVCI), 8 (QFI), 9 (LLPs) and 10
(DRs) of FEMA (Transfer or Issue of Security by Persons Resident
Outside India) Regulations. FCCBs and DRs having underlying of
instruments which can be issued under Schedule 5, being in the nature of
debt, shall not be treated as foreign investment. However, any equity
holding by a person resident outside India resulting from conversion of
any debt instrument under any arrangement shall be reckoned as foreign
investment under the composite cap. Sectoral cap is as per Annexure
referred above.

c) Foreign investment in sectors under
Government approval route resulting in transfer of ownership and/or
control of Indian entities from resident Indian citizens to non-resident
entities will be subject to Government approval. Foreign investment in
sectors under automatic route but with conditionalities, resulting in
transfer of ownership and/or control of Indian entities from resident
Indian citizens to non-resident entities, will be subject to compliance
of such conditionalities.

d) The sectors which are already under 100% automatic route and are without conditionalities would not be affected.

e)
Notwithstanding anything contained in paragraphs a) and c) above,
portfolio investment, upto aggregate foreign investment level of 49% or
sectoral/statutory cap, whichever is lower, will not be subject to
either Government approval or compliance of sectoral conditions, as the
case may be, if such investment does not result in transfer of ownership
and/or control of Indian entities from resident Indian citizens to
nonresident entities. Other foreign investments will be subject to
conditions of Government approval and compliance of sectoral conditions
as laid down in the FDI policy.

f) Total foreign investment, direct and indirect, in an entity will not exceed the sectoral/statutory cap.

g)
Any existing foreign investment already made in accordance with the
policy in existence would not require any modification to conform to
these amendments.

h) The onus of compliance of above provisions will be on the investee company.

6.
It is clarified that there are no sub-limits of portfolio investment
and other kinds of foreign investments in commodity exchanges, credit
information companies, infrastructure companies in the securities market
and power exchanges.

7 In Defence sector, portfolio investment
by FPIs/FIls/ NRIs/QFIs and investments by FVCIs together will not
exceed 24% of the total equity of the investee/joint venture company.
Portfolio investments will be under automatic route. 8. In Banking-
Private sector, where sectoral cap is 74%, FII/ FPI/ QFI investment
limits will continue to be within 49% of the total paid up capital of
the company.

9. There is no change in the entry route i.e.
Government approval requirement to bring foreign investment in a
particular sector/activity. Further, subject to the amendments mentioned
in this Press Note, there is no change in other conditions mentioned in
the Consolidated FDI Policy Circular of 2015 and subsequent Press
Notes.

10. Relevant provisions of the FDI policy and subsequent
Press Notes will be read in harmony with the above amendments in
Consolidated FDI Policy Circular of 2015.

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Scientific research expenditure – Weighted deduction – Section 35(2AB) – A. Y. 2003-04 – Denial of deduction by AO on ground that machinery is required to be installed and commissioned before expiry of relevant previous year – Not proper

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CIT vs. Biocon Ltd.; 375 ITR 306 (Karn):

The assessee was engaged in the business of manufacture of enzymes and pharmaceutical ingredients. The Assessing Officer rejected the assessee’s claim for weighted deduction u/s. 35(2AB) of the Income-tax Act, 1961 on three machineries acquired during the year on the ground that the machineries had not been installed and commissioned during the year. The Tribunal allowed the assessee’s claim.

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

“i) The provision nowhere suggests or implies that the machinery is required to be installed and commissioned before expiry of the relevant previous year. The provision postulates approval of a research and development facility, which implies that a development facility shall be in existence, which in turn, presupposes that the assessee must have incurred expenditure in this behalf.

ii) The Tribunal had rightly concluded that if the interpretation of the Assessing Officer were accepted, it would create absurdity in the provision inasmuch as words not provided in the statute were to be read into it, which is against the settled proposition of law with regard to the plain and simple meaning of the provision. The plain and homogeneous reading of the provisions would suggest that the entire expenditure incurred in respect of research and development has to be considered for weighted deduction u/s. 35(2AB) of the Act.”

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Processing of Registration applications submitted along with scanned documents

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Trade Circular 13T of 2015 dated 14.8.2015

The new office procedure for the grant of new registrations under the MVAT Act, 2002, The CST Act, 1956 and the Professional Tax Act, 1975 has been explained in the Circular issued by the Commissioner of Sales Tax.

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The Computerized Desk Audit (CDA) for the period 2012-13

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Trade Circular 12T of 2015 dated 14.8.2015

The department has generated Computerized Desk Audit (CDA) report for the period 2012-13 and made the same available on website www.mahavat.gov.in from 20.8.2015. Compliance to the CDA can be made on or before 18.9.2015. List of dealers in whose cases discrepancies have been found mentioned in CDA Dealer list 2012-13 is available on the website. Detailed procedure to comply electronically with CDA system has been explained in the Circular issued by the Commissioner of Sales Tax.

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Recent Developments in International Taxation

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Topic : Recent Developments in International Taxation

Speaker : M r. Pinakin Desai, Chartered Accountant

Date : 15th July, 2015

Venue : Jai Hind College Auditorium, Churchgate

Mr. Pinakin Desai commenced his talk by referring to the India-Mauritius DTAA and the fact that Mauritius has been quite popular among the Foreign Investors investing in India on account of the favourable provisions in the treaty. He mentioned that negotiations on India-Mauritius DTAA are under process and the renegotiated Treaty should be out in a couple of weeks’ time. There has been a lot of speculation around the changes which would be incorporated in the revised DTAA and looking at the same, he pointed out to a few provisions which could be a part of the new treaty. One such provision could be the insertion of LOB clause in the treaty. Other amendments could be on the lines of the India-Singapore DTAA which provides for an expenditure test for demonstrating commercial substance, a provision for insertion of a grandfather clause in regard to investments made prior to 2017. He then invited the attention to a news article which mentioned that under the revised DTAA , short term capital gains would be subject to capital gains tax under Income-tax Act, 1961.

The Speaker then commented upon the cumbersome reporting requirements contained in the amended section 195(6) of the ITA . Section 195(1) contains tax withholding obligations in case of payments made to a non-resident, provided the sum is chargeable to tax under ITA , whereas section 195(6) states that, irrespective of the sum being chargeable to tax, the person responsible for paying to a non-resident should furnish information about the same. The Speaker stressed upon the intention of the Income Tax Department of the amended section 195(6) which was to secure information about every remittance made outside India. The Speaker mentioned that though section 195(6) talks about all payments, whether chargeable to tax or not, provisions contained in Rule 37BB, the relevant rule for section 195(6), continues to talk about furnishing of information only relating to payments which are chargeable to tax under ITA . This has led to an anomalous situation and different views are taken by remitters. He mentioned that till new Rules are notified in this regard, problems would continue. However in his view, Form 15CB need to be obtained only in cases where income was chargeable to tax as mentioned in Rule 37BB and not for all remittances.

Mr. Pinakin Desai then dwelt on the provisions of the new Black Money Act and its far reaching implications. He cited a simple illustration wherein Mr. Kumar, an NRI, who was away for 5 years, comes back to India, and is now a Resident and Ordinarily Resident. While a non-resident, he claims to have acquired significant assets outside India and from FY 2015-16, Kumar will offer income from overseas assets to tax in India. Provisions of the Black Money Act empower an Assessing Officer to bring an undisclosed foreign asset to tax on the basis of FMV valuation in the year in which he receives information as to the ownership of the asset. Now in such a scenario, Mr. Kumar can have serious difficulties, if he has no records or evidence to correlate the source of investment with the items of investment.

The speaker then raised concerns about the impact of the Black Money Act on discretionary trusts set up outside India. In case of non-resident discretionary trusts where either the settlor or the trustees or the beneficiary is a Resident & Ordinarily Resident, provisions of BMA could apply. In case the Settlor is Resident in India, a question could arise as to whether he is under an obligation to make disclosures in his tax returns in relation to assets settled upon the discretionary trust set up outside India.The answer to this is possibly a ‘yes’. However, the Speaker further raised a question that, would the disclosure be required merely in the first year in which the Settlor is settling the property upon the trust or would the disclosure be required on a recurring basis in subsequent years? The Speaker discussed another scenario wherein the trustee of the discretionary trust is a ROR whereas the Settlor and the beneficiaries are non-residents. In this case too, the Speaker was of the view that the Trustee would be under an obligation to make disclosures in the tax returns since he is the holder of the assets on behalf of the beneficiaries. The speaker then referred to a person being ROR in India and is a beneficiary of the discretionary trust set up outside India. Highlighting the definition of the term ‘beneficiary’ as a person deriving benefit during the year, the Speaker commented that the beneficiary may not be required to make disclosure in this regard if he has not derived any benefit from the trust during the year.

The Speaker then drew attention to the disclosure requirements in the tax returns in case of an assessee holding a financial interest in an entity outside India. The Speaker raised a concern as to whether a beneficiary of a discretionary trust set up outside India, could be said to have a financial interest in that trust. In this regard, the Speaker was of the view that a beneficiary of a trust is merely a chance beneficiary depending upon the discretion of the trustees, and his right to the benefits of the trusts are not enforceable, and thus he may not be said to have a financial interest in the trust.

Thereafter, the Speaker commented upon applicability of BMA Act to expatriates in India. Referring to the FA Qs released by CBDT on Clarifications on Tax Compliance for Undisclosed Foreign Income and Assets, he mentioned that the expatriates who have come to India on a Student Visa, Business Visa or an Employment Visa, have been given a concession from reporting requirements in regard to assets situated outside India which do not yield any income, for example, a residential house which is not let out. However, no concession is granted to assets located outside India which yield income which is taxable under the ITA , for example, bank account or any other security yielding interest income. The Speaker raised a concern that if the spouse or the children accompany the expatriate to India, who do not come on a Student Visa or a Business Visa or an Employment Visa, theoretically no concession is available to them.

Thereafter, the Speaker discussed a few case studies relating to indirect transfers of capital assets read in conjunction with Circular 04/2015 issued by CBDT. By referring to the case studies, the Speaker conveyed that declaration of dividend by a foreign company outside India does not have the effect of transfer of any underlying assets located in India. The Circular 04/2015 has clarified that the dividends declared and paid by a foreign company outside India in respect of shares which derive their value substantially from assets situated in India would not be deemed to be income accruing or arising in India by virtue of section 9(1)(i) of ITA . The Speaker also cited an illustration highlighting the intricacies on determining the ‘Specified Date’ on which the value of a share deriving its value from assets located in India is computed.

The Speaker threw light upon deemed international transactions u/s. 92B(2). Referring to an illustration, the Speaker explained the provisions contained in section 92B(2) whereby a transaction between an enterprise with a person other than an associated enterprise would be deemed to be an international transaction if the terms and conditions of such a transaction are settled by the enterprise with its Associated Enterprise, where the enterprise or the associated enterprise or both of them are non-residents, irrespective of whether such other person is a non-resident or not.

The Speaker then shared his views on Corporate Residency in view of the amendment made by the Finance Act 2015. He mentioned that since many years, the test to determine the residential status of a Company in India was quite liberal and hence if some management decisions were taken outside India or if some directors were situated outside India, the Company was classified as a Non Resident. This had facilitated formation of shell companies which were effectively managed from India, however classified as Non Resident. To put an end to such practices, the Income Tax department has introduced the concept of ‘Place of Effective Management’ (POEM) as the test to determine the residential status of a Company. He mentioned that POEM is situated at the place where key commercial and management decisions of the Company are taken. He further mentioned that for a decision to be a key commercial or management, one would really have to look into the substance of the decision, the regularity at which the decisions are taken and the persons who are effectively making the decisions.

The Speaker then threw light on the various consequences which a Company might face if its POEM is in India. This would include taxation of its global income at the higher tax rate of 40% plus surcharge and education cess, obligation to withhold taxes u/s. 195 in respect of chargeable amounts, applicability of transfer pricing provisions, non-applicability of beneficial provisions u/ss. 44BB, 44BBB, 44BBA, since they apply only in case of non-residents, applicability of provisions of Black Money Act, etc.

The Speaker commented that in case of a US Company becoming a resident of India on account of POEM being situated in India, then the benefits under India USA DTAA will be lost, since the tie breaker test in such a situation cannot be invoked under the treaty and further there could be questions as to whether foreign tax credit would be available in respect of the transactions of the Company.

He mentioned that exchange of information is likely to be very active and relevant in the days to come and the BEPS provisions would also be having an impact. Exchange of information, multi-lateral treaty, and awareness on the part of all the foreign governments with regard to curbing of tax avoidance is going to be the order of the day.

The meeting ended with a vote of thanks to the speaker.

REPRESENTATI ON TO CBDT ON E-FILI NG OF WEALTH -TAX RETU RNS FOR A.Y. 2015-16

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20th August 2015

To

The Chairperson,
Central Board of Direct Taxes,
Government of India,
North Block, Vijay Chowk,
New Delhi 110 001.

Respected Madam,

Re: REPRESENTATI ON TO CBDT ON E-FILI NG OF WEALTH -TAX RETU RNS FOR A.Y. 2015-16

Your kind attention is invited to Notification 32/2014 dated 23rd June, 2014 (F.No.143/1/2014-TPL) wherein it was notified that wealth-tax returns are to be filed electronically for all categories of wealth-tax assessees. In the said Notification, certain amendments had been made to the Wealth-tax Rules, 1957. In particular, Rule 3 was substituted by a new Rule. The amended sub Rules (2) and (3) of the said Rule 3 are reproduced below for ready reference:

(2) Subject to the provisions of sub-rule (3), for the assessment year 2014-15 and any other subsequent assessment year, the return of net wealth referred to in sub-rule (1) shall be furnished electronically under digital signature.

(3) In case of individual or Hindu undivided family to whom the provisions of section 44AB of the Income-tax Act, 1961(43 of 1961) are not applicable, the return of net wealth referred to in sub-rule (1) may be furnished for assessment year 2014-15 in a paper form.

It may be noted from the above that in case of individuals and HUFs where tax audit was not applicable, the wealthtax returns could be filed electronically without the Digital Signature (DSC) for A.Y. 2014-15. However, now, for filing the wealth-tax returns for A.Y. 2015-16, even for such wealth tax assessees, it would be necessary to obtain and use the DSC for filing the wealth-tax return.

Assessment Year 2015-16 is the last year for which the Wealth-tax Act, 1957 is applicable. Thereafter, the question of filing wealth–tax returns will not arise.

It will therefore be appreciated that several tax payers will be put to great hardship as they will need to obtain a DSC only for the purpose of uploading the wealth-tax return for one last year i.e. A.Y. 2015-16.

On behalf of the taxpaying community, it is therefore humbly requested that the Rule 3(3) of the Wealth-tax Rules, 1957 be amended suitably to provide that the wealth-tax returns of individuals and HUFs who are not subject to tax audits can be filed electronically without using the DSC.

An early action in the matter would be greatly appreciated as the last date for filing the returns i.e. 31st August is fast approaching.

Thanking you.
Yours truly,
For Bombay Chartered Accountants’ Society

Raman H. Jokhakar
President

Ameet N.Patel
Co-Chairman, Taxation Committee

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Something More (Kuchh Aur)

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Pending Court Cases:
1. 376,604 (upto June 2015) are Pending Court Cases under different Laws/Acts, in Hon’ble Bombay High Court including its branches at Nagpur, Aurangabad, Panji-Goa

Hon’ble High Court has written many letters to the Govt of Maharashtra (GOM) for creation of additional 867 courts of various cadres of Judges in the State of Maharashtra. Hon’ble High Court has also written to GoM about funds for recurring and non-recurring expenditure for the said 867 courts.

2. 29.51 lakh (upto June 2015) are Pending Court Cases in District Judiciary (District & Subordinate Courts).

2,072 is the Sanctioned Strength and 1,784 is actual working Strength of Judicial Officers as on 1.1.2015 in the State of Maharashtra.

Sanctioned & Actual Strength of Hon’ble Judges in Hon’ble Bombay High Court. 94 is the Sanctioned Strength and 65 is the actual working Strength of the Hon’ble Judges in the Hon’ble Bombay High Court.

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How to tackle radical Islam: India can learn from the frankness of political discourse in the West

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Prime Minister David Cameron delivered a remarkable speech in Birmingham outlining a stepped up government campaign against Islamist extremism. India could learn a thing or two from him on how to address a sensitive subject without either flinching from the truth or carelessly tarring an entire community.

To be sure, Britain’s problems with Islamism (the drive to order all aspects of the state and society by sharia law) do not exactly mirror India’s. Nor are the two countries’ experiences with terrorism, Islamism’s most violent and visible manifestation, identical. Nonetheless, in the age of Lashkar-e-Taiba and the Islamic State, all pluralistic democracies face a challenge from an ideology that Cameron characterises as “hostile to basic liberal values such as democracy, freedom and sexual equality”.

This raises important questions. Which principles of confronting Islamism are equally applicable to London and Lucknow, Paris and Patna, Boston and Bangalore? How might you apply Cameron’s observations – a broad distillation of sensible centre-right discourse in the West – to an Indian context?

To begin with, the distinction between the ideology of Islamism and the faith of Islam cannot be made often enough. Bluntly put, Islamism is an exclusivist dogma that threatens non-Muslims, heterodox Muslims and secular Muslims alike. Islam is one of the world’s major faiths, practised by 1.6 billion people, most of whom are moderate. In India, the Left refuses to acknowledge the Islamist threat. The Right often fails to distinguish between Islamists and ordinary Muslims less interested in resurrecting a Caliphate than in simply getting on with their daily lives.

It follows that legitimate concerns about Islamism should not become an excuse to condone the excesses of the Hindu far Right. A politician or public intellectual ought to be able to condemn both West Bengal’s craven expulsion of dissident writer Taslima Nasreen and the poisonous ravings of Pravin Togadia of the Vishwa Hindu Parishad. In Birmingham, Cameron likened Islamist extremists to his country’s “despicable far right”. In India, unfortunately, the line between the responsible Right and the despicable Right is often blurry.

This is not to suggest a mindless equivalence. Every faith may have its share of extremists, but you have to be either blind or a member of the CPM politburo to ignore that the Islamic world is especially in turmoil today. Neither Cameron nor Barack Obama nor François Hollande need fret about their Hindu or Buddhist or Jewish compatriots boarding a plane to blow themselves up on a distant battlefield in search of paradise.

This brings us to another simple principle: Ideas matter. In both the West and India, apologists for Islamist extremism attempt to explain it away by blaming colonialism or Western foreign policy or poverty. But they can’t explain why formerly colonised Burmese and Cambodians aren’t strapping on suicide vests. Or why Islamist terrorists first tried to destroy New York’s World Trade Center in 1993 – long before George W Bush invaded Iraq. Or why so many prominent terrorists, from multimillionaire Osama bin Laden to Germaneducated 9/11 ringleader Mohammed Atta, weren’t exactly underprivileged.

Beyond the obvious counterterrorism component, what might a deeper Indian response to Islamism look like? For starters, people need to start paying more attention to ideology than to individual acts of terror. It’s no coincidence that Jamaate- Islami – along with Egypt’s Muslim Brotherhood, one of the world’s two main conveyor belts of Sunni extremism – birthed the Students Islamic Movement of India, which in turn spawned Indian Mujahideen.

These groups may differ in tactics. But they are bound by a shared belief that Islam is not merely a religion, but a complete way of life spanning everything from marriage to banking to politics. Many modern Islamists have grudgingly come to terms with democracy as a means to an end, but they ultimately agree that God’s law (sharia) is superior to man’s law (legislation).

Viewed against this backdrop, India’s failure to reform Muslim personal law in the 1950s at the same time that it undertook a sweeping modernisation of Hindu laws governing marriage, inheritance and adoption, must count among the republic’s most consequential blunders. Western democracies can defend themselves by drawing a clear line in the sand between democratic liberalism and the medieval practices enshrined in sharia. In India, the state itself ensures that Muslims follow sharia in civil matters.

Historical blunders notwithstanding, the media can do a lot more to even the playing field between extremist and moderate voices. In sum, what Cameron calls “the struggle of our generation” isn’t confined to a Britain roiled by homegrown Islamist extremism. It’s a global phenomenon whose lessons apply as much to India as to any other democracy.

(Source: Extracts from an Article by Mr. Sadanand Dhume in The Times Of India dated 23-07-2015. The writer is a resident fellow at the American Enterprise Institute in Washington, DC)

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Regulatory Emergency – Why India must act to improve its regulators

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The Food Safety and Standards Authority of India, or FSSAI, which is India’s apex food safety regulator, has not covered itself with glory of late. Its order to withdraw Nestle’s Maggi noodles from India’s grocery shelves has come under a cloud for several reasons. There is little doubt that Nestle deserves to be criticised for the manner in which it chose to handle the situation. But it now appears that the company had already decided to recall Maggi, and this spurred the FSSAI to action before additional reports had come in. The regulator has thus given the impression of acting in a bid to send out a message about its strictness rather than due consideration. Worse, Maggi noodles have now been cleared not just by laboratories in Singapore and Britain but also by FSSAI-approved domestic laboratories. This imbroglio is the climax of a period in which the FSSAI has gone after various puzzling but headline-grabbing targets – such as the world-famous Australian wine brand, Jacob’s Creek, for supposedly including tartaric acid, which gained the regulator an acid reproof from the Bombay High Court for an “adversarial” attitude. “Statutory authorities”, added the Court while overruling the FSSAI in this case, “must act in a manner that is fair, transparent and with a proper application of mind”. Certainly, these strictures appear deserved in the case of the FSSAI.

But the Court’s opinion sadly extends to many other regulators. India’s pharmaceutical regulator is a case in point. Following several controversial reports about lax standards in Indian companies – several of which wound up being banned from developed-country markets – the drug controller simply said, in effect, that American standards could not be applied to Indian pharma, because no drug would then get passed. The automobile sector is no better; Europe’s regulators tested five new Indian small cars in 2014 and found none met the safety standards. But that doesn’t matter for regulation back home. Then there’s aviation; India may be one of the world’s largest and fastest-growing airline markets, but the US Federal Aviation Authority in 2014 downgraded safety standards to its equivalent of junk status – because, the FAA said, the Indian aviation regulator didn’t have enough people to inspect all the planes they were supposed to.

This is an emergency – a public health, public safety, and economic emergency. India is the third-largest economy in the world (measured by its gross domestic product in terms of purchasing power parity), but it has one of the most tattered regulatory structures globally. It has laws that are so strict on paper that they become unmanageable. Then there is the problem of unconscionably lax application of these laws, which leads to Maggi-style discretion and controversy. Worse, fixing this does not appear to be on the government or business agenda. Instead, both the Centre and India Inc defend India’s lax regulation. Acting on pressure from domestic companies, India did not even participate in negotiations for the second-generation Information Technology Agreement, or ITA -II, for fear that freer trade would hurt. It insists on data-secure status in Europe for Indian companies without legislating basic privacy rights at home. This reveals a short-sighted lack of ambition in the Indian private sector; unless they push for updated regulation, they will never grow and become global giants. And the government must think of consumers – who have the right to global standards, to Maggi and to safer cars.

(Source: Editorial in the Business Standard dated 11-08-2015.)

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The Indian Dream – We desire modernity, moderation, a middle-income and well-managed society

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Is there an India Dream?

This is what a Japanese executive asked me at a talk that I was giving on India. In the midst of what I thought was quite an informative discussion on the homeland, he said: “Thank you for telling us where India is today. But where does it want to be tomorrow? What is the India Dream?”

While scratching my head in search of an answer, what came to mind fairly quickly was Prime Minister Narendra Modi’s “Make in India” dream, which is the idea that India is open for business, especially manufacturing. The Modi dream is a good one. Without a solid manufacturing base, the Indian economy cannot generate enough jobs for its growing, aspiring population.

My Japanese interlocutor was not terribly impressed by this answer. In his view “Make in India” could not be the sum total of the India Dream.

Reflecting on the matter, I suggested that in addition ,Indians dreamed of a modern India, a moderate India, a middleincome India and a well-managed India. This seemed to satisfy him better.

To say that most Indians want a modern India is quite a claim in a country where there are so many remnants of the medieval: child marriage, the dowry system, female infanticide and neglect, honour killings, purdah, caste discrimination, anti-rationalism, quackery in medicine, superstition, khap fatwas, and on and on.

Yet there is one clear, discernible, modern value that is spreading unstoppably, and that is the yearning everywhere in India for education. If there is one quintessential feature of a modern society, it is the desire to have every child going to school. For the first time in Indian history, all Indians dream of being educated. This is the greatest hope of India.

Indians want modernity, but they also want moderation — in personal and in social life. As far as I know, historically, there is no body of thought in India that encourages personal excess. A moderate life is widely regarded as a good life.

Indians also want social moderation. They want moderation in their political institutions and practices. In Nehru’s “Idea of India”, moderation meant constitutionalism, socialism, secularism, pluralism and non-alignment. Today, all these words are regarded as old-fashioned and somewhat misguided. But the idea of moderation is still a powerful one, and no Indian leader should forget this if he or she wants to prosper.

Indians have more material dreams too. They dream of India as a middle-income country. Most Indians are quite realistic about what their government, business executives, workers, farmers, professionals, intellectuals and civil society organisations can deliver. They are also aware of the limits of the natural world around them. Deep down they know that a rich, first-world India is neither feasible nor desirable in the next 20-30 years (perhaps ever). The majority of Indians will settle for a middle-income country, a country of say Thailand’s or Brazil’s per capita income and general prosperity over the next quarter of a century. Today, Thailand’s per capita GDP in purchasing power parity terms is roughly three times that of India, Brazil’s is roughly four times.

Finally, Indians dream of a well-managed country. Modi’s victory in the last general elections was engineered on the promise of good governance. India was fed up with illconceived, corrupt, chaotic, rudderless governance. The Prime minister still has a strong sense that Indians want clean, purposeful, efficient and effective administration. Whether he can deliver, is the great challenge.

There is an India Dream. It is not Amit Shah’s notion of a strutting “Vishwa guru”. Most Indians hold to a different dream — of a modern, moderate, middle-income and well-managed India, taking its modest place in the international society.

(Source: Extracts from an Article by Mr. Kanti Bajpai in The Times OF India dated 18-07-2015.)

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Practical aspects of acceptance of deposits by Private Companies and Non-Eligible Companies

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This article is divided into two Parts. This Part deals with conditions and restrictions on Private Companies and Non-Eligible Companies while accepting deposits from its Members. The subsequent later part will deal in acceptance of deposits by “Eligible Companies” compliance thereof and peculiar cases.

Background:
Every business requires funds, and all funds cannot be owned funds. Borrowing is an essential aspect of any business and debt servicing cost is a very common factor in any Company’s financial statements. A Company which is able to borrow, and is regular in servicing its debt with residual profits in its hand, can be said to be in good financial health. All forms of businesses, whether a Proprietorship or Partnership, borrow money, but the quantum of borrowing will always depend on the ability of the business to provide security for the money borrowed. In a corporate form of organisation, a deposit2 accepted by the Company is a way of borrowing money which is basically unsecured in nature. It is also an area where most violations, technical or otherwise, occur. In the following paragraphs, we have tried to answer questions pertaining to regulations on acceptance of deposits and related compliance.

1) What is a Deposit?

Section 73 of the Companies Act 2013 (Referred to hereinafter as the “Act”) has used the word Deposit but the same has been explained in Rule 2 (1) (c) of the Companies (Acceptance of Deposits) Rules 2014. (Referred hereinafter to as the “Rules”). According to the definition in the said Rule, “Deposits” includes any receipt of money by way of deposit or loan, or in any other form by a Company. From this inclusive definition it appears that, to tag any receipt of money as “deposit” the real intention of parties, the Company and person making deposit has to be ascertained. For better clarity, it is always advisable to have this understanding documented and signed as this will provide strong defence in case of objections or doubts raised in respect of such transactions. This is so because the definition in Rule 2 (1) (c) specifically excludes certain transactions described therein from the purview of deposits and thus they do not require compliance with the provisions of the Act3.

2) What are the specific pre-conditions applicable to Private Limited Companies pertaining to acceptance of Deposits:

In terms of provisions of section 73 of the Act, a Company, whether private or public, can accept deposits from its members only subject to compliance of the Rules. Deposits from persons other than members can now be accepted by “Eligible Companies” only. In terms of provisions of section 76 read with definition of an Eligible Company (Rule 2 (1) (e)), only a Public Company with net worth of Rs.100 crore or more or turnover of Rs.500 crore or more, and which has passed a Special Resolution at a meeting of its members, and has filed the same with the Registrar, may accept deposits from the public, these Companies are referred to as the Eligible Companies. Thus Private Companies and “Non-Eligible Companies” can accept deposits from members only. Pre-conditions for accepting deposits from members:

a) Amount as deposit can be accepted from person whose name appears on the Register of Members (RoM) of the Company, if a person whose name appears on RoM has transferred his shares but the transfer is pending registration, then the Company should take steps to re-pay deposits which it has accepted from such members;

b) Company must pass an ordinary resolution at a meeting of its members seeking authorisation for acceptance of deposits and should file the same with the Registrar. It is advisable that the Company should pass the res olution at every Annual General Meeting instead of a blanket resolution without any defined validity.

3) What is the quantum of amount that can be accepted as a Deposit by Private Companies and Non-Eligible Companies?

Non-Eligible Company
In terms of Rule 3 (1) (a) of the Rules, following are the limits for Companies for acceptance of deposits:

(a) D eposits which are secured or unsecured but amount accepted, is not payable on demand or is not payable before 6 months from the date of acceptance or after 36 months thereof including renewal, an amount not exceeding 10 % of the aggregate of paid up share capital and free reserves,

Provided that such deposits are not payable within 3 months of acceptance or renewal

In terms of Rule 3 (3) of the Rules, following are the limits on Companies for acceptance of deposits:

(b) Total deposits including other deposits and renewed deposits from members only shall not exceed 25% of the aggregate of the paid-up share capital and free reserves of the company;

Private Company:
(c) In terms of specific exemption vide Notification MCA GSR 464 (E) dated June 05, 2015, a Private Company can accept deposits ONLY from its Members upto 100% of its Paid up Capital and Free Reserves provided it files with the Registrar information about such acceptance.

Note: The above limit of 25% or 100% as the case may be should be reckoned on the basis of last audited Financial Statements adopted by the members

4) What are the Procedural aspects for Private Companies/ Non-Eligible Companies in the course of acceptance of Deposits?

Following are the Procedural requirements to be complied with:

(i) Hold a Board meeting for proposing acceptance of deposit and issue of notice for holding general meeting for obtaining approval of the shareholders for the proposal;

(ii) Hold general meeting and seek approval of the shareholders by means of a special or ordinary resolution for authorising the Board to accept deposits and file a copy of such resolution within 30 days of date of passing with RoC in e-Form MGT 14;

(iii) Hold the Board meeting to obtain the approval for the draft Circular in Form DPT-1 of the Rules and the get the draft Circular signed by majority of the directors of the Company, and file a copy of such signed circular with the Registrar of Companies in Form GNL-2 for registration; ensure that the circular issued for acceptance of deposits is sent by electronic mail or registered post A.D or speed post to Members only;

(iv) Appoint Deposit Trustees for creating security for the secured deposits by executing a deposit trust deed in Form DPT-2 at least seven days before issuing the circular;

(v) Enter into contract with Deposit Insurance services providers at least thirty days before the issue of the circular;

(vi) Issue deposit receipts in the prescribed format and under the signature of an officer duly authorised by the Board, within a period of two weeks from the date of receipt of money or realisation of the cheque.

(vii) Make entries in the Register of deposits accepted rules within seven days from the date of issuance of the deposit receipt and arrange to get such entries authenticated by a director or secretary of the Company or by any other officer authorised by the Board.

(viii) File deposit return in Form DPT-3 by furnishing information contained therein as on the 31st day of March, duly audited by the auditors before 30th June every year.

5) Following question was posed to us by parents of a young IIT graduate which will highlight the problem that the provision creates.

Q : My Son is an IIT graduate from IIT Powai and he has a girl friend who happens to be his classmate. They have incorporated a new private limited company in which both of them are directors. They do not have their own funds. Since it is a start-up company with a new idea, banks are not willing to finance them within their norm. Contrary to PM Modi’s pronouncement of “Make in India,” the Companies Act, 2013 is creating a hurdle because loan from either members or outsiders is not possible. What should we do to help him while ensuring that he remains within the framework of law?

Ans. : It is unfortunate that the law does not recognise the Indian tradition of family business although it is sometimes envied world over. In the circumstances of the case, both the parents, that is, yourself and your wife and the parents of your son’s girlfriend can give a loan to your son’s company as a deposit. In our opinion, in terms of banking terminology, this could be treated as “Quasi Equity” and not refundable until the repayment of loan of banks and financial institutions. You may need to obtain such a letter from the Bank as a precondition for considering their loan proposal, which in our opinion will not be difficult for the bank to issue. They would avoid possible classification of NPA in respect of the advances given by them. Please advise your son to follow this route as a matter of least resistance, precaution and still it could be argued that it is within the framework of the law and ..

Editors Note: A Company is a very important form of business organisation. Despite the advent of Limited Liability Partnerships, this form is still the most accepted one by most stakeholders. The coming into force of the Companies Act, 2013 has created a large number of problems. In this feature commencing from this issue, the authors will address them. Initially, the focus will be on problems faced by small and medium sized private limited Companies, for it is these bodies and their advisors/ consultants that need the maximum support. As the feature develops, other issues could be taken up. We welcome your suggestions.

Transactions of tax avoidance/evasion on the stock exchange and Securities Laws

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Introduction
Do transactions on stock exchange undertaken with the objective of tax avoidance/evasion violate Securities Laws? If such transactions are otherwise not in violation of Securities Laws, can SEBI attempt to ascertain the motive of such transactions and punish persons who undertake transactions that are for such purposes? As more and more Orders are passed where SEBI has, inter alia, alleged that there is tax avoidance/evasion, this question needs consideration.

It is common to hear that people transact on the stock exchange for tax avoidance. At times the sole purpose of entering into the transaction may be for avoiding tax and there may be no other commercial motive or implication. In other cases, while there may be a motive of tax avoidance, there are other commercial motives and/or implications. For example, a person may have short term capital gains during the year. He may transfer shares through the stock exchange whose price has fallen and thus book short term capital loss thereby avoiding tax on the short term capital gains. He may or may not reverse the transaction thereafter. Then there may be transactions of tax evasion where profits or losses may be “transferred” from one person to another.

The implications of such transactions under income-tax is an interesting, but a separate issue. But, for the purposes of this column, there are two questions to be answered . Are such transactions in violation of Securities Laws? If not, can SEBI still take action against them based on their ostensible motive? The question for the purposes here is limited to the provisions in Securities Laws relating to frauds, manipulative practices, etc. under the Act/Regulations. There is of course the general issue as to whether a transaction that involves an offence or violation of other laws would have implication under other laws. That, however, requires separate consideration.

These questions becomes even more relevant in the context of recent interim orders passed by SEBI in context of alleged massive tax evasion as also discussed in earlier columns (see February and June 2015 issues of the BCAJ). As discussed in those articles, it was allegedly found that bogus long term capital gains was made through increase of price of shares of defunct companies. Shares were allotted/ transferred to “investors” at a low price and the prices were considerably increased by manipulation. On sale at such high prices, the investors made huge long term capital gains which are said to be exempt as long term capital gains for income-tax. SEBI has held such transactions to be in violation of Securities Laws and debarred the parties involved.

Jurisdiction of SEBI
Securities Laws generally frown at transactions that interfere with the normal price discovery mechanism of stock exchanges. This is usually done through provisions prohibiting fraudulent trades and manipulative/unfair trade practices. Thus, a transaction that does not transfer beneficial interest of shares is generally not permitted. Transactions that are carried out not for bonafide purchase/sale are also generally not permitted. This is because they result in false or misleading appearance of trading in shares. The other reason is because price at which such transactions are undertaken also not being a result of normal price discovery process. The question is whether transactions undertaken wholly or partly with the objective of tax avoidance would fall foul of such provisions.

SAT View
The Securities Appellate Tribunal (“SAT ”) had several occasions to examine this issue. It appears that, generally, a benevolent view has been taken in such matters as far as tax avoidance is concerned. SEBI had raised objections to such transactions on grounds that they were fixed in advance, that they were synchronized trades, that they interfered with the normal price discovery mechanism of stock exchanges, etc. SAT has generally rejected such arguments.

In Viram Investment Private Limited vs. SEBI (order of SAT dated 11th February 2005), SEBI had debarred the appellants for six months on the allegations that they carried synchronized/matched deals on the stock exchange. The appellants claimed that the transactions were between related parties for the purpose of tax planning. SAT noted the facts and did not find anything wrong such as price manipulation, etc. by the appellants. It also noted that synchronized transactions by themselves were not barred nor illegal. On the issue that the transactions were for tax planning, the SAT observed as follows (emphasis supplied):-

“Even if we consider transactions undertaken for tax planning as being non genuine trades, such trades in order to be held objectionable, must result in influencing the market one way or the other. We do not find any evidence of that either in the investigation conducted by the Bombay Stock Exchange, copy of which has been annexed to the memorandum of appeal or in the impugned order that there was any manipulation. It is also seen that the impugned transactions have taken place at the prevailing market price. Trading in securities can take place for any number of reasons and the authorities enquire into such transactions which artificially influence the market and induce the investors to buy or sell on the basis of such artificial transactions. This is not even the case of the respondent, therefore it is not possible for us to sustain the impugned order.”

In another case of Rakhi Trading Private Limited vs. SEBI [(2010) 104 SCL 493 (SAT)], there were allegations of synchronized trading in Futures and Options segment of the stock exchange. The suspicion was that such trades were for shifting losses/profits for the purpose of “tax planning”. The SEBI whole-time member in his order had observed that “The range and scope with which such transactions have been carried out seems to suggest that there is a thriving market for such transfer of profits/losses providing the opportunity to avail of favourable tax assessments”. A penalty was levied. In its detailed order, SAT analysed the nature of transactions in Futures and Options and the implications of synchronised trades. Generally, the SAT did not find the appellants guilty of wrongs of price manipulation, etc. On the issue whether transactions carried out for tax planning purposes were in violation of the PFUTP Regulations, SAT observed (emphasis supplied):-

“When we analyse the nature of the trades executed by the appellant, we find that it played in the derivative market neither as a hedger nor as a speculator and not even as an arbitrageur. The question that now arises is why did the appellant execute such trades with the counter party in which it continuously made profits and the other party booked continuous losses. All these trades were transacted in March 2007 at the end of the financial year 2006-07. It is obvious and, this fact was not seriously disputed by the learned senior counsel appearing for the appellant, that the impugned trades were executed for the purpose of tax planning. The arrangement between the parties was that profits and losses would be booked by each of them for effective tax planning to ease the burden of tax liability and it is for this reason that they synchronized the trades and reversed them. They have played in the market without violating any rule of the game.

    We hold that the impugned transactions in the case before us do not become illegal merely because they were executed for tax planning as they did not influence the market. The learned counsel for the respondent Board drew our attention to Regulation 3(a), (b) & (c) and Regulation 4(1) and 4(2)(a) & (b) of the Regulations to contend that the trades of the appellant were in violation of these provisions. We cannot agree with him. Regulation 3 of the Regulations prohibits a person from buying, selling or otherwise dealing in securities in a fraudulent manner or using or employing in connection with purchase or sale of any security any manipulative or deceptive device in contravention of the Act, Rules or Regulations. Similarly, Regulation 4 prohibits persons from indulging in fraudulent or any unfair trade practices in securities which include creation of false or misleading appearance of trading in the securities market or dealing in a security not intended to effect transfer of beneficial ownership. Having carefully considered these provisions, we are of the view that market manipulation of whatever kind, must be in evidence before any charge of violating these Regulations could be upheld. We see no trace of any such evidence in the instant case. We have, therefore, no hesitation in holding that the charge against the appellant for violating Regulations 3 and 4 must also fail.”

However, such cases must be distinguished from cases where price of the securities are manipulated and profits or gains are literally created for tax purposes. As discussed earlier, recently, SEBI has alleged in five recent cases that
the prices of the shares were manipulated for tax purposes. The following observations in the matter of Pine Animation Limited (SEBI Order dated 8th May 2015) highlight the findings, concern and allegations of SEBI (emphasis supplied):-

“31. Since prior to the trading in its scrip during the Examination Period, Pine did not have any business or financial standing in the securities market, in my view, the only way it could have increased its share value is by way of market manipulation. In this case, it is noted that the traded volume and price of the scrip increased substantially only after the Exit Providers, preferential allotees and Promoter related entities started trading in the scrip. The average volume increased by 4433 times during the Examination Period i.e. from 62 shares per day to 2,74,922 shares per day. It is further noted that on the days when Pine Group was not trading, the traded volumes in the scrip were very low and the substantial increase in traded volumes as observed in this case was mainly due to their trading. I further note that Exit Providers, Preferential Allottees and Promoter related entities traded amongst themselves as substantiated by their matching contribution to net buy and net sell in Patch 3. There was no change in the beneficial ownership of the substantial number of traded shares as the buyers and sellers both were part of the common group and were acting in concert to provide LTCG benefits to the Preferential

Allottees    and    Promoter    related    entities.    In view of the above, I prima facie find that Exit Providers, Preferential Allottees and Promoter related entities used securities market system to artificially increase volume and price of the scrip for creating bogus non taxable profits (i.e. LTCG).

    In addition to the above, it is noted that after the preferential allotment and transfer of shares by the promoters to the Promoter related entities, about 92.52% of the share capital of Pine was with the Promoter related entities and Preferential Allottees. During the period from Mary 22, 2013 to June 19, 2013, the price of the scrip increased from Rs. 472 (unadjusted and Rs. 47.2 adjusted to share split) to Rs. 1006 (unadjusted and Rs. 100.6 adjusted to share split) in a matter of 19 trading days, with the trading volume as meager as 62 shares per day. The trading volume suddenly increased to 2,74,922 shares per day during the period from December 17, 2013 to January 30, 2015, when Exit Providers, Preferential Allottees and Promoter related entities started trading in the scrip. The prima facie modus operandi appears to be same as that used in the matter of Radford Global Limited where the stock exchange mechanism was used for the purpose of availing LTCG tax benefit and Pine was found actively involved in the whole design to misuse stock exchange mechanism to generate bogus LTCG. ?


    I am of the considered view that the scheme, plan, device and artifice employed in this case, apart from being a possible case of money laundering or tax evasion which could be seen by the concerned law enforcement agencies separately, is prima facie also a fraud in the securities market in as much as it involves manipulative transactions in securities and misuse of the securities market. The manipulation in the traded volume and price of the scrip by a group of connected entities has the potential to induce gullible and genuine investors to trade in the scrip and harm them.

As such the acts and omissions of Exit Providers, Preferential Allottees and Promoter related entities are ‘fraudulent’ as defined under regulation 2(1)(c) of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (‘PFUTP Regulations’) and are in contravention of the provisions of Regulations 3(a), (b), (c), (d), 4(1), 4(2)(a), (b), (e) and (g) thereof and section 12A(a), (b) and (c) of the Securities and Exchange Board of India Act, 1992.

…In my view, the stock exchange system cannot be permitted to be used for any unlawful/forbidden activities.”

    Conclusion

The SAT has thus held that transactions in securities on stock exchange that have avoidance of tax as its objectives may not by themselves be in violation of Securities Laws. However, transactions that involve price manipulation, false dealing in shares, etc., would generally be in violation of Securities Laws. SEBI also seems to have taken a view that transactions for tax evasion, for such reason itself, are in violation of such laws. It is very likely that these recent Orders of SEBI will see appeals. Thus, courts may consider and rule on whether and under what circumstances would transactions of tax avoidance/evasion be deemed to be a violation of Securities Laws.

Will Your Will Live On?

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Introduction
Consider this. A person makes a Will thinking he
has done all that is necessary for ensuring smooth succession of his
assets to his near and dear ones. Unfortunately, he dies. But even more
unfortunately, his Will is held to be invalid! Result – he is rendered
an intestate, i.e. one who died without making a valid Will and
accordingly, the law decides who gets what after his death. This could
have some unintended and unpleasant consequences. Through this Article,
let us, through Questions and Answers, consider some of those scenarios
when a deceased’s Will can and cannot be held to be invalid. The Indian
Succession Act, 1925 governs the law relating to the making and proving
of Wills.

Can a Person with Alzheimer’s disease make a Will?
Alzheimer’s
disease affects the mental capacity of a person. It is a degeneration
of the mental faculties and leads to memory loss, inability to think,
etc. In an advanced stage of the disease, it is highly doubtful whether a
person has control over his mental faculties in order to make a Will.
However, if a person suffering from Alzheimer’s disease is in a position
to make a Will, then it would be advisable to have a neurologist (and
not any doctor) who has been treating the person to certify the
testator’s mental state of mind to execute the Will. He could act as the
witness to the Will. This would add credence to the Will and the doctor
could even be examined before a Probate Court.

Similarly, in
the case of a schizophrenic, it may be advisable to have the consulting
psychiatrist certify the ability of the testator to prepare a Will at
the time of execution of the Will.

Can a Person suffering from Parkinson’s disease make a Will?
Parkinson’s
disease is also a degeneration of the brain but it affects the
movements of a person. Hence, the mental faculties of such a person may
remain intact as compared to a person suffering from Alzheimer’s
disease. Nevertheless, even in the case of such a person, it may be a
good idea to have a neurologist to certify the testator’s mental state
of mind to execute the Will, since it may be challenged in the Probate
Court whether such a person had control over his thinking ability? In
Maki Sorabji Commissariat vs. Homi Sorabji Commissariat, TS No. 60/2011
Order dated 30th April, 2014, the Bombay High Court was faced with the
very same issue as to whether the testator who was suffering from
Parkinson’s disease could make a Will? The Court held that even if the
deceased was suffering from Parkinson’s disease, the question that arose
was whether such disease could have affected sound and disposing mind
of the deceased at the time of execution of the Will? The Court held
that facts clearly indicated that he was active in various activities
including taking decisions in property matters. Thus, the Court held
that merely because he suffered from Parkinson’s disease, it would not
indicate or prove that it had affected his sound and disposing mind or
capacity to execute a Will. Unless the disease was of such a nature that
it would affect the sound and disposing mind of the testator, such
disease cannot be a ground to refuse a Probate.

Can a very old person make a Will?
Unlike
the Companies Act, 2013 which raises a question mark on a person over
the age of 70 to become a Managing Director, a Will of a very old person
is valid, provided he knows what he is doing. However, if the old age
has rendered him senile or forgetful or mentally feeble, then the Will
would be held to be invalid on account of the testator’s mental
capacity. As suggested before, a neurologist should certify the
testator’s mental state of mind which should specifically refer to his
extreme old age.

Can a person suffering from terminal illness make a Will?
In
Pratap Singh vs. State, 157 (2009) DLT 731, the Delhi High Court held
that the fact that a person was suffering from a very painful form of
terminal cancer of the mouth which prevented him from speaking and that
he succumbed to it within 2 weeks of executing a Will showed that he may
not have prepared the Will. Hence, in cases of terminal illness, it
becomes very important to prove how the testator could have prepared the
Will. The role of the witnesses in such cases also becomes very
important.

What if all pages of a Will are not signed?
The
Indian Succession Act, 1925 requires that a testator shall so sign a
Will that it appears that he intended to execute it. Thus, it need not
necessarily be at the end of the Will, it can also be at the beginning
of the Will. The key is that it should appear that he intended to give
effect to the Will. There is no requirement that each and every page
must be signed or initialled – Ammu Balachandran vs. Mrs. O.T. Joseph
(Died) AIR 1996 Mad 442 which was followed again in Janaki Devi vs. R.
Vasanthi (2005) 1 MLJ 357. Nevertheless, it goes without saying that for
personal safety, the testator must sign each and every page so that
there is no risk of pages being replaced.

Can a witness to a Will also be a Beneficiary under the Will?
Generally,
no. The Indian Succession Act states that any bequest (gift) to a
witness of a Will is void. However, the Will is not deemed to be
insufficiently attested for this reason alone. Thus, he who certifies
the signing of the Will should not be getting a bequest from the
testator. However, there is a twist to this section.

This
section does not apply to Wills made by Hindus, Sikhs, Jains and
Buddhists and hence, bequests made under their Wills to attesting
witnesses would be valid! Wills by Muslims are governed by their
Shariyat Law. Thus, the prohibition on gifts to witnesses applies only
to Wills made by Christians, Parsis, Jews, etc.

Does a witness need to know the contents of the Will?
This
is one of the biggest fears and myths in selecting a witness. A witness
only witnesses the signing of the Will by the testator and nothing
more! He or she need not know what is inside the Will and the contents
can very well be kept a secret till when it is opened after the death of
the testator. By signing as a witness, he only states that the testator
has actually signed the Will in his presence.

Can an executor be a beneficiary under the Will?
Yes,
he can, subject to certain conditions. He must either prove the Will or
at least manifest an intention to act as the executor. Thus, he must do
some act which would demonstrate his intention to act as the executor.
These acts could include, arranging for the funeral of the testator,
taking stock of his estate, writing letters to the other legatees,
arranging for religious rites, etc.

Can an executor be a witness under the Will?
Yes,
he can. An executor is the person who sets the Will in motion. It is
the executor through whom the deceased’s Will works. Just as a company
operates through its Board of Directors, the estate of a deceased
operates through its executors. There is no bar for a person to be both
an executor of a Will and a witness of the very same Will. In fact, the
Indian Succession Act, 1925 expressly provides for the same.

Does a bachelor/spinster need to make a new Will once he/she marries?
Yes, he can. An executor is the person who sets the Will in motion. It is the executor through whom the deceased’s Will works. Just as a company operates through its Board of Directors, the estate of a deceased operates through its executors. There is no bar for a person to be both an executor of a Will and a witness of the very same Will. In fact, the Indian Succession Act, 1925 expressly provides for the same.

    Does a bachelor/spinster need to make a new Will once he/she marries?

Yes. The law considers marriage as a major event in a person’s life and one which requires him/her to rethink the succession plan. Thus, any Will made prior to marriage is automatically revoked by law, on the marriage of a person. If a person dies without making a fresh Will after marriage, then he/she would be treated as dying intestate and the provisions of the relevant succession law, e.g., the Hindu Succession Act, 1956 for Hindus, would apply.

    Can a Will have a generic bequest?

Bequests can be general or specific. However, they cannot be so generic that the meaning itself is unascertainable. For instance, a Will may state “I leave all my money to my wife”. This is a generic bequest which is valid since it is possible to quantify what is bequeathed. However, if the same Will states “I leave money to my wife”, then it is not possible to ascertain how much money is bequeathed. In such an event, the entire Will is void.

    What happens if the shares bequeathed undergo a merger/ demerger?

Say a Will bequeaths 1,000 shares of ABC Ltd. After the Will is prepared and before the shares are bequeathed, ABC. Ltd undergoes a scheme of arrangement pursuant to which ABC Ltd is merged with XYZ Ltd and one division of the erstwhile ABC Ltd is hived off into PQR Ltd. The original ABC shares are replaced with shares of XYZ and PQR. Would the legacy survive such a change?

The Indian Succession Act provides that where a thing specifically bequeathed undergoes a change between the date of the Will and the testator’s death and the change occurs by operation of law/in the course of execution of the provisions of any legal instrument under which the thing bequeathed was held, the legacy is not adeemed (cancelled) by reason of such a change.

The position in this respect is not explicitly clear. However, one may refer to some English and American judgments on this issue. The judgments tend to suggest that whenever a specific item bequeathed has ceased to belong to the testator, the legacy is adeemed – Bridle 4 CPD 336. A legacy is not adeemed if the alteration/change is only formal or nominal – such as a name change/sub-division of shares – Oakes vs. Oakes 9 Hare 666/Clifford (1912) 1 Ch 29. Even in a case where the reorganised company was materially the same as the old one, there was no ademption – Leeming (1912) 1 Ch 828. However, where the gift is substantially altered, there is an ademption. The testator must have at the time of his death the same thing existing; it may be in a different shape, yet it must substantially be the same thing – Slater (1907) 1 Ch 665 / Gray 36 Ch D 205.

Hence, in the example given above, it may be possible to contend, relying upon Slater’s decision, that the gift has been substantially altered on account of the reorganisation and hence, a view may be taken that the legacy adeems. However, as mentioned earlier, this is an issue which is not free from doubt. It may be noted that on ademption of a legacy, the entire Will may or may not become void. For instance, if a legacy adeems and there is an alternative beneficiary, then it would go to him. However, if there is only one beneficiary to whom the entire estate goes without any alternative beneficiary, then on ademption of the legacy, the Will may itself fail. Hence, this is a question of fact to be decided on a case-by-case basis.

    Would a bequest to children of the testator include his adopted children, if not so specified?

Section 99 of the Indian Succession Act defines certain terms used in a Will. The words children means only the lineal descendants in the first degree of the testator. Thus, according to this section, adopted children would not be included in the definition of the term ‘children’ if so used in a Will. Similarly, a step-child would also not be included since that would not constitute a lineal descendant. However, it should be noted that this section does not apply to Wills made by Hindus, Sikhs, Jains and Buddhists and hence, if a Will made by them uses the term “children,” then it would include their adopted children also. Similarly, their step-children may also be included.

    Conclusion

While the above are just some of the scenarios when a Will may be held to be invalid, one must bear in mind that a little care and caution and at times, sound legal advice, would go a long way in perfecting a Will. Act in haste and repent in leisure is often the case with several testamentary documents. Always remember:

“Where there’s an invalid Will, there’s a Dispute Where there’s an invalid Will, there’s a Lawsuit!!”

Professional scepticism – continued

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(Professional scepticism – continued)

Arjun (A) — Hey Bhagwan,
in our last meeting, you were telling me about professional scepticism.
You mean, we need to always proceed with suspicion?

Shrikrishna
(S) —No, my dear! Scepticism does not mean suspicion always. It only
means, you should not accept anything at its face value blindly.
Howsoever clean a thing may appear, you cannot rule out a possibility of
something wrong or foul.

A — I understood. We were taught in
the very first year of B. Com that merely because a trial balance is
tallied, it does not mean that all accounts are right and flawless.

S
— Exactly. After all, you are supposed to be the financial police. A
policeman need not consider every man to be a thief; but at the same
time, he cannot close his eyes merely because a person appears to be a
gentleman.

A — But we were taught that an auditor is a watchdog and not a bloodhound.

S
— Agreed! But even a watch dog constantly smells something and barks
when a stranger comes. He promptly wakes up even if there is a soft
sound around.

A — And he stares at us!

S — Even the
presence of a dog puts one on one’s guard. It acts as a deterrent. That
kind of an image an auditor should develop. He should not be taken for
granted.

A — I see your point.

S — Moreover, the times
have changed. The concept of watchdog and bloodhound is also getting
diluted. In the good old days, manipulation in accounts used to be
apparent if there were scratches, erasures or shabbiness in manual
records.

A — Yes; now in a computerised set-up, everything appears to be clean!

S
— If you start signing the accounts on oral or even written assurances
of a client, then the very purpose of audit is defeated! You should
never sign without proper verification. And you should not be shy of
asking questions.

A — Agreed. But the records are so voluminous and time is so short, we cannot verify everything. The work is endless.

S
— That calls for experience and insight. You should know your client –
by KYC! You should have properly trained assistants. You should devote
adequate time to satisfy yourself as to the veracity of financials. And
you should always be updating your knowledge and not merely gathering
CPE hours!

A — I remember, one CA signed the tax audit of
another CA firm, his close friends, and it transpired that there was a
negative cash balance of a few hundred rupees on one particular day!

S — See! You have all technology at your command. Even a cursory glance at accounts would have revealed this discrepancy.

A
— Poor fellow! That other firm’s accounts were verified in a scrutiny
assessment. The Assessing Officer noticed this error and informed it to
the Institute! He had to face the music for four years!

S — Many
times, your people sign the accounts ‘at a previous date’. Quite often,
there is contrary evidence that you have sent queries even after that
‘back date’. One needs to be very vigilant.

A — You had told me
the case that an auditor signed the accounts when only one director of a
private limited company had put his signature. And later on, the other
director refused to sign and filed a complaint on a technical ground!

S
— Many times, the client or his accountant avoids to produce bank
statement of a particular account. They say, the account is either
inoperative; or the statement is not traceable. In one case, they told
the auditor that a bank account was used only for paying Government dues
like PF, ESI, TDS and so on; and there were only contra entries!

A — Then what happened?

S
— Later on, it was revealed that the Government dues were not paid at
all. There were bogus stamps on challans; and money was fraudulently
withdrawn. So, if somebody is avoiding giving details, it triggers
suspicion.

A — The best example is non-verification of bank
fixed deposits! An independent verification of debtors, creditors and
even bank balances. We simply write year after year that the balances
are subject to confirmation.

S — While in reality, you do not even attempt to get a third party confirmation.

A
— Now, the scepticism is getting clearer! Good faith is dangerous. S — T
here are many such instances that call for scepticism. We will discuss
them next time. But I suggest, you inculcate this attitude right now!
You are supposed to sign many balance sheets in the coming weeks.

A — Yes, My Lord!

Note: This dialogue is based on the same simple but basic principles which we professionals should religiously follow.

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Nominee – Insurance claim – Nominee is only custodian of amount – Insurance Act, 1938 section 39(6):

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Sailabala Barik & Anr vs. Divisional Manager LIC of India and Ors. AIR 2015 Orissa 102

The petitioner No. 1 got married to one Nimai Charan Barik on 10th March, 1996. Her husband died on 11th July, 2007 while in service of the Government. It was alleged that the petitioner No. 1’s husband during his life time had three different policies with opposite party No. 1 and opposite party No. 1 being Head of the Organisation was accountable for release of the amount involved in all the above three polices. The case of the petitioner No. 1 was that after the death of her husband she came to know that all the policies bore the name of the opposite party No. 4 as the nominee. Petitioner alleged that even though the opposite party No. 4 was a nominee, he was not entitled to the amount involved in the said policies. She alleged that even though opposite party No. 4 was not the successor to the policy holder, yet as a nominee, he was attempting to grab the amount involved in all the three above policies. The petitioner disclosed that the opposite party No. 4 happened to be the elder brother of petitioner No. 1’s husband.

After coming to know that opposite party No. 4 was attempting to usurp the proceeds of the policies, the petitioner No. 1 submitted a representation before the opposite party No. 1 on 24.09.2007. The opposite party No. 3 vide letter dated 29.09.2007 intimated her that the policy had a valid nomination in favour of opposite party No. 4 and as a consequence of which the amount involved in the policy following the conditions therein could not be released in their favour. The opposite parties relied on section 39(6) of the Insurance Act 1938. The Hon’ble Court observed that there was no doubt that the amount involved in the policies could be released in favour of the nominee. Question involved in the present case is whether nominee was entitled to the money involved in the policies? There was no denying the fact that the opposite party No. 4 was the nominee in all the policies and as nominee he would be the custodian of the amount involved. Question as to successors in interest would be entitled to such amount has been tested in the Hon’ble Apex Court and the Hon’ble Apex Court in deciding such a dispute in case of Smt. Sarbati Devi and another vs. Smt. Usha Devi, : A.I.R. 1984 Supreme Court 346. Wherein it was held that.

It is only successors of the deceased entitled to the amount involved in the Insurance Policy. The nominee is only the custodian of the amount and that does not mean the amount belonged to the nominee or nominees.

Thus, in view of the provision as contained in sub-section (6) of section 39 of The Insurance Act, 1938, and the decision of Hon’ble Apex Court, law is settled that the nominee is only the custodian of the amount involved in the Insurance Policies and the successors of the policy holder would be the persons entitled to the amount involved in the policies. The petitioners were directed to appear before the Insurance Company with their identification and the amount would be released by the Insurance Company in favour of the petitioners in the presence of the nominee.

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Income from house property – Annual letting value – Section 23 – A. Y. 1986-87 – Annual value is lesser of fair rent and standard rent

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Vimal R. Ambani vs. Dy. CIT; 375 ITR 66 (Bom):

For the A. Y. 1986-87, the Assessing Officer determined the annual value on the basis of the standard rent and not on the basis of the rateable value as determined by the municipal corporation. This was upheld by the Tribunal.

On appeal by the assessee, 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 right in holding that in computing the property income u/s. 23 of the Income-tax Act, 1961, the annual letting value of the self-occupied property has to be the sum equivalent to the standard rent under the Rent Control Act and not the municipal rateable value.”

The Bombay High Court held as under:

“(i) While determining the annual letting value in respect of properties which are subject to rent control legislation and in cases where the standard rent has not been fixed, the Assessing Officer shall determine the annual letting value in accordance with the relevant rent control legislation. If the fair rent is less than the standard rent, then, it is the fair rent which shall be taken as annual letting value and not the standard rent. This will apply to both self-acquired properties and general cases where the property is let out.

(ii) The order of the Tribunal had to be set aside. Matter stands remanded for consideration in accordance with the aforesaid norms.”

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Deemed dividend – Section 2(22)(e) – A. Y. 2009- 10 – Loan to shareholder – Amounts taken as loan from company and payments also made to company – AO directed to verify each debit entry and treat only excess as deemed dividend

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Sunil Kapoor vs. CIT; 375 ITR 1 (Mad):

For the A. Y. 2009-10,
the Assessing Officer made an addition of Rs. 76,86,829/- as deemed
dividend u/s. 2(22) (e) of the Income-tax Act, 1961, being the loan
received from KIPL of which the assessee was a shareholder. The
Assessing Officer noted that there were certain payments as on
31/03/2009 and the balance due to the company was Rs.39,32,345/-. The
assessee pointed out that there was credit balance in favour of the
assessee in a sum of Rs.45,44,303/- while there was debit balance of
Rs.39,32,345/-, and accordingly, the company itself had to pay
Rs.6,11,957/-. CIT(A) and the Tribunal held that the Assessing Officer
had erred in not taking into consideration the amount that has been
repaid by the assessee to KIPL. Therefore, the Assessing Officer was
directed to verify each and every transaction and, accordingly, to
determine the dividend amount.

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

“i)
Any amount paid to the assessee by the company during the relevant
year, less the amount repaid by the assessee in the same year, should be
deemed to be construed as “dividend” for all purposes. However, the
Assessing Officer had taken the entire amount of Rs.76,86,829/- received
by the assessee from the company as dividend, while computing the
income but had lost sight of the payments made.

ii) In such
circumstances, the Commissioner(Appeals) had rightly come to the
conclusion that the position as regards each debit would have to be
individually considered because it may or may not be a loan. The
Assessing Officer, was, therefore, directed to verify each debit entry
on the aforesaid line and treat only excess amount as deemed dividend
u/s. 2(22)(e) of the Act.”

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Charitable Institution – Exemption u/s. 11 – A. Y. 2006-07 – Where the objects of the trust include “(2)Devising means for imparting education in and improving the Ayurvedic system of Medicine and preaching the same. In order to gain objects No. 2, it is not prohibited to take help from the English or Yunani or any other system of medicine and according to need one or more than one Ayurvedic Hospital may be opened.”, it cannot be held that running an allopathic hospital is ultra vires to the ob<

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Mool Chand Khairati Ram Trust vs. DIT; [2015] 59 taxmann.com 398 (Delhi)

The Assessee was a charitable institution engaged in running a hospital (both Allopathic and Ayurvedic). For the A. Y. 2006-07, the Assessing Officer had denied the exemption claimed by the Assessee u/ss. 11 and 12 of the Act as the Assessing Officer was of the view that the activities of the Assessee were not in accordance with its objects. In addition, the Assessing Officer also denied the Assessee’s claim for depreciation on assets purchased by the Assessee by application of its income that was exempt u/s. 11 of the Act. The CIT (Appeals) allowed the Assessee’s claim and also held that the Assessee was entitled for depreciation on the assets purchased by application of its income, which was exempt u/s. 11 of the Act.

The Tribunal accepted the Revenue’s contention that the properties of the Assessee had not been applied towards its objects. The Tribunal held that the Assessee’s activities relating to Allopathic system of medicine had more or less supplanted the activities relating to Ayurvedic system of medicine and concluded that predominant part of the Assessee’s activities exceeded the powers conferred on the trustees and the objects of the Assessee Trust were not being followed. The Tribunal held that whilst the activities of the Assessee relating to providing medical relief by the Ayurvedic system of medicine were intra vires its objects, the activities of providing medical reliefs through Allopathic system of medicine was ultra vires its objects. Consequently, the Assessee was not entitled to exemption u/s. 11 of the Act in respect of income from the hospital run by the Assessee, which offered medical relief through Allopathic system of medicine. Accordingly, the Tribunal directed that the income and expenditure of the Assessee from the activities relating to the two disciplines of medicine, namely Ayurveda and Allopathy, be segregated. Insofar as the Assessee’s claim for depreciation was concerned, the Tribunal held that deprecation on assets, used for providing relief through Ayurvedic system of medicine or used in education and research relating to Ayurvedic system of medicine, was allowable notwithstanding that the expenditure on purchase of the assets was exempted u/s. 11(1)(a) of the Act. However, insofar as the assets purchased for providing medical relief through Allopathic system of medicine was concerned, the Tribunal held that depreciation would not be available if the expenditure incurred on purchase of the assets had been exempted u/s. 11(1)(a) of the Act.

On appeal by the assessee, the Delhi High Court held as under:

“i) In our view, the Assessing Officer and the Tribunal erred in concluding that the Assessee’s activities were in excess of its objects. Running an integrated hospital would clearly be conducive to the objects of the Assessee. The trustees have carried out the activities of the trust bonafide and in a manner, which according to them best subserved the charitable objects and the intent of the Settlor. Thus the activities of the Assessee cannot be held to be ultra vires its objects. The Assessing Officer and the Tribunal were unduly influenced by the proportion of the receipts pertaining to the Ayurvedic Research Institute and the hospital. In our view, the fact that the proportion of receipts pertaining to the Ayurvedic Research Institute is significantly lower than that pertaining to the hospital would, in the facts of the present case, not be material. Undisputedly, significant activities are carried out by the Assessee for advancement and improvement of the Ayurvedic system of medicine in the institution established by the Assessee and though the receipts from the Allopathic treatment are larger, the same does not militate against the object for which the institution has been set up and run.

ii) Insofar as the issue regarding depreciation on assets used for providing Allopathic systems of medicine is concerned, the learned counsel for the Revenue did not dispute that the depreciation would be allowable if the activities of the Assessee were considered to be within the scope of its objects. The Tribunal had denied the claim of depreciation, in respect of assets used for providing medical relief through Allopathic system of medicine, only on the basis that the Assessee’s activity for running the hospital was ultra vires its objects. In the circumstances, the third question is to be answered in the negative and in favour of the Assessee.”

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Business income or short term capital gain – A. Ys. 2005-06 and 2006-07 – Transaction in shares NBFC – Whether business transactions or investment – Frequency of transactions is not conclusive test – Concurrent finding that transactions not business activity – Upheld

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CIT vs. Merlin Holdings P. Ltd.; 375 ITR 118 (Cal):

The assessee was a certified NBFC. Its main activities were giving loans and taking loans and investing in shares and securities. For the A. Ys. 2005-06 and 2006-07, the Assessing Officer opined that the activity which, according to the assessee was on investment account amounted business activity and, therefore, he treated the short term capital gains of Rs.1,01,00,000 as business income. The Commissioner (Appeal) and the Tribunal accepted the assessee’s claim that it is short term capital gain.

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

“i) The frequency of transactions in shares alone cannot show that the intention of the investor was not to make investment. The Legislature has not made any distinction on the basis of frequency of the transactions. The benefit of short term capital gains can be availed of, for any period of retention of shares upto 12 months. Although a ceiling has been provided, there is no indication as regards the floor, which can be as little as one day. The question essentially is a question of fact.

ii) The assessee had adduced proof to show that some transactions were intended to be by way of investment and some transactions were by way of speculation. The revenue had not been able to find fault from the evidence adduced. The mere fact that there were 1,000 transactions in a year or mere fact that the majority of the income was from the share dealings or that the managing director of the assessee was also the managing director of a firm of share brokers could not have any decisive value.

iii) The Commissioner (Appeals) and the Tribunal have concurrently held against the views of the Assessing Officer. On the basis of the submissions made on behalf of the Revenue, it was not possible to say that the view entertained by the Commissioner (Appeals) or the Tribunal was not a possible view. Therefore, the decision of the Tribunal could not be said to be perverse. No fruitful purpose was likely to be served by remanding the matter.”

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Business expenditure – Section 37 – A. Y. 2005- 06 – Assessee running hospital – Daughter of MD working in hospital as doctor – Expenditure on her higher studies incurred by assessee – She comes back to work in hospital – Expenditure had nexus with business of assessee – Expenditure allowable as deduction

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Mallige Medical Centre P. Ltd. vs. JCIT; 375 ITR 522 (Karn):

The assessee company was running a hospital. In the A. Y. 2005-06, it had claimed deduction of Rs.5 lakh spent for the higher education of the daughter of the managing director of the company who was working in the assessee’s hospital as a doctor. The deduction was claimed on the ground that the daughter was committed to work for the assessee after successful completion of studies. The Assessing Officer disallowed the claim for deduction. The Tribunal upheld the disallowance.

On appeal by the assessee, the Karnataka High court reversed the decision of the Tribunal and held as under:

“i) Before the expenditure was incurred, the daughter had acquired a degree in medicine. She was employed by the assessee. She was sent outside the country for acquiring higher educational qualification, which would improve the services, which the assessee was giving to its patients. It was in this context, that the sum of Rs.5 lakh was spent. That was not in dispute. After acquiring the degree she had come back and she was working with the assessee.

ii) Therefore, there was a direct nexus between the expenses incurred towards the education, with the business, which the assessee was carrying on. In that view of the matter, the expenditure was deductible.”

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[2015] 59 taxmann.com 194 (Mumbai – CESTAT) – Rathi Daga vs. CCE, Nashik

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If assessee providing taxable and exempted services and not maintaining separate records under Rule 6(2) of CENVAT Credit Rules,2004 and also fails to follow procedure under Rule 6(3A) of the said rules, it would not mean that department is justified in invoking Rule 6(3) (i) in all cases. Procedure under Rule 6(3A) needs to be followed, but disallowance should be determined rationally avoiding undue hardship to assessee.

Facts:
The appellant paid service tax under chartered accountants service and his services also included certain exempt services. It was detected by the audit team of the department that it did not maintain separate accounts for services used in providing taxable and exempted services as required under Rule 6(2) of the CENVAT Credit Rules, 2004. Before issue of Show Cause Notice, the appellant however paid an amount equivalent to CENVAT credit based on proportionate reversal method under Rule 6(3) (ii). However, the department issued Show Cause Notice, demanding payment of CENVAT credit under Rule 6(3) (i) being an amount equal to 8% / 6% of the value of exempted services, as the conditions of Rule 6(3A) were not followed.

Held:
The Tribunal after going through Rule 6(3A) of CENVAT Credit Rules,2004 observed that submission of details to department as prescribed in the said rule such as name, address and registration number etc. are mostly factual details which are available from record. It also noted that the department has not disputed the amount paid by the assessee before issue of notice as per Rule 6(3)(ii). In such circumstances, having regard to disparity of amount of CENVAT credit under both the options, it was held that It would be too harsh to enforce payment as per Rule 6(3)(i) only because of non-payment of the due amount on time as per procedure prescribed in Rule 6(3A). The Tribunal however further held that the conditions do require that option should be exercised in writing to avail the facility and amount of CENVAT credit attributable to exempted goods must be paid provisionally for every month.

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2015 (39) STR 350 (Tri.-Bang.) CCE, Cus. & S. T., Visakhapatnam – I vs. Hindustan Petroleum Corp. Ltd.

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When completion of provision of services, payment thereof and CENVAT
credit availment is prior to the date of amendment, law prior to the
date of amendment is applicable.

Facts:
The
respondents availed health insurance services in March, 2011, payment
for which was made in March, 2011. However, the insurance was for the
period from April, 2011 to September, 2011. CENVAT credit on such
services was availed in March, 2011. Definition of input services was
substantially amended with effect from 1st April, 2011 with specific
exclusions. One such exclusion was in relation to insurance services,
when such services are used primarily for personal use or consumption of
employees. Accordingly, the department denied CENVAT credit since the
period of insurance was effective from 1st April, 2011. Commissioner
(Appeals) referred to Point of Taxation Rules, 2011 and also the
definition of Point of Taxation and concluded that CENVAT credit was
allowable to the extent of completion of provision of services prior to
1st April, 2011.

Held:
It is an undisputed fact that
services were availed prior to amendment, payment was made prior to
amendment and even CENVAT credit was taken prior to amendment.
Accordingly, provisions post amendment would not be applicable to the
activities completed prior to the date of amendment. As per the
definition, “Point of Taxation” means the point in time when a service
shall be deemed to have been provided. Accordingly, since everything was
completed in March, 2011, CENVAT credit was available.

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[2015] 59 taxmann.com 13 (New Delhi – CESTAT) R.B. Steel Services vs. CCE & ST.

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The CENVAT credit on inputs used for manufacture of final product can be used for payment of duty erroneously charged on such exempted final product.

Facts:
The adjudicating authority held that converting black rods/ bars into bright bars did not amount to manufacture during the relevant period and therefore the CENVAT credit taken on capital goods/black rods/bars used for making bright bars was not admissible. The appellant paid duty on their product, namely bright bars and the total duty paid by them was more than the amount of credit taken.

Held:
The Tribunal held that, converting black rods/bars into bright bars do not amount to manufacture as the said issue is covered by the decision of the Supreme Court against the assessee. However, relying upon various judicial pronouncements including decision of the Mumbai Tribunal in the case of Ajinkya Enterprises vs. CCE 2013 (288) ELT 247 (Tri. – Mum) which has been affirmed by the Hon’ble Bombay High Court, it held that CENVAT credit is allowed.

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2015 (39) STR 331 (Tri.-Ahmd) Memories Photography Studio vs. Commr. of C. Ex. & S. T., Vadodara

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If service recipient was unaware of nonpayment of service tax by service provider before taking CENVAT credit, the same shall be allowed.

Facts:
The limited question for consideration in the present case was whether CENVAT credit can be denied to the recipient of input services if service tax is not paid by service provider. The department contended that the appellants should have taken precaution to verify the fact of discharge of service tax liability by service provider. Since service provider had not paid service tax liability, CENVAT credit was not admissible to service recipient.

Held:
Revenue could not provide any evidence on record to prove that the appellants were aware of non-payment of service tax by service provider before taking CENVAT credit. Service recipient would only see CENVATA BLE document. It was not the case of non-existence of service provider. Therefore, CENVAT credit was correctly availed.

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2015 (39) STR 256 (Tri.-Del.) Shree Tirupati Balajee Agro vs. Commissioner of C. Ex., Indore

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If the assessee is registered under service tax law even though under a different category, penalty u/s. 77 is not warranted.

Facts:
The
appellants had got service tax registration under a different category.
Department sought to levy penalty u/s. 77 of the Finance Act, 1994 for
failure to take registration.

Held:
Even though the
appellants were registered under a different category of service, they
were recognised under service tax law. Therefore, penalty under section
77 was not warranted.

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2015 (39) STR 252 (Tri.-Del.) Bharat Electronics Ltd. vs. Commissioner of C. Ex., Ghaziabad

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Central Excise duty cannot be levied on services taxable under Service tax laws.

Facts:
The appellant manufactured a minor part which was supplied to its clients with other imported goods under two divisible contracts. Excise duty was paid on the minor part, however, department demanded excise duty on services forming part of these contracts. It was argued that service component was already under adjudication under Finance Act, 1994 and the services should be automatically excluded from Central Excise laws in the present adjudication, specifically when the items were outside the purview of Central Excise. Since, Central Excise department was not aware of adjudication proceedings initiated by service tax authorities, they had requested for extension of time to verify the fact. However, even after a long time span, department did not provide any reply to the Tribunal.

Held:
The Tribunal examined appellant’s submissions and observed that the divisible contracts were executed specifically demarcating provision of services. In view of separate contracts for supply and service and laws relating to taxation of goods and services, it was held that services cannot be taxed under Central Excise laws.

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2015 (39) STR 235 (Tri.-Mum.) CCE, Pune – III vs. Maharashtra State Bureau of Text Books Production & Curriculum Research

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Communication, determining the right of the party or likely to affect the rights, is appealable even though it may not be in the nature of an ‘order’.

Facts:
In view of centralised accounting system, the appellate authority allowed facility of centralised registration at the head office of the respondents, being the recipient of Goods Transport Agency services. Revenue argued that the rejection of centralised registration was through a letter, which cannot be appealed against and only service providers can be granted with centralised registration.

Held:
It is a well-settled law that a letter, conveying grounds of rejection and also the rejection, is an appealable order. The argument, that only service providers are eligible to obtain centralised registration, is meaningless and would defeat the objective of such registration. In Indirect tax laws, registration is linked with taxpayer, which is service recipient in the present case. Since respondents satisfied the conditions for centralised registration, centralised registration was rightly allowed.

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2015 (38) STR 143 (Tri.-Bang.) Commr. of C.Ex. & ST., Tirupati. vs. Gimpex Ltd

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The date of filing refund claim even though filed before wrong authority would be taken as date of filing for determining period of limitation.

Facts:
The Assessee filed refund claim of input service before the Assistant Commissioner of Service Tax, Chennai. The claim however was returned stating that the application was to be filed with the jurisdictional Assistant Commissioner of service tax. Consequently, the Assessee filed the claim accordingly. Thereafter, the claim was rejected on ground of time-bar. The first appellate authority granted relief by holding that the refund claim cannot be rejected on the ground of limitation when the claim was originally filed in time but before wrong authority, relying on the Tribunal’s decision in case of Gujarat Tea Processors and Packers Ltd [2010 (17) STR 489 (Tri-Ahmd)]. Hence, the revenue filed the appeal.

Held:
The Tribunal held that the decision of the first appellate authority was appropriate and took the view that the date of filing of refund claim before the wrong authority to be taken as the date of filing for determining limitation and rejected the department’s appeal.

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[2015] 59 taxmann.com 402 (Madras) V.N.K. Menon & Co vs. CEST

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There cannot be said to be any suppression after the activity comes to the knowledge of the department. Hence, demand of service tax under extended period of limitation is held invalid to the extent it related to the period after statements of appellant company’s officials were recorded.

Facts:
The assessee was manufacturing on job-work basis for his principal and also collected a fixed amount as service charges towards certain services provided to the principal. The department was of the view that these expenses incurred for providing the services were in the nature of overheads essential for manufacturing activity and therefore were required to be reckoned while the assessable value of the finished goods was calculated for payment of duty. In August 1996, the department recorded statement from the officials of the assessee-company. A show cause notice was issued in October 1998 for the period 1995-96 to November 1997. The Tribunal upheld the intention of evasion for the receipt of service charges from their principal as the activities of the assessee came to light subsequent to an investigation by the department. However, it also held that, as the department was aware of the activities of the assessee after recording the statement, demand under extended period is valid only to the extent it pertains to the period prior to August 1996. Before the High Court, assessee contended that if there is no suppression post August, 1996, no extended period could be invoked post August, 1996 and, therefore, the same analogy will have to be applied for the period prior to August, 1996 as well.

Held:
The High Court affirmed the order of the Tribunal on the ground that, findings recorded by the Tribunal in so far as the period prior to August, 1996 and post August, 1996 stems from strong judicial reasoning and there is no error on record warranting interference with the well considered finding of the Tribunal.

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[2015] 59 taxmann.com 252 (Andhra Pradesh) K.V. Narayana Reddy vs. Addl. Commissioner.

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Where appeals filed against the order-inoriginal are rejected by lower appellate authorities as barred by limitation, the said order cannot be entertained by the Court under writ jurisdiction.

Facts:
The assessee filed writ petition before the High Court as both the lower appellate authorities did not entertain the appeals filed by the petitioner on the ground that it was time barred and beyond permissible period for condonation. The contention of the petitioner was that attempt to prefer appeal unsuccessfully before the appellate authority does not preclude him from maintaining the writ as at present he is remediless.

Held:
Relying upon decision of the Court in the case of Resolute Electronics (P.) Ltd. vs. Union of India [WP No.1409 of 2015] and quoting judgment of Supreme Court in the case of Singh Enterprises vs. CCE [2008] 12 STT 21 (SC), the Court held that it is not legally permissible to accept the challenge to the order in writ jurisdiction when Appellant has unsuccessfully pursued other remedies for if it is done, the writ Court will unsettle a legally settled position. Thus, where appellate authority has already decided the matter against the petitioner, the writ Court is debarred from doing so as the same binds the writ Court applying the principle of res judicata, particularly, when the appellate authority’s orders are not challenged in the writ jurisdiction. Accordingly, the writ petition was dismissed as not maintainable.

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[2015] 59 taxmann.com 195 (Madras) – CCE vs. Integral Coach Factory

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Even if assessee pays duty on clearance of final products which are exempted under Exemption Notification, goods continue to remain “exempted goods” and do not become “other than exempted goods” for the purpose of Notification No.89/95-CE dated 18/05/1995.

Facts:
The assessee manufactures excisable goods falling under Chapter 86. During the disputed period, though it was entitled for exemption under Notification No.62/95- CE dated 16/03/1995, it cleared the exempted goods on payment of duty. It however did not pay duty on ferrous and non-ferrous scrap since as per Notification No.89/95- CE dated 18/05/1995, waste parings and scrap arising in the course of manufacture of exempted goods and falling within the schedule to the Central Excise Tariff Act, 1985, were exempted from the whole of excise duty. Department issued show cause notice demanding duty on the ground that as per the proviso to the said notification, such exemption would not be applicable if waste parings and scrap cleared from a factory in which any other excisable goods other than exempted goods are also manufactured. The case of the department was that since assessee cleared the goods after payment of duty and did not avail benefit of exemption notification No.62/95- CE, the goods cleared from factory cease to be exempted goods and hence benefit of notification No.89/95-CE is also not allowed to assessee. The Tribunal decided in favour of assessee

Held:
The High Court observed that erroneous payment of duty caused the department to hold that the goods are other than exempted goods and therefore demand was made. Affirming the Tribunal’s order it was held that proviso to this Notification would not apply to the facts of the case and the erroneous payment of duty would not render the goods other than exempted goods. Hence, so long as the goods manufactured are exempted goods, waste parings, scrap arising in the course of the manufacture of exempted goods would be entitled for the exemption.

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[2015] 59 taxmann.com 196 (Karnataka) – CCE vs. Federal Mogul TPR India Ltd.

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Notification No.8/2005-ST dated 01/03/2005 is not an absolute exemption notification. Further, unlike section 5A of Central Excise Act, 1944 exemption notifications u/s. 93 of the Act are optional.

Facts:
The assessee manufacturer sent goods to their sister concern for Chrome Plating on job work basis. After completion of the process of chrome plating, the sister concern returned the said goods to the assessee under cover of an invoice on payment of service tax on the value of job work charges and subsequently on receipt of such job worked goods, the assessee availed CENVAT credit of service tax so passed on by its sister concern. The job worked goods thereafter passed through various manufacturing processes at the assessee’s factory and then were cleared on payment of duty. As per department’s contention, the process of chrome plating does not amount to manufacture in terms of section 2(f) of the Central Excise Act, 1944 but is a “business auxiliary service” liable for payment of service tax. However an exemption is granted under Notification No. 8/2005- ST dated 01/03/2005 to taxable service of production of goods on behalf of the client on which appropriate duty is paid by the principal manufacturer. According to the department the said exemption notification is an unconditional notification and section 5A(1A) of the Central Excise Act, 1944 which mandates the assessee to avail the exemption notification is applicable to the facts of the case. Therefore, service tax has been charged wrongly in order to pass on service tax credit to assessee. The Tribunal decided in favour of assessee and the revenue is in appeal.

Held:
The High Court observed that, the said Exemption Notification applies only in cases where such goods are produced using raw materials or semi-finished goods supplied by the client i.e. the principal manufacturer and goods so produced are returned to the said client for use in or in relation to the manufacture of the goods on which appropriate duty of excise is paid.

Therefore the High Court held that the conditions stipulated in the notification establish that it is a conditional notification. As regards applicability of section 5A of the Central Excise Act, 1944 it was held that the mandatory requirement on the manufacturer of such excisable goods of not to pay the duty of excise on such goods in respect of which an exemption u/s 5A(1A) has been granted absolutely is not found in section 93 of the Finance Act, 1994. Further, absence of section 5A of Central Excise Act, in section 83 of the Finance Act, 1994, which provides for application of certain provisions of the Central Excise Act,1944 in relation to service tax, indicates that the provisions of section 5A of Central Excise Act, are not applicable to the Finance Act, 1994. Accordingly, the Tribunal order was upheld and CENVAT credit of the service tax paid by the job worker was allowed to the assessee.

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2015 (39) STR 24 (Mad.) V. Sathyamoorthy & Co. vs. CESTAT Chennai.

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A Tribunal can grant three adjournments in an appeal and if Tribunal decides the stay application ex-parte before granting three adjournments on the ground that Appellants have adopted dilatory tactics by not appearing and thereby abusing the law, the action of the Tribunal would be too harsh.

Facts:
The department during the adjudication passed an ex-parte order confirming the demand on Appellants. Appellants filed appeal and stay petition before Tribunal. Before the date of hearing on stay application, Appellants sought adjournment by filing request letter. Tribunal granted an adjournment without even taking into account the said request letter on record. Before the next date, Advocate of Appellant requested an adjournment vide a request letter. Tribunal on that occasion overlooked the letter and passed an ex-parte stay order stating that since no plea of financial hardship was taken, Appellant was directed to pre-deposit Rs.4 crore and also recorded that the Appellants had not cooperated during the adjudication process and also in the present appeal proceedings which amounted to abuse of the process of law.

Held:
Appellants challenged the said ex-parte order before the High Court stating that the Tribunal is entitled to grant three adjournments to a particular party as per proviso to section 35C of the Central Excise Act. The High Court observed that the Tribunal’s action of deciding the stay petition ex-parte on second adjournment and that too ignoring the Appellants request for an adjournment terming non-appearance as abuse to process of law is too harsh. Accordingly, the case was remanded to Tribunal for reconsideration and directed Appellants not to seek adjournment on the next date.

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2015 (39) STR 22 (Kar.) Atharva Associates vs. Union of India

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If the appeal has been filed along with stay application and neither stay application nor appeal has been disposed of, then recovery cannot be initiated.

Facts:
An Order was passed confirming demand proposed in the Show Cause Notice. Appellants preferred an appeal before first appellate authority along with stay application which was not disposed of. Meantime, the department initiated recovery proceedings by issuing notice for recovery. Appellants filed writ petition challenging the said recovery notice.

Held:
The High Court held that since the right of appeal has been exercised by the Appellants as per applicable provisions and since first appellate authority has yet to decide the stay application, the recovery notices though executable, could not be enforced or else the appeal will be infructuous or lead to multiplicity of proceedings. Enforcement of recovery was thus stayed till disposal of the stay petition by the first appellate authority.

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Free supply vis-a-vis Sale and Sale Price

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Under the Sales Tax Law, transaction of sale can be taxed as per sale price of that transaction.

A ‘sale’ can take place if the transaction fulfills certain criteria. The term ‘sale’ is defined in Sales Tax Laws and it has also been defined in (MVAT Act,2002). The said definition is given in section 2(24) of MVAT Act,2002 and it is reproduced below for ready reference.

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

The transaction, to be ‘sale’, should be for consideration.

The above term ‘sale’ has also been subject matter of interpretation by various courts. A reference can be made to the landmark judgment in case of Gannon Dunkerly and Co.(9 STC 353)(SC). In this judgment about ‘sale’, it is observed as under:

“Thus, according to the law both of England and of India, in order to constitute a sale it is necessary that there should be an agreement between the parties for the purpose of transferring title to goods, which of course presupposes capacity to contract, that it must be supported by money consideration, and that as a result of the transaction property must actually pass in the goods ……”

From the above passage, it is clear that to be a ‘sale’ following criteria should be fulfilled.

(i) There should be two parties to contract i.e. seller/ purchaser,
(ii) The subject matter of sale is moveable goods,
(iii) There must be money consideration and
(iv) Transfer of property i.e. transfer of ownership from seller to purchaser.

Thus, to consider the transaction as ‘sale’, consideration in money terms is necessary. Without consideration, no sale can take place.

In number of cases, the customer i.e. buyer may supply certain goods to its vendor which are to be incorporated in the finished goods to be supplied by vendor to the said buyer. Similarly there may be cases, where contractee may be supplying some goods to be used in contract to be executed for it by contractor appointed by it. Both above issues are common and the tax position of same can be analysed as under:

The supply of such goods by buyer to the vendor will be free supply, as it is to be incorporated in goods to be supplied to it. It is also possible that for the purpose of Excise etc. the vendor may be required to include value of such goods in its sale price and after calculating Excise on such total value, the value of free supply by buyer will be deducted again and in fact the net amount is only charged to the buyer.

The issue arises whether such value of free supply is part of sale price of vendor for which it will be required to discharge sales tax on the same.

There is a be possibility of considering above value as sale price, if, first there is sale by buyer of said goods to the vendor and thereafter vendor again selling the said goods along with its finished goods to the buyer. Therefore, it will be required to be seen whether there is sale by buyer of the free supply made by it to the vendor.

There are instances where supply made by customer to supplier has been considered as sale and accordingly liable to tax in the hands of customer as well as supplier. Reference can be made to the judgment of Supreme Court in case of M/s. N. M. Goel (72 STC 368)(SC). In this case, the facts were that the contractee has given certain materials to contractor for use in the contract executed for the said contractee. As per terms in contract the goods to be supplied were to be valued as per the prices mentioned in the contract. It is under the above circumstances, the Supreme Court held that the transaction of supply of goods by contractee fulfills the requirements of a transaction being ‘sale’. There are two parties i.e. contractee and contractor, supply of moveable goods and consideration. The Supreme Court also held that when the possession of the goods is given to the contractor there is transfer of property and hence, the sale transaction from contractee to contractor gets complete. The Supreme Court further held that when contractor uses these goods in the contract for contractee, there is again fresh transfer of property from contractor to contractee and hence one more sale transaction from contractor to contractee. In fact, the Supreme Court has noted facts of case as under.

“The appellant, a dealer registered under the Madhya Pradesh General Sales Tax Act, 1958, made an item rate tender to the PWD for construction of food grain godowns and ancillary buildings. In that tender, prices of the materials used for the construction including cost of iron, steel and cement were included. The PWD had, however, agreed to supply from its stores the iron, steel and cement and to deduct the prices of the materials so supplied and consumed in the construction, from the final bill of the appellant. Clause (10) of the contract provided: “. . . . . if it is required that the contractor shall use certain stores to be provided by the Engineer-in-Charge as shown in the Schedule of materials hereto annexed, the contractor shall be bound to procure and shall be supplied such material and stores as are from time to time required to be used by him for the purposes of the contract only, and the value of the full quantity of materials and stores supplied at the rates specified in the said Schedule of materials may be set-off or deducted from any sums then due or thereafter to become due to the contractor under the contract or otherwise, or against or from the security deposit, or the proceeds or sale thereof if the same is held in Government securities, the same or a sufficient portion thereof being in this case sold for the purpose. All the materials so supplied to the contractor shall remain the absolute property of the Government and shall not be removed on any account from the site of the work, and shall be at all times open to inspection by the Engineer-in- Charge.” For the construction, the appellant was supplied iron, steel and cement by the PWD and the appellant purchased other materials from the market. The prices of iron, steel and cement supplied to the appellant for the work were deducted from its final bill. The Sales Tax Officer assessed the appellant to entry tax for iron, steel and cement u/s. 6(c) of the Madhya Pradesh Sthaniya Kshetra Me Mal Ke Pravesh Par Kar Adhiniyam, 1976, on the ground that their entry had been effected by the PWD, which was not a registered dealer, at the instance of the appellant, because the appellant had ultimately used the materials for the construction work; and the Deputy Commissioner affirmed the assessments on revision. A writ petition filed by the appellant challenging the assessments to entry tax was dismissed by the High Court. On appeal to the Supreme Court:

Based on the above, the Supreme Court has held as under:

“On these set of facts, while dismissing the appeal, (i) that since the PWD was not a registered dealer the presumption u/s. 6(c) applied, that the entry of the goods had been effected by the appellant into the local area before they were purchased by the appellant; that in order to attract entry tax not only the property in the goods had to pass from the PWD to the appellant but there had to be an independent contract-separate and distinct-apart from the mere passing of the property: mere passing of property from the PWD to the appellant would not suffice; that, in this case, for the performance of the contract, the appellant was bound to procure the materials; but in order to ensure that quality materials were procured, the PWD undertook to supply such materials and stores as from time to time were required by the appellant to be used for the purpose of performing the contract only. The value of such quantity of materials and stores so supplied was specified at a rate and got set-off or deducted from any sum due or to become due thereafter to the appellant. Clause (10) of the contract read in proper light indicated that a sale inhered from the transaction. By the use or consumption of materials in the work of construction, there was passing of the property in the goods to the appellant from the PWD. By appropriation and by the agreement, there was a sale from the PWD to the appellant as envisaged in terms of clause (10); and that, therefore, the appellant was liable to pay entry tax on the materials supplied by the PWD.”

Based on above judgment of Supreme Court there are number of other judgments where the supply of goods by contractee to contractor has been held as ‘sale’, if such supply is against pre agreed price. In such cases, normally the contractor bills for gross value and gives deduction for the material value as arrived at as per the prices agreed and claims net amount from the contractee. Thus, if such is the mode of billing by the contractor it gives sufficient indication that the supply by the contractee is as per agreed price and hence will be considered to be ‘sale’. In such cases, even if, the supply is referred to as free supply, it will be a misnomer and in reality it will be a ‘sale’ from contractee to contractor and again from contractor to contractee.

However, if there is no such situation i.e. no prices are given for the materials supplied by contractee/buyer as well as no deduction for any value for same is made in the bills of contractor, then there is no sale/purchase of such materials. This position is also clear from judgment of the Hon. Tribunal in case of CIDCO Ltd. (M.A. No.122 of 2005 in S.A. no. 1707 of 1999 DT.6.10.2007).

In this case, the appellant has purchased cement from other state and given free to contractor. In assessment, tax was levied but in first appeal the same was deleted. When the appellant was in second appeal, the Department filed Misc. Application for levy of the tax on cement. The Hon. Tribunal held that when the supply is free of cost there is no question of levy and the Misc. Appl. was rejected. This covers up the legal position. The net result is that if in the contract there are no terms giving price to the goods to be supplied to contractor, and accordingly the same is also not considered in the bills prepared by the contractor, there is no question of any sale transaction involved in such supply. In other words, there is no question of attraction of any tax under Sales Tax Laws on such free supply on either side.

The other situation is consideration of value of such supply for Excise purpose.

For purpose of paying Excise duty the vendor may consider the value of goods supplied by buyer and may be mentioned on the invoice also.

However mentioning the value of goods for payment of Excise duty cannot amount to sale/purchase and cannot bring it in fold of sale price/purchase price.

This position is clear from judgment of the Hon. Tribunal in case of Ghadge Patil Ind. Ltd. & others (S. A. 320 to 327 of 2002 dt.30.3.2007). The short gist of judgment is as under:

The facts of the case relating to year 1994-95 and others are that appellant received an order for supply of certain manufactured parts. The buyer gave certain parts as free issue to be incorporated in the manufactured goods. In purchase order there was no term about creditor particular price to be considered for the said free issues. In its sale bill appellant added the cost of such free issues in his price to calculate excise duty. The cost so added was then given deduction. On above facts lower authorities considered the cost of such supplies as part of sale price and levied tax on the same. Before the Tribunal, appellant explained the facts. The Tribunal observed that in this case the supplies are not made with any particular consideration. There was no intention on part of buyer or seller to sale/ purchase above goods nor agreed for any consideration. Therefore, there cannot be sale from appellant to buyer. The addition in price was with sole purpose of calculating duty, as it was attracted even on free supply cost, as per Excise laws. The Tribunal distinguished the judgment in case of N. M. Goyal (72 STC 368) on above facts. The Tribunal made reference to judgment in case of Gannon Dunkerley & Co. (9 STC 353), Indian Coffee & Tea Distributors Co. (6 STC 47), Indian Alluminium Cables (115 STC 161), Hindustan Aeronautical Ltd. (55 STC 314) and Auto Comp Corpn. (S.A.1083 of 99 dt.26.9.2003). The Tribunal directed to delete the addition.

Thus, it is held that for considering the free supply value as sale/purchase there should be conscious decision on the same which can be ascertained from the fact of giving prices for such supply and billing mode by supplier. Simply mentioning value for Excise duty calculation cannot make it sale/purchase, and cannot be part of price of transaction, nor can it be included in sale price.

Conclusion

Whether free supply by buyer/contractee to the vendor/ contractor will amount to sale/purchase depends upon intention of the parties coupled with underlying documents. To make the intention clear, in documents it should be specifically mentioned that the supply is free to the vendor but the value may be considered for excise payment. If the documents are not clear, then the dispute may arise and the sales tax department will certainly try to claim tax on the same.

RECENT AMENDMENTS: INTEREST ON CENVA T CREDIT WRONGLY TAKEN

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Preliminary
The issue whether interest is leviable at the point of time when CENVAT credit is wrongly taken or at the point of utilization has been a matter of extensive judicial examination. An important amendment was made in Rule 14 of CENVAT Rules through Notification dated 17/03/2012 and further a significant amendment has been made vide Notification dated. 01/3/2015. Hence, the implication of the latest amendment in the backdrop of the earlier judicial controversies, are discussed hereafter.

Background
Relevant Statutory Provisions – [Rule 14 of CENVAT Credit Rules, 2004 (“CCR”)]

“Where CENVAT credit has been taken or utilized wrongly or has been erroneously refunded, the same along with the interest shall be recovered from the manufacturer or provider of the output service and the provisions of the sections 11A and 11AB of the Excise Act, or sections 73 and 75 of the Finance Act, shall apply mutatis mutandis for effecting such recoveries.”

[Note – The words “taken or utilized wrongly” have been substituted by the words “taken and utilized wrongly” vide Notification No. 18/2012 – CE(NT) dated 17/03/2012].

Supreme Court Ruling overruling High Court Ruling

Attention is particularly drawn to the ruling of the Punjab & Haryana High Court in the case of Ind – Swift Laboratories Ltd. vs. UOI (2009) 240 ELT 328 (P & H) (which was subsequently set aside by the Supreme Court), relevant extracts from which, are reproduced hereafter for reference :

Para 9

“The Scheme of the Act and the CENVAT credit Rules framed thereunder permit a manufacturer or producer of final products or a provider of taxable service to take CENVAT credit in respect of duty of excise and such other duties as specified. The conditions for allowing CENVAT credit are contained in Rule 4 of the Credit Rules contemplating that CENVAT credit can be taken immediately on receipt of the inputs in the factory of the manufacturer or in the premises of the provider of output service. Such CENVAT credit can be utilized in terms of Rule 3(4) of Credit Rules for payment of any duty of excise on any final product and as contemplated in the aforesaid sub-rule. It, thus, transpires that CENVAT credit is the benefit of duties leviable or paid as specified in Rule 3(1) used in the manufacture of intermediate products etc. In other words, it is a credit of the duties already leviable or paid. Such credit in respect of duties already paid can be adjusted for payment of duties payable under the Act and the Rules framed thereunder. Under section 11AB of the Act, liability to pay interest arises in respect of any duty of excise has not been levied or paid or has been short levied or short paid or erroneously refunded from the first day of the month in which the duty ought to have been paid. Interest is leviable if duty of excise has not been levied or paid. Interest can be claimed or levied for the reason that there is delay in the payment of duties. The interest is compensatory in nature as the penalty is chargeable separately.”

Para 10

“In Pratibha Processors vs. Union of India, 1996 (88) ELT 12 (SC) = (1996) 11 SCC 101, it was held that interest is compensatory in character and is imposed on an assessee who has withheld payment of any tax as and when it is due and payable. Similarly, in Commissioner of Customs vs. Jayathi Krishna & Co. – 2000 (119) ELT 4(SC) (2000) 9 SCC 402, it was held that interest on warehoused goods is merely an accessory to the principal and if principal is not payable, so is it for interest on it. In view of the aforesaid principle, we are of the opinion that no liability of payment of any excise duty arises when the petitioner availed CENVAT credit. The liability to pay duty arises only at the time of utilization. Even if CENVAT credit has been wrongly taken, that does not lead to levy of interest as liability of payment of excise duty does not arise with such availment of CENVAT credit by an assessee. Therefore, interest is not payable on the amount of CENVAT credit availed of and not utilized.”

Para 11

“Reliance of respondents on Rule 14 of the Credit Rules that interest under section 11AB of the Act is payable even if CENVAT credit has been taken. In our view, said clause has to be read down to mean that where CENVAT credit taken and utilized wrongly, interest cannot be claimed simply for the reason that the CENVAT credit has been wrongly taken as such availment by itself does not create any liability of payment of excise duty. On a conjoint reading of section 11AB of the Act and that of Rules 3 and 4 of the Credit Rules, we hold that interest cannot be claimed from the date of wrong availment of CENVAT credit. The interest shall be payable from the date CENVAT credit is wrongly utilized.”

In an important ruling the Supreme Court, in the case of Ind-Swift Laboratories Ltd. (2011) 265 ELT 3 (S.C.)], set aside the order passed by the Punjab & Haryana High Court (2009) 240 ELT 328 (P & H)] on the question of charging interest on CENVAT credit wrongly taken but not utilised. By interpreting the expressions and words used in the provisions of Rule 14 of CCR, the Supreme Court concluded that interest is payable on CENVAT credit wrongly taken even if such credit has not been utilised.

The issue for consideration was whether an assessee can be made liable to pay interest for taking wrong credit if such credit has not been utilised in as much as he has not derived any benefit out of his wrong action.

The more important observations of the Supreme Court are reproduced hereafter for ready reference:

Para 17

“…………….. In our considered opinion, the High Court misread and misinterprets the aforesaid Rule 14 and wrongly read it down without properly appreciating the scope and limitation thereof. A statutory provision is generally read down in order to save the said provision from being declared unconstitutional or illegal. Rule 14 specifically provides that where CENVAT credit has been taken or utilized would be recovered from the manufacturer or the provider of the output service. The issue is as to whether the aforesaid word “OR” appearing in Rule 14, twice, could be read as “AND” by way of reading it down as has been done by the High Court. If the aforesaid provision is read as a whole we find no reason to read the word ‘OR’ in between the expression ‘taken’ or “utilized wrongly” or has been erroneously refunded’ as the word ‘AND’. On the happening of any of the three aforesaid circumstances such credit becomes recoverable along with interest.”

Para 18

“We do not feel that any other harmonious construction is required to be given to the aforesaid expression / provision which is clear and unambiguous as it exists all by itself. So far as section 11AB is concerned, the same becomes relevant and applicable for the purpose of making recovery of the amount due and payable. Therefore, the High Court erroneously held that interest cannot be claimed from the date of wrong availment of CENVAT credit and that it should only be payable from the date when CENVAT credit is wrongly utilized. Besides, the rule of reading down is in itself a rule of harmonious construction in a different name. It is generally utilized to straighten the crudities or ironing out the creases to make a statue workable. This Court has repeatedly laid down that in the garb of reading down a provision it is not open to read words and expressions not found in the provision statute and thus venture into a kind of judicial legislation. It is also held by this Court that the Rule of reading down is to be used for the limited purpose of making a particular provision workable and to bring it in harmony with other provisions of the statute.”

The interpretation made by the Honorable Supreme Court considering the specific circumstances of a case involving evasion of duty, has been a matter of extensive deliberation by experts and rightly so in as much as if the same is applied generally, it would mean unsettling the settled law.

Important Ruling of Karnataka High Court in CCE & ST vs. Bill Forge Pvt. Ltd. (2012) 26 STR 204 (KAR) [Bill Forge Case]

    The observations of the Karnataka High Court in the Bill Forge case are very important, in as much as not only has it distinguished facts of the case of UOI vs. Ind-Swift Laboratories Ltd. (2011) 265 ELT 3 (SC) but it has made fine distinction between making an entry in the register and credit being ‘taken’ to drive home the point that interest is payable only from the date when duty is legally payable to the Government and the Government would sustain loss to that extent.

“It is also to be noticed that in the aforesaid Rule, the word ‘avail’ is not used. The words used are ‘taken’ or “utilized wrongly”. Further the said provision makes it clear that the interest shall be recovered in terms of sections 11A and 11B of the Act………”

Para 20

“From the aforesaid discussion what emerges is that the credit of excise duty in the register maintained for the said purpose is only a book entry. It might be utilized later for payment of excise duty on the excisable product………Before utilization of such credit, the entry has been reversed, it amounts to not taking credit.”

Para 22

“Therefore interest is payable from that date though in fact by such entry the Revenue is not put to any loss at all. When once the wrong entry was pointed out, being convinced, the assessee has promptly reversed the entry. In other words, he did not take the advantage of wrong entry. He did not take the CENVAT credit or utilized the CENVAT credit. It is in those circumstances the Tribunal was justified in holding that when the assessee has not taken the benefit of the CENVAT credit, there is no liability to pay interest. Before it can be taken, it had been reversed. In other words, once the entry was reversed, it is as if that the CENVAT credit was not available. Therefore, the said judgment of the Apex Court has no application to the facts of this case. It is only when the assessee had taken the credit, in other words, by taking such credit, if he had not paid the duty which is legally due to the Government, the Government would have sustained loss to that extent. Then the liability to pay interest from the date the amount became due arises under section 11AB, in order to compensate the Government which was deprived of the duty on the date it became due.”

  •     The ruling in Bill Forge case has been followed in a large number of subsequently decided cases. For example:

    CCE vs. Pearl Insulation Ltd. (2012) 27 STR 337 (KAR)

    CCE vs. Gokuldas Images (P) Ltd (2012) 28 STR 214 (KAR)

    CCE vs. Strategic Engineering (P) Ltd (2014) 45 GST 662 (MAD)

    Sharvathy Conductors Pvt. Ltd. vs. CCE (2013) 31 STR 47 (Tri – Bang)

    CCE vs. Sharda Energy & Minerals Ltd. (2013) 291 ELT 404 (Tri – Del)

    Gary Pharmaceuticals (P) Ltd vs. CCE (2013) 297 ELT 391 (Tri – Del)

    CCE vs. Balrampur Chinni Mills Ltd (2014) 300 ELT 449 (Tri – Del)

    Gurmehar Construction vs. CCE (2014) 36 STR 545 (Tri – Del)

  •     However, in many cases, Bill Forge case has not been followed and instead the position held by the Supreme Court in the Ind Swift case has been followed. For example:

    Dr Reddy Laboratories Ltd vs. CCE (2013) 293 ELT 89 (Tri)

    Bharat Heavy Electricals Ltd vs. CC & CCE (2014) 303 ELT 139 (Tri – Bang)

    CCE vs. Sundaram Fasteners Limited (2014) 304 ELT 7 (MAD)

    Balmer Lawrie & Co. Ltd vs. CCE (2014) 301 ELT 573 (Tri – Mumbai)

Important amendment in Rule 14 of CCR

In a very significant amendment in Rule 14 of CCR, with effect from 17/03/2012, the words CENVAT credit has been “taken or utilized wrongly” have been substituted by the words “taken and utilized wrongly”.

This amendment strongly reinforces the interpretation placed by the Punjab & Haryana High Court in Maruti Udyog Ind Swift Laboratories and Karnataka High Court in Bill Forge case to the effect that, no interest can be recovered in cases where CENVAT credit has been wrongly taken but not utilized by an assessee.

    Recent Amendment: Analysis

In the recent Budget, Rule 14 of CCR has been amended vide Notification No. 6/2015-Central Excise (NT) dated 01/03/2015. The amended Rule 14 reads as under:

“14. Recovery of CENVAT credit wrongly taken or erroneously refunded. –

“(1) (i) Where the CENVAT credit has been taken wrongly but not utilized, the same shall be recovered from the manufacturer or the provider of output service, as the case may be and the provisions of section 11A of the Excise Act or section 73 of the Finance Act, 1994 (32 of 1994), as the case may be, shall apply mutatis mutandis for effecting such recoveries;

(ii) Where the CENVAT credit has been taken and utilized wrongly or has been erroneously refunded, the same shall be recovered along with interest from the manufacturer or the provider of output service, as the case may be and the provisions of sections 11A and 11AA of the Excise Act or sections 73 and 75 of the Finance Act, 1994, as the case may be, shall apply mutatis mutandis for effecting such recoveries.

    For the purposes of sub-rule (1), all credits taken during a month shall be deemed to have been taken on the last day of the month and the utilization thereof shall be deemed to have occurred in the following manner, namely: –

    i)the opening balance of the month has been utilized first;
    ii)credit admissible in terms of these rules taken during the month has been utilized next;
    iii)credit inadmissible in terms of these rules taken during the month has been utilized thereafter.”
The amended Rule 14(1) of CCR deals with two distinct situations viz.

  •     one where credit has been wrongly taken but not utilised and
  •     the other where credit has been wrongly taken and also utilised.

Further, to deal with a scenario, where credit has been utilised, a deeming provision has been brought in through new sub-rule 14(2), to lay down the manner in which the utilisation shall be deemed to have occurred.

  •     Prior to the introduction of this sub-rule, the assessee used to avail CENVAT credit even where the eligibility of CENVAT credit was in dispute. As long as the balance of CENVAT credit in the books of the assessee was more than the amount of the disputed CENVAT credit, it was construed that the disputed amount of CENVAT credit availed by the assessee had not been utilised and consequently, the proceedings under Rule 14 of CCR for recovery of credit and interest thereon could not be initiated against it.

However, after the above amendment, the manner prescribed therein will have to be applied to determine the utilisation of ineligible credit or otherwise.

  •     The larger view of trade & industry and tax payers generally is that the amended Rule 14 of CCR continues to be in line with Government’s consistent view to the effect that:

  •     recovery of interest along with CENVAT credit would be applicable only in those situations where the assessee takes credit and also utilises the same; and

  •     in those cases, where the assessee takes CENVAT credit but does not utilise such credit for specified reasons, recovery would be only of credit wrongly taken and the question of any recovery towards interest does not arise at all.

  •     A better view which may be adopted while interpreting Rule 14(2) of CCR is that the opening balance of CENVAT credit should only include the admissible amount of CENVAT credit and the inadmissible amount of CENVAT credit should be recorded separately. In such a case, while computing the amount of CENVAT credit utilized in a particular month, the total admissible amount of CENVAT credit available with the assessee will have to be taken into account first and the inadmissible amount of CENVAT credit will be said to be utilised only after the admissible CENVAT credit is exhausted. In such a case, an assessee will become liable to pay interest only in those cases where the balance of inadmissible CENVAT credit available with it is less than the credit utilised in a month.

This view can be supported by the following reasons :

  •     the earlier rule was silent regarding manner of utilisation, the amendment in the said rule has been made as a matter of trade facilitation exercise.
  •     it is consistent with the leniency shown in the past when the provision of Rule 14 was amended to overcome the adverse impact of Supreme Court decision in case of Ind-Swift.

It is a need of every business and tax payer to keep some amount of CENVAT credit on hold without utilizing the same for excise duty payment or payment of service tax.

Eligibility to CENVAT credit is prone to extensive litigations. Hence, in many cases where credit eligibility is of a doubtful and disputable nature and could often involve substantially high amount, tax payers often opt to avail credits to protect their rights but choose not to utilize the credits pending clarity & judicial evolvement, so as to avoid any interest liability in case the matter is decided adversely.

However, in the amended Rule 14 (2) of CCR, due to employment of the words “For the purposes of sub-rule
(1)”, there is an apprehension that the field formations may erroneously interpret that the deeming provisions laid down in Rule 14(2) would also apply to the cases covered under Rule 14 (1) (i).

Further, to arrive at the due date for interest payable the Rule 14(2) is creating a deeming fiction that all the credits taken during a month shall be deemed to have been taken on the last day of the month and the utilisation thereof shall be deemed to have occurred in the following manner, namely:-

    the opening balance of the month has been utilised first;
    ………………..

    ………………..
It is apprehended by trade and industry that credits kept on hold during any month form part of the opening balance of the next month, the field formations may interpret the same to be deemed utilised and thus liable for interest. This could result in unnecessary litigations and hardships to trade and industry and tax payers generally.

Conclusion:

The amendment in Rule 14 of CCR vide Notification dated 01/03/2015 needs to be understood, in the backdrop of introduction of time limits for availment of credit under CCR, for the first time with effect from 01/09/2014. In cases where availment of CENVAT credits was of a doubtful nature/under litigations, substantial amounts of credits were availed by tax payers prior to 01/09/2014 (but kept unutilised) in order to protect their interest in a scenario where matter gets decided in their favour at a future point of time and at the same time, avoiding any interest liability in case the matter is decided against them.

Further, in the absence of specific provisions under CCR or clarification by CBEC, in practice, no systematic records are maintained by assessees with regard to CENVAT credits utilised but not availed. This would create practical difficulties for the audit team/field formations to ascertain correctness of credit utilisation and interest liability on wrong utilisation. It appears that though legislative intent behind the amendment is laudable, there is a clear disconnect in the fine print that has emerged. This leaves room for doubts and possible hardships to trade and industry and tax payers from the field formations.

Suggestions:

Appropriate amendment should be made in Rule 14(2) of CCR to avoid unnecessary litigations.

Alternatively, CBEC should issue suitable clarifications / instructions to the effect that :

the deeming provisions in Rule 14(2) would apply only in those cases where inadmissible credit has been taken and also utilised; and

On lines with Instructions under erstwhile MODVAT Rules, [Ref – Circular No. 4/91 – Cx 8 dated 14/02/91 (File No. 263/5/91-CX – 8)] lay down detailed procedure to be followed by assessees who desire not to utilise the credit taken by them in order to ensure that they are covered under Rule 14(1)(i) of CCR.

Rollatainers Ltd. vs. ACIT ITAT Delhi `F’ Bench Before R. S. Syal (AM) and C. M. Garg (JM) ITA No. 3134 /Del/2010 Assessment Year: 2003-04. Decided on: 6th August, 2015. Counsel for assessee / revenue : Gaurav Jain / Vikram Sahay

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Section 147 – Internal audit cannot perform functions of judicial supervision. Initiation of re-assessment on the basis of an interpretation of the provisions of law by the audit party is forbidden, the communication of law or the factual inconsistencies by the internal audit party, do not operate as a hindrance in the initiation of re-assessment proceedings.

Facts:
The assessee filed its return of income declaring a loss of Rs.12,48,92,067. The Assessing Officer (AO) completed the assessment u/s. 143(3) of the Act determining the loss at Rs.11,32,76,728. While assessing the total income the AO allowed deduction of Rs.3,61,75,597 out of unpaid interest of earlier year amounting to Rs.5,01,38,035 u/s. 43B on the basis of the claim of the assessee that it was discharged / paid.

The audit scrutiny of the assessment records revealed that out of the amount of Rs.3,61,75,597 which was allowed by the AO as a deduction, a sum of Rs.2,45,01,117 was transferred to a wholly owned subsidiary company. The audit party pointed out to the AO that this sum of Rs. 2,45,01,117 was not actually paid but only transferred to subsidiary company and consequently it ought to have been disallowed.

The AO, after recording reasons, issued notice u/s. 148 of the Act. In the order passed u/s. 143(3) r.ws. 147 of the Act, the AO disallowed the claim of Rs.2,45,01,117.

Aggrieved, the assessee preferred an appeal to CIT(A) who upheld the action of the AO in reopening the assessment and also on merits.

Aggrieved, the assessee preferred an appeal to the Tribunal where interalia, it challenged the re-opening on the ground that in view of the ratio of the decision of the Apex Court in the case of Indian and Eastern Newspaper Society vs. CIT 119 ITR 996 (SC) initiation of reassessment on the basis of internal audit report was not sustainable.

Held:
The Tribunal noted that it had to examine whether the assessee’s case fell within the ratio laid down in the case of CIT vs. PVS Beedis Pvt. Ltd. 237 ITR 13 (SC) in which the initiation of reassessment proceedings on the basis of audit objection has been held to be valid or in Indian and Eastern Newspaper Society (supra) and further CIT vs. Lucas T.V.S. Ltd. 249 ITR 306 (SC).

The logic in not sustaining the initiation of reassessment on the basis of interpretation of law by the audit party is that the internal auditor cannot be allowed to perform the functions of judicial supervision over the Income-tax authorities by suggesting to the AO about how a provision should be interpreted and whether the interpretation so given by the AO to a particular provision of the Act is right or wrong. An interpretation to a provision given by the audit party cannot be construed as a declaration of law binding on the AO.When an internal audit party objects to the interpretation given by the AO to a provision and proposes substitution of such interpretation with the one it feels right, it crosses its jurisdiction and enters into the realm of judicial supervision, which it is not authorised to do. In such circumstances, the initiation of reassessment, based on the substituted interpretation of a provision by the internal audit party, cannot be sustained.

The Tribunal noted that the Madras High Court has in the case of CIT vs. First Leasing Co. of India Ltd. 241 ITR 248 (Mad) aptly explained the position that although, the audit party is not entitled to judicially interpret a provision, but at the same time, it can communicate the law to the AO, which he omitted to consider. It also noted that the Madras High Court has observed that the Supreme Court has made a distinction between the communication of law and interpretation of law.

Where the audit party interprets the provision of law in a manner contrary to what the AO had done, it does not lay down a valid foundation for the initiation of reassessment proceedings. If however, the audit party does not offer its own interpretation to the provisions and simply communicates the existence of law to the AO or any other factual inaccuracy, then the initiation of reassessment proceedings on such basis cannot be faulted with.

In a nutshell, whereas the initiation of reassessment proceedings on the basis of an interpretation to the provisions of law by the audit party is forbidden, the communication of law or the factual inconsistencies by the internal audit party, do not operate as a hindrance in the initiation of reassessment proceedings.

The Tribunal noted the audit objection, in this case, divulged that the audit party simply suggested that the interest of Rs.2.45 crore was not actually paid, but, only transferred to a subsidiary company and the same should have been disallowed and this omission on the part of the AO resulted in over assessment of loss of Rs.2.45 crore. This, according to the Tribunal, showed that the AO was simply informed of the fact which had escaped his attention during the course of assessment proceedings to the effect that the sum of Rs.2.45 crore was not allowable u/s. 43B of the Act which is nothing, but a communication of law to the AO. The Tribunal observed that it was not confronted with a situation in which the AO, after due consideration of the matter in the original assessment proceedings interpreted 43B as allowing deduction for a sum of Rs.2.45 crore in respect of interest not paid to financial institutions, but, transferred to assessee’s wholly owned subsidiary company, but, the audit party interpreted this provision in a different manner from the way in which it was interpreted by the AO and then suggested that the amount ought to have been charged to tax. According to the Tribunal, the instant case is fully covered by the decision in the case of PVS Beedis Pvt. Ltd. (supra) and consequently the audit objection in the instant case constituted an `information’ about the escapement of income to the AO, thereby justifying the initiation of reassessment.

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Malineni Babulu (HUF) vs. Income Tax Officer ITAT “A” Bench, Hyderabad P. Madhavi Devi (J.M.) and Inturi Rama Rao (A. M.) I.T.A. No.: 1326/HYD/2014 Assessment Year: 2009-10. Decided on 07-08-2015 Counsel for Assessee / Revenue: S. Rama Rao/ D. Srinivas

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Section 40(a)(ia) – Non deduction of tax at source on interest paid as payees furnished Form 15H – Mere non-filing of Form 15H would not entail disallowance of interest paid.

Facts:
One of the issues before the Tribunal was regarding addition of Rs.0.98 lakh made under the provisions of Section 40(a)(ia). During the year, the appellant had made interest payment of Rs.0.98 lakh to the coparceners of the appellant. It was claimed that the taxable income of the payees was below the taxable limit hence Form 15H were obtained from them and it was claimed to have been submitted to the CIT, Guntur by post, but no proof in support of the dispatch by post was furnished before the CIT. However, copies of Form 15H were filed before the AO. The CIT acting u/s. 263 directed the AO to disallow the same for failure to adduce evidence in support of dispatch of Form 15H by post.

Held:
According to the Tribunal, mere non-filing of Form 15H with the CIT does not entail disallowance of expenditure. It is only a technical breach of law and the Act provides for separate penal provisions for such default. Thus, according to the Tribunal, where the taxable income of the payees is below the taxable limit and Form 15H is obtained from them no disallowance under the provisions of section 40(a)(ia) can be made. Further, relying on the decision of the Delhi Bench of the Tribunal in the case of Vijaya Bank vs. ITO [2014] [49 Taxmann.com 533, the tribunal allowed the appeal filed by the assessee.

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Smt. Rekha Rani vs. DCIT ITAT Delhi `F’ Bench Before G. C. Gupta (VP) and Inturi Rama Rao (AM) ITA No. 6131 /Del/2013 Assessment Year: 2009-10. Decided on: 6th May, 2015. Counsel for assessee / revenue : None / Vikram Sahay

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Section 271(1)(b) – The provision of section 271(1)(b) is of
deterrent nature and not for earning revenue. Penalty u/s. 271(1)(b)
could not be imposed for each and every notice issued u/s. 143(2) of the
Act, which remains not complied with on the part of the assessee.

Facts:
The
Assessing Officer (AO) issued notice u/s. 143(2) of the Act on five
different dates and the assessee failed to comply with the same. The AO
invoked the provisions of section 271(1)(b) of the Act and imposed
penalty of Rs. 10,000 for each default on the ground that the assessee
had no reasonable cause for not appearing on the date fixed for hearing.
Thus, he levied a total penalty of Rs.50,000. Aggrieved, the assessee
preferred an appeal before CIT(A) who confirmed the action of the AO.
Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The
Tribunal observed that there was no reasonable cause on the part of the
assessee for not appearing on the different dates of hearing before the
AO in response to the notices issued u/s. 143(2) of the Act. The
Tribunal found that the default was the same in all the five cases and
therefore, it held, that penalty of Rs.10,000 could be imposed for the
first default made by the assessee in this regard. It held that the
penalty u/s. 271(1)(b) could not be imposed for each and every notice
issued under section 143(2), which remained not complied with on the
part of the assessee. It observed that the provision of section 271(1)
(b) is of deterrent nature and not for earning revenue. It held that any
other view taken shall lead to imposition of penalty for any number of
times (without limits) for the same default of not appearing in response
to the notice u/s.143(2) of the Act. This, according to the Tribunal,
does not seem to be the intention of the legislature in enacting the
provisions of section 271(1)(b) of the Act. It observed that in case of
failure on the part of the assessee to comply with the notice u/s.143(2)
of the Act, the remedy with the AO lies in framing “best judgement
assessment” under the provisions of section 144 of the Act and not to
impose penalty u/s. 271(1)(b) of the Act again and again.

The
Tribunal restricted the penalty levied u/s. 271(1)(b) of the Act to the
first default of the assessee in not complying with the notice issued
u/s. 143(2) of the Act.

The appeal filed by assessee was partly allowed.

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Hindu Law – Partition – Doctrine of throwing Property in common hotchpot – Assessment under the Wealth tax Act would be evidence : Hindu Succession Act section 23

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Vineeta Sharma vs. Rakesh Sharma & Ors. AIR 2015 (NOC) 895 (Del)

The
plaintiff had filed a suit for partition against her brothers and
mother in respect of constructed premises. The undisputed facts were
that the suit premises were purchased and constructed by the plaintiff’s
father, wherein he along with his family stayed for some time and also
let out a portion thereof to the tenants. The plaintiff’s case was that
since her father and brother died intestate, she was entitled to
one-fourth share in the suit premises. She stated that whenever she
visited her paternal home, she stayed in the suit premises. The
plaintiff averred that the suit premises were never treated as HUF
property and no Will was ever executed by their father.

The
defendants No. 1 and 2 (sons) contested the suit. Their case was that
the plaintiff being the married daughter, had only restricted rights in
the suit premises and could not seek its partition. They averred that
the plaintiff was also not entitled to any share, as the suit premises
was a HUF property, and was so assessed by the Income Tax Department as
also the Wealth Tax Authorities.

The plaintiff deposed that her
father acquired the suit premises from his own earnings, savings and
loans and had constructed the same in March, 1966, when all the
defendants were studying and they could not have contributed to the
construction expenses.

On the other hand, the defendants stated
that their father had abandoned his individual rights in the suit
premises by making a declaration on affidavit dated 23.05.1966,
submitted by him with the Income Tax Department, and which was accepted
as HUF property vide Assessment Order dated 31.03.1976 for the
Assessment Year 1972- 73. They stated that from the Assessment Year
1972-73 to 1988-90 and until the demise of their father, the premises
had been assessed to Income-tax as well as Wealth-tax, as HUF under the
provisions of Income-tax Act as well as Wealth-tax Act.

The
Hon’ble Court observed that as per the plaintiff, the suit premises was
self-acquired property of their father, whereas as per defendants No. 1
and 2, though, it was the self-acquired property of their father, he had
thrown it in the hotchpot of HUF.

The law relating to blending
of separate property with joint family property is well settled.
Property, separate or self-acquired of a member of a joint Hindu family
may be impressed with the character of joint family property, if it was
voluntarily thrown by the owner into the common stock with the intention
of abandoning his separate claim therein, but to establish such
abandonment a clear intention to waive separate rights must be
established.

The separate property of a Hindu ceases to be
separate property and acquires the characteristics of a joint family or
ancestral property not by any physical mixing with his joint family or
his ancestral property but by his own volition and intention, by his
waiving and surrendering his separate rights in it as a separate
property. The act by which the coparcener throws his separate property
in the common stock is a unilateral act. There is no question of either
the family rejecting or accepting it. By his individual volition, he
renounces his individual right in that property and treats it as a
property of the family. No sooner than he declares his intention to
treat his self-acquired property as that of the joint family property,
the property assumes the character of joint family property. The
doctrine of throwing into the common stock is a doctrine peculiar to the
Mitakshara school of Hindu law.

The Hon’ble Court observed that
from the Assessment Order dated 31.03.1972 of the Assessment Year 1972-
73, it is seen that the plaintiff’s father had declared some income
from the suit premises in the status of HUF. It is also seen therefrom
that the HUF came into existence under the assessee’s declaration made
on 23.05.1966 on an affidavit. The Income Tax record of the subsequent
year upto the Assessment Year 1999-2000 would evidence that the
plaintiff’s father had been filing Income Tax Returns and been assessed
to Income Tax as Karta of HUF. The incomes received from the suit
premises was being declared by the plaintiff’s father as of HUF and was
assessed as such during all these years. The Assessment Order under the
Wealth Tax Act of the years 1977-78 onward would also evidence the suit
premises having been assessed as HUF for the purpose of Wealth Tax. From
all this record, it was concluded that the plaintiff’s father, for all
purposes, had consciously abandoned his individual rights in the suit
premises to HUF with effect from 23.05.1966. The affidavit filed by the
plaintiff’s father with Income Tax Department declaring the suit
premises as HUF on 23.05.1966 was not the solitary step taken by him,
but, he continued to maintain the HUF status of the suit premises till
he died. In view of all this, even the payment of property tax by the
plaintiff’s father in his name and not that of HUF or even for that
matter, filing of eviction case against the tenant Bank of Baroda in his
own name than that of HUF would not make any difference. There is no
dispute that the suit premises was initially acquired by the plaintiff’s
father in his own name and it was in those circumstances that the suit
premises continued to be assessed to property tax in his individual name
rather than that of HUF. The payment of property tax by any means does
not create any right or title in the name of the assessee. Filing an
eviction case by the plaintiff’s father in his own name instead of the
HUF, can also be said to be only for the convenience. In any case, the
partition could only be filed by him in his name, being the Karta of
HUF. Thus it was held that the suit premises was of the HUF property of
the plaintiff’s father, with he being the Karta thereof till his death.

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Foreign Judgement – Enforceable before Court in India – Civil Procedure Code, section 13(b)

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Masterbaker Marketing Ltd vs. Noshir Moshin Chinwalla, AIR 2015 (NOC) 771 (Bom.)

A foreign Court which has jurisdiction over the subject matter and passes a decree, the same is conclusive u/s. 13 of the CPC. The plea of the defendant that judgement was obtained by playing fraud hence could not be conclusive could not be considered as it had not submitted to the jurisdiction of the competent Court in a foreign country. The defendant would not be allowed to raise up his hands after the plaintiff has gone through the process of trial and undertaken the execution by applying to the executing Court to retry the issue.

The plaintiff had filed his plaint. The defendant was given notice of the action. He was served a summon. He was called upon to answer the plaintiff’s claim. The trial Court was bound to hear the defendant and to dismiss the plaintiffs claim if it was fraudulent or perjurial. It was, therefore, not only the defendant’s right to get the action of the plaintiff dismissed if it was perjurial or fraudulent, but also its duty to bring perjurial act constituting fraud to the notice of the Court if it was known to the defendant at the time of the trial. If that was not done at the time of trial then and was sought to be done later after the judgment was passed, it would constitute a retrial issue. That retrial is forbidden by the salutary principle of resjudicata. If permitted, it would allow all defendants not to defend the claim and allow any decree to be passed which would then be challenged whilst being executed. That would be an abuse of the Court process.

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Territorial Jurisdiction – Infringement of Copyright and/or Trademark

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Introduction
A question that arises in almost every matter
pertaining to violation of intellectual property rights is – Which Court
would have the necessary territorial jurisdiction to try, entertain and
dispose of the present proceedings? By this article, an endeavour shall
be made to explain which Court/Courts would have territorial
jurisdiction in respect of matters of infringement of copyright and/or
trademark.

The determination of territorial jurisdiction of a
civil court is governed by the Code of Civil Procedure,1908(“CPC”)1
Section 20 of the CPC which would be the relevant Section with respect
to cases of infringement of copyright and/or trademark provides that a
Suit may be filed, inter alia, either where the Defendant actually and
voluntarily resides or carries on business or works for gain or where
the cause of action arises wholly or in part. An explanation appended to
the said Section provides that a Corporation is deemed to carry on
business at its sole or principal office in India or at a place, where
in respect of any cause of action arising at such place it has a
subordinate office.

Hence, under these provisions, a Plaintiff
would be obliged to travel to where the Defendant actually and
voluntarily resides or carries on business or works for gain or where
the cause of action has arisen, wholly or in part. To illustrate this
point, consider a a case where an owner of copyright in a musical work
resides in Delhi, however, his musical work is being infringed by a
Defendant in Chennai by causing unauthorised communication thereof in a
bar in Chennai itself and nowhere else. In such a case, the Plaintiff
copyright owner would be constrained to travel to Chennai to file a
proceeding to restrain the acts of infringement of copyright since both
the Defendant is residing in Chennai as also the cause of action has
arisen in Chennai. Such acts of infringement often take place in remoter
parts of the country, making it even more cumbersome for a Plaintiff to
travel to every nook and corner of the country to protect his
intellectual property rights.

These difficulties were noted by
the Joint Committee that was constituted prior to the passing of the
Copyright Act, 1957 (“CA”) in as much as it was observed that many
authors are deterred from instituting infringement proceedings because
the court in which the proceedings are to be instituted are at a
considerable distance from the place of their ordinary residence. The
Joint Committee recommended that such impediments should be removed and
the proceedings should be allowed to be instituted in the local court
where the person instituting the proceedings ordinarily resides, carries
on business etc2.

Hence, it was in this background that an
additional forum was provided for by Legislature in section 62 of the CA
to enable authors to file a suit for infringement of copyright where
they reside or they carry on business or work for gain3. Subsequently,
section 134 was also brought into effect in the Trade Marks Act, 1999
(“TMA”) to provide an additional forum even in case of infringement of
trademark at a place where the Plaintiff resides or carries on business
or works for gain.

It is the scope and purview of both these
provisions that is sought to be explained and commented upon in this
Article. In fact, the Supreme Court has in a recent judgment dated 1st
July, 2015 in the case of IPRS vs. Sanjay Dalia4 dealt extensively with
the ambit and scope of the said provisions. My effort shall be to
explain the ratio decidendi of the Apex Court and thereafter highlight
certain issues which may still need to answered by the Hon’ble Courts to
afford complete clarity on these provisions.

STATUTORY PROVISIONS
Before
adverting to the aforesaid decision of the Apex Court in the case of
IPRS vs. Sanjay Dalia5, it would be helpful to consider the actual text
of the relevant provisions which provide, inter alia, as under :-

CA
“Section
62. Jurisdiction of court over matters arising under this Chapter. —
(1) Every suit or other civil proceeding arising under this Chapter in
respect of the infringement of copyright in any work or the infringement
of any other right conferred by this Act shall be instituted in the
district court having jurisdiction.

(2) For the purpose of sub-section (1), a “district court having jurisdiction” shall,
notwithstanding anything contained in the Code of Civil Procedure, 1908
(5 of 1908), or any other law for the time being in force, include a
district court within the local limits of whose jurisdiction, at the
time of the institution of the suit or other proceeding, the person
instituting the suit or other proceeding or, where there are more than
one such persons, any of them actually and voluntarily resides or
carries on business or personally works for gain.”

TMA
“134. Suit for infringement, etc., to be instituted before District Court. —
(1) No suit– (a) for the infringement of a registered trade mark; or
(b) relating to any right in a registered trade mark; or (c) for passing
off arising out of the use by the defendant of any trade mark which is
identical with or deceptively similar to the plaintiff’s trade mark,
whether registered or unregistered, shall be instituted in any court
inferior to a District Court having jurisdiction to try the suit.

(2) For the purpose of cls. (a) and (b) of sub-section (1), a “District Court having jurisdiction” shall,
notwithstanding anything contained in the Code of Civil Procedure, 1908
(5 of 1908) or any other law for the time being in force, include a
District Court within the local limits of whose jurisdiction, at the
time of the institution of the suit or other proceeding, the person
instituting the suit or proceeding, or, where there are more than one
such persons any of them, actually and voluntarily resides or carries on
business or personally works for gain…”

It may be noted
that though the current TMA contains Section 134 which provides an
additional forum to a Plaintiff, the earlier Trade and Merchandise Marks
Act, 1958 contained no such provision. Under the Trade and Merchandise
Marks Act, 1958, a Plaintiff was constrained to follow the Defendant
and/or the cause of action for vindication of his rights as u/s. 20 of
the CPC. This position has, however, now changed u/s. 134 of the TMA. A
bare perusal of both section 62(2) of the CA and section 134(2) of the
TMA which are pari materia6 in nature would show that they make a
significant departure from the provisions of the CPC and provide for the
existence of an additional forum in a Suit relating to infringement of
copyright and/or trademark, before a Court, where the Plaintiff actually
and voluntarily resides or carries on business or works for gain.

Both section 62(2) of the CA and section 134(2) of the TMA are additional forums and do not take away or abridge the right of a Plaintiff, if he so chooses to follow the Defendant and/or the cause of action u/s. 20 of the CPC. Hence, a Plaintiff in a suit for infringement of copyright and/or trademark would be entitled to approach the appropriate Court either u/s. 20 of the CPC or u/s. 62(2) of the CA or u/s. 134(2) of the TMA, as the case may be. It is possible, in a given case, that the appropriate Court could be the same Court whether section 20 of CPC is applied or the provisions of the CA or TMA are applied. An illustration would be that, take a case where an owner of copyright in a musical work resides in Delhi. The Defendant is also residing in Delhi and is infringing the musical work by causing unauthorised communication thereof in a bar in Delhi itself and nowhere else. In such a case, the Courts at Delhi would have the necessary territorial jurisdiction to entertain such a Suit for infringement of copyright since firstly, as u/s. 62 of CA, the Plaintiff resides in Delhi. Secondly, u/s. 20 of CPC, the Defendant also resides in Delhi and thirdly, even the cause of action is arising in Delhi. Hence, in such a case, it would only be the Courts at Delhi which would have the necessary territorial jurisdiction.

The question however, is of cases where only section 62 of the CA and/or section 134 of the TMA are invoked as conferring territorial jurisdiction on the Court.

    IPRS VS. SANJAY DALIA7

The Apex Court was dealing with two appeals from the Delhi High Court in this case. In the first Appeal, the facts were that the the Plaintiff was carrying on business through a Branch Office situate at Delhi and it was on this basis that the territorial jurisdiction of the Delhi High Court had been invoked. In the second Appeal, also the territorial jurisdiction of the Delhi High Court was invoked on the basis that the Plaintiff had a branch office at Delhi. In both these matters, the admitted position was that the registered office of the Plaintiffs was not in Delhi nor had any cause of action arisen in Delhi at the time of filing the suits but only the Branch Offices were in Delhi. Proceedings had been filed on the basis, as a suit could be filed wherever the Plaintiff was carrying on business and since these Plaintiffs had a branch office in Delhi, they must be deemed to carry on business in Delhi thereby, rendering the Delhi High Court as the Court having the necessary territorial jurisdiction. Objections were however, raised by the Defendants to the territorial jurisdiction of the Delhi High Court, on the basis that in both these matters the Plaintiff had a registered office in Bombay where the cause of action had also arisen and hence, it should be the Courts at Bombay which would have the necessary territorial jurisdiction. A Division Bench of the Delhi High Court upheld the objection of the Defendant in the first matter whilst in the second matter, the Division Bench of the Delhi High Court, allowed an amendment to be made to the Plaint to add averments to the effect that the infringing magazines were being circulated in Delhi as well thereby showing that cause of action had arisen in Delhi, and on this basis rejected the plea of the Defendant of lack of territorial jurisdiction. It was against these two Orders of the Delhi High Court, that appeals were preferred before the Apex Court.

The Supreme Court was thus called upon to answer whether in light of section 62 of CA and section 134 of TMA could a Plaintiff Corporation file a Suit anywhere it chose to, based on the existence of a branch office or must the Plaintiff Corporation be constrained to file proceedings at a place where either its registered office is situated or at a place where it has a branch office and where the cause of action has also arisen akin to the Explanation to section 20 of the CPC. The Explanation to section 20 of the CPC as mentioned earlier provides that a Corporation is deemed to carry on business at its sole or principal office in India or at a place, where in respect of any cause of action arising at such place it has a subordinate office.

The Supreme Court after considering the legislative history and the purpose for which the provisions had been brought onto the statute book observed that if the provisions are not interpreted purposively, as is being suggested by the Supreme Court, it could lead to abuse of the provisions, in as much as the Plaintiff will institute a suit in a wholly unconnected jurisdiction based solely on the existence of a branch office. The Supreme Court illustrated the possible abuse and observed, inter alia, that “There may be a case where plaintiff is carrying on the business at Mumbai and cause of action has

arisen in Mumbai. Plaintiff is having branch offices at Kanyakumari and also at Port Blair, if interpretation suggested by appellants is acceptable, mischief may be caused by such plaintiff to drag a defendant to Port Blair or Kanyakumari. The provisions cannot be interpreted in the said manner devoid of the object of the Act.” It has also been observed that such a counter mischief to the defendant was unforeseen by Parliament and it is the court’s duty to mitigate the counter mischief.

Hence, the Supreme Court has held that the additional right to institute a suit at a place where the Plaintiff resides or carries on business has to be read subject to certain restrictions, such as in case plaintiff is residing or carrying on business at a particular place/having its head office and at such place cause of action has also arisen wholly or in part, plaintiff cannot ignore such a place under the guise that he is carrying on business at other far flung places also. The very intendment of the insertion of provisions in the CA and TMA is the convenience of the plaintiff. The interpretation of provisions has to be such which prevents the mischief of causing inconvenience to parties. The Supreme Court whilst interpreting these provisions was also of the view that the issue raised before it had not been raised in any of the earlier cases cited before it

It was in light of these findings that the Supreme Court was pleased to dismiss both the appeals by holding that the provisions of section 62 of the CA and section 134 of the TMA have to be interpreted in the purposive manner. There is no doubt about it that a suit can be filed by the plaintiff at a place where he is residing or carrying on business or personally works for gain. He need not travel to file a suit to a place where defendant is residing or cause of action wholly or in part arises. However, if the plaintiff is residing or carrying on business etc. at a place where cause of action, wholly or in part, has also arisen, he has to file a suit at that place.

Whilst this judgment, brings much required clarity to the issue as to the interpretation of these provisions of the CA and TMA, in my opinion, these findings of the Supreme Court amount to introducing an Explanation or a Sub-section (3) to both section 62 of the CA and section 134 of the TMA, which explanation or sub-section had not been provided even by the Legislature whilst passing the said statutes.

The effect of this judgment would be to limit the scope and effect of these provisions. Plaintiffs would now be obliged to file proceedings in accordance with these principles laid down by the Apex Court. The effect of this judgment will, in fact, be felt in several pending proceedings, which proceedings may have been initiated prior to this judgment at a place where the Plaintiff had only a branch office but no cause of action, based on the bare language of these provisions. Already in several proceedings in different High Courts, to my knowledge, applications have been moved for rejection/return of plaint on account of lack of territorial jurisdiction of that Court based on this judgment.

    CONCLUSION

Even though this judgment does bring forth a fair amount of clarity on the issue of territorial jurisdiction in cases of infringement of copyright and/or trademark, in my opinion, certain important issues still remain to be answered in connection with the interpretation of these provisions.

To illustrate an issue which still needs to be addressed and has not been conclusively determined by the Supreme Court, consider a situation, where the Plaintiff is having a branch office in Delhi and the cause of action has also arisen there whilst its registered office is at Bombay. In such a case, can it be said that the Plaintiff is precluded from approaching the Courts at Bombay and must only file his case in the Courts at Delhi or is it still his option to choose the forum of his convenience between these two forums.

It may be noted that the Supreme Court in the IPRS judgment, was dealing with two cases where factually this position did not arise and in both cases, jurisdiction had been invoked only on the existence of a branch office and not on the basis of a combination of branch office plus cause of action. It is trite law that a decision is an authority for what it actually decides8 and hence, considering the nature of the facts involved, it would be difficult to assert that this issue has been conclusively adjudicated upon.

In my opinion, however, in the IPRS case itself, the Supreme Court had referred to its earlier judgment in Patel Roadways vs. Prasad Trading Co.9 wherein the Court whilst explaining the provisions of Section 20 of the CPC had observed, inter alia, that “The clear intendment of the Explanation, however, is that, where the corporation has a subordinate office in the place where the cause of action arises, it cannot be heard to say that it cannot be sued there because it does not carry on business at that place.”

Thus, from the perspective of the convenience of the Defendant and not the Plaintiff, the Supreme Court has already opined that it is the location of the subordinate office, within the local limits of which a cause of action arises, which is to be the relevant place for the filing of a suit and not the principal place of business.

On an analogy of this principle of convenience of parties as explained by the Supreme Court, in my opinion, it could be urged that a Plaintiff corporation which has a subordinate office in the place where the cause of action arises, ought not to be heard to say that it will not sue there since it would like to sue at a place where it has its registered office. The obvious convenience involved of both parties would have to be considered as has been explained by the Supreme Court. Considering that the Plaintiff has a branch office at that place he can hardly be heard to complain that the place is not convenient and also from the perspective of the Defendant, considering cause of action is arising at that place, it would mean that the Defendant and/or its products and/or services are to be found at that place thereby indicating that such a place would be convenient to the Defendant also. Hence, on the basis of convenience of both parties, it ought to be held that it is only the Court where the cause of action has arisen and where the Plaintiff also has a branch office which is the Court having the necessary territorial jurisdiction.

Another issue which has remained unanswered is the effect of this judgment on the Chartered High Courts i.e. the High Courts of Bombay, Calcutta and Chennai. As explained herein above, the Supreme Court has in a sense incorporated the Explanation to section 20 of CPC into the provisions of the CA and the TMA, however, by virtue of section 120 of CPC, section 20 of CPC itself does not apply to the Chartered High Courts. The territorial jurisdiction of the Chartered High Courts is governed by their respective Letters Patent and not by section 20 of CPC10. Hence, in such a situation can it be said that this interpretation would apply to these Chartered High Courts or would these Courts be able to exercise a more unrestricted jurisdiction than the other High Courts.

Whilst in my opinion, the judgment in IPRS does leave door ajar for several new issues to be resolved upon to bring forth complete clarity on the subject, the judgment is an important step forward towards interpreting and laying down the contours of the territorial jurisdiction of a Court in respect of proceedings initiated u/s. 62 of the CA or section 134 of the TMA.

SA 250: Consideration of Laws and Regulations in an Audit of Financial Statements

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Laws and regulations form the substratum of any economy to ensure the
forbearance of any acts, deeds or inaction by the regulated which may be
detrimental to the interest of the economy or part thereof. Compliance
with laws and regulations by corporates is imperative, both on the
frontiers of survival and continuance. In present times, given the
multifold increase in the complexity of applicable laws and regulations,
enterprises are finding it extremely difficult to keep pace with the
plethora of changes in regulatory landscape and effective implementation
and compliance.

SA 250 Consideration of Laws and Regulations in
an Audit of Financial Statements requires auditors to ensure compliance
with the applicable framework of laws and regulations by the audited.
However, as is time and again proclaimed, auditors are watchdogs and not
bloodhounds. The responsibilities advocated by this Standard are a
direct function of ‘ifs and buts’. The auditor is not responsible for
preventing non-compliance and cannot be expected to deter non-compliance
with all laws and regulations that apply to an enterprise.

Specific
attention must be paid to the fact that compliance or non-compliance
with all laws and regulations applicable to an enterprise does not find
an immediate reflection in the financial statements. For example, while
the contribution made by an employer to Employees’ Provident Fund is
reflected in the financial statements, but say for instance,
non-compliance with the requirements of filing of returns for effluent
disposal with the Pollution Control board by a chemical manufacturing
company need not necessarily find a mention in the financial statements.

SA 250 draws a thin line between those laws and regulations
which have and which do not have a direct effect on the determination of
material amounts and disclosures in the financial statements.
Accordingly, depending on which category these laws fall under, the
auditor’s responsibilities stand differentiated. For the former, the
auditor’s responsibility is to obtain sufficient appropriate evidence
about compliance with the provisions of those laws and regulations. For
the latter category, the auditor’s responsibility is limited to
undertaking specified audit procedures to help identify non-compliance
with those laws and regulations that have a material effect on the
financial statements. However, when the line between the black and white
is grey, the auditor is supposed to exercise his professional judgment
while determining the umbrella the law falls under.

Just like
every other SA, SA 250 cannot be applied in complete isolation. As
required by SA 200, professional skepticism needs to be maintained in
the backdrop of applicable laws and regulations applicable on the
entity. While adhering to SA 250, the auditor has to also bear in mind
SA 315, which requires the auditor to obtain a general understanding of
legal and regulatory framework applicable to the industry where the
entity operates. At times, when the outcome of non-compliance is severe,
questions get raised on the validity of the growing concern assumption,
in which case, the auditor would need to consider the requirements of
SA 570. The auditor can seek written representations from the management
in terms of SA 580 about management’s knowledge of identified or
suspected non-compliance with applicable laws. However, receipt of
written representations must not affect the nature and extent of other
evidence to be obtained by the auditor in this regard.

Further,
audit procedures applied to form an opinion on the financial statements
may bring instances of noncompliance or suspected non-compliance with
laws and regulations to the auditor’s attention. Such audit procedures
may include reading of minutes, inquiring of the entity’s management and
in-house legal counsel or external legal counsel concerning litigation,
claims and assessments; and performing substantive tests of details of
classes of transactions, account balances or disclosures – for e.g.,
scrutiny of payments made to government authorities towards
fines/penalties, scrutiny of legal and professional expenses to
understand whether unusual payments have been made for
legal/retainership fees as also to seek evidence of legal cases pending
against the company etc.

The next obvious question which arises
is – What is the auditor supposed to do in case of identified or
suspected non-compliance? Firstly, the auditor must have a discussion
with the management or where appropriate, with those charged with
governance, and if sufficient information is not obtained, the auditor
may evaluate the need of obtaining legal advice. If satisfactory
information is still not obtained, the auditor shall consider its effect
on the audit opinion.

A non-compliance with applicable law or
regulation does not merely impact the financial statements.
Noncompliance can also impact the level of reliance that the auditor
places on the integrity of the management or employees. It can also
cause the auditor to reassess the possibility of material misstatements
in other areas, as also the faith the auditor places in the management’s
Written Representations.

However, if the auditor suspects that
the management is involved in non-compliance, the auditor can escalate
the issue to those charged with governance and also consider the impact
of such non-compliance on the audit opinion. If the auditor concludes
that the non-compliance has a material effect on the financial
statements, and has not been adequately reflected in the financial
statements, the auditor may express a qualified or adverse opinion on
the financial statements. This standard also provides for the scenario
that if the auditor has identified or suspects noncompliance with laws
and regulations, the auditor shall determine whether he has a
responsibility to report the same to parties outside the entity, for
instance – regulatory and enforcement authorities.

Let us now examine certain case studies.

Case Study I
ABC
Limited (‘ABC’) is engaged in the manufacturing of pharmaceutical
products, having operations in many countries across the globe. During
the year, a manufacturing unit of ABC, which accounted for over 60% of
the company’s production, received notices from the Food and Drug
Administration Authority of the United States of America and regulators
in other countries, stating that pursuant to the inspection of the
manufacturing processes at the said unit, violations of Good Medical
Practices (GMP) were observed. Several prohibitions were imposed on the
functioning of the said unit, including a prohibition to sell the
products manufactured by the unit to US regulated markets. ABC decided
to voluntarily shut down its operations in this unit on a temporary
basis to examine ‘what went wrong’. ABC however is in dialogue with
regulatory authorities to assuage the restrictions. What would be the
auditor’s responsibility in such a scenario?

Analysis

The auditor must discuss with the management the severity of the case, and the company’s current standing in this regard. The auditor has also to bear in mind that the plant accounted for over 60% of the company’s production and also the fact that other markets may also raise questions on the acceptability of products manufactured in this plant. The auditor would also need to consider whether there is a need for reduction in the carrying value of inventories, whether any provisions are required for fines/penalties, accounting for possible sales returns and if such provisions are required to be made, then the basis used by the management for arriving at such estimates. Further, in such cases, there are inherent uncertainties regarding the future actions of the regulators, the impact of which may not be ascertainable and therefore, the actual amounts incurred may eventually differ from the estimates made. If the auditor concludes that this is a significant matter, he should also consider highlighting the same as a Matter of Emphasis (MOE) in the audit report.

    Case Study II

PQR Limited (‘PQR’) is a company engaged in production of steel. During the year, the company and some of its competitors received notices from Competition Commission of India (CCI) for alleged cartelization by certain steel manufacturing companies. CCI imposed a penalty of Rs. 100 Crores on PQR against which PQR has filed an appeal before Competition Appellate Tribunal. The Company has not made any provision in this regard. What would be the auditor’s responsibility in this case?

    Analysis

The auditor must assess the facts and circumstances, and must have a detailed discussion with the management on the Company’s standing in the case. The auditor, if he deems necessary, must also take an independent legal opinion to deduce whether the company has a fit case or whether there is a need for making provision on a best estimate basis of the likely penalty that may be levied. The auditor should also have a joint discussion with the company’s legal counsel in this regard. Depending on the significance of the matter, the auditors may consider including a ‘Matter of Emphasis’ in the audit opinion.

    Case Study III

LMN Limited is a public listed company engaged in the manufacture of automobiles. During the year ended 31 March 20X0, LMN has incurred loss of Rs.120 crore. LMN has paid to its Managing director Mr.DEF (‘DEF’) (who is also the promoter shareholder holding 51% of the paid up capital of LMN) managerial remuneration exceeding the limits set out by the Companies Act, 2013.

As LMN has incurred losses for the year, LMN was required to obtain approval from the shareholders as well as the Central Government for payment of remuneration to DEF as the same exceeded the limits set out in the Companies Act, 2013. LMN management contends that seeking approval of the shareholders was only a compliance formality as the Managing Director himself holds more than 51% of the paid up capital of LMN. What are the duties of the auditor in this regard?

    Analysis

Since LMN Limited had no profits for the year, it was required to comply with the requirements of Schedule V to the Companies Act, 2013 which sets out the limits for maximum managerial remuneration payable to managerial personnel for public listed entities in the event of a loss or inadequate profits. The auditor would need to explain the management the legal position and advise the client to seek approvals of the shareholders and the Central Government or alternatively recover the remuneration paid in excess of the prescribed limits from DEF. In the event DEF chooses not to return the excess payment, the auditor would need to qualify the audit opinion for non-compliance with the requirements of the Companies Act, 2013.

    Case Study IV

STU Limited (‘STU’) is engaged in the business of providing mobile telecommunication services. As per TRAI (Telecom Regulatory Authority of India) regulations, a prescribed percentage of Adjusted Gross Revenue (AGR) earned by a telecom operator is payable to the department of telecommunications as license fees. STU has been paying license fees on revenue earned from providing telecom services to its customers. According to TRAI, license fees are also payable on non-telecom revenues like profit on sale of fixed assets, rent, dividend and treasury income. TRAI has accordingly raised a demand of Rs.500 crore as license fees payable on non-telecom revenue earned by STU from inception till date. The definition of AGR is currently being challenged by all telecom operators including STU. The telecom operators have contested this interpretation of TRAI and have filed a petition before the appellate tribunal seeking injunction against TRAI demands. What would be the auditor’s responsibilities in such a case?

    Analysis

The issue of payment of license fees on non-telecom revenue seems to be a pan-industry issue as against being specific to STU. The company has contested the demand raised by TRAI. However, the auditor would need to discuss with the Company’s legal counsel the basis of demands raised by TRAI and their tenability. The auditor may consider requesting STU to obtain a formal legal opinion in this regard. It would also help if the auditor were to understand as how this issue has been dealt with by STU’s competitors. Based on this evaluation, the auditor would need to assess whether a provision is warranted or a disclosure as contingent liability would be sufficient compliance.

    Case Study V

HIJ Pharma Limited (HIJ) is a pharmaceutical company engaged in the manufacture of life saving drugs. HIJ is required to adhere to pricing norms as prescribed under Drug Price Control Order (DPCO). During the year ended 31 March 20X1, it was observed that some of the drugs were sold at prices much higher than those prescribed under the DPCO. Under DPCO, companies are liable to deposit the overcharged amount to the Credit of Drug Prices Equalization Account, which was not actioned by HIJ. HIJ received demand for payment of Rs.400 crores to the credit of the Drug Prices Equalisation Account under Drugs (Price Control) Order for few of its products, which was contested by HIJ. Based on its best estimate, HIJ made a provision of Rs.100 crore in its books of accounts towards the potential liability related to principal and interest amount demanded under the aforesaid order and believed that the possibility of any liability that may arise on account of penalty on this demand is remote. What are the Auditor’s duties in this regard?

    Analysis

The management believes that the company would not be liable for any penalties. The auditor must ensure that adequate provisions are made in books to the extent of overcharged amount and interest thereon. Considering the provisions of AS 29 – Provisions, Contingent Liabilities and Contingent Assets – the auditor must also evaluate whether any need arises for disclosure as Contingent Liability of the amount of penalties leviable by DPCO.

    Concluding remarks

The auditor’s responsibilities for reporting compliance with applicable laws and regulations have increased manifold with the increasingly changing regulatory landscape in India. Though the auditor’s professional duty to maintain confidentiality of client information precludes reporting of an identified or suspected non-compliance with laws and regulations to any third party, given the legal framework in India, the confidentiality consideration is overridden by statute, the law or courts of law. For instance, under the present legal and regulatory framework for financial institutions in India, the auditor has a statutory duty to report the occurrence, or suspected occurrence of non-compliance with laws and regulations to the supervisory authorities. The auditor therefore needs to perform his duty with due care and exercise adequate professional skepticism while providing assurance on compliance with applicable laws and regulations.

Income Computation and Disclos URE Standards (ICDS) – No Tax Neutrality

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Background
The Indian Accounting Standards (Ind AS), the
Indian version of International Financial Reporting Standards, will have
significant impact on financial statements for many entities. Ind AS’s
are meant to primarily serve the needs of investors and hence are not
suitable for the purposes of tax computation. A clear need was felt for
tax accounting standards that would guide the computation of taxable
income.

The Central Government (CG) constituted a Committee in
December 2010, to draft Income Computation and Disclosure Standards
(ICDS). Section 145 of the Indian Income tax Act bestows the power to
the CG to notify ICDS to be followed by specified class of taxpayers or
in respect of specified class of income.

In August 2012, the
Committee provided drafts of 14 standards which were released for public
comments by the CG. After revisions, the CG has notified 10 ICDS
effective from the current tax year itself (viz. tax year 2015- 16) for
compliance by all taxpayers following mercantile system of accounting
for the purposes of computation of income chargeable to income tax under
the head “Profits and gains of business or profession” or “Income from
other sources”.

Earlier, the CG had notified two standards in
1996 viz., (a.) Accounting Standard I, relating to disclosure of
accounting policies. (b.) Accounting Standard II, relating to disclosure
of prior period and extraordinary items and changes in accounting
policies. They now stand superseded. These standards were largely
comparable to the current AS corresponding to AS 1 & AS 5.

ICDS
are meant for the normal tax computation. Thus, as things stand now,
ICDS has no impact on minimum alternate tax (MAT ) for corporate
taxpayers which will continue to be based on “book profit” determined
under current AS or Ind AS, as the case may be.

ICDS shall apply
to all taxpayers, whether corporate or otherwise. Further, there is no
income or turnover criterion for applicability of ICDS. An entity need
not maintain books of accounts to compute income under ICDS. However, if
the differences between ICDS and Ind AS/current AS as the case may be,
are several, an entity may need to evolve a more sophisticated system of
tracking them as against doing it manually on an excel spreadsheet. It
is possible that the current tax audit requirements will be enhanced to
require auditors to report on the correctness of tax computation under
ICDS. Non-compliance of ICDS gives power to the Tax Authority to assess
income on “best judgement” basis and also levy penalty on additions to
returned income.

List of ICDS
Following is the list of 10 ICDS notified w.e.f. April 1,2015:
1. ICDS I relating to accounting policies
2. ICDS II relating to valuation of inventories
3. ICDS III relating to construction contracts
4. ICDS IV relating to revenue recognition
5. ICDS V relating to tangible fixed assets
6. ICDS VI relating to the effects of changes in foreign exchange rates
7. ICDS VII relating to government grants
8. ICDS VIII relating to securities
9. ICDS IX relating to borrowing costs
10. ICDS X relating to provisions, contingent liabilities and contingent assets

KEY differences between icds and current as A few key differences between ICDS and current AS are given below:

ICDS I prohibits recognition of expected losses or markto- market losses unless permitted by any other ICDS.

During
the early stages of a contract, where the outcome of the construction
contract cannot be estimated reliably, contract revenue is recognised
only to the extent of costs incurred. This requirement is contained both
in AS 7 and ICDS III. However, unlike AS 7, ICDS III states that the
early stage of a contract shall not extend beyond 25 % of the stage of
completion.

AS 7 requires a provision to be made for the
expected losses on onerous construction contract immediately on signing
the contract. Under ICDS III, losses incurred on a contract shall be
allowed only in proportion to the stage of completion. Future or
anticipated losses shall not be allowed, unless such losses are actually
incurred.

Under AS 9, revenue from service transactions is
recognised by following “percentage completion method” or “completed
contract method”. Under ICDS IV, only percentage of completion method is
permitted.

Under AS 11, all mark-to-market gains or losses on
forward exchange or similar contracts entered into for trading or
speculation contracts shall be recognised in P&L. In contrast, ICDS
VI requires gains or losses to be recognised in income computation only
on settlement.

Under AS 11, exchange differences on a
non-integral foreign operation are not recognised in the P&L, but
accumulated in a foreign currency translation reserve. Such a foreign
currency translation reserve is recycled to the P&L when the
non-integral operation is disposed. Under ICDS VI, exchange differences
on non-integral foreign operations shall also be included in the
computation of income.

Under AS 12, government grants in the
nature of promoter’s contribution are equated to capital and hence are
included in capital reserves in the balance sheet. Under ICDS VII,
government grants should either be treated as revenue receipt or should
be reduced from the cost of fixed assets based on the purpose for which
such grant or subsidy is given.

Under AS 12, recognition of
government grants shall be postponed even beyond the actual date of
receipt when it is probable that conditions attached to the grant may
not be fulfilled and the grant may have to be refunded to the
government. Under ICDS VII, recognition of Government grants shall not
be postponed beyond the date of actual receipt.

Under AS 16, in
the case of borrowings in foreign currency, borrowing costs include
exchange differences to the extent they are treated as an adjustment to
the interest cost. Under ICDS IX, borrowing cost will not include
exchange differences arising from foreign currency borrowings.

AS
16 requires the fulfilment of the criterion “substantial period of
time” for treating an asset as qualifying asset for the purposes of
capitalisation of borrowing costs. ICDS IX retains substantial period
condition (i.e. 12 months) only for qualifying assets in the nature of
inventory but not for fixed assets and intangible assets. Therefore,
ICDS requires capitalisation of borrowing costs for tangible and
intangible assets even when they are completed in a short period.

Under
ICDS IX, capitalisation of specific borrowing cost shall commence from
the date of borrowing. Under AS 16, borrowing cost is capitalised from
the date of borrowing provided the construction of the asset has
started.

Unlike AS 16, income on temporary investments of
borrowed funds cannot be reduced from borrowing costs eligible for
capitalisation in ICDS IX.

Unlike AS 16, requirement to suspend
capitalisation of borrowing costs during interruption of active
construction of asset is removed in ICDS IX.

Under ICDS X, a
contingent asset is recognized when the realisation of related income is
“reasonably certain”. Under AS 29, the criterion is “virtual
certainty”.

Impact of ICDS
The notification of ICDS was imperative to ensure smooth implementation
of Ind AS, and therefore should have maintained a tax neutral position.
Unfortunately, ICDS are not tax neutral vis-à-vis the current Indian
GAAP and tax practices currently followed and may give rise to
litigation. For example, based on AS 7 Construction Contracts, the
current practice is to recognise any expected loss on a construction
contract as expense immediately. In contrast, ICDS will require expected
losses to be provided for using the percentage of completion method.

ICDS
I lays out the “accrual concept” as a fundamental accounting
assumption. The prohibition on recognising expected or mark-to-market
losses appears to be inconsistent with the accrual concept. Though
mark-tomarket losses are not allowed to be recognised, there is no
express prohibition on recognising mark-to-market gains. The ICDS
therefore appears to be one-sided, determined to maximie tax collection,
rather than routed in sound accounting principles. Matters such as
these are likely to create litigious situations despite the Supreme
Court decision in the Woodword Governor case where the status of ICDS is
upheld.

The preamble of the ICDS states that where there is
conflict between the provisions of the Income-tax Act, 1961 and ICDS,
the provisions of the Act shall prevail to that extent. Consider that a
company has claimed markto- market losses on derivatives as deductible
expenditure u/s. 37(1) of the Income-tax Act. Can the company argue that
this is a deductible expenditure under the Incometax Act (though the
matter may be sub judice) and hence should prevail over ICDS, which
prohibits mark-to-market losses to be considered as deductible
expenditure?

Under ICDS, exchange differences arising on the
settlement or on conversion of monetary items shall be recognised as
income or as expense. Consider that a company uses foreign currency loan
for procuring fixed asset locally. Now under ICDS, the exchange
difference on the foreign currency loan will be recognised in the
P&L A/c. Now consider the following decision in Sutlej Cotton Mills
Ltd. vs. CIT (116 ITR 1) (SC) “The Law may, therefore, now be taken to
be well settled that where profit or loss arises to an assessee on
account of appreciation or depreciation in the value of foreign currency
held by it, on conversion into another currency, such profit or loss
would ordinarily be trading profit or loss if the foreign currency is
held by the assessee on revenue account or as a trading asset or as part
of circulating capital embarked in the business. But, if on the other
hand, the foreign currency is held as a capital asset or as fixed
capital, such profit or loss would be of capital nature”. As per this
decision the exchange difference in our fact pattern will be
capitalised. However, under ICDS it will be recognised in the P&L
A/c. It is not absolutely clear whether the court decision or ICDS will
prevail in the given instance.

All ICDS (except ICDS VIII
relating to Securities) contain transitional provisions. These
transitional provisions are designed to avoid double jeopardy. For
example, if foreseeable loss on a contract is already recognised on a
contract at 31st March 2015, those losses will not be allowed as a
deduction again on a go forward basis using the percentage of completion
method. On the other hand, if only a portion of the loss was
recognised, the remaining foreseeable loss can be recognised using the
percentage of completion method. The detailed mechanism of how this will
work is not clear from the ICDS.

The transitional provisions
are not always absolutely clear. In the case of non-integral foreign
operations, e.g. non-integral foreign branches, ICDS requires
recognition of gains and losses in the P&L (tax computation), rather
than accumulating them in a foreign currency translation reserve. It is
not absolutely clear from the transitional provision whether the
opening accumulated foreign currency translation reserve, which could be
a gain or loss, will be ignored or recognised in the first transition
year 2015-16. Since the amounts involved will be huge, particularly for
many banks, the interpretation of this transitional provision will have a
huge impact for those who have not already considered the same in their
tax computation in the past years.

Some of the transitional
provisions are also expected to have a material unanticipated effect.
For example, the ICDS requires contingent assets to be recognised based
on reasonable certainty as compared to the existing norm of virtual
certainty. Consider a company has filed several claims, where there is
reasonable certainty that it would be awarded compensation. However, it
has never recognised such claims as income, since it did not meet the
virtual certainty test under AS 29. Under the transitional provision, it
will recognise all such claims in the first transition year 2015-16. If
the amounts involved are material, the tax outflow will be material in
the year 2015- 16. This could negatively impact companies that have
these claims. The interpretation of “reasonable certainty” and “virtual
certainty” would also come under huge stress and debate. This may well
be another potential area of uncertainty and litigation.

Overall,
the CG through CBDT will have to play a highly pro-active role to
provide clarity and minimise the potential areas of litigation. An
amendment of the Incometax Act would have been more appropriate rather
than a notification of the ICDS because the impact is expected to be
very high and all pervasive.

IT A No. 599/LKW/2012 (Unreported) IT O vs. Shri Sharad Mishra A.Y. 2009-10 Order dated: 12-06-2015

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Presence in India for less than three hours on the day of arrival cannot be considered as one complete day in order to compute number of days of stay in India for determining residential status.

Facts:
Taxpayer arrived in India on 25.10.2008 from Hong-Kong by a flight at 9.10 P.M. Relying on Walkie vs. IRC [1952] 1 AER 92, Taxpayer contended that as his presence in India on the day of arrival to India was less than 3 hours, it should not be included in calculating the number of days of stay in India and since his total stay in India is 181 days in the relevant financial year, he qualifies as a nonresident for the relevant financial year. However, the Tax Authority contended that the day of arrival of the Taxpayer in India should be included for calculating the number of days of stay in India. Thus, the Taxpayer would qualify as a resident of India.

Held:
Arrival of the Taxpayer in India at 9.10 P.M and consequent presence in India for less than three hours cannot be treated as his stay for one complete day and should be excluded while computing the number of days of his stay in India.

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TS-336-ITAT-2015(Mum) Flag Telecom Group Limited v DDIT A.Ys: 2001-09 Order dated: 15-06-2015

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Sections 9(1)(i) and 9(1)(vii) – Standby maintenance charges does not amount to Fee for technical services (FTS) under the Act. Restoration services for restoring the telecommunication traffic is in the nature of business income and income would be attributable to the extent of length of cable situated in territorial waters of India.

Facts 1
The Taxpayer, a company incorporated in Bermuda, was engaged in the business of building high capacity submarine fiber optic telecommunication link cable system. The Taxpayer had built under-sea cable to link between United Kingdom and Japan for providing telecommunication link to various countries. The Taxpayer entered into a Capacity Sales Agreement (CSA) with an Indian Company (I Co). As per CSA, the Taxpayer was required to provide standby maintenance services to I CO.

The Tax Authority contended that the payment for standby maintenance is for rendering technical services and hence it is in the nature of Fee for technical services (FTS) under the Act.

Held 1:
U/s. 9(1)(vii) of the Act, FTS is defined to mean any payment in consideration of managerial, technical, or consultancy services.

Payment made for standby maintenance is a fixed annual charge payable for arranging standby maintenance arrangement which is required in a situation when undersea cable is being repaired. It is for keeping facility or infrastructure ready for rendering repair services, when required. Such charges are not for rendering of any services. Thus, receipt on account of standby maintenance charges is not FTS under the Act.

Facts 2:
The Taxpayer had sold certain cable capacity to various parties including I Co. The balance capacity remained with the taxpayer as its stock. The Taxpayer also entered into another agreement with certain telecom cable operators who carried telecommunication traffic for I CO. As per this agreement, the taxpayer was required to restore traffic to telecom cable operators’ customer (I Co) in the event of disruption in the traffic on their cable system by providing an alternative telecommunication link route through its own spare capacity in the cable. For these services, I Co directly made payments to the Taxpayer.

The Tax Authority contended that payment made by ICo to the Taxpayer for restoration services was in the nature of FTS under the Act. On appeal, First Appellate Authority held that income was not in the nature of FTS but it was in the nature of business income and treated 10% of the global receipts of the Taxpayer as income taxable in India. The Taxpayer contended that restoration services were not in the nature of managerial or consultancy services. They merely involved provision of standard facility of carrying telecommunication traffic and accordingly income from such services was in the nature of business income. Further, as no operations were carried on in India except for the fact that small part of the entire cable system, about 12 nautical miles from the shore, was laid down by the Taxpayer in territorial waters of India, the amount of income attributable only to such portion should be taxed in India.

Held 2:
Restoration services does not fall within the ambit of ‘managerial’ or ‘consultancy services’, in the absence of direction, regulation, administration or supervisory or advisory activities by the Taxpayer.

The Taxpayer has a cable system network in which it has spare capacity, which is being provided to I Co on behalf of telecom cable operators in case of disruption in their cable network. This amounts to provision of a standard facility for carrying telecommunication traffic to other telecom service providers. It does not involve transfer of technology or rendering of technical services.

Simple use of sophisticated technical equipment for providing the capacity in the cable to I CO ipso facto does not lead to any inference that any technical service is being provided by the Taxpayer to I Co. The Taxpayer earned business income.

Since part operations are carried on in India, only that income which is reasonably attributable to the proportion of the length of the cable in the territorial waters in India to the segments on which restoration have been provided should be taxed in India.

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TS-430-AAR-2015 Measurement Technology Limited Order dated: 29-06-2015

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Article 13 of India-UK DT AA – Amount received for rendering ‘managerial services’ and ‘procurement service’ not FTS – Routine managerial services cannot be classified as royalty if no intellectual property is created – Service PE not established as period of stay does not exceed the threshold

Facts:
Taxpayer, a company incorporated in the United Kingdom (UK), was engaged in the business of development and supply of intrinsic safety explosion protection devices, field bus and Industrial networks, lightning and surge protection and gas analysis equipment. Taxpayer had a subsidiary in India (I Co) which was engaged in the business of manufacturing industrial control equipment used for process control in hazardous environments.

Taxpayer entered into two service agreements with ICo. Under Agreement 1, Taxpayer was required to provide following services to I Co

  • Strategy and direction of business development of ICo;
  • Attendance in person or by phone at regular operational meetings to discuss progress of activities, both financial and operational;
  • Management of personnel including conducting staff interviews, setting individual targets and carrying out performance appraisals; and
  • Any other services related to the above.

The services under Agreement 1 were to be provided through one of the employees of Taxpayer who was designated as Group Operational Director (GD). GD provided services through telephone calls, e-mails and occasional visits to India. It was not disputed that the total presence of GD in India was less than 30 days. As part of its services GD also monitored financial and operational progress of I Co along with overseeing human resource matters of I Co and also undertook quality and design reviews for I Co.

Under the Agreement 2, the Taxpayer provided procurement services to I Co. The Taxpayer constituted a procurement team in UK to look into the global sourcing requirement of raw materials for all its group entities including I Co to consolidate the group’s purchase requirements resulting in cost savings for the group.

The Taxpayer contended that the services provided did not satisfy the make available condition and hence they did not constitute FTS under India-UK DTAA .

The Tax Authority contended that services rendered by the Taxpayer were in the nature of technical and consultancy services. Further, as the Taxpayer was required to provide report containing the technical details and plans to I Co, it would satisfy the make available condition. Additionally, services of the Taxpayer also partake the character of royalties for the use of plan, or for information concerning industrial, commercial or scientific experience under India-UK DTAA .

Held:
India-UK DTAA was amended to exclude “managerial services” from the definition of FTS and to include the make available condition in the DTAA for taxation of FTS. Thus post-amendment, managerial services are not covered in the definition of FTS and even the technical or consultancy services cannot be treated as FTS if they do not meet the criteria of ‘make available’.

Services provided under both the agreements are managerial in nature. The activities are routine managerial and procurement activities and cannot be classified as technical or consultancy services. Moreover, by providing such services, taxpayer was not making available any technical knowledge of enduring benefit in nature which would enable employees of ICO to apply them on their own in future.

Further, services provided under both the agreements were general and routine in nature and did not create any intellectual property. Thus payments made to the Taxpayer did not qualify as ‘royalty’ under the India- UK DTAA .

Since visits to India were not for more than 30 days in a year, ‘Service PE’ would not be constituted in India.

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TS-386-ITAT-2015 ABB Inc vs. DDIT(IT) A.Y: 2009-10 Order dated: 30-06-2015

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Article 12 of India-US DT AA – Business development, market services and other support service do not satisfy make available condition and hence, no Fees for Included Services (FIS) under the DT AA. Where a Permanent Establishment (PE) is created in respect of trading transactions only, income from rendition of services cannot be attributed to the PE

Facts
The Taxpayer, a US Company, was engaged in providing business development, marketing services and other support services to its Indian associated enterprise (AE). The Indian AE was also involved in purchase and sale of Taxpayers’ products in India.

Taxpayer claimed that services rendered to its AE do not satisfy “make available” condition and hence it could not be characterised as FIS under the India-USA DTAA . However, Tax Authority contended that technical services rendered by the Taxpayer to its AE satisfy “make available” condition and thus they are taxable in India.

On further appeal before the Dispute Resolution Panel (DRP), it was held that services constituted FIS under India-USA DTAA . Additionally, without prejudice to FIS taxation, DRP held that since the Indian AE to whom services were rendered was also involved in the purchase and sale of Taxpayer’s products in India, such AE’s would constitute a dependent agent Permanent establishment (DAPE) of the Taxpayer in India and the amounts received for services rendered to the AE (which constituted DAPE for the Taxpayer) would be attributable to the DAPE and is to be treated as profits and gains from business.

Held
Relying on the decision of Karnataka HC in the case of De Beers India (P) Ltd. (2012) 346 ITR 467 (Kar), it was held that consideration for services cannot be brought to tax under the India US DTAA as these services do not enable the recipient of the services to utilise the knowledge or know-how on his own in future without the aid of the service provider. Further the services do not involve transfer of technology. Thus the payment received by the Taxpayer from its AE does not constitute FIS under India-USA DTAA .

Under India-USA DTAA business profits are taxable in Source State but only so much of them as are attributable to (a) that PE (b) sales in the Source State of goods or merchandise of the same or similar kind as those sold through that PE or (c) other business activities carried on in the Source State of the same or similar kind as those effected through that PE. Thus, where a PE is constituted in respect of the trading transactions only, no part of the income earned from rendering of services by the Taxpayer can be attributed to the PE.

Further in the absence of any finding that the Indian AE was paid remuneration less than arm’s length, nothing can be attributed to DAPE of the Taxpayer in India.

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Koyo Tech Electro (P) Ltd, [2013] 60 VST 235 (WBTT)

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Cancellation VAT- Registration of Dealer – Rented Place of Business – Whether Landlord Holds legal Ownership of Building Complete or Incomplete- Not For Department to Consider – Carrying on Business and Filing of Returns and Paying of Tax – Sufficient Enough For Grant of Registration, section 29 of The West Bengal Value Added Tax Act, 2003.

FACTS
The dealer company had rented the office premises on monthly rent and had obtained registration certificate under The West Bengal VAT Act, and, filed periodical returns and paid taxes. Subsequently the company received order from VAT department cancelling registration certificate. The company applied to the Joint Commissioner, for restoration of registration which was rejected after taking report from the lower authority who cancelled the registration certificate on the ground of incomplete construction of building, non- confirmation of ownership of the owner, etc. The company filed an application before The West Bengal Taxation Tribunal against the aforesaid cancellation of registration certificate as well as the confirmation thereof by the Joint Commissioner.

HELD
The fact that building in which office of the dealer was situated was in an incomplete stage could not be considered in framing opinion that business could not be carried out from such premises. Business can be carried on from makeshift room. Such office-cum-godown does not require to be housed in a well furnished room. Further, in rejecting the prayer for restoration of certificate of registration, the Joint Commissioner had viewed that the landlord from whom the dealer had claimed tenancy, failed to establish her ownership of the building. In making such observation, the concerned authority sought to assume the role of a civil court. This is totally unwarranted. The landlady in question was not under any obligation to prove her legal ownership in respect of the building at the time of inspection conducted by the respondents. The Tribunal after considering fact of carrying on business, filing of return and payment of tax by the dealer, allowed the application and restored the registration certificate granted to the dealer.

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State of Karnataka vs. Vasavamba Stores, [2013] 60 VST 19 (Karn).

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VAT – Rate of Tax – ‘Fryums’ are “Pappad”- Exempt From Payment of Tax, section 4(1)(b) and Entry 40 of Schedule 1 of The Karnataka Value Added Tax Act, 2004.

FACTS
The respondent Company, the manufacturer, sold ‘Fryums’ and claimed exemption from payment of tax under Entry 40 of Schedule 1 of The KVAT Act being covered by the term ‘Pappad’. The respondent company was reassessed and the authority levied tax under residuary entry by treating ‘Fryums’ as Sandige. The VAT Tribunal allowed appeal. VAT department filed revision petition before The Karnataka High Court against the order of the Tribunal. The High Court held in favour of the respondent company.

HELD
The High Court, following judgement of SC in case of Shiv Shakti Gold Finger [1996] 9 SCC544, held that the shape of the “Pappad” is not a relevant consideration when the ingredients are the same. Accordingly, the High Court dismissed the revision Petition filed by the State Government and confirmed the order of Tribunal holding ‘Fryums’ are “Pappad” hence exempt from payment of tax under the KVAT Act.

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[2015] 59 taxmann.com 128 (New Delhi – CESTAT) Uniworth Ltd vs. CCEST

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100% EOU are entitled to avail and utilise the CENVAT credit in respect of duty paid on inputs, even if other inputs are procured duty free under CT-3 procedure. The assessee can exercise both the options simultaneously.

Facts:
The Appellant is a 100% EOU and procured goods duty free. They also procured furnace oil on payment of duty and took CENVAT credit thereof. The adjudicating authority was of the view that the Appellant is allowed only one of the two options i.e. either to procure goods duty free or to pay duty and avail CENVAT credit. Therefore CENVAT credit taken of duty paid on furnace oil was disallowed.

Held:
The Tribunal observed that as per Rule 3 of the CENVAT Credit Rules,2004, 100% EOUs are fully eligible to take CENVAT credit of duty paid on inputs used in or in relation to the manufacture of final products because this rule does not make any exception as regards 100% EOUs. It held that Notification No. 18/2004-C.E. (N.T.) dated 06/09/2004 did not in any way affect the eligibility of the EOU from taking CENVAT credit; it only allowed them the facility to pay duty either by debit to the PLA or by debit to the CENVAT credit account. Reproducing Para 4 of Circular No. 54/2004-Cus., dated 13/10/2004 and decision In the case of Tata Tea Ltd. vs. CCE 2006 taxmann.com 1952 (Bang. – CESTAT), the Tribunal further held that the legal position is clear that the 100% EOUs are eligible to take CENVAT credit of duty paid on the raw material procured by them for use in or in relation to the manufacture of their final product. Accordingly the appeal was allowed.

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[2015] 59 taxmann.com 321 (Mumbai – CESTAT) CESTAT, MUMBAI BENCH-Inox Air Products Ltd. vs. Commissioner of Central Excise, Raigad

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CENVAT credit cannot be denied just because invoices are in the name
of Head Office/ another unit not registered as Input Service Distributor
(ISD).

Facts:
The assessee was engaged in the
manufacture of natural gases having units at various places. Assessee’s
one unit took credit of Customs House Agent (CHA) services where invoice
was in the name of Head Office; and also of machine repair services
where invoice was in name of another Unit. The demand of duty was raised
because the invoices under which the credit was availed were in name of
Head Office/other units and assessee was not registered as Input
Service Distributor.

Held:
Tribunal held that since
assessee had nine units manufacturing the same product, the doubt of
nexus of input and output products would never arise. It is quite
natural that the service provided by a CHA would be in the name of the
Head Office as the clearance of goods through customs is centralized.
The only basis for denying credit has been that invoices are either in
the name of another unit of the appellant or in the name of their Head
Office. Since doubt has never been raised regarding actual receipt of
services, credit cannot be denied.

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[2015 (39) STR 210 (Tri.-Mumbai) Commissioner of Service Tax, Mumbai-I vs. N.V. Advisory Pvt. Ltd

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Recipient of Services located outside India – Money received in convertible foreign exchange – fact that advice resulted in investment in India not relevant.

Facts:
The Respondent is providing services in the nature of advice on investment opportunities and is also providing back office operation support to the firms situated outside India. The payments are received in convertible foreign exchange. A refund claim was filed in respect of service tax paid on the input services used and consumed by them in the course of providing output services which were exported. The Adjudicating Authority rejected the claim. The Commissioner (Appeals) allowed the refund claim citing the CBEC Circular No. 111/5/2009-ST dated 24/02/2009 clarifying the term “used outside India” to mean that the benefit of the service accrues outside India. Therefore, revenue has preferred the present Appeal.

Held:
The Tribunal held that Rule 3(i)(iii) and Rule 3(2) of the Export of Services Rules, 2005 is satisfied as the recipient is located outside India and the payment is received in convertible foreign exchange. Relying on the Larger Bench decision of Paul Merchants Ltd vs. Commissioner of Central Excise, Chandigarh [2013(29) STR 257 (Tri. Del) the Tribunal allowed the refund claim. Accordingly, the plea of the revenue that the services were used for making investment in India and therefore cannot be treated as export, was dismissed. Further in the matter of back office support operations, relying upon the decision of Commissioner of Central Excise, Hyderabad vs. Deloitte Tax Services India Pvt. Ltd [2008 (11) STR 266 (Tri.-Bang)] the Tribunal held that since the client was situated outside India, it is an export of service.

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[2015-TIOL-1719-CESTAT-DEL] Commissioner of Service Tax-Delhi vs. Ishida India Pvt. Ltd.

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Effective use and enjoyment of service of procuring purchase orders is abroad and therefore the services are exported.

Facts:
The Respondent, a wholly owned subsidiary of a foreign company is engaged in procuring purchase orders from Indian customers on behalf of the foreign company. Goods are supplied in India and they receive “indent commission” in convertible foreign exchange at a predetermined percentage. A refund claim was filed for the service tax wrongly paid by them on the export of services. Adjudicating authority rejected the claim stating that the condition of export of services was not satisfied. Commissioner (Appeals) allowed the refund, therefore revenue is in Appeal.

Held:
The Tribunal noted that if the respondents did not canvass the purchase orders and sent it to the foreign company, there would be no supply of goods or use of goods in India at all. Therefore the service is definitely utilized/benefited by the foreign company. Merely because the goods supplied were ultimately used in India, cannot be a reason to hold that there was no export of the output service. Accordingly, it was held that the effective use and enjoyment of the service is by the foreign company and therefore refund is allowable as the services were exported.

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