BCAJ | Bombay Chartered Accountant Journal

Reopening of a completed assessment

1. Issue for consideration :

1.1 S. 147 of the Income-tax Act, 1961 permits reassessment of income, where the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any assessment year so however no reassessment will ensue where there was no failure on the part of the assessee to disclose fully and truly the material facts necessary for assessment. No reopening is possible once it is shown that a mind is applied by the AO to the facts of the case unless the reopening is sought to be made in consequence of the possession of information obtained subsequent to an assessment.

1.2 Very often substantial details are collected and inquiries are made by the AO but assessment orders are passed without reference to such details and inquiries, allowing a deduction or exemption. The factual question that arises in such cases is whether there has been an application of mind by the Assessing Officer during the assessment proceedings to the issue involved, and whether the deduction, exemption or non-taxation was after due deliberation, in which case reassessment proceedings cannot be initiated. The issue gets added dimensions where the assessee is able to show that he has filed details in response to the AO’s inquiry but the AO claims that he had not noticed the same in the myriad of details furnished with him.

1.3 The issues that have arisen before the courts in such cases are whether, in a case where a regular order of assessment is passed u/s.143(3) without much discussion on a particular issue, there was an application of mind by the Assessing Officer; whether there was disclosure of material facts by the assessee and whether permitting reopening in such cases would amount to giving premium to an authority exercising quasi-judicial function to take benefit of its own wrong. While the full bench of the Delhi High Court has taken the view that no reassessment proceedings are permissible in such cases, the division bench of the Allahabad High Court, recently, has taken a contrary view.

2. Kelvinator’s case :

2.1 The issue came up before the Full Bench of the Delhi High Court in the case of CIT v. Kelvinator of India Ltd., 256 ITR 1.

2.2 In this case, the assessment of the assessee was completed u/s.143(3). Subsequently, it was noticed by the Assessing Officer that as indicated in the accounts and tax audit report, certain prior period expenditure and certain disallowable expenditure had been wrongly allowed as deductions. He therefore issued a notice for reassessment u/s.147.

2.3 The assessee challenged the reassessment proceedings in appeal. The Commissioner (Appeals) allowed the assessee’s appeal holding that the assessee had disclosed all the facts, that no new fact or material was available with the Assessing Officer, and that it was a mere change of opinion on the part of the Assessing Officer. The Tribunal upheld the order of the Commissioner (Appeals).

2.4 Before the Delhi High Court, on behalf of the department, it was argued that the change of opinion was relevant only for the purposes of clause (b) of S. 147, and that initiation of reassessment proceedings was permissible when it was found that the Assessing Officer had passed an order of assessment without any application of mind. According to the department, such application of mind could be found out from the order of assessment itself inasmuch as, if the order of assessment did not contain any discussion on the particular issue, the same may be held to have been rendered without any application of mind.

2.5 On behalf of the assessee, it was argued before the Delhi High Court that the expression ‘reason to believe’ contained in S. 147 denoted that the reassessment must be based on a change of fact or subsequent information or new law. According to the assessee, income escaping assessment must be founded upon or in consequence of any information which must come into the possession of the Assessing Officer after completion of the original assessment.

2.6 The Delhi High Court, after considering the various decisions cited before it, observed that it was not in dispute that the Assessing Officer did not have the jurisdiction to review his own order. His jurisdiction was confined only to rectification of mistakes as contained in S. 154. The power of rectification of mistakes could be exercised only when the mistake was apparent, and a mistake could not be rectified where it was a mere possible view or where the issues were debatable. Thus, where the Assessing Officer had considered the matter in detail and the view taken was a possible view, the order could not be changed by way of exercising the jurisdiction of rectification of mistake.

2.7 The Delhi High Court further noted that it was a well settled principle of law that what could not be done directly could not be done indirectly. If the Assessing Officer did not have the power of review, he could not be permitted to achieve the object by taking recourse to initiating a proceeding of reassessment.

2.8 According to the Delhi High Court, when a regular order of assessment is passed in terms of S. 143(3), a presumption can be raised that such an order has been passed on application of mind. In terms of S. 114(e) of the Indian Evidence Act, judicial and official acts are presumed to have been regularly performed. If it be held that an order which has been passed purportedly without application of mind would itself confer jurisdiction upon the Assessing Officer to reopen the proceeding without anything further, this would amount to giving a premium to an authority exercising quasi-judicial function to take benefit of its own wrong.

2.9 The Delhi High Court therefore held that since the material was before the Assessing Officer at the time of assessment, the reassessment proceedings were invalid.

3. EMA India’s case :

3.1 The issue again recently came up before the full bench of the Allahabad High Court in the case of EMA India Ltd. v. ACIT, (unreported — copy of order available on www.itatonline.org).

3.2 In this case also, the assessment proceedings were completed u/s.143(3), and reassessment proceedings were initiated u/s.147 to disallow prior period expenditure and to tax certain interest which were disclosed in the balance sheet, profit and loss account, tax audit report, and other documents submitted before the Assessing Officer in the earlier proceedings.

3.3 The assessee challenged the reassessment proceedings in a writ petition before the High Court. Before the Allahabad High Court, it was submitted on behalf of the assessee that the initiation of proceedings and issue of notice were based on mere change of opinion and were totally without jurisdiction. It was submitted that the action of the Assessing Officer amounted to review of the earlier assessment order, and that even though the Assessing Officer had noticed such items, he did not assess these items nor add the same to the income during the assessment proceedings. Reliance was placed by the assessee on the full bench decision of the Delhi High Court in Kelvinator’s case (supra).

3.4 On behalf of the department, it was submitted that the initiation of reassessment proceedings was permissible when it was found that certain items of income, though chargeable to tax, had escaped the notice of the Assessing Officer, and no discussion of chargeability to tax of such items of income was made in the assessment order.

3.5 According to the Allahabad High Court, where the assessment order had been passed and certain items of income are not at all discussed and it escaped the notice of the assessing Officer as a result of which the reassessment proceedings were initiated in respect of those items of income, in the circumstances it could not be said that it would amount to review. Since the Assessing Officer did not form any view or any opinion with regard to the items of income which escaped its notice in the original assessment order, it would not amount to review of the order or change of opinion. According to the Allahabad High Court, there could be no change of opinion when no opinion was formed by the Assessing Officer.

3.6 The Allahabad High Court was of review that initiation of reassessment proceedings was permissible where it was found that the Assessing Officer had passed an order of assessment without any application of mind and such application of mind could be found out from the order of assessment itself, inasmuch as, in the event the order of assessment did not contain any discussion on a particular issue, the same may be held to have been rendered without any application of mind. According to the Allahabad High Court, in view of Explanation 1 to S. 147, mere production of account books or other evidence from which material evidence could, with due diligence have been discovered by the assessing authority would not necessarily amount to disclosure. This aspect, according to the Allahabad High Court, had not been considered by the Delhi High Court in Kelvinator’s case.

3.7 The Allahabad High Court therefore held that the reassessment proceedings were valid.

Observations:

4.1 Some controversies do not lead to ‘closements’ soon. The issue being discussed here is an example of one such controversy. Even the attempt in the proposed Direct Tax Code for resolving the controversy in favour of smooth reopening will surely raise new controversies. The issue is fiercely con-tested by the tax payers, in spite of amendments, as they perceive the whole exercise of reassessment as unjust weilding of power by those in the power. One finds a lot of merit in this when one notices the ease with which completed cases are sought to be reopened in large numbers.

4.2 The sting is acutely painful in cases where the reopening is made after expiry of four years, in spite of the fact that there is no failure on the part of the assessee to disclose fully and truly the material facts necessary for assessment. Even in such cases the reopening is sought to be justified on the pretext that the AO had not applied his mind to the material disclosed, though it was produced. The action is sought to be explained by resorting to Explanation 1 to S. 147 and in many cases by relying on Explanation 2 to the said section.

4.3 Fortunately for the tax payers the courts have, by and large, frustrated such attempts of the Revenue in cases where disclosure is found to be evident and also in cases where the material has been furnished in response to an inquiry by the AO. The courts have not given great credence to the Revenue’s contention, often made, that the assessment order is silent on the relevant aspect under contest. The courts have advanced the cause of the tax payers even in cases involving reopening within four years on being convinced that material facts necessary for assessment were disclosed. The courts have also taken a unanimous view that the amendments of 1989 have not materially altered the available law on the subject and that a change of opinion can not lead to a valid reopening even post 1989.

4.4 The Courts have been consistent in holding that the law does not permit a review of an order, not even in the name of reassessment. A thing which can not be done directly can certainly not be done indirectly by resorting to the provisions of re-assessment. It is this principle that has been reiterated by the Full Bench of the Delhi High Court by stating that permitting an AO to reopen a completed case in given circumstances amounted to giving a premium to an authority exercising quasi-judicial function to take benefit of its own wrong.

4.5 Whether this position stated in paragraph 4.4 has been changed by insertion of Explanation 1 and 2. The Courts do not think so. Even after the said insertion the courts are more or less consistent, in holding that a change of opinion can not lead to reopening of a completed assessment and further that in cases where the assessee has not failed in disclosing truly and fully the material facts necessary for assessment, reopening is not possible irrespective of the time of reopening.

4.6 The Punjab & Haryana High Court, in the case of Hari Iron Trading Co. v. CIT, 263 ITR 437, observed that the taxpayer had no control over the actions of an AO and that he was not in a position to direct the framing of an order in a manner that would record fully and truly all that had actually transpired during the course of assessment and in such circumstances it was appropriate to assume that the order had been passed with due diligence unless it was otherwise proved by the AO. It is normally seen that an assessment order rarely records the findings of the inquiry by AO where he is satisfied with the assessee’s explanation furnished in response to his inquiry.

4.7 The Bombay High Court, consistently follow-ing the full bench decision of the Delhi High Court, has held that once an assessment order is passed u/s.143(3) and the assessee has not been found to have failed in disclosing material facts, no reopening was sustainable. Asian Paints Ltd. v. DCIT & Ors., 308 ITR 195, Idea Cellular Ltd. v. DCIT, 301 ITR 407 and GT v. Eicher Ltd., 294 ITR 310. The same is the ratio of the decisions of several High Courts and Tribunals including the latest one by the Tribunal in the case of Vardhman Industries, ITA No. 501/ Jd/2008 dated 14-9-2009 wherein the jodhpur Bench held that even within four years it was not possible to reopen an assessment where the material facts were found to have been disclosed by the assessee. It appears that in all cases of assessments completed after scrutiny, a reopening can follow only on the basis of an information received subsequent to assessment.

4.8 Even the Allahabad High Court in the case of Foramer v. CIT & Ors., 247 ITR 436 had held that no reopening was possible on a mere change of opinion in cases where there was no failure to disclose material facts by an assessee, a decision which was later on approved by the Supreme Court. Had this decision been noted by the court in EVA’s case, the outcome could have been different. It is interesting to note that the full bench of the Delhi High Court in coming to the conclusion in assessee’s favour had concurred with the abovementioned decision of the Allahabad High Court in Foramer’s case.

4.9 The twin decisions of the Gujarat High Court in the cases of Praful Chunilal Patel, 236 ITR 732 and Garden Silk Mills, 237 ITR 668, heavily relied upon by the Allahabad High Court in EVA’s case, were not even followed by the same Gujarat high court and importantly the full bench in Kelvinator’s case had specifically dissented from these decisions of the Gujarat High Court. Like Delhi, the Bombay High Court has refused to follow the said decisions of the Gujarat High Court.

4.10 CBDT Circular No. 549 dated 31-10-1989, while explaining the implication of the scheme of reassessment, specifically clarified vide para 7.2, that the new scheme does not bring about a material change in the existing law providing that no reopening would sustain in cases of change of opinion not involving any failure on the part of the assessee to disclose material facts. It is this circular which has helped information of a definitive judicial consen-sus in the era after amendment of 1989. It is need-less to note that the circulars of the Board are binding on its officers in administering the provisions of the Income-tax Act.

4.11 S. 114 of the Indian Evidence Act vide clause provides that due care has been taken by a public officer in performing his duty. Therefore on completion of assessment, it can be presumed that the AO has examined the material produced before him. Frankly, Explanation 1 is an unintended but serious reflection on the state of affairs in the Revenue department, indicating that orders as a rule are passed without due diligence, unless otherwise proved.

4.12 Article 14 has been favourably relied upon by the courts to support the contention that permitting an AO to review his order results in violation of the Constitution which guarantees protection against such administrative actions of the executive.

4.13 A point which emerges from the controversy is that the issue is debatable, and the language adopted by the law is capable of two interpretations. If that is so, a view that is favourable to the assessee should be accepted.

4.14 The decision of the Supreme Court, in the case of Indian Newspaper, relied upon by the Allahabad high court in EVA’s case, clearly supported the view that the reopening of an assessment was not possible for reviewing an order.

4.15 The decision in Kelvinator’s case was delivered by the full bench of the high court. The law of precedent required that the division bench of the high court, of two judges, in EVA’s case should have followed the decision of a larger bench instead of following decisions which were specifically dissented by the full bench. The decision in the case of Shyam Bansal, 296 ITR 95 (All.), again relied upon in EVA’s case did not consider the decision of the full bench and in any case the Revenue in that case was in possession of some information obtained post assessment. The binding force of the decision of the full bench in Kelvinator’s case was specifically considered in the case of KLM Royal Dutch Airlines 292 ITR 49 (Delhi) wherein the Court, in the context of the very same issue, had considered the validity of a decision delivered by the division bench in the case of Consolidated Photo and Finvest Ltd. 281 ITR 394 (Del.) wherein the division bench had failed to follow the decision of the full bench in Kelvinator’s case. The Court in KLM Royal Dutch Airlines’ case held that the decision of the full bench in Kelvinator’s case had to be followed by the division bench of the Court. This position in law of precedent has been reiterated by the Bombay High Court in the case of Eicher Ltd., 294 ITR 310.

Nirav Shah

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

1. Issue for Consideration :

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

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

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

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

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

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

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

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

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

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

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

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

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

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

3. Nexus Computer’s case:

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

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

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

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

4. Observations:

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

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

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

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

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

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

Nirav Shah

Interest u/s.234A — Taxes paid but return delayed

Controversies

1. Issue for consideration :

1.1 S. 234A(1) of the Income-tax Act provides for levy of
simple interest at the rate of one percent, for every month or part of the
month, for the default of non-furnishing the return of income u/s.139 or S. 142,
on the amount of the tax on total income as determined u/s.143(1) or on regular
assessment as reduced by the advance tax and the tax deducted or collected at
source and such other taxes as are specified in clauses (i) to (vi) of the said
Section.

1.2 The taxes to be reduced from the tax determined on
regular assessment are :

(i) advance tax, if any, paid;

(ii) any tax deducted or collected at source;

(iii) any relief of tax allowed u/s.90 on account of tax
paid in a country outside India;

(iv) any relief of tax allowed u/s.90A on account of tax
paid in a specified territory outside India referred to in that Section;

(v) any deduction, from the Indian income-tax payable,
allowed u/s.91 on account of tax paid in a country outside India; and

(vi) any tax credit allowed to be set off in accordance
with the provisions of S. 115JAA.

1.3 The interest is payable for the period commencing on the
date immediately following the due date for filing return of income defined
under Explanation 1 to mean the date specified in S. 139(1) and ending on the
date of furnishing the return or where no return is furnished, on the date of
completion of assessment u/s.144. Vide Ss.(2) the interest payable U/ss.(1) is
reduced by the interest, if any, paid u/s.140A towards the interest chargeable
u/s.234A.

1.4 A separate levy for default in payment of advance tax is
provided by S. 234B for levy of simple interest at the rate of one percent, for
every month or part of the month, on the amount of the tax on total income as
determined u/s.143(1) or on regular assessment as reduced by such taxes as are
specified in clauses (i) to (v) of Explanation 1 to the said
Section. Such interest is payable by an assessee liable to pay advance tax
u/s.208 where advance tax paid u/s.210 is less than ninety percent of the
assessed tax for the period commencing on 1st April next following the financial
year and ending on the date of determination of total income u/s.143(1) or
regular assessment. Vide Ss.(2)(i) the interest payable U/ss.(1) is reduced by
the interest, if any, paid u/s.140A towards the interest chargeable u/s.234B.

1.5 In cases involving twin defaults of delayed filing return
of income and short payment of advance tax, the person is made liable for
interest for the same period and in some cases on the same amount under two
different provisions of the Act, namely, u/s.234A and 234B. These simultaneous
levies have prompted assessees to challenge the double whammy without success;
however, some success was achieved in cases involving default of delayed return
of income where taxes were paid after the financial year end but before the due
date of filing return of income. The decision of the Delhi High Court upholding
the plea of the assessee that interest was not chargeable u/s.234A for the
period following the due date and ending on the date of filing of return has
recently been dissented by the Gujarat High Court holding that such simultaneous
levies were possible in law.

2. Pronnoy Roy’s case :

2.1 The issue was first considered by the Delhi High Court in
the case of Dr. Pronnoy Roy & Anr. v. CIT, 254 ITR 755. In that case, the
assessee had earned substantial capital gains for the assessment year 1995-96
for which the return was due to be filed on October 31, 1995. Though taxes due
were paid on September 25, 1995, i.e., before the due date of filing of
the return, the return was filed on September 29, 1996, i.e., after a
delay of about 11 months. While the returned income was accepted in assessment
of income, interest was charged u/s.234A on the ground that tax paid on
September, 25, 1995, could not be reduced from the tax due on assessment. A
revision petition u/s.264 of the Act was filed before the Commissioner
requesting for deletion of interest charged u/s.234A of the Act. The
Commissioner in his order, upheld the action of the Assessing Officer stating
that deduction of tax paid on September 25, 1995, was not provided in S. 234A of
the Act, as it compensated for delay/default in filing of return of income and
not the payment of tax. Against the order of the Commissioner, the assessee
filed a writ petition under Article 226/227 of the Constitution of India, before
the High Court seeking for a writ of certiorari/mandamus in respect of
the said order passed u/s.264 of the Act upholding the levy of interest u/s.234A
of the Act.

2.2 The following contentions were advanced by the assessee,
before the High Court, in support of the case that no interest be levied
u/s.234A for the period commencing with 25th September 1995, i.e., the
date on which the payment of taxes was made.

* The taxes were paid voluntarily before the due date of filing return of income and once the taxes were found to have been paid no interest u/s. 234A could be levied for the period thereafter in-asmuch as there did not remain any basis for such levy.

Levy of interest u/s.234A was compensatory in character and was introduced for compensating the Government for the loss of revenue and as in the assessee’s case there was no loss of revenue, on payment by the assessee, no compensation was due to the Government.

There was no deprival of resources for the State and in the absence of that it was not possible for it to seek damages for the same.

The taxes paid by him on 25th September, 1995 should be treated as payment of advance tax.

A separate provision, namely, S. 271F provided for the levy of penalty for the default of not filing the return of income by due date w.e.f. 1-4-1999.

Simultaneous levies for the same period were unjust and resulted in double jeopardy.

The provisions must be construed liberally.

In case of doubt, the benefit of doubt should be given to the assessee.

2.3 On behalf of the Revenue it was contended that by reason of S. 234A, interest was charged for default in filing return which did not cease or stop with payment of taxes. That not charging interest would defeat the very objective behind introduction of S. 234A.

2.4 The Delhi High Court upheld the contention of the assessee that no interest was to be charged u/ s.234A for the period commencing from 25th September 1995 for the following reasons:

Penalty and interest both could not be charged for failure to perform a statutory obligation.

Interest, was payable either by way of compensation or damages and penal interest could be levied only in the case of a chronic defaulter.

The common sense meaning of ‘interest’ must be applied in interpretation of S. 234A of the Act and even if the dictionary meaning was to be taken recourse to, the Court was supported by the Collins Cobuild English Language Dictio-nary reprinted in 1991, which defined it as; “Interest is a sum of money that is paid as percentage of a larger sum of money, which has been borrowed or invested. You receive interest on money that you invest and pay interest on money that you borrow.”

The question raised when considered from an-other angle was that interest was payable when a sum was due and not otherwise.

The object of the amendment was to levy mandatory interest where the return was filed late and tax was also not paid. The provisions made an exception for deduction of the amount of the interest if the same had otherwise been paid or deposited. A statute must be construed having regard to its object in view.

The Court noted that in Shashikant Laxman Kale v. UOI, 185 ITR 105, the Apex Court held that interest could not be charged when no tax was outstanding. It further noted that in Ganesh Dass Sreeram v. ITa, 159 ITR 221, it had been held that “Where the advance tax duly paid covers the entire amount of tax assessed, there is no ques-tion of charging the registered firm with inter-est even though the return is filed by it beyond the time allowed, regard being had to the fact that payment of interest is only compensatory in nature. As the entire amount of tax is paid by way of advance tax, the question of payment of any compensation does not arise.”

Penalty could not be imposed in the absence of a clear provision. Imposition of penalty would ordinarily attract compliance with the principles of natural justice.

Levy of penalty in certain situations would attract the principles of existence of mens rea. While a penalty was to be levied, discretionary power was ordinarily conferred on the authority. Unless such discretion was granted, the provisions might be held to be unconstitutional.

In situation of the nature involved in the case, the doctrine of purposive construction must be taken recourse to.

The submission of the Revenue to the effect that payment of tax although the same could be made along with the return, could not be a ground for not charging interest in terms of S. 234A; if given effect to, the object and purpose of S. 234A would be defeated and, thus, the same could not be accepted. The object of S. 234A was to receive interest by way of compensation. If such was the intention of the Legislature, it could have said so in explicit terms.

Judicial notice was required to be taken of the fact that the Legislature had enacted S. 271F with effect from April I, 1999, by the Finance (No. 2) Act of 1998, providing for penalty, in the case of a person who was required to furnish a return of his income as required U/ss.(I) of S. 139 of the Act who did not do so.

When the statute provided that an interest, which would be compensatory in nature would be levied upon the happening of a particular event or inaction, the same by necessary implication would mean that the same could be levied on an ascertained sum.

The definition of ‘Advance tax’ was not an exhaustive one. If the word ‘advance tax’ was given a literal meaning, the same apart from being used only for the purpose of Chapter XVII-C might be held to be tax paid in advance before its due date, i.e., tax paid before the due date. A person, who did not pay the entire tax by way of advance tax, might deposit the balance amount of tax along with his return.

2.5 The Court accordingly held that interest would be payable only in a case, where tax had not been deposited prior to the due date of filing of the income-tax return.

3. Roshanlal Jain’s case:

3.1 The assesseein Roshanlal S. lain (AOP) v. DCIT, 220 CTR 38 (Guj.), had defaulted in payment of advance tax before the year end, but had paid the shortfall after the year end, and before the due date of filing return of income. The return was filed beyond the due date prescribed u/s.139(1) and the Assessing Officer had charged interest u/ s.234A and u/ s.234B including for the period commencing on the day when the shortfall was made up and ending with the due date prescribed for filing the return of income.

3.2 The assessee challenged the validity of interest charged u/ s.234A and u/ s.234B,besides the constitutional validity of the provisions to submit that S. 234A be held to be ultra vires the Constitution to the extent it required an assessee to pay interest even after the tax has been paid before filing of the return. In relation to S. 234B, it was submitted that when the said provision charged interest for the same period for which interest had already been charged u/ s.234A, the said provision should be held to be unreasonable and should be struck down. The assessee strongly relied on the decision of the Delhi High Court in the case of Dr. Pronnoy Roy, 254 ITR 755 in support of his contentions.

3.3 The Gujarat High Court negatived the contentions of the assessee to hold as under:

On a plain reading of the provisions of S. 234A and S. 234B, it was apparent that S. 234A provides for the liability to pay interest for default in late furnishing of return or non-furnishing of return, while S. 234B levied interest for default in payment of advance tax.

Both the provisions, i.e., S. 234A and S. 234Bpro-vided for payment of interest on the amount representing the difference between the amount of tax payable on the total income as determined u/s.143(1) or on regular assessment as reduced by the specified taxes.

The scheme that emerged on a conjoint reading of S. 4, S. 2(1), S. 190 and S. 207, was that even though assessment of the total income might be made later in point of time, yet the liability to pay income-tax was relatable to the financial year immediately preceding the assessment year in question and such liability had to be dis-charged either by way of having tax deducted at source or collected at source, or by making payment by way of advance tax in accordance with the provisions of S. 208 to S. 219.

S. 208 stipulated that advance tax should be paid during a financial year in every case where the amount of such tax payable by the assessee during that financial year, as computed in accordance with the provisions of Chapter XVIIof the Act, exceeded the prescribed limit.

A statutory liability was cast on the assessee to pay advance tax during the financial year as provided by the legislative scheme.

In the instant case, the assessee did not dispute that there was default in payment of advance tax.

Payment of tax on which the assessee was resting its case was admittedly made beyond the financial year and therefore, contrary to the legislative scheme. In the circumstances, the question that was to be posed and answered was whether an assessee who had acted contrary to the legislative scheme could seek an equity.

For computing interest u/ s.234A, the difference of the amount on which interest became payable had to be worked out by deducting the advance tax paid, including any tax deducted or collected at source from the tax on the total income determined at the time of an assessment.

In the instant case, the default in filing of return of income beyond the prescribed date was also admitted. Therefore, it was not possible to accept the contention of the assessee that the amount paid beyond the financial year should be deducted from the tax on the total income as determined on regular assessment. This has to be so, considering the definition of the term ‘advance tax’ as appearing in S. 2, which categorically stipulates that ‘advance tax’ means the advance tax payable in accordance with the provisions of Chapter XVII-CoEven if contextual interpretation is adopted considering the opening portion of 5.2 which states ‘unless the context otherwise requires’, the contention raised by the assessee did not merit acceptance; the context and setting of the aforesaid provisions do not even, prima facie indicate that any other law, like the one canvassed by the assessee, was possible.

S. 140A stipulated that where any tax was payable on the basis of any return required to be furnished, such tax together with interest payable under any provision of the Act for any delay in furnishing return, or any default or delay in payment of advance tax before furnishing the return shall be paid. In other words, the Legislature had specifically provided that once there was default in either furnishing of return or in payment of advance tax or both, as regards the amount and the period, interest had to be worked out by the assessee himself. Thus, there is an inherent indication in the statutory scheme that any payment made beyond the financial year had to be considered, but such payment had to be accompanied by the interest payable for the default committed in filing of the return of income or default in payments of advance tax during the financial year. For this purpose, the Legislature had not equated both defaults, but had instead provided for computing interest separately for both the defaults. Therefore, merely because some amount was paid beyond the financial year but before the return was filed, the assessee could not plead that it was not liable to pay interest u/ s.234A; nor could it be given credit for such payment made beyond the financial year for the purpose of computing interest u/ s.234B for the default in payments of advance tax.

There was no merit in the contention of the assessee that it had not incurred any liability to pay interest either u/ s.234A or u/ s.234B. It also could not contend that there was any overlapping of the period for which it could not be made liable for paying interest under both the provisions, considering the fact that both the defaults were independent of each other.

The doctrine of double jeopardy envisaged by Article 20(2) of the Constitution or S. 300 of the Code of Criminal Procedure, 1973 could have no application in these proceedings. The defaults, and not offences, were not one; non-filing or late filing of return and non-payment or short-payment of advance tax could not be equated.

The period for which the liability to pay interest arose, had to be computed in accordance with the term fixed by each of the provisions, viz., S. 234A and S. 234B.

The contention, that if the statutory provision re-sulted in an absurdity or mischief not intended by the Legislature, the Court should import words so as to make sense out of the provisions, also did not merit acceptance, considering the fact that on a plain reading of the provisions, the discernible legislative intent could not be said to result in an absurdity.

If the plea raised by the assessee was accepted, not only would it require the Court to give a go-bye to the entire statutory scheme, but it would also result in discrimination against majority of the assessees who complied with requirements of the statutory provisions. No person was entitled to seek any relief on the basis of inverse discrimination.

There was also no merit in the contention of the assessee that the provisions contained in S. 234A and S. 234B were ultra vires to the constitution. It was true that the nature of the levy of interest u/ s.234A and u/ s.234Bwas compensatory in character, but from that it was not possible to come to the conclusion that there was any arbitrariness or unreasonableness which would warrant striking down the provision.

3.4 The Gujarat High Court specifically dissented from the decision of the Delhi High Court in Dr. Pronnoy Roy’s case, 254 ITR 755 cited before the Court by the assessee and proceeded to dismiss the writ petition filed by the assessee. The submission of the assessee as to the binding nature of the precedent based on uniformity of expression of opinion on the ground of wise judicial policy also did not deserve acceptance. The Court agreed that there was no dispute about the proposition that in income-tax matters, which were governed by an all India statute, when there was a decision of a High Court interpreting a statutory provision, it would be a wise judicial policy and practice not to take a different view. However, this in the opinion of the Court was not an absolute proposition and there were certain well-known exceptions to it. In cases where a decision was sub silentio, per incuriam, obiter dicta or based on a concession or where a view taken was impossible to arrive at or there was another view in the field or there was a subsequent amendment to the statute or reversal or implied overruling of the decision by a High Court or some such or similar infirmity was manifestly perceivable in the decision, a different view could be taken by the High Court.

4. Observations:

4.1 There are several angles to the issue under consideration, prominent being:

the true nature of interest charged u/ s.234A; whether the same is compensatory or penal or both,
whether any interest can be charged where the State does not lose any revenue,
whether interest can be charged without there being any basis. The base, normally, is the amount unpaid or delayed,
the true meaning of the term ‘advance tax’, the true meaning of the term ‘interest’,
whether the introduction of S. 271F for levy of penalty has made any difference,
whether interest can be levied simultaneously under two different provisions for the same period,
whether such simultaneous levies resulted in a case of double jeopardy,
whether the levy was in violation of the Indian Contract Act, and
whether the levy was in violation of the Constitution of India.

4.2 All these issues, including the issue of the binding nature of an available decision of the High Court, were considered in the above discussed judgments by the Courts in delivering the conflicting verdicts. The Courts have touched upon most of these aspects and have provided their views on the same. As these views so provided are conflicting, an attempt is made to express some views on the subject and reconcile some of them.

4.3 The provisions of S. 234A, S. 234Band S. 243C, replaced the provisions of S. 139(8),S. 215 and S. 216 which provisions in the past postulated for payment of interest. The new provisions are in pari materia with the said provisions. The old provisions were held to be compensatory and not penal in nature. The Courts time and again confirmed that the old provisions could not be anything except compensatory in character. The only material difference in the two situations is that while the old provisions conferred power to waive or reduce the levy of interest, the new provisions make the levy automatic.

4.4 The rationale of levy of interest and penalty has been succinctly stated by the Apex Court in crr v. M. Chandra Sekhar, 151 ITR 433, while considering S. 139(8) of the Act, which is in pari materia with S. 234A in the following terms:

“Now, it will be apparent that delay in filing a return of income results in the postponement of payment of tax by the assessee, resulting in the State being deprived of a corresponding amount of revenue for the period of the delay. It seems that in order to compensate for the loss so occasioned, Parliament enacted the provision for payment of interest.”

4.5 Considering the basis for calculation, the period of calculation and nature thereof implies that interest levy is compensatory in nature. The amount on which the interest is calculated is the amount payable by the assessee towards tax, less the amount already paid by him. The amount of tax which ought to have been paid by the assessee but was not paid because of the non-filing or the delayed filing only can attract interest.

4.6 The golden rule of interpretation of a statute is that it should be read liberally where a statute is capable of two interpretations, the principles of just construction should be taken recourse to. The issue surely admits of two meanings as is clear from the different meanings that the Courts have placed upon it. There is a room here for diverse construction and the provision can be construed to be ambiguous and in the circumstances a construction that leads to a result that is more just can be adopted.

4.7 No loss of revenue is suffered inasmuch as tax has already been paid. Interest is payable either by way of compensation or damages.

4.8 The insertion of S. 271F providing for levy of penalty for delay in filing the return of income abundantly clarifies that the levy of interest u/ s.234 A is compensatory in nature as the penalty, if any, for the default in filing the return of income has been provided by S. 271F. Once this is established, it is easier to accept the view that no compensation can be demanded in the absence of loss of revenue where the taxes are paid leaving no basis for calculation of interest. Two different provisions operating in the same field in the same statute is a proposition difficult to comprehend. If the Government itself has thought of introducing a provision of law levying penalty, having regard to the fact that no such provision existed earlier it cannot be interpreted differently by the Department as it is bound by interpretation supplied by the memorandum reproduced hereafter.

4.9 The memorandum explaining the insertion of S. 271F explains the objective behind its introduction; 231 ITR 228 (St) :

“Providing for penalty for non-filing of returns of income – Under the existing provisions, no penalty is provided for failure to file return of income. The interest chargeable u/ s.234A of the Income-tax Act for not furnishing the return or furnishing the same after the due date is calculated on the basis of tax payable.”

4.10 On a bare reading of the provisions of S. 234A it will be clear that in determining the amount on which interest is leviable, the amount paid by way of advance tax is to be reduced. On a careful reading, it will be clear that the term advance tax for the purposes of S. 234A has not been defined. This is clear from a simple comparison with the provisions of S. 234B which also provides for a similar reduction for the advance tax paid which clarifies that such tax is the one that is referred to in S. 208 and S. 210. In the circumstances, it is possible to take a view that any tax which is paid before the due date of filing the return of income is paid in advance and therefore represented ‘advance tax’. At the same time a note requires to be taken of S. 2(1) which defines the advance tax to mean the tax payable in accordance with the provisions of Chapter XVII-C. This conflict clearly establishes one thing and that is that the issue under consideration is debatable and in that view of the matter a view beneficial to the taxpayer requires to be adopted.

4.11 There also is a constitutionality angle to the issue that was examined by the Gujarat High Court specifically in Roshanlal [ain’s case. Whether Article 14 of the Constitution is violated in any manner, more so if it is found that the provisions of S. 234A provide for discriminatory treatment between persons of the same class placed in similar situations. In this connection the Court observed that a taxing statute enjoys a greater latitude and therefore it was difficult to uphold the proposition that the relevant part of S. 234A was unconstitutional. An inference in regard to contravention of Article 14 of the Constitution would, however, ordinarily be drawn if the provision sought to impose on the same class of persons similarly situated, a burden which led to inequality and the Court found that it was not so in the instant case. The assessee also in that case could not successfully contend that there was any unreasonable classification, considering the majority of assessees who comply with the statutory requirements.

4.12 Similarly the contention of the assessee, in Roshanlal [ain’s case, based on the provisions of S. 59 to S. 61 of the Indian Contract Act also could not carry the case of the assessee any further. The statutory scheme u/s.140A provides to make payment of tax and interest for the stated defaults before the return is filed and, therefore, to contend that the Assessing Officer could not have appropriated the amount paid towards interest did not merit acceptance. The Explanation U /ss.(l) of S. 140A specifically provides that where the amount paid by the assessee under the said sub-section falls short of the aggregate of the tax and interest payable U/ss.(l), the amount so paid shall first be adjusted towards the interest payable as aforesaid and the balance, if any, shall be adjusted towards the tax payable. In light of this specific provision under the Act, the general law under the Contract Act cannot be pressed into service by the assessee.

4.13 The views on the issue under consideration have been sharply divided and the conflict is strongly agitated by both the sides as is clear from the wide cleavage arising on account of the diametrically opposite views of the two High Courts. One must concede that both the views are tenable in law and the issue will continue to haunt the Courts unless the law is amended or the finality to the law is provided by a decision of the Apex Court. Sooner the better as the issue has an application to a very wide spectrum of taxpayers.

Authors’ note:

As we go to press, the Supreme Court in 309 ITR 231, has upheld the decision of the Delhi High Court in the case of Pronnoy Roy, on the ground that interest levied u/s.234A is compensatory in nature. Therefore, according to the Supreme Court, since the tax due had already been paid, which was not less than the tax payable on the returned income which was accepted, the question of levy of interest did not arise.

Nirav Shah

GAPs in GAAP – Discount rate for employee benefits (Proposed amendments to IAS 19)

Accounting Standards

IAS 19 Employee Benefits have required pension obligations to
be discounted at rates based on high quality corporate bond rates. However, in
countries with no deep market in such bonds the rate on government debt is to be
used.

One of the effects of the current financial crisis has been a
significant widening of the spread between yields on government bonds and those
on high quality corporate bonds. In particular, the current market results in
otherwise identical obligations being measured at very different rates due
solely to the presence or absence of a deep corporate bond market. In light of
this, the IASB published an exposure draft aiming to remove this lack of
comparability. The proposal will require the use of corporate bond rates in all
circumstances. The intention of the amendment of IAS 19 seems to be to require
use of a consistent reference in choosing the rate for discounting employee
benefit obligations regardless of whether there is a deep market in high quality
corporate bonds in the country concerned. The Board envisages that there will be
improved comparability between reporting entities due to a reduction in the
range of rates used.

Should the Board eliminate the requirement to use government
bond rates to determine the discount rate for employee benefit obligations when
there is no deep market in high quality corporate bonds ?

Since market interest rates differ considerably from country
to country or from currency zone to currency zone, consistency in application is
primarily important among plans operated in the same country or currency zone.
The financial crisis has not only widened the spread between government bond
rate and the rate on high quality corporate bonds, it has also widened the range
of corporate bond rates generally considered to be of high quality. In
particular, now that we see evidence of the spread between government bond rate
and corporate bond rate narrowing again, the range of applied corporate bond
rates within a jurisdiction is a significantly bigger concern than the spread
between government bond rate and corporate bond rate.

Generally, government bond rates are more reliably
determinable and show a significantly narrower range than high quality corporate
bond rates. In countries or currency zones where there is no or no deep market
for high quality corporate bonds the range of applied discount rates may be even
wider. The proposed change may actually decrease comparability among entities
within a jurisdiction (such as India) that would have previously applied a
discount rate determined by reference to government bond rates, as the range of
available rates for high quality corporate bonds tends to be much wider than
that of government bond rates.

This is aggravated by the fact that the current IAS 19, as
well as the proposed amendment, do not contain any further guidance regarding
the meaning of the phrase ‘high quality corporate bond rate’. So even if the
Board proceeds with this ED despite the concerns, more detailed guidance is
needed on what constitutes ‘high quality’. This would avoid the risk of
continued significant variability in discount rates selected, even within those
jurisdictions having a deep market for high quality corporate bonds.

The Board reminds its constituencies that it intends to
review the accounting for employee benefits more broadly in due course and notes
that these proposals are not meant to pre-empt that. Perhaps more ominously, the
Board notes that “The Board has not yet considered whether the measurement of
employee benefit obligations could be improved more generally and, in
particular, the Board has not yet considered whether the yield on high quality
corporate bonds is the most appropriate discount rate for postemployment benefit
obligations.”

Rather than proceeding with this ‘quick fix’, it is
recommended that the Board works expeditiously on its comprehensive review of
IAS 19, including the choice of discount rate. This will avoid a disruption of
financial information for those entities operating in jurisdictions that
currently use government bond rates to discount defined benefit obligations. In
those jurisdictions where entities currently use government bond rates due to
the absence of a deep market for high quality corporate bonds, users are
accustomed to this practice, the discount rate can be determined reliably and is
applied consistently by entities in that jurisdiction. The ED would lead to a
considerable widening of the range of discount rates applied and a move from a
‘level 1 fair value’ discount rate to a ‘level 3 fair value’ discount rate.

One would generally support proposals to improve
comparability and consistency. However, it appears inappropriate to have
consistency without having considered whether corporate bond rate or government
bond rate is appropriate to use. This quick fix proposed change only for
purposes of consistency does not match well with numerous accounting options
under IFRS — particularly one that needs mention is the manner in which
actuarial gains and losses are recognised in IFRS. Besides, for reasons
mentioned above, it is highly questionable if consistency would be achieved by
the proposed amendments.

The author would therefore recommend status quo and no haphazard changes to
IAS 19 discount rate at this stage.

levitra

Nirav Shah

Power to examine the validity of search

1. Issue for consideration :1. Issue for consideration :

1.1 S. 132 provides for the conduct of a search and seizure operation, by the specified person, under a warrant issued in consequence of information in his possession where he has a reason to believe, that the circumstances specified in S. 132 for conduct of search exist.

1.2 An assessment of the person being searched is made u/s.153A to S. 153C of the Act in cases of search conducted on or after 1-6-2003, which in the past was completed under Chapter XIVB in consequence of search up to 31-5-2003.

1.3 S. 246A provides for an appeal, before the CIT(A), against such an assessment made in consequence of a search and S. 253 provides for second appeal before the ITAT.

1.4 It is often that the person being searched challenges, in appeal, the validity of the search action, by contesting the adequacy of reasons, or, at times the very existence thereof. In such cases, the issue that often arises for consideration is about the power of the ITAT to examine the validity of a search action.

1.5 One school of thought holds that the ITAT being a quasi-judicial authority is not empowered to sit in judgment on the validity of the action of an Income-tax authority issuing the warrant, against whose action no specific appeal is provided in the Act. The other school upholds the power of the ITAT to question the validity of a search action.

1.6 The issue has been examined recently by two courts delivering conflicting decisions requiring us to take a note of the same.

2. Chitra Devi Soni’s case, 313 ITR 174 (Raj.) :

2.1 In Chitra Devi Soni, 313 ITR 174 (Raj.), the assessee, Chitra Devi, filed an appeal before the Tribunal challenging the validity of the assessment order on the ground that the said order was violative of the principles of natural justice. The assessee contended that the assessment order was bad in law for the reason that the same was passed merely on the surmises and beliefs of the authority without being in possession of any material as was required u/s. 132 of the Income-tax Act. According to the assessee, there was no material with the Director to form the belief as was required under the provisions of S. 132(1) and in the absence of any material to this effect, the assessment order passed was not maintainable and, therefore, the assessment order deserved to be set aside.

2.2 The Tribunal in appeal had adjudicated the said issue, after referring to the various judgments on the subject concerning the Tribunal’s jurisdiction to examine the validity of the authorisation when the same was challenged before the Tribunal.

2.3 The Tribunal noting the failure of the Revenue authorities to produce the records, held that the search action was invalid in the absence of an authorisation. It held that an authorisation for search was sine qua non for the purpose of passing the order of assessment by the assessing authority and in the case before it, even the factum of authorisation based on reasons had not come on record. In those circumstances, the Tribunal passed the order to the effect that search was not valid and consequentially, the block assessment was held to be illegal.

2.4 In the above background, the Revenue raised the following question in appeal before the High Court. “Whether for having recourse to assessment for the block period under Chapter XIV-B, a valid search u/s.132 is a condition precedent and mere fact of search is not enough to give jurisdiction to the Assessing Officer to have recourse to the provisions under Chapter XIV-B ? If so, whether, in the facts and circumstances of the present case the Tribunal was right to hold that the search conducted in the present case was invalid ?”

2.5 The Revenue contended before the Rajasthan High Court that the Tribunal could not look into the validity of the search, conducted under the provisions of S. 132 of the Income-tax Act. It was urged that the Tribunal had no jurisdiction or competence to look into this aspect, and therefore, the judgment rendered by the Tribunal was without jurisdiction and went beyond its competence and the Tribunal had no power to declare a search to be illegal or to be invalid.

2.6 In reply, the assessee submitted that when the basic foundation, i.e., the authorisation for search issued on the basis of the reasons was not in existence, then the Tribunal had no option but to hold that assessment of the block period was illegal and that the search was without valid authorisaton.

2.7 It was explained to the Court that for a valid block assessment, it was necessary that a search was conducted u/s.132 and for conducting such search, authorisation was required to be given only where the concerned authority had reasons to believe that there existed circumstances enumerated in clauses (a) to (c) of S. 132(1), and in the absence of authorisation based on such reasons, the block assessment itself could not be made.

2.8 The Court took note of the provisions of Chapter XIB and of S. 132 and observed that a bare reading thereof left the Court in no manner of doubt, in view of the use of word ‘then’, that the act of authorising a search had of necessity to be preceded by the existence of reason based on material in possession of the authority. In other words, existence of reason to believe, in consequence of information in possession of the officer was the sine qua non to entitle the authority to issue an authorisation as required by S. 132. It was obvious to the Court that on dissatisfaction of the abovementioned requirements of law, there could possibly be no authorisation, irrespective of the fact that it might have been made and issued and in turn if any search was conducted in pursuance of such an authorisation issued in the absence of requisite sine qua non, the search could not be said to be a ‘search’ u/s.132 of the Act, as contemplated by the provisions of S. 158B of the Act.

2.9 The Court held that the issue of an authorisation based on the reasons recorded in turn on the basis of the material available went to the root of the matter concerning the jurisdiction of the assessing authority to proceed under Chapter XIV-B and in that view of the matter, the Tribunal was very much justified, and had jurisdiction to go into the question as to whether the search was conducted consequent upon the authorisation having been issued in the background of the existence of eventualities and material mentioned in S. 132(1). In the end the Court observed that it was conscious of the fact that it was not open for the Court to go into the question of sufficiency of the reasons on the basis of which the competent authority might have had entertained the reason to believe the existence of one or more of the eventualities under clauses (a) to (c) but then the question as to whether there at all existed any material to entertain the reason to believe, even purportedly, consequent upon information in his possession, with the competent authority was the matter which could definitely be looked into by the Tribunal so also by the Court as the absence thereof would vitiate the entire action.

3. Paras Rice Mills’ case:

3.1 In the case of Paras Rice Mills, 313 ITR 182 (P &H), a search and seizure action u/s.132(1) of the Act was carried out on September 26, 1995, at the business premises of the assessee and the assessment u/s.158BC was completed in consequence of the said search. The assessee preferred an appeal and also raised grounds contesting the validity of search. The Tribunal held that the search and seizure was illegal as no material was produced before the Tribunal to show that the requirements of S. 132(1) of the Act were complied with.

3.2 The Revenue in an appeal before the High Court raised the following question for consideration of the Punjab & Haryana High Court. “Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was right in law in deciding to go into the validity of the action taken u/s.132(1) of the Income-tax Act, 1961?”

3.3 The Revenue contended that the Tribunal acted beyond its jurisdiction in deciding the issue of validity of the action by relying upon the judgments of the Delhi Tribunal in Virinder Bhatia, 79 ITD 340 and of the Madhya Pradesh High Court in Gaya Prasad Pathak, 290 ITR 128.

3.4 In reply, the assessee claimed that the Tribunal had the power to examine the validity of the search and in support of their claim relied on the judgment of the Rajasthan High Court in Smt. Chitra Devi Soni, 313 ITR 174 and also a judgment of the Delhi High Court in the case of Raj Kumar Gupta (ITA No. 50 of 2002 passed on August 21, 2003).

3.5 The Delhi High Court expressed their agreement with the view taken by the Delhi Tribunal in Virinder Bhatia, 79 ITD 340 and the Madhya Pradesh High Court in Gaya Prasad Pathak, 290 ITR 128 and for the same reason, respectfully disagreed with the view taken by the Rajasthan High Court in Smt. Chitra Devi Soni, 313 ITR 174 and observed that the judgment of the Court in Raj Kumar Gupta’s case (supra) did not deal with the issue of scope of the assessing authority and power of the Tribunal to go into the question of validity of search.

3.6 The Court held that the Tribunal when hearing an appeal against the order of assessment could not go into the question of validity or otherwise of any administrative decision for conducting the search and seizure which might be the subject matter of challenge in independent proceedings where the question of validity or otherwise of administrative order could be gone into. The appellate authority in the opinion of the court was concerned with correctness or otherwise of the assessment, only.

4. Observations:

4.1 It is puzzling for an ordinary mind to question the power of the Tribunal to examine the validity of a search action u/s.132, where the Tribunal’s power to otherwise deal with the validity of an assessment, reassessment or revision under the Income-tax Act is accepted without batting an eyelid. Like reassessment or revision, a search also is authorised by one of specified authorities and it becomes difficult to conceive as to how these acts are different in nature so that one is capable of being tried by the ITAT and the other is not.

4.2 On the first blush, it may appear to be obvious to side with the view of the Rajasthan High Court holding that the Tribunal is vested with the power to examine the validity or otherwise of the search action but on deeper examination of the fact one needs to concede that the case of the revenue also deserves due consideration as the same is also found on the edifice of sound reasoning.

4.3 A right of an appeal is not an inherent right but is derived form statute which in the present case is under S. 246A and S. 253. An appeal lies only in cases where the circumstances listed in these sections exist failing which no appeal can lie. On a reading of these provisions, one would agree that they do not specifically provide for an appeal against the action of the authority issuing a search warrant. There is no provision permitting a person being searched to challenge the act of the authority issuing the search warrant before any other Income-tax authority like CIT(A) or the quasi-judicial authority like Tribunal. The only remedy is to approach the Courts, under the writ jurisdiction, vested under Articles 32 and 226 of the Constitution of India, for challenging the validity of the search action. Relying on this understanding the Revenue authorities including the Courts have taken a view that it is not possible for the Tribunal to examine the validity of the search action.

4.4 It is in the context of what is stated above that the MP High Court in Gaya Prasad Pathak, CIT, 290 ITR 128, in an appeal against the third member order of the Tribunal concerning itself with S. 132A, observed that the jurisdiction exercised by the statutory authority while hearing the appeal could not extend to the examination of the justifiability of an action u/s.132A of the Act. That a search warrant issued by the Commissioner was without jurisdiction or not could not be the subject ma tter of assessment as the same did not arise in the course of assessment and therefore, neither the Assessing Officer nor the Appellate authority could dwell upon the said facet as the same was not a jurisdictional fact within the parameters of assessment proceeding or of an appeal arising therefrom where the scope was restricted to adjudication of the fact to the limited extent as to whether such search and seizure had taken place and what had been found during the search and seizure. The validity of search and seizure, in the considered opinion of the Court, was neither jurisdictional fact nor adjudicatory fact and therefore, the same could not be dwelt upon or delved into in an appeal.

4.5 A note also deserves to be taken of the decision of the Special Bench of the Delhi ITAT in the case of Promain Ltd. 95 ITD 489 wherein it has been held that the Tribunal appointed under the Income-tax Act does not have the power to examine the validity of a search action conducted u/s.132 or u/ s.132A while disposing of appeal against the order of block assessment.

4.6 Having noted the case of the Revenue, let us also appreciate the case of the taxpayer which also is founded on the strong base if not stronger than the Revenue’s base. On a careful observation of the provisions of Chapter XIVB as also S. 153A to S. 153C, it is noticed that a search assessment for the block period is made possible in cases where a search action u/s.132 or u/s.132A has taken place. It is only when the AO is satisfied about the fact of the search that he derives a jurisdiction to make a search assessment and it is at this stage that the authority vested with the power to make a search assessment has to satisfy himself about the validity of the search howsoever limited its scope is. Any failure by this authority to satisfy himself can be a subject matter of appeal before the CIT(A) and the tribunal and it is for this reason that the Appellate authority and with respect, an assessing authority has the power to examine whether the prima facie requirements for issue of a search authorisation were present or not.

4.7 An act of issuing a search warrant is an act carried out by the authority appointed under the Act which provides the very source on the basis of which a search assessment for the block period is carried out and it will be fair to subject such an act to examination by an appellate authority in cases where an appeal is filed against the order made on the basis of the presumption of a valid search. The power of a search assessment is derived only form an action u/s.132 or u/s.132A and in that view of the matter it is just to subject the same to the scrutiny of the appellate authorities otherwise empowered to examine the whole canvass of assessment that is springing form the search.

4.8 Article 323 of the Constitution of India lends the source for setting up of a Tribunal including ITAT. The said Article, vide clause 2(i) provides for power to examine material incidental to assessment by the Tribunal. It is this power that should empower the ITAT to examine the reasons and the validity of search.

4.9 It is true that the ITAT, being the creature of the Income-tax Act, derives its power under the statute and therefore its powers should be circum-scribed to those which are specifically vested in it by the Act. In our opinion, there is no reason to restrict the power of the ITAT where it is otherwise empowered to examine the validity of assessment.

Needless to say that when an Appellate authority is required to look into the validity of an assessment whose foundation is based on a single act, in this case a search action, it per force is required to examine the source material leading to such an assessment.

4.10 Initiating a search is an administrative action with dire consequences and therefore attracts principles of natural justice not only requiring but empowering the ITAT to examine the source material for search and its validity. Please see Rajesh Kumar, 287 ITR 91 (SC).

4.11 To contest such a scrutiny power of an Appellate authority only on the ground that as the AO does not have power to do so, the same cannot be done by the Appellate authorities as well is not in keeping with the prevailing times.

4.12 While two diametrically opposite views, genuinely possible, on the subject are considered, it will be fair and just and also equitable to read the power of examining validity of the Tribunal while interpreting its power u/s.253 and such reading will support the principles of natural justice instead of , frustrating it. Till such time a consensus of judicial opinion is achieved, an aggrieved person is advised to explore the possibility of approaching the High Court under Article 226 for suitable remedy which though costly may be expeditious.

Nirav Shah

Auditors should try old-fashioned auditing

Getting back to basic checks may be the only way for accounting firms to avoid flawed audits — says Emile Woolf, forensic and litigation consultant.

One of the defining features of the economic crisis is disclosure of high-level fraud on a breathtaking scale. Although the auditors’ traditional mantra —‘It is not the purpose of audits to detect fraud’ —is repeated at every opportunity, somehow those who rely on audits as a safeguard do not get the message.

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

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

‘Auditability’ Pressures

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

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

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

Missing the Obvious

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

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

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

Source : Accountancy, March 2009.

Nirav Shah

Retracted confession : No reliance can be placed on the retracted statement, unless the same was corroborated substantially in material particulars by some independent evidence : FERA, 1973.

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5 Retracted confession : No reliance can be
placed on the retracted statement, unless the same was corroborated
substantially in material particulars by some independent evidence : FERA,
1973.

Search action was undertaken at the office
premises of the appellant on 25-10-1994. He was detained for next two
succeeding days where he allegedly made two statements before the authorities
under the Act. He is stated to have confessed that he was responsible for
remittance of the foreign exchange.

On 28-10-1994, he was produced before the Chief
Metropolitan Magistrate, Bombay (CMM). Before the CMM he filed an application
retracting his confession. Thereafter the respondent initiated proceeding
u/s.8(3) of the Act. The appellant contended that no reliance should be placed
on the retracted confession statement unless the same was corroborated
substantially in material particulars by some independent evidence.

The authority on the basis of the confession
imposed a consolidated penalty of Rs.10 lacs. The Appellate Tribunal dismissed
the appeal and held that the onus of proof was on the appellant that the
confession was obtained from him by threat, coercion or force. On further
appeal the High Court upheld that finding of the Tribunal.

On further appeal to the Supreme Court, the Court
observed that indisputably, a confession made by an accused would come within
the purview of S. 24 of the Indian Evidence Act, 1872. The FERA Act is a
special Act, which confers various powers upon the authorities prescribed
therein. Even the salutary principles of mens rea and actus reus
in a proceeding under the Act may not be held to be applicable. It was now a
well-settled principle that presumption of innocence as contained in Article
14(2) of the International Covenant on Civil and Political Rights is a human
right, although per se it may not be treated to be a fundamental right
within the meaning of Article 21 of the Constitution of India.

It was a trite law that evidences brought on
record by way of confession which stood retracted must be substantially
corroborated by other independent and cogent evidences, which would lend
adequate assurance to the Court that it may seek to rely thereupon. In some of
the cases retracted confession has been used as a piece of corroborative
evidence and not as the evidence on the basis whereof alone a judgment of
conviction and sentence has been recorded.

A person accused of commission of an offence is
not expected to prove to the hilt that the confession had been obtained from
him by any inducement, threat or promise by a person in authority. The burden
is on the prosecution to show that the confession is voluntary in nature and
not obtained as an outcome of threat, etc. if the same is to be relied upon
solely for the purpose of securing a conviction. With a view to arrive at a
finding as regards the voluntary nature of a statement or otherwise of a
confession which has since been retracted, the Court must bear in mind the
attending circumstances which would include the time of retraction, the nature
thereof, the manner in which such retraction has been made and other relevant
factors. Law does not say that the accused has to prove that retraction of
confession made by him was because of threat, coercion, etc., but the
requirement is that it may appear to the Court as such.

In the instant case, the Investigating Officers
did not examine themselves. The authorities under the Act as also the Tribunal
did not arrive at a finding upon application of their mind to the retraction
and rejected the same upon assigning cogent and valid reasons therefor.
Whereas mere retraction of a confession may not be sufficient to make the
confessional statement irrelevant for the purpose of a proceeding in a
criminal case or a quasi-criminal case, but there cannot be any doubt
whatsoever that the Court is obligated to take into consideration the pros and
cons of both the confession and retraction made by the accused. It is one
thing to say that a retracted confession is used as a corroborative piece of
evidence to record a finding of guilt, but it is another thing to say that
such a finding is arrived at only on the basis of such confession although
retracted at a later stage.

The Court further observed that the appellant was
arrested on 27-10-1994; he was produced before the learned Chief Metropolitan
Magistrate on 28-101994. He retracted his confession and categorically stated
the manner in which such confession was purported to have been obtained.
According to him, he had no connection with any alleged import transactions,
opening of bank accounts, or floating of company export control, bill of entry
and other documents or alleged remittances. He stated that confessions were
not only untrue, but also involuntary.

The allegation that he was detained in the Office of
Enforcement Department for two days and two nights had not been refuted. No
attempt was made to controvert the statements made by the appellant in his
application filed on 28-10-1994 before the learned Chief Metropolitan
Magistrate. Furthermore, the Tribunal as also the authorities misdirected
themselves in law insofar as they failed to pose unto themselves a correct
question. The Tribunal proceeded on the basis that issuance and services of a
show-cause notice subserves the requirements of law only because by reason
thereof an opportunity was afforded to the proceedee to submit its
explanation. The Tribunal ought to have based its decision on applying the
correct principles of law. The statement made by the appellant before
the learned Chief Metropolitan
Magistrate was not a bald statement. The inference that burden of proof that
he had made those statements under threat and coercion was solely on the
proceedee does not rest on any legal principle. The question of the
appellant’s failure to discharge the burden would arise only when the burden
was on him. If the burden was on the Revenue, it was for it to prove the said
fact. The Tribunal on its independent examination of the factual matrix placed before it did not arrive at any finding that the confession being free from any threat, inducement or force could not attract the provisions of S. 24 of the Indian Evidence Act.

In view of the above the appeal was allowed.

[Vinod Solanki v. UOI & Anrs., Civil Appeal No. 7407 of 2008, dated 18-12-2008, Supreme Court. (source: itatonline.org), 2009 (233) ELT 157 (SC)

Nirav Shah

Public action : Bank has discretion to sell property below reserve price : Security Interest (Enforcement) Rules 2002, Rule 9

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4 Public action : Bank has discretion to sell
property below reserve price : Security Interest (Enforcement) Rules 2002,
Rule 9.

In the instant case, the Bank invited bids for
sale of the house and as per the Bank it had received highest bid of Rs.50
lakhs and reserved price of the house has been fixed at Rs.60 lakhs by the
Bank. Question arose as to whether the Bank can sell the house in a price less
than the reserve price ? The Court held that as per proviso of Rule 9(2) no
sale under this rule shall be confirmed if the amount offered by sale price is
less than the reserve price, however, the proviso to the aforesaid Rule
further provides that if the authorised officer fails to obtain a price higher
than reserve price, he may with the consent of the borrower and the creditor
effect the sale at such price.

Question arose whether authorised officer is
bound to sell the immovable property with the consent of the borrower and
secured creditor, if he fails to obtain higher price than reserve price or it
is the discretion of the authorised officer to obtain the consent of the
borrower and secured creditor or without consent he can effect the sale at
lower than the reserve price. The Court held that as per the aforesaid Rule
the Bank is obliged not to auction sale the property below the reserve price.
However, in the aforesaid Rule the word ‘may’ in the facts of the case cannot
be interpreted as a mandatory dictate to the Bank not to sell the property
below the reserve price. When the word ‘may’ has been used in statute or rule
it cannot always be interpreted that it is a mandatory provision and in view
of the provisions of the aforesaid Rule the word ‘may’ cannot be construed as
mandatory, because the Act has been enacted to facilitate recovery of loan by
financial institutions. It may be possible that in certain circumstances, as
in the instant case, financial institution is not in a position to fetch or
receive the reserve price, hence it has a discretion to sell the property
below the reserve price of the property.

[Smt. Godawari Shridhar v. Union Bank of India
& Anr., AIR 2009 Madhya Pradesh 13]

[Farhd K. Wadia v. UOI & Others, Civil
Appeal No. 7131 of 2008 {Arising out of SLP (Civil) No. 22939 of 2004), dated
5-12-2008 Supreme Court}

(source : itatonline.org) 2009 (1) scale
293]

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Nirav Shah

Hindu Marriage : A marriage under Hindu Marriage Act, 1955 can be entered into by two Hindus : Hindu Marriage Act, 1955

New Page 1

2 Hindu Marriage : A marriage under Hindu
Marriage Act, 1955 can be entered into by two Hindus : Hindu Marriage Act,
1955.

The issue involved in the instant case is as
under: Whether a marriage entered into by a Hindu with a Christian is valid
under the provisions of the Hindu Marriage Act, 1955 ?

The appellant, who is a Roman Catholic Christian
allegedly married the respondent, who is a Hindu, on 24-10-1996, in a temple
only by exchange of ‘Thali’ and in the absence of any representative from
either side. Subsequently, the marriage was registered on 2-11-1996 u/s.8 of
the Hindu Marriage Act, 1955.

Soon thereafter, on 13-3-1997, the
respondent-wife filed a petition before the Family Court u/s.12(1)(c) of 1955
Act, for a decree of nullity of the marriage entered into between the parties
on 24-10-1996 on the grounds mentioned in the said petition.

The main ground for declaring the marriage to be
a nullity was mainly misrepresentation by the appellant regarding his social
status and that he was a Hindu by religion, although it transpired after the
marriage that the appellant and his family members all professed the Christian
faith. The Family Court dismissed the said petition against which an appeal
was preferred by the respondent before the High Court, which allowed the
appeal by its judgment and order dated 12-9-2002 upon holding that the
marriage between a Hindu and a Christian under the 1955 Act is void ab
initio and that the marriage was, therefore, a nullity.

The appellant filed a Special Leave Petition out
of which the present appeal arises. The argument advanced on behalf of the
appellant, that the Hindu Marriage Act, 1955 does not preclude a Hindu from
marrying a person of some other faith.

The Court observed that there is no dispute that
at the time of the purported marriage between the appellant and the respondent
the appellant was a Christian and continues to be so, whereas the respondent
was a Hindu and continues to be so. There is also no dispute that the marriage
was alleged to have been performed under the Hindu Marriage Act, 1955, and was
also registered u/s.8 thereof.

The provisions of S. 5 of the 1955 Act which
prescribes the conditions for a Hindu marriage are as follows :

“A marriage may be solemnised between any two
Hindus, if the following conditions are fulfilled, namely : . . . .”

The Preamble to the Hindu Marriage Act, 1955,

reads as follows : “An Act to amend and codify the law relating
to marriage among Hindus.”

The Court observed that the Preamble itself
indicates that the Act was enacted to codify the law relating to marriage
amongst Hindus. S. 2 of the Act which deals with application of the Act, and
has been reproduced hereinabove, reinforces the said proposition.

S. 5 of the Act thereafter also makes it clear
that a marriage may be solemnised between any two Hindus if the conditions
contained in the said Section were fulfilled. The usage of the expression
‘may’ in the opening line of the Section, does not make the provision of S. 5
optional. On the other hand, it in positive terms, indicates that a marriage
can be solemnised between two Hindus if the conditions indicated were
fulfilled. In other words, in the event the conditions remain unfulfilled, a
marriage between two Hindus could not be solemnised. The expression ‘may’ used
in the opening words of

S. 5 was not directory, as has been sought to be
argued, but mandatory and non-fulfilment thereof would not permit a marriage
under the Act between two Hindus. S. 7 of the 1955 Act is to be read along
with S. 5 in that a Hindu marriage, as understood u/s.5, could be solemnised
according to the ceremonies indicated therein. Accordingly the appeal was
dismissed.

[Gullipilli Sowria Raj v. Bandaru Pavani,
Civil Appeal No. 2446 of 2005, dated 4-12-2008 Supreme Court. (Source :
itatonline.org) 2008 (16) SCALE 109]

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Nirav Shah

Noise pollution : Silence is one of the human rights as noise is injurious to human health : Violation of Articles 14 and 21 of the Constitution of India

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3 Noise pollution : Silence is one of the
human rights as noise is injurious to human health : Violation of Articles 14
and 21 of the Constitution of India.

The question involved in the appeal was as under
: Whether musical functions in an open theatre being Rang Bhavan should be
allowed to be carried on or not despite the fact that it is situated within
100 meters of an educational institution and a hospital ?

Rang Bhavan is an institution owned and run by
the State of Maharashtra. It is the only open theatre in the city of Mumbai.
It is let out on hire for the purpose of holding music and cultural programmes.
It charges a meagre amount for allowing private parties to hold functions. It
has a sitting capacity of 4000 persons. It is stated that the world’s greatest
artists, both Western and Indian, have performed therein. Dr. Yeshwant Trimbak
Oke & Ors. filed a public interest litigation bearing PIL No. 2053 of 2003 for
a direction to the State to curb noise pollution in general in the city of
Mumbai and particularly during the festive season of Navratri and Ganesh Utsav.
An order was passed by a Division Bench of the Bombay High Court, directing
that no loudspeaker permission be granted in respect of ‘Silence Zone’ as
defined and discussed in the Noise Pollution (Regulation & Control) Rules,
2000, as amended from time to time.

While the said order was operating, the appellant
made an application to book Rang Bhavan from 13th to 15th August, 2004 in
regard to performance of Western Cultural Music. The said application was
rejected by the State by an order dated 2-6-2004.

The Directorate of Cultural Affairs in a letter
dated 9-7-2004 addressed to the Secretary, Power Productions, also informed
that in accordance with the High Court’s order no. 2503, dated 25-9-2003,
Rangbhavan, Dhobi Talao, Mumbai, the open-air theatre comes under the silence
zone and hence the use of loudspeakers has been banned.

Contending that the said Rang Bhavan had been
lying closed for the past few years and the directions issued by the High
Court are not in consonance with the rules governing noise pollution framed by
the State of Maharashtra, a writ petition was filed by the appellant herein.
The purported public interest litigation was filed by the appellant herein to
seek an exception to the earlier order of the Bombay High Court.

The Court observed that the High Court in the
earlier public interest litigation, being writ petition No. 2053 of 2003,
admittedly passed an order of injunction. If the said order was required to be
modified or clarified and/or relaxation was to be prayed for and granted in
regard to Rang Bhavan, the appellant should have filed an application in the
said proceeding. An independent public interest litigation to obtain a relief
which would be contrary to and inconsistent with the order of injunction
passed by the Court was not maintainable. Inter alia, the doctrine of
comity or amity demands the same.

Silence Zone is an area comprising not less than
100 metres around hospitals, educational institutions, courts, religious
places or any other area which is declared as such by the competent authority.

Thus contention of the appellant that the State
Government has not declared the said zone was an irrelevant point. The High
Court, while passing its interim order dated 25-9-2003, did not state that
silence zone was required to be declared, but passed the order of restraint in
respect of silence zone, as ‘defined and discussed in the Rules’. The parties
thereto and particularly the State of Maharashtra had understood the said
order in that light.

Interference by the Court in respect of noise
pollution is premised on the basis that a citizen has certain rights being
‘necessity of silence’, ‘necessity of sleep’, ‘process during sleep’ and
‘rest’, which are biological necessities and essential for health. Silence is
considered to be golden. It is considered to be one of the human rights as
noise is injurious to human health which is required to be preserved at any
cost.

As there was no merit in this appeal the petition
was dismissed.

[Farhd K. Wadia v. UOI & Others, Civil
Appeal No. 7131 of 2008 {Arising out of SLP (Civil) No. 22939 of 2004), dated
5-12-2008 Supreme Court}

(source : itatonline.org) 2009 (1) scale
293]

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Nirav Shah

Co-operative Housing Society cannot be said to be public authority : Right to Information Act, S. 2(h)

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1 Co-operative Housing Society cannot be said to
be public authority : Right to Information Act, S. 2(h).

It is the case of the society that in the month of
Feb. 1970 it was registered under the Karnataka Co-operative Societies Act,
1959. The society is governed by bye-laws approved by the respondent. It is
contended that the society has not received any financial assistance from the
State Govt. and therefore the society cannot be a public authority within the
scope of the Act. But the respondent No. 2 Registrar of Cooperative Societies
has issued a notification dated 22-9-2005 to the effect that all co-operative
societies in the State are public authorities. When certain members sought for
information, the other members of the society opposed divulging information
pertaining to them. Therefore, the society rejected their request to furnish the
information on both counts. When the appeal was preferred to the Chairman of the
society, he wrote a letter to respondent No. 2 pointing out the provisions of
the Act. The Respondent No. 2 by his reply dated 30-10-2006 intimated the
Chairman of the society stating that u/s.2(h)(d) of the Act all co-operative
societies are public authorities. The respondent No. 1/Karnataka Information
Commission, on the basis of the notification dated 22-9-2005, by order dated
1-9-2006, directed the Registrar of Co-op. Societies to seek information from
the society and furnish the same to the applicant. The petitioner society
therefore filed writ under Article 226 of the Constitution of India before the
Court.

The Court observed that in the instant case the
petitioner/housing society is neither owned nor funded nor controlled by the
State. It is not the case of the State that the notification dated 22-9-2005 has
been issued u/s.2(h)(d) of the RTI Act. Solely on the basis of supervision and
control by the Registrar of Societies; and the definition of ‘public servant’ in
the Karnataka Co-op. Societies Act and in the Karnataka Lokayukta Act, 1984 a
society cannot be termed as ‘public authority’. So as to include a society
within the definition of the term ‘public authority’, it should fulfil the
conditions stipulated in sub-clause (d) of clause (h) of S. 2 of the RTI Act.
Therefore the petition was allowed holding that the petitioner-society was not a
public authority under the provision of the RTI Act, 2005.

[Dattaprasad Co-op. Hsg. Society Ltd., Bangalore
v. Karnataka State Chief Information Commissioner & Anr., AIR 2009 Karnataka
1.]

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Nirav Shah

HR Management in the Accounting Practice

Implementing the basic elements of HR Management can deliver powerful results for any size of firm — small, medium or big.

The secret lies in weaving this discipline of management into the everyday running of our practices.

The need for HR management :

People are the key ingredient of a professional practice. This is true whether the firm employs 10, 100 or 1000 people.

Most accounting practices struggle to employ and retain people. The gap between demand and supply is the most obvious reason why finding enough people (leave aside good talent) is so difficult. The problem is accentuated because different sectors (with very different paying capacities and glamour quotients) now compete for the same talent pool.

Retaining people is an equally big challenge because new employment opportunities (at significantly higher salaries and other perquisites and attractions) are opening up every day.

The result is that at most times we are short-staffed. Because of attrition we are unable to build and maintain a stable team with steadily improving skill sets. This results in upward delegation, putting the proprietor/partner and senior staff under constant execution and delivery pressure. There is the constant stress of missed deadlines and mistakes in delivery. This leaves us with little time and mind-space to grow and qualitatively improve our practice . . . and of course achieve the elusive work-life balance.

What we want :

As employers, we all want people who have the right attitude and appropriate and adequate skill sets to work for us. We would like to have a work environment in which our people enjoy working. We want our people to be committed to the Firm. And of course, we are concerned about salary cost since it is the biggest item on our profit and loss account.

And what employees (and articled clerks) want is professional development through learning and exposure, recognition for their work, a healthy work environment and of course, fair remuneration.

On the face of it, there is close congruence between the employer’s and employee’s needs which should guide our behaviour and actions to meeting these needs.

Reality check :

However, the truth is that most of us are so busy with day-to-day execution issues that we don’t pay any conscious attention to the people aspect of our practice. Its not that we don’t care or we don’t want to do it. We do. But our efforts in this direction are often passive, unfocussed, unstructured and sporadic.

The essential elements of HRM :

The basic objectives of HR management are :

Hiring the right people
Retaining them
Growing them

The following are the key processes of HRM that would help meet these objectives :

Recruitment and selection :

Writing clear job descriptions for each position : This is the foundation of good selection and performance management since it brings clarity to what exactly to expect from each position in the organisation. A good job description looks at all aspects of the job. In an accounting practice, the aspects could be clients, service delivery, people and growth and profitability. The specific expectations under each aspect can then be spelt out for each level of staff.

Identifying competencies required for each job/position : Using the job description we can identify the skills and competencies that would be required in order to meet the expectations of that role. Examples of skills and competencies are : expert knowledge of accounting — Accounting Standards and presentation of financial statements (in Schedule VI format), ability to supervise teams, and good report writing ability.

Systematic selection process : At the best of times, selecting people is a tricky business. Not only should the person we select be technically competent, s/he should also be a good fit for the practice in terms of attitude and temperament. Hiring mistakes are costly. An incompetent person puts delivery at risk, an undisciplined person sets a bad example to other staff, an aggressive and rude person can put client relationship at serious risk, and so on. Hence, having a systematic approach to hiring is critical to reduce the risk of a bad choice. A simple three-step process could be :

Initial screening based on CVs and job descriptions : Screening CVs in the context of your expectations help to filter out those that are obviously not a good fit for the position, either in terms of education or in terms of experience and exposure or perhaps even attitude.

Written tests for assessing technical ability : A good way to shortlist candidates is to put them through suitable tests that establish at least the baseline competency required for the job. After all, it would be a waste of time to interview everyone who applies for the job or whose CV is prima facie suitable.

Interview: This is the most important tool in selection, since it is an opportunity to assess the candidate face to face. Simply put, a good interview is one in which you find out whatever you need to know of the candidate in terms of the position in the shortest possible time. The thing to guard against is focus sing too much on technical knowledge at the expense of other attributes that are Decessary for the job. Needless to say, to get the most out of an interview, even the interviewer must plan and prepare carefully!

Performance management:

Training & Development: Development of people cannot be left to chance. It is also not the responsibility only of the employee. The organisation has (at least) an equal interest in ensuring that its people grow. This growth is in terms of technical competence, management ability and emotional maturity. While some skills and competencies can be taught (and learnt), others are acquired through experience. Again, there are technical skills and ‘soft’ skills. Whom to teach what? And who will teach? How? While these are no doubt tricky questions with no easy answers, the following approach may help to show the way:

Identify the skill gap for each person in your team. Job descriptions and competencies for each job can be a good point of reference to determine skill gaps.

Based on the skill gaps you have identified, determine the training that would need to be provided. Also choose carefully the format you will use. For example, while ‘classroom’ training is the easiest to deliver, there is a risk that it tends to be theoretical and if not delivered well, is ineffective. On the other hand, workshops and focussed case studies are much more effective, but they need careful preparation and skilful facilitation. Coaching and men toring are useful where you need to focus on the individual development of certain members of your team .

Deliver the training and TEST the participants. Needless to say, delivery of the training is the heart of the matter. This necessarily has to be effective and efficient. Short sessions of 60 to 90 minutes tend to be more effective than all-day sessions. The trainer’s preparation is critical for ensuring effectiveness. Also, the more participative the session, better is the retention of knowledge. It is very important to test the participants’ knowledge absorption by conducting a test (maybe multiple choice answers) or quiz. Of course, the ultimate test of effectiveness is how well the person actually applies his/her learnings at work!

Appraisals and feedback:

Feedback is a very powerful tool for people development and performance enhancement. While it is human nature to give feedback (usually in the form of criticism and often in public) when things go wrong, such feedback is counter productive in the long term. Also, contrary to normal practice, feedback should also be given when things go right! Feedback works best when it is given close to the event and is objectively given. While positive feedback should be given in public, negative feedback (as a general rule) should be given behind closed doors.

Even if the feedback is provided on an ongoing basis, formal performance appraisals should be conducted at least once a year. It is an opportunity to pause and objectively assess each person’s performance in all its aspects. Here again, using the job description and competencies helps to bring objectivity. In order to make the process transparent, it is useful to get each person to first do a self appraisal and then for the reporting senior to do an independent assessment which is then discussed with the staff member in a one-on-one meeting. Formal appraisals help to identify people with growth potential, training needs for strong as well as underperformers and provide an objective input for deciding on increments and promotions.

However, the one thing that we need to guard against is the ‘halo’ effect that influences the appraisal. ( The ‘halo’ effect means being un-duly influenced by recent events rather than taking the full year’s performance into consideration).

Compensation and rewards:

Fixed remuneration i.e., monthly salary: Given that this has a direct bearing on the practice’s profitability, most of us are instinctively good at it. However, one may like to be conscious of the following:

Since hiring takes place throughout the year, distortions creep into the salary structure. These need to be addressed during the annual increments.

Guard against the ‘halo’ effect described above.

Our insecurity in respect of staff on whom we are excessively dependent and its impact on their remuneration.

Giving in to requests (demands) for higher pay by some employees. While this may, in the short term, retain the person, in the long term it will be seen as unfair by those who are not as aggressive.

Variable remuneration i.e., performance-linked bonus: Most firms pay an annual bonus to their staff. However, it is not very common to link the bonus to performance. Consequently, the bonus becomes an expectation of the staff and therefore loses its influence as a motivation for better performance. If the bonus payment can be clearly linked to performance, it can indeed become a powerful driver for those with real ability. However, a very important condition for implementing such a scheme is that there be clearly defined performance expectations and performance measurements in place. In view of the issues involved in implementing a variable pay scheme, it is not recommended for very small practices and at the early stages of HR management.

Promotion: Done for the right reasons and in the right manner, promotions are a very visible recognition of a person’s abilities and send a powerful message to all staff. On the other hand, done for the wrong reasons or without an objective assessment of the person’s abilities, it sends out an even more powerful negative message ! Hence the points to keep in mind are:

Have clear reasons why the person is being promoted. Assess objectively the person’s capability to handle the new role. Else, you will neither get the role performed satisfactorily, nor will you be able to retain the person – s/he will soon be frustrated and leave.

Communicate the promotion within the organisation (an email announcing the promotion is one way of doing it) giving in brief the background of the person, his/her key achievements in the earlier role and what the new role and responsibilities will be.

Do ensure that the promotion actually results in a bigger role and is not just a change of designation.

Recognition (e.g., awards for exsra-ordinarq performance, special achievement, etc.) : Done for the right reasons and in the right manner, this can be a very powerful motivator for employees. It is not the monetary value of the award that is important, but rather the public acknowledgement of the achievement. Also, objectivity and consistency are key, else the recognition is seen to be hollow and insincere.

HR administration:

HR administration is the grease on which staff matters run. If not carried out efficiently and in a timely manner, they can result in staff dissatisfaction that can have serious repercussions for the practice. The basic elements are:

Payment of salaries: Timely and correct payment

Leave management: Clear leave policy, applied consistently, records updated promptly and balances struck regularly

Maintaining employment. records of staff

Statutory compliances (PF, ESI, profession tax, etc.)

Leadership:

For people to perform, it is essential that they have a good feeling about themselves and their organisation and they have a sense of purpose i.e., they feel that they are doing something worthwhile. This is the softest and most intangible element of HR management because it deals with people’s feelings, their emotions. It is also the most difficult but most important element. It needs to be created at the top – at the level of the proprietor or partners of the practice. Only if you yourself feel good about yourself, your practice and your organisation, will you be able to create the ‘feel good factor’ in your organisation. Every person has a different style for dealing with people. Hence there is no one-size-fits-all formula for motivational leadership. It is not important how you do it. But that you do, is. These are some general pointers:

Communicate with your people, share plans to the extent they affect the team. Give them visibil-ity so they know where they are going. This is very important for creating a sense of purpose, one of the key ingredients of ‘feel good’.

Be in touch with your people. Sense their level of motivation. The ability to understand body language is a big asset. Sensitivity and a genuine concern for people are imperative. Employee engagement activities like lunches/dinners, celebrating birthdays and festivals, picnics, etc. are an excellent way to not only give your people a break and an opportunity to de-stress but also to be one with them and to know them in an informal setting.

Celebrate successes. It is what we strive for. So when it comes, it needs to be recognised and welcomed. Else we will take it for granted and eventually lose the joy of achievement.

Show strength and courage in difficult times. Tough times are inevitable. It is in such times that staff actually look to their leaders for direction.

Hence the ‘tone at the top’ will really determine whether the team will rally behind you and put in that extra effort or whether they will look for their self interest and eventually drift away.

Give feedback. The powerful message it gives is this: ‘I have been noticed. What I do matters. Someone is interested enough in me and my work to tell me when I go well and when I don’t’. Without feedback, we feel neglected and unwanted.

The challenges and why we don’t do it:

1. It’s a big breakfrom the past: In the past (till about 15 years ago), the demand-supply gap for articled clerks and qualified staff ensured that staff was more or less readily available. By and large, clients’ expectations did not go beyond the very basic and the nature of work was such that the proprietors/partners did not have to rely very heavily on their staff for ‘brainware’ – they essentially needed their staff to do the ‘grunt’ work. So hiring, retention and building skills was not much of a constraint and was consequently did not get any serious attention.

2. We don’t have the mindset for this: Perhaps this is a legacy from the past – the point made above – and is the biggest stumbling block. Most of us are too focussed on the technical aspects of our core areas of work and think of HR functions as esoteric, fancy and ‘soft’.

3. I don’t have the time for this: This is a variation of the above.

4. My practice is too small for this: Certainly, this is a seemingly valid argument. Small practices are typically run with fairly informal structures and processes. The personal style of the proprietors/ partners has a dominating influence in the manner in which the practice is run. They are able to stay on top of things and drive the practice by the seat of its pants. In these practices, management ‘happens’ and is not something you need to do consciously,leave alone recognise its distinct facets. We tend to think of ‘formal’ management as relevant to companies and businesses, not to professional practices.

5. I am not trained for this or I don’t know what to do and how to do it: Our professional training (as articled clerks and the CA syllabus) does not give us any exposure to or training in management skills. Almost all our general management skills are self-taught and acquired from experience and reading. And HR management hardly ever comes on to our management radars.

6. I cant afford it: We have a feeling that ‘this probably costs a lot of money’ and in any case ‘is nice to have, but is not really essential for my practice’.

Busting the challenges:

The economic, social and professional environment has changed dramatically. Survival and success in the profession therefore demands that we look at managing our practices in a more business-like manner, managing all aspects of the practice (of which the technical or delivery aspect is only one) competently.

Given the benefits that good HR management can bring, spending time on this is an investment and not a cost. Initially, it does need extra effort (as any change does) but once set up properly, it is by and large ‘maintenance-free’.

How formal your HR management is will essentially be determined by the size of the practice and your own management style. What is important however, is to have the ‘HR mindset’ and to keep HR management firmly in the radar of practice management.

HR management (like all management) is essentially common sense and does not necessarily require formal training. Certainly, knowledge of basic HR functions would be a big help but is not a pre-requisite to get started.

Very importantly, none of this costs large sums of money. Like we said earlier, it will require an investment – of your time, mind space and common sense.

Ok, now where do we go from here?

Once we recognise the reality of the ‘people challenge’ and have dealt with our reasons for ‘Not Doing It’, we are ready to face the task at hand.

Getting started is a four-step process. Here are some questions to get you started:

1. Do I feel the need for HRM in my practice? This will test your need and its intensity.

2. Do I really want to implement HRM ? This will be your statement of resolution.

3. Why do I want to implement HRM ? This will test your clarity of purpose and also help to identify the ‘pay-offs’ that you expect.

4. Which elements of HRM should I implement? This will depend on the specific needs of your organisation. Your answer to 3 above will give you pointers to identify this. The section ‘Essential Elements of HRM’ above will also help to set this agenda.

5. How do I do it ? Once your reasons for implementing HRM are clear and you have set the agenda, it will then boil down to the actual implementation. The following tips may be useful:

a) Keep it simple. Don’t make a grand design. Don’t aim for the most ideal HRM practices. Do what you believe is right for you and your organisation.

b) Prioritise. Take small steps. Don’t take on too much at one time. Take what matters most first and implement it. Let it start working. Then move on to the next items.

c) Be disciplined. Once you have taken the plunge, stick to the task. Your efforts will take some time to show results, but they will. Have patience … and faith!

End Note:

Adopt HR management practices. They are simple. They are common-sense. Don’t think your practice is too small for it. Don’t be intimidated by the jargon. What is important is that YJU genuinely care for your people and that you have sincerity of purpose and discipline.

You are bound to reap the obvious benefits discussed earlier in this article. But more than that, you will experience the joy of watching people develop and grow, not by accident, but systematically and by design!

Nirav Shah

Business Combinations

Nirav Shah

Revised Schedule VI – Is it a step in the right direction ?

Accounting Standards

Schedule VI of the Companies Act, 1956, prescribes the format
of financial statements and disclosure requirements for corporate entities in
India. Considering the economic and regulatory changes that have taken place
globally, and being as old as the Act itself (1956), Schedule VI had completely
outlived its utility. The Ministry of Corporate Affairs (MCA) has issued two
drafts of revised Schedule VI for comments, namely, Saral Schedule VI for Small
and Medium Companies (SMCs) and the other for Non-Small and Medium Companies
(Non-SMCs). The revised draft aims at eliminating numerous statistical and
statutory disclosure requirements which are not relevant from an investor
perspective. Accordingly, capacity details, expenditure/income in foreign
currency, details of debts/advances due from companies under the same
management, quantitative information on inventories are done away with.

In May 2008, MCA issued a press release in which it has
committed to convergence with International Financial Reporting Standards (IFRS)
by April 1, 2011. Recently, at the G20 Summit on Financial Markets and the World
Economy, the then Finance Minister also committed to have convergence with IFRS in India. One aim of revising Schedule VI was to
attain compatibility and convergence with IFRS as well as Indian Accounting
Standards. Accordingly, the draft does not require capitalisation of exchange
gain or loss relating to fixed assets acquired from outside India. More
importantly, assets and liabilities are required to be classified as current and
non-current, which would help stakeholders in analysing the liquidity and
solvency status of a company.

Though the revision of Schedule VI aims at convergence with
IFRS, it would be far better to notify IAS 1, Presentation of Financial
Statements (or an Indian equivalent that will be issued in the near term),
in the Companies Accounting Standards Rules, rather than rewriting Schedule VI.
This is because accounting standards and disclosure requirements are dynamic in
nature and need to be updated frequently to keep pace with changes in economic
and regulatory environment. If these formats are contained in
an accounting standard, it would be easier to amend, add or delete the
requirements. However, if it is con-tained
in an Act, the process of amending will become very excruciating and difficult,
if not impossible.

Draft revised Schedule has suggested specific format
for profit and loss account. For Non-SMCs functional classification is required
and for SMCs, classification based on nature of expense is required. Considering
industry-specific requirements, IAS 1 provides entities with a choice to either
adopt the function of expense method or the nature of expense method. The
functional classification required in the draft Schedule VI would involve a
tedious process of allocating various expenses to functional heads like cost of
sales, selling and marketing expenses and administrative expenses, which is not
hitherto required. As regards Cash Flow Statement, draft Schedule VI has
mandated the use of indirect method only. This is a deviation from IAS 7
Statement of Cash Flows as well as AS-3 Cash Flow Statements which
permit both the direct and indirect method. It is rather unfortunate that
choices available to global companies are not being provided to Indian
companies.

IAS 1 is very prescriptive and sets out elaborate
requirements on presentation of financial statements. Draft Schedule VI, even
though modelled on lines of IAS 1, does not set out such important
requirements. For example, disclosures required under IAS 1, such as critical
judgements made in application of accounting policies; assumptions made about
the future and other major sources of estimation uncertainty that have a
significant risk of resulting in a material adjustment to the carrying amounts
of assets and liabilities within the next financial year are not required under
draft Schedule VI.

As per IAS 1, Statement of Changes in Equity (SOCIE) and
Statement of Comprehensive Income (SOCI) also form part of complete set of
financial statements. SOCIE includes all changes in equity arising from
transactions with owners in their capacity as owners, whereas SOCI includes
profit or loss for the period and other non-owner changes in equity. Draft
revised Schedule VI does not incorporate the concept of SOCIE and SOCI in the
financial statements. This would make revised Schedule VI out of sync with IFRS
(or an Indian equivalent that will be issued in the near term) even before it is
issued. Interestingly, in the general instructions contained in the draft
Schedule VI, an override clause allows accounting standards to override any
conflicting requirement of Schedule VI. If that be so, the point really is, do
we really need Schedule VI ?

Globally, the task of drafting accounting standards including
the format of financial statements and the disclosure requirements is carried
out by a specialised professional body, for example, in the United States the
task is carried out by FASB (Financial Accounting Standard Board). Accounting
standards and disclosure requirements is a specialised job, and the role of
regulators in this area is very limited. In light of various arguments, the
author believes that abandoning rather than revising Schedule VI is a step in
the right direction. This will also bring us in line with the global trend.

levitra

Nirav Shah

Enough !

Computer Interface

Information is rushing out to you from all directions —
letters, newspapers, magazines, phone calls, voice mails, SMS, twitter tweets,
facebook alerts and of course — emails on Blackberry and your PC.

There is enormous amount of content flowing in from all
directions. Just look at the developments at Twitter and other social media.

It was named Twitter by its founder, Jack Dorsey, because the
company wanted to capture the feeling of buzzing the world. With a limit of 140
characters, no one could have predicted the success of a communicator of
‘inconsequential information’.

It is estimated that 7.8% of Twitter users come from India,
making India the number 3 user of Twitter after the US and Germany.

Many famous personalities have a large number of followers on
Twitter. Shashi Tharoor, Minister of State for External Affairs has around
3,00,000 followers !

Youtube claims to have more than 350 million monthly visitors
and more than 3 billion photos and videos have been tagged on Flickr.

And what about emails ? For any professional around the
world, it is THE most critical form of communication. If your email server is
down, you might as well take a coffee break !

But, how do you manage the large traffic of emails which
inundates your inbox ? Do you feel overwhelmed ?

By pushing emails into handheld devices like Blackberry, the
ease of access has increased. However, it has also created some societal
problems. Children who are desperate to regain their parents’ attention from
Blackberry are often called ‘Blackberry orphans’. In some cities in Canada,
citizens have been requested to voluntarily turn off their Blackberry after 6.00
p.m. in the evening.

There is a way to manage this information overload.

Technology can help. There are software tools to help you
manage your inbox. It can prioritise your emails by importance, sort them by
senders and filter them. These tools can help you to personalise your email
settings.

Microsoft is now working on a futuristic application
(‘Priorities’) to sense work patterns and modulate the flow of emails — e.g.,
it will force a time lag in delivery of email depending on the urgency of the
email and the time of the day based on work pattern of the recipient.

Help is also available from personal productivity tools. You
can effect a change in your working habits. Some examples :

Don’t start
the day with powering on your PC and checking your emails. First, work out
your plan for the day.

Remove the
mail alert. You will avoid jumping on to the Inbox as soon as you hear the
alert, irrespective of the urgency of your other work.

Make
distinction between mails which are urgent, important and a combination of
both.

Have a few
hours of ‘email downtime’ in a day when you engross yourself fully in your
other work.

We live in a knowledge economy and information is the most
valuable commodity. Rather than be overwhelmed with it, you need to figure out
how to ‘tame the beast’. Enough !

levitra

Nirav Shah

Role of morality and estoppel in the delivery of justice

Article

Intended or not, an influence, or a dis-proportionate bearing
of supplementary factors on the process of legal adjudication could result in a
deviation from the set precedents of judicial thought. One such concept
discussed here is Morality, as understood in common parlance. The other
is the legal premise of Estoppel.

Morality, ethics, equity and Dharma :

Equity, an offspring of morality, is described as the quality
of being fair, impartial, and equal. Equity is a system of law, a body of legal
doctrines and rules developed to enlarge, supplement, or override a narrow rigid
system of law. The roots of morality and the allied concepts of ethics and
equity, in the Indian context, may be traced to the timeless principle of
Dharma. For brevity sake, all these noble, lofty concepts are hereinafter
sometimes collectively referred to under the banner of ‘Morality’.

Morality and law :

Morality on one hand and law on the other may or may not have
commonalities at a given point of time; but there are certainly perceptible
differences. While the purpose of both is to achieve an orderly society based on
equitable discrimination, there are significant differences in the nature,
scope, extent and administration of the two. Most importantly, all illegal
activities may not qualify as immoral; all immoral activities are not per se
illegal. To quote an example, the Supreme Court, in the case of Gherulal
Parakh v. Mahadeodas Maiya and Others, (AIR 1959 SC 781), observed that the
moral prohibitions in Hindu Law texts against gambling were not only not legally
enforced, but were allowed to fall into desuetude.

Morality, for instance the concept of Dharma, is on one hand
eternal, being fixed and sacrosanct in its basic principles; at the same time,
in its application at a point of time or under a set of circumstances, it is
evolving, inclusive and flexible, considering Kala (time), Desha (place) and
Sandarbha (situation). Evolution and change are attributes applicable to law
also. In the words of Roscoe Pound, a scholar, teacher, reformer, and Dean of
Harvard Law School, “The law must be stable, but it must not stand still“.
Pound strove to link law and society through his ‘sociological jurisprudence’
and to improve the administration of the judicial system and was viewed as a
radical thinker for arguing that the law is not static and must adapt to the
needs of society.

If so, does law include morality ? If yes, to what extent ?

The Indian Constitution incorporates in its preamble,
justice, liberty and equality. The Directive Principles of State Policy
are guidelines for creating a social order characterised by social, economic,
and political justice, liberty, equality, and fraternity as enunciated in the
Constitution’s preamble. Article 37 of the Constitution declares that these
principles shall not be enforceable by any court, but are nevertheless
fundamental in the governance of the country and it shall be the duty of the
state to apply these principles in making laws, so as to establish a just
society in the country. The Directive Principles of State Policy are
guidelines to the Central and State governments of India, to be kept in mind
while framing laws and policies. Thus, it may be said that the Indian
Constitution and the legislations, statutes and enactments thereunder
extensively embrace and comprehensively encompass within their folds, the
principles of Dharma, morality, ethics, equity and fair play, and if a residue
remains, it is intentional. Be it so, law, once codified by the Legislature is
presumed to inherently take care of these cherished principles without requiring
further additions.

Role of the judiciary :

If a statutory provision is open to more than one
interpretation, the Court has to choose that interpretation which represents the
true intention of the Legislature. Constitution entrusts the judiciary with
great power to declare the limits of the Legislature and Executive; Courts can
invalidate laws that run counter to the constitutional provisions. However,
morality is neither primary nor decisive here.

Can immorality, actual, alleged or perceived, influence the determination of
legality ?

The reader is bound to conclusively answer in the negative,
or rather, question the necessity of raising this issue, when the answer is well
settled and accepted. There is certainly no need to give citations or other
references to substantiate that as far as an act or omission is within the four
corners of established law, it is immaterial whether the same confines itself to
morality or not. However, simple as it may seem, there are notable instances
when morality seems to deceptively taint a decision as to legality or otherwise.
This may primarily be attributable to an appreciable and well-founded respect
for morality which unintentionally but unfortunately blurs the decision-making
process while determining legality.

Estoppel :

It may not be incorrect to say that Estoppel conceptually
derives its existence from the myriad labyrinths of morality, at least
partially. Estoppel is a legal rule that prevents somebody from stating or
claiming a position inconsistent with the position previously stated or held
out, especially when the earlier representation has been relied upon by others.
As per the Stroud’s Judicial Dictionary of Words and Phrases, the word ‘Estoppe’
comes of a French word estoupe, from which comes the English word
stopped, and it is called an estoppel, or conclusion. Summarising a host of
decisions, the Stroud’s Dictionary says, regarding estoppel by conduct or
representation, that the essential factors giving rise to an estoppel are :

(a) A representation or conduct amounting to a
representation intended to induce a course of conduct on the part of the
person to whom the representation was made,

(b) An act or omission resulting from the representation,
whether actual or by conduct, by the person to whom the representation was
made, and

While estoppel is no doubt an offspring of English law, which
was adopted by Indian law, innumerable instances can be found in ancient Dharma
in Indian scriptures which extol the virtues of estoppel, especially when
self-imposed. The popular acceptable disposition seems to be that once a
position or stand is taken, the person so doing is bound thereby and shall ‘at
any cost’, act and continue all future actions in accordance with such position
or stand.

Estoppel at any cost — at the cost of illegality ?

What if the primary position, which is sought to be adhered to following the rule of estoppel, is itself based on, or is alleged to be, or is a result of, an illegal act? Adherence to estoppel in such a case could mean negation of legality. In all fairness, the bar of estoppel cannot be claimed, alleged or raised by a counter party or respondent who has himself committed illegal acts, or could be genuinely alleged to have done so. Whether such allegation of illegality is genuine or not is to be determined on the facts and circumstances of each case. Simply stated, people living in glass houses should not throw stones at others.

Recent Court rulings:

What if a party to a contract claiming the contract to be illegal on specific grounds, is barred by the Court from doing so, on a reasoning presumably -” based on an alliance of morality and estoppel?

Consider the recent ruling of the Bombay High Court in [CICI Bank Ltd. v. Sundaram Multi Pap Ltd., (Company Petition No. 248 of 2008). Firstly, in ascertaining whether an agreement in question was binding in spite of it not being signed by one party thereto, the Court has held that the absence of the signature is not significant, since the said agreement has not been disputed by the other party and has been acted upon by both parties. Thus, it may be rightly inferred that by not disputing the agreement and by acting thereunder, the other party has ‘held out’ a position and is therefore estopped from questioning its existence now.

However, that being so, another defence by the respondent Company, was that the agreement in question is illegal, void, violative of its Articles of Association and not binding on it. The Court observed that prima acie, these contentions do not appear to be bonafide or substantial, in spite of being well aware that the Company had already filed separate suit(s) in this regard which were pending. More importantly, such observation was arrived at, not by subjecting the agreement to the tests of legality, but on the following grounds:

a) Resolution to generally execute agreements was passed by the Company

b) Agreement is signed by the authorised officer of the Company

c) The Company paid certain amounts and issued a cheque to the other party, and the other party also made a payment to the Company by crediting its bank account.

Further, the Court also directed the respondent Company to deposit the amount demanded from it by the petitioner.

Take another recent decision of the Madras High Court in Rajshree Sugars and Chemicals Ltd. v. Axis Bank Ltd. Mr. Justice V. Ramasubramanian, in his judgment, observed that the plaintiff claiming an agreement to be null, void, illegal or voidable had no qualms about the deal at the time of deriving a benefit or income therefrom, and compared the plaintiff to a horse which would open its mouth for food but close it for bridle.

By receiving certain benefits under an agreement or a contract, has the recipient party ‘held out’ that the same is legally binding? Even if he has so held out, does the same validate the agreement or contract merely by estoppel? Stating that such recipient, having enjoyed benefits, is morally bound to perform his obligation under the agreement or contract, can it be said that the same is legally binding? Is legality to be determined here with reference to the statute book, case laws, investigation and evaluation, or by merely looking into estoppel, morality, or the actions of the parties like passing generic resolutions or making payments purportedly in mistake of law?

Even applying the rules of morality and estoppel, the consistent principle as laid down in various decisions of Courts appears to be that the Rule of Estoppel would apply when a bona fide party to the agreement or contract has been misled by the position held out by the other. In the decisions discussed hereinabove, it cannot in any manner be said that the party receiving benefit under such agreement or contract in question has misled the opposite party in any manner. Moreover, receipt of benefit is a subsequent event post entering into the agreemer;t or contract, whereas the agreement or contract is being questioned as being void ab initio, that is, from its very inception, without reference to such subsequent event.

To add to our inference, the Indian Contract Act, 1872 could be pressed into service. S. 65 of the said Act deals with the obligation of a person who has received advantage under a void agreement or a contract that becomes void. It simply states that when an agreement is discovered to be void, or when a contract becomes void, any person who has received any advantage thereunder is bound to restore it, or to make compensation for it, to the person from whom he received it. This Section, which is based on equitable doctrine, provides for the restitution of any benefit received under a void agreement or contract. What if a counter is raised, that S. 65 would apply where the agreement is ‘discovered to be void’ or where the contract ‘becomes void’ and not to an agreement which is void from inception? The Supreme Court, in the case of Tarsem Singh v. Sukhminder Singh, (AIR 1998 SC 1400) has categorically held that this argument cannot be allowed to prevail. Further, S. 30 of the Specific Relief Act, 1941, states that on adjudging the rescission of a contract, the Court may require the party to whom such relief is granted to restore, so far as. may be, any benefit which he may have received from the other party and to make any compensation to him which justice may require.

Thus, to conclude, it is respectfully submitted that the legality or otherwise of an agreement or contract cannot be determined merely because a receipt of benefit thereunder, by default, binds the party to stick to morality and promissory estoppel.

All that is required of such party is to return all benefits received. The relevant yardsticks to determine the fundamental issue as to the validity of an agreement or a contract would be to apply the requirements of S. 10 of the Indian Contract Act – free consent, competence, lawful consideration and law-ful object. And of course, since the specific always overrides the general, such agreement or contract is to be cumulatively validated under all specific enactments, rules, regulations, guidelines or the like as may be applicable to it.

Nirav Shah

Release deed — Exemption from payment of stamp duty — Stamp Act Schedule 1

New Page 1

30 Release deed — Exemption from payment of
stamp duty — Stamp Act Schedule 1

Article 55.

On perusal of Article 55, Schedule 1 of the Indian Stamp Act,
1899 if any person renounced his interest, share or part, then he may be
exempted from payment of stamp duty if the release is made of ancestral property
in favour of brother or sister or son or daughter or father or mother or nephew
or niece. The nature of the property has to be ancestral.

The nature of the property sought to be transferred to the
petitioner cannot be considered ancestral in nature, because the property has
been transferred to the petitioner by Smt. Santoshi who is real sister of
petitioner’s father. In such a situation, the nature of the property cannot be
considered to be ancestral, because the property has come to Smt. Santoshi, from
her sons by virtue of release deed. It was thereafter that his aunt Smt.
Santoshi executed another release deed bearing No. 1909 in favour of the
petitioner. The meaning of expression ‘nephew’ used in Article 55 of Schedule I
of the Act cannot be extended to the petitioner who is alien to the property in
the hands of Smt. Santoshi. Accordingly, the petitioner has not been able to
prove that the nature of the property is ancestral and therefore ad valorem
stamp duty as per the Act was leviable.

[ Harender Singh v. State of Haryana & Ors., AIR
2008 P & H 217]

levitra

Nirav Shah

Recovery of interest : Debtor cannot be penalised with interest on amount that remained unpaid due to accounting errors : Contract Act S. 72.

New Page 1

31 Recovery of interest : Debtor cannot be
penalised with interest on amount that remained unpaid due to accounting
errors : Contract Act S. 72.

The petitioner-company was sanctioned a loan of Rs. 54 lakhs
for setting modern roller flour mill in 1987. On 24-5-2005 from the Branch
Office at Motihari of the respondent corporation from which loan had been
originally disbursed, the petitioner received statements of account showing a
total outstanding of Rs.6,12,361.70. The petitioner on the very same day paid
the entire amount and thereafter requested for being granted a non-dues
certificate. After two months, the petitioner was informed that after
meticulously recalculating the dues of the petitioner, it is found that an
amount of Rs.1,54,966.95 is still due and if the petitioner pays the same amount
by 31-8-2005, non-dues certificate would be issued. Correspondence was then
exchanged with the petitioner protesting that as per accounts furnished, the
total outstanding shown therein was paid by the petitioner, then, on what
account such huge dues were now projected against him. From the head office of
the corporation a letter was issued stating that there was mistake in charging
interest in the loan account in the initial stage. The Court observed that more
than a decade and a half back some accounting errors were committed by the
Corporation of small amount which all put together on recasting the account for
the 20 years with accrued interest was Rs.1.50 lacs. On such wrong accounting
the petitioner was now held liable to pay Rs.1,55,489.95. In other words, due to
Corpn. accounting mistake of about Rs.29,000 made more than a decade and a half
back the petitioner must suffer and pay over Rs.1.50 lakhs as compensation to
the Corpn. for Corporation’s own mistake.

The Court observed that under what law can the petitioner is
made to suffer for a mistake committed not by him but by the Corporation itself.
If such an action is permitted, the result would be that by such a delayed
action the Corporation would gain at expense of the entrepreneur for its own
mistake. Had the Corporation made the demand, the petitioner would have paid and
avoided the heavy interest burden which is sought to be enforced against him
now. This action is wholly arbitrary, unreasonable and unjust enrichment on the
part of the Corporation and cannot be permitted.

The Court relied on the Apex Court decision in the case of
Kusheshwar Prasad Singh v. The State of Bihar, 2007 AIR SCW 1911.

. . . . . It is settled principle of law that a man cannot
be permitted to take undue and unfair advantage of his own wrong to gain
favorable interpretation of law. It is sound principle that he should prevent
a thing from being done and shall not avail himself of the non-performance he
has occasioned. To put it differently ‘a wrongdoer ought not’ be permitted to
make a profit out of his own wrong . . . . . .

[ Radha Flour Mills P. Ltd. & Anr v. Bihar State Financial Corpn. & Ors.,
AIR 2009 Patna 12]

levitra

Nirav Shah

Precedent : Failure of Revenue to appeal in the case of one assessee; not open to it to question decision in the case of another assessee.

New Page 1

29 Precedent : Failure of Revenue to appeal
in the case of one assessee; not open to it to question decision in the case of
another assessee.

Where the Appellate authority allowed the appeals filed by
the assessee ‘A’ and ‘B’ holding the transactions exempt from tax and the
Appellate Tribunal dismissed the appeals filed by the State relating to those
two assessees by its common order dated March 26, 2003, thereby confirming the
order of the Appellate authority and the State aggrieved by the common order
filed writ petitions.

The Court observed that admittedly in respect of assessee B
the Dy. Commercial Tax Officer had passed a final order implementing the order
of the Asst. Commissioner confirmed by the Tribunal and had also ordered refund
to the assessee. If an earlier order is not appealed against by the Revenue and
had attained finality, it is not open to the Revenue to accept the judgment on
the same question in the case of one assessee and question its correctness in
the case of other assessee. Discrimination between two sets of assessees in
respect of a common order is not permissible. Therefore the writ petitions were
liable to be dismissed.

[State of Tamil Nadu v. Vaikundam Rubber Co. Ltd. & Anr.,
(2008) 18 VST 93 (Mad.)]

levitra

Nirav Shah

Bank guarantee : Bank guarantee given for performance of particular contract cannot be encashed for alleged breach of another contract : Contract Act S. 126.

New Page 1

28 Bank guarantee : Bank guarantee given for
performance of particular contract cannot be encashed for alleged breach of
another contract : Contract Act S. 126.

A contract agreement was arrived at between the petitioner
and the respondents for maintenance of Abu Road-Deesa Section National Highway.
As per the contract, during the period when the contract was in operation, the
petitioner had submitted two bank guarantees.

There was no dispute pertaining to the contract of
maintenance pursuant to which the aforesaid both the bank guarantees were
tendered by the petitioner. But there was dispute between the respondents and
the petitioner pursuant to another contract for calculation of toll and
maintenance of Samakhyali-Gandhidham National Highway No. 8-A. The respondents
authority found that there is huge loss caused by the petitioner in the said
contract by not crediting the actual toll, etc. and therefore, it had involved
the bank guarantee submitted pursuant to the said contract, namely, Samakhali
Gandhidham National Highway and it also invoked the bank guarantee which is
subject matter of the present petition pertaining to Abu Road-Deesa National
Highway No. 14. Under these circumstances, the petitioner had approached the
Court by preferring the present petition.

The Court observed that had the bank guarantee been given in
its absolute term, irrespective of any contract whatsoever, it might stand on
different footing, but in the present case, it is an admitted position that the
bank guarantee was given by way of performance of contract for maintenance of
Abu Road-Deesa National Highway and it was not irrespective of any contract
between the petitioner and the respondent No. 1 authority. Therefore, the
contention raised on behalf of the respondent No. 1 cannot be accepted.

The impugned action of respondent No. 1 for encashing the
bank guarantee submitted for maintenance of Abu Road-Deesa Section National
Highway is quashed and set aside.

[ Jivanlal Joitaram Patel v. National Highways Authority
of India & Ors., AIR 2008 Gujarat 181]

levitra

Nirav Shah

FSI-TDR : FSI/TDR is benefit arising from the land, consequently must be held as immovable property : Flats (Regulation of the Promotion of Construction, Sale, Management and Transfer) Act, 1963.

New Page 1

27 FSI-TDR : FSI/TDR is benefit arising from
the land, consequently must be held as immovable property : Flats (Regulation of
the Promotion of Construction, Sale, Management and Transfer) Act, 1963.

The agreement under consideration is an agreement for
entrusting the work of development to a party with added rights to sell the
constructed portion to flat purchasers, who would be forming a Co-operative
Housing Society to which society, the owner of the land, is obliged to convey
the constructed portion as also the land beneath construction on account of
statutory requirements.

The Court observed that an immovable property under the
General Clauses Act, 1897 u/s.3(26) has been defined as under :

” (26). ‘immovable property’ shall include land, benefits
to arise out of land, and things attached to the earth, or permanently
fastened to anything attached to the earth.” If, therefore, any benefit arises
out of the land, then it is immovable property. Considering S. 10 of the
Specific Relief Act, such a benefit can be specifically enforced unless the
respondents establish that compensation in money would be an adequate relief.

Can FSI/TDR be said to be a benefit arising from the land ?
In Sikandar & Ors. v. Bahadur & Ors., XXVII Indian Law Reporter, 462, a
Division Bench of the Allahabad High Court held that right to collect market
dues upon a given piece of land is a benefit arising out of land within the
meaning of S. 3 of the Indian Registration Act, 1877. A lease, therefore, of
such right for a period of more than one year must be made by registered
instrument. A Division Bench of the Oudh High Court in Ram Jiawan and Anr. v.
Hanuman Prasad and Ors., AIR 1940 Oudh 409 also held that bazar dues
constitute a benefit arising out of the land and therefore a lease of bazar dues
is a lease of immovable property. A similar view has
been taken by another Division Bench of the Allahabad High Court in Smt.
Dropadi Devi v. Ram Das and Ors., AIR 1974 Allahabad 473 on a consideration
of S. 3(26) of General Clauses Act. From these judgments what appears is that a
benefit arising from the land is immovable property. FSI/TDR being a benefit
arising from the land, consequently must be held to be immovable property and an
agreement for use of TDR consequently can be specifically enforced, unless it is
established that compensation in money would be an adequate relief.

[Chheda Housing Development Corpn., a Partnership firm
v. Bibijan Shaikh Farid & Ors., 2007 (3) MHLJ 402 (Bom.).]

levitra

Nirav Shah

Sale of scrap — Whether income derived from industrial undertaking ?

Controversies

1. Issue for consideration :

1.1 The Income-tax Act, 1961 has provided tax holidays from
time to time in respect of profits derived from certain types of industrial
undertakings, whereby a certain proportion of such profits is allowed as a
deduction under chapter VIA for certain number of years from the date of
commencement of the undertaking. S. 80HH, S. 80HHA, S. 80I, S. 80J and now S.
80IB have all contained such provisions allowing deduction of a certain
percentage of profits derived from such eligible undertakings.

1.2 The common requirement for all such incentive provisions
has been that the gross total income should include profits derived from such
eligible undertakings. Further, the deduction has always been a percentage of
the profits derived from such eligible undertakings. The quantum of the
deduction has therefore been linked to the profits of the eligible undertakings.

1.3 A question has arisen before the Courts as to whether
income from sale of scrap of the eligible undertaking can be regarded as profits
derived from such eligible undertaking, for the purpose of computing the
deduction under the incentive provisions. While the Madras High Court has
consistently taken the view that such income from sale of scrap would form part
of the profits derived from such eligible undertaking, the Madhya Pradesh High
Court has recently taken a contrary view that the income from such sale would
not form part of the profits derived from the eligible undertaking.

2. Fenner India’s case :

2.1 This issue had arisen before the Madras High Court in the
case of Fenner (India) Ltd. v. CIT, 241 ITR 803.

2.2 In this case the assessee was an industrial undertaking
in a backward area manufacturing V-belts, oil seals, O-rings, rubber moulded
products, etc. It was eligible for deduction u/s.80HH in respect of the profits
derived from such industrial undertaking. It claimed a deduction of 20% of the
net profits of such undertaking, including profit on sale of scrap.

2.3 The Assessing Officer disallowed the deduction in respect
of profit on sale of scrap. The Commissioner (Appeals) upheld the assessee’s
claim for deduction in regard to the profit on sale of scrap. The Tribunal
however allowed the Revenue’s appeal on further appeal by the Revenue.

2.4 The Madras High Court noted that there was no dispute
that the new industrial undertaking was set up to manufacture V-belts, oil
seals, O-rings, rubber moulded products, etc. and that in the process of
manufacture of the V-belts, oil seals, O-rings, rubber moulded products, certain
scrap resulted. The resulting product of scrap also had a market and was also
sold, such sale being reflected in the turnover of the industrial undertaking.

2.5 Before the Madras High Court, on behalf of the Revenue,
it was argued that profit on the sale of scrap materials could, by no stretch of
imagination, be stated to have been derived from the industrial undertaking, and
if at all, such profits were at best attributable to the industrial undertaking.
It was argued that profits on sale of the manufactured products of the
industrial undertaking alone could be stated to be profits or gains derived from
the industrial undertaking, in respect of which a deduction of 20% was
permissible.

2.6 The Madras High Court noted that an assessee must
establish that his profits and gains were derived from his industrial
undertaking. It was not sufficient if a commercial connection was established
between the profits earned and the industrial undertaking, and the law required
that such profits must have been derived from the industrial undertaking. The
industrial undertaking itself must be the source of that profit and the business
of the industrial undertaking must strictly yield that profit. It must be the
direct source of profit and not a means to earn any other profit.

2.7 The Madras High Court observed that to say that the scrap
materials had no direct link or nexus with the industrial undertaking could not
at all be expected to commend acceptance. The scrap materials came within the
manufacturing process of the industrial undertaking in the manufacture of its
products such as V-belts, oil seals, etc. Therefore, the Madras High Court was
of the view that the profits and gains from the sale of scrap materials were
eligible for deduction of an amount equal to 20% u/s.80 HH, inasmuch as such
gains or profits were derived from the industrial undertaking and includable in
the gross total income of the assessee.

2.8 A similar view had been taken by the Madras High Court in
the cases of CIT v. Wheels India Ltd., 141 ITR 745, CIT v. Sundaram
Clayton Ltd., 133 ITR 34 and CIT v. Sundaram Industries Ltd., 253 ITR
396.

3. Alpine Solvex‘s case :

3.1 The issue again came up for consideration before the
Indore Bench of the Madhya Pradesh High Court in the case of CIT v. Alpine
Solvex Ltd., 219 CTR (MP) 499.

3.2 In this case the assessee was a company which had a
solvent extraction plant where soya bean oil was manufactured from soya bean
seeds. The assessee claimed deduction u/s.80HH and u/s.80I on the amount
realised by it by sale proceeds of old gunny bags which were used as packing
material. The sale proceeds of such gunny bags were included in the total
turnover of the undertaking.

3.3 The Assessing Officer rejected the assessee’s claim,
holding that it was not an income derived by the assessee from an industrial
undertaking and that it was therefore not eligible for deduction u/s.80HH and
u/s.80I. The Commissioner(Appeals) allowed the assessee’s appeal. The Tribunal
dismissed the Revenue’s appeal and upheld the order of the Commissioner
(Appeals).

3.4 Before the Madhya Pradesh High Court, on behalf of the Revenue it was contended that the amount earned by the assessee from sale of certain gunny bags lying in the factory could not be said to be the business, much less regular business activity and hence the income derived from sale of such gunny bags could not be said to be an income derived from the industrial undertaking eligible for the benefit of special deduction u/s.80HH/80I. It was argued that the expression ‘income derived from industrial undertaking’ has to be interpreted in a restricted/narrower sense, and hence only income earned directly from the business carried on by the industrial undertaking can be taken into consideration for calculating total income and deduction available under these Sections. Nobody appeared on behalf of the assessee before the Madhya Pradesh High Court.

3.5 The Madhya Pradesh High Court, relying on the decision of the Supreme Court in the case of Cambay Electric Supply Industrial Co. Ltd. v. CIT, 113 ITR 84, noted that the expression’ derived from’ was more restricted than the term ‘attributable to’, which was a comparatively broader expression. It further placed reliance on the decision of the Supreme Court in the case of Pandian Chemicals Ltd. v. CIT, 262 ITR 278, to the effect that the words ‘derived from’ used in S. 80HH must be understood as something which had direct or immediate nexus with the appellant’s industrial undertaking.

3.6 According to the Madhya Pradesh High Court, the main business of the assessee was to manufacture and sell soya oil by extracting it from soya bean seeds in their extraction plant. Therefore, according to the High Court, all income is derived from sale of soya oil has to be held as income derived from industrial undertaking, and so far as income earned out of sale of gunny bags was concerned, it could not be kept at par with the income derived from sale of soya oil. The High Court was of the view that sale of gunny bags was not the main or even ancillary business activity of the assessee, was not even regular or continuous business activity of the assessee, and that no investment was made by the assessee for sale of gunny bags, inasmuch as no industrial undertaking was established for manufacture and sale of gunny bags. Further, according to the Court the gunny bags were not manufactured by the assessee in its plant, which was established only for production of soya oil. According to the High Court, merely because some gunny bags were lying in the factory as surplus or unused or as waste material and were sold to earn some income, it could not be regarded as an income directly derived from the industrial undertaking.

3.7 The Madhya Pradesh High Court expressed the view that in order to derive income from the industrial undertaking, it must be shown that it was so earned by sale of those goods which were manufactured in the industrial undertaking as a part of the main and day-to-day business activity. The Madhya Pradesh High Court therefore held that the sale of gunny bags did not have a direct or immediate nexus with the industrial undertaking. While placing reliance on the decision of the Supreme Court in CIT v. Sterling Foods, 237 ITR 579, the Madhya Pradesh High Court expressed its disagreement with the decision of the Madras High Court in the case of Fenner (India) Ltd., noting that the Madras High Court decision did not take into consideration any decision of the Supreme Court.

3.8 The Madhya Pradesh High Court therefore held that the profit on sale of gunny bags was not part of the profits derived from the industrial undertaking eligible for deduction u/s.80HH/80I.

4. Observations:

4.1 It is significant to note that the nature of scrap dealt with by the Madras High Court was quite different from the scrap dealt with by the Madhya Pradesh High Court. The Madras High Court was dealing with a situation where the scrap arose directly out of the manufacturing process, and was an incidental part (though insignificant in value) of the very manufacturing process itself. The Madhya Pradesh High Court, on the other hand, was dealing with a case where the scrap was incidental to the acquisition of raw materials (being packed in gunny bags) or to the packing of manufactured goods. The scrap was therefore not a direct outcome of the manufacturing process, but was incidental to activities associated with the manufacture of the goods. Therefore, on facts, it is possible to distinguish between the nature of the scrap resulting in two different views being taken by the High Courts.

4.2 On a broader level, however, the question that arises is whether the business of an industrial undertaking encompasses only the manufacturing process simpliciter or covers the entire business of manufacture. Can the business of manufacture be said to commence only when the raw material is subjected to the physical process of manufacture, or does it also cover the incidental processes of preparation for manufacture, finishing and ‘Packing? If one takes a view that the business of manufacture involves all these steps as well, then the waste gunny bags clearly arise directly out of the business of manufacture, and should be regarded as the profits of the industrial undertaking.

4.3 The decision of the Supreme Court in the case of Pandian Chemicals (supra) is clearly distinguishable, as it related to interest on electricity deposit, which as the Supreme Court noted:

“Although electricity may be required for the purposes of the industrial undertaking, the deposit required for its supply is a step removed from the business of the industrial undertaking.”

Similarly, the case of Sterling Foods (supra) involved sale of import entitlements, which process was not part of the manufacturing business at all.

4.4 Viewed in this manner, it appears that the Madhya Pradesh High Court took too technical a view of the matter in holding that the waste gunny bags did not arise out of the manufacturing process. It ought to have considered that any income arising from a process which was directly associated with the business of manufacture, and not only the sale of the finished products, was profits derived from the industrial undertaking. Therefore, the view taken by the Madras High Court that sale of scrap forms part of the profits derived from the industrial undertaking, seems to be the better view of the matter.

Nirav Shah

GAPs in GAAP – Accounting for rate-regulated entities

Many governments regulate the pricing of essential services such as natural gas, water and electricity. The objective is to provide price protection to consumers while providing a fair return to the supplier. These regulatory mechanisms have created significant accounting issues under IFRS, which does not have any elaborate guidance on the subject. The accounting for rate-regulated entities is now on the agenda of the International Accounting Standards Board (IASB) and a separate project has been set up to deal with it.

Accounting practices :

Regulators often set prices in advance, based on estimated volumes, cost and a target rate of return. At the end of the period, the regulator and the entity determine the actual volumes, cost and return. This will give rise either to a surplus that needs to be refunded to the customer or a deficit that needs to be recovered from the customer. This is done by way of future price adjustments. The question to be addressed is whether these assets and liabilities can be recognised within the IFRS framework.

In India, for example a power supply company recognised these assets/liabilities with the corresponding impact being adjusted against revenue. The following disclosure was made : “The Company determines surplus/deficit (i.e., excess/shortfall of/in aggregate gain over Return on Equity entitlement) for the year in respect of its licence area operations (i.e., generation, transmission and distribution) based on the principles laid down under the (Terms and Conditions of Tariff) Regulation, 2005 notified by MERC (Maharashtra Electricity Regulatory Commission) and the tariff order issued by it. In respect of such surplus/deficit, appropriate adjustments as stipulated under the regulations are made during the year. Further, any adjustments that may arise on annual performance review by MERC under the aforesaid tariff regulations are made after the completion of such review.” In the absence of similar disclosures by other companies, it is difficult to know the extent to which regulatory assets and liabilities are recognised on Indian balance sheet.

Are these assets and liabilities ?

This will be addressed by the IASB in the ED. In 2005, the International Financial Reporting Interpretations Committee (IFRIC) was asked to provide guidance on the subject. The IFRIC concluded that regulatory assets and liabilities can only be recognised if they qualify under the IASB’s Framework.

The main argument against recognising these rights and obligations as assets and liabilities under IFRS is that their recovery or payment is based only on future sales, over which the entity has no control or present obligation. Only in situations where there is a guarantee given to the entity by the regulator would an asset exist; however, that may not be the case in India.

The IASB staff have put forward many arguments supporting the recognition of certain rate regulated assets and liabilities. The IASB and the FASB (US Financial Accounting Standards Board) have agreed to remove the misunderstood notion of control and to focus the definition of an asset on whether the entity has some rights or privileged access to the economic resource.

With respect to liability recognition, the IASB and the FASB agreed, that their current respective definitions overemphasise the need to identify both the specific past events and the future outflow of economic benefits. Instead, the definition should focus on the economic obligation that presently exists.

When considering recognition issues, the Board will also need to consider whether an asset or liability can be recognised where the regulatory approval for the specific matter is anticipated but has not been formally received, as formal approval is obtained after recognition of the asset or liability, and can sometimes take years.

Whatever standard is finally issued, an assessment of the facts and circumstances of each regulatory mechanism will be required, as each jurisdiction is unique. As a result, regulators should pay close attention to this project to understand how their mechanisms affect the results of the rate-regulated enterprises in their jurisdiction.

It has been estimated that the US electricity industry alone has reported regulatory assets and liabilities of $ 675 billion and $ 450 billion, respectively in 2007. In India, the corresponding numbers could be a fraction, but would nevertheless be staggering, to make accounting of rate-regulated entities a high-priority accounting issue. Also, in India, there is no guidance on rate-regulated entities. With India adopting IFRS in 2011, the accounting for rate-regulated entities in the country would be dictated by the final outcome of the IASB project. As an interim measure the ICAI should provide some guidance.

Nirav Shah

GAPs in GAAP – AS-7 – Percentage of completion accounting based on an output measure

In applying percentage of completion accounting based on an output measure (e.g., completion of physical proportion of contract work), how should incurred costs be accounted for ? The following example is used to illustrate the issue. Assume that all contract costs incurred in each period can be attributed to the output in that period.

View 1: Allocate costs in the same proportion as revenue

AS-7, paragraph 21 requires both contract revenue and contract costs to be recognised as revenue and expenses by reference to the stage of completion. Paragraph 24 also states that contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit that can be attributed to the proportion of work completed. Therefore when revenue is recognised based on an output measure, the actual incurred contract cost should be allocated pro rata between expenses and inventory. This view results in the same gross margin percentage throughout the contract period as can be seen below.

View 2:

Recognise costs as incurred

Paragraph 25 indicates that contract costs usually are recognised as an expense in the accounting periods in which the work to which they relate is performed. Paragraph 26 requires incurred costs that related to future activity to be recognised as assets. Therefore incurred costs that can be attributed to activity in the current period should be expensed. This view results in a changing gross margin percentage throughout the contract period.

Conclusion:

As can be seen from a plain reading of the standard, two views are possible. The standard-setters should clarify this issue, so that there can be uniformity in practice on this issue.

Nirav Shah

Interest income and mutuality

1. Issue for consideration :

1.1 Income of certain associations of persons is exempt on the doctrine of mutuality. The common examples of these associations are clubs, societies, trade professional and mutual benefit associations, where the contributors to the fund and the recipients or beneficiaries of the fund are the same persons or class of persons. In other words, such persons are contributing to the common fund for their common good.

1.2 Receipt of subscription from members to the common fund is exempt on the grounds of mutuality, as in such cases, the contributors and the beneficiaries are the same persons or the same class of persons, and on the same principles, the receipt by the members on distribution is exempt from tax. The difficulty however arises often in cases where the funds are invested for earning interest income; whether such income also qualifies for exemption, on the grounds of mutuality in the hands of the association. The issue gets further complicated if the interest income is earned from investments made with members.

1.3 For quite some time it was believed that the issue has been settled in favour of non-taxation, as was discussed in the BCAJ in the past. The issue however has reemerged and it appears that the courts presently are divided on this issue under consideration, which fact has made us take note of the same and examine the aspect afresh to ascertain whether the view canvassed in the past requires a reconsideration. While the Andhra Pradesh, Karnataka and Delhi High Courts have taken the view in a few cases that such interest income is exempt on the grounds of mutuality, the Karnataka, Madras and Gujarat High Courts seem to have taken a contrary view in other cases.

2. Canara Bank Golden Jubilee Staff Welfare Fund’s case :

2.1 The issue recently came up before the Karnataka High Court in the case of Canara Bank Golden Jubilee Staff Welfare Fund v. Dy. CIT, 308 ITR 202 (Kar.).

2.2 In this case, the assessee was a society consisting of employees of Canara Bank, established with the object of promoting welfare amongst members who contributed towards the corpus fund. The welfare fund was utilised for advancing loans to members, on which it received interest, which constituted the major portion of its revenue. Surplus funds were kept with the bank, on which interest also was earned. The assessee also earned dividend income on shares.

2.3 The assessee filed the return of income claiming exemption on the principle of mutuality. The assessment was completed u/s.143(1)(a). Subsequently the income was reassessed, bringing to tax the interest income on investments and dividend income on shares. The Commissioner (Appeals) dismissed the appeals of the assessee. The Tribunal also dismissed the assessee’s appeals.

2.4 Before the High Court, on behalf of the assessee it was argued that the Society was established for mutual benefit of its members, and funds of the Society, consisting of contribution from the members, were used for advancing loans to members and collecting interest from the members. As such, it was claimed that the income was exempt from tax on the principle of mutuality. It was further claimed that the funds collected by the appellant were used to provide monetary assistance to members, and, as a matter of precaution, the surplus funds were kept in the bank, not with the primary object of earning interest, but to keep such funds in safe custody. Further, such interest earned had been used only for the ultimate benefit of members. It was claimed that while applying the principle of mutuality, it was the source of the deposit that had to be taken into consideration and not the manner in which the funds were applied. Reliance was placed by the assessee on the Supreme Court decision in the case of Chelmsford Club v. CIT, 243 ITR 89 and the Andhra Pradesh High Court decision in the case of CIT v. Natraj Finance Corporation, 169 ITR 732.

2.5 On behalf of the Department, reliance was placed on the earlier Karnataka High Court decision in the case of CIT v. ITI Employees Death and Superannuation Relief Fund, 234 ITR 308, in which case the High Court had taken the view that such interest income was taxable, to contend that the income in question was taxable.

2.6 The Karnataka High Court, while discussing the principle of mutuality, observed that the following three conditions should exist before an activity could be brought under the concept of mutuality; that no person can earn from himself, that there is no profit motivation, and that there is no sharing of profits. It noted that the source of funds in the case before it was only from the members of the assessee and that the assessee had not received any donations or other monetary grants from any outside source, apart from the members during the relevant years. It was therefore the member’s contribution which had become the corpus fund which was utilised to advance loans to members and invested, from which the interest and dividend has arisen.

2.7 The Karnataka High Court noted that the funds of the assessee had been invested in the term deposit with the bank which was not a member of the assessee’s welfare fund, and interest had been earned on such investment. Though the bank formed a third-party vis-à-vis the assessee, it could not be said that the identity between the contributors and the recipients was lost in such a case. The High Court observed that in ITI Employees Death and Superannuation Relief Fund’s case (supra), the ingredients of mutuality were missing as, apart from contributions made by members, there were other sources of funding of the trust fund, including contributions made by the ITI management and donations. Further, in that case, the object of the trust was to invest the funds of the trust in banks and securities for earning interest to discharge the liabilities and obligations created under the trust.

2.8 Taking into consideration the objects of the assessee, the source of funds during the relevant years and the applicability of the funds for the benefit of its members, and keeping in mind the interest on investments and dividend earned on shares was only a small portion of the total earned by investment of the surplus funds wholly contributed by the members of the assessee, the Karnataka High Court held that the interest earned on investment and dividend received on shares was deemed income from the property of the assessee contributed by its members, and was governed by the principle of mutuality and was therefore exempt.

2.9 The Court noted with approval a similar view which had been taken earlier by the Andhra Pradesh High Court in the case of CIT v. Natraj Finance Corporation, 169 ITR 733. In that case, the assessee was a firm which lent money to its partners, and during the relevant years, received income on out-standing dues from a former partner and on amounts deposited in a savings account with a bank. The Court held that such interest, considering the quantum of such interest in relation to the total income, was also exempt on the grounds of mutuality, as it could not be said that the assessee was carrying on business in order to derive such a small amount of income.

2.10 The Court also noted that the Delhi High Court also, in the case of DIT(E) v. All India Oriental Bank of Commerce Welfare Society, 130 Taxman 575, has held that the principle of mutuality applies to interest income derived by a co-operative society from deposits made out of contributions made by members of the society. In taking this view, the Delhi High Court took a cue from the decision of the Supreme Court in Chelmsford Club v. CIT, 243 ITR 89, where the Supreme Court had laid down the principle that where a number of persons combine together to a common fund for financing of some venture or object and in this respect have no dealings or relations with any outside body, then any surplus generated cannot in any sense be regarded as profits chargeable to tax.

3. Madras Gymkhana Club’s case:

3.1 The issue again recently came up before the Madras High Court in the case of Madras Gymkhana Club v. Dy. CIT, 183 Taxman 333.

3.2 The assessee in this case was a sports club providing various facilities to its members, such as restaurant, gymnasium, library, bar, coffee shop and swimming pool. Apart from the surplus funds derived from such activities, it also received interest income from its corporate members on the investment of surplus funds as fixed deposits with them. It claimed that such interest income was covered by the concept of mutuality and was therefore exempt from tax.

3.3 In the course of reassessment proceedings, the income from investment was subjected to tax along with certain other interest income. Both the Commissioner (Appeals) and the Income Tax Appellate Tribunal rejected the appeals of the assessee.

3.4 Before the Madras High Court, it was argued on behalf of the assessee that the interest earned by the club out of fixed deposits and other investments made with its own institutional members was covered by the principle of mutuality. On behalf of the Revenue, it was argued that the interest on such investments could not be brought within the concept of mutuality as such investments were in the regular course of business of such club and had no nexus with either membership or regular activities of the club.

3.5 The Madras High Court noted that it had held in an earlier case in Wankaner fain Social Welfare Society v. CIT, 260 ITR 241, that to satisfy the concept of mutuality, the identity was required to be established in relation to the relevant income as regards those contributing to the income and those participating in the distribution of that income. According to the Madras High Court, surplus funds deposited with a member bank enured to the benefit of that member alone, who was in a position to utilise the deposit in any manner it liked, thereby depriving other members of enjoyment of such benefit, which did not satisfy the test of identity of the contributors and the participants. Though the distribution of interest was to all members, there was no identity between the contributors and the participants, inasmuch as the distribution of interest was made both to members with whom funds were deposited and to those with whom funds were not deposited, while the interest was earned only from members with whom funds were deposited.

3.6 The Madras High Court also noted that the club had received donations and gifts as well as sponsorship for programmes and activities, and advertisements. According to the Madras High Court, on a reading of the objects of the club and the provisions for making the investments, the position which emerged was that the investment of surplus funds had nothing to do with the objects of the club. It also noted that substantial amounts had been earned by way of interest from such investment of surplus funds, and that there were no plans for immediate utilisation of such funds.

3.7 The Madras High Court, following the decision of the Karnataka High Court in the case of CIT v. Bangalore Club, 287 ITR 263, held that the interest earned on investment of surplus funds, being substantial, could not be held to satisfy the mutuality concept and was therefore taxable.

3.8 A similar view had been taken earlier by the Karnataka High Court in the case of Bangalore Club (supra), where the Karnataka High Court had held that interest on surplus funds placed by the club in fixed deposits with member banks was not exempt on the ground of mutuality. The Court noted that the Karnataka High Court had also earlier in the case of ITI Employees Death and Superannuation Relief Fund (supra) held that interest on investments earned by the fund was not exempt on the grounds of mutuality and so also the Gujarat High Court, in the case of Sports Club of Gujarat Ltd. v. CIT, 171 ITR 504, has held that in the case of a club whose object was to promote the game of cricket and other games and sports, which derived income from investments of surplus funds, the income from interest was not from mutual activity and was therefore liable to tax.

4. Observations:

4.1 When one analyses the decisions on the subject, one notices that the difference of opinion between the Courts hinges on the answers to the following questions:

Firstly, for application of the doctrine of mutuality, in order to claim exemption on the ground of mutuality, is it sufficient that an income arise out of an investment of surplus generated from members, or is it necessary that such income should also arise from members only?

Secondly, does the activity of investment with non-members amount to a separate activity, distinct from the main activity of the entity and therefore not covered by mutuality? Is it not sufficient that the funds invested are out of the surplus of the members and the income received on investment is also for the benefit of the members?

Thirdly, is the object for which funds are invested relevant, is it necessary that the investment income should arise out of the main activity in order for the income to qualify for mutuality?

4.2 The Supreme Court in CIT v. Bankipur Club Ltd., 226 ITR 97, held that a host of factors, not one single factor, have to be considered to arrive at a conclusion as to whether the principle of mutuality applies in a given case or not, and further observed that whether or not the persons dealing with each other are a mutual club or not and whether such persons are carrying on a trading activity or an adventure in the nature of trade is largely a question of fact.

4.3 In the case of Chelmsford Club (supra), the issue before the Supreme Court was whether the annual letting value. of the clubhouse of the Chelmsford Club, which provided recreational and refreshment facilities exclusively to its members and their guests, was liable to income-tax. In that case, certain observations of the Supreme Court indicate that the principle of mutuality has to be considered qua the business or the object thereof. However, one must keep in mind the facts of the case before the Supreme Court, where there was no actual income arising other than out of the activity of the club, and therefore the Supreme Court did not have occasion to consider whether the principle of mutuality should be applied to certain incomes separately.

4.4 In the case of Bankipur Club (supra), the Su-preme Court cited from the Halsbury’s Laws of England as under:

“Where a number of persons combine together and contribute to a common fund for the financing of some venture or object and will in this respect have no dealings or relations with any outside body, then any surplus returned to those persons cannot be regarded in any sense as profit. There must be complete identity between the contributors and the participators. If these requirements are fulfilled, it is immaterial what particular form the association takes. Trading between persons associating together in this way does not give rise to profits which are chargeable to tax.

Where the trade or activity is mutual, the fact that, as regards certain activities, only certain members of the association take advantage of the facilities which it offers does not affect the mutuality of the enterprise.

Members’ clubs are an example of a mutual undertaking; but, where a club extends facilities to non-members, to that extent the element of mutuality is wanting …. “.

The Supreme Court in that case also cited from Simon’s Taxes as under:

…. it is settled law that if the persons carrying on a trade do so in such a way that they and the customers are the same persons, no profits or gains are yielded by the trade for tax purposes and therefore, no assessment in respect of the trade can be made. Any surplus resulting from this form of trading represents only the extent to
which the contributions of the participators have proved to be in excess of requirements. Such a surplus is regarded as their own money and returnable to them. In order that this exempting element of mutuality should exist, it is essential that the profits should be capable of coming back at some time and in some form to the persons to whom the goods were sold or the services rendered …. “

4.5 In the above referred Bankipur Club’s case, the Court was concerned with the clubs’ entitlement to exemption for (i) the receipts or surplus arising from the sales of drinks, refreshments, etc., (ii) amounts received by way of rent for letting out the buildings, and (iii) amounts received by way of admission fees, periodical subscriptions and receipts of similar nature, from its members and guests. The Supreme Court noted that the amounts received by the clubs for supply of drinks, refreshments or other goods as also the letting out of building for rent or the amounts received by way of admission fees, periodical subscription, etc. from the members of the clubs were only for/towards charges for the privileges, conveniences and amenities provided to the members, which they were entitled to as per the rules and regulations of the respective clubs. It also noted that different clubs realised various sums on the above counts only to afford to their members the usual privileges, advantages, conveniences and accommodation. In other words, the services offered on the above counts were not with any profit motive, and were not tainted with commerciality. The facilities were offered only as a matter of convenience for the use of members (and their friends, if any, availing of the facilities occasionally). On that reasoning, the Supreme Court held that the excess-surplus arising from the mutual arrangement, including amounts received from guests (though third parties), was exempt on the grounds of mutuality. Incidentally, one of the assessees in this case was Cawnpore Club, where the income that was sought to be assessed was derived from property let out and also interest received from ED.R., N.s.C., etc. The Supreme Court delinked that case and did not decide it, directing it to be put up for a separate hearing.

4.6 In the case of Chelmsford Club (supra), the Supreme Court observed :

“It is clear that it is not only the surplus from the activities of the business of the club that is excluded from the levy of income-tax, even the annual value of the club-house, as contemplated in S. 22 of the Act, will be outside the purview of the levy of income-tax.”

” …. we are of the view that the business of the appellant is governed by the principle of mutuality – even the deemed income from its property is governed by the said principle of mutuality.”

4.7 From the foregoing, relying on the views of the the Courts and the commentaries on taxation, the emerging view is that the surplus from the activity of mutual benefit association of any form is exempt from taxation and such exemption is not restricted to some specific incomes.

4.8 An incidental question that may as well be addressed is whether the activity of investment is an integral part of the object of the mutual benefit association or is an independent activity which aspect would depend upon the facts of each case. Various factors as follows may be helpful in examining this aspect: (i) Whether the investment is a mere temporary deployment of surplus funds, or of a long-term nature? (ii) Whether the intention behind making the investment is merely to see that the funds are not kept idle, but deployed till such time as required? (iii) Is the quantum of investment income small as compared to members’ contributions ? (iv) Whether the surplus has been built up only out of member contributions? Generally, if the investment income is small in relation to member contributions and the investment is primarily with a view to deploy unutilised funds, the investment activity cannot be regarded as an activity independent of the object of the association, and would be part of the surplus qualifying for exemption.

4.9 The rigours surely will be easy when investment is made with the members of the association. However here also, difference might be carved out between an investment made as an investor and the one made in the normal course.

4.10 The rigours will also be eased in cases where an investment of the association’s funds has been made pending the use of surplus funds on activi-ties of the association.

4.11 With utmost respect for the Madras High Court, the insistence on commonality between the contributors and the beneficiaries in case of investments, seems to be misplaced. The test of commonality is required to be satisfied w.r.t. the members’ contributions, and not w.r.t. the interest income arisng out of deployment of such members’ contributions. It is also helpful that the interest income that arises out of the deployment of surplus funds of members is earned for the members’ benefit, who surely are the participants on distribution of such an income.

4.12 An important principle of mutuality is that the members receive back that which was their own. The fact that in the meanwhile the funds belonging to them were deployed would not materially alter the applicability of the principle where the income remains, in reality, the income of the members.

4.13 The issue however continues to be contentious as is evident from the conflicting decisions of the Courts including the decision in the case of Rajpath Club Ltd., 211 ITR 379 (Guj.), Gulmarg Association & Anr., 90 TTJ 184 (Ahd.) and Sagar Sanjog CHS Ltd. ITA No. 1972, 1973 and 1974/Mum./2005.

4.14 The better view in the meanwhile seems to be that interest income of a mutual benefit association earned on its investments is exempt from tax under the doctrine of mutuality and the case for its exemption is stronger where the deployment of funds is merely a part of and incidental to the object of the association.

Nirav Shah

Deductibility of expenditure on stamp duty and registration charges

1. Issue for consideration :

1.1 The deductibility or otherwise of payments connected with a property under a lease has always been a source of protracted litigation. Some of such issues are :

Whether payment of premium for acquiring a leasehold asset is a revenue or capital expenditure.

Whether payment of lease rent in lump sum is a revenue or capital expenditure.

Whether expenditure incurred for repairs and renovation of leasehold property is allowable as a deduction or not.

Whether expenses on construction of building on a leasehold property is a capital or revenue expenditure.

1.2 One more issue, which regularly comes for consideration of Courts, is about the deductibility of an expenditure incurred on stamp duty and registration charges, in executing a lease deed, paid by a lessee.

1.3 The issue remained controversial, in spite of several Courts holding the expenditure to be deductible, because of the decisions of the Karnataka and some other High Courts holding the expenditure in question to be not allowable. Recently, the Himachal Pradesh High Court had an occasion to examine the true purpose of the dissenting decision of the Karnataka High Court in adjudicating the issue under consideration, namely, deductibility of expenditure on stamp duty and registration charges.

2. Hotel Rajmahal’s case :

2.1 The issue earlier came for consideration of the Karnataka High Court in the case of Hotel Rajmahal v. CIT, 152 ITR 218.

2.2 The facts behind the legal formulation were that the assessee, a firm consisting of five partners, came into force with effect from March 2, 1974. The firm took over a running business with boarding and lodging facilities in the name and style ‘Hotel Rajmahal’ at Bangalore by executing a lease deed dated April 24, 1974, for which it incurred an expenditure of Rs.11,270 by way of stamp duty, registration fee and legal expenses. The lease was for a period of ten years with option for renewal for another period of ten years.

2.3 The assessee filed a return disclosing an income of Rs.67,220 for the A.Y. 1975-76, the relevant previous year ending December 31, 1974 after deducting the aforesaid sum of Rs.11,270. The AO completed the assessment accepting the return allowing the said deduction, but the Commissioner revised the order u/s.263 of the Act by disallowing the expenditure of Rs.11,270 on the ground that it was of capital nature having been incurred for acquisition of a capital asset. The appeal preferred by the assessee, against the order of the Commissioner, was dismissed by the Tribunal by holding that the assessee had started the business only during the relevant year for the first time and that the lease was for a considerably long period and therefore, the benefit arising from the transaction be considered as of an enduring nature.

2.4 At the instance of the assessee, the following question of law was referred for the opinion of the Court :

“Whether, on the facts and in the circumstances of the case, Rs.11,270 being the expenditure incurred by the assessee by way of stamp duty, registration fee and legal expenses for the execution of registration of the lease deed dated April 24, 1974, is to be allowed in computing its income for the A.Y. 1975-76 ?”

2.5 The assessee, urged before the Court that the period of lease was not relevant for deciding whether the sum claimed for deduction was in the nature of revenue expenditure or capital in nature; what was important to consider was whether the said amount spent was a necessary outgoing for the use of a thing from which the assessee was to earn profit.

2.6 In support of the contention, the assessee relied upon the decision of the Supreme Court in India Cements Ltd. v. CIT, 60 ITR 52 as also on the two decisions of the Bombay High Court in the cases of CIT v. Hoechst Pharmaceuticals Ltd., 113 ITR 877 and CIT v. Bombay Cycle & Motor Agency Ltd., 118 ITR 42.

2.7 The Court observed that the contention of the assessee could have been relevant, provided the assessee was engaged in a business prior to the execution of the lease deed and the expenditure incurred was incidental to such business, but the assessee in the given case, for the first time, entered into the business in respect of which he spent the amount for executing and registering the lease deed and but for the execution of the lease deed, he would not have got the apparatus of the business and the leasehold rights. The Court held that the expenditure had really brought into existence an asset of enduring nature and the expenditure in connection with the acquisition of such rights should be distinguished from the expenditure incidental to the existing business and that the former could not be allowed u/s.37 of the Act, though the latter may in certain circumstances be allowed.

2.8 The Court further observed that the assessee could not draw support from those decisions of the Supreme Court and the Bombay High Court since they concerned themselves with cases where a certain sum of money was spent towards stamp duty, registration fees, lawyer’s fees, etc., for the purpose of the existing business of the assessee.

2.9 In the instant case, as already stated by the Court, it was for the first time that the assessee entered into the business by executing the lease whereunder the assessee secured the leasehold rights for an initial period of ten years with an option to renew for another period of ten years and as such the expenditure incurred for securing this kind of asset, by way of stamp duty, registration charges and legal fees was an expenditure of capital nature.

2.10 At this juncture, we need to take note of the decisions in the cases of United Commercial Corporation, 78 ITR 800 (All) and Govind Sugar, 152 ITR 218 (Kar.), wherein the expenses in question were held to be not allowable, irrespective of the fact that they were incurred after the business was set up.

3. Gopal Associates’ case :

3.1 Recently, the Himachal Pradesh High Court in the case of CIT v. Gopal Associates, 222 CTR 307 was required to consider the issue of allowability of the expenditure on stamp duty and registration charges in executing a lease deed. In that case, during the A.Y. 1994-95, the assessee took on lease, a fruit processing plant from the HPMC. The lease deed was executed on 27th December, 1993 for a period of 7 years but was later terminated. The assessee had spent a sum of Rs.3,44,251 as stamp duty and registration charges on execution of the lease deed. The AO treated this expenditure as capital expenditure by relying upon the judgment of the Karnataka High Court in the case Hotel Rajmahal (supra). On the other hand, the assessee relying upon the judgments of the Madras, Kerala and Gujarat High Courts in Sri Krishna Tiles & Potteries Madras (P) Ltd. v. CIT, 173 ITR 311 (Mad.), Plantation Corporation of Kerala Ltd. v. Commissioner of Agri. IT, 205 ITR 364 (Ker.) and Gujarat Machinery Manufacturing Ltd. v. ClT, 211 ITR 1010 (Guj.) contended that the amount spent as stamp duty and registration charges should be treated as revenue expenditure. The CIT(A) and Tribunal accepted the plea of the assessee.

3.2 The Revenue filed an appeal challenging the order of the Tribunal by raising the following substantial question of law:

“Whether on the facts and in the circumstances of the case the Tribunal was right in law in holding that the expenditure incurred on stamp duty and registration charges at the time of execution of lease agreement for taking on lease the fruit processing plant for seven years was allowable as revenue expenditure.”

3.3 The Himachal Pradesh High Court noted that the Karnataka High Court in Hotel Rajmahal’s case (supra) did not really discuss the matter in detail but held that when for the first time the assessee entered a lease deed securing leasehold rights for a long period, the expenditure incurred on stamp duty registration and legal fees, etc. should be treated as expenditure of capital nature. The Court however chose to follow the decision of the Madras High Court in Sri Krishna Tiles & Potteries Madras (P) Ltd. case (supra) which in turn followed the law laid down by the Bombay High Court in ClT v. Cinceita Ltd., 137 ITR 652 (Born.) and accordingly dis-agreed with the decision of the Karnataka High Court to hold that irrespective of whether the incidental expenditure was incurred in connection with or related to capital expenditure, the same had to be treated as revenue expenditure.

3.4 The Court also noted that the Kerala High Court also took the same view in Plantation Corporation’s case (supra) and the Gujarat High Court in Gujarat Machinery’s case (supra) dealt with the same question and held that the amount spent on registration and stamp charges was a revenue expenditure.

3.5 The Court chose to follow the reasoning given by the Bombay, Madras, Kerala and Gujarat High Courts and respectfully disagreed with the judgment of the Karnataka High Court.

3.6 In view of the findings, the Court decided the substantial question against the Revenue by holding that the expenditure in question was a revenue expenditure allowable as a deduction.

Observations:

4.1 The short but interesting issue is whether the expenditure in question for drawing up a proper and effective deed of lease, namely, the expenditure in respect of stamp duty, registration charges and professional fees paid to the. solicitors who prepared and got registered the deed of lease is an expenditure resulting in an enduring benefit simply because it is in some manner incurred at the same time and is connected that way to a property acquired under a lease. Further, the fact that the lease is of a longer period will have any bearing in deciding the issue or not.

4.2 We need to note that there is no element of premium in the said amounts claimed as expenditure and the expenditure would have been the same even if the lease had been of a shorter duration. The expenditure in question is not for acquiring the lease-hold right which is normally acquired on payment of premium, but is incurred to meet certain expenses which have necessarily to be incurred in order to conform to the legal requirements laid down in this behalf for getting a legal deed of lease. It is incurred for drawing up and registering a valid deed of lease not suffering from legal infirmities to facilitate the carrying on of the business of the as-sessee.

4.3 The contention that the assessee obtains an en-during benefit by obtaining the lease deeds and any expenses incurred in connection therewith should be treated as capital expenditure, more so when the lease is for a longer a period should be examined in light of the decisions of the Supreme Court in the cases of Empire Jute Co. Ltd. CIT, 124 ITR I, CfT v. Associated Cement Companies Ltd., 172 ITR 257 and Alembic Chemicals Works Co. Ltd. v. CIT, 177 ITR 377, which have laid down pragmatic and practical tests to find out whether an expenditure is revenue or capital in nature. The Supreme Court held that even in a case where expenditure is incurred for obtaining an advantage of enduring benefit, emphasis should be placed on the nature of the advantage in a commercial sense and if the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or profitably, while leaving the fixed capital untouched, the expenditure should be held to be on revenue account, even though the advantage may endure for an indefinite future.

4.4 The test of ‘enduring benefit’ has been held to be not a decisive or conclusive test: it cannot be applied blindly and mechanically. The question must be viewed in the larger context of business necessity or expediency. If the expenditure is so related to the carrying on or the conduct of the business, it may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character. If the expenditure helps in the profit-earning process, it should not be treated as resulting in acquisition of a profit-earning machinery or apparatus.

4.5 The Bombay High Court in the case of CIT v. Cinceita Pvt. Ltd., 137 ITR 652, held that though the period of the lease was for 20 years with an option for renewal at a higher rent, yet the expenditure claimed by the assessee was the only expenditure required for drawing up a proper and effective lease deed, namely, the expenditure in respect of the stamp duty, registration charges and professional fees paid to the solicitors, who prepared and registered the lease deed. It noted that there was no element of premium in the amount claimed as expenditure for acquiring the leasehold premises and moreover, the expenditure would have been the same even if the lease was for a shorter duration of any period exceeding one year. Importantly, the Court held that merely because the period of the lease was longer it could not be held that the expenditure resulted in acquiring an asset or advantage of an enduring nature. Therefore, the sum spent was held to be allowable as revenue expenditure.

4.6 The Kerala High Court in the case of Plantation Corporation, 205 ITR 364, held that the Appellate Tribunal had overemphasised the fact that the assessee had acquired an enduring benefit on planting rubber trees by obtaining long-term lease arrangement. The expenditure incurred relating to stamp duty, adjudication fee, registration fee, etc. in respect of lease deeds covering the lands leased to the assessee by the Government was revenue expenditure according to the Court.

4.7 The Madras High Court in the case of Sri Krishna Tiles & Potteries Madras (P) Ltd., 173 ITR 317, held that there was a transfer of interest in the property which was the subject matter of the agreement and the Tribunal was justified in holding that the amount paid as salami was a capital expenditure; however, the sum paid towards stamp duty, registration charges and professional fees to the lawyers was allowable as revenue expenditure.

4.8 The Gujarat High Court in the case of Gujarat Machinery Mfg. Ltd. 211 ITR 1010, in a case dealing with the claim by the lessor, held that the assessee had let an immovable property in consideration of obtaining rent from the lessee and that the assessee (lessor) had not spent any money for acquisition of an asset or rights of a permanent character. On the contrary, the assessee, as a lessor, had parted with some of its rights as owner of the immovable property in favour of the lessee. The assessee was the owner of the property and by executing the lease deed in favour of the lessee, it was not acquiring any new source of income or new asset. Therefore, the expenditure for the stamp duty and the registration of the lease deed could not be said to have been laid out for acquisition of any asset or a right of a permanent nature. The expenditure was laid out for earning rent or was spent as part of the process of profit earning. The expenditure was related to the carrying on or conduct of the business or of earning income by letting out the immovable property which was already owned by the assessee. Merely because the expenditure was related to a capital asset, it did not become a capital expenditure. Therefore, the expenditure incurred by the assessee for letting out the property was revenue expenditure. The Court in arriving at the decision relied on CIT v. Khandelwal Mining and Ores Pvt. Ltd., 140 ITR 701 (Born.) and CIT v. Katihar Jute Mills (P) Ltd., 116 ITR 781 (Cal.).

4.9 In CIT v. Hoechst Pharmaceuticals Ltd., 113 ITR 877, it was held by the Bombay High Court that expenses incurred by way of brokerage and stamp duty for acquiring office premises on lease for a short period of five years were allowable as a deduction in computing the total income of the assessee, since the assessee could not be said to have acquired or brought into existence an advantage of an enduring character.

4.10 The Bombay High Court again in CIT v. Bombay Cycle & Motor Agency Ltd., 118 ITR 42, allowed the claim of the assesses for deduction of the expenses in question. In that case, one of the leases in question was for a period of ten years and the other for a period of five years. The Tribunal had taken the view that the fact that the amounts had been spent in connection with the opening of new branches was by itself no justification for disallowance, that no asset of an enduring nature had been brought into existence, and that the period of the lease by itself was not indicative of securing an asset of an enduring nature and that the expenditure could not be disallowed as of a capital nature.

4.11 It appears that the decisions in the cases of United Commercial Corporation, 78 ITR 800 (All.) and Govind Sugar, 152 ITR 218 (Kar.), wherein the expenses in question were held to be not allowable irrespective of the fact that they were incurred after the business was set up require reconsideration. The view that the expenditure on stamp duty, registration charges and professional fees for drafting the lease deed be allowed as a revenue expenditure is a better view.

Nirav Shah

Contact details of Income Tax Ombudsman, at different Centres

Nirav Shah

Whether accrued interest will be nullified by subsequent modification in terms ?

Closements

Introduction :

1.1 In respect of transaction of borrowing and lending,
agreements are entered into between the parties, under which interest is payable
by the borrower to the lender and such interest becomes income of the lender in
the year of accrual under the Mercantile System of Accounting. Many a time,
assets are purchased by the assessee (purchaser) on deferred credit basis and in
such cases, generally, the terms of agreement provide for the liability to pay
interest by the purchaser on the amount outstanding from time to time. Such
interest also becomes income of the person granting such credit in the year of
accrual under the Mercantile System of Accounting.

1.2 After determining the terms of credit and liability to
pay interest, sometimes, for various commercial reasons, such terms are modified
and such modification may also include change in the effective date from which
the interest becomes payable by the concerned party. For this purpose,
especially in case of companies, appropriate resolution is passed at the
relevant time, generally before the end of the relevant year recording modified
terms and the revised effective date from which the interest becomes payable. In
all such cases, the issue arises with regard to the effect of such resolution on
the past period as well as for the future period in the context of taxability of
interest income in the hands of the company passing such resolution.

1.3 Recently, the issue referred to in Para 1.2 above, came
up for consideration before the Apex Court in the case of Sarabhai Holding P.
Ltd. This judgment throws considerable light on the issue and the same would be
a good guide for dealing with such issues. Therefore, it is thought fit to
consider the same in this column, as such issue very often arises in the
day-to-day practice.

Sarabhai Chemicals Pvt. Ltd. v. CIT,

257 ITR 355 (Guj.) :

2.1 The name of the above Company had subsequently undergone
change and the Company was then known as Sarabhai Holdings P. Ltd. In the above
case, various issues with regard to liability to pay interest u/s.215, penalty
u/s.272(2) for under-estimate of income for payment of advance tax, concealment
penalty u/s.271(1)(c), etc. had come up before the Court, with which we are not
concerned in this write-up. The main issue was with regard to accrual of
interest income and taxability thereof, which is similar to the issue referred
to in Para 1.2 above and accordingly, only relevant facts in that context are
considered here. The accounting year of the assessee was July-June. The issue
related to A.Ys. 1979-80 and 1980-81. As such, the relevant previous years were
the periods from 1-7-1977 to 30-6-1978 and 1-7-1978 to 30-6-1979 as per the
provisions of the Act at the relevant time. The assessee was following the
Mercantile System of Accounting. The relevant facts were : Under an agreement
dated 28-2-1977, the assessee had transferred (effective from that date) its
industrial undertaking of Sara-bhai Chemicals & Business Activity of Sarabhai
Company Services Division as a going concern (hereinafter referred to as the
said Unit) to its wholly-owned subsidiary, namely, Elscope (P.) Ltd.
(hereinafter referred to as the said Elscope) for an agreed consideration and,
in turn, after four months, the said Elscope had transferred the said Unit to
its subsidiary, namely, Ambalal Sarabhai Enterprises Ltd. The said agreement
dated 28-2-1977 was amended by supplementary agreement dated 4-3-1977 and the
Deed of Assignment was executed on 28-6-1977. Under the terms of the agreement,
the said Elscope was liable to pay part of the consideration when demanded by
the assessee and payment of part consideration was deferred, which was to be
paid in eight equal annual instalments on 1st October of every year beginning
from 1-10-1979 and the same was to carry simple interest @ 11% per annum on the
amount outstanding from time to time.

2.1.1 On 15th June, 1978, the said Elscope wrote to the
assessee proposing modification in terms of payment and requested, inter alia,
that the interest be charged on the deferred sale consideration from 1-7-1979
instead of from 1-3-1977. It was also proposed that certain amount will be
payable (Rs.1.84 crores) as and when the assessee demands without any interest
and part of the amount (Rs.4.70 crores) will be paid in five annual instalments
beginning from 1-3-1987, which will carry simple interest @ 11% per annum with
effect from 1-7-1979. The said Elscope also offered to secure the said amount of
Rs.4.70 crores to the satisfaction of the assessee [eventually, it seems that
Secured Debentures of the said Ambalal Sarabhai Ltd. were given as security]. On
30th June, 1978, the proposal sent by the said Elscope vide letter dated
15-6-1978 was decided to be accepted by the assessee and a resolution to that
effect was passed (hereinafter referred to as the said Resolution) in the
Meeting of the Board of Directors. The relevant portion of the said Resolution
reads as under :

“. . . the company doth hereby approve, accept and adopt
the following revised mode of payment as contained in letter No. ELSCOPE/MC
dated 15th June, 1978, received from Elscope Pvt. Ltd.”

2.1.2 The assessee company furnished Returns of Income for the A.Y. 1979-80, declaring business income of Rs.772 and for the A.Y. 1980-81, declaring loss of Rs.17,345. In these returns, the assessee had not considered the interest income from the said Elscope, on the ground that as per the revised arrangement such interest was payable by the party only from 1-7-1979. The Income-tax Officer (ITA) took a view that by the date the said Resolution [dated 30-6-1978] was passed, the interest for the whole year had already accrued to the assessee. It was further held that the assessee has relinquished the interest without any commercial consideration as the two companies were closely related and it was the case of collusion to evade tax liability. Accordingly, the ITa added the interest income of Rs.66,29,236 for the A.Y. 1979-80. Almost for similar reasons, the ITa also made an addition of Rs.55,67,750 for the A.Y. 1980-81 on account of such interest. The first Appellate Authority [CIT(A)] confirmed the action of the ITa. The CIT(A) also commented on the nature of security given by the said Elscope while revising the terms of payment of interest and pointed out that the security of bonds of Ambalal Sarabhai Enterprises Ltd. were redeemable during the year 1991 or subject to some conditions in the year 1987. Accordingly, considering its quoted market price, the same are worth about %rd of the face value. Thus, in the process, the assessee company has accepted assets worth %rd of the market price as such security.

2.1.3 When the matter came up in the second appeal, the Tribunal took the view that it is pertinent to note that there is no indication in the said Resolution to suggest that the revised mode of payment was effective from any date prior to 30-6-1978. Therefore, it is not a case where the income though given up during the year could not be said to accrue, the accrual of interest commenced from the beginning of the accounting year as interest accrues from day to day. Accordingly, the Tribunal rejected the contention of the assessee that no interest accrued for the accounting year relevant to the A.Y. 1979-80 and confirmed the action of the ITA as well as CIT(A) for that year. However, for the A.Y. 1980-81, the Tribunal pointed out that there was a material distinction between the facts for that year and the earlier year. This difference was caused by the said Resolution (dated 30-6-1978), under which the original agreement stood modified. Accordingly, it was held that as a result of the said Resolution, no income could be said to have accrued to the assessee for this year, as the interest was to start accruing from 1-7-1979. The Tribunal also stated that as there was no accrual of income at all, no question of relinquishment of any right to receive arises. Accordingly, the Tribunal deleted the addition made in respect of interest income for the A.Y. 1980-81.

2.2 When the matter came up before the High Court, on behalf of the assessee, it was, inter alia, contended that in view of the said Resolution, there was no accrual of interest to the assessee till 30-6-1979. It was further contended that it was open for the assessee to agree to modification of the terms of payment and substitute the original stipulation re-garding the payment of interest by fixing time, from which the interest would accrue and that was done before the end of the relevant accounting year. Alternatively, it was contended that if the interest is treated as accrued for the A.Y. 1979-80, it should be held that the income accrued was given up by the assessee for valid commercial expediency and for that purpose, reliance was placed on concept of real income. It was pointed out that the assessee had agreed to modify the terms with a view to get his dues secured. Reliance was placed on the judgments of various High Courts and the Apex Court in support of such propositions.

2.3 On behalf of the Revenue, it was, inter alia, contended that there was no commercial expediency for which interest that had already accrued could have been given up. The transaction between the parties was not a genuine transaction as the said Elscope was only made a conduit pipe as the said Elscope had transferred the said Unit to its subsidiary within a short period of four months. It was also contended that the said Resolution did not effectively change the mode of payment even for the A.Y. 1980-81 and the interest continued to accrue to the assessee under the existing mode of payment stipulated in the agreement and the deed of assignment. It was also pointed out that the said Resolution could not be given retrospective effect, because on the last day of the accounting year, the interest had already accrued and the same could not have been affected by such resolution. It was also contended that there was no reason for the said Elscope to make the proposal for modification as its subsidiary (Ambalal Sarabhai Enterprises Ltd.) had also stepped in its shoes by that time. Reliance was also placed on the judgments of various High Courts and the Apex Court in support of such propositions.

2.4 After considering the contentions raised on behalf of both the parties and various judgments on which reliance was placed, the Court proceeded to decide the issue for the A.Y. 1979-80. For this purpose, the Court noted various terms and conditions stipulated in the original agreement, the supplementary agreement and the deed of assignment. Having referred to the same, the Court observed as under (pages 391/392) :

“It would be a trite thing to say that the terms of payment of interest which were binding on the parties were those which finally came to be incorporated in the deed of assignment. Payment of interest was treated as essence of the contract and as noted above. If the instalments were not duly paid, the rate of interest was to be higher than 11% per annum and the vendee was in the event of default of payment of instalment bound to pay interest at the rate payable by the vendor to its bankers in the ordinary course of business. These terms regarding mode of payment were never disturbed until the last date of the accounting year ending on June 30, 1978 on which date the assessee passed the resolution dated June 30, 1978, ‘by which it accepted the proposal of its subsidiary Elscope sent on June IS, 1978 and substituted the mode of payment by purporting to shift the date of charging of interest by July I, 1979.”

2.5 The Court, then, noted that from the terms of various agreements, it is seen that the transaction took place with effect from 1-3-1977 and the obligation to pay interest was incorporated in such agreement in the context of such transaction. The obligation to pay interest was not a separate debt, but the debt incurred under the contract included the obligation to pay interest. Therefore, to say that no date of accrual of interest was fixed in the contract is to misconstrue the provision thereto, despite the express stipulation about the obligation to pay interest which was to be treated as the essence of the contract. When no date is specified in the transaction which incorporated an obligation of party thereto to pay interest, it obviously would mean that the date from which the interest is to be paid would be the point of time from when the obligation to pay the outstanding amount starts and that will be the date from which the creditor’s entitlement to recover interest starts.

2.6 Having made the above-referred observations, the Court finally, while deciding the issue against the assessee with regard to accrual of interest, held as under (page 393) :

“Interest accrues in most circumstances on the time basis to be determined by the amount out-standing and the rate applicable. Recognition of the revenue requires that the revenue is measurable, and that at the time of sale, it would not be unreasonable to accept ultimate collection. In the present case, in view of the categorical stipulation that interest will be payable on the deferred consideration amount in respect of the sale which became effective from March 1, 1977, the interest started accruing on that time basis from March I, 1977 determined by the amount outstanding from time to time and the rate applicable which were stipulated in clearest possible terms in the deed of assignment dated June 28,1977, and the agreements which preceded it. That what already accrued during the accounting year from July I, 1977 to June 30,1978 could not be nullified by the resolution of June 30, 1978, said to have been passed at 2.00 p.m. on that day. As held by the Supreme Court in CIT v. Shiv Prasad Janak Raj and Co. (P.) Ltd. (1996) 222 ITR 583, the concept of real income cannot be employed so as to defeat the provisions of the Act and the Rules. In that case, it was held that waiver of interest after the expiry of the relevant accounting year only meant that the assessee was giving up the money which had accrued to it. It cannot be said that the interest amount had not accrued to the assessee.”

2.7 The Court, then, stated that now the only question remains to be examined is whether the interest that had accrued and which the assessee did not in fact receive was given up for any commercial expediency after its accrual as contended on behalf of the assessee on an alternative basis. For this, the assessee relies on the fact that the debt which was earlier unsecured became secured on such re-arrangement. After referring to the factual position in this regard, the Court stated that admittedly no security passed. The CIT(A) has admirably discussed this aspect in his order and exposed the hollowness of the assessee’s stand that it secured debt with the bonds of Ambalal Sarabhai Enterprises Ltd. According to the Court, the last-minute arrangement was made to ward off the payment of tax on interest income that had accrued to assessee during the accounting year ending 30-6-1978 (till the moment the resolution dated 30-6-1978 was passed at 2 p.m.). For this, the ground of commercial expediency was created of getting debt secured. In fact and reality, neither was there in particular security offered in the proposal, nor was there any acceptance of security. A ghost was created to hide the real object of modification of the mode of payment, which was to ward off payment of tax on interest income that already had accrued to the assessee. Accordingly, the Court confirmed the decision of the Tribunal for the A.Y. 1979-80 and upheld the addition on account of interest income made by the ITO.

2.8 The Court then noted that there was no challenge levelled against the genuineness of the said Resolution. The law permits the contracting parties to change their stipulations by mutual agreement and, therefore, there was no impediments in changing the terms of the contract. The resolution dated 30-6-1978 accepted the proposal of the said Elscope. In view of this, under the changed mode of payment adopted in it, no interest was to accrue during the accounting period from 1-7-1978 to 30-6-1979. Therefore, no interest accrued to the assessee during that period and hence, the reasoning of Tribunal for deleting the addition of such interest income for the A.Y. 1980-81 is correct. Since no interest accrued during this period, no question of relinquishment of interest for any commercial expediency arises, as you cannot relinquish the income that has not accrued at all. Accordingly, the Court decided the issue in favour of the assessee for the A.Y. 1980-81.

CIT v. Sarabhai Holdings P. Ltd., 307 ITR 89 (SC) :
3.1 The above-referred judgment of the Gujarat High Court came up before the Apex Court at the instance of the Revenue as well as the assessee. On behalf of both the parties various contentions were raised to support their case, which were similar to the contentions raised before the High Court.

3.2 After considering the factual position with regard to both the assessment years and the contentions raised by the parties, the Court, first dealt with the contention of the Revenue that the assessee was trying to avoid payment of tax on the interest by making such arrangements and in that context observed as under (page 98) :

“We cannot understand the criticism of learned senior counsel appearing on behalf of the Revenue that by resolution dated June 30, 1978, the assessee was avoiding the payment of tax on the interest which had accrued. The genuine nature of the resolution was not and could not be disputed. When we see the letter dated [une 15, 1978, and also note that the letter was complied with by Elscope in providing adequate security of the payable amount, there is nothing to dispute or suspect the genuineness of the transaction. The whole transaction would have to be viewed on that backdrop. In the commercial world, the parties are always free to vary the terms of contract. Merely because by resolution dated June 30, 1978, the assessee agreed to defer the payment of interest, that would not mean that it tried to evade the tax. What is material in tax jurisprudence is evasion of the tax, not the beneficial lawful adjustment therefor. Considering the genuine nature of the transaction based on the letter dated June 15, 1978, and the resolution dated June 30, 1978, it cannot be said that the whole transaction was in order to evade the tax.”

3.3 Having accepted the genuineness of the said Resolution and the object of the assessee, the Court confirmed the decision of the High Court for both the assessment years and held as under (page 99) :

“We agree with the High Court’s finding that the law permits the contracting parties to lawfully change their stipulations by mutual agreement and, therefore, the assessee and the vendee had no legal impediment in modifying the terms of their contract. We also agree with the further finding of the High Court that the resolution could not be given any retrospective effect so as to facilitate evasion of tax liability that had already arisen for the A.Y. 1979-80.We further agree with the High Court’s finding that it being a valid stipulation, it changed the mode of payment from the date of the resolution and, therefore, under the changed mode of payment adopted under the resolution dated June 30,1978, no interest was to accrue during the accounting period from July 1, 1978, up to June 30, 1979, and, therefore, the reasoning of the Tribunal on that count appeared to be correct as regards the assessment year 1980-81 is concerned. We further confirm the finding that since no interest had accrued in the accounting year July 1, 1978 to June 30,1979, there could arise no question of relinquishment of interest for any commercial expediency.”

Conclusion:

4.1 The above judgment of the Apex Court confirms the principle that generally interest accrues on day-to-day basis. The Court has also accepted the view of the High Court that the interest so accrued cannot be nullified by the resolution subsequently passed.

4.2 It seems to us that the effect of the resolution in the above case has been decided on the basis of the facts of that case. It also seems that the above principle cannot have universal application in every case dealing with the time of accrual of interest irrespective of the facts of the case. In a given case, based on the terms of agreement and/or facts and circumstances of the case, a different view may also emerge.

4.3 Though the concept of real income still holds good, the same has to be applied cautiously and in case of non-receipt of accrued interest, it may be difficult to apply when the assessee follows the Mer-cantile System of Accounting.

Nirav Shah

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

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

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

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

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

Nirav Shah

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

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

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

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

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

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

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

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

Nirav Shah

TDS on Discount on Airline Tickets

Controversies

1. Issue for Consideration :

1.1 Airlines generally sell air tickets through travel
agents who are paid a commission on sale of such tickets which commission is
worked out on the basis of the minimum fares prescribed by the airlines. Tax
is deducted by the airlines on this commission u/s. 194H of the Act. Where the
tickets are provided to the travel agent by the airlines at a price below the
published fare, the difference, known as ‘discount’, or a part thereof is
retained by him while selling the tickets to the passengers, which is in
addition to the regular commission earned by him. No tax is deducted by the
Airlines on this amount retained by the travel agents. All airlines are
required to file a list of their standard fares with the Director General of
Commercial Aviation, which are called published fares. Usually tickets are
provided by airlines to travel agents at significant discounts to the
published fares and sold by the agents to their customers by passing over the
difference in full or part. Under IATA rules, the travel agents receive their
commission as a percentage of the published fares, in respect of which tax is
deducted at source by the airline under Section 194H.

1.2 S. 194 H defines ‘commission or brokerage’, vide
Explanation(i), as under :

” ‘Commission or brokerage’ includes any payment received
or receivable, directly or indirectly by a person acting on behalf of another
person for services rendered (not being professional services) or for any
services in the course of buying or selling of goods or in relation to any
transaction relating to any asset, valuable article or thing not being
securities.”

1.3 In recent years, tax authorities have sought to take a
stand that the discount from published fares given by airlines to travel
agents (which in turn is generally passed on by the travel agent to the
customer in full or part) amounts to an additional special commission, and
that TDS is deductible on this amount under Section 194H.

1.4 The issue has now reached Courts and the Bombay High
Court has held that such discount is not in the nature of brokerage or
commission and no tax is deductible thereon. The Delhi High Court has taken a
view that tax is deductible on such discount.

2. Qutar Airways’ case :

2.1 The issue came up before the Bombay High Court in the
case of CIT vs. Qutar Airways (Income Tax Appeal No.99 of 2009),
ITATOnline.org.

2.2 In this case, it had been claimed by the Revenue that
the difference between the published price and the minimum fixed commercial
price amounted to an additional special commission, and that TDS was therefore
deductible by the airline on this amount under Section 194H.

2.3 The Tribunal had granted relief to the airline,
following its earlier decision in the case of Korean Air vs. DCIT,
holding that TDS was not deductible in similar circumstances.

2.4 Before the Bombay High Court, the counsel for the
Revenue contended that it was not the Revenue’s case that the difference
between the principal price of the tickets (as published) and the minimum
fixed commercial price amounted to brokerage.

2.5 The Bombay High Court noted that though an appeal had
been preferred against the decision of the Tribunal in Korean Air’s case, the
appeal had been rejected by the High Court for non-removal of office
objections under rule 986. The Court noted that for Section 194 H to apply,
the income being paid out by the airline must be in the nature of commission
or brokerage, and must necessarily be ascertainable in the hands of the
recipient.

2.6 On the facts of the case before it, the Bombay High
Court noted that the airlines had no information about the exact rate at which
the tickets were ultimately sold by the agents, since the agents had been
given discretion to sell the tickets at any rate between the fixed minimum
commercial price and the published price. It was noted by the Court that it
would be impracticable and unreasonable to expect the airline to get feedback
from their numerous agents in respect of each ticket sold. The Court was of
the view that if the airlines had discretion to sell the tickets at a price
lower than the published price, then the permission granted to the agent to
sell it at a lower price could neither amount to commission or brokerage in
the hands of the agent. The Bombay High Court however clarified that any
amount which the agent earned over and above the fixed minimum commercial
price would naturally be income in his hands and would be taxable as such in
his hands.

2.7 The Bombay High Court therefore held that no TDS was
deductible under Section 194H in respect of such discount over the published
fares given by airlines to travel agents.

3. Singapore Airlines’ case :

3.1 The issue again recently came up before the Delhi High Court in the case of Singapore Airlines and 12 other airlines — CIT vs. Singapore Airlines Ltd. (ITA Nos.306/2005 and 123/2006).

3.2 In this case, a survey was conducted on the airlines. This revealed that supplementary commission was being paid to travel agents. The travel agent, after sale, would send the details every two weeks to an organisation Billing Settlement Plan (‘BSP’), which was an organisation approved by the International Air Transport Association, which would prepare an analysis of the billing and send it to each airline. In this analysis, this amount was shown as supplementary commission. The airlines either accounted for this as supplementary commission or incentives/deals. Some travel agents confirmed that such supplementary commission had not been passed on by them to customers. From April 2002, the procedure was changed and tickets were sold at the net price. The Department started proceedings against the airlines for non-deduction of TDS under Section 194H on such supplementary commission.

3.3 The Commissioner (Appeals) upheld the stand of the Department. The Tribunal however allowed the airline’s appeal, holding that the airline received only the net fare from the agent, that any surplus or deficit from such net fare was the profit or loss of the agent, and since such profit or loss was on account of his own efforts and on his own account, did not emanate from services rendered to the airline.

3.4 Before the Delhi High Court, on behalf of the Department it was argued that:

i) the relationship between the assessee-airline and the travel agent was that of a principal and agent and not one of principal to principal.

ii) the supplementary commission retained by the travel agent was not a discount as claimed by the assessee-airline since it was paid for services rendered by the travel agent in the course of buying and selling of tickets;

iii) the submission of the assessee-airline that they had a dual/hybrid relationship with their agent, that is, insofar as the transaction which involved payment of standard commission was that of agency, while that which involved the retention of supplementary commission by the travel agent, that is, price obtained over and above the net fare, was a result of a principal-to-principal relationship ought to be rejected, for the reason that no evidence whatsoever was placed by the assessee-airline to establish that there was such a dual relationship between the parties. The Standard Format Agreement (as approved by lATA), that is, the Passenger Sales Agency (PSA) Agreement executed by the assessee airline was silent as regards any such dual relationship to which the assessee-airline had adverted to;

v) the main provision of Section 194-H included within its ambit payment by cash, cheque, draft or by any other mode. Thus retention of money by the travel agent was covered by the main provisions of Section 194H. It was not the case of the assessee-air line either before the Assessing Officer or the CIT(A) that the travel agent was required to only remit the net fare to the airlines, and this was not even a condition in the PSA Agreement. The net fare was actually arrived at by deducting from the gross fare, tax, standard commission and supplementary commission. While standard commission was fixed by lATA the supplementary commission was variable, as it was dependent on the policies of the airline vis-a-vis their agents. If net fare was the basis for the entire transaction, then there was no necessity of intervention of BSP to carry out a billing analysis, as then the amount payable by the travel agent to the assessee-airline could easily be calculated by taking into account the product of the number of tickets sold and the net fare; and

vi) the amount of supplementary commission which had to be paid on each transaction was embedded in the deal code which was known only to the three concerned parties, that is, the assessee-airline, the travel agent and BSP.Since the assessee-airline was the person responsible for payment of supplementary commission to the travel agent, the tax could have been deducted as and when the billing analysis statement was handed over by the BSP to the airline. It was thus contended that the supplemen-tary commission fell within the ambit of the explanation to Section 194H.

3.5 On behalf of the assessee-airlines, it was argued before the Delhi High Court that:

i) supplementary commission was only a nomenclature which finds mention in the billing analysis statement of BSP.The said supplementary commission denotes a notional figure which is the difference between the published fare less standard IATAcommission (9% or 7%). The net fare is the amount received by the assessee from its travel agents. In other words, the

supplementary commission is not a commission within the meaning of Section 194H;

ii) supplementary commission can only be brought within the ambit of Section 194H, if it fulfils the following criteria as prescribed under the said provision-

a. the sum received must be in the nature of income,

b. such income must denote any payment received or receivable directly or indirectly by the payee from the payer, that is, the assessee, and

c. the recipient should be a person acting on behalf of that another person, and that, the sum received or receivable whether directly or indirectly should be for services rendered in the course of buying and selling of goods, that is, tickets in the present case.

iii) the Department had not been able to produce any evidence to show that the difference between the published fare and the net fare (i.e., the fare the assessee received from the travel agents) was realised by the travel agents. The difference as reduced by standard commission and taxes which is referred to as supplementary commission is only a notional figure and this cannot be termed as a commission within the meaning of Section 194H. What the assessee is entitled to receive is only the net fare. There is no right in the assessee-airline to receive the published fare from the travel agent on sale of tickets;

iv) the notional figure of supplementary commission as appearing in the billing analysis statement of the BSP is neither income nor can it be construed as payment received or receivable, directly or indirectly by the travel agents in its capacity as the agent of the assessee-airline for any services rendered to the assessee-airline. The billing analysis statement of BSP is not a statement of account as contended by the Revenue;

v) since there was no evidence to suggest that the difference between published fare and the net fare was actually received by the travel agent, there was no obligation on the part of the assessee-airline to deduct tax at source on such notional commission which had not been realised;

vi) in these circumstances the provisions of Section 194H were unworkable;

vii) the travel agents had paid tax on the said supplementary commission and hence the Revenue was precluded from raising demands on the assessee-airline.

3.6 Analysing the provisions of Section 194H, the Delhi High Court noted that the provisions of Section 194H would be attracted only if:

i) there is a principal-agent relationship between the assessee-airline and the travel agent;

ii) the payments made by assessee-airline to the travel agent, who is a resident is an income by way of commission;

iii) the income by way of commission should be paid by the assessee-airline to the travel agent for services rendered by the travel agent or for any services in the course of buying or selling of goods;

iv) the income by way of commission may be received or be receivable by the travel agent from the assessee-airline either directly or indirectly; and

v) lastly, the point in time at ‘which obligation to deduct tax at source of the assessee-airline will arise only when credit of such income by way of commission is made to the account of the travel agent or when payment of income by way of commission is made by way of cash, cheque or draft or by any other mode, whichever is earlier.

3.7 Analysing the terms of the PSA agreement and the manner in which the airlines and travel agents functioned, the Delhi High Court concluded that:

i) the travel agent acted on behalf of the airline to establish a legal relationship between an airline and a passenger, and was therefore an agent of the airline, which was his principal;

ii) since it was undisputed that the amount received and retained by the travel agent over and above the net fare would be assessable to tax in his hands as his income, and tax had actually been paid by agents on such income, supplementary commission was ‘income’ within the meaning of Section 194H;

iii) the supplementary commission is not a discount, on account of the fact that the payment retained by the travel agent is inextricably linked to the sale of the traffic document/ air ticket, and the travel agent does not obtain proprietary rights to the traffic documents/air tickets;

iv) there are no two transactions, for one of which commission is paid to the agent, and the second of which is between principal to principal, but just one transaction of sale of tickets on behalf of the airline to the passenger;

v) the amount received by the travel agent over and above the net fare is known to the airline when it receives the billing analysis made by BSP.

The Delhi High Court therefore held that the amount received and retained by the travel agent over and above the net fare was in the nature of commission, liable to deduction of TDS under Section 194H.

4. Observations:
4.1 The conclusions of the Delhi High Court are weighed by one of the facts that the travel agent is an agent of the airline and therefore all and any receipt by him represents commission in his hands, including the difference between the published fare and the net fare.

4.2 The difference between the published fare and the net fare really consists of two components – one component is that of commission as a pre-agreed percentage of the published fare, which is undoubtedly commission covered by the provisions of Section 194H. The other component is the amount not realised by the agent from the client, and therefore not paid to the airline.

4.3 To illustrate, take a situation where the published fare is Rs.50,OOO, the agent’s commission is 7% (Rs.3,500), and the agent sells the ticket to the passenger for Rs.27,500. The agent would collect Rs.27,500 from the passenger and pay Rs.24,OOO to the airline as net fare (ignoring tax), after deducting his commission of Rs.3,500. In this case, the difference between the published fare and the net fare is Rs.26,OOO, consisting of the agent’s commission of Rs.3,500 and the discount passed on to the client of Rs.22,500. This amount of Rs.22,500 is really a discount given by the airline to the passenger through its agent, the travel agent. The travel agent is therefore holding such discount of Rs.22,500 in trust for the passenger, to whom the airline has permitted him to grant such discount.

4.4 With respect to the concerned parties, it was not impressed upon the Delhi High Court that the difference between the published fare and the net fare, in fact was a discount given to the passenger by the airline through the agent and it was the airline alone, ‘which undoubtedly had proprietary rights in the tickets, till such time it was sold to the passengers and the benefit derived by the passenger was a benefit passed on by the airline and not by the agent who received it in trust for the passenger. If the difference is viewed as a discount given to the passenger routed through the agent, as was done by the Bombay High Court, the view taken by the Delhi High Court might have been quite different. As rightly appreciated by the Bombay High Court, the factual position is that the airline has merely granted a permission to the agent to sell the tickets at a lower price, which discount granted through the agent can certainly not be regarded as commission.

4.5 The issue, if any, arises only where in the above example, the travel agent pays to the airline, Rs. 23,000 and not Rs. 24,000 and in the process retains for himself an amount of Rs. 1000. It is this Rs. 1000, whose true nature has to be examined w.r.t. the provisions of s. 194H. This difference so retained may not be a commission within the meaning of Section 194H, unless it is brought within the ambit of Section 194H by proving that the sum received was in the nature of income received or receivable directly or indirectly by the payee from the payer, (that -, IS, the airlines.) and the recipient, (that is, travel agent,) should be a person acting on behalf of that another person, and that, the sum received or reeivable, whether directly or indirectly should be for services rendered in the course of buying and selling of goods, (that is, tickets in the present case). The difference cannot be termed as a commission within the meaning of Section 194H. What the airline is entitled to receive is only the net fare. There is no right in the assessee-airline to receive the published fare from the travel agent on sale of tickets. It cannot be construed as payment received or receivable, directly or indirectly, by the travel agents in its capacity as the agent of the airline for any services rendered to the airline.

4.6 Therefore, the view taken by the Bombay High Court that such discount is not liable to deduction of TDS u/s.194H seems to be the better view of the matter, as compared to the view taken by the Delhi High Court.

Nirav Shah

Recovery of tax : Dues from company cannot be recovered from its directors who are partner in firm.

New Page 1

26 Recovery of tax : Dues from company cannot be recovered
from its directors who are partner in firm.

The petitioner is a partnership firm originally constituted
in the year 1984 and it is running a cinema theatre under a duly granted licence.
The partnership firm was registered under the Indian Partnership Act, 1932. The
petitioner firm is also an assessee on the file of the respondent under the
Tamil Nadu Entertainment Tax Act, 1939.

M/s. Sri Mappillai Vinayagar Spinning Mills Ltd. and M/s. Sri
Manicka Vinayagar Spinning Mills Ltd. are limited companies incorporated under
the Indian Companies Act, 1913 and some of the partners in the petitioner firm
are directors of the said limited companies.

According to the petitioner, the petitioner is not having any
arrears of entertainment tax. A notice of attachment in Form No. 5 had been
issued by the respondent u/s.27 of the Revenue Recovery Act and by the said
notice the respondent had attached the petitioner’s property for the sales tax
arrears of other two private limited companies and another partnership firm.
Being aggrieved by that, the petitioner filed the above writ petition.

The Court observed that the properties of the petitioner, a
firm, were attached by the Commercial Tax officer for non-payment of sales tax
arrears under the Tamil Nadu General Sales Tax Act, 1959 of two other companies
and another firm on the ground that the partners of the petitioner firm were
also admittedly the directors of the two companies and partners of the assessee
firm.

The Court held that the company being a legal entity by
itself could sue and be sued as a legal entity and any dues from the company had
to be recovered only from that company and not from its directors. Therefore,
the proceedings for attachment of the properties of the petitioner firm on the
ground that the partners of the petitioner firm were also directors of the two
private limited companies, could not be sustained.

[Sri Mappillai Vinayakar Cine Complex v. Commercial Tax Officer,
(2008) 146 Comp. Cas 110 (Mad.)]

levitra

Nirav Shah

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

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

2. The issue that arises for consideration in the present appeal is with regard to the scope of and ambit of the provisions of Section 630 of the Companies Act, 1956, more specifically, as to whether the proceedings under the said provisions would cover within its purview only an employee of the company or also persons claiming a right through him or under him.

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

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

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

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

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

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

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

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

Nirav Shah

Potential Voting Rights — Impact on Consolidated Financial Statements

Consolidated Financial Statements shall be prepared by an entity if it has control over another entity. ‘Control’ under IFRS, being power to govern the financial and operating policies, covers within its purview even those entities that have been excluded under Indian GAAP. This article attempts to analyse the meaning and scope of the term — Potential Voting Rights — when determining control.

India, in the year 2011, joins the global accounting revolution : International Financial Reporting Standards (IFRS). It’s being defined as a revolution by many, because significant conceptual level changes are envisaged. One such concept that is evidenced in the piece that follows is substance over form. Recognising the core substance of the transaction over its legal form will indisputably bring an evolution in financial decision making.

It’s not that Indian GAAP does not recognise the importance of substance over form, but its true application will happen only under IFRS. One such instance is consideration of potential voting rights to determine existence of ‘control’ for the purpose of consolidation.

What is Potential Voting Rights ?

An entity may own securities that are convertible into ordinary shares or other similar instruments that have the potential, if exercised or converted, to give the entity voting power or reduce another party’s voting power over the financial and operating policies of another entity.

Some of the key instruments that are considered to have potential voting rights are as under :

1. Equity share warrants

2. Share call options

3. Convertible preference shares

4. Convertible debts

Defining control :

Under IFRS, International Accounting Standard (IAS) 27 Consolidated and Separate Financial Statements defines Control as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

As per Indian GAAP — Accounting Standard (AS) 21 Consolidated Financial Statements, Control means

(i) the ownership, directly or indirectly through subsidiary(ies), of more than one-half of the voting power of an enterprise; or

(ii) control of the composition of the board of directors in the case of a company or of the composition of the corresponding governing body in case of any other enterprise so as to obtain economic benefits from its activities

The above definition is in line with that given under the Companies Act, 1956.

As per S. 4(1) of the Companies Act, 1956, a company shall be deemed to be a subsidiary of another if, but only if, :

(i) that other controls the composition of its Board of directors; or

(ii) that other :

where the first-mentioned company is an existing company in respect of which the holders of preference shares issued before the commencement of this Act have the same voting rights in all respects as the holders of equity shares, exercises or controls more than half of the total voting power of such company;

where the first-mentioned company is any other company, holds more than half in nominal value of its equity share capital; or

(iii) the first-mentioned company is a subsidiary of any company which is that other’s subsidiary.

Here, the expression ‘nominal value of its equity share capital’ means paid-up value of the equity shares and not its face value. The meaning is clear when it is read in conjunction with S. 87(1)(b) of the Companies Act, 1956 which provides that the voting rights in respect of a member holding equity shares in a company shall be in proportion to his share of the total paid-up value of equity shares of the company.

Exclusion of Potential Voting Rights under Indian GAAP :

From the above definition, it can be seen that the Companies Act, 1956 considers nominal value of equity share capital and not potential shares/voting rights.

Although AS 21 does not specifically exclude potential voting rights, Explanation to paragraph 4 of AS 23 Accounting for Investments in Associates in Consolidated Financial Statements states that the effects of potential voting rights are not to be considered for the purpose of determining control.

Based on the above analysis and in light of law prevailing over standards, potential voting rights are not considered for determining control under Indian GAAP.

However, the scope of IAS 27 is much wider as it considers the effects of potential voting rights.

Determining whether potential voting rights exist :

In assessing whether potential voting rights contribute to control, the entity examines all facts and circumstances (including the terms of exercise of the potential voting rights and any other contractual arrangements whether considered individually or in combination) that affect potential voting rights, except the intention of the management and the financial ability to exercise or convert. The intention of the management and the financial ability of an entity to exercise or convert does not affect the existence of power.

Example : An entity holding 35% voting rights in another entity, but having options to acquire another 20% voting interest, would effectively have 55% current and potential voting interests. This may lead to consolidation as per IAS 27.

Currently exercisable or convertible:

An entity has control when it currently has the ability to exercise that power, regardless of whether control is actively demonstrated or is passive in nature. The existence and effect of only those potential voting rights that are currently exercisable or convertible, including potential voting rights held by another entity, are considered when assessing whether an entity has the power to govern the financial and operating policies of another entity. Potential voting rights are not currently exercisable or convertible when they cannot be exercised or converted until a future date or until the occurrence of a future event.

Example: Company H issues Foreign Currency Convertible Bonds (FCCB) with the condition that they are redeemable or convertible only after a period of 3 years. In this case, potential voting rights shall be assumed to exist only after completion of the 3 year lock-in period.

When potential voting rights exist, the proportions of profit or loss and changes in equity allocated to the parent and minority interests are determined on the basis of present ownership and do not reflect the effects of potential voting rights. That is, potential ownership may necessitate consolidated financial reporting, but income or loss allocation is still to be based on actual, not potential, ownership percentages.

Can one subsidiary have two parents?

Potential voting rights are capable of changing an entity’s voting power over another entity – if the potential voting rights are exercised or converted, then the relative ownership of the ordinary shares carrying voting rights changes. Consequently, the existence of control is determined only after considering the existence and effect of potential voting rights. The definition of control in IAS 27 permits only one entity to have control of another entity. Therefore, when two or more entities each holding significant voting rights, both actual and potential, the factors are reassessed to determine which entity has control.

Whereas, under Indian GAAP, Explanation to paragraph 10 of AS 21 Consolidated Financial Statements states that both the entities should consolidate the financial statements of the controlled entity.

Potential voting rights held by others:

Thus, an entity will not be able to conclude that it controls another entity after considering the potential voting rights held by it without considering the potential voting rights held by other parties. Consequently, an entity considers all potential voting rights held by it and by other parties that are currently exercisable or convertible when determining whether it controls another entity.

As can be seen above, Company B holds 45 lakhs current and 15 lakhs potential voting rights in Company O. Thus, company B holds in all 60 lakhs voting rights. Company D, in turn, holds SS lakhs current voting rights in Company O. However, this fact alone shall not lead to a conclusion that company B is the controlling entity. Company B must also consider the potential voting rights held by company D, if any.

Can non-convertible Preference Share Holders have potential voting rights?

A combined impact of IFRSs and legislations like the Companies Act may give rise to unique circumstances. For instance, in the Indian scenario, non convertible preference shares may have a role to play in determining control, as described below.

As per S. 87(2)(b) of the Companies Act, 1956, every member of a company limited by shares and holding any preference share capital therein shall, in respect of such capital, be entitled to vote on every resolution placed before the company at any meeting, if the dividend due on such capital or any part of such dividend has remained unpaid:

i) in the case of cumulative preference shares, in respect of an aggregate period of not less than two years preceding the date of commencement of the meeting; and

ii) in the case of non-cumulative preference shares, either in respect of a period of not less than two years ending with the expiry of the financial year immediately preceding the commencement of the meeting or in respect of an aggregate period of not less than three years comprised in the six years ending with the expiry of the financial year aforesaid.

As per S. 87(2)(c) of the Companies Act, 1956, where the holder of any preference share has a right to vote on any resolution in accordance with the provisions of this sub-section, his voting right on a poll, as the holder of such share, shall, subject to the pro-visions of S. 89 and Ss.(2) of S. 92, be in the same proportion as the capital paid-up in respect of the preference share bears to the total paid-up equity capital of the company.

Also, one must not forget that a security will be considered to have potential voting rights only if it is currently exercisable or convertible. As the cumulative/non-cumulative preference shares will have right to exercise voting power only on default by the company, as mentioned above, the shares shall be considered for the purpose of ‘control’ only when they are entitled to vote. In short, the cumulative/ non-cumulative preference shareholders shall not be considered to be having potential voting rights till they actually are eligible to vote.

Takeaways:

As defined above, ‘Control’ is the power to govern financial and operating policies of an entity. Voting rights cannot be considered in isolation to determine control. There are several other factors, not having been touched upon by this article, which may deserve consideration to zero in on the entity that has power to govern policies.

To conclude, there are three important takeaways:

1. An entity has control when it currently has the ability to exercise that power

2. An entity shall consider all potential voting rights held by it and by other parties that are currently exercisable or convertible while determining whether it controls another entity

3. Income or loss allocation between parent and minority interests is still to be based on actual, not potential, ownership percentages.

Nirav Shah

Is rotation of auditors an answer to Satyam episode

Background

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

Concept of rotation of statutory auditors

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

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

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

Companies Bill, 1997

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

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

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

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

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

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

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

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

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

Naresh Chandra Committee report

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

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

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

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

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

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

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

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

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

The Companies Bill, 2008

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

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

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

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

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

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

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

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

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

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

To sum up

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

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

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

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

Nirav Shah

Kal, Aaj aur Kal

Computer Interface

In the previous article I wrote about technological innovations which shaped our present. Continuing from where we stopped, we know what the past is …. what everyone wants (usually) is what’s the future gonna be like ? . . . . well I can’t tell you that, but what I can talk about is what to look out for.

Some of the trends (according to me) to watch out for are :

Open document formats

XBRL

Mashups

Virtualisation

Convergence

Open Document Formats (‘ODF’) :

They say change is inevitable and with newer versions of software released in the market, we migrate to them like fish to water. But the trouble with change is that not everyone can change at the same pace and when that happens, then you are faced with the question posed in the movie — whats wrong with the old format, why do we have to change — so on so forth….

Using open standards like ODF ensures that the users’ information is accessible across platforms and applications, even as technologies change. Organisations and individuals that store their data in an open format avoid being locked in to a single software vendor, leaving them free to switch software if their current vendor goes out of business, raises its prices, changes its software, or changes its licensing terms to something less favorable for the user. Adoption of open standards is particularly important for governmental applications because it can effectively ensure that a government document saved today will not be technologically locked tomorrow.

ODF is likely to become a whole lot bigger in future (to learn more about open document formats read my write-ups in the Jan-Mar 2006 and May 2008 issues of the BCAJ).

eXtensible Business Reporting Language (‘XBRL’) :

As Chartered Accountants one thing we know better than most people is that — compliance is a huge part of our practice. We are always faced with the issue of shrinking deadlines and ever-increasing requirement to report information. Such reporting may not be limited to tax filings — it would also extend to financial, legal, statutory reporting, etc.

Part II

But reporting is one thing and analysing and interpreting i.e., using the reported information, is another thing. Interpretation and analysis is the real deal and as we all know, unless everyone follows the same set of rules the interpretation and analysis could lead to different results. In general we usually report the information in a generalised/resultoriented summary. These summaries are usually accompanied by a whole lot of notes (to help the user understand the summary). Nonetheless, users still spend humongous amounts of time trying to normalise data.

XBRL stands for eXtensible Business Reporting Language (XBRL), an XML-based technology standard, it is a language for capturing financial information throughout a business information process that will eventually be reported to shareholders, banks, regulators, and other parties. The goal of XBRL is to make the analysis and exchange of corporate information more reliable and easier to facilitate, in that it can help business in increasing the business value and provide reliable, and transparent financial data. The adoption of XBRL may permit stakeholders to access, compare and analyse data in ways that are at this time impractical or unreal. The reason is that the language is robust enough to boast of capabilities like :

Drill-down facility for abridged data

Reduced preparation time, effort and cost

Enhanced analytical capability

Standardised and simplified international access and acceptability

Platform neutrality ensures wider acceptability

Leverages the efficiencies of the Internet.

I am looking forward to the day that we will be able to file (upload) tons of information at a single click— hopefully this experience will be less painful as compared to what we face today. (learn more about open document formats — read my write-up in the Jan-Mar 2006 and May 2008 issues of the BCAJ).

Mashup tools :

In web development, a mashup is a web application that combines data from one or more sources into a single integrated tool. An example of a mashup is the use of cartographic data from Google Maps to add location information to real estate data, thereby creating a new and distinct web service that was not originally provided by either source. Mashups and meshups are different from simple embedding of data from another site to form a compound page. A mashup or meshup site must access third-party data and process that data to add value for the site’s users. Mashups typically ‘screen-scrape’ or use other brute-force methods to access the untyped linked data; meshups typically use APIs to access typed linked data. A mashup or meshup web application has two parts:

A new service delivered through a web page, using its own data and data from other sources.

The blended data, made available across the web through an API or other protocols such as HTTP, RSS, REST, etc.

Our methods of collecting and sharing information have evolved over a period of time. Mashup tools hold the promise of an intelligent information collection as well as a collaboration tool. Watch out for more on this tool.

Desktop virtualisation :

Desktop virtualisation is the decoupling of a user’s physical machine from the desktop and software he or she uses to work. Most desktop virtualisation products emulate the PC hardware environment of the client and run a virtual machine alongside the existing operating system located on the local machine or delivered to a thin client from a data center server. Virtual desktop infrastructure (VDI) is a server-centric computing model that borrows from the traditional thin-client model, but is designed to give system administrators and end users the best of both worlds: the ability to host and centrally manage desktop virtual machines in the data center while giving end users a full PC desktop experience. The user experience is intended to be identical to that of a standard PC, but from a thin-client device or similar, from the same office or remotely. Installing and maintaining separate PC workstations is complex, and traditionally users have almost unlimited ability to instal or remove software.

Desktop virtualisation provides many of the advantages of a terminal server, but (if so desired and configured by system administrators) can provide users much more flexibility. Each, for instance might be allowed to instal and configure his own applications. Users also gain the ability to access their server-based virtual desktop from other locations.

Advantages:

Instant provisioning of new desktops

Near-zero downtime in the event of hardware failures

Significant reduction in the cost of new application deployment

Robust desktop image management capabilities

Normal 2-3 year PC refresh cycle extended to 5-6 years or more

Existing desktop-like performance including multiple monitors, bi-directional audio/video, streaming video, USB support, etc.

Ability to access the users’ enterprise desktop environment from any PC, (including the employee’s home PC)

Convergence:

This is one development that has been talked about for as long as I can remember. Telecom Media Convergence is about crossing multiple industries. Fixed, mobile, and IP service providers can offer content and media services, and equipment providers can offer services directly to the end user. Content providers are consistently looking for new distribution channels. Convergence is the combination of all these different media into one operating plat-form. It is the merger of telecom, data processing and imaging technologies. This convergence is ushering in a new epoch of multimedia, in which voice, data and images are combined to render services to the user. I am waiting for the day when 3G/WIMAX will be a common thing and your mobile phone will be more than just a communication device – it would be your TV, your travel guide, your office away from office (yikes – strike that out), your wallet.

Well that’s all for now. Just to share a small secret, as I was penning this write-up, it gave me a chance to go thru my earlier articles and it made me realise what seemed outrageous then seems like a no-brainer today, innovation is so much a part of our life today, that, changes in the last few years also seem so significant.

I will probably revisit this write up next March to see where we stand……….

Nirav Shah

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

Introduction

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

[To be Concluded]

Nirav Shah

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

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

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

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

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

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

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

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

Nirav Shah

Deficiency in service by Doctor — Consumer Protection Act 1986.

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Deficiency in service by Doctor — Consumer Protection Act
1986.

Smt. Harjit Kaur, the wife of complainant received
accidental burns while making tea on the stove. She sustained 50% burns
involving both upper limbs, part of trunk and most of both lower limbs. The
wife was taken to Daya Nand Medical College and Hospital, Ludhiana where she
responded to the treatment well. Subsequently she was shifted to PGI Hospital
Chandigarh where Senior Resident Dr. Varun Kulshrestha attended to her. The
condition of wife started improving at PGI.

She was transfused A+ blood which was her blood group.
Subsequently, the patient was transfused B+ blood group although her blood
group was A+. In the night the urine of the patient was reddish like blood and
the attendant nurse was informed accordingly. As to the bad luck of Smt.
Harjit Kaur, on the next day, again one bottle of B+ blood group was
transfused. Because of transfusion of mismatched blood, the condition of Smt.
Harjit Kaur became serious; her hemoglobin levels fell down. and urea level
went very high. Later on, it transpired that due to transfusion of mismatched
blood, the kidney and liver of the patient got deranged. The complainant made
a written complaint to the Head of the Department of Plastic Surgery for
mismatched transfusion of blood to the patient whereupon an inquiry was
conducted through senior doctor and wrong transfusion of the blood to the
patient was found. The condition of Smt. Harjit Kaur started deteriorating day
by day and she ultimately died. In the complaint before the State Commission,
the complainants alleged that the death of Smt. Harjit Kaur was caused due to
the negligence of Dr. Varun Kulshrestha and the medical staff at PGI.

The State Commission after hearing the parties and upon
consideration of the materials made available to it, came to the conclusion
that there was serious deficiency and negligence on the part of PGI and its
attending doctor(s)/staff in transfusion of wrong blood group to the patient
which resulted in death of Smt. Harjit Kaur. The State Commission in its order
held that PGI was liable to pay sum of rupees two lac to the complainant.

The National Commission upheld the above order. On further
appeal the Court observed that the term negligence is often used in the sense
of careless conduct. In Grill v. General Iron Screw Collier Co. (1866)
L.R. 1 C.P. 600 at 612, Wills J. referred to negligence as “. . . the absence
of such care as it was the duty of the defendant to use.”

The Court further observed that insofar as civil law is
concerned, the term negligence is used for the purpose of fastening the
defendant with liability of the amount of damages. To fasten liability in
criminal law, the degree of negligence has to be higher than that of
negligence enough to fasten liability for damages in civil law.

As for the distinction between negligence in civil law and
in criminal law, it has been held that there is a marked difference as to the
effect of evidence, namely, the proof, in civil and criminal proceedings. In
civil proceedings, a mere preponderance of probability is sufficient, and the
defendant is not necessarily entitled to the benefit of every reasonable
doubt; but in criminal proceedings, the persuasion of guilt must amount to
such a moral certainty as convinces the mind of the Court, as a reasonable
man, beyond all reasonable doubt.

With regard to the professional negligence, it is now well
settled that a professional may be held liable for negligence if he was not
possessed of the requisite skill which he professed to have possessed or, he
did not exercise, with reasonable competence in the given case the skill which
he did possess. It is equally well settled that the standard to be applied for
judging, whether the person charged has been negligent or not, would be that
of an ordinary person exercising skill in that profession. It is not necessary
for every professional to possess the highest level of expertise in that
branch which he practises.

The Supreme Court held that the available material placed
before the State Commission shows that at the time of her admission, Smt.
Harjit Kaur was taking medicine orally and passing urine. Her condition had
substantially improved at PGI and she had no signs of septicemia. It was only
after mismatched blood transfusion B+ on two consecutive days, that she became
anemic (her hemoglobin level was reduced to 5 per gram) and her kidney and
liver were deranged. Although she survived for about 40 days after mismatched
blood transfusion but from that it cannot be said that there was no causal
link between the mismatched transfusion of blood and her death. Wrong blood
transfusion is an error which no hospital/doctor exercising ordinary care
would have made. Such an error is not an error of professional judgment but in
the very nature of things a sure instance of medical negligence.

Nirav Shah

Precedent — Different view amongst Co-ordinate Benches of Tribunal — Matter has to be referred to larger Bench.

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Precedent — Different view amongst Co-ordinate Benches of
Tribunal — Matter has to be referred to larger Bench.

A dispute arose before the Tribunal in the context of sales
tax liability towards development charges received by the appellant builders.

The Tribunal observed that it was not in agreement with the
view expressed by its earlier Co-ordinate Bench. Despite the existence of the
regulation 54(a)(i) of Karnataka Appellate Tribunal Regulations stipulating
that in the event of conflict of decisions, the matter is required to be
referred to the Chairman, that was not done in this matter. Thus the matter
referred to Tribunal to constitute a special bench in view of the conflicting
opinions of the co-ordinate benches of the Tribunal in terms of regulation
54(a)(i) of the Act.

[ Continental Builders & Developers v. State of
Karnataka, (2009) 21 VST 74 (SC)]

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Nirav Shah

Co-owner sale — Release of share by co-owner to other co-sharer did not amount to sale or conveyance — S. 2(10) Stamp Act 1899.

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Co-owner sale — Release of share by co-owner to other
co-sharer did not amount to sale or conveyance — S. 2(10) Stamp Act 1899.

The collector passed an order u/s.47-A of the Indian Stamp
Act by which he had imposed stamp duty on the respondents by coming to the
conclusion but the release deed dated 7-6-2002 was not a release deed but was
a conveyance within the meaning of S. 2(10) and stamp duty was attracted on
it. The court held that Release deed made by two co-sharers to other
co-sharers who had existing right in the property and it was simply an
extension of their existing share and no stranger had been admitted to the
property. Therefore it did not amount to a transfer of the property at all and
the release deed would be covered by the Full Bench decision of this Court in
the case of Balwant Kaur v. State reported in AIR 1984 Allahabad 107.

The co-owners in this case had transferred their shares to
other co-sharers who had pre-existing right in the property. It did not amount
to any transfer, rather it only amounted to an extension of their existing
share. Since there was no transfer to any outsider, it would not amount to a
sale or conveyance within the meaning of S. 2(10) even if the explanation is
taken into account.

[ State of UP v. Dharam Pal & Anr., AIR 2009 (NOC)
1372 (All.)]

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Nirav Shah

Appearance of retired members of CESTAT — Prohibition of practice by Ex-president, vice-presidents or members of CESTAT, before it held to be reasonable restriction : Constitution of India Art. 14, 19(1)(g) and 21.

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Appearance of retired members of CESTAT — Prohibition of
practice by Ex-president, vice-presidents or members of CESTAT, before it held
to be reasonable restriction : Constitution of India Art. 14, 19(1)(g) and 21.

The issue before the High Court was in respect of the right
of a member/president/vice-president of the Customs Excise Service Tax
Appellate Tribunal (‘CESTAT’) to appear, act and/or plead on their demitting
office before the very same Tribunal. The Legislature had sought to debar all
such like persons, by insertion of Ss.(6) to S. 129 of the Customs Act, 1962.
The aid provision was introduced by S. 110 of the Finance Act 2007 w.e.f.
11-5-2007.

The petitioners being aggrieved, have challenged the said
provision, on grounds that S. 129(6) of the Customs Act is ultra vires
Articles, 14, 19(1)(g) and 21 of the Constitution of India. Secondly that, in
any event, S. 129(6) of the Act has no applicability to the petitioners in
view of the fact that at the time when they were appointed to CESTAT and also
at a point in time when they demitted the office, the said provision was not
on the statute book.

The High Court observed that there was a time when a son
would appear in the court presided over by his father and no questions were
asked. The validity of a statute cannot be judged on the basis of rights of an
individual when an individual’s rights are pitted against a greater public
weal. Indi-vidual rights have to give way to a greater public interest.

The charge of violation of Article 14 was levelled on the
ground that provision was discriminatory, inasmuch as members of other
Tribunals, such as, the Income-tax Appellate Tribunal and the Appellate
Tribunal for Foreign Exchange were not barred from appearing, acting or
pleading before Tribunals of which they have been members.

The Court held that the purported discrimination claimed by
the petitioners on account of the fact that members of Tribunals such as the
Income-tax Appellate Tribunal and the Appellate Tribunal for Foreign Exchange
were not visited with such disability, was untenable. The fact that a
beginning had been made by incorporating such like provisions in respect of
some tribunals, such as, the CESTAT, the Central Administrative Tribunal
constituted under the Administrative Tribunal Act, 1985 would only conclude
that the impugned provision was not discriminatory. In the opinion of the
Court the step was taken towards insertion of the impugned provision was
reformatory and not discriminatory, as contended by the petitioners. Before
inserting the impugned provision, inputs were taken from various sources,
including the sitting president who was none else than a retired judge of a
High Court. The recommendation must have been made by a high functionary such
as the President of CESTAT, with a keen sense of responsibility after taking
into account his experience gained both on the judicial and administrative
side in the working of CESTAT.

The predominant rationale for introduction of this
provision is to strengthen the cause of administra-tion of justice then the
restriction cannot be said to be unreasonable under Article 19(6) of the
Constitu-tion. The petitioners have acquired expertise in the field of law
pertaining to customs, excise and ser-vice tax. Therefore the impugned
provision does not completely prohibit the petitioners from practising their
profession. The prohibition is with respect to a forum. The petitioners’
expertise can and is sought to be applied in superior forums, such as the High
Courts and also the Supreme Court. It would help to develop and foster entry
of fresh blood and talent at the level of the tribunals and at the same time
make available much needed expertise in the superior forums. There is no
denying that there is pauctity of lawyers who are experts in fields such as,
customs, excise and service tax in superior courts. The amendment meets
various facets of public interests and hence cannot be dubbed as one which was
unreasonably restrictive or one which completely forecloses all opportunities
available to the petitioners to exercise their profession.

There was a single tribunal, that is CESTAT which
adjudicates upon matters which pertain to customs, excise and service tax. The
members, vice-president and president are the same persons who hear and
adjudicate upon the matter involving the aforementioned three streams of law.
That being the position, the prohibition contained in the impugned provision
gets attracted no sooner the person who has held the office of the
president/vice-president or a member of the Appellate Tribunal which is a
common tribunal, that is, the CESTAT, seeks to appear, act or plead before the
CESTAT. It makes no difference that corresponding amendments have not been
brought about in the Excise Act or the Finance Act, 1994, because the
prohibition is not attached to the stream of law which is practised before
CESTAT. The prohibition or the bar on appearance is vis-à-vis the forum
and the trigger for invoking the bar is that the person concerned should have
held the office of a member, vice-president or president of the said forum.

Further there was no reason to draw a distinction between
persons who have demitted office prior to the insertion of the impugned
provision, and those who would demit office thereafter. The writ petition was
accordingly dismissed.

[ P. C. Jain v. UOI, 2009 (236) ELT 737 (Del.)
itatonline.org]

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Nirav Shah

Appeal : Territorial jurisdiction of Court — Where significant part of cause of action arises : S. 20 of CPC

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Appeal : Territorial jurisdiction of Court — Where
significant part of cause of action arises : S. 20 of CPC.

The issue that arose for consideration was whether the
Delhi High Court ought to exercise jurisdiction in respect of the impugned
order passed by CESTAT, New Delhi.

The respondent had raised preliminary objection pertaining
to lack of territorial jurisdiction of the High Court of Delhi. The appellant
operates from plot at Bareilly, U.P. The Commissioner of Central Excise,
Meerut-II issued show-cause notice; after adjudication the Commissioner
confirmed the demand and directed recovery of cenvat together with penalty. It
was that order which was appealed before CESTAT, New Delhi.

The Court observed that the significant part of the cause
of action should have arisen within the territorial sway of the Court which is
chosen by the Petitioner for ventilation of his grievances. The Court relied
on the decision in the case of Kusum Ingots and Alloys Ltd. v. Union of
India, AIR 2004 SC 2321 which clarifies the law as under :

“When an order, however, is passed by a Court or Tribunal
or an executive authority whether under provisions of a statute or
otherwise, a part of cause of action arises at that place. Even in a given
case, when the original authority is constituted at one place and the
Appellate authority is constituted at another, a writ petition would be
maintainable in the High Court within whose jurisdiction it is situate
having regard to the fact that the order of the appellate authority is also
required to be set aside and as the order of original authority merges with
that of the appellate authority.”

…….

“We must, however, remind ourselves that even if a small
part of cause of action arises within the territorial jurisdiction of the
High Court, the same by itself may not be considered to be a determinative
factor compelling the High Court to decide the matter on merit. In
appropriate cases, the Court may refuse to exercise its discretionary
jurisdiction by invoking the doctrine of forum convenience.”

In Stridewell Leathers (P) Ltd. v. Bhankerpur Simbhaoli
Beverages (P) Ltd., (1994) 1 SCC 34, the issue concerned was which High
Court would be the appropriate forum to adjudicate an appeal from the Company
Law Board, Principal Bench, New Delhi. The Supreme Court opined that — “the
expression “the High Court’ in S. 10-F of the Companies Act means the High
Court having jurisdiction in relation to the place at which the registered
office of the company concerned is situate as indicated by S. 2(11) read with
S. 10(1)(a) of the Act. Accordingly, the appeal against the order of the
Company Law Board would lie in the Madras High Court which has jurisdiction in
relation to the place at which the registered office of the company concerned
is situate and not the Delhi High Court merely because the order was made by
the Company Law Board at Delhi.

Similarly the Division Bench of the High Court of
Judicature at Bombay in Sun Pharmaceutical Inds. Ltd. v. Union of India,
2007 (218) ELT 495 (Bom.) held that even though the Settlement Commission was
physically located at Mumbai, since it was dealing with a case arising in
Tamil Nadu, it could be deemed to be located in that State and accordingly
amenable to the writ jurisdiction of the Madras High Court; the Bombay High
Court declined to exercise writ jurisdiction primarily because only a small
part of the cause of action had arisen within its jurisdiction.

The Court further observed that on a reading of Article
226(1) of the Constitution it will be palpably clear that without the next
following provision, that is, sub-clause (2) a High Court may not have been
empowered to issue a writ or order against a party which is not located within
the ordinary territorial limits of that High Court. The power to issue
writs against any person or Authority or government even beyond the
territorial jurisdiction of any High Court is no longer debatable. The rider
or prerequisite to the exercise of such power is that the cause of action must
meaningfully arise within the territories of that particular High Court. It
does not logically follow, however, that if a part of the cause of action
arises within the territories over which that High Court holds sway, it must
exercise that power rather than directing the petitioner to seek his remedy in
any other High Court which is better suited to exercise jurisdiction for the
reason that the predominant, substantial or significant part of the cause of
action arises in that Court. In other words any High Court is justified in
exercising powers under Article 226 either if the person, authority or govt.
is located within its territories or if the significant part of the cause of
action has arisen within its territories. The rationale of S. 20 of the Code
of Civil Procedure would, therefore, also apply to Article 226(2) of the
Constitution.

Thus the High Court should not exercise jurisdiction only
because the Tribunal whose order is in appeal before it, is located within its
territorial boundaries.

Merely because the order that is impugned has been
challenged by the CESTAT, New Delhi, the High Court at New Delhi ought not
exercise jurisdiction. The appeal was returned to be filed in the appropriate
court in accordance with law.

[Brindavan Beverages P. Ltd. v. Commissioner of C.
Ex., Meerut (2009) 237 ELT 658 (Del.)]

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Nirav Shah

Hindu Marriages Act : After decree of divorce is passed, relation between husband and wife with respect to matrimonial premises becomes that of licencesor and licensee : Easement Act S. 52.

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20 Hindu Marriages Act : After decree of divorce is passed,
relation between husband and wife with respect to matrimonial premises becomes
that of licencesor and licensee : Easement Act S. 52.

The present petitioner filed suit against the respondent, who
is his divorced wife, on the ground that she is residing in a portion of the
same building in which he has been residing and her stay is continued even after
his marriage with her came to be dissolved by a decree granted by the Family
Court.

The Trial Court held that since no right has been conferred
upon the wife in the divorce decree to stay in the said premises, after
dissolution of her marriage with petitioner, the relationship between the
petitioner and the respondent became that of licensor and licensee and therefore
the husband claimed possession of it by filing the said ejectment suit.

The High Court observed that it is the settled principle of
law that once a decree of divorce is passed by the competent Court, dissolving
the marriage between the husband and wife, they cease to be husband and wife and
consequently they cease to have any right or obligation against each other,
which they had during the subsistence of their marriage. Such rights and
obligations include the right of the wife to reside with her husband and the
obligation on the part of the husband to live with her under the same roof; her
right to succeed to his properties. Therefore, after obtaining a decree of
divorce, though the husband would be liable to pay alimony towards maintenance
of his divorced wife till she remarries or till she dies, he would not be liable
to make arrangement for her stay by securing an accommodation when she has to
leave his residence by reason of dissolution of his marriage with her. At best,
his obligation would extend to enhance the alimony payable by him to her so as
to enable her to meet the additional expenses towards rent of the residential
premises wherein she has to reside after leaving his residence. This being so,
the respondent herein cannot claim against the petitioner any right to reside in
the said premises after dissolution of her marriage with him. The relationship
between the petitioner and the respondent with respect to the said premises has
been that of licensor and licensee, but not that of husband and wife, so that
the respondent could exercise her right to residence in the said premises. She
has no alternative but to quit the said premises, stay in any other premises
suitable to her and claim from the petitioner enhancement in the monthly
alimony.

[B. Krishnappa v. Smt. Chandrika G., AIR 2008
Karnataka 175]

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Nirav Shah

Powers of Revenue authority : Revenue authority cannot decide question relating to genuineness of document : Stamp Act, 1899, S. 38(2).

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21 Powers of Revenue authority : Revenue authority cannot
decide question relating to genuineness of document : Stamp Act, 1899, S. 38(2).

When a document is sent to Revenue authority or District
Collector, for the purpose of impounding, levying the stamp duty and penalty he
is expected to decide the same in accordance with provisions of the Stamp Act
and cannot travel beyond that by entering into controversy whether document sent
by the Civil Court is genuine or not. It is for the competent Civil Court to
decide the question in relation to genuineness or otherwise of document
concerned. The authority or jurisdiction of Revenue authority/District Collector
would be limited for the purpose of deciding the question of impounding i.e.,
levying the stamp duty and penalty.

[Mohd. Qamruddin & Ors. v. Masula Narsimhulu, AIR 2008 Andhra Pradesh
249]

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Nirav Shah

Dishonour of cheque issued on behalf of a company : Negotiable Instruments Act, 1881 S. 141 and S. 138.

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19 Dishonour of cheque issued on behalf of a company :
Negotiable Instruments Act, 1881 S. 141 and S. 138.

The appellant filed a complaint u/s.138 read with S. 141 of
the Negotiable Instruments Act, 1881, against the accused Company on whose
behalf the bounced cheque was issued. The cheque in question was a post-dated
cheque. The cheque was signed by the respondent in April 1995, when he was
Director of the accused Company, but the cheque was post-dated as 28-1-1998.
However, before bouncing of the cheque in January 1998 or thereafter, the
respondent had already resigned from the accused Company on 25-5-1996, and had
also given intimation to all concerned including the appellant. Despite this
intimation the respondent was impleaded as co-accused, but no specific averment
was made in the complaint, as to in what capacity he was being impleaded.

The Trial Court accepted the respondent’s plea that he should
be deleted from the array of the accused persons for the reason that he had
already resigned from directorship when the cheque bounced. The High Court also
dismissed the appellant’s criminal revision petition.

The Apex Court held that S. 141 of the Act provides for a
constructive liability. A legal fiction has been created thereby. The statute
being a penal one should receive strict construction. It requires strict
compliance with the provision. Specific averments in the complaint petition so
as to satisfy requirements of S. 141 of the Act are imperative. Mere fact that
at one point of time some role had been played by the accused may not by itself
be sufficient to attract the constructive liability u/s.141 of the Act.

A person who had resigned within the knowledge of the
complainant in 1996 could not be a person in charge of the Company in 1998 when
the cheque was dishonoured. He had no say in the matter of seeing that the
cheque is honoured. He could not ask the Company to pay the amount. He as a
director or otherwise could not have been made responsible for payment of the
cheque on behalf of the Company or otherwise.

When post-dated cheques are issued and the same are accepted,
although it may be presumed that the money will be made available in the bank
when the same is presented for encashment, but for that purpose, the harsh
provision of constructive liability may not be available except when an
appropriate case in that behalf is made out.

S. 140 of the Act cannot be said to have any application
whatsoever in this case. Reason to believe on the part of a drawer that the
cheque would not be dishonoured cannot be a defence. But, then one must issue
the cheque with full knowledge as to when the same would be presented. It
appears to be a case where the appellant has taken undue advantage of the
post-dated cheques given on behalf of the Company. The statute does not envisage
misuse of a privilege conferred upon a part to the contract. Accordingly the
appeal was dismissed.

[ DCM Financial Services Ltd. v. J. N. Sareen and
Another, (2008) 8 Supreme Court Cases 1]

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Nirav Shah

Accident claim : Compensation awarded under Motor Vehicle Act is not a ‘debt’, nor a succession, therefore production of succession certificate by heirs of deceased not necessary : Motor Vehicles Act, S. 168, Succession Act, 1952, S. 214(1)

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17 Accident claim : Compensation awarded under Motor Vehicle
Act is not a ‘debt’, nor a succession, therefore production of succession
certificate by heirs of deceased not necessary : Motor Vehicles Act, S. 168,
Succession Act, 1952, S. 214(1)

Original claimant Abdul Razak Gulam Rasul Bhurwala had
sustained grave injuries in a vehicular accident and therefore, he had moved the
M.A.C. Tribunal for compensation. Ultimately, the said original claimant
succeeded in the claim petition and the Tribunal awarded amount of Rs.3,48,020
with cost and interest. Consequently, the insurance company deposited amount of
Rs.7,72,741 with the Tribunal. However, before the original claimant Abdul Razak
Gulam Rasul Bhurawala could realise the amount, he died of natural death. When
the heirs of the deceased claimant applied for disbursement of the amount, they
were asked to produce succession certificate.

The High Court observed that the Apex Court in the case of
Smt. Rakhsana and Others v. Nazrunnisa (Smt.) and Anr., reported in 2000 AIR
SCW 4941, held that the succession certificate as envisaged under the Indian
Succession Act was only granted in respect of ‘debts’ or ‘securities’ to which
the deceased was entitled and the compensation awarded under the Motor Vehicles
Act was not a debt, nor a succession. Therefore, a certificate was not required
to be obtained in order to claim the compensation awarded under the Motor
Vehicles Act. However, it would be open for the Tribunal to make appropriate
disbursement if there are any disputes amongst the heirs qua quantum of
compensation payable to each of the heirs.

[ Aktharbibi Abdul Razak Gulam Rasul & Ors. v. United
India Insurance Co. Ltd., AIR 2008 Gujarat 146]

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Nirav Shah

Condonation of delay of 4 years : Pendency of representation filed before State Government against alleged order, sufficient ground to condone delay : Constitution of India Article 226

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18 Condonation of delay of 4 years : Pendency of
representation filed before State Government against alleged order, sufficient
ground to condone delay : Constitution of India Article 226.

The petitioner had filed a writ petition before the High
Court against the decision of the State Government after 4 years from the date
of passing of such order. The High Court dismissed the petition on ground of
delay and laches.

The Supreme Court observed that the petitioner had filed a
representation/review of the decision of the State Government, and was expecting
that an order would be passed on the said representation. Therefore, the delay
in moving the writ petition was sufficiently explained by the petitioner and the
petition ought not to be dismissed on the ground of delay and laches. The High
Court was directed to decide the writ petition on merits in accordance with law.

[Ashok Kumar v. State of Bihar & Ors., AIR 2008
Supreme Court 2723]

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Nirav Shah

Recovery : Loan taken by cooperative society cannot be recovered from secretary of the society : Bihar Co-op. Societies Act, S. 52.

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25 Recovery : Loan taken by cooperative society cannot be
recovered from secretary of the society : Bihar Co-op. Societies Act, S. 52.

The petitioner Jay Mangal Singh was at the relevant time
secretary of the Ajanta Tel Utpadak Sahyog Samiti Ltd. duly registered under the
Bihar Co-op. Societies Act, 1935. The co-op had taken a loan from Central Co-op
Bank Ltd, Aurangabad. Having taken
the loan, it defaulted in repayment, the consequence, thereof, was that for
recovery of outstanding dues a certificate proceeding was initiated against the
said co-op. While doing so, petitioner was made a party to the certificate
proceeding and shown as a certificate debtor. This was done specifically
mentioning that the petitioner was the secretary of the said co-op. when the
loan was granted.

A co-operative is a body incorporate and an independent
juristic entity. That being so, it is distinct from not only its member but
members elected as office bearers. This distinction as between the co-operative
and its constituents is well established. That being so, the loan having been
taken by the co-operative, it cannot be recovered from petitioner who was
secretary of society. Especially, as petitioner was being proceeded against only
because he happened to be elected secretary of co-operative. He was not being
proceeded against on ground of having underwritten or guaranteed repayment of
loan. He had no personal liability in the matter, except, to the extent he may
be liable for any loan or advance taken and remaining unpaid from his
co-operative. That was not the case of the respondents. That being so, the
certificate proceedings as against the petitioner cannot be sustained and would
be wholly without jurisdiction.

[Jay Mangal Singh v. Bihar State Co-op. Bank Ltd.,

AIR 2008 Patna 192]

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Nirav Shah

Precedent : Non-challenge of order by Revenue preclude from challenging similar order passed in respect of another unit.

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23 Precedent : Non-challenge of order by Revenue preclude
from challenging similar order passed in respect of another unit.

The respondent M/s. Surcoat Paints (P.) Ltd. is engaged in
the manufacture of paints and varnishes. A show-cause notice was issued for
short payment of duty to the tune of Rs.40,33,903.73 on the goods cleared by the
manufacturer. As per the show-cause notice the SSI benefit is not available to
the respondents on the ground that SSI registration certificate was not
correctly given to the respondent.

The assessee being aggrieved by the order, filed an appeal
before the Tribunal. The Tribunal reversed the order passed by the Commissioner
of Central Excise, Allahabad, primarily relying upon the earlier decision of the
Tribunal in CCE v. Agra Leather Goods P. Ltd., (2000 (39) RLT 674 (T).

This appeal has been filed by the Revenue against the
judgment and order passed by the Customs, Excise and Gold (Control) Appellate
Tribunal, New Delhi.

The Court held that since the Revenue has accepted the
decision given by the Tribunal in Agra Leather Goods case (supra), the
Revenue is precluded from challenging the similar order passed in respect of
another unit. Since the order passed in Agra Leather Goods case (supra)
has attained finality, the present appeal deserves to be dismissed on this
ground alone and accordingly dismissed the appeal.

[Commissioner of Central Excise, Allahabad v. Surcoat
Paints (P) Ltd., 2008 (232) ELT 4 (SC)]

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Nirav Shah

Appeal : Condonation of delay : High Court is empowered to condone delay in filing appeals u/s.35G of the Central Excise Act, 1944.

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22 Appeal : Condonation of delay : High
Court is empowered to condone delay in filing appeals u/s.35G of the Central
Excise Act, 1944.

In view of conflicting decisions of two Division Benches of
the Bombay High Court on the issue of whether this Court is empowered to condone
the delay in filing appeals u/s.35G of the Central Excise Act, 1944, which are
filed beyond the prescribed period of 180 days, a Full Bench of three judges was
constituted.

One Division Bench in the case of Commissioner of Customs
v. M/s. Sujog Fine Chemicals (India) Ltd., by a judgment and order dated
13th August 2008 held that in the light of S. 29(2) of the Limitation Act, 1963,
in any appeal filed u/s.130 of the Customs Act, 1962, this Court is empowered
u/s.5 of the Limitation Act, 1963 to condone the delay.

Whereas another Division Bench in a group of cases in
Commissioner of Central Excise v. M/s. Shruti Colorants Ltd., by a judgment
and order dated 29th August 2008 involving appeals u/s.35G of the Central Excise
Act, 1944 held that this Court is not empowered to condone the delay taking
recourse to S. 5 of the Limitation Act, 1963.

The Full Bench after analysing the aspect in depth, came to a
conclusion that in such appeals, the High Court is empowered to have recourse to
S. 5 of the Limitation Act.

Unfortunately the two judgments of the Supreme Court in the
case of Mukri Gopalan v. Chepplat Puthanpurayil Aboobacker, AIR 1995 SC
2272 and also of State of West Bengal & Ors v. Kartik Chandra Das, (1996)
5 SCC 342 were not brought to the notice of the Division Bench which decided the
Shruti Colorants Case. In fact the above two judgments of the Supreme Court deal
with the scope and purport of S. 29(2) of the Limitation Act exhaustively,
clearly holding that unless expressly excluded, Civil Courts are empowered to
have recourse to S. 5 of the Limitation Act to condone the delay.

Similarly the Full Bench judgment of the Bombay High Court in
the case of Commissioner of Income-tax v. Velingkar Brothers, (2007) 289
ITR 382 (Bom.) (FB) was not brought to the notice of the above Division Bench
which dealt with the case of Shruti Colorants. In fact in that case the
expression appeal ‘shall’ be filed within 120 days was interpreted to mean that
it did not take away the Court’s power to condone delay having recourse to S. 5
of the Limitation Act.

The Full Bench observed that the High Court being the
Superior Court, the power to condone the delay in filing the appeal must be read
to be existent, more so by virtue of S. 29(2) of the Limitation Act, unless
there is a clear indication of its exclusion by implication.

The Full Bench also held that the word ‘shall’ and the longer
period of limitation (120 days) were not indicators of such exclusion.

In Mukri Gopalan’s case, it was found that there was no
express exclusion anywhere in the Rent Act, taking out the applicability of S. 5
of the Limitation Act. In the present case also there is no express exclusion of
S. 5 of the Limitation Act in S. 35G of the Central Excise Act, and the same
cannot be lightly implied or inferred.

Thus the Full Bench held that S. 5 of the Limitation Act will
be applicable to appeals filed u/s.35G of the Central Excise Act, 1944.

[The Commissioner of Central Excise v. M/s. Shree Rubber
Plast Co. P. Ltd. Notice of Motion No. 1485 of 2008 in CEXAL No. 88 of
2008 Bombay High Court (Full Bench), dated 19-12-2008. Source : itatonline.org]

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Nirav Shah

Liability of Partners of Limited Liability Partnerships — is it Limited ?

Article

1. The Limited Liability Partnership Act, 2008 (‘the LLP
Act’) was brought into force with effect from 31st March 2009 to permit
formation of Limited Liability Partnerships (‘LLPs’) in India. The main focus of
the LLP Act is to permit a partnership structure and at the same time, limit the
liability of partners which was heretofore unlimited under the provisions of the
Indian Partnership Act, 1932 (‘the Partnership Act’). This article discusses
briefly the limitation of liability of partners under the LLP Act as compared to
the limitation of liability of a shareholder of a limited company formed and
registered under the Companies Act, 1956 (‘the Companies Act’) and the manner in
which such liabilities are limited under the LLP Act.

2. A company formed and registered under the Companies Act is
a separate legal entity distinct from its shareholders and directors. The extent
to which the liability of shareholders of a limited company, formed and
registered under the Companies Act, towards the debts of such a company is
limited, is contained in the Memorandum of Association thereof. Accordingly, if
a company is limited by shares, a shareholder is not required to make any
contributions for the satisfaction of the debts of the company of any amount
over and above the amounts remaining due and payable on the shares held by him.
Such amount may be called up by the board of directors of the company in the
course of the day-to-day operations of the company or in the event of winding up
thereof, as the case may be. Where a company is limited by guarantee, a
shareholder is, upon a winding-up thereof, required to contribute the amounts
specified in the Memorandum of Association thereof for satisfaction of the debts
of such a company limited by guarantee. S. 426 of the Companies Act clearly sets
out the aforesaid position.

3. We now examine the provisions of the LLP Act in relation
to limitation of liability of the partners of an LLP. The LLP Act does not
specifically provide the manner in which liabilities of the partner would be
limited. However, the same can be deduced from several provisions of the LLP Act
as set out hereinafter.

4. S. 3 of the LLP Act, inter alia, provides that an
LLP is a body corporate separate from its partners, unlike a partnership firm
constituted under the Partnership Act, which has no separate legal existence. S.
4 of the LLP Act, inter alia, provides that the provisions of the
Partnership Act would not apply to an LLP. Ss.(3) and (4) of S. 27 of the LLP
Act, inter alia, provide that an obligation of the LLP whether arising
out of contract or otherwise is solely the obligation of such LLP and the
liabilities of such LLP are to be met out of the property of the LLP. Ss.(1) of
S. 28 of the LLP Act provides that a partner is not personally liable for any
obligation of an LLP solely by reason of being a partner thereof. Ss.(2) of the
said S. 28, inter alia, provides that such partner would be personally
liable for wrongful acts or omissions committed by him, but not those committed
by any other partner of the LLP. Therefore, in terms of the aforesaid provisions
of the LLP Act, a partner of an LLP is not personally liable for the obligations
of such LLP, except those arising as a result of his own wrongful acts or
omissions.

5. However, unlike the Companies Act, the aforesaid
provisions do not specifically indicate the circumstances and extent to which
any partner would be required to make contributions to the LLP. The provisions
in relation to such contributions are contained in S. 32 and S. 33 of the LLP
Act.

6. Ss.(1) of S. 32 of the LLP Act, inter alia,
provides that a partner may make contributions to the LLP in the form of
tangible or intangible property, money, promissory notes and the like. Ss.(2) of
S. 32 of the LLP Act, inter alia, provides that the monetary value of the
contribution of each partner is required to be accounted for and disclosed in
the manner prescribed. Rule 23 (1) of the Limited Liability Partnership Rules,
2009 (‘the Rules’), inter alia, provides that the contribution of such
partner is required to be accounted for and disclosed in the accounts of the LLP
along with the nature of contribution and amounts.

7. Ss.(1) of S. 33 of the LLP Act, inter alia,
provides that the obligation of a partner to contribute money or other property
or to perform services for an LLP is governed by the provisions of the limited
liability partnership agreement (‘the LLP Agreement’) executed between the
partners. The said provisions are broad enough to enable contractual
restrictions to be placed on the obligation of a partner to make contributions,
whether on incorporation of the LLP or dissolution thereof or at any time during
the continuance thereof. Therefore, generally speaking the LLP Agreement may
provide that a particular partner is required to contribute certain amounts upon
execution of the LLP Agreement or in the usual course of its business or for
that matter perform services in the course of the business of the LLP, but is
not required to contribute any amounts upon the winding-up thereof. The LLP
Agreement may also provide that a partner is bound to contribute certain sum
only upon winding-up thereof and not otherwise. The aforesaid clauses could, in
ordinary circumstances, be regarded as sufficient to restrict the liability of a
partner.

8. However, the LLP Act does not itself provide for the
circumstances in which the obligations of the LLP can be enforced against the
partners thereof and we need to consider as to whether provisions such as the
aforesaid are sufficient to protect the interests of a partner of the LLP
against any personal liabilities. We therefore examine the provisions of the LLP
Act which define the circumstances in which an obligation of a partner under the
LLP Agreement can be enforced.

9. It is obvious that an obligation in the LLP Agreement can be enforced against a partner by other partners being parties thereto. In addition thereto, Ss.(2) of S. 33 of the LLP Act, inter alia, provides that a creditor of the LLP which extends credit to or acts on an obligation described in the LLP Agreement may enforce the original obligation against such partner. The said Ss.(2) of S. 33 does not restrict the aforesaid right of the creditor to a circumstance in which the LLP is ordered to be wound-up, but appears to extend such right to the creditor in all circumstances. Therefore, an obligation of a partner to contribute any sum to the LLP can be enforced by a third party against such partner at any point of time and is not limited to the event of winding-up as in case of a company formed and registered under the Companies Act. Similarly, in case a partner has agreed to contribute any service to the customer or clients of the LLP, such an obligation may be enforced by the customer or client of the LLP against the particular partner of the LLP. Ss.(4) of S. 24 of the LLP Act in fact provides that the liability of a partner of the LLP to such LLP or its other partners or to third parties would not cease merely by virtue of his ceasing to be a partner of the LLP. Also, questions may arise as regards the contribution made by a partner at the time of setting-up of the LLP, which contributions are eventually refunded to the partner on account of profits made by the LLP. In such a case, it is necessary to consider as to whether the partner would be obliged to once again bring in such contributions in future, which have been refunded upon the LLP having made profits. All these aspects would have to be taken into account while drafting the LLP Agreement which may differ on a case-to-case basis.

10. To summarise the issue, the LLP Act is a very complicated piece of legislation. The LLP Agreement may need to take care of a large number of issues for protection of its members. Moreover, unlike companies formed and registered under the Companies Act, the LLP Act and the Rules do not prescribe the manner in which the liability of a partner of an LLP is limited. It is’ advisable and essential therefore that the LLP Agreement is carefully drafted by an experienced person so that the same contains all necessary provisions as per the LLP Act, so as to ensure that the liability of a partner thereof to make contributions to an LLP does not extend be-yond what is envisaged and the LLP remains as such in law and in spirit.

Nirav Shah

Torts : Person losing his right hand due to electrocution — Electricity Board liable to compensate.

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TORTS : Person losing his right hand due to
electrocution — Electricity Board liable to compensate.

Petitioner got electrocuted on account of a live wire which
snapped due to strong wind and fell on roof of petitioner’s house, which had
C1 sheet roofing. It was held that Electricity Board ought not to have carried
electrical wire over a dwelling house. A person undertaking activity involving
generation or transmission of electricity which is inherently dangerous to
human should take extra care and precaution to avoid harm. However, the
Electricity Board authorities have not shown that they have taken all
necessary care to avoid harm. The petitioner being sole bread-earner of his
family and has lost his right hand being amputed, is entitled to be
compensated for his sufferings and loss of earning and earning capacity.
Compensation of Rs.3,00,000 awarded including medical expenses.

[Md. Sahajuddin vs. ASEB & Ors., AIR 2009 (NOC) 1072 (Gau.)].

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Nirav Shah

Translation of document : Filing of translated copy of document in Court is not additional evidence — Only requirement is that counsel should certify that translation is correct : Civil Procedure Code : O.13, R.4, General Rules (Civil) 1986, Rule 37.

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Translation of document : Filing of translated copy of
document in Court is not additional evidence — Only requirement is that
counsel should certify that translation is correct : Civil Procedure Code :
O.13, R.4, General Rules (Civil) 1986, Rule 37.

The plaintiff filed a suit for permanent injunction. In the
suit the plaintiff relied upon a registered sale deed dated 26.7.1926,
executed by one Bhanwaria and based his title in the property upon the said
sale deed. The said registered sale deed was in Urdu script and language.

After filing of the appeal against the dismissal of suit by
the learned trial Court, the plaintiff-appellant submitted an application with
prayer that the plaintiff had during the trial filed a copy of the registered
sale deed which was written in Urdu script and with a view to facilitate the
Court to peruse and go through the contents of the said document, the
appellant is filing a correct translation of the same in Devanagari script
having translated the document from Urdu script to Devanagari script (in
Hindi).

The appellant further submitted that so far as the
application was concerned, it was not one under O. 41, R. 27, C.P.C. of
leading any additional evidence but in fact the appellant was only submitting
the translated version of the document, the registered sale deed of the year
1926 which has already been filed before the learned trial Court and admitted
in evidence of the plaintiff and since the parties were not conversant with
Urdu language or the script, the appellant could not state before the Court as
to what were the contents of the said documents. When the suit was dismissed
by the learned Trial Court the appellant with a view to overcome the aforesaid
difficulty, produced before the Court the translated version which cannot be
said to be by means of an additional evidence strictly in accordance with the
provisions of O. 41, R. 27, C.P.C. It was evident from the document that the
counsel had certified and put an endorsement.

The Hon’ble Court held that the provisions of O. 14, R.27,
C.P.C. were not strictly applicable as it was not a case where any additional
evidence was sought to be produced by the appellant which had not been filed
before the learned trial Court and was being sought to be filed for the first
time in the appeal. By the application, all that the petitioner sought to do
was to file a translated copy of sale deed which is in Urdu language by filing
a translation in Devanagari script in Hindi for being appreciated by the Court
and it is for this purpose that the application was filed by the plaintiff.

The Rule 37 of the General Rules (Civil), 1986 requires (1)
that a correct translation of the document which is not written in Hindi or
English to be accompanied by a translation of the same into Hindi written in
Devanagari script; (2) that the translated document must bear a certificate of
the party’s counsel to the effect that it is a correct translation; and (3)
that if the party filing the same is not represented by a counsel, the Court
shall have the same certified by any person appointed by it at the cost of the
party seeking to produce the document.

The document which had been filed before the Appellate
Court showed that it was signed by the advocate who had endorsed the same to
be the true translated copy from Urdu script into Devanagari script. It was
not the case that the aforesaid document was not a correct translation, but
the application had been rejected by the learned Appellate Court on the ground
that it does not bear endorsement and the name of the person who has
translated the said document.

A look at Rule 37 of the General Rules (Civil), 1986, goes
to show that the requirement is that “the translation shall bear a certificate
of the party’s counsel to the effect that the translation is correct.” The
Rule does not require an endorsement by the counsel that he has translated the
document into Hindi but only requires a certificate ‘the translation is
correct’.

In view of the matter, the learned Appellate Court which
did not advert to the provisions of Rule 37 of the General Rules (Civil),
1986, while passing the order committed an error of jurisdiction.

[Prahlad Singh vs. Suraj Mal & Ors., AIR 2009
Rajasthan 53].

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Nirav Shah

Public document : Certified copy of power of attorney which is registered document on file of Sub-Registrar is a public document : Evidence Act Sec. 74(2).

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Public document : Certified copy of power of attorney which
is registered document on file of Sub-Registrar is a public
document : Evidence Act Sec. 74(2).

The suit had been instituted by the petitioner on the
factual premise that as per the power of attorney executed by the respondent
on 29.01.1993, he was permitted to develop the land belonging to the
respondent, having an extent of 1.50 acres and a certified copy of the said
power of attorney was produced along with the plaint. However, the suit was
contested by the respondent on the ground that only an extent of 50% of
property were given as per the said power of attorney and the petitioner with
the connivance of the officials of the Registration Department fraudulently
changed the extent as 1.50 acres instead of the original extent of 50%.
Subsequently, during the course of trial, the petitioner attempted to mark the
certified copy of the power of attorney as a document on his side. The same
was objected to by the respondent mainly on the ground that loss of original
has not been properly accounted in terms of Section 65 of the Indian Evidence
Act.

The document produced by the petitioner was rejected by the
learned District Munsif on the ground that certified copy of power of attorney
cannot be admitted in evidence. The petitioner had contended before the Trial
Court that the original was lost and the same was also mentioned in the plaint
as well as in the proof affidavit and as such, he was entitled to lead
secondary evidence.

The Hon’ble Court observed that the document produced by
the petitioner as document No.1 is found to be a certified copy of the power
of attorney registered as document No.13/1993 on the file of Sub-Registrar.
Admittedly, the document was a registered document and what was produced by
the petitioner was only a certified copy of the said document. Section 74 of
the Indian Evidence Act, 1872 indicates as to what are all the documents which
could be termed as public documents. As per Sub-Section 2 of Section 74,
public records kept (in any State) of private documents are public documents.
Section 76 mandates that every public officer having the custody of the public
document, which any person has a right to inspect, shall give that person on
demand a copy of it on payment of the legal fees therefor, together with a
certificate written at the foot of such copy that it is a true copy of such
document or part thereof, as the case may be, and such certificate shall be
dated and subscribed by such officer with his name and his official title, and
shall be sealed, whenever such officer is authorised by law to make use of
seal; and such copies so certified shall be called certified copies.

As per Section 77, such certified copies may be produced in
proof of the contents of the public documents or parts of the public documents
of which they purport to be copies. Section 79 of the Indian Evidence Act
gives a statutory presumption with respect to the genuineness of certified
copies.

Therefore, it was evident that the certified copy of the
power of attorney produced by the petitioner is a public document within the
meaning of Section 74(2) of the Indian Evidence Act and the same is admissible
in evidence as provided under Section 76 of the Act.

The alleged alteration in the original deed was a matter
for evidence. It would be open to the respondent to summon the office copy of
the document sought to be marked and to take steps to send the same for expert
opinion. It is also possible for the respondent to take steps to prove her
contention that there were alterations made in the document subsequent to the
registration.

[P. K. Pandian vs. Komala, AIR 2009 Madras 51].

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Nirav Shah

Additional evidence : Permission to bring additional document can be granted in exercise of discretion of Court to achieve ends of justice

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10. Additional evidence : Permission to bring additional
document can be granted in exercise of discretion of Court to achieve ends of
justice.

The plaintiffs had challenged an order passed by the
learned Single Judge, dated 15th January, 2008 allowing the Chamber Summons
which is taken out by the defendants seeking liberty to lead evidence and to
place on record all documents referred to in the affidavit of documents which
was filed by the defendants. Grievance of the plaintiffs is that after they
had led their evidence, the defendants had specifically informed the Court
that they did not wish to lead any evidence. It is the contention of the
plaintiffs that after having taken a stand not to lead evidence, it was not
open for the defendants to subsequently file application seeking permission of
the Court to lead evidence.

The power to permit the party to lead additional evidence
had been given to the Appellate Court under Order XLI Rule 27. It is settled
position in law that the purpose of procedural law is not to frustrate the
rights of the parties, but the law is primarily to achieve the ends of justice
and fully and finally decide the controversy between the parties.

While interpreting the provisions of the Code, care should
be taken that substantial justice is not sacrificed for hypertechnical pleas
based on strict adherence to procedural provision. In this context, reference
be made to the Apex Court in the case of Ghanshyam Dass and Ors vs.
Dominion of India and Ors., reported in (1984) 3 SCC 46. Thus the Appeal
Court is entitled to allow the party to lead additional evidence.

In view of provisions of Order VIII Rule 1 & Order XLI Rule
27, the learned Single Judge has exercised a discretion vested in him and has
permitted the defendants to bring on record any such documents. In the present
case, it has to be noted that affidavit of documents was filed by the
defendants. The documents could not be traced and, subsequently, the
defendants were in a position to procure the said documents and, after an
application for amendment which was filed by the plaintiff was allowed and
permission was granted to the parties to file additional written statement,
the application for production of documents was made and the learned Single
Judge was pleased to allow the said application. Therefore, the order passed
by the learned Single Judge was upheld.

[Smt. Shantibai K. Vardhan & Ors. vs. Ms. Meera G. Patel
& Anr. AIR 2009 (NOC) 904 (Bom).]

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Nirav Shah

Family arrangement : If Family arrange-ment is for relinquishment of any immovable property it requires registra-tion — Registration Act, Sec. 17.

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Family arrangement : If Family arrange-ment is for
relinquishment of any immovable property it requires registra-tion — Registration
Act, Sec. 17.

In a suit for partition an alleged oral family arrangement
was relied in the written statement of the defendants. It was not known as to
when and on which date such oral arrangement took place and in whose presence.
There was no clinching evidence in that regard. The Hon’ble Court observed
that the law was clear on the point that family arrangement could be oral, but
if it was to be recorded it should be by way of memorandum so as to dispel
hazy notion about such oral arrangement and it should not be in evidence of
it. If it is in evidence of relinquishment of any immovable property it would
require registration within the meaning of Section 17 of the Registration Act.

[D. V. Narayana Sah & Ors. vs. A. G. Nagammal & Ors.
AIR 2009 (NOC) 1061 (MAD.)].

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Nirav Shah

Electricity tariff : Advocates running office from commercial place liable to be charged at Commercial basis : Electricity (Supply) Act, 1948 : S. 49.

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Electricity tariff : Advocates running office from
commercial place liable to be charged at Commercial basis : Electricity
(Supply) Act, 1948 : S. 49.

[ J.V.V.N. Ltd. & Ors. v. Smt. Parinitoo Jain & Anr.,
AIR 2009 Rajasthan 119]

The controversy involved is in regard to the electricity
tariff levied by the appellants on the offices of Advocates under category of
non domestic service.

The Single Judge relying on the judgement of Sajjan Raj
Surana v. JVVNL, AIR 2002 Raj 109 held that categorisation and inclusion
of profession of a lawyer as a commercial establishment or non domestic
services for the purpose of payment of electricity consumption at commercial
rate was illegal.

On further appeal it was held that the decision of Sajjan
Raj Surana (supra) had been overruled by Larger Bench and the Advocates
running their office from their residences cannot be charged the additional
tariff on the commercial basis. However, in case advocates are running their
office at independent commercial place, then the advocate cannot be exempted
from the same. A distinction has been made between the office in a residence
and office in a commercial place.

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Nirav Shah

Choice of one reasonable course of treatment to other — Not medical negligence : Consumer Protection : S. 2(1)(g).

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Choice of one reasonable course of treatment to other — Not
medical negligence : Consumer Protection : S. 2(1)(g).

[ Martin F. D’souza v. Mohd. Ishfaq, AIR 2009 SC
2049]

The respondent who was suffering from chronic renal failure
was referred by the Director, Health Services to the Nanavati Hospital, Mumbai
for the purpose of a kidney transplant.

On or about 24-4-1991, the respondent reached Nanavati
Hospital, Bombay and was under the treatment of the appellant Doctor.
Investigations were underway to find a suitable donor. The respondent wanted
to be operated by Dr. Sonawala alone who was out of India.

The respondent approached the appellant Doctor. At the
time, the respondent, who was suffering from high fever, did not want to be
admitted to the Hospital despite the advice of the appellant. Hence, a broad
spectrum antibiotic was prescribed to him. The appellant constantly requested
the complainant to get admitted to hospital but the respondent refused. On
29-5-1991 the respondent who had high fever of 104 F finally agreed to get
admitted to hospital due to his serious condition.

The blood culture report of the respondent was received,
which showed a serious infection of the blood stream. The respondent insisted
on immediate kidney transplant even though the appellant had advised him that
in view of his blood and urine infection no transplant could take place for
six weeks. The respondent was administered Amikacin injection. On 8-6-1991,
the respondent, despite the appellants advice, got himself discharged from
Nanavati Hospital. The respondent received haemodialysis at Nanavati Hospital
and allegedly did not complain of deafness during this period. On 25-6-1991,
the respondent, on his own accord, was admitted to Prince Aly Khan Hospital,
where he was also treated with antibiotics. The complainant allegedly did not
complain of deafness during this period and conversed with doctors normally,
as was evident from their evidence. The respondent returned to Delhi on
14-8-1991. After discharge. The respondent filed a complaint before the
National Consumer Disputes Redressal Commission, New Delhi, claiming
compensation of an amount of Rs.12,00,000 as his hearing had been affected.
The appellant filed his reply stating, inter alia, that there was no material
brought on record by the respondent to show any correlation between the drugs
prescribed and the state of his health.

The case of the respondent, in brief, was that the
ap-pellant was negligent in prescribing Amikacin to the
respondent of 500 mg twice a day for 14 days as such dosage was excessive and
caused hearing impairment. It is also the case of the respondent that the
infection he was suffering from was not of a nature as to warrant
administration of Amikacin to him.

The Commission allowed the complaint of the respondent and
awarded Rs.4 lakhs with interest @ 12% as well as Rs.3 lakhs as compensation
as well as Rs.5000 as costs.

On appeal the Supreme Court observed that law, like
medicine, is an inexact science. One cannot predict with certainty an outcome
of many cases. It depends on the particular facts and circumstances of the
case, and also the personal notions of the Judge concerned who is hearing the
case. However, the broad and general legal principles relating to medical
negligence need to be understood.

A medical practitioner is not liable to be held negligent
simply because things went wrong from mischance or misadventure or through an
error of judgment in choosing one reasonable course of treatment in preference
to another. He would be liable only where his conduct fell below that of the
standards of a reasonably competent practitioner in his field. It is not
enough to show that there is a body of competent professional opinion which
considers that the decision of the accused professional was a wrong decision,
provided there also exists a body of professional opinion, equally competent,
which supports the decision as reasonable in the circumstances.

The standard of care has to be judged in the light of
knowledge available at the time of the incident and not at the date of the
trial. Also, where the charge of negligence is of failure to use some
particular equipment, the charge would fail if the equipment was not generally
available at that point of time.

As regard the impairment of hearing of the respondent is
concerned it was observed that there is no known antibiotic drug which has no
side effect. Hence merely because there was impairment in the hearing of the
respondent that does not mean that the appellant was negligent.

The Court further observed that some times despite best
efforts the treatment of a doctor fails. For instance, sometimes despite the
best effort of a surgeon, the patient dies. That does not mean that doctor or
the surgeon must be held guilty of medical negligence, unless there was some
strong evidence to that effect. The appellant was held not guilty of medical
negligence.

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Nirav Shah

Nomination by Member of Society empowers nominee to hold property in trust for real owner : Maharashtra Co-op. Societies Act, S. 30.

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Nomination by Member of Society empowers nominee to hold
property in trust for real owner : Maharashtra Co-op. Societies Act, S. 30.

[Ramdas Shivram Sattur v. Rameshchandra alias Ramchandra
Popatlal Shah & Ors., AIR 2009 (NOC) 2058 (Bom.)]

One Shri Shivram had purchased a plot of land in his own
name from co-op. hsg. Society. He nominated his wife Smt. Tarabai the original
defendant No. 1 as his nominee pursuant to S. 30 of the Mah. Co-op. Societies
Act, r/w. Rule 25 of the Rules framed thereunder.

They had 4 children namely Ramdas, Krishnadas, Vithaldas
and Sangita. After death of Shivram, Tarabai sold the property to Ramchandran
Popattlal Shah. The respondent No. 1 instituted suit against Tarabai for
specific performance and declaration. The society was also impleaded as party.

In the above litigation inter alia among other issue
one issue that came up for consideration was about the status of a nominee who
has been validly nominated as a member of Co-op. society u/s. 30 of
Maharashtra Co-op. Society Act.

The Court observed that by virtue of nomination of wife by
her deceased husband u/s.30 of the Maharashtra Co-op Societies Act, 1960, she
does not become absolute owner of the property, however, was only empowered to
hold the property in trust for the real owners that too for the purpose of
dealings with the society. Wife as such, had no power, authority and title to
alienate the property to the exclusion of the other legal heirs of her
deceased husband. Wife as such, was not competent to enter into an agreement
for sale of the suit plot as she along with her four children were class I
heirs of her deceased husband.

S. 30 of the Maharashtra Co-op. Societies Act does not
provide for a special rule of succession altering the rule of succession laid
down under the personal law.

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Nirav Shah

Liability of a surety or a guarantor to repay loan of principal debtor arises only when a default is made by the latter : State Financial Corporation Act 1951 : S. 29(1) and S. 31.

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Liability of a surety or a guarantor to repay loan of
principal debtor arises only when a default is made by the latter : State
Financial Corporation Act 1951 : S. 29(1) and S. 31.

[ West Bengal Industrial Development Corpn. Ltd. & Anr
v. Niccon Electronics Devices P. Ltd. & Ors., AIR 2009 Calcutta 193.]

The appellant had given financial assistance of Rs. 55 lacs
to the respondent No. 1 a Pvt. Ltd. Company @ interest 14% p.a. for setting up
of a plant. The respondent 2 to 7 executed a deed of their personal guarantee.

On the failure on part of respondent No. 1 to pay dues a
notice u/s.29(1) read with S. 30 of the State Financial Corporations Act, 1951
was issued, asking the respondent No. 1 to liquidate the dues within a
stipulated period, but as the respondent No. 1 failed to liquidate its dues in
accordance with the said notice, the appellant took over all secured assets of
the respondent No. 1.

The assets were auctioned and after adjusting the sale
proceeds of the fixed assets of respondent No. 1 amounting to Rs.12,00,000 in
the loan account of respondent No. 1, the appellant sent demand notices dated
7th June, 2005, invoking guarantee of respondent Nos. 2 to 7. By the said
notices, the appellant called upon the said respondents to pay the sum.

The Single Judge by an order appointed Jt. Receivers to
sell the properties and assets of respondents 2 to 7. The respondent submitted
that the auction by financial corporation in terms of S. 29 of the Act must be
exercised only on a defaulting party. Only when there was a default on the
part of the principal debtor that the separate provision could be invoked
against a surety or a guarantor for repayment of loan.

The Court observed that S. 29 of the Act nowhere states
that the corporation can proceed against the surety even if some properties
are mortgaged or hypothecated by it. The right of the financial corporation in
terms of S. 29 of the Act must be exercised only on a defaulting party. There
cannot be any default as is envisaged in S. 29 by a surety or a guarantor. The
liabilities of a surety or the guarantor to repay the loan of the principal
debtor arise only when a default is made by the latter.

The demand was, therefore, specifically made and default
had admittedly not occurred on the part of the ‘industrial concern’, as on
date of the said notice, so as to enable the appellant to invoke the provision
of S. 31 of the Act for enforcing the liability of any surety.

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Nirav Shah

Accounting for financial instruments and derivatives — Part I

Article

Background :

Accounting Standards (AS) 30 and 31 have been issued by our
Institute and will come into effect from April 1, 2011 with early adoption being
recommendatory. AS-30 deals with recognition and measurement of financial
instruments (including derivatives). AS-31 deals with presentation aspects and,
in particular, with distinction between liabilities and equity. This distinction
can be complex where corporates issue instruments like convertible debentures
and foreign currency convertible bonds, which carry features of both debt and
equity. AS-32 deals with disclosures. Small and medium entities are exempted
from these Standards.

Chartered Accountants are likely to find these Standards
challenging in view of the sheer size (336 pages in all) and complexity of the
content as well as, in many cases, lack of exposure to the domain of derivatives
and complex instruments. The Barclays Bank Annual Report of 2007 is a 150+ page
document, more than one thirds of which is devoted to disclosures required under
the equivalent of AS-32 in the IFRS framework.

These three Articles propose to de-mystify the accounting of
key aspects of these important Standards.

Overview of AS-30 :

Financial engineering and innovation are increasingly making
inroads into the lives of common people. The annual GDP of the world is
estimated by experts to be in the region of $ 50 bio, while derivative open
positions are estimated to be more than $ 500 bio. Thus, the derivative world is
much larger than the ‘real’ world of real goods and real services.

Our own equity derivatives market daily turnover in Jan. 2008
was Rs.1 lakh crores per day as against an equity market turnover of Rs.25,000
crores (at that time). In a short span of less than 8 years, the derivative
market has grown to four times the underlying equity market. While on the one
hand, this proliferation of derivatives has created huge crises in the world,
including the subprime crisis, on the other hand, it has created huge challenges
for the accounting community which in many situations does not comprehend the
implications of such instruments on risk, on potential earnings, on actual
reported earnings and on recognition of assets or liabilities as a result of
such exposures.

AS-30 provides guidance on classification, initial
measurement, subsequent measurement and de-recognition of financial assets,
financial liabilities, derivatives and hedge accounting. Impairment of financial
assets, securitisation and guidance on fair valuation are also covered in AS-30.
Hedge accounting is a complex and vast area of literature covering fair value
hedges, cash flow hedges and hedges of net investment in foreign operations.

Financial instruments and key definitions :

A financial instrument is a contract that gives rise to a
financial asset for one entity and a financial liability or equity for the
other. A financial asset is :

cash

equity instrument of another entity

a contractual right to receive cash or other financial asset from another
entity

a contractual right to exchange financial assets or financial liabilities with
another entity under conditions that are potentially favourable to the entity

certain contracts that will or may be settled in the entity’s own equity
instruments.

A financial liability is :

a contractual obligation to deliver cash or other financial asset to another
entity

a contractual obligation to exchange financial assets or liabilities with
another entity on conditions that are potentially unfavourable to the entity

certain contracts that will or may be settled in the entity’s own equity
instruments.

Common examples of financial assets and liabilities :

Common examples of financial assets and liabilities are cash
and bank balances, accounts receivable and payable, bills receivable and
payable, loans receivable and payable, bonds receivable and payable, deposits
and advances. Contingent rights and obligations like in the case of financial
guarantees are financial assets or liabilities, notwithstanding the fact that
they may not be recognised on the balance sheet.

Finance lease receivables and payables are financial assets
or liabilities as these are blended amounts comprising principal and interest on
the lease. An operating lease contract does not represent financial assets or
liabilities as the contracted amount is indicative of future services to be
provided by the lessor. The amount already due to be received or paid under an
operating lease is a financial asset or liability.

Prepaid expenses, deferred revenues and warranty obligations
are not financial assets or liabilities as they represent the right to receive
goods or services and not cash. Income taxes and deferred taxes are not
financial assets or liabilities as they are not contractual obligations but
statutory obligations.

Initial measurement:

All financial assets and liabilities are required to be recognised at fair value at initial recognition. For financial assets and liabilities which are classified as at fair value through P&L, transaction costs are charged to P&L at the point of initial recognition itself. For other financial assets and liabilities, the carrying value at initial recognition includes transaction costs (which are added to or deducted from fair value as the case may be).

Example – if an entity buys equity shares of L&T for Rs. 1,500 and incurs brokerage and other transaction costs of Rs. 2, the carrying value of these shares will be Rs. 1,500 if these are classified as ‘fair value through P&L’ and Rs. 1,502 if these are classified as ‘available for sale’ securities.

Short-term receivables and payables with no stated interest rate are measured at invoice amount if the effect of discounting is immaterial.

Classification of financial assets and liabilities:

Financial assets are classified into four possible categories and financial liabilities into two possible categories as summarised in the following table. The framework for subsequent measurement (which could be at fair value, cost or amortised cost), recognition of mark-to-market gains and losses and impairment testing principles are also provided.

The table below is subject to the principles of hedge accounting which are discussed later in these Articles. When principles of hedge accounting are applied, the above recognition framework will be overridden by those principles.

Let’s now discuss each class of assets and liabilities in detail.

Financial assets at fair value through P&L:

Financial assets which are classified in this basket are carried at fair value in the balance sheet, with mark-to-market gains or losses being carried into the P&L. Fair valuation of such assets will result in earnings becoming volatile to the extent that such assets fluctuate in value from quarter to quarter. Financial assets held for trading belong here and so do derivatives which are not designated as hedging instruments. The Standard also permits management to designate qualifying financial assets into this basket in the following situations:

Such a designation may eliminate or significantly reduce a recognition or measurement inconsistency (accounting mismatch) that may arise by measuring assets and liabilities or recognition of gains or losses on different bases, or

A group of financial assets, liabilities or both is managed on a fair value basis and its performance evaluated on this basis.

Example – Finance company ABC issues a Nifty-linked debenture for Rs.500 crores. Debenture holders will be paid a return of upside on the Nifty over the next three years x 120%. If the Nifty falls over this period, holders will be paid back their capital. The company uses the amount collected to invest partly into its regular truck financing business and partly into Nifty-related instruments including derivatives. If Nifty moves up, it will be obliged to recognise its liabilities accordingly – in effect a fair valuation of liabilities based on Nifty will be necessitated. If its assets are recognised on cost, then an accounting mismatch will arise. It will be appropriate for the management to designate financial assets emanating out of the proceeds of these Nifty-linked debentures as ‘Fair Value thro P&L’.

Loans and receivables:

Loans and receivables are non-derivative financial assets that are not quoted in an active market. These should not be held for trading, nor should be designated at fair value through P&L or as available for sale by the entity.

Initial measurement of loans and receivables is at fair value plus transaction costs. Subsequent measurement is at amortised cost, except for short-term receivables which is at invoice amount if the effect of discounting is immaterial, if there is no stated interest rate in the invoice.

The concept of ‘amortised cost’ involves mathematical computations to which accountants are not accustomed in current practice and hence needs to be discussed in detail.

Example for amortised cost:

Your entity has provided a loan of Rs.25 lakhs at 12% interest (payable annually in arrears) and has collected a processing fee of Rs.1 lakh (4%) for this loan. The loan is repayable after 5 years (one bullet payment).

Regular interest income on the loan will be Rs.3 lakhs per annum (Rs.25 lakhs x 12%). The processing fee income of Rs.1 lakh is required to be amortised over the five-year tenor of the loan in a manner that the effective interest rate over this five-year period is constant.

If the cash flows of the loan are tabulated and an IRR function applied to these cash flows, the effective interest rate works out to 13.1412%. Thus the carrying value of the loan will be Rs.24 lakhs on day zero (Rs.25 lakhs disbursed minus Rs.1 lakh collected as fees). On this amount, income for year one will be computed as Rs.3.1539 lakhs. At the end of year one, the carrying value of the loan (at amortised cost) will increase to Rs.24.1539 lakhs (Rs.24 lakhs opening plus yield accrual of Rs.3.1539 minus collection of Rs.3 lakhs). This process will continue over the five-year tenor of the loan with carrying value becoming zero on repayment of principal at the end of the term.

Readers can imagine the complexity that financial institutions disbursing thousands of loans every year will face. In practice, loans are not repaid in bullet at the end of the tenor and could be repaid on a monthly basis, transactions happen every day and not neatly at the beginning of the financial year as in the above example (where IRR would not be adequate and XIRR would be called for), interest rates are not fixed but floating, processing fees vary, there are originat on costs apart from fees (which require similar amortisation treatment), contractual tenor is not the same as actual tenor in view of prepayments and sometimes rescheduling due to late payments and hence actual tenor is not known up front.

Nirav Shah

Worldwide Tax Trends Treatment of Tax Losses

No country stands immune to the global recession, even as the degree of its impact may vary. Companies world over are reeling under the brunt of declining revenues resulting in a consequential drop in bottomlines and even resulting in operating losses in some cases.

Though companies cannot often control the revenue or the top line in the current economic scenario, however, they may want to optimise the cash through cost control measures and efficient utilisation of incentives, such as tax losses.

In fact, some of the advanced tax jurisdictions provide for carry back of losses so as to utilise the available tax losses and thereby resulting in release of cash which is blocked in the form of taxes.

In the current times where several MNCs are facing the issue of operating losses (the term ‘operating losses’ for the purpose of this article denotes business losses) in various jurisdictions, it becomes imperative for them to evaluate the provisions on utilisation of tax losses in these jurisdictions so as to optimise the overall tax cost. Considering the above, this article contains a broad overview of provisions prevalent in certain key jurisdictions on utilisation of tax losses. However, it should be noted that there could be certain conditions prescribed under the respective tax laws which may need to be followed before offsetting the tax losses.

Before diving straight into the provisions prevalent in certain key jurisdictions on utilisation of tax losses, let us take a brief look at the relevant provisions prevalent in India.

India :

Indian tax laws provide for a distinction between operating losses and capital losses. In the year of losses, operating losses can be set off against capital income. However, capital losses can not be set off against the operating income.

Unutilised operating losses can be carried forward for a period of eight years to be set off against any future business income. Continuity of same business is not essential to set off carry forward operating losses.

Unutilised capital losses can be carried forward for a period of eight years to be set off against future capital gains. Indian tax laws classify capital gains as long-term capital gains or short-term capital gains depending on the period of holding of the capital asset. Accumulated long-term capital losses can be set off only against long-term capital gains and not against short-term capital gains. However, carry forward short-term capital losses can be set off against any capital gains i.e., long-term or short-term capital gains.

There are no provisions for carry back of tax losses to set off against the profit of earlier years.

Impact on carry over/utilisation of losses on change in ownership

Generally, Indian tax laws do not provide for any condition for continuity of ownership for utilisation of accumulated tax losses except in case of companies in which public are not substantially interested (i.e., Private Limited Companies).

In case of companies in which public are not substantially interested, there is a condition of continuity of a specified percentage of ownership in the year in which the losses are incurred and the year in which such losses are set off. There has to be a continuity of ownership of at least 51% in the year in which the losses are incurred and the year in which such losses are set off in order to set off accumulated tax losses.

Indian tax laws provide for carry over of tax losses to the resulting company in the event of business reorganisation viz. merger and demerger. In case of a merger which meets with the conditions specified under the Income-tax Act, the carry forward operating loss of the merged entity is rolled over to the surviving entity/resulting entity. However, there are certain specified conditions especially with respect to continuity of the merged business which need to be met, so as to avail the carry over benefit.

In case of demerger/hive-off, which meets the conditions specified in the Income-tax Act, the carry forward operating losses of the undertaking being hived off are transferred to the resulting company which can be set off against the profit of the resulting company. In the event, the carry forward operating losses do not pertain entirely to the undertaking being hived off, the carry forward operating losses of the demerged entity are allocated between demerged entity and the resulting entity on the basis of assets retained in the demerged entity and the assets transferred to resulting entity.

The provisions on continuity of ownership discussed hereinabove do not restrict the carry over of operating losses in case of the aforesaid reorganisation.

Transfer of losses to other group entities

Indian tax laws do not contain provisions for surrender/transfer of losses to other group entities for set off against their profit. In effect, Indian tax laws do not contain any provisions for group consolidation. Each of the group entities needs to file its tax return separately.

After evaluating the provisions under the Indian tax laws, let us now look at the provisions on utilisation of tax losses prevalent under certain key jurisdictions.

United States (US) :

Generally, US tax laws provide for a distinction between operating losses and capital losses. In general, capital losses can be set off only against capital gains and not ordinary income. Capital losses can be carried back for three years and carried forward for five years to be set off against capital gains in such years.

Operating losses can be carried back two years and forward twenty years to offset taxable income in those years. Operating losses can be set off against business income as well as capital gains.

Impact on carry over/utilisation of losses on change in ownership

There is a limitation on the amount of operating losses that can be utilised to offset against taxable income on ownership change. This limitation is provided in Section 382 of the Internal Revenue Code (IRC). Generally, an ownership change occurs when more than 50% of the beneficial stock ownership of a corporation in loss had changed hands over a prescribed period (generally three years). The three-year period can be shortened to the extent that the losses were incurred within the three year period or there was an ownership change within the three year period. Thus, Section 382 Limitation effectively prevents shifting of unfettered loss deduction from one group of corporate owners to a new group.

Generally, the limitation amount equals the value of the stock of the corporation immediately before the ownership change, multiplied by the long-term tax exempt rate. The long-term exempt rate changes monthly and is published by the Internal Revenue Service in the Internal Revenue Bulletin. Losses that cannot be deducted in a particular tax year due to aforesaid limitation can be carried forward.

In case of business reorganisation i.e., merger, generally, all the tax attributes of the merged corporation, induding net operating losses, transfer to the surviving corporation in a tax-free merger. The surviving corporation in a statutory merger can carry forward the net operating losses of the absorbed companies to reduce its taxable income in twenty subsequent tax years from the tax year in which the loss was incurred. Net operating losses can be carried back two years. Generally in case of merger, the net operating losses are not ‘ring fenced’. Such losses can be utilised against the income from business of the merged entity and the merging entity. However, such losses can not be offset against the income from business of the existing subsidiary of the resulting entity in case of consolidation. The limitation rules as discussed hereinabove would equally apply if there is a change in the ownership beyond a specified percentage pursuant to merger.

Transfer of losses to other group entities

US tax laws provide for group consolidation on fulfilment of certain stock ownership criteria. An affiliated group of US corporations may elect to determine its taxable income and tax liability on a consolidated basis.

Losses incurred by members of a group during the period of consolidation can be used to offset profits of other members of the group. However, losses incurred by a corporation prior to joining the group, referred to as separate return limitation year losses (SRLY losses), may not be used to offset profits of other group members or be carried back by such members to pre-consolidation taxable years. The SRLY loss rules also apply to built-in losses, i.e., losses realised during the first five years of consolidation to the extent attributable to assets with a value below adjusted tax basis at the time the member joined the group.

United Kingdom (UK) :

UK tax laws provide for a distinction between operating loss/trading loss and a capital loss. Generally, capital loss can be offset against capital gains of the same accounting period or can be carried forward indefinitely. However, capital loss cannot be carried back. Capital loss cannot be used to reduce the trading profits.

A trading loss incurred by a company in any accounting period may be set off against the total taxable profits (including capital gains) of the period and against the total taxable profits of an immediately preceding period, provided the same trade was then carried on. Losses can also be carried forward indefinitely for relief against future income from the same trade. Thus, losses can be set off only against the future profit from the same trade. Considering the above, a company with several trades or businesses may be required to keep separate accounts for each trade or business.

A company that ceases trading can carry back trading losses and offset them against profit of previous thirty-six months.

Impact on carry over/utilisation of losses on change in ownership

There is an important restriction on the carry-over of trading losses on a merger or acquisition if within any period of three years there is both a change in the ownership of a company and a major change in the nature or conduct of the trade carried on by the company to which the losses relate.

In case of change of ownership of the company and a major change in the nature or conduct of the relevant trade within a three-year period, trading losses otherwise available for carry forward are forfeited with effect from the date of the change of ownership.

Similar restrictions on the carryover of losses also apply if, at any time after the scale of activities in the trade carried on by the company has become small or negligible and before any considerable revival of the trade, there is a change in the ownership of the company.

The crucial issues that need to be considered in determining whether the above restrictions on the carry-over of trading losses apply on a merger or acquisition are: firstly whether there is a change of ownership and secondly whether or not there is a major change in the nature or conduct of the trade. There are specified provisions which define change of ownership for aforesaid purpose. The change of ownership is disregarded when the ownership is merely transferred between members of a 75% group.

The circumstances where there will be a major change in the nature or conduct of the trade for the purposes of these provisions are not exhaustively defined in the legislation. However, there are some indicative factors which can be used as reference to determine whether there is a major change in the nature or conduct of trade.

Transfer of losses to other group entities

UK tax laws do not provide for tax consolidation. However, a trading loss incurred by one company within a 75% owned group of companies may be grouped with profits for the same period realised by another member of the group.

Germany:

German corporate tax laws do not provide for distinction between operating losses and capital losses. Capital losses are generally deductible.

However, capital losses resulting from transactions which are exempt from tax are not deductible. In particular, this rule applies to capital loss from sale of shares or from write-down on shares. This, effectively, means that the capital loss on sale of shares is not tax deductible.

Net operating losses of up to EUR 511,500 may be optionally carried back for one year prior to the year in which the losses have been incurred for corporate tax purposes. Remaining tax losses can be carried forward indefinitely. However, the amount of loss carried forward is restricted to EUR 1 million of net income in a given year. Any remaining loss can only be set off against up to 60% of the net income exceeding this limit. This essentially means that 40% of the net income exceeding Euro 1 million is subject to tax even if there are available tax losses (so-called minimum taxation). There is no condition of continuity of same business to set off accumulated tax losses.

Impact on carry over/utilisation of losses on change in ownership

The 2008 Business Tax Reforms introduced new rules regarding the treatment of tax losses on changes of ownership in the loss company. These rules are effective from 1 January 2008. Under the new rules, tax losses expire proportionally if, within a 5-year period, more than 25% of the shares of a loss entity are directly or indirectly transferred to one acquirer or an entity related to such acquirer. If more than 50% of shares are transferred within a 5-year period, the entire tax losses will be lost. The new rules include a measure under which investors with common interests acting together are deemed to be one acquirer for the purpose of these rules.

The German Bundesrat Committee has proposed some changes to the loss carry forward limitation rules. The proposed rule includes an insolvency restructuring exception. Under the restructuring exception, a change in ownership would not result in forfeiture of a loss carry forward if :

i) the transfer of shares in a loss corporation is part of a plan to make the loss corporation solvent, and

ii) the plan preserves the ‘structural integrity’ of the loss corporation’s business. A preservation of structural integrity is deemed to exist if :

o there is an agreement with the German Workers’ Council of the loss corporation
concerning the preservation of jobs and that agreement has been honoured; or

o the company continued to pay a certain amount of gross salaries over a period of five years following the change in own:rship; or

o the shareholders made significant contributions to the equity of the loss corporation.

The insolvency restructuring exception would not apply if the loss corporation’s business was already shut down at the time of the share transfer, or if during a period of five years following the share transfer the loss corporation discontinues its historic business and engages in a different business sector.

Under the proposal, the insolvency restructuring exception would become effective for the year 2008
and would apply (also retroactively) to all ownership changes that occurred between December 31, 2007, and December 31, 2010.

In the event of business reorganisation e.g., merger, carry forward tax losses of the transferring entity are forfeited and cannot be further used by the receiving entity.

In the event of a spin-off wherein a part of the business is hived off into a separate company, carry forward tax losses relating to the business which is transferred is generally forfeited. However, carry forward tax losses relating to the existing business which has not moved will remain intact and can be utilised subject to German change of ownership rules discussed hereinabove.

Transfer of losses to other group entities

German tax laws provide for the filing of a consolidated tax return for a German group of companies which allow losses of group companies to be offset against profits of other group companies. The German parent company must file

the consolidated tax return. Only German companies in which the German parent company holds the majority of the voting shares at the beginning of the fiscal year of the subsidiary can be included in the group consolidation. In order to achieve group taxation, a profit and loss pooling agreement must be concluded. The profit and loss pooling agreement requires that the controlled company transfers all its profits to the controlled parent and that the controlling parent actually covers the losses of the controlled company.

Losses of controlled company incurred prior to group taxation cannot be used for corporate income tax purposes as long as group taxation applies. Such losses can be offset against the future profits of the controlled company after group taxation has ended.

Australia:

Australian tax laws provide for distinction between capital loss and business loss. Capital losses are calculated using the reduced cost base of assets without indexation for inflation. Capital losses are deductible only against taxable capital gains and not against ordinary income. Capital losses can be carried forward indefinitely to be offset against taxable capital gains in future. Capital losses cannot be carried back.

Operating loss is excess of allowable deductions over assessable and exempt income for a particular year. Operating loss can be carried forward indefinitely to be offset against taxable income derived during succeeding years. Operating loss can be offset against both operating income as well as capital gains. Operating losses cannot be carried back.

Impact on carry over/utilisation of losses on change in ownership

Companies must satisfy greater than 50% continuity of ownership tests for voting power, rights to returns of capital and dividend rights (COT) in order to deduct its prior year losses. Where continuity is failed losses can be deducted if the same business is carried on in the income year (the same business test). Thus, if there is a change in ownership, prior year losses can be offset provided the same business is being carried on in the year in which the prior year losses are set off. The aforesaid tests are applied with modification in the event losses are utilised on group consolidation.

Transfer of losses to other group entities

A wholly-owned group of Australian companies can choose to consolidate for income tax purposes. Where a consolidated group is formed, the group is treated as a single entity during the period of consolidation. The subsidiary entities lose their individual tax identities and are treated as part of the head company for the purposes of determining income tax liability.

Under the tax-consolidation regime, the carry forward losses of companies forming part of a consolidated group may be used by the consolidated group, subject to the limitation-of-loss rules, which limit the amount of losses that can be used, based on -a proportion of the market value of the loss-making company to the consolidated group as a whole.

Generally, losses can be transferred to the group only if the losses could have been used outside the group by the entity seeking to transfer them. Once a subsidiary member of a group transfers a loss, it is no longer available for use by the subsidiary, even if the subsidiary subsequently leaves the group.

China:

Generally, Chinese tax laws do not provide for any distinction between operating losses and capital losses. Under the Enterprise Income Tax Regulation (EITR), losses are allowed to be carried forward for a maximum of five years without any restriction. However, losses may not be carried back.

Impact on carry over/utilisation of losses on change in ownership

Generally, there is no restriction on utilisation of accumulated tax losses in the event of change in ownership. The company can set off the accumulated tax losses even if there is a change in the shareholding of the company.

In the event of merger, the amount of losses of the pre-merger entity can be rolled over to the surviving entity provided the merger qualifies under Special Restructuring (SR) defined under the corporate tax laws. The quantum of loss that can be rolled over is confined to ‘x’ times the fair value of pre-merger entity, where ‘x’ is the interest rate of the longest-term national debt issued in that year.

Transfer of losses to other group entities

There is no group consolidation provision in China. Accordingly, losses of one group entity in China cannot be set off against the profit of another group entity.

Conclusion

While most of the advanced economies provide for carry back of losses and transfer of losses within the group entities through the group consolidation mechanism, these provisions are not yet incorporated under the Indian tax laws. India today is no longer an isolated economy. It is aligned and integrated with the world economy. Further, in the current economic downturn wherein companies globally are facing heavy pressure on margins resulting in operating losses in some cases, it is just that companies are given the benefit of utilising losses against their prior year profits and also against the profit of other group entities. Further, in the current scenario where Indian companies are facing liquidity crunch, it is essential that aforesaid provisions are implemented in the Indian tax code so that companies can optimise on cash through effective utilisation of tax losses. Considering this, time is now ripe that India adopts the well-accepted international tax concept of provision of carry back of loss and group consolidation in its tax code.

For comparative purpose, the key provisions on utilisation of tax losses in key jurisdictions are tabulated below:

Nirav Shah

Windows 7

Computer Interface

This write-up is about Windows 7 operating system and the
objective is to highlight the pros and cons about the new operating system.
Generally users in their zeal to keep up with the latest technological
developments, rarely look ahead before leaping towards the unknown and
thereafter blaming others for their folly. This article has been written keeping
such average user in mind and for the record I consider myself to be an average
user too.

Once upon a time there was an operating system called Windows
95 which dominated most of the tech-world/desktop PCs. Windows 95’s dominance
continued when its new avatar i.e., Windows 98 took over. And then there
were others (Windows CE, Windows ME & Windows NT—CE ME NT?????), but none like
Windows XP. Windows XP was a wonderful desktop operating system and it ruled
over desktops for a very long time. Even today after it has (officially) passed
on the reins to Vista, Windows XP continues to overshadow its predecessors as
well as its successor. This is true because many buyers still ask for XP instead
of Vista. As a matter of fact many even sought to uninstall the preloaded
version of Vista in favour of XP. However, with newer applications and
technology being developed every day one needs to move on. With XP being more
popular than Vista and people preferring to downgrade from Vista to XP, what did
Microsoft do ? ? Did it infuse better code in Vista ? Was XP resurrected from
the dead?? . . . . on the contrary it announced the launch of Windows 7.

Microsoft has announced that the launch will be in the last
week of October 2009. In fact, Microsoft has already begun dishing out trial
versions to users in order to get a feedback and plug any bugs. The reactions of
the users however, have been guarded.

While other operating systems came and went, sometimes in the
blink of an eye, yet there were others like Windows XP which stayed firm. But
the question that begs to be answered is WHY ? ? ? An industry expert points out
that what many neglected to figure out was that Vista needed a different machine
and hardware to function properly at its optimum, not an XP designed machine.
It’s like when Bill Gates announced the launch of Windows 98, he said it was
faster than Windows 95 and better to use. What he failed to mention was that it
needed a different machine to work on and not the old machine itself. Oops, a
minor detail ! ! !.

Another fact about Windows Vista is that it gave
dedicated Windows users a tough time. For instance Vista takes up hogged
gigabytes of space, users had to interact with the machine saying ‘yes’ (as
someone put it) a million times before it starts to even contemplate copying a
small file from one place to another.

So what did Microsoft learn from all this (and after a couple
of million dollars down the drain) . . . looks like very little because (once
again) . . . they have forgotten to mention that e-mail, address book, calendar,
photo management, movie editing and instant messaging won’t be available with
Windows 7. These have to be downloaded from Microsoft’s website. What’s more, in
some cases, additional requirements are needed. For instance, the Windows XP
Mode requires an additional 1 GB of RAM, an additional 15 GB of available hard
disk space, and a processor capable of hardware virtualisation with Intel VT or
AMD-V enabled. OOPPSS ! !

There are news reports stating that while designing Windows
7, users were asked, if it were up to them, how would they make XP better ? What
would they want from a new OS ? The feedback was anything that combines
simplicity, sleek design, ease of operation and interactivity sits pretty much
at the top of a ‘to own’ list. The result ? Windows 7. In fact, the marketing
hype from Microsoft says, “To create the next generation OS, which would make
everyday tasks faster and easier and make new things possible, Windows 7
simplifies things with a more streamlined design and one-click access to
applications and files. It has a faster boot-up and shut-down time and comes
bundled with improvements in terms of reliability, battery life and fewer
alerts.” What’s more, Windows 7 promises not only to be faster but in fact
intuitive. Features like multi-touch, JumpLists and HomeGroup have been built in
to enable consumers to interact with their PCs in faster and more intuitive
ways. Enhancements to the Windows taskbar, JumpLists and search are designed to
make navigation much easier. Also, InPrivate browsing in IE 8 prevents browsing
history, temporary Internet files, form data, cookies and usernames and
passwords from being retained by the browser. Controlling the computer by
touching a touch-enabled screen or monitor is another core Windows 7 user
experience.

But the fact is that these features were always available in
MAC OS. For those who’ve used Apple’s systems, it’s easy to see what has been
borrowed. The taskbar looks and works like the Mac OS X’s Doc :
big square icons of your favourite programs. Other Apple borrowings include the
sticky notes programe, multi-touch gestures like rotating an image by twisting
your fingers and pinch to zoom. Aero Shake allows you to get all but one window
out of the way. One needs to grab the top of that window, shake it and all the
other open windows minimise to the taskbar. Shake the window again, and they all
pop back on screen.

Didn’t we see something similar in Vista as well —it was felt
nice initially, but then eventually I used to turn it off because the feature
would either slow down the PC or would result in disrupting other programs.
Whats the point of an enhancement which cannot balance user experience with
costs and performance degradation issues.

Another feature in Windows 7 is Snap. With Snap, one can
simply grab a window and pull it to either side edge of the screen to fill half
of the screen. If one wants to quickly see gadgets or grab a file from the
desktop, all one needs to do is move the mouse to the lower right corner of the
desktop. Peek makes all the windows transparent and one can view the desktop.
Windows Flip is a feature similar to Mac OS X’s Expose. The rate at which
they are borrowing the feature may be… one may want to wait for the Snow
Leopard (new OS announced by Apple) before switching to Windows 7.

There is also the issue of cost of the software. The cost remains unclear, though initial reports had indicated that the estimated prices for the full Windows 7 package in the US for the premium, professional and ultimate versions would be $ 199.99, $ 299.99 and $ 399.99, respectively. The hype however says that “Firstly, the price for the retail versions of Windows 7 Home Premium and Windows 7 Professional will reduce in the range of 15-25%. Secondly, India pricing for these two versions is lower by 25-40% in comparison with developed markets like the US. Pricing for other retail versions of Windows 7 remains the same as Windows Vista.” Of course this does not include the additional requirements in terms of RAM/CPU, etc. It’s still a wait and watch for me.

After all the cribbing readers may wonder whether its worth the upgrade … maybe … maybe not. Wait for the next write-up before you leap.

Cheers! ! .

This article is merely an attempt to give the readers a bird’s-eye view of the reactions. This article is not intended to be either an endorsement or critique of any particular software or feature.

Nirav Shah

Global Indian CAs

[Beware ! Corruption is injurious to the economic health of our nation]

No bribes for audits :

Additional Commissioner and Registrar Manohar Bhagaji Tribhuvan (54) of the State Co-operation Department was on Monday evening caught red-handed by ACB officials, Pune unit, while accepting a bribe of Rs.1.5 lakh from a chartered accountant near the Pune railway station. Tribhuvan, in charge of inspection and election in the department, will be produced before a special Court on Tuesday afternoon. Tribhuvan’s arrest has sent ripples across the Co-operative Department as he is ranked second in the Department after the Co-operative Commissioner.

ACB Superintendent of Police Vishwas Pandhare said the complainant, Jaywant Baburao Chavan (65) of Satara, was a member of the panel of auditors at the state and divisional level, which audits cooperative societies and banks.

According to Pandhare, Tribhuvan was responsible for allotting auditing work to chartered accountants on the panel. He had allotted the work of auditing the Jankalyan Co-operative Credit Society in Karad to Chavan on May 14, 2009.

Pandhare said Chavan’s fee depended on the turnover of the co-operative society, which in this case came to Rs.9 lakh.

“Tribhuvan would allegedly collect 30% of the auditor’s fee as commission for giving work to chartered accountants. Tribhuvan allegedly demanded Rs.2.7 lakh from Chavan, which he was supposed to receive after submitting the audit report,” Pandhare said.

“On Monday, Tribhuvan called Chavan and asked him to bring the money to his office in Central Building. But Chavan filed a case against him with the ACB. Chavan then visited Tribhuvan’s office around 6 p.m., but Tribhuvan asked him to wait downstairs for him. After some time Tribhuvan came downstairs, sat in Chavan’s car and asked him to stop the vehicle near Hotel Woodland. After collecting the bribe, he got out of the car and was caught redhanded by the ACB officials who had followed Chavan’s car,” Pandhare said.

(Source : www.taxguru.in dated 9-6-2009)

Nirav Shah

Technology news this week

In spite of the current downtrend, the investment and development in newer technology continues unabated. This month, I have pieced together some of the latest developments in the Information Technology industry to gain some insight about the recent developments.

Pirate Bay verdict and file-sharing

The internet has always been a symbol for knowledge sharing. Among other things, countless users have been sharing much more than just knowledge i.e., personal information, music, movies, etc. Sharing music and movies first began hurting the entertainment industry at large, that’s when law enforcement agencies started cracking down on such sites. Pirate Bay was one such file-sharing sites and is the latest casualty of the cause. The verdict against the founders of The Pirate Bay is being hailed by many as a triumphant win against illegal file-sharing. The four men involved in the BitTorrent tracking site were found guilty of being accessories to violating copyright law. A Swedish Court sentenced each of them to a year in jail and a collective fine of $3.6 million. In the long run, though, the verdict may not be as significant as some suggest, when it comes to the battle against online file-sharing. Other players have opined this because, just like Napster, The Pirate Bay doesn’t actually host copyrighted files — it simply allows users to post links to material hosted on third-party servers. That’s why, incidentally, prosecutors ended up dropping the initial charge of ‘assisting copyright infringement’ and pursuing only a ‘assisting making available copyrighted material’ charge instead.” The Court said even if you are distributed, you are nevertheless encouraging your customers to violate copyright, and we’ll hold you accountable.

Stealthy Rootkit

Countless websites have been rigged to deliver a powerful piece of malicious software that many security products may be unprepared to handle. The malicious software is a new variant of Mebroot, a program known as a ‘rootkit’ for the stealthy way it hides deep in the Windows operating system. An earlier version of Mebroot first appeared around December 2007 and used a well-known technique to stay hidden.

Since Mebroot appeared, security vendors have refined their software to detect it. But the latest version uses much more sophisticated techniques to stay hidden. The new variant inserts program hooks into various functions of the kernel, or the operating system’s core code. Once it has taken hold, the malware then makes it appear that the Master Boot Record (MBR) hasn’t been tampered with. The rootkit infects the computer’s MBR, as a result it’s the first code a computer looks for when booting the operating system after the BIOS runs. If the MBR is under a hacker’s control, so is the entire computer and any data that’s on it or transmitted via the Internet. Then, each time the computer is booted, Mebroot injects itself into a Windows process in memory, such as svc.host. Since it’s in memory, it means that nothing is written to the hard disk, another evasive technique. Mebroot can then steal any information it likes and send it to a remote server via HTTP.

The infection mechanism is known as a drive-by download. It occurs when a person visits a legitimate website that’s been hacked. Once on the site, an invisible iframe is loaded with an exploit framework that begins testing to see if the browser has a vulnerability. If so, Mebroot is delivered, and a user notices nothing.

Nokia’s new E75 phone

Nokia has unveiled a new addition to its E-series range, the Nokia E75 with Nokia Messaging Service which provides e-mail solutions on Nokia devices with the pre-installed Nokia Messaging push e-mail service. According to a press release the E75 is the first device from Nokia that offers complete integration of e-mail and messaging services and provides an easy process for instant e-mail set-up and supports up to 16 e-mail accounts. Among other things, the Nokia E75 boasts of full desktop e-mail functionality along with both standard keypad and QWERTY keypad. It is also touted to be capable of supporting all features of Nokia Messaging Service — a number of third party e-mail solutions, namely, Gmail, Yahoo, Rediffmail, Sify, Indiatimes, Net4, Hotmail and In.com amongst others.

Of course the Nokia E75 comes with the usual stuff i.e., an intelligent input feature with auto-completion and correction, a 3.2 megapixel camera, autofocus, flash, and comes integrated with a music player, media player, FM and internet radio, an integrated A-GPS and pre-loaded maps on the memory card and last but not the least, the device includes a built-in mobile VPN for intranet access. In case you are wondering . . . . it also comes with a price tag of approx 27K.

The most vulnerable browser

Firefox fans take note : News reports circulating on the net suggest that Firefox is far more vulnerable than Opera, Safari, and Internet Explorer — and by a wide margin. In 2008, it had nearly four times as many vulnerabilities as each of those browsers. The rumours suggest that Firefox had 115 vulnerabilities reported in 2008, compared to 30 for Opera, 31 for Internet Explorer, and 32 for Safari. That doesn’t mean, though, that Internet Explorer is off the hook for security concerns. Far from it. ActiveX remains the browser plug-in or add-on with the most number of vulnerabilities.

New iPhone 3.0 Beta software

Apple has released a third beta build of the iPhone 3.0 software, taking developers one step closer to the final release in June. One of the most significant additions to the latest beta of the iPhone 3.0 software is the way individual apps will be able to notify users of updates or additional content. At the moment, individual apps flag users only in iTunes of new events, but with the 3.0 build, they will be able to do so right on the phone via badge, text or sound notifications. Spotlight (phone-wide search) will now let users save the last search they made, and can set restrictions for inside-application purchases and location data. An interesting fact about the third beta of the iPhone 3.0 software is that the Skype app no longer works on 3G. With previous builds, Skype allowed 3.0 beta software users to place calls via 3G, unlike the same app on the current 2.2 platform, which can make calls only over Wi-Fi. Apple seems to have fixed this ‘bug’, so no more wishful thinking for cheap VolP in the 3.0 final release. This third beta of the iPhone 3.0 software indicates the imminent arrival of a final 3.0 software in June, just like Apple promised. However, the question remains whether we will get some new iPhone hardware as well, especially as rumors intensified over the last weeks, detailing hardware components and features.

That’s all for this month, I hope to have more interesting developments next month.

Nirav Shah

Property : Minor : Permission for sale of immovable property of minors can be granted only if in the interest of minors : Hindu Minority and Guardianship Act 1956, S. 8.

New Page 1

24 Property : Minor : Permission for sale of immovable
property of minors can be granted only if in the interest of minors : Hindu
Minority and Guardianship Act 1956, S. 8.

The petitioner filed a petition u/s.8 of the Hindu Minority
and Guardianship Act seeking permission to sell immovable property belonging to
her minor sons, which came to their share by inheritance. The daughter of the
petitioner was also having right by birth in the property inherited from Babu
Aade, husband of the petitioner and father of the minor children Krishna,
Ratansingh (Sons) and Mangala Aade (daughter). Permission was refused by learned
District Judge on the ground that besides the two sons, one daughter of the
petitioner also had share in the property, but the petitioner signed on her
behalf as a consenting party without the permission of the Court, which was
mandatory and as such excluding the name of the minor daughter was an attempt to
ignore her interest.

Perusal of the provisions of S. 8 of the said Act would show
that natural guardian of a Hindu minor has power, subject to the provisions of
this Section. to do all acts which are necessary or reasonable and proper for
the benefit of the minor or for the realisation, protection or benefit of the
minor’s estate. The import of this Section is that protection of the interest of
minors alone should be the necessary criteria. Further, Ss.(2) of S. 8 of the
said Act specifically bars the natural guardian to mortgage or charge, or
transfer by sale, gift, exchange or otherwise, any part of the immovable
property of the minor, or lease out any part of such property for a term
exceeding five years or for a term extending more than one year beyond the date
on which the minor will attain majority or disposal of the immovable property,
etc., without permission of the Court.

On appeal the Court observed that the petitioner had signed
as consenting party on behalf of daughter who is minor. It is nowhere the say of
the present petitioner that she sought permission u/s.8 of the Hindu Minority
and Guardianship Act, 1956 before signing as consenting party, because such
permission was mandatory.

The Court held that the claim of the petitioner that she
wants to sell the property which is standing in the name of her minor two sons
is erroneous because apart from these two sons, daughter of the petitioner,
namely, Mangal Aade has also right in the said property.

While giving consent on behalf of the minor daughter Mangal
Aade in the partition deed, the petitioner had not sought any permission from
the Court and the permission which is applied for the sale showing only two
minor sons as holders of the property and excluding the minor daughter, is also
an attempt by the petitioner to ignore completely the interest of the minor
daughter. The petition which was filed by the petition u/s.8 of the said Act
totally ignoring the interest of the minor daughter was rightly rejected by the
District Judge. The petitioner had acted in suspicious manner and excluded the
interest of the minor daughter.

[ Smt. Dropadabai, Aurangabad, v. State of Maharashtra, 2008 Vol.
110 (10) Bom L.R. 3600]

levitra

Nirav Shah

Kal, Aaj aur Kal — Part I

Computer Interface

Kal, Aaj aur Kal is the name of a movie released during the
70s. Befitting its name the cast consisted of three generations of the Kapoor
clan viz., Privthviraj Kapoor, Raj Kapoor and Randhir Kapoor — represent
Kal (the past), Aaj (the present) and Kal (the future). In the movie each
generation felt strongly about the genre of culture in which they were born and
brought up and couldn’t comprehend how the others could survive without it or
why the others had no respect for it. Taking a leaf from this theme, I have
pieced together past trends which changed our present and are likely to shape
our future.

Today, life without a cell phone, a laptop, or an Internet
connection seems unthinkable. Technology has infiltrated the daily life in so
many ways that it’s hard to remember entire generations found ways to reach
others, stay up-to-date, and do their jobs without the technology innovations we
take for granted. This write-up is about innovations that may seem standard now,
but whose creation changed the way business is conducted, directly affected
quality of life, broke new ground, and more. The list is not organised in any
particular order, however some of the biggest contributors to the present
technology are listed in the paras below.

The first among the trendsetters is Graphical User Interface
(‘GUI’). The first graphical user interface was invented by Douglas Englebert in
1968. But thanks to companies like Apple, who popularised the same, GUI design
advanced significantly in the late ’70s and early ’80s. Because of these
pioneers, we can take it for granted that we interact with our computer using a
mouse and have easy-to-understand icons and other graphical controls instead of
having to remember a bunch of computer commands.

Of course without the Personal Computer — PC/ laptop
computers, our progress would have been stunted. 1981 was a big year for
computers: IBM launched the 5150 model (which it called a ‘personal computer’)
and the Osborne 1 became the first portable computer. Weighing in at 24 pounds,
it challenges our current notion of laptop. Not to forget that it was MS DOS,
yes, a Microsoft product which opened up new possibilities.

Internet/broadband/WWW is an equal contributor. Our slavery
to Google, our addiction to Twitter. Not to mention our penchant to keep
up-to-date on any given news topic, our ability to send and receive far too many
e-mails. The Internet enabled so many other phenomena that it’s startling to
realise the Internet as we know it only arrived in the ’90s. But it didn’t take
long to change our lives forever.

Online shopping/ecommerce/auctions are also responsible for
turning the fortunes of many. Where would we be without all the Amazons, eBays
and other online stores ? Thanks to the Internet being
opened up to commercial use, the ability for companies to capitalise on
electronic transactions took off. As did our hunger for a more peaceful shopping
experience. Today, ecommerce is a given, we book our tickets for
travel or for movies online. It’s obvious
why those wonder years were called the ‘Roaring 90s’.

Mobile phones, take a look at your tiny little cell phone and
be thankful. The first mobile phones, which Motorola unleashed on the market in
1983, were confined to the car (until a few years later when they became more
mobile) and were the size of a briefcase, in fact my first handset would very
easily measure up to a remote control. I am absolutely speechless when people
say that they would be lost without their mobile phones. Come to think of just a
decade ago, most people survived with fixed telephones (apro MTNL). I still
prefer the old school — don’t call me, I’ll call you. In fact, the thought that
soon I will be forced to carry a Blackberry device is unsettling . . . .

Social networking via Internet. This is one trend that I
haven’t adjusted to as yet. Internet-based social networks really are very new.
SixDegrees.com (1997) is one of the earliest social network site. They say that
it wasn’t until MySpace, which launched in 2003, that social networks began to
appeal to the masses. Now, of course, there’s Facebook, which gives you endless
opportunities to have worlds collide, and Twitter, which empowers you to become
your own paparazzi by dropping life tidbits, wisdom, and your comings and goings
to your anxious followers. If you haven’t done it already do check out
SecondLife — (for some it is a second life . . . . literally).

In the next part I hope to cover some innovations which I think will shape
our future . . . .

levitra

Nirav Shah

Transfer pricing : Management fees — Are you following the best practices ? — Part II

Article

1. Background :

The previous issue of this article (see BCAJ, December 2008,
page 373) specified the criteria to determine whether an intra-group service has
been rendered by a related entity. Once it has been concluded that a service has
been rendered, the second of the two primary issues pertaining to intra-group
services needs to be addressed, namely, the amount to be charged for the service
rendered.1 This is in line with the fundamental concept of transfer pricing (i.e.,
the arm’s-length principle). In other words, a charge for intra-group services
between related parties should reflect the charge that would have been made and
accepted between independent enterprises in comparable circumstances.

2. Benchmarking the intra-group management fee charge :

As regards the selection of the most appropriate method for
benchmarking an intra-group management fee charge, it may be noted that the OECD
Guidelines indicate that the transfer pricing methods which can be used to
determine an arm’s-length transfer price for intra-group services could include
the comparable uncontrolled price (CUP) method and the cost-plus method.2
Sub-classifications of the cost-plus method are the direct charge method and the
indirect charge method.

2.1 Comparable uncontrolled price method3 :

The CUP method compares the price charged for services
rendered in a controlled transaction with the price charged for similar services
rendered in a comparable uncontrolled transaction under comparable
circumstances.4

In practice, services in the nature of intra-group support
services generally may not be rendered by the group service provider to any
third parties in India or abroad, nor would similar services under similar
circumstances be procured by the group service recipient from any third parties
in India or abroad. This is mainly because of the very nature of intra-group
services, in that they are in the nature of support services which the group
service provider would render only to the entities within the group.
Consequently, in general, no internal comparables may be available in practice.

Moreover, regard being had to the nature of intra-group
services generally provided, it might also be difficult to procure external
comparables from the public domain. Also in the context of intra-group services,
as services rendered by the overseas parent are generally in the nature of
support services, the CUP method would not be the most appropriate method.
Consequently, in the absence of internal or external comparables, the CUP method
is generally not selected as the most appropriate method from a transfer pricing
perspective for analysing the arm’s-length nature of transactions involving
intra-group services.

2.2 Cost-plus method5 :

The cost plus method tests the arm’s-length nature of a
transfer price in a controlled transaction by reference to the gross profit
mark-up (e.g., gross profits divided by cost of rendering services)
realised in a comparable uncontrolled transaction.

Given the facts that details about internal or external
transactions may not be available for the application of the CUP method, and the
costs incurred by the parent/group service provider inasmuch as are attributable
to its subsidiary/service recipient may be easily identified or computed, and
given the fact that details of margins of comparable companies from transfer
pricing databases would generally be available, the total cost-plus method
would, in practice, be the most appropriate method to benchmark intra-group
service transactions.

As mentioned earlier, there are two variants of the cost-plus
method — the direct charge method and the indirect charge method.

2.2.1 Direct charge method :

Under the direct charge method, associated enterprises are
charged for specific services. For example, the overseas subsidiary may be
directly charged for a two-day visit of a software engineer who is on the roll
of the parent company and who may have visited the overseas subsidiary’s site at
the latter’s request to render certain consultancy or advisory services. In such
a case, the parent company can charge the specific costs for these consulting
services with or without a profit mark-up (as the case may be), directly to the
overseas subsidiary. A third party would also, in all probability, proceed in
this way under similar conditions and circumstances.

The direct charge method is applicable primarily when
services can be specifically identified for cost attribution. In such
circumstances, the expenses of the specific support group responsible for the
service rendered can be directly attributed to the services rendered (for
example, in terms of hours, travel expenses, etc.).

2.2.2 Indirect charge method :

The indirect charge method is appropriate when the services provided and the costs attributable thereto relate to a number of different entities. For example, there may be situations when an MNE cannot attribute direct costs either because the associated costs of a service rendered are not easily identifiable or the costs are incorporated into other transactions between the related entities. In those circumstances, a cost allocation or apportionment method is used which often necessitates a degree of estimation or approximation. Essentially, the relevant controlled transactions may be aggregated if it is impractical to analyse the pricing or profits of each individual transaction, or if such transactions are so interrelated that this is the most reliable method of benchmarking the transactions against the arm’s-length out-come. An appropriate allocation and apportionment of costs incurred by the group member in rendering the service to a specific affiliate should be commensurate with the quantum of the service rendered.

2.2.3 Which method is appropriate – direct charge or indirect charge ?

From the above, it can be inferred that the direct charge method should be preferred over the indirect charge method in cases where the services rendered by the taxpayer to other group members:

are the same or similar to those rendered to un-related parties; or
can be reasonably identified and quantified.

However, in cases where a particular service has been provided to a number of non-arm’s-length parties and the portion of the value of the service directly attributable to each of the parties cannot be determined, it is possible to use the indirect charge method.

2.2.4 Identifying the cost base for the indirect charge method,’

For application of the indirect charge method, it becomes necessary to ascertain the chargeable cost base. In this regard, it is necessary to take all costs directly or indirectly related to the services performed.

2.2.5 Apportioning expenses included in the cost base and selecting the appropriate allocation key,’

Having identified the cost base, the next issue to be addressed is that of apportioning the cost among various service recipients.

There is no specific method or formula specified for allocating the centralised costs incurred. Therefore, if the portion of the value of the service directly attributable to each of the service recipients cannot be determined (e.g., where global advertisement campaign is intended to benefit all the related entities), an appropriate allocation key is used to al-locate the costs. Charges for services rendered are determined by allocating those costs across all po-tential beneficiaries using an appropriate allocation key. Even the tax authorities would be interested in assessing the arm’s-length nature of the allocation criterion, since the indirect allocation method is open to possible manipulation and is highly dependent on the nature and usage of the intra-group services. Hence, it becomes imperative to select the proper allocation key.

The choice of the allocation key should be made by giving due consideration to the nature of the service involved and the use to which it is put. Some examples of allocation keys are as under:

allocation of department costs based on sales of the group;
time spent by employees performing intra-group services;
units produced or sold;
number of employees;
total expenses;
space used;
capital invested;
asset quantum; and
a combination of the above.

When choosing an allocation key, the taxpayer should consider the nature of the services and the use to which the services are put. For example, if the services relate to human resource activities, the proportionate number of employees may be the best measure of the benefit to each group member.

2.3 Mark-up on costs:

2.3.1 Generally:

Having identified the cost base and the basis of allocation to various group companies, the issue of marking up costs is the next issue in any transfer pricing analysis for intra-group services. This is because, depending on the facts and circumstances, the tax authorities in the foreign subsidiary’s country of residence may not allow a mark-up on costs unless it is adequately substantiated. Similarly, there may be issues in the home country of the service provider if no mark up is charged on value added services. Therefore, the costs incurred for the provision of intra-group services needs to be properly examined with a view to determining whether a mark-up on the cost base is justifiable.

Based on the international tax practice generally followed, it may be noted that determining whether a mark-up is appropriate and, where appropriate, what should be the quantum of the mark-up, require careful consideration of factors such as :

the nature of the activity and the services rendered;
the significance of the activity to the group;
the functional profiling and the characterisation of the intra-group transactions involved;
the relative efficiency of the service supplier; and
any advantage that the activity creates for the group.

Mark-ups on costs should be applied, if at all, only after taking into account all the facts and circumstances surrounding the provision of intra-group services. Wherever the mark-up is applicable, it must be substantiated as being at arm’s length with a thorough analysis of arm’s-length comparables.

2.3.2 Benchmarking the mark-up:

In the case of certain value-added activities where a mark-up needs to be charged, the question arises as to how to compute the mark-up on such services. Determining whether a mark-up is appropriate and, where applicable, the quantum of the mark-up requires careful consideration of the factors referred above.

To determine the mark-up, one would have to run a search on a transfer pricing database that deals with financial details of potentially comparable companies. The objective of the search is to identify potentially comparable companies that render similar services and to ascertain the margins of such comparable companies. Such comparable margins could then be used as a benchmark for the mark-up on the intra-group services within an MNE. Generally, the appropriate comparables for such inter-company services should be third parties that offer services with similar risk profile and intangibles.

However, it may also be noted that transfer pricing is not an exact science and therefore, more often than not, the application of the most appropriate method or methods and the database search would produce a range of figures, all of which are relatively equally reliable. Therefore, the actual determination of the arm’s-length price based on arm’s-length margins would necessarily require exercise of good judgment.

3. Documentation:

In addition to the documentation requirement discussed in the earlier issue of this article (which primarily dealt with the documentation required to demonstrate the actual rendition/receipt of intra-group services and fulfilment of the benefit test), additional documentation which must be maintained to demonstrate the arm’s-length nature of the intra-group service charge is discussed hereunder.

Although the documentation to be maintained in each specific case must be determined based on all the facts and circumstances, at a minimum, it is generally advisable that the following documentation be maintained on file in relation to the arm’s-length nature of the management fee charge:

* the documentation that the service provider undertakes to supply in support of justification of the fee for the services rendered, e.g., copies of time sheets or cost centre reports;

* detailed fee accounts or invoices from the payee which include (1) full details of services rendered over the period covered by the charge, (2) confirmation that the fee calculation agrees with the service contract, and (3) any other documents supplied by the payee, which support the amount of the charge. In particular, any substantiating documentation which must be tendered in accordance with the contract of services;

* a certificate from a CPA, if possible, certifying the viability of the method for allocation and apportionment of costs among subsidiaries, and the authenticity of the cost apportioned to each entity;

* as noted above, where a fixed key is used under the indirect charge method, it is important to substantiate the cost basis and to have details on file to show which costs have been included/ excluded with a fixed-key method;

* where a mark-up has been charged by the service provider, and a benchmarking search has been carried out on the transfer pricing databases for finding potentially comparable companies, the following should form part of the documentation maintained:

description of the database, along with the limitations of the database, if any;

detailed description of the process used to search for potentially comparable companies on the database;

details of filters, qualitative or quantitative, applied to shortlist closely comparable companies: ‘.

criteria used to accept/reject potentially comparable companies found on the database;

precise reasons for accepting/rejecting the comparable companies;

adjustments, if any, made to account for differences between the functions performed, risks borne and assets employed by the comparable companies and the margins earned by the entity providing intra-group management services;

sensitivity analysis, if any, carried out in respect of these margins; and

actual workings of the margins of comparable companies, and the application of the margins of comparable companies to the transaction in question.

All in all, it can be noted that robust documentation is a pre-requisite for demonstrating the arm’s-length nature of the intra-group service charge.

4. Other issues impacting management fee policies in an international context:

Besides the above transfer pricing-related issues, there are also other issues which merit consideration while designing management fees policy from an international tax perspective. These include:

Applicability of Service Tax on the management fee charge

Applicability of VAT on the management fee charge in the foreign country

Constitution of a ‘Service PE’ under the tax treaty by virtue of services being rendered by employees or other personnel beyond a certain threshold (or even irrespective of a threshold in some of India’s tax treaties)

Withholding tax implications.

5. Conclusion:

Globally, tax authorities have adopted an increasingly proactive and more sophisticated approach to examining transfer pricing policies in respect of intra-group support services. The Indian tax authorities have already taken a cue from them and are following a similar and aggressive approach while examining intra-group services, especially when an Indian company is the recipient of services and management fee charge. Accordingly, Indian MNEs with subsidiaries abroad, and more importantly, foreign MNEs operating in India, are well advised to contemporaneously document their intra-group arrangements and practices in respect of support services, so as to prepare in advance for an inevitable transfer pricing examination. Because intra-group services are regarded by many as one of the most likely areas to be examined by the transfer pricing authorities, taxpayers that have not performed the necessary analysis and maintained adequate documentation run the definite risk of being audited (with the possible result that their income will be reassessed by those same authorities).

Experience shows that while formulating an intra-group transfer pricing strategy, many MNEs fail to work out the overall business strategy in tandem with various other pertinent international tax planning considerations. Formulating a comprehensive transfer pricing strategy for intra-group service transactions also requires a well-founded understanding of various international tax planning principles, detailed knowledge of applicable tax treaties, as well as a thorough understanding of the laws and practices in the home and host countries. The over-all message is that it is imperative to consider all of these factors in the course of designing a proper intra-group management policy.

All in all, the best strategy for any MNE having intra-group service transactions is to formulate the intra-group management fee policy (with the help of transfer pricing experts) in sync with the overall objectives of the group, taking into account various tax and non-tax considerations; and maintaining adequate documentation to present the best possible defence before tax and transfer pricing authorities of the home and host countries!

Nirav Shah

Classical Accountancy to IFRS (A bird’s-eye view) Part I

Article

I. Introduction :

1. These are challenging times in many respects. A global
financial meltdown in which India cannot escape without hurt, a gruesome
terrorist attack on 26/11 on the financial capital of India i.e., our
dear Mumbai, politicians’ continuous play and ensuing election and what not. In
the field of Accounting and Auditing also we are expected to start a new
reporting procedure, namely, IFRS. It is stated to be applicable from 1st April
2011. However in reality, one will have to start looking at the accounts in
accordance with IFRS requirements much earlier, say, from 1st of April 2009.

2. In this background, it is thought fit to take a bird’s-eye
view of the entire journey from the base of ‘Classical Accounting’ to the
present-day IFRS. I do not pretend to be an expert in the field of IFRS. I
however, being a Chartered Accountant and forever a student of accountancy, love
this subject and it is my intention to have glimpses of the journey right from
1200 to 2008. A study of history is not merely a study of the past events, but
often tends to be a proper guide for what is there in store for future.

3. I wish to cover this history as under :

(a) Bookkeeping and accounts for a trader.

(b) Accountancy problems of a machine age.

(d) Early development of Accounting Standards.

(e) Development of IFRS.

(f) Conclusion.

II. Bookkeeping and accounts for a trader :

1. All of us have studied in the first year of college
lectures the golden rules of bookkeeping, leading us to various types of
accounts. Through the medium of real, personal and nominal accounts, we have
also learnt the basis of preparation of ledger account, periodical trial balance
and a statement of final accounts, namely, profit & loss account and a balance
sheet. These were taught as golden rules of bookkeeping and accountancy and have
stood the test of time for approximately over 800 years.

2. The earliest evidence of present-day bookkeeping traces
back some 800 years, to an Italian Banker. The Italian monk Luca Paciolo, for
the first time documented these bookkeeping principles. He did not claim to be
an originator or an author of the system, but only a describer of a practice to
write the books of accounts. Even the book that documents this ‘Bookkeeping’ is
a book ‘Summa’ which is essentially a book on mathematics, containing some 36
chapters on bookkeeping and accounts. Since it is a part of a book on
mathematics, the present golden rules of bookkeeping have been expressed in the
said book in the form of algebraic equations and not in descriptive narration.
Since every business transaction has a two-way effect, it was easy to put it in
the form of an algebric equation. Truly, mathematics is the mother of all
sciences.

3. The reason for giving a brief account of the otherwise
well-known origin of bookkeeping is to emphasise that :

(a) Certain principles are fundamental and are not subject
to the normal notion of ‘Change’.

(b) IFRS is making a sincere attempt to make the
figures in Comprehensive Income Statement (earlier equivalent of P & L A/c)
and Statement of Financial Position (earlier equivalent of Balance Sheet) more
mathematics-based and avoiding hypothetical figures based on assumptions. It
involves a lot of valuation, but again the valuation is based on
mathematical modules.

4. In any event, the primary objective of bookkeeping and
accounts is to understand the results of business operations for a particular
period (either positive or negative) and to understand the position of assets
and obligations on a given date. Over a period of 800 years of bookkeeping and
accounts, this primary objective has also not undergone any change.

5. What has changed over the year however is the trade or
commerce in the following aspects :

(a) The nature of trade and commerce

(b) The volume and value of trade

(d) Entities carrying on the business.

(e) Number and groups of persons who need to know the
results of operations.

6. In early days, persons carrying on trade and commerce
across the globe were essentially individuals, although they might be
undertaking a Caravan in a group. Such an individual was adventurous and
enterprising, brave and astute, knowledgeable and intelligent, but was
essentially a loner and wanted to know the results of his operations for his own
calculations.

7. A simple double-entry bookkeeping for recording
transactions manually, leading to the preparation of final accounts of a trader
were sufficient for him to take future decisions. He was not required to
disclose the results of his operations to anyone except perhaps two other
dominant persons, whose patronage as well as blessings were considered important
by him. In today’s terminology these two persons could be described loosely as
stakeholders. These stakeholders were the kings of the regions he traded in and
of course the religious heads of the place he belonged to.

8. The king would demand mostly an ad hoc amount of
the booty depending on mutual needs and also the relative power enjoyed. The
share demanded in such a case hardly related to the results of operations, but
the trader knew his calculations and would pay depending on his business
profits.

9. The religious head, on the other hand exercised a lot of moral influence. Through the medium of ‘Confession’ according to the Christianity or in the name of Allah in Islamic traditions or in the name of ‘Dharma’ as per Hindu philosophy, voluntary contributions were made for the cause of religion by traders from time to time. I would, however, not call them stakeholders of a trader, but sharers of the income without there being an obligation to disclose the results of business operations. Essentially, therefore, simple bookkeeping sufficed for the businessman to know for himself where he stood.

III. Accounting problems of machine age:

The situation however dramatically changed with the discovery of engines and machineries for the purpose of trade because of the following developments:

a) Invention of machines creates the possibility of large-scale production. It was never a trading in simplicity, but it turned out to be manufacturing and or processing and trading on a very large scale.

(b) Development of banking system and monetary economics enabling a manufacturer and trader, to have a large volume for which large funds could be availed through multiple credit creation system described by the classical economists as multiplier effect of a bank deposit.

(c) Development of a joint stock company system of organisation creating a two-tier ownership – some people owned and managed a business; the others were passive owners through different types of stock and debt instruments.

(d) Establishment of a rule of law and administrative and judicial system to regulate the legal framework and a judicial system to oversee the administration having a nation-based sovereign sanction.

2. I have just noted the above four contributory factors without any historic elaboration, since our readers are well aware of these historic developments. However, the importance of all the above factors lies in the fact that the number of stakeholders in a business entity increased by leaps and bounds. The bookkeeping results were not only meant for the owner trader or sole proprietor him-self, but it was necessary to share the results of operations with larger number of persons. These large number of persons would come from different culture, speaking different language and also due to geopolitical and national differences, held different perceptions based on their own motives and objectives.

3. The mere bookkeeping and accounts was not enough, and the classification of income and expenses, classification of assets and liabilities became more prominent. At the end of the day, it is really a classification between Capital v. Revenue, either income or expenses. The classified capital expenditure occupied the assets side in a balance sheet, whereas the classified revenue expenditure occupied a place in profit and loss statement. Similarly classified capital receipt occupied the liability side of a balance sheet; the classified revenue receipt occupied the credit or income side of Profit & Loss Statement.

4. Although laws were made and the rules laid down, the difference between capitaland revenue, either expenditure or receipt has led to volumes of literature since the 17th Century till the beginning even of the 21st Century. So much so that various judicial and legal brains have tried this several times and still would conclude that the differences could be sorted out by long-drawn out arguments and litigations and equally efficiently by the toss of a coin.

5. This acute and fierce fight between capital and revenue arises basically because of ever conflicting interests of the stakeholders. The bare-bodied book-keeping and accountancy, fully transparent like naked human beings of early civilisation, started wearing clothes and more fancy clothes as the times changed. We have fancy clothes depending on an occasion like party, marriage or other ceremony, official function, sports, evening dress and what not. Similarly, our primitive bookkeeping and accountancy started wearing different clothes. The owner management was interested in showing its best operating results when it came to its own remuneration or when it wanted finance for its operations from financers like bankers or passive owners. It tried to pretend like a pauper when it faced the labour force which got more and more organised or the revenue collecting authorities created by legal frameworks.

IV. Stakeholders demand more transparency:

1. The large majority of passive owner stakeholders, the financial stakeholders were however not satisfied with the skeleton reporting, frauds and manipulations and window dressing of accounts. The owner managers were also equally skeptical in making complete disclosures for various reasons and this created a tug of war, a game of chess between them and selective disclosure followed.

2. The legal framework of a region invariably created an independent agency like that of an Auditor, who specialised in examining the books of accounts maintained in accordance with prescribed legal frameworks, and it really did its job to the best of its ability. The auditing profession has developed and adopted not only auditing procedures and standards but also participated in a great measure even for establishment of common language in accounts through the medium of accounting principles and policies. MAOCARO order in India in the year 1975 is only one such example.

3. In spite of this all-round development, accounting manipulations basically arising as a result of differing perceptions and conflicting interests of various stakeholders did take place from time to time and of various dimensions.

V. Development of Accounting Standards:

1. Land, labour, capital and enterprise were described by economists as the factors of production. Out of these, except for land, all other factors of production were and are always floating and capable of movement. In spite of various restrictions put forward by sovereign authorities, they would like to cross the barriers of any type put forward by any sovereign authority. For its relatively free movement, various stakeholders required that their stakes in a business entity are safeguarded for which the present system of accounting policies and principles are thoroughly inadequate.

2. In order to iron out the differing treatment to the same set of transactions, efforts were made for establishment of sound accountancy principles and policies. Similarly, the auditing profession was also required to adopt sound and well-documented reporting standards. These however were scattered and fragmented efforts and were sovereign specific. This created lot of problems for the scattered and diversified group of stakeholders and there was a demand for establishment of Accounting and Auditing Standards. As a result of this movement, Accountancy and Auditing Standards Boards were established by each sovereign power.

3. Even in India, ICAI set up its own Accounting Standards Board and started pronouncing Accounting Standards. The initial pace was of course very slow. Other countries specially the European countries set up various functional bodies and started pronouncing what is known as International Accounting Standards (IAS). These standards were not only followed in Europe, but even the Middle East and far-eastern countries also accepted them. The USA however created its own GAAPs and it considered its standards the best in the world. Anyone wanting to do business by using capital or technical know-how of the USA, was forced to con-vert his accounts in accordance with US GAAPs.

4. The pace of development was however very slow. These standards were initially only toothless tigers and powerful industrial lobbies hardly paid any attention to them, unless the standard was such as would suit their own policy. These AS in India or IAS were mostly based on intentions, permitted alternative treatment and were flexible to an extent to satisfy business entities. On the other hand US GAAPs were more rule-based and on the face of it appeared very stringent.

5. Although the growth of these standards took place, the last decade of the 20th Century also witnessed terrible business failures in the U.S.A. Another related development was that IAS and AS no longer remained toothless tigers, but acquired necessary bite because of legal compulsions.

VI. Development of worldwide IFRS :

1. The first decade of the 21st Century noticed severe expectation gap between the stakeholders and those who managed the business. Sarbanes-Oxley also played its part. Earlier business failures were also bothering everyone and a need was felt to have a worldwide common accounting language, along with stringent corporate governance provisions.

2. Even the US agreed to modify its own earlier tough stand and accepted in principle the world-wide common accounting language and IFRS has now evolved. Our country has also accepted gradual introduction of IFRS, to begin with, for listed companies.

3. We the Chartered Accountants, in the interest of our professional development, are required to accept them, study them and should take part in their proper presentation. There should be neither an ecstasy nor any agony in the use of a common language.

VII. Conclusion of Part I:

1. An attempt is made to give a bird’s-eye view leading us to the present study of IFRS. The language is purposely kept a non-technical narrative with a scope for the readers to read a lot between the lines to fill up the historical details. Essentially, bookkeeping captured business transactions some 800 years back through mathematical module and we are once again through IFRS, embracing in a way a mathematical base for presentation based on what is known as fair valuation. In the next and concluding part, I propose to cover some broader macro issues and some example-based micro issues again in non-technical language.

2. While I am making more noise on mathematics when dealing with IFRS, let me share with you a story about the present financial crisis in a meeting on the Wall Street (Courtesy: Abhijit Phadnis). One person while talking in the meeting in an angered voice stated that after all, 25/5 = 5. An old man attending the meeting challenged the mathematical equation and stated that 25/5 = 14. Still more angered, the young man asks the old guy to prove. The old man comes to the board and explains his equation as under:

25/5 = 14 because
5/5 = 1
25-5 = 20
20/5 = 4

so, two divisions give an answer 14.

The young man got wild with this mathematical knowledge and said that 5 X 5 = 25. Prove your equation in a reverse way. The old man once again said that 5 X 14 = 25 as under:

5 x 1 = 5
5 x 4 = 20
5+20 =25

The lighter vein and a bit of a smile on your face apart, the truth is mathematics is pure, but twisted mathematics can give any answer. What has happened on Wall Street and everywhere in the present situation is all-round confusion, giving rise to a crisis which has given rise to erosion in confidence, leading to depression and doom. I only sincerely hope that IFRS does not get caught by twisted mathematicians in the field of fair valuations. Do you get me, my dear friends?

Nirav Shah

Classical Accountancy to IFRS (A bird’s-eye view) Part II

ArticleI. Some macro
issues :

Accounting year :

1. Normally every sovereign state provides a legal framework
to decide about the accounting year. Every entity carrying on a business is
required to prepare the final accounts as understood by us for pre-defined
accounting year. Besides annual report to various stakeholders, collection of
tax revenue is also based on this pre-determined accounting year. In India, such
an accounting year is financial year starting from 1st April and ending on 31st
March. Earlier in India, sentimental luxury relating to choice of an accounting
year was given to every business entity. No longer is such a luxury permissible.

2. However, business entities are no longer national but one
invariably finds a multinational or a conglomerate of cross-border
holding/subsidiary and associate companies. When different countries have
different accounting years, there is a perpetual problem of consolidation of
group accounts. One will argue that a good business entity would be, in any
case, preparing quarterly accounts for presentation to various stakeholders.
Once quarterly accounts are made available, consolidation is merely an exercise
of year on year inclusion and exclusion of either one quarter or at the most two
quarters.

3. Year-end consolidation exercise, however, is not a simple
arithmetical affair but involves lot of work. The question is “What is the value
addition” as a result of this avoidable exercise ? When the world community is
accepting a common accounting language, should one not address this issue ? I
submit that at a macro level, it is necessary to have a debate and discussion
and the issue needs to be sorted out amicably. Government budget in our country
used to be presented in India at 5 p.m. on 28th February, every year, because
time zonewise it suited British colonial rulers for whom it used to be 11 a.m.
We continued this practice for almost over 50 years after independence. It is an
example of how in some convenient matters we choose to be rather causing
inconvenience perpetually.

II. Currency expression of accounting figures :

The illustrative schedule of Comprehensive Income Statement
and Statement of Financial Position as per IFRS are figures expressed in
thousands of currency unit. It would mean expressing the figures in millions and
billions and trillions. In India, we enjoy the luxury of expressing figures in
units, hundreds, thousands, lacs and even crores. There is no uniformity. Do we
wait for legal compulsion or would like to follow what is globally acceptable
and understood ? I submit that this apparently no impact area from the point of
view of results of operation needs to be changed so as to conform to the
International Standards.

III. Presentation of annual report :

An annual report is required to be presented to all the
stakeholders who are not necessarily shareholders. How should the annual report
look like ? Although it is a mandatory requirement as to what should appear in
annual report, there are companies which provide certain information on
voluntary basis. However, one finds a lot of diversity in use of paper, use of
type-setting, use of photographs, order of contents, etc. One must have come
across annual reports where not only the quality of paper is very poor, but the
type-setting is such that one cannot read without a binocular. This is the
information which the stakeholder is expected to read. I remember a couplet
written in the context of a prospectus and some of the poetic lines are as
under :

Before you invest, read the Prospectus,

It provides information, which is given to protect us.

Summarised in it are all the figures which are composed.

It contains all the risks to which you are exposed

Don’t you know where to start ?

Smaller the print, greater the hazard.

Well, I do not mean that in every case a small print is a
hazard (except to your eyesight), but standardisation in this apparently no
operational impact area is also necessary.

IV. Limitations of written figures :

1. Many times, the figures may not convey full meaning and
disclosure by way of written text without a legal compulsion may not be
forthcoming. I believe that even IFRS contains such areas. Alternatively, the
meaning would materially change with context explanation. Some years back, a
theatre personality was being interviewed on TV. A simple sentence of 3 words
‘Police caught thief’ was shown by him to have 3 different meanings depending on
which word you emphasise; and with different body language, he showed 10 more
meanings of a simple sentence of 3 words.

2. It is not the purpose of this article to write
specifically about what happened in Satyam. That would be a matter of a separate
article involving lot of debate and discussion and even perhaps a shock
treatment. However, I do reiterate that IFRS compliance is not much of a
difference qualitatively from classical accounting theory, but a classical
example of how to make simple things look extremely complex. And yet could be
far away from transparency, accountability due to window-dressing.
I write this because ‘Satyam’
claimed to be the first company to be IFRS compliant three years ahead of the
date of its applicability and its annual report for the year ended 31-3-2008 on
pages 125 to 167 contains complete conversion of accounts if IFRS is followed.

V. Adoption, adaptation and convergence :

1. News from USA :

The discussion between IASB and FASB continues. Just as we
have political and economic summits, the two bodies met and entered into what is
known as ‘Norwalk Agreement’ in 2002. At the end of the summit they made joint
announcements that they would undertake some joint research projects to iron out
difference between the two, some projects would be short term; others may take
little more time. In substance, they agreed that they should be together in long
term in defining and dictating (in a nice way — no pun intended) the world
accounting language. I am reminded of a famous satirical novel ‘Animal Farm’,
written by George Orwell where you get a message that “all animals are equal
but some are always more equal than others”.

2. Process of unification :

As a part of a move to extend a co-operative hand, SEC in the USA will review the faithfulness and consistency of foreign private issuers IFRS compliant Financial Statements from 2005. SEC issued a statement around that time that if few areas are looked into, SEC will not insist on reconciliation of IFRS compliant accounts with US GAAP, for US listing. This would avoid multiple accounting presentations. On its part, IASB also modified its several standards in line with US GAAP. As a result of the process, IASB assumes that countries will adopt IFRS 11 as issued by IASB without any modification”. This is based on the theory that IASB adopts some US GAAPs; some areas are jointly researched and issued as new IASB, other complicated and complex areas would be soon investigated to iron out the differences and then world accounting language would be the same.

3. Position in EU countries:

a) Countries in EU (European Union) have made IFRS mandatory for all listed companies and it is reported that starting 1st January 2005, 8000 EU listed companies adopted IFRS and proposed listed companies will follow suit.

b) Beyond listed companies, however, there appears to be a lot of confusion. Out of EU countries, only Greece, Italy and Denmark (effective from 2009) require IFRS for individual accounts of listed companies and none of them require it for non-listed companies. Germany allows companies to provide individual accounts using IFRS, but still requires them to prepare primary statements following German National Standards. Newly joined 10 countries in EU also require annual statements according to their own national accounting standards – a system of dual accounting (national and international standards !). National pride continues and legal adoption is still delayed. Some countries would like to adopt IFRS one by one and not as a package. In Europe, there are IASB approved IFRS as well as EU endorsed IFRS, besides national accounting stan-dards. Each of these serve a different purpose for different state of stakeholders. Though statements continue to be issued from time to time, the picture is far from clear and although a road map is constructed, there is always a difference between a map on a paper which looks very clear, and the actual road which is not an expressway or freeway. It has lot of potholes, blockages and rough patches.

4. Indian scenario:

Our Institute (ICAI) is awakening members, holding seminars, workshops for them. What was a trickle in 2007-08, is likely to become a flowing stream, but with a restricted speed. The members are bound to follow ICAI with respect and would become as usual, studious students. The revenue departments, the company law department and various industry associations, however, are still not enthusiastic supporters. The recent ‘Satyam Episode’, where the company claimed to be the first to be IFRS compliant, would also come in the way of proper studies because lot of defense mechanism will have to be used in damage control exercise. Regulatory authorities also may put lot of hurdles with justifiable reasons. One of the principles of investigation is ‘Distrust the obvious’ and that would come in the way of smoother regulatory work for some time. Members of the public would say with one voice, “Let the accounts be basically transparent” – whether they are Indian GAAP compliant or IFRS compliant or US GAAP compliant can be examined later.”

VI. Micro level simple examination of a part of Accounting Standard:

1. Having examined some macro issues, let me turn attention to a specific Accounting Standard, namely, Revenue Recognition (AS-9) to examine the Standard with reference to :

a) Accounting Theory and Practice.

b) IAS Standard.

c) IFRS Requirement

2. Case study accounting theory and practice:

As a case study for the purpose of this examination, I have taken a very simple example of sale of goods on credit, pure and simple. ABC Ltd. has sold goods worth Rs.50 crores to 100 different customers. Since these are the goods manufactured by ABC Ltd., beside sales price, the actual invoices also include excise duty and Vat at 16% and 12%, respectively. The credit term is 30 days and interest is to be charged @ 18% p.a. for non-payment in time. I am not involving additional complications such as export sales or sales out of the state, in our own country, but both these may be having implications in collection of indirect tax revenue with exceptions and exclusions on specific grounds.

3. In such a scenario, the accounting theory and practice, which is age-old and based on common sense and business experience and wisdom has taught us that

(a) Revenue generated is to be taken to the credit of profit and loss account to the extent of Rs.64.96 crores.

(b) Amount receivable at the end of the year is to be shown sundry debtors on the asset side, under the heading current assets exactly to the same extent.

(d) Actual bad debts must be written off.

(e) Depending on experience, a provision must be made for doubtful debts.

(f) If there is a policy, a provision is to be made for discount on prompt payment of debtors.

(g) A businessman should be conservative, i.e., he should quickly recognise losses and expenses, but should be slow in recognising possible gains. Interest on delayed payments by debtors is normally accounted for on actual receipt basis.

4. In accordance with the above principles, the businessman would pass the accounting entries and each of the entries that he passes, there would be impact on the actual revenue to be recognised and also debtors in the form of current assets to be shown. The conventional presentation, however make all fluctuating adjustments on the debit side of profit and loss account, without touching the figure of revenue by way of sales recognised. However, in the case of presentation of debtors, on the asset side, he would make all the adjustment to the figure of debtors. Common sense, uniformly applied acquires the force of law and Sch. VI, Form of profit and loss account and balance sheet also required us to do the same thing over a number of years.

5. Other permutations and combinations of accounting entries would follow depending on varying degrees of a contract of sale (Basically governed by the Sale of Goods Act.) Theses variations as per the Sale of Goods Act would not materially be different than the accounting entries as mentioned in para 3 above. However, for the sake of completeness, they are just narrated below:

(a) Changes in delivery schedule.
(b) Conditional delivery subject to installation and inspection
(c) Sale on returnable/approval basis
(d) Hire-purchase sales.
(e) Sales where there is time-bound after-sales service and guarantee
(f) Consignment sale
(g) Transit insurance claim as a result of loss of goods.

VII. Requirements of AS-9 :

1. If one goes through the actual standard parameters, it has accepted the conventional wisdom in its complete form, except for the fact that it has tried to visualise as many different possibilities as possible. Such an attempt at detailing, to my mind, is an attempt to make every businessman an ‘Arjun’ who could pierce the eye of a moving fish, by looking at its mirror image. Alternatively it could also be contended to be an attempt to count feathers of a flying bird.

2. The only difference is treatment of Indirect Taxes like State-level Vat and Central Excise Duty. The guidance note issued by ICAI on treatment of State-level Vat tells us that no economic benefit is earned by an enterprise in collecting and paying Vat on behalf of State Government and hence from the total turnover, State-level Vat should be excluded and the payment thereof should also not be taken as expenses. In our above illustration, 6.96 crores being Vat collection will have to be excluded and the turnover should be shown at Rs.58 crores. Adjustment arising out of input credit on Vat should be made in the purchase of goods shown on the debit side of the profit and loss account.

3. In case of Excise Duty however, it has been held to be a manufacturing cost by the decision of various courts, but instead of showing it on the debit side of the profit and loss account, it is required to be shown as a deduction from the turnover. As a result, on the credit side, one is expected to show turnover at 58 crores less ED Rs.8 crores and the net figure of 50 crores is to be shown. In addition to this there would always be some difference in the opening and closing inventory of finished goods which must be inclusive of Excise Duty and the difference between closing and opening inventory. Excise Duty of finished goods should be shown either on the debit side or the credit side separately and should not be mixed with the turnover, or with Excise Duty deducted from it.

4. There is no requirement of fair valuation of debtors because debtors is not treated as a Financial Instrument. However, AS-l ‘Disclosure of Accounting policy’ would invariably contain a statement indicating that adjustments are made to the realisation probability of debtors based on past experience on grounds of conservative policy.

VIII. IAS and IFRS requirement:

(a) Objective
(b) Disclosure policy
(c) Recording of transaction
(d) Presentation in final accounts

2. It is a nice way of presentation and makes understanding of a standard easy. IFRS and IAS is no exception and our AS also follows the same policy. Some standards are pure standards of disclosure, whereas in some standards one would come across a combination of all the 4 ingredients.

3. In IFRS and IAS, our conventional dear ‘Sundry Debtors’ and ‘Sundry Creditors’ of so many years would acquire a new name of ‘Accounts Receivable and Accounts Payable’. They would acquire a new status of a ‘Financial Asset’ and since it is capable of being sold or bought in the market by way of securitisation, they would get a further status of a ‘financial instrument’. An instrument could be tangible or intangible and capable of being stated cost less estimated expenses of realisation or could be valued under ‘Valuation Rules’ in the absence of a market and could be valued at market value if there is an active market for it. So our figure of conventional ‘Sundry Debtors’ of yester-years would get a designer status due to different clothing and make up, and naturally its valuation would always present lot many difficulties.

4. It is not my intention to describe the entire dress material, but the essential thing appears to be a quick attempt to convert everything into an instrument so that it could be sold, it could be provided as a margin and could also be used for the purpose of leveraging, so as to have the fastest of turnover of these figures involving mark-to-market valuations. Most of the complications are the result of this exercise which is required to be carried on when we turn to IFRS. Such an exercise will require mathematical modules.

IX. Limitations and reservations on IAS, IFRS :

Having examined a part of a standard AS-9 from a very limited angle, although it may be considered very late, I would like to express some limitations and reservations which are bound to be faced in the years to come and some of them could be listed as under:

1. The exercise in making a fair valuation is going to be a very subjective affair and what is described as fair value would be based on many assumptions incapable of remaining true in a dynamic business scenario.

2. Whereas common accounting language need not be a utopia, it should be a gradual process of adaptation one by one or a group of standards instead of a total adoption at one go from a predetermined date. Our ancestors have told us that one morsel of a food should be chewed 32 times before we take the second, so that the food is digested properly. If we gallop the food of these IFRS and that too imported food, we could be suffering from indigestion and all other diseases.

3. If substance over form is to be accepted as a proper understanding of a subject and if we want to prepare the accounts which are not only rule-based but based on the underlying intention, then there is no distinction between Excise Duty and state-level Vat. If the Vat does not have any economic benefit for an enterprise and therefore needs to be excluded from turnover and also as an ex-pense, then the same logic in substance can also be applied to Excise Duty. Different treatment for different elements of indirect tax appears difficult to digest and lot of time is wasted in trying to make these niceties in accounts rather than going into the business substance of the results of the operations. If only some more vigilance was shown by those connected with Enron, Worldcom or Satyam in finding the substance of the business rather than spending time in making the accounts IFRS compliant or US GAAP compliant, stakeholders at large would benefit and would curse the accounting less than what is done today.

4. Although there was a lot of pressure on our government and RBI to make the rupee fully convertible in late 90s including some intellectuals from our country, our RBI did not do it and we were spared from the currency crisis of late 90s in South-East Asia. This is the recent history. Most of our banking sector top brass taking decision is above the age of 40 and they do not fully understand currency derivatives and all other derivatives and mark-to-market mechanism fully. We are therefore substantially saved from the ‘Sub-prime’ crisis which has engulfed US and Europe although our country is also affected to some extent. People say that we were saved because of our relative ignorance in new financial instruments.

5. There is another reason for advocating adaptation stagewise instead of adoption. The main reasons for reservation on a national basis emanates from a fear of tax laws. Fiscal policy in any country determines the taxation policy – whether direct or indirect. It is accepted in a pure Brahminical way that Accounting Standards are basic accounting principles and they cannot be in any way remain fluctuating with a yearly fiscal policy with conse-quential changes in tax laws. However one cannot afford to totally neglect the strong feelings of a business community to prepare accounts in compliance with taxation laws to avoid conflict and tax litigation. Even in Europe the national spirit and multiple accounting standards is the result of tax orientation of a nation. One cannot neglect this tax consideration altogether.

6. The standard-setting exercise appears to be an intellectual exercise of bodies handed over to the fellow members without many times active support either from the Government or the business community. If it was not so, there would not have been such a resistance. How many years you have read notes on accounts stating that “Inventory of finished goods is exclusive of Excise duty. This is contrary to the Accounting Standard issued by the ICAI. However it has no impact on the profits of the year”. Business community was doing it only for the purpose of improving their ability to get higher working limits from the banks.

7. Feelings expressed in above paras are not only the feelings as a CA, but these are the feelings heard from a small and medium-size business entity with which I have spent a lot of time. It is felt many times that the complicated standards are only a burden on the accounting profession, because the business entities do not many times see any value addition to the exercise, but their voice does not get heard under the weight of what is ‘Big’ in every sphere.

x. Conclusion:

1. It is not the intention of this article either to downplay the AS, IAS or the attempt at convergence to make IFRS the world accounting language. However, a mathematical model required visualising every possible situation is bound to be a complex exercise when the global business itself is very dynamic. It is not only dynamic in value and volume, but is also largely unpredictable and based on shifting sands of precarious nature and future. Moreover I refuse to believe that stakeholder in a globe is a dumb animal who needs to be fed every bit of a detail. One should believe in his intelligence to make proper adjustments required to safeguard his own stake subject to normal risk. In such a scenario, a gradual adoption after proper understanding may be a better alternative rather than full and complete adoption at one time. A longer court-ship and dating may be a better idea to a love at first sight and marriage. Otherwise, there could be more chances of a divorce petition or a discord affecting marital bliss.

2. Even in the absence of a common language, a true love and affection between a man and a woman could flourish and let Adam eat the prohibited fruit to get his Eve and suffer the consequences. This is not only true for love making between a man and a woman, but also is true for love and affection in every human being. What is required is a standard of human integrity and this is something which cannot be laid down in black and white in any common language but is something, which is required to be examined and felt on an ongoing basis. This requires avoidance of greed and fear and building a confidence level, irrespective of a language barrier. Do you get me my dear friends?

Nirav Shah

IFRS for SMEs in India

Article

Background :

Published by the International Accounting Standards Board (IASB)
on 9 July 2009, International Financial Reporting Standard for Small and
Medium-Sized Entities (‘IFRS for SMEs’) is a simplified version of full IFRS
aimed at responding to the compelling need expressed by both developed and
emerging economies for a rigorous and common set of accounting standards for
smaller and medium-sized businesses that is much simpler than full IFRSs. Prior
to its release, the standard-setters engaged themselves in comprehensive
dialogue with SMEs worldwide in order to ensure that the document finally
released would meet the needs and capabilities of small and medium-sized
entities (SMEs), which are estimated to account for over 95% of all companies
around the world.

Application :

The IFRS for SMEs has the potential to revolutionise and
harmonise financial reporting by private companies across the world. It remains
a stand-alone product that is separate from the full set of International
Financial Reporting Standards (IFRSs).

Thus, it is available for any jurisdiction to adopt whether
or not it has adopted the full IFRSs. Also it is incumbent upon each
jurisdiction to determine which entities should use the standard.

In particular, the IFRS for SMEs will :

provide improved comparability for users of accounts

enhance the overall confidence in the accounts of SMEs

reduce the significant costs involved of maintaining
standards on a national basis, and

provide a platform to growing businesses that are
contemplating entering the public capital markets in due course of time and
thus give them an opportunity to prepare themselves for adopting full IFRSs.

South Africa is an example of a country that required all
companies to use IFRS and has responded very positively to benefits for SMEs
proposed by the new standard. It had adopted the Exposure Draft which preceded
the IFRS for SMEs in October 2007 as a ‘Statement of Generally Accepted
Accounting Practice for SMEs in South Africa’ in a bid to reduce the reporting
burden on SMEs and provide them with a simpler accounting framework that was
easier to understand and apply than full IFRS. Further, it has quickly published
the final version of the IFRS for SMEs (without any change to the text) as a
‘Statement of Generally Accepted Accounting Practice’ with relevant entities
allowed to apply it for annual financial statements authorised for issue after
13th August 2009.

In India, the concept paper on Convergence with IFRS, issued
by the Institute of Chartered Accountants of India aims to converge Indian
accounting standards to the equivalent of full IFRS for all public interest
entities effective 1st April 2011. In its present form, companies with turnover
exceeding Rs.100 crores or with borrowings in excess of Rs.25 crores qualify as
‘public interest entities’. This is expected to include a significant number of
unlisted entities. The concept paper refers to use of IFRS for SMEs only for
non-public interest entities.

Basis :

The principles enshrined in this standard have been derived
from IFRS foundation itself. However, so as to ensure that it addresses the
specific needs of users of SMEs’ financial statements and cost-benefit
considerations, many of the complexities inherent in the full IFRSs have been
removed. Furthermore a cost-benefit approach has been taken in developing the
IFRS for SMEs, with the emphasis being on easing the financial reporting burden
on private companies.

The key differences are enumerated below :

Topics not relevant to SMEs have been omitted.

Where full IFRSs allow accounting policy choices, the
IFRS for SMEs allows only the easier option.

Many of the principles for recognising and measuring
assets, liabilities, income and expenses in full IFRSs have been simplified.

Significantly fewer disclosures are required.

The standard has adopted a simplified redrafting so as to
facilitate ease of understanding and translation.

Moreover to further reduce the reporting burden for SMEs,
revisions to the IFRS will be limited to once every three years.

Full IFRS	IFRS for SMEs
Numbered by Standard	Organised by topic (e.g., inventories)
Around 3,000 potential disclosures	Around 300 potential disclosures
Around 2,800 pages in length	Less than 230 pages
Updated several times a year	Anticipated to be updated on a 3-yearly basis

Unlike full IFRS, the IFRS for SMEs contains illustrative
financial statements and a disclosure checklist. With around only 300 potential
disclosure requirements, compared to 3,000 under full IFRS, the advantages of
the IFRS for SMEs in terms of the amount of time to be spent preparing the
financial statements are already clear. The point is underlined however, by the
Illustrative Financial Statements that the IASB has prepared to accompany the
Standard. At just 17 pages in length, they compare favourably to full IFRS
financial statements which often run to over 100 pages.

Omitted topics :

The IFRS for SMEs does not address the following topics that
are covered in full IFRSs :

Earnings per share
Interim financial reporting
Segment reporting
Special accounting for assets held for sale.

Examples of options in full IFRSs NOT included in the IFRS for SMEs :

Financial instrument options, including available for sale, held-to-maturity and fair value options

The revaluation model for property, plant and equipment, and for intangible assets

Proportionate consolidation for investments in jointly-controlled entities

For investment property, measurement is driven by circumstances rather than allowing an accounting policy choice between the cost and fair value models

Various options for government grants.

Conclusion:

The potential of this new standard is that SMEs catapult themselves to a position where stakeholders (lenders and investors) would be able to assess company performance from financial statements that use directly comparable, authoritative, internationally recognised principles, regardless of the company’s country of origin. Further this transition to IFRS framework for them would be at a significantly reduced cost, as the standard has endeavored to reduce the complexities in accounting for transactions and disclosure of financials as compared to full IFRSs.

Nirav Shah

Deficiency in service by builder : Consumer Protection Act, 1986 S. 2(1)(g).

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Deficiency in service by builder : Consumer Protection Act,
1986 S. 2(1)(g).

[ Madan Builders v. R. K. Saxena, AIR 2009 (NOC)
2551 (NCC)]

Complainant purchased two shops in commercial complex. The
builder instead of providing two lifts as promised in advertisement and
brochure provided only one lift and that too was not a glass capsule lift as
promised. The reason was stated that glass capsule lift was not approved by
local administration. The Commission held that there was false representation
for luring complainant to make investment. Even the two shops booked by
complainant were changed by builder, without his consent and were allotted to
some other party. It was held that the deficiency in service was apparent as
builder failed to provide facilities as promised in representation made as per
advertisement and brochure. Thus the complainant was entitled to compensation
with interest.

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Nirav Shah

Memorandum of understanding — Void contract : Civil Court cannot refuse to entertain suit even if based on void contract.

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Memorandum of understanding — Void contract : Civil Court
cannot refuse to entertain suit even if based on void contract.

[ Govind Goverdhandas Daga and Mohan Brindavan Agrawal,
Field Mining and Ispat Ltd., (2009) Vol. 111(8) Bom L.R. 3524]

Plaintiffs No. 1 and 2 entered into Memorandum of
Understanding with Defendant No. 2 who was a director of Defendant No. 1
company. As per the MOU it was agreed that each family was to hold equal
shares in Defendant No. 1 company either directly or through family members.

The Plaintiffs paid Rs.3 lacs each as share application
money. As defendants failed to abide by the MOU the plaintiffs filed suit for
specific performance and permanent injunction. Defendants filed application
under Order 7 Rule 11 CPC for rejection of plaint contending that Memorandum
of Understanding was never acted upon by the parties and was entered into by
the director i.e. Defendant No. 2 in his individual capacity. Defendant
No. 1 had nothing to do with the said memorandum of understanding, no cause of
action disclosed and suit hit by provisions of Companies Act and Coal Mines
Act. Civil Judge rejected the plaint.

On further appeal the Court held that even if we assume
that the Memorandum of Understanding is void and illegal yet there was no law
which prohibits institution of suits and taking of its cognisance. Assuming
Memorandum of Understanding to be void that still does not prohibit plaintiffs
from approaching the court and deciding the question of its validity on merit.

The Court will always have to consider the facts, evidence
and the law to find out if the contract between the parties is enforceable or
not. The court may ultimately refuse its specific performance and may also
hold the contract to be void but there is nothing which prohibits the civil
court from entertaining such a suit.

Thus a party to void contract is still entitled to
institute a suit for enforcement of the contract and in the alternative to
pray for refund of the money.

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Nirav Shah

Award — Enforcement of foreign award.

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Award — Enforcement of foreign award.

[ Hugo Neu Corporation v. M/s. Llyods Steel Inds. Ltd.,
AIR 2009 (NOC) 2483 (Bom.); 2009 (5) AIR Bom R. 158]

A petition was filed u/s.47 of the Arbitration and
Conciliation Act, 1996 seeking Enforcement of an Award dated 10th October
1999, made in United States of America.

The question raised for consideration was whether the party
viz., the petitioner applying for enforcement of a Foreign Award has at
the time of the application produced before the Court the documents stipulated
by S. 47(1)(a) to (c) and whether the petitioner has produced a copy of the 26
Award duly authenticated in the manner required by the law of U.S.A.

There was no dispute that the Award is a foreign Award. To
that extent the evidence had also been produced. There was no dispute that
there was an agreement for Arbitration.

It was held that the petition should be accompanied by the
Award or a duly authenticated copy thereof. As per Rule 803-C of the Bombay
High Court O.S. Rules. Reading S. 47(1) so also Rule 803(C)(c) together, all
that was required was that the party applying for enforcement of Foreign Award
shall at the time of the application produce before the Court, the original
Award or copy thereof.

In facts of present case admittedly, the petitioner had
produced a copy of the Award duly authenticated under the law prevailing in
U.S.A.

The petitioner had also filed the affidavit to satisfy the
Court that the copy of the Award accompanying the Arbitration petition was
duly authenticated in the manner required by the law of the country in which
it was made. Respondent does not dispute the manner in which the
authentication has been done.

The Court held that a duly authenticated copy of the Award
was already filed and what was lacking was proof of the manner in which it was
authenticated but even that aspect has now been clarified by the affidavit and
the objection raised was overruled.

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Nirav Shah

Adjournment of hearing — Unaware of decision.

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Adjournment of hearing — Unaware of decision.

[Sunil Shipping Agency v. Commissioner of Customs (ACC &
Exports) Mumbai, 2009 (242) ELT 541 (Trib.-Mumbai)]

An application was moved before the Tribunal for waiver in
relation to the requirement of pre-deposit of the amount ordered to be paid
under the impugned order. The appellant had relied on the decision of Bombay
High Court in Commissioner of Customs (E.P.) v. Jupiter Exports, (2007)
213 ELT 641 (Bom.). The DR also submitted its arguments and relied on various
decisions of High Court and Tribunal.

With reference to the decision relied on by the DR. the
Advocate for the appellant submitted that he was not aware of the said
decision and therefore, time should be granted to him to go through the same
and to make submissions and for that purpose matter should be adjourned.

The Tribunal rejecting the request for adjournment held
that merely because the advocate for a party is unaware of the decisions cited
by the opposite party that cannot be a ground for adjournment of the hearing.
The advocate for the party very well can go through the judgment and make his
submission. Therefore, the question of adjournment of the matter on the said
ground cannot arise. On merits the application were disposed of directing the
appellants firm to deposit the amount.

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Nirav Shah

‘Literary work’ and ‘dramatic work’ Copyright Act. S. 2(o), (h).

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‘Literary work’ and ‘dramatic work’ Copyright Act. S. 2(o),
(h).

[Academy of General Education, Manipal & Anr. v. B.
Malini Mallya, AIR 2009 SC 1982]

One Dr. Karanth, a Jnanapeeth awardee had developed a new
form of ‘Yakshagana’ (a form of ballet dance). He was a director of the
appellant institute. Before he expired, he had executed a will in favour of
the respondent.

The said Yakshagana ballet dance was performed in New
Delhi. Respondent filed a suit for declaration, injunction and damages
alleging violation of the copyright in respect of the said dance vested in her
in terms of the said will and thus the appellants infringed the copyright
thereof by performing the same at New Delhi without her prior permission. The
respondent had claimed copyright in respect of literary and artistic works in
her favour in terms of the said will. The appellant denied and disputed any
copyright of the said dance in Dr. Karanth alleging that whatever work he had
done was in a capacity of a director of the Kendra and assistance of finance
and staff of the organisation.

S. 2(c) of the Act defines ‘artistic work’ to mean (i) a
painting, a sculpture, a drawing (including a diagram, map, chart or plan), an
engraving or a photograph, whether or not any such work possesses artistic
quality; (ii) a work of architecture; and (iii) any other work of artistic
craftsmanship.

The word ‘author’ is defined in S. 2(d) to mean, (i) in
relation to a literary or dramatic work, the author of the work; (ii) in
relation to a musical work, the composer; (iii) in relation to an artistic
work other than a photograph, the artist; (iv) in relation to a photograph,
the person taking the photograph; (v) in relation to a cinematograph film or
sound recording, the producer; and (vi) in relation to any literary, dramatic,
musical or artistic work which is computer generated, the person who causes
the work to be created.

S. 2(o) defines ‘literary work’ to include computer
programmes, tables and compilations including computer databases. S. 2(qq)
defines ‘performer’ to include an actor, singer, musician, dancer, acrobat,
juggler, conjurer, snake charmer, a person delivering a lecture or any other
person who makes a performance.

The Court observed that a dramatic work may also come
within the purview of literary work being a part of dramatic literature.
However, provisions of the Act make a distinction between the ‘literary work’
and ‘dramatic work’. Keeping in view the statutory provisions, there cannot be
any doubt whatsoever that copyright in respect of performance of ‘dance’ would
not come within the purview of the literary work but would come within the
purview of the definition of ‘dramatic work’.

The Court dismissed the appeal by modification of the
injunction order granted by High Court.

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Nirav Shah

Whether interest u/s.234A can be levied in case of delayed Return of Income even if self-assessment tax is paid before the due date ?

Closements

Introduction :

1.1 S. 234A provides for interest in case of default in furnishing return of income as provided in the Income-tax Act (the Act). S. 234A(1) effectively provides that if the return of income u/s.139(1)/(4) or in response to notice u/s.142(1) is furnished after the due date (or is not furnished), the assessee is liable to pay simple interest @ 1% for every month or part of a month for the period of delay. (In case of failure in furnishing the return of income also provision is made with which we are not concerned in this write-up.) The rate of interest was originally 2% per month, which has subsequently been reduced from time to time. Such interest is payable on the amount of tax on the total income as reduced by the advance tax, if any, paid and TDS (or TCS). Considering the issue under consideration in this write-up, it is assumed that the returned income is accepted and the amendment made by the Finance Act, 2007 with regard to granting credit for relief u/s.90, etc. is not relevant. In the context of this write-up, effectively, interest u/s.234A(1) is required to be charged on the tax on such total income as reduced by advance tax, if any, paid and TDS or TCS.

1.2 In many cases, furnishing of return of income gets delayed on the part of assessee for various reasons. However, in such cases, the assessee, in many cases, decides to pay the self-assessment tax before the due date of return of income. In such cases, the issue is under debate as to whether interest u/s.234A(1) can be charged even if the assessee has paid the full amount of tax before the due date of return by way of self-assessment tax. In short, the issue is: whether for the purpose of determining the amount of interest u/s.234A(1), tax paid by way of self-assessment before the due date of return of income can be given credit or not as there is no specific provision to grant such credit for such purpose. The Courts are divided on the issue.

1.3 Recently, the Apex Court had an occasion to consider the issue referred to in Para 1.2 above in the case of Dr. Prannoy Roy and Another and the issue got resolved. Considering the importance of the issue, it is thought fit to consider this judgment in this column.

Dr. Prannoy Roy and Another v. CIT and Another,

254 ITR 755 (Delhi) :

2.1 The above case was concerned with A.Y. 1995

96. The brief facts were: The assessee had made substantial capital gain and the return of income

was due to be filed on 31-10-1995, but such return was actually filed on 29-9-1996 (i.e., delay of about eleven months). However, the assessee has paid taxes due on 25-9-1995 (i.e., before the due date of furnishing the return of income). The return of income was accepted on 29-1-1998, but interest u/s. 234A was charged on the ground that the tax paid on 25-9-1995 cannot be reduced from the tax due on assessment for the purpose of determining the amount of tax on which interest is chargeable u/s. 234A(1). The assessee had filed revision petition u/s.264 before the Administrative Commissioner, requesting him to delete the interest u/s.234A charged by the Assessing Officer (AO). However, the Commissioner passed an order dated 9-3-1999 confirming the action of the AO on the ground that there is no provision in 234A to grant credit for self-assessment tax paid on 25-9-1995 and the interest u/s.234A compensates for the delay/default in filing return of income and not the tax. Against this order, the assessee filed the writ petition before the Delhi High Court. Accordingly, the issue referred in Para 1.2 above came up for consideration before the Delhi High Court.

2.2 For the purpose of determining the issue, the High Court referred to the provisions of S. 234A and also the historical background thereof as given in CBDT Circular No. 549, dated 31-10-1989 [182 ITR (St.) 37]. After referring to this, the Court noted that it is not in dispute that S. 234A of the Act is an amalgam of earlier S. 139(8), S. 271(1)(a) and S. 140A(3) of the Act. The said provisions mandate payability of the tax as the basis for calculation of the compensation or penalty due to the Department in case of violation.

2.3 The Court, then, considered various judgments of Courts [including the judgment of the Apex Court in the case of Central Provinces Manganese Ore Co. Ltd. (160 ITR 961), in which the Courts have taken a view that interest is compensatory in nature. The Court also noted the judgment of the Karnataka High Court in the case of Dr. S. Reddappa (234 ITR 62), wherein after considering various case laws, the Court has taken a view that it is fairly obvious that provisions of S. 234A, S. 234B and S. 234C, which replace the earlier provisions postulating payment of interest and are in pari materia with the said provisions cannot be anything except compensatory in character. The only material difference in the two sets of provisions is that while the old provisions conferred power to waive or reduce the levy of interest, the impugned provisions make the same automatic.

2.4 The Court then proceeded to consider the principles of interpretation of taxing statute and stated that it is true that the Court must interpret the provisions of the statute upon ascertaining the object of the Legislature through the medium or authoritative forms in which it is expressed. It is well-settled that the Court should, in such cases, assign its ordinary meaning. Referring to the judgment of the Apex Court in the case of Anjum M. H. Ghaswalla (251 ITR 1), the Court stated that it is well settled that for the purpose of imposition of penal interest express provision in that regard in a statute must exist. The Court, then, further observed as under (Page 763) :

“In relation to beneficent construction, the basic rules of interpretation are not to be applied where

(i) the result would be re-legislation of a provision by addition, substitution or alteration of words and violence would be done to the spirit of the provision; (ii) where the words of a provision are capable of being given only one meaning; and (iii) where there is no ambiguity in provision — where there is a doubt, however, the Court may apply the rule of beneficent construction in order to advance the object of the Act [see Shyam Sunder v. Ram Kumar, (2001) 8 SCC 24; AIR 2001 SC 2472].

We are not unmindful that the golden rule of interpretation of a statute is that it should be read liberally.”

2.5 After considering the above, the Court also stated that it is equally well settled that where the statute is capable of two interpretations, the principles of just construction should be taken recourse to.

2.6 Referring to the contentions raised on behalf of the Revenue, the Court observed as under Wage 764) :

“The contention of the Revenue is that by reason of S. 234A, interest is charged for default in filing return as regards whereto it does not cease or stop with payment of taxes, whereas on the other hand, the contention of the assessee is that in a situation of this nature, where the assessee could not file a return for reasons beyond his control, he is not liable to pay interest, as thereby the Revenue does not suffer any loss inasmuch as tax, although strictly not in terms of definition of advance tax as contained in S. 208 of the Act, has been paid, but tax therefore has already been paid.

For the purpose of determining the issue, it is necessary to consider as to whether penalty and interest both were charged for failure to perform a statutory obligation. We think not. Failure to comply with the statutory provisions may lead to penal consequences. Interest, on the other hand, is payable either by way of compensation or damages. Even penal interest can be levied only in the case of a chronic defaulter.”

2.7 Referring to the Full Bench judgment of Andhra Pradesh High Court in the case of SMS Schloemann Siemeg, A.G. (254 ITR 97), the Court stated that in this judgment, the High Court has taken a view that interest is payable if the sum is due. Where the assessee is in default in making payment of the assessed amount demanded from him, he is liable to pay interest by way of compensation, but the same would not mean that although there does not exist any demand, interest would become payable. After referring to this judgment, the Court took the view that in a situation of this nature, the commonsense meaning of ‘interest’ must be applied even in S. 234A of the Act. The Court also referred to the dictionary meaning of the word ‘interest’ to show that the same is compensatory in nature. To support the view that interest cannot be charged when no tax is outstanding, the Court also relied on the judgments of the Apex Court in the cases of Shashikant Laxman Kale (185 ITR 105) and Ganesh Das Sreeram (169 ITR 221).

2.8 Dealing with the principles of imposition of penalty, the Court observed as under (Pages 766-767) :

“Penalty cannot be imposed in the absence of a clear provision. Imposition of penalty would ordinarily attract compliance with the principles of natural justice. It in certain situations would attract the principles of existence of mens rea. While a penalty is to be levied, discretionary power is ordinarily conferred on the authority. Unless such discretion is granted, the provisions may be held to be unconstitutional.”

2.9 Having referred to the above principles, the object of levying interest and the nature of interest, the Court opined that in situation of this nature, the doctrine of purposive construction must be taken recourse to. For this, the Court referred to various judgments dealing with the principle of purposive construction to support the opinion formed by the Court.

2.10 Referring to the contentions raised by the counsel on behalf of the Revenue to the effect that such payment of tax cannot be a ground for not charging interest u/s.234A and that will defeat the object and purpose u/s.234A, the Court stated that the object of S. 234A is to receive interest by way of compensation, if such was not the intention of the Legislature, it could have said so in explicit terms.

2.11 The Court then took notice of insertion of 271F w.e.f. 1-4-1999, providing for penalty for delay/default in furnishing return of income as referred to therein. The Court also noted the object of introducing this provision as explained in the memorandum explaining the insertion of the provision. Having referred to this, the Court stated that the purpose and the object of the Act is to realise the direct tax. It imposes a fiscal burden. When the statute says that an interest, which would be compensatory in nature, would be levied upon the happening of a particular event or inaction, the same by necessary implication would mean that the same can be levied on an ascertained sum. The Court then also considered the meaning of the term ‘advance tax’ in the context of this situation and observed as under (page 769):

“The interpretation clause, as is well known, is not a positive enactment. The interpretation clause also begins with the word ‘unless the context otherwise requires’. Advance tax has been defined to mean the advance tax payable in accordance with the provisions of Chapter XVII-Co Such a definition is not an exhaustive one. If the word ‘advance tax’ is given a literal meaning, the same apart from being used only for the purpose of Chapter XVII-C may be held to be tax paid in advance before its due date, i.e., tax paid before the due date. The matter might have been otherwise, had there been an exhaustive definition of the said provision. The scheme of payment of advance tax is that it will have to be paid having regard to the anticipated income on September 15, December 15 and March 15. A person, who does not pay the entire tax by way of advance tax, may deposit the balance amount of tax along his return.

In the instant case, tax has been paid although no return has been filed. The Revenue, therefore, has not suffered any monetary loss.”

2.12 Finally, the Court took the view that in this case if the doctrine of purposive construction is not applied, the same may betray the purpose and object of the Act. Otherwise, we will have to read the penal provision in 234A, which was not and could not have been the object of the law for the reasons stated hereinbefore. The Court also stated that it is further well known that in the case of a doubt or dispute, taxation statute must be liberally construed. Therefore, we are not in a position to assign stringent meaning to the words, ‘advance tax’ as contended by the learned counsel on behalf of the Revenue.

2.13 Rejecting the contention raised on behalf of the Revenue with regard to the penal nature of the provision, the Court stated as under (Page 770) :

“If a penal provision is to be read in S. 234A, the same may border on unconstitutionality, as there-for the principles of natural justice are not required to be complied with. It is also well settled that when two constructions are possible, the construction which would uphold the constitutionality of a provision, be applied. Had the Leg-islature made the amendment only for the purpose of imposition of a penalty, there was no necessity of enacting S. 271F later on.”

2.14 Finally, the Court concluded that interest would be payable only in a case where tax has not been deposited prior to the due date of filing of the income-tax return and decided the issue in favour of the assessee.

CIT v. Dr. Prannoy Roy and Another, 19 DTR 102 (SC) :

3.1 At the instance of the Revenue, the above judgment of the Delhi High Court came up for consideration before the Apex Court along with another case, wherein the same was followed.

3.2 After referring to the facts in brief and the views expressed by the High Court, the Court decided the issue in favour of the assessee and held as under (Page 103) :

“Having heard counsel on both sides, we entirely agree with the finding recorded by the High Court as also the interpretation of S. 234A of the Act as it stood at the relevant time.

Since the tax due had already been paid, which was not less than the tax payable on the returned income which was accepted, the question of levy of interest does not arise. Thus, we find no merit in this appeal and the same is dismissed.”

Conclusion:

4.1 In view of the above judgment of the Apex Court, it is clear that interest u/ s.234A is compensatory in nature and the same cannot be charged if taxes are paid before the due date of furnishing return of income even if the furnishing of return gets delayed. It is also important to note that the Apex Court has agreed with the findings as well as interpretation of the High Court with regard to S. 234A.

4.2 Recently the Gujarat High Court in the case of Roshanlal S. Jain (309 ITR 174) has taken a contrary view on the issue referred to in Para 1.2 above and has dissented from the judgment of the Delhi High Court in the case of Dr. Prannoy Roy (supra). This has not been referred to in the above case before the Apex Court. However, in view of the above judgment of the Apex Court, the judgment of the Gujarat High Court will now no longer be regarded as given.

4.3 Incidentally, it may be mentioned that while filing an appeal against the levy of interest, care should be taken to deny the liability to pay such interest, so that the issue of maintainability of appeal against such interest does not create any difficulty.

Nirav Shah

Addition to value of closing stock and MAT

1.0 Facts of the case :

1.1 The following is the Profit and Loss account of ABC Ltd. for the year ended 31st March, 2006.

The company values its stock at lower of the cost or the net realisable value (NRV). The NRV in this case was lower than the cost.

1.2 The company filed the return of income for A.Y. 2006-07 as under:

1.3 The Profit and Loss account of the company for EY, 2006-07 relevant to A.Y. 2007-08 was as under:

1.4 The company declared income in its return for A.Y. 2007-08 as under:

1.5 Since there was no tax payable under the normal computation of income and since there was book profit as worked out u/s.115JB of the Act, the company paid MAT for A.Y. 2007-08 on the book profit of Rs.0.25 cr.

1.6 Thereafter, the AO completed assessment for A.Y. 2006-07 by adding Rs.0.25 cr. to the value of the closing stock on the ground that the company should have valued its stock at cost instead of at an amount being the lower of the cost or the NRV. Since the final tax still was nil the company did not opt to file an appeal. The assessed loss stood at Rs.0.25 cr. in place of the returned loss of Rs.0.50 cr.

1.7 The AO accepted the return for A.Y. 2007-08. Believing that the adjustment to the value of the closing stock would have a bearing on the taxable income of the succeeding year, the assessee contended in an application made u/ s.154 of the Act for A.Y. 2007-08 that the value of the opening stock should be adjusted by the amount of the adjustment made to the value of the closing of stock of the preceding year. It also contended that a similar adjustment should also be made to the book profit worked out u/s.115JB. According to the company, the revised book profit for A.Y. 2007-08 should appear as under:

It claimed refund of MAT paid.

1.8 The Aa rejected the application in so far as it concerned adjustment to the book profit, on the grounds that:

i) the accounts of the assessee for the year relevant to AY. 2007-08 were prepared in accordance with the provisions of parts II and III of Schedule VI to the Companies Act, 1956; and

ii) therefore, he had no power to make any adjustment to the book profit, as was held by the Honourable Supreme Court in Apollo Tyres Ltd. v. ClT, (2002) 255 ITR 273 and ClT v. Comnet Systems & Services Ltd., (2008) 305 ITR 409.

1.9 The company seeks your advice on whether an appeal should be filed against the stand of the AO.

2.0 Advice:

2.1 The company is advised to prefer an appeal for the reasons to be stated hereafter.

2.2 It is true that in the cases referred to by the AO, the SC held that the AO does not have power to make adjustment to the book profit other than the adjustments permitted in the provisions relating to MAT. The SC, however, did not say that no adjustment can ever be made by the AO to the book profit. The AO is empowered to make the permitted adjustments. Let us, therefore see the nature of the adjustment made by the AO in the form of addition to the value of closing stock for AY. 2006-07, and whether the adjustment sought by the assessee is a permitted one.

2.2.1 The assessee valued the closing stock at the lower of the cost or the NRV. Therefore, when the assessee found the NRV of the stock to be lower than the cost for AY. 2006-07, it scaled down the value of stock as at 31st March, 2006 in the books. Thus, the assessee effectively created a provision for eventual loss that might be incurred at the time of realisation of stock. When the AO did not allow the reduction in the value of stock for AY. 2006-07, what he was effectively doing was that he was disallowing the provision for loss, and he was permitted to make such adjustment to the ‘book profit’ for AY. 2006-07. (I leave aside for the present the ratio of decisions that hold that a provision in recognition of reduction in value of an asset is not it was not challenged in appeal). However, since the total book loss for A.Y. 2006-07 at Rs.0.50 cr. exceeded the disallowance of Rs.O.25cr., there was a negative ‘book profit’ after the said adjustment and there was no liability for AY. 2006-07 u/s.115JB of the Act.

2.2.2 It must be noted that though the Aa disallowed the hidden provision for loss in A.Y. 2006-07, the assessee had not made any corresponding changes in its books in the succeeding year. As a result, the assessee continued to carry the hidden provision in the books. In the next year relevant to AY. 2007-08, the profit and loss account of the assessee can be restated as under:

Based on the above, the assessee has the right to exclude the credit of Rs.0.25 cr. from the book profit since that figure represents provision recalled which was not allowed while computing the book profit for AY. 2006-07. S. 115JB, in clause (i) of Explanation (1) to S. 115JB, read with Proviso thereto, permits exclusion from the book profit of the amount withdrawn from reserve or provision (excluding a reserve created before 1-4-1997, otherwise than by way of a debit to the profit and loss account), if any such amount is credited to the profit and loss ac-count. The only issue that can survive is: whether the provision recalled at Rs.0.25 cr. as shown in the restated profit and loss account is an amount credited to the profit and loss account and thereby forming part of the book profit and therefore meriting exclusion from the book profit, for one may remember that this amount was not originally credited in the account and it appeared only in the rested profit and loss account. The author is of the view that though this amount did not appear in credit in the original profit and loss account, it was nevertheless de facto credited in the profit and loss account as is shown in the restated profit and loss account which is the same as the original profit and loss account except that it differs in presentation. It is submitted that the substance of a transaction rather than its presentation should decide taxability or otherwise.

2.2.3.1 There is one more aspect to be considered also. The assessee has prepared accounts for both the years following accounting standards in general and AS-2 relating to valuation of inventory in particular. Therefore, a question can arise whether there was any mistake committed by the AO in the next year as far as the working u/s.115JB is concerned. If there was no mistake, no rectification will lie u/s.154 of the Act.

2.2.3.2 In my view, it is true that AS-2 has been followed by the assessee for valuing inventory and therefore there is no mistake in the accounts which could be the subject matter of rectification u/s.154 of the Act. However, the AO, in my view, cannot take two different stands in two years in respect of one and the same issue. The AO holds the view for AY. 2006-07 that there is an uncalled for provision for loss in respect of closing stock, which should not be allowed. Here, for AY. 2006-07, I concede to the AO the right to make adjustment to the book profit of that year without providing justification to his right. However, as shown above, the book profit still would be a negative figure after such addition and the addition would have had no effect on the final tax. Now, when the AO comes to A.Y. 2007-08, he cannot hold the’ view that the addition to the closing stock for AY. 2006-07,which is also the opening stock for AY. 2007-08, did not represent addition on account of an uncalled for provision. If he could have made adjustment to the book profit for AY. 2006-07 on account of the addition, he should make adjustment to the book profit for AY. 2007-08. In other words, it is expected that the AO keeps his stand consistent for both the years.

3.0 Thus, in view of the above, the assessee is not liable to MAT for AY. 2007-08. MAT paid by it should be refunded.

Author’s Note:
There can be other angles to the issue. For example, it is a question whether the booking of reduction in value of stock in this case was a provision for a loss or was recognition of an actual loss. If it is a provision, the amended S. 115JB now may not permit reduction of the book profit by such amount, whereas if it is recognition of an actual loss, the provisions may permit reduction of the book profit. The issue discussed here also shows that it is advisable, in case the NRV of an inventory is less than the cost, that a separate provision is made by debiting the profit and loss account instead of reducing the closing value of the inventory in the trading account and recall such provision to the trading account in the next year and repeat the process every year. Thus, in case such a provision is disallowed u/s.115JB, its recall next year cannot form part of the book profit.

Nirav Shah

TDS and S. 40(a)(ia) of the Income-tax Act, 1961

1.0 Facts :

1.1 ABC Ltd. credits on 1st October, 2009 the account of Mr. X, a resident, with Rs.55,000 being commission on sales payable to him. ABC Ltd. deducts tax at source @ 5% being oblivious of the actual rate applicable. This results in a short deduction of tax of Rs.2,750.

1.2 ABC Ltd. also credits on the same day the account of Mr. Y, a resident, with Rs.55,000 being commission on sales payable to him. The company deducts tax at source @ 15%. This results in an excess deduction of tax of Rs.2,750.

1.3 The company has made accounting entries in accordance with the above facts, and cleared the accounts of Mr. X and Mr. Y before 31st December, 2009. Thus, the balances in these accounts are reduced to nil. It is believed that in neither account any further credit will arise till 31st March, 2010.

1.4 The company uploads its quarterly TDS statement with the above information.

1.5 When the CFO of the company is informed that commission paid to Mr. X is likely to be disallowed u/s.40(a)(ia) on account of short deduction of tax thereon, he argues that there is no overall short deduction when payments to Mr. X and Mr. Y are considered together.

1.6 The company seeks your opinion about the allowability of deduction in respect of commission paid to Mr. X. The company also seeks your views on whether the company is liable to pay interest u/s.201 in respect of this short deduction of tax.

2.0 Opinion :

2.1 Let us first see how S. 40(a)(ia) when read with the substantive part S. 194A would work. For a better comprehension, substantive parts of S. 40(a)(ia) and S. 194A are reproduced below :

40(a)(ia) : “any interest, commission or brokerage, rent, royalty, fees for professional services or fees for technical services payable to a resident, or amounts payable to a contractor or sub-contractor, being resident, for carrying out any work (including supply of labour for carrying out any work), on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid”.

194A : “(1) Any person, not being an individual or a Hindu undivided family, who is responsible for paying to a resident any income by way of interest other than income by way of interest on securities, shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force :

2.1.1 The following features of S. 40(a)(ia) when r.w. the substantive part of S. 194A stand out in order that the provisions of S. 40(a)(ia) may apply.

(i) Tax on interest is deductible in respect of every credit or payment of interest if the amount of credit or payment exceeds or is likely to exceed the specified amount in a financial year. Thus, the liability is fastened to credit or payment, as the case may be.

(ii) Tax on specified incomes should be deductible under Chapter XVII-B.

(iii) Such tax should not have been deducted;

(iii) after deduction, such tax should not have been paid before the specified dates.

2.1.2 It is admitted that tax in this case is deductible since income is a specified income and that the full tax has not been deducted. Further, when taxes deducted from payments made to Mr. X and Mr. Y are taken together, there is no shortfall.

2.2 The following issues arise out of the facts and the queries :

(i) Whether full tax at source should be deducted and paid on a specified income in order that no disallowance u/s.40(a)(ia) may be made.

(ii) Whether some tax deduced at source and paid to the Treasury on a specified income can make S. 40(a)(ia) inapplicable making thereby the entire underlying income eligible for deduction.

(iii) Is it possible that the amount of disallowance u/s.40(a)(ia) is restricted to the amount which bears to the amount of expenditure the same proportion as the amount of tax not deducted bears to the amount of full tax ? In other words, can the amount of disallowance be decided by the formula :

(iv) Whether an excess tax deduction in one case can be adjusted against shortfall arising in another case so as to avoid disallowance u/s.40(a)(ia) and interest.

2.2.1.1 As regards the first issue, a view can be taken that a small shortfall may make the entire underlying expenditure disallowable u/s.40(a)(ia). The reason for holding this view is that S. 40(a)(ia) applies when a tax in respect of a specified income is deductible and such tax has been either not deducted or not paid. Therefore, in this case, Rs.5,500 was the tax deductible from the payment made to Mr. X, and therefore, such tax should have been deducted and paid if one wants to avoid disallowance under these provisions. Since such tax was not deducted and paid, S. 40(a)(ia), prima facie, becomes applicable making the entire underlying expenditure disallowable.

2.2.1.2 Another view can also be taken that if some as against the full tax is deducted from credits or payments of specified incomes, full allowance for the underlying expenditure should be made. The reason for holding this view is that, as seen above, S. 40(a)(ia) will primarily apply if there is a tax deductible in respect of a specified income and such tax has not been deducted, meaning thereby, that full of such tax should not have been deducted. In other words, in order that this case may fall in S. 40(a)(ia), the amount not deducted should be Rs.S,SOO,no more and no less. In case a part deduction of tax has been made, as in the case of payment to Mr. X, no disallowance u/s.40(a)(ia) can be made.

2.2.1.3 I must admit that the views expressed in paragraphs 2.2.1.1 and 2.2.1.2 are unreasonable and outrageously extreme. A person, who deducts some tax from a specified income and another person who does not deduct any tax at all from a similar income, cannot be treated on par. If the views expressed in paragraph 2.2.1.1 are accepted, both these persons suffer full disallowance whereas the offence of the first person is certainly mitigated by the fact he has made some deduction of tax at source. For similar reasons, the views expressed in paragraph 2.2.1.2 can also not be accepted as these views put on par persons who have fully complied with the law, with persons who have shown no compliance at all. It would be absurd to say that two persons, one of whom has made the full payment of tax at source of Rs.5500 and the other person who has made no payment at all, will both enjoy full allowance of the underlying expenditure.

2.2.2 Therefore, the better view is that disallowance of the expenditure is restricted to the amount which bears to the amount of expenditure the same prociate that any amount is mathematically a sum of several amounts and any amount can be broken up into several sub-amounts. For example, a thousand is also a summation of eight hundreds and two hundreds, and likewise. Thus, a view can be taken, when Rs.2,7S0 is deducted in the case of Mr.X, that the underlying expenditure in respect thereof is Rs.27,SOO. Viewed thus, there is full deduction of tax @ 10% from Rs.27,500. The remaining Rs.27,500 of the expenditure is the amount in respect of which the default has been committed. It is this last amount which will suffer disallowance.

2.3.1 We shall now deal with issue No. 4 : whether excess deduction in one case can be adjusted against the shortfall arising on account of short deduction in anether case. In this particular case, since the information with excess and short deduction of tax has been uploaded, inter account adjustment between the two accounts is not possible unless this information is revised and reuploaded. The obligation on a person is to deduct proper tax in respect of an expenditure. Though expenditures incurred in favour of Mr. X and Mr. Y have a similar nature, they represent different expenditures, and there is admittedly a default committed in respect of payment made to Mr. X. Therefore, the excess deduction of tax in the case of payment to Mr. Y will not be available for adjustment against the shortfall of tax in the case of Mr. X.

2.3.2 However, inter account adjustment between Mr. X and Mr. Y would have been possible before uploading the information in the quarterly statement by debiting Mr. X’s account in whose case short tax was deducted and crediting Mr. Y’s account in whose case an excess tax was deducted and thereby a net short payment of commission was made. The company would, thereafter, recover Rs.2,750 from Mr. X and pay it over to Mr. Y. Or else, if the company is unable to recover such amount from Mr. X, the company could write it off and claim it as a commercial loss. It should be remembered that such tax borne by the company is not ‘a tax levied on the profits or gains ,of any business or profession’, and therefore S. 40(a)(ii) operating as a disallowance of expenditure by way of income-tax, will not apply.

Needless to say that if inter account adjustment is carried out between the accounts of Mr. X and Mr. Y, the TDS certificates should be issued accordingly.

3.0 Conclusion:

The amount to be disallowed in this case should be Rs. 27,500, that is, on a proportionate basis. No inter account adjustment is possible once the information is uploaded; unless the information is revised. TDS certificates should be issued in accordance with the information uploaded.

Nirav Shah

Auditing Companies’ Ethics

Accountant Abroad

Questions have been raised about the conduct of business on
the back of the global market collapse. Is the profession ready to be called
upon to audit companies’ ethics ? Michelle Perry reflects on this question in an
article published in Accountancy magazine (February 2009).

As the bewildering number of strands to the present global
financial crisis unfolds and new precedents are set daily, the role of the
accountancy profession in the financial meltdown is under review.

In the wake of the corporate collapses that began with Enron,
the finger was pointed keenly at auditors, who were demonised to such an extent
that lawmakers in Europe and America were kept so busy drafting new accounting
rules and regulations that any real in-depth analysis of the causes of those
corporate disasters didn’t happen until long after new rules were already in
place. But the rules did not prevent Madoff’s giant Ponzi scheme — at this
stage, it isn’t clear whether any of the audit firms should have known about the
scheme when they performed, for example, due diligence work for clients and
funds that lent him the money. And upon reflection of PricewaterhouseCooper’s
statement that its audits of Satyam were conducted ‘in accordance with
applicable auditing standards and were supported by appropriate audit
evidence’, it becomes apparent that the rules did not stop senior financial
executives from producing fictitious numbers.

Authorities aren’t making those same mistakes this time
round. So far, regulatory muscles haven’t been flexed in terms of drafting reams
of new rules, but questions are being asked again about whether auditors could
have done more to mitigate the current corporate collapses in this financial
crisis.

No more rules :

Although the profession says there are lessons to be learnt
from this current crisis, for now it doesn’t support the creation of any new
rules. ‘It’s wrong to say this is all about unethical behaviour by companies. We
would be very nervous about new standards,’ says Steve Maslin, Grant Thornton’s
head of external professional affairs. ‘What comes out of the analysis of this
financial crisis isn’t that we need new standards but that they are better
policed.’ Nina Barakzai, an ethics expert who sits on IFAC’s ethics standards
board, supports this view : ‘We don’t need to change any regulations until we
know why we are changing them and how that will impact on other things . . . It
becomes more important to stick with principles now in the current climate.’ To
ensure better policing of the existing rules, Maslin suggests companies could do
more to regularly check the composition of the executive and non-executive
boards to see if they are ‘fit for purpose’.

One issue that keeps resurfacing is the role of auditors in
assessing business ethics, and whether it is possible to accurately measure a
company’s ethics. The profession has always been supportive of increased
disclosure and narrative reporting, breaking ground with the development of the
operating and financial review (OFR), or the Business Review. Narrative
disclosure has increased significantly over the past decade and continues to
rise, but assurance of this for the most part is not widespread, and anyway its
currently unclear as to whether any existing assurance in this sphere did
anything to prevent the present financial crisis.

The question remains, is it possible to assess and measure
the business ethics of people and are auditors the best placed to do it ? There
are issues of conflict to seriously consider. Accountants may have the most
appropriate skills but aren’t often independent enough to do this kind of
reporting. You won’t get the equivalent of audit report on financial statements
by way of an audit opinion on business ethics.

Like many in the profession, Maslin is concerned that we
ended up forcing companies to report on so many different items that already
weighty financial reports have become even longer. Accountants nonetheless have
a role to play in fostering ethical behaviour in business.

‘In terms of measuring business ethics, we are really in our
nappies,’ says Leo Martin, Director and co-founder of Good Corporation, which
has developed a standard to measure companies’ business ethics. Martin points to
the Siemens corruption scandal, currently in the courts, as an example of how
difficult it would be to catch such unethical behaviour in an audit : Siemens
agreed to pay a record $ 1.34 bn (£ 970 m) in fines in December 2008 after being
investigated for serious bribery involving top executives and management board
members. The inquiry revealed questionable payments of roughly $ 1.9 bn between
2002 and 2006, leading to investigations in Germany and the US.

‘Most auditors would never catch that behaviour because it
didn’t appear in the accounts. That requires a different kind of auditing and
whistle-blowing,’ Martin adds. Auditors are already working closely with
anti-corruption and fraud organisations like Transparency International to
develop controls to combat corporate corruption, and research what role they can
play in detecting corruption.

Laurence Cockcroft, former Chairman of Transparency
International, says management attitudes have changed considerably since the mid
1990s in a positive way and there’s greater awareness now. We are in a new era,
but there’s a long way to go,’ he says.

Independence is integral :

What is certain is that any assurance or auditing of business
ethics must remain unquestionably independent, and more importantly be perceived
to be independent too. Credibility is vital in the current market.

The AIU – Audit Inspection Unit, part of the Professional Oversight Board, found the top seven audit firms’ methods of conducting audit to be generally acceptable, but the report also pinpointed a number of problem areas, expressing concerns over independence and ethical behaviour at several of the firms it reviewed. Accountants are keenly aware of the need to highlight their credibility and that objectivity is where auditors have to avoid compromising. There is general agreement the problem lies in the fact that there are vast questions of judgment involved. Normally these are discussed and mutually resolved; however, behind-the-scenes debate between auditors and boards isn’t appreciated as much as it should be.

Firms must work to allay any concerns the regulators and investors have and heed their suggestions to help restore credibility in the financial systems. No one knows what will happen next in terms of the global economy but economists and business experts predict worse is still to come, which means that the profession will need to illustrate its robustness.

Excerpted from article by Michelle Perry in Accountancy [ICAEW – UK] February 2009.

Nirav Shah

Independent Directors — Corporate governance in challenging times

Article

While in most of the countries in the world, the top
executives are trying to survive their jobs and positions and while this is the
first time when maximum CEOs are hated by their shareholders, the independent
Directors are trying to run away from their current position. One of the reports
of Economic Times says that, since Satyam scandal and Nagarjuna case, “there are
over 500 independent directors in India who have resigned from their respective
positions on the Board citing reasons ranging from ill-health to work
pressures”. The resignation of one director or a succession of them,
particularly of independent directors, may indicate something untoward in terms
of corporate governance or commercial developments. Investors should be made
aware of these changes. There is almost a situation of fear-psychosis amongst
almost all Boards where Directors who hardly spend any time and who are hardly
paid anything are expected to perform much more with all the responsibilities
and liabilities of the CEO or an executive director. This is not to suggest that
there is something untoward in every Indian company where independent directors
have resigned in the past. That would be too rash a conclusion to draw. It could
also be the fear of potential liability. Independent directors are often
understandably fearful about this issue for two reasons :

(i) they are not involved in the day-to-day activities of
the company although they may bear some responsibility for the actions of
management; and

(ii) there are countless directions from which liability
could strike since directors are responsible (subject to exceptions) for
violation of various statutes by companies, particularly for the so-called
socio-economic offences.

There is ‘fear of the unknown’ on both these counts. Problem
is law has not changed since January 2009 but cases like Satyam and Nagarjuna
have made it amply clear that all independent directors can be vulnerable to get
arrested for no fault of theirs. The independent directors are indeed concerned
not about direct financial liability but the time, cost, lost opportunity and
reputational risk that accompany the mere initiation of legal action against
them, even if that action does not succeed in the court of law in the end.

India is not doing so bad as compared to global scenario on
Corporate Governance at macro level. New York consulting firm GMI rates about
4,000 companies worldwide on dozens of metrics related to corporate governance :
board accountability, financial disclosure, internal controls, shareholder
rights, executive compensation, and more. Each company is given a score between
1 and 10. The 58 Indian companies studied by GMI got an average rating of 4.91,
placing India 19th out of 38 countries on the list. Topping the table is
Ireland, with an average ranking of 7.55 for the 19 Irish companies assessed by
GMI. Canada, Britain, and Australia are right behind. India is No. 3 in Asia,
behind only Singapore and Thailand. And it comes out ahead of Belgium, Denmark,
and France. It’s also well above the emerging markets average of 4.09. Thus
while India is not doing so bad in the area of Corporate Governance and has
built up quite good investors’ confidence, what can be the reason for so many
independent directors quitting their jobs and companies finding its extremely
difficult to get good independent directors ?

Legal & Real position on Independent Directors :

Clause 49 of the Listing Agreement talks about the
independent directors. Thus every listed company in India has to follow the
rules and regulations on independent directors. The Company having non-executive
Chairman can have not less than one third of the Board’s strength as independent
directors. If, otherwise, the company has executive Chairman, it needs to have
not less than 50% of its Board’s strength as independent directors. The recent
change in the position is that if the non executive chairman is ‘related’ — as a
family member or employee of the promoter, the independent directors on the
board should be 50% of its strength. This change has put many Indian listed
companies in a fix. Most of the companies where the promoters hold minority
stake, had ensured that the Chairman is one of their ‘own’ persons in
non-executive capacity to keep the majority strength on the Board of non
independent directors. After this amendment or clarification from SEBI, such
companies mostly are looking for their ‘own’ independent Chairman just to ensure
that they maintain majority strength on the Board. This clearly shows that India
Inc is still not comfortable with true ‘independent’ directors and fear of
losing control hounds the promoters.

For this purpose, I may classify companies in three
categories.

1. Professionally managed companies

2. Family or Group owned companies

3. PSUs

I think the first category of companies are not finding it
difficult to get the independent directors as they are looking for true trouble
shooters and expert professionals to come on the Board whereby reputation of
both, the company and the director, will be elevated by such person coming on
the Board. Such directors are well remunerated and spend reasonable time in the
committees and the Board meetings, asking all odd questions and seeking
clarifications to ensure that the company does not knowingly take any decision
against the interest of any of the stake holders. There is a misconception that
independent directors are sitting on the Board only to take care of the minority
shareholders’ interest. Legally that may not be the correct position.
Independent directors are expected to use their experience and professional
skills to take care of the interest of all the stakeholders, i.e.
shareholders, suppliers, customers, employees, regulators and the society at
large. Thus decisions like payment of dividend need not be looked at if they
benefit majority or minority shareholders but need to be verified with general
principles of the dividend payments, cash outflows, payout ratios, etc.

The second categories of companies generally appoint their ‘own’, ‘known’, ‘friendly’ independent directors. These directors are expected to create least resistance in the Board meeting on any proposal that promoter may bring in. If the family or group does not hold majority stake in the company, they are more careful while appointing independent directors. Though. the law prescribes the criteria of independent directors, such promoters like to have supportive board members rather than trouble-shooters. Thus, though these companies seemingly comply with the Board composition requirements, the independent directors may not act independently as expected by law and regulators. The paperwork of the board may be kept compliant with all the laws and regulations but in spirit, the Board may not be performing their expected duties. The public shareholders need to be more vigilant while investing in such companies.

The third category is more interesting. As per earlier SEBI observation, maximum non compliant companies to clause 49 so far as Board composition is concerned, were PSUs. The enormous delays in appointing independent directors by respective Government departments or ministries on PSU Boards were quite glaring. Here the independent directors are ‘nominated’ by Government who also happens to be the majority shareholder of the Company. How can one be sure that such directors nominated by the majority shareholders can act as independent directors? This particular point was raised at a few forums in front of Government officials but is never satisfactorily answered to my knowledge.

SEBI as the custodian of the shareholders’ interest, appointed various committees to advise on the Corporate Governance. Kumarmangalam Birla Committee (1999), Naresh Chandra Committee (2002), Narayan Murthy Committee (2003). Every report added a few more suggestions on Board composition, Board Remuneration, Board meeting Pro-cedure, disclosure of Directors’ interests, code of conduct for the Board and definition of independent directors. However, the law has sufficient scope for the improvement based on practical difficulties. While all the committee reports have the same objective of improving corporate governance, what needs to change is the mindset of the promoters and the independent directors. Legally one may’ qualify’ as independent director but what is important is if such person indeed acts independently and asks right probing questions. I think, currently importance is given more to ‘form’ than ‘substance’ and that has its own repercussions. On one side the independent directors of Satyam get clean chit while those who were members of the Board of Nagarjuna in 1999 get arrested in 2009 !

Liabilities of the Board Members:

Every law needs to have punishments and liabilities prescribed to ensure that the law is complied with. The economies in United States of America thrived due to various reasons, but one of them was promoters and owners had limited liability. This allowed them to take risks in the business. Some failed but many flourished. Post Enron, the laws like SOX put the limited liability concept to an end. The CEO and CFO of the company now are personally liable for various things. More than the actual liability, the fact that one is vulnerable to such draconian fines and/ or arrests has literally made senior management paranoid about day to day business of the business that they run. No business can progress when the Board, CEO and CFOs are running business in paranoia. In India, we are entering similar scenario after the non executive Board members were arrested in 2009 for something to the best of their recollection happened in 1999 or prior to that. Satyam is another example. While the law and regu-lators moved very quickly against the culprits, the fraud was disclosed by the confession letter from one of the promoters. Till then, even the Board, the regulators and the auditors and senior management of the company and the market analysts, who tear your numbers every quarter, had not doubted that the company had serious problems to the extent of Rs.7000 crores. On the other hand, the company was growing normally and receiving corporate governance awards! I think both these instances have put many independent directors in dilemma. I have seen the changed atmosphere in the Board meetings post Satyam. The questions that are asked to the Auditors are as basic as if they verified Bank Statements! This fear is forcing many independent directors to resign from their position.

In the recent past, independent directors were perceived as playing a passive role in the company. The recent resignation phenomenon may not be because the directors suspect any messy stuff in the company but god forbids, if there are skeletons in the cupboard, your reputation is at stake. The job of the Directors is truly becoming difficult. For mere Rs.20,000 sitting fees per quarter, it may not be worth making one vulnerable to bad publicity, financial fines and may be arrest. In reality, as independent director, one spends a few hours in the quarter in the Board room. The audit committee spends a few more hours with CFO and Auditors and goes through what is presented to them. With their experience, they can ensure that there does not seem any apparent wrong in the numbers and there is no ground not to believe the numbers based on variances and QoQ and YoY analysis. In the current recessionary conditions, many directors may suspect that the managements and promoters may have more tempting reasons to take extra business risks and do any unacceptable adjustments in the numbers. Such distrust might have made many sitting directors very uncomfortable. These circumstances taken together might have led to a situation where companies are finding very difficult to get independent directors on the board.

Having said that, the past track-record of directors being held liable for actions of the company favours independent directors. In an influential series of studies carried out across several countries (though not including India), it was found that the risk of liability on independent directors is far lower than what commentators and directors themselves believe. Even in a litigious society such as the U.S., it was shown that there were only a handful of cases where directors in fact had to make payments (and these include the high profile Enron and WorldCom settlements). The researchers show that these were cases where there was a ‘perfect storm’ scenario (e.g. where the company was in bankruptcy, the D&O insurance was inadequate, and so on), unlikely to occur in most circumstances. However, independent directors are indeed concerned not about direct financialliability but the time, cost, lost opportunity and reputational risk that accompany the mere initiation of legal action against them, even if that action does not succeed in the end. In the past the financial liabilities under company law were insig-nificant and in most of the cases, matters used to get settled between company secretary and the regulators without directors even being aware of it. However, now fear of arrest/imprisonment has really put a lot of scare in the minds of people. For example, the Chairman of the Audit Committee can be arrested for not attending the AGM. Empirical study may not reveal alarming examples in India in the past but the current instances make one feels vulnerable. On February 1 of this year the cn has made the representation to the Parliamentary Standing Committee on the subject suggesting that the liabilities of independent directors should be handled in a different way than that of the executive directors or non independent directors as independent directors are not involved in the day-to-day working of the company. Unless personally involved, there should not be any criminal liability attached to independent director.

Peculiar Indian scenario:

In a few international studies, India was found culturally in a unique situation. I am sure countries like Japan also would fall under similar situation. The study observed that in most of the cases in India, Chairman/Chairperson of the Board is a very senior (both by age, stature or experience) and hence it is not considered prudent to question the Chairman in the meeting on any matter. This kind of culture restricts the independence of a director. If you are an independent director, and if you feel the decision that is sought by the Board is not in the interest of the stakeholders, you must raise the point and question the decision. In the process of Board discussion, you may get convinced or you may convince the board. But having no discussion as a part of the culture is very harmful for the corporate governance process in the company.

A similar situation is observed in the PSUs as well. If the independent director, appointed by the Government is a person junior to the Chairman (which is normally the case), he or she does not contradict or question the Chairman of the Board. His or her organisational hierarchy comes in the way and prevents him/her from questioning the Chairman in the Board meeting.

I have seen in some cases where such directors discussing a situation what they call ‘off line’. However, such practices are not healthy from corporate governance point of view. Such discussions also do not get recorded in the minutes of the Board and hence are forgotten about later. I feel, once you are sitting on the Board, you are personally responsible for all the acts of the Board and one must act to the best of his or her ability to ensure that healthy, transparent and useful discussions take place in the Board irrespective of your positions outside the Board.

Going forward:

I think, globally, we have same issue on independent directors. The mind set of the person getting appointed as director must be of one to act without fear or favor. If in your professional capacity, you feel the company is not acting in the interest of the stakeholders, you must question such actions and ensure that they are recorded in the minutes. We may not overcome the problem overnight but to slowly get over this issue, I have following quick suggestions-:

1. Independent Directors must be appointed/ nominated by a separate meeting of the minority shareholders, not representing the majority investors. A separate meeting of such minority shareholders must be conveyed prior to the AGM to nominate such independent directors and AGM should formally appoint such independent directors. The majority shareholders should not play any role in such appointments directly or indirectly. Any vacancy of the Board seat between two AGMs may be filled in by other independent directors continuing on the Board like Additional Director.

2. To ensure that the independent directors spend adequate time, they must be compensated well. Mere sitting fees of Rs.20,000 is obviously not enough. Such fees can be capped based on profits of the company or can be a fixed sum.

3. Independent Directors should not get any options. Having options, generally may affect their independent status.

4. Chairmen of the committees must be a rotating position. At least in three years, a new member must be appointed as chairman of Audit /Compensation committee. Such provision would help a board to get new and fresh views.

5. Liability of independent directors should be distinguished from the executive directors and non independent directors. No criminal liability should be attached to independent director for the acts of the company or other executive directors unless the independent director has personally committed a willful criminal act. This obviates the situation where independent directors can not be arrested unless personally and willfully involved in a criminal act.

I feel, the above changes will bring some sanctity in the process and intent of having independent directors on the board.

Post Satyam, it is not only necessary that culprits are punished quickly but also the process is cleansed to achieve intended results that regains investors’ confidence in Indian Companies.

Nirav Shah

Code of Ethics — Disciplinary Mechanism of ICAI

1. Introduction :

Readers may recall that part I of my article on this topic was published in the BCA journal for May 2009. In the first part, I discussed the broad para-meters such as — the importance of Code of Ethics (COE), important statistics about the disciplinary cases, reasons for delays in disposal, procedure adopted by the Council prior to the CA Amendment Act, 2006, criteria adopted by the Council, perception of various agencies towards the COE, types of punishments, and so on. I also narrated a few real-life instances of complaints. It is my experience that whenever our fellow members hear me on this topic, they confess that it is an eye-opener. Indeed, it makes one lose one’s sleep at least for a few nights. It calls for lot of awakening since people have realised the nuisance value of the complaint. The most unfortunate part is that our own members out of petty self-interests, rivalry, mean-mindedness etc., bring the other members into serious trouble. At the same time, all of us need to do lot of introspection.

2. Certain important changes :

In recent years, there were quite a few changes brought about either by the Amendment Act, 2006 or by different Notifications/decisions of the Council. These are in respect of both — the substance as well as the procedure. A few highlights that directly affect an average practitioner are enumerated below :

2.1 Clause (4) of Part 1 of Second Schedule earlier read as follows :

‘expresses his opinion on financial statements of any business or any enterprise in which he, his firm or a partner in his firm has a substantial interest, unless he discloses the interest also in his report;

In the amendment, the last part — ‘unless he discloses the interest also in his report‘ is deleted. This means that now there is a blanket ban — and mere disclosure of interest is not a saving grace.

2.2 Clause (12) of Part I of First Schedule pertained to undercutting of fees. Quite intriguingly, this has been omitted. Basic intention was to remove rigidity in this regard, since situations do change.

2.3 Clause (7) of Part I of Second Schedule — the most important Clause — earlier read as follows :

‘is grossly negligent in the conduct of his professional duties’.

Now the following words are added at the beginning :

‘does not exercise due diligence, or is grossly negligent’.

It had been held by courts that this charge is not of ‘inefficiency’, but of gross negligence. Mere error or blunder or negligence is not ‘gross negligence’.

2.4 Henceforth, internal auditor will not be eligible to be appointed as tax auditor (applicable for financial year 2009-10 and onwards).

2.5 In the procedure,

(a) Form of complaint (Form 8) is changed as Form I.

(b) Filing fee raised from Rs.100 to Rs.2,500

(d) For the first time, monetary punishment has been introduced.

3. The new system :

The main elements of the erstwhile system were :

(a) Complaint, written statement by respondent, rejoinder by complainant and respondent’s reply to rejoinder.

(b) ‘Prima facie’ opinion about the ‘guilt’ — by the Council.

(d) Final decision by the Council —

re : Schedule I — ‘Guilt’ as well as ‘punishment’.

re : Schedule II — Recommendation to High Court for deciding the guilt as well as the punishment.

In the new system [refer The Chartered Accountants Procedure of Investigation of Professional and Other Misconduct of Cases] there will be :

(a) Complaint, written statement and rejoinder — No second inning for respondent.

(b) Decision regarding ‘prima facie’ guilt will be by the Director — Discipline. (DD)

(c) If prima facie guilty, then enquiry will be by Board of Discipline (BOD) for Schedule I offence. For Schedule II, or for mixed case of Schedule I and II it will be by Disciplinary Committee (DC). No further reference to the Council.

(d) Concept of ‘summary disposal’ introduced.

(e) Aggrieved party can approach ‘Appellate Authority’. (AA)

(f) If DD opines that there is no ‘prima facie’ guilt, DD has to seek concurrence from BOD or DC as the case may be.

(g) For withdrawal also, DD has to seek concurrence from BOD/DC.

In respect of all these stages, more rigid time schedules are prescribed. The power to grant extension of time is also restricted. This will speed up the disposal.

4. Constitution of BOD/DC/AA :

Previously, all members of Disciplinary Committee were Chartered Accountants and Central Council members. Henceforth,

BOD will consist of :

Rule 21A(1) — The Council shall constitute a Board of Discipline consisting of :

(a) a person with experience in law and having knowledge of disciplinary matters and the profession, to be its presiding officer;

(b) two members one of whom shall be a member of the Council elected by the Council and the other member shall be nominated by the Central Government from amongst persons of eminence having experience in the field of law, economics, business, finance or accountancy;

DC will consist of :

21B(1) — The Council shall constitute a Disciplinary Committee consisting of the President or the Vice-President of the Council as the Presiding Officer and two members to be elected from amongst the members of the Council and two members to be nominated by the Central Government from amongst persons of eminence having experience in the field of law, economics, business, finance or accountancy;

Provided that the Council may constitute more Disciplinary Committees as and when it considers necessary.

AA will consist of:

Rule 22A:

1) The Central Government shall, by Notification, constitute an Appellate Authority consisting of :

a) a person who is or has been a Judge of a High Court, to be its Chairperson;

b) two members to be appointed from amongst persons who have been members of the Council for at least one full term and who is not a sitting member of the Council;

c) two members to be nominated by the Central Government from amongst persons having knowledge and practical experience in the field of law, economics, business, finance or accountancy.

2) The Chairperson and other members shall be part-time members.

Thus, people from outside the profession will also now sit in judgment.

5. Under the old Act (prior to amendment in 2006) the Council had a power in terms of clause of Part II of Second Schedule to the Act, to issue Notifications. Under these Notifications, Council could provide that a breach of any of its Notifications would be regarded as a misconduct. Under the amended Act, such power is missing. As a consequence, Notifications issued between 1965 to 2004 stand repealed with effect from 8-8-2008.

In lieu of these, the ICAI has now issued ‘Council General Guidelines – 2008’ by a Notification dated 8-8-2008. These are published at page nos. 686 to 689 of CA journal of October 2008. More or less, these are the same ones as were issued between 1965 to 2004. (See page 333 of BCA journal, November 2008 ICAI and its Members)

Guidelines and self-regulatory measures can be found from page 313 to 327 in the publication Code of Ethics. – Revised edition published in January 2009.

The Guidelines pertain to :

i) Conduct of a member being an employee.

ii) Prohibition of appointment of member as cost auditor.

iii) Prohibition on expressing an opinion on financial statements of a relative.

iv) Maintenance of books of account by members,

v) Ceiling on tax audit assignments (Max. 45 nos. other than clause (c) of S. 44AB of Income-tax Act, 1961)

vi) Appointment of an auditor where undisputed audit fees of previous auditor are unpaid.

vii) Maximum number of audit assignments under Companies Act, 1956 (overall ceiling of 30 nos. despite the ceiling/liberties specified in Companies Act). Members are required to maintain a register of audits done.

viii) Ceiling on fees for other assignments of the same client whose statutory audit is done by a member.

ix) Not to accept audit where member is indebted for more than Rs.10,000.

x) Directions on unjustified removal of auditors.

xi) Minimum audit fees in certain cases.

CA Regulations 1988 have also been amended.

Other recommended self-regulatory measures:

i) Branch audit and joint audit vis-a-vis no. of partners.

ii) Ratio between qualified and unqualified staff.

iii) Disclosure of interest by auditors in other firms.

iv) Ceiling on the fees. Interestingly the clause re-lating to undercutting of fees is being deleted.

The Council in its 281st meeting held from 3rd October, 2008 to 5th October 2008 at New Delhi considered an issue arising from the Guidance Note on Tax audit u/s.44AB of the Income-tax Act, 1961 as to “Whether the internal auditor of an assessee, being an individual chartered accountant or a firm of chartered accountants can be appointed as his tax auditor”.

The Council decided that an internal auditor of an assessee, whether working with the organisation or independently practising chartered accountant or a firm of chartered accountants, cannot be appointed as his tax auditor.

The said clarification of the Council has been published in the January 2009 issue of ‘The Chartered Accountants’ Journal.

The said restriction has been relaxed by further clarification.

6. Miscellaneous points:

6.1 In para 3.2 of Part I of this article (BCAJ May 2009), I had stated a few points which are regarded as not of much consequence while deciding a case. One more such irrelevant factor is the motive behind the complaint. In many cases, respondents vehemently argue as to how the motive behind the complaint is unscrupulous or bad; or merely to settle a score against some third party. The Council is very much aware of such motives whereby the disciplinary mechanism is taken undue advantage of. However, when it comes to examining a case on facts and merits, the Council’s hands are tied. It does not give much weightage to such factors. The existence of ‘guilt’ is to be decided in an objective manner.

Conclusion:

This topic is also like a big ocean. New systems and procedures are yet to get stabilised. Hearings under the new system are yet to commence. We have to wait and watch as to how things will develop in terms of mindsets of members of various committees, particularly non-CAs, speed of disposal and so on. I have many more things to share even in respect of the existing system. I can deal with certain specific issues if I get further opportunity. A feedback from the readers will also enable me to write in a particular direction. Till then I only wish that all our readers will always remain out of this vicious net.

Nirav Shah

Mens rea and penalty u/s.271(1)(c) of the Income-tax Act, 1961

Case Study

Case Study No. 1

1.0 Facts of the case :

1.1 Mr. Shivdasani, the assessee, filed his return of
income for A.Y.2006-07 declaring an income of Rs.5,00,000. Mr. Shivdasani
claimed a deduction u/s.35 in respect of a contribution of Rs.1,00,000 to an
institution approved for the purpose of S.35. The institution has issued a
receipt in acknowledgement of the contribution. The receipt bore the approval
number.

1.2 In the course of assessment, it is found that the
institution to which the contribution was made was not approved for the
purpose of S.35. The institution had forged the approval. The A.O. disallows
the claim and initiates proceedings for imposing penalty under S.271(1)(c) for
furnishing inaccurate particulars of income.

1.3 Mr. Shivdasani replies to the show-cause notice issued
for imposing penalty. One of the contentions of Mr. Shivdasani is that he
genuinely believed that the institution was approved for the purpose of S.35,
and that the claim was not mala fide.

1.4 The A.O. nevertheless imposes penalty on the ground
that the issue whether there was a bona fide belief or that the
intention was not mala fide in making a claim for a deduction, was
irrelevant particularly after the Honourable Supreme Court’s decision in the
case of UoI vs. Dharmendra Textiles Processors, 306 ITR 277. According
to the A.O. it is sufficient for imposing penalty that there results evasion
of tax on account of a claim made in the return which claim is found untenable
on assessment. The A.O. also highlights the fact that the assessee has
accepted the disallowance by not preferring an appeal against the assessment
order.

1.5 The assessee prefers an appeal against the penalty
order. Your views are solicited on the submissions to be made to the CIT(A) in
connection with the appeal filed against the penalty order.

2.0 Submissions :

2.1 It is true that it is irrelevant in penalty proceedings
under civil law whether there was guilty mind (mens rea) or not. In
other words, it is not necessary to prove presence of mens rea in
penalties imposable under civil law, more so after the decision of the SC in
the case of Dharmendra Textiles Processors (supra). However, this
decision should not be applied in a blanket manner to all penalty matters
under the Income-tax Act, for the reasons, one, that the SC decision does not
directly deal with a penalty imposable under S.271(1)(c), and two, the
decision does not make S.273 B otiose. That is, an assessee can always explain
the circumstances which led him to believe that his claim for a deduction was
made bona fide. S.273 B requires an A.O. to consider the reply
furnished by the assessee under S.273B, and it is only after the A.O. has come
to the conclusion that there was no reasonable cause for the assessee to make
the claim under S.35 that the A.O. can impose penalty. In this case, the
appellant did have a receipt issued by the donee institution indicating that
it was an approved institution under S.35, giving no reason to the assessee to
suspect its genuineness. Thus, the appellant had reason to believe that his
claim was legitimate.

2.2 The case of the appellant is also not governable by
Explanation 1 to S.271(1) to say that the assessee is deemed to have
concealed the particulars of his income. The Explanation is reproduced here :

Explanation 1 — Where in respect of any facts
material to the computation of the total income of any person under this
Act, —

(A) such person fails to offer an explanation or offers
an explanation which is found by the Assessing Officer or the Commissioner
(Appeals) or the Commissioner to be false, or

(B) such person offers an explanation which he is not
able to substantiate and fails to prove that such explanation is bona
fide and that all the facts relating to the same and material to the
computation of his total income have been disclosed by him,

then, the amount added or disallowed in computing the
total income of such person as a result thereof shall, for the purposes of
clause (c) of this sub-section, be deemed to represent the income in respect
of which particulars have been concealed.

2.3 One can see that this is not a case where the appellant
fails to offer an explanation. It is also not a case where the explanation as
offered by the appellant is found to be false. It must be remembered that what
is found to be false in this case is the ‘receipt’ issued by the donee
institution, not the explanation of the appellant. Therefore clause (A) of
Explanation 1 does not apply.

The appellant has shown that his explanation is made
bona fide which he is substantiating with the receipt issued by the
institution. It is also not a case where all the facts relating to the claim
and material to the computation of income have not been disclosed. Therefore,
clause (B) of Explanation 1 will also not apply. The A.O., therefore, cannot
hold any income in respect of which particulars have been, or deemed to have
been, concealed.

2.5 In view of the above submissions, the penalty as
imposed may be deleted.

Case Study No. 2

1.0 Facts of the case :

1.1 Mr. Haridasani was a resident of Dubai for a number of years. Later, he moved to India and started business.

1.2 For F.Y.2005-06, relevant to A.Y.2006-07, Mr. Haridasani had acquired the status of Resident and Ordinarily Resident. Since the business operations of Mr. Haridasani were low and since Mr. Haridasani had only the income from investments held abroad, he had not engaged services of any professional to assist him in preparation of his return of income.

1.3 Mr. Haridasani declared only his Indian income in the return for A.Y.2006-07. He filed his full personal accounts with the return of income showing all his investments in India and abroad and also filed full extracts of bank accounts showing credit in respect of all income including income earned abroad. He had filed his earlier returns similarly in respect of the preceding years. The case for A.Y. 2006-07 was for the first time selected for scrutiny under 5.143. The A.O., on finding his income abroad, brought it to tax and imposed penalty for concealment of income. Mr. Haridasani had pleaded innocence and lack of familiarity with the Indian laws since he had stayed abroad for a number of years and also for the fact that he had not engaged any professional to advise him. His pleas were turned down and penalty for concealment of income was imposed. The A.a. also mentioned in”his penalty order that innocence, or lack of mens rea, was no longer available as a defence since the promulgation of the SC decision in the case of UoI. vs. Dharmendra Textiles Processors, 306 ITR 277. Mr. Haridasani had preferred an appeal against the order imposing penalty and seeks your advice in preparing arguments to be made before CIT(A).

2.0 Submissions:

2.1 The penalty in this case is imposed for the act of ‘concealment of income’ as opposed to the act of ‘furnishing inaccurate particulars of income’. The two acts, namely, of ‘concealment of income’ and of ‘furnishing inaccurate particulars of income’ are two different circumstances both leading to penalty under S.271(1)(c) — Please refer to eIT vs. Indian Metal & Ferro Alloys Ltd., 117 CTR (Ori) 378, which succinctly draws distinction between the two circumstances and explains what they mean. The following passage from the said decision is self explanatory.

“The expressions ‘has concealed the particulars of income’ and ‘has furnished inaccurate particulars of income’ have not been defined either in Section 271(1)(c) or elsewhere in the Act. One thing is certain that these two circumstances are not identical in details although they may lead to the same effect, namely, keeping off a certain portion of income. The former is direct and the latter may be indirect in its execution. The word ‘conceal’ is derived from the Latin word ‘concolare’ which implies ‘to hide’. Webster’s New International Dictionary equates its meaning to ‘hide or withdraw from observation; to cover or keep from sight; to prevent the discovery of; to withhold knowledge of’. The offence of concealment is thus a direct attempt to hide an item of income or a portion thereof from the knowledge of the Income-tax authorities. In furnishing its return of income, an assessee is required to furnish particulars and accounts on which such returned income has been arrived at. These may be particulars as per its books of account if it has maintained them, or any other basis upon which it has arrived at the returned figure of income. Any inaccuracymade in such books of account or otherwise which results in keeping off or hiding a portion of its income is punishable as furnishing inaccurate particulars of its income.”

2.2 Once the position is admitted that the circumstance leading to penalty is ‘concealment of income’, one must proceed to find out the applicability of the ratio of the SC decision in the case of UoI. vs. Dharmendra Textiles Processors, 306 ITR 277.

2.3 It is true that the said decision does lay down the principle that the presence of mens rea need not be proved in civil matters before imposing penalty unlike in criminal matters. However, the said principle comes with a caveat. The caveat is that mens rea need not be proved only if the language of a provision imposing penalty does not require the presence of mens rea to be proved. In other words, if the language requires that a penalty cannot be imposed unless the assessee had a guilty mind before committing the act leading to the penalty, then the presence or absence of a guilty mind assumes importance. As per the decision in the case of Dharmendra Textiles Processors what is of paramount importance is the language of the provisions imposing penalty. The Honourable SC has also relied on the language of S.276C providing for prosecution in cases where a person wilfully attempts to evade tax, to make the point since this provision requires the element of mens rea to be proved before the person can be prosecuted because the language of the provision clearly requires so, the person cannot be prosecuted unless he had a guilty mind. Moreover, while deciding the case of Dharmendra Textiles Processors, the SC has approvingly quoted from its earlier decision in the case of Gujarat Travancore Agency vs. CIT, 177 ITR 455. According to the said decision which was rendered in the context of S.271(1)(a) of the Act, the SC confirmed penalty imposed under S.271(1)(a)where the appellant had no malafide in filing his return late because the Court did not find anything in the language of S.271(1)(a) which required the presence of mens rea to be established before a penalty could be imposed. Thus, what is important is not whether the presence of mens rea is essential or not before imposing penalty in civil matters, but the language of the particular provision under which the penalty is sought to be imposed.

2.4 With the above back ground let us see whether the language of S.271(1)(c) requires the presence of mens rea when the penalty is sought to be imposed on the ground that the assessee has concealed the particulars of his income.

2.5 The words used in these provisions are ‘the assessee has concealed … ‘. As per the standard dictionary the word ‘conceal’ in ordinary English means, ‘I. to hide; withdraw or remove from observation; cover or keep from sight: e.g., He concealed the gun under his coat. 2. to keep secret; to prevent or avoid disclosing or divulging: e.g., to conceal one’s identity by using a false name. In this regard, please also refer to the decision in CIT vs. Indian Metal & Ferro Alloys Ltd., 117 CTR (Ori.) 378 and particularly to the passage reproduced in paragraph 2.1 above which explains the meaning of the word ‘conceal’.

2.6 One may appreciate that the idea of deliberateness is implicit in the word ‘conceal’. Concealment is not accidental or involuntary, it is planned and voluntary. The following observations of the Honourable SC made in the case of T. Ashok Pai vs. CIT, 292 ITR 11 still hold good:

“concealment of income’ and ‘furnishing of inaccura te particulars’ carry different connotations. Concealment refers to a deliberate act on the part of the assessee. A mere omission or negligence would not constitute a deliberate act of suppressio veri or suggestio falsi”.

2.6 Therefore, it is submitted that if the charge on the assessee is of concealing particulars of his income, the assessee can rebut the charge by proving lack of mens rea. This construction of the provision is not inconsistent with the ratio of the Honourable SC’s decision in the case of Dharmendra Textiles Processors (supra) for the reason that the said decision also lays stress on the language of particular provision imposing penalty. The decision merely forbids the presumption of requirement of proving mens rea; it does not say that one should ignore such requirement if it is demanded by the very provision imposing penalty.

2.7 In view of the submissions and the facts of the case, penalty should be deleted.

Author’s Note:
The stand taken in these case studies seems to be vindicated by the recent decision of the Supreme Court in the case of Uol vs. Rajasthan Spinning & Weaving Mills – Civil Appeal No. 2523 of 2009, where the Supreme Court has explained its decision in Dharmendra Textile Processor’s case.

Nirav Shah

Consolidation – redefining control and reflecting true net worth Part-2

In the previous article, we discussed the principles of control defined in the IFRS consolidation standards, the impact of rights available with non controlling interests, accounting for step-up acquisitions, accounting for dilution of stake with or without losing control and consolidation of special purpose entities.

Continuing with the topic of consolidation, in this article we will cover certain implementation issues and other differences which will have a significant impact on Indian companies.

Key differences and implications:

Concept of de facto control:

In the earlier article we discussed that control is defined as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. This definition of control under IFRS gives rise to another perspective, which is the’ defacto’ control model. De facto control arises when an entity holding a significant minority interest can control another entity without legal arrangements that would give it majority voting power. De facto control exists if the balance of holdings in an entity with other shareholders is dispersed and the other shareholders have not organised their interests in such a way that they commonly exercise more votes than the significant minority shareholder.

Under a de facto control model the power to govern an entity through a majority of the voting rights or other legal means is not essential for consolidation. Rather, the ability in practice to control (e.g., by casting a majority of the votes actually cast) in the absence of legal control may be sufficient if no other party has the power to govern. Under this approach, de facto control is evaluated based on all evidence available. Presence of de facto control can result in consolidation by the significant minority shareholder.

Both the ‘power to govern’ and ‘de facto’ control models meet the principles of control under IAS 27 – Consolidated financial statements. Accordingly, an entity has an accounting policy choice on assessing control and consolidation i.e. whether to assess as per the power to govern model or the de facto control model. This policy choice needs to be followed consistently and disclosed in the financial statements.

Accounting for joint ventures:

Currently, accounting for joint ventures under IFRS is not very different from accounting under Indian GAAP i.e. AS 27 – ‘Financial reporting of interests in joint ventures’. However, IAS 31- ‘Reporting interests in joint ventures’ gives the venturer a choice to account for a jointly controlled entity using either the proportionate consolidation method or the equity method in its consolidated financial statements. Interestingly, as part of the IASB/FASB convergence project, the exposure draft ED-9 on ‘Joint Arrangements’ issued by the IASB in September 2007 proposes to prohibit the proportionate consolidation method. Hence, once this ED becomes an effective IFRS, venturers would account for jointly controlled entities only as per the equity method of accounting in their consolidated financial statements.

The basis for such a change has been stated by the IASB as follows – ‘When a party to an arrangement has joint control of an entity, it shares control of the activities of the entity. It does not, however, control each asset nor does it have a present obligation for each liability of the jointly controlled entity. Rather, each party has control over its investment in the entity. Recognising a proportionate share of each asset and liability of an entity is not consistent with the Framework, which defines assets in terms of exclusive control and liabilities in terms of present obligations.’ Hence the equity method of accounting is more representative of the interests of a venturer in the joint venture. Going forward, this change would most impact the reported consolidated revenue of such venturers.

Accounting for associates:

The principles of accounting for associate entities in the consolidated financial statements of an investor under IFRS are the same as under Indian CAAP. Unlike Indian CAAP, IFRS considers potential voting rights that currently are exercisable in assessing significant influence, for example convertible debentures held by the investor.

Deferred taxes on consolidation:

Under Indian CAAP, deferred taxes in the consolidated financial statements are quite simply the summation of deferred taxes in each of the individual group companies. Unlike IFRS, the Indian CAAP accounting framework does not require any adjustments to be made to deferred taxes on consolidation. Under IFRS, the important adjustments that are required to be made to arrive at the consolidated deferred taxes and resultant profit after tax are as below:

Elimination of deferred taxes on inter company transactions/stock reserves:

In determining tax expense in consolidated financial statements, temporary differences arising from elimination of unrealised profits and losses resulting from intra-group transactions should be considered. Consider an example: Parent company sells goods to its subsidiary company worth Rs. 1000. Parent company’s profit on this transaction is Rs. 100. At the year end, these goods remain unsold by the subsidiary and are hence lying in its inventory. On consolidation an adjustment to eliminate the unrealised profit of Rs. 100 is made in the consolidated financial statements of the Parent company. Hence the accounting base of the inventory in the consolidated books has now become Rs.900 whereas the tax base of the same inventory still remains Rs. 1000. This gives rise to deductible temporary difference which should be recognised as a deferred tax asset in the consolidated financial statements.

Now the question that arises is at what tax rate should this deferred tax asset be recognised – at the seller’s (parent company’s tax rate) or the buyer’s (subsidiary company’s tax rate). IAS 12 states that an entity recognises deferred tax assets only when it is probable that taxable profits will be available against which the deductible temporary differences can be utilised/Since the reversal of the difference would result in lower current taxes in the buyer’s books, the recognition of this deferred tax asset is made on the buyer’s rate keeping into consideration whether the buyer would have sufficient taxable profits in the future to utilise this deferred tax asset.

Recognition of deferred taxes on undistributed profits of joint ventures and associates:

Currently under Indian CAAP, profits of subsidiaries, branches, associates and joint ventures (‘investee companies’) are included in consolidated profits of the Parent company. The consolidated performance results and net worth are accordingly reported to the shareholders of the Parent under Indian CAAP. However one important aspect that is not reported is the impact of tax leakage when the profit earned by the investee companies will be transferred to the Parent. Accordingly the consolidated profit and the net worth reported under Indian CAAP is over-stated to that extent, since the overall tax impact on the consolidated profit available to the Parent company is not completely recorded in the books of account. Such deferred tax impact is accounted for in the consolidated financial statements under IFRS.

For example: Parent Company P consolidates undistributed profits of Rs. 100 crores of Subsidiary company S in its consolidated financial statements of which Rs 15 crores is post acquisition profits. P plans to draw dividends of Rs.20 crores from S in 18 months’ time; P estimates that Rs.15 crores of that amount will relate to post-acquisition earnings already recognised in the financial statements. The dividend distribution tax rate in S’s jurisdiction is 15%. In this case, P should recognise a deferred tax liability of Rs.2.25 crores (at a rate of 15% on Rs.15 crores) in its consolidated financial statements.

Thus as explained above, undistributed profits of certain investee companies result in a taxable temporary difference in the consolidated books of accounts. However, as per Para 39 of IAS 12, taxable temporary differences in respect of investments in subsidiaries, branches, associates and joint ventures are not recognised if :

the investor is able to control the timing of the reversal of the temporary difference; and

it is probable that the temporary difference will not reverse in the foreseeable future.

Since an entity controls an investment in a subsidiary or branch, the entity may be exempt for recognising deferred tax liability on undistributed profits, if it can demonstrate that it controls the timing of the reversal of a taxable temporary difference and the temporary difference will reverse in the foreseeable future. The term ‘foreseeable future’ is not defined in the standard; generally it is necessary to consider in detail a period of 12 months from the reporting date, and also to take into account any transactions that are planned for a reasonable period after that date.

Since deferred tax assets and liabilities are measured based on the expected manner of recovery (asset) or settlement (liability); deferred taxes on undistributed profits of subsidiaries, joint ventures or associates could be recognised either based on the applicable dividend distribution tax or the capital gains tax rate depending on the expected manner of recovery of such profits.

In case where the difference is assumed to be reversed though capital gains i.e. on sale of investments deferred tax liability is created on the effective capital gain tax rate on the difference between the net assets attributable to the Parent’s share less the indexed cost of acquisition.

In the above example, consider that P plans to dispose of the investment in 15 months and the capital gains tax rate applicable to it is 30%. The excess of the net assets of S over the cost of acquisition is Rs.15 crores and the indexation benefit is assumed to be 3 crores. In this case, P would recognise a deferred tax liability of Rs.3.6 crores [(15-3)*30%]in its current consolidated financial statements.

In situations where the entity does not account for the aforesaid deferred tax liability in accordance with Para 39, a disclosure to that extent is required in the financial statements reporting the amount of deferred tax liability not accounted for in the books.

An investor does not control an associate or a joint venture and therefore is not in a position to control the associate/joint venture’s dividend policy. Therefore a deferred tax liability must be recognised unless the associate/joint venture has agreed that profits will not be distributed in the foreseeable future or the Parent company’s approval is mandatory for dividend distribution (as a protective right).

Uniform accounting policies:

Para 24 of IAS 27 states that ‘consolidated financial statements shall be prepared using uniform accounting policies for like transactions and other events in similar circumstances.’ Therefore, if a subsidiary, associate or joint venture uses different accounting policies from those applied in the consolidated financial statements, then appropriate consolidation adjustments to align accounting policies should be made when preparing those consolidated financial statements. In practice, this can often pose challenges, particularly in case of associates and joint ventures, where the parent entity has no control over the accounting policies considered by the investee companies for their separate financial statements.

Impact of business combination ‘fair value’ accounting on ongoing consolidation:

In the earlier article on IFRS 3 – Business Combinations (refer BCA Journal, June 2009 edition), we discussed the purchase method of accounting for all business combinations and in particular, acquisition of a subsidiary, which results in accounting for all assets and liabilities acquired at fair values. Since there is no option of push down accounting under IFRS, the subsidiary continues to carry the same assets and liabilities at their book values (or as per the IFRS accounting policy adopted by it for each asset and liability) in its stand alone books of ac-count. Whereas in the consolidated books of accounts, the assets and liabilities at acquisition date are continued to be carried at fair values as on that date. This results in the following additional adjust-ments that are required to be carried out as part of the consolidation procedure at every reporting period:

Restate the recognised assets and liabilities in the subsidiary’s books as on acquisition date to their fair values and accordingly make adjustments for depreciation or amortisation

Recognise intangibles identified as on the acquisition date at their fair values and accordingly make adjustments for amortisation or impairment

Recognise deferred taxes as on the acquisition date and accordingly make adjustments for reversals in the future periods.

Effectively, the acquired subsidiary would have to maintain two sets of financial statements:

Separate financial statements as per IFRS book values or the accounting policies applied

Financial statements for consolidation purposes as per the fair values on acquisition date with appropriate adjustments.

IAS 28 – ‘Investment in associates’ requires that on acquisition of the investment the excess between the cost of the investment and the investor’s share of the net fair value of the associate’s identifiable assets and liabilities should be accounted for as goodwill and included in the carrying amount of investments or any deficit arising on the same basis should be included as income in the period in which the investment is acquired. In either case, initial accounting requires the identification of the fair value of net assets of the investee as on the acquisition date. Consequently, appropriate adjustments the investor’s share of the associate’s profits or losses after acquisition are also made to account for the subsequent measurement of these initial fair values. For example, depreciation of the assets would be based on their fair values at the acquisition date. Hence, separate set of accounts of associates would also have to be maintained for consolidation purposes.

Conclusion:

Consolidated financial statements are considered as the primary set of accounts under IFRS. The differences highlighted in the earlier and the present article have far reaching effects on the procedures of consolidation and the resultant impact on various performance matrices. The goal under IFRS is to move towards more transparent and consistent reporting that reflects the true net worth of the group.

Nirav Shah

Business Valuations – An Important Part of M&A

Mergers and Acquisitions (M&A) is a buzz word in current business environment. It refers to that area of corporate strategy which deals with buying, selling, combining, splitting, restructuring, etc. of an enterprise to enhance shareholder value.

In India, the liberalisation process which started in early nineties provided the impetus for M&A transactions involving large businesses. In the initial years, the transactions were domestic but in last couple of years cross border transaction activity has increased. One of the first such large transactions was acquisition of Tetley by Tata Group. Barring last one year, M&A activity has shown constant growth over last many years. It is observed that M&A activities are at a peak in boom period. In the down-turn, such activities take back seat though it is probable that M&A in a downturn may yield higher returns to shareholders. At the same time, one cannot forget that risk attached to M&A activities is also very high during downturn.

M&A activity may be carried out through mergers, demergers, acquisitions, sale of business, spin offs, etc. Any transaction to get finally consummated needs to be settled by flow of consideration from the acquirer to the seller. The consideration may be discharged by actual payment or through any other financial instrument. The determination of consideration carries more weight as stakeholders would like to ensure that the transaction is done in most fair and transparent manner.

In any M&A transaction, valuation of the business being transferred becomes very critical from all angles. In view of this, the current article covers certain basic features of financial valuations along with practical issues connected thereto.

The importance and purpose of valuation:

The stakeholders will always ask following questions on valuation when a business or an asset is transacted:

What is the value at which it is sold?

Is it a fair value?

What are the principles applied to determine the fair value?

The professional who is carrying out the valuation needs to keep purpose of valuation constantly in mind. The methodology of valuation may differ according to the purpose. For example, in case of valuation for merger, relative valuation of the companies involved is more relevant than the absolute valuation. As against this, in case of valuation for sale of business, absolute value of the company / business is more relevant.

The date of the valuation is also very relevant. A valuation done today may not be valid after passage of time as underlying factors such as price earning multiple, market price of the share, the return expectation, etc. may change from time to time. It is always advisable that the valuation is finalised near to the date of the transaction; otherwise the conclusions may undergo a material change.

Business Value would also differ from the point of view of the Buyer and that of the Seller, depending on one’s own perception, vision, strategy and future projections made by each of them independently.

Some of the purposes for which valuation may be required are as follows:

Determining the Portfolio Value of Investments by Venture Funds or Private Equity Funds:

In the current environment, when funds are deployed in investee company through private equity or venture capital funds, it becomes important that at regular interval the basket of investments held by such funds is valued and reported to the concerned forum (investment committee or trustees) so that performance of the fund managers as well as return generated for the investors can be determined.

Determining the consideration for Acquisition/Sale of Business or for Purchase/Sale of Equity stake:

When a business or shares are proposed to be divested, valuation becomes very relevant as the consideration has to change hands between buyer and seller based on agreed valuation. It is general practice that both buyer as well seller undertakes the valuation exercise which becomes base for the negotiation process. Only in very few instances it is observed that a common valuer is appointed by both the parties to arrive at the fair value.

Determining the swap ratio for Merger:

In case of merger of two companies the role of valuer is to recommend fair exchange ratio (number of shares of Transferee Company to be issued to the shareholders of the transferor company). If the companies involved are listed on the stock exchanges, it is required that the valuation is also followed by a fairness opinion by a category I merchant banker. It is required that valuation of both the companies involved is carried out on a like to like basis to the extent applicable. It may be inappropriate to use asset-based valuation for company A and earnings-based valuation for company B, unless there are justifiable reasons to follow such different methodologies.

Determining the swap ratio for Demerger :

There is misconception that every demerger requires valuation of the division being demerged. In case of vanilla demerger where beneficial ownership of the two entities post-demerger remains with the same set of shareholders, valuation may not be required as both the companies will be held by the same shareholders in the same inter se proportion as they were owning the company prior to the demerger. (Example: Demerger of Reliance Industries Limited.) As against this, when a division is demerged from a company into an operating company with a different set of shareholders, valuation of the division as well as the company to which the division is being transferred are required to be carried out. (Example: Demerger of farm input division of E.I.D.-Parry (India) Limited into Coromandel Fertilisers Limited. Demerger of scheduled airlines business of Kingfisher Airlines Limited into Deccan
Aviation Limited)

Determining the Fair value of ESOPs as per the ESOP guidelines:

Generally such valuation is carried out using Black Scholes model for ‘option Valuation.

Determining the value offamily owned business and assets in case of Family Separation:

This is generally required when family members decide to part ways. Here the valuation exercise becomes sensitive as one of the parties involved will always feel that fair treatment is not given. There are instances where valuers are dragged to court of law in case of valuation for family separation.

Sale/purchase of Intangible assets including brands, patents, copyrights, trademarks, rights:

In case of acquisition of a business for a lumpsum price, the identification and valuation of intangible assets becomes a requirement. In recent times, many transactions of intangibles are carried out. (Example sale of certain brands by Pfizer to Jhonson and Jhonson)

Liquidation of company:

When a company is liquidated valuation of each and every asset and liability is carried out and cost required to be incurred for closure is reduced from such values.

Determining the fair value of shares for Listing on the Stock Exchange:

when a company decides to offer its security for public participation, an estimation of the fair valuation of the security is required to guide the promoters and merchant bankers to decide the offer price. There are instances where shares are issued at a discount to the fair value to encourage public at large to invest.

Other reasons:

Many times valuations are required for litigation, buyback of shares, raising of funds, open offer in case of takeover, approval under the FEMA regulations, etc.

The above list is not exhaustive but only indicative of the purposes for which valuation is attempted.

Methods of valuation:

As discussed earlier that the value changes with the change in the purpose holds true also for the use of methodologies of Valuation. A valuer may use different methods to value the Shares of a Company / Business. In practice, however, the valuer normally uses different methodologies of valuation and arrives at a fair value for the entire business by combining the values arrived, using various methods and giving appropriate weights to the values so arrived to opine on fair value.

Each method proceeds on different fundamental assumptions, which have greater or less relevance, and at times even no relevance to a given situation. Thus, the methods to be adopted for a particular valuation must be judiciously chosen.

Commonly used methods of valuation are as under:

A. Asset Based Approach:

i. Net Assets Method:

Valuation of net assets is calculated with reference to the historical cost of the assets owned by the company. Such value usually represents the minimum value or a support value. of a going concern. It is also necessary to make adjustments for market value of non operating assets, contingent liabilities likely to materialise, outstanding warrants, appreciation/ diminution in the value of investments, etc. This method is mainly applicable for investment companies or companies which are yet to commence their operations. For a manufacturing concern the value under this method is a floor value below which a transaction may not be carried out.

ii. Net Realisable Value Method:

Where the business of the company is being liquidated, its assets have to be valued as if they were individually sold and not on a going concern basis. This method is generally used in case of liquidation. One has to take a note of liabilities that would arise on account of closure, tax implications, and dividend distribution tax, etc.

iii. Remainder Replacement Value Method:

Under this method, the replacement value of assets and not the book value is captured. Net replacement value of the assets indicates the value of an asset similar to the original asset whose life is equal to the residual life of the existing asset. The term replacement cost refers to the amount that a company would have to pay, at the present time, to replace anyone of its existing assets.

B. Earnings-based Approach:

i. Profit Earning Capitalisation Value Method (PECV) :

Earnings-based methods are generally regarded as more appropriate in case of ‘going concern’ valuation. Capitalisation of future maintainable earnings on a post tax basis is carried out under Earnings Approach. For this purpose past profitability generally gives the indication. However, for a company where past profits are not representative of future maintainable earnings then, future expected profitability may be used after taking into account present value of future expected profits. Any extraordinary item of income/ expenditure is adjusted for arriving at future maintainable profit. The most common example of such adjustments are profit/loss on sale of assets/investments, impact of VRS, one time write off of stocks / debtors, loss on account of natu-ral calamities, etc. The price earning multiple is to be carefully chosen taking into account multiples enjoyed by similar quoted companies.

ii. Discounted Cash flow Method (DCF) :

DCF method considers cash flow and not the profits of the business. The DCF method values the business by discounting its free cash flows for the explicit forecast period and the perpetuity value thereafter. The free cash flows represent the cash available for distribution to both the owners and the creditors of the business. The cash flows are considered keeping in mind the projections, horizon period, growth rate, and the residual value. Discounting is done taking into account the weighted average cost of capital which is based on the cost of equity and cost of capital and after taking into account the proportion of debt and equity used to fund the business.

iii. EBITDA Multiple Method:

The EBITDA multiple is the ratio of Enterprise value to EBITDA. It involves determination of maintainable EBITDA.

This method ensures that the valuation is not affected by the pattern of funding adopted by the company or comparable companies. One has to keep in mind that value of debt is reduced from the enterprise value to arrive at the equity value.

iv. Sales Multiple Method:

Sales multiple may be used to arrive at the enterprise value particularly if the business is not making profits. The information needed is annual sales and an industry multiplier, which will depend on industry. The industry multiplier can be obtained from public sources including data relating to listed comparables. This method is easy to understand and use. However, this method is generally used to cross check the values arrived at under other methods of valuation.

C. Market-based Approach:

Market Price Method :

The Market Price Method takes into consideration prices quoted on the stock exchange. Average of quoted price is considered as indicative of the value perception of the company by investors operating under free market conditions. Adjustments have to be made for issue of bonus shares or right shares during the period. Regulatory bodies often consider market value as important basis – Preferential allotment, Buyback, Open offer price calculation under the Takeover Code. Market Price Method is not relevant where the shares are not listed or are thinly traded etc.

Market comparables :

This method is generally applied in case of unlisted entities. This method estimates value by relating the same to underlying elements of similar companies. It is based on market multiples of ‘comparable companies’. e.g.

Earnings/Revenue Multiples (Valuation of Pharmaceutical Brands)

Book Value Multiples (Valuation of Financial Institution or Banks)

Industry-Specific Multiples (Valuation of cement companies based on Production capacities, Valuation of BPO companies based on number of seats)

Multiples from Recent M&A Transactions.

Though this method is easy to understand and quick to compute, it may not capture the intrinsic value and may give a distorted picture in case of short term volatility in the markets. There may often be difficulty in identifying the comparable companies or comparable transactions.

Data used to carry out valuations :

Valuation starts with collection of relevant and optimal information required for valuing Share or Business of a company. Such information can be obtained from one or more of the following sources:

Historical results:

Annual Reports for atleast 3 years of the Company are required for valuation exercise. Apart from review of detailed financials, it is necessary to

carefully consider the Directors Report, Management Discussions, Corporate Governance Reports, Auditors’ Report and Notes to accounts. A detailed analysis of the past performance is starting point in any valuation exercise. From the past results various important aspects can be worked out such as one time non-recurring income, expenditure, change in Government/Tax regulations affecting business, tax benefits enjoyed, etc.

Projections:

Future expected Profitability, Balance Sheet and Cash Flows along with detailed assumptions underlying the projections are required. The projections considered for valuation should not be at variance with the outlook discussed in the Annual Report. It is important to cover the period which will comprise the entire cycle of the business. In certain industry even 3 year period will cover the cycle whereas in certain industries like heavy engineering or cement, a longer period of 5 to 7 years may capture the cycle. It is impossible to predict the future in a precise way particularly considering the dynamic nature of the economy. One should ensure that the assumption behind the future projections is reasonable at a point of time when they are prepared. A few common mistakes which are found in the projections are: assuming production much higher than the capacities without capturing additional capital cost, showing unreasonable changes in selling price of the final products or of raw materials, showing unreasonable change in the working capital movements, capturing tax benefits even after sunset clause under the Tax laws, unreasonable changes in manpower cost, etc.

Discussions with the Management:

Discussions with management may sometimes reveal issues that may drive the valuation. It is very important that open, fair and detailed discussions are carried out between the valuer and the management. The discussions should not be restricted to only representatives of Finance Department but involve other key functional heads.

It is advisable to obtain written confirmation of the inputs provided by the Management. This helps the valuer in defending the valuation in the eventuality of its being challenged by any Authority.

Market surveys, other publicly available data:

A valuer carries out market surveys and obtains publicly available information. It may pertain to the industry as well as the Company being valued. Due to technology advancement, most 6£ these data are available on the net. Various newspaper reports are also available on the subject. It is advisable to double check the accuracy of these data before relying on such data. Various software packages that have the relevant data are available. It should be ensured that updated version of such data is used.

Data on comparable companies:
Review of data on comparable companies is an important feature in any valuation exercise. Area of operations and the extent of the market share also play an important role in considering the comparable companies. It is possible that geographically the companies are located in different areas because of which there are substantial differences in the operational cost. For example cement companies located near to limestone reserve and those which are located far off are not strictly comparable. Further, different funding pattern of two companies and investment also makes them non-comparable.

Steps in valuation:

Obtaining information:
It is always experienced that the time available to carry out the valuation is short as the parties want to complete the transaction as fast as possible. In view of this, it is very critical that one seeks relevant information. Obtaining and processing unrelated data may take away precious time without obtaining desired result. For example if the transaction is only for an intangible asset, processing the data for working capital of the business may not be required. At the same time there should not be compromise on obtaining critical data on the ground of shortage of time. It goes without saying that this stage comes only after appropriate Engagement letter setting out scope of work, time lines and fees is in place.

Reviewing data provided:
Having obtained the relevant information, next step is to process the same. Some of the items on which extra emphasis should be given are analysis of various ratios, comparison with comparable companies, current Regulatory environment, future plans, contingent liabilities, surplus assets, outstanding warrants, etc. Use of technologies and other software will be maximum during this stage of valuation.

Review of underlying assumptions of projections:
Depending on the facts of the case, one can decide whether projections should be used or not. If one is using the future projections, review of underlying assumption for various critical items such as growth in turnover, raw material consumption, inflation rate, foreign exchange rate, working capital movement, capital expenditure needs, etc. will be important. One should always keep in mind the requirement of the Institute of Chartered Accountants of India while dealing with future projections.

Selecting method(s) :
Having obtained and processed the data, the valuer will have to decide on methods to be used for valuation. There is no fixed rule or principle regarding methods to be used for valuation. It is more dependent on valuer as to which method is relevant in a particular case. The selection of method(s) may differ from valuer to valuer as it a very subjective issue. The valuer should be in a position to justify the method(s) used as well as factors considered in case the valuation is challenged by any Authority. If multiple methods are used for a particular valuation, it is a common practice to assign weights to different methods to arrive at the fair value. Guidance may be taken from past decided case laws as to the selection of methods and weights.

Reporting:
Once the valuer concludes on his opinion as to the fair value, the next step will be Report of valuation. The typical contents of the report should be purpose of valuation, date of valuation, background of the Company, sources of information, methods of valuation used alongwith major adjustments, conclusions and disclaimers. There are some valuers who attach entire workings with the report where as some valuers just mention the final value.

Conclusion:
It may be relevant to mention that valuation is not at all a rocket science. It is always seen as a very specialised field. However it is more an application of common sense. The more you practise a particular work, more conversant and proficient you become. It is always seen that the easiest target in any transaction to get challenged is valuation. The reason is that valuation is very subjective. The discount rate, the price earnings multiple, the selection of methods, determination of maintainable profits, etc. will differ from one individual to other. There is no single correct answer to any valuation. That is why it is considered more an art and not an exact science.

Nirav Shah

Fictione Legis

‘Fictio’ in old Roman Law was a term of pleading and signified a false averment on the part of the plaintiff which the defendant was not allowed to traverse e.g. an averment that the plaintiff was a Roman citizen, when he was a foreigner, if the object was to give jurisdiction over him [Maine’s Anc. Law Ch. II]. The term, meaning ‘fiction’, therefore, came to be used for those things that have no real essence in their own body but are so accepted in law for a special purpose. In the words of Viscount Dunedin in CfT v. Bombay Trust Corporation, AIR 1930 PC 54, “Where a person is deemed to be something, the only meaning possible is that whereas he is not in reality that something, the Act of Parliament requires him to be treated as if he were”.

2. Fictions in law are created for definite purposes to result in a situation which would not otherwise have resulted and to treat an imaginary state of affairs as real. It is introduced for necessity, generally to avoid inequity caused by mischief made possible under general provisions and concepts of law. In tax laws the object is mainly ‘to prevent mischief arising out of circumvention of normal legal provisions resulting in tax avoidance while remaining within the confines of the law, as also to remove unintended consequences. The introduction of legal fictions thus introduces equity in legislation which is expressed in the maxim, “In fictione legis acquitas exist it” i.e. the legal fiction is consistent with equity. Beyond the purpose for which they are created legal fictions must injure no one as expressed in the maxim ‘fictio legis neminem ladit’.

3. The English law has always abounded in fictions, so are taxation laws in India. The unrestricted operation of treating the imaginary as real has the potentiality of upsetting the whole scheme of legislation and the basic fundamentals of law causing injury to untargeted subjects and areas and thus violating equity. Courts have, therefore, in keeping with the maxim, been cautioning against extending them beyond their legitimate field. The Apex court has repeatedly observed that legal fictions are created only for a definite purpose. They are limited to the purposes for which they are created and should not be extended beyond their legitimate field. [CfT v. Elphinstone Spg. & Wvg. Mills Co. Ltd., 40 ITR 124].

4. In CfT v. Amarchand N. Shroff, 48 ITR 59, the court was to interpret the fiction contained in S. 24B(1) of 1922 Act making a legal representative an assessee in respect of the income which the deceased would have earned had he not died. Attempt was made to extend the fiction to post-death income as well. The court disapproved extending the fiction, the legitimates purpose of which was to tax income earned upto the year in which death took place. As a result, the 1961 Act made a specific provision in S. 168 to cover income upto the date of complete distribution of assets.

5. Commenting on Rule 8 of the Income-tax Rules which apportions the business income of the growers and manufacturers of tea, between agricultural and business income in the context of deduction u/s.80 HHC, the Calcutta High Court in Warren Tea Ltd v. UOf, 236 ITR 492 held that the applicability of the fiction is limited to computation of taxable income from business by apportioning the total business income computed after all deductions and, accordingly, held that since the stage of grant of deduction u/s.80HHC would be at the time before applying Rule 8 and not after apportionment is made, the Rule cannot be extended to computation of deduction u/s.80HHC. On that basis it struck down the CBDT Circular No. 600 dated May 23, 1991.

6. Fictions are suppositions and, unless it is clearly and expressly provided, it is not permissible to impose a supposition on a supposition of law. In Executors and Trustees of Sir Cawasji Jehangir v. CFT, 35 ITR 537, the Bombay High Court was to consider the scope of the jictio juris’ in S. 23A of the 1922 Act under which the undistributed income of the company, as computed in accordance with that provision, was deemed to have been distributed as dividend amongst the shareholders and included in their total income as such. The issue arose that if such income of the company constituted partly of capital gains, should the dividend which is deemed as distributed also be apportioned between capital gains and dividend in the hands of the shareholder. While accepting that full effect has to ‘fictio juris’ the court ruled out sub-joining or tacking a fiction upon fiction and observed that there is nothing even remotely suggesting the assessee to identify himself with the company or to assert an equivalence between his income and the income of the company. The argument, if accepted, would amount to imposing supposition upon the supposition of law.

7. Within its legitimate area of application, the fictione legis has to have its full effect. The question of chargeability of interest u/s.234B and u/s.234C came for consideration before the Gauhati High Court in Assam Bengal Carriers Ltd v. CIT, 239 ITR 862. Brushing aside all the arguments based on the impracticability of estimation of income before the book profit is arrived at, the Court directed full effect to be given to the fiction contained in the provision with its obvious fall out. Observing that, where fall out of the fiction leads to an obvious inference, there can be no half way house, the court held S. 234B & S. 234C applicable even in case where income is determined u/s.115JB. They quoted with approval the following observations of Lord Asquith in East End Dwellings Co. Ltd v. Finsbury Borough Council, (1951) 2 All ER 587 (HL) which was also relied upon by the Bombay High Court in the case of Executors and Trustees of Sir Cawasji Jehangir (supra).

“If you are bidden to treat an imaginary state of affairs as real, you must surely, unless prohibited from doing so, also imagine as real, the conse-quences and incidents which, if the putative state of affairs had in fact existed, must inevitably have flowed from or accompanied it”.

The Supreme Court, however, in CIT v. Kwality Biscuits Ltd., 284 ITR 434 disapproved the judgment of the Gauhati High Court on a different ground of the impracticability of arriving at the total income before arriving at the ‘book profit’.

8. In a recent judgement delivered by the Special Bench of the Ahmedabad Tribunal in Assistant Commissioner of Income-tax v. Goldmine Shares and Finance P. Ldt 302 ITR (AT) 208, the Tribunal considered the fiction contained in S. 80IA(5) which bids one to treat the eligible business as the only source of income of an undertaking. Applying the observations of Lord Asquith (supra), the Tribunal took note of the consequences and incidents flowing from it and held that the profit from the eligible business for the purpose of deduction u/s.80IA has to be computed after deduction of the notional brought forward losses and depreciation of eligible business even though they have been allowed set off against other income in earlier years.

9. Fictions are generally by way of deeming provisions where imaginary or unreal state of affairs is deemed to exist in the presence of certain facts. Income-tax Act abounds in deemed provisions in which, all are not restricted to imaginary state only. Deemed provisions are sometimes used to give an artificial construction to a word or phrase that would otherwise not prevail. A clear example is to be found in the provisions of S. 2(22)(e) of the Act deeming advances to specified persons as dividend to shareholders. The Act defines ‘Income’ in an inclusive manner including receipts of the nature which would not otherwise be taken as such. They are also used to put beyond doubt a particular construction that might otherwise be capable of different interpretation. One may refer to the provisions of S. 9 which deems certain income as accruing or arising in India to keep them outside the pale of uncertainly. We have fiction in S. 45(3) and S. 45(4) to avoid unintended situation legalised by courts decisions and S. 115 JB to partly neutralise the impact of various tax incentives and thus introduce horizontal equity. All these provisions involve some digression from the normal provisions and the concepts in tax law. The peculiar sense in which the provision is employed has to be judged in the light of the scheme of the section and the context in which deeming is made.

10. Fictions in law, therefore, give completeness to the scheme of law and the intention of the legislature.

Nirav Shah

Rewriting and Revising Securities Laws – Highlights of some recent amendments

This series of articles introducing securities laws for listed companies to the lay reader continues …

1) SEBI has been busy in recent times and several revisions/amendments have been made, some of which are highlighted here.

2) SEBI rewrites and replaces the DIP Guidelines 2000 with ICDR Regulations 2009

a. While not comparable to the Direct Taxes Code which seeks to rewrite the direct taxes laws into what is hoped to be an easy to understand law, SEBI too has undertaken a comparable exercise and has replaced the almost one-decade old DIP Guidelines with a re-written (though not overhauled) Regulations – the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 or ‘the Regulations’.

b. Readers may recollect that the DIP Guidelines mainly regulate issue of securities to the public, shareholders and others. They regulate initial pubic offers, rights issues, preferential issues, etc. They provide for very detailed provisions which border on micro-regulation of every aspect of the process of such issues. These Guidelines are very frequently amended. For listed companies, their promoters and merchant bankers, these guidelines are literally like a Bible which they need to keep handy for regular reference.

c. As can be expected, frequent changes have made the Guidelines unwieldy and complex. Further, when one writes a set of clauses, one may have a central theme in mind. However, as new clauses and provisos and explanations are inserted and amended, the new set of clauses represent neither the original harmo-nious theme nor a new one but represent a hotch potch of ideas.

d. Another aspect of these Guidelines was that they were not, in my opinion and also as held in decisions, law in the strictest sense of the word. These guidelines were obviously not Parliament-made law nor could they be compared to Regulations and Rules which the Act provides for and which are also laid before Parliament later. Rather, they represented the provisions made by SEBI from time to time. While there is nothing wrong in SEBI prescribing such Guidelines – indeed this manner is inevitable and required in dealing with the dynamics of the capital market, a question often arises as to what their legal status is and what could be the penal consequences of their violations.

e. Thus, the replacement of the Guidelines with Regulations at least removes this concern over their legal status. Incidentally, though, the SEBI Act will now need to be amended to provide for specific punishment for violation of these Regulations since otherwise, the violation of these newly notified Regulations will fall under the residuary provisions and this mayor may not achieve the object that SEBI may have in mind. In fact, it may make sense if different provisions of these new Regulations are treated differently and thus separate punishment is provided for violations having differing intensity or seriousness. However, that would require a Bill to amend the SEBI Act itself.

f. In any case, to reiterate, the Guidelines are now replaced by Regulations whose violations can be punished with significant penalty and/or prosecution.

g. While it would be a mammoth exercise to compare the old Guidelines and the new Regulations and even to highlight the changes, suffice it to say that the intention has not been to completely rehaul the provisions. Future articles here may highlight some interesting implications particularly arising out of change in wording.

h. Further, the Regulations represent the DIP Guidelines rewritten but in most cases without any intention of changing the law. However, how well this intention of keeping the substantive law intact will be successful will be shown by time and experience in varying situation since the wording would often show up differently when one tries to apply and interpret them.

i. On first appearances, the substantive provisions and clauses have been trimmed and made more compact. However, part of the reason for the substantive clauses appearing more compact is also because the Regulations are now divided into substantive clauses and drafts of various precedents, forms, agreements, etc.

j. Consequential changes have been made in the SEBI ESOPs Guidelines and the Listing Agreement.

3) Ban on issue of shares with superior voting rights:

a. SEBI has issued a circular dated July 21, 2009, to make amendments to prohibit issue of shares with superior voting rights by listed companies. Earlier to this, SEBI had a Press Release announcing the decision to make such changes. Incidentally, the actual amendment covers all superior rights as to voting as well as dividends. The original decision as per the Press Release read that “No listed company can issue shares with superior voting rights.”.

b. The amendment is by way of insertion of a new clause 28A to the Listing Agreement. The amendment is to come into immediate effect though because of the peculiar status of Listing Agreement, one will also have to wait for amendment of the Listing Agreement by the respective stock exchanges.

4) The new clause is brief and is reproduced for ready reference:

“28A. The company agrees that it shall not issue shares in any manner which may confer on any person, superior rights as to voting or dividend vis-a-vis the rights on equity shares that are already listed.”

5) The following are some quick comments and concerns :

a) The prohibition is on issue of shares with ‘superior’ rights and not on ‘inferior’ rights.

b) A corollary from the earlier point, if a company issues shares with ‘inferior’ rights, those shares will then become the new benchmark. If one takes this further logically, then, thereafter, even ‘normal’ equity shares cannot be issued since these normal shares would have ‘superior’ rights as compared to the existing shares with ‘inferior rights’ assuming such latter shares are also listed !

c) Can the amendment affect issue of preference shares which have priority of dividends and at times even rights of sharing further dividends? Or can one say that the intention is to cover issue of equity shares only since the comparison is made to existing equity shares?

d) To bring the change into effect, the Listing Agreement is amended. This is curious. One would have thought the SEBIDIP Guidelines/ ICDR Regulations could have been a better place.

e) Would special rights given to certain investors/ promoters under the Articles of Association such as veto rights, special rights, etc. be deemed to be ‘superior rights as to voting’ ? Can it be said that the ban applies only where the superior rights are given to the ‘shares’ and not to the ‘persons’ holding such shares?

6) SEBI issues circular to formalise clarifications on 5% additional creeping acquisition

a) It may be recollected that late last year, SEBI had amended the Takeover Regulations to provide for a creeping acquisition window between 55-75%. These amendments permitted acquisition of further shares upto 5% for persons who held shares between 55-75%. A circular has been issued recently to clarify on some of the concerns expressed.

b) The circular is fairly self explanatory. A few quick comments though.

i) The clarifying circular is issued under Regulation 5 which permits SEBI to, inter alia, issue directions to remove difficulties in interpretation. S. 11 of SEBI Act is also relied on.

ii) It is seen that some of the interpretations so given go clearly beyond the plain wording and meaning. It is possible that in the future, a legal issue may come up whether such ‘clarification’ can go beyond the express and unambiguous wording of the Regulations.

iii) It is clarified that the 5% acquisition may be made in one or more tranches and also without any time limit.

iv) For calculating the 5% acquisitions, sales cannot be netted off. Thus, only gross purchases would be counted. For example, the acquirer cannot purchase 4%, then sell 3% and then acquire another 4% and claim that the net purchases are within the 5% limit.

v) The cumulative holding of the acquirer cannot exceed 75%. Thus, a person holding, say, 73% can acquire only a further 2%.

vi) The cumulative holding limit of 75% is irrespective of the minimum public share-holding that is required to be maintained under the Listing Agreement. Thus, e.g., in respect of a company having a 10% minimum public shareholding, the upper limit for this Regulation will still be 75% and not 90%.

7) SEBI clarifies on Insider Trading Regulations amendments of November 2008.

a) SEBI had amended the Insider Trading Regulations 1992 vide a Notification dated November 19, 2008. SEBI has now released a set of ‘Clarifications’ on 24th July 2009 on certain issues arising out of the amendments made.

b) Curiously, the ‘clarifications’ have no formal standing or reference. It is neither a circular, nor a notification, nor even a press release. It is neither signed nor dated. But it seeks to ‘clarify’ and give meaning to the Regulations that have legal standing and where such ‘meaning’ is quite contrary – as we will see to the plain reading of the text. Having said that, the ‘clarifications’ mostly relax the requirements and hence, being gift horses, one should not examine them in the mouth too closely!

C) Let us consider the clarifications given.

i. lt may be recollected that specified persons were banned from carrying out opposite transactions’ (banned transactions’) for six months of original buy/sale (‘original transactions’). The question was whether acquisition of shares under ESOP scheme and sale of such shares would be considered as transactions that trigger off such ban and whether these themselves are banned. It is clarified that exercise of ESOPs will neither be deemed to be ‘original transaction’ nor ‘banned transaction’. Thus, by acquiring shares under ESOPs, you don’t trigger a ban and if you are banned for six months, you can still exercise ESOPs. The reasoning given is that the ban is only on transactions in secondary market.

ii. Sale of shares acquired through ESOPs is covered but it will only be deemed to be an ‘original transaction’ and not a ‘banned transaction’. In other words, even if you are under a ban, you can still sell shares acquired under ESOPs but once you sell such shares, you have triggered a ban of six months. On this aspect, I do not understand the basis of clarifying that the sale of shares acquired under ESOPs scheme will not be an ‘original transaction’ – the logic of covering secondary market transactions should apply here also.

iii. Then, it is clarified that every later transaction triggers a fresh six month ban. A purchase on 1st February results in ban till 1st August. However, if there is a fresh purchase on 15th March, there is a ban now till 15th September. Effectively, this means that the ban period is from 2nd February till 15th September.

iv. What about transactions before this amendment – will the amendment create ban in respect of them too – this is an academic issue now at least as the six month period is now complete. It is clarified though that the transactions before the amendment are not to be considered. On a similar note, unwinding of positions in derivatives held on the date of this amendment is possible.

v. A crucial clarification is that the ban on ‘sale’ of shares for personal emergencies is permissible by waiver by the Compliance Officer. This is not evident from a plain reading of the provision. But SEBI thinks it is so evident and hence let us accept this gift without creating legal niceties! Note that this clarification applies only to sales and there can be no purchases within these six month ban period – obviously there cannot be any personal emergency to purchase shares !

vi. It is also clarified that tile ban on derivatives does not apply to NIFTY/SENSEX futures.

Nirav Shah

Limited Liability Partnerships Part-III

1. Winding-up of an LLP:

1.1 There are two ways in which an LLP can be wound-up, by an order of the Court or voluntarily.

1.2 An LLP can be wound-up by an order of the High Court under any of the fall owing circumstances:

a) If the LLP decides that it should be wound-up by a Court Order.

(b) If the minimum number of partners reduces to less than two and remains sa far mare than 6 months,

c) If it is unable to pay its debts. The Act does not prescribe any minimum amount of debts or any conditions under which an LLP is deemed to be unable to pay its debts. All these are contained in the draft Concept LLP (Winding-up and Dissolution) Rules.

d) If it has acted against the interests of the sovereignty and integrity of India, security of the State or public order.

e) If it has made a default in filing the Statement of Account and Solvency or the Annual Return far any 5 consecutive years.

f) If the Court is of the opinion that it is just and equitable to wind-up the LLP.

1.3 The above section is similar in its operation to S. 433 of the Companies Act. However, unlike the Companies Act, the LLP Act does not contain any provisions far the compulsory or voluntary winding-up of an LLP. All these provisions are contained in the draft Concept LLP (Winding-up and Dissolution) Rules. The final Rules have yet not been notified. It is interesting to note that while normally Rules only contain the procedures and the substantive portion is contained in the Act, the Winding-up Rules, even deal with the substantive portion of winding-up of LLPs. One would expect that such an important provision is passed by the Parliament rather than notified by the Ministry of Corporate Affairs.

1.4 S. 51 of the Act also provides that if an LLP’s affairs are under investigation if, based an an inves-tigatian report made u/s.49, the Central Covernment is of the view that it is expedient to do sa, then the Gavernment may present a winding-up petition to the High Court, The petition may be presented an the ground that it is just and equitable to wind-up the LLP.

2. Investigation of an LLP:

2.1 S. 43 of the Act empawers the Central Government to appoint an inspector to investigate the affairs of an LLP in any of the following circumstances:

a) If partners having at least 20% voting pawer apply to the Tribunal far an investigation and the Tribunal passes an order to that effect. An application should be accompanied with a security of an amount calculated based an the turnover. The amount of security ranges from Rs.2 to 25 lakhs.

b) If the Tribunal sua moto passes an order far an investigation into the affairs of an LLP.

c) Any Court passes an Order that the affairs of an LLP should be investigated.

d) If in the opinion of the Central Gavernment, there are circumstances suggesting that the business of the LLP is being conducted :

with an intent to defraud creditors, partners
otherwise far a fraudulent/unlawful purpase
in a manner .oppressive or unfairly prejudicial to its partners

e) If in the opinion of the Central Gavernment, there are circumstances suggesting that the LLP was farmed far any fraudulent or unlawful purpase.

f) If in the opinion of the Central Gavernment, there are circumstances suggesting that the LLP’s affairs are not being conducted in accordance with the provisions of the Act.

g) If in the opinion .of the Central Gavernment, there are circumstances suggesting that, based an a rep art of the RaC, there are sufficient reasons that the affairs of the LLP should be investigated.

2.2 The inspector may make interim reports and on conclusion of the investigation make a final report.

2.3 If based on this report, the Central Government is of the view that any person named in the report is guilty of any offence, then it may launch crimi-nal prosecution against him. The Government may also initiate proceedings:

a) for the recovery of damages; or

b) for the recovery of any property of the LLP/ any entity which has been misappropriated or wrongfully retained.

3. Defunct LLPs :

3.1 The RoC may strike off the name of an LLP from its register. It can do so, where an LLP is not carrying on any business or operation:

a) For a period of 2 years or more and the RoC has reasonable cause to believe the same, for taking suo moto action for striking off the LLP’s name; or

b) For a period of 1 year or more and it has made an application to the RoC in Form 24 with the consent of all the partners for striking off its name from the register.

3.2 The RoC shall in all cases of suo moto action provide an opportunity of being heard to the LLP. After that if the RoC is satisfied that the name should be struck off then it will publish a notice in the Gazette and from that date, the LLP shall stand dissolved.

4. Offences and penalties:

4.1 The LLP Act lays down various penalties and prosecutions for non-compliance with the provisions of the Act. It also lays down penalties for various procedural offences such as not filing forms on time. Further, where any document or return is required to be filed and if it is not so done on time, then it may be filed within 300 days from the original date of filing along with a daily fine of Rs. 100 for every day of delay.

4.2 In offences where no penalty has been pre-scribed, the punishment shall be a fine ranging from Rs.50,000 to Rs.5 lakhs along with a further fine which may extend to Rs.50 per day for every day after which the default continues.

4.3 A petition for compounding of offences can be made in From 31 to the RoC. Only those offences can be compounded for which the punishment is only a fine. Thus, offences which are punishable with imprisonment are not compoundable. This is different from the provisions of S. 621A of the Companies Act. Under this Act, offences for which the punishment is a fine or imprisonment are compoundable. One reason for the same is that there are no offences under the LLP Act for which the punishment is a fine or an imprisonment. The punishments under the Act are in the form of fines and imprisonment. Where any offence by an LLP is compounded no prosecution would be launched against the offender.

4.4 Offences in relation to the Incorporation Document, carrying on of a fraudulent business, making of false statements under the Act, matters arising out an Inspection Report and non-compliance of any Order of the Tribunal, are offences under the Act which also attract imprisonment as a punishment.
Thus, these offences would not be compoundable.

4.5 Where any offence by an LLP is proved to be because of the consent or connivance of a partner or attributable to the neglect of any partner, then such person shall be proceeded against and punished under the Act.

5. Whistle blowers:

5.1 A Court or Tribunal is empowered to reduce or waive any penalty leviable against any partner or employee of an LLP who is a whistle blower, if :

he provided useful information during the investigation of the LLP; or

he provided some information which lead to the LLP or its partner / employee being convicted under any Act.

5.2 The Act also contains a safeguard against harassment of such a whistle blower by providing that he would not be discharged, demoted, suspended, threatened, harassed or discriminated against merely because he provided the above information.

Nirav Shah

RBI/FEMA

4. Press Note No. 6 (2009) dated September 4, 2009 – Foreign Direct Investment (FDI) into Small Scale Industrial Under-taking (SSI)/Micro & Small Enterprises (MSE) and in industrial undertaking manufacturing items reserved for SSI/MSE – clarification

This Press Note relaxed the limit for FDI in SSI/MSE and clarified issues relating to FDI in industrial undertaking manufacturing items reserved for SSI/MSE.

1. FDI in SSI/MSE :

The Micro, Small and Medium Enterprises Development (MSMED) Act, 2006, has removed the ceiling for equity participation (both domestic and foreign) in the micro and small enterprises, by other enterprises. Under this Act Micro and Small Enterprises (MSE) (earlier small scale industries) are defined solely on the basis of investment in plant & machinery (for micro and small enterprise engaged in manufacturing) and equipment (for micro and small enterprise engaged in providing or rendering of services).

The Press Note amends Press Note 18 (1997 Series) but stating that FDI in MSE is subject only to the sectoral equity caps, entry routes and other relevant sectoral regulations.

2. FDI in an Industrial Undertaking manufacturing items reserved for SSI/MSE

This Press Note clarifies the position, as stated at Part III (ii) of Annex to Press Note 7 (2008), in respect of FDI in an industrial undertaking manufacturing items reserved for SSI/MSE. Accordingly, any industrial undertaking, with or without FDI, which is not an MSE, manufacturing items reserved for manufacture in the MSE sector (presently 21 items) as per the Industrial Policy, would:

a) Require an Industrial License under the Indus-tries (Development & Regulation) Act, 1951, for manufacture of the reserved items.

b) Apart from fulfillment of certain general conditions, the undertaking will have to export a minimum of 50% of the new or additional annual production of the MSE reserved items to be achieved within a maximum period of three years.

c) The export obligation will be applicable from the date of commencement of commercial production.

d) Such an industrial undertaking would also require prior approval of the Government (FIPB) where foreign investment is more than 24% in the equity capital.

5. A.P. (DIR Series) Circular No. 8 dated September 14, 2009 — Foreign Currency Account by diplomatic missions — Credit of Visa Fees.

Notification No. FEMA 193/2009-RB dated June 2, 2009 — Foreign Exchange Management (Deposit) (Amendment) Regulations, 2009.

Presently, Diplomatic Missions are permitted to credit proceeds of inward remittances received from outside India through normal banking channels to their foreign currency accounts.

This circular, in addition to the existing permission, permits Diplomatic Missions to transfer visa fees collected in India in Indian rupees from their rupee accounts to their foreign currency accounts.

Part D : Miscellaneous

The Government of India has signed a Social Security Agreement with the Government of Switzerland on 3rd September, 2009. The said agreement is intended to benefit cross-border operations in the two countries by avoiding the hardship of double payment of the social security (by employer and employee) in India and Switzerland. The same will come into effect after the fulfillment of the necessary requirements in both the countries.

Nirav Shah

Tribunal News: PART B

Bomi S. Billimoria v. ACIT ITAT ‘F’ Bench, Mumbai Before D. Manmohan (VP) and J. Sudhakar Reddy (AM)
ITA No. 2120/Mum./1998 A.Y. : 1993-94. Decided on: 30-6-2009

Counsel for assessee/revenue: Prakash Jotwani/ J. V. D. Langstieh

S. 48 – Amount received on transfer of shares under cashless option not liable to tax under the head ‘Income from Capital Gains’ since such option does not have cost of acquisition.

Per D. Manmohan :

Facts:

The assessee was an employee of Johnson & Johnson, Bombay which was a subsidiary of Johnson & Johnson, USA. Under stock option plan, the USA company granted to the assessee, on 7-12-1989, a cashless option to purchase 2500 shares of Johnson & Johnson, USA at a price of USD 57.88 per share which price was the fair market value of the stock on the day of granting the option. The Reserve Bank of India had approved the stock option scheme on the condition that there should not be any payment, either in India or abroad, for acquiring the shares.

During the previous year relevant to A.Y. 1993-94, on 13-8-1992, the assessee exercised his option to realise the value of the options under the scheme and accordingly sold 1000 shares in USA and received a sum of Rs.4,59,405 in Indian currency. After considering the amount retained in USD in EEFC Account and also the bank charges the net gain was computed at Rs.5,44,925. The assessee regarded this amount as a capital receipt not chargeable to tax.

The Assessing Officer (AO) held the profit on sale of option to be chargeable either as salary or short term capital gains or as speculation profit.

The CIT(A) held that the shares obtained under the ESOP were a capital asset and as they were held for less than 3 years, the gain was assessable as short term capital gain. He rejected the argument that as there was no ‘cost of acquisition’, ‘the capital gains were not assessable.

Aggrieved, the assessee preferred an appeal to the Tribunal. The issue before the Tribunal was whether the amount received by the assessee was liable to tax under the head’ capital gains’ and if so whether there was any cost of acquisition so as to bring to tax the net receipts.

Held:

1) As the CIT(A) had held that the shares acquired under ESOP amounted to acquisition of a capital asset one had to proceed on that premise;

2) Since on the date of exercising the option there was no cost of acquisition of shares, in accordance with the ratio of the decision of the Apex Court in the case of B. C. Srinivasa Shetty (128 ITR 294) the gains could not be taxed;

3) Even if it is assumed that the market value of the shares is the benefit given to the assessee, such benefit can be said to accrue to the assessee only on the date of exercise of the option. As the date of exercise of option as well as the date of sale is the same, there was no difference between the ‘deemed cost of acquisition’ and the actual price realised by assessee and thus there is no capital gain chargeable to tax.

The Tribunal allowed the appeal filed by the assessee.

2. Shree Capital Services Ltd. v. ACIT ITAT Special Bench Kolkata Before G. D. Agrawal (VP) and B. R. Mittal (JM) and C. D. Rao (AM) ITA No. 1294 (Kol.) of 2008

AY. : 2004-05. Decided on: 31-7-2009

Counsel for assessee/revenue: Manish Sheth/ Sushil Kumar s. 43(5) – For a period prior to A. Y. 2006-07 transactions in futures and options are speculative transactions u/s.43(5) – S. 43 (5) (d) is not retrospective.

Per G. D. Agrawal :

Facts:

During the previous year relevant to A.Y. 2004-05 the assessee company, which was engaged in the business of financing and investment in shares and securities, suffered a loss of Rs.9,25,065 on account of futures and options. The Assessing Officer (Aa) treated the same as speculation loss as per S. 43(5) of the Act.

The CIT(A) confirmed the order of the Aa. Aggrieved, the assessee preferred an appeal to the Tribunal. The Special Bench (SB) of the Tribunal adjudicated two questions viz. (i) whether a transaction in derivatives falls within the meaning of ‘speculative transaction’ as provided u/s.43(5); and if the answer to the first question is in the affirmative, whether clause (d) of S. 43(5), introduced by the Finance Act, 2005 w.e.f. 1-4-2006, is clarificatory in nature and therefore retrospective in operation.

Held:

1. Derivative is a security which derives its value from the underlying assets. When the underlying asset of any derivative is share and stock, for all practical purposes, the treatment given to such derivative should be similar to stock and securities.

2. S. 43(5) uses the term ‘commodity’ in a very wide sense and covers ‘derivatives’.

3. The fact that S. 43(5)(d) exempts certain derivatives from the ambit of the definition of ‘speculative transaction’ itself shows that they would otherwise have come within the term. If ‘derivatives’ are held to be not covered by the definition of ‘speculative transaction’ the amendment would be redundant.

4. Since clause (d) of S. 43(5) does not exempt all transactions in derivatives but only the ‘eligible transactions’ on ‘recognised stock exchanges’ this clause cannot be held to be clarificatory. Further, Rules 6DDA and 6DDB which deal with ‘recognised stock exchanges’ were inserted w.e.f. 1-7-2005. Consequently, clause (d) of S. 43(5) applies to AY. 2006-07 and onwards.

The Tribunal dismissed the appeal filed by the assessee.

3. Western Coalfields Ltd. v. ACIT ITAT Nagpur Bench
Before N. L. Dash (JM) and V. K. Gupta (AM)
IT A No. 289 and 290/N ag.l2006

AYs. : 2002-03 and 2003-04. Decided on: 30-6-2009 Counsel for assessee/revenue: Nani Daruwala/ A K. Singh

Explanation to S. 37(1) – Penalty which is not of the nature of illegal! unlawful expenditure is not covered by the Explanation to S. 37(1).

Per V. K. Gupta :

Facts:

The assessee company was a colliery which trans-ported coal to Electricity Boards in railway wagons. Freight paid to the railways depended upon the carrying capacity of the wagons. In case the wagons were overloaded as compared to their carrying capacity, the railways charged ‘overloading charges’ at a rate which was generally six times the normal freight. The assessee’ claimed these overloading charges as a deduction on the ground that they have been incurred for a commercial purpose and were not for infraction of any law. The Assessing Officer (Aa), however, held these to be penal in nature and did not allow the same.

The CIT(A) confirmed the action of the AO.

Aggrieved, the assessee preferred-an appeal to the Tribunal.

Held:

The Tribunal observed that had the amounts been paid to a private carrier the same would have been allowable. The fact that the same are paid to Railways which is an institution owned by the Government, working under an Act of Parliament, the nature of overloading charges which are essentially of commercial nature cannot be characterised as of penal nature irrespective of the nomenclature given to such charges by the Railways. It held that:

i. the substance of the matter has to be looked into and given preference over the form;

ii. the amount was essentially of a commercial nature and incurred in the normal course of the business and was consequently allowable;

iii. the object of Explanation 1 also supports the claim of the assessee as these expenses are not of the nature of any illegal/unlawful expenditure;

iv. the decision of Punjab & Haryana High Court in the case of Hero Cycles Ltd. is squarely applicable.

This ground was decided in favor of the assessee.

4. ACIT v. RPG Life Sciences Ltd. ITAT ‘C’ Bench, Mumbai Before P. M. Jagtap (AM) and V. D. Rao OM) ITA No. 1579/Mum.l2006

A.Y. : 2002-2003. Decided on: 31-8-2009
Counsel for revenue/assessee:
Yashwant V. Chavan/B. V. Jhaveri

S. SOB read with S. 2 (42 C) – Slump sale – Sale of one of the manufacturing divisions of the assessee
– Whether the transaction could be considered as slump sale – On the facts, Held: No.

Per P. M. Jagtap :

Facts:

The assessee was engaged in the business of manufacturing pharmaceutical and agrochemical prod-ucts. During the year under consideration, its agro-chemical division was sold for an agreed consider-ation of Rs.72.70 crares. During the course of assessment proceedings, the assessee was asked to explain as to why the said sale be not treated as a slump sale and capital gain arising therefrom be not computed u/ s.50B. In reply, the assessee explained that it had sold the assets and liabilities of its agrochemical division by identifying the value of each and every item. In support, the break up of the agreed consideration of Rs.72.7 crore was given. The attention of the AO was drawn to the various schedules of the agreement where the fixed assets were valued item-wise by ascertaining the value of land, building, plant and machinery, furniture and fixtures and capital work-in-progress separately.

However, the assessee’s submissions were not found acceptable by the AO for reasons, amongst others, as under:

Assessee had transferred the entire undertaking as a going concern along with all existing employees.

The intention of the contracting parties was to sell the agrochemical undertaking and not the land, building, plant and machinery and furniture and fixtures and other intangible and current assets, all of which comprised the agro-chemical division separately.

The individual assets of agrochemical division I.were not separately valued but only group of assets were valued.

The valuation report valuing individual assets and/or schedules to the agreement listing out individual assets and value thereof have no relevance unless the consideration is determined on the basis of itemised value.

All the licences, old records of account books, vouchers pertaining to agrochemical business were also transferred by the assesses.

Accordingly, it was held that that the sale of the agrochemical division by the assessee was slump sale and the capital gain arising there from was chargeable to tax in its hand as per the provisions of S. SOB.

On appeal the CIT(A) accepted the stand of the assessee that sale of its agrochemical division was not a slump sale.

Held:

The Tribunal noted that as confirmed by the CIT(A) in his order – all the fixed assets as well as the current assets of agrochemical division were valued. The fixed assets were valued itemised by ascertaining the value of each and every asset separately and after adding non-compete fee of Rs.4 crores to the said value, the value of the fixed assets was worked out at Rs.54.33 crores. In a similar manner, net current assets were valued at Rs.58.38 crores and after deducting the value of net current liabilities therefrom, the total value was arrived at Rs.88.68 crores. As against the said value, the consideration finally agreed was Rs.72.70 crores and the reconciliation to explain the difference between the same was also furnished. The Revenue was not able to controvert or rebut the findings recorded by the CIT(A). Therefore, the Tribunal upheld the order of the CIT(A).

Nirav Shah

Tribunal News: PART A

1. (2009) 119 ITD 1 (Pune) Bhagwandas Associates v. ITO, Ward 5(4), Pune A.Y.: 1988-89. Dated: 28-9-2007

The mistake which is otherwise rectifiable u/s.154 cannot be adjusted at the time of giving effect to appellate order u/s.250/254 particularly when that mistake is absolutely out of context and purview of appellate order.

Facts:

The assessee claimed deduction u/s.32AB in his return for A.Y. 1988-89 based on audit report. The AO wrongly allowed deduction of higher amount and also made addition on account of sales tax refund. The Tribunal deleted the addition of sales tax refund. While giving effect to Tribunal’s order AO rectified deduction u/s.32AB to the correct figure. The CIT(A) also held that ‘rectification was consequential of giving effect to the Tribunal’s order’ and upheld the addition in favour of AO. On an appeal to Tribunal, it was held that:

There are 2 types of orders of appellate authority. One is specific relief pertaining to specific ad-dition and the other is de novo assessment i.e. setting aside assessment and making a fresh assessment. In second case, AO has same powers as at the time of making fresh assessment.

‘When Tribunal sets aside the assessment and remands the case for making fresh assessment, the power of AO is confined to the subject matter of the appeal before Tribunal. He can not take up the questions which were not subject matter of appeal before the Tribunal even though no specific direction has been given by the Tribunal.’

The contention of CIT(A) is not correct because thetquaritum of deduction u/s.32AB is not linked with the assessed income. Rather it is based on the quantum of investment. Giving effect to the Tribunal’s order can not be equated with the regular assessment order.

Even though AO can make rectification of order u/s.154, he has exceeded his limits while giving effect to the order of the Tribunal.

Hence, it was held that even though a mistake is rectifiable u/ s.154, it can not be adjusted while giving effect to the order of Tribunal particularly when that mistake is absolutely out of context and purview of appellate order.

2. (2009) 119 ITD 13 (Mumbai) Smarttalk (P.) Ltd. v. ITO, Ward 8(3)(2), Mumbai A.Y. : 2001-02. Dated: 31-3-2008

Assessee co., a joint venture, took bank loan guaranteed by co-venturers – Payment by one of the venturers to discharge his obligation credited by company to capital reserve. Repayment taxed u/s. 10(3) – CIT(A) upheld addition u/s.28(iv)/41(1) – Since assessee has not claimed deduction of the amount originally, repayment of loan not taxable u/s.28(iv)/41(1). Also can not be taxed u/s.10(3) as S. 10 deals with income which does not form part of total income – Additions, therefore to be deleted.

Facts:

The assessee company was a joint venture between ‘M’ (holding 49%) and ‘B’ (holding 51% of shareholding). The company took a loan of Rs.7 crores from Bank of America which was guaranteed by eo-venturers in proportion to their shareholding. The agreement also restricted the right of the asses-see to enter into any merger, acquisition or sale without prior permission of bank. In A.y. 2002-03~ ‘ASC’ took over 51% shareholding of ‘B’ and’ AW’ took over 49% shareholding of ‘M’. The company had repaid the loan to the extent of Rs.2 crores. 49% of the balance loan was repaid by ‘M’ (i.e. Rs.2.45 crores) along with outstanding interest which was credited by assessee to capital reserve. The AO taxed the same u/s.l0(3). On appeal to CIT (A), it upheld the addition u/s.28(iv)/41(1). On appeal to Tribu-nal, it applied the ratio laid down by the Bombay High Court in Mahindra & Mahindra Ltd. v. CIT, and followed by the Third Member Bench in ITO v. Ahuja Graphic Machinery Ltd., holding that waiver of loan is neither covered u/s.28(iv) nor u/s.4l(l). As the assessee has not claimed deduction of loan taken, repayment of the same by eo-venturer cannot be taxed as cessation of liability u/s.4l(l). Further, the said sum can also not be taxed u/s.lO(3) as S. 10 deals with only such incomes, which are not to be included in the total incomes of the assessee. Hence, the appeal filed by the assessee is allowed.

3. (2009) 199 ITD 15 (Agra) (Third Member) ITO, Range 3(1), Gwalior v. Laxmi Narain Ramswaroop Shivhare A.Y.: 2001-02. Dated: 26-12-2008

S. 145 – A.Y. 2001-02 was the first year of business of the assessee – Aa rejected books of accounts on the ground that there were no support-ing vouchers for sales and all sales made in cash
– Applied different G.P. ratio on comparative basis – Since due to the nature of business of the assessee it is not possible to maintain proper sales bills, it cannot be said that books of accounts were defective – Therefore, books cannot be rejected and actual G.P. ratio to be considered.

Facts:

The assessee firm was engaged in the business of trading in country liquor and IMFL. The supplies of country liquor to the assessee were made through the Government warehouse on payment of duty and purchase of IMFL was made from other private parties in accordance with the permit given by the Government. The assessee got his accounts audited and furnished audit report in Form 3CD. However, he could not produce supporting vouchers in respect of sale of country liquor as the sales were recorded on the basis of daily sales records given by employees of the shops. AO rejected books of accounts on the ground that the sales were not subject to any independent evidence and applied G.P. ratio of 5% against actual G.P. ratio of 3.11%. On an appeal to CIT(A), he reduced G.P. ratio to 4%. On appeal before Tribunal, the Third Member held that:

The AO rejected books of accounts for want of sales bills and accepted sales value declared by the assessee. Hence, he has no reason to reject books of accounts.

The CIT(A) has reduced G.P. ratio and has given a finding that there was no significant defect in the books.

The nature of business of the assessee is such that it is not possible to maintain proper bills.

Hence, the books of accounts can not be rejected and actual results declared by the assessee be accepted.

4. (2009) 119 ITD 49 (Ahd.) ITO, Ward-4(2), Ahmedabad v. Krishnonics Ltd. A.Y. : 1996-97. Dated: 19-12-2007

Held 1:

Provisions of S. 2(22)(e) are not applicable when loan is advanced in the course of normal money lending business – Further, in determining ‘sub-stantial part of business’, income criteria is not relevant but objects and deployment of funds are relevant factors.

Held 2:

Foreign travelling expenses incurred for the purpose of business are allowable expenditure especially when they are proved to be incurred for the purposes of business.

Facts 1 :

The assessee company took loan of Rs.37,77,475 from ‘I’ Ltd. which was claimed to be engaged in the business of money lending. ‘I’ Ltd. also advanced the loan of Rs.1,08,099 to G Ltd. a third party not connected with any of the above parties. It was found that one of the directors of assessee was holding more than 10% of share-capital in ‘I’ Ltd. and more than 20% capital in assessee company. The AO invoked the provisions of S. 2(22)(e) on the ground that ‘I’ Ltd. derived more income from dividend than from interest income. On appeal to CIT(A), it deleted the addition. However, Revenue preferred an appeal to Tribunal. The Tribunal held that as per S. 2(22)(e)(ii) ‘substantial income’ is not the relevant criteria for determining substantial part of business but objects and deployment of funds are relevant. As money lending business was one of the six objects of assessee company and it carried on that object in preference to others it was engaged in the business of money lending and hence provisions of S. 2(22)(e) are not attracted.

Facts 2:

The assessee company claimed expenses on account of travelling of managing director to Taiwan. It was claimed that the expenditure was incurred to find out the possibility of expanding export sales and to acquaint company regarding latest automation machinery concept. The AO disallowed the expenditure on the ground that assessee did not prove it to have been incurred for the purposes of business.

The CIT(A) allowed the claim of assessee. However, department preferred an appeal to Tribunal. It was shown that as a result of the visit to Taiwan, assessee was able to make exports to Taiwan which was not contested by AO. Hence, Tribunal allowed the appeal in favour of assessee and upheld the decision of CIT(A).

5. (2009) 119 ITD 62 (Kolkata) (TM) Shanti Ram Mehta v. ACIT, Circle-3, Asansol A.Ys.: 2000-01 and 2003-04 Dated: 11-11-2008

Additions u/s.69C for unexplained expenditure cannot be made on ad hoc basis or on presumptions.

Facts:

The assessee mainly dealt in two products namely Kerosene Oil and Fertilizers. During A.Ys. 2000-01 and 2003-04, assessee made purchases from different parties. He was to bear some expenses relating to transportation charges. However, he submitted to AO that the purchases were made in bulk. Regard-ing kerosene oil it was submitted that supplying dealers redirect the Tankers to assessee’s business place hence no charges were incurred towards trans-portation. However, AO accepted the contention of assessee only in respect of Kerosene oil and added transportation charges of Rs.50,OOOon estimated basis in respect of purchase of fertilizers as they were purchased in small quantities in a day which was revealed from books of accounts. On an appeal to C!T(A), he upheld the addition. On appeal before the Tribunal, the Tribunal held that 5. 69C is applied when assessee is unable to explain the source of any expenditure however ‘the AO has to first find the evidence of incurring the expenditure. S. 69C cannot be applied on mere presumption or suspicion’. In the present case, the’ AO didn’t bring on record any evidence of incurring transportation charges. Consequently, the Tribunal deleted the addition of Rs.50,OOOalleged to have been incurred towards transportation charges.

6. 2009 TIOL 526 ITAT Mum. Livingstones Jewellery (P) Ltd. v. DCIT ITA No. 187/Mum./2007 A.Y. : 2003-04. Dated: 12-5-2009

S. 10A – All the profits which have nexus with the business of the undertakingqualify for deduction u/s.10A – Interest income on FDRs given by the assessee to the Bank for obtaining credit facilities has nexus with the business of the undertaking and qualifies for deduction u/s.10A.

Facts:

The assessee having its business of manufacturing and export of studded and plain jewellery of gold and platinum filed its return of income for A.Y. 2003-04 declaring total income after claiming deduction u/s.10A. Interest of Rs.9,OO,961 received on fixed deposits was netted against the interest payment of Rs.1,04,37,835 and net interest of Rs.95,36,873 was debited to its P&L account. The AO held that interest income on FDs with bank cannot be said to be derived from export of goods and merchandise. He, denied the deduction u/s.10A of this amount of interest on FDs.

The CIT(A) did not allow any relief to the assessee.

Aggrieved, assessee preferred an appeal to the Tribunal.

Held:

The expression ‘profits derived from export of articles or things or computer software’ as employed in 5s.(1) or 5s.(lA) has been given a specific meaning in 5s.(4). 5s.(4) states that the ‘profits derived from export of articles or things or computer software’ shall be the amount which bears to the ‘profits of the business of the undertaking’, the same proportion as the export turnover in respect of such articles or things or computer software bears to the total turnover of the business carried on by the undertaking. By providing for considering the ‘profits of the business of the undertaking’, the position has been made clear that the restricted general meaning given to eligible profi ts as derived from the export of articles in 5s.(1) ha; been given a go by in 5s.(4) and the scope of the benefit has been expanded by extending to all the profits of the business carried on by the undertaking. The Tribunal noted that the wording of 5s.(4) as amended w.e.f. 1-4-2000 is on the pattern of 5. 80lA prior to its substitution w.e.f. 1-4-2000. It also noted that in the context of 5. 80IA the Arnritsar Bench of the Tribunal had in the case of Dy. CIT v. Chaman Lal & Sons, 3 50T 333 held that the benefit of deduction was available in respect of purchase and sale which was part and parcel of the business of the industrial undertaking. All the profits which have nexus with the business of the undertaking will qualify for deduction. The Tribunal noted since that the FDRs were given to obtain credit facility, interest income had nexus with the business of the undertaking and falls under the head ‘Income from Business’. It allowed the claim of deduction u/s.lOA in respect of interest income.

The appeal filed by the assessee was allowed.

7. 2009 TIOL 559 ITAT Mum. ITO v. P & R Automation Products Pvt. Ltd. ITA No. 2119/Mum./2007 A.Y.: 2003-04. Dated: 25-3-2009

32 – Machinery purchased and given to sister concern for manufacturing goods for the assessee, which in turn exports them, is utilised by the assessee for business – No part of depreciation can be disallowed on such machinery on the ground that spare capacity was utilised by the sister concern for manufacturing its own goods which were sold locally.

Facts:

As per the agreement entered into between the assessee and PAL (its sister concern) a CMG machine was purchased by the assessee and was installed at the factory premises of the sister concern. The sister concern was to use the machine at its premises for manufacturing goods by utilising its power, labour and other facilities and sell the goods so manufactured to the assessee at fair market price to meet the assessee’s export obligation. PAL was authorised to develop indigenous market for said products by using spare capacity. The total sales declared by PAL were Rs.2.28 crores out of which sales to the assessee were Rs.1.50 crores. 93% of the capacity of the machine had been utilised for goods sold to the assessee and spare capacity to the tune of 7% had been utilised for others. The assessee had not charged any rent or hire charges from the sister concern.

The assessee claimed depreciation on the machine on the ground that it was utilised by it for the purposes of its business. While assessing the total income of the assessee the Aa disallowed the claim of depreciation on this machine on the ground that the sister concern had also utilised the machine for manufacturing its own goods which were sold locally.

The CIT(A) relying upon the decision of the Madras High Court in the case of Indian Express Pvt. Ltd. 255 ITR 68 held that the assessee was entitled to deduction u/s.32 of the Act.

Aggrieved, the Revenue preferred an appeal to the Tribunal.

Held:

The Tribunal observed that u/s.32 an assessee is entitled to deduction by way of depreciation on machinery, if it is owned by the assessee and is used for the purpose of its business. The Tribunal noted the undisputed facts viz. that the assessee had purchased the machinery and the same was provided to the sister concern essentially to manufacture goods for the assessee and supplying the same at fair market price. The Tribunal held the conditions required to be satisfied for deduction u/s.32 as having been satisfied. It stated that its view is supported by the decision of the Madras High Court in the case of Indian Express Pvt. Ltd.

The appeal filed by the Revenue was dismissed.

8. 2009 TIOL 550 ITAT Mum. Popatlal Fulchand v. ACIT ITA No. 358/Mum./2008 A.Y. : 2004-05. Dated: 6-5-2009

s. 22. – Property owned by individuals and used by a firm, without paying any rent, whose partners are HUFs of the individuals owning the property can be said to be used for the purposes of business by such individuals and consequently its notional income is not chargeable.

Facts:

The assessee alongwith other individuals were owners of a property which was being used by M/s. F C International, a partnership firm, whose partners were HUFs of the assessee and other individual owning the property. The HUFs were partners through the individuals owning the property. The firm did not pay any rent for the property.

The assessee was of the view that annual value of this property is not chargeable to tax since the same is being used for the purposes of his business. The Assessing Officer (Aa) was of the view that the firm is a distinct entity than its individual partners and since the property has been utilised for the purpose of the business of the firm, the benefit of S. 22 cannot be given to individual partners.

The CIT(A) upheld the view of the AO.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:

The Tribunal held that the assessee was not liable to tax in respect of the notional income of the house property used by the firm for its business without paying any rent to the owners of the property. It also observed that the issue under consideration is squarely covered by the decision of the Delhi High Court in the case of Cl’T v. H. S. Singhat & Sons, 253 ITR 653 (Del.). The Tribunal allowed the appeal filed by the assessee.

Nirav Shah

Is it fair to insist on e-compliance without adequate machinery

1. Computerisation is the need of the day in all walks of life. Even various government departments are gradually (in fact, in some sectors, rapidly) thrusting e-compliance on citizens. In the context of income-tax, it all started with e-filing of Quarterly TDS Statements, then e-filing of Returns, followed bye-payment of Taxes, e-filing of remittance certificate (S. 195) and now forthcoming is e-credit of Taxes (Form 26AS). This article examines certain grievances faced by tax practitioners and taxpayers at large in the context of e-compliance under Income-tax Act, 1961.

2. E-payment of taxes:

E-payment has been made mandatory for all corporate assessees (and those non-corporate assessees who are liable for audit u/s.44AB) w.e.f. 1-4-2008. The general difficulties faced in e-payment are:

2.1 On the NSDL website, once we click the relevant link for e-payment, a web-page appears where we have to fill up the basic information like PAN I TAN, Assessment Year, Name, Address etc. After filling all these details, we have to click to the relevant link, submit to the bank and then proceed with the e-payment gateway.

If at all in this whole process, there is any interruption due to whatever problem like power failure, internet connection failure, bank password mis-match etc., then the whole process is to be restarted from filling of the Basic data. Even otherwise, when multiple payments for different sections (TDS) are to be made; for all the challans, one has to fill up the basic data like name, address, etc. over and again. There should be a facility that once PAN I TAN is entered all the Basic data should automatically appear because it is already in the database of the department.

2.2 At present, there are only 30 banks which are authorised to accept e-payment of taxes ..This creates practical difficulties for taxpayers who are not maintaining account with these Banks. Though, in practice, certain other Banks are also accepting e-payment of taxes but since they are not authorised, ultimately they also have to route it through one of the authorised Banks. This, at times, results in de-lay in credit of tax-payments, with consequential loss of interest u/s.234A, u/s.234B, u/s.234C, u/s. 201 etc. and at times may become a cause of 40a(ia) disallowance.

3. e-filing of quarterly TDS statements:

3.1 Once a quarterly TDS statement is uploadedl filed with NSDL, if any corrections are to be done, deductor has to upload/file a correction statement. For this, first of all he has to give the link of fvu file of original statement. Once this is done, the original statement appears on the screen, which can be corrected and new fvu file is generated. There are instances, where the deductor has lost the original fvu file due to computer problem etc. There is no procedure to get the lost fvu file back either from NSDL web site or income tax department’s website. In such a scenario, as the correction statement can never be filed, the deductee will lose the credit for taxes?

3.2 There was a suggestion from NSDL official that, if 95% PAN compliance is not possible, the deductor should submit only those deductee records where PAN is available. As and when other PANs are obtained, correction statement should be filed. This may create 3 difficulties. Firstly, the Challan Details and Deductee Details amount will not match. Secondly, it may amount to a default on the part of deductor of not submitting the details of all tax deducted. Thirdly, filing correction statements repeatedly, is a cumbersome process, as explained in para 3.1 and also it comes at a cost every time.

4. Form 26AS :

It is proposed that in the near future, even credit for tax deducted will be based on Form 26AS which is electronically generated by NSDL, based on data submitted by deductor. If PAN is wrongly given by deductee, it will not be reflected in his Form 26AS. The deductee will, therefore, have to request the deductor to file a correction statement. In case of large deductors, especially government departments or public sector banks, the feasibility of filing such correction statement, at the instance of a large number of deductees, is really a question mark. Admittedly, there is a facility on the NSDL website to verify PAN, but it comes at a huge cost of Rs.12,OOO. Should there be such a huge charge for statutory compliance?

5. Conclusion:
It is rightly said that change is the only constant in life and generally, change is for the better. Admittedly, even if e-compliance is for the better, the transition should be pain-free and at least in the transitional period, the system should not be faceless. There has to be a sort of ombudsman for handling these technical grievances of the taxpayer.

Nirav Shah

Inter-State sales vis-a-vis Branch Transfer

A debatable issue arises about nature of transaction of dispatch of goods from one branch to another branch in other state. If the dispatch amounts to Branch transfer, the sale by branch to customer will be local sale.

On the other hand if the dispatch is not considered as branch transfer it will amount to inter-State sale from the moving state. To decide the nature of movement, whether inter-State sale or branch transfer, reference is required to be made to CST Act, 1956.

Under CST Act the nature of inter-State sale transaction is defined. Therefore, if the transaction falls into said definition, it will be inter-State and if not covered by the said definition, it will be a local sale. The definition of the inter-State sale is given in S. 3 of the CST Act, 1956. The said section is reproduced below for ready reference:

“A sale or purchase of goods shall be deemed to take place in the course of interstate trade or commerce if the sale or purchase –

a) occasions the movement of goods from one State to another; or

b) is effected by a transfer of documents of title to the goods during their movement from one State to another.”

It can be seen that if there is movement of goods from one state to another state because of sale, such sale will be inter-State sale. There is no condition that the clause for movement from one state to another state should be expressly provided in the sale agreement. In other words, even if the implied link between the movement and sale is established, it will be inter-State sale.

On the other hand, if the movement of goods from one state to another state is without reference to any pre-existing sale, it will not be an inter-State sale.

The cases of inter-State sales vis-a-vis branch transfers are required to be seen in light of above legal position. The branch and the head office or other branch in other State, are one and the same entity. Therefore, when a branch in one State transfers goods to branch in other State, there can be two situations: First, the branch in one State may be
transferring goods to branch in other State without reference to any particular sale agreement etc. in the transferee State. In other situation, the branch in transferee State may have pre-committed sale agreement and the branch in transferring State may be sending the goods to the branch in pursuance of said agreement. The receiving branch may thereafter deliver the goods to the customer. In this case also, though the delivery is to a branch, the transaction will be considered as an inter-State sale. In short, if there is nexus between dispatch from one State and sale in other State, such sale will be in the category of inter-State sale.

There are number of judicial pronouncements deciding nature of transactions. Reference can be made to following few important judgments:

Nivea Time (108 STC 6) (Born.)

The observations of the Bombay High Court on nature of interstate sale are as under:

“8. S. 3 of the Central Sales Tax Act, 1956 lays down when a sale or purchase of goods is said to take place in the course of interstate trade or commerce. It says:

‘A sale or purchase of goods shall be deemed to take place in the course of interstate trade or commerce if the sale or purchase –

c) occasions the movement of goods from one State to another; or

d) is effected by a transfer of documents of title to the goods during their movement from one State to another.’

In this case, we are concerned with sale or purchase falling under clause (a).

9. It is well-settled by now by a catena of decisions of the Supreme Court that a sale can be said to have taken place in the course of inter-State trade under clause (a) of S. 3, if it can be shown that the sale has occasioned the movement of goods from one State to another. A sale in the course of inter-State trade has three essentials: (i) there must be a sale; (ii) the goods must actually be moved from one State to another; and (iii) the sale and movement of the goods must be part the same transaction. The words ‘occasions’ is used as a verb and means to cause to be the immediate cause of. There must exist a direct nexus between the sale and the movement of the goods from one State to another. In other words, the movement should be an incident of and necessitated by the contract of sale and be inter-linked with the sale of goods. [See Kelvinator of India Ltd. v. State of Haryana, (1973) 32 STC 629 (SC)]. It is not necessary for a sale to be an interstate sale that the covenant regarding inter-State movement must be specified in the contract itself. It would be enough if the movement was ‘in pursuance of’ or ‘incidental to’ the contract of sale. Similarly, if the movement of goods is the result of contract and is an incident to the agreement between the parties, the transaction will remain an inter-State one no matter in which State the delivery of goods is taken by the purchaser. In other words, the question whether it is an inter-State sale or intra state sale, does not depend upon the circumstances as to in which state the property in the goods passes. It may pass in either State and yet the sale can be an inter-State sale. What is decisive is whether the sale is one which occasions the movement of goods from one State to another.”

English Electric Company of India Ltd. v. Deputy Commercial Tax Officer, (1976) (38 STC 475) (SC)

In this case, it was observed by Supreme Court as under:

“When the movement of goods from one State to another is an incident of the contract it is a sale in the course of inter-State sale. It does not matter in which State the property in the goods passes. What is decisive is whether the sale is one which occasions the movement of goods from one State to another. The interstate movement must be the result of a covenant, express or implied, in the contract of sale or an incident of the contract. It is not necessary that the sale must precede the interstate movement in order that the sale may be deemed to have occasioned such movement. It is also not necessary for a sale to be deemed to have taken place in the course of inter-State trade or commerce, that the covenant regarding inter-State movement must be specified in the contract itself. It will be enough if the movement is in pursuance of and incidental to the contract of sale.”

It was further observed:

…… If there is a conceivable link between the movement of the goods and the buyer’s contract, and if in the course of inter-State movement the goods move only to reach the buyer in satisfaction of his contract of purchase and such a nexus is otherwise inexplicable, then the sale or purchase of the specific or ascertained goods ought to be deemed to have taken place in the course of inter-State trade or commerce as such a sale or purchase occasioned the movement of the goods from one State to another . . . .

Cheeseborough Pond’s Inc. v. State of Tamil Nadu (52 STC 164)

The short gist of the judgment is as under:

The assessee was a manufacturer and dealer in face powder, having its head office and manufacturing unit at Madras and branches at Bombay and other places. A department of the Government of India, known as Canteen Stores Department which was part of the Defence Ministry, placed orders for the purchase of the goods manufactured by the assessee with the Bombay branch of the assessee. The orders, when received by the Bombay branch, were forwarded by that branch to the head office at Madras. The head office then consigned the goods by lorry to the Bombay branch warehouse, mentioning in the lorry way-bill that the goods had been dispatched against orders passed by the Canteen Stores Department. When the goods reached Bombay, these were cleared by the Bombay branch and immediately supplied to the Canteen Stores Department, after raising invoices in terms of the orders already placed. The assessing authorities as well as the Tribunal rejected the assessee’s contention that the transactions could not be regarded as sales in the course of inter-State trade, chargeable to tax u/s.3(a) of the Central Sales Tax Act, 1956. On revision, the assessee contended that the goods moved from Madras to Bombay in what was described as stock transfers and that the Canteen Stores Department placed the orders not with the head office at Madras direct, but only with the Bombay branch:

Madras High Court held,

i) that if all that the stock transfers evidenced was displacement of goods from a head office to a branch, then there would be no difficulty at all in accepting the contention that there was no inter-State sale for the simple reason that the transfers from Madras to Bombay involved no sale at all; but as found by the Tribunal, the stock transfer notes relied on by the assessee themselves clearly referred to the particular orders placed by the Canteen Stores Department with the Bombay branch of the assessee against which the goods were sent in the particular consignment or consignments, by lorry. It was, therefore, not accurate to describe the movements of the goods as inter-office, or non-sale, consignments from the head office to a branch;

ii) that the fact that the head office at Madras did not dispatch the goods direct to the Canteen Sores Department which placed the orders, but sent the goods to the Bombay branch from where the goods ultimately found their way to the purchaser did not make any difference to the application of S. 3(a) of the Act. It did not matter how many stop-overs were there in the delivery State before the goods reached the purchaser’s hands. All that mattered was that the movement of the goods was in pursuance of the contract of sale or as a necessary incident to the sale itself; and

iii) that, therefore, the transaction between the assessee and the Canteen Stores Department, Bombay, was an inter-State sale liable to tax.

M/s. Tan India Ltd. v. State of Tamil Nadu, (133 STC 311) (Mad.)

The brief gist of the judgment is as under:

Identifiable ultimate buyers in Kerala State placed specific orders at the dealer’s branch office at Palghat in Kerala. The branch office at

Pal ghat informed the head office at Kumarapalayam in Tamil Nadu about the specific requirements of the ultimate customers in Kerala. It is only on the information so furnished by the branch office, the head office either effected dispatches directly to the ultimate buyers in some transactions or to its branch office in other transactions and thereafter effected delivery to those ultimate buyers. The assessing officer treated the transactions as inter-State sales and also imposed penalty at 150% of the tax due upon the dealer. The Appellate Assistant Commissioner confirmed the same. The Tamil Nadu Sales Tax Appellate Tribunal found some transactions as inter-State sales and other transactions as stock transfer to dealer’s branch. It reduced the penalty to fifty per cent of the tax due. On revision petition both by the dealer and the Revenue:

Madras High Court held, (i) that whether the dispatches were effected from the head office to the ultimate buyers directly at Kerala or whether the deliveries were effected to the ultimate buyers outside the State through the branch make no difference in the eyes of law. The goods moved from the State of Tamil Nadu to the State of Kerala, pursuant to or incident of a contract of sale entered into by the dealer with the identifiable ultimate buyers. Further from the orders placed at the branch located at a different State and the order subsequently having been communicated to the head office in the State of Tamil Nadu, no legal consequence was likely to flow for the simple reason that the head office and the branch office were offices of the same company and they did not possess separate juridical personalities. The movement of goods from the head office was occasioned by the order placed by the customers and was an incident of the contract and therefore from the very beginning from Kumarapalayam in the State of Tamil Nadu, all the way until delivery to customers in Kerala State, it was an inter-State movement. Therefore, the transactions were inter-State sales u/ s.3(a) of the Central Sales Tax Act, 1956. [Sahney Steel and Press Works Ltd. v. Commercial Tax Officer, (1985) 60 STC 301 (SC) followed.]

Thus, the legal position is very clear. If the move-ment from transferring branch is without reference to any pre-existing sale, it will be a case of branch transfer. The sale by transferee branch to customer will be a local sale. On the other hand, if the en-marked (ascertained) goods are sent to branch for a particular customer, it will be an inter-State sale from the transferring branch, whether delivery is given through the transferee branch or directly given by the transferor branch. On the other hand, movement without reference to pre existing sale agree-ment, will amount to branch transfer.

Nirav Shah

Part C – TRIBUNAL & AAR INTERNATIONAL TAX DECISIONS

1. M/s. Invensys Systems Inc 183 Taxman 81 (AAR)
S. 5, S. 9(1), S. 195, Income-tax Act; Articles 7(1), 12(1), 12(2) 12(4)(b)
India-USA   DTAA
Dated:   6-8-2009

Issues:

   i) Under Article 12(4)(b) of India-USA DTAA, ‘managerial’ services are not chargeable to tax in India.

   ii) In absence of PE in India, payments for stew-ardship/shareholder activities are not charge-able in India.

Facts:

The applicant was an American company (‘US Co’) engaged in the business of process control instruments, engineering and research and technology based services, cooperative or consortium services, etc. US Co had a group company in India (‘I Co’). US Co was incurring expenditure in relation to various functions for the benefit of Group as a whole. US Co and I Co had executed a Cost Allocation Agreement dated 1-4-2007. In terms of the Agreement, US Co raised invoices on I Co for the amounts computed as per the formula in the Agreement. No personnel of US Co visited India nor were they to visit India in future for providing centralised assistance to I’Co. The amount of invoice of US Co was to be determined: the entire cost of centralised assistance directly provided to I Co was charged to I Co; and where such direct cost could not be specifically identified, it was allocated prorate, based on turnover or headcount of I Co.

US Co raised the following two questions for ruling by the AAR.

1 Whether payment made by I Co towards cost allocation was taxable in terms of India-USA DTAA?
2 Whether I Co is liable to withhold tax u/s.195 of the Act on cost allocation payments made to US Co?

Before the AAR, US Co contended that:

Various services provided by it to I Co were managerial in nature and cannot be considered technical or consultancy services.

Even assuming they were technical or consultancy services, they did not ‘make avail-able’ technical knowledge, skill, know-how, etc. which was an essential requirement under Article 12(4)(b) ofIndia-USA DTAA.

As the entire services/ assistance was rendered from outside India, in terms of Supreme Court’s decision in Ishikawajima-Harima Heavy Industries Ltd. v. DIT, (2007) 288 ITR 408 (SC), amount received by US Co would not be taxable u/s.9(1) or u/ s.5 of the Act because, according to the Supreme Court, it is not sufficient that the ser-vices are utilised in India but they should also be rendered in India.

US Co furnished a list of the functions divided in five broad categories. It also drew attention of the AAR to the meaning of the word ‘manage’ as inter-preted in Intertek Testing Services India P Ltd., in re (2008) 307ITR 418 (AAR).

The tax authorities contended that the payments made under the Agreement were in the nature of service fee and not entirely on cost-to-cost basis and hence, profit element cannot be ruled out. The AAR noted that the underlying question was: whether the receipts under the Agreement were mere reim-bursement of expenses or in the nature of income.

According to AAR, although this question was not raised in the application, it did need to be answered. Hence, AAR considered the question: assuming that it is a fee received for rendering certain services, can it be subjected to tax under the provisions of the Act or India-USA DTAA ?

The AAR then referred to Article 7(1) and Article 12(1) and (2) of India-USA DTAA. The AAR analysed the nature of the functions stated in the Agreement and commented that most of them were managerial in nature and unlike some DTAAs, where apart from the terms ‘technical’ and ‘consultancy’, the term ‘managerial’ was also included within the Fees for Technical Services clause, it was not so included in case of India-USA DTAA. To examine the scope of the expression ‘technical services’, the AAR discussed the decisions in Intertek Testing Services India P Ltd., in re (2008)307 ITR 418 (AAR), G. V. K. Industries Limited v. ITO, (1997) 228 ITR 564 (AP) and J. K. (Bombay) Ltd. v. CBDT, (1979) 118 ITR 312 (Del.).

The AAR then mentioned the specific requirement of ‘make available’ in Article 12(4)(b) of India-USA DTAA and observed that even if it was to be assumed that some of the services/functions of US Co could be brought within the definition of technical or consultancy services, still they did not satisfy the requirement of ‘make available’. It then referred to Intertek Testing Services India P. Ltd., in re (2008) 307 ITR 418 (AAR), WorIey Parsons Services Pty Ltd., in re (2009) 313 ITR 74 (AAR) and Anapharm Inc, in re (2008) 305 ITR 394 (AAR) wherein the expression ‘make available’ was discussed and construed. The AAR observed that applying the test given in these decisions, one could hardly find any service of US Co which ‘makes available’ the technical knowledge, experience or skills to I Co and concluded that even if the services are ‘technical’, they do not ‘make available’ the technical knowledge, etc. within the meaning of Article 12(4)(b) of India-USA DTAA. It further noted that in view of the foregoing conclusion, it was not necessary to deal with the contention of US Co that even if the services were to be covered within the definition in Article 12(4), the income cannot be taxed in India in view of the fact that the services are rendered from abroad.

As regards certain specific services, the AAR considered the aspect whether any of these services was really rendered to I Co or they were merely in the nature of stewardship or shareholder activities.

Held:

The AAR held that:

on facts, services rendered by US Co to I Co were ‘managerial’ in nature;

even if these were assumed to be technical, they did not ‘make available’ the technical knowledge, etc. within the meaning of Article 12(4)(b); and

assuming that some of these activities were not really services but were in the nature of stew-ardship or shareholder activities, in the absence of PE of US Co in India, the payments cannot be taxed in India.

2. Fujitsu Services Limited (unreported) AAR No. 800/2009 S. 48 (Ist proviso, S. 112(1) (Proviso), Income-tax Act

Dated: 23-7-2009

Issue:

Capital gain on sale of ‘listed securities’, by non-resident investor chargeable @10%.

Facts:

The applicant was a company incorporated in United Kingdom (‘UK Co’). It was a non-resident as per the Act. It was engaged in the business of information technology services. During the years 1963 to 1994, UK Co had acquired shares of an Indian company. The funds for investment were remitted in foreign currency after obtaining RBI’s approval. The shares of the Indian company were listed on the Stock Exchanges in India. UK Co held 26.55% of the share capital of the Indian company.

UK Co executed a Share Purchase Agreement dated 1-3-2007 with another Indian company (‘Purchaser’). Pursuant to the Agreement, on 4 July, 2007, UK Co sold its entire shareholding to the purchaser and a Cyprus company, which was an affiliate of the Purchaser. As per UK Co, the Cyprus company was an affiliate of the Purchaser and therefore, eligible to purchase the shares. The Purchaser and its affiliate both deducted tax @20% from the sale consideration. However, as per UK Co the correct applicable rate was 10%.

Before the AAR, UK Co sought ruling on the following two issues:

(1) Whether on facts and in law, tax applicable on long term capital gains arising on sale of shares of an Indian company would be 10% as per the proviso to S. 112(1) of the Act?

(2) Whether the beneficial rate of 10% can be applied where the long term capital gains arising to UK Co are computed in terms of S. 48 of the Act by applying the first Proviso to S. 48, read with Rule 115A ?

UK Co contended that even if the benefit under the first Proviso to S. 48 was availed of by the non-resident, the non-resident was not disentitled to invoke the Proviso to S. 112(1). As the shares of the Indian company were listed on the Stock Ex-changes, the long term capital gains were chargeable to tax @ 10% as benefit of indexation was not claimed by the assessee.

The AAR observed that the shares of the Indian company which were sold by UK Co were ‘listed securities’ in terms of S. 112(1) of the Act. In the context of the expression ‘before giving effect to the second proviso to S. 48’ (i.e. giving benefit of indexation), the AAR had consistently ruled that the said expression pre-supposes the existence of a case where the computation of long term capital gains could be made in accordance with the formula contained in the second proviso to S. 481. The AAR had also referred to Mumbai Tribunal’s decision in BASF Aktiengesellschaft v. DOlT, (2007) 293 ITR (AT) 1 (Mum.) and had expressed its disagreement with the view of Tribunal.

Held:
Following its earlier rulings, the AAR held that UK co was liable to pay tax @ 10% as per the proviso to S. 112(1) of the Act.

Nirav Shah

Regulatory Risk – Case Study

Overview:

It is the duty of every government of a civilised society to regulate economic activity. The function of regulation is to encourage economic activity with ethics which benefits society. However, our (Indian) experience has been that of having ‘over-regulation’ leading to corruption and unethical practices. Reversal of ‘over-regulation’ in the past two decades has changed the environment to an extent, but over regulation and desire to increase the same continues to manifest itself. Let us not forget that too many and that too, complex laws convert ordinary honest citizens into criminals – e.g. – everyone who drinks in areas where prohibition prevails becomes converted from an ordinary citizen into a criminal in the eyes of law. Today there exist many laws which impact normal economic activity. In addition to laws which are common to all businesses – there are industry-specific laws, e.g. – pharma, food, health, chemicals, refineries etc. Compliance with the applicable laws, rules and regulation is an integral part of running a business.

Hence, business runs the risk of non-compliance with laws, rules and regulations resulting at times even in the suspension or closure of business in addition to the levy of penalties, legal action by customers, bureaucratic hassles and corruption.

Non-compliance also at times entails prosecution and imprisonment.

Regulatory Risk is the risk that a change in laws and regulations will materially impact a business, industry and activity, an organisation or an entity. However there is another dimension to regulatory risk. This is the risk of government agencies exercising control over the functioning of commercial and other activities of various entities.

Thus on the one hand a change in laws and regulations can disturb a level playing field; it can give skewed advantage to certain entities, organisations and companies. These regulations can be those pertaining to taxes, duties, licences, other regulations and procedures or relating to human operations.

On the other hand regulatory authorities at the behest of the government, the public or even on its own may step in to regulate, control and guide business or other activity by way of certain norms, rules and regulations which have to be followed and involve a cost, compliance load, and impact the operations, returns and profitability of enterprises. e.g. Drug price control order and the rules there-under is a case in point. The website – ‘Investopedia’ has given the well known example of utility companies like electricity companies to explain regulatory risk. The government through legislation and administrative orders introduces a significant amount of regulation in the way they operate, set their tariffs and even the quality of infra-structure and the controls on the system. Regulations also affect investment market and investment activity which means that any change in these (for example margin requirements) can affect prices, returns and valuations.

The first significant characteristic of regulatory risk is that it is an additional source of risk due to the wide variation in regulations across countries, regions, industries and even regulators. The second significant characteristic is that due to the diversity of cause and effect, the nature of regulatory risks is difficult to understand, perceive, capture and communicate. As a result such risk is not well understood and consequently at times difficult to quantify, estimate, measure and manage.

Also many times this type of risk materialises without any warning or indication and takes most of us by surprise. Thus on the one hand a change in laws and regulations can disturb a level playing field; it can give skewed advantage to certain entities, organisations and companies. These regulations can be those pertaining to taxes, duties, licences, other regulations and procedures or relating to human operations.

The first step for mitigating the risk of violation is to identify applicable laws and put in place, compliance procedures. To ensure compliance there should also exist means of ensuring that the pre-scribed procedures are followed. This is normally achieved by having an effective internal audit or periodic review of functioning of ‘internal controls’.

The regulatory risk can be captured as under:

Regulatory risk

Risk of changes in legislation and its impact.

Risk of changes in rules and regulations and its impact

Risk emanating from government agencies exercising controls by way of regulations and compliances on business.

Risk of corrective controls and palliative measures that can affect businesses and organisations.

A formal analysis of this risk is difficult because it is an external risk that is affected by the frequency of changes in the several laws applicable to a business. The risk also depends directly on the duration of regulation, nature of regulation, whether involving strategy, operations or procedures and finally the extent of discretion exercised by the regulatory agencies. In fact business and industry would do well to study and understand regulatory preferences, styles, policies and trends. To summarise, regulatory risk even in the least regulated free environment is inevitable. The magnitude of risk is inversely proportional to the credibility, accountability and- stability, of the regulators.

The example for this month is the case study of a company engaged in conducting coaching classes for students in the context of regulatory risk. Expert Coaching Classes Ltd is one of the leading coach-ing classes for the 10th SSC and ICSE examinations, the 11th & 12th HSC, CBSE and for entrance exami-nations of lIT like JEE and Engineering and Medi-cal CET and others.

Expert Coaching Classes began as a small venture in the living room of Sri Prakash – a retired senior teacher from Vidya Mandir School about twenty years back with three students. Today it has over 50 in house faculty, 25 visiting faculty, 5000 + students and over 10 branches in two metro cities. In the good old days students were charged Rs.SO per month, today the fees for a year is in lakhs. The business model comprises holding awareness and introductory lectures that are attended by students and their parents. This is followed by a rigorous program for students using in-house well developed material and question bank. The course is inter-spersed with tests, the results of which are periodically communicated to the parents directly apart from communicating the same to the students. Intensive coaching takes place and students’ doubts are cleared. Expert coaching classes thus imparts quality education by limiting the number of students in a batch. Discussions are also held with parents of non-performing students.

There is some turnover in staff and faculty, and at times the advent of new classes means losing a few existing and potential students. Of late on the heels of the use of ‘Right to Information Act’ to uncover overcharging of fees by schools and the ever increasing pressure on the education system following issues have emerged:

i) There is a growing awareness of the need for quality education with adequate facilities, infrastructure and good faculty at school among students and their parents.

ii) After regulating functioning of schools, their admission procedures and fees, there is now a demand to regulate coaching classes.

iii) There is a move to mandate registration for coaching classes which is fast gaining ground.

At present ‘coaching classes’ are fairly independent of the regulatory system except obtaining some municipal licenses. Hence, coaching classes do not face any serious regulation. The risk is that some serious regulation is likely to be put in place. If this happens it is bound to affect the infrastructure needs, working, and functioning of the classes substantially in as much as the fees charged per student are likely to be also regulated. This change will affect both the top and bottom line. Further with conflicting reports emerging about scrapping of CETs, it is not clear if students would continue to patronise these coaching classes. It is in this context that the CEO of the classes has invited you, as the risk manager, to prepare a note identifying, estimating and measuring risks likely to be faced and advise the possible course of action to prevent, protect and mitigate the identified risks and come up with an action plan.

Regulatory Risk Analysis & Solution:

An analysis of the case reveals the following issues:

Well drafted regulations when fairly implemented help in the smooth functioning of business. Hence fair monitoring of certain sets of activities is necessary for implementation of law. However experience tells us clear language is rare and the absence of clear language leads to chaos and corruption. This has a bad impact on both the business and the organisation. It is because of this aspect that business advocates free market with minimum regulation and giving a free hand to the market forces. The following challenges and their impact have been identified:

changes in law and regulations will impact size, fees and profitability.

cost of compliance will increase.

possible increase in unhealthy practice by unregistered, flyby night, small operators.

possible increase in working school teachers conducting private tuitions.

lower profitability.

lower profitability could lead to lower standards

cost cutting measures could lead to increase in faculty turnover – impacting quality.

reduction in visiting faculty to reduce cost – impacting quality.

reduction in investment in infrastructure – impacting quality.

reduction in the number of students because of the above and proposed abolition of Std. X exams – impacting profitability.

Solutions for Expert Coaching Classes (ECC) :

The possible solution to deal with this risk is out-lined in the steps given below:

1. Preparing a sensitivity analysis and assessing its impact on revenue and faculty related concerns.

2. Channelise existing cash flow into higher savings to meet unforeseen contingencies.

3. Centralise operations to reduce costs.

4. Preparing online version of coaching sessions whereby it gives flexibility of time to students, reduces dependence on faculty and investment in infrastructure and reduces operating costs. – encourage e-learning.

5. Identifying areas of diversification – e.g. – corporate training, starting hobby classes, starting health education classes.

6. Initiate a network of coaching classes and form a trade association to take on unfair regulations.

Anticipating risk and taking planned and persistent steps are today essential elements of running a successful business. Suggestions made by the risk adviser have been appreciated by the management. The management has initiated steps in line with the suggestions made.

Nirav Shah

Fraud by illusion and trickery

Nirav Shah

The Professional

Title:   The Professional
Author:   Subroto Bagchi, Gardener and Vice-Chairperson, MindTree Limited
Price:   Rs.399
Publisher: Penguin (Portfolio)
Author’s official website : http://www.mindtree.com/subrotobagchi

The Satyam episode led to some uncomfortable situations for us CA-professionals. The general public did tend to paint us all with the same brush. It may have led to some uncomfortable encounters at networking events when people came up to us during the tea-break and questioned us about ‘our profession’. Hopefully we will never have to face such a scenario again.

This incident brought to the forefront the moot question. Does having a professional qualification (say: the much coveted CA tag), make one a professional?

The answer is no. Anyone can with the right amount of hard work (and luck, as most of us CAs would like to add) can acquire a professional degree. However, it is the ability to stay true to ourselves and our vocation that makes us a true professional.

Subroto Bagchi, Gardener and Vice-Chairperson to the Board, MindTree Limited in his latest book ‘The Professional’ answers this important question: What does it take to be considered a true professional in any field?

‘The Professional’ comprises of seven distinct parts and the author does tell us to read each part sequentially in the order it is presented in the book, so as to get the maximum benefit from it. Each part comprises of short narratives drawn from real-life – both positive and negative examples – covering various professions and work-life scenarios. These narratives comprise situations which you and I have encountered/witnessed or are most likely to encounter or witness as we move up in our professional careers.

Part 1, explains the concept of integrity and how and why it is the key stone of professionalism, In fact, during the c.ourse of writing this book, Subroto Bagchi reached out to a group of people whom he admired for their professionalism and asked them to share the qualities of a professional. Integrity was a quality that topped. Little wonder then, that integrity is also the key stone of this book.

In Part 2, we move on to read about self-awareness and learn some valuable lessons, which include the power to say NO, which can be daunting when we have not yet risen in our career and the need to be generous, gracious and courteous to others when we are at the pinnacle of our professional career. Part 3 deals with basic qualities that make one a well rounded professional. Subroto Bagchi calls the first three parts, the foundational pillars.

As people become more experienced they have to deal with a larger volume of work, responsibilities and complexity. Yes, Part 4 and 5 provide us tools to cope with this. Integrity also makes good business sense and Subroto Bagchi describes this with ample illustrations, those of his own and those which he witnessed. The Abilene Paradox, where people agree to do strange things, when they suppress their own voice and simply go along with what everyone else is saying has been well described in the back drop of the Satyam episode. Yes, the voice of dissent plays a very important role and this is not the same as unconstructive criticism or plain whining.

All of us increasingly have to operate in global market-place. Part 6 guides us on how best to do so. Based on his experiences, Subroto Bagchi touches upon important facets of : Inclusion and Gender, Cross Cultural Sensitivity, Governance, Intellectual Property and Sustainability. Towards the end of the book is a chapter titled ‘The Unprofessional,’ with a list of ten markers of unprofessional conduct, such as: Missing a deadline, Non-escalation of issues on time, Non-disclosure, Not respecting privacy of information, Not respecting ‘need to know’, Plagiarism, Passing on the blame, Overstating qualifica-tions and experience, Mindless job-hopping and Unsuitable appearance.

There is no beginning or end in being a professional it is a life-long learning curve. Yet, this book provides a handy, well illustrated, tool-kit to be a better professional. Ultimately Professionalism boils down to individual choice, and indeed it is for you and me to continue on the path towards becoming a better professional.

A paragraph in the book aptly states this: ‘A doctor becomes part of an insurance fraud. A policeman colludes with a criminal. A lawyer bribes a judge. In each instance, the professional breach is justified as the price to be paid to be part of a system. The truth is, it is an individual choice”.

Subroto Bagchi in his book adds : ” … Society on the while may not always put a premium on the practice of professional values and hence most people do not incorporate it into their lives. But practising professional values is about who you are and what you want to be known as – a professional or merely professionally qualified. And, in the end, even the most corrupt society hails the ones that choose to be different.”

This itself, gives me hope. Amen.

Subroto Bagchi speaks to BCAS members:

No one can become a professional just by acquiring a so-called professional degree or diploma. Some practising individuals who have a professional education behind them and a few years of experience, think that they are professionals. Neither qualification nor just the skill makes you worthy of being called ‘a professional’. In reality, it requires much more than that. That capacity, to build a professional reputation, which only a few can, comes from building ‘affective regard’ for your profession, it comes from conscious practice of unique tenets of a profession, it is about sustained self-regulation.

In the end, professionalism is about personal choices we must make, prices we have to be willing to pay and sometimes, choosing the right over the convenient is a difficult thing, even a risky thing. But it is that quality which separates the legends from the ordinary mortals.

Integrity is one of the key attributes of a good professional. It is here that organisations such as the Bombay Chartered Accountants Society (BCAS) have a huge role to play. Integrity can be taught. It is because the idea is based on the principles of natural justice. It is our natural state. Most people, most of the times are reasonable, they want to live in harmony and that means they have a natural affinity for fairness. When people are given an understanding of the concept of integrity and the power of self-regulation, most people can lead a life without contradictions. I have also seen people change for the better when they are given the right environment and the knowledge. The seeds of integrity can be sown in the minds of young CA students and CAs through collective efforts, such as by the BCAS.

Nirav Shah

Ponzi scheme

Accountant Abroad

Chapter Eight

Ponzi’s Ghost

All scams are basically the same,

and the people running them are typically not very bright,

but they’re brighter than their victims,

which is all they need to be.

— David Marchant, investigative journalist

Carlos Bianchi left Italy in the waning hours of the
nineteenth century, arriving in the New World to change his name from Carlos to
Charles and from Bianchi to Ponsi. By the end of World War I, he’d not only
served time in a Montreal jail for cheque forging, he’d changed his name again,
this time from Ponsi to Ponzi.

Around 1919, looking for greener pastures, Ponzi left Canada
for Boston where, one day, he received a letter from someone in Italy containing
an international postal reply coupon. Still in existence today, it’s a simple
method of paying for postage in one country with the currency of another — if
you will, the global answer to self-addressed stamped envelopes. Because someone
in, say, Glasgow, can’t buy stamps to pay for return postage for his
correspondent in, say, Vancouver, Canada, he buys one of these coupons from his
local post office. Worth a fixed amount, the fellow in Glasgow sends it to his
correspondent in Vancouver who exchanges it at his local post office for a stamp
which covers the postage back to Glasgow.

What caught Ponzi’s eye was that the coupon he received from
Italy had been purchased in Spain. He soon learned that while international
postal reply coupons were priced at fixed rates of exchange, actual currency
rates fluctuated to the point where this particular coupon had cost only about
15% of the value of the US stamps he could buy with it. In other words, coupons
bought in Spain and cashed in the States represented an instant profit of nearly
660%. So Charles Ponzi promptly announced his entry into the international
postal reply coupon business.

However, instead of funding the venture himself, which might
have been legal and would have been profitable, he invited investors to join
him. As he outlined the plan, he would personally travel to Spain to buy tens of
thousands of coupons, bring them back to the States where he would exchange them
for stamps, and then wholesale the stamps to businesses. Promising 40% profits
in just 90 days, he reinforced investor confidence with the old trick of forming
a corporation with a legitimate-sounding name: ‘The Securities and Exchange
Company’, which, of course, abbreviated to ‘S.E.C.’

For the first few months, money trickled in slowly but
steadily. It’s when he upped the promise to 100% profits that the flood-gates
opened and, on good days, hundreds of thousands of dollars arrived at his S.E.C.
In fact, he got so rich so quickly that, within six months, he purchased a large
stake in a New York bank and a Boston import-export firm. The only problem was,
his fortune wasn’t based on postal reply coupons, he was simply spending his
investors’ money.

Towards the middle of 1920, the Boston Post newspaper
began asking questions. Reporters canvassed post offices all over town, only to
discover that Ponzi couldn’t possibly be buying as many coupons as he claimed,
because that many coupons hadn’t been cashed in. The newspaper articles brought
investors to Ponzi’s front door demanding their money back. While fervently
praising the scheme, he obligingly returned investors’ money, plus interest,
paying them with the money sent in by new investors. Robbing Peter to pay Paul
worked for a while, but by August, the Boston Post was claiming that Ponzi was
millions of dollars in debt.

Maintaining a calm and reassuring exterior, Ponzi did what
conmen typically do when faced with the truth — he sued the messenger. He filed
a $ 5 million claim for damages against the Post and then, in the next
breath, announced a $ 100 million international investment syndicate. Before he
could get it off the ground, the Massachusetts State Banking Commission closed
down his bank. Newspapers across the country jumped on the bandwagon, reminding
the public of Ponzi’s earlier scuffles with the Canadian authorities, while
auditors fine-tooth-combed his S.E.C.’s books. They quickly discovered that
legitimate transactions were negligible. In fact, the grand total was a mere
$ 30. It meant that Ponzi never even bothered with his international postal
reply coupon idea.

His house of cards crumbled to the tune of $ 3 million. Ponzi
went to jail for a few years in Massachusetts, was allowed out on parole,
skipped and headed for Florida where he set up a real estate scam which earned
him another trip to prison. At the time he admitted, ‘Only a fool would have
trusted a crook like me.’ Around 1930-31, he was deported home to Italy. From
there he made his way to Brazil, where, eventually, he died penniless. His
legacy is the ‘Ponzi scheme’, and his ghost blithely lives on.

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Nirav Shah

Bring back substance

Accountant Abroad

When ‘true and fair’ accounts disclose either favourable
results that are factually unsupportable, or a position much worse than
warranted due to an ‘accounting quirk’, with no bearing on actual performance,
we are bound to wonder what is going on.

Arbitrary losses may arise when a company is forced to
separate its foreign exchange credits from the transactions that they cover,
even when inventory is costed at the FE rate for all decision-making purposes.
Or results may be burdened with the ‘value’ of options granted to a company’s
directors, when all we ever wanted was a note on the options granted, their
pricing, and how much they made when exercised. Worse, if the company cancels
the options, the grant cost allocable to future years becomes an immediate
revenue hit, even though it will never actually be paid.

A deferred tax ‘liability’ arises with virtually every ‘fair
value’ revaluation (even when there is no intention to sell), despite deferred
tax not being a liability at all under the International Accounting Standards
Board’s own definition.

The requirement to split land and buildings in property
revaluations, to calculate deferred tax on only the building portion of the
revaluation, then split that portion between ‘recover through use’ and
‘recover through sale’ and apply different tax rates over different time
horizons, is enough to convince you that we are dealing with the ramblings of an
unhinged mind.

Little wonder that we come across instances of exasperated
non-compliance.

A note in the accounts of one public company: ‘In view of
the size of the property portfolio, and the complexity of determining the
residual value and anticipated sale dates of these properties, and the fact that
any deferred tax liability raised will be offset by deferred tax assets,
management believe that an exercise to determine the requisite amounts would
require expenditure well in excess of any expected benefit.’

Arbitrary and indiscriminate :

The reverse effect can arise too. British Telecom’s pension
fund deficit doubled to £ 5.8 bn in the second quarter of 2009. Yet its IAS 19,
Employee Benefits, ‘mark-to-market’ measure of liabilities showed a £1 bn
improvement ! Said a spokesman : ‘While BT is obliged to report the IAS
19 figure each quarter, it has no relevance to the funding of the
scheme.’ To what, pray, does it have relevance ?

Banks continue to be the main beneficiaries of
‘compliance-generated’ profits. Years ago Enron showed that the most deceitful
words in the accounting lexicon are ‘off balance sheet’, yet banks still dodge
toxic asset impairment recognition by using credit derivatives held in
off-balance sheet vehicles.

General Electric in the US agreed in July to pay a settlement
of $ 50m (£ 30m) without admitting or denying wrongdoing following Securities
and Exchange Commission allegations that it fiddled its accounting repeatedly,
to preserve its reputation for ‘making the numbers’.

The SEC refers to discoveries by inhouse accountants of
misstatements that more senior executives ordered them to ignore. Two (out of
four) violations descended to the level of fraud, including an Enron-type scheme
to inflate profits by booking phony sales. In none of these cases has there been
a breach of standards or a murmur from the auditors. Yet giving such accounts
the true and fair imprimatur insults readers’ intelligence. The abiding
principle of preferring substance to rule-based form has all but been abandoned.

Our accounting rules have descended into farce and do not
lack mirth; however, they utterly lack commonsense.

Excerpted from an article by Emile Woolf
(Source : Accountancy, October 2009)

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Nirav Shah

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