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Year: 2010

Industrial undertaking : Deduction u/s.80-IA of Income-tax Act, 1961 : A.Y. 2000-01 : Computation of eligible amount to be on the basis of the profits of the eligible unit : Adjustment of loss of other unit not proper : Deductible amount not to exceed the

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15 Industrial undertaking : Deduction u/s.80-IA of Income-tax
Act, 1961 : A.Y. 2000-01 : Computation of eligible amount to be on the basis of
the profits of the eligible unit : Adjustment of loss of other unit not proper :
Deductible amount not to exceed the total income.




[CIT v. Accel Transamatic Systems Ltd., 230 CTR 206
(Ker.)]

The assessee was entitled to deduction u/s.80-I of the
Income-tax Act, 1961. The assessee had two units. In the relevant year i.e.,
A.Y. 2000-01, there was profit from one unit and a loss from the other unit.
The assessee was eligible for deduction of 25% of the profit of the eligible
unit. The assessee computed the eligible amount at Rs.18,12,770 being 25% of
the profit of the first unit and limited the claim for deduction to
Rs.8,51,697 being the total income. The Assessing Officer did not accept the
method of computation adopted by the assessee. The Tribunal accepted the
assessee’s method.

On appeal by the Revenue, the Revenue relied on the
judgment of the Supreme Court in the case of Synco Industries Ltd.; 299 ITR
444 (SC) wherein the disallowance of the claim for deduction was upheld on the
ground that the total income was nil and claimed that the eligible amount
should be computed on the basis of the net figure of first unit after setting
off the loss of the second unit. The Kerala High Court explained the judgment
of the Supreme Court and held as :

“(i) U/s.80A(2) total deduction under Chapter VI-A have to
be limited to the gross total income of the assessee computed under the
provisions of the Act. Therefore, the assessee cannot claim deduction
u/s.80-IA in excess of gross total income computed, no matter eligible amount
may be higher than such income.

(ii) The procedure to be followed for the purpose of
granting deduction u/s.80-IA is to first compute the profits and gains of the
eligible unit and then to determine the eligible deduction therefrom in terms
of S. 80-IA(5). Thereafter, in the computation of total income under the
provisions of the Act, the eligible deduction has to be reduced and if the
total income computed is less than the eligible amount, deduction has to be
limited to such amount.

(iii) Since there have been variations in the total income
computed by virtue of disallowances and later orders of the higher authorities
allowing it, the Assessing Officer is directed to rework the total income and
therefrom allow eligible deduction u/s.80-IA(5) with reference to the profits
of the eligible unit, but limiting it to the total income, if the claimed
amount is higher than such amount.”

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Industrial undertaking : Deduction u/s.80-I of Income-tax Act, 1961 : A.Ys. 1992-93 to 1995-96 and 2000-01 : Computation of eligible amount to be on the basis of the profits of the eligible unit : Adjustment of loss of other unit not proper.

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14 Industrial undertaking : Deduction u/s.80-I of Income-tax
Act, 1961 : A.Ys. 1992-93 to 1995-96 and 2000-01 : Computation of eligible
amount to be on the basis of the profits of the eligible unit : Adjustment of
loss of other unit not proper.




[CIT v. Sona Koyo Steering Systems Ltd., 230 CTR 251
(Del.)]

The assessee was entitled to deduction u/s.80-I of the
Income-tax Act, 1961. The assessee had two units, one making profit and the
other incurring losses. The assessee computed the amount deductible u/s.80-I
on the basis of the profits of the unit making profits ignoring the loss of
the other unit. For the A.Ys. 1992-93 to 1995-96 and 2000-01, the Assessing
Officer did not accept the computation and computed the eligible amount after
setting off the loss of the other unit. The Tribunal allowed the assessee’s
claim.

On appeal by the Revenue, the Revenue relied on the
judgment of the Supreme Court in the case of Synco Industries Ltd.; 299 ITR
444 (SC) wherein the disallowance of the claim for deduction was upheld on the
ground that the total income was nil. The Delhi High Court explained the
judgment of the Supreme Court, upheld the decision of the Tribunal and held as
under :

“(i) In view of S. 80-I(6), the quantum of deduction is to
be computed as if the industrial undertaking were the only source of income of
the assessee during the relevant years. In other words, each industrial
undertaking or unit is to be treated separately and independently. It is only
those industrial undertakings, which have a profit or gain, which would be
considered for computing the deduction. The loss-making industrial undertaking
would not come into the picture at all.

(ii) The plain reading of the provision suggests that the
loss of one such industrial undertaking cannot be set off against the profit
of another such industrial undertaking to arrive at a computation of the
quantum of deduction that is to be allowed to the assessee u/s.80-I(1).”

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Industrial undertaking : Deduction u/s.80-IB of Income-tax Act, 1961 : A.Y. 2001-02 : Sum offered to tax by assessee to cover up certain discrepancies : Is income from industrial undertaking eligible for deduction u/s.80-IB ?

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13 Industrial undertaking : Deduction u/s.80-IB of Income-tax
Act, 1961 : A.Y. 2001-02 : Sum offered to tax by assessee to cover up certain
discrepancies : Is income from industrial undertaking eligible for deduction
u/s.80-IB ?




[CIT v. Allied Industries, 229 CTR 462 (HP)]

The assessee was in the business of manufacturing tractors
and automobile components. The assessee was entitled to deduction u/s.80-IB of
the Income-tax Act, 1961. In the course of the assessment proceedings for the
A.Y. 2001-02, the assessee offered a sum of Rs.2,50,000 for taxation to cover
up all discrepancies. The Assessing Officer added the amount but disallowed
the claim for deduction u/s.80-IB in respect of this amount. The Tribunal
allowed the assessee’s claim and held that the amount offered by the assessee
as addition for the purposes of taxation would amount to profits and gains of
business and were entitled for deduction u/s.80-IB.

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

“Additional income surrendered by the assessee firm having
been added to the income of the business itself, is to be considered while
work-ing out deduction u/s.80-IB, in the absence of any finding of any
authority that the said income was derived from any undisclosed source.”

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Depreciation — Membership card of Bombay Stock Exchange is an ‘intangible asset’ on which depreciation is allowable u/s.32(1)(ii).

Glimpses of supreme court rulings

12. Depreciation — Membership card of Bombay Stock Exchange
is an ‘intangible asset’ on which depreciation is allowable u/s.32(1)(ii).


[Techno Shares and Stocks Ltd. v. CIT, (2010) 327 ITR
323 (SC)]

The assessee-company filed its return of income for the A.Y.
1999-2000, disclosing a loss of Rs.10,77,276. The return was processed
u/s.143(1) on November 8, 2000. The case stood re-opened u/s.147 and the notice
u/s.148 was issued to the assessee on July 16, 2002. The assessee filed its
return of income under protest. The assessee filed its return of income pursuant
to the notice u/s.148 once again declaring loss of Rs.10,77,276, the same as was
in the original return of income. The main reason for reopening of the
assessment u/s.147 was the claim of depreciation by the assessee on the BSE
membership card amounting to Rs.23,65,000. The claim of depreciation of the
assessee was based on S. 32(1)(ii) which stood inserted by the Finance (No. 2)
Act, 1998, with effect from April 1, 1999. However, the said Section deals with
claims for depreciation of items acquired on or after April 1, 1998. The
assessee claimed before the Assessing Officer that the BSE membership card is a
‘licence’ or ‘business or commercial right of similar nature’ u/s.32(1)(ii) and
is, therefore, an intangible asset eligible for depreciation u/s.32(1)(ii), the
submission of which was not accepted by the Assessing Officer. It was held that
membership is only a personal permission which is non-transferable and which
does not devolve automatically on legal heirs and, therefore, it is not a
privately owned asset. That, there is no ownership of an asset and that what
ultimately can be sold is only a right to nomination. Further, according to the
Assessing Officer, in the case of BSE membership, there is no obsolescence, wear
and tear or diminution in value by its use, hence, the assessee was not entitled
to claim depreciation u/s.32(1)(ii). This decision of the AO stood affirmed by
the Commissioner of Income-tax (Appeals) in the appeal filed by the assessee.

Aggrieved by the said decision of the Commissioner of
Income-tax (Appeals), the assessee carried the matter in appeal to the Tribunal
which took the view that since the assessee had acquired a right to trade on the
floor of the BSE through the membership card, it was entitled to depreciation
u/s.32(1)(ii) of the 1961 Act. That, the said card is a capital asset through
which the right to trade on the floor of the BSE is acquired and since it is an
intangible asset the said assessee was entitled to depreciation u/s.32(1)(ii).

Against the said decision, the Department carried the matter
in appeal to the High Court which came to the conclusion, following certain
decisions of the Supreme Court, that the BSE membership card is only a personal
privilege granted to a member to trade in shares on the floor of the stock
exchange; that such a privilege cannot be equated with the expression ‘licence’
or ‘any other business or commercial rights of similar nature’ u/s.32(1)(ii);
that, there is a difference between acquiring a know-how, patent, copyright or
trade mark or franchise; that the expression ‘business or commercial rights of
similar nature’ in S. 32(1)(ii) of the 1961 Act would take its colour from the
preceding words. Namely, know-how, patent, copyright, trade mark and franchise
which belong to a class of intellectual property rights and applying the rule of
ejusdem generis, the High Court held that the expression ‘licence’ as well as
the expression ‘business or commercial right of similar nature’ in S. 32(1)(ii)
of the 1961 Act are referable to IPRs such as know-how, patent, copyright, trade
mark and franchise and since the BSE membership card does not fall in any of the
above categories, the claim for depreciation was not admissible on the BSE
membership card acquired by the assessee u/s.32(1)(ii). Consequently, the
appeals filed by the Department stood allowed.

On civil appeals against the decision of the High Court, the
Supreme Court observed that the question which it was required to examine was —
whether the right of nomination in the non-defaulting continuing member comes
within the expression ‘business or commercial right of similar nature’ in S.
32(1)(ii) of the 1961 Act ?

The Supreme Court held that on the analysis of the Rules of
the BSE, it was clear that the right of membership (including right of
nomination) got vested in the exchange on the demise/default committed by the
member; that, on such forfeiture and vesting in the exchange that the same got
disposed off by inviting offers and the consideration received thereof was used
to liquidate the dues owned by the former/defaulting member to the exchange,
clearing house, etc. (see Rule 16 and bye-law 400). It was this right of
membership which allowed the non-defaulting member to participate in the trading
season on the floor of the exchange. Thus, the said membership right was a
‘business or commercial right’ conferred by the rules of the BSE on the
non-defaulting continuing member.

The next question was — whether the membership right could be said to be owned by the assessee and used for the business purpose in terms of S. 32(1)(ii). The Supreme Court held that its answer was in affirmative for the reason that the rules and bye-laws analysed hereinabove indicated that the right of nomination vested in the exchange only when a member committed default. Otherwise, he continued to participate in the trading session on the floor of the exchange; that he continued to deal with other members of the exchange and even had the right to nominate a subject to compliance with the Rules. Moreover, by virtue of Explanation 3 to S. 32(1)(ii) the commercial or business right which was similar to a ‘licence’ or ‘franchise’ was declared to be an intangible asset. Moreover, under Rule 5, membership was a personal permission from the exchange which was nothing but a ‘licence’ which enabled the member to exercise rights and privileges attached thereto. It was this licence which enabled the member to trade on the floor of the exchange and to participate in the trading session on the floor of the exchange. It was this licence which enabled the member to access the market. Therefore, the right of membership which included right of nomination, was a ‘licence’ which was one of the items which fell in S. 32(1)(ii) of the 1961 Act. The right to participate in the market had an economic and money value. It was an expense incurred by the assessee which satisfied the test of being a ‘licence’ or ‘any other business or commercial right of similar nature’ in terms of S. 32(1)(ii).

The Supreme Court however clarified that the present judgment was strictly confined to the rights of membership conferred upon the member under the BSE membership card during the relevant assessment years. This judgment should not be understood to mean that every business or commercial right would constitute a ‘licence’ or a ‘franchise’ in terms S. 32(1)(ii) of the 1961 Act.

Business expenditure — Foreign exchange borrowings — Loss on account of fluctuation in rate of foreign exchange on the last date of balance sheet — If the borrowings are on revenue account, the loss is allowable as deduction u/s.37(1) and if the same is o

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 25 Business expenditure — Foreign exchange borrowings — Loss
on account of fluctuation in rate of foreign exchange on the last date of
balance sheet — If the borrowings are on revenue account, the loss is allowable
as deduction u/s.37(1) and if the same is on capital account, prior to its
amendment of S. 43A w.e.f. 1-4-2003, even if the repayment is not due, the cost
of the asset acquired is to be increased.

The assessee, a public sector undertaking, substantially
owned by the Government of India, was engaged in capital intensive exploration
and production of petroleum products for which it had to heavily depend on
foreign loan to cover its expenses, both capital and revenue, on import of
machinery on capital account and for payment to non-resident contractors in
foreign currency for various services rendered. The assessee had made three
types of foreign exchange borrowings : (i) in revenue account; (ii) in capital
account, and (iii) for general purposes, partly utilised in revenue account and
partly in capital account. As per terms and conditions of foreign exchange
borrowings, some of the loans became repayable in the year under consideration
but the date of repayment of some loans fell after the end of the relevant
accounting year. The assessee revalued in Indian currency all its foreign
exchange loans in revenue account, capital account as also in its general
purposes account, outstanding as on March 31, 1991 and claimed the difference
between their respective amounts in Indian currency as on 31st March, 1990 and
on March 31, 1991 as revenue loss u/s.37(1) of the Act in respect of loans used
in revenue account, and also took into consideration the similar difference in
foreign exchange on capital account loans as an increased liability u/s. 43A of
the Act for the purposes of depreciation. The foreign exchange loss incurred by
the assessee in the revenue account, on account of repayment of these loans made
in the year under consideration was allowed by the Assessing Officer as a
deduction u/s.37(1) of the Act, and he also took into consideration an increased
liability of foreign exchange loans taken in capital account and repaid in the
accounting year, for the purposes of depreciation, u/s.43A of the Act. He,
however, did not allow to the assessee its claim for foreign exchange loss
claimed on such foreign currency loans both in revenue account and in capital
account which were outstanding on the last day of the accounting year under
consideration and were as per the terms of borrowings repayable after the end of
the relevant accounting year. Similar treatment was given to the foreign
exchange loans for general purposes, used partly in revenue account and partly
in capital account. Thus, the assessee’s claim for foreign exchange
loss/increased liability on revaluation of these foreign exchange loans at the
end of the accounting year under consideration both in the revenue account and
capital account as also on loans used partly in revenue account and partly in
capital account, made on the ground that it had followed mercantile system of
accounting in this regards, was disallowed by the Assessing Officer. According
to the Assessing Officer, such a loss could be allowed to the assessee on
discharge of liability at the time of actual repayment of these loans.

Aggrieved, the assessee preferred appeal before the
Commissioner of Income-tax (Appeals). Inso-far as the assessee’s claim for
foreign exchange loss in revenue account was concerned, the Commissioner of
Income-tax (Appeals) affirmed the view taken by the Assessing Officer on the
ground that it was a notional liability and the same had not crystallised or
accrued in the relevant assessment year. However, as regards the adjustment for
increased liability made by the assessee for the purposes of S. 43A of the Act
in respect of foreign exchange loans in capital account, which were outstanding
as on March 31, 1991, the Commissioner accepted the stand of the assessee and
directed the Assessing Officer to allow the benefit of such increased liability
for computation of depreciation allowance on plant and machinery purchased out
of such foreign exchange loans for the assessment year under consideration.

Being dissatisfied, both the assessee as well as the Revenue
carried the matter in further appeal to the Income Tax Appellate Tribunal (for
short ‘the Tribunal’). The Tribunal observed that the method of accounting
adopted by the assessee right from the A.Y. 1982-83 is mercantile system; it has
been consistently claiming loss suffered by it on account of fluctuation in
foreign exchange rates on accrual basis; in respect of the A.Y. 1982-83 to
1986-87, the assessee’s claim on this account had been allowed by the Assessing
Officer himself; in respect of the A.Y. 1997-98, the assessee had shown a gain
of Rs.293.37 crores on account of fluctuation in foreign exchange because of the
Indian rupee had appreciated as compared to the foreign currency and that the
said amount was taxed as the assessee’s income. Taking all these factors into
consideration, the Tribunal held that the loss claimed by the assessee on
revenue account was allowable u/s.37(1) of the Act. The appeal preferred by the
Revenue on the question whether the assessee was entitled to adjust the actual
cost of imported assets acquired in foreign currency on account of fluctuation
in the rate of exchange, in terms of S. 43A of the Act, was also dismissed.

For the A.Ys. 1992-93, 1993-94, 1994-95 and 1997-98 similar
findings were given by the Tribunal. The Revenue took the matter in further
appeal to the High Court. By a common judgment pertaining to the A.Ys. 1991-92
to 1994-95 and 1997-98, the High Court reversed the decision of the Tribunal on
both the issues. Terming the order of the Tribunal as perverse, having been
passed without any material on record and against the statutory provisions, the
High Court held that the foreign exchange loss by the assessee being only a
contingent and notional liability, it was not allowable as deduction u/s.37(1)
of the Act. Insofar as the applicability of S. 43A of the Act was concerned, the
High Court observed that the said provision is confined only to those
liabilities which have become due as per the terms and conditions of written
agreement between the assessee and the foreign creditors but since in the
present case, no such agreement was made available by the assessee at any stage
of the proceedings, the claim of the assessee was not justified. According to
the High Court, the variation in foreign exchange was neither quantified, nor
had it become due or repaid and, therefore, deductions on that account had been
allowed by the Tribunal without application of mind and were, therefore,
illegal.

On an appeal by the assessee, the Supreme Court was of the
opinion that the ratio of the decision in CIT v. Woodward Governor of India P.
Ltd., (2009) ITR 254 (SC) squarely applied to the facts at hand and, therefore,
the loss claimed by the assessee on account of fluctuation in the rate of
foreign exchange as on the date of balance sheet was allowable as expenditure
u/s.37(1) of the Act.

The Supreme
Court further held that all the assessment years in question being prior to the
amendment in S. 43A of the Act (made with effect from April 1, 2003), the
assessee would be entitled to adjust the actual cost of the imported capital
assets, capital assets acquired in foreign currency, on account of fluctuation in
the rate of exchange at each of the relevant balance sheet dates pending actual
payment of the varied liability.

 

[Oil and Natural Gas Corporation Ltd. v. CIT,
(2010) 322 ITR 180 (SC)]

Loan in foreign currency for acquisition of capital asset — Forward contract for obtaining foreign currency at a pre-determined rate — Roll-over charges paid to carry forward the contract have to be capitalised in view of S. 43A.

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24 Loan in foreign currency for acquisition of capital asset
— Forward contract for obtaining foreign currency at a pre-determined rate —
Roll-over charges paid to carry forward the contract have to be capitalised in
view of S. 43A.

The assessee was engaged in the manufacture of gears and
mechanical handling equipment. It procured a foreign currency loan for expansion
of existing business. Since the repayment of loan was stipulated in instalments,
the assessee wanted to ensure that foreign currency required for repayment of
the loan be obtained at a pre-determined rate and cost. Accordingly, the
assessee booked forward contracts with Citibank for delivery of the required
foreign currency on the stipulated dates. The contract was entered into for the
entire outstanding amount and the delivery of foreign currency was obtained
under the contract for instalment due from time to time. The balance value of
the contract, after deducting the amount withdrawn towards repayment, was rolled
for a further period up to the date of the next instalment. The assessee filed
its return of income for the A.Y. 1986-87 on June 30, 1986. A revised return was
filed by it on March 27, 1989, declaring a total income of Rs.2,10,08,640. The
Assessing Officer disallowed an amount of Rs.8,86,280, being the roll-over
premium charges paid by the assessee in respect of foreign exchange forward
contracts to Citibank N.A. on the ground that the said charges were incurred in
connection with the purchase of a capital asset (plant and machinery), hence, it
was not admissible for deduction u/s.36(1)(iii) or u/s.37 of the Act. On appeal,
the Commissioner of Income-tax (Appeals) held that the roll-over premium charges
incurred by the assessee were allowable as they were incurred by the assessee to
mitigate the risk involved in higher payment because of adverse fluctuation of
rate of exchange. According to the Commissioner of Income-tax (Appeals),
roll-over premium charges constituted an expenditure incurred for raising loans
on revenue account, hence, the said expenditure was allowable under the Act.

The Tribunal held that roll-over premium charges (carry
forward charges) were required to be paid to the authorised dealer as
consideration for permitting the unutilised amount of the contract (balance
value of the contract) to be availed of at a later date and in the circumstances
the roll-over premium charges had to be capitalised under Explanation 3 to S.
43A of the said Act. Consequently, the Tribunal upheld the order of the
assessment.

The High Court came to the conclusion that the roll-over
premium charges paid by the assessee were in the nature of interest or committal
charges, hence, the said charges were allowable u/s.36(l)(iii) of the said Act.

The Supreme Court observed that S. 43A, before its
substitution by a new S. 43A vide the Finance Act, 2002, was inserted by the
Finance Act, 1967, with effect from April 1, 1967, after the devaluation of the
rupee on June 6, 1966. It applied where as a result of change in the rate of
exchange there was an increase or reduction in the liability of the assessee in
terms of the Indian rupee to pay the price of any asset payable in foreign
exchange or to repay moneys borrowed in foreign currency specifically for the
purpose of acquiring an asset. The Section has no application unless an asset
was acquired and the liability existed, before the change in the rate of
exchange. When the assessee buys an asset at a price, its liability to pay the
same arises simultaneously. This liability can increase on account of
fluctuation in the rate of exchange. An assessee who becomes the owner of an
asset (machinery) and starts using the same, becomes entitled to depreciation
allowance. To work out the amount of depreciation, one has to look to the cost
of the asset in respect of which depreciation is claimed. S. 43A was introduced
to mitigate hardships which were likely to be caused as a result of fluctuation
in the rate of exchange. S. 43A lays down, firstly, that the increase or
decrease in liability should be taken into account to modify the figure of
actual cost and, secondly, such adjustment should be made in the year in which
the increase or decrease in liability arises on account of fluctuation in the
rate of exchange. It is for this reason that though S. 43A begins with a non
obstante clause, it makes S. 43(1) its integral part. This is because S. 43A
requires the cost to be recomputed in terms of S. 43A for the purpose of
depreciation [S. 32 and 43(1)]. A perusal of S. 43A makes it clear that insofar
as the depreciation is concerned, it has to be allowed on the actual cost of the
asset, less depreciation that was actually allowed in respect of earlier years.
However, where the cost of the asset subsequently increased on account of
devaluation, the written down value of the asset has to be taken on the basis of
the increased cost minus the depreciation earlier allowed on the basis of the
old cost. U/s.43A, as it stood at the relevant time, it was, inter alia,
provided that where an assessee had acquired an asset from a country outside
India for the purpose of his business, and in consequence of a change in the
rate of exchange at any time after such acquisition, there is an increase or
reduction in the liability of the assessee as expressed in Indian currency for
making payment towards the whole or part of the cost of the asset or for
repayment of the whole or part of the moneys borrowed by him for the purpose of
acquiring the asset, the amount by which the liability stood increased or
reduced during the previous year shall be added to or reduced from the actual
cost of the asset as defined in S. 43(1). This analysis indicated that during
the relevant assessment year adjustment to the actual cost was required to be
done each year on the closing date, i.e., year end. Subsequently, S. 43A
underwent a drastic change by virtue of a new S. 43A inserted vide the Finance
Act, 2002. Under the new S. 43A, such adjustment to the cost had to be done only
in the year in which actual payment is made. The Supreme Court noted that in
this case, it was not concerned with the position emerging after the Finance
Act, 2002. Under Explanation 3 to S. 43A, if the assesse had covered his
liability in foreign exchange by entering into forward contract with an
authorised dealer for the purchase of foreign exchange, the gain or loss arising
from such forward contract was required to be taken into account.

According to the assessee, S. 43A was not applicable in this
case as there was no increase or reduction in liability because such roll-over
charges were paid to avoid increase or reduction in liability consequent upon
change in the rate of exchange.

The Supreme Court held that during the relevant assessment years, S.
43A applied to the entire liability remaining outstanding at the year end, and
it was not restricted merely to the instalments actually paid during the year.
Therefore, at the relevant time, the year-end liability of the asessee had to
be looked into. Further, it could not be said that the roll-over charges had
nothing to do with the fluctuation in the rate of exchange. In the present
case, the notes to the accounts for the year ended December 31, 1986 (Schedule
17) indicated adverse fluctuations in the exchange rate in respect of
liabilities pertaining to the assets acquired. This note clearly established
the existence of adverse fluctuations in the exchange rate which made the
assessee opt for forward cover and which made the assessee pay the roll-over
charges. The word ‘adverse’ in the note itself pre-supposes increase in the
liability incurred by the assessee during the year ending December 31, 1986. In
the circumstances, the Supreme Court found no merit in the contention of the
assessee that roll-over charges had nothing to do with the fluctuation in the
rate of exchange.

 

According to the Supreme Court, roll-over
charges represented the difference arising on account of change in foreign
exchange rates. The Supreme Court therefore held that roll-over charges
paid/received in respect of liabilities relating to the acquisition of fixed
assets should be debited/credited to the asset in respect of which liability
was incurred. However, roll-over charges not relating to fixed assets should be
charged to the profit and loss account.

Diversion overriding title — Whether the payment of citizen tax payable to the employees who were Japanese citizens constituted an overriding charge on the salary and therefore would not be income of such employees and consequently no tax was to be deduct

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23 Diversion overriding title — Whether the payment of
citizen tax payable to the employees who were Japanese citizens constituted an
overriding charge on the salary and therefore would not be income of such
employees and consequently no tax was to be deducted at source — Matter remanded
to the Tribunal.

The assessee, a Japanese organisation set up for transmission
of news and broadcasting, paid salary to its employees. It also paid some
housing allowance.

The Assessing Officer included citizens tax as a part of the
income of the expatriates employed by the assessee-company in India as part of
the employee’s income on the ground that it was an amount paid by the assessee
to its employees. According to the Assessing Officer, the assessee ought to have
deducted tax at source at the time of payment.

On appeal, the Commissioner of Income-tax (Appeals) held that
citizen tax was a statutory levy in Japan on the Japanese citizens and such tax
constituted an overriding charge on the salary income and, therefore, the same
had to be excluded in computation of taxable income. This view of the
Commissioner (Appeals) was upheld by the Tribunal.

The High Court took the view that in view of the concurrent
finding of fact, no interference was called for and the appeal was dismissed
accordingly.

The Supreme Court was however of the view that the
Commissioner of Income-tax (Appeals) ought to have examined the provisions of
the Citizen Individual Inhabitant Tax Act which was a Japanese law and it ought
to have analysed the provisions of that law, particularly when it was required
to decide the question as to the nature of the levy being an overriding charge
on the salary income, as stated hereinabove. The controversy in the present case
was that whether citizens tax was a statutory levy in Japan on the Japanese
citizens constituting an overriding charge. If it was an overriding charge, then
of course the Commissioner of Income-tax (Appeals) was right in saying that it
would not be an income. However, according to the Supreme Court, since the
provisions of the Act had not been examined, the matter needed to be considered
afresh by the Tribunal. Accordingly, the Supreme Court remitted the matter to
the Tribunal for fresh consideration in accordance with law. The Supreme Court
did not express any opinion on the merits of the case.

[CIT v. NHK Japan Broadcasting Corporation, (2010) 322
ITR 628 (SC)]

 

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Heads of income — Business income or income from other sources — Interest on short-term deposits with bank of surplus fund — Income from other sources — No deduction u/s.80P is allowable as it is not a part of operational income.

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 22 Heads of income — Business income or income from other
sources — Interest on short-term deposits with bank of surplus fund — Income
from other sources — No deduction u/s.80P is allowable as it is not a part of
operational income.

The assessee, a co-operative credit society, which provides
credit facilities to its members and also markets the agricultural product of
its members, during the relevant assessment years in question, had surplus funds
which it invested in short-term deposits with banks and in Government
securities. Interest accrued to the assessee on such investments.

The Assessing Officer held that the interest income which the
assessee had disclosed under the head ‘Income from business’ was liable to be
taxed under the head ‘Income from other sources’. According to the Assessing
Officer the assessee-society had invested the surplus funds as and by way of
investment by an ordinary investor, hence, interest on such investment has got
to be taxed under the head ‘Income from other sources’. Before the Assessing
Officer, it was argued by the assesssee that it had invested the funds on
short-term basis as the funds were not required immediately for business
purposes and, consequently, such act of investment constituted a business
activity by a prudent businessman; therefore, such interest income was liable to
be taxed u/s.28 and not u/s.56 of the Act, and, consequently, the assessee was
entitled to deduction u/s.80P(2)(a)(i) of the Act. This argument was rejected by
the Assessing Officer as also by the Tribunal and the High Court, hence, the
civil appeal was filed by the assessee before the Supreme Court.

The Supreme Court held that the assessee-society regularly
invested funds not immediately required for business purposes. Interest on such
investments, therefore, could not fall within the meaning of the expression
‘profits and gains of business’. Such interest income cannot be said also to be
attributable to the activities of the society, namely, carrying on the business
of providing credit facilities to its members or marketing of the agricultural
produce of its members. The Supreme Court was of the view that such interest
income would come in the category of ‘Income from other sources’, hence, such
interest income would be taxed u/s.56 of the Act.

The Supreme Court further held that to say that the source of
income is not relevant for deciding the applicability of S. 80P of the Act would
not be correct because weightage need to be given to the words ‘the whole of the
amount of profits and gains of business’ attributable to one of the activities
specified in S. 80P(2)(a) of the Act. The words ‘the whole of the amount of
profits and gains of business’ emphasise that the income in respect of which
deduction is sought must constitute the operational income and not the other
income which accrues to the society. In this particular case, the evidence
showed that the assessee-society earned interest on funds which were not
required for business purposes at the given point of time. Therefore, on the
facts and circumstances of this case, the Supreme Court was of the view, such
interest income fell in the category of ‘Other Income’ which had been rightly
taxed by the Department u/s.56 of the Act.


[Totgar’s Co-operative Sale Society Ltd. v. ITO, (2010)
322 ITR 283 (SC)]

 

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Head of income — Business income or income from other sources — Interest on short-term deposits with bank — In the absence of factual matrix, matter remanded to the Tribunal for fresh adjudication.

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21 Head of income — Business income or income from other
sources — Interest on short-term deposits with bank — In the absence of factual
matrix, matter remanded to the Tribunal for fresh adjudication.


The assessee was an exporter. The Tribunal held that the
interest income was generated by way of keeping the ‘advances’ received by the
assessee in the course of its regular business activity. According to the
Department, it was the case of surplus being invested in FDR, whereas according
to the assessee it was the case of advance having been received from the
exporter which was in FDR for short duration.

The Supreme Court observed that in the present case there was
no factual data to decide the aforesaid issue. The nature of the receipt was not
discussed. The High Court while disposing of the matter had also not examined
the factual basis. In view of the absence of factual matrix the Supreme Court
was of the view that to decide the question as to whether the receipt fell
u/s.28 or u/s.56, the matter was required to be remitted to the Tribunal for
fresh consideration in accordance with law.

[CIT v. Producin Pvt. Ltd., (2010) 322 ITR 270 (SC)]

 

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Interest on excess refund : S. 234D of Income-tax Act, 1961 : Section came on statute books w.e.f. 1-6-2003 : Provision not retrospective : Interest u/s.234D cannot be charged in respect of refunds granted prior to 1-6-2003.

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Unreported :


12. Interest on excess
refund : S. 234D of Income-tax Act, 1961 : Section came on statute books w.e.f.
1-6-2003 : Provision not retrospective : Interest u/s.234D cannot be charged in
respect of refunds granted prior to 1-6-2003.

[CIT v. M/s. Bajaj
Hindustan Ltd. (Bom.), ITA No. 198 of 2009 dated 15-4-2009]

In an appeal by the Revenue
the following question was raised before the Bombay High Court :

“Whether in the facts and
circumstances of the case and in law the ITAT was right in holding that the
interest u/s.234D cannot be charged in respect of refunds granted prior to
1-6-2003 ?”

The High Court upheld the
decision of the Tribunal and held as under :

“It is seen that the
subject provision came on statute book w.e.f. 1-6-2003. If that be so, the
said provision does not have retrospective effect. In this view of the matter
we do not see the appeal giving rise to any substantial question of law.”

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Reassessment : Power and scope : S. 147 of Income-tax Act, 1961 : A.Ys. 1994-95 and 1995-96 : If the AO does not assess the income, which he had reason to believe had escaped assessment, then the reassessment order will be invalid.

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13. Reassessment : Power and
scope : S. 147 of Income-tax Act, 1961 : A.Ys. 1994-95 and 1995-96 : If the AO
does not assess the income, which he had reason to believe had escaped
assessment, then the reassessment order will be invalid.


[CIT v. M/s. Jet Airways
(I) Ltd. (Bom.), ITA No. 1714 of 2009 dated 12-4-2010]

In an appeal by the Revenue
the following question was raised before the Bombay High Court :

“Where upon the issuance of
a notice u/s.148 of the Income-tax Act, 1961 r/w. S. 147, the Assessing Officer
does not assess or, as the case may be, reassess the income which he has reason
to believe had escaped assessment and which formed the basis of the notice
u/s.148, is it open to the Assessing Officer to assess or reassess independently
any other income, which does not form the subject matter of the notice ?”

The High Court upheld the
decision of the Tribunal and held as under :

“(i) S. 147 has the effect
that the Assessing Officer has to assess or reassess the income (such income)
which escaped assessment and which was the basis of the formation of belief
and if he does so, he can also assess or reassess any other income which has
escaped assessment and which comes to his notice during the course of the
proceedings. However, if after issuing a notice u/s.148, he accepts the
contention of the assessee and holds that the income in respect of which he
has initially formed has reason to believe had escaped assessment, has as a
matter of fact not escaped assessment, it is not open to him independently to
assess some other income. If he intends to do so, a fresh notice u/s.148 would
be necessary, the legality of which would be tested in the event of a
challenge by the assessee.

(ii) We have approached
the issue of interpretation that has arisen for decision in these appeals,
both as a matter of first principle, based on the language used in S. 147(1)
and on the basis of the precedent on the subject. We agree with the submission
which has been urged on behalf of the assessee that S. 147(1) as it stands
postulates that upon the formation of a reason to believe that income
chargeable to tax has escaped assessment for any assessment year, the AO may
assess or reassess such income ‘and also’ any other income chargeable to tax
which comes to his notice subsequently during the proceedings as having
escaped assessment. The words ‘and also’ are used in a cumulative and
conjunctive sense. To read these words as being in the alternative would be to
rewrite the language used by the Parliament.

(iii) In that view of the
matter and for the reasons that we have indicated, we do not regard the
decision of the Tribunal in the present case as being in error. The question
of law shall accordingly stand answered against the Revenue and in favour of
the assessee.”

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Interest for non/short payment of advance tax and on excess refund : S. 234B and S. 234D of Income-tax Act, 1961 : A.Y. 2001-02 : Interest not chargeable u/s.234B where short payment of advance tax is attributable to non/short deduction of tax at source :

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Unreported :

11. Interest for non/short
payment of advance tax and on excess refund : S. 234B and S. 234D of Income-tax
Act, 1961 : A.Y. 2001-02 : Interest not chargeable u/s.234B where short payment
of advance tax is attributable to non/short deduction of tax at source : S. 234D
applies only for the A.Y. 2004-05 and onwards and is not retrospective.

[DIT v. M/s. Jacabs Civil
Incorporated (Del.), ITA No. 491 of 2008 dated 30-8-2010]

The assessee is a foreign
company. For the A.Y. 2001-02, the assessee had filed return of income declaring
income of Rs.96 lakhs. The assessee had claimed that it is not liable for
interest u/s.234B of the Income-tax Act, 1961 in view of the fact that it was
not liable to pay advance tax since whole of the tax liability was deductible
u/s.195 by the payee. The assessee had also claimed that S. 234D is not
applicable since it is operative only from the A.Y. 2004-05. The Assessing
Officer rejected the assessee’s claim and levied interest u/s.234B and u/s.234D
of the Act. The Tribunal accepted the assessee’s claim.

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

“(i) U/s.209(1)(d), the
tax ‘deductible or collectible at source’ has to be reduced from the advance
tax payable. S. 195 puts an obligation on the payer to deduct tax at source.
Therefore, the entire tax is to be deducted at source which is payable on such
payments made by the payee to the non-resident. The non-resident recipient is
not liable to pay advance tax. Though in Anjum Ghaswala 252 ITR 1(SC), it was
held that S. 234B is mandatory, the present is a case where S. 234B does not
apply at all. Accordingly, it is not permissible for the Revenue to charge
interest u/s.234B.

(ii) S. 234D inserted by
the Finance Act, 2003 w.e.f. 1-6-2003 is in the nature of a substantive
provision and applies only for the A.Y. 2004-05 and onwards. It is not
retrospective.”

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Company : Book profits : S. 80HHC and S. 115JA of Income-tax Act, 1961 : In case of MAT assessment amount deductible u/s. 80HHC has to be computed on the basis of adjusted book profits and not on basis of profit computed under the normal provisions.

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12 Company : Book profits : S. 80HHC and S. 115JA of
Income-tax Act, 1961 : In case of MAT assessment amount deductible u/s. 80HHC
has to be computed on the basis of adjusted book profits and not on basis of
profit computed under the normal provisions.




[CIT v. SPEL Semiconductor Ltd., 188 Taxman 130 (Mad.)]

The assessee-company was engaged in manufacture and sale of
integrated circuits. For the relevant year, the assessment was completed u/s.
115JA. The assessee claimed that the amount deductible u/s.80HHC has to be
computed on the basis of the adjusted book profits and not on the basis of the
profit computed under the normal provisions. The Assessing Officer rejected
the assessee’s claim. The Tribunal allowed the assessee’s claim.

On appeal by the Revenue, the Madras High Court upheld the
decision of the Tribunal following its judgment in the case of CIT v.
Rajanikant Schnelder & Associates (P) Ltd., 302 ITR 22 (Mad.).

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Capital gains : Cost of acquisition : A.Y. 2003-04 : Interest on loan taken for purchase of property : Interest to be included in the cost of acquisition for computing capital gain on sale of property.

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11 Capital gains : Cost of acquisition : A.Y. 2003-04 :
Interest on loan taken for purchase of property : Interest to be included in the
cost of acquisition for computing capital gain on sale of property.




[CIT v. Sri Hariram Hotels (P) Ltd.; 229 CTR 455
(Kar.), 188 Taxman 178 (Kar.)]

The assessee company had purchased an immovable property
out of borrowed funds. On sale of the property, for computation of capital
gain the assessee company included the interest on the borrowed funds in the
cost of acquisition of the property. The Assessing Officer held that the
interest on the borrowed funds does not form part of the cost of acquisition.
The Tribunal allowed the assessee’s claim.

On appeal by the Revenue, the Karnataka High Court followed
its decision in the case of CIT v. Maithreyi Pai, 152 ITR 247 (Kar.) and
upheld the decision of the Tribunal.

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Additional non statutory disclosures in Annual Reports

From Published Accounts

Compiler’s Note :


Infosys has over the years been a pioneer in providing
additional relevant information in its annual reports. Keeping up with the same,
the company has, in its annual report for 2010, given (as additional
information), an Intangible Assets Score Card which makes a very interesting
reading. The same is reproduced below.

1 Infosys Technologies Ltd. — (31-3-2010)

Additional information :

Intangible assets score sheet :

We caution investors that this data is provided only as
additional information to them. We are not responsible for any direct, indirect
or consequential losses suffered by any person using this data.

From the 1840s to the early 1990s, a corporate’s value was
mainly driven by its tangible assets — values presented in the corporate Balance
Sheet. The managements of companies valued these resources and linked all their
performance goals and matrices to these assets — Return on investment and
capital turnover ratio. The market capitalisation of companies also followed the
value of tangible assets shown in the Balance Sheet with the difference seldom
being above 25%. In the latter half of the 1990s, the relationship between
market value and tangible asset value changed dramatically. By early 2000, the
book value of the assets represented less than 15% of the total market value. In
short, intangible assets are the key drivers of market value in this new
economy.

A knowledge-intensive company leverages know-how, innovation
and reputation to achieve success in the marketplace. Hence, these attributes
should be measured and improved upon year after year to ensure continual
success. Managing a knowledge organisation necessitates a focus on the critical
issues of organisational adaptation, survival, and competence in the face of
ever-increasing, discontinuous environmental change. The profitability of a
knowledge firm depends on its ability to leverage the learnability of its
professionals, and to enhance the reusability of their knowledge and expertise.
The intangible assets of a company include its brand, its ability to attract,
develop and nurture a cadre of competent professionals, and its ability to
attract and retain marquee clients.

Intangible assets :

The intangible assets of a company can be classified into
four major categories: human resources, intellectual property assets, internal
assets and external assets.

Human resources :

Human resources represent the collective expertise,
innovation, leadership, entrepreneurship and managerial skills of the employees
of an organisation.

Intellectual property assets :

Intellectual property assets include know-how, copyrights,
patents, products and tools that are owned by a corporation. These assets are
valued based on their commercial potential. A corporation can derive its
revenues from licensing these assets to outside users.

Internal assets :

Internal assets are systems, technologies, methodologies,
processes and tools that are specific to an organisation. These assets give the
organisation a unique advantage over its competitors in the marketplace. These
assets are not licensed to outsiders. Examples of internal assets include
methodologies for assessing risk, methodologies for managing projects, risk
policies and communication systems.

External assets :

External assets are market-related intangibles that enhance
the fitness of an organisation for succeeding in the marketplace. Examples are
customer loyalty (reflected by the repeat business of the company) and brand
value.

The score sheet :

We published models for valuing two of our most important
intangible assets — human resources and the ‘Infosys’ brand. This score sheet is
broadly adopted from the intangible asset score sheet provided in the book
titled, The New Organisational Wealth, written by Dr. Karl-Erik Sveiby and
published by Berrett-Koehler Publishers Inc., San Francisco. We believe such
representation of intangible assets provides a tool to our investors for
evaluating our market-worthiness.

Clients :

The growth in revenue is 3% this year, compared to 12% in the
previous year (in US $). Our most valuable intangible asset is our client base.
Marquee clients or image-enhancing clients contributed 50% of revenues during
the year. They gave stability to our revenues and also reduced our marketing
costs.

The high percentage 97.3% of revenues from repeat orders
during the current year is an indication of the satisfaction and loyalty of our
clients. The largest client contributed 4.6% to our revenue, compared to 6.9%
during the previous year. The top 5 and 10 clients contributed around 16.4% and
26.2% to our revenue, respectively, compared to 18.0% and 27.7%, respectively,
during the previous year. Our strategy is to increase our client base and,
thereby reduce the risk of depending on a few large clients.

During the year, we added 141 new clients compared to 156 in
the previous year. We derived revenue from customers located in 66 countries
against 67 countries in the previous year. Sales per client grew by around 3.7%
from US $8.05 million in the previous year to US $8.35 million this year. Days
Sales Outstanding (DSO) was 59 days this year compared to 62 days in the
previous year.

Organisation :

During the current year, we invested around 2.58% of the
value-added (2.37% of revenues) on technology infrastructure, and around 2.09%
of the value-added (1.93% of revenues) on R&D activities.

A young, fast-growing organisation requires efficiency in the
area of support services. The average age of support employees is 30.4 years, as
against the previous year’s average age of 29.6 years. The sales per support
staff has come down during the year compared to the previous year and the
proportion of support staff to the total organisational staff, has improved over
the previous year.

People :

We are in a people-oriented business. We added 27,639 employees this year on gross basis (net 8,946) from 28,231 (net 13,663) in the previous year. We added 4,895 laterals this year against 5,796 in the previous year. The education index of employees has gone up substantially to 2,96,586 from 2,72,644. This reflects the quality of our employees. Our employee strength comprises people from 83 nationalities March 31, 2010. The average age of employees as at March 31, 2010 was 27. Attrition was 13.4% for this year compared to 11.1% in the previous year (excluding subsidiaries).

Notes:

  •     Marquee or image-enhancing clients are those who enhance the company’s market-worthiness, typically, Global 1,000 clients. They are often reference clients for us.

  •     Sales per client is calculated by dividing total revenue by the total number of clients.

  •     Repeat business revenue is the revenue during the current year from those clients who contributed to our revenue during the previous year too.

  •     Value-added statement is the revenue less payment to all outside resources. The statement is provided in the value-added statement section of this document.

  •     Technology investment includes all investments in hardware and software, while total investment in the organisation is the investment in our fixed assets.

  •     The average proportion of support staff is the average number of support staff to average total staff strength.

  •     Sales per support staff is our revenue divided by the average number of support staff (support staff excludes technical support staff).

The education index is shown as at the year end, with primary education calculated as 1, secondary education as 2 and tertiary education as 3.

Capital receipt or income from other sources : Interest on share capital during pre-operative period : A.Ys. 2001-02 and 2002-03 : Due to legal entanglement with respect to title of land to be acquired for the assessee, share capital contribution put in f

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10 Capital receipt or income from other sources : Interest on
share capital during pre-operative period : A.Ys. 2001-02 and 2002-03 : Due to
legal entanglement with respect to title of land to be acquired for the
assessee, share capital contribution put in fixed deposit with bank : Interest
earned on fixed deposit is capital receipt liable to be set off against
pre-operative expenses : Not income from other sources.




[Indian Oil Panipat Power Consortium Ltd. v. ITO, 230
CTR 199 (Del.)]

Due to legal entanglement with respect to title of land
which was sought to be acquired by the Government for the assessee, share
capital contribution was temporarily put by the assessee in fixed deposit with
bank. Interest earned on fixed deposit in the A.Ys. 2001-02 and 2002-03 was
assessed by the Assessing Officer as income from other sources. The CIT(A)
accepted the stand of the assessee that the interest was in the nature of
capital receipt which was liable to be set off against pre-operative expenses.
The Tribunal reversed the decision of the CIT(A).

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

“(i) The test is whether the activity which is taken up for
setting up of the business and the funds which are generated are inextricably
connected to the setting up of the plant. The clue is perhaps available in S.
3 which states that for newly set up business the previous year shall be the
period beginning with the date of setting up of the business. Therefore, as
per the provisions of S. 4 which is the charging Section, income which arises
to an assessee from the date of setting of the business but prior to
commencement is chargeable to tax depending on whether it is of a revenue
nature or capital receipt. It is clear upon a perusal of the facts as found by
the authorities below that the funds in the form of share capital were infused
for a specific purpose of acquiring land and the development of
infrastructure. Therefore, the interest earned on funds primarily brought for
infusion in the business could not have been classified as income from other
sources.

(ii) Since the income was earned in a period prior to
commencement of business, it was in the nature of capital receipt and hence
was required to be set off against pre-operative expenses.

(iii) On account of the finding of fact returned by the
CIT(A) that the funds infused in the assessee by the joint venture partner
were inextricably linked with the setting up of the plant, the interest earned
by the assessee could not be treated as income from other sources.

(iv) The Tribunal misdirected itself in law in holding that
interest which accrued on funds deployed with the bank could be taxed as
income from other sources and not as capital receipt liable to be set off
against pre-operative expenses.”

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Business expenditure : A.Y. 2004-05 : Premium paid by assessee-firm on keyman insurance policy of partner is business expenditure allowable as deduction.

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8 Business expenditure : A.Y. 2004-05 : Premium paid by
assessee-firm on keyman insurance policy of partner is business expenditure
allowable as deduction.




[CIT v. M/s. B. N. Exports (Bom.); ITA No. 2714 of
2009, dated 31-3-2010]

The assessee is a partnership firm. For the A.Y. 2004-05,
the assessee’s claim for deduction of the premium paid by the assessee-firm on
the keyman insurance policy of the partners was disallowed by the Assessing
Officer. The Tribunal allowed the assessee’s claim.

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

“(i) The Circular No. 762, dated 18-2-1998 issued by the
CBDT clarifies the position by stipulating that the premium paid for a keyman
insurance policy is allowable as business expenditure.

(ii) In the present case, on the question whether the
premium which was paid by the firm could have been allowed as business
expenditure, there is a finding of fact by the Tribunal that the firm had not
taken insurance for the personal benefit of the partner, but for the benefit
of the firm, in order to protect itself against the setback that may be caused
on account of the death of the partner.

(iii) The object and purpose of a keyman insurance policy
is to protect the business against the financial setback which may occur, as a
result of a premature death, to the business or professional organisation.
There is no rational basis to confine the allowability of the expenditure
incurred on the premium paid towards such a policy only to a situation where
the policy is in respect of the life of an employee.

(iv) A keyman insurance policy is obtained on the life of a
partner to safeguard the firm against a disruption of the business that may
result due to the premature death of the partner. Therefore, the expenditure
which is laid out for the payment of premium on such a policy is incurred
wholly and exclusively for the purpose of business.”

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Deemed dividend : S. 2(22)(e) of Income-tax Act, 1961 : A.Y. 2003-04 : Loans and advances from one company to another with common shareholder with substantial interest : Deemed dividend to be assessed in the hands of the shareholder and not in the hands o

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9 Deemed dividend : S. 2(22)(e) of Income-tax Act, 1961 :
A.Y. 2003-04 : Loans and advances from one company to another with common
shareholder with substantial interest : Deemed dividend to be assessed in the
hands of the shareholder and not in the hands of the recipient company.




[CIT v. Universal Medicare Pvt. Ltd. (Bom.); ITA No.
2264 of 2009, dated 22-3-2010]

An amount of Rs.32,00,000 was transferred from the bank
account of a company CSPL to the bank account of the assessee in the Chembur
branch of the State Bank of India. There was a common shareholder holding the
number of shares in the two companies as specified in S. 2(22)(e) of the
Income-tax Act, 1961. The amount was misappropriated by an employee of the
assessee and the transaction was not entered in the accounts of the assessee.
The Assessing Officer treated the said amount as deemed dividend u/s.2(22)(e)
of the Act and made the addition of the said amount. The Tribunal held that
the amount was part of a fraud committed on the assessee and the transaction
was not reflected in its books of account. The Tribunal therefore held that S.
2(22)(e) was not applicable. The Tribunal further held that even otherwise,
the amount would have to be taxed in the hands of the shareholder who obtained
the benefit and not in the hands of the assessee-company.

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

“(i) The Tribunal has found that as a matter of fact no
loan or advance was granted to the assessee, since the amount in question had
actually been defalcated and was not reflected in the books of account of the
assessee. Consequently, according to the Tribunal the first requirement of
there being an advance or loan was not fulfilled. In our view, the finding is
a pure finding of fact which does not give rise to any substantial question of
law.

(ii) Even on the second aspect which has weighed with the
Tribunal, we are of the view that the construction which has been placed on
the provisions of S. 2(22)(e) is correct.

(iii) The effect of clause (e) of S. 22 is to broaden the
ambit of the expression ‘dividend’ by including certain payments which the
company has made by way of a loan or advance or payments made on behalf of or
for the individual benefit of a shareholder. The definition does not alter the
legal position that dividend has to be taxed in the hands of the shareholder.
Consequently, in the present case the payment, even assuming that it was a
dividend, would have to taxed not in the hands of the assessee, but in the
hands of the shareholder.”

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Business expenditure : Deduction u/s.37 of Income-tax Act, 1961 : A.Y. 2003-04 : Agreement executed in August 2002 with retrospective effect from January 1, 2002 : Disallowances of expenses of January to March 2002 on ground that it crystallised in preced

New Page 1

Reported :

23. Business expenditure :
Deduction u/s.37 of Income-tax Act, 1961 : A.Y. 2003-04 : Agreement executed in
August 2002 with retrospective effect from January 1, 2002 : Disallowances of
expenses of January to March 2002 on ground that it crystallised in preceding
year : Liability under agreement arises and accrues when agreement executed :
Addition cannot be sustained.

[CIT v. Exxon Mobil
Lubricants P. Ltd., 328 ITR 17 (Del.)]

In August 2002, the assessee
had executed an agreement with M/s. Exxon Mobil Asia Pacific Pte. Ltd. with
retrospective effect from January 2002. The expenditure under the said agreement
for the period January to March 2002 was also claimed as deduction in the A.Y.
2003-04. The Assessing Officer disallowed the claim, holding that the
expenditure pertained to the preceding year resulting in the addition of the
equal amount. The Tribunal deleted the addition.

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

“(i) The liability of the
assessee under the agreement had arisen and accrued in August 2002, when the
agreement was executed and, therefore, the liability of the assessee to pay
for the period January 2002 to March 2002 arose and crystallised in August
2002.

(ii) The Commissioner
(Appeals) had observed that the assessee had shown prior period expense
against which the prior period income was shown and the net amount had been
shown as expenditure in the profit and loss account. If the assessee had shown
the prior period income and the Assessing Officer had not excluded it while
working out the current years taxable income, then there was no reason on the
part of the Assessing Officer to disallow only one part of the prior period
adjustments, i.e., the prior period expenditure.

(iii) The addition made by
the Assessing Officer could not be sustained.”

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Deduction u/s.80-O of Income-tax Act, 1961 : Amount allowable is restricted to the total income and not to the income computed under the head business.

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Unreported :

21. Deduction u/s.80-O of
Income-tax Act, 1961 : Amount allowable is restricted to the total income and
not to the income computed under the head business.

[CIT v. M/s. J. B. Boda &
Co. P. Ltd. (Bom.), ITA No. 3224 of 2009 dated 18-10-2010.]

The Assessing Officer
determined the amount eligible for deduction u/s.80-O at Rs. 1,29,41,830 being
50% of the income so received or brought into India. However, he restricted the
deduction u/s.80-O to
Rs. 69,70,000, being the total income under the head ‘Business’, on the ground
that allowing further deduction would amount to allowing the deduction from
income under other heads. The Tribunal found that the gross total income
exceeded Rs. 1,29,41,830 and therefore allowed the full claim of the assessee.

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

“(i) The only question
sought to be canvassed is that out of these deductions the admissible
deduction u/s.80-O ought to be limited to the extent of
Rs. 69,70,127 which represents business income. In other words, income from
interest and dividend shall not form part of the gross total income as defined
u/s.80B(5) of the Act.

(ii) Considering the
definition of the gross total income, it is difficult to hold that the
interest income and the dividend income would not form part of the gross total
income computed in accordance with the provisions of the Act.

(iii) The view taken by
the Tribunal, in our considered view, is in consonance with what is stated
herein.”

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Business expenditure : S. 37(1) r/w S. 145 of Income-tax Act, 1961 : Year in which deductible : Assessee following mercantile system of accounting claimed prior period expenses and was allowed every year : Doctrine of consistency would come into play : Tr

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Reported :

22. Business expenditure :
S. 37(1) r/w S. 145 of Income-tax Act, 1961 : Year in which deductible :
Assessee following mercantile system of accounting claimed prior period expenses
and was allowed every year : Doctrine of consistency would come into play :
Tribunal justified in allowing prior period expenses claimed by assessee.

[CIT v. Jagatjit
Industries Ltd., 194 Taxman 158 (Del.)]

The assessee-company was
following mercantile system of accounting. During the relevant assessment year,
it had claimed prior period expenses pertaining to earlier years on ground that
vouchers of such expenses from employees/branch employees were received after
31st March of the financial year. The Assessing Officer disallowed the said
expenses, holding that the nature of the expenses was such that they had
occurred and crystallised during the earlier years. The Tribunal allowed the
assessee’s claim.

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

“(i) On a scrutiny of the
facts, that had been brought on record, it was discernible that the assessee
had been claiming prior period expenses, on the ground that the vouchers of
such expenses from the employees/branch employees were received after 31st
March of the financial year. The said accounting practice had been
consistently followed by the assessee and accepted by the Department.

(ii) If a particular
accounting system has been followed and accepted and there is no acceptable
reason to differ with the same, the doctrine of consistency would come into
play. In the instant case, the said accounting system had been followed for a
number of years and there was no proof that there had been any material change
in the activities of the assessee as compared to the earlier years. Nothing
had been brought on record to show that there had been distortion of profit or
the books of account did not reflect the correct picture.

(iii) In the absence of
any reason whatsoever, there was no warrant or justification to depart from
the previous accounting system which was accepted by the Department in respect
of the previous years.

(iv) Therefore, there was
no merit in the instant appeal and the same was to be dismissed.”

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Depreciation : WDV : S. 32 and S. 43(1) of Income-tax Act, 1961 : A.Ys. 2001-02 and 2002-03 : Depreciation is a privilege : WDV can only be on basis of depreciation ‘actually allowed’ and not ‘notionally allowed’.

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Reported :

34. Depreciation : WDV : S. 32 and S. 43(1) of Income-tax
Act, 1961 : A.Ys. 2001-02 and 2002-03 : Depreciation is a privilege : WDV can
only be on basis of depreciation ‘actually allowed’ and not ‘notionally
allowed’.

[CIT v. Hybrid Rice International (P) Ltd., 185
Taxman 25 (Del.)]


The assessee company was engaged in the business of
producing superior-quality hybrid seeds of rice for supply to farmers. For
that purpose, it was using germplasm seeds. Prior to the A.Y. 2001-02, the
assessee had not claimed depreciation on the germplasm seeds. In the relevant
years, the assessee claimed depreciation on the germplasm seeds on the basis
of the actual cost taking it as the WDV. The Assessing Officer found that the
germplasm seeds were purchased in the preceding years and therefore held that
even though depreciation was not claimed or allowed in the preceding years,
the WDV for the relevant years has to be determined after reducing the
notional depreciation for the preceding years. The Tribunal allowed the
assessee’s claim.


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


“(i) In the instant case, in the earlier assessment
years, there did not arise any question of calculation of actual cost,
because no depreciation was claimed in the earlier years. Therefore, it
could not be understood as to how the assessee was taking advantage of his
own wrong as contended by the Revenue. Once it was held that depreciation is
a privilege and can only be on the basis of ‘actually allowed’ and not
‘notionally allowed’, there did not remain any issue of any wrong by the
assessee. There was no wrong and as held by the Supreme Court in CIT v.
Mahendra Mills, 243 ITR 56 (SC), it is only a privilege which the
assessee may choose to exercise or not.

(ii) Therefore, the Tribunal was correct, in law, in
allowing depreciation to the assessee on the actual cost of the germplasm
seeds and the actual cost incurred by the assessee much before becoming an
assessee could still be treated as an actual cost to the assessee when
depreciation had to be claimed.”



 


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Company in liquidation : Director’s liability : S. 179 of Income-tax Act, 1961 : Liability of director u/s.179 is limited to tax and it does not extend to penalty and interest.

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Reported :

33. Company in liquidation : Director’s liability : S. 179 of
Income-tax Act, 1961 : Liability of director u/s.179 is limited to tax and it
does not extend to penalty and interest.

[H. Ebrahim v. Dy. CIT, 185 Taxman 11 (Kar.)]


Dealing with the scope of the director of a company u/s.179
of the Income-tax Act, 1961, the Karnataka High Court held in this case as
under :


“The phrase ‘tax’ as contemplated u/s.179 does not
include penalty and interest, insofar as the directors of the company are
concerned. However, this interpretation of phrase ‘tax would not be’ is
u/s.179 and does not encompass the company. Indeed the company was liable to
pay all the three components, i.e., ‘tax’, ‘interest’ and ‘penalty’
and any other sum due or recoverable from it as contemplated u/s.222.”

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Assessment : Notice u/s.143(2) of Income-tax Act, 1961 : Service : A.Y. 2001-02 : Service of notice by affixture on last day after office hours : Not valid service : Assessment not valid.

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Reported :

  1. Assessment : Notice u/s.143(2) of Income-tax Act, 1961 :
    Service : A.Y. 2001-02 : Service of notice by affixture on last day after
    office hours : Not valid service : Assessment not valid.

[CIT v. Vishnu and Co. P. Ltd., 319 ITR 151 (Del.)]

For the A.Y. 2001-02, the assessee had filed the return of
income on 28-9-2001. A valid notice u/s. 143(2) of the Income-tax Act, 1961,
was required to be served on or before 30-9-2002. On 30-9-2002, the Assessing
Officer issued a notice u/s.143(2) and got it served by affixture on the
office premises of the assessee after the office hours on that day. The
Tribunal cancelled the assessment made pursuant to the said notice holding
that there was no valid service of notice u/s.143(2) within the prescribed
period.

In appeal, the Revenue contended that the assessee having
appeared in the assessment proceedings it should be treated as a valid notice.
The Delhi High Court upheld the decision of the Tribunal and held as under :

“(i) S. 143(2) of the Income-tax Act, 1961, is a
mandatory provision whether from the standpoint of a regular assessment or
from the standpoint of an assessment under Chapter XIV-B.

(ii) The Revenue could not disclose as to when the
assessee had appeared, namely, whether the assessee had appeared on October
10, 2002, pursuant to the affixation or on a later date after the alleged
service of the subsequent notice. Even such appearance by the assessee, on a
date when the proceedings had become time-barred because of no proper
service of notice, would be of no consequence.”

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Refund : Delayed return claiming refund : On facts refusal to condone delay not justified : Order of rejection set aside for fresh disposal as per directions.

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Unreported :

31. Refund : Delayed return claiming refund : On facts
refusal to condone delay not justified : Order of rejection set aside for fresh
disposal as per directions.

[Sitaldas K. Motwani v. DGIT (International Taxation) (Bom.);
W.P. No. 1749 of 2009, dated 15-12-2009]

The assessee petitioner is a non-resident Indian. In the
previous year relevant to the A.Y. 2000-01, the assessee had invested in
shares of Indian companies and earned short-term capital gains of Rs.
2,09,05,250. The concerned bank deducted tax at source at the rate of 30%. The
said short-term capital gain was taxable at the rate of 20% and accordingly
the assessee was entitled to a refund of Rs. 20,78,871. The assessee filed
belated return on 24-9-2003 and claimed refund. Along with the return the
assessee had filed an application u/s.119(2)(b) of the Income-tax Act, 1961
for condonation of delay in filing of return. The DGIT (International
Taxation) rejected the application for condonation of delay relying on the
CBDT Instruction No. 13 of 2006, dated 22-12-2006. Accordingly, he refused to
grant refund.

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

“(i) The Board Circular prescribes that at the time of
considering the case u/s.119(2)(b) of the Act, it is necessary for the
authorities to consider that the income declared and the refund claimed are
correct and genuine and that the case is of genuine hardship on merits and
correctness of the refund claim.

(ii) While considering the genuine hardship, the
respondent No. 1 was not expected to consider a solitary ground as to
whether the petitioner was prevented by any substantial cause from filing
return within due time. Other factors ought to have been taken into account.

(iii) The phrase ‘genuine hardship’ used in S. 119(2)(b)
should have been construed liberally even when the petitioner has complied
with all the conditions mentioned in Circular dated 12th October, 1993. The
Legislature has conferred the power to condone delay to enable the
authorities to do substantial justice to the parties by disposing of the
matters on merit.

(iv) The expression ‘genuine’ has received a liberal
meaning and while considering this aspect, the authorities are expected to
bear in mind that ordinarily the applicant, applying for condonation of
delay does not stand to benefit by lodging its claim late.

(v) Refusing to condone delay can result in a meritorious
matter being thrown out at the very threshold and cause of justice being
defeated. As against this, when delay is condoned the highest that can
happen is that a cause would be decided on merits after hearing the parties.
When substantial justice and technical considerations are pitted against
each other, cause of substantial justice deserves to be preferred for the
other side cannot claim to have vested right in injustice being done because
of a non-deliberate delay.

(vi) There is no presumption that delay is occasioned
deliberately, or on account of culpable negligence, or on account of mala
fides. A litigant does not stand to benefit by resorting to delay. In
fact he runs a serious risk. The approach of the authorities should be
justice-oriented so as to advance cause of justice. If refund is
legitimately due to the applicant, mere delay should not defeat that claim
for refund.

(vii) Whether the refund claim is correct and genuine,
the authority must satisfy itself that the applicant has a prima facie
correct and genuine claim, does not mean that the authority should examine
the merits of the refund claim closely and come to a conclusion that the
applicant’s claim is bound to succeed. This would amount to prejudging the
case on merits. All that the authority has to see is that on the face of it
the person applying for refund after condonation of delay has a case which
needs consideration and which is not bound to fail by virtue of some
apparent defect. At this stage, the authority is not expected to go deep
into the niceties of law. While determining whether the refund claim is
correct and genuine, the relevant consideration is whether on the evidence
led, it was possible to arrive at the conclusion in question and not whether
that was the only conclusion which could be arrived at on that evidence.

(viii) The Respondent No. 1 did not consider the prayer
for condonation for delay in its proper perspective. As such, it needs
consideration afresh. In the result, we set aside the impugned order and
remit the matter back to the respondent No. 1 for consideration afresh, with
the direction to decide the question of hardship as well as that of
correctness and genuineness of the refund claim in the light of the
observations made hereinabove.”

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

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


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

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

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

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

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

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

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Impact of IFRS on the real estate sector : Developing a new reporting framework

IFRS

Impact of IFRS on the real estate sector : Developing a new
reporting framework

As Indian companies get poised to converge with IFRS in April
2011, some of the sectors may witness significant changes in the financial
statements used for reporting their performance to various stakeholders. The
foremost amongst them is the real estate industry. This article seeks to discuss
these changes and their related impact in greater detail.

Revenue recognition :

Generally, developers start marketing the project before
construction is complete or perhaps, even before construction has started.
Buyers enter into agreements to acquire a spe+cific unit within the building on
completion of the construction. The contracts may require the buyer to pay a
deposit and progress payments, which are refundable only if the developer fails
to complete and deliver the unit.

Under IFRS, IFRIC 15 Agreements for the Construction of
Real Estate provides detailed guidance on recognition of revenue from real
estate contracts. Under the Indian GAAP, the matter is currently dealt through
the Guidance Note on Accounting for Real Estate Developers issued by the
Institute of Chartered Accountants of India (‘ICAI’).

There are significant differences between the accounting
recommended under the two pronouncements.

Under the Indian GAAP, the ICAI Guidance Note permits the
real estate development contracts to be accounted on percentage of completion
method.

Accounting for real estate construction arrangements under IFRS

An agreement for construction of real estate can be accounted
as :


(a) Construction contract, which is within the scope of
IAS 11 on construction contracts; or

(b) Sale of goods and service, which is within the scope
of IAS 18 on revenue recognition.


An agreement for construction of real estate meets the
definition of a construction contract when the buyer is able to specify major
structural elements of the design of the real estate before construction begins
and/or specify major structural changes once construction is in progress
(whether or not it exercises that ability). In such cases, IAS 11 on
construction contracts applies.

In contrast, an agreement for construction of real estate in
which buyers have only limited ability to influence the design of the real
estate, e.g., to select a design from a range of options specified by the
entity, or to specify only minor variations to the basic design, is an agreement
for sale of goods within the scope of IAS 18. IAS 18 prescribes the following
criteria for revenue recognition — Revenue from the sale of goods shall be
recognised when all the following conditions have been satisfied :


(a) the entity has transferred to the buyer the
significant risks and rewards of ownership of the goods;

(b) the entity retains neither continuing managerial
involvement to the degree usually associated with ownership, nor effective
control over the goods sold;

(c) the amount of revenue can be measured reliably;

(d) it is probable that the economic benefits
associated with the transaction will flow to the entity; and

(e) the costs incurred or to be incurred in respect of
the transaction can be measured reliably.


An analysis of general agreements for sale of real estate in
India shows that the buyers have only limited ability to influence the design of
the real estate, in fact they have no influence over the basic design/layout of
the building/apartment. Hence the sale would generally fall under IAS 18
principles as an agreement for sale of goods.

There could be two scenarios under sale of goods :




? the entity may transfer to the buyer control and the significant risks and
rewards of ownership of the real estate in its entirety at once (e.g.,
at completion, upon delivery). In such cases, the revenue will be recognised
only at the point of completion coupled with delivery.



? the entity may transfer to the buyer control and the significant risks and
rewards of ownership of the work in progress in its current state as
construction progresses, and then the revenue is recognised on percentage
completion method, provided all criteria (mentioned above) of IAS 18 are
satisfied.




Determining continuing managerial involvement :

At the time of signing the provisional letter of allotment or
the agreement for sale, generally the seller has significant pending acts to
perform for completion of its obligations to deliver the apartment. All
decisions related to construction are with the seller and also, the construction
risk is to the account of the seller. This indicates continuing managerial
involvement in the property.

Determining transfer of risks and rewards :

The following indicators in real estate sale agreements
demonstrate that the risk and rewards of ownership are not continuously
transferred to the buyer :


— If the agreement is terminated before completion of the
construction by the buyer, the buyer does not retain the work-in-progress
and the developer does not have the right to be paid for the work performed.
The developer has to refund the money received from the buyer.

— The agreement does not give the buyer the right to take
over the incomplete property in case of default by the developer or
otherwise.


These indicate that the seller effectively retains control
and has continuing managerial involvement over the flats until possession is
transferred.

Hence the completed contract method will have to be applied
and revenue shall be recorded in its entirety on transfer of possession.
Construction costs incurred will be carried in the books of the developer as
work-in-progress under ‘Inventory’.

Difference from accounting for construction contracts :

As discussed above, determining whether an agreement for the
construction of real estate is within the scope of IAS 11 or IAS 18 depends on
the terms of the agreement and all the surrounding facts and circumstances. Such
a determination requires judgment with respect to each agreement.

IAS 11 applies when the agreement meets the definition of a construction contract set out in paragraph 3 of IAS 11: ‘a contract specifically negotiated for the construction of an asset or a combination of assets ….’ An agreement for construction of real estate meets the definition of a construction contract when the buyer is able to specify major structural elements of the design of the real estate before construction begins and/ or specify major structural changes once construction is in progress (whether or not it exercises that ability).

One view could be that IAS 11 should apply to all agreements for the construction of real estate. In support of this view, it is argued that:

    a) these agreements are in substance construction contracts. The typical features of a construction contract — land development, structural engineering, architectural design and construction — are all present

    b) IAS 11 requires a percentage of completion method of revenue recognition for construction contracts. Revenue is recognised progressively as work is performed. Because many real estate development projects span more than one accounting period, the rationale for this method — that it ‘provides useful information on the extent of contract activity and performance during a period’ (IAS 11 paragraph 25) — applies to real estate development as much as it does to other construction contracts. If revenue is recognised only when the IAS 18 conditions for recognising revenue from the sale of goods are met, the financial statements do not reflect the entity’s economic value generation in the period and are susceptible to manipulation.

In reaching the consensus that IAS 11 should apply only when the agreement meets the definition of a construction contract and apply IAS 18 when the agreement does not meet the

definition of a construction contract, the IFRIC noted that:

    a) the fact that the construction spans more than one accounting period and requires progress payments are not relevant features to consider when determining the applicable standard and the timing of revenue recognition;

    b) determining whether an agreement for the construction of real estate is within the scope of IAS 11 or IAS 18 depends on the terms of the agreement and all the surrounding facts and circumstances. Such a determination requires judgement with respect to each agreement. It is not an accounting policy choice;

    c) IAS 11 lacks specific guidance on the definition of a construction contract and further application guidance is needed to help identify construction contracts.

The IFRIC concluded that the most important distinguishing feature is whether the customer is actually specifying the main elements of the structural design. In situations involving the sale of real estate, the customer generally does not have the ability to specify or alter the basic design of the product. Rather, the customer is simply choosing elements from a range of options specified by the seller or specifying only minor variations to the basic design. The IFRIC decided to include guidance to this effect in the Interpretation to help clarify the application of the definition of a construction contract.

Currently under the Indian GAAP, guidance note on recognition of revenue by real estate developers states that revenue can be recognised once significant risks and rewards are transferred. In case of real estate sales, price risk is considered as the most significant risk; and the buyer has the right to sell or transfer his interest in the property without any conditions or with immaterial conditions attached. Thus under the current scenario, revenue from real estate sales can be recognised on the completion of an agreement for sale, even though the legal title or possession has not been delivered.

Consolidation of land acquisition companies:
Real estate companies in India are regulated under the Land Ceiling Act, 1976, which fixes a maximum limit on the area of land that may be owned by one company. To overcome these restrictions, real estate companies float various special purpose entities (SPEs) that purchase land from the market. A real estate company may have differing arrangements with SPEs. These arrangements would have to be closely evaluated and in light of SIC Interpretation 12 Consolidation — Special Purpose Entities.

In certain cases, real estate companies directly or indirectly hold 100% or majority share capital of such SPEs and/or have majority representation on their board of directors. However in other cases, the share capital of SPEs, which is generally a small amount, is held by a third party that also controls the governing body of the SPE. In such cases, the real estate companies are involved with the SPE in various other ways, such as provision of finance to carry out the activities, exclusive rights to develop land, provide guarantee against finance taken by SPEs, guarantee minimum return to the shareholders and/or enter contract, which may restrict the decision-making powers of SPE.

Under the Indian GAAP, companies consolidate only those entities where they directly or indirectly hold majority share capital and/or have majority representation on the board of directors or other governing bodies. However, under IFRS a special purpose entity may have to be consolidated even in cases where a company is not holding majority share or controlling the composition of the governing board of the SPE on account of certain arrangements like provision of finance to carry out the activities, exclusive rights to develop land, etc. which may be indicative of a control. As per SIC 12, the following circumstances, for example, may indicate a relationship in which an entity controls an SPE and consequently should consolidate the SPE?:

  a)  In substance, the activities of the SPE are being conducted on behalf of the entity according to its specific business needs, so that the entity obtains benefits from the SPE’s operation.

b)    In substance, the entity has the decision-making powers to obtain majority of the benefits of the activities of the SPE or, by setting up an ‘autopilot’ mechanism, the entity has delegated these decision-making powers.

   c)  In substance, the entity has rights to obtain majority of the benefits of the SPE and therefore may be exposed to risks incident to the activities of the SPE.

 d)   In substance, the entity retains majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities.

Upon transition to IFRS, real estate companies will need to evaluate their relationship with SPEs based on the criteria laid down in SIC 12. Further, real estate companies will also need to examine whether such consolidation may have any legal or other implications.

Structured financing arrangements:

Structured financing arrangements for entities floated by real estate companies for projects, would need to be closely evaluated to identify the substance of the transaction; and accounting will have to reflect this underlying substance. For example, instruments issued for which the entity has an obligation to pay cash would need to be classified as debt and the underlying committed returns or fluctuations in the value of such instruments would have to be recorded in the income statement. This would also increase the volatility of the reported earnings and reduce reported profits.

Impacts of change in financial reporting framework on other operational areas:

Executive compensation plans:

Some real estate companies pay commissions/ variable incentives to employees based on sales or profits. Given the impact of IFRS, there will be a high degree of volatility in the reported revenues and reported profits of companies, thereby impacting these compensation plans. Further in case of payments to directors, which in India is limited to a specified percentage of profits, companies will need to address the impact on managerial remuneration due to insufficient profits in the period when construction activity is ongoing but possession is not transferred, though companies would have positive cash flows.

Tax:

Another important area which deserves attention is the impact on the tax liability for a company due to the change in the accounting framework with special emphasis on changes in revenue recognition. It will be important to understand whether tax authorities will recognise profits under IFRS as taxable profits and thereby postpone the tax incidence till the possession of the property is transferred. Alternatively, the authorities may require the companies to recompute revenue using percentage of completion method for tax purposes. Further, interplay between the minimum alternate tax (MAT) provisions and the reported profits under IFRS would be equally important.

Debt covenants:

In preparing its first IFRS financial statements, an entity recognises all assets and liabilities in accordance with the requirements of IFRS, and derecognises assets and liabilities that do not qualify for recognition under IFRS. Further, the entity would have to reclassify items that it recognised in accordance with previous GAAP as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity in accordance with IFRS.

This may impact various business ratios like gearing, liquidity and profitability ratios of a first-time adopter. Further, a reclassification of a long-term loan as current due to, say, a default in meeting any covenant (example business ratios) may impact debt covenants of other loans. In extreme situations, it may even impact the company’s ability to continue as a going concern. It would be therefore pertinent to conduct a detailed examination of the various loan and borrowing agreements and identify the covenants which may be impacted by the transition. An early discussion with the lenders of funds around these areas would go a long way in avoiding last minute surprises.

Conclusion:

As convergence with IFRS is inevitable, the key now lies in getting this transition right. The most important factors for real estate companies would be educating their stakeholders including investors, bankers and align internal budgets and performance measurement matrices. Companies would have to closely examine various debt covenants and clearly identify the ones which may be impacted due to the transition and discuss the same with their financiers/ bankers. At the same time, it will have to sensitise the market participants with respect to the unique impact of certain standards on the industry. This in turn would help to realign the valuation matrices based on the different set of accounting policies that will be used by these companies to report their performance results. Given the aforesaid implications, an early start towards the convergence process is pertinent for both preparers and users of financial statements to understand the impact on how the financial performance will be reported going forward.

Comparison of IFRS Exposure Draft on Insurance Contracts and Insurance Accounting in India

Comparison of IFRS Exposure Draft on Insurance

On 30 July 2010, the International Accounting Standards Board
(IASB) issued its long-awaited exposure draft on Insurance Contracts. This
Exposure Draft (ED) has been many years in preparation and represents a
significant step forward towards the IASB’s goal of providing comprehensive
guidance for accounting for insurance contracts.

Although IFRS 4 Insurance Contracts (the existing accounting
standard) addressed some of the more urgent issues in insurance contract
accounting, it was only transitionary. It permits a wide variety of existing
accounting practices to continue, which hinders comparability for users.

Given the Indian context and impending convergence with IFRS
from 1 April 2012 for insurance companies in India, the provisions of this ED
are critically important and will guide the corresponding provisions of the
Indian accounting standard to be issued in this regard.

Insurance contracts often expose entities


to long-term and uncertain obligations. There are several complex policies,
principles and calculations involved in measuring these obligations. As a
result, stakeholders need to be informed adequately about the insurer’s business
model, risk management practices, measurement approaches, solvency, asset
management, profitability, etc. The ED is a step in the right direction.

This article is a summary of the ED. It provides an overview
of the main proposals published for public comment by the IASB and the
differences with regards to the existing practice in India for the insurance
industry.

Executive summary of the Exposure Draft on Insurance Contracts :

  • The
    ED proposes a new standard on accounting for insurance contracts which would
    replace IFRS 4 Insurance Contracts.
     


  • The
    ED proposes a comprehensive measurement model for all types of insurance
    contracts issued by entities with a modified approach
    for some short-duration contracts. The measurement model is based on a
    principle that insurance contracts create a bundle of rights and obligations
    that work together to create a package of cash inflows (premiums) and outflows
    (benefits, claims and costs). The measurement model, which applies to that
    package of cash flows, uses the following building blocks :



  • a
    current estimate of future cash flows;


  • a
    discount rate that adjusts those cash flows for the time value of money;


  • an
    explicit risk adjustment; and


  • a
    residual margin.




  • For
    short-duration contracts, a modified version of the measurement
    model applies. As a proxy for the measurement model, during the coverage
    period, the insurer measures the pre-claims liability by allocating premiums
    receivable across the coverage period. For these contracts, the insurer would
    apply the building block measurement model to measure claim liabilities for
    insured events that have already occurred and for onerous contracts.
     


  • The
    ED proposes that an insurer include incremental acquisition costs (i.e.,
    costs of selling, underwriting and initiating an insurance contract) as part
    of the contract’s cash flows. As a result, those costs would generally affect
    profit or loss over the coverage period rather than at inception. All other
    acquisition costs (i.e., fixed salary related to underwriting and
    front-line sales staff) would be expensed when incurred through profit and
    loss account.
     


  • The
    proposals also include revised unbundling criteria for non-derivative
    components of an insurance contract; a revised presentation for the statement
    of financial position and statement of comprehensive income; a building block
    measurement model for reinsurance contracts; an expected loss model for credit
    risk of reinsurance assets; accounting guidance for investment contracts with
    a discretionary participation feature (DPF) including an expanded definition
    of a DPF compared to IFRS 4; revised accounting guidance for business
    combinations and portfolio transfers; and extensive disclosure requirements.
    Below, we consider some of the critical areas in the ED.



Differences between the IFRS ED and existing practice of
recognition and measurement of insurance contracts in the Indian insurance
industry :

The differences are broadly classified and discussed below :


  • Classification of insurance contracts;



  • Measurement of insurance contracts;



  • Treatment of acquisition costs;



  • Unbundling;



  • Embedded derivatives



  • Derecognition;



  • Reinsurance;



  • Presentation, and



  • Disclosure



Classification of insurance contracts :

  • The
    proposals in the ED apply to all insurance contracts (including reinsurance
    contracts) that an entity issues and reinsurance contracts that an entity
    holds. Financial instruments containing a discretionary participation feature
    (DPF) that an entity issues are also in the scope of this proposal.

    Under the proposal, an insurance contract is de-fined as a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncer-tain future event (the insured event) adversely affects the policyholder. This definition is consistent with the current definition of an insurance contract under IFRS 4.

    Under the proposals, insurers should begin recognising the contract when they are bound by the coverage, which could be prior to the effective date or the date on which a contract is signed (i.e., when there is an unconditional offer extended for coverage) and may be heavily influenced by local regulatory requirements.

Classification of insurance contracts in India:

    There is no specific standard for the purpose of classifying Insurance contracts under Indian GAAP. Currently, traditional, unit-linked insurance plan and pension products are sold by insurance companies and premium received on all these policies are accounted as premium income in revenue account.

    This will be a significant shift in the method of accounting for premium for life insurance companies as pension products having zero death benefits will not fall under the purview of insurance contracts and have to be accounted as Investment contracts and investment component pertaining to ULIP contracts would have to be accounted separately.

    However this will be a P/L neutral adjustment as currently they are adjusted as part of provision for insurance liabilities at the period end.

Measurement of insurance contracts — The building-block approach?:
The proposed model uses a building- block ap-proach to the measurement of insurance contracts The measurement model includes a ‘fulfilment’ objective which reflects the fact that an insurer generally expects to fulfil its liabilities over time by paying benefits and claims to policyholders as they become due, rather than transferring the li-abilities to a third party.

An insurer measures a contract as the sum of

    the present value of the fulfilment cash flows, being the expected present value of the future cash outflows less future cash inflows that will arise as the insurer fulfils the contract, including a risk adjustment for the effects of uncertainty about the amount and timing of those future cash flows; and

    a residual margin that eliminates any gain at inception of the contract. A residual margin arises when the present value of the fulfilment cash flows is less than zero. If the present value of the fulfilment cash flows at inception is positive (i.e., the expected present value of cash outflows plus the risk adjustment is greater than the expected present value of cash inflows), then this amount is immediately recognised as a loss in profit or loss.

The residual margin is determined on initial recognition at a portfolio level for contracts with a similar inception date and coverage period. This residual margin amount is ‘locked-in’ at inception. The residual margin is recognised in profit or loss over the coverage period in a systematic way that best reflects the exposure from providing insurance coverage, either on the basis of the passage of time or on the basis of the expected timing of incurred claims and benefits if that pattern differs significantly from the passage of time. Also, the insurer accretes interest on the carrying amount of the residual margin using the discount rate determined on initial recognition to reflect the time value of money.

The present value of the fulfilment cash flows contains the following ‘building blocks’ and is re-measured at each reporting period.

    an explicit, unbiased and probability-weighted estimate (i.e., expected value) of the future cash outflows less the future cash inflows that will arise as the insurer fulfils the insurance contract;

    a discount rate that adjusts those cash flows for the time value of money; and

    a risk adjustment — an explicit estimate of the effects of uncertainty about the amount and timing of those future cash flows.

Measurement of insurance liabilities by Indian insurance companies?:

The Gross Premium Methodology for life insurance contracts is governed by the IRDA (Assets, Liabilities and Solvency Margin of Insurers), Regulations, 2000 and Guidance Notes GN1, GN2 and GN7 issued by the Institute of Actuaries of India (IAI). The regulations govern the valuation of liabilities for both non -linked and linked business with some additional requirements for linked business.

Mathematical reserves are determined separately for each contract. The valuation method primarily takes into account all prospective contingencies including cost of any options that may be available to the policyholder. The reserves have to be at least as large as any guaranteed surrender value and never less than zero.

In addition, for unit-linked business?:

    The value to be placed on the unit reserve shall be the current value of the assets underlying the unit fund determined in accordance with the IRDA Regulations.

    If unit liabilities are not matched, a mismatch reserve shall be created.

    Separate unit and non-unit reserves shall be held. The sum of these reserves would represent the total reserve for a unit-linked policy.

    The total reserve in respect of a policy shall not be less than the guaranteed surrender value on the valuation date. Neither the unit reserve nor the non-unit reserve in respect of a policy shall be negative.

  • The proposed IFRS measurement model focusses on the key drivers of insurance contract profit-ability, and would provide users with a clearer insight than they gain from today’s patchwork of different models for different types of contract. The same model would apply to all insurance contracts. However a modified version would apply to short duration insurance contracts.


Insurers would present information in the financial statements that focusses on the drivers of performance, i.e.,?:

  •     release from risk, as the risk adjustment decreases


  •     what insurers expect to earn from providing insurance services


  •     investment returns on invested premiums, and


  •     the investment returns provided to policyholders (either implicitly through pricing or explicitly)     differences between expected and actual cash flows and changes in estimates and the discount rate.

The current problem in cash flow estimates is that insurers use ‘locked in’ estimates which do not provide current information about insurance liabilities. However the proposed changes in ED would require changes in cash flow estimates to be reflected in profit or loss in the period in which they arise. This would enhance transparency and provide more relevant information for users.

Pre-claims liabilities for short-duration contracts (General Insurance Contracts):

The proposals contain a modified measurement approach for pre-claim liabilities of short duration contracts. This model is intended to be a proxy for the building-block measurement model in the pre-claims period. In the proposals ‘short-duration’ contracts are defined as insurance contracts with a coverage period of approximately 12 months or less that do not contain any embedded options or derivatives that significantly affect the variability of cash flows.

In this measurement approach an insurer is required to measure its pre-claims obligation at inception as premiums received at initial recognition plus the present value of future premiums within the boundary of the contract less incremental acquisition costs.

This pre-claims obligation is reduced over the coverage period in a systematic way that best reflects the exposure from providing insurance coverage, either on the basis of the passage of time or the expected timing of incurred claims and benefits if this pattern differs significantly. Pre-claims liabili-ties are the preclaims obligation less the present value of future premiums within the boundary of the contract. The insurer is also required to accrete interest on the carrying amounts of the preclaims liabilities. If the contract is onerous, the excess of the present value of the fulfilment cash flows over the carrying amount of the pre-claims obligation is recognised as an additional liability and expense.

Liabilities for claims incurred are measured at the present value of fulfilment cash flows in accor-dance with the general measurement model.

Measurement of general insurance contracts by Indian insurance companies:

For short-duration contracts the IRDA regulations specifies

  •     reserve for unexpired risks as a percentage of the premium, net of reinsurances, received or receivable during the preceding twelve months, and


  •     reserve for outstanding claims reasonably estimated according to the insurer, on a ‘case-by-case method’ after taking into account the explicit allowance for changes in the settlement pattern or average claim amounts, expenses and inflation.


The ED on insurance contract gives a comprehensive measurement model for general insurance contracts as against the existing practice currently followed.

Acquisition costs:

  •     Incremental acquisition costs (costs of selling, underwriting, and initiating an insurance contract that would not have been incurred if the insurer had not issued that particular contract) are included in the present value of the fulfilment cash flows of a contract. All other acquisition costs are expensed when incurred in profit or loss.


  •     Non-incremental acquisition costs would be recognised as an expense.


  •     Indian insurers recognise acquisition costs as an expense immediately. This would result smaller losses at inception than they do today.


Unbundling:
Insurance contracts may include multiple elements, such as insurance coverage, investment compo-nents and embedded derivatives i.e., insurance contracts contain one or more components that would be within the scope of another IFRS if the insurer accounted for those components as if they were separate contracts, e.g., an investment (financial) component or a service component.

If a component is not closely related to the in-surance coverage specified in a contract, the ED proposes that an insurer does unbundle and ac-count separately for that component.

This would require Indian life insurance companies to unbundle the investment component from ULIP contracts from total premium and disclose it sepa-rately since inception. Currently the deposit portion is unbundled only at the end of the reporting period by way of including them in the actuarial reserves and then disclosing them in provision for linked liabilities.

Moreover, the pension and annuity products which are having no risk cover i.e., zero death benefits would not be under the purview of insurance contracts. These would have to be accounted as investment contracts under IAS 39 and the premium received on such contracts would have to separately shown in the balance sheet.

Embedded derivatives

Under the proposals, IAS 39 applies to an embed-ded derivative in an insurance contract unless the embedded derivative itself is an insurance contract. If the economic characteristics and risks of the embedded derivative are not closely related to those of the host insurance contract, the insurer is required to separate the embedded derivative and measure it at fair value with recognition of changes in fair value in profit or loss if the embed-ded derivative meets the following criteria?:

    a) the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host insurance contract

    b) a separate instruments with the same terms as the embedded derivative would meet the definition of a derivative and be within the scope of IAS 39 (e.g., the derivative itself is not an insurance contract).

Derecognition

An insurer shall remove an insurance contract liability (or a part of an insurance contract liability) from its statement of financial position when, and only when it is extinguished, i.e., when the obligation specified in the insurance contract is discharged or cancelled or expires. At that point, the insurer is no longer at risk and is therefore no longer required to transfer any economic resources to satisfy the insurance obligations.

The insurance liability ceases as soon as the policy lapses i.e., if the premium is not honoured on the due date including grace period provided by the insurance company.

However the Indian life insurance companies carry out an analysis of lapsed unit-linked policies not likely to be revived and likely to be revived. For policies not likely to be revived, the insurance reserves are transferred to funds for future appropriation and then to the profit and loss account after a period of two years and for policies likely to be revived the insurance liabilities are still maintained though the policy has lapsed and the risk cover has expired.

It appears that the ED on insurance contracts would require the risk reserves to be derecognised as soon as the policy lapses. Only the deposit component would be maintained as a liability for such policies with corresponding investments.

Reinsurance

At initial recognition, a cedant measures reinsurance contract as the sum of:

  •     the present value of the fulfilment cash flows, which is made up of the expected present value of the cedant’s future cash inflows plus a risk adjustment less the expected present value of the cedant’s future cash outflows less any ceding commissions received; and


  •     a residual margin that eliminates any loss at inception of the contract.


The expected present value of losses from default by the reinsurer or coverage disputes are incorporated in the measurement of reinsurance assets.

The ED on insurance contract requires reinsurance assets and reinsurance liabilities to be shown separately.

However the current practice in India is that the insurance companies net-off the reinsurance receivable and payable and disclose only the net amount as receivable or payable, as the case may be.

Presentation in the statement of financial position and the statement of comprehensive income

Statement of financial position

The ED proposes that an insurer present each portfolio of insurance contracts as a single-line item within insurance contract assets or insurance contract liabilities. It also proposes that an insurer present a pool of assets underlying unit-linked contracts as a single- line item separate from the insurer’s other assets and that the portion of the liabilities linked to the pool be presented as a single-line item separate from the insurer’s other liabilities. Reinsurance assets are not offset against insurance contract liabilities.


Statement of comprehensive income

The ED proposes a presentation model that focuses on margins and other key insurance performance information. The ED proposes a new presentation for the statement of comprehensive income which follows the proposed measurement model. The underwriting margin is subject to disaggregation requirements (in the notes or on the face of the financial statements), disclosing the change in risk adjustment and release of the residual margin. The margin presentation requires insurers to treat all premiums as deposits and all claims and benefits as repayments to the policyholder. An insurer is expected to present at a minimum, the following items?:

  •     Change in the risk adjustments;


  •     The release of the residual margin during the period;


  •     The difference between the expected and the actual cash flows;


  •     Changes in estimates; and


  •     Interest on insurance liabilities.


Other items to be presented in the statement of comprehensive income include?: gains and losses at initial recognition (further disaggregated on the face or in the notes into losses at initial recognition of an insurance contract, losses on insurance contracts acquired in a portfolio transfer, and gains on rein-surance contracts bought by a cedant); acquisition costs that are not incremental at the level of an individual contract; experience adjustments and changes in estimates (further disaggregated on the face or in the notes into experience adjustments, changes in estimates of cash flows and discount rates, and impairment losses on reinsurance as-sets); and interest on insurance contract liabilities. Income and expense from unit-linked contracts are presented as a separate single-line item.

Premiums and claims generally are not presented in the statement of comprehensive income on the basis that they represent settlements of insurance contract assets or liabilities rather than revenues or expenses. However, for short-duration contracts subject to the alternative measurement approach for pre-claims liabilities, the underwriting margin is disaggregated into line items reflecting each of pre-mium revenues, claims and other expenses, amortisation of incremental acquisition costs and changes in additional liabilities for onerous contracts.

Presentation of insurance accounts by Indian insurance companies

The financial presentation format currently comprises the Revenue Account, Profit and Loss Account and Balance Sheet. The Revenue account contains all insurance-related captions and income earned from investments out of policyholders’ funds.?The?Profit and Loss account includes deficit funding if any, profit transfers from revenue account and investment income earned out of shareholders’ funds.

The proposed method of accounting is a complete paradigm shift as compared to the existing financial reporting model.

Disclosures:

To help users of financial statements understand the amount, timing and uncertainty of future cash flows arising from insurance contracts, extensive disclosures are required that include qualitative and quantitative information about the amounts arising from insurance contracts, including?: the reconciliation of contract balances; methods and inputs used to develop the measurements; and the nature and extent of risks arising from insurance contracts.

Currently the insurance disclosures are not very extensive for Indian insurance companies. The current actuarial disclosures merely give basic assumptions, interest rates and references to mortality and morbidity tables published by Life Insurance Corporation of India.

Effective date, transition and impact on other aspects:

The ED does not include an effective date for the proposals or state whether they may be adopted early. The IASB plans an additional consultation, in conjunction with the FASB, on the effective dates of these proposals and other proposed standards to be issued in 2011, including consideration of IFRS 9 Financial Instruments. The Board will con-sider delaying the effective date of IFRS 9 (annual periods beginning on or after 1 January 2013) if the new IFRS on insurance contracts has a mandatorily effective date later than 2013 so that an insurer would not have to face two major rounds of change in a short period.

Additionally, an insurer is exempt from disclosing previously-unpublished information about claims development that occurred earlier than five years before the end of the first financial year in which it applies the proposals. An insurer is required to disclose if it is impracticable to prepare information about claims development that occurred before the beginning of the earliest period presented.

The ED requires that an insurer should measure each portfolio of insurance contracts at the present value of the fulfilment cash flows, starting at the beginning of the earliest period presented. If there is a difference between the new measure-ment amount and the amount under the insurer’s previous accounting policies, the difference should be recognised in retained earnings.

The insurer also should derecognise any existing balances of deferred acquisition costs.

The transition requirements apply both to a first-time adopter of IFRS and to an insurer currently reporting under IFRS.

Example measurement of insurance contracts — Indian GAAP v. IFRS ED:

An insurer issues an insurance contract, receives Rs.50 as the first premium payment and incurs acquisition costs of Rs.70, of which incremental acquisition costs are Rs.40. The insurer estimates an expected present value (EPV) of subsequent premiums of Rs.950 and a risk adjustment of Rs.50. In the example the insurer estimates that the EPV of future claims is Rs.900.

Measurement under Indian GAAP

Particulars

 

Indian
GAAP

 

 

 

 

 

 

 

Premium

 

50

 

 

 

 

 

 

 

Acquisition costs

 

(70)

 

 

 

 

 

 

 

Policy liability reserve (Estimate)

 

(40)

 

 

 

 

 

 

 

Loss
at initial recognition

 

60

 

 

 

 

 

 

 

Liability
at initial recognition

 

(40)

 

 

 

 

 

 

 

Measurement under IFRS ED

 

 

 

 

 

 

 

 

Particulars

 

IFRS
ED

 

 

 

 

 

 

EPV of cash outflows

 

940

 

 

 

 

 

 

Risk adjustment

 

50

 

 

 

 

 

 

EPV of cash inflows

 

(1000)

 

 

 

 

 

 

Present value of the fulfilment

 

 

cash flows

 

(10)

 

 

 

 

 

 

Residual margin

 

10

 

 

 

 

 

 

Liability
at initial recognition

 

0

 

 

 

 

 

 

Loss
at initial recognition

 

 

(Non-incremental acquisition costs)

 

30

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Framework to IFRS : The foundation to financial accounting concepts

IFRS

Purpose and scope of framework :

The Framework to IFRS (‘the framework’) sets out the concepts
that underline the preparation and presentation of financial statements for
external users. The basic purpose of the IFRS framework is to (i) assist the
standard-setting body with the development and review of existing and new
accounting standards; (ii) assist the preparers of financial statements in
applying the IFRS; (iii) assist the auditors to assess whether the financial
statements are prepared in line with IFRS; and (iv) assist the users of
financial statements to interpret the financial statements prepared in
conformity with IFRS.

The framework is not an accounting standard and hence does
not prescribe recognition, measurement and disclosure requirements. As per the
framework, in limited circumstances where there is a conflict between the
framework and the accounting standards, the accounting standard is required to
be followed. Further, the framework is applied in preparation of general-purpose
financial statements, which under IFRS are consolidated financial statements.
This is a significant departure from traditional Indian GAAP where the
general-purpose financial statements are separate financial statements of the
reporting entity.

The framework deals with :


(i) the objective of financial statements;

(ii) the qualitative characteristics that determine the
usefulness of information in financial statements;

(iii) the definition, recognition and measurement of the
elements from which financial statements are constructed; and

(iv) concepts of capital and capital maintenance.



Objective of financial statements :

The objective of the financial statements is to provide
information about the financial position, financial performance and cash flows
of the reporting entity to the users of financial statements.

As compared to Indian GAAP, IFRSs place more emphasis on cash
flows. For instance, the framework states that financial statements provide
information on the ability of an entity to generate cash and cash equivalents
and of the timing and certainty of their generation. Users are better able to
evaluate this ability to generate cash and cash equivalents if they are provided
with information that focusses on the (1) financial position, (2) performance,
and (3) changes in financial position of an entity.

The information about financial position of an entity is
affected by the economic resources it controls, its financial structure, its
liquidity and solvency, and its capacity to adapt to changes in the environment
in which it operates. Information about the performance of an entity, in
particular its profitability, is required in order to assess potential changes
in the economic resources that it is likely to control in the future.
Information concerning changes in the financial position of an entity is useful
in order to assess its investing, financing and operating activities during the
reporting period.

Underlying assumptions :

The framework sets out the underlying assumptions upon which
the IFRS accounting standards are based.

Accrual basis of accounting :

    The financial statements are prepared on the accrual basis of accounting, i.e., the effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.

Going concern :

    The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future.

Prudence :

    Unlike Indian GAAP, IFRS does not consider ‘Prudence’ as an underlying assumption. For instance, the unrealised gains on an ‘available-for-sale financial asset’ is required to be recognised under IFRS, whereas the same is prohibited under Indian GAAP on the grounds of prudence. The framework makes it clear that prudence means exercising a degree of caution in making judgments under conditions of uncertainty, but that it should not lead to the creation of hidden reserves or excessive provisions.

Qualitative characteristics of financial statements :

    The qualitative characteristics are the attributes that make the information provided in financial statements useful to users. There are four principal qualitative characteristics
    (1) understandability, (2) relevance, (3) reliability, and (4) comparability, of which some are divided into sub-categories.

1. Understandability :

    Information should be presented in a manner that it is readily understood by users.

2. Relevance :

    Information must be relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. Financial statements must have both predictive value and confirm past events.

Materiality :

    The relevance of information is affected by its nature, and materiality. In some cases the nature of information alone is sufficient to determine its relevance (e.g., managerial remuneration). In other cases both nature and materiality are important (e.g., estimates of provisions that involve significant judgment). Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements (e.g., no provision made on non-performing assets in case of banks). As materiality depends on the size and nature of the item or error judged in the surrounding circumstances, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.

    Either the size or the nature of the item, or a combination of both, could be the determining factor. Consideration of materiality is relevant to judgments regarding both the selection and application of accounting policies and to the omission or disclosure of information in the financial statements.

    Materiality needs to be assessed on disclosures in case when items may be aggregated, the use of additional line items, headings and sub-totals. Materiality also is relevant to the positioning of these disclosures (on the face of the financial statements or in the notes). As such, IFRSs are not intended to apply to immaterial items.

        3. Reliability:

    Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. Information may be relevant but so unreliable in nature or representation that its recognition may be potentially misleading. Reliability depends on:

        a) Faithful representation:
    To be reliable, information must represent faithfully the transactions and other events it either purports to represent or could reasonably be expected to represent, e.g., a statement of financial position should represent faithfully the transactions and other events that result in assets, liabilities and equity at the reporting date which meet the recognition criteria.

        b) Substance over form:
    Information must be accounted for and presented in accordance with its substance and economic reality and not merely its legal form.

        c) Neutrality:
    Information must be free from bias. Financial statements are not neutral, if by the selection or presentation of information, they influence the making of a decision or judgment in order to achieve a predetermined result or outcome.

        d) Prudence:
    Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty. However, the exercise of prudence does not allow, for instance, the creation of hidden reserves or excessive provisions, the deliberate understatement of assets or income, or the deliberate overstatement of liabilities or expenses, because the financial statements would not be neutral and, therefore, not have the quality of reliability.

        e) Completeness:
    To be reliable, the information must be complete within the bounds of materiality and cost. An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance.

        4. Comparability:
    Users must be able to compare the financial statements of an entity (a) through time — internal comparability and (b) with different entities — external comparability. The measurement and display of the financial effect of like transactions and other events must be carried out in a consistent manner throughout an entity and over time for that entity and in a consistent manner for different entities. It is important that the accounting policies used and changes to these are disclosed. It also is important that the financial statements present corresponding information for the preceding periods.

    Constraints on relevant and reliable information:

        1. Timeliness:
    If there is undue delay in the reporting of information it may lose its relevance. Management may need to balance the relative merits of timely reporting and the provision of reliable information.

        2. Benefit and cost:
    The benefits of information should be greater than the cost of providing it. The evaluation of benefits and costs is, however, a judgmental process.

        3. Balance between qualitative characteristics:
    In practice, a balancing or trade-off between qualitative characteristics is often necessary. The relative importance of the characteristics in different cases is a matter of professional judgment.

    Definitions of assets, liabilities and equity:

        1. Assets:
    An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. The future economic benefit embodied in an asset is the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity. Like Indian GAAP, the physical form is not essential to the existence of an asset, e.g., patents and copyrights. However, unlike Indian GAAP, the legal ownership is not of primary concern under IFRS; economic ownership is the essential characteristic.

        2. Liabilities:
    A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. It is important to note here the term ‘present obligation’ (as opposed to ‘future commitment’), i.e., a decision by management to buy an asset in the future does not give rise to a present obligation — an obligation normally arises only when the asset is delivered or when management enters into an irrevocable agreement to acquire the asset.

        3. Equity:
    Equity is the residual interest in the assets of the entity after deducting all its liabilities. Although equity is defined as a residual, it may be sub-classified in the balance sheet. For instance, in a corporate entity, funds contributed by shareholders, retained earnings, reserves representing appropriations of retained earnings and reserves representing capital maintenance adjustments may be shown separately.

    Recognition criteria for assets and liabilities: Assets and liabilities must be recognised if the recognition criteria are satisfied. Items are to be recognised as assets or liabilities (or as income and expenses) if:

        1. it is probable that any future economic benefit associated with the item will flow to or from the entity, and

        2. the item has a cost or value that can be measured with reliability.

    The recognition criteria stresses on the ‘probability’ rather than ‘certainty’ of occurrence of future economic benefits. The probability of future economic benefits is to be assessed when the financial statements are prepared. The concept of probability refers to the degree of uncertainty that the future economic benefits associated with the item will flow to or from the entity. Assessments of the degree of uncertainty attaching to the flow of future economic benefits are made on the basis of the evidence available when the financial statements are prepared.
    Specific criteria for recognition of assets:

  •             Probable that future economic benefits will flow to the entity, and
  •             The cost or value can be reliably measured.

    The future economic benefits may flow to the entity in a number of ways. For instance:

  •             Inventories, fixed assets and know-how may be used in the production of goods or services to be sold by the entity;

  •             Cash and cash equivalents, receivables or marketable securities may be exchanged for other assets;

  •             Cash and cash equivalents may be used to settle a liability; or

  •             Cash and cash equivalents may be distributed to the owners of the entity.

    Specific criteria for recognition of liabilities:

  •             Probable outflow of resources will result from settlement of a present obligation, and

  •             The amount can be measured reliably. The settlement of a present obligation usually involves the entity giving up assets in order to satisfy the claim of the other party.

    Settlement may occur in a number of ways, for instance, by:

  •             The payment of cash or cash equivalents as is the case with most payables;
  •             The transfer of other assets, for example, in a barter transaction or in some business combination;

  •             The rendering of services to the other party as is the case with a liability for warranty repairs; or

  •             The replacement of the obligation with another obligation.

    Definition of income and expense:

    Income:
    Income is an increase in economic benefits during the accounting period, in the form of direct inflow, enhancement of assets, or decrease in liabilities; and that results in increase in equity, other than those relating to contributions from equity participants.

    The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity, including sales, fees, interest, dividends, royalties and rent. Gains represent other items that meet the definition of income and may not arise in the course of the ordinary activities of an entity (e.g., gains on the disposal of non-current assets). Gains represent increase in economic benefits and as such is no different in nature from revenue. Hence, gains are not regarded as constituting a separate element in the framework. Unlike Indian GAAP, the definition of income also includes unrealised gains (e.g., unrealised gains arising on the revaluation of marketable securities).

    Expense:

    The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the entity. Losses represent other items that meet the definition of expense and may, or may not, arise in the course of the ordinary activities of the entity.

    Recognition criteria for income and expense: The recognition criteria for income and expense are the same as for the recognition of assets and liabilities.

    Income is recognised in the profit and loss account when increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means, in effect, that recognition of income occurs simultaneously with the recognition of increase in assets or decrease in liabilities.

    Expenses are recognised in the profit and loss account when decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets.

    Measurement of elements of financial statements:
    Different measurement bases mentioned in the framework are historical cost, current cost, realisable (settlement) value and present value.

    Historical cost:
    Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.

    Current cost:
    Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.

    Realisable (settlement) value:

    Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.

    Present value:

    Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business. This is different from Indian GAAP, where the assets and liabilities are recognised at transaction values without reference to the time value of money.

    Key GAAP differences in the frameworks:

  •             The primary financial statement is consolidated financial statement under IFRS framework, unlike Indian GAAP where the primary financial statement is standalone financial statements.
  •             Unlike Indian GAAP, IFRS does not identify ‘Prudence’ as one of the fundamental accounting assumptions in preparation of financial statements. Thus unrealised gains of available-for-sale securities are recognised under IFRS, unlike Indian GAAP.
  •             As compared to Indian GAAP, IFRS places more importance on the statement of cash flows as it provides information on the ability of an entity to generate cash and cash equivalents and of the timing and certainty of their generation.
  •             Unlike Indian GAAP, the legal ownership is not a criterion for recognition of an asset. IFRS recognises an asset based on the assessment of ‘control’ over the economic benefits accruing from the asset.
  •             Unlike Indian GAAP, certain assets and liabilities are recognised at the present value of future cash flows when the time value of money is significant.

    While barring the above differences, the framework under Indian GAAP and IFRS are similar, the said differences will have far-reaching implications on the Indian industry. Some of the accounting and reporting GAAP differences have their roots in the differences in the underlying frameworks.

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

IFRS

Background:


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

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

(1) Outsourcing arrangements, and

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

Embedded leases :

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

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

Price terms are as under :

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


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


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







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

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

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

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


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



Arrangement dependent on use of a specific asset or assets :

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

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

Specified assets explicitly identified in an arrangement :

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

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

Specified assets implied in an arrangement :

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

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

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

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

The arrangement conveys a right to use the asset :

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

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

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

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

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

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

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

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

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

Initial assessment:

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

Subsequent reassessment:

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

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

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

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

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

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

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

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

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

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

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

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

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

Terms of arrangements:

Cancellation clause in embedded lease:

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

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

Absence of binding contract:

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

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

Financial statement impact:

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

    a) Accounting by lessee — Finance lease:

Initial recognition and measurement:

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

Subsequent measurement:

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

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

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

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

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


    b) Accounting by lessor — Finance lease:

Initial recognition and measurement:

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

Subsequent measurement:

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

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

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

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

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

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

    c) Accounting by lessee and lessor — Operating lease:

Recognition and measurement:

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

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

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

First-time adoption of IFRS:

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

Conclusion:

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

Revenue recognition principles under IFRS for Real Estate Industry

IFRS

Background


Around the world, real estate development and sale
transactions are structured with various permutations and combinations, in order
to comply with local tax regulations, local practices and other market
conditions. As a result, a sale deed may be entered on the date of allotment or
it can be entered into on the date of delivery. Many geographies also permit the
developers to sell the underlying land first to be followed by the development
of land.

The divergence in the manner in which real estate
transactions are carried out was also reflected in the accounting principles
applied by companies prior to the introduction of IFRIC 15 in respect of revenue
recognition from real estate development. Some developers accounted for such
agreements under IAS 18 Revenue, i.e., revenue is recognised when the completed
real estate is delivered to the buyer. Other developers accounted for them under
IAS 11 Construction Contracts, i.e., revenue is recognised by reference to the
stage of completion as construction progresses.

The International Accounting Standards Board (‘IASB’) noted
that divergence in practice exists in these circumstances with regard to the
identification of the applicable accounting standard for the construction of
real estate and the timing of the associated revenue recognition. To address
this, IFRIC 15 – Agreements for the construction of real estate, was issued on 3
July 2008 and is effective for annual periods beginning on or after January
2009.

IFRIC 15 addresses this divergence and provides guidance on
the accounting for agreements for the construction of real estate with regard
to:

  • the accounting standard to
    be applied (IAS 11 or IAS 18); and


  • the timing of revenue
    recognition.


The scope of the interpretation also includes agreements that
are not solely for the construction of real estate, but which include a
component for the construction of real estate.

Revenue recognition

Broadly, the analysis required by IFRIC 15 has four possible
outcomes with the following revenue recognition requirements in each case:


(1) Agreements meet the definition of a construction
contract in accordance with IAS 11 Construction Contracts – revenue recognised
by reference to the stage of completion of the contract activity (“stage of
completion approach”).

Example:
Company A, owner of the land, appoints Company B to construct a residential
property for a fixed sum of INR 1 million. Company A decides the technical
specifications of the residential property and will remain the owner of the
land as well as the constructed property. This will be a contract specifically
negotiated for construction of an asset as specified in paragraph 3 of IAS 11.

Accordingly, revenue will be recognised by the stage of
completion set out in IAS 11.

(2) Agreements which are only for rendering of services in
accordance with IAS 18 Revenue – stage of completion approach.

If an entity is not required to acquire and supply
construction materials, the agreement may be only an agreement for the
rendering of services, which need to be accounted for under IAS 18. For
example: an agreement to maintain a real estate property.

(3) Agreements for the sale of goods but the
revenue recognition criteria of IAS 18.14 are met continuously as construction
progresses – stage of completion approach.

Example: Company A, a real estate developer, who owns a
piece of land, enters into an agreement with Company B to construct a bungalow
on the aforementioned land for a fixed sum of INR 1 million. As per the terms
of the agreement, the title and risk and rewards of the land as well as the
property under construction get transferred to Company B.

This principle is discussed in further detail in the
following paragraphs. In case a transaction meets the continuous transfer of
risk and rewards criteria, Company A will recognise revenue by the stage of
completion approach set out in IAS 11.

(4) Agreements for the sale of goods other than those in
type 3 – revenue recognised when all of the criteria of IAS 18.14 are
satisfied (“sale of goods approach”).

Example:
Company A, a real estate developer, who owns a piece of land, enters into an
agreement with Company B to construct a bungalow on the aforementioned land
for a fixed sum of INR 1 million. The title to the land and the property under
construction gets transferred to Company B. However, Company A still continues
to have managerial involvement and control over the property under
construction (for e.g. Company A controls the design and specifications of the
property, Company B’s right to sell / let / sub-let the property is
established only on physical completion of the property etc.).



Principle of continuous transfer of risk and rewards

One of the practical difficulties faced in the above assessment is the identification of agreements, which will fulfil the continuous transfer of risk and rewards and control (i.e. those which fall with in type 3 above), and so qualify for stage of completion accounting on the grounds that the revenue recognition criteria of IAS 18.14 are met continuously as construction progresses.

The approach of meeting the revenue recognition criteria in IAS 18.14 on continuous basis has not previously been common under IFRS. Historically, it was generally assumed that the stage-of-completion method for construction of real estate was only ap-plicable if the activity fell within the scope of IAS
11. However, other GAAPs (like Indian GAAP for example) have permitted stage-of-completion basis more readily than was generally the case under IFRS, prior to IFRIC 15. IFRIC 15 itself does not provide extensive guidance on identifying when this approach may be appropriate, though it includes some simplistic illustrative examples.

Paragraph 17 of IFRIC 15 states the following:

“The entity may transfer to the buyer control and the significant risks and rewards of ownership of the work in progress in its current state as con-struction progresses. In this case, if all the criteria in paragraph 14 of IAS 18 are met continuously as construction progresses, the entity shall recognise revenue by reference to the stage of completion using the percentage of completion method. The requirements of IAS 11 are generally applicable to the recognition of revenue and the associated expenses for such a transaction”.

Paragraph 14 of IAS 18 states the following:

“14    Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied:

  •     the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;

  •     the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

  •     the amount of revenue can be measured reliably;

  •     it is probable that the economic benefits associated with the transaction will flow to the entity; and

  •     the costs incurred or to be incurred in respect of the transaction can be measured reliably.”

Identifying indicators of continuous transfer under IAS 18.14

In the context of the requirement of paragraph 14 above, it will be important to identify which indicators / factors are more important to assess the question of whether continuous transfer is, or is not, occurring while the con-struction activity progresses.

Some factors, collectively or individually, may in-dicate that continuous transfer is occurring while construction progresses:

  •     The construction activity takes place on land owned by the buyer and the buyer has clear title to the land and the construction work in progress;

  •     The buyer cannot cancel the contract before the construction is complete;

  •     If the agreement is terminated before construc-tion is complete, the buyer retains the work in progress and the entity has the right to be paid for the work performed; and

  •     The agreement gives the buyer the right to take over the work in progress (albeit with a penalty) during construction, e.g., to engage a different entity to complete the construction.

Some other factors, collectively or individually, may indicate that continuous transfer is not occurring while construction progresses:

  •     The sales agreement gives the buyer the right to acquire a specified unit in an apartment building when it is ready for occupation;

  •     The sales agreement restricts the right of the buyer to sell / let or sub-let the property while under construction, or requires the developer’s explicit permission;

  •     The deposit paid by the buyer is refundable if the entity fails to deliver the completed unit in accordance with the contractual terms;

  •     The developer is required to perform significant obligations (for e.g. rental guarantee commitment) subsequent to completion of the property; and

  •     the balance of the purchase price is paid only on contractual completion, when the buyer obtains possession of its unit.

 

Other factors to be considered

It will be important to consider all the relevant facts and circumstances of the agreement before reaching a conclusion on which category the sale agreement should fall into. In addition to the illustrative examples set out in IFRIC 15, the following questions, collectively or individually, may provide indicators as to whether the continuous transfer of risk and rewards and control is met during the construction phase:

  •     Which party is able to sell / let / sublet or mortgage the property under construction?

  •     What are the rights of the buyer in case the developer is unable to complete the construction (i.e. if the developer files for bankruptcy)?

In such a case, will the buyer be able to enforce his rights on the property under construction? Will the buyer have preferential rights over other parties i.e. creditors of the developer?

  •     Are the payments made by the buyer to the developer held in an escrow account to be used solely for the construction of the property? Or are these funds available for the developer to fund his other projects?

  •     Which party bears the construction risk and which party bears the market risk related to the value of the property?

  •     Who bears the risk of loss or damage to the construction in progress and who pays the insurance cost of damage to the construction work? Who bears the loss in case the actual loss exceeds the insurance cover?

  •     Which party has the right to cancel / withdraw from the contract?

  •     Does the buyer have the right to complete the construction by replacing the developer?

Accounting for real estate development under current Indian GAAP

Based on the Guidance note on recognition of revenue by real estate developers issued by the Institute of Chartered Accountants of India, on the seller transferring all significant risks and rewards of ownership to the buyer, revenue can be recognised at that stage, provided the following conditions of AS 9, Revenue recognition, are fulfilled:
    a) no significant uncertainty exists regarding the amount of the revenue; and

    b) it is not reasonable to expect ultimate collection, provided the seller has no further substantial acts to complete under the contract.

However, in case the seller is obliged to perform any substantial acts after the transfer of all significant risks and rewards of ownership, revenue is recognised by applying percentage of completion method as stated under AS 7, Construction Contracts.

In India, the title to the property is considered to be transferred on entering into a sale deed / agreement to sell with the buyer. However, the developer retains control and has managerial involvement in the property under development till physical possession is handed over to the buyer. The developer also retains the significant obligation of completing and handing over the property to the buyer.

As the developer still retains the obligation to construct and deliver the property, revenue is generally recognised on stage of completion basis under Indian GAAP. However, the Guidance note on recognition of revenue by real estate developers does not explicitly require the entity to consider if the risk and rewards and control over the property under construction have been transferred to the buyer on a continuous basis throughout the construction period, as required by IAS 18 and IFRIC 15.

Summary

To summarise, under IFRS, there is specific guidance on when one can use the completed contract method vis -à-vis the stage of completion method, in order to recognise revenue from real estate development held for sale. IFRS lays emphasis on absence of continuing managerial involvement to the degree usually associated with ownership and effective control over the constructed real estate, which impact the timing of revenue recognition.

Further, determining whether an agreement falls within one of the four categories outlined earlier is not a matter of accounting policy choice, but rather an application of a single accounting policy to specific facts and circumstances. That is, the specific terms of each agreement should be analysed in the context of the relevant legal jurisdiction in
order to determine which of the aforementioned categories it falls into.

In case an entity wants to continue the current Indian GAAP mode of recognising revenue on percentage of completion basis (as per the Guidance note on recognition of revenue by real estate developers), it will have to make a positive assertion in respect of continuous transfer of risk and rewards and control (to be classified as a type 3 arrangement mentioned earlier) based on the various indicators discussed earlier in this article. This positive assertion will be based on facts and circumstances specific to each arrangement, taken individually or collectively. Such judgements in the application of the accounting policy will need to be disclosed in accordance with IFRIC 15.20(a).

Currently there is limited guidance available on ‘continuous transfer’ requirements in the nature of illustrative examples and this will be developed over a period of time. In the interim, there will continue to be some divergence in actual implementation of IFRIC 15, based on the legal laws practised in different geographies. Due to the practical challenges in being able to demonstrate continuous transfer of risk and rewards and control, IFRIC 15 will prompt more and more entities to recognise revenue on completion or delivery of the projects.

Block assessment — Only brought forward losses of the past years under Chapter VI and unabsorbed depreciation u/s.32(2) were to be excluded while aggregating the total income or loss of each previous year in the block period, but set-off of the loss suffe

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  1. Block assessment — Only brought forward losses of the past
    years under Chapter VI and unabsorbed depreciation u/s.32(2) were to be
    excluded while aggregating the total income or loss of each previous year in
    the block period, but set-off of the loss suffered in any of the previous
    years in the block period against the income assessed in other previous years
    in the block period was not prohibited.

[ E. K. Lingamurthy & Anr. v. Settlement Commission (IT
and WT) & Anr., (2009) 314 ITR 305 (SC)]

The Income-tax Department conducted a search u/s.132 of the
Act on 11-10-1996 on the business premises of the petitioner-assessees as well
as on their family members who were partners in various firms. The assessment
proceedings were initiated under Chapter XIV-B of the Act. A consolidated
application was filed before the Settlement Commission for the block period
1-4-1986 to 11-10-1996. The said application was admitted. The petitioners
claimed unabsorbed depreciation and business loss for the A.Y. 1995-96 and
1996-97 comprised in the block period. The claim was rejected by the
Settlement Commission by referring to S. 158BB(4) and Explanation (a) to S.
158BA(2) holding that the unabsorbed loss and current depreciation claimed in
the regular return should be determined and allowed to be carried forward for
future adjustment only in the regular assessment and consequently, the claim
for adjustment of unabsorbed depreciation against the undisclosed income in a
block assessment would not be considered. The High Court rejected the writ
petition filed by the petitioners holding that the provisions of Chapter XIV-B
did not indicate even a remote possibility for considering a claim of set-off
or brought forward losses under Chapter VI or unabsorbed depreciation
u/s.32(2) to be considered in determination of undisclosed income.

Before the Supreme Court the assessee contended that there
was a conceptual difference between current depreciation and carried forward
unabsorbed depreciation. It was the case of the assessee that Explanation (a)
to S. 158BB did not rule out current year’s losses or current year’s
depreciation; it only ruled out the brought forward losses or unabsorbed
depreciation u/s.32(2).

The Supreme Court held that S. 158BB, inter alia,
states that undisclosed income of the block period shall be “the aggregate of
the total income of the previous years falling within the block period”
computed in accordance with the provisions of Chapter IV. ‘Total income’ is
defined in S. 2(45) to mean the total amount of income referred to in S. 5,
computed in the manner laid down in the Act. In other words, Chapter XIV does
not rule out Chapter IV of the Act in the matter of computation of undisclosed
income under Chapter XIV-B. Ordinarily, in the case of regular assessment, the
unit of assessment is one year consisting of twelve months whereas in the case
of block assessment, the unit of assessment consists of ten previous years and
the period up to the date of the search. S. 158BB provides for aggregation of
income/loss of each previous year comprised in the block period. The block
period assessment under Chapter XIV-B is in addition to regular assessment.

According to the Supreme Court, analysing S. 158BB(4) read
with Explanation (a) thereto, it was clear that only brought forward losses of
the past years under Chapter VI and unabsorbed depreciation u/s.32(2) were to
be excluded while aggregating the total income or loss of each previous year
in the block period, but set-off of the loss suffered in any of the previous
years in the block period against the income assessed in other previous years
in the block period was not prohibited. According to the Supreme Court the
Settlement Commission had erred in disallowing the application of the assessee
for set-off of inter se losses and depreciation accruing in any of the
previous years in the block period against the income returned/assessed in any
other previous year in the block period.

Depreciation — Balancing charge — Assets whose cost does not exceed Rs.5,000 — Depreciation claimed at 100% — Sale of scrap — Those purchased after 1-4-1995 taxable u/s.50 — Those purchased prior to 1-4-1995, not liable to tax.

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  1. Depreciation — Balancing charge — Assets whose cost does
    not exceed Rs.5,000 — Depreciation claimed at 100% — Sale of scrap — Those
    purchased after 1-4-1995 taxable u/s.50 — Those purchased prior to 1-4-1995,
    not liable to tax.

[Nectar Beverages P. Ltd. v. Dy. CIT, (2009) 314 ITR
314 (SC)]

The assessee (Nectar Beverages P. Ltd.), a company which
derived income from manufacture and sale of soft drinks, claimed depreciation
in respect of the bottles and crates (trays) purchased by it at 100 percent
under the proviso to S. 32(i)(ii) of the Act, which was allowed from time to
time. During the financial year relevant to the A.Y. 1991-92, the assessee
sold scrap of bottles and trays (crates) for Rs. 50,850. However, in the
computation of income, the assessee reduced the sale consideration from the
income on the ground that the amount received was a capital receipt and since
it did not form part of the block of assets, even the provision of S. 50 of
the said Act relating to short-term capital gain on sale of depreciable asset
was not attracted. The Assessing Officer held that depreciation having been
allowed to the assessee, the proviso to S. 50 of the Act was applicable. The
Commissioner of Income-tax (Appeals) dismissed the appeal, however, holding
that a deduction had been made in the earlier assessment year in respect of
the expenditure incurred and, subsequently, the assessee having obtained the
amount in respect of such expenditure, the same was chargeable to tax
u/s.41(1) of the Act. The Tribunal confirmed the order of the Commissioner of
Income-tax (Appeals). The High Court also dismissed the appeal.

On appeal, the Supreme Court held that prior to April 1,
1988, S. 41(1) and S. 41(2), both existed on the statute book. S. 41(2)
specifically brought to tax the balancing charge as a deemed income under the
1961 Act. It stated that where any plant owned by the assessee and used for
business purposes was sold, discarded or destroyed and the moneys payable in
respect of such plant exceeded the written down value, then so much of the
surplus which did not exceed the difference between the actual and the
written-down value was made chargeable to tax as business income of the
previous year in which moneys payable for the plant became due. In other
words, S. 41(2) made the balancing charge taxable as business income.
According to the Supreme Court if the argument of the Department of reading
the balancing charge u/s.41(2) into S. 41(1) was to be accepted, then it was
not necessary for the Parliament to enact S. 41(2) in the first instance. In
that event, S. 41(1) alone would have sufficed. The Supreme Court held that,
S. 41(1), S. 41(2), S. 41(3) and S. 41(4) operated in different spheres.

In another batch of appeals, the Supreme Court considered
the effect of introduction of the Finance (No. 2) Act, 1995, with effect from
April 1, 1996. The Supreme Court noted that by the above Finance Act, the
first proviso to S. 32(1)(ii) stood deleted with effect from April 1, 1996.
Consequently, bottles, crates and cylinders whose individual cost did not
exceed Rs.5,000 also came to be included in the block of assets. One of the
assessees, M/s. Goa Bottling Company Pvt. Ltd. was a company registered under
the Companies Act, 1956, and was in the business of manufacture and sale of
soft drinks. For the purposes of its business, it bought bottles and crates
whose cost per unit did not exceed Rs. 5,000. During the year ending March 31,
1998, the company received a sum of Rs.6,89,91,901 on sale of scrap bottles
and crates. The sale proceeds were segregated in two parts :

(a) in respect of bottles and crates purchased prior to
March 31, 1995; and

(b) those purchased after April 1, 1995.

In the return of income filed, the sale proceeds relating
to bottles and crates purchased after April 1, 1995, were taken into
consideration for the purpose of computation of short-term capital gains
u/s.50 whereas the sale proceeds relating to bottles and crates purchased
prior to March 31, 1995, was not offered for short-term capital gains on the
ground that the assets stood depreciated at 100% under the proviso to S.
32(1)(ii) and hence did not form part of the block of assets.

For the reasons given hereinabove, the Supreme Court held
that the bottles and crates purchased prior to March 31, 1995, did not form
part of the block of assets, hence, profits on sale of such assets were not
taxable as a balancing charge, neither u/s.41(1) nor u/s.50. In respect of
bottles and crates purchased after April 1, 1995, on account of deletion of
the proviso to S. 32(1)(ii) (vide Finance Act, 1995) such bottles and crates
formed part of block of assets and consequently such assets purchased after
April 1, 1995, in this case, became exigible to capital gains tax u/s.50.

Capital or revenue expenditure — Matter remanded to the High Court to decide whether the assessee had acquired assets of enduring benefit.

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  1. Capital or revenue expenditure — Matter remanded to the
    High Court to decide whether the assessee had acquired assets of enduring
    benefit.

[Shreyas Industries Ltd. v. CIT, (2009) 314 ITR 302
(sc)]

The appellant was running a paper mill at Ahmedgarh in
District Sangrur, Punjab. During the previous year relevant to the A.Y.
1996-97, the appellant applied to the Pollution Control Board and the Forest
Department to allow it to discharge its effluent water from its mill to the
Village Tallewal. The Department of Environment and Forests agreed to provide
forest land for an open drain to be constructed by the assessee (user agency)
for carrying its effluent to the Tallewal drain, subject to certain
conditions. One of the conditions was that the appellant will transfer 4.063
hectares of non-forest land in favour of the Forest Department. That was done.
The appellant claimed that an amount of Rs. 70,79,862 incurred by the
appellant on construction of the open drain for disposal of effluents was
revenue expenditure. According to the Department, the expenditure was on
capital account, particularly, when the appellant had debited the building
account to the extent of Rs.70,79,862.

The Commissioner of Income-tax (Appeals) as well as the
Tribunal held that the expenditure incurred was on revenue account. However,
aggrieved by the decision of the Tribunal the matter was carried by the
Department in appeal to the High Court. The High Court reversed the concurrent
finding given by the Commissioner of Income-tax (Appeals) as well as by the
Tribunal.

On appeal the Supreme Court held that the basic question
which the High Court was required to answer was whether the assessee
(appellant) had acquired assets of enduring benefit. For that purpose, the
High Court was required to examine the terms and conditions on which the
Forest Department had permitted the appellant to construct an open drain. The
High Court was required to consider the effect of diversion of forest land. It
was not in dispute that the open drain ran for approximately fourteen
kilometers. It was not in dispute that it cuts through the forest land. It was
not in dispute that in lieu of this diversion, non-forest land came to be
surrendered by the appellant in lieu of the forest land. Further, the
appellant was required to raise plantation on both sides of the open drain.
Under the terms and conditions, it was stipulated that the Forest Department
shall have afforestation on both sides of drain having tree growth with an
amount of Rs.1.62 lakhs to be paid by the user agency (appellant) for raising
and maintenance of plantation. Further, even with regard to the open drain,
the terms and conditions made it very clear that the open drain would be lined
to avoid any seepage/leakage of effluent in due course of time. None of the
terms and conditions imposed by the Forest Department had been examined in the
above circumstances for deciding the question framed hereinabove.

The Supreme Court therefore set aside the order of the High
Court and remitted the matter to the High Court for fresh consideration in
accordance with law.

 

levitra

Business expenditure — Provision for warranty expenses at certain percentage of turnover of the company based on past experience is allowable as a deduction u/s.37.

New Page 2

 

  1. Business expenditure — Provision for warranty expenses at
    certain percentage of turnover of the company based on past experience is
    allowable as a deduction u/s.37.

[ Rotork Controls India P. Ltd. v. CIT, (2009) 314
ITR 62 (SC)]

The appellant-company sold valve actuators. The bulk of the
sales was to BHEL. At the time of sale, the appellant (assessee) provided a
standard warranty whereby in the event of any beacon rotork actuator or part
thereof becoming defective within 12 months from the date of commencing or 18
months from the date of dispatch, whichever was earlier, the company undertook
to rectify or replace the defective part free of charge. This warranty was
given under certain conditions stipulated in the warranty clause. For the A.Y.
1991-92, the asessee made a provision for warranty at Rs.10,18,800 at the rate
of 1.5% of the turnover. This provision was made by the assessee on account of
warranty claims likely to arise on the sale of effected by the appellant and
to cover up that expenditure. Since the provision made was for Rs.10,18,800
which exceeded the actual expenditure, the appellant revised Rs.5,00,246 as
reversal of excess provision. Consequently, the assessee claimed deduction in
respect of the net provision of Rs.5,18,554 which was disallowed by the
Assessing Officer on the ground that the liability was merely a contingent
liability not allowable as a deduction u/s.37 of the Act. This decision was
upheld by the Commissioner of Income-tax (Appeals). The matter was carried in
appeal to the Tribunal by the appellant. It was held by the Tribunal that
right from the A.Y. 1983-84 the Commissioner of Income-tax (Appeals) as well
as the Tribunal had allowed the warranty claim(s) on the ground that valve
actuators are sophisticated equipment; that in the course of manufacture and
sale of valve actuators a reasonable warranty was given to the purchases; that
every item of sale was covered by the warranty scheme; that no purchaser was
ready and willing to buy valve actuators without warranty and consequently
every item sold had a corresponding obligation under the warranty clause(s)
attached to such sales. All through this period between the A.Y. 1983-84 and
the A.Y. 1991-92, the Tribunal took the view that the provision made by the
appellant was realistic. Applying the rule of consistency, the Tribunal held
that the assessee on the facts and circumstances of the case was entitled to
deduction u/s.37 of the 1961 Act in respect of the provision for warranty
amounting to Rs. 5,18,554. Aggrieved by the decision of the Tribunal, the
Department carried the matter in appeal to the Madras High Court.

The High Court held that the assessee was not entitled to
deduction in respect of the provision made for warranty claims. It was held
that no obligation was ever cast on the date of the sale and consequently
there was no accrued liability. According to the High Court, the warranty
provision was made against the liability which had not crystallised against
the appellant and consequently it was a provision made for an unascertained
liability and, therefore, the appellant was not entitled to claim deduction
u/s.37 of the 1961 Act.

On appeal, the Supreme Court held that in the case of
manufacture and sale of one single item, the provision for warranty could
constitute a contingent liability not entitled to deduction u/s.37 of the said
Act. However, when there is manufacture and sale of an army of items running
into thousands of units of sophisticated goods, the past events of defects
being detected in some of such items lead to a present obligation which
results in an enterprise having no alternative to settling that obligation in
the present case.

The appellant has been manufacturing valve actuators in
large numbers. The statistical data indicated that every year some of these
manufactured actuators are found to be defective. The statistical data over
the years also indicated that being sophisticated item no customer is prepared
to buy a valve actuator without a warranty. Therefore, the warranty became
integral part of the sale price of the valve actuators. In other words, the
warranty stood attached to the sale price of the product. Therefore, the
warranty provision was needed to be recognised because the appellant was an
enterprise having a present obligation as a result of past events resulting in
an outflow of resources. Also, a reliable estimate could be made of the amount
of the obligation.

The Supreme Court observed that there are following options
for accounting the warranty expense :

(a) account warranty expense in the year in which it is
incurred;

(b) to make a provision for warranty only when the
customer makes a claim; and

(c) to provide for warranty at certain percentage of
turnover of the company based on past experience (historical trend).
According to the Supreme Court, the first opinion is unsustainable since it
would tantamount to accounting for warranty expenses on cash basis, which is
prohibited both under the Companies Act as well as by the Accounting
Standards which require accrual concept to be followed. In the present case,
the Department is insisting on the first option which, as stated above, is
erroneous as it rules out the accrual concept. The second option is also
inappropriate since it does not reflect the expected warranty costs in
respect of revenue already recognised (accrued). In other words, it is not
based on the matching concept. Under the matching concept, if revenue is
recognised the cost incurred to earn that revenue including warranty costs
has to be fully provided for. When valve actuators are sold and the warranty
costs are an integral part of that sale price, then the appellant has to
provide for such warranty costs in its account for the relevant year,
otherwise the matching concept fails. In such a case the second option is
also inappropriate. Under the circumstances, the third option is the most
appropriate because it fulfils accrual concept as well as the matching
concept.

Taxing times — IFRS and Taxation

IFRS

On 22 January 2010, the Ministry of Corporate Affairs (MCA)
in India issued a press release setting out the roadmap for International
Financial Reporting Standards (IFRS) convergence in India.

It is now a widely held view that in addition to accounting
issues, transition to IFRS would trigger implications under various
legislations, including taxes, corporate laws and other regulations.

Through this article we aim to bring to light a few key
direct tax issues that are likely to arise when companies transition to IFRS.

Potential additional areas of differences between book
profits (per IFRS) and taxable profits :

Accounting policies and practices for many transactions will
change on convergence with IFRS. The discussion below provides an illustrative
listing of items involving a change in accounting, where the tax implications of
the change need to be evaluated. Several additional changes may require a
similar assessment from a taxation perspective.


  • Treatment of dividend and premium on redemption of preference shares :



Currently preference shares are treated as part of share
capital, consequently the dividend on preference shares is charged to the
profit and loss appropriation account. Under IFRS, preference shares will be
treated as a financial liability and dividend thereon will be in the nature of
a finance expense. Under Indian GAAP, the premium or discount on redemption of
preference shares is adjusted from the securities premium account. IFRS
requires such premium or discounts to be charged to the income statement.

Presently, dividend and premium on redemption of preference
shares is considered to be capital in
nature and hence not tax deductible.

The Government would need to clarify whether such costs
charged to income statement would be allowed as a tax deductible expense.

Also, this would lead to reduction in the tax liability of
a company under MAT provisions. The Government would need to clarify whether
this would be acceptable from a tax perspective.


  • Stock compensation cost :



Under Indian GAAP, the employee stock options are
recognised at their intrinsic value. IFRS requires the stock options to be
recognised at their fair value. The impact of the same will be in the employee
cost.

The Government would need to clarify whether the employee
costs resulting from fair valuation of the stock option will be a deductible
expense.

Cost of stock options granted by a related entity to
employees of the reporting entity would need to be recorded e.g. : companies
would need to accrue for notional compensation cost for options granted by
parent to subsidiary employees with a corresponding impact on the cost of
investments or dividend distribution, respectively.

The Government would need to consider the deductibility of
such compensation cost in the hands of the entity receiving the grant and
impact on cost of acquisition for tax purposes to compute capital gain tax or
tax impact on dividend distribution in the hands of the entity giving the
grant.


  • Unrealised gains and losses :



IFRS requires all financial assets and liabilities to be
measured initially at fair value. Subsequent measurement of the financial
instrument would depend on their classification. This accounting treatment
results in unrealised gains and losses in the income statement. For instance —
all derivatives will have to be fair valued at each reporting date and the
gain or loss on such fair valuation is charged to the income statement (unless
hedge accounting is followed).

The Government would need to clarify whether the unrealised
gains and losses will be taxable in the reporting period in which they arise.
This may pose difficulty to entities, given that they may not have the
liquidity to settle the tax dues on these unrealised gains. Alternatively, the
Government could tax these instruments based on the actual realised gains or
losses.

Further, the Government would also need to consider the tax
implications of unrealised gains/losses on financial instruments which are
permitted to be adjusted directly in the reserves without impacting the income
statement. For example : Unrealised gains/losses related to available for sale
(AFS) securities and effective portion of cash flow hedges are recognised
through other comprehensive income within equity.


  • Taxation of notional gains and expenses :



In many instances, the accounting treatment envisaged by
IFRS could result in recognition of notional gains and expenses. The following
are examples of instruments which could give rise to notional gains or
expenses :

(1) Low interest or interest-free loans to employees —
Loans given to employees at lower than market interest rates should be
measured at fair value which is the present value of anticipated future cash
flows discounted using a market interest rate. Any difference between the fair
value of the loan and the amount advanced shall be a prepaid employee benefit.
The Government will need to consider implication of tax deducted at source on
salaries.

(2) Inter-group loans, advances and deposits at
concessional interest rates — If low interest/interest-free loans and
deposits have been forwarded among group entities, the loan or deposit is
initially measured at fair value using market rate of interest. Thus, where
the parent has granted a loan to the subsidiary, in the separate financial
statements of the parent, the difference between the nominal value and fair
value of the loan should be recognised as an additional investment in the
subsidiary and notional interest income is recognised by the parent and
corresponding interest expense by the subsidiary during the loan period. On
the other hand, where a loan has been given by the subsidiary to the parent,
in the separate financial statements of the subsidiary, the difference shall
be accounted for as dividend distribution to the parent and notional interest
income is recognised by the subsidiary and interest expense by the parent
company.

The Government will need to consider the taxation aspects of these notional interest and expenses and also implications on provision for tax deducted at source for such interest. Authorities will also need to consider impact on cost of acquisition for tax purposes to compute capital gain tax or tax impact on dividend distribution in the hands of the entity giving the loan at concessional interest rate.

    Interest-free security deposit on leasing arrangements — If an interest-free deposit is given as part of leasing transaction, the interest-free deposit will have to be discounted at the market rate and the difference will be treated initially as prepaid rent. The prepaid rent will be amortised to the income statement over the life of the lease.

The Government will have to clarify the tax treatment for such notional gains and expenses. Also the Government will need to consider implications on provision for tax deducted at source on rent.

    Revenue recognition :

Some of the revenue recognition principles under IFRS are different and will need to be carefully evaluated from tax perspective. For example :

    Under IFRS, if a contract contains multiple elements which have stand-alone value to the customer, the contract will have to be split and only revenue relating to the delivered component will be recorded in the reporting period. Further, the split of revenue between components will have to be done based on their relative fair values. For instance, if an entity sells machinery along with operations and maintenance services (O&M) for the machinery, the entity can recognise the fair value of the machinery in the reporting period in which the risk and rewards of the machinery are transferred to the buyer and the revenue from operations and maintenance will be deferred and recognised over the life of the O&M contract. The Government would need to clarify whether the entity will be taxed upfront only on the revenue recognised in a reporting period, or also on the deferred portion of the contract or will the tax impact of the deferred income also be deferred and taxed in the year in which such income is recognised in the accounts.

    In some cases two or more transactions may be linked so that the individual transactions have no commercial effect on their own. In these cases, IFRS requires that the combined effect of the two transactions together is ac-counted for. For instance a telecom company may sell mobile subscription to the customer and charge them the activation fees and talk time separately. However, in practice, these are linked transaction and the activation fee does not have any stand-alone value to the customer (in absence of the talk time or subscription agreement). Thus the telecom operator cannot recognise the activation revenue upfront and will have to defer it over the average life of the subscription agreement. The Government would need to clarify the method of taxation in such cases and consider to defer the tax implications in consonance with the deferral of revenue.

    IFRS provides guidance on accounting treat-ment of service concession agreements. For concession agreements, the contractor recognises certain profit (unrealised) dur-ing the construction phase and the balance during the operations phase when realised e.g., Company incurs cost of Rs.1,000 for construction of road and in consideration for the same has received a right to charge toll of Rs.30 on all vehicles plying on that road for 30 years (after which the road is handed over to the Government body). Under Indian GAAP, Company would capitalise Rs.1,000 as a fixed asset and depreciate it over 30 years.

However under IFRS, Company would need to accrue a notional margin on the construction activity as well and the cost of Rs.1,000 plus 10% margin (assumption) i.e., Rs.1,100 will be accounted as an intangible asset and amor-tised over 30 years. Although the manner of accounting will not result in any change in the total amount of profit or loss from the contract during the concession period (since the notional gain of 10% margin is offset by higher amortisation charge over the concession period), the proportion of the profit or loss over different reporting periods within the concession arrangement may differ.

The Government would need to consider the method of taxation in such cases. In this in-stance, entities may need to recognise profit margins upfront, though they would not have received cash inflows from the customers, thus entities may not have sufficient liquidity to settle tax dues, in case tax is charged based on the net profit reported in the financial statements.

Minimum Alternate Tax (‘MAT’) :

In case companies in India do not have sufficient taxable profits in India, as per the Income-tax Act companies are required to pay MAT as a specified percentage of book profits. Further, the new direct tax code proposes to charge MAT as a specified percentage of the total assets of the company.

Various differences discussed above and in particular the fair value implications and notional gains/ losses would have substantial impact on the reported profits or reported assets by companies.

The Government would need to assess the implications of such impacts on the tax liability arising due to provision of MAT, given that companies may find it difficult to pay tax dues (actual cash outflow) on unrealised gains which have not yet resulted in cash inflows for the company.

Further the proposal to charge MAT as a percentage of asset poses the following challenges for companies converging with IFRS, which need to be considered by tax authorities in formulating appropriate provisions :
    IFRS provides an option to account for its property, plant and equipment and investment properties at fair value at each reporting date. This could also result in increase in tax liability without any cash inflow to the company.

    Under IFRS, companies may need to account for certain embedded leases in normal sale/ purchase transactions e.g., Company has contracted to buy the entire output from suppliers production line and also given a minimum commitment to reimburse the fixed cost including capital cost of the supplier (these arrangements are commonly used as take or pay arrangement), in such cases, companies will need to account the production plant of the supplier as its own plant. This would increase the gross asset base of the Company and the corresponding MAT liability.

The above, being notional accounting aspects would cause significant issues for companies, if these are considered for taxing the entities and result in potential cash outflows.

The taxation model needs to be framed to ensure that companies that are required to follow the IFRS converged standards are not at a disadvantage as compared to other entities that are not required to follow the IFRS converged standards from April 1, 2011.

Matters for consideration by the Government :

Overall the Government will need to consider how to incorporate the implications of IFRS in the tax rules to be applied by companies, such that they do not result in unintended difficulties and adverse cash flow implications for companies.

The options to be considered to manage this transition :

Option 1 — Taxation based on current Indian accounting standards :
Require companies to prepare reconciliation of profit reported/assets reported under IFRS with profits and assets per the current accounting standards. Taxation based on such reconciled profits, assets and book balances. This is also generally followed in many of the European countries where taxation is determined based on the GAAP of the respective countries. For example : Germany, Spain.

Option 2 — Taxation based on IFRS with additional differences between IFRS financial statements and taxable income :

IFRS financial statements as a starting point for taxation. However, tax laws to be modified to identify additional areas where taxation (both current taxation and MAT) will be different from the basis used in the IFRS financial statements. These areas may be limited in number, and would not necessarily cover all differences that arise due to transition from current accounting standards to the IFRS converged standards. Additionally, under Option 2, the Government would need to determine how the one-time adjustments recorded in the books of accounts to transition to IFRS are treated for tax purposes.

It is important to note that the Income-tax Act in India applies to all entities i.e., corporate, partnership firms, trusts, individuals, etc. and IFRS will be applicable from 1st April 2011 only for a limited number of companies covered by Phase 1. If Option 2 is followed, this would result in different IFRS-based taxable models for some entities and a different model for other entities (that are not required to converge with IFRS immediately).

While Option 1 appears to be attractive, it poses challenges relating to maintaining two sets of records — one under IFRS and the other under current accounting standards. The benefits and costs of each of these options may need to be further debated to decide the best option from an Indian perspective.

Tax audit : S. 44AB of Income-tax Act, 1961 : In the case of individual carrying on business as a sole proprietor, it is necessary to comply with the provisions of S. 44AB only in respect of his business income and not in respect of his other income.

New Page 1

Reported :

37. Tax audit : S. 44AB of Income-tax Act, 1961 : In the case
of individual carrying on business as a sole proprietor, it is necessary to
comply with the provisions of S. 44AB only in respect of his business income and
not in respect of his other income.

[Ghai Construction v. State of Maharashtra, 184
Taxman 52 (Bom.)]

In this case the question for consideration before the
Bombay High Court was as to whether an individual who has income from
different sources including income from business is bound to have his income
from sources other than the business also audited u/s.44AB of the Income-tax
Act, 1961 ?

The Bombay High Court held as under :

“(i) The recommendation for the presentation of the
audited account was in all ‘cases of business or profession’ and not in
respect of the entire income of a person carrying on a business or a
profession. It is these recommendations which were accepted in the form of
S. 44AB of the Income-tax Act.

(ii) In the case of an individual carrying on business as
a sole proprietor, it is necessary to comply with the provisions of S. 44AB
only in respect of his business income. It would not be necessary to comply
with the provisions of S. 44AB in respect of his other income. In the case
of a professional, it is his professional income and not his income from
other sources which would be covered by the provisions of S. 44AB.”

levitra

Income : Deemed dividend : S. 2(22)(e) of Income-tax Act, 1961 : A.Y. 1996-97 : Trade advance to shareholder, etc. : Not assessable as deemed dividend.

New Page 1

Reported :

36. Income : Deemed dividend : S. 2(22)(e) of Income-tax Act,
1961 : A.Y. 1996-97 : Trade advance to shareholder, etc. : Not assessable as
deemed dividend.

[CIT v. Raj Kumar, 318 ITR 462 (Del.)]


The assessee was in the business of manufacturing
customised kitchen equipments. He was also the managing director and held
nearly 65% of the paid-up share capital of a company C. A substantial part of
the business of the assessee, was obtained through C. For this purpose, C
could pass on the advance received from its customers to the assessee to
execute the job work entrusted to the assessee. The Assessing Officer held
that the advance money received by the assessee is in the nature of the loan
given by C to the assessee and accordingly is deemed dividend within the
meaning of the provisions of S. 2(22)(e) of the Income-tax Act, 1961. He
therefore made the addition by treating the advance money as the deemed
dividend income of the assessee. The Tribunal deleted the addition.


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


“(i) The word ‘advance’ has to be read in conjunction
with the word ‘loan’. Usually attributes of a loan are that it involves the
positive act of lending, coupled with acceptance by the other side of the
money as loan : it generally carries interest and there is an obligation of
repayment. On the other hand in its widest meaning the term ‘advance’ may or
may not include lending. The word ‘advance’ if not found in the company of
or in conjunction with the word ‘loan’ may or may not include the obligation
of repayment. If it does, then it would be a loan.

(ii) The word ‘advance’ which appears in the company of
the word ‘loan’ could only mean such advance which carries with it an
obligation of repayment. Trade advances which are in the nature of money
transacted to give effect to a commercial transaction would not fall within
the ambit of the provisions of S. 2(22)(e) of the Act.

(iii) The trade advance given to the assessee by C could
not be treated as deemed dividend u/s. 2(22)(e) of the Act.”

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Educational institution : Exemption u/s. 10(23C)(vi) of Income-tax Act, 1961 : A.Y. 2007-08 : Assessee, deemed university, modified its MOA as per the UGC guidelines to include in the objects clause extra mural studies, extension programmes and field outr

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Reported :

35. Educational institution : Exemption u/s. 10(23C)(vi) of
Income-tax Act, 1961 : A.Y. 2007-08 : Assessee, deemed university, modified its
MOA as per the UGC guidelines to include in the objects clause extra mural
studies, extension programmes and field outreach activities to contribute to the
development of society : Assessee entitled to approval for exemption
u/s.10(23C)(vi).

[Jaypee Institute of Information Technology Society v.
DGIT (Exemption), 185 Taxman 110 (Del.)]


The assessee was a registered society. It was imparting
formal education by running an institute of information technology. On its
request, the UGC conferred on it the status of deemed university, subject to
the condition that the institute would revise/amend its Memorandum of
Association (MOA)/Rules as per the UGC model/guidelines. Accordingly the
assessee amended the MOA to include in the object clause extra mural studies,
extension programmes and field outreach activities to contribute to the
development of society. The assessee’s application for grant of approval for
exemption u/s.10(23C)(vi) of the Income-tax Act, 1961 was rejected on the
ground that education was not the only objective of the assessee-institute
inasmuch as the objective clause in the MOA mentioned that the institute was
also established for undertaking extra mural studies, extension programmes and
field out reach activities to contribute to the development of society.


On a writ petition filed by the assessee challenging the
said rejection, the Delhi High Court held as under :


“(i) In the instant case, the assessee was running an
educational institute imparting education in a systematic manner. The very
fact that it was granted the status of ‘Deemed university’ by the UGC, would
be a clinching factor insofar as institutionalised education conducted by
the assessee was concerned. It was imparting education in an organised and
systematic manner and was accountable to UGC even for maintaining the
standard of education. Further, in the assessee-institute, teachers were
employed and students enrolled were taught by these teachers; and they
remained under their control and supervision.

(ii) The main reason given by the respondent in rejecting
the application of the assessee was that the assessee-institute was having
multiple objectives and education was only one of them. In coming to that
conclusion, the respondent had been swayed by the so-called other
objectives, namely, ‘greater interface with society through extra mural,
extension and field action-related programmes’ stipulated in MOA. What was
perceived by the respondent was that those objectives were independent of
each other and it could not be said that the main object was education and
others were related to it. The first aspect which was totally ignored was
that said object was included at the instance of UGC, without which the UGC
would not have entertained the application of the assessee-institute for
grant of status of ‘Deemed university’. Obviously, the UGC would not insist
on including an objective, which was unrelated to ‘education’. There was a
clear purpose behind it. The aforesaid activity/objective was stated by the
UGC as a part of education. Normal schooling was provided by the assessee-institute.
What was emphasised by the UGC by necessitating incorporation of the
aforesaid objective was that imparting education was not limited to seeking
knowledge through textbooks alone. The UGC also wanted students to have
greater interface with society. That was necessary because of the modern
concept of education which needs to be imparted at schools’ and
universities’ levels.

(iii) If pure learning, which is one of the purposes of
the universities, is to survive, it will have to be brought into relation
with the life of the community as a whole, not only with the refined
delights of a few gentlemen of leisure. Real education is one which makes a
student socially relevant. For this purpose, his greater interface with
society is required. UGC perceives that this can be achieved through extra
mural, extension and field action-related programmes. These programmes may
include NSS and NCC activities, other social service programmes and
projects. It was with that purpose in mind that the aforesaid objective was
introduced so that students in the assessee-institute were able to get
‘real’ education. The main purpose, therefore, remained ‘education’ which
was imparted in a formal way by the assessee-institute with the status of
‘Deemed university’ through the help of teachers. The aforesaid activities
would only develop the knowledge, skill or character of the students further
by achieving education in true sense.

(iv) Therefore, the assessee-institute fulfilled the
requirement of imparting formal education by a systematic instruction. If an
institute/university introduces the courses with the objective of ‘greater
interface with the society through extra mural, extension and field
action-related programmes’, these are not the objectives independent of
education, but are an aid to the education. Therefore, the assessee-institute
fulfilled all the requirements of S. 10(23C)(vi) and was, thus, entitled to
grant of registration and, consequently, exemption under the aforesaid
provision.”

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Disclosures regarding Amalgamation

From Published Accounts

1 TV Today Network Ltd.
(31-3-2010)

From Notes to
Accounts :

Pursuant to the
Composite Scheme of Arrangement under the provisions of the Companies Act,
1956 (The Scheme), approved by the shareholders, sanctioned by the High Court
at Delhi and the Ministry of Information and Broadcasting on November 21,
2009, February 24, 2010 and May 20, 2010, respectively, the undertaking of the
radio broadcasting business of Radio Today Broadcasting Limited, a company
engaged in the radio broadcasting and trading business (the Transferor
Company), was transferred to and vested in the Company (the Transferee
Company) with effect from 1st April, 2009 (Appointed Date). ‘The Scheme’, a
copy of which was filed with the Registrar of Companies subsequent to the
year-end on 13th April, 2010, is an amalgamation in the nature of merger and
has been given effect to in these accounts under pooling of interest method.

In accordance
with ‘The Scheme’, the Company will issue 1,655,999 equity shares of Rs.5 each
as fully paid up to the equity shareholders of Radio Today Broadcasting
Limited, in the ratio of 1 equity share of Rs.5 each fully paid up of the
Company for every 6 equity shares of the face value of Rs.10 each fully paid
up, held in Radio Today Broadcasting Limited towards consideration for the
aforesaid transfer and vesting of radio business, which will be credited in
its books at face value, pending issuance of the shares as at the year-end,
the face value of Rs.8,279,995 has been credited to Share Capital Suspense.

In accordance
with ‘The Scheme’, all assets and liabilities pertaining to the radio
broadcasting business of the Transferor Company, as on the appointed date,
have been incorporated in the books of the Company at book value and the
excess of the Share Capital Suspense over the book value of net assets
acquired, amounting to
Rs.423,622,791, has been adjusted against Securities Premium Account of the
Company. The unamortised licence fees pertaining to the Transferor Company and
transferred to the Company pursuant to the Scheme, amounting to Rs.244,229,509
has also been adjusted against the Securities Premium Account. Further, the
Company has determined the deferred tax assets, amounting to Rs.249,529,332,
based on the assets and liabilities of the radio broadcasting business which
has been adjusted with the General Reserve Account.

The accounting
treatment in respect of excess of Share Capital Suspense over the book value
of net assets acquired and unamortised licence fee are different from that
prescribed by the Accounting Standard (AS) 14, Accounting for Amalgamations,
notified u/s.211(3C) of the Companies Act, 1956 with respect of Amalgamation
in the nature of Merger. AS-14 requires the difference between the amount
recorded as share capital and the amount of share capital of the transferor
company to be adjusted against reserve.

The difference
in accounting treatment as above, in compliance with the High Court Order, is
as permitted by paragraph 42 of the AS-14. As the said paragraph 42 of AS-14
requires disclosure of the impact of the amalgamation on all accounts, had the
accounting treatment as per AS-14 been followed, this is given below for
information.

Had the
accounting treatment prescribed in AS-14 been followed, amortisation of
intangible assets would have been higher by Rs.27,990,000 with its
consequential impact on the profit of the Company, General Reserve would have
been lower by Rs.423,622,791, Unamortised Licence Fees would have been higher
by Rs.216,239,509 and Share Premium Account would have been higher by
Rs.667,852,300.

2. Titagarh Wagons Ltd.
(31-3-2010)

From Notes to Accounts :

25. (a) Pursuant to a
Scheme of Amalgamation (the Scheme) sanctioned by the High Court of Calcutta
by order dated September 14, 2009, Titagarh Steels Limited (TSL) and Titagarh
Biotec Private Limited (TBPL) were amalgamated with the Company with effect
from April 1, 2009 (the appointed date). The amalgamation has been accounted
for under the Pooling of Interest Method as prescribed by the Institute of
Chartered Accountants of India (ICAI). TSL was in the business of
manufacturing of steel castings and TBPL was in the process of setting up
biotech business. The transferred companies carried on all their businesses
and activities for the benefit of and in trust for, the Company from the
Appointed Date. Thus, the profit or income accruing or arising to or
expenditure or losses arising or incurred by the transferred companies from
the Appointed Date are treated as the profit or income or expenditure or loss,
as the case may be, of the Company. The Scheme has accordingly been given
effect to in these accounts upon filing of certified copy of the Order of the
High Court at Calcutta on November 27, 2009 (the Effective Date).

(b) In terms of the
Scheme, the following assets and liabilities of TSL and TBPL have been
transferred to and stand vested with the Company at their respective book
values with effect from 1st April 2009:

 

 

(Rs. in lacs)

Particulars

TSL

TBPL

 

 

 

Fixed Assets (Net, including

1,804.35

Nil

Capital work in progress)

 

 

 

 

 

Current Assets, Loans and

 

 

Advances

4,858.09

2.09

 

 

 

Total Assets

6,662.44

2.09

 

 

 

Less
:

 

 

Current Liabilities and

 

 

Provisions

4,033.32

0.28

 

 

 

Loans

914.55

Nil

 

 

 

Total
Liabilities

4,947.87

0.28

 

 

 

Net
Assets

1,714.57

1.81

 

 

 

    c) The Company has issued 3,66,954 equity shares of Rs.10 each aggregating to Rs.36.70 lakhs to the shareholders of TSL on January 16, 2010, while in case of TBPL which was a wholly-owned subsidiary of the Company, all the shares held by the Company in TBPL were cancelled and extinguished.

    d) A sum of Rs.1288.85 lakhs being the difference between the amounts recorded as additional shares of the Company and the total share capital of TSL and TBPL has been adjusted and reflected as general reserve, instead of capital reserve as prescribed under Accounting Standard-14 in terms of the above court order.

    e) To make the accounting policies followed by TSL fall in line with those of the Company, a sum of Rs. 411.13 lakhs as on April 1, 2009 representing the impact of following accounting policy differences has been adjusted against General Reserve which as per Accounting Standard-5 should have been charged to Profit and Loss Account:

Particulars

Amount

 

(Rs. in lacs)

 

 

Depreciation

77.09

 

 

Liquidated damages (Net of Taxes)

334.04

 

 

Total

411.13

 

 

    f) Certain immoveable properties, investments, licences, contracts/agreements which were acquired pursuant to the above Scheme are in the process of registration in the name of the Company.

3    HCL Infosystems Ltd. (30-6-2010)
From Notes to Accounts:
    The Scheme of Amalgamation (‘Scheme’) for merging the wholly-owned subsidiary Natural Technologies Private Limited (NTPL) with the Company u/s.391 to u/s.394 of the Companies Act, 1956 sanctioned by the High Courts of Delhi and Rajasthan vide their respective orders dated 11-8-2008 and 29-5-2009 has come into effect on July 6, 2009 from the appointed date of 1-7-2008. On the scheme becoming effective NTPL stands dissolved without winding up in the previous year.

Pursuant to the Scheme:

The amalgamation of erstwhile NTPL with the Company was accounted for under the ‘pooling of interest method’ in the manner specified in the Scheme and complies with the Accounting Standard notified u/s.211(3C) of the Companies Act, 1956 and the following balances as at July 1, 2008 of erstwhile NTPL was adjusted with the profit and loss account forming part of reserves of the Company

 

(Rs. crores)

 

 

Assets

 

Fixed assets (including Capital

 

Work-in-progress Rs.0.80 crore)

4.09

 

 

Deferred Tax Assets

0.13

 

 

Sundry Debtors

3.34

 

 

Cash & Bank Balance

0.78

 

 

Other Current Assets

2.19

 

 

Loans & Advances

0.03

 

 

Total

10.56

 

 

Liabilities

 

Current Liabilities and Provisions

3.68

 

 

Secured Loan

1.52

 

 

Unsecured Loan

1.34

 

 

Total

6.54

 

 

Net
Assets acquired on

 

amalgamation
(a)

4.02

 

 

Transfer of balances of

 

Amalgamated Company

 

 

 

Securities Premium Account

0.45

 

 

Profit and Loss

0.55

 

 

Revaluation Reserve

2.54

 

 

Total
Reserves and Surplus (b)

3.54

 

 

Less
:

 

Adjustment for cancellation of

 

Company’s investment in Transferor

 

Company (c)

8.41

 

 

Shortfall
arising on Amalgamation

(7.93)

(a)
– (b) – (c) = (d)

 

 

 

Adjusted with :

 

— Revaluation Reserve

5.70

 

 

— Profit and Loss Account

2.23

 

 

Total

7.93

 

 


4. Godrej Consumer Products Ltd. (31-3-2010)
From Notes to Accounts:

    a) A Scheme of Amalgamation (‘the Scheme’) for the amalgamation of Godrej Consumer Biz Ltd. (GCBL) [a 100% subsidiary of Godrej & Boyce Manufacturing Company Ltd. (G&B)] and Godrej Hygiene Care Ltd. (GHCL) [a 100% subsidiary of Godrej Industries Ltd. (GIL)] together called ‘the Transferor Companies’, with Godrej Consumer Products Limited (the Transferee Company), with effect from June 1, 2009, (‘the Appointed Date’) was sanctioned by the High Court of Judicature at Bombay (‘the Court’), vide its Order dated October 8, 2009 and certified copies of the Order of the Court sanctioning the Scheme were filed with the Registrar of Companies, Maharashtra on October 15, 2009 (the ‘Effective Date’).

    b) The amalgamation has been accounted for under the ‘pooling of interests’ method as prescribed by AS-14 — Accounting for Amalgamations and the specific provisions of the Scheme. Accordingly, the Scheme has been given effect to in these accounts and all assets and liabilities of the Transferor Companies stand transferred to and vested in the Transferee Company with effect from the Appointed Date and are recorded by the Transferee Company at their book values as appearing the books of the Transferor Companies.

    c) The value of Net Assets of the Transferor Companies taken over the Transferee Company on Amalgamation are as under :
   

 

 

 

(Rs. in lac)

 

 

 

 

 

Particulars

GHCL

GCBL

Total

 

 

 

 

 

 

Investments in

 

 

 

 

Godrej Sara Lee

 

 

 

 

Limited

4,741.61

14,958.91

19,700.52

 

 

 

 

 

 

 

 

Cash and Bank

 

 

 

 

Balances

1.34

15.02

16.36

 

 

 

 

 

 

Loans and Advances

—

0.30

0.30

 

 

 

 

 

 

Advance Taxes Paid

—

1.03

1.03

 

 

 

 

 

 

Current Liabilities

 

 

 

 

and Provisions

(2.94)

(15.31)

(18.25)

 

 

 

 

 

 

Provision for taxes

—

(1.20)

(1.20)

 

 

 

 

 

 

Net Assets

4,740.01

14,958.74

19,698.76

 

 

 

 

 

 

    d) GCBL and GHCL held 29% and 20%, respectively, in Godrej Saralee Ltd., which is a 49 : 51 unlisted joint venture company between the Godrej Group and Saralee Corporation, USA. As a result of the amalgamation, Godrej Sara Lee Limited has become a joint venture between the Company and Sara Lee Corporation USA.

    e) In accordance with the Scheme of Amalgamation, the Company has issued and allotted 30,296,727 equity shares having a face value of Re.1 each to G&B and 20,939,409 equity shares having a face value of Re.1 each to GIL, being 10 equity shares in the Transferee Company for every 11 equity shares held by them in GCBL an GHCL, respectively, as consideration for the transfer. Consequently, the issued, subscribed and paid up equity shares capital of the Company stands increased to 308,190,044 equity shares having a face value of Re.1 each aggregating Rs.3,081.90 lac.

    f) The excess of book value of the net assets of the Transferor Companies taken over, amounting to Rs.18,455.25 lac, after adjusting the expenses and cost of the Scheme which amounted to Rs.731.15 lac, over the face value of shares issued as consideration to the Members of the Transferor Companies has been credited to the General Reserve as per the Scheme.

    g) Had the Scheme not prescribed the above treatment, the balance in Security Premium Account would have been higher by Rs.19,165.65 lac, investments would have been higher by Rs.731.15 lac, Capital Reserve would have been higher by Rs.51.24 lac, the Profit and Loss Account and the General Reserve would have been lower by Rs.30.50 lac and Rs.18,455.25 lac, respectively.

    h) Since the aforesaid Scheme of amalgamation of GCBL and GHCL with the Company, which is effective from June 1, 2009, has been given effect to in these accounts, the figures for the current year to that extent are not comparable with those of the previous year.

IFRS and Indirect Taxes : Need for Dual Reporting !

IFRS

The corporate sector is closely monitoring the changes in the
accounting and tax frameworks — Implementation of International Financial
Reporting Standards (IFRS), and Goods and Services Tax (GST).

Interestingly, IFRS (for large entities) and GST
principles/rules apply with effect from a common date i.e., 1 April 2011. While
the changes in the accounting and tax frameworks would have a substantial impact
on the Indian industry, there is a need felt for more clarity on some of these
impact areas. Further, the differences in recognition and measurement principles
under the revised accounting and tax frameworks would lead to additional efforts
of maintaining different accounting records — one for accounting purposes and
the other for tax purposes. This article attempts to illustrate some of the
practical challenges relating to the adoption of IFRS and GST frameworks.

Date on which the tax will be levied :

Under current excise law, the levy of excise duty is at the
point of manufacture of goods. However under GST framework, the levy of tax will
be on ‘sale’ of goods. However, it is unclear today whether the date of levy of
GST will be the date of invoice, date of dispatch of goods or the date on
recognition of revenue as per books of accounts (i.e., depending on the delivery
terms in the sales contract).

If the levy of tax will be on the date of recognition of
revenue in the books of the entity, then the date of levy of GST might differ
depending on whether the entity follows Indian GAAP or IFRS. Under IFRS, apart
from the transfer of risk and rewards to the buyer along with effective control,
IFRS also prescribes an additional condition in relation to the continuing
managerial involvement to the degree usually associated with ownership of goods.
Thus revenue recognition under IFRS might be later than that under Indian GAAP.

If the levy of GST is based on the invoice date or the
dispatch date, then under certain circumstances the timing of revenue
recognition under IFRS may not be the same as the date of levy of GST. This
difference in recognition of revenue under the accounting and taxation
frameworks will need to be periodically reconciled.

Barter sales :

Unlike Indian GAAP, IFRS prescribes specific accounting
guidance on barter transactions. Under IFRS, a barter transaction shall be
recognised as such only when there is an exchange of dissimilar goods. As such
there is no accounting implication in case of exchange of similar goods.

It is widely anticipated that the GST framework shall levy
tax on barter transactions. However, more clarity is awaited on whether GST
would be applicable on exchange of similar goods, even though these are not
recognised as sale for accounting purposes.

Intangible asset model under service concession arrangements
:

Under IFRS, IFRIC 12 provides guidance on accounting by
private sector entities (operators) for public-to-private service concession
arrangements.

In some arrangements, the operator is not awarded a fixed
consideration, but is awarded a right to collect toll fees for a fixed period of
time. Accounting under IFRS for such arrangements is similar to the barter
transactions, whereby the operator renders construction services (and recognises
construction revenue) in lieu of a right to collect toll fees from the users of
the infrastructure facility (i.e., intangible asset which is depreciated over
the concession period). Thus the construction service (revenue) is exchanged for
an intangible asset that provides the operator the right to collect toll
revenue. This accounting treatment is akin to accounting for barter
transactions. The subsequent collection of toll revenue is recognised as
separate revenue, while the depreciation on the intangible asset represents the
cost for the operator.

Currently no indirect taxes are levied on the construction
services provided by the operator under a service concession arrangement. The
indirect tax incidence, if any, is on the collection of toll revenue. It would
be interesting to see whether the GST framework shall also view such service
concession arrangements as barter revenue in line with IFRS accounting. If the
current indirect tax treatment is retained under GST framework, the revenue from
construction and other services needs to be periodically reconciled with the
revenue for accounting purposes.

Branch transfers :

As widely deliberated, GST will also be levied on the stock
transfers from one location of the entity to the other. Like Indian GAAP, IFRS
shall not recognise the branch transfers as revenue of the company. This
difference in recognition of branch transfers under the accounting and taxation
frameworks needs to be periodically reconciled.

Discounts and rebates :

IFRS requires all discounts including cash discounts given by
way of separate credit notes, free goods to the buyer to be reduced from
revenue. Further, the cash discounts and volume rebates need to be recognised on
an estimated basis as at the date of sale. Like the current indirect taxes, GST
is expected to be levied on the transaction value as per the invoice after
deduction of discount as specified on the invoice. This difference in
recognition of discounts under the accounting and taxation frameworks needs to
be periodically reconciled.

Customer loyalty programmes :

Customer loyalty programmes, comprising offering of loyalty
points or award credits, are offered by a diverse range of businesses, such as
supermarkets, retailers, airlines, telecommunication operators, credit card
providers and hotels. Award credits may be linked to individual purchases or
groups of purchases, or to continued custom over a specified period. The
customer can redeem the award credits for free or discounted goods or services.

IFRS requires an entity to recognise the award credits as a
separately identifiable component of revenue and to defer the recognition of
revenue related to the award credits. The revenue attributed to the award
credits takes into account the expected level of redemption. The consideration
received or receivable from the customer is allocated between the current sales
transaction and the award credits by reference to fair values. The component of
the revenue pertaining to award credits is deferred until the redemption of the
award credit against the future sale.Cash flow from operations — in terms of stabil-ity, timing and certainty — if the target does not prepare a cash flow statement merely because it is not mandatorily required to do so, it is no excuse for the FDD team not to carry out this analysis. The FDD team would be well advised to develop the cash flow statement of the business with the aid of two balance sheets and the profit and loss account for the intervening period and to then analyse the same. One lesson that the Enron debacle has taught us is that ‘Cash is king’ and that if one is able track where cash is being generated and where it is deployed, potential accounting ‘juggleries’ tend to get exposed.

Like the current indirect tax treatment, the GST may be levied on the transaction value of the goods. Thus on the initial sale transaction, GST may be levied on the entire sale value, whereas the accounting revenue as per IFRS would be lower to the extent of the fair value of award credits (that is deferred). Subsequently, as the buyer is provided other goods free of charge in lieu of the award credit, GST may not be levied as there is no sale consideration. For accounting purposes, the fair value of the award credit that was deferred on initial recognition will now be recognised as revenue. Thus the accounting revenue would be recognised subsequently, though there would be no revenue for GST purposes.

This difference in recognition of benefits provided under customer loyalty programmes under the accounting and taxation frameworks needs to be periodically reconciled.

Multiple deliverables within a contract :

Oftentimes a contract involves multiple deliverables such as sale of goods, installation services, warranty benefit and maintenance services. For revenue recognition, IFRS requires identification of different revenue components, allocation of the contractual revenue to each component based on their relative fair values and recognition of revenue for each component based on compliance with the revenue recognition criteria for each such component. The timing and amount of revenue recognition may not strictly follow the contractual arrangement.

GST is expected to be levied on the transaction value that is based on the contract. Hence there will be a need for reconciliation between the revenue as per IFRS and revenue as per GST. An entity may be required to maintain this reconciliation on a periodic basis.

Sales on deferred payment terms :

Deferred payment term is a credit term that is higher than the normal credit term. In case of deferred payment term, IFRS requires the sales to be recognised by discounting the future receivables to its present value. The difference between the nominal value and discounted value shall be recognised as interest income over the credit term.

Under the GST framework, if the levy of tax would be on the invoice value, then it might be viewed as if GST is levied on interest income as well (From an accounting perspective under IFRS, the invoice value comprises two parts — Revenue and Interest Income). More clarity is required on the assessable value of goods and services for GST purposes.

Lease deposits received by lessor :

Under IFRS, lease deposits are classified as financial instruments that are measured at fair value on initial recognition. When a lessor provides a leased asset to a lessee on a non-cancellable operating lease, the fair value of interest-free lease deposits is not equal to the nominal value (i.e., face value). The fair value of the lease deposit would be the present value of the future cash flows under the contract discounted at the market interest rate. The difference on initial recognition between the nominal value and the fair value of the lease deposits would be recognised as lease income received in advance. This advance lease income is recognised on straight-line basis over the lease term. Correspondingly the deposit liability would accrete interest expense over the lease term. Thus the lease income as per IFRS would be higher than the contractual lease rent.

Like the practice under current indirect tax laws, GST may be levied on the contractual lease rent without the impact of the notional lease rent on account of interest-free lease deposit. Thus the lessor will need to reconcile the lease revenue between IFRS and GST on a periodic basis. This would have a substantial impact on leasing companies.

Embedded leases :

Under IFRS, there is specific guidance on accounting for certain arrangements which include lease components. If the contract involves use of dedicated assets by a service provider, then such contract needs to be assessed from the perspective of a lease. Determining whether an arrangement is, or contains, a lease shall be based on the substance of the arrangement and requires an assessment of whether : (a) fulfilment of the arrangement is dependent on the use of a specific asset or assets (the asset); and (b) the arrangement conveys a right to use the asset.

For the purpose of applying the requirements of lease accounting, payments and other consideration required by the arrangement shall be separated at the inception of the arrangement into those for the lease and non-lease elements on the basis of their relative fair values.

Further, the entity may need to determine the classification of lease into operating or finance lease. In case of operating lease, the entity needs to recognise the lease component of the non-cancellable arrangement on a straight-line basis. In case of finance lease, the lessor would recognise the sale of the leased assets upfront and interest income over the lease period. The lessor shall recognise the non-lease components based on the accounting guidance from other relevant IFRS standards.

While the accounting for embedded leases could get complicated in practice, the GST is expected to be levied based on the same principles that are currently in existence i.e., transaction values. Thus when an arrangement is classified as a finance lease under IFRS, the earnings would comprise sale of ‘leased’ asset and interest income, whereas it would be taxed as job work charges in the hands of the service provider. The entity needs to periodically reconcile the impact of different measurement principles relating to revenue recognition under IFRS and GST.

Interest-free loan to job worker :

Under IFRS, loans are financial instruments that are initially recognised at fair value. In case of interest-free loans, the loans are initially recognised at fair value by discounting the future cash flows. The discounted value accretes interest expense over the term of the loan. The difference between the nominal value and fair value is recognised as notional job work charges over the tenure of the loan.

Under the current excise valuation rules, where a customer provides an interest-free loan to the job worker and the loan has influenced the price charged, then a notional interest is added to the assessable value of the goods sold by the job worker.

The GST framework so far is silent on the assessable value of goods/services. It would be interesting to see whether the notional interest and the notional job work charges are also to be added to the computation of assessable value for the purpose of levy of tax.

While industry believes that the changes in the accounting and taxation frameworks are steps in the right direction, they are unable to estimate the exact impact on their business. Further, unless some more clarity emerges in the near future, the industry shall face challenges around maintaining an efficient and planned tax structure. Further, some of the apparent transition implications, where the IFRS and tax treatment is relatively clear, indicate maintenance of two sets of records — one for accounting purpose and the other for tax purposes.

The financial and taxation aspects relating to the IFRS/ GST convergence need to be planned and tested in advance of the implementation date. In view of this, the Industry needs to start their transition process early, preferably now. Global experience has shown that the early adopters are generally more successful in managing the overall IFRS and GST transition. The early-mover advantage not only provides adequate time to carry out required changes, but protects critical decisions being taken within the constraints of time and resources.

IFRS 8 : Operating Segments

Background information :

IFRS 8 on ‘Operating Segments’ sets out requirements for disclosure of information about an entity’s operating segments and also about the entity’s products and services, the geographical areas in which it operates, and its major customers.

(1) Core principle :

    The core principle of IFRS 8 is that an entity shall disclose such information as to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates.

(2) Applicability of IFRS 8 :

    IFRS 8 shall apply to the separate/individual/consolidated financial statements of an entity. IFRS 8 is not applicable to all entities. It is applicable only to those companies whose securities are either listed or are in the process of listing in a public market.

(3) Management approach :

(a) Management approach :

    IFRS requires segment disclosure based on the components of the entity that management monitors in making decisions about operating matters (the ‘management approach’). Such components (operating segments) are identified on the basis of internal reports that the entity’s Chief Operating Decision Maker (‘CODM’) reviews regularly in allocating resources to segments and in assessing their performance.

    The management approach is based on the way in which management organises the segments within the entity for making operating decisions and in assessing performance. Consequently, the segments are evident from the structure of the entity’s internal organisation and the information reported internally to the CODM. The adoption of the management approach results in the disclosure of information for segments in substantially the same manner as they are reported internally (and used by the entity’s CODM) for purposes of evaluating performance and making resource allocation decisions. In that way, financial statements users are able to see the entity ‘through the eyes of management’.

(b) Identifying the CODM :

    The term CODM refers to a function, rather than to a specific title. The function of the CODM is to allocate resources to the operating segments of an entity and to assess the operating segments’ performance. The CODM usually is the highest level of management (e.g., CEO or COO), but the function of the CODM may be performed by a group rather than by one person (e.g., a board of directors, an executive committee or a management committee).

    For example, an entity has a CEO, a COO and a president. These individuals comprise the executive committee. The responsibility of the executive committee is to assess performance and to make resource allocation decisions related to the individual operations of the entity, and each of these individuals has an equal vote. The executive committee is the CODM because the committee is the highest level of management that performs these functions. The segment financial information provided to and used by the executive committee to make resource allocation decisions and to assess performance is the segment information that would be the basis for disclosure for external financial reporting purposes.

    However, the mere existence of an executive committee, management committee or other high-level committee does not necessarily mean that one of those committees constitutes the CODM. Assume the same fact pattern as in the previous example except that the managing director can override decisions made by the executive committee. Because the managing director essentially controls the committee and therefore has control over the operating decisions that the executive committee makes, the managing director will be the CODM for purposes of applying IFRS 8.

(4) Identifying operating segments :

    An operating segment is a component of an entity :

    (a) that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity),

    (b) whose operating results are regularly reviewed by the entity’s CODM to make decisions about resources to be allocated to the segment and assess its performance, and

    (c) for which discrete financial information is available.

    An operating segment generally has a segment manager. Essentially, the segment manager is directly accountable for the functioning of the operating segment and maintains regular contact with the CODM to discuss operating activities, forecasts and financial results. Like the CODM, a segment manager is a function, rather than a specific title.

    (a) Business activity is essential :

        A corporate headquarters would carry out some, or all, of the functions in the treasury, legal, accounting, information systems and human resources areas. However, corporate activities generally would not qualify as operating segments under IFRS 8, because typically they are not business activities from which the entity earns revenues.

    (b) Multiple segment information reviewed by CODM :

        Apart from the core principle as mentioned above, the additional factors that can be considered in determining the appropriate operating segments are as under :

        (a) the nature of the business activities of each component;

        (b) the existence of managers responsible for the components;

        (c) information presented to the board of directors; and

        (d) information provided to external financial analysts and on the entity’s website.

Some entities use a ‘matrix’ form of organisation, whereby business components are managed in more than one way. For example, some entities have segment managers who are responsible for geo-graphic regions, and different segment managers who oversee products and services. If the entity generates financial information about its business components based on both geography and products or services (and the CODM reviews both types of
information, and both have segment managers), then the entity determines which set of components constitutes the operating segments by reference to the core principle to IFRS 8 as mentioned above.

For example, an entity has six business components (A, B, C, D, E and F). Three of these business components (A, B and C) are located in India and each manufactures and sells a different product to customers in India. The CEO (who is the CODM) assesses performance, makes operating decisions and allocates resources to these business components based on financial information presented on a product-line basis. The entity also has three business components in the U.S. (D, E and F), which are organised to mirror the India operations (i.e., each manufactures and sells its products to customers located in the U.S.). However, the CODM assesses performance, makes operating decisions and allocates resources based on the financial information presented for the U.S. as a whole. The entity’s presi-dent of the U.S. operations is responsible for assessing performance, making operating decisions and allocating resources to the business components within the U.S. The entity’s president of the U.S. operations also is directly accountable to the CODM. The entity therefore has four operating segments: Segments A, B and C, which are determined on a product-line basis, and Segment U.S., which consists of business components D, E and F and is determined on a geographic basis. There is no requirement to disaggregate information for segment reporting purposes if it is not provided to the CODM in a disaggregated form on a regular basis.

Further, determination of the industry in which a business component of an entity operates generally is not decisive for purposes of identifying properly all of the operating segments under IFRS 8. For example, an entity historically reported that it had one industry segment (mining), but presented financial information in its MD&A and press releases on the following business components: gold, copper and coal. The entity determines that the CODM does, in fact, make resource allocation decisions based on the financial performance of each of these three business components. Accordingly, each of the three business components is an operating segment under IFRS 8, despite the fact that they all are in the mining industry.

c) Discrete and sufficient financial information :

In order to assess performance and to make resource allocation decisions, the CODM must have financial information about the business component. This information must be sufficiently detailed to allow the CODM to assess performance and to make resource allocation decisions. For example, an entity’s CODM receives revenue information for three different services delivered by segment A (Segment A is one of the five operating units of the entity). However, its operating expenses are reported to the CODM on a combined basis for the entire segment. Because a measure of profit or loss by service is not presented, the CODM might not have enough information to assess the performance or make resource (capital) allocation decisions regarding the individual services. Thus Segment A, in aggregate, is likely to be one operating segment, as opposed to the three individual services delivered by the Segment A.

5) Aggregation of segments :

Two or more operating segments may be aggregated into a single operating segment if

a) aggregation is consistent with the core principle of IFRS 8,

b) the segments have similar economic characteristics, and

c) the segments are similar in each of the following respects :

  •     the nature of the products and services;

  •     the nature of the production processes;

  •     the type or class of customer for their products and services;

  •     the methods used to distribute their products or provide their services; and

  •     if applicable, the nature of the regulatory environment, for example, banking, insurance or public utilities.

    6) Reportable segments :

    a) Quantitative thresholds :

An entity shall report separately information about an operating segment that meets any of the following quantitative thresholds :

    a) Its reported revenue, including both sales to external customers and inter-segment sales or transfers, is 10% or more of the combined revenue, internal and external, of all operating segments.

    b) The absolute amount of its reported profit or loss is 10% or more of the greater, in absolute amount, of

  •     the combined reported profit of all operating segments that did not report a loss and
  •     the combined reported loss of all operating segments that reported a loss.

    c) Its assets are 10% or more of the combined assets of all operating segments.

Operating segments that do not meet any of the quantitative thresholds may be considered reportable, and separately disclosed, if management believes that information about the segment would be useful to users of the financial statements or more reportable segments need to be identified until at least 75% of the entity’s revenue is included in reportable segments.

The term ‘combined’ in each of the three tests as mentioned above means the total amounts for all operating segments before the elimination of intra-group transactions and balances (i.e., not the entity’s financial statement amounts). It does not include reconciling items and activities that do not meet the definition of an operating segment under IFRS 8 (e.g., corporate activities).

b) Use of different accounting policies for segment reporting :

The measures of the segment amounts are based on the amounts reported to the CODM. As a result, the entity can measure the segment amounts based on segment accounting policies that may be different from the entity’s accounting policy for preparation of financial statements. In such cases, the entity measures the segment amounts based on segment accounting policies and provides additional disclosure reconciling the segment amounts to the entity’s financial statements.

c) Measures for profits, assets or liabilities :

The segment information is based on the actual measure of segment profit or loss that is used by the CODM for purposes of evaluating each reportable segment. Adjustments and eliminations made in preparing the entity’s financial statements, as well as allocations of revenue, expenses, gains or losses, are included in the reported segment profit or loss only if these items are included in the segment profit or loss measure used by the CODM. Additionally, the allocation of amounts included in the measure of segment profit or loss must be on a reasonable basis.

d) Use of multiple measures of profits, assets or liabilities for different segments :

If the CODM uses more than one measure of a segment’s profit or loss, or more than one measure of a segment’s assets or the segment’s liabilities, then the measure disclosed in reporting segment profit or loss, or segment assets or liabilities, should be the measure that management believes is determined in accordance with the measurement principle most consistent with the corresponding amounts in the entity’s financial statements.

For instance, the CODM receives and uses the operating profit, operating profit less corporate charges and operating profit less corporate charges and an allocated cost of capital measures of segment profit or loss for each of the operating segments, the measure of segment profit or loss used to report segment profit or loss should be operating profit because this measure is most consistent with the corresponding amounts in the entity’s financial statements.

e) Operating segments below quantitative thresholds :

An entity is allowed to combine information about two or more such operating segments that do not meet the quantitative thresholds (as discussed above) to produce a reportable segment only if the operating segments have similar economic characteristics and share a majority (but need not be all) of the aggregation criteria listed in point 5 above.

If the total of external revenue reported by operating segments constitutes less than 75% of total consolidated revenue, then additional operating segments are identified as reportable segments (even if they do not meet the quantitative threshold criteria) until at least 75% of the total consolidated revenue is included in reportable segments.

Information about other business activities and operating segments that are not reportable shall be combined and disclosed in an ‘all other segments’ category separately from other reconciling items. The sources of the revenue included in the ‘all other segments’ category shall be described.

7. Change in reportable segments :

a) Operating segment becomes reportable segment only in current period :

If an operating segment is identified as a reportable segment in the current period in accordance with the quantitative thresholds, segment data for a prior period presented for comparative purposes shall be restated to reflect the newly reportable segment as a separate segment, even if that segment did not satisfy the criteria for reportability in the prior period, unless the necessary information is not available and the cost to develop it would be excessive.

b) Operating segment was reportable segment in previous period but does not meet quantitative thresholds in current period :

An operating segment that historically has been a reportable segment might not exceed any of the quantitative thresholds in the current period. In this situation if management expects it to be a reportable segment in the future, then the entity should continue to treat that operating segment as a reportable segment in order to maintain the inter-period comparability of segment information.

c) Change in composition of operating segments :

If an entity changes the structure of its internal organisation in a manner that causes the composition of its reportable segments to change, the corresponding information for earlier periods, including interim periods, shall be restated unless the information is not available and the cost to develop it would be excessive. Following a change in the composition of its reportable segments, an entity shall disclose whether it has restated the corresponding items of segment information for earlier periods.

The entity shall disclose segment information for the current period on both the old basis and the new basis of segmentation, unless the necessary information is not available and the cost to develop it would be excessive.

    8) Disclosure of segment information :

    a) Disclosures :

An entity shall disclose the following for each period for which a statement of comprehensive income is presented :

  •     general information as described in point b below

  •     information about reported segment profit or loss, including specified revenues and expenses included in reported segment profit or loss, segment assets, segment liabilities (refer point c below) and the basis of measurement (refer point d below) and

  •     reconciliations of the totals of segment revenues, reported segment profit or loss, segment assets, segment liabilities and other material segment items to corresponding entity amounts. Reconciliations of the amounts in the statement of financial position for reportable segments to the amounts in the entity’s statement of financial position are required for each date at which a statement of financial position is presented. (refer point e below).


b) General information :

IFRS 8 requires an entity shall disclose the following general information about its segments :

  •     factors used to identify the entity’s reportable segments, including the basis of organisation (for example, whether management has chosen to organise the entity around differences in products and services, geographical areas, regulatory environments, or a combination of factors and whether operating segments have been aggregated), and

  •     types of products and services from which each reportable segment derives its revenues.

c) Information about profit or loss, assets and liabilities : Segment profit or loss disclosures :

IFRS 8 requires an entity to report a measure of profit or loss and total assets for each reportable segment, and a measure of liabilities for each reportable segment if such an amount is provided regularly to the CODM. It also requires that an entity disclose the following about each reportable segment if the specified amounts are included in the measure of segment profit or loss reviewed by the CODM or are otherwise provided regularly to the CODM, even if not included in that measure of segment profit or loss :

  •     revenues from external customers;

  •     revenues from transactions with other operating segments of the same entity;

  •     interest revenue;

  •     interest expense;

  •     depreciation and amortisation;

  •     material items of income and expense disclosed in accordance with paragraph 97 of IAS 1 Presentation of Financial Statements (as revised in 2007);

 

  •     the entity’s interest in the profit or loss of associates and joint ventures accounted for by the equity method;

  •     income tax expense or income; and

  •     material non-cash items other than depreciation and amortisation.

If the amounts specified above are inherent in the measure of segment profit or loss used by the CODM, then those amounts are required to be disclosed even if they are not provided explicitly to the CODM.

Segment asset disclosures :

IFRS 8 requires an entity to disclose the following about each reportable segment if the specified amounts are included in the measure of segment assets reviewed by the CODM or are otherwise regularly provided to the CODM, even if not included in the measure of segment assets :

  •     the amount of investment in associates and joint ventures accounted for by the equity method, and

  •     the amounts of additions to non-current assets (i.e. PPE and Intangible assets) other than financial instruments, deferred tax assets, post-employment benefit assets and rights arising under insurance contracts.

d) Disclosure of measurement basis :

IFRS 8 requires an entity to provide an explanation of the measurements of segment profit or loss, segment assets and segment liabilities for each reportable segment. At a minimum, an entity shall disclose the following :

  •     the basis of accounting for any transactions between reportable segments;

  •     the nature of any differences between the measurements used for segments reporting (i.e. for profits or losses, assets and liabilities) and the entity’s financial statements (if not apparent from the reconciliations as required under point e below). Those differences could include accounting policies and policies for allocation of common items of income, expenses, assets and liabilities that are necessary for an understanding of the reported segment information.

  •     the nature of any changes from prior periods in the measurement methods used to determine re-ported segment profit or loss and the effect, if any, of those changes on the measure of segment profit or loss.

  •     the nature and effect of any asymmetrical allocations to reportable segments. For example, an entity might allocate depreciation expense to a segment without allocating the related depreciable asset to that segment.

e) Reconciliation disclosures :

IFRS 8 requires an entity to provide reconciliations of all of the following :

  •     the total of the reportable segments’ revenues to the entity’s revenue.

  •     the total of the reportable segments’ measures of profit or loss to the entity’s profit or loss before tax and discontinued operations. However, if an entity allocates to reportable segments items such as tax expense (tax income), the entity may reconcile the total of the segments’ measures of profit or loss to the entity’s profit or loss after those items.

  •     the total of the reportable segments’ assets to the entity’s assets

  •     the total of the reportable segments’ liabilities to the entity’s liabilities

  •     the total of the reportable segments’ amounts for every other material item of information disclosed to the corresponding amount for the entity.

All material reconciling items shall be separately identified and described. For example, the amount of each material adjustment needed to reconcile reportable segment profit or loss to the entity’s profit or loss arising from different accounting policies shall be separately identified and described.

9) Entity-wide disclosures :

Entity-wide disclosures about products and services (refer point a below), geographic areas (including country of domicile and individual foreign countries, if material) (refer point b below) and major customers (refer point c below) for the entity as a whole are required, regardless of whether the information is used by the CODM in assessing segment performance. These disclosures apply to all entities subject to IFRS 8, including entities that have only one reportable segment. However, information required by the entity-wide disclosures need not be repeated if it is included already in the segment disclosures.
 
a) Information about products and services :

There might be situations in which additional disclosures of external revenue from products and services are necessary on an entity-wide basis when those revenues are not evident from the operating segment disclosures (including situations in which the operating segment disclosures are determined by products and services). For example, an entity might not be organised on the basis of related products and services, and therefore its individual reportable segments include revenues from a broad range of essentially different products and services. In this situation supplemental disclosure of revenues by groups of similar products and services is required, unless the necessary information is not available and the cost to develop it would be excessive. In this case that fact is disclosed.

b) Information about geographical areas :

An entity is required to report the following geo-graphical information :

    1. revenues from external customers :

  •     attributed to the entity’s country of domicile and

  •     attributed to all foreign countries in total from which the entity derives revenues. If revenues from external customers attributed to an individual foreign country are material, those revenues shall be disclosed separately. An entity shall disclose the basis for attributing revenues from external customers to individual countries.

    2. non-current assets other than financial instruments, deferred tax assets, post-employment benefit assets, and rights arising under insurance contracts :

  •     located in the entity’s country of domicile and

  •     located in all foreign countries in total in which the entity holds assets. If assets in an individual foreign country are material, those assets shall be disclosed separately.

c) Information about major customers :

Revenue from individual external customers that represents 10% or more of an entity’s total revenue must be disclosed. Specifically, the total amount by significant customer and the identity of the segment that includes the revenue must be disclosed. However, IFRS 8 does not require the identity of the customer or the amount of revenues that each segment reports from that customer to be disclosed.

d) Measure of segment profits, assets and liabilities for entity-wide disclosures :

The entity-wide disclosures should be based on the same financial information that is used to produce the entity’s financial statements (i.e., not based on the management approach). Accordingly, the revenue reported for these disclosures should equal the entity’s total revenue. Further, if the necessary information is not available and the cost to develop it would be excessive, that fact shall be disclosed.

10) Issues on first-time adoption :

There is no specific first-time adoption exemption within IFRS 1 for presentation of segment information. However, the reportable segments which, in the past, were identified based on management’s assessment of dominant source and nature of entity’s risks and returns, shall now be identified based on the manner in which the entity’s Chief Operating Decision Maker (‘CODM’) reviews the business components regularly in allocating resources to segments and in assessing their performance.

11) Summary of key differences compared to AS 17 :


Conclusion :

The management needs to reassess the identified business segments based on the manner in which the entity’s Chief Operating Decision Maker (‘CODM’) reviews the business regularly in allocating resources to segments and in assessing their performance.

Is this move to a management approach a good thing ? There is some risk that moving to a management approach may reduce comparability between entities because entity-specific measures override ‘normal’ measurement requirements. But this risk will be offset by the user understanding how does the management assess their own performance and see the business ‘through the eyes of the management’.

IFRS 9: Financial Instruments: The new “Avatar”

IFRS

1. Background information



The IASB has undertaken a project to replace the existing IAS
39 on Financial
Instruments: Recognition and Measurement
in order to improve the usefulness of financial statements for users by
simplifying the classification and measurement requirements for financial
instruments. The accounting standard on financial instruments is large and
complex; hence the International Accounting Standard Board (‘IASB’ or ‘the
Board’) has decided to replace the IAS 39 in three phases:


  • Classification and
    measurement of financial instruments:
    IFRS 9 was published in November 2009. This standard is currently applicable
    for financial assets only. The Exposure draft (ED) on financial liabilities is
    expected in 2010.


  • Impairment of
    financial assets:
    The IASB has issued an ED in November 2009


  • Hedge Accounting:
    An ED is expected in the first quarter of 2010


Apart from the above, the IASB has also issued an exposure
draft relating to Derecognition and Fair Value Measurements that would either be
part of, or relevant to, accounting for financial instruments.

IFRS 9 currently is applicable only to financial assets
(accordingly, this article covers only financial assets within the scope of IFRS
9). Financial liabilities are currently removed from the scope of IFRS 9 due to
concerns raised on entity’s own credit risk in liability measurement. IASB needs
more time for deliberation and exploring alternative approaches to account for
financial liabilities.



2. Scope and recognition principle for financial assets

The objective of IFRS 9 is not to dramatically change the
accounting for financial instruments, but to simplify the accounting. Hence, the
standard has not modified the scope of financial assets under IAS 39.

3. Measurement principle for financial assets

3.1. Initial measurement

Like IAS 39, all financial assets under IFRS 9 shall be
initially recorded at fair value plus, in case of assets not classified as ‘fair
value through profit or loss’ (FVTPL), transaction costs directly attributable
to its acquisition.

3.2. Subsequent measurement

Like IAS 39, IFRS 9 has retained the ‘mixed model approach’
whereby, at inception, the financial assets are categorized into those that will
be subsequently remeasured at (a) amortised cost or (b) fair value. Thus IFRS 9
has eliminated the three categories of financial assets viz loans and
receivables, held to maturity (HTM) and available for sale, while the FVTPL
category is retained.





4. Principles for classification of financial assets

4.1. Classification criterion

An entity shall classify financial assets (as subsequently
measured) at either amortised cost or fair value on the basis of both (a) the
entity’s business model for managing the financial assets; and (b) the
contractual cash flow characteristics of the financial asset. The standard aims
at aligning the accounting in line with how management deploys assets in its
business, while also considering its characteristics.

4.2. Amortised Cost

Unlike IAS 39, the revised standard has laid down specific
criteria for classification of financial assets at amortised cost. A financial
asset shall be measured at amortised cost if the following two conditions are
met:

(a) the asset is held within a business model whose objective
is to hold assets in order to collect contractual cash flows.

(b) the contractual terms of the financial asset give rise on
specified dates to cash flows that are solely payments of principal and interest
on the principal amount outstanding.

If both the above criteria for amortised cost accounting are
not met, then it is measured at fair value.

4.3. Business Model

The Board clarified that an entity’s business model does not
relate to a choice (i.e. it is not a voluntary designation) but rather, it is a
matter of fact that can be observed by the way an entity is managed and
information is provided to its management. IFRS 9 requires the key managerial
personnel (as defined in IAS 24 on Related Party Disclosures) to determine the
objective of the business model. The entity’s business model is not determined
at the level of every instrument, but is determined at a higher level. An entity
may also have more than one business model for managing financial assets. For
example, a bank’s retail banking division may hold its loan assets and manage
the same in order to collect contractual cash flows while its investment banking
business has the objective to realise fair value changes through the sale of
loan assets prior to their maturity.

4.4. Cash flow characteristics

For amortised cost measurement, the cash flows from financial asset should represent solely payments of principal and interest on the principal amount outstanding on specified dates. Interest here means the consideration for the time value of money and for the credit risk associated with the principal amount outstanding during a particular period of time.

Leverage is not consistent with the ‘solely payments of principal and interest’ criterion. Leverage is described as increasing the variability of the contractual cash flows such that they do not have the economic characteristics of interest. The standard lists

freestanding swaps, options and forwards as instruments that contain leverage.
Examples

The following are examples when both the above conditions are met and hence the financial asset is subsequently remeasured at amortised cost:

    A bond with variable interest rate and an interest cap;

    A fixed interest rate loan;

    Zero coupon bond;

    Variable interest loans including an element of fixed credit spread which is determined at inception e.g. LIBOR + 300 bps;

    Purchase of impaired / discounted loans which are then held to collect the contractual cash flows.

On the other hand, an investment in a convertible loan note would not qualify for amortised cost measurement because of the inclusion of the conversion option which is not deemed to represent payment of principal and interest. Similarly, an inverse floating interest loan which has an inverse relationship to market rates does not represent consideration for the time value of money and credit risk.

4.5. Impact of sale of financial assets on business model

Under IAS 39, subject to certain exemptions, if the entity sells / reclassifies held-to-maturity assets before maturity, tainting provisions under paragraph 9 to IAS 39 shall apply. Under IFRS 9, not all of the assets in a portfolio have to be held to maturity in order for the objective of the business model to qualify as holding assets to collect contractual cash flows. A sale of financial asset may not preclude subse-quent measurement at amortised cost if, for example, a financial asset is sold as per entity’s investment policy when the credit rating of the financial asset declined below certain threshold or a financial asset is sold to fund capital expenditures. The standard does not give any bright line or indicator as to what frequency of anticipated sales would preclude an amortised cost classification.

IAS 39 prescribed very limited circumstances under which sale of financial assets within HTM category were permitted without attracting tainting provisions. Under IFRS 9, portfolio of financial assets continue to be measured at amortised cost as long as the sale of financial assets is infrequent in number. Thus the scope for permitted sales of financial assets is much wider for the reporting entities.

4.6. Contractually linked instruments especially for securitisation transactions

An entity may have prioritised payments to holders of multiple ‘contractually linked’ instruments that create concentrations of risk e.g. the tranches of securitised debt. The complexity arises because the junior tranches provide credit protection to the more senior tranches and the characteristics of the tranches depend on the underlying instruments held. The holder should ‘look through’ the structure until the underlying pool of instruments that are creating (rather than passing through) the cash flows are identified for assessment for solely pay-ments of principal and interest, instruments which reduce cash flow variability and exposure to credit risk. Determining whether a tranche has a lower credit risk than that of the underlying instruments should, in many cases, be straightforward. The most senior tranches will qualify, while the most junior tranches will not. For the tranches in between, the entity may have to evalu-ate on a quantitative basis. E.g. Tranches with underlying instruments where the interest rate is linked to a commodity index would not have contractual cash flows that are solely payments of principal and interest.

When it is impracticable to assess the underlying pool of instruments, the test is deemed to fail and the tranche must be measured at FVTPL.

In practice, significant management judgement shall be required for classifying a financial asset where sale of some of these assets is anticipated. In such cases, management needs to determine whether the particular activity involves one business model with some infrequent sale of assets, or whether there are two business models where one is held for collecting contractual cash flows while the other could be sold in future. However, an entity that actively manages a portfolio in order to realise fair value changes, or a portfolio that is managed and whose performance is evaluated on a fair value basis, does not hold the asset under a business model to collect contrac-tual cash flows. Such instruments would not qualify for amortised cost measurement; hence the portfolio would be subsequently remeasured at fair value every reporting date.


5.    Option to designate financial asset at FVTPL

Like IAS 39, an entity can choose to designate a financial asset which otherwise would qualify for amortised cost accounting as measured at FVTPL only if it eliminates or significantly reduces a recognition or measurement inconsistency that otherwise would arise from measuring financial assets or liabilities, or recognising gains or losses on them, on a different basis. The election is available only on initial recognition of the asset and is irrevocable.

For instance, an entity may have issued foreign currency convertible bonds (FCCB) that is measured at fair value in entirety. These funds were utilised in investment of fixed rate bonds and met the amortised cost criteria in accordance with IFRS 9. This would lead to accounting mismatch as the liability is mea-sured at fair value while the asset is measured at amortised cost. This accounting mismatch can be significantly reduced by designating the financial asset at fair value through profit or loss as per IFRS 9.

IAS 39 also permitted an entity to designate a financial asset at FVTPL in two other scenarios.

    IAS 39 permitted designating financial asset at FVTPL if the portfolio consists assets managed on a fair value basis. For instance, an entity may hold a portfolio of debt securities. The entity manages the portfolio to maximise its returns (i.e. interest and fair value changes) and evaluates its performance on that basis. In such a case, IAS 39 permitted the entity to designate the portfolio as FVTPL.

As discussed above, these assets cannot qualify for amortised cost measurement under IFRS 9 and therefore are required to be measured at fair value.

  a)  IAS 39 permitted hybrid instruments (containing an embedded derivative and the host contract) to be designated as FVTPL. Under IFRS 9, hybrid instrument as a whole is assessed for classification as amortised cost or FVTPL. If not classified as at amortised cost, entire instrument is measured at fair value through profit or loss. Point 9.4 below explains the difference in the accounting treatment under IAS 39 and IFRS 9 with an example.

    Option to designate investment in equity shares at fair value through other comprehensive income (FVOCI)

6.1. Initial designation

The standard allows an entity, at initial recognition only, to elect to present changes in fair value of an investment in an equity instrument (not held for trading) in ‘Other comprehensive income’ (‘OCI’). The election is irrevocable and can be made on an instrument-by-instrument basis. However, investments in associates and joint ventures for venture capital organizations, mutual funds, unit trusts are not permitted such an option on account of equity accounting or proportional consolidation.

6.2. Subsequent measurement of equity instruments

IFRS 9 requires all investments in equity instruments (including unquoted equity instruments) to be measured at fair value. IFRS 9 permits cost to be an appropriate estimate of fair value of unquoted equity instruments in very limited circumstances.

6.3. Accounting implications on profit or loss

The amounts recognised in OCI are not recycled to profit or loss on disposal of the investment. However, dividend income on these investments continues to be recogn-ised in profit or loss, unless the dividend clearly represents a repayment of part of cost of the investment. Under IFRS 9, no separate impairment loss is to be recognised in profit or loss even if the equity invest-ment is designated as FVOCI.
 

7.    Reclassifications

7.1. Change in business model

Classification of financial instruments is determined on initial recognition. Subsequent reclassification is prohibited. However, when an entity changes its business model in a way that is significant to its operations, a re-assessment is required of whether the initial classification remains appropriate. The standard expects such changes to be very infrequent and demonstrable to external parties.

7.2. New carrying value

If a financial asset is reclassified from fair value measurement to amortised cost measurement, then the fair value at the reclassification date becomes the new carrying amount. Conversely, if a financial asset is reclassified from amortised cost measurement to fair value measurement, then the fair value at the reclassification date becomes the new carrying amount and the difference between amortised cost and fair value is recognised in profit or loss.

7.3. Reclassification date

The reclassification date is the first day of the next reporting period. The reason that the reclassification date is different from the actual date of change in business model is that the IASB did not want to allow entities to choose a reclassification date to achieve an accounting result. Thus, from the date of change in business model until the reclassification date, financial assets continue to be accounted as if the business model has not changed.

8.    Embedded derivatives

8.1. Embedded derivatives on financial asset host

Under IAS 39, embedded derivatives on financial assets hosts are assessed whether they need to be accounted separately. If the embedded derivative is separated from the host contract, the embedded derivative is measured at fair value while the host could be measured at amortised cost. IFRS 9 requires an entity to assess whether the hybrid instrument (i.e. host with embedded derivative) being a financial asset within the scope of the standard meets the criteria provided in the standard for amortised cost measurement. If the amortised cost measurement criteria are fulfilled, the entire hybrid instrument is measured at amortised cost (Refer 9.4 below). Else, the entire hybrid instrument is measured at fair value (Refer 9.3 below). However, in both cases, the embedded derivative is not separated.

8.2. Embedded derivatives on non-financial asset host

IFRS 9 does not change the accounting prescribed under IAS 39 for embedded derivatives with host contracts that are not financial assets within the scope of the standard. E.g. rights under leases, insurance contacts, financial liabilities and other non-financial assets

9.    Examples for classification under IFRS 9 and IAS 39

9.1. Investment in quoted as well as unquoted equity instruments

    Under IAS 39, the investments shall be classified as Available-for-sale (AFS), unless held for trading, and measured at fair value every reporting date. The fair value changes shall be recognised in OCI. The entity may also have recorded the unquoted equity instrument at cost based on the exemption given in IAS 39.

    Under IFRS 9, the investment does not meet the criteria for amortised cost measurement. Hence they will be measured at fair value at every reporting date. The fair value changes shall be recognised in profit or loss, unless the entity elects to recognise the same in OCI.

9.2. Investment in quoted debt securities

    Under IAS 39, an investment in a debt instrument quoted in active market is not permitted to be classified as loans and receivable category. Hence, these investments shall be classified as Available for sale unless there is a stated intent and ability to hold the instrument to maturity (in which case, the instrument would be classified as Held to Maturity and measured at amortised cost)

    Under IFRS 9, if the objective of the business model is to collect solely principal and interest on the principal, then the instrument shall be subsequently measured at amortised cost. Thus, the fact that the debt instrument is quoted in active market has no impact on classification of financial asset.

9.3. Investment in Convertible bonds (at the option of investor)

    Under IAS 39, the presence of the con-version feature that is exercisable by the investor precludes classification as HTM category. Such convertible bonds are clas-sified as AFS by the investor. Further, the embedded conversion option shall have to be separately accounted for.

    Under IFRS 9, the conversion option shall preclude the amortised cost measurement as the investment shall not be considered to collect solely principal and interest. The entire instrument shall be classified at fair value through profit or loss (FVTPL) with fair value changes reported in income state-ment.


9.4. Prepayment options with reasonable additional compensation for early termination

    Under IAS 39, if a debt instrument has a prepayment option that permits the holder to redeem the debt instrument for an amount that is approximately equal on each exercise date to the amortised cost of the debt instrument, such option is deemed to be closely related to the host and does not require separation.

    IFRS 9 does not preclude amortised cost classification for a financial asset with a prepayment option when the prepayment amount substantially represents unpaid amounts of principal and interest, including reasonable additional compensation for early termination. Thus, in some cases, amortised cost accounting may be possible for the entire hybrid contract under IFRS 9, while separation of prepayment option may be required under IAS 39.

9.5. Term extending options

    Under IAS 39, term extending option is an embedded derivative. The embedded derivative does not require separation if the rate of interest for the extended period approximates to the market rate of interest at the time of obtaining extension. Else, the derivative would require separation.

    Under IFRS 9, amortised cost classification
 

for a term extension option is not precluded if the instrument is held under a business model whose objective is to collect contractual cash flows. Thus in such cases, the entire hybrid instrument shall be carried at amortised cost.
 

    Summary of key differences between IAS 39 and IFRS 9

Particulars

IAS 39

IFRS 9

1.

Categories  of

There are four categories of financial

There are two categories of
financial assets:

 

financial assets

assets:
(a) Held-to-maturity; (b) Loans

(a) Fair value through profit or loss and

 

 

and
receivables, (c) Available for sale,

(b)
Amortised cost

 

 

(d) Fair value through profit or loss.

 

 

 

 

 

2.

Embedded
de-

Under
IAS 39, the embedded derivative

Under
IFRS 9, the hybrid instrument shall

 

rivatives
on a

is
assessed whether it is closely related

be assessed for amortised
cost classification

 

financial asset

to the
host contract. If closely related,

in its
entirety. If the amortised cost clas-

 

 

the
embedded derivative is accounted

sification criteria are met, the entire instru–

 

 

separately
from the host contract at

ment is
measured at amortised cost. Else,

 

 

fair
value.

the
entire hybrid instrument is measured

 

 

 

at fair
value.

 

 

 

 

3.

Equity
instru-

All
equity instruments that are classi-

All instruments, other than those classified

 

ments

fied as AFS securities are subsequently

as
amortised cost, shall be classified as

 

 

measured
at fair value with changes

FVTPL.
However, in case of investment in

 

 

recognised
in OCI. On disposal of

equity
instruments, an entity has an option

 

 

AFS
securities, the fair value changes

to
designate individual equity instruments

 

 

recognised
in OCI are recycled to the

as
FVOCI. In such case, the fair value

 

 

income
statement.

changes
are recognised in OCI. However,

 

 

 

these
fair value changes are not recycled

 

 

 

to the
income statement on disposal.

 

 

 

 

4.

Designation
of

Apart
from accounting mismatch, IAS

IFRS 9
provides an option to designate any

 

financial assets

39 permits designating financial assets

financial asset at FVTPL only to eliminate

 

as
FVTPL

as at
FVTPL in two other scenarios: (a)

or
substantially reduce accounting mis-

 

 

the portfolio
of assets is managed on

match. As discussed above, the classifica–

 

 

a fair
value basis and performance is

tion in case of a portfolio of financial
assets

 

 

evaluated
on that basis; or (b) it is a

managed
on fair value bases and a hybrid

 

 

hybrid
instrument

instrument
(i.e. embedded derivative on a

 

 

 

financial asset) shall be
classified as FVTPL

 

 

 

(without
providing any option).

 

 

 

 

The standard is effective for annual periods beginning on or after 1 January 2013. Early application is permitted.
 

The standard has given certain transitionary provisions which provide guidance on how companies who are currently following IAS 39 principles can transition to IFRS 9 within the period when the standard is issued and the effective date of application referred above.

The transitionary provision also provides guidance on classification and measurement of financial as-sets existing on the date of initial application of IFRS 9.

IFRS reconstructs the accounting for Public Private Partnerships (‘PPP’)

IFRS

In India, many infrastructure contracts are executed on BOT
(build, operate and transfer) terms under which a company enters into a
contractual agreement with the government or any quasi-government agency to
construct an asset (for example, a road) and to operate it for a specified time
period, before transferring the asset back to the government at the end of the
contracted term.

BOT arrangements are common in areas such as roads, bridges,
airports and power plants. Under such arrangements, there are mainly two types
of contracts : (1) a fixed annuity-based contract under which the operator
company builds the infrastructure asset and gets annuity from the grantor (i.e.,
government body); and (2) a usage based (i.e., toll-based) contract under
which the operator builds the infrastructure asset and collects toll from users.

Under existing Indian GAAP (‘IGAAP’), companies recognise the
infrastructure asset as their own fixed asset, and depreciate it over the
concession period. The amount received from the government and the users of the
infrastructure asset is recognised as income over the period of the concession.
The accounting treatment for such contracts will change under International
Financial Reporting Standards (‘IFRS’). IFRIC 12 (IFRICs are interpretations to
IFRS) on Service Concession Arrangements provides guidance on accounting for
such
arrangements.

Scope of IFRIC 12 :

IFRIC 12 applies to public-to-private service concession
arrangements in which the grantor controls and/or regulates the services
provided and the price, and controls any significant residual interest in the
infrastructure.

Whether or not an arrangement is within the scope of IFRIC 12
will affect the nature of the assets that the operator recognises. For example,
for an arrangement that is within the scope of IFRIC 12, the operator does not
recognise public service infrastructure as its property, plant and equipment (PPE).

Public-to-private service concession arrangements :

While IFRIC 12 does not define public-to-private service
concession arrangements, it does describe the typical features of such
arrangements. Typically a public-to-private service concession arrangement
within the scope of IFRIC 12 will involve most of the following :

(a) Infrastructure is used to deliver public services :

IFRIC 12 states that a feature of public-to-private
arrangements is the public service nature of the obligation undertaken by the
operator.

(b) A contractual arrangement between the grantor and
the operator :


This is the agreement, often termed as concession
agreement, under which the grantor specifies the services that the operator is
to provide and which governs the basis upon which the operator will be
remunerated.

(c) Supply of services by the operator :


These services may include the construction/upgrade of the
infrastructure and the operation and maintenance of that infrastructure.

(d) Payment of the operator over the term of the
arrangement :


In many cases the operator will receive no payment during
the initial construction/upgrade phase. Instead, the operator will be paid by
the grantor directly or will charge users during the period that the
infrastructure is available for use.

(e) Return of the infrastructure to the grantor at the
end of the arrangement :


For example, even if the operator has legal title to the
infrastructure during the term of the arrangement, then legal title may
transfer to the grantor at the end of the arrangement, often for no additional
consideration. In most such arrangements in India, legal title does not pass
on to the operator even during the concession period.

Public-to-private service concession arrangements within the
scope of IFRIC 12 :

The scope of IFRIC 12 is defined by reference to control of
the infrastructure. An arrangement is within the scope of IFRIC 12 if :

(a) the grantor controls what services the operator must
provide with the infrastructure (control of services);

(b) the grantor controls to whom it must provide them
(control of services);

(c) the grantor controls at what price services are charged
(control of pricing); and

(d) the grantor controls through ownership, beneficial
entitlement or otherwise, any significant residual interest in the
infrastructure at the end of the term of the arrangement (control of the
residual interest).


Control of services :

The grantor may control the services to be provided by the
operator in a number of ways. For example, the services may be specified through
the terms of the concession agreement and/or a licence agreement and/or some
other form of regulation. All of these forms of control are consistent with the
scope criteria of IFRIC 12. Furthermore, the degree of specification of the
services may vary in practice. In some cases the grantor will specify the
services to be provided in detail and by reference to specific tasks to be
undertaken by the operator. In other cases the grantor will specify the services
that the infrastructure should have the capacity to deliver.

Control of pricing :

The grantor may control or regulate the pricing of the
services to be provided using the infrastructure in a variety of ways. The
criterion in IFRIC 12 is generally satisfied when the service concession
involves explicit and substantive control or regulation of prices.

In some cases, particularly when the grantor pays the
operator directly, prices (or a price formula) may be set out in the concession
agreement. In other cases prices may be re-set periodically by the grantor, or
the grantor may give the operator discretion to set unit prices but set a
maximum level of revenue or profits that the operator may retain. All of these
forms of arrangement are consistent with the control criteria in IFRIC 12.

Control of residual interest :

The simplest way in which the grantor may control the residual interest is for the concession agreement to require the operator to return all concession assets to the grantor, or to transfer the infrastructure to a new operator, at the end of the arrangement for no consideration. Such a requirement is a common feature of service concession arrangements involving concession assets with long useful lives, such as road and rail infra-structure. However, other forms of arrangement also are within the scope criteria of IFRIC 12.

‘Whole-of-life’ arrangements, that is, arrangements for which the residual interest in the infrastructure is not significant, are within the scope of IFRIC 12 if the other scope criteria are met.

Accounting for public service infrastructure cost and related revenue:
Accounting for construction/upgrade of infra-structure:
Under IGAAP, the operator recognises the infra-structure as its PPE. However for arrangements within the scope of IFRIC 12 under IFRS, the operator does not recognise public service infrastructure as its PPE, as the operator does not control the public service infrastructure. The control require-ment is determinative irrespective of the extent to which the operator bears the risks and rewards of ownership of the infrastructure.

IFRIC 12 characterises operators as ‘service providers’, who should recognise revenue in accordance with the stage of completion of the services as measured by reference to the fair value of the consideration receivable. This is irrespective of whether the sale consideration is guaranteed by the grantor or is variable based on the usage of infrastructure asset.

Accounting for sale consideration:

The operator recognises consideration received or receivable for providing construction/upgrade services as a financial asset and/or as an intangible asset depending upon the assessment of demand risk.

The operator recognises a financial asset to the extent that it has an unconditional right to receive cash from the grantor irrespective of the usage of the infrastructure.
The operator recognises an intangible asset to the extent that it has a right to charge fees for usage of the infrastructure.

Assessment of demand risk:

The grantor bears the demand risk to the extent it guarantees certain minimum sale consideration irrespective of the usage of the asset. To the extent the grantor bears the demand risk, the operator recognises a financial asset.

Where an arrangement does not guarantee sales consideration and the consideration is linked to the usage of the infrastructure, the demand risk rests with the operator. In such cases, the operator recognises an intangible asset. Even in cases where the arrangement provides a cap on total consideration to be collected from users but does not guarantee minimum sales consideration, the operator shall recognise an intangible asset.

Impact of borrowing costs:

Under IGAAP, borrowing costs incurred during the construction phase are capitalised as part of qualifying fixed assets. Under IFRS, the treatment of borrowing costs differs depending on whether the arrangement qualifies under the financial asset model or the intangible asset model (as discussed above) . In the intangible asset model, the borrowing costs are required to be capitalised to the intangible asset. However, in the financial asset model, the borrowing costs are charged to profits, as financial assets cannot be qualifying assets under borrowing cost standard (i.e., IAS 23).

Recognition and measurement of revenue:

We look at the recognition and measurement of revenue under both the above scenarios — financial asset model and intangible asset model.

Financial asset model:

When the demand risk is with the grantor (i.e., the grantor guarantees the collections that will be recovered over the concession arrangement), the arrangement is said to contain deferred payment terms where the construction revenue is recognised at fair value. It is subsequently measured at amortised cost; i.e., the amount initially recognised plus the cumulative interest on that amount cal-culated using the effective interest method minus repayments. Thus, the overall consideration is broken down into revenue and interest income.

Intangible asset model:

For arrangements where the operator earns revenue purely from collection of tolls that are not guaranteed by the grantor, the right to collect the toll revenue is obtained as a consideration for rendering construction services to the grantor. For accounting purposes, these transactions are treated as barter arrangements. Thus, for such infrastructure projects, companies are required to recognise construction revenue (corresponding amount is debited to the intangible asset i.e., right to collect toll revenue from users) during the course of the construction period; and the toll revenue is recognised separately on collection. The intangible asset is amortised to the income statement over its useful life.

As such, the total amount of revenue recognised over the term of the arrangement is greater than the cash flows received during the period.

Subsequent measurement of financial asset:

The operator accounts for any financial asset it recognizes in accordance with the financial instruments standards (i.e., IAS 39) . There are no exemptions from these standards for operators. As such, the operator is required to classify the financial asset as a loan or receivable, available-for-sale, or at fair value through profit or loss if so designated. Generally, such assets are recorded as loans and receivables.

Subsequent measurement of intangible asset:

IAS 38 allows intangible assets to be measured using either the cost model or the revaluation model. The revaluation model is permitted to be used only if there is an active market for that asset. In most cases there will be no active market for intangible assets recognised under service concession arrangements, and therefore the cost model will be used.

Under the cost model the intangible asset is measured at its cost less any accumulated amortisation and any accumulated impairment losses. The depreciation is based on the asset’s economic useful life, which is generally the concession period.

Financial statement impact for operators on transition to IFRS:
Construction phase of the arrangement:

Under IGAAP, the operator recognises the cost of construction of infrastructure as part of its fixed assets. The fixed assets are depreciated over its useful life (usually over the concession period). Under IFRS, the costs incurred during the construction phase are recognised in income statement as construction

costs (along with the corresponding construction revenue). As the construction cost is recognised upfront in income statement, there would be no impact of depreciation in future years. Thus cost recognised in income statement during initial years is higher under IFRS as compared to IGAAP. Further under IGAAP, no revenue is recognised during the course of the construction phase of the concession arrangement. Under IFRS, revenue is recognised during the course of construction activities (in line with construction cost, based on percentage of completion method). Thus, companies will recognise higher revenues and costs (and higher profits) during the construction period.                

Operation revenue:                
                
Under IGAAP, revenue is recognised during the operations phase based on the terms of the concession arrangement. Under IFRS, revenue is recognised depending on whether the concession arrangement falls into financial asset model or intangible asset model. When the operator recognises an intangible asset during the construction phase (i.e., it receives a right to collect fees that are contingent upon the extent of use of the public service), it recognises operation revenue as it is earned i.e., the toll collection is recognised as revenue. Thus there is no impact of IFRS transition on revenue recognition during operations phase. The intangible asset recognised during the construction phase is amortised to income statement over the term of the concession arrangement. Further unlike IGAAP where the fixed asset is capitalised at cost, IFRS requires capitalisation of the intangible asset based on the fair value of construction services. Thus in most cases, the carrying value of intangible asset and related depreciation/amortisation would be higher under IFRS.


When the operator recognises a financial asset during the construction phase (i.e., it receives an unconditional right to receive cash that is not dependent upon the extent of use of the public service), a portion of payments received during the operation phase is allocated to reduce this financial asset (including related imputed interest income. Thus revenue recognition during the operations phase is severely impacted, as a portion of the revenues currently recognized during the operations phase would be adjusted as a recovery of the financial asset.

The table alongside provides a summary impact of the service concession arrangements on transition to IFRS.

Impact of IFRS beyond accounting:

Indian Industry is cautious of the financial statement impact on account of transition to IFRS. However, contrary to the general belief, the impact of transition to IFRS is not restricted to impact on profits and equity.

Financial budget:

On account of transition to IFRS, the financial budgets and performance matrices would undergo a change. Consider, for instance, revenue recognition under financial asset model where the construction revenue is recognised during the course of the construction phase and only interest income/operations revenue recognised during the term of the concession arrangement. This may impact key performance indicators which form a basis on incentive payments to senior employees and also bank covenants (asset cover age ratio, etc.).

Communication with stakeholders:

Management would need to keep stakeholders informed on the change in profitability due to transition related issues.

Contractual impact:

Certain grantors charge companies a certain revenue share every year (which is a percentage of the reported revenues). In case of PPP arrangements accounted under the intangible asset model, total reported revenue is much higher than cash flows earned (as explained above), since the revenue reported during the construction phase is notional. This may lead to higher leakage of regulatory dues which are based on reported revenues.

Similarly, even in the case of a financial asset model, acceleration of revenue recognition (during the construction period) would result in acceleration of contractual cash payments for revenue share (even though the revenues reported have not been realized in cash).

Taxes:

There is a need felt for more clarity on taxation matters vis-à-vis IFRS transition, especially around GST and MAT.

Regulatory:

It remains to be seen whether the statutory financial statements that will now be prepared under IFRS will be accepted for the purposes of filing business plans with banks for borrowing purposes and with RBI/FIPB for investment purposes.

Redefining the systems, processes and data points:

Capturing information under IFRS at a transaction level would pose a significant challenge, atleast in the initial years. The biggest hindrance will be faced on reconfiguration of IT systems, where the investment of time, cost, resources and complexity should not be underestimated. Further, the entity needs to be relook at the process of collecting additional data required under IFRS and make consequential amendment to the internal controls.

While industry believes that the change in the accounting framework is a step in the right direction, they are in the process of estimating the exact impact on their business. The financial and non-financial aspects relating to the IFRS convergence need to be planned and tested in advance of the implementation date. Global experience has shown that the early adopters are generally more successful in managing the overall IFRS transition. The ear-ly-mover advantage not only provides adequate time to carry out required changes, but protects critical decisions being taken within the constraints of time and resources.

succession, survivorship, inheritance, purchase, partition, mortgage, gift, lease, etc., in any land, then he must give a notice of the same to the Talathi within three months of such event.

The Talathi would then enter such changes in a Register of Mutations which would alter the original record of rights.

5.4 Any person buying land especially in a rural or semi-urban area would be well advised to do a thorough title search by checking the Record of Rights, Register of Mutations, etc., which would show whether or not the land in question is an agricultural land, who is the owner, what important developments have taken place in respect of the land, etc.

5.5 In the next Article we shall look at the process for converting an agricultural land into a non-agricultural land.

Revision : S. 263 of Income-tax Act, 1961 : A.Y. 2004-05 : Commissioner setting aside assessment order and directing AO to pass fresh order following procedure u/s. 50C(2)(b) : Not proper : Commissioner has no power to direct AO to complete asessment in a

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Reported :


45 Revision : S. 263 of Income-tax Act, 1961 : A.Y. 2004-05 :
Commissioner setting aside assessment order and directing AO to pass fresh order
following procedure u/s. 50C(2)(b) : Not proper : Commissioner has no power to
direct AO to complete asessment in a particular manner.

[CIT v. Smt. Tasneem Z. Madraswala; 324 ITR 67 (Mad.)]

For the A.Y. 2004-05, the assessment was completed u/s.143(3)
of the Income-tax Act, 1961 determining the total income at Rs.8,02,440.
Subsequently, the Commissioner set aside the assessment order exercising the
powers u/s.263 of the Act and also directed the Assessing Officer to pass a
fresh assessment order following the procedure contemplated u/s.50C(2)(b) of the
Act. The Tribunal deleted the direction given by the Commissioner for invoking
the procedure contemplated u/s.50C(2)(b) of the Act to value the capital asset
in a particular manner.

The Madras High Court dismissed the appeal filed by the
Revenue and held as under :

“While cancelling the order of assessment, there was no power
vested with the Commissioner to direct the Assessing Officer to complete the
assessment in a particular manner. Therefore, the Tribunal had correctly set
aside that portion of the order passed by the Commissioner, directing the
Assessing Officer to complete the assessment by recourse to the provisions
contained u/s.50C(2)(b) of the Act.”

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Revision : S. 263 of Income-tax Act, 1961 : A.Ys. 2004-05 and 2005-06 : Assessment order consistent with binding ruling of AAR : Revision of assessment order by Commissioner u/s.263 not permissible.

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Reported :

44 Revision : S. 263 of Income-tax Act, 1961 : A.Ys. 2004-05
and 2005-06 : Assessment order consistent with binding ruling of AAR : Revision
of assessment order by Commissioner u/s.263 not permissible.

[Prudential Assurance Co. Ltd. v. DIT (International
Taxation); 232 CTR 12 (Bom.), 191 Taxman 62 (Bom.)]

For the A.Ys. 2004-05 and 2005-06, the assessments were
completed in accordance with the binding rulings of the AAR in the case of the
assessee. Thereafter the Commissioner sought to reopen the assessments by
exercising the revisional powers u/s.263 of the Income-tax Act, 1961.

The assessee challenged the notice issued by the Commissioner
by filing a writ petition. The Bombay High Court allowed the writ petition and
held as under :

“(i) There is no dispute that the transaction in respect of
which the petitioner sought a ruling and in respect of which the AAR had
issued a ruling to the petitioner is of the same nature as that for A.Ys.
2004-05 and 2005-06. Evidently, the CIT has ignored the clear mandate of the
statutory provision that a ruling would apply and would be binding only on the
applicant and the Revenue in relation to the transaction for which it is
sought. The ruling in Fidelity Northstar Fund cannot possibly, as a matter of
the plain intendment and meaning of S. 245S displace the binding character of
the advance ruling rendered between the petitioner and the Revenue.

(ii) That apart, the CIT could not possibly have found
fault with the AO for having followed a binding ruling. Where the AO has
followed a binding principle of law laid down in a precedent which has binding
force and effect, it is not open to the CIT to exercise his revisional
jurisdiction u/s.263.

(iii) For the aforesaid reasons, on both counts the
invocation of the jurisdiction u/s.263 was improper.”

 

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Penalty : Concealment of income : S. 271(1)(c) of Income-tax Act, 1961 : A.Y. 2004-05 : Incorrect claim for deduction made u/s.10(36) on the basis of advice from counsel : Claim bona fide : No concealment : Penalty not justified.

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Reported :


43 Penalty : Concealment of income : S. 271(1)(c) of
Income-tax Act, 1961 : A.Y. 2004-05 : Incorrect claim for deduction made
u/s.10(36) on the basis of advice from counsel : Claim bona fide : No
concealment : Penalty not justified.


[CIT v. Deepak Kumar, 232 CTR 78 (P&H)]

For the A.Y. 2004-05, the assessee had made a claim for
deduction u/s.10(36) of the Income-tax Act, 1961 on the basis of the advice
given by the counsel. The claim was found to be incorrect and accordingly was
disallowed. As regards the disallowed amount, the Assessing Officer held that
there was concealment of income and accordingly imposed penalty u/s.271(1)(c) of
the Act. The Tribunal cancelled the penalty.

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

“(i) The question concerning bona fide mistake or belief is
more or less a question of fact, which has been decided by the CIT(A) on the
basis of the affidavit filed by the counsel. There is no finding of
intentional or motivated mistake which might have been resorted to by the
assessee. It is not unknown that IT returns are filed through the tax experts
in the IT laws and, therefore, the advice given by the counsel can be acted
upon with bona fide belief to be correct.

(ii) There is no rule of law that the aforesaid issue
should have been only before the AO or there was any bar on the assessee not
to raise this issue before the Appellate Authority. The affidavit filed by the
counsel of the assessee has been readily accepted by the CIT(A) as well as the
Tribunal.

(iii) It is well settled that if on the evidence adduced
before the AO or the Appellate forum, a possible view has been taken, then
u/s. 260A, no substantive question of law could be framed merely because
another view is possible.

(iv) The appeal is, thus, without merit and accordingly the
same is dismissed”

 

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Deduction u/s.80-O of Income-tax Act, 1961 : A.Y. 2003-04 : Supply of architectural designs for use outside India : Receipt of fees in foreign exchange : Assessee entitled to deduction u/s.80-O.

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 Reported :


41 Deduction u/s.80-O of Income-tax Act, 1961 : A.Y. 2003-04
: Supply of architectural designs for use outside India : Receipt of fees in
foreign exchange : Assessee entitled to deduction u/s.80-O.


[CIT v. Charles M. Correa; 232 CTR 61 (Bom.)]

The assessee is an architect. In the A.Y. 2003-04 the
assessee had claimed deduction u/s.80-O of the Income-tax Act, 1961, in respect
of the professional fees received in convertible foreign exchange for providing
design to foreign enterprise. The Assessing Officer disallowed the claim. The
Tribunal allowed the assessee’s claim.

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

“(i) The object underlying S. 80-O is to allow a deduction
in respect of incomes received in convertible foreign exchange in
consideration for the use outside India of certain categories of intellectual
property, namely, patents, inventions, designs or registered trademarks. The
fact that the assessee supplies designs is not in dispute.

(ii) The contention that the assessee was providing
professional services and could not regarded as the owner of the intellectual
property has no merit. The income in respect of which a deduction is claimed
u/s.80-O was not income, generally speaking, received for rendering
professional services outside India. The income which was received was
specifically in consideration for use outside of the designs which were
supplied by the assessee.

(iii) For the purposes of S. 80-O, use that is made outside
India may be single or multiple use, which may vary upon the facts and
circumstances of each case. So long as the use has taken place outside India
and the payment which is received in convertible foreign exchange is in India,
the benefit of the deduction would have to be granted.

(iv) The assessee had prepared designs in India and had
supplied them to its foreign counterpart outside India in pursuance of the
contracts. Explanation (iii) to S. 80-O clarifies that services rendered or
agreed to be rendered outside India, would include services rendered from
India but shall not include services rendered in India. There is no dispute
about the fact that the designs were supplied and used outside India. All the
conditions requisite for an exemption u/s.80-O were fulfilled. For the
aforesaid reasons no substantial question of law would arise.”

 

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Free Trade Zone : Deduction u/s.10A of Income-tax Act, 1961 : A.Y. 2001-02 : Explanation 1 to S. 10A(9) operative from 1-4-2001 is not retrospective : Assessee treated as newly established undertaking in free trade zone since A.Y. 1997-98 : Explanation 1

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Reported :


42 Free Trade Zone : Deduction u/s.10A of Income-tax Act,
1961 : A.Y. 2001-02 : Explanation 1 to S. 10A(9) operative from 1-4-2001 is not
retrospective : Assessee treated as newly established undertaking in free trade
zone since A.Y. 1997-98 : Explanation 1 to S. 10A(9) not applicable.


[Zycus Infotech (P) Ltd. v. CIT; 191 Taxman 13 (Bom.)]

The assessee-company had been treated as a newly established
undertaking in the free trade zone in the A.Y. 1997-98 and was enjoying
deduction of its profits and gains u/s.10A since then. On 31-3-1998, the two
promoters of the company, viz., ‘A’ and ‘N’ were having 100% of voting power in
respect of shares held by them. During the accounting year ending on 31-3-2001,
the assessee-company issued new shares to NRIs, as a result of which
shareholding of promoters reduced to 42.63% and voting power in respect of
shares held by them was reduced to 51.42%. The Assessing Officer held that the
percentage of shares of the company held by the promoters was reduced to less
than 51% in the year under consideration and, as such, it was clearly
established that the beneficial interest in the undertaking was transferred. He,
therefore, applied the provisions of the Explanation 1 to S. 10A(9) and denied
deduction u/s.10A to the assessee for the A.Y. 2001-02. The order of the
Assessing Officer was confirmed by the Commissioner (Appeals) as well as by the
Tribunal.

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

“(i) The Explanation 1 to S. 10A(9) provides that the
promoters of the assessee-company should continue to hold shares of the
company, carrying not less than 51% of the voting power.

(ii) In the instant case, the assessee-company had issued
shares without voting rights. As a result, original promoters, i.e., ‘A’ and
‘N’ continued to hold shares of the company carrying not less than 51% of the
voting power. It was, thus, clear that during the previous year relevant to
the A.Y. 2001-02, the ownership of the assessee-company was not transferred by
any means and, therefore, the assessee-company was right in claiming
entitlement to deduction u/s.10A(9).

(iii) So far as retrospectivity of provision is concerned,
one has to keep in mind the settled principle of interpretation that
retrospectivity cannot be lightly inferred unless it is clearly provided for
in the statute. The first proviso to S. 10A implies continuity. If the
intention is to deprive the existing industries or to impose a condition,
which is not capable of being fulfilled in the context of transfer having
already occurred prior to the statute, it would have been specifically made
clear. Under these circumstances, keeping in mind the general principle that
vested right cannot be divested, one cannot assume retrospectivity to a
greater extent than what the Section intends.

(iv) In the Explanation 1 to S. 10A(9), present tense has
been used with an injunction that the shares ‘are not beneficially held by the
persons who hold the shares in company’. The present tense cannot be assumed
to describe the status of the shareholder as the owner, but the status of the
shares which are beneficially held. On this interpretation, the language of
the Section can only be understood to describe ‘the date on which the
undertaking was set up’ as applicable only for those who were setting up the
undertaking after the new provision, so that in case of others, the date had
to be understood at best, as on 1-4-2001, the date on which the law was
brought in the statute.”

 

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Search and seizure — Whether the High Court was justified in holding that the Additional Director (Investigation) do not have jurisdiction to authorise Joint Director to effect search ? — Matter left open since it had become academic.

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3 Search and
seizure — Whether the High Court was justified in holding that the Additional
Director (Investigation) do not have jurisdiction to authorise Joint Director to
effect search ? — Matter left open since it had become academic.


[DCIT v. Dr. Nalin Mahajan,
(2009) 314 ITR 340 (SC)]


The Delhi High Court (257 ITR
123) had inter alia held that the Additional Director (Investigation) did not
have the power to issue any authorisation or warrant to the Joint Director as he did not have any statutory authority to
issue such authorisation or warrant. Consequently, the High Court declared the
Notification dated 6th September, 1989 as not valid to that extent.

The aforesaid decision of the
High Court was challenged before the Supreme Court.

The Supreme Court found that the
above question had become academic because after the impugned judgment, the
Commissioner of Income-tax, Delhi, had issued order u/s.132B of the Act for
release of cash, for release of jewellery and for release of the books of
account that were seized during the search and seizure operations conducted
u/s.132(1), which indicated that the matter had become final so far as the
assessment and recovery of tax was concerned. The Supreme Court therefore did
not examine the issues raised in the civil appeal and dismissed the civil appeal
keeping the questions of law raised therein expressly open.


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Assessment — Intimation u/s.143(1)(a) — Effect of amendment of S. 143(1A) by Finance Act, 1993 — Whether retrospective in case of reduction of loss ? — Matter remanded to the High Court.

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1 Assessment —
Intimation u/s.143(1)(a) — Effect of amendment of S. 143(1A) by Finance Act,
1993 — Whether retrospective in case of reduction of loss ? — Matter remanded to
the High Court.


[CIT v. Ashok Paper Mills,
(2009) 315 ITR 426 (SC)]

In an appeal against the
decision of the learned Single Judge passed in the writ petitions, the Division
Bench of the Gauhati High Court (250 ITR 673) found that there was no challenge
to the decision of the learned Single Judge about the constitutional validity of
the provisions of Ss.(1A) of S. 143 of the Act and therefore it was only
required to deal with the second limb of the order related to the
retrospectivity of the provisions of the aforesaid sub-section substituted by
the Finance Act, 1993.

The Division Bench of the High
Court, referring to the decisions of the Supreme Court in CIT v. Hindustan
Electro Graphites Ltd., (2000) 243 ITR 48 and in ACIT v. J. K. Synthetics
Ltd., (2001) 251 ITR 200, held that the Act or omission for which no
income-tax was payable as per law in force at a given time, could not be
subjected to additional tax with retrospective
effect and thus dismissed the appeal.

In an SLP filed in a connected
tax reference which was decided following the above decision of the Gauhati High
Court, the Supreme Court remanded the matter to the High Court for considering
it afresh in the light of its judgment in
ACIT v. J. K. Synthetics Ltd. (supra).


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Penalty — Concealment of income — Penalty could be imposed u/s.271(1)(c) of the Act even if the returned income as well as the assessed income is a loss.

New Page 1

2 Penalty —
Concealment of income — Penalty could be imposed u/s.271(1)(c) of the Act even
if the returned income as well as the assessed income is a loss.


[CIT v. Moser Baer India Ltd.,
(2009) 315 ITR 460 (SC)]

The assessee had filed a return
of income declaring a loss of Rs.2,72,12,620. In the course of the assessment
proceedings it was found that although the assessee had excluded the income of
floppy units II and III from its total income by claiming exemption u/s.10A and
u/s.10B of the Act, the depreciation in respect of these units had been deducted
from its income. The assessee had explained that the claim for depreciation was
a clerical mistake. The assessee filed a further application withdrawing its
claim of deduction u/s.10B of the Act in respect of floppy unit II for the
assessment year in question, since that unit had incurred a loss.

The Assessing Officer computed
the total income at Rs. Nil after adjusting the brought forward
losses/depreciation of Rs.47,01,433.11. The Assessing Officer disallowed the
depreciation in respect of floppy unit II and III of Rs.4,81,83,139. The
Assessing Officer also initiated penalty proceedings u/s.271(1)(c) of the Act.
An order imposing penalty of Rs.4,43,28,488 u/s.271(1)(c) of the Act came to be
passed.

The Commissioner of Income-tax
(Appeals) allowed the appeal holding that since the tax payable on the total
income as assessed was nil, there was no positive income, and therefore, the
penalty could be levied.

On an appeal to the Tribunal by
the Revenue, the assessee filed a cross-objection to support the order of the
Commissioner of Income-tax (Appeals) additionally on the ground that the
Assessing Officer had not recorded his satisfaction in the assessment order that
the penalty proceedings ought to be initiated against the assessee.

The Tribunal inter alia,
relied on the decision of the Delhi High Court in CIT v. Ram Commercial
Enterprises Ltd., (2000) 246 ITR 568 and concluded that the Assessing Offer
had not recorded a specific satisfaction before initiating the penalty
proceedings against the assessee and accordingly, the entire penalty proceedings
were set aside.

The High Court dismissed the
appeal of the Revenue following the decision of the Supreme Court in Virtual
Soft Systems Ltd. (2007) 289 ITR 83 (SC) in which it was held that no penalty
could be levied u/s.271(1)(c) of the Act, prior to amendment made to S. 271 by
the Finance Act, 2002, where there is no positive assessed income on which any
tax is payable.

The Supreme Court reversed the
judgment of the High Court in view of the decision of its Larger Bench in CIT
v. Gold Coin Health Food Pvt. Ltd., (2008) 304 ITR 308 and remitted the
matter to the Tribunal for considering the question regarding concealment.

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Bad debt — Write-off — After 1st April, 1989, if an assessee debits an amount of doubtful debt to the profit and loss account and credits the asset account like Sundry Debtors’ Account, it could constitute a write-off of an actual debt and it is not neces

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28 Bad debt — Write-off —
After 1st April, 1989, if an assessee debits an amount of doubtful debt to the
profit and loss account and credits the asset account like Sundry Debtors’
Account, it could constitute a write-off of an actual debt and it is not
necessary to square off each individual account.


[Vijaya Bank v. CIT & Anr.,
(2010) 323 ITR 166 (SC)]

For the A.Y. 1994-95, the
Assessing Officer disallowed a sum of Rs.7,10,47,161 which the assessee-bank had
reduced from loans and advances or debtors on the ground that the impugned bad
debt had not been written off in an appropriate manner as required under the
accounting principles. According to him, the impugned bad debt supposedly
written off by the assessee-bank was mere provision and the same could not be
equated with the actual write-off of the bad debt, as per the requirement of S.
36(1)(vii) of the Income-tax Act, 1961 (‘the 1961 Act’ for short) read with
explanation thereto which Explanation stood inserted in the 1961 Act by the
Finance Act, 2001, with effect from April 1, 1989. The assessee carried the
matter in appeal before the Commissioner of Income-tax (Appeals) [‘CIT(A)’, for
short], who opined that it was not necessary for the purpose of writing off of
bad debts to pass corresponding entries in the individual account of each and
every debtor and that it would be sufficient if the debit entries are made in
the profit and loss account and corresponding credit is made in the ‘bad debt
reserve account’. Against the decision of the Commissioner of Income-tax
(Appeals) on this point, the Department preferred an appeal to the Income-tax
Appellate Tribunal (‘Tribunal’, for short). Before the Tribunal, it was argued
on behalf of the Department that write-off of each and every individual account
under the head ‘Loans and advances’ or ‘debtors’ was a condition precedent for
claiming deduction u/s.36(1)(vii) of the 1961 Act. According to the Department,
the claim of actual write-off of bad debts in relation to banks stood on a
footing different from the accounts of the non-banking assessee(s), though it
was not disputed that S. 36(1)(vii) of the 1961 Act covered banking as well as
non-banking assessees. According to the assessee, once a provision stood created
and, ultimately carried to the balance sheet wherein loans and advances or
debtors depicted stood reduced by the amount of such provision, then there was
actual write-off, because, in the final analysis, at the year end, the so-called
provision did not remain and balance sheet at the year ended only carried the
amount of loans and advances or debtors, net of such provision made by the
assessee for the impugned bad debt. The Tribunal, upheld the above contention of
the assessee on three grounds. Firstly, according to the Tribunal, the assessee
had rightly made a provision for bad and doubtful debt by debiting the amount of
bad debt to the profit and loss account so as to reduce the profit of the year.
Secondly, the provision account so created was debited and simultaneously the
amount of loans and advances or debtors stood reduced and, consequently, the
provision account stood obliterated. Lastly, according to the Tribunal, loans
and advances or the sundry debtors of the assessee as at the end of the year
lying in the balance sheet was shown as net of ‘provision for doubtful debt’
created by way of debit to the profit and loss account of the year.
Consequently, the Tribunal, on this point, came to the conclusion that deduction
u/s.36(1)(vii) of the 1961 Act was allowable.

On the question whether it
was imperative for the assessee to close each and every individual account and
its debtors in its books or a mere reduction in the loans and advances to the
extent of the provision for bad and doubtful debt was sufficient, the answer
given by the Tribunal was that, in view of the decision of the Gujarat High
Court in the case of Vithaldas H. Dhanjibhai Bardanwala v. CIT, reported in
(1981) 130 ITR 95, the Commissioner of Income-tax (Appeals) was right in coming
to the conclusion that since the assessee had written off the impugned bad in
its books by way of a debit to the profit and loss account simultaneously
reducing the corresponding amount from loans and advances or debtors depicted on
the assets side in the balance sheet at the close of the year, the assessee was
entitled to deduction u/s.36(1)(vii) of the 1961 Act. This view was not accepted
by the High Court which came to the conclusion by placing reliance upon a
judgment in the case of CIT v. Wipro Infotech Limited that in view of the
insertion of the Explanation, vide the Finance Act, 2001, with effect from April
1, 1989, the decision of the Gujarat High Court in the case of Vithaldas H.
Dhanjibhai Bardanwala (supra) no more held the field and, consequently, mere
creation of a provision did not amount to actual write-off of bad debts.

In the civil appeals filed
against the order of the High Court, the Supreme Court observed that broadly,
two questions arose for its determination. The first question that arose for
determination concerned the manner in which actual write-off takes place under
the accounting principles. The second question that arose for determination was,
whether it was imperative for the assessee-bank to close the individual account
of each debtor in its books or a mere reduction in the ‘loans and advances
account’ or debtors to the extent of the provision for bad and doubtful debt was
sufficient.

According to the Supreme
Court, the first question was considered by it in Southern Technologies Ltd. v.
Joint CIT, (2010) 320 ITR 577, in which it had an occasion to deal with the
first question and in that case it had been held that after 1st April, 1989, if
an assessee debits an amount of doubtful debt to the profit and loss account and
credits the asset account like sundry debtors’ account, it would constitute a
write-off of an actual debt. However, if an assessee debits ‘provision for
doubtful debt’ to the profit and loss account and makes a corresponding credit
to the ‘current liabilities and provisions’ on the liabilities side of the
balance sheet, then it would constitute a provision for doubtful debt. In the
latter case, the assessee would not be entitled to deduction.

In regards to view expressed by the Gujarat High Court in Vithaldas H. Dhanjibhai Bardanwala (supra) and sequent insertion of Explanation in S. 36(1)(vii) w.e.f. April 1, 1989 the Supreme Court clarified that in the aforesaid judgment of the Gujarat High Court, a mere debit to the profit and loss account was sufficient to constitute actual write-off, whereas after the Explanation, the assessee is now required not only to debit the profit and loss account, but simultaneously also reduce the loans and advances or the debtors from the assets side of the balance sheet to the extent of the corresponding amount so that at the end of the year, the amounts of loans and advances/debtors is shown as net of the provisions for the impugned bad debt. According to the Supreme Court, the High Court had lost sight of this aspect in its impugned judgment. The Supreme Court, on the first question, therefore, held that the assessee was entitled to the benefit of deduction u/s.36(1)(vii) of the 1961 Act as there was actual write-off by the assessee in its books.

Coming to the second question, the Supreme Court noted that what is being insisted upon by the Assessing Officer is that mere reduction of the amount of loans and advances or the debtors at the end would not suffice and, in the interest of transparency, it would be desirable for the assessee-bank to close each and every individual account of loans and advances or debtors as a pre-condition for claiming deduction u/s.36(1)(vii) of the 1961 Act. This view has been taken by the Assessing Officer because the Assessing Officer apprehended that the assessee-bank might be taking the benefit of deduction u/s.36(1)(vii) of the 1961 Act, twice over. The Supreme Court held that it cannot decide the matter on the basis of apprehensions/desirability. It is always open to the Assessing Officer to call for the details of individual debtor’s account if the Assessing Officer has reasonable grounds to believe that the assessee has claimed deduction, twice over. The Supreme Court observed that the assessee had instituted recovery suits in courts against its debtors. If individual accounts were to be closed, then the debtor/defendant in each of those suits would rely upon the bank statement and contend that no amount is due and payable in which event the suit would be dismissed.

The Supreme Court further observed that according to the Department, it was necessary to square off each individual account, failing which there was likelihood of escapement of income from assessment. According to the Department, in cases where a borrower’s account is written off by debiting the profit and loss account and by crediting loans and advances or debtors accounts on the assets side of the balance sheet, then as and when in the subsequent years if the borrower repays the loan, the assessee will credit the repaid amount to the loans and advances account not to the profit and loss account, which would result in escapement of income from assessment. On the other hand, if bad debt is written off by closing the borrower’s account individually, then the repaid amount in subsequent years will be credited to the profit and loss account on which the assessee-bank has to pay tax. The Supreme Court held that although, prima facie, this argument of the Department appeared to be valid, on a deeper consideration, it is not so for three reasons. Firstly, the head office accounts clearly indicated, in the present case, that on repayment in subsequent years, the amounts were duly offered for tax. Secondly, one had to keep in mind that under the accounting practice, the accounts of the rural branches have to tally with the accounts of the head office. If the repaid amount in subsequent years is not credited to the profit and loss account of the head office, which is ultimately what matters, then there would be a mismatch between the rural branch accounts and the head office accounts. Lastly, in any event, S. 41(4) of the 1961 Act, inter alia, lays down that where a deduction has been allowed in respect of a bad debt or a part thereof u/s.36(1)(vii) of the 1961 Act, then if the amount subsequently recovered on any such debt is greater than the difference between the debt and the amount so allowed, the excess shall be deemed to the profit and gains of business and, accordingly, chargeable to income-tax as the income of the previous year in which it is recovered. In the circumstances, the Supreme Court was of the view that the Assessing Officer was sufficiently empowered to tax such subsequent repayments u/s.41(4) of the 1961 Act and, consequently, there was no merit in the contention that if the assessee succeeded, then it would result in escapement of income from assessment.

The Supreme Court, therefore, upheld the judgment of the Tribunal and set aside the impugned judgment of the High Court.

Bad debt — After April 1, 1989, it is not necessary for the assessee to establish that the debt, in fact, has become irrecoverable.

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27 Bad debt — After April 1,
1989, it is not necessary for the assessee to establish that the debt, in fact,
has become irrecoverable.


[T.R.F. Ltd. v. CIT,
(2010) 323 ITR 397 (SC)]

The Supreme Court was
concerned with the appeals for the A.Y. 1990-91 and the A.Y. 1993-94. The
Supreme Court observed that prior to April 1, 1989, every assessee had to
establish, as a matter of fact, that the debt advanced by the assessee had, in
fact, become irrecoverable. That position got altered by deletion of the word
‘established’, which earlier existed in S. 36(1)(vii) of the Income-tax Act,
1961 (‘the Act’, for short).

The Supreme Court held that
this position in law was well settled. After April 1, 1989, it is not necessary
for the assessee to establish that the debt, in fact, has become irrecoverable.
It is enough if the bad debt is written off as irrecoverable in the accounts of
the assessee. The Supreme Court further held that however, in the present case,
the Assessing Officer had not examined whether the debt had, in fact, been
written off in the accounts of the assessee. When a bad debt occurs, the bad
debt account is debited and the customer’s account is credited, thus, closing
the account of the customer. In the case of companies, the provision is deducted
from sundry debtors. This exercise having not been undertaken by the Assessing
Officer, the Supreme Court remitted the matter to the Assessing Officer for de
novo consideration of the above-mentioned aspect only and that too only to the
extent of the write-off.

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Block assessment — Appeal to the Tribunal (prior to 1-10-1998) against the assessment order could be filed even in the absence of payment of admitted tax.

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6 Block assessment — Appeal
to the Tribunal (prior to 1-10-1998) against the assessment order could be filed
even in the absence of payment of admitted tax.


[CIT v. Pawan Kumar
Laddha, (2010) 324 ITR 324 (SC)]

At the hearing of the appeal
filed by the assessee before the Income-tax Appellate Tribunal against the order
u/s.158C of the Act, the Revenue raised a preliminary objection as to the
maintainability of the appeal on the ground that the assessee having not paid
the admitted tax before filing the appeal, the appeal preferred by him should be
dismissed as not maintainable. In this connection, reliance was placed by the
Department in support of its preliminary objection on S. 249(4)(a) of the 1961
Act.

After going through to
provisions of S. 249(4)(a) and S. 253(1)(b) of the 1961 Act, which at the
relevant time, dealt with an order passed by the Assessing Officer u/s.158C(c)
of the 1961 Act, the Appellate Tribunal held that one cannot read S. 249(4)(a)
into the provisions of S. 253(1)(b) of the 1961 Act, that while S. 253(1) was an
enabling provision giving right of appeal to the assessee to file an appeal to
the Appellate Tribunal, there was no provision similar to S. 249(4)(a), which
fell in Chapter XX-A in S. 253(1)(b), hence, it was not a condition mandatory to
the filing of the appeal to the Appellate Tribunal to pay undisputed tax amount
as condition precedent. Consequently, according to the Appellate Tribunal, there
was no merit in the contention of the Department that an assessee must pay the
admitted tax due before or at the time of filing of the appeal before the
Appellate Tribunal.

Aggrieved by the decision of
the Appellate Tribunal on the preliminary objection raised by the Department,
the matter was carried in appeal u/s.260A of the 1961 Act by the Department to
the High Court of Madhya Pradesh, Indore Bench, which affirmed the view of the
Appellate Tribunal. Hence, the civil appeals were filed before the Supreme
Court.

The Supreme Court held that
Chapter XX deals with ‘Appeals and revisions’. Chapter XX is divided into
headings ‘A’ to ‘F’ S. 246 enumerates a list of orders of the Assessing Officer
against which appeals would lie. In that list of orders, an appeal to the
Appellate Tribunal u/s.253(1) is not mentioned. This was a very important
indicia to show that each heading in Chapter XX deals with a different subject
matter and one could not read the words in Chapter XX-A into the words used in
Chapter XX-B. Chapter XX-A deals with appeals to the Deputy Commissioner and the
Commissioner of Income-tax (Appeals), whereas Chapter XX-B deals with appeals to
the Appellate Tribunal. Similarly, reference to the High Court lies under
Chapter XX-C. It was for this reason that the Supreme Court came to the
conclusion that each heading was a stand-alone item and, therefore, one could
not read the provisions of S. 249(4)(a) into S. 253(1)(b) of the 1961 Act.
According to the Supreme Court, if the argument of the Department was to be
accepted, then, in that event, no appeal or reference could lie even to the High
Court without complying with the provisions of S. 249(4)(a) of the 1961 Act.
This could not be the scheme of the Chapter XX of the 1961 Act. There was one
more reason why the Supreme Court was of the view that 249(4)(a) could not be
read into S. 253(1)(b) of the 1961 Act. S. 253(1)(b) refers to an assessee
filing an appeal to the Appellate Tribunal against an order passed by an
Assessing Officer u/s.158BC(c) of the 1961 Act, Clause (b) came to be inserted
into S. 253(1) by the Finance Act, 1995, and, that too, with effect from 1st
July, 1995. The very concept of block assessment came to be inserted in the
Income-tax Act, 1961, with effect from 1st July, 1995, whereas the words ‘this
Chapter’ in S. 249(4) came to be inserted in the Income-tax Act, 1961, vide the
Taxation Laws (Amendment) Act, 1975, with effect from 1st October, 1975. This
was one more reason to confine the expression ‘this Chapter’ in S. 249(4) to
Chapter XX-A without it being extended to S. 253(1)(b) which is there in Chapter
XX-B. Further, under the scheme of Chapter XX as stated above, no appeal
u/s.249(4)(a) in Chapter XX-A was admissible without the assessee having paid
the admitted tax due on the income returned by him. It appeared that once S.
249(4)(a) is treated as a mandatory condition for filing an appeal before the
Commissioner of Income-tax (Appeals) and once that condition stood satisfied at
the time of his filing an appeal to the Commissioner of Income-tax (Appeals),
then there was no necessity for the assessee to once again pay the admitted tax
due as a condition precedent to his filing the appeal before the Appellate
Tribunal u/s.253(1)(b) of the 1961 Act. The Supreme Court held that lastly, one
must keep in mind the principle that the doctrine of incorporation cannot be
invoked by implication. A provision which insists on the assessee satisfying a
condition of paying the admitted tax as condition precedent to his filing of
appeal u/s.253(1)(b) of the 1961 Act is a restrictive provision. Such a
restrictive provision must be clearly spelt out by the Legislature while
enacting the statute. The Courts have to be careful in reading into the Act such
restrictive provisions as that would tantamount to judicial legislation which
the Courts must eschew. It is for the Parliament to specifically say that no
appeal shall be filed or admitted or maintainable without the assessee(s) paying
the admitted tax due. That has been done only in the case of an appeal u/s.
249(4)(a) of the 1961 Act. The Supreme Court held that it could not read such a
restrictive provision into S. 253(1)(b) of the 1961 Act. If it did so, it was
judicially legislating by reading something into the Act which was not there.

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Co-operative society — Whether the society could be said to be engaged in a cottage industry or whether it could be said to be engaged in a collective disposal of labour of its members — Though Court did not interfere in the matter in absence of material,

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26 Co-operative society —
Whether the society could be said to be engaged in a cottage industry or whether
it could be said to be engaged in a collective disposal of labour of its members
— Though Court did not interfere in the matter in absence of material, a
direction was given to determine the issue having regard to the bye-laws of the
society and Janata Cloth Scheme of the Central Government.


[CIT v. Rajasthan Rajya
Bunker S. Samiti Ltd., (2010) 323 ITR 365 (SC)]

The assessee-society, an
apex society carried on the activity of manufacturing of cloth by supplying raw
material, i.e., yarn, to the weavers, who were the members of the primary
society. The weavers produced cloth strictly in accordance with the directions
given and under the control of the assessee. The assessee paid weaving charges
to the weavers and thereafter marketed and sold the goods so produced. During
the relevant assessment years, cloth was manufactured and sold under the Janata
Cloth Scheme of the Government of India.

For the relevant assessment
years, the assessee claimed a deduction u/s.80P(2)(a)(vi) and u/s.80P(2)(a)(ii)
of the Income-tax Act, 1961 (‘Act’, for short).

The narrow question which
arose for determination before the Supreme Court in those cases was — whether
the assessee-society could be said to be engaged in a cottage industry
u/s.80P(2)(a)(ii) of the Act or whether it could be said to be engaged in the
collective disposal of labour of its members u/s.80P(2)(a)(vi) of the Act ?

It was the contention of the
Department that the weavers were not the members of the apex society. They were
the members of the primary societies. Therefore, the assessee was not entitled
to claim the benefit of deduction u/s.80P(2)(a)(vi) of the Act.

According to the Supreme
Court on both these questions, the Assessing Officer ought to have called for
the bye-laws. It appeared that the bye-laws were not produced before the
Assessing Officer. It appeared that the bye-laws had not been examined by the
Assessing Officer. Further, it was not clear as to whether a weaver could or
could not have become a member of the apex-society under the bye-laws. Even to
answer the question whether the assessee-society was engaged in the cottage
industry, the Department ought to have called for the bye-laws. This exercise
had not been done. In the circumstances, for the relevant assessment years, the
Supreme Court did not interfere with the findings given by the lower courts.
However, the Supreme Court made it clear that this order would not come to the
way of the Department in making assessment for the future assessment years.
However, in such an event, the Department will decide the applicability of S.
80P of the Act [including the proviso to S. 80P(2)] keeping in mind the
provisions of the bye-laws. The said provisions of the bye-laws would point to
the nature of the business of the assessee as also entitlement of the weavers to
become members of the apex society. The Department will examine the Janata
Scheme of the Central Govt. to decide whether the payments made thereunder would
be entitled to deduction u/s.80P(2)(a)(ii) and u/s.80P(2)(a)(vi) of the Act.

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Penalty — Concealment of income — Penalty leviable even in a case where the concealed income reduces the returned loss and finally the assessed income is also a loss or minus figure — Also illustrative guidelines for Courts while writing orders/judgments.

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5 Penalty — Concealment of
income — Penalty leviable even in a case where the concealed income reduces the
returned loss and finally the assessed income is also a loss or minus figure —
Also illustrative guidelines for Courts while writing orders/judgments.


[JCIT v. Saheli Leasing
and Industries Ltd., (2010) 324 ITR 170 (SC)]

On return being filed by the
respondent-assessee, an order u/s.143(3) of the Act was passed on February 28,
1998, showing a total income of Rs. Nil for A.Y. 1995-96.

During the course of
assessment proceedings, it was noticed that the assessee had claimed
depreciation, which was held to be incorrect. Thus, an amount of Rs.24,22,531
was disallowed out of depreciation. Penalty proceedings u/s.271(1)(c) of the Act
were initiated. In response to the show-cause notice issued by the Revenue, the
assessee filed its reply denying the allegations and contending that no penalty
can be imposed on it, when the returned income was nil.

The Deputy Commissioner of
Income-tax, Special Range-2, Surat on the basis of the discussion in the order
held that the assessee was liable to pay penalty, with reference to such
additions to income to be treated as its total income, with reference to
Explanation 4(a) to S. 271(1)(c) of the Act.

Accordingly, the penalty was
levied on concealed income of
`24,22,531 at the
minimum rate of 100 per cent of tax sought to be evaded. Thus, a penalty of
`11,14,364 was imposed on the assessee.

Feeling aggrieved thereby,
the assessee preferred an appeal before the Commissioner of Income-tax
(Appeals). Considering various judgments of the Tribunal and the High Courts,
the appeal of the assessee came to be dismissed and the penalty levied on it
stood confirmed.

The assessee preferred
further appeal before the Income-tax Appellate Tribunal, Ahmedabad. The
Tribunal, on the strength of an earlier order passed by a Special Bench of the
Ahmedabad Tribunal in the case of Apsara Processors (P) Ltd. in ITA No. 284/Ahd./2004,
dated December 17, 2004, came to the conclusion that no penalty can be levied if
the returned income and the assessed income is loss. Accordingly, the orders
passed by the Assessing Officer as well as the Commissioner of Income-tax
(Appeals) were set aside and quashed and the penalty imposed on the assessee was
deleted. It was this order of the Tribunal which was carried further by filing
appeal u/s.260A of the Act in the High Court, which met the fate of dismissal by
the Division Bench.

However, the Division Bench
in its wisdom thought it fit to dispose of the appeal as under :

“Admitted facts are that the
appellant had filed return showing loss and the income is also assessed as ‘nil
income’. When the return was shown as loss as well as assessment of income is
also nil, no penalty u/s.271(1)(c) of the Income-tax Act is attracted. No case
is made out for admission of the appeal. The appeal stands dismissed at the
admission stage.

(Sd.)………………………….
Judge

(Sd.)………………………..
Judge”

On a further appeal, the
Supreme Court found that the Division Bench of the High Court in the impugned
order had decided the question of law as projected before it in the appeal
preferred u/s.260A of the Act, in a most casual manner. The order was not only
cryptic, but did not even remotely deal with the arguments which were sought to
be projected by the Revenue before it.

The Supreme Court observed
that it had, time and again, reminded the Courts performing judicial functions,
the manner in which judgments/orders are to be written but, it was, indeed,
unfortunate that those guidelines issued from time to time were not being
adhered to.

The Supreme Court further
observed that no doubt it is true that brevity is an art, but brevity without
clarity is likely to enter into the realm of absurdity, which is impermissible.

The Supreme Court therefore,
before proceeding to decide the matter on the merits, reiterated few guidelines
for the Courts, while writing orders and judgments to follow the same,
clarifying that the guidelines were only illustrative in nature, not exhaustive
and could further be elaborated looking to the need and requirement of a given
case :

(a) It should always be
kept in mind that nothing should be written in the judgment/order, which may
not be germane to the facts of the case. The ratio decided should be clearly
spelt out from the judgment/order.

(b) After preparing the
draft, it is necessary to go through the same to find out, if anything,
essential to be mentioned, has escaped discussion.

(c) The ultimate finished
judgment/order should have sustained chronology, regard being given to the
concept that it has readable, continued interest and one does not feel like
parting or leaving it midway. To elaborate, it should have flow and perfect
sequence of events, which would continue to generate interest in the reader.

(d) Appropriate care
should be taken not to load it with all legal knowledge on the subject as
citation of too many judgments creates more confusion than clarity. The
foremost requirement is that leading judgments should be mentioned and the
evolution that has taken place ever since are pronounced and thereafter, the
latest judgment, in which all previous judgments have been considered, should
be mentioned. While writing judgment, psychology of the reader has also to be
borne in mind, for the perception on that score is imperative.

(e) Language should not be
rhetoric and should not reflect a contrived effort on the part of the author.

<

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

2. Nestle India Ltd. — (31-12-2009)

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

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

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

3. Fulford India Ltd. — (31-12-2009)

From Notes to Accounts :

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

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

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


4. Pfizer Ltd. — (30-11-2009)

From Notes to Accounts :

Personnel-related provisions :

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

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

The movement in the above provisions are summarised as under :

Capital or revenue expenditure – Replacement of machinery in a spinning mill is not revenue expenditure.

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25 Capital or revenue expenditure – Replacement of machinery
in a spinning mill is not revenue expenditure.



[A]
CIT vs. Sri Mangayarkar
Mills P. Ltd. [2009] 315 ITR 114 (SC)

Entries in the book of accounts may not be determinative as
to the nature of expenditure but were indicative of what the assessee himself
thinks of the expenditure.

The respondent assessee was engaged in the manufacture and
sale of cotton yarn. During the assessment year 1995-96, the assessee claimed an
amount of

Rs.61, 28,150 as being expenditure incurred on replacement of
machinery as revenue expenditure. The assessee believed that such expenditure
was merely expenditure on replacement of spare parts in the spinning mill system
and, therefore, amounted to revenue expenditure. The Assessing Officer (AO) did
not, however, accept this view of the assessee. According to him, each machine
in a spinning mill performs a different function and the product from one
machine is taken and manually fed into another machine and the output obtained.
All the machines are thus not integrally connected. Based on this reasoning, the
Assessing Officer disallowed the above claim of the assessee and held the said
expenditure to be of a capital nature. The AO further held that the assessee had
treated the said expenditure as capital expenditure by capitalizing the assets
in the books of account and had, thus, shown profit in its profit and loss
account to third parties like bankers, financial institutions, creditors,
shareholders, etc. However, from the tax point of view, the respondent wanted to
reduce the net profit and the total taxable income by claiming such huge
expenditure in the statement of total income computation for acquisition of
fixed assets as revenue expenditure. The AO further held that the assessee could
claim depreciation on the said assets as per Income-tax Rules.

On an appeal, the Commissioner of Income Tax (Appeals)
allowed the appeal of the assessee, inter alia, holding that the replacement of
machinery by the assessee in this case constituted revenue expenditure.

On appeal by the Revenue, the Tribunal followed the decision
of the Madras High Court wherein it was decided that replacement of the ring
frame constitutes only replacement of a part of the machinery in textile mills.
The Tribunal thus upheld the order of the Commissioner of Income-tax (Appeals)
and dismissed the appeal of the Revenue.

The High Court, relying on its own decision in CIT vs.
Janakiram Mills Ltd. [2005] 275 ITR 403 (Mad) and CIT vs. Loyal Textile Mills
Ltd. [2006] 284 ITR 658 (Mad), dismissed the appeal filed by the Revenue and
held that the expenditure on replacement of machinery was revenue in nature. The
High Court further held that the question whether the expenditure on replacement
of machinery was capital or revenue in nature was not determined by the
treatment given to it by the assessee in the books of account or in the
balance-sheet. The claim had to be determined only by relying on the provisions
of the Act and not by the accounting practice followed by the assessee.

On further appeal, the Supreme Court observed that the first
issue was whether each machine in a textile mill is an independent item or
merely a part of a complete spinning textile mill, which only together are
capable of manufacture — and there is no intermediate product produced.
According to the Supreme Court, this issue had been satisfactorily answered by
its decision in CIT vs. Saravana Spinning Mills P. Ltd. [2007] 293 ITR 21 (SC).
In that case, the court had held unambiguously that “each machine in a segment
of a textile mill has an independent role to play in the mill and the output of
each division is different from the other.” The Supreme Court thus held that
each machine in a textile mill should be treated independently as such and not
as a mere part of an entire composite machinery of the spinning mill. It can at
best be considered part of an integrated manufacture process employed in a
textile mill.

On the issue of “current repairs” under section 31 of the
Act, in CIT vs. Saravana Spinning Mills P. Ltd. (Supra), it has been laid down
that in order to determine whether a particular expenditure amounted to “current
repairs”, the test was “whether the
expenditure was incurred to preserve and maintain”, an already existing asset
and not to bring a new asset into existence or to obtain a new advantage. For
“current repairs” determination, whether the expenditure was “revenue or capital
was not the proper test”.

The Supreme Court held that replacement of such an old
machine with a new one would constitute the bringing into existence of a new
asset in place of the old one and not repair of the old and existing machine.
Thus, replacement of assets as in the instant case could not amount to “current
repairs”, and the expenditure made by the assessee could not be allowed as a
deduction under Section 31 of the Act.

The Supreme Court observed that given that Section 31 of the
Act was not applicable to the said expenditure of the assessee, the next issue
was whether it could be considered “revenue expenditure” of the nature envisaged
under Section 37 of the Act. The Saravana Mills’ case held that the expenditure
was deductible under Section 37 only if it: (a) was not deductible under Section
30-36, (b) was of a revenue nature, (c) was incurred during current accounting
year, and (d) was incurred wholly and exclusively for the purpose of the
business. According to the Supreme Court, the assessee’s expenditure satisfied
requirements (a), (c) and (d) as stated above. The dispute was with respect to
the nature of expenditure, that is, whether it was revenue or capital in nature.
The Supreme Court was of the opinion that the expenditure of the assessee in
this case was capital in nature.

Before concluding, the Supreme Court observed that it was
clear on record that the assessee had sought to treat the said expenditure
differently for the purpose of computing its profit and for the purpose of
payment of income-tax. The said expenditure had been treated as an addition to
existing assets in the former and as revenue expenditure in the latter. Though
accounting practices may not be the best guide in determining the nature of
expenditure, in this case they were indicative of what the assessee itself
thought of the expenditure it made on replacement of machinery, and that the
claim for deduction under the Act was made merely to diminish the tax burden,
and not under belief that it was actually revenue expenditure.

 

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Co-operative Society – Deduction under Section 80P(2)(e): An assessee-society engaged in distribution of controlled commodities on behalf of the government under Public Distribution System and getting commission is not entitled to deduction under section

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26 Co-operative Society – Deduction under Section 80P(2)(e):
An assessee-society engaged in distribution of controlled commodities on behalf
of the government under Public Distribution System and getting commission is not
entitled to deduction under section 80P(2)(e), as it earned its income from
business and not from letting of godowns or warehouses for the purpose of
storage, processing or facilitating the marketing of commodities.



[B]
Udaipur Sahakari
Upbhokta Thok Bhandar Ltd. vs. CIT [2009] 315 ITR 21 (SC)


The appellant, a co-operative society registered under the
Rajasthan Co-operative Societies Act, 1965, was running a consumer co-operative
store at Udaipur since 1963. It had 30 branches. The appellant was dealing in
non-controlled commodities through its branches. In addition, the appellant was
also doing the work of distribution of controlled commodities such as wheat,
sugar, rice and cloth on behalf of the government under the public distribution
scheme (PDS) for which it was getting commission. The distribution of the
controlled commodities was regulated by the District Supply Officer (DSO
–Authorized Officer) under the Rajasthan Foodgrains and other Essential Articles
(Regulation of Distribution) Order, 1976 (for short, “the 1976 Order”). The
appellant claimed to be stockist/distributor of controlled commodities. It took
delivery from the Food Corporation of India (FCI) and the Rajasthan Rajya
Upbhokta Sangh, as per the directives of the state government. The price,
quantity and the person from whom the delivery was to be taken was fixed by the
state government under the said 1976 Order. After taking the delivery, the
appellant stored these goods in its godowns, both owned and rented. The storage
godowns were open to checking by the concerned officers of the state government.
The stocks stored by the appellant were delivered to fair price shops
(FPS-retailers), as per the directives of the state government. The quantity
price and the FPS to whom the delivery was to be given, were fixed by the state
government. According to the appellant, therefore, the above modus operandi
indicated that the state government exercised total control over the stock of
controlled commodities stored in the godowns of the appellant-society. On
February 28, 1977, the appellant was granted licence for purchase/sale/storage
for sale of foodgrains under the Rajasthan Foodgrains Dealers Licensing Order,
1964.

 

On August 31, 1990, the appellant filed its returns for the
assessment year 1989-90, claiming deduction under section 80P(2)(e) of the 1961
Act on the income of commission received by it from the government for storage
of controlled commodities. The appellant later filed its returns of income for
the subsequent assessment years 1990-91, 1991-92, 1992-93, 1993-94, 1994-95,
1995-96, inter alia, claiming deduction on the income of commission received by
it from the state government for storage of controlled commodities. Vide order
dated March 26, 1992, the AO (Assessing Officer) disallowed the claim on the
ground that the appellant-society was a wholesaler of foodgrains and it was not
a mere stockist as claimed, and consequently, it was not entitled to deduction
under section 80P(2)(e) of the 1961 Act. This order was applied for the
assessment years in question. Aggrieved by the assessment order(s), the
appellant filed appeals before the Commissioner of Income-tax (Appeals). The
Commissioner of Income-tax (Appeals) held that the appellant was entitled to
deduction under section 80P(2)(e) of the 1961 Act on the income of commission
received from the state government for stocking the above foodgrains. This
decision was affirmed by the Tribunal, vide its decision dated October 20, 2000,
dismissing the department’s appeal by a common order holding that the appellant
was entitled to deduction under the said section. This view of the Tribunal,
however, was overruled by the decision dated November 2, 2006, of the Rajasthan
High Court which took the view that the appellant-society was storing the said
controlled commodities in its godowns as part of its own trading stocks; that
the appellant acted as a trader in the essential commodities in question and
consequently the appellant was not entitled to deduction under section 80P(2)(e)
of the 1961 Act. Against the impugned decision, the appellant went to the
Supreme Court by way of petition for special leave.

The Supreme Court, at the outset, noted that the appellant
had composite business. The appellant was a dealer in non-controlled commodities
and it was an authorization holder in respect of controlled commodities under
the 1976 Order. It owned godowns and it also hired godowns on rent. It earned
commission during the relevant assessment years at the rate of 2.25 per quintal
(e.g. for rice). Under clause 20 of the 1976 Order, every authorization holder
had to comply with general or special directions given in writing from time to
time by the Collector in regard to purchase, sale, storage for sale,
distribution and disposal of controlled commodities. The Supreme Court further
noted that the appellant earned commission on the principle of “netting”. In
other words, the appellant set off “issue price” against “sale price” and
retained commission fixed at Rs.2.25 per quintal.

The Supreme Court, referring to the rate fixation mechanism
indicated by one of the orders issued on 12th March, 1987, w.e.f. 1st May, 1987
and adverting to the working given therein, observed that the said working
indicated that Rs.247.82 (issue price) was treated by the appellant as expense
and it was set off against the sale price of Rs.251.07. In other words, the
working indicated cost plus mechanism, i.e. Rs.247.82 was the cost plus profit
margin which included Rs.2.25 as commission. Therefore, Rs.2.25 was part of the
profit margin. The Supreme Court, referring to the written submissions filed by
the appellant, observed that the appellant had taken into its books of account
the consolidated value of the closing stock. According to the Supreme Court, the
circumstances reinforced the finding of the High Court in its impugned judgement
that the appellant was storing the commodities in its godowns as a part of its
own trading stock.

The Supreme Court noted that Section 81(iv), followed by the
Section 14(3)(iv) in the 1922 Act (as amended) was a predecessor to Section
80P(2)(e) of the 1961 Act; and it had come up for consideration before the
Gujarat High Court in the case of Surat Venkar Sahakari Sangh Ltd. vs. CIT
[1971] 79 ITR 722. In that case, it was inter alia held that:

(i) On a plain natural construction of the language used in
section 81(iv) that what is exempted under that section is income derived from
the letting of godowns or warehouses, provided the letting is for any of the
three purposes, namely, ‘storage’, ‘processing’ or ‘facilitating the marketing
of commodities”.

ii) On a proper interpretation of Section 14(3) (iv) and Section 81(iv), separate exemption is not granted in respect of income from the letting of godowns or warehouses for storage, income from processing and income from facilitating the marketing of commodities. But the exemption is available only in respect of income derived from letting of godowns or warehouses where the purpose of letting is storage, processing or facilitating the marketing of commodities.

The Supreme Court approved the reasoning given by the Gujarat High Court on the interpretation of Section 81(iv) and Section 14(3)(iv) of the 1922 Act. The Supreme Court held that on reading the above judgement, it became clear that under Section 80P(2) of the 1961 Act, an assessee is entitled to claim special deduction from its gross total income to arrive at total taxable income. The burden is on the assessee to establish that exemption is available in respect of income derived from the letting of godowns or warehouses, only where the purpose of letting is storage, processing or facilitating the marketing of commodities.

According to the Supreme Court two points arose for its determination, namely, whether the appellant acted as an agent of the government in the subject transaction, and the real nature of the payment received by the said society under the head “commission”. In the view of the Supreme Court, both the points stood covered by the judgement of the Supreme Court in A. Venkata Subbarao vs. State of Andhra Pradesh, AIR 1965 SC 1773. In that case, it was inter alia held that the margin or difference in the purchase and sale price was necessary in order to induce any one to engage in this business, and it was of the essence of a control over procurement and distribution which utilized normal trade channels. It would, therefore, be a misnomer to call it ‘remuneration’ or ‘commission’ allowed to an agent; and so, really no argument could be built on it in favour of the relationship being that of principal and agent. Coming to the question of agency, it was held that the government can derive no advantage from the words “procurement agent” mentioned in the Procuring Order, 1946, from the agreement executed by such procuring agent. The court specifically dismissed the argument advanced on behalf of the government that A. Vernkata Subbarao (appellant) had acted as an “agent” on behalf of the government.

Applying its judgement in the case of A. Venkata Subbarao, the Supreme Court held that the High Court was right in coming to the conclusion that the assessee was storing the commodities in question in its godowns as part of its own trading stock, hence, it was not entitled to claim deduction for such margin under Section 80P(2)(e) of the 1961 Act.

Income or capital receipt : S. 4 of Income-tax Act, 1961 : A.Y. 2004-05 : Assessee built temple of Goddess Adhiparasakthi : Devotees offered gifts to assessee on birthday : Gift amount not income : Not taxable.

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Reported :

19. Income or capital
receipt : S. 4 of Income-tax Act, 1961 : A.Y. 2004-05 : Assessee built temple of
Goddess Adhiparasakthi : Devotees offered gifts to assessee on birthday : Gift
amount not income : Not taxable.

[CIT v. Gopala Naicker
Bangaru, 193 Taxman 71 (Mad.)]

As per profile submitted by
the assessee, he was born in a village. During his childhood, Goddess
Adhiparasakthi frequented his dreams to make it known that she wanted a temple
to be built to alleviate the sufferings of humanity and, accordingly, the
assessee had built a temple which was also known as ‘Sakthi peedam’. Out of
love, and affection and veneration, the devotees of the temple used to assemble
in great numbers on the eve of the assessee’s birthday and offer gifts. The
amounts of gifts so received by the assessee were shown as capital receipts in
his balance sheet. The Assessing Officer treated the gifts as having
nexus to his profession as a religious head and assessed the amount as income.
The Tribunal deleted the addition.

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

“(i) In the instant case,
the assessee, as a religious head, was not involving himself in any profession
or vocation and also not performing any religious rituals/poojas for his
devotees for some consideration or the other. In fact, he was doing charitable
and spiritual work and made his devotees to follow the same for the benefit of
the mankind.



(ii) The devotees out of natural love,
affection and veneration used to assemble in large numbers on the birthdays of
the assessee and voluntarily made gifts, and by any stretch of imagination, it
could not be said that the amounts received by the assessee by way of gifts
would amount to vocation or profession. It was not the case of the Department
that the devotees were compelled to make gifts on the occasion of the
assessee’s birthday. The amounts/gifts received by the assessee could not be
said to have any direct nexus with any of his activities as a religious
person/head.

(iii) Moreover, in the
assessee’s own case in the A.Y. 1988-89, the Department had accepted the
position that gifts received by him on birthdays and other occasions were not
taxable. Since, there was no change in facts and law in the instant case, the
reasons assigned by the Tribunal were correct and there was no infirmity or
error apparent on the face of record in the impugned order.”


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Educational institution : Exemption u/s. 10(23C(vi) of Income-tax Act, 1961 : A.Ys. 2000-01 to 2007-08 : Tests to be applied similar to S. 10(22) : Generation of surplus not a bar : Surplus to be applied to the educational objects of assessee : No distinc

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Reported :

18. Educational institution
: Exemption u/s. 10(23C(vi) of Income-tax Act, 1961 : A.Ys. 2000-01 to 2007-08 :
Tests to be applied similar to S. 10(22) : Generation of surplus not a bar :
Surplus to be applied to the educational objects of assessee : No distinction
between revenue expenditure and capital expenditure.

[Pinegrove International
Charitable Trust v. UOI, 327 ITR 73 (P&H)]

The assessee was running a
school. For the relevant years, the assessee was granted exemption
u/s.10(23C)(vi) of the Income-tax Act, 1961. The exemption was then withdrawn by
the Chief Commissioner on the ground that the profits were substantial and arose
year after year and stating that if substantial profits were earned in one year,
it should be the duty of the institution to lower its fees for the subsequent
year so that such profits were not intentionally generated.

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

“(i) Merely because
profits have resulted from the activity of imparting education that would not
change the character of the institution existing solely for educational
purposes.

(ii) The words ‘not for
the purposes of profit’ accompanying the words ‘existing solely for
educational purposes’ have to be read and interpreted in view of the third
proviso to S. 10(23C)(vi), which prescribes the methodology for the
utilisation and accumulation of income at the hands of the educational
institutions.

(iii) Both on principle
and precedent the capital expenditure is to be deducted from the gross income
of the educational institutions.

(iv) The interpretation of
the Chief Commissioner that there had to be a reasonable profit, only and only
then can an institution be said not to exist solely for the purposes of
profit, was totally a misconception of law.

(v) The Chief Commissioner
failed to keep in view the third proviso while wrongly holding that since
substantial profits were being earned year after year it could not be said
that the surplus was arising incidentally and, therefore, the assessee was not
entitled to exemption.

(vi) The methodology
adopted by the Chief Commissioner while computing surplus in not deducting the
capital expenditure incurred by the assessee from the gross income was
contrary to the third proviso to S. 10(23C)(vi) of the Act. Admittedly, in the
case of the assessee the application of income for the attainment and
achievement of the objects in the last three years, was more than 100%. The
assessee could not be held to be an institution existing for the purpose of
making profit so as not to be entitled to exemption in view of the provisions
of S. 10(23C)(vi) of the Act.”

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Business expenditure : Disallowance u/s.43B of Income-tax Act, 1961 : Luxury tax deferral scheme : Benefit under CBDT Circular Nos. 496 and 674 with reference to sales tax should be given for luxury tax also.

New Page 6

17. Business expenditure :
Disallowance u/s.43B of Income-tax Act, 1961 : Luxury tax deferral scheme :
Benefit under CBDT Circular Nos. 496 and 674 with reference to sales tax should
be given for luxury tax also.


[CIT v. Eastbourne Hotels
(P) Ltd., 233 CTR 86 (HP)]

The assessee had claimed
that in view of the luxury tax deferral scheme the payment of luxury tax be
deemed to be made in the year in which it fell due and accordingly requested not
to make any disallowance of luxury tax u/s.43B of the Income-tax Act, 1961. The
Assessing Officer disallowed the claim. The Tribunal allowed the assessee’s
claim.

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

“(i) The argument of the
Revenue that the CBDT Circular Nos. 496 and 674 make reference to the Sales
Tax Act only and not to luxury tax and, therefore, do not cover the luxury tax
deferral scheme is wholly without force. Deferral schemes for grant of
incentives whether under the Sales Tax Act or any other Act have the same
effect. The purpose is to encourage the industry. The Circulars issued by the
CBDT relate to the manner in which S. 43B has to be interpreted. This
interpretation has to be consistent for every tax deferral scheme and the
interpretation cannot change from Act to Act.

(ii) The CBDT has not
granted any exemptions from the provisions of S. 43B, but has held that if its
instructions are complied with then it will be deemed that the requirements of
S. 43B has been met. This will be applicable across the board to all Acts and
cannot be limited only to the Sales Tax Acts.

(iii) However, before
taking the benefit of the deferral scheme the assessee must produce before the
Assessing Officer the requisite certificates showing that it is covered under
the deferral scheme.”

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Business expenditure : S. 37(1) of Income-tax Act, 1961 : A.Y. 2004-05 : Assessee a cine artist : Expenditure relating to fans association is deductible business expenditure.

New Page 1

Reported :

16. Business expenditure :
S. 37(1) of Income-tax Act, 1961 : A.Y. 2004-05 : Assessee a cine artist :
Expenditure relating to fans association is deductible business expenditure.

[CIT v. A. Vijayakant,
234 CTR 103 (Mad.)]

The assessee is a popular
cine actor. For the A.Y. 2004-05, the assessee had claimed a deduction of
Rs.20,19,000 towards Rasigar Manrams (fans associations) expenses. The Assessing
Officer rejected the claim. The CIT(A) noticed that for the A.Ys. 2001-02 to
2003-04, 80% of the claim was allowed. The CIT(A) therefore restricted the
disallowance to 20%. The Tribunal upheld the order of the CIT(A).

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

“(i) It is a well-known
fact that popular cine artists promote their Rasigar Manrams for the purpose
of promoting their films among the public at large. For that purpose when it
is claimed that substantial amount was spent towards dress, food, etc., at the
time of release of new films as well as for regular maintenance of the Rasigar
Manram activities, it cannot be held that it was not part of their
professional activities, namely, acting in cine field.

(ii) Therefore, the
perception of the CIT(A), which found favour with the Tribunal, cannot be
faulted.

(iii) The appeal fails and
the same is dismissed.”

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Appeal to High Court : Power and duty : S. 260A of Income-tax Act, 1961 : Where a substantial question of law arises, a party should not be denied to raise that question of law at the time of final hearing on the ground that such question was not framed a

New Page 1

Reported :

15. Appeal to High Court :
Power and duty : S. 260A of Income-tax Act, 1961 : Where a substantial question
of law arises, a party should not be denied to raise that question of law at the
time of final hearing on the ground that such question was not framed at stage
of admission of appeal.

[Ankita Deposites and
Advances (P) Ltd. v. CIT, 193 Taxman 36 (HP)]

In this case, the question
before the Himachal Pradesh High Court was as to whether a party can be
permitted to raise a substantial question of law at the time of final hearing,
which has not been framed earlier.

The High Court held as under
:

“(i) A bare reading of S.
260A clearly shows that an appeal to the High Court u/s.260A can only be filed
if a substantial question of law is involved in the appeal. It is the duty of
the High Court to frame the substantial questions of law at the time of the
admission of the appeal. In terms of Ss.(4) of S. 260A, normally, the appeal
should only be heard on the question of law so formulated and the respondent
would have a right to urge that the question so framed is not a substantial
question of law or the question so framed does not arise in the appeal.

(ii) However, the proviso
to this sub-section clearly lays down that nothing in sub-section shall in any
manner impinge on the right of the Court to hear, for the reasons to be
recorded, the appeal on any other substantial question of law not framed by
it, if it is satisfied that the case involves such a question.

(iii) It is the duty of
the Court to do justice and in case a substantial question of law arises, it
would be extremely unfair not to permit the party to raise the substantial
question of law only on the ground that such substantial question of law was
not framed at the stage of admission of the appeal.”

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AOP : Share of member in AOP : S. 86 r/w S. 40(ba), of Income-tax Act, 1961 : Assessee-company member of AOP : No bar on company member from getting benefits of S. 86.

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Reported :

14. AOP : Share of member in
AOP : S. 86 r/w S. 40(ba), of Income-tax Act, 1961 : Assessee-company member of
AOP : No bar on company member from getting benefits of S. 86.

[CIT v. Ideal
Entertainment (P) Ltd., 194 Taxman 81 (Mad.)]

The assessee-company was a
member of an association of persons (AOP). The assessee claimed exemption of
interest received from AOP u/s.86 of the Income-tax Act, 1961. The Assessing
Officer disallowed the claim on the ground that the provisions of S. 86 of the
Income-tax Act, 1961 can be made applicable only to the assessee who is not a
company or co-operative society. On a consideration of S. 86 and comparing the
same with S. 40(ba) the Tribunal allowed the assessee’s claim and held that
there is no bar for the assessee to claim the benefits provided thereunder.

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

“(i) A perusal of S. 86
would clearly show that in the case where the assessee is a member of
association of persons, income-tax was not to be payable by the assessee in
respect of his share in the income of the association or body in the manner
provided u/s.67A of the Act. The exclusion provided under the Section that
other than the company or the co-operative society or a society registered
under the Societies Registration Act, 1860 would be made applicable only to
the association of persons or a body of individuals and not to the member. In
other words, if the association of persons or a body of individuals happened
to be a company or a co-operative society or a society registered under the
Societies Registration Act, 1860 then in such an eventuality the member, who
is also an assessee is not entitled to get the benefits provided u/s.86 of the
Act.

(ii) Further, a reading of
S. 40(ba) of the Act would also make it clear that the share of the assessee
under the income of association of persons shall not be taxable. Hence, a
combined reading of the abovesaid provisions would make it clear that there is
no bar for a private company like the assessee from getting the benefits of S.
86 of the Act.”

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

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


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

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

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

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


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

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

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

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


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

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

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

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

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

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

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

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

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



Notes :

(i) The assessee had chosen not
to appear.

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


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Assessment Order passed at the dictates of higher authority is a nullity – Though the revision and reassessment were held to be not maintainable, the Supreme Court in the exercise of its jurisdiction under 142 of the Constitution of India, directed the as

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29 Assessment Order passed at the dictates of higher
authority is a nullity – Though the revision and reassessment were held to be
not maintainable, the Supreme Court in the exercise of its jurisdiction under
142 of the Constitution of India, directed the assessment to be reopened by the
Commissioner of Income Tax, Delhi.


[CIT vs Greenworld Corporation, (2009)

314 ITR 81 (SC)]

M/s Green World Corporation, a partnership concern of Shri R.
S. Gupta and his wife Smt. Sushila Gupta, had set up two units for manufacturing
exercise books, writing pads, etc., at Parwanoo, in the state of Himachal
Pradesh, in the year 1995. The said units were established after declaration and
enforcement of a policy for tax holiday for a certain period specified in the
Union Budget. They had also set up a third unit for manufacturing computer
software. They started filing income-tax returns from the assessment year
1996-97 showing huge profits. In the return for the assessment year 2000-01,
they disclosed their total sales to the tune of Rs 1, 51, 69,515, of which a sum
of Rs 74, 69,314 was shown as net profit. Thus, the profits bore a proportion of
49 per cent to the gross sales. For the earlier assessment year, i.e.,
1999-2000, the proportion of the net profit to the total sales was as high as 66
per cent; of the total sales of Rs 2,97,12,106, net profits were declared to be
to the tune of Rs 1,96,77,631. For the subsequent three assessment years, i.e.,
2001-02, 2002-03 and 2003-04, the proportion of net profit to the gross sales
were 81 per cent, 95 per cent and 95 per cent respectively. The total investment
on plant and machinery for Unit No. I was shown to be just Rs 1, 25,000, and a
very small amount of money was shown to have been spent on plant and machinery
for the second unit.

On or about February 7, 2000, the Assessing Officer (“AO” )
conducted a survey at the premises of the assessee in terms of section 133A of
the Income-tax Act, 1961 (hereinafter referred to for the sake of brevity as,
“the said Act”) and verified for herself the following: (a) factum of the
existence and actual working of the unit; (b) installation of plant and
machinery working with the aid of power; (c) presence of requisite number of
workers, some of whose statements were recorded; (d) availability of stock of
raw, semi-finished and finished material prior to the assessment year 2000-01.
On or about December 19, 2002, the AO, after completing the proceeding for
assessment, passed an order for the assessment year 2000-01, accepting the
income returned by the assessee.

In the said order of assessment, the AO recorded a note which
read as follows:

“The case was thoroughly discussed with (sic) records and
relevant worthy Commissioner of Income Tax, Shimla, in the presence of the
learned Additional Commissioner of income Tax, Solan Range, Solan. Commissioner
of Income Tax has directed that since the reply submitted by the assessee is
satisfactory and up to the mark, no more information is required to be called
for and to assess the case as such. He, therefore, directed in presence of the
learned Additional Commissioner of Income-tax, Solan Range, Solan, to
incorporate that discussion in the body of the order sheet. A copy of the draft
assessment order was sent to the Additional Commissioner of Income Tax, Solan
Range, Solan, under the office letter No. ITO/PWN. 2002/03/2127, dated December
13, 2002, for according necessary approval. Approval to complete the assessment
was received telephonic from the office of the Additional Commissioner of
Income-tax, Solan Range, Solan, and assessment has been completed and the
assessment order has been served upon the assessee on December 19, 2002”.

The Commissioner of Income Tax (‘CIT”, for short), on whose
dictates the order of assessment, dated December 19, 2002, purported to have
been passed, was transferred and his successor, on or about December 5, 2003,
issued notice to the assessee under section 263 of the Act for the assessment
year 2000-01 only, inter alia, on the premise that the said order of assessment
dated December 19, 2002, was prejudicial to the interests of the revenue.

The CIT (Shimla) passed an order dated July 12, 2004, under
section 263 of the Act, inter alia, on the premise that the AO, while finalizing
the assessment had not examined the case properly. In the said order, the
following directions were issued:

a. To estimate the assessee’s income from the units at
Parwanoo at 5 per cent of the declared turnover. The income shown in excess of
5 per cent was to be treated as undisclosed income from undisclosed sources.

b. As the assessee did not fulfil many of the conditions
for being entitled to deduction under section 80-IA/IB, no part of total
income — not even the income estimated at 5 per cent of the turnover at
Parwanoo — would be entitled for deduction u/s. 80-IA/IB.

c. To charge interest under section 234B/C for non-payment
of advance tax.

d. To initiate penalty proceedings under section 271(1)
(c).

e. To examine the case records for all the preceding
assessment years including those for the assessment year 1996-97, and initiate
necessary proceedings under section 148, within a week.

f. To examine the succeeding assessment years also, i.e.,
the assessment year 2001-02, 2002-03 and 2003-04 and initiate appropriate
action under section 148/143(2), as may be applicable, in a week’s time.

The assessee preferred an appeal against the order dated July
12, 2004, before the Income Tax Appellate Tribunal (for short “ITAT”). In its
memo of appeal, the assessee raised contentions relating to: (1) Jurisdiction,
(2) Bias on the part of the CIT (Shimla), and (3) On the merits of the matter.

By reason of an order dated April 15, 2005, the ITAT allowed
an appeal filed by the assessee, setting aside the order of the CIT (Shimla) on
the jurisdictional issue alone. It did not enter into the merits of the matter.

Pursuant to the said order dated July 12, 2004 or in
furtherance thereof, notices under section 148 of the Act were issued to the
assessee for the assessment year 1996-97 to 1999-2000, 2001-02 and 2002-03.

On or about July 5, 2005, a notice under section 148 of the
Act was also issued for the assessment year 2000-01.

The assessee questioned the legality of the notice under
section 148 of the Act by filing a writ petition before the Himachal Pradesh
High Court.

Also, the CIT (Shimla) preferred an appeal before the High
Court under section 260A of the Act.

The High Court by its order dated March 2, 2006, while
allowing the appeal filed by the CIT (Shimla), dismissed the writ petitions
filed by the assessee.

On an appeal, the Supreme Court held that section 263 provides for a power of revision. It has its own limitations. An order can be interfered with suo motu by the said authority not only when an order passed by the AO is erroneous but also when it is prejudicial to interests of the revenue. Both the conditions for exercising the jurisdiction under section 263 of the Act are conjunctive and not disjunctive. An order of assessment should not be interfered with only because another view is possible.

The Supreme Court held that only in terms of the directions issued by the Commissioner under section 263 of the Act, notices under section 148 were issued. The CIT (Shimla) had no jurisdiction to issue directions. Notices issued pursuant thereto would be bad in law.

The Supreme Court considered the effect of the “noting” made by the Assessing Officer. The Supreme Court observed that the noting was specific. It was stated so in the proceedings sheet at the instance of higher authorities. No doubt in terms of the circular letter issued by the CBDT, the Commissioner or for that matter any other higher authority may have supervisory jurisdiction, but it is difficult to conceive that even the merit of the decision shall be discussed and the same shall be rendered at the instance of the higher authority who, as noticed hereinabove, is a supervisory authority. It is one thing to say that while making the orders of assessment the AO shall be bound by statutory circulars issued by the Central Board of Direct Taxes, but it is another thing to say that the assessing authority, exercising a quasi judicial function and keeping in view the scheme contained in the Act, would lose its independence to pass an order of assessment. The Supreme Court held that when a statute provided for different hierarchies and forums in relation to passing of an order as also appellate or original order, by no stretch of imagination can a higher authority interfere with the independence, which is the basic feature of any statutory scheme involving adjudicatory process.

The Supreme Court, in its conclusion observed that the case before it posed some peculiar questions. Whereas the order under section 263 and consequently the notices under section 148 have been held to be not maintainable, the Supreme Court was constrained to think that the AO had passed an order at the instance of the higher authority, which was illegal. The Supreme Court was of the view that for the aforementioned purpose, it may not go into the question of the authorities acting bona fide or otherwise under the Income Tax Act. They might have proceeded bona fide, but the assessment order passed by the AO on the dictates of the higher authorities being wholly without jurisdiction, was a nullity.

The Supreme Court, therefore, was of the opinion that with a view to do complete justice between the parties, the assessment proceedings should be gone through again by the appropriate assessing authorities. The Supreme Court, therefore, in the exercise of jurisdiction under article 142 of the Constitution of India, directed the assessment to be reopened by the CIT, Delhi.

Manufacture or production of article – Ship breaking activity gives rise to the production of a distinct and different article

New Page 1

28 Manufacture or production of article – Ship breaking
activity gives rise to  the production of a distinct and  different article


[Vijay Ship Breaking Corporation & Ors. vs CIT, (2009) 314
ITR 309 (SC)]

The assessee firm was engaged in the business of ship
breaking at Alang port during the previous year, relevant to the assessment year
1995-96. Old and condemned ships were acquired by the assessee for demolishing.
The Assessing Officer in his order, inter alia, applying the ratio of decision
in CIT vs N.C. Budharaja & Co. [204 ITR 412 (SC), held that ship breaking would
not constitute a manufacturing activity and, therefore, disallowed the claim of
deductions u/s. 80 HH and 80-I of the Act. The Commissioner of Income Tax
(Appeals) agreed with the above view of the Assessing Officer. On appeal, the
Tribunal, relying on the decision in Ship Scrap Traders (251 ITR 806) and
Virendra & Co. vs ACIT (251 ITR 806), inter alia, held that ship breaking
results in production of articles and amounts to manufacture, and that
deductions should be allowed to the assessee under sections 80HH and 80-I of the
Act. On appeal by the revenue, the High Court, inter alia, reversed the order of
the Tribunal holding that ship breaking activity is not an activity of
manufacture or production of any article or thing for the purpose of availing of
the benefit of deductions under section 80HH and 80I of the Act.

On appeal by the assessee, the Supreme Court observed that
the impugned judgment of the Gujarat High Court proceeds on the basis that when
a ship breaking activity is undertaken, the articles which emerged from the
activity continued to be part of the ship; such parts did not constitute new
goods and, consequently, the assessee was not entitled to claim the benefits
under sections 80HH and 80-I of the 1961 Act, as there was neither production
nor manufacture of new goods by the process of ship breaking.

The Supreme Court held that the legislature has used the
words “manufacture” or “production”. Therefore, the word “production” cannot
derive its colour from the word “manufacture”. Further, even in accordance with
the dictionary meaning of the word “production” , the word “produce” is defined
as something which is brought forth or yielded either naturally or as a result
of effort and work (see Webster’s New International Dictionary). It is important
to note that the word “new” is not used in the definition of the word “produce”.
The Supreme Court also drew support from its judgment in CIT vs Sesa Goa Ltd
[2004] 271 ITR 331, which affirmed the judgment of the Bombay High Court in the
case of Ship Scrap Traders (supra). The Supreme Court held that the Tribunal, in
the present case, was right in allowing the deductions under section 80 HH and
80-I to the assessee, holding that the ship breaking activity gave rise to the
production of a distinct and different article.

Another question that arose before the Supreme Court in this
petition was whether the assessee was bound to deduct TDS under section 195(1)
of the Act, in respect of usance interest paid for the purchase of vessel for
ship breaking. The Supreme Court held that it was not required to examine this
question because after the impugned judgment which was delivered on March 20,
2003, the Income Tax Act was amended on September 18, 2003, with effect from
April 1, 1983. By reason of the said amendment, Explanation 2 was added to
section 10(15) (iv) (c). On reading Explanation 2, it was clear that usance
interest was exempt from payment of income-tax, if paid in respect of ship
breaking activity. The assessee was not bound to deduct tax at source once
Explanation 2 to section 10(15)(iv)(c) stood inserted, as TDS arises only if the
internet is assessable in India. And since internet was not assessable in India,
there was no question of TDS being deducted by the assessee.

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Business Expenditure – Allowable only on actual payment – Bank guarantee is nothing but a guarantee for payment on some happening and cannot be equated with actual payment as required under section 43B of the Act for allowance as deduction in the computat

New Page 127 Business Expenditure – Allowable only on actual payment –
Bank guarantee is nothing but a guarantee for payment on some happening and
cannot be equated with actual payment as required under section 43B of the Act
for allowance as deduction in the computation of profits – Bottling Fees is
neither cess nor tax, hence does not fall within the purview of section 43B.

[CIT vs Mc Dowell & Co. Ltd. (No.1), (2009)

314 ITR 167 (SC)]

 

The dispute relates to the assessment year 1988-89. The
question arose in the background of the view of the Assessing Officer as well as
the Commissioner of Income Tax (Appeals), Jodhpur (in short “the Commissioner”),
that the assessee was not entitled to deductions in terms of section 43B of the
Act. The amount in question related to payability of excise duty on wastage. The
assessee took the stand that the provision for excise duty made on wastage of
IMFL in transit which is debited to the customer’s account and credited to this
account does not attract section 43B of the Act. The Income Tax Officer as well
as the Commissioner held that the assessee’s stand was not acceptable. An appeal
was filed before the Income-tax Appellate Tribunal, Jodhpur Bench, Jodhpur (in
short “the ITAT”) which decided the issue in favour of the assessee. In the High
Court, the assessee took the stand that a bank guarantee had been furnished in
respect of the amount and, therefore, there was no scope for applying section
43B of the Act. It was also submitted that section 43B of the Act applied to
payments relatable to tax, duty, cess, or fee. But bottling fees, chargeable
from the assessee under the Rajasthan Excise Act, 1950 (in short “the Excise
Act”) and the Rajasthan Excise Rules, 1962 (in short “the Rules”), and interest
chargeable for late
payment, did not amount to tax, duty and cess. The High Court held that such
fees were not covered under the ambit of section 43B.

The revenue appealed against the said view of the High Court
which, nevertheless, held that furnishing of bank guarantee was not the same as
making payment as stipulated in section 43B of the Act. The Supreme Court held
that the requirement of section 43B of the Act is actual payment and not deemed
payment as condition precedent for making the claim for deduction in respect of
any of the expenditure incurred by the assessee during the relevant previous
year specified in section 43B. The furnishing of bank guarantee cannot be
equated with actual payment which requires that money must flow from the
assessee to the public exchequer, as required under section 43B. By no stretch
of imagination can it be said that furnishing of bank guarantee is actual
payment of tax or duty in cash. The bank guarantee is nothing but a guarantee
for payment on some happening and that cannot be actual payment as required
under section 43B of the Act for allowance as deduction in the computation of
profits.

The Supreme Court further held that section 43B, after
amendment with effect from April 1, 1989, refers to any sum payable by the
assessee by way of tax, duty or fee by whatever name called under any law for
the time being in force. The basic requirement, therefore, is that the amount
payable must be by way of tax, duty and cess under any law for the time being in
force. The bottling fees for acquiring a right of bottling of IMFL which is
determined under the Excise Act and rule 69 of the Rules is payable by the
assessee as consideration for acquiring the exclusive privilege. It is neither
fee nor tax but the consideration for grant of approval by the government as
terms of contract in the exercise of its rights to enter into a contract in
respect of the exclusive right to deal in bottling liquor in all its
manifestations. Referring to various precedents on the subject, the Supreme
Court concluded that the High Court was justified in holding that the amount did
not fall within the purview of section 43B.

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Prosecution: I. T. Act, 1961 and IPC: Withdrawal of prosecution by Public Prosecutor does not require permission from Central Government

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Reported
:

58 Prosecution: I. T. Act, 1961 and IPC: Withdrawal of
prosecution by Public Prosecutor does not require permission from Central
Government

[G.S.R. Krishnamurthy Vs. ITO 228 CTR 562 (Mad)]

 

In 1984, the Income-tax Department had filed a complaint
before the Chief Judicial Magistrate against a number of accused for offences
under the Income-tax Act, 1961 and the corresponding provisions under IPC. In
2006 the Public Prosecutor filed application for seeking consent to  withdraw
the prosecution against Accused Nos. 1 to 3. The operative portion of the order
passed by the Magistrate dismissing the application reads as under:

“12. In view of the above findings that IPC offences u/ss.
120B and 420 are still on record for prosecution and no permission has been
granted by the Central Government to the Special Public Prosecutor to withdraw
the entire case including the IPC offences against A1 to A3, the present
petition to withdraw the case against A1 to A3 is not maintainable and the
same is liable to be dismissed.”

Being aggrieved, the Accused Nos. 1 to 3 filed revision
petitions before the Madras High Court. The High Court allowed the petition
and held as under:

“i) A Public Prosecutor who is appointed by the Central
Government was not required to obtain permission from the Central Government
to withdraw the prosecution against the accused for offences under the IPC and
I. T. Act.

ii) Therefore, the Addl. Chief Judicial Magistrate
misdirected himself in refusing to give consent to withdraw the prosecution
for want of permission of the Central Government.

iii) The impugned order is set aside and the matter is
remitted back to the Magistrate for disposal as per law”

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Offences and Prosecution: Wilful attempt to evade tax: S. 276C of I. T. Act, 1961: A. Y. 1983-84: Disallowance of payment by company to proprietary concern of director: Reduction of disallowance by Tribunal: Reasonableness of payment disputed question of

New Page 1

Reported
:

57 Offences and Prosecution: Wilful attempt to evade tax: S.
276C of I. T. Act, 1961: A. Y. 1983-84: Disallowance of payment by company to
proprietary concern of director: Reduction of disallowance by Tribunal:
Reasonableness of payment disputed question of fact: No deliberate intent to
evade tax: S. 276C not applicable



[K. K. Mohta Vs. Asst. CIT; 320 ITR 387 (Del)]

 


In the A. Y. 1983-84 the assessee company had claimed
deduction of an expenditure of Rs. 29,46,422/- being the amount paid to HSP
towards the work of annealing and pickling of steel slabs at the rate of Rs.
2,500/- per metric tonne. HSP was a proprietary concern of one of the directors
of the company. The Assessing Officer allowed the expenditure at the rate of Rs.
500/- per metric tonne as reasonable. The Tribunal increased the allowance to
Rs. 1,250/- per metric tonne. A complaint was filed by the Asst. Commissioner
u/s. 276C(1) of the Income-tax Act, 1961, on the basis of the disallowance made
by the Assessing Officer. Charge was directed to be framed against the
petitioner (the managing director) and the company for offence u/s. 276C(1) of
the Act. The petitioner filed a revision petition before the trial court. The
revision petition was dismissed on the ground of maintainability.

 

The petitioner, therefore, filed a petition u/s. 482 of the
Code of Criminal Procedure, 1973 before the Delhi High Court for quashing the
proceedings. The High Court allowed the petition and held as under:

“i) The power of High Court u/s. 482 of the Code of
Criminal Procedure, 1973, is intended to ensure that there is no miscarriage
of justice. The High Court may exercise its jurisdiction u/s. 482 of the Code
in a given case even where a revision petition against an order on charge has
already been dismissed by the trial court. The scope of interference by the
Court in such cases u/s. 482 would depend on the facts of a particular case.
In other words, the merits of the case would necessarily have to be examined
in order to determine if interference u/s. 482 is warranted.

ii) If the issue whether the amount paid by the company to
HSP was reasonable or not admitted of more than one point of view, as was
evident from the orders of the Assessing Officer and the Tribunal, then
certainly the essential ingredients of section 276C(1) of the Act of a
deliberate intent on the part of the company to evade the payment of
income-tax could not be said to exist in the present case.”

 


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Full value of consideration: S. 50C of I. T. Act, 1961: A. Y. 2004-05: Section 50C providing for deeming the value for stamp duty purposes as full value of consideration is applicable only for capital assets and not for business assets

New Page 1

Reported
:

56 Full value of consideration: S. 50C of I. T. Act, 1961: A.
Y. 2004-05: Section 50C providing for deeming the value for stamp duty purposes
as full value of consideration is applicable only for capital assets and not for
business assets

[CIT Vs. Thiruvengadam Investments P. Ltd.; 320 ITR 345
(Mad)]

The assessee was engaged in the business of
investment in shares and property development. In the relevant year, i.e. A. Y.
2004-05, the assessee had sold a property held as business asset for a
consideration of Rs. 5 crores. The Sub-Registrar took the guideline value of Rs.
6,94,45,920/-. The Assessing Officer invoked the provisions of section 50C of
the Income-tax Act, 1961 and substituted the stamp duty value of Rs.
6,94,45,920/- for the consideration of Rs. 5 crores. The Tribunal held that the
invocation of the provisions of section 50C was not warranted as the property
was never held by the assessee as capital asset and as per the accounts also the
amount given to the owner of the property has been shown as loans and advances
thereby the property had been treated as a business asset and not as a capital
asset.

 

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

“i) Since the property in the hands of the assessee was
treated as a business asset and not as a capital asset, there was no question
of invoking the provisions of section 50C which pertains to determining the
full value of the capital asset.

ii) The Tribunal had come to the correct
conclusion”


Editor’s Note: The Finance Bill 2010 has proposed an
amendment which accepts this ratio

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Company: Book profit: S. 115J of I. T. Act, 1961: A. Y. 1989-90: Book profit as per the accounts prepared in accordance with Parts II and III of Sch. VI of the Companies Act and not as per the accounts approved at the annual general meeting has to be cons

New Page 1

Reported
:

54 Company: Book profit: S. 115J of I. T. Act, 1961: A. Y.
1989-90: Book profit as per the accounts prepared in accordance with Parts II
and III of Sch. VI of the Companies Act and not as per the accounts approved at
the annual general meeting has to be considered

[Dy. CIT Vs. Arvind Mills Ltd.; 228 CTR 208 (Guj)]

 

In the A. Y. 1989-90, for the purpose of section 115J of the
Income-tax Act, 1961, the assessee company had worked out the book profits in
the accounts prepared in accordance with Sch. VI, part II and III of the
Companies Act. The Assessing Officer adopted the book profit as worked out in
the P & L a/c as per published audited accounts, approved by the annual general
meeting. The Tribunal accepted the assessee’s claim.

 

In the appeal filed by the Revenue, the following question
was raised before the Gujarat High Court:

“That the Tribunal has seriously erred in law and on facts
in holding that preparation of P & L a/c in accordance with Sch. VI, part II
and III of the Companies Act, which is different from the P & L a/c approved
at the annual general meeting is permissible”

 


The Gujarat High Court upheld the decision of the Tribunal
and held as under:

“i) The only requirement of provisions of sub-section (1A)
of section 115J is that the accounts, more particularly, the P & L a/c, for
the relevant previous year has to be
prepared in accordance with Part II and III of Sch. VI of the Companies Act
and accounts so prepared have to be certified by the Chartered Accountant. In
the facts
of the present case, it is not found by any authority that the revised
accounts submitted with revised return of income were not audited. In fact,
the positive averment made by the assessee before CIT(A) remains unrefuted.

ii) In the circumstances, the AO had no powers or
jurisdiction under the provisions of the Act to take a different view of the
matter and had no option but to proceed to determine the taxable profits u/s.
115J as per the said provisions without disturbing the accounts in any manner
whatsoever, including discarding of such accounts, except to the extent
provided in the Explanation to s. 115J. The AO is not vested with any powers
to ignore accounts prepared in accordance with requirements of Parts II and
III of Sch. VI of the Companies Act.

iii) Therefore, the impugned order of Tribunal which holds
so does not suffer from any legal infirmity so as to warrant interference”

 


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Deduction u/s. 80-IA of I. T. Act, 1961: A. Y. 1997-98: Interest received from trade debtors is part of sale price: Is profit derived from industrial undertaking: Is eligible for deduction u/s. 80-IA

New Page 1

Reported
:

55 Deduction u/s. 80-IA of I. T. Act, 1961: A. Y. 1997-98:
Interest received from trade debtors is part of sale price: Is profit derived
from industrial undertaking: Is eligible for deduction u/s. 80-IA

[CIT Vs Advance Detergents Ltd.: 228 CTR 356 (Del)]

 

The assessee is an industrial undertaking which manufactured
and supplied goods to its customers. Some of these customers did not make
payments in time. The dues which were payable by those buyers attracted interest
on late payment charges. In this manner, ultimately, the payments which were
received by the assessee against the supply of goods also included interest on
overdue payments. The Tribunal allowed the assessee’s claim for deduction u/s.
80-IA of the Income-tax Act, 1961 in respect of the sale price including the
interest.


 


In appeal by the Revenue, before the Delhi High Court the
following question was raised:

“Whether the Tribunal was correct in law in holding that
the interest earned by the assessee on late payment received from the
customers is eligible for deduction u/s. 80-IA of the IT Act, 1961?”

 


The Delhi High Court considered the judgment of the Supreme
Court in Liberty India Vs. CIT; 317 ITR 218 (SC). The Court concurred with the
judgment of the Gujarat High Court in Nirma Industries Ltd. Vs. Dy. CIT; 283 ITR
402 (Guj) and upheld the decision of the Tribunal. The Court held as under:

“i) According to the Gujarat High Court, when interest is
paid on delayed payment, it can be treated as higher sale price which is the
converse situation to offering of cash discount because the transaction
remains the same and there is no distinction as to the source. Looking from
this angle, the interest becomes part of the higher sale price and is clearly
derived from the sales made and is not divorced therefrom. It is, thus, the
direct result of the sale of goods and the income is derived from the business
of the industrial undertaking.

ii) We answer this question in favour of the assessee and
against the Revenue”


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Capital or revenue receipt: S. 17(3)(iii) of I. T. Act, 1961: A. Ys. 2003-04 and 2004-05: Amount received by way of compensation for denial of job on basis of gender discrimination: Not in nature of “profit in lieu of salary”: Capital receipt:

New Page 1

Reported
:

53 Capital or revenue receipt: S. 17(3)(iii) of I. T. Act,
1961: A. Ys. 2003-04 and 2004-05: Amount received by way of compensation for
denial of job on basis of gender discrimination: Not in nature of “profit in
lieu of salary”: Capital receipt:


[CIT
Vs. Smt. Rani Shankar Mishra; 320 ITR 542 (Del)]


The assessee applied for a job in the Voice of America which
is a state owned broadcasting agency. The assessee was denied a job on the basis
of gender discrimination. On a class action suit filed on behalf of the women
who had been denied employment, a proposal was made by the Government of United
States to settle the entire class action. The settlement offer was accepted and
a consent decree was drawn up awarding compensation of $ 508 million to the
persons who were not offered the job. The Assessing Officer made addition to the
income of the assessee in respect of the compensation amount and interest
received by the assessee treating it as “profit in lieu of salary” u/s.
17(3)(iii) of the Income-tax Act, 1961. The Tribunal deleted the addition and
held that the amount received by the assessee was in the nature of capital
receipt since the amount was received by the assessee by way of compensation in
respect of job not offered to the assessee on the basis of gender
discrimination.

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

“The Tribunal was justified in holding that the amount
received by way of compensation for not being offered the job on the basis of
gender discrimination was a capital receipt.”

 


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Block assessment proceedings — The question whether the proviso appended to S. 113 imposing surcharge from 1-6-2002 is prospective or retrospective referred to a Larger Bench by the Supreme Court.

New Page 2

  1. Block assessment proceedings — The question whether the
    proviso appended to S. 113 imposing surcharge from 1-6-2002 is prospective or
    retrospective referred to a Larger Bench by the Supreme Court.

[ CIT v. Vatika Township P. Ltd., (2009) 314 ITR 338
(SC)]

In the case before the Supreme Court, the search and
seizure took place on October 6, 2001. An order of block assessment in terms
of S. 158BC was made in respect of the A.Ys. 1984 to 2003. The surcharge was
levied on June 30, 2003.

The question which fell for consideration before the High
Court was as to whether the proviso appended to S. 113 of the Income-tax Act,
1961, is clarificatory and/or curative in nature. The Delhi High Court
following its decision in CIT v. Devi Dass Malhan dismissed the appeal
holding that no substantial question of law arose from the finding of the
Tribunal that proviso is prospective in effect.

Before the Supreme Court in support of his contention that
the said proviso was retrospective in nature, the learned Additional Solicitor
General relied upon a Division Bench decision of the Supreme Court in CIT
v. Suresh N. Gupta, (2008) 297 ITR 322 (2008) 4 SCC 362, 379.

The Supreme Court held that as the said proviso was
introduced with effect from June 1, 2002, i.e., with prospective effect
and by reason thereof, tax chargeable u/s.113 of the Income-tax Act is to be
increased by surcharge levied by a Central Act, it was of the opinion that
keeping in view the principles of law that the taxing statute should be
construed strictly and a statute, ordinarily, should not be held to have any
retrospective effect, it was necessary that the matter be considered by a
larger Bench.

Exemption — Amount received by employees of Reserve Bank of India opting for Optional Early Retirement scheme was eligible for exemption u/s.10(10C).

New Page 1

Exemption — Amount received by employees of Reserve Bank of
India opting for Optional Early Retirement scheme was eligible for exemption
u/s.10(10C).


[Chandra Ranganathan and Others v. CIT, (2010) 326 ITR
49 (SC)]

The appeals before the Supreme Court were directed against
the order passed by the High Court in several tax appeal cases where the
question involved was with regards to the deduction available to the appellants
u/s.10(10C) of the Income-tax Act, 1961. The order of the Commissioner of
Income-tax (Appeals)-IV, Chennai, relating to the A.Y. 2004-05, was questioned
before the Income-tax Appellate Tribunal, Chennai Bench, which were
disposed of by the Tribunal upholding the claim for deduction made by the
appellants. The same was the subject-matter of the tax appeal cases before the
High Court, which referred to the order of the Appellate Tribunal on the basis
of letter F. No. 225/74/2005-ITA-II, dated October 20, 2005, of the Central
Board of Direct Taxes so far as the Reserve Bank of India was concerned. The
High Court held that having regard to the above letter of the Central Board of
Direct Taxes, the amount received by the employees of the RBI opting for
Optional Early Retirement Scheme did not qualify for deduction u/s.10(10C) of
the aforesaid Act.

During the course of hearing of the appeals, it was brought
to the notice of the Supreme Court that by the subsequent letter dated May 8,
2009, issued by the Central Board of Direct Taxes, it was indicated that the
matter had been reviewed on the basis of the judgment of the Bombay High Court
dated July 4, 2008, in the case of CIT v. Koodathil Kallyatan Ambujakshan,
(2009) 309 ITR 113 (Bom.); and it was held that amount received by the retiring
employees of the RBI would be eligible for exemption under the aforesaid
provisions of the Income-tax Act. On behalf of the Union of India and the
Commissioner of Income-tax, the respondent herein, it was submitted that in view
of the said Circular, the respondent would allow the benefit of deduction to the
appellants u/s.10(10C) of the Income-tax Act, 1961, as far as the retired
employees of the Reserve Bank of India were concerned.

Having regard to the above, the Supreme Court held that the
appeals had succeeded and were allowed. The impugned order passed by the High
Court was set aside and that of the Tribunal was restored.

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Business expenditure — Differential payment to cane-growers — Matter remanded.

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Business expenditure — Differential payment to cane-growers —
Matter remanded.


[DCIT v. Shri Satpuda Tapi Parisar SSK Ltd., (2010)
326 ITR 42 (SC)]

The Supreme Court after considering the contentions of the
parties at length was of the view that a large number of questions had remained
unanswered in the case and the following questions were required to be
considered by the Department :

Whether the differential payment made by the assessee(s) to
the cane-growers after the close of the financial year or after the balance
sheet date would constitute an expenditure u/s.37 of the Income-tax Act, 1961,
and whether such differential payment would, applying the real income theory,
constitute an expenditure or distribution of profits?

In deciding the above questions, the Assessing Officer will
take into account the manner in which the business works, resolutions of the
State Government, the modalities and the manner in which the S.A.P. and the
S.M.P. are decided, the time difference which will arise on account of the
difference in the accounting years, etc. In a given case, if the assessee has
made provision in its accounts, then the Assessing Officer shall enquire whether
such provision is made out of profits or from gross receipts and whether such
differential payment is relatable to the cost of the sugarcane or whether it is
relatable to the division of profits amongst the members of the society ?

Another point which would also arise for determination by the
Assessing Officer will be on the theory of overriding title in the matter of
accrual or application of income. Therefore, in each of these cases, the
Assessing Officer will decide the question as to whether the obligation is
attached to the income or to its source.

The Supreme Court observed that none of these questions were
examined by the authorities below. These questions were required to be examined
because, in these cases, it was not only concerned with the applicability of S.
40A(2) of the Act, but was primarily required to consider whether the said
differential payments constituted an expense or distribution of profits. The
Supreme Court held that ordinarily it would not have remitted these matters,
particularly when they were for the A.Y. 1992-93, but, for the fact that this
issue was going to arise repeatedly in future. It would also help the
assessee(s) in a way that they would have to re-write their accounts in future
depending upon the outcome of this litigation. Therefore, in the interest of
justice, the Supreme Court remitted the cases to the concerned Commissioner of
Income-tax (Appeals). It was made clear that both parties were at liberty to
amend their pleadings before the Commissioner of Income-tax (Appeals). The
Supreme Court expressed no opinion on the merits of the case. The parties were
at liberty to argue their respective points uninfluenced by any observations
made in the impugned judgments on the applicability of S. 28 or S. 37 of the
Act.

[Note : Decision of the Bombay High Court in CIT v.
Manjara Shetkari Sahakri Karkhana Ltd., (2008) 301 ITR 191 (Bom.) set aside
and matter remanded.]

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Deduction of Tax at source — When 85% of the fish catch is received after valuation in India by the non-resident company, the same is chargeable to tax in India — Tax ought to have been deducted at source on such value.

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Deduction of Tax at source — When 85% of the fish catch is
received after valuation in India by the non-resident company, the same is
chargeable to tax in India — Tax ought to have been deducted at source on such
value.


[Kanchanganga Sea Foods Ltd. v. CIT & ITO & Ors.,
(2010) 325 ITR 540 (SC)]

The appellant M/s. Kanchanganga Sea Foods Limited, a company
incorporated in India, engaged in sale and export of seafood had obtained a
permit to fish in the exclusive economic zone of India. To exploit the fishing
rights, the appellant-company (hereinafter referred to as the ‘assessee’)
entered into an agreement dated March 7, 1990 chartering two fishing vessels,
i.e., two pairs of Bull trawlers, with Eastwide Shipping Co. (HK) Ltd., a
non-resident company incorporated in Hong Kong.

According to terms of the agreement, the Eastwide Shipping
Co. (HK) Ltd., the owner of the fishing trawlers (hereinafter referred to as the
‘non-resident company’) was to provide fishing trawlers to the assessee for an
all inclusive charter fee of US $ 600,000 per vessel per annum. In terms of the
agreement, the assessee was to receive Rs.75,000 or 15% of the gross value of
catch, whichever was more. The charter fee was payable from earning from the
sale of fish and for that purpose, 85% of the gross earning from the sale of
fish was to be paid to the non-resident company.

Necessary permission to remit 85% of the gross earning from
the sale of fish towards charter fee was granted by the Reserve Bank of India.
As per the agreement, the trawlers were to be delivered at the Chennai Port for
commencement of fishing operation.

The trawlers were delivered to the assessee with full
equipment and complements of staff at the Chennai Port. Actual fishing
operations were done outside the territorial waters of India but within the
exclusive economic zone. The voyage commenced and concluded at the Chennai Port.
The catch made at the high seas was brought to Chennai, where the surveyor of
the Fishery Department verified the log books and assessed the value of the
catch over which local taxes were levied and paid. The assessee, after paying
the dues, arranged customs clearance for the export of fish and the trawlers
which were used for fishing, carried the fish to destination chosen by
non-resident company. The trawlers reported back to the Chennai Port after
delivering fishes to the destination and commenced another voyage. The assessee
did not deduct tax from the payments to the non-resident company, nor produced
any clearance certificate during the A.Ys. 1991-92 to 1994-95. Notice u/s.
201(1) of the Income-tax Act was issued to it to show cause as to why it should
not be deemed to be an assessee in default in relation to tax deductible but not
deducted. The assessee filed objection contending that the non-resident company
did not carry out activities or operations in India which had the effect of
resulting in accrual of income in India and hence it was not obliged to make any
deduction. Alternatively, it contended that even if the operation of bringing
the catch to India Port for customs appraisal and export to the non-resident
company resulted in an operation, it was an operation for mere purchase of goods
and, therefore, there was no income liable for assessment. It also contended
that even if 85% of the catch was considered as charter fee to the non-resident
company, it was paid outside India. Accordingly, the plea of the assessee was
that where the entire income is not taxable, there is no obligation to deduct
tax at source. The Income-tax Officer considered the objections raised by the
assessee and finding the same to be untenable, rejected the same.

On appeal by the assessee, the Deputy Commissioner of
Income-tax (Appeals) declined to
interfere and affirmed the order of the Income-tax Officer.

The assessee unsuccessfully preferred appeal before the
Income-tax Appellate Tribunal.

The High Court answered all the questions referred to it
against the assessee and in favour of the Revenue.

The Supreme Court held that from a plain reading of the provisions of S. 5(2), it was evident that total income of a non-resident company shall include all income from whatever source derived, received or deemed to be received in India. It also includes such income which either accrues, arises or is deemed to accrue or arise to a non-resident company in India. The legal fiction created has to be understood in the light of the terms of contract. Here, in the present case, the chartered vessels with the entire catch were brought to the Indian Port, the catch was certified for human consumption, valued, and after customs and port clearance, the non-resident company received 85% of the catch. So long as the catch was not apportioned, the entire catch was the property of the assessee and not of the non-resident company, as the latter did not have any control over the catch. It was after the non-resident company was given share of its 85% of the catch, it did come within its control. It is trite to say that to constitute income the recipient must have control over it. Thus, the non-resident company effectively received the charter fee in India. Therefore, the receipt of 85% of the catch was in India and this being the first receipt in the eye of law and being in India, would be chargeable to tax. According to the Supreme Court, the non-resident company having received the charter fee in the shape of 85% of the fish catch in India, the sale of fish and realisation of the sale consideration of fish by it outside India shall not mean that there was no receipt in India. When 85% of the catch is received after valuation by the non- resident company in India, in sum and substance, it amounts to receipt of value of money. Had it not been so, the value of the catch ought to have been the price of which the non-resident company sold at the destination chosen by it. According to the terms and conditions of the agreement, charter fee was to be paid in terms of money, i.e., U.S. dollar 600,000 per vessel per annum “payable by way of 85% of gross earning from the fish sales”. In view of the above, there was no escape from the conclusion that the income earned by the non-resident company was chargeable to tax u/s.5(2) of the Income-tax Act.

Therefore, the assessee was liable to deduct tax u/s.195 on payment made to non-resident company and admittedly it having not deducted and deposited was rightly held to be in default u/s.201.

Income — S. 94(7) applies to transactions entered into after its insertion vide Finance Act, 2001 w.e.f. April 1, 2002.

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Income — S. 94(7) applies to transactions entered into after
its insertion vide Finance Act, 2001 w.e.f. April 1, 2002.


[CIT v. Walfort Share and Stock Brokers P. Ltd.,
(2010) 326 ITR 1 (SC)]

The assessee, a member of the Bombay Stock Exchange, earned
income mainly from share trading and brokerage. During the financial year
1999-2000, relevant to the A.Y. 2000-01, the Chola Freedom Technology Mutual
Fund came out with an advertisement stating that tax-free dividend income of 40%
could be earned if investments were made before the record date, i.e.,
March 24, 2000. The assessee by virtue of its purchase on March 24, 2000 became
entitled to the dividend on the units at the rate of Rs. 4 per unit and earned a
dividend of Rs. 1,82,12,862.80. As a result of the dividend payout, the NAV of
the said mutual fund which was Rs. 17.23 per unit on March 24, 2000, at which
rate it was purchased, stood reduced to Rs. 13.23 per unit on March 27, 2000,
which was the succeeding working day in the stock exchange. This fall in the NAV
was equal to the amount of the dividend payout. The assessee sold all the units
on March 27, 2000 at the NAV of Rs. 13.23 per unit and collected an amount of Rs.
5,90,55,207.75. The assessee also received an incentive of Rs. 23,76,778 in
respect of the said transaction. Thus, the assessee thereby received back Rs.
7,96,44,847 (Rs. 1,82,12,862.80 + Rs. 5,90,55,207.75 + Rs. 23,76,778) against
the initial payout of Rs. 8,00,00,000. For income-tax purposes, the assessee in
its return, claimed the dividend received of Rs. 1,82,12,862.80 as exempt from
tax u/s.10(33) of the Income-tax Act, 1961 (‘the Act’) and also claimed a
set-off of Rs. 2,09,44,793 as loss incurred in the sale of the units, thereby
seeking to reduce its overall tax liability.

The Assessing Officer in his assessment order dated March 21,
2003, accepted that the dividend income amounting to Rs. 1,82,12,862.80 was
exempt u/s.10(33) of the Act. However, the Assessing Officer disallowed the loss
of Rs. 2,09,44,793 claimed by the assessee, inter alia, on the ground
that a dividend stripping transaction was not a business transaction, and since
such a transaction was primarily for the purpose of tax avoidance, the so-called
loss was an artificial loss created by a pre-designed set of transactions.
Accordingly, the Assessing Officer deducted the incentive income of Rs.
23,76,778 received by the assessee + transaction charges from the loss of Rs.
2,09,44,793 and added back the reduced loss of Rs. 1,82,12,862.80 to the
repurchase price/redemption value amounting to Rs. 5,90,55,207.75.

Being aggrieved by the disallowance of the reduced loss of Rs.
1,82,12,862.80, the assessee filed an appeal before the Commissioner of
Income-tax (Appeals), who by his order dated December 12, 2003, confirmed the
order of the Assessing Officer saying that the loss of Rs. 1,82,12,862.80
incurred by the assessee on the sale of units should be totally ignored and that
the same should not be allowed to be set off or carried forward.

The assessee moved the Tribunal against the order dated
December 12, 2003. The disallowance stood deleted by the Special Bench of the
Tribunal vide its impugned order dated July 15, 2005, by holding that the
assessee was entitled to set off the said loss from the impugned transactions
against its other income chargeable to tax. This view of the Tribunal was
affirmed by the High Court.

The Supreme Court formulated three points which it required
to decide and those were as follows :


(i) Whether ‘return of investment’ or ‘cost recovery’
would fall within the expression ‘expenditure incurred’ in S. 14A.

(ii) Impact of S. 94(7) with effect from April 1, 2002 on
the impugned transactions.

(iii) Reconciliation of S. 14A with S. 94(7) of the Act.


According to the Department, the differential amount between
the purchase and sale price of the units constituted ‘expenditure incurred’ by
the assessee for earning tax-free income, hence, liable to be disallowed
u/s.14A. As a result of the dividend payout, according to the Department, the
NAV of the mutual fund, which was Rs. 17.23 per unit on the record date, fell to
Rs. 13.23 on March 27, 2000 (the next trading date) and, thus, Rs. 4 per unit,
according to the Department, constituted ‘expenditure incurred’ in terms of S.
14A of the Act.

The Supreme Court held that, expenditure, return on
investment, return of investment and cost of acquisition were distinct concepts.
Therefore, one needed to read the words ‘expenditure incurred’ in S. 14A in the
context of the scheme of the Act and, if so read, it was clear that it
disallowed certain expenditure incurred to earn exempt income from being
deducted from other income which was includible in the ‘total income’ for the
purpose of chargeability to tax.

According to the Supreme Court, a return of investment cannot
be construed to mean ‘expenditure’ and if it is construed to mean ‘expenditure’
in the sense of physical spending, still the expenditure was not such as could
be claimed as an ‘allowance’ against the profits of the relevant accounting year
u/s.30 to u/s.37 of the Act and, therefore, S. 14A cannot be invoked.

The Supreme Court further held that the real objection of the Department appeared to be that the assessee was getting tax-free dividend; that at the same time, it was claiming loss on the sale of the units; that the assessee had purposely and in a planned manner entered into a pre-meditated transaction of buying and selling units yielding exempted dividends with full knowledge about the fall in the NAV after the record date and the payment of tax-free dividend and, therefore, the loss on sale was not genuine. According to the Supreme Court, there was no merit in the above argument of the Department. The Supreme Court observed that there were two sets of cases before it. The lead matter covered assessment years before insertion of S. 94(7) vide the Finance Act, 2001 with effect from April 1, 2002. With regard to such cases, the Supreme Court stated that on the facts it was established that there was a ‘sale’. The sale price was received by the assessee. That, the assessee did receive dividend. The fact that the dividend received was tax- free was the position recognised u/s.10(33) of the Act. The assessee had made use of the said provision of the Act. That such use cannot be called ‘abuse of law’. Even assuming that the transaction was pre-planned, there was nothing to impeach the genuineness of the transaction. With regard to the ruling in McDowell and Co. Ltd. v. CTO, (1985) 154 ITR 148 (SC), the Supreme Court observed that in its later decision in Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706, it has been held that a citizen is free to carry on its business within the four corners of the law. That, mere tax planning, without any motive to evade taxes through colourable devices is not frowned upon even by the judgment of this Court in McDowell and Co. Ltd.’s case (supra). Hence, in the cases arising before April 1, 2002, losses pertaining to exempted income could not be disallowed. However, after April 1, 2002, such losses to the extent of dividend received by the assessee could be ignored by the Assessing Officer in view of S. 94(7).

The next question which the Supreme Court needed to decide was about reconciliation of S. 14A and S. 94(7). According to the Supreme Court, the two operated in different fields. S. 14A deals with disallowance of expenditure incurred in earning tax-free income against the profits of the accounting year u/s.30 to u/s.37 of the Act. On the other hand, S. 94(7) refers to disallowance of the loss on the acquisition of an asset which situation is not there in the cases falling u/s.14A. U/s.94(7), the dividend goes to reduce the loss. S. 14A applies to the cases where the assessee incurs expenditure to earn tax-free income, but where there is no acquisition of an asset. In the cases falling u/s.94(7), there is acquisition of an asset and existence of the loss which arises at a profit of time subsequent to the purchase of units and receipt of exempt income. It occurs only when the sale takes place. S. 14A comes in when there is a claim for deduction of expenditure, whereas S. 94(7) comes in when there is a claim for allowance for the business loss. One must keep in mind the conceptual difference between loss, expenditure, cost of acquisition, etc., while interpreting the scheme of the Act.

Income or capital — Compensation received for sterilisation of the profit-earning source, not in the ordinary course of business, was a capital receipt.

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Income or capital — Compensation received for sterilisation
of the profit-earning source, not in the ordinary course of business, was a
capital receipt.


[CIT v. Saurashtra Cement Ltd., (2010) 325 ITR 422
(SC)]

The assessee, engaged in the manufacture of
cement, etc., entered into an agreement with M/s. Walchandnagar Industries
Limited, Mumbai, (hereinafter referred to as ‘the supplier’) on September 1,
1967 for purchase of additional cement plant from them for a total consideration
of Rs. 1,70,00,000. As per the terms of contract, the amount of consideration
was to be paid by the assessee in four instalments.

The agreement contained a condition with regard to the manner
in which the machinery was to be delivered and the consequences of delay in
delivery.

As per clause 6 of the agreement, in the event of delay
caused in delivery of the machinery, the assessee was to be compensated at the
rate of 0.5% of the price of the respective portion of the machinery, for delay
of each month by way of liquidated damages by the supplier, without proof of
actual loss. However, the total amount of damages was not to exceed 5% of the
total price of the plant and machinery.

The supplier defaulted and failed to supply the plant and
machinery on the scheduled time and, therefore, as per the terms of contract,
the assessee received an amount of Rs. 8,50,000 from the supplier by way of
liquidated damages.

During the course of assessment proceedings for the relevant
assessment year, a question arose whether the said amount received by the
assessee as damages was a capital or a revenue receipt. The Assessing Officer
negated the claim of the assessee that the said amount should be treated
as a capital receipt. Accordingly, he included the said amount in the total
income of the assessee. Aggrieved, the assessee filed an appeal before the
Commissioner of Income-tax (Appeals), but without any success. The assessee
carried the matter further in an appeal to the Tribunal.

According to the Tribunal, the payment of liquidated damages
to the assessee by the supplier was intimately linked with the supply of
machinery, i.e., a fixed asset on capital account, which could be said to
be connected with the source of income or profit-making apparatus rather than a
receipt in course of profit-earning process and, therefore, it could not be
treated as part of receipt relating to a normal business activity of the
assessee. The Tribunal also observed that the said receipt had no connection
with loss or profit, because the very source of income, viz., the
machinery was yet to be installed. Accordingly, the Tribunal allowed the appeal
and deleted the addition made on
this account.

Being dissatisfied with the decision of the Tribunal, as
stated above, at the instance of the Revenue, the Tribunal referred the
questions of law on the above issue for the opinion of the High Court. The
reference having been answered against the Revenue and in favour of the
assessee, the Revenue filed an appeal before the Supreme Court.

The Supreme Court noted that It was clear from clause No. 6
of the agreement dated September 1, 1967, that the liquidated damages were to be
calculated at 0.5% of the price of the respective machinery and equipment to
which the items were delivered late, for each month of delay in delivery
completion, without proof of the actual damages the assessee would have suffered
on account of the delay. The delay in supply could be for the whole plant or a
part thereof but the determination of damages was not based upon the calculation
made in respect of loss of profit on account of supply of a particular part of
the plant. The Supreme Court observed that it was evident that the damages to
the assessee were directly and intimately linked with the procurement of a
capital asset, i.e., the cement plant, which would obviously lead to
delay in coming into existence of the profit-making apparatus, rather than a
receipt in the course of profit-earning process. The Supreme Court held that the
compensation paid for the delay in procurement of capital asset amounted to
sterilisation of the capital asset of the assessee as the supplier had failed to
supply the plant within time as stipulated in the agreement and clause No. 6
thereof came into play. The aforestated amount received by the assessee
toward compensation for sterilisation of the profit-earning source, not in the
ordinary course of their business, was a capital receipt in the hands of the
assessee. The Supreme Court therefore was in agreement with the opinion recorded
by the High Court that the amount of Rs. 8,50,000 received by the assessee from
the suppliers of the plant was in the nature of a capital receipt.

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Industrial undertaking: Deduction u/s. 80IB of I. T. Act, 1961: A Y 2002-03: Deduction allowable in respect of exchange rate difference:

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Unreported :

41 Industrial undertaking: Deduction u/s. 80IB of I. T. Act,
1961: A Y 2002-03: Deduction allowable in respect of exchange rate difference:


CIT Vs. M/s. Rachna Udyog (Bom); ITA No. 2394 of 2009 dated
13/01/2010:

The assessee’s industrial undertaking was entitled to
deduction u/s. 80IB of the Income-tax Act, 1961. The Tribunal had allowed the
deduction in respect of (1) Duty drawback; (2) Export entitlement; (3) DEPB
licence, and (4) Exchange rate difference.

In an appeal by the Revenue, the Bombay High Court set aside
the order of the Tribunal as regards the first three items, in view of the
judgment of the Supreme Court in Liberty India Vs. CIT; (2009) 317 ITR 218 (SC).
And as regards the fourth item, the Bombay High Court held as below:

“i) In so far as the question of difference in the rate of
exchange is concerned, the submission of the assessee before the Assessing
Officer was that exchange rate fluctuation forms a part of the sale proceeds
eligible for deduction u/s. 80IB. According to the assessee, the receipt was
directly related to the process of carrying on the business of the industrial
undertaking. The export invoices were made in terms of US $. When the sale
proceeds of goods exported are received in India in convertible foreign
exchange, the rupee equivalent of the sale proceeds is liable to vary
consequent to the fluctuations in the rate of foreign exchange between the
date when the goods are exported and the date on which the sale proceeds are
received in India. In other words, it was the contention of the assessee that
the value of the goods exported remains the same but the rupee equivalent is
liable to vary due to fluctuation in the rate of foreign exchange.
Consequently, a book entry is made in order to ensure that the rupee
equivalent of the value of the goods exported out of India is correctly
reflected in the books of account, since the books are maintained in rupee
terms.

ii) We are of the view that the difference on account of
exchange rate fluctuation is liable to be allowed u/s. 80IB. The exchange rate
fluctuation arises out of and is directly related to the sale transaction
involving the export of goods of the industrial undertaking. The exchange rate
fluctuation between the rupee equivalent of the value of the goods exported
and the actual receipts which are realized arises on account of the sale
transaction. The difference arises purely as a result of a fluctuation in the
rate of exchange between the date of export and the date of receipt of
proceeds, since there is no variation in the sale price under the contract.

iii) In the circumstances, we would affirm the judgment of
the Tribunal in so far as the question of exchange rate fluctuation is
concerned.

 

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Appeal to ITAT by undertaking owned by the government: Approval from the Committee on Disputes not required:

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Unreported :

 


39 Appeal to ITAT by undertaking owned by the government:
Approval from the Committee on Disputes not required:

M/s. Shivshahi Punarvasan Prakalp Ltd. Vs. UOI (Bom); W. P. No. 2270 of
2009 dated 05/01/2010:


The petitioner is an undertaking owned by the Government of
Maharashtra. The Income Tax Appellate Tribunal dismissed the appeal filed by the
petitioner on the ground that no approval was obtained of the Committee on
Disputes constituted in pursuance of the judgment of the Supreme Court in ONGC
Vs CCE (1992 Suppl (2) SCC 432).

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

“i) The Counsel appearing on behalf of the Revenue has
stated before the court that it was not, and is not the contention of the
Revenue that the approval of the Committee on Disputes was required in order
to prefer an appeal before the Income Tax Appellate Tribunal in a matter
relating to an adjudication of dispute relating to exaction of revenue under
the Income-tax Act, 1961. The learned counsel appearing on behalf of the
assessee has also adopted the same contention. In that view of the matter, the
basis on which the Tribunal dismissed the appeal, namely, on the footing that
approval had to be obtained from the Committee on Disputes appears to be
fallacious.

ii) During the course of this proceeding, we have requested
the Additional Solicitor General to assist the court. The Additional Solicitor
General states that the Union of India would be ready and willing to
constitute a committee to look into a dispute between the central government
and state government entities, on a case to case basis, if so directed by the
court; but this would not be necessary in a matter such as the present which
relates to the adjudication of a dispute under the Income-tax Act, 1961.

iii) Since we have come to the conclusion that the basis on
which the appeal was dismissed by the Tribunal was erroneous, it would be only
appropriate and proper to set aside the order of the Tribunal in order to
facilitate adjudication on merits. In the circumstances, the order of the
Tribunal is restored to the file of the Tribunal for a decision on its
merits.”

 


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Capital gain or business income: Rule of consistency: Profit on sale of shares taken as capital gain in past: Assessment of such profit as business income in the relevant year as business income: Not just:

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In The High Courts

K. B. Bhujle
Advocate


Unreported :



40 Capital gain or business income: Rule of consistency:
Profit on sale of shares taken as capital gain in past: Assessment of such
profit as business income in the relevant year as business income: Not just:

CIT Vs. Gopal Purohit (Bom); ITA No. 1121 of 2009 dated
06/01/2010:

In an appeal u/s. 260A of the Income-tax Act, 1961 by the
Revenue before the Bombay High Court, the following two queries were raised:

"a) Whether, on the facts and circumstances of the case
and in law, the Hon’ble ITAT was justified in treating the income from sale
of 7,59,003 shares for Rs. 5,00,12,879/- as an income from short-term
capital gain, and the sale of 3,88,797 shares for Rs. 6,65,02,340/- as
long-term capital gain, as against the "Income from business" assessed by
the A.O.

b) Whether, on the facts and circumstances of the case
and in law, the Hon’ble ITAT was justified in holding that the principles of
consistency must be applied here as the authorities did not treat the
assessee as a share trader in preceding year, in spite of existence of a
similar transaction, which cannot in any way operate as res judica to
preclude the authorities from holding such transactions as business
activities in current year


The Bombay High Court held as hereunder:


"i) The Tribunal has achieved a pure finding of fact that
the assessee was engaged in two different types of transactions. The first
set of transactions involved investment in shares. The second set of
transactions involved dealing in shares for the purpose of business. The
tribunal has correctly applied the principle of law in accepting the
position that it is open to an assessee maintaining two separate portfolios:
one relating to investment in shares and another relating to business
activities involving dealing in shares. The tribunal held that delivery
based transactions in the present case should be treated as those in the
nature of investment transactions, and the profit received thereof should be
treated either as short-term or, as the case may be, long-term capital gain,
depending on the period of holding. A finding of fact has been arrived at by
the Tribunal as regards the existence of two distinct types of transactions,
namely, those by way of investment on the one hand, and those for the
purposes of business on the other hand. Query (a) above, does not raise any
substantial question of law.

ii) In so far as query (b) is concerned, the Tribunal has
observed in paragraph 8.1 of its judgment that the assessee has followed a
consistent practice with regard to the nature of the activities, the manner
of keeping records and the presentation of shares as investment at the end
of the year, in all the years. The Revenue submitted that a different view
should be taken for the year under consideration, since the principle of res
judicata is not applicable to assessment proceedings. The Tribunal correctly
accepted the position that the principle of res judicata is not attracted
since each assessment year is separate in itself. The Tribunal held that
there ought to be uniformity in treatment and consistency when the facts and
circumstances are identical, particularly in the case of the assessee. This
approach of the Tribunal cannot be faulted. The Revenue did not furnish any
justification for adopting a divergent approach for the assessment year in
question. Query (b), therefore, does not also raise any substantial
question."

 


 



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Tax Deduction at Source in THE Absence of PAN

Editorial

The 1st of April 2010 is not just All Fools Day. It is the
day on which section 206AA of the Income Tax Act comes into effect. This section
basically provides that in cases where tax is deductible at source and the payee
does not furnish his Permanent Account Number (PAN) to the payer, or where the
PAN furnished is invalid, or does not belong to the payee, tax would be
deductible at the actual rate of tax deductible at source (TDS) or 20%,
whichever is higher. This provision will have far-reaching consequences for all
businesses and taxpayers.

Firstly, this provision does not apply only to resident
payees, but also to non-residents and foreign companies which may not have a
presence in India. There are many foreign companies who are paid royalty or fees
for technical services by Indian companies, foreign companies otherwise not
having anything else to do with India. Even in such cases, the tax laws seem to
require such foreign companies to obtain a PAN, or else suffer a higher rate of
TDS. On a practical level, most foreign companies not having a presence in India
are reluctant to obtain a PAN in India, for fear of having to file tax returns
in India, or having further obligations on account of obtaining PAN, etc. Even
if they are willing to obtain a PAN, the procedural requirement of getting their
documents certified by the Indian consulate or embassy in their home country,
acts as a definite dampener and obstacle to their applying for a PAN.

Further, in many cases, the burden of the additional tax
would not fall upon the foreign companies but on the Indian payer companies,
since the foreign companies insist upon receiving their payments tax-free. One
understands that the purpose of ensuring that every payee has a PAN is to
facilitate tax credit under the electronic mode in the Tax Information Network.
In cases where the tax is borne by the Indian payee, is this purpose really
served or does it just add to the cost of the Indian companies?

So far as resident payees are concerned, the income tax
department seems to believe that everybody should have a PAN. In a way, the tax
department is seeking to counter its inefficiency in finding tax evaders through
this measure. Today, PAN is already rquired for most transactions, such as
opening of a bank account, opening of a demat account, subscription to mutual
funds above a limit, share applications above a limit, etc. However, there are
often cases where a person does not have a PAN, and he can give a declaration
instead. It is therefore possible that certain recipients may still not have a
PAN. In such cases, having a higher rate of TDS seems to be justified, to ensure
that such recipients of income are part of the tax net, and if they choose to
remain outside the tax net, they are penalised for it.

The problem however is in cases where the PAN is misstated,
and therefore appears to be of another person or to be invalid. Wherever human
efforts are involved, there are bound to be mistakes. Further, we have to accept
that a large part of our population is not yet fully literate or conversant with
English, and therefore unable to correctly provide the PAN. The presumption of
the tax authorities seems to be that every recipient of income is well trained,
knowledgeable and efficient. While this may be true in a large part for larger
businessmen in bigger cities, the same does not hold good for all depositors or
small businessmen in smaller towns or villages. Common errors can and should be
expected.

In such cases, the payee may be disproportionately penalised
for common clerical errors. While a taxpayer having taxable income can adjust
such excess deduction against his normal tax liability,
persons with income below the taxable limit may have to wait for their refunds,
and lose out in the process. The provision could therefore have the negative
effect of driving certain transactions into the black economy, to avoid these
problems.

The requirement of stating the PAN on all correspondence
between the payee and the payer also seems to be an overdose. Would it mean that
all businesses or depositors should now put their PAN on their letterheads?

Also, while the burden on the taxpayers and public is being
increased, the tax department has to realise that it does have a corresponding
obligation to improve the quality of its services. The process of giving tax
credit has to be improved and made error free, so that no person is deprived of
the legitimate tax payments made on his behalf. TDS payments lying in suspense
in the Tax Information Network have to be sorted out by follow up with the tax
deductor, and proper credit has to be given to the correct deductee. The process
of refunds has to be improved, and speeded up.

It may also be advisable for the tax department to restrict
the applicability of this provision only to resident payees, given the
underlying intention behind the provision. The documentation procedures for
obtaining PAN by foreign companies should also be simplified, so that obtaining
PAN is not regarded as a nuisance. A proper online facility needs to be provided
to all tax deductions free of charge to verify the correctness of the PAN. It is
only then that the provisions would work without causing undue hardship to many.

Gautam Nayak

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TDS : S. 194LA of Income-tax Act, 1961 : Compensation for acquisition of agricultural land : Collector had no jurisdiction to deduct tax at source : Deduction illegal.

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7. TDS : S.
194LA of Income-tax Act, 1961 : Compensation for acquisition of agricultural
land : Collector had no jurisdiction to deduct tax at source : Deduction
illegal.



[Risal Singh v. UOI, 321 ITR 251
(P&H)]

The petitioners received
compensation for acquisition of their agricultural land. While disbursing the
compensation, the Collector made deduction of tax at source and remitted the
amount to the Revenue. The Collector rejected the petitioners’ objection stating
that the deduction has been made on the instructions of the Haryana Urben
Development Authority.

On a writ petition filed by the
petitioners, the Revenue contended that alternative remedy is available to the
petitioners to seek refund after getting assessment done. The Punjab and Haryana
High Court allowed the petition and held as under :


“(i) In the absence of
jurisdiction to deduct tax from compensation for agricultural land, the
stand of the Income-tax Department that since there was a remedy of getting
the assessment done and to receive refund could not be accepted.

(ii) The Collector could not
have made deduction without determining the jurisdictional fact that
compensation was for property other than agricultural land. Thus deduction
of tax at source without determining the plea of the petitioner that the
land was agricultural land was not justified. The amount was said to have
been remitted to the Income-tax Department which was illegal.


(iii) We allow this petition and
direct the Income-tax Department to refund the amount to the Collector within
one month from the date of receipt of a copy of this order. Thereafter, the
Collector will determine whether compensation paid is for property other than
agricultural land or otherwise and whether deduction of tax at source was
permissible under any provisions of law. Whether deduction is permissible or not
will be decided by the Collector within two months from the date of receipt of a
copy of this order. If deduction is found not permissible, the amount will be
refunded to the petitioners not later than three months from receipt of a copy
of this order.”

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Deemed profit : S. 41(1) of Income-tax Act, 1961 : A.Y. 1996-97 : Outstanding liability : Continued as liability in the books : Liability not written back : Liability cannot be said to have ceased to exist : It cannot be treated as income u/s.41(1).

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5. Deemed profit
: S. 41(1) of Income-tax Act, 1961 : A.Y. 1996-97 : Outstanding liability :
Continued as liability in the books : Liability not written back : Liability
cannot be said to have ceased to exist : It cannot be treated as income
u/s.41(1).


[CIT v. GP International Ltd.,
229 CTR 86 (P&H)]

For the A.Y. 1996-97, the
Assessing Officer made an addition of Rs.3,30,000 in respect of the outstanding
amount payable to one M/s. ACP relying on the provisions of S. 41(1) of the
Income-tax Act, 1961. The Tribunal found that the assessee has continued to show
the liability as the outstanding liability and has not written back the same.
The tribunal therefore deleted the addition.

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

“The assessee having shown the
amount payable by it to another company as an existing liability in its books
and not written back the same, it cannot be said that the aforesaid liability
has ceased to exist and, therefore it cannot be treated as income by invoking
the provisions of S. 41(1).”

 

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Manufacture : Exemption u/s.10A, u/s. 10AA of Income-tax Act, 1961 : A.Y. 2004-05 : Definition in Exim Policy applicable : Has wide and liberal meaning : Blending and packing of tea qualifies for exemption.

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6. Manufacture :
Exemption u/s.10A, u/s. 10AA of Income-tax Act, 1961 : A.Y. 2004-05 : Definition
in Exim Policy applicable : Has wide and liberal meaning : Blending and packing
of tea qualifies for exemption.


[Girnar Industries v. CIT, 187
Taxman 136 (Ker.)]

The assessee was an industrial
unit located in the special economic zone, engaged in blending and repacking of
tea for export. For the relevant assessment year i.e., A.Y. 2004-05, it claimed
deduction of export profit in respect of the blended tea exported from the
industrial unit u/s.10A. The assessing authority denied the deduction on the
ground that ‘blending’ did not answer the description of manufacture or
processing before the definition clause of ‘manufacture’ contained in S. 2(r) of
the Special Economic Zones Act, 2005 was incorporated in the provisions of S.
10AA with effect from 10-2-2006. The Tribunal upheld the decision of the
Assessing Officer.

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


“(i) Prior to the passing of
the Special Economic Zones Act, 2005, the assessee’s industry was located in
the zone previously known as ‘Cochin Export Processing Zone’ which is a Free
Trade Zone covered by S. 10A. It is clear from the provisions of S. 10A that
deduction is of the profits and gains derived by the industrial undertaking
from the export of articles, etc., manufactured or produced by it.

(ii) In substance, the
provisions of S. 10A and provisions S. 10AA, which were introduced later on,
serve the very same purpose of granting exemption on the profit earned by
the industrial units in the FTZ/SEZ. These provisions introduced in the
Income-tax Act are essentially for implementation of the EXIM Policy
periodically announced by the Government providing incentives to the
export-oriented units located in the FTZ/SEZ mainly to augment the foreign
exchange earnings. In fact, though S. 10A does not contain a definition for
‘manufacture’, definition of the said term contained in S. 2(r) of the SEZ
Act has been incorporated in S. 10AA with effect from 10-2-2006. Admittedly,
the said definition covers blending also. Therefore, blending and packing of
tea done by the assessee qualified for exemption u/s.10AA from 10-2-2006
onwards.

(iii) The question to be
considered was whether the benefit was available to the assessee for the A.Y.
2004-05 for the reason that the then existing provision of S. 10A did not
contain a definition clause. Admittedly, S. 10A also provides for exemption
in respect of goods manufactured or produced and sold by units in the FTZ.
Undoubtedly, the exemption to industries in the FTZ is granted based on the
EXIM Policy framed by the Government periodically. The definition of
‘manufacture’ as per the EXIM Policy is given a very wide definition to take
in even processing involving conversion of something to another thing with a
distinct name, character and use. Even refrigeration of an item, which
involves only freezing, repacking, labelling, etc., is also covered by the
definition of ‘manufacture’. Blending of tea is mixing of different
varieties of tea produced in estates located in different regions having
different altitudes, climatic conditions, etc. It is common knowledge that
new flavours of tea are generated by blending its different varieties.

(iv) Since the purpose of
exemption u/s.10A is to give effect to the EXIM Policy of the Government,
the definition of ‘manufacture’ contained in the EXIM Policy is applicable.
For the purpose of the said provision, ‘manufacture’ as defined under the
EXIM Policy has a wide and liberal meaning covering tea blending as well
and, therefore, blending and packing of tea qualifies for exemption u/s.10A.

(v) Besides that, the
assessee-industry, presently in the SEZ engaged in the same process of
blending and packing of tea, was specifically brought under the exemption
clause through incorporation of S. 2(r) of the SEZ Act in the provisions of
S. 10AA. Therefore, the later amendment is only clarificatory and the
definition of ‘manufacture’ contained in S. 2(r) of the SEZ Act incorporated
in S. 10AA with effect from 10-2-2006, which is essentially the same as the
definition contained in the EXIM Policy, applies to S. 10A also. Therefore,
blending of tea was a manufacturing activity which entitled the assessee to
exemption u/s.10A for the A.Y. 2004-05.”


 

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Deemed profit : S. 41(1) of Income-tax Act, 1961 : Remission or cessation of trading liability : A.Y. 2004-05 : Trading liability shown as outstanding in books and not written back : No remission or cessation of liability merely on account of passage of t

New Page 1

4. Deemed profit
: S. 41(1) of Income-tax Act, 1961 : Remission or cessation of trading liability
: A.Y. 2004-05 : Trading liability shown as outstanding in books and not written
back : No remission or cessation of liability merely on account of passage of
time : S. 41(1) not attracted : Addition not just.


[CIT v. Smt. Sita Devi Juneja,
187 Taxman 96 (P & H)]

For the A.Y. 2004-05, the
Assessing Officer made an addition of Rs.1.47 crores on account of outstanding
sundry credit balances as on 31-3-2004, relying on the provisions of S. 41(1) of
the Income-tax Act, 1961. CIT(A) held that there was no cessation or remission
of liability and deleted the addition. The Revenue’s appeal was dismissed by the
Tribunal.

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


“(i) It was the conceded
position that in the
assessee’s balance sheet, the liability of Rs.1.47 crores had been shown,
which was payable to the sundry creditors. Such liability shown in the
balance sheet indicated the acknowledgement of the debt payable by the
assessee. Merely because such liability was outstanding for the last six
years, it could not be presumed that the said liability had ceased to exist.

(ii) It was also conceded
position that there was no bilateral act of the assessee and the creditors,
which indicated that the said liability had ceased to exist. In absence of
any bilateral act, the said liability could not have been treated to have
ceased. In view of these facts, the Commissioner (Appeals) as well as the
Tribunal had rightly come to the conclusion that the Assessing Officer had
wrongly invoked the Explanation I to S. 41(1) and made the aforesaid
addition on the basis of presumptions, conjectures and surmises.

(iii) It had been further
found that the Assessing Officer had failed to show that in any earlier year
allowance of deduction had been in respect of any trading liability incurred
by the assessee.

(iv) It was also not proved
that any benefit was obtained by the assessee concerning such a trading
liability by way of remission or cessation thereof during the concerned
year. Thus, there did not accrue any benefit to the
assessee, which could be deemed to be the profit or gain of the assessee’s
business, which would otherwise not be the assessee’s income. It had been
further found as a fact that the assessee had filed the copies of accounts
of sundry creditors signed by the concerned creditors. In view of this fact,
it was to be opined that the ITAT had rightly come to the conclusion that
confirmations from the creditors were produced.”

 



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Appellate Tribunal : Ruling of Authority for Advance Rulings : Not binding on Tribunal : Tribunal can decide in consonance with ruling.

New Page 1

 2 Appellate
Tribunal : Ruling of Authority for Advance Rulings : Not binding on Tribunal :
Tribunal can decide in consonance with ruling.



[CIT v. P. Sekar Trust, 321 ITR
305 (Mad.)]

In this case the Tribunal had
decided an issue before it accepting the ruling of the Authority of Advance
Ruling in Advance Ruling P. No. 10 of 1996, In re (1997) 224 ITR 473 (AAR).

In the appeal filed by the
Revenue, the question raised was as to whether the Tribunal was justified in
following the decision in the Advance Ruling
Authority which does not have binding effect on the assessee’s case.

The Madras High Court held as
under :


“(i) The ruling of the
Authority for Advance Ruling is not binding on others, but there is no bar
on the Tribunal taking a view or forming an opinion in consonance with the
reasoning of the Authority for Advance Ruling de hors the binding nature.

(ii) Since the Tribunal had
not rested its decision on the ruling of the Authority for Advance Rulings,
but had taken in aid and relied on the decision of the Court, the question
of law did not arise for consideration from the order of the Tribunal.”

 



levitra

Deemed dividend : S. 2(22)(e) of Income-tax Act, 1961 : Assessee company received funds from sister concern PE Ltd. for expansion of production capacity as advance for commercial purpose to be adjusted against monies payable by PE Ltd. in subsequent years

New Page 1

3. Deemed
dividend : S. 2(22)(e) of Income-tax Act, 1961 : Assessee company received funds
from sister concern PE Ltd. for expansion of production capacity as advance for
commercial purpose to be adjusted against monies payable by PE Ltd. in
subsequent years : Provisions of S. 2(22)(e) not attracted.


[CIT v. Creative Dyeing &
Painting (P) Ltd., 229 CTR 250 (Del.)]

The assessee company was engaged
in dyeing and printing of cloth and was acting as an ancillary unit of PE Ltd.,
a sister concern, for the last several years. In order to increase its export
business and to compete with the international standards and garment exports
M/s. PE Ltd. suggested modernisation and expansion of the plant and machinery of
the assessee company. Towards this project M/s. PE Ltd. paid to the assessee
company an amount equal to 50% of the project cost as advance to be adjusted
against the entitlement of the moneys of the assessee company payable by PE Ltd.
in the subsequent years. The Assessing Officer treated the said advance amount
as deemed dividend u/s.2(22)(e) of the Income-tax Act, 1961 and made addition
accordingly. The Tribunal deleted the addition, holding that the payment of an
advance for a commercial purpose to the assessee company by its sister concern
is not deemed dividend u/s.2(22)(e) of the Act.

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


“(i) The contention that
since PE Ltd. is not into the business of lending of money, the payments
made by it to the assessee company would be covered by S. 2(22)(e)(ii) and
consequently payments even for business transactions would be a deemed
dividend is not acceptable.

(ii) The provision of S.
2(22)(e)(ii) is basically in the nature of an Explanation. That cannot
however, have bearing on interpretation of the main provision of S. 2(22)(e)
and once it is held that the business transactions do not fall within S.
2(22)(e), one need not go further to S. 2(22)(e)(ii).

(iii) The provision of S.
2(22)(e)(ii) gives an example only of one of the situations where the
loan/advance will not be treated as a deemed dividend, but that’s all. The
same cannot be expanded further to take away the basic meaning, intent and
purport of the main part of S. 2(22)(e). This interpretation is in
accordance with the legislative intention of introducing S. 2(22)(e).

(iv) Therefore, the Tribunal
was correct in holding that the amounts advanced for business transaction
between the parties, namely, the assessee company and PE Ltd. was not such
to fall within the definition of deemed dividend u/s.2(22)(e).”


 

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Agricultural land : Capital Gain : Capital asset : S. 2(14)(iii) of Income-tax Act, 1961 : A.Y. 2001-02 : Measurement of distance from municipality : To be measured in terms of the approach by road and not by a straight-line distance on horizontal plane o

New Page 1

 1 Agricultural
land : Capital Gain : Capital asset : S. 2(14)(iii) of Income-tax Act, 1961 :
A.Y. 2001-02 : Measurement of distance from municipality : To be measured in
terms of the approach by road and not by a straight-line distance on horizontal
plane or as per crow’s flight.


[CIT v. Satinder Pal Singh, 229
CTR 82 (P&H)]

For the purposes of determining
as to whether an agricultural land constitutes a capital asset, the Tribunal
held that the distance from the municipal limits has to be measured as per the
road distance and not as per the straight-line distance on a horizontal plane or
as per crow’s flight.

On appeal by the Revenue, the
Punjab and Haryana High Court upheld the decision of the Tribunal.

 

levitra

TDS : Fees for technical services : Ss. 9(1)(vii) Expl. 2 and 194J of Income-tax Act, 1961 : Assessee cellular network provider : Fee for interconnection between networks not involving human interface : Services not technical services : Not liable for TDS

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Reported :

38. TDS : Fees for technical services : Ss. 9(1)(vii) Expl. 2
and 194J of Income-tax Act, 1961 : Assessee cellular network provider : Fee for
interconnection between networks not involving human interface : Services not
technical services : Not liable for TDS.

[CIT v. Bharati Cellular Ltd., 319 ITR 139 (Del.)]


The assessee, company engaged in providing cellular
telephone facilities to their subscribers, had been granted licences by the
Department of Telecommunication for operating in specific circles. For
providing interconnection, the assessee entered into agreements with MTNL/BSNL,
which were regulated by the TRAI and under the agreement the assessee had to
pay interconnection, access charges and port charges to the interconnection
providers. The Department was of the view that interconnection/port access
charges were liable for tax deduction at source in view of the provisions of
S. 194J of the Income-tax Act, 1961 and that these charges were in the nature
of fees for technical services. The Tribunal held that there was no liability
for TDS.


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


“(i) The services rendered qua interconnection/port
access did not involve any human interface and, therefore, the services
could not be regarded as ‘technical services’ as contemplated u/s.194J of
the Act. The interconnect/port access facility was only a facility to use
the gateway and the network of MTNL/other companies. MTNL or other companies
did not provide any assistance or aid or help to the assessee in managing,
operating, setting up their infrastructure and network.

(ii) No doubt, the facility of interconnection and port
access provided by MTNL/other companies was ‘technical’ in the sense that it
involved sophisticated technology. The expression ‘technical service’ was
not to be construed in the abstract and general sense but in the narrower
sense as circumscribed by the expressions ‘managing service’ and
‘consultancy service’ as appearing in Explanation 2 to S. 9(1)(vii) of the
Act. The expression ‘technical service’ would have reference to only
technical service rendered by a human. It would not include any service
provided by machines or robots.



(iii) The interconnect charges/port access charges could not be regarded
as fees for technical services.”

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Business Income: Deemed Profit: S. 41(1) of I. T. Act, 1961: A. Y. 2002-03: Write back/off of amount which had not entered P & L a/c: S. 41(1) has no application

New Page 1

Reported
:

52 Business Income: Deemed Profit: S. 41(1) of I. T. Act,
1961: A. Y. 2002-03: Write back/off of amount which had not entered P & L a/c:
S. 41(1) has no application

[CIT Vs. Saden Vikas India Ltd.; 320 ITR 538(Del)]


 


The assessee had received Rs. 50 lakhs as advance from PAL
for supply of components for automobiles manufactured by the latter. After
receipt of the amount a strike took place in the plant of PAL which resulted in
the suspension of the production and all transactions. PAL requested the
assessee to subscribe the said amount of Rs. 50 lakhs in its sister concern.
Accordingly the assessee invested the sum of Rs 50 lakhs in 12% optionally
convertible debentures of the said sister concern of PAL. However, both PAL and
its sister concern ran into difficulties and the assessee did not receive any
interest from the debentures and even the prospect of recovery of the maturity
value of the debentures became uncertain. The assessee therefore decided to
write off the amount both in the debit and credit sides of the balance-sheet.
The Assessing Officer made an addition of Rs. 50 lakhs invoking the provisions
of section 41(1) of the Income-tax Act, 1961. The Commissioner (Appeals) deleted
the addition and held that the assessee was entitled to write off the amount.
The Tribunal confirmed the order of the Commissioner (Appeals).

 

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

“i) The assessee had received the sum of Rs. 50 lakhs only
on the capital account for infrastructure on behalf of PAL and it had a right
to use such capital asset for manufacture of air-conditioning systems for cars
to be produced by PAL. The undisputed fact was that the amount of Rs. 50 lakhs
written off was not allowed as deduction nor did it represent trading
liability which had gone into the computation of income for earlier years.

ii) The Tribunal noted the above facts and held that
writing off the amount would not attract the provisions of section 41(1). The
conclusion arrived at by the Tribunal was correct and justified.”


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Constitutional validity — National Tax Tribunal — Challenge not similar to the appeal relating to the constitutional validity or National Company Law Tribunal — Matter separated.

New Page 1

4 Constitutional validity —
National Tax Tribunal — Challenge not similar to the appeal relating to the
constitutional validity or National Company Law Tribunal — Matter separated.


[Madras Bar Association
v. Union of India and Another, (2010) 324 ITR 166 (SC)]

In the petitions before the
Supreme Court, the constitutional validity of the National Tax Tribunal Act,
2005 (‘the Act’ for short) was challenged. In T.C. No. 150 of 2006, additionally
there was challenge to S. 46 of the Constitution (Forty-second Amendment) Act,
1976 and Article 323B of the Constitution of India. It was contended that S. 46
of the Constitution (Forty-second Amendment) Act, is ultra vires the
basic structure of the Constitution as it enables proliferation of Tribunal
system and makes serious inroads into the independence of the judiciary by
providing a parallel system of administration of justice, in which the executive
has retained extensive control over matters such as appointment, jurisdiction,
procedure, etc. It is contended that Article 323B violates the basic structure
of the Constitution as it completely takes away the jurisdiction of the High
Courts and vests it in the National Tax Tribunal, including trial of offences
and adjudication of pure questions of law, which have always been in the
exclusive domain of the judiciary.

On January 21, 2009, when
arguments in C.A. No. 3067 of 2004 and C.A. No. 3717 of 2005, which related to
the challenge to Parts IB and IC of the Companies Act, 1956 were in progress
before the Constitution Bench, it was submitted that these matters involved a
similar issue and they could be tagged and disposed of in terms of the decision
in those appeals. Therefore the Constitution Bench directed these cases to be
listed with those appeals, even though there was no order of reference in these
matters.

C.A. No. 3067 of 2004 and
C.A. No. 3717 of 2005 were subsequently heard at length and were reserved for
judgment. The matters which were tagged were also reserved for judgment.

While disposing of C.A. No.
3067 of 2004 and C.A. No. 3717 of 2005, the Supreme Court observed that insofar
as the cases relating to the National Tax Tribunal were concerned, the T.C.
(Civil) No. 150 of 2006 involved the challenge to Article 323B of the
Constitution. The said Article enables appropriate Legislatures to provide by
law, for adjudication of trial by Tribunals of any disputes, complaints or
offences with respect to all or any of the matters specified in clause (2)
thereof. Sub-clause (i) of the clause (2) of Article 323B enables such Tribunals
to try offences against laws with respect to any of the matters specified in
clauses (a) to (h) of clause (2) of the said Article.

One of the contentions urged
in support of the challenge to Article 323B related to the fact that the
Tribunals do not follow the normal rules of evidence contained in the Evidence
Act. In criminal trials, an accused is presumed to be innocent till proved
guilty beyond reasonable doubt, and the Evidence Act plays an important role, as
appreciation of evidence and consequential finds of facts are crucial. The trial
would require experience and expertise in criminal law, which means that the
judge or the adjudicator to be legally trained. The Tribunals which follow their
own summary procedure, are not bound by the strict rules of evidence and the
members will not be legally trained. Therefore it may lead to convictions of
persons on evidence which is not sufficient in probative value or on the basis
of inadmissible evidence. It was submitted that it would thus be a retrograde
step for separation of executive from the judiciary.

The Supreme Court observed
that the appeals on issues on law are traditionally heard by the Courts. Article
323B enables the Constitution of Tribunals which will be hearing appeals on pure
questions of law which is the function of the Courts. In L. Chandra Kumar v.
Union of India (1997) 3 SCC 261 it had considered the validity of only clause
(3)(d) of Article 323B, but did not consider the validity of other provisions of
Article 323B.

The Supreme Court noted that
the appeals relating to constitutional validity of the National Company Law
Tribunal under the Companies Act, 1956 did not involve the consideration of
Article 323B. The constitutional issues raised in T.C. (Civil) No. 150 of 2006
were not touched as the power to establish company Tribunals was not traceable
to Article 323B but to several entries of Lists I and III of the Seventh
Schedule and consequently there was a challenge to this article.

The Supreme Court observed
that the basis of attack in regard to Parts IB and IC of the Companies Act and
the provisions of the NTT Act were completely different. The challenge to Parts
IB and IC of the Companies Act, 1956 sought to derive support from Article 323B
by contending that Article 323B was a bar for constitution of any Tribunal in
respect of matters not enumerated therein. On the other hand the challenge to
the NTT Act was based on the challenge to Article 323B itself.

The Supreme Court therefore
was of the view that these petitions relating to the validity of the NTT Act and
the challenge to Article 323B raised issues which did not arise in the two civil
appeals. Therefore these cases could not be disposed of in terms of the decision
in the civil appeals, but were required to be heard separately. The Supreme
Court accordingly directed that these matters be delinked and listed separately
for hearing.

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Disclosure of Accounting Policies by Professional Bodies

5 International Accounting Standards Committee (IASC) Foundation — (31-12-2009)

    Accounting Policies :

    (a) Basis of preparation :

    These financial statements have been prepared in accordance with International Financial Reporting Standards, on the historical cost basis, as modified by the revaluation of financial assets and liabilities, including derivative financial instruments, at fair value through profit or loss. The policies have been consistently applied to all years presented, unless otherwise stated.

    For the purposes of organising the financial information the IASC Foundation has categorised income and expenses into two categories. Standard-setting and related activities include all activities associated with standard-setting and support functions required to achieve the organisations objectives. Publications and related activities include information related to the sales of print and electronic IFRS materials, educational activities and Extensible Business Reporting Language (XBRL).

    (b) Contributions :

    Contributions are recognised as revenue in the year designated by the contributor.

    (c) Publications and related revenue :

    Subscriptions to the IASC Foundation’s comprehensive package and eIFRS products are recognised as revenue on a time-apportioned basis over the period covered by the subscriptions. Royalties are recognised as revenue on an accrual basis. Publications’ direct cost of sales comprises printing, salaries, promotion, computer and various related overhead costs.

    (d) Inventories :

    Inventories of current publications are valued at the lower of net realisable value and the cost of printing the publications, on a first-in-first-out basis. Inventories that have been superseded by new editions are written off.

    (e) Depreciation :

    Leasehold improvements and furniture and equipment are initially measured at cost, and depreciated on a straight-line basis (in the case of leasehold improvements over the period of the lease). All other assets are depreciated over 5 years, except computer equipment, which is depreciated over 3 years.

    (f) Foreign currency transactions :

    The IASC Foundation’s presentational and functional currency is sterling. Transactions denominated in currencies other than sterling are recorded at the exchange rate at the date of the transaction. Differences in exchange rates are recognised in the Statement of Comprehensive Income. Monetary assets and liabilities are translated into sterling at the exchange rate at the end of the reporting period.

    (g) Operating leases — Office accommodation :

    Lease payments for office accommodation are recognised as an expense on a straight-line basis over th e non-cancelable term of the lease. Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. The aggregate benefit of lease incentives is recognised as a reduction of the rental expense over the lease term on a straight-line basis.

    (h) Financial assets :

    Regular purchases and sales of financial assets are recognised on the trade date, the date on which the IASC Foundation is committed to purchase or sell the asset. Investments are recognised initially at fair value plus transaction costs for all financial assets not carried at fair value through profit or loss. Financial assets are derecognised when the rights to receive cash flows from the investments have expired or have been transferred and the IASC Foundation has transferred substantially all risks and rewards of ownership. The IASC Foundation classifies financial assets as subsequently measured at either amortised cost or fair value based on its business model for managing the financial assets and the contractual cash flow characteristics of the financial asset. All financial assets, except for bonds and derivatives, are carried at amortised cost as the objective is to hold these assets in order to collect contractual cash flows and those cash flows are solely principal and interest. Investments in bonds are classified as subsequently measured at fair value through profit or loss, and the corresponding gains or losses are included within profit (loss) before tax. Bond holdings are discussed more fully in Note 10.

    (i) Derivative financial assets and liabilities :

    The IASC Foundation uses contributions, primarily in US dollars and euro, to fund a portion of sterling obligations arising from its activities. In accordance with its financial risk management policy, the IASC Foundation does not hold or issue derivative financial instruments for trading purposes; the forward foreign currency hedges are entered into to provide certainty regarding funding to protect against currency fluctuation on future cash flows that are designated in US dollars and euro. Derivative financial instruments are recognised and subsequently measured at fair value. The corresponding gains or losses are included within profit (loss) before tax.

    (j) Provisions and contingencies :

    Provisions are recognised when the following three conditions are met — the IASC Foundation has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. The amount of the provision represents the best estimate of the expenditure required to settle the obligation at the end of the reporting period. Provisions are measured at the present value of the expenditure expected to be required to settle the obligation using a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the obligation. The increase in the provision due to the passage of time is recognised as interest expense.

    (k) Critical accounting estimates and judgments :

    The IASC Foundation makes estimates and assumptions regarding the future. In the future, actual experience may differ from those estimates and assumptions. The Trustees consider there are none that are material to the preparation of the financial statements.

        l) New standards and interpretations issued:

    The financial statements have been drawn up on the basis of accounting standards, interpretations and amendments effective at the beginning of the accounting period on 1 January 2009, except for that explained below. The IASC Foundation has concluded that there are no other relevant standards or interpretations in issue not yet adopted.

    l Standard adopted early IFRS 9 Financial Instruments was issued in November 2009 and is required to be applied from 1st January 2013. The presentation of the IASC Foundation’s financial statements has not significantly changed as a result of the early adoption of the new standard as it did not change the measurement of any assets.

        m) Reclassification of items in the financial statements:

    In order to conform to the current year’s presentation in the financial statements, the following comparative amounts were reclassified. The changes in presentation are to improve the information provided :

        Recruitment expenses are included in Other Costs and listed in Note 9. The prior year amount of £ 126,000 was presented as follows : £ 121,000 was included in salaries, wages and benefits; £ 5,000 was included in Trustees’ fees. A corresponding change has been made to the statement of cash flows and the details of salaries, wages and benefits as disclosed in Note 5.

        Fundraising expenses are included in Other Costs and listed in Note 9. In the prior year, £ 36,000 was listed separately in the statement of comprehensive income.

        The details of accommodation expenses presented in Note 8(a) has been expanded to disclose the amount included in publication costs.

        The details of cash holdings presented in Note 10(a) have been clarified by listing currencies irrespective of their country location.

    6. The Institute of Chartered Accountants of  India — (31-3-2009)

    Statement on Significant Accounting Policies:

    I.    Accounting convention:

    These accounts are drawn up on historical cost basis and have been prepared in accordance with the applicable Accounting Standards issued by the Institute of Chartered Accountants of India and are on accrual basis unless otherwise stated.

    II) Revenue recognition:

        a. Membership Fee

    i. The Entrance Fee is collected at the time of admission of a person as a member and one-third thereof is recognised as income in that year.

    ii. Annual Membership and Certificate of Practice Fee(s) are recognised in the year as and when these become due.

    b. Distant Education and Post-Qualification Course Fee are recognised over the duration of the course.

    c.Examination Fee is recognised on the basis of conduct of examination.

    d. Subscription for Journal is recognised in the year as and when it becomes due.
    e. Revenue from Sale of Publications is recognised at the time of preparing the sale bill i.e., when the property in goods as well as the significant risks and rewards of the property get transferred to the buyer.

    Income from Investments:

        i. Dividend on investments in units is recognised as income on the basis of entitlement to receive.

        ii.     Income on Interest-bearing securities and fixed deposits is recognised on a time-proportion basis taking into account the amount out-standing and the rate applicable.

    III. Allocations/transfer to reserves & surplus and earmarked fund :

    a) Admission Fee from Fellow Members and brd portion of the Entrance Fee from persons ad-mitted as Members are taken to Infrastructure Reserve.

    b) Donations received during the year for build-ings and for research purpose are accounted for directly under the respective Reserves Account.

    c) 25% of the Distant Education Fee not ex-ceeding 50% of the net surplus of the year is transferred to Education fund.

    d) 0.75% of Membership Fee (Annual and Certificate of Practice Fee) received from the members during the year is allocated to the Employees’ Benevolent Fund.

    e) Transfer to Education Reserve from the following earmarked funds :

 

    f) Income from investments of Earmarked Funds is allocated directly to Earmarked Funds on opening balances of the respective Earmarked Funds on the basis of weighted average method.

    IV.    Fixed assets/depreciation and amortisation :

    a) Fixed Assets excluding land are stated at historical cost less depreciation.

    b) Freehold land is stated at cost. Leasehold land is stated at the amount of premium paid for acquiring the lease rights. The premium so paid is amortised over the period of the lease.

    c) Depreciation is provided on the written down value method at the following rates as approved by the Council based on the useful life of the respective assets :

  

       
    d) Depreciation on additions is provided on monthly pro-rata basis.

    e) Library books are depreciated at the rate of 100% in the year of purchase.

    f) Intangible Assets (Software) are amortised equally over a period of three years.

        V) Investments:

    a. Long-term investments are carried at cost and diminution in value, other than temporary is provided for.

    b. Current investments are carried at lower of cost or fair value.
     

    VI.    Inventories:

    Inventories of paper, consumables, publications and study material are valued at lower of cost or net realisable value. The cost is determined on FIFO Method.

    VII. Foreign currency transactions:

        a) Foreign currency transactions are recorded on initial recognition in the reporting currency by applying to the foreign currency amount at the exchange rate prevailing on the date of transaction.

        b) All incomes and expenses are translated at average rate. All monetary assets/liabilities are translated at the year-end rates whereas non-monetary assets are carried at the rate on the date of transaction.

        c) Any income or expense on account of ex-change rate difference is recognised in the Income and Expenditure Account.

    VIII.    Employee benefits:

        a) Short-term employee benefits are charged off in the year in which the related service is rendered.

        b) Post-employment and other long-term employee benefits are charged off in the year in which the employee has rendered services. The amount charged off is recognised at the present value of the amounts payable determined on the basis of actuarial valuation. The actuarial valuation is done as per Projected Unit Credit Method. Actuarial gain and losses in respect of post-employment and other long-term benefits are charged to Income & Expenditure Account and are not deferred.

        c) Retirement benefits in the form of Provident Fund are a defined contribution scheme and the contribution to the Provident Fund Trust is charged to the Income and Expenditure Account for the period when the contribution to the respective fund is due.

    IX.    Impairment of assets:

        a) The carrying amounts of assets are reviewed at each Balance Sheet date if there is any indication of impairment based on internal/ external factors. An impairment loss is recognised wherever the carrying amount of an asset exceeds its recoverable amount. The recoverable amount is higher of asset’s net selling price and value in use. In assessing the value in use, the estimated future cash flows are discounted to their present value at the weighted cost of capital.

        b) After impairment, depreciation is provided on the revised carrying amount of the assets over its remaining useful life.

        x. Provisions:

    A provision is recognised when an enterprise has a present obligation as a result of past events; it is probable that an outflow of resources will be required to settle the obligation, in respect of which a reliable estimate can be made. Provisions are not discounted to its present value and are determined based on best estimates required to settle the obligations at the Balance Sheet date. These are reviewed at each Balance Sheet date and adjusted to reflect the current best estimates.

    7. Bombay Chartered Accountants’ Society — (31-3-2010)

    Significant accounting policies:

        a) Method of Accounting:

    Accounts are maintained on accrual basis.

        b) Fixed Assets and Depreciation:

    Fixed assets are stated at cost. Depreciation is provided on fixed assets as per the written-down value method at the rates prescribed in the Income Tax Rules except for books on which depreciation is provided at the rate of 50% per annum.

        c) Investments:

    Investments are stated at cost of acquisition less permanent diminution (if any) in compliance with AS-13 issued by The Institute of Chartered Accountants of India.

        d) Inventories:

    Inventories are stated at cost.

        e) Life Membership & Entrance Fees:

    Life Membership fees and Entrance fees are credited to Corpus Fund.

        f) Gratuity:

    The premium payable each year on the Group Gratuity Policy taken with Life Insurance Corporation of India is recognised as Gratuity expenses of that year.

Transfer of case: S. 127 of I. T. Act, 1961: Before transfer, assessee should be given reasonable opportunity of hearing:

New Page 1

Reported:

47 Transfer of case: S. 127 of I. T. Act, 1961: Before
transfer, assessee should be given reasonable opportunity of hearing:

Reasons must be recorded and must be part of the order of
transfer:

Deep Malhotra Vs. Chief CIT; 185 Taxman 290 (P&H):

Allowing the writ petition challenging the transfer of case
u/s. 127 of the Income-tax Act, 1961, the Punjab & Haryana High Court held as
under:

“i) The legislature has provided by Section 127(2) that
before transferring any case from one
Assessing Officer, subordinate to him, to another Assessing Officer, the
assessee is required to be given reasonable opportunity of hearing and the
reasons are to be recorded for passing such an order.

ii) The provisions of section 127(2), in substance, provide
for hearing, besides requiring an agreement between the Chief Commissioner and
Commissioner of transferring the place where the cases are to be transferred.
Further, the agreements between both the Commissioners cannot be withheld from
the assessee and a copy thereof also has to be furnished to the assessee.

iii) The argument of the Revenue that the reasons had been
recorded in a separate order would not satisfy the requirement of section 127;
because the reasons have to be part of the order and recording of separate
reasons on file without communicating the same to the assessee, has been
considered as unfair and unwarranted. Therefore, the aforesaid argument was to
be rejected.

iv) For the reasons aforementioned, the impugned order was
to be set aside.”


 


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