BCAJ | Bombay Chartered Accountant Journal

Penalty – Furnishing inaccurate particulars of income – Assessee inadvertently claiming a deduction though in tax audit report it was clearly stated that the amount debited to Profit & Loss Account was not allowable as deduction indicated that the assessee made a computation error in its return of income – Imposition of penalty was not justified.

[Pricewaterhouse Coopers Pvt. Ltd. v CIT & Another (2012) 348 ITR 306 (SC)]

The assessee, engaged in providing multidisciplinary management consultancy services having a worldwide reputation, filed its return of income for the assessment year 2000-01 on 30-11-2000 accompanied by tax audit report u/s. 44AB of the Act. In column 17(i) of the Form No.3CB, it was stated that the provision for payment of gratuity of Rs.23,70,306/- debited to the Profit & Loss Account was not allowable u/s 40A(7). Even though the statement indicated that the provision towards payment of gratuity was not allowable, the assessee inadvertently claimed a deduction thereon in its return of income. On the basis of return, the assessment order was passed u/s.143 (3) on 26-3-2003 allowing the aforesaid deduction.

A notice u/s. 148 of the Act was issued on 22-1-2004 reopening the assessment for the assessment year 2000-01 for disallowing the provision of gratuity of Rs.23,70,306/- u/s. 40A(7). The reason recorded for reopening the assessment was communicated to the assessee on 16-12-2004.

Soon after the assessee was communicated the reasons for reopening the assessment, it realised that a mistake had been committed and accordingly by a letter dated 20-1-2005, it informed the Assessing Officer that there was no willful suppression of facts by the assessee, but that a genuine mistake or omission had been committed. The assessee filed a revised return on the same day. The assessment order was passed on the same day and the assessee paid the taxes due, as well as the interest thereon.

The Assessing Officer however initiated penalty proceedings u/s. 271(1)(c), and after obtaining response from the assessee, levied penalty of Rs.23,37,689 being 300% on the tax sought to be evaded. The Commissioner of Income Tax (Appeals) upheld the penalty imposed on the assessee. The Tribunal upheld the imposition observing that though the mistake could be described as silly it could be not be expected from the assessee which was a high calibre and competent organisation. However, the Tribunal reduced the penalty to 100%. The High Court dismissed the appeal of the assessee.

The Supreme Court allowed the appeal, observing that the assessee was undoubtedly a reputed firm and had great expertise available with it. Notwithstanding this, it was possible that even the assessee could make a “silly” mistake and this was acknowledged both by the Tribunal as well as by the High Court. The fact that the tax audit report was filed along with the return and that it unequivocally stated that the provision for payment was not allowable u/s. 40A(7) of the Act, indicated that the assessee made a computation error in its return of income. Apart from the fact that the assessee did not notice the error, it was not noticed even by the Assessing Officer who framed the assessment order. In that sense, even the Assessing Officer had made a mistake in overlooking the contents of the tax audit report. According to the Supreme Court, the contents of the tax audit report suggested that there was no question of the assessee concealing its income. There was also no question of the assessee furnishing any inaccurate particulars. In the opinion of the Supreme Court through a bona fide and inadvertent error, the assessee while submitting its return, failed to add the provision for gratuity to its total income. This could only be described as a human error, which everyone is prone to make. The calibre and expertise of the assessee had little or nothing to do with the inadvertent error. That the assessee should have been careful cannot be doubted, but the absence of due care, in a case such as the present one, did not mean that the assessee was guilty of either furnishing inaccurate particulars or had attempted to conceal its income.

According to the Supreme Court, the assessee had committed an inadvertent and bona fide error and had not intended to or attempted to either conceal its income or furnish inaccurate particulars.

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GAPs in GAAP — FAQs on Revised Schedule VI

The issuance of Revised Schedule VI to the Companies Act applicable from 1-4-2011 was a landmark event in financial reporting in India. As could be expected, there were numerous interpretation issues that arose. To address them the Institute of Chartered Accountants of India (ICAI) issued the Guidance Note on the Revised Schedule VI to the Companies Act, 1956 (GNRVI). Further, in May 2011 Frequently Asked Questions FAQ — Revised Schedule VI was posted on the ICAI website to provide further guidance. At the time of writing this article, none of the following was clear with respect to the FAQ’s — (a) the unit of ICAI that issued the FAQ’s (b) the review process — whether the Accounting Standard Board or the Technical Directorate of the ICAI reviewed the FAQ’s, and most importantly (c) the authority attached to the FAQ’s.

In this article, we take a look at some of the contentious FAQ’s.

A company, having December year-end, will prepare its first revised Schedule VI financial statements for statutory purposes for the period 1 January to 31 December 2012. Whether such a company needs to prepare its tax financial statements for the period from 1 April 2011 to 31 March 2012 in accordance with revised Schedule VI or pre-revised Schedule VI?

Response in FAQ

It is only proper that accounts for tax filing purposes are also prepared in the Revised Schedule VI format for the year ended 31 March 2012.

Author’s view with respect to companies to which MAT is applicable

S.s (2) of section 115JB states as follows “Every assessee, being a company, shall, for the purposes of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Part II and III of Schedule VI to the Companies Act 1956 . . . . . . ” The Finance Act, 2012, enacted recently, has removed reference to part III from section 115JB of the Income-tax Act. This amendment is applicable for A.Y. 2013-14, i.e., for tax financial year 2012-13.

From the above amendment to section 115JB, it is clear that a company will use revised Schedule VI format for preparing its tax financial statements for the tax financial year 2012-13 (i.e., 1 April 2012 to 31 March 2013). For preparing tax financial statements for the tax financial year 2011-12 (i.e. 1 April 2011 to 31 March 2012), the fact that the Finance Act removes reference to part III of schedule VI only for previous year beginning 1 April 2012 suggests that the company may need to prepare its tax financial statements for the period 1 April 2011 to 31 March 2012 in accordance with pre-revised Schedule VI. This appears to be a straight forward interpretation of the amendment to the Income-tax Act.

Note: Generally in determining the tax liability, it should not matter whether the accounts are prepared in accordance with pre-revised Schedule VI or revised Schedule VI. However, in certain situations it may have a significant impact, for example, where the company has to pay MAT . The P&L account in pre-revised Schedule VI had the P&L appropriation account. Therefore typically certain adjustments to reserves (e.g., debenture redemption reserve) would appear in the P&L appropriation account, and the net balance would be added to the retained earnings in the balance sheet. In the revised Schedule VI, the P&L ends with PAT (profit after tax) and all the appropriations are carried out under the caption ‘Reserves’ in the balance sheet. For determining the book profits under 115JB, and consequently the MAT liability, one would achieve different results if one were to start with PAT (under revised Schedule VI) or start with the net appropriated P&L (under pre-revised Schedule VI) and treat debenture redemption reserve as an allowable expenditure (in accordance with certain favourable judicial precedents) for determining book profits for MAT purposes.

There is a breach of major debt covenant as on the balance sheet date relating to long-term borrowing. This allows the lender to demand immediate repayment of loan; however, the lender has not demanded repayment till the authorisation of financial statements for issue. Can the company continue to classify the loan as current? Will the classification be different if the lender has waived the breach before authorisation of financial statements for issue?

Response in FAQ

As per the Guidance Note on the Revised Schedule VI, a breach is considered to impact the noncurrent nature of the loan only if the loan has been irrevocably recalled. Hence, in the Indian context, long-term loans, which have a minor or major breach in terms, will be considered as current only if the loans have been irrevocably recalled before authorisation of the financial statements for issue.

Author’s view

In accordance with revised Schedule VI, a liability is classified as non-current if and only if the borrower has unconditional right to defer its payment for atleast 12 months at the reporting date. GNRVI clarifies that if a term loan becomes repayable on demand because of violation of a minor debt covenant (for e.g., submission of quarterly financial information), the company can continue to classify the same as non-current unless the lender has demanded repayment before approval of financial statements.

GNRVI does not clarify the classification where a company has violated a major debt covenant as on the reporting date. However, a reading of GNRVI suggests that the exemption is given only with regard to violation of minor debt covenants and not for violation of major covenants. Thus, if major debt covenant is violated, there can be three situations — (a) the banker has asked for repayment before approval of financial statements, (b) the banker has not asked for repayment and has not forgiven the violation before approval of financial statements, and (c) the banker has forgiven the violation before the approval of financial statements. In situations (a) and (b), the author believes that the loan should be classified as current liability. In situation (c), where the banker has actually forgiven the violation before approval of financial statements, one may argue that the intention of the ICAI is that a company should continue to classify the loan as non-current, if the possibility of loan being recalled is negligible. Subsequent waiver of breach confirms this aspect and therefore the company may continue to classify the loan as non-current.

Thus, there is a difference in view, with respect to situation (b). In the author’s view and based on the GNRVI, the same would be treated as current. However, as per the FAQ’s, the same would be treated as non-current.

How would rollover/refinance arrangement entered for a loan, which was otherwise required to be repaid in six months, impact current/non-current classification of the loan? Consider three scenarios: (a) rollover is with the same lender on the same terms, (b) rollover is with the same lender but on substantially different terms, and (c) rollover is with a different lender on similar/different terms? In all three cases, the rollover is for non-current period.

Response in FAQ

In general, the classification of the loan will be based on the tenure of the loan. Thus, in all the above cases, if the original term of the loan is short term, the loan would be treated as only current, irrespective of the rollover/refinance arrangement. However, in exceptional cases, there may be a need to apply significant judgment on substance over form. In such cases, categorisation could vary as appropriate.

Author’s view

If the rollover arrangements are with the same lender at the same or similar terms, the company will continue to classify the loan as non-current, provided that the rollover arrangement was in existence at the balance sheet date. If the rollover arrangement has been entered into with a different lender either on similar or different terms, the arrangement is more akin to extinguishment of the original loan and refinancing the same with a new loan. Hence, in such cases, the existing loan should be classified as current liability. If the rollover arrangement is entered into with the same lender but on substantially different terms, the position is not clear. We understand that the matter is under debate at the IASB level and mixed practices are being followed globally as well. Keeping this in view, one may argue that it can classify the loan as non-current, provided that the rollover arrangement was in existence at the balance sheet date.

The author believes that view taken in the ICAI FAQ is technically flawed, since rollover of loan with the same lender on the same terms for non-current period clearly results in non-current classification. This is because it is not due to be settled within the 12 months after the reporting date and the company has an unconditional right to defer settlement of the liability for atleast 12 months after the reporting date.

The company has received security deposit from its customers/dealers. Either the company or the dealer can terminate the agreement by giving 2 months’ notice. The deposits are refundable within one month of the termination. However, based on past experience, it is noted that deposits refunded in a year are not material, i.e., 1% to 2% of amount outstanding. The intention of the company is to continue long term relationship with their dealers. Can the company classify such security deposits as non-current liability?

Response in FAQ

As per Revised Schedule VI, a liability is classified as current if the company does not have an unconditional right to defer its settlement for at least 12 months after the reporting date. This will apply generally. However, in specific cases, based on the commercial practice, say for example electricity deposit collected by the department, though stated on paper to be payable on demand, the company’s records would show otherwise as these are generally not claimed in short term. Treating them as non-current may be appropriate and may have to be considered accordingly. A similar criterion will apply to other deposits received, for example, under cancellable leases.

Author’s view

As per revised Schedule VI, a liability is classified as current if the company does not have an unconditional right to defer its settlement for at least 12 months after the reporting date. In the given case, the company does not have such right since the customer/dealer can terminate the agreement by giving 2 months notice and deposit has to be refunded within 1 month of termination. Hence, the security deposit should be classified as current liability. The intention of the company to not terminate the agreement or past experience is not relevant.

In case of provision for gratuity and leave encashment, can current and non-current portions be bifurcated on the basis of actuarial valuation?

Response in FAQ

The actuary should be specifically requested to indicate the current and non-current portions, based on which the disclosure is to be made.

Author’s view

Paragraph 7.3(b) of GNRVI states as below:

“In case of accumulated leave outstanding as on the reporting date, the employees have already earned the right to avail the leave and they are normally entitled to avail the leave at any time during the year. To the extent, the employee has unconditional right to avail the leave, the same needs to be classified as ‘current’ even though the same is measured as ‘other long-term employee benefit’ as per AS-15. However, whether the right to defer the employee’s leave is available unconditionally with the company needs to be evaluated on a case to case basis — based on the terms of Employee Contract and Leave Policy, Employer’s right to postpone/ deny the leave, restriction to avail leave in the next year for a maximum number of days, etc. In case of such complexities the amount of Non-current and Current portions of leave obligation should normally be determined by a qualified Actuary.”

The author believes that ICAI FAQ needs to be read with GNRVI and it cannot override paragraph 7.3(b) of GNRVI. Hence, there is no question of any part of leave liability being classified as non-current liability, if a company does not have a right to postpone/ deny the leave for 12 months. In other words, if an actuary is appointed to do this classification, he or she should apply the principles set out in paragraph 7.3(b) of GNRVI.

Conclusion

In light of the above arguments, the author would request the ICAI to reconsider and reissue some of the FAQ’s.

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Reassessment: Sections 147 and 148, 1961: In spite of repeated request reasons for reopening not furnished to assessee before completion of assessment: Reassessment not valid.

[CIT v. Videsh Sanchar Nigam Ltd., 340 ITR 66 (Bom.)]

In this case the assessment was reopened u/s.147. The assessee had requested for the reasons recorded, but the same were not furnished till the passing of the reassessment order. Following the judgment in the case of CIT v. Fomento Resorts and Hotels Ltd., (Bom.); ITA No. 71 of 2006, dated 27-11- 2006, the Tribunal held that though the reopening of the assessment is within three years from the end of the relevant assessment year, since the reasons recorded for reopening the assessment were not furnished to the assessee till the completion of the assessment, the reassessment order cannot be upheld.

The Bombay High Court dismissed the appeal filed by the Revenue and observed that the special leave petition filed by the Revenue against the decision of the Bombay High Court in the case of Fomento Resorts and Hotels Ltd. has been dismissed by the Apex Court.

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Principle of mutuality: Club: A.Y. 2003-04: Principle of mutuality applies to interest on fixed deposits, dividend, income from Government securities and profit on sale of investments.

[CIT v. Delhi Gymkhana Club Ltd., 339 ITR 525 (Del.)]

The assessee-club was granted exemption from paying income-tax on the income from its members on the basis of the principle of mutuality. On the same basis the assessee also claimed exemption in respect of income from fixed deposits, dividend, income from Government securities and profit on sale of investment. The Assessing Officer did not allow the claim. The Tribunal allowed the assessee’s claim and held that the principle of mutuality would apply even on these incomes.

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

“We are of the opinion that the aforesaid finding of the Tribunal is correct on facts and in law, which does not call for any interference.”

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Educational institution: Section 10(23C)(vi): A.Y. 2010-11: Petitioner-society was engaged in teaching all forms of music and dance with no profit motive: Run like a school or educational institution in a systematic manner: Not recognised by any university or Board: Is eligible for exemption u/s.10 (23C)(vi).

[Delhi Music Society v. DGIT, 17 Taxman.com 49 (Delhi)]

The petitioner-society was established in 1953 with the aim and object of teaching music and dancing in all its forms. It was allotted government land and was claiming tax exemption u/s.10(22) of the Income-tax Act, 1961. During the financial year 2008- 09, gross receipts of the petitioner exceeded Rs.1 crore and thus, it had to comply with the condition prescribed in section 10(23C)(vi), as to procurement of approval from the prescribed authority, to continue enjoying the tax exemption. Accordingly, the petitioners moved an application before the prescribed authority, i.e., DG (Exemption) for approval. The prescribed authority rejected the claim for exemption on ground that it did not satisfy criteria of being an ‘educational institution’. As per prescribed authority the petitioner was not awarding any degree or certificate and was merely imparting coaching/training in India as per norms of foreign colleges; that it was not an institution recognised by the UGC or by any board constituted by government for imparting formal education in the field of western music. The prescribed authority observed that the petitioner could not be distinguished from any coaching or training institute preparing the students for appearing in any examination for obtaining a formal degree by a formally recognised institution. The prescribed authority, therefore, held that the petitioner was not entitled to be characterised as an ‘educational institution’ within the meaning of section 10(23C)(vi).

The Delhi High Court allowed the writ petition filed by the assessee-society and held as under:

“(i) The Supreme Court in the case of Sole Trustee, Loka Sikshana Trust v. CIT, (1975) 101 ITR 234 interpreted the word ‘education’ in section 2(15) and held that the word has been used to denote systematic instruction, schooling or training given to the young in preparation for the work of life and it also connotes the whole course of scholastic instruction which a person has received. It has further been observed that the word also connotes the process of training and development of knowledge, skill, mind and character of students by normal schooling.

(ii) It is seen that the petitioner is being run like any school or educational institution in a systematic manner with regular classes, vacations, attendance requirements, enforcement of discipline and so on. These provisions in the rules and regulations satisfy the condition laid down in the judgment of the Supreme Court in Sole Trustee, Loka Sikshana Trust (supra). It cannot be doubted that having regard to the manner in which the petitioner runs the music school, that there is imparting of systematic instruction, schooling or training given to the students so that they attain proficiency in the field of their choice — vocal or instrumental in western classical music.

(iii) The Calcutta High Court in CIT v. Doon Foundation, (1985) 154 ITR 208/22 Taxman 9 has observed that section 10(22) does not impose a condition that an educational institution to be eligible for exemption thereunder should be affiliated to any university or any board. As per the High Court, so long as the income is derived from an education institution existing solely for educational purposes and not for purposes of profit, such income is entitled to exemption u/s.10(22). This judgment takes care of the objection of the prescribed authority that the petitioner is not affiliated to, or recognised by any university or board in India and that it merely awards certificates or grades which are issued by the Trinity College and Royal School of Music, London. Since section 10(23C)(vi) also uses the same language as section 10(22), the same principle should govern the interpretation of that provision also.

(iv) The Supreme Court in S. Azeez Basha v. Union of India, AIR 1968 SC 662 has considered the nature of an educational institution. It was held by the Supreme Court that there is a good deal in common between educational institutions which are not universities and those which are universities in the sense that both teach students and both have teachers for the purpose. It was further observed by the Supreme Court that what distinguishes a university from any other educational institution is that a university grants degrees of its own, whereas other educational institutions cannot. These observations of the Supreme Court support the stand of the petitioner that the fact that it does not conduct its own examination or awards degrees of its own is not decisive of the question whether it is an educational institution or not. It also lends support to the petitioner’s stand before the prescribed authority that it is not a mere coaching centre preparing students for competitive examinations.

(v) For the above reasons, it is held that the petitioner meets the requirements of an educational institution within the meaning of section 10(23)(c)(vi).

(vi) Accordingly, the impugned order passed by the prescribed authority is quashed. The prescribed authority will now deal with the asses-see’s application for approval afresh in accordance with law. The writ petition is accordingly allowed.”

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Deduction u/s.10A/10B: FTZ: A.Y. 2007-08: Assessee received pure gold from a nonresident, converted same into jewellery and exported it to said non-resident: Activity amounted to ‘manufacture or production’ which qualified for deduction u/s.10A/10B.

[CIT v. Lovlesh Jain, 204 Taxman 134 (Del.); 16 Taxman. com 366 (Del.)]

The assessee had received pure gold supplied by ‘R’ Jewellery, Dubai, and the same after conversion into jewellery was ‘exported’ by the assessee to ‘R’ Jewellery, Dubai. In the meantime ‘R’, Jewellery Dubai continued to remain the legal owner of the gold and had not sold the gold to the assessee. The assessee was paid conversion charges or production/ manufacturing charges for converting the gold into jewellery. The Assessing Officer held that the assessee was not manufacturing ornaments/ jewellery and was not an exporter as he was paid making charges for the job work/services for making ornaments as per specification of third parties. Accordingly, the AO held that the assessee was not entitled to deduction u/s.10A. The Commissioner (Appeals) and the Tribunal allowed the assessee’s claim for deduction.

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

“(i) Section 10A/10B is applicable when an undertaking manufactures, or is engaged in production of articles or things. The term ‘production’ has a larger magnitude and is more expansive and liberal than the term ‘manufacture’.

(ii) In the present case, manufacture as well as production of goods, articles or things is covered u/s.10A/10B. The activity for converting gold bricks, biscuit or bars, into jewellery amounts to ‘production or manufacture’ of a new article and, therefore, qualifies for deduction u/s.10A/10B.

(iii) Case of the Revenue is that the assessee had not exported jewellery as the assessee was not owner of the imported gold or the exported jewellery and was paid making charges. Thus, the income earned does not qualify for deduction u/s.10A/10B.

(iv) The expressions/terms, ‘importer’ and ‘exporter’ are wide and not restricted to the owner of the goods at a particular point of time. Owner is treated as the importer/ exporter but a person who holds himself out as an importer or exporter is also an importer or exporter. The activity undertaken i.e., export/import is important and the person involved and associated with the said activity is important/relevant, mere ownership is not the sole criteria to determine whether a person is an importer or exporter. Further the expression ‘exported’ or ‘imported’ goods has reference to the nature of the goods as in the case of expressions ‘import’ or ‘export’ and not a person/owner.

(v) In the present case, the standard gold was imported into India and then converted into jewellery or ornaments and was sent out of India i.e., jewellery and ornaments were exported. When the import was made, the assessee was shown as a consignee and an importer and when the export was made the assessee was shown as a consignor i.e., the exporter. The assessee complied with the various formalities, when the standard gold was imported and then again when the jewellery/ornaments were exported. The assessee was in actual physical possession of the gold when it remained in India and would have been liable in case of loss, etc. The concept of and the term ‘ownership’, has various jurisprudential connotations. For all practical purposes, the assessee was in possession of gold and had a right, dominance and dominion over it. They were liable to pay Customs duty, etc. in case export was not made. Keeping in view the nature of transactions in question, it is not possible to hold that the assessee did not ‘export’ the jewellery/ornaments and that the transactions in question cannot be regarded as export for the purpose of section 10A/10B. Thus, when the assessee had exported the ornaments, it was exporting articles or things. The assessee were exporters or had exported articles/things as understood in common parlance.

(vi) Section 10A does not apply to export income earned by an assessee from merely trading the goods and postulates that the assessee must be an undertaking, which manufactures or produces articles or things, which are exported.

(vii) This condition in the present case is satisfied. Accordingly, the contention raised by the Revenue fails and has to be rejected. Appeals are accordingly dismissed.”

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CIT(A): Power to issue directions against third party: Sections 153C and 251(1)(c) of Income-tax Act, 1961: In the matter of lis between the assessee and the Revenue before it, it is not open to the CIT(A) to proceed to determine the rights or liabilities of a third party, who is not before it.

[CIT v. Krishi Utpadan Mandi Samiti, 245 CTR 591 (All.)]

The assessee, a charitable institution transferred development cess to Mandi Parishad and claimed deduction of the said amount. The Assessing Officer disallowed the claim for deduction. The CIT(A) allowed the assessee’s claim and held that the payment treated as expenditure or application by the assessee shall be treated as business receipt by Mandi Parishad and directed the Assessing Officer to make a reference to the Assessing Officer of Mandi Parishad to take remedial measures, if necessary, in the relevant assessment years to tax the relevant receipts in the hands of the Mandi Parishad. The Tribunal held as under:

“The learned CIT(A) while referring to the cases of Mandi Parishads had not afforded any opportunity to the said assessees and it is also noticed that the learned CIT(A) made these observations in spite of the fact that no such material relating to Mandi Parishads was available to him. In our opinion, these observations of the learned CIT(A) are unnecessary, because the facts of the case which is pending for adjudication are only to be considered. However, in the instant case, neither the material relating to other issues was available to the learned CIT(A) nor opportunity of being heard was given to the said assessee whose cases have been referred by the learned CIT(A). We, therefore, modify the order of the learned CIT(A) to this extent that the impugned observations made by him are unwarranted in the case of present assessees.”

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

“(i) It is not open to another quasi-judicial authority of limited jurisdiction, in the matter of lis between the assessee and Revenue before it to proceed to determine the rights or liabilities of the third party, who is not before it, in the assessment of the assessee.

(ii) The CIT(A) had no jurisdiction to direct the Assessing Officer to make a reference to the Assessing Officer of Mandi Parishad, to whom the assessee used to pay cess and claim it as deduction, to take a remedial action and, if necessary, to tax the receipts in the hands of Mandi Parishad.”

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Capital gain: Exemption: Sections 54 and 139(1), (4): A.Y. 2006-07: Condition precedent: Profit to be used for purchase of residential property or deposited in specified account before due date for furnishing return: Due date can be u/s.139(4).

[CIT v. Ms. Jagriti Aggarwal, 339 ITR 610 (P&H); 245 CTR 629 (P&H)]

The assessee had sold a house property on 13-1-2006 and had purchased another house property on 2-1- 2007. The Assessing Officer disallowed the assessee’s claim for deduction u/s.54 of the Income-tax Act, 1961 holding that the assessee failed to deposit the amount in the capital gains account scheme and also failed to purchase house property before the due date for filing the return of income. The Commissioner (Appeals) allowed the assessee’s claim and held that the assessee had complied with the provisions of section 54 as she had purchased the new residential property on 2-1-2007 i.e., before the due date u/s.139(4) of the Act. The Tribunal affirmed the order of the Commissioner (Appeals).

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

“(i) The sale of the asset had taken place on 13- 1-2006, falling in the previous year 2006-07, the return could be filed before the end of the relevant A.Y. 2007-08 i.e., 31-3-2007. Thus, s.s(4) of section 139 provides the extended period of limitation as an exception to s.s(1) of section 139 of the Act.

(ii) S.s (4) was in relation to the time allowed to an assessee u/ss.(1) to file the return. Therefore, such provision is not an independent provision, but relates to the time contemplated u/ss.(1) of section 139. Therefore, s.s(4) had to be read along with s.s(1).

(iii) Therefore, due date for furnishing return of income according to section 139(1) of the Act was subject to the extended period provided u/ss.(4) of section 139 of the Act.”

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Business expenditure: Capital or revenue: A.Y. 2003-04: Assessee stopped manufacturing and continued trading: Severance cost paid to employees is revenue expenditure.

[CIT v. KJS India P. Ltd., 340 ITR 380 (Del.)]

The assessee-company was manufacturing soft drinks. In the A.Y. 2003-04, the assessee-company stopped manufacturing soft drinks as it was found to be non-profitable. Many employees who were directly in the manufacturing activity were laid off and severance cost of these employees of Rs. 93,91,706 was paid. The assessee’s claim for deduction of this amount was disallowed by the Assessing Officer holding that it is capital in nature. The Tribunal found that apart from manufacturing soft drinks, the assessee was also trading in soft drinks. The Tribunal held that suspension of one of the activities did not amount to closure of business and allowed the assessee’s claim.

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

“Since the assessee had been doing other business activity also, namely, ‘trading’, it could not be said that the assessee had closed its business with the suspension of manufacturing soft drinks. The expenditure was deductible.”

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Reassessment — Assessee allowed to raise all contentions on merits in the reassessment proceedings

The assessment for the A.Y. 2000-01 was re-opened after the expiry of four years from the end of the relevant assessment year for the reason that though in the tax audit report an amount of Rs.107.70 lakh had been shown u/s.41 of the Act, only Rs.9.23 lakh on account of provision for warranties no longer required was written back under the head ‘Other sources of Income’ leaving a balance of Rs.98.46 lakh resulting in escapement of income. The other reason for reopening was that though dividend income of Rs.188.73 lakh was earned which was exempt u/s.10(33), no disallowance was made of the expenses related to purchase/sale of the investment.

In fact the balance amount of Rs.98.46 lakh was added back under different heads, but was not separately indicated and in its objection the assessee did not take this specific plea. It only stated that Rs.1,07,69,936 was added back/credited to the profit and loss account and one item of Rs.9,23,471 was reflected on the credit side of the profit and loss account. As regards, disallowance of expenses incurred for earning tax-free income it was contended that section 14A was introduced in the statute by the Finance Act, 2001, with retrospective effect from April 1, 1962 and the return was filed on 30-11-2000 and therefore it was not obligatory to make a disallowance and there was no failure on the part of the assessee in disclosing fully and truly the material facts in respect of the expenditure incurred for earning the tax-free income. The assessee also relied upon the proviso to section 14A which prohibited reopening of assessment for any assessment year beginning on or before 1-4-2001.

On a writ challenging the notice issued u/s.148 for want of jurisdiction, the Delhi High Court noted that in reply to the notice issued u/s.154 of the Act the assessee had given the full break-up and specific details with regard to credit/adjustment of Rs.98.46 lakh into profit and loss account and hence it found some merit in the contention of the assessee. However, it did not dwell further on this aspect since the notice was sustainable on the ground of section 14A. According to the High Court the proviso to section 14A only barred the reassessment/rectification and not the original assessment on the basis of retrospective amendment. Since the Assessing Officer had failed to apply section 14A when he passed the original assessment order, it had prima facie resulted in escapement of income. According to the High Court there was an omission and failure on the part of the assessee to point out the expenses incurred relatable to tax-free/exempt income which prima facie have been claimed as a deduction in the income and expenditure account and hence there was omission and failure on the part of the petition to disclose fully and truly the material facts.

On an appeal, the Supreme Court held that in its view the reopening of the assessment was fully justified on the facts and circumstances of the case. However, on merits of the case, it would be open to the assessee to raise all contention with regard to the amount of Rs.98.46 lakh being offered for tax as well as its contention on section 14A of the Act.

[Honda Siel Power Products Ltd. v. Dy. CIT and Others, (2012) 340 ITR 53 (SC)]

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The Concept of Propriety’— Dynamics & Challenges for Auditors

Introduction

There is a saying that “we take propriety to encompass not only financial rectitude, but a sense of the appropriate values and behaviour”. Though the concept of propriety is generally associated with public sector activities, the time has now come to apply this concept even in the private sector due to the enhanced application of the ‘Agency Theory’ which requires an eloquent demonstration of the roles and responsibilities of the professional management running a company to all the stakeholders. With the changing environment, the expectations of the society have also changed and as a result, there is a greater emphasis on conformance with prescribed values, customs, procedures and practices, keeping in mind the public interest and greater application of prudence. This has resulted in an expectation of applying the concept of propriety in all the transactions carried out by the corporates and an endorsement of the same by an independent person. Consequently, the Statutory Auditors of the company, being independent, are expected to fill this vacuum. However, the Statutory Auditors focus more on the true and fair view of the financial statements and generally do not deal with the propriety aspects in depth due to various limitations and challenges. Whilst the auditors can certainly consider this emerging expectation as part of their audit process to the extent the same is significant and impacts the financial statements, there are certain practical challenges in dealing with the same. This article focusses on the concept of propriety along with its relevance for audits, propriety expectations from the auditors, responsibilities of the auditors in general, practical challenges in application of the concept of propriety in audits, audit defense to propriety concerns and the nuances of reporting propriety concerns by the auditors. This article is not intended to elucidate the responsibilities of the auditors regarding the frauds, if any, committed by the management.

What is Propriety?

In general, there is no fixed definition of the term ‘propriety’ which keeps changing, reflecting the changing expectations of society. The literal dictionary meaning of the term propriety encompasses ‘appropriateness’, ‘rightness’, ‘correctness in behaviour or morals’, ‘conformity with convention in conduct’, ‘the standards of behaviour considered correct by polite society’.

The core principles of the concept of propriety could be summarised as under:

Integrity
Openness
Objectivity
Honesty
Selflessness

The concept of propriety can be related to various other concepts which are commonly known. To list a few:

Accountability
Legality
Probity
Value for money
Fraud & Corruption
Governance
lInternal Control Environment

Practically, there is also a reasonable degree of overlap amongst application of these concepts and all the above can be analysed from the broad umbrella of propriety.

Propriety expectations from Auditors in India

Whenever the auditors carry out a Propriety Audit, they not only evaluate the underlying evidence, but also attempt to examine the regularity, reasonability, prudence and impact of various acts. In India, the audits performed by the Comptroller & Auditor General (C&AG) focus more on the propriety aspects and check the conformity with the established financial propriety standards.

Though the expectations of the statutory audit conducted under the provisions of the Companies Act, 1956 do not necessarily mandate a propriety focus on the part of the auditors, various amendments made to the Companies Act, 1956, specifically on the reporting requirements in the Auditors’ Report under the Companies (Auditor’s Report) Order, 2003 over a period of time indicate move in that direction. Certain illustrative instances of the same are given below:

Auditors’ responsibility to inquire on the terms and conditions of the loans and advances to identify whether they are prejudicial to the interests of the company and its members.
Reporting on transactions of the company which are represented merely by book entries and are prejudicial to the interests of the Company.
Reporting on whether personal expenses have been charged to the revenue account.
Reporting on reasonability of the pricing mechanism on transactions where directors are interested.
Reporting on preferential allotment of shares to interested parties and the impact of the pricing on the interests of the entity.
Reporting on the disqualification of the directors u/s.274(1)(g) of the Companies Act, 1956.
Reporting on the frauds by or on the company.

In addition to the aforesaid reporting requirements, propriety expectations are also embedded in the Accounting Standards such as reporting requirements related to the Related Party Transactions in accordance with the AS-18. Needless to add, the Companies Act, 1956 contains several provisions relating to propriety elements such as greater level of monitoring/approval for transactions with directors/other interested parties, remuneration paid to directors, etc.

Responsibility of the Auditors

The Statutory Auditors who conduct their audit in accordance with the Auditing Standards for reporting on the true and fair view of the financial statements may not necessarily be in a position to meet the propriety expectations of society in totality due to their role/legal boundaries. In this regard, it is worth noting that propriety challenges would invariably result in fraud on the company or by the company which needs to be reported and considered by the Auditors. As per the Generally Accepted Auditing Standards in India, the Auditors should always conduct the engagement with a mindset that recognises the possibility that a material misstatement due to fraud could be present, regardless of any past experiences with the entity and regardless of their belief about the management’s honesty and integrity.

The relevant/specific Auditing Standards which need to be considered by the Auditors in responding to the propriety challenges are as under: SA 240 — The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements
SA 250 — Consideration of Laws and Regulations in an Audit of Financial Statements ? SA 260 — Communication with those in charge of Governance
SA 265 — Communicating Deficiencies in internal control to those charged with Governance and Management
SA 315 — Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment
SA 330 — The Auditor’s Responses to Assessed Risks.

The primary responsibility for prevention and detection of fraud and error rests with both those charged with governance and the management of an entity. The objective of an audit of financial statements prepared in accordance with the framework of recognised accounting policies and practices and relevant statutory requirements, if any, is to enable the auditors to express an opinion on them. An audit conducted in accordance with the Generally Accepted Auditing Standards in India is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatements, whether caused by fraud or error. The fact that an audit is carried out may act as a deterrent, but the auditors are not and cannot be held responsible for prevention and detection of fraud and error.

A Financial Statement Audit conducted in accordance with the applicable auditing framework does not guarantee that all material misstatements will be detected because of such factors as the use of judgment, the use of testing, the inherent limitations of internal controls and the fact that much of the evidence available to the auditors is persuasive rather than conclusive in nature. For these reasons, the Auditors are able to obtain only a reasonable assurance that material misstatements in the financial statements will be detected.

In view of the above, the responsibility of the Statutory Auditors towards the propriety aspects would be more limited and focussed on specific aspects of reporting and need not necessarily extend to the entire gamut of the transactions carried out by a company. However, propriety concerns, if any, noticed by the Auditors during their audit process should be given adequate importance and should not be overlooked. They should consider the same as part of assessing the risk associated with the entity and the environment in which it functions, and should deal with the same appropriately, including reporting to those in charge of governance, wherever required.

Propriety challenges for Auditors
Propriety is concerned with compliance with expectations of conduct and behaviour, which although not written into legislation or regulations, are generally accepted as being central to the management of the affairs of an entity. Acts of impropriety will be concerned with specific misconduct, knowingly perpetrated for personal or political gain. Similar acts, undertaken with lack of knowledge and motivation, are on the other hand, omissions of propriety. The effects on an entity are often the same but the auditors may need to bear this distinction in mind. Whether an act constitutes improper behaviour within the generally accepted standards of conduct expected in business is often a matter of interpretation and professional judgment. Invariably, the question of proving the propriety element would depend on facts and circumstances of the case. The availability of the proof and its adequacy is a matter of personal judgment of the Auditor.

Root cause for propriety issues
Propriety issues arise in entities due to the following:

Corporate culture

Poorly designed or operated internal controls

Ignorance of the rules or expectations of proper behaviour, especially in small and medium-sized entities

Urge to achieve targets/results in the short-term

Greed

Symptoms for propriety issues
The propriety challenges for the auditors could take different dimensions depending on the nature of the entity and the activities carried out by it. The symptoms of propriety concerns could arise from various matters such as:

Absence of business rationale for significant transactions

Lack of transparency in awarding contracts

Liberal/flexible arrangements with contractors

Transactions without written contracts

Entering into side agreements/arrangements with contracting parties

Avoidance of proper tendering procedures

Excessive involvement of agencies/ third parties

Having an overriding authority with few individuals for allowing exceptions

Situations where there is a conflict of interest

Large infructuous expenses triggering propriety concerns

Abnormally high hospitality expenses

Lack of conclusive evidence regarding the ultimate usage of funds

Weak Audit Committee/Board Members who are silent spectators

Absence of appropriate disclosures in the financial statements

Lack of sanctity for the Internal Audit/other audit observations.

Acts of impropriety
By studying the symptoms carefully, the Auditor may identify transactions where there are propriety concerns for the entity. Though the acts of propriety may vary from entity to entity depending on the nature, environment, etc., instances of the acts of impropriety could take any of the following dimensions:

Facilitation payments, bribes, speed money paid for expediting clearances, getting things done fast which are coloured differently.

Awarding contracts at a price lower than the expected value.

Exorbitant service charges which are not commensurate with the services rendered.

Excessive remuneration to promoters/directors which does not commensurate with the services rendered.

Preferential treatment in making appointments either of contractors or of staff.

Misuse of office for personal purposes.

Foreign travel by senior management and board members without proper justification or clear benefit to the entity.

Inflating the payments to vendors for services rendered/goods delivered where the vendors make certain improper payments on behalf of the entity which triggers propriety issues.

Disposal of scrap at a value much lower than its realisable value.

Selling shares held by a company to another company at a consideration above cost but substantially below the market value.

Structuring the transactions with group companies which are de facto related parties in a manner that does not apparently fit into the definition of related party.

Recruitment of employees based on recommendations of authorities as a quid pro quo for consideration received.

Though the propriety concerns could be factored in by the Auditors as part of their audit process, there are a number of factors that significantly limit the extent to which an audit of financial statements can be expected to identify impropriety, including:

Multiple versions of the concept of propriety and its meaning

Absence of adequate evidence of conducting the business

Concealment and collusion

Difficulties in identification of impropriety elements by an outsider

Application of the concept of materiality by the auditors

Actual/Perceived scope limitation on the part of the audit process

Skills required on the part of the auditors for identifying transactions involving impropriety

Lack of clarity in the statutory provisions dealing with the roles and responsibilities of the auditors.

In view of the various challenges listed above, it may not be possible for the Statutory Auditors to confirm propriety aspects of all the transactions entered into by the entity as part of his audit. Hence, subsequent discovery of acts of impropriety by the entity audited may not imply inadequate/ improper audit.

Audit Defense for Propriety Concerns
Whilst external Auditors of companies are not required to perform specific procedures for the purpose of identifying improprieties as part of their audit of the financial statements, they should remain alert to instances of significant possible or actual non-compliance with general standards of public conduct. In particular, the Auditors may develop a general appreciation of the framework of governance and standards of conduct within which the company conducts its activities during the course of their audit to gain an understanding of the overall internal control environment. This can be an important potential source of information on any impropriety.

As part of the Auditor’s responsibility to assess the overall internal control environment, the Auditor is required to assess inherent risk, taking account of factors relevant to the entity as a whole. In this regard, the Statutory Auditors could:

Familiarise themselves with the general regulations, rules and other guidance relating to the conduct of the company’s business.

A thorough understanding of the company and its business and a review of its financial control environment.

Enquire of the management about the company’s policies and procedures regarding the implementation of code of conduct and instructions, while having regard to whether the policies and procedures are comprehensive and up to date.

Discuss with the management and internal auditors the policies or procedures adopted for promulgating and monitoring compliance with relevant codes and instructions.

Read minutes of the board and management meetings to pick up matters of propriety concern.

Read the newspaper articles related to the company.

Review the arrangements for whistle-blowing.

Discuss with client staff in various departments including operations.

Focus on areas, if any, which have not been reviewed by them for a number of years.

Introduce surprise elements in the audit process.

The Auditors may also discuss their plan to perform the stipulated audit procedures to identify any propriety concerns with the Audit Committee/ those in charge of governance. This by itself could create moral pressure on the environment as well as on the management. In the process of identifying the propriety concerns, the Auditors should not go overboard and over audit the entity which may not be warranted.

The Auditors may also closely assess the following to form their opinion regarding the entity’s response towards propriety challenges:

Tone at the top in dealing with the matters of impropriety.

Extent of evangelism of the principles of propriety amongst the employees by the management through code of conduct/ ethical training, etc.

Process of obtaining compliance declarations from the management to confirm the propriety elements for all the contracts/transactions entered into by the company.

Extent of interference by the promoters with the professional management personnel.

Sanctity given to various processes and procedures.

Reporting by the Auditors
If there are impropriety symptoms identified in the course of enquiry/discussion or verification by the Auditors, it is appropriate for them to report the same to the management or even to those in charge of governance and to consider their impact on audit risk. When the Auditors become aware of any failure of propriety, they should aim to understand its nature and the circumstances under which it has occurred and sufficient additional information should be obtained to evaluate the possible impropriety. If the Auditors consider that the impropriety could be significant, they may perform appropriate additional procedures and document the results.

The extent of additional procedures the auditors decide to perform in response to impropriety is a matter of professional judgment and depends on:

Its impact on the financial statements

Nature of the impropriety

Persons involved

Likelihood that the impropriety may have led to loss of funds

Likelihood that the suspected impropriety involves fraud

Extent to which further procedures can be expected to clarify the situation

Extent to which the impropriety indicates that other impropriety or mismanagement may be present

Likelihood of the need to report.

Where there is suspicion of impropriety but an absence of evidence, the Auditors may consider drawing the management’s attention to the possibility of introducing procedures that would generate evidence were the suspicion to be well founded.

To explain this concept further with an example, if the management has entered into a contract for disposing of the scrap for a value which is less than its actual realisable value for benefiting somebody, the amount received and recorded as per the books and pursuant to the contract, duly approved by an appropriate authority, need not necessarily pose an accounting challenge; however, the real value of the transaction has not been reflected in the books of account due to an act of impropriety which would definitely trigger an audit concern. This has to be investigated further and the same has to be appropriately dealt with.

Significant matters of impropriety would require appropriate reporting by the Auditors not only in their Audit Report but also communication to those in charge of governance. At the earliest suitable opportunity, the Auditors should discuss their findings at an appropriate level of management whom they do not suspect of involvement with the impropriety. Wherever there is an Audit Committee, the auditors should also discuss their findings with them.

If the auditors consider that impropriety may have or has occurred, they may need to reconsider their assessments of audit risk and the validity of the management’s representations. For example, a series of suspected or actual instances of impropriety that are not significant financially may be symptomatic of the management’s general disregard for proper conduct and hence may cast doubt on the general integrity of the management.

The method of reporting on audit work relating to propriety will vary depending on the nature of the work undertaken and its results. The auditors may also consider communicating the propriety concerns, if any, primarily due to internal control lapses to the management through a management letter. The auditors should also request the managements to place the management letters along with the management’s responses before the Audit Committee.

Conclusion
Impropriety is considered as one of the serious evils in all the countries and in particular in the developing countries. Governments in various countries are attempting to enact/strengthen various laws to combat impropriety. They are aware of the fact that the first stage in the dynamics of the rule of law is the framing of effective rules and laws, which are equipped to hinder the ever-rising escalation of the impropriety graph. There is nothing in this world which can guarantee high standards of propriety but appropriate safeguards can be put in place to minimise the risk of impropriety occurring or remaining undetected. These safeguards include:

Clear expectations of standards of individual behavior.

Appropriate internal controls to provide checks and balances against individual misconduct.

External supervision to hold the organisation accountable.

Above all, such safeguards help to create a climate and culture in which high standards of propriety is valued.

In India, the proposed Companies Bill, 2011 contains various provisions relating to propriety aspects, including a provision of direct reporting of frauds by the Auditors to the appropriate authority which would enhance the role and the responsibilities of the Auditors considerably and is in the direction of thrusting propriety principles as part of the audit expectation. The Auditors should be cognizant of propriety concerns and the expectations of society in discharging their professional duties within the legal framework which would go a long way in setting the standards for audit excellence.

Reference material

Indian Auditing Standards

Report of the Public Audit Forum, UK

Nolan Committee Report, UK

Various Research Reports on Audit process available for General public.

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Eligibility of Contractual workers for inclusion in Number of Workers

Issue for consideration

Section 80I(2)(iv) (effective up to 31-3-1991) of the One finds that similar language and expression has been used under the Act of 1922 and has been continued to be used by the Legislature even under the provisions of the 1961 Act while stipulating one of the conditions for the ‘tax holiday’. For ready reference, the language and expressions as used in different provisions over the period are tabulated below:

Comparison of incentive provisions where employment of workers is mandated.

Section

Language
and Expression used

15C(2)(iii) of the

Employs ten or more workers in manufacturing process carried on with
the aid

1922 Act

of power, or employs twenty or more workers in a manufacturing
process carried on

without the aid of power.

84(2)(iv)
of the

It
employs ten or more workers in a manufacturing process carried on with the

1961 Act

aid of power, or employs twenty or more workers in a manufacturing
process carried

on without the aid of power.

80J(4)(iv)
of the

In
a case where the industrial undertaking manufactures or produces articles,
the

1961 Act

undertaking employs ten or more workers in a manufacturing process
carried on with

the of power, or employs twenty or more workers in manufacturing
process carried

on without the aid of power.

80HH(2)(iv)
of the

It
employs ten or more workers in a manufacturing process carried on with the

1961 Act

aid of power, or employs twenty or more workers in a manufacturing
process carried

on without the aid of power.

80I(2)(iv)/

In
a case where the industrial undertaking manufactures or produces articles,
the

80IB(2)(iv) of the

undertaking employs ten or more workers in a manufacturing process
carried on

1961 Act

with the of power, or employs twenty or more workers in manufacturing
process

carried on without the aid of power.

10BA(2)(e) of the

It employs twenty or more workers during the previous year in the
process of

1961 Act

manufacture or production.

Income-tax Act, 1961, analogous to present section 80IB(2)(iv) of the Act, requires employment of certain number of workers by the new industrial undertaking as one of the conditions for the undertaking to qualify for the ‘tax holiday’. The industrial undertaking should employ ten or more workers in a manufacturing process where the manufacture or production of articles or things takes place with the aid of power or employ twenty or more workers in a manufacturing process if manufacture or production is undertaken without the aid of power.

It appears that one of the aims and objects of the Legislature under the scheme of ‘tax holidays’ over the period is to generate employment in the country.

The language and expression as used in the aforesaid sections have been subject of the judicial interpretation by Courts on different counts viz., the determination of period for which the aforesaid condition needs to be satisfied in a financial year, interpretation of the expression ‘employs’, meaning of the word ‘workers’, etc.

The controversy, sought to be discussed here, revolves around the issue whether the contractual workers or the workers supplied by a contractor for manufacture or production of articles or things could be treated as ‘workers’ employed by the assessee undertaking for the purpose of deduction u/s.80IB/u/s.80I of the Act.

The Bombay High Court recently had an occasion to deal with the aforesaid issue under consideration, wherein the High Court held that it was immaterial as to whether the workers were directly employed or employed by hiring them from a contractor. What was relevant was the employment of ten or more workers and not the mode and the manner in which the said workers were employed. In deciding the issue, the Bombay High Court dissented with the findings that were given on the subject by the Allahabad High Court.

Jyoti Plastic’s case The issue came up recently before the Bombay High Court in the case of CIT v. M/s. Jyoti Plastic Works Private Limited, [339ITR 491 (Bom)]

Jyoti Plastic Works Private Limited (‘Jyoti Plastic’) was engaged in the manufacture of plastic parts which were excisable and had claimed deduction u/s.80IB of the Act. In the reassessment proceedings, the AO disallowed the deduction u/s.80IB of the Act for the following two reasons:

(1) Jyoti Plastic was not a manufacturer, as the goods were manufactured at the factory premises of the job worker; and

(2) The total number of permanent employees employed in the factory were less than ten and thereby the condition as required u/s.80IB (2)(iv) was not satisfied.

The first Appellate Authority and the Mumbai Tribunal allowed the claim of Jyoti Plastic and the Revenue, being aggrieved, carried the issue to the Bombay High Court. As regard the first issue, the Court held in favour of Jyoti Plastic. With respect to the second issue, the Court, in the absence of the meaning of the word ‘worker’ under the Act, referred to the following external aids of construction to determine the meaning of the word ‘worker’:

(1) Black Law Dictionary — ‘worker’ means a person employed to do work for another;

(2) Section 2(L) of the Factories Act, 1948 — ‘worker’ is a person employed directly or by or through any agency (including a contractor) with or without the knowledge of the principal employer, whether for remuneration or not, in any manufacturing process, or in any other kind or work incidental to or connected with the manufacturing process.

The Court further relied on its earlier judgment in the case of CIT v. Sawyer’s Asia Limited (122 ITR 259) (Bom.), wherein the Court while considering the provisions of section 84(2)(iv) of the Act had observed that the word ‘workers’ should also include ‘casual workers’.

The Revenue relied on the following decisions of the Allahabad High Court to submit otherwise :

(1) R and P Exports v. CIT, (279 ITR 536); and

(2) Venus Auto Private Limited v. CIT, 321 ITR 504.

The Bombay High Court distinguished the decision of the Allahabad High Court in the R and P Exports’ case on the ground that the Tribunal in the case before the Bombay High Court had recorded a specific finding of fact that the agreement between Jyoti Plastic and the contractor was a ‘contract of service’ and not ‘contract for service’, whereby the contractual workers were under direct control and supervision of Jyoti Plastic as against the facts which were to the contrary in the case of R and P Exports (supra).

With regard to the decision of Venus Auto Private Limited (supra), the Court acknowledged that the facts in the said case were similar to the facts of the case before the Court; it dissented with the ratio of the decision in the said case and chose to rely on its own decision in the case of Sawyer’s Asia Limited (supra).

The Court finally concluded that since the agreement with the contractor was a ‘contract of service’ i.e., of employer-employee relationship and just because it differed with terms of contract of service with regular employees, that could not be a ground to deny the deduction u/s.80IB of the Act. In other words, so long as the agreement between the parties was a ‘contract of service’ and not ‘contract for service’, it would satisfy the condition prescribed u/s.80IB(2)(iv) of the Act.

Venus Auto’s case

The issue had come up earlier before the Allahabad High Court in the case of Venus Auto Private Limited v. CIT, (321 ITR 504).

Venus Auto Private Limited (‘Venus Auto’) was engaged in the manu-facturing activity of the scooter seat and claimed deduction u/s.80HH and u/s.80I of the Act. In the assessment and appellate proceedings up to the Tribunal stage, Venus Auto’s claim for deduction was rejected on the ground that the condition u/s.80I(2) (iv) of workers employed was not satisfied as the workers employed through the contractor were not to be treated as the workers employed in the industrial undertaking.

On appeal by Venus Auto before the High Court, the Allahabad High Court observed that the word ‘employment’ meant employment of workers by Venus Auto. There should be a relationship of employer and employee between the workers and Venus Auto. The Court observed that with regard to the contractual employees, there was no such employer-employee relationship between Venus Auto and the contractual employees; such relationship existed between the contractor and the contractual employees. The Court on facts and in law distinguished the reliance of Venus Auto on the following decisions:

(1)    Aditya V. Birla v. CBDT, (170 ITR 137) (SC);
(2)    CIT v. K. G. Yediyurappa, (152 ITR 152) (Kar.);
and
(3)    CIT v. V. B. Narania & Co., (252 ITR 884) (Guj.)

Further, the Court observed that vide word ‘it employs’, the Legislature sought to limit the relationship between employer and employee only i.e., between Venus Auto and the workers and therefore, it would not include the workers employed by the contractor.

Observations

‘Tax holidays’ have been provided from time to time vide various sections, viz., section 15C of the Act of 1922 section 84, section 80J, section 80HH, section 80I, section 80IA and section 80IB of the Act of 1961. The intention of the Legislature has been all along to encourage the setting up of new industrial undertakings with a view to expanding industries, employment opportunities and production of goods. The Courts have acknowledged the intention of the Legislature in introducing the said deduction/exemption/relief provisions of the Act and have held that such provisions should be interpreted liberally and reasonably and they should be so construed as to effectuate the object of the Legislature and not to defeat it.

The purpose of ‘tax holiday’ provisions has been apparently to provide tax incentives to stimulate the industry and manufacture of articles, resulting in more employment and economic gain for the country. The element of ‘number of workers to be employed’ being consistently present in all the ‘tax holiday’ provisions justifies the intention of the Legislature to promote and create employment opportunities in the country, thereby reducing unemployment.

In the case of CIT v. P. R. Alagappan, (173 ITR 522) (Mad.), the Court for the purpose of section 80J (4) of the Act explained that a ‘worker’ was a person who worked relying on the definition of ‘worker’ in the Factories Act.

The Court approved of the reference to the definition of ‘worker’ under the Factories Act and also observed that the expression ‘employs’ contemplated ‘contract of service’.

The Karnataka High Court in the case of CIT v. K. G. Yediruppa & Co., (152 ITR 152) in context of section 80HH(2)(iv) of the Act has held that in absence of definition of the word ‘worker’, the ordinary meaning of the word ‘worker’ meant casual, permanent or temporary workers.

Similarly, in the case of CIT v. Sawyer’s Asia Ltd. (supra), the Bombay High Court for the purpose of deduction u/s.84(2)(iv), observed as under:

“………The undertaking is not required to have ten or more regular workers and it may be said to have satisfied that requirement if the aggregate actual number of workers engaged in the manufacturing process, both regular and normal, is ten in number……….If it chooses to have less than 10 regular workers on its muster roll, it runs the risk of not satisfying the requirement on such days on which the necessary number of casual workers is not available.”

The Court also considered even persons employed on casual basis as eligible to be ‘workers’ for the purpose of satisfaction of condition u/s.84(2)(iv) of the Act.

Similarly, in the case of CIT v. V. B. Narania & Co., (252 ITR 884), the Gujarat High Court, in context of provisions of section 80HH(2)(iv) and section 80J(2) (iv), held by relying on the decision of Apex Court in the case of Harish Chandra Bajpai v. Triloki Singh, (AIR 1957 SC 444), that a contract of employment may be in respect of either piece work or time work. It held that the real test of deciding whether the contract was one of employment or not was to find whether the agreement was for the personal labour of the person engaged, and if that was so, the contract was one of employment and the rest of the facts were immaterial like, whether the work was time work or piece work, or whether the employee did the whole of the work himself, or whether he obtained the assistance of other persons also for the work.

In interpretation of the analogous provisions to sec-tion 80IB(2)(iv)/section 80I(2)(iv) the Courts have interpreted the word ‘worker’ to also include ‘casual and temporary workers’ and the expression ‘employ’ has been interpreted to mean a contract of service, where the requirement of personal labour of the person employed is of importance as against whether the employee is in normal employment of the undertaking or otherwise. The stress is upon the substance of the arrangement rather than its legal form.

Looking from the perspective of intention of the Legislature in creating employment and supported by the above-referred decisions, the better view appears to be that the casual and contractual workers employed directly or through the contractor are to be treated as the ‘workers’ for the purposes of the ‘tax holiday’. The decision in the case of Venus Auto (supra) may require reconsideration.

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Legitimacy of Reference to OECD Commentary for Interpretation of Income Tax Act and DTAs

Recently, in the case of Gracemac Corporation and Others v. ADIT, (47 DTR 65) (Del.) (Tri.), the appellant had relied on the Commentary of OECD Model Tax Convention (‘the OECD Commentary’) in order to differentiate between ‘copyright’ and ‘copyrighted article’ for interpretation of the term ‘royalty’ in respect of computer software. The Tribunal rejected the reliance on the OECD Commentary after referring to the decision of the Apex Court in the case of CIT v. P.V.A.L. Kulandagan Chettiar, (137 Taxman 460) for the following reasons:

The phrase ‘copyrighted article’ is not used under the Income-tax Act, 1961 (‘the Act’) or in the Double Taxation Avoidance Agreements (‘DTAA’) or even under the Copyright Act, 1957; and

As held by the Apex Court in the aforesaid decision, OECD Commentary is not a safe or acceptable guide or aid for interpretation of provisions of the Act or DTAAs between India and other countries.

The Tribunal concluded that royalty in respect of computer software has to be decided on the basis of provisions of the Act or relevant DTAA under consideration.

On the other hand, the Delhi High Court recently in the case of Asia Satellite Telecommunications Co. Ltd. v. DIT and vice versa, (332 ITR 340) upheld the reliance on OECD Commentary while interpreting the definition of ‘royalty’ in respect of leasing out transponder capacity on a satellite. The Court held that the technical terms used in DTAA are the same which appear in section 9(1)(vi) and for better understanding of the terms, OECD Commentary can always be relied upon. The Court relied on the decision of the Apex Court in the case of UOI and Anr v. Azadi Bachao Andolan & Anr., (263 ITR 706) and other catena of decisions1 to emphasise that the international accepted meaning and interpretation placed on identical or similar terms employed in various DTAAs should be followed by the Courts in India when it comes to construing similar terms occurring in the Act.

On a combined reading of the findings of the aforesaid decisions, one may reconcile that for better understanding of the terms used in the Act or DTAAs, one may refer to the OECD Commentary provided and subject to:

The technical terms as sought for interpretation are ambiguous; and

Technical terms as used in the Act or DTAAs are identical or similar to terms employed in OECD Commentary.

The true significance however, lies in the practical implementation of the aforesaid principle while interpreting the provisions of the Act and DTAAs, which may be subject to criticisms or limitations similar to reliance on English decisions and other international decisions and/or statutes. In addition, India not as a ‘Member’ of OECD but as ‘Observer’ has expressed its position/views on the Articles of OECD Model Convention and its commentary thereon, which has been published in the OECD Model Tax Convention on Income and on Capital 2010 (version dated 22 July 2010). The position is presented qua the Articles under the Tax Convention as regard to its disagreement with the Text of the Article or disagreement with an interpretation given in the commentary in relation to the Article. It would be further necessary to highlight that while nations like Indonesia and China, (non-OECD economies like India) have expressly clarified that in the course of negotiations with other countries, they will not be bound by their stated positions in the OECD Commentary; India has not expressly clarified as such. Therefore, one may suggest that India may be bound by its stated positions in respect of the OECD Commentary in its course of negotiation and interpretations of DTAAs with other countries.

In the backdrop of the aforesaid discussion, it may then be necessary to consider the legitimacy in relying on OECD Commentary for interpretation of provisions of the Act and DTAAs entered into by India with other countries.

Reliance on OECD Commentary in interpreting provisions of the Act

Reference to English and other International decisions for interpretation and construction of the provisions of the Act have been subject of concern and criticism, time and again by the Courts2 since the provisions of the Act are not in pari materia with the provisions of the other statues, as well as the fundamental concepts and the principles on which the provisions are incorporated under the Act are different vis-à-vis the other statues. The provisions of the Act though may at times appear to be similar to the provisions of OECD Tax Convention, on deeper scrutiny may reveal differences not only in the wording but also in the meaning of a particular expression which has been acquired in the context of the development of law in those countries. Reliance on OECD Commentary in interpreting the provisions of the Act may therefore be subject to similar criticisms and concerns.

OECD is a 31 Member country organisation where the respective governments work together to address the economic, social and environmental challenges of globalisation. The OECD Model Tax Convention on Income and on Capital was designed and developed by the member countries as a means to settle on a uniform basis the most common problems that arise in the field of International juridical double taxation. India while negotiating its tax treaties maintains a balance and follows either OECD Model or UN Model on Tax Convention or a mix of the two. So, the provisions and terms as used in the Act may not confirm to the same language, interpretation and meanings as used in the DTAAs by India with other countries. Observations have been made by various Courts in catena of decisions3 with respect to various provisions of the Act as being wider/narrower in scope to the analogous provisions of DTAAs.

One may therefore say that the provisions of the Act should be construed on their own terms without drawing any analogy of the OECD Commentary, subject to principles as drawn above.

Reliance on OECD Commentary in interpreting provisions of DTAAs

Though, India is not a signatory to Vienna Convention on the Law of Treaties (‘VCLT’), but the judicial forums4 in India have acknowledged its importance in interpreting the provisions of DTAAs and have observed as under:

“The DTAAs are international agreements entered into between States. The conclusion and interpretation of such convention is governed by public international law, and particularly, by the Vienna Convention on the Law of Treaties of 23 May 1969. The rules of interpretation contained in the Vienna Convention, being customary international law also apply to the interpretation of tax treaties. . . . .”

The principles governing the interpretation of tax treaties can be broadly summed up as follows:

(i) A tax treaty is an agreement and not a taxing statute, even though it is an agreement about how taxes are to be imposed.

(ii) The principles adopted in the interpretation of statutory legislation are not applicable in interpretation of treaties.

(iii) A tax treaty is to be interpreted in good faith in accordance with the ordinary meaning given to the treaty in the context and in the light of its objects and purpose.

(iv) A tax treaty is required to be interpreted as a whole, which essentially implies that the provisions of the treaty are required to be construed in harmony with each other.

(v) The words employed in the tax treaties not being those of a regular Parliamentary draughtsman, the words need not examined in precise grammatical sense or in literal sense. Even departure from plain meaning of the language is permissible whenever context so requires, to avoid the absurdities and to interpret the treaty ut res magis valeat quam pereat i.e., in such a manner as to make it workable rather than redundant.

(vi) A literal or legalistic meaning must be avoided when the basic object of the treaty might be defeated or frustrated insofar as particular items under consideration are concerned.

(vii) Words are to be understood with reference to the subject-matter, i.e., verba accopoenda sunt secundum subjectum materiam.

(viii) When a tax treaty does not define a term employed in it, and if the context of the treaty so requires, the terms can be given a meaning different from its meaning in the domestic law. The meaning of the undefined terms in a tax treaty should be determined by reference to all of the relevant information and the context.

The rules of interpretation in VCLT can be found in Article 31 to 33 of the Convention. Article 32 of the Convention provides recourse to supplementary means of interpretation, which in turn should confirm to the broad principles of Article 31 as summarised above. According to Article 32 of VCLT, the ‘supplementary means of interpretation’ include the preparatory work of the treaty and the circumstances of its conclusion. The word ‘include’ indicates that the rule is not exhaustive and there may be other supplementary means of interpretation. One such means is provided by the commentaries appended to the OECD Model Tax Convention. To the extent, the provisions of DTAAs are similar to OECD Model Convention, the OECD commentaries may become relevant to interpretation of DTAAs.

The Kolkata Tribunal in the case of Graphite India Ltd. v. DCIT, (86 ITD 384) while deciding whether the services rendered by an American Consultant to an Indian Company are covered under the Article 15, being in the nature of professional services or under Article 12, being in the nature of Fees for Technical services, observed as under as regard to interpretation of OECD and UN Model Commentaries:

“17. The aforesaid interpretation is clearly in harmony with the OECD and UN Model Conventions’ official commentaries, ………….. Andhra Pradesh High Court has, in the case CIT v. Visakhapatnam Port Trust, (1984) 38 CTR (AP) 1: (1983) 144 ITR 146 (AP), referred to OECD commentaries on the technical expressions and the clauses in the model conventions, and referred to, with approval, Lord Radcliffe’s observations in Ostime v. Australian Mutual Provident Society, (1960) AC 459, 480: (1960) 39 ITR 210, 219 (HL), which have described the language employed in these documents as the ‘international tax language’. In view of the observations of Andhra Pradesh High Court, in Visakhapatnam Port Trust’s case (supra), these model conventions and commentaries thereon constitute international tax language and the meanings assigned by such literature to various technical terms should be given due weightage. In our considered view, the views expressed by these bodies, which have made immense contribution towards development of standardisation of tax treaties between various countries, constitute ‘contemporanea expositio’ inasmuch as the meanings indicated by various expressions in tax treaties can be inferred as the meanings normally understood in, to use the words employed by Lord Radcliffe, ‘international tax language’ developed by bodies like OECD and UN.”

As discussed earlier, India by giving its stance on the text of the Article of OECD Model Tax Convention and commentaries thereon has helped in confirming an interpretation, in resolving ambiguities and obscurities and in displacing interpretation which appears absurd or unreasonable from India’s point of view. India’s position qua the text of the Articles and commentaries thereon as stated in the OECD Model Tax Convention — July 2010 version under the chapter ‘Non -OECD Economies’ positions on the OECD Model Tax Convention’ is tabulated below:

Relevant
Article

OECD
— India’s position

Text
of the Article

Commentary
of the Article

Article 1 – Persons
covered

No disagreement5

Disagreement6

Article 2 – Taxes
Covered

No disagreement

Article 3 – General
Definitions

Reservations7

No disagreement

Article 4 – Resident

Reservations

Disagreement

Article 5 – Permanent
Establishment

Reservations

Disagreement

Article 6 – Income
from Immovable Property

Reservations

No disagreement

Article 7 – Business
Profits (position after 22-7-2010)

Reservation and

Disagreement

disagreement

Article 7 – Business
Profits (position before 22-7-2010)

Reservations

Disagreement

Article 8 – Shipping,
Inland Waterways Transport and

Air Transport

Reservations

Article 9 –
Associated Enterprises

No disagreement

Article 10 –
Dividends

Reservations

Disagreement

Article 11 – Interest

Reservations

Disagreement and
Reservations

Article 12 – Royalties

Reservations

Disagreement and Reservations

Article 13 – Capital
Gains

Reservations

No disagreement

Article 14 –
Independent Personal Services

Article and
commentary thereon has been deleted by OECD

Article 15 – Income
from Employment

Reservations

Disagreement

Article 16 – Director’s
Fees

No disagreement

Article 17 – Artists
and Sportsmen

Reservations

No disagreement

Article 18 – Pensions

No disagreement

Article 19 –
Government Service

No disagreement

Disagreement

Article 20 – Students

Reservations

No disagreement

Article 21 – Other
Income

Reservations

No disagreement

Article 22 – Taxation
of Capital

Reservations

No disagreement

Article 23A –
Exemption Method

Reservations

No disagreement

Article 23B – Credit
Method

Article 24 – Non
Discrimination

Reservations

Article 25 – Mutual
Agreement Procedure

No disagreement

Disagreement

Article 26 – Exchange
of Information

Reservations

No disagreement

Article 27 –
Assistance in the Collection of Taxes

Article 28 – Members
of Diplomatic Missions and

There are no disagreements which India has
raised as regard to Text

Consular Posts

Article 29 – Territorial Extension

of the Article and
Commentary thereon.

Article 30 – Entry
into Force

Article 31 –
Termination

However, a question that arises is whether the position by India with respect to provisions of OECD Model Tax Convention is binding on taxpayers, tax authorities and more so, on the judicial forums of India.

To begin with, it is necessary to find the statutory force or lack of it, under which India has provided its position to the OECD Model Tax Convention, since its nature will determine the legitimacy of reference to OECD Commentary for interpreting the provisions of DTAAs.

After considering the OECD Commentary — ‘Non-OECD Economies’ Positions on the OECD Model Tax Convention’ Chapter, one understands that these are official statements made by Government of India as regard its interpretation of the Tax Convention. The clarifications or comments provided to OECD are not issued as a rule u/s.295, Circular or order u/s.119 of the provisions of the Income-tax Act, 1961. A pos-sible conclusion which can then be drawn is that even though such clarification may not be binding on taxpayers, they shall have high persuasive value considering contemporary official statements made by the Government of India on the subject of interpretation.

One also needs to consider whether these official statements can be considered as an aid for construction of the DTAAs entered into by India and which are based on OECD Model Tax Convention.

The aforesaid explanations received from the Indian Government could be considered as an aid for construction, which is in accordance with the Latin Maxim Contemporanea expositio. The Indian Courts8 have time and again held that Contemporaneous Exposition by the administrators entrusted with the task of executing the statute is extremely significant in interpretation of the statutory instruments. The rule of contemporanea expositio provides that “administrative construction (i.e., contemporaneous construction placed by administrative or executive officers) generally should be clearly wrong before it is over-turned; such a construction commonly referred to as practical construction, although non-controlling, is nevertheless entitled to considerable weight, it is highly persuasive.” [Crawford on Statutory Construction, 1940 Ed, as in K. P. Varghese (supra)]. However, generally, such expositions from the administrators are subject to the following limitations:

The plain and unambiguous language of the statutory instruments shall hold

good against such expositions; and

Such expositions even though binding on the Income-tax Department, are not binding on the Tribunal and Courts.

Therefore, based on the aforesaid discussion and doctrine of Contemporanea exposition, one may hold that provisions of DTAAs could be construed based on the explanation as received from the Indian Government on the OECD Model Tax Convention, provided the said exposition adheres to the broad principles of Article 31 of the VCLT, even though the applicability of VCLT to India may be a question in itself.

So, besides, decisions delivered by the various Indian judicial forums interpreting the provisions of DTAAs, one can now rely on India’s position on the Articles of the OECD Model Tax Convention and commentary thereon.

Lastly, the relevant extracts of the decision of the Apex Court in the case of UOI v. Azadi Bachao Andolan and Anr. (supra) as regard to interpretation of DTAAs are reproduced below:

“………… Interpretation of Treaties

96. The principles adopted in interpretation of treaties are not the same as those in interpretation of statutory legislation. While commenting on the interpretation of a treaty imported into a municipal law, Francis Bennion observes:

“With indirect enactment, instead of the substantive legislation taking the well-known form of an Act of Parliament, it has the form of a treaty. In other words the form and language found suitable for embodying an international Agreement become, at the stroke of a pen, also the form and language of a municipal legislative instrument. It is rather like saying that by Act of Parliament, a woman shall be a man. Inconveniences may ensue. One inconvenience is that the interpreter is likely to be required to cope with disorganised composition instead of precision drafting. The drafting of treaties is notoriously sloppy, usually for very good reason. To get Agreement, politic uncertainty is called for.

…… This echoes the optimistic dictum of Lord Widgery CJ that the words “are to be given their general meaning, general to lawyer and layman alike… the meaning of the diplomat rather than the lawyer.” [Francis Bennion, Statutory Interpretation, p. 461 (Butterworths) 1992 (2nd Ed.)]

An important principle which needs to be kept in mind in the interpretation of the provisions of an international treaty, including one for double taxation relief, is that treaties are negotiated and entered into at a political level and have several considerations as their bases. Commenting on this aspect of the matter, David R. Davis in Principles of International Double Taxation Relief, p. 4 (London Sweet & Maxwell, 1985), points out that the main function of a Double Taxation Avoidance Treaty should be seen in the context of aiding commercial relations between treaty partners and as being essentially a bargain between two treaty countries as to the division of tax revenues between them in respect of income falling to be taxed in both jurisdictions”

On a more practical front, one finds that since the publication of India’s position on OECD Model Tax Convention, the Courts have not acknowledged much, the said publication as an aid for construction in interpreting the provisions of DTAAs. The taxpayers could however look forward to taking re-course to the India’s position on OECD Commentary as an aid for construction, for the favourable interpretations with respect to provisions of DTAA.

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Subscription fees received by FCO for providing social media monitoring services for market intelligence constitutes royalty u/s.9(1)(vi) of Income-tax Act and Article 12(3) of India- Singapore DTAA.

ThoughtBuzz Pvt. Ltd.
AAR No. 1036 of 2010
explanation 2 to section 9(1)(vi),
article 12(3) of India-Singapore DTAA
Dated: 7-4-2012
Justice P. K. Balasubramanyan (Chairman)
Present for the appellant: None
Present for the respondent: P. Selvaganesh

Subscription fees received by FCO for providing social media monitoring services for market intelligence constitutes royalty u/s.9(1)(vi) of income-tax act and article 12(3) of india-Singapore DTAA.

Facts:

Taxpayer, a Singapore company (FCO), is engaged in providing social media monitoring service for a company, brand or product. The service is a platform for users to hear and engage with their customers, brand ambassadors, etc. on the Internet. The clients who subscribed, for a subscription fee, could login to the website and search on what is being spoken about various brands.

The system operated by FCO generated a report of analytics with inputs provided by clients. FCO obtained information, for generating report, from various external sources by using its own crawlers (computer program that gather and categorise information on the Internet).

FCO approached AAR on taxability of subscription fee received from Indian subscribers under the Income-tax Act and also India-Singapore DTAA.

Tax Department contended that the subscription fee was in the nature of royalty as the basic mechanism of providing service was through a computer program (crawler) which was owned by FCO. Hence, subscription fee could not be disassociated from the user of computer system and it constituted fee paid for equipment use as also for imparting technical, commercial or scientific knowledge under Income-tax Act and India-Singapore DTAA

FCO contended that the subscription fee received from the Indian customers was not royalty u/s.9(1) (vi) or under India-Singapore DTAA as no exclusive right or copyright was given to its customers. There was no control of software and they did not have any possessory rights in relation to the equipments. Also, information passed on to its clients was not its own knowledge, experience or skill.

As FCO had no PE in India, the income was only taxable in Singapore under Article 7 of the DTAA.

AAR Ruling:

AAR upheld the Tax Department’s contentions and held that subscription fee received by FCO constitutes royalty for the following reasons:

As FCO was in business of gathering collating and making available or imparting information concerning industrial and commercial knowledge, experience and skill, the subscription fee would be covered under clause (iv) of Explanation 2 to section 9(1)(vi) of Income-tax Act.

Payment received by FCO would constitute royalty under Article 12(3)4 of the DTAA, as it represents consideration for use of or right to use the process or information concerning industrial, commercial or scientific experience.

As subscription fee received by FCO is taxable under the Income-tax Act as also India-Singapore DTAA, tax is required to be deducted at source u/s.195 of the Income-tax Act.

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Income from inspection, verification, testing and certification services (IVTC) provided by FCO in India qualifies as Fees for Technical Services (FTS) under Income-tax Act. IVTC does not qualify as FTS under treaties containing a ‘make available’ clause, as services cannot be independently applied by service recipient. Under treaties having a Most Favoured Nation (MFN) clause, benefit of a restricted meaning of FTS in terms of make available clause is available. Income from IVTC qualifies as ‘<

XYZ (a.a.r. Nos. 886 to 911, 913 to 924, 927, 929 and 930 of 2010)
Section 9(1)(vii) 139, 195, 245 of ITA,
article 7, 22 of india-US DTAA
Dated: 19-3-2012
Justice P. K. Balasubramanyan (Chairman)
V. K. Shridhar (Member)
Present for the applicant: G and others
Present for the Department: Mahesh Shah, Ashish Heliwal

Income from inspection, verification, testing and certification services (IVTC) provided by FCO in india qualifies as Fees for Technical Services (FTS) under income-tax act.

IVTC does not qualify as FTS under treaties containing a ‘make available’ clause, as services cannot be independently applied by service recipient.

Under treaties having a Most Favoured Nation (MFN) clause, benefit of a restricted meaning of FTS in terms of make available clause is available.

Income from IVTC qualifies as ‘other income’ under treaties not having specific FTS article.

Facts:

X group of companies is engaged in the business of inspection, verification, testing and certification (IVTC) services. Taxpayer, part of X group and a non-resident in India (FCO), provides IVTC services directly to Indian customers from outside India and payments are also made outside India.

FCO provides services, issues an analysis reports and raises invoices on ICO or directly on Indian customers.

FCO approached the AAR for determining the taxability in India of its income from IVTC services. Questions were also raised about the taxability of recovered costs, withholding obligations of the payers and obligation of FCO to file ROI in India.

The above questions were also raised, before AAR, by various entities of X group belonging to different countries.

AAR examined the position separately under the Income-tax Act/DTAAs:

FTS under Income-tax Act

IVTC services are in the nature of technical services and taxable as FTS under the Income-tax Act.

The exclusion in respect of services to be utilised in businesses carried on by residents outside India or earning income from a source outside India does not apply to facts of the case.

Under the DTAA with ‘make available’ clause:

Services did not ‘make available’ technical know-how, experience, skill, know-how or process to the Indian customers as:

Utility of services came to an end soon after its rendition.

There was no system in place which equipped ICO to carry on IVTC services independently.

AAR also held:

MFN clause extended ‘make available’ benefit in suitable cases even though the treaty was on FTS.

In absence of FTS Article, services would get covered by other Income Article.

Reimbursement of expenses partook the character of FTS. FCO obligated to file return of income if non-taxability is based on treaty entitlement.

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Appeal to Supreme Court – Special Leave Petition – Delay by the Government bodies – Unless there is a reasonable and acceptable explanation for the delay and there is bona fide effort, the usual explanation regarding procedural delay should not be accepted.

[Office of the Chief Post Master General and Others v. Living Media India Ltd. and Anr. (2012) 348 ITR 7 (SC)]

Living Media India Ltd., a company incorporated under the Companies Act, 1956, publishes the magazines Reader’s Digest and India Today. These magazines are registered newspapers, vide Registration Nos. DL 11077/03-05 and DL 11021/01-05 respectively issued by the Department of Posts, Office of the Chief Post-Master General, Delhi Circle, New Delhi (in short “the Postal Department”) under the provisions of the Indian Post Office Act, 1898 (in short “the Act”), read with the Indian Post Office Rules, 1933 (in short “the Rules”), and the Post Office Guide and are entitled for transmission by post under concessional rate of postage.

On 14th October, 2005, the manager (circulation), Living Media India Ltd., submitted an application to the Postal Department seeking permission to post December, 2005, issue of Reader’s Digest magazine containing the advertisement of Toyota Motor Corporation in the form of booklet with calendar for the year 2006 at concessional rates in New Delhi. By letter dated 8th November, 2005, the Postal Department denied the grant of permission for mailing the said issue at concessional rates on the ground that the booklet containing advertisement with calendar is neither a supplement nor a part and parcel of the publication. On 17th November, 2005, the Director (Publishing), Living Media India once again submitted an application seeking the same permission which was also denied by the Postal Department by letter dated 21st November, 2005.

In the same way, the Postal Department also refused to grant concessional rate of postage to post the issue dated 26th December, 2005, of India Today magazine containing a booklet of Amway India Enterprises titled “Amway”, vide their letter dated 18th February, 2006, and 17th March, 2006, stating that the said magazine was also not entitled to avail of the benefit of concessional rate available to registered newspapers.

Living Media India Ltd., being aggrieved by the decision of the Postal Department filed a Writ Petitions before the High Court. The learned single judge of the High Court, by order dated 28th March, 2007, allowed both the petitions filed by Living Media India Ltd.

Being aggrieved, the Postal Department filed LPA’s before the High Court. The Division Bench of the High Court, vide common final judgment and order dated 11th September, 2009, while upholding the judgment of the learned single judge, dismissed both the appeals.

Challenging the said order, the Postal Department preferred appeals by way of special leave before the Supreme Court. There was a delay of 427 days in filing the above appeals.

The learned senior counsel for Living Media India Ltd., seriously objected to the conduct of the appellants in approaching the Supreme Court after the enormous and inordinate delay of 427 days in filing the above appeals.

The Supreme Court, after noting the various judgments cited by both the parties and the affidavits filed by the Postal Department dismissed the applications, holding that the Postal Department had itself mentioned and was aware of the date of the judgment of the Division Bench of the High Court as 11th September, 2009. Even according to the department, their counsel had applied for the certified copy of the said judgment only on 8th January, 2010, and the same was received by the department on the very same day. There was no explanation for not applying for certified copy of the impugned judgment on 11th September, 2009, or at least within a reasonable time. The fact remained that the certified copy was applied only on 8th January, 2010, i.e., after a period of nearly four months. In spite of affording another opportunity to file better affidavit by placing adequate material, neither the Department nor the person in-charge had filed any explanation for not applying the certified copy within the prescribed period. The other dates mentioned in the affidavit clearly showed that there was delay at every stage and there was no explanation to why such delay had occurred. The Supreme Court observed that, though it was stated by the Department that the delay was due to unavoidable circumstances and genuine difficulties, the fact remained that from day one, the Department or the person/persons concerned had not evinced diligence in prosecuting the matter to the court by taking appropriate steps. The person(s) concerned were well aware or conversant with the issues involved including the prescribed period of limitation for taking up the matter by way of filing a special leave petition in the court. The Postal Department cannot claim that they have separate period of limitation when the Department was possessed with competent persons familiar with court proceedings. According to the Supreme Court in the absence of plausible and acceptable explanation, the delay could not to be condoned mechanically merely because the Government or a wing of the Government was a party before it. The Supreme Court held that though it was conscious of the fact that in a matter of condonation of delay when there was no negligence or deliberate inaction or lack of bona fide, a liberal concession had to be adopted to advance substantial justice, but in the facts and circumstances, the Department could not be allowed to take advantage of various earlier decisions. The claim on account of impersonal machinery and inherited bureaucratic methodology of making several notes could not be accepted in view of the modern technologies being used and available. According to the Supreme Court, the law of limitation undoubtedly binds everybody including the Government.

In the opinion of the Supreme Court, unless all the Government bodies, their agent and instrumentalities have reasonable and acceptable explanation for the delay and there was bona fide effort, there is no need to accept the usual explanation that the file was kept pending for several months/ years due to considerable degree of procedural red-tape in the process. The Government departments are under a special obligation to ensure that they perform their duties with diligence and commitment. Condonation of delay is an exception and should not be used as an anticipated benefit for Government departments. The law shelters everyone under the same light and should not be swirled for the benefit of a few.

According to the Supreme Court, there was no proper explanation offered by the Department for the delay except mentioning of various dates; the Department had miserably failed to give any acceptable and cogent reasons sufficient to condone such a huge delay. The Supreme Court dismissed the appeals on the ground of delay.

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Business Expenditure – Where payment is for acquisition of know-how to be used in the business of the assessee, deduction is to be allowed u/s. 35AB and section 37 has no application.

[Drilcos (India) Pvt. Ltd. v. CIT (2012) 348 ITR 382 (SC)]

The assessee, a manufacturer of mining equipments, entered into an agreement with an American company on 7th June, 1990. The agreement with the American company was called “licence and technical assistance agreement” under which the American company was required to transfer technical know-how to the assessee for consideration of $ 25,000 to be paid in three instalments. The first instalment in convertible Indian currency amounting to Rs.17,49,889 was paid on 29th November, 1990. Subsequently, disputes arose between the contracting parties and the know-how was not transferred by the American company.

The short question which arose for determination before the Supreme Court was, whether the amount of Rs.17,49,889 could be claimed by the assessee as a deduction u/s. 37 of the Income-tax Act, 1961.

The claim of the assessee u/s. 37 of the Income Tax Act, 1961 was rejected by the Department. However, the Department allowed the expenditure to be amortised u/s. 35AB of the Act.

The contention of the assessee was that section 35AB of the Act was not applicable to this case. The Supreme Court found no merit in the said contention.

The Supreme Court observed that s/s. (1) of section 35AB of the Act clearly states that, where the assessee has paid in any previous year any lump sum consideration for acquiring any knowhow for use for the purpose of his business, then one-sixth of the amount so paid shall be deducted in computing the profits and gains of the business for that previous year and the balance amount shall be deducted in equal instalments for each of the five immediately succeeding previous years. The Explanation to the said section says that the word “know-how” means any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine. According to the Supreme Court if one carefully analyses section 35AB of the Act, it would be clear that prior to 1st April, 1986, there was some doubt as to whether such expenditure could fall u/s. 37 of the Act. To remove that doubt, section 35AB of the Act stood inserted. In s/s. (1) of section 35AB of the Act, there is a concept of amortisation of expenditure. The Supreme Court observed that in the present case, it was true that on account of certain disputes which arose between the parties, the balance amount was not paid by the assessee to the American company. However, the word “for” in section 35AB of the Act, which is a preposition in English grammar, has to be emphasised while interpreting section 35AB of the Act. Section 35AB of the Act says that the expenditure should have been incurred for the purposes of the business of the assessee. In the present case, the technical assistance agreement was entered into between the assessee and the American company for acquiring know-how which was, in turn, to be used in the business of the assessee. Once section 35AB of the Act comes into play, then section 37 of the Act has no application.

According to the Supreme Cour,t there was no error in the impugned judgment of the High Court. The Supreme Court dismissed the civil appeal filed by the assessee.

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Valuation of stock – In valuing the closing stock the element of excise duty is not to be included.

[CIT v. Dynavision Ltd. (2012) 348 ITR 380 (SC)]

The assessee, a private limited company, carried on the business of manufacture and sale of television sets. For the assessment year 1987-88, the Assessing Officer while completing the assessment u/s. 143(3) found that the assessee had not included in the closing stock the element of excise duty. Accordingly, he added a sum of Rs.16,39,000 to the income of the assessee on the ground of undervaluation of closing stock.

The question before the Supreme Court was whether the Department was right in alleging that the closing stock was undervalued to the extent of Rs.16,39,000/-.

The Supreme Court noted that, it was not in dispute that the assessee had been following consistently the method of valuation of closing stock which was “cost or market price, whichever is lower.” Moreover, the Assessing Officer had conceded before the Commissioner of Income Tax (Appeals) that he revalued the closing stock without making any adjustment to the opening stock. According to the Supreme Court though u/s. 3 of the Central Excise Act, 1944, the levy of excise duty in on the manufacture of the finished product, the same is quantified and collected on the value (i.e. selling price). The Supreme Court referred to the judgment in the case of Chainrup Sampatram v. CIT reported in [1953] 24 ITR 481 (SC) in which it has been held that, “valuation of unsold stock at the close of the accounting period was a necessary part of the process of determining the trading results of that period. It cannot be regarded as source of profits. That the true purpose of crediting the value of unsold stock is to balance the cost of the goods entered on the other side of the account at the time of the purchase, so that on canceling out the entries relating to the same stock from both sides of the account, would leave only the transactions in which actual sales in the course of the year has taken place and thereby showing the profit or loss actually realised on the year’s trading. The entry for stock which appears in the trading account is intended to cancel the charge for the goods bought which have remained unsold which should represent the cost of the good”.

The Supreme Court for the above reasons, held that, the addition of Rs.16,39,000 to the income of the assessee on the ground of undervaluation of the closing stock was wrong.

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Seminar on Finance Act, 2012 — Direct Tax Provisions

Seminar on Finance Act, 2012 — Direct Tax Provisions

This seminar was organised by the Taxation Committee on Saturday 9th June, 2012 at Walchand Hirachand Hall, IMC. The faculty Kishor Karia, Pradip Kapasi, and Sanjeev Pandit analysed threadbare various changes in the direct tax provisions enacted by the Finance Act, 2012. The programme received enthusiastic response from the participants who gained immensely from the wealth of knowledge and experience shared by the learned faculties.

Release of BCAS Referencer 2012-13

The most awaited Golden Jubilee Collector’s Edition of the BCAS Referencer for the year 2012-13 was released on Thursday, 14th June, 2012 at Swatantrya Veer Savarkar Rashtriya Smarak, Shivaji Park at the hands of our Past Presidents Narayan Varma, Pradyumna Shah and Arvind Dalal. The release was followed by a musical programme on the theme of ‘Kal, Aaj aur Kal’ where the artists regaled audience of over 400 with melodious and memorable songs from films of Raj Kapoor, Rishi Kapoor and Ranbir Kapoor.

6th Residential Study Course on Service Tax & VAT

The Indirect Taxes and Allied Laws Committee organised this 6th Residential Study Course on Service Tax & VAT from 22nd June to 24th June, 2012 at Rio Resort, Goa that was attended by nearly 150 participants from various parts of India including Hyderabad, Mumbai, Ahmedabad, Secunderabad, Chennai, Jaipur and Pune. L to R: Kishor Karia (Speaker), Pradip Thanawala (President), Gautam Nayak (Speaker) and Saurabh Shah Front Row: L to R – Deepak Shah, Narayan Varma (Past President), Pradyumna Shah (Past President), Arvind Dalal (Past President), Rajesh Shah, Pradip Thanawala (President), Pranay Marfatia. Behind Row: L to R – Rajeev Shah, Naushad Panjwani, Yatin Desai, Narayan Pasari Sunil Gabhawalla, Chartered Accountant, presented paper on ‘Concept of Negative List based Taxation of Services, Important Definitions, Exclusions and Exemptions’. Adv. P. K. Sahu presented paper on ‘Sale vs. Service — Overlap of VAT and Service Tax’.

Case Studies in POT Rules, Valuation of Services and Bundled Services were presented jointly by Sunil Gabhawalla, Chartered Accountant and A. R. Krishnan, Chartered Accountant.

Adv. K. Vaitheeswaran presented a paper on ‘Indirect Tax Issues in Real Estate Industry’.

A. R. Krishnan, Chartered Accountant also presented a paper on ‘Analysis of Place of Provision of Services Rules’.

The participants gained immensely from the wealth of knowledge and experi-ence shared by the learned faculty at this residential study course. n

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Commencement of Activity – whether pre-requisite for registration u/s.12AA

Issue for Consideration

Section 12A r.w.s. 12AA of the Income-tax Act, 1961 provides the procedure for grant of registration of a trust or institution (“trust”). According to this procedure, the trust has to make an application for registration in Form No. 10A prescribed under Rule 17A of the Income-tax Rules, 1962 within one year from the date of creation of the trust or the establishment of the institution. Upon receipt of the application, the Commissioner (SIT) shall call for documents and information and conduct inquiries to satisfy himself about the genuineness of the trust or institution.

After he is satisfied about the charitable or religious nature of the objects and genuineness of the activities of the trust, he will pass an order granting registration. If he is not satisfied, he will pass an order refusing registration. The order granting or refusing registration has to be passed within six months from the end of the month in which the application for registration is received by the Commissioner.

Section 12AA, inserted by the Finance (No. 2) Act, 1996 with effect from assessment year 1997-98, reads as under:

“12AA Procedure for registration.

(1) The Commissioner, on receipt of an application for registration of a trust or institution made under clause (a) or clause (aa) of ss. (1) of section 12A, shall—

(a) call for such documents or information from the trust or institution as he thinks necessary in order to satisfy himself about institution and may also make such inquiries as he may deem necessary in this behalf; and

(b) after satisfying himself about the objects of the trust or institution and the genuineness of its activities, he—

(i) shall pass an order in writing registering the trust or institution;

(ii) shall, if he is not so satisfied, pass an order in writing refusing to register the trust or institution, and a copy of such order shall be sent to the applicant :

Provided that no order under sub-clause (ii) shall be passed unless the applicant has been given a reasonable opportunity of being heard……

(2) Every order granting or refusing registration under clause (b) of subsection (1) shall be passed before the expiry of six months from the end of the month in which the application was received under clause (a) or clause (aa) of sub-section (1) of section 12A.

(3) Where a trust or an institution has been granted registration under clause (b) of sub-section (1) or has obtained registration at any time under section 12A as it stood before its amendment by the Finance (No. 2) Act, 1996 (33 of 1996) and subsequently the Commissioner is satisfied that the activities of such trust or institution are not genuine or are not being carried out in accordance with the objects of the trust or institution, as the case may be, he shall pass an order in writing cancelling the registration of such trust or institution:

Provided that no order under this sub-section shall be passed unless such trust or institution has been given a reasonable opportunity of being heard.”

Section 12AA therefore, details the provisions for registration of a trust for which an application has been filed u/s 12A. A reading of sub-clauses (a) and (b) of Section 12AA(1) makes it clear that the CIT has to satisfy himself about the genuineness of the activities of the trust and also about the objects of the trust.

As regards the objects of the trust, these can be determined from a perusal of the Memorandum or the deed of the trust, which is filed along with the registration application. If the objects of the trust are not for any charitable or religious purpose, registration may be refused by the CIT.

On the other hand, in order to determine the genuineness of the activities of the trust or the institution, the CIT has powers to make inquiries, call for documents or information. In cases where application is made after the activity is commenced, the CIT would exercise such powers of inquiry.

Given the time limit prescribed for making application for registration of a trust, in many cases, the application is made before the commencement of any activity by the applicant-trust. A controversy has arisen as to whether the CIT can reject the registration application of a trust, which has not commenced any activity, on the ground of non-determination of genuineness of activities of the trust. While the Delhi, Karnataka and Allahabad High Courts have taken a view that registration u/s. 12AA of the Act cannot be rejected by the CIT on the ground that it had not yet commenced any activity, the Kerala High Court has held that until the activity is commenced by the applicant trust/institution, registration should not be granted by the CIT.

Grant of Registration to a trust u/s. 12AA of the Act is important, since it is one of the conditions for grant of exemption u/s. 11 and 12 for the income of a trust.

Self Employers Service Society’s Case

The issue first came up before the Kerala High Court in the case of Self Employers Service Society v CIT 247 ITR 18.

The society was registered as a charitable society under the Travancore Cochin Literary Scientific and Charitable Societies Registration Act, 1955. The members of the society were mainly merchants. Though it had a large number of charitable objects, it had not commenced any of them during the first year of its functioning. It was accepting recurring deposits from its members and fixed deposits from the public. Loans were being given to its members at 21 % interest. The Commissioner found that in spite of the reference to a large number of charitable objects in its bye-laws, the activity carried on by the society was confined to its members, numbering about 150. Since such activities could not be regarded as charitable in nature, the Commissioner refused registration u/s.12AA.

The High Court noted that though several charitable activities were included in the objects of the society, it had not been able to do any of such charitable activities during the first year of its functioning. The proposal to start a technical educational institution itself was taken after the order of the CIT, rejecting the registration. The Court observed, that in the present case, the charitable society had not done any charitable work during the relevant period, but the activity which was undertaken during the said period was only for the generation of income for its members. It also noted that there were no materials before the Commissioner to be satisfied of the genuineness of the activities of the trust or institution. The Court therefore held that the rejection of the application could not be termed as illegal or arbitrary.

Foundation of Opthalmic and Optometry Research Education Centre’s Case

The issue under consideration again recently arose before the Delhi High Court in the case of DIT vs. Foundation of Ophthalmic and Optometry Research Education Centre 210 Taxman 36.

In this case, the assessee, a society registered under the Society Registration Act on 30th May 2008 with charitable objects of Optometry and Ophthalmic Education applied for registration before the Director of Income-tax (Exemption) [‘DIT(E)’] and filed other documents as sought by DIT(E)’s office from time to time. The DIT(E) refused to grant registration to the assessee by relying on the decision of Kerala High Court in the case of Self Employers Service Society vs CIT (supra), on the ground that no charitable activity was undertaken by the newly established assessee society.

On appeal by the assessee, the Tribunal, following the decision of the Allahabad High Court in the case of Fifth Generation Education Society (185 ITR 634), held that non-commencement of charitable activity cannot be a ground for rejection of application of registration filed by the assessee u/s. 12AA of the Act and thereby upheld the contention of the assessee.

Aggrieved with the judgement of the Tribunal, the Revenue filed an appeal before the High Court reiterating its arguments as placed before the Tribunal. The assessee-applicant on the other hand, relied on the decision of the Karnataka High Court in the case of DIT(E) v. Meenakshi Amma Endowment Trust (2011) (50 DTR 243) , wherein the High Court while considering similar facts of the assessee applicant held that when no activities are undertaken by the newly established trust/institution, then in such a scenario, the objects of the trust have to been taken into consideration by the CIT for determination of question of registration.

The High Court, after hearing the arguments of both the parties, upheld the contention of the assessee. The Court distinguished the judgements of Self Employers Service Society (supra) and Aman Shiv Mandir Trust (Regd.) v. CIT (296 ITR 415)(P&H) relied on by the Revenue on the ground that reasons for refusal of registration in the aforesaid decisions were not that the Trusts were newly registered, but that the activities of the Trusts under consideration were not charitable.

The High Court, after referring to the provisions of section 12AA, further held that the provision did not prohibit or enjoin the CIT from registering a trust solely based on its objects, without any activity, in the case of a newly registered trust. It also observed that the statute did not prescribe a waiting period for a trust to qualify itself for registration. Based on the said observations and following the decision of the Karnataka High Court of Meenakshi Amma Endowment Trust (supra), the appeal of the Revenue was rejected.

The Karnataka High Court in the case of Meenakshi Amma Endowment Trust (supra ) had earlier interpreted the provisions of section 12A r.w.s. 12AA of the Act and opined in context of registration of a newly established trust without undertaking any activity, as under:

“….When the trust itself was formed in January 2008 with the money available with the trust, one cannot expect them to do activity of charity immediately…. In such a situation, the objects of the trust could be read from the trust deed itself. In the subsequent returns by the trust, if the Revenue comes across that factually trust has not conducted any charitable activities, it is always open to the authorities concerned to withdraw the registration already granted or cancel the said registration u/s. 12AA of the Act.

A trust can be formed today and within a week registration u/s. 12A could be sought as there is no prohibition under the Act seeking such registration…..… the objects of the trust for which it was formed will have to be examined to be satisfied about its genuineness and activities of the trust cannot be the criterion, since it is yet to commence its activities.”

In other words, the High Court held that where a trust has not commenced its activities, then the CIT is required to examine the objects of the trust in order to ascertain the genuineness of its activities.

The Allahabad High Court in the case of Fifth Generation Education Society (supra) also had opined on the issue. The Court, while considering the provisions of registration of trust/institution u/s. 12A of the Act relating to assessment years prior to Finance (No. 2) Act, 1996, held that at the time of considering the application for grant of registration u/s. 12A, the CIT was not required to examine the application of income or carrying on of any activity by the trust. The Court further held that the CIT may at this stage examine whether the application was made in accordance with the requirements of section 12A r.w. Rule 17A, Form 10A was properly filled, along with determination of whether the objects of the trust were charitable or not.

Observations

On perusal of the decisions as discussed above, one may find that the Delhi, Karnataka and Allahabad High Courts have rightly interpreted the procedural provisions of section 12AA of the Act and rejected the contention of the Revenue to read in the condition of actual conduct of charitable activities for grant of registration of trusts, who have not commenced their charitable activities. Instead, in such situations, where trusts are yet to commence their activities, the Courts have sought to ascertain the genuineness of the activities of the trust by relying on their objects.

The Courts have also acknowledged that, injecting such subjectivity of satisfaction of conduct of charitable activities may be susceptible to varied interpretations by the relevant authorities, wherein some may be satisfied with activities of a month or few months, while others may wish to examine the activities of the applicant for a longer time.

The plain and simple procedures laid down in section 12AA do not empower the CIT to reject the grant of registration to trust, until the actual charitable activities are undertaken by the trust. On the contrary, in case of any abuse of procedures of section 12AA by any non-genuine trust, the Act provides for a safeguard by empowering the CIT u/s. 12AA(3) of the Act to cancel the registration of such trusts.

Further, the decision of the Kerala High Court was rightly distinguished by the Delhi High Court, wherein the refusal of registration of trust was not on account of non-commencement of activities of the newly constituted trust, but was for undertaking non-charitable activities. So, the view taken by the Kerala High Court that there had to be some material before the CIT showing the genuineness of activities actually carried on by the trust does not seem to be justified, and the view taken by the other high courts, that carrying on of activity is not a prerequisite for grant of registration u/s.12AA, seems to be the better view of the matter.

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Jal Erach Dastur Students’ Annual Day:

Jal Erach Dastur Students’ Annual Day celebration was organised on Saturday, 26th May 2012 at the Navinbhai Thakkar Auditorium of Shri Vile Parle Gujarati Mandal, Vile Parle (East), Mumbai-400057.

The event commenced with Saraswati Vandana followed by welcome address by President Pradip Thanawala. Chairman Mayur Nayak commended the efforts put in by students in organising this event. He briefed about various activities of the students undertaken by the BCAS. He welcomed the Key Note Speaker Padmashri T. N. Manoharan, past president of the ICAI. The key-note speaker made a very inspiring presentation with the help of Power point. The topic was ‘Transcending the challenges’. The talk was motivational and inspirational. He touched upon various topics such as values of life, setting goals, managing time, putting hard work, focusing on the career, sacrificing unimportant things and distractions, keeping physical, emotional and mental balance, maintaining highest standards in profession, etc. There were three competitions, namely Essay Writing, Elocution and Quiz.

1. Essay competition

46 students took part in the Essay competition; three essays were selected for printing in the BCA journal. The judges for the Essay Competition were Mihir Sheth, core group member and member of the HR Committee, Vipin Batavia, Past President of the Chamber of Tax Consultant and member of the HR Committee and Sangeeta Pandit, core group member. The winners were (1) Rohan Shah (2) Rushab Vora (3) Chhaya Joshi 2. Elocution competition The Elocution Competition was organised under the auspices of Smt. Chandanben Maganlal Bhatt Foundation. Mukesh Bhatt from the said Foundation graced the occasion and presented trophies to the winners. 31 students took part in the Elocution competition. After the elimination round, finally eight participants competed on the Annual Day for the 1st, 2nd and 3rd positions. It was a close competition as all of them did a good job. The judges for the elimination round of Elocution competition were, Ashok Solanki, Aliasgar Kherodawala and Vijay Bhatt. The judges for the final round were TV actor Sumeet Raghavan, Rajesh Muni, Past President and Stanny Pinto, an academician.
The winners of the Elocution competition were:

First Prize – Utsav Shah – Rashmin Sanghvi & Associates
Second Prize – Shweta Agarwal
Third Prize -Shweta Mishra – PHD & Associates

3. Quiz competition 45 students took part in the Quiz competition. Four teams comprising two students each were selected for the final round. The Quiz competition was hosted by the Ashish Fafadia in his inimitable style. He made even the audience to participate in the quiz.

The winners of the Quiz competition were:

First – Murtaza Bootwala – B.D. Jokhakar & Co.- Prize Riken Patel C.M. Gabhawala & Co.
Second – Ashish Shukla – M.B. Nayak & Co.Prize Ashwini Shah M.B. Nayak & Co.
Third – Bhuma Iyer -R.R. Muni & Co. Prize Sonal Pilwankar R.R. Muni & Co.

This year more than 400 students registered and about 50 principals and parents witnessed the talent presented by students. The event was compered by Shweta Agarwal and Nishad Vora and was well supported by Khusboo Shah. The event concluded with a sumptuous and delicious dinner.

Students left for home with lots of learning, fun and rich experience.

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Harness technology, do not become its slave!

The recent post on Facebook which caused a furore has been the inspiration for this editorial. I do not intend to dwell upon, the right of the person concerned to make a comment, the subsequent actions of the law-enforcement authorities and the reactions of various sections of the public. These aspects of the matter have already been and will continue to be debated upon. However what one really needs to appreciate are various issues that platforms such as Facebook and other technologically advanced communication tools have created.

Social networking sites have grown tremendously over the last decade. These sites have two significant attributes, namely that of a global platform with virtually unlimited access, and communication at substantial speed virtually in real-time. These characteristics could both be virtues as well as lead to disastrous consequences. Whatever is expressed on the platform is accessible to the world, and in fact, that seems to be intent for which the platform was promoted.

These platforms have changed the meaning of concepts and words. In my generation, the concept of a “friend” was one with whom you shared some degree of commonality. A person with whom you had nothing in common was rarely termed as a friend. On these sites you have “ friends” with whom you do not have a single common trait. So the neighbour who stays next door is a stranger, but a person in a distant country whom you have not seen in a life time is a friend !

If you” liked” a particular act or thing, there was a degree of feeling which resulted in your making the comment. It is true that at times, one said that one liked a particular thing only as a matter of courtesy, but if that was the case the manner of communication made it apparent. If one looks at the “likes” that one receives on some of the posts on networking sites, one really wonders whether the word has any meaning at all.

While networking platforms have encouraged a trend to disclose everything ( including certain private experiences) to the world at large, other advances in technology have resulted in an invasion of privacy. The cell or the mobile has been a culprit. In the good old days, if you wanted to maintain a degree of solitude, one stayed away from a landline. Callers on account of choice or by way of compulsion respected an individual’s desire to remain unavailable. With the advent of the mobile, the caller calls on the cell and expects the same to be answered. Not answering the cell when the caller calls repeatedly is taken as being impolite. Unsolicited calls and messages are extremely disturbing as my professional colleagues would have experienced in the past few weeks, and will probably have to endure this problem for a few more days.

The use of information technology, without understanding its fallout, has also led to two very disturbing trends. On account of the ability to store information which can be accessed virtually real-time, most of us have stopped using what we call the “memory” within. Earlier, we memorised the personal details of our relatives and friends like their telephone numbers and addresses etc. Since this information is now stored on our handheld cell phones, we rarely find the need to remember it. Consequently, if the cell phone is lost so are we. In the words of Henry Thoreau “men have become the tools of their tools”. Information or knowledge was earlier accessed from books or journals. Today, one rarely uses the printed word. If some information is required, one simply “googles”. In fact, when I was discussing the virtues of memorising tables with one of my nephews, he pointed out that it was a total waste of “memory” when these tables could be easily stored in a machine. In his view, the memory in our brain should remain free for better use. What sort of use it is now being put to is a matter of debate.

Another aspect of the matter is a perception that technology can substitute human attributes or human characteristics. It is now possible to communicate with any person across the globe at the touch of a button. One can not only hear a person irrespective of the geographical distance but can also see him. Unfortunately, this has its own disadvantages. An old lady in our family was depressed after her daughter, consequent to her marriage left for the United States . I tried to console her by stating that “geography was now history” and that she could speak to her daughter at any time and through the web cam could even see her. The old lady merely smiled and told me that it was in fact the web cam that caused immense pain. She explained that earlier she was able to only speak to her daughter and was content in the belief that her daughter was enjoying a good life in the States, because that is what she heard over the phone. Seeing her on the web cam, the old lady could see the pain on her daughter’s face and what was hidden in words was now unmasked. Being unable to physically comfort or console her daughter resulted in the old lady having sleepless nights.

This is not to say that we should shun technology. In fact, even if we wanted to, it is now impossible. One must however sensitise society in regard to the pitfalls of excessive reliance on technology. It needs to be emphasised particularly to youngsters that technology is a tool and not a substitute for human attributes and values. We should harness technology and put it to use. Tools are means and not an end. We must remain the master of our tools and not permit them to become ours!

Anil J. Sathe
Joint Editor

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Namaskar to Modern Day Rishis – Dr. Kavita and Dr. Ashish Satav

For those who wish to climb the mountain of spiritual awareness, the path is selfless work! Bhagavad Gita 6.3

India has a rich ancient heritage of thousands of years where Rishi-Munis lived with their families deep in the forests and jungles and worked for the welfare of the people.Recently I had the fortune of meeting and listening to Dr. Kavita and Dr. Ashish Satav, modern-day Rishis, and understood the true purpose of life, courtesy ‘Caring Friends’ and Shri Pradeep Shah.

Dr. Ashish Satav, MD, influenced by his ‘nana’, a close associate of Vinoba Bhave, has been leading a simple life right from his impressionable years. Inspired by the Sarvodaya philosophy of Mahatma Gandhi and encouraged by Baba Amte and Dr. Abhay Bang, Dr. Satav decided to serve the tribals of Melghat, instead of pursuing a lucrative medical practice in the comfort and security of a metropolis. Dr. Kavita’s background and outlook are also Gandhian. With hardly any resources, they set up the MAHAN (Meditation, AIDS, Health, Addiction and Nutrition) Trust in 1997 and started a small hospital in a small hut at Melghat, a hilly forest area in the Satpuda mountain ranges in Amravati District.

Melghat is known by two words, “Malnutrition” and “Project Tiger’’ and is an underdeveloped area of about 320 villages spread over 4,000 sq. km. It is 150km away from the district headquarters and the uneven road crosses through a dense forest and sharp ghats. Even today a large number of these villages have very poor or no infrastructure like transportation, electricity & communication and the area lacks basic amenities. Most of the tribals (>75%) are below poverty line and illiterate (>50%) and live in hamlets (>90%), with very high maternal and infant mortality rates.

MAHAN hospital started from a small hut with very limited facilities. The patients were brought in bullock carts as there was no ambulance. Initially, the locals were very suspicious and reluctant for modern medical treatment and relied on traditional faith healers and quacks. Over last 15 years, Dr. Ashish and Dr. Kavita have braved many challenges such as superstitions, limited infrastructure, political interference and lack of funds. Both Dr. Ashish and Dr. Kavita have gone beyond the conventional notions of service – for instance, Dr. Kavita narrated how she became a “Milk Mother” to a newly born adivasi child when their only son was just a few months old. This is being true to the concept of service before self.

This journey has enabled Satavs to demystify a lot of medical myths as well. They have proved how even without sophisticated medical facilities a lot can be achieved and even serious ailments can be treated. Within four years of MAHAN’s intervention, the infant mortality rate has reduced by more than 50%. MAHAN identifies local villagers, mostly women, and trains them in basic health care segments. It has built a team of close to 40 trained village health workers. MAHAN now serves more than 75,000 persons in Melghat region.

The opposition to their work, especially from local politicians and government officials, has been tackled with the Gandhian thought of ‘truth can be troubled but cannot be defeated’. Dr. Satav has also fought the bureaucratic system through numerous applications under the RTI Act and PILs and has been instrumental in ensuring improvement in benefits of the Government’s welfare spending reaching the needy.

The hospital based in a hut, shifted to a larger structure in July 2007 and presently has an ambulance, two operation theaters, an OPD, a spectacle shop and staff quarters. Now, Dr. Satav has a vision to carry out various research projects and develop models that can be replicated nationally.

Work done by Dr. Kavita and Dr. Ashish Satav is nothing short of a Yagna, often translated as “sacrifice” or “worship”. A heartfelt Namaskar to this modern day Rishi Couple!

Errata
In our October 2012 issue,
In ‘Namaskaar’ featuring ‘Remembering Mahatma Gandhi’, two paragraphs at the end of the feature were inadvertently omitted. These paragraphs are reproduced on page 19.
The error is regretted – Editor.

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Introduction to the New Revenue Recognition Standard Issued by IASB

The IASB issued the first exposure draft of the new revenue recognition standard in June 2010. This new standard is a joint project of the IASB and FASB to clarify the principles for recognising revenue from contracts with customers. It intends to provide a single revenue recognition model which integrates the numerous revenue recognition guidances under US GAAP and the broader principles provided under IFRS to improve comparability over a range of industries, companies and geographical boundaries. The revenue recognition model under this exposure draft is a step-by-step analysis of contracts focussing on control i.e.,

identify the contract with the customer;

identify separate performance obligations in the contract;

determine and allocate the transaction price; and

recognise revenue when or as each performance obligation is satisfied by transferring control of a good or service to the customer.

Nearly thousand comment letters were received in response to this exposure draft. Considering the representations, the IASB issued a revised exposure draft in November 2011. One of the principles that the revised draft clarifies is on distinguishing when control of a good or service is transferred over a period of time or at a point in time. This article focusses on this aspect of the revised exposure draft in relation to its implications on revenue recognition for real estate companies.

Implications of IASB’s revised revenue recognition exposure draft for real estate companies

One of the most debated matter in India’s convergence with IFRS was point of revenue recognition from sale of real estate, more commonly known as the application of IFRIC 15 principles. The assessment of IASB’s IFRIC 15 principles which deals with agreements for the construction of Real Estate would lead to most real estate companies in India accounting for sale of apartments/flats as sale of goods and recognising revenue on completion of the contract i.e., transfer of physical possession of the units to the customer as opposed to accounting for these as construction contracts using the percentage completion method. This would have a major impact on the performance measures of real estate companies. Consequently, when Ind AS were issued in February 2011, the Ind AS on construction contracts had a carve-out from the IASB principles to include development of real estate as a construction contract and accrue revenues using the percentage completion method.

IFRIC 15 principles have been debated internationally. Malaysia and Philippines had also deferred applicability of IFRIC 15 when they adopted IFRS while Singapore decided to issue a modified IFRIC 15 providing specific guidance in the context of legal situations prevailing in that country. The issue under debate was that IFRIC 15 principles were leading to a completed contract method of accounting sometimes due to the legal framework of a country for instance, continuous transfer of legal title of the work in progress was legally not allowed in many jurisdictions and hence leading to a completed contract method of accounting although that was not the substance of these transactions. In that case, the profit and loss account of the developers will not truly reflect the performance of the business, as during the years the real estate project development continues, no revenue will be recognised and all revenue will be recognised in the year when possession is given.

IFRIC 15 principles were incorporated in the original exposure draft of revenue recognition standard. However, based on the representations and comment letters received, the IASB in its revised exposure draft has changed criterion for determining whether performance obligations are being satisfied over a period of time impacting the timing of revenue recognition from the sale of real estate.

The earlier principles of IFRIC 15 allowed the percentage completion method when either the unit is based on a customer-specific design or it could be demonstrated that there is a continuous transfer of units while construction progresses which is evidenced:

— if construction activity takes place on land owned by the buyer;
— the buyer cannot put the incomplete property back to the developer;
— on premature termination the buyer retains the work in progress and the developer has the right to be paid for the work performed; or
— the agreement gives the buyer the right to take over the work in progress during construction.

These criterions have been changed significantly under the revised exposure draft. Under the revised exposure draft, performance obligations of the company can be met over a period of time if the entity:

(a) creates or enhances an asset (for example, work in progress) that the customer controls as the asset is created or enhanced. Or

(b) does not create an asset with an alternative use to the entity and at least one of the following criteria is met:

(i) the customer simultaneously receives and consumes the benefits of the entity’s performance as the entity performs or

(ii) another entity would not need to substantially re-perform the work the entity has completed to date if that other entity were to fulfil the remaining obligation to the customer, or

(iii) the entity has a right to payment for performance completed to date and it expects to fulfil the contract as promised.

Most typical Indian real estate contracts for sale of apartments are for specific unit sales to customers, require progress payments based on completion of work and are intended to be fulfilled which would fall under the above criterion of satisfying performance obligations over time.

The following example illustrates the above criterion:

Example 1:

Company Z is developing residential real estate and starts marketing individual units (apartments). Z has entered into the minimum number of contracts that are needed to begin construction. A customer enters into a binding sales contract for a specified unit that is not yet ready for occupancy. As per the contract, the customer pays a non-refundable deposit at inception of the contract and agrees to make progress payments throughout the contract. Those payments are intended to at least compensate Z for performance completed to date and are refundable only if Z fails to deliver the completed unit.

Z receives the final payment on delivery of possession of the unit to the customer. To finance the payments, the customer borrows from a financial institution that makes the payments directly to Z on behalf of the customer. The lender has full recourse against the customer. The customer can sell his or her interest in the partially completed unit, which would require approval of the lender but not Z. The customer is able to specify minor variations to the basic design, but cannot specify or alter major structural elements of the unit’s design. The contract precludes Z from transferring the specified unit to another customer.

The apartment created by the Z’s performance does not have an alternative use to Z, because it would lead to breach of contract with the customer. Z concludes that it has a right to payment for performance completed to date, because the customer is obliged to compensate Z for its performance rather than only a loss of profit if the contract is terminated. In addition, Z expects to fulfil the contract as promised. Hence, Z has a performance obligation that it satisfies over time.

The new rules are more pragmatic and will enable percentage completion method for real estate where the criterions are met. This essentially means that Indian real estate companies need to reassess the implications of revenue recognition under the revised exposure draft to understand whether their contracts would meet the conditions of satisfying performance obligations over time. It is important to analyse in which exact cases the new principles would allow percentage completion method. This would also then eliminate the need for a carve-out under Ind AS. Comment period for this exposure draft is open until 13 March 2012. This should be regarded as an opportunity to voice out any concerns or clarifications to the IASB so that the standard achieves global acceptance.

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Indians among world’s happiest people.

Despite economic woes, wars, conflicts and natural disasters the world is a happier place today than it was four years ago and Indonesians, Indians and Mexicans seem to be the most contented people on the planet. More than three-quarters of people around the globe who were questioned in an international poll said they were happy with their lives and nearly a quarter described themselves as very happy.

“The world is a happier place today and we can actually measure it because we have been tracking it,” said John Wright, senior vice-president of Ipsos Global, which has surveyed the happiness of more than 18,000 people in 24 countries since 2007. But he added that expectations of why people are happy should be carefully weighed. “It is not just about the economy and their well being. It is about a whole series of other factors that make them who they are today.”

Brazil and Turkey rounded out the top five happiest nations, while Hungary, South Korea, Russia, Spain and Italy had the fewest number of happy people. Perhaps proving that money can’t buy happiness, residents of some of the world biggest economic powers, including the United States, Canada and Britain, fell in the middle of the happiness scale. “Sometimes the greatest happiness is a cooked meal or a roof over your head,” he explained. “Relationships remain the No. 1 reason around the world where people say they have invested happiness and maybe in those cultures family has a much greater degree of impact.”

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White lies on black money.

Estimates of ‘black money’ generated in the Indian economy vary: from rather minuscule amounts of a couple of billion dollars to more unbelievable numbers. The Union finance ministry issued a white paper on the subject that highlighted various measures of black money and what needs to be done to curb its generation. The analysis carried out in it does not represent anything new; it certainly does not give a road map for handling this problem.

In India, the easy fixes to curb tax evasion and the generation of black money have all been exhausted: there will be few, if any, taxpayers who try and evade what they owe the government. The tax administration is robust enough to detect and capture evasion by these citizens. The problem lies elsewhere.

The white paper itself illustrates these issues. Three examples can be highlighted. The issue of taxation of wealth generated in the businesses linked to exploitation of natural resources such as mining, hydrocarbons, telecom and other related sectors; the problem of income in “vulnerable” sectors such as real estate and, finally, the issue of political willpower required to make a difference. In each of these, this government has been an abject failure.

Consider the natural resources sector first. The problem lies in the vast discretionary powers enjoyed in allocating these resources. From spectrum allocation to that of issuing mining licences, there has been little or no transparency. The result is that there are inbuilt drivers to generate illicit wealth. If anything, this government is complicit in this process: it is deeply unhappy with auctions as a process to allocate these resources. In a firstcome- first-served process, there is ample scope for corrupt practices. Clearly, it has to address that issue before it can even argue that natural resource allocation processes are a problem. In fact, the sector can only be dubbed as a ‘politically exposed sector’.

In case of ‘vulnerable’ sectors such as real estate, the cause and effect are mixed: real estate is both a recipient and a generator of black money. Illicit gains made elsewhere can be parked in residential and commercial property without much fear of tax enforcers. But that is just one part of the problem. The high taxes — stamp duty is a prime example — levied make evasion a worthwhile chase. And high stamp duty being an important source of revenue for many states ensures that undervalued transactions are a norm and not an exception.

Finally, this government lacks the willpower to deter potential tax evaders — the big fish that is. The surest way to do so will be to disclose the names of evaders that are available with the government. Given that our politicians are sure to figure on such a list, confidentiality of agreements with other governments and, hold your breath, human rights of tax evaders (page 68 of the white paper) come in the way of public disclosures. This is difficult to believe.

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Don’t blame Greece for our problems.

In the gloomy economic environs of a falling rupee, slowing economy and a general drift of things, an easy way to shirk responsibility would be to lay the blame at Greece’s door. Former ICICI Bank chairman N. Vaghul would strongly recommend not to rummage through the ruins of the Athenian economic Acropolis to explain our problems away.

“No one is going to believe if we say our problems are because of Greece. Our problems are self-inflicted”, says the celebrated banker, reasoning that the “root cause of India’s troubles lies in a decline in its values”.

“It isn’t a question of some fiscal, inflation or some other problem like a fall in the value of the rupee. It doesn’t have to do with the change in recent times in our tastes with regard to music, clothes, marriage or some social mores. Those are irrelevant. What is hurting is that our core values are disappearing and it has been six decades of decline with the political, economic and industrial leaderships dropping in integrity,” he says. Blending his characteristic wit with banking analogy, Vaghul says,

“the root cause of our financial crisis is that we have created derivatives without underlying assets,” referring to the decline in values in all spheres of life. Holding forth on the importance of upright leadership at an event here to remember banking stalwart and former SBI chairman R. K. Talwar, Vaghul said work ethics ought to be the cornerstone on which to build careers and industry and that the decline in values witnessed all around reminded one of the importance of the philosophy of those like Talwar, who thought everyone was an instrument of the divine.

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Corporate anonymity — Incorporation with limited liability is a privilege. It should not include anonymity.

Limited liability — A commercial venture that protects its shareholders from personal bankruptcy —is one of the greatest wealth-creating inventions of all time. The law allows companies to borrow money, to take risks and to make contracts as if they were people, but without the human beings who own it going bust if things go wrong, as they would in an unlimited partnership.

Limited liability allowed Elizabethan adventurers to finance voyages to spice islands; it allows Silicon Valley technologists now to make similarly risky bets. But limited liability is a concession — something granted by society because it has a clear purpose. It is unclear why in parts of the world anonymity became part of the deal. Efforts to withdraw that unjustified perk deserve to succeed. In dozens of jurisdictions, from the British Virgin Islands to Delaware, it is possible to register a company while hiding or disguising the ultimate beneficial owner.

This is of great use to wrongdoers, and a huge headache for those who pursue them. Anonymously owned companies can buy property, make deals (and renege on them), launch intimidating lawsuits, manipulate tenders — and disappear when the going gets tough. Those who seek redress run into baffling bureaucracy and a legal morass. Seeking real names and addresses means dealing with lawyers and accountants who see it as their job to shield their clients from nosy outsiders.

Owning up

Reform ought to be simple. Anyone registering a limited company should have to declare the names of the real people who ultimately own it, wherever they are, and report any changes.

Lying about this should be a crime. Some dodgy places will try to hold out. But anti-money-laundering rules show international co-operation can work. You can no longer open an account at a respectable bank merely with a suitcase of cash. Let the same apply to starting a limited company.

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How to declutter your mind.

By life overloads our senses with a barrage of sensations: information, sights, sounds and choices. We have portable devices that inform, entertain, update and connect. We are not designed to deal with so much information all at once. The noise keeps us from focussing on what matters, keeping us disconnected from the big picture.

Breath: Take a few deep breaths and relax. Concentrate on your breathing as it comes in and goes out of your body. This has a calming effect and allows other thoughts to float away.

Write it down: Pen down your thoughts. It helps to get them on paper and off your mind. This keeps your head from being filled with everything you need to do and remember. List and prioritise: Tasks that are critical to do today, tasks that you need to do in the next 1-2 weeks — prioritise what’s urgent and important.

Eliminate: Now that you’ve identified the essential, identify what’s not essential and eliminate those items. It declutters your mind really fast.

Decide now: List the things which you are yet to decide. Stop procrastinating and tackle them. Do a physical activity: Spending some physical energy clears the mind. Reduce TV time: It fills your head with noise. By reducing it, you will find that you have time for the more important things in life.

Take a break: Short breaks during work hours will help you feel more re-energised and fresh. Go slow: Life is not a race all the time. Do things one at a time. Relax and move at your own pace. As a result, your mind is less hassled.

Forgive and forget: Harbouring negative emotions of anger and frustration only add to the mental stress.

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Time for change — The country needs a new government, under a new leader.

The second UPA government is observing its third anniversary. The second of those three years saw rampant and large-scale corruption emerge as a hot-button issue. The third and latest year has been disastrous for the economy. So the two principal attributes credited to Prime Minister Manmohan Singh — as a man of probity and as the author of economic reforms — have ceased to be political assets for the government. At the heart of the government’s problems is the dyarchy that prevails, something which the Westminster system of parliamentary government is simply not equipped to deal with. Political power rests with Sonia Gandhi, and she therefore has an important say in what must happen. In practice, therefore, the prime minister serves so long as he enjoys her confidence, and he has to consult her on ministerial appointments. More importantly, he cannot dispense with any of them if he so chooses. This fundamentally undermines his authority in the Cabinet, a situation which many ministers have exploited to thumb their noses at him.

Many other things are wrong with this government. For a start, its leading lights are simply too old. The prime minister will be 80 in a few months, while the foreign minister is already 80. Mr. Mukherjee is 77, and Mr. Antony 71. Among those exercising the sovereign functions of the state, only Mr. Chidambaram (67) is below 70. In the Cabinet as a whole, 15 of 34 ministers are 70 or older. Any government with so many old people, who have little to look forward to other than political survival for a few more years, is likely to be short on energy and initiatives, and tied to old ways of thinking. It also matters that most of the stalwarts in the Cabinet are political lightweights who have no real clout with voters in their states.

A lightweight prime minister has around him a bunch of other lightweights. This may have to do with the nature of the Congress party — if it is to be protected and preserved as family property, the party’s only real vote-getters must be from the Gandhi family; and young ministers like Jyotiraditya Scindia and Sachin Pilot cannot be allowed to flower too early or they might outshine Rahul Gandhi. It is frequently said that the bane of this government has been its recalcitrant allies. Perhaps, but how much of the failure to carry them along rests with the Congress? How often has the UPA actually met as an alliance? Why does it not have a common minimum programme, which everyone has agreed on? Why is there no effective system of discussion and consultation? Is it simply because the leading lights of the UPA lack political ability — the prime minister is reticent if not retiring, the home minister gets people’s backs up, and the finance minister has too much on his plate to focus on anything in particular? In any case, the ministerial mathematics tells its own story: 28 out of 34 Cabinet posts are with the Congress, as also all seven positions of minister of state with independent charge; that’s a score of 35 out of 41. Of the six posts with five allies, the government has got almost unstinting support from Sharad Pawar’s Nationalist Congress, Farooq Abdullah’s National Conference and Ajit Singh’s Rashtriya Lok Dal. When push came to shove, the Dravida Munnetra Kazhagam too played along, even allowing its Cabinet representation to shrink. The sole problem case can be said to be Mamata Banerjee. Is this really an unmanageable situation, or a failure of management?

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Lionising the indicted — Politics must reconnect with respect for law, propriety.

In Punjab, the declared killer of a former state chief minister is honoured by those speaking in the name of a whole community. In Tamil Nadu, Andimuthu Raja returns to his home state as a conquering hero, after having had to resign as communications minister and then spending 15 months in jail. In the first case, the killer is awaiting execution, while in the second the trial is still to get under way.

In that sense, the two are on different planes. But it is necessary to ask whether the Dravida Munnetra Kazhagam (DMK) is no better than some of the Akali factions when they cock a defiant snook at the law. It was left to the General who led Operation Bluestar to express his unhappiness at a memorial being built in memory of those killed by soldiers during Bluestar, since those killed included terrorists and armed separatists.

As for Mr. Raja, he is technically innocent, since no court has declared him guilty, but he has been indicted in no uncertain terms, as a simple reading of the Comptroller and Auditor General’s (CAG’s) report on the telecoms scam shows. He twisted the principle of ‘first-come-first-served’ by fixing arbitrary cut-off dates and other criteria in such a manner as to make the ultimate choice of licensees completely arbitrary, and therefore devoid of principle. Even when it came to simple paperwork, he gave licences to companies that did not qualify or were not eligible because they had not given the prescribed information or the prescribed documentation in time. Whether he committed any crime is something that is yet to be determined, as also the question of any quid pro quo. But on the evidence already set forth, it is clear that Mr. Raja is not someone who should be getting lionised by any serious political party, given that his handling of a ministerial portfolio did not set standards worthy of emulation. That the DMK has chosen to lionise such a person tells the country that politics in Tamil Nadu is as disconnected from propriety as it is in Punjab.

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White paper on Black Money:

Generation of black money and its stashing abroad in the tax havens and offshore financial centres has dominated discussion and debate in the Parliament and in public forum in recent years. In the White Paper on Black Money recently laid before the Parliament this problem and its complexities have been discussed in detail. In this report para 5.2.75 deals with ‘Enhancing the Accountability of Auditors’ which reads as under.

“5.2.75 Unlike many developed countries, Auditors in India have not been requisitely accountable, resulting in frequent undermining of this important aspect. Apart from recent cases of distortionary corporate governance involving highly reputed firms, cases are detected regularly by the regulatory authorities where the Auditors have failed to point out gross violations and even blatant misrepresentations. In the absence of adequate effective provisions, the Auditors are hardly ever held accountable for these lapses. Another aspect of this problem is the way in which a firm opts for an Auditor in this environment of low accountability and prevalent evasion, since a strict Auditor ready to blow the whistle can hardly expect to thrive amidst competitors, many of whom may be more than willing to co-operate and compromise at different levels. As a result, a very important regulatory tool is virtually losing its role in contributing towards greater compliance. There will be need in future to look into various aspects of the functioning and regulation of the role of Auditors and various other professionals verifying the declarations and statements made by firms and ensure that there are adequate safeguards and sufficient accountability of such professionals.”

Such sweeping remarks about our profession in an official document laid before the Parliament indicate the present thinking in the minds of these who govern and regulate our profession. Members of ICAI should adequately respond to such remarks.

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EAC opinion – Revenue recognition in case of construction contracts

Facts:

A public sector company (‘company’), listed in the stock exchanges, is engaged in the field of engineering, manufacture of equipments, erection & commissioning of power projects. In power project business, the contracts received by the company are either Engineering, Procurement and Construction (EPC) contracts or Boiler, Turbine and Generator (BTG) Packages, where civil works and Balance of Plant (BOP) package items are not in the scope. The normal execution period of a contract ranges between 3 to 5 years. The scope of the contract includes supply of equipments, erection, commissioning, ensuring guarantee output from the machines, completing the trial operation and synchronising the plant to the grid.

The company has stated that long-term construction contracts are obtained by the company’s marketing wing which allocates the scope and value to various manufacturing units and regions/ sites for execution. The units/regions bill the customers based on Billing Break Up (BBU) agreed with the customers.

The accounting policy of the company for revenue recognition in respect of construction contracts is on percentage completion method based on percentage of actual cost incurred up to the reporting date to the total estimated cost of the contracts. Actual cost incurred up to reporting period is worked out on actual cost incurred for each contract in respect of items manufactured and physically dispatched to the project site. Further, in power sector regions/sites, actual cost incurred towards engineering, commissioning, etc. by region/site is considered for working out percentage of completion for revenue recognition. Items like steel, cement and bought-outs directly supplied from supplier to project site and billed to the customer are also considered as part of actual cost incurred for working out percentage of completion for revenue recognition.

Query

On the above facts, the company has sought the opinion of the EAC: (a) whether the practice of cost of manufactured items dispatched to project site alone being considered as ‘cost incurred’ without considering the cost of raw material in stocks, works in progress at the plant, finished goods at stores as cost incurred is in line with the revenue recognition principle as per AS-7?, (b) In case of erection sites, whether the cost of cement and steel procured and delivered at the project site, specific to the project, in respect of which billing has been done as per the BBU agreed with the customer can be considered as ‘cost incurred’ in working out the percentage of completion as per AS-7 and whether the same is in line with the revenue recognition principle as per AS-7?, and (c) Whether change in estimated revenue and estimated cost in respect of long-term contracts executed over a longer period needs to be disclosed as ‘change in estimate’ as per AS-5?

Opinion:

After considering paragraphs 21, 29 and 30 of AS-7, the Committee is of the view that determination of contract costs incurred for calculating stage of completion depends upon the performance of contract activity rather than mere incurrence of cost. Costs that relate to future activity are to be recognised as ‘work in progress’. Accordingly a judgment is to be exercised by the management while determining the contract costs incurred considering various factors, such as terms and specifications of the contract, identifiability with the contact, achievement of milestone in relation to the contract, etc.

In view of the above, the practice of the company to consider the cost of manufactured items dispatched to the project site alone as ‘cost incurred’ is not correct, since mere event of dispatch can not be considered as a completion of a stage and may not trigger revenue recognition.

As regards steel and cement procured and delivered at the contract site and billed to the customer cannot trigger considering a cost as ‘contract cost incurred’. These items are general in nature for a construction activity and cannot be said to be specific for a project even though supplied directly to the contract site. Accordingly, this should be considered for determining ‘contract cost incurred’ only when these have been used/ applied for performance of contract activity. Till that time, these should be considered as ‘work in progress’.

Change in estimate on account of changes in estimated contract revenue and costs should be disclosed in accordance with AS-5 read with AS-7. Accordingly, the effect of change in estimated contract revenue and cost which has or is expected to have a material effect in the current period or subsequent periods needs to be disclosed. However, if it is impracticable to quantify the amount of change, the fact should be disclosed. [Please refer pages 1825 to 1830 of C.A. Journal, June, 2012]

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Doctrine of merger — If for any reason an appeal is dismissed on the grounds of limitation and not on merits, that order would not merge with the orders passed by the Appellate Authority.

[Raja Mechanical Co. (P) Ltd. v. CCE, (2012) 345 ITR 356 (SC)]

The Supreme Court noted that the facts were not in dispute and could not be disputed that there was a delay in filing the prescribed forms before the assessing authority. Therefore, the assessing authority had rejected the claim of the assessee and accordingly, had directed him for payment of the excise duty credit availed of by the assessee. Aggrieved by that order, the assessee had belatedly filed an appeal before the proper Appellate Authority. Since there was delay in filing the appeal and since the same was not within the time that the Appellate Authority dismissed the same. It is that order which was questioned before the Tribunal. Before the Tribunal, the assessee had requested the Tribunal to first condone the delay and next to decide the appeal on the merits, i.e., to decide whether the adjudicating authority was justified in disallowing the benefit of the MODVAT credit that was availed of by the assessee. The Tribunal had not conceded to the second request Kishor Karia Chartered Accountant Atul Jasani Advocate Glimpses of supreme court rulings made by the assessee and only accepted the findings and conclusions reached by the Commissioner of Appeals, who had rejected the appeal.

The question that fell for the consideration and decision of the Supreme Court was whether the Tribunal was justified in not considering the case of the assessee on merits. The assessee’s stand before the Tribunal and before the Supreme Court was that the orders passed by the adjudicating authority would merge with the orders passed by the first Appellate Authority and the Tribunal ought to have considered the appeal filed by the assessee on merits also. According to the Supreme Court such a stand of the assessee could not be accepted in view of the plethora of decisions of the Supreme Court, wherein it has been categorically observed that if for any reason an appeal is dismissed on the ground of limitation and not on merits, that order would not merge with the orders passed by the first Appellate Authority. In that view of the matter, the Supreme Court was of the opinion that the High Court was justified in rejecting the request made by the assessee for directing the Revenue to state the case and also the question of law for its consideration and decision. According to the Supreme Court there was no merit in the appeal.

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Section 37(1) — Whether payments towards noncompete fees can be claimed as deferred revenue expenditure — Held, Yes.

31. (2011) 131 ITD 385 (Chennai) Orchid Chemicals & Pharmaceuticals Ltd. v. ACIT A.Y.: 2003-04. Dated: 18-6-2010

Section 37(1) — Whether payments towards non-compete fees can be claimed as deferred revenue expenditure — Held, Yes.

Facts:

The assessee was engaged in the business of manufacture and export of bulk drugs and other pharmaceuticals. The assessee in the previous year paid a sum of Rs.24 crore to three of the parties for acquiring the Intellectual property rights, brands and drug licences. The above payment also included a sum of Rs.2 crore paid towards non-compete clause. The assessee claimed the above expense as revenue expenditure. The Assessing Officer refused the claim on the basis that the expenditure incurred for non-compete agreement was for a fairly long period of four years and as it was of enduring nature, it cannot be treated as revenue. On appeal the Commissioner (Appeals) upheld the order. The assessee thus appealed to the Tribunal. The assessee raised additional grounds which were alternative to other grounds. The assessee contended that the sum paid may be allowed as deferred revenue expenditure or alternatively depreciation on the same should be allowed.

Held:

(1) The payment made for non-compete fee cannot certainly be treated as revenue expenditure in view of decisions in the case of Hatsum Agro Products Ltd. (ITA No. 1200/Mad./1999, dated 27th July, 2005), Asianet Communications (P) Ltd. (ITA No. 4437/Mad./2004, dated 3th January, 2005) (ITA No. 615/Mad./1999, dated 10th February, 2005) and Act India Ltd. No doubt section 28(va) of the Act considers a receipt of non-compete fee as income but it would not by itself lead to a conclusion that any payment of like nature would be on revenue account only. (2) Further, relying on the decision of the Apex Court in the case of Madras Industrial Investment Corporation Ltd. (225 ITR 802) (SC), the expenses should be held in the nature of deferred revenue expenses since the noncompete agreement precluded the sellers from engaging in a competing activity for a period of four years. (3) Hence, the payment made for non-compete fee should be allowed as deferred revenue expenses over a period of four years.

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(2012) 25 STR 242 (Tri.-Del.) — C. M. Goenka & Co. v. Commissioner of Central Excise, Jaipur-I

Stockbroker — Sub-broker — Sale and purchase of securities listed on stock exchange for their clients — Service tax is leviable considering the activity as that of stockbroker. It is not Business Auxiliary Service provided to the main broker.

Facts:
The appellant was a sub-broker. Prior to April 2005 in all the transactions through sub-broker, sub-broker used to issue bill to the client for their brokerage, stockbrokers used to bill the sub-brokers and as such the brokerage was being charged by both stockbroker as well as sub-broker in their respective bills and both were making separate payment of service tax. Since April 2005, in all the transactions in respect of purchase and sale of securities, it is the main broker who issues the transaction note and charges brokerage, a part of which is shared by him with the sub-broker.

Held:
The appellant was treated as a broker for the period post 2005. The service provided by him is the service of sub-broker of the stockbroker in connection with sale or purchase of securities listed in the stock exchange for their clients and during the period of dispute, it is the main broker who was issuing the transaction note and was receiving the commission from clients, a part of which was received by the appellant i.e., the subbroker. The question therefore related to whether or not the part of brokerage received by the appellant as sub-broker would attract service tax as it could not be held business auxiliary service as the service provided related to sale or purchase of stock. However, according to the Tribunal, this had to be decided in the light of the Larger Bench of Tribunal’s decision in case of Vijay Sharma & Co. v. CCE, Chandigarh (2010) 20 STR 309 (Tri.- LB) after ascertaining whether the main broker had paid service tax on the amount paid to the appellant. Since this judgment was not discussed in the order appealed against, the matter was remanded to the Commissioner (Appeals) for de novo decision in the light of judgment in the case of Vijay Sharma & Co. (supra).

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(2012) 277 ELT 353 (Tri.-LB) — Bharat Petroleum Corporation Ltd. v. CCE

CENVAT credit — Capital goods pending installation, whether 50% credit can be availed in the subsequent year — Assessee held eligible — Goods lying in the factory for installation — The process of erection was carried out — Thus, capital goods were in possession of manufacturer as per Rule 4(2b) of the CENVAT Credit Rules, 2004 (CCR).

Facts:
The question of law referred to the Larger Bench was, whether an assessee is eligible to avail the credit of balance 50% of the credit in respect of capital goods in the subsequent financial year without installing the same and putting it to use as held by Ispat Industries v. Commissioner, (2006) 199 ELT 509 (Tri.) or the assessee cannot avail credit as held by Parasrampuria Synthetics Ltd. v. Commissioner, (2004) 170 ELT 327 (Tri.-Del.). The issue thus involved related to interpretation of provisions of Rule 4(2)(b) of CCR as to whether the situation of goods would be regarded as possession of capital goods and use for the manufacture of final products in such subsequent years. In Ispat’s case (supra), in Revenue’s appeal before the Bombay High Court, reported at (2012) 275 ELT 79 (Bom.), the High Court held that since the Tribunal had held that the expression ‘possession and use of the manufacture of final products’ have to be read together and would denote that the goods were available for use in the manufacture of final products and since the finding of the fact was that capital goods were under erection process, no substantial question of law had arisen and therefore the appeal was dismissed.

Held:
In terms of the above decision of the Bombay High Court, it was held that the condition under the relevant Rule for taking 50% credit in subsequent financial years when capital goods are lying in the factory for installation and under the process of erection has to be interpreted as capital goods in possession and use for manufacture and accordingly the Division Bench was directed to decide the appeal on merits.

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Examination of Balance Sheets by ROC’s

The Ministry of Corporate Affairs has vide General Circular No 37/2012 dated 06-11-2012 has informed that Registrars shall routinely scrutinise the Balance Sheets of the following Companies:

a) Of Companies against whom there are complaints
b) Companies that have raised money from public through public issue of shares or debentures
c) Cases where auditors have qualified their reports
d) Where there is default in payment of matured deposits and debentures
e) References received from regulatory authorities pointing out violations/irregularities calling for action under the Companies Act, 1956

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(2011) TIOL 748 HC-Kar.-ST — Commissioner of Service Tax v. Aravind Fashions Ltd.

Service tax — Tax payable under reverse charge on services received from abroad — Tax can be paid from CENVAT credit account.

Facts:
The assessee had paid service tax as a receiver of intellectual property service using CENVAT credit on advertisements, manpower recruitment, repairs and maintenance, construction services, etc. The Tribunal held that though the assessee is a recipient of service in law, as the service provider is outside the country, the tax is levied on him. But to discharge such liability, he can use CENVAT credit which is to his credit. The Revenue filed appeal against the Tribunal’s order.

Held:
In law, though the person is a service recipient, he is treated as service provider and is levied tax. To discharge his liability, he is entitled to use the CENVAT credit available with him. The Tribunal was held justified in holding so. No merit was found in the appeal of the Revenue. The Revenue’s appeal for penalty was also dismissed as substantial question of law was decided in favour of the assessee.

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Appointment of cost auditor by companies

The Ministry of Corporate Affairs has, vide circular No. 36/2012 dated 06-11-2012, made the following changes for appointment of Cost Auditor, in continuation to Circular No. 15/2011 dated 11-04-2011,

a) Companies are required to inform within 30 days from the date of approval of the MCA of Form 23 C ( i.e. Form for approval of Government for Appointment of Cost Auditor) with a formal letter of Appointment to the Cost Auditor, as approved by the Board.

b) The cost Auditor needs to file the prescribed Form 23D along with the letter of Appointment from the Company within 30 days of the date of formal letter.

c) In case of change of cost auditor caused by death of existing cost Auditor, the fresh e-form 23C is to be filed without additional fee within 90 days of the date of death.

d) Change of Cost Auditor for reasons other than death then fresh Form 23C to be filed with applicable fee and additional fee unless supported by relevant documents for the change.

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Time Limit for Filing of Form 23D extended to 16th December 2012

Vide Circular No. 35/2012, dated 05-11-2012, the Ministry of Corporate Affairs, Cost Audit Branch, has noted the default of filing of Form 23D by many Cost Auditors and has requested that cost auditors appointed by the Companies vide filing of applications by Form 23C, to file the delayed form 23D by 16th December 2012. In case of further default, the names of the defaulting members would be sent to the Institute for Disciplinary Proceedings under the Cost and Works Accountants Act, 1959. Further, in case of Companies that have failed to issue formal letter of Appointment to the Cost Auditor, they shall do so within 15 days of this Circular to enable the cost Auditor to file Form 23 D within the extended time limit.

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(2012) 25 STR 231 (M.P.) — Entertainment World Developers Ltd. v. Union of India.

Tax liability — Retrospective effect — Validity of service tax on renting of immovable property — Amended section 65(95)(zzzz) of the Finance Act, 1994 with retrospective effect — Even if the amendment is not clarificatory but creates a substantive liability or right, the Parliament’s right to legislate and create liabilities or rights with retrospective effect can be curtailed only by restriction placed upon the legislative power of Parliament by one or the other provision of Constitution of India — No provision of Constitution of India shown restricting the right of Parliament to legislate retrospectively creating a tax liability.

Facts:
The amended section 65(95)(zzzz) of the Finance Act, 2010 defined taxable service as “any service provided or to be provided to any person, by any other person, by renting of immovable property”. This amendment is not clarificatory, but brings about a substantive liability of taxation upon the service providers. It was also contended that the service provider is liable to pay interest as well as penalty on default in payment of service tax for the past period.

Held:
The Parliament’s right to legislate or create liability of service tax with retrospective effect can be curtailed by a restriction placed upon its legislative powers by one or other provision of the Constitution of India. Hence it was held that the service tax liability arises retrospectively.

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Extension of time limit for filing XB RL Form 23 AC/ACA to 15th December 2012

Vide Circular No. 34/2012 dated 25-10-2012, the Ministry of Corporate Affairs has extended the time limit for filing the financial statements in the XBRL Mode without any additional fee/penalty upto 15th December 2012 or within 30 days from the date of AGM of the Company, whichever is later. The other terms and conditions of the General Circular No 16/2012 dated 06-07-2012 remain the same.

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(2012) 25 STR 277 (Guj.) — Commissioner of Central Excise & Custom, Vadodara-II v. Dynaflex Pvt. Ltd.

Interest — CENVAT credit wrongly availed — Entry reversed before its utilisation — It amounted to not taking credit — Department pleas that there was no discretion in authorities for consideration of factors that (i) wrongly taken credit was not utilised or was reversed voluntarily or (ii) there was no mala fide intent on part of assessee — Liability to pay interest was rejected.

Facts:
The respondent is engaged in manufacture of poly bags/flat films. During the course of audit, it was observed that the assessee wrongly availed CENVAT credit. The assessee reversed the said credit account and failed to pay the interest on the credit availed by it. A show-cause notice was issued for the recovery of interest. The adjudicating authority held the show-cause notice as dropped. The Department filed an appeal before the Commissioner (Appeals) who dismissed the appeal. The Department preferred second appeal before the Tribunal which also was dismissed. The adjudicating authority recorded that the assessee has not paid interest on the amount of CENVAT credit which was admittedly availed wrongly, but was subsequently reversed by it on being pointed out during the course of audit by the Departmental officer. It was urged that if the restrictive interpretation adopted by the adjudicating authority is accepted for non-chargeability of interest, then no recovery of interest on erroneous credit taken can be made.

Held:
In both situations i.e., where CENVAT credit has been wrongly taken or wrongly utilised, interest is recoverable. It was held that when the entry has been reversed before utilisation, the same amounts to not taking credit. Comment: The above judgment is in contradiction with a recent judgment of the Apex Court in the case of Ind-Swift laboratories. However, the ratio laid down by the above judgment of the Gujarat High Court is incorporated in law by amending the provisions in the CENVAT Credit Rules with effect from 1-4-2012.

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C.A. rendering legal services

It has been reported in a leading newspaper that the Supreme Court has recently held that both litigation and non-litigation matters are covered by the Advocates Act, 1961. Therefore, only persons qualified as Advocates can render services in the legal field. Accordingly, the Society of Indian Law Firms has intimated to ICAI that Chartered Accountants and Firms of Chartered Accountants should not advice their clients on legal matters which are exclusively reserved for Advocates under the Advocates Act, 1961. Let us hope the Council of ICAI issues a clarification on this issue and advises our members as to which type of legal work cannot be undertaken by our members (H.T. 9-7-2012).

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A. P. (DIR Series) Circular No. 51 dated 15th November, 2012

Know Your Customer (KYC) norms/Anti-Money Laundering (AML) standards/Combating the Financing of Terrorism (CFT) Obligation of Authorised Persons under Prevention of Money Laundering Act, (PMLA), 2002, as amended by Prevention of Money Laundering (Amendment) Act, 2009 Money changing activities.

This circular has modified certain KYC requirements as under: –

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EAC Opinion Treatment and disclosure of interest on fixed deposits in the financial statements of a financial enterprise.

Facts

The entire equity capital of a public limited company registered under the Companies Act is held by the Government of India. The company was set up as a special purpose vehicle to provide long-term infrastructure finance as per scheme for Financing Viable Infrastructure Projects (‘the financing scheme’).

The company provides infrastructure finance through direct lending, refinancing and take-out finance as per the financing scheme. The company has raised long-term debt by way of loans from Life Insurance Corporation of India, National Small Saving Fund (NSSF), bonds listed in India and foreign currency loans from bilateral and multilateral institutions. Borrowings of the company are backed by sovereign guarantee.

The resources raised by the company are utilised for providing infrastructure finance through direct lending, refinancing and take-out finance as per the financing scheme. Pending disbursement, the resources of the company are held in the form of bank deposits and investments, such as Central/ State Government (PSUs), Certificate of Deposits with scheduled banks, etc. as per investment policy approved by the board of directors of the company.

The company has stated that as the nature of its business is that of an NBFC, the company has been treating interest on bank deposits as income from operations in its books of account and, accordingly, discloses interest on bank deposits as income from operations in the financial statements as well as in the cash flow statements. The Comptroller and Auditor General of India (CAG), while conducting audit of accounts of the company for the year ended 31st March, 2010 and subsequently for the year ended 31st March, 2011 inter alia, however, commented that interest on fixed deposits with banks has been included under income from operational activities instead of disclosing the same as other income. This has resulted in the overstatement of income from operations and understatement of other income by Rs.56,516.94 lakh.

Query:

In view of the above, the company sought the opinion of the Expert Advisory Committee (EAC) as to whether it is appropriate for the company to treat interest on bank deposits as income from operations in its books of account and accordingly, to consider the disclosure interest on bank deposits as income from operations in the preparation of financial statements, including cash flow statement.

Opinion:

As far as the disclosure of such interest income in the financial statements including cash flow statement is concerned, the Committee after considering the definition of the term ‘operating activities’ as provided in paragraphs 5, 12 and 30 of AS-3, is of the view that operating activities are the principal revenue producing activities of the enterprise. The main business of the company is to provide longterm infrastructure loans and financial assistance while optimally managing and utilising its funds. Thus, the company is in the business of earning income by managing its funds which also includes the management of surplus funds between the date of receipt of funds to the date when the funds are finally disbursed. Accordingly, the Committee is of the view that interest earned on investment of surplus funds of the enterprise arises from its principal revenue producing activities and therefore, it should be treated and classified as income from operating activities. Further, in the context of cash flow statement, the Committee notes that paragraph 30 of AS-3 specifically states that cash flows arising from interest and dividends received in case of financial enterprise should be classified as ‘cash flow from operating activity’. Therefore, according to EAC, the treatment given by the company in the books of account is appropriate.

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“Overlap of Indirect Taxes” How far justified?

Introduction

What is overlapping?
Overlapping can be said to take place when service tax and sales tax are both levied on the same amount.

The issue of overlapping arises because the divisions of taxation power in the Constitution are not watertight compartments. A transaction may have many aspects wherein some aspects fall within the domain of the Central list and other aspects fall in the State list. Taking clue of respective aspects involved in a transaction, the Central/State authority try to levy tax on gross/ higher amount of the transaction, which results in levy of both the taxes – Central and State (i.e., service tax and sales tax) on the same amount. Whether, overlapping is permissible or not is a debatable issue. And the issue can be said to be confusing. There are judgments saying service tax and VAT cannot be levied on the same amount. Reference can be made to the judgment of the Supreme Court in the case of Bharat Sanchar Nigam Ltd. (145 STC 91) (SC) in which the Supreme Court has observed as under:

“88. This does not however allow State to entrench upon the Union list and tax services by including the cost of such service in the value of the goods. Even in those composite contracts which are by legal fiction deemed to be divisible under Article 366(29A), the value of the goods involved in the execution of the whole transaction cannot be assessed to sales tax. As was said in Larsen & Toubro v. Union of India, (1993) 1 SCC 365;

“The cost of establishment of the contractor which is relatable to supply of labour and services cannot be included in the value of the goods involved in the execution of a contract and the cost of establishment which is relatable to supply of materials involved in the execution of the works contract only can be included in the value of the goods.”

89. For the same reason the Centre cannot include the value of the SIM cards, if they are found ultimately to be goods, in the cost of the service. As was held by us in Gujarat Ambuja Cements Ltd. v. Union of India, (2005) 4 SCC 214, 228:

“This mutual exclusivity which has been reflected in Article 246(1) means that taxing entries must be construed so as to maintain exclusivity. Although generally speaking, a liberal interpretation must be given to taxing entries, this would not bring within its purview a tax on subject-matter which a fair reading of the entry does not cover. If in substance, the statute is not referable to a field given to the State, the Court will not by any principle of interpretation allow a statute not covered by it to intrude upon this field.”

From the above observations of the Supreme Court of India, it appears that though both service tax and VAT can be levied on the same transaction, there should not be overlapping and amount subjected to respective taxes should not exceed more than the total amount of the transaction.

However reference can also be made to the following observations of the Supreme Court in case of Tamil Nadu Kalyana Mandapam Assn. v. Union of India and Others, (135 STC 480) (SC).

“43. The concept of catering admittedly includes the concept of rendering service. The fact that tax on the sale of the goods involved in the said service can be levied, does not mean that a service tax cannot be levied on the service aspect of catering. Mr. Mohan Parasaran, learned Senior Counsel for the appellant, submitted that the High Court before applying the aspect theory laid down by this Court in the case of Federation of Hotel & Restaurant Association of India v. Union of India ought to have appreciated that in that matter Article 366(29A)(f) of the Constitution was not considered which is of vital importance to the present matter and that the High Court ought to have differentiated the two matters. In reply, our attention was invited to paragraphs 31 and 32 of the judgment of the High Court in which the service aspect was distinguished from the supply aspect. In our view, reliance placed by the High Court on Federation of Hotel & Restaurant Association of India and, in particular, on the aspect theory is, therefore, apposite and should be upheld by this Court. In view of this, the contention of the appellant on this aspect is not well-founded.

44. It is well settled that the measure of taxation cannot affect the nature of taxation and, therefore, the fact that service tax is levied as a percentage of the gross charges for catering cannot alter or affect the legislative competence of Parliament in the matter.”

From the above it appears that the respective authorities can levy taxes on gross amount and it will not be a violation of Constitutional provisions. In fact recently the Karnataka High Court has also dealt with the issue of overlapping in the case of M/s. Sasken Communication Technologies Ltd. v. The Deputy Commissioner of Sales Taxes (Aud-52), DVO-5 (W.A. Nos. 90-101/2011, dated 15-4-2011) and fairly observed that the issue is very vexed and should be resolved by the Court on particular facts of the case. The relevant observations are as under:

“30. Wherever legislature powers are distributed between the Union and the States, situations may arise where the two legislative fields might apparently overlap. It is the duty of the Courts, however difficult it may be, to ascertain to what degree and to what extent, the authority can deal with matters falling within these classes of subjects exists in each Legislature and to define, in the particular case before them, the limits of the respective powers. It could not have been the intention that a conflict should exist; and, in order to prevent such a result the two provisions must be read together, and the language of one interpreted, and, where necessary modified by that of the other.”

From the above observations, it seems that the issue about overlapping will continue to exist till these taxes are merged (like GST) or the Constitution provisions are made absolutely clear.

Whether overlapping affects validity of legislation?

Though overlapping has become an order of day, legislations are held to be valid in spite of overlapping. Reference can be made to the judgment of the Supreme Court in the case of Govind Saran Ganga Saran v. Commissioner of Sales Tax and Others, (60 STC 1) (SC), wherein it is observed that the law to be valid, must fulfil the criteria discussed in the following para of the judgment:

“The components which enter into the concept of a tax are well known. The first is the character of the imposition known by its nature which prescribes the taxable event attracting the levy, the second is a clear indication of the person on whom the levy is imposed and who is obliged to pay the tax, the third is the rate at which the tax is imposed, and the fourth is the measure or value to which the rate will be applied for computing the tax liability. If those components are not clearly and definitely ascertainable, it is difficult to say that the levy exists in point of law. Any uncertainty or vagueness in the legislative scheme defining any of those components of the levy will be fatal to its validity.”

Therefore when measure of tax is not clear, it can be said that there is bad taxation and it can be challenged as invalid. In relation to levy of service tax and sales tax there are so many transactions in day-to-day practice where the measure of tax is not clearly ascertainable. Examples can be about levy of tax on hotels and restaurants, construction activity, repair and maintenance, works contracts, softwares and many others.

Whether overlapping justified
In light of the above judicial pronouncements a mixed picture emerges. Howsoever, avoiding the overlapping is very much necessary. Due to confusion of overlapping it is seen that the concerned dealers/persons charge both service tax and sales tax on full amount. This not only results in unjustified and undue enrichment to respective Governments, but also increases cost to consumers and ultimately leads to inflation. Though we are hopeful that the implementation of GST will resolve the issue, but such a hope is dimming day by day as the implementation itself is under cloud, getting postponed again and again.

Whatever may be the necessities of collecting taxes, the Government at Centre as well as at State level must ensure that consumers should not suffer. It is bounded duty of respective Governments to avoid menace of double taxation and, therefore, to come out with clear guidelines about taxation position for themselves so the tax is not levied on more than total amount of a transaction. In the circumstances, pending implementation of GST, it is desirable that the issue should be resolved by other legal/administrative measures.

May we expect an early resolution of this overlapping position?

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Some historical facts about ICAI

(i) First Indian to become Member of ICAE W: Shri A. E. Cama was the first Indian to become a member of the Institute of Chartered Accountants of England and Wales in 1908.

(ii) Accountancy got statutory recognition in India in 1913: When the Indian Companies Act, 1882, was replaced by the Indian Companies Act, 1913, it was for the first time that statutory provision was made for audit of accounts of companies.

(iii) First Accountancy Board: The first Accountancy Board was appointed under the Auditors’ Certificate Rules, 1932, in 1932. Its members were appointed by the Governor General in Council. Later on, in 1939, elective element was brought into the constitution of the Board.

(iv) GDA and Unrestricted Certificate: Scheme for Government Diploma in Accountancy along with apprenticeship under an approved Accountant for 3 years was introduced in 1918. This Diploma was abolished in 1943. Unrestricted Auditors Certificates were granted under the Companies Act, 1913.

(v) C.A. Act, 1949: Chartered Accountants Bill, 1948, was introduced in Constituent Assembly and C.A. Act, 1949 was passed on 1-5-1949.

The C.A. Act was brought into force on 1-7-1949. Late Shri G. P. Kapadia was elected as the First President and held this position for first three years. (vi) Women Power:

(a) First lady to qualify as GDA in 1930 was Ms. Shirin K. Engineer. After completion of Articles she was enrolled as R.A. in 1933 and thereafter as CA in 1949.

(b) First lady who topped CA Final Examination in 1984 was Ms. Nandita Shah (Now Nandita Parekh).

(d) Incidentally, no lady has occupied the position as President of ICAI.

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A. P. (DIR Series) Circular No. 50 dated 7th November, 2012

Memorandum of Instructions governing Money Changing Activities

Presently, all single branch authorised money changers (AMC) having a turnover of more than $ 100,000 or equivalent per month and all multiple branch AMC are required to institute a system of monthly audit.

This circular has modified the above procedure in respect of multiple branch AMC. As a result, multiple branch AMC are required to put in place a system of Concurrent Audit, which will cover 80 % of the transactions value-wise under a system of monthly audit and rest 20 % of the transactions value-wise under quarterly audit.

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Filing fees on Form 23B.

The Ministry vide Circular No. 14/2012, dated 21-6-
2012 had imposed fees on Form 23B (Information by auditor to Registrar)
w.e.f. 22-7-2012. The last date for filing the Form 23B without fee has
been extended for two weeks. Fee shall be charged on any eForm 23B
filed on or after 5th August, 2012.

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A. P. (DIR Series) Circular No. 49 dated 7th November, 2012

Money Transfer Service Scheme – List of Sub Agents

Presently, authorised persons (AP), who are Indian Agents under the Money Transfer Service Scheme (MTSS), are required to submit a list of their subagents to the Foreign Exchange Department (FED), Central Office (CO) of RBI on a half yearly basis.

This circular provides that, since the list of subagents is already placed on RBI website (www.rbi. org.in), AP are no longer required to submit a list of their sub-agents to BI on a half-yearly basis. AP are now required to inform immediately any change/ addition/deletion to the list of their sub-agents to the Regional Offices of FED of RBI. AP are further required to verify the correctness of the list from the RBI website and intimate the same to RBI either through a letter or by e-mail within 15 days of the end of each quarter.

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A. P. (DIR Series) Circular No. 48 dated 6th November, 2012

External Commercial Borrowings (ECB) Policy – ECB by Small Industries Development Bank of India (SIDBI)

This circular states that SIDBI has been added as an eligible borrower for availing of ECB upto $ 500 million per financial year for on-lending, for permissible end uses, to the Micro, Small and Medium Enterprises (MSME) sector, subject to the following conditions: –

(a) On-lending must be done directly to the borrowers, either in INR or in foreign currency (FCY): –

(i) Foreign currency risk must be hedged by SIDBI in full in case of on-lending to MSME sector in INR; and

(ii) on-lending in foreign currency can only be to those beneficiaries who have a natural hedge by way of foreign exchange earnings.

(b) ECB, including the outstanding ECB, upto 50% of owned funds, can be availed under the automatic route and ECB beyond 50% of owned funds, can be availed under the approval route.

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A. P. (DIR Series) Circular No. 47 dated 23rd October, 2012

Export of Goods and Services – Simplification and Revision of Softex Procedure

Presently, the simplified & revised procedure for submitting Softex Form is applicable/available only to units in Software Technology Parks of India (STPI) at Bengaluru, Hyderabad, Chennai, Pune and Mumbai.

This circular states that the said simplified and revised procedure for submitting Softex Form is now applicable/available to units in all STPI in India.

The circular further provides that a software exporter, whose annual turnover is at least Rs.1000 crore or who files at least 600 SOFTEX forms annually on all India basis, can now submit a statement in excel format as detailed in A. P. (DIR Series) Circular No. 80 dated 15th February, 2012.

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A. P. (DIR Series) Circular No. 46 dated 23rd October, 2012

Supply of Goods and Services by Special Economic
Zones (SEZs) to Units in Domestic Tariff Areas (DTAs) against payment
in foreign exchange

Presently, units in the DTA can make
payment in foreign currency to units in SEZ against supply of goods by
the unit in SEZ to the unit in DTA.

This circular permits units in the DTA to make payment in foreign currency to units in SEZ against supply of services by the unit in SEZ to the unit in DTA. However, care should be taken to ensure that the Letter of Approval issued to the SEZ unit by the Development Commissioner of the SEZ contains a provision permitting the SEZ unit to supply goods /services to units in DTA and consequent receipt of payment from units in DTA in foreign currency.

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A. P. (DIR Series) Circular No. 45 dated 22nd October, 2012

Facilities for Persons Resident outside India – FIIs

Presently, FII are permitted to hedge the currency risk on the market value of their entire investment in equity and / or debt in India, as on a particular date, only with designated bank branches.

This circular permits FII to hedge the currency risk on the market value of their entire investment in equity and / or debt in India, as on a particular date, with any bank, subject to certain conditions. However, when the FII undertakes hedge with a non-designated bank branch, the same has to be settled through the Special Non-Resident Rupee A/c maintained with the designated bank through RTGS / NEFT.

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Section 40(b) and Interest to partners

The present section 40(b) of the Income-tax Act has
been introduced by the Finance Act, 1992 w.e.f. 1-4-1993 to coincide
with the introduction of the new scheme of taxation of the firm and the
partners. The section provides for the conditions, on compliance of
which the remuneration and the interest to partners, by the firm, shall
not be disallowed in the hands of the firm. In other words the claim of
the firm, for deduction of remuneration and interest to partners, shall
be allowed where it satisfies the conditions stipulated in section
40(b).

For allowance of an interest to the partner, it is
essential that the payment is authorised by and is in accordance with
the terms of the partnership deed and relates to a period falling after
the date of partnership deed and the amount does not exceed the amount
calculated at the rate of 12% simple interest per annum.

It is
usual that the interest is paid to a partner on the capital introduced
by him as increased by the deposits made by him and the share of profits
credited to his account and as reduced by the amounts withdrawn by him
and the share of losses debited to his account. At times, the account is
credited with the share of notional profits arising on revaluation or
is debited with the transfer to reserves created to meet certain
contingencies.

Section 40(b) is silent about the ‘base amount’,
with reference to which the interest of 12% is to be calculated. It also
does not specify the manner in which such base amount is to be
calculated. In the circumstances, issues regularly arise about the
determination of the base amount, with reference to which the interest
payable to a partner is to be ascertained so as to face no disallowance.
Unlike section 115JB, it does not provide for the manner of preparation
of the profit & loss account, nor does it lay down any guidelines
for ascertaining the book profit of the firm, the share of which is to
be credited to the partner’s account.

A controversy has arisen
about the need and necessity to provide depreciation by the firm in its
books of account, while ascertaining the amount of the profit or loss of
the year, to be shared amongst the partners and credited to their
respective accounts. Providing no depreciation or a lower depreciation
results in higher profits being credited to partners’ accounts which in
turn helps in payment of higher interest to them. Is this practice of
not providing depreciation in the books in accordance with the
provisions of the Act, for allowance of interest in the hands of the
firm, is a question that has been addressed by the different benches of
the Tribunal to arrive at the different and conflicting views.

The relevant part of section 40(b), pertaining to interest to partners, reads as under:

“Amounts not deductible.

40.
Notwithstanding anything to the contrary in sections 30 to 38, the
following amounts shall not be deducted in computing the income
chargeable under the head ‘Profits and gains of business or profession’,
—

(b) in the case of any firm assessable as such:

(i) ……………..

(ii)
any payment ………….., or of interest to any partner, which, in
either case, is not authorised by, or is not in accordance with, the
terms of the partnership deed; or

(iii) any payment
……………. , or of interest to any partner, which, in either case,
is authorised by, and is in accordance with, the terms of the
partnership deed, but which relates to any period (falling prior to the
date of such partnership deed) for which such payment was not authorised
by, or is not in accordance with, any earlier partnership deed, so,
however, that the period of authorisation for such payment by any
earlier partnership deed does not cover any period prior to the date of
such earlier partnership deed; or

(iv) any payment of interest
to any partner which is authorised by, and is in accordance with, the
terms of the partnership deed and relates to any period falling after
the date of such partnership deed insofar as such amount exceeds the
amount calculated at the rate of twelve per cent simple interest per
annum; or………………”

The Visakhapatnam Bench of the
Tribunal had an occasion to deal with the issue, wherein the Tribunal
held that the Assessing Officer (‘AO’) was not entitled to recompute the
balance of capital account of the partners, so determined by the
assessee firm. In deciding the said issue, the Bench did not follow the
findings to the contrary of another Bench of the Visakhapatnam Tribunal
on the subject.

Arthi Nursing Home’s case

The
issue under consideration was examined by the Visakhapatnam Tribunal in
the case of Arthi Nursing Home v. ITO, 119 TTJ 415 (Visakha).

In
that case, Arthi Nursing Home, a partnership firm, had claimed
deduction of interest paid to partners on their respective capital
accounts. Consequent to the findings in the course of the survey
operations conducted on the firm and during the course of assessment
proceedings, it was noticed by the AO that the firm was not providing
for depreciation in the books of account, but was claiming depreciation
in computation of taxable income. The AO was of the view that the firm
by following the practice of not providing the depreciation was
inflating the capital accounts of the partners on which higher interest
was paid. He observed that the said practice was for the purposes of
claiming higher deduction, towards payment of interest, in the hands of
the firm. He was of the view that the firm was required to draw its
profit & loss account by debiting the depreciation. The AO
recomputed the balances in capital accounts of the partners after
charging depreciation. Consequently, the claim for deduction of interest
to partners was disallowed u/s.40(b) as the balance in the capital
accounts of the partners had turned negative after apportioning the
recomputed profits and losses.

On appeal before the CIT(A), the
action of the AO in disallowing the deduction of interest to partners
u/s.40(b) was confirmed for the following reasons:

The
assessee claimed benefit of depreciation in computing the total income,
but did not provide the same in computing the profit of the firm to be
shared amongst the partners. The said practice led to showing higher
amount of profits in the books of account which inflated the capital
balances of the partners and the consequent interest to partners;
Depreciation,
like any other head of expenditure, was required to be debited to the
profit and loss account to arrive at the real profits of the business;
Debiting of depreciation was a cardinal principle of mercantile system of accounting; and
The
figures of accretion to the capital balances, were exaggerated and
fictitious, not in accordance with any principles of accountancy.

The
assessee firm’s contention that the AO could not have rewritten books
of account of the firm based on the decisions in the cases of Ambica
Chemical Products v. Dy. CIT, (ITA No. 612/Vizag./1999, dated 31st May,
2005 and 9/Vizag./1999) dated 9th January, 2009, respectively; and ACIT
v. Sant Shoe Store, 88 ITD 524, (Chd.) (SMC) was negatived by the CIT(A)
by holding that the AO had only undertaken an exercise of discovery of
correctness of accounts which was not an exercise of rewriting the books
of account.

Aggrieved with the order of the CIT(A), on appeal
before the Tribunal, the following additional arguments were made by the
firm:

Section 40(b) did not provide for the manner of
computing the profit of the firm for the year and did not have any
relevance to the claims made in computing the total income; and

The firm had been consistently over the years not charging depreciation
in the books of account, but had claimed depreciation in computing the
taxable income, which had been accepted by the Revenue authorities.

Likewise, the following additional contentions were raised by the Revenue:

Explanation 5 to section 32 of the Act and the Accounting Standards
prescribed by ICAI required charging of depreciation in the books of
account; and

The Apex Court in the case of CIT
v. British Paints India Ltd., (188 ITR 44) held that the books disclosed
the true state of accounts and the correct income.

The Tribunal after considering the rival submissions upheld the contention of the Revenue authorities for the following reasons:

In light of the Apex Court decision in the case of British Paints Ltd.
(supra), the AO was duty bound to recompute the profit/accretion to the
capital account of the partners after charging depreciation to the
profit and loss account;

Explanation 5 to
section 32 and the Accounting Standards prescribed by the ICAI required
mandatory charging of depreciation to determine profit and loss of the
firm for the year; and

The profit and loss
account prepared without charging depreciation did not reflect the true
and correct state of affairs of the partnership firm.

The
Tribunal concluded that the AO was justified in correcting the aforesaid
error, thereby disallowing the interest claimed by the assessee firm
u/s.40(b).

Swaraj Enterprises case

The issue under consideration subsequently came up before the Division Bench of the Visakhapatnam

Tribunal in the case of Swaraj Enterprises v. ITO, 132 ITD 488.

In
this case, the assessee firm, like in the case of Arthi Nursing Home
(supra), did not charge depre-ciation in the books of account, but
claimed depre-ciation in computing the total income. As a result the
partners’ accounts were credited with higher share of profits on which
interest was paid to the partners. The AO, by relying on the several
decisions of the High Courts, held that the depreciation was a charge on
profits of the firm and the same should be provided for in computing
the profit that was distributed amongst the partners. He recomputed the
capital account balances of the partners and interest thereof.

On
appeal the CIT(A) relying on the decision in the case of Arthi Nursing
Home (supra) upheld the action of the AO of recomputing the interest to
partners for the purposes of section 40(b).

Aggrieved with the order of the CIT(A), the assessee firm filed an appeal before the Tribunal and contended that:

There was no provision under the Act that allowed an AO to rework the
capital balances of the partners and to recompute the interest to
partners u/s.40(b);

There was no statutory compulsion for partnership firms to provide for depreciation under the Indian Partnership Act, 1932;

The determination of profit for the purposes of the books of account
and the computation of total income for income tax were two different
exercises and hence the allowance or disallowance made in computing the
total income under the Act did not in any way affected the balances in
the capital accounts of the partners disclosed in the books of account;
and

Without prejudice, the firm in any case had
the discretion to select the method of charging depreciation and also
the rates at which such depreciation was charged, which discretion was
not vested in the AO.

The Revenue contended that the
depreciation was a charge on the profits of the year and it was a must
for the firm to provide for depreciation to arrive at the true profits
of the firm; that the AO following the British Paints’ case was duty
bound to rework the profit; that action of the firm was not in
accordance with the Accounting Standards and principles and that the
Explanation 5 to section 32 required that the depreciation was charged
to the accounts.

After considering the rival submissions and the decision in the case of Arthi Nursing Home (supra), the Tribunal held as under:

The findings of the Apex Court in the case of British Paints Ltd.
(supra) for reworking the profits were in context of determination of
taxable income and could not be employed for recomputing the capital
account of the partners;

The total taxable
income of the firm remained the same, since the depreciation was already
claimed in computing the taxable income;

Under, the Partnership Act, 1932, there was no statutory compulsion to
provide for depreciation in the books of account or to follow the
Accounting Standards prescribed by ICAI;

The
Companies Act that required an enterprise to follow the mercantile
method of accounting and employ the Accounting Standards did not apply
to a partnership firm;

Explanation 5 to section
32 provided for compulsory depreciation for the purpose of computation
of taxable income under the Act and nowhere it was provided that it was
to be applied even in preparing the books of account;

U/s.40(b), the AO was allowed only to verify whether the payment of
interest to any partner was authorised by and was in accordance with the
terms of partnership deed and whether the period of interest so paid
fell after the date of partnership deed. The AO could not have reworked
or redetermined the balance in the capital accounts of the partners; and

Even if the depreciation was required to be charged in the books of
account, the choice to determine the method and the rate of depreciation
would be at the discretion of the assessee firm and not of the AO.

Based
on the aforesaid findings, the Tribunal ignored its own findings in the
case of Arthi Nursing Home (supra) and upheld the claim of deduction of
inter-est to partners.

Observations

Section 40(b)
is silent as to the amount on which the interest to partners is to be
calculated. As noted, the ‘base amount’ remains to be defined by the
provision. In the context of interest, it has no reference to the books
of account, nor to the book profit unlike the provisions of section
115JB or even those within the section that provide for calculating the
quantum of remuneration payable to the partners. It may not be incorrect
to state that the claim of interest, in the context, is independent of
the books of account.

Unlike section 115JB, this section does not
provide for the method of accounting to be followed, the method of
depreciation to be employed and the rates at which the assets are
required to be de-preciated.

Section 40(b) provides that no
disallowance shall take place where the interest to partners is;
authorised by the partnership deed; in accordance therewith; for the
period falling after the date of partnership deed and the rate of
interest does not exceed 12%. In the circumstances, what is of paramount
importance is that the interest to partners should be authorised by the
deed and if it is so what remains to be seen is that such interest is
paid in the manner provided by the said deed which of course should be
in conformity with the other stipulations stated above. Nothing, beyond
these simple rules, is required to be read in to the provision.

The
computation of total income, under the Act, is largely independent of
the books of account. A debit or credit does not decide the taxability
or allowance of an income or an expenditure. Unless otherwise expressly
stated, the books of account do not determine the taxability or
otherwise under the Act. The allowance or a deduction and the taxability
of an income is governed by the provisions of the Income-tax Act and
not the books of account.

Explanation 5 to section 32 has a very
limited relevance and its application is mainly restricted to the
provisions of section 32(1) and section 43(6) which provide for
determination of the written down value of an asset or a block of
assets. The said provision, at the most, has the effect of altering the
total income that is computed under the Act and does not travel beyond,
to the computation of the book profit, not even for the purposes of
section 115JB.

The Partnership Act, 1932 does not prescribe the
manner in which the books of account are to be maintained, nor do they
provide for the method of accounting to be followed by the firm for
determining its profit or loss. They also do not prescribe for
compulsory depreciation and the rate thereof.

The Companies Act
has no application to the partnership firms and the provisions therein
for mercantile system of accounting, true and fair profit and the
mandatory application of the Accounting Standards do not apply to the
partnership firms.

The Chandigarh Bench of the Tribunal in Sant
Shoe Store’s case was concerned with the allowance of interest on the
capital account of the partners which included credits on revaluation of
the assets, not involving any inflow of funds. The Tribunal even in
such a case approved of the claim of interest made by the firm. Again,
the Tribunal in Ambica Chemical Products approved of the claim of
interest in circumstances where the firm had not provided for
depreciation in the books of account; the claim was allowed to the firm
in two different appeals vide orders passed after a gap of four years
and one of it was passed after the decision in the case of Aarthi
Nursing Home was rendered. A useful reference may be made to the
decision of the Pune Bench in the case of Deval Utensils Factory, 98 TTJ
501 wherein the action of the AO in reworking the capital account
balance, on the basis of which interest was paid to partner was
disapproved.

The rewriting of the books by either side should
be discouraged. If permitted, it may invite the tax-payers to indulge
in creative accounting, for example; by adding back the provision for
taxation where debited to the profit & loss account so as to enhance
the amount of share of profit that is credited to the capital accounts
by holding out that the tax is not an allowable deduction in computing
the total income. The example amplifies the need to stick to the books
of account and the need to avoid importing the computation provisions in
calculation of interest.

The interest to the partners, where
allowed in the hands of the firm, is taxable in the hands of the
partners as business income by virtue of section 28(v). The one that is
disallowed in the hands of the firm, is not taxable in the hands of the
partners by virtue of the proviso to the said section 28(v) of the Act.
The disallowance largely does not result in any loss or gain of revenue
for either side.

This essentially leaves us with the conclusion
that no disallowance shall take place under the provisions of section
40(b) in cases where the interest to partners is authorised by the
partnership deed and the same is calculated as per the terms of the
partnership deed. The case of the firm gets forti-fied where the deed
does not make it mandatory for the firm to charge depreciation in
computing the profit for the year.

shailesh.kwebmaker

Why income from sale of computer soft ware not taxable as royalty?

While best efforts were made from world over to persuade the then Finance Minister of India to have second thoughts on the retrospective proposals introduced in the Finance Bill, 2012, nothing seems to have appealed. The retrospective amendments as were proposed in the Finance Bill, 2012 have received the President’s assent. In this backdrop, an effort is made to consider whether the Income-tax Department under the so retrospectively amended section 9(1)(vi) of the Act would be able to tax, income from sale of computer software as royalty under the Income-tax Act, 1961 (‘the Act’) and/or Double Taxation Avoidance Agreements (‘DTAAs’) entered in by India with other countries?

From the following three Circulars issued by the Central Board of Direct Taxes at different points in time, one understands that the intention of the Legislature was very clear to tax any income from ‘right for use’ or ‘right to use’ any copyright (viz., computer program) as royalty under the Act:

Circular No. 152, dated 27th November 1974;
Circular No. 588, dated 2nd January 1991; and
Circular No. 621, dated 19th December 1991.

However, the controversy whether income from sale of computer software is taxable as royalty under the Act or not, developed only from the year 2005, with the judgment of the Special Bench of Delhi Tribunal in the case of Motorola Inc. v. DCIT, (95 ITD 269). The decision pertained to A.Ys. 1997-98 and 1998-99, though the first Circular justifying the taxability of income as royalty under the Act was issued in 1974.

Such an unusual scenario could be the result of imperfect drafting of section 9(1)(vi) to support the taxability of sale of computer software as royalty. This article examines whether the retrospective introduction of Explanation 4 to section 9(1)(vi), achieves the object of the Legislature to tax the income from sale of computer software as royalty under the Act. The said retrospective amendment in section 9(1)(vi) reads as under:

“Explanation 4 — For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of licence) irrespective of the medium through which such right is transferred.”

Section 9(1)(vi) provides that any income payable by way of royalty in respect of any right, property or information is deemed to accrue or arise in India. So, to determine the taxability of income u/s.9(1)(vi), an income needs to satisfy the following twin conditions, apart from the principle of ‘source rule of taxation’ in section 9(1)(vi): The income should be covered under the definition of ‘royalty’ i.e., under Explanation 2 to section 9(1) (vi); and
l It has to be in respect of any right, property or information.

The expression ‘any right, property or information’ is explained in the definition of ‘royalty’ viz., intellectual properties, equipments, know-how, experience or skills, etc. In other words, the definition of ‘royalty’ gives colour to or limits the scope of, the expression, which is otherwise very wide in scope.

Explanation 4 retrospectively includes, ‘right for use or right to use computer software’ under the expression ‘any right, property or information’. The text of Explanation 4, however, does not include the said rights of a computer software under the definition of ‘royalty’, which is specifically required as discussed, for applicability of section 9(1)(vi). Even though, the Memorandum explaining the amendments relating to Direct Taxes in the Finance Bill, 2012 mentions that ‘transfer of all or any right in respect of any right, property or information’ used in Explanation 4 defines the rights, property or information referred to in Explanation 2 to section 9(1)(vi), the text of Explanation 4 does not refer to Explanation 2. Therefore, one may argue that until the language of Explanation 4 is amended to include the aforesaid rights of computer software under Explanation 2, section 9(1)(vi) may not apply to the said rights of computer software.

The said argument also draws support from the Karnataka High Court judgment in the case of Jindal Thermal Power Company Ltd. v. DCIT, (321 ITR 31). The High Court while considering the retrospective amendment in context of Explanation to section 9(2) r.w.s. 9(1)(vii) held that since the purport of Explanation 2 is plain in its meaning, it is unnecessary and impermissible to refer to the Memorandum Explaining the provisions. Apart from the above or assuming that the Legislature amends Explanation 4 on the lines as suggested above or the Courts hold otherwise, the question that arises is, what is the meaning of the expression ‘right for use’ or ‘right to use’ a computer software? The provisions of the Act do not define ‘right for use’ or ‘right to use’.

Broadly, there are two schools of thought emerging for interpretation of the aforesaid rights of computer software. One school of thought suggests that the said expression should be construed in its general sense. Whereas, the other school of thought suggests the said expression should be construed in the light of the meaning as given in 2010 OECD Commentary on Model Tax Convention on Income and on Capital.

First school of thought

The Memorandum justifies the retrospective insertion, so as to restate the intention of the Legislature to tax the income from use or right to use computer software as royalty under the Act, which was interpreted otherwise by some judicial authorities. The judicial authorities1 in India have given conflicting findings on different questions relating to taxability of income from sale of computer software as royalty. Out of these questions, the Legislature has by Finance Act, 2012 sought to address only the question whether the expression ‘transfer of all or any rights’ includes ‘right for use’ or ‘right to use’?

The Memorandum does not refer to the conflicting judgements. The findings of these conflicting judgements were summarised in a Table in the feature Direct Tax Controversy in the BCAS Journal for the month of December 2011, (page no. 54).

In such a scenario, it would be relevant to understand the meaning of the expression ‘right for use’ or ‘right to use’ a computer software in the light of the findings of Heydon’s case (1584) (3 Co Rep 7a, 7b), better known as Mischief Rule. The Heydon’s case requires that to construe a provision of a statute, it would be just and proper to see what was the position before an amendment and find out what was ‘the mischief’ sought to be remedied and then discover the true rationale for such remedy. The aforesaid rule which is more than four hundred years old requires the following four questions to be answered in order to construe the provisions of section 9(1)(vi):

1. What was the common law before making the amendment in section 9(1)(vi)?

Judicial authorities were divided as regard the taxability of the subject. Some of the findings of the said decisions are:

— Passing on the right to use and facilitating the use of a product for which the owner has a copyright is not the same thing as transferring or assigning rights in relation to copyright and therefore, consideration to authorise the end-user to have an access to and make use of the licensed computer software, does not amount to royalty under the Act.

— On the other hand, some judicial authorities, held that payments made by end-users or distributors for granting of licence to use copyright i.e., computer program in respect of sale of computer software is royalty under the Act. Right of user of computer software involves right to use the computer program. When the right for user is given, right to use copyright is also given and therefore, consideration amounts to royalty under the Act.

2. What was the mischief and defect for which the Act did not provide?

The mischief and the defect for which the Act did not provide and which seems to be the intent of the Legislature was to tax ‘right for use’ or ‘right to use’ computer program [involved in a sale of/ licence to use computer software] as royalty under the Act.

3. What remedy the Legislature/Parliament has resolved and appointed to cure the defect?

The remedy effected by the Legislature to cure the aforesaid defect is retrospective insertion of Explanation 4.

4. What is the true reason for the remedy?

The true reason for the remedy seems that the Legislature wanted to subject ‘right for use’ or ‘right to use’ computer program involved in sale of computer software as royalty under the Act. The Legislature instead of using the expression to achieve its remedy to tax “right for use or right to use computer program embedded in a computer software” has chosen to use the expression “right for use or right to use computer software”, in a way suggesting that words ‘computer software’ and ‘computer program’ are used interchangeably.

In other words, the true expression ‘right for use or right to use a computer software’ is referred to as having a general meaning of act of using the property i.e., computer program embedded in a computer software and right to transfer such usage, respectively. Therefore, if one agrees with the conclusion of first school of thought, then purchase of any computer software viz., either shrinkwrap, bundled, canned or customised software, would be taxable as ‘royalty’ under the Act.

Second school of thought

The second school of thought suggests that the impugned expression should be construed in the light of the meaning as given in 2010 OECD Commentary on Model Tax Convention on Income and on Capital. The Para 2 of Article 12 of 2010 OECD Model defines ‘royalty’ as under:

The term ‘royalties’ as used in this Article means payments of any kind received as a consideration for the use of, or the right to use any copyright of literary, artistic or scientific work including cinematograph films, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.

The expressions ‘right for use’ or ‘right to use’ as referred in Explanation 4 to section 9(1)(vi) is also found in Article 12(2). Paras 12 to 17 of the OECD Model Commentary on Article 12 cover the various facets of taxability of computer software as royalty. Para 13.1 of the Commentary explains the meaning of the expression ‘right for use’ or ‘right to use’ any copyright in the context of a computer software. This is similar to rights referred to in section 14 of the Copyright Act, 1957 (‘the Copyright Act’) and India has not raised any reservations or disagreements to such construction. The rights referred in section 14 of the Copyright Act for computer program are reproduced below:

to reproduce the work in any material form including the storing of it in any medium by electronic means;

to issue copies of the work to the public not being copies already in circulation;

to perform the work in public, or communicate it to the public;

to make any cinematograph film or sound recording in respect of the work;

to make any translation of the work;

to make any adaptation of the work;

to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in any of the points mentioned above; and

to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer program.

So, it is the transfer or granting of licence of rights in section 14 of the Copyright Act which refers to use or right to use the copyright in context of computer software.

Further, there is a case to presume that the expression ‘right for use’ and ‘right to use’ in the context of taxability of computer software as royalty, has acquired a particular meaning, when India has accepted the meaning of that expression as explained in the 2010 OECD Model Commentary. Therefore, it is worth arguing that when India has accepted the meaning of the expression in a particular sense, then the use of the said expression subsequently should also be given similar meaning. The Courts also have in a catena of decisions2 held that internationally accepted meaning and interpretation placed on identical or similar terms employed in various DTAAs should be followed when construing similar terms occurring in the Act. However, the said reference/is subject to certain limitations, and for better understanding of the subject, one may refer to the Article ‘Legitimacy of References to OECD Commentary for interpretation of provisions under the Act and DTAAs’ published in BCAJ, February 2012, (page no. 9).

Therefore, if one agrees with the conclusion of the second school of thought, then it is only the income from the transfer or granting of licence of rights in section 14 of the Copyright Act which means use or right to use copyright in the context of computer soft-ware and accordingly will be taxable as royalty under the Act. In other words, purchase of any computer software viz., either shrinkwrap, bundled, canned or customised software would still continue to remain non-taxable as ‘royalty’ under the Act.

Analysis

Based on the above discussion, if the text of the Explanation 4 to section 9(1)(vi) is brought to test then one feels that the Legislature may still fail to pass the muster to tax the income from sale of computer software as royalty under the Act for want of the following broad reasons:

In Explanation 4, the Legislature has used the words ‘all or any’ which are prefixed to expression ‘right for use’ or ‘rights to use’ computer software. The expression ‘transfer of all or any right for use or right to use a computer software (including granting of licence)’ gives an impression of there being many ‘rights for use’ or ‘rights to use’ a computer software, which can either be transferred or licensed. However, as concluded under the first school of thought, ‘right for use’ or ‘right to use’ computer software in its general sense refers to only a simple case of ‘usage’ of property. One fails to determine the various rights ‘for use’ or rights ‘to use’ involved in context of a computer software and is forced to doubt whether the Explanation 4 supports the construction of the expression as sought under the first school of thought. On the contrary, considering the multiple rights referred in section 14 of the Copyright Act, one may agree that the expression ‘all or any’ could be construed as referring to those multiple rights u/s.14 of the Copyright Act, thereby supporting the meaning as drawn under the second school of thought.

Further, Explanation 3 to section 9(1)(vi) of the Act defines ‘computer software’ to mean computer program recorded on any medium. In a sense, suggesting that even though the Copyright Act distinguishes between ‘original copyrighted computer program’ and ‘copy of said computer program embedded in computer software’, the Income-tax Act, 1961 does not recognise such a distinction for the purpose of taxation and the words ‘computer software’ and ‘computer program’ may be used interchangeably. The same conclusion is also drawn under question no. 4 – What is the true reason for remedy, while discussing the findings of Heydon’s case in the context of computer software, under the first school of thought? So, the expression ‘right for use or right to use a computer software’ may be read as ‘right for use or right to use a computer program’ in respect of computer software.

Conclusion

Considering the above, one may conclude that Explanation 4 to section 9(1)(vi) of the Act, in its present form, may fail to achieve its object for want of the following broad reasons:

Expressions viz., ‘transfer of all or any rights in respect of any right, property or information’, ‘all or any’, ‘rights for use’ or ‘right to use’ are neither defined nor properly referenced in section 9(1)(vi) of the Act;

Expression ‘right for use’ or ‘right to use’ referred to in Explanation 4 to section 9(1)(vi) may suggest a meaning different than meaning in general sense of usage of property and transfer thereof; and

Explanation 4 to section 9(1)(vi) supports the construction of the expressions ‘right for use’ or ‘right to use’ to cover the rights referred to in section 14 of the Copyright Act.

Apart from the above, it would be possible for non-resident taxpayers to take recourse to the beneficial provisions of DTAAs entered in by India with other countries. The Article on taxability of ‘royalty income’ generally defines “royalty as payment of any kind from ‘use or right to use’ any copyright”. It thus restricts the scope of royalty income and one may rely on the 2010 OECD Model Commentary and India’s position thereof for non-taxability of computer software as royalty.

Further, the Central Government has recently issued a Notification giving relief from multiple level of tax deduction at source (‘TDS’) u/s.194J in the context of computer software. The said Notification No. 21 of 2012, dated 13rd June 2012 is issued u/s.197A(1F) effective from 1st July 2012 and provides as under:

The transferee has been defined to be a person who acquires the software. He may be a resident or a non-resident of India and the transferor is defined to be a person from whom the software is acquired, but he has to be a resident of India (as a precursor for applicability of section 194J of the Act).

Acquisition of the software has to be in the course of transfer of software (referred to as ‘subsequent transfers’) and tax should have been deducted at source either u/s.194J or section 195 of the Act, as the case may be, in any of the previous transfers;

The software so acquired under subsequent transfer should not have been modified; and

The transferee should obtain a declaration from the transferor that the tax has been deducted in any of the previous transfers along with PAN of the transferor.

This Notification has a narrow scope and has several limitations, which are as under:

The exemption from multiple level of deduction of tax has only been provided to payments subject to tax deduction as royalty u/s.194J of the Act and not u/s.195 of the Act; and

The acquisition of software under subsequent transfers should be without modification. One generally finds that in a direct arrangement between a copyright owner and end-user, the standard End-User Licence Agreement (‘EULA’) specifically prevents the end-user for resale of acquired software and therefore, the question of multiple level of deduction of tax will not arise in such a scenario. However, in case of copyright owner-distributor- end -user chain, it may be possible to undertake the benefit of the said Notification.

A fact pattern which is generally involved in the case of copyright owner-distributor-end user chain of transfer of software and its TDS implications thereof are explained in the Diagram for ease of understanding and ready reference:

Generally, the copyright owner of a computer program assigns/licenses rights to commercially exploit the copyright to the distributor. The rights to commercially exploit copyright provide for making multiple copies of software along with rights to sell and/or rent computer software qua a geographical location i.e., in the given example could be India. Pursuant to aforesaid rights, the end-user in India acquires the software copy from the distributor, subject to terms and conditions as provided in a EULA.

(Note: It is assumed that under the Scenario 1 and 2, the income from sale of computer software is taxable as ‘royalty’ under the Act and respective DTAAs between India and other countries. The analysis has been limited with respect to TDS implications, which arise in the light of aforesaid notification.)

The important question which is relevant to determine the TDS implications in context of non-residents transferors that is discussed here is ‘Can a non-resident transferor take recourse to Article on ‘Non-discrimination’ under the DTAAs as regard the discriminatory treatment sought by the Notification by limiting the benefit to only resident transferors u/s.194J of the Act?’

Section 40a(ia) r.w.s. 194J and Notification No. 21 of 2012 provides for deduction of royalty expenses for payment to resident transferor for acquisition of software without any deduction of tax. On the other hand, for similar payment to non-resident transferor, if the transferee has not deducted tax u/s.195, then the said expense will not be allowed as deduction u/s.40a(i). Such discrimination is addressed in an indirect manner by Article 24(3) of the respective DTAAs entered in between India and other countries. Article 24(3), generally reads as under:

“Except where the provisions of para 1 of Article 19, para 7 of Article 11, or para 8 of Article 12 apply, interest, royalties, and other disbursements paid by a resident of a Contracting State to a resident of the other Contracting State, shall for the purposes of determining the taxable profits of the first mentioned person, be deductible under the same conditions as if they had been paid to a resident of the first mentioned State.”

Article 24(3) deals with the treatment of the enterprises of Contracting State under the tax laws of that State. The said Article provides that interest, royalties and other disbursements paid to a resident of the other contracting State should be deductible to the same extent as would be deductible if paid to a resident of the same State. The said para of the Article is designed to end a particular form of discrimination resulting from a fact that in certain countries the deduction of interest, royalties and other disbursements is allowed without restriction when the recipient is a resident, but is restricted or prohibited when the recipient is non-resident4.

A similar discriminatory treatment is sought by Notification No. 21 of 2012. Therefore, by taking recourse to Article 24(3) of DTAAs read with Notification No. 21 of 2012, similar exemption from multiple level of TDS may be claimed on payment to non-resident transferors.

Given the aforesaid situation, one is reminded of the proverb, ‘Once burnt is twice shy.’ But the hard lesson of consequences from imperfect drafting do not seem to have learnt and therefore, the Income-tax Department may still fail to tax income from sale of computer software as ‘royalty’ under the Act and may also fail to simultaneously impose onerous and discriminatory treatment of multiple level of TDS u/s.195 of the Act.

shailesh.kwebmaker

Inspire a generation

When this issue of the journal reaches you, the Olympic Games would have begun in London. Sportsmen, athletes from all over the world would be putting their best foot forward, competing fiercely but fairly to win laurels wearing national pride on their sleeve.

The Olympics held every four years is a mega event. It is a celebration of various qualities of human beings, grit, determination, endurance and many others. When an athlete climbs onto the victory stand a medal adorning his chest swelled with pride, and the national anthem is played, a dream is fulfilled.

While achieving success in sporting events is undoubtedly important, the games mean much more. It is a time that athletes representing different countries mingle with each other and respect for others is built. One of our fellow countrymen who is facing criminal action for alleged corruption in sport wanted to remain present at the games. He had been “invited”, by the organisers. For once, our judicial system acted swiftly and he was prevented from representing our country at the game’s opening ceremony. The person may be disappointed but the Institution he once headed, maintained its track record, with our sportsmen complaining about their substandard equipment and shabby attire just before the games.

Each of the Olympic Games has a motto and this time it is” inspire a generation”. The motto set me thinking. I attempted to list down living individuals, particularly Indians who would fit into the class that would inspire an entire generation, and the difficulty in finding such people was a cause for concern.

In every area – culture, art, sports, professions, science, social service and of course politics if one is to identify titans one has to travel back for at least three to four decades if not more.

Every Maharashtra leader worth his salt praises Shivaji an icon, but one cannot forget that the Maratha warrior breathed his last more than 300 years ago. What has gone wrong? The answer lies within us. Leaders who inspire, those who will be lighthouses for a generation do not fall from heaven. They arise from amongst us. There are a number of individuals whose deeds should inspire their kith and kin, friends and associates may be not a generation. I still recall those images of a Bollywood celebrity being splashed across the front page pointing a finger at a security guard who stood his ground and blew the whistle. In the glare of the media that person and his adherence to the call of duty was quickly forgotten. From that humble security guard to the jawan who stands in biting icy weather at the peak of the Himalayas, there are many such inspiring individuals.

We need to appreciate those who show intrinsic human qualities like honesty, determination and courage albeit in a small measure. For too long have we permitted society to use materialistic parameters to judge the success of a person. If you look at the news which is displayed among all forms of media be it print or electronic, there is great adulation about those who achieve economic success. To borrow a phrase from my last editorial, most of us are concerned at how much wealth a person has earned but we do not bother to question how.

It is true, that it is not easy to find persons whom we can all look up to. But let us look around amongst us and we will find a number of such examples. Let us give them the recognition, respect and the social status they deserve. Once that is done their breed will grow. Man is a social animal. If society starts rewarding those who show some courage in upholding human values however small the deed may be the numbers will swell. Great leaders swim against the tide. But if such leaders are not in sight, let us build small dams so that the tide can be stemmed, the current diverted.

It is because we have drifted from the emphasis on basic human values and embraced materialistic goals that we find a dearth of role models. To conclude, there is no point in sitting back and lamenting that there are no leaders who can inspire. We may not be able to find shining stars but will definitely be able to locate small lights which will show us the path. A candle cannot dispel darkness but it is enough to show the next step. If we sit back waiting for someone to inspire us we will get nowhere. Yes the goal can be quickly reached if we run behind torch bearer, but if there is none, even a small step at a time will also lead us to the destination. When your house is on fire, it is better to use the stairs rather than the elevator. I am sure those working in Mumbai’s Mantralaya will agree. Let us inspire those around us and if we all do so, the future generation will definitely be inspired!

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ANXIETY

‘Anxiety’ itself is neither helpful not hurtful. It is our response to anxiety that is helpful or hurtful. – Winston Churchill

Anxiety is normal and is part of our existence. The base of ‘anxiety’ is insecurity and possessiveness – hence, fear of loss is the cause of anxiety. ‘Anxiety’ and its twin sister ‘worry’ are killers. It is rightly said that worry over the past, anxiety over the future and frenzy in the present kill energy – energy which is essential for action. ‘Anxiety’ impacts our performance. According to Thomas J. Delong, ‘anxiety is possibly the single largest inhibitor of growth’. The normal response to ‘anxiety’ is flight or fight. However, I believe, anxiety can be a powerful stimulant arousing the senses to function at their sharpest.

We are normally anxious about our family, economic activity, social and professional status, living up to expectations, ours and others, and lastly we are also anxious about our health – though health should take priority over other concerns, because no action can happen without being healthy, both in body and mind. Let us consider a few examples of ‘anxiety’:

a doctor is anxious before a major surgery.
a lawyer is anxious before a major case.
an actor is anxious about forgetting his/her lines or success of his or her performance.
a student is anxious about results.
a lover is anxious about relationship.
a sick person is worried about getting well.
a housewife is anxious about her family.
a business person is worried about ‘topline’ and ‘bottomline’.
a chartered accountant is worried about his client.

Unexpected events and contingencies also create and cause anxiety. Hence, I reiterate anxiety is normal and is part and parcel of our existence. All these anxieties are genuine and the answer to anxiety is one and only one and that is possession of a cool mind. With a cool mind and with proper preparation we can face ‘anxiety’. If we are adequately prepared, all anxiety giving issues would look small and there is a good old saying: ‘The art of living is: ‘don’t fret over small things’. The fear of failure is the biggest cause of ‘anxiety’. The response to ‘anxiety’ should also be acceptance of failure, because failure is nothing but a stepping stone to success.

Personally, in recent times I experienced a traumatic experience – I was anxious – about the outcome – anxious to the extent of losing sleep – what brought me out was faith in my god, my guru, my family, my friends and faith in myself and above all proper preparation. I am grateful to Him for both the ‘anxiety’ and the ‘faith’. We forget, anxiety is all about future which robs us of the pleasures of the present.

We have to learn to befriend ‘anxiety’ and use it as a stepping stone and never to yield to ‘anxiety’. I repeat, use ‘anxiety’ to improve ourselves, our environment and our life. Use this emotion as a tool of success and success will be ours.

The answer to ‘anxiety’ is:

Faith Faith in the concept that from bad emerges good, Faith in the fact that every problem has a solution, Faith that with help and guidance from Him one can overcome every obstacle, Faith in oneself that one will win,

Above all we must learn to bond with people instead of possessing them. If we do this there will be no ‘anxiety of loss’.

Anxiety to achieve our objective actually dilutes our efforts. So stop being anxious. Success in life, I repeat, can be achieved only through clarity, courage and commitment.

I would conclude by quoting George Bernard Shaw:

‘In this world, there is always danger for those who are anxious (afraid) of it’.

So to have a happy successful life let us hang our anxieties – fears – on the tree and leave them to Him and work with, nay for Him.

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Undisclosed investment: Section 69B: Search revealed that assessee had purchased a flat for Rs. 17.55 lakh: Said flat was fetching an income of Rs. 7.02 lakh per annum: AO estimated the value and made an addition of Rs. 65.32 lakh u/s. 69B: No incriminating material found: Addition not justified.

[CIT Vs. Dinesh Jain HUF ;25 taxmann.com 550 (Delhi)]

During a search at the residential and business premises of the assessee, certain material was seized which, inter alia, revealed investment in various properties by the assessee. One such property was a flat, which was purchased for Rs. 17.55 lakh. The Assessing Officer noticed that it was a commercial property which was fetching rent of Rs. 7.02 lakh per annum. He was of the view that a property which was fetching such a substantial rental income could not have been acquired for Rs. 17.55 lakh. He concluded that the fair market value of the property should be estimated in accordance with Rule 3 of Schedule III to the Wealthtax Act, 1957. The difference between value of the property calculated in accordance with the said rule and the amount shown in the sale document came to Rs. 65.32 lakh which was assessed as unexplained investment u/s. 69B of the Income-tax Act, 1961. The Tribunal deleted the addition.

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

“i) Section 69B in terms requires that the Assessing Officer has to first ‘find’ that the assessee has ‘expended’ an amount which he has not fully recorded in his books of account. It is only then that the burden shifts to the assessee to furnish a satisfactory explanation. Till the initial burden is discharged by the Assessing Officer, the section remains dormant.

ii) A ‘finding’ obviously should rest on evidence. In the instant case, it is common ground that no incriminating material was seized during the search which revealed any understatement of the purchase price. That is precisely the reason why the Assessing Officer had to resort to Rule 3 of Schedule III to the Wealth Tax Act.

iii) Section 69B does not permit an inference to be drawn from the circumstances surrounding the transaction that the purchaser of the property must have paid more than what was actually recorded in his books of account for the simple reason that, such an inference could be very subjective and could involve the dangerous consequence of a notional or fictional income being brought to tax contrary to the strict provisions of article 265 of the Constitution of India and Entry 82 in List I of the Seventh Schedule thereto which deals with ‘Taxes on income other than agricultural income’.

iv) Applying the logic and reasoning in K.P. Varghese v. ITO [1981] 131 ITR 597/7 Taxman 13 (SC) , for the purposes of section 69B, it is the burden of the Assessing Officer to first prove that there was understatement of the consideration (investment) in the books of account. Once that undervaluation is established as a matter of fact, the Assessing Officer, in the absence of any satisfactory explanation from the assessee as to the source of the undisclosed portion of the investment, can proceed to adopt some dependable or reliable yardstick with which to measure the extent of understatement of the investment. One such yardstick can be the fair market value of the property determined in accordance with the Wealth Tax Act.

v) Since the entire case has proceeded on the assumption that there was understatement of the investment, without a finding that the assessee invested more than what was recorded in the books of account, the decision of the Income-tax Authorities cannot be approved.

vi) Section 69B was wrongly invoked. The order of the Tribunal is upheld.”

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Unexplained expenditure: Section 69C: A. Ys. 2000-01 to 2003-04: Hospital: Search disclosed unaccounted collection of fees in the name of doctors and distribution thereof to doctors: Explanation that amount was collected and distributed to doctors: Doctors not examined: Amount not assessable in hands of hospital.

[CIT Vs. Lakshmi Hospital; 347 ITR 367 (Ker):]

The assessee is a hospital. In the course of search, the Department discovered unaccounted collection of fees in the name of doctors and distribution thereof to doctors in the relevant period. The assessee hospital contended that it had distributed the entire amount to the doctors in whose names the collections were made and no part of the collections was retained as its income. The Assessing Officer assessed the entire amount as unexplained expenditure falling u/s. 69C. The Tribunal deleted the addition.

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

“i) Cases falling u/s. 69C are of essentially expenditure accounted as such by the assessee. The entire amount was collected without bringing it into the regular accounts and the payments were also made by the assessee without accounting for them.

ii) This was not a case of failure of the assessee to explain the expenditure. In fact the assessee, on being confronted with the accounts seized from it, conceded that the entire amounts were collected by it for payment to doctors serving the hospital. The assessee, prima facie, discharged its burden or at least shifted the burden to the Revenue when it gave particulars of payments made to the doctors.

iii) The Department should have issued notice to the doctors for confirmation of the payments and if they confirmed receipts, made assessments on doctors and if they denied the receipts, proceeded against the assessee and direct it to prove assessment of the amount u/s. 69C. Since this exercise had not been done, the addition u/s. 69C was not justified. ”

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Refund: Delay in claiming refund: Power to condone delay: Section 119: A. Ys. 1995-96 to 1998-99: Refund due to charitable trust: Trust not under obligation to file return: Delay in filing return claiming refund due to bifurcation of trust: Delay had to be condoned.

[North Eastern Electric Power Corporation Employees Provident Fund Trust Vs. UOI; 348 ITR 584 (Gauhati):]

The petitioner was a trust recognised under the Income-tax Act. For the relevant period, the petitioner was not required to file return of income u/s. 139. However, in order to claim refund of TDS, the petitioner filed returns claiming refunds. Since the returns were filed beyond the time limit, they were treated as invalid returns and the Assessing Officer rejected the application for the refunds. The petitioner filed applications before the Chief Commissioner u/s. 119(2) of the Act requesting to condone the delay in filing the returns claiming refunds. The petitioner explained that the delay was caused due to bifurcation of the trust. The application was rejected by the Chief Commissioner.

The Gauhati High Court allowed the writ petition filed by the petitioner and held as under:

“i) The Revenue authorities did not dispute the entitlement of the petitioner for refund of the deducted amount. The Trust in this case was being deprived of a sum of Rs. 8,93,773/- for which it could not be blamed at all. It had no liability whatsoever to pay this amount to the Revenue. Yet, the Revenue had refused to refund the sum taking a hypertechnical view of the matter.

ii) The petitioner was entitled to condonation of delay in filing the claim for refund.”

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Recovery of tax: S/s. 156 and 220: A. Y. 1985-86: Service of demand notice u/s. 156 is condition precedent for recovery proceedings: Demand notice not received by assessee: Recovery proceedings not valid.

[Saraswati Moulding Works Vs. CIT; 347 ITR 161 (Guj):]

For the A. Y. 1985-86, the petitioner did not receive the assessment order and the demand notice u/s. 156. However, the Department served recovery notice. In response to the recovery notice, the petitioner had objected to the initiation of the recovery proceedings pointing out that it had not received the assessment order and the demand notice u/s. 156 of the Act. Thereafter, over the years, from time to time, recovery notices were issued to the petitioner and on each occasion, the petitioner had responded to the notice by requesting the Assessing Officer to serve the assessment order and the demand notice u/s. 156 of the Act on the petitioner. However, the assessment order and the demand notice u/s. 156 was not served on the petitioner.

In the circumstances, the petitioner filed a writ petition before the Gujarat High Court requesting to quash the recovery notices and the recovery proceedings. Gujarat High Court allowed the petition and held as under:

“I) In the absence of service of demand notice u/s. 156 of the Act on the petitioner, which was a basic requirement for invoking the provisions of section 220 of the Act, the petitioner could not have been treated to be an assessee in default. The subsequent proceedings u/ss. 220 to 226 of the Act were without jurisdiction.

ii) The impugned notice and the recovery proceedings are hereby quashed and set aside.”

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Recovery of tax: Adjustment of refund against demand: S/s. 220(6) and 245: A. Y. 2006-07: Appeal pending before Tribunal: Tribunal has power to stay recovery and not permit adjustment of refund.

[Maruti Suzuki India Ltd. Vs. Dy. CIT; 347 ITR 43 (Del):]

For the A. Ys. 2003-04 and 2004-05, the assessee was entitled to refund of Rs. 122.57 crore and Rs. 107.42 crore respectively. In the normal course, refund should have been paid by the authorities to the petitioner. However, the refund amount was not paid to the petitioner. The refund was adjusted against the demand for A. Y. 2006-07 in respect of which the assessee was in appeal before the Tribunal. The petitioner had made an application before the Assessing Officer u/s. 220(6) for stay of recovery till the disposal of the appeal by the Tribunal. The petitioner had also made a stay application before the Tribunal. The Tribunal held that the Assessing Officer should first dispose of the application u/s. 220(6) of the Act.

The petitioner therefore filed a writ petition before the Delhi High Court, requesting for the stay of the recovery and refund of the amounts. Delhi High Court allowed the petition and held as under:

“i) Section 220(6) which permits the Assessing Officer to treat the assessee as not in default is not applicable when an appeal is referred before the Tribunal, as it applies only when an assessee has filed an appeal u/s. 246 or 246A.

ii) As per Circular No. 1914 dated 2nd December, 1993, the Assessing Officer may reserve a right to adjust, if the circumstances so warrant. In a given case, the Assessing Officer may not reserve the right to refund. Further, reserving a right is different from exercise of right or justification for exercise of a discretionary right/power. Moreover, the circular is not binding on the Tribunal.

iii) The Tribunal has power to grant stay as an inherent power vested in the appellate authority as well as u/s. 254 and the rules. The Tribunal is competent to stay recovery of the demand and if an order for “stay of recovery” is passed, the Assessing Officer should not pass an order of adjustment u/s. 245 to recover the demand. In such cases, it is open to the Assessing Officer to ask for modification or clarification of the stay order to enable him to pass an order of adjustment u/s. 245 of the Act.

iv) Different parameters can be applied when a stay order is passed, against use of coercive methods for recovery of demand and when adjustment is stayed. Therefore, the Tribunal can stay adoption of coercive steps for recovery of demand but may permit adjustment u/s. 245. When and in what cases, adjustment u/s. 245 of the Act should be stayed would depend upon the facts and circumstances of the case.

v) The discretion should be exercised judiciously. The nature of addition resulting in the demand is a relevant consideration. Normally, if the same addition/ disallowance/issue has already been decided in four of the assessee by the appellate authority, the Revenue should not be permitted to adjust and recover the demand on the same ground. In exceptional cases, which include the parameters stated in section 241 of the Act, adjustment can be permitted/allowed by the Tribunal.

vi) The action of the Revenue in recovering the tax in respect of additions to the extent of Rs. 96 crore on issues which were already covered against them by the earlier orders of the Tribunal or the Commissioner (Appeals) was unjustified and contrary to law.

vii) Accordingly, directions are issued to the respondents to refund Rs. 30 crore, which will be approximately the tax due on Rs. 96 crore.”

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Reassessment: S/s. 54EC, 147 and 148: A. Y. 2006-07: Benefit of section 54EC granted taking into account investment before date of transfer: Reopening of assessment to deny benefit: change of opinion: Reopening not valid.

[Mrs. Pravin P. Bharucha Vs. Dy.CIT; 348 ITR 325 (Bom):]

For the A. Y. 2006-07, the assessee had claimed deduction u/s. 54EC of the Income-tax Act, 1961. On the request of the Assessing Officer, the assessee had filed the details of the investment u/s. 54EC. The Assessing Officer considered and allowed the deduction to the extent of Rs. 7.40 crore. Subsequently, the Assessing Officer issued notice u/s. 148 for withdrawing the deduction. Assessee’s objections were rejected.

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

“i) While granting the benefit, the Assessing Officer took a view that investment made out of earnest money/advance received as a part of the sale consideration before the date of the transfer of the assets would also be entitled to the benefit of section 54EC. This view was possible, in view of Circular No. 359 dated 10-05-1983, and the decision of the Tribunal.

ii) The reasons recorded did not state that the deduction u/s. 54EC was not considered in the assessment proceedings. In fact, from the reasons, it appeared that all facts were available on record and, according to the Revenue, the deduction was only erroneously granted. This was a clear case of review of an order.

iii) The application of law or interpretation of a statute leading to a particular conclusion, cannot lead to a conclusion that tax has escaped assessment, for this would then certainly amount to review of an order which is not permitted unless so specified in the statute.

iv) The order disposing of the petitioner’s objections also proceeded on the view that there had been non-application of mind during the original proceedings for assessment. This was unsustainable and a fresh application of mind by the Assessing Officer on the same set of facts amounted to a change of opinion and did not warrant reopening.

v) In view of the above, the notice u/s. 148 is without jurisdiction and we set aside the same.”

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Reassessment: Section 17 of W. T. Act, 1957: Notice in the name of person who did not exist i.e. a company which is wound up and amalgamated with another company: Notice and subsequent proceedings not valid.

[I. K. Agencies Pvt Ltd. Vs. CWT; 347 ITR 664 (Cal):]

A company AP was wound up by virtue of the order of the company court and was amalgamated with the assessee company w.e.f. 01-04-1995. On 20-01-1997, the Assessing Officer issued notice u/s. 17 of the Wealth-tax Act, 1957 on AP directing it to file its wealth tax return in respect of a period prior to 01-04-1995 i.e. prior to amalgamation. Pursuant to the notice, reassessment order was passed. The notice and the reassessment was upheld by the Commissioner (Appeals) and the Tribunal.

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

“i) Section 17 of the Wealth-tax Act, 1957, is similar to the provisions contained in section 148 of the Income-tax Act, 1961, and section 34 of the Indian Income-tax Act, 1922. The jurisdiction to reopen a proceeding depends upon issue of a valid notice under the provisions, which gives power to the Assessing Officer to reopen a proceeding. A notice to a person who is not in existence at the time of issuing such notice is not valid. The fact that the real assessee subsequently filed its return with the objection that such notice is invalid and cannot cure the defects which go to the root of the jurisdiction to reopen the proceedings.

ii) The authorities below totally overlooked the fact that initiation of the proceedings for reassessment was vitiated for not giving notice u/s. 17 of the Act to the assessee and the notice issued upon AP which was not in existence at that time, was insufficient to initiate proceedings against the assessee which had taken over the liability of AP prior to the issue of such notice.

iii) Reassessment proceedings were not valid and were liable to be quashed.”

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Export: Deduction u/s. 10A: Gain from export on account of fluctuation in rate of foreign exchange is eligible for exemption.

[CIT Vs. Pentasoft Technologies Ltd.; 347 ITR 578 (Mad):]

The assessee was an exporter and was eligible for deduction u/s. 10A. Due to diminution in rupee value, the assessee gained a higher sum in rupee value while earning the export income. The assessee claimed the deduction of the whole of the export profit u/s. 10A including the gains on account of fluctuation in rate of foreign exchange. The Assessing Officer disallowed the claim in respect of the gains on account of rate of foreign exchange. The Tribunal allowed the assessee’s claim.

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

“In order to allow a claim u/s. 10A, what is to be seen is whether such benefit earned by the assessee was derived by virtue of export made by the assessee. When fluctuation in foreign exchange rate was solely relatable to the export business of the assessee and the higher rupee value was earned by virtue of such exports carried out by the assessee, the benefit of section 10A should be allowed to the assessee.”

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Reassessment: S/s. 147 and 148: A. Y. 2005-06: Notice u/s. 148 issued by AO not having jurisdiction to assess: Notice and reassessment proceedings invalid: Disgraceful and deplorable conduct of ACIT and CIT in seaking to circumvent law condemned.

[Fiat India Automobiles Ltd. V/s. ACIT (Bom); W. P. No. 8657 of 2012 dated 16-10-2012:]

On shifting the registered office of the petitioner from Mumbai to Pune, the petitioner in June-July 2009 had applied for transfer of assessment records from Mumbai to Pune. After exchange of several letters, by his order dated 22-11-2011, the CIT-10 Mumbai transferred the powers to assess the petitioner from ACIT-10(1) Mumbai to DCIT, Circle-1(2) Pune. However, on 30-03-2012, ACIT-10(1) Mumbai issued notice u/s. 148 with a view to reopen the assessment for the A. Y. 2005-06.

The Bombay High Court allowed the writ petition filed by the petitioner and quashed the impugned notice u/s. 148 dated 30-03-2012 and held as under:

“i) In the affidavit-in-reply filed by the DCIT-10(1) Mumbai, it is stated that by a corrigendum order dated 27-03-2012, the CIT-10 Mumbai has temporarily withdrawn/cancelled the earlier transfer order dated 22-11-2011 for the sake of administrative convenience and therefore, the notice dated 30-03-2012 would be valid. It is the case of the petitioner that neither any notice to pass a corrigendum order was issued to the petitioner nor the alleged corrigendum order dated 27-03-2012 has been served upon the petitioner.

ii) The question therefore to be considered is, when the CIT-10 Mumbai has transferred the jurisdiction to assess/reassess the petitioner from ACIT-10(1) Mumbai to DCIT Circle-1(2) Pune u/s. 127 of the Act after hearing the petitioner on 22-11-2011, whether the CIT-10 Mumbai at the instance of ACIT-10(1) Mumbai is justified in issuing a corrigendum order on 27/03/2012 behind the back of the petitioner and whether the ACIT-10(1) Mumbai is justified in issuing the impugned notice u/s. 148 of the Act dated 30-03-2012 on the basis of the said corrigendum order dated 27-03-2012 which was passed without issuing a notice to the petitioner, without hearing the petitioner and which is uncommunicated to the petitioner.

iii) The conduct of the ACIT and CIT is highly deplorable. Once the jurisdiction to assess the assessee was transferred from Mumbai to Pune, it was totally improper on the part of ACIT Mumbai to request the CIT to pass a corrigendum order with a view to circumvent the jurisdictional issue. Making this request was in gross abuse of the process of law. If there was any time barring issue, the ACIT Mumbai ought to have asked his counterpart at Pune to whom the jurisdiction was transferred to take appropriate steps in the matter instead of taking steps to circumvent the jurisdictional issue.

iv) It does not befit the ACIT Mumbai to indulge in circumventing the provisions of law and his conduct has to be strongly condemned. Instead of bringing to book persons who circumvent the provisions of law, the CIT has himself indulged in circumventing the provisions of law which is totally disgraceful. The CIT ought not to have succumbed to the unjust demands of the ACIT and ought to have admonished the ACIT for making such an unjust request.

v) The CIT ought to have known that there is no provision under the Act which empowers the CIT to temporarily withdraw the order passed by him u/s. 127(2) for the sake of administrative convenience or otherwise. If the CIT was honestly of the opinion that the order passed u/s. 127(2) was required to be recalled for any valid reason, he ought to have issued notice to that effect to the assessee and passed an order after hearing it.

vi) Writ petition is allowed by quashing the impugned notice dated 30-03-2012. Though the CCIT agrees that the actions of CIT and ACIT are patently unjustified and not as per law, he has expressed his helplessness in the matter. It is expected that the CCIT shall take immediate remedial steps to ensure that no such incidents occur in the future. Department shall pay a cost of Rs. 10,000/- which may be recovered from CIT and ACIT.”

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Charitable Purpose – Application of income – Amounts transferred by the Mandi Samiti to the Mandi Parishad in accordance with the Adhiniyam constitutes application of income for charitable purposes.

[CIT v. Krishi Utpadan Mandi Samiti (2012) 348 ITR 566 (SC)]

Krishi Utpadan Mandi Samiti, a market committee incorporated and registered u/s. 12 of the Uttar Pradesh Krishi Utpadan Mandi Adhiniyam, 1964 (“the 1964 Adhiniyam” for short), carried out its activities in accordance with section 16 of the 1964 Adhiniyam, under which it is required to provided facilities for sale and purchase of specified agricultural produce in the market area. The members of the said market committee consisted of producers, brokers, agriculturists, traders, commission agents and arhatiyas. The source of income of the assessee was in the form of receipt collected as market fee from buyers and their agents, development cess on sale and purchase of agricultural products and licence fees from traders. U/s. 17(iv), the Mandi Samiti has to utilise the market committee fund the purpose of the 1964 Adhiniyam.

Under the 1964 Adhiniyam, broadly there are two distinct entities or bodies. One is Mandi Samiti (assessee) and the other is Mandi Parishad.

Section 26A of the 1964 Adhiniyam deals with establishment of the Mandi Parishad (Board). Under the 1964 Adhiniyam, the Board shall be a body corporate. Section 26A, inter alia, states that the Mandi Parishad (Board) shall have its own fund which shall be deemed to be a local fund and in which shall be credited all monies received by or on behalf of the Board, except monies required to be credited in the State Marketing Development Fund u/s. 26PP. U/s. 26PP, the State Marketing Development Fund has been established for the Mandi Parishad (Board) in which amounts received from the market committee u/s. 19(5) shall be credited. Section 19(5), inter alia, states that every market committee shall, out of its total receipts realised as development cess, shall pay to the Mandi Parishad (Board) contribution at a specified rate. The said payment from the Market Committee (Mandi Samiti) shall be credited to the State Marketing Development Fund u/s. 26PP. The State Marketing Development Fund shall be utilised by the Mandi Parishad (Board) for purposes indicated u/s. 26PP(2). Section 26PPP deals with establishment of Central Mandi Fund to which amounts specified in s/s. (1) shall be credited. Section 26PPP(2), inter alia, states that the Central Mandi Fund shall be utilised by the Mandi Parishad (Board) for rendering assistance to financially weak and underdeveloped market committees; that the funds would be used for construction, maintenance and repairs of link roads, market yards and other development works in the market area and such other purposes as may be directed by the State Government or the board.

The short question that arose before the Supreme Court was, whether transfer of amounts collected by Mandi Samiti to Mandi Parishad would constitute application of income for charitable purposes.

The Supreme Court noted that, both the Mandi Samiti and the Mandi Parishad were duly registered u/s. 12AA of the Income-tax Act, 1961 (“the 1961 Act”, for short). That, after the amendment of section 10(20) and section 10(29) by the Finance (No.2) 2 of 2002 with effect from 1st April, 2003, the words “local authority” had lost its restricted meaning and, therefore, the assessee (market committee) had to satisfy the conditions of section 12AA read with section 11(1)(a) of the 1961 Act, like any other body or person.

According to the learned senior counsel for the Department, in view of the said amendment, vide the Finance (No.2) Act of 2002, the assessee had to show that, during the relevant assessment year, income had been derived from property held under trust and that the said income stood applied to charitable purposes. According to the learned counsel, if one analysed the scheme of the 1964 Adhiniyam, it would become clear that the amounts transferred by the assessee to the Mandi Parishad could not constitute application of income for charitable purposes within the meaning of section 11(1)(a) of the 1961 Act in view of the fact that the assessee (Mandi Samiti) was only a conduit which collected Mandi shulk (fees) whereas utilisation of the said Mandi shulk was not by the assessee but is made by another entity, i.e., Mandi Parishad whose accounts were not verifiable and, therefore, according to the Department, such income would not get the benefit of exemption u/s. 11(1)(a) of the 1961 Act.

The Supreme Court held that u/s. 19(2) of the 1964 Adhiniyam, all expenditure incurred by the assessee in carrying out the purposes of the 1964 Adhiniyam (which includes advancing credit facilities to farmers and agriculturists as also construction of development works in the market area) had to be defrayed out of the market committee fund and the surplus, if any, had to be invested in such manner as may be prescribed. This was one circumstance in the 1964 Act to indicate application of income. Similarly, u/s. 19B(2) of the 1964 Adhiniyam, the assessee was statutorily obliged to apply the market development fund for the purposes of development of the market area. U/s. 19B(3), the assessee was statutorily obliged to utilise the amounts lying to the credit in the market development fund for extending facilities to the agriculturists, producers and payers of market fees. The market development fund was also to be statutorily utilised for development of market yards. Similarly, all contributions received by the market committee (Mandi Samiti) from the members u/s. 19(5) were to be statutorily paid by the market committee (assessee) to the Uttar Pradesh State Marketing Development Fund. These provisions indicated application of income of the assesee to the statutory funds set up under the 1964 Adhiniyam. According to the Supreme Court, keeping in mind the statutory scheme of the 1964 Adhiniyam, whose object falls u/s. 2(15) of the 1961 Act, there was no doubt that the assessee satisfied the conditions of section 11(1)(a) of the 1961 Act. The income derived by the assessee (which was an institution registered u/s. 12AA of the 1961 Act) from its property had been applied for charitable purposes, which includes advancement of an object of general public utility.

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Deduction of tax at sources – The Transaction of purchase of stamp papers at discount by the Stamp Vendors from the State Government is a transaction of sale and there is no obligation on the State Government to deduct tax at source u/s. 194 H on the amount of discount.

[CIT v Ahmedabad Stamp Vendors Association (2012) 348 ITR 378 (SC)]

The registered association of the stamp vendors of Ahmedabad approached the Gujarat High Court to quash the communication received from the Income Tax Department calling upon the State Government to deduct tax at source u/s. 194 H on commission or brokerage to the person carrying the business as “Stamp Vendors” and for a declaration that section 194H was not applicable to an assessee carrying on business as a stamp vendor.

The principal controversy before the High Court was whether the stamp vendors were agents of the State Government who were being paid commission or brokerage or whether the sale of stamp papers by the Government to the licensed vendors was on principal to principal basis involving the contract of sale.

The High Court after considering the Gujarat Stamps and Sales Rules, 1987, Gujarat Sales Tax Act, 1969 and the authorities cited held that the stamp vendors were required to purchase the stamp papers on payment of price less the discount on the principal to principal basis and there was no contract of agency at any point of time and that the discount made available to the licensed stamp vendors under the provisions of the Gujarat Stamps and Supply and Sales Rules, 1987, does not fall within the expression ‘commission’ or ‘brokerage’ u/s. 194H of the Act.

On appeal by the Department, the Supreme Court held that 0.50 % to 4 % discount given to the stamp vendors was for purchasing the stamps in bulk quantity and the said discount was in the nature of the cash discount. The Supreme Court concurred with the judgement of the High Court that the impugned transaction was a sale and consequently, section 194H had no application.

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(2012) 26 taxmann.com 265 (Mumbai Trib) Shrikant Real Estates (P.) Ltd. v ITO Assessment Year: 2008-09. Dated: 19-10-2012

Section 143(1), 154 – Keeping in mind the present system of e-filing, application u/s. 154 is maintainable in a case where assessee has not shown Short Term Capital Gain u/s. 111A in Schedule CG of e-return.

Facts:
For assessment year 2008-09, the assessee e-filed return which was revised by filing another e-return on 05.01.2009.

During the said year the assessee had short term capital gain of Rs. 2,65,853 which was chargeable at special rates u/s. 111A. In the returns, the assessee had at Item No. 3(a)(i) inadvertently/due to clerical error mentioned the amount as Nil but at the same time in item no. 3(a)(ii) and 3(a)(iii) short term capital gain of Rs. 2,65,853 was shown. Also in Schedule CG–Capital Gains on page 19 of e-return shown short term capital gain at item no. 6 but due to inadvertence/clerical error at item No. 7 – Short Term Capital Gain u/s. 111A included in 6 above the amount was stated to be Nil.

In the intimation received by the assessee, short term capital gain was charged to tax at normal rates instead of rate mentioned u/s. 111A. The assessee’s application u/s. 154 to rectify this was rejected on the ground that the assessee ought to have rectified the mistake in the returns by filing a revised return and this mistake is not rectifiable u/s. 154 of the Act.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted that in the present system of e–filing of return which is totally dependent upon usage of software, it is possible that some clerical errors may occur at the time of entering the data in the electronic form. The return is prepared electronically which is converted into an XML file either through the free downloaded software provided by CBDT or by the software available in the market. In either of the case, there is every possibility of entering incorrect data without the expert knowledge of preparing an XML file. The Tribunal also noted that the assessee had under Schedule SI – income chargeable to income-tax at special rate IB which is at internal page 24 of the return shown short term capital gains at Rs 2,65,853 and tax thereon @ 10% to be Rs 26,585. The Tribunal directed the AO to rectify intimation u/s. 143(1) and to charge tax on short term capital gains @ 10%.

The appeal filed by the assessee was allowed.

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(2012) 27 taxmann.com 104 (Chennai Trib) ACIT v C. Ramabrahmam Assessment Year: 2007-08. Dated: 31-10-2012

Section 24, 48 – Interest on loan taken for acquisition of property can be regarded as cost of acquisition even though the same has been claimed as deduction u/s. 24 in earlier years.

Facts:
During the previous year relevant to the assessment year under consideration, the assessee returned capital gain arising on transfer of house property. While computing such capital gain, the assessee had regarded interest on loan taken in 2003 for purchasing the property as forming part of cost of acquisition of the property. In the course of assessment proceedings, the Assessing Officer (AO) noticed that the amount of interest which has been regarded as cost of acquisition had already been claimed as deduction u/s. 24(b). He was of the view that since the amount of interest was already claimed u/s. 24(b) the same could not again be allowed u/s. 48. He added the amount of interest to the income of the assessee from short term capital gains.

Aggrieved, the assessee preferred an appeal to the CIT(A) who allowed the assessee’s appeal and held that the assessee was entitled to include interest amount for computation u/s. 48 despite the fact that the same had been claimed u/s. 24(b) while computing income from house property.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:
The Tribunal noted that admittedly the loan was taken to acquire house property and the deduction allowed u/s. 24(b) was in accordance with the statutory provisions. Upon going through the provisions of section 48 the Tribunal held that the deduction u/s. 24(b) and computation of capital gains u/s. 48 are altogether covered by different heads of income i.e. `income from house property’ and `capital gains’. A perusal of both the provisions makes it unambiguous that none of them excludes operation of the other. The Tribunal held that it did not have the slightest doubt that interest in question was indeed an expenditure in acquiring the asset. Since both the provisions are different, the assessee was held to be entitled to include interest amount at the time of computing capital gains u/s. 48 of the Act. CIT(A) was right in accepting the contention of the assessee and deleting the addition made by the AO.

The appeal filed by the revenue was dismissed.

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Controversy on taxability of cross-border software payments

Introduction:

Section 4 and section 5 r.w.s. 9(1)(vi) of the Incometax Act, 1961 (the Act) provide for taxability of income from royalty in India. Section 9(1)(vi) of the Act by a deeming fiction provides for the taxation of income from royalty in India. Explanation 2 to section 9(1)(vi) of the Act defines the word ‘royalty’, which is wide enough to cover both industrial royalties as well as copyright royalties, both being forms of intellectual property. Computer software is regarded as an ‘industrial royalty’ and/or a ‘copyright royalty’. Industrial properties include patents, inventions, process, trademarks, industrial designs, geographic indicators of source, etc. and are generally granted for an article or for the process of making such article, on the other hand, copyright property includes literary and artistic works, plays, films, musical works, knowledge, experience, skill, etc. and are generally granted for ideas, principles, skills, etc.

Just as tangible goods are sold, leased or rented in order to earn monetary gain, on similar lines, the Intellectual Property laws enable authors of the intellectual properties to exploit their work for monetary gain. The modes of exploitation of intellectual property for monetary gains are different for each type of intellectual property covered in various sub-clauses of the definition of ‘royalty’ under Explanation 2 to section 9(1)(vi) and subjected to tax as per the scheme of the Act.

The controversy on taxability of cross-border software payments basically relates to characterisation of the income in the hands of the non-resident payee. The controversy, sought to be discussed here, revolves around the issue “whether the payment received by non-resident for giving licence of the computer software, popularly known as ‘sale of software’, is chargeable to tax as ‘royalty’, or it is a ‘sale’. The Revenue holds such sales to be royalty on the ground that during the course of sale of computer software, computer program embedded in it is also licensed and/or parted with the end-user of the software, and as against the claim of the taxpayers who treat the transaction as one of transfer of ‘copyrighted article’ and not transfer of the right in the copyright or licence of the software. Typically the tax authorities seek to tax these payments in the hands of non-residents as royalty and subject the same to withholding taxes. The non-resident payees seek to label such receipts as business income not chargeable to tax, in the absence of a Permanent Establishment in India. Taxability of software-related transaction depends upon the nature and extent of rights granted or transferred under the particular arrangement regarding use and exploitation of the program.

Determining the taxability of any cross-border software transaction involves an understanding and analysis of the following aspects:

I. Definition and classification of Computer Software;
II. Definitions of Royalty under the Act and Double Tax Avoidance Agreement (DTAA);
III. Relevant provisions of the Copyright Act, 1957;
IV. OECD Commentary on Software Payments; and
V. Key judicial and advance rulings.

I. Definition and classification of Computer Software

Definition: Income-tax Act: Explanation 3 to Section 9(i)(vi) of the Act defines ‘Computer Software’ to mean any computer program recorded on any disc, tape, perforated media or other information storage device and includes any such program or any customised electronic data.

Copyright Act: Under the Indian Copyright law (Copyright Act, 1957), computer program and computer databases are considered literary works.

Section 2(ffc) defines ‘Computer Programme’ as a set of instructions expressed in words, codes, schemes or any other form, including a machine-readable medium, capable of causing a computer to perform a particular task or achieve a particular result.

Commentary on Article 12 of the OECD Model Convention describes software as a program, or series of programs, containing instructions for a computer required either for the operational processes of the computer itself (operational software) or for the accomplishment of other tasks (application software).

The New Oxford Dictionary for the Business World defines ‘software’ as programs used with a computer (together with their documentation), including program listings, program libraries, and user and programming manuals.

Typical Business Model relating to computer software:

Single End-user model — Foreign Company supplies a single copy of the software to the end-user.

Distributor Model — Foreign Company either supplies soft copies to an independent distributor in India for onward distribution to Indian customers either directly or through distribution channels or supplies a single copy of the software to a distributor in India who is given the licence to make copies and distribute soft copies to the customers.

Multiple-user licence model — Foreign Company supplies a single disk containing the software program to an Indian Company with a right to make copies of the software and distribute to in-house end users.

Customised model — Foreign Company customises the software as per Indian buyer’s requirements/ specifications — Enterprise Resource Planning software.

Software embedded in hardware — Foreign Company supplies integrated equipment (software bundled with hardware).

Cost contribution model — Foreign Company incurs expenditure for installation and maintenance of software system for the benefit of the group companies. It provides access to such Indian group company to use the system and recharges the cost on the basis of use of the system.

Electronic model — Payment to Foreign Company for purchase of software through electronic media.

Payment to Foreign Company for provision of services for development or modification of the computer program (incl. for upgradation, training, installation, maintenance, etc.).

Payment to Foreign Company for know-how related to computer programming techniques.

Definition of Royalty

Under the Act:Explanation 2 to Section 9(i)(vi) of the Act defines the term ‘Royalty’ to mean consideration for:(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trademark or similar property;

(ii) …………….
(iii) …………….
(iv) …………….
(v) …………….
(vi) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films; or

(vii) the rendering of any services in connection with the activities referred to above in subclauses (i) to (iv), (iva) and (v).

Under the DTAA:
Most DTAAs define the term ‘royalty’ to mean:

(i) payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films or work on films, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience; and

(ii) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise of a Contracting State from the operation of ships or aircraft in international traffic.

III. Relevant provisions of the Copyright Act, 1957

Section 2(o): Literary Work

includes computer programs, tables and compilations including computer databases.

Section 14: Meaning of Copyright:

Copyright means the exclusive right, subject to the provisions of this Act, to do or authorise the doing of any of the following acts in respect of a work or any substantial part thereof, namely;

(i) in the case of a literary, dramatic or musical work, not being a computer program —

(a)    to reproduce the work in any material form including the storing of it in any medium by electronic means;
(b)    to issue copies of the work to the public and not being copies already in circulation;
(c)    to perform the work in public, or communicate it to the public
(d)    to make any cinematograph film or sound recoding in respect of the work
(e)    to make any translation of the work
(f)    to make any adaptation of the work
(g)    to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in sub-clauses

(i) to (vi).

(ii) in the case of computer program —

(a)    to do any of the acts specified in clause (a) above;
(b)    to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer program
(c)    No copyright except as provided in this Act, i.e., Copyright does not extend to any right beyond the scope of section 14.

Section 52: Certain acts not to be infringement of copyright.

(1) The following act shall not constitute an infringement of copyright, namely:

(a) …………

(aa) The making of copies or adaptation of a computer program by a lawful possessor of a copy of such computer program, from such copy —

a) In order to utilise the computer program for the purpose for which it was supplied; or
b) To make back-up copies purely as a tem-porary protection against loss, destruction or damage in order only to utilise the computer program for the purpose for which it was supplied.

IV. OECD on Software Payments

The 1992 OECD Model Convention (MC):

(1)    Following a survey in the OECD member states, the question of classification of computer software was first considered in 1992 and accordingly revision made in the Commentary to the OECD Model Convention on Article 12.
(2)    Software was generally defined as a program, or a series of program, containing instructions for a computer either for the computer itself or accomplishing other tasks. Modes of media transfer were also discussed.
(3)    Acknowledged that OECD member countries typically protect software rights under copyright laws.
(4)    Different ways of transfer of software rights e.g., Alienation of entire rights, alienation of partial rights (sale of a product subject to restrictions on the use).

The taxability was analysed under 3 situations:

First situation: Payments made where less than full rights in the software are transferred:

In a partial transfer of rights the consideration is likely to represent a royalty only in very limited circumstances.

One such case is where the transferor is the author of the software and alienates part of his right in favour of a third party to enable the latter to develop or exploit the software itself commercially — for example by development and distribution of it.

In other cases, acquisition of the software will generally be for personal or business use of the purchaser and will be business income or independent personal services. The fact that software is protected by copyright or there are end use restrictions is of no relevance.

Second situation: Payments made for alienation of Complete Rights attached to the software:

Payments made for transfer of a full ownership cannot result in royalty.

Difficulties can arise where there are extensive transfer of rights, but partial alienation of rights involving:

exclusive right of use during a specific period
or in a limited geographical area.
additional consideration related to usage.
consideration in the form of substantial lump-sum payment.

Subject to facts, generally such payments are likely to be commercial income or capital gains rather than royalties.

Third situation: Software payments under mixed contracts:

Examples include sale of computer hardware with built-in software with concessions of the right to use software with provision for services.

In such a scenario, it was felt that the consideration be split on the basis of information contained in the contract or by a reasonable apportionment with the appropriate tax treatment being applicable to each part.

Thus for the first time these three situations were envisaged by the OECD in its 1992 MC.

2000 OECD MC brought in further refinements to the earlier positions.

It acknowledged that software can be transferred as an integral part of computer hardware or in independent form available for use with various hardware. For the first time, the 2000 MC suggested a distinction between a copyright in the program and software which incorporates a copy of the copyrighted program. The transferee’s rights will in most cases consist of partial rights or complete rights in the underlying copyright or they may be rights partial or complete in a copy of the program. — It does not matter, if such copy is provided in a material medium, or electronically. Payments made for acquisition of partial rights in the copyright will represent ‘royalty’ only if consideration is for granting of rights to use the program that would, without such licence, constitute an infringement of copyright.

The 2000 MC also throws light on rights to make multiple copies for operation within its own business and these are commonly referred to as ‘site licences’, ‘enterprise licences’, or ‘network licences’. If these are for the purposes of enabling the operation of the program on the licensee’s computers/network and reproduction for any other purpose is not permitted, payments for such arrangements would not be reckoned as royalty, but may be business profits.

2008 MC to the OECD Model expanded the scope of software payments by including transactions concerning digital products such as images, sounds or text. The downloading of images, sounds or text for the customers own use or enjoyment is not royalty as the payment is essentially for acquisition of data transmitted digitally. However, if the essential consideration for the payment for a digital product is the right to use that digital product, such as to acquire other types of contractual rights, data or services, then the same would be characterised as royalty.

Example a book publisher, who would download a picture and also acquire the right to reproduce that picture on the cover of a book that it is producing.

India’s position on OECD: India reserves its position on the interpretations provided in the OECD MC and is of the view that some of the payments referred therein may constitute royalties.

Issues in the controversy:
(1) Whether payment for purchase of computer software is payment for ‘goods’ or payment for ‘royalty’?

(2) Whether payment for computer software can be said to be payment for ‘use of process’ as referred to in clauses (i), (ii) and (iii) of the royalty definition in the Act?

(3) Whether payment for computer software is for ‘right to use the copyright in a program’ or ‘right to use the program only’? [Copyright v. Copyrighted Article]

(4) Whether mere grant of non-exclusive licence would fall within the ambit of ‘royalty’ definition under the Act? [Ref. clause (v) of the royalty definition in the Act which also includes the phrase ‘granting of a licences’]

(5) Whether payment for computer software can be said to ‘impart information concerning technical, industrial, commercial or scientific knowledge’ and hence falling under clause (iv) of the royalty definition under the Act?

(6) Section 115A prescribes the rate of tax applicable to a foreign company on income by way of ‘royalty’ or ‘fees to technical services’. Whether as per section 115A(1A) of the Act, it is not necessary that copyright therein should be specifically transferred as consideration in respect of any computer software is stated to be taxable u/s.115A?

V. Key judicial and advance rulings

CIT v. Samsung Electronics Co. Ltd., 64 DTR (Kar.) 178

Facts:

The assessee was engaged in the development and export of computer program. The assessee imported ‘shrinkwrapped’/‘off-the-shelf’ software from suppliers in foreign countries for use in its business and made payment for the same without deducting tax at source u/s.195.

Ruling of the High Court:

U/s.9(1)(vi) of the Act and Article 12 of the DTAA, “payments of any kind in consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work” is deemed to be ‘royalty’.

It is well settled that in the absence of any definition of ‘copyright’ in the Act or DTAA with the respective countries, reference is to be made to the respective law regarding definition of Copyright, namely, the Copyright Act, 1957, in India, wherein it is clearly stated that ‘literary work’ includes computer programs, tables and compilations including computer (databases).

On reading the contents of the respective agreement entered with the non-resident, it is clear that under the agreement, what is transferred is a right to use the copyright for internal business by making copies and back-up copies of the program.

The amount paid to the supplier for supply of the ‘shrinkwrapped’ software is not the price of the CD alone nor software alone nor the price of licence granted. It is a combination of all. In substance unless a licence was granted permitting the end-user to copy and download the software, the CD would not be helpful to the end-user.

There is a difference between a purchase of a book or a music CD, because while these can be used once they are purchased, software stored in a dumb CD requires a licence to enable the user to download it upon his hard disk, in the absence of which there would be an infringement of the owner’s copyright. Therefore, there is no similarity between the transaction of a computer program and books.

The decision of the Supreme Court in case of TCS v. State of AP, (271 ITR 404) distinguished as being in the context of sales tax.

Thus, held that the payments made in respect of computer program would constitute ‘royalty’ under the applicable DTAA and would also fall within the ambit of ‘royalty’ under the broader definition in the Act. Thus, the assessee would be required to deduct tax on the payment made in respect of computer programs.

Further, the Karnataka High Court in case of CIT v. M/s. Wipro Ltd., (ITA No. 2804 of 2005) has also held that payment for subscription/access to database is payment for licence to use the copyright hence taxable as ‘royalty’.

Director of Income-tax v. Ericsson Radio System AB, (ITA No. 504 of 2007) (Delhi High Court)

Facts:

The assessee, a Swedish company, entered into con-tracts with ten cellular operators for the supply of hardware equipment and software. The installation and testing were done in India by the assessee’s group entities.

The contracts were signed in India. The supply of the equipment was on CIF basis and the assessee took responsibility thereof till the goods reached India. The assessee claimed that the income arising from the said activity was not chargeable to tax in India.

The Assessing Officer and the Commissioner of Income-tax (Appeals) held that the assessee had a ‘business connection’ in India u/s.9(1)(i) and a ‘permanent establishment’ under Article 5 of the DTAA. It was also held that the income from supply of software was assessable as ‘royalty’ u/s.9(1)(vi) and Article 13. On appeal, the matter was referred to Special Bench of the Tribunal. The Tribunal held that as the equipment had been transferred by the assessee offshore, the profits therefrom were not chargeable to tax. It also held that the profits from the supply of software were not assessable to tax as ‘royalty’ either under the Act or DTAA with Sweden.

Aggrieved by the common order of the Special Bench in case of Motorola Inc. 95 ITD 269 (Del.) (SB), which also covered the case of Ericsson, the Tax Authority filed an appeal before the High Court.

Ruling of the High Court:

The profits from the supply of equipment were not chargeable to tax in India because the property and risk in goods passed to the buyer outside India. The assessee had not performed installation service in India.

The argument that the software component of the supply should be assessed as ‘royalty’ is not acceptable because the software was an integral part of the GSM mobile telephone system and was used by the cellular operator for providing cellular services to its customers.

Software was embedded in the equipment and could not be independently used. It merely facilitated the functioning of the equipment and was an integral part thereof. The Tax Authority accepts that it could not be used independently. The fact that in the supply contract, the lump -sum price was bifurcated is not material. The same was only because differential customs duty was payable.

To qualify as royalty, it is necessary to establish that there is transfer of all or any right (including the granting of any licence) in respect of copy right of a literary, artistic or scientific work. Section 2(o) of the Copyright Act makes it clear that a computer program is to be regarded as a ‘literary work’. Thus, in order to treat the consideration paid by the cellular operator as royalty, it is to be established that the cellular operator, by making such payment, obtains all or any of the copyright rights of such literary work. In the present case, this has not been established. It is not even the case of the Revenue that any right contem-plated u/s.14 of the Copyright Act, 1957 stood vested in this cellular operator as a consequence of Article 20 of the supply contract.

A distinction has to be made between the acquisition of a ‘copyright right’ and a ‘copyrighted article’. The submissions made by the assessee on the basis of the OECD commentary are correct.

Even assuming the payment made by the cellular operator is regarded as a payment by way of royalty as defined in Explanation 2 below section 9(1)(vi), nevertheless, it can never be regarded as royalty within the meaning of the said term in Article 13, para 3 of the DTAA. This is so because the definition in the DTAA is narrower than the definition in the Act. Article 13(3) brings within the ambit of the definition of royalty a payment made for the use of or the right to use a copyright of a literary work. Therefore, what are contemplated are a payment that is dependent upon user of the copyright and not a lump-sum payment as is the position in the present case.

The payment received by the assessee was towards the title of the equipment of which software was an inseparable part incapable of independent use and it was a contract for supply of goods. Therefore, no part of the payment could be classified as payment towards royalty.

Solid Works Corporation, ITA No. 3219/Mum./2010 (Mum. Tribunal), dated 8-2-2012

Recently the Mumbai ITAT on the issue of characterisation of shrinkwrapped computer software in the case of Solid Works Corporation (Taxpayer) has held that the consideration received by the taxpayer for the shrinkwrapped software is not ‘royalty’ under the provisions of the India-USA DTAA, but business receipts.

While arriving at its decision, the ITAT relied on the favourable view taken by the Delhi High Court in the case of Ericsson, after considering the decision of the Karnataka High Court in the case of Samsung (supra).

It may be noted that the ITAT has also accepted the argument of the taxpayer that when two views are available, the one favourable to the taxpayer should be followed. This principle should apply even to a non-resident in view of the non-discrimination article in the DTAA.

This ruling should be helpful, especially to taxpayers coming within the jurisdiction of the Mumbai ITAT, and is likely to have persuasive value in case of other neutral jurisdictions (i.e., other than the jurisdiction of the Karnataka High Court), in defending the tax position that is taken based on whether a transaction is a ‘copyright right’ or a ‘copyrighted article’.

Further, the Mumbai Tribunal in the following cases had ruled the issue in favour of the taxpayer by following the Special Bench decision in case of Motorola Inc.:

Kansai Nerolac Paints Ltd. v. Addl. DIT, 134 TTJ 342 (Mum.)

DDIT v. M/s. Reliance Industries Ltd., 43 SOT 506 (Mum.)

Addl. DIT v. Tata Communications Limited, 2010 TII 157 ITAT-Mum.

Controversy before the AAR:

The Authority for Advance Rulings (‘AAR’) recently in its ruling in the case of Citrix Systems Asia Pacific Pty. Limited (AAR No. 882 of 2009) and Millennium IT Software Ltd., 338 ITR 391 had an occasion to deal with the aforesaid issue under consideration, wherein the AAR while deciding against the taxpayer’s contention, held that the income from the transaction be regarded as a royalty, liable to tax in India. In deciding the issue in this case the AAR gave findings that were contrary to its own findings on the subject given in the earlier decisions in the cases of Dassault Systems K. K., 322 ITR 125 and FactSet Research Systems Inc., 317 ITR 169.

Citrix Systems Asia Pacific Pty. Limited (AAR):

In this case, the AAR held that the payment received from Indian distributor under software distribution agreement is taxable as royalty u/s.9(1)(vi) of the Act as well as Article 12 of the India-Australia DTAA. It also observed that sale/licence to use software entails transfer of rights in copyrights embedded in software. The AAR took a contrary view to its earlier ruling in the case of Dassault Systems and refused to rely on the Delhi HC ruling in the case of Ericsson (supra), thereby following the ruling in the case of Millennium IT Software and the Karnataka HC in the case of Samsung (supra).

It is interesting to note that the Chairman of the AAR has mentioned in the ruling of Citrix that the differing views on the issue can get resolved and the matter can be set at rest only by a decision of the Supreme Court, laying down the law finally, to be followed by all the Courts and Tribunals including the AAR. Only an authoritative pronouncement by the Apex Court can settle this controversy.

Millennium IT Software’s case:

In this ruling, the AAR held that the licence fees paid for use of ‘Licenced Program’ is taxable as ‘royalty’ under clause (v) of Explanation 2 to section 9(1)(vi) of the Act and Article 12 of the India-Sri Lanka DTAA. Thus the provisions of withholding tax u/s.195 are applicable to the applicant. The AAR’s ruling was based on the ruling of the Delhi ITAT in the case of Gracemac Corporation v. DIT, (42 SOT 550).

The said Delhi ITAT ruling has been distinguished by the Mumbai ITAT in the case of TII Team Telecom Inter-national Pvt. Ltd., 60 DTR 177. Also, the Mumbai ITAT has distinguished the AAR ruling of Millennium in the case of Novel Inc. (ITA No. 4368/Mum./2010) where income of non-resident from re-selling of software via Indian distributor was held as not taxable.

Conclusion:

The issue under consideration is otherwise a multi-faceted issue and has several dimensions which are sought to be addressed through a few questions and answers thereon. An analysis of the above-discussed important decisions rendered in the context of software/ use of technology-related payments give rise to the following open-ended questions before the taxpayers:

What is meant by the expression ‘transfer of all or any rights (including granting of licence) and which rights are sought to be covered?

Whether the rights referred in section 14 of the Copyrights Act, 1957 are transferred in sale of computer software to end-users?

Whether ‘computer program’ is copyright and/or industrial intellectual property?

Whether the payment made in relation to shrink-wrapped/off-the-shelf software would constitute payment for a copyright, would need to be determined as per section 14 of the Copyright Act, 1957?

Where there is any distinction between a copyright v. copyrighted article in light of the decision of the Karnataka High Court in the case of Samsung Electronics?

Whether in case of bundled contract i.e., software supplied along with hardware, any bifurcation can be made between the payments made for software and hardware?

Whether every payment made by the taxpayer for use of computer program would constitute ‘royalty’ under the Act and relevant DTAA?

Is the position under the DTAA stronger than un-der the Act as the definition of royalty under the DTAA is restrictive than under the Act?

What would be the position, where the DTAA between two Contracting States specifically cover the payments for computer software program within the ambit of taxation as royalty, vis-à-vis the DTAA where such inclusion is not there.

Key takeaways:

The ruling of the Karnataka High Court in the case of Samsung would have significant tax implications on the industries operating under jurisdiction of the Karnataka High Court dealing in computer software/ other technology. The Delhi High Court in the case of Ericsson Radio System A.B., New Delhi having upheld the decision of the Special Bench on this issue, could help the taxpayers to reinforce its position on this contentious issue before various Tribunals (except Bangalore Tribunal). Although, the AAR rulings in the case of Dassault, Geo quest, Citrix’s and Millennium are applicable only to the applicant and Tax Department, they have persuasive value.

Analysis of Finance Bill, 2012 — Proposals:

Controversy revolving around the tax-ability of software payments, is sought to be resolved by amendment to section 9(1)(vi) of the Act. The Finance Bill, 2012 has proposed to insert Explanation 4 and Explanation 5 to the section 9(1)(vi) with retrospective effect from 1st June 1976. The definition of the royalty in Explanation 2 is sought to be expanded by these two explanations.

Explanation 4 clarifies that the transfer of all or any rights in respect of any right, property or information includes transfer of all or any right for use or right to use a computer software (including granting of a licence), irrespective of the medium through which such right is transferred.

Implications of Explanation 4:

By insertion of proposed Explanation 4 to section 9(1) (vi) the controversy surrounding taxability of software payment by characterising it as royalty is sought to be put at rest. The main issue would be whether by inserting Explaination and expanding the scope of the definition ‘royality’ by way of clarificatory retro-spective amendment, can a payment for software be brought to tax?

The dispute was whether by making a payment for software, the licensee gets rights in the ‘copyright’ of the software. It appears that it is felt by the law-makers that by specifically inserting payment for software itself in the definition of royalty, this purpose will be achieved. The moot question however is, whether it can be done retrospectively from 1 June 1976?

Further, Explanation 5 clarifies that royalty includes consideration in respect of any right, property or information whether or not the payer has the possession or control of it, the payer is using it directly or such right, etc. are located outside India.

Implications of Explanation 5:

Explanation 5 seeks to clarify that once a right, property or information is deemed to be covered under Explanation 2 read with Explanation 4 to the section 9(1)(vi), the interpretation would continue to remain so, irrespective of possession or control of the right, property or information, direct or indirect use of the right, property or information or location of the right, property or information.

While it remains to be seen how Explanation 5 will be interpreted by the Courts. It would not be correct to say that on fulfilment of the situations laid down in Explanation 5, the taxability of sale of software is, per se, attracted.

Existence of beneficial treaty provisions:

As mentioned above, the payment for the sale or licence of software, would now get covered u/s. 9(1) (vi), if provisions of the Act are to be applied. However, if the provisions of the treaty are beneficial than the provisions of section 9(1)(vi), still it will be possible to contend that payment for software as per the provisions of the treaty is not liable to tax in India. Further, out of several treaties signed by India, only in 4 to 5 treaties, namely, Morocco, Rus-sia, Turkmenistan, Malaysia and Tobago specifically payment for software is covered as part of royalty. Therefore, it will still be a good case to argue that in case of, off-the-shelf or standardised software are not chargeable to tax in India except where as per treaty it is specifically covered.

It is, therefore, important to note here that the taxpayers who are entitled to claim benefit of tax treaty will still be able to take shelter under the beneficial treaty provisions as the scope of provisions (generally Article 12) under the treaty is restricted than under the Act.

Way forward:

It is learnt that the taxpayer has filed an SLP against the Karnataka High Court ruling in the case of Samsung Electronics Company Ltd. in December 2011 which is yet to be admitted. The SC has reacted that adjudication on this issue is going to be the next big thing after Vodafone judgment.

The proposed amendment, as mentioned above, may resolve the controversy in respect of future transactions, however, whether the amendment will apply retrospectively or not will be a matter of debate and litigation. So in cases where applicable the treaty does not specifically cover the software, the non-taxability could be claimed.

Hence, till the time, the issue gets settled at the highest level, litigation over taxability of software payments is likely to continue. So let’s WAIT & WATCH.

Year of	Decision in the case of	Authority	Jurisdiction	Favourable	Against
judgment

2004	Tata Consultancy Services	Supreme	—	3
		Court

2004	Wipro Ltd.	ITAT	Bangalore	3

2005	Motorola Inc.	Special	Delhi	3
		Bench ITAT

2005	Lucent Technologies Hindustan Ltd.	ITAT	Bangalore	3

2005	Samsung Electronics Company Ltd.	ITAT	Bangalore		3

2005	Sonata Software Ltd.	ITAT	Bangalore	3

2006	Hewlett-Packard (India) (P) Ltd.	ITAT	Bangalore	3

2006	Sonata Information Technology Ltd.	ITAT	Bangalore	3

2006	IMT Labs (India) Pvt. Ltd.	AAR	—		3

2006	Metapath Software International Ltd.	ITAT	Delhi	3

2008	Airports Authority of India	AAR	—		3

2009	FactSet Research Systems Inc.	AAR	—	3

2009	Samsung Electronics	High Court	Karnataka		3

2010	Lotus Development (Asia Pacific) Ltd. Corp.	ITAT	Delhi	3

2010	Microsoft Corporation and
	Gracemac Corporation	ITAT	Delhi		3

2010	Reliance Industries Ltd.	ITAT	Mumbai	3



2010	M/s. Tata Communications Ltd.	ITAT	Mumbai	3

2010	M/s. Daimler Chrysler AG	ITAT	Mumbai	3

2010	Dassault Systems K.K.	AAR	—	3

Year of	Decision in the case of	Authority	Jurisdiction	Favourable	Against
judgment

2010	GeoQuest Systems BV	AAR	—	3

2010	Velankani Mauritius Ltd.	ITAT	Bangalore	3

2010	Kansai Nerolac Paints Ltd.	ITAT	Mumbai	3

2010	Bharati AXA General Insurance Co. Ltd.	AAR		3

2011	Asia Satellite Co. Ltd.	High Court	Delhi	3

2011	Dynamic Vertical Software India Pvt. Ltd.	High Court	Delhi	3

2011	Standard Chartered Bank Ltd.	ITAT	Mumbai	3

2011	ING Vysya Bank Ltd.	ITAT	Bangalore		3

2011	TII Telecom International Pvt. Ltd.	ITAT	Mumbai	3

2011	M/s. Abaqus Engineering Pvt. Ltd.	ITAT	Chennai	3

2011	Millennium IT Software	AAR	—		3

2011	Samsung Engineering Company Limited	High Court	Karnataka		3

2011	Novel Inc. (Mum.)	ITAT	Mumbai	3

2011	Lucent Technologies	High Court	Karnataka		3

2011	Ericsson Radio System AB	High Court	Delhi	3

2012	Solid Works Corporation	ITAT	Mumbai	3

2012	Citrix Systems Asia Pacific Pty. Limited	AAR			3

2012	Acclerys K. K.	AAR	—		3

2012	People Interactive (I) P. Ltd.	ITAT	Mumbai	3

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DAY 4

After breakfast participants discussed the paper written by Himanshu Kishanadwala on Case studies in Accounting and Auditing. The Group Discussion was followed by a precise presentation on the subject. He dealt with some burning issues affecting the CA’s in practice as well as industry. He analyzed all issues in great detail. His command over the topic and flawless analysis resulted in participants giving him a very patient hearing.

This session was chaired by K. C. Narang, Past President of the Society.

In concluding session Uday Sathaye, Chairman Seminar Committee took an overview of the RRC and recognized the contribution made by everybody, Pradip Thanawala, President of Society thanked everybody for making the RRC memorable. Participants departed after lunch to their respective destinations with a promise to meet again next year at the 46th RRC.

K.C. Narang, Chairman Addressing Participants. Also seen from L to R – Yatin Desai, Himanshu Kishnadwala, Paper Writer and Nitin Shingala

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Sections 200(3), 272(2)(k), Rule 31A — When assessee derives no benefit from failure to file e-TDS return, no penalty is called for. In a case where assessee has deposited TDS on time but failed to file e-TDS return because of delay in collecting PANs from landowners, such breach is only technical in nature and no penalty is warranted.

38. (2012) TIOL 399 ITAT-Mum.
The Collector, Land Acquisition Department of Industries and Commerce v. Addl. CIT (TDS)
A.Ys.: 2007-08 to 2010-11. Dated: 9-3-2012

Sections 200(3), 272(2)(k), Rule 31A — When assessee derives no benefit from failure to file e-TDS return, no penalty is called for. In a case where assessee has deposited TDS on time but failed to file e-TDS return because of delay in collecting PANs from landowners, such breach is only technical in nature and no penalty is warranted.

Facts:

The Person Responsible (PR) in respect of Collector, Land Acquisition, Department of Industries & Commerce, Punjab Chandigarh (PR) had not filed e-TDS quarterly returns on respective due dates and so had defaulted u/s.200(3) of the Act. In response to the show-cause notice issued by the Assessing Officer, the PR submitted that the delay was due to landowners not having submitted their PAN numbers and therefore the delay was for a reasonable cause and no penalty could be levied. The AO rejected this explanation and held PR to be an assessee in default and levied penalty u/s.272A(2) (k) of Rs.6,11,600.

Aggrieved, the PR filed an appeal to the CIT(A) and contended that the interest on compensation was disbursed to landowners not directly but was deposited in the District/High Courts and as per guidelines issued for submission of e-TDS quarterly returns Form No. 26Q with less than 70% PAN data was not accepted for quarter ended 30-9-2007. Since PAN data was not available with PR, the quarterly returns could not be filed. The CIT(A) upheld the order passed by the AO. Aggrieved, the assessee preferred an appeal to the Tribunal

Held:

The Tribunal noted that the Collector, Land Acquisition, Department of Industries is a government organisation acquiring land on behalf of Punjab Government. The land compensation is paid by the organisation to the landowners through the District/High Courts. The tax is deducted at source on the interest payment to the landowners, but the compensation and interest is deposited in the Court and not paid directly to the landowners. The landowners/agriculturists do not have PAN numbers. The Department was not able to find PAN numbers of these landowners.

Letters written to the landowners to furnish their PAN Numbers, at the available address, but no response was received due to improper addresses. The amount of tax was deducted at source and paid to the credit of the Government on time. The Tribunal held that the assessee was prevented by sufficient cause from filing the returns within the statutory period. Nonfiling of quarterly returns was only a technical and venial breach to the provisions contained in Rule 31A(2). Even otherwise also, the assessee did not derive any benefit whatsoever by not filing the e-TDS returns in time, as the amount of TDS was duly deposited in the Government Treasury within prescribed time. Such delay has not caused any loss to the Revenue/ Income-tax Department. The Tribunal cancelled the penalty levied by the AO. The appeals filed by the assessee were allowed.

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DAY 3

After the breakfast the participants discussed the paper written by S. Thirumalai on “Important Aspects of CENVAT credit & POT Rules.”

Thereafter Yogesh Thar Chartered Accountant presented paper on “TDS- Some important issues”. His liking and mastery over the subject made his presentation very informative and useful.

Yogesh Thar, Paper Writer Addressing Participants. Also seen from L to R – Bharat Oza, Rajesh Shah, Chairman and Krishna Kumar Jhunjhunwala.

This session was chaired by Rajesh Shah, Past President of the Society

Shri S. Thirumalai dealt with his paper and made his presentation very interesting and satisfied the participants by resolving issues raised during Group Discussion. Service Tax today is gaining importance with more services being added under the Service Tax net. Issues raised by him were of real significance to all. His depth of knowledge in Service Tax and masterly analysis was indeed a treat for the participants

This session was chaired by in his unique style by Govind Goyal, Past President of the Society.

S. Thirumalai, Paper Writer Addressing Participants. Also seen from L to R – Narayan Pasari, Govind Goyal, Chairman and Naresh Sheth.

The day ended with Gala Dinner and Musical Evening.

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Sections 143(3), 147, 254 — In an assessment completed u/s.143(3) r.w.s. 254, the AO should confine himself to the directions issued by the Tribunal. He does not have jurisdiction to go beyond the directions given by the Tribunal.

37. (2012) TIOL 383 ITAT-Mum.
Ambattur Flats Ltd. v. ITO
A.Y.: 2001-02. Dated: 22-5-2012

Sections 143(3), 147, 254 — In an assessment completed u/s.143(3) r.w.s. 254, the AO should confine himself to the directions issued by the Tribunal. He does not have jurisdiction to go beyond the directions given by the Tribunal.

Facts:

For A.Y. 2001-02, the original assessment of the assessee-firm, engaged in the business as builder and developer, was completed by estimating the income at 8% of the total contract receipts of Rs.94,57,500.

The assessment was subsequently reopened and in an order passed u/s.143(3) r.w.s. 147 of the Act, the total income was determined at Rs.28,11,700. This income was determined by the AO by adopting a profit rate of 20% of the gross profit. Aggrieved by the order passed u/s.147, the assessee preferred an appeal to the CIT(A) who gave a deduction of Rs.20,00,000 towards cost of land. The total income was modified at Rs.16,12,679. The assessee accepted the order of the CIT(A) but the Revenue preferred an appeal to the Tribunal.

The Tribunal found that the issue about cost of land was never raised before the AO and there was no discussion in the order of the AO on this issue. The Tribunal remitted the issue of deducting the cost of land to the AO and directed him to make necessary adjustments in accordance with law. In proceedings initiated u/s.254 and completed u/s.143(3), the AO collected evidences from sellers and accepted the contention of the assessee that it has incurred Rs.20 lakh towards purchase of land. However, he went further and reworked the profit and ultimately determined the income of the assessee at Rs.32,69,228.

Aggrieved by the order passed u/s.143(3) r.w.s. 254, the assessee preferred an appeal to the CIT(A) who held that the AO was justified in estimating the profit at 12%, which was also the rate adopted by the CIT(A) earlier.

Aggrieved the assessee preferred an appeal to the Tribunal.

Held:

The Tribunal noted that the single issue was remitted back by the Tribunal to the file of the AO. Having examined the issue remitted and having concluded that the assessee’s contention on the issue remitted was to be accepted the AO should have stopped there. The Tribunal observed that the action of the AO in going further and reworking the profit was against law. It held that in an order passed u/s.143(3) r.w.s. 254, the AO should confine himself to the directions issued by the ITAT. He does not have jurisidction to go beyond the direction given by the Tribunal.

Since the AO had gone beyond the direction of the Tribunal and had redetermined the income, the Tribunal held the order passed by the AO to be contrary to law and set aside the same. The order of the CIT(A) was vacated. The Tribunal remitted the matter to the AO to determine the income at Rs.16,12,679 as detemined by the CIT(A) and to close the file. The Tribunal allowed the appeal filed by the assessee.

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DAY 2

The
participants discussed the paper written by Dr. Pravin P. Shah on
Business Structuring/ Restructuring some important issues. The Group
Discussion was followed by a marvelous presentation paper by
Chandrashekhar N. Vaze who presented his views on Code of Ethics –
Practical Issues. His command over subject and presentation skills made
the session very lively. This session was chaired by Padamshri Shri T. N
Manoharan, Past President of the ICAI. The salient features of the
paper were explained by rapporteur Shri Jayant Gokhale member of the
central council of ICAI.

Padmashree T.N. Manoharan Addressing Participants. All seen from L to R – Manmohan Sharma, Chandrashekhar Vaze, Paper Writer, Jayant Gokhale, Rapertoire and Rajeev Shah.

Thereafter Dr. Pravin P. Shah dealt
with his paper and analyzed the implications and rationale of various
Tribunal, High Court, and Supreme Court Judgments. He explained that
every decision of the judgment forum is with respect to a set of facts
and it is important for reader to appreciate these facts before using
the judgment for any purpose. He answered brilliantly all the queries
raised by the participants.

Dr Pravin Shah, Paper Writer Addressing Participants. Also seen from L to R – Ashok Dhere, Chairman, Saurabh Shah and Mukesh Trivedi.

This session was chaired by Ashok Dhere,
Past President of the Society. In the afternoon participants visited
Ramoji Film City. Participants were made aware about the technicalities
in making the Film. Participants took keen interest and enjoyed the
unique experience. In the evening an additional session was held for the
benefit of all the participants on the burning topic “Revised
schedule-VI” Himanshu Kishanadwala did a masterly analysis of the
important changes which are relevant to a Chartered Accountant , whether
he is performing the accounting or audit function. The session was
effectively chaired by Uday Sathaye, Past President of the Society.

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DAY 1

The RRC began with the Group Discussion on paper written by T. S. Ajai on Case Studies in Taxation.

In
the inaugural function which was held in the evening, Pradip Thanawala
President of the Society welcomed the members. For the benefit of the
outstation members attending RRC he gave an overview of Society’s
activities which are conducted through out the year.

Uday
Sathaye Chairman of Seminar Committee highlighted activities of the
Seminar Committee which are gaining popularity , like study tours in the
form of interactive meetings with Industries all over the Country. He
mentioned about the rationale behind the subjects chosen for the RRC and
thanked all paper writers for giving justice to the subjects and
delivering the papers well within committed time frame.

RRC was
inaugurated by Chief guest Shri N. Chandra Babu Naidu, Leader of
opposition, Andhra Pradesh, Guest of Honour G. Ramaswamy, President ICAI
and Jaydeep Shah, Vice-President ICAI, by lighting of lamp. Shri. N.
Chandrababu Naidu is a very acclaimed, learned and senior professional
politician. He expressed his views in regard to various issues which
have arisen on account of the current trend of giving importance to
technological changes, Governance

Uday Sathaye, Chairman, Seminar Committee delivering Welcome Address. Also seen from L to R – Krishna Kumar Jhunjhunwala, Pradip Thanawala, N. Chandrababu Naidu, G. Ramaswamy, Jaydeep Shah, Deepak Shah and Rajeev Shah.

and values in life. He felt that even
though change is an accepted part of life, departure from certain age
old principles is unwarranted. In his opinion, while one should welcome
the good things from the new generation,

T.S. Ajai, Paper Writer Addressing Participants. All seen from L to R – Mandar Telang, Anil Sathe, Chairman and Manish Sampat.

one should also respect Indian
Ethos. His views on Indian Economy impressed everyone present . Shri G.
Ramaswamy, President ICAI updated members about the development and
initiatives taken by the ICAI for the benefit of members. Shri Jaydeep
Shah, Vice President ICAI addressed the participants about the various
programs run by ICAI.

Krishna Kumar Jhunjhunwala Convenor of the Seminar Committee proposed a hearty Vote of Thanks.

After
the inaugural session T. S. Ajai covered in his presentation all the
case studies.. His clinical analysis on the controversies and his
forthright views were unique and of immense benefit to the participants.

This session was ably chaired by Anil Sathe, Past President of the Society.

The day ended with tasty dinner being served

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Section 194C — Where the arrangement was more of a sharing of fees under contract, provisions of section 194C cannot be applied. Section 36(1)(ii) — Bonus paid to directors could not have been otherwise paid as dividend. Hence provisions of section 36(1)(ii) cannot be applied. Income v. receipt — Only that part of the receipt as has accrued during the year should be taxed as income.

36. (2011) 131 ITD 414 (Delhi)
Career Launcher (India) Ltd. v. ACIT,
Circle 3(1), New Delhi
A.Ys.: 2005-06 & 2006-07. Dated: 27-12-2010

Section 194C — Where the arrangement was more of a sharing of fees under contract, provisions of section 194C cannot be applied.

Section 36(1)(ii) — Bonus paid to directors could not have been otherwise paid as dividend. Hence provisions of section 36(1)(ii) cannot be applied.

Facts:

The assessee was into the business of running coaching classes. The assessee had entered into standardised agreements with various persons willing to run similar coaching classes in form of franchisees. The franchisees were allowed to use the trademark, tradename and course material belonging to the assessee, in lieu of which assessee received an amount equal to 25% of the net value earned from the operations. The assessee showed ‘Franchisee payments’ under the head ‘administrative and other expenses’. The Revenue held that payment made by the assessee to the franchisees was in nature of payment to contractor/sub-contractor and hence provisions of section 194C were applicable. Resultantly, the expenses were disallowed u/s.40(a) (ia). The CIT(A) upheld the order.

Held:

As per the agreement, the franchisees make payment to the assessee and not the other way round. However, the accounts of the assessee have been drawn in a manner which shows that the assessee pays to franchisees. This anomaly between the agreement and the accounts has not been explained by either party. This matter has also not been dealt with by the lower authorities. At this juncture, the matter has to be decided as per law and not merely as per entries in the books of account, which may only be indicative in nature, but not conclusive of the matter.

The franchisees set up the premises, equipment and infrastructure at their own cost as per specifications of the assessee. The assessee was to provide entire study material, upgradation thereof, technical knowhow and product details. The franchisee collected fees from students and taxes/duties leviable were borne by them. They retained 75% of the profit from operations and handed over 25% to assessee. Hence, from the facts of the terms, it clearly emerges that the franchisee is not doing work for the assessee and it is a case of running a study centre and apportionment of profits thereof between the assessee and the franchisee. The agreement is not regarding work done on behalf of the assessee rather it is a case of sharing fees under the contract.

Though the term ‘work’ in explanation of section 194C is wide enough, it does not cover the case of the assessee. Thus, the ground was allowed in favour of the assessee. Facts: The assessee paid bonus to directors who were also the shareholders of the assessee-company. The AO held that bonus was paid instead of dividends so as to avoid payment of dividend distribution tax. Hence, by invoking provisions of section 36(1)(ii) bonus was disallowed. The CIT(A) also upheld action of the AO. Held: Section 36(1)(ii) provides that any sum paid to an employee as bonus or commission for services rendered is to be deducted in computing the total income, where such sum would not have been payable to him as profits or dividend if it had not been paid as bonus or commission.

Taking the example of director A, it is clear that if the amount of Rs.7,02,231 had not been paid to him as bonus, the same amount would not have been paid to him as dividend, because he would have got 40.93% as dividend from the total dividend declared. In other words, he would have received higher dividend than the bonus. The position in case of S would be opposite. He was paid bonus of Rs.4,13,077 although his sharehold-ing is only 1.09%. Relevant facts are similar in case of other directors. Thus, it can be said that none of the directors would have received the bonus as dividend in case bonus was not paid. Also the bonus was paid as per resolution of Board of Directors. Therefore, the provision of 36(1)(ii) was not applicable. Facts: Being a coaching class, the assessee received nonrefundable fees in a year. However, the coaching was to be rendered in current year and subsequent year. Hence, the obligation was to be discharged in two accounting years. The assessee booked part fees in this year and part in the subsequent year. However, the AO added the entire amount to income.

The CIT(A) also upheld AO’s observation. Held: The decision as held in case of K. K Khullar v. Dy. CIT, (2008) 304 ITR (AT) 295 was considered. It was held that a distinction has to be made between the terms ‘receipt’ and ‘income’. Income is liable to be taxed and not receipt. Hence, only that part of receipt was taxable to assessee which accrued as income. Thus, the accounting policy followed by the assessee was correct. The CIT(A) erred in treating the nonrefundable deposit as income.

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Section 80-IB(10) — There is no precondition that the assessee should be the owner of the land for claiming deduction — Terrace in front of penthouse should not be considered while measuring built-up area.

35. (2011) 131 ITD 142
Amaltas Associates v. ITO
A.Y.: 2006-07. Dated: 21-1-2011

Section 80-IB(10) — There is no precondition that the assessee should be the owner of the land for claiming deduction — Terrace in front of pent-house should not be considered while measuring built-up area.

Facts:

The assessee was a builder and developer of housing projects and claimed deduction u/s.80-IB. During the relevant year under consideration, it constructed a housing project and claimed deduction u/s.80-IB. The AO disallowed the deduction u/s.80-IB on the ground that the builder was not the owner of the land and various permissions and approvals were granted in the name of the co-operative society. Further, based on the DVO report, the AO observed that, out of 110 flats, the penthouses on the top floor of each building had a built-up area of more than 1500 sq.ft.

Held:

The contention of the Revenue authorities that the assessee must be the owner of the land to claim deduction u/s.80-IB has no force. There is no such condition for claiming deduction u/s.80- IB. Further, the agreement to sell showed that assessee purchased the property in question for a consideration of Rs.3 lakh. All the responsibilities for carrying out the construction, permission and development of the project lie with the assessee. The dominant control over the land was with assessee. The real owner was only to co-operate with the assessee. Also the assessee was only entitled to enrol members for selling the units within its own rights. Further, the deduction u/s.80-IB is not exclusively to an assessee but to an undertaking developing and building housing project, be it by a contractor or by an owner. Hence, the assessee cannot be denied deduction u/s.80-IB on this ground.

The next issue was of ‘built-up area’ exceeding the prescribed limits of 1500 sq.ft. in case of some of the flats. The AO, based on DVO’s report, had included the area of open terrace in front of the penthouses on the top floor of each building in the total builtup area, thereby increasing the maximum limits. The contention of assessee was that the definition of built-up area means inner measurement of residential unit at floor level including projections and balconies. But open terrace in front of penthouse, not being a covered area and open to sky, should not be considered as a part of built-up area. This contention was accepted by the Tribunal and hence the assessee’s appeal was allowed.

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Section 254(2) and Rules 23 and 25 of Income Tax (Appellate Tribunal) Rules, 1963 — Assessee’s chartered accountant having filed an affidavit stating that he did not appear at the time of hearing as he had wrongly recorded the date of hearing in his diary and also furnished a photocopy of the diary showing the wrong noting, it has to be accepted that there was sufficient cause for his non-appearance on the date of hearing.

34. (2012) 145 TTJ 537 (Delhi) (TM)
Five Star Health Care (P.) Ltd. v. ITO A.Y.: 2006-07. Dated: 2-3-2012

Section 254(2) and Rules 23 and 25 of Income Tax (Appellate Tribunal) Rules, 1963 — Assessee’s chartered accountant having filed an affidavit stating that he did not appear at the time of hearing as he had wrongly recorded the date of hearing in his diary and also furnished a photocopy of the diary showing the wrong noting, it has to be accepted that there was sufficient cause for his non-appearance on the date of hearing.

The assessee filed a miscellaneous application for recalling the said order against the exparte order passed by the Tribunal. The only ground taken by the assessee in its miscellaneous application was that there was a bona fide reason for non-appearance on the part of the assessee on the fixed date of hearing. There was a difference of opinion between the members of the Tribunal and, therefore, the matter was referred to the Third Member u/s.255 (4). The agreed point of difference was

“Whether on facts and in the circumstances of the case, it will be appropriate in law to recall order dated 8th Oct., 2010 passed in ITA No. 1063/Del./2010”. The Third Member held that it would be appropriate to recall the ex-parte order of the Tribunal. It noted as under:

(1) Though in the miscellaneous application there is neither the mention of Rule 25, nor section 254(2), but, from the contents of the application, it is evident that it was under Rule 25 only because u/s.254(2) the assessee can request the rectification of an apparent mistake while under Rule 25, the assessee can request for the recalling of the order of the Tribunal which has been passed ex-parte due to non-appearance of the assessee.

(2) A perusal of Rule 25 shows that, as per proviso, where an appeal has been disposed of as provided in the rule and the respondent appears afterwards and satisfies the Tribunal that there was sufficient cause for his non-appearance on the date of hearing, the Tribunal is at liberty to recall the ex-parte order passed by it and restore the appeal.

(3) In the present case, the chartered accountant has given an affidavit. In support of the affidavit, he has also furnished the photocopy of his diary in which the hearing of the assessee’s appeal was wrongly noted as 9th September, 2010, instead of 7th September, 2010.

(4) Therefore, there was sufficient cause for nonappearance by the assessee on the date of hearing i.e., 7th September, 2010. Proviso to Rule 25 was squarely applicable and the Tribunal was justified in recalling the order of the Tribunal.

(5) Rule 23 provides the procedure to be adopted at the time of hearing the appeal. Tribunal having effectively decided the matter against the respondent-assessee by setting aside the order of the CIT(A) and restoring the matter back to the Assessing Officer without hearing the assessee, the ex-parte order of the Tribunal must be recalled as required by Rule 23 of ITAT Rules.

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Section 40(a)(ia) — Disallowance can be made only in respect of an amount which is sought to be deducted u/ss.30 to 38 and not in respect of reimbursement simplicitor which is profit neutral and not routed through the P & L a/c.

33. (2012) 145 TTJ 1 (Kol)
Sharma Kajaria & Co. v. Dy. CIT
A.Y.: 2006-07. Dated: 17-2-2012

Section 40(a)(ia) — Disallowance can be made only in respect of an amount which is sought to be deducted u/ss.30 to 38 and not in respect of reimbursement simplicitor which is profit neutral and not routed through the P & L a/c.

In the re-assessment proceedings, the Assessing Officer noted that the assessee had made payments to various lawyers for their professional services but had not deducted tax at source u/s. 194J from the same. The Assessing Officer was of the view that the assessee was under statutory obligation to deduct tax at source u/s.194J and, since the assessee had failed to perform this obligation, such payments were disallowed u/s. 40(a)(ia).

The CIT(A) rejected the assessee’s contention that expenditure which is not claimed in and did not appear in the Return and the P & L a/c should not be disallowed by application of section 40(a)(ia). The CIT(A) upheld the Assessing Officer’s order. The Tribunal, setting aside the orders of the lower authorities, noted as under:

(1) Unless a deduction is claimed in respect of the said amounts u/ss.30 to 38, the disallowance u/s.40(a)(ia) cannot come into play at all. The question of disallowance u/s.40(a)(ia) can arise only when something is claimed as a deduction in computation of business income; reimbursements simplicitor, being profit neutral, are not routed through the P & L a/c.

(2) Whether the assessee had claimed the fees paid to outside lawyers as a reimbursement from its clients or not was simply a matter of fact which will be evident from the bills raised on the clients and there was no need for making any inferences in respect of the same.

(3) If in the bills raised on its clients, the assessee had separately itemised the payments made to the outside counsel and claimed reimbursements in respect of the same, then these expenses cannot be of such a nature as to seek deduction in respect of the same. When the expenses are being reimbursed by the clients, these expenses cease to be expenses of the assessee and, therefore, there is no question of deduction in respect of the same.

(4) However, if the assessee has raised composite bills for professional services, on gross basis and without giving details of payouts to outside lawyers on behalf of his clients, the payments to outside lawyers will be in the nature of deduction to be claimed by the assessee.

(5) Without there being any categorical finding to the effect that the payments to outside lawyers were claimed as deductions in computation of profits, the disallowance u/s.40(a)(ia) in respect of such payments is not legally sustainable.

The matter was remanded back to the Assessing Officer for adjudication de novo in light of the above observations.

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Sections 2(47) and 45 — Purchase and sale of land and flat necessary parts of business of construction. Loss arising on sale of these properties is business loss.

32. (2012) 144 TTJ 1 (Chennai) (TM)
Vijaya Productions (P) Ltd. v. Addl. CIT
A.Y.: 2007-08. Dated: 25-11-2011

Sections 2(47) and 45 — Purchase and sale of land and flat being necessary parts of the regular business of construction carried on by the assessee, the losses arising on sale of these properties have to be considered as loss incurred in the course of carrying on its regular business.

For the relevant assessment year, the Assessing Officer disallowed the assessee’s claim for loss on sale of one flat and land as business loss.

The Assessing Officer was of the opinion that such loss was not proved to have been incurred in the course of the assessee’s business of civil construction but, on the other hand, incurred due to purchase and sale of land. Further, according to him, the purchase and sale were effected in close proximity of time and land value could not have depreciated to such a large extent in a prime location of the city. The CIT(A) allowed the assessee’s claim. The Tribunal held in favour of the assessee. The Tribunal noted as under:

(1) Both the assertions of the Assessing Officer were misplaced.

(2) The assessee was engaged in the business of promoting commercial and residential flats and was authorised by the partnership deed to carry on any line or lines of business.

(3) Even if one considers the authorisation given in the partnership deed ‘to carry on any other line or lines of business’, to be ejusdem generis with the earlier terms of ‘promoting commercial and residential flats’, sale and purchase of land would still come within the ambit of the ‘business’ of the assessee.

(4) In a business of promoting commercial and residential flats and other lines of business, it cannot be said that purchase and sale of land would be alien and not a part of the business.

(5) Further, the land was treated as stock-in-trade and this has not been disputed by the learned Department representative. When stock-intrade is sold result can only be business profit or business loss. The assessee might have been forced to sell it at a loss for a myriad of reasons. It is not for the Revenue to sit on the armchair of a businessman and to decide appropriate point of time in which a sale or purchase has to be effected in the course of his business.

(6) Neither the sale deed, nor the purchase deed had been doubted. Neither books of account have been rejected, nor the seller or purchaser were called up by the Revenue for any verification. Without doubting the purchase and sale deed, the loss could not have been disallowed.

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Archives and archaism.

The Government of India has a curious habit. It spares no effort on buying documents and personal effects of Gandhiji and storing them in its lightless archives. At the same time, it is most reluctant to grant access to scholars to any papers it remotely considers ‘sensitive’.

The latest example is its purchase of the Gandhi- Hermann Kallenbach papers. Kallenbach, an architect, was a close collaborator of Gandhiji in South Africa. The two issues may appear distinct, but they are not. The history of a country can’t be divided into what is acceptable to the government and what is not: that is not history, it is hagiography.

No Indian scholar has access to papers on vital post-1947 events such as the 1962 war with China, let alone recent matters such as our involvement in Sri Lanka after 1987. India’s archives access policy is perhaps one of the most illiberal anywhere in the world. It should be discarded fast.

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Recent Global Developments in International Taxation

In this Article, we have given brief information about the recent global developments in the sphere of international taxation which could be of relevance and use in day-to-day practice and which would keep the readers abreast with various happenings across the globe. We intend to keep the readers informed about such developments from time to time in future.

(1) United States

(i) IRS issues updated Publication 519 — US Tax Guide for Aliens

The US Internal Revenue Service (IRS) has released the 2012 revision of Publication 519 (US Tax Guide for Aliens). The publication is dated 7 February 2012 and is intended for use in preparing tax returns for 2011.

Publication 519 provides detailed guidance for resident and non-resident aliens to determine their liability for US federal income tax. Specifically, Publication 519 discusses:

the rules for determining US residence status (e.g., the US green card test and the US substantial presence test);

the rules for determining the source of income; ? exclusions from US gross income;

the rules for determining and computing US tax liability;

US tax liability for a dual-status tax year (i.e., where an individual has periods of residence and non-residence within the same tax year);

filing information;

paying tax through withholding tax or estimated tax;

benefits under US income tax treaties and social security agreements;

exemptions for employees of foreign governments and international organisations under US tax treaties and US tax law;

sailing and departure permits for departing aliens; and

how to get tax help from the IRS.

Publication 519 also includes:

filled-in individual income tax returns (IRS Form 1040 and Form 1040NR) as illustrations of dualstatus returns;

Table of US tax treaties (updated through 31 December 2011);

Appendix A (Tax Treaty Exemption Procedure for Students), which contains the statements non-resident alien students and trainees must file with IRS Form 8233 [Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Non-resident Alien Individual] to claim a tax treaty exemption from withholding of tax on compensation for dependent personal services; and

Appendix B (Tax Treaty Exemption Procedure for Teachers and Researchers), which contains the statements non-resident alien teachers and researchers must file for the same purpose as Appendix A.

Revised Publication 519 provides information on relevant tax changes for 2011 and 2012, including:

the requirement to file new IRS Form 8938 (Statement of Specified Foreign Financial Assets) to report certain foreign financial assets (for 2011);

exclusion of interest paid on non-registered (bearer) bonds from portfolio interest (for 2012); and

expiration of the exemptions for certain USsourced interest-related dividends and shortterm capital gain dividends that are received from a mutual fund or other regulated investment company (for 2012).

Additionally, Publication 519 refers to the other IRS publications that are relevant in this context, including:

Publication 514 (Foreign Tax Credit for Individuals);

Publication 515 (Withholding of Tax on Nonresident Aliens and Foreign Entities);

Publication 597 (Information on the United States-Canada Income Tax Treaty); and

Publication 901 (US Tax Treaties).

(ii) IRS Notice 2010-62: Application of codified economic substance doctrine

The Internal Revenue Service (IRS) has issued Notice 2010-62 with information on implementation of the economic substance doctrine. This doctrine previously applied under US common law and has now been codified by the Health Care and Education Act of 2010, effective for transactions entered on or after 31 March 2010.

The economic substance doctrine permits the IRS to deny tax benefits from a transaction unless (i) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and (ii) the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into the transaction.

Notice 2010-62 provides information on how the IRS intends to apply the newly codified doctrine. Particular guidance is provided with respect to:

the application of the two-part conjunctive test of the doctrine;

the calculation of net present value of reasonably expected pre-tax profit (which is a necessary requirement for meeting the test); and

the treatment of foreign taxes as expenses in appropriate cases.

Application of the US accuracy-related penalties is also discussed.

Notice 2010-62 provides, in general, that the IRS will apply the codified economic substance doctrine in the same manner as the doctrine was applied by the US courts under common law. The IRS states, however, that it does not intend to issue administrative guidance regarding the types of transactions to which the doctrine will or will not be applied.

(iii) Offshore Voluntary Disclosure Program reopened indefinitely

The US Internal Revenue Service (IRS) issued a News Release (IR-2012-5) on 9 January 2012 to announce reopening of the Offshore Voluntary Disclosure Program (OVDP) to allow taxpayers with undisclosed offshore accounts to report such accounts to the IRS and get current with their US taxes. The new OVDP is effective from 9 January 2012 and will remain open for an indefinite period until otherwise announced.

The new OVDP requires participants to pay a penalty of 27.5% of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the 8 full tax years prior to the disclosure. That is increased from 25% in the 2011 program. The new OVDP maintains the reduced 5% and 12.5% penalties that applied in limited situations under the 2011 program.

Participants must file all original and amended tax returns and include payment for back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties.

The IRS stated that more details will be released within the next month.

The IRS also announced in the press release that more than USD 4.4 billion have been collected so far from the two previous disclosure programs.

(iv) Joint Committee on Taxation issues report on taxation of financial instruments

The Joint Committee on Taxation of the US Congress has released a report on US Federal tax rules relating to financial instruments.

The report is entitled Present Law and Issues Related to the Taxation of Financial Instruments and Products. The report is dated 2 December 2011 and is designated JXC-56-11.

The report is divided into four sections, as follows:

Section I describes economic, financial accounting, and regulatory considerations related to holding, issuing, and structuring financial instruments;

Section II describes the basic US income tax principles of timing, character, and source that underlie the taxation of financial instruments;

Section III provides an overview of the timing, character, and source rules for five types of financial instruments (i.e., equity, debt, options, forward contracts, and notional principal contracts), plus a description of the economic relationships among various financial instruments (including so-called put-call parity) and the financial accounting treatment of financial instruments; and

Section IV discusses selected timing, character, source, and categorisation issues in taxation of financial instruments.

The report also includes an appendix with data on holdings and issuance of financial instruments.

(v) IRS updates annual list of international no-ruling areas

The US Internal Revenue Service (IRS) has issued Revenue Procedure 2012-7 with its updated list of international tax issues on which it will not accept applications for private letter rulings and determination letters.

Revenue Procedure 2012-7 includes two lists of international no-ruling areas, i.e., (i) areas in which rulings or determination letters will not be issued, and (ii) areas in which rulings or determination letters will ‘not ordinarily be issued’.

Inclusion of an item on the ‘not ordinarily be issued’ list means that the IRS will not issue a private letter ruling or determination letter on the issue absent unique and compelling reasons given by the taxpayer that would justify a ruling or determination letter.

The 2012 lists have not changed from the 2011 lists, and include such no-ruling and ordinarily no-ruling areas as, among others:

whether a payment constitutes portfolio interest u/s.871(h) of the US Internal Revenue Code (IRC), regarding the US tax exemption on certain portfolio interest received by non-resident foreign individuals;

whether a taxpayer is eligible to claim benefits under the limitation on benefits provision (LOB) of a US income tax treaty;

whether a foreign individual is a non-resident of the United States;

issues that are the subject of a pending request for competent authority assistance under a US tax treaty;

whether a foreign taxpayer is engaged in a trade or business in the United States, and whether income is effectively connected to a US trade or business;

whether a foreign taxpayer has a permanent establishment in the United States, and whether income is attributable to a US permanent establishment;

whether a foreign levy meets the requirements of a creditable tax or in-lieu-of-tax in the United States; and

specified issues concerning conduit financing arrangements.

Revenue Procedure 2012-7 is effective from 3 January 2012.

(vi) Final regulations issued for CSAs in transfer pricing

The US Treasury Department and Internal Revenue Service (IRS) have issued final regulations (TD 9568) on the transfer pricing rules for cost-sharing arrangements (CSAs). The final regulations were issued u/s.482 of the US Internal Revenue Code (IRC) and are effective from 16 December 2011.

The final regulations provide guidance on the determination of and compensation for economic contributions by controlled participants in connection with a CSA in accordance with the arm’s-length standard. The final regulations adopt with modifications the 2008 temporary and proposed regulations on this topic, which was published on 5 January 2009. The final regulations provide modifications and clarifications to the 2008 regulations, including:

treatment of research tools as platform contributions;

clarification on updating reasonably anticipated benefit (RAB) shares;

supplemental guidance on transfer pricing methods applicable to platform contribution transactions (PCTs);

supplemental guidance on application of the best method analysis and the income method;

clarifications with regard to the acquisition price and market capitalisation methods;

clarifications with regard to the residual profit split method;

clarifications regarding forms of payment; and

determinations of periodic adjustments.

The Treasury Department and the IRS state in the preamble to the final regulations that they continue to consider the matters regarding the valuation of stock options and other stock-based compensation and intend to address this issue in a subsequent regulations project.

(2) Germany: Guidance on amended Anti-Treaty Shopping rules published

On 25 January 2012, the Ministry of Finance published official guidance (IV B 3 – S 2411/07/10016) on the application of the anti-treaty-shopping rules embodied in Article 50d(3) of the Income-tax Act as amended in 2011.

Under the revised rules, treaty benefits to a non-resident (intermediate) company are denied if:

as far as its shareholders would not be entitled to the treaty benefits if they would have invested directly; and

as far as the functional requirements of Article 50d(3) are not fulfilled, i.e., the company derives harmful revenue.

The functional requirements are met if:

as far as the company generates its gross income from its own active business activities; or

in regard to the company’s gross income that is not generated from its own business activities:

– there are economic or other important reasons for the use of the intermediate company in view of the respective income; and

– the foreign company is adequately equipped for carrying out its own business activities and for participating in the general commerce.

The amendments brought by the bill on the implementation of Directive 2010/24 and other tax laws were necessary in response to the infringement procedure initiated by the European Commission in 2010. Under the old rules, treaty benefits were denied to an intermediate company, inter alia, if the company did not generate more than 10% of its gross income from its own active business activities. The European Commission considered this all-or-nothing approach as disproportionate and going beyond what is necessary to attain the objective of preventing tax evasion. The amended rules provide for a pro-rata relief, to the extent the functional requirements of Article 50d(3) of the ITA are met and there is non-harmful gross income.

Article 50d(3) of the ITA imposes the burden of proof on the non-resident company in respect of the existence of economic or other important reasons for the interposition of the intermediate company as well as for its adequate business substance. The Guidance defines ‘own business activities’ as activities that exceed the mere management of assets and require a participation in general commerce. Further, the interposition of an EU entity can only qualify if the interposed company participates in general commerce within the Member State of its jurisdiction in an active, permanent and persistent fashion. Services for group companies qualify as business activities if invoiced at arm’s length.

Regarding the notion of ‘economic or other important reasons’ for the use of the intermediate company, the Guidance stipulates that an economic reason is given, if the intermediate company is used in order to start an own business activity and the respective activities can be clearly proven.

Other business reasons, relating to the concerns of the entire group (e.g., coordination and organisation, customer relationship building, cost reduction, location preferences or overriding group business objectives) do not qualify as sufficient economic reason. The Guidance further points out that the mere securitisation of assets or shareholders’ pensions in times of economic crisis, as well as the structuring of ancestral successions, do not qualify as an economic reason in this respect.

The amended rules generally apply as from 1 January 2012. However, the rules shall apply as well to all pending cases in which the application of the amended rules lead to more beneficial results for the taxpayer.

(3) New Zealand: Exposure draft of interpretation statement on tax avoidance

An exposure draft of an interpretation statement, released by Inland Revenue on 19 December 2011, has invited comments from the public on tax avoidance and Inland Revenue’s interpretation of sections BG1 and GA1 of the Income Tax Act, 2007 (ITA). Following a number of significant court decisions on tax avoidance in recent years, the exposure draft discusses Inland Revenue’s interpretation of tax avoidance.

In Ben Nevis Forestry Ventures Ltd. & Ors. v. Commissioner of Inland Revenue; Accent Management Ltd. & Ors. v. Commissioner of Inland Revenue (2009) 24 NZTC 23, 188, the Supreme Court examined the approach between section BG1 and the rest of the Income Tax Act. Subsequently, the approach adopted in Ben Nevis was endorsed as the correct approach to apply section BG1 in Penny and Hooper v. Commissioner of Inland Revenue (2011) NZSC

95. The exposure draft sets out the analysis to be undertaken to determine whether an arrangement is a tax avoidance arrangement, viz.:

identify the arrangement;

review all information to ensure all aspects and effects of the arrangement are understood;

identify the provisions of the ITA that were used or circumvented under the arrangement and its outcomes;

identify the commercial reality and economic effects of the arrangement;

ascertain Parliament’s purpose for the provisions of the ITA used or circumvented in the whole arrangement and its outcomes;

decide whether the arrangement, viewed in a commercially and economically realistic way, falls outside Parliament’s purpose; and

exclude any arrangements where the tax avoidance is ‘merely incidental’ to a non-tax purpose.

The deadline for comments on the exposure draft is 31st March, 2012.

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Construction — Various business models — Circular No. 151/2/2012-ST, dated 10-2-2012.

In the light of varying business models and business practices prevalent in the construction sector across the country, the CBEC has vide this Circular clarified some of the significant issues pertaining to taxability and collection of service tax on different business models like:

(a) Tripartite Business Model

(b) Redevelopment including Slum Rehabilitation Projects

(d) Conversion Model

(e) Non-requirement of Completion Certificate/ where it is waived or not prescribed

(f) Build-Operate-Transfer (BOT) Projects

(g) Joint Development Agreement Model

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Leviability of Service Tax on toll fees — Circular No. 152/3/2012-ST, dated 22-2-2012.

Board has examined the representation received for leviability of service tax on toll fee paid by users and it is clarified that service tax is not leviable on toll paid by the users of roads including those roads constructed by Special Purpose Vehicle (SPV) created under an agreement between NHAI or State Authority, unless SPV engages an independent entity to collect toll from users on its behalf and part of toll is retained by that independent entity as commission or is compensated in any other manner.

It is also clarified that renting, leasing or licensing of vacant land by the NHAI or State Authority to a SPV for construction of road will not attract service tax.

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Gross amount w.r.t. Works Contract — Circular No. 150/1/2012-ST, dated 8-2-2012.

By this Circular it is clarified that the meaning of the expression ‘Gross Amount’ appearing in Explanation to Rule 3(1) of the Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007 shall not be applicable where execution of works contract has commenced or where any payment except payment through credit or debit to any account has been made towards works contract prior to 7-7-2009.

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Amendment in Rules — Notification No. VAT 1512/C.R 12/Taxation-1, dated 16-2-2012.

Vide this Notification amendments are carried to Rules 52, 53 and 54.

In Rule 52, for the words ‘the Commissioner shall’ the words ‘the Commissioner shall subject to the provisions of Rules 53, 54 and 55’ are substituted. This amendment is effective from 1st April 2005. This amendment is clarificatory in nature and has no effect on the position of set-off after amendment.

Rule 53 amended to provide that if the dealer manufacturer, of high-speed diesel oil, aviation turbine fuel, aviation gasoline and motor spirit covered under entries 5, 6, 7, 8, 9 and 10 of Schedule D, dispatches the goods by way of branch transfer, reduction in set-off should be calculated @2% of the values of goods dispatched.

Rule 54 amended with effect from 1-4-2005 so that set-off will not be admissible on purchase of the high-speed diesel oil, aviation turbine fuel (duty paid), aviation turbine fuel (bonded), aviation gasoline (duty paid or bonded), and petrol, unless such motor spirits are sold/resold in the course of interstate trade or commerce or in the course of export outside India.

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Submission of certain annexures by the dealers not required to file audit report in Form 704 — Notification No. VAT/AMD-2011 /1B/ADM-6, dated 4-2-2012 and Trade Circular No. 3T of 2012, dated 27-2-2012.

Dealers who are not required to file audit report in Form 704 will now be required to file annexures C, D, G, H, I, J1 & J2 along with the last return of the financial year. The said annexures will have to be filed for the entire financial year commencing from F.Y. 2012-12.

Annexure C: details of TDS certificates received by dealer, Annexure D: details of TDS certificates issued by the dealer, Annexure G: details of the various certificates or declarations as provided under the Central Sales Tax Act, 1956 received by the dealer, Annexure H: details of the declarations in Form H (Local Form H) received by the dealer, Annexure I: details of the various certificates or declarations as provided under the Central Sales Tax Act, 1956 that are not received, Annexure J1: Customer-wise sales, Annexure J2: Customer-wise purchases.

Such dealers will make payments as per earlier provisions i.e., before 21st/30th April for the period ended 31st March, 2012 and for filing return the due date has been extended by 90 days that is before 30th June. Uploading of the said annexures shall be a pre-requisite for uploading the last return. The deemed dealers i.e., Custom Dept., Dept. of Union Govt., Insurance & Finance Corporations, institutions, banks who are not required to file audit report in Form 704 are also required to file the said annexures.

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(2011) 41 VST 9 (Mad.) Audio India Ltd. v. CTO

Sale price — Sale to deemed exporter — Refund of excise duty to the manufacturer by the Government of India — Not recovered from the buyer — Does not form part of sale price — Section 2(h) of the Central Sales Tax Act, 1956.

Facts:
The dealer had sold industrial valves to the deemed exporter and issued sale bills showing price of the goods and CST without recovering excise duty, as under the Excise Act, under the scheme framed by the Government of India, the manufacturer was entitled to refund of excise duty paid on effecting sales to certain specified projects having status of deemed export. Accordingly, no excise duty was charged by the dealer on sale of goods to Oil India Ltd. having status of deemed exporter. The Department levied CST on cash assistance received from the Government of India for refund of excise duty by including it in sale price of goods sold. The dealer filed writ petition before The Madras High Court against the decision of the Tribunal, dated October 3, 2005.

Held:
Under the Scheme of Refund of excise duty, to the manufacturers supplying goods to specified parties had to bear the Central Excise duty and cash assistance is paid later by the Government of India. The benefit by way of cash assistance to the supplier was an exclusive arrangement between the Government of India and the supplier for certain specified reasons. This had no effect on the sale effected between the petitioner and its buyer. Under the agreement with buyer, the petitioner agreed to supply goods without recovering excise duty paid by it on such supply. Accordingly, sale is effected for a price excluding excise duty. The tax is payable on a sale price charged to buyer and would not include refund of excise duty by the Government of India by way of cash assistance to the petitioner. The writ petition filed by the dealer was allowed and the order of the Tribunal was set aside.

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(2011) 40 VST 505 (P&H) Thermade Pvt. Ltd. v. State of Haryana

Rate of tax — Electrical appliances — Laminar flow clean air equipment used in manufacturing of pharmaceutical products — Whether electrical appliances covered by Schedule A — Entry 18 of Haryana General Sales Tax Act, 1973.

Facts:
The dealer referred question of law to the Punjab and Haryana High Court arising out of decision of Tribunal holding against dealer for attracting higher rate of tax on sale of laminar flow clean air equipment being held as electrical appliances.

Held:
The High Court confirmed the decision of the Tribunal and held that no distinction can be made on the basis of domestic or industrial use of any article. The equipment runs with the electrical energy and provides filtered air. Accordingly, it was held that goods sold by the dealer is an electrical appliances and covered by Entry 18 of Schedule A of the Act attracting higher rate of tax and not as industrial machinery (general goods) as claimed by the dealer.

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(2011) 40 VST 249 (Mad) Sri Rajeshwari Agencies v. Additional Deputy Commercial Tax Officer II, Puducherry

C Forms — Cannot be refused for arrears of tax — Section 9(2) of the Central Sales Tax Act, 1956.

Facts:
The dealer filed writ petition before the Madras High Court challenging issue of show-cause notice for refusing to issue C forms for want of payment of arrears of tax.

Held:
The High Court held that there is no provision under the CST Act to refuse to issue C forms pending arrears of tax. Accordingly issued direction for issue of C forms to the dealer.

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(2011) 41 VST 1 (SC) CST v. Chitrahar Traders

Rate of tax — Sale of condemned plant closed as unviable — Machinery dismantled by buyer using explosives and transported as scrap — Sale of scrap of iron and steel — Attracts rate of 4% tax — Schedule-II, Entry 4(1)(a) of the Tamil Nadu General Sales Tax Act, 1959.

Facts:
The Department filed appeal before the SC against the judgment of the Division Bench of the Madras High Court holding sale of plant closed as unviable and dismantled by buyer using explosives and transported as scrap, attracting 4% rate of tax applicable to scrap of Iron Steel under Entry 4(1)(a) of Schedule-II of the Tamil Nadu General Sales Tax Act, 1959.

Held:
The SC after considering terms and conditions of agreement and other documents held that what was sold by the dealer was nothing else but scrap and not the machinery. The appeal filed by the Department was dismissed and the decision of the Division Bench of the Madras High Court was upheld.

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(2012) STR J 157 & 158 — Basti Sugar Mills

Manufacturer of sugar — Took over management of the sugar mill of another entity for a consideration — Levy of tax as management consultancy agreement — Held, it was management function and hence not liable for tax.

Facts:
The appellant was engaged in the manufacture of sugar in its sugar mill and under an agreement with Indo Gulf Industries Limited, it took over the management of Indo Gulf Industries Limited sugar mill in consideration for certain payment. The Service Tax Department treated the above agreement as a Management Consultancy agreement and demanded service tax on this payment.

Held:
The appellant was in-charge of the operation of the factory and thus was performing the management function. The Tribunal held that no service tax would be applicable for rendering these management functions.

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(2012) 25 STR J 157 (Tri.-Chennai) — Macro Marvel Projects Ltd. v. CST.

Service tax — Construction of complex service — Construction of individual houses is not taxable under ‘construction of complex service’ or under ‘works contract’.

Facts:
The appellants constructed individual residential houses, each being a residential unit. The appeal was against demand of service tax under the head ‘construction of complex’ service. The demand was on the amount collected by the appellants from their clients as consideration for construction and transfer of residential houses.

Held:
The construction of residential complex having not more than 12 residential units was not sought to be taxed under the Finance Act, 1994. For the levy, it should be a residential complex comprising more than 12 residential units. Hence the construction of individual residential units was not subject to levy of service tax.

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(2012) 34 STT 592 (Mumbai-CESTAT) — Bharti Airtel v. CCE.

CENVAT credit — Cell towers, prefabricated building (pfb), printer, office chair, etc. — Neither capital goods nor inputs for providing cellular telephone services — Availed CENVAT credit on the towers, pfb, printer and office chairs. Held, CENVAT credit disallowable — The tower being an immovable property, would not qualify as a capital good or an input which was used for providing output service.

Facts:
The assessee was engaged in the business of providing cellular telephone service which was taxable under the Finance Act for provision of services. The appellant availed CENVAT credit on the towers, pfb, printer and office chairs. Revenue disallowed the CENVAT credit on the said goods on the ground that the tower being an immovable property, would not qualify as a capital good or an input which was used for providing output service.

Held:
The Tribunal held as follows:

The towers and pfb were not a part of an integrated system and were not included in the definition of capital goods.

Alternatively, the tower and pfb would not be considered as components since the components are inputs required to make a good a finished item. As the tower was not an input for the antennas, it would not be considered as a component of the antenna.

Also, as the tower being an immovable property did not satisfy the definition of goods, it would not be considered as an input used for providing output service. The same conclusion was drawn in respect of chairs, printer, etc.

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(2012) 25 STR 251 (Tri.-Del.) — Convergys India Services P. Ltd. v. Commissioner of Service Tax, New Delhi.

Rebate of CENVAT credit on exported services — No dispute as regards the services on which rebate claimed were ‘input services’ in terms of Rule 2(l) of CCR — Deficiency in declaration — A technical lapse — Genuine claim not deniable — Provisions of unjust enrichment not applicable to rebate claim.

Facts:
The appellant filed a declaration for claiming rebate on export of service with the Jurisdictional Assistant/Deputy Commissioner of Central Excise within the limitation period. The appellant mentioned some input services specifically and other input services were described as ‘other services’ instead of mentioning each input service separately. No allegations were made that either services not specifically declared had not been received or invoices for all input services had not been submitted. This declaration was accepted. The Commissioner reviewing this order concluded that the declaration filed was incorrect on the grounds that the appellant did not mention all the services but mentioned some input services along with the words ‘other services’. The appellant produced a statement showing the correlation between export invoices and Foreign Inward Remittance Certificate (FIRC) but did not mention the invoice numbers of the export invoices and hence it was not possible to establish that FIRCs pertained to export services. The appellant claimed a rebate for services of Advertisement, Chartered Accountant and Management Consultant Services. The Department did not dispute that the same were covered by the definition of ‘input service’ but they contended that these services were not used for providing the Customer Care Services which were exported. The Commissioner rejected the rebate claim and ordered the same to be credited to Consumer Welfare Fund on the ground of unjust enrichment. The Commissioner alleged that there was willful misstatement and suppression of facts by the assessee. The assessee had submitted rebate claims with all relevant documents to the jurisdictional authority, which sanctioned rebate after being satisfied about its correctness. This sanction did not discover any new document indicating misstatement or suppression of any information.

Held:
Even if certain services were not mentioned in the declaration, it was considered only a technical lapse, for which rebate could not be denied. Since only some input services were not mentioned, it was highly irrational to deny the entire rebate claim. Further, simply because FIRCs did not bear the export invoice numbers, it could not be concluded that the same did not pertain to the service provided by the appellant to their client abroad. It was held that whenever credit was permitted to be taken, the same were permitted to be utilised and when the same is not possible, there is provision for grant of rebate. Hence the Department could not object that these services were not used for providing services exported by the assessee. It was held that the principle of unjust enrichment was not applicable to rebate claims and the rejected refunds/rebates could not be credited to the Consumer Welfare Fund. It was held that penalty could be imposed only if there was evidence of collusion with jurisdictional authorities sanctioning the inadmissible rebate.

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