BCAJ | Bombay Chartered Accountant Journal

Not textbook stuff — The NCERT cartoon issue is more about degeneration of political debate.

At its root, the whole controversy on cartoons in NCERT textbooks underlines the malaise afflicting political debate in the country: passions whipped up in aid of divisive political ambitions. Here, rage and slanging matches trump reasoned debate. One of the stated reasons for the order of the six-member panel constituted to review cartoons — that politicians and bureaucrats can’t be shown in an ‘incorrect’ way — amply reveals that undemocratic spirit. Some of the suggestions of the panel, say, about changing the captions of cartoons that have appeared years ago border on the Orwellian. This is not just tantamount to changing history, it is indicative of school textbooks and curriculum being tinkered with according to ideological inclinations in India. Often, it is one political party or the other raising a furore over such issues, citing the oft-invoked ‘hurt sentiments’ theory.

Which is just another means of reinforcing the social and political faultlines the entire political class thrives on, given that it envisages politics as a competitive identity management project. Just as people’s representatives cannot amend, just because they have a majority, say, the theory of relativity, they cannot decide the school syllabus. There is a National Curriculum Framework, meant to further a consultative approach to framing school textbooks, but that fact is drowned in the cacophony of contesting, and largely manufactured, rage.

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Putting integrity into finance.

Behaviour that lacks integrity leads to value destruction. This paper analyses some common beliefs, actions, and activities in finance that are inconsistent with being a person or a firm of integrity. Each of these beliefs leads to a system that lacks integrity, i.e., one that is not whole and complete and therefore creates unworkability and destroys value.

Focussing on these phenomena from the integrity viewpoint, makes it possible for managers to focus on the value that can be created by putting the system back in integrity and correcting the non-value maximising equilibrium that exists in capital markets. In effect, integrity is a factor of production just like knowledge, technology, labour, and capital, but it is undistinguished — and its affect (by its presence or absence) is huge. We summarise our new positive theory of integrity that has no normative content, and argue that there are large gains from putting integrity into finance — into both the theory and practice of finance. We define integrity as being whole and complete and unbroken. We argue that if finance scholars, teachers and practitioners take this approach to applications in finance, there are huge gains to be achieved.

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The Big Stick — The time for soft words is over, we need concrete action.

It is all very well for the Prime Minister to say that he will cut red tape, reassure investors and keep the India growth story intact. He can hardly say the opposite. The whole point is to act, rather than talk or set up yet more committees to produce yet another report on a subject on which an endless number of committees have already produced an equal number of reports. Of the 40,000 MW of power generation capacity added over the last two years, only 6,000 MW of capacity generates power, the rest idles for want of coal or want of regulatory permission to pass on the higher cost of imported coal to willing consumers. Scrap the anti-national Coal Mines Nationalisation Act.

This will not only ensure that the country’s coal sector transforms from a dark realm of loot and thuggery to an efficient supplier of the country’s most abundant fuel, but also reassure potential inves- 36 37 38 Tarunkumar Singhal Raman Jokhakar Chartered Accountants Miscellanea tors that India is serious about economic growth. Muster courage to implement a Cabinet decision to decontrol diesel, and institute competition, including from independent operators, in the retailing of petro-fuels. This will slash the fiscal deficit, reduce inefficiency at India’s oil companies and increase energy efficiency across the spectrum. By reducing the fiscal deficit, the reform would also reduce the current account deficit, thereby easing pressure on the rupee. This move, too, would go a long way in restoring investor confidence.

Make progress on the ground on implementing the goods and services tax, getting the IT infrastructure and procedural framework for seamless integration of the tax ready. This will put pressure on the BJP-led states holding out against the transition. Concrete action of this kind is what we need, to restore investor confidence and get the economy vrooming. Kind words of good intent spoken with sincerity are always welcome. But the big stick that needs to back up soft talk is what has been missing and needs to be found.

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Procedure for rebate of duty on export of services — Notification No. 39/2012-ST, dated 20-6-2012.

Vide this Notification, rebate has been granted of whole of duty paid on excisable inputs or service tax and cess paid on all input services used in providing services exported in terms of Rule 6A of the Service Tax Rules, subject to complying with conditions and procedures.

The said Notification also contains conditions and limitations of such rebate along with procedures and forms of application for rebate claims.

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Amendment in provisions of continuous supply of services Notification No. 38/2012-ST, dated 20-6-2012.

Vide this Notification provision of (a) taxable services of telecommunication service, and (b) service portion in execution of a works contract will be treated as continuous supply of service, for the purpose of Rule 2(c) of the Point of Taxation Rules, 2011.

The other three services which were also notified as continuous supply of service vide Notification No. 28/2011-ST, but now removed are

(i) Commercial or industrial construction;

(ii) Construction of complex and

(iii) Internet telecommunication.

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Baba Promoters & Developers v. ITO ITAT ‘B’ Bench, Pune Before I. C. Sudhir (JM) and G. S. Pannu (AM) ITA Nos. 629/PN/2009; 625/PN/2009 and 159/PN/2010 A.Ys.: 2004-05, 2006-07 and 2005-06 Decided on: 29-2-2012 Counsel for assessee/revenue: Sunil Ganoo/ Satindersingh Navrath and Ann Kapthuama

Section 80IB(10) — While computing the area of plot, the area of a plot acquired subsequently for providing approach road also needs to be included in the measurement of total plot area. Areas of open land/garden/store/gym room meant for common use are not to be included for calculating built-up area of the residential unit. Merger of flats, after purchase, by the owners thereof to make it into a larger flat for their own convenience cannot be a cause for denial of deduction u/s.80IB(10).

Facts:
The assessee-firm started construction of a residential project at Aundh, Pune. As per the original lay-out plan approved by Pune Municipal Corporation (PMC), the total area of the plot was shown to be 3995.34 sq.mts. i.e., marginally less than the prescribed area of 1 acre. The assessee submitted that in addition to the above-stated area of land, an additional land measuring 5 ‘Are’ was also acquired by the assessee for the approach road to the said project vide a separate agreement made with the same landlords from whom the above-stated area of 3995.34 sq.mts. of land was purchased. On including this area, the size of the plot exceeded 1 acre. The assessee submitted that if this area would not have been acquired, the PMC would not have sanctioned the plan and issued commencement certificate. The AO visited the site and being satisfied allowed the deduction.

The CIT found this order to be erroneous and prejudicial to the interest of the revenue on the ground that: (1) the area of the plot is less than 1 acre; (2) as per sale agreement of row house, the saleable area mentioned is more than 1500 sq. feet; (3) in A.Y. 2005-06 the AO has in order passed u/s.143(3) denied deduction u/s.80IB(10); and (4) flats have been merged together and the modification is not as per approved plans.

Aggrieved, the assessee filed an appeal questioning the validity of revisional order passed u/s.263 of the Act.

Held:
The Tribunal noted that in the case of Haware Engineers and Builders (P) Ltd. v. ACIT, (11 Taxmann.com 286) (Mum.) deduction claimed u/s.80IB(10) was denied by the A.O. on the ground that the additional plot acquired subsequently, by allotment, was a distinct plot which cannot be included in computation of the area of the plot. The Mumbai Bench of Tribunal held that in case an assessee finds that he is not eligible for deduction u/s.80IB(10), because size of the plot on which project is built is less than minimum necessary size, and he makes good that deficiency, and ensures that all the necessary pre-conditions are satisfied and approvals obtained, the assessee is eligible for deduction u/s.80IB(10). It was further held that the fact that he satisfied the conditions later, does not adversely affect its claim for deduction. What is material is that at the point of time when matter comes up for examination of the claim, the necessary pre-conditions for being eligible to claim are satisfied. The Tribunal held that the facts in the present case are similar as the assessee has acquired the additional land of 5 ‘Are’ subsequently after the acquisition of the main plot of land from the same seller. It held that it is a well-established proposition of law that for transfer of a plot within the meaning of the Act, the requirement is handing over of the possession and payment of consideration. Thus, registration of document of the transaction is not the foremost requirement to establish the transfer for the purpose of the Act. The Tribunal also noted that the Pune Bench of the Tribunal has in the case of Bunty Builders v. ITO held that housing project constitutes development plan, roads and grant of other facilities, therefore, those areas should exist within the prescribed limits and area to be considered as part and parcel of the project. In the present case, after addition of 5 Are of land purchased by the assessee vide agreement dated 20th March, 2004, for the purpose of approach road, to the area given in the lay-out plan, it fulfils the prescribed area for eligibility of claiming deduction u/s.80IB(10) of the Act.

As regards the second ground about row house having area exceeding 1500 sq.ft., the Tribunal noted that sale area included area of open land/garden and if that is excluded, then area of the row house is less than 1500 sq.ft.

As regards the merger of flats and thereby exceeding the prescribed limit of 1500 sq.ft. being taken as a basis for denial of deduction in A.Y. 2005- 06, the Tribunal held that there is no substance since it is undisputed fact that each flat was within the prescribed limit of 1500 sq.ft. area and if after purchasing of 2 flats the owner(s) of flats merges it into a larger flat, the claimed deduction cannot be denied to the assessee.

The Tribunal held that the grounds on which the assessment order has been treated as erroneous and prejudicial to the interest of the Revenue are debatable and hence revisional powers cannot be invoked.

The Tribunal allowed the appeal filed by the assessee.

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Amendment in Point of Taxation Rules, 2011 Notification No. 37/2012-ST, dated 20- 6-2012.

By this Notification, the Point of Taxation Rules, 2011 are amended by

(i) omitting the definition of associated enterprises and taxable services as given in sub-rule 2(b) and 2(f), respectively, from the said rules and

(ii) substituting the words ‘provided or to be provided’ wherever they occur in the said rules, with the words ‘provided or agreed to be provided’.

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Amendment in Service Tax Rules, 1994 — Notification No. 36/2012-ST, dated 20-6-2012.

Vide this Notification, Service Tax Rules, 1994 have been amended in light of introduction of negative list of services and to facilitate various changes made by the Finance Act, 2012. The new amended rules shall be known as Service Tax (Second Amendment) Rules, 2012. The gist of changes made in the said rules is given below:

(i) Various definitions of the terms used in Rules are inserted in Rule 2.

(ii) Changes brought in Rule 2(1)(d) for effecting the revised reverse charge mechanism.

(iii) Substitution of the word and figures ‘Section 66B’ for the word and figure ‘Section 66’ wherever used in the said rules.

(iv) Insertion of new Rule 6A for determining whether the service is exported or not.

(v) Omission of Rule 5B-Date for determination
of rate.

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State of Tamil Nadu V. Lakshmi Opticals [2011] 43 VST (Mad)

Sales Tax – Sale – Spectacles Made to Prescription for Customer – Not a Works Contract but a Sale Of Goods, Manufacture-Second Sale – Sale of Lens Along with Frames – Resale of Frames and First Sale of Lens – S/s. 3B(2), 12(3)(B) and Entry 54 of Part C of Schedule I Of The Tamilnadu General Sales Tax Act, 1959

Facts:
The respondent/assessee is a dealer in opticals, and sold frames after having purchased frames as such without fitting them into spectacles, while the assessing authority has given categorical finding that the frames had not been sold as such without fitting them in spectacles to its customers as a product through separate bills for (i) frame and (ii) lens.

Before the Tribunal, the respondent/assessee contended that the manufacture of spectacles based on a specific description issued by the Doctors and choosing the lens pertaining to the power prescribed, the same is handed over to the skilled labourers for processing and sizing the lens such as grinding the shape of the lens, etc., before fitting the same into frames. It was therefore contended that such a process of manufacture according to the specific requirement is based on prescription issued by the Doctor, which would fall within the concept of “works contract” falling u/s. 3B of the Tamil Nadu General Sales Tax Act and as such eligible for claim of second sale not liable to tax. The Tribunal allowed the appeal filed by the assesse and set aside the order of assessment and first appeal. The Department filed Revision Petition before the Madras High Court challenging the order of the Sales Tax Appellate Tribunal, for the period 1994-95.

Held:
In the first place, what is sold by the respondent/ assessee to their customers is the spectacle. The spectacle is manufactured to the requirement of each of the customers based on a prescription of an ophthalmologist. What is being carried out by the respondent/assessee falls within the expression “manufacture”, i.e., manufacture of spectacle based on the orders placed by the customers. Even such manufacturing activity is carried on by the respondent/assessee in their workshop. Therefore, in every respect, the necessary ingredients of works contract are absent. The contract is of sale and not a works contract.

The spectacle manufactured by the respondent/ assessee which contains a frame and lens and certain other parts, can be independently analysed in order to find out whether any tax is leviable on such different parts contained in the spectacles. Therefore, the action of the respondent/assesse in having raised two separate bills, one for the frame and the other for the lens and thereby, there would be collection of tax on sale of lens alone and not on the frame was permissible and cannot be questioned.

Accordingly, the HC dismissed the revision petition filed by the Department and answered the question of law in favour of the respondent/assessee.

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Scholars Home Senior Secondary School vs. State of Uttarakhand and another and other cases [2011] 42 VST 530 (Utk)

VAT – Dealer – Residential School – Main Activity of Imparting Education – Not Business – Activity of Providing Food in Hostel – Incidental Activity Also Not Business-School not a Dealer- S/s.2(6),(11),(27) and (40) of the Uttarakhand Value Added Tax Act, 2005

Facts:
Petitioners were educational institutions providing boarding and lodging facilities to students staying inside the campus in the hostel and they were provided food. The supply of foodstuff was sought to be assessed as a sale under the Act. The petitioner managing the institution on a non-profit basis as a charitable organisation without there being any profit-motive involved and, in this regard, also registered u/s. 12A of the Income-tax Act as a charitable organisation. Many students of the petitioner-institution are using the boarding facilities provided by the institution and, for this purpose, the petitioner charged a lump sum amount towards tuition fee and boarding fee. The petitioner was not charging any separate amount or cost for food supplied to the students, who were using the hostel facility. The mess was run by the institution itself and was not being done by any catering contractor. It was alleged that before the promulgation of the Uttarakhand Value Added Tax Act, 2005 (hereinafter referred as “the Act”), the U.P. Trade Tax Act was applicable in the State of Uttarakhand and, while the said Act was in force, the petitioner was not subjected to any tax for the supply of food to its residential students nor was the petitioner recognised as a “dealer” under the Act, but after coming into force the Act of 2005, the petitioner received a notice dated 2nd June 2009, for the assessment years 2005-06, 2006-07, 2007-08 and 2008-09 from the Assistant Commissioner Commercial Tax to show cause as to why the petitioner should not be liable to pay value added tax on the supply of food to its students, which amounted to a sale under the Act.

The petitioner, being aggrieved by the issuance of the notice, filed the writ petition before the High Court praying for the quashing of the notice for assessment years 2005-06, 2006-07, 2007-08 and 2008-09, for a direction restraining the respondents from making any assessment pursuant to the notice dated 2nd June 2009, as it is not carrying on the business of sale of foodstuff and, therefore, is not liable to be taxed, nor the Act is applicable and consequently, the issuance of the notice is wholly illegal and without jurisdiction.

Held:
Merely because there is a deemed sale or the fact that the deemed sale is incidental or casual, the tax could only be imposed if the person is a dealer and is engaged in a business activity of purchase and sale of taxable goods. The main activity of the petitioner is imparting education and is not business. Any transaction, namely, supply of foodstuff to its residential students which is incidental would not amount to “business” since the main activity of the petitioner could not be treated as commerce or a business as defined u/s. 2(6) of the Act. Consequently, since no business is being carried out and there is no sale, the petitioner would not come within the meaning of the word “dealer” as defined under the Act.

Accordingly, the HC allowed all writ petitions and said notices were consequently quashed.

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DCIT v. Tejinder Singh ITAT ‘B’ Bench, Kolkata Before Pramod Kumar (AM) and Mahavir Singh (JM) ITA No. 1459/Kol./2011 A.Y.: 2008-09. Decided on : 29-2-2012 Counsel for revenue/assessee: A. P. Roy/ L. K. Kanoongo

Section 50C — Transfer of leasehold rights in a building does not attract provisions of section 50C.

Facts:
The assessee along with one Amardeep Singh had vide registered lease deeds dated 19th November, 1992 acquired from Shree Khubchand Sethia Charitable Trust (Owner), leasehold rights for 99 years, in a house property at Kolkata.

By a tripartite registered deed dated 20th July, 2007 entered into between the owner, the assessee and Amardeep Singh (lessees) and three entities viz. Sugam Builders Pvt. Ltd., Neelanchal Sales and Suppliers Pvt. Ltd. and Pleasant Niryat Pvt. Ltd. (purchasers), the purchasers purchased this property. Under this deed dated 20th July, 2007 the owner transferred its ownership and reversionary rights in the said property for a consideration of Rs.1,00,00,000; the lessees for a consideration of Rs.3,19,00,000 gave up all their rights and interests in the said premises. Thus, purchasers paid total consideration of Rs.4,19,00,000 — Rs.1,00,00,000 to the owner and Rs.1,59,50,000 to the assessee and Rs.1,59,50,000 to Amardeep Singh — co-lessee. As against the consideration of Rs.4,19,00,000 the stamp duty valuation of the property was Rs.5,59,57,375.

The Assessing Officer (AO) computed the capital gains by adopting the stamp duty valuation to be the full value of consideration and notionally divided the said amount amongst the owner and the lessees in the ratio of actual consideration received by them. Accordingly, as against actual consideration of Rs.1,59,50,000 the AO computed capital gain by adopting Rs.2,12,47,375 to be the full value of consideration. He considered the lease rents paid over a period of time, duly indexed, to be the indexed cost of acquisition and on this basis arrived at LTCG of Rs.1,84,17,692. Since the assessee had invested Rs.1,96,03,685 and not the entire consideration adopted by the AO for computing capital gains, the AO granted proportionate exemption u/s.54F and charged balance Rs.14,46,692 to tax as LTCG.

Aggrieved the assessee preferred an appeal to the CIT(A) who relying upon various Tribunal decisions held that provisions of section 50C do not apply to transfer of leasehold rights.

Aggrieved the revenue preferred an appeal to the Tribunal and the assessee filed cross-objection on the ground that the CIT(A) has not adjudicated the alternative ground of the assessee viz. for the purposes of section 54F, full value of consideration does not mean value determined u/s.50C.

Held:
The Tribunal noted that the assessee was a lessee of the property which was sold by the owner of the property, yet the AO had treated the assessee as a seller apparently because the assessee was a party to the sale deed. The Tribunal held that in case of purchase of tenanted property the buyer pays the owner for ownership rights and if he wants to have possession of the property and remove the fetters of tenancy rights he would pay the tenants for surrendering their tenancy rights. Merely because the amount is paid at the time of purchase of the property, the character of receipt will not change.

The provisions of section 50C are not applicable where only tenancy rights are transferred or surrendered. On facts, the assessee had the rights of the lessee and not ownership rights. The assessee had granted, conveyed, transferred and assigned leasehold right, title and interest.

The Tribunal dismissed the appeal filed by the Revenue.

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(2011) 130 ITD 287/9 taxmann.com 69 (Mum.) Ashok Kumar Damani v. Addl. CIT A.Y.: 2005-06. Dated: 3-12-2010

Allowability of penalty paid to stock exchange for violation of bye-laws of the stock exchange — The payment made to the stock exchange on account of short payment of margin money is only a compensatory payment under the rules of the stock exchange and not for infraction of law. Hence the same is allowable as revenue expenditure.

Facts:
The assessee had made short payment of margin money to the stock exchange. The penalty is levied by the stock exchange for the same which was paid by the assessee during the period under consideration. The AO disallowed the same on belief that the said expenditure is not an allowable expenditure being in the nature of penalty.

Before the Tribunal, the assessee relied on the decision of the Tribunal in ACIT v. Ramesh M. Damani, [ITA No. 5143 (Mum.) of 2006].

Held:
Following the judgment of the Mumbai Bench of the Tribunal in the case of ACIT v. Ramesh M. Damani, (supra), it is held that the payment had been made to stock exchange on account of short payment of margin money. This is only a compensatory payment under the rules of the stock exchange which is allowable as revenue expenditure as the same is not for infraction of law.

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2012 (28) STR 150 (Tri.-Chennai) T V S Motor Co. Ltd. vs. Commissioner of Central Excise, Chennai-III

In cases of import of services, service tax is leviable on consideration inclusive of tax deducted at source.

Facts:
The appellants had received consulting engineering services from outside India for the period March, 2004 to September, 2007 and had paid service tax under reverse charge u/s. 66A of the Finance Act, 1994 read with Rule 2(1)(d)(v) of the Service Tax Rules, 1994. However, service tax was paid on the value of services excluding tax deducted at source (TDS) under the Indian Income Tax laws. The appellants contended that there should not be any tax on the amount of TDS specifically in view of the fact that the payment to foreign consultant should be the basis of service tax levy. The revenue contested that the agreement stated that the consideration was net of all Indian taxes and such taxes were payable by the appellants in addition to the amount payable to foreign consultant and therefore, forms part of the contract price. Further, vide section 66A of the Finance Act, 1994, the recipient was treated as service provider and therefore, by legal fiction, the consideration inclusive of TDS, shall be the assessable value. It was also the case of the respondents that the appellants could not prove its contention as to why TDS should not form part of the “gross amount charged” vide Rule 7 of the Service Tax (Determination of value) Rules, 2006, according to which, service tax was leviable on actual consideration charged for services provided or to be provided.

Held:
The Tribunal held that the appellants were not liable to pay service tax under reverse charge prior to 18/04/2006 in absence of statutory provisions in this regard as had been upheld by the Hon’ble Supreme Court in case of Union of India vs. Indian National Shipowners Association 2010 (17) STR J57 (SC). In the present case, as per the terms of the contract, TDS formed part of the contract price and therefore, was includible in the value of taxable services. The benefit of cum-tax should be available to the appellants while raising the modified demand on the basis of the observations made by the Tribunal. In view of the law being at the stage of inception, penalty u/s. 78 of the Finance Act, 1994, was set aside.

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2012 (28) STR 182 (Tri.-Ahmd.) Bloom Dekor Ltd. vs. Commissioner of Central Excise, Ahmedabad

CENVAT Credit is available on the basis of an invoice issued on registered office instead of the factory if the services are received in the factory.

Facts:
The appellants availed CENVAT credit on the basis of an invoice issued on registered office and not on factory. Revenue relied on various Tribunal and High Court decisions and contended that the registered office should have taken input service distributor registration and thereafter, should have issued a separate invoice on factory for availment of CENVAT credit. However, the appellants contended that they had only one factory and therefore, there was no question of distribution by taking input service distributor registration. Further, it was not disputed by the department that the services were received in the factory of the appellants and relying on Tribunal precedents in case of CCE, Vapi vs. DNH Spinners 2009 (16) STR 418 (Tri.) and Modern Petrofils vs. CCE, Vadodara 2010 (20) STR 627 (Tri.-Ahmd.) the credit should not be disallowed.

Held:
The Tribunal observed that the decisions relied upon by the revenue were not applicable to the facts of the present case. All those cases dealt with the effective date of registration of an input service distributor, whereas the dispute in the present case is totally different. The dispute is whether the registered office of the appellant is required to be registered at all when they have one factory and where the credit has been taken by the factory on the basis of invoices issued by service providers. The Tribunal also observed that the case laws cited by the appellants squarely covered the present case. Therefore, the Tribunal held that CENVAT credit was available to the appellants since the appellants had only one factory and the services were received in the factory, though the invoice was in the name of the registered office.

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2012 (28) STR 174 (Tri.-Ahmd.) Venus Investments vs. Commissioner of Central Excise, Vadodara

Services used for construction of immovable property are not eligible input services to avail CENVAT Credit.

Facts:
The appellants were engaged in providing renting of immovable property services. The appellants availed CENVAT credit of industrial or commercial construction services for construction of an immovable property. The department contested that vide Circular no. 98/1/2008-ST dated 04-01-2008, commercial or industrial construction services or works contract services, were input services for immovable property which was neither goods exigible to excise duty nor service leviable to service tax and therefore, CENVAT credit was not available to the appellants. The appellants argued that the Circular clarified the position contrary to law and was required to be ignored as held in the case of Ratan Melting and Wire Industries 2008 (12) STR 416 (SC).

Held:
As observed by this Tribunal in case of Mundra Port and Special Economic Zone Ltd. vs. CCCE, Rajkot 2009 (13) STR 178 (Tri.-Ahmd.), the phrase “used for providing output services” has to be differentiated from the phrase “used in or in relation to the manufacture of the final product”. The Hon’ble Supreme Court’s decision in case of Ratan Melting and Wire Industries (Supra) was misconstrued. In the said case, the Hon’ble Supreme Court had only held that departmental circulars and instructions issued by the board were binding on the authorities of respective statute and not on Hon’ble Supreme Court or High Courts and rejected the appellant’s claim of CENVAT credit.

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(2011) 130 ITD 255 (Jp.) Dy. CIT v. Abdul Latif A.Y.: 2005-06. Dated: 30-4-2010

Section 145 — Method of accounting — Rejection of accounts — Addition cannot be made simply on the basis of closing stock without considering the opening stock.

Facts:
The assessee was engaged in the business of manufacture of papers. He had shown purchases of packing material and colour and chemicals as on 31- 3-2005. Also, he had shown closing stock of colour and chemicals as on 31-3-2005, but no amount of packing material was shown in the closing stock. On being asked by the AO as to why the purchases of packing material purchased on the last day of the accounting period were not shown in the closing stock, it was submitted:

(1) that the packing material shown as purchased on last day was actually purchased in earlier months, which due to some computer error were posted on 31-3-2005; (2) that such packing material was consumed during the process; and

(3) that entire packing material remains after the end of year becomes obsolete and, therefore, it was not shown in the closing stock.

The Assessing Officer having noticed that there could be a possibility that some purchases made in the previous year could have been booked during the year, held that the book results were not acceptable. He, therefore, rejected the books of account of the assessee and made a certain addition to his income.

The assessee on the appeal before the CIT(A) had submitted that the packing material is used by him within a period of 7 to 15 days and the same is recognised as expenditure. Further, it was submitted that such practice is followed consistently.

Before the CIT(A), the assessee relied upon the decision of the ITAT, Chandigarh Bench in the case of ACIT v. Ram Sahai Wool Combers (P.) Ltd., (2002) 120 Taxman 84 (Mag.) in which it was held that the addition on account of closing stock cannot be made in case the assessee is consistently showing the purchases as expense.

Relying on the decision of the ITAT in the above case, the learned CIT(A) held that in respect of packing material, there was consistent practice of showing the entire purchase of packing material as consumed. Once this consistent practice was accepted, merely not including the stock of packing material in the closing stock could not be a reason for invoking section 145(3) or making the addition.

On second appeal by the Revenue —

Held:
In case the Assessing Officer felt that such purchases were entered on the last day of the accounting period, then he could have made an investigation to enquire about the genuineness of the purchases. However, he had not taken any step to verify as to whether such purchases were genuine or not. It was not the case of the Revenue that the purchases were not genuine. Moreover, in case the AO wanted to change the method of valuation of closing stock, then he was also required to consider opening stock on the same basis as he had taken for the closing stock. The assessee was following a consistent method of valuing the closing stock by including the packing material as consumed at the time of purchase.

Hence, the Assessing Officer had rejected the books of account on an improper ground. Further, the addition cannot be made simply on the basis of closing stock without considering the opening stock.

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2012 (28) STR 166 (Tri.-Ahmd.) Navaratna S. G. Highway Prop. Pvt. Ltd. vs. Commr. Of S. T., Ahmedabad.

Services used for construction of mall are eligible input services to avail and utilise CENVAT credit for output service of renting of immovable property.

Facts:
The appellants were engaged in the business of construction of malls and renting out spaces in such constructed malls and providing space for advertisement in malls. The appellants availed CENVAT credit of input services such as tours and travel agent services, security services, etc. during the year 2007-2008 and utilised the same against renting of immovable property services during the year 2008-2009 once the mall was opened commercially.

The contention of the department was that the appellants were not eligible to avail CENVAT credit, since input services were not used by the appellants for providing taxable output service. The appellants in response to the department’s contention argued that input services were used for construction of mall which was owned and leased by the appellants. The appellants further added that without a mall, there could not be any output service and therefore, services were eligible input services vide provisions of CENVAT Credit Rules, 2004. The department contested that vide Circular no. 98/1/2008-ST dated 04-01-2008, commercial or industrial construction services or works contract services, were input services for immovable property which was neither goods exigible to excise duty nor service leviable to service tax and therefore, CENVAT credit was not available to the appellants.

Held:
The definition of input and input services are pari materia as far as service providers are concerned and therefore, following the decision delivered by the Andhra Pradesh High Court in case of Sai Samhita Storages (P) Ltd. 2011 (23) STR 341 (AP), the Tribunal held that without utilising services, the mall would not have been constructed and renting would not have been possible and therefore, the services used for construction of malls were eligible input services for availment of CENVAT credit even when the output service was renting of immovable property services.

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2012 (28) STR 135 (Tri.-Mumbai) DHL Lemuir Logistics Pvt. Ltd. vs. Commissioner of C. Ex., Mumbai

Notification no. 4/2004-ST dated 31-03-2004 grants exemption to services only when the same are consumed within Special Economic Zone.

Facts:
The department issued a SCN for the period from 01-12-2005 to 31-07-2007 contesting that the appellants wrongly availed benefit of exemption Notification no. 4/2004-ST dated 31-03-2004 in respect of CHA services rendered outside SEZ. The appellants contended that during the period under consideration, services provided to SEZ unit were exempted vide the said Notification. Further, as per section 26 of the Special Economic Zone Act, 2005 and Rule 31 of the Special Economic Zone Rules, 2006, every developer and entrepreneur was entitled for exemption from service tax on the taxable services provided to a developer or a unit to carry out the authorised operations in a SEZ. Accordingly, Notification no. 4/2004-ST dated 31-03-2004 should be read alongwith the said section and Rule and interpreted to provide service tax exemption to the appellants.

The department submitted that the said Notification was a conditional exemption and was available only with respect to services provided within SEZ. Since the services were not provided within SEZ, benefit of the said exemption was not available to the appellants.

Held:
The Tribunal observed that in terms of various decisions of the Hon’ble Supreme Court, an exemption notification has to be interpreted as per the language used therein and the notification should be interpreted strictly to ascertain whether a subject falls in the notification. Accordingly, exemption under Notification no. 4/2004-ST dated 31-03-2004 was available only if the services were consumed within SEZ. The cannon of interpretation “Expresso unius est exclusion alterius” was applicable to the said notification which meant express mention of one thing excluded all others and in the present case, services consumed within SEZ were only covered by the said notification which was a conditional exemption. Further, the notification was issued in 2004 whereas the SEZ Act and Rules were introduced in 2005 and 2006 and therefore, the notification cannot be interpreted on the basis of SEZ Act and SEZ Rules. If the intention of the legislation was to align the exemption with SEZ Act or Rule, then the notification would have been amended to reflect the same. In view of no prima facie case in favour of the appellants and no pleading for financial hardship and taking into consideration the interest of revenue, the appellants were directed to pre-deposit part of the service tax demand.

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2012 (28) STR 104 (Tri.-Ahmd.) Commissioner of Central Excise, Surat vs. Survoday Blending (P) Ltd.

CENVAT credit not available on the basis of true copy of bill of entry certified by the customs authorities.

Facts:
The
respondents availed CENVAT credit of Countervailing Duty (CVD) paid on
imported inputs on the basis of true copy of bill of entry. The
department contested that the CENVAT credit was not available on the
basis of the copy of bill of entry vide Rule 9 of the CENVAT Credit
Rules, 2004 and CENVAT credit was available only on original documents
relying on the decision of the Hon’ble Supreme Court and High Court. The
respondents argued that the original bill of entry was available at the
time of receiving the inputs. However, the same was misplaced after
availment of CENVAT credit and therefore the respondents got the copy of
the ex-bond bill of entry certified by the customs authority, relying
on the High Court and Tribunal precedents. Further, the erstwhile rules
allowed CENVAT credit on the basis of triplicate or duplicate bill of
entry. However, the present rules, used the phrase “bill of entry” and
therefore, in absence of any prefix and nature of bill of entry, the
same can be understood to include copy of the bill of entry and the
CENVAT credit should not be denied.

Held:
The
Tribunal observed and held that CENVAT credit was available based on
various documents mentioned under Rule 9 of the CENVAT Credit Rules,
2004. In the said rules, if the phrase “bill of entry” was interpreted
to include copy of bill of entry, then all other documents such as
invoice, challan, supplementary invoice, etc., should also include
copies thereof. However, at earlier occasions, the said interpretation
was not accepted by High Courts and Supreme Court.

Further, the
bill of entry was dated 10-02-2005 and the CENVAT credit was availed on
14-04-2006 and it was not obvious that the original bill of entry was
misplaced only after April, 2006. It was also observed that the
respondents had only produced a copy of challan and the original challan
also could not be produced.

Therefore, the Tribunal held that
the CENVAT credit was not available to the respondents, relying on the
Hon’ble Supreme Court’s decision and the Punjab and Haryana High Court’s
decisions in Union of India vs. Marmagoa Steel Ltd. 2008 (229) ELT 481
(SC) and S. K. Foils Ltd. vs. CCE, New Delhi 2009 (239) ELT 395
(P&H), affirmed by Hon’ble Supreme Court reported in 2010 (252) ELT
A100 (SC) respectively.

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Rescinding of certain Notifications — Notification No. 34/2012-ST, dated 20-6-2012.

In order to switch over to the negative list-based new service tax regime, it was necessary to do away with certain existing provisions which conflict with the new provisions of service tax applicable from 1st July, 2012. Accordingly, vide this Notification, a total of eighty one Notifications have been rescinded

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A.P. (DIR Series) Circular No. 113, dated 24-4-2012 — External Commercial Borrowings (ECB) for Civil Aviation Sector.

Presently, ECB cannot be raised to finance working capital requirements. This Circular, however, permits companies in the civil aviation sector to avail ECB for working capital requirements under the Approval Route, subject to the following:

(i) Airline companies must be registered under the Companies Act, 1956 and possess scheduled operator permit licence from DGCA for passenger transportation.

(ii) ECB will be allowed to the airline companies based on the cash flow, foreign exchange earnings and its capability to service the debt.

(iii) The ECB for working capital must be raised within 12 months from the date of issue of this Circular.

(iv) ECB must be raised with a minimum average maturity period of three years.

(v) The overall ECB ceiling for the entire civil aviation sector would be one billion and the maximum permissible ECB that can be availed by an individual airline company will be INR18,437 million. This limit can be utilised for working capital as well as refinancing of the outstanding working capital Rupee loan(s) availed of from the domestic banking system.

(vi) Foreign exchange required for repayment of ECB cannot be raised from Indian markets and the liability can be extinguished only out of the foreign exchange earnings of the borrowing company.

(vii) No roll-over of ECB availed for working capital/refinancing of working capital will be allowed.

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A.P. (DIR Series) Circular No. 112, dated 20-4-2012 — External Commercial Borrowings (ECB) Policy — Refinancing/Rescheduling of ECB.

This Circular permits borrowers to refinance, under the Approval Route, an existing ECB by raising fresh ECB at a higher all-in-cost/reschedule an existing ECB at a higher all-in-cost. However, the enhanced all-in-cost must not exceed the current all-in-cost ceiling.

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A.P. (DIR Series) Circular No. 111, dated 20-4-2012 — External Commercial Borrowings (ECB) Policy — Liberalisation and Rationalisation.

This Circular has modified the ECB guidelines with immediate effect as under:

(i) Enhancement of refinancing limit for power sector

Indian companies in the power sector can now, under the Approval Route, utilise up to 40% of the fresh ECB raised by them towards refinancing of the Rupee loans availed by them from domestic banks/institutions. The balance amount raised b way of fresh ECB must be utilised for fresh capital expenditure for infrastructure projects.

(ii) ECB for maintenance and operation of toll systems for roads and highways

ECB can be raised, under the automatic route, for capital expenditure in respect of the maintenance and operations of toll systems for roads and highways provided they form part of the original project.

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Are Builders/Developers Construction Service Providers

Background:

Service tax on commercial or industrial service was introduced in 2004 and that on residential complex was introduced in 2005 in the Finance Act, 1994 (the Act). Later in the year 2007, under the entry of `Execution of works contract service’, specifically construction contracts of new commercial or industrial buildings and new residential complex during the execution of works contract chargeable as sale of goods were made liable for service tax. The scope of these entries covered contractors providing construction services.

The Finance Act, 2010 with effect from July 01, 2010 inserted explanation in clause (zzq) and in clause (zzzh) of section 65(105) of the Act dealing with these construction services. By these explanations, a legal fiction is created and a builder is deemed to be a service provider of construction service to the prospective buyer of the immovable property or a unit thereof and thus liable for service tax. The explanation to become applicable has two pre-requisites:

Construction of a new building or a complex must be intended for sale wholly or partly by a builder or his authorised person either before, during or after construction; and

A sum must be received from or on behalf of prospective buyer by the builder before the grant of completion certificate by a competent authority under the applicable law.

Challenging the service tax imposed on the builders on the ground that between the builder and a buyer there is no provision of service, writ petition filed in the Bombay High Court by the Maharashtra Chamber of Housing Industry (MCHI) & Others (Writ Petition No.1456 of 2010) and similar petitions filed by various builders were dismissed.

Brief analysis of the decision:
The petitioners urged that title to the building under construction vests in the builder. On completion of construction, a final transfer of title takes place, there is no event of provision of service. Thus, the tax is directly on the transfer of land and buildings, which falls within the legislative power of the States under Entry 49 of List II to the Seventh Schedule of the Constitution. The builders also challenged the levy made under the new entry in section 65(105) (zzzzu) of the Act dealing with preferential location of the property or an extra advantage accorded on a payment over and above the basic sale price of the property sold. This was also challenged on the ground that it is a tax on land per se, because it is a tax on location and there is no voluntary act of rendering service.

The Revenue urged that the explanation does not tax transfer of property at all. The tax is on construction service, but it is triggered when there is intent to sell and some payment is received. These are incidents but do not form the subject-matter of the tax. Further, there is no tax imposed when the duly constructed property is sold after receiving completion certificate.

The Hon. High Court observed that it had the task to examine the object of taxation or the taxable event to determine whether the tax in its true nature is a tax on land and buildings. Incidence of the tax is not relevant to construing the subject-matter of tax and it is distinct from the taxable event; it identifies, as it were, the person on whom the burden of tax would fall. As regards the explanation, it observed that intent to sell whether before, during or after construction is the touchstone of the deeming definition of the service of the builder to the buyer. The explanation expanded the scope materially to include deemed service provided by builders to buyers. According to the Court, an explanation could be of different genres and the Legislature is not prevented to enact an explanation which is not clarificatory but expansive. In this frame of reference, reliance was placed on the Supreme Court decisions, Dattatraya Govind Mahajan v. The State of Maharashtra (AIR 1977 SC 915) and an earlier decision in Hira Ratan Lal v. The Sales Tax Officer (AIR 1973 SC 1034).

To address the issue of challenge of legislative competence of the levy, the Court in its order has discussed inter alia the following decisions of the Supreme Court almost on identical lines as it discussed the issue of legislative competence in relation to renting of immovable property service in Retailers Association of India v. Union of India (Writ Petition 2238 of 2010 & connected petition decided on 21/08/2011 – Refer BCAJ – October 2011 Issue – Service Tax feature):

Sudhir Chandra Nawn v. Wealth Tax Officer – AIR 1969 SC 59

Second Gift Tax Officer, Mangalore v. D.H. Nazareth – AIR 1970-SC 999

Union of India v. H. S. Dhillon AIR 1972 SC 1061

India Cement Limited v. State of Tamilnadu AIR 1990 SC 85

State of Bihar v. Indian Aluminium Company AIR 1997 SC 3592

The Court stated that principles emerging from the Supreme Court decisions were that in order to be a tax on land and buildings, it must be directly imposed on land and buildings as units, whereas one imposed on a particular use of land or building or an activity in connection therewith or arrangement in relation therewith or a tax on income arising therefrom or a tax on transaction of a transmission of title to or a transfer of land and building is not a tax on land and buildings. In the instant case, the charge of tax is on rendering of taxable services. The taxable event is rendering of a service which falls within the description set out in sub-clauses (zzq), (zzzh) and (zzzzu) of the Act. The Legislature has imposed levy on the activity involving provision of service by a builder to the buyer in the course of the execution of a contract involving intended sale of immovable property. The charge is not on land and buildings as a unit and it is not on general ownership of land. The activity rendered on land does not make the tax a tax on land. A service rendered in relation to land does not alter the character of the levy.

The explanation bringing in two fictions of a deemed service and deemed service provider is not ultra vires the provisions of sections 67 and 68 of the Finance Act, 1994. Such submission by the petitioners lacked substance. Further, builders following the practice of levying charges under diverse heading including preferred location involved value addition and a service before obtaining a completion certificate. If no charge is levied for a preferential location or development, no service tax is attracted. Therefore there is no vagueness and uncertainty and there is no excessive delegation. Accordingly, finding no merits and no other submission other than the recorded being urged, the petitions were dismissed.

The question therefore arises is whether the observation made in Magus Construction P. Ltd. v. UOI in 2008 (11) STR 225 (Gau) stands completely negated by the deeming fiction? The Guwahati High Court in this case held that when a builder or a promoter undertakes construction activity for its own self, in the absence of relationship of “service provider”, and “service recipient” the question of providing taxable service to any person does not arise at all. Advance made by a prospective buyer is against consideration of sale of flat or building and not for the purpose of obtaining any service. Now in the scenario, it remains to be seen whether filing an appeal to the Supreme Court would bring a change in the situation or the above decision has decided the fate of the builders.

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A.P. (DIR Series) Circular No. 109, dated 18-4-2012 — Authorised Dealer Category II — Permission for additional activity and opening of Nostro account.

This Circular suggests that Authorised Dealers Category-II wanting to open Nostro accounts must approach RBI for a one-time approval to open and operate Nostro accounts.

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A.P. (DIR Series) Circular No. 108, dated 17-4-2012 — Anti-Money Laundering (AML)/ Combating the Financing of Terrorism (CFT) Standards — Cross Border Inward Remittance under Money Transfer Service Scheme.

This Circular advises authorised persons, their agents/franchisees to consider the information contained in the Statement issued by the FATF on February 16, 2012 on the above subject.

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A.P. (DIR Series) Circular No. 107, dated 17-4-2012 — Anti-Money Laundering (AML)/ Combating the Financing of Terrorism (CFT) Standards — Money changing activities.

This Circular advises authorised persons, their agents/franchisees to consider the information contained in the Statement issued by the FATF on February 16, 2012 on the above subject.

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DTAA between India and Georgia notified — Notification 4/2012, dated 6-1-2012.

DTTA between India and Georgia shall be given effect from 1st April, 2012

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Central Processing of Returns Scheme, 2011 and related amendments/clarifications in relevant sections of the Act — Notification No. 2/2012 and Notification No. 3/2012, dated 4-1-2012.

The CBDT has notified the aforementioned scheme which lays down the procedure for E-filing of the returns of income either digitally signed or not, filing of ITR V in the latter case, receipt and acknowledgement of such returns, procedure for filing revised return of income, cases wherein the returns would be considered invalid or defective and the remedy thereof, processing of the returns filed and rectification procedure for the same, adjustment of refund against the arrears of demand outstanding as per the records of the CPC, service of notice or communication, appellate proceedings, etc.

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Guidelines for Notification of affordable housing project u/s.35AD — Notification No. 1/2012, dated 2-1-2012.

The Board vide the Income-tax (First Amendment) Rules, 2012 has Rule 11-0A prescribing guidelines for approval of affordable housing projects u/s.35AD. This includes Form No. 3CN in which the application needs to be made to Member (IT), Central Board of Direct Taxes, the manner in which the form would be approved and the objections/defects if any would be treated, the circumstances under which the application would be rejected, etc. It also lays down the conditions for eligibility of such projects. Conditions are as under:

The project shall have prior sanction of the competent authority empowered under the Scheme of Affordable Housing in Partnership framed by the Ministry of Housing and Urban Poverty Alleviation, Government of India.

Date of commencement of the project should be on or after 1st April 2011 and date of completion should be within five years from the end of financial year in which the above authorities have sanctioned it.

The plot of land should not be less than one acre.

Of the total allocable rentable area of the project, affordable housing units for Economically Weaker Section (EWS), Lower Income Group (LIG) and Middle Income Group (MIG) should be as prescribed in the Rule.

Separate books need to be maintained for the project. Also the various terms like date of commencement, housing unit, etc. have been defined in the said rules.

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SRL Ranbaxy Ltd. v. Addl. CIT ITAT ‘G’ Bench, Delhi Before A. D. Jain (JM) and Shamim Yahya (AM) ITA Nos. 434/Del./2011 A.Y.: 2006-07. Decided on: 16-12-2011 Counsel for assessee/revenue: Ajay Vohra & Rohit Garg/Gajanand Meena

Section 194H — Existence of principal-agency relationship is a sine qua non for invoking section 194H. Amount of discount retained by the collection centres is not ‘commission’ paid by the assessee to the collection centres and consequently section 194H does not apply to such amounts. Since assessee has not paid any amounts to the collection centres, provisions of section 194H could, not have been met.

Facts:
The assessee entered into non-exclusive agreements with domestic and international collection centres comprising of hospitals, nursing homes, clinics and other laboratories/entrepreneurs also. In accordance with the said agreements, the collection centres collected samples from patients/ customers seeking various laboratory testing services. The collection centres had their own premises, infrastructure, staff and necessary licences/ approvals. The collection centres acted as authorised collector for collecting samples and availed of the professional services of the assessee with respect to testing of samples and issue of necessary reports. The assessee charged a discounted price to the collection centres. The price to be charged by the collection centres to its patients/customers was fixed by them and not by the assessee. The assessee raised an invoice on the collection centre which was paid by the collection centre after deduction of TDS u/s.194J. The payment made by the collection centres to the assessee was not dependent on the collection centres receiving the payment from its patients/customers. The amount of discount given to collection centres was not claimed by the assessee as expenditure, but the amount charged to collection centres was shown as its income. The collection centres had flexibility and freedom to choose the laboratory to which samples should be sent for testing, unless the patient/ customer mandated that it be sent to the assessee.

While assessing the total income of the assessee u/s.143(3), the Assessing Officer (AO) held that a sum of Rs.16,80,66,667 being discount offered by the assessee to collection centres was liable for deduction of TDS u/s.194H/194C and since tax was not deducted at source, he disallowed this sum u/s.40(a)(ia).

Aggrieved the assessee preferred an appeal to the CIT(A) who restricted the disallowance from Rs.16,80,66,627 to Rs.11,78,24,030 but affirmed the disallowance, in principle, holding that the relationship between the assessee and the collection centres was that of principal and agent attracting the provisions of section 194H of the Act.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The element of agency is necessarily to be there in cases of all the services or transactions contemplated by section 194H. Where the dealing between the parties is not on a principal to agent basis, section 194H does not get attracted. The Tribunal held that the relationship between the assessee and the collection centres was not on a ‘principal & agent’ basis because (a) the centres issued their own bill to the customer/patient, collected the fees and issued the receipt; (b) the rates charged by the centres from its customers were not decided by the assessee; (c) there was no privity of contract between the assessee and the patients; (d) the amounts were not collected by the centres on behalf of the assessee; (e) the set-ups of the collection centres was entirely different from that of the assessee; (f) the collection centres were not under an obligation to forward the samples for testing only to the assessee, but could forward them to other laboratories as well unless mandated by the patients/customers; (g) the expenditure of the collection centres did not show any interlacing with that of the assessee and also the staff of the two was distinct and separate; (h) the collection centres had no authority to bind the assessee in any form.

Further, the disallowance u/s.40(a)(ia) r.w.s. 194H can be made only in respect of expenditure in the nature of commission paid/credited to the account of the recipient, or to any other account. In the present case, the assessee received the amount of the invoice raised, net of discount, from the collection centres. The Tribunal held that this discount, indisputably, cannot, in any manner, be said to be expenditure incurred by the assessee and so, section 40(a)(ia) of the Act is not attracted.

The appeal filed by the assessee was allowed by the Tribunal.

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DCIT v. Tide Water Oil Co. (India) Ltd. ITAT ‘A’ Bench, Kolkata Before Mahavir Singh (JM) and C. D. Rao (AM) ITA No. 2051/Kol./2010 A.Y.: 2003-04. Decided on: 20-1-2012 Counsel for revenue/assessee: D. R. Sindhal/A. K. Tulsiyan

Section 80IB, Form No. 10CCB — By filing Form No. 10CCB in the course of reassessment proceedings (which form was not filed with the return of income, nor was it filed in the course of assessment proceedings) the assessee is not making any fresh claim for deduction u/s.80IB but merely furnishing the documents to substantiate its claim made during the course of assessment and even reassessment proceedings.

Facts:
For A.Y. 2003-04, the assessee filed its return of income by due date mentioned in section 139(3) of the Act. In the return of income filed the assessee claimed deduction u/s.80IB. The Assessing Officer (AO) assessed the total income u/s.143(3) to be Rs.7,31,51,920 as against returned income of Rs.5,16,02,964 by restricting deduction u/s.80IB on allocation of corporate expenses proportionately over all units. Subsequently, the AO noticed that the assessee had not filed audit report in Form No. 10CCB, hence is not eligible for deduction u/s.80IB and due to that the income has escaped assessment. The AO initiated proceedings u/s.147 r.w.s. 148 of the Act.

In the course of reassessment proceedings the assessee filed Form No. 10CCB and claimed that nonfiling of Form No. 10CCB is only a technical default and since original Form No. 10CCB was filed along with return of income u/s.148, technical default is removed and deduction u/s.80IB should be allowed. The AO noticed that the due date of filing return of income u/s.139(3) was 30-11-2003 and the assessment u/s.143(3) was completed on 31-3-2006, but the audit report filed along with return u/s.148 was dated 23-2-2007 and also balance sheet of Silvasa Unit, in respect of which deduction u/s.80IB was claimed, was audited on 23-2-2007, whereas the P & L Account of Silvasa unit was audited on 16-10- 2003. He held that there was severe non-compliance on the part of the assessee. He, accordingly, denied claim for deduction u/s.80IB. Aggrieved, the assessee preferred an appeal to the CIT(A).

The CIT(A) confirmed the jurisdiction, but he allowed the claim of the assessee u/s.80IB by holidng that submission of audit report in Form No. 10CCB is directory in nature and it is not mandatory and that submission of audit report even during reassessment proceedings is sufficient compliance u/s.80IB of the Act. The assessee did not challenge the decision of the CIT(A) confirming jurisdiction. Therefore, the assumption of jurisdiction became final.

Aggrieved, the Revenue preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the AO while framing assessment u/s.143(3) of the Act, originally, accepted the claim of deduction u/s.80IB of the Act despite the fact that there was no audit report in Form No. 10CCB i.e., that means that the AO was also under bona fide belief that the assessee is entitled to deduction u/s.80IB of the Act and he allowed the same. It was subsequently that he noticed that the assessee had not filed the audit report along with return of income, nor had it filed the same during the course of assessment proceedings. He, accordingly, recorded reasons and re-opened the assessment.

The Tribunal held that the assessee is not making any fresh claim for deduction u/s.80IB of the Act, but merely furnishing the documents to substantiate its claim made during the course of assessment and even reassessment proceedings. The Tribunal held that there is no infirmity in allowing the claim of deduction even though the assessee has filed audit report in Form No. 10CCB during the course of reassessment proceedings. It upheld the order of the CIT(A).

The Tribunal dismissed the appeal filed by the Revenue.

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Rachna S. Talreja v. DCIT ITAT ‘D’ Bench, Mumbai Before J. Sudhakar Reddy (AM) and V. Durga Rao (JM) ITA No. 2139/Mum./2010 A.Y.: 2006-07. Decided on: 28-12-2011 Counsel for assessee/revenue : G. P. Mehta/ C. G. K. Nair

Section 143 — Assessment — Assessee during the course of assessment proceedings filed revised computation of income and claimed additional deduction — Whether AO justified in refusing to consider the revised income and insisting that only by filing revised return u/s.139(5) the additional deduction can be claimed — Held, No.

Facts:
The assessee had filed her return of income on 31-10-2006 declaring income of Rs.11.05 lakh. Subsequently, during the course of assessment proceedings, the assessee filed revised computation of income by claiming deduction on account of interest of Rs.2.1 lakh paid to a bank. The AO did not consider the revised computation of income filed by the assessee on the ground that there was no provision in the Act to file a revised computation of income. According to him, the assessee should file revised return of income as per section 139(5). On appeal, the CIT(A), relying on the Supreme Court decision in the case of Goetz India Ltd. (284 ITR 323) upheld the AO’s order.

Held:
The Tribunal noted that a similar issue had arisen before the Mumbai Tribunal in the case of Pradeep Kumar Harlalkar v. ACIT, (47 SOT 204) wherein the Tribunal following the decision in the case of Goetz India Ltd. observed that ‘power of the Appellate Authority to entertain claim in question was still there . . . . .’. In view thereof the Tribunal admitted the claim made by the assessee and restored the matter to the file of the AO with a direction to consider the revised computation of income filed by the assessee and decide the issue afresh.

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Baba Amarnath Educational Society v. CIT ACE Educational & Charitable Society v. CIT ITAT ‘B’ Bench, Chandigarh Before Sushma Chowla (JM) and Mehar Singh (AM) ITA Nos. 825 & 826/Chd./2011 Decided on: 29-12-2011 Counsel for assessees/revenue : P. N. Arora/ Jaishree Sharma

Section 12A read with section 2(15) — Registration of charitable institution — Assessees engaged in educational activities — One of the objects permitted assessee to export computer and other similar activities — The said object was never acted upon by the assessee — Whether the CIT justified in rejecting registration application of the trust — Held, No.

Facts:
In the present two appeals, since the facts of the cases as well as the grounds of appeal were identical, the Tribunal decided to dispose of the same by a consolidated order.

The assessee-trusts were established primarily to promote education. The assessees’ application for registration u/s.12A was rejected by the CIT on the ground that their one of the object clauses provided for promotion of export of computers hardware/ software, telecommunication, internet, e-commerce and allied services. For the purpose the CIT relied on the decisions of the Supreme Court in the cases of Yogi Raj Charities Trust v. CIT, (103 ITR 777) and of East India Industries (Madras) Pvt. Ltd. (65 ITR 611).

Held:
From the detailed list of activities carried out by the two assessees, the Tribunal noted that they have carried out activities pertaining to achieving their charitable objects viz., imparting education. The object clause, which was objected to by the CIT and the ground on which the registration was rejected was never acted upon and it remained on paper. According to it, single inoperative object cannot eclipse the whole range of other charitable objects and actual conduct of charitable activities. According to it, it was not the letter or language of one single object clause which is conclusive, but it was the activity of the appellants, which was more relevant. Further, it observed that the first proviso to section 2(15) was not applicable to the first three objects enumerated in the definition. The said proviso only restricts the scope of the expression ‘ advancement of any other object of general public utility’. The proposition was also supported by the Board Circular No. 11/2008, dated 19-12-2008 which inter alia states “where the purpose of a trust or institution is relief of the poor, education or medical relief, it will constitute charitable purpose, even if it incidentally involves the carrying on of commercial activities”.

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Hansraj Mathuradas v. ITO ITAT ‘H’ Bench, Mumbai Before R. V. Easwar (President) and P. M. Jagtap (AM) ITA No. 2397/Mum./2010 A.Y.: 2006-07. Decided on: 16-9-2011 Counsel for assessee/revenue : Mehul Shah/ A. G. Nayak

Section 37(1) — Business expenditure — Whether the expenditure, which are subjected to FBT, can part thereof be disallowed on the ground that the same are not for the purpose of the business — Held, No.

Facts:
The assessee is a partnership firm engaged in the business of providing services as insurance surveyor and loss assessor. In one of the grounds before the Tribunal, the assesse had challenged disallowance made by the AO and confirmed by the CIT (Appeals), conveyance and telephone expenses of Rs.4,818 and Rs.17,224 out of Rs. 24,088 and Rs.86,120, respectively. In the absence of any record maintained by the assessee in the form of log book or call register to establish that the said expenses were wholly and exclusively for the purpose of its business, the same were disallowed by the AO to the extent of 20%.

Held:
The Tribunal referred to the CBDT Circular No. 8/2005, dated 29-8-2005 and opined that once fringe benefit tax is levied on expenses incurred, it follows that the same are treated as fringe benefits provided by the assessee as employer to its employees and the same have to be appropriately allowed as expenses incurred wholly and exclusively incurred by the assessee for the purpose of its business.

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2012 (28) STR 3 (Ker.) Security Agencies Association vs. Union of India

Salaries and statutory dues paid by security agencies are leviable to service tax and cannot be excluded from “gross amount charged” u/s. 67 of the Finance Act, 1994.

Facts:
A writ petition was filed stating that, inclusion of the expenses and salary paid to the security guards and statutory payments such as ESI, EPF, etc. in the “gross amount charged” was ultra vires to the Constitution of India. The appellant contended that they received a petty amount as commission, while providing security personnel to any service receivers and bulk of the amount received was expended towards salary and statutory dues. Further, sometimes, the service receivers directly paid salaries to security personnel. Therefore, it was not logical to include salary and statutory dues in “gross amount charged” u/s. 67 of the Finance Act, 1994 dealing with valuation of taxable services and that it was violation of Article 14 and 19(1)(g) of the Constitution of India. The appellant stated that the gross amount without segregating the expense towards salary and statutory payment should not form part of taxable service and reliance was also placed on Advertising Club vs. CBEC, 2001 (131) ELT 35 (Mad). The appellant contended that service tax is not a charge on business but on services as held by the Hon’ble Supreme Court in case of All India Federation of Tax Practitioners and others vs. Union of India 2007 (7) STR 625 (SC). The learned counsel of the appellant submitted that the challenge is not in regards to the leviability of service tax on the applicant, but on the gross amount as determined u/s. 67.

The revenue, relying on various Supreme Court and High Court precedents, contended that the provisions were introduced through powers vested with the parliament vide relevant entry under List I of the 7th Schedule. Further, the Hon’ble Apex Court and Madras High Court had held that sustainability of the provision cannot be questioned or established with reference to the “measure of taxation”.

Held:
Following various Supreme Court and High Court precedents, the Honourable High Court observed that there was no case for the petitioner that the Parliament did not have legislative competence to enact the law and there was no violation of any fundamental rights with respect to the business. The measure of tax could not alter the nature of taxation. The legislation had the discretion to decide the class of taxpayers, events, quantum etc. There was no master and servant relationship between the security personnel and the service receivers and the appellants could raise invoices on service receivers for the salaries, expenses and service tax thereon and therefore, the appellants were not aggrieved by the said levy in any manner and therefore, the writ petition failed.

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2012 (28) STR 193 (SC) Union of India vs. Madras Steel Re-rollers Association Whether statutory circular issued by CBEC binding on quasi-judicial authorities?

Facts:
The High Court of Madras and Punjab & Haryana held that Circular No.8/2006-Customs dated 17-01-2006 was beyond the powers conferred on the CBEC u/s. 151 of the Customs Act, 1961 and therefore quashed the said circular. The issue framed before the High Court was, that a question of fact is to be decided by the authorities under the Act and the appeals were filed under the contention that circular being statutory circular issued under the Statute, cannot be quashed by the High Courts.

The High Court observed that the assessing authority while adjudicating any issue, functions as a quasi judicial authority and that the powers exercised by the appellate authority or Central Government as revisional authorities, are quasi judicial powers. Reliance was placed on the ruling of the Hon’ble Supreme Court’s decision in case of Orient Paper Mills vs. Union of India 1978 (2) ELT J345 (SC), stating that the powers of the Collector were quasi judicial powers and cannot be controlled by the directions issued by CBEC. The respondents argued on the same lines that unless the quasi judicial authority was allowed to function independently and impartially, the orders passed by it cannot be said to be orders passed in accordance with the law.

Held:
The assessing authorities, appellate and revisional authorities are quasi judicial authorities and orders passed by them are also quasi judicial orders. Therefore, such orders should be passed by exercising independent mind and without being biased. The circulars guiding the authorities should be considered as evidence available before them. Accordingly, based on all the material available on record including these circulars, the assessing authority has to come to an independent finding. Therefore, the appeals were disposed off, directing the assessing authorities to consider the matter afresh in the light of the above observations without examining the merits of the case.

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GAPS in GAAP Accounting for BOT contracts

Background

Governments are always
starved of funds. To mitigate this problem, they enter into contracts
with private parties; particularly in the area of public service for the
development, financing, operation and maintenance of infrastructural
facilities such as, roads, bridges, ports, etc. An arrangement typically
involves a private sector entity (an operator) constructing the
infra-structural facilities used to provide the public service and
operating and maintaining those infrastructural facilities for a
specified period of time. The operator is paid for its services over the
period of the arrangement through user fees or the grantor pays
annuity. Such an arrangement is often described as a
‘build-operate-transfer’ (BOT) or a ‘public-to-private service
concession arrangement’. A feature of these service arrangements is:

1.
The grantor (generally the Government or a public sector company)
controls or regulates what services the operator must provide with the
infrastructural facilities, to whom it must provide them, and at what
price; and
2. The grantor controls through ownership, beneficial
entitlement or otherwise any significant residual interest in the
infrastructural facilities if remaining at the end of the term of the
arrangement.

Typically under current Indian GAAP, practice is
that the grantor records the cost of constructing the infra-structure as
fixed assets or in some cases as intangible assets. No profit is
recognised on the construction, since it is not appropriate to recognise
any profit on constructing fixed assets/intangible assets for own use.

However,
if one were to look more deeply into the current Indian GAAP, a more
appropriate accounting interpretation of the arrangement would be as
follows:

1. The infrastructure facilities should not be
recog-nised as property, plant and equipment of the operator, because
the contractual service arrangement does not convey the right to control
the use of the public service infrastructure facilities to the
operator. The operator has access to operate the infrastructure
facilities to provide the public service on behalf of the grantor in
accordance with the terms specified in the contract.

2. Under
the terms of contractual arrangements, the operator acts as a service
provider. The operator constructs infrastructure facilities used to
provide a public service and operates and maintains those infrastructure
facilities (operation services) for a specified period of time.

3.
The operator should recognise and measure revenue in accordance with
Accounting Standard (AS) 7, Construction Contracts and Accounting
Standard (AS) 9, Revenue Recognition for the construction and operating
the services it performs.

If the operator performs more than one
service under a single contract or arrangement, consideration received
or receivable should be allocated by reference to the relative fair
values of the services delivered, when the amounts are separately
identifiable.

4. Paragraph 34 of AS 26 Intangible Assets
states that “An intangible asset may be acquired in exchange or part
exchange for another asset. In such a case, the cost of the asset
acquired is determined in accordance with the principles laid down in
this regard in AS 10, Accounting for Fixed Assets.” Paragraph 11.1 of AS
10 states that “When a fixed asset is acquired in exchange for another
asset, its cost is usually determined by reference to the fair market
value of the consideration given. It may also be appropriate to consider
the fair market value of the asset acquired, if this is more clearly
evident.”

5. If the operator provides construction services,
the consideration received or receivable by the operator should be
recognised at its fair value. The consideration may be, rights to a
financial asset (annuities are received from the government), or an
intangible asset (toll charges are collected from public).

6. The operator should recognise a financial asset when it receives annuities from the grantor.

7.
The operator should recognise an intangible asset to the extent that
it receives a right (a licence) to charge users of the public service.

Let’s consider a simple example of how the intangible asset model would work.

Example

The
terms of the arrangement requires an operator to construct a road
within two years and maintain and operate the road to a specified
standard for eight years (i.e. years 3–10). At the end of year 10, the
arrangement will end and the road ownership will continue with the
government. The operator estimates that the costs it will incur to
fulfill its obligations will be as shown in Table 1.

Table 1 — Estimate of Costs

Assume
the operator collects Rs. 200 per year in years 3–10 from users of the
road. The user rates are fixed by the government. Fair value of
construction services is forecast cost plus 5%.

The operator
recognises contract revenue and costs in accordance with AS 7,
Construction Contracts and AS 9, Revenue Recognition. In year 1, for
example, construction costs of Rs. 500, construction revenue of Rs. 525
(cost plus 5 per cent), and hence construc-tion profit of Rs. 25 is
recognised in the statement of profit and loss. The operator provides
construction services to the grantor in exchange for an intangible
asset, i.e. a right to collect tolls from road users in years 3–10. In
accordance with AS 26, Intangible As-sets, the operator recognises the
intangible asset at cost, i.e. the fair value of consideration
transferred to acquire the asset, which is the fair value of the
consideration received or receivable for the construc-tion services
delivered. In accordance with AS 26, the intangible asset is amortised
over the period in which it is expected to be available for use by the
operator, i.e. years 3–10. The depreciable amount of the intangible
asset (Rs. 1,050) is allocated using a straight-line method. The annual
amortisation charge is therefore Rs. 1,050 divided by eight years, i.e.
Rs. 131 per year. The road users pay for the public services at the same
time as they receive them, i.e. when they use the road. The operator
therefore recognises toll revenue when it collects the tolls. The
statement of P&L for years 1-10 will appear as shown in Table 2.

The
above example has been kept simple and numerous other complications
have not been considered such as capitalisation of borrowing costs,
resurfacing obligation, negative grants, revenue sharing arrangements,
etc.

To sum up, it could be said that the current Indian GAAP is
not explicit as to how BOT contracts should be accounted for.
Therefore, there appears to be two methods in which BOT contracts can be
accounted.

Method 1

A classic and conventional
method has been to recognise the construction cost of the infrastructure
as fixed asset and depreciate it over a period of time. The
corresponding revenue on user fees is recognised when user fees are
collected.

Challenges in applying method 2

Scope

Since
the accounting model involved in method 2 is so different from the
traditional ”fixed asset” model, it is critical to determine whether an
arrangement falls within its scope. This is not always straightforward
due to the complexity of the contracts setting out the key terms of the
concession arrangements. One challenge that may arise, is in
deter-mining whether the government body controls any significant
residual interest in the infrastructure asset at the end of the
concession arrangement. Another challenge that may arise in some
circumstances, is to determine whether the government in substance
controls the user price.

Intangible asset, financial asset, or both

The
next step is to determine which of the two ac-counting models
(intangible asset or financial asset) to apply. This decision will have a
significant impact on the revenues recognised from the contract. For
example, it is not uncommon for a contract accounted for by applying the
intangible model to give rise to double the revenues, compared to a
contract with nearly identical cash flows that is accounted for using
the financial asset model. Fortunately, the selection of the model to
apply is not an option. Rather, the model flows from whether the
operator has the right to charge for services (intangible model) or the
right to receive cash flows from the grantor (financial asset). This may
require careful analysis, since a contract that initially appears to
fall within the intangible model may have an element of guaranteed cash
flows. For example, if in the early years of the contract, the
government body guarantees a minimum level of revenues from the
operation of a new expressway to encourage private investment, there may
be both a financial asset and an intangible asset. Accounting for these
“combined model” concessions can become very complex, since costs and
revenues must be divided between the two components of the contract.
Dividing the total consideration into the two components may involve the
use of significant management judgment and estimation.

Estimates and fair values

Accounting
for concession arrangements typically involves an extensive use of
estimates and valuations, which are expected to have a significant
impact on the company’s financial statements. For example, revenues and
costs need to be recognised for the construction of the infrastructure
asset in accordance with AS-7. Since the contract is unlikely to specify
separately the revenue from construction, it is typically necessary to
impute construction revenues by applying an appropriate margin to the
construction costs, and to assign the balance of revenue to operations,
maintenance, etc. Companies may need to use either internal or external
benchmarking for similar construction contracts, since an assessment of
profitability on a service concession arrangement is normally made on an
overall IRR basis and not separately for the construction and operation
phases of the project.

Accounting for negative grants

Certain
arrangements include the provision for negative grants, wherein the
operator is required to make the payment to the grantor during the
duration of the arrangement. The negative grant may be either in the
form of fixed payment (upfront or annual throughout the service
concession arrangement) or in the form of a percentage of revenue earned
during the arrangement. The upfront fixed payment should be treated as
an intangible asset. In the case of annual fixed payment, intangible
assets should be recognised at the present value of the annual amounts.
However, there are mixed practices under Indian GAAP in these matters.
Where the negative grant is in the form of share in the percentage of
revenue earned during concession arrangement, the company should assess
whether the revenue is to be shown on a net or gross basis.

Other factors

Numerous
other issues need to be considered such as capitalisation of borrowing
costs, provision for maintenance obligation, etc. and the efforts
involved in applying method 2 should not be undermined.

Issue

Parent
Ltd is a listed entity. Parent Ltd has set up a special purpose vehicle
(SPV) which is its 100% subsidiary, for the purposes of entering into
an arrangement with NHAI. SPV has entered into BOT contract with NHAI.
As per the Agreement, NHAI has granted an exclusive right to the SPV to
construct, operate and maintain the road for a period of thirty years.
The SPV has sub-contracted the construction for 60% of the road contract
to Parent. In 2012-13, Parent has executed the work of above road
project and the profit margin is approximately 5%. Parent recognises the
margin earned in its stand-alone financial statements. Whether Parent
should eliminate the profit on revenue received from SPV from
construction services provided to the SPV, in its consolidated financial
statements (CFS)?

Response

The response to the
above question will depend on the method the Parent is following with
respect to the accounting of service concession arrangements.

Method 1

If
method 1 as described above is used, Parent should eliminate the profit
on revenue received from SPV from construction services provided to the
SPV, in its

CFS. This is primarily for two reasons. Firstly,
paragraph 10.1 of AS-10 Accounting for Fixed Assets states as follows
“In arriving at the gross book value of self-constructed fixed
assets…………

Any internal profits are eliminated in arriving at such costs.” Secondly, paragraph 16 of AS-21 Consolidated Financial

Statements
states as follows “Intragroup balances and intragroup transactions and
resulting unrealised profits should be eliminated in full.”

Method 2

If
method 2 is applied, Parent should not eliminate the profit on revenue
received from SPV from construction services provided to the SPV, in its
consolidated financial statements; provided method 2 is applied in its
entirety. Under this method, the company applies the principles of the
Guidance Note/IFRIC 12. The group is not controlling the infrastructure,
which in substance has been sold to the grantor in lieu of a right to
use (intangible asset). As the group has sold the infrastructure, an
appropriate profit should be recognised. In other words, the arrangement
is seen as providing construction services to the government, rather
than a construction service provided by the Parent to the SPV.

The
application of accounting treatment above should not be seen as a means
of applying the Indian GAAP principles (method 2) to selectively
recognise the profits that Parent has made on its billing to the SPV.
Rather, it is a holistic application of Indian GAAP principles to the
entire service concession arrangement. Therefore, in addition to the
cost incurred by the SPV on billings by Parent, there may be other cost
incurred in executing the contract. The Indian GAAP principles
enumerated above should be applied to the total construction cost
including those charged by Parent to the SPV. This would mean that in
addition to not eliminating the profit made by the Parent on its billing
to the SPV, Parent would also have to recognise an additional profit
representing the margin on other cost. Further, all service concession
arrangements that fulfils certain specific criteria (and explained in
this article), will have to be accounted for in this manner. In
ad-dition, other matters may need careful consideration such as
provision for maintenance and resurfacing obligation, negative grant,
sharing of revenue with grantor, capitalisation of borrowing cost, etc.

Thus
under method 2, the entire arrangement is recorded based on Guidance
Note/IFRIC 12 principles. There are numerous challenges in applying
method 2 and it is not a straight forward exercise. This may have the
effect of recognising the profit made on the construction services
including the billings of the Parent to the SPV; however, it has too
many other repercussions and accounting consequences (discussed in this
paper) which would need careful consideration.

Method 2
An
alternative method under current Indian GAAP is to recognise the
construction of the infrastructure as a construction service rendered to
the grantor in exchange of an acquisition of a right to use (an
in-tangible asset) or an unconditional right to annuities (a financial
asset). Those principles of current Indian GAAP are more clearly
articulated in the Exposure Draft Guidance Note on Accounting for
Service Concession Arrangements. International Financial Reporting
Standards IFRIC 12 Service Concession Arrangements also has similar
requirements. The working model with respect to this method has been
explained in this article, using a simple example where the construction
service is exchanged for an intangible asset (right to use). There are
numerous challenges in applying method 2, which are described below.
When method 2 is used, it should be applied to all contracts in the
group that meet the requirements set out in the Guidance Note ED/ IFRIC
12.

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CENVAT credit — Landscaping of factory garden — Held, it is social responsibility and statutory obligation of employer to maintain eco-friendly environment — Activities related to business and falls within the concept of ‘modernisation, renovation, repair, etc. of premises’ — Service tax paid on such services form cost of final products — Definition of input service wide enough to cover — Credit allowable. Medical and personal accident policy, catering services — Held, activities relating to bu<

Facts:

The respondent a manufacturer of excisable goods claimed credit of service tax paid on various services availed like: medical and personal accident insurances, personal vehicle services, landscaping of factory garden, etc. Revenue denied the credit and the order was also upheld by the CCE — Appeals. The Tribunal held that the aforesaid services fall within the phrase ‘activities relating to business’ and therefore, the assessee was eligible to claim the credit. Against such order, the Revenue preferred appeal before the High Court.

Held:

Affirming the order of the Tribunal the Court held that in view of CAS-4, the above services are taken into consideration while fixing the costs of the final products and in such a case, the assessee would be entitled to the CENVAT credit of the tax paid on such services. The Court also observed that the definition of the input service is very broad. What is contained in the definition is illustrative in nature. Landscaping of factory garden falls within the concept of ‘modernisation, renovation, repair, etc. of premises’. It is social responsibility and statutory obligation of employer to maintain eco-friendly environment. Moreover, medical and personal accident premium, vehicle insurance, etc. form part of salaries of employees and are activities relating to business. Therefore, the Tribunal’s order was upheld allowing credit of such items.

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Sale Price in Works Contract vis-à-vis Cost plus Gross Profit Method

Introduction
Works contract is a composite transaction where supply of materials and supply of labour are both involved. As held by Hon’ble Supreme Court in the case of Builders Association of India vs. UOI (73 STC 370), the works contract transaction can be notionally divided into supply of materials and supply of labour. It is further held that the sales tax/VAT can be levied only to the extent of value of goods.

A further question arose as to how value of the goods can be found out from composite value of the contract. The issue has again been dealt with by the Supreme Court in the case of Gannon Dunkerly & Co. vs. State of Rajasthan (88 STC 204). In relation to finding out value of goods, Supreme Court has observed as under;

“The aforesaid discussion leads to the following conclusions:

(1) to (3)……

(4) The tax on transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract falling within the ambit of article 366(29-A)(b) is leviable on the goods involved in the execution of a works contract and the value of the goods which are involved in the execution of works contract would constitute the measure for imposition of the tax.

(5) In order to determine the value of the goods which are involved in the execution of a works contract for the purpose of levying the tax referred to in article 366(29-A)(b) it is permissible to take the value of the works contract as the basis and the value of the goods involved in the execution of the works contract can be arrived at by deducting expenses incurred by the contractor for providing labour and other services from the value of the works contract.

(6) The charges for labour and services which are required to be deducted from the value of the works contract would cover (i) labour charges for execution of the works, (ii) amount paid to a sub-contractor for labour and services, (iii) charges for obtaining on hire or otherwise machinery and tools used for execution of the works contract, (iv) charges for planning, designing and architect’s fees, and (v) cost of consumables used in the execution of the works contract, (vi) cost of establishment of the contractor to the extent it is relatable to supply of labour and services, (vii) other similar expenses relatable to supply of labour and services, and (viii) profit earned by the contractor to the extent it is relatable to supply of labour and services.

(7) To deal with cases where the contractor does not maintain proper accounts or the account books produced by him are not found worthy of credence by the assessing authority, the Legislature may prescribe a formula for deduction of cost of labour and services on the basis of a percentage of the value of the works contract but while doing so, it has to be ensured that the amount deductible under such formula does not differ appreciably from the expenses for labour and services that would be incurred in normal circumstances in respect of that particular type of works contract. It would be permissible for the Legislature to prescribe varying scales for deduction on account of cost of labour and services for various types of works contract.

(8) While fixing the rate of tax, it is permissible to fix a uniform rate of tax for the various goods involved in the execution of a works contract, which rate may be different from the rates of tax fixed in respect of sales or purchase of those goods as a separate article.”

Determination of sale price in works contract
From the above observations of the Supreme Court, it is clear that value of the goods on which sales tax can be levied is to be arrived at by taking contract value as the base. From the contract value, labour portion can be deducted as narrated above and where determination of labour charges is not possible, it is to be arrived at by taking standard deduction as may be prescribed by the government.

Cost plus gross profit method
In the present controversy about levy of tax on builders and developers, one issue which was hotly discussed was about adopting cost plus gross profit method. One view was that, it is not mandatory to start from contract value and take the deductions for labour charges to arrive at value of goods. As per the said view, the value of the goods can be arrived at by taking cost price of the materials involved and adding gross profit to the same. In other words, the aggregate of cost of the goods involved and gross profit margin on the same will constitute value of goods for levy of tax.

The Commissioner of Sales Tax, Maharashtra State, issued Circular bearing no. 18 T of 2012 dated 26.9.2012. In this circular, Commissioner of Sales Tax, amongst others, clarified that the working as per cost plus gross profit is not the statutory method and will not be admissible. It was clarified that the working should be as per statutory methods, as mentioned in the circular i.e. as per rule 58 read with rule 58(1A) of the MVAT Rules, 2005 or as per the composition schemes. In other words, it was effectively clarified that the cost plus gross profit method will not be admissible.

Writ Petition before Bombay High Court
A Writ Petition was filed before Hon’ble Bombay High Court by the Builders Association of India (Writ Petition (LODG) No. 2440 of 2012). Amongst others, it was challenged that the circular disallowing cost plus gross profit method is unconstitutional, as well as ultra virus. The plea was that the same method should be allowed to work out the value of goods. Hon’ble Bombay High Court has decided the said Writ Petition vide judgment dated 30th October, 2012. In respect of the above plea about the method of working out value of goods for levy of tax, Hon’ble Bombay High Court has observed as under;

“17. Essentially, what rule 58(1A) does is to provide a particular modality for determining the value of goods involved in the execution of construction contracts where an interest in land or land is also to be conveyed under the contract. The provisions of rule 58(1A) are not under challenge. Where the Legislature has an option of adopting one of several methods of determining assessable value, it is trite law that the legislature or its delegate can choose one among several accepted modalities of computation. The legislature while enacting law or its delegate while framing subordinate legislation are legitimately entitled to provide, in the interest of uniformity, that a particular method of computation shall be adopted. So long as the method which has been adopted is not arbitrary and bears a reasonable nexus with the object of the legislation, the Court would not interfere in a statutory choice made by the legislature or by its delegate. In the present case, rule 58(1A) mandates on how the value of goods, involved in the execution of a construction contract at the time of the transfer of property in the goods is to be determined in those cases where contract also involves a transfer of land or interest in land. The Circular dated 26.9.2012 does no more than specify the mandate of the statute. The Circular has not introduced a condition by way of a restriction which is not found in the statute. Plainly, rule 58(1A) does not permit the developer to take recourse to a method of computation other than what is specified in the provision. Hence, the Circular dated 6th September 2012 was only clarificatory.”

Observing as above, at the end of the judgment, Hon’ble High Court has held that the circular is not ultra virus.

In view of above, it can be said that effectively Hon’ble High Court has put a seal of approval on the proposition made in the circular. The contractor has to find out the value of goods as per the statutory provisions and cannot adopt other methods like cost plus gross profit etc.

Conclusion

The above judgment is in relation to builders and developers. However, the legal position discussed is about validity of the method for finding out the value of goods for levy of VAT. From the judgment, it is clear that no method other than statutory method can be adopted for working out the value of goods. Therefore, though the judgment is in relation to builders and developers, it will govern the position in relation to other contracts also. In other words, even in relation to other contracts, it may be difficult to adopt cost plus gross profit method and the working may have to be done as per the statutory methods.

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Certain Important Amendments in MVAT Act and Rules

Introduction

Amendments are effected in the MVAT Act, 2002 and the MVAT Rules, 2005 as a consequence to budget proposals for the year 2012-13. Though there are a number of amendments, few important amendments, having a wide effect are noted below.

Amendments in MVAT Act, 2002

(a) Levy of purchase tax and consequential changes

Under the MVAT Act, 2002, up till today there was no scheme for levy of purchase tax. However, now the same has been introduced by inserting section 6A, and section 6B in the MVAT Act, 2002. As per section 6A purchase tax is provided on cotton, purchased from unregistered dealer and which is branch-transferred out side the state or used in manufacture of tax-free goods or taxable goods, where such manufactured goods are branch-transferred out side the state. As per section 6B, purchase tax is provided on oil seeds in the same circumstances, as discussed in relation to cotton as above.

The rate of purchase tax will be the same as mentioned in the schedule i.e., as applicable on the sale of above goods from time to time. The purchase tax provision of section 6B has come into effect from 1-5-2012 and the provision of section 6A will come into force as and when a date is notified for the said purpose.

The purchase tax so levied will be eligible for set-off as per the scheme of set-off.

Consequential amendments have also been made in section 3(2), 3(4) and s.s 3(5A) has been newly inserted. This is to provide liability for registration based on purchase turnover, which is liable to purchase tax as per the above sections 6A and 6B.

(b) Late fee for delayed filing of return

S.s (6) has been inserted in section 20 of the MVAT Act, 2002, whereby late fee of Rs.5000 is prescribed in case of delayed filing of return. It may be remembered that at present, there is section 29(8) providing for levy of penalty in case of delayed filing of return. However, in case of Vasu Enterprises (Writ petition No. 1451 of 2011, dated 8-9-2011) Bombay High Court held that penalty u/s.29(8) cannot be levied without hearing opportunity. This would require the Sales Tax Department to issue show-cause notice in each case and to pass a speaking order. It appears that, to avoid above exercise, this concept of late fee has been introduced. The said late fee amount will be required to be paid before the delayed return is uploaded. The provision has not come into effect till today, but will be brought into operation by issue of Notification. The penalty provision of section 29(8) will also become inoperative from such date.

The above provision shows harsh approach of the Department towards dealers. There can be several reasons for delay. Some of them will be beyond the control of the dealer. Under the above circumstances, levying mandatory late fee of Rs.5000 is not justified. Further, a dealer may not be liable to pay tax but will be liable to pay late fee, simply because the return is delayed. The constitutional validity of such levy is also debatable as there cannot be said to be ‘quid pro quo’ for providing such a fees.

(c) Mandatory part payment

As per present appeal provisions, in section 26 of the MVAT Act, 2002, the litigant dealer is entitled to get stay order upon filing appeal. The Appellate Authority has discretionary power to fix suitable amount of part payment as a condition for grant of stay. Now a new proviso has been added in section 26(6). By this proviso, it is provided that if the matter has been adjourned on 3 occasions on the request of the appellant or the appellant has failed to attend on 3 occasions, then the part payment should become 15% of the disputed dues or Rs.15 crore, whichever is less. Thus, the appellant will be required to make good the difference between earlier part payment and amount calculated as above. If such payment is not made, then the stay will come to an end and the disputed demand will be open for recovery. Thus, one more strict provision has been introduced.

The above provision will not apply to appeals under the BST Act, 1959. However, for VAT appeals the dealers will be required to be more attentive. It can also be noted that when the appeal is being adjourned, it should be carefully seen whether the adjournment is on behest of the appellant or on account of the Department. The factual position should get recorded accordingly in proceeding sheet, to avoid unnecessary counting of number of adjournments.

(d) Appeals to High Court

As per section 27, appeals can be filed before the Bombay High Court out of order passed by the MST Tribunal. Now, by insertion of section 26A, it is provided that the Commissioner will have power to notify monetary limit for filing appeals before the Bombay High Court. The provision is similar to such provision under the Income-tax Act. It is clarified that such non-filing of appeals due to monetary limits, will not prejudice subsequent cases. This provision is effective from 1-5-2012.

(e) Penalty for remaining unregistered

Section 29(2A) has been inserted in the MVAT Act, 2002 from 1-5-2012, by which penalty is provided for remaining unregistered dealer. The said penalty can apply for unregistered period after the date of coming into effect of above section i.e., 1-5-2012. The said penalty is 100% of the amount of tax payable during unregistered period. However, it will be discretionary qua levy as well as qua quantum in view of judgment of the Bombay High Court in case of Ankit International (46 VST 1).

(f) Tax collection at source (TCS)

A novel concept of TCS has been introduced in the MVAT Act, 2002 by insertion of section 31A.

TCS has been provided in the following two eventualities:

(i) When right for excavation of sand is auctioned. The notified person, auctioning the right will be liable to collect TCS.

(ii) The other eventuality is that the notified person having temporary possession or control over the goods, will be required to collect TCS.

Though, the provision has come into effect, the actual Notification notifying the persons and rate of TCS has still not been issued, therefore the provision is practically still not effective.

It can be seen that there is no provision for lesser collection or no collection, etc. Therefore, even if the buyer, from whom TCS is to be effected, is not liable to pay tax, still will be required to pay the TCS. Therefore, the provision can be claimed to be unconstitutional.

Certain important changes in MVAT Rules, 2005 Important changes have been effected by Notification dated 1-6-2012.

(a) Returns for unregistered period

As per section 20(1) registered dealers are liable to file returns i.e., returns are required to be filed from effective date of registration. However, now for unregistered period also returns are provided. For this purpose Rule 18(1) has been substituted. As per the said sub-rule, quarterly returns are prescribed for unregistered period and the last return from start of the quarter till date of registration. Thereafter the returns will be as a registered dealer. Of course, the returns for unregistered period can be filed only after getting registration.

The above provision appears to be not in consonance with provisions of section 20(1). However, for the sake of compliance, dealers will be required to file the returns for unregistered period also. It is expected that no late fee will be applicable in such case.

(b) Set-off on natural gas

In Rule 53, sub-rule (1A) has been inserted. By this new sub-rule 3% reduction is provided in respect of calculation of set-off on purchase of natural gas. This reduction will apply in the specified circumstances given in the rule. The language of the rule is not very clear. It appears that except where the natural gas is resold, the reduction will apply.

(c) Reduction in respect of branch transfer [Rule 53(3)]

Vide Notification dated 31-3-2012 the rate of reduction in case of branch transfer [rule 53(3)] has been enhanced from 2% to 4%. This is effective from 1-4-2012.

(d) Due date for submission of audit report in Form 704 (Rule 66)
Rule 66 has been amended so as to provide that audit report (Form 704) shall be submitted within eight months from the end of financial year. Earlier the due date for submission was within 10 months. (Thus the audit report for financial year 2011-12 will be required to be submitted by 30th November 2012.)

(e) Preservation of books of account, registers, etc. (Rule 68)

The books of account and other records, as required to be preserved u/r 68, will have to be preserved now for eight years from the expiry of financial year to which they relate. (Earlier these records were required to be preserved for a period of six years.)

Conclusion

There are many other amendments like changes in rate of tax, rules regarding forms for TCS, etc. However, for sake of brevity all these are not discussed here.

shailesh.kwebmaker

VAT on Builders and Developers in the State of Maharashtra

Although the title given above is very wide, the scope of this quick write up is limited to liability to pay tax on agreements for sale of flats or units in a building under construction by builders and developers in the State of Maharashtra, keeping in view the likely impact of recent decision of Bombay High Court in the matter of Maharashtra Chamber of Housing Industry and others (51 VST 168).

The controversy regarding liability to pay VAT on agreements for sale flats and units by builders and developers has been looming around for over six years. While the Sales tax Department has been contending that through such agreements the builder enters into a contract to construct building for and on behalf of the purchasers, therefore, such contracts fall under the category of ‘Works Contract’, the builders say these agreements are for sale of immovable property, thus liability to pay VAT does not arise.

It may be noted that in a case where a builder sells readymade flat i.e. after the flat is constructed, there is no controversy, it is considered as a sale of immovable property and there is no question of VAT liability. The debatable issue arises only in those cases where builder enters into an agreement for sale of flat with prospective buyer when the construction is yet to commence or is under progress. Such agreements are normally referred to as “Under Construction Contracts/Agreements”. Till the judgment of Hon’ble Supreme Court in case of K. Raheja Development Corporation vs. State of Karnataka 141 STC 298 (SC), such contracts were considered to be for sale of immovable property and the Sales Tax Department did not contemplate any levy on the same. However, after the above judgment a debatable position arose.

The Sales Tax Department of Maharashtra holds a view that the judgment is applicable in all cases, hence, will cover all “under construction agreements” for flats/premises. On the basis of this view the Commissioner of Sales Tax issued a Trade Circular, viz. Circular No.12T of 2007 dated 7th February, 2007. Similarly, a new definition of “Works Contract” was introduced by amending section 2(24) of Maharashtra Value Added Tax Act. 2002 (MVAT Act), w.e.f. 20th June 2006, so as to bring the position of the said definition at par with the definition as was under consideration before the Supreme Court in the case of K Raheja. Changes were also made to the Maharashtra Value Added Tax Rules, 2005, vide notification dated 1st June, 2009 (with retrospective effect from 20th June, 2006), in respect of determination of value in case of works contracts involving such agreements.

However, inspite of the above mentioned changes and the judgment of the Supreme Court, the builders as well as the purchasers of such flats and units held a strong view that in most of the cases, it was possible to contend that such agreements (“under construction contracts”) were not covered under the Sales Tax Laws and they were not liable to tax under MVAT Act as a Works Contract.

Amongst others, the facts of K. Raheja’s case were cited vis-à-vis agreement for sale of flats and units as being generally entered into in the State of Maharashtra. The facts of K. Raheja’s case were such that there the value for undivided share in land was shown separately and the cost of construction was shown separately. However, when such is not the position i.e. when the cost of land and construction are not shown separately, then such contracts cannot be made liable to tax. There is no enabling power with the State Government to bifurcate the composite value into land and construction. Hence, if such construction agreements are considered to be for sale of immoveable property and they cannot be taxed as works contracts under Sales Tax Laws.

With this view in mind, the association of builders and developers i.e. Maharashtra Chamber of Housing Industry (MCHI) and others preferred a writ petition before the Bombay High Court challenging the constitutional validity of the amendment to section 2(24) of MVAT Act, consequentially challenging the insertion of Rule 58(IA) of MVAT Rules, 2005 and the Circular dated 7th February, 2007. A few others also filed similar writ petitions, including challenging the notification dated 9th July, 2010. The Bombay High Court recently disposed of this group of writ petitions vide its order dated 10th April, 2012.

Among several arguments, on behalf of petitioners, main arguments were on the ground that the agreement for sale entered into between a builder/ developer and the purchaser of a flat is basically agreement to sale an immovable property. Such an agreement cannot be considered as a ‘works contract’.

A contract which involves sale of immovable property cannot be split by the State Legislature, even if there is an element of a works contract. In other words the State Legislature cannot locate a sale of immovable property and then attempt to trace out what are the goods involved in the execution of the contract; It was also argued that a works contract involves only two elements viz.

(i) the transfer of property in goods; and

(ii) supply of labour and services. If a third element is involved in the contract viz. the sale of immovable property it does not constitute a works contract and hence to such a contract, the legal fiction created by Article 366(29A) does not apply.

The amendment to Section 2(24) has the effect of expanding the definition of the expression sale of goods under Article 366(29A) and is, therefore, beyond the legislative competence of the State Legislature. The Trade Circular dated 17th February, 2007, the amendment to Rule 58 and the Notification dated 9th July, 2010 indicate the agreements which are contemplated to be brought within the purview of Section 2(24). Those agreements are agreements simplicitor for the sale of immovable property; A contract which is governed by the Maharashtra Ownership Flats (Regulation of the Promotion of Construction, Sale, Management and Transfer) Act, 1963 (MOFA) cannot be regarded as a works contract. Such a contract is an agreement for the purchase of immovable property in its complete sense.

In a works contract property gets transferred as a result of accretion during the course of the execution of the contract and there is no transfer of immovable property simplicitor. The essence of a works contract is the transfer of property by accretion. Consequently, where a contract involves sale of immovable property, it can never be regarded as involving a works contract.

When a promoter appoints a sub contractor and gets a building constructed, that contract is a works contract under Article 366(29A) and a transfer of the property in the goods involved in the execution of the works contract takes place to the developer. That would be the first deemed sale. When the developer enters into an agreement with a purchaser under the MOFA thereafter, this does not involve a sale of goods since that would amount to a second deemed sale of the same goods which cannot be brought to tax.

On the other hand, the learned Advocate General, appearing on behalf of the State Government, submitted that:

(a) The provisions of Section 2(24) which defines the expression “sale” fall within the compass of Article 366(29A);

(b) A works contract is a contract to execute works and encompasses a wide range of contracts. The expression works contract is not restricted to building contracts having only two elements viz. the sale of material and goods and the supply of labour and services;

(c) The well settled connotation of the expression works contract is that a building contract may also involve in certain situations a sale of land;

(d) An unduly restrictive or contrived meaning should not be given to the provisions of Article 366(29A) of the Constitution otherwise the object underlying the constitutional amendment would be defeated;

(e) The purpose underlying the enactment of the deeming fiction in Article 366(29A) was to override the limited definition of the expression sale in the Sale of Goods Act, 1930 and to isolate the sale of goods element involved, inter alia, in a contract which is a works contract;

(f) A works contract is one where there is a con-tract to do works and it does not cease to be such merely because any other obligation exists.

(g) In an agreement which is governed by the MOFA, a conveyance of the interest in the flat or at any rate an interest therein is created at the stage of the execution of an agreement under Section 4.

(h) The Trade Circular and the amendment to Rule 58(1A) are only clarificatory in nature.

The Hon’ble High Court, after considering rival sub-missions, referred to many judgments. The Hon’ble High Court, in its order, also went through the 61st Report of Law Commission, 46th Amendment to the Constitution of India, section 2(24) of MVAT Act, Rule 58(1) & 58(1A) of MVAT Rules, relevant circulars and notifications. Notable amongst others, the High Court referred to a publication i.e. ‘Hud-son’s Building and Engineering Contracts’ (Eleventh edition, page 3). The High Court, at para 22 of its order, noted as follows:

“Hudson’s Building and Engineering Contracts contains an instructive elucidation of a building or engineering contract:

‘A building or engineering contract may be defined, for the purposes of this book, as an agreement under which a person, in this book called variously the builder or contractor, undertakes for reward to carry out for another person, variously referred to as the building owner or employer, works of a building or civil engineering character. In the typical case, the work will be carried out upon the land of the employer or building owner, though in some special cases obligations to build may arise by contract where this is not so, for example, under building leases, and contracts for the sale of land with a house in the course of erection upon it.’

The extract from Hudson is indicative of the fact that in a typical case work will be carried out upon the land of the employer or building owner though in some special cases an obligation to build may arise by contract where this is not so. The author cites the illustration of building leases and contracts for the sale of land with a house in the course of erection upon it. The elaboration of the concept in Hudson is indeed on the same lines as the judgment of the Supreme Court in Builders’ Association which notes the variations implicit in the notion of works contracts.

Therefore, as a matter of first principle, it cannot be postulated that a contract would cease to be a works contract if any more than only two elements are involved in its execution viz. (i) a supply of goods and materials; and (ii) performance of labour and services. In the modern context and having regard to the complexity of work, it would be simplistic to reduce the connotation of works contracts to contracts only involving the aforesaid two elements. When the Forty Sixth Amendment was enacted, no decided case had reduced the substratum of a works contract only to contracts involving the aforesaid two elements. As a matter of principle it would not be permissible to constrict or restrict the scope of works contracts and to exclude from their purview contracts involving situational modifications. Indeed, as Hudson’s treatise notes, a works contract may even involve a factual situation of a building lease or a contract for the sale of land with house in the course of erection upon it.”

The High Court further noted at para 24:

“Works contracts have varying connotations. The scale and complexity of commercial transactions in modern times has increased on a scale that has been unprecedented before.

The modern complexity of business is as much a product of as it is a cause for the complexity of regulatory mechanisms. Traditional forms of contract undergo a change as business seeks to meet new requirements and expectations from service providers in an increasingly competitive market environment. Increasing competition, following the opening up of the Indian economy to increased private investment has had consequences for the land market and the business of building and construction. The nature and complexity of building contracts has changed over time. The obligations which business promoters assume under works contracts may vary from situation to situation and contractual clauses are drafted to meet the demands of the trade, the needs of consumers of services and the requirements of regulatory compliance. So long as a contract provides obligations of a contract for works, and meets the basic description of a works contract, it must be described as such. The assumption of additional obligations under the contract will not detract from the situation or the legal consequences of the obligations assumed.”

While dealing with various provisions of the MOFA, the High Court referred to various decisions under MOFA and under Bombay Stamp Act, 1958, and, noted as follows:-
“The Act imposes restrictions upon a developer in carrying out alterations or additions once plans are disclosed, without the consent of the flat pur-chaser. Once an agreement for sale is executed, the promoter is restrained from creating a mortgage or charge upon the flat or in the land, without the consent of the purchaser. The Act contains a specific stipulation that if a mortgage or charge is created without consent of purchasers, it shall not affect the right and interest of such persons. There is hence a statutory recognition of the right and interest created in favour of the purchaser upon the execution of a MOFA agreement. Having regard to this statutory scheme, it is not possible to accept the submission that a contract involving an agreement to sell a flat within the purview of the MOFA is an agreement for sale of immovable property simplicitor. The agreement is impressed with obligations which are cast upon the promoter by the legislature and with the rights which the law confers upon flat purchasers.

Agreements governed and regulated by the MOFA are not agreements to sell simpiciter, as construed in common law. The legislature has intervened to impose statutory obligations upon promoters; obligations of a nature and kind that are not traceable to the ordinary law of contract.”

The Hon’ble Court, at para 30 of the order, also referred to certain provisions of Maharashtra Apartment Ownership Act, 1970, and noted:

“The provisions of the Apartment Ownership Act, 1970 hence recognise an interest of the purchaser of an apartment, not only in respect of the apartment which forms the subject matter of the purchase, but an undivided interest, described as a percentage in the common areas and facilities.”

In conclusion, while upholding the constitutional validity to of section 2(24) of MVAT Act, the High Court noted that “The submission which has been urged on behalf of the petitioners proceeds on the foundation that a works contract is a contract for the purpose of work which involves only two elements viz. a supply of goods and material and a supply of labour and services. Works contracts have numerous variations and it is not possible to accept the contention either as a matter of first principle or as a matter of interpretation that a contract for work in the course of which title is transferred to the flat purchaser would cease to be a works contract. As the Supreme Court noted in its judgment in Builders’ Association of India vs. Union of India (1989) 2 scc 645, the doctrine of accretion is itself subject to a contract to the contrary. The provisions of the MOFA, enacted in the State of Maharashtra, evince a legislative intent to protect the interest of flat purchasers by creating an interest in the property which is agreed to be acquired, in terms of the statutory provisions.”

The challenge to Rule 58(1A) was rejected on the ground that the legislature had acted within the field of its legislative powers in devising a measure for the tax by rightly excluding cost of land from the value liable to tax.

Circular, dated 7th February, 2007, was held to be clarificatory in nature, and, the notification dated 9th July, 2010 was upheld on the basis that the composition scheme is made available at the option of a registered dealer. There is no compulsion or obligation upon a registered dealer to settle or opt for a composition scheme.

Although, Bombay High Court has dismissed the writ petitions upholding the constitutional validity of the amendments to section 2(24), certain aspects still remain to be answered, one of them may be the basic route of amendment i.e. the K. Raheja’s case, which is pending for consideration before a larger bench of the Supreme Court. A similar issue is also involved in the matter of Larsen & Toubro. Thus, whether an agreement for sale of flats (under construction agreement) can be included in the definition of works contract (and, therefore, can be dissected into three elements i.e. land, labour and goods) or it is to be considered as an agreement for sale of immovable property only (as that is the substance as well as the intention of the parties), the final answer can be provided now only by the Supreme Court.

However, till the Supreme Court provides us guidance in the matter, the sales tax authorities in Maharashtra can enforce the levy of tax on all such transactions of agreements to sale flats (under construction contracts), entered into on or after 20th June, 2006.

The question, therefore, arises how to calculate the quantum of tax which a builder/developer may be liable to pay and whether the same can be passed on to the ultimate purchasers of such flats and units.

Let us now consider the relevant provisions of MVAT in this regard. It may be noted that once it is accepted that such “under construction agreements” are covered by the concept of ‘works contract’ it follows that the builder has to be considered as a contractor and the purchaser of flat as the principal. Thus, all such provisions as are applicable to a normal contractor will apply to the builder also. The following important aspects may be noted in this regard:

1. The liability to pay tax under the MVAT Act is on the dealer (as defined). A dealer having turnover of sales more than the prescribed limits is liable to take registration.

2. A registered dealer shall pay tax on his turnover of sales of ‘goods’ at the rates prescribed in the Schedule. Before making payment of tax as above he is entitled to deduct the amount of input tax credit (setoff of taxes paid on purchases) as may be available to him in accordance with the Rules.

3. An unregistered dealer, although liable to pay tax on his turnover of sales, is not entitled to collect tax from the purchasers and also not entitled to claim input tax credit.

4. In case of works contract, tax is levied under the concept of ‘deemed sale’ of goods. Thus, the rate of tax applicable has to be considered with reference to the nature of goods involved, the property in which passes from the contractor to the principal in the course of execution of works contract.

5. As the agreements for sale of flats have one composite value of the transaction, there is no price mentioned separately for land, services and goods, the value of goods involved has to be determined in accordance with the provisions of Rule 58 of MVAT Rules.

6. Rule 58(1) provides for deduction of various charges in relation to services and Rule 58(1A) provides for deduction in respect of value of land.

7. In case of construction of building done through sub-contractor/s, deduction is also available for amounts paid to sub-contractor/s.

8. In case of difficulty in arriving at the value of various services involved in the execution of works contract for the purposes of deduction u/r 58(1) a table is appended to the Rule, listing various types of contracts and a lumpsum percentage of deduction from the total contract value. (In case of construction of building contract, rate of deduction on account of services is provided at 30%.)

9. For agreements, registered on or after 1st April, 2010, there is a specific composition scheme, designed for these kinds of agreements, whereby a registered dealer (builder) may opt to discharge his tax liability by paying composition money @ 1% of total agreement value. Although the composition scheme contains certain conditions and restrictions such as no deduction u/r 58 and no setoff etc., many may find it easy to follow.

10. There is another composition scheme, known as 5% Composition Scheme, applicable to construction contracts (as defined). However, the said scheme was designed in the year 2006 with reference to normal construction contracts. (i.e. contracts having basically two elements supply of goods and labour). The Rule to provide deduction for value of land was introduced in the year 2009 and thereafter the composition scheme of 1% was notified, which has a specific reference to agreements entered into by builders and developers including value for transfer of interest in land.

11. For agreements, registered before 1st April, 2010, till a specific scheme is designed by the Government, the builders may have to go through the exercise of determining value u/r 58, calculate setoff of taxes paid on input and discharge their tax liability.

shailesh.kwebmaker

Self Supply of Services

Preliminary:

Taxability of self supply of services (i.e. transactions between mutual concerns and its members/transactions between various units a single legal entity) has been a contentious issue prior to 1/7/12, more particularly in the context of cross border transactions due to deeming provisions in section 66A of the Finance Act, 1994 (Act) as existed prior to 1/7/12.

An attempt is made to discuss the tax implications of self supply of services under the Negative List based Taxation regime introduced w.e.f. 1/7/12, more particularly in regard to cross border transactions.

Relevant Statutory Provisions (w.e.f. 1/7/12)

Section 65 B(44) of the Finance Act, 1994 (as amended)

“Service” means any activity carried out by a person for another for consideration, and includes a declared service, but shall not include –

a) An activity which constitutes merely, –
I) A transfer of title in goods or immovable property, by way of sale, gift or in any other manner; or

II) Such transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A) of article 366 of the Constitution; or III) A transaction in money or actionable claim;

b) a provision of service by an employee to the employer in the course of or in relation to his employment;

c) fees taken in any Court or Tribunal established under any law for the time being in force.

Explanation 1. – For the removal of doubts, it is hereby declared that nothing contained in this clause shall apply to, –

(A) the functions performed by the Members of Parliament, Members of State Legislative, Members of Panchayats, Members of Municipalities and members of other local authorities who receive any consideration in performing the functions of that office as such member; or

(B) the duties performed by any person who holds any post in pursuance of the provisions of the Constitution in that capacity; or

(C) the duties performed by any person as a Chairperson or a Member or a Director in a body established by the Central Government or State Government or local authority and who is not deemed as an employee before the commencement of this section.

Explanation 2. – for the purposes of this clause, transaction in money shall not include any activity relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged.

Explanation 3. – For the purposes of this Chapter, –

a) an unincorporated association or a body of persons, as the case may be, and a member thereof shall be treated as distinct persons;

b) an establishment of a person in the taxable territory and any of his other establishment in a non – taxable territory shall be treated as having an establishment of distinct persons.

Explanation 4. – A person carrying on a business through a branch or agency or representational office in any territory shall be treated as having an establishment in that territory.

Service Tax Rules, 1994 as amended (ST Rules)

Rule 6A – (Export of Services)

The provision of any service provided or agreed to be provided shall be treated as export of service when –

a) The provider of service is located in the taxable territory,

b) The recipient of service is located outside India,

c) The service is not a service specified in section 66D of the Act,

d) The place of provision of the service is outside India,

e) The payment for such service has been received by the provider of service in convertible foreign exchange, and

f) The provider of service and recipient of service are not merely establishments of a distinct person in accordance with item (b) of Explanation 2 of clause (44) of Section 65B of the Act.

Where any service is exported, the Central Government may, by notification, grant rebate of service tax or duty paid on input services or inputs, as the case may be used in providing such service and the rebate shall be allowed subject to such safeguards, conditions and limitations, as may be specified by the Central Government, by notification.

Relevant Departmental Clarifications

Extracts from departmental clarifications titled “Education Guide” dated 20/6/12 issued in the context of Negative List based taxation of services introduced w.e.f. 1/7/12, are as under :

Para 2.4.1

What is the significance of the phrase “carried out by a person for another”?

The phrase “provided by one person to another” signifies that services provided by a person to self are outside the ambit of taxable service. Example of such service would include a service provided by one branch of a company to another or to its head office or vice versa.

Para 2.4.2

Are there any exceptions wherein services provided by a person to oneself are taxable?

Yes, Two exceptions have been carved out to the general rule that only services provided by a person to another are taxable. These exceptions, contained in Explanation 2 of clause (44) of section 65B, are:

An establishment of a person located in taxable territory and another establishment of such person located in non-taxable territory are treated as establishments of distinct persons. [Similar provision exists presently in section 66A(2)].

An unincorporated association or body of persons and members thereof are also treated as distinct persons. [Also exists presently in part as explanation to section 65].

Para 10.2.2

Can there be an export between an establishment of a person in taxable territory and another establishment of same person in a non – taxable territory?

No. Even though such persons have been specified as distinct persons under the Explanation to clause (44) of section 65B, the transaction between such establishments have not been recognised as exports under the above stated rule.

Mutuality Concept

Relevance under Service tax

Though the concept of “mutuality” has been a subject matter of extensive judicial consideration under Income tax & Sales tax, under Service tax, it has been tested judicially to a very limited extent. However, it assumed significance in the context of Club or Association Services Category introduced w.e.f 16/6/05, more particularly in the context of co-operative societies, trade associations & clubs.

The following Explanation was inserted at the Section 65 (105) of the Act w.e.f. 1/5/06:

“For the purpose of this section, taxable service includes any taxable service provided or to be provided by any unincorporated association or body of persons to a member thereof, for cash, deferred payment or any other valuable consideration.”

Attention is particularly invited to the following Explanation inserted to newly introduced section 65B(44) which defines ‘Service’:

Explanation 2 – For the purpose of this Chapter, –

a) An unincorporated association or a body of persons, as the case may be, and a member thereof shall be treated as distinct persons.

General Concept

It is widely known that no man can make a profit out of himself. The old adage that a penny saved is a penny earned may be a lesson in household economics, but not for tax purposes, since money saved cannot be treated as taxable income. It is this principle, which is extended to a group of persons in respect of dealings among themselves. This was set out by the House of Lords in Styles vs. New York Life Insurance Co.. (1889) 2 TC 460 (HL). It was clarified by the Privy Council in English and Scottish Joint Co -operative Wholesale Society Ltd. vs. Commissioner of Agricultural Income-tax (1948) 16 ITR 270 (PC), that mutuality principle will have application only if there is identity of interest as between contributors and beneficiaries.

It was the lack of such a substantial identity between the participants, with depositor shareholders forming a class distinct from the borrowing beneficiaries, that the principle of mutuality was not accepted for tax purposes for a Nidhi Company (a mutual benefit society recognised under section 620A of the Companies Act, 1956) in CIT vs. Kumbakonam Mutual Benefit Fund Ltd. (1964) 53 ITR 241 (SC).

Judicial Considerations under Service tax

The service tax authorities had issued show cause notices to various clubs demanding service tax under the Category of “Mandap Keeper” on the ground that the Clubs have allowed the members to hold parties for social functions. Two of such clubs disputed the levy before the Calcutta High Court viz:

Dalhousie Institute v. AC (2005) 180 ELT 18 (CAL)

Saturday Club Ltd. v. AC (2005) 180 ELT 437 (CAL)

In Saturday Club’s case, a members Club, permitted occupation of club space by any member or his family members or his guest for a function by constructing a mandap. On the principle of mutuality, there cannot be (a) any sale to oneself, (b) any service to oneself or (c) any profit out of oneself. Therefore, the Calcutta High Court, held that the same principle of mutuality would apply to Income tax, sales tax and service tax in the following words:

“……….. Income tax is applicable if there is an income. Sales tax is applicable if there is a sale. Service tax is applicable if there is a service. All three will be applicable in a case of transaction between two parties. Therefore, principally there should be existence of two sides/entities for having transaction as against consideration. In a members’ club there is no question of two sides. ‘Members’ and ‘club’ both are same entity. One may be called as principal when the other may be called as agent, therefore, such transaction in between themselves cannot be recorded as income, sale or service as per applicability of the revenue tax of the country. Hence, I do not find it is prudent to say that members’ club is liable to pay service tax in allowing its members to use its space as ‘mandap’.

……………

Therefore, the entire proceedings as against the club about the applicability of service tax stands quashed……”.

[Chelmsford Club vs. CIT (2000) 243 ITR 89 (SC) & CIT vs. Bankipur Club Ltd. (1997) 226 ITR 97 (SC) were referred]

Principles laid down by the Calcutta High Court under Service tax

The principles laid down by the Calcutta High Court in Saturday Club & Dalhousie Institute discussed earlier, have been followed in a large number of subsequently decided cases. To illustrate:

Sports Club of Gujarat Ltd vs. UOI (2010) 20 STR 17 (GUJ)

Karnavati Club Ltd vs. UOI (2010) 20 STR 169 (GUJ)

CST vs. Delhi Gymkhana Club Ltd (2009) 18 STT 227 (CESTAT – New Delhi)

Ahmedabad Management Association vs. CST (2009) 14 STR 171 (Tri – Ahd) and

India International Centre vs. CST (2007) 7 STR 235 (Tri – Delhi)

In CST vs. Delhi Gymkhana Club Ltd. (2009) 18 STT 227 (New Delhi – CESTAT) the Tribunal observed:

“using of facilities of club, cannot be said to be acting as its clients and hence, in respect of services provided to its members, a club would not be liable to pay service tax in the category of club or association service”.

Revenue appeal against the above ruling has been dismissed by the Delhi High Court on technical grounds. It needs to be noted that, Explanation inserted at the end of section 65 (105) of the Act w.e.f. 1/5/06, has not been discussed in the aforesaid ruling.

Recent Judgement in Ranchi Club Ltd v CCE & ST (2012) 26 STR 401 (JHAR)

The said ruling has been analysed and discussed in detail in the July, 2012 issue of BCAJ. In this ruling, the High Court observed as under:

“It is true that sale and service are two different and distinct transactions. The sale entails transfer of property whereas in service, there is no transfer of property. However, the basic feature common in both transaction requires existence of the two parties; in the matter of sale, the seller and buyer, and in the matter of service, service provider and service receiver. Since the issue whether there are two persons or two legal entity in the activities of the members’ club has been already considered and decided by the Hon’ble Supreme Court as well as by the Full Bench of this Court in the cases referred above, therefore, this issue is no more res integra and issue is to be answered in favour of the writ petitioner and it can be held that in view of the mutuality and in view of the activities of the club, if club provides any service to its members may be in any form including as mandap keeper, then it is not a service by one to another in the light of the decisions referred above as foundational facts of existence of two legal entities in such transaction is missing. [Para 18]”

Self Supply of Services – Judicial & Other Considerations under Service tax

Some judicial considerations under service tax are as under:

Under Central Excise, the concept of captive consumption has been in force, for many years. However under the service tax law ,there is as such no concept of captive consumption of services whereby services provided by one division of a company to another division are liable to service tax. As such, service provider–customer/client relationship is necessary for being liable for service tax.

In this connection, attention is drawn to the Ban-galore tribunal ruling in the case of Precot Mills Ltd. vs. CCE (2006) 2 STR 495 (Tri – Bang) wherein it was held as under :

“Technical Guidance provided by applicant to its own constituent (a Sister Concern), cannot be brought with the ambit of Management Services and Service Tax in the absence of Consultant – Client relationship between the two”.

Attention is drawn to the following observations of Tribunal in Rolls Royce Industrial Power (I) Ltd v Commissioner (2006) 3 STR 292 (Tribunal):

“…………Thus, there are no two parties, one giving advise and the other accepting it. Service tax is attracted only in a case involving rendering of service, in this case, engineering consultancy. That situation does not take place in the present case. Therefore, we are of the opinion that the duty demand raised is not sustainable………..”

Magus Construction Pvt. Ltd. Vs. UOI (2008) 11 STR 225 (GAU)

In the said ruling, the Honourable Gauhati High Court observed:

“In the light of the various statutory definitions of “service”, one can safely define “service” as an act of helpful activity, an act of doing something useful, rendering assistance or help. Service does not involve supply of goods; “service” rather connotes transformation of use/user of goods as a result of voluntary intervention of “service provider” and is an intangible commodity in the form of human effort. To have “service”, there must be a “service provider” rendering services to some other person(s), who shall be recipient of such “service”. (Para 29)

In the context of construction services, it has been repeatedly clarified that, in case of self supply of services there can be no liability to service tax. In this regard, useful reference can be made to the department circular dated 17/9/04 on estate builders, Master Circular dated 23/8/07 in regard to applicability of service tax to real estate builders/developers and department Circular dated 29/1/09 regarding imposition of service tax on builders.

In the context of cross border transactions, a deeming fiction was introduced in section 66A of the Act w.e.f. 18/4/06 (relevant upto 30/6/12), whereby reverse charge liability was triggered in cases of payments made by an establishment based in India to an establishment based outside India, despite the fact that the said establishments are part of one legal entity.

In this regard, attention is drawn to the para 4.2.5 from department circular dated 19.4.06:

“Provision of service by a permanent establishment outside India to another permanent establishment of the same person in India is treated, for the purpose of charging service tax, as provision of service by one person to another person. In other words, permanent establishment in India and the permanent establishment outside India are treated as two separate legal persons for taxation purposes.”

It is pertinent to note that, there was no deeming fiction on similar lines, under the Export of Services Rules, 2005 (ESR) which were in force upto 30/6/12.

Taxability of transactions between mutual concerns and their members

The terminology employed in Explanation 3 [Para (a)] inserted in section 65B (44) of FA 12 which defines ‘Service’, w.e.f. 1/7/12, is identical to that employed in Explanation to section 65 (105) of the Act which was in force upto 30/6/12. Hence, it would appear that, principles of mutuality upheld by the Calcutta High Court in Saturday Club and Dalhousie Institute and Jharkhand High Court in Ranchi Club would continue to be relevant.

Further, under sales tax law, a constitutional amendment was carried out to enable States to levy sales tax on sale of goods by a club or association to its members. No such amendment is carried out for service tax.

However, it needs to be expressly noted that the issue is likely to be a subject of extensive litigation.

Taxability in case of self supply of services within India

As discussed above, upto 30-06-2012 it is a reasonably settled position to the effect that, in the absence of a service provider – client relationship transactions between divisions/units within a legal entity would not result in any service tax liability.

In the context of Negative List based taxation of services introduced w.e.f. 01-07-2012, it would appear that, the above stated position would continue. However, in regard to transactions between units located in India and J & K, the implications discussed below would be relevant to note.

Taxability in case of self supply of services in cross border transactions

As regards the position upto 30-06-2012 as discussed above, deeming fiction enacted in section 66A of the Act would be triggered, resulting in service tax liability under reverse charge in case of payments made by an establishment based in India to an establishment based outside India despite the fact that two establishments are a part of one legal entity.

However, in the absence of deeming fiction under ESR, if the cross border transactions between two establishments of one legal entity satisfy the conditions of ‘export’ under ESR, there may not be any liability to service tax.

To conclude, it would appear that, whether cross border transactions in the nature of self supply of services can be made liable to service tax at all, needs to be judicially tested inasmuch principles of taxability of self supply of services discussed above would be relevant.

As regards position w.e.f. 1/7/12, vide Explanation 3 [Para (b)] to section 65B (44), a legal fiction has been created whereby two establishments of a person, one located in the taxable and other in non–taxable territory are to be treated as two separate persons. The obvious intention of the deeming fiction is to tax the transactions between two branches or between head office and branch office, where one is located in the non–taxable territory and other is located in the taxable territory.

For example, in a case of a head office in India remitting salaries for its staff employed at branches in 50 different countries world wide, section 65B (44) of FA 12 specifically excludes services provided by employees from the definition of ‘service’. However, an issue could arise, as to whether deeming fiction created in Explanation 3 [Para (b) ] to section 65B (44) can be triggered and a view adopted that transactions between two separate entities cannot be regarded as “salary”, but on an application of deeming fiction transactions are in the nature of supply of services between two persons liable to service tax. This would be an extreme and highly controversial view which could result in extensive litigation.

There could be similar issues in case of several other transactions between head office and overseas branches. For example, disbursements by head office to sales offices for meeting establishment ex-penses and funding of losses in the initial set up period. By invoking the deeming fiction stated earlier, reverse charge provisions could be triggered, if the transactions are not excluded in terms of 66B (44)/ Negative List/Exempted List of Services.

Let us now discuss the implications in case of cross borders transactions between head office/branches which result in inward remittances in India in convertible foreign exchange. These transactions could be either genuine ‘export’ transactions or could be for salary disbursements, establishment disburse ments etc. to branches/sales offices set up in India by an overseas company based outside India.

In this context, it is very important to note that para 1(f) of Rule 6A of ST Rules which defines “Export of Services” specifically excludes transactions between two establishments within one legal entity. Hence, even if all the other conditions for ‘export’ specified under Rule 6A of ST Rules are satisfied, the benefit of export would be denied, resulting in a possible service tax liability.

It has been a stated policy of the Government to the effect that, we should export our goods & services and not taxes. However, it seems provisions of Rule 6A of ST Rules would result in export of taxes, which is clearly contrary to the policy of the Government. This needs to be addressed immediately.

To conclude, it would appear that, deeming fiction created through Explanation 3 [Para (b)] to Section 65B (44) of FA 12 read with Para 1(f) of Rule 6A of ST Rules, is likely to have far reaching implications on cross border transactions under Negative List based taxation regime and is likely to increase costs of international transactions. This needs to be appropriately addressed to encourage cross border business and avoid litigations as well.

However, though deeming fictions are to be construed strictly, whether cross borders transactions between two units of one legal entity in the nature of self supply of services can be taxed at all in the absence of service provider client relationship, needs to be judicially tested.

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Dy. Director of Income tax vs. G. K. R. Charities Income tax Appellate Tribunal “G” Bench, Mumbai. Before G. E. Veerabhadrappa (President) and Amit Shukla (J. M.) ITA No. 8210/Mum /2010 Asst. Year 2007-08. Decided on 10.08.2012. Counsels for Revenue/Assessee: Pavan Ved/A. H. Dalal

Section 11 – Charitable institution – (1) Claim for depreciation on fixed assets is treated as application of income; (2) Receipt of loan in violation of the Bombay Public Trust Act does not invite denial of exemption u/s. 11; (3) Repayment of loan originally taken for the objects of the trust will amount to an application of income.

Facts:
The assessee is a charitable trust registered with the Charity Commissioner as well as u/s 12A of the Act. In the assessment order passed for the year under appeal, the AO held as under:

1. In respect of depreciation of Rs. 19.48 lakh claimed: Since cost of fixed assets had already been allowed as application of income in the earlier years, relying on the decision of the Supreme Court in the case of Escorts Ltd. & Anr. Vs. Union of India (199 ITR 43), the claim for depreciation was denied;

2. Re: Treatment of repayment of loan of Rs. 2.92 crore as the application of income: Since the loan when it was raised was not declared/treated as income in the year of receipt, relying on the decision of the Supreme Court in the case of Escorts Ltd. & Anr. (supra), the assessee’s claim would result into double deduction, hence not permissible;

3. The above loan was taken without the Charity Commissioner’s permission, thus in violation of the provisions of section 36A(3) of the Bombay Public Trust Act. Therefore, relying on the Bombay high court decision in the case of CIT vs. Prithvi Trust (124 ITR 488), he forfeited the exemption granted u/s. 11.

Being aggrieved by the order of the CIT(A), who held in favour of the assessee, the revenue filed appeal before the tribunal. Before the tribunal, the revenue justified the order passed by the AO and further relied on the decision of the Cochin bench of tribunal in the case of DDIT Vs. Adi Shankara Trust (ITA no. 96/Coch/2009 dated 16-06-2011) and on the Cochin tribunal decision in the case of Lissie Medical Institution (2010 TIOL 644). According to it, the later decision was also affirmed by the Kerala high court. Further, it was contended that the decision of the Bombay high court in CIT vs. Institute of Banking Personnel Selection (264 ITR 110) relates prior to insertion of section 14A of the Act without considering the judgment of Escorts Ltd.

Held:
As regards the denial of exemption u/s. 11 on the ground that loan taken by the assessee in earlier years from managing trustee was in violation of the Bombay Public Trust Act, the tribunal held that under the Act, once the CIT grants registration u/s. 12AA, looking to the objects of the trust, the same cannot be withdrawn until and unless there was a violation of provisions of section 13 or the registration is cancelled u/s. 12AA(3). The tribunal further observed that once the loan taken was duly shown in the Accounts, there was no requirement under the Act that the provisions of other Acts have to be complied with. According to it, the Bombay high court decision in the case of Prithvi Trust was on a different ground, hence, not applicable to the case of the assessee. According to it, the decision of the Supreme court in the case of ACIT vs. Surat City Gymkhana (300 ITR 214) and Mumbai tribunal decision in the case of ITO (Exemption) vs. Bombay Stock Exchange (ITA No. 5551/Mum/2009 dt. 22. 08. 2006) also support the case of the assessee.

As regards the allowability of depreciation – the tribunal preferred to follow the decision of the Bombay high court in the case of Institute of Banking Personnel Selection. It further noted that on the similar issue, the Punjab & Haryana high court in the case CIT vs. Market Committee, Pipli (330 ITR 16) after considering the decision of the Supreme Court in the case of Escorts Ltd., held in favour of the assessee. Also, taking note of the Mumbai tribunal decision in the case of ITO vs. Parmeshwaridevi Gordhandas Garodia (ITA No. 4108/ Mum/2010 dated 10-08-2011), the tribunal held that allowing of depreciation is application of income and it does not amount to double deduction. Hence, the order of the CIT (A) was upheld on this ground also.

As regards the claim for treating repayment of loan as the application of income, the tribunal agreed with the order of the CIT (A) and relying on the CBDT Circular No. 100 dated 24-01-1973 and the decision of the Gujarat high court in the case CIT vs. Shri Plot Swetamber Murti Pujak Jain Mandal (211 ITR 293)and of the Rajasthan high court in the case of Maharana of Mewar Charitable Foundation (164 ITR 439), held that such repayment of loan originally taken to fulfill one of the objects of the trust will amount to an application of income for charitable and religious purposes.

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(2012) 75 DTR (Chennai)(Trib) 113 Smt. V.A. Tharabai vs. DCIT A.Y.: 2007-08 Dated: 12-1-2012

54F – Inability to construct the residential house within three years due to restraint order by competent Court will not disentitle the assessee from the exemption.

Facts:
The assessee sold her capital asset resulting in long-term capital gains which was claimed as exempt as the the assessee was proposing to construct a residential house property out of the sale consideration. The exemption was claimed u/s. 54F. The assessee sold the property on 8th June, 2006 and immediately thereafter, on 5th July, 2006, purchased a landed property to construct a house. The purchase price paid for the land was more than the long-term capital gains arisen in the hands of the assessee on sale of her capital asset. But the assessee could not construct the residential house in the land purchased by her as proposed, due to injunction granted to the owners by the Civil Court. The expiry of the threeyear period from the date of sale of the property was on 8th June, 2009. The matter went upto the Hon’ble Supreme Court, which was dismissed by the Hon’ble Supreme Court and all proceedings were dismissed on 13th September 2011.

Held:
The facts demonstrate that the assessee had arranged the transaction in such a bona fide manner so as to claim the exemption available u/s. 54F. It is after the purchase of the property that hell broke loose against the assessee in the form of civil litigation. The litigation started on 25th February, 2008 and ended only on 19th September, 2011. By that time, the available period of three years to construct the house was already over, on 8th June, 2009. It is an accepted principle of jurisprudence that law never dictates a person to perform a duty that is impossible to perform. In the present case, it was impossible for the assessee to construct the residential house within the stipulated period of three years.

A dominant factor to be seen in the present case is that the entire consideration received by the assessee on sale of her old property has been utilised for the purchase of the new property. The conduct of the assessee unequivocally demonstrates that the assessee was in fact proceeding to construct a residential house, based on which the assessee had claimed exemption u/s. 54F. It is true that the assessee could not construct the house. In the special facts and circumstances of the present case, therefore, it is necessary to hold that the amount utilised by the assessee to purchase the land was in fact utilised for acquiring/constructing a residential house.

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RTI — A weakened right

One way to defeat a measure is to have your ‘yes men’ in places where decisions are taken. The Right to Information is meeting a similar fate.

In 2012, two-thirds of the 83 information commissioners at the Union and State levels are retired civil servants; three out of four chief information commissioners are retired members of the Indian Administrative Service (IAS). That is not all: on 1st May, 30% of the posts of information commissioners in states were vacant. It is no one’s case that all civil servants are placemen.

But the esprit de corps of the IAS in this domain is less likely to help the cause of accessing information. A bit more of diversity — say persons from civil society (and not merely those who claim to be from civil society), former soldiers, businesspeople and others — can go some distance in achieving the goal of transparency.

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Facebook co-founder says bye to US — Absurd American tax laws prompt Ed Saverin to move to Singapore ahead of landmark IPO

Eduardo Saverin, the billionaire cofounder of Facebook, renounced his US citizenship before an initial public offering (IPO) that values the social network at as much as INR5,938 billion, a move that may reduce his tax bill.

“It’s plainly lawful and at the same time profoundly ungrateful to the country that provided these opportunities for him,” said Edward Kleinbard, a tax law professor at the University of Southern California. “He benefited from his US education, the contacts he made at Harvard, and most important the extraordinary openness and flexibility of our economy that encourages start-up ventures to flourish.”

Saverin’s name is on a list of people who chose to renounce citizenship as of April 30, published by the Internal Revenue Service.

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China orders big four audit firms to restructure

The world’s top four accounting firms will have to bring in Chinese citizens to run their operations in China and end the dominance of foreign partners under new rules announced by the finance ministry.

The Big Four auditors — Deloitte Touche Tohmatsu, Pricewaterhouse Coopers, Ernst & Young and KPMG — must start to convert their practices this August and comply with all the new rules by the end of 2017.

The rules require them to ‘localise’ their operations so that they are led by Chinese citizens and dominated by accountants holding China’s accountancy qualifications. The changes come at a difficult time for the Big Four, grappling with the fall-out from a string of accounting scandals at Chinese companies listed in the US that has left investors questioning the quality of auditing in China. US securities regulators charged Deloitte’s China practice for refusing to provide audit work papers related to a US-listed Chinese company under investigation for accounting fraud.

The new rules will force the proportion of foreign partners at the Big Four to be a maximum of 40% when the structure is adopted in August, and fall to under 20% by 2017. This is likely to come as a relief to the firms, as there had been concerns that China could force them to convert more quickly to Chinese-dominated practices. Tougher though, will be the requirement that each of the Big Four’s senior partner be a Chinese citizen. All are currently led by foreigners.

The foreign joint venture arrangements currently used by the Big Four were signed 20 years ago and allowed foreign-qualified accountants to dominate their China practices. Since then, the firms have come to dominate the country’s accounting industry, having won much of the lucrative work to audit the books of stateowned enterprises when they first listed.

In 2010, their audit practices, excluding their consultancy businesses, had combined revenue of more than 9.5 billion yuan (INR93 billion), according to the Chinese Institute of CPAs. However, their market share has slipped in recent years to about 70% of the revenue among the top-10 auditors, down from 85% in 2006.

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Info exchange pacts turn troublesome for NRIs — Inbound investment may suffer as foreign taxmen seek info on funds parked by NRIs in India

India’s search for black money overseas is having an unintended consequence, one that could affect one of its stable sources of dollars. Investments by non-resident Indians, or NRIs, and their funds parked in India are coming under the glare of the tax authorities in their home countries.

Indian income-tax authorities are sending financial details of NRIs to their respective countries under the information exchange agreements inked by New Delhi with many countries.

Indians settled overseas have collectively pumped in nearly INR600 billion in NRI deposits in India in April- February 2011-12 financial year to take advantage of the higher returns available here. Interest rates of these NRI deposits can be as high as 9.5% in some cases, which yields a handsome tax-free package for investors even after adjusting the rupee depreciation.

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Flipkart faces heat of rivals’ discounts

Flipkart, the big daddy of the online books trade, is feeling the heat of competition. Of late, several other portals are making a strong pitch for the pie with bigger discounts. Book lovers have options galore with players like Infibeam, Dial-a-Book, Bookadda, Friends of Books, Indiatimes Shopping, eBay, Junglee, uRead and more.

The new kids on the block offer bigger discounts than Flipkart, which range up to 40% on bestsellers. Retail industry insiders say the online books business is all about customer acquisition. Books help get customers online.

It’s hard to damage books while shipping. It builds trust that can later get customers to transact from other categories.

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World’s biggest rubbish dump out at sea, twice the size of America

A ‘plastic soup’ of waste floating in the Pacific Ocean is growing at an alarming rate and now covers an area twice the size of the continental United States, scientists have said.

The vast expanse of debris — in effect the world’s largest rubbish dump — is held in place by swirling underwater currents. This drifting ‘soup’ stretches from about 500 nautical miles off the Californian coast, across the northern Pacific, past Hawaii and almost as far as Japan.

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Harvard, MIT to launch free online courses soon

Harvard University and Massachusetts Institute of Technology have joined hands to launch an ambitious INR3,711 million initiative under which they will offer free online courses to students, a collaboration that will be headed by Indian-origin professor Anant Agarwal.

The new online education platform ‘EdX’ would be overseen by a Cambridge-based not-for-profit organisation and be owned and governed equally by the two universities. MIT and Harvard have committed INR1,856 million each in institutional support, grants and philanthropy to launch the collaboration.

Director of MIT’s Computer Science and Artificial Intelligence Laboratory, Agarwal led the development of the platform.

“EdX represents a unique opportunity to improve education on our own campuses through online learning, while simultaneously creating a bold new educational path for millions of learners worldwide,” MIT president Susan Hockfield said.

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Putting integrity into finance

Behaviour that lacks integrity leads to value destruction. This paper analyses some common beliefs, actions and activities in finance that are inconsistent with being a person or a firm of integrity.

Each of these beliefs leads to a system that lacks integrity, i.e., one that is not whole and complete and, therefore, creates unworkability and destroys value. Focussing on these phenomena from the integrity viewpoint, we argue, makes it possible for managers to focus on the value that can be created by putting the system back in integrity and correcting the non-value maximising equilibrium that exists in capital markets.

In effect, integrity is a factor of production just like knowledge, technology, labour and capital, but it is undistinguished — and its effect (by its presence or absence) is huge. We summarise our new positive theory of integrity that has no normative content, and argue that there are large gains from putting integrity into finance — into both the theory and practice of finance. We define integrity as being whole and complete and unbroken. We argue that if finance scholars, teachers and practitioners take this approach to applications in finance, there are huge gains to be achieved.

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A Third Industrial revolution calls for radical changes in our thought and action

There is a paradigm shift underway in manufacturing, points out The Economist. New technologies in computing, materials and processes such as three-dimensional printing are making fundamental changes in the way things are made, where they are made and by whom, whether workers or smart robots.

Three-dimensional printing, in which a computeraided printing machine deposits successive layers of different materials to produce solid designs and objects, is a key exemplar of this third industrial revolution. The knowledge and service content of the final value of a manufactured product would go up, and the labour cost would go down.

Mass customisation would be in and locating manufacture to low-wage countries would be out. Boston Consulting Group foresees a resurgence of manufacture in a country like the US at the expense of a China, or an India. Several policy ramifications follow.

One, India will find it well-nigh impossible to take the route to prosperity that Asia’s miracle economies, including South Korea and China, followed, of outsourced manufacture to feed demand in developed economies. Ten years from now, much of the manufacture to meet demand in the US and Germany could well take place in those countries themselves. Two, low wages would only be a drag for attracting investments, whereas smart labour and a huge home market would be a big draw.

Three, knowledge would drive the entire economy: not the rote-driven mastery of yesterday’s verities but a ceaseless quest to challenge established wisdom and produce new knowledge. Universities have to not just train manpower but create new knowledge, serving as hubs of new production ideas. Our school and education systems would have to undergo a fundamental change in terms of organisational structure and culture. The way ahead is to universalise not just secondary education but also tertiary education, with extensive modular course offerings.

Four, the financial ecosystem must evolve to mediate funds towards knowledge acquisition, knowledge creation and conversion of knowledge into production. Finally, high-speed broadband must become ubiquitous and cheap, to enable all this.

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Retrospective amendments

The day after the Budget, 2012 was presented by Pranavda in the Parliament, I bumped into Herambha Shastri.

After Hi, Hello, How are you rituals, Herambha broached the Budget issue. I was reluctant to discuss.

As a run-up to his commentary on the Budget he said, “If a human being dies, it is believed that to fulfil his unfulfilled wishes he becomes ghost. It means he or she exists even after death so we experience ghost effect sometimes.”

I could not help but ask Herambha, “I didn’t get the hang of what are you referring to?” Herambha clarified “It’s all about ghost; I mean ghost of retrospective amendments by Pranavda, 50 years backward effect, utter nonsense!”

“Retrospective amendment is required to plug revenue leakage” I said, adding fuel to the fire. “What revenue leakage? Past or future?” queried Herambha. “Of course future!” said I. “How innocent you are! My dear friend Pranavda and his battery of babu colleagues are trying to reduce the ‘deficit’ of past several budgets through these ghost amendments you know. It is beyond anybody’s imagination.

You are aware once you squeeze the toothpaste, you cannot put it back in the tube, but our Finance Minister — Pranavda is a superman; he can do it with retrospective amendments, 50 years backward!” elaborated Herambha. I was just staring at Herambha nodding my head. What else could I say?

“Apart from this, retrospective amendments are also useful to plug administrative undoing in the Income-tax Department. If action could not be taken in the past due to limitation of time, bring retrospective amendment extending the time limit. So taxpayers or rather their consultants have sleepless nights after every budget presentation. It is not just a hanging sword but the sword about to hit on your neck. Look at the functioning of bureaucrats working in the Income-tax Department and the plethora of reassessments initiated after retrospective amendments.”

“Have you ever come across any retrospective amendment in any Budget in favour of taxpayers requiring the government to pay back the tax collected in the past? If there is one, it would be the rarest of rare amendment so far” said Herambha in one breath. While concluding his reaction to budget he remarked,

“My dear friend, it is normal practice as a prologue to the Budget, the Finance Minister talks about government’s spending in the coming year on various sectors of the economy like industry, agriculture and infrastructure, so on so forth and on various projects. With announcement of each project, the stock market in the country goes up or down, industry leaders on various channels puff their views, favourable or unfavourable. I think all these rituals should be scrapped since eventually most of the government spending goes into scams and scandals running into lakhs of crores leaving the country’s economy in lurch and making the Aam Aadmi’s day-to-day life difficult. So it is useless to make those announcements on the floor of the House. Instead the Finance Minister should just introduce Direct and Indirect Tax Bill on the floor of the House and sit down. What do you say?”

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Aplicability of Explanation to Section 73

Section 73 of the Income-tax Act prohibits set-off of losses of speculation business except against profits and gains of another speculation business. The Explanation to section 73 extends the meaning of speculation business for the purposes of such set-off, by deeming any part of the business of a company which consists in the purchase and sale of shares of other companies to be a speculation business.

There are however two exceptions to this deeming fiction — one is for a company whose gross total income consists mainly of income which is chargeable under the heads ‘Interest on Securities’, ‘Income from House Property’, ‘Capital Gains’ and ‘Income from Other Sources’ and the second is for a company the principal business of which is the business of banking or the granting of loans and advances.

The Explanation to section 73 reads as under:

“Where any part of the business of a company (other than a company whose gross total income consists mainly of income which is chargeable under the heads ‘Interest on Securities’, ‘Income from House Property’, ‘Capital Gains’ and ‘Income from Other Sources’, or a company the principal business of which is the business of banking or the granting of loans and advances) consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carried on a speculation business to the extent to which the business consists of the purchase and sale of such shares.”

Two issues have arisen before the Courts, in the context of the first fiction, above, as to how the composition of the gross total income is to be looked at for the purpose of considering the applicability of this Explanation. One issue has been as to how negative income (loss) has to be considered — whether in absolute terms ignoring the negative sign, or to be taken as lower than a positive figure, for determining the majority composition of the gross total income. The second issue has arisen as to whether, for considering the applicability of this Explanation, the deemed speculation business loss is to be set off first against the other business profits, and only the net business income after such set-off is to be considered as ‘included’ in the gross total income and that it is such net business income, so included, that is to be compared with the income from the other heads of income to determine the composition of the gross total income. Naturally, the income under the other heads of income shall gain a higher share in composition of the gross total income where the business income is first set off against the losses of the deemed speculation business.

Considering the second issue, the Calcutta High Court has taken the view that for considering the applicability of the Explanation, the share trading loss is not to be set off against other business profits by adopting the ratio of its earlier decisions in the context of the first issue, the Bombay High Court has held that only the net business income after setting off the share trading loss against other business profits is to be considered as included in the gross total income.

Park View Properties’ case
The issue first came up before the Calcutta High Court in the case of CIT v. Park View Properties P. Ltd., 261 ITR 473.

In this case, the assessee-company had incurred a loss of Rs.8,98,799 in share trading, and had other business profits of Rs.12,32,469, the net business profits being Rs.3,33,670. The assessee had income from other sources and dividend income (which was taxable at that point of time) of Rs.5,73,701. The gross total income, determined after set-off of the share trading loss, was therefore Rs.9,07,371.

The Assessing Officer denied the benefit of the exception to the Explanation to section 73, denying set-off of share dealing loss on the ground that such losses were to be deemed as the loss of a speculation business, on application of the said Explanation. The Commissioner (Appeals) allowed the appeal of the assessee, holding that the main source of income of the assessee consisted of income from interest on securities and income from house property. The Tribunal upheld the order of the Commissioner (Appeals), allowing set-off of the share trading business loss without treating the same as a speculation loss.

The Calcutta High Court noted that the Tribunal had allowed the benefit of the exception to the Explanation to section 73 by setting off the share trading loss against the profits of other business for the purposes of determining whether the said Explanation was applicable or not. The Court did not approve the approach of the Tribunal. According to the Calcutta High Court, in order to ascertain whether an assessee would be covered by the Explanation to section 73, it had to be first examined whether the assessee came within the exception provided to the Explanation. This, according to the Court, was to be done by taking into consideration only the business profits, excluding the share trading loss, as could be gathered from the expression ‘gross total income consists mainly of income chargeable under the heads . . . . .’ used in the Explanation that was clear and unambiguous, and reflected the intention of the Legislature.

The Calcutta High Court noted that while computing the gross total income, loss was also to be taken into account, since loss was treated as a negative profit. The Calcutta High Court noted that in the case of Eastern Aviation and Industries Ltd. v. CIT, 208 ITR 1023, the Calcutta High Court had held that the explanation to section 73 could be applied before the principle of deduction was applied, namely, after computing the gross total income.

Applying this principle, the Court observed that if the loss in the share dealing account of Rs.8,98,799 was treated as a negative profit, then definitely the income from other sources and dividend income of Rs.5,73,701 was lower. Therefore, according to the Calcutta High Court, the main income consisted of the business of share trading, which was the main object of the assessee. The Calcutta High Court expressed the view that the business income computed after setting of the loss in share trading of Rs.3,33,670 did not represent the business income, since it was arrived at after applying the benefit of the explanation to section 73, namely, setting off the speculative income.

The Calcutta High Court therefore held that the case did not fall within the exception in the explanation to section 73, and the loss incurred on share trading was to be treated as speculation loss and could not be set off against other income.

Darshan Securities’ case
The issue again recently came up before the Bombay High Court in the case of CIT v. Darshan Securities Pvt. Ltd., (ITA No. 2886 of 2009, dated 2-2-2012 — available on www. itatonline.org).

In this case, the assessee had an income from service charges of Rs.2,25,04,588, and share trading loss of Rs.2,23,32,127, besides a taxable dividend income of Rs.4,79,325. The assessee claimed that in computing the gross total income for the purposes of the Explanation to section 73, the share trading loss had to be first adjusted against the income from service charges.

The Assessing Officer disallowed the set-off of the share trading loss, holding it to be a speculation loss. The Commissioner (Appeals) accepted the assessee’s claim that the case of the company was covered by the first exception to the said Explanation to section 73, as did the Tribunal.

On behalf of the Revenue, it was argued before the Bombay High Court that in computing the gross total income for the purposes of the Explanation to section 73, income under the heads of profits and gains of business or profession must be ignored. Alternatively, it was urged that where the income from business included a loss in trading of shares, such loss should not be allowed to be set off against income from any other source under the head of profits and gains of business or profession.

The Bombay High Court analysed the provisions of section 73 and the Explanation thereto. It noted that the Explanation to section 73 was a deeming fiction applying only to a company and extending only for the purposes of that section. It noted that the bracketed portion of the Explanation carved out an exception.

The Bombay High Court noted that ordinarily income which arose from one source, which fell under the head of profits and gains of business or profession could be set off against the loss, which arose from another source under the same head. Section 73(1) however set up a bar to setting off a loss which arose in respect of a speculation business against the profits and gains of any other business. Consequently, such speculation loss could be set off only against the profits and gains of another speculation business.

According to the Bombay High Court, the explanation provided a deeming fiction of when a company is deemed to be carrying on a speculation business. If the Department’s submissions were accepted, it would lead to an incongruous situation, where in determining as to whether a company was carrying on a speculation business within the meaning of the explanation, section 73(1) would be applied in the first instance. According to the Bombay High Court, this would not be permissible as a matter of statutory interpretation, as the explanation was designed to define a situation where the company was deemed to carry on speculation business. It is only thereafter that section 73(1) can apply. Applying the provisions of section 73(1) to determine whether a company was carrying on speculation business would reverse the order of application, which was impermissible and not contemplated by Parliament.

The Bombay High Court observed that in order to determine whether the exception carved out by the Explanation applied, the Legislature had first mandated a computation of the gross total income. Further, the words ‘consists mainly’ were indicative of the fact that the Legislature had in its contemplation that the gross total income consisted predominantly of income from the 4 heads referred to therein. Obviously, according to the Bombay High Court, in computing the gross total income, the normal provisions of the Act must be applied, and it was only thereafter that it had to be determined as to whether the gross total income so computed consisted mainly of income which was chargeable under the heads referred to in the Explanation.

The Bombay High Court followed the ratio of its earlier decisions in the cases of CIT v. Hero Textiles and Trading Ltd. , (ITA No. 296 of 2001 dated 29-1-2008) and CIT v. Maansi Trading Pvt. Ltd., (ITA No. 47 for 2001 dated 29-1-2008). It also noted that it had dismissed Notice of Motion No. 1921 of 2007 in ITA (Lodging) No. 852 of 2007 for condonation of delay against the Tribunal Special Bench decision in the case of Concord Commercial Pvt. Ltd., which decision had been followed by the Tribunal in this case.

The Bombay High Court therefore held that since the net business income of Rs.1,72,461 was less than the dividend income of Rs.4,79,325, the assessee was covered by the exception carved out in the Explanation to section 73, and would not be deemed to be carrying on a speculation business for the purposes of section 73(1).

Observations

The Calcutta High Court seems to have placed reliance on its decision in the case of Eastern Aviation and Industries Ltd. (supra) in arriving at its conclusion. In particular, it followed the view taken in that case that negative profits are also income and are to be considered in the absolute sense (ignoring the positive or negative signs) for the purpose of the exception carved out in explanation to section 73(1). The Calcutta High Court, however, failed to appreciate that Eastern Aviation’s case dealt with a situation where there was a negative speculation income and negative share trading income, but no other profits from any other business. The question of set-off of share trading loss against any other business profit, therefore, did not arise for consideration in that case. In that case, the gross total income itself also was a negative figure. The reliance placed on the ratio of that decision, therefore, seems to have been misplaced.

Even assuming that the ratio of Eastern Aviation’s case that even negative incomes should be considered in the absolute sense were correct, what needs to be considered is the net position of the income under each head of income, and not the net position of each source of income. In Darshan Securities’ case, the net position of the income under the head business or profession was a positive figure, which was lower than the income under the head ‘Income from Other Sources’. Therefore, even applying Eastern Aviation’s case, the ratio of Darshan Securities’ case seems justified.

As rightly observed by the Bombay High Court, one cannot start with a presumption that the explanation applies and that the loss is a loss from speculation business for determining whether the explanation applies. One would therefore have to compute the gross total income without applying the explanation for finding out the applicability of the explanation. In doing so, one would have to apply the normal provisions for computation of gross total income ignoring the explanation to section 73, i.e., by setting off the share trading loss against other business profits, which would normally have been the position in the absence of the explanation. It is only then if it is determined that the explanation applies, as the case falls outside the exception to the explanation, that the prohibition on set-off of the loss would apply.

The view taken by the Bombay High Court that the share trading loss is to be set off against other business income for determining whether explanation to section 73 applies, is therefore the better view of the matter.

shailesh.kwebmaker

War Against Offshore Tax Evasion — Will Tax Information Exchange Agreements Work?

In the recent crackdown against errant taxpayers, the Income-tax Department has initiated action against many Indians who had stashed their wealth in the HSBC bank in Geneva. This is similar to the action it had taken earlier against the Indian account holders in LGT Bank in Lichtenstein. Similarly, proceedings are also expected to be initiated against many tax evaders on the basis of more than 10,000 pieces of information reportedly received from the different countries. This news may be comforting to the majority of taxpayers who honestly pay their taxes and believe that the Government ought to severely punish tax evaders.

This development gives hope that such trickle would turn into a flow of information to bring back Indian black money stashed abroad after the Indian Government has entered into Tax Information Exchange Agreements (TIEAs) with the tax havens. India has so far signed TIEAs with Bermuda, Bahamas, Isle of Man, British Virgin Island, Cayman Island, Liberia, and Jersey and more TIEAs are under negotiation. India is also seeking to amend its 75 existing Double Taxation Agreements with the countries to provide for effective exchange of tax information.

However, sceptics feel that Tax Information Exchange Agreements are unlikely to make any meaningful contribution in fight against tax evasion, more particularly against offshore tax evasion. Their scepticism is because of several reasons. However, before discussing their views it may be necessary to go through a bit of background to understand the issues involved in TIEAs.

Background
The global financial crisis triggered TIEA drive. One of the fallout of the global financial crisis was that of growing realisation among the governments on the menace of tax evasion, particularly offshore tax evasion, which has resulted in massive revenue loss hitting developing countries harder, which need more funds for their development and poverty eradication. Various agencies and organisations have estimated the magnitude of the problem. For example, a non-profit organisation, ‘Global Financial Integrity’ in its report published in January 2009, has estimated that the developing countries lost between $ 858 billion to $ 1.06 trillion in illicit financial outflows in 2006. ‘Oxfam’, another non-profit organisation in a study carried out in March 2009 found that at least $ 6.2 trillion wealth of the developing countries is held offshore, depriving them annual tax receipts between $ 64-124 billion. Therefore, considering the sheer size of the revenue loss, the governments are looking to collect tax from the funds deposited in the offshore accounts, on which tax was not paid.

Role of a tax haven

Critical role played by tax havens in offshore tax evasion is well known, which often ignore and many a time aid tax evasion taking place in their jurisdiction. Tax evaders find tax havens attractive because many tax havens have developed ‘liberal’ systems, such as simple registration of a company with bearer shares, minimum capitalisation, nominal reporting requirements, provide ease of funds transfer and offer possibility of keeping ownership anonymous. Such rules make tax evasion easier. More importantly, tax havens are attractive to tax evaders because of lack of transparency and little exchange of information apart from the fact that it levies nominal tax or no tax on them. On the other hand, for a tax haven, on-going financial activity in its jurisdiction is beneficial for its survival and prosperity. It is win-win situation for both: the tax haven and the tax evaders.

OECD response
Tax administrations cannot function beyond their country’s jurisdiction, although globalisation of economy and growing international business require tax administrations to operate internationally. Tax administrations find it difficult to detect tax evasion involving tax haven because of the lack of adequate information on such transactions. Therefore, ‘Organisation of Economic Cooperation and Development’ (OECD) decided to tackle two critical elements — which make a jurisdiction a tax haven — lack of transparency and lack of or little exchange of information. The OECD, strongly supported by the G20 Nations, has aggressively promoted international co-operation in tax matters through exchange of information by promoting TIEAs with tax havens.

The OECD started its campaign in 1998 with the publication of the report ‘Harmful Tax Competition: Emerging Global Issue’ emphasising the need for effective exchange of information. Subsequently, the OECD developed a model ‘Tax Information Exchange Agreement’ which is largely followed by all nations. The OECD also devised a compliance standard for the tax havens to ensure that each of them sign and effectively implement TIEAs. This compliance standard required each tax haven to sign TIEAs with minimum 12 nations other than tax havens. As standards for monitoring their compliance, the OECD also calls for willingness on part of the tax haven to continue to sign agreements even after reaching threshold and insists on effective implementation of the TIEAs.

The ‘Global Forum’ created by the OECD member countries has devised a system to monitor jurisdiction’s standards on transparency and exchange of tax information by carrying out phase-wise peer reviews by other jurisdictions. Peer review assesses jurisdiction’s legal and regulatory framework on criteria of 10 key elements in 1st Phase of review and in Phase 2 review, examines effective implementation of exchange of tax information after a jurisdiction removes deficiencies identified in its legal and regulatory framework. The peer reviews assess the availability of ownership, accounting and bank information and authorities’ power to access as well as capacity to deliver information along with rights and safeguards and provisions of confidentiality.

So far various countries world over have signed more than 700 TIEAs. The tax havens have signed these agreements to come out of the OECD’s ‘grey list’ to avoid possible sanctions imposed on them if they fail to comply with the stipulated standard of signing minimum 12 TIEAs with the countries other than tax havens.

TIEA
TIEAs provide for exchange of requested information even in the cases in which the conduct of the taxpayer does not constitute crime in the jurisdiction of the requested country (Tax haven). The country is also required to provide requested information which is not in its possession by gathering it. Most importantly, the TIEAs provide for obtaining information from the banks and the financial institutions regarding ownership of companies, partnerships, trusts including ownership information of the persons in the ownership chain and also information on the settlers, trustees, and beneficiaries. This is one of the most important provisions of the agreement, which make it possible, at least theoretically, to unravel ultimate beneficiaries of the tax haven bank accounts. It is too well known that beneficiaries of the tax haven bank accounts are often shielded by a deliberately created complex ownership structure consisting of a maze of entities. It is also important to note that TIEA does not place any restrictions on information exchange caused by the bank secrecy or domestic tax interest requirements.

Why TIEAs cannot be effective

Despite having the well-designed provisions in the TIEA and seriousness of the OECD and governments in dealing with tax evasion, many professionals believe that the TIEAs will not work. There are various reasons for this negative sentiment.

Firstly, there is a conflict of interests among tax haven and non-tax haven countries. Secrecy jurisdictions are hardly interested in sharing information about their customers.

In many jurisdictions, ownership and beneficial ownership information is protected by domestic law.

From the OECD’s Progress Report Tax Transparency of 2011, it becomes clear that making legal and structural changes in secrecy jurisdictions is going to be a time-consuming affair. So far, out of total 81 peer reviews launched, Global Forum has adopted 59 reports. Out of the 59 reviews completed, 42 are Phase 1 reviews and 17 are combined reviews (reviews of both the Phases conducted simultaneously). Nine Jurisdictions will move to Phase 2 after they fix the deficiencies pointed out in the peer reviews. Thus, jurisdictions have to do considerable work to enable them to exchange tax information effectively. Moreover, one of the conclusions of the Report is that the information exchange is too slow.

Secondly, there is no automatic exchange of information. The TIEA requires that for getting information on a taxpayer, the applicant country has to provide specific information of the taxpayer such as (a) the identity of the taxpayer under examination or investigation; (b) the period for which information is requested; (c) the nature of the information requested and the tax purpose for which the information is sought; (d) grounds for believing that the requested information is present in the requested country or is in the possession of a person within the jurisdiction of the requested country; (e) to the extent known, the name and address of any person believed to be in possession of the requested information; (f) a statement that the request is in conformity with the law and administrative practices of the applicant country, that if the requested information was within the jurisdiction of the applicant country, then the applicant country would be able to obtain the information under the laws of the applicant country or in the normal course of administrative practice and that it is in conformity with this agreement; (g) a statement that the applicant country has pursued all means available in its own territory to obtain the information, except which would give rise to dispro-portionate difficulties. Thus, very high amount of information is required to be furnished for making a request meaning that the tax administration should already have substantial evidence against the taxpayer rather than gathering evidence against a taxpayer to make a case of tax evasion. Very often, furnishing such information before the completion of investigation is like putting a cart before the horse.

Thirdly, a taxpayer can move his deposits from the bank account of one tax haven to another before developing of an enquiry making tax administration’s efforts futile. Lastly, experiences of some of the countries indicate little usefulness of TIEAs as they have sparingly used it for the information exchange.

It may be recalled here that the information on the basis of which the Income-tax Department has recently initiated action was not received under the TIEA. The information on Indian account holders in LGT bank Lichtenstein was provided by Germany, which in turn had bought it from the disgruntled employee of the Bank, whereas France reportedly passed on the information on the account holders of the HSBC Bank, Geneva.

Responses by other countries

Probably considering the limitations of the TIEA, some of the countries have adopted multi-pronged strategy to counter offshore tax evasion. On the one hand, US, Germany and Australia had offered Voluntary Income Disclosure Scheme and on the other, some of them have enacted specific legislations to deal with it.

The US has strengthened domestic legislation by enacting specific laws to counter offshore tax evasion by creating additional sources of information gathering.

The US introduced ‘Hiring Incentives to Restore Employment Act’ (HIRE) providing tax incentives for hiring and retaining unemployed workers also imposes 30% withholding on payment made to foreign financial institution, unless such institution agrees to adhere to certain reporting requirements with respect to US account holders. It has also enacted legislation — FATCA (the Foreign Account Tax Compliance Act) which is to be implemented from 2013 requiring non-US banks to report the accounts of US clients to the US Internal Revenue Service. There is also a proposal in the US for enacting additional law, ‘Stop Tax Haven Abuse Act’ strengthening FATCA and plugging specific offshore tax evasion schemes. Similarly, UK’s new law introduced in 2010 provides for higher penalty at 200% on offshore tax evasion.

In addition, many countries have stepped up their counter offensive by allocating more work force to investigate the cases of offshore tax evasion. It is reported that the IRS of the US had placed more than 1400 agents on a project to investigate the merchants who were directly depositing credit card sales in their offshore accounts.

Conclusion

The real challenge to willingness to exchange of information comes from the difference in the tax laws and law on confidentiality along with conflicting interests among countries. Therefore, there is a need to take additional measures along with the TIEAs. However, the measures for information gathering which may work for the countries such as the US, Germany or the UK because of their political and economic clout may not work for India. India will have to supplement its measures — legislative as well as administrative — for information gathering in its battle against tax evasion leveraging at the international level its position of a giant emerging market.

On a positive note, the biggest contribution of the TIEAs is providing legal instrument in an environment against tax evasion. With the result, tax evaders are now increasingly realising that there will be no safer havens in near future for their tax evaded funds, which is the fundamental requirement in a fight against tax evasion.

shailesh.kwebmaker

Input Tax Credit vis-à-vis Tax Payment by Vendor

Introduction

Input Tax Credit (Set-off) is the back bone of an efficient VAT system. Therefore, an unambiguous mechanism of input tax credit is necessary to avoid cascading effect of taxes. The Maharashtra Value Added Tax Act, 2002 (MVAT Act) contains a well-codified scheme of set-off by way of section 48 and Rules.

As per section 48(2) of the MVAT Act, a purchasing dealer is entitled to claim set-off subject to production of valid tax invoice containing declaration as specified in Rule 77. The declaration, amongst others, specifies that the vendor has paid tax or shall pay tax on the sale of goods described in the said tax invoice. However, there is section 48(5) and its interpretation is a subject-matter of dispute. The Sales Tax Department has taken a view that set-off will be granted to the extent of tax actually received in the Government treasury on the same goods in spite of production of tax invoice. Section 48(5) reads as under:

“48. Set-off, refund, etc.

(5) For the removal of doubt it is hereby declared that, in no case the amount of set-off or refund on any purchase of goods shall exceed the amount of tax in respect of the same goods, actually paid, if any, under this Act or any earlier law, into the Government treasury except to the extent where purchase tax is payable by the claimant dealer on the purchase of the said goods effected by him:

Provided that, where tax levied or leviable under this Act or any earlier law is deferred or is deferrable under any Package Scheme of Incentives implemented by the State Government, then the tax shall be deemed to have been received in the Government Treasury for the purposes of this sub-section.”

Similar provision existed under the BST Act also [section 42(3)] and the said section was interpreted by the Larger Bench of the Tribunal in the case of Saujesh Chemicals (S.A. No. 1109 of 2007 and 1701 of 2003, dated 15-12-2007). In this judgment the Larger Bench held that the set-off will be governed by the said section and the setoff will be available to the extent of tax actually paid in the treasury. The arguments about constitutional validity of such provision could not be made before the Appellate Tribunal as the same cannot be entertained by the Tribunal. However, the Tribunal has held that the responsibility of determining tax actually paid in the Government treasury is on the Department.

Recently the Sales Tax Department has come out with information that many dealers under VAT have not paid taxes. Therefore, they are contemplating disallowance of set-off to the purchasers. There is also allegation that these transactions are hawala transactions.

In light of the above scenario, certain writ petitions were filed before the Bombay High Court. The said writ petitions came up for hearing and they have been now decided. These writ petitions can be divided in two parts:

One set of writ petitions

In one set of writ petitions the Department made allegation about purchases being hawala purchases. The High Court, therefore, held that unless the fate of set-off is decided by way of verification and assessment, no challenge to validity of section 48(5) can be maintained. In other words, the writ petitions were held to be premature and hence were disposed of as dismissed. For this purpose reference may be made to the judgments in the case of Premium Paper and Board Industries Ltd. v. The Joint Commissioner of Sales Tax, Investigation-A & Ors. (W.P. No. 347 of 2012 dated 30-4-2012) and other matters.

Other set — Validity of section 48(5) on merits

The other set of writ petitions was in the case of Mahalaxmi Cotton Ginning Pressing and Oil Industries, Kolhapur v. The State of Maharashtra & Ors., (W.P. No. 33 of 2012, dated 11-5-2012) and others.

In these cases there was no allegation of hawala transactions. The dealer had purchased goods from a registered dealer supported by tax invoice and claimed refund. However, refund was disallowed on the ground that the vendors had not paid the tax.

In this case the High Court heard the matter about constitutional validity of section 48(5) on merits. The gist of submission of the petitioners can be noted as under:

(a) Section 48(5) is in connection with rate of tax or amount of sale price, but not about non-payment of tax by vendor.

(b) If interpreted in the manner done by the Department, it will be a burden impossible of performance.

(d) The collection of VAT by vendor is as agent of the Government and hence payment to him amounts to payment to the Government.

(e) It will create discrimination and two purchasing dealer will not be getting equal protection under the law. For example, if two buyers have purchased from the same seller and the said seller pays tax in relation to one buyer only, then such buyer will get set-off whereas the other will not get the same, since no tax is paid on his sale. Thus, though both the buyers are similarly situated from purchaser’s point of view, still there is no equal protection. This is ultra vires Article 14.

(f) There is no system/mechanism for finding out actual tax paid by vendors, which is also to be paid in future and not at the time of sale. Therefore, there will always be a hanging sword on the buyer and this will be unreasonable condition, that is why the provision is ultra vires Article 19(1)(g).

(g) VAT is an indirect tax and it is to be passed on to the consumer. If the set-off is disallowed after goods are already sold, then there will not be an opportunity to recover the same from the buyer/consumer. Thus, this will bring unexpected burden and will also be against the principles of VAT, that there should not be a cascading effect.

(h) A number of judgments were also relied upon to show importance of registration certificate as well as effect of declaration.

On the other hand the Department’s contentions were as under:

(a) The set-off is concession and the Government can put conditions as may be deemed fit.

(b) Set-off contemplates something to be given from the amount already received.

(c) Though the vendor collects tax, it is as a part of the sale price and is not under obligation to collect the same as tax.

(d) There are number of transactions where taxes are not collected like hawala and allowing set-off will be unjustified.

(e) The judgments cited were distinguished on the ground that there was no provision like section 48(5) in those cases.

The High Court, after hearing both the sides, felt that there is no doubt hardship to buyers, but at the same time it is not in favour of striking down the constitutional validity. However, the High Court suggested for bringing some balance between the two sides. At this juncture the Department gave stepwise action in relation to vendors. The said stepwise action is reproduced in para 51 of the judgment which is reproduced below for ready reference. “51. The Learned Advocate General appearing on behalf of the State has tendered a statement of the steps that would be pursued against defaulting selling dealers:

(1) The Sales Tax Department will identify the defaulters, namely, registered selling dealers who have not paid the full amount of tax due in the Government Treasury either by not filling their returns at all or by filing returns but not paying the full tax due (i.e., ‘short filing’) or where returns are filed but sales to the concerned dealers are not shown (i.e. ‘undisclosed sales’).

(2) Set-off will be denied to dealers where at any stage in the chain of sales a tax invoice/ certificate by a defaulter is or has been relied on:
(a) In the event of no returns having been filed by the defaulter, the dealers will be denied the corresponding set-off;

(b) In the case of short filing, dealers who have purchased from the defaulter will be granted set-off pro rata to the tax paid;

(c) In the case of undisclosed sales, the dealers will be denied the entire amount being claimed as set-off in relation to the undisclosed sale;

(d) To prevent a cascading effect, the tax will be recovered only once. As far as possible, the Sales Tax Department will recover the tax from the dealer who purchases from the defaulter.

However, the Sales Tax Department will retain the option of denying a set-off and of pursuing all selling dealers in the chain until recovery is ultimately made from any one of them.

(3) The full machinery of the Act will be invoked by the Sales Tax Department wherever possible against defaulters with a view to recover the amount of tax due from them, notwithstanding the above. Once there is final recovery (after exhaustion of all legal proceedings) from the defaulter, in whole or part, a refund will be given (after the end of that financial year) to the dealer(s) claiming set-off to the extent of the recovery. This refund will be made pro rata if there is more than one dealer who was denied set-off;

(4) Refund will be given by the Sales Tax Department even without any refund application having been filed by the dealers, since the Sales Tax Department will reconcile the payments, inform the dealer of the recovery from the defaulter concerned and grant the refund;

(5) Details of defaulters will be uploaded on the website of the Sales Tax Department and dealers denied set-off will also be given the names of the concerned defaulter(s);

(6) The above does not apply to transactions by dealers where the certificate/invoice issued is not genuine (including hawala transactions). In such cases, no set-off will be granted to the dealer claiming to be a purchaser;

(7) The above should not prevent dealers from adopting such remedies as are available to them in law against the defaulters.”

The High Court has upheld enactment of section 48(5). The Bombay High Court distinguished the judgment of the Punjab and Haryana High Court in the case of Gheru Lal Bal Chand (45 VST 195) (P&H) on the ground that in that case provision like section 48(5) was not available, though petitioner had tried to explain that the provisions in that case were almost similar as under the MVAT Act, 2002. The High Court, while upholding the validity of section 48(5) has expected the Department to follow action plan scrupulously.

From the action plan given by the Department it transpires that the following course of action will be followed by the Department.

(a) The Department will identify the vendors who are defaulters like non-filer of returns, short filer of returns and non-disclosure of sales. This requires assessment of the defaulting vendor. Therefore, unless such assessment of vendor is carried out, no demand can be made on the buyer. The letters issued, as on today, are issued based on mismatch on the computer. However, in light of the above action plan this cannot be the correct position. The buyer can be approached only after assessment of the vendor.

(b) The Department has also to bifurcate Input Tax Credit based on pro rata theory. This also requires assessment of the defaulting vendor.

(c) Refunds to be given subject to the recovery from the vendors. Therefore, the Department has to assess buyers also and keep the record including pro rata allowance of set-off, so as to tally with subsequent refund.

(d) If there is allegation of hawala no set-off will be allowed. However as noted above in the case of Premium Paper and Board Industries Ltd. v. The Joint Commissioner of Sales Tax, Investigation-A & Ors. (W.P. No. 347 of 2012, dated 30-4-2012), for deciding hawala transactions assessment of the buyer will be necessary.

Conclusion

The judgment as on today may bring unexpected liability on purchasers without having any mechanism to protect themselves from defaulting vendors.

We hope that the innocent buyers will get justice from higher forum in due course of time.

We can also understand the anxiety of the Department to collect legitimate revenue of the State. However, it is also necessary to note that the individual buyer cannot bear unexpected burden because of fault on part of the third person i.e., vendor. Therefore, it is necessary to apply the law, keeping best interest of both the sides and it is better that the action plan as given in the judgment is followed in true spirit. The Government can also think of bringing other suitable modalities for giving protection to the innocent buyers, while safe guarding interest of the Revenue.

shailesh.kwebmaker

Interest on Cenvat Credit Wrongly Taken And (Or) Utilised

Issue for consideration:

The issue whether interest is leviable at the point in time when CENVAT credit is wrongly taken or at the point of time of utilisation has been a matter of debate for over many years and hence judicially dealt with at great length and breadth. In a welcome move to close the issue to the relevant rule viz. Rule 14 of the CENVAT Credit Rules, 2004 (CCR) is amended (w.e.f. 17th March, 2012) to read as follows:

Rule 14 of CCR 04:

“Where CENVAT Credit has been taken and* utilised wrongly or has been erroneously refunded, the same along with the interest shall be recovered from the manufacturer or provider of the output service and the provisions of the sections 11A and 11AB of the Excise Act, or sections 73 and 75 of the Finance Act, shall apply mutatis mutandis for effecting such recoveries.”

The amendment in the rule undoubtedly not only ends the undesirable litigation but is also indicative of intent of the legislation. The issue was discussed at length under this column in June 2010. However, considering judicial developments occurring in recent times, pending litigation on the issue and litigation that may come for the period till March 16, 2012, need is felt to revisit the issue.

When can a manufacturer or service provider ‘take’ credit?

For this, relevant statutory provisions are reproduced below:

Rule 4(1) of CCR 04:

“CENVAT credit in respect of inputs may be taken immediately on receipt of the inputs in factory of the manufacturer or premises of provider of output service . . . . . . . .” Rule 4(2)(a) of CCR 04: “The CENVAT Credit in respect of Capital goods . . . . at any point of time in a given financial year shall be taken only for an amount not exceeding 50% of duty paid on such Capital goods in the same financial year.”

Rule 4(7) of CCR 04:

“The CENVAT Credit in respect of input service shall be allowed, on or after the day on which payment is made of the value of input service and service tax paid or payable as indicated in Invoice . . . . . . . .”

To understand the difference, if any, between the terms, ‘taken’ and ‘utilised’, we examine below the dictionary meanings of these words used in Rule 14 ibid. ‘Taken’ means ‘to gain or receive into possession, to seize, to assume ownership’ (Black’s Law Dictionary).

To take, signifies to lay hold of, grab, or seize it, to assume ownership, etc. (Advance Law Lexicon — 3rd Edition).

‘Utilise’ means ‘to make practical and effective use of’ (Compact Oxford Dictionary Thesaurus). Utilise means to make use of, turn to use (The Chambers Dictionary).

In the context of CENVAT credit, generally it may mean that taking a CENVAT credit means committing an act of making an entry in the CENVAT credit register and/or return, etc. However, there is a fresh thought on the subject wherein a question arises as to whether merely making an entry in the register really means that credit is taken? This is because until credit is used for making a payment towards duty or tax, can it be said credit has been taken is an issue that requires thought-process. Whether the two terms — ‘taken’ and ‘utilised’ are interchangeable or almost similar or they are different is the issue discussed here in terms of judicial analysis.

At the outset, we peruse below the landmark rulings on the subject matter:

Chandrapur Magnet Wires (P) Ltd. v. CCE, (1996) 81 ELT (SC). The Supreme Court observed in para 7:

“We see no reason why the assessee cannot make a debit entry in the credit account before removal of the exempted final product. If the debit entry is permissible to be made, credit entry for the duties paid on the inputs utilised in manufacture of the final exempted product will stand deleted in the accounts of the assessee.”

In CCE v. Bombay Dyeing & Mfg. Co. Ltd., (2007) 215 ELT 3 (SC) it was held that reversal of credit before utilisation amounts to not taking credit.

In CCE v. Maruti Udyog, (2007) 214 ELT 173 (P&H), agreeing with the Tribunal’s decision, observed as follows:

“Learned Counsel for the appellant is unable to show as to how the interest will be required to be paid when in absence of availment of Modvat credit in fact, the assessee was not liable to pay any duty. The Tribunal has clearly recorded a finding that the assessee did not avail of the Modvat Credit in fact and had only made an entry.”

Little after the above ruling again the P&H High Court in the case of Ind-Swift Laboratories Ltd. v. UOI, (2009) 240 ELT 328 (P&H) held as follows:

“CENVAT credit is the benefit of duties leviable or paid as specified in Rule 3(1) used in the manufacture of intermediate products, etc. In other words, it is a credit of the duties already leviable or paid. Such credit in respect of duties already paid can be adjusted for payment of duties payable under the Act and the Rules framed thereunder. Under section 11AB of the Act, liability to pay interest arises in respect of any duty of excise has not been levied or paid or has been short-levied or short-paid or erroneously refunded from the first day of the month in which the duty ought to have been paid. Interest is leviable if duty of excise has not been levied or paid. Interest can be claimed or levied for the reason that there is delay in the payment of duties. The interest is compensatory in nature as the penalty is chargeable separately.” (emphasis supplied)

The High Court further observed and opined:

“We are of the opinion that no liability of payment of any excise duty arises when the petitioner availed CENVAT credit. The liability to pay duty arises only at the time of utilisation. Even if CENVAT credit has been wrongly taken, that does not lead to levy of interest as liability of payment of excise duty does not arise with such availment of CENVAT credit by an assessee. Therefore, interest is not payable on the amount of CENVAT credit availed of and not utilised.”

The High Court concluded in the following words:

“In our view, the said clause has to be read down to mean that where CENVAT credit taken and utilised wrongly, interest cannot be claimed simply for the reason that the CENVAT credit has been wrongly taken as such availment by itself does not create any liability of payment of excise duty. On a conjoint reading of section 11AB of the Act and that of Rules 3 and 4 of the Credit Rules, we hold that interest cannot be claimed from the date of wrong availment of CENVAT credit. The interest shall be payable from the date CENVAT credit is wrongly utilised.”

However, the above ruling was unsettled by the Supreme Court in UOI v. Ind-Swift Laboratories Ltd., (2011) 265 ELT 3 (SC). The important observations made by the Supreme Court in para 17 read as follows:

“17. . . . . In our considered opinion, the High Court misread and misinterpreted the aforesaid Rule 14 and wrongly read it down without properly appreciating the scope and limitation thereof. A statutory provision is generally read down in order to save the said provision from being declared unconstitutional or illegal. Rule 14 specifically provides that where CENVAT credit has been taken or utilised or has been erroneously refunded, the same alongwith interest would be recovered from the manufacturer or the provider of the output service. The issue is as to whether the aforesaid word ‘OR’ appearing in Rule 14, twice, could be read as ‘AND’ by way of reading it down as has been done by the High Court. If the aforesaid provision is read as a whole we find no reason to read the word ‘OR’ in between the expression ‘taken’ or ‘utilised wrongly’ or has been erroneously refunded as the word ‘AND’. On the happening of any of the three aforesaid circumstances such credit becomes recoverable along with interest.”

The Supreme Court also noted:

“Besides, the rule of reading down is in itself a rule of harmonious construction in a different name. It is generally utilised to straighten the crudities or ironing out the creases to make a statue workable. This Court has repeatedly laid down that in the garb of reading down a provision it is not open to read words and expressions not found in the provision/statute and thus venture into a kind of judicial legislation. It is also held by this Court that the Rule of reading down is to be used for the limited purpose of making a particular provision workable and to bring it in harmony with other provisions of the statute.”

On reading the above judgment, a question may arise whether ‘or’ can be interpreted as ‘and’. As a matter of fact, there was no finding as to why the word OR used between ‘taken’ and ‘utilised’ could not be interpreted to mean ‘AND’ as in some situations, the Courts have found it necessary or desirable to do so. For instance, the expression ‘established or incorporated’ used in sections 2(f), 22 and 23 of the University Grants Commission Act was read as ‘established and incorporated’ having regard to the constitutional scheme and in order to ensure that the Act was able to achieve its objective and the UGC was able to perform its duties and responsibilities. [Prof. Yashpal v. State of Chattisgarh, AIR 2005 SC 2026 (para 40)]. However, in the context of Rule 14 ibid, as per the Supreme Court, recovery with interest is required to be made under three circumstances viz. on wrongfully taking credit, on wrongfully utilising it and on erroneously refunding CENVAT credit. Whether the judgment given by the Supreme Court in the case of Ind-Swift Laboratories Ltd. (supra) required reconsideration as some felt or whether the facts of the case (in this case, the credit was claimed based on fake invoices and application was filed with Settlement Commission) necessitated the decision in the manner it is pronounced, is a matter of opinion.

A recent decision:

However, observation of the Karnataka High Court in a very recently reported case of CCE & ST LTU, Bangalore v. Bill Forge Pvt. Ltd., 2012 (279) ELT 209 (Kar.)/2012 (26) STR 204 (Kar.) is important to discuss here mainly on account of the fact that not only has it distinguished facts of the case of UOI v. Ind-Swift Laboratories Ltd., 2011 (265) ELT 3 (SC) but it has made a fine distinction between making an entry in the register and credit being ‘taken’ to drive home the point that interest is payable only from the date when duty is legally payable to the Government and the Government would sustain loss to that extent. This judgment has placed reliance and discussed at a fair length the following decisions

Chandrapur Magnet Wires (P) Ltd. v. Collector, (1996) 81 ELT 3 (SC)

Collector v. Dai Ichi Karkaria Ltd., (1999) 112 ELT 353 (SC)

Commissioner v. Ashima Dyecot Ltd., (2008) 232 ELT 580 (Guj.)

Commissioner v. Bombay Dyeing and Mfg. Co. Ltd., (2007) 215 ELT 3 (SC)

Pratibha Processors v. Union of India, (1996) 88 ELT 12 (SC)

In para 18 of the said judgment (supra), the High Court referring to the Apex Court’s judgment in case of UOI v. Ind-Swift Laboratories Ltd., (supra) observed:

“In fact, in the case before the Apex Court, the assessee received inputs and capital goods from various manufacturers/dealers and availed CENVAT credit on the duty paid on such materials. The investigations conducted indicated that the assessee had taken CENVAT credit on fake invoices. When proceedings were initiated, the assessee filed applications for settlement of proceedings and the entire matter was placed before the Settlement Commission. The Settlement Commission held that a sum of Rs.5,71,47,148.00 is the duty payable and simple interest at 10% on CENVAT credit wrongly availed from the date the duty became payable as per section 11AB of the Act till the date of payment. The Revenue calculated the said interest up to the date of the appropriation of the deposited amount and not up to the date of payment. Therefore, it was contended that interest has to be calculated from the date of actual utilisation and not from the date of availment. Therefore, an application was filed for clarification by the assessee. The said application was rejected upholding the earlier order, i.e., interest is payable from the date of duty becoming payable as per section 11AB. Therefore, the Apex Court inter-fered with the judgment of the Punjab and Haryana High Court and rightly rejected by the Settlement Commission as outside the scope and they found fault with the interpretation placed on Rule 14.”

The High Court of Karnataka further observed:

“It is also to be noticed that in the aforesaid Rule, the word ‘avail’ is not used. The words used are ‘taken’ or ‘utilised wrongly’. Further the said provision makes it clear that the interest shall be recovered in terms of section 11A and 11B of the Act……….”

“20……… From the aforesaid discussion what emerges is that the credit of excise duty in the register maintained for the said purpose is only a book entry. It might be utilised later for payment of excise duty on the excisable product…..Before utilisation of such credit, the entry has been reversed, it amounts to not taking credit.”

The judgment concluded in the following words:

Extracts from para 22:

“Therefore interest is payable from that date though in fact by such entry the Revenue is not put to any loss at all. When once the wrong entry was pointed out, being convinced, the assessee has promptly reversed the entry. In other words, he did not take the advantage of wrong entry. He did not take the CENVAT credit or utilised the CENVAT credit. It is in those circumstances the Tribunal was justified in holding that when the assessee has not taken the benefit of the CENVAT credit, there is no liability to pay interest. Before it can be taken, it had been reversed. In other words, once the entry was reversed, it is as if that the CENVAT credit was not available. Therefore, the said judgment of the Apex Court* has no application to the facts of this case. It is only when the assessee had taken the credit, in other words by taking such credit, if he had not paid the duty which is legally due to the Government, the Government would have sustained loss to that extent. Then the liability to pay interest from the date the amount became due arises under section 11AB, in order to compensate the Government which was deprived of the duty on the date it became due.”

Conclusion:

Despite the amendment in Rule 14 of CCR, the above judgment of the Karnataka High Court would be of great use to all those manufacturers and service provider organisations which are facing litigation for the period prior to the date of amendment of March 17, 2012 on account of making book entries of credit in the CENVAT register and keeping utilisation consciously pending on account of uncertainty of eligibility of credit. However, the facts of each case and time would determine its persuasive value.

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Guidelines for setting up an Infrastructure Debt Fund u/s.10(47) — Notification No. 16/2012, dated 30-4-2012.

A new Rule 2F has been inserted vide Income-tax (Fifth Amendment) Rules, 2012 prescribing guidelines and conditions for setting up an infrastructure debt fund for the purpose of claiming exemption u/s.10(47) of the Act. These conditions inter alia provide as under:
(a) The fund shall be set up as a NBFC as per the Guidelines issued by RBI.
(b) The fund shall invest in Public Private infrastructure projects as prescribed.
(c) The fund shall issue Rupee denominated Bonds as well as Foreign Currency Bonds in accordance with guidelines issued by RBI and regulations under FEMA.
(d) Restrictions are imposed on investment by the fund as well as lock-in period for the investor.

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Section 54EC — Exemption from payment of capital gains tax provided the amount is invested within six months from the date of transfer — Whether the investment made within six months from the date of the receipt of consideration is eligible — On the facts held yes.

Mahesh Nemichandra v. ITO
ITAT ‘A’ Bench, Pune
Before Shailendra Kumar Yadav (JM) and
G. S. Pannu (AM)
iTa Nos. 594 to 597/PN/10
A.Y.: 2006-07. Decided on: 29-3-2012
Counsel for assessee/revenue : S. U. Pathak/Ann Kapthuama

Section 54EC — exemption from payment of capital gains tax provided the amount is invested within six months from the date of transfer — Whether the investment made within six months from the date of the receipt of consideration is eligible — on the facts held yes.

Facts:

The assessee jointly owned with three others land at Pune. The
assessee entered into a joint venture development agreement with a
builder on 12-7- 2005, in which the consideration was fixed at Rs.2.50
crore. This document was registered later by way of confirmation deed
dated 23-1-2007. Thereafter, a correction deed was entered into on
2-7-2007 in which the sale consideration was increased to Rs.4.90 crore.
Out of the total sale consideration at Rs.4.90 crore, the assessee’s
share was 1/4th i.e., Rs.1.22 crore. On these facts, the Assessing
Officer inferred that the date of joint venture agreement, i.e.,
12-7-2005 was the date of transfer for the capital asset. Further the
claim for relief u/s.54EC on account of investments of Rs.12.5 lac and
Rs.37.5 lac made on 3-8-2007 and 27-10-2007 was denied. The assessee
objected to taxation of the capital gain in A.Y. 2006-07, and contended
that it should be considered in the A.Y. 2007-08 since the joint venture
agreement was registered on 23-1-2007 and only after which it was acted
upon and implemented. On appeal the CIT(A) confirmed the order of the
AO. Before the Tribunal the Revenue supported the orders of the
authorities below by pointing out that the Bombay High Court in the case
of Chaturbhuj Dwarkadas Kapadia v. CIT, (260 ITR 491) (Bom.) has noted
that after insertion of clauses (v) and (vi) in section 2(47) of the
Act, the expression ‘transfer’ includes any transaction which allowed
possession to be taken/retained in part performance of a contract of the
nature referred to in section 53A of the Transfer of Property Act,
1882. Therefore, it contended that in the case of the assessee, as he
had granted possession with an irrevocable permission for development of
the land in favour of the builder, the date of development agreement
was the date of transfer for the purpose of ascertaining the year of
taxability of capital gains.

Held:

The Tribunal noted that under the
agreement dated 12-7-2005 the builder was given the possession of the
property for development. This according to it, fulfils the requirements
of section 2(47)(v) as understood and explained by the Mumbai High
Court in the case of Chaturbhuj Dwarkadas Kapadia. Accordingly, it held
that the ‘transfer’ in terms of section 2(47)(v), had taken place during
A.Y. 2006-07. As regards the issue relating to granting of exemption
u/s.54EC of the Act in respect of the investment Rs.12.5 lakh and
Rs.37.5 lakh made on 3-8-2007 and 27-10-2007, respectively, in eligible
bonds, the Tribunal noted that the assessee had received the aforestated
consideration on subsequent dates, namely, 12-2-2007, 14-5-2007,
19-6-2007 and 3-7-2007. The Tribunal referred to the CBDT Circular No.
791 issued in the context of the provisions of sections 54EA, 54EB and
54EC. Under the said provisions the assessee is similarly granted
exemption from capital gains tax arising from the conversion of capital
assets into stock-in-trade provided the assessee makes investment in the
specified bonds within six months of the date of conversion.

The CBDT
in consultation with the Ministry of Law decided that the period of six
months for making investment in specified assets for the purpose of
sections 54EA, 54EB and 54EC of the Act should be taken from the date
such stockin- trade is sold or otherwise transferred in terms of section
45(2) of the Act, though the taxability of capital gain was on the
basis of ‘transfer’ as understood in section 45(2) of the Act. According
to the Tribunal, the interpretation placed by the CBDT in the
above-referred Circular to the condition of making investment within six
months from the date of transfer in section 54EC would support the
claim of the assessee for exemption from capital gain with respect to
the impugned sum of Rs.50 lakh invested in specified assets on 3-8- 2007
and 27-10-2007.

Accordingly, the contention of the assessee on this
ground was accepted and exemption u/s.54EC as claimed by the assessee
was granted.

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Sections 37, 40(a)(ii) — Taxes levied in foreign countries whether on profit or gain or otherwise are deductible u/s.37 — Payment of such taxes does not amount to application of income.

Mastek Ltd. v. DCIT
ITAT ‘A’ Bench, Ahmedabad
Before D. K. Tyagi (JM) and
a. Mohan alankamony (aM)
iTa Nos. 1821/ahd./2005, 2274/ahd./2006 and
2042/ahd./2007
A.Ys.: 2003-04 to 2004-05
Decided on: 11-5-2012
Counsel for assessee/revenue:
S. N. Soparkar/Kartar Singh

Sections 37, 40(a)(ii) — Taxes levied in foreign countries whether on profit or gain or otherwise are deductible u/s.37 — Payment of such taxes does not amount to application of income.

Facts:

The assessee had, in its accounts, debited Rs.42,57,297 on account of taxes paid in Belgium and claimed this amount as a deduction u/s.37 on the ground that all taxes and rates were allowable irrespective of the place where they are levied i.e., whether in India or elsewhere. The exception to this being Indian income-tax which is not allowable by virtue of provisions of section 40(a)(ii). The Assessing Officer (AO) held that the term ‘tax’ u/s.40(a)(ii) is not limited to tax levied under the Indian Incometax Act, but is wide enough to include all taxes which are levied on profits of a business. He disallowed the entire amount of Rs.42,57,297 charged to P & L Account. Aggrieved the assessee preferred an appeal to the CIT(A) who held that the amount is allowable u/s.37 of the Act. He allowed this ground of the appeal. Aggrieved, the Revenue preferred an appeal to the Tribunal.

Held:

Taxes levied in foreign countries whether on profits or gains or otherwise are deductible u/s.37(1). Such taxes are not hit by section 40(a)(ii). It is also not application of income. The Tribunal noted that in the case of South East Asia Shipping Co. (ITA No. 123 of 1976) the Mumbai Bench of ITAT has held that tax levied by different countries is not a tax on profits but a necessary condition precedent to the earning of profits. In this case reference application of the Revenue was rejected by the Tribunal which has been upheld by the Bombay High Court in ITA No. 123 of 1976. The Tribunal also noted that in the case of Tata Sons Ltd. (ITA No. 89 of 1989) the Department’s reference applications u/s.256(1) and 256(2) were rejected and the issue has reached finality. The Tribunal upheld the order passed by the CIT(A) on this ground. The Tribunal decided this ground in favour of the assessee.

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Section 54F — Exemption u/s.54F can be claimed in respect of deemed long-term capital gain u/s.54F(3) arising on transfer of new house if net consideration thereof is again invested in purchase of a residential house within a period of two years.

(2012) 21 taxmann.com 385 (Chennai)
aCiT v. Sultana Nazir
A.Y.: 2007-08. Dated: 23-3-2012

Section 54F — exemption u/s.54F can be claimed in respect of deemed long-term capital gain u/s.54F(3) arising on transfer of new house if net consideration thereof is again invested in purchase of a residential house within a period of two years.

Facts:

On 5-5-2005 the assessee sold land held by him as long-term capital asset, for a consideration of Rs.81 lakh. On 1-10-2005, the assessee invested Rs.75 lakh in purchase of new house property at Alwarpet. In A.Y. 2006-07, the assessee claimed Rs.73,94,157 to be exempt u/s.54F of the Act, which was allowed. On 13-11-2006, the assessee sold the house purchased at Alwarpet for a consideration of Rs.50 lakh and purchased another residential house at Spur Tank Road on 15-11-2006 for Rs.70,80,620. The Assessing Officer (AO) while assessing the total income for A.Y. 2007-08 held that the long-term capital gain of Rs.73,94,157 claimed to be exempt u/s.54F in A.Y. 2006-07 was to be withdrawn in A.Y. 2007-08. According to the AO, the assessee suffered a capital loss of Rs.25 lakh on sale of house property situated at Alwarpet and therefore, allowing set-off of such loss, he brought to tax the balance amount of Rs.48,94,157. Aggrieved the assessee preferred an appeal to the CIT(A) who allowed the appeal. Aggrieved, the Revenue preferred an appeal to the Tribunal.

Held:

The Tribunal after considering the provisions of section 54F(3) of the Act held that the AO was justified in treating Rs.73,94,157 as long-term capital

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Natural justice — Officer involved in audit — Officer not competent to assess the dealer — VAT Act, 2004.

The petitioner dealer filed writ petitions challenging the assessment orders passed by the Joint Commissioner u/s.42 of the Orissa Value Added Tax Act, 2004 as a result of audit prescribed under Rule 49(1) of the Orissa Value Added Tax Rules, 2005, inter alia, contending that the orders of assessment were passed by the Joint Commissioner who was not competent to assess the petitioner, that they were passed violating the principles of natural justice and that the orders were time-barred as they were passed beyond the time stipulated u/ss. (6) and (7) of section 42 of the Act i.e., one year from January 18, 2010, when the audit visit report was approved and given by the Jt. Commissioner.

The High Court held that it was stated by the Department that the audit was directed by the Jt. Commissioner, Sales Tax of the Range and that he was required to constitute an audit team and monitor the progress of the audits assigned to the team. In view of this, it could not be said that the Jt. Commissioner was not involved in the audit process. In order to maintain transparency, any officer who was involved in any manner or had acted in the process of audit and preparation of the audit report in respect of the dealer should not be the Assessing Officer of that dealer. Otherwise, there would be violation of cardinal principles of natural justice. Therefore the orders passed by the Jt. Commissioner were to be set aside.

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Authority for Advance Ruling Jurisdiction — Application for Ruling — Discretionary — Holding and subsidiary.

[ GSPL India Transco Ltd. & Anr. In re (2012) 49 VST 310 (AAR)]

The applicant, a subsidiary of a subsidiary of a Dr. K. Shivaram Ajay R. Singh Advocates Allied laws Govt. company, filed an application seeking a ruling by the Authority for Advance Rulings on its proposed transactions. The maintainability of the application was challenged by the Dept. contending that since a question identical to the one sought to be raised by the applicant was pending before the Customs, Excise and Service Tax Appellate Tribunal at the instance of the company of which the applicant was a subsidiary, the application by the applicant raising the identical question was barred by the proviso to s.s (2) of section 96D of the Finance Act, 1994. The AAR on the stated facts held that the question sought to be raised was pending before the Tribunal, though at the instance of the holding company of the applicant. If the argument of the applicant was accepted, the ruling to be given by the Authority would only bind the applicant and the authorities under the Act would be bound to implement that ruling only in the case of the applicant.

That would mean that in the appeal filed by the holding company of the applicant involving the identical question, the Tribunal was free to render a ruling ignoring what was being ruled by the Authority. That could lead to incompatible decisions concerning the same question, being rendered by two different authorities on an identical transaction. Therefore, in the facts and circumstances of the case, such a situation should be avoided. This would be in furtherance of the spirit of enacting the bar to the jurisdiction of this Authority to entertain an application for advance ruling, when the identical question was pending before an authority under the Act, the Tribunal or Court. Therefore the application was to be rejected exercising the discretion of the Authority not to allow the application u/s.96D(2) of the Act for the purpose of giving a ruling u/s.96D(4) of the Act.

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Appeal — Tribunal — Adjournment — Medical certificate not necessary while seeking adjournment on medical ground.

[Megh Raj Bansal v. Customs Excise and Service Tax Appellate Tribunal & Anr., (2012) 13 GSTR 75 (P&H)]

The petitioner, a sub-contractor, was served with a show-cause notice u/s.73 of the Finance Act, 1994, stating that the petitioner had evaded payment of service tax during the relevant period. The stand of the petitioner was that service tax stood paid by the main contractor on the total amount inclusive of the service part, which was allotted to the petitioner by the main contractor. The adjudicating authority, raised demand of certain amount towards tax, interest u/s.75 and penalties u/s.76 and 78. In appeal by the petitioner before the Tribunal, a request for adjournment on medical ground was sought by the petitioner but the same was rejected, as the medical certificate had not been attached. The said order of the Tribunal was challenged in writ before the High Court.

The Court held that while seeking adjournment on medical ground that medical certificate was not expected to be produced. It was the statement made by the counsel, which was expected to be accepted unless the circumstances were brought to the notice of the Court or the Tribunal to decline the request for adjournment sought on medical ground. As no reason could be found to decline the request for adjournment by the counsel for the petitioner, the Tribunal was not justified in not accepting the request for adjournment for the reason that the medical certificate was not attached.

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Microsoft Office 2013

About this write-up

MS Office is a popular application software and enjoys wide usage across the world. Recently Microsoft released the Customer Preview of the latest version of its Office suite i.e., Microsoft Office 2013 (a.k.a Office 15). This write-up briefly discusses some of the new features proposed to be introduced in the new software, product enhancements to existing features, and some pros & cons associated therewith.

In my last write-up I had mentioned that developments and product announcements/launches were happening in such quick succession, that hardly a day passes by and a new product is launched. As a consequence, products are becoming out of fashion (in relative terms) almost immediately after launch.

When I was penning my previous write-up, I chose to write about the Flamer worm instead of writing about Samsung Galaxy S-III, iOS 6 and Microsoft Surface) . . . . don’t ask me why. Anyhow, I had ended the write up with the note that the next write-up would be about Samsung Galaxy S-III. In all honesty, I was all set to keep this commitment and suddenly out of the blue I read about Microsoft’s latest. All of a sudden it felt like Galaxy S-III had already become ‘old news’ and I had to write about the latest offering (announcement for now) from Microsoft. And so . . . . here we are . . . .

Background

Microsoft Office 2013 (a.k.a Office 15) is a productivity suite from Microsoft Windows and is likely to succeed the hugely popular Microsoft Office 2010. A developmental version (build 2703.1000) was leaked in May 2011. Subsequently, in January 2012, Microsoft released a technical preview of Office 15 (build 3612.1010). Almost six months later, on 16 July 2012 (to be precise) Microsoft unveiled the Customer Preview.

In this write-up, I have tried to highlight some of the new features proposed to be introduced in the new software, product enhancements to existing features, and some pros & cons associated therewith.

Whats new in Office 15

While there are several features that one can describe, here are a few features that I found exciting:

Cloud integration
Will respond to touch, Stylus and the good ol’ keyboard
The new ‘Metro’ look
Edit PDFs in Word 2013
Will support Open Document Format (‘ODF’) 1.2
Sharing, embedding web elements like YouTube videos
Social media integration — skype, flicker
Enhancements in Excel, Word, Outlook, One Note.

Some of the things that might not excite a few people:

Will have to upgrade from Windows XP/Vista
Get used to SkyDrive cloud storage.

Cloud integration

Cloud integration is now becoming a de facto ‘must have feature’. Cloud storage has been around for a quite some time (X drive types). Without getting into ‘who started it all’, Google’s chrome OS was a serious attempt to move towards cloud integration. If you recall, the Chrome OS was touted as one of slimmest OS because it required very little time to boot and Google had famously said that there was no need for providing any apps within the OS because everything was on the internet and that most people only boot their PCs and log on to the net — hence all the apps would be on the net. Last year when Apple unveiled its latest offering, it also announced a new service iCloud (5 GB storage). Gone were those days when you need to synchronise your PCs at different locations, no need to carry data in a portable drive or disc. With Office 15, Microsoft too has joined the gang. SkyDrive is default storage location for all your files (effectively SkyDrive is expected local C drive). Subscribers will be given 20GB storage space.

With this version, the Microsoft is moving to a subscription-based model wherein your Office files are tied to your Microsoft ID. Once you sign up, you can download the various desktop apps to a certain number of devices and, as with Windows 8, your settings, SkyDrive files and even the place where you left off in a document will follow you from device to device. Office 365, which is currently being sold to businesses, will be available to home-users as well.

In addition to receiving future Office upgrades automatically, subscribers will get additional Sky- Drive storage, multiple installs for several users, and added perks such as international calls via Skype. You’ll also be able to stream Office apps to an Internet-connected Windows PC.

Responds to touch, stylus also

The preview page says “Office 15 will take you beyond the mouse and keyboard — to embrace touch and pen input” (one can hope for a much better experience while using One note). While multi-touch laptops aren’t — and probably won’t be — a mainstream choice for business and homeusers anytime soon, touch is an essential component of smartphones and tablets, obviously. The pen may be making a comeback too, judging by the popularity of Samsung’s stylus-equipped Galaxy Note. Office 2013 will allow you to swipe a finger across the screen to turn a page; pinch and zoom to read documents; and write with a finger or stylus — just like you do on your smart phone or tab. Additionally, when you write an email by hand, Office 2013 will automatically convert it to text. The user interface has been modified (especially the Ribbon feature — its flattened up or as Microsoft likes to call it ‘Metrified’). While this may seem a bit odd when you see it on a desktop, but you may appreciate it more when you try using it on a tablet PC or on your smart phone.

The new ‘Metro’ look

Microsoft loves Metro user interface, which was first introduced in Windows Phone 7 around two years ago. Since then Metro has become the user interface of future for Microsoft and the company is putting it in all its products. Office 2013 too has been given a Metro makeover. It is a slick interface, with clean lines, lots of empty space and looks modern.

For the uninitiated

Metro is an internal code name for a typographybased design language created by Microsoft. Originally meant for use in Windows Phone 7. Early uses of the Metro principles began as early as Microsoft Encarta 95 and MSN 2.0. Later on, these principles evolved into Windows Media Center and Zune. Now they are included in Windows Phone, Microsoft’s website, the Xbox 360 dashboard update, and Windows 8. A key design principle of Metro is better focus on the content of applications, relying more on typography and less on graphics (‘content before chrome’). WinJS is a JavaScript library by Microsoft for developing Metro applications with HTML.

There are two aspects to the design changes introduced in Office 2013 — visual changes and usability changes. Microsoft thinks that there is no need for any faux chrome or aero fluff around windows. Hence, the interface has been ‘Metrified’ (that’s how Microsoft likes to say it). The icons have been flattened, things have been cleaned up (i.e., the heavy boundaries, bevelled edges, shadows, etc. . . . . all gone.

In fact, icons are likely to be a thing of the past. Under Metro there will be hardly any need for icons. While some argue that icons were simple (graphic, easy to remember) indicators for tools like copy, paste, etc., they kinda spruced things up. Microsoft argues that when you have as many as 4000 of such icons it eats away most of your display area.

Microsoft justifies the Metrification by saying that Office 15 is likely to used and seen on screens of different shapes and sizes, consider the screen of a typical smart phone…… would you rather see the screen or the numerous icons. Duh!!! It’s about getting the content front and centre and trying to get the application content out of the way — there when you need it, but out of the way when you don’t. On tablets and smart phones, you want to put the application stuff to one side.

Microsoft thinks that once you get the hang of it, you will appreciate the thought process.

Edit PDF documents in Word 2013

Until now you could only ‘save’ office files in PDF format. To edit these files or other PDF files, either you would have to edit the original office file and then (again) save as PDF or you had to buy third-party software/utilities. Going forward, you will be able to open PDF files and edit them in MS Word 2013 and then save them as word files or as PDF.

Word 2013 will maintain the formatting such as headers, columns, and footnotes and elements such as tables and graphics, of the PDF and permit you to edit them as though they were created in Office 2013 itself.

Users feedback suggests that Office 2013 handled simpler PDF files with ease. But it was not so graceful with the complex ones that had many images and elements.

Will support Open Document Format (‘ODF’) 1.2

Microsoft fought ODF1 as it became an open international standard (ISO/IEC 26300) by creat-ing its own standard OOXML (ISO/IEC 29500) and pushing it through standards organisations. But Microsoft has now apparently accepted that ODF has widespread support with other vendors, governments and organisations.

Microsoft already supports ODF 1.1 in Office 2007 SP1, Office 365, SharePoint and SkyDrive WebApps. Now Office 2013 will support ODF 1.2.

ODF 1.2 has already been widely adopted and is supported by, along with others such as Gnumeric, Google Docs, Zoho Office and AbiWord.

Sharing, embedding web elements like YouTube videos & social media integration — Skype, flicker

Office 2013 uses Sky Drive to enable better sharing of documents. You can invite people to work on to the document or use PowerPoint to give a presentation on the web. Word files can also be published as blogs on several popular blogging services directly from Office 2013.

YouTube videos can be now embedded into the documents directly and users don’t have to save these clips to the local computer. Office 2013 also includes Flickr integration that allows users to search for photographs on the popular photo sharing websites and embed pictures using Office 2013.

Microsoft acquired Skype last year, and Office 2013 will be the first suite to incorporate the popular VoIP service. You can integrate Skype contacts with Microsoft’s enterprise-oriented Lync communications platform for calling and instant messaging. Office subscribers get 60 minutes of Skype international calls each month.

User feedback suggests that there’s room for improvement, though.

shailesh.kwebmaker

GAP in GAAP Accounting for Dividend Distribution Tax

Introduction to Dividend Distribution Tax (DDT)

Prior to 1st June 1997, companies used to pay dividend to their shareholders after withholding tax at prescribed rates. This was the “classic” withholding tax where shareholders were required to include dividend received as part of their income. They were allowed to use tax withheld by the company against tax payable on their own income. Collection of tax from individual shareholders in this manner was cumbersome and involved a lot of paper work. In case of levy of tax on individual shareholders, tax rate varied depending on class of shareholders. For example, corporate shareholders and shareholders in high income group paid tax at a higher rate, whereas shareholders in low income group paid tax at a lower rate or did not pay any tax at all. Also, certain shareholders may not comply with tax law in spirit, resulting in a loss of revenue to the government.

The government realised that it may be easier and faster to collect tax at a single point, i.e. from the company. It, therefore, introduced the concept of Dividend Distribution Tax (DDT). Under DDT, each company distributing dividend is required to pay DDT at the stated rate (currently 15% basic) to the government. Consequently, dividend income has been made tax free in the hands of the shareholders.

DDT paid by the company in this manner, is treated as the final payment of tax in respect of dividend and no further credit, therefore, can be claimed either by the company or by the recipient of the dividend. However, DDT is not required to be paid by the ultimate parent on distribution of profits arising from dividend income earned by it from its subsidiaries (section 115-O). Such exemption is not available for dividend income earned from investment in associates/joint ventures or other companies. Also, no exemption is available to a parent which is a subsidiary of another company.

DDT is applicable irrespective of whether dividend is paid out of retained earnings or from current income. DDT is payable even if no income-tax is payable on the total income; for example, a company that is exempt from tax in respect of its entire income still has to pay DDT, or a company pays DDT even if distribution was out of capital; though those instances may be rare.

Accounting for DDT under Indian GAAP in standalone financial statements

The accounting for DDT under Indian GAAP is prescribed by the “Guidance Note on Accounting for Corporate Dividend Tax”. As per this Guidance Note, DDT is presented separately in the P&L, below the line. This guidance was provided prior to revised Schedule VI. Under revised Schedule VI, DDT is adjusted directly in Reserves & Surplus, under the caption P&L Surplus. The guidance note justifies the presentation of DDT below the line as follows – “The liability in respect of DDT arises only if the profits are distributed as dividends, whereas the normal income-tax liability arises on the earnings of the taxable profits. Since DDT liability relates to distribution of profits as dividends which are disclosed below the line, it is appropriate that the liability in respect of DDT should also be disclosed below the line as a separate item. It is felt that such a disclosure would give a proper picture regarding payments involved with reference to dividends.”

Accounting for DDT under IFRS in stand alone financial statements

It is highly debatable under IFRS, whether DDT in the standalone financial statements is a below the line or above the line adjustment. In other words, is DDT an income tax charge to be debited to P&L or is it a transaction cost of distributing dividend to shareholders, and hence, is a P&L appropriation or Reserves & Surplus adjustment.

The argument supporting a P&L charge under IFRS is as follows:

1 Paragraph 52A and 52B of IAS 12 Income Taxes clearly treats DDT as an additional income tax to be charged to the P&L A/c.

52A – In some jurisdictions, income taxes are payable at a higher or lower rate, if part or all of the net profit or retained earnings is paid out as a dividend to shareholders of the entity. In some other jurisdictions, income taxes may be refundable or payable if part or all of the net profit or retained earnings is paid out as a dividend to shareholders of the entity. In these circumstances, current and deferred tax assets and liabilities are measured at the tax rate applicable to undistributed profits.

52B – In the circumstances described in paragraph 52A, the income tax consequences of dividends are recognised when a liability to pay the dividend is recognised. The income tax consequences of dividends are more directly linked to past transactions or events than to distributions to owners. Therefore, the income tax consequences of dividends are recognised in profit or loss for the period as required by paragraph 58, except to the extent that the income tax consequences of dividends arise from the circumstances described in paragraph 58(a) and (b).

2 Paragraph 65A of IAS 12 states as follows – “When an entity pays dividends to its shareholders, it may be required to pay a portion of the dividends to taxation authorities on behalf of shareholders. In many jurisdictions, this amount is referred to as a withholding tax. Such an amount paid or payable to taxation authorities is charged to equity as a part of the dividends.” Some may argue that DDT is not paid on behalf of the shareholders, because they do not get any credit for it. The shareholders do not get the credit for the tax paid by the entity on dividend distribution. The obligation to pay tax is on the entity and not on the recipient. Further, there is no principalagency relationship between the paying entity and the recipient. In other words, the tax is on the entity and on the profits made by the entity.

The arguments supporting a below the line adjustment (also referred to as equity or P&L appropriation adjustment) are as follows:

1 IFRIC at its May 2009 meeting, considered an issue relating to classification of tonnage taxes. The IFRIC was of the view that IAS 12 applies to income taxes, which are defined as taxes based on taxable profit. Taking a cue from the IFRIC conclusion, it can be argued that DDT is not an income tax scoped in IAS 12. Firstly, a company may not have taxable profit or it may have incurred tax losses. If such a company declares dividend, it needs to pay DDT on dividend declared. This indicates DDT has nothing to do with the existence of taxable profits. Secondly, DDT was introduced in India, without a corresponding reduction in the applicable corporate tax rate. Thus, DDT has no interaction with other tax affairs of the company. Lastly, the government’s objective for introduction of DDT was not to levy differential tax on profits distributed by a company. Rather, its intention is to make tax collection process on dividends more efficient. DDT is payable only if dividends are distributed to shareholders and its introduction was coupled with abolition of tax payable on dividend. Thus, DDT is not in the nature of an income tax expense under IAS 12.

2 As per The Conceptual Framework for Financial Reporting, “expenses” do not include decreases in equity relating to distributions to equity participants. DDT liability arises only on distribution of dividend to shareholders. Thus it is in the nature of transaction cost directly related to transactions with shareholders in their capacity as shareholders and should be charged directly to equity.

3 Support for treating DDT as an equity adjustment can also be found in paragraph 109 of IAS 1 reproduced here – “Changes in an entity’s equity between the beginning and the end of the reporting period reflect the increase or decrease in its net assets during the period. Except for changes resulting from transactions with owners in their capacity as owners (such as equity contributions, reacquisitions of the entity’s own equity instruments and dividends) and transaction costs directly related to such transactions, the overall change in equity during a period represents the total amount of income and expense, including gains and losses, generated by the entity’s activities during that period.”

4 Support for treating DDT as an equity adjustment can also be found in paragraph 35 of IAS 32 reproduced here – “Interest, dividends, losses and gains relating to a financial instrument or a component that is a financial liability, shall be recognised as income or expense in profit or loss. Distributions to holders of an equity instrument shall be debited by the entity directly to equity, net of any related income tax benefit. Transaction costs of an equity transaction shall be accounted for as a deduction from equity, net of any related income tax benefit.” It may be noted that this paragraph has now been amended to remove the reference to income-tax; and consequently to bring income-tax purely in the scope of IAS 12 only.

Although DDT is paid by the company, the economic substance is similar to the company withholding the tax and paying it on behalf of the shareholders. The shareholder has the entire dividend income exempt from tax, to reduce the administrative effort to track the flow from the company to the shareholder. In other words, DDT in substance is a type of with-holding tax borne by the shareholder that should be accounted as a deduction from equity.

Almost all companies in India that prepare IFRS financial statements treat DDT as an equity adjustment rather than as an income-tax charge.

Accounting for DDT in the consolidated financial statements (CFS) under IFRS & Indian GAAP

There is an interesting but very significant difference when it comes to presentation of DDT at the CFS level under IFRS. Consider an example, where a group comprises of a parent, a 100% subsidiary and the parents investment in a joint venture. The joint venture pays dividend to the parent and the corresponding DDT is paid to the government.

In the CFS, the group would account for its proportionate share of the DDT (paid by the joint venture) as an income -tax charge in the P&L account (and not as a P&L appropriation or equity adjustment). The reason for this treatment is that it is a cost of moving cash from one entity to another in a group. In the standalone accounts of the joint venture, when the dividends are paid to the ultimate shareholder (the parent company in this case) from the perspective of the joint venture, the DDT is reflected as an equity adjustment, and one of the arguments for doing so was that in substance, it is tax paid on behalf of shareholders. In the CFS, even if the DDT paid by the joint venture was on behalf of the parent, the parent does not get any tax credit for the same. In other words, at the group (CFS) level, there is ultimately a tax outflow, for which no tax credit is available. Hence, the same is charged to the P&L account as an income tax charge. In India, almost all companies preparing IFRS CFS, adopt this approach. However, strangely, this approach is not followed by most companies in the CFS prepared under Indian GAAP. This is perhaps done erroneously and due to lack of understanding of the standards, which needs to be rectified by appropriate intervention from the Institute of Chartered Accountants of India.

shailesh.kwebmaker

Changes in ownership — Approach under Ind AS

Currently under Indian GAAP, presenting consolidated financial statements is not mandatory for all entities. Only listed entities are required to present consolidated financial statements as per SEBI regulations. Ind AS requires mandatory preparation of consolidated financial statements by all companies, which have subsidiaries. In this article, we aim to understand the accounting for changes in stake held in subsidiaries and associates in the consolidated financial statements of a parent entity.

A. Changes in stake held in a subsidiary without loss of control

When there is a change (increase or decrease) in parent’s ownership in a subsidiary without loss of control, such change is accounted for as a transaction with owners in their own capacity i.e., any acquisition of minority interest is recorded as a capital transaction.

As a result, no gain or loss on such changes is recognised in the income statement. Also, no change in the carrying amounts of assets (including goodwill) or liabilities is recognised as a result of such transactions. Any difference between the consideration paid and the acquired minority interest is adjusted against reserves.

Example 1

Acquisition by parent of Non-Controlling Interest (NCI) of a subsidiary that has other comprehensive income Company P owns 80% of the shares in Company S. On 1st January 2011, P acquires an additional 10% of S for cash of INR 350. The carrying amount of the NCI in S before the acquisition is INR 500, which includes 100 in respect of the NCI’s portion of gains recognised in other comprehensive income in relation to foreign exchange movements.

In P’s consolidated financial statements the decrease in NCI in S is recorded as follows:

The amounts are based on the following calculation:

Example 2

Disposal of shares in an existing subsidiary without losing control

Company P owns 100% of the shares in Company S. On 1st January 2011, P sells 10% of S for cash of INR 350, thereby reducing its interest to 90%. The carrying amount of the net assets of S (including goodwill) in the consolidated financial statements of P on 1st January 2011 before the sale is INR 3,000. S has no other comprehensive income.

In P’s consolidated financial statements the sale of the 10% interest in S is recorded as follows:

The amounts are based on the following calculation:

P recognises the difference between the adjustment to the carrying amount of NCI and the fair value of the consideration received directly in equity. No adjustments are made to the recognised amounts of assets, including goodwill, and liabilities.

Example 3

Subsidiary issues new shares — Control retained but ownership interest changes

Company S has 100 ordinary shares outstanding and the carrying amount of its equity (net assets) is INR 400. Company P owns 90% of S, i.e., 90 shares. S has no other comprehensive income. S issues 20 new ordinary shares to a third party for INR 150 in cash, as a result of which:

S’s net assets increase to INR 550.
P’s ownership interest in S reduces from 90% to 75% (P now owns 90 shares out of 120 issued).
NCI in S increases from INR 40 (400 x 10%) to INR 137.5 (550 x 25%). In P’s consolidated financial statements the increase in NCI in S arising from the issue of shares is recorded as follows:

One of the common situations under which a subsidiary issues new shares which affect the parent’s percentage holding is when employees exercise share options granted to them under Employee Stock Option Plan (ESOP) schemes. Similar to example 3 above, there is a change in ownership interest but control is retained. Therefore, the accounting treatment in the consolidated financial statements to record the change in shareholding is similar to example 3 above.

B. Control acquired by purchasing additional stake in an existing equity method investment

Sometimes controlling stake in an entity is obtained in stages, for example Entity A acquires 20% of interest in entity B on 1st January 2009 and thereafter on 1st January 2010, entity A acquires another 40%.

In such cases, the fair value of any non-controlling equity interest in the acquiree that is held immediately prior to obtaining control is used in the determination of goodwill, i.e., it is re-measured to fair value at the acquisition date with any resulting gain or loss recognised in profit or loss. The basis of fair valuing the original interest is that the economic nature of the investment changes and hence this is akin to disposing of the original investment and recording a new investment in the books.

In such step acquisitions

the previously-held non-controlling equity interest is re-measured to its fair value at the acquisition date, with any resulting gain or loss recognised in profit or loss;
the acquirer de-recognises the previouslyheld non-controlling equity interest and recognises 100% of the acquiree’s identifiable assets acquired and liabilities assumed; and
any amounts recognised in other comprehensive income relating to the previously-held equity interest are recognised on the same basis as would be required if the acquirer had disposed of the previously-held equity interest.

Example 4:

Associate becomes subsidiary

On 1st January 2011, Company P acquired 30% of the voting ordinary shares of Company S for INR 50,000. P accounts its investment in S under Ind AS-28 Investments in Associates.

At 31st December 2011, P recognised equity accounted earnings of INR 8,500 in profit or loss. The carrying amount of the investment in the associate on 31st December 2011 was therefore INR 58,500 (50,000 + 8,500). On 1st January 2011, P acquires the remaining 70% of S for cash of INR 200,000. At this date the fair value of the 30% interest owned already is INR 70,000 and the fair value of S’s identifiable assets and liabilities is INR 250,000.

The transaction would be accounted for as follows:

Note 1

Calculation of goodwill

Note 2

Calculation of gain on previously held interest in S recognised in profit and loss

Another example where similar accounting treatment as above would be followed is when control is obtained through the acquiree repurchasing its own shares. For example, an investor holds a non-controlling equity investment in an investee. If the investee buys back enough of its own shares such that the investor obtains control of the investee, then the investor company needs to adopt consolidation procedures and account the investee company as a subsidiary i.e., Entity A owns 40% interest in entity B. On 1st January 2011, B repurchases a number of its shares such that A’s ownership interest increases to 65%. The repurchase transaction results in A obtaining control of B.

C. Dilution of ownership interest by disposal of shares resulting in loss of control

Under Ind AS, when a change in controlling interest results in loss of control (e.g., due to sale of investment in the subsidiary), such a change is accounted for in two parts.

Firstly de-recognise the net assets and good-will of the subsidiary and recognise the relating gain or loss in income statement (by comparing it to the fair value of consideration received).

Secondly, recognise any balance investment in the former subsidiary at fair value.

Example 5

Subsidiary becomes associate

Entity A owns 60% of the shares in Entity B. On 1st January 2011, Entity A disposes of a 30% interest in Entity B and loses control over Entity B. The consideration received for the sale of shares of Entity B is INR 700. At the date that Entity A disposes of a 30% interest in Entity B, the carrying amount of the net assets of Entity B is INR 2000. The amount of non-controlling interest in the consolidated financial statements of Entity A on 1st January 2011 is INR 800. The fair value of the remaining 30% investment is determined to be INR 700.

Entity A would record the following entry to reflect its disposal of a 30% interest in Entity B at 1st January 2011:

Debit

Credit

Cash
(fair value of consideration

received)

700

Equity
(non-controlling interest)

800

Investment
in Entity B

(at
fair value)

700

Net
assets of Entity B

(including
goodwill)

2000

Gain
on disposal

200

The gain represents the increase in the fair value of the retained 30% investment of INR 100 [700 — (30% x 2,000)], plus the gain on the sale of the 30% interest disposed of INR 100 [700 — (30% x INR 2,000)].

The remaining interest of 30% represents an associate, the fair value of INR 700 represents the cost on initial recognition and Ind AS 28 — Account

shailesh.kwebmaker

Hedge Accounting for Foreign Currency Firm Commitments under Indian GAAP

Introduction

Institute of Chartered Accountants of India
(ICAI) had come out with an announcement in February 2011, on
Application of AS 30, Financial instruments: Recognition and
Measurement. It was clarified that ‘the prepares of Financial Statements
are encouraged to follow the principles enunciated in accounting
treatments contained in AS 30’. This is subject to any existing
accounting standard or any regulatory requirement, which will prevail
over AS 30. Thus, considering the above exception, an entity can only
follow ‘Hedge Accounting’ only to a certain extent i.e. only for forward
contracts for highly probable future transactions or firm commitments
in foreign currency, as these are excluded from the scope of AS 11.

This
Article brings out the aspect of hedging currency exposure during the
commitment period, by applying cash flow hedge accounting, taking a
currency forward contract as an example for the concept, accounting and
measurement; with limited application of AS 30, in line with ICAI’s
announcement in February 2011 in comparison to accounting such contract
without applying AS 30.

To begin with, till the time Ind AS
implementation dates are notified, entities can take the benefit of
following hedge accounting and avoid volatility in income statement that
arises from mark to market of forward contracts, taken for highly
probable forecast transactions or firm commitments.

Entities
enter into foreign exchange transactions during its regular course of
business. These foreign exchange transactions include purchase &
sale of goods and services as well as financing transactions such as
foreign currency borrowings to leverage the interest rates of the
international market. It is to be noted that these entities continue to
operate in India and are thus exposed to foreign exchange fluctuation.

Foreign Currency Exposure in a Business
Let
us consider an entity that has started a trading business with a $100
loan, received on 1/4/xx when the rate was Rs. 45. Thus the total loan
amount received in is Rs. 4,500. The same amount was invested to buy
goods for trade in the Indian domestic market. Assume the repayment
period of 12 months and margin of 10%, the entity could recover Rs.
4,950 (Rs. 4,500 investment and Rs. 450 profit) over a period of 12
months. If the exchange rate remains constant, there is no risk or
exposure to the entity on foreign exchange borrowings. It will be able
to retain Rs. 450 in its own bank account and repay the $100 loan by
transferring Rs. 4,500 to the lending bank.

In the above case,
if the exchange rate depreciates to Rs. 50, the expected cash obligation
for repayment of $100 loan will be Rs. 5,000. In this case, the entity
would lose the entire margin earned from its pure business and incur a
loss of Rs. 50 (Rs. 4,950 – Rs. 5,000).

The above example
considers one side exposure of foreign exchange. If the business was to
trade the goods in the international market with the dollar, it would
have been able to get some natural offset on exchange fluctuations on
the revenue front. This is because the debtors would have also got
converted in Rupees at a higher rate. Thus, the loss would have
restricted only to the extent of mismatch in foreign currency inflows
and outflows.

What is Hedge?
In simple terms, it is a
technique or an approach whereby the entity in the above example can
secure or protect its profit margin, even when the exchange rate
depreciates to Rs. 50. However, if the exchange rate goes to Rs. 40, the
opportunity to take advantage of the exchange is lost. Thus, the profit
may not increase but will remain intact.

It is to note that
hedging is not about gaining or losing. It is about fixing the price
risk, like freezing the volatility for the future. It can be on account
of interest rates, commodity prices, currency, etc.

“Hedge is a way of protecting oneself against financial loss or other adverse circumstances” – Oxford Dictionary

“A hedge
is an investment position intended to offset potential losses that may
be incurred by a companion investment. In simple language, Hedge
(Hedging Technique) is used to reduce any substantial losses suffered by
an individual or an organization.” – Wikipedia

An entity
can protect its profits and meet its business plan by entering into
various types of derivative contracts. Exposure on foreign currency can
be hedged by forward contracts, future contracts and currency options,
etc. These contracts can be entered into with various banks as counter
parties.

The entity can buy these contracts from market
participants such as banks who charge certain costs that include the
interest differential and transaction fees. This cost is known as
‘premium’. In above example discussed, the entity could protect its
margin by paying a premium, say Rs. 50, and thus, secure a net margin of
Rs. 400 irrespective of change in exchange rates.

Hedge Accounting:
“A hedging instrument
is a designated derivative or (for a hedge of the risk of changes in
foreign currency exchange rates only) a designated nonderivative
financial asset or non-derivative financial liability whose fair value
or cash flows are expected to offset changes in the fair value or cash
flows of a designated hedged item.

“A hedged item is an
asset, liability, firm commitment, highly probable forecast transaction
or net investment in a foreign operation that (a) exposes the entity to
risk of changes in fair value or future cash flows and (b) is designated
as being hedged”. (Paragraph 8 of AS 30)

The objective of Hedge accounting is to offset the gain/loss of the Hedge instrument with that of the hedge item.

A
hedge taken by way of a forward contract can be of two types, namely
cash flow hedge or fair value hedge. The governing factor for
identifying the correct type of designation is dependent on the hedged
item and goes with the objective of hedge accounting.

“Cash flow hedge is a hedge of the exposure to variability in cash flows that:

(i)
is attributable to a particular risk associated with a recognised asset
or liability (such as all or some future interest payments on variable
rate debt) or a highly probable forecast transaction and

(ii) could affect profit or loss.

Fair
value hedge is a hedge of the exposure to changes in fair value of a
recognised asset or liability or an unrecognised firm commitment, or an
identified portion of such an asset, liability or firm commitment, that
is attributable to a particular risk and could affect profit or loss.” (Paragraph 86 of AS 30)

“A hedge of the foreign currency risk of a firm commitment may be accounted for as a fair value hedge or as a cash flow hedge.” (Paragraph 97 of AS 30)

As an exception to the identification of a type of hedge, entities can choose to account derivatives taken such as forward contracts, to hedge the foreign currency exposure on raw material or capital commitments, as either a ‘cash flow hedge’ or a ‘fair value hedge’.

As seen from various practical implementations, an entity usually chooses to designate such forward contracts as a cash flow hedge. This designation allows posting of mark to market (MTM) gains and losses in ‘hedging reserve’, which is part of reserves and surplus, without impacting the profit & loss account. Since the transaction will happen in the future, there is no offset available in the current period’s profit & loss account and hence, it is more logical to defer the impact till the transaction happens.

The documentation, accounting treatment and hedge effectiveness testing can be done on the assumption that the hedge is entered into prior to booking the asset and related liability in the accounts, i.e. there is only a commitment at the point the hedge is entered into.

Sample documentation for hedging a foreign currency exposure on firm commitment for purchase of raw material is illustrated in Table 2.

Table 2: Documentation for Hedging of a Foreign Currency Exposure

COMPLETED BY: ______________________________________

DATE: _________________

Application of AS 30 under existing Indian GAAP as per ICAI’s announcement:

ICAI vide its circular dated 11th February 2011, has clarified that in respect of the financial statements or other financial information for the accounting periods commencing on or after 1st April 2009 and ending on or before 31st March 2011, the status of AS 30 would be as below:

(i) To the extent of accounting treatments covered by any of the existing notified accounting standards (for eg. AS 11, AS 13 etc,) the existing accounting standards would continue to prevail over AS 30.

(ii) In cases where a relevant regulatory authority has prescribed specific regulatory requirements (e.g. Loan impairment, investment classification or accounting for securitisations by the RBI, etc), the prescribed regulatory requirements would continue to prevail over AS 30.

(iii) The preparers of the financial statements are encouraged to follow the principles enunciated in the accounting treatments contained in AS 30. The aforesaid is, however, subject to (i) and (ii) above.

From 1st April 2011 onwards
(i) the entities to which converged Indian accounting standards will be applied as per the roadmap issued by MCA, the Indian Accounting Standard (Ind AS) 39, Financial Instruments; Recognition and Measurement, will apply.

(ii) for entities other than those covered under paragraph (i) above, the status of AS 30 will continue as clarified in paragraph above.

Let us take an example of an Indian entity:
– Entered into a $ 100 payable commitment to import raw material on 1st January, 20xx
– Delivery of raw material is on 31st December, 20xx and payment on the same date.
– On 1st January, 20xx, the entity enters into a forward contract to hedge the foreign currency risk
– As part of the treasury policy, the entity first enters a shorter period contract till 30th June, 20xx
– Rolls it over on 30th June, 20xx to meet the cash outflow on 31st December, 20xx
– Refer Table 3 for details of exchange rates and MTMs on various dates.

Note:
a. Forward rates mentioned in the above table are the Mark to Market (MTM) rates. They are arrived at by considering the spot rate with reference to reporting date plus premium quoted for balance maturity of each contract on that date.

b. Forward rate and spot rate on final settlement is same because
the balance period in that case for premium quote is Zero.
c. Entity has designated the forward to hedge ‘forward rates’ and has been fully effective during the period.

Accounting Schema as follows:

1st January, 20xx:
The contract has zero value; therefore no entry is required. The commitment is also not yet recognised. The hedge is designated as cash flow hedge in line with the choice available under para 97 of AS 30 read with notification issued by ICAI in February 2011.

Example: A Forward cover is taken on 01/01/xx with maturity of 30/06/xx @ Rs. 42.5/$ for $100. There would be no accounting entry as on 01/01/xx.

31st March, 20xx:
The commitment is not yet recognised. MTM gain/loss on cover till the date of period closing would be recognised in hedging reserve (Equity), following cash flow hedge accounting.

As on 31/03/xx, forward cover for maturity of 30/06/xx is available @ Rs. 43.50/$, thus MTM gain of Rs. 1.00/$ (MTM forward rate – Original forward rate) would be accounted as under.

31/03/11 Debit Derivative Asset 100
Credit Hedging Reserve 100

30th June, 20xx:
The commitment is not yet recognised hence the cover is rolled forward. The rolled forward contract is treated as a new contract, part of the existing hedge strategy. It is still a Cash flow hedge.

[Paragraph 112a of AS 30:”……replacement or rollover of a hedging instrument into another hedging instrument is not an expiration or termination if such replacement or rollover is part of the entity’s documented hedging strategy”.]

As on 30/06/xx, the rolled forward rate is Rs. 44/$ for maturity of 31/12/xx when the spot rate is Rs. 43.75/$, thus following entries are passed:

a. For booking Settlement gain on cover (43.75/$ – 43.50/$) (i.e. Spot value – last MTM forward rate)

30/06/xx Debit Derivative Asset 25
Credit Hedging Reserve 25

b. Rollover gain received from bank (43.75/$ – 42.50/$) (i.e. Spot value – Original forward value)

30/06/xx Debit Bank 125
Credit Derivative Asset 125

30th September, 20xx :

The commitment is not yet recognised. MTM gain/ loss on cover till the date of period closing would be recognised in hedging reserve (Equity), following cash flow hedge accounting.

As on 30/09/xx, forward cover with maturity of 31/12/xx is available @ Rs. 44.50/$. Thus, MTM gain of Rs. 0.50/$ . (MTM forward rate $44.50– original forward rate of the rolled over contract $ 44.00)

30/09/xx Debit Derivative Asset 50
Credit Hedging Reserve 50

31st December, 20xx :

a. Record the purchase at spot rate of 43.5/$:

31/12/xx Debit Raw Material 4,350
Credit Liability 4,350

b. For booking MTM Settlement loss (43.50/$ – 44.50/$) (i.e. Spot value – last MTM forward rate)

31/12/xx Debit Hedging Reserve 100
Credit Derivative Asset 100

c. Record the payment of the liability to vendor

31/12/xx Debit Liability 4,350
Credit Bank 4,350

d. Net Settlement loss paid to bank (43.5/$ – 44.0/$) (i.e. Spot value – Original forward value)

31/12/xx Debit Derivative Asset 50
Credit Bank 50

e. Balance in hedging reserve transferred to income statement

31/12/xx Debit Hedging Reserve 75
Credit Cost of Goods Sold 75

The commitment recognised in books at the rate mentioned in Bill of lading and the change in fair value of forward contract from the date of inception to the date of recognising commitment is allocated to cost of raw material consumed.

“Paragraph 109b of AS 30: “It removes the as-sociated gains and losses that were recognised in other comprehensive income in accordance with paragraph 106, and includes them in the initial cost or other carrying amount of the asset or liability”

Note: As per AS 30 para 109b, head of Profit & Loss Account would depend upon the nature of underlying for which the cover the taken. Since AS 2 on Inventory Valuation does not permit MTM as part of valuation for unsold goods, the MTM will be released from hedging reserve to profit & loss account as and when the inventory is consumed. Thus the MTM will remain in Hedging Reserve till the underlying transaction is debited in Profit & loss account. This essentially in line with option available under para 109a of AS 30.

Refer table 4 for various accounts at a glance for entries passed above at various dates.

Commercial Analysis

It can be seen in the above example, that the organisation had an exposure on import of raw material. The exposure started from the date when it entered into a firm commitment and ended when the actual outflow is made.

The exchange rate has been volatile during the period as it moved upwards from Rs. 42.5/$ as on 01/1 to Rs. 44.25/$ on 30/9 before closing at Rs. 43.5/$ on 31/12. The company decided to fix its outflow on the date of its commitment and entered into a forward contract to buy dollars at Rs..42.5 per dollar. Subsequently the same contract was rolled over for meeting the scheduled payment to the creditor by incurring 0.25 paisa premium per dollar bought. The Company’s exposure was hedged by two contracts at the effective cost of Rs. 42.75 per dollar. These types of two contracts are common where the underlying exposure is longer.

The Company’s cost of raw material has not been impacted on account of the volatilities in foreign exchange rate and is accounted at Rs. 4,275. Refer Table 5 below to understand the effective rate per $.

The above entries hold true even when the entity has a commitment for capital asset. The raw material account in the above example will be replaced by fixed asset account/depreciation.

Accounting without Application of AS 30 Principles

The forward contract being taken for a firm commitment, will not fall under AS 11. It will have to follow the conservative principles of AS 1 as laid down by ICAI in its announcement on 29-03-08.

“In case an entity does not follow AS 30, keeping in view the principle of prudence as enunciated in AS 1, Disclosure of Accounting Policies, the entity is required to provide for losses in respect of all outstanding derivative contracts at the balance sheet date by marking them to market.”

In the above example, as on 31st March, the MTM is a gain and hence, there is no accounting entry for this contract. Had there been a loss in the contract, entity would have provided for the same.

The auditors would consider making appropriate disclosures in their reports if the aforesaid accounting treatment and disclosures are not made.

One may note that ICAI’s announcement dated 16-12-05 on disclosure continues to apply in both scenarios (i.e. AS 30 is applied or ICAI announcement dated 29-03-08 is followed). Thus, enterprises continue to make the following disclosures regarding Derivative

Instruments in their financial statements irrespective of accounting choice:

1. category-wise quantitative data about derivative instruments that are outstanding at the balance sheet date,

2. the purpose, viz., hedging or speculation, for which such derivative instruments have been acquired, and

3. the foreign currency exposures that are not hedged by a derivative instrument or otherwise.

A. Industry Applications

Mahindra & Mahindra Ltd (March 2012)

Derivative Instruments and Hedge Accounting:

The Company uses foreign currency forward contracts/options to hedge its risks associated with foreign currency fluctuations relating to certain forecasted transactions. Effective 1st April, 2007, the company designates some of these as cash flow hedges, applying the recognition and measurement principles set out in the Accounting Standard 30 “Financial Instruments: Recognition and Measurements”(AS 30).

Foreign currency forward contract/option derivative instruments are initially measured at fair value and are re-measured at subsequent reporting dates. Changes in the fair value of these derivatives that are designated and effective as hedges of future cash flows are recognised directly in reserves and the ineffective portion is recognised immediately in Profit & Loss Account.

The accumulated gains and losses on the derivatives in reserves are transferred to Profit and Loss Account in the same period in which gains or losses on the item hedged are recognised in Profit & Loss Account.

Changes in the fair value of derivative financial instruments that do not qualify for hedge accounting are recognised in the Profit & Loss Account as they arise.

Great Eastern Shipping (March 2012)
Derivative Financial Instruments and Hedging

Cash Flow Hedge:

Commodity future contracts, forward exchange contracts entered into to hedge foreign currency risks of firm commitments or highly probable fore-cast transactions, forward rate options, interest rate swaps and currency swaps which do not form an integral part of the loans, that qualify as cash flow hedges, are recorded in accordance with the principles of hedge accounting enunciated in Accounting Standard (AS) 30–Financial Instruments: Recognition and Measurement as issued by the Institute of Chartered Accountant of India. The gains or losses on designated hedging instruments that qualify as effective hedges is recorded in the Hedging Reserve Account and is recognised in the Statement of Profit and Loss in the same period or periods during which the hedged transaction affects profit and loss or is transferred to the cost of the hedged non-monetary asset upon acquisition. Gains or losses on the ineffective transactions are immediately recognised in the Statement of Profit and Loss. When a forecasted transaction is no longer expected to occur, the gains and losses that were previously recognised in the Hedging Reserve, are transferred to the Statement of Profit and Loss immediately.

Companies that have adopted AS 30 under Indian GAAP include Essar Shipping Limited, First Source Solutions, Tata Coffee, Sterlite Industries (I) Limited, etc.

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Section A : Disclosure in Notes to Accounts under Revised Schedule VI for Long Term Borowings and details thereof

3.1 Non-convertible Debentures referred above to the extent of:
(a) Rs.1,593 crore are secured by way of first mortgage/charge on the immovable properties situated at Hazira Complex and at Jamnagar Complex (other than SEZ unit) of the Company.
(b) Rs.5,000 crore are secured by way of first mortgage/charge on the immovable properties situated at Jamnagar Complex (other than SEZ unit) of the Company.
(c) Rs.1,720 crore are secured by way of first mortgage/charge on all the properties situated at Hazira Complex and at Patalganga Complex of the Company.
(d) Rs.110 crore are secured by way of first mortgage/charge on certain properties situated at village Mouje Dhanot, District Kalol in the State of Gujarat and on fixed assets situated at Hoshiarpur Complex of the Company.
(e) Rs.50 crore are secured by way of first mortgage/charge on certain properties situated at Ahmedabad in the State of Gujarat and on fixed assets situated at Nagpur Complex of the Company.
(f) Rs.44 crore are secured by way of first mortgage/ charge on certain properties situated at Surat in the State of Gujarat and on fixed assets situated at Allahabad Complex of the Company.
(g) Rs.51 crore are secured by way of first mortgage/ charge on movable and immovable properties situated at Thane in the State of Maharashtra and on movable properties situated at Baulpur Complex of the Company.
(h) Rs.500 crore are secured by way of first mortgage/charge on the immovable properties situated at Jamnagar Complex (SEZ unit) of the Company.

3.2 Maturity profile and rate of interest of Non-convertible Debentures are as set out below:

3.3 Finance Lease obligations are secured against leased assets

3.4 Maturity profile and rate of interest of bonds are as set out below:

3.5 Maturity profile of Unsecured Term Loans are as set out below:

Bajaj Electricals Ltd. (31-3-2012)

Long-term Borrowings

4.2 Sales Tax Deferral
Terms of repayment: Sales Tax deferral liability/loan is repayable free of interest over predefined instalments from the initial date of deferment of liability, as per respective schemes of incentive.

Petronet LNG Ltd. (31-3-2012)
Long-term Borrowings

Note:

1. Secured by first ranking mortgage and first charge on pari-passu basis on all movable and immovable properties, both present and future including current assets except on trade receivables on which second charge is created on pari-passu basis.

2. Term of repayment and interest are as follows:

3. In respect of external commercial borrowings of INRNaN million from International Finance Corporation Washington D.C., USA and INRNaN million from Proparco, France, outstanding as on 31st March, 2012, the Company has entered into derivative contracts to hedge the loan including interest. This has the effect of freezing the rupee equivalent of this liability as reflected under the Borrowings. Thus there is no impact of in the Profit & Loss, arising out of exchange fluctuations for the duration of the loan. Consequently, there is no restatement of the loan taken in foreign currency. The interest payable in Indian Rupees on the derivative contracts is accounted for in the Statement of Profit & Loss.

Uttam Galva Steels Ltd. (31-3-2012)
Note 3 long-term borrowing (Rs. in crores)

(i) Details of terms of repayment for the Secured Non-convertible Redeemable Debentures issued by the Company and security provided in respect thereof:

(ii) Details of terms of repayment for the Secured Long-term Borrowings and security provided in respect thereof:

(1) 11.25% Non-convertible Redeemable Debentures are secured by first pari-passu mortgage of all immovable property and hypothecation of all movable properties including movable machineries, machinery spares, tools and accessories both present and future except packing machine supplied by PESMEL Finland.

(2) Term loans from Banks and Financial Institutions namely, Axis Bank, Bank of Baroda, Dena Bank, Exim Bank of India, Oriental Bank of Commerce, Punjab National Bank, State Bank of India, Syndicate Bank, State Bank of Hyderabad, IDFC and ICICI Bank Limited are secured by mortgage and the lenders have paripassu charge on all the present and future movable and immovable assets of the Company except packing machine supplied by PESMEL Finland, but not limited to plant and machinery, machinery spares, tools and accessories in possession or not, stored, or to be brought in companies premises or lying at any other place of the companies representative affiliates and all the intangible assets of the Company. The above security will rank pari-passu amongst the lenders.

(3) ECB loans from ICICI Bank Limited are secured by mortgage of all immovable property and hypothecation of all movable properties including movable machineries, machineries spares, tools and accessories both present and future except packing machine supplied by PESMEL Finland.

(4) ECA from Nordea Bank is secured by hypothecation of packing machine supplied by PESMEL Finland.

(5) Term loan from ICICI Bank Limited, IFCI, LIC, GIC, and UII ranking pari-passu are secured by mortgage of all immovable property and hy-pothecation of all movable properties including movable machineries, machineries spares, tools and accessories both present and future except packing machine supplied by PESMEL Finland. 25,02,500 Equity shares (previous year 25,02,500 equity shares) held by Promoters are pledged against term loan of Rs.9.55 crore availed from ICICI Bank Limited.

15 Ramco Industries Ltd. (31-3-2012)

Long-term
Borrowings

Term
Loan from

Banks
Secured

11,409.37

9,056.18

Deposits
from Public

9.85

11.58

Total

11,419.22

9,067.76

(1)Long-term Loans of Rs.11409.37 lac borrowed from banks for expansion of Textile and Wind Mill Division under TUF Scheme are secured by pari-passu first charge on the fixed assets and pari-passu second charge on the current assets of the company.

In
lacs

Rate of

Outstanding

Repayment schedule

interest

as on

31-3-2012

2013-14

2014-15

2015-16

2016-17

13.25%

164.20

131.20

33.00

0.00

13.25%

768.69

400.00

368.69

0.00

12.25%

5000.00

2500.00

0.00

4.77%

3052.50

2416.56

635.94

0.00

12.25%

68.92

45.84

23.08

0.00

12.50%

245.10

89.13

66.84

0.00

11.75%

2109.96

529.40

521.76

Total

11409.37

6112.13

4179.24

596.24

521.76

(2) External Commercial Borrowing Loan of USD 6.00 million amounting to Rs.3052.50 lac borrowed from DBS Bank Ltd., Singapore is secured by pari-passu first charge on fixed assets and pari-passu second charge on current assets in favourof Security Trustee DBS Bank Ltd., Chennai.

As per requirements of Accounting Standard 11, ECB Loan has been valued at 50.875 per USD, at the closing rate on 31-3-2012.

This has resulted in a notional loss of Rs.375.50 lac which has been accounted as per Notification dated 31-3-2009 and 11th May, 2011 amending the Accounting Standard AS-11 relating to the Effects of Foreign Exchange Rates as 79.85 lac towards interest and 295.65 lac towards fixed assets.

(3) The Working Capital Borrowings of the Company are secured by hypothecation of stocks of raw materials, work-in progress, stores, spares and finished goods and book debts and second charge on fixed assets.

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AUDITOR’S DILEMMAS!

Introduction
It is well known that any kind of external supervision cannot replace rigorous self-evaluation in any profession. However, the need for supervision and monitoring is universally recognised. The role of an auditor is very critical from an external verification and supervision point of view. This role has changed quite dramatically over a period of time, during which the expectations from the auditor have increased exponentially. Numerous studies have shown that there are considerable differences between what the public expects from an audit and what the auditing profession believes that the auditor should do. The expectation gap resulting from this is a major source of concern for the audit profession since the greater the gap in expectations, the lower is the credibility and prestige associated with audit. It is an issue for the public at large, because the proper functioning of a market economy depends heavily on confidence in the audited financial statements. The role of the statutory auditor should consider the needs and the expectations of the users to the extent that they are reasonable, as well as his ability to respond to those needs and expectations.

In the backdrop of the above, an auditor faces several dilemmas in practising his profession and conducting the audit process primarily because of the complexities of the business transactions, regulatory requirements, nature of his job, and the varying expectations of the stakeholders. This article summarises some of those dilemmas, for better understanding of the ground level issues relating to the audit profession and the dynamics surrounding the same.

Profession Vs Business
In simple terms, business generally involves an activity relating to purchase and sale of goods with an objective of earning profit, whereas a profession renders specialised services for a reward called a fee.

Whether a Chartered Accountant when acting in his capacity as an auditor is performing the role of a professional or like any other service provider selling his service or as a businessman? The border line between the two is very thin and many times, an auditor has to balance the same carefully. Whilst, in a competitive environment, he has to necessarily carry out his job in a manner which makes commercial sense for him, and he should never forget the fact that audit is statutorily required in order to serve the interests of the general public and various other stakeholders.

The role of the statutory auditor has recently been the subject of serious debates worldwide. In view of the number of major financial failures, questions have been raised concerning the function of the statutory audit and the independence of the auditor. In recent years, concern has been expressed about the threats which have developed to the auditor’s independence. Several surveys have reported that companies were increasingly prepared to challenge their auditors, to shop for opinions, to seek legal advice on their auditors’ views and to change auditors. Some reports concluded that, given the competitive pressures, it would be idealistic to assume that all auditors are at all times unmindful of the risk of losing business. Criticism has been voiced that the professionalism of the audit function has diminished, in favour of a more “business-like” and “accommodative” attitude.

In view of these perceptions, there is a compelling need for the auditor to keep in mind the core principles of a profession, which should never be compromised at any cost inspite of business compulsions.

Propriety Focus Vs. Accounting Focus
What is the role of an auditor regarding propriety matters? Is he responsible for matters of impropriety? Can he take a blind view on such matters? Performing audits with a propriety focus poses serious challenges in carrying out the audits especially of private entities. Whilst the expectations from the regulators and other stakeholders could demand comfort from the auditors on propriety aspects as well, meeting such expectations totally through the audit process for private entities is usually a big challenge. Identification of acts of impropriety also poses challenges to the auditor in view of the subjectivities involved.

However, the auditor should perform the required procedures in accordance with the auditing standards, to ensure that there is no cause of concern relating to propriety aspects within the defined boundary and if there are any propriety issues, the same need to be reported to those in charge of governance.

Fraud Specialist Vs. Financial Accountant
Until recently, the standard quote on the role of the auditor was to say that an auditor’s prime role is not to prevent or detect fraud, which is, in any event, impossible. Regulatory bodies in many countries have issued auditing guidelines related to the statutory auditor’s responsibility in relation to fraud, other irregularities and errors. In India, Auditing Standard SA 240 – “The Auditor’s Responsibilities relating to fraud in an audit of the financial statements” specify the responsibilities of the auditor.

It is a known fact that the management of an entity has the primary responsibility for the prevention and detection of fraud, other irregularities and errors which is seen as part of the management’s stewardship role. The auditor’s responsibility is to plan, perform and evaluate his audit work so as to have a reasonable expectation of detecting material misstatements in the accounts, whether they are caused by fraud, other irregularities or errors.

If a fraud is identified in an entity post audit completion, the first and the foremost important question raised by everyone is the role of the auditor and the effectiveness of his audit. Inspite of such allegations, the fact remains that the auditor is not an investigating specialist challenging and suspecting each and every transaction, which would change the entire purpose of the audit and the true nature of the profession. However, in view of the peculiarity of the role played by him, an auditor has to be cognizant of this aspect and he needs to perform procedures to ensure that there are no significant frauds impacting the true and fair view of the financial statements.

Representation to the Auditor Vs. Information to the Reader of the Financial Statements
While executing the audit, an auditor many times faces a situation where he has to rely on the representations made by the auditee/management. At times, such representations have far reaching implications on the financial statements. One has to remember that, whilst obtaining representations from the auditee/management is a required audit procedure, it does not absolve the auditor from his responsibilities.

A typical dilemma that could arise during the audit process, is the extent of disclosures that are required to be made in the financial statements or in the audit report, regarding such representations having a material impact on the financial statements. Careful evaluation needs to be made as regards the representations made by the auditee/management on significant matters, having a material impact as to whether such representations are part of the audit documentation or the same should be made available to any reader of the financial statements by way of an appropriate disclosure in the financial statement or in the audit report. For example, if a provision is made for an item based on a technical evaluation, which is very significant to the financial statements, the need for disclosing that fact along with the basis, rationale and significant assumptions driving such provisions etc., need to be evaluated by the auditor.

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GAPS in GAAP — Account ing for Government Grant

Government Grants are common in India and therefore accounting for Government Grant could have a significant impact on financial statements. Firstly, whether there is a grant or not; and if there is a grant whether the same is a fixed asset-related grant, revenue grant or promoters contribution will have to be decided. If the grant is a revenue grant, then its immediate impact is recorded in the P&L account, if the grant is a fixed asset grant, the grant income is released systematically to the P&L account in proportion to the depreciation on the related fixed asset. Alternatively, the grant is reduced from the amount of fixed asset capitalised, which will have the same P&L effect. Government grant in the nature of promoter’s contribution is treated as equivalent of shareholders fund and credited to the capital reserve. Needless, to say, the accounting will not only have a significant impact on the financial statements, but will also have a significant incometax impact, including MAT computation. Therefore the manner in which the government grant is accounted for becomes critical.

In this article the author discusses an EAC opinion on the issue of whether a sales tax exemption under a scheme of the government is a grant or not. This article does not discuss the issue on the nature of the grant, whether fixed asset-related or revenue grant or promoters contribution. The issue of whether sales tax exemption scheme is a grant came to the Expert Advisory Committee (EAC) of the ICAI for an opinion (EAO-VOL-20-05). In the said fact pattern, the company was entitled to sales tax exemption over a period of three years, subject to an upper monetary limit. The upper limit was computed based on the additional investment in plant, machinery and building required for expansion. The EAC considered the definition of government grant in AS-12 Accounting for Government Grants.

As per paragraph 3.2 ‘government grant’ is defined as “Government grants are assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government, which cannot be distinguished from the normal trading transactions of the enterprise”. The EAC felt that sales tax exemption is not assistance in cash or kind and is therefore not a government grant within the meaning of this term under AS-12.

As such AS-12 is not applicable to sales tax exemption. However, there was no further elaboration on this point. The EAC further noted the definition of Revenue in AS-9 Revenue Recognition and was of the view that the entire sales proceed of the company constitutes revenue. It is immaterial whether the sale proceeds result from sales at normal prices or at higher than normal prices that the unit is able to charge due to sales tax exemption.

In the author’s view, sales tax exemption is a government grant for the following reasons:

(1) It is a sacrifice by the government for achieving a particular social objective (e.g., dispersion of industry). The upper limit on the grant is clearly quantified. It may not be possible to quantify the sales tax exemption for the entire period of grant upfront; nonetheless, it is possible to quantify the amount of exemption included in each sales transaction. The grant is provided subject to fulfilment of certain conditions.

(2) The manner in which a grant is received does not affect the accounting method to be adopted in regard to the grant. Thus a grant is accounted for in the same manner, whether it is received in cash or as a reduction of a liability to the government.

(3) Government grants exclude assistance provided by the government which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the entity. Examples of these assistance are free technical or marketing advice and the provision of guarantees, etc. Sales tax exemption is a scheme granted by the government, subject to fulfilment of conditions relating to investment and operation in underdeveloped areas. Sales tax foregone by the government is in substance a transfer of resources by the government to the company.

In accordance with the EAC opinion, the grant will be included in the revenue amount. Going by the author’s view, the grant would be included in other income if it is concluded that it is a revenue-related grant. If the grant is concluded to be a fixed assetrelated grant it would be presented as deferred income and released over time in proportion to the depreciation of the relevant asset. Alternatively it would be reduced from the fixed asset, which would have the same impact.

As can be seen the accounting and presentation of the grant will not only have a significant impact on the financial statements, but also on the tax and MAT computation. This is therefore an issue, the ICAI would need to reconsider.

levitra

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Avoiding Common Errors in XBRL Financial Statements

“Tagging” of financial information by using eXtensible Business Reporting Language, an accounting specific mark-up language creates XBRL financial statements which can be stored in a financial database such as MCA-21. XBRL tagging process converts the financial information contained in document in PDF, Word or Excel format to a document or file with electronic codes which makes the document computer readable as well as searchable. Once the tagged financial statements are stored in a financial database like MCA-21, not only the financial data in those XBRL financial statements can be compared or analysed by use of computer systems but investors, investment analysts or other users can also download it and carry out comparison and analysis more quickly and efficiently than with data stored in traditional formats such as PDF.

Many people have a misconception that tagging of financial information/data in XBRL is similar to converting a Word document into PDF format and that tagged financial information/data is as accurate as the underlying information/data in the source documents. This is an inappropriate analogy, because the process of tagging financial information involves judgment of the person creating XBRL financial statements and there is a potential for intentional or unintentional errors in the XBRL documents which could result in inaccurate, incomplete or misleading information. This is a problem because it is the XBRL tagged data which not only will be used by the regulators e.g. Ministry of Corporate Affairs, for comparison & analysis purpose but will also be used by investors, investment analysts etc. Therefore, completeness, accuracy and consistency of XBRL tagged data is of paramount importance.

As with any new technology, XBRL, a new financial reporting technology also brings new risks. XBRL can’t be read by the human eye. The data in XBRL is filtered through rendering applications or viewers to visually present tagged data. Companies can easily underestimate the challenges posed by XBRL and make mistakes along the way. This article describes common errors appearing in XBRL financial statements filed at MCA-21 and how these can be prevented. Practitioners can use this information to get an insight into the challenges of XBRL Instance creation and providing assurance over XBRL financial statements being filed at MCA-21. To gain a better insight into the challenges faced by the companies in XBRL filings, we examined the XBRL financial statements of a few listed Companies on a test check basis. As a part of this initiative, we downloaded Form 23AC-XBRL & Form 23ACA-XBRL of the Companies from MCA-21 and detached XBRL financial statements attached to these forms and then compared XBRL financial statements rendered by MCA Validation Tool with the financial statements in traditional format, tracing the errors to the XBRL documents containing the computer code.

Completeness Errors

The Company’s XBRL financial statements are required to fairly present the audited financial statements in traditional format. Therefore, all information and data that is contained in the audited financial statements or additional information required to be reported under the scope of tagging defined by Ministry of Corporate Affairs needs to be formatted in XBRL financial statements.

Examples

Some examples of lack of completeness are: (i) Financial information/data of all subsidiaries not formatted in XBRL financial statements. (ii) Financial information/ data of all related party transactions not formatted in XBRL financial statements. (iii) Parenthetical information, for example tax deducted at source on rent, not tagged in XBRL financial statements. (iv) Detailed Tagging of Notes to Accounts wherever required, if not done also falls under completeness error. (v) Not tagging complete “Cash Flow Statement.” (vi) Not tagging the “Foot notes” in financial statements. “Foot Notes” in financial statements provide additional information which helps in having a better understanding of financial information. The absence of “Foot Notes” in financial statements can not only make the task of understanding the financial information difficult, but user could also reach erroneous conclusions.

Solution

A careful tracing of all financial information/data from source documents to rendered XBRL financial statements can detect many such errors. However, this cannot detect all completeness errors because there is some information/data which is required to be formatted in XBRL financial statements, but the same is not reported in traditional financial statements.

Accuracy Errors

Accuracy of numerical data including amounts, signs, reporting periods and units of measurements is critical for the reliability of data in XBRL financial statements. Accuracy errors, though less common than other type of errors, are more serious in nature because the erroneous data not only distorts the financial statements but is also not suitable for downloading in software for comparison and analysis purpose. In a closed taxonomy environment, XBRL Instance documents cannot truly present the audited financial statements, because many times reporting entity may be required to tag a line item in the financial statements with the residuary tag or club two or more line items together. Although, this doesn’t affect the mathematical accuracy of the financial statements, the data may not be suitable for comparison and analysis purposes.

Example

Data entry errors in reporting amount of Profit & Loss Account under the group heading “Reserves & Surplus” and “Loans & Advances” in the Balance Sheet. Duty Drawback”, “Export Incentive” “Other Claim Receivable” all clubbed together and tagged with “Other Receivables”.

Solution

A careful tracing of all financial statement data to the rendered XBRL financial statements can detect errors in values. However, attribute accuracy needs to be checked by verifying all contextual information. A foot note can be added in XBRL financial statements which can provide a break-up of all line items clubbed and mapped with one taxonomy element or with the residuary tag.

Mapping Errors

Mapping is the process of selecting the right element in Indian GAAP Taxonomy for each line item in the financial statement. Mapping errors can result in misleading information and the user of data could reach to an erroneous conclusion.

Examples

“Loss on Sale of Fixed Assets” tagged with “Loss on Sale of Long Term Investments” although a tag “Loss on Sale of Fixed Assets” is available in the taxonomy. “Interest Accrued but not due on Fixed Deposit” tagged with “Other Cash Bank Balance”. Another example of mapping error is “Deferred Tax Liability (Net)” tagged with “Net Deferred Tax Assets” with a negative sign or vice versa. Although, it doesn’t create any mismatch in the assets & liabilities, it distorts the view of the Balance Sheet.

Solution

Although good XBRL Tools have an in-built feature for searching taxonomy element which can assist in mapping, the importance of judgment involved in the process can’t be undermined. A precise understanding of the Company’s financial statements and of Indian GAAP Taxonomy is required to ensure the correct mapping of line items in financial statements with taxonomy elements.

Validation Errors

The final step in preparing XBRL financial statements for submission to MCA-21 involves:-

(i) Validation Test and

(ii) Pre-scrutiny Test

MCA Validation Tool checks and identifies most, but not all, errors. For example, it does not check the financial information/data in ‘Block Tagging’. It verifies the mathematical accuracy and mandatory information/data in XBRL financial statements.

Pre-scrutiny Test conducts server side validation of the data in XBRL financial statements. An XBRL financial statement must pass the “Validation Test” before the “Pre-scrutiny Test” can be conducted.

Examples

Corporate Identity Number (CIN) of an Associate entity not provided in XBRL financial statements. Another example of validation error is “Basis of Presentation of Accounts” not tagged.

Solution

Validation Test on XBRL financial statements should be conducted on the latest available MCA Validation Tool. In case the validation test throws any errors, the same should be removed before uploading at MCA-21. After the XBRL Instance passes the validation test, Pre-scrutiny Test should be conducted and if there are any errors, the same should be removed before uploading of XBRL financial statements at MCA-21.

Rendering Errors

`Rendering’ is a necessary evil. Tagged data needs to be rendered in order to see it. This puts undue focus on presentation vis-à-vis MCA compliant XBRL and use for financial analysis. This is contrary to the original purpose of XBRL. Many filers have noticed during the last filing year that XBRL rendering has not been as accurate as they would prefer it to be. We tend to think of financial reporting in a visual way – in a way we can view it. That is the old way of thinking about financial reporting. “Tagging” of financial statements provide a choice to the users to grab the entire financial statement or individual values in isolation.

Examples

Financial information/data in “Block Tagging” is not properly rendered making the information illegible e.g. information/ data in foreign currency transactions in Notes to Accounts. Another example of rendering error is of certain foot notes attached to the values which are visible in XBRL Viewer but not rendered in the PDF file.

Solution

Rendering errors are mainly related to XBRL software used in generating XBRL financial statements and vendors of software need to look into this aspect. Rendering engine also needs improvement to properly render the information in XBRL Viewer as well as in PDF files. However, the preparer can also improve the formatting of information/data in XBRL financial statements.

Conclusion

It is of prime importance for companies to be aware of these potential errors, whether their XBRL financial statements are prepared in-house or prepared by a third party service provider. There is a legal liability attached to XBRL mandate for companies and its officers in default for submission of inaccurate or false data in XBRL financial statements. There is also a provision for disciplinary complaint against the practitioners to the professional bodies for deficiency in certification of XBRL financial statements. The deficiency in XBRL financial statements could invite avoidable litigation and adversely affect company’s goodwill.

shailesh.kwebmaker

Big Data – II

About this Article

This article is
part 2 of the series on Big Data. This article briefly deals with issues
such as, why Big Data is gaining so much importance and what are the
recent trends in Big Data collection and analysis. The write up also
discusses some of the technologies being used for Big Data analysis.

The
previous write up briefly touched upon what is Big Data and some
background on the vital role played by it. This write up will delve a
little further and deal with some of the trends and developments in this
arena.

Background:
Big Data, as discussed earlier,
is all about collecting, storing, analysing and using the results for
betterment (one sincerely hopes so). It is typically characterised by
features such as volume, velocity, variety and veracity. While Big Data
is not entirely a recent development, but the manner in which data is
gathered, the sources of information, techniques for storage and
technologies for analysis, have evolved significantly in recent times.

Big Data is for Everyone:
Generally
speaking, most people believe that Big Data is for large corporations
and businesses or for the Government. But the truth is, whether you’re a
5 person shop or part of the Fortune 500, you can have Big Data and it
can help you to grow and become profitable. Today, if one wants to
remain competitive, he has to analyse both internal and external data,
as quickly and cost effectively as possible. This (rule) applies equally
to all types of organisations, big or small, giants or dwarfs.

Right
now, you may be asking how will Big Data help me to find the
opportunities by analysing new sources of data? Here is one small
example:

As the world becomes more instrumented, with RFID tags,
sensors and other sources, we are creating more and more data. When
paired with external data – like that generated by social media sites –
there’s incredible opportunity that is largely untapped and unanalysed.
This is where Big Data analysis comes into the picture. Every day,
companies of all sizes “cut through the noise” created by so much data
to find valuable insights.

Not just businesses and commercial
organizations, Big Data analysis can be applied to the social sector
too. Using the same techniques and tools (i.e. used for developing
marketing and risk management tools), Big Data analysis when applied to
the social sector, has the potential to revolutionise the functioning of
those sectors. For instance, imagine the advantages of using Big Data
analysis in:

the public sector;

the healthcare sector; or

(to put it more generally,) mainly those sectors where an ethos of treating all citizens in the same way is kind of expected.

Advantages would traverse beyond commercials to the realm of mass social betterment.

How Big Data is Used:
Big data allows organisations to create highly specific segmentations
and to tailor products and services precisely to meet those needs.

Consumer
goods and service companies that have used segmentation for many years
are beginning to deploy ever more sophisticated Big Data techniques,
such as the real-time micro-segmentation of customers to target
promotions and advertising. As they create and store more transactional
data in digital form, organisations can collect more accurate and
detailed performance data, in real or near real time, on everything from
product inventories to personnel sick days. Information Technology is
used to instrument processes and then set up controlled experiments.

Data
generated therefrom is used to understand the root causes of the
results, thus enabling leaders to make decisions and implement change.

Big Data technologies:
Some of the key Big Data technologies which are in play are described below:

Cassandra: Cassandra is an open source (free) database management
system, designed to handle huge amounts of data on a distributed system.
This system was originally developed at Facebook and is now managed as a
project of the Apache Software foundation.

Dynamo: Is a proprietary software developed by Amazon.

Hadoop: Is an open source software framework for processing huge
datasets on certain kinds of problems on a distributed system. Its
development was inspired by Google’s MapReduce and Google File System.
It was originally developed at Yahoo! and is now managed as a project of
the Apache Software Foundation.

R: “R” is an open source
programming language and software environment for statistical computing
and graphics. The R language has become a de facto standard among
statisticians for developing statistical software and is widely used for
statistical software development and data analysis. R is part of the
GNU Project, a collaboration that supports open source projects.

HBase: Is an open source (free), distributed, non-relational database
modeled on Google’s Big Table. It was originally developed by Powerset
and is now managed as a project of the Apache Software foundation as
part of the Hadoop.

MapReduce: A software framework introduced
by Google for processing huge datasets on certain kinds of problems on a
distributed system.32. This too has been implemented in Hadoop.

Stream processing: Also known as event stream processing. This refers
to technologies designed to process large real-time streams of event
data. Stream processing enables applications such as algorithmic trading
in financial services, RFID event processing applications, fraud
detection, process monitoring, and location-based services in
telecommunications.

Visualisation: This refers to technologies
used for creating images, diagrams, or animations to communicate a
message that are often used to synthesise the results of big data
analyses. Some of the instances of visualisation are: Tag clouds,
Clustergram, History flow, etc.

Myths surrounding Big Data:
While
there are many myths surrounding Big Data, for the purpose of this
write up, I have briefly summarised few myths commonly associated with
Big Data. These are:

Big Data is only about massive volumes of data:

As
discussed in part 1, volume is only one of the factors. Generally, the
industry considers petabytes of data as a starting point. However, it is
only a starting point, there are other aspects such as velocity,
variety and veracity to deal with.

Big Data means unstructured data:

While
variety is an important characteristic, it should be understood in
terms of format in which the data is gathered and stored. Many people
have a mistaken belief that the data would be in an unstructured format.
As a matter of fact, the term “unstructured” is misleading to a certain
extent. This is because, one doesn’t take in to account the many
varying and subtle structures typically associated with Big Data types.
Candidly, many industry insiders admit that Big Data may well have
different data types within the same set that do not contain the same
structure. Some suggest that the better way to describe Big Data would
be to term it “multi structured”.

Big Data is a silver bullet type solution:

This
is an avoidable pitfall. Most businesses have a tendency to believe
that Big Data is a silver bullet to their growth strategy. The
applications available only offer one of the means to analyse data.
Application of the learnings from the analysis is altogether a different
thing. What needs to be understood is that, Big Data is only a means to
the end and not the end itself.

What to expect in future:

Big Data will be an important driver of business activities in the future. Almost all businesses will leverage the insights from Big Data based research to hone in their strategy. Be it innovations, competition or value addition, Big Data’s contribution will be significant.

The impact of Big Data will span across sectors. Among these health sciences and natural sciences are likely to have a positive impact on the larger society.

One can expect that the sources of data and volume of data itself will grow exponentially. Consequently, the data integration process will become more efficient.

There will be a demand for talented personnel. Notable demand will not be restricted to personnel possessing the requisite skill for collecting and analysing Big Data. The need will be for personnel who know how to use the results of Big Data analysis in effective decision making.

Decision making as we know it (and put in practice) today, is likely to undergo a drastic change. Sophisticated analytics can substantially improve decision making, minimise risks, and unearth valuable insights that would otherwise remain hidden.

We are likely to see a sea of change in the regulatory environment, mainly related to privacy, intellectual property rights and public liability.

Well, this concludes the part 2 of the write up on Big Data. In my next write up I intend to deal with “the (ab)use of social media”. I intend to cover some (disturbing) trends that have caught the attention of many. Its still a thought, but the idea is fresh.

Disclaimer: The information/factual data provided in the above write up is based on several news reports, articles, etc., available in the public domain. The purpose of this write up is not to promote or malign any person or company or entity, the purpose is merely to create an awareness and share the knowledge that is already available in the public domain.

shailesh.kwebmaker

Ind AS: Functional Currency and Consequential Impact on Deferred Tax

Executive summary

This
article covers the ‘Functional Currency’ aspect differentiating with
‘Presentation Currency’ as laid in Ind AS 21, which will be a new
concept when India converges to IFRS.

It also highlights the
consequential impact of having two sets of functional currencies (one
for GAAP reporting and other Tax submissions) on deferred tax
computation under Ind AS 12, which again is based on a new approach
i.e., ‘Temporary difference’ as against ‘Timing difference’ under
existing AS-22.

Temporary difference is essentially arrived at by
comparing the balance sheet under tax books with financial books. This
approach is also known as ‘Balance Sheet approach’ and the approach in
AS-22 is termed as ‘P&L approach’.

Introduction

India
has laid down the convergence plan of ‘Indian Accounting Standards’
(AS) with ‘International Financial Reporting Standards’ i.e., IFRS in a
phased manner. The first phase implementation was expected to begin from
April 1, 2011 but due to practical challenges, the implementation is
delayed. ICAI, as part of convergence approach, has come out with 35 Ind
AS which are the same as IFRS except for the carve-outs. The Ministry
of Corporate Affairs (MCA) has notified 35 Ind ASs on February 25, 2011.

Amongst these standards, there is one standard that has the potential
to entirely turn the Indian financial statements topsy turvy and that is
IAS 21 i.e., Ind AS 21. The consequential impact of this standard on
deferred taxes, is not part of the carve-outs and hence would need due
care while the standard is implemented in India.

Currency for accounting and presentation

While
all Indian entities prepare books of accounts in Indian Rupees, we have
never thought of preparing our books in any other currency. There may
be some who did wish of using currency other than Indian Rupee (INR) on
account of huge foreign exchange exposures, but they did not have any
guidance or literature to support them. The spot will now be addressed
in ‘Ind AS 21 — The Effects of Changes in Foreign Exchange Rates’.

Once
India starts converging to Ind AS, we will have this standard on
effects of exchange fluctuations, which has considered the aspect of
huge volatility and exposures to operations due foreign currency (i.e.,
other than INR). It requires the managements of companies to adopt a
suitable currency for maintaining their accounts. Since the entities may
vary their exposures to currency in different years, the standard has
mandated the assessment of such book-keeping currency every year.

If any
other currency, say, USD is considered as the currency that influences
the primary economic environment, managements will have to prepare
themselves to consider INR as foreign currency exposure and mark to
market all INR monetary assets and liability at each balance sheet date.

Ind AS 21 — ‘The Effects of Changes in Foreign Exchange Rates’ is a
standard that brings a new dimension to the financial statements
prepared in India. Now, the book-keeping currency i.e., Functional
currency will no more be optional or default INR, it will be governed by
specific principles laid down under the standard and functional
currency can be different than the presentation currency.

Functional currency

Let
us appreciate the governing principles of functional currency under Ind
AS 21:

“Functional currency is the currency of the primary economic
environment in which the entity operates.” (para 7)

“The primary
economic environment in which an entity operates is normally the one in
which it primarily generates and expends cash. An entity considers the
following factors in determining its functional currency:

(a) the
currency:

(i) that mainly influences sales prices for goods and
services (this will often be the currency in which sales prices for its
goods and services are denominated and settled); and

(ii) of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.

(b)
the currency that mainly influences labour, material and other costs of
providing goods or services (this will often be the currency in which
such costs are denominated and settled).” (para 8) Ind AS 21 defines the
functional currency and differentiates it from the presentation
currency. The primary factor that drives the choice of currency is
influenced by stream of revenue and operating costs. Additional factors
that the standard requires to examine are the currency of loan
obligations.

“Many reporting entities comprise a number of
individual entities (e.g., A group is made up of a parent and one or
more subsidiaries). Various types of entities, whether members of a
group or otherwise, may have investments in associates or joint
ventures. They may also have branches. It is necessary for the results
and financial position of each individual entity included in the
reporting entity to be translated into the currency in which the
reporting entity presents its financial statements. This Standard
permits the presentation currency of a reporting entity to be any
currency (or currencies). The results and financial position of any
individual entity within the reporting entity whose functional currency
differs from the presentation currency are translated in accordance with
paragraphs 38- 50.” (para 10)

Under existing AS-11 definitions, foreign
currency is a currency other than the reporting currency, and reporting
currency is the currency used for reporting financial statements.
The
rules of translating the subsidiary accounts into reporting currency
are similar to those under Ind AS 21, which prescribes using closing
rate for balance sheet items and transaction rate or average rate for
income statement items (para 38-50).

Point of difference

Under Indian
GAAP, a currency used for preparing as well as reporting i.e.,
presenting financial statements to regulatory authorities, lenders,
investors, etc. is foreign currency is no other than INR. There is no
concept of having the currency to report financial statements
(presentation currency) different from the currency in which books of
accounts are to be maintained (functional currency).

Functional currency: Industry perspective

Under Indian GAAP there is no concept of functional currency identification. It however has reference to ‘Reporting Currency’, which is expected to be the same currency of the country in which it is domiciled.

The definition of functional currency in Ind AS will encompass all the companies whose primary economic environment is not the Indian economy.

The impact of this standard will be more evident on commodity market-linked companies engaged in mining, refining, and trading products, whose primary revenue is governed by international commodity prices prevail-ing on London Metal Exchange in US Dollars. Another industry that may be impacted by the implementation of Ind AS will be Business Process Outsourcing Companies and Software Companies whose primary revenue is again governed in terms of Dollars and Euros. Oil and Gas companies are also prone to get functional currency assessment and application in India since the oil prices are quoted in USD per barrel globally.

It will also be impacting the bullion companies that are listed on Indian stock exchanges and others that are planning to list soon on Indian and international bourses. The revenues of these companies are always traded in USD in India and internationally.

Domestic prices for sales within India, of these companies though in INR, are arrived at by first considering the respective International prices in USD and then making certain adjustments such as duty differentials, domestic market premium, freight differentials, competitive discounts, etc. which in industry terms is called as ‘Shadow Gap’ pricing.

Each company will have to apply its own judgment and access all the criteria of primary environment and other additional factors that influence the choice of its functional currency.

Challenges on adoption of functional currency other than INR in India:

(1) If the accounting records of these Indian companies are to be prepared under Ind AS, then the financial statements will altogether give a different picture. Since currency fluctuation on, say, USD may now sit in transaction amounts and change company’s profitability.

(2) Change in mindset and budgets required.

(3) Will lead to difficulty in decision-making processes by Indian managements specifically in assessing its foreign exchange exposure which so far was on currencies other than INR.

(4) Continuing a parallel accounting system for Income Tax submission since Direct Tax Code does not provide for similar changes.

(5) Updation/modification to ERP solutions. It is also worth noting that accounting softwares such as SAP have a functionality to address the dual currency accounting which can take care of both tax reporting using INR as functional currency and IFRS reporting using any other currency.

(6) Accounting for deferred tax and unwanted volatility in income statement.

Indian Industry including managements, lenders, investors, analysts of financial statements will have to prepare for seeing a currency different than INR as accounting currency in annual financial statements. Many companies internationally have adopted this standard which aligned their accounting currency i.e., functional currency in line with their respective primary economic environments.

In the international markets most of the transactions happen in US Dollars and India is now a part of a global economic platform and thus is very much influenced by USD in its financial statements. The impact is more evident in industries that are primarily dependent on USD and whose profitability is affected by any change in USD: INR exchange rate such as Mining & Metals, Oil & Gas, Software exports and Business Processing Operations among others.

Let us now appreciate the challenge in point 6 above, on how deferred tax is impacted by change in functional currency from INR

Ind AS 12: Income Taxes

A deferred tax asset or liability shall be recognised for all taxable temporary differences.

‘Temporary differences’ are differences between the carrying amount of an asset or liability in the balance sheet and its tax base. The ‘tax base’ of an asset or liability is the amount attributed to that asset or liability for tax purposes.

The primary approach of accounting of deferred tax under Ind AS is using the balance sheet approach. For example, revaluation of fixed assets under Indian the GAAP with no corresponding revaluation in tax books i.e., tax base has no impact on deferred tax computation under AS-22 since the revaluation impact is only a balance sheet adjustment with corresponding impact directly in reserves.

Under Ind AS 12, even though the revaluation does not impact the income statement, there is a requirement to adjust the deferred tax and post the net impact in revaluation reserve. This is because this originates a temporary difference on comparison between the balance sheet value of asset and tax base for that particular asset. This is true for all such differences between the balance sheet value and tax base, that have a potential of reversal either in tax books such as 43B items or financial books itself such as revaluation adjustments.

While comparing the balance sheet values and tax base, the following paragraph of Ind AS 12 brings out the impact of functional currency on deferred tax computation.

“The non-monetary assets and liabilities of an entity are measured in its functional currency (see Ind AS 21 The Effects of Changes in Foreign Exchange Rates). If the entity’s taxable profit or tax loss (and, hence, the tax base of its non -monetary assets and liabilities) is determined in a different currency, changes in the exchange rate give rise to temporary differences that result in a recognised deferred tax liability or (subject to paragraph 24) asset. The resulting deferred tax is charged or credited to profit or loss.” (Para 41)

The application of this paragraph will not trigger if the currency in which the company maintains its books of accounts i.e., functional currency and the ones used for calculating taxable profit under tax laws is the same i.e., INR for India. It is pertinent to note that choosing a different currency for presentation of financial statements to stock market, lender, investors, etc., will not attract application of paragraph 41 of Ind AS 12.

However, with the change in accounting standard wherein the accounting records may have to be made under, say, USD (considering primary economic environment criteria under Ind AS 21) and taxable profit or loss is to be calculated under INR, this may cause the temporary difference if the USD:INR exchange rates changes at every balance sheet date.

We will take an example to understand the implications of functional currency on deferred tax.

(1) Entity A has INR as tax currency and USD as functional currency.
(2) The value of non-monetary assets as maintained for tax books in INR is Rs.3,150 and as maintained with USD as functional currency stood at $77.73.

The transactions under both sets of books were accounted at respective historical exchange rates and thus the INR numbers of tax books when divided by USD numbers of financial books, will give historical transaction rates, thus different from the closing rate.

(3) The original and subsequent cost under tax base for the assets are the same as that in financials books, with the exception to the difference that originates due to application of para 41 of Ind AS 12.

(4) Example considers only non-monetary assets assuming monetary assets are valued at closing rate and thus would not lead to any difference while comparing the tax base using translation rate.

(5) The exchange rate at March 31 is 1 USD = Rs. 50 and tax rate is 33.99%

Closing deferred tax status of deferred tax liability as on March 31, XXXX of Entity A is as shown in Table 1:

Deferred tax under Ind AS will be calculated as follows:

Under Ind AS, the deferred taxes are measured in the functional currency

As can be seen from the above calculation, the translation of tax base using closing rate has led to a difference of $14.73. It is pertinent to note that this difference is only for deferred tax computation and not for accounting in the financial books.

The notional comparison has reduced the tax base in USD by 14.73 and this leads to creation of a deferred tax liability with a corresponding deferred tax expense in the income statement. The impact of $ 5.01 over net assets of $ 63 will be a material impact on the profits of the company. It will vary depending upon the value of non monetary assets as on the reporting date and movement of exchange rates during the period.

There would not have been any temporary difference in the above example if the functional currency was INR, since tax base and book base would have been the same.

Impact of accounting of deferred tax such functional currency difference

(1) The accounting for deferred tax on account of such notional differences creates high volatility in the income statement.

(2) The gain/loss on account of such treatment has no corresponding charge/income in the income statement. It is accounted based on pure out of books comparison of exchange rates on non-monetary items. ($14.05 is notional only for comparison but tax of $ 5.01 is real for accounting.)

(3) This item has no bearing to operations or profit; instead it pulls down/up financial results from operations due to tax provision and thus calls for suitable disclosures in financial statements to explain the earnings per share to investors, analysts, etc.

It is pertinent to note that i.e. US GAAP, Financial Accounting Standard (FAS) 109 prohibits recognition of a deferred tax liability or asset for differences related to assets and liabilities that, under FASB Statement No. 52, Foreign Currency Translation, are re-measured from the local currency into the functional currency using historical exchange rates and that result from (a) changes in exchange rates or (b) indexing for tax purposes.

On the one hand Ind AS 21 aims to reduce the volatility in results on account of currency exposure and on the other hand Ind AS 12 brings in volatility in income taxes on account of notional difference created on account of comparing the balance sheet value and tax base in functional currency at the closing date.

Thus, choice of functional currency other than that used for tax reporting will lead to such temporary differences and will continue to exist until book currency and tax currency are aligned.

Change in functional currency
“When there is a change in an entity’s functional currency, the entity shall apply the translation procedures applicable to the new functional currency prospectively from the date of the change.”

The entity will have to assess the criteria for deciding the functional currency year and apply the accounting impacts for change prospectively. Here the country’s policies also would influence the decision such as restrictions on holding foreign currency and INR being the only legal tender in India.

The entity will also have to explain in notes to financial statement as to why it considers such change in its functional currency.

Presentation currency
Ind AS 21 allows the entity to present its financial statements in any currency and does not restrict any one currency. However, considering the Indian requirements for ROC filing, tax submission, stock exchange filings, etc. the presentation currency will be preferred to be INR.

INR as the presentation currency in Indian market will also be preferred currency for reporting to facilitate easy comparability with its peer group. This can be achieved by either following the rules of translation (using average rate for income statement and closing rate of balance sheet) which will give rise to translation reserve or convenient translation using a single rate for all the items in the balance sheet and income statement.

International precedence
In order to relate to the new concept, financial statements of some international companies who have gone through the change in functional currency may be referred. Following relevant excerpts are for reference:

“StatoilHydro (OSE:STL; NYSE:STO) changed the company structure as per 1st January 2009. The parent company, StatoilHydro ASA, and two subsidiaries, consequently changed their functional currencies to USD from the same date.

The accounts for these companies are therefore now recorded in USD, while the presentation currency for the Group remains NOK. The changes in functional currencies have no cash impact.

The companies changing functional currency will no longer have currency exchange effects, deriving from USD denominated monetary assets and liabilities, related to the ‘Net financial items’. Conversely, monetary assets and liabilities, denominated in other currencies than USD, may now generate such currency effects.”

Radiance Electronics Limited, Singapore
“Certain subsidiaries of the Group have changed their functional currency from SGD and RMB to USD in FY2008A. Revenue for these subsidiaries is mainly denominated in USD while purchases are mostly made in USD. Administrative expenses are denominated based on their country of domicile and are mainly in SGD and RMB.

While the factors used to determine its functional currencies are mixed, the Company is of the opinion that USD best reflects the economic substance of the underlying transactions and circumstances relevant to the foregoing subsidiaries. Accordingly, the subsidiaries adopt USD as its functional currency with effect from the current financial year ended 31st December 2008. This change shall be applied retrospectively to the prior years.

The Company and the Group continues to present its financial statements in SGD consistent with prior years.”

For deferred tax implications under IFRS Tenaris S.A.’s annual financial statements may be referred. It carries a note in its financial statements under ‘Tax reconciliation note’ to explain the investors and readers on the volatility caused due to tax accounting.

Tax note from Tenaris S.A. 2008 financial statements

“Tenaris applies the liability method to recognise deferred income tax expense on temporary differences between the tax bases of assets and their carrying amounts in the financial statements. By application of this method, Tenaris recognises gains and losses on deferred income tax due to the effect of the change in the value of the Argentine Peso on the tax bases of the fixed assets of its Argentine subsidiaries, which have the U.S. Dollar as their functional currency. These gains and losses are required by IFRS even though the devalued tax basis of the relevant assets will result in a reduced Dollar value of amortisation deductions for tax purposes in future periods throughout the useful life of those assets. As a result, the resulting deferred income tax charge does not represent a separate obligation of Tenaris that is due and payable in any of the relevant periods.”

Internationally it was easier for companies to adopt a change in currency of accounting since these are fully convertible economies i.e., they can operate bank accounts in foreign currency. Thus the change in mindset was comparatively easier, however the common challenge was again ERP which had to be equipped with dual currency reporting for tax purposes.

With respect to deferred taxes, we can see that note in financial statements was given to explain notional volatility to guide the analysts and readers of financial statements.

Forward path
It will be a challenging journey for Indian corporates who will adopt Converged IFRS i.e., ‘Ind AS’ and will have to consider the implications of these standards on its accounting and reporting requirements.

From stability of profitability and ultimately EPS perspective, the companies may avoid the volatility of currency exposure, but may not escape the volatility created by foreign exchange rates in computing deferred taxes. In order to explain the volatility on deferred tax front, companies may prefer to give note disclosures as given by international peers.

Alternative approach: Ind AS 12 ‘Income Taxes’
Considering the amount of volatility of foreign exchange rates with INR and its notional impact on financial statements, the Institute of Chartered Accountants of India can consider a ‘Carve-out’ while converging to IAS 12 or represent to International Accounting Standards Board for granting an exemption under IAS 12 which will flow in Ind AS 12. This is keeping in mind the deferment of Ind AS implementation in India and practical hardships that will be faced by Indian multinational congloromates.

shailesh.kwebmaker

Section 54 — Exemption u/s.54 can be claimed when under a development agreement an assessee exchanges his old flat for a new flat. Such acquisition amounts to construction of new flat and therefore time period of 3 years is available for such acquisition.

(2012) 21 taxmann.com 316 (Mumbai)
Jatinder Kumar Madan v. ITO
A.Y.: 2006-07. Dated: 25-4-2012

Section 54 — exemption u/s.54 can be claimed when under a development agreement an assessee exchanges his old flat for a new flat. Such acquisition amounts to construction of new flat and therefore time period of 3 years is available for such acquisition.

Facts:

Vide development agreement dated 8-7-2005 the assessee surrendered his flat of carpet area 866 sq.ft. to the builder and in lieu thereof was allotted new flat of carpet area 1040 sq.ft. and also given cash compensation of Rs.11,25,800. The cash compensation was invested by the assessee in REC bonds and was claimed to be exempt u/s.54EC. Since the assessee had acquired new flat in lieu of the old flat, capital gain arising on account of the transfer of the old flat was claimed to be exempt u/s.54 of the Act. The assessee submitted that the capital gain computed at Rs.55,91,866 was less than the value of the new flat and, therefore, the same was exempt u/s.54 of the Act.

The AO held that the assessee had neither purchased, nor constructed the new flat and therefore was not eligible to claim exemption u/s.54. He denied the claim u/s.54. He computed sale consideration of old flat to be Rs.86,96,760 comprising Rs.75,64,960 being market value of the new flat and Rs.11,25,800 being cash compensation. After deducting indexed cost of acquisition from the sale consideration, he computed the long-term capital gains to be Rs.55,91,866.

Aggrieved the assessee preferred an appeal to the CIT(A) who confirmed the disallowance u/s.54. Aggrieved the assessee preferred an appeal to the Tribunal.

Held:

The Tribunal held that acquisition of a new flat under a development agreement in exchange of the old flat amounts to construction of new flat. This view was also taken in the case of ITO v. Abbas Ali Shiras, (5 SOT 422). The Tribunal held that the provisions of section 54 are applicable and the assessee is entitled to exemption if the new flat had been constructed within a period of 3 years from the date of transfer. Since cash compensation was part of consideration for the transfer of old flat and the assessee had invested money in REC bonds, the exemption u/s.54EC will be available. Since the longterm capital gain computed by the AO including cash compensation as part of sale consideration was much below the cost of new flat and therefore, the cash component was also held to be exempt u/s.54. The Tribunal noted that to substantiate the completion of new flat within 3 years the assessee had filed a copy of letter dated 30-5-2007 of the builder in which it was mentioned that the builder had applied for occupation certificate and possession was given on 14-6-2007. This letter was not available with lower authorities. The exact date of taking possession of the flat was also not clear. The Tribunal directed the AO to verify these facts.

The Tribunal held that the assessee is entitled to exemption u/s.54, subject to verification of the date of taking possession by the assessee. The Tribunal decided this ground of appeal in favour of the assessee.

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SOME IMPORTANT AMENDMENTS IN SERVICE TAX

Introduction:
A conceptual change taking place in taxation of services. The Finance Bill, 2012 has introduced negative list of services which will not be taxed. In addition, a list of exempt services is notified. Certain activities are defined as ‘declared as services’. However, these provisions are yet to be enacted with or without modifications and the effective date of their coming into force would be notified thereafter. Therefore, they are not discussed here. However, alongside the increase in the general rate of service tax from 10% to 12% and increasing the rate of service tax levied on services of life insurance, exchange of foreign currency, distribution or selling of lotteries, works contract service, composition scheme and transportation of passengers by air to come into effect from 1st April, 2012, there are a few other significant amendments coming into force from 1st April, 2012 or from 17th March, 2012 as the case may be. Some important amendments are discussed below:

Benefit to pay service tax on receipt basis restricted:

Point of Taxation Rules, 2011 (POT Rules) were introduced with effect from 01/04/2011. In terms of Rule 7(C) of the POT Rules (before their amendment by notification No.4/2012), various professional service providers viz. architects, interior decorators, practising chartered accountants, practising cost accountants, practising company secretaries, scientific or technical consultants, legal consultants and consulting engineers paid service tax on receipt basis if such services were provided in capacity as individuals, proprietors or partnership firm.

The POT Rules have been amended vide Notification No.4/2012-Service tax and the amended Rules come into effect from 1st April, 2012. The amendment has substituted Rule 7 and the new Rule 7 does not have provisions contained in the above Rule 7(C). This provision permitting payment of service tax on receipt basis now finds a place in Rule 6 of the Service Tax Rules, 1994 (Service Tax Rules) by way of a proviso in a modified form. The benefit of payment of service tax on the basis of payment towards the value of taxable service is now extended to all the service providers rendering service in capacity as individuals and partnership firms instead of the above eight stated categories of service providers. However the benefit is restricted only to those cases where the value of taxable services provided from one or more premises in aggregate did not exceed Rs. 50 lac in the previous financial year. In effect, all individuals and partnership firms whose gross receipts exceeded Rs. 50 lac in the Financial Year 2011-12 would now be required to pay service tax in accordance with the point of taxation as determined under the amended POT Rules i.e., earlier of the three events i.e., date of provision of service, date on which invoice is issued or the date of payment. In terms of the amended Rule 4A of the Service Tax Rules, the invoice is required to be issued within 30 days instead of 14 days. (In case of banking and financial services, the time limit to issue the invoice is extended to 45 days).

As a matter of fact, professionals like chartered accountants, legal practitioners etc. account their professional receipts on “cash basis” and this is accepted under section 145 of the Income Tax Act, 1961. Payment towards professional fees in many cases is made after a delay. Moreover, for a portion of fees of interior decorators or architects is customarily ‘retained’ by the clients until completion of long-drawn projects. Thus, the very basic purpose of permitting under the Income Tax Act, 1961 for maintenance of accounts on “cash basis” is not only defeated or contradicted by the above provisions becoming effective on 1st April, 2012 but it also appears unfair vis-à-vis all individuals or partnership firms maintaining their books of account on “cash basis”. In any case, as service tax is required to be paid on advances received for services to be provided. Therefore, if the amended rule are implemented without considering the difficulty and avoidable paper work, it is likely to cause hardship to all professionals.

CENVAT Credit Rules, 2004:
Capital goods:

The definition of ‘capital goods’ as provided in Rule 2(a) of the CENVAT Credit Rules, 2004 (CCR) has undergone some noteworthy amendments coming into force from April 1, 2012. Motor vehicle used for transportation of passengers or goods covered by Tariff Headings 8702, 8703, 8704 and 8711 are not considered as ‘capital goods’ and therefore the duty paid on such vehicles used for business purposes including trucks/lorries used for transportation of goods except in the case of *seven specified categories of service providers is not available as CENVAT credit. However, in the financial year 2012- 13, excise duty paid on tractors and special purpose motor vehicles such as breakdown lorries, crane lorries, fire-fighting vehicles, concrete mixer lorries, mobile radiological units and trailers covered by Chapter Entry 8716, etc. and their chassis would be available as CENVAT credit as these vehicles now form part of the definition of capital goods. Thus to a limited extent when these assets are required for a business activity, excise duty paid would be eligible for claiming credit against duty liability or service tax liability. However, service providers other than goods transport agencies such as logistics service providers, freight forwarders, clearing and forwarding agents, construction contractors, etc. purchase transport vehicles including refrigerated vans, etc. only for providing logistics services. The duty payable on such vehicles forms part of the cost to the service provider, as no CENVAT credit is available as they are not treated as capital goods and for these service providers, CENVAT credit will continue to be unavailable. However, authorised service stations possess special purpose motor vehicles fitted with equipments to provide emergency repair services ‘on-road’ when vehicles on road face breakdown. These vehicles are not used for transportation of goods or passengers. Since special purpose vehicles now qualify as capital goods, the motor vehicles specifically designed to provide specific services should qualify to be considered ‘capital goods’.

Input service: The Finance Act, 2011 significantly restricted the scope of the definition of ‘input service’ provided in Rule 2(1) of CCR by specifically providing artificial exclusions. A small relaxation is now made by amending the definition of input service.

With effect from 1-4-2011 till 31-3-2012, except in case of *seven specified services, credit was not available for service tax paid on insurance and repairs or maintenance of motor vehicles. Now, credit in respect of service tax on insurance services and of repair or maintenance services will be available to manufacturers of motor vehicles for vehicles manufactured by them and to insurance service providers for the motor vehicles insured or reinsured by them. The insurance service however will be restricted to reinsurance and third-party insurance for insurance companies and in-transit insurance for the vehicle manufacturers according to the Government-Tax Research Unit’s letter dated 16-3-2012.

In case of hiring of a motor car or any other tangible goods for use, the credit of service tax paid was restricted from 1-4-2011 till 31-3-2012 to only *seven categories of service providers. In case of hiring of vehicles or any other goods, credit for service tax paid will be available to the extent such vehicles or goods hired are considered ‘capital goods’ for an assessee as a manufacturer or as a service provider.

As discussed above, the motor vehicles used for transportation of passengers and goods, covered by tariff headings 8702, 8703, 8704 and 8711 and their chassis are not considered ‘capital goods’ except for *seven categories of service providers. Implications of the above is that e.g., if a machinery or any other equipment which qualifies to be ‘capital goods’ for a manufacturer or a service provider, service tax paid on hiring of such machinery will now be available. By excluding this service in entirety, except to the specified seven categories from 1-4-2011 to 31-3-2012, the service used for bona fide business use was not treated as input service as it was specifically excluded. With the amendment, credit of service tax paid on such services will be available.

Removal/disposal of capital goods after use:

In Rule 3(5) of CCR, in its third proviso it was provided that when capital goods on which CENVAT credit has been taken are removed after they are used i.e., as second-hand capital goods, the manufacturer or service provider was required to pay an amount equal to CENVAT credit taken on such capital goods, as reduced by 2.5% for each quarter of a year or part thereof from the date of taking CENVAT credit in case of capital goods other than computers and computer peripherals. In case of computers and its peripherals, considering that they become obsolete fast, accelerated reduction or depreciation is allowed whereby at the end of fifth year, the value becomes Nil [i.e., 10% of every quarter of the first year (40% in the first year)] in the first year, 8% of every quarter of the second year (32% in the second year), 5% of every quarter of the third year (20% in the third year) and 1% for each quarter of fourth and fifth year (8% in aggregate in fourth and fifth year).

In a separate sub-clause viz. in sub-clause (5A) of the said Rule 3 of CCR, it was provided that when any capital goods are cleared as scrap and waste, the manufacturer was required to pay an amount equal to the duty leviable on the transaction value of the sale of such capital goods as scrap. This was applicable only to those capital goods on which CENVAT credit was taken. When such capital goods were sold as waste and scrap, the service provider was not required to pay any amount.

Now, with effect from 17th March, 2012, both the above provisions are aligned in a common rule viz. the substituted sub-rule (5A) in place of the third proviso in sub-rule (5) and the erstwhile sub-rule (5A) as discussed above. The implications of the substituted sub-rule (5A) of Rule 5 is that 17th March 2012 onwards, whether capital goods are disposed of as second-hand goods or waste and scrap and whether by a manufacturer or a service provider and if CEN-VAT credit was taken on such capital goods, the assessee would pay amount equal to CENVAT credit taken as reduced at the same rates (as applicable prior to the amendment provided above) in case of computers and other capital goods as the case may be. However, if the amount so calculated is less than the duty levi-able on the actual transaction value of the sale of such used capital asset, then the amount equal to the duty leviable would be required to be paid by the assessee.

Thus, service providers are now required to pay an amount equal to the duty on sale of any capital goods, whether as scrap or otherwise. For instance, if a computer was sold after 5 years of its date of receipt, no amount equal to the duty on its sale was required to be paid. However, now with effect from 17-3-2012, on sale of second-hand capital goods or scrap value of any capital goods whether a manufacturer or a service provider as the case may be will be required to pay an amount equal to the duty payable on its transaction value or an amount equal to CENVAT credit as reduced by permissible deprecation, whichever is higher. Further, hardship is expected to be faced for sale of very old assets as scrap or the transfer of various capital goods occurring in slump sale, mergers and acquisitions, etc. as the assessee may find it hard to prove whether CENVAT credit was at all taken. At times, even when records are available, the unit of measurement for virgin capital goods may be different from the unit of measurement for scrap. Scrap may be sold based on say kilogram, whereas at the time of purchase per unit price or per meter price may have been applied. Therefore, removal of scrap ideally should have been subjected only to transaction value for reversal of credit as in the past.

Conditions for allowing credit:

Rule 4 of CCR provides conditions for allowing CENVAT credit. Sub-rules (1) and (2) of the said Rule 4 provides for condition vis-à-vis output service provider that inputs and capital goods, respectively, are eligible for CENVAT credit when they are received in the premises of output service provider. With effect from 1-4-2012, a proviso is inserted under both the sub-sections to provide that the CENVAT credit in respect of inputs as well as capital goods may be taken when inputs or capital goods are delivered to the provider of service, subject to documentary evidence of delivery and location of inputs or capital goods as the case may be. Thus the condition of receipt of inputs or capital goods in the premises of the output service provider is deemed to be fulfilled by a mere documentary evidence of delivery of capital goods or inputs. For instance, if a person providing site formation and clearance services purchases a dumper, such ‘capital goods’ cannot be practically received in the premises of the service provider. Therefore, the proviso would dispel practical difficulty in implementation of the condition of the receipt of inputs or capital goods in the premises of the output service provider.

Distribution of credit by Input Service Distributor:

Rule 7 dealing with distribution of CENVAT credit by input service distributor is replaced as a whole with effect from 1st April, 2012. Input service distributor means an office of a manufacturer or producer of final products or output service provider which receives invoices towards purchase of input services and which in turn would issue invoice or challan for distribution of credit of service tax paid on such services to its units located elsewhere. Hitherto, there were only two simple conditions underlying distribution of credit viz.:

Credit distributed against the invoice or challan would not exceed the amount of service tax actually paid.

Credit of service tax attributable to service used in a unit exclusively engaged in manufacture of exempted goods or providing exempted services would not qualify to be distributed.

Now, retaining the above two conditions, further two conditions are laid down, thus implying restrictions on the distribution of eligible credit. These conditions are:

Credit of service tax attributable to service used wholly by a unit would be distributed only to such unit; and

Credit of service attributable to service used for more than one unit such as common services like audit services would be distributed pro rata on the basis of the turnover of the concerned unit to the sum total of the turnover of all the units to which the service relates. For the purpose of this condition, the unit would include premises of output service provider and premises of a manufacturer including the factory whether registered or not and the term ‘turnover’ is required to be determined as it is required to be determined under Rule 5 of CCR for the purposes of refund. In effect, these conditions would increase substantial paper-work for the input service distributor.

Interest: Recovery of CENVAT credit wrongly taken:

Rule 14 of CCR deals with situations when CENVAT credit is taken or utilised wrongly or is erroneously refunded, and the same is payable by a manufac-turer or provider of output service with interest. Since Rule 14 provides for interest liability on CEN-VAT credit ‘taken or utilised wrongly’, there were numerable disputes occurring between the revenue and assessees as to whether interest is leviable on the amount of credit was ‘taken’ by the assessee in the CENVAT credit account, but not ‘utilised’ against any liability of excise duty or service tax. The appeal by the revenue in the case of Maruti Suzuki Ltd. reported in (2007) 214 ELT 173 (P&H) was dismissed by the Supreme Court wherein the P&H High Court had upheld the Tribunal’s decision that no interest was payable when CENVAT credit was taken but not utilised. However, the Supreme Court in the case of UOI v. Ind-Swift Laboratories Ltd., (2011) TIOL 21 SC-CX held that the High Court erroneously held that interest cannot be claimed from the date of wrong availment of CENVAT credit. It had further held that provisions are to be read as a whole. We find no reason to read the word ‘or’ as the word ‘and’ which appears between the expression ‘taken’ or ‘utilised wrongly’ or ‘has been’ erroneously refunded. In (2011) 266 ELT 41 (Guj.) CCE v. Dynaflex P. Ltd., it was held that when a wrong entry was reversed voluntarily before utilisation, no interest was payable. The amendment made in the Rule 14 now by using the words ‘taken and utilised wrongly’ in place of ‘taken or utilised wrongly’ is well intended to extend fairness and to put an end to the controversy over payment of interest from the date of availment of wrong credit instead of its utilisation, if any.

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Section 26 — Income of co-owners of house property — Cannot be assessed as income of an association of persons (AOP) in spite of the fact that a return was filed in the legal status of AOP.

30. (2011) 131 ITD 377 (Mum.) Sujeer Properties (AOP) v. ITO A.Y.: 2002-03. Dated: 28-1-2011

Section 26 — Income of co-owners of house property — Cannot be assessed as income of an association of persons (AOP) in spite of the fact that a return was filed in the legal status of AOP.

Facts:

A particular house property was co-owned by five persons. A return of income was filed by the association of persons (AOP) of these five persons declaring NIL income and claiming that income is to be assessed in the hands of the respective coowners of the building as share of each co-owners is predetermined. The assessment of AOP was subsequently reopened since the AO observed that the assessee had not paid any municipal taxes but had claimed the same in computation of house property. Before the ITAT, the assessee argued that in view of clear provisions of section 26, there was no question of first ascertaining the property income in the hands of the AOP and then ascertaining the share in the hands of each co-owner. He further argued that the entire exercise of filing of return of AOP was an entirely infructuous exercise and had no income tax implications at all. The DR argued that since the assessee had not taken up this plea of nontaxability while filing the original return, the same cannot be taken up before the Tribunal.

Held:

(1) Since the plea of non-taxability of income is a purely legal ground which does not require any further investigation of facts, there is no bar on dealing with the said plea.

(2) Further, there is a merit in the argument that the very act of filing return of income by the AOP as far as co-ownership of house property is concerned has no income tax implications. This is because the income from house property is to be taxed as per sections 22 to 26. There is no support for the proposition that annual value of the property is to be determined in the course of the AOP itself. So far as the income from house property is concerned, the Act does not envisage that annual value of the co-owned property, upon being determined in the assessment of the AOP, is to be divided amongst the co-owners in predetermined ratio.

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(2011) 130 ITD 219 (Cochin) (TM) Dy. CIT, Circle 2(1), Range-2, Ernakulam v. Akay Flavours & Aromatics (P.) Ltd. A.Y.: 2004-05. Dated: 20-9-2010

Section 10B, r.w.s. 32 and section 72 — For hundred percent export-oriented unit eligible for deduction u/s.10B, set-off of unabsorbed depreciation and business loss brought forward from relevant assessment year in which deduction was so claimed for the first time up to A.Y. 2000-01, will be allowed against business income or under any other head of income including ‘income from other sources’, for all assessment years up to assessment year in which deduction was last claimed (i.e., during the tax holiday period).

Facts:
The assessee is a hundred percent export-oriented unit and is eligible for deduction u/s.10B of the Income-tax Act. The first relevant assessment year for which deduction u/s.10B claimed was A.Y. 1996- 97 and therefore the last assessment year for which the deduction will be available to assessee will be A.Y. 2005-06. During the assessment of return of income for A.Y. 2004-05, the AO noticed that the assessee had claimed set-off brought forward unabsorbed depreciation up to A.Y. 2000-01 against income computed under the head ‘Income from other sources’. The AO disallowed the claim of deduction under grounds of provision of section 10B(6) and while computing the income of the assessee during the assessment, the AO, first set off the brought forward business loss and unabsorbed depreciation against the income from the export unit and balance income was considered for deduction u/s.10B. Thus the AO neutralised the claim of deduction u/s.10B by setting off the brought forward loss and unabsorbed depreciation first and disallowed the assessee’s claim of set-off against income under the head ‘Income from other sources’.

The assessee, against said order of the AO, preferred an appeal to the CIT(A). The CIT(A) reversed the order of the assessing officer and upheld the claim of the assessee. The CIT(A) opined that reading of provision u/s.10B(6)(ii) clearly states that set-off of unabsorbed depreciation and business loss brought forward up to A.Y. 2000-01 will not be allowed to be carried forward beyond the tax holiday period. In the instant case, the last year of claim of deduction u/s.10B was A.Y. 2005-06, whereas the assessment year for which appeal was referred is A.Y. 2004-05, therefore the view of AO could not be upheld and the assessee’s claim was allowed.

Aggrieved the Revenue appealed before the ITAT.

Held:
(1) On simple reading of section 32 with section 72, it is apparent that unabsorbed depreciation can be set off against business income or under any head of income including ‘Income from other sources’. There is no provision in law which prohibits set-off of unabsorbed depreciation from income computed under head ‘Income from other sources’.

(2) The benefit given u/s.10B is deduction and not an exemption and is evident from the wordings of the said provision which states that only 90% of the business profits are allowed as deduction. Thus the balance 10% has to be treated only as business income. The perusal of section 10B(1) clearly reveals that deduction under the section from profits and gains derived by undertaking from the export has to be made first while computing income under the head ‘Income from business’ and not at a later stage of computation of the gross total income of the assessee.

(3) Provision of section 10B(6)(ii) states that no loss insofar as it relates to the business of the undertaking including unabsorbed depreciation, so far it relates to any relevant assessment year up to A.Y. 2000-01 shall be carried forward for set-off while computing income for any assessment year subsequent to the last relevant assessment year in which deduction under this section is claimed i.e., after the tax holiday period. Therefore, setoff of such brought forward business loss or unabsorbed depreciation can be made in accordance with provisions of section 32, section 71 and section 72 while computing the total income of the assessee for assessment year within the tax holiday period.

(4) Thus, set-off of brought forward business loss and unabsorbed depreciation up to A.Y. 2000-01 cannot be disallowed for A.Y. 2004- 05, where the last year of claim for deduction u/s.10B was A.Y. 2005-06 as the assessment year in consideration falls within the tax holiday period. Thus Revenue’s appeal stood dismissed and the view taken by the CIT(A) was upheld.

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Section 12A of the Income-tax Act, 1961 — Registration under charitable institutions — Trust formed for propagating the knowledge of Vedas cannot be said to be benefiting only a particular community — Registration cannot be denied on this ground.

29. 2011) 131 ITD 370 (Cochin) Kasyapa Veda Research Foundation v. CIT A.Y.: 2008-09. Dated: 28-4-2011

Section 12A of the Income-tax Act, 1961 — Registration under charitable institutions — Trust formed for propagating the knowledge of Vedas cannot be said to be benefiting only a particular community — Registration cannot be denied on this ground.

Facts:

The assessee-trust filed an application u/s.12A of the Income-tax Act, 1961 seeking registration as a charitable trust. It was formed for preaching and propagating the knowledge of Vedas. The Commissioner of Income-tax was of the opinion that the trust was not benefiting the public at large and was confined to only the Hindu community. He thus cancelled registration u/s.12A of the Income-tax Act. He further passed an order declaring the trust as religious trust.

Held:

There is a very thin line of difference so as to identify whether the nature of activity is a charitable one or a religious one. The assessee-trust was formed to propagate and spread the knowledge of Vedas and Vedanta amongst the public so that they can change their living habits and take the necessary steps for the betterment of humanity. This would not only help the common public to improve their current status but also would enhance their ability to think about the humanity as a whole. The overall appeal of Vedas and its contents are universal and a representation of religious scriptures. The whole purpose of imparting education in Vedas is to promote the behavioural patterns of the people. Also as mentioned in the Trust deed, the other activities are pure charitable in nature. Thus, the assessee-trust was thus allowed a status of charitable trust.

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Section 11 of the Income-tax Act — Accumulation @ 15% should be calculated on the gross income and before deducting other expenses.

28. (2011) 131 ITD 335 (Luck.) Krishi Utpadan Mandi Samiti v. DCIT A.Y.: 2006-07. Dated: 7-6-2010

Section 11 of the Income-tax Act — Accumulation 15% should be calculated on the gross income and before deducting other expenses.

Facts:

The assessee-trust has earned total receipts of Rs. 1.32 crore as per their books of accounts. As per the provisions of section 11 of the Act, it accumulated 15% of the receipts and claimed as an exemption. However, the AO computed exemption @ 15% after deducting administrative expenses.

Held:

According to section 11(a) of the Act, income derived from the property held by the trust and applied for religious or charitable purposes will be exempt. Where any income is accumulated, exemption to the extent of fifteen percentage of the said income will be available. The assessee-trust calculated the exemption on the basis of gross income received from the property. As per the AO and the CIT(A) the exemption should be calculated after deducting the expenses incurred for charitable purposes. Relying on the decision of CIT v. Programme for Community Organisation, (248 ITR 1) (SC) it was held that the exemption of 15% must be taken on the gross income and not on net income as determined for income tax purposes.

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Section 22 r.w.s 28(1) — Principle of res judicata though not applicable to income tax proceedings, principle of consistency applicable and in absence of any change of circumstances or non-consideration of material facts or statutory provisions, Department cannot change the stand taken in earlier years.

27. (2011) 131 ITD 171 (Luck.)ACIT v. Harbilas Cold Storage and Food ProductsA.Y.: 2006-07. Dated: 12-11-2010

Section 22 r.w.s 28(1) — Principle of res judicata though not applicable to income tax proceedings, principle of consistency is applicable and in absence of any change of circumstances or non-consideration of material facts or statutory provisions, Department cannot change the stand taken in earlier years.

Facts:

(1) The assessee was engaged in carrying on business of running cold storage till 1989. Thereafter, the assessee made some alterations and additions in cold storage building and rented out certain portions for use as warehouse and office.

(2) The rent income was offered by the assessee as income under the head income from house property and the same was accepted by the Department in all earlier assessment years. Further, there was no change in facts in the year under consideration as compared to earlier years.

(3) However for the assessment year under consideration, the AO treated the income as profits and gains from business and profession on the ground that the assessee was not just letting property, but also providing various facilities.

(4) On appeal filed by the assessee, the CIT(A) held that the income is chargeable under the head income from house property only, thus allowing the appeal filed by the assessee.

(5) Against the order of the CIT(A), the Department filed appeal before the Tribunal.

Held:

(1) Though principle of res judicata is not applicable in tax proceedings, the principle of consistency is applicable as held by the Supreme Court in the case of Radhasoami Satsang (100 CTR 267) and the Jurisdictional High Court in case of Goel Builders (supra).

(2) Where an issue is decided either in one manner or other and the same has not been challenged by either of the parties, it would not be appropriate to change the position in subsequent years.

(3) The Department has got the right to depart from its earlier practice only on change of circumstances or non-consideration of material facts or statutory provisions.

(4) In the present case, no new facts have been brought on record by the AO so as to justify departure from the earlier stand taken by the Department.

(5) Thus, appeal of the Revenue was dismissed.

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Reassessment: Sections 143(3), 147 and 148: A.Y. 2004-05: Original assessment u/s.143(3): Notice u/s.148 beyond 4 years: No allegation in the reasons of failure on the part of the assessee to state fully and truly all material facts necessary for assessment: Reopening not valid.

38. Reassessment: Sections 143(3), 147 and 148: A.Y. 2004-05: Original assessment u/s.143(3): Notice u/s.148 beyond 4 years: No allegation in the reasons of failure on the part of the assessee to state fully and truly all material facts necessary for assessment: Reopening not valid.

[Shriram Foundry Ltd. v. Dy. CIT, 250 CTR 116 (Bom.)]

For the A.Y. 2004-05, the original assessment was made u/s.143(3) of the Income-tax Act, 1961. Subsequently, on 10-2-2011 i.e., beyond the period of 4 years, the Assessing Officer issued notice u/s.148 for reopening the assessment. The reasons recorded for reopening are as under: “You have claimed a melting loss in excess of 7.24%, which is higher than what is found in the similar line of business. So the melting loss earlier allowed is excess.” Objections filed by the assessee were rejected. Thereafter the assessee filed a writ petition challenging the reopening.

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

“(i) The original assessment was completed u/s.143(3). The assessment is sought to be reopened beyond a period of 4 years from the end of the relevant assessment year. The jurisdictional condition is that in such case, before an assessment can be validly reopened, there must be a failure on the part of the assessee to state fully and truly all the material facts necessary for the assessment.

(ii) There is no such allegation in the reasons which have been disclosed to the assessee. The Assessing Officer has purported to reopen the assessment only recording that according to him the melting loss of 7.24% which was claimed by the assessee is higher than what is found in a similar line of business. This ex facie would amount merely to a change of opinion.

(iii) The reopening of the assessment u/s.148 is not valid. The consequential assessment order dated 30-12-2011 would have to be quashed and set aside.”

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Presumptive income: Section 44AE: A.Y. 2001- 02: Transporters: Section 44AE stipulates tax on presumptive income, which may be more or less than actual income: Assessee is not required to maintain any account books: No addition could be made as income from other sources on ground that assessee was not able to explain discrepancies in account books.

37. Presumptive income: Section 44AE: A.Y. 2001- 02: Transporters: Section 44AE stipulates tax on presumptive income, which may be more or less than actual income: Assessee is not required to maintain any account books: No addition could be made as income from other sources on ground that assessee was not able to explain discrepancies in account books.

[CIT v. Nitin Soni, (2012) 21 Taxman.com 447 (All.)]

The assessee, a proprietor of transport business possessed eight trucks. In the income-tax return for the A.Y. 2001-02, he disclosed income u/s.44AE. The Assessing Officer made additions to the income of the assessee on ground that the assessee did not have sufficient withdrawals to explain as to how he had been meeting daily expenses. He held that the assessee must have got income from other sources. The Tribunal deleted the addition holding that it could not be treated as income from other sources.

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

(i) Section 44AE inserted by the Finance Act, 1994 provides special provision for computing profits and gains of business of plying, hiring or leasing goods carriages. It opens with an non obstante clause by giving an overriding effect over sections 28 to 43C, in the case of an assessee who owns not more than ten goods carriages. Income of such assessee chargeable to the tax under the head ‘Profits and gains of business or profession’ shall be deemed to be the aggregate of the profits and gains, from all the goods carriages owned by him in the previous year, computed in accordance with the provisions of s.s (2).

(ii) The very purpose and idea of enactment of provision like section 44AE is to provide hassle-free proceedings. Such provisions are made just to complete the assessment without further probing provided the conditions laid down in such enactments are fulfilled. The presumptive income, which may be less or more, is taxable. Such an assessee is not required to maintain any account books. This being so, even if, its actual income in a given case, is more than income calculated as per s.s (2) of section 44AE, cannot be taxed. (iii) Thus, it follows the query of the Assessing Officer as to how the assessee met his daily expenses, there being no withdrawal and conclusion of additional income was uncalled for. (iv) The addition made by the Assessing Officer due to increase in the capital cannot be taxed u/s.56 as income from other sources as the accretion, if any, in the capital is relatable to profit from transport business of the assessee. A reading of the assessment order would show that the addition was made on account of excess generation of income of the assessee from the goods carriages business, u/s.56.”

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Method of accounting: Hybrid system: Section 145: A.Y. 1991-92: Amendment of Incometax Act w.e.f. 1-4-1997 not permitting hybrid system: Assessee can follow hybrid system in A.Y. 1991-92: Amendment of Companies Act in 1988 not permitting hybrid system: Not applicable.

36. Method of accounting: Hybrid system: Section 145: A.Y. 1991-92: Amendment of Income tax Act w.e.f. 1-4-1997 not permitting hybrid system: Assessee can follow hybrid system in A.Y. 1991-92: Amendment of Companies Act in 1988 not permitting hybrid system: Not applicable.

[Pradip Chemical P. Ltd. v. CIT, 344 ITR 171 (Cal.)]

For the A.Y. 1991-92, the assessee-company had followed hybrid system of accounting for the purpose of computation of income. The Assessing Officer discarded the hybrid system and adopted the mercantile system and made addition. The Tribunal upheld the order of the Assessing Officer.

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

(i) The method of accounting referred to section 145 of the Income-tax Act, 1961, prior to its substitution by the Finance Act, 1995. w.e.f. 1-4-1997, included hybrid or mixed systems of accounting and it was open to a company-assessee to follow the cash system of accounting in respect of a particular source of income and the mercantile system in respect of the others.

(ii) The provisions of the Companies Act, 1956, are meant for the requirement of the 1956 Act and in case of infraction thereof necessary consequences as provided in the 1956 Act itself follows. Section 209 of the 1956 Act does not have overriding effect over any other law, nor has the 1956 Act elsewhere provided that the provisions of the 1956 Act have overriding effect over income-tax and fiscal statutes.

(iii) The Tribunal was not right in holding that for the A.Y. 1991-92, the assessee could not follow the cash system for accounting for its interest income and in upholding the assessment of interest income on accrual basis.”

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TDS: Interest: Section 2(28A) and section 194A of Income-tax Act, 1961: Interest on amount deposited by allottees on account of delayed allotment of flats: Interest on account of damages: Tax need not be deducted at source.

[CIT v. H. P. Housing Board, 340 ITR 388 (HP)]

The assessee, the Himachal Pradesh Housing Board, floated a self-financing scheme for sale of house/ flats wherein the allottees were required to deposit some amount with the assessee and construction was to be carried out out of these amounts. One of the conditions of the terms of allotment was that in case the possession of the house/flat was not given to the allottee within a particular time frame, the assessee was liable to pay interest to the allottees on the money received by it. There was a delay in construction of the houses and thereafter the assessee paid interest at the agreed rate to the allottees in terms of the letter of allotment. The Assessing Officer held that the assessee was liable to deduct tax at source on payment of such interest u/s.194A of the Income-tax Act, 1961. The CIT(A) and the Tribunal held that section 194A was not applicable.

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

“(i) The amount which was paid by the assessee was not payment of interest, but was payment of damages to compensate the allottee for the delay in the construction of his house/ flat and the harassment caused to him.

(ii) Though compensation had been calculated in terms of interest, this was because the parties by mutual agreement agreed to find out a suitable and convenient system of calculating the damages, which would be uniform for all the allottees. The allottees had not given the money to the assessee by way of deposit, nor had the assessee borrowed the amount from the allottees.

(iii) The amount was paid under a self-financing scheme for construction of the flats and the interest was paid on account of damages suffered by the claimant for delay in completion of the flats.”

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A.P. (DIR Series) Circular No. 129, dated 21-5-2012 — Risk Management and Inter-Bank Dealings.

This Circular provides that:

(i) The current Net Overnight Open Position Limit (NOOPL) of banks as applicable to the positions involving Rupee as one of the currencies will not include the positions undertaken in the Currency Futures/Options segment in the exchanges.

(ii) The positions in the exchanges (both Futures and Options) cannot be netted/offset by undertaking positions in the OTC market and vice versa. The positions initiated in the exchanges mt be liquidated/closed in the exchanges only.

(iii) The position limit for the Banks in the exchanges for trading Currency Futures and Options will be US INR6,265 million or 15% of the outstanding open interest, whichever is lower.

Further, Banks, whose positions are not in line with the above requirements, are required to bring down their positions to the above limits by June 30, 2012.

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SEBI AMENDS GUIDELINES TO SETTLE VIOLATIONS — Complex Provisions Make Professional Help Inevitable

SEBI has recently, on 25th May 2012, made significant amendments to its guidelines for settlement of violations. In the process, they have made them so complex that, from the initial do-it-yourself simple scheme, now the new Scheme has made involving lawyers and accountants almost inevitable. There are several positive changes though and particularly some of the major criticisms of the earlier scheme have been addressed.

To recollect, in 2007, SEBI had introduced guidelines for settlement of alleged violations through consent orders and, in case of prosecution, through compounding. The Scheme was very simple and widely framed in its drafting and implementation. Any violation at any stage of punitive proceedings (or, even without proceedings) could be settled. The arbiter of what should be the agreed terms of settlement was an independent Committee (called High-Powered Advisory Committee or HPAC) though, being a voluntary settlement, obviously both sides had to agree. The settlement was usually very swift in practice, the procedures being so simple that even an educated layman could apply for it — and many did. Even the HPAC was co-operative in this regard and, in fact, as an unwritten rule, legal arguments and submissions were neither required, nor generally entertained though a fair and patient hearing was granted. Simple and brief orders were passed so that the spirit of the Settlement Scheme was upheld and a person who has not been held guilty was not seemed to be held guilty by the settlement order.

But, as was almost inevitable, the seeds of malaise were in the simplicity of the Scheme itself and serious concerns were raised. A major concern was that serious violations got settled and the stringent and exemplary punishment required in some cases was avoided through monetary penalties, even if those that appeared to be large. The settlement process was also felt to be opaque. Wide differences in settlement amounts were observed with no reason expressed explaining this and the brief orders giving no further clues. Settlement proceedings were sometimes felt to be used for delaying the regular proceedings. Inevitably, allegations — though unsubstantiated — of corruption were also made.

SEBI has taken the experience and criticism both of 5 years seriously — perhaps too seriously. Several types of serious violations have been put on the negative list though a small window of discretion even for such violations has been kept open. Many of the actual procedural details of the internal process of settlement have been formalised and made transparent. The time limits of making the application — both the earliest and the last dates — have been specified. A significant amendment is the introduction of a very detailed and fairly complicated method of determining what would be the amount at which a particular type of violation having the specified features would be settled. This is obviously to partly remove the discretion involved. On the other hand, it makes the settlement process complex requiring professional help unavoidable. The process itself becomes mechanical which to some extent is antithesis of a settlement process.

Let us consider some important amendments proposed.

First is the negative list of those violations for which settlement is not permitted. But before we examine some of important items in this list, some thoughts on what is the purpose of the settlement process. The objective of settlement is quite obviously to shorten the proceedings for investigating and punishing violations of securities laws. SEBI is benefitted as it saves time and costs, has the benefit of not having to prove the violation in accordance with due process of law and often also has the benefit of the party’s cooperation. Importantly, a punishment — even if lower than what could have been levied if the allegation had been proved — is also meted out. The party accused also saves on time and costs, gets benefit of a lower penalty and also does not have a stigma of a past violation attached, at least on record. Thus, the settlement process is — or, I think, ought to be — a consideration of how the inter- ests of justice and capital markets would be achieved on the facts of the case — a careful balance between the benefit of further proceedings with attached costs and delays and the likelihood of the accused going scot-free.

The offence of Insider trading is now prohibited from being settled. There was strong criticism that inside traders were getting away by settling their cases. Insider trading is in many ways an evil of capital markets. The perpetrator takes advantage of the trust reposed on him as an insider. He makes profits illegitimately by this trust. While some argue that it is a victimless crime, I believe that other shareholders usually do pay the cost. The need to punish such perpetrators is justifiable. However, the fair criticism of disallowing settlement is that insider trading is rather difficult to investigate and prove on facts though SEBI has put in a series of deeming provisions to make up. Prohibiting settlement of allegation of insider trading means that the long process of establishing it will have to be followed in all cases. It would have made better sense to put a higher settlement amount in such cases than an absolute ban. To clarify, though, violation of insider trading cannot be settled, other violations of the insider trading Regulations such as delay/default in disclosures, etc. can be settled.

Serious fraudulent and unfair trade practices causing substantial losses to investors and/or affecting their rights cannot be settled. However, if the person makes good the losses to the investors, the case can be settled. These perhaps constitute the single largest of violations, but a more detailed analysis would be beyond the scope of this article. But suffice is to say that words such as ‘serious’, ‘substantial’, etc. are not defined and may lead to discretion.

Failure to make an open offer under the Takeover Regulations cannot be settled except where (i) the entity is willing to make an offer unless, in the opinion of SEBI, the open offer will not be in interest of shareholders or (ii) where SEBI has decided to refer the matter to adjudication.

Front running transactions also now cannot be settled. As is known, front running transactions involve trading in anticipation of information about impending large orders. As held in some earlier cases, persons connected with mutual funds, who came to know the impending large orders of the mutual funds, traded ahead (or shared such information) and the mutual fund’s investors thus had to buy/sell at a little adverse price because of the earlier orders so placed. Strangely, SEBI defines front running here — which is inappropriate since the law does not define this term — as placing or using non-public information on an impending transaction of substantial quantity. Generally, front running is understood to be a situation where a person in a position of trust having access to non-public information uses this information to carry out front running. The analogy is of an insider. And just as having unpublished information and trading on it does not necessarily make a person guilty of insider trading, the same way a person not connected with such an institution but who still in some way has information of impending large transactions cannot necessarily be held to be guilty of front running.

Other violations on the negative list include net asset value manipulation by mutual funds, failure to redress investor grievances, failure to comply with orders of specified SEBI officers, failure to comply with orders of summons, etc.

However, interestingly, discretion has been retained to settle cases even amongst the negative list, though no criteria has been laid down how such discretion will be exercised.

Another important amendment is that now time limits are specified for making the application.

First time limit is how early can the consent application be made. It is now provided that an application cannot be made before the investigation/inspection of the alleged default is complete. Earlier, the Guidelines provided that that the application could be made at any stage, but in case of serious and intentional violation, the settlement would not be made till the fact-finding process was complete. This was a sensible provision. If a person is coming forward voluntarily, then unless SEBI had indication that more violations could be detected, the matter should be taken up. An important purpose of settlement is to shorten the proceedings.

Second time limit is specification of the last date the application for settlement should be made. The earlier Guidelines had no last date. It is now provided that the application cannot be made more than sixty days from the date of serving the show-cause notice. This would sound fair. Sixty days for examining the show-cause notice, which is expected to be comprehensive, are sufficient to decide whether one wants to fight further or come forward and settle. A concern is whether the time taken for obtaining information and documents relied on in the notice but not provided upfront should be taken (though the law requires such information/documents be provided upfront, some times this is not done). However, there is discretion for extending this last date, if the delay is beyond the control of the applicant.

Repetitive consent applications are now restricted. If an alleged default takes place within two years of the last consent order, then that default cannot be settled through these Guidelines. Further, if two consent orders are already obtained, then no further applications can be made for a period of three years from the date of the last consent order. Strangely, a consent application/order once made for a certain violation, will bar consent order in the above manner for even any other type of violation. This is unlike, say, the Reserve Bank of India Regulations for compounding where restrictions are placed for repetitive compounding of ‘similar’ contraventions. Thus, one would have to be very careful in making a consent application.

A lump-sum non-refundable fee of Rs.5000 is now provided to be paid. This amount is irrespective of the amount involved in the alleged violation or its gravity.

The process of settlement has been changed. The applicant has to first appear before an internal committee of SEBI who will work out the terms of consent in accordance with the formula. These terms will then be forward to the HPAC for its recommendation. Finally, these recommendations of the HPAC will be sent to a Panel of two Whole-time Members of SEBI who will take a final decision and if they deem fit, increase or decrease the terms or reject the application. However, it is provided that this whole process should be ‘preferably’ completed within six months of registration of the consent application. While this period of six months may sound short, it may be recollected that in actual practice, earlier, the process used to be completed much earlier in many cases.

There is an elaborate and complex formula provided for determining the settlement amount. The formula is too detailed to be within the scope of this short article. Suffice is to say that the formula considers the stage at which the application is made, the nature of the violation, etc. and provides for quantitative parameters to determine the settlement amount. Clearly, this is to make the settlement more transparent and remove discretion and discrimination. Minimum amounts have also been provided depending upon the nature of the violation or the alleged perpetrator.

It has been stated — though with some ambiguity — that the minimum settlement amount for first-time applicants will be Rs.5 lac and in case of ‘name-lenders’, this minimum will be Rs.2 lac. Curiously, the minimum amount for second-time applicants is not specified. This minimum limit is strange and perhaps even inequitable. Firstly, even orders passed with due process by SEBI for minor offences have fine far less than Rs.5 lac. Secondly, this would obviously hit persons having made less serious violation. Serious violations even otherwise would be settled for, or punished with, higher amount.

Another common complaint was that the formal orders published do not bring out the facts properly and were too brief and opaque. Thus, one could not know what were the merits of the case and whether the case was fairly settled. To meet this criticism, on the one hand, as explained above, to a large extent, the discretion is diluted. On the other hand, it is now provided that the order shall be more detailed in specific matters including the facts and circumstances of the case. It will have to be seen though how much detailed the orders are in actual practice.

In conclusion, the experience of five years is brought out well in the amendments. While one will miss the simplicity of the earlier provisions and lament the complex new law requiring the need of professional help, it will be also fair to say that the earlier provisions were too simplistic. Where the basic matter itself is complex, the settlement has to be complex. A professional analysis of a complex matter is a must for fair and transparent dealing on both sides. One hopes though that in practice, the amendments are implemented in their true spirit, since the earlier Scheme, despite its short-comings, did set an enviable benchmark to settlement proceedings in India.

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GAPs in GAP — Foreign Exchange Differences — Capitalisation/Amortisation

The Central Government has notified two amendments dated 29 December 2011 to AS-11 The Effects of Changes in Foreign Exchange Rates. Given below is a brief overview of these two amendments, practical issues arising thereon and the author’s perspective.

Overview of the first amendment The first amendment extends the sunset date for the use of option given in paragraph 46 of AS-11 whereby a company can opt to capitalise/amortise exchange difference arising on longterm foreign currency monetary items. It substitutes the words ‘in respect of accounting period commencing on or after 7 December 2006 and ending on or before 31 March 2012,’ in paragraph 46, by the words ‘in respect of accounting periods commencing on or after 7 December 2006 and ending on or before 31 March 2020.’

Overview of the second amendment The second Notification inserts a new paragraph, viz., paragraph 46A, in AS-11. This paragraph deals with accounting for both companies which had exercised option given in paragraph 46 of AS-11 as well as any other company which had not exercised that option. According to this paragraph, a company may choose to adopt the following treatment in respect of accounting periods commencing on or after 1 April 2011:

(i) Foreign exchange differences arising on longterm foreign currency monetary items related to acquisition of a fixed asset are capitalised and depreciated over the remaining useful life of the asset.

(ii) Foreign exchange differences arising on other long-term foreign currency monetary items are accumulated in the ‘Foreign Currency Monetary Item Translation Difference Account’ and amortised over the remaining life of the concerned monetary item.

The option once elected is irrevocable. Like paragraph 46, paragraph 46A also does not apply to exchange differences arising on long-term foreign currency monetary items that in substance form part of a company’s net investment in non-integral foreign operation.

Main issues There are numerous questions on the interplay of these two amendments and the manner in which they would work in consonance with each other. Lets us understand what is clear and what is confusing.

What is clear?
(1) Those companies that were hitherto amortising/ capitalising exchange differences can continue to do so till 2020.

(2) Those companies that were hitherto not amortising/capitalising exchange differences can avail of the new option in paragraph 46A. Such an option is available on a prospective basis for the remaining life of the loan and is not restricted to 2020.

What is confusing?
(1) Those companies that were hitherto amortising/capitalising exchange differences can continue to do so till 2020 under paragraph 46. The amortisation was done restricting the amortisation period to 2012. If the company wishes to continue with paragraph 46, the amortisation period is extended because of the extension from 2012 to 2020. It is not clear whether the amortisation on the loan is calculated on a retrospective basis or on a prospective basis over the balance amortisation period.

(2) Can a company, which had earlier exercised the option given in paragraph 46, now opt out of that exemption on the grounds that it chose the option because it was restricted to 31-3-2011 and not 31- 3-2020? Hence, can it start recognising exchange differences on foreign currency monetary items, including long-term items, immediately in profit or loss?

(3) It is not clear if companies that were amortising/ capitalising exchange differences under paragraph 46 can switch over to paragraph 46A. How the two paragraphs (46 & 46A) will work in consonance with each other? Let us assume that a company has taken a foreign currency loan, not related to acquisition of fixed asset, whose term extends till 31 March 2025. Will the company amortise exchange differences arising on such loan till 31 March 2020 or till 31 March 2025? The manner in which paragraph 46A is drafted appears to allow both existing option users and new option users to capitalise/amortise exchange differences on a prospective basis. If that is true, what is the relevance of paragraph 46?

(4) In paragraph 46, the sunset date has been used at two places: one for the date range during which the option given can be used and the second to specify the period up to which the balance in the ‘Foreign Currency Monetary Item Translation Difference Account’ needs to be amortised. The Notification dated 29 December 2011 has extended the sunset date to 31 March 2020 at the first place. However, a similar change has not been made with regard to the second date. The strict legal and technical interpretation of the paragraph suggests that a company can continue using the option given in paragraph 46 till accounting periods ending on or before 31 March 2020. However, there cannot be any balance in the ‘Foreign Currency Monetary Item Translation Difference Account’, created for exchange differences arising on long-term monetary items not related to acquisition of a depreciable capital asset, post 31 March 2011. In practical terms, this means that after 31 March 2011, a company will be able to use the option given in paragraph 46 only for capitalisation of exchange differences arising on long-term monetary item related to acquisition of a depreciable asset. Other exchange differences will be immediately recognised in the P&L Account. Whilst this may be the strict legal interpretation of the paragraph, certain companies may question whether it really reflects the intention of the regulator. They may also argue that the amendment intends to extend the option given in its entirety. Hence, they can also amortise any balance in the ‘Foreign Currency Monetary Item Translation Difference Account’ till 31 March 2020. Many companies are taking this approach.

The MCA or the Institute of Chartered Accountants of India, will need to clarify the above issues.

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Crowdsourcing

About this article:
This write-up is (in a manner of speaking) a continuation of the previous write-up on mass collaboration. The basic idea remains the same: there is a large problem, capable of being broken into several small manageable parts. The task, though simple to humans, is difficult for computers to achieve (as yet). This idea is applied differently to achieve a variety of objectives. Some are commercial and then there are others which contribute to the growth of society as a whole.

Background:
The term ‘crowdsourcing’ as you may have already guessed, is a derivative of the words ‘crowd’ and ‘sourcing’. While this phrase was first coined by Jeff Howe in June 2006 Wired magazine article, you may be surprised to know that this concept was being commonly applied for several years before that. Few examples which have become huge:

Wikipedia

Captcha and recaptcha

Some lesser known examples:

Brooke Bond/Lipton runs a slogan contest, the winner of the slogan gets a cash reward (and Brook Bond gets 1000+ new catchy slogans for future marketing — virtually for free);

An ad agency organises photography contest. Contestants use their own cameras and film. They are given themes/concepts and come up with innovative ideas/snaps. The ad agency spends on promoting the event and some refreshments for the contestants. Post the contest the ad agency retains all the photos (1000’s of ideas — virtually for free);

Very recently, two leading business houses in India announced in newsprint and media that they would invest in start ups. They invited entrepreneurs all over the country (and abroad) to register and share their ideas (basic idea, sample model, estimates for commercials). Everyone would be given the opportunity to make an ‘elevator’ pitch. Once again 1000+ ideas virtually for free.

And then there are some blacksheep . . . . . .

Remember Speak Asia . . . . if you do some digging you may find that similar schemes were floated in the African continent . . . . very successful . . . . all stakeholders made money. Somehow the idea didn’t click in India.

If you have seen Die Hard 4 — the villan uses the skill of amateur hackers to develop a code, this code is used to disrupt systems.

If you look at any of the above-mentioned ideas, you may agree that all of them were simple ideas, brilliantly executed.

What is crowdsourcing and how does it work:

Simply put, crowdsourcing is a distributed problem solving and production model. Typically, a problem is broadcast to an unknown group of solvers in the form of an open call for solution. The ‘users’ or the crowd (i.e., the online community) comes together and submits solutions. Yet another crowd sifts through these solutions and finds the more acceptable/better solutions. These solutions are then owned by the broadcasting agency (i.e., the crowdsourcer). The winning solutions are sometimes rewarded, sometimes monetarily, sometimes with a prize or recognition (i.e., the contributors are paid crumbs and the broadcaster keeps the cake).

Advantages of crowdsourcing:

Without getting in to the ethical aspect of the subject, one needs to appreciate that there are certain advantages that crowdsourcing can offer :

Problems can be explored at a comparatively small cost, often very quickly.

Possible to achieve a win-win proposition sans monetary compensation — best example is Luis von Ahn’s Recaptcha and the efforts to translate wikipedia’s German version.

Crowdsourcing makes it possible to tap a wider range of talent (or prospective customers) than normally feasible — best example — auto industry has been using social media to source ideas from prospective customers — ideas about car design, features, accessories, etc.

Resultant rewards have potential of spurring activities — more entrepreneurship, growth in business, investments, employment, etc.

Criticism about crowdsourcing:

Once the crowd starts contributing, somebody has to sort and sift through the information. This is a costly affair, unless the right resources are used the costs outweigh the benefits;

Given that there is no monetary compensation, increases the likelihood of the project failing. Without money one may face problems with fewer participants, lower quality of work, lack of personal interest in the project/results, etc.;

Barter may not always be possible;

Risks mitigation through contracts may not be possible since there are no written contracts, non-disclosure agreements or for that matter non-transparency about how the information will be used;

Difficulty in managing and maintaining a working relationship with the crowd throughout the duration of the project;

Susceptibility to faulty results and failure is still too high.

Though there are several pros and cons, so far the perception has been positive. With the success of ideas like recaptcha and the translation project, people have started believing in crowdsourcing’s potential to balance global inequalities. A rather tall statement, but its still a wait-and-watch situation.

I would like to end this write-up by sharing my experience with crowdsourcing. Sometime ago, I downloaded a free app on my phone called Waze. At the time I didn’t know that it was a crowdsourcing app. However after using the app, I have (kind of) started leaning in favour of crowdsourcing and hope to see more developments in this field.

Waze app:

Waze is a free iPhone app which tries to crowdsource real-time traffic and navigation data. The application has advantages because it provides information which is ‘almost’ real-time and updated. It is quite different from your navigation/GPS systems because apart from providing you information about routes, Waze also provides information about traffic, speed at which the traffic is moving (it’s been a mixed experience for me), information about roads under construction (this is based on user inputs and quite accurate) — if there is a obstruction or an accident and the road gets blocked, users can send an instant update and all users will be pinged instantly.

The best part is that most of the time the user simply has to switch on the application and leave it on. The software keeps tracking your speed (using GPS and your GPRS/3G bandwidth) and broadcasts this information to other users. If your car slows down the app sends you a prompt asking if you are stuck in traffic. The information is broadcast almost instantly (have noted that it is broadcast in 5-10 seconds).

I have been using the app intermittently and have found it quite useful to avoid traffic. Have benefitted from updates quite a few times and that’s why I rate it as a pretty good ‘time-saving app’. While the app is free, there is a downside — the constant tracking can drain your battery and unless you have a good data plan, it will also drain your wallet.

That’s all for this month. Next month is likely to be dominated with the budget proposals, but I promise that I will have some interesting ideas and stories to share with you.

Cheers.

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MTV Asia LDC v. DDIT ITA No. 3530/Mum/ 2006 (unreported) A.Ys.: 2002-03 to 2005-06. Dated: 31-1-2012 Before P. M. Jagtap (AM) & N. V. Vasudevan (JM) Counsel for taxpayer/revenue: A. V. Sonde/ Malathi Sridharan

Article 7 of India-Singapore DTAA

Despite payment of arm’s-length remuneration to the agent, further profit could be attributable to the PE in India.

Facts:
The taxpayer was a company incorporated in Cayman Islands and conducted its business operations from Singapore. Singapore tax authority had issued tax residency certificate to the taxpayer confirming that its control and management was exercised from Singapore. During the relevant years, the taxpayer was conducting its entire TV channel activities for Asia-Pacific Region from Singapore.

During the course of assessment proceedings, the AO noted as follows.

The taxpayer had appointed an Indian company (‘IndCo’) as its agent in India.

IndCo was entitled to 15% commission on the gross advertisement revenue from India.

The income of the taxpayer comprised only the advertising time sold by IndCo.

IndCo also collected the payments and remitted them to Singapore.

The AO, therefore, held that the taxpayer had an agency PE in India. The AO further held that even if the taxpayer paid arm’s-length remuneration to the agent, further profits could be attributed to the agency PE. The AO, accordingly, attributed profits at 40, 30, 25 and 25% for the relevant years. The CIT(A) upheld the further attribution of profits, but reduced the quantum.

The issue before the Tribunal was about proper profit attribution to the PE in India. Held:

The Tribunal held as follows:

The audit of the accounts of the taxpayer was completed subsequently. Further, the taxpayer had not maintained separate accounts for the Indian operations. Hence, application of Rule 10(i) read with Rule 10(iii) was proper.

The tax computation filed by taxpayer with the Singapore tax authority in respect of its global operations reflected losses. Hence, margin attributed by the AO was on the higher side.

Transponder charges and programme charges cannot be said to be only for Indian operations since the satellite footprint also covered neighbouring countries.

The erstwhile CBDT Circular No. 742 of 1996 provided for presumptive taxation of 10% of the advertisement revenue of foreign telecasting companies as their income. Hence, even though the said Circular was withdrawn, as there was no change in the business model of the taxpayer, attribution of 10% of the advertisement revenue earned by the taxpayer from India was reasonable.

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SEPCO III Electric Power Construction Corporation, In re AAR No. 1008 of 2010 (unreported) Dated: 31-1-2012 Before P. K. Balasubramanyan (Chairman) & V. K. Shridhar (Member) Counsel for applicant/revenue: N. Venkataraman, Satish Aggarwal, Akil Sambhar, Nageswar Rao & Atul Awasthi/Vivek Kumar Upadhyay

Article 7 of India-China DTAA Section 9 of Income-tax Act On facts, since the sale transaction was concluded outside India, payment made for offshore supplies was not taxable in India.

Facts:
The applicant was a Chinese company engaged in the business of supplying equipment for electric power projects. An Indian company awarded contract to the applicant for offshore supply. The scope of the work required the applicant to carry out design, engineering, procuring and transportation of the equipment for a thermal power plant to the port of loading.

The applicant contended that the supply of the equipment was made outside India and hence, the payment received by it was not taxable under Income-tax Act or India-China DTAA. In support of its contention, the applicant claimed:

As per the contract, title to the equipment was passed at the port of loading, which was located outside India.

The shipping documents showed the Indian company as the owner of the equipment.

The transit insurance was obtained in the name of the Indian company.

The payment was to be made in foreign currencies.

The payment was to be received outside India by the applicant by electronic funds transfer.

The applicant also relied on the Supreme Court’s decision in Ishikawajima-Harima Heavy Industries v. DIT, (2007) 288 ITR 408 (SC) and AAR’s ruling in LS Cable Ltd., In re (2011) 337 ITR 35 (AAR).

The tax authority contended that the contract was not merely a supply contract and the applicant had done considerable work in India, such as testing of equipment during project commissioning, coordination with other contractors for precommissioning activities, etc. Further, the applicant was required to provide assistance and support to the other contractors for 90 days after provisional completion of the unit. Also, the contract was indivisible. Therefore, the applicant had PE in India and consequently, the payment was taxable in India.

Held:
The AAR held as follows:

The question raised is only on offshore supply of equipments and not on other activities. On perusal of the contract, the conduct of the parties which is apparent from the shipping documents and taking of transit insurance in the name of the Indian company, the transaction is that of an offshore sale. In light of the Supreme Court’s decision in Ishikawajima-Harima Heavy Industries v. DIT, (2007) 288 ITR 408 (SC), the transaction cannot be considered as one and indivisible. Hence, the tax authority does not have the jurisdiction to tax payment made outside India for offshore supplies.

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Shell India Markets Pvt. Ltd. AAR No. 833 of 2009 (unreported) Dated: 17-1-2012 Before P. K. Balasubramanyan (Chairman) & V. K. Shridhar (Member) Counsel for applicant: Rajan Vora, G. V. Krishna Kumar and Gaurav Bhauwala

Article 13.4 of India-UK DTAA; Section 9 of Income-tax Act

(i) Since provision of services required special knowledge and human intervention, they were consultancy services.

(ii) As the applicant was free to utilise the knowhow/ intellectual property generated from services and independent of service provider, service can be regarded as ‘made available’.

(iii) Even if the provision of services does not have any element of profit, the consideration was taxable, both under Income-tax Act and under India-UK DTAA.

Facts:
The applicant was an Indian company and a member of Shell Group. The applicant entered into Cost Contribution Agreement (‘CCA’) with a Shell Group Company in UK (‘UKCo’) for providing Business Support Services (‘BSS’). BSS were primarily in the nature of management support services. UKCo was providing BSS to other Shell Group Companies also. Under CCA, UKCo provided services at cost and without charging markup.

Before the AAR, the applicant contended as follows:

The services excluded R&D, technical advice and services. Hence, they were only managerial services, which were excluded from Article 13.4(c) of India-UK DTAA.

Services were provided at cost, which was reimbursed by Group Companies. Hence, no income had arisen to UKCo in terms of certain judicial decisions1.

Due to cost contribution, the contributing companies became economic owners of knowhow/ intellectual property. Hence, question of UKCo granting right to use such intellectual property to applicant did not arise.

UKCo did not have a PE in India. In absence of any chargeable income, payment received by UKCo should not be taxable in India.

The issues before the AAR pertained to the nature of services provided by UKCo; whether the services were ‘made available’ in the context of India-UK DTAA; and whether any income accrued even if there was no element of profit.

Held:
The AAR ruled as follows:

Nature of services:
Advice given for taking a commercial decision is technical or consultancy services. The services provided by UKCo were of specialised nature. Consultancy services require special knowledge or expertise and human intervention. Provision of services through staff visits and interchanges was important ingredient under CCA which indicated that they were consultancy services. Certain services may not have been such services. However, since all the services were bundled and cannot be segregated, services as a whole would be consultancy services.

Make available under India-UK DTAA:

In Perfetti Ven Melle Holding BV (AAR No. 869 of 2010), the AAR has held that ‘make available’ means recipient should be in a position to derive enduring benefit and to utilise the knowledge or know-how in future on its own. In case of BSS, UKCo closely works with employees of the applicant and advises them. Further, as the applicant’s own averment, the applicant is able to use know-how/intellectual property generated from BSS independent of the service provider and hence services can be regarded as ‘made available’ to the applicant. Also, since a DTAA relates only to the rights and duties of subjects/citizens of respective States, one cannot rely on the meaning assigned to ‘make available’ under India-USA DTAA.

Income accruing and CCA:

The AAR held2 that even if the provision of services do not have any element of profit, the consideration would be taxable. Hence, the consideration was taxable as FTS, both under the Income-tax Act and India-UK DTAA and the applicant was obliged to deduct tax at source.

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ADIT v. Ballast Nadam Dredging ITA No. 999/Mum./2008 (unreported) A.Y.: 2004-05. Dated: 30-12-2011 Before B. R. Mittal (JM) & Pramod Kumar (AM) Counsel for taxpayer/revenue : Kanchan Kaushal & Dhanesh Bafna/Malati Sridharan

Retention money received pursuant to furnishing of bank guarantee is not taxable until successful completion of the contract and expiration of the guarantee.

Facts:
The taxpayer was a Dutch company. The taxpayer was engaged in execution of a contract awarded by the Government of India. The contract pertained to the construction of breakwaters, dredging and land reclamation. As per the contract, 5% of the amount was to be held as retention money. When retention money reached 2% of the contract price, the taxpayer could ask for release of 1% of the retention money by furnishing bank guarantee.

The taxpayer received certain payments by way of release of retention money by furnishing bank guarantee. The taxpayer did not offer the same for taxation in the year of release. It contended that the payments would be taxable in the year when the taxpayer satisfactorily completed the work and removed the defects. However, the AO held that the payments had accrued to the taxpayer and accordingly, taxed the same.

The CIT(A) held that since the taxpayer did not have an absolute right over the payments, they were not taxable.

Held:
The Tribunal held as follows: As long as performance guarantee remains and is enforceable without notice to the taxpayer, the retention money received cannot be recognised as income and have to be excluded while computing the income until successful completion of the contract and expiration of the guarantee.

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Taxation of Commission Payments to Non-Residents

Taxability of commission paid to a non-resident agent has become a contentious issue especially after withdrawal of the celebrated CBDT Circular No. 23 of 1969, dated 23rd July 1969 and Circular No. 786, dated 7th February 2000 on 22nd October 2009. Many issues arise in characterisation as well as taxability of commission income in light of provisions under the Income-tax Act, 1961 and under the provisions of a Tax Treaty. This Article discusses various such issues.

1. Provisions under the Income-tax Act, 1961 (the ‘Act’)

Indian exporters and/or businessmen avail services of foreign agents for a variety of purposes, such as securing export orders, sourcing of raw materials and plant & machinery, participation in exhibitions, buying or selling of properties and so on. When a non-resident receives commission for rendering such services outside India, from an Indian payer, whether it is taxable in India? Whether resident payer needs to deduct tax at source u/s.195 of the Act?

We will discuss various issues arising in this context such as:

Whether taxability of the commission income received by a non-resident depends upon the nature of the underlying transaction?

Whether commission income of a non-resident agent is taxable u/s.5 or u/s.9(1)(i), being source of income in India or u/s.9(1)(vii) as Fees for Technical Services (FTS)?

What is the impact of withdrawal of CBDT Circulars (No. 23 of 1969 and 786 of 2000) dealing with taxability of commission income of foreign agents of Indian exporters?

Whether the payment of commission to non-resident agent be taxed as ‘Other Income’ under Article 21 of a Tax Treaty relating to Other Income?

Let us first examine provisions of the Act in this regard.

(i) Section 5 r.w. Section 9 of the Act deals with this situation. Section 5 defines the scope of total income according to which, income of a nonresident is taxed in India if it is received, accrue or arise or deemed to be received, accrue or arise in India. Section 9 of the Act deals with Income deemed to accrue or arise in India. Inter alia it covers any income accruing or arising to a non-resident, directly or indirectly, through or from (i) any business connection (BC) in India and (ii) any asset or source of income in India.

(ii) Explanation to 2 to section 9(1)(i) defines the term ‘business connection’ (BC). The analysis of the said Explanation would show that any business activity in India carried out by a broker, general commission agent or any other agent having an independent status in his ordinary course of business will not constitute a BC in India and conversely that of a dependent agent will constitute a BC.

Thus, commission income of a foreign agent will not be taxed in India unless that agent has a BC in India. In absence of a BC, can it be construed that ‘source’ of commission income is in India as the payer is a tax resident of India?

(iii) In this connection, it is interesting to note the relevant contents of the CBDT Circular 23 of 1969 (since withdrawn), which is as follows:

“. . . . . . (4) Foreign agents of Indian exporters — A foreign agent of Indian exporter operates in his own country and no part of his income arises in India. His commission is usually remitted directly to him and is, therefore, not received by him or on his behalf in India. Such an agent is not liable to income-tax in India on the commission.” (Emphasis supplied)

The above position was reaffirmed by the CBDT vide its Circular No. 163, dated 29-5-1975.

(iv) In this connection, it is interesting to note the observations of the AAR in case of SPAHI Projects (P.) Ltd. (2009) 183 Taxman 92 (AAR), wherein it held that “irrespective of the existence or otherwise of the business connection of ‘Z’, in India, since no business operations are carried out in India by ‘Z’, the attribution in terms clause (a) of the Explanation 1 is not possible and, therefore, no income can be deemed to accrue or arise in India merely because ‘Z’ promotes the business of the applicant in South Africa.”

Here the AAR held that even if it is assumed that there exists a BC in India, only so much of income as is attributable to that BC in India would be taxable in India as provided in Explanation 1 to section 9(1) of the Act, which reads as follows:

“Explanation 1 — For the purposes of this clause

— (a) In the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India;”

Therefore, in a case where there exists a BC, but commission is paid in respect of services which are rendered outside India only, then no income can be said to accrue or arise in India.

(v) The Supreme Court in the case of Carborandum Co. v. CIT, (1977) 108 ITR 335, has held that “the carrying on of activities or operations in India is essential to make the non-resident have business connection in India in order that he may be liable to tax in respect of the income attributable to that business connection”.

(vi) In case of CIT v. Toshoku Ltd., (1980) 125 ITR 525 the Apex Court, while dealing with the issue of taxation in India of commission paid to a nonresident agent, held that “the assessees did not at all carry on any business operations in the taxable territories and as such the receipt in India of the sale proceeds of tobacco remitted or caused to be remitted by purchasers from abroad, did not amount to an operation carried by the assessees in India as contemplated by clause (a) of the Explanation to section 9(1)(i). The impugned commission could not, therefore, be deemed to be income which had either accrued or arisen in India”.

1.1 Applicability of TDS provisions u/s.195 on commission paid to non-resident

The Income-tax Department vide its Circular No. 786, dated 7-2-2000 clarified that “the deduction of tax at source u/s.195 would arise if the payment of commission to the non-resident agent is chargeable to tax in India. In this regard attention to CBDT Circular No. 23, dated 23rd July, 1969 is drawn where the taxability of ‘Foreign Agents of Indian Exporters’ was considered along with certain other specific situations. It had been clarified then that where the non-resident agent operates outside the country, no part of his income arises in India. Further, since the payment is usually remitted directly abroad it cannot be held to have been received by or on behalf of the agent in India. Such payments were therefore held to be not taxable in India. The relevant sections, namely, section 5(2) and section 9 of the Income-tax Act, 1961 not having undergone any change in this regard, the clarification in Circular No. 23 still prevails. No tax is therefore deductible u/s.195”.

Many decisions wherein taxability of Commission paid to foreign agents was examined are rendered in the context of deductibility of tax at source u/s.195 of the Act.

The Tribunals, AAR and Courts in following cases held that provisions of section 195 of the Act are not applicable in case of commission payments to foreign agents of Indian entities as the said income is not taxable in India in the hands of the recipient.

(i) CIT v. Cooper Engineering Ltd., (1968) 68 ITR 457 (Bom.)

(ii) CIT v. Toshoku Ltd., (1980) 125 ITR 525 (SC)

(iii) Ceat International S.A. v. CIT, (1999) 237 ITR 859 (Bom.)

(iv) Indopel Garments Pvt. Ltd. v. DCIT, (2001) 72 TTJ 702

(v) Ind. Telesoft (2004) 267 ITR 725 (AAR)

(vi) DCIT v. Ardeshir B. Cursetjee & Sons Ltd., (2008) 24 SOT 48 (Mum.) (URO)

(vii) Jt. CIT v. George Williamsons (Assam) Ltd., (2009) 116 ITD 328 (Gau.)

(viii) Dr. Reddy Laboratories Ltd. v. ITO, (1996) 58 ITD 104 (Hyd.)

(ix) SOL Pharmaceutical Ltd. v. ITO, (2002) 83 ITD 72 (Hyd.)

(x) Eon Technology (P) Ltd. v. DCIT, (2011) 11 tax-mann.com 53 (Del.)

(xi) ACIT v. Meru Impex, (2011) 16 Taxmann.com 219 (Mumbai ITAT)

(xii) ITO v. Asiatic Colour Chem Ltd., (2010) 41 SOT 21 (Ahd.) (URO)

(xiii) ACIT v. Tamil Nadu Newsprints and Papers Limited, (2011 TII 215 ITAT Mad.-Intl.)

(xiv) DCIT v. Divi’s Laboratories Ltd., (2011 TII 182 ITAT Hyd.-Intl.)/(2011) 12 taxmann.com 103

(xv) ADIT (IT) v. Wizcraft International Entertain-ment (P.) Ltd., (2011) 43 SOT 470 (Mum.)

(xvi) DCIT v. Mainetti (India) (P.) Ltd., (2011) 12 tax-mann.com 60 (Chennai)

All controversies arising in respect of interpretation of section 195 regarding non-deduction of tax at source were put to rest by with decision of the Supreme Court in the case of GE India Technology Centre P. Ltd. v. CIT, (2010) 327 ITR 456 wherein the Apex Court following Vijay Ship Breaking Corporation v. CIT, (2009) 314 ITR 309 (SC) held that “The payer is bound to deduct tax at source only if the tax is assessable in India. If tax is not so assessable, there is no question of tax at source being deducted”.

The decision of GE India Technology Centre P. Ltd. (supra) assumes special significance as it explained the decision of the Supreme Court in case of Transmission Corporation of A. P. Ltd. v. CIT,(1999) 239 ITR 587 (SC) in proper perspective. The said decision is often invoked by the Income-tax Department to fasten TDS obligation on the payer on a gross basis and even when the income is not chargeable to tax in the hands of the recipient thereof. The Apex Court stated that in the case of decision of the Transmission Corporation (supra), the issue was of deciding on what amount of tax is to be deducted at source, as the payment was in respect of a composite contract. The said composite contract not only comprised supply of plant, machinery and equipment in India, but also comprised the installation and commissioning of the same in India.

With the above-mentioned correct interpretation of the decision in the case of Transmission Corporation (supra), the Apex Court set aside the decision of the Karnataka High Court in the case of CIT v. Samsung Electronics Co. Ltd. (2010) 320 ITR 209 wherein it was held that resident payer is obliged to deduct tax at source in any type of payment to a non-resident be it on account of buying/purchasing/ acquiring a packaged software product and as such a commercial transaction or even in the nature of a royalty payment. Applying the ratio of this decision the Income-tax Department used to disallow any payment to a non-resident where tax was not withheld, irrespective of the fact that the corresponding income was not chargeable to tax in the hands of a non-resident.

The CBDT vide circular 7/2009 [F. No. 500/135/2007-FTD-I], dated 22-10-2009 withdrew all three Circulars, namely, (i) 23 dated 23-7-1969 (ii) 163 dated 29-5-1975 and (iii) 786 dated 7-2-2000 which is giving rise to many controversies.

1.2 What is the impact of withdrawal of CBDT Circulars mentioned above?

Even though the above Circulars stand withdrawn, principles contained therein still hold the ground. Circular 23 of 1969 provided certain clarification regarding taxability in India in respect of certain transactions by a non-resident with an Indian resident, for example, sale of goods to India by a non-resident exporter, commission income of foreign agents of Indian exporters, purchasing of goods by a non-resident from India, sale of goods by non-resident in India either directly or through agents, etc. The Circular clarified about various situations that would not result in any business connection in India. One of the clarifications pertained to commission income earned by foreign agents of Indian exporters where the Circular clearly stated that no income shall deem to accrue or arise in India. In essence the said Circular interpreted provisions of section 9 of the Act whereby the underlying principles propounded were that the commission income of a foreign agent cannot be taxed in India if there exists no business connection in India and the income is not received in India. The subsequent amendments to section 9 of the Act, which relates to clarification of business connection in case of dependent/independent agent and taxability of Fees for Technical Services, do not alter the legal position. Therefore, even post withdrawal of impugned CBDT Circulars, commission earned by foreign agents of Indian exporters would not be taxable in India provided all services are rendered outside India (i.e., the foreign agent does not have any BC in India) and the income is not received in India.

This position has been upheld in DCIT v. Divi’s Laboratories Ltd., 2011 TII 182 ITAT Hyd.-Intl./(2011) 12 taxmann.com 103, wherein the Tribunal held as follows:

“We have considered the submissions of both the parties and perused the relevant material available on record. The moot question that arises out of these appeals is whether the payment of commission made to the overseas agents without deduction of tax is attracted disallowance u/s.40(a)(ia) of the Act or not. Whether the payment in dispute made by way of cheque or demand draft by posting the same in India would amount to payment in India and consequently whether mere payment would be said to arise or accrue in India or not? First we will take up the issue whether the payment of commission to overseas agents without deduction of tax is attracted disallowance u/s.40(a)(ia) of the Act or not. We find that the CBDT by its recent Circular No. 7, dated 22-10-2009 withdrawn its earlier Circular Nos. 23, dated 23-7-2009, 163 dated 29-5-1975 and 786, dated 7-2-2000. The earlier Circulars issued by the CBDT have clearly demonstrated the illustrations to explain that such commission payments can be paid without deduction of tax. Thus, the main thrust in such a situation is whether the commission made to overseas agents, who are non-resident entities, and who render services only at such particular place, is assessable to tax. Section 195 of the Act very clearly speaks that unless the income is liable to be taxed in India, there is no obligation to deduct tax. Now, in order to determine whether the income could be deemed to be accrued or arisen in India, section 9 of the Act is the basis. This section, in our opinion, does not provide scope for taxing such payment, because the basic criteria provided in the section is about genesis or accruing or arising in India, by virtue of connection with the property in India, control and management vested in India, which are not satisfied in the present cases. Under these circumstances, withdrawal of earlier Circulars issued by the CBDT has no assistance to the Department, in any way, in disallowing such expenditure. It appears that an overseas agent of Indian exporter operates in his own country and no part of his income arises in India and his commission is usually remitted directly to him by way of TT or posting of cheques/demand drafts in India and therefore the same is not received by him or on his behalf in India and such an overseas agent is not liable to income-tax in India on these commission payments. This view is fortified by the judgment of Apex Court in the case of Toshoku Ltd. (supra).”

Thus, in respect of payment of commission to non-resident agent by a resident in respect of services rendered outside India, it is clear that withdrawal of the aforesaid CBDT Circulars would not affect the existing settled position in law that the same would not be taxable in India.

1.3 Can the withdrawal of aforesaid CBDT Circulars have retrospective effect?

In Satellite Television Asia Region Advertising Sales BV v. ADIT, (2010 TII 58 ITAT Mum.-Intl.) the Mumbai Bench, in the context of payment for sale of advertising time, held that though the Circular No. 23, dated 23rd July, 1969 was withdrawn on 22nd October, 2009, the withdrawal is prospective in nature. Since for the year under consideration, the Circular was in force, the Circular was still applicable to the case under consideration.

The Mumbai ITAT reiterated the same view in the case of DDIT v. Siemens Aktiengesellschaft, 2010 TII 09 ITAT Mum.-Intl.

1.4 Can commission paid to an individual be classified as salaries?

Can a commission payment be classified as salaries if the same is paid to a non-resident individual who represents an Indian entity was a question examined by the Mumbai Tribunal in case of ACIT v. Meru Impex, (2011) 16 Taxmann.com 219. In this case the Assessing Officer held that the appointment as agent to represent the assessee before foreign buyer was sham and not genuine; and that even assuming said payment to be genuine, the same was in nature of salary. However, the Tribunal ruled that the said payment cannot be classified as salaries in absence of employer-employee relationship.

1.5 Can commission be classified as fees for technical services?

In the case of Wallace Pharmaceuticals P. Ltd. (2005) 278 ITR 97 (AAR), on the facts of the case the AAR held that “though Penser is a tax resident of USA, it has rendered consultancy services in India and as the consultancy fee payable in respect of services utilised is not in connection with a business or profession carried on by the applicant outside India for the purposes of making or earning any income from any source outside India, the consultancy fee would be deemed income of Penser in India. In addition to the monthly consultancy fee under the agreement, Penser is also entitled to 10% commission on the orders procured by it. The commission will also be deemed income arising to Penser in India.”

It appears that since the commission was linked to monthly consultancy fees, the AAR considered it at par with the consultancy fees, notwithstanding the fact that services, inter alia, included promotion of Wallace’s products in the USA. Ironically, provisions of India-US DTAA were not considered/applied in this case. If the provisions of India-US DTAA were considered, probably the conclusion of the AAR would have been different due to existence of ‘Make Available’ clause in Article 12(4)(b) of the DTAA. Also if Penser had no PE in India, it would also not be taxable under Article 7 of the DTAA.

The AAR in case of SPAHI Projects (P.) Ltd. (2009)183 Taxman 92 (AAR) held that there could possibly be no controversy that the non-resident will not be rendering services of a managerial, technical or consultancy nature and, therefore, the liability to tax cannot be fastened on it by invoking the provisions dealing with fee for technical services.

However, in case of DCIT v. Mainetti (India) (P.) Ltd., (2011) 12 taxmann.com 60 the Chennai Tribunal held that “No doubt technical service would definitely include managerial services. However, canvassing of orders abroad could not be regarded as managerial services, nor could it be said to be for any consultation. Thus, definitely technical services as per Explanation 2 to section 9(1)(vii) of the Act would have no application.”

2. Taxability under a tax treaty

Under the provisions of a tax treaty, the income is taxed under different sub-heads with each having a separate set of distributive rules and definition. For example, profits from operation of ships and aircrafts, royalties and Fees for Technical Services (FTS) are dealt by separate articles though essentially they are all part and parcel of business activities. Under domestic tax law, they are all taxed under the same head of business profits. Therefore, difficulty arises about characterisation of income under a treaty scenario.

Under a tax treaty, business profits earned by an enterprise resident of one country are taxed only in its country of residence unless it has a Permanent Establishment (PE) in the source country. However, royalties and FTS can be taxed in a source country even if there is no PE.

Another difference is that whereas business profits are taxed on a net basis (that too only to the extent they are attributable to the PE in the source country), royalties and FTS are taxed on gross basis, albeit at a concessional rate.

In the treaty context the following situations arise:

2.1 Commission income treated as business income

Ideally, commission income should be classified as business income as it is neither royalty nor fees for technical services. In such a scenario, taxability in India would depend upon whether the foreign agent has a PE in India or not. If the foreign agent has a PE in India, then commission income which is attributable to it would be subject to tax in India. Usually, foreign agents of Indian exporters operate outside India and therefore there will not be a PE in India. In such a scenario, commission earned by them would not be taxed in India.

In SPAHI Projects (P.) Ltd. (supra), the AAR held that income received by the non-resident on account of commission paid by the resident is not chargeable to tax in India by virtue of Article 7 of the India-South Africa Tax Treaty and therefore the payer is not obliged to deduct tax at source u/s.195 of the Act.

2.2 Can commission paid to a non-resident be classified as Professional Fees?

In case of ACIT v. Meru Impex (supra) the assessee claimed benefit of Article 15 of the India-USA Tax Treaty which provides that income of a USA tax resident from the performance in India of professional services or other independent activities of a similar character shall be taxable only in the USA as the non-resident agent did not have a fixed base in India, nor did his stay in India exceeded 90 days. Incidentally India-USA treaty requires two conditions to be satisfied to claim exemption from tax in the State of source, which are:

(i) non-existence of fixed base, and
(ii) stay of 90 days or less in the relevant taxable year, in the State of Source.

The assessee relied on the term ‘other independent activities of a similar character’ to classify commission income into professional income and claimed exemption in India. However, the Mumbai Tribunal rightly observed that though the definition of ‘Professional Services’ is not exhaustive, it contemplates existence of professional skill and performance of such professional skill for which they receive payments. In absence of relevant details, the matter was remanded back to the AO for fresh determination. Interestingly, the CIT (Appeals) had granted benefit of Article 15 to the NR agent on the ground that he did not have a fixed base in India.

2.3 Can commission paid to a non-resident be classified as ‘Other Income’ falling under Article 21?

Almost every tax treaty contains a residuary clause, namely, ‘Other Income’ which gives right of taxation to both the countries (as per majority of Indian tax treaties). This Article covers income not dealt with in any other Articles of the concerned tax treaty.

In Rajiv Malhotra’s case (2006) 284 ITR 564 (AAR) the overseas agent rendered services abroad in respect of an exhibition to be organised in India. On the facts of the case, the AAR held that “though the agent rendered services abroad and pursued and solicited exhibitors there, the right of the agent to receive the commission arose in India only when the exhibitor participated in the Food and Wine Show to be held in India and made full payment to the applicant in India. The commission income would, therefore, be taxable in India, as income arising from a ‘source of income’ in India in view of the specific provisions of section 5(2)(b) read with section 9(1) of the Income-tax Act, 1961. The facts that the agent rendered services abroad in the form of pursuing and soliciting participants and that the commission was to be remitted to him abroad were wholly irrelevant for the purpose of determining the situs of the income”.

Surprisingly, AAR applied Article 23 on ‘Other Income’ to commission income instead of Article 7 on Business Profits and held that “paragraph 3 of Article 23 of the Agreement for the Avoidance of Double Taxation between India and the French Republic was at par with the provisions of section 5(2) read with section 9(1) and did not grant any further benefit”.

In our humble opinion, with due respect, this decision needs reconsideration. In any case, being advance ruling, it is case specific and therefore it does not render any binding precedent.

2.4 Taxability of commission paid to a non-resident for events held in India

CBDT Circular Nos. 23 of 1969 and 786, dated 7-2-2000 dealt with commission paid to foreign agents of Indian exporters. Therefore, a question often arises as to their applicability to payment of commission otherwise than for exports. However, in the case of ADIT(IT) v. Wizcraft International Entertainment Pvt. Ltd., (2011) 43 SOT 470 (Mum.), the Mumbai Tribunal held that “Though, the above Circular (i.e., Circular No. 786, dated 7-2-2000) is issued in the context of commission paid to foreign agent of Indian exporters, it applies with equal force to commission paid to agents for services rendered outside India”.

In this case one Mr. Colin Davie, a resident of UK earned commission from co-ordinating an entertainment event which was performed in India. The Mumbai Tribunal held that no income is deemed to accrue or arise in India in view of the fact that the services were rendered outside India. The Tribunal also rejected the argument of the Income-tax Department that the income of Mr. Davie be taxed under Article 18 of the India-UK Tax Treaty (dealing with income of ‘Artists and Athletes’) as Mr. Davie neither took part in events during the dates of engagements, nor did he exercise any personal activities in India. It further observed that the income of Mr. Davie by way of commission does not relate to the services of entertainer/artiste. The Tribunal held that the commission income was in the nature of Business Income and was not taxable in India in absence of a PE.

3. Whether written agreement is crucial to establish commission payment and to get deduction thereof

In ACIT v. Meru Impex, (2011) 16 taxmann.com 219, the Mumbai Tribunal held that “if the services rendered are established, then the assessee would be entitled to claim deduction on account of commission paid. The existence or non-existence of written agreement would not be fatal to claim deduction on account of expenditure on account of commission. Therefore, the finding of the Assessing Officer with regard to the agreement being a sham document cannot be sustained and in any event, they are irrelevant”.

4. Conclusion

The law on taxability of commission income of foreign agents of Indian exporters does not seem to have altered with withdrawal of the CBDT Circulars. In view of the clear provisions of the Act as well as decisions of Tribunals, Courts and AAR one can conclude that carrying on of business operation in India is crucial to result in a BC and in case of foreign agents where services are rendered outside India, commission cannot be said to be accruing or arising in India [refer the Supreme Court’s observations in case of Carborandum Co. at para 1.1 (v) (supra)]. In fact, even in a case where the event had taken place in India [refer the decision of the Mumbai Tribunal in the case of Wizcraft International Entertainment Pvt. Ltd. at para 2.4 (supra)], no income was deemed to accrue in India as long as services were rendered outside India.

The AAR has recently rendered a Ruling dated 22.02.2012, in the case of SKF Boilers and Driers Pvt. Ltd. (AAR No. 983-983 of 2010), wherein the AAR has held that such Export Commission is taxable in India u/s 5(2)(b) r/w Section 9(1)(i) of the Act. As the Applicant was not present and the Ruling was rendered in absentia, the correct position in Law as discussed above and the catena of decisions favourable to the Assessee (listed in Para 1.1 above) could not be presented and considered by the AAR, which followed its own Ruling in Rajiv Malhotra [284 ITR 564 (AAR) refer Para No. 2.3 above] but ignored its Ruling in SPAHI Projects (P.) Ltd. [2009] 183 TAXMAN 92 (AAR) discussed in Para Nos. 1(iv) and 1.5 above. In our humble opinion, if the correct position in Law and the relevant favourable case laws were presented and considered by the AAR, the Ruling could have been different.

As far as applicability of provisions of section 195 are concerned, the Supreme Court [in the case of GE India Technology, para 1.1 (supra)] has held that they are applicable only if income is chargeable to tax. The taxpayer can refrain from deducting tax at source if according to him the income is not chargeable to tax in India in the hands of the non-residents.

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Acountability in governance

As the financial year draws to a close, bureaucrats, entrepreneurs, institutions, push themselves to achieve targets. This year is no different. Normally targets are quantitative and not qualitative, and very rarely does one look at the manner in which these goals are achieved.

The Vodafone judgment was a huge jolt to the government and the already elusive direct tax target now looks impossible. Pressure from the ministry coupled with statements that future postings of taxmen would depend on the collection they achieved, galvanized them into action. In the past month or so, we have seen stringent , at times coercive action for recovery of taxes. While one accepts that the government must collect the tax that is due, and it is the duty of every citizen to pay the same, it cannot be forgotten that the law prescribes a process for ascertaining what tax is “due”. Much before the first appeal is heard an assesse is expected to pay 50% of the tax as per the assessment order. It is a well established judicial principle that when collecting such tax before the final stage of its determination one has to see the balance of convenience. This is very rarely done. Going by the number of cases that go in the assessee’s favour at the various stages of appeal, particularly at the tribunal, this interim collection becomes refundable. In these situations collecting officials must take responsibility and be accountable for coercive collection of taxes. What is required is humane approach in recovery matters.

While this form of active recovery is not new to tax payers, the “indirect” recovery by way of adjustment of refunds, is like an epidemic that has spread to all parts of the country. The culpability for this lies entirely with the Income tax department. The computerized processing centre ‘CPC’ where all electronically filed returns are processed is accessing a data base which is totally different from the one being used by assessing officers in the field. In these cases the errors in assessment orders have been rectified or effects of appeal have been given by the assessing officers and in some cases consequential refunds have also been issued. However the data base furnished to the CPC has not been updated. The result is an unwarranted adjustment of refunds due against non-existing demands. When one tries approaching one authority to get the error committed by the other rectified, the blame game starts with each justifying its action. It is like two different doctors prescribing two different therapies based on two distinct reports pertaining to the same patient. The consequence is unbearable pain and anguish for the patient. It will be of little solace to him that it was the two different reports and not the skill or ability of the medico that was to blame. It is here that those responsible must be held accountable.

The illustration in the paragraphs above is regarding tax authorities because we, as professionals, interact with them every day. However, this attitude of those who enjoy power either as government officials or as elected representatives of the people pervades every walk of life. When one complains of the poor state of roads, we find one authority blaming the other. When a pedestrian falls into a ditch and loses a limb it is of little concern to him whether the Mumbai Municipal Corporation or the Mumbai Metropolitan Road Development Authority is responsible. What he requires are walkable and motorable roads.

In this context one really envies the position of the Indian bureaucrat. This is because once he joins the service he enjoys virtual immunity from any punitive or disciplinary action. Even when such action is taken it takes an unduly long time for any disciplinary action to reach its logical conclusion. We tend to criticise politicians but they have to face the public in every election and can be held accountable at that time. While saying that one must hold the politicians responsible, it is necessary that citizens do their mite. It was extremely disappointing to note that after a campaign by the government as well as efforts by NGOS, the voting percentage in the recently concluded municipal election in Mumbai was approximately, an abysmal 50%. During a number of discussions and debates the refrain of a large number of educated voters was that they did not vote because they did not find any candidate worthy of their vote. Though I personally do not subscribe to this thought process, I think it will be worthwhile to give the voter the option of rejecting all the candidates. This will enable the electorate to express their disapproval of the candidates put up by political parties.

If this situation is to undergo a change the process of investigation must become transparent and that of dispensing justice must be expedited. It is only when citizens demand from authorities an account of their performance and erring authorities are held accountable, will democracy be strengthened. It is disturbing to note that many a relevant document or paper which will be material evidence goes “missing“ from government records. This has become a regular feature with the missing papers in the Adarsh scam being a recent example. Even if a person does not get justice on this planet he can expect it in life beyond. One only hopes that the greatest accountant of them all Chitragupt, keeps his books and record safe and secure, for no one can underestimate the reach of the wily Indian politician and bureaucrat!

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Standards and Structures

Order in Society exists because of ‘standards and structures’. Without standards we would be in chaos and anarchy will rule. We accountants are aware of the importance of standards. Accounting standards are required to usher in clarity, comparison and accountability — the three ingredients fundamental to economic decisions. We accountants also have our ‘code of conduct’. Violation of the code leads to censure and punishment.

Similarly, social conduct has its own code. Our social code of conduct is not codified though laws are nothing but codification of behaviour — violation of which leads to punishment. All religions and religious practices are also nothing else but codes of behaviour — though non-observance or violation of these normally do not in today’s environment entail even social censure.

‘Standards and structures’ are in the interest of both the rulers and the ruled. They bring into focus accountability and these should be the basis of our decisions and actions. ‘Standards and structures’ build society. On the other hand lack of standards destroy and cut at the very roots of stable society. The basis of the French revolution was moving away from normal standards. The current LokPal crisis in India is because our rulers have probably unwittingly moved away from ethical standards and encouraged actions which have increased corruption — Satyam happened because standards were violated.

The issue is: Are standards immutable? Except for certain standards like living in truth with love, having compassion and living an ethical life, no standards are immutable. They are nothing but hypotheses and represent the current environment. We must never forget that the present keeps changing hence the social standards also keep changing — for example — live-in relationships were not accepted — today they are accepted and even the courts have approbated this relationship.

Another issue is: What is the duty of doubt in establishing standards and creating structures? Doubt plays an important role in establishing standards. It is to avoid doubt, unpredictability, uncertainty and unaccountability that standards are required. Doubt is the basis of all standards with the object of bringing clarity — clarity in our thinking and behaviour.

To live a happy life — whether social or professional, let us respect ‘standards and structures’ and live by and within them.

I would conclude by quoting Reinhold Wiebuhur:

“Grant me the serenity to accept the things I cannot change; the courage to change the things I can, and the wisdom to know the difference”.

If we practice this, there will be no anxiety and peace and happiness will prevail and pervade our lives.

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Lokpal Bill: A bitter pill for political parties.

It is for the 545 members of Lok Sabha to decide on the Bill. It is not being done in undue haste . . . What were political leaders doing sitting on Anna Hazare’s platform?

— Pranab Mukherjee

Minority reservation and 50% quota are unconstitutional . . . . it will be struck down by the courts on the very first day. Do you want such a legislation?

— Sushma Swaraj

Making the PM accountable to Lokpal is against the soul of the Constitution. No official will take a decision. Won’t the Lokpal machinery blackmail the Government?

— Mulayam Singh Yadav

It’s wrong to bring ex-MPs under the law . . . even Anna did not ask for this. He will consider us slaves and threaten us with dharnas in front of our houses.

— Lalu Prasad

Why are we so scared of an ex-bureaucrat, an excop and somebody who is pretending to be another father of the nation?

— Gurudas Dasgupta

(Source: The Times of India, dated 23-12-2011) (Comments: Why do our politicians of all hues dread scrutiny of their decisions and actions by a strong Lokpal. Daal mein kuch kaala zaroor hai!)

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Stop indiscriminate raids on industry, reform political funding.

Several captains of industry have complained to the Government that taxmen are harassing India Inc. Harassment is unacceptable and must be halted. Raids and searches that have been rampant this year are blunt and opaque instruments of tax collection. The lack of transparency raises questions on the intent of such operations. Agreed, the Government is desperate to raise revenues in a slowing economy, but that is no justification for indiscriminate raids on businessmen. A system is already in place to scrutinise tax returns of companies and individuals by selecting cases through the computer-assisted scrutiny system. CASS should be strengthened as it minimises interface with taxpayers.

The point is for taxmen to make intelligent and creative use of technology to establish audit trails of transactions. This is eminently feasible if every financial transaction is dovetailed to the permanent account number (PAN), the tax department’s unique identifier. A foolproof PAN and an efficient tax information network will help track evaders and stem black money generation. What is truly troubling about these raids is that they bring back memories of an ugly, pre-reform past, when extraction of tribute through use of the state’s coercive powers was a standard procedure of mobilising political funding, with considerable amounts sticking to those who collect, before the tribute reaches party coffers. Economic reform and modern tax administration should bring such practices to an end. Lingering suspicion on what precisely motivates the state’s coercive machinery to descend on businessmen can be wholly removed only when a system of transparent funding of politics is instituted. Creating this is as important as creating and operating a modern tax information network married to intelligent analytics.

In parallel, the Government should widen the tax base, implement the proposed goods and services tax, correlate, if not unify, the databases of direct and indirect tax payment, lower rates and simplify laws and procedure. This is the best way to improve compliance and raise collections. Let raids and searches join the 97% tax rate.

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