BCAJ | Bombay Chartered Accountant Journal

Capital or revenue receipt: A. Y. 2003-04: Business of Multiplexes and Theatres: Exemption from entertainment tax under Scheme of Incentive for Tourism Project, 1995 to 2000 for giving boost to tourism sector: Scheme offering incentive for recouping or covering capital investment:

Is capital receipt: Dy. CIT vs. Inox Leisure Ltd.; 351 ITR 314 (Guj):

The assessee was engaged in the business of operating multiplexes and theatres in Pune and Baroda. During the previous year relevant to the A. Y. 2003-04 the assessee received an amount of Rs. 1,14,47,905/- by way of exemption from payment of entertainment tax relating to its Baroda multiplex unit. The exemption was granted by the State Government under the New Package Scheme of Incentive for Tourism Projects 1995 to 2000. Likewise, the assessee also received a similar entertainment tax exemption of Rs. 1,85,06,998/- from the State of Maharashtra under its own incentive scheme for its multiplex unit at Pune. The assessee claimed that the incentives were granted for covering the capital outlay and, therefore, the receipt was capital in nature. The Assessing officer treated the receipt as revenue receipt. The CIT(A) and the Tribunal allowed the assessee’s claim.

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

“i) The character of receipt of a subsidy in the hands of the assessee has to be determined with respect to the purpose for which the subsidy is granted. In other words, one has to apply the purpose test. The point of time at which the subsidy is paid is not relevant. The source is immaterial. If the object of the subsidy is to enable the assessee to run the business more profitably then the receipt is on revenue account. On the other hand, if the object of the assistance under the scheme is to enable the assessee to set up a new unit or expand the existing unit then the receipt of subsidy would be on capital account.

ii) The salient features of the scheme showed that the incentive was being offered for recouping or covering a capital investment or outlay already made by the assessee.

iii) The Tribunal was right in holding that the entertainment exemption of Rs. 1,85,06,998/- and Rs. 1,14,47,905/- in respect of Pune and Baroda multiplexes, respectively, was a capital receipt, which was not eligible to tax for the A. Y. 2003-04.”

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Nirav Shah

Capital or revenue receipt: Entertainment subsidy: Object of subsidy to promote cinema houses by constructing Multiplex Theatres: Subsidy is capital receipt:

CIT vs. Chaphalkar Bros.; 351 ITR 309 (Bom):

The following question was raised before the Bombay High Court in this case:

“Whether the entertainment duty subsidy given to the assessee by the State Government for construction of multiplexes is in the nature of revenue receipt or capital receipt?”

The High Court held as under:

“i) The purpose for which the subsidy was given is the relevant factor and if the object of subsidy was to enable the assessee to setup a new unit then the receipt of subsidy would be on capital account.

ii) Since the object of the subsidy was to promote construction of multiplex theatre complexes, the subsidy would be on capital account. The fact that the subsidy was not meant for repaying the loan taken for construction of multiplexes should not be ground to hold that the subsidy receipt was on revenue account because if the object of the scheme was to promote cinema houses by constructing multiplex theatres, irrespective of whether the multiplexes had been constructed out of the assessee’s own funds or borrowed funds, the receipt of subsidy would be on capital account.

iii) Therefore, the decision of the Tribunal that the amount of subsidy received by the assessee is on capital account could not be faulted.”

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Nirav Shah

Capital gains: Exemption u/s. 54/54F: A. Y. 2007-08: A residential house includes a building with a basement, ground floor, first floor and second floor constituting two residential units: Exemption allowable:

CIT vs. Gita Duggal; 257 CTR 208 (Del): 214 Taxman 51 (Del): 30 Taxman.com 320 (Del):

Under a development agreement the assessee received by way of consideration Rs. 4 crore and a building consisting of basement, ground floor, first floor and the second floor constituting two residential units. In the computation of income for the A. Y. 2007-08, the assessee had computed capital gain with reference to the cash consideration of Rs. 4 crore. The Assessing Officer estimated the cost of construction of the said building at Rs. 3,43,72,529/- and included the same in the total sale consideration. The Assessing Officer rejected the assessee’s claim for exemption u/s. 54, but allowed the claim for exemption u/s. 54F in respect of one residential unit. The assessee’s reliance on the judgment of the Karnataka High Court in CIT vs. D. Anand Basappa; (2009) 309 ITR 329 (Kar) was not accepted by the Assessing Officer. Accordingly, he recomputed the capital gain and made an addition of Rs. 98,20,722/-. The CIT(A) allowed the assessee’s claim following the judgment of the Karnataka High Court. The Tribunal upheld the decision of the CIT(A).

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

“i) Fact that the residential house consists of several independent units cannot be permitted to act as an impediment to the allowance of the exemption u/s. 54/54F. It is neither expressly nor by necessary implication prohibited.

ii) Tribunal was therefore justified in allowing exemption u/s. 54F in respect of entire investment in construction of a building consisting of two residential units.”

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Nirav Shah

Business expenditure: Fines and penalties: Section 37(1) : A. Y. 2004-05: Dishonour of export commitment in view of losses: Encashment of bank guarantee by Export Promotion Council: Payment recorded as penalty in assessee’s books and claimed as deduction: Compensatory in nature:

Deduction allowable: CIT vs. Regalia Apparels Pvt. Ltd.; 352 ITR 71 (Bom):

The assessee is a manufacturer of garments. The Apparel Export Promotion Council granted to the assessee entitlements for export of garments and knit ware. In consideration of the export entitlements, the assessee furnished a bank guarantee in support of its commitment that it shall abide by the terms and conditions in respect of the export entitlements and produce proof of shipment. It was also provided that failure to fulfill the obligation to export would render the bank guarantee liable to being forfeited/ encashed. In view of the fact that the assessee was incurring losses, it decided not to utilise the export entitlements. This led the Council to encash the bank guarantee. The assessee recorded the payment as penalty in its books of account. The assessee claimed deduction of the said amount u/s. 37 of the Income-tax Act, 1961 for the A. Y. 2004-05. The Assessing Officer disallowed the claim holding that it is in the nature of penalty. The CIT(A) and the Tribunal allowed the assessee’s claim.

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

“i) The finding of fact recorded by the Commissioner (Appeals) and upheld by the Tribunal was that the assessee took a business decision not to honour its commitment of fulfilling the export entitlements in view of losses being suffered by it. The Assessing Officer did not dispute the fact nor did he doubt the genuineness of the claim of the expenditure being for business purposes.

ii) In these facts the Tribunal held that the assessee had not contravened any provisions of law and, thus, the forfeiture of the bank guarantee was compensatory in nature u/s. 37(1) of the Act.

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Nirav Shah

Service tax paid under reverse charge mechanism under the category of “Business Auxiliary Services” whether is a valid input service as defined in Rule 2(l) of the CCR, 2004.

Facts

The Appellant engaged in providing renting of immoveable property and export of customised software appointed Syntel Inc., USA as its agent for identifying customers overseas. Appellant paid commission to Syntel Inc., USA and discharged service tax liability under the category of “Business Auxiliary Services”. Since the Appellant was unable to utilise the total credit, filed refund claim of unutilised CENVAT credit under Rule 5 of CCR, 2004. The Appellant’s claim was rejected on the grounds that no proof was submitted proving the nexus of business auxiliary services to the output services.

Held

On perusal of the Business Associates Agreement between Syntel International Pvt. Ltd. and Syntel Inc., USA, the services were held in the nature of sales promotion and thus covered under “business auxiliary services”, a valid input service and eligible of refund. Further, the department had allowed subsequent refund claim and hence, the above refund was also allowed.

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Nirav Shah

Relief for Shareholders Agreements – SEBI Notifies Long-overdue Relaxations

SEBI finally resolves an age-old self-created problem SEBI has finally set at rest, substantially though not fully, a controversy that affected for decades some core issues in Shareholders Agreements and related agreements/structures. An age old provision in the form of a circular existed that was meant to prevent certain ills but ended up affecting innumerable agreements between two or more groups of shareholders and others. A brief introduction of the issue is first necessary to understand what the problem was and what SEBI has now provided.

What was the problem?

Take an example of a situation where such a provision created hurdles. When two or more groups get together in a company, to control and run it together, it is common and even inevitable that they will agree that one group will not exit without the other having a say. Thus, if Group A wants to sell its shares, Group B would want certain safeguards/rights. It would require Group A to give what is known was Right of First Refusal. This means that if Group A is getting an offer to acquire its shares at say, Rs. X per share, then Group B would have right to buy the shares at the same price. In other words, it has a right of pre-emption. Of course, Group B could choose not to buy and let the shares be sold to the offering party. At times, they may agree that on completion of certain conditions, one group (or a third party, say an executive) would have a right to acquire a certain number of shares. One could go on with more such examples but, in essence, rights are given over to one person to acquire another person’s shares in the future. Similar rights could be given to a person to sell its shares.

The law makers had a certain concern on an entirely unrelated issue. Considering the evils of unregulated trading in shares (including what is known as dabba trading in common parlance) it was decided that trading in securities otherwise than on regulated and recognized stock exchanges should not be permitted. Thus, trading – or even contracting to buy/sell – securities except on a recognised stock exchange was made null and void. Thus, such a contract was not enforceable. The only real exception (apart from certain territorial exceptions) to was “spot transactions”. This covered a contract of purchase and sale of securities where the delivery/payment was spot – which was effectively defined to be that the delivery of shares and payment was to be made within one day of the contract.

The law as so framed ensured that forward/futures/ options trading in securities could not be carried out without being regulated. However, a simple transaction of private sale and purchase of shares and other securities on ready payment/delivery basis was exempted.

The wording of this law, however, had a peculiar consequence. It meant that no contract of sale/ purchase of securities could be entered into unless it fell into the very narrow exempted category. For most practical purposes, one could not enter into a valid agreement to buy/sell shares in the future. Or enter into an agreement where involving postponement of the payment of consideration and/or delivery of the securities beyond one day. As joint ventures, private equity, co-promoted companies, etc. became increasingly common, this became a serious concern. Parties entering into such agreements could not bind each other with such basic commercial safeguards. This was despite the fact that almost all of such agreements could not even remotely affect public interest, being entered into by informed parties on a negotiated basis without any intention of trading.

In practice, this problem was dealt with parties by often being in denial or half-baked structuring or even sheer ignorance. Some legal counsels even opined that, structured in a particular way, the notification did not apply to private agreements. The reality, however, was that even in the most optimistic scenario, often, there was concern that, if put to test, many of such clauses in agreements may not be held valid. Thus, what was referred to euphemistically as a “calculated risk” was taken. The fact that Supreme Court, other courts and SEBI held many of such agreements to be unenforceable worsened matters (the various decisions and their legal basis can be subject for a separate detailed article).

The matter became more complicated when this issue spilled over to other laws including laws regulating foreign exchange.

SEBI’s recent circular gives relief – with some conditions

Finally, on 3rd October 2013, SEBI issued a circular withdrawing the earlier notification and allowing parties to enter into agreements for purchase/sale of shares, though with certain conditions which are fairly reasonable. Let us consider which of such contracts are exempted and under what conditions.

The first two exemptions are as expected and continuing ones. “Spot Delivery Contracts” are exempted. Purchase or sale of securities/derivatives on stock exchanges in accordance with law and bye-laws, etc. of such exchanges are also exempted.

Next exempted category is “contracts for preemption including right of first refusal, or tag-along or drag- along rights contained in shareholders agreements or articles of association of companies or other body corporate”. Thus, all contracts of pre-emption are exempted, including the specified ones such as right of first refusal, etc. These may be contained in the agreements between shareholders and/or incorporated in the articles of association of the company.

Then come certain “options” in agreements between shareholders (or contained in the articles of association). Such options provide a right to one person to buy or sell shares. On exercise of such options, the actual purchase/sale of shares is effected. Such agreements are also exempted, subject, however, to certain conditions. Firstly, the securities underlying such options should have been held continuously for at least one year by the selling party. This is effectively a lock-in period. Secondly, the price/consideration for such purchase/sale of shares should be in compliance with prevailing laws. Finally, the contract, i.e., the purchase/sale is settled by actual delivery of the underlying securities.

The circular makes it clear that the contracts will continue to have to adhere to FEMA and Regulations/Rules issued thereunder. FEMA has other policy considerations and hence such agreements particularly with parties across the border would require such compliance.

Will the relaxations apply to existing agreements?

An interesting provision is made for agreements for purchase/sale of shares existing on the date of this circular. It is clarified that this circular shall neither affect nor validate agreements existing immediately prior to the date of the circular. In other words, all such existing agreements shall continue to be subject to the earlier law. Only those contracts having such clauses and which are entered into on or after the date of this circular would benefit from the relaxations made in it, subject of course complying with the conditions stated therein.

There have been views expressed that parties could merely re-execute such contracts as of a date after the date of such circular. This sounds like a fairly simple solution to the thousands of agreements existing as on such date, though one wonders whether it is simplistic too. The practical hurdle is whether all the parties concerned would readily agree to re-execute such past agreements. In practice, often relations may have soured between the parties who may want to re-negotiate certain terms of the agreement if it has to be re-executed. Obviously, though the party entitled to the rights may be keen, the party who is subject to the obligations may not readily agree. Then there is a commercial reality that was often observed in practice. Many parties entered into some version of such agreements knowing quite well that they are likely to be unenforceable. Hence, they considered the likelihood of being required to act upon it fairly remote and considered that if at all such transactions were to be executed, the parties could consider the offered terms and generally the reality at that time. The party entitled to the rights too may not have really believed that it would actually get them. Clearly, these parties never intended such agreements to have unqualified binding force and they may not agree to re-execute them to give them such force. Thus, the parties would want to re-negotiate the contract instead of merely printing out a copy and re-executing the same today.

Applicability to other laws for certain contracts

The circular also clarifies that as far as government securities, gold related securities, money market securities, contracts in currency derivatives, interest rate derivatives and ready forward contracts in debt securities entered into on the stock exchange are concerned, they shall be in accordance with various specified laws such as securities laws, banking laws, FEMA, etc.

Anomalous provision in Companies Act, 2013

In this context, it is necessary to discuss a strange provision in the recently notified Companies Act, 2013. Section 194, which incidentally has been notified as to have come into effect, prohibits certain contracts by directors/key managerial persons of companies. The specified contracts are rights (or a right exercisable at option of such person) to call for delivery or make delivery of a specified quantity of shares/debentures, at a specified price and within a specified time. It appears that the intention is to prohibit contracts of futures/options. While this is consistent with the existing provisions under the SEBI Regulations relating to prohibition of insider trading, this provision is too widely worded. The SEBI Regulations are intended to prohibit directors/officers/designated employees from entering into derivatives transactions of their companies. However, the scope of section 194 is very broad. It is a blanket ban on all agreements giving any right or option to acquire/sell shares. Further, the section applies to all companies – listed, unlisted or even private. It does not even give exemption to employees’ stock options. Thus, despite the relaxation by the circular, this ill-advised provision in the Act can present problems. On the other hand, it applies only to directors/key managerial persons and not others including other promoters or promoter companies.

Curiously, the Explanation to this section seems to modify its scope. Firstly, it states that it would apply to those shares/debentures where the concerned person is a whole -time director and not merely a director. Secondly, the shares/debentures may be of the employer company or its holding company or its subsidiary. Even more curiously, the initial part of the section refers also to “associate” companies. Further, the ban in the section is on “buying” such rights and one thus wonders whether such rights granted to employees or otherwise forming part of contracts are also covered. The section is an example of bad drafting. To summarise, however, this provision will create hurdles in case of whole-time directors/key management persons in entering into agreements to buy/sell shares in the future or acquire options for such buy/sell of shares.

To conclude, SEBI has finally provided relaxation to genuine contracts between parties that faced the possibility of being treated as impermissible under SEBI regulations though they did not affect public interest.

Nirav Shah

2013-TIOL-1541-CESTAT-MUM Commissioner of C. Ex., Pune vs. Aztecsoft Ltd.

Testing and analysis of IT Software – specific amendment in the definition of “Technical Testing and Analysis” to bring within its fold testing and analysis of IT software with effect from 16-05- 2008. Activity not taxable prior to the said date under any category.

Facts:
The Department appealed against the order of the Hon. Commissioner dropping the demands of the assessee for the period prior to 16-05-2008 for providing services of testing and analysis of computer software. Since the definition of “Technical Testing and Analysis” service was specifically amended on 16-05-2008 to include the said activity, it was taxable only with effect from 16-05-2008 according to the assessee. The decision of Stag Software Pvt. Ltd. in 2008 (10) STR 329 (Tri-Bang) and Relq Software Pvt. Ltd. in 2011 (23) STR 449 (Kar) were relied upon.

Held:
Referring to the definition of “Technical Testing and Analysis” prior to 16-05-2008 and as amended with effect from 16-05-2008, the budget instructions letter 334/1/2008 – TRU dated 29-02-2008 was referred to and relying on the decision of Relq Software (supra) held that testing and analysis of IT software would be effective only from 16-05-2008 when the said activity was specifically included under technical testing and analysis service as IT software services were introduced on the said date. Similar amendments were made in the taxable services of Business Auxiliary Services, technical inspection & certification, management repair of properties and consulting engineer’s services to include IT software services.

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Nirav Shah

2013-TIOL-1504-CESTAT-DEL M/s. Ujjawal Parivahan Sahakari Samiti Ltd. vs. Commissioner of Central Excise, Jaipur-II

Loading/unloading & transportation of limestone with processing cannot be classified as cargo handling services.

Facts:
The appellant entered into an agreement to provide services as a contractor for hiring of machines, equipments, crushing & screening plant and other services for production of low silicon limestone gitties. The Department issued a show cause notice and contended to levy tax on the said activities under the category of “Cargo Handling Services” for the period up to 09-09-2004 and under the category of “Business Auxiliary Services” for the period from 2004-08. The appellant contended that the activity of transportation/loading and unloading was only incidental to the actual activity of processing of goods carried out by them on behalf of their principals which became taxable only with effect from 16-06-2005 under Business Auxiliary Services.

Held:
Referring to the definitions of “Cargo Handling Services” and “Business Auxiliary Services” and discussing the rules for clarification laid down in section 65A, it was concluded that the essential characteristic of the composite service was not Cargo Handling Service. Allowing the appeal, it was held that the activity of transportation/loading and unloading was only incidental to the actual activity of processing of goods which formed the essential character and that such activity became taxable only after the amendment in the definition of “Business Auxiliary Services” with effect from 16-06-2005, the liability of which the appellant discharged under Business Auxiliary Service, thus no penalty was also found leviable.

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Nirav Shah

2013 (32) STR 86 (Tri.-Mum) Global Transgene Ltd. vs. Commr. of C. Ex., Cus. & S.T., Aurangabad

Package containing only a mark showing the technology used which is not a logo or trademark or hallmark of the assessee, cannot be considered to be granting representational rights. Therefore, the same is not covered under franchise services.

Facts:
The appellant obtained licenses, for self-use and to transfer the technology to sub-licensees, from a Chinese company. Accordingly, the department contested that the activity of sub-licensing was covered under franchise services as franchise rights
were given to the sub-licensees. The appellants stated that the activity of sub-licensing was not covered under the definition of ‘franchise service’. The appellants also produced samples of products which did not contain any logo or hallmark or trademark of theirs. In fact, the package label clearly indicated that the seeds were manufactured and marketed by sub-licensees in their own name. The agreement was for transfer of technology in the form of seeds for a consideration. Further, though they provided certain training, the same was common in case of imported technologies and it could not be construed as providing representational rights. Revenue argued that one of the sub-licensees stated that the appellants had granted right to use logo and 3D hallmark of the technology which are clearly identifiable with the appellants. Further, only after testing the seeds, the appellants supplied 3D hallmark.

Held:
The appellants were not granted any representation rights to represent the Chinese company in India and the appellants neither were entitled to nor granted any representational rights to sublicensees. The mark denoted on the package was neither a logo nor a trademark or hallmark of the appellants but was only denoting that the seeds contained the technology. The case thus was decided in favour of the appellants.

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Nirav Shah

2013 (32) STR 113 (Tri.-Ahmd.) Larsen & Toubro Ltd. vs. Commissioner of C. Ex., Vadodara – II

Transactions between SEZ unit and DTA unit of the same entity are not leviable to service tax.

Facts:
The appellant set up 2 units viz. in an SEZ and in DTA. The SEZ unit also provided certain in-house work to DTA units. The respondents demanded service tax on the said transactions between SEZ and DTA units considering them as separate legal entities on the grounds that both the units were separately registered with the service tax department, raised invoices and fell under the definition of ‘persons’ as per the SEZ Act. The appellants contested that in the present case there was absence of two parties for the provision of taxable service by one person to another and also that the SEZ Act had no relevance for interpretation of the service tax law. Further, invoices were issued to satisfy SEZ law and internal monitoring purposes only. Also, SEZ Units never received any amount from DTA units as the same were interunit entries in books of accounts which were not taxable transactions.

Held:
Confirming the contentions of the appellant, the Hon. Tribunal held that merely entering into agreements and raising invoices did not mean SEZs were separate legal entities. Further, the definition of ‘person’ as per the SEZ Act, which included AOP or BOI, whether incorporated or not was not applicable in the present case as the units were not shown as AOP or BOI. Further, the presence of two persons was a must to levy service tax. In the absence of any definition under service tax law, the persons were held not to be separate legal persons and the transaction between SEZ and DTA units was not liable to service tax.

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Nirav Shah

2013 (32) STR 95 (Tri–Delhi) – Endurance Technologies Pvt. Ltd. vs. Commr. Of C. Ex., Aurangabad

Service tax paid on mandap keeper services to celebrate the annual day function is eligible for CENVAT credit.

Facts:
The appellant manufacturer of assessable goods availed mandap keeper’s services to celebrate the annual day function which was attended by the employees, their family members and employees of their sister units and claimed CENVAT credit thereon. They relied upon Toyota Kirloskar Motor Pvt. Ltd. 2011 (24) STR 645 (Kar) and Ultratech Cement Ltd. 2010 (20) STR 577 (Bom.) in support of their claim. The revenue rejected the claim relying on the decisions of Manikgarh Cement 2010 (20) STR 456 (Bom.) and Eicher Motors Ltd. 2010 (20) STR 281 (Tri.-Del.).

Held:
Considering the inapplicability due to facts being distinct than in the present case than in the cases of Manikgarh Cement (Supra) and Eicher Motors Ltd. (Supra), the Hon. Tribunal relying on Toyota Kirloskar Motor Pvt. Ltd. and Ultratech Cement Ltd., allowed the claim of the appellant wherein the facts were similar.

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Nirav Shah

2013 (32) STR 209 (Tri.-Del) Kansara Modler Ltd. vs. CCEx, Jaipur-II

Whether the receiver of services is entitled to utilise the CENVAT credit for payment of service tax under the Import Rules? Held, Yes.

Facts:
Appellant received “supply of tangible goods service” from outside India for the provision of its output services in India and utilised CENVAT credit for discharging the service tax payable as the service recipient of the said services. The department issued a show cause notice disallowing the utilisation of such CENVAT credit payment of service tax and confirmed the demand.

Held:
Referring to Rule 2(q) of the CENVAT Credit Rules, 2004 read with Rule 2(1)(d)(iv) of Service Tax Rules,1994 it was held that the Appellant was a person liable to service tax and thus becomes a taxable service provider under Rule 2(r) of the CENVAT Credit Rules, 2004 and consequently becomes output service provider under Rule 2(p) of the said Rules. Thus the order of the Commissioner (Appeals) disallowing the payment under reverse charge mechanism vide CENVAT credit was set aside.

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Nirav Shah

2013 (32) STR 31 (Bom.) Oil & Natural Gas Corpn. Ltd. vs. Commissioner of C. Ex., S. T. & Cus., Raigad

Input services used indirectly in or in relation to manufacture of final dutiable products even at a distant place, are eligible to avail CENVAT credit.

Facts:
The appellant was engaged in the manufacture of dutiable goods such as naphtha, ethane-propane, LPG and residual gases at its Uran plant and exempted goods such as crude oil and natural gases at its Mumbai offshore location. The crude oil was either directly sold from Mumbai Offshore or further used to manufacture goods at the Uranplant. The appellant being registered input service distributors, distributed CENVAT credit. Revenue contended that crude oil manufactured at Mumbai Offshore was sold to its buyers therefrom before the Uran plant came into existence. Therefore, crude oil, used at the Uran plant to manufacture dutiable products, cannot be termed as semifinished goods and thereby concluded that input services were entirely used for exempted products and no CENVAT credit was admissible.

Analysing the definition of input services, the appellant contested that the services used whether directly or indirectly in or in relation to the manufacture of a final product are eligible input services to claim CENVAT credit. Accordingly, the definition was wide enough to cover current instance and as per Rule 6(1) and Rule 6(2) of the CENVAT Credit Rules, 2004, the appellant was entitled to CENVAT credit on pro-rata basis of service tax paid on the input services used in the manufacture of final dutiable products only.

Held:
Since the definition of input services under Rule 2(l)(ii) of CENVAT Credit Rules, 2004, uses expressions “directly or indirectly” and “in or in relation to” in conjunction, the intention of the legislature was to widen the scope and purview of the entitlement. Merely because the appellant manufactured exempted goods, the revenue cannot disallow benefit of CENVAT credit on the input services used in or in relation to the manufacture of dutiable final product. The dutiable final products manufactured at the Uran plant were fundamentally premised upon the manufacturing process commenced at Mumbai Offshore i.e., manufacture of dutiable products was impossible unless the process starts at Mumbai Offshore and there is continuous supply of crude oil from Mumbai Offshore to the Uran plant. Therefore, relying on the Hon. Supreme Court’s decisions in case of Escorts Ltd. 2004 (171) ELT 145 (SC) and Solaris Chemtech Ltd. 2007 (214) ELT 481 (SC), it was held that the appellant was entitled to CENVAT credit of input services used even indirectly in manufacture of dutiable final products subject to Rule 6 of CENVAT Credit Rules, 2004.

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Nirav Shah

Search and seizure: Block assessment: Section 158BC; Block period 01-04-1986 to 26-06- 1996: Undisclosed income to be determined on basis of evidence found during search: Cannot be computed on the basis of best judgment:

CIT vs. Dr. Ratan Kumar Singh; 357 ITR 35 (All)

The assessee was a practicing medical doctor having different sources of income such as income from agricultural activities, medical profession and pathology. On 25-09-1996, a search u/s. 132 at the residential premises of the assessee was simultaneously conducted with a survey u/s. 133A at his business premises where an x-ray clinic and blood bank were located. During the survey a register marked pertaining to the blood bank was found and seized. Another register pertaining to x-ray was also seized. No search was conducted at the business premises of the assessee from where these registers were impounded. The assessing Officer made an assessment u/s. 158BC of the Act, of the assessee’s undisclosed income for the block period making additions pertaining to the blood bank and x-ray. The Tribunal deleted the addition.

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

i) Undisclosed income of the block period has to be determined on the basis of evidence found as a result of search or requisition of books of account or other documents and such other materials or information as are available with the Assessing Officer and relatable to such evidence with certain other conditions. It is not open to the Assessing Officer to compute the income on the basis of best judgment.

ii) A search was conducted at the residential premises of the assessee and survey was conducted at the business premises. During the search, no cash, bullion, jewellery or any material was found, which could be considered as undisclosed income.

iii) The additions were made on estimate basis after seizing the register from the business premises of the assessee. The Tribunal was justified in deleting the addition.”

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Nirav Shah

Salary: Perquisite: Sections 15 and 17(2): A. Y. 1994-95: Assesee R but NOR: Employer to bear the tax on salary: Assessee paid tax of Rs. 50 lakh: Got reimbursement from employer of Rs. 35 lakh: Salary received by the assessee to be enhanced by Rs. 35 lakh only and balance Rs. 15 lakh paid by assessee not to be enhanced:

CIT vs. Jaydev H. Raja; 261 CTR 408 (Bom):

The assesee a resident but not ordinarily resident individual was an employee of Coca Cola Inc. USA having salary income. Under the tax equalisation policy framed by the company, the assessee’s tax liability arising out of his foreign assignment was to be borne by the company. In the relevant year, the assessee had received salary of Rs. 77 lakh and the tax payable thereon was Rs. 35 lakh which was reimbursed by the employer. The assessee returned the total income of Rs. 1.12 crore ( 77 + 35 lakh) and paid tax thereon of Rs. 50 lakh. The Assessing Officer made an addition of Rs. 15 lakh treating the same as the amount reimbursable by the employer. The Tribunal allowed the assessee’s appeal and held that though the assesee had paid the tax amounting to Rs. 50 lakh, the assessee was entitled to reimbursement of tax amounting to Rs. 35 lakh only from the employer and the balance Rs. 15 lakh was borne out of the salary income received by the assessee in India.

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

“Only the actual reimbursement of tax by the employer could be included in the salary of the employee and not the tax paid by employee from his salary income for the purposes of grossing up u/s. 195A.”

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Nirav Shah

Revision: Scope: Section 263: A. Y. 2006-07: CIT feeling inquiry inadequate: CIT must make enquiry and show that assessment order was erroneous: CIT has no power to remand and direct AO to conduct enquiry:

DIT vs. Jyoti Foundation: 357 ITR 388 (Del):

For the A. Y. 2006-07, the assessment was completed u/s. 143(3) r/w. section 147, making enquiry as regards the consideration on sale of the four plots. Subsequently, exercising powers u/s. 263 of the Act, the Commissioner held that the enquiry made by the Assessing Officer was inadequate and therefore directed the Assessing Officer to make fresh enquiry and pass a fresh order of assessment. The Tribunal cancelled the order of the Commissioner passed u/s. 263.

On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under: “
i) Revisionary power u/s. 263, is conferred by the Act on the Commissioner/Director of Income-tax when an order passed by the lower authority is erroneous and prejudicial to the interest of the Revenue, but orders which are passed after inquiry/ investigation on the question/issue are not per se or normally treated as erroneous and prejudicial to the interest of Revenue because the revisionary authority feels and opines that further inquiry/investigation was required or deeper or further scrutiny should be undertaken.

ii) In cases where there is inadequate enquiry but not lack of enquiry, the Commissioner must record a finding that the order/inquiry made is erroneous. This can happen if an enquiry and verification is conducted by the Commissioner and he is able to establish and show the error or mistake made by the Assessing Officer, making the order unsustainable in law. An order of remit cannot be passed by the Commissioner to ask the Assessing Officer to decide whether the order was erroneous.

iii) Inquiries were certainly conducted by the Assessing Officer. It was not a case of no inquiry. The order u/s. 263 itself recorded that the Director felt that the inquiries were not sufficient and further inquiries and details should have been called for. The inquiry should have been conducted by the Director himself to record the finding that the assessment order was erroneous. He should not have set aside the order and directed the Assessing Officer to conduct the inquiry. iv) We do not think any substantial question of law arises for consideration. The appeal is dismissed.”

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Nirav Shah

Sale Price in Banquet Hall under MVAT Act, 2002

Introduction
Under Maharashtra Value Added Tax Act, 2002, (MVAT Act), tax is levied on the ‘sale price’. There are situations where the transactions are composite and only part of it would be liable to VAT. In case of Works Contract the situation is clear due to judicial pronouncements. However, there are new types of transactions coming up for determination of ‘sale price’. One such instance is sale price, for the purpose of MVAT Act, in case of charges for Banquet Hall. Banquet halls normally arrange programs as per requirement of clients. Entire arrangement includes various services including serving of food and drinks. For example, if a marriage function is arranged in a banquet hall, then there will be arrangement for a stage, furniture, decoration, music, etc. and also supply of food and drinks.

Banquet Hall, a composite transaction
In case of banquet hall, the service provider i.e. hotels etc., are liable to pay service tax. Simultaneously there being supply of food and drinks, VAT is also applicable. An issue arises as to on what amount VAT is payable. One view can be that the entire charges are liable to VAT. Other view can be that only that portion of price, which is relating to food and drinks, can be liable to VAT.

Determination of disputed question (DDQ) in caseof Tip Top Enterprises
The dealer, M/s. Tip Top Enterprises, filed an application for determination, before the Commissioner of Sales Tax, to get the issue of ‘sale price’ for banquet hall under the MVAT Act decided. In the DDQ dated 25-05-2009, the learned Commissioner of Sales Tax, rejecting all the arguments of the dealer, held that the whole amount charged by the dealer (banquet hall) is liable to VAT.

Decision of Tribunal in above case
The matter went to Maharashtra Sales Tax Tribunal by way of appeal no. 41 of 2009. In the appeal, on behalf of appellant, following arguments were reiterated.

a) Referring to definition of ‘sale price’ in MVAT Act which reads as under:

“Section 2(25) “sale price” means the amount of valuable consideration paid or payable to a dealer for any sale made including any sum charged for anything done by the seller in respect of the goods at the time of or before delivery thereof, other than the cost of insurance for transit or of installation, when such cost is separately charged,” it was submitted that the amount received against sale/supply of goods only can be considered and not the amount received for services as the ‘sale price’.

b) As per the definition of ‘sale’, the supply of food is deemed to be sale. The said definition of ‘sale’ is as under in section 2(24) of MVAT Act, 2002:

“Section 2 (24) “sale” means a sale of goods made within the State for cash or deferred payment or other valuable consideration but does not include a mortgage, hypothecation, charge or pledge; and the words “sell”, “buy” and “purchase”, with all their grammatical variations and cognate expressions, shall be construed accordingly;

Explanation,-—For the purposes of this clause,—

a. a sale within the State includes a sale determined to be inside the State in accordance with the principles formulated in section 4 of the Central Sales Tax Act, 1956;
b.
i. the transfer of property in any goods, otherwise than in pursuance of a contract, for cash, deferred payment or other valuable consideration;

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

iii. a delivery of goods on hire-purchase or any system of payment by installments;

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

v. the supply of goods by any association or body of persons incorporated or not, to a member thereof or other valuable consideration;

vi. the supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service is made or given for cash, deferred payment or other valuable consideration:”

Accordingly, it was submitted that in a banquet hall transaction, only supply of food and drinks part is ‘sale’.

c) Relying upon judgment of Hon. Supreme Court in case of Builder Association of India vs. Union of India (73 STC 370), the above argument was reiterated, more particularly citing the following observation.

“The latter part of clause (29-A) of article 366 of the Constitution makes the position very clear. While referring to the transfer, delivery or supply of any goods that takes place as per sub-clauses (a) to (f) of clause (29-A), the latter part of clause (29-A) says that “such transfer, delivery or supply of any goods” shall be deemed to be a sale of those goods by the person making the transfer, delivery or supply and a purchase of those goods by the person to whom such transfer, delivery or supply is made.”

Accordingly, it was submitted that under Article 366(29A)(f) only supply of goods is deemed to be a sale which can be subject matter of sales tax and not the total price of transaction. Therefore, it was urged that the levy on total amount was unconstitutional.

d) Based on judgment in case of Imagic Creative P. Ltd. (12 VST 371(SC), it was submitted that on the amount on which service tax is paid, VAT cannot be attracted, as both are mutually exclusive.

e) Citing judgment in case of Cap ‘N’ Chops Caterers vs. State of Haryana (37 VST 226) (P & H), it was submitted that the banquet transaction is in the nature of works contract and can be liable to the extent of goods value and service portion cannot be taxed.

f) Reliance was placed on the judgment in case of Bharat Sanchar Nigam Ltd. (145 STC 91) (SC). In this judgment Hon. Supreme Court has observed that the receipts towards hotel activity are divisible.

g) Reliance was also placed on following observation of Hon. Supreme Court in case of T. N. Kalyan Mandpam (135 STC 480)(SC).

“42. In regard to the submission made on article 366(29A)(f), we are of the view that it does not provide to the contrary. It only permits the State to impose a tax on the supply of food and drink by whatever mode it may be made. It does not conceptually or otherwise include the supply of services within the definition of sale and purchase of goods. This is particularly apparent from the following phrase contained in the said sub-article “such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods”.

Contentions of the Department
a) Relying upon judgment of Hon. Supreme Court in case of K. Damodarsamy Naidu [(2000) (117 STC 1), it was contended that the whole amount is liable to VAT. In this judgment, the Hon. Supreme Court was considering sale price in case of Restaurant.

b) Department also relied upon judgment of Bombay High Court decision in East India Hotels Ltd. (99 STC 197). In this case the restaurant was claiming reduction from sale price on account of luxuries provided in restaurant like AC facility etc., on the ground that they are towards providing extra facilities. However, the Hon. High Court has held that the whole price is liable to sales tax.

Conclusion of Tribunal
Hon. Tribunal delivered its judgment in above appeal no. 41 of 2009 dated 23-04-2013 and referred to above arguments as well as looked into the factual position. Tribunal referred to booking documents for banquet hall. It was seen that the hotel has quoted separate charges, towards rent of hall, about food and drinks and decorating etc. The charges towards food and drinks were almost at par with charges for same menu, when provided by hotel, in other than banquet hall.

In view of the above factual and legal position Tribunal held that the sale price for food and drinks will be the price agreed between the parties. In other words, Tribunal disapproved the DDQ, that whole amount towards banquet hall is liable to VAT. As per Tribunal, VAT can be levied on amount towards food and drinks as agreed between the parties. In relation to decoration charges, which were also charged separately in the quotation, Tribunal held that the same items may attract tax as lease transaction.

The above judgment will be useful to avoid double taxation. In absence of such judgment, dealer may become liable to service tax as well as VAT on the same amount. This is not expected, hence, it will certainly give relief from such double taxation.

Nirav Shah

Rectification: Interest: Sections 154 and 244A: A. Y. 2002-03: While giving effect to order of CIT(A) the assessee was allowed refund with interest u/s. 244A: Rectification u/s. 154 to withdraw interest is not sustainable: Question whether there was delay and to whom the delay was attributable is a debatable question of fact:

CIT Vs. Nathpa Jhakri Joint Venture; 261 CTR 110 (Bom):

In the assessment order giving effect to the order of the CIT(A), the Assessing Officer allowed refund and also interest u/s. 244A of the Income-tax Act, 1961. Subsequently, the Assessing Officer passed a rectification order withdrawing the interest allowed u/s. 244A of the Act. The Tribunal allowed the assessee’s appeal and cancelled the rectification order.

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

“Whether or not, there was a delay in the proceedings and to whom is such delay attributable is a question of fact, requiring investigation and therefore interest granted u/s. 244A could not be withdraw by rectification u/s. 154.”

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Nirav Shah

Education: A Taxable Commercial Training Service?

Introduction:

Commercial training or coaching service was introduced in the service tax law from 1st July, 2003 by defining the expression, “commercial training or coaching” and “commercial training or coaching centre” in sections 65(26) and 65(27) respectively of the Finance Act, 1994 (the Act) as reproduced below:

Section 65(26):

““Commercial training or coaching” means any training or coaching provided by a commercial training or coaching centre”.

Section 65(27):

““Commercial training or coaching centre” means any institute or establishment providing commercial training or coaching for imparting skill or knowledge or lessons on any subject or field other than the sports, with or without issuance of a certificate and includes coaching or tutorial classes but does not include preschool coaching and training centre or any institute or establishment which issues any certificate or diploma or degree or any educational qualification recognized by law for time being in force.”

Consequently, taxable service in relation to this service was defined in section 65(105)(zzc) of the Act. Within a span of 4 to 5 years of the introduction of the service, in a significant number of cases, the co-ordinate Benches of the Tribunal at Bangalore and Chennai pronounced various decisions wherein various large and well-known institutions were held to be not liable under this taxing entry mainly on account of their status as non-profit making or charitable institutions. Understandably, as a consequence thereof, the Government appended an explanation to the definition to section 65(105)(zzc) of the Act vide the Finance Act, 2010 to come into effect retrospectively from 01-07-2003. Thus, the relevant provisions read as follows:

Section 65(105)(zzc):

““Taxable service” means any service provided or to be provided to any person, by a commercial training or coaching centre in relation to commercial training or coaching.

Explanation.—For the removal of doubts, it is hereby declared that the expression “commercial training or coaching centre” occurring in this sub-clause and in clauses (26), (27) and (90a) shall include any centre or institute, by whatever name called, where training or coaching is imparted for consideration, whether or not such centre or institute is registered as a trust or a society or similar other organization under any law for the time being in force and carrying on its activity with or without profit motive and the expression “commercial training or coaching” shall be construed accordingly.”

It is also relevant to note here that the Finance Act, 2011 with effect from 01-05-2011 amended the definition of commercial training or coaching centre in section 65(27) whereby exclusionary part of the definition was omitted and instead the said exclusion part was simultaneously declared exempt vide Notification 33/2011-ST from 01-05-2011.

Primarily, in terms of the above explanation, the scope of the service was expanded to exclude profit motive element. When the decision of the Madras Tribunal in Great Lake Institute of Management Ltd. (GLIM) vs. CST Chennai 2008 (10) STR 202 (Tri.-Chennai) was challenged by the Revenue in the Supreme Court, on noticing the above explanation the Apex Court set aside the Tribunal’s order and remanded the case for denovo consideration in the light of the said Explanation [2010 (19) STR 481 (SC)].

Larger Bench direction vide Interim Order No.ST/443/2013 in Great Lake Institute of Management Ltd. vs. CST Chennai & 5 others: [2013-TIOL- 1480-CESTAT-DEL-LB]

Recently, in a bunch of appeals filed before the Tribunal, a Division Bench prima facie doubted the reasons recorded in one of the decisions viz., Magnus Society vs. CC&CE, Hyderabad 2009 (13) STR 509 (Tri.-Bang). In this decision, a distinction was made between higher learning through a proper format of education imparted by institutions on one hand and those which are characterised as commercial training or coaching centres preparing students for entrance examinations to universities or the like. The matter therefore was referred to the Larger Bench of CESTAT (LB or the Bench). The limited reference however was made to examine whether the provisions relating to commercial coaching or training service as defined in sections 65(26), 65(27) and 65(105)(zzc) of the Act accommodate a distinction between imparting of specific skill by an institution such as in computer literacy, computer operations, spoken English or accountancy at one end and a broader format of education imparted by an institution of higher learning providing a course of instructions in MBA, management, computer science or similar disciplines. The Bench headed by Hon. President, CESTAT examined the said relevant statutory provisions in relation to commercial training or coaching services specifically considering the scope of the service in the light of the above explanation inserted with retrospective effect and also analysed various precedents including Magnus Society (supra), GLIM (supra) and a few others as summarised below.

On making primary examination of the statutory provisions, the Bench held a view that for an institution or establishment to claim immunity from the liability of service tax, it must establish any one of the following exclusionary parameters:

• The institute/establishment is not imparting skill, knowledge or lessons on any subject or field except sports.
• If the establishment is a pre-school coaching or a training centre.
• Institute/establishment which issues any certificate, diploma, degree or an educational qualification recognised by the extant law.

Thus, as per the preliminary remark of the LB, if any institute fails to fulfill any of the listed parameters, it would be considered a commercial training or coaching centre and consequently be liable for service tax.

Gist of analysis of various precedents:

In case of GLIM vs. CST, Chennai 2008 (10) STR 202 (Chennai), the appeal was allowed by holding that it being a recognised charitable organisation under the Income- tax Act, 1961 and engaged in public utility areas, profit motive was absent although it may have earned surplus. Since the decision was pronounced prior to incorporation of the Explanation and profit motive was excluded by virtue of the Explanation, the Supreme Court in Revenue’s appeal remanded the matter (2010 (19) STR 481 (SC) for denovo consideration in the light of the Explanation. Another pre- amendment decision in the case of Administrative Staff College of India vs. CC&CE, Hyderabad 2009 (14) STR 341 (Tri.- Bang), the Tribunal concluded that although profit might have been earned, the laudable objectives of the institution registered as a society could not be equated with those of a tutorial college and that the expression ‘commercial’ in the definition indicates that it qualifies coaching or training centre and not coaching or training. Further, that the registered society also exempted from income tax as charitable organisation cannot be considered a commercial centre. Revenue’s appeal to Supreme Court in this case was dismissed without recording any reasons—reported in 2010 (20) STR J117 (SC). In another decision in Magnus Society vs. CC&CE, Hyderabad (supra) following the decision in GLIM (supra), the appeal was allowed. In this case, in addition to the reason of absence of profit motive involved in services of the institution, Hon. Tribunal carved out distinction for the term ‘education’ as against coaching or training by observing that ‘education’ was a much broader term of which coaching and training was only a part and the breadth of the term education could not be encompassed in the definition containing narrow meaning. Institutes offering degrees recognised by law could not be covered within the ambit of the defined category of the service. This view was also reiterated in Institute of Chartered Financial Analysts of India vs. CE&CE, Hyderabad 2009 (14) STR 220 (Tri. -Bang) while noting that the states Governments have recognised ICFAI University by notifications and there also existed UGC recognition. Further, considering the exempt nature of the income, the activity being non-commercial was held as not liable for service tax. This deci-sion also was pronounced prior to incorporation of the explanation.

The stated provisions were also considered by the Kerala High Court in Malappuram District—Parallel College Assn. vs. UOI 2006 (2) STR 321 (Ker) wherein challenge was made on several grounds interalia including the grounds of discrimination and violation of Article14 of the Constitution. The pleas regarding education being non-taxable under the Constitution and coverage of parallel colleges by exclusionary clause were repelled. The Hon. Court however ruled that the impugned levy was discriminative since the burden of the levy ultimately fell on students and there was no ap-parent distinction between the students pursuing education in regular colleges or in parallel colleges. The case of Indian Institute of Aircraft Engineering vs. UOI & Ors 2013-TIOL -430-HC-DEL-ST also was discussed by the Bench with reference to what constituted approved institution regulated by law. In this case, the High Court had concluded that the institution in question provides education resulting in degree/diploma/qualifications recognised by law and therefore was covered by the exclusionary clause and consequently not subject to service tax. In addition to various decisions by CESTAT, decisions involving issue of entitlement to exemption from income tax on the ground of educational purpose, under the Income-tax Act also were discussed. The Bench however, noted that neither the precedents nor the relevant provisions of the Income-tax Act assisted them significantly to interpret the scope of the expression “commercial training or coaching” or “commercial training or coaching centre” which was for their limited consideration.

Training & Education: Whether literal meaning relevant?

In addition to discussing various precedent decisions on behalf of the appellants, reference was made to various textual authorities to analyse contours of relevant terms such as teach, education, training, coach etc. to elucidate what the words meant and consequently to draw distinction between the concept of ‘training’ and ‘education’ or to examine whether they overlap. However, it was noted that when legislatively mandated definition was available, it is impermissible to look to extra textual guidance. “A good faith interpretation of section 65(27) requires that whatever skills/ knowledge/lessons are imparted on any subject or field, the activity must be considered to be training or coaching.”

Conclusion:

The Bench finally concluded that the retrospectively introduced Explanation in section 65(105) (zzc) of the Act redefined the scope of the expres-sion “commercial training or coaching” in section 65(26) by virtue of which a commercial element or profit motive became an irrelevant ingredient to bring an institute or establishment within the fold of “commercial training or coaching centre” nor would any organisational structure of registration of the entity as a trust or society would determine taxability. On analysing the other facet of the definition of “commercial training or coaching centre” in section 65(27), it was held that the training or coaching for imparting skill, knowledge or lessons on any subject or field constitutes commercial training or coaching and the scope of “training or coaching” could not be restricted by super-adding any conditions by parameters of course content, syllabus, duration, etc. The Bench declined to agree with the restricted interpretation pleaded or as was made in the precedent decisions and held that in the definition contained in section 65(27), there would be no rationale for engrafting an exclusionary clause broadly formulated other than what is specifically excluded viz., an institute or establishment which issues any certificate, diploma, degree or any educational qualification recognised by law. The Bench further held that since Parliament introduced the ‘Explanation’ retrospectively to clarify ambiguities to ascertain the expression ‘commercial’, recourse to guidance from precedents was not warranted. The reference to the Larger Bench was accordingly answered holding that the activities of imparting skill, knowledge, lessons on any subject or field or when imparted by an entity, institution or establishment which is excluded by a specific and legislated exclusionary clause would alone be outside the fold of the taxable territory. Considering the scope of the reference, the Bench declined to consider whether any of the appellants were taxable or otherwise in terms of the exclusionary clause in section 65(27) as it stood prior to its amendment with effect from 01-05-2011 and therefore the appeals stood remitted to the respective Bench to decide based on principles discussed above.

The direction provided by the Larger Bench is likely to have far-reaching implications on various institutions offering higher studies especially in absence of appropriate regulatory authority in this regard as the exclusion in terms of the direction of the Larger Bench is meant only for the degree, diploma, a certificate or any qualification recognised by the law for the time being in force. It appears therefore that the litigation hereafter would hinge mainly around whether a degree/ diploma certificate issued by an institution can be construed as one recognised under the law in force. It may be noted that in the new era of negative list based taxation effective from 1st July, 2012, what is specifically non-taxable is by way of entry in the “negative list” of services contained in section 66D of the Act is “education as a part of a curriculum for obtaining a qualification recognised by any law for the time being in force.” In addition to preschool education, higher secondary education and approved vocational courses. Thus, a course or education recognised by law is the sole criterion for non-taxability

Nirav Shah

Penalty: Sections 139A and 272B: A. Y. 2003- 04: Quoting PAN in TDS certificates: Failure: Where assessee-deductor did not mention PAN of deductees on TDS certificates issued by it, as same was not provided by deductees within time prescribed, there was reasonable cause for non-compliance of section 139A(5A), and, therefore, penalty u/s. 272B could not be imposed:

CIT vs. Gail (India) Ltd.; [2013] 36 taxmann.com 336 (All)

The assessee, a public sector undertaking, had deducted income tax at source as per the provisions of sections 194C and 194J on all the payments made to contractors/professionals during the financial year 2002-03. The tax so deducted was also deposited by it in the government treasury in time. The annual return of TDS as per the provisions of section 203 was also filed in the prescribed ‘Form 26C’ and TDS certificates were issued to contractors/professionals. However, penalty at the rate of Rs. 10,000 for each 350 defaults committed by the respondent-assessee was imposed by the revenue on the ground that the respondent-assessee has not mentioned PAN in Form 16A issued to 350 contractors. The assessee’s contention that there was reasonable cause for not mentioning the PAN in Form 16A since the deductee had not provided the PAN was rejected and penalty was imposed. The Tribunal deleted the penalty, holding that there was reasonable cause for default.

On appeal by the Revenue, the Allahabad High Court upheld the decision of the Tribunal and held as under “
i) A perusal of section 139A(5A) shows that it puts an obligation on the person receiving any sum or income or amount from which tax has been deducted under the provisions of Chapter XVII (which include sections 194C and 194J) to intimate his permanent account number to the person responsible for deducting such tax under the Chapter. In the present case, it is clear that it was statutory obligation of the contractors, who received certain amounts from the respondent-assessee, from which tax was deducted under the provision of Chapter XVII-B, to intimate their permanent account number to the respondent-assessee.

ii) It is the specific stand of the assessee that certain contractors had not intimated their permanent account number, and for that reason it could not be mentioned in Form 16A issued to such contractors. Section 139A(5B) makes it obligatory for every person deducting tax under Chapter XVII-B to quote the permanent account number of the person to whom such sum or income or amount has been paid by him. Thus, reading both the provisions together, namely, sections 139A(5A) and section 139A(5B), it appears that the deductor may be at fault under section 139A(5B) if he does not quote the permanent account number of the persons to whom the amount has been paid, despite the intimation of permanent account number by such person to the deductor u/s. 139A(5A) of the Act. There is nothing on record to show that the contractors to whom certain amounts were paid by the respondentassessee, had intimated their permanent account number to the respondent-assessee as required u/s. 139A(5A). In the circumstances, therefore, the assessee successfully explained the reasonable cause to satisfy the provisions of section 273B.

iii) Considering the provisions of section 272B, 273B and sections 139A(5A) and 139A (5B), a bare reading of the provision itself makes it clear that the penalty u/s. 272B would not ordinarily be imposed, unless the assessee had either acted deliberately in defiance of law or was guilty of conduct which is contumacious, dishonest or acted in conscious disregard to its obligation. The penalty u/s. 272B cannot be imposed merely because it is lawful to do so. It can be imposed for failure to perform statutory obligation. The imposition of penalty for failure to perform a statutory obligation is a matter of discretion of the authority to be exercised judicially, after considering the explanation of reasonable clause submitted by the assessee and on a consideration of all the relevant circumstances.

iv) On the findings recorded by the Tribunal that there was no revenue loss and mere technical breach, it clearly satisfies the test of reasonable cause u/s. 273B. In the present case the levy of penalty u/s. 272B by the assessing authority was fully unjustified.”

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Nirav Shah

Income from industrial undertaking: Deduction u/s. 80-IB and 80-IC: A. Ys. 2004-05 and 2006-07: Transport subsidy, power subsidy, interest subsidy and insurance subsidy resulting in increase of profits of the undertaking: Such increased profit is income derived from the industrial undertaking and is eligible for deduction u/s. 80-IB/80-IC of the Act:

CIT vs. Meghalaya Steels Ltd.; 356 ITR 235 (Gau): 261 CTR 17 (Gau):

The assessee’s industrial unit was eligible for deduction u/s. 80-IB/80-IC of the Income-tax Act, 1961. For the relevant years, the Assessing Officer disallowed the claim for deduction in respect of the profit relating to the transport subsidy, power subsidy, interest subsidy and insurance subsidy. The Tribunal held that the subsidies in question would go on to reduce the corresponding expenses incurred and the resultant profit would be the profits and gains of the business of the industrial undertaking, that all these subsidies are interlinked, interlaced and having a direct nexus with the manufacturing activities of the assessee which are inseparable from the expenditure incurred by the assessee on account of transportation of purchase as well as sales, power, interest, insurance cover of the business of the assessee and, therefore, there is a direct nexus between the subsidy received by the asessee’s industrial undertaking and the resulting profits and gains thereof and the assessee is eligible for deduction u/s. 80-IB/80-IC of the Act.

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

i) Transport subsidy, power subsidy, interest subsidy and insurance subsidy received under various Government Schemes go to reduce the cost of gains derived by it and there is direct and first degree nexus between the industrial activities of the assessee on one hand, and the subsidies received by it on the other.

ii) The profits and gains earned on the strength of such subsidies are profits and gains derived by, the industrial undertaking and are deductible under the provisions of section 80—IB or section 80-IC as the case may be.”

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Nirav Shah

(2013) 92 DTR 345 (Rajkot)(SB) Bharti Auto Products vs. CIT A.Ys.: 2009-10 & 2010-11 Dated: 06.09.2013

Section 206C: A seller of scrap is liable for collection of tax at source irrespective of the fact that such a seller has not himself generated scrap from manufacture or mechanical working of materials undertaken by him. The mode of sale of scrap need not be necessarily akin to the auction or tender for this purpose but it can be any mode.

Section 206C(6A): First proviso inserted by the Finance Act, 2013 with effect from 01-07-2012, would apply retrospectively.

Facts:
The assessee imported brass scrap and sold it without collecting tax at source. The assessee’s case was that the brass scrap sold by him was not generated from the manufacture or mechanical working of material and therefore, it was not ‘scrap’ within the meaning of Explanation (b) to section 206C. According to him, the provisions of section 206C would be attracted only when scrap was sold to a “buyer”, which is defined as a person who obtains in any sale, by way of auction, tender or any other mode, goods of specified nature. It was submitted that sale of goods by an assessee to a buyer in retail sale of such goods cannot therefore be construed as sale to a buyer as such sale was not by way of auction or tender or any other like mode and therefore such transactions in retail sale between the assessee and his buyer would clearly be outside the scope of section 206C.

The Assessing Officer rejected the assessee’s explanation. He held that since the assessee had failed to collect the tax at source as required by section 206C(6) on the sale of scrap made by him to various dealers, he was liable to pay it u/s. 206C(6) alongwith interest u/s. 206C(7).

Held:
The isues in this case are
a) Is it necessary that the scrap should have been generated by the assessee himself from the manufacture or mechanical working of material undertaken by him in order to apply the provisions of section 206C?

Explanation (b) to section 206C defines ‘scrap’ as ‘waste and scrap from the manufacture or mechanical working of materials which is definitely not usable as such because of breakage, cutting up, wear and other reasons’. It is evident that the word ‘scrap’ occurs twice in the said definition. The first part of the definition, namely, ‘waste and scrap from the manufacture or mechanical working of materials’ seeks to cover both ‘waste’ as well as ‘scrap from the manufacture or mechanical working of materials’. In the absence of any definition of the term ‘waste’ in the Act, one has to turn to its meaning as it is understood in common parlance. In common parlance, ‘waste’ is understood as something unusable or unwanted material. According to the Concise Oxford Dictionary, ‘waste’ is something which has been ‘eliminated or discarded as no longer useful or required’. ‘Scrap’, on the other hand, represents something which is left over after the greater part has been used or consumed. ‘Scrap’ thus refers to the incidental residue derived from certain types of manufacture, which is recoverable without further processing. It is in this context that the words ‘from the manufacture or mechanical working of materials’ qualify the preceding word ‘scrap’ and not ‘waste’. The definition of ‘scrap’ as given in Explanation (b) is not limited to scrap fromthe manufacture or mechanical working of materials alone but extends to cover ‘waste’ also. Therefore, the scope of the term ‘scrap’ as defined in Explanation (b) cannot be interpreted so as to restrict its application to scrap from the manufacture or mechanical working of materials alone.

The word ‘and’ in the expression ‘waste and scrap from the manufacture or mechanical working of materials’ has been used to enlarge the scope of ‘scrap’, so as to cover both, i.e., waste as well as scrap from the manufacture or mechanical working of materials.

Section 206C seeks to prevent evasion of taxes. It therefore, needs to be construed in a manner that seeks to achieve the purpose for which it has been enacted.

Further, the use of the words ‘business of trading’ in the head note of section 206C makes it clear that the applicability of section 206C is not restricted to sale of scrap generated from the business of manufacturing undertaken by the assessee himself but covers sale of scrap in the business of trading in scrap also.

b) Should the mode of sale of scrap be akin to auction or tender in order to fall in the definition of “buyer” u/s. 206C?

It was submitted that the provisions of section 206C require a seller to collect the tax at source from the buyer (and from none else) on sale, inter alia, of scrap. Attention was drawn to the definition of ‘buyer’ as given in sub-clause(i) of clause (aa) of Explanation to section 206C, which defines a ‘buyer’ as ‘a person who obtains in any sale, by way of auction, tender, or any other mode, goods of the nature specified in the Table in sub-s. (1) ……’.

Placing reliance on the interpretative tools of noscitur a sociis and ejusdem generis, it was contended that the phrase ‘any other mode’ in the expression ‘a person who obtains in any sale, by way of auction, tender or any other mode …..’ in Explanation (aa)(i) would get its meaning from the words preceding it, namely, ‘by way of auction, tender’ and, therefore, the said phrase, namely, ‘any other mode’ would have to be construed narrowly and in the same sense as something akin to auction or tender.

It was contended that the assessee has sold the scrap in retail trade and not by way of auction or tender or any similar mode or mode akin to auction or tender and, therefore, it was not required to collect tax at source from them u/s. 206C as such purchasers in retail trade were not buyers within the meaning of Explanation (aa)(i) to section 206C.

The principles of ‘noscitur a sociis’ and ‘ejusdem generis’ apply only when meaning of questionable or doubtful words or phrases in a statute is required to be ascertained. If a given provision is plain and unambiguous and the legislative intent is clear, there is no occasion to call in aid those rules.

The use of the word ‘or’ in the aforesaid expression shows that all the three phrases (namely, auction, tender or any other mode) are intended to carry independent meaning without being controlled by each other. The words “any other mode” are words of wide amplitude and, therefore, cover all possible modes of sales in addition to specific modes of sales by way of auction or tender. Hence, they cannot be construed ejusdem generis or as referring to similar sales as those by way of auction or tender.

c) Does the first proviso to section 206C(6A) apply retrospectively?

The attention of Tribunal was also drawn to the first proviso inserted in section 206C(6A) with effect from 01-07-2012 which stipulates that the payer who fails to deduct tax on the payment made to payee shall not be deemed to be an assessee in default if the payee has paid the tax due on his returned income and fulfilled the other conditions specified therein.

In the aforesaid background, the issue that arises for consideration is whether the first proviso to section 206C(6A) is applicable to pending matters also notwithstanding the fact that it has been made effective from 01-07-2012.

Keeping in view the fact that the first proviso to s/s. (6A) of section 206C not only seeks to rationalise the provisions relating to collection of tax at source but is also beneficial in nature in that it seeks to provide relief to the collectors of tax at source from the consequences flowing from non/short collection of tax at source after ensuring that the interest of the revenue is well protected, thus, there is no hesitation to hold that the said proviso would apply retrospectively and, therefore, to both the assessment years under appeal.

Nirav Shah

(2013) 144 ITD 325 (Hyderabad) Vittal Krishna Conjeevaram vs. ITO A.Y. 2009-2010 Dated: 10th July, 2013

Section 54F, read with section 54 – Capital Gains– The expression ‘a residential house’ appearing in sections 54 and 54F has to be understood in the sense that building should be of a residential nature and word ‘a’ should not be understood to indicate a singular number.

Facts:-
The assessee was a co-owner of a residential property. The assessee entered into a development agreement for construction of flats with a developer. As per development agreement the owner had to transfer 50 % of his land for superstructure received as consideration. The assessee received 7 flats towards his share. The Ld AO held that the assessee was entitled to exemption u/s. 54F but only in respect of one flat out of seven flats. CIT (A) also upheld the order of AO.

Held:-
Both the sections, 54 and 54F, speak of either purchase or construction of “a residential house”. Following the decision of the Hon’ble Karnataka High Court in case of. CIT v. Smt. K.G. Rukmini Amma [2011] 331 ITR 211, the Tribunal held that the expression “a residential house” as appears in section 54 of the Act, cannot be interpreted in a manner to suggest that the exemption would be restricted to a single residential unit. “A residential house” as mentioned in section 54(1) of the Act, has to be understood in a sense that the building should be of a residential nature and the word “a” should not be understood to indicate a singular number. Assessee was entitled to exemption u/s. 54F in respect of all the seven flates.

Note:
As the decision of Special Bench, Mumbai in case of ITO vs. Sushila M. Jhaveri [2007] 107 ITD 327 (Mum.) (SB) has been disapproved by the High Court in case of CIT vs. Syed Ali Adil. [2013] 352 ITR 418, the same was not considered to be a good law and hence not followed. CIT vs. D. Anand Basappa [2009] 309 ITR 329/180 Taxman 4 (Kar.) followed CIT vs. Syed Ali Adil [2013] 352 ITR 418/215 Taxman 283/33 taxmann. com 212 (AP) followed

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Nirav Shah

[2013] 144 ITD 461 (Hyd) S. Ranjith Reddy vs. DCIT AY : 2006-07 Date of order : June 07, 2013

Section 2(47) – joint development agreement – mere signing of agreement without any other performance cannot be termed as transfer for the purpose of capital gains.

Facts :
The assessee had received certain land from his late father. He, alongwith other family members entered into joint development agreement (joint venture) on 28-02-2006 with L constructions which itself held land in the same area. As per the agreement the assessee was to receive developed plots (i.e. constructed properties) in lieu thereof. The assessing officer, relying on the decisions of Chaturbhuj Dwarkadas Kapadia [2003] 260 ITR 491 (Bom.) held that there was a transfer of land on 28-02-2006 itself.

Held:
The Hon’ble tribunal held as under: The joint venture project was in a nascent stage. In the concerned previous year, nothing happened other than the execution of the agreement. The transfer of an immovable property always contemplates transfer of an existing property, i.e., a property in praesenti. . As far as the assessee is concerned, there was only an agreement. The proposed project was still to be born as the offshoot of the assessee.

The assessee was not transferring any right or any property to ‘L’. The assessee assigned its landed property in favour of ‘L’ by the joint venture agreement between the assessee and ‘L’. There cannot be a sale to oneself. Nothing was exchanged in the previous year relevant to the assessment year under appeal. No rights are relinquished. It only proposes to redefine the rights.

The assessing officer has concluded that providing land for the purpose of development is a transfer. The consent given by the assessee to provide its land for developing the housing project is only one of the necessary stipulations of the whole scheme. It cannot be broken into an independent segment so as to conclude the same as transfer. The provision of land to facilitate the implementation of the joint venture is always to be read with other equally important stipulations.

Even though the agreement entered into is an enforceable one, that by itself does not take the character of an immovable property. The agreement speaks about the intentions of the parties. Once the project is completed and all the stipulations are satisfied, the parties may come to declare the final satisfaction of the agreements. Only at that point of time, the question really arises as to whether there was any transfer within the meaning of section 2(47). The housing project was a proposed project. As already stated, a transfer is contemplated only in the case of an existing property. In the present case the property was only in the nature of mutual rights. The project and development are yet to happen. Strictly, speaking, the projects and plans may happen or may not happen.

As far as applicability of section 53A of the Transfer of Property Act is concerned, it is one of the necessary preconditions that transferee should have or is willing to perform his part of the contract.

It is clear that willingness to perform for the purposes of section 53A is something more than a statement of intent; it is the unqualified and unconditional willingness on the part of the vendee to perform its obligations. It is only elementary that, unless provisions of section 53A of the Transfer of Property Act are satisfied on the facts of a case, the transaction in question cannot fall within the scope of deemed transfer u/s. 2(47)(v).

Both the developer and the assessee were having the landed property. They pooled together the landed property along with some other parties who were owners of some other landed property and all parties together gave licence to the builder to enter the premises and construct houses. No sale was effected on the date of agreement. No consideration has passed between the parties on signing theagreement. Further from the date of signing of development agreement dated 28-02-2006 to 31-03- 2006, no progress has taken place in the said landed property which is subject-matter of the development agreement. Further, there was no consideration in the form of money that passed between the parties. There was no construction, whatsoever, that took place during the period. Even otherwise, there was a General Power of Attorney given by the assessee to the developer. In such a situation, it is only the actual performance of transferee’s obligation which can give rise to the situation envisaged in section 53A of the TP Act. On these facts, it is not possible to hold that the developer performed its obligation during the period in which the capital is sought to be taxed by the Revenue authorities. Thus, the condition laid down u/s. 53A of TP Act was not satisfied during the period. Once it is concluded that the developer did not perform the stipulation as required by the development agreement during the period under consideration and within the meaning assigned to the expression in section 53A of TP Act it cannot be said that there was a transfer u/s. 2(47)(v) so as to levy capital gain tax.

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Nirav Shah

[2013] 144 ITD 76 (Mum) Mattel Toys (I) (P) Ltd. vs. Dy. CIT, Mumbai A.Y. 2002-2003 Order dated- 12.06.2013

Section 92C – Transfer Pricing
(i) Resale price method is an appropriate method in case where resale takes place without any value addition to product – where the assessee had followed Transactional Net Margin method but later on during the assessment proceedings claimed that Resale Price Method be followed, the same should be considered.

(ii) An internal comparable can be followed for computation of ALP against external comparable where the assessee sends goods back to its associated enterprise (AE) to get a best available price in comparison to the sale made to a third party.

Facts I:
The assessee-company, a subsidiary of a U.S.A. company being its Associated Enterprise (‘AE’), was engaged in marketing and selling of toys and games imported from its AE. The assessee adopted Transactional Net Margin Method (TNMM) in its transfer pricing report and rejected the Resale Price Method (RPM). Further, the assessee claimed that RPM should be followed instead of TNMM which was rejected by the Commissioner as detailed analysis was given in the TP study report as to why RPM was not taken.

Held I:
The assessee is a distributor of toys and resells the same to independent parties without any value addition. In such situation, RPM can be the best method as there is no much alteration to the products which are resold by the assessee. On the other hand, TNMM can be resorted to only if the other methods have been rendered inapplicable. The revenue contended that once the assessee has chosen a method as appropriate then it should not resort to any other method at an assessment or appellate stage. If a particular method will not result in proper determination of the ALP then it will not serve the purpose of transfer pricing. Therefore, it was held that if at any stage of the proceedings, it is found that another method will result in more appropriate ALP then the assessment officers and the appellate Courts cannot reject the plea of the assessee.

Facts II:
The assessee resells the goods which are imported from the associated enterprise. The assessee in this case has sent the goods back to the associated enterprise. These goods were the unsold ones. The assessee preferred to return the goods to the AE as there was no demand for the product due to change in consumer preferences. The Transfer Pricing officer treated these goods as export to the AE.

Held II:
The assessee returned the goods to the assessee due to a negative trend in the market. It was stated that the assessee had suffered a greater loss while making sale in case of third party in comparison to the sale made to the AE. Thus, the margin of export sale to third party i.e internal comparable should be compared to the export sale made to the AE. Therefore, the issue was remanded to the file of the Transfer Pricing Officer for the purpose of carrying out comparability analysis under internal CUP.

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Nirav Shah

2013-TIOL-955-ITAT-PANAJI ACIT vs. Joe Marcelinho Mathias ITA No. 43/PNJ/2013 Assessment Years: 2009-10. Date of Order: 26.04.2013

S/s. 45, 47(xiv) – In a case where an assessee transfers all its assets and liabilities to a private limited company and all conditions of section 47(xiv) are satisfied, AO cannot deny exemption on the ground that sale consideration was higher than the book value.

Facts:
The assessee, an individual, was carrying on business of real estate, as a sole proprietor, by acquiring land, developing the same by sub-dividing the same into plots and selling the said plots. The land was held as stock-in-trade. The net worth of the concern, as per audit report u/s. 50B(3) was Rs. 1.62 crore. On 31-03-2009, vide Deed of Succession, all the assets and liabilities of the proprietory concern were transferred to a private limited company for a consideration of Rs. 963 crore against acquisition of shares of a company at a high premium. The assessee contended that the transfer was covered by section 47(xiv) and therefore, the provisions of section 45 were not attracted.

The Assessing Officer (AO) was of the view that section 47(xiv) does not exempt capital gains if the assets are transferred at a value which is higher than the book value. He held that receipt of additional consideration by way of allotment of shares over and above the proprietor’s capital was in violation of conditions laid down in section 47(xiv). He held that since the assessee got additional income/benefit than what was due as per books of accounts this amounted to receiving any direct or indirect benefit other than by way of allotment of shares and therefore the assessee is not entitled to exemption. The AO taxed the capital gains and denied the benefit of section 47(xiv).

Aggrieved the assessee preferred an appeal to the CIT(A) who allowed the assessee’s appeal.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held :
The assessee has disposed off the industrial undertaking to a private limited company and in exchange thereof, the assessee has received consideration by way of shares in the company. Therefore, this is a clear cut case of a transfer of an undertaking to a private limited company. Section 45 is applicable when there is a profit or gain arising from the transfer. Profit and gains will also include losses. The undertaking has been valued by the assessee more than the net worth, therefore, there is profit and gain and the provision of section 45 was clearly applicable in the case of the assessee. Once a capital gain arises and is chargeable to tax u/s. 45, section 47 provides for certain exceptions according to which certain transactions are not regarded to be transfer.

The only objection on the part of the revenue is that the assessee did not comply with the condition no. 3 of section 47(xiv) since assessee has received consideration by way of allotment of shares in the company and the value of those shares are more than the value of the assets as was disclosed in the books of the proprietory concern. In our opinion, the assessee has duly complied with the condition as stipulated in clause (c) to section 47(xiv). This proviso only requires that same proprietor does not receive any consideration or benefit directly or indirectly in any form or manner other than way of allotment of shares in the company. The words form or manner other than by way of allotment of shares in the company qualify the words `does not receive any consideration or benefit’ as well as `directly or indirectly’. This clearly denotes that proviso (c) permits receiving consideration or benefit directly or indirectly by way of allotment of shares in the company. It is not a case where the assessee has received any other consideration or benefit other than the allotment of shares in the company.

The Tribunal held that receipt of higher value of shares because of revaluation of assets at the time of succession cannot be treated as consideration or benefit received other than by way of allotment of shares. The Tribunal confirmed the order of CIT(A).

This ground of appeal of revenue was dismissed.

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Nirav Shah

A Parable of Life

Mankind’s journey of life is variously described as a journey of life and greed. In this journey, he forgets the true purpose of his life and gets stuck in the material world.

Here is a parable taken from the Jain literature which best describes the journey. The words/phrases in parenthesis endeavour to give an interpretation which one can relate to in his spiritual quest. This interpretation is said to be provided by Haribhadra Maharaj, a Jain monk from the 7th century.

A man (Soul), seeking fortunes (Salvation) was passing through a thick jungle (Cycle of rebirths). Suddenly, a wild elephant (Death) with upraised trunk charged him fiercely. He tried to run fast, but his path was blocked by an evil demon (Old Age). The only escape route now was to climb the huge, tall, banyan tree (Path to salvation). He ran and reached the tree but could not decide if he had the will and power to climb the mighty tree. Right below the mighty tree was a deep well (Human Life), all covered with grass and reeds. “This well (Human Life) would save me”, he thought, and jumped in it.

As he was falling through the grass and the reeds, he looked below and was terrified. Right below him lay many terrible snakes (Passions which impede human judgment) enraged and hissing fearsomely. To make matters worse, deep down below was a black and mighty python (Hell) with angry red eyes. Afraid, he held on to a clump of reeds hanging from the top and clung on to it. He thought, “My life will only last as long as these reeds hold fast” and he looked up.

There he saw two large mice (The day and night – the passages of time), one white and one black, their sharp teeth ever-gnawing at the roots of the reed-clump. Up above, the wild elephant (Death) was charging, repeatedly, at the banyan tree (Path to salvation). This disturbed the beehive hanging from a branch right above him. The angry bees ( Diseases of Life) swarmed down on him and his whole body was stung. Just then, as he was looking up and cursing himself for not climbing the tree, a drop of honey (trivial pleasures) fell on his face and somehow reached his lips.

That was a moment of sweetness. He looked up again, forgot all the dangers around him and just craved and waited for more drops of honey to come down his way. In his excited craving for yet more drops of honey, he lost awareness of the reality – the python (Hell), the snakes (Passions), the mice (the day and night the passages of time), the elephant (Death), or the bees (Diseases of Life).

It is for each one of us to understand and appreciate the parable in its true spirit as we journey through life.

(Acknowledgements: Jainism and the New Spirituality by Vastupal Parikh)

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Nirav Shah

2013-TIOL-941-ITAT-DEL Rachna Gupta vs. ITO ITA No. 5527/Del/2012 Assessment Years: 2003-04. Date of Order: 05.07.2013

S/s. 147, 148 – Reassessment cannot be done on the basis of a notice issued at the address mentioned as per PAN data when the new address was available in returns of income filed.

Facts :
On 30-03-2010 the Assessing Officer (AO), with the prior approval of the Additional CIT, issued a notice u/s. 148 requiring the assessee to file return of income for AY 2003-04. The notice was issued at an address taken from PAN data. The address given in the PAN data was address of the employer of the assessee where she was then working. Subsequently, the said employer company had shifted its address and the change in address was intimated to ROC as well. In the return of income filed for AY 2003-04, 2004-05 and 2005-06 (all filed before 30.3.2010) the assessee had stated her new address.

The assessee failed to comply with this notice and no return was filed. Thereafter, AO issued notices u/s. 142(1) on 09-06-2010, 06-08-2010 and 14-09-2010. The assessee claimed that it received first notice on 14-09- 2010. In response, the assessee filed a letter dated 22-09-2010 enclosing acknowledgement of Saral form and further stated that the assessee was not holding the relevant record for the assessment year and also that the initiation of the proceedings after lapse of six years was unjustified.

The AO was of the view that the provisions of the Act require issue of notice within a period of six years and not service thereof. The notice was issued within six years from the end of the assessment year. The AO completed the assessment by making an addition of Rs. 6,15,000.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held :
The Tribunal noted that it is not disputed by the Department that notice dated 30-03-2010 u/s. 148 was issued at BE-63, Hari Nagar, New Delhi address. From the copy of returns filed for assessment years 2003-04, 2004-05 and 2005-06 prior to 30-03-2010, it is evident that the address of the assessee was BK- 22, Shalimar Bagh, Delhi – 110 052 which was available with the Department and, therefore, admittedly the notice was issued at the wrong address. The 6 year period from the end of the assessment year expired on 30-03-2010. Therefore, in view of the decision of the Hon’ble Delhi High Court in the case of CIT v. Eshaan Holding (P) Ltd. (2012) 344 ITR 541 (Del), it cannot be said that valid notice was issued u/s 148 to the assessee. The Delhi High Court had held as under:

“The first notice issued on January 29, 2004, by speedpost was said to have been served at the old address at East of Kailash. There was no proof of service on record. Even otherwise, this was not valid service because the assessee had already filed its return on November 28, 2003, and in this return address shown was Panchsheel Park. Thus, the record of the Department already contained the new address of the assessee. Before issuing notice u/s 148, it was expected of the Assessing Officer to have checked up if there was any change of address, because valid service of notice of reopening the assessment is a jurisdictional matter and this is a condition precedent for a valid reassessment.”

Following the ratio of the above mentioned decision, the Tribunal set aside the order of CIT(A) holding that initiation of proceedings u/s. 148 was not legal and, therefore, consequent assessment order framed by AO is quashed.

The appeal filed by the assessee was allowed.

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Nirav Shah

Google Hangout – III

About this write up: This write up is the 3rd part of the series of articles on Google Hangout. This write up focuses mainly on some of the more popular instant messaging apps. The article briefly describes some of the features of these apps and highlights how hangout appears to have an edge over its peers. This article is the third and final installment of a series of articles on this topic. The first write up dealt with the telecom ecosystem and the different messaging apps/options available to users. The write up also dealt with the rise and fall of these apps/options over time. The second installment mainly dealt with the apps like SMS and BBM and why they are losing momentum. In this write up, we will briefly look at the current favourites in the instant messaging apps space and how they compare with Google Hangout (or vice versa for that matter).

Popular instant messaging apps

The previous write ups have dealt in brief why instant messaging apps became popular. Some of the key factors were:

• Cost factor: Short Messaging Services (i.e. SMS) became a rage during the time period when the cost of voice calls were sky high. Their popularity started declining when the telecom service providers started reducing the voice call rentals. As a matter of fact, the general perception today is that it is cheaper to call then to send an SMS especially when it cost 1p per second and 1 minute would cost Re. 1/- as against Re. 1 for just 140 characters /SMS.

• Instant Communication: The fact that the message would be delivered instantly – almost anywhere in the world – to the persons phone was a huge advantage over emails. This was true before the Blackberry boys came in and before the smart phones joined the race. Even today, a good majority of the population prefers instant messaging to emails. To be candid, I can’t even recall when was the last time I shared a joke or a personal message with my friends or dear ones on email. As a matter of fact, not a day goes by when one of my colleagues or friends, etc. share that whatsapp, etc., have made it so much easier to connect with family members.

• Ease of use: This perhaps is one of the most important factors, especially when seniors are concerned. The younger generation has always been known to be tech savvy and have the uncanny ability to adapt to the latest technological development. One would say that the younger generation thrives on the changes. As against this, the seniors find change unnerving, they prefer the security of the old, tried and tested. This is even a bigger hurdle when they have to take a number of steps to achieve the same goal. Instant messaging has changed that significantly. To give you a simple illustration, if you are using whatsapp and you create groups and include your parents, it gives them an opportunity to know what’s going on, etc. There is a small illustration later in this write-up on this.

• Informal communication: This is another reason why instant messaging is very popular is that emails generally have been associated with formal communication as against this instant messaging is perceived to be less formal and mostly casual.

• Mass reach: If one compares instant messaging with voice calls i.e. alerts for charges on your debit card, reminders for utility payments, etc. – which would you prefer. My vote would certainly go for instant messages – they are far less intrusive. Imagine receiving a telephone call everytime a charge was made on your card or a utility payment was due – one more voice to nag you….

That being said, let’s move on to the apps which are popular:

Popular instant messaging apps:

Whatsapp:
This one is my favourite. In fact I wrote an article recommending this app in the BCAJ. It is one of the apps (out of 75 on my phone) for which I have paid money (it’s free now) (have only 5 paid apps 70 are free).

This app is quite efficient. Apart from allowing you to send text messages, the user can also send photos, videos and sound files (this was added after we chat came on the scene). This app will help you save a lot of money on the phone bill (especially if you have an unlimited data plan). Some of the other useful features include group messaging, sharing location, time stamp. What I particularly like about whatsapp is that

• it works on a simple GRPS connection as well as a WIFI (no need for a data plan)
• I don’t need to add contacts separately (unlike BBM)
• Even if I change my phone, new messages will come to the new phone, even if I don’t have anyone’s PIN
• It works on all popular devices/operating systems

We Chat:
This is app is fast gaining popularity and there are several ads being aired on almost all channels. The biggest plus is that apart from texting (and the ones described above), users can also send voice messages.

To be honest, I don’t have much comment or experience in using this app. There were a couple of turnoffs however:

• One needs to register an account with we chat
• Why bother sending a voice message – just call
• Chinese ……snooping….

Skype:
Has been around for several years now, recently bought over by Microsoft. Quite popular even today. It is available on the desktop as well as on the phone. This was popular because it gave the users the ability to have a real time voice conference (one to one or one to many or many to many). Many seniors use this to talk to their dear ones living around the world. Once again, I don’t have much comment or experience in using this app. There were a couple of turnoffs however:

• The app is very resource hungry – takes a lot of space and RAM when in operation

• Voice quality is decent but the video is often grainy and jerky (could be a bandwidth or a hardware issue on either side – did not face the as much in google hangout though)
• Need to register an account. You could call on the phone but (I think) you have pay charges for this facility

Viber:
This app is also quite popular. The biggest plus is that it allows real time voice calls. Have tried this from my phone, there is some time lag but the voice clarity is pretty good (even on GPRS). The app gives you the convenience of group chatting and alerts you as and when users download and activate it on their phone (Whats app doesn’t give an alert). It is fairly popular and in many ways scores over skype due to ease of use and speed. Unlike skype, it doesn’t offer video chat. Recently, they have started offering a desktop version.

Google Hangout:
Google has taken its time testing this app….. moving from google chat to google talk and now hangout. This app works on most smart phones (desktop — its already linked to your gmail account). The pluses are that it allows you to send text messages and hold video conference. Have tried it a couple of times and when compared to Skype and Facetime (iPhone/iPad specific), the video quality is somewhere in between (better than skype but still miles away from facetime). Just last week, I was trying to get on a video chat with someone located in Canada and after 10 minutes of skyping he said why don’t we switch to google hangout it some much better. I think that more or less summed it up for me.

The next write up will focus on what google hangout has to offer and what the future may have in store for users. It will also be the concluding part of this series. Do look forward.

Disclaimer: The purpose of this article is not to promote any particular site or person or software. Further comments about various products and services are based on the user experience related information available in the public domain. There is no intention to malign any product or service in any manner whatsoever. The sole intention is to create awareness and to bring in to limelight some thought provoking content.

Nirav Shah

Business expenditure: Disallowance u/s. 40(a)(ia): A. Y. 2007-08: Amendment by Finance Act, 2010 permitting TDS payment till due date for filing return of income is retrospective:

CIT vs. Rajinder Kumar (Del); ITA No. 65 of 2013 dated 01-07-2013, 06-09-2013:

For the A. Y. 2007-08, the Assessing Officer found that TDS on the expenses of Rs. 78,51,800/- paid in the month of March 2007 was deposited in April 2007. The Assessee contended that the said expenditure should be allowed since the TDS has been deposited within the due date. The Assessing Officer disallowed the said amount of Rs. 78,51,800/- relying on the provisions of section 40(a)(ia) of the Income-tax Act, 1961 on the ground that TDS has been deposited after March 2007. The Tribunal allowed the assessee’s claim relying on the decision of the Calcutta High Court in the case of CIT vs. Vergin Creations, ITA No. 302/11, G.A. No. 3200/11 dated 23/11/2011, wherein it has been held that the proviso to section 40(a)(ia) of the Act, amended by the Finance Act, 2010 has retrospective effect. On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under: “i) The intention behind section 40(a)(ia) is to ensure that TDS is deducted and paid. The object of introduction of section 40(a)(ia) is to ensure that TDS provisions are scrupulously implemented without default in order to augment recoveries. It is not to penalise an assesee when payment has been made within the time stated.

ii) Failure to deduct TDS or deposit TDS results in loss of revenue and may deprive the Government of the tax due and payable. The provision should be interpreted in a fair, just and equitable manner. It should not be interpreted in a manner which results in injustice and creates tax liabilities when TDS has been deposited/paid and the Respondent who is following cash system of accountancy has made actual payment to the third party for services rendered.

iii) Also, section 40(a)(ia), prior to the insertion of the proviso by the Finance Act, 2010, was not free from interpretative difficulties and problems. The amended provisions are clear and free from any ambiguity and doubt and help curtail litigation. The amended provision clearly support the view that the expression “said due date” used in clause A of proviso to the unamended section refers to the time specified in section 139(1) of the Act. The amended section 40(a)(ia) expands and further liberalises the statutes when stipulates that deductions made in the first eleven months of the previous year but paid before the due date for filing of the return, will constitute sufficient compliance.

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Nirav Shah

Appeal to High Court – Fresh material produced before the Supreme Court – The Supreme Court remanded the matter to the High Court to consider the said material as it was of relevance.

In an appeal against the judgement and order passed by the High Court of Punjab and Haryana at Chandigarh, the Supreme Court while issuing notice to the respondent, by its order dated 3rd February, 2012 had passed the following order:

“Issue notice as to why the matter should not be sent back to the High Court as, today, learned counsel for the petitioner has placed before us a number of documents which earlier were not placed before the High Court.”

At the time of admission, the Supreme Court was of the opinion, the documents, which the appellants had filed before it were of some relevance and those documents should be looked into by the High Court before it comes to a conclusion whether the appeal requires to be allowed or to be rejected.

Taking that view of the matter, the Supreme Court set aside the order passed by the High Court and remanded the matter back to the High Court for fresh disposal after accepting the documents that were/ may be filed by the appellants, keeping all the contentions of both the parties open.

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Nirav Shah

Educational Institution: Exemption u/s. 10(22):A. Y. 1998-99: Denial of exemption disputing genuineness of transaction: Contributor to assessee denying the transaction: Assessee should be given opportunity to cross-examine the disputant:

Sri Krishna Educational and Social Trust vs. ITO; 351 ITR 178 (Mad):

For the A. Y. 1998-99, the Assessing Officer made additions denying exemption u/s. 10(22) of the Income-tax Act, 1961, disputing the genuineness of a transaction wherein the contributor to the assessee had denied transaction. The assessee was not given the opportunity to cross-examine the said person. The Tribunal upheld the decision of the Assessing Officer. The Tribunal held that the assesee did not have the right to cross-examine the witness who made the adverse report, especially when the records did not indicate that the assessee had made any attempt to produce witnesses.

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

“i) When the authorities entertained a doubt about the genuineness of the transaction, the Tribunal ought to have afforded the assessee an opportunity to cross examine the disputant. The Revenue had not accepted the explanation given by the assessee. The assessee would not have expected one of the contributors to have denied the factum of contribution. This view was inevitable because but for this the assessee would not have opted to cross-examine the contributor.

ii) Therefore, when there was unexpected change of facts, the party should not be deprived of the opportunity to cross-examine the witness branded as the assessee’s witness. The Evidence Act also permits a party to cross-examine his own witness under stated circumstances.

iii) Unless it is proved that the income derived was covered u/s. 10(22) it could not be decided whether the addition u/s. 68 was possible or not. Therefore, the matter was remitted to the Assessing Officer for further consideration in the light of the legal position.”

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Nirav Shah

Capital or revenue receipt: Test: A. Y. 1997- 98: assessee receiving amount in terms of release agreement: Compensation for loss of source of income: Capital receipt: Not taxable:

Khanna and Annadhanam vs. CIT; 351 ITR 110 (Del):

The assessee is a firm of Chartered Accountants. Since 1983, the assessee had an arrangement with a foreign firm whereunder the foreign firm referred work to the assessee through a Calcutta firm in respect of clients based in Delhi and nearby areas. The arrangement was reduced to writing in 1992. In 1996, the foreign firm wanted a firm of Chartered Accountants of Bombay to represent its work in India. Accordingly, an agreement was entered into on 14-11-1996, which was called a release agreement, under which the assessee was to no longer represent the foreign firm in India and thereafter the foreign firm would not refer any work to the assessee. In consideration of the termination of the services of the assessee, the assessee received an amount of Rs. 1,15,70,000/- in terms of the release agreement. The assessee claimed the amount to be capital receipt. The assessing Officer assessed the amount as professional income. The CIT(A) deleted the addition. The Tribunal upheld the decision of the Assessing Officer.

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

“i) The fact that the assessee continued its business or its usual operations even after termination of an agency is of no consequence. If the receipt represents compensation for the loss of a source of income, it would be capital and it matters little that the assessee continues to be in receipt of income from its other similar operations.

ii) There was no evidence that the assessee had entered into similar arrangements with other international firms of Chartered Accountants. The arrangement with the foreign firm was in operation for a fairly long period of 13 years and had acquired a kind of permanency as a source of income. When that source was unexpectedly terminated, it amounted to the impairment of the profit-making structure or apparatus of the assessee. It was for that loss of the source of income that the compensation was calculated and paid to the assessee.

iii) The compensation was thus a substitute for the source. Therefore, the amount of Rs. 1,15,70,000/- received by the assessee in terms of the release agreement represented a capital receipt, not assessable to tax.”

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Nirav Shah

Capital gains: Forfeiture of earnest money: Section 51 r/w. s. 4: A. Y. 2007-08: Earnest money forfeited on cancellation of sale agreement is capital receipt: Not taxable as income:

CIT vs. Meera Goyal; 30 Taxman.com (Del):

The assessee entered into an agreement to sell his house property to a company and in terms of agreement received certain sum as earnest money Since purchaser failed to pay balance consideration by stipulated period, the assessee forfeited the earnest money and claimed same as capital receipt. The Additional Commissioner on reference u/s. 144A directed the Assessing Officer to the effect that earned money so received and forfeited was to be adjusted against the cost of property and capital gain was to be worked out on the basis of the resultant cost as and when the property was sold. However, the Assessing Officer held that entire transaction was a sham transaction in which purchaser attempted to book bogus losses. He accordingly made addition of the forfeited amount. The Commissioner (Appeals) deleted the addition. The Tribunal upheld the order of Commissioner (Appeals) observing that the earnest money was received through banking channels and genuineness of the receipt was not in dispute.

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

“i) The Tribunal has rightly noted that the provisions of section 51 would come into play as it specifically covers this type of a transaction. Once the transaction has been held to be genuine, there is no question of the transaction being without any consideration.

ii) Consequently, there is no merit in the revenue’s appeal, much less any substantial question of law.”

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Nirav Shah

Recovery: Stay of demand pending appeal: Section 220(6) : A. Y. 2010-11: Stay can be granted on the basis of the merits even if there is no financial hardship:

UTI Mutual Fund vs. ITO (Bom); WP(L) No. 523 of 2013 dated 06-03-2013:

In respect of the A. Y. 2010-11, the application of the petitioner u/s. 220(6) for keeping the demand in abeyance till the disposal of the appeal was rejected by the Assessing Officer. The Assessing Officer refused to follow the order of the Bombay High Court (see. UTI Mutual Fund vs. ITO; 345 ITR 71 (Bom); wherein stay was granted in similar circumstances for the preceding year. CIT also rejected application for stay.

On a writ petition filed by the Petitioner challenging the order of rejection, the Department relied on the order of the Karnataka High Court in CIT vs. IBM India Pvt. Ltd.(Kar); ITA No. 31 of 2013 dated 04-02-2013, taking the view that in a revenue matter an interim order should be passed only in the case of genuine financial hardship and not otherwise.

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

“i) The order of the Karnataka High Court cannot be read to mean that consideration of whether an assessee has made out a strong prima facie case for stay of enforcement of a demand is irrelevant. Nor is the law to the effect that except a case of financial hardship, no stay on the recovery of demand can be granted even though a strong prima facie case is made out.

ii) In considering whether a stay of demand should be granted, the Court is duty bound to consider not merely the issue of financial hardship if any, but also whether a strong prima facie case raising a serious triable issue has been raised which would warrant a dispensation of deposit. That is a settled position in the jurisprudence of our revenue legislation. In CEAT Ltd. vs. UOI; 2010 (250) E.L.T. 200 (Bom), the Division Bench of this Court has held as follows. “If the party has made out a strong prima facie case, that by itself would be a strong ground in the matter of exercise of discretion as calling on the party to deposit the amount which prima facie is not liable to deposit or which demand has legs to stand upon, by itself would result in undue hardship of the party.”

iii) Where a strong prima facie case is made out calling upon the petitioner to deposit, would itself occasion undue hardship. Where the issue has raised a strong prima facie case which requires serious consideration as in the present case, the requirement of predeposit would itself be a matter of hardship.

iv) Finally, we express our serious disapproval of the manner in which the Revenue has sought to brush aside a binding decision of this Court in the case of the assessee on the issue of the stay on enforcement for the previous year. The rule of law has an abiding value in our legal regime. No public authority, including the Revenue, can ignore the principle of precedent. Certainty, in tax administration is of cardinal importance and its absence undermines public confidence.

v) For these reasons, we direct that pending the disposal of the appeals for the A. Y. 2010-11 and for a period of six weeks thereafter, no coercive steps shall be taken against the assessee for the recovery of the demand in pursuance of the impugned notices dated 25-02-2013.”

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Nirav Shah

Advance Tax – Levy of interest u/s. 234A/234B/234C is mandatory and the interest could be levied without specific direction in the assessment order.

Karanvir Singh Gossal vs. CIT & Anr. [2012] 349 ITR 692 (SC)

The short point that was involved in the case before the Supreme Court was whether levy of interest u/s. 234A/234B of the Income-tax Act, 1961 ( “the Act”), is mandatory or not. The Supreme Court observed that at one point of time, there was a doubt on the nature of interest payable by the assessee u/s. 234A/234B of the Act and that the controversy was finally settled by its five judge bench decision in the case of CIT vs. Anjum M.H. Ghaswala [2001] 252 ITR 1.

According to the Supreme Court, the position that emerged after the judgment in Anjum Ghaswala’s case (supra) was that if interest is leviable in a given case u/s. 234B/234C, then in such a case that levy is mandatory and compensatory in nature. The recitation by the Assessing Officer directing institution of penal proceedings was not obligatory and penal proceedings could be initiated for such default without a specific direction from the Assessing Officer.

The Supreme Court noted that in the said judgment, it had been held that in appropriate cases, the Chief Commission had an authority to waive the interest.

The Supreme Court observed that in the present case, the assessee had placed reliance on the Circular issued by the Central Board of Direct Taxes, which had been referred to and mentioned in Anjum Ghaswala’s case (supra) and that this aspect had not been considered by the High Court in its impugned order, and it was not considered even by the Tribunal.

For the above reasons, the Supreme Court set aside the impugned orders of the Tribunal as also of the High Court. The Supreme Court directed the Tribunal to consider whether the assessee would be entitled to waiver of interest under the Circular bearing No.400/234/95-IT(B) dated 23rd May, 1996, which had been referred to in the case of Anjum Ghaswala (supra).

[Note: Since the decision of the Punjab and Haryana High Court is not available, it is not clear as to how the reference of initiation of penalty proceedings is made in paragraph 2 above. In the context and considering the cases referred to, the reference to penalty proceedings seems inadvertent. It should instead be read as “the recitation by the Assessing Officer directing levy of interest is not obligatory and interest could be levied for such default without a specific direction from the Assessing Officer.]

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Nirav Shah

Export – Profits derived from export of granite not eligible for deduction under section 80HHC

Tamil Nadu Minerals Ltd. vs. CIT [2012] 349 ITR 695 (SC) Manufacture –

Mining of granite from quarries and exporting them after cutting, polishing, etc. tantamounts to manufacture.

The following question of law arose from determination before the Supreme Court in Civil Appeal No.2997 of 2004.

“Whether the assessee is entitled to claim deduction to the extent of profits referred to in s/s. (IB) of section 80HHC of the Income-tax Act, 1961, derived from export of goods – in this case, granite, for the assessment year 1988-89?”

The Supreme Court answered above question against the assessee in view of its judgment in the case Gem Granites vs. CIT reported in [2004] 271 ITR 322 (SC). In Civil Appeal Nos. 7472-7473 of 2004 the following question of law arose for determination before the Supreme Court.

“Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was right in law in holding that the assessee is entitled to investment allowance on the activities of the assessee, viz., mining granite from quarries and exporting them after cutting, polishing etc., which tantamount to manufacture for the purpose of section 32A of the Income-tax Act, 1961?

The Supreme Court held that this issue was squarely covered in favour of the assessee, vide its judgment in the case of CIT v. Sesa Goa Ltd. [2004] 271 ITR 331 (SC).

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Nirav Shah

Co-operative Society – Income from underwriting commission and interest on PSEB Bonds and IDBI Bonds derived by a banking concern is income from banking business and hence qualified for deduction u/s. 80P(2)(a)(i).

CIT vs. Nawanshahar Central Co-op. Bank Ltd. (2012) 349 ITR 689 (SC)

The following two questions, arose for determination before the Supreme Court: (a) Whether the High Court was justified in holding that the respondent-assessee was entitled for deduction u/s. 80P(2)

(a)(i) of the Income-tax Act, 1961, in respect of income from underwriting commission and interest on PSEB Bonds and IDBI Bonds?

(b) Whether the High Court was justified in affirming the decision of the Tribunal that the income earned by the assessee which was derived from underwriting the issue of bonds and investments in PSEB Bonds was in the nature of income from banking business and hence qualified for deduction u/s. 80P(2)(a)(i) of the Income Tax Act, 1961 ?

The Supreme Court dismissed the appeals filed by the Department in view of its decision in CIT vs. Nawanshahar Central Co-op. Bank Ltd. (2007) 289 ITR 6 (SC).

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Nirav Shah

Business Expenditure – Interest paid in respect of borrowings for acquisition of capital assets not put to use in the concerned financial year is allowable as a deduction u/s. 36(1)(iii).

Vardhman Polytex Ltd. vs. CIT (2012) 349 ITR 690 (SC)

The assessee, who was engaged in the business of yarn, filed its return of income for the assessment year 1992-93 declaring its taxable income at Rs. 3,59,86,359/-. A revised return thereafter was filed declaring taxable income of Rs. 3,48,09,071/-. In the computation of income filed alongwith the revised return, the assessee claimed additional deduction amount of Rs. 1,97,290/- and Rs. 9,80,000/- on account of interest u/s. 36(1)(iii) and up front fees respectively. The claim was made on account of loans raised for set up of a new unit at Baddi (HP). The Assessing Officer, in view of the fact, that the loan was raised for setting up a new unit for creating a capital asset which was yet to come into production, disallowed the interest, relying upon Explanation 8 to section 43(1).

The Commissioner of Income Tax (Appeals) allowed the appeal of the assessee and the Tribunal rejecting the appeal of the Revenue approved the order passed by the Commissioner of Income Tax (Appeals).

The Full Bench of the Punjab and Hariyana High Court reversed the order of the Tribunal [CIT vs. Vardhaman Polytex Ltd. – 299 ITR 152 (P & H) (FB)] holding that the loan was not raised for the purpose of running of the business for its day to day requirements, but for the purpose of creating additional assets, new capacity at a new location and as such the interest on the loan was not deductible u/s. 36.

The Supreme Court reversed the order of the High Court following its judgement in Deputy CIT vs. Core Healthcare Ltd. reported in (2008) 298 ITR 194(SC).

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Nirav Shah

Charitable Trusts – Depreciation on Cost of Assets Allowed as Application of Income

Issue for Consideration

U/s. 11 of the Income Tax Act, 1961, a charitable or religious trust, subject to certain conditions,is entitled to exemption in respect of income from property held under trust for charitable or religious purposes, to the extent that such income is applied for charitable or religious purposes, or accumulated for charitable or religious purposes.

The CBDT has clarified vide its circular number 5 – P(LXX-6) dated 19th June 1968 that for the purposes of such exemption u/s. 11, the income of a trust is to be taken in the commercial sense, and not as computed under the provisions of the Income Tax Act. In other words, the income, that is eligible for exemption, is the one that has been determined as per the books of account. This position clarified by the CBDT is also confirmed by the decisions of the various high courts .

Taking this into account, various high courts have also held that that depreciation had necessarily to be deducted in computing the commercial income, as depreciation was a necessary accounting adjustment to income. Further, various courts, including the Supreme Court in the case of M. Ct. M. Tiruppani Trust vs. CIT 230 ITR 636, have held that all capital expenditure laid out in furtherance of the objects and purposes of the trust would be treated as an application of the income.

The question that has arisen before the courts as to whether, when a trust has claimed the capital expenditure on acquisition of an asset as an application of income for the purposes of claiming exemption u/s. 11, whether depreciation on such asset was also allowable as a deduction in computing the income of the trust. While the Bombay, Punjab and Haryana and Delhi High Courts have taken the view that depreciation would be allowable as a deduction even in such cases where the capital expenditure had been allowed as an application of income for charitable purposes, the Kerala High Court has taken a contrary view, holding that such depreciation should be added back to the income of the trust as disclosed in its books of account.

Institute of Banking Personnel Selection’s case:

The issue came up before the Bombay High Court in the case of CIT vs. Institute of Banking Personnel Selection 264 ITR 110. In that case, the assessee was a charitable trust registered under the Bombay Public Trusts Act, 1950, as well as u/s. 12A of the Income Tax Act. It claimed depreciation on buildings, the cost of which had been allowed as a deduction in earlier years. It also claimed depreciation on furniture and fixtures which had been received by transfer from another trust, whose income was also exempt u/s. 11, and which had claimed the cost of such furniture and fixtures as an application of income in earlier years. The Assessing Officer disallowed the depreciation on buildings as well as on furniture and fixtures, on the grounds that capital expenditure incurred was allowed as a deduction from the income of the assessee, and that if depreciation was allowed, it would result in double deduction as full capital cost of furniture and fixtures had been allowed.

The Bombay High Court referred to its earlier decisions in the cases of CIT vs. Munisuvrat Jain Temple Trust (1994) Tax LR 1084 and DIT(E) v Framjee Cawasjee Institute 109 CTR 463. In the first case, it had been held that the income of a charitable trust was liable to be computed in normal commercial manner, although the trust might not be carrying on any business and the assets in respect whereof depreciation was claimed might not be business assets. It was also held that section 32 of the Income Tax Act would not apply to such depreciation, and that income was to be computed after providing for allowance for normal depreciation, and deducting such depreciation from gross income of the trust.

In Framjee Cawasjee Institute’s case, it was held that though the amount spent on acquiring the assets had been treated as application of income of the trust in the year in which the income was spent on acquiring those assets, that did not mean that in computing income from those assets in subsequent years, depreciation in respect of those assets could not be taken into account.

The Bombay High Court followed its earlier decisions and took the view that depreciation was allowable even on those assets whose actual cost had been allowed as a deduction in computing the income of the earlier years. A view similar to that of the Bombay High Court has been taken by the Punjab and Haryana High Court in the case of CIT vs. Market Committee, Pipli 330 ITR 16 and by the Delhi High Court in the case of DIT vs. Vishwa Jagriti Mission 73 DTR (Del) 195.

Lissie Medical Institutions’ case:

The issue also came up before the Kerala High Court in the case of Lissie Medical Institutions vs. CIT 76 DTR (Ker) 372.

In this case, the assessee was a charitable institution registered u/s.12A, and running a hospital. It acquired medical equipment, such as x-ray units, scanning machines, etc., the expenditure for acquisition of which was treated as application of income for charitable purposes u/s. 11. In computing the income from the hospital, the assessee also claimed depreciation on such equipments, on assets acquired during the year as well as on assets acquired during earlier years.

The Assessing Officer was of the view that the assessee’s case was that of a double deduction of capital expenditure, since acquisition of assets was treated as acquisition of income for charitable purposes, and the value of the assets stood fully written off. On appeal, the tribunal, following the judgment of the Supreme Court in the case of Escorts Ltd vs. Union of India 199 ITR 43, confirmed such disallowance.

On a further appeal by the assesee, the Kerala High Court observed that if the assessee treated an expenditure on acquisition of assets as application of income for charitable purposes u/s. 11, and the assessee also claimed depreciation on the value of such assets, then in order to reflect the true income that was available for application for charitable purposes, the assessee should write back the depreciation amount in the accounts to form part of the income to be accounted for application for charitable purposes. If this was not done, according to the Kerala High Court, the income which would be available for application for charitable purposes got reduced by the depreciation amount, which in the court’s view was not permissible u/s. 11. The net effect in a case where an assessee claimed depreciation in respect of an asset the full value of which was claimed as an application of income for charitable purposes, such notional claim of depreciation became cash surplus available with the assessee, which remained outside the books of account of the trust, unless it was written back, which was not done by the trust.

The Kerala High Court observed that it did not think it was permissible for a charitable institution to generate income outside the books in this fashion. The Kerala High Court noted that in all the other decisions cited before it of the other high courts, none of the courts had examined the aspect of availability of income to the trust on write back of the depreciation, in cases where depreciation was claimed as a notional cost after the assessee claimed 100% of the cost incurred for it as application of income for charitable purposes, the depreciation so claimed was to be added back as income available.

Interestingly, the Kerala High Court, on a consideration of the clarification of the CBDT filed before it, observed that based on the decisions of other high courts, all the charitable institutions were generating unaccounted income equal to the depreciation amount claimed on a year-to-year basis, which was nothing but black money, and that this aspect had not been considered in any of these decisions.

The Kerala High Court also was of the view that the issue was covered by the decision of the Supreme Court in Escorts’ case (supra), where the Supreme Court had observed that “the mere fact that a baseless claim was raised by some overenthusiastic assessees who sought a double allowance or that such claim may perhaps have been accepted by some authorities is not sufficient to attribute any ambiguity or doubt as to the true scope of the provisions as they stood earlier”.

However, considering the fact that depreciation had been allowed for several years to the assessee, the Kerala High Court observed that the assessee could not be taken by surprise by disallowing depreciation, which was being allowed for several years. It therefore allowed the assessee to write back the depreciation for the year before it, and even for previous years, and carry forward such income for application for subsequent years.

Observations

The CBDT, in spite of its clarification vide its circular number 5 – P(LXX-6) dated 19th June 1968 that for the purposes of such exemption u/s. 11, the income of a trust is to be taken in the commercial sense, and not as computed under the provisions of the Income Tax Act put forward following the interesting contention before the Kerala High Court that seem to have appealed to the court to a great extent :

“The CBDT is of the considered view that where an assessee has acquired an asset, through application of income and has also claimed this amount as expenditure in its income and expenditure account, depreciation on such assets would not be allowable to the assessee. Such notional statutory deductions like depreciation, if claimed as deduction while computing the income of the property held under trust under the relevant head of income, is required to be added back while computing the income for the purpose of application in the income and expenditure account. This would imply that the correct figure of surplus from the trust property is reflected in the income and expenditure account of the trust to determine the income for the purposes of application under section 11 of the Income Tax Act. This would reduce the possibility of revenue leakage which may be a cause for generation of black money.”

One fails to understand as to why depreciation should be written back in the books of account of the assessee, when it is otherwise a charge on the profits of the year and is required to be provided for as per the accounting standards and practices. The accounts will represent a fallacious view where on one side it provides for the depreciation and on the other side it credits a write back of the same depreciation. Again, it is impossible to fathom as to how black money could ever be generated by not writing back depreciation, because there is no outflow of funds from the trust, depreciation is merely a notional entry in accordance with accounting standards and practices. At best, there is a reduction in the commercial profit of the trust.

Perhaps, what the CBDT desired was that in computing the commercial income for the purposes of grant of exemption, the amount of such depreciation should be added back and treated as income available for application for charitable purposes, since the cost of the assets had been treated as an application of income for charitable purposes. This desire however, is not set out in the provisions of the Act and in any case is contrary to its own circular clarifying that the profit of the trust is the one that is understood in the commercial sense and as a consequence thereof has to be computed in the manner as is computed by a commercial man, i.e after providing for depreciation on the assets used by it, irrespective of the fact that the cost of it is treated as an application of income and as a consequence of such treatment is allowed, as a deduction in computing the income of the trust.

Can such depreciation ever be regarded as an income of the trust in commercial terms? In the context of repayment of loan scholarships by scholars who had taken loans by way of scholarships for their studies from a trust, the CBDT had clarified, vide Circular No. 100 dated 24-01-1973 that when such loans were given, they should be treated as an application of income for charitable purposes, but that the re-payment of the loans should then be regarded as income of the trust. No such clarification is issued in the context of application of income qua the capital assets and incidental claim if depreciation thereon. The said circular in fact, supports the view of the assessee, where it goes on to state that the repayment of loan by a trust originally taken is an application of income in the hands of the trust. The Bombay High Court, in the case of CIT vs. Trustees of Kasturbhai Scindia Commission Trust 189 ITR 5, had held that return of a loan by a debtor to a creditor could never constitute an income, even though the trust might have got a deduction as an application for charitable purposes for the amount of loans given, in the year of grant of such loans. By the same logic, depreciation provided by a trust can never be added back as its income, as it is never commercially considered to be income.

The Punjab and Haryana High Court in the Market Committee’s case (supra) has rightly observed, in relation to the argument that allowance of such depreciation amounted to a double deduction and therefore was covered by the decision in the Escorts’ case (supra), that it was not a double deduction. The court observed that the income of the assessee being exempt, it was only claiming that depreciation that was required to be reduced from the income for determining the percentage of funds that were to be applied for the charitable purposes. According to the Punjab and Haryana High Court, it was therefore not a case of a double benefit, and that the decision in the Escorts’ case (supra) was distinguishable.

Similarly, the Delhi High Court in the Vishwa Jagriti Mission’s case (supra), while noting the various High Court decisions holding that depreciation was a necessary deduction in computing the commercial income, observed that the allowance of depreciation was necessary on commercial principles. It distinguished the Escorts’ case on the grounds that the Supreme Court, in that case, was not concerned with the case of a charitable trust involving the question as to whether its income should be computed on commercial principles in order to determine the amount of income available for application to charitable purposes, but was dealing with a case where a deduction was allowed in computing business profits and depreciation was also being claimed while computing business profits. In case of charitable trusts, what was relevant was only the concept of commercial income as understood from the accounting point of view, and there was an authority for the proposition that depreciation was a necessary charge in computing the net income. The Delhi high court also noted that the Supreme Court was concerned with a case where the assessee had claimed deduction of the cost of an asset u/s. 35, which allowed deduction for capital expenditure incurred on scientific research, and the question was whether, after claiming deduction in respect of the cost of the asset u/s. 35, whether the assessee could again claim deduction on account of depreciation in respect of the same asset. The Supreme Court in that case had observed that under general principles of taxation, double deduction was not intended unless clearly expressed and , the case before it was not one of that type.

A capital expenditure is treated as an application of income for charitable purposes, under the Act, while depreciation is a deduction in computing the income itself, which is available for application for charitable purposes. These are two different things. Claiming the cost of an asset as an application for charitable purposes is not the same thing as providing depreciation in computing the profit available for spending for charitable purposes. This is therefore not a case of a double deduction.

The better view of the matter therefore seems to be that of the Bombay, Punjab and Haryana and Delhi High Courts which holds that reduction of depreciation from the income is not a double deduction. The view taken by the Kerala High Court requires reconsideration.

Nirav Shah

Law will Take its Own Course

‘Law will take its own course’ – we hear this phrase whenever there is a serious law and order situation, a case involving a politician, a celebrity or a rich and mighty.

What does this phrase mean? For a layperson, it connotes that justice will be done – the guilty will be punished while a person who is not guilty will be not harassed and acquitted within a reasonable time. The law will treat all persons equally and equitably. Is this a utopian expectation?

When an ordinary person is accused of a wrongdoing, he is arrested immediately for investigation; for him getting bail becomes a nightmare; he or she has to spend days in jail. We saw this when two young girls were arrested for making a comment on the Facebook, we saw this when artists drew cartoons which were critical of the political system or politician. On the other hand, when MLAs allegedly thrashed a police officer within the precincts of the Legislative Assembly, one had to wait for the accused MLAs to surrender and the Home Minister declared that the CCTV footage is inconclusive. When politicians make a hate speech, the arrest has to wait till the enquiry is complete. So much for the law taking its own course!

Does the law take its own course? One wonders! In fact, often, the law does not have its own course at all. Law enforcing agencies and persons with political patronage can influence and drag the law on the course that they want or desire to suit their convenience. At times, law enforcing agencies are used by the government of the day to serve its political goals.

When somebody says that law will take its own course, possibly he or she actually means that after getting bail the law will be made to take a long winding course before reaching any logical conclusion, if at all it reaches any such conclusion. In fact, when a celebrity or a politician uses that phrase and expresses his great respect for and belief in the legal system in general and judiciary in particular, he actually expresses his ability to influence or delay the legal process; he believes in the proverb – ‘This too shall pass’. We have a film celebrity facing prosecution for hit-and-run accident and hunting of blackbucks. Both the cases are pending for over a decade while the celebrity is leading his normal life.

Recently, the Supreme Court gave its verdict in Mumbai Blasts case 20 years after the event occurred. Conviction of a large number of persons has been upheld. But the media focussed on only one celebrity convict. There is already a clamour for leniency and pardon for him on the ground that he has gone through mental torture all these years and that is a good enough punishment. A retired judge of the Supreme Court, the film fraternity and many others are pleading his case. We forget there are other convicts who have gone through similar agony, some of whom had unwittingly become part of the whole episode and the law took its own course in their case.

While often the law does not take the desired course, at times the law makers avoid enacting an effective law so that there is no question of law taking its own course. (We are still waiting for the law on Lokpal.) Then at times, the law makers enact the law that suits them and ensure what course the law should take. In the Income tax Act there are provisions (existing and proposed) to curb unaccounted money. If a person buys or sells immovable property or buys shares of unlisted company etc. at less than the prescribed value, the difference is charged to tax on the presumption that unaccounted money has exchanged hands. If a charitable trust receives anonymous donations, the trust is taxed on the premises that such donations are out of unaccounted money. In the Finance Bill, 2013 there is also a provision for disallowing deduction to the donor for cash donations made to political parties. But there is no provision to tax political parties for the anonymous donations received by them so long as the amount of each donation in the accounts does not exceed Rs. 20,000.

According to a study conducted by the Association of Democratic Reform (working across the country for transparency in political and electoral system), a very substantial portion of the contributions collected as donations or `sale of coupons’ by political parties is in cash or anonymous. One has to only guess the source or nature of these funds. All such collections are exempt from income tax in the hands of political parties. Article 14 of the Constitution of India strikes at arbitrariness and ensures fairness and equality of treatment. But it also permits rational classification. And after all, political parties are a class by themselves!

Sanjeev Pandit
Editor

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Nirav Shah

A Bird at the Window

It was a beautiful spring morning. Disciples had gathered in a hall to listen to a discourse by Buddha. People were eagerly awaiting his arrival and looking forward to an enlightening discourse. Buddha entered the hall and a hushed silence enveloped the disciples as everyone became quiet. Buddha took his seat and was about to commence his talk when a strange thing happened. A pretty little bird flew in and alighted on the window. It looked around at the august gathering, fluttered its pretty little wings and burst out in a melodious song. After delighting the onlookers with its clear notes, the bird spread its wings and flew away. Buddha commenced his discourse. He just told the gathering that the lesson of the day was over! The little bird had taught everything that Buddha wanted to teach on that day!

The questions for us are:

• What was the lesson taught by the bird!

• What was the message that Buddha gave!

The message was: lead a simple peaceful life. Our lives should be like that of the bird: ‘come to the window of the world, live a natural peaceful carefree life, look, admire and enjoy what is around, sing our song and fly away free from all cares, without a trace of attachment to what is left behind in essence, live in the present. Be like the bird – it was neither haunted by the past nor filled with anxieties of the future. It sang in the present’. Questions which arise are: Can we ever live such a life? Is it possible to lead such a peaceful serene life?

I believe it is possible. Was our life not like that when we were children? Our days were filled with fun and laughter. We went around playing, singing without a care. We were not even worried about the unfinished homework which we had to do and take to the school the next day. We built sand castles on the sea shores, not bothered that the next tide will wash away all that we had carefully built. Our lives were like that described in the ghazal sung by Jagjit Singh…

At the end of the day, tired and exhausted we went to sleep and migrated to the land of dreams which had rainbows and rivers, stars and moon and we were princes or princesses just enjoying. Yes, life was carefree like that of the little bird at the window. Let us then, take a lesson from the little bird and learn to live a carefree life. In other words, a life of acceptance and not expectations.

We live when we are true to ourselves and are not living to please others. Our only obligation is to be true to ourselves. I am not for a moment suggesting a selfish, self-centred life because a life led to please our inner self can never be selfish or self cantered.

One recalls the story of Akbar and Tansen. Akbar considered Tansen to be the greatest singer, which Tansen never accepted. According to Tansen, his Guru Swami Haridas was the greatest, and he, Tansen, was no match. Akbar wanted to call Swamiji to his court to listen to him. Tansen told him that that was not possible. One had to go to Swami Haridas, and wait till Swamiji chose to sing. Tansen took Akbar where Swamiji used to stay and made him wait till Swami Haridas chose to sing. As divine music flowed from Swamiji, calm prevailed and the whole atmosphere became peaceful. Akbar listened with rapt attention and became totally spellbound.

He had no doubt and was totally convinced that Swami Haridas was the greatest. He still could not understand as to why Tansen, a disciple of Swamiji could not reach the heights attained by Swamiji. When asked by Akbar, Tansen explained: He said, “It is simple. While I sing for you, Swami Haridas only sings for God!”

It is only when we dedicate our work to God that music flows in and from our life and we become like the bird on the window who came, sang, gave us pleasure and left without expectation – it was free.

So, let us offer our work to God and be free.

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Nirav Shah

Accountability

The ancient Romans had a tradition: whenever one of their engineers constructed an arch, as the capstone was hoisted into place, the engineer assumed accountability for his work in the most profound way possible: he stood under the arch. (Quoting Michael Armstrong)

We talk of accountability of government and government agencies, public companies and NGOs. Then there is accountability of individuals – those working in a group or team as well as in their individual capacity. Accountability of an individual is not restricted only to his work but extends to his family and the social circle within which he moves.

At times accountability is fixed by law, rules and regulations. This can be considered as the statutory accountability. In every civilised society there are regulators appointed under various statutes which seek accountability from organisations and individuals. There regulators oversee that organisations and individuals remain accountable.

When it comes to governments and organisations (commercial or otherwise), transparency in their affairs often brings about better accountability. That has been the genesis of ‘Right to Information’. Generally, when governments and organisations have to disclose more, their policies, decisions and actions are such that they become more accountable. After all, sunlight is the best disinfectant!

It is also a fact that the scope of statutory accountability in various fields has been increasing. This is true of various professions, professionals as well as organisations. May be this is due to the fact that there is an attempt from those accountable to limit their accountability.

An auditor may feel that he is accountable only to the shareholders to whom he reports. But today, he is accountable, responsible and liable not only to the shareholders, but also to many other stakeholders like potential investors, lenders, employees of the company and many more.

When CAG questions decisions and actions of the Government, his powers and jurisdiction are questioned and thus avoiding accountability.

Political parties talk of being accountable to people, serving the people. But when it comes to being transparent about their affairs, these parties take shelter behind technicalities. All major political parties are united in opposing the recent order of the Central Information Commission holding political parties as ‘Public Authorities’ and ordering them to disclose information. There is even the talk of promulgating an Ordinance to amend the Right to Information Act to keep the political parties outside the purview of the RTI.

Often, there is a conflict (either perceived or real) while doing one’s duty when one is accountable in more than one way or to those whose interests may be conflicting. Such a conflict is not unique to one profession but it may arise in various situations. For example, a bureaucrat or a police officer is accountable to his political master, his colleagues and also to the public (not necessarily in that order). Given our system, one can imagine the plight of an honest government servant. This may happen to a lawyer, a chartered accountant, an independent director, or for that matter any person. These are tricky situations where one needs to reason, reconcile, muster courage and above all, listen to one’s conscience. Certainly, this is not easy.

Accountability of media – whether it is the print media or the electronic media – is another area which raises a lot of debate. No doubt, the media has played a yeoman role in drawing public attention to scams, corruption, and the plight of people who have suffered injustice. Media depends on news and at times on creating news, sensationalising events and conducting trial by media under the garb of debates. The controversy raised by Radia tapes which disclosed the role played by some senior journalists in government affairs or promoting certain industrial houses is still fresh in mind. Freedom of speech and expression is of utmost importance and media plays and has an important role in safeguarding that. It can do that only if the media itself is accountable and takes that accountability seriously.

Rules and regulations may impose accountability. But the true accountability is “the quality or state of being accountable; especially: an obligation or willingness to accept responsibility or to account for one’s actions”. (http://www.merriam-webster.com/dictionary/accountability) It is a state of mind, a sense of doing one’s duty with clear conscience.

In this Special Issue, we bring you articles from respected persons from various fields – Mr. S. E. Dastur, Senior Advocate, Padmashree Mr. T. N. Manoharan, past President of our Institute and Mr. Jaideep Bose, Editorial Director, the Times of India dealing with the issue of accountability and duty. My special thanks to each of them for sharing their thoughts. This month, the features – Namaskar, Accounting World and RTI also deal, directly or indirectly, with the issue of accountability.

With this issue of the Journal, I pass the baton to Mr. Anil Sathe who will take over as the Editor of this Journal.

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Nirav Shah

Laxman Rekha – Accountability

At his best, man is the noblest of all animals, separated from law and justice he is the worst’. —Aristotle.

The issues for us are:
• what do we mean by ‘Laxman Rekha’. Is it an imaginary line or does it prescribe the limits of human behaviour ?
• why is it prescribed only for humans ? and
• what are the consequences of crossing the ‘laxman rekha’ ?

I don’t have the answers but will still make an attempt to share my thoughts on these perennial issues. In my view, ‘laxman rekha’ is meant for us humans because we have the capacity to think and act. Other creations act according to their nature as they don’t have the faculty of thinking.

‘Laxman Rekha’ I believe is a code of conduct for us — human beings – laid down by us as members of society.

Whenever a person crosses the ‘laxman rekha’, he/she faces the consequences – our epics and history depicts this. For example :

• When Bali – a very learned and powerful ruler crossed it by co-habiting with his brother’s wife – and usurping his kingdom, he met his end at the hands of Ram.

• Aahilya for wrongly and not wilfully crossing the ‘laxman rekha’, became a stone and had to wait for Ram to revive her.

• Sita had to go through ‘ágni pariksha’ and suffer separation from Ram for crossing the ‘laxman rekha’.

• Draupadi crossed the ‘laxman rekha’ of a ‘good host’ when she called Duryodhan ‘andhi ka beta andha’ and she sowed the seeds of war – Mahabharat.

• Clinton crossed the ‘laxman rekha’ for his immoral behaviour and was impeached. He apologised and survived but the damage he did to the office of the President survives. The blemish hasn’t gone away despite his services to society.

• Cancer survivor and cancer care evangelist Lance Armstrong – super cyclist and super hero – the man whom fame and fortune favoured, confesses to the use of drugs and paid a big price – loss of respect.

• Walmart, the largest retailer in the world has been charged for violation of Foreign Corrupt Practices Act for indulging in bribery and corruption in Mexico. This has resulted in Walmart initiating investigations in India and China. Newspapers report that some officers, vendors and consultants have been suspended in India and expansion of Bharti Walmart is on hold — the result – loss of reputation and business, and possibility of prosecution in the USA.

• Ramalinga Raju – the founder of Satyam suffered in prison for over two years and is facing a host of civil and criminal cases.

• Recently, our Law minister had to resign for interfering with investigation reports.

The list is metaphorically unending.

It is a fact that the pain of leaders and icons crossing the ‘laxman rekha’ for the followers becomes personal – which makes the followers revolt both mentally and physically.

Consequences of crossing the ‘laxman rekha’ are visible in society today – the cancer of corruption is having disastrous consequences on governance and economic and social environment and behaviour. The way our parliamentarians (leaders) behave in parliament – exhibits a kind of violence which is abhorring. The tragedy that it is that these very leaders ask us not to indulge in violence and remain within ‘laxman rekha’. They forget it is not words but actions which are emulated by people. Parliament is a forum created to discuss, debate and decide and not for storming into the well and tearing bills being tabled. It is a forum created to create laws and not break laws. Our leaders have probably forgotten the maxim: ‘lead by example’.

All this violence of crossing the ‘laxman rekha’ is for us to feel – Society is on tenterhooks and explosive. At the drop of a hat we have strikes, dharnas and violence – which I reiterate are nothing but consequences of crossing the ‘laxman rekha’. We are experiencing violence of all kinds — we have become intolerant and are sacrificing our right to express the banning of books, art, people and movies that is not only adversely impacting us, but will also affect future generations. Salman Rushdie christens the present environment as ‘cultural emergency’. Shobhaa De says ‘we are living in the republic of hate and nightmares’. We as a nation cross the ‘laxman rekha’ when we stifle ‘freedom of speech’, a fundamental right guaranteed by the constitution. We are giving up the concept of – ‘live and let live’. Any time whether at home or at office or as citizen the moment, I indulge in ‘you have no right’, I am crossing the ‘laxman rekha’ of tolerance and this crossing leads to strife. Believe me, the ‘right to express’ includes the ‘right to dissent’ Mr. Manish Tewari, our Minister for Information and Broadcasting affirms that :

‘Freedom of expression must include right to offend’.

‘Laxman rekha’ is not only for sinners or saints or for those in power but is also for us – the normal – the householder, the office goer and the entrepreneur – who despite corruption value ‘values’.

It is a sad fact that we are unconsciously imbibing the culture of conflict, crime and corruption and I dare say all of us are directly or indirectly have contributed to it and are affected and impacted by this. We are impatient and intolerant. We need to remember that today’s leaders have risen from amongst us. We in India and probably people across the world have crossed the ‘Laxman rekha’ – the result is unrest. Let us not forget that all crimes – social or economic – represent crossing the ‘laxman rekha’. For example:

• The Chief Minister of a State – a beloved leader – wants her driver to be whipped for being 15 minutes late – the Times of India of 08-02-2013.
• Khaps in Haryana and Punjab have mandated and ensured that a couple though married be separated because marriage between the two castes to which they belong is not permitted by custom.
• Minister of a State is said to be involved in the murder of a police officer.
• Members of a state assembly are charged with assaulting a police officer. The questions we have to ask ourselves are :
• Is this the secular India we gave ourselves and was dreamt by the leaders who drafted our Constitution
• Is this non – tolerant environment that we want to live in and leave for our children.

The issue is: if this is what we don’t want, then what should we do to contain this and bring back the culture of love, compassion and confidence in law to live within the ‘laxman rekha’ and be happy.

I believe ‘laxman rekha’ is the litmus test of accountability not only for the society but for each one individually. Hence , it is for us as members of society to lay down, modify or reject the norms. We are the ones who cross or maintain the ‘laxman rekha’. Being an optimist, I believe that there is a ray of hope because there is a silent revolt against the present environment of corruption and intolerance. Ministers are resigning apparently because of intolerant behaviour of a chief minister. The recent protests against corruption and misbehaviour (rape) are instances of this resurgence. People and press are talking about ‘ethical values’. We also now have the Right to Information Act – which is bringing transparency in governance and probably instilling some ‘fear of retribution’ in those who govern – the powerful. It was Kahlil Gibran who said:

‘Life without freedom is like a body without a soul and freedom without thought is like a confused spirit’.

To bring ‘laxman rekha’ back in society, let us join this silent movement by contributing to it both ‘time and money’. Gandhi had resilience. It was his faith in our desire and need for freedom that gave us freedom. Let us develop ‘resilience’ and return to ‘values’ even despite having been bent and battered. Let us revive the spirit to live by ‘values’ by living ‘values’. This will be our legacy to the young and coming generations.

Let us do and we can. Let us not cross ‘laxman rekha’. Let us bring back ‘accountability’.

Nirav Shah

Safe Harbour Provisions in Indian Transfer Pricing Regime

Recently, CBDT has notified the much awaited “Safe Harbour Rules”, which at present are applicable to certain select International Transactions. Rules 10TA to 10TG and Form no. 3CEFA have been notified and the same have come into force from the date of their publication in the Official Gazette i.e. 18th September, 2013. These Rules aim at reducing litigation in the arena of Transfer Pricing. This article analyses various provisions, their impact and potential issues that may arise there from.

Introduction

The genesis of “Safe Harbour Rules” (SHR) in India is found in the Finance (No. 2) Act, 2009 whereby the Government of India empowered CBDT to formulate safe harbour rules vide insertion of section 92CB. The Memorandum explaining provisions of the Finance Bill mentioned the objective for introduction of SHR is to reduce litigation. A safe harbour has been defined to mean circumstances in which the Income-tax authorities shall accept the transfer price declared by the assessee.

The United Nation’s Practical Manual on Transfer Pricing for Developing Nations released in the year 2013 defines Safe harbour rules as follows: “Safe harbour rules are rules whereby if a taxpayer’s reported profits are below a threshold amount, be it as a percentage or in absolute terms, a simpler mechanism to establish tax obligations can be relied upon by a taxpayer as an alternative to a more complex and burdensome rule, such as applying the transfer pricing methodologies”.

OECD Transfer Pricing Guidelines defines a safe harbour as “a provision that applies to a defined category of the taxpayers or transactions and that relieves eligible taxpayers from certain obligations otherwise imposed by a country’s general transfer pricing rules.”

Globally, SHR aim at reducing litigation and compliance cost, providing certainty, reduction in documentation etc. It would be pertinent to note that Indian SHR does not give any relief from maintenance of rigorous documentation to justify arm’s length pricing.

Let us proceed to analyse some of the salient features of the Indian SHR.

Applicability of SHR

Selection of Option (Rule 10TE)

Safe Harbour provisions are applicable in respect of select international transactions (Refer Table below) in respect of those assesses who specifically opts for the same by filing a declaration in Form 3CEFA. The validly exercised option shall continue to remain in force for the period specified in Form 3CEFA or a period of five years, whichever is less. An Assessee has an option to opt out of the safe harbour provisions for any assessment year by fur-nishing a declaration to the Assessing Office (AO) to that effect.

SHR applicability is subject to filing the return of income of the relevant Assessment Year (AY) in time as well as furnishing every year a statement to the AO, before furnishing the return of income of that year, providing details of eligible transactions, their quantum and profit margins or the rate of interest or commission.

Transactions with Tax Havens (Rule 10TF)

Benefit of safe harbour rules is not available in respect of transactions entered into with an associ-ated enterprise located in any country or territory notified u/s. 94A or in a no tax or low tax country or territory. To illustrate, an Indian company who has given a loan to its wholly owned subsidiary in one of the free trade zones of UAE, cannot opt for the safe harbour provisions.

Select International Transactions and Safe Harbour Limits

Other Important Features

Eligible Assessee

Rule 10TB defines “Eligible Assessee” to mean a person who has exercised a valid option for application of safe harbour rules in accordance with the procedure laid down in Rule 10E [refer paragraph on Selection of Option (Rule 10TE) supra] and is engaged in eligible international transactions (as mentioned in the Table herein above).

Significance of “Insignificant Risk”

Rule 10TB further provides that in case of assessees who are engaged in software development, ITES, KPO or contract R&D services in software or generic pharmaceutical drug sectors, they must be working with “insignificant risk” profile. Insignificant risk of the assessee is broadly classified as circumstances wherein foreign principal takes all major risks relating to capital and funds, performs most of the economically significant functions, conceptualises and designs the product, controls and supervises the assessee and owns legal, economic and commercial rights in the intangible generated or outcome of the services. (Refer Clauses 2 & 3 of the Rule 10TB)

Mutual Agreement Procedure

Rule 10TG provides that where the transfer price is accepted by the income tax authorities u/s. 92CB, the assessee shall not be entitled to invoke mutual agreement procedure under a DTAA or specified territory outside India as referred to in sections 90 or 90A.

Operating Expenses

Rule 10TA (j) defines “Operating Expense” as mentioned below:

“Operating Expense” means the costs incurred in the previous year by the assessee in relation to the international transaction during the course of its normal operations including depreciation and amortization expenses relating to the assets used by the assessee, but not including the following, namely:-

(i) interest expense;

(ii)    provision for unascertained liabilities;
(iii)    pre-operating expenses;
(iv)    loss arising on account of foreign currency fluctuations;
(v)    extra-ordinary expenses;
(vi)    loss on transfer of assets or investments;
(vii)    expense on account of income-tax; and
(viii)    other expenses not relating to normal operations of the assessee;

Rule 10TA (k) defines “ Operating Revenue” as mentioned below:

“Operating Revenue” means the revenue earned by the assessee in the previous year in relation to the international transaction during the course of its normal operations but not including the following, namely:-

(i)    interest income;
(ii)    income arising on account of foreign currency fluctuations;
(iii)    income on transfer of assets or investments;
(iv)    refunds relating to income-tax;
(v)    provisions written back;
(vi)    extraordinary incomes; and
(vii)    other incomes not relating to normal operations of the assessee;

From the above definition, one can draw the conclusion that while doing benchmarking analysis (even otherwise than for safe harbour), one may adjust expenses and income on above lines such that revenue and expenses of other companies/entities become comparable by removing abnormality. For the purpose of safe harbour we need to consider depreciation and amortisation expenses, however for doing a normal TP analysis one may compare profits before depreciation and amortisation if there is a significant difference in assets employed of comparable companies.

Some issues/important points to be noted

Safe harbour provisions as notified now do leave some gaps or issues unanswered. Some of these issues which come to our mind are as follows:

(i) Documentation

Clause (5) of Rule 10TD provides that the provisions of section 92D (pertaining to maintenance of documentation) in respect of international transaction shall apply irrespective of the fact that the assessee exercises his option for safe harbour in respect of such transaction. There is no respite from maintaining documentation even if one opts for safe harbour provisions.

(ii) No Comparability Adjustment

Clause (4) of Rule 10TD provides that once the assessee opts for safe harbour provi-sions, he is not eligible for comparability adjustment and allowance under the second proviso to s/s. 92C which provides for al-lowance/variation of 3 % between the arm’s length price determined under the Income-tax Act, 1961 and the price at which the international transactions have actually been undertaken. This provision is appropriate in that if additional allowance/adjustment of 3 % is allowed to the safe harbour margin then it will dilute the acceptable profit margin to that extent.

However, the difficulty may arise when the foreign country does not accept the safe harbour margin of an Indian entity and disallows excess compensation/expenses (which may be required to fall within Indian SHR). In this situation, if Indian entity has opted for safe harbour benefit, then it cannot invoke Mutual Agreement Procedure also and it will have to live with some double taxation.

(iii)No Threshold-Safe Harbour

Unlike Domestic Transfer Pricing, there is no threshold for application of transfer pricing in respect of international transactions.

Global Trends

Developments at OECD

OECD has revised its stand on safe harbour pro-visions in the recently amended guidelines on Transfer Pricing. Earlier OECD members did not favour safe harbour rules as they challenge the fundamental concept of arm’s length principle. However, as number of countries have adopted safe harbour rules especially for smaller taxpayers and/or less complex transactions, even OECD recognized the need and importance of these rules.

The revised Section “E” on Safe Harbours in Chapter IV of the OECD Transfer Pricing Guidelines (issued on 16th May 2013) discusses some potential advantages and disadvantages of safe harbour provisions as follows:

Advantages of Safe Harbours:

(i) They may simplify compliance and reduce compliance costs for eligible taxpayers;

(ii) They provide certainty about the acceptance of the transactions with limited or no scrutiny;

(iii) They allow tax administrations to allocate their administrative resources efficiently.

Disadvantages of Safe Harbours:

(i) They deviate from arm’s length principle;

(ii) They may increase the risk of double taxation especially when adopted unilaterally;

(iii) They may provide an opportunity for tax planning;

(iv) They may result in issues of equity and uniformity as taxpayers are allowed to adopt differential pricing for similar transactions in similar set of circumstances.

In light of the above analysis, the OECD Guidelines recommends bilateral or multilateral safe harbours and for that purpose it provides a sample MOU.

The United Nation’s Practical Manual on Transfer Pricing for Developing Nations released in 2013

Though apparently United Nations has not taken any stand in favour or against safe harbour rules, it recognises advantages and limitations of these provisions. Chapter 3 of the Manual contains discussion on Safe Harbour Rules. It states that Safe harbour rules can be an attractive option for developing countries, mainly because they can provide predictability and ease of administration of the transfer pricing regime by a simplified method of establishing taxable profit.

Korean Experience on Safe Harbour1

Before joining the OECD, the Republic of Korea’s national tax authority, the National Tax Service (NTS), employed a so-called “standard offer-commission rate” for import and export business taxation. Under this scheme, the NTS used a standard offer commission rate based on a survey on actual commission rates. This was available as a last resort under its ruling only in cases where other methods for identifying the arm’s length rate were inapplicable in determining commission rates received from a foreign party. The NTS finally repealed this ruling as it considered the ruling to be contrary to the arm’s length principle.

Summation/Way Forward

Unilateral safe harbour provisions may result in some double taxation as tax treaties by and large provide relief from double taxation only in cases where income is taxed in accordance with provisions of the relevant tax treaty. Since safe harbour provisions are in the domestic tax law, relief may not be available under a tax treaty. Therefore, to avoid potential double taxation, the recent amendment to the OECD Transfer Pricing Guidelines advocates bilateral or multilateral safe harbour agreements. In fact bilateral or multilateral safe harbour agreements could be quite useful also in case of Cost Contribution or Cost Sharing Arrangements among Associated Enterprises of Multinational Enterprises situated in various jurisdictions.

Despite limitations, safe harbour provisions provide much needed certainty and will reduces litigation and compliance cost for small taxpayers. Some companies may like to bear the brunt of some additional tax as an additional cost of capturing a developing market.

Even if one feels that the prescribed margins provided in the Indian Safe Harbour provisions are higher, they may found to be acceptable considering the cost of litigation in terms of time, energy and money. Secondly, as it is a voluntary provision, if the assessee strongly feels that it can justify lower margin, it can opt out of the safe harbour provisions. There is an option to hop on and hop off from the safe harbour provisions which provides great flexibility to taxpayers. The only point of concern is that opting for safe harbour provisions should not become precedence in the year of opting out of it.

All in all, safe harbour provisions can land companies in the safe territory in a blissful state free of litigation if these provisions are administered in a fair, equitable and judicious manner.

1The United Nation’s Practical Manual on Transfer Pricing for Developing Nations released in 2013

2A maquiladora or maquila is the Mexican name for manufacturing operations in a free trade zone (FTZ), where factories import material and equipment on a duty-free and tariff-free basis for assembly, processing, or manufacturing and then export the assembled, processed and/or manufactured products, sometimes back to the raw materials’ country of origin.

Nirav Shah

Two-Day Orientation Workshop specially designed for fresh Articled Students, 26th & 27th April 2013, at the M.C. Ghia Hall, Fort, Mumbai

Two-Day Orientation
Workshop specially designed for fresh Articled Students, 26th & 27th
April 2013, at the M.C. Ghia Hall, Fort, Mumbai

L to R – Mr. Bharatkumar Oza, Mr. Mayur Nayak, Ms. Nina Kapasi, Ms. Smita Acharya

In
this workshop organised by the Human Resources Committee, the following
learned faculties imparted learning to the articled students, on the
topics mentioned below:

In this workshop organised by the Human Resources Committee, the following learned faculties imparted learning to the articled students, on the topics mentioned below:

The workshop received a good response where newly enrolled articled students got a broad perspective of various subjects that they will handle during the course of their articleship.

Press Conference, 29th April 2013, at the Indian Merchants’ Chamber, Mumbai

A Press Conference was organised by the BCAS Foundation to discuss and explain the 97th Amendment to the Constitution of India dated 13th January 2012 wherein under Article 19, the term “Co-operative Societies” has been inserted. As per the legal opinion of Senior Advocate Firoze Andhyarujina released at this Press Conference, “After the Constitutional Amendment and the status granted to the co-operative societies of self-governance, the RTI Act would be applicable to the Co-operative Society, more particularly after it being self-governed by the Maharashtra State Ordinance of 2013, laying down the by-laws, rule, regulations, procedure and modalities”. However, as per the opinion of the former Central Information Commissioner Shailesh Gandhi, who was the chief guest at the occasion, the Right to Information Act would not be applicable to co-operative societies of any kind, including co-operative housing societies. Leading luminary Mr. Julio Rebeiro, and Mr. Narayan Varma, Trustee, BCAS Foundation, also discussed the implications of this amendment. The conclusion at the meeting was, that the applicability of RTI Act to co-operative societies would have to be tested by filing some RTI applications to housing societies, and pursuing the matter in appeal until it reaches the High Court.

mPower Summit, 10th & 11th May 2013, at the West End Hotel, Mumbai

The mPower Summit, held on 10th & 11th May, 2013 at the West End Hotel, Mumbai, was designed to help professional firms focus on “Mergers, Managing Growth and Mentoring Talent”.

The 2-day Summit, attended by over 50 participants, was unique in many ways – the speakers were drawn from 4 cities and the participants from 11 cities. Most of the participants represented the leadership team of their professional firms.

The keynote speaker, Ketan Dalal, connected well with the audience as he took them through his journey from a family firm to the leadership team of a Big-4. His talk was candid and inspiring as he not only opened up the windows of opportunities, but also cautioned on the hurdles along the way. His strongest message to the forum was that managing people is the key to a professional services firm, no matter what the size may be. In his charismatic and emphatic way, he concluded “remember, people leave people, people do not leave organisations….

When you see talent walking out of your door, introspect on how you are nurturing your human capital”.

The first day had interesting sessions. Sundeep Gupta, Chartered Accountant from Delhi explained the merger process, the science and art of engaging with another professional firm and the need to ensure a cultural match prior to merging. Sujal Shah, Chartered Accountant played the devil’s advocate and explored the possibility of separating out a niche practice when the firm is considering a merger. He presented the audience with the ecstasy of creating one’s own institution built on one’s values and belief system and nurturing a niche area as opposed to becoming a part of a large set up having multiple service lines.

The first day concluded with a session by the Committee Chairman Ameet Patel, Chartered Accountant who awakened the audience to the need for innovation in the professional services firm – he stressed on the need for providing innovative solutions for clients as also for the internal functioning of the firm. He smartly presented the pressing need for professional services firms to shift focus from delivery to discovery – from execution to innovation – from time based billing to value pricing.

The highlight of the Summit was the uplifting session by Padmashri T. N. Manoharan, Chartered Accountant where he spoke of the role of the senior partners in creating an institution. With anecdotes and real life examples, he touched the hearts of the audience as he explained that “we are all mortal individuals with the power to create lasting institutions”. His humility reflected in his participating in the entire 2-day Summit as a quiet observer and his leadership reflected in the values and vision that he rolled out in his talk.

The next session, by Nandita Parekh, Chartered Accountant, Convenor of the Committee and the co-architect of the Summit, spelt out the formula for “living happily ever after” post a professional merger. She emphasised the need for a Code of Conduct, succession plan for the leadership of the firm and strategy for nurturing and retaining talent. Her illustrated presentation drove home the points with ease, as also added some colour to the event.

The next session by Sagar Shah, Chartered Accountant from Pune, rolled out a strategy for growth through geographic spread and networking. Young and energetic, he showed the participants the wonders that can be achieved with a clear focus, with a well-defined strategy and with mastering technology. He shared the HR initiatives taken by his firm to ensure excellence, excitement and energy at all levels. A very interesting remark by him about how unimportant one’s own name was in the context of overall growth of one’s firm was an eye opener for the participants.

The last session, “Of the Participants, By the Participants, For the Participants” ably anchored by Ameet Patel, Chartered Accountant provided a grand finale to an Empowering Summit where each of the participants shared their key ‘take aways‘ from the Summit.

The mPower Summit, a third in the series of Power summits, has been successful in taking forward BCAS image as an innovator and as an organisation which addresses the need of its members even before they become a necessity. The vision of the committee in identifying the need and designing the Summit year after year has provided a legacy that needs to be continued. May the Power summit of the BCAS be the meeting place for future partners and the starting point for lasting relationships!

Half-day training workshop on Empathy, 16th April 2013, at the Navinbhai Thakkar Board Room, Vile Parle, Mumbai

The Human Resources Committee organised this workshop as a continuation of the leadership camp conducted earlier with the theme of “Living in Harmony”. The learned faculty Shri M. K. Ramanujam guided the participants on Empathy and discussed various connected issues such as Feeling, Emotions, Understanding and Empathising. The learned faculty also discussed Triggers of Anger and shared tips on Anger Management. The workshop received very good response and participants gained immensely from the wealth of knowledge and experience shared by the speakers.

Nirav Shah

Difficulties being Faced by Charitable Organisations on account of the first proviso of s.2(15)

29th March 2013
To
The Chairperson,
Central Board of Direct Taxes,
New Delhi.
Madam,
representation
Re: Difficulties being Faced by Charitable Organisations on account of the first proviso of s.2(15)

We wish to draw your attention to the harassment and difficulties being caused to genuine charitable organisations in Mumbai on account of the farfetched interpretation being adopted by assessing officers on the provisions of the first proviso to section 2(15).

Various charitable organisations running educational institutions and carrying on various other forms of charity, including relief of poverty, have been denied the exemption under section 11 by assessing officers, on the ground that the first proviso to section 2(15) applies to them. This is notwithstanding the fact that the CBDT has clarified vide its circular number 11 of 2008 dated 19.12.2008, that the first proviso to section 2(15) does not apply to the first 3 limbs of the definition of “charitable purpose” under section 2(15), and only applies to the last limb, advancement of any other object of general public utility.

We would like to draw your attention to the fact that this is likely to lead to substantial litigation, locking up of money intended for charitable purposes in payment of taxes pending disposal of appeals, resulting in the ultimate beneficiaries of such charities losing out on the benefits that they would otherwise have got from such charitable organisations. A significant impact is already being felt on the charitable activities being carried out, with many trusts having decided to scale down their activities, due to their funds being locked up in tax litigation.

In fact, earlier also, the definition of “charitable purpose” included the words “not involving the carrying on of any activity for profit” from 1961 till 1983. At that time as well, there had been substantial litigation on this aspect, including various decisions of the Supreme Court and many high courts. It was with the purpose of putting an end to this litigation that these words were omitted by the Finance Act, 1983 with effect from 1st April 1984. Reintroducing such provisions in the form of the first proviso to section 2(15) has again revived this litigation, which surely cannot be the intention behind this amendment.

It is submitted that the business carried on by a charitable trust could be of 3 kinds –
(a) where the business itself is the main object of the trust,
(b) where the business is incidental to the attainment of the objects of the trust, and
(c) where the business is in no way connected to the objects of the trust, but is a property held upon trust.

In businesses of type (a) above, if carrying on of the business itself is the main object, the trust would not be regarded as charitable, as held by the Supreme Court in the case of Sole Trustee, Loka Shikshana Trust 101 ITR 234, as the charitable purpose itself would be merely a sham. This was the position even prior to the insertion of the first proviso to section 2(15).

In businesses of type (b) above, the provisions of section 11(4A) would apply, and the trust was entitled to exemption of such income if separate books of accounts were maintained, prior to the insertion of the first proviso to section 2(15). This position continues for trusts engaged in activities other than that of the advancement of any other object of general public utility, and it is only trusts engaged in this residuary object of advancement of any other object of general public utility, which should lose the benefit of exemption after the insertion of the first proviso to section 2(15).

In businesses of type (c) above, the provisions of section 11(4) read with section 11(4A) applied prior to the insertion of the first proviso to section 2(15). Even after the amendment, such businesses continue to enjoy the benefit of exemption where the objects of the trust are not those of advancement of any other object of general public utility.

The purpose of the amendment was to ensure that trusts do not carry on business in the garb of charity. However, the amendment made by insertion of the first proviso to section 2(15) is unfortunately being interpreted by assessing officers as a blanket prohibition on carrying on of businesses by all charitable trusts. Again, assessing officers are treating all types of activities as business, including activities of mere letting of premises, conduct of educational courses, etc. This results in denial of exemption to a large number of genuine charitable organisations, which certainly does not seem to have been the intention behind the amendment.

It is therefore strongly suggested that the following amendments be carried out:

1. Both the provisos to section 2(15) be deleted;

2. Section 11(4) be amended to provide that “property held under trust” shall not include a business undertaking so held; and

3. Section 11(4A) be amended by inserting a proviso to that subsection to the effect that a business shall not be regarded as incidental to the attainment of the objectives of the trust merely on account of the fact that the income from such business feeds the charitable purposes.

These amendments will ensure that in all cases where business carried on by a trust is unrelated to its objects, the business income would be subjected to tax, and the trust would not lose exemption in respect of its other income which is actually utilised for its charitable purposes. As mentioned earlier, where the main object itself is the carrying on of a business, in any case, the trust would not be entitled to exemption, as the object would not be regarded as charitable, in light of the Supreme Court decision in Loka Shikshana Trust.

This amendment will also ensure that genuine charitable trusts do not suffer the harassment of efforts to treat charitable activity carried on by such trusts as business activity, and will not be denied exemptions on that ground.

We trust you will make efforts to implement our suggestions at the earliest, so as to enable charitable trusts to focus on their charitable activities, rather than on tax litigation.

Thanking you,

Yours faithfully

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Nirav Shah

Coalgate – Hysteria over individual culpability at the expense of institutional change is futile

India is in thrall to sleaze. The executive is hostage to serial charges of corruption, enfeebling it. The judiciary feels encouraged to step outside the remit of determining what is lawful, to pronounce on policy. The legislature is dysfunctional, as the Opposition professes outrage and prevents both debate and lawmaking. Public focus is on the empirical specifics of particular scams, rarely on quick fixes, and never on systemic and institutional reform.

Take the coal scam. What precisely is the scam? Once a framework of state monopoly in coal mining is taken for granted, as also that monopoly’s incapacity to mine sufficient quantities to meet the demand, it makes sense to allow those who use coal as a vital input to have their own captive mines. In this framework, the sources of government revenue are royalty on the mined coal and taxes on the profits generated from the use of coal. These accrue, regardless of the identity of the captive miners. So, the malfeasance in allocating captive mines to cronies lies not so much in loss of revenue for the government as in some entities arguably more entitled to the mines losing them to those less deserving.

Two things make access to domestic coal scamworthy: state monopoly in coal leading to shortages and repressed pricing at a discount to imported coal. Remove these two features, and auction coal mines to whoever offers the highest lease rental/ royalty/revenue share, there would be no more coal scams. But such institutional remedies are not on anyone’s mind. The closest thing to a policy remedy on the agenda is auctioning captive mines, which is a flawed, suboptimal solution. Differential importance of coal in different industries calls for separate, industry-wise auctions of captive mines. Instead of holistic policy remedies, the entire debate is on fixing culpability at individual and political levels. Such arbitrary grant of mines and other patronage have been part and parcel of the default mode of funding politics in India â€” through the proceeds of corruption. The systemic solution is to institute complete transparency as to the source of every paisa collected and spent by politicians and political parties. This interests few.

And the few institutional reforms that are in vogue are horrendous. Take the demand to make the CBI autonomous of the government, implicit in the criticism of the agency sharing its draft status report on coal allocation with officials in the Prime Minister’s Office, the coal ministry and the law minister. Can the CBI get clarity on intricate policy details without interacting with the concerned officials? And what is wrong if its report is vetted for accuracy by the same officials who have been helping the CBI formulate its report, before submission to the court? Will not any attempt to manipulate the findings be exposed before the courts? The only guarantee against police/investigative agencies going rogue is multiple lines of accountability to different institutions, the government, the courts, a committee of Parliament and the human rights watchdog.

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Nirav Shah

Freeing the parrot – Govt cannot brazen out Supreme Court’s observations

The Supreme Court’s observations on the Central Bureau of Investigation’s affidavit regarding alterations made to the status report on its investigation into coal-block allocations were not as specific and stringent as they could have been. The Court chose not to view it directly as contempt the way it had seen it in a 1997 case on hawala transactions, where the apex court had demanded that the CBI not share information with those who could be an accused in the case. But the broad tenor of the Court’s observations yesterday was to highlight how the “heart of the CBI report was changed on the suggestions of government officials”. There were thus sharp questions on why the CBI should be sharing its findings with those it might be investigating. The court did not entirely spare the law minister Ashwani Kumar either, questioning if the law minister asking to see the report was legally permissible. It appears the Court holds the CBI primarily responsible for allowing its independence to be called into question, and repeating what the government wishes it to say – memorably comparing the agency to a “caged parrot”. However, the tongue-lashing that the SC gave the CBI and the government’s law officers – who have been caught in flagrantly misleading the Court – should warn the government that this is not a crisis it can afford to ignore. The resignations of Mr Kumar and of the Attorney General are to be expected. The government cannot brazen it out for much longer.

The Court also addressed itself to the central question of the CBI’s investigation, making explicit a threat that it had earlier made implicitly – that if the government does not legislate proper independence for the CBI, the SC will step in and do something. This is a warning that the government cannot afford to overlook. There would be legitimate concerns about an unaccountable super-cop, but the situation is such that the government must work post-haste on legislative safeguards for the CBI against political interference. Naturally, controls for the CBI will have to be worked in to any solution, but it is clear that the current system is not working and that the SC’s patience, like that of the public, is at an end. The SC on this occasion chose to drag former CBI DIG Ravi Kant Mishra back from the Intelligence Bureau to head the investigation into coal-block allocations.

Politically, the Court’s strictures could not have been worse; the SC has found impropriety in the actions of both the law minister and of the bureaucrats of the coal ministry and the prime minister’s office. Before the SC spoke, the prime minister said in Parliament that he was “seized of the issue” and that “action would be taken”. That action should include a clear accounting of guilt, as well as the dismissal of the law minister and the Attorney General. And, finally, a draft for statutory independence of the CBI must be prepared.

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Nirav Shah

2013-TIOL-528-HC-AHM-ST Sports Club of Gujarat vs. Union of India

“Club or Association” service – levy of service tax on sums received from members held to be ultra vires.

Facts:
The
petitioner along with two other clubs filed a writ petition to declare
section 65(25a), section 65(105)(zzze) and section 66 of the Finance
Act, 1994 as amended by the Finance Act, 2005 to the extent that the
said provisions purported to levy service tax on amount received by the
club from its members as being ultra vires, beyond the legislative
competence of the parliament, unconstitutional, illegal and void. The
petitioners substantiated their contentions by referring and relying
upon the decision of Ranchi Club Ltd. vs. Chief Comm. of C.Ex. &
S.T. 2012 (26) STR 401 (Jhar) which further relied upon the decision of
the Full Bench of Patna High Court in Commissioner of Income Tax vs.
Ranchi Club Ltd. 1994 (1) PLJR 252 (Pat) (FB).

Held:
Considering
the decisions of the Hon. Jharkand High Court and the Full Bench of the
Patna High Court in Ranchi Club Ltd. (supra), the Hon. High Court
allowed the petitions and declared section 65(25a), section
65(105)(zzze) and section 66 of the Finance Act, 1994 as amended by the
Finance Act, 2005 to be ultra vires.

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Nirav Shah

Vested interest has a say in India’s policy making: Shell

India is a growing economy, but vested interests have a play in India’s policy making, says the Netherlands-based energy giant Royal Dutch Shell Plc Jeremy B Bentham, vice-president, global business environment, Shell, said such interests were “a force in one direction”.

Citing Paul Krugman’s three ‘I’s—ignorance, interests and ideology — that do not let things happen when they should rationally be happening, Bentham said he had added two more to these —institutional inadequacy and inertia. According to him, all five factors were present in India.z

Bentham’s comments come at a time when India’s energy sector is mired in controversies around pricing and contractual and allocation issues.

“As a business, we cannot do with an energy ministry. We have issues fragmented across different departments, each of which has its different agenda, which is not very well joined up here,” he told Business Standard in an interview.

The presence of such elements brings up the question whether “transitional changes are trapped and is there a room to maneuver”. Bentham later presented to an industry audience the ‘New Shell Scenarios’, which looks at the trends in the economy, politics and energy as far ahead as 2100.

The first scenario, labelled “mountains”, sees a strong role for the government and introduction of firm and far-reaching policy measures. These help develop more compact cities and transform the global transport network. New policies unlock plentiful natural gas resources, making it the largest global energy source by the 2030s, and accelerate carbon capture and storage technology supporting a cleaner energy system.

The other scenario is of “oceans”, a more prosperous and volatile world. Energy demand surges due to strong economic growth. Power is more widely distributed and governments take longer to agree to major decisions. Market forces, rather than policies, shaped the energy system: oil and coal remain part of the energy mix but renewable energy also grows. By the 2070s, solar becomes the world’s largest energy source.

Bentham said India was developing more “oceancentric” and was growing economically. He said India needed to look more into developing of infrastructure to deal with the supply and demand issues in the energy sector.

“On supply, India is already a significant component in the global energy consumption and is going to be 10-15 per cent of global energy in the decades ahead. For that, you need to have infrastructure.”

That not only enables “supply investments”, but also ports and the railways participating in global economy. On the demand side also infrastructure questions are there. Important here is to develop cities in a planned way.

He indicated the country should look more into how it could participate in the energy scenario of South Asia and Asia Pacific. “It has to look into how to take advantage of the developments in global shale gas? Not only necessarily in encouraging production here, but also opening up opportunities globally,” he added.

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Nirav Shah

Challenge to Arbitration Award issued in foreign country should be in the country where award is published

In the present case, the parties agreed that the arbitration would be held at Geneva, Switzerland. Hence, the Swiss law could be the curial law. The parties agreed, rules framed by ICC, Paris would be the appropriate procedure. In any event, Indian law would have no role to play when the parties expressly agreed that they would have sitting of arbitration abroad where Indian law would have no force.

When there was no express designated venue, the law applicable to the seat of arbitration would be the curial law.

If a contracting party feels, his counterpart in contract committed any breach, place of committing of breach would be ordinarily place where he should ventilate his grievance. Similarly, when arbitration is held in a particular place and losing party feels, the Tribunal did not decide issue in the way it ought to have, he has to approach the Court where arbitration was held and/or award was published unless parties mutually agree to be guided by another law or law of place where contract was performed.

Coal India Ltd vs. Canadian Commercial Corporation AIR 2013 (NOC) 265 (Cal.)

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Nirav Shah

NEW BANKING LICENSES-THE WAY FORWARD

1. Objective and Evolution of Global Banking

The word “bank” was borrowed from Middle French “banque”, from Old Italian “banca”, from Old High German “banc” which means “bench, counter”. Benches were used as desks or exchange counters during the Renaissance by Florentine bankers , who used to make their transactions atop desks covered by green tablecloths. Today, Industrial and Commercial Bank of China Limited (ICBC) the world’s largest bank , has about $2.43 trillion of deposits, which is almost higher than the nominal GDP of India, Italy, Russia, France and the UK.

Section 5 (c) of the Banking Regulation Act, 1949 defines a bank as “a banking company which transacts the business of banking in India”. Further, section 5 (b) of the Act defines banking as “accepting, for the purpose of lending or investment, or deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise.”

Typically, the provision of deposit and loan products normally distinguishes banks from other types of financial firms. The core activity of banks is to act as intermediaries between depositors and borrowers. However, several banks have successfully leveraged this relationship with depositors and borrowers (channel) to provide all sort of financial services ranging from core services (ATM, Cards, project finance) to ancillary services (Bancassurance, Investment banking, Wealth Management, etc.) to complex & structured solutions (Mortgage Backed Securities, Collateralised Debt Obligation, etc.). For example, other income (non-funded revenues) of Axis Bank was at ~20% of total revenues in FY13.

Conversely, non-financial entities having eminent distribution networks have migrated to the role of providing banking services. For example, Japan Post Bank which is owned by Japan Post Holdings Co., has the largest public deposit in Japan ($1.81 trillion) garnered through a nationwide network of post offices. However, the bank primarily invests its money in government bonds and acts merely as a savings bank. In India, the Department of Posts has applied for a banking license and perhaps is pursuing a similar model.

Banks can create new money when they make a loan. New loans throughout the banking system generate new deposits elsewhere in the system. The money supply is usually increased by the act of lending, and reduced when loans are repaid faster than new ones are generated. In the United Kingdom between 1997 and 2007, there was a big increase in the money supply, largely caused by much more bank lending, which served to push up property prices and increase private debt. The amount of money in the economy in the UK went from £750 billion to £1700 billion between 1997 and 2007, much of the increase caused by bank lending. In fact in many European countries, bank assets dwarf the size of the local economy and are far in excess of other regions in the world as per Table 1.

Excessive or risky lending can cause borrowers to default, the banks then become more cautious, so there is less lending and therefore less money so that the economy can go from boom to bust as happened in the UK and many other Western economies after 2007. Consequently, European banks’ profits have plummeted from 46% to 1.58% in the Top 1000 bank profits list whereas Asia’s banks have increased their profits from 19% to 56%.

2. Evolution of Banking in India and need for new banking licenses

While global banking has seen regional disproportional growth due to country specific economic and regulatory requirements, India has its own model for financial development and its regulations. To a great extent, the conservative approach adopted by the Reserve Bank of India (RBI) has helped insulate the domestic banks from global crisis; on the other hand, none of the Indian banks have become global in size.

India has 168 Scheduled Commercial Banks (SCBs) and 82 cooperative banks. Of the 168 SCBs, 82 are Regional Rural Banks and 26 are Public Sector Banks. Thus, only 60 banks are private of which, 40 are foreign banks. According to RBI’s quarterly statistics on deposits and credit of scheduled commercial banks in March 2012, PSBs accounted for approximately 75% per cent of the aggregate deposits. This lopsided structure, where all the eggs are in the same basket, increases the risks to the economy and erodes financial stability while adding a lot of stress on the public banks to increase financial Inclusion. Further, Indian banks will have to bring in additional capital of Rs. 5 lakh crore to meet Basel III norms. The government on its part has to infuse Rs. 90,000 crore into the PSBs to maintain majority shareholding under Basel III.

RBI has as a strategy, since the economic liberalisation in 1991, has followed the cycle of permitting new bank licenses once every decade—in 1993, 2003 and 2013. This permits RBI to regulate the growth and stability of the banking system as well as the new entrants.

The key economic environment under which new banking licenses will be awarded in 2013 could be summarised as below:

• Overall economic growth

We are in a situation where economic growth has collapsed, industrial output has stagnated for two years, jobs are being shed, consumer inflation is close to 10%, the current account deficit (CAD) in the balance of payments is nearly 5% of GDP at last count, investment is fleeing abroad, external debt maturing in the current fiscal year exceeds $170 billion and the rupee is touching new lows against the dollar each week. While the RBI and the Government are intervening with short-term measures, longer term initiatives are imperative.

As per the discussion paper on the entry of new banks into the private sector (Discussion Paper): “It is generally accepted that greater financial system depth, stability and soundness contribute to economic growth. But beyond that for growth to be truly inclusive requires broadening and deepening the reach of banking. A wider distribution and access of financial services helps both consumers and producers raise their welfare and productivity.”

There are three fundamental reasons for this cor-relation: (1) the banking system creates a more stable employment environment and provides more business opportunity, (2) it helps enlarging the per capita GDP as it brings the unaccounted sector into its fold and (3) it brings additional capital to the banking system, which has a snowball effect.

• Financial Inclusion

As per the census of India about 59% of households had access to banking services in 2011 and the all-India average population per bank branch was 12,500 in 2012. The majority of India’s 6,50,000 villages do not have even one bank branch, and just 3.5 of every 10 Indians have access to formal banking services in the country, according to a 2011 World Bank survey. Only 37,471 branches were operational in rural India, as of March 2012, while the total banking outlets in villages (including branches, business correspondents and other modes) number just 1,81,753.

While the existing banks also function as per the same mandate (one rural branch out of every four branches), the entry of new players, with a specific and deeper financial inclusion as a license condition, should augment the overall rural presence.

• Efficiency and Competition

While the overall efficiency of banks in India is increasing, there exists a lot of scope to improve the efficiency of the public sector banks. Net impaired assets (net NPAs + restructured assets) have increased rapidly in FY12 and FY13. Net impaired assets to net worth ratios are now at alarming levels, particularly for PSU banks. Barring BOB and SBI, for all other PSU banks, net impaired assets are almost equal to or even more than 1Q14 net worth. However, for private sector banks, stress levels are very much under control and manageable. Net impaired assets as a percentage of net worth is ~10% for private sector banks (except for Axis Bank at 14% and ICICI Bank at 12%).

Even for private banks, bringing in fresh competition from well-managed business houses, having proven track record in both profitability and setting up pan-India networks (e.g. telecom), will improve the competition and bring in innovation into the system which will only benefit the consumer. Currently, since there are only 3-4 private banks which have pan-India presence, entry of larger business houses will provide competition and much required depth to the financial system in India.

3. New banking license guidelines

RBI granted licenses to 10 private players between 1993 and 2003. The players were ICICI Bank, HDFC Bank, UTI Bank (now Axis), Global Trust Bank (GTB), IDBI Bank, Times Bank, Centurion Bank, Bank of Punjab, IndusInd Bank, and businessman CR Bhansali, who was accorded an in-principle approval but the bank never materialised. Of the 10, four were promoted by financial institutions and the remaining six by individual banking professionals. As it turned out, all those promoted by individuals either failed or merged with other banks, (viz., GTB with Oriental Bank of Commerce and Times Bank, Bank of Punjab and Centurion Bank with HDFC Bank).

The central bank become more cautious, and be-tween 2004 and 2010 granted licenses only to Kotak Mahindra Bank and Yes Bank.

The failures/mergers were essentially due to (1) weak corporate governance/frauds (CR Bhansali and GTB) and (2) lack of promoter interest or deep pockets (Times Bank, Bank of Punjab and Centurion Bank). RBI also noted that the experience of the Local Area Banks have also not been encouraging due to small size and concentration risk. Similar is the situation with RRBs.

The discussion paper thus notes: “The experience of the Reserve Bank over these 17 years has been that, only those banks that had adequate experience in broad financial sector, financial resources, trust-worthy people, strong and competent managerial support could withstand the rigorous demands of promoting and managing a bank.”

Further, Indian regulators have also learnt that during the 2008 crisis, it was the strength of the Indian JV partner which helped sustain the business, for example, an entity like Tata AIG. Further, RBI also learnt that only domestic banks (unlike foreign banks) have been able to penetrate the country and support financial inclusion.

In light of the macroeconomic situation and experiences both domestically and internationally (Lehman Brothers collapse, etc), RBI has come out with guidelines for issuance of new banking licenses. The table below attempts to summarise the key conditions of the guidelines and rationale for the same:

While the objective tests have been laid down as above, RBI has retained subjectivity in the allotment of banking license to give itself flexibility in decision making. It is expected that the RBI may consider the following and perhaps more, while evaluating each of the applications:

• Industrial and business houses having a long history of building and nurturing new businesses in highly regulated sectors such as Telecom, Power,

Automobiles, Defence, infrastructure projects like Airports, Highways, Dams, Ports probably may be considered favourably as industrial and business houses with presence across various sectors would face a higher reputational risk compared to a pure individual promoter or financial services player.

• Background of promoter, directors and top executives. No objection certificate of the promoter’s credentials, integrity and background will probably be taken from banks, other regulatory agencies and also from investigating agencies.

• Corporate governance standards in the corporate entity, extent of financial activities carried out by the industrial/business house, comfort with the corporate structure within the group, whether ownership is diversified and separate from management and the source of promoters’ equity.

4. Applicants and way forward

Unlike an NBFC License, a banking license is controlled with an occasional window which opens briefly, once in a decade. Essentially, some sort of excitement is expected over the number of applicants. In 1993, 13 applications were received out of which 10 were awarded the license. In 2003, 100+ applications were received out which license was awarded only to two. When the current guidelines of 2013 were announced, media reports expected over 100 applications to be received by RBI before the cut-off date of 1st July, 2013. To everyone’s surprise, only 26 applicants were received. Expected big names like Mahindra & Mahindra Financial Services Ltd opted not to apply citing that the new rules may be too hard for businesses to implement.

Of course, each applicant would have done his cost benefit analysis before applying. The apparent benefits, amongst others, would be

(1) Scalability and stability of business,

(2) Better cost of capital due to access to public deposits,

(3) Distribution network so as to improve the fee based income (eg- Bancassurance), and

(4) Return on investments. Table 2 indicates the share price performance of new banks commenced since 1993.

The key challenges for setting up the bank would, amongst others, be

(1) Stringent regulations, not just for the bank, but for all financial regulated entities in the Applicant group and

(2) Cost on account of priority sector lending, branch expansion and financial inclusion.

The bigger issue arises from the fact that the conditions are expected to be complied with from day one of the commencement of the bank business. RBI has emphasised that it will not deviate from the guidelines while allotting licenses and thus, will not grant any exemptions.

The list of applicants along with a possible classification, and RBI’s potential key consideration for that bucket is tabled below.

RBI is now expected to set up a committee to screen and shortlist the applicants who will be called for interviews and discussion on the business plan. The in-principle approvals for the licenses are expected to be issued anywhere before the election next year and most probably between January to March 2014. It also needs to be seen if Mr Raghuram Rajan, the new RBI Governor (and former IMF chief economist) who was not in favour of the government giving banking licenses to industrial houses, has a decisive role to play in the grant of the banking licenses. His opinion has been that existing peers, like NBFCs and MFIs, should be given preference over corporates owing to their experience in this business. According to Mr Rajan, “If corporates are given license, the regulator needs to ensure there is no inter-company lending, proper risk management processes are followed and there is enough transparency.”5

Of the number of applicants, RBI will now be required to address several critical questions, including:

• How many banking licenses should be issued, assuming the industry is likely to consolidate?

• Will players with pan-India focus be given preference over regional players? Or whether both the categories of applicant will be considered?

• Whether large industrial houses with experience in setting up pan-India networks like telecom, automobiles, etc., will get preference?

* The authors are senior officials of a well-known financial company. The views expressed in the article are their personal views.

1Medici Bank

2The Bankers Top 1000 World Banks Ranking – July 2013

5http://articles.economictimes.indiatimes.com/2011-04-02/ news/29374475_1_banking-licence-corporate-houses-raghuram-rajan

Nirav Shah

A. P. (DIR Series) Circular No. 94 dated 1st April, 2013

21. A. P. (DIR Series) Circular No. 94 dated 1st April, 2013

Foreign investment in India by SEBI registered FIIs in Government Securities and Corporate Debt

This circular has revised, with immediate effect, the guidelines relating to investment in Government Securities & Corporate Debts by removing/merging the sub-limit in each category into a single limit. The details of the said revision are as under: –

The above limits are not applicable to Non-Resident Indians and they can invest without any limit in Government Securities as well as corporate debt.

Nirav Shah

Recent Global Developments in International Taxation – Part II

In this Article, we have given brief information about the recent developments in U.S.A. in the sphere of international taxation which could be of relevance and use in day to day practice and which would keep the readers abreast with various happenings across the globe in the arena of international taxation. We intend to keep the readers informed about such developments from time to time in future.

United States (i) FAQs released for streamlined procedures for delinquent US taxpayers overseas

The US Internal Revenue Service (IRS) has released frequently asked questions (FAQs) regarding the streamlined filing compliance procedures for nonresident, non-filer taxpayers, which went into effect on 1st September 2012.

The streamlined procedures were introduced to provide US taxpayers residing overseas, including dual citizens, who have not filed US federal income tax returns or Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, FBAR) with an opportunity to comply with their tax requirements by filing their delinquent income tax returns for the past 3 years and filing their delinquent FBARs for the past 6 years.

The streamlined procedures are designed for taxpayers who present a low compliance risk, which is generally specified as a tax liability of less than $ 1,500 for each delinquent year.

In addition, the streamlined procedures provide retroactive relief for taxpayers who failed to make a timely election for income deferral on certain foreign retirement and savings plans (e.g., Canadian Registered Retirement Savings Plans) for which relevant treaties allow deferral only if an election is made on a timely basis.

The FAQs include the following clarifications:

• Taxpayers will not be disqualified from admission to the streamlined procedures even if their tax liability exceeds $ 1,500 for any of the 3 years. However, submissions by such taxpayers may be determined to be higher risk, and applicable penalties and an examination may ensue.

• If qualifying taxpayers have been accepted into one of the offshore voluntary disclosure programs (OVDPs) prior to 1st September 2012, they may opt out of the OVDP and request the streamlined procedures

• Qualifying taxpayers may have their case reconsidered under the streamlined procedures even if they have entered into a closing agreement (IRS Form 906) with the IRS under one of the OVDPs. For the streamlined procedures, taxpayers should use IRS Form 1040 (US Individual Income Tax Return), except that taxpayers should use IRS Form 1040X (Amended US Individual Income Tax Return) if they are submitting amended returns for the sole purpose of submitting late-filed IRS Form 8891 (US Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans).

The FAQs indicate a last reviewed or updated date of 27th February 2013.

(ii) IRS issues updated Publication 519 – US Tax Guide for Aliens

The US IRS has released the 2013 revision of Publication 519 (US Tax Guide for Aliens). The publication is dated 7th March 2013 and is intended for use in preparing tax returns for 2012.

Publication 519 provides detailed guidance for resident and non-resident individuals to determine their liability for US federal income tax. Specifically, Publication 519 discusses:

• the rules for determining US residence status (e.g. the US green card test and the US substantial presence test);

• the rules for determining the source of income;

• exclusions from US gross income;

• the rules for determining and computing US tax liability;

• US tax liability for a dual-status tax year (i.e. where an individual has periods of US residence and US non-residence within the same tax year);

• filing information;

• paying tax through withholding tax or estimated tax;

• benefits under US income tax treaties and social security agreements;

• exemptions for employees of foreign governments and international organisations under US tax treaties and US tax law;

• sailing and departure permits for departing aliens; and

• how to get tax help from the IRS. Publication 519 also includes:

• a table of US tax treaties (updated through 31 December 2012);

• appendix A (Tax Treaty Exemption Procedure for Students), which contains the statements non-resident alien students and trainees must file with IRS Form 8233 (Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Non-resident Alien Individual) to claim a tax treaty exemption from withholding of tax on compensation for dependent personal services; and

• appendix B (Tax Treaty Exemption Procedure for Teachers and Researchers), which contains the statements non-resident alien teachers and researchers must file for the same purpose as appendix A. Revised Publication 519 provides information on relevant tax changes for 2012, including:

• increase in the personal exemption amount to $ 3,800;

• disqualification of interest paid on non-registered (bearer) bonds from treatment as portfolio interest that is eligible for exemption from US withholding tax, effective for obligations issued after 18th March 2012;

• extension of the treatment of a regulated investment company (RIC, or mutual fund) as a qualified investment entity (QIE) under The Foreign Investment in Real Property Tax Act of 1980 [FIRPTA] through 2013 for purposes of taxing RIC distributions that are attributable to gains from the sale of US real property interests;

• extension of the withholding exemption on certain interest-related dividends and shortterm capital gain dividends paid by a mutual fund or other RIC through 2013; and

• increase in the withholding rate on effectively connected income of a partnership that is allocable to non-corporate partners to 39.6%.

Additionally, Publication 519 refers to the other IRS publications that are relevant in this context, including:

• Publication 514 (Foreign Tax Credit for Individuals); Publication 515 (Withholding of Tax on Non-resident Aliens and Foreign Entities);

• Publication 597 (Information on the United States-Canada Income Tax Treaty); and

• Publication 901 (US Tax Treaties). Publication 519 is available on the IRS website.

(iii) Public comments requested on cross-border transfer of stocks and securities

The US IRS and the US Treasury Department have issued a notice requesting comments on final regulations (TD 8770, Certain Transfers of Stock or Securities by US Persons to Foreign Corporations and Related Reporting Requirements) and final regulations (TD 8862, Stock Transfer Rules) issued in connection with cross-border transfers of stock and securities. TD 8770 was issued with regulations on the transfer of stocks and securities in international transactions under section 367(a), (b), and (d) of the US Inter nal Revenue Code (IRC) and IRC section 6038B to address:

• the tax treatment of transfers of stocks and securities to foreign persons in outbound reorganisation transactions;

• the terms and conditions for entering a gain recognition agreement (GRA) with the IRS with regard to such transfers;

• the tax treatment of stock transfers under IRC section 351 dealing with incorporation transactions and IRC section 368(a)(1)(B) dealing with stock-for-stock reorganisations; and

• the rules for complying with the notice and information reporting requirements when property is transferred by a US person to a foreign person.

• TD 8862 was issued with regulations under IRC section 367(b), which is intended to prevent the avoidance of US tax when stock or assets are transferred outside the US taxing jurisdiction pursuant to corporate transactions that would otherwise qualify for tax-free treatment under the IRC.

TD 8862 provides guidance on:

• the treatment of US-inbound transactions (i.e. repatriation transactions where assets are transferred from a foreign corporation to a US domestic corporation) and foreign-to-foreign transactions (i.e. where stock or assets are transferred between foreign corporations that have US ownership);

• the tax consequences for the parties to such transactions, including foreign currency aspects; and

• the requirement that persons who realised income from such transactions file a notice with the IRS.

(iv) Public comments requested on bilateral safe harbours for transfer pricing

The US IRS has issued a News Release (IR-2013-30) with the announcement that it is seeking public comments regarding the development of a model memorandum of understanding between competent authorities on certain transfer pricing issues. Specifically, the IRS is requesting comments on bilateral safe harbours with regard to arm’s length compensation for routine distribution functions.

On 6th June 2012, the Organization for Economic Co-Operation and Development (OECD) issued a discussion draft on safe harbours as part of its project to improve the administrative aspects of transfer pricing. The discussion draft is entitled “Discussion Draft – Proposed Revision of the Section on Safe Harbours in Chapter IV of the OECD Transfer Pricing Guidelines and Draft Sample Memoranda of Understanding for Competent Authorities to Establish Bilateral Safe Harbour”.

This discussion draft includes proposed revisions of the section on safe harbours in Chapter IV of the Transfer Pricing Guidelines and related sample memoranda of understanding for competent authorities to establish bilateral safe harbours.

The OECD has released public comments to the discussion draft in the form of a report entitled “The Comments Received with respect to the Draft on the Revision of the Safe Harbour Section of the Transfer Pricing Guidelines”

The IRS notes that such safe harbours could support sound tax administration. The IRS requests comments that are highly specific to the issues at hand, to the point of proposing text for draft model agreements involving routine distribution functions.

(v) Public comments requested on information return for stock ownership of foreign corporations

The US IRS and the US Treasury Department have issued a notice requesting comments on IRS Form 5471 (Information Return of US Persons With Respect to Certain Foreign Corporations) and related schedules.

IRS Form 5471 and the related schedules are used to satisfy the reporting requirements of sections 6038 and 6046 of the US IRC and the regulations issued thereunder, which require US persons to file reports with the IRS if they have certain ownership interests in a foreign corporation.

IRS Form 5471 is required to be filed by any US person who falls into one of the following categories:

• any US person that has acquired 10% or more of the stock of a foreign corporation (either combined with stock already owned or without regard to such stock);

• any US person that has control (i.e. has more than a 50% stock ownership, by voting power or value) of a foreign corporation; and

• any US person who owns 10% of more of the voting stock of a controlled foreign corporation (CFC) or owns any stock in a CFC that is also a captive insurance company.

The term US person generally includes a US citizen or resident, a domestic corporation, a domestic partnership, or an estate or trust other than a foreign estate or trust.

IRS Form 5471 is also required to be filed by any US citizen or resident who is an officer or director of a foreign corporation in which a US person owns or acquires 10% or more of the stock either by voting power or value.

(vi) IRS issues updated Publication 515 – With-holding of Tax on Non-resident Aliens and Foreign Entities.

The US IRS has released the 2013 revision of Publication 515 (Withholding of Tax on Non-resident Aliens and Foreign Entities). The publication is dated 4 February 2013 and is intended for use in 2013.

Publication 515 provides guidance for withholding agents who pay income to foreign persons, including non-resident aliens, foreign corporations, foreign partnerships, foreign trusts, foreign estates, foreign governments and international organisations.

The topics discussed in Publication 515 include:

• the persons responsible for withholding (withholding agents);

• the types of income subject to withholding;

• the information return and tax return filing obligations of withholding agents;

• withholding by a partnership on its income effectively connected with a US trade or business that is allocable to its foreign partners;

• withholding on transfer or distribution of a US real property interest under FIRPTA; and

• how to get tax help from the IRS.

Revised Publication 515 also contains the following US tax treaty tables:

• Table 1 lists the withholding rates under US tax treaties on income other than personal service income for 2013 (i.e. interest, dividends, and royalties).

• Table 2 lists the different types of personal service income that are entitled to an exemption from, or reduction in, withholding under US tax treaties.

• Table 3 lists US tax treaties (updated through 31 December 2012) with information on where the full text of each treaty and protocol may be found in the IRS Cumulative Bulletin, which is available on the IRS web site.

Revised Publication 515 includes discussion of the new rules regarding:

• information reporting for interest paid to non-residents on US deposits on or after 1st January 2013

• exclusion of interest paid on non-registered (bearer) bonds from portfolio interest, effective for obligations issued after 18th March 2012

• extension of the treatment of a regulated investment company (RIC, or mutual fund) as a qualified investment entity (QIE) under FIRPTA through 2013 for purposes of taxing RIC distributions that are attributable to gains from the sale of US real property interests

• extension of the withholding exemption on certain interest-related dividends and short-term capital gain dividends paid by a mutual fund or other RIC through 2013

• increase in the withholding rate for non-corporate partners to 39.6%); and

• the FATCA withholding requirement for US withholding agents with regard to certain types of payments made to non-participating foreign financial institutions (NPFFIs) beginning in 2014.

Additionally, Publication 515 refers to the other IRS publications that are relevant in this context, including:

• IRS Publication 15 (Circular E, Employer’s Tax Guide);

• Publication 15-A (Employer’s Supplemental Tax Guide);

• Publication 15-B (Employer’s Tax Guide to Fringe Benefits);

• Publication 51 (Circular A, Agricultural Employer’s Tax Guide);

• Publication 519 (US Tax Guide for Aliens); and

• Publication 901 (US Tax Treaties).

Publication 515 is available on the IRS web site at www.irs.gov.

(vii) IRS issues updated Publication 514 – Foreign Tax Credit for Individuals.

The US IRS has released the 2013 revision of Publication 514 (Foreign Tax Credit for Individuals). The publication is dated 29th January 2013 and is intended for use in preparing 2012 tax returns.

Publication 514 explains the provisions of US federal income tax law that apply to US citizens and resident aliens who paid or accrued taxes to a foreign country on foreign source income and intend to take a US credit or itemised deduction for such taxes. Publication 514 discusses:

• claiming a credit or deduction for foreign income taxes;

• benefits of claiming the foreign tax credit (FTC);

• persons eligible for the FTC;

• taxes eligible (or not eligible) for the FTC;

• computation of the FTC, including application of the US basket system;

• carry-back and carry-over of the FTC;

• procedures for claiming the FTC; and

• information on how to obtain tax help from the IRS.

Revised Publication 514 includes information on:

• new rules for determining who is considered to pay a foreign income tax when the tax is imposed on the combined income of multiple persons; and

• inclusion of Iraq in the list of countries that participate in international boycotts, with the result that taxpayers may be denied a US FTC for taxes paid to Iraq in addition to taxes paid to the other countries on the list.

Publication 514 also refers to the other IRS publications that are relevant in this context, including IRS Publication 54 (Tax Guide for US Citizens and Resident Aliens Abroad), Publication 519 (US Tax Guide for Aliens), and Publication 570 (Tax Guide for Individuals With Income From US Possessions).

Additionally, Publication 514 provides two examples with filled- in IRS Form 1116, Foreign Tax Credit (Individual, Estate, or Trust). To claim an FTC, it is generally required to file a Form 1116 with the income tax return. A separate Form 1116 is required for taxes paid on certain designated categories of income, including separate basket income, for which a foreign tax credit is claimed.

Publication 514 is available on the IRS web site at www.irs.gov.

(viii) Proposed regulations issued on gain recognition in cross-border corporate transactions

The US Treasury Department and the IRS have issued proposed regulations (REG-140649-11) regarding gain recognition in cross-border corporate transactions. The regulations propose amendments to the existing rules on failures to file gain recognition agreements (GRAs) and related documents, or to satisfy other reporting obligations, in connection with certain transfers of property to foreign corporations in non-recognition transactions.

Section 367(a) of the US IRC imposes tax on US outbound reorganisations and other corporate transactions that would otherwise qualify for tax-free treatment if undertaken in a domestic context. Section 367(a) permits exceptions in certain cases, however, including the outbound transfer of stock or securities of foreign corporations in cross-border corporate transactions (i.e. incorporations, liquidations, mergers, acquisitions, and other reorganizations). These exceptions generally require the US transferor, among other things, to file a GRA and other related documents under Treasury Regulation section 1.367(a)-8 (the IRC section 367(a) GRA regulations).

IRS section 367(e)(2) further provides exceptions with regard to recognition of gain on a liquidation of an 80%-owned subsidiary into a foreign parent in a transaction described in IRC section 332 (i.e. an US outbound liquidation in the case of a liquidation of a US subsidiary, or a foreign-to-foreign liquidation in the case of a liquidation of a foreign subsidiary).

In addition, under IRC section 6038B and the related regulations, a US transferor of property to a foreign corporation in a non-recognition transaction covered by IRC section 367(a) is required to file IRS Form 926 (Return by a US Transferor of Property to a Foreign Corporation), describing the transferee foreign corporation and the property transferred.

Under the current regulations, a US transferor is subject to full gain recognition under IRC section 367(a)(1) if the US transferor fails to timely file an initial GRA, or to comply in any material respect with the IRC section 367(a) GRA regulations or with the terms of an existing GRA. Relief may be granted if the US transferor demonstrates that its failure was due to reasonable cause and not wilful neglect.

The proposed regulations remove the reasonable cause requirement, and accordingly gain recognition will apply only if the taxpayer’s failure is wilful. The proposed regulations provide guidance on the interpretation of a wilful failure, which will generally be based on the facts and circumstances in each case, and include illustrative examples.

The proposed regulations also eliminate the current requirement that the IRS must respond within 120 days to requests received from taxpayers seeking relief from gain recognition due to non-compliance under IRC section 367. The IRS will no longer be subject to a strict processing time for taxpayer requests in this regard.

The current reasonable cause standard, however, will continue to apply to a US transferor seeking relief from penalty for failure to satisfy the IRC section 6038B reporting requirement. Therefore, a US taxpayer seeking relief from IRC section 6038B penalty will still need to demonstrate that its failure was due to reasonable cause and not wilful neglect.

In addition, the proposed regulations provide rules similar to the rules under the IRC section 367(a) GRA regulations and related IRC section 6038B regulations for failures to file the required documents or statements and failures to comply under the IRC section 367(e)(2) regulations and related section 6038B regulations with respect to liquidation transactions.

The proposed regulations also modify the information that must be reported to the IRS with respect to liquidating distributions under the IRC section 367(e)(2) regulations, including the addition of a requirement to report the basis and fair market value of the property distributed.

The current Treasury Regulation section 1.367(a)–3 also require certain other statements to be filed in connection with certain transfers of stock or securities, but do not provide rules of application for taxpayers who fail to meet these requirements. The proposed regulations incorporate rules in this regard that are similar to the rules that apply with respect to failures to file or failures to comply with the IRC section 367(a) GRA regulations. The proposed regulations are designated Treasury Regulation sections 1.367(a)-3 and -8, 1.367(e)-2, and 1.6038B-1.

The proposed regulations will apply to documents or statements that are required to be filed with a timely filed return on or after the date on which the regulations are published as final, as well as to requests for relief that are submitted on or after the date on which the regulations are published as final.

(ix) Public comments requested on allocation of interest expenses by foreign corporations engaged in US business

The US IRS and the US Treasury Department have issued a notice requesting comments on final regulations (TD 9465, Determination of Interest Expense Deduction of Foreign Corporations).

The final regulations were issued u/s. 882(c) of the US IRC to provide guidance on the determination of the interest expense deduction for foreign corporations engaged in a trade or business within the United States.

The final regulations adopted, without substantive change, the temporary regulations (TD 9281) issued on this topic. The temporary regulations, among other things, also implemented the views of the US Treasury Department and IRS that were expressed in IRS Notice 2005-53 regarding the operation of the three-step formula used to allocate interest expenses to the United States (see United States-1, News 21st July 2005).

The final regulations made substantial modifications to the three-step formula in Treasury regulation section 1.882-5. In particular, the final regulations increased the fixed-ratio that may be used by foreign banks to compute US-connected liabilities in Step 2 from 93% to 95%.

The final regulations also provided guidance for coordinating the interest allocation rules of Treasury regulation section 1.882-5 with US income tax treaties that, pursuant to the authorised OECD approach (AOA), apply the OECD Transfer Pricing Guidelines, by analogy, in determining the profits of a permanent establishment. The final regulations recognised that an income tax treaty or accompanying documents might provide alternative rules for allocating interest expense to a permanent establishment.

(x) Final regulations issued on requirements under FATCA

The US Treasury Department and the IRS issued final regulations (TD 9610) on 17th January 2013 to provide guidance on account identification, information reporting, and withholding requirements that the Foreign Account Tax Compliance Act (FATCA) imposes on foreign financial institutions (FFIs), other foreign entities, and US withholding agents.

The final regulations adopt with modifications the proposed regulations (REG-121647-10) issued on 15 February 2012 , and the amendments described in IRS Announcement 2012-42 issued on 24th October 2012. The final regulations are effective 28th January 2013.

The issuance of the final regulations was announced in a Press Release issued by the Treasury Department on 17th January 2013. The Press Release states that the final regulations implement FATCA in the following manners:

• The final regulations coordinate the obligations for FFIs under the regulations and the intergovernmental agreements in order to reduce administrative burdens for FFIs that operate in multiple jurisdictions.

• The final regulations phase in over an extended transition period to provide sufficient time for FFIs to develop necessary systems.

• The final regulations align the regulatory timelines with the timelines described in the intergovernmental agreements to avoid confusion and unnecessary duplicative procedures.

• The final regulations provide relief from with-holding with respect to certain grandfathered obligations and certain payments made by non-financial entities.

• The final regulations expand and clarify the treatment of certain categories of low-risk institutions, such as governmental entities and retirement funds.

• The final regulations permit certain investment entities to be reported by the FFIs with which they hold accounts rather than being required to register as FFIs and report to the IRS.

• The final regulations clarify the types of passive investment entities that must be identified and reported by FFIs.

• The final regulations provide more stream-lined registration (which will take place through an online system) and compliance procedures for groups of financial institutions, including commonly managed investment funds.

• The final regulations provide additional detail regarding FFIs’ obligations to verify their compliance under FATCA.

FATCA was enacted in 2010 as Sections 1471 to 1474 of the US IRC to combat non-compliance by US taxpayers using foreign accounts. FATCA requires FFIs to report to the IRS information about financial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold a substantial ownership interest.

FFIs that do not register and enter into an agreement with the IRS will be subject to withholding on certain types of payments relating to US investments

(xi) Final regulations issued to prevent tax-avoidance in stock acquisitions by related corporations

The US Treasury Department and the IRS have issued final regulations (TD 9606) to prevent tax-avoidance in connection with stock acquisitions by related corporations under section 304 of the US IRC.

IRC section 304 is intended to prevent the use of stock sales between brother-sister or parent-subsidiary corporations as a means to produce capital gains rather than dividend treatment.

Specifically, IRC section 304(a)(1) provides that, if a corporation (acquiring corporation), in return for property, acquires stock in another corporation (issuing corporation) from a transferor in control of each of the two corporations, property received by the transferor is treated as a distribution in redemption of the stock of the acquiring corporation.

The redemption is then analysed under the tests described in IRC section 302(b), which are intended to distinguish a true stock redemption (treated as a sale) from a distribution of corporate earnings. If none of the tests are met, the transaction is treated as a corporate distribution with possible dividend consequences, rather than as a sales transaction.

In determining the amount of the corporate distribution that is a dividend, the earnings and profits (E&P) of both the acquiring corporation and the issuing corporation are taken into account under IRC section 304(b)(2). IRC section 304(b)(5) limits the amount of E&P of a foreign acquiring corporation that are taken into account for this purpose. Under IRC section 301(c)(2) and (3), if the amount of the distribution exceeds the combined E&P of the acquiring corporation and the issuing corporation, the excess reduces the transferor’s basis in the stock and is treated as a tax-free return of capital to that extent and as gain from a sale of the stock to the extent of any further excess.

It was observed that some taxpayers attempted to artificially eliminate the amount of a distribution constituting a taxable dividend by, for example, having an existing corporation with a positive E&P account form a new corporation with no E&P and having the newly formed corporation (“acquiring corporation”) acquire the stock of an issuing corporation using the capital contributed by the existing corporation (“deemed acquiring corporation”) to form the acquiring corporation.

On 14th June 1988, the Treasury Department and the IRS promulgated Treasury regulation section 1.304-4T (TD 8209) to treat the deemed acquiring corporation as having acquired the stock of the issuing corporation if the deemed acquiring corporation controls the acquiring corporation and the acquiring corporation was created, organised, or funded primarily to avoid the application of IRC section 304 to the deemed acquiring corporation.

On 30th December 2009, temporary regulations (TD 9477) and proposed regulations (REG–132232–08) were issued to extend the application of the anti-abuse rule of Treasury regulation section 1.304-4T to a “deemed issuing corporation”. A deemed issuing corporation refers to a corporation that is controlled by an issuing corporation if the issuing corporation is a newly formed corporation having no E&P and the issuing corporation acquired the stock of the deemed issuing corporation in connection with the acquisition of the stock of the issuing corporation by an acquiring corporation with a principal purpose of avoiding the application of IRC section 304 to the deemed issuing corporation. The acquiring corporation then will be treated as acquiring the stock of the deemed issuing corporation subject to the regular IRC section 304 analysis described above.

The final regulations adopt the 2009 temporary regulations without change. The final regulations are designated Treasury regulation section 1.304-4.

The final regulations are effective on 26th December 2012 and apply to acquisitions of stock occurring on or after 29th December 2009.

(xii) Treaty between US and Norway – IRS releases competent authority agreement regarding source of income

The US IRS has released the official text of the recent competent authority agreement between the United States and Norway.

The agreement clarifies the meaning of the phrases “remuneration described in article 17 (Governmental Functions)” and “payments described in article 19 (Social Security Payments)” as used in the last sentence of article 24(6) (Source of Income) of the 1971 US-Norway Income Tax Treaty.

The first sentence of article 24(6) provides a general source rule for compensation received by an individual for his personal services, under which such compensation is treated as income from sources within a contracting state only if the services are performed in that state.

The last sentence of article 24(6) provides an exception to the general source rule with regard to remuneration described in article 17 and payments described in article 19. Such remuneration is treated as income from sources within a contracting state only if paid by, or from the public funds of, that state.

According to the competent authority agreement, the following understandings have been reached for the purposes of article 24(6):

• remuneration described in article 17 is limited to income paid by, or from public funds of, one of the contracting states to a citizen of that contracting state, and thus, for example, remuneration that is paid by Norway to a person who is not a citizen of Norway would be subject to the general source rule instead of the exception;

• payments described in article 19 refers to Social Security payments and other public pensions paid by a contracting state to a resident of the other contracting state or to a US citizen, without regard to the location in which the underlying services are performed;

• remuneration that is not described in article 17 is subject to the provisions of the applicable article; and

• the saving clause of article 22(3) (General Rules of Taxation) applies if remuneration described in article 17 is paid by Norway to a citizen of Norway who is also either a US citizen or a US lawful permanent resident (i.e. a green card holder), and the entire amount of the payment will be treated as income from sources without the United States for the purpose of applying article 22(3) (Relief from Double Taxation).

The competent authority agreement was entered into under article 27(2) (Mutual Agreement Procedure) of the Treaty.

[Acknowledgment: We have compiled the above information from the Tax News Service of the IBFD for the period 18-12-2012 to 18-03-2013.]

Nirav Shah

UK’s drive for competitiveness

The UK has undertaken a series of changes in its tax policy in recent years with the aim of improving the attractiveness of the UK as a place to do business. These changes are continuing with a key goal of making the UK tax system the most competitive in the G20. This is becoming a reality as a result of a number of measures that have recently been introduced.

The change in tax policy was brought about by the threat that existing UK businesses were considering moving their headquarters outside the UK (referred to as ‘inversions’) and that international businesses were choosing other locations for investment. As a result the UK government has three clear goals in making the changes it has made:

1. To keep existing business activities in the UK (both UK groups and international groups with existing UK businesses);

2. To stimulate new business activity by existing UK businesses; and

3. To attract new business activity to the UK. One of the countries which the UK government is specifically targeting for new investment in the UK is India. Historically, Indian groups have made significant investments into the UK and the UK government is keen for this to continue.

In this article, we will look at the key changes that have been implemented in the UK under the tax reforms and how the UK is positioned today as a holding company and regional hub location.

Perceived “barriers” to the UK’s competitiveness The UK tax regime has traditionally had some key attributes that groups look for in headquarter or holding company jurisdictions. For example, the UK does not, under its domestic tax law, levy withholding tax on dividend distributions paid to overseas investors in UK companies. It also exempts capital gains derived from share disposals from tax.

However, several areas of UK tax law continued to make the UK appear uncompetitive especially when viewed against territories such as Singapore, Ireland and the Netherlands. These included the UK’s comparatively high corporation tax rate, the system of taxing dividends received by UK companies, the taxation of overseas branch profits and the CFC rules.

Foreign profits reform

Reduction in corporation tax rate

The “Corporate Tax Roadmap” released by the HM Treasury in November 2010 set out the plans for the reduction in the corporation tax rate. The rate at that time was set to steadily decline to 22% by 2014. The government has since announced a further reduction to 20% from April 2015. This would make the UK’s main corporation tax rate the lowest in the G20 alongside Russia, Turkey and Saudi Arabia.

Introduction of the UK’s foreign dividend exemption

Prior to the introduction of this new regime, the UK taxed the receipt of foreign dividends with credits potentially available for overseas and withholding tax suffered under the UK’s “double taxation relief” regime. This regime grew increasingly complex – creating an administrative and commercial burden on UK plc, which required reserves and cash to fund shareholder distributions. In many cases, the regime resulted in UK companies having to “top up” corporation tax payable even after taking credits, particularly when the headline UK corporation rate was as high as 30%.

Following representations from business and a consultation period, the UK’s dividend exemption was introduced with effect from 1 July 2009. The system introduced a number of “exempt classes” into which the vast majority of distributions should now fall. The main areas where dividends may still be taxable are if the distribution is itself deductible for overseas tax purposes, or where a distribution is funded from a previous structure designed to erode the UK corporation tax base.

Introduction of the “branch profits exemption”

Another area where the UK was seen as lagging behind other more competitive territories was the taxation of overseas branches of UK companies. As with distributions from overseas companies, the UK taxed the overseas branch profits of UK companies, with a credit for local tax suffered. Again this was a complex regime which often meant that additional UK corporation tax was payable, and impacted a purely commercial decision as to whether it was more efficient to enter a new territory via a branch or an overseas incorporated company.

To remove this barrier the UK authorities introduced an extremely flexible “branch profits exemption” with effect from 2011. Broadly, the regime allows a UK company to elect for its overseas branches to be exempt from UK tax. Electing companies will be exempt from UK tax on branch profits, but will not receive loss relief in respect of branch losses. There are certain conditions which need to be met in order to qualify for the election. For example, the branches must be ‘good’ branches as determined by applying the principles under the CFC rules. Also, if the UK company had taken the benefit of the losses of the branch, these losses must first be offset with taxable profits before the company can elect into the branch exemption rules. The branch profits are calculated using tax treaty principles. With this “optin” system, groups have the choice of applying the regime on a UK company-by-company basis through an election system. This is particularly useful as it allows groups to maintain the “old” position where it makes sense to do so – for example where a UK company has branches, or a majority of branches, with losses or “high tax” profits.

Fundamental relaxation of the UK CFC rules

Compared to the above changes, which could be termed “easy wins”, the relaxation of the UK CFC rules has been the most discussed and involved process. The previous incarnation of these rules was one of the primary drivers behind some of the corporate “inversions” mentioned earlier (where existing UK businesses were moving their headquarters outside the UK), and in some cases prevented overseas groups from viewing the UK as a viable holding or regional holding company jurisdiction. A particular complaint of UK groups was that the rules were applied in a disproportionate manner. In order to tax profits artificially diverted from the UK they also often caught profits generated overseas through genuine commercial operations, i.e., amounting to an effective system of “worldwide taxation” employed by the UK.

After significant consultation, the revised CFC rules are now on the statute book and have taken effect from 1 January 2013. The driving principle behind the new rules is one of “territoriality”. The revised CFC rules have been carefully crafted only to apply to target profits which are shown to have been “artificially diverted” from the UK. Profits which have been generated overseas through genuine economic activities and through activities which pose no risk to the UK corporation tax “base” should be left untaxed by the new UK CFC rules.

The rules remain relatively detailed, but include a wide-range of exemptions from the CFC rules, only one of which has to apply to prevent a CFC charge. As such, we anticipate that a majority of overseas subsidiaries of UK companies should be exempt under the new CFC rules. For overseas trading activities, only where it can be shown that profits have arisen, to a significant extent, due to UK activities (such as key decision makers or developers of intellectual property being in the UK) do we expect to see taxation of profits under the UK CFC provisions.

For interest income, the UK regime includes UK CFC taxation at one quarter of the UK headline corporation tax regime (which would be a rate of 5% by 2015), with the potential for 0% under certain specific conditions.

Whilst the UK has chosen to retain CFC rules and is therefore at a disadvantage compared to other territories which does not have such rules, the practical impact of the UK CFC rules for groups which choose to locate their headquarters or holding or regional holding companies in the UK is likely to be limited to that of compliance going forward.

‘Above the line’ research and development (“R&D”) tax incentive

The UK has had an R&D tax incentive for large companies for over 10 years but following a series of consultations it was decided by the government that a fundamental change is required in order to make the incentive more attractive to innovative businesses. Under the old rules, a ‘super deduction’ was available, i.e. a deduction in addition to that for the qualifying R&D expenditure was available. For example 130% of qualifying expenditure was deductible in certain cases.

Under the new rules, the benefit by way of credit will be ‘above the line’. This will allow the benefit of the R&D relief to be accounted for as a reduction of R&D expenditure within the Profit & Loss account. The associated tax credit is offset against corporation taxes payable.

The change to an above the line credit is being made in order for the benefit of the incentive to be more directly linked to the amount of R&D expenditure and also to show an improved pre -tax profit as a result. By applying the credit against the R&D expense, thus reducing the cost of the R&D in the accounts of the company and reflecting the impact within the pre-tax profit, it is thought that the incentive will have more of an effect in encouraging R&D activity in the UK.

The new credit will be a taxable credit of 10% of qualifying expenditure. The credit will be fully payable to companies which have no corporation tax liability, subject to a cap equivalent to the Pay As You Earn/National Insurance Contributions (PAYE/NIC – employment and social security) liabilities of the company. The new credit will be available for qualifying expenditure incurred on or after April 1, 2013 and will initially be available as an alternative to the current super deduction, before completely replacing the super deduction from April 1, 2016.

This is of great benefit to loss making groups in that they will be able to obtain payment for the credit, subject to the PAYE/NIC cap.

Patent Box

As part of the UK Government’s aim to encourage innovation in the UK and ensure the commercialisation of UK inventions in the UK, a new 10% tax rate has been introduced from 2013 and will apply to Patent Box profits. This is a significant saving as compared to the main headline tax rate of 20% (by 2015).

The relief applies to worldwide profits from pat-ented inventions protected by the UK Intellectual Property Office of the European Patent Office as well as patents granted by other recognised patent offices. It is not only royalties and income from the sale of IP that qualifies for this regime – all profits (less a routine profit and marketing charge) from sales of products which incorporate a patented invention qualify. This is a very broad definition and is intended to ensure that the tax rate of 10% applies to all profits arising from patents and not just the profits attributable to the patent itself.

A company qualifies if it has the ownership (or an exclusive licence) of patents and the company (or the wider group) has performed qualifying development and has the responsibility for and is actively involved in the ongoing decision making concerning the further development and exploitation of the IP. This allows a business to benefit from the regime even where they did not develop the IP originally. This supports the objectives of the Patent Box to encourage continuing development and commercial exploitation of patents by UK businesses.

The new Patent Box provides an attractive opportunity for businesses to reduce the costs associated with the commercial exploitation of patented IP. The regime is flexible and generous and should prompt global businesses to favourably consider using the UK as a place to invest in innovation.

Substantial Shareholdings Exemption (SSE)

The Substantial Shareholdings Exemption (SSE) regime was introduced in 2002. The SSE broadly exempts from UK corporation tax any capital gain on disposals by trading companies or groups, of substantial shareholdings in other trading companies or groups. Generally speaking, ‘trading’ refers to operating companies/groups with an active trade/business. The important point here is that the business should be an operating business with income from its operations (as against a business with minimal operations receiving mainly passive income). However, the legislation has also set out detailed technical conditions for the exemption to apply, and anti-avoidance provisions, all of which must be met. Care in particular cases is therefore needed in order to determine the availability of this relief.

Broadly, there are three sets of conditions which must be satisfied in order to obtain the exemption:

1. The substantial shareholding requirement – The investing company (the company making the disposal) must own at least 10% of the ordinary share capital of the investee (company whose shares are being disposed) for a continuous period of 12 months preceding the disposal

2. Conditions relating to the ‘investing’ company/ group, i.e., the company/group making the disposal – The investing company must be a ‘sole trading company’ or a member of a ‘qualifying group’. This condition must be met from the start of the latest 12 months period for which the substantial shareholding requirement (above) is satisfied, until the time of the disposal. It must also be met immediately after the disposal takes place. A ‘sole trading company’ is a company which is not a member of a group, which is carrying on trading activities and whose activities do not to a substantial extent include activities other than trading activities. A ‘qualifying group’ is a group, the activities of whose members, taken together, do not to a substantial extent include activities other than trading activities. Intra-group activities, such as intercompany loans, rental streams or royalty charges are ignored for this purpose. As stated earlier, ‘trading’ here refers to operating companies/groups with an active trade/business, i.e. the business should be an operating business with income from its operations. Whether a company or group is carrying on trading activities requires a consideration of the activities, income, assets, liabilities and people functions of the relevant company/group.

3. Conditions relating to the ‘investee’ company/ sub-group, i.e., the company/sub-group being disposed of – The investee must have been a ‘qualifying company’ from the start of the latest 12 month period for which the substantial shareholding requirement (above) is satisfied, until the time of the disposal. This condition must also be met immediately after the disposal. A ‘qualifying company’ means a trading company or the holding company of a trading group or a trading sub-group. Broadly, this means that the activities of the company being sold and its 51% subsidiaries (if any) will be considered. To qualify for the exemption, at least one of these companies must be carrying on trading activities. Also, the activities of all the group/subgroup companies, taken together, must not include to a substantial extent activities other than trading activities. As stated earlier, ‘trading’ here refers to operating companies/groups with an active trade/business, i.e. the business should be an operating business with income from its operations. Whether a company or group is carrying on trading activities requires a consideration of the activities, income, assets, liabilities and people functions of the relevant company/group.

Where these conditions are met, gains arising on the disposal of shares will be exempt from corporation tax on chargeable gains. Equally, capital losses arising on such disposals are not allowable. Where there is significant uncertainty on the applicability of the SSE to a proposed transaction, an application can be filed with the UK tax authorities, Her Majesty’s Revenue and Customs (HMRC) to obtain a clearance that the conditions of the SSE would be considered to be met.

General Anti-Abuse Rule (GAAR)

There has been substantial consultation by the UK government on the introduction of a GAAR.

The GAAR is not part of the package of measures (discussed above) which have a key goal of making the UK tax system the most competitive in the G20. While the introduction of a GAAR could be considered to introduce some uncertainty, the government has clearly stated that the aim of the GAAR is to target only artificial and abusive schemes.

In addition, the introduction of the UK GAAR will bring the UK in line with most other European (and other) countries, which already have GAARs.

The government has confirmed that the GAAR should only apply to arrangements which begin after the legislation becomes the law (expected to be by July 2013) and it will apply only to arrangements which pass two tests. Arrangements will pass the first test if one of their main purposes is to obtain a tax advantage, judged objectively. The second test is a reasonableness test which will only be met if the arrangements entered into cannot be regarded as a reasonable course of action, having regard to the consistency of the substantial results of the arrangements with the principles and policy underlying the relevant tax provisions. Tax advantages which are caught by the GAAR will be counteracted on a just and reasonableness basis.

As part of the GAAR being introduced, an advisory panel will be formed which will have two main roles. Firstly, to provide opinions on the potential application of the GAAR, after representations have been made to them, and secondly to approve the guidance which HMRC will prepare on the GAAR.

It is the stated aim that the GAAR should target and counteract only artificial and abusive schemes. On the basis that any tax planning undertaken by Indian businesses generally has commercial substance, the GAAR is not expected to have any significant impact on normal commercial transactions undertaken by Indian groups in the UK.

The UK is ‘open for business’

As mentioned above, the recently announced changes to the UK corporate tax system are part of a package of measures which have been introduced over the last few years. To summarise, the most significant of the changes include:

• A continued reduction in the UK’s main rate of corporation tax to 20% from 1 April 2015 (the rate is currently 23% and was 30% before April 2008).

• A Patent Box regime, from 1 April 2013, which will result in qualifying patent box profits being taxed at a significantly reduced rate of only 10%, the aim being to encourage the development and exploitation of patents and other similar intellectual property in the UK.

• An exemption system for most dividends received by UK companies and for gains made on the sale, by a UK company, of most shareholdings in trading companies.

• An elective exemption system for overseas activities of a UK company (overseas branches).

• A reformed controlled foreign companies (CFC) regime which is targeted at only taxing profits that have been artificially diverted from the UK.

• The introduction of the new ‘above the line’ R&D tax incentive.

These changes have resulted in the UK’s tax system becoming more territorial and making the UK a very attractive location for regional holding and “hub” companies, acquisition companies and publicly listed parent companies, particularly when combined with a number of long standing attractive features, including being the G20 country with the most double tax treaties and the absence of a withholding tax on dividends paid by a UK company.

The UK as a headquarter and holding company jurisdiction

Over the last three years, a number of groups, particularly US groups (for example – Ensco Inter-national and Rowan Companies), have relocated their headquarters to the UK, partly because they understood that there should no longer be adverse UK corporation tax implications from doing so. Other US and non- US groups have also been actively using the UK as a regional holding company jurisdiction, particularly since the structure of the new UK CFC rules has been settled. The interaction between HMRC and these groups has also been encouraging, with HMRC actively engaging in pre-transaction discussions with businesses and offering pre-transaction clearances.

For Indian groups investing overseas, particularly into Europe and the US, the UK is now competitive with other more traditional holding company jurisdictions such as Singapore, Netherlands and Luxembourg. In addition to offering similar benefits in terms of low or zero holding company corporation tax, many groups often have substantial existing operations in the UK. This, combined with the UK’s extensive double tax treaty network, offers plenty of potential for multinationals to use the UK as an efficient regional management and financing hub.

Nirav Shah

E-filing of tax returns goes to the next level

Readers would be aware of the e-filing requirements with reference to income-tax returns. These were brought onto the statute long back and, by now, most of us are well versed in the process of e-filing of the ITR forms. We also have the e-filing requirements under Company Law whereby we have been filing documents electronically with the MCA. For the past few years, ever since the e-filing of returns was made mandatory, we have had a situation where the audited accounts, the tax audit report, the MAT certificate etc., have not been submitted to the tax department unless specifically called for during a scrutiny. This, in my opinion, has inadvertently led to a bit of leniency being shown by many of our members in terms of timely closure of documentation and filing.

Background:
Section 139 requires certain categories of persons to file tax returns in India. Section 139(1) states that the returns need to be in prescribed form. Rule 12 lays down the prescribed forms. Proviso to Rule 12(3) as amended vide Notification No. 37/2011/F. No. 149/68/2011-SO(TPL) dated 01-07-2011 makes it mandatory for some of these categories of return filers to e-file their returns mandatorily. For others, there is an option to e-file the returns (section 139(1B)) but only if they are assessable in specified cities. Section 139(1B) empowers the Government to formulate a scheme for e-filing. In pursuance of this power, the “Furnishing of Return of Income on Internet Scheme 2004” was notified on 30-9-2004. Then, this scheme was superseded by the “Electronic Furnishing of Return of Income Scheme 2007” vide notification No. SO 1281 (E) d. 27-70-2007.

As per Rule 12 (2), ITR-1, 2, 3, 4, 4S, 5 & 6 are not required to be accompanied by any documents. For A.Y. 2009-10, vide Circular No. 3/2009 d. 21-05-2009, the TP reports were to be filed physically before the due date. Thereafter, we have not had any such similar circulars but the practice of filing the TP reports on or before the due date for filing the returns has continued.

Recent notifications:
Now, on 1st May, 2013, the CBDT issued a Notification (No. 34/2013/F. No. 142/5/2013-TPL) which made amendments to Rule 12 whereby, the following proviso has been inserted in sub Rule (2) w.e.f. 1st April, 2013:

“Provided that where an assessee is required to furnish a report of audit under sections 44AB, 92E or 115JB of the Act, he shall furnish the same electronically.”

It is on account of this amendment that now, tax payers who are subject to a tax audit or a transfer pricing audit or who have to pay MAT, are now required to file the respective reports electronically.

Subsequent to the abovementioned notification, another notification has been issued on 11th June, 2013 (Notification No. 42/2013/ F.No.142/5/2013-TPL) which amended the proviso to Rule 12(2) which was inserted by the earlier notification dated 1st May. Now, the amended proviso reads as under:

“Provided that where an assessee is required to furnish a report of audit specified under sub-clauses (iv), (v), (vi) or (via) of clause (23C) of section 10, section 10A, clause (b) of sub-section (1) of section 12A, section 44AB, section 80-IA, section 80-IB, section 80-IC, section 80-ID, section 80JJAA, section 80LA, section 92E or section 115JB of the Act, he shall furnish the same electronically.”

As a result of the above amendment, now, many more reports are required to be filed electronically.

Another interesting amendment that was made vide the notification dated 11th June is the insertion of second proviso to sub rule (3) of Rule 12. The newly inserted proviso reads as under:

“Provided further that a person who is required to furnish any report of audit referred to in proviso to sub-rule (2) electronically, other than a person to whom clause (aaa) or clause (ab) of the first proviso is applicable, shall furnish the return, in Form as applicable to him, in the manner specified in clause (ii) or clause (iii).”

The cumulative impact of all the amendments is that any taxpayer who is subject to any audit will have to file the audit report electronically and, in addition, also have to file its tax return electronically.

The new e-filing regime:
Before we look at the details of the new e-filing regime, a quick look at the changes in type of tax return forms that can be filed for A.Y. 2013-14:

Form No.

Change applicable from A.Y. 2013-14

ITR-1 (Sahaj)

Cannot be used by an individual having:
i. A loss under IFOS
ii. A claim for foreign tax credit/relief under section 90/90A/91
iii. Exempt income exceeding Rs. 5,000

ITR-4S (Sugam)

Cannot be used by an individual/HUF having:
i. A claim for foreign tax credit/relief under section 90/90A/91
ii. Exempt income exceeding Rs. 5,000

Similarly, the amended position regarding how the tax returns can be filed with effect from A.Y. 2013-14:

Registration of Chartered Accountant on e-filing portal:

Significantly, the onus of uploading the tax audit report, transfer pricing report, MAT certificate, trust audit report etc., has been cast on the concerned Chartered Accountant who signs such a report/certificate. As a result, the process of e-filing of such reports would begin with the concerned CA having to register himself/herself on the e-filing portal. It may be noted that many CAs would already be registered with the said portal and would have been filing their personal tax returns electronically. However, even such CAs would still need to register themselves once again on the portal. For this, one would need to visit www. incometaxindiaefiling.gov.in and register on the site under the sub-category of “Chartered Accountants” under the main category of “Tax Professional”.

While registering, the CA will have to provide his ICAI Membership Number and date of enrolment with the ICAI. We need to be careful with this data since I am informed by a Regional Council Member of ICAI that this data is cross-verified by the portal with the ICAI records. While this information is not verified by me, if it is true, then even a small mistake may lead to problems in registration. Once the CA is registered successfully, he/she would get a notification by email and on a mobile (so, both these fields are mandatory and we will have to provide a valid email ID and a valid mobile number while registering). The activation link received through email has to be activated and then the registration would be completed. The CA would then get a new login name which is based on this ICAI Membership Number as opposed to the PAN-based login ID that we are generally accustomed to.

Once the CA registers on the site, his client will then need to register the CA as the signatory to the respective report/certificate. So, for example, in case of a taxpayer XYZ Pvt. Ltd., the tax audit report will be signed by CA Mr. A, the transfer pricing report will be signed by CA Ms. B and the MAT certificate will be signed by CA Mr. C, then the said company will have to log onto the e-filing portal and register each of these CAs for the respective report/ certificate. When this is done, the concerned CA will get a mail informing that a particular taxpayer has registered the CA as its signatory. The message contains the following line:

Dear AMEET NAVINCHANDRA PATEL,

User AAXXXXXX1B has added you as the CA for FORM3CA, FORM3CB for 2013-14.

Filing of tax returns only after uploading other reports:

It may be noted that it is no longer possible for a taxpayer to file the ITR form unless the various applicable audit reports (tax audit, transfer pricing, trust, MAT) are uploaded electronically. In the ITR form, the date of uploading of each such document has to be mentioned.

Actual uploading of tax audit reports:

Once the CA has registered himself/herself and the client has also registered the CA as the tax auditor, the uploading of the tax audit report (TAR) can be done. This has to be done by the concerned CA. It may be noted that in case of partnership firms who are appointed as the tax auditors, it is the individual partner who has to register himself/herself and not the firm. Also, the same partner will also need a Digital Signa-ture Certificate (DSC) to be able to upload the TAR.

For uploading the TAR, a CA would need to download the utility provided by the tax department on their portal. Once the utility is downloaded onto a local computer, the CA can start feeding in the data. This is offline preparation of the form. The CA also has the option of going online and preparing the form and submitting it immediately thereafter. However, considering the various issues that have already been faced by the CAs who have tried to use the utility, and also considering that this is the first year of e-filing of the TAR, one would need to be very courageous to attempt an online preparation and submission.

A very important feature of the utility provided by the tax department on their site is that it is NOT MS Excel based. This is one of the biggest drawbacks of the said utility. The utility is not user friendly and requires every bit of data to be manually entered by the CA. Also, it does not allow a user to “cut-paste” from any other file. So, if you thought that you could keep an Excel sheet open and then cut from there and paste the data into the utility, you have a shock in store for you. Many CA firms use private software for preparing the computation of income and also the ITR forms. Such firms will need to decide whether they would like to use the utility provided by the Government for uploading the TAR or whether their private software vendors will provide the utility. This article refers to the utility provided by the Government. For running this utility, you will require your computer to have Java Runtime Environment Version 7 Update 6 or above (32 bit) installed in it.

Once the data is entered into the utility, the entire file needs to be validated (on similar lines as the validation required for ITR forms). Upon successful validation, the CA needs to generate a .XML file. The .XML file then has to be uploaded onto the portal with the help of a DSC (which can be either in the form of a .pfx file or a USB token). Once this is done by the CA, the ball then moves to the court of the concerned taxpayer who will get a notification that his CA has uploaded the TAR for his (taxpayer’s) approval. The taxpayer will then have to review the TAR and “Approve” or “Reject” the same. If for any reason, the assessee rejects the TAR, then the concerned CA would need to resolve the difference that the assessee has and then once again generate a fresh .XML file and upload it. The assessee would then again need to log in and “Approve” the same. Once the assessee approves the TAR with the help of a DSC, the same gets officially filed with the Income-tax department and an e-acknowledgement gets generated. This closes the e-filing procedure as far as the TAR is concerned.

Uploading of financials:

Quietly, along with the e-filing of the TAR, the Government has also simultaneously made it mandatory for the tax auditor to also upload the scanned copies of the audited accounts. Fortunately, the tax auditor does not need to feed in the balance sheet and P&L items all over again but merely scan the accounts and upload the same. This has to be done at the time of uploading the TAR. The scanned documents can be either in .TIFF format or in .PDF format. The overall size of the files cannot exceed 20MB. It appears that this limit stands increased to 50MB as per the General Instructions in the utility. However, the main screen where the said accounts are to be uploaded continues to show the size restriction as 20MB.

Actual uploading of other reports:

The same procedure as is adopted for uploading the TAR has to be followed for other forms as well. Thus, whether it is the Transfer Pricing Report in Form 3CEB or the MAT certificate in Form 29B or the audit reports of trusts, the same procedure of uploading data by the CA, validating the file, generating .XML file, uploading the said .XML file with the help of a DSC and then approving of the same by the assessee with the help of his DSC has to be followed. Upon successful “approval” of each report by the assessee, a separate e-acknowledgement gets generated.

Issues currently being faced:

There are a number of hardships that CAs are facing in the context of e-filing of the various audit reports. Some of the important ones (on which the BCAS has already made a representation) are:

1. After the notification, the forms and the utility files were hosted on the e-filing website in the month of July, 2013 and have undergone several changes. After each change, an assessee, who has partly filled in a report but has not uploaded it, is required to re-feed the entire data, verify and then upload in the latest version, for the report to be furnished on the website. As a result, all the work-in-progress is wasted.

2. It is not clear as to whether the financial statements to be attached have to be a scanned copy of the manually signed statements or even a PDF file digitally signed will be treated as sufficient compliance. Also, it is unclear as to where the notes to account, the auditor’s report, director’s report and the schedules are to be uploaded. In the portal, there are only the following fields for uploading the accounts:

a) Balance Sheet

b) Profit & Loss Account

3. In respect of several clauses of the Form 3CD, it is normal practice for CAs to give appropriate comments. But in the e-filing utility, there is no space provided for such comments/notes/ remarks/disclaimers etc. In such a situation, would it be legally valid for the assessee/tax auditor to keep the appropriate comments/remarks/explanation in the hard copy and in the utility, mention either “Yes”/”No”/”0” etc. as the case may be? Here the real question is whether an assessee can have two sets of 3CD—one that is uploaded electronically and another one that is signed physically? My personal view is that this would not be correct. However, considering the problem at hand, one needs a written clarification from the Government. The other option that a tax auditor may consider is of putting all comments/remarks/ disclaimers etc. in the 3CA/3CB. However, there seems to be an overall limit on the number of characters that one can feed into the 3CA/3CB. So, in many cases, this option may not work. Also, whether doing such a thing results in the report being perceived to be a qualified report is also a question that needs pondering over.

4. In the clause relating to depreciation on fixed assets, there is no column to give details of additional depreciation. Further, it appears that date-wise details of all the minor items of additions to fixed assets are also required to be given. This data could run into a few thousand entries for many businesses, and would take substantial time to re-enter.

5. In the clause relating to quantitative details, often, such data is not available. In such cases, the tax auditor simply reports “Information Not Available”. Now, in the e-filing utility, it is not possible to give such a comment. What does one do in such a situation? In the same clause, in case of manufacturing assessees, if the yield is more than 100%, the utility does not accept the figure. On a lighter vein, does it indicate that the Government does not expect taxpayers to be extra-efficient?

6. In the clause relating to ratios, in case of service industry or professionals, normally the tax auditor states that “since the activity of the assessee is neither trading nor manufacturing, such ratios are not applicable.” In the e-filing utility, there is no space for such a comment. In this situation, can a tax auditor simply skip this clause?

7. If one sees the Income-tax Rules, in Form 3CD, Annexure II is still a part thereof despite the fact that from A.Y. 2010-11, the provisions of FBT are made ineffective. The e-filing utility does not provide this Annexure II. It is not clear as to what the exact position is. Can an e-filing utility override the statutory forms prescribed?

8. In the clause relating to payments covered u/s. 40(A)(2)(b), it appears that every payment so made is required to be reported. Hitherto, the tax auditor used to report only the total amount for each type of transaction with a particular party. Now, it seems that the date-wise transaction details are to be given. This will cause a lot of hardship to the tax auditor while filling in the data.

9. In the clause relating to loans taken or repaid, one has to give the PAN of the party reported. It appears that the utility matches this PAN with the Government’s PAN records and if the name and PAN do not match exactly then the file does not get validated. If this is true, then this is likely to cause tremendous slowdown in the preparation of the reports.

Thus, as can be seen from the above paragraphs, filing of returns and tax audit and other reports for A.Y. 2013-14 is going to be a very cumbersome and difficult process and unless the tax department comes up with solutions to the numerous problems very soon, we are very clearly headed for an extremely stressful month of September and then later, November. One hopes that the CBDT will read the representations sent by professional bodies like BCAS and act expeditiously.

Nirav Shah

Appeal filing Forms ST-5, ST-6 & ST-7 amended Notification No. 5/2013 – ST dated 10th April, 2013

By this Notification, Service Tax Rules, 1944 have been amended which may be called Service Tax (Second Amendment) Rules, 2013 effective from 1st June, 2013. Under the amended Rules Form ST-5, ST-6 & ST-7 for filing appeal to Appellate Tribunal have been amended.

MVAT UPDATE

Mvat Notifications
Notification No. VAT-1513/CR-46(1)/Taxation-1 dated 30-03-2013

Vide this notification various amendments have been effected in Schedules A, B, C and D with effect from 01-04-2013.

Notification No VAT.1513/CR 46(7)/Taxation -1 dated 04-04-2013

By this notification, MVAT rate has been increased from 1% to 1.1% for sale of diamonds, articles made of precious metals and precious metal for the financial year 2013-2014. For pearls, precious stones and semiprecious stones, the MVAT rate continues to remain at 1%.

LA BILL XI OF 2013

Introduction of Maharashtra Tax Laws [Levy and Amendment] Bill, 2013, thereby providing amendments to the Maharashtra Stamp Act, the Maharashtra Value Added Tax Act, 2002 and the Maharashtra Tax on Lotteries Act, 2006.

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Nirav Shah

Section 271(1)(c) – No penalty can be imposed if Assessing Officer has not pointed out any specific fact not disclosed by the assessee or any wrong particulars furnished by the assessee. Based on the primary facts disclosed by the assessee inference drawn by the AO could have been drawn.

Facts:

The assessee is a company incorporated in the USA. It was awarded three distinct contracts by a company in India viz., PGCIL. The contracts entered into were for on shore supply of goods and services as well as for off shore supply of goods. The assessee executed only the offshore supply contract and sub-contracted onshore supply and the major part of the onshore service contracts to an Indian party on cost to cost basis with approval of PGCIL. All the above contracts were being carried forward from preceding years. That in AY 2003-04, on the same facts, the Assessing Officer had accepted that the assessee was not having any PE in India and, therefore, no tax was levied on offshore supply of equipment and services rendered outside India. However, during the year under consideration, the Assessing Officer held that the assessee is having PE in India and accordingly, taxed the income from offshore supply of hardware equipment and also in respect of payment for onshore services. Since a small amount was involved, the assessee, with a view to buy peace and end the litigation, did not file any appeal against the assessment order. The AO then levied penalty u/s. 271(1)(c) of Rs. 13.12 lakh for furnishing inaccurate particulars of income. On appeal, however, the penalty order was struck down by the CIT(A).

Held:

The tribunal noted that the facts of the year under consideration and of assessment year 2003-04 are identical. In AY 2003-04, the Assessing Officer had accepted the assessee’s claim that the assessee company did not have any PE in India. However, on the basis of the same facts in the year under consideration, the Assessing Officer came to the conclusion that there was a PE. The Assessing Officer has not pointed out any specific fact which was not disclosed by the assessee or any wrong particulars furnished by the assessee. It was the question of inference to be drawn from the primary facts which were duly disclosed by the assessee.

The tribunal further observed that merely because the assessee’s claim that it was not having a PE in India was not accepted by the Revenue in the year under consideration, by itself, will not amount to furnishing of inaccurate particulars regarding the income of the assessee. It further noted that on identical facts, the assessee’s claim that it was not having a PE was accepted by the Revenue in the immediately preceding year. In view of the above, the tribunal following the decision of the Apex Court in the case of Reliance Petroproducts Pvt. Ltd. [322 ITR 158 (SC)] upheld the order of the CIT(A).

levitra

Nirav Shah

(2012) 150 TTJ 590 (Pune) Dy.CIT vs. Magarpatta Township Development & Construction Co. ITA No.822 (Pune) of 2011 A.Y.2007-08. Dated 18-09-2012

Section 80-IB(10) of the Income-tax Act 1961 – Assessee is entitled for deduction u/s. 80-IB(10) on enhanced income resulting from statutory disallowance u/s. 40(a)(ia), 43B and 36(1)(va).

Facts

For the relevant assessment year, the Assessing Officer did not allow assessee’s claim u/s. 80-IB(10) on the enhanced income resulting from statutory disallowances u/s. 43B, 40(a)(ia) and 36(1)(va). The CIT(A) allowed the claim of the assessee.

Held

The Tribunal, relying on the decision in the case of S.B.Builders & Developers V. ITO (2011) 136 TTJ 420 (Mum.)/(2011) 50 DTR (Mumbai) (Trib) 299, allowed the assessee’s claim. The Tribunal noted as under:

It is held by the jurisdictional High Court in the case of CIT vs. Gem Plus Jewellery India Ltd. (2010) 233 CTR (Bom) 248/(2010) 42 DTR (Bom) 73 that the claim of deduction u/s. 10A was to be allowed on enhanced profit resulting from disallowance u/s. 43B/36(1) (va).

It is held by the Ahmedabad bench in the case of ITO vs. Computer Force [(2011) 136 TTJ 221 (Ahd.)/(2011) 49 DTR (Ahd.)(Trib) 298, ITA Nos.1636/Ahd./2009, 2441/Ahd./2007, 2442/Ahd./2007 and 1637/Ahd./2009 order dt.30.07.2010] that enhanced income due to disallowance u/s. 40(a)(ia) was eligible income under the head `Profits and gains of business or profession’, on which claim u/s. 80-IB was allowable.

In view of the ratio of these decisions, it is abundantly clear that in the appellant’s case also deduction u/s. 80-IB(10) was liable to be allowed in case there was enhanced income on account of statutory disallowances u/s. 43B, 40(a)(ia) and 36(1) (va) etc. as mentioned above. Since the nature of receipts on the credit side of P&L a/c. for the eligible housing project u/s. 80-IB(10) was the same and the disallowance was of the expenditure on the debit side for the same eligible housing project, it would result into enhancement of the net profit of the said eligible housing project. Therefore, the appellant’s claim is to be allowed.

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Nirav Shah

(2012) 150 TTJ 581 (Mum.) Dy.CIT vs. Ranjit Vithaldas ITA No.7443 (Mum.) of 2002 A.Y.1998-99. Dated 22-06-2012

54 is allowable where capital gains arising from sale of two residential houses are invested in a single residential house.

Facts

The assessee sold one residential flat in A.Y.1997-98 and another residential flat in 1998-99. He invested part of the capital gain arising from sale of these two flats for construction of a residential house and paid tax on the balance (uninvested) amount. He claimed exemption u/s. 54 in respect of the amount invested. The assessee contended that though the two flats were not contiguous, both had been used as one residential house and, therefore, it was submitted that the same should be treated as one house in view of judgment of the Honourable Allahabad High Court in the case of Shiv Narain Chaudhari vs. CWT 1977 CTR (All) 149: (1977) 108 ITR 104 (All).

The Assessing Officer did not accept the claim of the assessee that both flats constituted one residential house. The Assessing Officer also observed that section 54 allowed exemption in respect of one residential house, the income from which was chargeable under the head “Income from house property”. In this case, the assessee owned two residential houses and exemption from house property income was available only in respect of one house as self-occupied property. The assessee had claimed exemption u/s. 54 in respect of the first flat in the A.Y.1997-98, meaning thereby that the said flat had been treated as selfoccupied property. Therefore, the income from the second flat was chargeable to tax but since the assessee had not declared any income under the head “Income from house property” in respect of the said flat, the assessee had treated the flat as being used for the purpose of business because only in such a case, the income from the property is not chargeable. The Assessing Officer, therefore, held that since the second flat had been used for the purpose of business, income from the same was not chargeable to tax under the head “Income from house property”. Hence, the exemption u/s. 54 was not available. He, therefore, held that the assessee was not entitled to exemption u/s. 54 in the A.Y.1998-99.

The CIT(A) allowed the contentions of the assessee and allowed the exemption u/s. 54.

Held

The Tribunal allowed the exemption u/s. 54, but it was unable to agree with the view taken by the CIT(A) that the two flats constituted one residential house. The flats were located in two different buildings owned by the two different housing societies and were situated on two different roads. These flats were acquired in two different years. There was no common approach road to the buildings. Therefore, the two flats cannot be treated as one residential property only on the ground that two buildings in which the flats were located were within walking distance, as claimed by the learned Authorised Representative. The judgment of the Honourable Allahabad High Court in the case of Shiv Narain Chaudhari (supra) is distinguishable and not applicable to the facts of the present case. Therefore, the CIT(A) has wrongly placed reliance on the judgment of the Honourable High Court of Allahabad (supra) which is not applicable to the facts of the present case.

Having held that the two flats were two different residential houses, the Tribunal proceeded to examine whether the assessee was entitled for exemption u/s. 54 of the Act in respect of the sale of more than one residential house. The Tribunal noted as under:

No restriction has been placed in section 54 that exemption is allowable only in respect of sale of one residential house. Even if the assessee sells more than one residential house in the same year and the capital gain is invested in a new residential house, the claim of exemption cannot be denied if the other conditions of section 54 are fulfilled.

In section 54, there is an in-built restriction that capital gain arising from the sale of one residential house cannot be invested in more than one residential house. However, there is no restriction that capital gain arising from sale of more than one residential house cannot be invested in one residential house. In case capital gain arising from sale of more than one residential house is invested in one residential house, the condition that capital gain from sale of a residential house should be invested in a new residential house gets fulfilled in each case individually, because the capital gain arising from sale of each residential house has been invested in a residential house. Therefore, even if two flats are sold in two different years and the capital gain of both the flats is invested in one residential house, exemption u/s. 54 will be available in case of sale of each flat provided the time-limit of construction or purchase of the new residential house is fulfilled in case of each flat sold.

The assessee had shown no income from the second flat because the assessee had treated both the flats as one residential house which had been used as a self-acquired property. Therefore, only on the ground that the assessee had not shown any income from the second property, it cannot be concluded that the flat had been used for the purposes of business when there is no material to support the said conclusion. Even at the time of hearing before the Tribunal, the Departmental Representative did not produce any material to show that the second flat had been used for the purposes of business. Therefore, the flat had to be treated as residential house, the income from which is chargeable to tax under the head “Income from house property”.

The only requirement of section 54 is that income should be chargeable to tax under the head “House property income” and it is not necessary that income should have been actually charged. Therefore, capital gain arising from the sale of the second flat would be eligible for exemption u/s. 54 subject to fulfillment of other conditions.

levitra

Nirav Shah

Clarification on Multi Brand Retail Trading Dated June 6, 2013

Paragraph 6.2.16.5 of ‘Circular 1 of 2013-Consolidated FDI Policy’

The
Department of Industrial Policy & Promotion (DIPP) has issued a
clarification in the form of FAQ on queries of prospective
investors/stakeholders on FDI policy for multi-brand retail trading.
These clarifications are in respect of Paragraph 6.2.16.5 of ‘Circular 1
of 2013-Consolidated FDI Policy’.

A. P. (DIR Series) Circular No. 108 dated June 11, 2013

levitra

Nirav Shah

(2012) 150 TTJ 444 (Mum.) Kishore H.Galaiya vs. ITO ITA No.7326 (Mum.) of 2010 A.Y.2006-07 Dated 13-06-2012

Section 54 of the Income-tax Act 1961 – Amount exceeding capital gains arising from sale of old residential house having been paid by assessee to a builder within three years for construction of new residential house, assessee was entitled to exemption u/s.54 notwithstanding that assessee obtained possession after three years and also failed to deposit capital gains in the capital gains account scheme before due date of fling return of income u/s.139 (1) for relevant year.

Facts

The assessee’s claim for exemption u/s. 54 of long term capital gain on sale of a residential house was denied by the Assessing Officer. The CIT(A) confirmed the disallowance.

Held

The Tribunal, relying on the decisions in the following cases, held that the assessee was entitled to exemption u/s. 54 :
a. Asst. CIT vs. Smt. Sunder Kaur Singh Gadh (2005) 3 SOT 206 (Mum.)
b. ITO vs. Mrs. Hilla J.B. Wadia 113 CTR 173 (Bom.)/ (1995) 216 ITR 376 (Bom.)
c. Jagan Nath Singh Lodha vs. ITO (2004) 85 TTJ 173 (Jd.)
d. CIT vs. Mrs. Jagriti Aggarwal (2011) 245 CTR 629 (P&H)/(2011) 64 DTR 333 (P&H)/(2011) 339 ITR 610 (P&H)
e. Jagtar Singh Chawla vs. Asst. CIT ITA No.4923 (Del.) of 2010 dated 30-06-2011

The Tribunal noted as under:

The assessee had booked a new residential flat with the builder jointly with his wife and he had paid booking amount of Rs.1,00,000 to the builder before the due date of filing of the return of income u/s. 139(1) for the A.Y.2006-07 and the balance amount had been paid in instalments after the said date. The builder was to handover the possession of the flat after construction. It has, therefore, to be considered as a case of construction of new residential house and not purchase of flat. This position has been clarified by the CBDT in Circular No.672, dated 16-12-1993 in which it has been made clear that the earlier Circular No.471, dated 15-10- 1986 in which it was stated that acquisition of flat through allotment by DDA has to be treated as a construction of flat, would apply to co-operative societies and other institutions. The builder would fall in the category of “other institutions”. Thus, in the present case, the period of three years would apply for construction of new house from the date of transfer of the old flat.

The assessee had invested the capital gains in construction of a new residential house within a period of three years and this should be treated as sufficient compliance of the provisions of the Act. It is not necessary that the possession of the flat should also be taken within the period of three years. The taking of the possession may be delayed because of many factors not under the control of the assessee due to default on the part of the builder and, therefore, merely because the possession had not been taken within the period of three years, the exemption cannot be denied. Within the period of three years, the assessee had invested more than the amount of capital gain in the construction of new residential house. Therefore, the claim of the exemption in this case cannot be denied on the ground that the possession of the flat had not been taken within the period of three years.

The other objection raised by the Revenue is that the assessee had paid/utilised only a sum of Rs. 1 lakh towards the construction of flat till the due date of filing of the return of income u/s. 139(1) for the relevant year, and, therefore, the balance amount of capital gain was required to be deposited in the Capital Gains Account Scheme which had not been done. This is only a technical default and on this ground, the claim of exemption cannot be denied particularly when the amount had been actually utilised for the construction of residential house and not for any other purpose.

The assessee has also made a point that the due date of filing of the return of income u/s. 139(1) for the purpose of utilisation of the amount for purchase/ construction of residential house has to be construed with respect to the due date prescribed for filing of the return u/s. 139(4). In the present case, the capital gain earned by the assessee was Rs. 9.98 lakh and the assessee had utilised a sum of Rs. 13.50 lakh towards the construction of residential house by 05-07-2007, which was within the extended period of filing of the return u/s. 139(4) till 31-03-2008 for the A.Y.2006-07. The assessee had, thus, utilised the amount which was more than capital gain earned towards construction of new residential house within extended period u/s. 139(4) and, therefore, there was no default in not depositing the amount under the Capital Gains Account Scheme.

levitra

Nirav Shah

Press note 2 (2013 Series) – D/o IPP F. No. 5/3/2005-FC.I Dated June 03, 2013

Nirav Shah

A. P. (DIR Series) Circular No. 107 dated June 4, 2013

Import of Gold by Nominated Banks / Agencies

Presently, banks can import gold on consignment basis only to meet the genuine needs of exporters of gold jewellery.

This circular provides that, with immediate effect: –

1. Along with banks, all nominated agencies/premier /star trading houses can import gold on consignment basis only to meet the genuine needs of exporters of gold jewellery.

2. Except in the case of import of gold to meet the needs of exporters of gold jewellery, all Letters of Credit (LC) opened by banks/nominated agencies for import of gold under all categories will only be on 100 % cash margin basis and all imports of gold have to be compulsorily on Documents against Payment (DP) basis.

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Nirav Shah

A. P. (DIR Series) Circular No. 106 dated May 23, 2013

Liberalised Remittance Scheme for Resident Individuals – Reporting

Presently, banks are required to submit LRS data in hard copy as well as through the Online Returns Filing System (ORFS) of RBI.

This circular provides that henceforth, i.e. LRS data for 30th June, 2013 and subsequent months have to be uploaded in ORFS on or before the 5th of the following month. Where there is no data to be furnished, banks must to upload ‘nil’ figures in the ORFS system.

levitra

Nirav Shah

A. P. (DIR Series) Circular No. 105 dated May 20, 2013

Export of Goods and Software – Realisation and Repatriation of export proceeds – Liberalisation

Presently, exporters were permitted to realise and repatriate the full value of goods or software exported up to 31st March, 2013 within twelve months from the date of export.

This circular provides that exporters are required to realise and repatriate the full value of goods or software exported up to 30th September, 2013 within nine months from the date of export. However, there are no changes in the provisions with respect to period of realisation and repatriation of the full export value of goods or software exported by a unit situated in a Special Economic Zone (SEZ) as well as exports made to warehouses established outside India.

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Nirav Shah

Money transfer from abroad whether banking and financial services or business auxiliary services – Whether it is export of services when performed in India and whether the sub-agents appointed also deemed to have exported the services. Reimbursement of advertisement and sales promotion is export of services.

Facts:

Paul Merchants Ltd (PML) entered into an agreement with Western Money Union Network Ltd., Ireland (Western Union or WU) to enable the receipt of money transferred from persons from outside India to persons in India. PML had also appointed sub-agents to provide transfer of money services to Western Union. Western Union also reimbursed PML the advertisement and promotional expenses in India. The question arose whether the service of PML is categorised under Banking & Financial Services or Business Auxiliary Services and whether such services were to be considered as deemed to be export under Export of Services Rules, 2005 for the period 1st July 2003 till 30th June 2007. Similarly, the services of sub-agents were to be considered export or not as sub-agents were appointed by PML in India. Thirdly, whether the reimbursement of advertisement and promotion expenses were also to be treated as export and hence, no tax was chargeable. Lastly, whether a longer period was invokable. The two members of the Delhi Tribunal had a difference of opinion as to whether the services were in the nature of export as the said services were performed in India. The case was referred to the third member due to difference of opinion.

Held:

• The services provided by PML or the sub-agents were classified as “Business Auxiliary Services” which both the members agreed on and hence, no discussion was required on this subject. The major question was whether the service was to be considered as export as the services were provided in India. The term ‘export’ has not been defined either in Article 280(l)(b) or in any of the articles of the Constitution of India. “Though the Apex Court’s judgments in the case of the State of Kerala vs. The Cochin Coal Company Ltd. [(1961) 2 STC 1 SC] and Burmah Shell Oil Storage & Distribution Co. of India vs. Commercial Tax Officer & Others reported in (1960) 11 STC 764 (SC) explain the meaning of the term ‘export’. The ratio of these judgments which are with regard to export of goods, is not applicable for determining what constitutes the export of services. There was no question of Export of Service Rules, 2005, being in conflict with Article 286(1)(b) of the Constitution of India. The principle of equivalence between the taxation of goods and taxation of service had been laid down by the Apex Court in the case of Association of Leasing & Financial Service Companies vs. Union of India (2010-TIOL-87-SCST- LB) and All India Federation of Tax Practitioners vs. Union of India (2007-TIOL-149-SC-ST) in the context of constitutional validity of levy of service tax on certain services. This principle does not imply that service tax should be levied and collected in exactly the same manner as the levy and collection of tax on goods or that export of service should be understood in an exact manner in which the export of goods is understood. The question as to what constitutes export or import of service was neither raised nor discussed in the judgments of the Apex Court. There is nothing in Export of Service Rules, 2005 which can be said to be contrary to the principle that a service not consumed in India is not to be taxed in India. What constitutes export of service is to be determined strictly with reference to Export of Service Rules, 2005. The service is classified as “Business Auxiliary Service” and provided to WU and it is WU who is the recipient and consumer of this service provided by PML and their sub-agents, not the persons receiving money in India. Thus, when the person under whose instructions the services in question had been provided by the agents/sub-agents in India and who is liable to make payment for these services, is located abroad, the destination of the services in question has to be treated abroad.

The destination has to be decided on the basis of the place of consumption, not the place of performance of service.

• Reimbursement of advertisement and sales promotion received from WU is not taxable as the same are for the services provided to WU, which are exports of services. • The question of time bar is not relevant when the main question has been answered in favour of the agent and sub-agents.
• The services provided by the agent and subagents throughout during the period of dispute are classifiable as “Business Auxiliary Service” and the same have been exported. Hence no service tax is leviable. The following judgements were relied on for this matter:

• Muthoot Finance Corpn. Ltd. vs. CCE reported in 2010 (17) STR 303 (Tribunal-Bang)

• Nipune Service Ltd. vs. CCE, Bangalore reported in 2009 (14) STR 706 (Tribunal-Bang)

• Kerala State Financial Enterprises vs. CCE, reported in 2011 (24) STR 585 (Tribunal-Bang)

[Readers may note that contrary to the above, recently the Mumbai Tribunal did not grant complete stay in Life Care Medical System relying on Microsoft Corporation (I) Pvt. Ltd. vs. CST. New Delhi 2009 (15) STR 680 (Tri.-Del) reported at 2013 (29) STR 129 (Tri.-Mum), digest of which was provided in January 2013 of BCAJ under this feature].

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Nirav Shah

Levy on Restaurants & Hotels Held Unconstitutional

Background

Service tax levy was introduced on Restaurants & Hotels as under:

• Services provided by air-conditioned restaurants with license to serve liquor, with effect from 01-05-2011, with an abatement of 70%.

• Short Term Accommodation Services provided by hotels, with effect from 01-05-2011, with an abatement of 50%.

The above services have been discussed earlier in this column in the August, 2011 and September, 2011 issues respectively of BCAJ and in particular, the dual taxation issues arising therefrom. The same are not repeated for the sake of brevity.

The above stated levies continued under negative list based taxation of services introduced with effect from 01-07-2012 also, with a few minor changes in the scope and rate of abatement. However, the scope of air-conditioned restaurant service was substantially expanded with effect from 01-04- 2013, withdrawing the condition of having license to serve liquor. Far reaching implications of this amendment also were discussed in the April, 2013 issue of BCAJ. With these facts in the background, discussed below is the recent Kerala High Court’s ruling wherein levy of service tax on restaurants and hotels has been held beyond the legislative competence of the Parliament. Considering that levy of tax on supply of food or drink whether by way of or as a part of service is a State subject, the levy by the Centre is held unconstitutional in a Single Member Bench’s decision.

Kerala High Court Ruling in Kerala Classified Hotels & Resorts Association & Others (2013) 31 STR 257 (KER)

The Petitioners through writ petitions challenged the validity of sub-clause (zzzzv) and (zzzzw) of clause 105 of section 65 of the Finance Act, 1994 (Act) and section 66 of the Act, as amended by the Finance Act 2011 relating to levy of service tax on taxable services referred there and for consequential reliefs. The relevant portion reads as under:

“(zzzzv) Services provided or to be provided to any person, by a restaurant, by whatever name called, having the facility of air-conditioning in any part of the establishment, at any time during the financial year, which has license to serve alcoholic beverages, in relation to serving of food or beverage, including alcoholic beverages or both, in its premises;

(zzzzw) Services provided or to be provided to any person, by a hotel, inn, guest house, club or camp-site, by whatever name called, for providing of accommodation for a continuous period of less than three months;”

Contentions of the Petitioner

The main contention urged by the petitioners was that the imposition of service tax in relation to serving of food or beverage including alcoholic beverages represents only sale of goods which transaction squarely falls under Entry 54 of List II (State List) of the 7th schedule to the Constitution of India and therefore within the exclusive competence of the State legislature. The service tax was originally introduced by Parliament in exercise of the residuary power under Entry 97 of List I. Though Entry 92 C has been introduced to List I of the 7th schedule which enables the Union to levy “taxes on services”, the said entry had not come into effect as it was not notified by the Government. Similarly the State legislature had enacted Kerala Tax on Luxuries Act, by which tax is levied for accommodation. By introducing service tax on the basis of sub-clauses (zzzzv) and (zzzzw) to clause 105 of section 65, the Parliament has encroached upon the legislative powers of the State under Entry 54 and 62 of List II.

Hence, the main contention of the petitioners was with reference to the legislative competence of Parliament to impose a tax on sale of goods/ luxuries which is absolutely the domain of the State legislation.

Contention of the Revenue

The respondents contended that the legislation has been brought in terms of Article 248 of the Constitution read with Entry 97 of List I of the 7th schedule. Therefore according to the respondent, on a perusal of judgments cited by them it is all the more clear that service tax can be imposed on the service involved during the sale of a product and so long as the Statute does not transgress upon any restriction contained in the Constitution, contentions regarding lack of legislative power cannot be sustained. It is further contended that the Sales Tax Act and the Kerala Tax on Luxuries Act are framed by the State Government. Service tax levied by the Government of India is not for serving alcoholic beverages and it is a tax on the services provided by restaurants and hotels. In that view of the matter, according to them, the challenge to the provisions aforesaid is absolutely baseless and seeks for dismissal of the writ petitions.

Questions for Consideration before the Court

The following questions arose for consideration by the Court:

Whether “taxes on the sale and purchase of goods” in Entry 54 of List II of the seventh schedule covers service in the light of the definition of “tax on sale and purchase of goods” under Article 366 (29A)(f) of the Constitution of India.

Whether the service provided in a hotel, inn, guest house, club etc. imposed with luxury tax under the State Act in terms of Entry 62 of List II can be separately assessed and imposed by the Union with service tax, invoking the residuary powers at Entry 97 of List I of the Constitution.

Judgment relied upon by the Revenue for Consideration of Constitutionality of a statute

The judgment in State of M.P. vs. Rakesh Kohli, (2012) 6 SCC 312) = (2012-TIOL-44-SC-MISC) was relied upon by the respondent to highlight the principles to be kept in mind by courts while considering constitutionality of a statute and the Supreme Court held as under:

“32. While dealing with constitutional validity of a taxation law enacted by Parliament or State Legislature, the Court must have regard to the following principles:

(i) there is always presumption in favour of constitutionality of a law made by Parliament or a State Legislature,

(ii) no enactment can be struck down by just saying that it is arbitrary or unreasonable or irrational but some constitutional infirmity has to be found,

(iii) the Court is not concerned with the wisdom or unwisdom, the justice or injustice of the law as Parliament and State Legislatures are supposed to be alive to the needs of the people whom they represent and they are the best judge of the community by whose suffrage they come into existence,

(iv) hardship is not relevant in pronouncing on the constitutional validity of a fiscal statute or economic law, and

(v) in the field of taxation, the legislature enjoys greater latitude for classification.”

Similar views were expressed by the Supreme Court in Karnataka Bank Ltd. vs. State of A.P. [(2008) 2 SCC 254], Govt. of A.P. vs. P. Laxmi Devi [(2008) 4 SCC 720] and Greater Bombay Coop. Bank Ltd. vs. United Yarn Tex (P) Ltd. (2007) 6 SCC 236). There is no dispute regarding the proposition as held in the above judgments and hence the only enquiry is to find out whether the impugned legislation has trenched upon the legislative powers of the State Government, keeping in mind the limitations as held in the aforesaid judgments.

• Important and Relevant Judgments for consideration by the Court

In Godfrey Phillips India Ltd. vs. State of U.P., (2005) 2 SCC 515) = (2005-TIOL-10-SC-LT-CB) the Supreme Court held as under:

“83. Hence on an application of general principles of interpretation, we would hold that the word “luxuries” in Entry 62 of List II means the activity of enjoyment of or indulgence in that which is costly or which is generally recognised as being beyond the necessary requirements of an average member of society and not articles of luxury.”

“93. Given the language of Entry 62 and the legislative history we hold that Entry 62 of List II does not permit the levy of tax on goods or articles. In our judgment, the word “luxuries” in the entry refers to activities of indulgence, enjoyment or pleasure. Inasmuch as none of the impugned statutes seek to tax any activity and admittedly seek to tax goods described as luxury goods, they must be and are declared to be legislatively incompetent. However, following the principles in Somaiya Organics (India) Ltd. vs. State of U.P. while striking down the impugned Acts we do not think it appropriate to allow any refund of taxes already paid under the impugned Acts. Bank guarantees if any furnished by the assessees will stand discharged.”

In T.N. Kalyana Mandapam Assn. vs. Union of India, (2004) 5 SCC 632) = (2004-TIOL-36-SC-ST) the Supreme Court was considering whether the imposition of service tax on the services rendered by the mandap-keepers was intra vires the Constitution, and held as under:

“44. In regard to the submission made on Article 366(29-A)(f), we are of the view that it does not provide to the contrary. It only permits the State to impose a tax on the supply of food and drink by whatever mode it may be made. It does not conceptually or otherwise include the supply of services within the definition of sale and purchase of goods. This is particularly apparent from the following phrase contained in the said sub-article “such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods”. In other words, the operative words of the said sub-article are supply of goods and it is only supply of food and drinks and other articles for human consumption that is deemed to be a sale or purchase of goods.”

In K. Damodarasamy Naidu & Bros. vs. State of T.N., (2000) 1 SCC 521) = (2002-TIOL-884-SC-CT-CB) while considering the entitlement of the States to levy tax on the sale of food and drink a Constitutional Bench of the Supreme Court held as under:

“9. The provisions of sub-clause (f) of clause (29-A) of Article 366 need to be analysed. Sub-clause (f) permits the States to impose a tax on the supply of food and drink. The supply can be by way of a service or as part of a service or it can be in any other manner whatsoever. The supply or service can be for cash or deferred payment or other valuable consideration. The words of sub-clause (f) have found place in the Sales Tax Acts of most States and, as we have seen, they have been used in the said Tamil Nadu Act. The tax, therefore, is on the supply of food or drink and it is not of relevance that the supply is by way of a service or as part of a service. In our view, therefore, the price that the customer pays for the supply of food in a restaurant cannot be split up as suggested by learned counsel. The supply of food by the restaurant-owner to the customer though it may be a part of the service that he renders by providing good furniture, furnishing and fixtures, linen, crockery and cutlery, music, a dance floor and a floor show, is what is the subject of the levy. The patron of a fancy restaurant who orders a plate of cheese sandwiches whose price is shown to be Rs.50 on the bill of fare knows very well that the innate cost of the bread, butter, mustard and cheese in the plate is very much less, but he orders it all the same. He pays Rs. 50 for its supply and it is on Rs. 50 that the restaurant-owner must be taxed.”

Other judgments considered by the Court were as follows:

Assn. of Leasing & Financial Services Companies vs. UOI (2011) [2 SCC 352 = 2010–TIOL–87–SC–ST– LB.]

All India Federation of Tax Practitioners vs. UOI (2007) [TIOL–149 –SC– ST]

BSNL vs. UOI (2006) [TIOL–15–SC–CT–LB]

Federation of Hotel & Restaurant Assn of India vs. UOI (2002) [TIOL- 699 –SC–MISC]

• Observations & Findings of the Court

On a consideration of the law laid down by the Supreme Court, I am of the view that:

Para 18

“There are two judgments which throw light on the subject matter in issue. Those are K. Damoda-rasamy Naidu (Supra) and T.N. Kalyana Mandapam Assn. (Supra). In fact, the effect of Article 366(29-A)(f) has been considered by the Supreme Court in Assn. of Leasing & Financial Service Companies (Supra) and other judgments referred above includ-ing BSNL (Supra) . But the factual situation with reference to the case on hand is available only in the cases referred above. But it could be seen that in T.N. Kalyana Mandapam Assn. (Supra) the question was with reference to services rendered by mandap-keepers which is not the situation here. Here the factual situation is almost similar to the statement of law as held by the Supreme Court in K. Damodarasamy Naidu (Supra).”

Para 19

Now, coming to Article 366(29-A)(f) of the Constitution of India one could see that a deeming provision has been incorporated by way of 46th amendment to the Constitution of India and the history of such a legislation has been clearly dealt with in the judgments cited above. The very purpose of incorporating the definition of tax on sale or purchase of goods in Article 366 was to empower the State Governments to impose tax on the supply, whether it is by way of or as a part of any service of goods either being food or any other article for human consumption or any drink either intoxicating or not intoxicating whether such supply or service is for cash, deferred payment or other valuable consideration. The words “and such transfer delivery or supply of goods” is deemed to be a sale of those goods by the person making the transfer. Therefore the incidence of tax is on the supply of any goods by way of or as part of any service. When food is supplied or alcoholic beverages are supplied as part of any service, such transfer is deemed to be a sale. Apparently, the transfer is during the course of a service and when the deeming provision permits the State Government to impose a tax on such transfer, there cannot be a different component of service which could be imposed with any service tax in exercise of the residuary power of the Central Government under Entry 97 of List I of the Constitution of India.

Para 20

Therefore, it can be seen from Article 366(29-A)(f) that service is also included in the sale of goods. If the constitution permits sale of goods during service as taxable, necessarily Entry 54 has to be read giving the meaning of sale of goods as stated in the Constitution. If read in that fashion, necessarily service forms part of sale of goods and State Government alone will have the legislative competence to enact the law imposing a tax on the service element forming part of sale of goods as well, which they have apparently imposed. I am supported to take this view in the light of the Constitution Bench judgment in K. Damodarasamy Naidu (Supra).

Para 21

Coming to the next question regarding the imposition of service tax in respect of hotel, inn, guest house, club or camp site etc., the contention of the petitioners is based on Entry 62 of List II. What exactly is the meaning of the expression ‘luxuries’ in Entry 62 of List II has been held by the Constitution Bench judgment of the Supreme Court in Godfrey Philips India Ltd. (Supra), wherein it is held that luxuries is an activity of enjoyment or indulgence which is costly or which is generally recognised as being beyond the necessary requirements of an average member of society. While giving the said meaning to Entry 62 and if we look at the sub-clause (zzzzw), the service tax is imposed on services provided in a hotel and other similar establishments when State Legislature had enacted the Kerala Tax on Luxuries Act by exercising their legislative power under Entry 62 of List II. When applying the dictum laid down in Godfrey Philips India Ltd. (supra) which gives an extended meaning to the word ‘luxuries’, I am of the view that the amendment now made to the service tax trenches upon the legislative function of the State under Entry 62 of List II.

Having come to the aforesaid findings, these writ petitions are allowed as follows:

• It is declared that sub-clauses (zzzzv) and (zzzzw) to clause 105 of section 65 of the Finance Act 1994 as amended by the Finance Act 2011 is beyond the legislative competence of the Parliament as the sub-clauses are covered by Entry 54 and Entry 62 respectively of List II of the Seventh Schedule.

• That if any payments have been made by the petitioners on the basis of the impugned clauses, they are entitled to seek refund of the same.

Impact of Kerala High Court Ruling

• As per the Court order, the petitioners are entitled to seek refund of service tax. However, it may not be easy and feasible inasmuch as the restaurants merely collect service tax from the customers and pay to the Government. Hence, if the service tax collected (rightly or wrongly) is duly deposited with the Government, onus stands discharged under the law. Alternatively, the prospect of each customer filing for refund of tax is highly unlikely.

• Since the ruling is a consequence of a Writ Petition and there being presently no other conflicting High Court ruling, a view could be adopted (although debatable) to the effect that this ruling is applicable to restaurants across the country. However, the Government would without any doubt file an appeal before the Supreme Court against the High Court Order. Hence, it would appear that there is no finality on the issue.

• Whether the Kerala High Court ruling would apply under the negative list based taxation regime introduced with effect from 01-07-2012, is a matter which is being intensely debated.

It is interesting to note the following clarification issued in the context of Negative List regime of service tax:

• Extracts from Education Guide (TRU Circular dt. 20/6/12)

Para 6.9

Service portion in an activity wherein goods, being food or any other article of human consumption or any drink (whether or not intoxicating) is supplied in any manner as part of the activity. [Section 66E (i) of the Act]

Para 6.9.1

What are the activities covered in this declared list entry?

The following activities are illustration of activities covered in this entry –

• Supply of food or drinks in a restaurant;

• Supply of food and drinks by an outdoor caterer.

In terms of Article 366(29A) of the Constitution of India, supply of any goods being food or any other article of human consumption or any drink (whether or not intoxicating) in any manner as part of a service for cash, deferred payment or other valuable consideration is deemed to be a sale of such goods. Such a service therefore cannot be treated as service to the extent of the value of goods so supplied. The remaining portion however constitutes a service. It is a well settled position of law, declared by the Supreme Court in BSNL’s case [2006 (2) STR 161 (SC)], that such a contract involving service along with supply of such goods can be dissected into a contract of sale of goods and contract of provision of service. This declared list entry has been incorporated to capture this position of law in simple terms.

Based on the above, the Government could contend that what is being taxed is only the service component without encroaching upon the powers of the State Government under the Constitution. This aspect would have to be judicially tested.

The 46th amendment to the Constitution which introduced clause 29A to the Article 366 contained six transactions which were deemed to be a transaction of sale or purchase of goods. For example, tax on the transfer of property in goods involved in the execution of a works contract is one of the deemed sales transportation under this amendment.

After the judgment by the Kerala High Court, an old debate is likely to be revived. The question arises is that whether on similar grounds, the levy of service tax on a transaction of works contract where the buyer only intends to buy, say for example a constructed building and pay consideration on per square foot of constructed building could also be challenged? The buyer of the building has no interest in the services that the builder has used in construction of such building. Therefore, can the Central Government tax the services that are provided in a works contract when these transactions are deemed sales under the Constitution?

The clause 29A was introduced in Article 366 of the Constitution, as it was felt necessary to declare those transactions as deemed sale of goods which could otherwise lead to a dilemma in classification between sale of goods and/or services.

• Yet another question arising out of this situation is, shouldn’t there be a similar provision in the Constitution to declare the other portion of such transactions as the deemed/declared services as is done for sales tax/VAT, before the same could be brought under the tax net by the Centre?

There are no ready answers to the above posers. However, it appears that, there could to be a fresh round of litigations and resultant uncertainties.

Conclusion

To conclude, it would appear that the Kerala High Court does not resolve the larger burning issue of dual taxation of transactions by the Centre and the States whereby the increased burden is being felt by the end user/consumer. To put it in simple terms, an ideal scenario would be that in case of composite transactions, one component is taxed by the States and the other by the Centre in terms of clear statutory provisions. However, presently despite the fact that service tax is being levied on the service component (40%), the States continue to charge VAT on the 100% amount, resulting in dual taxation and increased burden on the end user/consumer.

It is expected that the GST regime would address this burning issue impacting businesses and end users. However, it is felt that the Government needs to urgently address this issue without waiting for the introduction of GST Regime whereby Empowered Committee of State Finance Ministers can have a dialogue with the Centre and States and arrive at an agreement for a consistent abatement regime across the country which can be adopted by the Centre as well as the States.

Nirav Shah

Right to information – The details disclosed by a person in his income-tax returns are “personal information” which stand exempted from disclosure under clause (j) of section 8(1) of the Right to Information Act, 2005.

Girish Ramchandra Deshpande vs. CIC & Ors. [2013] 351 ITR 472 (SC)

The Supreme Court was concerned with the question whether the Central Information Commissioner acting under the Right to Information Act, 2005 was right in denying information regarding the third respondent’s personal matters pertaining to his service career and also denying the details of his assets and liabilities, movable and immovable properties on the ground that the information sought for was qualified to be personal information as defined in clause (j) of section 8(1) of the Right to Information Act, 2005.

The Supreme Court held that the details called for by the petitioner, i.e., copies of all memos issued to the third respondent, show-cause notices and orders of censure/punishment, etc. were qualified to be personal information as defined in clause (j) of section 8(1) of the RTI Act. The performance of an employee/officer in an organisation is primarily a matter between the employee and the employer and normally those aspects are governed by the service rules which fall under the expression “personal information”, the disclosure of which has no relationship to any public activity or public interest. On the other hand, the disclosure of which would cause unwarranted invasion of privacy of that individual. Of course, in a given case, if the Central Public Information Officer or the State Public Information Officer of the appellate authority is satisfied that the larger public interest justifies the disclosure of such information, appropriate orders could be passed but the petitioner cannot claim those details as a matter of right.

The Supreme Court further held that the details disclosed by a person in his income-tax are “personal information” which stand exempted from disclosure under clause (j) of section 8(1) of the RTI Act, unless involves a larger public interest and the Central Public Information Officer or the State Public Information Officer or the appellate authority is satisfied that the larger public interest justifies the disclosure of such information.

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Nirav Shah

The substantial benefit of CENVAT credit should not be denied for procedural defects of minor nature. On the other part, the assessees should also make an honest attempt to follow the procedures laid down under relevant Rules.

Facts:

The appellants providing telephone services throughout India took CENVAT credit on certain equipments installed at other secondary switching areas (SSAs) registered separately with service tax authorities. Since the equipments were not used in the premises of the appellants, CENVAT credit was disallowed.

However, the appellants argued that the services were rendered throughout India from any SSA using capital goods installed anywhere in the country. Since the issue was technology based and facts were to be determined, the matter was remanded back by the Tribunal. On examination, the Tribunal observed that in case the proposition of the appellants is accepted, all the SSAs using equipment installed at any other SSA would be eligible for CENVAT credit. Further, DGM (Projects), Salem had placed the order for these capital goods and had handed over the duty paying documents to BSNL, Salem and CENVAT credit was availed only once by BSNL, Salem and the capital goods were used in the premises of BSNL. It was contested by the appellants that there was no condition of installing the capital goods in the premises of service provider unlike in the case of capital goods used in the manufacture of excisable goods as per Rule 2(a)(A) of the CENVAT Credit Rules, 2004. The only condition to be satisfied was that the capital goods should be used for providing output services and accordingly, the appellants were eligible for the CENVAT credit. The department’s contention was that the equipments had to be used by the registered entity and if it is used elsewhere, the department cannot verify the use of the capital goods and correctness of the CENVAT credit availment. Hence, the appellants should have taken registration as input service distributor and should have followed the proper procedures.

Held:

The present case was of not following appropriate procedures and not a case of misutilisation of ineligible CENVAT credit. No CENVAT credit was distributed since the entire CENVAT credit was availed by only one office and the same could have been verified by the department. The premises, where equipments were installed, belonged to BSNL and also the capital goods were used for providing output services.

Therefore, substantial benefit of CENVAT credit was not to be denied for procedural defects of minor nature. However, the procedures laid down under the Rules should not be circumvented quoting different decisions of the Tribunal and BSNL was directed to make an earnest attempt to follow such procedures.

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Nirav Shah

Eligibility for Deduction u/s. 80-IB(10) in Respect of Amount Disallowed u/s. 40(a)(ia)

Issue for consideration

100% of the profits derived from a housing project is eligible for deduction u/s. 80-IB(10) of the Income -tax Act. Like many other provisions of chapter VI-A of the Act, this provision also does not lay down the guidelines for computing the profits from the housing project and in turn leaves a doubt about the quantum of profits that is eligible for deduction. Is it the amount of profits that is computed as per the books of account that is eligible for deduction or is the deduction based on the amount of income computed as per the provisions of the Act and if yes, is deduction limited to the returned income or is allowed w.r.t the assessed income? These are the questions that routinely arise in interpretation of the provisions of chapter VI-A that grant deduction for profits derived from specified sources.

While many of the decisions have taken a view that the term ‘profits’ referred to in the said chapter means and includes the assessed profit that should be eligible for deduction under the respective provisions, some of the decisions, including the recent one of the Ahmedabad bench of the tribunal, have taken a view that the entire assessed income after disallowance should not be eligible for deduction and the deduction should be restricted to profits as per the books of account. The Ahmedabad bench of the tribunal in holding so, also distinguished the case where profits as per the books is increased on account of the disallowance of an expenditure and the one on account of statutory non compliance of the law. The position also needs to be examined in view of the decisions of the apex court in the cases of Pandian Chemicals Ltd. and Liberty India.

Rameshbhai C. Prajapati’s case
The issue recently arose in the case of Rameshbhai C. Prajapati, 23 ITR (Trib.) 516 (Ahd.). In this case, the AO disallowed an amount of Rs. 1,20,895 representing a business expenditure, on which tax, though deducted, was deposited after the due date of filing the return of income. The disallowance had the effect of enhancing the business income of the assessee, the source of which was from a housing project that was otherwise eligible for full deduction u/s. 80-IB(10). The AO restricted the deduction u/s. 80-IB(10) to the profits as per the books of account and denied the deduction on the amount disallowed u/s. 40(a)(ia) in the course of assessment. On appeal, the CIT(A) allowed the deduction based on the assessed business income by observing as under;

“3……., there is merit in the submissions that the addition on account of disallowance of expenditure would result in increased business income of the appellant which would be eligible for deduction u/s. 80-IB(10). Hence while holding that he Assessing Officer’s disallowance u/s. 40(a)(ia) is justified the appellant’s claim of admissibility of deduction u/s. 80-IB(10) on this addition is also justified. Therefore while confirming the order of the Assessing Officer with regard to disallowance of Rs. 1,28,895 he is directed to consider the amount while computing the assessee’s claim of deduction u/s. 80-IB(10).”

On appeal to the tribunal, the Revenue supported the findings of the AO and contended that the CIT(A) erred in allowing deduction u/s. 80-IB (10) of the Act on the addition made u/s. 40(a)(ia) of the Act, without appreciating the fact that the addition was not on account of disallowance of any expenditure but was on account of infringement of law, and the AO’s finding that the assessee had deducted tax at source but had violated the law by not depositing the same in time, thereby attracting provisions of section 40(a)(ia) of the Act. The assesssee on the other hand relied upon the order of the CIT(A).

The tribunal, on hearing the rival submissions, and carefully perusing the materials on record, noted that, in the case before them, the addition made on account of disallowance of expenditure was due to the deeming fiction created by the penal section of 40(a)(ia) of the Act and the effect of the same could not be imported into a beneficial provision of section 80-IB(10) of the Act. It observed that the deeming fiction created under any provision of the Act could not be imported into a beneficial provision of the Act. It also noted that while computing deduction u/s. 80-IB (10) of the Act, the plain meaning of the language of the Act had to be given effect to and the legal fiction created by virtue of section 40(a)(ia) could not be extended to determine the profit of the business for the purpose of computing deduction u/s. 80-IB(10) of the Act, which had to be applied only for the definite and limited purpose for which it was created.

The tribunal noted with approval the decision in the case of Executors & Trustees of Sir Cawasji Jehangir vs. CIT, 35 ITR 537 (Bom), where it had been explained that unless it was clearly and expressly provided, it was not permissible to impose a supposition on a supposition of law and that it was not permissible to sub-join or track a fiction upon fiction. In light of the said decision, it was apparent to the tribunal that in determining the quantum of deduction u/s 80 IB of the Act, one had to strictly follow the provisions of that section and compute the deduction accordingly without infusing any other provision of the Act, which created a legal fiction. The tribunal held that for computing the profits derived from the business of an undertaking that was developing and building housing projects, for claiming deduction u/s. 80-IB(10) of the Act, any deeming fiction provided under the Act, such as section 40(a)(ia), should not be infused. Instead the normal provisions of the Act had to be adopted and only the profits thus worked out should be eligible for deduction u/s. 80-IB(10) of the Act.

It was accordingly held that the deduction u/s. 80-IB(10) should not be increased on account of disallowance u/s. 40(a)(ia).

S.B. Builders & Developers’ case
The same issue had come up before the Mumbai bench of thee tribunal in the case of S.B. Builders & Developers, 136 TTJ 420 (Mum.). The assessee in that case was a partnership firm, engaged in the business of building and developing a housing project. During the relevant accounting year, the assessee had only one housing project in hand in respect of which, in filing the return of income, it had claimed a deduction u/s. 80-IB(10) of Rs. 3,76,78,403 which represented the profits from the said project as shown in the Profit & Loss Account. The AO found that, in respect of certain payments relating to the cost of construction, RCC consultancy, architect’s fees, commission and professional charges aggregating to Rs. 4,50,12,485, the assessee had not deducted tax in time, though it was required to do so. He accordingly disallowed the said payments u/s. 40(a)(ia) and added back the said amount to the net profit and determined the gross total income at Rs. 8,26,90,888. Finally, he restricted the deduction u/s. 80-IB(10) to Rs. 3,76,78,403, only, i.e. the amount originally claimed in the return of income, and brought to tax Rs. 4,50,12,485, the amount that was disallowed u/s. 40(a)(ia).

On appeal to the CIT(A), the firm claimed that the assessee was entitled to the deduction u/s. 80-IB(10) in respect of the profits computed by AO after making the disallowance u/s. 40(a)(ia). The CIT(A), not impressed by the contention, held that the disallowed expenditure could not be considered to be the profits generated by the industrial undertaking, i.e. the housing project, there being no nexus between the disallowed expenditure and the industrial undertaking. In other words, he held that insofar as the disallowed expenditure was concerned, the industrial undertaking was not the source of the same and section 80-IB(10) could apply only in relation to profits which were “derived” from the industrial undertaking. Relying on the judgments of the Supreme Court in CIT vs. Sterling Foods, 237 ITR 579, Pandian Chemicals Ltd. vs. CIT, 262 ITR 278 and Liberty India vs. CIT, 317 ITR 218 , he held that the assessee was not entitled to the deduction u/s. 80-IB(10) in respect of the disallowed expendi-ture of Rs. 4,50,12,485 and the deduction was rightly restricted by the AO to the profit of Rs. 3,76,78,403 shown in the Profit and Loss Account. He accordingly confirmed the action of the AO.

On second appeal to the tribunal, the assessee firm relied upon several decisions in support of the case for deduction. In reply, the Revenue contended as under;

• The decisions relied upon by the assesseee were concerned with deductions to be allowed, whereas in the present case, the deduction was not to be allowed because the assessee had failed to deduct and pay the taxes within the time-frame prescribed and thus it was a case of statutory disallowance of an expenditure and add-back of the same, to which the ratio of the judgments cited could not apply.

• In the case of Distributors (Baroda) (P.) Ltd. vs. Union of India 155 ITR 120(SC) , the earlier judgment of the court in the case of Cloth Traders (P.) Ltd. vs. Addl. CIT, 118 ITR 243, wherein the court had held that the deduction u/s. 80M had to be computed with reference to the gross amount of dividend received by the assessee, was overruled and it was held that the deduction was to be given on the net amount of dividend calculated in accordance with the provisions of the Act.

• The Supreme Court in Liberty India’s case (supra) held that the profits derived from the eligible business in section 80-IB(1) only meant the operational profits of the eligible business and since in the given case before the tribunal, the amount disallowed u/s. 40(a)(ia ) could not be termed as such profits, it could not qualify for the deduction.

• Acceptance of the assessee’s contention would result into an artificial inflation of the profits from the housing project which would be against common sense and reality, and would convert an expenditure disallowed into qualifying income of the assessee; a proposition which could not at all be accepted.

• The Amritsar Bench of the tribunal in the case of Kashmir Tubes vs. ITO ,IT Appeal No. 145 (Asr.) of 2005, dated 07-12-2007, held that a disallowed expenditure could not be considered to be profits derived from the eligible business for the purpose of section 80-IA/80-IB.

The tribunal, on a detailed consideration of the law on the subject, observed as under;
• U/s. 80-IB(1), an assessee was allowed a deduction in respect of the profits and gains ‘derived’ from any eligible business which inter alia included developing and constructing a housing project mentioned in s/s. (10). The deduction in computing the gross total income was to be given @ 100% of the profits and gains derived from the housing project.

• Though profits and gains ‘derived’ from the eligible business was not defined in the relevant section as also in chapter VI-A of which the said section was part of, section 80AB afforded a complete answer to the issue in dispute, while stating that for the purpose of computing any deduction under the chapter, notwithstanding anything contained in that section, it was the amount of income of the nature as computed in accordance with the provisions of this Act (before making any deduction under this Chapter) that alone shall be deemed to be the amount of income of that nature which was derived or received by the assessee and which was included in his gross total income.

• In other words, u/s. 80AB, the income that was derived from the eligible business must be computed in accordance with the provisions of sections 30 to 43D, as provided in section 29, and as such, effect must be given to section 40(a)(ia) in computing the profits and gains derived from the housing project.

• The payment made without tax deduction had to be disallowed and added back to the profits and the resultant figure of profits, enhanced by the amount of disallowance, was eligible for the deduction u/s. 80-IB(10).

• It hardly mattered whether, while computing the profits in accordance with the above sections, an amount was allowed as a deduction or was disallowed and added back to the profits, since ‘computation’ included both allowance of a deduction and disallowance or restriction of a deduction in accordance with the statutory provisions.
• The contention of the revenue, that the accep-tance of the assessee’s claim resulted in an artificial inflation of the profits from the housing project, was against common sense and reality.

• The words “computed in the manner laid down in this Act” must take precedence over notions like “commercial profits” and one should not be bogged down by the theory that the disallowed expenditure could not be considered as profits “derived” from the housing project or as “operational profits”.

• The ratio of the judgments in the cases of CIT vs. Albright Morarji & Pandit Ltd. 236 ITR 914 , Grasim Industries Ltd. vs. ACIT, 245 ITR 677, Plastibends India Ltd. vs. Addl. CIT, 318 ITR 352 and Cambay Electric Supply Industrial Co. Ltd. vs. CIT 113 ITR 84. supported the case for an enhanced deduction.

The tribunal distinguished the decisions relied upon by the revenue and in particular the decisions in the cases of Distributors (Baroda) (P.) Ltd., Sterling Foods (supra) and Pandian Chemicals Ltd.(supra).

In the result, it was held that the assessee would be entitled to the deduction u/s. 80-IB(10) in respect of the profits of Rs. 8,26,90,888 assessed by AO as prof-its of the housing project for the year under appeal.

4. Observations

It is very disturbing that in the present time, when the law is believed to be settled on the subject, the revenue should press such issues in unwarranted litigation. The courts are flooded with such frivolous cases, and one of the major steps to avoid piling up of the cases in the courts will be to stop flooding them with such issues. The only reason this controversy is addressed in this column is to highlight and understand the very novel contention of the revenue for denying the deduction on the enhanced income that found favour with the tribunal. There was no need to have engaged ourselves in this analysis, had the tribunal rejected the revenue’s contentions.

Section 40(a)(ia) disallows a claim for the deduction of an expenditure, in respect of which tax has not been deducted at source and/or paid in time. Section 40(a)(ia) is a part of chapter IV-D that provides for computation of the profits and gains of business. While computing the profits and gains in accordance with the said chapter, no distinction can be made between a section which allows the deduction and a section which disallows or restricts the deduction for failure to fulfill certain conditions. Neither can a distinction be made between an addition or a disallowance. Both the types of sections, those providing for allowance and those for disallowance, are parts of the computation provisions and both have to be given effect to in computing the profits and gains of business. It is this profit so determined, which constitutes the profits that is deemed to be derived from the eligible business. This understanding of the law, as pointed out by the Mumbai bench of the tribunal, is amply clarified by section 80AB when it advisedly uses the expression “…the amount of income of that nature as computed in accordance with the provisions of this Act.”

Section 80AB has an overriding effect over the sections under Chapter VI-A, insofar as the computation of the income eligible for the deduction is concerned. The Mumbai bench of the tribunal, in S.B. Builders case, very aptly took notice of the first proviso to section 92C, which provides that no deduction u/s. 10A, 10AA and 10B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under the said section 92C. The said section 92C provides for computation of arms length price in relation to an international transaction, and the effect of the proviso is that if an addition is made on the ground that the price charged is not at arms’ length, the added amount will not enjoy the exemption under the aforementioned sections. No such provision is available in chapter VI-A and in particular in section. 80AB or in section 80-IB(10) or in section 40(a)(ia) of the Act, and to read such a prescription therein, in the absence of statutory mandate, is impermissible in law.

In dealing with the effect of an addition u/s. 41(2) on the quantum of deduction u/s. 80E of chapter VI-A, the Supreme Court in the case of Cambay Electric Supply Industrial Co. Ltd. (supra) while explaining the steps involved in allowing the deduction, observed that the first step involved was to compute the total income of the assessee in accordance with the other provisions of the Act, without considering section 80E. It was then observed that the words “as computed in accordance with the other provisions of this Act” clearly contain a mandate that the total income of the concerned assessee must be computed in accordance with the other provisions of the Act without reference to section 80E and since in the case before them, it was income from business, the same was to be computed in accordance with sections 30 to 43A, that included section 41(2).

The Mumbai bench of the tribunal in S.B. Builders’ case observed that “We will be ignoring the mandate of section 80AB read with section 29 of the Act if we are to accept the stand of the revenue. There is no authority given by these sections to ignore the effect of section 40(a)(ia). Those sections do not say that the assessee will be allowed all the deductions from the profits, but when it comes to disallowing certain claims of expenditure, somehow those provisions will have to be ignored.”

It is useful to note that the Gujarat high court in the case of Keval Constructions, 33 taxmann.com 277 has held that the assessee was eligible for deduction u/s. 80-IB(10) on an amount that was increased by disallowance u/s. 40(a)(ia). This decision delivered on 10-12-2012 was delivered subsequent to 21-09-2012, the date on which the Ahmedabad bench of the tribunal rendered its decision in the case of Ramesh C. Prajapati. We are sure that, with the sole high court decision on the subject, the controversy for the time being should be rested. The Pune bench of the tribunal in the cases of Magarpatta Township Development, 32 taxmann.com 63 and Kalbhor Gawde Builders, 141 ITD 612 has also upheld the claim of the assessee for a higher deduction u/s. 80-IB(10) on the profits derived from housing project duly enhanced by the amount of disallowance u/s. 40(a)(ia) of the Act.

Nirav Shah

CENVAT credit can be availed on capital goods received in the premises of service provider only after the services became taxable.

Facts:

The respondents were brought into service tax net with effect from 16-6-2005. They availed CENVAT credit on capital goods received in the premises of service provider on 5-5-2005 i.e. prior to services became taxable.

Held:

Decision delivered by Gujarat High Court in case of Gujarat Propack 2009 (234) ELT 409 (Guj) was not applicable to the present case as the facts of the case were completely different. Following the decision delivered by larger Bench of the Tribunal in case of Spenta International Ltd. 2007 (216) ELT 133 (Tri.-LB), it was held that CENVAT credit was available in respect of capital goods received in the premises of service provider only after the goods became dutiable and therefore, the respondents were not eligible for the said CENVAT credit on capital goods received prior to the date of the service becoming taxable.

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Nirav Shah

Payment of duty made under protest during investigation – To be considered as ‘deposit’ and not duty – Principle of unjust enrichment not applicable.

Facts:

Appellant paid duty under protest during the investigation and later, it was held that it was not dutiable. Revenue asked to prove there was no unjust enrichment. It was a case of refund of ‘deposit’ and not of ‘duty’ as per the appellant wherein the principle of unjust enrichment was not applicable.

Held:

The Department did not bring anything on the record that the appellant had passed on the incidence of the duty. Further, the amount was paid under protest. Therefore, the same was in the nature of ‘deposit’ and not ‘duty’.

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Nirav Shah

Imported as well as indigenous drawings and designs – Once considered as ‘goods’ by customs authorities, cannot be considered ‘services’ by service tax authorities – Import of services cannot be taxed prior to insertion of section 66A.

Facts:

• Appellant, a company incorporated in Japan, entered into four different contracts with TISCO to set up a Skin Pas Mill at Jamshedpur. Two agreements were for supply of imported as well as indigenous designs and drawings and the other two were for supply of plant, machinery and equipments. A demand of Rs. 76 lakh was made treating supply of drawings and designs as “consulting engineer’s services”.

• Appellant’s appeal before Tribunal was remanded with a direction to consider the bill of entry and determine whether they were goods. The Commissioner after considering the relevant bill of entry, confirmed the demand and also levied equal amount of penalty. Hence, this appeal. According to the appellant, customs authorities had assessed the imported drawings and designs as ‘goods’ and appropriate customs duty was paid under chapter 49 by TISCO, and therefore, the same could not be considered as services by the service tax department for the levy of service tax and that erection, commissioning and installation activities were not covered under the head of “Consulting Engineer’s Services” as per CBEC circular dated 13-5-004.

• Further, the Indian service tax authorities had no jurisdiction to tax the appellant being a foreign company. Moreover, such services became taxable only after 18-4-2006 in the hands of recipient under reverse charge. The impugned activities were carried out much before the same. Whereas according to the revenue, designs and drawings were in essence system engineering or basic engineering and the scope of “consulting engineer’s services” was very wide. Though the appellant was a foreign company, it had a project office as well as representational office in India for more than 15 years which can be considered as fixed establishments.

Held:

• Designs and drawings imported and assessed as ‘goods’ cannot be considered as ‘services’ and be subjected to service tax. The activities purported before the insertion of section 66A, i.e. before 18-4-2006 could not be taxed under service tax.

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Nirav Shah

CENVAT credit pertaining to input services for the period prior to having service tax registrationallowed.

Facts:

The appellant having an office in Software Technology Park was engaged in software export. They obtained registration in 2009 and availed CENVAT credit in respect to period from April 2008 to March 2009. Revenue took a view that they had not obtained registration during the said period and therefore, could not be said to be provider of taxable output services. Hence, CENVAT credit cannot be allowed. The appellant argued that the issue was no more res integra as the same is fully covered by Tribunal’s decision in case of Well Known Polyesters Ltd. reported in 267 ELT 221, wherein it was held that service tax registration is not a pre-requisite to avail CENVAT credit.

Held:

Admitting appellant’s plea and relying on the Tribunal’s decision in case of Well Known Polyesters Ltd. (supra), Tribunal held that the appellant was eligible to claim CENVAT credit of the service tax paid on input services, after getting registration even if the registration is not in place at the relevant time of availing input services.

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Nirav Shah

Service tax not collected along with insurance premium in first three instalments – Insurance policy silent about service tax – Unfair trade practice – Insurance company cannot claim it subsequently.

Facts:

Second respondent took life Insurance policy from the appellant at an annual premium of Rs. 4,810/- in 2006. Service tax was applicable to insurance premium during the extant period. However, for the initial three years, appellant did not charge service tax on the premium. In 2009, the appellant asked for service tax along with the insurance premium. The second respondent approached the first respondent, who in turn held that no separate charge of service tax could be collected by the appellant over and above the premium of Rs. 4,810/-. A writ petition filed by the appellant against the order of the first respondent was dismissed and therefore, this appeal.

Held:

Policy was issued when service tax was in force. The appellant showed by way of its conduct that service tax was included in the premium in the initial three years. If the premium did not include service tax, the insurance company could have stated it explicitly. The company offered services to public at large and was duty bound to disclose real price being charged. Non disclosure of real price would be tantamount to conduct of unfair trade practice as per Consumer Protection Act, 1986 and the appeal was dismissed.

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Nirav Shah

High Court should examine and decide the case on merits when huge stakes are involved and Puloma Dalal, Jayesh Gogri Chartered Accountants Part a: Service Tax Recent Decisions ? Indirect Taxes 45 46 56 Bombay Chartered Acountant Journal, February 2013 BCAJ INDIRECT TAXES 596 (2013) 44-B BCAJ not dispose the case on the grounds of delay in filing appeal by department.

Facts:

High Court disposed off the case on the grounds of delay in filing appeal by the department.

Held:

In cases where huge stakes are involved, the High Court should examine and decide the case on merits and should not dispose off the same based on the mere grounds of delay in filing appeal by the department. In such a case, the High Court may impose costs on the department. Accordingly, the present matter was remitted to the High Court to decide the case de novo in accordance with the law.

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Nirav Shah

Composite construction contracts entered into prior to 1-6-2007 on which service tax was discharged already, cannot be reclassified as works contract services post 1-6-2007 to avail the benefit of composition scheme.

Facts:

The appellant was engaged in executing various composite construction contracts and paid service tax taking abatement under Notification No. 1/2006-ST dated 1-3-2006 prior to 1-6-2007 under erection, commissioning or installation services, commercial or industrial construction services and construction of residential complex service. Works contract service was introduced with effect from 1-6-2007 and consequently, a composition scheme was introduced whereby service tax was payable @ 2% on the gross amount charged for works contract. The appellant classified the ongoing contracts as on 01.06.2007 under works contract service.

Circular No. 98/1/2008 dated 4-1-2008 clarified that classification of services was to be determined as per the nature of services and it cannot be vivisected into two different taxable services on the criteria of time of receipt of consideration. Based on this circular, a SCN notice was issued challenging such change in the classification and payment under the Composition Scheme.

The appellant contested the said Circular on the ground of being contrary to Rule 3(3) of the Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007 and section 65(105) (zzzza) of the Finance Act, 1994 and that this would result in keeping the similar contracts on different footing and that it could not override the statutory provisions.

According to revenue, the Circular was explanatory in nature which merely explained Rule 3(3) of the said Rules and that the appellant had challenged the Circular and not the provisions of Rule 3(3). Therefore, as per the provisions of Rule 3(3), the appellant cannot opt for the Composition Scheme. The revenue also contended that reclassification was not permissible and in view of Rule 3(3), the appellant did not enjoy the benefit of Composition Scheme.

Held:

• Circular No.98/1/2008-ST dated 4-1-2008 only explained the provisions of Rule 3(3) and it was not contrary to the Act or the Rules.

• Since the appellant had not challenged constitutional validity of Rule 3(3), the Honourable Supreme Court did not comment on the same.

• Even if the Circular were to be set aside, Rule 3(3) was operational and as per Rule 3(3), the assessees had the option to pay service tax under Composition Scheme before payment of service tax in respect of the works contract and the option so exercised was applicable to the entire works contract. Since the appellant had already paid service tax prior to 1-6-2007, Composition Scheme was not available to the appellant.

• Thus, the Supreme Court has upheld the decision of Andhra Pradesh High Court (2010 (19) STR 321 (AP).

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Nirav Shah

“Goods/Sales Return” – Scope

Introduction

Under Sales Tax laws, the sales effected are liable to tax. However, if there is sales return (also referred to as “Goods return”) then the amount relating to such returns is not liable to tax. However, there are certain time limits for allowing this deduction. For example, under MVAT Act, 2002 and CST Act, 1956 following are the time limits for allowing the claim of ‘goods return’.

Rule 3 of MVAT Rules, 2005

“3. Goods returned and deposits refunded:- The period for return of goods and refund of deposits for the purposes of clauses (32) and (33) of section 2 shall be six months from the date of the purchase or, as the case may be, the sale.”

Similarly, Section 8A (1) (b) of CST Act provides as under:

“Section 8A (1)(b) The sale price of all goods returned to the dealer by the purchasers of such goods,-

(i) Within a period of three months from the date of delivery of the goods, in the case of goods returned before the 14th day of May, 1966.

(ii) Within a period of six months from the date of delivery of the goods, in the case of goods returned on or after the 14th day of May, 1966.

Provided that satisfactory evidence of such return of goods and of refund or adjustment in accounts of the sale price thereof is produced before the authority competent to assess or as the case may be, re-assess the tax payable by the dealer under this Act.”

It can be seen from above, that the total period (time limit) allowed for claim of goods returns is six months. The issue, for consideration herein is, if the goods return is beyond a period of six months, because of valid reasons, whether the claim is tenable. More particularly, such issue arises in relation to medicines where there is date of expiry of the medicines. In normal circumstances, the said dates are beyond the period of six months. In other words, if there are unsold medicines lying with the dealer after the expiry date, such medicines have to be returned, which may be beyond six months. In such a situation, whether the statutory time limits for ‘sales return’ can be ignored and deduction can be allowable.

Recently, Honourable Kerala High Court had an occasion to deal with such an issue. The judgment is in case of Glaxo Smithkline Pharmaceuticals Ltd. vs. State of Kerala (50 VST 486)(Ker). In this case, the medicines were returned by the buyers after the expiry date and such dates were beyond six months. In other words, the sales returns were beyond six months and the assessing authority disallowed the claim. Before the Honourable High Court, the dealer made two fold arguments. It was his submission that either sales returns should be allowed or the sales should be considered as unfructified sales. The High Court, after considering the arguments, gave detailed judgment on the same, observing as follows:

“3. After hearing both sides, what we find is that the petitioner’s claim of sales return was not allowed because the rule does not permit it. What was sold was medicines with potency and what is returned much after sale and second round of sale is medicines, the life period of which is over. Having had a pre-fixed period of potency, it is unlikely that sales return of life expired medicines will be within three months. Manufacture of medicines itself is geared up to patient demand soon after marketing is done. Therefore, when first sales are made, the medicines sold will have beyond three months shelf-life. Therefore, sales returns do not happen within three months of sales. So much so, under the existing rules which permit deduction of sales return only within three months of sale, the petitioner or other medical companies cannot get deduction of sales returns. The Kerala General Sales Tax Act or the Rules do not specifically provide any provision for refund or adjustment of tax paid in respect of sale of medicines which have lost potency at the hands of the dealer and which have been collected and destroyed by the company. The only provision for granting deduction is rule 9(b)(i) which provides for sales return within three months of sale which does not happen, because no medicine sold will have such short-period of three months of shelf-life. The petitioner also has no case that the sales return claimed of shelf-life expired medicines were within three months of the sale by the petitioner and so much so, the claim was rightly rejected in assessment and confirmed by the Tribunal. We do not find any error with the finding of the lower authorities.

The counsel for the petitioner raised an alternate contention that transaction should be treated as unfructified sales and so much so, since there is no time-limit for claiming deduction, the petitioner is entitled to refund of tax paid. This is opposed by the Government Pleader on several grounds.

In the first place, the sale of the item has really taken place from the petitioner to the distributor and from the distributor in turn to the dealer. The fact that the last retail dealer could not sell the medicine with the shelf-life period does not mean that the sale by the petitioner to distributor and in turn to dealer had not taken place. On the other hand, goods reach retail dealers only on second sales and admittedly the petitioner has not directly sold medicines to the retail dealers who returned the goods through distributors.

Therefore, the petitioner’s claim that the sale has not taken effect and on return of the medicines after expiry of the shelf-life, the original sale gets cancelled or frustrated is unacceptable. The practice followed is that shelf-life expired medicines are collected by the company from distributors and destroyed as part of the condition of the marketing to save dealers from loss. In fact, such loss is essentially borne by the manufacturing company, and the dealers or distributors obviously and rightly are not called upon to meet the loss. Further, as a matter of practice, the medicines returned on expiry of shelf-life are not replaced by the petitioner as such. But its value is reimbursed to the distributors through credit notes who in turn issue credit notes to retail dealers. Therefore, it is not a case of return of medicine on expiry of shelf-life and cannot be treated as fructified sales or unfructified sales. So much so, the petitioner’s contention in this regard is also not acceptable.”

Conclusion

It can be seen that statutory provisions apply in spite of genuine difficulties. The claim of unfructified sale is also not maintainable. The legislatures should provide relief in such genuine cases. In fact, in the above judgment, the Honourable High Court has observed for providing necessary statutory relief.

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Nirav Shah

Taxability of Sub-Contracted Services

Preliminary

Sub–contracting is a significant mode of business operations in the country (both in the manufacturing sector as well as the service sector).

In order to deal with the issue of multiple taxation, Central Excise exemptions have been granted by issuing Job work Notifications, which have the force of law. Under service tax, there are no statutory provisions which specifically deal with taxability of sub-contracted services. However, clarifications have been issued by the service tax authorities in the matter from time to time, while taxability of sub–contracted services remains a highly contentious issue.

With effect from 1-7-2012, taxability of sub-contracted services has assumed increased significance with the introduction of Negative List based taxation of services, more particularly in view of the fact that, despite substantially widening the taxation base, the threshold exemption continues to be 10 lakh. Hence, the same is discussed hereafter, separately for position prior to 1-7-2012 and after 1-7-2012.

Position prior to 1-7-2012:

• Department clarifications on or after 23/08/2007.

A Master Circular No.96/8/2007-ST dated 23-8- 2007 was issued by the Government whereby all the earlier circulars, clarifications etc. from time to time till the date of the said circular were superseded. An extract from the said circular is provided in Table 1:

• Circular No. 138/07/2011, May 2011

“Subject: Representation by Jaiprakash Associates Limited, Noida, in terms of Judgement dated 14-2-2011 in W.P. No. 7705 of 2008 – regarding

1. The Works Contract Service (WCS) in respect of construction of dams, tunnels, road, bridges etc. is exempt from service tax. WCS providers engage sub-contractors who provide services such as Architect’s Service, Consulting Engineer’s Service, Construction of Complex Service, Design Services, Erection Commissioning or Installation Service, Management, Maintenance or Repair Service etc. The representation by Jaiprakash Associates Limited seeks to extend the benefit of such exemption to the sub-contractors providing various services to the WCS provider by arguing that the service provided by the sub-contractors are “in relation to” the exempted works contract service and hence they deserve classification under WCS itself.

2. The matter has been examined.

(i) Section 65A of the Finance Act, 1994 provides for classification of taxable services, which mentions that classification of taxable services shall be determined according to the terms of the sub-clauses (105) of section 65. When for any reason, a taxable service is prima facie, classifiable under two or more sub-clauses of clause (105) of section 65, classification shall be effected under the sub-clause which provides the most specific description and not the sub-clauses that provide a more general description.

(ii) In this case, the service provider is providing WCS and he in turn is receiving various services like Architect service, Consulting Engineer service, Construction of complex, Design service, Erection Commissioning or installation, Management, Maintenance or Repair etc., which are used by him in providing output service. The services received by the WCS provider from its sub-contractors are distinctly classifiable under the respective sub-clauses of section 65(105) of the Finance Act by their description. When a descriptive sub-clause is available for classification, the service cannot be classified under another sub-clause which is generic in nature. As such, the services that are being provided by the sub-contractors of WCS providers are classifiable under the respective heads and not under WCS.” …………………..

3. “Therefore, it is clarified that the services provided by the subcontractors/consultants and other service providers are classifiable as per section 65A of the Finance Act, 1994 under respective sub-clauses (105) of section 65 of the Finance Act, 1944 and chargeable to service tax accordingly.”

• CBEC Circular No. 147/16/2011-ST dated 21-10-2011 “

1. Reference is invited to the Circular No.138/07/2011– Service Tax dated 06.05.2011 wherein it was clarified that the services provided by the sub-contractors/consultants and other service providers to the Works Contract Service (WCS) provider in respect of construction of dams, tunnels, road, bridges etc. are classifiable as per section 65A of the Finance Act, 1994 under respective sub-clause (105) of section 65 of the Finance Act and are chargeable to service tax accordingly. Clarification has been requested as to whether the exemption available to the Works Contract Service providers in respect of projects involving construction of roads, airports, railways, transport terminals, bridges, tunnels, dams etc., is also available to the subcontractors who provide Works Contract Service to these main contractors in relation to those very projects.

2. It is thus apparent that just because the main contractor is providing the WCS service in respect of projects involving construction of road, airports, railways, transport terminals, bridges, tunnels, dams etc. it would not automatically lead to the classification of services being provided by the sub-contractor to the contractor as WCS. Rather, the classification would have to be independently done as per the rules and the taxability would get decided accordingly.

3. However, it is also apparent that in case the services provided by the sub-contractors to the main contractor are independently classifiable under WCS, then they too will get the benefit of exemption, so long as they are in relation to the infrastructure project mentioned above. Thus it may happen that the main infrastructure projects of execution of works contract in respect of roads, airports, railways, transport terminals, bridges, tunnels and dams, is sub-divided into several sub-projects and each such sub-project is assigned by the main contractor to the various sub-contractors. In such cases, if the sub-contractors are providing works contract service to the main contractor for completion of the main contract, then service tax is obviously not leviable on the works contract service provided by such sub-contractor.”

Taxability of sub-contractors under VAT – Important Judicial Principles

In the case of Larsen & Toubro Ltd. v. State of Andhra Pradesh (2006) 146 STC 610 (AP), there were three parties, viz.:
Contractee – One who awarded the contract

Contractor – One who took the whole con-tract

Sub–Contractors – To whom main contractor gave the contract.

Petitioner filed a writ petition praying for a declaration that section 4(7), Explanation VI to section 2(28) of the Andhra Pradesh Value Added Tax Act, 2005, Rule 17(1)(a) and 17(1)(c), read with Rule 17(1)(e) of the Andhra Pradesh Value Added Tax Rules, 2005 are against Article 366(29A)(b) of the Constitution of India and the scheme of levy and recovery of taxes both at the hands of the nominated sub-contractors and the main contractor is beyond the legislative competence of the state legislature. The Andhra Pradesh High Court held as under:

• “Sub–contractor is an agent of the contractor – Though there are two agreements in the transaction of execution of works contract by a contractor through sub-contracts, satisfying the definition of “works contract” under the APVAT Act, it must be noticed that there is no agreement between the contractee and the sub -contractor and, consequently, there is no legal relationship creating either rights or obligations between them under an agreement. In between the contractee and the sub -contractor, the relationship is simply that the sub-contractor is an agent of the contractor.

• Property in goods passes directly from the sub-contractor to the contractee – In a works contract, the property in goods passes directly to the contractee by the theory of accretion. In the event of a contractor awarding the contract to a sub-contractor, the property in goods does not pass to the contractor at any point of time. The sub-contractor is only an agent of the contractor and the property in goods passes directly from the sub-contractor to the contractee and, therefore, there can be only one sale recognised by the legal fiction created under Article 366(29A).”

• Taxing both contractor and sub-contractor would be double taxation – That to hold that there are two taxable events in such a transaction, enabling the State to levy and collect tax both from the sub-contractor and the contractor, would be violative of Article 14 also for the reason that wherever a contractor executes a works contract himself without employing the sub-contractor, the deemed sale of goods involved in such execution of works contract would attract the tax only once and whenever the contractor employs a sub-contractor, the transfer of property in the same goods involved in the execution of such works contract attracts the tax twice, which is plainly irrational and violative of article 14 of the Constitution of India.

• Finally, the Andhra Pradesh High Court concluded that it is open for the State to frame appropriate rules to collect the same either from the sub-contractor or from the contractor, we emphasise, not from both. That means that tax can be collected from sub-contractor or from the contractor, but not from both.

The Supreme Court in State of Andhra Pradesh v. Larsen & Toubro Ltd. [2008] 17 VST 1 (SC) affirmed the above decision of AP High Court.

The Supreme Court explained that by virtue of Article 366(29A)(b) of the Constitution of India, once the work was assigned by the contractor the only transfer of property in goods would be by the sub-contractor, who was registered dealer, and who claimed to have paid the taxes under the Act on the goods involved in the execution of works.

Once the work was assigned by the assessee to the sub-contractor, the assessee ceased to execute the works contract in the sense contemplated by Article 366(29A)(b) because the property passed by accretion and there was no property in the goods with the contractor which was capable of re-transfer, whether as goods or in some other form. Thus, in such a case, the work executed by the sub-contractor resulted only in a single transaction and not multiple transactions.

The position emerging from the ruling of Larsen & Toubro Ltd. by the Andhra Pradesh High Court (affirmed by the Supreme Court) can be summed up as under:

• Sub-contractor is an agent of main contractor and has no privity of contract with contractee.

• Property in goods in a sub-contract works contract passes directly from the sub-contractor to the contractee and there can be only one sale recognised by legal fiction created under Article 366 (29A) of the Con-stitution of India.

• Taxation of contractor and sub-contractor on the same works contract (or a part thereof) would mean double taxation.

The above important principle laid down by the Supreme Court in the context of VAT, could be relevant for service tax, in appropriate cases.

Taxability of sub-Contracted services under service tax – judicial considerations

• In regard to position for the period prior to 23.08.2007, based on relaxations granted through departmental clarifications, the matter stands settled by various judicial rulings viz.

• Urvi Construction vs. CST, (2010) 17 STR 302 (Tri.-Ahmd)

• CCE vs. Shivhare Roadlines (2009) 16 STR 335 (Tri.–Del)

• Harshal & Company vs. CCE (2008) 12 STR 574 (Tri.– Ahmd)

• Semac Pvt Limited vs. CCE (2006) 4 STR 475 (Tri.–Bang)

• Shiva Industrial Security Agency vs. CCE (2008) 12 STR 496 (Tri.– Ahmd)

• Synergy Audio Visual Workshop P. Ltd. vs. CST (2008) 10 STR 578 (Tri.– Bang)

• OIKOS vs. CCE, (2007) 5 STR 229 (Tri.–Bang)

• Viral Builders vs. CCE (2011) 21 STR 457 (Tri.– Ahd)

to the effect that there cannot be double taxation in cases where services are rendered by a person through another person to the ultimate consumer, as long as the main contractor who has the privity of contract with the final cus-tomer has paid service tax on the gross amount.

• Some of the important observations by judicial authorities as regards taxation of sub–contracted services are as under:

Vijay Sharma & Co. vs. CCE (2010) 20 STR 309 (Tri.–ND) (LB)

Para 9

It is true that there is no provision under Finance Act, 1994 for double taxation. The scheme of service tax law suggest that it is a single point tax law without being a multiple taxation legislation. In absence of any statutory provision to the contrary, providing of service being event of levy, self same service provided shall not be doubly taxable.

CCE vs. Areva T&D India Ltd (2011) 23 STR 33 (Tri – Chennai)

Para 6

……………..

The dispute relates to services rendered by the respondents to their customers utilising engineering firms as sub-contractors. The original authority held that the respondents have not rendered any “Repair Service”. It is not being disputed that the respondents are having contract for rendering services with the ultimate customers and they receive payment from them and ensure the quality of services rendered to them. Mere engagement of sub-contractors for some of the activities does not take away the role of respondents as service provider to their ultimate clients. The reasoning adopted by the original authority may lead to the conclusion that the respondents are not liable to pay any service tax at all in respect of activities undertaken through sub-contractors. Apparently, the implications are not being understood or appreciated by the original authority. From the facts of the case, it emerges that the respondents are rendering services to their ultimate customers and while rendering the said service, they are receiving services from the engineering firms appointed by them. They receive payment of service charges from the ultimate customers and part of it is paid to the sub-contractors for the services rendered by them and naturally the respondents are making some profits…………..

National Building Construction Corp Ltd vs. CCE & ST (2011) 23 STR 593 (Tri.–Kolkata)

In this case, NTPC awarded contract to NBCC who entrusted work for site formation and clearance to two sub-contractors and Demand raised against sub-contractors for providing service to NTPC on behalf of NBCC. The Tribunal observed as under:

Services were rendered by sub–contractor to main contractor who are answerable to NTPC, and no service was rendered by sub-contractors to NTPC on behalf of NBCC main contractor. Hence, no tax was demandable as a case of revenue neutrality & NBCC having paid tax on the entire amount received from NTPC.

Taxability position of sub-contracted services

• For the period prior to 23-8-2007, it would appear that there was reasonable clarity based on department clarifications and judicial rulings to the effect that in case of sub-contracting of services, where the main contractor has discharged the service tax liability on the gross amount, there would be no liability to service tax at the end of the sub-contractor.

• For the period on or after 23-8-2007, based on department clarifications dated 23-8-2007, 6-5-2011 and 21-10-2011 stated above and subject to observations in paras (c) & (d) hereafter, it would appear that a better view would be that sub–contracted service provider (SCSP) is to be treated as an independent service provider and taxability needs to be determined based on appropriate service classification, applying the principles for classification of services contained in section 65A of the Act.

• In the context of works contract services, based on Supreme Court ruling in the L&T case discussed above, it can be contended that in case of sub-contracting, tax can be collected either from the sub-contractor or the main contractor, but not from both.

• In the absence of statutory provisions under service tax law as regards taxability of sub-contracted services, larger issue as to whether there can be liability at the end of sub-contractor at all, in cases where main contractor has discharged the service tax liability on the gross amount, remains judicially unresolved for the period on or after 23-8-2007.

• Taxability of sub-contracted services provided to SEZ Units are discussed separately.

Position on or after 01/07/2012

Provisions u/s. 66F of the Finance Act, 1994 (Act)

Section 66F of the Act (principles of interpretation of specified description of services or bundled services) provides as under:

“(1) Unless otherwise specified, reference to a service (hereinafter referred to as main service) shall not include reference to a service which is used for providing main service.”

……………..

Para 9.1-1 of Guidance Note 9 of Education Guide issued by CBEC dated 20/06/2012 provides the following illustrations to explain this first rule of interpretation contained u/s. 66F of the Act:

“Provision of access to any road or bridge on payment of toll is a specific entry in the negative list in section 66D of the Act. Any service provided in relation to collection of tolls or for security of a toll road would be in the nature of service used for providing such specified service and will not be entitled to the benefit of the negative list entry.

Transportation of goods on an inland water-way is a specific entry in the negative list in section 66D of the Act. Services provided by an agent to book such transportation of goods on inland waterways or to facilitate such transportation would not be entitled to the benefits of the negative list entry.”

From the above illustrations, it is clear that, as per section 66F(1), services procured for providing a service (main service) are not automatically classifiable under the same category as the main service. The above provision seems to confirm the position clarified by CBEC in May, 2011 and October, 2011 (referred earlier)

Mega Exemption Notification No.25/2012 – ST dated 20/6/12 (Mega N 25)

Despite the fact that excepting provisions u/ s. 66F(1), no specific provisions have been made under service tax law in regard to taxability of sub-contracted services, significant exemptions have been granted to specific sections of sub–contracted services under Mega N25. The relevant entry is reproduced hereafter:

• Entry No. 29

“Services by the following persons in respective capacities –

(a)    sub-broker or an authorised person to a stock broker;
(b)    authorised person to a member of a commodity exchange;
(c)    mutual fund agent to a mutual fund or asset management company;
(d)    distributor to a mutual fund or asset management company;
(e)    selling or marketing agent of lottery tick ets to a distributor or a selling agent;
(f)    selling agent or a distributor of SIM cards or recharge coupon vouchers;
(g)    business facilitator or a business corre spondent to a banking company or an insurance company, in a rural area; or
(h)    sub-contractor providing services by way of works contract to another contractor providing works contract services which are exempt.”

• In addition to (a) above, sub-contracted services could be exempted from service tax, if they fulfill the criteria for entitlement to specific exemption under a notification (other than 10 lakh exemption). To illustrate:

Mega N25 (Entry No. 13)

“Services provided by way of construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration of –

(a) a road, bridge, tunnel, or terminal for road transportation for use by general public;

(b) a civil structure or any other original works pertaining to a scheme under Jawaharlal Nehru National Urban Renewal Mission or Rajiv Awaas Yojana;

(c) a building owned by an entity registered u/s. 12AA of the Income-tax Act, 1961(43 of 1961) and meant predominantly for religious use by general public;

(d) a pollution control or effluent treatment plant, except when located as a part of a factory; or a structure meant for funeral, burial or cremation of deceased;”

Mega N25 (Entry No. 14)

“Services by way of construction, erection, commissioning, or installation of original works pertaining to,-

(a) an airport, port or railways, including monorail or metro;

(b) a single residential unit otherwise than as a part of a residential complex;

(c) low-cost houses up to a carpet area of 60 square meters per house in a housing project approved by competent authority empowered under the “Scheme of Affordable Housing in Partnership” framed by the Ministry of Housing and Urban Poverty Alleviation, Government of India;

(d) post-harvest storage infrastructure for agricultural produce including a cold storages for such purposes; or

(e) mechanised food grain handling system, machinery or equipment for units processing agricultural produce as food stuff excluding alcoholic beverages;”

Taxability position of sub-contracted services

• Subject to observations in paras hereafter, it would appear that, a better view would be that SCSP is to be treated as an independent service provider and taxability needs to be determined based on appropriate service & classification applying the principles contained in section 66F of the Act.

• In the context of works contract services, based on Supreme Court ruling in L&T case discussed earlier, it can be contended that in case of sub-contracting, tax can be collected either from the SCSP or the main service provider (MSP), but not from both.

• Despite the fact that specific exemptions have been granted to a large section of sub-contracted services, it is a well settled principle laid down by the Supreme Court to the effect that, an exemption cannot necessarily imply liability to tax/duty. Hence, the larger issue as to whether there can be liability at the end of SCSP at all in cases where MSP has discharged the service tax liability on the gross amount, needs to be tested judicially.

• Another point required to be noted is that all SCSPs do not necessarily enjoy the exemption that is available to MSP under Mega N25. For instance, certain services provided to the Government, local authority etc. are exempt under “entry No. 25” of the said Mega N25. However, when a sub-contractor is retained by MSP providing services to the Government, technically services provided by SCSP to MSP are not provided to the Government, Therefore unless SCSP enjoys exemption independently under any other entry, he would be liable for service tax in spite of the fact that his services are merged into the services of MSP who ultimately provides services to the Government.

• Taxability of sub-contracted services provided to SEZ units are discussed herein below:

Taxability of sub–contracted services provided to SEZ Units

The relevant extracts from Notification No. 40/2012–ST dated 20-6-2012 (“N40”) are as under:

“The exemption contained in this notification shall be subject to the following conditions, namely:-

(a)the exemption shall be provided by way of refund of service tax paid on the specified services received by a unit located in a SEZ or the developer of SEZ and used for the authorised operations:

Provided that where the specified services received in SEZ and used for the authorised operations are wholly consumed within the SEZ, the person liable to pay service tax has the option not to pay the service tax ab initio, instead of the SEZ unit or the developer claiming exemption by way of refund in terms of this notification.

Explanation – For the purposes of this notification, the expression “wholly consumed” refers to such specified services received by the unit of a SEZ or the developer and used for the authorised operations, where the place of provision determinable in accordance with the Place of Provision of Services Rules, 2012 (hereinafter referred as the POP Rules) is as under:-

(i) in respect of services specified in Rule 4 of the POP Rules, the place where the services are actually performed is within the SEZ ; or

(ii) in respect of services specified in Rule 5 of the POP Rules, the place where the property is located or intended to be located is within the SEZ; or

(iii) in respect of services other than those falling under clauses (i) and (ii), the recipient does not own or carry on any business other than the operations in SEZ;

…………………”

The substantive position of exemption in regard to services provided to SEZ units prior to 1-7-2012 continues with effect from 1-7-2012 as well, excepting consequential changes due to introduction of POP Rules in lieu of Rules for Export of Services/lImport of Services which were in force upto 30-6-2012.

According to one school of thinking, benefit of exemption under N 40 would not be available in regard to services availed by a MSP from a SCSP in regard to services provided by them for SEZ projects. This is supported by one or more of the following reasons:

• SCSP has privity of contract with MSP and has no independent legal relationship with SEZ clients of MSP. Hence, MSP is the recipient of Services provided by SCSP and not SEZ clients of MSP.

• According to department clarifications dated 23-8-2007, 6-5-2011 and 21-10-2011 and provisions of section 66F(1) of the Act, SCSP is to be treated as an independent service provider and taxability determined accordingly.

• Though according to Rule 10 of SEZ (Amendment) Rules, 2009 benefit of exemptions & concessions available to a Contractor shall also be available to sub-contractors read with section 51 of SEZ Act, it has been judicially held that, provisions of SEZ Act/Rules do not necessarily override the provisions of the relevant statute. [Reference can be made to UOI v. Essar Steel Ltd. (2010) 249 ELT 3 (GUJ) affirmed by Supreme Court – (2010) 255 ELT A 115]

According to an alternative school of thinking, benefit of exemption under N 40 would be available in regard to services availed by MSP from SCSP in regard to services provided by them for SEZ projects. This is supported by one or more of the following/reasons:

• SCSP has provided services on behalf of MSP to their SEZ clients. Hence, though privity of contract is between MSP and their SEZ clients, there is a constructive receipt of service by units located in SEZ from SCSP. Hence, benefit of N 40 would be available.

• Views expressed through department clarifications that, a SCSP is an independent service provider, has no statutory force. Hence, taxation at the end of SCSP results in multiple taxation which is not contemplated under the scheme of service tax law generally.

• Section 51 of SEZ Act read with Rule 10 of SEZ (Amendment) Rules, 2009 supports the contention that benefits available to a MSP should also be available to a SCSP.

Based on the above, it would appear that entitlement to the benefit of N 40 by a SCSP continues to be a contentious issue.

CENVAT credit on service tax paid on input services availed in connection with services provided by MSP to units in SEZ/developers of SEZ.

For availment of CENVAT credit under CENVAT Credit Rules, 2004 (CCR) on input services availed for “exported services”, it has been a settled position that, “exported services” are to be treated in the nature of “taxable services” and not “exempted services”. Hence, restrictions on availment of CENVAT credit under Rule 6 of CCR, would not apply and benefit of CENVAT credit of service tax paid on input services is available. However, whether services provided to a unit in SEZ/developer of SEZ, are to be treated as being in the nature of “exported services” or “exempted services” has also been a very contentious issue.

With effect from 1-3-2011, however, a new sub–rule (6A) has been inserted in Rule 6 of CCR to the effect that provisions of sub–rules (1), (2), (3) & (4) of Rule 6 of CCR shall not apply in cases when taxable services are provided, without payment of service tax to a unit in SEZ/developer of a SEZ for their authorised operations. Hence, with effect from 01/03/2011, benefit of CENVAT credit would be available on service tax paid on input services availed in connection with services provided to a unit in SEZ/developer of SEZ. This amendment has been given a retrospective effect, by the Finance Act, 2012. Hence, MSP can avail benefit of CENVAT Credit in cases where service tax is paid on services availed from SCSP for SEZ Projects on which Service tax has been paid by a MSP, subject to conditions stipulated under CCR.

Nirav Shah

Food for consumption……food for thought!

The National Food Securities Bill, 2013 is being hotly debated across the nation. It is an undisputed fact that the object of the Bill is entirely laudable. The real question is, will the much hyped Bill, achieve its objective? There is an obvious political angle to the timing of the Bill. The beleaguered UPA government probably believes that this Bill could be its saviour in the forthcoming elections in 2014. In order to ensure that the political advantage is not lost in the din in Parliament, the President has already promulgated an ordinance. However, one need not grudge the political mileage sought to be gained because in this regard all politicians across the political spectrum are of the same colour.

The aspect that requires to be addressed is that, why after 66 years of independence we still need such a Bill. There are three issues that come to mind, the first one being of principle. The Bill seeks to create a huge subsidy for food. However, the thinking of the Government now appears to be that subsidies are an inefficient way of delivering welfare measures. Consequently, in various areas subsidies are being done away with. The freeing of petrol and diesel prices from the administered price mechanism is a very recent example. Whether the step was advisable could be debated, but it reflects the thinking of the government in regard to subsidies. While these actions are being taken, the Government proposes to embark on one of the largest subsidy programmes in recent times.

The second question is that while it is absolutely true that the number of malnourished citizens, men women and children is large, the problem does not seem to be availability of foodgrains but the weaknesses in the distribution system created by poor policies and rampant corruption. It is well-known that India has a sufficient buffer stock of foodgrain; unfortunately, it does not have an efficient distribution mechanism to reach these foodgrains to the poor and needy. While action in this regard is necessary, the issue is of priorities. Agriculture has been a neglected sector for a very long time. Planners, lawmakers, politicians and bureaucrats have paid only lip service to this sector. Expenditure on fundamental research in agriculture has been extremely meagre and agrarian reforms have been painfully slow. Consequently, agricultural productivity has not increased significantly. If these issues are addressed, it would result in increase in purchasing power of the rural population. That would be a permanent solution rather than subsidies which are temporary.

The third aspect is whether this is the right time to introduce a bill which will create a huge fiscal burden. The figures that are being given by various persons are at substantial variance with each other. However, it is well accepted that if this program is to be really implemented, the funds required over the next 2 to 3 years are huge. The Government is already reeling under a fiscal deficit which has crossed the budgeted limits. While some of the reasons for this deficit can be attributed to the globalisation of the Indian economy, the inefficiencies and inactions of the Government are also major contributors. Therefore, funds required for such an ambitious programme will obviously have to be met from increased taxes or from diverting from other welfare spending. This in itself may slow down the growth further. The drop in the growth will reduce purchasing power in the hands of people, increase unemployment and all this will have a cascading effect. Therefore, assuming that the Government’s intention is absolutely genuine, this is perhaps not the right time to create further fiscal burden.

Finally, it has become increasingly apparent that the Government believes that the solution to all ills is legislation. When will we understand that the need of the hour is action, proper implementation of the existing laws and schemes rather than adding to the mass of legislation already existing. The Right to Education Act, 2009 is an excellent example of a very noble object being sought to be achieved through the wrong means. It is true that a substantially large number of children are being denied access even to primary education. The reason for the lack of enrolment in schools or a high school dropout rate is economic. It is because children are used as breadwinners that they are not sent to schools. The need was to administer the existing legislation in regard to child labour strictly. What needs to be ensured is that more children enroll in schools and do not dropout, rather than reserving 25% seats in private schools.

Only time will tell whether the Food Securities Bill will be passed and whether the political advantage really materialises. Even if the Bill creates more focus in regard to the problem of the malnourished sections of the society and results in some incremental action, it will have achieved its objective to a limited extent.

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Nirav Shah

Awake, Arise……………..

The clarion call given by the patriot saint Swami Vivekananda is as relevant today as it was when it was given more than a century ago. He said ” Awake, arise and stop not till the goal is reached.”

His passionate appeal to the youth of this country was to get up from the stupor, dream big, have faith in oneself and take action. He said “Take up one idea. Make that one idea your life – think of it, dream of it, live on idea. Let the brain, muscles, nerves, every part of your body, be full of that idea, and just leave every other idea alone. This is the way to success.” His emphasis on the power of the mind and thoughts was clear when he expressed that the infinite library of the universe is in our own mind.

His concern for the poor and downtrodden was almost unparalled. God manifests in them and when we serve them we serve God. ‘Daridranarayan’, a phrase which Mahatma Gandhiji popularised, was an expression of Swamiji’s call to serve the under privileged. ‘The God in them wants you to serve him’ is how he put it.

Another area of concern was the evil of trampling on women. He felt that God is the omnipresent force manifesting in women and that our country was weak because women were not honoured. The recent case of Nirbhaya is a stark reminder of this reality. Swamiji observed that along with other things, women should acquire the spirit of valour and heroism. He had great faith in the power of women folk which is evident in his observation that – “with five hundred men, the conquest of India might take fifty years: with as many women not more than a few weeks.”

“Have faith in yourself”, he said, “all power is in you – be conscious and bring it out.” Swamiji considered an individual an atheist if he did not believe in himself.

His love for India is evident in his utterances. Dr Annie Besant called him a Warrior Monk whose figure was instilled with the pride of India. Sister Christine remarked that “our love for India came to birth when we first heard him say the word ‘India’.” Swamiji described himself as condensed India. So much was he India personified that Rabindranath Tagore is said to have told Roman Rolland “read Vivekananda if you want to know India.”

He desired national integration because he felt that sectarianism was the reason for the colonial rule. He made an ardent appeal of oneness and observed that India shall rise out of chaos, strife, glorious and invincible with Vedantic brain and Islamic body.

Speaking of true religion, he observed that each soul is potentially divine and the goal is to manifest divinity within and advocated the practice of karma yoga, bhakti yoga, raj yoga and gyan yoga to achieve pure Bliss.

As we celebrate Swamiji’s 150th birth anniversary, let us imbibe his spirit. Let us awake and arise. Let us work towards realising the India of his dreams.

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Nirav Shah

2013-TIOL-720-ITAT-MUMBAI ITO vs. Wadhwa and Associates Realtors Pvt. Ltd. ITA No. 695/Mum/2012 Assessment Year: 2008-09. Dated: 03-07-2013

S/s. 194I, 201(1) – Lease premium paid to acquire leasehold land is not rent and tax on such payment, made by the assessee to MMRDA, is not deductible u/s. 194I.

Facts:
The assessee, a private limited company dealing in real estate, during the previous year under consideration paid a sum of Rs. 949.92 crore for allotment of a plot of land namely C-59 in ‘G’ Block of Bandra Kurla Complex, Bandra (E), Mumbai as per lease deed dated 22-11-2004 and also for additional FSI in respect of the said plot. The lease premium was paid without deduction of tax at source u/s. 194I. The Assessing Officer (AO) held that this payment attracted provisions of section 194I and since the assessee failed to deduct tax at source it has committed default within the meaning of section 201(1) of the Act and therefore, he treated the assessee to be an assessee in default and directed the assessee to make payment of interest along with TDS totaling to Rs. 314.26 crore.

Aggrieved, the assessee filed an appeal to CIT(A) where it contended that the payment under consideration was not covered by the term `rent’ u/s. 194I but was made to MMRDA (a) for additional built-up area and (b) for granting free-of-FSI area of Rs. 4 crore. The CIT(A) observed that the amount charged by MMRDA as lease premium was equal to the rate prevalent as per stamp duty recovery for acquisition of the commercial premises. These rates are prescribed for transfer of property and not for use as let-out tenanted property. He also observed that even the additional FSI was given for additional charges as per Ready Reckoner rates only. He found that the whole transaction towards grant of leasehold transaction rights to the assessee is nothing but a transaction of transfer of property and the lease premium is the consideration for the purchase of the said leasehold rights. Relying on the ratio of the decision of Mumbai Tribunal in the case of M/s. National Stock Exchange of India Ltd. (ITA Nos. 1955/M/99, 2181/M/99, 4853/M/04, 4485/M/04, 4854/M/04, 356/M/01and 5850/M/00) he decided the appeal in favour of the assessee.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:
The Tribunal observed that a careful reading of the lease deed shows that the premium is not paid under a lease but is paid as a price for obtaining the lease, hence it precedes the grant of lease. Therefore, by any stretch of imagination, it cannot be equated with the rent which is paid periodically. It also noted that the payment to MMRDA is also for additional built-up area and also for granting free-of-FSI area, such payment cannot be equated to rent. It held that the assessee has made payment to MMRDA under Development Control for acquiring leasehold land and additional builtup area. Considering the precedents relied upon by the CIT(A) and the definition of the term `rent’ as provided in section 194I, the Tribunal confirmed the order of the CIT(A) and decided the issue in favour of the assessee.

The appeal filed by the Revenue was dismissed.

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Nirav Shah

2013-TIOL-764-ITAT-INDORE DCIT vs. Roop Singh Bagga ITA No. 44/Ind/2013 Assessment Year: 2009-10. Dated: 31-05-2013

S/s. 40(a)(ia), 271(1)(c)–Disallowance u/s. 40(a) (ia) does not attract penalty u/s. 271(1)(c). Making an incorrect claim in law does not tantamount to furnishing of inaccurate particulars of income. Levy of penalty is not justified merely because the assessee has claimed certain expenditure that expenditure is not eligible in view of the provisions of section 40 (a)(ia) of the Act and for that reason, expenditure is disallowed.

Facts: The Assessing Officer (AO) while assessing the total income of the assessee, a transport contractor, found that payment of freight was made without deducting tax at source. Accordingly, he disallowed the freight u/s. 40(a)(ia). The assessee did not challenge the addition and paid tax thereon. The AO also levied penalty u/s. 271(1)(c) with reference to the disallowance so made by him. Aggrieved, the assessee preferred an appeal to the CIT(A) who following the decisions of the Hyderabad `A’ Bench of the Tribunal in the case of ACIT vs. Seaway Shipping Ltd. (ITA No. 80H/2011, order dated 11th June, 2010) and Ahmedabad `D’ Bench of the Tribunal in the case of L.G. Chaudhary (2012-TIOL-205-ITAT-AHM) deleted the penalty.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held: The Tribunal noted that—

(a) the default for non-deduction of tax in respect of payment for freight charges was accepted by the assessee himself by filing letter dated 21-12- 2009 before the Assessing Officer;

(b) the Supreme Court has in the case of Suresh Chand Mittal (supra) observed that additional income offered by the assessee to buy peace and to come out of vexed litigation would be treated as bona fides;

(c) the issue with regard to levy of penalty u/s. 271(1)(c) on the plea of non-deduction of tax u/s. 40a(ia) has been considered by the coordinate Bench in the case of Seaway Shipping Ltd and L.G. Choudhary (supra) wherein exactly on the similar issue, levy of penalty was held to be not justified;

(d) Supreme Court in the case of Reliance Petro Products (P) Ltd. (322 ITR 158)(SC) has categorically observed that “By any stretch of imagination, making an incorrect claim in law cannot tantamount to furnishing inaccurate particulars”.

The Tribunal confirmed the order passed by CIT(A) and decided the issue in favour of the assessee.

The appeal filed by the revenue was dismissed.

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Nirav Shah

2013-TIOL-746-ITAT-DEL ACIT vs. Delhi Public School ITA No. 4878 & 4879/Del/2012 Assessment Year: 2008-09 & 2009-10. Dated: 24-05-2013

S/s. 194C, 194I–Payments made by school to bus
owners/contractors for transportation of students from their home to
school and back qualify for deduction of tax at source u/s. 194C and not
u/s. 194I.

Facts:
The assessee, a school, had
taken on hire vehicles which were used for carrying students from their
homes to school and back. In view of the contracts entered into by the
assessee with the bus owners, the assessee deducted tax u/s. 194C.
Before the Assessing Officer (AO) the assessee submitted that
considering the fact that the contract provided for transportation of
children, drivers and conductors were appointed by the contractor, after
school trips were over the contractor was free to utilise the vehicle
for any manner and purpose, tax was deductible u/s. 194C. However, the
AO held that since the name of the school was written on the buses and
also that the buses were in exclusive possession of the school, the
transporter cannot ply buses for any purpose other than for the school.
He, accordingly, held that the payments made qualify for deduction of
tax u/s. 194I and not u/s. 194C. The AO calculated the difference in
amount deductible u/s. 194I and the amount deducted u/s. 194C.

Aggrieved,
the assessee preferred an appeal to CIT(A). The CIT(A) noted that the
contract was on a per trip basis for specified route. The rates per trip
were frozen for a period of one year. The vehicle i.e., the school bus
remains in possession of the transporter and the staff required to
operate the vehicle was also engaged by the transporter. All costs
incurred for running and maintenance of buses including the salaries of
driver and conductor were to be incurred by the transporter. Once the
trips made by these buses for carrying and dropping children from/to
school are complete, the transporter is at liberty to use the vehicle in
any manner. Following the ratio of the following decisions he held that
the contract was a works contract and provisions of section 194I were
not applicable.

a) Lotus Valley Education Society vs. ACIT (TDS) Noida 46 SOT 77 (Delhi) (URO)

b) Ahmedabad Urban Development Authority vs. ACIT 46 SOT 75 (Ahd) (URO)

c) ACIT (TDS) vs. Accenture Services Pvt. Ltd. 44 SOT 290 (Mumbai)

d) ITO vs. Indian Oil Corporation (15 Taxmann. com 210)(Delhi ITAT)

He decided the appeal in favour of the assessee.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:
The
Tribunal noted that the issue is covered by various cases decided by
the Tribunal. It also noted that the facts are similar to the facts in
the case of Lotus Valley Education Society vs. ACIT (TDS), which was
decided by Delhi Bench in ITA No. 3254 & 3255 /Del/2010. Relying
upon the observations in para 6 of the said order the Tribunal decided
the issue in favour of the assessee.

The appeal filed by the revenue was dismissed.

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Nirav Shah

SA 240 (Revised): A Practical Insight

In our professional practice, how often do we come across defences such as:

“Whatever I did was in the interest of the organisation without any intention of personal gratification whatsoever”.

“You need to pay bribes to get your work done, there is no other way”.

“If the senior executives can have their fat bonuses, then why can’t I have my piece of cake?”

“Cooking the books or creative accounting is not fraud; it is just bending the rules”.

These are the usual defences which one puts forth when faced with the prospect of being held answerable or responsible for fraud (or even potential fraud). But let us examine the auditor’s duty and responsibility relating to fraud in an audit of financial statements.

SA 240 (Revised) (which is effective for audits of financial statements for periods beginning on or after 1st April 2009) deals with “the auditor’s responsibility to consider fraud and error in an audit of financial statements” and defines fraud as “an intentional act by one or more individuals among management, those charged with governance, employees or third party, involving the use of deception to obtain an unjust or illegal advantage”. The distinction between ‘fraud’ and ‘error’ is whether the underlying action resulting in misstatements is intentional (i.e. fraud) or unintentional.

Let us understand the application of SA 240 (Revised) with the following two case studies. These cases represent ‘frauds’ as they were intentionally committed by the management/employees to gain an illegal advantage resulting in misstatement in financial statements resulting either from misappropriation of assets (cash in the first case) or fraudulent financial reporting (misstatement of inventories in the second case).

Case 1

Background
ABC Ltd. was engaged in the manufacturing of hot rolled steel plates. The manufacturing process involves melting iron ore and converting the molten ore into iron sheets of required size(s). During the course of production, a given proportion of ore had to be scrapped. The scrap generated was measurable in terms of standard yield and was also dependent on the quality of ore used. The scrap generated was sold to two scrap dealers at an agreed upon price. Scrap sales as a percentage of total income were insignificant. The entire process of scrap sales was handled by the CFO under the direct supervision of the Managing Director. The documentation maintained by the CFO for scrap sales included the quantity sold, the price charged and the quotations supporting the price charged as well payment of statutory levies such as excise and VAT. The realisation of scrap sales was never an issue as scrap was always sold on the basis of ‘advance payment by cheque’. From an audit standpoint, given that scrap sales (as recorded in the books) did not constitute a material amount, the auditors’ verification was restricted to ensuring compliance with excise and VAT rules and performing an overall analytical review.

The real situation was quite different. The actual quantity of scrap generated was much higher than that recorded in the books. The actual price realisation was also significantly higher with the difference between the amount disclosed in the books and actual price being received in cash. The cash was used to make facilitation payments (‘bribes’) to secure favours/approvals from various authorities in relation to day-to-day business operations. The actual scenario came to light when the business with the scrap dealer was discontinued on account of dispute and the scrap dealer informed the board of directors of the arrangement.

Analysis with respect to SA 240 (Revised)

Responsibility of management and those charged with governance

Per SA 240 (Revised), the primary responsibility to ensure prevention and detection of fraud and error rests with the management and those charged with governance. Since senior management was involved in the fraud, it was imperative that those charged with governance exercised much greater control and supervision over management function. They should have, using their authority of management oversight, ensured that this aspect of the company’s operation was reviewed independently and reported.

? Understanding the entity’s internal controls— The entire process of scrap sales was being managed by the CFO who had the authority to negotiate the rates with the scrap dealer, was responsible for dispatch of scrap and was also responsible for ultimate collection. There was no segregation of duties resulting in one individual being able to initiate and complete the entire transaction singlehandedly. There was an absence of an independent check of the overall reconciliation of materials consumed and goods produced. There was no independent verification of the quotes obtained to support the prices charged. This could have been mitigated by establishing a process of selection of scrap dealers such as tendering or by formulating a scrap negotiation committee comprising operational/functional heads responsible for negotiating terms with scrap dealers.

? Deterrents to improper conduct by management— The arrangement was being managed by the CFO with the knowledge of the Managing Director leading to management override of controls. Establishing a ‘code of conduct’ mandating compliance by one and all and stipulating disciplinary action (including termination and legal recourse) for non-compliance could have acted as a deterrent in fraud prevention/detection.

? Independent review by internal audit function reporting directly to those charged with governance could also have assisted in fraud detection/prevention. In situations where the entity has an internal audit function, the auditor can make enquiries of the internal auditor about any specific procedures performed to detect fraud and whether satisfactory responses were received from management to any findings resulting from those procedures.

? Whistle-blower mechanism—In terms of SA 315, responsibilities of those charged with governance include oversight of the design and effective operation of whistle blower procedures, establishment of these procedures could act as a ‘deterrent’.

Auditors’ Responsibilities
Per SA 240 (Revised), owing to the inherent limitations in an audit, the auditor cannot obtain absolute assurance that the material misstatements in the financial statements (either because of fraud or error) will be detected. The auditor has to, however, obtain reasonable assurance that the financial statements as a whole are free from material misstatement and should therefore ensure that they have followed the auditing procedures in accordance with the auditing standards generally accepted in India. However, the auditor could be held responsible where the misstatements due to fraud or error remained undetected due to nonapplication of the required audit procedures and professional scepticism.

In this regard it is important to note that the risk of not detecting a material misstatement due to fraud is greater than that arising from an error, since fraud may involve a sophisticated modus operandi, and could include collusion, forgery and intentional misrepresentation. This risk increases with management fraud since they are in a position to manipulate records and override controls.

In the given case, applying the guidance given in SA 240 (Revised) and SA 200 (Revised) Overall Objectives of the Independent Auditor and the Conduct of an Audit in accordance with Standards on Auditing, the auditors should have considered the following factors while auditing scrap sales:

Identify and assess fraud risk—the auditor should have designated scrap sales as an area susceptible to fraud in view of the fact that scrap sales were controlled entirely by the CFO and the Managing Director.

Understanding of the entity’s business and maintaining professional scepticism—the auditors should have considered obtaining deeper understanding of the manufacturing process, understood the relationship of scrap generated with quantity produced and enquired into reasons why the quantity of scrap generated as recorded in the books was low in relation to finished goods produced. The auditors could also have considered the usual quantum of scrap generated in similar/like industries and related this to the scrap quantity recorded in the company’s books. The auditors should have compared the rates charged to scrap dealers with independent sources such as market prices of steel scrap.

Understanding of internal control environment—There was no segregation of duties as the entire function was being performed by the CFO and MD. Further, as senior management was involved, there existed the risk of management override of controls. The auditor should have communicated these deficiencies in internal controls to those charged with governance and should also have formally enquired whether the governance body has any knowledge of actual, suspected or alleged fraud relating to scrap sales.

Respond appropriately to identified (or suspected) fraud—The auditors should have given due consideration to controls over scrap sales while reporting on internal controls in the Companies (Auditor’s Report)
Order, 2003 (‘CARO’) report. Post identification of the fraud, the auditor would have to appropriately modify the reporting relating to paragraph 4(xxi) of the CARO report.

As such, applying analytical procedures alone on the consideration that scrap income was insignificant to the overall financial statements was not appropriate and would not constitute sufficient appropriate audit evidence.

CASE 2

Background

XYZ Ltd. was engaged in the business of manufacturing gypsum boards, the primary raw material for which is natural gypsum. Gypsum was purchased in huge quantities in rock form in uneven size and shape. Given the quantity, size and shape, gypsum had to be stored in open spaces resulting in gypsum being exposed to the external environment. No physical verification was conducted during the year and at year-end, physical verification was not feasible given the huge quantum and uneven size/shape of the material in stock, the technical specifications (in terms of extent of exposure to light/air/water) as well as inability to draw inference based on test check. The quantity in stock was therefore certified by an independent surveyor and the auditors’ relied on the surveyor’s report. The quantity reported by the surveyor was used by the company to account for stocks in the books at the year-end.

The actual scenario was far different than that disclosed in the books. The quantity of gypsum in stock reported by the independent surveyor was as instructed by the factory manager. The factory manager reported the desired results given the arrangement with the valuer and the auditor’s reliance on the valuer’s work. The fraud came to light when during the course of interim audit for the subsequent financial year, the auditor insisted on physical verification of the stock by weighment at a point in time when the quantity of gypsum in the warehouse was at the lowest level. The quantity weighed physically was far less than that shown in the books at the time of physical verification.

Analysis with respect to SA 240 (Revised)

Responsibility of management and those charged with governance

In the present case, the perpetrator of the fraud was a functional manager (factory employee) as against a member of senior management in Case
1. The responsibility for preventing and detecting fraud primarily rests with the management; however, the administration and monitoring of controls in Case 2 would be different. This could have been achieved by:
Management evaluation of the expertise of the independent valuer engaged by the factory manager including considering obtaining a separate valuation from another valuer (given the quantum of stocks involved). Management could also independently test the methodology applied and assumptions made by the valuer in arriving at the likely quantity of stocks lying in the open ware-house.

Mandating physical verification by physical weighment of stocks at least once in a year and reconciliation of physical balances with book records, and also considering increasing the frequency of verification (based on the significant value of such stocks).

Formulating a policy of rotation of valuers at appropriate intervals.

Employees performing functions having high susceptibility to fraud being made to compulsorily avail annual leave.

Monitoring control in the form of an over-all exercise reconciling quantity of gypsum purchased, expected gypsum consumption (relative to finished goods produced) and derived closing inventory of gypsum would have also revealed the overstatement of closing inventory as per books.

Establishing a ‘code of conduct’ mandating compliance by one and all and stipulating disciplinary action (including termination and legal recourse) for non-compliance could have acted as a deterrent in fraud prevention/detection.

Auditors’ Responsibilities

Per SA 240 (Revised), while performing risk assessment procedures to obtain an understanding of the entity and its environment, the auditor should perform procedures to identify material misstatements due to fraud which includes A 620—Using the Work of an Expert requires that an auditor ought to have satisfied himself as to the expert’s skills, competencies and objectivity. The auditor should have considered whether the source data used by the expert, the assumptions made and methodology used is reasonable having regard to the auditor’s knowledge of the client business.

incorporating an element of unpredictability in selecting the nature, timing and extent of audit procedures. Accordingly, the auditor could have mandated that management conduct actual physical verification of stocks at a time other than the year-end and the auditor being present at such count.

The auditor should have performed analytical procedures to deduce the expected quantity of gypsum that would be in closing inventory at the year-end considering the production and expected input-output yield.

The auditor would need to appropriately modify his opinion in relation to paragraph 4(ii) of the CARO report relating to physical verification of inventories. Consequent to the fraud being detected, the auditor would need to consider modifying the audit opinion as well as consider fraud reporting under paragraph 4(xxi) of CARO report.

As such, mere reliance on the expert’s work by the auditors could not be considered as sufficient audit evidence for the purpose of expressing an opinion.

Whom should the auditor communicate with when the fraud is detected?

On fraud being identified or where the auditor has obtained information that fraud exists, the auditor must inform the same to the appropriate level of management who are primarily responsible for the prevention and detection of fraud. If the auditor suspects the fraud involving management, the communication should be done to those charged with governance. In other cases it should be to the management, at least one level above the level at which the fraud is suspected.

Although the auditor’s professional duty to maintain the confidentiality of client information may preclude him from reporting to any outside entity, the auditor’s legal responsibilities may override his duty of confidentiality on certain occasions, for e.g., when an auditor is required to disclose information under any law or under a directive of a judicial body/court.

Management Representations

The auditor should obtain written representations from the management or those charged with governance which include acknowledging their responsibility for the design, implementation and maintaining internal controls to prevent and detect fraud, that they have disclosed to the auditor the results of management’s assessment of the risk that the financial statements may be misstated on account of fraud and their knowledge of actual, suspected or alleged fraud. However, the obtaining of mere representation does not absolve an auditor from the responsibilities cast upon him under SA 240.

Compatibility with the corresponding International Standards of Auditing-ISA 240

The application section of paragraph A6, A56 and A66 of ISA 240 specifically deals with the application of the requirement of ISA 240 to the audits of public sector entities. However, since SA 240 (Revised) applies to all entities irrespective of their form, nature and size, a specific reference to the applicability of the Standard to public sector entities has not been included.

However the spirit of the corresponding para-graphs in ISA 240 has been retained in SA 240 (Revised) as follows:

Para A6 has been retained such that in certain cases the auditor may be required by the legislature or the regulator to specifically report on the instances of the actual/ suspected fraud in the client entity.

Para A56 has been retained such that the auditors may not have an option to withdraw from the engagements in certain cases.

Para A66 has been retained such that the requirement for reporting fraud, whether or not discovered through the audit process, may be subject to the specific provisions of the audit mandate or related legislation or regulation.

Conclusion:

Considering the nature and characteristics of a fraudulent act and the responsibility cast upon the auditor, it is imperative that due professional scepticism is exercised throughout the audit and the requirements of SA 240 (Revised) are followed to assist the auditor in identifying and assessing the risk of material misstatement due to fraud and in designing procedures to detect such mis-statement.

Nirav Shah

Changing Face of the Auditor’s Report

Our July 2013 issue focused on accountability. There cannot be a more relevant backdrop to the recent global developments taking place in enhancing the role of audit and the auditor’s reporting model.

A concern we have often heard but has remained unaddressed over the decades is the ‘expectation gap’ between the role of an auditor as expected or perceived by the users of the financial statements and what the real role of an auditor is under the applicable laws and regulations. The primary reason for this gap is the lack of communicative value of the auditor’s report. Investors have often indicated that auditors, in the audit process, obtain and review critical information relating to the company, areas of significant impact on the company’s financial position and exercise of management judgement around these areas. These insights do not make it through to the auditor’s report creating a gap between the information that is available to the auditors and their appointers. Consequently, the primary purpose of the audit report has remained limited to opining on whether the financial statements pass or fail the ‘true and fair’ presentation test.

To address these concerns, regulators around the world have worked together and are proposing changes in what is seen as an overhaul of the auditor reporting model.

On 25th July 2013, the International Auditing and Assurance Standards Board (IAASB) issued an exposure draft (the ED) of Reporting on Audited Financial Statements: Proposed New and Revised International Standards on Auditing (ISAs). The ED revises a number of existing ISAs and proposes a new ISA. The new ISA (ISA 701) Communicating Key Audit Matters in the Independent Auditor’s Report introduces requirements to include ‘key audit matters’ (KAMs) in the auditor’s report of listed entities. KAMs are those matters that the auditor considers of most significance in the audit of the entity’s current period financial statements.

Other changes to the auditor’s report are proposed by revising other ISAs including ISA 700 Forming an Opinion and Reporting on Financial Statements.

In summary, key changes in the auditor’s report proposed are as follows:

• Reporting Key Audit Matters

• A new section on the auditor’s opinion on the management’s assessment and appropriateness of the use of going concern basis and whether the auditor has identified a material uncertainty casting significant doubt on the entity’s ability to continue as a going concern

• A statement of auditor’s independence and compliance with other ethical responsibilities under the applicable law and regulations

• An improved description of the auditor’s responsibilities

• Reporting on the auditor’s responsibilities relating to other information

• Engagement partner’s name in the auditor’s report of listed entities.

While the IAASB was working on these proposals, the regulator on the other side of the North Atlantic Ocean wasn’t far behind. Within a matter of few days, on 13 August 2013, the Public Company Accounting Oversight Board (PCAOB) issued its own new auditing standard The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion with related amendments for public comment. The objective of this new PCAOB standard is, in essence, the same as that of the IAASB’s, i.e., to make the auditor reporting model more informative and relevant to investors and other financial statement users.

In addition to the existing pass/fail opinion, key proposals of the new PCAOB auditing standard in the auditors’ report are as follows:

• Reporting Critical Audit Matters (CAMs) identified and addressed by the auditor during the audit of the current period’s financial statements.

• Enhance the current reporting language by including the phrase ‘whether due to error or fraud’ in the context of whether the financial statements are free of material misstatements

• A specific statement on the auditor tenure (i.e. the year since the auditor has been serving the company consecutively)

• A specific statement on the auditor independence and compliance with the United States federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”) and the PCAOB

• Communication related to other information in accordance with the new PCAOB auditing standard proposed concurrently—The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report

Although the IAASB’s and the PCAOB’s proposals refer to the key reporting matters differently—key audit matters vs. critical audit matters—the guidance around how these matters will be determined by an auditor is similar. These are both identified as significant risks or areas involving significant auditor judgment; areas that posed significant difficulty in obtaining sufficient appropriate audit evidence or forming an opinion on the financial statements; and those that required an auditor to significantly change the planned audit approach. Under both sets of standards, these are matters of such importance that they are communicated by the auditors with those charged with governance, e.g. the audit committee.

In addition to the IAASB and the PCAOB proposals, the European Commission is also working on similar projects that will change the auditor reporting model through new/revised accounting and audit directives. The changes proposed by the IAASB and the PCAOB are expected to be effective from fiscal periods beginning on or after 15th December 2015. However, different countries may adopt a different timeline in implementing these changes in their version of the ISAs. For example, even ahead of the IAASB’s proposals, in June 2013, the Financial Reporting Council already revised ISA 700 (UK & Ireland) The Independent Auditor’s Report on Financial Statements and is effective from the periods commencing on or after 1st October 2012 for the companies reporting against the UK Corporate Governance Code. Some of the changes in the ISA 700 (UK & Ireland) are over and above those proposed by the IAASB. For example, the ISA (UK & Ireland) also requires the auditor to report on how the concept of materiality was applied in planning and performing an audit.

The way ahead
These changes seem distant and are still at the proposal stage. It should be borne in mind though that these are based on extensive outreach activities conducted by the international regulators and have closely followed each other’s projects. Therefore, these are quite likely to make their way through to the final standards.

As regards the impact on audit reporting in India is concerned, the global developments may put forward an interesting challenge to the regulators and standard-setters in India. Currently, paragraphs 4 and 5 of the Companies (Auditor’s Report) Order, 2003 already require reporting on specific items but these may not align with the definition of a key/ critical audit matter referred to in the IAASB and the PCAOB proposals. Also, there are proposals that do not currently exist in an auditor’s report under the Indian Companies Act. Accordingly, it will have to be seen whether Indian audit reports get even longer by bringing on board these additional sections to make it more consistent with the global reporting model or get a bit more concise by replacing/ removing some of the items reported on currently.

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Nirav Shah

Google Hangout – II

At the outset, I would like to mention that when I started penning the series titled Google Hangout, I had intended to cover more than just the features of the Google Hangout app. The intention was to build a bit of background and create awareness of where we were and where we are heading. While there is a growing perception that Google Hangout may be a game-changer, there is very little awareness as to what are the dynamics involved. In this series on Google Hangout, I have endeavoured to bring out some of the facts which I thought would put things in perspective. The concluding write-up of this series will cover some of the features which suggest that Google Hangout will change the way we communicate with each other.

About this write-up: This is the 2nd part of the series of articles on Google Hangout. This write-up focuses mainly on the events before Google Hangout was put up in the public domain and how these events directly or indirectly will influence the things to come—one of which is the success of Google Hangout as an instant messaging app.

The previous article briefly discussed the events related to the development of the app-based ecosystem and the rise and decline of various players in the arena of instant messaging apps. In this write-up, we will discuss some of the popular instant messaging apps, which are relevant today, but in the foreseeable future may become ‘also rans’.

The previous write-up briefly touched upon the early events leading to the advent and subsequent developments related to the instant messaging ecosystem. The previous write-up also discussed why Short Messaging Service (SMS) became popular. Thereafter, BlackBerry Messenger (BBM) came into the picture and shook up the world. Today, the scene has changed; the tide has turned for BBM, which is fast losing ground to newer and more nimble players in the market. The following paragraphs, are some of the facts which help the readers understand some of the key factors at play.

The rise and fall of SMS

As discussed in the previous write-up, between the years 2000–2005, SMS was a popular means of communication. The (prohibitive) minimum cost of a voice call was the primary reason. But as time went by, technological advancements, easy and cheap access to mobile telephony, drop in the minimum cost per call, etc., led to the decline in the popularity of SMS as a means of communication. Once voice call rentals started to fall, users started realising that there were disadvantages to using an SMS, i.e., other than the difference in the cost of an SMS vs. voice call, factors such as limit to number of characters per SMS, limitations of the keypad on the phone, perceived need for rich media compared to plain vanilla text, abuse of the SMS system by mass advertisers, etc.

One may say that the role of SMS as an enabler of instant communication reached its peak when it became the de facto means of mass communication. At its peak, SMS was used to exchange greetings during festivals like Diwali, Christmas and Id; banks and other service providers sent updates of transactions related to money transfers, credit card use, bank balance; users exchanged daily SMS’s (containing jokes, positive thoughts, etc) on a mass scale. A whole new ecosystem had spawned due to mass SMS-ing.

While mass SMS-ing capability was the bright side, there was a dark side too. Mass advertisers started targeting a number of mobile users for mass messaging. Consumers across the country started receiving (mostly unwanted) messages. These would range from offers to supply services of a plumber, AC repairmen, to selling insurance, stock trading tips, so on and so forth. Somehow this development seemed inevitable. Mass marketers then found that their calls to mobile phone users (for selling various products and services) were being ignored due to the caller ID facility. Mass advertisers realised that while a call could be ignored, there was no way to stop someone from sending an SMS. The abuse became so rampant that the Telecom Regulatory Authority of India (TRAI) was forced to clamp down hard. TRAI imposed several restrictions such as the National Do Not Call Registry, imposed requirement to register mass advertisers and enforced a limit on the number of messages per phone number per day, among other diktats.

Thus, the fate of SMS as a means of instant communication was more or less sealed. Today, savvy users consider SMS-ing not only an expensive option; they also find it to be a limiting factor when they want to reach out to their ever-expanding network of friends.

The rise and (eminent) fall of BBM
During 2005–2010, i.e., right about the time that the reign of SMS was nearing its end, BBM started gaining ground as the de facto means of instant messaging and communications. The BlackBerry (BB) device was already quite popular as a smart device for official communication (i.e., emailing). With a growing number of users and easy access to the BB data services, BBM started covering ground lost by SMS. By 2008-09, BBM was already accepted by the corporate world as a reliable instant messaging service. In the BB world, email was the official means of corporate communication and BBM was the unofficial yet cool means of communication. Users formed groups and used BBM to exchange jokes, positive messages, etc., just like they had used SMS in the past. The advantage that BBM offered was zero cost. As pointed out in my last write-up, while the BBM service itself was free, one would need to purchase a BB (approx cost 18K plus) and pay for the data charges. Another relevant point was that right up to 2007-08, users would restrict their BB subscription to mail and data services, voice calls were used sparingly. Apparently, at that time, BB had not been permitted due to which the cost of a voice call was far too high. Soon thereafter, various Indian telecom players started offering BB services (data & voice) at an affordable cost. Even then a user would have to purchase a BB device, the cost of which was quite steep for the common man.

Post 2008, a series of changes took place:

• Increase in the penetration of mobile technology— widespread usage across the country
• Advent of global players in the telecom sector
• Falling rentals for voice calls
• Introduction of 3G technology
• Easy access to Internet, through smart phones
• Introduction of better quality of smart phones
• Rise of the iPhone

While one could argue both ways on all of the above factors, it remains an accepted fact that easy access to the Internet and availability of cheaper technology, i.e., both hardware as well as software, were the key factors to the upheaval that was to come. By 2008, Nokia had already started losing ground to BB devices. It was no longer a “status symbol”. At that time, users (and to a great extent Nokia too) started realising the perils of not keeping up with the changing times. Users realised that Nokia’s Symbian-based phones could not match up with increasing end-user expectations, mainly related to emailing and access to the Internet. Also, BB was uniquely positioned because it offered a full QWERTY keyboard. While other device makers did try to play ‘catch-up’, they had already missed the boat.

BB’s troubles really began to surface after the introduction of the iPhone 4. It was slick, userfriendly and what many industry watchers would say ‘path-breaking’. There were several reasons for and against the iPhone, some of which are:

• It was expensive but users felt it was worth it.

• While users were restricted to the iOS and the iTunes environment, these environments themselves provided for so much that one did not feel the need to look beyond that factor. As a matter of fact, the feeling was that none of the other players provided so much.

• There was a paradigm shift in the user interface environment. While a standard number pad was considered as a serious limitation, the famed QWERTY keyboard and track ball/pad also seemed to be laborious when compared the iPhone’s touch-based interface.

The dynamics were completely stacked against the QWERTY keyboard when Apple introduced Siri, its much touted voice-based interface.

• The ease in Internet access gave much needed succour to Internet-dependant apps like Google Talk and WhatsApp. (Here I would confess that I started using an iPhone just about then— around December 2009, and at the instance of my mentor, installed WhatsApp. To be candid, I was more than happy to see my phone bill go down due to the lower number of SMS’s).

• The Apple app store made sure that more and more (free as well as paid) apps kept cropping up. Users were spoilt for choices. It was only a matter of time that they realised the limitations in the offerings of BBM.

• The increasing popularity of the apps market place and introduction of iPhone clones was a strong sign that BB, and as a natural consequence BBM, would see that its days were numbered.

• Many IT players saw the growing popularity of instant messaging apps and felt that there was a gap between what BBM had to offer and what the consumers at large were expecting. Thus, WhatsApp, WeChat, etc., came into the market. Text-based messaging was destined to be a thing of the past. People were already expecting more. Between WhatsApp and We-Chat they got to sent voice-based messages, videos, pictures, map locations, etc. It seemed that BBM was already gasping for breath at that time.

While there are several other facts which one would want to consider, I think it would be suf-ficient to say that players like Nokia (which recently decided to sell out to Microsoft) and BB (taking losses, likely to cut approx 5,000 jobs, considering a sellout, recent announcement that it would of-fer BBM on Android phones) are feeling the heat or as one can say, are dropping out of the race.

The next write-up will be about the popularity of apps like Skype, WhatsApp, WeChat, etc., and how these apps (like their predecessors) are likely to face competition from Google Hangout—the new kid on the block.

I wish all the readers the best of luck with the tax audit season.

Nirav Shah

Karwat Steel Traders vs. ITO Income tax Appellate Tribunal Mumbai Bench “A”, Mumbai Before B. Ramakotaiah (A. M.) and Vivek Varma (J. M.) ITA No. 6822 / Mum / 2011 A Y 2008-09. Decided on 10.07.2013 Counsel for Assessee / Revenue: K. S. Choksi / Manoj Kumar

Section 40(a)(ia) – No disallowance can be made merely on the ground of non filing of Form 15H / 15G to CIT as prescribed u/r 29C.

Facts:
The AO had disallowed interest paid to various parties amounting to Rs. 5.3 lakh u/s. 40(a)(ia) on the ground that the assessee had not filed Form 15H /15G to CIT as prescribed u/r 29C. On appeal, the CIT(A) upheld the order of the AO.

Held:
According to the tribunal, u/s. 40(a)(ia) the amount cannot be allowed as deduction only when tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction has not been paid. In the case of the assessee, since the assessee had received the prescribed forms viz., Form 15H / 15G, from the parties to whom interest was paid, there was no liability to deduct tax. For nonfurnishing of Form 15H / 15G to the CIT as prescribed under the Act, according to the tribunal, it may result in invoking penalty provisions u/s 272A(2)(f). Since no tax was deductible, the tribunal held that the provisions of section 40(a)(ia) were not applicable to the facts of the case and the interest paid was allowable as deduction. In coming to the above conclusion the tribunal also relied on the decision of the co-ordinate bench in the case of Vipin P. Mehta vs. ITO (2011) [11 taxmann.com 342 (Mum)].

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Nirav Shah

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

This circular provides that the revised Softex procedure which was applicable only to software exporters in Software Technology Parks of India (STPI) will, with immediate effect, be applicable to all software exporters whether in SPTI/SEZ/EPZ/100% EOU/DTA.

As per the revised procedure, a software exporter whose annual turnover is at least Rs. 1,000 crore or who files at least 600 SOFTEX forms annually on all India basis, will be eligible to submit statements in the revised excel format sheets as per formats Annexed to this circular.

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Nirav Shah

ACIT vs. Goodwill Theatres Pvt. Ltd. ITAT Mumbai `G’ Bench Before R. K. Gupta (JM) and N. K. Bllaya (AM) ITA No. 8185/Mum/2011 A.Y.: 2008-09. Decided on: 19th June, 2013. Counsel for revenue / assessee: D. K. Sinha / Vijay Mehta

Mesne Profits received, for unauthorized occupation of the premises, constitute capital receipt not chargeable to tax. The decision of the Madras High Court in the case of CIT vs. P. Mariappa Gounder (147 ITR 676) is distinguishable on facts.

Mesne profits, being capital receipts, were deductible while computing book profits u/s. 115JB.

Facts I :
During the year under consideration the assessee company received mesne profits for unauthorised occupation of the premises from Central Bank of India who was in possession of rented premises belonging to the assessee.

The tenancy of Central Bank of India (“the Bank”) ended on 01-06-2000. The Bank handed over possession of the premises to the assessee on 30-09- 2003 though the Supreme Court had vide its order directed the bank to handover the possession by 30- 06-2003. The Small Causes Court vide its order dated 28-03-2007 (received by the assessee on 30th June, 2007) disposed off the suit filed by the assessee company for mesne profit for the period 01-06-2000 to 30-09-2003 by fixing the compensation to be Rs. 3,33,38,960 plus interest thereon at 6% i.e. Rs. 8,33,474 per month.

The application of the Bank to stay execution and operation of the order dated 28-03-2007 was disposed of by the Small Causes Court by directing the Bank to pay Rs. 1,47,28,280. The Bank also filed an appeal against the determination of mesne profits, which appeal was admitted and was pending. In the meantime, the Bank paid assessee company Rs. 1,47,28,280 which the assessee regarded it as capital receipt. The Assessing Officer relying on the ratio of the decision of the Madras High Court in the case of P. Mariappa Gounder 147 ITR 676 (Mad) considered this amount to be chargeable to tax.

Aggrieved, the assessee preferred an appeal to CIT(A) who held that in the case before the Madras High Court which has been affirmed by the Supreme Court the issue was of the year of taxability of mesne profit. Relying on the ratio of the decision of Special Bench of Mumbai Tribunal in the case of Narang Overseas P. Ltd. 111 ITD 1, appeal against which was dismissed by Bombay High Court vide order dated 25-06-2009 (ITA No. 1797 of 2008), the CIT(A) allowed the appeal of the assessee.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Fact II : The assessee had treated the sum of Rs. 1,47,28,280 as capital receipt and had taken it directly to capital reserve account without crediting the profit & loss account. The AO held that since the receipt is revenue in nature the same needs to be added back to book profit in view of the provisions of section 115JB. He brought the same to tax while computing the book profits.

Aggrieved, the assessee preferred an appeal to CIT(A) who deleted the addition by observing that the receipt is capital in nature. However, while deleting the addition he observed that since the mesne profit is reflected in profit & loss account, it is rightly taxable for computing book profit, hence, on principle, the findings of AO were upheld. Aggrieved by these observations the assessee preferred an appeal to the Tribunal.

Held I: The Tribunal noted that the AO decided the issue against the assessee by following the decision of Madras High Court in the case of P. Mariappa Gounder (supra). The Special Bench of the Mumbai Tribunal has while deciding the case of Narang Overseas (supra) considered the decision of the Madras High Court and also the decision of the Supreme Court confirming the decision of the Madras High Court. It also noted that the decision of the Special Bench has been confirmed by the Bombay High Court vide order dated 25-06-2009. The Tribunal found the order of CIT(A) to be in consonance with the order of the Special Bench. The Tribunal confirmed the order of the CIT(A) on this issue.

Held II: The Tribunal held that since the mesne profit is capital in nature in view of the decision of the Special Bench, they cannot be brought to tax u/s. 115JB of the Act. Even Explanation 2 to section 115JB supports the case of the assessee. CIT(A) was justified in deleting the addition computed by the AO u/s. 115JB of the Act. The Tribunal observed that the assessee’s counsel is correct in objecting to the findings of the CIT(A).

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Nirav Shah

After the stimulus phase-out – Govt errs in focusing only on financing current account deficit.

The US Federal Reserve has dropped clear hints that its long phase of quantitative easing, in which it bought bonds in an “open-ended” manner, will come to an end. It will not cease abruptly – which is why it is now being called a “tapering”. However, even the prospect that the end of the Fed’s massive stimulus, which flushed global markets with liquidity, is on the horizon has been enough to cause jitters among investors. The question that many should now ask is: what will be the medium-term fallout of the shift in the Fed’s stance? In particular, how will it affect emerging markets – especially India? So far, under the influence of easy money, the stock market index in India has run up 4,000 points to around 19,000; bond markets, too, were long buoyed by one-way inputs. The Sensex has taken a few losses. But it’s the debt market that has seen the real action, with well over $3 billion of foreign money flowing out of Indian government bonds in the last two weeks. The rupee, in its recent rapid depreciation to close to 59 against the dollar, has suffered a fate similar to the currencies of other growthchallenged emerging market countries – both Brazil and South Africa have seen their currencies hit a four-year low against the dollar. India, however, has a particularly large current account deficit, around five per cent of GDP, making it particularly dependent on foreign investors being willing to take on emerging market risk so that their inflows finance India’s imports.

Finance Minister P Chidambaram spoke obliquely about this situation when he called for a “longterm view” on the part of investors, and promised more reform that would address the problem. There weren’t too many details on offer, but even the broad hints that Mr Chidambaram dropped suggest the government is looking at the problem primarily from a limited perspective of financing the current account gap, without addressing the fundamental cause of the deficit. He referenced, in particular, the reviewing of caps on foreign direct investment (FDI) in various sectors. Meanwhile, the Securities and Exchange Board of India raised investment limits for long-term foreign investors in government debt by another $5 billion to $30 billion. These two measures are, broadly, more of the same approach that the government has tried so far. They are not in and of themselves a problem, and should even be welcomed. But measures to promote FDI and FII holding of debt merely paper over the current account deficit problem – they do not solve it. As long as there is an imbalance on India’s books with the rest of the world, these steps will never be enough.

The focus on financing the current account deficit is, thus, the wrong focus. What is needed instead is to boost exports, and to improve India’s macroeconomic fundamentals. The latter is complicated by the fact that the effects of the end of quantitative easing elsewhere may well upset India’s monetary schedule, making the Reserve Bank of India less likely to reduce interest rates. The space to do so has to be provided from somewhere, however, and thus fiscal correction must accelerate – allowing borrowing rates to come down and investment to rise. Without that, investment-led growth – as well as consumption in rate-sensitive sectors like automobiles, real estate and so on – will not recover. Meanwhile, the lopsided balance of trade shows the need for fundamental reform. A good proportion of the current account deficit, for example, is due to imports of pulses and cooking oil. Pushing foodgrain-specific food security will make this problem worse, not better. And promoting exports will need basic labour law reform. This is where the government should be looking.

(Source: The Business Standard dated 14.06.2013)

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Nirav Shah

Simple Encryption Software Can Keep Govt Snoops at Bay

Despite vast surveillance operations, governments will not be able to detect every suspicious interaction that takes place on phone and internet network. By using encryption software that is readily available off the shelf, citizens can make it very difficult for government agencies to snoop in on their phone conversations or even messages exchanged over the internet.

So, electronic surveillance programmes, such as the US government’s PRISM — through which it clandestinely keeps a tab on people around the world by gathering data from several corporations —and India’s Central Monitoring System, can do very little if users are determined to go Concerns about governments invading into the privacy of its citizens have come to the fore after classified documents about the PRISM programme were leaked to the media by Edward Snowden, a former American intelligence officer and technical contractor.

The leaked documents revealed that several large technology companies, including Microsoft, Yahoo, Google, Facebook and Apple, participated in the programme and gave US authorities access to their data. In India, the government began rolling out its Central Monitoring System in April. The system gives the National Investigation Agency, as well as other investigating authorities, access to everything that happens over India’s telecommunications networks, including phone calls, text messages and social media conversations. But such indepth surveillance programmes could end up achieving very little of what they were set up for in the first place. They could also be misused.

Experts have pointed out that users can employ encryption software like TrueCrypt to hide data from everyone other than the intended recipient. Also, IP addresses, which give away the computer’s or mobile device’s location, can be hidden using Tor, a free software that redirects internet traffic through thousands of proxy computers before it reaches its final destination. Other options include www.encryptfiles.net, where users can encrypt files that they send over email, and free and easily accessible tools such as Steganos Lock-Note, Gpg4win and SendInc.

(Source: The Economic Times dated 13-06-2013)

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Nirav Shah

Rupee responses – Address the current account deficit with concrete steps

Given recent tendencies, it was only a matter of time before the rupee fell below its previous low, touched a little under a year ago. When the downward trend first began in August 2011 and then intensified later that year, there was a strong opinion that the Reserve Bank of India (RBI) should take on the responsibility of containing the decline. Many stakeholders, including, prominently, companies that had borrowed large sums abroad, were taking a beating because they had not hedged their foreign currency exposures. The costs of a large depreciation are unquestionably high – but, as the experience of several countries teaches, probably not as high as the costs imposed by a failed defence of the currency. This was the RBI’s position during that episode and remains its stance during the current one, as articulated by RBI Governor D Subbarao recently. And it is a legitimate one. The trigger for the recent bout of depreciation was the statement by the chairman of the US Federal Reserve, Ben Bernanke, that they would have to start thinking of rolling back liquidity now that macroeconomic conditions were showing signs of improving. In a global marketplace buoyed by successive infusions of liquidity over the past four years, this statement signalled a return to normalcy in the US monetary policy stance and a consequent revaluation of the dollar. All currencies were devalued by the markets as a consequence. There is absolutely no case for any country to draw down its foreign exchange reserves to defend its currency against the dollar in these circumstances. This would simply add to the vulnerability of the currency to persistent pressure. And stakeholders seem to have accepted this: there is far less clamour to resist the depreciation.

However, even though there are global forces at work here, the contribution of domestic factors should not be underplayed. While all currencies are depreciating against the dollar, the ones that have declined the most are from countries with large current account deficits. India is, unfortunately, a leader in this category and looks like it will remain so for a while. Despite all the public handwringing about the size of the current account deficit, very little has actually been done to rein it in. While domestic fuel prices are gradually being corrected, consumers are yet to pay the full rupee price of diesel and liquefied petroleum gas for domestic use. Measures have been taken to dampen demand for gold, but these are widely perceived to be misdirected and unlikely to have any real impact. And on the mineral front, little has been done to revive the once substantial iron ore exports, while the country’s power sector will remain dependent on imported coal for some time to come. All of these will combine to keep the current account deficit at dangerous levels, with the inevitable downward pressure on the rupee. The risks of a spiral between currency depreciation, a widening current account deficit due to more expensive critical imports and declining capital inflows due to lower dollar returns are tangible. Rather than trying futilely to talk the rupee up, the government needs to take credible actions to address each of the threats of the current account deficit. Even if they take some time to have an impact, the signalling effect will be worth something.

(Source: The Business Standard dated 17-06-2013)

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Nirav Shah

Interests in conflict – Coal probe shows business in politics needs to be tackled

The Central Bureau of Investigation on Tuesday raided, and registered a first information report against, two Congress politicians. They are Naveen Jindal, who owns Jindal Steel and Power Ltd (JSPL) and is a member of the Lok Sabha; and the Andhra film maker-turned-Rajya Sabha member Dasari Narayana Rao, once minister of state for coal. Essentially, a company in Mr Jindal’s group is alleged to have bought, through an intermediary company, shares in Mr Rao’s Saubhagya Media at prices more than three times the market rate. The difference, it is being argued, was the payment for allowing the allocation of several captive coal mines to JSPL’s operations, which vastly helped that company’s bottom line. On the one hand, this is a fairly straightforward accusation of corruption and bribery; if it is proved, there exist laws to deal with it. On the other hand, it throws up further knotty questions. After all, it is worth noting that Mr Jindal and Mr Rao were both men of business – and both were from the same party. Nor are they alone; an increasing number of members of Parliament (MPs) are businessmen who have entered politics, or senior politicians who have extensive business interests in either their own names or in those of close associates and family members. In this case, if an attempt was indeed made to pay off Mr Rao, it was thought possible to try and conceal it under the cloak of regular business transactions. Matters can get even worse when the direct pay-offs are replaced with more complex transactions – perhaps business favours of one sort or another, or crucial information. Yet India’s thinking on conflict-of-interest issues remains sadly backward.

This is not to say that India has no regulations on the books. Lok Sabha members, for example, are expected to declare their assets and liabilities – if not their actual interests. Before joining a debate, an MP is expected to declare all personal or pecuniary interests in the matter at hand. Ministers are forbidden to have any connections with businesses that are related to the work they conduct for the government. The Rajya Sabha maintains a register of members’ interests, which includes lists of consultancies and majority shareholdings, but it is far from exhaustive. It is not made public. The primary check on any overlap between business and political interests of an MP is his or her fellow parliamentarians – Lok Sabha members’ votes can be “challenged” by another member if a conflict of interest is perceived; the House ethics committee is expected to investigate any declarations of conflict.

The sad truth, however, is these genteel systems have not evolved enough to match the rapidly changing ways in which administrative processes can be subverted. Even in the United States, where a substantial ethics staff examines declared interests of Congress members and federal employees to discover conflicts and require divestiture of officials’ holdings, loopholes are regularly discovered – most recently, regarding insider trading. In India, no declarations or challenges have been issued in many years. Meanwhile, the Election Commission is supposed to take up complaints of unethical behaviour by ministers; it has long failed to do so, or even to make the Rajya Sabha’s book of interests public – which might have made Mr Jindal and Mr Rao more cautious. The mechanisms exist, but it seems they do so only on paper. If there are loopholes in the current regulatory system, they need to be plugged. Politicians and bureaucrats need to realise public opinion will not sit by while the regulatory system rusts.

(Source: The Business Standard dated 13-06-2013)

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Nirav Shah

Infosys’ N.R. Murthy’s Second coming – at risk as Infosys

If one were to analyse the initial reactions to the news that NR Narayana Murthy was returning to Infosys, with son in tow, it has been sharply divided. The company’s stock price went up following the announcement, reflecting investor perceptions; and there are those who believe that the founder’s return will help the company find its bearings again. There are others who think it is not a great idea to bring back a 67-year-old to take executive leadership, and that tagging on his son as executive assistant doesn’t make it any better-surely there must be people in Infosys who can at least be competent executive assistants!

No one so far has looked at it from Mr Murthy’s perspective; he is probably committing himself to a busier schedule and a knottier set of problems than he might have wanted at this stage, risking a reputation built over a lifetime, and perhaps also disrupting whatever career plans his son might have had. On the other hand, you could argue that Mr Murthy had no choice-he created today’s situation by pushing into leadership positions people who should not have been there, he did so for the wrong reasons (the company’s founders were playing a silly and irresponsible game of round-robin!), and he watched while the company lost touch with the market and also lost key human resources.

So can he make it work a second time? Comparisons with Steve Jobs are not relevant, except to the extent that both are/were inspirational leaders. Apple is built around unique products, and Jobs was their creator, while Infosys is a service organisation. Comparisons with Sachin Tendulkar, of the kind that Mr Murthy unfortunately made, are even worse-the cricketer’s batting average today is way short of what it used to be. But it is a net positive that there is no one in the company with Mr Murthy’s external stature, so he could perhaps win over customers more effectively than others can. It helps that he is nothing if not a relentless salesman who knows how to pitch to the audience of the moment, internal as well as external, and that is a good starting point for a fresh innings.

The big risk is that an old warhorse tries the same old business tricks that he knows, but they don’t work in a changed environment. And the fact is that the business situation today is radically different from the world full of opportunities that presented itself to Infosys in the second half of the 1990s, with unique cost and other advantages for an Indian firm. New US visa regulations are being debated that could put a huge spanner in the works of India’s software service exporters. Competition has got way more difficult, some of India’s cost advantages have been neutralised, the old business models will not work today, and Infosys simply does not have the halo it once enjoyed-so that both employees and customers now look at the company differently. The further problem is that the old-new chairman may be unwilling to rock the managerial boat, and to get tough with people who have been with him for half a lifetime. Finally, India’s tech companies, for all their vaunted reputations, have not always been great at service delivery.

The lesson this whole episode drives home is that, even if you can build a successful company, it is an altogether different challenge to prevent it from becoming a shooting star. How do you keep a company successful through different business cycles, changing market realities and successive generations of technology? The answers have to go beyond the personalities of a company’s founders.

(Source: Weekend Ruminations by T.N. Ninan in Business Standard dated 08-06-2013).

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Nirav Shah

Protocol amending the DTAA between India and Netherlands notified with effect from 2nd November 2012 signed – Notification no. 2/2013 dated 14-1-2013

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Nirav Shah

Extension of time limit for filing ITR V – Notification no. 1/2013 under the CPR Scheme 2011 dated 7-1-1203

Time limit for filing ITR V for AY 2010-11 filed during financial year 2011-12 and for AY 2011-12, for returns filed on or after 1-4-2011, the due date is extended till 28th February, 2013. For returns filed for AY 2012- 13, the due date is extended till 31st March, 2013 or 120 days from filing the return whichever is later.

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Nirav Shah

A country for scandal? – What do IPL and Ranbaxy tell us?

Pillorying the government of the day for pervasive
corruption is the easy thing to do, whereas it might just be an escapist
option. It helps those of us who are neither in politics nor in the
government to pretend that we are not tainted, and therefore have the
right to point fingers at politicians, who we assume are not. The truth,
as recent events have brought home forcefully, is that corruption has
permeated fields that have nothing to do with politics and government.

The
cricket establishment is a disgrace, and now suspected of far worse
than the misdemeanors of the Indian Olympic Association, for which that
body has suffered the deserved misfortune of being thrown out of the
international Olympic movement. If it is spot fixing in cricket, it has
been widespread doping in wrestling; problems persist in half a dozen
sports bodies, whose recognition the government has withheld. You could
argue that it is politicians who mostly run the sports bodies, except
that none of the people around Mr Kalmadi were from the world of
politics. In any case, the cricket boss is a businessman.

And
what does one make of Ranbaxy – once a poster boy for the emerging
India, but which now stands exposed for falsifying its research results,
and then selling what must presumably be described as adulterated drugs
to unsuspecting consumers, at home and abroad? The US authorities have
slapped a penalty of half a billion dollars (about Rs 2,800 crore), but
where have India’s own drug authorities been all this while? What about
the criminal liability of all those who were in the company and part of
the fraud? What is the responsibility of the company’s directors of the
time, including many well-known worthies – who, according to the
whistle-blower, chose to ignore the red flag that he waved?

The
building collapse that killed 1,100 hapless garment workers in
Bangladesh has undermined that country’s $20-billion garment export
industry, and raised systemic questions about building regulation. At
home, now that Wockhardt too has run into trouble with the US
authorities, what is the message to the world about India’s drug
industry – seen not so long ago as a global winner? When fraudulent
accounting at Satyam cast an international shadow on India’s IT services
sector, the damage was contained because the other companies in the
field were squeaky clean and Satyam itself was quickly sanitised through
changes of management and ownership. Ranbaxy casts a darker shadow,
because faking drugs is a more lethal business than faking accounts –
though bogus financials too can cause suicides, as the Saradha mess in
West Bengal shows. The older of the two billionaire brothers who sold
the company five years ago (and now run hospitals) has pleaded an angry
innocence because five years have passed since he stepped out of the
company, but the faking of research results was taking place on his
watch, and liability for that is independent of whether the Japanese who
bought the company in 2008 did proper due diligence.

No
system-wide questions are answered by doing nothing. If the canker is
widespread, there have to be systemic solutions. An obvious step is to
come down hard on anyone who is caught, as a lesson to everyone else.
System legitimacy suffers only when businessmen find ways of avoiding
being brought to justice. But perhaps the worst outcome would be to
treat this as just one more kind of reality TV, for nightly
entertainment. All troubling questions can be evaded if we just watch
Arnab Goswami shout at, hector and pillory his “guests” for an hour
every night, for thereby we’ve earned our absolution!

(Source: Weekend Ruminations by T.N. Ninan in Business Standard dated 25-05-2013)

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Nirav Shah

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