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Year: 2013

USA – Advance agreements between related parties properly characterized as equity

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The US Tax Court has held that advance agreements executed between related parties were appropriately characterised as equity for US Federal income tax purposes. PepsiCo Puerto Rico, Inc. v. Commissioner of Internal Revenue; PepsiCo, Inc. and Affiliates v. Commissioner of Internal Revenue, T.C. Memo. 2012-269 (Docket Nos. 13676-09, 13677-09, 20th September 2012).

The case involved a US parent corporation (PepsiCo) and its group of affiliated corporations that included Netherlands Antilles companies. The Netherland Antilles companies held promissory notes issued by the group’s US affiliated corporations (Frito-Lay, Metro Bottling, and PepsiCo) and held interests in foreign entities that were treated as partnerships for US Federal income tax purposes (foreign partnerships).

The deficits of the foreign partnerships reduced the earnings and profits of the Netherland Antilles companies, which in turn reduced the amount of the interest income from the notes that would otherwise have flowed-through to PepsiCo as subpart F income. To avoid the adverse consequences that would result from the pending termination of the extension of the US-Netherlands treaty to the Netherlands Antilles, and also to benefit from the favourable tax treatments of the US-Netherlands DTAA and Dutch corporate income tax, PepsiCo transferred the ownership of some of the foreign partnerships from the Netherland Antilles companies to newly-formed Dutch companies (PWI and PGI).

During this global restructuring, Frito-Lay, Metro Bottling, and PepsiCo issued new promissory notes to replace the existing promissory notes and the new promissory notes were ultimately contributed to PWI and PGI. In exchange for the contributed promissory notes, PWI and PGI issued advance agreements to the group’s US affiliates (BFSI and PPR). The advance agreements had terms of 40 years, which could be unilaterally extended by PWI and PGI for an additional 15 years.

The advance agreements, however, would be rendered perpetual if a related party defaulted on any loan receivables held by PGI or PWI. A preferred return unconditionally accrued on any unpaid principal amounts of the advance agreements. The preferred return included a base rate determined by reference to LIBOR plus a premium rate. However, PWI and PGI were required to make any payments of the accrued preferred return only to the extent their net cash flow exceeded the sum of accrued but unpaid operating expenses and capital expenditures made or approved by them, but in no event could the cash-flow amount be less than the interest received from the affiliated companies.

PWI and PGI were allowed to make payments on the advance agreements in full or in part at any time. In addition, the rights of the creditors of PWI and PGI were superior to the holders of the advance agreements. The group treated payments of preferred return on the advance agreements as distributions on equity on its US Federal income tax returns. Interest payments on the promissory notes were deducted by Frito-Lay, Metro Bottling, and PepsiCo u/s. 163 of the US Internal Revenue Code (IRC) and were also exempt from US withholding tax pursuant to the US-Netherlands tax treaty.

The issue of the case was whether the advance agreements were appropriately characterised as equity for US Federal income tax purposes. The US Internal Revenue Service (IRS) asserted that the advance agreements and the promissory notes were merely intercompany loans between commonly controlled related companies. The US Tax Court stated that, while the substance of a transaction governs for tax purposes, the form of a transaction often informs its substance.

The US Tax Court further stated that, although the greater scrutiny should be afforded to relatedparty transactions, disregarding the taxpayers’ international corporate structure based solely on the entities’ interrelatedness is, without more, unjustified. The US Tax Court noted that the focus of a debt-versus-equity inquiry is whether there was intent to create a debt with a reasonable expectation of payment and, if so, whether that intent comports with the economic reality of creating a debtor-creditor relationship.

The US Tax Court then applied 13 factors that it has articulated for the debt-versus-equity inquiry. After analysing those factors, the US Tax Court concluded that the advance agreements exhibited more qualitative and quantitative indicia of equity than debt. The US Tax Court determined that the advance agreements were appropriately characterised as equity for US Federal income tax purposes. 10. Netherlands Supreme Court: burden of proof regarding transfer of legal seat on taxpayer On 30th November 2012, the Supreme Court of the Netherlands (Hoge Raad der Nederlanden) gave its decision in case No. 11/05198 as to whether or not, in the context of the transfer of the legal seat of a company, the burden of proof (of the transfer) rests on the taxpayer. For the facts, legal background and issues of the case, as well as the opinion of the Advocate General (AG), the Taxpayer presented the Supreme Court with two arguments:

• Firstly, the Taxpayer appealed against the finding of the Court of Appeal (Gerechtshof) of Arnhem that it (the Taxpayer) had not shown that the place of effective management had, since 1st July 2001, been transferred to the Netherlands Antilles. The Court dismissed this appeal on the grounds that it is a reasonable finding of facts, which can as such not be considered by the Supreme Court.

• Secondly, the Taxpayer essentially argued that the burden of proof regarding its (Netherlands Antilles) residence status only extends to the year in which the transfer takes place, i.e. to 2001. The AG had concluded that the shift in the burden of proof to the Taxpayer applies for a period of 1 year after the transfer of the place of effective management has been “made plausible”.

• The Court noted, as the Court of Appeal had, that the aim of article 35b(7) of the Tax Regulation for the Kingdom of the Netherlands, as deduced from parliamentary and legislative documentation, is to combat tax avoidance which may arise from the nominal (paper) transfer of the legal seat of a company. This article provides for a shift in the burden of proof to the taxpayer in certain situations where there is a transfer of the legal seat.

• On this point, the Supreme Court agreed with the Court of Appeal, and decided that the burden of proof is shifted to the taxpayer until that taxpayer can make plausible the transfer of the place of effective management.

• This second argument, the Court noted, was somewhat academic as the first hurdle, namely proving that the place of effective management had indeed been transferred, had not been taken by the taxpayer.

[Acknowledgement/Source: We have compiled the above summary of decisions from the Tax News Service of IBFD for the period 18-09-2012 to 17-12-2012.]

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Netherland’s Supreme Court decides that Dutch thin capitalisation provisions are not incompatible with EC law and article 9 of Dutch tax treaties with France, Germany and Portugal

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On 21st September 2012, the Dutch Supreme Court (Hoge Raad der Nederlanden) gave its decision in X BV v. the Tax Administration (case No. 10/05268) on the compatibility of the Dutch thin capitalisation rules with EC law and article 9 of the tax treaties Dutch tax treaties with France, Germany and Portugal.

The Supreme Court rejected the taxpayer’s argument that the thin capitalisation rules are incompatible with the EC Treaty. In the taxpayer’s view this is the case because the rules apply if a Dutch company for 95% or more is owned by a foreign company, which means that in such case mainly foreign companies are affected. The Court based its judgment on an earlier decision of 24th June 2011 (LJN BN3537) in which it was held that domestic and foreign holding companies are not in a comparable situation.

Referring to the decision of the European Court of Justice (ECJ) of 21st July 2011 in Scheuten (Case C-397/09), the Court also held that the thin capitalization rules are not incompatible with the Interest and Royalties Directive (2003/49) because that Directive deals with the position of the creditor and not with that of the debtor.

Following the opinion of the AG, the Court rejected the appeal based on article 25(5) (Non-discrimination) under the treaty with France, because the Taxpayer is not treated differently from another company which is not part of a group and is not comparable with a group company.

Thereafter, the Court decided that the provision at issue is also not incompatible with the arm’s length provisions under article 9 of the France – Netherlands Income and Capital Tax Treaty (1973) (as amended through 2004) and article 9 of the Germany – Netherlands Income and Capital Tax Treaty (1959) (as amended through 1991) because those provisions only provide for a corresponding adjustment in case of contracts and financial relations between related parties which are not at arm’s length, while the Dutch thin capitalisation rules concern the entire financing structure of a company.

Finally, the thin capitalisation rules are also not incompatible with article 9 of the Netherlands – Portugal DTAA because article X of the protocol specifically allows the Member States to apply their domestic thin capitalisation rules. Those rules may only not be applied if related companies prove that their agreements are at arm’s length based on their activities or their specific economic circumstances.

The term “thin capitalisation” is not defined in the Treaty, the term must be interpreted by means of article 31(1) of the Vienna Convention on tax treaty interpretation, which means that the meaning of the term must be determined in good faith based on the subject and purpose of the treaty. Based on the thin capitalisation rules applicable in Portugal at the time of signing of the Treaty, the Court held that the term refers to interest deduction restrictions concerning interest paid on loans to related companies. This is in line with article 9 of that Treaty, which aims to determine whether the conditions in a concrete legal case are at arm’s length. Therefore, the Court held that the term “thin capitalisation” in the Treaty with Portugal only concerns certain loans and not a general thin capitalisation rule which concerns the total financing structure of a company.

Consequently, the Supreme Court held that Dutch thin capitalisation provisions are not incompatible with EC law and article 9 of the Dutch tax treaties with France, Germany and Portugal.

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ECJ rules on definition of fixed establishment: taxable person carrying out only technical testing or research work in another Member State does not have a “fixed establishment from which business transactions are effected”

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On 25th October 2012, the Court of Justice of the European Union (ECJ) gave its decision in the joined cases of Daimler AG v Skatteverket (C-318/11) and Widex A/S v Skatteverket (C-319/11). The Swedish Administrative Court of Falun (Förvaltningsrätten i Falun) had requested a preliminary ruling from the ECJ on 27th June 2011. No Advocate General’s opinion regarding this case was issued. Details of the judgment are summarised below:

(a) Facts:

In C-318/11, Daimler AG (Daimler) is a company having the seat of its economic activity in Germany and carrying out winter testing of cars in Sweden. Daimler does not carry out any activity subject to VAT at the installations in Sweden, but has a wholly-owned subsidiary there which provides it with premises, test tracks and related services. Daimler applied for a refund of input VAT paid on the purchases it had made, which had not been used for any activity subject to VAT in Sweden (i.e. the testing of cars).

In C-319/11, Widex A/S (Widex) is a company established in Denmark manufacturing hearing aids and has a research centre in Sweden carrying out research into audiology, which constitutes a division within Widex. Widex acquires goods and services for the research activity which it carries out in its division in Sweden. Widex also has a subsidiary in Sweden which sells and distributes its goods in Sweden, but the subsidiary operates totally independently from the research activities of the division.

The Swedish tax authorities rejected Daimler’s and Widex’s applications for the refund of VAT paid in Sweden on the grounds that the applicants have a fixed establishment in Sweden.

(b) Legal background: Under articles 170 and 171 of the EU VAT Directive (2006/112) taxable persons who are not established in the Member State in which they purchase goods and services or import goods subject to VAT but are established in another Member State may obtain a refund of that VAT in so far as the goods and services are used for the purposes of certain specific transactions. Under article 1 of the Eighth VAT Directive (79/1072) and, now, under article 3 of the Directive 2008/9, a taxable person is not established within a Member State and qualifies for a refund of input VAT if that person has neither the seat of his economic activity, nor a fixed establishment from which business transactions are affected in that particular Member State.

(c) Issue:

The issue was whether a taxable person for VAT established in one Member State and carrying out in another Member State only technical testing or research work, not including taxable transactions, can be regarded as having in that other Member State a “fixed establishment from which business transactions are effected” within the meaning of article 1 of the Eighth Directive and, now, in article 3(a) of Directive 2008/9 and as such be denied the right to refund of VAT in that State.

(d) Decision:

The ECJ pointed out that the criterion under which a refund of VAT can be denied due to the fact that there is a “fixed establishment from which business transactions are effected” includes two cumulative conditions: firstly, the existence of a “fixed establishment”; and secondly that “transactions” are carried out from that establishment. By referring to Commission v. Italy (Case C-244/08), the ECJ emphasised that the expression “fixed establishment from which business transactions are effected”, must be interpreted as regarding a non-resident taxable person as a person who does not have a fixed establishment carrying out taxable transactions in general. The existence of active transactions in the Member State concerned constitutes the determining factor for exclusion of the right to refund of VAT. Furthermore, the term “transactions” used in the phrase “from which business transactions are effected” can affect only output transactions. Consequently, in order to deny the right to refund, taxable transactions must actually be carried out by the fixed establishment in the State where the application for refund is made, while the mere ability to carry out such transactions does not suffice. In the cases at hand, it is not in dispute that the undertakings concerned do not carry out input taxable transactions in the Member State where the refund applications have been made through their technical testing and research departments. As such, a right to refund of the output VAT paid must be granted. As this criterion is cumulative, there is no need to examine whether Daimler and Widex do actually have a “fixed establishment”. The purpose of the Directives is to enable taxable persons to obtain a refund of the output VAT where they could not deduct output VAT paid from input VAT due because they have no active taxable transactions in the Member State of refund. The actual carrying out of taxable transactions in the Member State of refund is therefore the common requirement for excluding the right to refund, whether or not the applicant taxable person has a fixed establishment in that State.

The ECJ concluded that a taxable person for VAT established in one Member State and carrying out in another Member State only technical testing or research work, not including taxable transactions, cannot be regarded as having in the other Member State a “fixed establishment from which business transactions are effected” within the meaning of article 1 of the Eighth Directive and article 3(a) of Directive 2008/9.

In respect of the third question in Case C-318/11 on whether the fact that the taxable person has in the Member State where it has applied for the refund a wholly-owned subsidiary whose purpose is almost exclusively to supply the person with services in respect of technical testing activity influences the interpretation given to the concept of “fixed establishment from which business transactions are affected”, the ECJ noted that a subsidiary is a taxable person on its own account and that the purchases of goods and services in the main proceedings were not made by it. The case at hand also differed from DFDS (Case C-260/95) where the independent status of the subsidiary was disregarded due to the commercial reality under which both the parent and the subsidiary had carried out the active taxable transactions of supplies of services in the Member State concerned. The condition that there are active input taxable transactions carried out by the technical department is not met and hence the existence of a wholly-owned subsidiary did not influence the interpretation given to the concept.

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FCE Bank case – Court of Appeal holds UK’s former group relief rules in breach of treaty non-discrimination article

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On 17th October 2012, the Court of Appeal dismissed HMRC’s appeal in CRC v FCE Bank Plc. (a) Facts and legal background HMRC had appealed against a decision from the Upper Tribunal that the UK’s pre-2000 group relief rules breached the non-discrimination article in the United Kingdom – United States DTAA (1975). The Upper Tribunal’s decision itself upheld that of the First Tier Tribunal. The domestic tax rules at issue provided for the surrender of losses between two companies in a 75% group. As respects the subsidiaries, the rules provided that either (a) one company should be a 75% subsidiary of the other, or (b) that both companies should be 75% subsidiaries of a third company. The rules however provided that, where both the claimant and the surrendering company were 75% subsidiaries of a third company, that third company had to be resident in the United Kingdom. Two UK subsidiaries (FCE Bank Plc and Ford Motor Company Ltd.) wished to avail of the group relief provisions. Their parent company Ford Motor Company was resident in the United States of America. HMRC had refused the claim for group relief. FCE Bank argued that the denial of group relief was based on the fact that their parent company was not UK-resident, and contended that the provision was in breach of the non-discrimination article of the 1975 United Kingdom – United States double taxation treaty. (b) Decision The Court of Appeal accepted the taxpayer’s argument. The Court did not accept HMRC’s argument that the discrimination was not as a result of the place of residence of the parent company, but rather, was because the parent company was not subject to UK corporation tax. According to the Court, the parent company’s liability to UK corporation tax was immaterial for the purposes of the group relief provisions at issue. HMRC’s appeal was dismissed.
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Residence Tie-Breaker Test – A home is not a home once you lease it – Australia

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The Australian Taxation Office released Interpretative Decision ATO ID 2012/93 that deals with a definition of a “permanent home available to the taxpayer” in the residence tie-breaker article of the Australia – Malaysia DTAA.

The taxpayer, after living in his own house in Australia, contracts to work in Malaysia for two years. The taxpayer anticipates that after two years, he will return to Australia and leases his house for a fixed term of two years. The taxpayer is a tax resident in both countries and therefore article 2.a of the Treaty will determine the residence of the taxpayer by reference to the country in which the taxpayer has a permanent home available to him. The question is therefore whether a permanent home that the taxpayer owns in Australia, but leases while he is away in Malaysia, continues to be a permanent home available to him.

The Interpretative Decision focuses on “available” and finds, through article 3.3, that the Oxford dictionary defines “available” as “capable of being used” and since the home is temporarily rented, it is not capable of being used by the taxpayer, in a sense that he cannot occupy it. It follows that the home is not available to him for the term of the lease agreement.

The Interpretative Decision also finds that the home would not be “permanent” under the OECD Commentaries, as the taxpayer has not “arranged to have the home available to him at all times continuously” (paragraph 13 of the Commentary on article 4).

It could perhaps be noted that the full sentence in the Commentaries says “… continuously, and not occasionally for the purpose of stay which is of short duration”.

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Belgian Constitutional Court decides that denial of carry-forward of non-deductible part of 95% foreign dividend deduction re non-EEA countries is compatible with equality principle of Belgian constitution – DTAA between Belgium and Korea (Rep) and between Belgium and Venezuela

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On 10th November 2012, the Belgian Constitutional Court(Cour Constitutionelle/Grondwettelijk Hof) gave its decision in the case of Agfa Gevaert NV v. Belgische Staat, FOD Financiën, Administratie der Directe Belastingen en de Belgische Staat, Fod Financiën (No. 5259) on the constitutionality and compatibility with the 1994 protocol to the Belgium – Korea (Rep.) DTAA (1977) (as amended through 1994) and the 1993 protocol to the Belgium – Venezuela DTAA (1993) of the denial of a carry-forward of the non-deductible part of foreign dividends received from a Korean and Venezuelan subsidiary.

Court of Appeal Antwerp (Hof van Beroep Antwerpen) requested a preliminary ruling from the Belgian Constitutional Court on 22nd November 2011.

The Court first held that the denial of the carryforward possibility with respect to the non-deductible part of the 95% foreign dividend deduction for non EEA-countries is not incompatible with the equality principle of articles 10 and 11 of the Belgian Constitution. The Court held decisive that the EEA constitutes a special legal order which may justify that cross-border economic activities within the EEA are not always taxed in the same manner as economic activities between an EU/EEA Member State and third countries.

Furthermore, the Court considered that the legislature may take into consideration the budgetary consequences, when deciding whether or not to expand the carry-forward possibility with respect to non-deductible part of 95% foreign dividend deduction to third countries. In this context, the Court held that its decision will not be different if the budgetary aspect is not mentioned in the Parliamentary Documentation. Based on those arguments, the Court held that the different treatment is not incorrect or unreasonable.

With respect to the compatibility with articles 63 and 64 of the DTAA on the Functioning of the EU (TFEU) on the free movement of capital in respect of third countries, the Court held that the different treatment at issue does not result from the domestic provision at issue, but from the relevant EU provisions. The Court held that it is not competent to decide on such different treatment.

Finally, the Court also held that the laws concerning the ratification of the protocol to the tax treaty with Korea (Rep.) and the treaty with Venezuela are compatible with the equality principle of the Belgian Constitution. The Court based its decision on the fact that it held that a different treatment of dividends received from an EEA Member State and a third state is compatible. This means that the legislator also has the leeway to ratify a tax treaty which maintains such distinction.

In addition, the Court held that the equality principle neither requires that Belgium under each tax treaty signed guarantees the most beneficial outcome for the taxpayer under the laws existing at the time of signing nor that the same issues are regulated in the same manner under all tax treaties. Note: It has to be seen whether the different treatment at issue will also be EU compatible. In the first place, it must be noted that with respect to domestic provisions whose application does not depend on the size of the participation, both the freedom of establishment as well as the freedom of capital can be applicable.

If the freedom of capital would be applicable, the European Court of Justice (ECJ) has repeatedly held that the freedom of capital, generally, precludes all restrictions of the freedom of capital between EU Member States and third countries. For the determination whether a restriction nevertheless can be justified, it must be considered that capital flows with third countries take place in a different legal context than capital flows with EU Member States.

Finally, the ECJ has decided that movement of capital vis-à-vis third countries may, however, be justified for a reason, which would not constitute a valid justification for a restriction on capital movements between Member States. The different treatment in such cases can be based on the need to ensure the effectiveness of fiscal supervision or fiscal coherence.

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GAP in GAAP Accounting for Warranty Obligations

In the case of construction companies, the issue of
accounting for revenue and warranty obligations subjects itself to
multiple possibilities. Consider a construction company that executes a
long term contract, which takes 2 years to complete and which comes with
a warranty period of 2 years. The question is, how does the contractor
account for revenue and warranty costs in accordance with (AS) 7,
‘Construction Contracts’ and other accounting standards. Let us take an
example. The total contract value is 120.

View 1

Paragraph
11 and 14 of Accounting Standard (AS) 29, ‘Provisions, Contingent
Liabilities and Contingent Assets’, states as follows:

“11. An
obligation is a duty or responsibility to act or perform in a certain
way. Obligations may be legally enforceable as a consequence of a
binding contract or statutory requirement. Obligations also arise from
normal business practice, custom and a desire to maintain good business
relations or act in an equitable manner.”

“14. A provision should be recognised when:

(a)    an enterprise has a present obligation as a result of a past event;

(b)    it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and

(c)    a reliable estimate can be made of the amount of the obligation.

If these conditions are not met, no provision should be recognised.”

In
the extant case, let us further assume that the contractor is bound to
rectify, rework and compensate any defects, short supplies, operational
problems of the individual equipment already supplied/ work already done
under construction contracts. In other words, the contractual
obligation in respect of warranty coexists from the date of first supply
and not from the date of completion of contract. Thus, there exists a
contractual/customary present obligation in respect of warranty service,
which will require out-flow of resources embodying economic benefits to
settle the obligation. Therefore a provision in respect of warranty
service should be recognised.

As far as timing of recognition of
provision is concerned, the following relevant paragraphs 15, 16 and 21
of AS 7, are reproduced below:

“15. Contract costs should comprise:

(a)    costs that relate directly to the specific contract; …

16.    Costs that relate directly to a specific contract include: …

(g)    the estimated costs of rectification and guarantee work, including expected warranty costs; and …”

“21.
When the outcome of a construction contract can be estimated reliably,
contract revenue and contract costs associated with the construction
contract should be recognised as revenue and expenses respectively by
reference to the stage of completion of the contract activity at the
reporting date. …”

Based on the above, it may be argued that the
estimated warranty cost is a contract cost which is directly related to
the specific contract. When the outcome of a construction contract can
be estimated reliably, contract revenue and contract costs associated
with the construction contract should be recognised as revenue and
expenses respectively by reference to the stage of completion of the
contract activity at the balance sheet date. Accordingly, following the
percentage of completion method, the contract costs, including provision
for expected warranty costs should be recognised by reference to stage
of completion of the contract activity at the reporting date. Thus, the
present obligation in respect of contractual warranty as per the
provisions of AS 29 arises from the performance of a contract activity
in respect of which contract cost is recognised even during the progress
of the contract and as such, the proportionate warranty cost can be
included as ‘cost incurred’ to determine the stage of completion for
recognition of revenue as per the principles of AS 7.

This view
is also aligned to the current practice with respect to sale of goods
which contains a warranty obligation. The current practice is to
recognise the entire revenue when the goods are sold, and make a
provision with respect to warranty costs.

View 2

It
is questionable whether the warranty on the project commences as each
equipment in the project is installed. Generally the warranty is on the
entire project, and it commences on the handover of the project to the
customer. The activities involved in ensuring that the equipments are in
working condition during the construction of the project are more in
the nature of a project activity rather than a warranty activity. If
this be the case, then the warranty provisions and the corresponding
revenue would be recognised at the end of Year 2. Therefore the only
difference in view 1 and 2 is the timing of the recognition of the
warranty provisions and the corresponding revenue.

View 3

Paragraph
26 of AS 7 states as follows, “A contractor may have incurred contract
costs that relate to future activity on the contract. Such contract
costs are recognised as an asset provided it is probable that they will
be recovered. Such costs represent an amount due from the customer and
are often classified as contract work in progress”.

Since the
warranty activity is a future activity, any provision for the
contractual obligation on the warranty should also be correspondingly
recognised as an asset. However, no revenues/costs are recognised when
the contract is in progress with regards to warranty. Once the project
is commissioned and the warranty commences, revenue and cost with
respect to warranty is recognised. For sake of simplicity, the margins
on the contract activity and warranty activity in the above example have
been maintained at the same level. However, in practice the margins may
differ.

Conclusion

The author believes that each of the above views may be tenable under current Indian accounting standards.

France – Court of Appeals – Hertogenbosch decision that sportsman is entitled to avoidance of double taxation for foreign employment income attributable to a test match not appealed before Supreme Court

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In a Circular (No. 2012/03814HR) of 9th October 2012, the State Secretary for Finance announced that the decision of the Court of Appeals-Hertogenbosch that a sportsman is entitled to avoidance of double taxation for foreign employment income attributable to a test match will not be appealed before the Supreme Court.

The State Secretary held decisive that the test matches (held in Spain and Thailand) were open for the public, which means that the sportsman’s performance was aimed at an audience. In addition, he took the view that the Dutch Supreme Court would confirm its earlier decision of 7th February 2007, in which it was decided that if the employment contract obliges a sportsman to participate in games and races in foreign countries, the basic salary, generally, has to be allocated to his income from personal activities in the state of performance on a pro-rata basis, unless the employment contract indicates otherwise. In that case, the Supreme Court indicated that the term “personal activities” covers the performance aimed at an audience and time spent for activities related to such performance as training, availability services, travel and a necessary stay in the country of performance.

Furthermore, avoidance of double taxation was in that case also granted for training activities, sponsoring activities and contacts with the press.

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US Supreme Court grants certiorari regarding allowance of foreign tax credit for UK windfall tax

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On 29th October 2012, the US Supreme Court granted a petition for a writ of certiorari filed by PPL Corporation and Subsidiaries (petitioner). PPL Corporation and Subsidiaries v. Commissioner of Internal Revenue, No. 12-43 (29th October 2012).

The petitioner filed the petition for a writ of certiorari on 9th July 2012 to request the US Supreme Court to resolve the conflicts between the US Third Circuit and Fifth Circuit regarding whether the US foreign tax credit (FTC) should be granted u/s. 901 of the US Internal Revenue Code (IRC) for the windfall tax imposed in the United Kingdom.

The question presented in the petition is whether, in determining the creditability of a foreign tax, courts should employ a formalistic approach that looks solely at the form of the foreign tax statute and ignores how the tax actually operates, or should employ a substance-based approach that considers factors such as the practical operation and intended effect of the foreign tax.

The windfall tax is a UK tax that was imposed on the privatised UK utilities as a one-time 23% assessment on the difference between the company’s “profit-making value” and its “floating value”, i.e. the price for which the UK government sold the company to investors. In the PPL Corporation case, the Court of Appeals for the Third Circuit concluded that the UK windfall tax fails to satisfy the gross receipts requirement and thus is not an income tax that is creditable against the US income tax.

PPL Corporation and Subsidiaries v. Commissioner of Internal Revenue, Docket No. 11-1069 (22nd December 2011). The Third Circuit made this conclusion on the ground that the UK windfall tax can be formulated as a 23% tax on a 2.25 multiple (i.e. 225%) of profits, which leads to the calculation of a tax base that begins with an amount greater than 100% of gross receipts.

In a similar case involving the UK windfall tax, the Fifth Circuit found the Third Circuit’s analysis to be too formalistic and determined that the UK tax is an income tax for which a US FTC is allowable. Entergy Corporation and Affiliated Subsidiaries v. Commissioner of Internal Revenue, Docket No. 10- 60988 (5th June 2012) Certiorari is a procedure by which the US Supreme Court exercises its discretion in selecting the cases it will review.

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Belgian Constitutional Court held that retroactive effect of 2009 Protocol is not unconstitutional – DTAA between Belgium and France

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On 30th October 2012, the Belgian Constitutional Court (Grondwettelijk Hof/Court Constitutionelle) gave its decision in Xavier Deceunick and Stéphanie Coquard v. Belgian State (Case No. 5054) on the constitutionality of the retroactive effect of the 2008 protocol to the Belgium-France DTAA (“the Protocol”), with respect to the municipal surcharge. A preliminary ruling was requested by the Court of First Instance Bergen on 23th January 2012. Details of the case are summarised below:

(a) Facts:

The taxpayers were both residents in Belgium in 2008. One of the Taxpayers was a frontier worker who received employment income from France. Based on the Protocol, which became effective on 1st January 2010, the French employment income was included in the taxable base for the calculation of the municipal surcharge. Because several provisions of the Protocol for frontier-workers applied retroactively from 1st January 2009, the tax administration imposed municipal surcharges on the employment income derived in 2008, because it was taxed in the assessment year 2009. The Taxpayer reasoned that the retroactive effect was incompatible with the non-discrimination principle of articles 10 and 11 and 172 of the Belgian Constitution.

(b) Article 1 of the Protocol provides that employment income derived by frontier-workers is taxable in the source state. Articles 2 and 3 of the Protocol provide that:

• employment income derived by a Belgian resident in France, may be included in the taxable base for the municipal surcharge, which is in Mayur Nayak Tarunkumar G. Singhal, Anil D. Doshi Chartered Accountants International taxation line with article 466 of the Belgian Income Tax Act; and

• the Protocol will have retroactive effect from 1st January 2009.

(c) Decision: The Court observed that the retroactive effect creates legal uncertainty and therefore, only can be accepted if it can be justified by overriding reasons in the general interest. The Belgian government stipulated that it was necessary to include foreign employment income derived by frontier workers in the tax base for the municipal surcharge to decrease the financial problems of Belgian municipalities located in the frontier zone.

In the Explanatory Memorandum to the Protocol, it was indicated that it would be applied to income derived in the tax year 2008 (assessment year 2009). The Court held that the retroactive imposition does not disproportionately infringe the Taxpayer’s rights. The Court based its view on the fact that:

• taxpayers were sufficiently informed about the Protocol when it was signed; and

• taxpayers in France are taxed at a lower rate than in Belgium.

Consequently, the Court held that the retroactive effect of the Protocol was not unconstitutional.

Note: The decision deviates from a decision of the Court of First Instance (Gerecht van Eerste Aanleg) Leuven of 6th April 2012, in which it was decided that municipal surtax was due on income derived in the year that the 2008 protocol became effective. Article 167(2) of the Belgian Constitution regulates that Belgian tax treaties and protocols can only take effect after ratification. The decision of the Court of First Instance Leuven ignores the fact that contracting states often agree that a treaty or protocol should have retroactive effect. Nevertheless, it can be argued that the decision of the Court could be correct because article 3 of the Protocol provides that it will only take effect from 1st January 2009. Therefore, it can be reasoned that it was not the intention of the contracting states that the protocol applies to foreign employment income derived in 2008.

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[2013] 32 taxmann.com 250 (Delhi – Trib.) Zeppelin Mobile System GmbH vs. ADIT A.Y.:2007-08, Dated: 12-04-2013

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Section 48 – RBI guidelines for valuation of shares for transfer of shares are issued for FEMA purposes. Any addition to income on the ground of violation of same guidelines is not justified since the obligation to examine compliance with guidelines is that of RBI and Authorised Dealers.

Facts:
The taxpayer was a German company, and also a tax resident of Germany. The taxpayer had a closely held shares of unlisted subsidiary company in India. During the year under consideration, the taxpayer sold a portion of the shares held by it in the subsidiary to another unrelated Indian company @ Rs. 390 per share. AO assessed capital gain taking selling price of Rs. 400 per share on the ground that the value of the said shares was Rs. 400 per share as per the guidelines prescribed by RBI, and observing that since the transfer of shares was from non-residents to residents, RBI guidelines were binding. The DRP confirmed the addition made by the AO.

Held:
Perusal of guidelines shows that they are addressed to the Authorised Dealer banks and hence, they are required to examine the compliance and to take appropriate action for non-compliance. However, RBI had accorded its approval for transaction. Since lower authorities had not brought any adverse material on record, the DRP was not justified in confirming the addition.

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[2013] 33 taxmann.com 23 (Mumbai – Trib.) KPMG vs. JCIT A.Y.: 2004-05, Dated: 22-02-2013

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Articles 4, 14 of India-UAE DTAA; Section 40(a)(i) – Mere right of a contracting state to tax a person is sufficient to treat him as resident even if no tax is paid in residence country

Facts
The taxpayer had paid professional fee and had reimbursed expenses to ‘V’ who was the sole proprietor of a professional firm in UAE without withholding tax at source, since the payee had not stayed in India for more than 183 days and he did not have a fixed base in India in terms of Article 14 of India-UAE DTAA.

According to the AO, under Article 4(1) of India- UAE DTAA, only a person who paid tax in UAE could be treated as a resident of UAE and since ‘V’ was not liable to pay tax in UAE, he cannot be treated as resident of UAE and hence, he disallowed the payments under section 40(a)(i) of the Act.

Held
a) The term “liable to tax” in the contracting State does not necessarily imply that the person should actually pay the tax in that contracting State. Right to tax on such person is sufficient.

b) Taxability in one country is not sine qua non for availing relief under DTAA. What is necessary is that a person should be liable to tax by reason of domicile, residence, place of management, place of incorporation or any other similar criterion which refers to fiscal domicile of such person. If the fiscal domicile of a person is in the contracting State, he is to be treated as resident of that contracting State irrespective of whether that person is actually liable to pay tax in that country.

c) Since fiscal domicile of ‘V’ in UAE has not been doubted, he should be treated as resident of UAE.

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Notification No VAT 1512/CR-139/Taxation-1 Dated 21.11.2012

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The Government of Maharashtra has issued Notification dated 21.11.2012 amending the Maharashtra Value Added Tax Rules, 2005 thereby extending the period for submission of MVAT Audit report u/s. 61 of the MVAT Act, 2002 from Eight Months to Nine months and fifteen days from the end of the year to which report relates.
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Minority Shareholder Squeezeout – Multiple, Conflicting, Loosely Drafted Provisions

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Companies Act, 2013

The Companies Act, 2013, (“the Act”) is gradually coming into force, with 98 sections duly notified and several set of draft rules circulated for feedback. The target for the Act to fully come into force by end of this financial year seems achievable. But how desirable is such speedy implementation? The common argument for quick implementation is that the new law has been in contemplation/consideration for too long and it is high time we have a modern law. The reality is that each successive version of the Bill has seen major changes/new provisions which, both in terms of drafting and implications, have been inadequately discussed. Worse, and that is one of the issues presented in this article, there are provisions that seem to overlap or are in conflict with other laws. In particular, for some reason, the lawmakers have sought to duplicate requirements that SEBI has already framed. These include provisions relating to Independent Directors, Audit Committee, bonus shares and many others. In subsequent issues, we will discuss such duplicate provisions. To begin with, the vexed topic of ‘Minority Squeeze-out’ is considered here.

What is buy-out vs. squeeze-out?

Simply described, minority Squeeze-out involves marginalising of and buying out of minority shareholders, often forced (hence the word “squeeze”) out of a lower value than fair value. As compared to buyouts which may be mandatory on the offers or but optional for the sellers, a squeeze-out gets greater publicity in case of listed companies though it is common in unlisted companies also. There was a time when companies sought to increase minority shareholding by issuing shares through a public issue. The process of listing ensured a higher issue price. Over a period, with increasing compliance and other requirements and depressed share prices, the status of listing can become burdensome. Worse, unscrupulous managements sometimes pursue acquisition of public (minority) shareholding at depressed value. Forced buybacks were thus seen in many companies (discussed earlier in this column) with minorities being bought off against their will and in many cases, at prices that were lower than fair value. The stratagem used was to carry this out through a court-approved scheme of arrangement/ reduction of capital where often the criteria for approval are different. The ignorant and scattered shareholders usually did not offer vigorous opposition. SEBI and stock exchanges took some belated inadequate action. Certain provisions such as requirement of pre-approval of schemes by stock exchanges were introduced. However, this was not enough and even circumvented.

Be as it may be, finally, the Act now makes certain specific provisions in relation to such minority squeeze-outs.

What do the new provisions in the Act provide?

Firstly, the new Act prohibits buyback of shares through schemes of reduction or arrangement. Thus, companies cannot buy back shares of shareholders through such schemes. Effectively, they will have to resort to the procedure for buyback of shares as prescribed in section 68 of the Act relating to ‘buyback of shares’. This means they will also have to follow the Rules that would be notified by the Central Government (for unlisted companies) and the Regulations as notified by SEBI (for listed companies). The provisions for buyback in the Act/ Rules/Regulations ensure that it cannot be forced upon unwilling shareholders. It is another issue that these provisions are not well drafted. Further, the provisions relating to buyback of shares suffer from several limitations, particularly the size of buyback. Hence, even genuine cases may face difficulties. Nevertheless, one abusive method will come to an end.

Secondly, there are two specific provisions that enable minority buy-outs. Essentially, they provide for purchase of shares of the minority shareholders when more than 90% of the shares are bought by a company or group. When minority shareholders are reduced to below 10%, they have minimal rights, except those provided generally by the Act or the articles of association. They have no powers to veto a general or special resolution. They also cannot file a petition complaining of oppression/mismanagement or initiate class action. The minority may thus want to have an opportunity provided by the majority shareholders to be bought out at a fair price, even if they did not avail of an earlier opportunity.

 Sections 235 and 236 deal with such situations. While section 235 is a slightly modified version of the existing section 395 of the Companies Act, 1956, section 236, though overlapping to an extent, provides for a different situation and procedure.

 Section 395, as may be recollected, provides for an opportunity and obligation both to an acquirer of 90% or more shares in a company to acquire the shares of the minority. The minority shareholders thus have a chance to exit the company.

Weak drafting

Section 235, however, continues the weak drafting of existing section 395 but with some modifications. It essentially provides that if a scheme or contract to acquire shares of a company is approved by more than 90% of shareholders (excluding shares held by acquirer company), then the shares of dissenting minorities may be acquired by the acquirer on the same terms. This section can be fairly dubbed as a squeeze-out provision since the acquirer can acquire the shares of the minority shareholders without the latter’s consent. The minority shareholders may, however, apply to the Tribunal and the Tribunal may give appropriate directions for relief. It appears that a window of negotiation for a higher price gets opened for the minority shareholders. The acquirer has the option, but not the obligation, to make such an offer to acquire shares of the minority shareholders. The minority shareholders, however, cannot force the acquirer to acquire their shares.

Section 236 is in many ways a variant of section 235 though with some important differences. Generally stated, it provides for an obligation for an acquirer/ persons acting in concert who have acquired 90% or more of the shares in a company to make an offer to the remaining shareholders. The offer has to be on the same terms and has to be valid for a prescribed period of time. Though the drafting is ambiguous at some places, it appears that the remaining shareholders are not under an obligation to sell their shares. Thus, it is not a squeeze-out. There is a provision that provides for negotiation by a specified section of the shareholders for a higher price. It is provided that in such a case, the higher price received by such shareholders will have to be distributed pro rata amongst the other shareholders who did not get such higher price. This is strange in one aspect. If a section of shareholders is given a higher price, the better course is to make the acquirer give such higher price to the other shareholders too.

Contrast with the SEBI Delisting Regulations Sections 235/236 apply to listed and unlisted companies. For listed companies, it is necessary to also consider the SEBI Regulations on delisting (SEBI (Delisting of equity shares) Regulations, 2009 or “the Regulations”). Simply put, the Regulations provide for procedure that Promoters/companies seeking to delist shares from stock exchanges need to follow. These Regulations are relevant in this context because the Promoters holding has to increase to at least 90% for delisting to be successful. The regulations also provide for the steps to be taken after the holding is increased to more than 90%. Some important steps relevant to the present context are as follows:

•    The proposed delisting has to be approved by a special resolution. Such special resolution has to be by a postal ballot thus giving all shareholders a better opportunity to participate.

•    Further, the resolution can be acted upon only if at least two-thirds of the non-Promoter share-holders approve delisting.

•    The Promoters have to make an offer to acquire the shares of non-Promoters.

•    A minimum benchmark offer price, based on recent prices and acquisitions by the Promoters, is fixed.

•    The offer needs to result in such number of acceptances that would make the holding of the Promoters higher of two figures. The first figure is 90% of the equity share capital. The second is the existing holding plus 50% of the non-Promoters holding. Thus, if the Promoters held 75%, then they should get at least 15% acceptances. If they held, say, 85%, then they should get at least 7.50% acceptances. If this minimum figure is reached, then the Promoters are entitled to delist the shares.

•    They are also required to make another offer and, in effect, keep it valid for the next one year, to acquire the remaining shares at the same price. The remaining shareholders have a right, but not an obligation, to offer their shares during this period. In other words, they may choose to remain shareholders, in the unlisted company.

If one compares these Regulations with section 235/236, clearly the Regulations give better protection to the minority shareholders, though they make it difficult for the Promoters to delist the company. The provisions of sections 235/236 and the Regulations are obviously not alternate to each other and both need to be complied with. Thus the stricter of the two provisions would apply. However, there may be a grey area as regards seemingly beneficial provisions. For example, if the provisions in the Act give a right to the acquirer to acquire the remaining shares, can the remaining shares be so acquired, though the Regulations do not provide such a right? One factor involved in interpreting this issue is whether a beneficial provision in the Regulations would override provisions in another enactment.

In any event, even for unlisted companies, section 235/236 are beneficial to those minorities who are reduced to such a number that their voice does not matter. The 90% majority acquirer also has an opportunity to acquire 100% control of the company so as to be able to run the company without any outside involvement. In the author’s opinion the provisions are worded in such a manner that the acquirer may escape from such obligation. Section 235 uses the term “transferee company” (including its nominees/subsidiaries) on whom such obligation is created. Thus, effectively, it will not apply if the acquirer is not a company or if the acquirer is more than one. This may even become a limitation on the acquirer if it seeks to acquire the shares in more than one entity. Section 236 is worded more broadly. However, several protections that are available in the regulations for listed companies are missing. Loose drafting is evident at several places.

Conclusion

To conclude, competition between two regulators to provide better protection to minority shareholders and generally other persons may seem commend-able. However, conflicting provisions may in the long run be counter productive and create hurdles for genuine transactions. Worse, unscrupulous companies may be found to resort to legislative arbitrage, seeking those provisions or methods that avoid both laws or use the ill-drafted one with lesser restrictions. The fact that the Act is carved in stone, in the sense of being very difficult to amend can only make matters more difficult. Ideally, SEBI, with its expertise, experience and resources, should be given a monopoly or at least a priority as far as listed companies are concerned.

Works Contracts vis-à-vis Builders and Developers

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Introduction

A very interesting issue was under litigation in relation to scope of ‘Works Contract’. The background of the works contract taxation is the landmark judgment of Hon’ble Supreme Court in case of Gannon Dunkerly & Co. (9 STC 353)(SC). While examining the scope of ‘sale’ for levy of sales tax, the Hon’ble Supreme Court held that the word ‘sale’ has to be interpreted in a limited sense. In fact, the Hon’ble Supreme Court held that ‘sale’ will have following meaning.

“Thus, according to the law both of England and of India, in order to constitute a sale it is necessary that there should be an agreement between the parties for the purpose of transferring title to goods, which of course presupposes capacity to contract, that it must be supported by money consideration, and that as a result of the transaction property must actually pass in the goods ……”

From the above passage, it is clear that to be a ‘sale’, the following criteria should be fulfilled:

(i) There should be two parties to contract i.e. seller and purchaser,
(ii) The subject matter of sale is moveable goods,
(iii) There must be money consideration and
(iv) Transfer of property i.e., transfer of ownership from seller to purchaser.

Therefore, if the transaction was composite i.e. it also had labour as well as service element in it, it was held that it was not covered within the sales tax laws.

46th Amendment to the Constitution of India
To bring the ‘works contract’ transactions within the purview of sales tax levy, the Constitution of India was amended vide 46th amendment to the Constitution, in the year 1983. Along with other transactions, the ‘works contract’ transactions were also ‘deemed to be a sale’ for the purpose of levy of sales tax. The said purpose was achieved by inserting clause (29A) in Article 366 of the Constitution of India.

The relevant part is reproduced herein below for ready reference:
(29A) “tax on the sale or purchase of goods” includes–
(a) ……
(b) a tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract;
(c) to (f) …… and 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;”

Scope of the Supreme Court judgment
Wherever composite transactions were involving goods and services, they were deemed to be covered within the scope of above constitutional amendment and were considered to be taxable under sales tax laws. In other words, there was no controversy about such coverage.

However, the issue arose in relation to sale of under construction premises like sale of premises by builders and developers. Normally, the builders and developers come up with their own projects and enter into agreement with prospective buyers for sale of premises like flats and offices etc. The intention of the builder and prospective buyer is to give/get possession of immovable property like a ready flat. It was believed that such contracts are not works contracts.

The first controversy arose before Supreme Court in case of K. Raheja Construction (141 STC 298)(SC). In this case there was tri-party agreement where landlord as owner of land, K. Raheja as developer and prospective buyer were parties. The agreement was entered into when the construction was in progress.

The value of the land and construction was shown separately. The argument of the dealer i.e. K. Raheja was that the agreement is for sale of immovable property as premises and not for carrying out any ‘works contract’. However, the Supreme Court rejected the argument holding that the agreement is ‘works contract’.

Maharashtra Chamber of Housing Industry judgment
After above judgment in K. Raheja, MVAT Act, 2002, was amended on 20-06-2006, whereby definition of ‘works contract’ was provided in the Act. In view of this provision, the Commissioner of Sales Tax, Maharashtra State issued a circular fastening liability on builders. The amendment and the circular were challenged before the Hon’ble Bombay High Court based on sample agreement under Maharashtra Ownership Flat Act (MOFA). The main plea before the Hon’ble High Court was that the State cannot consider the agreement involving third element i.e. land, as works contract.

The Hon’ble Bombay High Court delivered a judgment as reported in (51 VST 168), wherein rejecting arguments of the builders and developers, the agreements under MOFA were considered to be works contract transactions and the levy of tax on such transactions was held to be constitutionally valid.

Judgment of Larger Bench of Supreme Court in Larsen & Toubro Limited and another vs. State of Karnataka and another & Others.

The K. Raheja judgment came to be analysed by the Hon’ble Supreme Court in case of Larsen & Toubro Limited and another vs. State of Karnataka and another (17 VST 460)(SC), Hon’ble Division Bench did not concur with the judgment in K. Raheja and referred the matter to Larger Bench. The Hon’ble Larger Bench has resolved the above controversy vide recent judgment in Larsen & Toubro Limited vs. State of Karnataka, Civil Appeal No. 8672 of 2013 dated 26.9.2013. Alongwith the above, Larger Bench also considered judgment of MCHI (51 VST 168), as it was also before Supreme Court out of an SLP filed by MCHI.

Out come of Larger Bench Judgment
The Hon’ble Supreme Court has analysed the arguments of both the sides. The main argument of the developers was that the contract involving two elements only i.e. goods and services, can be considered as ‘works contract’ under above article 366 (29A)(b). However, the Hon’ble Supreme Court has held that there is no such limitation and a contract involving a third element like land can also be considered as a works contract.

A further argument that was advanced was that there is transfer of immovable property and not transfer of movable goods. In this respect also, the Hon’ble Supreme Court rejected the argument observing that even if the goods used get transformed into immovable property and such immovable property get transferred to the buyer, still it will be taxable ‘works contract’ for sales tax purposes. However, the Hon’ble Supreme Court observed that while taxing value of goods in the contract, no portion relating to immovable property should get taxed.

The Hon’ble Supreme Court has also observed that the contract will commence from the stage when the agreement is entered into with the prospective buyer. In other words, the work completed prior to such agreement will not be taxable.

It is also held that if the sale is of completed premises then it will not be covered by the sales tax laws.

In relation to MVAT Act, 2002, the Hon’ble Supreme Court has observed that rule 58(1A) of the MVAT Rules, 2005 should be relooked at by the government and the effect should be clarified by the government. It is also observed that double taxation should be avoided.

Conclusion

The above judgment will have far reaching effect. It has expanded the scope of ‘works contract’ transactions which can be subjected to sales tax. The Bombay High Court judgment in case of MCHI was relating to agreement under MOFA, whereas the observations of the Supreme Court suggest that other contracts though not falling within the ambit of MOFA can also be covered under the works contract category.

In relation to MVAT Act, 2002 the Hon’ble Supreme Court has directed clarification of rule 58(1A), and has also directed to ensure that there is no double taxation. Under the above circumstances, the builders and developers in Maharashtra should wait till such clarification is given by the government, as for proper discharge of liability such clarification is absolutely essential.

Services by Directors

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Services by Directors

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

(a) an activity which constitutes merely, –
i) A transfer of title in goods or immovable property, by way of sale, gift or in any other manner; or
ii) Such transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A) of Article 366 of the Constitution; or
iii) A transaction in money or actionable claim;

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

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

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

(A) the functions performed by the Members of Parliament, Members of State Legislative, Members of Panchayats, Members of Municipalities and Members of other local authorities who receive any consideration in performing the functions of that office as such member; or
(B) the duties performed by any person who holds any post in pursuance of the provisions of the Constitution in that capacity; or
(C) the duties performed by any person as a Chairperson or a Member or a Director in a body established by the Central Government or State Government or State Governments or local authority and who is not deemed as an employee before the commencement of this section. ……………

Services provided by Director to a Company – Taxability under Reverse Charge

• Vide Notification No.45/2012–ST dated 07-08- 2012, an amendment is made in the notification No.30/2012–ST dated 20-06-2012 by including the services provided or agreed to be provided by a director of a company to the said company, as a service taxable under reverse charge mechanism. Further, the extent of service tax payable on the same by the service provider and the service recipient is also stipulated as under:-

• Vide Notification No.46/2012–ST dated 07-08- 2012 the Rule 2(1)(d) of the Service Tax Rules, 1994, (ST Rules) which defines “person liable for paying service tax” is amended to insert a new item (EE) after item E as under : – “(EE) in relation to service provided or agreed to be provided by a director of a company to the said company, the recipient of such service”.

Payments to Directors – Service tax implications
i) Remuneration to Executive Directors

Sections 198 and 309 of the Companies Act, 1956 (“CA 56”) supplemented by Schedule XII, deal with remuneration of directors (including managing director and whole-time director) of a public company or a private company which is a subsidiary of a public company.

Section 309 of CA 56 lays down the ceilings on the remuneration payable to managing and whole-time employment of the company or a managing director may be paid remuneration either by way of a monthly payment or at a specified percentage of the net profits of the company or partly by one way and partly by the other.

The term ‘remuneration” is inclusively defined in the Explanation appended to section 198 of CA 56. This definition is relevant for the purposes of all the provisions of CA 56 which deals with director’s remuneration. The definition of ‘remuneration’, indicates that any payment by whatever name called and whether in cash, kind or money’s worth, or by way of perquisite, amenity or benefit, or by discharging an obligation amounts to ‘remuneration’, and such payment would attract the provisions of CA 56 regarding remuneration to directors

Section 309(2) of CA 56 contemplates payment to a director of remuneration by way of a fee for attending meetings of the board of directors or committees constituted by the board.

In case of managing director and whole time director, the payment of sitting fees forms part of managerial remuneration and if amounts are payable in accordance with Schedule XIII, no such sitting fees is payable to them; Department letter No. 3/1/90 CL – V, dated 18/07/1990, makes it very clear that, sitting fee may be paid only to a director who is not a whole time director or a managing director.

(ii) Remuneration to Non-Executive Directors

According to section 309 of CA 56, a public company can pay its non-executive director (meaning a director who is not a managing or a whole time director) remuneration in the form of fees for attending board meetings at the rate prescribed under CA 56, which are to be excluded for the purpose of the percentage limits on directors’ remuneration as specified in section 198 and 309 of CA 56.

In addition to sitting fees, a company’s nonexecutive director can be paid commission on net profits for a financial year. The total remuneration to all directors (executive and non–executive) excluding the fees for attending meetings, should not exceed the percentage limits laid down in section 198.

Section 309(4) permits payment of remuneration to the non–executive directors in two alternative ways:
• by way of monthly, quarterly or annual payment; or
• by way of commission.

(iii) Whether all Directors are employees of a Company

In terms of the provisions of CA 56 Act managing and whole time directors are executive directors and those who are not managing and whole time directors are non – executive directors. They are called “managerial personnel” and their appointment and remuneration are governed by the provisions of CA 56. Even when an executive director is designated as “executive chairman” or “executive vice chairman” or any other designation, such executive director is either a managing director or a whole–time director under CA 56 depending upon the nature and extent of powers of management because CA 56 does not recognise any other designation although it does not prohibit it. Therefore, a company has to treat its executive director either as managing director or whole–time director but both are equal so far as the provisions of the CA 56 regarding appointment and remuneration are concerned, all the provisions equally apply to both.

An important issue for consideration is, whether employer–employee relationship exists between the company and the executive directors.

It is a well–settled principle in company law that a director of a company as such is not a servant of the company and that the fees he receives are in recognition of services, but the same does not prevent a director or a managing director from, entering into a contractual relationship with the company, so that, quite apart from his office of director he becomes entitled to remuneration as an employee of the company. Further that relationship may be created either by a service agreement or by the articles themselves. [Refer CIT vs. Armstrong Smith (1946) 14 ITR 606 (Bom); (1946) 16 Comp as 172 (Bom)]

However, a managing director has a dual capacity. He may both be a director as well as an employee. It is, therefore, evident that, in his capacity as a managing director, he may be regarded as having not only the capacity as persona of a director but also the persona of an employee, or an agent depending upon the nature of his work and the terms of his employment. Where he is so employed, the relationship between him as the managing director and the company may be similar to a person who is employed as a servant or as an agent, for the term ‘employee’ can cover any of these relationships. The nature of his employment may be determined by the Articles of Association of the company and/or the agreement, if any, under which a contractual relationship between the director and the company has been brought about, under which the director is constituted as an employee of the company. The control which the company exercises over the managing director need not necessarily be one which tells him what to do from day-to-day. That would be too narrow a view of the test to determine the character of the employment. Nor does supervision imply that it should be a continuous exercise of the power to oversee or supervise the work to be done. The control and supervision is exercised and is exercisable in terms of the Articles of Association by the board of directors and the company in its general meeting.

It has been held in an English case that as directors they are not employees, but it cannot be doubted that a managing director may for many purposes properly be regarded as an employee. [Refer Boulting vs. Association of Cinematograph, Television and Allied Technicians (1963) 33 Comp. Cases 475 (CA)]

In one case, the question was whether the managing director was ‘employed’ by the company in any capacity. The managing director had claimed that he was not employed by the company, but that his position was an office or function of a director, i.e. he was an ordinary director entrusted with some special powers. However, this argument was rejected, and it was held that the proposition that a director can be regarded as having not only the persona of director but also the persona of employee was plain from the case of Beeton and Co. In re [1913] 2 Ch 279. Lord Normand summarised the position as follows :

“In my opinion, therefore, the managing direc-tor has two functions and two capacities. Qua managing director he is a party to a contract with the company, and this contract is a contract of employment; more specifically I am of opinion that it is a contract of service and not a contract for services. There is nothing anomalous in this; indeed it is a common place of law that the same individual may have two or more capacities, each including special rights and duties in relation to the same thing or matter or in relation to the same persons.”

Useful reference can also be made to Fowler vs. Commercial Timber Co. Ltd. [1930] 2 KBI (CA)

There are several cases under the Income Tax Act which dealt with this issue and the consensus appears to be that regardless of whether there is an agreement of service between the assessee company and the managing director the relationship between the company and the managing director is that of employer and employee. In some cases a provision or a term as to the removal or termination of the managing director has been considered to be one of the factors determining the relationship of employer and employee. [Refer Travancore Chemical Manufacturing Co (1982) 133 ITR 818 (KER) affirmed by SC – (1982) 137 ITR (St) 13]

The various provisions of CA 56 Act relating to managing director also indicate that a managing director has a role of an employee. For instance, the use of the term ‘agreement’ (section 2(26); use of the term “appoint or employ” (sections 316, 317); the expression “occupying the position of a managing director by whatever name called” (section 2(26); use of the expressions “appointment or employment” (section 267), the various kinds of remuneration enumerated in Schedule XIII, etc., go to indicate that a managing director is a director in the garb of an employee. Moreover, the Schedule also allows certain perquisites to the managing director and some of them (e.g. LTC) are to be given “in accordance with the rules of the company”. Section 17(2) of the Income Tax Act defines the term ‘perquisite’ the purport of which is that it is an amenity or a benefit granted by an employer to an employee. In fact, clause (iii)(a) of the said section specifically covers as perquisite the value of any benefit or amenity granted or provided free of cost or at concessional rate by a company to an employee who is a director thereof.

The nature of extent of control which is requisite to establish the relationship of employer and employee must necessarily vary from business to business and is by its very nature incapable for precise definition. It is not neces-sary for holding that a person is an employee, that the employer should be proved to have exercised control over his work. The test of control is not one of universal application and that there are many contracts in which the master could not control the manner in which the work was done.

There may be a formal contract between a managing director and the company evidencing the contractual relationship between the two. However, in the absence of a formal agreement the relationship may be established by an implied contract. Where a managing director is appointed, and acts as such, in accordance with the company’s articles, and no separate formal contract is entered into, the existence of an implied contract may be inferred, although the articles do not constitute a contract between the company and the managing director qua managing director.

Summation

In light of discussion above, it would reasonably appear that, a managing director is an employee of the company. This principle equally applies to any whole–time director or any other director (by whatever name called) who has executive powers relating to the management of the affairs of a company and responsibility to look after the day-to-day affairs of the company (fully or partly) under a service contract which is either express or implied and evidenced by the board/shareholders resolution appointing him and additionally, a formal agreement between him and the company.

Taxability of Services provided by Directors

According to one school of thinking, since a company is a legal entity, it has no option but to operate through the medium of directors. Therefore, services provided by directors to a company (excepting those on a contractual or professional basis), are essentially in a fiduciary capacity. Hence, such services would not fall within the ambit of ‘service’ as defined u/s. 65B(44) of the Act so as to be liable to service tax. However, this is a very extreme view, which is likely to be disputed by the service tax authorities.

Subject to such extreme view, it would reasonably appear that, with effect from 01-07-2012 services provided by directors to companies would be taxable except in the following cases:

•    Services provided by a director to a company in the course of or in relation to his employment as discussed in detail above.

•    Services provided by a director in a non– taxable territory to a company located in a non–taxable territory.

•    Services provided by a director to a company without consideration (for example in case of nominee directors where no sitting fee is paid).

•    According to Point of Taxation Rules, 2011, the point of taxation of services provided by a director to a company, would be either the time when invoice is issued for service provided or to be provided. If invoice is not issued within 30 days, point of taxation will be the date of completion of service. For sitting fees, date of completion of services, would generally be the date of meeting or the time when the payment/advance is received to the extent of such payment.

•    In case of reverse charge payments, point of taxation is reckoned from the date of payment by the company to the director.

Subject to the above discussion, the taxability for the period 01-07-2012 to 06 -08 -2012 (the period till amendment was brought in vide Notifications 45/2012 and 46/2012 provided above) and 07-08-2012 onwards and taxability of reimbursements is discussed hereafter.

Taxability of services provided by directors during the period 01-07-2012 to 06-08-2012.

Liability at the end of Directors

•    During this period, the director’s services were not covered under reverse charge, the directors would be liable to pay service tax and also comply with the requirements under the service tax law. The said position is confirmed by draft CBEC Circular F.No.354/127/2012–TRU dated 27-07-2012, which states that when a director receives payment in his personal ca-pacity, the same is liable to be taxed in the hands of the director. However, the concerned director would be entitled to the threshold exemption of Rs. 10 lakh, subject to compliance of stipulated conditions.

•    However, in the following cases, service tax would not be payable by the directors:

As per draft CBEC circular dated 27-07-2012, a director may also be appointed to represent an entity including Government who has either invested in the company or is otherwise authorized to nominate a director. Where the fee is charged by the entity appointing the director and is paid to such entity, the services shall be deemed to be provided by such entity and not by the individual director. Accordingly, in such cases, the service tax would be payable not by the director but by such entity appoint-ing the director. Nevertheless, in the case of Government nominee directors where the fee is charged by the Government appointing the director and is paid to the Government, the services may be deemed to be provided by the Government and may be liable to be taxed under the exclusion sub-(iv) of clause (a) of section 66D of the Act viz. support services by Government to a business entity. Such services are liable to be taxed on reverse charge basis from 01-07-2012 and therefore, tax is to be paid by the service recipient i.e. the company. Secondly, if the director is located in a non-taxable territory i.e. the State of Jammu & Kashmir or outside India, then service tax is not payable by such director. In this case, if the company is located in a taxable territory, the transaction would be covered under reverse charge from 01-07-2012 and tax is payable by the company.


Implications at the end of Company receiving the service

•    No service tax would be payable in respect of fees paid to directors located in taxable territory. However, in case of any payment towards taxable service to a director, located outside India or in the State of Jammu and Kashmir or in case of payment to Government against consideration of Government nominee director as discussed above, the company receiving the service is required to pay service tax under reverse charge as per Rule 2(1)(d) of ST Rules read with Notification No. 30/2012–ST dated 20-06-2012. Further, in case of reverse charge the threshold exemption of Rs. 10 lakh is not applicable.

•    Vide Circular No.24/2012, dated 09-08-2012 of Ministry of Corporate Affairs, Government of India, it is clarified that any increase in remuneration of non–whole time director(s) of a company solely on account of payment of service tax on commission payable to them by the company shall not require approval of Central Government u/s. 309 and 310 of the CA 56 even if it exceeds the limit of 1% or 3% of the profit [u/s. 309(4)] of the company, as the case may be in the financial year 2012-13.

Taxability of services provided by directors from 07-08-2012 onwards

Implications at the end of directors

For the period 07-08-2012 onwards, since the services by directors are covered under reverse charge, the directors are not liable to pay service tax. Even the entities receiving fee in respect of directors nominated by them are not required to pay service tax on the same.

Implications at the end of the Company receiving the service

The companies other than those located in a non taxable territory, would be required to pay service tax under reverse charge basis in respect of taxable services received from the directors for a consideration, irrespective of fact whether they are located within or outside the taxable territory or are nominee directors of Government/ other entitles. Further, as discussed earlier, the threshold exemption of Rs. 10 lakh is not applicable when the liability is fastened under reverse charge mechanism.

Further as stated above, the Circular No.24/2012-ST of the Ministry of Corporate Affairs is equally relevant here as well.

Taxability of reimbursements/out of pocket expenses

From 19- 04-2006, stringent provisions were introduced under the service tax law in regard to taxability of reimbursements. The Constitutional Validity of Rule 5 of the said Valuation Rules has been challenged before the Delhi High Court in International Consult & Tech (P) Ltd vs. UOI (2009) 19 STT 320 (DELHI), in particular on the ground being ultra vires the provisions of section 66 and 67 of the Act. The Delhi High Court has recently ruled in 2012 TIOL 66 DEL HC that Rule 5(1) of Valuation Rules is ultra vires of sections 66 & 67 of the Act. Implications of the said ruling in particular the continued relevance of principles laid down in Larger Bench ruling in Shri Bhagawathy Traders vs. CCE, Cochin 2011 (24) STR 290 (Tri.-LB) is discussed in detail in the January, 2013 issue of BCAJ. Hence the same are not repeated here.

Subject to the above, the following needs to be noted in particular, while determining taxability of expenses reimbursed to directors since the liability vests in the company under reverse charge:

•    According to Rule 5(1) of Valuation Rules, where any expenditure or costs are incurred by the service provider in the course of providing any taxable services, all such expenditure or costs shall be treated as consideration for the taxable services provided or to be provided and shall be included in the ‘value’ for purpose of charging of service tax on the said services. Expenditure or costs incurred by a service provider as “pure agent” of the recipient of service shall be excluded from the value of taxable service if all the conditions specified in Rule 5(2) of valuation Rules are satisfied.

•    For the purpose of Rule 5(2) of Valuation Rules, a pure agent is defined to mean a person who receives only the actual amount incurred to procure such goods or services.

•    According to the department clarification dated 19-04-2006, “value for the purpose of charging service tax is the gross amount received as consideration for provision of service. All expenditure or costs incurred by the service provider in the course of providing a taxable service forms integral part of the taxable value and are includible in the value. It is not relevant that various expenditure or costs are separately indicated in the invoice or bill issued by the service provider to his client”.

ITO vs. Roche Goplani ITAT “G” Bench, Mumbai Before Rajendra Singh (A. M.) and Amit Shukla (J. M.) ITA No. 7737 / Mum / 2011 Asst. Year : 2008-09. Decided on 24-05-2013 Counsel for Assessee / Revenue: D. K. Sinha / Dr. P. Daniel

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Explanation 5 to section 271(1)(c) – undisclosed income declared in return filed u/s. 139(4) and assessed as such entitled to immunity from penalty.

Facts:

In the order passed u/s 143(3) r.w. section 153A, the AO accepted the income of Rs. 1.31 crore retuned by the assessee. Thereafter, he initiated the penalty proceedings u/s. 271(1)(c) for the reasons that the assessee declared the additional income as a result of the search operation carried out by the department and secondly, the return of income was filed after the due date of filing of return. The assessee explained that the income was offered voluntarily which was on estimate basis and the same had been accepted in the assessment order as such. Therefore, the provisions of section 271(1) (c) was not applicable. However, the AO rejected the explanation offered and imposed a penalty of Rs. 42.41 lakh. Before the CIT(A) the assessee submitted that in view of clause (b) of Explanation 5A to section 271(1)(c), penalty cannot be levied as the assessee filed the return of income on the due date which can also be inferred as return of income filed u/s. 139(4). The CIT(A) however, didn’t accept the assessee’s explanation on Explanation 5A but deleted the penalty on the ground that the income which was offered was only on estimate basis, therefore, the additional income offered to tax can neither be held as concealed income or furnishing of inaccurate particulars of income.

Before the tribunal, the revenue submitted that it was not a case of estimate made by the AO in the regular assessment proceedings but it is a case of search and seizure, wherein the assessee has himself declared additional income in the statement recorded u/s. 132(4). Even if such surrender was based on estimate, then also it represents undisclosed income. Thus, the penalty cannot be deleted on the ground that it was based on the estimated income. Further it was submitted that as per the language of the Explanation 5A to section 271(1)(c), if any undisclosed income is found which is not shown in the return of income either prior to the date of search or before the due date of filing of return, penalty was levieable.

Held:

According to the tribunal, Explanation 5A to section 271(1)(c) provides that if during the course of search, the assessee is found to be the owner of any asset or income which has not been shown in the return of income which has been furnished before the date of search and the “due date” for filing the return of income has expired, the assessee is deemed to have concealed the particulars of his income or furnish inaccurate particulars of income and liable for penalty u/s. 271(1)(c). In other words, if the income is offered in the return which is filed by the “due date”, no penalty can be imposed.

The tribunal then examined whether the “due date” in Explanation 5A encompasses a belated return filed u/s. 139(4). It observed that the “due date” can be very well inferred as due date of filing of return of income u/s. 139(4) because wherever the legislature has provided the consequences of filing of the return of income u/s. 139(4), then the same has also been specifically provided. E.g., section 139(3) which denies the benefit of carry forward of losses u/s. 72 to 74A if the return of income is not filed within the time limit provided u/s. 139(1). In the absence of such a restriction, the limitation of time of “due date” cannot be strictly reckoned with section 139(1). Even a belated return filed u/s. 139(4) will be entitled to the benefit of immunity from penalty. For the said proposition the tribunal also relied on the decisions of the Gauhati high court in the case of Rajesh Kumar Jalan (286 ITR 276), the Punjab & Haryana high court in the cases of Jagriti Aggarwal (339 ITR 610) & of CIT vs. Jagtar Singh Chawla. In view of the above, the tribunal held that the assessee gets immunity under clause (b) of Explanation 5A to section 271(1) (c) because the assessee has filed return of income within due date.

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Recovery of tax pending stay application – A draconian directive

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New Year Shock

The Central Board of Excise and Customs (CBEC) has, in supersession of seven previous circulars on the same subject, issued Circular No. 967/01/2013 CX dated 1-1-2013 (the new Circular), directing the departmental officers to initiate recovery action in cases where 30 days have expired after the filing of appeal by an assessee before an appellate authority. This action by CBEC is highly unprecedented and totally unjust and unfair inasmuch as it would not only result in penal consequences for reasons beyond the control of an assessee, but also render the statutory right of appeal nugatory.

While the taxpayer fraternity fully recognises that the Government is empowered under the relevant statutory provisions to collect and recover legitimate taxes due from assessees, at the same time, the taxpayer fraternity does feel that as a good tax administration practice, it is essential that, in regard to tax demands which are pending in appeal before various appellate authorities, the legitimate rights of assessees under the relevant statutory provisions are also recognised, before initiation of coercive action for recovery of tax dues.

Impact

The new Circular which seeks to instruct departmental officers to initiate recovery action, if no stay is granted by the concerned appellate authorities within 30 days of filing of an appeal, is likely to result in severe hardships to taxpayers. Coercive actions for recovery of tax like attachment of bank accounts, assets and properties, etc. of assessees pending disposal of stay applications would adversely impact businesses in a significant way and also cause unprecedented hardships. It is also likely to result in filing of writ petitions before the High Courts across the country in large numbers. In fact, the Honourable Andhra Pradesh High Court has granted interim stay against the operation of the new Circular in a writ petition.

 Reasons for High Level of Tax Litigation

Before issuing such a drastic and draconian circular, the Government needs to appreciate and take cognizance of the fact that, the principal reason for extensive tax litigation is high pitched adjudications which do not fully appreciate the correct legal position in a matter. A perusal of records available with the Government would clearly reveal that, in a high number of tax litigations, the matters are finally decided against the revenue and in favour of tax payers. Statistics (Refer Table) given by the Union Minister of State for Finance, Mr. S.S. Palanimanickam in a written reply to a question in the Lok Sabha on 5-9-2012, regarding the outcome of revenue cases supports the above view.

Table – Revenue Department’s Success Rate (%)

Year

Supreme

Court

High
Court

CESTAT

2008-09

9.81

29.6

10

2009-10

7.85

35.1

18.2

2010-11

5.5

27.1

17.2

2011-12

10.64

29.85

19.7

The Minister also mentioned that, even though approx. Rs. 86,000 crore were held up in court cases, it should not create an impression that the Government would get much monies upon finalisation of litigation. It may get only about 10% to 15% of the said amount. In the light of the above stated position, in a scenario where tax demands are unrealistic and sustained in a very small number of cases by the appellate authorities, it is totally unfair, unjust and unwarranted on the part of the Government to pressurise tax payers for no fault on their part.

Unjust and Unfair Circular

The new Circular is unjust and unfair to the taxpayer due to the following reasons, in particular:
a) Initiation of coercive actions to recover the tax dues in regard to which appeal and stay application are pending disposal before the concerned appellate authorities, is not in consonance with the settled principles of natural justice, laid down by the Supreme Court of India from time to time.

b) It also needs to be appreciated that, in a large number of cases, stay applications are not disposed off due to inactions at the end of the concerned appellate authority and for no fault of the assessee.

c) The new Circular refers to a very old Supreme Court ruling in Krishna Sales (P) Ltd (1994) 73 ELT 519 (SC) wherein it was observed as under: “As is well known, mere filing of an Appeal does not operate as a stay or suspension of order appealed against”.

However, the significant observations made by the the Honourable Supreme Court of India in a subsequent ruling in Commissioner of Cus & CE vs. Kumar Cotton Mills Pvt. Ltd. (2005) 180 ELT 434 (SC), have been totally ignored. The relevant observations are reproduced below for ready reference :

Para 6

“The s/s. which was introduced in terrorem cannot be construed as punishing the assessees for matters which may be completely beyond their control. For example, many of the Tribunals are not constituted and it is not possible for such Tribunals to dispose of matters. Occasionally by reason of other admin-istrative exigencies for which the assessee cannot be held liable, the stay applications are not disposed within the time specified. ….

The aforesaid observations need to be appropriately recognised and appreciated by the Government.

d)    There are a large number of judicial decisions including those of various High Courts, to the effect that, no recovery actions should be taken until the disposal of the stay application by the appellate authorities. In this regard, useful reference can be made to the following rulings:

i)    In Legrand (India) vs. UOI (2007) 216 ELT 678 (BOM HC DB), the Asst. Commissioner enforced the bank guarantee even before the expiry of the statutory period of filing appeal, despite a directive of High Court (in another case) not to take coercive action for recovery in such cases. It was held that this was a civil contempt of Court.

ii)    Quoting CBEC Circular, in Shree Cement Ltd vs. UOI (2002) 126 STC 324 (Raj HC DB), it was held that no coercive action for recovery should be taken when stay application is pending.

iii)    A view similar to the view expressed in the above case was expressed in Delhi Acrylic Mfg C6 vs. CC (2002) 144 ELT 24 (DEL HC DB).

It is most inappropriate for the CBEC to issue a circular in disregard to the binding court judgments and showing no respect for judicial precedence on the subject.

Suggestions

The following is suggested so as to ensure that undue hardship is not caused to tax payers:

a)    CBEC Circular No. 967/01/2013 – CX dated 1-1-2013 needs to be immediately withdrawn/appropriately modified to provide that no recovery actions are initiated until the disposal of the stay applications by the appellate authorities.

b)    Suitable instructions need to be issued that recovery action be restricted to cases where stay applications are disposed off and stipulated conditions are not complied with.
c)    Vacancies existing in Tribunals/Courts should be filled up at the earliest.
d)    All stay applications pending before appellate authorities be disposed off, in terms of existing provisions under the relevant law, on a war footing by appointing fast track Tribunals/Courts.
e)    Alternatively, in all cases where appeals are filed, stay be granted and appeal itself be taken up for disposal.

Reforming Tax Administration – Some Recommendations

In order to promote and encourage good tax administration practices, from a long term perspective, the following measures are recommended:

a)    Establish accountability in tax administration whereby statutory provisions are enacted in tax laws specifically providing for actions against departmental officers passing inappropriate orders.
b)    Install quality reviews/audits of tax administration processes including adjudication process in particular.
c)    Expand the scope of Advance Ruling Mechanism to minimise litigation.
d)    Evolve new speedy dispute redressal mechanisms.
e)    Award costs to the assessees so as to cover litigation expenses.
f)    Increase the existing rate of interest on refunds of pre-deposit pending appeals as well as other refunds so as to be on par with prevailing commercial rate of interest.
g)    Introduce incentive schemes for team of departmental officers, in cases where, demands are sustained at higher judicial levels.

Conclusion

It is projected that by 2030, India is likely to become a World Economic Power. Hence, the entire world is looking at us. As per the taxation policy announced by the Government, it is expected that substantive tax reforms (viz. DTC & GST) are likely to be introduced in the near future. However, the Government needs to expressly recognise and take cognizance of the fact that, from a taxpayer perspective, the need of the hour is reforming tax administration. Employing unfair, unjust and coercive tax administration methods, would only encourage dishonest practices and non-compliances, rather than boosting tax revenues. Government needs to recognise that employing coercive tax administration methods is not the right policy to boost tax revenues. Instead, in order to boost tax revenues, priority focus of the government should be on evolving good tax administration practices.

Centralised Processing of Statements of Tax Deducted at Source Scheme, 2013 – Notification No. 03 /2013 dated 15th January 2013

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CBDT has made the subject scheme to set out the procedures for filing correction statement, rectifications, appeals, etc in connection with TDS statements filed online.

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Clarifications regarding deduction for software related expenses – Circular 1/2013 dated 17-1-13

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Exemption would be available u/s. 10A, 10AA and 10B (as applicable) vis-à-vis software business in following scenario:

• Software developed abroad at a client’s place amounting to ‘deemed export’, so long as there exists a direct and intimate nexus or connection of development of software done abroad with the eligible units set up in India pursuant to a contract between the client and the eligible unit.

• Profits earned from deployment of technical manpower at the client’s place abroad specifically for software development work pursuant to a contract between the client and the eligible unit provided such deputation of manpower is for the development of such software and all the prescribed conditions are fulfilled.

• In case of each Statement of Works which is a part of a Master Service Agreement.

 • Research and Development activities pertaining to software development would be covered under the definition of ‘Computer Software’.

• In case of a slump sale, the tax holiday can be availed of for the unexpired period at the rates as applicable for the remaining years, subject to fulfilment of prescribed conditions.

• Separate books of account need not be maintained for each eligible unit. However, the assessee should be able to produce the required details called for by the AO.

• When an eligible SEZ unit relocates physically to another SEZ in accordance with the prescribed rules, tax holiday would be available for the unexpired period at the rates applicable to such years.

• Exemption would be available to a freshly set up unit, as long as it is set-up after obtaining necessary approvals from the competent authorities; has not been formed by splitting or reconstruction of an existing business; and fulfils all other conditions prescribed in the relevant provisions of law.

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Penalty for inadvertent errors – Penalty not imposable when no malafide intention alleged in the Show Cause Notice.

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Facts

Appellant inadvertently availed CENVAT credit of the value of invoice instead of the amount of service tax. On being pointed out, the Appellant immediately reversed the inadmissible portion of the credit and also paid interest.

Held

Show Cause Notice did not allege any malafide intention on part of the Appellant. Moreover, Appellant has shown its bonafide by reversing CENVAT credit on being pointed out and also paying interest on the same. Tribunal set aside the penalty.

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The value of study materials is excludible from the value under the taxable category of “commercial Training and Coaching services” in terms of Notification No.12/2003-ST.

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Facts

The Appellant engaged in providing the services of commercial training and coaching discharged service tax after excluding the value of study materials supplied to the students as per Notification No.12/2003. Based on CBEC Circular No. 59/8/2003 dated 20-6- 2003, Revenue contended that the exemption was available only to standard textbooks and not to the study material supplied as part of the service.

Held

Though the word “standard textbook” was used in CBEC Circular, the same was not used in the Notification No.12/2003. Also, the department did not dispute the fact of supply of study materials to students and documentary evidence for the same and thus satisfying all the conditions of 12/2003-ST. Held that there was no merit in the contention of the Respondent as the said notification has not used the word “standard textbook” and the books sold are of another entity and hence the appeal was allowed.

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Debit notes issued by the service provider. No formal Invoice, Bill or challan issued. Can such debit note be considered as a valid document to avail CENVAT credit – Held, yes.

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Facts

The service provider raised debit notes for provision of services instead of raising an Invoice or a challan. The Appellant having availed CENVAT credit on the basis of such debit notes, the Respondent objected to the same stating that they were not eligible documents as prescribed under Rule 9(1)(f) and disallowed the credit. Whether is it necessary to verify that service tax is paid by the vendor before claiming the CENVAT credit?

Held

The Honourable Tribunal allowed the CENVAT credit by applying the principle of Substance over Form. It stated that “a ‘bill’ is that which gives right to an actionable claim”. A party raising the bill communicates its intention to the recipient of such service, making him aware of his contractual obligation and value involved to provide such service. The Appellant cannot be denied benefit of CENVAT credit in case of reimbursement of expenses as it is already included in the taxable value. The Tribunal in this regard held that the department on its own can verify the claim and in the event of failure of such verification, the law will take its own recourse.

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Can recovery be made from the bank in spite of interim stay granted by Tribunal?

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Facts

The Appellant had filed an appeal along with the stay application with CESTAT in March, 2012. Hearing for the stay application was listed on 14th January, 2013 for which the department sought adjournment. However, the Tribunal granted interim stay as mentioning was made by the Appellant. In the meantime, the department had issued an attachment notice to the banker and the banker had deposited an amount of Rs. 6 crore into the exchequer.

Held

Interim stay was granted by the Tribunal vide its order dated 14th January 2013 and hence, it directed the department to refund the amount to the Appellant and not to proceed with the recovery proceedings during the pendency of the stay application.

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Circulars No.158/9/2012-ST and No.154/5/2012-ST challenged on the ground that they are contrary to the Act and hence the differential service tax of 2% in case of chartered accountant’s services provided and invoices raised before 1st July 2012 and consideration received later than the said date cannot be collected.

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Facts

The question of law arose as to when a “taxable event” occurs for the levy of service tax. In Association of Leasing & Financial Service Companies vs. UOI 2010-TIOL-87-SC-ST-LB, the Supreme Court held that the taxable event was the rendition of the service. However, from 1-4-2011, the Point of Taxation, 2011 were notified and accordingly, the point of taxation would be the point in time when a service is deemed to be provided. Rule 7(c) of the Point of Taxation Rules, 2011 provided the point of taxation for the 8 specified categories of service providers (one of them being chartered accountant) to be the time of receipt of consideration. The said Rule 7 was amended w.e.f. 1st April, 2012 and as a result, the said Rule 7(c) was deleted. Accordingly, the 8 categories of services (including CAs) are required to pay service tax on the date of issuance of invoice, instead of on the date of the receipt of consideration with effect from 1st April, 2012. The dispute arose on account of Government’s Circular No.154 (supra) read with Circular No.158 (supra) which provided to the effect that for the eight categories of persons (including CAs) even cases when invoice was raised prior to 31st March, 2012 (when the prevailing service tax rate was 10.3%) for a service provided before 31-3-2012, if the fee/consideration was received on or after 1st April, 2012, the new rate i.e. 12.36% amended with effect from 1-4-2012 would be applicable.

The Appellant pleaded that the Rule 4(a)(ii) of the Point of Taxation Rules, 2011 specifically covers a situation determining the point of taxation in case of change in rate of tax and the Appellant’s case falls under the said sub-clause and therefore the point of taxation would be the date of issuance of invoice.

Held

Circulars were quashed holding them contrary to the Finance Act, 1994 and the Point of Taxation Rules, 2011 and it was observed that in case a circular is contrary to the Act or the Rules, it has no existence in law.

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Right to use trademark being intangible, whether it was “deemed sale” as defined under the Kerala Value Added Tax Act, 2003 when service tax was paid on royalty received.

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Facts

Petitioner is engaged in marketing, trading, export and import of jewellery, diamond ornaments, platinum, watches etc. and the sole proprietor of the trademark “Malabar Gold”. The petitioner has entered into franchise agreements with several companies situated inside and outside Kerala and also abroad, to use the trademark and receives royalty as consideration. The petitioner paid service tax on royalty. The respondent contended that the transfer to use trademark is transfer of goods and therefore exigible to Kerala Value Added Tax Act, 2003.

The petitioner on receipt of show causes notices filed writ petition before the Honourable High Court. The petitioner relied on the case of Imagic Creative (P) Ltd vs. Commissioner of Commercial Taxes 2008 (9) STR 337 (SC) and BSNL vs. UOI 2006 (2) STR 161 (SC) while the respondents relied on the provisions of Article 366(29A) of the Constitution of India and decisions of Tata Consultancy Services vs. State of A.P. 2004 (178) ELT 22 (AP) and other similar decisions of the Kerala High Court. According to the petitioner, the cases relied by the respondent were prior to the application of the Finance Act, 1994 and they had paid service tax on the use of trademark and therefore, VAT should not have been levied as decided by the Supreme Court in the case of Imagic Creative (supra) and that VAT and service tax are mutually exclusive and both cannot be levied on the same transaction. The petitioner also contended that the right to use trademark not to the exclusion to the transferor was transferred and as held in BSNL (supra) this was one of the necessary attributes for treating the transaction as sale of goods not satisfied.

Held

The Honourable High Court held that the facts of the present case wherein it has been conceded by the petitioner that trademark is transferred for use for consideration i.e. royalty is distinguishable from the facts of BSNL case (supra) wherein the issue examined was whether BSNL provided sale or service in the light of the fact that BSNL was retaining physical control and possession and hence, BSNL case (supra) could not be considered. The Honourable High Court also held that the transfer of trademarks for use was exigible to Kerala VAT tax and as the petitioner did not challenge the applicability of service tax on such a transaction, it did not comment upon the same and hence, Imagic Creative (supra) could not be relied upon.

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DCIT vs. Kaushik Shah Shares & Securities Pvt. Ltd. ITAT Mumbai `A’ Bench Before B. Ramakotaiah (AM) and Vivek Varma (JM) ITA No. 2163/Mum/2013 A.Y.: 2008-09. Decided on: 10th July, 2013.

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Counsel for revenue / assessee: Surinder Jit Singh/ Jinesh Doshi Section 88E, 115JB—It is the gross tax payable under normal provisions without deducting rebate u/s. 88E is to be compared with tax payable u/s. 115JB. From the higher of the two, rebate u/s. 88E is to be allowed. Rebate u/s. 88E is allowable even from tax payable on book profits u/s. 115JB.

Facts:
The Assessing Officer noticed that the assessee had made tax payment under normal provisions by comparing its tax liability (before claiming rebate u/s. 88E) on total income with income u/s. 115JB. The assessee submitted that tax rebate is a step which comes after determining income-tax payable on total income computed as per applicable provisions. It supported its view by income tax return ITR 6 prescribed by CBDT wherein gross tax liability before claim of rebate u/s 88E is first to be compared with tax credit under MAT and then from the higher of the MAT liability and tax liability under normal provisions of the Act, tax rebate u/s. 88E is to be reduced to arrive at a final tax payable by the assessee. The contention of the assessee was rejected by the AO.

Aggrieved, the assessee preferred an appeal to CIT(A) where it was contended that rebate u/s. 88E was also to be allowed while working out tax liability u/s. 115JB for the purpose of determining tax liability u/s. 115JB. Reliance was placed on decision of Bangalore Bench of ITAT in the case of Horizon Capital Ltd and also on the decision of Mumbai Bench of ITAT in the case of Naman Securities Finance Pvt. Ltd. The CIT(A) allowed the appeal of the assessee on this ground.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the issue is covered by the decision of the Karnataka High Court in the case of CIT vs. Horizon Capital Ltd. (ITA No. 434 of 2010 dated 24.10.2011) and by the following decisions of coordinate Bench –

1 Ambit Securities Broking P. Ltd. vs. ACIT (ITA No. 7856/M/2011, AY 2008-09, order dated 6.6.2013);
2 DCIT vs. Arcadia Share & Stock Brokers Pvt. Ltd. (ITA No. 1515/M/2012, AY 2008-09, order dated 20.3.2013);
3 SVS Securities Pvt. Ltd. (ITA No. 6149/M/2011, AY 2008-09, order dated 8.8.2012).
Since the CIT(A) had followed the decision of the co-ordinate Bench in the case of Horizon Capital Ltd which was confirmed by the Karnataka High Court and also the decision of the co-ordinate Bench in the case of Naman Securities Finance Pvt. Ltd. which in turn has been followed by other co-ordinate Benches, the Tribunal did not see any merit in the grounds raised by the revenue.
The appeal filed by the revenue was dismissed.

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AAR: Section 245R : Application for ruling: No requirement of recording reasons at stage of admission: Commissioner or his representative need not be heard at that stage: Hearing Commissioner or his representative before pronouncing advance ruling only if Authority considers necessary:

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DIT vs. AAR; 352 ITR 185 (AP):

The second Respondent sought an advance Ruling on the question whether the capital gains arising from the sale of shares of a French incorporated entity by the applicant, a French incorporated entity, was liable to tax in France or in India. Notice was given by letter to the CBDT. The Department objected that since proceedings had already been taken in terms of section 195 to 201 in the applicant’s case, the application was hit by the bar in proviso to section 245R(2) of the Income-tax Act, 1961. However, before the objections were received by the Authority for Advance Ruling, the Authority passed an order admitting the application.

In a writ petition filed by the Department, the following question was considered by the Andhra Pradesh High Court:

“Whether while allowing the application filed u/s. 245Q(1) it was essential for the Authority for Advance Rulings to consider the issue of admissibility as a preliminary issue, with regard to the threshold bar u/s. 245R(2), by recording reasons in writing and whether the Department was entitled to a hearing before allowing the application for pronouncing its advance ruling?”

The High Court dismissed the petition and held as under:

“i) S/s. (1) of section 245R, which contemplates forwarding of a copy of such application to the Commissioner, if necessary, calling upon him to furnish the relevant records, does not contemplate the filing of objections or response to the application so made. S/s (2) authorises the Authority, after examining the application and the records called for, by order, either allow or reject the application, but a rider is added by way of proviso that the Authority shall not allow application, inter alia, where the question raised in the application is already pending before any income-tax authority or Appellate Tribunal. The second proviso provides that no application shall be rejected unless an opportunity has been given to the applicant of being heard. If the application is rejected, reasons for such rejection shall be given as per the third proviso to section 245R.

ii) Nowhere does section 245R state that the Commissioner from whom records were called for is to be called upon to make his objections to the admission of application and record reasons when it allowed the application for an advance ruling.

iii) While exercising the jurisdiction under Article 226 of the Constitution, if the High Court is of the opinion that there is no other convenient or efficacious remedy open to the petitioner, it will proceed to investigate the case on its merits and if the Court finds that there is an infringement of the petitioner’s legal rights, it will grant relief, otherwise relief should be rejected.

iv) The entire exercise to be undertaken by the Authority for allowing the application is only to verify the records called for whether an advance ruling on the question specified in the application was required to be made or not. There is a clear dichotomy between the threshold stage of allowing the application for advance ruling and pronouncing of advance ruling. If the Authority admits the application for pronouncing an advance ruling recording of reasons at that stage is not at all required nor is hearing contemplated to the Commissioner or his authorised representative. Only on such admission before pronouncing its advance ruling hearing of the Commissioner or his authorised representative is provided if the Authority considers necessary to hear but not at the threshold stage of admitting the application.

v) The Director of Income-tax and the Additional Commissioner failed to substantiate the infringement of legal right conferred on them under the statute while allowing the application for advance ruling. The writ petitions were devoid of merit and were accordingly dismissed.”

iii) Therefore, the sum forfeited by the assessee to the Council was allowable u/s. 37(1).”

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136 ITD 315 (Mum.) Arrow Coated Products Ltd. vs. ACIT A.Y 2006-07 Dated : 14th March, 2012

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Section 36(1)(vii)—Deduction of bad debts available when debited to P&L Account—In order to claim deduction on account of bad debts, it is not necessary that individual debtor’s account has to be closed by crediting said account—a mere reduction in loans and advances/debtors account to extent of provision for bad and doubtful debt is sufficient

Facts:
The assessee had made provision for bad and doubtful debts in books of accounts in AY 2004-05 of Rs. 70 lakh. The provision was debited to Profit and Loss Account and also correspondingly reduced from gross total sundry debtors in the balance sheet. The individual ledger of debtor account was not written off by the amount of doubtful debts. In the return of income the assessee had not claimed deduction of provision of doubtful debts for AY 2004-05. In AY 2005-06 & 2006-07, the assessee wrote off the provision of doubtful debts of Rs. 20,36,000 (being part of Rs. 70 lakh) from the individual account of debtors thereby closing debtors account. The AO held that as the amount of doubtful debts was not transferred to P&L Account, the claim cannot be allowed. The CIT(A) upheld the order of the AO.

Held:
After insertion of Explanation to section 36(1)(vii), the taxpayer is now required to debit Profit and Loss Account and also simultaneously reduce debtors account to the extent of corresponding amount. It is not necessary that individual debtors account be closed in order to claim deduction of bad debts. In the present case the assessee had not claimed deduction on account of bad debts in AY 2004-05. It is not required for the assessee to actually close the individual account of each debtor.

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Industrial Undertaking – Deduction u/s. 80IA – Texturing and twisting of polyester yarn amounts to manufacture.

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CIT vs. Yashasvi Yarn Ltd. (2013) 350 ITR 208 (SC).

A short question that arose for determination before the Supreme Court was whether texturing and twisting of polyester yarn amounts to “manufacture” for the purpose of computation of deduction u/s. 80IA.

The High Court had dismissed the appeals of the Revenue following its decision in CIT vs. Emptee Poly-Yarn Pvt. Ltd. (2008) 305 ITR 309 (Bom).

The Supreme Court dismissed the civil appeals of the Revenue holding that the question had been squarely answered by it in CIT vs. Emptee Poly-Yarn P. Ltd. (2010) 320 ITR 665 (SC).

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Exports – Profits on telecasting rights of a T.V. Serial are entitled to the benefit of section 80HHC

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CIT vs. Faquir Chand (HUF) (2013) 350 ITR 207 (SC)

The question that arose before the Supreme Court was whether the profit on telecasting rights of a T.V. serial are entitled to the benefit of section 80HHC.

The High Court had dismissed the appeal of the Revenue in view of its judgment in Abdul Gafar A. Nadialwala v. ACIT (2004) 267 ITR 488 (Bom).

The Supreme Court dismissed the civil appeal of the Revenue holding that the issued was squarely covered in favour of the assessee by its decision in CIT vs. B. Suresh (2009) 313 ITR 149(SC).

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(2012) 135 ITD 233 (Mumbai) Pranik Shipping & Services Limited vs. ACIT (Mumbai ITAT) ITA No.5962 /Mum/2009 18th January, 2012

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Section 36(1)(iii)- Interest free loans given to sister concerns—if assessee held interest free funds and also interest bearing funds, presumption would be that investments were made from interest free funds available with assessee.

Section 40(a)(ia) and section 194A—Business expenditure—assessee claimed deduction of interest expenditure for which no accounting entry was passed in books of account— the event for deduction of tax at source arises when the amount of interest is credited to the account of the payee or when it is paid, whichever is earlier—Since the said interest was neither credited in the books of account nor paid in the year, section 194A cannot be attracted—Once there is no liability to deduct tax at source u/s. 194A, the provisions of section 40(a)(ia) cannot be attracted.

Facts I:
The assessee had given interest-free funds to its sister concerns. The AO observed that no interest was charged on such advances to sister concerns whereas substantial interest was paid on borrowed funds. In absence of any nexus between the interest-free funds advanced and interest-free funds available with the assessee, the AO made disallowance by applying 15% rate of interest. The CIT(A) also upheld the AO’s action.

Held I:
The Tribunal observed that the interest-free funds available at the disposal of the assessee were far in excess of the interest-free loans advanced to the sister concerns. Relying on the decision of Hon’ble jurisdictional High Court in the case of CIT vs. Reliance Utility and Power Limited [(2009) 313 ITR 340 (Bom.)], the Tribunal held that if the assessee has interest-free funds as well as interest-bearing funds at its disposal, it shall be presumed that investments were made from interest-free funds available with the assessee. The addition was deleted.

Facts II:
Assessee claimed deduction of interest expenditure in the computation of total income for which no accounting entry was passed in the books of account. The AO held that assessee followed cash system of accounting in respect of accounting of interest expenditure and as assessee had not made any payment of interest, the same was not deductible. The Ld CIT(A) held that the assessee had not deducted TDS on interest payable and hence u/s. 40(a)(ia) the deduction was not allowed.

Held II:
The Ld. AO was not justified in applying hybrid system of accounting i.e., applying cash system for accounting of interest expenditure and mercantile system for accounting for all other items. As per section 145, income under the head ‘Profits and gains of business or profession’ is to be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. The assessee was regularly following mercantile system of accounting.

In the mercantile system of accounting, deduction is allowed on accrual of liability and it is not material whether the amount is paid or not or whether or not it is recorded in the books of account. Assessee’s similar claim of deduction of such interest expenditure was allowed in earlier assessment years also.

As per sections 40(a)(ia) and 194A, the event for deduction of tax at source arises when the amount of interest is credited to the account of the payee or when it is paid, whichever is earlier. The assessee did not credit such interest in the books of account under any account and further such interest had not been paid during the year. The deduction had been claimed on the basis of mercantile system of accounting straightway in the computation of income, without routing it through books of account, which had been held by us to be allowable. Hence, the mandate of section 194A cannot be attracted. As there is no liability to deduct tax at source u/s. 194A, the provisions of section 40(a)(ia) cannot be attracted.

This loophole was probably not contemplated by the Legislature while enacting the relevant provisions, which has been exploited by the assessee as a measure of tax planning.

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(2011) 135 ITD 398 (Pune) Patni Computer Systems Ltd vs. DCIT A.Y 2002-03 & 2003-04. Dated : 30th June, 2011

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Section 92B—Transfer Pricing—Extension of credit to the Associated Enterprises (‘AEs’) beyond the stipulated credit period vis-a-vis others cannot be construed as an “international transaction” for the purposes of section 92B(1) so as to require adjustment for ascertaining the ALP.

Section 92B—Transfer pricing—Adjustment for cost of consultancy fees paid for undertaking study for the purpose of restructuring the assessee’s organisational structure—Apportionment of impugned cost is permissible only in a situation where there exists a “mutual agreement or arrangement” between two or more AEs for apportionment of cost.

Section 10A—Establishment of three new units at three different locations, with investments in fixed assets is not mere expansion and would be eligible for deduction u/s 10A.

Facts I:
Assessee had international transactions with AEs and on this count, the AEs had some outstandings due to the assessee. Such outstandings were overdue and no interest was charged by the assessee on such amounts. The TPO has considered non-charging of interest as an ‘international transaction’ requiring adjustment to determine the ALP on the basis that the normal period of credit allowed to the AEs was 90 days, and to the other similarly placed customers the credit period allowed was 30 to 45 days. The fundamental question raised by the assessee was as to whether extending the credit limit can be considered as “international transaction” under section 92B(1) of the Act.

Held I:
Relying on the judgement of the Mumbai Bench Tribunal in case of Nimbus Communications Ltd. vs. Asst. CIT. ITA No. 6597/Mum/2009, it was held that a continuing debit balance is not an international transaction per se, but is a result of international transaction. The commercial transaction, as a result of which the debit balance has come into existence, and the terms and conditions, including terms of payment, has to be examined for the purpose of arm’s length price.

Facts II:
The assessee had undertaken a study for the purpose of restructuring the organisational structure. According to the TPO, changes proposed in the study would also give benefits to the AEs and thus an arm’s length allocation of cost of consultancy expenses paid for study was required to be made. According to the Revenue, it was imperative for the assessee to have recovered such costs from the AEs and since the assessee had not done so, certain expenditure was allocated by the TPO on this score.

Held II:
Apportionment of impugned cost is permissible only in a situation where there exists a “mutual agreement or arrangement” between two or more AEs for apportionment of cost. There existed no such agreement or arrangement in the given case. The study reports may bring certain intangible benefits in the form of enhanced productivity to the businesses of the AEs, however, this would not ipso facto justify the apportionment of the cost incurred, where the use of such studies by the AEs is not obligated in terms of any mutual agreement or arrangement between the assessee and the AEs, but the use is only discretionary on the part of the foreign AEs.

Moreover, there would not be any justification for apportioning the expenditure unless it is shown that the expenses incurred on such activities was disproportionate and the benefit which accrued to the AEs in the form of increased business productivity was not merely incidental, but was tangible and concrete. There was no material to show that any tangible and concrete benefit has accrued to the AEs as a result of the expenditure incurred by the assessee in obtaining consultancy.

Facts III:
The AO noted that the assessee has treated three new units as separate independent units for the purpose of deduction u/s. 10A of the Act. The AO further noted that approval from STPI reflected the new units as expansion of existing units. On the basis of this the AO concluded that the profitability of the aforesaid three units was liable to be combined with that of the corresponding old units and thus the eligible period for deduction u/s. 10A of the Act with respect to the said three units would be reckoned from the first year of the eligibility of the corresponding old units. The CIT(A), however, held that the assessee fulfilled all the conditions prescribed u/s. 10A(2) of the Act. All the three units had their own plant and machinery having substantial investment and substantial turnover and were located in different premises.

Held III:
For claim of deduction u/s. 10A of the Act, examination as to whether the three units are independent units and whether they fulfil the conditions prescribed u/s. 10A(2) of the Act is important. There is no prohibition that an expansion in the same line of business achieved by setting up a new independent unit would lead to denial of deduction u/s. 10A of the Act. The assessee would not be disentitled to deduction u/s. 10A merely due to the fact that the requisite permissions from STPI refer them as expansions of the existing units.

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Business Expenditure – Interest on borrowed capital by an assessee carrying on manufacture of ferro-alloys and setting up a sugar plant – where there is unity of control and management in respect of both the plants and where there is intermingling of funds and dovetailing of business the interest could not be disallowed on the ground that the assessee had not commenced its business.

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CIT vs. Monnet Industries Ltd. (2012) 350 ITR 304 (SC)

In 1991, the assessee had set up a ferro-alloys manufacturing plant in Raipur, which was engaged in both the manufacture of ferro-alloys, as also, trading of ferro alloys.

In the years 1994-95 and 1995-96, the assessee set up a sugar manufacturing plant at Muzaffanagar in the state of UP. The sugar plant had an installed capacity 2500 RD. The assessee’s trial in respect of sugar plant commenced on 20-03-1996. The assesee spent a sum of Rs. 5,66,79,270/- as pre-operative expenses in respect of the sugar plant which inter alia included financial charges of Rs.3,50,83,472/-.

In its return of income for the assessment year 1996-97, the assessee declared loss of Rs.7,23,18,949/- in which the assessee, inter alia, had claimed the aforesaid sum of Rs. 5,66,79,270/- as revenue expenditure.

The Assessing Officer disallowed the expenditure for the reason that the sugar plant constituted new source of income as it was not the same business in which the assessee was engaged.

The Commissioner of Income-tax (Appeals) came to the conclusion that the expenditure in issue was in the nature of revenue expenditure since the sugar plant project was in the same business fold.

The Tribunal allowed deduction of only that expenditure which was incurred towards finance charges, being a sum of Rs. 3,50,83,472/- incurred for setting up of sugar plant as revenue expenditure u/s. 36(1)(iii). In respect of the balance amount in the sum of Rs. 2,15,95,798/-, the Tribunal restored the matter back to the Assessing Officer to ascertain whether the expenditure was of capital or revenue nature.

On an appeal to the High Court by the Revenue, the High Court observed that the Tribunal had given the finding that there was unity of control and management in respect of the ferro alloys plant as well as the sugar plant and there was also intermingling of funds and dovetailing of business. The High Court held that in the circumstance, it could not be said that the assessee had not commenced its business and hence, interest would have to be capitalised. The High Court confirmed the order of the Tribunal.

The Supreme Court dismissed the civil appeal filed by the Revenue in view of the concurrent finding recorded by court below.

Note: W.e.f. 01.04.2004, the Finance Act, 2003 inserted proviso to section 36(i)(iii) which effectively, prohibits the deduction under this section in respect of interest on capital borrowed for acquisition of an asset for extension of existing business for the period up to the date on which such asset is first put to use.

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When Can an Open Offer be Avoided? – Supreme Court Decides

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The Supreme Court recently had an occasion to
render an interesting decision (Nirma Industries Limited vs. SEBI
((2013) 33 Taxmann.com 333(SC), dated 9th May 2013) on the Takeover
Regulations. It examined the very rationale of the Regulations. In
particular, the question was when could a person taking over a listed
company avoid an open offer? More specifically, having already paid the
promoters for acquiring the controlling interest in a company, can the
acquirer avoid paying the public for their shares? Can the acquirer be
allowed to withdraw if he later finds that the value of the shares was
substantially lower than he was supposedly aware of?

This
decision has drawn a lot of controversy and criticism. It has been said
that the acquirer, having already suffered by getting over valued
promoters shares, should not be made to suffer again by being required
to acquire shares of the public. Partly this owes to certain peculiar
facts and legal interpretation on certain issues which the Court upheld.
Partly also because it is said that the law creates certain hurdles and
then punishes the acquirer for not being able to cross them. But mainly
on certain substantive grounds. I respectfully differ with contrary
views on certain aspects and submit that the Supreme Court has rightly
required the acquirer to comply with its obligations to the public. The
few areas of legal ambiguity have also been rightly interpreted by the
Court.

The facts are indeed peculiar and on a first glance raise
certain sympathy too. To summarise, certain lenders (collectively
referred herein as “Nirma”) granted certain loans to the promoters of a
listed company (“the Company”) against security of shares of the
Company. When there was default in repayment, Nirma exercised the pledge
and acquired the shares. This resulted in trigger of requirement of
open offer which Nirma initiated. However, on later investigation, Nirma
found that there were allegedly serious misappropriations, etc. in the
Company. Nirma applied to SEBI for grant of exemption from making an
open offer or other alternate reliefs. SEBI refused. The Securities
Appellate Tribunal (“SAT”) upheld this decision. On appeal, the Supreme
Court too upheld the decision. Now, let us consider the background of
the law, then the more detailed facts, the decision of the Supreme Court
and the areas of contention.

What do the Takeover Regulations provide?

The
Takeover Regulations, since their inception, are based on a particular
concept. Whoever acquires a listed company (control or substantial
shares in it) ought to also acquire further shares from the public. The
principle behind this is that members of the public invest in the shares
of such company based on the existing promoter group. If another group
replaces the existing group, the public should have a chance to exit
with them. The other objective is to provide the public shareholders an
opportunity to sell their shares at least at the same price as the
exiting promoters. Curiously, despite several rounds of amendments, the
public shareholders are given step-fatherly treatment in one important
aspect. While the Promoters can sell 100% of their shares at a
particular price, the public shareholders cannot. Only 26% (earlier 20%)
of the share capital needs to be acquired from the public.

What happened in this case?

Nirma
lent a certain sum of money to promoters (“the Promoters”) of the
Company against pledge of shares of the Company. The promoters
defaulted. Nirma exercised the pledge and acquired the pledged shares
that triggered the open offer requirements. Nirma made an open offer at
the prescribed price to the public. However, because of findings of
multiple audits, Nirma realised that there were allegedly huge
misappropriations, understatement of liabilities, etc. Consequently, the
value of the shares was far lower than the open offer price.

Nirma
requested SEBI that it should not be required to make the open offer to
the public. Alternatively, the open offer could be at a lower than the
prescribed price nearer to the actual valuation if the alleged
misappropriations, etc. were factored in the valuation.

SEBI
rejected this request. Nirma appealed to SAT which too rejected it.
Nirma appealed to the Supreme Court, which also dismissed the appeal on
grounds discussed in the succeeding paragraphs.

Grounds why Supreme Court rejected the plea for exemption

Nirma
raised several contentions. One set of them was on legal issues. It
contended that SEBI did have general powers to grant exemption that SEBI
said it did not have. The other set of contentions was that if SEBI had
powers, the facts of the case had enough merits that SEBI ought to have
granted the exemption. The Supreme Court rejected both the contentions.

The first contention was that SEBI did have generic powers to
grant exemption. The specific grounds listed in the Regulations were, it
was contended, not exhaustive and, further, SEBI did not have power to
grant exemption on grounds similar to the specified ones but had broader
powers. The Regulations provided for three grounds for withdrawal of
open offer. First was that statutory approvals for making of the open
offer were refused. Second was that the sole acquirer, being a natural
person, had died. The third clause was “such circumstances as in the
opinion of the Board merits withdrawal”.

The contention of Nirma
was that (since the first two grounds did not apply here) SEBI had wide
and unrestricted powers under the residuary powers under the third
ground. SEBI, however, contended that its powers were ejusdem generis
the earlier powers. The present circumstances were not such that could
place pari materia with the earlier grounds and hence exemption could
not be considered.

The Supreme Court noted that Regulation 27 first provides that “No public offer, once made, shall be withdrawn”.
The exceptions to this thus shall be strictly construed. It also held
that the residuary power to grant exemption had to be considered ejusdem
generis the earlier powers. Since such powers conceived of a practical
impossibility of the open offer going further, the residuary power of
SEBI has also to be restricted to those other situations where the there
was similar practical impossibility. It held that the present
circumstances did not have any such practical impossibility. Nirma had
contended that an earlier specific ground that was deleted ought to have
been considered. This deleted ground provided that the open offer could
be withdrawn in case there was a competing bid. However, the Court
rejected this contention too.

The Supreme Court observed as follows:-

“Applying the aforesaid tests, we have no hesitation in accepting the conclusions reached by SAT that clause (b) and (c) referred to circumstances which pertain to a class, category or genus, that the common thread which runs through them is the impossibility in carrying out the public offer. Therefore, the term “such circumstances” in clause (d) would also be restricted to situation which would make it impossible for the acquirer to perform the public offer. The discretion has been left to the Board by the legislature realising that it is impossible to anticipate all the circumstances that may arise making it impossible to complete a public offer. Therefore, certain amount of discretion has been left with the Board to determine as to whether the circumstances fall within the realm of impossibility as visualised under sub- clause (b) and (c). In the present case, we are not satisfied that circumstances are such which would make it impossible for the acquirer to perform the public offer. The possibility that the acquirer would end-up making loses instead of generating a huge profit would not bring the situation within the realm of impossibility.”

Even on the issue whether the facts warranted exemption on generic grounds, if SEBI indeed had such powers, the Supreme Court answered in the negative. The Court held that Nirma’s real reason for seeking withdrawal was for avoiding economic losses. However, such a ground could not be permitted at the cost of the public shareholders. The Court noted that there were several red flags in the Company such as litigations against the Company, etc. and Nirma took the decision to acquire the shares fully conscious of these. Hence, such ground was also rejected.

The other major ground on general legal principles that a fraud vitiated any contract or obligation was also rejected.

The Court also refused to grant downward revision of price nearer to the value had the alleged siphoning off/understatement of liabilities, etc. were taken into account.

Criticism and support of the decision

The decision has been criticised on certain grounds. It was suggested the Court ought to have interpreted the powers of SEBI broadly and not applied the principle of ejusdem generis. Even if this principle was applied, it ought to have taken a broader view and taken into account the deleted ground also. All in all, it should have held that SEBI did have powers to grant withdrawal.

On merits too, criticism was made that the offeror was already subjected to loss on account of having acquired the shares from the promoters through pledge. Forcing the acquirer to suffer further loss was unfair and also resulted in unintended benefit to the public shareholders. The acquirer was victim of fraud and should not have been victimised further.

It is also stated that the law does not permit extensive due diligence by acquirers because of restrictions in Regulations relating to insider trading. In such a situation where an acquirer is handicapped, he should not be forced to carry out an acquisition when later investigation does throw up a fraud that could have been found through earlier due diligence.

It is submitted that while the circumstances were peculiar, the acquirer cannot escape the liability of making an open offer. This was a case where the acquirer acquired control and not merely 3substantial quantity of shares. The directors representing the erstwhile promoters resigned and Independent Directors were appointed. Further, though the acquisition was really in the form of exercise of pledge, it was a conscious act. Though not specified, it appears to me that these shares could have been immediately sold in the market at the then prevailing higher market price. However, the acquirer proceeded to carry out further investigations that revealed the hidden losses.

Further, effectively, the acquirer acquired shares of the erstwhile promoters but did not want to carry out the inevitable next step of acquiring shares of the public. In effect, the promoters did get money through original lending and exercise of pledge. Having acquired the controlling interest, the acquirer could not avoid the open offer that came as a package deal with it.

It is submitted that permitting exemption from making an open offer would have been a bad precedent and opened litigation in future cases where acquirers would come before SEBI on several pretexts seeking exemption and even benefitting from the sheer delay. It would be extremely unfair to allow acquisition of a controlling interest without making the public offer.

One may also recollect that the public shareholders even otherwise suffer from an inequity in takeover of companies. The promoters get to sell all their shares while only 26% (earlier 20%) of the public shareholding is to be acquired under an open offer.

Perhaps what is needed is change in law relating to pledge of shares. It is true that pledges are subject to misuse since an acquisition may be disguised as a pledge. Usually, however, financial lenders are not interested in acquiring control of a company. Thus, there is a case for amending the law to give some relief. For example, an exemption could be granted in cases where pledge is exercised but the shares so acquired are sold by way of auction within a time frame. The acquirer of shares through such sale would be required to make an open offer. If the lender does not sell within the time frame, the lender should be required to make an open offer.

Land Acquisition Rehabilitation and Resettlement Bill, 2011

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Introduction
The Land Acquisition Act, 1894 (“the Act”) provides for instances when the Government can compulsorily acquire private land for public purposes and for companies. It also provides for the manner of compensation and other incidental matters in this connection. The provisions of the Act have been found to be inadequate in addressing certain issues related to the exercise of the statutory powers of the State for involuntary acquisition of private land and property. The Act does not address the issues of rehabilitation and resettlement of the affected persons and their families. The definition of the crucial term “public purposes” is very wide and is often the subject-matter of great dispute. There have been multiple amendments to the Land Acquisition Act, 1894 not only by the Central Government but also by the State Governments. Further, there has been heightened public concern on land acquisition, especially multi-cropped irrigated land and there is no central law to adequately deal with the issues of rehabilitation and resettlement of displaced persons. As land acquisition and rehabilitation and resettlement need to be seen as two sides of the same coin, a single integrated law to deal with the issues of land acquisition and rehabilitation and resettlement was necessary.

Accordingly, to have a unified legislation dealing with acquisition of land, to provide for just and fair compensation and make adequate provisions for rehabilitation and resettlement mechanism for the affected persons and their families, the Land Acquisition Rehabilitation and Resettlement Bill, 2011 (“the Bill”) was introduced in Parliament. The Bill thus provides for repealing and replacing the Land Acquisition Act, 1894 with broad provisions for adequate rehabilitation and resettlement mechanism for the project affected persons and their families. An important milestone was crossed by the Bill when the Government managed a broad all-party consensus on this crucial legislation. Hence, let us look at some of the salient provisions of this very important Law relating to land acquisition.

Applicability of the Bill

The provisions relating to land acquisition, rehabilitation and resettlement, shall apply, when the Government acquires land,—

(a) for its own use, hold and control; or

(b) with the purpose to transfer it for the use of private companies for public purpose (including Public Private Partnership projects but not including national or state highway projects); or

(c) on the request of private companies for immediate and declared use by such companies of land for public purposes.

The provisions relating to rehabilitation and resettlement shall also apply in cases where,—

(a) a private company purchases or acquires land, equal to or more than 100 acres in rural areas or equal to or more than 50 acres in urban areas, through private negotiations with the owner of the land;

(b) a private company requests the Government for acquisition of a part of an area so identified for a public purpose:

The Bill does not apply to certain land acquisition Acts, such as:

(a) The Ancient Monuments and Archaeological Sites and Remains Act, 1958
(b) The Atomic Energy Act, 1962
(c) The Metro Railways (Construction of Works) Act, 1978
(d) The National Highways Act, 1956
(e) The Special Economic Zones Act, 2005
(f) The Electricity Act, 2003
(g) The Railways Act, 1989

Determination of Social Impact and Public Purpose

Whenever the Government intends to acquire land for a public purpose, it shall carry out a Social Impact Assessment study in consultation with the Gram Sabha in rural areas or an equivalent body in urban areas, in the affected area in such manner and within such time as may be prescribed.

Public Purpose has been defined to include the provision of land for:

(a) strategic defence purposes/national security /safety of the people;

(b) railways, highways, ports, power and irrigation purposes for use by Government and public sector companies or corporations;

(c) project affected people;

(d) planned development of villages or any site in the urban area or provision of land for residential purposes for the weaker sections or the provision of land for Government administered educational, agricultural, health and research schemes or institutions;

(e) residential purposes to the poor or landless or to persons residing in areas affected by natural calamities, or to persons displaced by reason of the implementation of any Government scheme

(f) the provision of land in the public interest for any other use or in case of PPPs (Public Private Partnership) projects with the prior consent of at least 80% of the project affected people

(g) the provision of land in the public interest for private companies for the production of goods for public or provision of public services with the prior consent of at least 80% of the project affected people. However, if public sector companies want the land for similar uses then the 80% consent condition does not apply.

To ensure food security, multi-crop irrigated land shall be acquired only as a last resort. An equivalent area of culturable wasteland shall be developed, if multi-crop land is acquired. In districts where net sown area is less than 50% of the total geographical area, no more than 10% of the net sown area of the district will be acquired. The Social Impact Assessment study shall include all the following:

(a) assessment of nature of public interest involved;

(b) estimation of affected families and the number of families among them likely to be displaced;

(c) study of socio-economic impact upon the families residing in the adjoining area of the land acquired;

(d) extent of lands, public and private, houses, settlements and other common properties likely to be affected by the proposed acquisition;

(e) whether the extent of land proposed for acquisition is the absolute bare-minimum extent needed for the project;

(f) whether land acquisition at an alternate place has been considered and found not feasible;

(g) study of social impact from the project

It remains to be seen whether such a Study delays the land acquisition process. The Study should be evaluated by an independent multi-disciplinary expert group constituted by the Government.

If the land sought to be acquired is 100 acres or more, then the Government must constitute a Committee to examine the land acquisition proposals. It would be headed by the Chief Secretary of State/ Union Territory. The role of the Committee would be to ensure the following:

(a) there is a legitimate and bona fide public purpose for the proposed acquisition which necessitates the acquisition of the land identified;

(b) the public purpose referred shall on a balance of convenience and in the long term, be in the larger public interest so as to justify the social impact as determined by the Social Impact Assessment that has been carried out;

(c) only the minimum area of land required for the project is proposed to be acquired;

(d) the Collector of the district, where the acquisition of land is proposed, has explored the possibilities of—

(i) acquisition of waste, degraded or barren lands and found that acquiring such waste, degraded or barren lands is not feasible;

(ii) acquisition of agricultural land, especially land under assured irrigation, is only as a demonstrable last resort.

Acquisition Process

Whenever it appears to the Government that land in any area is required or likely to be required for any public purpose, a preliminary notification to that effect along with details of the land to be acquired in rural and urban areas shall be published.

The notification shall also contain a statement on the nature of the public purpose involved, reasons necessitating the displacement of affected persons, summary of the Social Impact Assessment Report and particulars of the Administrator appointed for the purposes of rehabilitation and resettlement.

No person shall make any transaction or cause any transaction of land specified in the preliminary notification or create any encumbrances on such land from the date of publication of such notification till such time as the proceedings under this Chapter are completed.

Where a preliminary notification u/s. 11 is not issued within 12 months from the date of appraisal of the Social Impact Assessment report submitted by the Expert Committee, then, such report shall be deemed to have lapsed and a fresh Social Impact Assessment shall be required to be undertaken prior to the acquisition proceeding.

Where no declaration is made u/s. 19 within twelve months from the date of preliminary notification, then such preliminary notification shall be deemed to have been rescinded.

Any person interested in any land which has been notified, may object within 60 days from the date of the publication of the preliminary notification.

The decision of the Government on the objections made shall be final.

Upon the publication of the preliminary notification by the Collector, the Administrator for Rehabilitation and Resettlement shall conduct a survey and undertake a census of the affected families.

The Administrator shall, based on the survey and census, prepare a draft Rehabilitation and Resettlement Scheme as prescribed, which shall include particulars of the rehabilitation and resettlement entitlements of each land owner and landless whose livelihoods are primarily dependent on the lands being acquired. The same shall be open to suggestions /objections in a public hearing. The Administrator shall, on completion of public hearing submit the draft Scheme for Rehabilitation and Resettlement along with a specific report on the claims and objections raised in the public hearing to the Collector.

The Collector shall review the draft Scheme submitted by the Administrator with the Rehabilitation and Resettlement Committee at the Project level. He shall submit the draft Rehabilitation and Resettlement Scheme with his suggestions to the Commissioner Rehabilitation and Resettlement for approval of the Scheme.

When the Government is satisfied that any particular land is needed for a public purpose, a declaration shall be made to that effect, along with a declaration of an area identified as the ‘resettlement area’ for the purposes of rehabilitation and resettlement of the affected families. The declaration shall be conclusive evidence that the land is required for a public purpose and, after making such declaration, the appropriate Government may acquire the land in such manner as specified under this Act.

The Collector shall thereupon cause the land to be marked out and measured, and if no plan has been made thereof, a plan to be made of the same. The Collector shall also make an award of—

(a)    the true area of the land;

b) the compensation as determined along with Rehabilitation and Resettlement award as determined; and

(c)    the apportionment of the said compensation among all the persons believed to be interested in the land.

The Collector shall make an award within 2 years from the date of publication of the declaration and if no award is made within that period, the entire proceedings for the acquisition of the land shall lapse.

Market value of land

The Collector shall adopt the following criteria in assessing and determining the market value of the land, namely:

(a)    the minimum land value, if any, specified in the Indian Stamp Act, 1899 for the registration of sale deeds or agreements to sell, as the case may be, in the area, where the land is situated; or

(b)    the average sale price for similar type of land situated in the nearest village or nearest vicinity area. The average sale price shall be determined taking into account the sale deeds or the agreements to sell registered for similar type of area in the near village or near vicinity area during immediately preceding 3 years of the year in which such acquisition of land is proposed to be made. For this purpose, 50% of the sale deeds in which the highest sale price has been mentioned shall be taken into account.

whichever is higher:

The market value calculated as per sub-section (1) shall be multiplied by a specified factor. For instance, it is 2 in rural land, 1 in urban area land, etc. Thus, only value in rural areas is doubled.

The Collector having determined the market value of the land to be acquired shall calculate the total amount of compensation to be paid to the land owner (whose land has been acquired) by including all assets attached to the land. For determining the market value of the building and other immovable property attached to the land, the Collector may use the services of an Engineer/Other Specialists. Similarly, for assessing the value of crops, trees, plants, attached to the land, the Collector can use the services of an experienced person in the field of agriculture, etc.

The Collector having determined the total compensation to be paid, shall, to arrive at the final award, impose a ‘Solatium ’ amount equivalent to 100% of the compensation amount. The solatium amount shall be in addition to the compensation payable to any person whose land has been acquired. Thus, it is like an additional compensation.

The provisions of the Income- tax Act are also relevant in this respect. Section 45(4) of the Act provides that where capital gains arises from the compulsory acquisition of a capital asset under any law, then the compensation awarded in the first instance shall be taxable in the year of award. If the same is enhanced subsequently, then the enhancement amount would be taxable in the year of receipt by the assessee.

R&R Provisions

The Bill contains provisions for Rehabilitation and Resettlement of Project Affected People (PAP) in case of an acquisition.

The Government may appoint an Administrator for carrying out the R&R provisions. The Government may also appoint a Commissioner for R&R. He may be appointed for supervising the formulation of R&R Schemes and for their proper implementation.

In case the land is purchased privately and is more than or equal to 100 acres within rural areas or is more than or equal to 50 acres in urban areas, then the permission of the Commissioner is required. Thus, the obligation to rehabilitate for private acquisition is only if the area acquired is 50 acres or more.

A Land Acquisition and Rehabilitation and Resettlement Authority would be established for settling any disputes relating to acquisition, compensation and R&R. This would be headed by a sitting/retired High Court Judge.

Temporary Acquisition

Whenever it appears to the Government that the temporary occupation and use of any waste or arable land are needed for any public purpose, or for a company, the appropriate Government may direct the Collector to procure the occupation and use of the same for such terms as it shall think fit, not exceeding 3 years from the commencement of such occupation.

The compensation may be either in a gross sum of money, or by monthly or other periodical payments, as shall be agreed upon in writing between him and such persons respectively.

In case the Collector and the persons interested differ as to the sufficiency of the compensation or apportionment thereof, the Collector shall refer such difference to the decision of the Land Acquisition and Rehabilitation and Resettlement Authority

Other Important Provisions

Any award for land acquisition is exempt from stamp duty.

If any land or part thereof acquired remains unutilised for a period of 10 years from the date of taking over the possession, the same shall return to the Land Bank of the Government by reversion. Whenever the ownership of any land acquired under this Act is transferred to any person for a consideration, without any development having taken place on such land, 20% of the appreciated land value shall be shared amongst the persons from whom the lands were acquired or their heirs, in proportion to the value at which the lands.

Comparison with the Act

A broad comparison of the Act vis-à-vis the Bill reveals the key differences as shown in the table:

Conclusion

The Bill is one of the most important recent laws in the real estate sector. It would have far reaching implications and consequences. Hence, it becomes essential to carefully study and understand this Law.

(2012) 54 SOT 263 (Bangalore) ITO vs. Mahaveer Calyx ITA Nos.153 & 998 (Bang.) of 2011 A.Ys.2007-08 & 2008-09. Dated 31-08-2012

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Section 80-IB of the Income-tax Act 1961 – Deduction available even if sold area exceeds approved area and assessee has not paid fees to regularise the same.

Facts

For the relevant assessment year, the Assessing Officer disallowed the assessee’s claim for deduction u/s. 80-IB since the built-up area sold by the assessee was in excess of the sanctioned area. The Assessing Officer, therefore, held that the project constructed by the assessee was not an approved housing project. Before the CIT(A), the assessee contended that though it had not made payment of the compounding fee for regularisation of the excess area constructed, it could not be said that the housing project was not approved. The CIT(A) held that the assessee was entitled for deduction u/s. 80IB(10).

Held

The Tribunal, relying on the decisions in the following cases, held that the CIT(A)’s order in favour of the assessee was in accordance with law: a. Petron Engg. Construction (P.) Ltd. V CBDT (1989) 175 ITR 523/(1988) 41 Taxman 294 (SC) b. Pandian Chemicals Ltd. V CIT (2003) 262 ITR 278/129 Taxman 539 c. CIT V N.C. Budharaja & Co. (1993) 204 ITR 412/10 Taxman 312 d. IPCA Laboratories Ltd. V Dy. CIT (2004) 266 ITR 521/135 Taxman 594 The Tribunal noted as under : It was clear that the assessee has fulfilled the conditions mentioned in section 80-IB(10). The assessee has obtained approval of the concerned local authorities for construction of a housing project. The fact that the compounding fee for regularisation of the excess area constructed by the assessee has not yet been paid would not mean that the housing project constructed by the assessee is unlawful. Thus, there was no violation of the provisions of section 80-IB.

The incentive provisions must be interpreted in a manner which advances the object and intention of Legislature. The fact that the assessee has obtained approval for the housing project cannot be lost sight of. As for the excess area constructed, it is for the local authority to look into the violations, if any, in the construction of the housing project. That, however, does not authorise the Assessing Officer to hold that the assessee has not got approval for the housing project or that the conditions laid down in section 80-IB(10) violated.

Therefore,the assessee was entitled to deduction u/s. 80-IB(10).

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Service of Notice – Presumption Rebuttable – Endorsement as “Refused” – The respondent as the plaintiff filed suit alleging that the defendant was a monthly tenant. [Section 114 (e) Evidence Act]

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Kanak Pramanik vs. Indrajit Bandopadhya AIR 2013 Calcutta 60

Defendant defaulted in payment of rent and accordingly plaintiff sent a notice u/s. 106 of the Transfer of Property Act under registered post with A/D asking the defendant to quit and vacate the suit premises on expiry of the month of Agrahayan 1395 B. S. The defendant refused to accept such notice and did not also vacate the suit premises. Accordingly, the suit for ejectment and recovery of khas possession with consequential reliefs was filed.

The Appellant/defendant contested the said suit by filing a written statement denying the material allegations of the plaint and contending inter alia that the defendant was a tenant under the plaintiff’s father Haripada Banerjee and that on the death of Haripada Banerjee, all his heirs became joint landlords and that the plaintiff was not the sole landlord and had no authority to file said ejectment suit as the sole landlord. It was further alleged that defendant did not receive any notice and that plaintiff managed to obtain a postal endorsement “refused” in collusion with postal peon.

The Trial Court framed several issues including an issue as to whether there was relationship of landlord and tenant between the parties and whether the notice u/s. 106 of the Transfer of Property Act was legal, valid and sufficient and was duly served upon the defendant. After hearing the Trial Court decreed the suit for ejectment observing that the defendant was a tenant under the plaintiff and that the notice u/s. 106 of the Transfer of Property Act was legal, valid and sufficient and that on account of refusal on the part of the defendant to accept the same it amounted to good service.

The Hon’ble Court observed that now it is settled law that once a notice is sent under registered post with A/D with proper stamp and proper address and is returned with an endorsement of the postal peon “refused” then there is a presumption of tender and refusal amounting to a good service of notice. However, said presumption is rebuttable. If the addressee denies said tender and alleged refusal on his part in his pleadings as well as in his evidence and the same is found believable to the Courts then the presumption of service will be deemed to be sufficiently rebutted. In that case, the onus will shift back to the addressor for proving such alleged tender and refusal by calling the postal peon to the witness box.

In the case in hand, admittedly the appellant tenant took specific plea not only in his written statement but also in his evidence that there was no tender of said notice to him by the postal peon and as such there was no question of refusal on his part to accept the same. The Courts below, however, refused to accept his version on the ground that he did not file any document to show that he was present in his office on that day. The respondent landlord has also admitted that the appellant tenant was an employee of the Government mint at Alipur. It also came out from evidence that the defendant remained absent from the suit shop room during the working period of the working days and that a barber shop was run therein through his employee Gour Chandra Pramanik. A Government employee is expected to be in his office during the office hours in a working day, in absence of any evidence to the contrary. Neither of the parties produced any evidence to show that on the relevant date of alleged tender or alleged refusal the appellant tenant was present in the said suit shop by not going to his office.

During hearing the learned counsel for the appellant tenant drew the attention of the Court to the cross-examination of the appellant landlord wherein he categorically stated that the postal peon told him that he went to the defendant’s shop room but he did not meet with him. According to the counsel, said admission of the plaintiff coupled with denial on the part of the appellant tenant belied the story of alleged tender by the postal peon to the defendant or refusal on the part of the defendant.

Section 106 of the Transfer of Property Act requires that notice to quit has to be sent either by post to the party or be tendered or delivered personally to such party or to one of his family members or servants at his residence/place of business or if such tender or delivery is not practicable, it be affixed to a conspicuous part of the property. In the case in hand, only one notice to quit was sent to the appellant tenant under registered post with A/D. It returned with the endorsement of the postal peon “refused”. The appellant tenant took specific plea not only in his written statement but also in his evidence that the postal peon did not tender any notice to him and accordingly there was no question of refusal on his part to accept the same. It also came out from evidence that the suit premises is a barber shop being run by appellant tenant through an employee Gour Chandra Pramanik. As such even in the absence of the appellant tenant if the postal peon tendered the notice to his employee Gour Chandra Pramanik to be refused to be accepted by Gour still it might amount to refusal on the part of the tenant treating it to be good service of notice. But there is no evidence to that effect also from the side of the respondent landlord. Rather the appellant tenant also examined said employee Gour Chandra Pramanik who categorically stated that on the relevant date i.e. 17-10-1988 postal peon did not visit said barber shop for service of the notice nor to speak of tendering the same to him. Said evidence remained unshaken in spite of cross-examination. In view of the aforesaid evidence on record it is palpable that the appellant tenant was able to rebut the presumption of due service in view of postal endorsement “refused” on the envelope of notice and that it was a duty of the respondent landlord to produce the postal peon on the dock to discharge the burden of proving the service of the notice.

Proper service of notice to quit is the very backbone of a suit of ejectment filed under the Transfer of Property Act. In this case, the deemed service of notice in view of postal endorsement “refused” is found to be not acceptable. As such, the Ejectment Decrees passed by learned Courts below banking on said deemed service of notice were not sustainable in law. As a result, the appeal was allowed.

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Partnership firm – Legal entity – Income-tax Return (Income Tax Act, 1961 Section 184)

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PBR Select Infra Projects, Rep by Partner vs. Commissioner of Tenders and Anr. AIR 2013 NOC 126 AP

The Hon’ble Court observed that for the limited purpose of the Act, a firm is conferred legal recognition as an entity and the Act made its assessment compulsory. But, I do not find any conceivable reason why the Income-tax returns of such a firm shall not be made use of by its partners for the purpose of satisfying the prequalification criteria of a tender document. Even if individual partners are liable for getting their individual incomes separately assessed u/s. 10 of the Act, in the absence of any legal bar under the provisions of the Act, there can be no reason for preventing a partner of a partnership firm from filing the Income-tax returns of the firm for the purpose of showing his turnover, financial capacity and other requirements as prescribed by the tender conditions.

The Court observed that the fiction introduced in section 184 of the Act, whereby a legal status is conferred on a partnership firm, cannot be extended to destroy the legal relationship between the partners and the firm. Such a water-tight compartment can be presumed only when the question of compliance with the requirement of section 184 of the Act arises. For instance, where a firm was not assessed under the Act and its partners who got their individual incomes assessed separately plead that the assessments in their individual capacity shall be deemed to be the assessment of the firm, section 184 can be pressed into service to negate such stand of the partners. But once the firm is assessed under the Act, such assessment would, enure to the benefit of its partners for the purposes such as the present one, where proof of assessment of the tenderer is required.

With regard to the second submission, respondent No. 3 filed the VAT clearance for the immediately preceding year in which the tender was called. However, along with the VAT clearance certificate dated 21-01-2011, respondent No. 3 has filed the VAT Returns Report dated 27-01-2012 of the Commercial Tax Department for the period from December 2010 to December 2011. This Report needs to be read along with the VAT clearance certificate dated 21-01-2011. None of the respondents have disputed the authenticity of the VAT Returns Report, which were up to December 2011, i.e., a couple of months prior to the issuance of the tender notification. In this view of the matter, the tender conditions is duly satisfied and hence the technical bid of respondent No. 3 is not liable for rejection on a hyper-technical ground that the formal latest VAT clearance certificate was not filed by him.

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Foreign Judgement – Insolvency proceedings – Initiation of in India directly without any testing or filtration provided in CPC for execution of foreign decree in India – Not permissible: [Code of Civil Procedure 1908 section. 13, 14, 44A].

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Abraaj Investment Management Ltd vs. Neville Tuli & Ors. AIR 2013 (NOC) 91 (Bom.)

The CPC provides specific provisions for execution of the decree passed by the court in reciprocating territory. The reciprocating territory means the territory as is defined u/s. 44-A of the CPC. It is clear even from the specific provision that any foreign judgment or decree cannot be put for execution unless there is reciprocating agreement or treaty as contemplated. The national or international treaties and or conventions and or agreements have their own value for the purposes of inter-border transactions and various such jurisdictional aspects. Everything is under control of the respective provisions of the respective States and the countries. Nothing is free and or no one can take any steps in any country without the sanction/ permission and or the filtrations so contemplated under the respective acts of the country. Section 13 of CPC contemplates when a foreign judgment shall be conclusive so that appropriate suits and or proceedings can be initiated by the concerned court/ parties in India. It provides the procedure to be followed before accepting the foreign judgment’s conclusiveness. It also means the merits of such judgments. Section 14 of CPC contemplates presumption so far as the foreign judgments are concerned. Section 114 of the Evidence Act deals with the presumptive value, even of the foreign judgment. The concept of presumption itself means that it is always rebuttable if a case is made out. Therefore, merely because it is a foreign judgment and or decree, that itself is not conclusive judgment for the purpose of final execution in India. Both required pre-testing or pre-filtrations as provided under the CPC and other relevant laws and rules. There are no provisions whereby any party/person can directly invoke the insolvency Act, based upon such foreign ex-parte judgment/decree. Even the foreign award cannot be executed in such fashion in India. It is also subject to the procedural filtration and the challenge.

The concept of execution of any decree and or order is different than initiation of the insolvency action based upon the decree or order. If these two concepts are totally different then it is difficult to accept the submission that for the initiation of the insolvency proceedings, no steps or permission and or the filtrations is necessary, as there are no specific boundaries or rules to restrict the same.

Once the insolvency notice is issued and if not complied with, the consequences are quite disastrous. The Insolvency Act provides various consequences in case the party in spite of service of insolvency notice failed to comply with the same. The act of insolvency in the commercial world has its own effect to destroy and or hamper the name, fame and the market and the business. Once the act of insolvency is committed, the declaration will be “for all the debtors” though action was initiated by the party for recovery of their respective monetary claims. The concept of “action in rem” and its effect just cannot be overlooked even at this stage, while considering the scheme of the insolvency Act.

In view of the Insolvency Act, the officer/official assignee based upon the averments made by the decree holder and believing the certified copies and or copies of the foreign judgment and or decree thought it to be correct and binding even on merit and issued the insolvency notice. The debtor after receipt of the same if failed to comply with the same, asked to face the consequences. For execution of a foreign decree, the filtration is provided and it is difficult for the party to execute the foreign judgment and or decree in India without following the procedure of law how the official assignee can initiate insolvency notice straightway on the basis of such foreign judgment by treating the same to be a final decree or order passed by the foreign court. Admittedly, there is nothing under the Insolvency Act and or CPC which permit and or entitles any one to put such foreign decree or judgment as the basis for initiating the insolvency proceedings in such fashion. If there are no provisions there is no permission. The Indian Court under the Insolvency Act is not empowered and or authorised to initiate insolvency proceedings in such fashion directly on the basis of the foreign judgment and or order.

The Court observed that such initiation of insolvency proceedings based upon a foreign judgment and or decree directly without any testing and or filtration as available for execution of the foreign decree in India will create more complications because of its various multifaceted problems and the situations. The initiation of such proceedings itself is not sufficient.

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2013 (31) STR 343 (Tri.– Bang) Ambience Constructions India Ltd vs. Comm. of ST, Hyderabad

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Refund of service tax paid under mistake of law – limitation period of section 11B is applicable.

Facts:
The Appellant, engaged in providing services of lodging and boarding in a hotel, paid service tax on 16-01-2008 under the category of “Renting of immovable property”. Since the taxing entry specifically excluded the said activity, the Appellant filed a refund claim on 28-01-2009 by virtue of payment under mistake of law.

Held:
The Hon. Tribunal relying on Mafatlal Industries vs. UOI 1997 (89) ELT 247 (SC) dismissed the appeal and held that since the provisions of law excluding the said activity existed while the payment was made and also when the refund claim was filed, the provisions of section 11B relating to time bar cannot be ruled out on the pretext of “payment under mistake of law” and the refund was eligible for rejection.

(Note: When tax was paid where there was no liability to pay, the Hon. High Courts have decided in favour of the assessees in Natraj & Venkat Associates 2010 (17) STR 3 (Mad.) and in KVR Constructions 2012 (26) STR 195 (Kar.))

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2013 (31) STR 370 (Tri.-Chennai) Amalgamations Repco Ltd vs. C. C. Ex, Chennai

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CENVAT credit – period prior to Notification No. 17/2009-ST dated 07-07-2009 – CHA and other services availed by manufacturer for exports – credit admissible

Facts:
The Appellant-manufacturers- availed CENVAT credit of service tax paid on CHA and other services used at ports for exporting goods, prior to the introduction of Notification No. 17/2009-ST dated 07-07-2009.

The department denied the CENVAT credit on the grounds that such services did not have any nexus with the manufacture and that the business activities sought to be included in the extended definition of input service did not include services rendered in the port area.

Held:
Considering various decisions of coordinate Benches and High Courts, the Hon. Tribunal allowed the appeal and held that it was the policy of the Government not to burden the export goods with domestic taxes and thus, the exporters were either exempted from taxes or were provided for alternative schemes of rebate/drawback of duties etc. Notification No. 17/2009–ST dated 07-07-2009 granted exemption to various taxable services provided to an exporter. Since the period involved was prior to the said notification date, the only way of following the EXIM policy and freeing export goods from domestic taxes is to allow the credit of service tax paid in respect of such consignments.

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2013 (31) STR 300 (Tri.-Ahmd) Gujarat Co- 0p. Milk Mktg. Federation Ltd. vs. CCE, Vadodara:

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Refund – Technical testing & analysis service used for export of goods – Absence of written contract between exporter and importer – No refund admissible.

Facts:
The Appellant, an exporter of goods, filed a refund claim for service tax paid on technical testing & analysis service. The Respondent rejected the said refund claim on the ground that the Notification provided for the existence of written agreement/ contract for such technical testing/analysis before export of goods which the appellant had not entered.

Held:
Since there was an absence of written contract between the Appellant and foreign party for technical testing of goods before export and also that there was no reference in the export order for the prerequisite of testing, the appeal was rejected.

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2013 (31) STR 285 (Tri.-Ahmd) Comm. of ST vs. Krishna Communications

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CENVAT credit – output servioces written off as bad debts – No reversal of CENVAT credit is required.

Facts:
The respondents providing advertising services were duly registered with the department and discharged service tax liability as and when the payments were received. The amounts already billed but subsequently found irrecoverable, were written off by it as bad debts.

The department demanded reversal of proportionate CENVAT credit taken on input services on account of such output service invoices being written off as bad debts which the Commissioner (Appeals) dropped holding that credit on input services was taken correctly and that the said input services were used for providing output services liable for payment of service tax.

The appellants contended that the value of bad debts constituted only 0.8% and that the eligibility of availment and utilisation the credit was not in question.

Held:
Observing that there cannot be one-to-one corelation for availing and utilising CENVAT credit of input services with provision of output service, the Hon. Tribunal held that the reasoning of the first appellate authority was correct and in consonance with the law and requires no interference and thus, rejected revenue’s appeal.

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2013-TIOL-1068-CESTAT-MUM Magarpatta Township Development & Construction Co. Ltd. vs. Commissioner of Central Excise, Pune-III

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Valuation – Notional interest on Interest-free security deposit, whether amounts to additional additional consideration – Held, No.

Facts:
The appellant provided renting of immovable property services and collected interest-free security deposit from the lessees for the damages, if any, caused to the property. The department contended to levy tax along with interest and penalty on the notional interest on security deposit considering it as an additional consideration for the provision of service. Relying on the decision of ISPL Industries Ltd. 2003 (154) ELT 3 (SC), the appellant contended that there was no evidence on record which proved that the security deposit in any way influenced the rent of property leased out and it was merely a presumption on part of the department.

Held:
Applying the case of ISPL Industries Ltd. (supra), the Hon. Tribunal observed that there was no evidence on record to prove that the notional interest on interest-free security deposit influenced the consideration received by the appellant and thus granted full waiver from pre-deposit.

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2013-TIOL-1261-CESTAT-MUM Laxmi Tyres vs. Commissioner of Central Excise, Pune

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Valuation – re-treading of tyres – Notification No.12/2003-ST dated 20-06-2003 – whether ‘sale’ includes ‘deemed sale’ Held “No’ – gross amount charged liable to tax.

Facts:
The Appellant was engaged in retreading of tyres and thus claimed the benefit of Notification No.12/2003-ST dated 20-06-2003 by deducting approximately 70% as material cost on which sales tax/VAT was paid and service tax was paid only on 30% of the remaining value.

Relying on Aggarwal Colour Advance Photo System 2011-TIOL-1208-CESTAT-DEL-LB which stated that the term ‘sold’ appearing in the said notification was to be interpreted using the definition of ‘sale’ in the Central Excise Act, 1944 and not as per the meaning of deemed sale under Article 366 (29A) (b) of the Constitution the department contented that tax was payable on the entire amount.

The appellant relied on the cases of Chakiti Ranjini Udyam 2009 (16) STR 172 (Tri-Bang) and PLA Tyre Works 2009 (14) STR 32 (Tri-Chennai) in support of its contentions.

Held:
Perusing the sample invoice issued by the appellant and relying on the larger Bench’s decision in Aggarwal Colour Advance Photo System (supra), the Hon. Tribunal disposed the appeal and held that the appellant was not eligible for the benefit of Notification No. 12/2003-ST and liable to discharge service tax liability on the gross amount charged for the said transaction.

(Note: Further, an application for Rectification of Mistake was filed by the appellant to consider the aspect of time bar not considered at the time of hearing of appeal which was dismissed by the Hon. Tribunal as the same would tantamount to ‘review’ of own order which is not permissible under law-2013-TIOL-1345-CESTAT-MUM).

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2013-TIOL-1295-CESTAT-MAD M/s. C. H. Robinson Worldwide Freight India Pvt. Ltd. vs. Commissioner of Service Tax, Chennai

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Stay – Taxability of ocean freight collected by multi-modal transporter – whether ‘reimbursement of expenditure while provoding Business Support Service’ or ‘Business Auxiliary Services’ – Held – neither reply to SCN nor OIO provide a clear picture of activity – ordered pre-deposit of part amount.

Facts:
The appellant, a multi-modal transporter, charged service tax under heads like terminal handling, bill of lading, agency charges etc., and diligently discharged the same under the category of “Business Support Services”. They also collected ocean freight on which no service tax was paid. The department contended to levy tax on the same considering it as reimbursable expenditure and thus issued SCN and demanded tax on such value of ocean freight under the category of “Business Support Service” which the adjudicating authority confirmed under the category “Business Auxiliary Service”.

Relying on the decision of O.K. Play (India) Ltd. 2005 (180) ELT 300 (SC), the department contended that the said service was rightly classified under “Business Auxiliary Service” and further relied on Leaap International Pvt. Ltd. which ordered a pre-deposit in a similar case under the category “Business Auxiliary Service”.

The appellant contended that 1) the order of the Adjudicating Authority was beyond the scope of the SCN, 2) there was no taxing entry under the Finance Act, and 3) Rule 5 of the Service Tax (Determination of Valuation) Rules, 2006 was struck down in the case of Intercontinental Consultants and Technocrafts Pvt. Ltd. and thus no demand was warranted.

Held:
Referring to the submissions made by the appellant, the Hon. Tribunal stated that the reply to the SCN and order-in-original did not provide a clear picture of the activity and thus ordered a pre-deposit of part amount.

(Note: The Hon. Tribunals, on similar facts, allowed the appeal in Interocean Shipping Company vs. CST, Delhi (2012) 28 Taxamann. com 238 (New Delhi – CESTAT); remanded the matter in Agility Logistics Pvt. Ltd. vs. CST–30 Taxmann.com 382 (Chennai– CESTAT); and granted full waiver of pre-deposit in M/s. Freight Systems Pvt. Ltd vs. CST, Chennai 2012-TIOL-1558-CESTAT-Mad).

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2013-TIOL-1270-CESTAT-MAD Thiru Arooran Sugars Ltd. vs. Commissioner of Central Excise, Tiruchirapalli.

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CENVAT Credit—’rent a cab service’, ‘telephone service’ and ‘contract bus service’ – no distinction between services used at factory and corporate office and both are eligible CENVAT credit.

Facts:
The Appellant, a manufacturer, availed CENVAT of “Rent-a-cab Service”, “Telephone Services” and “Contract Bus Services” received at the corporate office against which the department demanded tax, interest and penalty.

The department contended that providing “rent-acab service” for officers at the corporate office was a welfare activity and not related to manufacturing. It further contended that the said services do not fall within the inclusive portion of the definition and argued that unless proved that the said services were essential for the manufacture, they cannot be considered as input services.

Held:
Allowing the appeal, the Hon. Tribunal held that:

• As many Courts and Tribunals have already held earlier, rent-a-cab service is covered under the definition of “input service” and that it also includes the transportation of executives and employees from residence to corporate office and back.

• All the three services (supra) are covered by the definition of input service and that no distinction can be made between the factory and corporate office as per the provisions of the CENVAT Credit Rules, 2004.

• Where the expenditure is incurred by the company in its books of accounts there is a presumption in favour of the appellant that the service is availed in relation to its business and thus no nexus is required to be proved so long as Revenue did not contend anything to the contrary.

(Note: In a similar case in 2013 (31) STR 441 (Tri-Bangalore) Emcon Technologies India Pvt. Ltd. vs. Commissioner of C. Ex., Bangalore also the Hon. Tribunal allowed the credit of rent-a-cab service. Further, in case of rent-a-cab service, the issue pertains to the period prior to 01-04-2011, i.e., prior to amendment of definition of “input service”).

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2013-TIOL-1322-CESTAT-MUM M/s Seva Automotive Pvt. Ltd. vs. CCE, Nagpur

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Valuation – value of spare parts sold during rendering of service not to be included in transaction value – matter remanded.

Facts:
The department contended to levy tax on the value of spare parts sold during rendering of services which were charged separately in the bill/ invoice and on which VAT/sales tax liability was also discharged. 

Held:
Relying on the Board Circular dated 23-08-2007 and on the decisions of Ketan Motors Ltd. and Sudarshan Motors, the Hon. Tribunal allowed the appeal by way of remand and held that the cost of spare parts sold during the rendering of service cannot form part of the transaction value.

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2013-TIOL-834-CESTAT-DEL M/s. Cerebral Learning Solutions Pvt. Ltd. vs. Commissioner of Central Excise, Indore.

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Commercial training and coaching services – validity of CBEC Circular No. 59/8/2003-ST dated 20-06-2003 vis-a-vis Exemption Notification No.12/2003-ST dated 20-06-2003 – Held, circular is ultra vires.

Facts:
The Appellants provided “Commercial Training & Coaching Services” and composed and furnished course materials relevant to the coaching to its students. Relying upon Notification No.12/2003-ST dated 20-06-2003 granting exemption to the value of goods or materials sold, the Appellants separately raised an invoice of the materials sold and did not charge service tax on the same.

Relying on Circular No. 59/8/2003-ST dated 20-06- 2003 which stated that the Exemption Notification was applicable only where the value of the course material met the description of the standard textbooks which were priced, the department contended to levy tax along with interest and penalty on the said value of supply of materials.

Held:
Considering the circular to be misconceived, illegal and contrary to the statutory Exemption Notification dated 20-06-2003, the Hon. Tribunal stated that where the legislature had spoken in exercise of its statutory power exemption granted by the Central Government u/s. 93 of the Act, the CBEC had no manner of power, authority or jurisdiction to deflect the course of an enactment or the exemption granted. Grant of exemption from the liability to tax was a power exclusively authorised to the Central Government and no participatory role to the Board. In seeking to restrict the generality of the exemption granted by the Central Government, the CBEC transgressed into the domain of the Central Government which was clearly prohibited.

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2013 (31) STR 334 (Tri.– Ahmd) Chowgule & Co. (Salt) Pvt. Ltd. vs. CCEx., Rajkot

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Refund – wrong classification- service tax paid under category notified under Notification – Refund claim allowed.

Facts:
The
Appellant filed a refund claim under Notification No. 17/2009 –ST,
dated 07-07-2009 in respect of service tax paid on stevedoring &
documentation charges classified by the vendor under “Other Port
Services”. The department contended that since the said charges were
classifiable under “Cargo Handling Services” as per the Karnataka High
Court decision in case of M/s. Konkan Marine Agencies 2009 (13) STR 7
(Kar), the refund was liable to be rejected.

Held:
Examining
the notification, the Hon. Tribunal observed that the refund claim was
required to be sanctioned where service tax was paid under the category
of services notified under the notification. The service providers were
registered under the category of “Other Port Services” which was
notified in the said notification and thus, the appeal was allowed

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A. P. (DIR Series) Circular No. 113 dated 24th June 24, 2013 External Commercial Borrowings (ECB) for low cost affordable housing projects

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Presently, Developers/Builders, Housing Finance Companies (HFC) & National Housing Bank (NHB) can avail of ECB for financing low cost affordable housing under the Approval Route.

This circular has modified the guidelines as under: –

General
The aggregate limit for ECB under the low cost affordable housing scheme for the financial years 2013-14 and 2014-15 has been fixed at $1 billion per year. This limit will be reviewed thereafter.

Developers/Builders
i. Developers/builders must have at least 3 years’ experience in undertaking residential projects (as against the earlier requirement of 5 years’ experience) and must also have a good track record in terms of quality and delivery.

ii. The ECB availed of must be swapped into Rupees for the entire maturity on fully hedged basis.

National Housing Bank (NHB)
NHB must decide the interest rate spread after taking into account cost and other relevant factors. However, NHB has to ensure that interest rate spread for HFC for on-lending to prospective owners’ of individual units under the scheme is reasonable.

Housing Finance Companies (HFC)
Henceforth, HFC are required to have minimum Net Owned Funds (NoF) of Rs. 300 crore for the past three financial years only, as the condition requiring a minimum paid-up capital of not less than Rs. 50 crore, as per the latest audited balance sheet has been withdrawn by this circular. HFC while making the application for ECB must:

i. Submit a certificate from NHB that ECB is being availed for financing prospective owners of individual units for the low cost affordable housing.

ii. Ensure that the cost of such individual units does not exceed Rs. 30 lakh and loan amount does not exceed Rs. 25 lakh.

iii. Ensure that the units financed have a maximum carpet area of 60 square metres.

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Section 199 – Assessee entitled to TDS credit based on the evidences even if the same is not shown in Form 26AS

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Section 199 – Assessee entitled to TDS credit based on the evidences even if the same is not shown in Form 26AS

Facts:

In the original return filed the assessee claimed TDS of Rs. 165.21 crore. In the revised return, the assessee made further claim of TDS of Rs. 1.43 crore. Thereafter, during the course of the assessment proceedings, it claimed further sum of TDS of Rs. 3.57 crore by its letter dated 28-12-2010. The AO, however, gave credit of TDS only to the extent of Rs. 11.9 crore, the amount as appearing in Form 26AS. On appeal, the CIT(A) directed the AO to give credit of TDS as per original challans available and/ or the details available in the computer system of the department.

The assessee had also claimed petitioned that it is entitled to interest on excess amount of TDS and in case the interest is not granted by due date, it was entitled to interest on delayed payment of interest.

Held:

The tribunal referred to the Bombay high court decision in the case of Yashpal Sawhney vs. ACIT (293 ITR 539) where it was held that even if the deductor had not issued a TDS certificate, the claim of the assessee has to be considered on the basis of the evidence produced for deduction of tax at source. Further, the tribunal noted that the Delhi High Court has also in Court On Its Own Motion vs. CIT 352 ITR 273 directed the department to ensure that credit is given to the assessee even where the deductor had failed to upload the correct details in Form 26AS, on the basis of evidence produced before the department. Therefore, the tribunal allowed the appeal of the assessee on this point and held that the department is required to give credit for TDS once valid TDS certificate had been produced or even where the deductor had not issued TDS certificates on the basis of evidence produced by assessee regarding deduction of tax at source and on the basis of indemnity bond.

As regards the claim for interest on delayed payment of interest, the tribunal relying on the decision of the Supreme court in the case of Sandvik Asia Ltd. vs. CIT (280 ITR 643) held in favour of the assessee.

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Reassessment: Limitation: Exclusion from limitation: S/s. 147, 148, 149 and 150: A.Ys. 1999-00 to 2002-03: Reassessment pursuant to order of appellate authority in case of third party: Condition precedent for exclusion of limitation: Assessee must be given opportunity to be heard: Order of Tribunal in case of third party holding that interest income belonged to assessee: Notice for reassessment beyond six years to assessee without giving opportunity to be heard: Notice barred by time:

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Rural Electrification Corporation Ltd. vs. CIT; 355 ITR 345 (Del):

The assessee advanced loans to a co-operative society which created a special corpus fund. The society earned interest on the special fund but did not disclose it in its return of income on the ground that the money actually belonged to the assessee and that any income earned thereon was on behalf of the assessee. The Tribunal agreed with the submissions of the society and held that the interest was not taxable in the hands of the society but ought to be taxed in the hands of the assessee. On the basis of the said observations of the Tribunal the Assessing Officer issued notices u/s. 148 of the Income-tax Act, 1961 on 23-03-2011 for reopening the assessment for the A.Ys. 1999-00 to 2002-03.

The Delhi High Court allowed the writ petition filed by the assessee, set aside the notices issued u/s. 148 and held as under:

“i) Before a notice u/s. 148 can be issued beyond the time limit prescribed u/s. 149, the ingredients of Explanation 3 to section 153 have to be satisfied. Those ingredients require that there must be a finding that income which is excluded from the total income of one person is income of another person. The second ingredient is that before such a finding is recorded, such other person should be given an opportunity of being heard.

ii) When the Tribunal held in favour of the society concluding that the interest was not taxable in its hands and that the interest ought to have been taxed in the hands of the assessee, an opportunity of hearing ought to have been given to the assessee. No opportunity of hearing was given to the assessee prior to the passing of the order by the Tribunal in the case of the society.

iii) As such, one essential ingredient of Explanation 3 was missing and, therefore, the deeming clause would not get triggered. Thus, section 150 would not apply and, therefore, the bar of limitation prescribed by section 149 was not lifted. In such a situation, the normal provisions of limitation prescribed u/s. 149 would apply.

iv) Those provisions restrict the time period for reopening to a maximum of six years from the end of the relevant assessment year. The notices u/s. 148 having been issued beyond the period of six years were time barred.”

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2013 (31) STR 279 (P&H) Commissioner of Central Excise, Ludhiana vs. City Cables

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Benefit of reduced penalty – non-paymeny of penalty along with service tax and interest – 2nd proviso to section 78 applicable – directed to pay only 25% of the penalty.

Facts:
The respondent was a cable operator unregistered with the service tax department. After a search was conducted, the respondent deposited the entire amount of service tax with interest thereon before the issue of show cause notice. The adjudicating authority demanded tax along with interest and penalties and the Commissioner (Appeals) set aside penalties. On appeal, the Hon. Tribunal directed the respondent to pay penalty of 25% of the service tax demanded, relying upon J.R. Fabrics 2009 (238) ELT 209 and Bajaj Travels 2011 (21) STR 497 (P&H). The revenue appealed against the said order of the Hon. Tribunal contending that the benefit of reduced penalty of 25% can be availed only if the respondent had deposited the said amount within 30 days of the order.

Held:
Relying upon the decisions of the Delhi High Court in K.P. Pouches 2008 (228) ELT 31 and J. R. Fabrics (supra), the Hon. High Court allowed the appeal and held that the respondent was required to be informed to avail the benefit of reduced penalty. Such option only could have satisfied the purpose of insertion of such benefit in the Act. Since the amount of tax was already deposited before the issue of SCN, the direction of the Hon. Tribunal was fair, reasonable and met the ends of justice.

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Know Your Customer (KYC) norms/Anti-Money Laundering (AML) standards/Combating the Financing of Terrorism (CFT)/Obligation of Authorised Persons under Prevention of Money Laundering Act, (PMLA), 2002, as amended by Prevention of Money Laundering (Amendment) Act, 2009 – Cross Border Inward Remittance under Money Transfer Service Scheme

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Authorised persons engaged in Money transfer services and their agents & sub-agents can accept, where the address on the document submitted for identity proof by the prospective customer is same as that declared by him/her current address, the same document can be accepted as a valid proof of both identity and address. However, in cases where the address indicated on the document submitted for identity proof differs from the current address declared by the customer, a separate proof of address should be obtained.

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Notification no- 52/2012 [S.O.2805(E)] dated 29th November 2012, Income tax (Fifteenth Amendment) Rules, 2012 – Amendment in Rules 11U and 11UA

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Rule 11UA is amended to interalia provide that the Discounted free cash flow method is recognised as one of the methods for valuation for the purpose of issue of shares The Capital Gains Account (First Amendment) Scheme, 2012 – Notification no. 44/2012 dated 25-10-2012
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Cash credits : Section 68: A. Y. 2004-05: Assessee sold shares and claimed to have earned capital gains: Assessee produced purchase bills of shares, letter of transfer, sale bills, accounts with brokers, purchase and sale chart and copy of quotations from stock exchange showing rate of shares at relevant time and letters from brokers confirming sale of shares: Payment of sale price was made through bank channel and not in cash: Sale transactions of shares could not be disbelieved only for reaso<

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CIT vs. Sudeep Goenka; 29 Taxman.com 402 (All)

In the A. Y. 2004-05, the assessee had showed long term capital gains on sale of shares. The Assessing Officer found that the assessee had purchased the shares for a price of Rs. 1,37,750/- in April 2002 and had sold the shares in May and November 2003 for a price of Rs. 42,34,350/-. The Assessing Officer found that the shares were sold for a price more than 30 times of the purchase price. He therefore held that the transactions are bogus. Therefore, he treated the sale price of the shares as the income from undisclosed sources u/s. 68 of the Income Tax Act, 1961. The Commissioner (Appeals) deleted the addition as the assessee had filed purchase bills of shares, letters of transfer, sale bills, accounts of brokers, purchase and sale chart, copy of quotations of Stock Exchange showing the rate of shares at relevant times and letters from broker confirming sale. On an independent inquiry, ICICI Bank informed that payment of sale price of shares was made through bank draft. Thus, documentary evidence proved that the transactions were actual and not fictitious accommodation entries. On appeal, the Tribunal upheld the order of Commissioner (Appeals).

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

“i) The Commissioner (Appeals) after considering entire evidence of record, found that purchase and sale transactions were proved. He further found that payment of the sale price was made to the assessee through bank channel and not in cash and as such, the transactions are actual transactions and not a fictitious accommodation entries.

 ii) The sale transactions cannot be disbelieved only for the reason that the assessee could not give the identity of the purchasers.”

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Income – In determining whether a receipt is liable to be taxed, the taxing authorities cannot ignore the legal character of the transaction which is the source of the receipt – Amounts collected from customers towards disputed Sales Tax liability were not kept in a separate bank account and hence formed part of business turnover and thus constituted income.

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Sundaram Finance Ltd. v. ACIT [2012] 349 ITR 356 (SC)

The assessee, a non-banking financial company, was engaged in the business of the hire purchase financing, equipment leasing and allied activities.

The assessee had filed its return of income for the assessment year 1998-99 for a total income of Rs.50,38,16,950.

The assessee had been collecting certain sums as “contingent deposit” from the leasing/hire purchase customers with a view to protect themselves from sales tax liability. These amounts were collected on ad hoc basis.The assessee did not offer such sums to tax as income on the ground that such sums were collected as contingent deposits.

The case of the assessee before the Supreme Court was that the said collection was in anticipation of sales tax liability, which was disputed. According to the assessee, in order to safeguard itself against, inter alia, the said sales tax liabilities, the assessee received Rs.36,47,585 as contingent deposits from its customers which were “refundable”, if the assessee was to succeed in its challenge to the levy of the said sales tax. According to the assessee, the sum of Rs.36,47,585 was, therefore, an imprest with a liability to refund, that the said sum had the character of “deposits” and hence, were not taxable in the year of receipt, but would be taxable only in the year in which the liability to refund the sales tax ceased [in case the assessee failed in the pending sales tax appeals).

The Supreme Court observed that it is well settled that in determining whether a receipt is liable to be taxed, the taxing authorities cannot ignore the legal character of the transaction which is the source of the receipt. The taxing authorities are bound to determine the true legal character of the transaction. In the present case, the assessee had received Rs.36,47,585 in the assessment year 1998-99. As per the statement made by learned counsel for the assessee in court, the said sum of Rs.36,47,585 was not kept in a separate interest bearing bank account but it formed part of the business turnover. In view of the said statement, the Supreme Court was of the view that there was no reason to interfere with the impugned judgment of the High Court. Applying the substance over form test, the Supreme Court was satisfied that in the present case the said sum of Rs.36,47,585 constituted income. The said amount was collected from the customers. The said amount was collected towards sales tax liability. The said amount formed part of the turnover.

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S/s. 43B & 145A – Service tax on unrealised service charges cannot be added back to the income

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3. (2013) 82 DTR 303 (Mum)
Pharma Search vs. ACIT
A.Y.: 2007-08 Dated: 2.5.2012

S/s. 43B & 145A – Service tax on unrealised service charges cannot be added back to the income


Facts:

The assessee was engaged in the business of rendering consultation in pharmaceuticals, chemicals and drugs. In the P & L A/c, the assessee has shown fees for rendering consultancy services net of service tax. The service charges of Rs. 32 lakh was not realised and outstanding at the year end. The Assessing Officer was of the view that the service tax should have been shown as receipts in the P & L A/c on the principle laid down by the Honourable Supreme Court in the case of Chowringhee Sales Bureau (P) Ltd. vs. CIT [87 ITR 542] and also as per the provisions of section 145A. The Assessing Officer made an addition of Rs. 3,91,680/- on account of service tax on the ground that the assessee ought to have made payment of the service-tax in order to claim deduction as per provisions of section 43B.

Held:

As per the service tax law, service tax is payable as and when the payments/fees for underlying service provided are realised. As the assessee has not received the sum till the end of the financial year, question of paying the same did not arise at all. If for any reason the payment for services rendered is not realised, there was no liability as to payment of service tax. Thus, the service tax law stands on a different footing as compared to other laws like Central excise or VAT.

The application of section 145A is restricted to purchase and sale of goods only, and does not extend to service contracts. Therefore, the action of the Assessing Officer in invoking provisions of section 145A and adding service-tax to gross receipts is incorrect in as much as against the very basic principles of section 145A.

The rigours of section 43B might be applicable to the case of sales-tax or excise duty, but the same could not be said to be the position in case of service tax because of two reasons. Firstly, the assessee is never allowed deduction on account of service tax which is collected on behalf of the Government and is paid to the Government account. Therefore, a service provider is merely acting as an agent of the Government. Secondly, section 43B(a) uses the expression “any sum payable”. If there is no liability to make the payment to the credit of the Central Government because of nonreceipt of payments from the receiver of the services, then it cannot be said that such service tax has become payable in terms of section 43B(a).

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Section 9 (i) (vii), Article 12 of India UK DTAA – Person exercising control and supervision real and economic employer of seconded employees – on facts payments by ICO to UK Co pure reimbursement – mere secondment does not result in rendering of services and hence not FTS – services did not make available any technical knowledge

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16. Abbey Business Services  (P) Ltd v DCIT
[2012] 53 SOT 401 (Bang)
Asst Years: 2005-06 & 2006-07. Dated: 18/07/2012

Section 9 (i) (vii), Article 12 of India UK DTAA – Person exercising control and supervision real and economic employer of seconded employees – on facts payments by ICO to UK Co pure reimbursement – mere secondment does not result in rendering of services and hence not FTS –  services did not make available any technical knowledge


Facts:

The taxpayer was an Indian subsidiary company of a foreign company (“FCo”). FCo was a group company of a British company (“UKCo”). UKCo entered into an agreement with an Indian company (“ICo”) to outsource the provision of certain process and call centres to ICo. ICo was to provide financial and insurance services to customers of UKCo in the UK.

In order to ensure that high quality services were provided by ICo, UKCo entered into a consultancy agreement with the taxpayer for which the taxpayer was to be compensated at cost plus 12 %. Further, to facilitate the outsourcing agreement between UKCo and ICo, UKCo entered into an agreement for secondment of employees (“Secondment Agreement”) from UKCo to the taxpayer.

In terms of the Secondment Agreement, secondees were under the direct management, supervision and control of the taxpayer during the period of secondment. UKCo was not responsible for any loss or damage occasioned by the works done by the secondees. Secondees performed the tasks at such place, as instructed by taxpayer. At the same time, the secondees remained employees of. UKCo during secondment. Accordingly, UKCo (and not the taxpayer) was responsible to pay remuneration and any other employment benefits to secondees. In terms of section 192 of I T Act, UKCo withheld tax at source on salaries paid to secondees.

The taxpayer reimbursed to UKCo all payments and expenses incurred by UKCo in respect of seconded employees. However, the taxpayer did not withheld taxes on the amount reimbursed to UKCo. The AO was of the view that the reimbursements made to UKCo were in the nature of FTS and hence, the taxpayer ought to have withheld taxes on the same.

In appeal, the CIT(A) held that while reimbursement of salary cost was not subject to withholding, only reimbursement of other administrative expenses was liable for withholding. The issues before the Tribunal were as follows.

1. Whether the taxpayer can be regarded as the real and economic employer of the seconded employees?

2. Whether the payments made by the taxpayer to UKCo were pure reimbursement of expenses and if so, whether they constituted income of UKCo?

3. Whether the payments made by the taxpayer to UKCo constituted FTS u/s. 9(1)(vii) of I T Act?

4. Whether the payments made by the taxpayer to UKCo constituted FTS under Article 13(4) of India-UK DTAA?

Held:

The Tribunal observed and held as follows.

(i) Whether the taxpayer can be regarded as the real and economic employer of the seconded employees. The Tribunal reviewed the Secondment Agreement to determine who was vested with control and supervision of the seconded employees. It found that the taxpayer had control of the seconded employees and if the taxpayer so required, UKCo was obligated to withdraw any seconded employee. Also, UKCo was not liable or responsible for any loss or damage caused due to work of secondees. Thus, direct control and supervision of the seconded employees vested in the taxpayer. The clause stating that UKCo was to remain the employer was for ensuring social security and other benefit to the seconded employees. Hence, UKCo was mere ‘legal employer’ while the taxpayer was ‘real and economic employer’.

(ii) Whether the payments made by the taxpayer to UKCo were pure reimbursement of expenses and if so, whether they constituted income of UKCo

The Tribunal referred to the clause of the Secondment Agreement stating that in consideration for secondment of staff by UKCo, the taxpayer shall make payments equivalent to costs and expenses incurred by UKCo in respect of seconded employees. It further referred to the relevant account in the ledger of the taxpayer as also the Notes to Accounts which stated that the taxpayer reimburse all expenses incurred by UKCo in respect of seconded employees. Hence, following IDS Software Solutions (India) (P) Ltd v ITO [2009] 32 SOT 25 (Bang) (URO), the Tribunal held that the payments were mere reimbursements of salary and other costs.

As regards the second limb of the issue (i.e., whether these payments would be regarded as income chargeable in the hands of UKCo), the Tribunal reiterated the principle laid down in the case of TISCO v Union of India [2001] 2 SCC 41 that reimbursement of salary cost and other expenses cannot be regarded as income in the hands of the recipient since there was no profit or gain element in it.

(iii) Whether the payments made by the taxpayer to UKCo constituted FTS u/s. 9(1)(vii) of I T Act To constitute FTS u/s. 9(1)(vii) of I T Act, the consideration paid should have been for rendition of managerial, technical or consultancy services. Under the Secondment Agreement, the taxpayer had paid consideration only for secondment of staff and not for rendition of any services.
Therefore, the payments made by the taxpayer did not constitute FTS.

(iv) Whether the payments made by the taxpayer to UKCo constituted FTS under Article 13(4) of India-UK DTAA. As held earlier, the reimbursement cannot be regarded as income of UKCo. Also, it does not constitute FTS u/s. 9(1(vii) of I T Act. Since a DTAA cannot impose tax which is not contemplated or levied under I T Act, question of such payments constituting FTS under India-UK DTAA does not survive. In terms of Article 13(4) of India-UK DTAA, to constitute FTS, following two conditions should be satisfied.

(a) The consideration is paid for rendering of technical or consultancy services; and

(b) Such services ‘make available’ technical knowledge, experience, skill, know-how or process or consist of the development and transfer of a technical plant or design.

UKCo has not rendered any service to the taxpayer. Hence, condition (a) would not be satisfied. Further, even if secondment were to be considered as ‘service’, it could only be ‘managerial service’ (mentioned in section 9(1(vii)). However, Article 13(4) (c) includes only technical or consultancy services. Hence, the payment fails the test in (a) above. Additionally, condition (b) requires that services ‘make available’ technical knowledge, etc. As no technical knowledge, etc. was ‘made available’ by UKCo, it also fails the test in (b) above.

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A. P. (DIR Series) Circular No. 50 dated 20th September, 2013

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Opening of Trading Office/Non-Trading Office/ Branch Office/Representative Office abroad

Presently, banks are required to submit, on halfyearly basis, a statement in Form ORA with the Regional Offices of RBI containing particulars of approvals granted for opening of Trading Office/ Non-Trading Office/Branch Office/Representative Office overseas.

This circular has done away with the requirement of filing Form ORA with the Regional Offices of RBI. However, Banks are required to maintain records of approvals granted by them for opening of Trading Office/Non-Trading Office/Branch Office/Representative Office overseas.

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Capital gain: Rate of tax: Section 112: A. Y. 2010-11: Non-residents are eligible for the benefit of 10% tax rate on long term capital gains under proviso to section 112(1): AAR should avoid giving conflicting rulings:

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Cairn UK Holdings Ltd. vs. DIT (Del); W. P. (Civil) No. 6752/2012 dated 07-10-2013:

The petitioner, a non-resident company, had transferred certain equity shares of a company CIL in the relevant year resulting in a long-term capital gain of INR532,84,251 after applying the benefit under the first proviso to section 48 of the Income-tax Act, 1961. The petitioner made an application to AAR for an advance ruling on the following question.

“Whether on the stated facts and in law, the tax payable on long term capital gains arisen to petitioner assessee on sale of equity shares of CIL will be 10% of the amount of capital gains as per proviso to section 112(1) of the Act?”

AAR accepted the plea and contention of the Revenue and held that the proviso to section 112(1) was not applicable and therefore, the petitioner cannot avail the lower rate of tax at 10% on capital gains. The reason and ratio applied was that for the proviso to section 112(1) to apply, second proviso to section 48 should be also applicable and as second proviso to section 48 was excluded and was not applicable to the petitioner, benefit of lower rate of tax at 10% was not available.

The petitioner assessee filed a writ petition before the Delhi High Court and challenged the order of the AAR. The petitioner submitted that they are covered by the proviso to section 112(1) as they are not taking benefit of indexation under the second proviso to section 48. The assets sold by them were shares listed on the Bombay Stock Exchange and National Stock Exchange. This satisfies the statutory requirement of assets to be listed securities. The proviso nowhere stipulates that if an assessee takes benefit of first proviso to section 48, the proviso to section 112(1) is not applicable. Neither does the language postulates that the assessee must be entitled to benefit of the second proviso to section 48 and only when the said proviso is applicable but not applied, that an assessee can get benefit under proviso to section 112(1) of the Act. It was further submitted that the view of the petitioner was accepted by the AAR on 01-10-2007 in Timken France SAS, In Re, reported in (2007) 294 ITR 513 (AAR), and was repeatedly followed in the subsequent decisions and even in one decision after the present impugned decision.

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

i) It is not possible to decipher the exact legislative purpose behind the proviso to section 112(1) in a categorical and unambiguous manner. However, if one squarely focuses on the words used in the proviso and interpret them without extracting or subtracting any phrase or word, a non-resident assessee is entitled to benefit of the said provision.

ii) The proviso to section 112(1) does not state that an assessee, who avails benefits of the first proviso to section 48, is not entitled to lower rate of tax at 10%. The said benefit cannot be denied because the second proviso to section 48 is not applicable. In case the legislature wanted to deny the said benefit where the assessee had taken the benefit of the first proviso to section48, it was easy and this would have been specifically stipulated. The fact that by this interpretation, a non-resident becomes entitled to double deductions by way of computation of gains in foreign currency under the first proviso to section 48 and the benefit of lower rate of tax under the proviso to section 112(1) is no reason to interpret the proviso differently.

iii) Further, as the AAR had taken a view in Timken France SAS which was followed in several cases over several years, it ought not to have taken a opposite view and brought about uncertainty in understanding the effect of the proviso to section 112(1). There should be consistency and uniformity in interpretation of provisos as uncertainties can disable and harm governance of tax laws. The AAR should follow its earlier view, unless there are strong grounds and reasons to take a contrary view.”

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Capital gains: Exemption u/s. 54F: A. Y. 2008-09: Exemption in case of investment in residential house: For claiming deduction u/s. 54F, new residential house need not be purchased by assessee exclusively in his own name: Purchase of new house in name of wife: Exemption could not be denied

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CIT vs. Kamal Wahal; 30 Taxman.com 34 (Del)

The assessee sold his joint property which gave rise to proportionate long term capital gains. He invested the sale proceeds in a residential house in the name of his wife and claimed deduction u/s. 54F. The Assessing Officer denied the claim for deduction holding that for deduction u/s. 54F, investment in residential house should be in the assessee’s name. The Commissioner (Appeals) allowed the assessee’s claim. The Tribunal confirmed the order of the Commissioner (Appeals), holding that section 54F, being a beneficial provision enacted for encouraging investment in residential houses, should be liberally interpreted.

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

“i) In CIT vs. Ravinder Kumar Arora [2012] 342 ITR 38 /[2011] 203 Taxman 289/ 15 taxmann.com 307 (Delhi), it was held that where the entire purchase consideration was paid only by the assessee and not a single penny was contributed by any other person, preferring a purposive construction against a literal construction, more so when even applying the literal construction, there is nothing in section 54F to show that the house should be purchased in the name of the assessee only.

ii) Section 54F in terms does not require that the new residential property shall be purchased in the name of the assessee; it merely says that the assessee should have purchased/constructed ‘a residential house’.

iii) Therefore, the predominant judicial view for the purposes of section 54F is that the new residential house need not be purchased by the assessee in his own name nor is it necessary that it should be purchased exclusively in his name. It is moreover to be noted that the assessee in the present case has not purchased the new house in the name of a stranger or somebody who is unconnected with him. He has purchased it only in the name of his wife.

iv) The substantial question of law is answered in favour of the assessee and against the revenue.”

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Appeal to CIT(A): S/s. 245C and 251: Appeal can be made only by assessee: Assessee cannot withdraw appeal: Order of CIT(A) allowing assessee to withdraw appeal is not valid

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M. Loganathan vs. ITO; 350 ITR 373 (Mad)

While the assessee’s appeals were pending before the CIT(A), the assessee moved the Settlement Commission for settlement of the cases. Thereafter, the assessee withdraw the appeals and the CIT(A) allowed the assessee to do so for the A. Ys. 1992-93,1993-94 and 1996-97. The Settlement Commission passed an order that by reason of the withdrawal of the appeals after the date of filing of the application, and that there was no appeal pending before the authorities, the application itself was not maintainable for the A. Ys. 1992-93,1993-94 and 1996-97. It proceeded with the settlement of the case for the A. Y. 1997-98 alone. The assessee preferred appeals before the Tribunal against the orders of the CIT(A) allowing the assessee to withdraw the appeals. The Tribunal dismissed the assessee’s appeals.

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

“i) Section 251 of the Income Tax Act, 1961, provides that the powers of the Commissioner (Appeals) extend not only to the subject matter of the appeal against the assessment, but, in a given case, it is open to him to even enhance the assessment. Thus, apart from confirming an assessment or granting relief to the assessee or cancelling the assessment, he has the power of an Assessing Officer to enhance the assessment which is under appeal before him. He has the jurisdiction to examine all matters covered by the assessment order and correct the assessment in respect of all such matters even to the prejudice of the assessee.

ii) An assessee having once filed an appeal cannot withdraw it. After filing an appeal, the tax payer could not, at his option or at his discretion, withdraw an appeal to the prejudice of the Revenue.

 iii) The Tribunal was not justified in its reasoning that the order passed by the first appellate authority allowing the withdrawal of appeal was justifiable on the facts as the Revenue had not objected to the same.

 iv) We have no hesitation in setting aside the order of the Tribunal and restoring the matter back to the file of the Commissioner of Income Tax (Appeals) for considering the assessment on the merits and pass orders thereon in accordance with law, after giving the assessee an opportunity. In the result, the appeals stand allowed.”

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Method of Accounting – Valuation of Stock – Manufacturer of sugar – the closing stock of incentive sugar to be valued at levy price which was less than the cost

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CIT vs. Bannari Amman Sugars Ltd. [2012] 349 ITR 708 (SC)

The assessee is a company engaged in the business of manufacture and sale of sugar. The assessee filed its return of income for the assessment year 1997-98. In its return of income, confined to its Karnataka unit, the assessee valued the closing stock of incentive sugar (free sugar) at levy price. The Assessing Officer valued the closing stock of incentive sugar at cost, whereas the assessee claimed that the said stock should be valued at levy price which has less than the cost.

The Commissioner of Income Tax (Appeals) allowed the appeal of the assessee. The Tribunal and the High Court dismissed the appeal of the Revenue. According to the Supreme Court, to answer that above controversy, the following facts are required to be noted. By virtue of the provisions of the Essential Commodities Act, 1955, and the Sugar Control Order read with the Notification issued thereunder, a sugar manufacturer (assessee in this case) was required to sell 40 % of his sugar production at the notified levy price to the public distribution system. At the relevant time, on an average, the levy price came to be less than the manufacturers’ cost of production. Consequently, it was found by the manufacturers that under the above price control regime, the establishment of new sugar manufacturing units was not viable. It was found that even the existing sugar manufacturing units had become unviable and uneconomical. Therefore, an incentive scheme was framed, as suggested by the Sampat Committee, the committee that was set up to examine the economic viability by establishing new sugar factories and expanding the existing factories. The Sampat Committee gave its report. Under the report, an incentive scheme was evolved. The said incentive scheme provided an inducement for persons to set up new sugar factories or to expand the existing one. Under the scheme, 40 % of the total sugar production was permitted to be sold at market price (“incentive sugar” for short). However, the scheme provided that excess amount realised by the manufacturer over the levy price by sale of incentive sugar would be utilised only for repayment of loans taken from the banks/financial institutions for establishing the new units. In regard to utilisation of excess realisation towards repayment of loans, the sugar mills were directed to file certificate of chartered accountant subject to which further release orders would be issued by the Directorate of Sugar. This scheme came up for consideration before the Supreme Court in the case of CIT vs. Ponni Sugars and Chemicals Ltd. [2008] 306 ITR 392 (SC) in which it was held that the excess amount realised by the manufacturer over the levy price by sale of incentive sugar should be treated as a capital receipt which was not taxable under the Income-Tax Act, 1961. In that case, one of the arguments advanced on behalf of the Department, as in this case, was that the excess amount realised by the manufacturer over the levy price should be treated as a revenue receipt.

The Supreme Court observed that there are different methods of valuation of closing stock. The popular system is cost or market, whichever is lower. However, adjustments may have to be made in the principle having regard to the special character of assets, the nature of the business, the appropriate allowances permitted, etc., to arrive at taxable profits. The Supreme Court noted that in the present case, it was the case of the assessee, that following the judgment in Ponni Sugar and Chemicals Ltd. (supra), the closing stock of incentive sugar should be allowed to be valued at levy price, which on facts is found to be less than the cost of manufacture of sugar (cost price). According to the Supreme Court, there was merit in this contention. In Ponni Sugars and Chemicals Ltd. (supra), on examination of the scheme, it was held that, the excess realisation was a capital receipt, not liable to be taxed and in view of the said judgment, the Supreme Court held that the assessee was right in valuing the closing stock at levy price.

The Supreme Court dismissed the civil appeals filed by the Department.

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Business Expenditure – Scheduled Commercial Banks – Bad and doubtful debts – Entitled to deduction of irrecoverable debts written off u/s. 36(1)(vii) in addition to the deduction of provision for bad and doubtful debts u/s. 36(1)(viia).

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Dy. CIT (Assessment) & Anr. vs. Karnataka Bank Ltd. [2012] 349 ITR 705 (SC)

The Assessing Officer noticed that for the relevant assessment year, while the assessee had claimed a deduction of a sum of Rs.3,36,78,394 under clause (vii) of s/s. (1) of section 36, the assessee had also claimed a deduction in terms of section 36(1)(viia) to the extent of Rs.5,75,00,000 and therefore, being of the opinion that the deduction claimed u/s. 36(1)(vii) being less than the amount claimed u/s. 36(1)(viia) disallowed the entire amount of deduction claimed u/s. 36(1)(vii). It was this dispute which had been carried to the first appellate authority by the assessee which was not successful but in the appeal before the Appellate Tribunal, the Tribunal purporting to follow its decision in the case of the very assessee for the assessment years 1990-91 to 1993-94 and having allowed the assessee’s appeals for the relevant assessment year thought it fit to allow the appeal for the year relevant to the subject-matter of the appeal.

The High Court while examining the very questions in the case of the very assessee and for the years 1993-94 and 1994-95, had answered similar questions in favour of the assessee and against the Revenue and dismissed the appeals as per the judgment dated 19th March, 2008 [Deputy CIT vs. Karnataka Bank Ltd. [2009] 316 ITR 345 (Karn)].

The Supreme Court held that the issue involved in these cases was covered in favour of the assessee, vide its judgment in the case of Catholic Syrian Bank Ltd. v. CIT reported in (2012) 343 ITR 270.

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Small Scale Industrial Undertaking – Reference not to be made to the Eleventh Schedule for the purposes of consideration of the claim u/s. 80-IB. Manufacture – Process of blending of Extra Neutral Alcohol (ENA) to make various products like whiskey, brandy, rum, etc. is a manufacturing activity.

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CIT vs. Vinbros And Co. [2012] 349 ITR 697 (SC)

The assessee, a small–scale industry recognised as such by the Director of Industries, Pondichery, set up a second unit to manufacture and bottle Indian manufactured foreign liquor (IMFL) at Pondichery. In its return for the assessment years 2003-04 and 2004-05, it claimed deduction u/s. 80-IB of the Act in respect of the profits and gains derived from the second unit. The Assessing Officer, however, rejected the plea on the issue that the process carried on by the assessee for its product, did not constitute ‘manufacture’ within the meaning of section 80-IB. He further held that setting up of the second unit was only an expansion or reconstruction of the existing unit. Aggrieved by the same, the assessee preferred an appeal before the Commissioner of Income Tax (Appeals).

In the proceedings before the Commissioner of Income Tax (Appeals), the assessee explained the process of blending as follows:

The assessee purchased rectified spirit or extra neutral alcohol (ENA) made of grain or grapes or malt to which it added demineralised water in required proportion to reduce the strength of the ENA to make various products like whiskey, brandy, rum, etc. Apart from that, other ingredients like caramel, sugar, etc., were also added as per the blending formulations. This blend was subject to filtration for required time, blend inspection and then bottling in empty bottles. The finished products were packed and sold.

The Commissioner of Income Tax (Appeals) considered the fact that the alcoholic strength of ENA which was around 95 % v/v was reduced to a maximum of 42.8 % v/v. Consequently, the Commis- sioner of Income Tax (Appeals) held that there was no manufacture or production of any new article or thing as the alcohol which was the input remained as alcohol. In the circumstances, he rejected plea for deduction u/s. 80-IB of the Act.

On further appeal before the Tribunal, the assessee reiterated the contentions as regards the process undertaken to result in a totally different marketable commodity. Considering the entirety of the issue and applying the decision of the Allahabad High Court in the case of CIT vs. Rampur Distilleries and Chemicals Co. Ltd., reported in [2005] 277 ITR 416 (All), the Tribunal held that the rectified spirit is not mentioned in the first item of the Eleventh Schedule ‘beer, wine and other alcoholic spirits’ and, consequently, the assessee as a small-scale industrial unit was entitled to deduction u/s. 80-IB of the Act.

On appeal by the Revenue before the High Court, it was held that a perusal of section 80-IB showed that a deduction under the said provision is available only where the assessee engages in the manufacture or production of an article or thing, not being an article or thing as specified in the list in the Eleventh Schedule or operates one or more cold storage plant or plants in any part of India. The proviso to sub-clause (iii) of s/s. (2) of section 80-IB of the Act showed that the condition with reference to the list in the Eleventh Schedule did not apply at all to the case of an industry being a small scale undertaking or an undertaking referred to in s/s. (4). The industry run by the assessee was admittedly a small-scale industry, reference to the Eleventh Schedule for the purpose of consideration of the claim u/s. 80-IB of the Act did not arise.

As regards the second issue as to whether the assessee had engaged itself in the manufacturing or producing of an article or thing by the act of blending, the High Court observed that (i) the assessee did not just add water and sell the final product, apart from water, the assessee had to add several items to make it fit for human consumption; (ii) the assessee was not a manufacturer of ENA which was the basic raw material required for making various IMFL products; (iii) it was mixing water and other ingredients with ENA formulations; (iv) the alcoholic strength of the ENA which was around 95 % v/v was reduced to a maximum of 42/8 % v/v in respect of the final marketable commodity, namely, whiskey, brandy, rum, vodka and gin; (v) the blending was subject to filtration for required time and thereafter only, the final product was sold. On the face of the facts stated above, the High Court opined that it was not possible for it to accept that the blending should not be treated as a manufacturing activity u/s. 80-IB of the Act.

The Supreme Court dismissed the civil appeal filed by the Revenue holding that there was no infirmity in the impugned judgment of the high Court.

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US Decision Giving Relief to Satyam Directors – Implications for Independent Directors in India

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The recent US Court decision to give relief to Satyam independent directors/audit committee members has raised both – concerns and hopes. Concerns on corporate governance are indeed ineffective in practice and impossible to enforce, as has long been the suspicion. Hopes are that SEBI’s actions against independent directors and others in several recent cases, are perhaps unwarranted or probably even without legislative sanction.

Recently, the independent directors/audit committee members of Satyam Computers Limited were given relief in a class action suit filed against them in USA, for their alleged recklessness (it may be recollected that, as widely reported, in 2009, in settlement of class action claims, Satyam had paid INR7,797 million and the Auditors had paid INR1,591 million). Would the latest decision change SEBI’s approach ? Will independent directors in India be also treated with the same standards by SEBI or will they continue to be punished, as they have been punished in several recent cases, for alleged negligence, connivance, etc.?

First of all, what does the US decision say? It will be beyond the competence of this author to comment on what the scheme of provisions is in the US in this regard nor is it relevant significantly here. But a summary of some aspects apparent on the face of the decision can be made.

The decision is related to many issues, apart from the role of independent directors, such as whether the US courts had jurisdiction if shares of an Indian company was acquired on Indian stock exchanges. However, the relevant issue for discussion here is whether the independent directors (including audit committee members) could be held liable for loss caused to the investors.

The allegations in Satyam may be recollected. The company falsified its records and showed fictitious revenues, profits and assets. Further, it showed fictitious expenditure through which monies were channeled out in group companies. Loans from related parties were shown to have been taken in Satyam to compensate for the cash shortage. Such funds diverted were used in a related party – Maytas – to acquire huge amounts of immovable properties. Such fictitious amounts rose over the years and in a last ditch effort to cure the fraud, it sought to merge the related party into Satyam and show that the fictitious assets were used to acquire immovable properties and that too at an inflated price. Though this alleged fraud was carried out over several years, neither the independent directors, the Audit Committee members, nor the auditors detected or reported it. The question in the US decision was whether independent directors (including audit committee members) could be held liable for the fraud?

It needs to be noted that the US decision was not given on merits – that is — where the facts of the case were examined in great detail and decision given. The decision was on whether the class action could be dismissed on preliminary grounds that the facts, as alleged, were insufficient to determine reasonable scienter or state of mind/knowledge. The standards for this decision were simple. Are the facts – as merely alleged and not even proved – sufficient to reach the standards of scienter or a guilty state of mind, in terms of recklessness, connivance, etc.?

Thus, the plaintiffs were required to have alleged a certain level of facts which, assumed to be wholly true, should show a level of scienter/recklessness on the part of the independent directors. Several facts were alleged. That the fraud was so huge that it could not have escaped scrutiny of such competent people. That the auditors raised certain red flags in the form of certain internal control systems not being followed. That the independent directors approved the Maytas purchase without sufficient scrutiny. That though the auditors were paid huge amount for “other services”, the independent directors did not question this properly and grasp why the auditors were engaged for ‘other services’. That the norms of corporate governance in India required several things to be done by the independent directors/audit committee members who failed in performing. And so on.

The Court found that these alleged facts were not sufficient to establish scienter/recklessness. Hence, the class action was dismissed. More specifically, it was even observed that the independent directors were more likely the victims of a sophisticated fraud themselves rather than its perpetrators. The Court observed, “The majority of the allegations in the FACC concern an intricate and well-concealed fraud perpetrated by a very small group of insiders and only reinforce the inference that the AC Defendants were themselves victims of the fraud. The strength of this competing inference outweighs the inference of scienter asserted by lead plaintiffs.”

The Court dismissed the case, stating as follows:-

“Having considered the FACC in its entirety, the Court finds that lead plaintiffs have failed to plead sufficient facts to raise a strong inference of recklessness on the part of the AC Defendants that is at least as compelling as the non-fraudulent inference reasonably drawn from the allegations.”

There are some important points to note here. Firstly, this was a private action for damages, and not an action by a regulator against persons having certain statutory obligations. Secondly, certain actions were already taken against the company and its auditors and settlement for compensation was made. Arguably, the provisions of law and standards of proof required for fraud/negligence/recklessness, etc. are different in the US as compared to India, even though some of the obligations of the independent directors in the Satyam case were traced to Indian laws. Further, what are the obligations of persons under US law and how are they deemed to be contravened are also different. The specific allegations made in the class action is also to be seen in this context.

Nevertheless, it makes a difference that the actions/ omissions of the independent directors were held as not to constitute recklessness/scienter and it has some relevance in general times in India too. This is because, unless it is alleged and found that the independent directors did not comply with specific obligations under law, the issue before the Indian regulator would be similar – and that is, did the independent directors do their duties correctly? Interestingly, to the best of the author’s knowledge, there are no findings made as of today for any of such independent directors in the Satyam case. And it would be interesting to see whether what finding SEBI makes against the same independent directors who are given relief by the US Court.

However, it is also noteworthy for comparable or even lesser levels of manipulations in several cases, SEBI has taken stringent actions against independent directors, members of audit committee, CFOs, etc. For example, in several cases (Bharatiya Global Infomedia Limited, Pyramid Saimira, Tijaria Polypipes Limited, etc. as also discussed earlier in this column), independent directors and audit committee members (and even CFOs/CSs) have been strongly acted against by SEBI. The question that will be relevant is whether such actions were correct in context of the US decision. Or whether, in India, even the Satyam independent directors would be held liable.

On balance, this author submits that the US decision should be taken in its context and will result in change in India’s approach

Having said that, there are some basic wrong things that exist in the Indian framework for corporate governance. Firstly, and perhaps most importantly, they are contained in Clause 49 of the listing agreement, which is not a law, but an agreement. Moreover, it is an agreement between the stock exchange and the company. Of course, recently, violation of the listing agreement has been made punishable. However, still, it is a legally bad place to be for a provision that is meant to have such significance.

Secondly, while a significant level of obligations are laid down on independent directors in Clause 49, their rights are fairly marginal and difficult to enforce, particularly when one compares the powers of auditors under the Companies Act, 1956. Often, the only recourse left for an independent directors is to resign or otherwise report what he has already found to be objectionable.

Thirdly, this weak basis of law making causes problems even for SEBI. It really does not have any specific powers – as it has for various other ills – for taking action against errant companies, independent directors, etc. Thus, it uses its generic powers – which are meant to be used in exceptional cases – and debars them. While it is true that SEBI as an expert body needs certain wide and discretionary powers to take action in the face of newer and innovative types of market manipulations, corporate governance is fairly old now for resorting to such actions.

Finally, the scheme of law leaves the investors uncompensated. Whether it is Satyam, Pyramid or other cases, it was the investors who were left stranded with their shares devalued, as they assumed that SEBI had put in an effective system of corporate governance, where there are responsible persons to carry out the safeguards. The weak basis of law which, at best, punishes the independent directors by debarring them, does not help the investors recover their losses.

There is another dimension too. The general principles and even the concept of corporate governance are borrowed from the West where the management is with executives whose total holdings is usually in single digits. In comparison, in India, companies are promoter controlled, usually families and who often hold 35-50% and even more of the company. The concept of independent directors, etc. are relevant where shareholders holding 90% can appoint such people to safeguard their interests. While in India, if such concepts are blindly introduced for similar purposes, they would be – and indeed they are often – defeated by promoters, having full power to appoint people who are favourably disposed to them and the inherent power to remove them.

In the end, it seems that a transparent, effective, and comprehensive scheme of law governing corporate governance relevant to Indian realities, is needed. In this context, then, it is sad that neither the concept paper on corporate governance recently issued by SEBI nor the Companies Bill 2011 addresses these fundamental issues. The result then is likely to be a false sense of security, which would often be taken away by scams and which would be acted against by SEBI using its discretionary and arbitrary powers.

Crystal Phosphates Ltd. vs. ACIT ITAT Delhi `B’ Bench Before B. R. Mital (JM) and B. R. Jain (AM) ITA No. 3630/Del/2009 A.Y.: 2006-07. Decided on: November, 2012. Counsel for assessee / revenue: Gautam Jain / Deepak Sehgal

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Notice issued u/s. 143(2) to initiate proceedings for scrutiny assessment needs to be quashed if the said notice does not comply with the instructions issued by CBDT for selection of cases for scrutiny. Instructions so issued have to be followed in letter and spirit.

Facts:
The assessee filed its return of income for AY 2006-07 on 28-11-2006 declaring the income of Rs. 3,97,17,920. The case was selected for scrutiny by notice dated 17-10-2007 issued u/s. 143(2) of the Act. The CBDT had issued instructions for selection of cases for corporate assessee in FY 2007-08. Clause 2(v)(b) of the Scrutiny Guidelines provided as under:

“2. The following categories of cases shall be compulsorily scrutinised:-

……
……

(vb) All cases in which an appeal is pending before the CIT(Appeals) against an addition/ disallowance of Rs. 5 lakh or above, or the Department has filed an appeal before the ITAT against the order of the CIT(Appeals) deleting such an addition/disallowance and an identical issue is arising in the current year. However, as in (i) above, the quantum ceiling may not be taken into account if a substantial question of law is involved.”

The assessee vide its letter dated 07-12-2007 challenged the assumption of jurisdiction on the ground that no addition/disallowance exceeding Rs. 5 lakh was made in an earlier year, which was pending in appeal before the CIT(A). Further, there was no identical issue arising in the current year as arising in the earlier year.

The Additional CIT and CIT vide orders dated 25- 11-2008 and 15-12-2008 respectively rejected the contention of the assessee and held that the notice issued was in accoundance with law on the ground that the aggregate of additions made in AY 2004-05 was Rs. 5,60,207 which was pending before CIT(A).

The CIT(A) held that the notice was valid.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted from the assessment order for AY 2004-05 that no disallowance was made in excess of Rs. 5 lakh though aggregate of all the disallowances was Rs. 5,60,207. It noted that the AO had considered the aggregate of disallowances. It held that there has to be an addition or disallowance of Rs. 5 lakh or more against which an appeal is pending and such an issue must also arise in the year under consideration. All these facts must be available to the AO on the date of assumption of jurisdiction. The burden is on the assessing authority to establish that jurisdiction was assumed in accordance with the instructions of the Board. It held that the notice issued u/s. 143(2) was not in terms of the instructions issued by the CBDT.

As regards the question whether jurisdiction assumed, by issue of a notice which is not in terms of instructions issued by CBDT, was illegal so as to hold the entire proceedings as invalid. Relying on the decision of the Andhra Pradesh High Court in the case of CIT vs. Smt. Nayana P. Dedhia 270 ITR 572 (AP) it held that once the CBDT has issued instructions for assumption of jurisdiction for selection of cases of corporate assessees for scrutiny and assessment thereof, the same have to be followed in letter and spirit by the AO. The Tribunal quashed the notice issued u/s. 143(2) of the Act since assumption of jurisdiction was not in terms of the instructions of CBDT. The notice and the assessment framed  were held to be without valid jurisdiction and were quashed.

The appeal filed by the assessee was allowed.

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Venkata Ramana Umareddy vs. DCIT ITAT Hyderabad `A’ Bench Before Chandra Poojari (AM) and Saktijit Dey (JM) ITA No. 552/Hyd/2012 A.Y.: 2008-09. Decided on: 18th January, 2013. Counsel for assessee / revenue: Roopanjali / M H Naik

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Exemption u/s. 54 and 54F of the Act can be claimed with reference to investment in the same residential house purchased/constructed, if the other conditions are satisfied.

Facts:
During the previous year 2007-08 the assessee transferred land to a developer under a development agreement and also sold a house along with land. Long term capital gain earned on transfer of land to developer was Rs. 49,19,513 and long term capital gain on sale of house was Rs. 44,05,302. The assessee claimed the entire amount of long term capital gain of Rs. 93,24,815 to be exempt u/s. 54 and 54 F of the Act towards investment in a new house purchased for a total price of Rs. 1,43,26,665.

The Assessing Officer (AO) held that to claim exemption under both sections i.e. 54 and 54F the assessee has to invest in two houses. He disallowed exemption claimed u/s. 54 and added back an amount of Rs. 44,05,302 to the total income of the assessee.

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: Section 54 and 54F apply under different situations. While section 54 applies to long term capital gain arising out of transfer of long term capital asset being a residential house, section 54F applies to long term capital gain arising out of transfer of any long term capital asset other than a residential house. However, the condition for availing exemption under both sections is purchase or construction of a new residential house within the stipulated period. There is also no specific bar either u/s. 54 and 54F or any other provision of the Act prohibiting allowance of exemption under both the sections in case the conditions of provisions are fulfilled.

Since the assessee had invested long term capital gain arising from sale of two distinct and separate assets in purchase of a new residential house, the Tribunal held that he was entitled to claim exemption both u/s. 54 and 54F of the Act. The Tribunal directed the AO to delete the addition of Rs. 44,05,302.

This ground of appeal filed by the assessee was decided in favour of the assessee.

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2013-TIOL-641-ITAT-MUM Cinetek Telefilms P. Ltd. v ACIT ITA No. 7834 and 7645/Mum/2010 Assessment Year: 2007-08. Date of Order: 07.06.2013

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Section 40(a)(ia) – Provisions of section 40(a)(ia) do not apply to a case where there is shortfall in deduction of tax at source.

Facts:
The assessee engaged in the business of making T.V. serials and ad films had incurred certain expenses on which tax was deductible at source but the assessee had either not deducted tax at source at all or had deducted it at a lower rate. The Assessing Officer disallowed a sum of Rs. 71,30,633 u/s. 40(a)(ia) – Rs. 62,33,890 for short deduction of tax at source and Rs. 8,96,743 for non-deduction of tax at source. 

Aggrieved, the assessee preferred an appeal to CIT(A) who on the basis of some additional evidence deleted certain disallowances and confirmed the remaining.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted that in some cases the assessee treated the payment to be covered u/s. 194C of the Act whereas the authorities below treated the same payment as being covered u/s. 194I of the Act thereby resulting in short deduction of tax at source. It held that the issue whether disallowance u/s. 40(a)(ia) can be made where assessee short deducted tax at source instead of non-deduction of tax at source is no mere res integra in view of several orders passed by various benches of the Tribunal across the country holding that no disallowance u/s. 40(a)(ia) can be made in such cases. The Tribunal made a mention of U.E. Trade Corporation (India) Ltd. vs. DCIT (2012) 54 SOT 596 (Del) and DCIT v. Tekriwwal (2011) 48 SOT 515 (Kol). It also noted that the Calcutta High Court has vide its judgment dated 03-12-2012 in the case of CIT vs. S. K. Tekriwal (2012 – TIOL- 1057-HC-KOL) upheld the view of the Kolkata Bench of the Tribunal. Following these, it held that CIT(A) was not justified in sustaining disallowance u/s. 40(a)(ia) in respect of expenses on which short deduction of tax at source was made.

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2013-TIOL-632-ITAT-AHM Shrinivas R Desai v ACIT ITA No. 1245 and 2432/Ahd/2010 Assessment Year: 2007-08. Date of Order: 28.06.2013

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S/s. 45, 54(1) & 54 (2), 55(1)(b) – Cost of purchase includes any capital expenditure incurred by the assessee on the property purchased to make it livable though the expenditure may be incurred after having purchased the property. The use of words `purchased or constructed’ does not mean that the property can either be purchased or constructed and not a combination of both the actions.

Facts:
During the relevant previous year the assessee earned long term capital gain of Rs. 98,76,855 on sale of his residential house in August 2006. In May 2006, he purchased a house property for Rs. 71,94,570 and claimed to have spent Rs. 15,48,773 on its improvement. The expenditure on improvement was claimed to have been incurred till 31st March, 2007. The assessee claimed exemption u/s. 54 with reference to both the cost of purchase as well as expenditure incurred on improvement. It was submitted that “cost of improvement, as per section 55(1)(b), in any other case, means all the expenditure of capital nature incurred in making any addition or alteration to the capital asset by the assessee, after it becomes his property.”

The Assessing Officer (AO) was of the view that cost of improvement can be allowed as a deduction only to the transferor and not to the transferee. He denied claim of exemption u/s. 54 with reference to cost of improvement incurred by the assessee.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal took note of the fact that the authorities below had laid a lot of emphasis on the fact that as the original house property was sold by the assessee in August 2006, it cannot be believed that the new house property was not habitable till September 2007. These observations were on the assumption that on sale of the old house, the assessee had to shift to new house. However, this overlooked the uncontroverted fact that the assessee had, during the period from August 2006 to June 2007 lived in a residential unit taken on lease. Lease rent was paid by cheque, copies of lease agreement and broker’s note were also filed and no errors were found in these evidences. Thus, the contention of the Department that the new house was habitable at the time of purchase was held to be unsustainable.

The Tribunal held that the cost of purchases does include any capital expenditure incurred by the assessee on such property to make it livable. As long as the costs are of such a nature as would be included in the cost of construction in the normal course, even if the assessee has bought a readymade unit and incurred those costs after so purchasing the readymade unit – as per his taste and requirements, the costs so incurred will form an integral part of the qualifying amount of investment in the house property. The use of words `purchased or constructed’ does not mean that the property can either be purchased or constructed and not a combination of both the actions. A property may have been purchased as a readymade unit but that does not restrict the buyer from incurring any bonafide construction expenditure on improvisation or supplementary work.

The Tribunal held that as long as the assessee has incurred bonafide construction expenditure, even after purchasing the unit, the additional expenses so incurred would be eligible for qualifying investment u/s. 54. The Tribunal restored the matter to the file of the AO for carrying out factual verifications, which was not done, in the light of its observations and to pass a speaking order after giving an opportunity of hearing to the assessee.

The appeal filed by the assessee was allowed for statistical purposes.

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Asst. CIT vs. B.V.Raju, Hyderabad(SB) (2012) 135 ITD 1 Date of the order : 13.02.2011 A.Y.2000-01

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Section 28(va)(a) – When compensation is paid for not carrying out any activity in relation to any business which transferor is not carrying on same would be chargeable u/s. 28(va)(a) and not as capital gain.

Facts:
Assessee was a chairman of two companies namely, Rassi Cements Ltd. (RCL) and Sri Vishnu Cements Ltd. (SVCL) without any controlling interest. Both these companies were subjected to a hostile takeover by India Cements Ltd. (ICL).

ICL Paid Rs. 11 crore to assessee under Non-compete agreement (NCA). After takeover assessee lost his business and died. Mean while, Search was conducted in the premises of one of the close relatives of the assessee where copy of NCA disclosing Rs. 11 crore paid to assessee were found. Based on the same, AO issued notice u/s. 148 and added the above sum to income of the assessee under the head Capital gain.

Aggrieved by the order of Ld. A.O. legal heirs of the assessee preferred appeal before CIT(A). CIT(A) held that sum was in the nature of capital receipt and not chargeable to tax before insertion of provisions of section 28(va)(a) w.e.f. 01-04-2003. Revenue preferred appeal against order of CIT(A).

Held:
Taxability of amount paid at the time of takeover of business depends upon:

1- Purpose of payment.

2- What was the right transferred by assessee.

When Right to manufacture, produce or process any article or thing is transferred, there is an extinguishment/relinquishment of rights, the same being capital asset chargeable to capital gain tax.

In the instant the case assessee had no controlling interest in the transferred companies. He was associated with business in his managerial capacities and was not carrying on any business directly. Hence, the amount received by assessee under NCA is for “not carrying out any activity in relation to business” which is taxable u/s. 28(va)(a).

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2013 (30) STR 679 (Tri-Mumbai) Syntel International Pvt. Ltd. vs. C.C.Ex. Pune.

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Refund of – Service tax paid on marketing services of foreign service provider u/s 66A as Business Auxiliary Services – Whether ‘input service’ – Held ‘yes’.

Facts:
The Appellant provided Customised Software Development services, renting of immovable property services etc. They engaged a company registered in USA to market/sell software services developed by them. For this service, they paid consideration to the foreign service provider and discharged service tax liability on reverse charge u/s. 66A. As these services were used in providing exported software development services, the Appellant being unable to utilise the full CENVAT credit on these input services, filed a refund claim which was rejected. The Appellant contended that for the subsequent period, the department allowed CENVAT credit of service tax paid on marketing services under the category of business auxiliary service and there was no issue in this regard.

Held:
The Hon. Tribunal, after placing reliance on the copy of the agreement with the foreign service provider and on the copy of the order passed by the department allowing the refund claim for the subsequent period, held that, the service so received by the Appellant qualifies as “Business Auxiliary Service” and further held that this was also considered as input service under Rule 2(l) of the CENVAT Credit Rules, 2004 and therefore the credit of service tax paid was admissible and eligible for refund as the appellant was unable to utilise the same.

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Attest function where the member is personally interested (Clause 4 of Part I of the Second Schedule).

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Attest function where the member is personally interested (Clause 4 of Part I of the Second Schedule). Shrikrishna (S) – Arjun, I rang your office. They told me you are not attending for the last three days. Somebody said you were at home only. Arjun
(A) – Yeah! While doing duniyabharka work, our own family’s work remains pending.

S – What was pending?

A – My brother’s all the returns are pending. Tax audit as well as VAT audit! 15th January was the last date. Now everything is done. Great relief!

S – VAT I can understand. But tax audit date has gone long back.

A – Agreed. But my experience is that while doing VAT audit, many ‘lochas’ in tax audit are revealed! That is why, in some cases, I prefer to do it together!

S – But then, you should prepone VAT audit, rather than postponing tax audit.

A – True. But who has time to do VAT audit in the September pressure! Continuously, firefighting is going on in our office. S – Anyway, I hope, your brother’s audit is done by somebody else.

A – Why? Mere bhaika audit doosre ko kyo doo?

S – Arey baba, you cannot certify the financial statements of your relatives. It is a misconduct!

A – Yes. But I make it clear in the report that the person whose audit I am signing is my relative. That’s what we learnt when we did our CA

S – That was the position long ago! Prior to 2006. But your CA Act was amended in 2006. Are you not aware?

A – We recognise only Income Tax Act. All other Acts are of no relevance to me!

S – Then remember. As I mentioned to you, you cannot sign the financial statements of any business or enterprise where you have a substantial interest.

A – Baap Re! It doesn’t talk of mere relative?

S – No. Not only that. Even if your firm or any of your partner has a substantial interest, that also you cannot attest.

A – So wide! That means I cannot sign the balance sheet of even my partner’s wife!

S – This is only to ensure your independence. If you are interested in something how can you be impartial?

A – This is strange !

S – Otherwise, people will always believe that you have ‘accommodated’ the relative. Your credibility is in doubt.

A – But I make a disclosure of interest?

S – That won’t suffice. Previously, it was permitted. But now they have deleted the words – ‘unless he discloses the interest also in his report’. Thus, that exception is a thing of the past now !

A – Oh. I never knew.

S – Your Council has issued further guidelines on 8th of August of 2008 – Date is easy to remember – 8-8-8 !

A – And what it says?

S – It says – not only your own interest – But even if one or more persons who are your relatives have a substantial interest in a concern, then that also you cannot audit.

A – Ah – But relative is a very narrow concept in Income Tax, section 2(41) only talks of parents, spouse, brother and sister !

S – Listen carefully. It is not ‘relative’ under tax act; but under the Companies Act. Section 6!

A – Oh My God! That will cover many persons. And that again I have to check in respect of my partners also!

S – Yes, my dear. Don’t take it lightly. A – And what is substantial interest?

S – For that, you need to refer to your CA Regulations. – In that, Appendix (9).

A – But it would be 20%, I believe.

S – Yes. But read it at least once! See, the Council feels that you should err on safer side; and not merely adhere to the words of law. Try to understand the spirit of it. Otherwise you may lose or compromise your independence.

A – You mean, there should not be conflict of interest and duty. Right?

S – Exactly. Therefore, as an employee of an organisation, you cannot sign as auditor. Not only that, even if you are an employee of a group concern under the same Management, then also you cannot sign.

A – What if I am a part-time lecturer in a college – and I want to sign the audit of the college? S – Even that is not allowed. For that matter, if your partner is a trustee or employee of a trust, that trust’s audit also you cannot sign.

A – Where shall I get all this to read? And who has time to read? After all who is going to see even if I sign?

S – Remember. In the Mahabharata, I supported you because you were on the right side of law. If you are casual and don’t take your rules seriously, I cannot side with you. Then you be prepared to suffer.

A – I believe, apart from our CA Act, there is some prohibition in the Company Law also.

S – Of course, yes. Section 226 of Companies Act directly states the disqualifications of auditors.

A – I will have to read it again. What other things should I see?

S – I am sure, you are not writing the accounts of any client and also signing them.

A – Ah! That I know. Therefore, I give the accounts writing invoice in my wife’s name. Sometimes in Draupadi’s name, sometimes in Subhadra’s. Advantage of having two wives!

S – But do they know what is accounting? They have learnt only classical dancing. Take care. You may invite trouble.

A – You are giving me shock after shock. Ultimately then how to practice?

S – One more thing. Just as you cannot audit the books which you have written, same way you cannot sign statutory audit where you have also done internal audit. I feel, an internal auditor should also not sign a tax audit.

A – Well, you have told me so many things. I cannot remember all this. I’d better get the literature and read it myself.

S – I can see that you have become nervous after hearing all these. But if you see the provisions of the Companies Bill, 2012, they are even more stringent and wider.

A – Oh my God!
The above dialogue is with reference to Clause 4 of Part I of the Second Schedule which reads as under:

Clause (4): expresses his opinion on financial statements of any business or enterprise in which he, his firm or a partner in his firm has a substantial interest; Further, readers may also refer to the following: – Chapter IV of Council General Guidelines, 2008 dated 8th August, 2008 (refer page nos. 313 – 323 of the Code of Ethics publication January 2009 edition or the website of ICAI). – pages 239 – 244 of ICAI’s publication on Code of Ethics, January 2009 edition (reprinted in May 2009).

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2013 (30) STR 458 (Tri-Del)-Air India Ltd. vs. Commissioner of Service Tax, New Delhi.

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Import of Service – Sec. 66A – Services of repair and overhaul of aircraft performed wholly abroad – Held not taxable – commission paid to GSA’s abroad in relation to business in India– Held taxable.

Whether service tax applicable u/s. 66A on services of repair and overhaul of aircrafts and in respect of commission paid to GSA’s abroad?

Facts:
The Appellant, a wholly Government of India Company, engaged in the business of transportation of passengers and goods by air appointed “General Sales Agents” (GSA) who represented them and handled their affairs in other countries for which they received commission. Appellant also received services of repair and overhaul of aircrafts abroad.

The revenue demanded service tax of Rs. 65.48 Crores on the said activities along with interest and penalty. According to the Appellant, the repair services were performed abroad and therefore not taxable u/s. 66A of the Finance Act, 1994. In respect of services received from GSA’s, the Appellant submitted that since the services were received by the Appellant’s branches, the same is not taxable in India and referred to Rajesh Exports Ltd. reported in 2013 (29) STR 147 (Tribunal).

Held:
There being no evidence to the contrary, the Hon. Tribunal held that the services of repair and maintenance were performed wholly abroad and hence the demand was unsustainable in terms of the provisions of Rule 3(1) of the Taxation of Service (Provided from outside India and received in India) Rules, 2006. After perusing the relevant clauses of the agreement with the GSAs as regards commission paid to them, the Tribunal held that the said service was used by the Appellant in India in relation to their business located in India and therefore would be liable to pay service tax on the same.

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2013-TIOL-518-HC-MAD-CX Comm. Of C. Ex., Salem vs. Crocodile India Pvt. Ltd.

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Inadmissible CENVAT credit – Reversal before utilisation thereof and before issue of SCN- No Penalty.
Facts:

The respondent a manufacturer of readymade garments claimed inadmissible credit of Rs. 15,07,414/- and subsequently reversed the same, evidently before the issue of SCN. The department confirmed interest and penalty although the assessee did not utilise credit and reversed immediately on receipt of intimation about the error. In absence of any other intention of wrongful gain, the Tribunal set aside the levy of penalty. The revenue challenges it in this appeal.

Held:
Undoubtedly, the respondents claimed inadmissible CENVAT and reversed the same before the issue of Show Cause Notice. Further, the Show Cause Notice being bereft of detailing grounds for imposing penalty under Rule 13(1) of the CENVAT Credit Rules, 2004 and following the decision of UOI vs. Rajasthan Spinning & Weaving Mills 2008 (231) ELT 3 (SC) wherein it was pointed out that application of section 11AC would depend on existence or of conditions expressly stated in the said section, the appeal was dismissed.

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Industrial Undertaking – Deduction u/s. 80 HH and 80-I – Neither section 80HH nor section 80-I (as it stood in assessment year 1992-93) statutorily obliged an assessee to maintain its accounts unit-wise and it was open to maintain accounts in a consolidated form from which unit-wise profits could be worked out for computing deduction u/s. 80HH/80I.

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[2012] 349 ITR 352 (SC) CIT v. Bongaigaon Refinery and Petrochemical Ltd.

Bongaigaon Refinery and Petrochemical Ltd. (for short “BRPL”) (before it merged in IOC) was a public sector undertaking engaged in refinery, petrochemical and polyester staple fibre business. Three different and separate units were set up by BRPL in the financial year 1979-80, 1985-86 and 1988-89 respectively. The three units were engaged in the production of separate and distinct types of products. They were three different industrial undertakings. BRPL was entitled to claim deduction u/s. 80HH and 80-I of the Income-tax Act, 1961, during the relevant assessment year 1992-93. BRPL could not claim such deduction till the assessment year 1992-93, as its net taxable income for earlier assessment years was nil. It was only in the assessment year 1992-93 when the gross total became positive that BRPL claimed relief for its petrochemical unit u/s. 80HH and u/s. 80-I of the Income-tax Act 1961. However, BRPL could not claim such deduction for its refinery unit, as the period for which such relief could be claimed had expired. Further, it could not claim such deduction for its polyester staple fibre unit as it had negative income during the accounting year ending 31st March, 1992, corresponding to the assessment year 1992-93.

The Assessing Officer while framing assessment had allowed the claim of deduction u/s. 80HH and 80I. Subsequently, the Commissioner of Income Tax revised the assessment u/s. 263 on the grounds that the assessee had not maintained its accounts unit-wise for claiming deduction u/s. 80HH and 80-I. On an appeal, the Tribunal held that there was no s tatutory requirement u/s. 80HH(5)/80-I(7) to maintain unit-wise accounts, but to put an end to the litigation directed the assessee to submit unit-wise accounts. The assessee went in an appeal before the High Court which set aside the direction of the Tribunal. On an appeal to the Supreme Court by the Department, the Supreme Court held that though neither section 80HH nor section 80-I (as it stood) statutorily obliged assessee to maintain its accounts unit-wise and that it was open to assessee to maintain the accounts in a consolidated form, however in order to put an end to the litigation between the Tax Department and PSU, it remitted the case to the Assessing Officer, to ascertain whether the assessee had correctly calculated its net profits for the assessment year in respect of its petrochemical units for the purposes of claiming deduction u/s. 80HH and 80-I. The Supreme Court observed that in the present case, the assessee had prepared its financial statements on consolidated basis from which it had worked out unit-wise net profits. If not done, it could be done by the Auditors even today from the Consolidated Books of Accounts. Once such working is certified by the Auditors, the net profit computation (unit-wise) could be placed before the Assessing Officer, who can find out whether such profits are properly worked out and on that basis compute deduction u/s. 80HH/80-I.

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Commission to Non-resident Agents – Whether Accruing or Arising in India

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Issue for Consideration Many exporters, located in India, use the services of commission agents located abroad, for procuring orders from abroad. These agents locate customers in foreign countries, and procure orders from them on behalf of the Indian exporters . The goods are then shipped from India to such customers by the Indian exporters, and payment is received directly from such customers by the Indian exporters. The commission agents are generally paid a commission by the Indian exporters as a percentage of the orders procured by the agents, such commission generally being remitted directly from India to the overseas bank accounts of the agents.

The taxability of such commission in India had been an issue that had arisen long back, and the CBDT as far back as 1969, had issued a circular no. 23 dated 23.7.1969, clarifying that such commission was not taxable in India. Further, vide circular no. 786 dated 7.2.2000, the CBDT had again reiterated that such commission was not taxable in India u/s. 5(2) and 9, and that therefore no tax was deductible at source u/s. 195 from such commission. However, vide circular no. 7 of 2009 dated 22.10. 2009, the CBDT has withdrawn both the above referred circulars, no. 23 as well as no. 786, besides the circular no. 163 dated 29.5.1975 which dealt with an agent engaged in the activity of purchase of goods for export. The ostensible reason behind withdrawal of the said circulars was that the interpretation put on the said circulars by some of the taxpayers to claim relief in the opinion of the Board was not in accordance with the provisions of section 9, or the intention behind the issue of the circulars.

In the light of the withdrawal of the above circulars, the question has arisen as to whether such commission to foreign agents is subject to tax in India, and whether tax is accordingly deductible u/s. 195 from such commission. In case of agents who are tax residents of countries with which India has Double Taxation Avoidance Agreements, such income may not be taxable in India on account of the applicability of Article 7 of the DTAA dealing with Business Profits, as business profits are not taxable in India in the absence of a permanent establishment in India. The issue would however assume significance in the case of agents who are tax residents of countries with which India does not have DTAAs, and who would be governed by the provisions of the Income Tax Act.

While the Authority for Advance Rulings has recently taken a view that such commission is chargeable to tax in India under the provisions of the Income Tax Act, the Hyderabad bench of the tribunal has taken a contrary view of the matter.

SKF Boilers & Driers’

Case The issue came up before the Authority for Advance Rulings (AAR) in the case of SKF Boilers and Driers Pvt Ltd, in re, 343 ITR 385.

In this case, the applicant was an Indian company engaged in the manufacture and supply of rice par boiling and dryer plants as per customer requirements. It had received an order from a Pakistani company through two Pakistani agents. The plant was shipped to the Pakistani customer, and on completion of the export order, the commission became payable to the agents as per the agreed terms. A ruling was sought from the AAR as to whether such commission income of the nonresident agents could be deemed to accrue or arise in India and whether tax was required to be deducted at source u/s. 195.

On behalf of the revenue, it was pointed out that there was no DTAA with Pakistan which covered such payment, nor was there any other tax exemption available. It was also stated that circular no. arising to the agents on account of export commission fell u/s. 5(2)(b), as the income had accrued in India when the right to receive the income became vested.

On behalf of the applicant, it was argued that the agents had rendered services abroad and would be entitled to receive commission abroad for the services rendered to foreign clients of the applicant. As services were rendered outside India, and the payment was receivable by the agents abroad, no income would arise u/s. 5(2)(b) read with section 9(1).

The AAR considered the provisions of sections 5 and 9, and observed that they proceeded on the assumption that income had a situs, and the situs had to be determined according to the general principles of law. According to the AAR, the words ‘accrue’ or ‘arise’ occurring in section 5 had more or less a synonymous sense, and income was set to accrue or arise when the right to receive it came into existence. The AAR expressed the view that no doubt the agents had rendered services abroad and had solicited orders abroad, but the right to receive the commission arose in India when the order was executed by the applicant in India. According to the AAR, the fact that the agents had rendered services abroad in the form of soliciting the orders and that the commission was to be remitted to them abroad were wholly irrelevant for the purpose of determining the situs of their income.

The AAR therefore held that the income arising on account of commission payable to the two agents was deemed to accrue and arise in India and was taxable in India in view of the specific provisions of section 5(2)(b) read with section 9(1)(i), and that the provisions of section 195 would therefore apply.

Avon Organics’ case

The issue again came up recently before the Hyderabad bench of the tribunal in the case of ACIT v Avan Organics Ltd., 28 taxmann.com 170.

In this case, the assessee was engaged in the activity of manufacture and sale of chemicals and bulk drugs. It paid commission to foreign agents for services rendered by them in connection with effectuating export sales, and such payments were made by telegraphic transfer directly to the overseas bank accounts of the agents. Such payments were made without deducting tax at source. It was claimed by the assessee that the foreign agents operated in their respective countries and no part of the income arose in India, and hence no tax was required to be deducted at source on the payments made to the foreign agents.

The assessing officer rejected the assessee’s contention by observing that the non-residents were paid by way of telegraphic transfer obtained from banks in India, that the banks acted as agents of the non-residents, and therefore, the non-residents had received the payment in India. He accordingly disallowed the payment of the commission u/s. 40(a)(i). The Commissioner (Appeals) reversed the order of the assessing officer.

Before the tribunal, it was argued on behalf of the revenue that the commission payment being for services rendered by the foreign agents in connection with business activities arising in India, was taxable in the hands of the foreign agents, and therefore the assessee was required to deduct tax at source.

On behalf of the assessee, it was argued that the foreign agents did not render any part of the services in India, did not have an establishment in India and therefore, commission was not deemed to have arisen in India as per section 5(2)(a). It was further argued that the mere fact of transmission of the commission to foreign agents through telegraphic transfer did not make the banks as agents of the foreign commission agents, amounting to receipt of payment on their behalf in India.

The tribunal examined the material on record and noted that besides the fact of telegraphic transfer of the remittances being made from a bank in India, the assessing officer had no other material on record to show that the foreign agents either rendered any services in India or had any permanent establishment in India. According to the tribunal, only the fact that the remittances towards commission were telegraphically transferred to the foreign agents from banks in Hyderabad would not lead to the inference that the income to the foreign agents accrued or arose in India in terms of section 5(2)(a).

The tribunal therefore held that the assessee was justified in not deducting tax at source from the commission paid to the foreign agents.

A similar view had been taken earlier by the AAR in the case of SPAHI Projects (P) Ltd, in re 183 Taxman 92 and by the Tribunal earlier in the case of DCIT v Divi’s Laboratories Ltd 131 ITD 271 (Hyd). In the latter case, the Tribunal has expressly taken the view that the withdrawal of earlier circulars by the CBDT did not assist the Department in disallowance of such expenditure.

Observations

The controversy to an extent revolves around the question whether the withdrawal of the said circulars changed the legal position, as it was understood that the said circulars only confirmed the legal position that such commission was not taxable in India. Circular nos. 23 and 786, clarified the legal position and confirmed that even the interpretation of the CBDT was that, where the non-resident agent operated outside the country, no part of his income arose in India, and since the payment was usually remitted directly abroad, it could not be held to have been received by or on behalf of the agent in India. The CBDT confirmed that this was its interpretation of sections 5(2) and 9, and this view prevailed within the CBDT right till 22.10. 2009, when circular no. 7 of 2009 was issued for withdrawing the above circulars.

The position stated by the earlier circulars is the correct legal position, and the circulars merely clarified this position, a fact that has been confirmed by the number of tribunal and High Court decisions which, in the past, have upheld the validity of the reasoning and conclusion given in the said circular nos. 23 and 786. Therefore, the mere withdrawal of a circular which clarified the correct legal position would not change the legal position in this regard and if that is so , the stand now taken by the CBDT under the said circular 7 of 2009 has to be taken as the one that is contrary to the true legal position under the Act for taxation of such commission.

The AAR in SKF Boilers & Driers case perhaps erred holding that the place of accrual of an income is to be determined w.r.t the time of its accrual. While it is true that the point of time when commission arises is the time when the export of goods takes place, the AAR, in SKF Boilers & Driers case, erred in taking the view that even the situs of accrual of the income was the place from where the goods were exported. Under tax laws in India, it has been generally accepted that the place where the work is actually done is normally the situs of accrual of the income. For instance, in the case of salary income, the place of rendering of services is regarded as the place of accrual of income. The commission agent did not carry on any activity in India, and just the fact that the moment of accrual of income was linked to the moment of export of goods from India, did not mean that the commission income also accrued in India. The income from the export of goods was not the same as the income by way of commission. The linkage between the quantum or time of accrual between two events does not necessarily imply a linkage between the place of accrual of the two events. For instance, the value of a derivative is derived from its underlying fact, but the place of its accrual would be the place where the contract is entered into, and not the

place where the delivery of the underlying goods takes place. The AAR seems to have mistaken the linkage between the two events vis-a -vis the moment of accrual, to also imply a linkage in the place of accrual.

The AAR in the SKF Boilers & Driers case seems to have overlooked clause (a) of explanation 1 to section 9(1)(i). This clause provides that in the case of a business of which all the operations are not carried out in India, the income of the business that is deemed under this clause to have accrued or arisen in India is only such part of the income as is reasonably attributable to the operations carried out in India. This clause supports the view that the Income Tax Act treats the place where the activity is carried out as a place of accrual of income. This effectively means that if a business is only partly carried out in India, only that part of the income attributable to the business activity carried out in India would be taxable in India. This position is further reiterated by explanation 3 to section 9(1)(i) of the Act. That being the case, if no part of the business activity is carried out in India, as in the case of a foreign commission agent, then no part of the income can be taxed in India.

Further, the Supreme Court, in the case of CIT v Toshoku Ltd 125 ITR 525, considered a situation where an Indian exporter had appointed a non-resident sales agent for exports. The commission was credited in the books of the Indian exporter, and was subsequently paid. While holding that such credit did not constitute receipt of the commission in India, the Supreme Court also considered whether the commission accrued or arose in India. The Supreme Court observed as under:

“The second aspect of the same question is whether the commission amounts credited in the books of the statutory agent can be treated as incomes accrued, arisen, or deemed to have accrued or arisen in India to the non-resident assessees during the relevant year. This takes us to section 9 of the Act. It is urged that the commission amounts should be treated as incomes deemed to have accrued or arisen in India as they, according to the department, had either accrued or arisen through and from the business connection in India that existed between the non-resident assessees and the statutory agent. This contention overlooks the effect of cl. (a) of the Explanation to cl. (i) of s/s (1) of section 9 of the Act, which provides that in the case of a business of which all the operations are not carried out in India, the income of the business deemed under that clause to accrue or in India shall be only such part of the income as is reasonably attributable to the operations carried out in India. If all such operations are carried out in India, the entire income accruing therefrom shall be deemed to have accrued in India. If however, all the operations are not carried out in the taxable territories, the profits and gains of business deemed to accrue in India through and from business connection in India, shall be only such profits and gains as are reasonably attributable to that part of the operations carried out in the taxable territories. If no operations of business are carried out in the tax-able territories, it follows that the income accruing or arising abroad through or from any business connection in India cannot be deemed to accrue or arise in India.

In the instant case, the non-resident assessees did not carry on any business operations in the taxable territories. They acted as selling agents outside India. The receipt in India of the sale proceeds of tobacco remitted or caused to be remitted by the purchasers from abroad, does not amount to an operation carried out by the assessees in India as contemplated by cl. (a) of the Explanation to section 9(1)(i) of the Act. The commission amounts which were earned by the non -resident assessees for services rendered outside India cannot, therefore, be deemed to be incomes which have either accrued or arisen in India.”

From the above decision of the Supreme Court, it is clear that in the absence of any activity being carried out in India by a non-resident commission agent, the commission does not accrue or arise in India, and is not taxable in India.

A view similar to the view taken in the case of Avon Organics in favour of the assessee has been taken by the Hyderabad tribunal in the case of Priyadarshini Spinning Millls (P) Ltd. , 25 taxmann. com 574. The tribunal in this case took a view that no tax was deductible at source u/s. 195 on payment of such commission and that expenditure on commission could not be disallowed u/s. 40(a) (i) of the Act.

In view of the discussion here, it is appropriate to hold that the said Circular No. 7 of 2009 is without the authority of the law and shall have no application in determining the taxability of income by way of commission in the hands of a foreign commission agent rendering services outside India.

Educational Institution: Exemption: Section 10(23C)(vi): A. Y. 2008-09: Rejection of approval for exemption on the ground of defect in admission procedure: Rejection not just:

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CCIT vs. Geetanjali University Trust; 352 ITR 433 (Raj): 257 CTR 239 (Raj):

During the relevant year, i.e. A. Y. 2008-09, the admission to the college run by the assessee-trust were not on the basis of the system approved by the medical council of India and Rajasthan University. The Single Judge and the Division Bench of the High Court held that the admission was illegal. A Special Leave Petition filed by the assessee was pending before the Supreme Court. The Chief Commissioner rejected the application of the assesee for approval for exemption u/s. 10(23C)(vi) of the Income-tax Act, 1961 holding as under:

“In the institution’s case, the Hon’ble High Court has held that the admissions made for the academic year 2008-09 were illegal. The purpose of education would not be served, if the education is for students who have been illegally admitted. The purpose of education as contemplated in the section would be served only if the students have been legally admitted and not otherwise. The spending of funds on education of students who have been admitted illegally will not amount to application of income for the purpose of education. In the trust’s case, neither the condition regarding existence for the purpose of education nor the application of funds for the objects, are being fulfilled.”

However, an order granting approval was passed for the A. Y. 2010-11 and onwards.

On a writ petition challenging the order of rejection, the Single Judge of the Rajasthan High Court (352 ITR 427) set aside the order of rejection for fresh disposal and observed as under:

“The sanction was to be granted within the parameters laid down u/s. 10(23C) which are relevant and not the admission procedure undertaken by the assessee.”

On appeal by the Revenue, the Division Bench of the High Court upheld the decision of the Single Judge and held as under:

“i) U/s. 10(23C)(vi) and (via), what is required for the purpose of seeking approval is that the university or other educational institution should exist “solely for educational purposes and not for purposes of profit”. It was nowhere the case or the finding of the Chief Commissioner that on account of the defect in the admission procedure, the assessee ceases to exist solely for educational purposes or it existed for the purpose of profit. Further, it was not the case of the Revenue that the students who were admitted were not imparted education in the college in which they were admitted or the admissions granted were fake or non-existent or that the income generated by admitting the students was not used for the purpose of the assessee.

ii) The emphasis on the part of the Chief Commissioner that the purpose of education would not be served if the education is for students who have been illegally admitted and the purpose of education as contemplated in the section would be served only if the studentshave been legally admitted and not otherwise, went beyond the requirements of the section.

iii) Of course, the requirement of an educational institution to provide admission strictly in accordance with the prescribed rules, regulations and statute need to be adhered to in letter and spirit, but violation could not lead to its losing the character as an entity existing solely for the purpose of education.

iv) Therefore, there is no interference with the order of the Single Judge.”

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Capital gain: A. Y. 2007-08: Family settlement: Principle of owelty: Payment to assessee to compensate inequalities in partition of assets: Amount paid is immovable property: No capital gain arises:

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CIT vs. Ashwani Chopra; 352 ITR 620 (P&H):

In the course of the assessment for the A. Y. 2007-08, the Assessing Officer found that the assessee (Group A) had received compensation from group B at the time of partition of properties of the group of HSL and that the amount had been kept in fixed deposit receipts in accordance with the orders passed by the High Court and by the Supreme Court. The Assessing Officer considered the family settlement and found that 8.56% of Rs. 24 crore of compensation was the share of the assessee and levied long term capital gains on the amount. The Commissioner (Appeals) held that the distribution of assets including the sum of Rs. 24 crore was not complete during the relevant year as the matter was subjudice and the assessee was not allowed to use the money by the order of this court, and therefore, the sum of  Rs. 24 crore transferred to the assessee and the other members of the Group A did not accrue to the income of this group including the assessee. The Tribunal upheld this decision.

The Punjab and Haryana High Court dismissed the appeal filed by the Revenue and held as under:

“i) The payment of Rs. 24 crore to the assessee was to equalize the inequalities in partition of the assets of HSL. The amount so paid was immovable property. If such amount was to be treated as income liable to tax, the inequalities would set in as the share of the recipient would diminish to the extent of tax.

ii) Since the amount paid during the course of partition was to settle the inequalities in partition, it would be deemed to be immovable property. Such amount was not an income liable to tax.

iii) Thus, the amount of owelty, i.e. compensation deposited by group B was to equalise the partition and represented immovable property and would not attract capital gains.”

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Capital gain: Section 50C: A. Y. 2005-06: Amendment by Finance (No. 2) Act, 2009, w.e.f. 01/10/2009 is prospective: Amended provision not applicable to transactions completed prior to 01/10/2009:

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CIT vs. R. Sugantha Ravindran; 352 ITR 488 (Mad):214 Taxman 543 (Mad): 32 taxman.com274 (Mad):

In the A. Y. 2005-06, the assessee had transferred a property to a third party under an agreement for sale. Physical possession was given to the buyer but the agreement was not registered. The assessee computed the capital gain without applying the provisions of section 50C. The Assessing Officer applied section 50C and adopted the guideline value given by the stamp valuation authority as the sale consideration instead of the consideration admitted by the assessee. The Commissioner (Appeals) held that section 50C can be invoked only when the property was transferred by way of registered sale deed and assessed for stamp valuation purposes. The Tribunal held that section 50C could not be invoked as the property was not transferred by way of registered sale deed.

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

“i) The insertion of the words “or assessable” in section 50C of the Income-tax Act, 1961, w.e.f. 1st October, 2009, is neither a clarification nor an explanation to the existing provision and it is only an inclusion of new class of transactions, namely, the transfer of properties without or before registration.

ii) Before the amendment, only transfer of properties where the value was adopted or assessed by the stamp valuation authority were subjected to section 50C application. However, after introduction of the words ”or assessable” such transfers where the value is assessable by the valuation authority are also brought into the ambit of section 50C. Thus such introduction of a new set of class of transfer would certainly have prospective application only. The amendments have been made applicable w.e.f. 1st October, 2009 and will apply only in relation to transactions undertaken on or after such date.

iii) Since the transfer in the assessee’s case was admittedly made prior to the amendment, section 50C, as amended w.e.f. 1st October, 2009, was not applicable.”

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Business expenditure : Section 37(1) : A. Y. 2008-09: Software development and upgradation expenditure: Is allowable revenue expenditure:

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CIT vs. N.J. India Invest (P.) Ltd.; [2013] 32 taxmann. com 367 (Guj):

In the relevant year, the assessee claimed deduction on account of software development and upgradation expenditure. The Assessing Officer held that software development and upgradation would give the assessee an enduring benefit and such expenditure should be treated as capital expenditure. Accordingly, he disallowed the claim. The Tribunal allowed the assesee’s claim. On appeal by the Revenue , the Gujarat High Court upheld the decision of the Tribunal and held as under:

“i) The assessee had entered into contract with a company, which had agreed to provide certain services. These services, thus, essentially were in the nature of maintenance and support  services providing essentially backup to the assessee, who had procured software for its purpose. These services, thus, essentially did not give any fresh or new benefit in the nature of a software to be used by the assessee in the course of the business but were more in nature of technical support and maintenance of the existing software and hardware. For example, the service provider had to provide technical support to the employees of the company and to maintain the computers and the laptop, had to supply security service for controlling the data theft and providing checks on access by unauthorised persons to the data etc.

ii) In essence, these services, therefore, were in nature of maintenance, back up and support service to existing hardware and software already installed by company for the purpose of its business. The Tribunal, therefore, rightly held that the expenditure was revenue in nature.”

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Business expenditure : Section 37(1) : A. Y. 2003-04: Landlord incurred expenditure on construction as per assessee’s requirements: Compensation paid to landlord for nonoccupation of premises, in lieu of withdrawing all claims against assessee: Was in the course of business and was allowable as revenue expenditure:

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CIT vs. UTI Bank Ltd.; [2013] 32 taxmann.com 282 (Guj):

The assessee had contracted with a landlord to take premises on lease for opening its branch, but no formal agreement was entered into. The landlord started the construction of the premises as per assessee’s requirements. However, before completion of construction, assessee came to know of the proposed construction of an overbridge over the said property which would cause hindrance to conduct its business and services. The assessee, therefore, terminated the understanding with the landlord and paid compensation to the landlord for the work done, in lieu of withdrawing all claims against the assessee. In the A. Y. 2003-04, the assessee claimed such amount paid as revenue expenditure. The Assessing Officer disallowed the claim. The Tribunal deleted the disallowance as the compensation was paid in the course of business and for the purpose of business, to protect the assessee’s interest and in lieu of the claims that could have been raised by the landlord.

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

“i) The Tribunal referred to the case of J.K. Woollen vs. CIT [1969] 72 ITR 612 (SC) in which it was held, that in applying the test of commercial expediency for determining whether an expenditure was wholly and exclusively laid out for the purpose of the business, reasonableness of the expenditure has to be adjudged from the point of view of the businessman and not of the IT department.

ii) No question of law arises. Tax appeal is, therefore, dismissed.”

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Assessment giving effect to order of Tribunal: Section 254, r/w. s. 154 : A. Y. 2001-02: Tribunal restored proceeding back to AO for fresh examination of nature of share transaction: AO passed an order giving effect to order of Tribunal: Subsequently, successor AO recomputed loss and passed a fresh order: Fresh order is without jurisdiction:

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Classic Share & Stock Broking Services Ltd. vs. ACIT; [2013] 32 taxmann.com 273 (Bom.):

For the A. Y. 2001-02, the assessee filed return of income claiming loss of Rs. 16.82 crore which included a loss from share transactions of Rs. 13.63 crore. An assessment order was passed u/s. 143(3) determining a total loss of Rs. 3.13 crore after disallowing the loss from the share transactions. The Tribunal restored the assessment proceeding back to Assessing Officer for fresh examination of the nature of the share transactions in view of SEBI guidelines and to decide the matter. The Assessing Officer passed an order giving effect to the order of the Tribunal and recomputed the total loss at Rs. 16.83 crore. Subsequently, the successor in office of the Assessing Officer passed another order computing the loss at Rs. 3.19 crore.

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

“i) Once the Assessing Officer had given effect to the order of the Tribunal, his successor-in- office had no jurisdiction to pass a fresh order. The impugned order of the successor-in-office in fact reflects his awareness of the earlier order which was passed by the predecessor in order to give effect to the order of the Tribunal became the successor Assessing Officer has, in his computation, commenced with a total income as computed in the order of the predecessor Assessing Officer (viz., a loss of Rs. 16.83 crore). The successor Assessing Officer has not purported to exercise the jurisdiction u/s. 154.

ii) Once effect was given to the order of the Tribunal by the passing of an order u/s. 254 that order could have been modified or set aside only by following a procedure which is known to the Act. What the Assessing Officer has done by the impugned order is to conduct a substantive review of the earlier order of the predecessor which was clearly impermissible. Since the order of the successor Assessing Officer is clearly without jurisdiction, there was no reason or justification to relegate the Petitioner to the remedy of an appeal.

iii) Therefore, the instant petition was allowed and the assessment order passed by the successor Assessing Officer was quashed and set aside.”

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Exemption – Trust issuing a receipt on 31st March, 2002 for the cheque of donation dated 22nd April, 2002 – No Violation of provisions of section 13 since the Trust had shown the amount as donation receivable in the Balance Sheet and the donor had not availed the exemption in accounting year 2001-02 but claimed it in 2002-03 only.

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DIT vs. Raunaq Education Foundation (2013) 350 ITR 420 (SC)

During the relevant accounting year 2002-03 of the respondent-assessee had, by way of donation, received two cheques for a sum of Rs.40 lakhs each from M/s. Apollo Tyres Ltd. One of the cheques was 22nd dated April, 2002, and yet it was given in the accounting year 2001-02, i.e., before 31st March, 2002.

In the assessment proceedings for the assessment year 2002-03, the Assessing Officer came to the conclusion that with an intention to do undue favour to M/s. Apollo Tyres Ltd., the cheque dated 22nd April, 2002, given by way of donation for a sum of Rs. 40 lakh had been accepted by the respondentassessee and receipt for the said amount was also issued before 31 March, 2002, i.e., in the accounting year 2001-02. According to the Assessing Officer, many of the trustees of the assessee-trust were related to the directors of M/s. Apollo Tyres Ltd., and as to give undue advantage under the provisions of section 80G of the Act, the cheque had been accepted before 31st March, 2002, although the cheque was dated 22nd April, 2002.

In the opinion of the Assessing Officer, this was clearly in violation of the provisions of section 13(2)(d), (h) and as such exemption u/s. 11 and 12 could not be allowed to the assessee. The assessment was made in the status of an association of persons.

The appeal which was filed against the assessment order was dismissed by the Commissioner of Income-tax (Appeals).

The second appeal filed before the Income-tax Appellate Tribunal by the respondent-assessee was however allowed. The Tribunal held that there was no violation of the provisions of sections 13(2)(b) and 13(2)(h) of the Act and the assessee-trust had not acted in improper and illegal manner.

The Tribunal noted the fact that the amount of donation, i.e., Rs. 40 lakhs received by way of a cheque dated 22nd April, 2002, was treated as donation receivable and, accordingly, accounting treatment was given to the said amount. The said amount was not included in the accounting year 2001-02 as donation but was shown separately in the balance-sheet as amount receivable by way of donation. Moreover, M/s. Apollo Tyres Ltd., had also not availed of the benefit of the said amount u/s. 80G of the Act during the accounting year 2001-02 but had availed of the benefit only in the accounting year 2002-03, the period during which the cheque had been honoured and the amount of donation was paid to the assessee-trust.The High Court dismissed the appeal to the Revenue observing that the Tribunal found that it was only a post-dated cheque and it could not be said to be an amount which was made available for the use of the drawer of the cheque and, therefore, the provisions of section 13(2)(b) of the Act did not apply.

Also, no service of the assessee was available to the drawer of cheque and, therefore, the provisions of section 13(2)(d) also did not apply.

In the civil appeal filed by the revenue the Supreme Court noted certain undisputed facts. It was not in dispute that though the assessee-trust has issued receipt when it received the cheque dated 22nd April, 2002, for Rs. 40 lakh in March 2002, it was clearly stated in its record that the amount of donation was receivable in future and, accordingly, the said amount was also shown as donation receivable in the balance-sheet prepared by the assess-trust as on March 31, 2002. It was also not in dispute that M/s. Apollo Tyres Ltd., did not avail of any advantage of the said donation during the accounting year 2001-02. Upon a perusal of the assessment order of M/s. Apollo Tyres Ltd., for the assessment year 2002-03, it was clearly revealed that the cheque dated 22nd April, 2002, was not taken into account for giving benefit under section 80G of the Act as the said amount was paid in April 2002, when the cheque was honoured.

Looking into the aforestated undisputed facts, and the view expressed by the court in the case of Ogale Glass Works Ltd. [(1954) 25 ITR 529 [(SC)], the Supreme Court was of the view that no irregularity had been committed by the assesseetrust and there was no violation of the provisions of section 13(2(b) or 13(2)(h) of the Act. The fact that most of the trustees of the assessee-trust and the directors of M/s. Apollo Tyres Ltd., were related was absolutely irrelevant. The Supreme Court therefore dismissed the appeal.

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Principle of mutuality – Interest earned on surplus funds placed by the members club with members bank not covered by mutuality principle, liable to be taxed in the hands of the club.

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CIT vs. Bangalore Club. (2013) 350 ITR 509 (SC)

The Bangalore Club (“the “assessee”), an unincorporated association of persons, (AOP), in relation to the assessment years 1990-91, 1993-94, 1994- 95, 1995-96, 1996-97, 1997-98 and 1999-2000, had sought an exemption from payment of incometax on the interest earned on the fixed deposits kept with certain banks, which were corporate members of the assessee, on the basis of the doctrine of mutuality. However, tax was paid on the interest earned on fixed deposits kept with non-member banks.

The Assessing Officer rejected the assess’s claim, holding that there was a lack of identity between the contributors and the participators to the fund, and hence, treated the amount received by it as interest as taxable business income. On appeal by the assessee, the Commissioner of Income-tax (Appeal) reversed the view taken by the Assessing Officer, and held that the doctrine of mutuality clearly applied to the assessee’s case. On appeal by the Revenue, the Income-tax Appellate Tribunal affirmed the view taken by the Commissioner of Income-tax (Appeals).

The High Court reversed the decision of the Tribunal and restored the order of the Assessing Officer holding that on the facts of this case and in the light of the legal principles it was clear to us what has been done by club is nothing but what could have been done by a customer of a bank. The principle of ‘no man can trade with himself’ is not available in respect of a nationalised bank holding a fixed deposit on behalf of its customer.

On appeal to the Supreme Court by the assessee, the Supreme Court observed that the assessee was an association of persons. The concernedbanks were all corporate members of the club. The interest earned from fixed deposits kept with non-member banks was offered for taxation and the tax due was paid. Therefore, it was required to examine the case of the assessee, in relation to the interest earned on fixed deposits with the member banks, on the touchstone of the three cumulative conditions.

The Supreme Court held that: Firstly, the arrangement lacks a complete identity between the contributors and participators. Till the stage of generation of surplus funds, the setup resembled that of the mutuality; the flow of money, to and fro, was maintained within the closed circuit formed by the banks and the club, and to the extent, nobody who was not privy to this mutuality, benefited from the arrangement. However, as soon as these funds were placed in fixed deposits with banks, the closed flow of funds between the banks and the club suffered from deflections due to exposure to commercial banking operations. During the course of their banking business, the members banks used such deposits to advance loans to their clients. Hence, in the present case, with the funds of the mutuality, member bank engaged in commercial operations with third parting outside of the mutuality, rupturing the ‘privity of mutuality’, and consequently, violating the one to one identity between the contributors and participators. Thus, in the case before it the first condition for a claim of mutuality was not satisfied.The second condition demands that to claim an exemption from tax on the principle of mutuality, treatment of the excess funds must be in furtherance of the object of the club, which was not the case here. In the instant case, the surplus funds were not used for any specific service, infrastructure, maintenance or for any other direct benefit for the member of the club. These were taken out of mutuality when the member banks placed the same at the disposal of third parties, initiating an independent contract between the bank and the clients of the bank, a third party, not privy  to the mutuality. This contract lacked the degree of proximity between the club and its members, which may in a distant and indirect way benefit the club, nonetheless, it cannot be categorised as an activity of the club in pursuit of its objectives. The second condition postulates a direct step with direct benefits to the functioning of the club. For the sake of arguments, one may draw remote connections with the most brazen commercial activities to a club’s functioning. However, such is not the design of the second condition. Therefore, it stood violated.

The facts at hand also failed to satisfy the third condition of the mutuality principle, i.e., the impossibility that contributors should derive profits from contributions made by themselves to a fund which could only be expended or returned to themselves. This principle required that the funds must be returned to the contributors as well as expended solely on the contributors. In the present case, the funds do return to the club. However, before that, they are expended on non-members, i.e., the clients of the bank. Banks generate revenue by paying a lower rate of interest to club-assessee, that makes deposits with them, and then loan out the deposited amounts at a higher rate of interest to third parties. This loaning out of funds of the club by banks to outsiders for commercial reasons, snaps the link of mutuality and thus, breached the third condition.

The Supreme Court further observed that there was nothing on record which showed that the banks made separate and special provisions for the funds that came from the club, or that they did not loan them out. Therefore, clearly, the club did not give, or get, the treatment a club gets from its members; the interaction between them clearly reflected one between a bank and its client.

According to the Supreme Court, in the present case, the interest accrued on the surplus deposited by the club like in the case of any other deposit made by an account holder with the bank.

The Supreme Court further observed that the assessee was already availing of the benefit of the doctrine of mutuality in respect of the surplus amount received as contributions or price for some of the facilities availed of by its members,before it was deposited with the bank. This surplus amount was not treated as income; since it was residue of the collections left behind with the club. A façade of a club cannot be constructed over commercial transactions to avoid liability to tax. Such setups cannot be permitted to claim double benefit of mutuality.

In the opinion of the Supreme Court, unlike the aforesaid surplus amount itself, which is exempt from tax under the doctrine of mutuality, the amount of interest earned by the assessee from the banks would not fall within the ambit of the mutuality principle and would, therefore, be exigible to income-tax in the hands of the assessee-club.

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Should Gains be Recognised due to ‘Own’ Credit Deterioration

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Since the start of the global financial crisis in 2008, the credit risk of counter parties has become increasingly important. Globally, the financial environment has been very volatile and has created a lot of uncertainty in the minds of stakeholders as well as prospective investors.

 Volatility in credit worthiness of entities, not only has a significant impact on the business of these entities (ability to raise funds and capital at attractive rates), but has also resulted in a unique accounting implications.

This implication arises from provisions relating to gains/ losses due to ‘changes in fair value of financial liability due to changes in ‘own’ credit risk’ in certain cases.

The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board’s (FASB) inclusion of own credit risk in liability measurement has proved controversial over the years. Several media articles have focused on the fact that due to EU accounting rules, banks may have systematically overstated their net assets and distributed non-existent profits as dividends and bonuses.

Let us take an example to understand how change in own credit risk, results in reflecting a better performance and increases the net assets for entities.

Balance sheet for Bank XYZ

*Measured at fair value through profit or loss account Keeping all other external parameters constant, if the creditworthiness of Bank XYZ decreases, it will result in an increase in its credit spreads (as the cost of funds for a more risky instrument will be higher). This in turn will result in a reduction in the fair value of the underlying instruments issued by the Bank. The revised balance sheet of XYZ may be as under (fair value is presumed to be Rs 800)

Balance sheet for Bank XYZ (Rs)

This reduction in the financial liability by Rs 200 is recorded as a gain in the income statement and has a favourable impact on reported PAT and EPS of the Bank.

Relevant accounting literature under IFRS supporting the aforesaid accounting treatment

IAS 39 “Financial Instruments: Recognition and Measurement” permits an entity to classify any financial liability into the category of “Fair value through profit or loss (FVTPL)” when:

• It is acquired or incurred principally for the purpose of selling or repurchasing it in the near term

• Part of a portfolio managed together and evident by recent pattern of short term profit taking

•    It contains more than one embedded derivatives.

Generally derivative liabilities, structured financial products etc are recognised by entities at fair value.

IAS 39 requires an entity to reflect credit quality in determining the fair value of financial instruments and related changes in fair value are accounted in the profit and loss account.

Impact on results

During 2011, a number of international banks reported positive earnings in spite of increasing credit spreads i.e., declining credit worthiness. This outcome was due to own-credit-risk adjustments allowed in terms of IAS 39 (referred above) and similar guidance under US GAAP laid down in FASB Standard No. 159 “Fair Value Option for Financial Assets and Financial Liabilities”. Own-credit risk adjustments can result in unrealised losses as well when banks’ creditworthiness improves.

Below is a summary of the impact, this provision had on the performance results of a few large banks

One can logically argue that it is misleading for an entity to report a gain on its liabilities as a direct result of its own creditworthiness deteriorating, particularly as the entity would not be able to realise this gain unless it repurchases its debt at current market prices. However, there is another view in support of fair valuation, which is based on the principle of “increase in shareholder value”. As per this view increase in shareholder value resulting from a credit downgrade is based on differing contractual claims of shareholders and bondholders. Under this approach wealth is transferred from the existing bondholders, who have already committed to a lower interest rate and thus bear the risk of changes in interest rates, to the shareholders. If bondholders had waited to purchase the obligations they may well have received a higher interest rate. Thus, the gain is attributable to the lower interest rate that the entity enjoys in the current period as compared to the market interest rate (for another entity with the present (deteriorated) credit rating).

In India, The Ministry of Corporate Affair (MCA) has issued accounting standards which are aligned to IFRS (known as “Ind AS’), to be notified at a future date. Ind AS 39 “Financial Instruments: Recognition and Measurement” prescribes that in determining fair value of a financial liability, which on initial recognition is designated at fair value through profit or loss, any change in fair value consequent to changes in the company’s own credit risk should be ignored. This was a concious difference from IFRS incorporated under Ind AS. This difference was because Indian standard setters were not comfortable with companies recognising ‘gains’ in the financial statements just because their credit worthiness has deteriorated.

Even Basel III rules, require banks to “derecognise in the calculation of Common Equity Tier 1, all unrealised gains and losses that have resulted from changes in the fair value of liabilities that are due to changes in the bank’s own credit risk.” This rule ensures that an increase in credit risk of a bank does not lead to a reduction in the value of its liabilities, and thereby an increase in its common equity.

Given the ongoing volatility in the economic environment, this is an area which needs to be closely monitored, particularly due to the implications on reported financial performance and capital adequacy considerations.

Section A: AS 29: Disclosures regarding provision for potential civil and criminal liability

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Section A: AS 29: Disclosures regarding provision for potential civil and criminal liability

Ranbaxy Laboratories Ltd Year ended 31-12-2011

From Notes to Accounts (Rupees in millions)

On 20th December 2011, the Company agreed to enter into a Consent Decree with the Food and Drug Administration (“FDA”) of United States of America (“USA”) to resolve the existing administrative actions taken by FDA against the Company’s Paonta Sahib and Dewas facilities. The Consent Decree was approved by the United States District Court for the District of Maryland on 26th January 2012. The Consent Decree establishes certain requirements intended to further strengthen the Company’s procedures for ensuring the integrity of data in its US applications and good manufacturing practices at its Paonta Sahib and Dewas facilities. Successful compliance with the terms of the Consent Decree is required for the company to resume supply of products from the Dewas and Paonta Sahib facilities to USA.

Further, the Company is negotiating towards a settlement with the Department of Justice (“DOJ”) of USA for resolution of potential civil and criminal allegations by DOJ. Accordingly, the Company has recorded a provision of Rs. 26,480 million ($500 million) which the Company believes will be sufficient to resolve all potential civil and criminal liability.

From Auditor’s Report

Without qualifying our opinion, we draw attention to note 2 of schedule 24 of the financial statements, wherein it has been stated that the management is negotiating towards a settlement with the Department of Justice (“DOJ”) of the United States of America for resolution of potential civil and criminal allegations by the DOJ. Accordingly, a provision of Rs. 26,480 million has been recorded which the management believes will be sufficient to resolve all potential civil and criminal liability.

From CARO report
According to the information and explanations given to us, the provisions created for FDA/DOJ for Rs. 26,480 million (as explained in Note 2 of Schedule 24) by the Company has resulted into long-term funds being lower by Rs. 21,754.09 million compared to long-term assets as at 31st December 2011. Accordingly, on an overall examination of the balance sheet of the Company as at 31st December 2011, it appears that short term funds of Rs. 21,754.09 million have been used for long-term purposes during the current year (without considering the impact of excess remuneration paid to Chief Executive Officer and Managing Director as explained in paragraph (d) of the audit report). As represented to us by the management, the shortfall is temporary in nature, hence resulting in long-term funds being lower.

From Directors’ Report

With regard to qualifications contained in the auditors’ report, explanations are given below:

i) Long term funds lower than long term assetsnote no. 2 of Schedule 24 to the financial statements.

The Company has made a provision of Rs. 26,480 million for settlement with the Department of Justice (DoJ) of U.S.A., which the Company believes will be sufficient to resolve all potential civil and criminal liability. This has resulted into long-term funds being lower by Rs. 21,754.09 million compared to long-term assets as at 31st December 2011. The Company believes that the abovementioned shortfall is temporary in nature.

From Management Discussions and Analysis statement

Regulators across the world have become stricter, in respect of compliance to requirements with even more severe consequences for non-compliance.

Ranbaxy signed a Consent Decree (“CD”) with the United States Food & Drug Administration (“US FDA”) in December 2011 to resolve the existing administrative actions taken by the US FDA against the Company’s Poanta Sahib, Dewas and Gloversville facilities. The CD was subsequently approved by the United States District Court for the Court of Maryland on 25th January, 2012. The CD establishes certain requirements intended to further strengthen the Company’s procedures for ensuring the integrity of data in the US applications and good manufacturing practices at its Poanta Sahib and Dewas facilities.

Specifically, the CD requires that Ranbaxy comply with detailed data integrity provisions before FDA will resume reviewing drug applications containing data or other information from the afore-mentioned plants. These provisions include:

1. Hire a third party expert to conduct a thorough review at the facilities and audit applications containing data from affected plants;

2. Implement procedures and controls sufficient to ensure data integrity in the Company’s drug applications; and

3. Withdraw any applications found to contain untrue statements of material fact and/or a pattern or practice of data irregularities that could affect approval of the application.

The Company will have to relinquish 180 days exclusivity for 3 pending generic drug applications. This will not have material impact on the performance of the Company. The Company could also be liable for liquidated damages to cover potential violations of the law and CD. The implementation of CD, is expected to put to rest the legacy issue that impacted Ranbaxy, and requires strict adherence.

The Company separately announced a provision of $500 Mn in connection with the investigation of the Department of Justice, which the Company believes will be sufficient to resolve all potential civil and criminal liabilities. The Company has taken corrective actions to address the CD concerns and is confident of working together with the regulators towards its satisfactory closure.

Ranbaxy Laboratories Ltd Year ended 31-12-2012

From Notes to Accounts (Rupees in millions)

The Company is negotiating towards a settlement with the Department of Justice (“DOJ”) of the USA for resolution of potential civil and criminal allegations by DOJ. Accordingly, the Company had recorded a provision of Rs 26,480 ($500 Million) in the year ended 31st December 2011, which on a consideration of the progress in the matter so far, the Company believes will be sufficient to resolve all potential civil and criminal liability. The Company and its subsidiaries are in the process of negotiations which will conclusively pave the way for a Comprehensive DOJ Settlement. The settlement of this liability is expected to be made by the Company in compliance with the terms of settlement, once concluded and subject to other regulatory/statutory provisions.

From Auditor’s Report
No mention

From CARO Report


Clause 10
The accumulated losses of the Company at the end of the year are not less than fifty percent of its net worth (without adjusting accumulated losses). As explained to us, these are primarily due to provision created for settlement with the Department of Justice (DOJ) of the United States of America for resolution of potential civil and criminal allegations by the DOJ (refer to note 8 of the financial statements). The Company has not incurred cash losses in the current financial year though it had incurred cash losses in the immediately preceding financial year.

Clause 17

According to the information and explanations given to us, the provision created for settlement with the DOJ amounting to Rs. 26,480 million (refer to note 8 of the financial statements) by the Company in the previous accounting year have resulted in long-term funds being lower by Rs. 5,558.22 million compared to long-term assets as at 31st December 2012. Accordingly, on an overall examination of the Balance Sheet of the Company as at 31st December 2012, it appears that short term funds of Rs. 5,558.22 million have been used for long-term purposes. As represented to us by the management, the shortfall is temporary in nature and action is being taken to have long term funds within a short period of the amount being actually paid.

From Directors’ Report
In continuation of signing of the Consent Decree with the USFDA, the Company is in the final stage of settlement with the U.S. Department of Justice (DOJ) to resolve civil and criminal liabilities.

With regard to comments contained in the Auditors’ Report, explanations are given below:

i)    The accumulated losses of the Company at the end of the year are not less than fifty percent of its net worth:

The accumulated losses are primarily due to provision of Rs. 26,480 million created by the Company in the year ended 31st December, 2011 for settlement with the DOJ for resolution of potential civil and criminal allegations by the DOJ.

ii) Short term funds used for long term purposes:

The Company had made a provision of Rs. 26,480 million in the previous accounting year for settlement with the DOJ. This has resulted into long-term funds being lower by Rs. 5,558.22 million compared to long-term assets as at 31st December, 2012. Accordingly, short-term funds of Rs. 5,558.22 million have been used for long-term purposes which are temporary in nature.

A. P. (DIR Series) Circular No. 14 dated 22nd July, 2013

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Export of Goods and Software – Realisation and Repatriation of export proceeds – Liberalisation

This circular clarifies that exporters are required to realise and repatriate the full value of goods or software exported upto 30th September, 2013 within nine months from the date of export i.e. the provision will be applicable for exports undertaken between 1st April, 2013 and 30th September, 2013. 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.

levitra

Section 9(1)(vii) – Royalty received by a non resident (NR) from various NR manufacturers of CDMA equipments (which were sold worldwide, including India) is not taxable in India, as the NR manufacturer did not carry on a business in India nor did the customers who purchased the equipment constitute the source of income in India.

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21. TS-35-ITAT-2013(Del)
Qualcomm Incorporated vs. ADIT
A.Ys.: 2000-2001 to 2004-05, Dated: 31-1-2013

Section 9(1)(vii) – Royalty received by a non resident (NR) from various NR manufacturers of CDMA equipments (which were sold worldwide, including India) is not taxable in India, as the NR manufacturer did not carry on a business in India nor did the customers who purchased the equipment constitute the source of income in India.


Facts

 A US Company (Taxpayer) had licensed certain intellectual property (IP) relating to the manufacture of Code Division Multiple Access (CDMA) mobile handsets and network equipment to non-resident Original Equipment Manufacturers (OEMs). The OEMs used the licensed IP to manufacture CDMA handsets and wireless equipment outside of India and sold them to customers worldwide, including India. The Indian customers, in turn, sold the handsets to end-users of telecom services in India.

The tax authority assessed a part of royalty, to the extent it related to equipment sold to customers in India by suggesting that part was taxable in India as the IP that was licensed was utilised in a business carried on in India or was for earning income from India sources (the secondary source rule) as per section 9(1)(vii)(c) of the Act. The CIT(A) upheld the order of the tax authority. Aggrieved, the Taxpayer filed an appeal before the Tribunal.

Held

The Tribunal based on the following ruled that the secondary source rule was not applicable to the facts of the case, as the OEMs did not carry on a business in India nor did the Indian customers who purchased the equipment constitute the source of income. Accordingly, the royalty was not taxable in the hands of the taxpayer.

Onus of proof is on tax authority to establish that the non-resident (NR) was carrying on business in India. It is not important whether the right or property is used “in” or “for the purpose of a business”, but to determine whether such business is “carried on by the NR in India”.

Sale to Indian customers without any operations being carried out in India would amount to business ‘with’ India and not business ‘in’ India. For business to be carried out in India, there should be some activity carried out in India.

Further, the IP was not used in India. Use of the products by Indian customers which embed the licensed technology does not amount to use of the IP by the OEMs in India. The OEMs manufactured the products outside India. Hence, the license for the IP of the Taxpayer was used by the OEMs in manufacturing the products outside India. The source of royalty is the place where patent (right, property or information) was exploited, and in the facts of the case, it is where the manufacturing activity took place, which was outside India. Further, as per the agreement, the title of the equipment passed to the Indian customers in high seas before arrival in India. Notwithstanding this, the mere passing of the title with no other activity in India does not result in any income being attributable to the NR for taxation in India.

The clarification inserted to the definition of royalty by the Finance Act, 2012 with regard to taxability of computer software as royalty, has no effect in the present case as the issue on hand was regarding taxability of royalty on patents relating to licensing of IP for manufacture of CDMA handsets and equipment and not on licensing of any computer software.

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Taxability of Capital Gains in India in Respect of Transfer of Shares of a Non-resident Entity Holding Shares of an Indian Company, Between two Non-residents in a Tax treaty Situation

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Background

In the present era of globalisation, cross border movement of goods, services, capital and people has gone up significantly over the years. With the increased quantum of international trade, commerce and services, issues relating to double taxation of income in two different countries/ jurisdictions assume a lot of significance. Issues and considerations relating to cross border taxation of income have become a very important part of the structuring of businesses, entities and transactions, in the case of Multinational Enterprises/corporations [MNCs].

In order to encourage cross border movement of goods, services, capital and people and avoidance of double taxation, various bilateral Double Taxation Avoidance Agreements [DTAAs] have been entered into, between various countries. India has so far entered into DTAAs with 84 countries.

To minimise the tax cost of undertaking the cross border business/commerce, various measures are evaluated in depth and adopted in structuring various cross border business entities/transactions. This has led to growth/ identifications of various low tax jurisdictions/ tax havens, through which business entities/ transactions are structured/entered into, to save/ lower overall tax cost of the MNCs and/or to shift profits to low tax jurisdictions.

One of the most common measures used is to Mayur Nayak Tarunkumar G. Singhal, Anil D. Doshi Chartered Accountants International taxation create intermediate holding companies in the low tax/nil tax jurisdictions which would hold shares in the operating subsidiary companies in the source countries where the operations of the MNCs are carried out through the wholly owned subsidiaries and/or joint ventures. At the intended time of exit/transfer of business of the subsidiary, instead of transfer of the shares in the subsidiary company in the source country, the shares of the intermediate company are transferred by the MNCs to the prospective nonresident buyers, whereby no tax is payable in the source country, but at the same time, business is effectively transferred to the prospective nonresident buyers. This kind of practice has led to erosion of tax base of various countries and significantly impacted the tax revenues of those countries. Accordingly, the governments/ revenue department of various counties have, in order to protect their tax base, taxed such transactions based on various prevalent/innovative legal principles.

In this regard, in the Indian context, the case of Vodafone International Holdings BV (Vodafone) generated a lot of discussions and has been intensely debated in the country and outside.

Vodafone’s case

Vodafone International Holdings BV (Vodafone), a company resident for tax purposes in Netherlands, acquired the entire share capital of CGP Investments (Holdings) Ltd. (CGP), a company resident for tax purposes in Cayman Islands qua a transaction dated 11-2-2007. On 31-05-2010, the Revenue passed an order u/s. 201(1) and 201(1A) of the Income-tax Act, 1961 [the Act] declaring the transaction to be taxable under the Act. Revenue raised a demand for tax on capital gains arising out of the sale of CGP share capital contending that CGP, while not a tax resident in India, held the underlying Indian assets of Hutchison Essar Ltd. [HEL] and the aim of the transaction was the acquisition of a 67% controlling interest in HEL, an Indian company. On a writ petition by Vodafone against the order u/s. 201(1)/201(1A), the Bombay High Court held against the assessee. Vodafone challenged this decision successfully before the Supreme Court [SC] where SC held in favour of Vodafone. [Vodafone International Holdings B.V. vs. Union of India [2012] 341 ITR 0001 (SC)].

Hutch group (Hong Kong) through participation in a joint venture vehicle invested in telecommunications business in India in 1992. The JV later came to be known as Hutchison Essar Ltd. (HEL). In 1998, CGP was incorporated in Cayman Islands, with limited liability and as an “exempted company”. CGP later became a wholly owned subsidiary of a company which in turn became a wholly owned subsidiary of a Hong Kong company – HTL, which was later listed on the Hong Kong and New York Stock Exchanges in September, 2004.

Vodafone, though not directly a case involving Tax-Treaty implications on domestic tax laws (there being no tax Treaty between India and Cayman Islands), nevertheless considered the application and interpretation of Indian Tax Legislation (the ‘Act’) in the context of an applicable and operative tax treaty, since the correctness of Union of India vs. Azadi Bachao Andolan [2003] 263 ITR 703 [SC] [Azadi Bachao] was raised by Revenue. Revenue contended that Azadi Bachao requires to be over-ruled to the extent it departs from McDowell and Co. Ltd. vs. CTO [1985] 154 ITR 148 [SC] [McDowell] and on the ground that Azadi Bachao misconstrued the essential ratio of McDowell and had erroneously concluded that Chinnappa Reddy, J’s observations were not wholly approved by the McDowell majority qua the leading opinion of Ranganath Misra, J.

Relevant observations/conclusions in Vodafone

Tracing the history and evolution of relevant principles by the English Courts commencing with IRC vs. Duke of Westminster 1936 AC 1[Duke of Westminster] through W.T. Ramsay vs. IRC 982 AC 300 [ Ramsay]; Furniss (Inspector of Taxes) vs. Dawson [1984] 1 All E. R. 530 [Furniss] and Craven vs. White (1988) 3 All E. R. 495 [Craven], the Supreme Court in Vodafone explained that the Westminster principle was neither dead nor abandoned; Westminster did not compel the court to look at a document or transaction isolated from the context to which it properly belonged and it is the task of the court to ascertain the legal nature of the transaction and while so doing, to look at the entire transaction as a whole and not adopt a dissecting approach;

The Court ruled that Westminster, read in the proper context, permitted a “device” which was colourable in nature to be ignored as a fiscal nullity; Ramsay enunciated the principle of statutory interpretation rather than an over-arching anti-avoidance doctrine imposed upon tax laws; Furniss re-structured the relevant transaction, not on any fancied principle that anything done to defer the tax must be ignored, but on the premise that the inserted transaction did not constitute “disposal” under the relevant Finance Act; from Craven the principle is clear that Revenue cannot start with the question as to whether the transaction was a tax deferment/saving device but must apply the “look at” test to ascertain its true legal nature; and that strategic tax planning has not been abandoned.

McDowell majority held that tax planning may be legitimate, provided it is within the framework of law; colourable devices cannot be a part of tax planning and it would be wrong to encourage the belief that it is honourable to avoid payment of tax by resorting to dubious methods; and agreed with Chinnappa Reddy, J’s observations only in relation to piercing the (corporate) veil in circumstances where tax evasion is resorted to through use of colourable devices, dubious methods and subterfuges.

McDowell does not hold that all tax planning is illegal/illegitimate/impermissible. While artificial schemes and colourable devices which constitute dubious methods and subterfuges for tax avoidance are impermissible, they must be distinguished from legitimate avoidance of tax measures.

The court held that reading McDowell properly and as above, in cases of treaty shopping and/ or tax avoidance, there is no conflict between McDowell and Azadi Bachao or between McDowell and Mathuram Agrawal vs. State of Madhya Pradesh [1999] 8 SCC 667 [Mathuram].

Vodafone on International Tax aspects of holding structures

In matters of corporate taxation, provisions of the Act delineate the principle of independence of companies and other entities subject to income tax. Companies and other entities are viewed as economic entities with legal independence vis-à-vis their shareholders/participants. A subsidiary and its parent are distinct taxpayers. Consequently, entities subject to income tax are taxed on profits derived by them on stand-alone basis, irrespective of their actual degree of economic independence and regardless of whether profits are reserved or distributed to shareholders/participants.

It is fairly well-settled that for tax treaty purposes, a subsidiary and its parent are totally separate and distinct taxpayers.

The fact that a group parent company gives principle guidance to group companies by providing generic policy guidelines to group subsidiaries and the parent company exercises shareholder’s influence on its subsidiaries, does not legitimise the assumption that subsidiaries are to be deemed residents of the State in which the parent company resides. Mere shareholder’s influence (which is the inevitable consequence of any group structure) and absence of wholesale subordination of the subsidiaries’ decision making to the parent company, would not per se legitimise ignoring the separate corporate existence of the subsidiary.

Whether a transaction is used principally as a colourable device for the division of earnings, profits and gains, must be determined by a review of all the facts and circumstances surrounding the transaction. It is in the aforementioned circumstances that the principle of lifting the corporate veil or the doctrine of substance over form or the concept of beneficial ownership or of the concept of alter ego arises.

It is a common practice in international law and is the basis of international taxation, for foreign investors to invest in Indian companies through an interposed foreign holding company or operating company (such as Cayman Islands or Mauritius based) for both tax and business purposes. In doing so, foreign investors are able to avoid the lengthy approval and registration processes required for a direct transfer, (i.e., without a foreign holding or operating company) of an equity interest in a foreign invested Indian company.

Holding structures are recognised in corporate as well as tax law. Special purpose vehicles (SPV) and holding companies are legitimate structures in India, be it in Company law or Takeover Code under the SEBI and provisions of the Act.

When it comes to taxation of a holding structure, at the threshold, the burden is on Revenue to allege and establish abuse in the sense of tax avoidance in the creation and/or use of such structure(s). To invite application of the judicial anti-avoidance rule, Revenue may invoke the “substance over form” principle or “piercing the corporate veil” test only after Revenue establishes, on the basis of the facts and circumstances surrounding the transaction, that the impugned transaction is a sham or tax- avoidant. If a structure is used for circular trading or round tripping or to pay bribes (for instance), then such transactions, though having a legal form, could be discarded by applying the test of fiscal nullity. Again, where Revenue finds that in a holding structure an entity with no commercial/ business substance was interposed only to avoid tax, the test of fiscal nullity could be applied and Revenue may discard such inter-positioning. This has however to be done at the threshold. In any event, Revenue/Courts must ascertain the legal nature of the transaction and while doing so, look at the entire transaction holistically and not adopt a dissecting approach.

Every strategic FDI coming to India as an investment destination should be seen in a holistic manner; and in doing so, must keep in mind several factors: the concept of participation in investment; the duration of time during which the holding structure exists; the period of business operations in India; generation of taxable Revenues in India; the timing of the exit; and the continuity of business on such exit. The onus is on the Revenue to identify the scheme and its dominant purpose.

There is a conceptual difference between a pre-ordained transaction which is created for tax avoidance purposes, on the one hand, and a transaction which evidences investment to participate in India. In order to find out whether a given transaction evidences a preordained transaction in the sense indicated above or constitutes investment to participate, one has to take into account the factors enumerated hereinabove, namely, duration of the time during which the holding structure existed, the period of business operations in India, generation of taxable revenue in India during the period of business operations in India, the timing of the exit, the continuity of business on such exit, etc. Where the court is satisfied that the transaction satisfies all the parameters of “participation in investment”, then in such a case, the court need not go into the questions such as de-facto control vs. legal control, legal rights vs. practical rights, etc.

A company is a separate legal persona and the fact that all its shares are owned by one person or by its parent company has nothing to do with its separate legal existence. If the owned company is wound up, the liquidator, and not the parent company, would get hold of the assets of the subsidiary and the assets of the subsidiary would in no circumstance be held to be those of the parent, unless the subsidiary is acting as an agent. Even though a subsidiary may normally comply with the request of the parent company, it is not a mere puppet of the parent. The dis-tinction is between having power and having a persuasive position.

Unlike in the case of a one man company (where one individual has a 99% shareholdings and his control over the company may be so complete as to be his alter ego), in the case of a multinational entity, its subsidiaries have a great measure of autonomy in the country concerned, except where subsidiaries are created or used as sham. The fact that the parent company exercises shareholders’ influence on its subsidiary cannot obliterate the decision making power or authority of its (subsidiary’s) Directors. The decisive criterion is whether the parent company’s management has such steering interference with the subsidiary’s core activities that the subsidiary could no longer be regarded to perform those activities on the authority of its own managerial discretion.

Exit is an important right of an investor in every strategic investment and exit coupled with continuity of business is an important telltale circumstance, which indicates the commercial/ business substance of the transaction.

Court’s Analysis of the transaction and persona of CGP

Two options were available for Vodafone acquiring a controlling participation in HTIL, the CGP route and the Mauritius route. The parties could have opted for anyone of the options and opted for the CGP route, for a smooth transition of business on divestment by HTIL. From the surrounding circumstances and economic consequences of the transaction, the sole purpose of CGP was not merely to hold shares in subsidiary companies but also to enable a smooth transition of business, which is the basis of the SPA. Therefore, it cannot be said that the intervened entity (CGP) had no business or commercial purpose.

The above conclusions, of the business and commercial purpose of CGP, were arrived at despite noticing that under the Company laws of Cayman Islands an exempted company was not entitled to conduct business in the Cayman Islands; that CGP was an exempted company; and its sole purpose is to hold shares in a subsidiary company situated outside Cayman Islands.

Revenue’s contention that the situs of CGP shares exist where the underlying assets are situated (i.e., in India), was rejected on the ground that under the Companies Act, 1956, the situs of the shares would be where the company is incorporated and where its shares can be transferred. On the material on record and the pleadings, the court held that the situs of the CGP shares was situated not in India where the underlying assets (of HEL) are situated but in Cayman Islands where CGP is incorporated, transfer of its shares was recorded and the register of CGP shareholders was maintained.

The Supreme Court in Vodafone concluded that the High Court erred in assuming that Vodafone acquired 67% of the equity capital of HEL. The transaction is one of sale of CGP shares and not sale of CGP or HEL assets. The transaction does not involve sale of assets on itemised basis. As a general rule, where a transaction involves transfer of the entire shareholding, it cannot be broken up into separate individual component assets or rights such as right to vote, right to participate in company meetings, management right, controlling right, controlled premium, brand licenses and so on, since shares constitute a bundle of rights – Charanjit Lal Chowdhury vs. UoI AI 1951 SC 41; Venkatesh (Minor) vs. CIT [1999] 243 ITR 367 (Mad) and Smt. Maharani Ushadevi vs. CIT [ 1981] 131 ITR 445 [MP] were referred to with approval and followed.

Merely since at the time of exit capital gains tax does not become payable or the transaction is not assessable to tax, would not make the entire sale of shares a sham or tax avoidant.

Parties to the transaction have not agreed upon a separate price for the CGP share and a separate price for what is called “other rights and entitlements” [including options, right to non-compete, control premium, customer base, etc]. It is therefore impermissible for Revenue to split the payment and consider a part of such payment for each of the above items. The essential character of the transaction as an alienation is not altered by the form of consideration, the payment of the consideration in installments or on the basis that the payment is related to a contingency (“options”, in this case), particularly when the transaction does not contemplate such a split up.

Retrospective amendments in sections 2(14), 2(47) and 9(1)(i) of the Act by the Finance Act, 2012

Provisions of sections 2(14), 2(47) and 9(1) (i) of the Act were amended by the Finance Act, 2012, to operate with retrospective effect from 1-4-1962, effectively to nullify the impact of the judgement of the Supreme Court in the case of Vodafone and to protect the tax base as well as to safeguard revenue’s interest in many such similar cases.

In this connection, it is important to note the relevant portion of the Finance Minister’s speech on 7-5-2012, while introducing the Finance Bill, 2012, which reads as under:

“7.    Hon’ble Members are aware that a provision in the Finance Bill which seeks to retrospectively clarify the provisions of the Income Tax Act relating to capital gains on sale of assets located in India through indirect transfers abroad, has been intensely debated in the country and outside. I would like to confirm that clarificatory amendments do not override the provisions of Double Taxation Avoidance Agreement (DTAA) which India has with 82 countries. It would impact those cases where the transaction has been routed through low tax or no tax countries with whom India does not have a DTAA.” (emphasis added)

Taxability of capital gains in India in respect of transfer of shares of a non-resident entity holding shares of an Indian Company, between two non-residents in a tax treaty situation

As mentioned above, in the Vodafone’s case, there was no Tax treaty involved as shares of a Cayman Islands company were transferred by the Hongkong based holding company to the Netherlands based Buyer company Vodafone and India does not have any DTAA with Cayman Islands or Hong Kong.

In the context of taxability of capital gains in India in respect of transfer of shares of a non-resident entity holding shares of an Indian Company, between two non-residents, in a similar case but in a tax treaty situation, some very important questions arise for consideration, which are, inter alia, as follows:

(1)    Whether an intermediate entity [IE] is not with commercial substance; is a sham or illusory contrivance, a mere nominee of its holding company and/or holding company being the real, legal and beneficial owner(s) of Indian Company’s [Indco] shares; and a device incorporated and pursued only for the purpose of avoiding capital gains liability under the Act?

(2)    Whether it can be said that an investment, initially made by the holding company through IE in Indco, a colourable device designed for tax avoidance? If so, whether the corporate veil of IE must be lifted and the transaction (of the sale of the entirety of IE shares by Holdco to non -resident buyer) treated as a sale of Indco’s shares?

(3)    Is such a transaction (on a holistic and proper interpretation of relevant provisions of the Act and the applicable DTAA), liable to tax in India?

(4)    Whether retrospective amendments to provisions of the Act (by the Finance Act, 2012) alter the trajectory or impact provisions of the DTAA and/or otherwise render the trans-action liable to tax under the provisions of the Act?

Andhra Pradesh High Court’s [High Court] land-mark decision in the case of Sanofi Pasteur Holding SA [2013] 30 taxmann.com 222 (AP) dated 15-2-2013

On similar issues which arose for consideration of the Andhra Pradesh High Court in the Writ petitions filed by Sanofi Pasteur Holding SA and others, the AP High Court, in a very detailed, very well considered and articulated judgement, has affirmed certain long established principles. Primarily, it has reiterated the view that the retrospective amendment does not alter the provisions of tax treaty. It has also reaffirmed the various factors brought out in the Vodafone decision while considering whether an entity is a sham entity or conceived only for tax-avoidance purposes.

The court also refused to lift the corporate veil in the absence of sound justification and more so where a case of tax avoidance is not established. This decision also reiterated that an Indian Tribunal or Court is bound by the ruling of jurisdictional superior judicial authority.

The brief facts of the case, issues before court, the tax department’s contention, the petitioner’s contention and the conclusions of the High Court are summarised below.

Brief facts:

Shantha Biotechnics Limited (SBL) is a company incorporated under the Companies Act, 1956 having its registered office in Hyderabad, India. Sanofi Pasteur Holding (Sanofi) is a company incorporated under the laws of France. During the year 2009, Sanofi had purchased 80.37 % of the share capital of another French company (i.e. ShanH) from Merieux Alliance (MA), a French company, and balance 19.63 % share capital of ShanH from Groupe Industriel Marcel Dassault (GIMD), another French company. ShanH held 82.5 % of the share capital of SBL.

The tax department passed an order on Sanofi dated 25th May 2010, u/s. 201(1)/(1A) of the Act, holding Sanofi as an `assessee-in-default’ for not withholding taxes on payments made to MA and GIMD on acquisition of shares of ShanH. MA and GIMD made an application to the Authority for Advance Ruling (the AAR) on the taxability of the transaction. The AAR in November 2011 ruled that the capital gain arising from the sale of shares of ShanH by MA and GIMD was taxable in India in terms of Article 14(5) of the India-France tax treaty.

Later, both the parties i.e. the Buyer (Sanofi) and Sellers (MA and GIMD) filed writ petitions before the High Court.

Department’s contentions

The Share Purchase Agreement (SPA) dated 10th July, 2009 between MA, GIMD and Sanofi was only for the acquisition of the control, management and business interests in SBL and was not mere divestment of shares of ShanH. As a result, capital assets in India were transferred and capital gains had accrued to MA and GIMD in India. ShanH is not a company with an independent status and is only an alter ego of MA and GIMD, the latter are the legal and beneficial owners of shares of SBL. ShanH had no control over SBL management nor enjoyed any rights and privileges in SBL as a shareholder. ShanH is at best a nominee of MA in relation to SBL’s shares.

There was no conflict between the provisions of the Act pursuant to the retrospective amendments carried out by the Finance Act, 2012 and the tax treaty. The transaction was taxable in India since the right was allocated to India under Article 14(5) of the tax treaty. For a proper and purposeful construction of the tax treaty provisions, the expression ‘alienation of shares’ in Article 14(5) of the tax treaty must be understood as direct as well as indirect alienation.

The retrospective amendments to section 2(47) of the Act, by the Finance Act, 2012, clarifies that ‘transfer’ would mean and would deem to have always meant the disposal of an asset whether directly or indirectly or voluntarily or involuntarily. The retrospective clarificatory amendments do not seek to override the tax treaty. In case of a conflict between the domestic law and the tax treaty, the tax treaty will prevail in terms of Section 90 of the Act. In the present case, there is however, no conflict between the tax treaty and the provisions of the Act. Therefore, once the right to tax the gains stand allocated to the source country, domestic law provisions of the source country will have to be read into the tax treaty in terms of Article 3(2) of the tax treaty, where any expression has not been defined in a tax treaty. Since ‘alienation’ is not defined in the tax treaty, its meaning has to be imported from the domestic law, as amended by the FA 2012. This exercise does not amount to overriding the tax treaty and in fact amounts to giving effect to Article 3(2) of the tax treaty.

Since MA and GIMD are owners of SBL shares, both legal and beneficial, it is MA and GIMD which have the participating interest in SBL. The disposal of participating interest, whether directly or through a nominee entity like ShanH would not take the capital gains out of the ambit of Article 14(5) of the tax treaty. If the right to tax vests in India, the mode of disposal was immaterial, whether direct, indirect or deemed disposal.

Petitioner’s contentions

On a reading of section 90 of the Act with relevant provisions of the tax treaty, the capital gain in the Sanofi’s transaction was taxable only in France. Only Article 14(4) of the tax treaty permits a limited ‘see through’, not Article 14(5) of the tax treaty. Neither in law nor qua Article 14 of the tax treaty could an asset held by a company be treated as an asset held by a shareholder.

Controlling interest is not a separate asset independent of shares. Even if controlling interest over SBL by ShanH is viewed as a separate right or asset, the situs of the controlling Interest was located and taxable only in France under Article 14(6) of the tax treaty.

Since the cost of acquisition was not determinable for controlling rights and underlying assets; there being no date of acquisition nor there being any part of the consideration apportionable to these rights, the computation provision of capital gains would fail and taxing the transaction on the underlying assets theory would be inoperative.

ShanH is a company incorporated in France. It is a joint venture between MA and GIMD to act as an investment vehicle. It had a separate Board of Directors and was filing tax returns in France. Setting up of SPVs (France) is considered necessary to protect the interest of investors. Without incorporation of ShanH as a distinct investment entity, it would not have been possible to interest GIMD (with no expertise in the field of vaccines to come on board ShanH, as an investment partner.)

Further, ShanH obtained FIPB approval for investment in the shares of SBL. The AAR ruling is contrary to settled legal principles and erroneous. Since the transaction was not taxable in India, Sanofi was not required to withhold tax.

Relevant issues before High Court

Is ShanH not an entity with commercial substance? Is it a mere nominee of MA and/or MA/ GIMD who are the real, legal and beneficial owners of SBL’s shares? Is ShanH a device incorporated and pursued only for the purpose of avoiding capital gains liability under the Act?

Was the investment, initially by MA and thereafter by MA and GIMD through ShanH in SBL, a colourable device designed for tax avoidance? If so, whether the corporate veil of ShanH must be lifted and the transaction (of the sale of the entirety of ShanH shares by MA/GIMD to Sanofi) treated as a sale of SBL shares?

Is the transaction (on a holistic and proper interpretation of relevant provisions of the Act and the tax treaty), liable to tax in India?

Whether retrospective amendments to provisions of the Act (by the Finance Act, 2012) alter the trajectory or impact provisions of the tax treaty and/or otherwise render the transaction liable to tax under the provisions of the Act?

Decision of the High Court

In respect of commercial substance of ShanH

The High Court observed that ShanH as a French resident corporate entity is a distinct entity of commercial substance, distinct from MA and GIMD. It was incorporated to serve as an investment vehicle, this being the commercial substance and business purpose i.e. of foreign direct investment in India by way of participation in SBL.

ShanH received and continues to receive dividends on its SBL shareholding which have been and are assessable to tax under provisions of the Act; and even post the transaction in issue, the commercial and business purpose of ShanH as an investment vehicle is intact. These indicators/ factors are, in the light of Vodafone International Holdings B.V., adequate base to legitimise the conclusion that ShanH is not a sham or conceived only for Indian tax-avoidance structure.

In respect of lifting of corporate veil of ShanH

The High Court observed that, on an analysis of the transactional documents and surrounding circumstances, ShanH was not conceived for avoiding capital gains liability under the provi-sions of the Act. The same has also not been contested by the tax department. Further, the High Court observed that in the light of the ratio laid down by the SC in Azadi Bachao Andolan and Vodafone International Holdings B.V., ShanH is not a corporate entity brought into existence and pursued only or substantially for avoiding capital gains tax liability under the provisions of the Act.

As observed in the Vodafone International Holdings B.V. factual context (equally applicable in this case), ShanH was conceived and incorporated in conformity with MA’s established business prac-tices and organisational structure.

The fact that a higher rate of capital gains tax is payable and has been remitted to Revenue in France, lends further support to the Sanofi’s contention that ShanH was not conceived, pursued and persisted with, to serve as an India tax-avoidance device. Since the tax department failed to establish that the genesis and continuance of ShanH establishes as an entity of no commercial substance and/or that ShanH was interposed only as a tax avoidant device, no case was made out for piercing or lifting the corporate veil of ShanH. Even subsequent to the transaction in issue and currently as well, ShanH continues in existence as a registered French resident corporate entity and as the legal and beneficial owner of shares of SBL.

Independent of the conclusion that there was no case piercing the corporate veil of ShanH, the transaction in issue was clearly one of transfer by MA and GIMD of their shareholding in ShanH to Sanofi and it was not a case of transfer of shareholding in SBL, which continues with ShanH.

In respect of impact of retrospective amendments

The meaning and trajectory of the retrospective amendments to the Act must be identified by ascertaining the legal meaning of the amendments, considered in the light of the provisions of the Act and the mischief that the amendments are intended to address. The retrospective amendments do not alter the provisions of the tax treaty and given the text of section 90(2) of the Act, these amendments do not alter the taxability of the present transaction.

Further, the retrospective amendments in section 2(14), 2(47) and section 9 of the Act are not fortified by a non -obstante clause to override the provisions of the tax treaties.

No liability to tax in India

The present transaction was for alienation of 100 %    of shares of ShanH held by MA and GIMD in favour of Sanofi and such transaction falls within Article 14(5) of the tax treaty. The transaction neither constitutes the transfer nor deemed transfer of shares or of the control/management or underlying assets of SBL.

The controlling interest of ShanH over the affairs, assets and management of SBL being identical to its shareholding and not a separate asset, it cannot be considered or computed as a distinctive value. The assets of SBL cannot be considered as belonging to a shareholder (even if a majority shareholder). The value of the controlling rights over SBL attributable to ShanH shareholding is also incapable of determination and computation. There was also the issue of value of Shantha West, a subsidiary of SBL. For these reasons, the computation component which is inextricably integrated to the charging provision (section 45 of the Act) fails, and consequently the charging provision would not apply. The transaction was not liable to tax in India under the provisions of the Act read with the provisions of the tax treaty.


Conclusions
It appears that in the case of Sanofi, the fact that the intermediate company ShanH was located in France and tax was paid in France on the capital gains at a rate of tax higher than in India, may have had significant influence in deciding the case in favour of the petitioners.

In this connection, attention of the readers is invited to the Report of the Expert Committee on Retrospective Amendments relating to Indirect Transfer headed by Shri Parthasarathi Shome.

Considering the decision of Vodafone, subsequent retrospective amendments by the Finance Act, 2012 and the landmark decision of the AP high Court in Sanofi’s case, it may be plausible to take a view that in similar transactions, in a tax treaty situation, the same may not be liable to tax in India. Media reports indicate that many such cases are pending before various high courts. However, keeping in mind the past trend and the approach of the tax department, surely the final word on the subject would be probably said only after the decision of the SC is rendered on the issue.

Reassessment: S/s. 147 and 148: A. Y. 2007-08: Where AO has acted only under compulsion of audit party and not independently, action of reopening assessment is not valid:

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Vijay Rameshbhai Gupta vs. ACIT; 32 Taxman.com 41 (Guj):

In the course of assessment proceedings u/s. 143(3), the Assessing Officer took a view that income earned by assessee from leasing out his restaurant was taxable as business income. Subsequently, the Assessing Officer initiated reassessment proceedings on the ground that aforesaid lease income was liable to be taxed as income from other sources and, thus, business expenses were wrongly allowed against said income.

The assessee filed writ petition challenging the validity of reassessment proceedings contending that the Assessing Officer was compelled by the audit party to reopen the assessment, though on the reasons recorded, the Assessing Officer was of the belief that no income chargeable to tax had escaped assessment.

The Gujarat High Court allowed the petition and held as under:

“i) From the series of evidence, it stands clearly established that the Assessing Officer was under compulsion from the audit party to issue notice for reopening. This is so because after the audit party brought the controversial issue to the notice of the Assessing Officer, he had not agreed to the proposal for reexamination of the issue. Thereupon, he in fact, wrote a letter and gave elaborate reasons why he did not agree to make any addition on the controversial issue.

ii) In the said letter, the Assessing Officer firmly asserted that the assessee’s income from lease was to be assessed as business income and not as income from other sources. Despite his firm assertion, the audit party once again wrote to the jurisdictional Commissioner that the reply of the Assessing Officer was not acceptable.

iii) Thus, it is apparent on the face of the record that the Assessing Officer was compelled to issue notice for reopening, though he held a bona fide he had accorded in the original assessment was as per the correct legal position.

iv) By now, it is well settled that even if an issue is brought to the notice of the Assessing Officer by the audit party, it would not preclude the Assessing Officer from acting on such communication as long as the final opinion to take appropriate action is that of the Assessing Officer and not that of the audit party. It is equally well settled however that if the Assessing Officer has acted only under compulsion of the audit party and not independently, the action of reopening would be vitiated.

v) In view of above, the impugned notice seeking to reopen the assessment was to be quashed.”

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Penalty: Limitation: S/s. 271D and 275(1)(c): A. Y. 2001-02: On 27/03/2003 AO served show cause notice for penalty u/s. 271D: Matter referred to Jt. CIT on 22/03/2004: Jt. CIT passed order of penalty u/s. 271D on 28/05/2004: The order is barred by limitation u/s. 275(1)(c):

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CIT Vs. Jitendra Singh Rathore; 257 CTR 18 (Raj):

For the A. Y. 2001-02, the assessment was completed by an order u/s. 143(3), 1961 dated 25/03/2003. The Assessing Officer noticed that the assessee had accepted cash loans exceeding the limit specified u/s. 269SS to the tune of Rs. 4,00,000/- and the same being in contravention of section 269SS initiated penalty proceedings u/s. 271D of the Act and served show cause notice on the assessee on 27/03/2003. The matter was referred to the Jt. CIT on 22/03/2004, who was the competent authority to impose such penalty u/s. 271D. On 28/05/2004, the Jt. CIT passed an order of penalty u/s. 271D imposing the penalty of Rs. 4,00,000/-. The Tribunal cancelled the penalty holding that the order is barred by limitation.

In appeal by the Revenue, the following question was raised:

“Whether on the facts and in the circumstances of the case as well as in the law, the learned Tribunal was justified in deleting the penalty u/s. 271D holding that the penalty was not imposed within the prescribed period u/s. 275(1)(c) from the date of initiation by the AO ignoring the legal provision that the authority competent to impose penalty u/s. 271D was Jt. CIT and hence the period of limitation should be reckoned from the issue of first show cause by the Jt. CIT?”

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

“i) Even when the authority competent to impose penalty u/s. 271D was Jt. CIT the period of limitation for the purpose of such penalty proceedings was not to be reckoned from the issue of first show cause by the Jt. CIT, but the period of limitation was to be reckoned from the date of issue of first show cause for initiation of such penalty proceedings.

ii) For the purpose of the present case, the proceedings having been initiated on 25/03/2003, the order passed by the Jt. CIT u/s. 271D on 28/03/2004 was hit by the bar of limitation.

iii) The CIT(A) and the Tribunal have, thus, not committed any error in setting aside the order of penalty. Consequently, the appeal fails and is, therefore, dismissed.”

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Penalty: S/s. 269SS and 271D: Amount received by assessee from her father-in-law for purchasing property: Transaction genuine and source disclosed: Penalty u/s. 271D not to be imposed:

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CIT vs. Smt. M. Yeshodha: 351 ITR 265 (Mad):

In the previous year relevant to A. Y. 2005-06, the assessee received a loan of Rs. 20,99,393/- in cash from her father-in-law for purchasing property. In the penalty proceedings u/s. 271D r/w. s. 269SS, the assessee claimed that the amount received in cash from father-in-law was a gift and not a loan. The Assessing Officer held that the assessee had received the amount as a loan and not as a gift, because the amount was shown as a loan in the balance sheet of the assessee, which was filed with the return of income. He therefore imposed penalty of Rs. 20,99,393/- u/s. 271D of the Act. The Tribunal held that the transaction was between the father-in-law and the daughter-in-law and the genuineness of the transaction in which the amount had been paid by the father-in-law for the purchase of property was not disputed, and the cash taken by the assessee from her father-in-law was not a loan transaction. The Tribunal, accordingly, deleted the penalty.

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

“i) The contention of the Revenue is that the amount received by the assessee from her fatherin- law has to be treated only as a loan and if it is a loan, then the assessee is liable to pay penalty u/s. 271D of the Act.

ii) Whether it is a loan or other transaction, still the other provision, namely, section 273B, comes to the rescue of the assessee, if she is able to show reasonable cause for avoiding penalty u/s. 271D. The Tribunal has rightly found that the transaction between the daughter-in-law and the father-in-law is a reasonable transaction and a genuine one owing to the urgent necessity of money to be paid to the seller. We find that this would amount to reasonable cause shown by the assessee to avoid penalty u/s. 271D of the Act.

iii) The Tribunal has rightly allowed the appeal. We do not find any error or infirmity in the order of the Tribunal to warrant interference. Accordingly, the substantial question of law is answered in favour of the assessee.”

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US Tax Goes Global

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Introduction

Ensuring tax compliance and establishing tax discipline is the basic objective of lawmakers and for some unexplained reasons, jumping the tax payments is many tax payers’ delight across the world. Eventually when law enforcers realise the weakness of the stick, they offer carrots of amnesty schemes now and then and the United States of America is no exception.

In 2009 and 2011 the Internal Revenue Service (IRS) offered schemes of Overseas Voluntary Disclosure Initiatives (OVDI) for tax defaulters to come clean about paying their taxes on their hitherto undisclosed foreign income and also to adhere to the requirements of yearly disclosure of foreign financial assets under the Foreign Bank Account Reporting (FBAR). Having received a lukewarm response to the OVDI, the IRS introduced Overseas Voluntary Disclosure Programme (OVDP), which is presently open. Apart from this, Foreign Assets Tax Compliance Act (FATCA) has become effective from the year 2011.
Under FATCA, tax payers who are US citizens, Green Card holders or resident aliens are required to declare their foreign financial assets to the IRS. However, through FATCA, US lawmakers have, probably for the first time, also sought to stretch the geographical limits of the IRS jurisdiction to almost all the nations, and the responsibility of collecting taxpayer’s information is cast on global institutions. No doubt, Double Tax Treaties grant abundant rights to tax authorities to seek tax payer’s information, but FATCA turns the tables by entrusting the responsibility of collecting and providing information as regarding financial affairs of all US citizens and US address accounts on banks, mutual funds, insurance companies, broking houses and other financial institutions across the world, thereby tightening the IRS grip to control possible tax evasion.
[http://www.treasury.gov/press-center/press-releases/ Pages/tg1759.aspx]
Effective 1st January, 2014 many Non-Resident Indians (NRI) of US who by ignorance or otherwise have failed to submit FBAR and FATCA reports or declare Indian income in US tax returns may face punitive action. It would therefore, be prudent for every NRI to understand and address these important changes being implemented next year. The most innocent mistake NRIs residing in the US tend to make is the non-declaration of their Indian assets owned prior to migration and financial assets inherited or received through partition of family which are otherwise covered by reporting requirements of FBAR and FATCA and non-payment of tax on income generated out of such assets.
US Engaging with India for compliance
US Treasury has initiated the signing of agreements with various Governments requiring domestic financial institutions operating in their country to provide requisite information for the calendar year 2013 of all US citizens and US addressee customers to the IRS from 1st January, 2014. While governments of UK, Denmark and Mexico have already signed such an agreement. France, Germany, Spain, and Italy are in the process of concluding the agreements. Efforts are being made to enter into similar agreements with many other countries.
As posted in the US Embassy report, US Treasury Secretary Mr. Timothy Geithner and US Federal Reserve Chairman Mr. Ben Bernanke met the Finance Minister of India and the Prime Minister of India on the 9th October, 2012 and discussed various options and possible actions for combating tax evasion by US-based NRIs.[http://newdelhi.usembassy.gov/sr100913.html].
As a consequence, the Reserve Bank of India has been asked to draft a domestic legislation requiring Indian banks, mutual funds, insurance companies, broking houses and other financial institutions to provide information of investments of US citizens and US addressees to the IRS from 1st January, 2014. [http://articles.economictimes.indiatimes.com/2012-11- 27/news/35385827_1_financial-assets-fatca-financialinstitutions ]

To take an overview of the subject, salient features of the FBAR, FATCA and taxability of global income under US tax laws are briefly discussed below.

FBAR
It is a simple form to collect basic information of US citizens or US residents of their overseas financial accounts in their names or wherein they have signing authority or control.
Applicability: The FBAR is required to be filed by a person who is a US citizen, resident of US, a US partnership firm, a Limited Liability Company (LLC) or trust (referred as United States Person) which has financial interest or signing authority in overseas financial investment exceeding INR621,672 during a calendar year. It may be noted that filing of tax returns jointly by a married couple is common in US but the limit of INR621,672 is for each individual.
Foreign Financial Account:
It includes all accounts maintained with a financial institution and also includes:
• Securities or brokerage account;
 • Bank account including savings, current or deposits held as NRE, NRO, FCNR account and also Resident account.
• Commodity Futures & Options Accounts;
• Whole life insurance policy and any annuity with cash value;
 • Mutual fund or similar pooled fund and
• Any account maintained with a foreign financial institution or other person performing the services of a financial institution. It may be noted that investment in a partnership or proprietorship firm, private limited company, personal loans and personal assets like jewellery are not included and hence not required to be reported. Immovable properties are also not covered under FBAR but bank balances generated by funds remitted for purchase of immovable property in India need to be reported. Financial Interest: A United States person is said to have a financial interest in a foreign financial account if:
 • He is the owner of record or holder of legal title, or
• The owner of record or holder of legal title is another person who may be:

a) an agent, nominee, attorney or a person acting on behalf of the US person with respect to the account;

 b) a corporation/company in which the US person owns directly or indirectly more than 50% of the total value of shares or voting power;

 c) a partnership in which the US person owns directly or indirectly or has interest greater than 50% of the profits or capital;

d) a trust of which the US person is the trust grantor and has an ownership interest in the trust for US federal tax purposes;

e) a trust in which the US person has a more than 50% beneficial interest in the assets or income of the trust for the calendar year; or

f) any other entity in which the US person owns directly or indirectly more than 50% of the voting power or total value of equity interest or total assets or interest in profits.

Joint Owners: A husband and wife owning a joint account need not file separate reports. But if either spouse has a financial interest in any other account not held jointly then such a person should file a separate report for all accounts including those owned jointly with the spouse.

Form and Filing: The report is to be submitted in form TD F 90-22.1 with the US Department of the Treasury, Detroit by June 30 of the following year.

Penalty: Improper filing of FBAR attracts penalty of $10,000 whereas wilful failure to file FBAR is liable to penalty of greater of $100,000 or 50% of the balance at the time of violation and also is subjected to criminal penalties.

FATCA

FATCA is enacted with the primary goal to gain information about US persons and requires US persons to report their foreign financial assets to the IRS and also requires foreign financial institutions to report directly to the IRS details of financial accounts of US persons held with them.

Applicability: Individuals who are US citizens, tax residents, non-residents who elect to be resident aliens and non-residents who are bonafide residents of American Samoa or Puerto Rico having foreign financial assets above the threshold limit.

Foreign Financial Assets: It includes following financial assets:

•  Checking, savings and deposit accounts with banks held as NRE, NRO, FCNR or Resident accounts;

•    Brokerage accounts held with brokers & dealers;

•    Stocks or securities issued by a foreign corporation;

•    Note, bond or debenture issued by a foreign person;

•    Swaps of all kinds including interest rate, currency, equity, index, commodity and similar agreements with a foreign counterparty;

•    Options or other derivative instruments of any currency, commodity or any other kind that is entered into with a foreign counterparty or issuer;

•    Partnership interest in a foreign partnership;

•    Interest in a foreign retirement plan or deferred compensation plan;

•    Interest in a foreign estate;

•    Any interest in a foreign-issued insurance contract or annuity with a cash-surrender value; and

•    Any account maintained with a foreign financial institution and every foreign financial asset, income or gain whereof is to be reported in the tax return to be filed with the IRS.

It is significant to note, that unlike FBAR, FATCA covers investments of any and every size in equity shares of a private limited company, capital in partnership or proprietorship, loans and advances including personal loans, etc. Immovable properties are excluded. If the US person is not required to file US tax return for any reason, then he is not required to file the FATCA report.

Both FBAR and FATCA cover erstwhile investments in India and inherited or partitioned family assets.

Reporting Threshold: Individuals are covered by FATCA if the value of foreign financial assets exceeds $50,000 as on 31st December or $75,000 during the tax year and in case of married couple tax-payers $100,000 and $150,000 respectively.

For individual tax-payers living abroad these limits are raised to $200,000 and $300,000 respectively and $400,000 and $600,000 for a married couple filing joint return.

Joint Owners: The tax return of a married couple will include assets of both the spouses.

Form and Filing: The report is to be submitted in form 8938 with the IRS with the tax return. The due dates for filing tax returns with the IRS including extension provisions will apply accordingly.

Penalty: Failure to file Form 8938 by the due date or filing an incomplete form attracts a penalty of $10,000. Additional penalty of $10,000 per month up to a maximum penalty of $ 50,000 may become payable for failure to file inspite of IRS notice.

Tax Withholding: FATCA also requires 30% tax withholding on certain payments of US source income paid to non participating foreign financial institution or account holders who fail to provide requisite information. [http://www.irs.gov/uac/Treasury,-IRS-Issue-Proposed-Regulations-for-FATCA-Implementation]

Global Income of US Persons being Taxed in the US

Internal Revenue Code (IRC) requires a US citizen irrespective of his place of residence or resident of the US to declare and pay income tax on worldwide income. Of course, taxpayers having income in India can choose between the IRC and the regulations of India-USA Double Tax Treaty for income arising in India, and opt to be governed by provisions which are more beneficial to him, subject to conditions as may be applicable.

US Offshore Voluntary Disclosure Programme

The IRS has once again given an opportunity for voluntary disclosure of overseas assets and income thereon under the OVDP.

The OVDP is similar to the earlier OVDI under which tax payers are required to pay tax on hitherto undisclosed income of earlier eight tax years together with interest thereon, and in addition to a penalty of 27.5% of the highest balance of hitherto undisclosed foreign bank accounts and/or value of foreign assets over the last eight years. For balance upto $ 75,000 reduced penalty of 12.5% applies. In cases of tax payers disclosing and paying tax on foreign incomes but failing only to file FBAR returns, delinquent reports may be filed possibly saving oneself from penal provisions. [http://www.irs.gov/uac/2012-Offshore-Voluntary-Disclosure-Program]

Many NRIs may not have abided by the FBAR provisions and few by ignorance have also failed to pay tax on their Indian income in the US but ignorance of law cannot be an excuse, and therefore, it would be appropriate for US-based NRIs and Chartered Accountants advising them to take advantage of the OVDP before the programme is discontinued.

Exemption: Interest on tax free bonds: Section 10(15) : A. Y. 1988-89: Interest for period between application for allotment and actual allotment: Entitled to exemption: CIT vs. Bharat Heavy Electricals Ltd.; 352 ITR 88 (Del):

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For the A. Y. 1988-89, the assessee had claimed exemption of interest on tax free bonds u/s. 10(15). The Assessing Officer disallowed the claim for exemption in respect of the interest for the period from the date of application for allotment and the date of actual allotment. The Tribunal held that the assessee was entitled to exemption.

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

“i) In view of the amplitude of section 10(15)(iv), the fact that interest was paid for a brief period of about six days would not make it any less an amount of interest payable “in respect of bonds”.

ii) The assessee was entitled to exemption on the interest earned on tax free bonds between the date of their application by the assessee and the date of their allotment.”

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Double taxation relief: Section 91(1): A. Y. 1997- 98: Income earned in foreign country: Relief of taxes paid abroad: Relief not dependent upon payment of taxes being made in foreign country in previous year:

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CIT vs. Petroleum India International; 351 ITR 295 (Bom):

The assessee had paid taxes of Rs. 82 lakh in Kuwait on the income earned in Kuwait by it during the period relevant to the A. Y. 1997-98. Its claim for deduction of the said amount u/s. 91(1), was denied by the Assessing Officer on the ground that the payment of taxes in Kuwait was not made in the previous year relevant to the A. Y. 1997-98. 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) There was no requirement that the benefit of section 91(1) would be available only when payments of taxes had been made in the previous year relevant to the assessment year under consideration.

ii) The object of section 91(1) is to give relief from taxation in India to the extent taxes have been paid abroad for the relevant previous year. This deduction/ relief is not dependent upon the payment also being made in the previous year.

iii) The payment of taxes on the income earned in Kuwait during the previous year had been examined and found to be correct. Therefore, the assessee was entitled to double taxation benefit for the taxes paid in Kuwait.”

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Depreciation(Unabsorbed): Carry forward and set off: A. Y. 2006-07: Effect of amendment of section 32(2) w.e.f. 01/04/2002: Unabsorbed depreciation from A. Y. 1997-98 to 2001-02 got carried forward to A. Y. 2002-03 and became part thereof: It is available for carry forward and set off against the profits and gains of subsequent years, without any limit:

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General Motors India (P) Ltd. vs. Dy. CIT; 257 CTR 123 (Guj):

In this case, the question for consideration before the Gujarat High Court was as to “whether the unabsorbed depreciation pertaining to A. Y. 1997-98 could be allowed to be carried forward and set off after a period of eight years or it would be governed by section 32 as amended by Finance Act 2001?”. The reason given by the Assessing Officer is that section 32(2), was amended by Finance Act No. 2 Act of 1996 w.e.f. A.Y. 1997-98 and the unabsorbed depreciation for the A. Y. 1997-98 could be carried forward up to the maximum period of 8 years from the year in which it was first computed. According to the Assessing Officer, 8 years expired in the A. Y. 2005-06 and only till then, the assessee was eligible to claim unabsorbed depreciation of A. Y. 1997-98 for being carried forward and set off. But the assessee was not entitled for unabsorbed depreciation of Rs. 43,60,22,158/- for A. Y. 1997-98, which was not eligible for being carried forward and set off against the income for the A. Y. 2006-07.

The Gujarat High Court held as under:

“i) Amendment of section 32(2) by Finance Act, 2001 is applicable from A. Y. 2002-03 and subsequent years. Therefore unabsorbed depreciation from A. Y. 1997-98 upto the A. Y. 2001-02 got carried forward to the A. Y. 2002-03 and became part thereof.

ii) It came to be governed by the provisions of section 32(2) as amended by Finance Act, 2001 and was available for carry forward and set off against the profits and gains of subsequent years, without any limits whatsoever.”

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