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Year: 2016

TDS – Rent – Section 194I – Where One Time Nonrefundable Upfront Charges paid by the assessee was not (i) under the agreement of lease and (ii) merely for the use of the land and the payment was made for a variety of purposes such as (i) becoming a co-developer (ii) developing a Product Specific SEZ(iii) for putting up an industry in the land and both the lessor as well as the lessee intended to treat the lease virtually as a deemed sale, the upfront payment made by the assessee for the acquisition of leasehold rights over an immovable property for a long duration of time say 99 years could not be taken to constitute rental income at the hands of the lessor and hence lessee, not obliged to deduct TDS u/s. 194-I

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Foxconn India Developer (P.) Ltd. vs. ITO; [2016] 68 taxmann.com 95 (Mad)

In the appeal filed by the assessee, the following questions were raised before the Madras High Court:

“i)
Whether the upfront payment made by an assessee, under whatever name
including premium, for the acquisition of leasehold rights over an
immovable property for a long duration of time say 99 years, could be
taken to constitute rental income at the hands of the lessor, obliging
the lessee to deduct tax at source u/s. 194-I ?

ii) Whether in
the facts and circumstances of the case and in law, the Tribunal was
right in confirming the levy of interest u/s. 201(1-A) ?”

The High Court held as under:

“i)
The One Time Non-refundable Upfront Charges paid by the assessee was
not (i) under the agreement of lease and (ii) merely for the use of the
land. The payment made for a variety of purposes, such as (i) becoming a
co-developer (ii) developing a Product Specific Special Economic Zone
in the Sriperumbudur Hi-Tech Special Economic Zone (iii) for putting up
an industry in the land. The lessor as well as the lessee intended to
treat the lease virtually as a deemed sale, giving no scope for any
confusion. In such circumstances, we are of the considered view that the
upfront payment made by the assessee for the acquisition of leasehold
rights over an immovable property for a long duration of time, say 99
years, could not be taken to constitute rental income at the hands of
the lessor, obliging the lessor to deduct tax at source u/s. 194-I.
Hence, the first substantial question of law is answered in favour of
the appellant/assessee.

ii) Once the first substantial question
of law is answered in favour of the appellant/assessee, by holding that
the assessee was not under an obligation to deduct tax at source, it
follows as a corollary that the appellant cannot be termed as an
assessee in default. As a consequence, there is no question of levy of
interest u/s. 201(1-A).

iii) In the result, the appeal is allowed.”

Revision against a deceased person is not valid – Sections 263 and 159 and 292BB – A. Y. 2009-10 – Where revision Proceedings u/s. 263 are initiated against a deceased assessee after the Income Tax Department comes to know of his death by notice returned by postal dept with remarks “addressee deceased”, such proceedings are a nullity and are not saved by section 292BB by reason of legal heirs having co-operated in revision proceedings nor by section 159

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CIT vs. M. Hemananthan; [2016] 68 taxmann.com 22 (Mad)

For the A. Y. 2009-10, the assessment was completed u/s. 143(3) on 26/03/2011 in the case of the assessee, M. A. Margesan. Subsequently, a notice u/s. 263 of the Act dated 06/09/2013 was issued in the name of the assessee, who had died on 13/06/2013. The notice was sent by post, but was returned with the endorsement ‘addressee deceased’. This fact was intimated by the Income Tax Officer to the Assistant Commissioner, by a communication dated 23/9/2013. However, thereafter the Department served the very same show cause notice on the son (Resdpondent)of the deceased assessee through a messenger. Left with no alternative, the son engaged the services of an authorised representative, who participated in the proceedings u/s. 263. Eventually, an order was passed by the Commissioner on 21/3/2014, sustaining the show cause notice, setting aside the scrutiny assessment order dated 23/6/2011 and remitting the matter back to the Assessing Officer to pass orders afresh. The Tribunal allowed the appeal holding that the order passed u/s. 263 against a dead person is a nullity.

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

“Where revision proceedings u/s. 263 are initiated against a deceased assessee after the Income Tax Department comes to know of his death by notice returned by postal dept with remarks “addressee deceased”, such proceedings are a nullity and are not saved by section 292BB by reason of legal heirs having co-operated in revision proceedings nor by section 159. There is a distinction between proceedings initiated against a person, who is alive, but continued after his death and a case of proceedings initiated against a dead person.”

Non-resident – Royalty – Sections 9 and 90 – A. Ys. 2007-08 and 2009-10 – Royalty having same meaning under I. T. Act and DTAA – Subsequent scope in I. T. Act widening scope of “royalty” – Meaning under DTAA not changed – Assessee entitled to exemption as per DTAA

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DIT vs. New Skies Satellite BV; 382 ITR 114 (Del):

The assessee, a non-resident, derived income from the “lease of transponders” of their respective satellites. This lease was for the object of relaying signals of their customers; both resident and non-resident television channels, that wished to broadcast their programs for a particular audience situated in a particular part of the world. The assessees were chosen because the footprint of their satellites, i.e. the area over which the satellite could transmit its signal, included India. Having held the receipts taxable u/s. 9(1)(vi), the Assessing Officer held that the assessee would not get the benefit of DTAA between India and Thailand and between India and Netherlands. The Tribunal held that they were not taxable in India in view of the DTAA .

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

“i) Just because there is a domestic definition similar to the one under the DTAA , amendments to the domestic law, in an attempt to counter, restrict or expand the definition under its statute, cannot extend to the definition under DTAA . In other words, the domestic law remains static for the purpose of DTAA . Consequently, the Finance Act, 2012 will not affect article 12 of the DTAA , and it would follow that the first determinative interpretation given to the word ”royalty” in the case of Asia Satellite, when the definitions were in fact pari materia, will continue to hold the field for the purpose of assessment years preceding the Finance Act, 2012 and in all cases which involve DTAA , unless the DTAA s are amended jointly by both parties to incorporate income from data transmission services as partaking the nature of royalty, or amend the definition in a manner so that such income automatically becomes royalty.

ii) T he receipts of the assessee from providing data transmission services were not taxable in India.”

A. P. (DIR Series) Circular No. 55 dated March 29, 2016

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Investment by Foreign Portfolio Investors (FPI) in Government Securities

This circular contains the increased limits for investment by FPI in Government Securities over the next 2 quarters as under: –


Any limit which remains unutilised by the long term investors at the end of a half-year will be available as additional limit to the investors in the open category for the following half-year. Accordingly, limits for the long term investors remaining unutilized at the end of half year ending Sept 30, 2016 will be released for investment under the open category in October, 2016.

A. P. (DIR Series) Circular No. 54 dated March 23, 2016

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Diamond Dollar Account (DDA) – Reporting Mechanism

Presently, banks are required to submit to RBI: –
1. Quarterly reports giving details of the name and address of the firm / company in whose name a Diamond Dollar Account is opened, along with the date of opening / closing the said Account.

2. Fortnightly statements giving data on DDA balances maintained by them.

This circular states that, with immediate effect, the above two reports / statements are not required to be submitted to RBI. However, banks are required to maintain the said database at their end and submit the same to RBI whenever called upon to do.

Liability of Stock Brokers for clients’ frauds – Supreme Court Decides

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Background
A fairly common allegation
made by SEBI against stock and sub brokers concerns frauds, price
manipulation, etc. that their clients may have carried out on stock
exchanges. SEBI often holds brokers also liable for such acts of their
clients. They are held to be liable for having acted negligently or even
having deliberately allowed such acts. Sometimes they may be also held
liable for having actually participated in such acts. Many large stock
brokers having thousands or lakhs of clients may end up being
unwittingly used by such clients who carry out their nefarious deals
through them. Such frauds usually involve synchronised trading, i.e.,
the buyers and sellers both coordinate their purchase/sale in time and
quantity both. For the broker, who faces an opaque electronic trading
terminal where the counter parties cannot be known, it is difficult to
monitor whether such trades take place.

Nevertheless, brokers
are routinely proceeded against. Their defences are often ignored or
dealt with as per varying/subjective standards. The fact that
allegations of frauds are serious in nature and hence require a higher
degree of proof is not fully appreciated. This is not of course to say
that brokers are necessarily and always innocent.

In this light,
a recent decision of the Supreme Court (SEBI vs.Kishore R. Ajmera
[2016] 66 taxmann.com 288 (SC)) is very helpful. It lays down several
parameters and guidelines as to how the role of the stock brokers would
be determined in such cases.

Before we discuss the relevant
facts of the case and the decision of the Court, it is worth
understanding some concepts involved here.

Basic concepts
The
following paragraphs discuss briefly some of the concepts relevant to
such frauds/manipulation. The background is that certain parties carry
out pre-determined trades on the stock exchange through the electronic
trading mechanism. Such automated mechanism does have some safeguards.
However, determined and coordinated efforts by a group of persons can
easily override them, particularly if the shares are relatively
illiquid. The objective of such efforts may be several but they usually
involve manipulation of price, volumes, etc. of the shares/securities
and thus present an artificial/fake impression of what is happening in
the stock market. In essence, the normal market mechanism of
price/volume determination is tampered with for various purposes.

Opaque electronic Stock Exchange mechanism
The
electronic stock market trading mechanism is opaque. This means that
the buyer does not know who is the seller or how many sellers are there,
and vice versa. He punches in his order, and the mechanism matches his
order with the best orders presently available from any person spanning
across the country. He may end up buying from several sellers or just
one. He may end up buying at several prices too, but obviously not
exceeding the price that he has keyed in. The defence of a person
accused of price manipulation is usually that he does not know, cannot
know, and in any case cannot control, who the counter party is.

Synchronized dealing
While
stock market trading mechanism is opaque, it is still possible for
determined persons to override this system. They ensure that in terms of
price, volume and timing, their trades are matched. Two or more parties
enter orders simultaneously by prior coordination at such price and
volumes and at such time that usually the whole or most of their trades
match. Person A may enter an order to buy 10000 shares at Rs. 31.30
which person B at the same time enters an order to sell at same price
and of same quantity. Unless the shares are quite liquid, their orders
will wholly or substantially match.

Price/volume manipulation
Usually
the objective of such exercise is to manipulate the price or volumes of
the shares in such a way that an artificial picture is shown. The
parties may carry out such synchronized trading to, say, progressively
increase the price of the shares. The parties may also carry out
continuous trading amongst themselves whereby a fake picture arises that
the stock is quite liquid. The public gets a wrong picture and may end
up participating, and may incur a loss.

No transfer of beneficial interest in securities
The
essential feature of such acts is that, on the whole, there is no
transfer of beneficial interest in securities outside the group. The
group may start with a certain quantity of shares and finally end up
with the same or nearly the same quantity of shares. The whole objective
is to circulate these shares amongst themselves. Of course, at certain
stages, the shares actually move within the group. For this reason,
trading without transfer of beneficial interest in shares is
specifically considered to be a fraudulent/manipulative act under
certain circumstances.

Facts of the case
The decision
gives a common ruling for appeals in matter of several stock/sub
brokers accused of price manipulation/ fraud and/or violation of Code of
Conduct applicable to them, on account of acts of their clients. In
each of such case, it appears that price manipulation/fraud was indeed
carried out. The question to be answered was how would the role of the
brokers be determined? The Court lays down certain guiding factors.
Thereafter, it applied such factors to the facts of each case and
determined the role of each broker.

The various levels of liability of brokers as determined by Court and tests therefor
The Court essentially laid down various levels of liability of brokers, which have been summarised as follows.

Firstly,
the Court divided the liability under law in two parts. First concerned
a civil liability that could result in a monetary penalty, suspension,
etc. on the broker. The second concerned a criminal liability that would
result in prosecution. The criteria to determine whether broker was
guilty would differ depending on whether the proceedings were civil or
criminal. Further, the allegation may be of having violated the Code of
Conduct whereby the broker may not have exercised due diligence/been
negligent. The allegation may also be of the broker having deliberately
allowed such trading for earning brokerage. Finally, the allegation may
be of having been actively involved in such price manipulation.

For
criminal proceedings, the Court observed that, “Prosecution u/s. 24 of
the Act for violation of the provisions of any of the Regulations, of
course, has to be on the basis of proof beyond reasonable doubt.”
(emphasis supplied).

For civil proceedings, the Court observed,
“While the screen based trading system keeps the identity of the parties
anonymous it will be too naive to rest the final conclusions on said
basis which overlooks a meeting of minds elsewhere. Direct proof of such
meeting of minds elsewhere would rarely be forthcoming. The test, in
our considered view, is one of preponderance of probabilities so far as
adjudication of civil liability arising out of violation of the Act or
the provisions of the Regulations framed thereunder is concerned”.

To determine what, if at all, the role of the broker was, the Court laid down the following factors:-

“The
conclusion has to be gathered from various circumstances like that
volume of the trade effected; the period of persistence in trading in
the particular scrip; the particulars of the buy and sell orders,
namely, the volume thereof; the proximity of time between the two and
such other relevant factors. The fact that the broker himself has
initiated the sale of a particular quantity of the scrip on any
particular day and at the end of the day approximately equal number of
the same scrip has come back to him; that trading has gone on without
settlement of accounts i.e. without any payment and the volume of
trading in the illiquid scrips, all, should raise a serious doubt in a
reasonable man as to whether the trades are genuine. The failure of the
brokers/sub-brokers to alert themselves to this minimum requirement and
their persistence in trading in the particular scrip either over a long
period of time or in respect of huge volumes thereof, in our considered
view, would not only disclose negligence and lack of due care and
caution but would also demonstrate a deliberate intention to indulge in
trading beyond the forbidden limits thereby attracting the provisions of
the FUTP Regulations. The difference between violation of the Code of
Conduct Regulations and the FUTP Regulations would depend on the extent
of the persistence on the part of the broker in indulging with
transactions of the kind that has occurred in the present cases. Upto an
extent such conduct on the part of the brokers/sub-brokers can be
attributed to negligence occasioned by lack of due care and caution.
Beyond the same, persistent trading would show a deliberate intention to
play the market. The dividing line has to be drawn on the basis of the
volume of the transactions and the period of time that the same were
indulged in. In the present cases it is clear from all these surrounding
facts and circumstances that there has been transgressions by the
respondents beyond the permissible dividing line between negligence and
deliberate intention.”

It can be seen that, the Court also
highlighted a difference between liability of negligence / lack of due
care and caution under the Code of Conduct and liability for frauds/
manipulation under the Regulations.

The type of evidence to be gathered by SEBI to determine liability of the broker
The
Court then discussed the type of facts that SEBI would have to gather
and place on record to determine the liability and nature thereof of the
broker. As discussed above, where proceedings are civil in nature and
also considering that liability has to be determined by preponderance of
factors, direct proof may not be available nor needed. The Court
observed:-

“It is a fundamental principle of law that proof of
an allegation levelled against a person may be in the form of direct
substantive evidence or, as in many cases, such proof may have to be
inferred by a logical process of reasoning from the totality of the
attending facts and circumstances surrounding the allegations/charges
made and levelled. While direct evidence is a more certain basis to come
to a conclusion, yet, in the absence thereof the Courts cannot be
helpless. It is the judicial duty to take note of the immediate and
proximate facts and circumstances surrounding the events on which the
charges/allegations are founded and to reach what would appear to the
Court to be a reasonable conclusion therefrom. The test would always be
that what inferential process that a reasonable/ prudent man would adopt
to arrive at a conclusion.” (emphasis supplied).

Finally, the
Court laid down the following specific facts as relevant to determine
the liability of broker in each case. Whether the scrip was illiquid? It
has to be considered whether “the scrips in which trading had been done
were of illiquid scrips meaning thereby that such scrips were not
actively traded in the Bombay Stock Exchange and, therefore, was not a
matter of everyday buy and sell transactions. While it is correct that
trading in such illiquid scrips is per se not impermissible, yet,
voluminous trading over a period of time in such scrips is a fact that
should attract the attention of a vigilant trader engaged/engaging in
such trades.” Whether the Stock Exchange has issued any caution in
regard to the dealing in the scrip? Dealing in such scrips thus needs
greater attention by the broker.

Whether the clients who deal
through the broker know each other and such fact is known to the broker?
If such clients deal with each other through the broker, that should
surely attract concern from the broker. Whether the volumes in illiquid
scrips was huge, as was found in a case?

Whether the gap in time
of matching of the trades was too short (between 0-60 seconds in the
case before the Court)? Whether such trades were very frequent?

It
also emphasised that while the point relating to opaque screen trading
was relevant, this does not always rule out manipuation/frauds where
offline prior meeting of minds could be demonstrated by other factors.

Decision of the Supreme Court
The
Court applied the guiding factors to the facts of each case and
depending on individual facts, it either confirmed the adverse action
against the broker or set it aside.

Conclusion
This
decision should help make the law clearer and should be also helpful to
brokers in laying down systems and procedures to ensure that
frauds/manipulations by their clients do not take place and make them
liable for negligence or otherwise. Decisions by SEBI and the Securities
Appellate Tribunal will also thus become consistent and based on
certain pre-decided specific factors.

Penalty – Sections 269T, 271E and 275(1)(c) – A. Y. 2005-06 – Assessment order u/s. 143(3) with direction to initiate penalty proceedings u/s. 271E passed on 28/12/2007 – Penalty order u/s. 271E passed on 20/03/2012 is barred by limitation

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Principal CIT vs. JKD Capital and Finlease Ltd.; 378 ITR 614 (Del):

For the A. Y. 2005-06, the assessment order u/s. 143(3) was passed on 28/12/2007 with a direction to initiate proceedings for penalty u/s. 271E of the Act. A show cause notice initiating penalty proceedings u/s. 271E was issued on 12/03/2012 and a penalty of Rs.17,90,000/- was imposed. The Commissioner (Appeals) deleted the penalty on the ground that, in terms of section 275(1) (c), the penalty order should have been passed on or before 30/06/2008 and therefore, penalty order passed on 20/03/2012, was barred by limitation. The Tribunal confirmed the order of the Commissioner (Appeals).

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

“i) There are two distinct periods of limitation for passing a penalty order, and one that expires later will apply. One is the end of the financial year in which the quantum proceedings are completed in the first instance. In the present case, at the level of the Assessing Officer, the quantum proceedings were completed on 28/12/2007. Going by this date, the penalty order could not have been passed later than 31/03/2008. The second possible date was the expiry of six months from the month in which the penalty proceedings were initiated. With the Assessing Officer having initiated the penalty proceedings in December 2007, the last date by which the penalty order could have been passed was 30/06/2008. The later of the two dates was 30/06/2008.

ii) The decision of the Tribunal did not suffer from any legal infirmity.”

Depreciation – Section 32 – A. Y. 1996-97 – Purchase and lease back of energy measuring devices – Lessee not claiming depreciation – Assessee entitled to depreciation

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CIT vs. Apollo Finvest (I) Ltd.; 382 ITR 33 (Bom):

In the relevant year, the assessee claimed 100% depreciation on energy measuring devices purchased from the Haryana State Electricity Board. After purchase, they were leased back to the Board, under a lease agreement dated 29/09/1995. The Assessing Officer held that the purchase and lease back transaction was in fact and in substance a finance lease agreement. He disallowed the depreciation relying on the Circular No. 2 of 2001 dated 09/02/2001 and added the amount to income of the assessee. The CIT(A) and the Tribunal allowed the assessee’s claim.

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

“i) The condition precedent in a case of hire purchase is ownership of the assets and user for purposes of the business, i.e., not usage of the assets by the assessee itself but for purposes of its business of leasing.

ii) The entire case of the Department was based on Circular No. 2 of 2001, dated 09/02/2001. CIT(A) had examined the transactions and found them to be genuine. It was not disputed that the lessee had not claimed depreciation and the assessee had also taken loan against security of the leased assets.

iii) Accordingly, appeal is dismissed.”

ITA No. 1625/Mum/2014 Morgan Stanley Mauritius Company v. DCIT (IT) A.Y.: 2007-08, Date of Order – 29th January, 2016

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Article 13 of India-Mauritius DTAA – Additional consideration received for delay in making open offer, being an integral part of share transfer is a part and parcel of sale consideration, is covered by Capital Gains Article of the DTAA . Such payment does not constitute interest income in absence of a debtor- creditor relationship.

Facts
The Taxpayer, a company incorporated in Mauritius held the shares of an Indian Company (ICo). The Taxpayer transferred ICo’s shares to a Mauritius Company (FCo) under a scheme of open offer.

Together with the consideration for sale of shares, the Taxpayer also received additional consideration for delay in processing of open offer by FCo. As per the letter of open offer, it was clear that the initial offer price of the shares for transfer of each share was increased due to the delay in making the open offer. The Tax authority contended that such consideration was received for delay in making payment. Hence, it represented interest and was not part of sale consideration for the open offer. Accordingly, such additional payment would qualify as interest under the India-Mauritius DTAA and liable to source taxation in India.

However, the Taxpayer argued that as FCo had not provided any loan to Taxpayer, additional consideration cannot be said to be received in respect of any monies borrowed or for use of money. In absence of a debtorcreditor relationship between the Taxpayer and FCo, such additional consideration cannot be treated as interest.

Held
It is a fact that the regulatory authority i.e., SEBI, had approved the transaction. Further, since the transaction could not be completed in time due to certain reasons, FCo revised the offer price. The Taxpayer had no control over the decisions of FCo. Business decisions are governed by their own rules and laws and if considering the time factor, FCo agreed to increase the share price, it has to be taken as part of sale.

The Taxpayer owned shares of ICo and in response to the open offer by FCo, the Taxpayer agreed to sell the shares of ICo. It was a pure and simple case of selling of shares by the Taxpayer. The Taxpayer did not enter into any negotiations with FCo and transferred shares as per a scheme approved by SEBI.

Further, there was no debtor-creditor relationship between the Taxpayer and FCo. The Taxpayer had not advanced any sum to FCo and has not received any interest for the delayed repayment of principal amount. Reliance in this regard was placed on the Tribunal decision in the case of Genesis Indian Investment Company (ITA /2878/Mum/2006 dated 14th August 2013) wherein it was held that where the interest is received for delay in processing of buy back of shares in open offer after announcement of the intention of acquiring shares, such additional amount shall form part of consideration towards shares tendered in open offer.

Thus, the additional consideration received is part and parcel of total consideration and cannot be segregated under the head ‘original sales consideration’ and ‘penal interest’. Such additional consideration is not taxable in India by virtue of Article 13 of India-Mauritius DTAA .

TS-15-AAR-2016 Dow AgroSciences Agricultural Products Date of Order : 11th January, 2016

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Article 13(4) of India-Mauritius Double Taxation Avoidance Agreement (DTAA ) -Transfer of shares of an Indian company (ICo) by the applicant to its Singapore group entity (SCo) upon re-organisation, not a tax avoidant transaction

Facts
The Applicant is part of a large MNE group (Group) and a company resident and incorporated in Mauritius. The Applicant held majority (nearly 99.99%) of the shares of Indian Co (ICo) which was acquired by it in various tranches over a period of 10 years from 1995 to 2005.

The Group had presence all over the world and was divided into various regions based on their geographical locations. The Applicant belonged to the European region, while ICo belonged to the India, Middle East and Africa (IMEA) region. In the past, the IMEA region was dismantled and entities were realigned with other regions as per the geographical convenience. As a result of this realignment, ICo became a part of the focused Asia-Pacific region.

In order to achieve the objective of operational excellence, better control and administrative convenience, it was proposed to realign the holding of ICo and shift it to an entity in the Asia- Pacific region. Accordingly, it was proposed that Applicant would transfer the shares of ICo to its group entity in Singapore i.e., SCo.

Issues before the AAR were as follows:
Whether the entire arrangement of transfer of ICo’s shares in favor of SCo was a scheme to avoid taxes in India?

Whether the Applicant had a Permanent Establishment (PE) in India?

Whether income arising from such a transfer was taxable in India?

Held
On the issue of whether the arrangement was a tax avoidance transaction For the following reasons, it was held that the transaction of transfer ICo’s shares to SCo by the Applicant was not a tax avoidance transaction –

The Applicant had acquired shares of ICo in various tranches over a 10 year period. Such share acquisition which was carried out around 20 years ago for a substantial cost cannot amount to a scheme to avoid payment of taxes in India. ? T he Applicant had been operating for more than 10 years in Mauritius and hence, it cannot be said to be a shell company. Investment in ICo’s shares was carried out with prior approval of the Department of Industrial Policy and Promotion and Reserve Bank of India. In these circumstances, it cannot be said that shares were acquired with a view to sell them in future.

The need for realignment of the Group arose upon dismantling of the IMEA group in 2010. As a result, and in order to ensure better control, ICO’s holding was shifted to Asia-Pacific region. SCo was an upcoming entity in the Asia-Pacific region and, hence, it was proposed to realign the holding of shares of ICo from the Applicant to SCo. Additionally, all the shares of ICo were acquired five years prior to the present proposed re-organisation of the group. Hence, the proposed transaction is for sound business consideration.

On the issue of PE
It was a stated fact that the Applicant did not have an office or employees or agents in India. Neither did it have any activities in India. A tax residency certificate from Mauritius was also furnished by the Applicant. Further nothing was brought on record to show that Applicant had a PE in India. Therefore, it was held that the Applicant does not have a PE in India. On the taxability of transfer of shares of ICo

Considering the accounting treatment, intention, as also quantum of the transaction, the equity shares held by the Applicant in ICo should be considered as capital asset and not stock-in-trade.

The shares of ICo were held for a very long period of time (10-20 years). The objective of acquiring ICo’s shares as stated by the Applicant was not to trade in them but to hold them as investments. In fact, there was no trading in ICo’s shares by the Applicant, except for the proposed transfer. Hence, the shares of ICo would constitute capital asset in the hands of Applicant. Consequently gains from transfer of shares of ICo would result in capital gains in the hands of the Applicant. Such capital gains are taxable in India under the provisions of the Act

Gains on transfer of ICo’s shares would be covered by Article 13(4) of the DTAA which exempts gains from tax in India.

Taxation of Artistes and Sportsmen

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1. Overview
In recent years, it has been observed that various
International sporting events like Formula 1 Race, Indian Premier
League (IPL), Indian Super League (ISL) and I-League etc. are being
successfully held in India year after year. It is worth noting that
India has largest number of very keen cricket fans in the world viewing
various cricket matches. Similarly, there are various Indian films &
advertisements where international artistes are featuring. Many foreign
filmmakers have been shooting films in India such as Life of Pi, The
Bourne Supremacy, Slum Dog Millionaire etc. On various occasions,
concerts by non-resident entertainers are regularly held in India e.g.
concerts/performances by Metallica, Lady Gaga, Katy Perry etc. In
addition, performances by International Artistes & entertainers are
increasingly becoming a part of big Indian theme parties, wedding
extravaganzas and Reality shows etc.

Taxation of such
non-resident Artistes and Sportsmen, corporates and sports
associations/bodies involved in organising, managing and regulating such
events, concerts or performances is gaining increasing importance in
view of huge sums by way of fees and other contract amounts involved. In
this Article, we have attempted to give an overview of the taxation
provisions under the Income-tax Act and various model Tax Treaties.

2. Taxability under the Domestic Law

The relevant provisions and circulars under the Income-tax Act, 1961 [the Act] are as follows:
Section 5 r.w.s. 9 will determine taxability of income of Artistes etc. in India
Section 115BBA – Tax on non-resident sportsman or sports association
Withholding tax provisions u/s. 194E
CBDT Circular No. 787 dated 10.02.2000

2.1 Section 115BBA of the Act reads as follows:
“Tax on non-resident sportsmen or sports associations. 115BBA. (1) Where the total income of an assessee, –

a) being a sportsman (including an athlete), who is not a citizen of India and is a non-resident, includes any income received or receivable by way of –
i. participation in India in any game (other than a game the winnings wherefrom are taxable under section 115BB) or sport; or
ii. advertisement; or
iii. contribution of articles relating to any game or sport in India in newspapers, magazines or journals; or

b) being a non-resident sports association or institution, includes any amount guaranteed to be paid or payable to such association or institution in relation to any game (other than a game the winnings wherefrom are taxable u/s. 115BB) or sport played in India; or

c) being an entertainer, who is not a citizen of India and is a non-resident,
includes any income received or receivable from his performance in
India, the income-tax payable by the assessee shall be the aggregate of —

i. the amount of income-tax calculated on income referred to in
clause (a) or clause (b) or clause (c) at the rate of twenty per cent;
and
ii. the amount of income-tax with which the assessee would have
been chargeable had the total income of the assessee been reduced by the
amount of income referred to in clause (a) or clause (b) or clause (c):

Provided that no deduction in respect of any expenditure or allowance shall be allowed under any provision of this Act in computing the income referred to in clause (a) or clause (b) or clause (c).

2) It shall not be necessary for the assessee to furnish under sub-section (1) of section 139 a return of his income if—
(a)
his total income in respect of which he is assessable under this Act
during the previous year consisted only of income referred to in clause
(a) or clause (b) or clause (c) of sub-section (1); and

(b) the tax deductible at source under the provisions of Chapter XVII-B has been deducted from such income.”

(Emphasis supplied)
2.2 Analysis of Section 115BBA
It applies only to a non-resident and a person who is not a citizen of India

Who is a sportsman (including athlete) and

Earns income from
• Participation in India in any game or sports
• Advertisement
• Contribution of article in newspaper, magazine or journals relating to any game or sport in India

Applies to a non-resident sports association or institution

Who earns income from
• Guarantee money in relation to any game or sport played in India
• Except games referred to in section 115BB

Applies only to a non-resident and a person who is not a citizen of India
• Who is an entertainer and
• Earns income from his performance in India
• Applicable tax rate is 20% on gross income
• Deduction of any expenditure incurred for earning such income is not allowed
• No need to file return if tax deductible at source has been deducted from such income.

3. CBDT Circular No. 787 dated 10-02- 2000 – Income of artists, entertainers, sportsmen etc.

The salient features of the said circular are as under:

Income derived from event or show for entertainment or sports includes:
• Sponsorship money;
• Gate money;
• Advertisement revenue;
• Sale of broadcasting or telecasting rights;
• Rents from hiring out of space, etc.
• Rent from caterers.

Article on “Artistes and Sportsman” will apply to
• Income from personal activities of sportsman or artist in India
• Advertising income and Sponsorship income, if it is related directly or indirectly to performance or appearance in India.

Article on “Royalty” will apply to
• Royalty payment for recorded performance

Article on “Other income” will apply to
• Guarantee money earned by Sports association
• E.g. Tax treaty with U.S, U.K., Japan, Australia, New Zealand, Sri Lanka, France etc.

Illustrations given in the Circular
Income not taxable in India
• Artist performing in India gratuitously without consideration.
• Artist performing in India to promote sale of his records without consideration.
• Consideration paid to acquire the copyrights of performance in India for subsequent sale or broadcast or telecast abroad.

Income taxable in India
• Consideration for the live performance or simultaneous live telecast or broadcast in India.
• Consideration paid to acquire the copyrights of performance in India for subsequent sale or broadcast or telecast in India.
• Endorsement fees (for launch or promotion of products, etc.) which relates to the artist’s performance.

4. Relevant Case Laws – Section 115BBA and 194E
Some of the important case laws are as under:

4.1 International Merchandising Corporation vs ADIT [2015] 57 Taxmann.com 179 (Delhi-Trib)

Issues:
i. Payment made to Association of Tennis Professionals (ATP), whether liable to Tax u/s. 115BBA?
ii. Whether section 194E does not apply as AT P is just a governing body of sport and not a sports association?

Held:
a) 194E read with section 115BBA apply to payments made to a non-resident sports association or an institution.
b)
ATP is undisputedly a governing body of the world wide men’s
professional Tennis Circuit responsible for ranking of its players and
co-ordinating the Tennis tournament in the world.
c) ATP is a
non-resident sports institution and therefore section 194E applies to
the payments made by the assessee to the AT P.

4.2 PILCOM vs. CIT [2011] 198 Taxman 555 (Cal.)
In this case, it was held as follows:
a)
Section 115BBA is completely independent from other sections such as
section 5(2) or section 9 and it has got nothing to do with the accrual
or assessment of income in India as mentioned in section 9.
b) Non-resident individual has to pay the tax, the moment he participates in India in any game or sport.
c)
Once the payment is made to non-resident sports association or
institution or it becomes payable in relation to any game or sports
played in India, there is accrual of income in India.
d) Section 115BBA is to be applied irrespective of place of making payment.
e)
Payment received by any sports association or personalities for the
matches not played in India is not taxable or liable for withholding
tax.
f) Department’s contention that source of payment is from India irrespective of place of game is overruled.

4.3 Indcom vs. CIT (TDS) [2011] 11 taxmann.com 109 (Cal.)

Issues:
Whether
tax will be deductible on amounts paid to foreign teams for
participation as prize money or administrative expenses, is deemed to
accrue in India u/s. 115BBA?

Whether the match referees and umpires will be considered as sportsmen?

Held:
The
amount paid to the foreign team for participation in the match in India
in any shape, either as prize money or as the administrative expenses,
was the income deemed to have accrued in India and was taxable u/s.
115BBA and, thus, section 194E was attracted.

The payments made
to the umpires or match referees do not come within the purview of
section 115BBA because the umpires and match referee are neither
sportsmen (including an athlete) nor are they non-resident sports
association or institution so as to attract the provisions contained in
section 115BBA. Therefore, although the payments made to them were
‘income’ which had accrued in India, yet, those were not taxable under
the aforesaid provision and thus, the liability to deduct u/s. 194E
never accrued.

The umpires and the match referee can, at the
most, be described as professionals or technical persons who render
their professional or technical services as umpire or match referee. But
there is no scope of deducting any amount u/s. 194E for such payment.

The
reader may also refer to the decision in the case of Board of Control
for Cricket in India vs. DIT (Exemption) [2005] 096 ITD 263 (Mum), on
the subject.

5. Scope of the Article 17 of OECD Model Tax Convention

Salient features of Article 17 are as under:
• Primary taxing rights is with the State of Source / State of performance
• It overrides Article 7, 14 and 15.
• It applies to entertainer, sportsperson or any other person

6. Article 17 (1)

6.1 Model Conventions – A Comparison

6.2 Scope of Article 17(1)
a. A pplies to Individual resident of one of the contracting state.
b. I ndividual is either an entertainer or a sportsperson.
c. He derives income from personal activities.
d. Word “personal activities” suggests “public appearance” is necessary.
e. Personal activities/performance are exercised in the source State i.e. country of performance.
f. Performance should be in public or recorded and later produced for an audience.
g. Performance must be artistic and entertaining.
h. Entertainer or sportsperson must be present in the state of source during the performance.
i. It is not necessary to remain present in the Source State for any minimum period.
j. Person performing even for a single event is covered.
k. Person involved in a political, social, religious or charitable nature is covered, if the entertaining character is present.
l. It covers both professional activities and occasional activities.
m. Source State gets right to tax income earned in that state.

6.3 Meaning of ‘Entertainer’
a. There is no precise definition of the term in Model convention or in treaty.
b. Dictionary meaning of “Entertainer”
i.
“A person whose job is amusing or interesting people, for example, by
singing, telling jokes or dancing” – Oxford Advanced Learner’s
Dictionary
ii. “A person, such as a singer, dancer, or comedian, whose job is to entertain others” – Oxford Dictionary of English
iii. “A person who entertains; a professional provider of amusement or entertainment” – Shorter Oxford Dictionary
c.
Term ‘Entertainer’ includes the stage performer, film actor or actor
(including for instance a former sportsperson) in a television
commercial.
d. Entertainer or sportsperson includes anyone who acts as such even for a single event.

6.4 Meaning of “artiste” and “artist”
a. There is no precise definition in Model convention or in treaty.
b. Dictionary meaning of “Artiste” is:
i. “An artist, especially an actor, singer, dancer, or other public performer” Random House Webster’s Dictionary
ii.
“A public performer who appeals to the aesthetic faculties, as a
professional singer, dancer, etc. also one who makes a ‘fine art’ of his
employment, as an artistic cook, hair dresser, etc. Oxford English
Dictionary
iii. “A professional entertainer such as singer, a dancer or an actor” Oxford Advanced Learner’s Dictionary

c. Difference between the word “artiste” and “artist”:
i. “Artist” has a broader meaning compared to “artiste”
ii. Artist includes those who create work of art, such as painter, sculptors etc.
iii. Artist is a person whose creative work shows sensitivity and imagination
iv. A rtiste is restricted to performing arts.
v. Artiste is a person who is a public performer or skilled performer.
vi. A rtiste is the one who has an entertaining character
vii. The word “entertainer” seems to cover the lighter versions of the performing arts.

6.5 Relevant decisions regarding meaning of ‘Artist’ given in the context of Section 80-RR of the Act

a. Sachin Tendulkar vs. CIT [2011] 11 taxmann. com 121 (Mum).
The
Mumbai Tribunal in case of Sachin Tendulkar held that Sachin should be
regarded as an artiste while appearing in advertisements and
commercials, modeling etc. and hence is entitled to deduction u/s. 80RR.

b. Amitabh Bachchan vs. CIT [2007] 12 SOT 95 (Mum)
The
Mumbai Tribunal held that both Amitabh Bach chan receiving income for
acting as an anchor for a TV programme and Shahrukh Khan receiving in
come from endorsement of performance where he has to give photographs,
attend photo sessions, video shoots, etc. are entitled to deduction u/s.
80RR.

The reader may also refer to the following decisions on the subject:

Tarun Tahiliani-[2010] 192 Taxman 231(Bom)
Harsha Ahyut Bhogale vs. ACIT – [2008] 171 Taxman 108 (Mum) (Mag)
David Dhawan vs. DCIT – [2005] 2 SOT 311 (Mum)
Anup Jalota – [2003] 1 SOT 525 (Mum)

6.6 Meaning of ‘Sportsperson’
a. There is no precise definition is given of the term “sportspersons”.
b.
N ot restricted to participants in traditional athletic events (e.g.
runners, jumpers, swimmers). Also covers e.g. golfers, jockeys,
footballers, cricketers and tennis players, as well as racing drivers.
c.
A lso includes activities usually regarded as of an entertainment
character such as billiards, snooker, chess and bridge tournaments
d.
Since sportsperson is grouped with entertainer, Article 17 will apply
only to those who perform in public. Therefore, mountaineers or scuba
divers are not covered.
e. Sportsperson also covers the one whose
activities includes advertising or interviews that are directly or
indirectly related to such an appearance.
f. Sportsperson does not include managers or coaches of the sports team.
g.
Merely reporting or commenting on a sports event in which the reporter
does not participate is not an activity as a sportsperson.
h. Owner
of a horse or a race car is not covered under Article 17 unless the
payment is received on behalf of the jockey or car driver.

6.7 Meaning of “Athlete”
A person who is trained or skilled in exercises, sports, or games requiring physical strength, agility or stamina

Dictionary meaning is one who is engaged in sport more specifically in the field and track events

6.8 Persons covered under Article 17 and regarded as performing entertainers or artistes

6.9 Persons not covered under Article 17 and not regarded as performing entertainers or artistes

6.10 Article 17(1) – Illustrative types of Income covered:

a. Income derived from performance.

b. Income connected with performance such as awards
i. Payment received by a professional golfer for an interview given during a tournament in which he participates.
ii. Payment made to a star tennis player for the use of his picture on posters advertising a tournament in which he will participate.

c. Advertising and sponsorship fee directly or indirectly related to performance in source country

i. Payments made to a tennis player for wearing a sponsor’s logo, trade mark or trade name on his tennis shirt during a match.

d. Income generated from promotional activities of the entertainer during his presence in source country.

e. Payments for the simultaneous broadcasting of a performance by an entertainer or sportsperson made directly to the performer or for his or her benefit (e.g. a payment made to the star-company of the performer).

f. Income from combined activities (for e.g. Steven Spielberg directing and acting in a movie – Predominantly performing nature – Article 17 would apply – Performing element negligible – entire income out of Article 17).

g. Performance based fees/remuneration such as participation fees, share in gate receipts.

h. Income from writing a column in daily newspaper or journals related to performance.

i. Salary income of a member of an orchestra or troupe for his performance.

j. Entertainer earning salary as an employee is liable to pay tax in source country in proportion to his salary which corresponds to his performance.

k. Income of one person company belonging to entertainer if domestic law of Source State permits “look through” approach.

l. Illustration:
• Film actor is performing in India where a film is shot. Article 17 will apply to the income of the film actor.
• If the film is released worldwide except India, Article 17 will apply to the income of Film actor irrespective of where the film is released.

6.11 Article 17(1) – Illustrative types of Income not covered

a. Payments received upon cancellation of a performance are not taxable under Article 17(1).

b. Royalties for intellectual property rights will normally be covered under Article 12 i.e. Income to third party holding IPR for broadcasting rights.

c. Income received by impresarios etc. for arranging the appearance of an entertainer or sportsperson is outside the scope of the Article, but any income they receive on behalf of the entertainer or sportsperson is of course covered by it.

d. Income received by administrative or support staff (e.g. cameramen for a film, producers, film directors, choreographers, technical staff, road crew for a pop group, etc.

e. Income from speaking engagement in conferences.

f. Income as reporter or commentator h. Promoters involved in production of event i. Guest judge in singing competition

j. Income not attributed to performance in source state.

6.12 Items of Income Covered by Other Articles

Taxation of the following types of income is governed by other Articles of a Tax Treaty:

a. Income for Image rights not closely connected with performance

b. Sponsorship and advertising fees not related to performance

c. Merchandising income from sale which is not related to performance

d. Income against the cancellation of performance, since it is compensation for income lost due to cancellation of performance and not associated with performance.

e. Income from restrictive covenants

f. Income earned by a former sportsperson providing commentary during the broadcast of a sport event or reporting on sport event in which he is not participating.

g. Income from repeat telecast

h. Fees for interview with music channel not closely connected with performance.

6.13 Aspects which are not relevant while applying Article 17

a. Location or residence of Payer

b. Number of days stay in the source country

c. Having PE or fixed base of the entertainer in the source country

d. Entertainer or sportsperson performing as an employee or independently on contract

e. Entertainers present directly on the stage or through radio or TV.

f. One time performance or regular performance

g. Indian Treaty examples
i. India-Egypt tax treaty provides time threshold of 15 days during the relevant fiscal year.

ii. India-USA tax treaty – Exception provided where net income derived does not exceed USD 1,500.

6.14 Foreign Judicial Precedents

a) Agassi vs. Robinson – UK Judicial Precedent
• Mr. Andre Agassi, a US-tax resident visited UK for short duration to play in various tournaments and in particular at Wimbledon.

• He controlled a US corporation (Andre Agassi Enterprises Inc) through which he negotiated endorsement contracts with manufacturers of sporting equipment including Nike and Head, neither of which had a tax presence in UK.

• Revenue authorities assessed Andre Agassi for tax in connection with the sponsorship income received by the non-resident corporation.

• UK House of Lords upheld the extra-territorial applicability of the UK domestic tax law provisions and held that endorsement income paid by non-resident UK sponsors to non-resident corporation is liable to tax in UK.

b) Canadian decision in Cheek vs. The Queen (2002 DTC 1283 (Tax Court of Canada))

• Issue: Whether a “radio broadcaster” of baseball games would fall under Article XVI (Artistes and Athletes) of the 1980 Canada–United States Income Tax Convention?

• The radio broadcaster Thomas Cheek, had been the commentator of the Toronto Blue Jays together with a partner-commentator.

• Thomas Cheek was resident in the United States, was not an employee and did not have a fixed base in Canada that would have made him taxable under Article XIV (Independent Personal Services).

• In a baseball game of three hours, only 16-18 minutes are actual “motion”, the rest is “down time”. The challenge facing the broadcaster is to hold the attention of the radio audience, even when there is no activity on the field.

• The court stated that professional sports in itself is entertaining, but doubted whether the broadcaster could be seen as an entertainer, that is, as a “radio artiste”, such as for example the late Bing Crosby. The baseball fan who turns on the radio to hear a particular baseball game wants to know how the players are performing on the field.

• The broadcaster may be able to hold the attention of the fan with his “down time” commentary but he is not the reason why the fan turns on the radio. Therefore the court decided that Thomas Cheek was not a radio artiste, although he was a very skilful and experienced radio journalist.

c) NL: HR, 7 May 2010, 08/02054 (Tax Treaty Case Law IBFD)

• A football player who was resident in Sweden was transferred by a Swedish club to a team resident in the Netherlands.

• He took up residence in the Netherlands after the transfer.

• Pursuant to the terms of his contract with the Swedish club, he received a share of the transfer price paid by the Dutch club;

• He received this payment when he had already become a resident of the Netherlands.

• The taxpayer claimed that this payment related to his past employment activity with the Swedish club and was covered by Article 15 (Income from employment) of the treaty.

• Conversely, the Dutch tax authorities maintained that the payment was within the scope of Article 17 (allowing Sweden the primary right to tax and double taxation should in that case be relieved in the Netherlands via a credit under Article 24(4).

• Held – The payment was clearly related to the past activities of the taxpayer as football player for the Swedish team and that, therefore, Article 17 doubtlessly applied. As a consequence, the taxpayer had to include this payment in his income for Dutch tax purposes and then ask a credit for the taxes paid to Sweden upon that same income.

7.2 India’s DTAA s – Article 17 (2)

• India’s treaties with Egypt, Libya, Syria and Zambia provide that income accrued to another person is not taxable in source country.

• India’s treaty with Zambia provides for deemed PE if the enterprise carries on business of providing the services of public entertainer

• India’s treaty with USA provides that income accrued to another person is not taxable if entertainer establishes that neither the entertainer or athlete nor persons related thereto participate directly or indirectly in the profits of that other person in any manner, including the receipt of deferred remuneration, bonuses, fees, dividends, partnership distributions, or other distributions.

• Paragraph applies when income from personal activities exercised by an entertainer or a sportsperson accrues to another person and not to an entertainer or sportsperson.

• Another person could be a corporate or non-corporate entity

• Such entity may be owned by the performer himself

• Even if another person and entertainer are tax resident of different countries, paragraph applies

• Source state may tax such income.

• It overrides the provisions of Article 7 (Business profit) and 15 (Income from employment).

7.3 Article 17 (2) – Anti Avoidance Rule
• Another person i.e. entity could be a Management Company, team, troupe, orchestra or “renta- star” company.

• “Rent a star” company is controlled by the performer or artist and performer would be the beneficiary of maximum profit of the company

• Income for the performance of entertainer in the source state is received by such entity and not by the entertainer.

• An entertainer or sportsperson is either hired or employed by such entity for the entertainment program to be held in Source State.

• Such entity may pay nominal amount or modest salary to the performer.

• Such entity, in the absence of Permanent Establishment or business connection, may avoid tax in the Source State.

• Income does not accrue to the performer, hence paragraph 1 of Article 17 will not apply.

• Individual performer/entertainer may avoid tax for non-application of Article 15 or may pay tax on modest salary.

• Paragraph 2 deal with such an arrangement and gives taxing rights to the Source State.

7.4 Article 17(2) – Important Points

a. Para 2 does not apply to Prize money that the owner of a horse or the team to which a race car belongs, derives from the results of the horse or car during a race or during races, taking place during a certain period.

b. Does not cover the income of all enterprises that are involved in the production of entertainment or sports events, e.g.:

i. income derived by the independent promoter of a concert from the sale of tickets; and

ii. allocation of advertising space is not covered by paragraph 2.

c. Computation Mechanism – as per the domestic laws of the Source country.

7.5 Computation and rate of tax
Approach for computing income
• Treaty does not provide for method of computing income

• Income is to be computed as per domestic law of the source state (e.g. section 115 BBA of the Act)

• Domestic law may tax only company or the entertainer or both on their respective income

• Non-resident may choose to be governed by the treaty law or the domestic law.

Rate of tax
• Rates are generally not provided in the treaty

• Domestic law may provide for tax on gross income or give an option to be taxed on net income (@20% u/s. 115 BBA of the Act).

7.6 Taxation of Team Performance

A team performance is defined as the exercise of personal activities by more than one entertainer or sportsperson who come together as a group ? Group entity may or may not be a resident or have a permanent establishment in the state of source ? Each team member is classified as entertainer or sportsperson or support staff based on the nature of services rendered

Entertainer or sportsperson of the team are taxed in the state of performance

Support staff, technical personnel and all employees other than artistes or sportsmen are governed by Article 15.

Tax treatment in the state of source is as under:

Payments attributable to entertainer and sportsperson is taxed under Article 17(1)

• Profit earned by the team is apportioned between profit attributable to the performance of entertainer or sportsperson and profits attributable to activities of non-performing members

• Profit attributable to the performance of entertainer or sportsperson is taxed under Article 17(2)

7.7 Relevant Case Law re Article 17(2)

Wizcraft International Entertainment Private Limited vs. ADIT [2014] 45 taxmann.com 24 (Bombay)

• Commission paid to the UK agent was not for services of entertainers/artists.

– The UK agent had not taken any part in the events, nor performed any activities in India. Hence, it was not covered by Article 18 of India- UK DTAA .

• The UK agent did not have any PE in India [Carborandum Co. vs. CIT, (1977) 108 ITR 335 (SC) and CBDT Circular Nos. 17 dated 17.07.1953 and 786 dated 07.02.2000], commission paid to the UK agent was not taxable in India and no obligation on Indian Co to deduct tax at source.

• Reimbursement of expenses – The law is well settled that reimbursement of expense not chargeable to tax and hence, no obligation to deduct tax at source [DIT (IT) vs. Krupp UDHE Gmbh (2010) 38 DTR (Bom) 251 following own decision in CIT vs. Siemens Aktiongesellschaft 220 CTR (Bom) 425].

• Reliance was placed on Circular No. 786 dated 7 February 2000 in respect of non-taxability in India of export commission payable to non-resident agents rendering services abroad.

Note: The aforementioned Circular No. 786 dated 7 February 2000, is withdrawn by Circular No. 7/2009 dated 22nd October, 2009. However, the ITAT and the courts in various cases have held that even after the withdrawal of said circular, export commission payable to non-resident agents rendering services abroad, is not taxable in India.

8. Additional Consideration relating to paragraph 1 & 2 of Article inserted as Article 17(3) in many India’s DTAAs

Article 17 ordinarily applies when the entertainer or sportsperson is employed by a Government and derives income from that Government. However, certain conventions contain provisions excluding entertainers or sportspersons employed in organisations which are subsidised out of public funds from the application of Article 17.

Some countries may consider it appropriate to exclude from the scope of the Article events supported from public funds.

This has been provided as additional consideration in Commentary to Model Convention July 2014 with modifications.

8.1 Such provisions are existing in most of India’s DTAA s and are inserted as paragraph (3) or (4) of Article 17.

8.2 A rticle 17(3) in some of the India’s DTAA s
India – Armenia and India – Japan tax treaty Income taxable only in the resident state, if the event is for approved cultural or sports exchange program.

India – Australia, India – Belgium, India – Indonesia, and India – Mauritius tax treaty Income taxable only in the resident state, if the event is supported by public funds of resident state.

India-Brazil and India – Bangladesh Tax Treaties

Paragraph 1 and 2 will not apply if the activity is wholly or mainly or substantially supported from the public funds of the other contracting state.

9. Conflicts

It is important to note that all the income of the Artistes and Sportsmen may not in all cases be covered by Article 17. It is nature of income which will determine whether the same would fall within the scope of Article 17 or the same would be covered by Article 18 relating to Pensions or Article 19 relating to remuneration in respect of government service.

Conflicts between Article 17 and 18
• Remuneration derived from the entertainment show is governed by Article 17.

• Pension received after termination of performance activity will fall under Article 18.

• Golden handshakes are payment linked to employment and not to the performance, hence does not fall under Article 17.

Conflicts between Article 17 and 19

In case Artists or Sportsperson renders service to Government and receives remuneration then normally Article 17 applies if the activity of the Government is in the nature of business, otherwise Article 19 will apply.

The above article provides just a bird’s eye view of the subject. To gain an in-depth understanding of the subject, the reader would be well advised to study the commentaries on Article 17 of various model conventions and the relevant judicial pronouncements.

AMP: A CONTROVERSY FAR FROM OVER

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Background
Over the past decade, Indian Revenue has been the centre of global attention for its positions on controversies surrounding tax and transfer pricing. In the last few rounds of Transfer Pricing assessments, taxpayers promoting international brands in India have been scrutinised for the level of Advertising, Marketing and Promotion (‘AMP’) expenses incurred by them. These issues largely affected multinational enterprises (‘MNEs’) in consumer durables, electronics, automotive and media sectors. The controversy snowballed, leading to constitution of a three-member Special Bench of the Income-tax Appellate Tribunal (‘Appellate Tribunal’), for expert examination of the issues involved. Dissatisfied taxpayers later escalated the issue to the High Court and the same is now pending with the Indian Supreme Court. The most interesting aspect of the AMP controversy is the manner in which this issue has evolved in the judicial hierarchy. While some contentious issues are gradually dwindling as they move up the appellate forums, some issues remain unresolved and with each resolution come new challenges in practical implementation. In the next few paragraphs, we have attempted to summarise the controversy, the evolving judicial elucidation and some unresolved issues.

AMP in the Indian landscape
Under a typical license/distributor arrangement, the Indian entity of a MNE group uses the international brand/ trademark to sell its products in India. For doing so, the Indian entity would pay royalty for using such brand/ trademark. In order to spread awareness of the products and increase/maintain the market share of the products manufactured or distributed by them in India, the Indian entity would incur expenses on advertising, marketing and promotion of such brand/trademark.

During the course of Transfer Pricing assessments, the Indian Revenue has consistently been taking a position that the Indian entity of the MNE group provides assistance to the overseas affiliate, legal owner of the brand/trademark, by enhancing or building the international brand/trademark in India. According to the Revenue, AMP expense beyond the level of expense incurred by comparable businesses (termed as ‘Bright Line Test’ or ‘BLT ’) is non-routine and the same results in creation of marketing intangibles for the legal owner of the brand. Transfer Pricing adjustments have been made on the premise that the Indian entity ought to recover the excess costs along with an appropriate mark-up for such assistance.

Advent of the AMP controversy
The issue of AMP came to limelight in 2010, when the Delhi High Court pronounced a ruling in response to a writ petition filed by Maruti Suzuki1 challenging the show cause notice issued by the Transfer Pricing Officer. The High Court remarked that if the intensity of AMP expenses (defined by a ratio of AMP expense to sales) by the Indian taxpayer is more than what a comparable company would incur, the Indian taxpayer should be compensated at arm’s length, particularly when the use of trademark or logo of the foreign affiliate is obligatory on the part of the Indian taxpayer. With a shot in the arm, the Revenue Authorities made several transfer pricing adjustments in cases of distributors, licensed manufacturers, service providers, etc. using international brands. Without appreciating the difference in functional characterisation, business model and industry life-cycle of the Indian taxpayers, the Indian Revenue painted everyone with the same broad brush and made transfer pricing adjustments for excess AMP expenses.

The Indian Revenue seems to have taken inspiration from the US Tax Court ruling in the year 1998 in the case of DHL2, which was subsequently reversed by Ninth Circuit US Court of Appeal3. In the case of DHL, the Tax Court asked the taxpayer to prove that it incurred more than routine AMP expenses outside US, in order to substantiate that it was the developer of the non-US rights of trademark/brand. However, the Ninth Circuit Court of Appeal rejected the approach of the Tax Court holding that there was no such requirement of comparing the AMP expenses incurred by the taxpayer with comparable companies under 1968 Regulations.

Evolution of Transfer Pricing Jurisprudence on AMP in India:
As the Delhi High Court ruling on Maruti Suzuki’s writ petition led to a plethora of transfer pricing adjustments for AMP spends, affected taxpayers filed appeals to challenge their legality. The Appellate Tribunal, in one such case, deleted the transfer pricing adjustment on the technical ground that the Transfer Pricing Officer had no jurisdiction to assess any transaction which was not specifically referred by the tax officer assessing the case. The Revenue challenged this technical ground before the High Court but failed, with no discussion being recorded on merits of the transfer pricing adjustment. To overturn this defeat in 2012, the Indian Government amended the transfer pricing provisions through Finance Act, 2012. In the amended provisions, the term ‘intangible property’ was defined to include, inter alia, ‘marketing related intangible assets’, such as trademarks, trade names, brand names, logos, etc. Further, Transfer Pricing Officers were bestowed with the right to test transactions even if not specifically referred by the tax officer. After these amendments, the Appellate Tribunals started adjudicating the AMP issue on merit. However, a disparity in the decisions in different cases created uncertainty around the transfer pricing implication of AMP expenses. Considering the conflicting decisions, the importance and the complexity of the issue, a three-member special bench was constituted by the Appellate Tribunal to adjudicate on the transfer pricing aspects of AMP expenses.

Special Bench Ruling in the case of LG Electronics India Private Limited4 (LG India):

The appeal before the Special Bench of the Appellate Tribunal was led by LG India, while other Indian taxpayers5 also affected by the issue joined as interveners to the case. The key findings of the Special Bench were as under:

AMP expenses incurred by an Indian taxpayer result in creating and improving marketing intangibles for the overseas affiliates

Expenses for the promotion of sales directly lead to brand building, the expenses incurred directly in connection with sales are only sales specific

In addition to promoting its products through advertisements, LG India simultaneously promoted the foreign brand

The concept of economic ownership does not find place under the Indian tax law. It is the legal owner of the brand who is benefitted

If the level of AMP expenses incurred by the Indian taxpayer is in excess of that of comparables, the excess AMP ought to be recovered by the Indian taxpayer from the overseas affiliate along with appropriate mark up

Selling expenses which do not lead to brand promotion do not form part of AMP expenses and hence to be excluded for the purpose of benchmarking.

Subsequent to the decision of the Special Bench, most cases pending before the Appellate Tribunal were sent back to the Transfer Pricing Officers with specific direction to follow the principles laid down by the Special Bench in the LG India case. This resulted in transfer pricing adjustments in many cases, barring some relief on account of exclusion of routine sales expenses from the ambit of AMP spends.

Delhi High Court rulings

In the case of Sony Ericsson:
Aggrieved by the order of the Appellate Tribunals following the decision in LG India, taxpayers (including consumer electronics and consumer durables giants like Daikin, Haier, Reebok, Canon and Sony) appealed before the High Court. While adjudicating the case of Sony Ericsson, the High Court laid out the following broad principles:

Upholding the decision in LG India, AMP expenses were treated as an international transaction with associated enterprise (‘AE’) and thus subject to Transfer Pricing Regulations in India

Excess AMP expenses incurred by Indian taxpayers warrant a compensation, but BLT is not well suited for computing the same

Distribution and marketing are intertwined functions and should be analysed in a bundled manner for determining arm’s length remuneration, unless need for de-bundling is adequately demonstrated

If under bundled approach, the gross margins or net margins of the Indian taxpayers are sufficient to cover the excess AMP expenses, then a separate remuneration for such excess from the foreign affiliate is not required

If the distribution and marketing functions are to be debundled then the taxpayer should be allowed a set-off for additional remuneration in one function against a shortfall in the other function

In order to apply bundled approach using an overall Transactional Net Margin Method (‘TNMM’) / Resale Price Method (‘RPM’), it must be ensured that the level of AMP functions in comparables should be similar to that of the Indian taxpayer or the tested entity

An attempt be made to find comparables with similar level of AMP functions and if such comparables cannot be found then proper adjustment be made to even out the differences

All the AMP may not necessarily result in brand building

The concept of economic ownership of intangibles was recognised.

The High Court also suggested that the Appellate Tribunals try to adjudicate the pending cases (rather than remitting the same to the Transfer Pricing Officer) following the broad principles laid down in the case above. However, the Appellate Tribunals have been remitting the issue back to the Transfer Pricing Officer on the ground that no analysis has been carried out in respect of comparability in the level of AMP functions.

In the case of Maruti Suzuki
The case of Maruti Suzuki was also made a part of the appeals heard by the Delhi High Court along with that of Sony Ericsson (supra). However, as against the other appellants alongside Sony Ericsson, who were primarily distributors of their AEs’ products, Maruti Suzuki was a manufacturer. The appeal of Maruti Suzuki was thus de-linked and heard separately by the High Court. In its ruling, the High Court clearly distinguished the facts of the case from its earlier decision in Sony Ericsson. The High Court’s observations were made taking into consideration the specific profile of a manufacturer in the AMP scenario. Further, the High Court re-examined the applicability of Chapter X of the Income-tax Act, 1961 (‘Act’) to the AMP issue, since the existence of an international transaction was specifically questioned by the taxpayer. The observations of the High Court were as under:

The Court noted that Chapter X of the Act makes no specific mention of AMP expenses as one of the items of expenditure which can be deemed to be an international transaction.

Even if the same is considered to be covered under “any other transaction having a bearing on its profits, incomes or losses”, for a transaction to exist there has to be two parties. Therefore, the onus is on the Revenue authorities to show that there exists an ‘agreement’ or ‘arrangement’ or ‘understanding’ between Maruti Suzuki and its AE, whereby Maruti Suzuki is obliged to spend excessively on AMP in order to promote its AE’s brand8.

A transfer pricing adjustment envisages substitution of price of an international transaction with ALP. An adjustment is not expected to be made by deducing that an international transaction exists based on difference between AMP expenses of the taxpayer and comparable entities.

By applying BLT , the Revenue Authorities had deduced the existence of an international transaction on excessive AMP spend of Maruti Suzuki, and then added back the excess expenditure as transfer pricing adjustment. This was contrary to the High Court’s approach, which required the Revenue Authority to examine an international transaction. The High Court observed that the very existence of an international transaction cannot be matter for inference or surmise.

 In the absence of international transaction involving AMP spend with an ascertainable price, neither the substantive nor machinery provisions of Chapter X of the Act are applicable to the transfer pricing adjustment exercise.

In the cases of Honda Siel9 and Whirlpool10

The Maruti Suzuki ruling has apparently set the precedence for the interpretation of AMP spend in the case of manufacturers. Subsequent rulings have followed the distinct perspective of the High Court and questioned the existence of an international transaction merely on account of excessive AMP expenditure:

In the case of Honda Siel:

  •  The High Court observed that the Revenue Authorities ascertained existence of an International transaction only by applying the BLT. Accordingly, the High Court distinguished the case from its earlier Sony Ericsson ruling.

  • The High Court also observed that mere existence of a license for use of the AE’s brand name would not ipso facto imply any further understanding or arrangement between the taxpayer and its AE regarding the AMP expense for promoting the brand of the foreign AE.

  • Further, the High Court also noted that since the taxpayer was an independent manufacturer, it was incurring AMP expenses for its own benefit and not at the behest of the AE.

  • In the absence of any categorical evidence provided by the Revenue Authorities, the High Court followed the Maruti Suzuki decision and ruled out the existence of an International transaction.

In the case of Whirlpool:

  • The High Court observed that the provisions under Chapter X of the Act do envisage a ‘separate entity concept’. Therefore, there cannot be a presumption that since the taxpayer is a subsidiary of the foreign AE, its activities are dictated by the AE.

  • Once again, the High Court put the onus on the Revenue Authorities to factually demonstrate through some tangible material that the two parties acted in concert, and further, that there was an agreement to enter into an International transaction concerning AMP expenses.
  • Regarding the deductibility of AMP expenses u/s. 37 of the Act, the High Court ruled in favour of the taxpayer and held that merely because the AE is also benefitted by the AMP expenses, their allowability is not precluded.


Subsequent cases

The Delhi High Court as well as the Appellate Tribunal have been speedily disposing cases covering AMP issues by following the ratio laid down in the Sony Ericsson and Maruti Suzuki rulings. An unspoken trend seems to have been set in the pattern of disposal – while the Sony Ericsson ruling is being followed in the case of appellant who are distributors, the Maruti Suzuki ruling is being followed in the case of manufacturers.

  • In the case of Haier Appliances11, the Appellate Tribunal observed that for application of RPM, it is necessary to examine the comparability of the AMP functions performed by the Appellant with those of the comparables. In the absence of adequate information to this effect, the case was remanded back to the Revenue Authorities for fresh consideration. However, the Appellant being a distributor, the presence of an international transaction was not negated (following the ruling in Sony Ericsson case).

  •  Similarly, in the case of Johnson & Johnson12, the Appellate Tribunal held that the Revenue Authorities are duty bound to apply the existing methods under the Act (as against BLT, which has been rejected in the Sony Ericsson ruling).

  • The case of Yum Restaurants13, was remitted back by the High Court for further examination of the franchise marketing model in question. The Sony Ericsson ruling was followed in this case as well. However, here the High Court held that once a transfer pricing adjustment has been made for AMP expenses, the said expenses cannot be disallowed again u/s.40A(2)(b) of the Act.
The case of Bausch & Lomb14 involved manufacturing as well as trading activities. Here, the High Court ruled out the existence of an international transaction, following the Maruti Suzuki ruling. Further, the High Court also observed that ‘function’ needs to be distinguished from ‘transaction’ and that every expenditure forming part of a function cannot be construed as a ‘transaction’.

Is It The End Of The AMP Controversy?
The year 2015 witnessed disposal of several cases by the Delhi High Court and various benches of the Appellate Tribunal. While moving steadily ahead in its appellate journey, the AMP controversy still seems to be far from over.

A special leave petition (‘SLP’) has been filed before the Indian Supreme Court by affected taxpayers challenging the ruling of the Delhi High Court in the case of Sony Ericsson. The coming months are likely to reveal the taxpayers’ and Revenue’s responses to the other rulings of the High Court.

The High Court has not negated the existence of an international transaction where there is excessive AMP spend by Indian distributors. In such cases, the High Court has emphasised the need for comparability of the level of AMP function between the taxpayer and the independent comparable companies. If companies with comparable AMP functions cannot be found, the High Court directed necessary adjustment to even out the difference in the AMP functions. However, neither the High Court nor the Appellate Tribunals have provided any guidance on determining the level of AMP function or computing adjustment for difference in AMP functions. In absence of clear guidance, another round of litigation seems inevitable.

In the case of manufacturers, the existence of an International transaction has been ruled out in absence of specific provisions under Chapter X of the Act. The High Court has also explicitly expressed the need for a clear statutory scheme to check arbitrariness and address existing loopholes. In view of the same, one could expect some legislative amendments in the transfer pricing provisions in the upcoming budget.

The key issue that needs consideration and deliberation is whether the Indian taxpayers have incurred the AMP expenses in their capacity as service providers or as entrepreneurs on their own account. The issue of compensating for AMP function at arm’s length would arise only in case where the Indian taxpayer is incurring AMP expenses in the capacity of a service provider. The answer to this may lie in the functional analysis and conduct of the Indian tax payer and the overseas affiliate. Further, indicative facts like exclusivity, longevity of contract, premium pricing and increase in the market share, etc. could be used to demonstrate the economic ownership of the brand. Documentation by the MNE group would play the key role in helping the MNE find answers, determine the course of action and/or build appropriate defense.

Consideration also needs to be given to the mode of remunerating such service. In place of recovering the AMP expenses from the overseas affiliates, MNEs could consider remunerating the Indian taxpayers by way of higher gross margin to cover the AMP expenses. Lastly, while the MNE groups evaluate their value chains in the wake of BEPS, it may be worthwhile to consider the above implications while aligning ownership of intangible property, compensation and related structures.

1. Maruti Suzuki India Limited vs. Addl. CIT TPO [W.P.(C) 6876/2008] [2010] 328 ITR 210 (Del)

2. DHL Corporation & Subsidiaries vs. Commissioner of Internal Revenue (T.C. Memo.1998-461, December 30, 1998)

3. DHL Corporation & Subsidiaries vs. Commissioner of Internal Revenue (Ninth Circuit Court ruling, April 11

4. L.G. Electronics India Private Limited vs. Asstt. Commissioner of Income Tax (ITA No. 5140/Del/2011)

5. Haier Telecom Pvt. Ltd; Goodyear India; Glaxo Smithkline Consumer India;
Maruti Suzuki India; Sony India; Bausch & Lomb; Fujifilm Corporation; Canon
India; Diakin India; Amadeus India; Star India; Pepsi Foods India

6. Sony Ericsson Mobile Communication India Pvt. Ltd vs. Com-missioner of Income-tax (ITA No. 16/2014) (Del)

7. Maruti Suzuki India Limited vs. Commissioner of Income-tax (ITA 110/2014; ITA 710/2014) (Del)

8. With reference to meaning of ‘international transaction’ u/s. 92B(1) if the Act and meaning of ‘transaction’ u/s. 92F(v) of the Act

9. Honda Siel Power Products Limited vs. Deputy Commissioner of Income-tax [2015] 64 taxmann.com 328 (Delhi)

10. Commissioner of Income-tax – LTU vs. Whirlpool of India Limited [2015] 64 taxmann.com 324 (Delhi)

11. Haier Appliances India Limited vs. DCIT, OSD, CIT-IV [2016] 65 taxmann.com 74 (Delhi – Trib.)

12. Johnson & Johnson Limited vs. Addl. CIT – LTU (ITA No. 829/M/2014)

13. Yum Restaurants (India) (P.) Ltd. vs. Income-tax Officer [2016]
66 taxmann.com 47 (Delhi)

14. Bausch & Lomb Eyecare (India) (p.) Ltd. vs. Addl. CIT [2016] 65 taxmann.com 141 (Delhi)

M/s. Southern Refineries Ltd. vs. State of Kerala and others, [2013] 64 VST 25 (Ker)

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Sales Tax – Scheme of Rehabilitation – Directing State to Grant Exemption From Payment of Tax- State not Granting It – Dealer Relying on Scheme and Not Collecting Tax – State Directed to Consider the Matter for Exemption, The Sick Industrial Companies (Special Provisions) Act, 1985.

FACTS
The appellant company, a Medium Scale Industries fell sick due to initial problems, could not avail one third of the sales tax exemption limit. BIFR declared the company sick and approved the rehabilitation scheme which provided for specific relief to the company in the form of sales tax exemption and concessional rate of CST.

This was circulated to all concerned. Accordingly the company had claimed exemption from payment of tax and not collected any tax. At the same time, CST was paid at concessional rate of 2%. The company approached the Government to extend the exemption of KGST and concessional rate of CST till March, 31, 2005 as contemplated in the Sanctioned Scheme. However, the tax department issued pre-assessment notices and demanded tax without extending the benefits of exemption under SRO as also the concessional rate of CST at the rate of two per cent. The company filed writ petition before the Kerala High Court to quash the order passed by the Government, as well as, notices and also soughtfor the benefit of exemption and concessions as per sactioned scheme by the BIFR.

HELD
In the present case, the respondent State participated in the proceedings before the BIFR. Taking note of the reluctance by the sales tax authorities to extend the relief envisaged by the sanctioned scheme, BIFR, issued revised directions u/s. 22A of the Act. The State did not prefer any appeal u/s. 25 of the Act. If order and notices allowed to stand, the same would put things out of gear and the entire efforts taken so far by the BIFR for reviving the appellant company from sickness would terribly be watered down, The burden is heavily on the Government to establish that it would be inequitable to hold the Government bound by the promise on account of public interest. The State was unable to establish overriding public interest which made it inequitable to enforce the estopple against them.

The High Court upheld the plea of promissory estoppels raised by the appellant company. The High Court allowed the appeal and order as well as notices were quashed and directed the respondent State to reconsider the matter and guided by the directions in Sanctioned Scheme by BIFR.

State of Kerala vs. Balsara Hygiene Products [2013] 63 VST 535 (Ker) Sales Tax “Odonil” – Room /Cup Board Freshener Not Taxable As “Shampoo Talcum Powder, Perfumeries and Cosmetics” or As “Repellent”- Taxable Under Residuary Entry.

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Sales Tax – Second Sale by Holder of TradeMark – Not a Resale – Taxable as First Sale, Section 5(2) and Entry 85 and 127 of Schedule I of The Kerala General Sales Tax Act, 1963.

FACTS
The Company engaged in sale of consumer products like toothpaste, Moth repellants, etc. within the State and also holder/owner of trademark claimed second sale in respect of sale of its products like “Promise” “Meswak” “Odonil” etc. being purchased from registered dealer. The company paid tax @8% on sale of “Odonil” moth repellant under entry 85 of Schedule I the Act. The assessing authority disallowed the claim of resale u/s. 5(2) of The Act being sale of goods by trade mark Holder/Owner and levied tax thereon.

Further, the assessing authority levied tax @20% on sale of “Odonil” as the same is an “Air Freshener” would be classified as “perfumery” coming within entry 127 of the schedule I of the Act.

The Tribunal held in favour of the company for levy of tax @8% on sale of “Odonil”. The Tribunal also allowed the claim of resale of the assessee company. The State filed appeal before the Kerala High Court against the said decision of Tribunal.

HELD
The entry 127 of Schedule I covers goods like “shampoo”, “Talcum Powder” etc. The item so specifically mentioned are all relating to items which are used on the human body for beautification, grooming and having cosmetic qualities or properties. By including the specific items, the expansions to include other perfumeries and cosmetics would also be restricted to such items which would answer the description of the specific items mentioned in the entry. The principle of “ejusdemgeneris” would compel to understand the meaning of a word from the meaning of the works employed together with it. The product “Odonil” which is admittedly a room/ cup-board fresher cannot be brought under the description of perfumery in entry 127. As regards claim of the company for levy of tax at 8% under entry 85 of Schedule-I, as “Mosquito Repellents”, the court held that the predominant function is not descernible from the records. The wrapper of products indicates that it is an air freshener and also a moth repellant. The fragrance provided is projected as masking the bad odour of chemical and also avoiding bad odour in rooms /covered space. In such circumstances, it cannot be said that the dominant use of the product is that of a moth repellant and the same would fall under residuary entry of schedule I of The Act. Accordingly, the High Court held it covered by residuary entry of the Schedule I of the Act.

In respect of the second issue of claim of resale, the High Court held that u/s. 5(2) of the Act sale of goods under a trademark or name, by the brand name holder or trademark holder within the State shall be the first sale for the purpose of this Act. In this case, the company is a trademark/brand name holder of certain products more specifically tooth paste and toothbrush sold in the trade name “Promise” and “Meswak”. The company had purchased the said goods from M/s. Besta Cosmetics Limited who manufactured said goods under grant of license by the assessee company to manufacture under the said trade name. Section 5(2) of the act is an anti evasion measure and it contemplates the liability to be at that point of sale in case sale of manufactured goods other that tea, within the State:-

i) Made under a trademark or brand name,
ii) By a trademark / brand name holder

The sale hence would be not only by a trademark / brand name holder, but it should also be under trademark / brand name. The first sale by the manufacturer to the assessee company is of course sale by a trademark/brand name holder but, not a sale under trademark/brand name. Hence the second sale effected by the assessee company being again a sale by a trade mark / brand name holder and also a sale under trademark / brand name, is liable to tax u/s. 5(2) of the Act. Accordingly, the order of Tribunal allowing the claim of resale of the assessee company was set aside and the order of first appellate authority levying tax was confirmed.

2016 (41) STR 191 (Tri.-Ahmd.) Gujarat State Fertilizers & Chemicals Ltd. vs. CCE & ST, Surat –II.

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Commission paid to distributors for selling goods does not amount to sales promotion. Therefore, CENVA T credit was held inadmissible.

Facts
Adjudicating authority disallowed CENVAT credit on commission charges paid to the distributors/consignment stockist following Hon’ble Gujarat High Court’s decision in Cadila Healthcare Limited 2013 (30) STR 3 (Guj). It was contested that the case was factually different as the agreement was not only for sale of the products but it also included sales promotion activities. Department contested on the ground that the contract did not provide for any monetary consideration for the sales promotion activity and therefore, the entire consideration was held to be for sale of goods based on the value of the goods sold.

Held
After analysing the agreement, the Tribunal observed that sales promotion activity was not required to be carried out by distributors on behalf of the appellant. Even though display photographs, brochures and sales promotion material were provided, no consideration was towards such activity. Relying upon jurisdictional High Court’s decision in Cadila Healthcare Ltd. (supra), it was held that activities undertaken by the distributors of the appellant were purely distribution/ sales and had no element of sales promotion and hence, CENVAT credit was held inadmissible. However, since it was a debatable issue, penalty was set aside.

2016 (41) STR 123 (Tri-Chennai) SRF Ltd vs. CCEx., Trichy

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Penalty u/s. 77 cannot be imposed on the ground of non-endorsement of new service in registration certificate.

Facts
The Appellant was registered under category of GTA as a receiver of service for payment of service tax and was paying tax under that category. Subsequently, it has received BAS services from abroad and accordingly discharged service tax under BAS. However penalty u/s. 77 of the Finance Act, 1994 was imposed for not amending its registration certificate which is challenged before the Tribunal.

Held
The Appellant was a registered assessee and there was no default in payment of tax under the new category though endorsement was not done at that point of time. Since there was no deliberate default to evade the tax, penalty was waived.

[2016] 65 taxmann.com 282 (Mumbai-CESTAT) Lupin Ltd. vs. Commissioner of Central Excise & Service Tax, Mumbai

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Even if exemption to education cess or secondary & higher secondary education cess are not specifically mentioned in notification, they are also eligible for exemption/refund in addition to basic excise duty.

Facts
Refund of Education Cess (EC) and Secondary & Higher Education Cess (SHEC) paid in cash claimed under Notification No. 56/2002-CE dated 14/11/2012 (area based exemption) was denied to the appellant on the ground that said notification exempts only basic excise duty. Appellant’s plea that its issue was squarely covered by Bharat Box Factory Ltd. vs. CCE 2007 (214) ELT 534 which was initially rejected by Commissioner (Appeals) on the ground that revenue has filed SLP in Hon’ble Supreme Court.

Held
The Tribunal held that since revenue could not obtain stay from Hon’ble Supreme Court and status of case is still shown as pending, mere filing of SLP should not result in denial of applying the ratio of a case which is in favour of appellant. In Bharat Box Factory Pvt. Ltd. (supra), the Tribunal had held that when for operationalizing exemption, exempted amount of duty is required to be refunded, there was no question of levying education cess and hence it is also required to be refunded. Following the same, it was held that appellant should be entitled to refund of EC & SHEC paid on clearances of goods under Notification No. 56/2002-CE. Decision of Cyrus Surfactants (P.) Ltd. vs. CCE 2007 taxmann.com 806 (New Delhi – CESTAT) was also relied upon.

[2016] 65 taxmann.com 128 (Ahmedabad-CESTAT) Commissioner of Central Excise, Ahmedabad- II vs. Nova Petrochemicals Ltd.

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Recovery under Rule 14 of CENVA T credit Rules cannot be initiated merely because instead of making transfer through ST-3 return, manufacturer-cum-service provider assessee availed input service tax credit directly in ER-1 return.

Facts
The Assessee, a manufacturer availed service tax credit which was utilised for making payment of excise duty. The credit was directly claimed in ER-1 return without reflecting the same in ST-3. Department issued SCN for recovery of alleged wrong utilisation of CENVAT credit by invoking Rule 14 of CENVAT Credit Rules read with proviso to section 11A(1) of the Central Excise Act, 1944 and confirmed by adjudication. Commissioner (Appeals) decided the matter in favour of assessee, relying upon verification report of the department where the credits taken were verified and found in order. Aggrieved by the same, the department filed appeal before the Tribunal.

Held
The Tribunal observed that assessee was required to enter the credit of said amount in relevant ST-3 return and put a remark of transfer of the said credit in the ER-1 return utilised for payment of excise duty. Instead, input service tax credit was debited from the CENVAT account register and utilised in ER-1 return and it was not reflected in ST-3 return. However, it was noted that amount taken and utilised in ER-1 return of the respective month was deducted from total credit balance and only the balance amount was shown in respective column of ST-3 return and therefore the department’s appeal was dismissed.

Capital or revenue receipt – A. Y. 2009-10 – Money to be used in purchase of plant and machinery temporarily placed in fixed deposits – Inextricably linked with setting up of plant – Interest on fixed deposits is capital receipt

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Princ. CIT vs. Factor Power Ltd.; 380 ITR 474 (Del):

In the A. Y. 2009-10, the assessee received an amount of Rs. 70,75,843/- from the bank as interest on fixed deposits but did not declare that amount in the return. Instead the assessee reduced the interest amount from the capital work-in-progress. The assessee claimed that it is a capital receipt and not income. The Assessing Officer rejected the claim of the assessee and made an addition of Rs. 70,75,843/- as “income from other sources”. The Tribunal allowed the assesee’s claim and deleted the addition.

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

“i) The test that is required to be employed is whether the activity which is taken up for setting up of the business and the funds which are garnered are inextricably connected to the setting up of the business.

ii) The findings of fact had been returned by the Commissioner(Appeals) and had been confirmed by the Tribunal to the effect that the funds were inextricably connected with the setting up of the power plant of the assessee. The Revenue had also not been able to point out any perversity in such finding and, therefore, the factual findings had to be taken as those accepted by the Tribunal which is the final fact finding authority in the income-tax regime.

iii) Thus, the revenue generated on account of interest on the fixed deposits would be in the nature of capital receipt and not a revenue receipt.”

Business expenditure – Section 37 – A. Y. 2003-04 – Year in which allowable – Project abandoned as unviable at capital-work-in-progress stage – No claim made in earlier year – Expenses allowable in the year of write-off

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Binani Cement Ltd. vs CIT; 380 ITR 116 (Cal):

In the A. Y. 2003-04, the assessee claimed deduction of the expenditure on a project which had been abandoned when it was found to be unviable. The expenditure was not claimed or allowed earlier as business expenditure and was written off as capital-work-in-progress in the relevant year. The Commissioner (Appeals) held that when construction/acquisition of a new facility was abandoned when it was found to be unviable at the work-in-progress stage, the expenditure did not result in an enduring advantage and such expenditure, when written off, had to be allowed u/s. 37. The Tribunal reversed the order of the Commissioner(Appeals) holding that the expenditure incurred in the earlier years could not be deducted in the A. Y. 2003-04.

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

“There was no challenge on the finding of the Commissioner(Appeals) on the facts before the Tribunal or even the appeal. There would have been no occasion to claim the deduction if the work-in-progress had completed its course. Because the project was abandoned the workin- progress did not proceed any further. The decision to abandon the project was the cause for claiming the deduction. The decision was taken in the relevant year. Thus the expenditure arose in the relevant year. The question is answered in favour of the assessee.”

ALP – International transaction – Sections 92CA and 144C – A. Y. 2012-13 – Amount in dispute exceeding Rs. 5 crore – Matter has to be referred to TPO

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Carrier Race Technologies Pvt. Ltd. vs. ITO; 380 ITR 483 (Mad):

For the A. Y. 2012-13, the assessee had entered into international transactions. The international transactions were certified to be at arm’s length, based on the transactional net margin method as defined. The transfer pricing report and the transfer pricing documentation had been filed. The Assessing Officer computed the arm’s length price on his own and completed the assessment which resulted in an addition of more than Rs. 5 crore.

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

“i) Under the CBDT Instruction dated 20/05/2003, once the disputed value crosses a sum of Rs. 5 crore, necessarily the assessing authority has to refer the matter to the Transfer Pricing Officer so as to proceed further.
ii) Since the provisions of the Act make it clear that u/s. 92CA the only option was to place the matter before the Transfer Pricing Officer, and that option had not been followed, the assessment order was not valid and had to be set aside.”

Business Income – Special Deduction – Proceeds generated from sale of scrap not includable in “Total turnover” for the determining the admissible deduction u/s. 80HHC.

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Mahavira Cycle Industries vs. CIT & Anr. [2015] 379 ITR 357 (SC)

The assessee-firm was dealing in trading and manufacturing of cycle parts. It claimed that the scrap was bi-product of manufacturing which was not part of the total turnover. On November 29, 1999, the assessee filed its original return for the assessment year 1999-2000 declaring a total income as nil. The assessee claimed deduction of Rs.1,73,53,957 u/s. 80HHC of the Act. The return was processed u/s. 143(1)(a) on March 21, 2001. The case was reopened u/s. 148 of the Act. During the assessment proceedings, it was found that the assessee had made sale of scrap amounting to Rs.79,25,489. According to the view point of the Revenue, the sale proceeds of the scrap was a part of the total turnover though the assessee had ignored to include the amount of sale of scrap while computing the deduction u/s. 80HHC of the Act. At the same time, the Assessing Office excluded the profit on sale of scrap from the profit of the business on proportionate basis for the purposes of calculation of deduction u/s. 80HHC. The Assessing Officer, thus, vide order dated July 10, 2006, modified the deduction admissible u/s. 80HHC.

The assessee filed an appeal before the Commissioner of Income Tax (Appeals) (for short “the CIT(A)”). The Commissioner of Income Tax (Appeals) held that the Assessing Officer fell in legal error by including the sale of scrap in the total turnover for the purpose of computation of deduction u/s. 80HHC. It was also clarified that the sale of scrap shall not be considered while computing the profits of the business and, accordingly, by its order dated September 25, 2006, the Commissioner of Income Tax (Appeals) allowed the appeal.

The order giving effect to the order of the Commissioner of Income Tax (Appeals) was passed on October 3, 2006 by the Assessing Officer wherein the total income was assessed at nil. However, later on the Assessing Officer was of the opinion that while giving effect to the order of the Commissioner of Income Tax (Appeals), a mistake apparent on the face of the record had occurred as the scrap sales amounting to Rs.79,25,489 had to be excluded from the total turnover as well as from the profits of the business for computing deduction u/s. 80HHC. The Assessing Officer rectified its earlier order giving appeal effect by exercise of the powers under section 154 of the Act, vide order dated November 28, 2006 and recomputed the deduction by excluding the entire turnover of sale of scrap from the profits of the business. The assessee again filed an appeal before the Commissioner of Income Tax (Appeals) challenging the order dated November 28, 2006 of the Assessing Officer. The Commissioner of Income Tax (Appeals), however, dismissed the appeal, vide order dated December 28, 2007, in the light of its earlier order dated September 25, 2006, holding that u/s.154 the Assessing Officer was competent to initiate proceedings to exclude the turnover of sale of scrap from the profit of business for the purpose of computation of deduction u/s. 80HHC. The assessee further took the matter in appeal before the Tribunal, impugning the orders passed by the Commissioner of Income Tax (Appeals) dated December 28, 2007, and September 25, 2006. The main submission that was raised on behalf of the assessee was that the Commissioner of Income Tax (Appeals) had erred in holding that the entire turnover of sale of scrap was to be excluded from profits of business while computing the deduction u/s. 80HHC.

The Tribunal vide order dated September 29, 2008, held that the deduction u/s. 80HHC of the Act should be computed after excluding the profit on sale of scrap from the profit of business and the sale of scrap also would not form part of the total turnover, for the purpose of calculation of deduction u/s. 80HHC and dismissed both the appeals of the assessee.

The High Court held that the question regarding the inclusion of profit on sale of scrap in calculating business profit u/s. 80HHC had come up for consideration before the Kerala High Court in CIT vs. Kar Mobiles Ltd.’s case (311 ITR 478) where after examining the provisions of section 80HHC and Explanation (baa)(1) attached thereto, it was held that the profits arising from the sale of scrap shall form part of business profits referred to in the formula for determining admissible deduction u/s. 80HHC of the Act. It was also recorded that the sale of scrap shall also form part of the total turnover of the assessee.

Before the Supreme Court, the Revenue acknowledged that the controversy in hand has been adjudicated upon by the Supreme Court in CIT vs. Punjab Stainless Steel Industries (364 ITR 144), in which it was held that sale proceeds of scrap were not includible in turnover.

The Supreme Court therefore allowed the application of the assessee and disposed of the civil appeals in terms of the judgment in CIT vs. Punjab Stainless Steel Industries.

Penalty u/s. 271E -When the original assessment is set aside, the satisfaction recorded therein for the purpose of initiation of penalty proceeding would not survive – Penalty imposed on the basis of original order cannot be sustained.

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CIT vs. Jai Laxmi Rice Mills (2015) 379 ITR 521 (SC)

In respect of the assessment year 1992-93, assessment order was passed on February 26,1996, on the basis of the CIB information informing the Department that the assessee was engaged in a large scale purchase and sale of wheat but it was not filing income–tax return. Ex parte proceedings were initiated, which resulted in the aforesaid order, as per which the net taxable income of the assessee was assessed at Rs. 18,34,584. While framing the assessment, the Assessing Officer also observed that the assessee had contravened the provisions of section 269SS of the Act and because of this, the Assessing Officer was satisfied that penalty proceedings u/s. 271E of the Act were to be initiated.

The assessee carried out this order in appeal. The Commissioner of Income-tax (Appeals) allowed the appeal and set aside the assessment order with a direction to frame the assessment de novo after affording adequate opportunity to the assessee.

After remand, the Assessing Officer passed a fresh assessment order. In this assessment order, however, no satisfaction regarding initiation of penalty proceedings u/s. 271E of the Act was recorded.

It so happened that on the basis of the original assessment order dated February 26, 1996, show-cause notice was given to the assessee and it resulted in passing the penalty order dated September 23, 1996. Thus, this penalty order was passed before the appeal of the assessee against the original assessment order was heard and allowed thereby setting aside the assessment order itself. It is in this backdrop, a question arose as to whether the penalty order, which was passed on the basis of the original assessment order and when that assessment order had been set aside, could still survive.

The Tribunal as well as the High Court held that it could not be so for the simple reason that when the original assessment order itself was set aside, the satisfaction recorded therein for the purpose of initiation of the penalty proceeding u/s. 271E would also would not survive. According to Supreme Court this was the correct proposition of law stated by the High Court in the impugned order.

The Supreme Court observed that, in so far as the fresh assessment order was concerned, there was no satisfaction recorded regarding the penalty proceeding u/s. 271E of the Act though in that order the Assessing Officer wanted penalty proceeding to be initiated u/s. 271(1)(c) of the Act. The Supreme Court thus held that in so far as penalty u/s. 271E was concerned, it was without any satisfaction and, therefore, no such penalty could be levied. The Supreme Court accordingly dismissed the appeals filed by the Revenue.

Business Expenditure – Interest on borrowed capital cannot be disallowed in a case where advances are made to subsidiary out of such borrowed capital due to business expediency.

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Hero Cycle P. Ltd. vs. CIT (2015) 379 ITR 347( SC)

In the income-tax return filed by the assessee for the aforesaid assessment year, the assessee, inter alia, claimed deduction of interest paid on borrowed sums from bank under the privisions of section 36(1)(iii) (hereinafter referred to as “the Act”). The aforesaid deduction was disallowed by the Assessing Officer, vide his assessment order dated March 26, 1991, on the following two points:

(1) The assessee had advanced a sum of Rs. 1,16,26,128 to its subsidiary company known as M/s. Hero Fibres Ltd. and this advance did not carry any interest. According to the Assessing Officer, the assessee had borrowed the money from the banks and paid interest thereupon. Deduction was claimed as business expenditure but substantial money out of the loans taken from the bank was diverted by giving advance to M/s. Hero Fibres Ltd. on which no interest was charged by the assessee. Therefore, he concluded that the money borrowed on which interest was paid was not for business purposes and no deduction could be allowed.

(2) In addition, the assessee had also given advances to its directors in the sum of Rs. 34 lakh on which the assessee charged from those directors interest at the rate of 10%, whereas interest payable on the money taken by way of loans by the assessee from the banks carried interest at the rate of 18%. On that basis, the Assessing Officer held that charging of interest at the rate of 10% from the abovementioned persons and paying interest at much more rate, i.e., at the rate of 18% on the money borrowed by the assessee could not be treated for the purposes of business of the assessee.

The assessee had claimed deduction of interest in the sum of Rs. 20,53,120. The Assessing Officer, after recording the aforesaid reasons, did not allow the deduction of the entire amount and re-calculated the figures, thereby disallowed the aforesaid claim to the extent of Rs. 16,39,010.

The assessee carried the matter in appeal before the Commissioner of Income-tax (Appeals).

In so far as the advance given to M/s. Hero Fibres Ltd. was concerned, the case put up by the assessee even before the Assessing Officer was that it had given an undertaking to the financial institutions to provide M/s. Hero Fibres Ltd. the additional margin to meet the working capital for meeting any cash losses. It was further explained that the assessee-company was the promoter of M/s. Hero Fibres Ltd. and since it had the controlling share in the said company that necessitated giving of such an undertaking to the financial institutions. The amount was, thus, advanced in compliance with the stipulation laid down by the three financial institutions under a loan agreement which was entered into between M/s. Hero Fibres Ltd. and the said financial institutions and it became possible for the financial institutions to advance that loan to M/s. Hero Fibres Ltd., because of the aforesaid undertaking given by the assessee. No interest was to be paid on this loan unless dividend was paid by that company.

On that basis, it was argued that the amount was advanced by way of business expediency. The Commissioner of Income-tax (Appeals) accepted the aforesaid plea of the assessee.

In so far as the loan given to its own directors at the rate of 10 % was concerned, the explanation of the assessee was that this loan was never given out of any borrowed funds. The assessee had demonstrated that on the date when the loan was given, that is on March 25,1987, to these directors, there was a credit balance in the account of the assessee from where the loan was given. It was demonstrated that even after the encashment of the cheques of Rs. 34 lakh in favour of those directors by way of loan, there was a credit balance of Rs. 4,95,670 in the said bank account. The aforesaid explanation was also accepted by the Commissioner of Income-tax (Appeals) arriving at a finding of fact that the loan given to the directors was not from the borrowed funds. Therefore, the interest liability of the assessee towards the bank on the borrowing, which was taken by the assessee had no bearings because otherwise, the assessee had sufficient funds of its own which the assesse could have advanced and it was for the Assessing Officer to establish the nexus between the borrowings and advancing to prove that the expenditure was for non-business purposes which the Assessing Officer failed to do.

The Revenue challenged the order of the Commissioner of Income-tax (Appeals) before the Income-tax Appellate Tribunal. The Income-tax Appellate Tribunal upheld the aforesaid view of the Commissioner of Income-tax (Appeals) and, thus, dismissed the appeal preferred by the Revenue.

The appeal of the Revenue before the High Court filed u/s. 260A of the Income-tax Act, however, was allowed by the High Court, by simply following its own judgment in the case of CIT vs. Abhishek Industries Ltd. (286 ITR 1).

The Supreme court applying the ratio of its decision in S. A. Builders vs. CIT (288 ITR 1) to the facts of this case and referring to the decision of the Delhi High Court in CIT vs. Dalmia Cement (B) Ltd. (254 ITR 377) which was approved in S. A. Builders (supra), held that it was manifest that the advance to M/s. Hero Fibres Ltd. became imperative as a business expediency in view of the undertaking given to the financial institutions by the assessee to the effect that it would provide additional margin to meet working capital for cash losses.

The Supreme Court noted that, subsequently, the assessee-company had off-loaded its shareholding in the said M/s. Hero Fibres Ltd. to various companies of the Oswal group and at that time, the assessee-company not only got the back the entire loan given to M/s. Hero Fibres Ltd. but this was refunded with interest. In the year in which the aforesaid interest was received, the same was shown as income and offered to tax.

In so far as the loans to the directors was concerned, the Supreme Court observed that it could not be disputed by the Revenue that the assessee had a credit balance in the bank account when the said advance of Rs. 34 lakh was given. Further, as observed by the Commissioner of Income-tax (Appeals) in his order, the company had reserve/surplus to the tune of almost 15 crore and, therefore, the assessee-company could in any case, utilise those funds for giving advance to its directors.

In view of above, the Supreme Court allowed the appeal thereby setting aside the order of the High Court and restoring that of the Income-tax Appellate Tribunal.

Note:- The judgment of the Apex Court in the case of S. A. Builders was analysed in the column ‘ Closements’ of BCAJ in the month of February, 2007.

Obligation of Foreign Company to File Return of Income where Income Exempt under DTAA

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The obligation to file a return of income under the Income -tax Act, 1961 arises by virtue of section 139 of that Act. Section 139(1) provides that every person, being a company or a firm, or being a person other than a company or a firm, having total income exceeding the maximum amount not chargeable to income tax during the previous year, shall file a return of income in the prescribed manner. The provisos to this s/s. and s/s.s (4A) to (4F) of this section, require filing of returns of income by various entities, even where these entities’ income may not be chargeable to tax.

The 3rd proviso to section 139(1) provides that every company or firm shall furnish its return of income or loss before the due date in every previous year. The 4th proviso further requires every person, who is resident and ordinarily resident and who otherwise is not required to furnish a return of income, and who holds any foreign asset as a beneficial owner or otherwise, or who is a beneficiary of any foreign asset, to file a return of income. Sub-section (4A) applies to charitable or religious institutions claiming exemption u/s.s 11 and 12, s/s. (4B) applies to political parties, s/s. (4C) applies to research associations, news agencies, profession regulatory bodies, educational institutions, hospitals, mutual funds, securitisation trusts, venture capital funds, trade unions, infrastructure debt funds, etc., s/s. (4D) applies to research organisations, s/s. (4E) applies to real estate investment trusts and infrastructure investment trusts, while s/s. (4F) applies to alternative investment funds.

A foreign company may at times have income which is chargeable to tax in India under the provisions of the Act, but which may be exempt from tax by virtue of the provisions of a Double Taxation Avoidance Agreement (“DTAA”). The issue has arisen before the Authority for Advance Rulings (“AAR”) as to whether such a foreign company, whose entire Indian income is not taxable in India by virtue of a DTAA, is required to file its return of income in India. There have been conflicting rulings of the AAR on this issue, at times holding that there is no such obligation to file a return of income in India, while at times holding that a return of income has necessarily to be filed in India by a foreign company, irrespective of the fact that its income is not liable to tax in India.

Castleton Investment Ltd ’s case
The issue had arisen before the AAR in the case of Castleton Investment Ltd, in re, 348 ITR 537.

In this case, the assessee was a Mauritius company, part of a multinational group, which held shares of a listed company in India, amounting to 3.77% of the paid-up capital of the listed company. As a part of the reorganisation of the group structure, it proposed to transfer the shares held by it in the listed company in India to another group company based in Singapore, either through a transaction on a recognised stock exchange on which the shares were listed, or through an off market sale.

It filed an application for a ruling before the AAR, as to whether the capital gains arising from transfer of the shares of the listed company would be subjected to tax in India, or whether such capital gains would be exempt from tax by virtue of paragraph 4 of Article 13 of the India Mauritius DTAA . It also raised the question as to whether the provisions of section 115JB, relating to Minimum Alternate Tax (MAT) was applicable to it. One of the other questions raised by it in the application was that if the transfer of shares of the listed company was not taxable in India, whether it was required to file any return of income u/s. 139.

The authority held that the capital gains arising to the assessee was not chargeable to tax in India by virtue of paragraph 4 of Article 13 of the DTAA between India and Mauritius. As regards the issue of whether the assessee was under an obligation to file the return of income, it was argued on behalf of the assessee that since the income was not taxable in India under the Act read with the DTAA, there was no obligation on the assessee to file a return of income u/s. 139. On behalf of the revenue, it was argued that whatever may be the position under the DTAA , the applicant was bound to file a return of income as mandated by section 139.

The AAR, analysing the provisions of section 139, observed that every person, being a company, firm or a person other than a company or firm, had to file a return of income if its/his total income exceeded the maximum amount which was not chargeable to income tax. If an assessee had income which was chargeable under the Act, or after claiming the benefit of a DTAA, if it had chargeable income exceeding the maximum amount not chargeable to tax, it was bound to file a return as per the language of section 139.

The Authority observed that a person claiming the benefit of the DTAA could do so by invoking the provisions of section 90(2) of the Income-tax Act to claim such benefit. In other words, a person earning an income that was otherwise chargeable to tax under the Act had to make a claim by invoking section 90(2) of the Act for getting the benefit of a DTAA in order to enable him to be not liable to payment of tax in India. According to the AAR, even if a person was entitled to a relief under the DTAA , he had to seek it, and that would be during the consideration of his return of income or at best, while filing the return of income. The AAR accordingly was of the view that the obligation u/s. 139 did not simply disappear merely because a person was entitled to claim the benefit of a DTAA.

Addressing the argument that a DTAA overrides the Act, and was not the same as claiming an exemption under the Act, the AAR observed that surely, in terms of section 90(2), it had to be shown that the benefit of a DTAA was being claimed, that the claimant was eligible to make that claim, and that the DTAA was more beneficial to the claimant than the Act. According to the AAR, that had to be shown before the assessing authority, and this emphasised the need to file a return of income to claim such a relief. The AAR therefore held that the assessee had an obligation to file a return of income in terms of section 139. Incidentally, in this case, the AAR also held that the provisions of section 115JB relating to MAT on book profits, applied to the assessee.

A similar view had been taken by the AAR in the cases of VNU International BV, in re 334 ITR 56, SmithKline Beecham Port Louis Ltd., in re 348 ITR 556, ABC International Inc., in re 199 Taxman 211, and XYZ/ABC Equity Fund, in re 250 ITR 194, in all of which cases, the income was taxable in India under the Act, but exempt under the DTAA . In XYZ/ABC Equity Fund’s case, a case where business profits earned in India were held not liable under the DTAA in absence of a permanent establishment in India, a view has been taken that:

“‘Total income’ is to be computed in accordance with the provisions of the Income-tax Act. According to section 5, total income of a non-resident includes all income from whatever source derived which is received or is deemed to be received in India in a given year or accrues or arises or is deemed to accrue or arise to the non-resident in India during such year. Therefore, if the income received by or on behalf of the non-resident exceeds the maximum amount which is not chargeable to income-tax, a return of income has to be filed. It may be that in the final computation after all deductions and exemptions are allowed, it will turn out that the assessee will be not liable to pay any tax. The exemptions and deductions cannot be taken by the assessee on his own. He is obliged to file his return showing his income and claiming the deductions and exemptions. It is for the Assessing Officer to decide whether such deductions and exemptions are permissible or allowable. The assessee cannot be allowed to pre-judge the issues and decide for himself not to file the return, if he is of the view that he will not have any taxable income at all.”

Even in the case of Deere & Co, in re 337 ITR 277 (AAR), where the transaction of gift of shares to another group company was not chargeable to capital gains tax at all even under the Act, as well as under the DTAA , the AAR has taken the view that the assessee was under an obligation to file its return of income, following its earlier rulings.

FactSet Research System’s case
The issue had also come up before the AAR in the case of FactSet Research Systems Inc, in re 317 ITR 169.

In this case, the assessee was a US company, which maintained a database of financial and economic information, including fundamental data of a large number of companies worldwide, at its data centres located in the USA. The databases contained the published information collated, stored and displayed in an organised manner, which facilitated retrieval of publicly available information in a shorter span of time and in a focused manner by its customers, who were mostly financial intermediaries and investment banks. The customers paid a subscription to access the database.

Besides seeking a ruling from AAR as to whether such subscription received from customers in India would be taxable in India under the Income-tax Act or under the DTAA between India and the USA, the assessee also raised the question of whether it was absolved from filing a tax return in India under the provisions of section 139 with regard to the subscription fees, assuming that it had no other taxable income in India.

The AAR held that the payment of the subscription fees did not constitute royalty either under the Act [as it then stood before the retrospective amendment to section 9(1)(vi)] or under the India USA DTAA. While examining whether the subscription fees was taxable as business income under the DTAA , the AAR took note of the assessee’s submissions that the Mumbai office of a group subsidiary provided marketing and support services to its customers in India, but that, after initial discussions with the prospective customers, the contract was signed by the customer and by the assessee, and that the Mumbai office did not have the authority to conclude contracts with customers. The AAR accepted the assessee’s submission, but left it open to the Department to make enquiry as to the existence or otherwise of an agency PE, and as to the attribution of income to such PE.

As regards the question of obligation to file a return of income, based on its finding that there was no royalty income and on the facts stated by the assessee that there was no PE in India, the AAR held that there was no obligation on the assessee to file the return of income in India.

A similar view had been taken by the AAR in the case of Venenburg Group BV, in re (2007) 289 ITR 462, where the AAR observed that the liability to pay tax was founded upon sections 4 and 5 of the Act, which were the charging sections. Section 139 and other sections were merely machinery sections to determine the amount of tax. According to the AAR, relying on the decision in the case of Chatturam vs. CIT (1947) 15 ITR 302, there would be no occasion to call a machinery section to one’s aid, where there was no liability at all. Therefore, the assessee was not required to file any tax returns, though the capital gains from the proposed transaction would be chargeable to tax under the Act, but would be exempt under the DTAA .

Observations
Section 139(1) requires a filing of return of income by a person other than a company or a firm if income exceeds the maximum amount which is not chargeable to income tax. Clause(a) provides for filing of return of income by a company or a firm and in doing so does not expressly limit the requirement to the cases of income exceeding the maximum amount not chargeable to tax. This may be on account of the fact that a company or a firm does not have any maximum amount which is not chargeable to income tax, since it is liable to pay tax on its entire chargeable income at a flat rate of tax.

The definition of “company” u/s. 2(17) includes a body corporate incorporated by or under the laws of the country outside India and a foreign company would be subjected to the provisions of the Act provided its activities has some connection with India. Obviously, every company in the world cannot be required to file its return of income in India, if it does not have any source of income in India keeping in mind the fact that the scope of the Act as envisaged in section 1(2) is restricted to India and the intention is to charge income, which has some connection with India.

Section 5 of the Act in a way spells out the connection with India which creates a charge to tax, when read with section 4. For a non-resident, the charge to tax is of income received or deemed to be received in India, or income accruing or arising or deemed to accrue or arise in India.

Section 90(2) of the Act spells out the overriding nature of DTAA s. It provides that where a DTAA has been entered into by the Central Government with the Government of any country outside India for granting relief of tax or avoidance of double taxation, in case of an assessee to whom the DTAA applies, the provisions of the Act will apply to the extent that they are more beneficial to the assessee. Therefore, the provisions of the DTAA or the Act, whichever is more beneficial to the assessee, would apply. The DTAA would therefore override all the provisions of the Act, except chapter X-A relating to General Anti-Avoidance Rules, as provided in section 90(2A).

It must be remembered that the charge to tax u/s. 4 is on the total income, and the total income is computed under the Act, after various exemptions and deductions, including those available under the DTAA . If income of an assessee is completely exempt from tax, there is no charge to tax at all. Similarly, if the income does not accrue or arise or is not deemed to accrue or arise or is not received or deem to be received in India, it does not fall within the scope of total income, and there is no charge to tax of such income. Given the fact that there is no charge to tax, can the other machinery provisions relating to filing of return, computation of tax, etc. apply?

The AAR in Venenburg Group’s case (supra) rightly referred to the decision of in Chatturam’s case. In that case, the assessee was a resident of a partially excluded area, and received a notice to furnish his return of income. His assessment was completed, and his appeals to the tribunal were dismissed. A notification was issued after he had filed his return, but before completion of his assessment, directing that certain income tax laws would apply to that area where the assessee was a resident retrospectively. The Court, while holding that the assessments were validly made on the assessee, observed as under:

“The income-tax assessment proceedings commence with the issue of a notice. The issue or receipt of a notice is not, however, the foundation of the jurisdiction of the Income-tax Officer to make the assessment or of the liability of the assessees to pay the tax. It may be urged that the issue and service of a notice under Section 22(1) or (2) may affect the liability under the penal clauses which provide for failure to act as required by the notice. The jurisdiction to assess and the liability to pay the tax, however, are not conditional on the validity of the notice. Suppose a person, even before a notice is published in the papers under Section 22(1), or before he receives a notice under Section 22(2) of the Income-tax Act, gets a form of return from the Income-tax Office and submits his return, it will be futile to contend that the Income-tax Officer is not entitled to assess the party or that the party is not liable to pay any tax because a notice had not been issued to him The liability to pay the tax is founded on Sections 3 and 4 of the Income tax Act, which are the charging sections. Section 22 etc are the machinery sections to determine the amount of tax. Lord Dunedin in Whitney v. Commissioners of Inland Revenue [1926] AC 37; 10 Tax Cas 88 stated as follows:—”Now, there are” three stages in the imposition of a tax. There is the declaration of liability, that is the part of the statute which determines what persons in respect of what property are liable. Next, there is the assessment. Liability does not depend on assessment, that ex hypothesi has already been fixed. But assessment particularizes the exact sum which a person liable has to pay. Lastly, come the methods of recovery if the person taxed does not voluntarily pay”. In W.H. Cockerline & Co. v. Commissioners of Inland Revenue [1930] 16 Tax Cas 1, at p. 19, Lord Hanworth, M.R., after accepting the passage from Lord Dunedin’s judgment quoted above, observed as follows:—”Lord Dunedin, speaking, of course, with accuracy as to these taxes was not unmindful of the fact that it is the duty of the subject to whom a notice is given to render a return in order to enable the Crown to make an assessment upon him; but the charge is made in consequence of the Act, upon the subject; the assessment is only for the purpose of quantifying it He quoted with approval the following passage from the judgment of Sargant, L.J., in the case of Williams Not reported: —” I cannot see that the non-assessment prevents the incidence of the liability, though the amount of the deduction is not ascertained until assessment. The liability is imposed by the charging section, namely, Section 38 (of the English Act) the words of which are clear. The subsequent provisions as to assessment and so on are machinery only. They enable the liability to be quantified, and when quantified to be enforced against the subject, but the liability is definitely and finally created by the charging section and all the material for ascertaining it are available immediately”. In Attorney-General v. Aramayo and Others [1925] 9 Tax Cas 445, it was held by the whole Court that there may be a waiver as to the machinery of taxation which inures against the subject. In India these well-considered pronouncements are accepted without reservation as laying down the true principles of taxation under the Income-tax Act.”

These observations of the Court, when applied to provisions of section 139, clarifies that the machinery provisions cannot be divorced from the charging provisions.

There are various persons whose income is exempt from tax, and which were earlier not required to file a return of income u/s. 139, on account of the fact that the total income was exempt from tax. Wherever the legislature thought fit that such persons should file their returns of income, the law has been amended by insertion of various sub-sections to section 139, from time to time, being s/s.s (4A) to (4F) referred to earlier. There has been no such amendment requiring foreign companies whose total income is exempt under a DTAA to file their returns of income, in spite of the fact that the AAR has held as far back as 2007 that foreign companies need not do so.

As regards the argument that the availability of the exemption under the DTAA needs to be examined, and therefore the return of income needs to be filed, taking the argument to its logical conclusion, can one say that every agriculturist in India is required to file his return of income, even though he has only agricultural income, on account of the fact that, whether his income is agricultural or not and whether the exemption u/s. 10(1) is available or not, needs to be examined by the assessing officer?

Interestingly, this aspect of examination of the availability of exemption has also been a matter of controversy between the High Courts in the context of assessees exempt u/s. 10(22), with the Bombay High Court holding, in the case of DIT(E) vs. Malad Jain Yuvak Mandal Medical Centre (2001) 250 ITR 488, that the return of income was required to be filed for such examination of whether exemption was available, and the Delhi High Court, in the case of DIT(E) vs. All India Personality Enhancement & Cultural Centre For Scholars Aipeccs Society 379 ITR 464, holding that there was no such requirement to file return of income if the income was exempt u/s. 10(22).

A DTAA cannot be read in exclusion, but has to be read in conjunction with the Act. In particular, a DTAA does not create a charge to tax, but modifies the charge to tax created by the Act. The fact that DTAAs override the Act implies that, by virtue of the provisions of a DTAA , an income which would otherwise have been chargeable to tax under the Act, may not be chargeable to tax on account of the beneficial provisions of the DTAA. In such a case, one cannot take the view that the income is chargeable to tax in India under the Act, even though it is exempt from tax, since the DTAA takes such income outside the purview of sections 4 and 5 of the Act.

Given this background, the liability to file returns by a foreign company can perhaps be viewed by looking at the different possible situations relating to tax liability of a foreign company in India.

The first would be a situation where the income is chargeable to tax under the Act, as well as under the DTAA . In such a case, there is no doubt that the foreign company is liable to file its income tax return in India.

The second would be a situation where the income is exempt under the Act, as well as under the DTAA. In such a case, since even under the Act, there is no income chargeable to tax, the machinery section, section 139, cannot be brought into play, since it would serve no purpose. Therefore, in such a case, there would be no obligation to file the return of income in India.

The third will be the situation where the income is chargeable to tax under the provisions of the Act, but is exempt from tax by virtue of the DTAA beneficial provisions. In such a case, as discussed above, the better view would be that there is again no obligation to file the return of income in India, in the absence of a specific provision containing such requirement.

The fourth will be the situation where the foreign company has no activity in India and its income cannot be taxed in India under the Act and therefore, it is under no obligation at all to file its return of income under the Act, in India.

A House divided

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As this issue reaches you, the Finance Bill 2016 would have been tabled in the Parliament. Before the presentation of the budget, Parliament has seen a heated debate on the concept of nationalism. It has been triggered by two unfortunate events occurring in two universities in the country. The first was a suicide by a Dalit student, and the second was the agitation in the Jawaharlal Nehru University (JNU). The way the politicians of all hues have attempted to take benefit of the situation, and politicise both the events causes deep anguish.

One must note that 68 years after we became an independent nation the Parliament is debating the concept of nationalism. Expectedly most of the speeches were politically motivated though some were really thought provoking. In many of the speeches persons were criticised for what they had said at some point of time but the context was not explained. All of us tend to label, very quickly a person by the thoughts, beliefs and sentiments that he echoes. We treat him as national, antinational, patriotic, traitor, secular, pseudo secular, etc. What we must appreciate is that the person may and is entitled to hold various beliefs. We may not agree with all of them. The right to express dissent has been the cornerstone of any democracy. We have had a number of transitions of power in the recent past, which have taken place in a virtually non-violent manner due to this strong foundation of democratic beliefs.

It is in this context that, the events in both educational institutions are disturbing. The entire world is talking of the demographic dividend that India will enjoy on account of its young population. It is in these universities that, the youth of India develop their academic skills which they will use when they step out to earn their bread in this highly competitive world. The diversity of thought makes them mature, and discerning. They learn to accept that there would be people of their own breed who hold different views; at times the diametrically opposite from theirs. Healthy debate and exchange of thoughts shapes their destiny.

It is equally true that, events in these institutions need to be looked at carefully. The youth who are the future do have impressionable minds and therefore one needs to tread with caution. One feels that meeting verbal violence, with some strong action like arrests, detention could have been avoided. Instead it may be more appropriate to reason with the students. They are after all our future. It was painful to see that fisticuffs were exchanged in an arena where thoughts should be.

As for nationalism, it has many hues. History tells us that those who fought in the freedom struggle had serious differences amongst them over the manner in which freedom was to be achieved. All of them contributed their mite, and it would be unfair calling one more patriotic and the other one less.

The same holds good for the array of thoughts and expressions of the youth. It is not necessary that one has to be in total agreement with all the thoughts of the other person. It is possible that one may have serious differences with some of his beliefs. Educational institutions are the ideal place where after a stirring debate, one may be able to change the other person’s beliefs or come around to accepting them. If they are suppressed, this process can never happen.

We as responsible citizens must try and ensure that, purity and sanctity of these educational institutions should be protected. Politicians and other elements will always try to take advantage of the situation and score some brownie points. It would be better if, the discontent is permitted to be expressed. Let the powers that be, give the youth the freedom to commit mistakes as long as those are not fatal to our national fabric. I believe that we have a rich heritage and our nationalism is strong and not brittle, and it will not crumble with a few slogans or posters.

Many times when we interact with youth we find a degree of disappointment with a number of issues. They are restless with the slow pace of development, decision-making etc. It is their youthful energy that makes them restive. Let Parliament debate as to how these expectations can be met rather than making an attempt to define nationalism. I hope this happens. Otherwise, we might be left with the lines of a soulful melody of Guru Dutt’s film “ Jinhe naaz hain hind par woh kahan hain!”

DUTY

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‘He only thought of duty done’ —Sadhu Vaswani

1. Right from our childhood our parents talked of `Duty’. So did our leaders like Tilak, Gandhi and others. The only `right’ Tilak talked about was our right to `swaraj’. Let us look at how society looks at `duty’. To list a few: there is duty to parents, teachers, spouse, children, society, country and above all duty to `oneself’ – because unless one looks after oneself it would not be possible – nay impossible – to discharge any or all other duties.

2. Further :

Business owes a duty to its customers and suppliers. Corporates owe a duty to all its stakeholders and society as society is one of the stakeholders – it is for the first time in the world that duty to society has been codified in India. Corporates are now expected to spend 2% of their net profits in the discharge of their `social responsibility’.I believe this is a mandate, though initially it is being treated as somewhat optional.

We professionals owe a duty to our clients – to render a service to the best of our ability and never feel shy of seeking help where we need it. We also have a duty to those articled with us to train them to be good professionals.

The government owes a duty towards its citizens for being fair and transparent and citizens have a corresponding duty of living according to the code of conduct and paying our taxes. There is a good old saying `yield to ceaser what is due to him’.

The sage owes a duty to the seeker as much as the seeker owes a duty to the sage by following his preceptor with faith.

3. Moreover, in life `following’ is as much a duty as the `duty’ to lead – for every one of us without exception is both a leader and a follower.

4. Duty to society, per se, includes duty to obey laws, both natural and manmade. Hence, if one discharges one’s duties – he favours no one as doing one’s duty is discharging an obligation. As a matter of fact, one should not even seek appreciation or a `thank you.’ If it comes it comes as a `bonus’ in accounting language.

5. Duty to oneself is not only looking after one’s body but includes taking care of our mind and emotions. Hence in management parlance, it is in this sense that it is said that E.Q. is as important as I.Q. if not more – because if one cannot take care of one’s emotions – how will one discharge one’s duty with care and compassion. However, doing one’s duty is not easy – difficulties will arise but difficulties don’t deter the doer of duties. He faces the difficulties with faith and courage – faith in himself – and overcomes them with the guidance of his preceptor and help of God. Living upto one’s duty, though not easy, develops harmony.

6. However, the irony is that we have moved from `duties’ to `rights’ and the result is–strife, commotion, intolerance and uneasiness prevails at home, workplace and in society. We have forgotten that if all of us discharge our duty, there would be peace and harmony. Mahatma Gandhi advises :

  • The true source of rights is duty; if we all discharge our duties, rights will not be far to seek’.
Maulana Wahiduddin Khan opines :

  • The best society is a duty-conscious society,

           the worst society is a rights-conscious society’.

7. The issue is, can we once again live by the concept of duty’.

8. I believe we can and it will happen, for it is the only way to bring peace, harmony and happiness in one’s life and in society. Doing our duty sets us free. Charles Bandclair declares :

  • the habit of doing one’s duty drives away fear’.
Let us not forget that it is the individual who creates the environment at home and in the society. In conclusion I would say, let us understand what Mark Twain says on duty :

Duties are not performed for duty’s sake,
but because their neglect would make
us uncomfortable’.
So to have a happy life – let us think and do our duty.

Comments and Suggestions on Draft Guiding Principles for Determination of Place of Effective Management (POEM) of a Company

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30th December 2015

To
The Director
Tax Policy & Legislation – I,
Central Board of Direct Taxes,
Room No 147-D, North Block,
New Delhi 110001.

Dear Sir,

Comments and Suggestions on Draft Guiding Principles for Determination of
Place of Effective Management (POEM) of a Company

On 23rd December 2015, the Central Board of Direct Taxes has released the draft Guiding Principles for Determination of Place of Effective Management of a Company for public comments and suggestions.

We give below our representation on, and suggestions in respect of the draft.

General
1. In principle, we welcome the issuance of guidelines, to bring further clarity on what constitutes a POEM in India, and which will help to reduce the subjectivity. This will help to reduce possible litigation in this regard.

2. While the purpose of the guidelines is to reduce the subjectivity as to what constitutes POEM in India, and to have greater certainty as to the existence or non-existence of a POEM in India, we believe that the draft guidelines are too subjective in nature, and leave too much room for interpretation by the assessing authorities. The guidelines, if issued in the present draft form, will therefore not serve the purpose behind the issue of such guidelines. We set out below some of the reasons as to why we believe the guidelines are too subjective. We suggest that, at least in the initial stages, the guidelines should be more objective, to prevent misuse of discretion by assessing officers.

Definition of “Passive Income”
3. The definition of “passive income” includes income by way of royalty, dividends, capital gains, interest or rental income. There are often instances where such incomes could be active incomes. For example, royalty for a research and development company or for a company providing value added services to a telecommunications company, interest for a bank or financial services company, rental income for a mall, etc., are incomes arising out of active business activity, and cannot be regarded as passive incomes. Such incomes of such types of companies need to be classified as active incomes.

Companies Carrying on Active Business
4. In case of companies carrying on active business outside India, in paragraph 7, it has rightly been laid down that the POEM shall be presumed to be outside India if the majority meetings of the board of directors of the company are held outside India. This is an objective test. However, paragraph 7.1 completely negates such objective test laid down under paragraph 7, by stating that if, on the basis of facts and circumstances, it is established that the board of directors are standing aside and not exercising their powers, which powers are being exercised by either the holding company or any other person resident in India, the POEM should be regarded as being in India.

This paragraph fails to appreciate the commercial reality that every company exists for the benefit of its shareholders. Therefore, it is inevitable that every holding company always exercises some amount of control over its subsidiaries, and that certain crucial decisions are always taken in principle by the holding company, particularly in case of wholly owned subsidiaries. The board of directors, which takes the final detailed decisions, is very often guided by the views expressed by and the needs of the holding company, though they may also have their independent views in relation to the relevant matter, and do consider the impact of their decisions on the subsidiary.

Further, though directors may be resident in India, it is not necessary that by virtue of their residence, decisions are being taken in India, since very often the directors would be visiting the country where the subsidiary is carrying on operations, and taking decisions during the course of such visits, in consultation with the local management of the subsidiary.

Paragraph 7.1, which is supposed to be an exception, rather than the norm, is likely to be taken as the norm by assessing officers, rather than the exception, rendering the provisions of paragraph 7 redundant. A view will likely be taken by most assessing officers, where even a couple of or a few decisions are taken by the holding company, which are confirmed by the board of the subsidiary outside India, or where a majority of the directors are resident in India, that the POEM is in India. This will lead to unwarranted litigation.

We therefore strongly recommend that paragraph 7.1 be deleted altogether.

Companies Carrying on Passive Business
5. The guiding principles laid down in paragraph 8.2 are many, and it is not clear as to in which order of precedence they are to be considered. It is possible that some guiding principles may indicate existence of POEM, while others may indicate non-existence of POEM. In such cases, invariably the assessing officer may take the view in favour of existence of POEM, while the assessee is of the view that there is no POEM, given the subjectivity of the guiding principles, leading to avoidable litigation.  It is therefore suggested that the guiding principles should be given in order of precedence, step by step, similar to the tie-breaker test contained in Double Taxation Avoidance Agreements for determination of residence. This will bring clarity and objectivity to the tests. This is important, at least in the initial years of the introduction of the concept of POEM.

Approval of CIT
6. Paragraph 11 provides that in case the assessing officer proposes to hold a company, on the basis of its POEM, as being resident in India, then he needs to seek the prior approval of the Principal Commissioner or Commissioner.

In order to prevent unnecessary harassment of foreign companies, it is suggested that even in cases where an assessing officer wishes to investigate the existence of POEM in India of a foreign company, he should seek such prior approval, giving his reasons for such investigation. Besides, instead of approval by the Commissioner/ Principal Commissioner, the approval required both for investigation, as well as for holding a foreign company as resident in India on the basis of existence of its POEM in India, should be that of the Chief Commissioner/Principal Chief Commissioner.

Other Suggestions
7. It is suggested that it should be clarified that in case a foreign company is regarded as being resident in India, based on its POEM being in India, it should yet to be entitled to all treaty benefits under the treaty of India with the country in which the foreign company is located.

8. Since the guidelines would be issued only in January 2016, it is suggested that the concept of POEM should be introduced only with effect from assessment year 2017-18. An amendment should be made to the Income Tax Act, 1961 through the Finance Act 2016, making the amendment in section 6(3) applicable with effect from assessment year 2017-18, instead of with effect from assessment year 2016-17.

For Bombay Chartered Accountants’ Society
Raman Jokhakar
President Chairman,

Gautam Nayak
International Taxation Committee

Buy Back of Shares by Private and Public unlisted Companies under the Companies Act, 2013

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This artice is intended as a basis for understanding the provisions in brief and does not claim to be a critical analysis of the provisions – Editorial Note.

1. What is Buy Back?

A share of an incorporated company is a property transferable between people entitled to hold the same, by following a set of procedures. Shares are of different types – Equity, Preference, Convertible, quasi debt, having differential voting rights, etc. These shares when issued provide a bundle of rights to the Subscriber, Purchaser or Registered Holder of shares as the case may be. These rights include, right to receive dividend, right to participate in the decision making of the Company to the extent permitted by Law.

Buy back is a term specifically used when shares are repurchased by the issuing Company. Buy back reduces the number of shares outstanding; it increases earnings per share and tends to increase the market value of the remaining shares.

2. What are the statutory provisions related to buy back of shares?

The provision related to buy back were introduced in the Companies Act, 1956 u/s. 77A, 77AA and 77B vide Companies (Amendment) Act, 1999 with retrospective effect from 31-10-1998. These provisions have been incorporated in the Companies Act, 2013 effective from 1st April, 2014 in sections 68, 69 and 70. Apart from the said sections 68 to 70 which provide for pre-conditions, limits, prohibitions and post buy- back compliance, Rule 17 of the Companies (Share Capital and Debentures) Rules 2014 mandates the procedure to be followed to carry out buy-back of shares.

3. What are the broad conditions of the Act on buy-back?

Any company undertaking a buy-back has to have its compliance up-to-date. Mainly such compliance falls in two categories (i) pre-conditions facilitating buy-back and; (ii) conditions on the basis of which buy-back is actually carried out. These conditions are like pre-operative check-up :

(i) pre-conditions facilitating buy-back:

i) Express provision in the Articles of Association of the Company empowering buy-back. It is well known fact that provisions of the Act override the provisions of Memorandum of Association- MoA and Articles of Association-AoA (section 6 of the Companies Act, 2013), but wherever the Act requires a specific provision in the Company’s constitutional document i.e. MoA AoA, it is necessary that the Company’s AOA should contain the same. It is therefore advisable that the Company should check that its AoA contains clear provision for buying back its securities. In the event the buy-back is not authorised by the Articles, steps should be taken to amend the same. A simple provision in the Articles which merely states “the Company may be subject to following requisite procedure of law can buy-back its securities” is sufficient empowerment for the Company to initiate buy-back.

ii) Up-to-date submission of returns with Registrar: The Company should check that all its returns mandatorily required to be filed every year i.e. Annual Accounts, Auditors report with Directors Report and other enclosure and Annual Returns have been submitted. With 100% e-filing of MCA returns, it is easy for the Registrar to check at a click of a mouse about e-filing position of every Company. Therefore, if the Registrar flags this matter as pending, the process of buy-back will be in question.

iii) Strict compliance with the provisions of the Act related to acceptance of deposits and repayment of Loans taken from Bank and Financial Institutions: The Company should ensure that it has adhered to the strict compliance related to acceptance of deposits as envisaged in section 73 to 76 (as applicable) and Companies (Acceptance of Deposits) Rules 2014. Any violation pertaining thereto or any default in respect of payment of interest on deposits or debentures or default in redemption of principal amount or any default in repayment of installment of loan or interest thereon will be termed as violation of the provisions of the Act and such Company will not be allowed to undertake buy-back.

Though the Act provides for prohibition of buy-back by Companies who have defaulted in repayment of loan or interest thereon, it will have to be viewed on a case-to-case basis. In case of a Company availing cash credit and overdraft facility, it is not a term loan or there is no default which can be linked, unless the Company has no turnover or is unable to, in time, convert its debtors into cash.

iv) Compliance with the provisions related to declaration and payment of dividend: The Company undertaking buy-back should ensure that, it has complied with conditions for issue of dividend and has not violated the timeline for issuing dividend payment instruments. In case of a question raised by any shareholder entitled for dividend about non-receipt of dividend, the Company should be in a position to prove beyond doubt that, it has adhered to the procedure u/s. 123 and 127 read with Rules pertaining to declaration and payment of dividend.

v) Adherence to provisions related to Financial Statement as provided in section 129 of the Act: The Company should ensure that provisions related to Financial Statements, disclosure requirements, approval and adoption thereof by the Board and the Members at AGM, disclosure about subsidiary, associate and joint venture Companies as applicable are adhered to, before commencing buy-back.

In our view, adherence to the compliance of this section is possible when a Company maintain its accounts according to standards set by ICAI and that there are no material adverse comments by the Auditors in its report.

vi) Indirect buy-back: The Company undertaking buy-back should not carry out the same though its’ subsidiary and/or through investment Company or group of investment companies.

According to one view, the condition of Company buying-back its shares through its subsidiary is not possible now in view of the provisions of section 19, which prohibits a subsidiary Company from holding shares of its Holding Company.

(ii) Conditions on the basis of which buy-back is actually carried out. After the Company has confirmed that it complies with all pre-conditions empowering itself for undertaking a buy back, the following aspects should be ensured by the Company;

  • Authorisation by the members in the General Meeting by way of special resolution for carrying out buy-back with complete details of shares to be bought back and other aspects as mentioned in Rule 17 of the Cos (Share capital & Debentures) Rules 2014.
  • Shares to be bought back should be fully paid up;
  • No further issue of shares by the Company whether by way of rights issue, preferential issue or bonus shares after getting authorisation for buy-back from members, till the issue process is complete. However, any quasi–debts instrument issued by the Company, which are convertible into equity are exempt from this condition. Thus, conversion by third party on the basis of pre-granted rights is possible.
  • Shares to be bought back can be from:

(i) existing shareholders or security holders on a proportionate basis;
(ii) from open market;
(iii) securities issued under Employee Stock Option Scheme/Plan (ESOS/ESOP) or sweat equity

  • Funding for buy-back can be made from any one or combination of following sources:

a) Free reserves;
b) Balance in securities premium account; or
c) Proceeds of the issue of any shares or other specified securities.

However, the Company cannot issue shares for buying back shares of same type or issue specified securities for buying-back the same type of securities

4. What are the limits on buy-back of shares by the Company?

The Company buying back its shares has two options;

a) Buy-back on the basis of only resolution of the Board:- A buy-back on the basis of Board Resolution can be upto 10% of the paid up capital and free reserves;

b) Buy-back on the basis of Members’ Special resolution : A buy-back on the basis of Members ‘special resolution can be upto 25% of the paid up capital and free reserves.

5. Gist of other terms and conditions for buyback. A Company undertaking a buy-back has to keep in mind the following terms and conditions:

  • Every buy-back authorised by the Members or Board shall be completed within a period of one year from the date of passing the relevant resolution;
  • Once the offer of buy-back is announced to the shareholders, the same cannot be withdrawn;
  • A minimum period of one year should have elapsed from the closure date of previous buyback and date of offer of present buy-back;
  • The debt to equity ratio of a Company post buyback should not be more than 2:1; or such other ratio as may be prescribed by the Govt. for that class of Companies; It is to be noted here that debt includes secured and unsecured debts;
  • If the Company has used its free reserves or securities premium account for funding buyback consideration, then a sum equal to nominal value of the shares so purchased is required to be transferred to the capital redemption reserve account;
  • Company buying back its shares is required to make complete disclosure of information in the Explanatory statement issued to members and is required to follow process and documentation as provided in rule 17 of the Companies (Share Capital and Debentures) Rules 2014;

6. What is Letter of Offer (L of O) and Compliance related thereto?

Letter of Offer is a document which is issued to shareholders disclosing all information about buy-back process, schedule and mandatory information which will help the shareholder to take a decision on exercising his buy-back option. The Company is required to electronically file this document with the RoC in format SH-8, before offer opens for shareholders. The Letter of Offer shall be dispatched to all shareholders immediately after the same is filed with the RoC but not later than 21 days of filing.

7. What are the other obligations on the Part of Company once Letter of Offer is filed with RoC?

Once the Letter of Offer is filed with the Registrar, it is information in the public domain and the Company has to adhere to disclosures made therein to complete the process of buy-back. Broad obligations of the Company are as follows;

(i) Keep open offer for buy-back for minimum period 15 days but not more than 30 days from the date of dispatch of Letter of Offer to shareholders;

(ii) Verification of details of shareholders on the basis of KYC data to be completed by the Company within fifteen days. If Company wishes to communicate the rejection of shares offered, the same should be communicated with 21 days of closure of offer. This also means that in case of pro-rata buy-back the Company is required to communicate to the shareholder accordingly.

(iii) Separate Bank account to be opened for depositing total consideration payable to all shareholders whose offer has been accepted.

8. What is the post buy-back closure compliance?

(i) The Company shall destroy securities certificate/ share certificates for the securities bought back or where the securities are in a dematerialised form, it should place a request through Depository for cancellation for the same. The company should keep record of securities destroyed in Register in form SH-10

(ii) File Return of Buy-back in Form SH-11 along with Certificate signed by 2 Directors confirming compliance with the provisions of Act and Rules pertaining to buy back in Form SH-15

Independent Directors – some issues

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Background

Major amendments in law in recent years have made the status of Independent Directors important, responsible and difficult. Consequently, so has the life of listed companies who are required to appoint such directors. On the other hand, the remuneration of Independent Directors has actually been reduced/limited while simultaneously accompanied with a manifold increase in their role and liabilities.

This issue has been compounded by the fact that, recently, Clause 49, that is part of the Listing Agreement and hence with far limited liability for people who contravene it, has been replaced by the SEBI Listing Regulations effective from December 2015. The result is that several types of punitive actions including penalty, debarment, etc. can be imposed on the Independent Director, the listed company, etc. The liabilities of Independent Director under the new Companies Act, 2013, are also now substantial. If and when provisions under that Act relating to class actions are brought into force, their liability will be even more.

Moreover, and which is the subject matter of this article, the legal provisions relating to them have become more complex. As many of the amendments are relatively recent, difficulties in their implementation come gradually into light. This article discusses some of such issues that are worthy of consideration.

Low remuneration to Independent Directors, which is actually decreased now

Remuneration of Independent Directors can be a sensitive issue and there are some fundamental and conceptual concerns. It is often the company and effectively the promoters who decide their remuneration, though there are certain safeguards. If he is paid too much, then his very independence is at stake. If he is paid too less, then too in a sense he loses his independence since he may lose some motivation. However, instead of creating a constructive mechanism to resolve this issue, the lawmakers have, through the Companies Act, 2013, actually limited his remuneration. He can be paid mainly in two modes. One is in the form of sitting fees (maximum Rs. 1 lakh per meeting) and the other is in the form of commission based on profits. The demands of competence, qualifications and stature makes even the maximum Rs. 1 lakh per meeting limit ridiculously low. One can of course pay remuneration based on profits made, but this makes it difficult for loss making companies. Such losses may be because of business difficulties or because the companies may be in their early/recovery stages. Such companies and their shareholders whose interests Independent Directors also protect are deprived of competent Independent Directors.

Curiously, Independent Directors cannot even be given stock options. This could have been an appropriate way, particularly for loss making companies or those in their early stages. While significant holding by Independent Directors in the company may compromise their independence, as a mode of remuneration, it could have been a good way, with due restrictions.

Significant liability of Independent Directors with a limited and ambiguous exempt clause

The liability of directors and others have increased substantially. This is not only about the increased penalty generally for violation of provisions. There are now substantial and direct provisions that can result in huge penal and other consequences on directors. There are for example, multiple provisions relating to fraud (u/s. 447 of the Companies Act, 2013) and several others that can result in prosecution of, inter alia, directors under a wide variety of circumstances. Perhaps for the first time, a corporate law prescribes minimum and mandatory imprisonment. As discussed earlier, there are provisions for class action which, when brought into effect, can result in direct action by shareholders/depositors against directors. To also reiterate, now that Clause 49 has been replaced by the Listing Regulations, it creates another set of liabilities for directors. There are elaborate Codes under the Companies Act, 2013, and the Listing Regulations (in the regulations corresponding to the earlier Clause 49) that describe what is the role of directors/Independent Directors. In comparison, the rights of Independent Directors are minimal and often vague too, particularly on the individual level. Independent Directors have also been given primary role in important committees like Audit Committee, Nomination/Remuneration Committee, etc.

In principle, thus, they potentially face huge action even though they have limited involvement, limited rights and very limited remuneration.

There is of course a broad exemption provided which is worded similarly in Companies Act, 2013, as well as the Listing Regulations. One of such provision is contained in section 149(12) of the Act. There are similar provisions elsewhere in the Act and the Listing Regulations. The broad intention is that Independent Directors should have liability limited to what they access, discuss, decide, etc. at Board Meetings . They should also be made liable if they do not act diligently. That may sound a good exit clause and perhaps it is to an extent. Having said that, this still exposes them to very significant liability. For example, their liability is not only on resolutions/decisions taken at Board Meetings. Even if they are informed about things, and if they fail to take action, they may be exposed to action.

Cross directorship and independence

The definition of Independent Director throws up many challenges. Ideally and even by the legal definition, the Independent Director is a person who has no or minimal connection with the Promoters, the company, etc. He should have mental and financial independence. However, in practice, there will be several categories of persons whose independence generally may come under question at least in spirit. Take the example of cross directorship. A member of promoter group A may become an Independent Director of a listed company controlled by promoter group B, and vice versa. At times, instead of such one-to-one cross directorship, there may be such cross/circular directorship in a group of companies. It would not be entirely wrong to say that there could be a ‘you-scratch-my-back and I-scratch-yours’ situation.

Annual Meeting of independent directors

Regulation 25(3) and (4) of the SEBI Listing Regulations now require that the Independent Directors should meet once a year and discuss certain specific matters such as performance of non-independent directors, Chairperson, quality/quantity/timelines of flow of information to the Board, etc. Here again, this is a well meaning provision and enables Independent Directors to discuss issues without the, sometimes, intimidating presence of the Promoters, senior management, etc. However, no rights to make any decision have been given to such group. Indeed, it is not even wholly clear whether they can be even paid sitting fees for such a meeting!

Nominee directors – whether independent?

Nominee directors are commonly appointed by lenders/ investors pursuant to loan/investment agreements. Earlier, there were two views on whether a nominee director was independent or not, and also whether they ought to be treated as independent. Now, under the Act as well as the Listing Regulations, such nominee directors are specifically treated as not independent.

In terms of section 149(6), a person who is a nominee director cannot be treated as an Independent Director. A nominee director is defined in the Explanation to 149(7) as follows:-

For the purposes of this section, “nominee director” means a director nominated by any financial institution in pursuance of the provisions of any law for the time being in force, or of any agreement, or appointed by any Government, or any other person to represent its interests.

A question that arises is that under Regulation 24(1) of the Listing Regulations, an independent director of the parent listed company is required to be appointed on the Board of the material subsidiary in India. Will such director be treated as independent director as far as the subsidiary company is concerned? The concern here is whether the independent director can be treated as nominee director of the holding company and thus, in spirit if not the letter of the requirements relating to nominee directors, such person ought not be treated as independent director. However, it appears that, this ought not be so. This is assuming such person otherwise complies with the requirements relating to independent director. Thus, the mere fact that they are also independent director of the holding listed company ought not result in loss of their independence vis-à-vis the subsidiary company.

Whether small shareholders’ director IS an Independent Director?

The requirement relating to small shareholders’ directors as contained in section 151 is drafted in such a way that it is very unlikely that such a director may be appointed.

As in the case of nominee directors, the question remains whether he would be an Independent Director since he is appointed by and thus can be said to represent the small shareholders. However, Rule 7(4) of the Companies (Appointment and Qualification of Directors) Rules 2014 makes it clear that, provided he otherwise does not attract any of the specified disqualifications, he will be treated as an Independent Director.

Woman director and independence

The Act as well as the SEBI Listing Regulations prescribe the requirement of having at least one woman director on the Board for the specified companies. It has been reported that a fairly significant number of companies have not yet appointed Independent Directors.

It is to be noted, however, that the requirement relating to Woman Director does not make it a condition that she shall also be independent. This has of course resulted in many companies having appointed a member of the promoter family as a Woman Director and thus perhaps the intention of such provision may not have been served.

Companies in which there are no Promoters

There are companies in which there are no specified Promoters. It is also possible for a company now to declare itself as not having any specific group of persons as Promoters. Directly or indirectly, many of the significant conditions/disqualifications relating to Independent Directors are dependent on the relations that the director may have with the Promoters. In such a case, unless the directors concerned attract conditions such as having financial relations with the listed company, etc. they would be treated as independent. Indeed, it is very likely that except the executive directors, the remaining directors may thus be independent.

Exited Promoters

Often there are more than one promoter groups in a company. One or more of such groups may desire to be no more associated with the company by selling off all or most of their shareholding and otherwise not being associated with the management and control of the company. It may also happen that even if there may be one Promoter Group, some persons may desire to be excluded from the Promoter Group. Now, the Listing Regulations have a formal procedure for such exclusion. Clearly, such excluded Promoters and persons having any of the specified relations with such excluded Promoters would not be treated as Independent Directors.

Conclusion

The coming years will reveal how well companies and Independent Directors are generally in compliance of the complex requirements and heavy responsibilities. In case of contraventions – technical and substantial, frauds, etc. it will be seen what type of action is taken against Independent Directors. An action that is proportionate to the context of their powers and responsibilities will encourage them to continue but the result may be opposite if strict interpretation and harsh action is taken.

Domestic Violence and Endangered stridhan—sC to the Rescue!

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Introduction

Stridhan is one of the unique features of Hindu Law. It signifies the exclusive property of a Hindu married lady and the Courts, generally, would strive to protect the same at all costs, including from her husband and in-laws. However, what happens when the lady’s marriage has undergone a judicial separation? Further, what happens if she has approached the Courts after the decree of judicial separation? Can she compel her husband and in-laws to return her stridhan in such a scenario? Recently, all these interesting questions were posed before the Supreme Court in the case of Krishna Bhatacharjee vs. Sarathi Choudhury, Cr. Appeal No. 1545 /2015 (hereinafter referred to as “Krishna’s case”). Let us analyse some of these interesting facets through this Article.

Factual Matrix of the Case
In Krishna’s case, on dowry demands not being satisfied, a married lady was driven out of her husband’s home. Ultimately, the couple were granted judicial separation by the Family Court. Thereafter, since the husband stopped paying monthly maintenance, the lady sought help from a Protection Officer, constituted under the Protection of Women from Domestic Violence Act, 2005, and sought his help for recovery of her stridhan which was yet in her husband’s custody. She also filed a criminal appeal claiming a criminal breach of trust by her husband which was punishable u/s. 405/406 of the Indian Penal Code, 1860. All the lower Courts, including the High Court, denied relief to the lady since the claim for stridhan was made after the decree for judicial separation was passed. Further, they held that the criminal plea was time-barred by virtue of section 468 of the Criminal Procedure Code. It was in the light of these facts, that the aggrieved lady approached the Supreme Court and sought relief.

STRIDHAN
First and foremost it becomes important to understand the concept of stridhan. The term is coined from two different Sanskrit words “Stri” (meaning a lady) + “Dhan” (meaning property) = “Stridhan” (meaning a lady’s property). It thus, represents that property of a married lady over which she has exclusive domain. Only she can decide what she wants to do with such property. She can use it, gift it and will it away. The general meaning is the gift she received on marriage, from her parents, her husband, her in-laws, etc. In certain cases, property inherited by a female can also become stridhan. Thus, jewellery, personal belongings, etc., received by her on marriage would form part of her stridhan.
The position of stridhan has been explained by the Supreme Court in Pratibha Rani vs. Suraj Kumar, (1985) 2 SCC 370. The Court held that the position of stridhan of a Hindu married woman is that, she is the absolute owner of such property and can deal with it in any manner she liked. She may spend the whole of it or give it away at her own pleasure by gift or will without any reference to her husband. The entrustment to the husband of her stridhan property was like something which the wife kept in a bank and could withdraw any amount whenever she liked without any hitch or hindrance. The husband had no right or interest in it with the sole exception that in times of extreme distress he could use it. It further held that the husband had no jurisdiction over the stridhan and must return the same as and when demanded by the wife and he could not burden her with the losses of his business by using her stridhan. It was manifest that the husband, being only a custodian of the stridhan of his wife, could not be said to be in joint possession thereof and thus did not acquire a joint interest in the stridhan property.
Again in Smt. Rashmi Kumar vs. Mahesh Kumar Bhada, (1997) 2 SCC 397, the Supreme Court held that stridhan is the exclusive property of the wife on proof that she entrusted the custody over the stridhan to her husband or any other member of the family, there is no need to prove any further special agreement to establish that the property was given to the husband or other member of the family. It was always a question of fact in each case as to how property came to be entrusted to the husband or any other member of the family by the wife when she left the matrimonial home or was driven out therefrom. No absolute or fixed rule of universal application could be laid down in that behalf.
Domestic Violence Act
Next, it becomes essential to understand the important provisions of the Protection of Women from Domestic Violence Act, 2005 (“the 2005 Act”). It is an Act to provide for more effective protection of the rights, guaranteed under the Constitution of India, of those women who are victims of violence of any kind occurring within the family. It provides that if any act of domestic violence has been committed against a women, then she can approach designated Protection Officers to protect her. Hence, it becomes essential to consider as to what constitutes an act of Domestic Violence and who can claim shelter under this Act? Any aggrieved woman under the Act is one who is, or has been, in a domestic relationship with an adult male and who alleges to have been subjected to any act of domestic violence by him. A domestic relationship means a relationship between two persons who live or have, at any point of time, lived together in a shared household, when they are related by marriage, or through a relationship in the nature of marriage or are family members living together as a joint family. A live-in relationship is also considered as a domestic relationship. In D. Velusamy vs. D. Patchaiammal, (2010) 10 SCC 469, it was held that in the 2005 Act, Parliament has taken notice of a new social phenomenon which has emerged in India, known as livein relationships. According to the Court, a relationship in the nature of marriage was akin to a common law marriage and must satisfy the following conditions:-
(i) T he couple must hold themselves out to society as being akin to spouses.
(ii) T hey must be of a legal age to marry.
(iii) They must be otherwise qualified to enter into a legal marriage, including being unmarried.
(iv) T hey must have voluntarily cohabited and held themselves out to the world as being akin to spouses for a significant period of time.
(v) T he parties must have lived together in a `shared household’
The concept of domestic violence is very important and section 3 of the 2005 Act defines the same as an act committed against the lady, which :
(a) harms or injures or endangers the health, safety, or well being, whether mental or physical, of the lady and includes causing abuse of any nature, physical, verbal, economic abuse, etc.; or
(b) harasses or endangers the lady with a view to coerce her or any other person related to her to meet any unlawful demand for any dowry or other property or valuable security; or
(c) otherwise injures or causes harm, whether physical or mental, to the aggrieved person.
Thus, economic abuse is also considered to be an act of domestic violence under the 2005 Act. This term is defined in a wide manner and includes deprivation of all or any economic or financial resources to which she is entitled under any law or custom or which she requires out of necessity including, household necessities, stridhan property, etc.
Various Supreme Court decisions have analysed the provisions of the 2005 Act. For instance, in V. D. Bhanot vs. Savita Bhanot, (2012) 3 SCC 183, it was held that this Act applied even to cases of domestic violence which have taken place before the Act came into force. The same view has been expressed in Saraswathy vs. Babu, (2014) 3 SCC 712.
Judicial Separation a Roadblock?
The question posed before the Supreme Court in Krishna’s case, was whether the decree of judicial separation was a hindrance to a plea for recovery of stridhan under the 2005 Act? Thus, does a lady cease to have recourse to this Act merely because she has obtained a decree of judicial separation. If a divorce is obtained she would not be entitled to relief under the 2005 Act. However, the Court held that the position in the case of a judicial separation was different. Judicial separation lied between a subsisting marriage and a marriage severed by a divorce. It observed that a judicial separation created rights and obligations. It permitted the parties to live apart. There would be no obligation for either party to cohabit with the other. Mutual rights and obligations arising out of a marriage were suspended. However, judicial separation did not severe or dissolve the marriage. It afforded an opportunity for reconciliation and adjustment. Though judicial separation after a certain period may become a ground for divorce, it was not necessary and the parties were not bound to have recourse to that remedy and the parties could live keeping their status as wife and husband till their lifetime. It held after considering various earlier decisions in the cases of Jeet Singh vs. State of U.P., (1993) 1 SCC 325; Hirachand Srinivas Managaonkar vs. Sunanda, (2001) 4 SCC 125; Bai Mani vs. Jayantilal Dahyabhai, AIR 1979 209; Soundarammal vs. Sundara Mahalinga Nadar, AIR 1980 Mad 294, that there was a distinction between a decree for divorce and decree of judicial separation; in divorce, there was a severance of the status and the parties did not remain as husband and wife, whereas in judicial separation, the relationship between husband and wife continued and the legal relationship continued as it had not been snapped.
Accordingly, the Supreme Court in Krishna’s case held that the decree of judicial separation did not act as a deterrent for the lady from claiming relief under the 2005 Act since the relationship of marriage was yet subsisting.
Period of Limitation under Cr. PC applicable?
The Code of Criminal Procedure, 1973 provides for the method and manner in which criminal cases, prosecutions, etc. would be tried in the Courts. The Code also provides for the limitation period after which the Courts would not entertain any prosecutions in respect of offences. The object of enunciating a bar on prosecutions was explained by the Apex Court in its decision in the case of State of Punjab vs. Sarwan Singh AIR 1981 SC 722. The Supreme Court held that the object in putting a time limit on prosecution is clearly to prevent parties from filing of vexatious and belated prosecutions. Section 468 of the Code provides the periods of limitation after the expiry of which a Court shall not take cognizance of an offence. The term “cognizance” may be defined to mean the judicial recognition or the judicial notice of any cause of action. According to the Supreme Court in the case of Darshan Singh Ram Kishan vs. State of Maharashtra, (1971) 2 SCC 654, cognizance takes place at a point when a magistrate first takes judicial notice of an offence.
A question arose as to whether a belated complaint by the aggrieved lady under the 2005 Act for recovering her stridhan was hit by the period of limitation provided u/s. 468 of the Code? Connected with section 468 is the concept of continuing offence u/s. 472 of the Code. Section 472 provides that for a continuing offence, a fresh period of limitation begins to run at every moment of the time during which the offence continues. The term continuing offence has not been defined and thus, one must depend upon the language of the Act. In Maya Rani Punj vs. CIT, 157 ITR 330 (SC), the Supreme Court observed that if a duty continued from day to day, then its non-performance from day to day was a continuing wrong. Again, in State of Bihar vs. Deokaran Nenshi, (1972) 2 SCC 890, the Court held that a continuing offence is one which is susceptible of continuance and is distinguishable from the one which is committed once and for all. In the case of a continuing offence, there is thus the ingredient of continuance of the offence which is absent in the case of an offence which takes place when an act or omission is committed once and for all.
Based on this discussion, the Supreme Court in Krishna’s case, concluded that the retention of stridhan by the husband or any other family members was a continuing offence. The concept of “continuing offence” got attracted from the date of deprivation of stridhan, for neither the husband nor any other family members had any right over the stridhan and they only remained custodians. Further, as long as the status of the aggrieved lady remained and stridhan remained in the custody of the husband, the wife could always put forth her claim under the 2005 Act. There could be no dispute that wife could file a suit for realisation of the stridhan but that did not debar her from lodging a criminal complaint for criminal breach of trust. Accordingly, it held that the application was not barred by the period of limitation u/s.468 of the Criminal Procedure Code.
Conclusion

Finally, the Supreme Court, in Krishna’s case, held that retention of stridhan by a husband was a continuing offence against which no period of limitation applied for filing a criminal appeal for a criminal breach of trust. Further, a decree for judicial separation was not a bar against claiming relief under the 2005 Act. Thus, she could avail of a dual remedy. The Supreme Court held that a more sensitive approach was expected from the courts in such matters. If relief could not be granted under the 2005 Act then so be it. However, before disposing of any petition for want of maintainability, a thorough discussion was a must. Courts must bear in mind that, under the 2005 Act, it was a hapless and a helpless lady who approached them and that too under compelling circumstances. The 2005 Act being a beneficial Act and one which asserts the rights of women, it must be viewed sensitively to ensure that women are not wrongly deprived of their rights.
Through this very important judgment, the Apex Court has untangled the complex criss-cross web of domestic violence, economic abuse, stridhan, period of limitation under Criminal Procedure Code and judicial separation. The cross currents flowing under each of these concepts have been analysed and dissected to arrive at a considered view.

Strictures against Department – Delay of 22 months in passing order after hearing – No reason for inordinate delay

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S2 Infotech Pvt. Ltd. vs. UOI (2015) (323) E.L.T. 464 (Bom.)(HC)

There was a recovery or demand of Service Tax. A reply to the show cause notice was given by the petitioners on 21/6/2010. On 1/8/2012, a personal hearing was given and concluded on the same date. However, the impugned order was passed after a period of almost 22 months.

The petitioner relied upon a series of circulars issued by the Central Board of Excise and Customs emphasising that the Law laid down by the Hon’ble Supreme Court in Anil Rai vs. State of Bihar, 2009 (233) E.L.T. 13 (S.C.) : 2009 (13) S.T.R. 465 (S.C.) would apply and there should not be any unreasonable delay in passing adjudication order which will be causing difficulties and obstacles in realising Public revenue expeditiously. The Hon’ble Supreme Court has clarified that inordinate, unexplained and negligent delay in pronouncing judgments hampers the exercise of right of appeal. Therefore, the belief, faith and trust of the people in the institution and judiciary is shaken by such delay. This dictum also applies to the quasi judicial adjudication as is contemplated by laws such as Central Excise Act, 1944, Customs Act, 1962 and Finance Act, 1994 as amended from time to time. That is why these circulars were issued.

The court was of the opinion that prima facie there appears to be no explanation for the inordinate delay. The court further observed that even if there is any restructuring and reorganising of the Department of Service Tax and the Commissionerate thereof, there is no reason why such an inordinate delay should occur.

Eventually, all Commissioners must realise that delay in proceedings and passing of orders would be contrary to public interest. They are conferred with powers to determine and adjudicate the demands raised only in a hope that they take steps expeditiously and recover outstanding amount from the defaulters, if any. Hence, sitting on files for months together and sometimes beyond the financial year is, thus, not conducive to the interest of nation’s economy. The trust and faith reposed in them is also then betrayed. If no action is taken against such officers and they are allowed to go scot-free, then, apart from the Revenue getting involved in litigation in higher Courts, Tribunal and others would be encouraged.

Therefore, the Court directed the Chief Commissioner of Service Tax to file a comprehensive affidavit by narrating measures that he proposes to take or has already taken. He shall, then, disclose number of files and matters pending and serially. It should not happen that one who comes to Court, challenges the adverse order only on the ground of delay, the High Court, then, directs that the matter be taken and decided out of turn. The Court observed that the Commissioner has to enlighten us as to how much time would be taken at the end of his Commissionerate to dispose of pending cases.

Evidence – Secondary Evidence – Photocopy of true copy of document – Is inadmissible when existence of Original document is disputed : Evidence Act, 1872, Section 63(2) & (3) & 65

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Brij Mohan vs. State of Rajasthan AIR 2015 (NOC) 1168 (Raj.)

In a case where original documents are not produced at any time, nor any factual foundation has been laid for giving secondary evidence, the secondary evidence relating to contents of a document is inadmissible, until the non-production of the original is accounted for, so as to bring it within one or other of the cases provided for in the section. Secondary evidence must be authenticated by foundational evidence that the alleged copy is, in fact, a true copy of the original. Mere admission of a document in evidences does not amount to its proof. Therefore, the documentary evidence is required to be proved in accordance with law. The court has an obligation to decide the question of admissibility of a document in secondary evidence before making endorsement thereon. Clause 2 of section 63 provides that secondary evidence means the copies made of their original by mechanical process, which in themselves ensure the accuracy of the copy, and copies compared with such copies, which can be termed as secondary evidence. Clause 3 of section 63 of the Indian Evidence Act covers the kind of document which the petitioner sought to produce as secondary evidence.
Illustration (a) refers to photograph of original is secondary evidence of its contents, though the two have not been compared but if it is proved that the thing photographed was the original. Illustration (b) refers to copy compared with copy of a letter made from copying machine as secondary evidence of the contents of letter if it is shown that the copy made by copying machine was made from the original.
Illustration (c) covers a copy transcribed from a copy, but afterwards compared with the original as secondary evidence.

The Hon’ble Court observed that in the instant case, the original document is claimed to be relating to the year 1965, the era when the use of the photocopy machines and photocopier was not in vogue. Besides, it cannot be accepted as secondary evidence because the document, which sought to be produced, is not a photocopy of the original but is a photocopy of the true copy. This is not a true copy of the original, which may have been compared with its original by the attesting authority but is the document, which is claimed to be photocopy of the true copy of its original. Not only the existence of the original of this document is disputed but the attestation of the true copy also has not been ‘proved’. Therefore, the said photocopy of the true copy cannot be said to be admissible as secondary evidence.

Additional Evidence – Appellate court can suo motu receive additional evidence either oral or documentary – For pronouncing a satisfactory judgment: CPC 1908, 0.41 R. 27

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N. Natarajan vs. Executive Officer, Chitalpakkam Town Panchayat, Chennai AIR 2015 (NOC) 1305 (Mad.)(HC).

In the instant case, the fundamental question was whether document granting patta was a true document or a forged document.

The Trial Court had held the same to be a genuine document because the other registers were not produced before it. Only to resolve this issue and the additional issue as to whether the plaintiff had got title to 1000 sq. ft. of land, the truthfulness of the document had to be ascertained and without ascertaining this fact, the Court cannot pronounce a satisfactory judgment. Thus, for pronouncing a satisfactory judgment, the oral evidence of witness and the documentary evidence are absolutely necessary. In the absence of the same, the High Court cannot pronounce a satisfactory judgment. When forgery is alleged, the additional evidence was absolutely required in order to find out the truth.

There is no prohibition for the Court to go into the question of facts, provided the Court is satisfied that the findings of the Courts below were vitiated by non-consideration of relevant evidence or by showing erroneous approach to the matter and findings recorded by the Court below are perverse.

So far as the phrase “to enable it to pronounce judgment” as expressed in Sub-Rule 1(b) of C.P.C. is concerned, the true test is as to whether in the absence of the additional evidence sought to be adduced whether the Court would be in a position to pronounce the judgment from the other materials already available on record or not. If the Court finds that in the absence of the additional evidence sought to be produced (either oral or documentary), the Court could effectively and satisfactorily adjudicate upon the issues so as to pronounce a satisfactory judgment then, the Appellate Court shall not receive additional evidence either oral or documentary.

Additional evidence, whether oral or documentary, can be received by the appellate Court either at the instance of the parties as provided in Sub-Rules (1)(a) and (1)(aa) or suo motu by the Court as provided in Sub-Rule (1)(b) provided any one of the contingencies enumerated in Sub- Rule 1(b) exists impelling the Appellate Court to receive such additional evidence, both oral and documentary. To exercise the power to receive additional evidence under Sub-Rule (1)(b), it is not at all necessary that a party to the appeal should make an application. What is required is the satisfaction of the Appellate Court that the additional evidence is required either for pronouncing the judgment satisfactorily or for any other substantial cause.

Thus, it was held that the court is fully empowered to receive additional evidence at the Second Appeal stage.

Effect given for amalgamation of another large company and integration of accounting policies for accounting of derivative instruments

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48. Pursuant to the Scheme of Arrangement u/s. 391 to 394 of the Companies Act 1956 for amalgamation of erstwhile Ranbaxy Laboratories Ltd. (RLL) with the Company as sanctioned by the Hon’ble High Court of Gujarat and Hon’ble High Court of Punjab and Haryana on March 24, 2015 (effective date) all the assets, liabilities and reserves of RLL were transferred to and vested in the Company with effect from 1st April 2014, the appointed date. RLL along with its subsidiaries and associates was operating as an integrated international pharmaceutical organisation with business encompassing the entire value chain in the production, marketing and distribution of pharmaceutical products. The scheme has accordingly been given effect to in these financial statements.

The amalgamation has been accounted for under the “Pooling of Interest Method” as prescribed under Accounting Standard 14-“Accounting for Amalgamations” (AS 14) issued by the Institute of Chartered Accountants of India and as notified u/s. 133 of the Companies Act 2013 read with Rule 7 of the Companies Accounts Rules 2014. Accordingly and giving effect in compliance of the Scheme of Arrangement all the assets, liabilities and reserves of RLL, now considered a division of the Company, were recorded in the books of the Company at their carrying amounts and the form as at the appointed date in the books of RLL.

On April 10, 2015, in terms of the Scheme of Arrangement 0.80 equity share of Re. 1 each (Number of Shares 334,956,764 including 187,583 Shares held by ESOP trust) of the Company has been allotted to the shareholders of RLL for every 1 share of Rs. 5 each (Number of Shares 418,461,476 including 234,479 shares held by ESOP trust) held by them in the share capital of RLL, after cancellation of 6,967,542 shares of RLL. These shares have been considered for the purpose of calculation of earnings per share appropriately. An amount of Rs. 1,792.4 Million being the excess of the amount recorded as share capital to be issued by the Company over the amount of the share capital of erstwhile RLL has been credited to Capital Reserve.

49. RLL had earlier adopted Accounting Standard (AS) 30 “Financial Instruments: Recognition and Measurement” and AS 31 “Financial Instruments: Presentation” for accounting of derivative instruments which are outside the scope of Accounting Standard 11 ‘The Effects of Changes in Foreign Exchange Rates’ such as forward contracts to hedge highly probable forecast transactions, option contracts, currency swaps, interest rate swaps etc. In order to align with the Company’s policy, derivative instruments are now accounted for in accordance with the announcement issued by the Institute of Chartered Accountants of India dated March 28, 2008. On the principles of prudence as enunciated in Accounting Standard 1 “Disclosure of Accounting Policies” which requires to provide losses in respect of all outstanding derivative instruments at the balance sheet date by marking them to market. Accordingly, the unrealised MTM gain of Rs. 905.4 Million as at April 1, 2014 has been reversed and MTM gain as at March 31, 2015 amounting to Rs. 1,121.0 Million has not been recognised in these financial statements.

50. Out of a MAT credit of Rs. 8,222.7 Million which was written down by the erstwhile RLL during the quarter ended December 31, 2014, an amount of Rs. 7,517.0 Million has been recognised by the Company, on a reassessment by the Management at the year-end, based on convincing evidence that the combined amalgamated entity would pay normal income tax during the specified period and would therefore be able to utilise the MAT credit so recognised. Current tax for the year also includes Rs. 284.7 Million pertaining to earlier years.

Re-adoption of financial statements to give effect to scheme of arrangement

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51. Pursuant to the Scheme of Amalgamation u/s. 391 to 394 of the
Companies Act, 1956 and u/s. 52 of the Companies Act, 2013 for
amalgamation of erstwhile Sun Pharma Global Inc.(Transferor Company)
with the Company, with effect from January 1, 2015 (appointed date), as
sanctioned by the Hon’ble High Court of Gujarat, filed with the
Registrar of Companies on August 6, 2015 (effective date), all the
assets, liabilities, reserves and surplus of Transferor Company were
transferred to and vested in the Company without any consideration, on a
going concern basis. Transferor Company is a wholly owned subsidiary of
the company and was engaged in the business activities of strategic and
non-strategic investments and financing mainly to its group subsidiary
or associate companies worldwide. The amalgamation has been accounted
for under the “Pooling of Interest Method” as prescribed under
Accounting Standard 14 – “Accounting for Amalgamations” (AS 14) issued
by the Institute of Chartered Accountants of India and as notified u/s.
133 of the Companies Act, 2013 read with Rule 7 of the Companies
Accounts Rules 2014.

The scheme has been given effect to in these
financial statements and accordingly;

(i) The Financial Statements for
the year ended March 31, 2015 which were earlier approved by Board of
Directors on May 29, 2015 and audited by the statutory auditors of the
Company have been revised.

(ii) All the assets, liabilities, reserves
and surplus of Transferor Company were recorded in the books of the
Company at their carrying amounts and in the same form as at the
appointed date. Transferor Company being a wholly owned subsidiary of
the Company neither any shares are required to be issued nor any
consideration is paid. The Equity Share Capital, Preference Share
Capital, Share application money pending allotment and securities
premium account of the Transferor Company and the carrying value of
investment in Equity Shares, Preference Shares and Share application
money of the Transferor Company in the books of the Transferee Company
stands cancelled. Accordingly, the difference of Rs. 6,498.8 Million
between the amount of share capital of the Transferor Company and the
consideration being Nil, after adjusting for the carrying value of
Investments in the books of the Company is credited to Capital Reserve.

From Auditors’ Report Emphasis of Matter

We draw attention to Note 51 to
the standalone financial statements. As referred to in the said Note,
the financial statements of the Company for the year ended 31st March,
2015 were earlier approved by the Board of Directors at their meeting
held on 29th May, 2015 which were subject to revision by the Management
of the Company so as to give effect to the Scheme of Arrangement for
amalgamation of Sun Pharma Global Inc., a wholly owned subsidiary, into
the Company w.e.f 1st January, 2015. Those financial statements were
audited by us and our report dated 29th May, 2015, addressed to the
Members of the Company, expressed an unqualified opinion on those
financial statements and included an Emphasis of Matter paragraph
drawing attention to the foregoing matter. Consequent to the Company
obtaining the required approvals, the aforesaid financial statements are
revised by the Company to give effect to the said Scheme of
Arrangement.

Apart from the foregoing matter and the provision for
proposed dividend, the attached financial statements do not take into
account any events subsequent to the date on which the financial
statements referred to in paragraph 1 above were earlier approved by the
Board of Directors and reported upon by us as aforesaid.

Accounting by Real Estate Companies

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Accounting for real estate construction under Indian GAAP was covered
under the Guidance Note on Accounting for Real Estate Transactions
(Revised 2012). Under Ind AS real estate construction accounting is
specifically scoped into Ind AS 11 Construction Contracts. In this
article, Dolphy D’Souza discusses the similarities and dissimilarities
of accounting between the Guidance Note and Ind AS 11.

Scoping – Ind AS 18 or Ind AS 11?

Under
IFRS, IFRIC Interpretation 15 Agreements for the Construction of Real
Estate deals with accounting of real estate contracts. Determining
whether an agreement for the construction of real estate is within the
scope of IAS 11 (Ind AS 11) Construction Contracts or IAS 18 (Ind AS 18)
Revenue depends on the terms of the agreement and all the surrounding
facts and circumstances. Such a determination requires judgement with
respect to each agreement.

IAS 11 applies when the agreement
meets the definition of a construction contract set out in paragraph 3
of IAS 11: ‘a contract specifically negotiated for the construction of
an asset or a combination of assets …’ An agreement for the construction
of real estate meets the definition of a construction contract when the
buyer is able to specify the major structural elements of the design of
the real estate before construction begins and/or specify major
structural changes once construction is in progress (whether or not it
exercises that ability). Thus, a customer may ask a real estate
contractor to construct a villa (a) on a land owned by the customer and
(b) as per design and specification approved by the customer. The
customer controls the work-in-progress on an ongoing basis, and can
generally sack the contractor (albeit by payment of penalty) and hire a
new contractor. In situations such as this, the contractor will have to
apply IAS 11.

In contrast, an agreement for the construction of
real estate in which buyers have only limited ability to influence the
design of the real estate, e.g. to select a design from a range of
options specified by the entity, or to specify only minor variations to
the basic design, is an agreement for the sale of goods within the scope
of IAS 18. The entity may transfer to the buyer control and the
significant risks and rewards of ownership of the work in progress in
its current state as construction progresses. In this case, if all the
criteria in paragraph 14 of IAS 18 are met continuously as construction
progresses, the entity shall recognise revenue by reference to the stage
of completion using the percentage of completion method. The
requirements of IAS 11 are generally applicable to the recognition of
revenue and the associated expenses for such a transaction. The entity
may transfer to the buyer control and the significant risks and rewards
of ownership of the real estate in its entirety at a single time (e.g.
at completion, upon or after delivery). In this case, the entity shall
recognise revenue only when all the criteria in paragraph 14 of IAS 18
are satisfied. Thus, consider a scenario where a real estate developer
own a piece of land in which it constructs a building with about 100
flats. In this scenario, the risk and rewards are transferred to the 100
customers, when the building construction is complete and the flats are
ultimately delivered to the customers. It is inconceivable that the
risk and rewards are transferred to the 100 customers on an ongoing
basis. If that was the case, each customer would own the work in
progress and have the ability to hire another contractor to construct
his/her individual flat. That is neither legally nor practically
possible, for example, it is not possible that 100 different contractors
representing 100 different customers could possibly complete the
construction of the building.

In the Indian situation,
considering the demand of the real estate developers the standard
setters decided to carve out IFRIC 15. Further, a real estate contract
was specifically scoped in Ind AS 11. In accordance with Ind AS 11
Construction Contracts, the standard would apply to accounting in the
financial statements of contractors including the financial statements
of real estate developers. The definition of construction contracts in
Ind AS 11 also includes agreement of real estate development to provide
services together with construction material in order to perform
contractual obligation to deliver the real estate to the buyer.

Thus,
real estate construction contracts would be accounted for in accordance
with Ind AS 11, like any other construction contract. Therefore, in the
above example, the sale of 100 flats would be treated like a
construction contract to be accounted for using the percentage of
completion method (POCM) rather than accounting for them as sale of
goods, wherein, revenue is recognised when the completed flat is
ultimately delivered to the customer.

The carve in to Ind AS 11
is somewhat nebulously drafted. As per this carve in, Ind AS 11 would
apply to accounting in the financial statements of contractors including
the financial statements of real estate developers. Does that mean Ind
AS 11 would apply to contractors other than real estate contractors
also? For example, it is not absolutely clear, whether Ind AS 11 or Ind
AS 18 would apply to construction of a standard equipment such as a ship
or aircraft or windmill. The author believes that Ind AS 18 should
apply to these items, since the buyer is unable to specify the major
structural elements of the design of the equipment before construction
begins and/ or specify major structural changes once construction is in
progress whether or not it exercises that ability. In other words, the
author believes that the above items should be treated like a sale of
goods. This can also be supported by the intention of the ICAI to allow
construction contract accounting to real estate development only.

Ind AS 11 vs Guidance Note on Accounting for Real Estate Transactions (Revised 2012)

On
account of the diverse practices under Indian GAAP, the ICAI felt it
necessary to issue a revised Guidance Note titled Guidance Note on
Accounting for Real Estate Transactions (Revised 2012) to harmonise the
accounting practices followed by real estate companies in India. Under
Ind AS 11, accounting for real estate development would be accounted for
as a construction contract in accordance with Ind AS 11. An interesting
point to note is that the requirements of Ind AS 11, may or may not be
the same as those contained in the Guidance Note. This section deals
with some critical areas of similarities and differences that exist
between Ind AS 11 and the Guidance Note. Under both Ind AS 11 and the
Guidance Note, completed contract method would be prohibited. However,
there are significant dissimilarities in the way POC method is applied.

Question 1: Is the scope of the Guidance Note and Ind AS 11 the same?

The
revised Guidance Note would apply to any enterprise dealing in real
estate as sellers or developers. The term ‘real estate’ refers to land
as well as buildings and rights in relation thereto. The Guidance Note
provides an illustrative list of transactions which are in scope. The
Guidance Note applies not only to development and sale of residential
and commercial units, row houses, independent houses, with or without an
undivided share in land, but to many other real estate transactions.
These are sale of plots of land with or without any development. The
development may be in the form of common facilities like laying of
roads, drainage lines, water pipelines, electrical lines, sewage tanks,
water storage tanks, club house, landscaping etc. The sale of plots of
land, include long term sale type leases. What is a long term sale type
lease is not defined. Typically a 99 year lease would generally fulfill
the definition of a sale type lease. However, whether a 50 year lease
would be a sale type lease is a matter of conjecture and judgment will
have to be applied. However, the principles that would be used to apply
the judgment are not contained in the Guidance Note. In the author’s
view, conditions that establish whether a lease is a finance lease or
operating lease may serve as a good basis for making that decision. For
example, in the case of a 99 year lease, if the present value of the
minimum lease payments is atleast 90% or higher of the fair value of the
land, it could be construed, subject to other requirements that the
lease in substance is a sale type lease. Another example, which may be
construed as a sale type lease is a 50 year lease of land, where the
ownership is transferred to the lessee at the end of the lease period.
Whether a lease is a sale type lease or not, will have a significant
impact on the accounting. In the case of a lease, the revenue is
recognised over the lease period; whereas in a sale type lease the
revenue is accounted for when the sale type lease is executed.

The
revised Guidance Note also scopes in the acquisition, utilisation and
transfer of development rights, redevelopment of existing buildings and
structures and joint development agreements for real estate activities.

Other
than scoping in joint development agreements, the revised Guidance Note
does not provide any guidance on how to account for such agreements.
Real estate transactions of the nature covered by Accounting Standard
(AS) 10, Accounting for Fixed Assets, Accounting Standard (AS) 12,
Accounting for Government Grants, Accounting Standard (AS) 19, Leases,
and Accounting Standard (AS) 26, Intangible Assets, are outside the
scope of the Guidance Note. For example if a real estate contract was
being constructed for own administrative use, AS-10 principles rather
than this Guidance Note would apply. Similarly short-term leasing of
real estate would be covered by AS-19; however, a long term sale type
lease would be covered under the Guidance Note.

Ind AS 11 would
apply to accounting in the financial statements of contractors including
the financial statements of real estate developers. Under Ind AS 11,
there is no definition of what constitutes a real estate developer or
real estate development. Generally, the guidance in the Guidance Note
with respect to scoping may be used for Ind AS 11 purposes.

Question 2: How are transactions which are in substance delivery of goods accounted for under Ind AS and the Guidance Note?

Requirement under the Guidance Note

In
respect of transactions of real estate which are in substance similar
to delivery of goods, principles enunciated in Accounting Standard (AS)
9, Revenue Recognition, are applied. For example, sale of plots of land
without any development would be covered by the principles of AS-9.
These transactions are treated similar to delivery of goods where the
revenues, costs and profits are recognised when the revenue process is
completed. For recognition of revenue in case of real estate sales, it
is necessary that the conditions specified in paragraph 10 and 11 of
AS-9 are satisfied. Those conditions are enumerated below.

10.
Revenue from sales or service transactions should be recognised when the
requirements as to performance set out in paragraphs 11 ……. are
satisfied, provided that at the time of performance it is not
unreasonable to expect ultimate collection. If at the time of raising of
any claim it is unreasonable to expect ultimate collection, revenue
recognition should be postponed.

11. In a transaction involving
the sale of goods, performance should be regarded as being achieved when
the following conditions have been fulfilled:

i. the seller of
goods has transferred to the buyer the property in the goods for a price
or all significant risks and rewards of ownership have been transferred
to the buyer and the seller retains no effective control of the goods
transferred to a degree usually associated with ownership; and

ii.
no significant uncertainty exists regarding the amount of the
consideration that will be derived from the sale of the goods.

In
accordance with the above, the point of time at which all significant
risks and rewards of ownership can be considered as transferred, is
required to be determined on the basis of the terms and conditions of
the agreement for sale. The completion of the revenue recognition
process is usually identified when the following conditions are
satisfied:

(a) The seller has transferred to the buyer all
significant risks and rewards of ownership and the seller retains no
effective control of the real estate to a degree usually associated with
ownership;

(b) The seller has effectively handed over possession of the real estate unit to the buyer forming part of the transaction;

(c) No significant uncertainty exists regarding the amount of consideration that will be derived from the real estate sales; and

(d) It is not unreasonable to expect ultimate collection of revenue from buyers.

Revenue
from sale of lands or plots without any development is recognised when
the above conditions are satisfied. In the case of sale of developed
plots, where the development activity is significant, these would be
treated as transactions which are in substance construction type
contracts and accounted for accordingly. The Guidance Note does not
elaborate further as to when development activity would be treated as
significant or insignificant. This may have a material impact on revenue
recognition in some cases. Consider an example, where at the end of
reporting period a company sells plots of land, which will entail start
and completion of development activity subsequent to the reporting
period. If the development activity is considered significant, entire
revenue will be recognised in the subsequent reporting period, because
the 25% threshold criterion in the Guidance Note for revenue recognition
under POCM will be met only in the subsequent reporting period. If the
development activity is considered insignificant, revenue on the plot
will be recognised in the current reporting period, and revenue on the
development (to be allocated on market value basis) will be recognised
in the following reporting period. Requirement under Ind AS 18/Ind AS 11
Revenue from sale of lands or plots without any development is
recognised like a sale of goods under Ind AS 18. This is similar to the
requirement in the Guidance Note. In the case of sale of developed
plots, where the development activity is significant, these may be
treated in accordance with the Guidance Note which is to treat them as
construction type contracts. However it is questionable whether the 25%
revenue recognition threshold criterion in the Guidance Note would apply
under Ind AS. The author believes that the 25% threshold in the
Guidance Note is not relevant under Ind AS and entities will have to
apply judgement to assess whether the general revenue recognition
criteria are fulfilled.

Question 3: What are in substance
construction type contracts and how are they accounted for under the
Guidance Note and Ind AS?

Requirement in the Guidance Note

In
the case of real estate transaction which has the same economic
substance as construction contracts, the Guidance Note draws upon the
principles enunciated in Accounting Standard (AS) 7, Construction
Contracts and Accounting Standard (AS) 9, Revenue Recognition. Some
indicators of construction type contracts are:

(a) The duration
of such projects is beyond 12 months and the project commencement date
and project completion date fall into different accounting periods.

(b)
Most features of the project are common to construction contracts,
viz., land development, structural engineering, architectural design,
construction, etc.

(c) While individual units of the project are
contracted to be delivered to different buyers these are interdependent
upon or interrelated to completion of a number of common activities
and/or provision of common amenities.

(d) The construction or development activities form a significant proportion of the project activity.

For
example, construction and sale of units in a residential complex would
be covered by the principles of AS-7 and AS-9. The
construction/development of commercial and residential units has all
features of a construction contract – land development, structural
engineering, architectural design and construction are all present. The
natures of these activities are such that often the date when the
activity is commenced and the date when the activity is completed
usually fall into different accounting periods.

In case of real
estate sales, which are in substance construction type contracts, a two
step approach is followed for accounting purposes. Firstly, it is
assessed whether significant risks and rewards are transferred to the
buyer. The seller usually enters into an agreement for sale with the
buyer at initial stages of construction. This agreement for sale is also
considered to have the effect of transferring all significant risks and
rewards of ownership to the buyer provided the agreement is legally
enforceable and subject to the satisfaction of conditions which signify
transferring of significant risks and rewards even though the legal
title is not transferred or the possession of the real estate is not
given to the buyer. After satisfaction of step one, the second step is
applied, which involves the application of the POCM method. Once the
seller has transferred all the significant risks and rewards to the
buyer, any acts on the real estate performed by the seller are, in
substance, performed on behalf of the buyer in the manner similar to a
contractor. Accordingly, revenue in such cases is recognized by applying
the POCM method on the basis of the broad methodology explained in AS
7, Construction Contracts and detailed in the Guidance Note.

Paragraph
3.3 of the 2012 Guidance Note states as follows: “The point of time at
which all significant risks and rewards of ownership can be considered
as transferred, is required to be determined on the basis of the terms
and conditions of the agreement for sale. In the case of real estate
sales, the seller usually enters into an agreement for sale with the
buyer at initial stages of construction. This agreement for sale is also
considered to have the effect of transferring all significant risks and
rewards of ownership to the buyer provided the agreement is legally
enforceable and subject to the satisfaction of conditions which signify
transferring of significant risks and rewards even though the legal
title is not transferred or the possession of the real estate is not
given to the buyer.”

The 2012 Guidance note contains an
anti-abuse clause to prevent companies from recognising revenue in
certain circumstances. Paragraph 3.4 of the Guidance Note states that
“The application of the methods described above requires a careful
analysis of the elements of the transaction, agreement, understanding
and conduct of the parties to the transaction to determine the economic
substance of the transaction. The economic substance of the transaction
is not influenced or affected by the structure and/or legal form of the
transaction or agreement.” Though this appears to be an anti-abuse
clause the full meaning of this paragraph is not clear and hence,
judgement would be required in many situations.

The anti-abuse
clause was more clearly spelt out in paragraph 9 of the 2006 Guidance
Note which required the nature and extent of continuing involvement of
the seller to be assessed to determine whether the seller retains
effective control. In some cases, real estate may be sold with a degree
of continuing involvement by the seller such that the risks and rewards
of ownership are not transferred; for example, this may happen in the
case of a sale and repurchase agreements which include put and call
options, and agreements whereby the seller guarantees occupancy of the
property for a specified period. The anti-abuse clause in the 2012
Guidance Note is more broadly drafted and some may argue that it
encompasses many other situations. For example, a real estate company
may be precluded from considering real estate sales made to related
parties that are not genuine for the purposes of determining whether it
has satisfied the various threshold limits prescribed in the Guidance
Note for recognising revenue.

Paragraph 4.3 of the 2012 Guidance
Note sets out a very interesting perspective on the linkage between the
transfer of a legal title and the transfer of risks and rewards of
ownership. Paragraph 4.3 states “Where transfer of legal title is a
condition precedent to the buyer taking on the significant risks and
rewards of ownership and accepting significant completion of the
seller’s obligation, revenue should not be recognised till such time
legal title is validly transferred to the buyer”. For example, a real
estate company may have entered into a sale contract with a customer, of
a flat in a building that would take two years to complete. The
customer prefers to register the contract and pay stamp duty after two
years at the time of receiving possession of the flat to postpone the
cash outflow and thereby save on interest. On the other hand, another
customer that is availing a bank loan may have to register the sale
deed, pay stamp duty and obtain legal title immediately on entering into
the contract. In the former case, just because the customer is
obtaining legal title only at the time of possession, should not
preclude revenue recognition in the books of the real estate company. In
many cases, legal title would be deemed to be transferred to the
customer on entering into an agreement for sale, and registration with
the local authority may be seen as a formality that could be completed
at a later date. What is important is the agreement for sale, has to be
legally enforceable. In addition to selling to end users, real estate
companies often sell units to investors. In such cases, real estate
companies should be able to recognise revenue as long as there is a
legally enforceable contract between the real estate company and the
investor and the real estate company has no obligation to buy back the
unit or provide any other form of guarantee.

Requirement under Ind AS 11

The
above guidance may be applied under Ind AS 11, as it may not be
inconsistent with the intention of the ICAI. The Guidance Note applies
to projects where the duration of such projects is beyond 12 months and
the project commencement date and project completion date fall into
different accounting periods. There is no such restriction under Ind AS
11, and even projects below 12 months duration may qualify for
“construction type contracts”.

Question 4: For applying POCM how is “project” defined under Ind AS 11 and the Guidance Note?

Requirement under the Guidance Note

Project
is the smallest group of units/plots/saleable spaces which are linked
with a common set of amenities in such a manner that unless the common
amenities are made available and functional, these units/plots /
saleable spaces cannot be put to their intended effective use. The
definition of a project is very critical under the Guidance Note,
because that determines when the threshold for recognising revenue is
achieved and also the manner in which the POCM is applied. In other
words, the manner in which the project is defined by a company may have a
significant impact on the revenue, cost and profit that is recognised.
If the entire township is considered as a project then it is likely that
the threshold limit for recognising revenue is achieved much later as
compared to when each building in the township is identified as a
project.

Consider an example where two buildings are being
constructed adjacent to each other. Both these buildings would have a
common underground water tank that will supply water to the two
buildings. As either of the building cannot be put to effective use
without the water tank, the project would be the two buildings together
(including the water tank). Consider another example, where each of
those two buildings have their own underground water tank and other
facilities and are not dependant on any common facilities. In this
example, the two buildings would be treated as two different projects.
Consider a third variation to the example, where each of those two
buildings has their own facilities, and the only common facility is a
swimming pool. In this example, judgment would be required, as to how
critical the swimming pool is, to make the buildings ready for their
intended use. If it is concluded that the swimming pool is not critical
to the occupancy of either of those two buildings, then each of those
two buildings would be separate projects. Where it is concluded that the
swimming pool is critical to put the two buildings to its intended
effective use, the two buildings together would constitute a project.

The
definition of the term ‘project’ in the Guidance Note is somewhat
nebulous. Firstly, it is defined as a smallest group of dependant units.
This is followed by the following sentence in the Guidance Note “A
larger venture can be split into smaller projects if the basic
conditions as set out above are fulfilled. For example, a project may
comprise a cluster of towers or each tower can also be designated as a
project. Similarly a complete township can be a project or it can be
broken down into smaller projects.” Once the term ‘project’ is defined
as the smallest group of dependant units, it is not clear why the word
‘can’ is used instead of ‘should’. Does it mean that there is a
limitation on how small a project can be, but no limitation on how big a
project could be? In the example, where two buildings are being
constructed adjacently, and each have their own independent facilities
and are not dependant on common facilities, there is a choice to cut
this as either a project comprising two buildings or two projects
comprising one building each. If this is indeed the case, the manner in
which this choice is exercised is not a matter of an accounting policy
choice but rather a choice that is exercised on a project by project
basis.

Requirement under Ind AS 11

The requirement under
Ind AS 11 with respect to combining or separating contracts for
accounting purposes is irrelevant in the context of accounting for real
estate. For example, under Ind AS 11, two contracts need to be combined
together for accounting purposes if they are negotiated as a single
package; the contracts are so closely interrelated that they are, in
effect, part of a single project with an overall profit margin; and the
contracts are performed concurrently or in a continuous sequence. This
guidance is inapplicable to real estate development as they involve
multiple customers. Therefore the definition of the term “project” under
the Guidance Note may well be applied under Ind AS 11.

Question 5: For applying POCM how is “project cost” defined under Ind AS 11 and the Guidance Note?

Requirement
under the Guidance Note Project cost includes cost of land,
construction costs and borrowing costs. Cost of land may include cost of
land itself or development rights and other related costs such as stamp
duty, registration and brokerage. It also includes rehabilitation
costs. For example, when land is acquired, companies have an obligation
towards rehabilitating the displaced people by providing alternative
property and/or incurring various other social obligations.

Construction
and development costs include costs that are related directly to a
specific project such as cost of designing, labour, material, equipment
hiring or depreciation costs, but would exclude depreciation of idle
plant and equipment. It would include site supervision and site
administration costs and cost of obtaining municipal sanction or
building permissions, but would exclude head office general
administration costs. Construction costs would include expected warranty
costs/provisions, that may be incurred during or post the completion of
the construction. It may be noted that real estate companies were
accounting for warranties in numerous ways. By treating warranties as
any other input cost, this Guidance Note will bring consistency in the
treatment of warranty costs. Costs that may be attributable to a project
activity in general and can be allocated are also included as
construction and development costs; for example, insurance, cost of the
technical, architecture or supervision department, construction or
development overheads, etc. Such costs are allocated using methods that
are systematic and rational and are applied consistently to all costs
having similar characteristics. Construction overheads include costs
such as the preparation and processing of construction personnel
payroll. The allocation is based on the normal level of project
activity, similar to overhead absorption in the case of inventories.
Therefore in periods of low activity, not all of the general
construction overheads would be absorbed on the fewer projects that may
be in progress.

Borrowing costs are capitalized in accordance
with AS-16 Borrowing Costs. The borrowing costs incurred towards
purchase of land forming part of construction of a commercial or
residential project are eligible for capitalisation since it does not
represent an asset in itself, but forms part of the project, which
requires substantial period of time to get ready for its intended use or
sale. However, borrowing costs incurred while land acquired for
building purposes is held without any associated development activity do
not qualify for capitalisation [Para 16 of AS 16]. Interest
capitalisation will be based on utilisation of funds, i.e., on the basis
of actual cash flow, and not on the accrual of liability. Thus,
warranty expenses that are included as project cost would be excluded
for the purposes of borrowing cost capitalisation, unless it involved an
actual cash flow. Sometimes real estate companies have to place
security deposits for the purposes of securing land or development
rights. EAC has opined that borrowing cost on the cash outflow on
security deposit cannot be capitalised, as the security deposit is not
part of the project cost.

Certain costs should not be considered
as part of the project cost, such as selling costs, costs of unconsumed
or uninstalled material delivered at site; and payment made to
sub-contractors in advance of work performed. Payment made to
sub-contractors for work performed will be considered as part of the
project cost. Further, accrual made for work done by sub-contractor will
also be considered as part of the project cost, but will be excluded
for the purposes of borrowing cost capitalisation, unless it results in
actual cash flows.

Requirement under Ind AS 11

The
above requirements of the Guidance Note would generally apply to Ind AS
11 as well. However, there is a significant difference. Under the
Guidance Note, the EAC had opined that borrowing cost on security
deposit paid for securing land cannot be capitalised. Under Ind AS,
security amount paid for land by the contractor is an advance
consideration for land. If the security amount was paid out of borrowed
funds, then borrowing cost should be capitalised provided the
construction on that land is taking place.

Question 6: How is Percentage of completion method (POCM) applied under Ind AS 11 and the Guidance Note?

Requirement under the Guidance Note

POCM
method is applied when the outcome of a real estate project can be
estimated reliably and when all the following conditions are satisfied:

(a) total project revenues can be estimated reliably;

(b) it is probable that the economic benefits associated with the project will flow to the enterprise;

(c)
the project costs to complete the project and the stage of project
completion at the reporting date can be measured reliably; and

(d)
the project costs attributable to the project can be clearly identified
and measured reliably so that actual project costs incurred can be
compared with prior estimates. Further to the above conditions, there is
a rebuttable presumption that the outcome of a real estate project can
be estimated reliably and that revenue should be recognized under the
POCM method only when the following events are completed:

  • All
    critical approvals necessary for commencement of the project have been
    obtained; for example, environmental and other clearances, approval of
    plans, designs, etc., title to land or other rights to development/
    construction and change in land use
  • When the stage
    of completion of the project reaches a reasonable level of development.
    A reasonable level of development is not achieved if the expenditure
    incurred on construction and development costs is less than 25 % of the
    construction and development costs. Such costs would exclude land cost
    but include borrowing costs.
  • Atleast 25% of the saleable project area is secured by contracts or agreements with buyers.
  • Atleast
    10 % of the total revenue as per the agreements of sale or any other
    legally enforceable documents are realised at the reporting date in
    respect of each of the contracts and it is reasonable to expect that the
    parties to such contracts will comply with the payment terms as defined
    in the contracts.

When POCM is applied, project revenue
and project costs associated with the real estate project should be
recognised as revenue and expenses by reference to the stage of
completion of the project activity at the reporting date. For
computation of revenue the stage of completion is arrived at with
reference to the entire project costs incurred including land costs,
borrowing costs and construction and development costs. Interestingly,
land cost is not included to determine whether the threshold for
recognizing revenue is reached. But once the threshold is reached land
cost is included for the purposes of determining the stage of completion
and is included in revenue and costs accordingly. As mentioned earlier,
costs incurred that relate to future activity on the project and
payments made to sub-contractors in advance of work performed under the
sub-contract are excluded and matched with revenues when the activity or
work is performed. The recognition of project revenue by reference to
the stage of completion of the project activity should not at any point
exceed the estimated total revenues from ‘eligible contracts’/other
legally enforceable agreements for sale. ‘Eligible contracts’ means
contracts/ agreements where at least 10% of the contracted amounts have
been realised and there are no outstanding defaults of the payment terms
in such contracts. To illustrate – if there are 10 Agreements of sale
and 10 % of gross amount is realised in case of 8 agreements, revenue
can be recognised with respect to these 8 agreements.

The
Guidance Note does not prohibit other methods of determination of stage
of completion, e.g., surveys of work done, technical estimation, etc.
However, computation of revenue with reference to other methods of
determination of stage of completion should not, in any case, exceed the
revenue computed with reference to the ‘project costs incurred’ method.
When it is probable that total project costs will exceed total eligible
project revenues, the expected loss should be recognised as an expense
immediately. The amount of such a loss is determined irrespective of
commencement of project work; or the stage of completion of project
activity.

The percentage of completion method is applied on a
cumulative basis in each reporting period to the current estimates of
project revenues and project costs. Therefore, the effect of a change in
the estimate of project costs, or the effect of a change in the
estimate of the outcome of a project, is accounted for as a change in
accounting estimate. The changed estimates are used in determination of
the amount of revenue and expenses recognised in the statement of profit
and loss in the period in which the change is made and in subsequent
periods. The changes to estimates include changes arising out of
cancellation of contracts and cases where the property or part thereof
is subsequently earmarked for own use or for rental purposes. In such
cases any revenues attributable to such contracts previously recognized
should be reversed and the costs in relation thereto shall be carried
forward and accounted in accordance with AS 10, Accounting for Fixed
Assets. A contract that was an eligible contract (10% of the contract
value is realised and there are no outstanding defaults) may become an
ineligible contract on subsequent default in payment by the customer.
The Guidance Note does not prescribe any requirements with respect to
the same. However, it appears logical that the guidance contained above
of treating the same as a change in accounting estimate is applied.
Thus, revenue recognized previously is reversed, and the associated
costs are transferred to inventory.

Requirement under Ind AS 11

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. An expected loss on the construction contract should
be recognised as an expense immediately. In the case of a fixed price
contract, the outcome of a construction contract can be estimated
reliably when all the following conditions are satisfied:

  • total contract revenue can be measured reliably;
  • it is probable that the economic benefits associated with the contract will flow to the enterprise;
  • both
    the contract costs to complete the contract and the stage of contract
    completion at the balance sheet date can be measured reliably; and
  • the
    contract costs attributable to the contract can be clearly identified
    and measured reliably so that actual contract costs incurred can be
    compared with prior estimates. In making a judgment about reliability of
    measurement, the following requirements under the Guidance Note may
    appear consistent with the overall Ind AS framework:
  • All
    critical approvals necessary for commencement of the project have been
    obtained; for example, environmental and other clearances, approval of
    plans, designs, etc., title to land or other rights to development/
    construction and change in land use. However the following requirement
    in the Guidance Note appears inconsistent with the overall Ind AS
    framework:
  • When the stage of completion of the project
    reaches a reasonable level of development. A reasonable level of
    development is not achieved if the expenditure incurred on construction
    and development costs is less than 25 % of the construction and
    development costs. Such costs would exclude land cost but include
    borrowing costs.

This requirement appears inconsistent
with Ind AS because a threshold of 25% for a real estate company that
routinely constructs real estate appears very arbitrary. Real estate
entities therefore should make their own judgment based on the
particular facts and circumstances.

In accordance with the
Guidance Note, a real estate developer will start recognising revenue
from constructiontype contracts only after it satisfies the prescribed
criteria, e.g., the project has reached a reasonable level of
development and minimum 25% of the estimated revenues are secured by
contracts. Apparently, Ind AS 11 does not allow deferral of revenue in
this manner. Rather, it requires a company to start recognising revenue
from a construction contract immediately. In cases where the outcome of
the contract cannot be estimated reliably, the recognition of revenue is
restricted to the extent of costs incurred, which are probable of
recovery.

An interesting question that is often asked is the
treatment of land in a real estate construction contract. Some may argue
that under Ind AS 11 the cost of land does not represent “contract
activity” or “work performed” and therefore is not to be considered in
determining the stage of completion. In addition, when the percentage of
completion is based on physical inspection, no activity will be
measured if land has been acquired but the actual construction has not
yet commenced. In the Guidance Note, land is included as an input cost
and in the application of the POCM method for recognizing revenue, costs
and profits. However, land cost is not included to determine if the 25%
threshold is reached to start applying the POCM method.

Question 7: How are multiple elements accounted for under the Guidance Note and Ind AS 11?

Requirement
under the Guidance Note An enterprise may contract with a buyer to
deliver goods or services in addition to the construction/development of
real estate [e.g. property management services, sale of decorative
fittings (excluding fittings which are an integral part of the unit to
be delivered), rental in lieu of unoccupied premises, etc]. In such
cases, the contract consideration should be split into separately
identifiable components including one for the construction and delivery
of real estate units. For example, a real estate company in addition to
the consideration on the flat, charges for property maintenance services
for a period of two years, after occupancy. Such revenue is accounted
for separately and over the two year period of providing the maintenance
services. The consideration received or receivable for the contract
should be allocated to each component on the basis of the fair market
value of each component. Such a split-up may or may not be available in
the agreements, and even when available may or may not be at fair value.
When the fair market value of all the components is greater than the
total consideration on the contract, the Guidance Note does not specify
how the discount is allocated to the various components. Under the
proposed revenue recognition standard Ind AS 115, the allocation is done
on a proportion of the relative market value.

Requirement under Ind AS 11

The above guidance is generally not inconsistent with the requirements of Ind AS.

Illustration : Guidance Note vs Ind AS

Example under Guidance Note Relevant Details of a project are as below:

Total saleable area 20,000 Square Feet
Land cost Rs. 300.00 lakh
Estimated construction costs Rs. 300.00 lakh
Estimated project costs Rs. 600.00 lakh
Work Completed till the reporting date (includes land cost of Rs. 300 lakh and construction cost of Rs. 60
lakh) – Scenario 1		 Rs. 360.00 lakh
Work Completed till the reporting date (includes land cost of Rs. 300 lakh and construction cost of Rs. 90
lakh) – Scenario 2		 Rs. 390.00 lakh
Total Area sold till reporting date. 5,000 Square Feet
Total sale consideration as per agreements of sale executed Rs. 200.00 lakh
Amount realised till the end of reporting period Rs. 50.00 lakh
Percentage of work completed
Scenario 1 60% of the total project cost
(including land cost or 20% of construction
cost)
Scenario 1 65% of the total project cost
(including land cost or 30% of construction
cost)
Application of requirements

Scenario 1

At
the end of the reporting period the enterprise will not be able to
recognise any revenue as reasonable level of construction, which is 25%
of the total construction cost, has not been achieved, though 10% of the
agreement amount has been realised. Scenario 2 Apparently, the company
meets all the criteria for revenue recognition from the project. It
therefore recognised revenue arising from the contract using the POCM.
However, revenue recognised should not exceed estimated total revenue
from legally binding contracts. The revenue recognition and profits will
be as under:

Revenue Recognised
(65% of Rs. 200 lakh as per the agreement
of sale)		 Rs. 130.00 lakh
Proportionate cost of revenue
(5000 /20000 x 390)		 Rs. 97.50 lakh
Income from the Project Rs. 32.50 lakh
Work in progress to be carried forward
(Rs. 390 lakh – Rs. 97.50 lakh)		 Rs. 292.50 lakh
Example under Ind AS 11

Analysis of Scenario 1

  • It is questionable
    whether the 25% threshold under
    the Guidance Note for revenue recognition will apply under Ind AS. The
    real estate entity may conclude that the 20% threshold is reasonable and
    thereby start recognising revenue.
  • Even if the real estate
    entity believes that the threshold of revenue recognition has not been
    reached, revenue will have to be recognised. The recognition of revenue
    is restricted to the extent of costs incurred, which are probable of
    recovery. Analysis of Scenario 2
  • Some may argue that under
    Ind AS 11 the cost of land does not represent “contract activity” or
    “work performed” and therefore is not to be considered in determining
    the stage of completion. Therefore percentage completion is not 65% but
    is 30%.

Rs in lakhs
Revenue recognised 30% if Rs 200 lakh 60
Proportionate cost of revenue 30% of (5000/20000 x 600) 45
Profit to be recognised 15
Work in progress (390 – 45) 345

Overall Conclusion

The ICAI should address all the above issues and preferably
come out with a Revised Guidance Note to deal with
Real Estate Accounting under Ind AS.

[2015-TIOL-07-ARA-ST] M/s Emerald Leisures Limited

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Post 01/07/2012, the relationship between club and members should be
considered as provision of service by one person to another. Further
refundable security deposit and notional interest thereon cannot be
exigible to service tax.

Facts
The Applicant is a
resident public limited company engaged in establishing and running an
indoor sports complex and club and proposes membership from prospective
members. A refundable interest free security deposit was proposed to be
collected from the members in a range depending upon the category of
membership. Further the Applicant has shareholders and dividends are
distributed to them.

The issue raised before the Authority is in
relation to whether the relationship between the Applicant and members
of the club could be considered as service by one to another for the
purpose of section 65B(44) of the Finance Act, 1994, accordingly whether
the membership fee, annual fee received from the members be liable for
service tax or will be excluded on the principles of mutuality and
whether refundable security deposit would be exigible to service tax.
The Applicant relied upon various High Court decisions in relation to
clubs and associations holding that principle of mutuality is applicable
and no service tax is leviable. The Revenue submitted that by virtue of
Explanation 3 to the definition of service, an unincorporated
association and the member shall be treated as distinct persons. It was
also argued that the applicant has a profit motive considering their
objects and the fact that dividends are distributed to the members and
thus is purely a business activity and not in the nature of a
conventional members’ club. Therefore, the principles of mutuality have
no relevance.

Held
It was argued by the Applicant
that there is no ‘activity’ undertaken by the Applicant for the members
and there is complete absence of identity between the contributors and
the beneficiaries being one and the same. The Authority observed that
the Applicant carries out the club as business and has shareholders, who
may not be members of the club. Thus the prime objective being profit
motive, the principles of mutuality would not apply. However, in
relation to the second issue, the Authority observed that the security
deposit is towards various facilities and amenities in the club and not
for any services rendered. Moreover it is not in the nature of
consideration as the same would be refunded to members. Further notional
interest on refundable security deposit will also not be liable for
service tax as section 67(1) of the Finance Act, 1994 provides that
service tax is chargeable with reference to value which is the gross
amount charged for the services provided or to be provided. Thus since
the notional interest is not a charge by the Applicant there is no
service. Moreover, it was also stated that the Revenue has not been able
to establish that the notional interest has led to depression or
reduction in value of taxable service.

[2015-TIOL-2315-CESTAT-MUM] M/s Chiplun Nagari Sahakari Patsanstha Ltd. vs. Commissioner of Central Excise, Kolhapur

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Services provided by a co-operative society lub to its own members is not chargeable to service tax.

Facts
The Appellant is a Co-operative Society of members and is engaged in accepting deposits from their members and distributing the said amounts as loan to its own members and is not extending loans to outsiders. In order to process loan applications certain charges are levied from the members incurred for stationery and other expenses. The department contended that these charges are collected in the course of rendering services under the category of Banking and Other Financial services.

Held
The Tribunal, in order to determine the ratio of tax liability on the members of a society relied on the decision of the High Court of Gujarat in the case of Green Environment Services Co-op. Soc. Ltd. [2015 (37) STR 961 (Guj.)] wherein the Court declared “Club and Association” service ultravires to the extent the services are provided by the Club to its members. Accordingly, applying the said ratio the order was set aside and the appeal was allowed.

Salman Khan’s Acquittal – A Strong Argument Against Being Lawful

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There should be enough evidence by now that in India, being rich or well-connected provides a reliable amount of protection against the law. The irony being that such evidence will probably hold up in a court of law. So, Salman Khan’s acquittal by the Bombay High Court on Thursday was not the anomaly . What was the surprise was the trial court’s verdict in May that found him guilty of driving over and killing a homeless man and delivered a five-year jail sentence. No one is asking for a kangaroo court where the procedures of jurisprudence are tossed aside -even in cases that seem watertight.

But in far too many high-profile cases, it is this very procedure that is abused by methods far removed from convincing judicial arguments, thereby making the law look like, to quote a character in Oliver Twist, “a ass”. But in Dickensian India -where someone who could have easily stood in as the victim of Khan’s killer Land Cruiser on September 28, 2002, is today celebrating the movie star’s acquittal -the law is the only thing that everyone, from a powerful parliamentarian to a resident of a jhuggijhompri cluster, should be answering to. That, sadly , isn’t the case in the real world. This particular verdict makes anyone who should be fearful of the law be more fearful of not being well connected as insurance. The fact that the prosecution, the state of Maharashtra, failed to prove the charges “on all counts” makes incompetence and unwillingness equal suspects. The single witness who insisted that Khan was behind the wheel when the incident took place was not considered a “wholly reliable witness” on account of a legal technicality -as well as the fact that he had died eight years ago. The prosecution will appeal against the verdict. All one can do is hope that the holes that the state of Maharashtra inflicted on its own argument, can be repaired by proving something about the acquitted more convincing than his guilt not being proven “beyond reasonable doubt”. Otherwise, this will add to the string of incentives to prepare oneself to -proverbially , of course -get away with murder.

[2015-TIOL-2691-CESTAT-MUM] D S Chavan Engineering Works vs. Commissioner of Central Excise and Customs, Nasik

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The scope of work order indicating a specific job to be undertaken by the Appellant cannot be considered as a supply of manpower.

Facts
The Appellant had contract on a firm rate basis for welding and gas cutting on various locations of NTPC. The department contended that the control is exercised by NTPC and welding machine, electricity and gas required was given by them and the Appellant was required to supply manpower and accordingly liable under “Manpower Recruitment and Supply Agency Service”. Further, a demand was also raised on the cleaning services.

Held
Relying on the decision of the Bombay High Court in the case of Commissioner of Customs & Central Excise & Service Tax vs. Godavari Khore Cane Transport Company P. Ltd [2015-TIOL-253-HC-MUM-ST], the Tribunal held that work order does not indicate supply only of the manpower, on the contrary, scope of work indicates a specific job of welding and gas cutting to be done. Accordingly the liability under ‘Manpower Recruitment and Supply Agency” is set aside. As regards cleaning services, without contesting service tax along with interest was discharged. Observing a genuine misunderstanding, the Court dropped the penalty by invoking section 80 of the Finance Act, 1994.

GST – Subramaniam panel’s Workable Blueprint

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The Arvind Subramanian panel has done well to recommend a moderate standard goods and services tax (GST) rate of 17-18%, and also scrap the 1% inter-state sales tax. The rate, worked out after excluding real estate, electricity, alcohol and petroleum products, is higher than the 12% GST recommended by the 13th Finance Commission task force, whose model had exempted nothing. GST would eliminate the cascade of multiple taxes that products bear now and allow manufacturers to claim credit for the taxes paid on inputs across the value chain, creating a built-in incentive to pay tax and thus widen the tax base. It is welcome that the panel has pegged the average GST rate at which existing indirect tax revenues, excluding import duties, would be recouped, the so-called revenue neutral rate, at 15-15.5%.

Other rates—lower rates of 2-6% on precious metals, a 12% rate, and the highest rate of 40% for luxury cars, aerated water, tobacco and tobacco products—are fine. Multiple rates are not inimical to GST.

They have worked in the EU where the value-added tax rates vary across member countries. Instead of a composite 40% excise duty on non-merit goods, what would be desirable is a combination of GST at the standard rate and a ‘sin’ tax component not eligible for input tax credit. This will keep the GST chain unbroken while earning extra revenue and discouraging ‘sin’ consumption. It is welcome that the panel wants petroleum, electricity, real estate and alcohol to be included in GST. Subsuming all taxes and keeping exemptions to the minimum, is the way to go.

Scrapping the 1% inter-state sales tax on which the buyer cannot claim input tax credit is rational. This indirectly accepts one Congress condition for cooperating on GST. The panel, however, is not in favour of specifying a cap on the GST rate in the Constitution, another key Congress demand. However, there is a logic to having a cap.

Without a cap, the states can ratchet up the rate using their constitutional right, and defeat the GST reform’s goal of creating an efficient indirect tax structure.

Non-state actors have upstaged the superpowers

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The era of superpower hegemony is over, and that of nonstate actors has arrived. Fourteen years after 9/11, the US has — let’s be blunt — been repeatedly defeated by radical Islam. Look at Afghanistan, Iraq, Syria, Libya, Lebanon, or even Yemen. The US can drop a thousand bombs from a thousand drones, yet cannot dictate outcomes to a hydraheaded monster. The California school shooting showed that the US is unsafe even at home. Paris is the latest European scene of devastation. Radical Islamic thought has effortlessly penetrated national borders and created terrorists within the US and Europe.

At the recent TimesLitfest in New Delhi and Mumbai, many speakers addressed these issues. Many lambasted US military interventions that had created not democracy but anarchy and mass deaths.

Yet, historically, imperial powers alone could end local wars, and thus bring stability in place of anarchy. Superpowers could overthrow regimes they disliked, and install stable, controllable rulers across the world. Pax Britannica, Pax Americana or Pax Sovietica (in Eastern Europe) provided stability, and set rules for property, trade and commerce. This facilitated economic progress, providing handsome dividends for imperial controllers and also lifting living standards for the entire region.

That now looks so 20th century. Earlier, the state was allpowerful and individuals and groups were mostly powerless. But in the 21st century, the internet and social media have empowered non-state actors so much that superpowers can no longer install stable regimes at will. So, intervention now brings anarchy, not stability. This is a totally new development.

The internet and social media can now create and mobilize radical ideologues across the world, and create homegrown fanatics in every country. There is no military defence against these new developments. The ability to spread subversive ideas, once the hallmark of liberation movements, is now the hallmark of radical Islam.

The US easily ousted the Taliban from Afghan cities after 9/11, but could not dislodge it from rural areas. High technology could pulverise conventional armed forces but could not control low-tech rural areas, or stop the Taliban’s spread of ideas and arms, or even stop the Taliban raising funds through local taxes, smuggling and the opium trade. Obama’s military surge in Afghanistan gained ground only temporarily. He ultimately exited tail between legs, leaving the Taliban smiling.

Tech and terror: Islamic radicals use the internet as much as those fighing them, which makes the war more unpredictable.

ISIS is more fanatical than al-Qaida, and has enjoyed tremendous success in Iraq and Syria. Unlike most nonstate actors, ISIS has grabbed considerable territory, but this may be unsustainable. However, even if ISIS gives up most of its territory, it will retain the power to persuade and mobilize through social media and the internet, inspiring an unending succession of alienated Muslims in many countries to become suicide killers.

New forms of communication have enabled non-state actors to spread their tentacles, and to mobilize money and arms, on a scale that even strong states cannot foil. Somali pirates have shown that even commercial hoodlums, seeking millions without a shred of ideology, can defy the greatest naval superpowers. Capturing hostages for ransom has proved an easy way to raise enormous sums that terrorists in earlier times could not dream of.

Hacking and other 21st century tools enable radicals to undercut the most powerful states. One day hackers may steal nuclear secrets, or direct government missiles at targets chosen by terrorists. Leftist anti-imperialists might rejoice at western discomfiture but a wide array of international jihadi literature classifies India too as an enemy, as an imperial tyrant in Kashmir that also kills Muslims in Gujarat and elsewhere. Those celebrating the end of superpower hegemony must understand the consequences. India is at risk, no less than the US or France.

Yet most Indian intellectuals are in denial. They would rather focus on the threat from communal Hinduism at home — which is very real — and dismiss Islamic communalism as a distant threat that mostly affects the West. This is sheer myopia.

How does one meet this threat? Ideally, by creating a sense of universal brotherhood. But radical Islamists are uninterested. They need gain only a few adherents a day to create danger for everybody else. In the absence of 20th century solutions, western states may retreat into fortresses. India may have to follow.

At the Mumbai Litfest, Dileep Padgaokar declared that a tough state had to replace the era of ever-expanding civil liberties. The greatest threat to civil liberty now came from nonstate actors, not the state. This could not be tackled by motherhood, brotherhood and other 20th century virtuous solutions.

Today, diabolical viruses, placed by both state and nonstate actors, sit on every smartphone and computer, monitoring everyone. Radical ideas are buzzing in the airwaves all around us. We face new dangers, and an unprecedented loss of security and privacy. There are no easy answers.

[2015] 63 taxmann.com 231 (New Delhi- CESTAT) Rohan Motors vs. Commissioner Service Tax

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If penalty is imposed u/s. 77(1)(c)(ii) of the Finance Act, 1994 for failure to produce documents called for, the Department has to state specifically which document was called from the appellant.

Facts
Based on information from CERA Auditors, the Range Superintendent issued 5 letters/summons to the assessee, to submit the requisite information. Since no information was submitted the Show cause notice was issued to assessee, inter alia for imposition of penalty u/s. 77(1) of the Act for failure to furnish information/ documents. The assessee, on the other hand contended that, the department asked for repetitive information and that requisite details called for were provided by it, hence penalty u/s. 77 cannot be levied.

Held
The Tribunal noted that as per the adjudicating authority the appellant failed to respond to letters and submit desired information and therefore penalty was imposed u/s. 77(1)(c) of the Act; whereas the first appellate authority found that though information was supplied vide reply letters, it failed to submit documents and thus confirmed the penalty. Based on these contrary observations, the Tribunal expressed a view that the department itself is not sure whether the appellant is guilty of failure to furnish information or failure to produce documents. It held that, if penalty is imposed u/s. 77(1)(c)(ii), the Department has to state specifically which document was called from the appellant. The show cause notice does not specify the document that was called for. Imposition of penalty being in the nature of punishment, it cannot be imposed on flimsy and shaky evidence. It was further observed that, it is not a case where the department was obstructed from conducting a search or that a specific document was withheld resulting in particular revenue implication. Accordingly, it held that, though the appellant failed to reply to few letters, the explanation for failure that the appellant was under bona fide belief that necessary information was given cannot be rejected in toto and therefore imposition of penalty is not justified.

End all corporate tax breaks to give country a break from favouritism

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Should some industries get tax breaks that others don’t? In general, no. The finance ministry has come out with proposals, for public discussion, to abolish several existing tax breaks. This is a building block of the Budget promise of finance minister Arun Jaitley to cut the corporate tax rate within four years from the current 30 per cent to 25 per cent. This aims at matching corporate tax rates in most Asian competitors, removing India’s current disadvantage of high taxation.

Many exemptions were irrational, benefited a few favoured industries with good political connections, violated economic fairness, and deprived the exchequer of huge revenues.

The finance ministry proposes to end all tax breaks linked to profits, investment or specific areas. No longer will industries get tax breaks for locating in a favoured region. Some tax breaks like accelerated depreciation, linked to the amount invested, favored capital-intensive industries over labourintensive ones, terrible priorities in a country needing new jobs. Weighted deductions, which gave tax breaks for favoured types of spending (like R&D in pharmaceuticals), are also on the list for axing.

The new proposal represents a welcome wholesale junking of exemptions. Cherry-picking only some of these would have been an invitation to charges of favouritism and cronyism. Wholesale junking also moves the tax code towards simplicity and transparency , two desperately needed goals.

Some states will groan at losing tax breaks. But any state that provides good investment conditions will always attract investment. Those that don’t, should suffer the consequences. We need competition between the states to provide good infrastruc ture, rapid clearances, and a bribe-free climate.Investment will follow.

Some tax breaks already have a date of expiry , and those will be, quite rightly , honoured. Where no sunset date exists, the tax breaks will expire on March 31, 2017. This sunset date will apply to concessions for infrastructure, special economic zones, and oil production.

Many industrialists will complain that the new proposals go too far. Every government, including neighbouring ones in Asia, gives tax breaks to sectors and activities which it regards as having high priority . Doesn’t India have priorities, too? This rhetorical question will resonate with politicians. Yes, they will want to give some sectors high priority and offer these tax breaks. To some extent, this is inescapable in a democracy . But it can open up Pandora’s Box of endless demands, cronyism and complexity . Almost every industry and region can find one reason or other to demand a tax break.

If, indeed, exceptions are to be made, the guiding principle must be the same driving India towards a 25per cent corporate tax. Tax exemptions, like the corporate tax rate itself, should as far as possible mirror exemptions given by our competitors. Rather than listen to domestic lobbies with fat pockets or political clout, we need an expert committee to objectively identify tax breaks in competing countries that affect our exporters, and so need to be matched. Tax breaks for R&D in pharma are possible candidates for such matching. This will be a crony-free, corruption-free way of identifying a limited number of exemptions clearly linked to international competitiveness, without opening up the floodgates to a zillion demands from cronies.

There is also the matter of timing. If most tax breaks are to go by March 2017, the corporate tax rate should also be cut to 25per cent by that deadline. If the tax cut will come only by 2019, as Jaitley hinted in his Budget speech, the removal of tax breaks may need similar phasing.

Remembering to Hedge – Promises and perils of external commercial borrowing

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The Reserve Bank of India – after consultation with the central government – released an updated set of guidelines applicable to Indian corporate groups’ external commercial borrowing (ECB). The change is a significant liberalisation, in that it considerably lessens the number of restrictions placed on the end-use of funds that companies have borrowed from abroad. The focus of the RBI, according to its statement, was on long-term borrowing, which it said would make “repayments more sustainable and minimise roll-over risks for the borrower.” The list of permissible lenders has also been expanded. It now includes pools of long-term capital such as pension funds, insurance companies and even sovereign wealth funds. Simultaneously with expanding the scope of ECBs, the RBI also acted to effectively narrow the number of Indian companies, which would successively raise ECBs in foreign currency, by cutting the allowable ceiling for borrowing rates above the London Inter-Bank Offered Rate or LIBOR. For foreign currency borrowing with maturity of between three and five years, the permissible rate was cut by 50 basis points (bps) to 300 bps above LIBOR. The permissible spread for longer-term borrowing is correspondingly higher.

The dangers of an ECB debt binge are well known. Indian companies are faced with high interest rates at home, and dollar-denominated foreign rates can look attractive. In the past, corporate groups have funded over-expansion and acquisition sprees through such debt, only to be left stranded when the situation turned adverse. Few Indian companies hedge carefully enough – and, indeed, the market for hedging currency risk beyond a few months may not be deep and liquid enough to be attractive. Nor is such hedging cheap. The RBI clearly thinks that this is more of a problem for short-term debt, in which temporary volatility of the currency can cause crises when large tranches of debt become difficult to roll over or repay. It is, thus, incentivising longer-term debt that could be used by, say, real estate investment trusts to help bail out India’s 38 struggling realty sector. While this logic is certainly sound as far as it goes, there remains the larger question of the future direction of the rupee. If it is significantly overvalued at the moment but nevertheless apparently stable, some companies could take on long-term debt that will grow on their balance sheets when the rupee depreciates to closer to its real value.

The option, of course, is to seek out rupee-denominated debt abroad. Certainly, the government has made significant progress in promoting rupee-denominated “masala bonds”. And as this newspaper has reported, some markets have seen excellent growth in retail bonds with the rupee as the base currency. These have largely been issued so far by offshore institutional lenders, but earlier this year the RBI allowed Indian companies to borrow abroad in rupees too. The guidelines released on Monday put rupee-denominated borrowing on a par with dollar-denominated ECB – and, in fact, made special allowances for non-bank financial corporations and microfinance institutions to raise rupees from abroad. It is to be hoped that Indian companies will recognise that currency risk is best borne by large global financiers and will not be overly tempted by low interest rates and the associated currency risk.

[2015] 63 taxmann.com 20 (Mumbai – CESTAT) Hiranandani Constructions (P) Ltd. vs. Commissioner of Central Excise, Thane-I

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Maintenance Charges collected by builders from prospective buyers for payment of local taxes and other charges would not attract service tax.

Facts
The adjudicating authority held that the maintenance charges recovered from the prospective flat buyers towards management, maintenance or repair service are liable for service tax.

Held
Relying upon decision of Tribunal in the case of Kumar Beheray Rathi vs. CCE [2013-TIOL-1806-CESTAT-MUM] and Goel Nitron Constructions vs. CCE [2015-TIOL-1787- CESTAT-MUM], it was held that no service tax liability arises on the appellant under the category ‘Management, Maintenance or Repair Service’ for the amounts collected by them from the prospective flat owners.

The future of India: Private splendour and public squalor?

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India, and most Indians, are getting wealthier. With a per capita income of $6,000 (PPP), India is now a lower middle-income nation. If our GDP continues to grow at a modest 7% CAGR, millions of Indians will gradually escape poverty and hundreds of millions of us will grow steadily more affluent. The probability of this seems fairly reasonable – not because of the competence of any government — but because of the aspirations, drive and entrepreneurship of millions of Indians, especially young Indians.

But even as we grow wealthier, the quality of life especially in urban India will continue to plummet. I live in Koramangala, Bangalore, the epicenter of India’s entrepreneurial ecosystem, a place brimming with talent and energy .

But it is also brimming with mounds of festering garbage. The stench of sewage permeates the air. A commute to the airport that once took an hour now takes more than two. However, Koramangala’s residents have it good compared to those who live in other suburbs like Whitefield.This story of unlivable cities is repeated across India. Delhi’s residents complain about the barely breathable air and awful traffic. Mumbaikars lament the disappearance of public spaces. Rain has shut Chennai down. As population and consumption rise, we are seeing the degradation of everything public -infrastructure, justice, law and order, healthcare, education -from bad to unbearable.

Our response to this degradation has been privatization by default. Companies create their own worldclass infrastructure. The affluent and growing middleclass retreat behind gated communities and highrise apartments and to a world of privatized education, privatized healthcare, private security and transportation. This retreat has given rise to what we see today: oases of private splendour in an ocean of public squalor. But how sustainable is this? What’s the point in rising affluence if the quality of our life is plummeting? What’s the point in owning more cars or better cars if it takes an hour or more to travel 10km? What’s the point of rising GDP if we can’t breathe our air, if most of our food is contaminated and the judicial system fails to deliver timely justice? As someone remarked about China, what’s the point in growing the pie if the pie is inedible? The ocean of public squalor is beginning to engulf our private cocoons.

It is very easy to get angry and blame “government” for this mess. Our deplorable situation is clearly the failure of successive governments of every political hue at the Center, the state and local level. They have failed to curb corruption and have failed even more miserably to build institutions. Institutions are the foundations of society . Even as our population surged and our economy multiplied, successive governments have allowed key institutions to atrophy; indeed, in many cases, they have been deliberately weakened.Weak institutions -regulatory institutions, institutions of administration, policing, and justice -are the root cause of government’s inability to stem corruption and deliver essential services to citizens.

But much as government is to be blamed, the bigger problem might be our own behaviour. Why is there so much rotting rubbish on the streets of Bangalore? It isn’t primarily because the municipal contractor doesn’t pick up the rubbish every day. It is that residents refuse to segregate garbage the way the law prescribes and most households furtively throw their garbage on the street corner. Why is corruption so rampant? Because fewer and fewer of us see anything wrong in either taking or paying bribes; bribery is simply a transaction cost. How many of us are willing to take the metro or bus to the airport instead of our car? The total refusal on the part of babus, politicians and middle-class citizens to use public services results in the lack of any incentive to improve these.

How many talented executives are willing to give up their lucrative careers for just a few years to help rebuild public institutions or strengthen good NGOs?

How many of us are willing to give up part of a weekend to participate in a community initiative to get rid of garbage, plant trees in our neighbourhood or attend meetings of the resident wel fare association?

How many business leaders are personally engaged in the CSR work of their company to ensure that financial contributions and employee talent are directed towards building institutional capacity? How many of us make the effort to vote in elections instead of seeing it as another holiday?

It is time that we realize that we get the kind of government and society we deserve. To a very large extent, the sorry state of our society is the result of our own indifference. To make a democratic society work, we need to redefine what it means to be a citizen.

Citizenship is not just a birthright, it is also an obligation. A democratic society is fragile and its success demands vigilance, collective action and even sacrifice from its citizens. It took great sacrifice to win our free dom. It will take at least as much leadership and sac rifice to create a functioning society.

Quality of universities determines nation’s fate: Economist Summers

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Faster decision-making is the key to India’s higher growth. American economist Lawrence Summers who was at Mumbai university said India could take inspiration from a slogan pasted on the wall of the Facebook office: “Done is better than perfect”.

Speaking of Facebook COO Sheryl Sandberg, who earlier worked on his team as the chief in staff of treasury, Summers said, ” An attitude that she has now became a slogan at Facebook. It’s up on the wall -`Done is better than perfect.’ “If your government internalised that bit and it just had an idea that decisions had to be made, and we hoped that were made right, but they just had to be made, and there was a substantial acceleration of decision making in every sphere, I think that would make a very big difference for India over time. I guess the other thing that one is stuck by is a variety of kinds of infrastructural improvements in India as well. But in general, faster decision making in presumptial permission, rather than a presumptial prohibition, would go a long way ,” said he.

The President Emeritus and Charles W Eliot professor at Harvard University , former treasury secretary in the Clinton administration was speaking on “Reinventing the university: Reconciling equity and excellence in higher education worldwide”. While topclass universities are a microcosm of what India needs, he believed that the quality of universities determines the ate of a nation.

“The prosperity of nations is tied up with their success of their universities. It is no accident that Silicon Valley is essentially in the same place as Stanford University . It is no accident that the city of Boston is where Harvard University and is also the leading concentration of biomed talent….”

Emphasising that India will not be great without great universities, he said, “I know it is fashionable to argue that prosperity comes from the ground up and it does. But when it is suggested that it so mehow means that prim and secondary education should be a focus to the exclusion of higher education I will suggest that is a grave and enormous error.”

“No matter how universal literacy is, no matt how many people have been taught arithmatic, no matter how healthy all the children are, a society will not move forward without learning the touches of frontiers of what man knows and without being part of the ad venture of pushing those frontiers and that I would suggest is the work of universities.”

A great university he said, must be governed by the right academic culture of openness, have autonomy and a sense of fierce competition.Summers said India could be an export house of education.He said he could not think of a better place than India for Indian students to study .

Have faith in the citizen – Begin administrative reforms by undoing the colonial mindset of babus

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“Just reform the bureaucracy” – this advice to India by GE CEO Jeffrey Immelt is echoed across the world. Why administrative reforms haven’t taken place, best intents notwithstanding, requires a nuanced understanding. Global experience suggests administrative reforms need to be undertaken within the first 100 days of a new government coming to office, else the system takes over the government – the will to change is dwarfed by the logic of continuity.

Nowhere in the world have substantive administrative reforms been successful if not directly supervised by the political leader of the country. Successful administrative reforms are by definition transformational; there are no worthwhile examples of meaningful incremental administrative reforms.

Administrative reforms don’t happen when entrusted to the bureaucracy. The bureaucracy has to be kept at arm’s length and prevailed upon. These are cardinal rules; India is past the expiry date of the first 100 days, but it may still want to sail ahead.

The imperatives for administrative reforms in India are more fundamental than the leaking bucket and dilapidated administrative framework. First, in a historical oversight, India continued with the administrative framework of the British. This system was designed to inhibit the native, chain initiative and enterprise and enable a select few to rule the multitudes. These objectives have been faithfully served by the legacy framework even 68 years after the departure of colonial masters.

Post- the reforms of 1991, the framework designed to control and regulate has become anachronistic in the exercise of freedom, which is intrinsic to the market. As a participant in the global economy, either India rewrites its administrative system to compete with the best investment destinations of the world or perishes, for nothing except competitive advantage matters to the investment community. The way ahead will require a comprehensive roadmap as well as a strategy to pierce the chakravyuha, but a few principles may be useful reference points. At a philosophical level we need to adopt a trust based system with implicit faith in the citizen. Filling forms, providing attested documents, undergoing verification and awaiting decisions by higher ups are all instruments of an alien administration to disempower and dispirit the individual.

Government must take the word of the citizen at face value and devise a system to take care of exceptions without impeding the quest of the rest.

A second beacon for administrative reforms should be ending the dichotomy between government and national interest, again a colonial legacy. Basically government should stop acting in its own interest and should work in national interest which includes the interests of private individuals and the private sector.

The success of Japan, Korea and Singapore came from government deciding that its main role is to support and facilitate enterprise, be it individual or corporate. This is both an issue of mindset/ideology as well as a systemic issue of a very fundamental kind that requires recasting the administrative mould, not simply reshaping the existing one.

Finally, the government and technology intersect needs to be calibrated. Just about all our IT-based systems have merely computerised physical processes with, at best, marginal efficiency and transparency gains.

India is ready to transit from the physical to the virtual world like no other country. The almost ubiquitous access to mobile telephony can connect an individual to a service provider, the electronic bank account can be used to make payment when required and the Aadhaar card authenticates the individual online. Given that all these three components are approaching the one billion mark, such a proposition is neither esoteric nor futuristic – except to a mindset and system steeped in the past.

2015 (40) STR 509 (Tri. –Bang.) Kakinada Seaports Ltd. vs. C.C.E., S.T, & Cus., Visakhapatanam- II

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Order cannot be set aside only on the grounds that the provision is not quoted properly in SCN specifically if the assessee is aware of the provisions of law. Service Tax cannot be demanded from service receiver under RCM if service provider has already discharged the same. CENVAT credit availed on the basis of Challan of service provider may be eligible document for availment of CENVAT Credit if it contains all the requisite details. CENAVT credit cannot be denied on the ground that service provider was eligible for exemption.

Facts
The appellant engaged in providing “other port services” in Kakinada Port were issued Show cause notice (SCN) for the period post negative list of services under Reverse charge mechanism (RCM) for business support services and also with respect to CENVAT credit availed on certain input services. It was contested that during the period under consideration, definition of Business Support Services had to be referred u/s. 65B as against section 65 of the Finance Act, 1994 as provided in SCN. Though there was nothing regarding introduction of negative list of services in SCNs and orders, there was no mention that section 65 ceased to have effect. Since RCM was introduced recently on such services, due to ignorance, service tax was already discharged by service provider in routine manner. Therefore, tax cannot be demanded twice on same transaction. Further CENVAT credit availed on the basis of acknowledgment of service provider was disallowed by department. However, the appellant contended that they had availed CENVAT credit on the basis of challan of service provider which must be considered to be valid document for availing CENVAT Credit. Further, CENVAT credit was denied on certain input services and capital goods were contested by the appellant. CENVAT credit was also denied on the ground that input services were eligible for exemption.

Held
The services were covered under business support services either before or after negative list. Even though specific provision were not quoted, the entire demand cannot be set aside especially in view of the fact that RCM and introduction of negative list were mentioned in SCNs and orders. In the scenario of self-assessment, the assessee would be aware of classification and the fact that the assessee contended that section 65 ceased to be in effect, reveals that the assessee was not prejudiced due to omission of section in SCN. Further since service provider had already discharged service tax, even though not liable, demand of service tax cannot be sustained on service receiver. In this case, as a remedy, penalty may be imposed for contravention of law but no penalties may be imposed for non-payment of service tax. It was held that CENVAT Credit was available on the basis of challan (containing all requisite details) under RCM and therefore, it was considered to be sufficient document for availment of CENVAT credit. CENVAT Credit was also allowed on health services, insurance services, Rent-a-cab services, works contract services in relation to erection and installation activity. It was also held that CENVAT credit cannot be denied on the ground that service provider was eligible for exemption.

India’s Cinderella syndrome

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The Oxford historian, Felipe Fernandez-Armesto, in his large tome titled Millennium: A History of Our last Thousand Years, described India as “the Cinderella civilisation of our millennium: beautiful, gifted, destined for greatness, but relegated to the backstairs by those domineering sisters from Islam and Christendom”. Looking at Arvind Kejriwal’s last-minute desperation to clear Delhi’s air before people choke to death, one can also talk of the country’s Cinderella syndrome: the tendency to not act until the clock is about to strike midnight, and then to rush for solutions. Cinderella lost her slippers in the process, India has lost much more over the decades.

One can think of many examples. There is the Green Revolution itself—the belated move to reform neglected agriculture after the country had suffered twin droughts in the mid-1960s and been forced to depend on food aid to feed itself. There is the 1971 war, for which India was caught unprepared (not the first or last time); Gen. Manekshaw told Indira Gandhi he needed nine months in which to get ready—a period during which the country rushed through with the purchase of all manner of armaments, including second-hand tanks from Soviet satellite countries because nothing else was available. Economic reform, introduced in baby steps through the 1980s, was rushed through only after the country went nearly bankrupt, in 1991. There is also the great haste with which the Commonwealth Games were put together at the last minute (the toilets in the Games Village were being cleaned even as athletes started arriving).

Everyone has known for years that Delhi’s air is unfit to breathe in the winter months. More than a decade ago, the Supreme Court provided temporary relief to the city’s residents when it forced an unwilling Sheila Dikshit to allow only gas-powered engines for public transport (politicians owned the diesel-driven buses and naturally were opposed to change). Now, in a typical Cinderellahour solution, Mr Kejriwal has decided on the odd-even number rule for cars, though the city has had no time to prepare for such a disruptive step. Phase III of the metro system will add 75 per cent to track length and therefore accessability, and more than 50 per cent to daily ridership, but it is a year away from completion. And the idea of bus rapid transit (BRT ) corridors, which would have encouraged people to move from cars to buses in phases, has been given up after a botched trial.

In the absence of these two pressure-relieving transport systems, Mr Kejriwal plans as an emergency step to throw over a thousand additional buses on to the roads. Other possible solutions like encouraging car-pooling (special fast lanes on arterial roads for cars with more than one passenger) have not been tried. So expect initial chaos, plus a traffic police unprepared for the sudden extra work of checking all car numbers. We might well end up with a repeat of the BRT denouement: premature demise of the idea. It does not need great knowledge of human affairs to know that this is not how societies should organise themselves. But we are, it would seem, a Cinderella civilization; we need an 11th-hour crisis before we stir ourselves.

So we have to ask ourselves: is the disastrous drowning of Chennai a result of the Cinderella syndrome, and ditto the Mumbai dunking 10 years ago? What about the Uttarkashi flood? Which part of the country is due next? We take pride in how good we usually (though not always) are at relief measures in a crisis, but what about action to prevent man-made crises—as all these episodes were? Perhaps a civil society organization should draw up a list of the priority issues that need attention but are being ignored—and put a Cinderella clock on each issue to indicate how close we are to midnight. It might help focus the mind.

2015 (40) STR 519 (Tri.-Del.) Mannat Farms vs. CCE & ST, Ghaziabad

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The discretion to condone delay is not a personal discretion of the Appellate Commissioner but is discretion of law and should be exercised appropriately as law requires.

Facts
The appellant preferred an appeal to Commissioner (Appeals) with a delay of 29 days beyond the period of limitation. Since the Commissioner (Appeals) is granted discretionary powers to condone delay upto 30 days, the appellant pleaded to admit the appeal citing the reason that his wife was ill and provided medical certificate to this effect. The Commissioner (Appeals) dismissed the appeal observing that the wife of appellant had no specific role to play in day-to-day affairs of the firm and nothing was brought on record to show that illness of wife had affected the business of the firm.

Held
Having regard to the peculiar facts of the case, condonation of delay should be liberally considered. The discretion to condone delay is not a personal discretion of the Commissioner and the same should be exercised properly as dictates of law require. It was perverse for the Appellate commissioner to hold that care of a spouse and need to attend to her was not a relevant criterion. Accordingly, order was set aside.

Where Art Thou !

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Who was Narayan Varma ! An accomplished Chartered Accountant, a visionary professional and above all a social service oriented human being. Narayan qualified and enrolled as a member of our Institute in 1955. He completed 60 years of practice in 2015 and celebrated the occasion by inviting many of those who articled with him. He was International President of GIANTS, an international social organisation established by his friend Nana Chudasama. Narayan was our President in 1978 and President of Chamber of Tax Consultants in 1988. During his tenure he initiated changes in their functioning. During the last few years he served the society as an RTI activist and authored books on the Right To Information Act. His contribution on the subject in this journal will be missed. Narayan’s contribution to our journal is immeasurable. He was publisher of the journal since for more than two decades. He was editor and the initiator of many features in the Journal – the most notable being Namaskar.

On a personal note, we met at the RRC held at Mahabaleshwar in 1975 where I presented my first paper and started my journey with BCAS. The acquaintance developed into a relationship I have with few. We formed a group of professionals who have met regularly for the last thirty eight years on every Friday. From ten of us with his passing away we are now only three.

In our philosophy during our life we are expected to repay three debts : viz; Dev rin, Guru rin and Pitri rin. Let us see how Narayan repaid these three debts, in a measure very few of us are capable of. Pitri rin was discharged by having progeny and looking after the family. He has two sons who are loving and successful human beings. Narayan and Ursula have reared a loving family. Guru rin has been repaid by training and mentoring many chartered accountants, amongst them there are many who are our members and lastly Dev rin has been repaid by serving society directly and indirectly through the various social organisations.

Hence, where is Narayan ! I believe he is having fun with our Creator.

God Bless his Soul
Adieu
KC

2015 (40) STR 547(Tri. –Delhi) Coca Cola (I) Pvt. Ltd. vs. CST, Delhi

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Best judgment order not sustainable if it is non-speaking, does not disclose reasons and is arbitrary.

Facts
The
adjudicating authorities confirmed demand of service tax on certain
foreign expenditure under reverse charge mechanism (RCM) and also on
certain incomes to be in the form of services liable to service tax.

A
‘Best Judgment Order’ was passed on the basis of documents submitted
vide section 72 of the Finance Act, 1994. Also certain expenses like
renting of immovable property and supply of movable property for use in
India were wrongly construed as income. Further share in the expenses
relating to marketing support were treated as income. On perusal of the
records and correspondence, it appeared that adjudicating authority had
just reproduced the facts and the definitions as given under law and no
speaking order was passed citing reasons for such best judgement
assessment without providing explanations.

Held
Adjudicating
authority merely reproduced assessee’s submissions and there were
hardly any reasons to justify demand. After analysing various paragraphs
of the impugned order which were either a reproduction or irrelevant,
the Tribunal observed that the analysis therein was cryptic and
inadequate to arrive at the findings. The order was completely
non-speaking about the methodology/reasons/grounds adopted for arriving
at ‘Best Judgment’ figures.

In fact, the authority was not even
sure whether it was justified to invoke best judgment assessment in the
present case which was evident from the phrase used in impugned order as
‘In order to safeguard the revenue, I find that section 73 appears to
be inviolable…”This was an arbitrary best judgment assessment and
therefore, was not sustainable quasi-judicially. Appreciating the
observations made by the Hon’ble Supreme Court in case of M. L. Capoor
(AIR 1974 SC 87), it was held that the adjudicating authority was
conspicuously non-speaking, non-reasoned, arbitrary and cavalier while
passing the impugned order. Accordingly, along with setting aside the
impugned order, costs were imposed on adjudicating authority to be
deposited in Prime Minister’s National Relief Fund.

The Companies (Meetings of Board And Its Powers) Second Amendment Rules, 2015.

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The Ministry of Corporate Affairs has vide Notification dated 14th December 2015, amended the Companies (Meetings of Board and its Powers) Rules, 2014. They have been notified in the Official Gazette on 15th December 2015.

Rule 6A has been inserted as follows:

‘6A. Omnibus approval for related party transactions on annual basis – All related party transactions shall require approval of the Audit Committee and the Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to the following conditions, namely:-

(1) The Audit Committee shall, after obtaining approval of the Board of Directors, specify the criteria for making the omnibus approval which shall include the following, namely:-

(a) maximum value of the transactions, in aggregate, which can be allowed under the omnibus route in a year;

(b) the maximum value per transaction which can be allowed;

(c) extent and manner of disclosures to be made to the Audit Committee at the time of seeking omnibus approval;

(d) review, at such intervals as the Audit Committee may deem fit, transaction entered into by the company pursuant to each of omnibus approval made

(e) transactions which cannot be subject to the omnibus approval by the Audit Committee.

(2) The Audit Committee shall consider the following factors while specifying the criteria for making omnibus approval, namely:

(a) repetitiveness of the transactions (in past or in future);

(b) justification for the need of omnibus approval.

It is provided that where the need for related party transaction cannot be foreseen and aforesaid details are not available, Audit Committee may make omnibus approval for such transactions subject to their value not exceeding rupees one crore per transaction.

The omnibus approvals are valid for a period not exceeding 1 financial year and shall require fresh approval after the expiry of such financial year. Omnibus approval is not to be made for transactions of disposing of the undertaking of the company.

Rule 10 which pertains to “Loans to Director etc. u/s. 185” has been omitted.

Rule 15 which pertain to “Contract or arrangement with a related party” where prior approval of the company by a special resolution was required, will now require only an ordinary resolution.

The Companies (Audit And Auditors) Amendment Rules, 2015

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The Ministry of Corporate Affairs has vide Notification dated 14th December 2015, amended the Companies (Audit and Auditors) Rules, 2014. They have been notified in the Official Gazette on 15th December 2015.

As per the Notification, the Rule 13 now reads :

Rule 13 : Reporting of frauds by auditor and other matters:

(1) If an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of rupees one crore or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the Central Government. The rule also contains the time period for reporting to the Board or Audit Committee, and to the Central Government in case the auditor fails to get replies or observations. In case of a fraud involving lesser than the amount of Rs. 1 crore, the auditor shall report the matter to Audit Committee constituted u/s. 177 or to the Board immediately but not later than two days of his knowledge of the fraud and he shall report the matter specifying the nature of fraud with description; approximate amount involved and parties involved.

2015 (40) STR 537 (Tri. – Mum.) Osho International Foundation vs. CCE, Pune

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In case there is a change in the view of CBEC regarding taxability, the same shall be applicable from the date when such change took place and was informed to the assessee.

Facts
The appellants provided services relating to meditation, yoga and massage. The department contested the same to be “health and fitness services”. It was contended that the activities of meditation were spiritual in nature. Therefore, the same is not liable to service tax. In 2003, Chief Commissioner, Pune informed CBEC’s view to the appellants that the activities of meditation and yoga would not be taxable. Thereafter, CBEC, on request for clarification by Commissioner, Pune, informed that Service tax was leviable on the said activity. Therefore, even if services are adjudged taxable, tax shall be payable only from the day there is a change in view of the department. However, since the definition of health and fitness centre included meditation specifically, department strongly submitted that the activities were taxable.

Held
Though, the activities of Yoga and Meditation were taxable, since there was a change in view of the highest body of indirect taxes, the same would be applicable only from the date when the change of view took place and informed to the assessee. Therefore, the demand prior to such clarification was set aside.

2015 (40) STR 560 (Tri.–Mum.) Kunal IT Services Pvt. Ltd. vs. CCE, Pune-III

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The franchisee may be liable to pay service tax only on the amount paid to him by the franchisor provided the total amount is first received by the franchisor.

Facts
The appellants took-up franchise and provided Commercial Coaching and Training Services. The course fees were collected and deposited in the accounts of Franchisor. Service tax was paid on 80% of fees received from the franchisor. Revenue authorities demanded service tax on full amount of the fees received. It was argued that the amount collected and deposited to Franchisor’s account was not in the nature of consideration. In contrast, Department was of the view that the fees received and was ‘gross amount received’ for provision of services.

Held
Appellant were service provider and students were service receiver. Having regard to section 67 of the Finance Act, 1994, it was observed that the gross value charged for provision of services was only 80% of the fees in view of the peculiar fact that the cheques issued by students were directly drawn in the name of Franchisor. Accordingly, appeal stood allowed.

2015 (40) STR 608 (Tri. –Del.) Tanay Landcon India Pvt Ltd. vs. CCE & ST, Jaipur

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Adjudicating authorities should pass the orders only after considering evidences on record. In case of doubt regarding facts of the case, adjudicating authorities should resort to means to gather the correct facts of the case as against passing order without any basis. It is a misconception that the burden of proof is on assessee in case of allegation by department.

Facts
Show Cause Notice was issued proposing recovery of irregular availment of CENVAT Credit in violation of Rule 6 of CENVAT Credit Rules, 2004 for failure to maintain separate accounts of CENVAT credit on common inputs used for taxable as well as exempted services. It was submitted that it had only availed credit of inputs and input services used for providing taxable services. Further, Show cause notice (SCN) failed to reveal any basis for the allegation of irregular availment of CENVAT credit. The adjudicating authority completely disregarded the submissions and observed that it is not the duty of the Department to establish that the appellant have not maintained separate records.

Held
The Tribunal held that the adjudication order jumped to the conclusion of irregular availment of Cenvat credit without substantiating it by any material evidence or analysis. Even when the contention was not accepted, the adjudication order mentioned that the appellant did not dispute availment of CENVAT credit on common inputs and input services. In case of doubt by revenue authorities, it ought to have summoned the appellants’ records or should have verified from their premises whether the they had correctly pleaded to have maintained separate records or not. If no summons were issued and there was a failure to inspect records, conclusion regarding non-maintenance of separate accounts was without any basis. It was also held that It is a misconception that the burden of proof is on assessee in case of allegation by department. In the present case, in absence of clear findings regarding non-maintenance of separate accounts by the appellants without any evidence, the inference of failure to maintain separate records is perverse. In order to enable the adjudicating authority to pursue judicial discipline in recording adjudication orders and eschew perversity in adjudication functions, matter was remanded back for fresh adjudication on the basis of observations made in this order.

Section 92B of the Act – Issuance of corporate guarantees to compensate for lack of subsidiary’s core strength to raise bank finance being in the nature of quasi capital or shareholder activity and not provision of service, does not constitute ‘international transaction’.

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Facts

The Taxpayer, an Indian company, was engaged in the business of ink manufacturing. Taxpayer had a subsidiary company in USA (FCo) which manufactured ink for US markets by using material supplied by the Taxpayer. Taxpayer had issued corporate guarantees on behalf of FCo without charging any consideration for the same.

Taxpayer contended that neither these guarantees cost anything to it nor did it recover any charges for the same from FCo. Further, the guarantees were in the nature of quasi capital and not in the nature of any services. Accordingly, no income was required to be imputed.

However, the TPO computed the arm’s length price (ALP) of the corporate guarantee and proceeded to make Transfer Pricing adjustment in the hands of the Taxpayer.

Held

It is elementary that the determination of arm’s length price can only be done in respect of an ‘international transaction’. As per section 92B of the Act, an International transaction means a transaction between two or more associated enterprises (AE) either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises.

Explanation to section 92B provides that the expression “international transaction”, inter-alia, includes capital financing, including any type of long-term or short-term borrowing, lending or guarantee and provision of services. The Explanation is to be read in conjunction with the main provision. A transaction of capital financing and provision of services can be covered only in the residual part of the definition of international transaction, i.e., “any transaction having a bearing on the profits, income, losses or assets of such enterprises”. In other words, the impact on “profit, income, losses or assets” is a sine qua non and it should be on real basis and not on a contingent or hypothetical basis, for a transaction of provision of service and capital financing to fall under the ambit of ‘international transaction’.

Reliance in this regard was placed on Tribunal decision in the case of Bharti Airtel Limited [(2014)(63 SOT 113)]. It is not correct to compare corporate guarantee and bank guarantee. A bank guarantee is a surety that the bank or the financial institution issuing the guarantee provides by committing that banks, will pay off the debts and liabilities incurred by an individual or a business entity in case they are unable to do so. Even when such guarantees are backed by one hundred percent deposits, the bank charges guarantee fee. However, corporate guarantee is issued without any security or underlying assets. There is no recourse available with the guarantor if there is any default. Such guarantees are issued based upon the business needs and group synergies and not based on the risk assessment or underlying asset which generally the banks ask for.

Corporate guarantees can also be a mode of ownership contribution, particularly where a guarantee given compensates for the inadequacies in the financial position of the borrower. There can be number of reasons, including regulatory issues and market conditions in the related jurisdictions, in which such a contribution, by way of a guarantee, would justify to be a more appropriate and preferred mode of contribution vis-a-vis equity contribution. For these reasons, bank guarantees are not comparable with corporate guarantees.

In the facts of the present case, guarantee has been provided to compensate for lack of core strength of the subsidiary for raising the finances from bank. Nothing was brought on record to contradict the same. Therefore the transaction of issuance of corporate guarantee is in the nature of shareholder activity and not provision of service. A transaction which is in the nature of shareholder activity does not amount to “provision of services”. Hence, it is outside the ambit of international transaction. Even if issuance of corporate guarantee is to be treated as ‘provision for service’, such service would need to be re-characterised in tune with commercial reality, as no independent enterprise would issue a guarantee without an underlying security. Reliance for this was placed on the decision of EKL Appliances [(2012) 345 ITR 241 (Del)]

Further, where the issuance of a corporate guarantee does not have a bearing on the profits, income, losses or assets, it does not constitute an international transaction. In the present case, the taxpayer had extended corporate guarantee to FCo. The guarantee did not cost anything to the Taxpayer and the Taxpayer could not have realised money by giving such guarantee to someone else during the course of its normal business. Thus, such arrangement did not impact the profits, income, losses or assets of Taxpayer. Hence, it falls outside the ambit of international transaction u/s. 92B of the Act.

Article 12 of India-Netherlands Double Tax avoidance Agreement (DTAA) – Payment of composite consideration for various interdependent services rendered as part of the basic refinery service package should be apportioned between chargeable technical services and non-chargeable commercial services.

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Facts

Taxpayer, a company incorporated and tax resident of Netherlands, rendered certain services to an Indian Company (ICo), who owned and operated refineries in India. These services contained two parts – basic refinery service package and certain optional services.

As part of the basic services, Taxpayer was required to provide ICo with certain deliverables such as manuals, guidelines, standards, etc., which were developed by the Taxpayer based on its expertise and experience in running refineries. Additionally after referring to the manuals if the employees of ICo required any personal assistance or advice, Taxpayer would render the requisite consultancy services and assistance to ICo.

As part of optional services, Taxpayer, when specifically requested by ICo, was required to provide consultancy services and assistance relating to various commercial or technical aspects of the day to day operations of the refinery.

Taxpayer contended that some part of basic refinery services represented supply of goods in the form of deliverables such as training manuals, guidelines, etc., and consideration for such outright transfer, was not in the nature of fee for technical services (FTS) under the India-Netherlands DTAA .

Further, Taxpayer contended that certain part of basic refinery package which were commercial in nature did not qualify as technical service. In any case, such service did not ‘make available’ any technical knowledge, experience, skill, know-how. By virtue of the MFN clause in the India-Netherlands DTAA , the make available condition contained in the India-USA DTAA can be read into India-Netherlands DTAA and since services rendered by Taxpayer did not satisfy the make available condition, it did not fall within the definition of fees for technical services of India-Netherlands DTAA . Taxpayer offered the balance portion as taxable in terms of India-Netherlands DTAA .

However, Tax Authority contended that the payments made by ICo towards basic refinery services was composite payment for holistic technical services and which cannot be split into technical and commercial services. Also, it is not correct to suggest that some part of services satisfy “make available” condition and other part of service does not satisfy “make available” condition. Accordingly, entire consideration should be treated as FTS even under the DTAA . Tax Authority also contended that India-Netherlands DTAA should be interpreted independently without making reference to the MOU between India-USA.

Held

Most Favoured Nation (MFN) clause of India-Netherland DTAA provides that if under any DTAA , India limits its taxation at source on dividends, interest, royalties, or fees for technical services to a rate lower or a scope more restricted than the rate or scope in the India- Netherlands DTAA , the same rate or scope shall apply under the India- Netherlands DTAA also. India-USA DTAA provides a restricted definition of FIS, wherein services can be regarded to fall within the scope of FTS only if the same makes available technical knowledge, skill etc.

By virtue of MFN clause in India- Netherlands DTAA , FTS Article of India-Netherlands DTAA would stand amended in light of the beneficial provisions in India-USA DTAA.

Further, in terms of specific Notification, the MOU between India and USA with reference to Article 12 applies mutatis mutandis to India-Netherlands DTAA .

Certain services rendered as part of the basic refinery services, did not involve any transfer of technology and hence cannot be treated as FTS. Further services in relation to physical delivery of manuals, etc. would also not constitute FTS. The fact that these services or physical deliverables are interlinked with certain technical services does not alter the basic character of these services and physical deliverables.

The mere fact that the overall package is considered as a whole and the services are interlinked cannot be the basis for not apportioning the consideration. The consideration under the composite contract needs to be apportioned between chargeable technical services and non chargeable commercial services.

Framework of Sources of Exchange of Information in Tax Matters – An Overview

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Introduction and Need for Exchange of Information [EoI]

Tackling
offshore tax evasion and tax avoidance and unearthing of unaccounted
money stashed abroad have become a pressing concern for governments all
around the world. The information and/or evidence of such tax
avoidance/evasion and the underlying criminal activity is often located
outside the territorial jurisdiction and thus this menace can be
addressed only through bilateral and multilateral cooperation amongst
tax and other authorities. India has played an important role in
international forums in developing international consensus for such
cooperation as per globally accepted norms and continuous monitoring of
their adoption by every jurisdiction including offshore financial
centres.

Initially, the international norms were to provide
assistance to other countries only on satisfaction of the norms of “dual
criminality”, i.e., in cases of drug trafficking, corruption, terrorist
financing etc. which are criminal activities in both countries.
However, at present the cooperation has extended to cases of tax evasion
and avoidance and countries are obliged to exchange information
requested as per provisions of tax treaties/agreements. The third stage
of cooperation would be automatic exchange of financial account
information without countries having to make requests for the same,
thereby enabling the receiving country to verify whether such accounts
indicate tax evaded money and to take necessary action. Despite a global
consensus on coordinated action to tackle the problem of tax evasion
and tax avoidance, foreign governments, particularly offshore financial
centres, are most unlikely to provide information on the basis of just
letters or on a plea regarding their moral obligations to prevent tax
evasion. Among other factors, parting with information without a legal
basis may be challenged in their own Courts and may be against their own
public policy or public opinion of their citizens. Such information
about money and assets hidden abroad and about undisclosed transactions
entered into overseas, can be obtained only through “legal instruments”
or treaties entered into between India and those countries.

Tax
Treaties, which include, Double Taxation Avoidance Agreements (DTAA s),
Tax Information Exchange Agreements (TIEAs), Multilateral Convention on
Mutual Administrative Assistance in Tax Matters (Multilateral
Convention) and SAARC Limited Multilateral Agreement (SAARC Agreement),
are the legal instruments which provide a legal obligation on a
reciprocal basis for providing various forms of administrative
assistance, including Exchange of Information, Assistance in Collection
of Taxes, Tax Examination Abroad, Joint Audit, Service of Documents etc.
Through one or more of these tax treaties, India has exchange of
information relationships with more than 130 countries/jurisdictions
including well known offshore financial centres and these jurisdictions
are legally committed to provide administrative assistance and are
actually providing the same in cases where requests are made.
Information and other forms of assistance can also be requested through
Mutual Legal Assistance Treaties (MLAT s) through Ministry of Home
Affairs, particularly with countries/jurisdictions with which there is
no tax treaty. Information/evidence obtained through MLAT s can also
supplement the information received under tax treaties when a criminal
complaint is made for tax evasion on the basis of information received
under tax treaties. Information can also be obtained through Egmont
Group of Financial Intelligence Units (FIUs) which may be further
supplemented by making further requests under tax treaties/ MLAT s.

Despite
the existence of legal instruments for administrative assistance and
the willingness of India’s treaty partners to provide information, these
provisions are still underutilised, largely because tax officials are
not fully aware of the provisions and need guidance for framing
effective requests for information under appropriate legal instruments.
The taxpayers, their advisers and the tax officers may also not be fully
aware of the recent international developments in transparency
including the global adoption of the new standards on automatic exchange
of information, which will bring about a sea-change in India’s ability
to receive and utilize information regarding Indians having financial
accounts in offshore financial centres.

Thus there are nine major sources of EoI of various kinds relating to tax matters, which are summarised below:

1. EoI Article under the Model Conventions on Income and on Capital

2. Tax information Exchange Agreements [TIEAs]

3.
Automatic Exchange of Information [AEoI] under The Multilateral
Convention on Mutual Administrative Assistance in Tax Matters [CoMAA]
alongwith Multilateral Competent Authority Agreement on Automatic
Exchange of Financial Account Information [MCAA]

4. EoI under
Inter-Governmental Agreement [IGA] and Memorandum of Understanding (MoU)
between India and USA to improve International Tax Compliance and to
implement Foreign Account Tax Compliance Act [FAT CA] of the USA

5. SAARC Limited Multilateral Agreement [SAARC Agreement]

6. Mutual Legal Assistance Treaties [MLAT s]

7. The Egmont Group Financial Intelligence Units (FIUs)

8. Joint International Tax Shelter Information & Collaboration – JITSIC

9. EoI under Base Erosion and Profit Shifting [BEPS] Project.

Brief
outline of nine major sources of EoI of various kinds, is as under: In
this article, we aim to introduce to the readers various sources of EoI
amongst various authorities and various countries. Each one of the above
are discussed below in brief:

Sr. No. Source of EOI
Type of EoI and Purpose
1 Article 26 -OECD
Model Convention 		EoI under bilateral DTAA framework covering
EoI on request, Spontaneous and Automatic
EoI
2 TIEA TIEA facilitates EoI with countries where comprehensive
DTAA is non-existent to promote
international co-operation in tax matters
3 CoMAA EoI including AEoI in tax matters under the
most comprehensive Multilateral Convention.
AEoI is facilitated by MCAA.
4 IGA-FATCA AEoI on a reciprocal basis under the IGA
signed with USA
5 SAARC Agreement Limited Multilateral Agreement incorporating
EoI amongst 7 SAARC member Countries
6 MLATs EoI and mutual assistance in criminal matters,
inter alia, involving tax evasion
7 Egmont group of
FIUs		 International co-operation including EoI against
money laundering and financing of terrorism –
8 JITSIC To enhance collaboration amongst tax administrators
enabling EoI to combat multinational tax
evasion and to counter abusive tax schemes
and tax avoidance structures
9 Action plan 5,12
& 13 – BEPS project		 EoI including automatic exchange of countryby-
country reports, spontaneous exchange of
rulings and exchange of mandatory disclosure
regimes
1. Exchange of Information [EoI] Article under the Model Conventions on Income and on Capital

(a)
1928 Model developed by the League of Nations provided for provision of
Information on request and for Automatic EoI relating to Specific
Categories such as Immovable properties etc. In the London and Mexico
draft models of 1946, a Draft Agreement on Administrative Co-operation
was included. Both the Obligation and Form of Information Exchange were
narrowed during the formalisation of OECD Model after World War-II by
removing the obligation for Automatic Exchange of Information. The Draft
OECD Model was first developed in 1963 which contained Article on EoI.
Until 8th Edition released in 2010, Article 26 of the OECD Model
Convention contained the pre-updated version of Article 26. On 17th
July, 2012 Update to Article 26 and its commentary was approved by OECD
Council which extensively revised the commentary on Article 26. There
are three forms of EoI (On Request, Automatic and Spontaneous). Para 9
of the Commentary on Article 26 provides that all three forms of EoI are
covered by the Article.

In the update, in para 2 of Article 26
the following sentence was added: “Notwithstanding the foregoing,
information received by a Contracting State may be used for other
purposes when such information may be used for such other purposes under
the laws of both States and the competent authority of the supplying
State authorises such use.” Many of India’s DTAA s signed before July
2012 have been amended in recent past by way of Protocols to incorporate
the updated EoI Article. Most of the India’s DTAA s signed before July
2012 contain pre-updated Article 26 and DTAA s signed after July 2012
contain updated Article 26. (b) OE CD Model Convention – Text of Article
26 – Exchange of Information Text of the updated Article 26 of the OECD
Model Convention is reproduced below for ready reference: 1. The
competent authorities of the Contracting States shall exchange such
information as is foreseeably relevant for carrying out the provisions
of this Convention or to the administration or enforcement of the
domestic laws concerning taxes of every kind and description imposed on
behalf of the Contracting States, or of their political subdivisions or
local authorities, insofar as the taxation thereunder is not contrary to
the Convention. The exchange of information is not restricted by
Articles 1 and 2. 2. Any information received under paragraph 1 by a
Contracting State shall be treated as secret in the same manner as
information obtained under the domestic laws of that State and shall be
disclosed only to persons or authorities (including courts and
administrative bodies) concerned with the assessment or collection of,
the enforcement or prosecution in respect of, the determination of
appeals in relation to the taxes referred to in paragraph 1, or the
oversight of the above. Such persons or authorities shall use the
information only for such purposes. They may disclose the information in
public court proceedings or in judicial decisions. Notwithstanding the
foregoing, information received by a Contracting State may be used for
other purposes when such information may be used for such other purposes
under the laws of both States and the competent authority of the
supplying State authorises such use. 3. In no case shall the provisions
of paragraphs 1 and 2 be construed so as to impose on a Contracting
State the obligation: a) to carry out administrative measures at
variance with the laws and administrative practice of that or of the
other Contracting State; b) to supply information which is not
obtainable under the laws or in the normal course of the administration
of that or of the other Contracting State; c) to supply information
which would disclose any trade, business, industrial, commercial or
professional secret or trade process, or information the disclosure of
which would be contrary to public policy (ordre public). 4. If
information is requested by a Contracting State in accordance with this
Article, the other Contracting State shall use its information gathering
measures to obtain the requested information, even though that other
State may not need such information for its own tax purposes. The
obligation contained in the preceding sentence is subject to the
limitations of paragraph 3 but in no case shall such limitations be
construed to permit a Contracting State to decline to supply information
solely because it has no domestic interest in such information. 5. In
no case shall the provisions of paragraph 3 be construed to permit a
Contracting State to decline to supply information solely because the
information is held by a bank, other financial institution, nominee or
person acting in an agency or a fiduciary capacity or because it relates
to ownership interests in a person.” 2. Tax information Exchange
Agreements [TIEAs] The Model TIEA was released in April 2002, containing
Two Models of Bilateral Agreements. The Model TIEA covered only EoI on
Request. A large No. of bilateral agreements have been based on Model
TIEA. In June 2015, OECD approved a Model Protocol to the TIEA for the
purpose of allowing Automatic and Spontaneous exchange of information
under a TIEA. India has so far signed 16 TIEAs with countries with whom
India has not signed a Comprehensive DTAA , namely: Argentine, Bahrain,
Belize, Gibralter, Principality of Liechtenstein, Liberia, Macao SAR,
Monaco, Bahamas,

Bermuda, British Virgin Islands, Cayman Islands, Guernsey, Isle of Man, Jersey and Maldives.

The Model TIEA contains the following Articles:

Article Article heading
1 Object and Scope of the Agreement
2 Jurisdiction.
3 Taxes Covered
4 Definitions
5 Exchange of Information upon Request
6 Tax Examinations Abroad
7 Possibility of Declining a request
8 Confidentiality
9 Costs
10 Implementation Legislation
11 Language [This article may not be required in Bilateral TIEA.]
12 Implementation Legislation
13 Other international agreements or arrangements [This article may
not be required in Bilateral TIEA.]
14 Mutual Agreement Procedure
15 Depositary’s functions [This article may not be required in Bilateral
TIEA.]
16 Entry into Force
17 Termination

3. The Multilateral Convention on Mutual Administrative Assistance in Tax Matters [Co- MAA]

The
CoMAA was developed jointly by the OECD and the Council of Europe in
1988 and amended by Protocol in 2010. The CoMAA was amended to align it
to the international standard on exchange of information on request and
to open it to all countries. The amended Convention was opened for
signature on 1st June 2011.

The CoMAA has now taken an
increasing importance with the G20’s recent call for automatic exchange
of information to become the new international tax standard of exchange
of information.

As of 27-11-2015, 77 countries, including India
have signed the CoMAA and it has been extended to 15 jurisdictions
pursuant to Article 29 of The CoMAA. This represents a wide range of
countries including all G20 countries, all BRICS, almost all OECD
countries, major financial centres and a growing number of developing
countries.

India signed the CoMAA on 26-1-2012 which was notified on 28-8-2012 and which entered into force wef 1-6-2012.

a. Relevance of the CoMAA

  •  Designed
    to facilitate international co-operation among tax authorities to
    improve their ability to tackle tax evasion and avoidance and ensure
    full implementation of their national tax laws, while respecting the
    fundamental rights of taxpayers.
  •  Most comprehensive multilateral instrument available for tax cooperation and exchange of information.
  • Provides for all possible forms of administrative cooperation between states in the assessment and collection of taxes.
  • Co-operation
    includes automatic exchange of information, simultaneous tax
    examinations and international assistance in the collection of tax
    debts.

b.Benefits of the CoMAA

Scope of the Convention is broad: it covers a wide range of taxes and goes beyond exchange of information on request.

  •  Provides
    for other forms of assistance such as: spontaneous exchanges of
    information, simultaneous examinations, performance of tax examinations
    abroad, service of documents, assistance in recovery of tax claims and
    measures of conservancy and automatic exchange of information.
  • Facilitates joint audits.
  • Includes extensive safeguards to protect the confidentiality of the information exchanged.

c. Chapter III Section I – Article 4 to 5 relevant for EoI

The text of the same are given below for ready reference. Article 4 – General Provision

 “1.
The Parties shall exchange any information, in particular as provided
in this section, that is foreseeably relevant for the administration or
enforcement of their domestic laws concerning the taxes covered by this
Convention.

2. Deleted.

3. Any Party may, by a
declaration addressed to one of the Depositaries, indicate that,
according to its internal legislation, its authorities may inform its
resident or national before transmitting information concerning him, in
conformity with Articles 5 and 7.

Article 5 – Exchange of Information on Request

“1.
At the request of the applicant State, the requested State shall
provide the applicant State with any information referred to in Article 4
which concerns particular persons or transactions.

2. If the
information available in the tax files of the requested State is not
sufficient to enable it to comply with the request for information, that
State shall take all relevant measures to provide the applicant State
with the information requested.”

d. The CoMAA and Automatic Exchange of Information

Article
6 of the CoMAA provides for AEoI. It is an ideal instrument to
implement AEoI swiftly and multilaterally. To implement Article 6, an
administrative agreement between the competent authorities of two or
more interested Parties to the Convention is required. It would address
issues such as the procedure to be adopted and the information that will
be exchanged automatically.

Sharing of information with other
law enforcement authorities to counteract corruption, money laundering
and terrorism financing is permissible subject to certain conditions;
information received by a Party may be used for other purposes when

(i) such information may be used for such other purposes under the laws of the supplying Party and
(ii) the competent authority of that Party authorises such use.

e. Main benefits of Automatic Exchange

  • AE
    oI can provide timely information on non-compliance where tax has been
    evaded either on an investment return or the underlying capital sum.
  • Help detect cases of non-compliance even where tax administrations have had no previous indications of non-compliance.
  • Has deterrent effects, increasing voluntary compliance and encouraging taxpayers to report all relevant information.
  • Help
    in educating taxpayers in their reporting obligations, increase tax
    revenues and thus lead to fairness – ensuring that all taxpayers pay
    their fair share of tax in the right place at the right time.
  • Possibility
    to integrate the information received automatically with their own
    systems such that income tax returns can be prefilled.

f. Chapter III Section I – Article 6 to 10 relevant for AEoI

The text of the same are given below for ready reference. Article 6 – Automatic Exchange of Information

“With
respect to categories of cases and in accordance with procedures which
they shall determine by mutual agreement, two or more Parties shall
automatically exchange the information referred to in Article 4.”

Article 7 – Spontaneous Exchange of Information

“1.
A Party shall, without prior request, forward to another Party
information of which it has knowledge in the following circumstances:

a. the first-mentioned Party has grounds for supposing that there may be a loss of tax in the other Party;
b.
a person liable to tax obtains a reduction in or an exemption from tax
in the first mentioned Party which would give rise to an increase in tax
or to liability to tax in the other Party;
c. business dealings
between a person liable to tax in a Party and a person liable to tax in
another Party are conducted through one or more countries in such a way
that a saving in tax may result in one or the other Party or in both;
d.
a Party has grounds for supposing that a saving of tax may result from
artificial transfers of profits within groups of enterprises;
e.
information forwarded to the first-mentioned Party by the other Party
has enabled information to be obtained which may be relevant in
assessing liability to tax in the latter Party.

2. Each Party
shall take such measures and implement such procedures as are necessary
to ensure that information described in paragraph 1 will be made
available for transmission to another Party.”

Article 8 – Simultaneous Tax Examinations

“1.
At the request of one of them, two or more Parties shall consult
together for the purposes of determining cases and procedures for
simultaneous tax examinations. Each Party involved shall decide whether
or not it wishes to participate in a particular simultaneous tax
examination. 2. For the purposes of this Convention, a simultaneous tax
examination means an arrangement between two or more Parties to examine
simultaneously, each in its own territory, the tax affairs of a person
or persons in which they have a common or related interest, with a view
to exchanging any relevant information which they so obtain.”

Article 9 – Tax Examinations Abroad

“1.
At the request of the competent authority of the applicant State, the
competent authority of the requested State may allow representatives of
the competent authority of the applicant State to be present at the
appropriate part of a tax examination in the requested State.

2.
If the request is acceded to, the competent authority of the requested
State shall, as soon as possible, notify the competent authority of the
applicant State about the time and place of the examination, the
authority or official designated to carry out the examination and the
procedures and conditions required by the requested State for the
conduct of the examination. All decisions with respect to the conduct of
the tax examination shall be made by the requested State.

3. A
Party may inform one of the Depositaries of its intention not to accept,
as a general rule, such requests as are referred to in paragraph 1.
Such a declaration may be made or withdrawn at any time.”

Article 10 – Conflicting Information

“If
a Party receives from another Party information about a person’s tax
affairs which appears to it to conflict with information in its
possession, it shall so advise the Party which has provided the
information.”

g. Confidentiality of Information Exchanged under Co- MAA and Protection of taxpayers’ rights

  • The CoMAA has strict rules to protect the confidentiality of the information exchanged.
  • Provides
    that information shall be treated as secret and protected in the
    receiving State in the same manner as information obtained under its
    domestic laws.
  • If personal data are provided, the Party
    receiving them shall treat them in compliance not only with its own
    domestic law, but also with the safeguards that may be required to
    ensure data protection under the domestic law of the supplying Party.

h. Articles of Model CoMAA

The outline of the contents of the Model CoMAA is as under:

i. Standard for Automatic Exchange of Financial Account information in Tax Matters [Standard]

For facilitating the AEoI amongst various countries, OECD has developed a Standard. The Standard sets out

Chapter/Section/
Article		 Chapter / Section/ Article heading
Chapter I Scope of the convention
1 Object of the convention and persons covered
2 Taxes Covered
Chapter II General Definitions
3 Definitions
Chapter III Forms of Assistance
Section I Exchange of Information
4 General Provision
5 Exchange of Information on Request
6 Automatic Exchange of Information
7 Spontaneous Exchange of Information
8 Simultaneous Tax Examinations
9 Tax Examinations Abroad
10 Conflicting Information
Section II Assistance in Recovery
11 Recovery of Tax Claims
12 Measures of Conservancy
13 Documents accompanying the Request
14 Time Limits
15 Priority
16 Deferral of Payment
Section III Service of Documents
17 Service of Documents
Chapter IV Provisions relating to all forms of assistance
18 Information to be provided by the Applicant State
19 Deleted
20 Response to the Request for Assistance
21 Protection of Persons and Limits to the Obligation to provide
Assistance
22 Secrecy
23 Proceedings
Chapter V Special Provisions
24 Implementation of the convention
25 Language
26 Costs
Chapter VI Final Provisions
27 Other international agreements or arrangements
28 Signature and entry into force of the convention
29 Territorial application of the convention
30 Reservations
31 Denunciation
32 Depositaries and their functions
the financial account information to be exchanged, the financial
institutions & intermediaries that need to report, the different
types of accounts and taxpayers covered, as well as common due diligence
procedures to be followed by the financial institutions &
intermediaries. It consists of two components: (I) the CRS, which
contains the reporting and due diligence rules to be imposed on
financial institutions; and(II) the Model Competent Authority Agreement
[Model CAA], which contains the detailed rules on the exchange of
information.

The full version of the Standard, as approved by
the Council of the OECD on 15 July 2014, also includes the Commentaries
on the Model CAA and the CRS, and following seven annexes to the
Standard:

1. M ultilateral Model CAA;
2. N onreciprocal Model CAA;
3. CRS schema and user guide;
4. Example questionnaire with respect to confidentiality and data safeguards;
5. Wider Approach to the CRS;
6. Declaration on Automatic Exchange of Information in Tax Matters; and
7. Recommendation on the Standard.

j. Confidentiality of the Information Exchanged

The
Standard contains specific rules on the confidentiality of the
information exchanged and the underlying international legal exchange
instruments already contain safeguards in this regard.

  • Where the Standard is not met (whether in law or in practice), countries will not exchange information automatically.
  • To
    facilitate the decision making by Global Forum members as to which
    jurisdictions they will automatically exchange information with, the
    Global Forum AEOI Group is undertaking high level assessments of the
    confidentiality and data safeguards of jurisdictions committed to AEOI.
    Centralising this work in the Global Forum will further assist
    jurisdictions in speedily implementing AEOI, by reducing the need for
    each jurisdiction to conduct its own assessment of the information
    security practices of each of the many jurisdictions committed to
    implementing AEOI. The process is now underway with the first batch of
    around 50 assessments due to be finalised by the end of 2015 and the
    assessments with respect to the remaining committed jurisdictions due to
    be finalised by mid-2016.

k. Implementation of Standard at domestic level

  • No particular timelines in the Standard.
  • Implementation at co-ordinated timelines would bring benefits for both business and governments.
  • Over
    95 jurisdictions have already publicly committed to implement the
    Standard, either through the signing of the Multilateral Competent
    Authority Agreement, the G20 or the Global Forum commitment process,
    with first exchanges of information to occur in 2017 or 2018.

 l. Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information [MCAA]

The Agreement contains 8 sections and 6 Annexes as follows:

Section Section heading
1 Definitions
2 Exchange of Information with respect to Reportable Accounts
3 Time and Manner of Exchange of Information
4 Collaboration on Compliance and Enforcement
5 Confidentiality and Data Safeguards
6 Consultations and Amendments
7 Term of Agreement
7 Co-ordinating Body Secretariat
Annex Annex heading
A List of Non-reciprocal Jurisdictions
B Transmission Methods
C Specified Data Safeguards
D Confidentiality Questionnaire
E Competent Authorities for which this is an Agreement in effect
F Intended Exchange Dates

4. EoI under IGA re FATCA

FATCA is a USA law which seeks
to facilitate flow of financial information. FAT CA requires Indian
banks to reveal account information of persons connected to the USA.
Indian financial institutions in India, i.e. an insurance company, bank,
or mutual fund, would be required to report all FAT CA-related
information to Indian governmental agencies, which would then report
these information to Internal Revenue Service (IRS). Indian Financial
Institutions must report account numbers, balances, names, addresses,
and U.S. identification numbers. There is punitive 30% withholding tax
on any financial institution that fails to report.

India signed a
Model 1 (reciprocal) IGA with the U.S which is notified vide
Notification No. 77/2015 dated 30- 9-2015. For effective implementation
of FAT CA, Rules 115G to 115H has been notified vide Notification no.
62/2015 dated 7-8-2015. The IGA would require Indian financial
institutions to report information on U.S. account holders to India’s
CBDT, which would then share the information with the U.S. IRS. The
agreement would provide the IRS, access to details of all offshore
accounts and assets beyond a threshold limit held by American citizens
in India, while a reciprocal arrangement would be offered for Indian tax
authorities as well.

a. Articles of India-USA IGA
The contents of the Agreement are as follows:

Article Article heading
1 Definitions
2 Obligations to obtain and Exchange Information with respect
to Reportable Accounts
3 Time and Manner of Exchange of Information
4 Application of FATCA to Indian Financial Institutions
5 Collaboration on Compliance and Enforcement
6 Mutual commitment to continue to enhance the effectiveness
of Information Exchange and Transparency
7 Consistency in the application of FATCA to Partner Jurisdictions
8 Consultations and Amendments
9 Annexes
10 Term of Agreement
Annex Annex heading
I Due Diligence obligations for identifying and reporting on U.S.
Reportable Accounts and on payments to certain nonparticipating
financial institutions
II List of Entities treated as exempt beneficial owners or
deemed-compliant FFIs and accounts excluded from the
definition of Financial Accounts

Memorandum of Understanding [MoU]
b. Main differences between the Standard and FATCA

  • The Standard consists of a fully reciprocal automatic exchange system from which US specificities have been removed.
  • It is based on residence and unlike FAT CA does not refer to citizenship.
  • Terms,
    concepts and approaches have been standardised allowing countries to
    use the system without having to negotiate individual annexes.
  • Unlike
    FAT CA, the Standard does not provide for thresholds for pre-existing
    individual accounts, but it includes a residence address test building
    on the EU Savings Directive.
  • It also provides for a simplified indicia search for such accounts.
  • It
    has special rules dealing with certain investment entities where they
    are based in jurisdictions that do not participate in automatic exchange
    under the Standard. 5. SAARC Limited Multilateral Agreement SAARC
    Limited Multilateral Agreement (SAARC Agreement) is a multilateral
    agreement amongst SAARC countries and has been in force since 1st April,
    2011. It has provisions for a wide range of administrative assistance
    including EoI on a reciprocal basis. SAARC comprises of 7 countries i.e.
    Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. The
    text of Article 5 of the SAARC Agreement, relating to EoI is given
    below for ready reference.

“Article 5 – Exchange of Information

1.
The Competent Authorities of the Member States shall exchange such
information, including documents and public documents or certified
copies thereof, as is necessary for carrying out the provisions of this
Agreement or of the domestic laws of the Member States concerning taxes
covered by this agreement insofar as the taxation thereunder is not
contrary to the Agreement. Any information received by a Member State
shall be treated as secret in the same manner as information obtained
under the domestic laws of that Member State and shall be disclosed only
to persons or authorities (including courts and administrative bodies)
concerned with the assessment or collection of, the enforcement or
prosecution in respect of, or the determination of appeals in relation
to the taxes covered by the agreement. Such persons or authorities shall
use the information only for such purposes. They may disclose the
information in public court proceedings or in judicial decisions.

2. In no case shall the provisions of paragraph 1 be construed so as to impose on a Member State the obligation:
(a)
to carry out administrative measures at variance with the laws and
administrative practices of that or of the other Member State;
(b)
to supply information, including documents and public documents or
certified copies thereof, which are not obtainable under the laws or in
the normal course of the administration of that or of the other Member
State;
(c) to supply information which would disclose any trade,
business, industrial, commercial or professional secret or trade
process, or information, the disclosure of which would be contrary to
public policy (ordre public).”

6. Mutual Legal Assistance Treaties [MLATs]

The MLAT s are legal instruments through which the Contracting States agree to provide each other with the

widest measures of mutual legal assistance in criminal
matters emanating out of proceedings under direct taxes
and not for other tax enquiries. India has a MLAT with 39
countries enabling assistance from countries with which
there is no tax treaty such as Hong Kong.

The scope of cooperation is different in various MLAT s
but is normally quite wide and may include the following:

  • Provision of information, documents and other records
  • Taking of evidence and obtaining of statements of
    persons
  • Location and identification of persons and objects Execution of requests for search and seizure
  • Measures to locate, restrain and forfeit the proceeds
    and instruments of crime
  • Facilitating the personal appearance of the persons
    giving evidence
  • Service of documents including judicial documents
  • Delivery of property, including lending of exhibits
  • Other assistance consistent with the objects of the
    MLAT which is not inconsistent with the law of the requested
    State (catch all provision).

7. The Egmont Group Financial Intelligence
Units (FIUs)

The Egmont Group is an informal network of FIUs established
with a view to have international cooperation
including information exchange in the fight against
money laundering and financing of terrorism. As on 1st
May, 2015, FIUs of 147 countries are part of the Egmont
Group. The FIUs of the Group exchange information in
accordance with Egmont Principles for Information Exchange
and Operational Guidance for FIUs, which is
available on the Internet.

The tax authorities may request information available
with FIUs of other countries through FIU-IND (the Indian
FIU) using the information exchange mechanism of the
Egmont Group.

MoU between FIU and CBDT

On 20th September, 2013, a Memorandum of Understanding
(MoU) was entered into between FIU and CBDT
in which it has been provided that if CBDT requires information
from a foreign FIU, a request will be made to
FIU-IND in Egmont prescribed proforma in electronic
format and CBDT shall abide by the conditions that may
be imposed by the foreign FIU on the use of information
provided by the foreign FIU.

Clause Clause heading
1 General
2 Exchange of Information
3 Data Protection and Confidentiality

8. Joint International Tax Shelter Information & Collaboration – JITSIC

The
original Joint International Tax Shelter Information Centre was created
in 2004 as a joint revenue authority initiative of Australia, Canada,
the United Kingdom and the United States to counter abusive tax schemes
and tax avoidance structures. Later on, Japan, Germany, South Korea,
France and China joined the JITSIC. The Competent Authorities of these
countries exchange information through the legal instrument of DTAA s
including sharing expertise relating to the identification and
understanding of abusive tax arrangements. Under the JITSIC framework,
the Competent Authorities are able to put the various international
pieces together to examine complex cross border transactions, such as
non-commercial capital and finance arrangements, aggressive transfer
pricing strategies and foreign tax credit generation schemes. Similarly,
structures involving tax havens and trust structures in connection with
high net wealth individuals also came under JITSIC scrutiny.

Recognising
that the information exchanges should not be limited to the original
JITSIC member countries, on a call from G20, the Forum on Tax
Administration A) of the OECD in its 9th Meeting in Dublin on 24th
October, 2014, determined that the composition of JITSIC would be
expanded and remodeled with a greater focus on collaboration. Reflecting
this change, the taskforce was renamed as the Joint International Tax
Shelter Information & Collaboration (still called JITSIC) with an
emphasis on collaboration on information exchange and a de-emphasis on
the need for exchange to occur through central hubs. The JITSIC Network
is open to all FTA members on a voluntary basis and integrates existing
JITSIC cooperation procedures among tax administrators within the larger
FTA network. India has joined the JITSIC Network and Joint Secretary
(FT&TR-I) has been appointed as the Single Point of Contact for
India.

9. EoI under BEPS Project

Base Erosion and
Profit Shifting refers to strategies adopted by taxpayers having
cross-border operations to exploit gaps and mismatches in tax rules of
different jurisdictions which enable them to shift profits outside the
jurisdiction where the economic activities giving rise to profits
areperformed and where value is created. At the request of G20 Finance
Ministers, in July 2013 the OECD, working with G20 countries, launched
an Action Plan on BEPS, identifying 15 specific actions needed in order
to equip governments with the domestic and international instruments to
address this challenge.

A number of recommendations for
combating BEPS envisage enhanced cooperation amongst the tax
administrations and exchange of information as per the provisions of the
existing network of tax treaties, including the following:

a. Automatic Exchange of Country by Country [CbC] Reports – Action 13

Action 13 of the BEPS Action Plan relates to a three-tiered standardised approach to transfer-pricing documentation comprising:

  • a master file of information relating to the global operations of the MNE Group, which will be filed by all MNE group members,
  • a local file referring specifically to material transactions of the local taxpayer, and
  • a
    CbC report of information relating to the global allocation of the MNE
    group’s income and taxes paid, alongwith certain indicators of economic
    activity. While the master file and local file will be filed by the
    taxpayer in the local jurisdiction, the CbC report will be filed in the
    country where the MNE is resident and will be transmitted on an
    automatic basis to the jurisdictions in which the MNE operates through a
    multilateral instrument modelled on the basis of MCAA, maintaining
    confidentiality and data safeguarding standards.

b. Spontaneous Exchange of Rulings – Action 5

Action
5 of the BEPS Project relates to countering harmful tax practices more
effectively taking into account transparency and substance. To address
this, the taxpayer specific rulings related to tax regimes resulting in
BEPS need to be mandatorily exchanged on a spontaneous basis.
Taxpayer-specific rulings for this purpose would include both
pre-transaction, including advance tax rulings or clearances and advance
pricing agreements, and post transaction.

c. Exchange of Mandatory Disclosure Regimes – Action 12 Under

Action
12, modular rules for mandatory disclosure of aggressive or abusive
transactions, arrangements, or structures would be recommended to enable
tax administrators to receive information about tax planning strategies
at an early stage so as to respond quickly to tax risks either through
timely and informed changes to legislation and regulations or through
improved risk assessment and compliance programmes (targeted audits).
Under these rules, the “international tax schemes” would also be
disclosed and the same may be shared by tax administrators using the
mechanism of EoI

This Article gives only a brief overview of the
framework of the Exchange of Information in Tax matters. The subject is
receiving increasing attention of the Governments and Tax
Administrations of various countries. It is very important for the
taxpayers & their advisors to gain an in-depth understanding of the
evolving subject. Therefore, the reader needs to study the relevant
Agreements / MOUs / Protocols / Standards in greater detail.

DTAA – “International traffic” under Art 8 of India-Singapore DTAA – Journey of a vessel between two Indian ports is “international traffic” if the same is part of a larger journey between two foreign ports – It is only when a ship or aircraft is operating ‘solely’ between places in a contracting state that the transport is excluded from scope of “international traffic”

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CIT vs. Taurus Shipping Services; [2015] 64 taxmann. com 64 (Guj):

The
assessee is a company and had acted as an agent of three vessels which
had transported goods from Kandla Port to Visag. The freight beneficiary
was one M/s. Jaldhi Overseas Pte Limited, who claimed benefit of DTAA
between India and Singapore. The vessels had undertaken such freight
transportation during the journey from Singapore elude to Dubai. The
Assessing Officer came to the conclusion that such transportation
between Kandla to Visag cannot be considered as international traffic as
defined in DTAA between India and Singapore. The Tribunal held in
favour of the assessee relying on the decision of the Tribunal in
similar cases.

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

“i)
U nder Art 8 of India-Singapore DTAA , the journey of a vessel between
two Indian ports is “international traffic” if the same is part of a
larger journey between two foreign ports. It is only when a ship or
aircraft is operating ‘solely’ between places in a contracting state
that the transport is excluded from scope of “international traffic”.

ii)
It is not the case of the Revenue that the journey being undertaken by
such vessels in question were confined between the two ports in India
either routinely or even in individual isolated case.”

Depreciation – Additional depreciation – Section 32(1)(iia) – A. Y. 2008-09 – Assessee is engaged in the business of FM radio broadcasting, producing, recording, editing and making copies of the radio programme amounts to manufacture/production of article or things – Radio programme produced is “thing” if not an “article” as Dictionary meaning of the word envisages that “thing” could have intangible characteristic – Assessee is entitled to additional depreciation

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CIT vs. Radio Today Broadcasting Ltd.; [2015] 64 taxmann.com 164 (Delhi):

Assessee is engaged in the business of FM radio broadcasting. In the A. Y. 2008-09, the assessee had claimed additional depreciation u/s. 32(1)(iia). AO rejected the Assessee’s contention that the above radio programmes were “the articles or things produced by it”. The AO held that “by no stretch of imagination can ‘production of radio programmes’ be considered as ‘production of article or thing’. The additional depreciation claimed was disallowed. The Tribunal allowed the assessee’s claim.

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

“i) Radio programme produced is “thing” if not an “article” as Dictionary meaning of the word envisages that “thing” could have intangible characteristic. The production of radio programmes involved the processes of recording, editing and making copies prior to broadcasting.

ii) When the radio programmes is made there comes into existence a ‘thing’ which is intangible, and which can be transmitted and even sold by making copies. ‘manufacture’ could include a combination of processes. In the context of ‘broadcast’ it could encompass the processes of producing, recording, editing and making copies of the radio programme followed by its broadcasting. The activity of broadcasting, in the above context, would necessarily envisage all the above incidental activities which are nevertheless integral to the business of broadcasting.

iii) In that view of the matter, the Assessee can be said to have used the plant and machinery acquired and installed by it after 31st March 2005 for manufacture/ production of an ‘article or thing.’

 iv) Since the Assessee has satisfied the requirements of Section 32 (1) (iia) of the Act, it is entitled to the additional depreciation as claimed by it for the assessment year in question.”

Charitable purpose – Exemption u/s. 11 – Management and development programme and consultancy charges part and parcel of Institute of management studies set up by assessee – No element of business in conducting management courses – Surplus funds applied towards attainment of objects of institute – Income generated from giving various halls and properties – Assesse entitled to exemption u/s. 11

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DIT(E) vs. Shri Vile Parle Kelvani Mandal; 378 ITR 593 (Bom):

The assessee trust set up thirty schools and colleges. The Tribunal held that the management and development programme and consultancy charges were part and parcel of the institute of management studies set up by the assessee. The Tribunal found that the element of business was missing in conducting the management courses and that some surplus was generated which itself was applied towards the attainment of the object of the educational institute and that separate books of account could not be insisted upon. The Tribunal held that the assessee is entitled to exemption u/s. 11.

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

“i) The finding of fact arrived at by the Tribunal could not be termed perverse and it was in consonance with the factual aspect regarding the activities of the trust and the object that it was seeking to achieve.

ii) The letting out of halls for marriages, sale and advertisement rights had not been found to be a regular activity undertaken as a part of business. The income was generated from giving various halls and properties of the institution on rental only on Saturdays and Sundays and on public holidays when they are not required for educational activities, and this could not be said to be a business which was not identical to attainment of the objects of the trust. This being merely an incidental activity and the income derived from it having been used for the educational institute and not for any particular person, and separate books of account having been maintained, this income could not be brought to tax.”

Penalty – Concealment of income – Section 271(1) (c): A. Y. 2001-02 – Allowability of deduction pending consideration by High Court in appeal – Admission of appeal makes it clear that addition is debatable – No concealment of income – Penalty could not be imposed

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CIT vs. Ankita Electronics Pvt. Ltd.; 379 ITR 50 (Karn):

The assessee is engaged in the business of computer consumables. Assessee’s quantum appeal was admitted by the High Court and was pending adjudication u/s. 260A . The Tribunal cancelled the penalty imposed by the Assessing Officer u/s. 271(1)(c) on account of the fact that the quantum appeal has been admitted by the High Court.

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

“i) In the present case, the details of the claim were provided by the assessee. The question whether or not on such details, deduction could be allowed was still in doubt. Such questions had been admitted for determination by the High Court in the appeal filed by the assessee. The mere admission of the appeal by the High Court on the substantial question of law would make it apparent that the additions made were debatable.

ii) There was no concealment of income or furnishing of inaccurate particulars of income. Penalty could not be imposed u/s. 271(1)(c) of the Act.”

Assessment – Sections 143(2), 143(3) and 147 – A. Ys. 2006-07 to 2011-12 – Assessment u/s. 143(3) – Condition precedent – Issue of valid notice u/s. 143(2) – Difference between issue and service of notice – Deeming fiction – Section 292BB not applicable to non-issue of notice

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ACIT vs. Greater Noida Industrial Development Authority; 379 ITR 14 (All): 281 CTR 204 (All):

The assessee challenged the validity of the assessment orders before the Tribunal on the following ground:

“That the order of learned Assessing Officer is void ab initio in so much as no mandatory notice u/s. 143(2) of the Income-tax Act, 1961, was issued at any stage of the assessment proceedings.”

The Tribunal allowed the appeals and quashed the assessment orders holding that the mandatory requirement of issuance of a notice u/s. 143(2) was not followed and, therefore, it was incurable and that the defect in the assumption of jurisdiction by the Assessing Officer could not be cured by taking recourse to the deeming fiction u/s. 292BB of the Act.

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

“i) Since the Assessing Officer failed to issue notice within the specified period u/s. 143(2) of the Act, the Assessing Officer had no jurisdiction to assume jurisdiction u/s. 143(2) of the Act and this defect could not be cured by recourse to the deeming fiction provided u/s. 292BB of the Act.

ii) Consequently, the Tribunal was justified in setting aside the orders of the Assessing Officer.”

Deduction u/s 80-IB(10) – Delay in Receipt of Completion Certificate

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Issue for Consideration
Section 80-IB(10) of the Income-tax Act, 1961 provides for a deduction of 100% of the profits derived from the undertaking of developing and building a housing project approved before 31st March 2008 by a local authority. One of the conditions, contained in clause(a) of s. 80IB(10), subject to which this deduction is granted is that the undertaking has commenced development and construction of the housing project on or after 1st October 1998, and completes such construction:

(i) where the housing project has been approved by the local authority before 1st April 2004, on or before 31st March 2008;

(ii) where the housing project has been approved by the local authority on or after 1st April 2004 but not later than 31st March 2005, within 4 years from the end of the financial year in which the housing project was approved by the local authority;

(iii) where the housing project has been approved by the local authority on or after 1st April 2005, within 5 years from the end of the financial year in which the housing project was approved by the local authority.

The explanation to clause (a) of this sub-section clarifies that the date of completion of construction of the housing project shall be taken to be the date on which the completion certificate in respect of the housing project is issued by the local authority.

Given the fact that there are often delays in issue of the completion certificate by the local authority, the question has arisen before the courts as to whether the benefit of the deduction would be available in a situation where the completion certificate is issued by the local authority beyond the specified time limit, though the actual construction may have been completed within the permissible time-limit. The issue has also arisen as to whether this time limit applies to housing projects whose plans have been approved prior to 1st April 2005, and whether the deduction would be available where the completion certificate has been obtained belatedly, though the housing project has been certified to have been completed within the specified time period.

While the Gujarat and the Delhi High Courts have taken the view that the deduction would be available in cases where completion certificate is not obtained within the prescribed time, the Madhya Pradesh High Court has taken a contrary view and held that the deduction would not be available in such cases.

CHD Developers’ case
The issue came up for consideration before the Delhi High Court in the case of CIT vs. CHD Developers Ltd. 362 ITR 177.

In that case, the assessee, a real estate developer launched a project in Vrindavan, for which it obtained the approval from the Mathura Vrindavan Development Authority on 16th March 2005. It applied for a completion certificate from the authority on 5th November 2008. For assessment year 2007-08, the assessee claimed a deduction u/s. 80-IB(10).

The assessing officer disallowed the claim for deduction u/s. 80-IB(10), on the ground that the completion certificate had not been granted for the project. The Commissioner(Appeals) upheld the order of the assessing officer.

The Tribunal allowed the benefit of the deduction to the assessee on the following grounds:

(i) the approval for the project was granted on 16th March 2005, before the insertion of the time limits for completion of the project u/s. 80-IB(10), which came into effect from 1st April 2005. Prior to insertion of these time limits for completion of the project, the only requirement of time was that the development and construction of the housing project should commence on or after 1st October 1998. Therefore, at the time of sanction of the project, there was no condition for production of completion certificate.

(ii) It is a settled position in law that the law existing at a particular point of time will be applicable unless and until it is specifically made retrospective by the legislature. The insertion of the requirement of completion certificate within a particular time frame was applicable prospectively and not retrospectively. Had the legislature so intended, nothing prevented the legislature from doing so.

(iii) It was evident from the letter filed for request of completion certificate on 5th November 2008 that the construction had been completed and the request was made for grant of completion certificate of phase I. Since the development authority had neither said that the project was not complete, nor completion certificate was issued to the assessee, the project was presumed to be complete as on 5th November 2008.

(iv) if such certificate was not issued to the assessee, the assessee could not be penalised for the act of an authority on which it had no control, in the absence of any variation or allegation.

Reliance was placed by the tribunal on the decision in the case of CIT vs. Anriya Project Management Services (P) Limited 209 Taxman 1 ( Karn.) for the proposition that the amendment was prospective and did not apply to projects approved before 1st April 2005, where the court had held that another amendment made at the same time to section 80-IB(10), inserting the definition of built-up area, was prospective in nature applicable from 1st April 2005, and did not apply to housing projects approved by the local authority prior to that date.

Besides various other decisions of the Tribunal, the Tribunal had also relied upon the decision of the Gujarat High Court in the case of CIT vs. Tarnetar Corporation 362 ITR 174, in deciding the issue in favour of the assessee.

The Delhi High Court, after considering the decision of the tribunal, noted the decisions of the Karnataka High Court in the case of Anriya Project Management Services (P) Limited (supra), the Bombay High Court in the case of CIT vs Brahma Associates 333 ITR 289, and the Gujarat High Court in the case of Manan Corpn. vs. Asst CIT 214 Taxman 373, all of which had taken the view that the amendments to section 80-IB(10) , effective 1st April 2005 were prospective in nature, and not retrospective.

The Delhi High Court also considered instruction number 4 of 2009 dated 30th June 2009 issued by the CBDT, where the CBDT had clarified that the deduction u/s. 80- IB(10) could be claimed on a year-to-year basis, where the assessee was showing profit from partial completion of the project in every year, and in case it was later found that the condition of completion of the project within the specified time limit of 4 years had not been satisfied, the deduction granted to the assessee in earlier years should be withdrawn. The Delhi High Court inferred from the said instruction that in the post-amendment period, strict adherence to completion period of 4 years was insisted upon where project completion method was followed, and that the limitation of period did not exist prior to the amendment. If an assessee was following percentage of completion method, it would have got the deduction for the earlier years prior to the amendment, but because it was following completed contract method, and the contract was completed after the amendment, the deduction was being denied to it. According to the Delhi High Court, the amendment could not discriminate against those assessees following project completion method.

The Delhi High Court noted that in the case before it, the approval of project for commencement was given prior to the amendment, which required the obtaining of completion certificate within the end of the 4 year period. It agreed with the Gujarat High Court, that the application of such stringent conditions, which were left to an independent body such as the local authority, which was to issue the completion certificate, would have led to not only hardship, but absurdity. Accordingly, the Delhi High Court held that the assessee was entitled to the deduction, and upheld the decision of the Tribunal.

A similar view was taken by the Gujarat High Court in the case of CIT vs. Tarnetar Corporation (supra). In that case, the assessee had applied and got approval for the housing project from the local authority before 1st April 2004, and therefore, had to complete the project by 31st March 2008. It completed the construction in the year 2006 and applied for completion certificate in February 2006. This application was rejected in July 2006 for technical reasons, and thereafter, after fresh effort, the completion certificate was received on 19th March 2009. In the meanwhile, several residential units were sold and occupied without the necessary permission before the last date for completion of construction, for which the assessee paid a penalty and got such occupation regularised.

The Gujarat High Court held that it was not in doubt that the assessee had completed the construction well before 31st March 2008. It was true that formal completion certificate was not granted by the municipal authority by that date, and that section 80-IB linked the completion of the construction to the completion certificate being granted by the local authority. However, according to the Gujarat High Court, not every condition of the statute could be seen as mandatory. If substantial compliance of the conditions was established on record, the court could take the view that minor deviation therefrom would not vitiate the very purpose for which deduction was being made available. Accordingly, the Gujarat High Court had held that the assessee was entitled to the benefit of the deduction in that case.

A similar view was also taken by the Bombay High Court in the case of CIT vs. Hindustan Samuh Awas Ltd. 377 ITR 150, holding that mere delay in receipt of completion certificate could not result in denial of the deduction.

Global Reality’s case
The issue came up again recently before the Madhya Pradesh High Court in the case of CIT vs. Global Reality 379 ITR 107.

In this case, the approval for the housing project was granted by the Municipal Corporation before 31st March 2004. The assessee on completion of the project applied to the Municipal Corporation for completion certificate on 16th January 2008. The Inspector of the Municipal Corporation inspected the site on 27th February 2008. The completion certificate was however issued on 4th May 2010, and the certificate did not mention the date of completion of the project. By a subsequent letter dated 23rd March 2011, the Municipal Corporation clarified that the date of completion of the project was 27th February 2008.

The assessee claimed deduction u/s. 80-IB(10) on the basis that the project was completed before the cutoff date, but this claim was rejected by the assessing officer on the ground that in spite of repeated opportunity given to the assessee during assessment proceedings, the completion certificate obtained before 31st March 2008 was not produced before him, and that on inquiry, in December 2008, the Municipal Corporation had confirmed that completion certificate had not been issued to the assessee till that date, and that the application of the assessee was still being processed. The assessee’s appeal was dismissed by the Commissioner(Appeals), but was allowed by the Income Tax Appellate Tribunal.

Before the High Court, it was argued on behalf of the revenue, that the tribunal had misconstrued the effect of section 80-IB(10)(a), as amended, and that the benefit was available only to specified housing projects, which were completed within the prescribed time. According to the revenue, the express provision introduced in the form of amended clause (a) of section 80-IB(10) must be construed on its own, and not on the logic applicable to other situations mentioned in the same section, where the courts had taken the view that the amended law applied only to projects approved on or after 1st April 2005. The stipulation contained in clause(a) was in the nature of withdrawal of benefit of deduction in respect of projects which had not or could not be completed within the stipulated time. The date of completion of construction had been defined to be the date on which the completion certificate was issued by the local authority. For that, sufficient time had been provided to the developer to complete the project and obtain completion certificate from the local authority well within time.

According to the revenue, in case of housing projects approved before the amendment, they were required to be completed before 31st March 2008, irrespective of the date of approval. In respect of housing projects approved on or after 1st April 2004, they were required to be completed within 4 years from the end of the financial year in which the housing project was approved by the local authority.

It was argued on behalf of the Department that as per clause (ii) of the explanation to section 80-IB(10)(a), compliance of this condition was mandatory. Any other interpretation would result in rewriting the amended provision and render the legislative intent of explicitly providing for the date on which completion certificate was issued by the local authority otiose. The very nature of amended provision in clause (a) showed that it could not be construed as having retrospective effect. Further, developers of housing projects had been treated evenly by giving 4 years time frame from the coming into force of the amendment to complete their projects and for obtaining completion certificate from the local authority with the same time. Any other interpretation would be flawed, as it would result in treating similarly placed persons unequally, as projects approved prior to the amendment would get an unlimited extended period to obtain completion certificate from the local authority to avail of the deduction. By providing an identical cut off period for obtaining completion certificate to similarly placed persons, no hardship whatsoever had been caused.

It was further argued that it was always open to the legislature to provide benefit of deduction to be availed of during a specified period on fulfilment of certain conditions. The 4 years time frame given to the respective class of developers could, by no standards, be said to be asking them to do something which was impossible. Further, it was not a case of withdrawal of benefit or of any vested rights in the concerned assessee, since no developer could claim vested right to continue with the project for an indefinite period. It was argued that the amended provision could neither be termed as amounting to change of any condition already specified nor could it said to be unreasonably harsh or producing absurd results.

On behalf of the assessee, reliance was placed on the Supreme Court decisions in the cases of CIT vs. Veena Developers 227 CTR 297 and CIT vs. Sarkar Builders 375 ITR 392, where the Supreme Court had held that section 80-IB(10) as a whole had prospective application and would not apply to housing projects approved by the local authority before the amendment. It was claimed that in any case, an assessee, who maintained books of accounts on work in progress method, as in the assessee’s case, would not be covered by the condition of obtaining completion certificate before the cut-off date. It was further argued that there was a substantial compliance with the condition, even if the completion certificate issued by the local authority was issued after the cut-off date, since the certificate unambiguously recorded the date of completion of project before the cutoff date. The assessee had no control over the working of the local authority, and once the application for issue of completion certificate had been filed prior to 31st March 2008, but the local authority finally issued the certificate after 1st April 2008, confirming that the project was in fact completed before the cut-off date, the assessee must be granted the benefit of the deduction. Taking a contrary view would result in asking an assessee to do something which was impossible and not within its control. The delay caused by the local authority in processing and issuing the completion certificate could not be the basis of denial of benefit to the assessee. Besides placing reliance on the two Supreme Court decisions, the assessee relied on various other High Court decisions, including those of the Gujarat High Court in the case of Tarnetar Corporation (supra) and of the Delhi High Court in the case of CHD Developers Ltd (supra).

The Madhya Pradesh High Court referred to the decision of the Supreme Court in the case of Sarkar Builders (supra). It noted that the issue in that case, as well as in the case of Veena Developers, related to non-compliance with the conditions in other clauses of section 80-IB(10), in particular, clause (d), relating to the commercial area not exceeding 5% of the total project area, and not in relation to the conditions in clause (a), which were the subject matter of the appeal before the High Court. In the case of Sarkar Builders, the Supreme Court had noted that all other conditions were fulfilled by the assessee, including the date by which approval was to be given and the date by which the projects were to be completed. The Supreme Court observed that if clause (d) was applied to projects approved prior to the amendment and completed within the specified time, it would result in an absurd situation and would amount to expecting the assessee to do something which was almost impossible. It was on that basis that the Supreme Court held that the provisions such as clause (d) would have prospective application, and would not apply to projects approved prior to the amendment. Since clause (d) was treated as inextricably linked with the approval and construction of the housing project, the assessee could not be called upon to comply with a new condition, which was not in contemplation either of the assessee or even of the legislature, at the time when the housing project was given approval by the local authority.

Further, the Madhya Pradesh high court observed, the Supreme Court noted that if such a condition was held applicable to projects approved prior to the amendment, then an assessee following the project completion method of accounting would not be entitled to the entire deduction claimed in respect of such housing project merely because he offered his profits to tax in assessment year 2005-06 or a subsequent year, while an assessee following the work in progress method of accounting would be entitled to the deduction u/s. 80-IB(10) up to assessment year 2004-05, and would be denied the benefit only from assessment year 2005-06. According to the Supreme Court, it could never have been the intention of the legislature that the deduction u/s. 80-IB(10) available to a particular assessee should be determined on the basis of the method of accounting followed. The Supreme court therefore held that section 80-IB(10)(d) was prospective in nature, and would not apply to projects approved prior to the amendment.

The Madhya Pradesh High Court, then referred to the decisions of the Delhi High Court in the case of CHD Developers and of the Gujarat High Court in the case of Tarnetar Corporation. The court noted that though the Delhi High Court had referred to the prospective applicability of clause (d) of section 80-IB(10), which was dealt with by the Supreme Court in Veena Developers and Sarkar Builders cases, it finally concluded on the basis that the application of a stringent condition, which was left to an independent body, such as a local authority, which was to issue the completion certificate, would result in causing hardship to an assessee and also result in absurdity. The court further noted that the Gujarat High Court had found that the assessee completed the construction well before the last date, and also sold several units which were completed and actually occupied, and it had also applied for the permission to the local authority before that date and the court’s decision was on the basis of the finding recorded by the tribunal that the construction was completed in 2006, and that the application for completion certificate was submitted to the principal authority in February 2006. It was in the context of those facts that the Gujarat High court went on to observe that not every condition of statute can be seen as mandatory and that a substantial compliance of such condition was substantiated, the court can take the view that minor deviation thereof would not vitiate the very purpose for which deduction was being made available. The Madhya Pradesh High Court having noted the above stated facts and the reasons for the decisions by the high courts, expressed its inability to agree with the decisions of the Delhi and Gujarat High Courts.

According to the Madhya Pradesh High Court, the Supreme Court decisions in the case of Veena Developers and Sarkar Builders had to be understood only in the context of a new condition stipulated regarding the built-up area of the project, by way of an amendment through clause (d), with which the assessee could not have complied at all, even though the construction of the housing project was otherwise in full compliance of all conditions set out in the approval given by the municipal authority. In the view of the Madhya Pradesh High Court, clause (a) could not be considered as a condition that was sought to be retrospectively applied, and that too incapable of compliance, since it dealt with the time frame within which the incomplete housing project was expected to be completed to get the benefit of the prescribed deduction.

According to the Madhya Pradesh High Court, it could not be treated as a new condition linked to the approval and construction, or having retrospective effect as such, since it gave at least 4 years timeframe to both class of housing projects, those approved prior to 1st April 2004 or after 1st April 2004. The 4 years period obviously had prospective effect, though limiting the period for completion of the project to avail of the benefit and such period of 4 years could not be said to be unreasonable, harsh, absurd or incapable of compliance.

The Madhya Pradesh High Court was of the view that it was also not a case of withdrawal of vested right of the developer, since no developer could claim vested right to complete the housing project in an indefinite period. The right arising from section 80-IB was coupled with the obligation or duty to complete the project in the specified time frame. If the developer did not complete the housing project within the specified time, it would not receive that benefit. According to the Court, the provision for claiming tax deduction for profits could certainly prescribe reasonable conditions and time frame for completion of the project in larger public interest.

Addressing the argument as to whether the stipulation contained in clause(a) of section 80-IB(10) could be said to be directory, the Madhya Pradesh High Court observed that considering the substantial benefit offered by section 80-IB of 100% of the profits, which was a burden on the public exchequer due to waiver of commensurate revenue, and the purpose underlying the same, the stipulation for obtaining completion certificate from the local authority before the cut-off date must be construed as mandatory. The fact that compliance with this condition was dependent on the manner in which the proposal was processed by the local authority, could not make the provision a directory requirement. According to the Madhya Pradesh High Court, it was a substantive provision mandating issuance or grant of completion certificate by the local authority before the cut-off date, as a precondition to get the benefit of tax deduction. Otherwise, it would be open to an assessee to rely on other circumstances or evidence to plead that the housing project was complete, requiring enquiry into those matters by the tax authorities, in the absence of a completion certificate. According to the High Court, if the argument of substantial compliance were accepted, it would lead to uncertainty about the date of completion of the project, which was the hallmark for availing of the benefit of tax deduction. It was only with this intent, according to the High Court, that the legislature had laid down that the date of completion of construction was taken to be the date on which the completion certificate was issued by the local authority. The Madhya Pradesh High Court observed that to interpret it to include a subsequent certificate issued after the cut-off date would not only result in rewriting of the express provision, but also run contrary to the unambiguous position pronounced in the section and would be against the legislative intent.

According to the Madhya Pradesh High Court, the provision should then have read as “date of completion of construction of the housing project shall be taken to be the date certified by the local authority in that behalf”, irrespective of the date of issuance of such certificate by the local authority. The High Court observed that only if the assessee was able to prove that the completion certificate was in fact issued by the local authority before the cut-off date, but could not be produced by the assessee within the time due to reasons beyond its control, the argument of substantial compliance of the provision could be tested. Any other interpretation would result not only in uncertainty, but the finding regarding the date of completion also would depend upon the subjective satisfaction of the assessing authority and invest wide discretion in that authority, which eventually would lead to litigation. According to the High Court, if the assessee had failed to comply with the condition of obtaining completion certificate from the local authority before the cut-off date, it must bear the consequence thereof of the denial of benefit of tax deduction offered to it.

The Madhya Pradesh High Court therefore held that the issuance of completion certificate after the cut-off date by the local authority, though mentioning the date of completion of the project before the cut-off date, did not fulfil the conditions specified in 80-IB(10)(a) read with explanation (ii), and accordingly the assessee was not entitled to the benefit of the deduction.

Observations
The condition of obtaining the completion certificate within the prescribed time is applicable to all the projects irrespective of the date of commencement of project and, looked at from the said point of view, the issue on hand has wider implications. The ratio of the decision of the Madhya Pradesh High Court, if held to be laying down the correct law on the subject, can have serious ramifications. The courts generally, while dealing with the requirement of obtaining certificates by prescribed dates, have taken a liberal view in favour of assesses in cases where the compliance in principle is shown to have been ensured. On touchstone of this test, it may be fair to demand that the benefit of deduction u/s. 80IB(10) should not be denied in cases where the project has been completed by the prescribed date but the application for certificate has been delayed or the cases where the application has been made within the prescribed time but the certificate is issued after the prescribed date. This position in law can be supported by the ratio of the decisions of the Delhi and Gujarat High Courts, squarely and fairly. In our considered opinion, no issue should revolve around the situation discussed in this paragraph and the assesseee should be conferred with the benefit of deduction in respect of the profits and gains derived from a housing project.

In cases where the project has commenced on or after the amendment, difficulties would arise where the assessee has failed to even complete the project by the prescribed date. In such cases, it may be difficult for the assessee to be the beneficiary of the deduction unless the courts read down the explanation to clause(a) or grant deduction on liberal construction of incentive provisions. It may not be possible otherwise to claim deduction, as the legislature has not only forewarned the assessee but has given sufficient time for completion, unless of course the courts read down the said explanation that stipulates time for completion, independent of the main provision. It may not be appropriate to suggest that the condition providing for obtaining of certificate from a local body is absurd, simply because it is a local body. It may also not be possible for the post amendment projects to be covered by the ratio of the decision in Veena Developers’ case, which dealt with the pre amendment project, and that too a pre amended assessment year. Nor will it be possible to be covered by the ratio of the decision in the case of Sarkar Builders’ case which dealt with the pre amended project and post amendment assessment of such a project. The post amendment projects claiming deduction in post amendment assessment years can be said to be claiming deduction with eyes wide open, and would be expected to comply with the conditions. Seeking a ‘read down’ is the best option for them.

As regards the pre-amendment projects, claiming deduction in the post amendment assessment years’, the decision of the Madhya Pradesh High Court has added an interesting dimension by separating the condition of clause (a) from the remaining conditions in clauses(b) to (d) of section 80IB(10). Subsequent to the decision of the Supreme Court in the case of Sarkar Builders, it was widely believed that such project would not be subjected to the conditions of the post amendment period. The decision has expressly dissented with the decisions of the Gujarat High Court delivered on similar facts. The Madhya Pradesh High Court has chosen to distinguish the ratio of the Supreme Court decision by restricting the scope of the said decision to clauses (b) to (d). Whether such was the view of the apex court or not, that can be clarified by the court only. In the meanwhile, we hereafter explain how the views of the Gujarat and Delhi High Courts represent a better view.

The whole basis of the Madhya Pradesh High Court order seems to be on the fact that the approval granted is not inextricably linked to the period within which the project construction would be completed. It needs to be kept in mind that the provisions of section 80-IB applied only to large projects, where the project was on the size of a plot of land which had a minimum area of one acre. Obviously, such large projects take a substantial time to complete.

The approval granted by the local authority is of the plans of the project. In most cases, the developer would have planned a phased development of the project, on the basis of which the plans were submitted. If at the point of time of approval of the plans, there was no time limit for completion of the project, a subsequent time limit of 4 years laid down for completion of the project may not suffice to complete the phased development. In such a case, the developer would either need to change the entire plan of the project, so as to ensure completion within the time limit of 4 years, which process would need an amended approval, or would suffer the loss of the deduction u/s. 80-IB in the event of failure to do so. At times, a change of plan may also not be possible on account of the fact that the construction may have been carried out in a particular manner based on the original plan, which does not permit of alteration to reduce the time period of construction.

Therefore, in most cases, the approved plan and the period of construction are inextricably linked to each other, in the same manner as the breakup of the constructed area into commercial area and residential area is linked to the plans approved. Therefore, the ratio of the Supreme Court decisions in Veena Developers and Sarkar Builders applies equally to the period of construction, as it applies to the percentage of commercial area in the project. This commercial aspect does not seem to have been properly appreciated by the Madhya Pradesh High Court.

Secondly, the Madhya Pradesh High Court held that the time limit for issue of the certificate is mandatory, and not directory, on the ground that otherwise an assessing officer would have to make enquiries and use his discretion to find out the correct date of completion. Various decisions of High Courts and the Supreme Court, in the context of different time periods specified under the Income-tax Act, have held that the purpose of laying down a time limit for furnishing of a certificate or audit report is to ensure that the assessing officer is able to complete the assessment on the basis of the certificate or audit report, and that so long as the certificate or audit report is available before the completion of assessment, that would suffice to give the benefit of the deduction or exemption to the assessee, even though the law may have prescribed a time limit for filing of the certificate or audit report, beyond which limit it was actually furnished. In these decisions, it has been invariably held that while the requirement of furnishing of the certificate or audit report is mandatory, the requirement of the time limit within which it has to be furnished is directory. A few such cases where this view has been taken by the Supreme Court is in the cases of CIT vs. Nagpur Hotel Owners Association 247 ITR 201 in the context of application for accumulation u/s. 11(2), CIT vs. G.M. Knitting Industries (P.) Ltd 376 ITR 456 in the context of audit certificate for additional depreciation, CIT vs. AKS Alloys (P.) Ltd. 376 ITR 456 in the context of audit report for deduction u/s. 80-IB, etc.

Therefore, though the obtaining of the certificate should be regarded as mandatory, the time limit for obtaining such certificate should be regarded as directory, particularly so as the actual issue of the certificate is not within the control of the assessee, once he has applied for it within the specified time.

Once the plans had been approved prior to the amendment, and all the conditions then applicable for claim of deduction u/s. 80-IB(10) had been fulfilled, viz. commencement of development of the project on or after 1st October 1998, minimum size of plot of land of one acre, and residential units having a maximum built-up area as specified, the assessee had a right to claim the deduction u/s 80-IB. That was a vested right, which could not have been taken away by a subsequent amendment, adding an additional condition, as rightly held by the Supreme Court in the cases of Veena Developers and Sarkar Builders.

The whole purpose of obtaining the certificate of completion from the local authority was to ensure that the project has been completed within the specified time. This ensured that the objective of the deduction u/s. 80-IB(10) of making residential housing available was fulfilled. So long as the completion of the project before the specified date could be demonstrated, even if it was by a certificate issued on a later date, and so long as that evidence was available at the time of assessment, the benefit of the deduction should be granted to the assessee.

As held by the Supreme Court in the case of Bajaj Tempo Ltd .196 ITR 188, in case of an incentive provision, the law should be interpreted in a liberal manner so as to grant the benefit of the deduction of the assessee, rather than deny it to the assessee on technical grounds, particularly where there is substantial compliance by the assessee. In that case, the Supreme Court observed:

“A provision in a taxing statute granting incentives for promoting growth and development should be construed liberally. Since a provision intended for promoting economic growth has to be interpreted liberally the restriction on it too has to be construed so as to advance the objective of the section and not to frustrate it.”

Therefore, the view taken by the Delhi and Gujarat High Courts, that the belated obtaining of the completion certificate beyond the prescribed time limit in cases where the plans were approved prior to 1st April 2005, is not fatal to the assessee’s claim for deduction u/s. 80- IB, so long as the completion of the housing project is within the prescribed time, seems to be the better view of the matter.

In any case, if a part of the project is completed and certificate of completion has been received for such part in time, the assessee would certainly be entitled to deduction in respect of the part of the project which has been completed, as held by the Gujarat High Court in the case of CIT vs. B. M. and Brothers 42 taxmann.com 24.

Penalty –Assessee having already paid tax and interest u/s. 201 (1) and (1A) so as to end the dispute with the Revenue, the deletion of penalty levied u/s. 271C did not give rise to any substantial question of law.

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CIT vs. Bank of Nova Scotia [2016] 380 ITR 550 (SC)

The Tribunal after noting the case of the assessee that it had already paid the tax and interest u/s. 201(1) and (1A) so as to end the dispute with Revenue deleted the penalty levied u/s. 271C following the decision of Delhi High Court in CIT vs. Itochu Corporation [2004] 268 ITR 172 (Del) and CIT vs. Mitsui and Co. Ltd. [2005] 272 ITR 545 (Del).

The High Court rejected the appeal of the Revenue on the ground that no substantial question of law, arose in the matter.

On further appeal, Supreme Court dismissed the appeal of the Revenue holding that there was no substantial question of law, the facts and law having properly and correctly been assessed and appreciated by the Commissioner of Income-tax (Appeals) as well as by the Income- Tax Appellate Tribunal.

Section 263 – An Analysis

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Introduction:
1.1 Section 263 empowers the Commissioner of Income Tax to revise any order passed under the Income-tax Act, 1961, “ the Act” which is erroneous insofar as it is prejudicial to the interest of the revenue. These are special and wide powers conferred upon the Commissioner of Income Tax, to bring to tax any loss of revenue from the orders passed under the Act. At the same time, these are not unfettered powers but are specific and are subject to conditions contained in the section for invoking the jurisdiction. A bare reading of section 263, makes it clear that the prerequisite to exercise of jurisdiction by the CIT suo moto under it is that the order of the ITO is erroneous insofar as it is prejudicial to the interests of the Revenue. The CIT has to be satisfied of twin conditions, namely, (i) the order of the AO sought to be revised is erroneous; and (ii) it is prejudicial to the interests of the Revenue. If one of them is absent—if the order of the ITO is erroneous but is not prejudicial to the Revenue or if it is not erroneous but is prejudicial to the Revenue—recourse cannot be had to section 263(1) of the Act.

1.2 In the above background, in many cases, the ground of invoking jurisdiction u/s. 263 is found to be non-inquiry or failure to make inquiry by the Assessing Officer that warrants revision of the order passed by the Assessing Officer. The law had been settled that if there is a failure to make enquiry which causes prejudice to the interest of the revenue, the Commissioner gets the jurisdiction to revise the order. By the Finance Act 2015, an amendment has been brought in by adding an Explanation to section 263 providing that an order passed by the Assessing Officer shall be deemed to be erroneous insofar as it is prejudicial to the interests of the revenue, if, in the opinion of the Principal Commissioner or Commissioner, the order is passed without making inquiries or verification which should have been made. The Amendment has raised concerns about the exact implications of the Amendment and the possible interpretations of the Explanation. An attempt is therefore made to analyse the law that prevailed and the ramifications of the Amendment.

2. Failure to make inquiry – Erroneous:
2.1 Whenever the orders passed by the Assessing Officers are found to be cryptic and without any inquiry, thereby accepting the return of income as filed by the assessee, the orders have been held to be erroneous and prejudicial to the interest of revenue. The Supreme Court in case of Rampyari Devi Sarogi vs. CIT ( 67 ITR 84) and in Smt. Tara Devi Aggarwal vs. CIT ( 88 ITR 323) have upheld the orders u/s. 263 on this ground. In these cases, the assessment record showed lack of inquiry by the Assessing Officers and mere acceptance of the returned income. The Commissioners made independent inquiries to show that the order caused prejudice to the revenue. In these facts, the Supreme Court came to the conclusion that passing an order without any inquiry would make the order erroneous.

The Delhi High Court in case of Ghee Vee Enterprises vs. Add CIT ( 99 ITR 375) has given a further dimension to the aspect of ‘failure to make inquiry.’ It held that the position and function of the ITO is very different from that of a civil Court. The statements made in a pleading proved by the minimum amount of evidence may be accepted by a civil Court in the absence of any rebuttal. The civil Court is neutral. It simply gives decision on the basis of the pleading and evidence which comes before it. The ITO is not only an adjudicator but also an investigator. He cannot remain passive in the face of a return which is apparently in order but calls for further inquiry. It is his duty to ascertain the truth of the facts stated in the return when the circumstances of the case are such as to provoke an inquiry. The meaning to be given to the word “erroneous” in section 263 emerges out of this context. It is because it is incumbent on the ITO to further investigate the facts stated in the return when circumstances would make such an inquiry necessary. The word “erroneous” in section 263 includes the failure to make such an inquiry. The order becomes erroneous because such an inquiry has not been made and not because there is anything wrong with the order if all the facts stated therein are assumed to be correct.

It implies that the Assessing Officer is bound to carry out prudent inquiries so as to ascertain and assess the correct income of the assessee. If they are lacking, the order becomes erroneous.

3. Failure to make inquiry – Scope:
The ground of failure to make inquiry would cover different situations. They can be categorised as follows

i. There is a complete failure to make inquiry while passing the order. The entire assessment order is passed summarily. The record does not show any examination or verification of the details furnished. The AO called for the basic details of income returned and accepted the same. The record, order sheet as well as the order is cryptic and silent about the application of mind by the AO. In this situation, the simple ground of non-enquiry by AO is sufficient to make the order erroneous and could warrant action u/s. 263 by CIT.

ii. In a given case, the AO may have completely missed verification of one aspect of income and no facts or details have been called for and furnished by the assesse. This lack of inquiry then results into prejudice to the revenue. In this situation both the error as well as prejudice to revenue is so apparent and glaring which could not have escaped the attention of any prudent Assessing Officer. E.g. the assessee had significant borrowings and at the same time, there are significant non-business advances to sister concerns. The rates of interest are variable. If the AO does not make any inquiry whatsoever about the claim of interest, the order may become erroneous if the facts prima facie indicate prejudice to the revenue.

iii. The AO has made enquiries about the income of the assessee. After applying his own judgment about the inquiries to be carried out, the income was assessed by him. The record is speaking about the inquiries, examination and application of mind by the AO. In such situation, CIT feels that a particular inquiry should have been carried out in a particular manner which has not been done or the AO should have taken particular view about a particular income. On such ground of failure of inquiry, action for revision is invoked. The Bombay High Court in a well- known decision in the case if CIT vs. Gabriel India Ltd. ( 203 ITR 108) has dealt with the situation and explained the law as –An order cannot be termed as erroneous unless it is not in accordance with law. If an ITO acting in accordance with law makes certain assessment, the same cannot be branded as erroneous by the Commissioner simply because according to him the order should have been written more elaborately. This section does not visualise a case of substitution of judgment of the Commissioner for that of the ITO , who passed the order, unless the decision is held to be erroneous. Cases may be visualised where ITO while making an assessment examines the accounts, makes enquiries, applies his mind to the facts and circumstances of the case and determines the income either by accepting the accounts or by making some estimates himself. The Commissioner, on perusal of the records, may be of the opinion that the estimate made by the officer concerned was on the lower side and, left to the Commissioner, he would have estimated the income at a higher figure than the one determined by the ITO . That would not vest the Commissioner with power to re-examine the accounts and determine the income himself at a higher figure. It is because the ITO has exercised the quasi-judicial power vested in him in accordance with law and arrived at a conclusion and such a conclusion cannot be termed to be erroneous simply because the Commissioner does not feel satisfied with the conclusion. It may be said in such a case that in the opinion of the Commissioner the order in question is prejudicial to the interest of the Revenue. But that by itself will not be enough to vest the Commissioner with the power of suo moto revision because the first requirement, namely, the order is erroneous, is absent.”

In CIT vs. Honda Siel Power Products Ltd., the Delhi High Court held that while passing an order u/s. 263, the CIT has to examine not only the assessment order, but the entire record of the profits. Since the assessee has no control over the way an assessment order is drafted and since, generally, the issues which are accepted by the AO do not find mention in the assessment order and only those points are taken note of on which the assessee’s explanations are rejected and additions/disallowances are made, the mere absence of the discussion would not mean that the AO had not applied his mind to the said provisions. In this connection, reference is invited to the decisions in CIT vs. Mulchand Bagri (108 CTR 206 Cal.) CIT vs. D P Karai (266 ITR 113 Guj) and Paul Mathews vs. CIT ( 263 ITR 101 Ker).

4. Failure to make inquiry vs. Application of mind:
4.1. In Malabar Industrial Co. Ltd. vs. CIT 243 ITR 83 (SC) the Apex Court considered the scope of the word “erroneous” and held that:

“The provision cannot be invoked to correct each and every type of mistake or error committed by the AO; it is only when an order is erroneous that the section will be attracted. An incorrect assumption of facts or an incorrect application of law will satisfy the requirement of the order being erroneous. In the same category fall orders passed without applying the principles of natural justice or without application of mind. The phrase “prejudicial to the interests of the Revenue” is not an expression of art and is not defined in the Act. Understood in its ordinary meaning, it is of wide import and is not confined to loss of tax. The scheme of the Act is to levy and collect tax in accordance with the provisions of the Act and this task is entrusted to the Revenue. If due to an erroneous order of the ITO , the Revenue is losing tax lawfully payable by a person, it will certainly be prejudicial to the interests of the Revenue. The phrase “prejudicial to the interest of the Revenue” has to be read in conjunction with an erroneous order passed by the AO. Every loss of revenue as a consequence of an order of the AO cannot be treated as prejudicial to the interests of the Revenue, for example when an ITO adopted one of the courses permissible in law and it has resulted in loss of revenue, or where two views are possible and the ITO has taken one view with which the CIT does not agree, it cannot be treated as an erroneous order prejudicial to the interests of the Revenue unless the view taken by the ITO is unsustainable in law.”

4.2 The above observations of the Supreme Court highlight the fact that if there is an application of mind by the AO, the order cannot become erroneous. The question has to be decided by evaluating the process of assessment undertaken by the AO. If the assessment has been done after proper application of mind and thereby adopting a permissible course of action, it cannot be said to be erroneous.

5. Prejudice to the Revenue:
5.1 The lack of inquiry making the order erroneous has to be coupled with prejudice to the interest of the revenue. As explained by Bombay High Court in case of Gabriel India Ltd., there must be some prima facie material on record to show that tax which was lawfully exigible has not been imposed or that by the application of the relevant statute on an incorrect or incomplete interpretation a lesser tax than what was just has been imposed. There must be material available on record called for by the Commissioner to satisfy him, prima facie, that the aforesaid two requisites are present. If not, he has no authority to initiate proceedings for revision. Exercise of power of suo moto revision under such circumstances will amount to arbitrary exercise of power.

6. Principles Emerging:
The following principles emerge from the above discussion-

1. Failure to make inquiries coupled with prejudice to revenue makes the order vulnerable for revision u/s. 263 being erroneous and prejudicial to the interest of the revenue.

2. For evaluating as to whether inquiry was made or not, the complete record at the time of assessment has to be seen. Absence of discussion in the assessment order is not sufficient to conclude that there has been no noninquiry.

3. The ground of lack of inquiry so as to substitute the judgment of CIT over that of AO is not permissible. If AO has used his judgment and passed the order in accordance with law, CIT cannot substitute his judgment about how a particular assessment has to be done by carrying out enquiries in a particular manner.

4. The powers of revision cannot be invoked to correct each and every mistake but only when the order is erroneous on account of an incorrect assumption of facts or an incorrect application of law or without applying the principles of natural justice or without application of mind or inquiry.

5. Every loss of revenue as a consequence of an order of the AO cannot be treated as prejudicial to the interests of the Revenue, for example when an ITO adopted one of the courses permissible in law and it has resulted in loss of revenue, or where two views are possible and the ITO has taken one view with which the CIT does not agree, it cannot be treated as an erroneous order prejudicial to the interests of the Revenue unless the view taken by the ITO is unsustainable in law.

7. Amendment by Finance Act 2015:

7.1 With effect from 1st June 2015, an Explanation is added to section 263 which provides as under-

“Explanation 2.—For the purposes of this section, it is hereby declared that an order passed by the Assessing Officer shall be deemed to be erroneous in so far as it is prejudicial to the interests of the revenue, if, in the opinion of the Principal Commissioner or Commissioner,—

(a) the order is passed without making inquiries or verification which should have been made;

(b) the order is passed allowing any relief without inquiring into the claim;
(c) the order has not been made in accordance with any order, direction or instruction issued by the Board under section 119; or
(d) the order has not been passed in accordance with any decision which is prejudicial to the assessee, rendered by the jurisdictional High Court or Supreme Court in the case of the assessee or any other person.”

8. Memorandum Explaining the Provisions:
The memorandum explaining the provisions states as under

“Revision of order that is erroneous in so far as it is prejudicial to the interests of revenue

The existing provisions contained in sub-section (1) of section 263 of the Income-tax Act provides that if the Principal Commissioner or Commissioner considers that any order passed by the assessing officer is erroneous in so far as it is prejudicial to the interests of the Revenue, he may, after giving the assessee an opportunity of being heard and after making an enquiry pass an order modifying the assessment made by the assessing officer or cancelling the assessment and directing fresh assessment. The interpretation of expression “erroneous in so far as it is prejudicial to the interests of the revenue” has been a contentious one. In order to provide clarity on the issue it is proposed to provide that an order passed by the Assessing Officer shall be deemed to be erroneous in so far as it is prejudicial to the interests of the revenue, if, in the opinion of the Principal Commissioner or Commissioner,—

(a) the order is passed without making inquiries or verification which, should have been made;
(b) the order is passed allowing any relief without inquiring into the claim;
(c) the order has not been made in accordance with any order, direction or instruction issued by the Board under section 119; or
(d) the order has not been passed in accordance with any decision which is prejudicial to the assessee, rendered by the jurisdictional High Court or Supreme Court in the case of the assessee or any other person.”

9. Analysis of the Amendment:
9.1 A plain reading of the above amendment implies that the said Explanation has been added for clarifying the scope of the words ‘erroneous so far as prejudicial to the interest of the revenue.’ The term was not been defined under the Act. But by way of this amendment, the scope of the term has been clarified. While clarifying the position, four different situations have been contemplated so as to call an order to be ‘erroneous so far as prejudicial to the interest of the revenue.’ The provision further creates a fiction as to order being erroneous in so far as prejudicial to the interest of revenue if the Commissioner or Principal Commissioner forms an opinion about the existence of four situations stated therein.

9.2 Considering the phraseology or the words used in the amendment and also considering the fact that the amendment pertains to procedural or machinery provisions, the same is perceived as clarificatory and may apply to pending proceedings. The amendment can also be understood to be a “Declaratory Law” thereby explaining or clarifying the law that prevailed all along. Needless to mention, assessee would like to argue that the amendment is substantive in nature and therefore would operate prospectively. In that situation, the question would become debatable and would be left for the Courts to decide.

9.3 The question arises as to whether it implies a subjective opinion of the Commissioner or Principal Commissioner and having formed such opinion, the jurisdiction u/s. 263 can be invoked without any fetters. The question has relevance to mainly to first situation as well as second situation regarding inquiry not done by AO as it deals with more of a factual or practical situation and may lend unfettered powers to the Commissioner for revising the order. The other two situations mainly consider the incorrect application of law by not applying the relevant circular or judicial decisions. Extending the question further, does the provision mean merely a formality on the part of the Commissioner or Principal Commissioner to form an opinion and invoke the jurisdiction?

9.4 To answer the above question, the scheme of revision provisions under the Act has to be considered. The power of revision is vested with Commissioner which is perceived to be his exclusive jurisdiction to be excercised upon satisfaction of conditions stated therein. The powers can be invoked on his satisfaction arrived after examination of record. The words satisfaction or opinion of Commissioner perceived in section 263 has been explained by Bombay High Court in Gabriel India Ltd. as- “ It is well-settled that when exercise of statutory power is dependent upon the existence of certain objective facts, the authority before exercising such power must have materials on records to satisfy it in that regard. If the action of the authority is challenged before the Court, it would be open to the Courts to examine whether the relevant objective factors were available from the records called for and examined by such authority. Any other view in the matter will amount to giving unbridled and arbitrary power to revising authority to initiate proceedings for revision in every case and start re-examination and fresh enquiries in matters which have already been concluded under the law. It is quasi-judicial power hedged with limitation and has to be exercised subject to the same and within its scope and ambit. So far as calling for the records and examining the same is concerned, undoubtedly it is an administrative act, but on examination, “to consider”, or in other words, to form an opinion that the particular order is erroneous in so far as it is prejudicial to the interest of the Revenue, is a quasijudicial act because on this consideration or opinion the whole machinery of reexamination and reconsideration of an order of assessment, which has already been concluded and controversy about which has been set at rest, is again set in motion. It is an important decision and the same cannot be based on the whims or caprice of the revising authority. There must be materials available from records called for by the Commissioner.”

The above principles explained by the Bombay High Court therefore enable us to reach to the conclusion that the formation of opinion cannot be arbitrary and left at the whims of the authority this being a quasi judicial act that would be subjected to judicial review by higher authorities.

9.5 The further question arises about the application of fiction as to whether it allows an interpretation that having formed an opinion about non inquiry the order becomes erroneous and prejudicial to the interest of revenue. The fiction impliedly raises a presumption. It can be seen that the factum of inquiry is always verifiable with reference to record. If after forming an opinion by Commissioner about non inquiry, the record speaks about proper inquiry and application of mind by AO, the presumption should be open for rebuttal. More so since the question of inquiry is a factual aspect. The Explanation therefore can be interpreted to raise a rebuttable presumption. The rebuttal can be made before the higher authorities contesting the validity of action with reference to the actual record. The possibility of rebuttal can also be supported with the power of revision being a quasi judicial act subjected to judicial review.

9.6 The law that prevailed all along with reference to the application of mind by AO or adopting a permissible course of action in law cannot be understood to have been disturbed. Since the Income-tax Act gives exclusive jurisdiction of assessment to the Assessing Officer, the act of assessment is perceived as an independent quasi judicial act. The Commissioner under the provisions of revision could not substitute his judgment over the Assessing Officer about the manner in which the assessment or inquiry or a particular view to be adopted. The said amendment nowhere makes a departure from the above position by the phraseology or the contextual meaning.

9.7 The Explanatory Memorandum with reference to the said amendment refers to the intention behind the said amendment. In view of that, the interpretation of ‘erroneous in so far as prejudicial to the interest of the revenue’ was a contentious issue. In order to provide clarity on the issue, an amendment has been brought in by way of an Explanation. Considering the law explained by Courts with reference to the expression used in the amendment, there does not appear to be any deviation from the principles evolved. It broadly defines the scope of ‘erroneous in so far as prejudicial to the interest of the revenue’ and provides support to the main section. Reading the main provision along with the Explanation, the Scheme of revision with reference to the principles laid down, remains the same.

9.8 In the first situation, the words used are ‘if the order is passed with making inquiries or verification which should have been done’. The expression ‘which should have been done’ suggests an objective test to be applied so as to highlight necessity of making appropriate inquiry for assessing the correct income and absence of which may cause prejudice to the revenue. The condition of ‘prejudice to the interest of the revenue’ also cannot be said to have toned down or understood to have impliedly complied with formation of an opinion.

10. Conclusion:
The amendment by way of an Explanation to section 263 may give rise to extreme interpretations or an impression that the power of revision is at the whims of Commissioner. The Department is likely to adopt such interpretation and use the same causing to revision of the orders passed by the Assessing Officers at the sweet will of the Commissioners. However, considering the law laid down and on proper interpretation of the amendment, such view is unlikely to be supported by higher judicial forums. Let us hope that the judiciary would make a just interpretation and avoid giving unfettered powers to the Commissioner.

[2016] 65 taxmann.com 130 (Ahmedabad-CESTAT) Sunflag Filaments Industries vs. Commissioner, Central Excise & Service Tax, Vapi

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Where exemption is granted subject to nonavailment/ non-utilisation of CENVA T credit, utilisation of CENVA T credit which was to lapse in terms of Rule 11(3) of CENVA T Credit Rules would not result in denial of exemption, but would only result in action under Rules 14 & 15.

Facts
The Appellant opted for Exemption Notification No. 30/2004-CE for duty free clearances of their finished product on 01/08/2005 which was on the condition of nonavailment of CENVAT credit of duty on inputs or capital goods. Therefore, credit on inputs available in stock on that date was reversed and duty was paid on clearance of finished goods in stock on 01/08/2005. However, they also had excess credit in CENVAT account which pertained to the credit of duty on inputs which were already utilised in the manufacture of the finished goods which were cleared on payment of duty before the said date. In the absence of any clarification regarding treatment for such excess, the same was not reversed.

Subsequently, Rule 11(3) of CENVAT credit Rules, 2004 was inserted from 01/03/2007 providing lapsing of such excess CENVAT credit available on date of opting exemption notification. The Appellant did not allow such credit lying in their account as on 01/03/2007 to lapse and utilised portion of it for payment of duty for some other purposes. The Adjudicating authority held that because of this utilisation of excess credit as on 01/03/2007, the benefit of exemption notification was not available.

Held
The Tribunal observed that the Appellant fulfilled the conditions of the notification on the date of their opting for the same and thereafter. However, the only lapse was that they had not expunged the excess credit they had in their account when Rule 11(3) of the CENVAT Credit Rules 2004 was introduced on a subsequent date. In such circumstances violation of Rule 11(3) should invite necessary action under Rules 14 & 15 of CENVAT Credit Rules 2004 only and cannot be extended to the extent of denying the benefit of the substantial notification for that mere reason.

Levy of Tax on Interest on NRE Deposits

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20th January, 2016

The Editor,
Bombay Chartered Accountants Journal
Mumbai.

Dear Sir,

Re: Levy of Tax on Interest on NRE Deposits

Presently, interest received on NRE Deposits by a Non Resident Indian (NRI) is exempt under section 10(4) of the Income-tax Act. However, the NRIs working and residing in advanced / western countries such as USA, UK, Australia, Canada, New Zealand, France, Germany etc. are liable for tax in the respective home countries on their global income. In this respect, the Taxation Laws in foreign countries are at par with the Law in India [Section 5(1) of the Act] which mandates that a resident in India is liable to pay tax in India on all incomes from whatever source derived.

Now, in view of FAT CA in USA and other similar Laws in other countries, such NRIs are required to declare their Indian Financial Assets and income there from in their Home Countries and pay tax thereon, irrespective of Tax Treatment extended by Indian Government to the NRIs in respect of Income from their Foreign Exchange Deposits /Financial Assets. Therefore, it makes no sense for India to continue to have provisions like Section 10(4) exempting interest income of NRIs from certain bank deposits and Government Securities as the law abiding NRIs are bound to declare such Indian Income and pay tax thereon at full rate in their respective countries of residence.

Therefore, I feel that such Income should be taxed at a reasonable rate, say between 10-15%, so that the Tax Revenue is reasonably shared between the source country(i.e. India) and the country of NRI’s residence (Home Country). The NRI would not be a loser because he would get tax credit / set off in respect of taxes paid / withheld in India against his tax liability in his Home Country.

The tax rate under various Tax Treaties signed by India prescribe tax rate between 10% to 15%. Therefore, it would be eminently feasible to levy tax on NRE deposits @ 10% without causing any additional tax burden on NRIs or causing flight of capital /NRI deposits from India. Such a levy of tax needs to be properly explained/ communicated to the NRIs.

To facilitate easy tax compliance, the Law may prescribe rate of TDS on Interest earned by NRIs (including Interest earned by them on NRO deposits) @ 10%. However, in case of those NRIs who have such Interest income below basic exemption limit, they should be entitled to submit Tax Return like any other Indian Citizen and claim various exemptions and deductions available under the Law and claim refund of TDS which should be granted expeditiously.

In this manner, India can garner substantial tax revenue from NRIs without posing any additional tax burden on the NRIs or causing flight of NRI Deposits.

Yours sincerely,

Tarunkumar Singhal


TS-113-ITAT-2016 (Mum) Rheinbraun Engineering Und Wasser GmbH v DDIT A.Y. 2002-03, Date of Order: 4th March, 2016

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Article 7, 12 of India-Germany DTAA – provision of consulting services for exploration, mining and extraction do not constitute PE in India under India-Germany DTAA.

Facts
The Taxpayer was a German company engaged in providing consulting services in relation to exploration, mining and extraction. During the relevant year, the Taxpayer had received remuneration from three Indian companies (ICo) for rendering Consultancy services in relation to exploration, mining and extraction projects undertaken by ICo. The Taxpayer offered the income from such services to tax as Fee for technical services (FTS) under Article 12 of India-Germany DTAA .

In the course of assessment, the AO observed that the project undertaken by ICo lasted for more than six months. Accordingly, the AO held that the services rendered by the Taxpayer being supervisory in nature, constituted a PE in India in terms of Article 5(2)(i) of India-Germany DTAA . Since income was effectively connected with the PE, the same had to be taxed as business income under Article 7. However, such business income had to be taxed on gross basis u/s. 44D (as subsisted for the relevant year).

However, the Taxpayer argued that the tenure of supervisory services should be considered independently and since the duration such services was less than 180 days, it did not create a PE in India. Even if a PE is triggered in terms of the specific provisions in the protocol to India-Germany DTAA such services would constitute FTS and not business income.

Held
The Taxpayer had rendered consultancy services and hence shall be governed by the provisions of in terms of Article 12 of the DTAA .

For the purpose of reckoning continuous stay for determination of PE, actual stay of employees should be considered and not the entire contract period1 .

While the Taxpayer had deputed one employee to India, that employee had not stayed in India for more than 180 days. Further, in two of the contracts, no supervisory charges were rendered.

Since Article 12(4), which deals with FTS, mentions ‘services of managerial’, technical or consultancy nature, payments received by the Taxpayer should be assessed in terms of Article 12 and not Article 7 of the DTAA .

Protocol to India-Germany DTAA provides that with respect to Article 7, income derived from a resident of a Contracting State from planning, project construction or research activities as well as income from technical services exercised in other State in connection with a PE situated in that other State, will not be attributed to PE. Hence, even if it is assumed that the Taxpayer had a PE in India, having regard to the Protocol, the income will not be treated as business income.

Accordingly, the payments received by the Taxpayer were to be taxed @10% and further, the provisions of section 115A of the Act were also not applicable.

[2016-TIOL-1104-CESTAT-MUM] Benzy Tours & Travels Pvt. Ltd vs. Commissioner of Service Tax, Mumbai-I

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The provisions of section 11B of the Central Excise Act, 1944 applies to every case of refund irrespective of the fact that the payment is made without authority of law.
Facts

The Appellant wrongly paid service tax and made an application for refund. The refund claim was rejected stating that it was filed beyond one year from the relevant date as provided under section 11B of the Central Excise Act, 1944. It was argued that the payment made was without authority of law and therefore was not barred by limitation.

Held

The Tribunal noted that in every case of refund the amount is refundable only where it is not payable, accordingly the section will not apply for the reason that it is neither service tax nor excise duty. If this is accepted then section 11B will stand redundant. Therefore it was held that when payment is made under a particular head such as service tax, excise duty etc. the subsequent refund of the amount not payable should be treated as refund of service tax / duty only and therefore the time limitation provided under section 11B shall apply.

Note: (Readers may note that the decision has distinguished the decision of Geojit BNP Paribas Financial Services Ltd [2015-TIOL-1602-HC-KERALA-ST] reported in August-2015 issue of BCAJ, decision of Madhvi Procon P. Ltd [2015-TIOL- 87-CESTAT-AHM, Jyotsana D.Patel [2014-52 taxmann.com 255 (Mumbai-CESTAT )] referred to in February 2015 issue of BCAJ).

Section 69 – Treating the long-term capital gain disclosed on the sale of shares as non genuine, bogus and sham transaction – Off market transaction not unlawful

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SLP Dismissed CIT vs. Mukesh R. Marolia SLP No. 20146 / 2012 dt. 27th January, 2014; (Mukesh R. Marolia vs. Addl. CIT (2006) 6 SOT 247 (Mum.); Affirmed by Hon’ble Bombay High Court Judgement CIT vs. Mukesh R. Marolia ITA No. 456 of 2007, dated 7th Sept. 2011;)

Statement of one Mukesh Choksi was recorded during the search proceedings u/s. 132 on the group companies run by him, and it was recorded that the group companies are involved in business of accommodation entries. The transaction carried out by the assessee were outside stock exchange i.e. off market transaction. The assessing officer treated sale proceed of shares as unexplained investment u/s. 69 of the Act and added the same as income of the assessee. The Tribunal held that Mr. Mukesh Choksi has nowhere in the statement, recorded during the search proceedings, has referred to the Appellant; or made any statement against the appellant. The statement given by him is general in nature wherein he has described the manner in which accommodation of entries were carried out by his group companies. Books of account maintained by assessee clearly reflected the transaction. It is not unlawful to carry out sale or purchase transaction outside the floor of the Stock exchange. Off market transactions are not illegal. The Hon’ble Bombay High Court upheld the order of ITAT . The Revenue filed SLP before Supreme Court which was dismissed.

Business expenditure – Capital or revenue – A. Y. 1996-97 – Assessee carrying on business of letting out properties – Payment to tenant for vacating premises – Rental income earned by the assessee is assessed under the head ‘Business’ and the compensation of Rs. 53,50,000/- paid by it for obtaining possession from lessee/tenant so as to earn higher income is an admissible revenue deduction

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Shyam Burlap Company Ltd. vs CIT; 281 CTR 458 (Cal):

The
assessee was the owner of the property and was carrying on the business
of letting out. The assesee had paid compensation of Rs. 53,50,000/- to
obtain possession from the lessee/tenant so as to earn a higher rental
income. For the A. Y. 1996-97, the assessee offered the rental income as
business income and claimed the deduction of compensation of Rs.
53,50,000/- as revenue expenditure. The Assessing Officer and the
Tribunal held that the rental income is assessable as house property
income and disallowed the claim for deduction.

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

“i) Though in earlier assessment years the assessee had shown rental income as “income from house property”’ however, in this assessment year it has claimed rental income as business income, in view of the object as set out in clause 4 of its Memorandum of association. Since the object in the said memorandum permitted the assessee to carry on business in letting out properties and as 85% of the income of the assessee was by way of deriving rent and lease rentals, the income from rent constituted business income.

ii) Observations of the Tribunal that the assesssee had all along shown the income under the head “income from house property” cannot be a ground for treating the income as business income.

iii) Rental income earned by the assessee was assessable under the head ‘business’ and the compensation of Rs. 53,50,000/- paid by it for obtaining possession from lessee/tenant so as to earn higher income is an admissible revenue deduction.”

Important Representations of BCAS Incorporated in Amended Model GST Law

The draft model GST law released by the empowered Committee was hosted on the website of DOR inviting comments from stake holders and public at large. BCAS had made a detailed representation to the  finance minister on the model GST law.

“We are pleased to inform you that the Government has accepted most of our suggestions and incorporated the same in the amended model GST law released on 26th november 2016”.

Reproduced below is the detailed table of recommendations that have been accepted in the amended model GST law.

62. [2015-TIOL-2705-CESTAT-MUM] M/s Vamona Developers Pvt. Ltd vs. Commissioner of Customs, Central excise and Service Tax, Pune-III

62. [2015-TIOL-2705-CESTAT-MUM] M/s Vamona Developers Pvt. Ltd vs. Commissioner of Customs, Central excise and Service Tax, Pune-III

Input services used for construction prior to 01/04/2011 are allowable as CENVAT credit. Further registration is not a condition for availing of CENVAT credit.

Facts

The Appellant engaged in the construction and sale of commercial properties constructed a mall at Pune for which they received various input services and capital goods during the period June 2007-March 2011. They availed the entire credit on input services in 2011 when the construction was ready for renting out and also took centralised registration in Pune on the said date. The department contended that the input service credit is inadmissible for the construction of a mall resulting in an immovable property which is neither excisable nor any service tax is payable and is used for Renting of Immovable Property Service. Further the credits pertained to the period prior to registration.

Held

The Tribunal held that the entire credit has been availed on input services which have been used for providing the output service of Renting of Immovable Property service for which there is no restriction under clause (l) of the definition of “input service”. The words “setting up” in the definition of input service were deleted only from 01/04/2011. Accordingly, there is no restriction on use of input service for construction of building prior to the said date. Further, relying on the decision of the Karnataka High Court in the case of mPortal India Wireless Solutions Pvt. Ltd [2011-TIOL-928-HC-KAR-ST], it was held that registration is not a condition for availing CENVAT credit. Further, the Tribunal also validated the availing of credit after a period of five years by stating that it is only in 2011 that the Appellant was sure of whether the property would be sold or rented and 20% of the property was sold and therefore they availed credit only when the remaining property was ready for renting out.

Note: Readers may note a similar decision in the case of Maharashtra Cricket Association vs. Commissioner of Central Excise, Pune-III [2015-TIOL-2418-CESTAT-MUM] digest provided in the BCAJ December 2015 issue. Further it should be noted that the proviso to Rule 4(7) of the CENVAT Credit Rules with effect from 01/09/2014 provides that the credit should be taken within a period of 6 months of the issue of the document specified in Rule 9(1) of the said rules. [Extended to one year with effect from 01/03/2015].

Section 9(1)(vi) of the Act and Article 12 of India-USA DTAA – Indian distributor selling advertisement airtime customers held to have authority to conclude contract on behalf of foreign company and consequently, treated as Dependent Agent Permanent Establishment.

15. TS-714-ITAT-2015(Mumbai)
NGC Network Asia LLC vs. JDIT
A.Y.s: 2007-08 and 2008-09,
Date of Order: 16.12.2015

Section 9(1)(vi) of the Act and Article 12 of India-USA DTAA – Indian distributor selling advertisement airtime customers held to have authority to conclude contract on behalf of foreign company and consequently, treated as Dependent Agent Permanent Establishment.

Facts 1

Taxpayer, a US Delaware LLC, was engaged in the business of broadcasting its channels in various countries including India. The Taxpayer appointed its Indian affiliate (ICo) as its distributor to distribute its television channels for which ICO paid a fixed distribution fee to the Taxpayer. The Tax Authority held that the revenue generated on granting of distribution rights was in the nature of “royalty” as per Act as well as Article 12 of the India-USA DTAA.

The taxpayer contended that payment received by it did not fall under any of the clauses of the definition of the term “Copyright under the Copyright Act, Further, based on combined reading of section 37 and 39A with section 2(dd) of the Copyright Act, the consideration paid by ICo for Broadcast Reproduction and distribution rights was in the nature of commercial rights which were distinct and different from copyright. The broadcast and distribution rights, enables the broadcast to be heard or seen by the subscribers on payment of certain charges. Such rights did not fall within the definition of copyright as provided under the copyright law. Hence, the payment did not amount to royalty. Reliance in this regard was placed on Delhi HC rulings in case of ESPN Star Sports [RFA (OS) NO. 25/2008 (Del)] and Star India Pvt. Ltd. [CS(OS) Nos. 2722/2012, 3232/2012 and 2780/2012 (Del)].

Facts 2

The taxpayer also entered into an ‘advertisement sale agreement’ (Agreement) to sell the ‘advertisement and sponsorship time on the channels’ (advertisement airtime) to ICo for a lump sum consideration. ICo, in turn, was to sell the advertisement airtime to its customers in India. While the Taxpayer was obliged to broadcast such advertisements on its channels, the Taxpayer could accept or reject any advertisement provided by ICo. The Agreement also clarified that there would be no privity of contract remain between Taxpayer and the customer, ICo would not be deemed to be acting on behalf of the Taxpayer and risk and responsibility of sale of advertisement airtime by ICo to its customers was that of ICo and on such terms and conditions as ICo may deem fit.

The Tax Authority contended that ICo qualifies as a Dependent Agent PE (DAPE) of the Taxpayer in India under the India-USA DTAA and hence the income from sale of advertisement time to ICo was taxable in India.

The Taxpayer contended that ICo did not qualify as DAPE of Taxpayer in India. Without prejudice, even in a case where ICo is held to be creating a DAPE of the Taxpayer in India, there cannot be any further attribution of profits to such DAPE as the transaction was accepted to be at ALP by the Transfer Pricing officer (TPO). Reliance in this regard was placed on Supreme Court ruling in the case of Morgan Stanely & Co. Inc. (292 ITR 416), Delhi HC in BBC Worldwide Ltd (2011)(203 Taxman 554) as well as Bombay HC decisions in the case of B4U International Holdings Ltd (2015)(57 taxmann.com 146) and Set Satellite (Singapore) Pte Ltd. (307 ITR 205).

Held 1

Definition of the term “royalty” under the Act as well as in the India-US DTAA uses the expression “process”. The term process has been defined under the Act to include ‘transmission by satellite (including up-linking, amplification, conversion for downlinking of any signal), cable, optic fibre or by any other similar technology, whether or not such process is secret’. This definition of process was inserted under the Act vide Finance Act 2012 whereas the decisions referred by the Taxpayer were rendered prior to such insertion by Finance Act 2012 and hence, they did not deal with the issue whether such rights would fall within the definition of “process”.

Hence, the matter was remanded back to the Tax Authority to examine if the payment towards granting of distribution rights would fall under the term ‘process’ so as to get covered by the definition of royalty.

Held 2

As per the judicial precedence, the properties which are capable of being abstracted, consumed and used and/or transmitted, transferred, delivered, stored or possessed etc. can be regarded as ‘goods’. The ‘advertisement airtime’ can be identified, abstracted, possessed or stored till the time of its expiry. However, in the instant case, the “advertisement air time” is related to the television channels owned by the Taxpayer only and same does not have any value independent of the Taxpayer. Thus, ‘advertisement airtime’ fails to satisfy the test that it is capable of being used/consumed independently, i.e., independent of the Taxpayer. Accordingly, ‘advertisement airtime’ is merely a “right to procure advertisements” and does not qualify as ‘goods’ within the legal meaning of the said term.

Tribunal held that advertisement airtime, per se, does not have any value without the Taxpayer agreeing to telecast the advertisement material. Thus, in substance, ICo is actually canvassing the advertisements for the Taxpayer through the purchase and sale of advertisement airtime relating to the television channels owned by the Taxpayer. Thus the transaction between Taxpayer and ICo was not on principal-to-principal basis.

ICo provides agency services to the Taxpayer and in turn, the Taxpayer provides advertisement services or telecasting services to the clients. Hence, the relationship between the Taxpayer and ICo is in the nature of principal-to-agent basis.

Further, as per the agreement, ICo could enter into agreement with the customers to sell the advertisement airtime and Taxpayer was obliged to telecast such advertisement on its channel as per the schedule given by ICo. Accordingly, ICo had an authority to conclude contracts with the customers on behalf of the Taxpayer. Therefore ICo constituted DAPE of the Taxpayer.

On attribution of profits, the tribunal distinguished the cases referred by the Taxpayer, on the grounds that:

  • Certain rulings were delivered while examining the existence of PE under Article 5(5) of the DTAA, i.e., independent agent, whereas, in this case, DAPE is held to be created under article 5(4) and hence support cannot be drawn from these rulings;

  • Also, in some of those cases, courts were concerned with the payment made by foreign entity to its Indian PE. It is in this context, the courts have held that once transactions are considered to be at ALP, there need not be any further attribution to the PE. However, in the facts of the present case payments were received by the foreign entity (i.e. the Taxpayer) from its Indian PE (i.e. ICo).

Accordingly, the Tribunal restored the matter back to Tax Authority for the limited purpose of computation of profit attribution to PE.

Section 9(1)(vii), 195 of the Act – Withholding obligation needs to be discharged based on the law that existed at the time of making payments from which taxes were to be withheld.

14. ITA No. 1629/Kol/2012 (Unreported)
DCIT vs. Shri Subhotosh Majumder
A.Y.s: 2006-07, 2008-09 & 2009-10,
Date of Order: 27-11-2015

Section 9(1)(vii), 195 of the Act – Withholding obligation needs to be discharged based on the law that existed at the time of making payments from which taxes were to be withheld.

Facts

Taxpayer, a resident of India and a patent law practitioner specialised in Intellectual Property Laws. Taxpayer facilitated filing of Patents outside India for its clients. For this purpose, Taxpayer acted as an interface between the client and foreign lawyers and law firms and communicated and co-ordinated with them. Taxpayer also made payments to foreign lawyers on behalf of its clients after receiving payment instruction from its clients. For these facilitation services, taxpayer charged a nominal fee.

Taxpayer contended that it only acted as an interface between the client and foreign law firms and it does not have the right or capability or the need to utilise services of the overseas lawyers. In fact, the services were rendered by the foreign lawyers to the Taxpayer’s clients and not to the Taxpayer. Further, even from the view of Taxpayer’s clients, the patents in foreign country could be utilised only in that country in which such patent is granted as the patent protection provided by a country would be valid only in that country. As the services were rendered outside India as well as utilised outside India, income from such services did not accrue or arise in India. Consequently, taxes were not required to be withheld u/s 195 of the Act. In any case, Explanation 5 to section 9(1) inserted by Finance Act, 2010 (inserted retrospectively) provides that FTS would be deemed to accrue or arise in India irrespective of whether such services are rendered in India cannot make the Taxpayer liable to withhold taxes.

However, the Tax Authority held that the Taxpayer availed technical and consultancy services from non-residents and such services, although performed outside India, was for the benefit of Taxpayer’s profession carried on in India and hence, income from services accrued in India in the hands of the foreign lawyers u/s. 9(1)(vii) of the Act. Accordingly, tax was required to be withheld on payments made by Taxpayer to foreign lawyers u/s. 195 of the Act.

Held

Before the insertion of Explanation 5 to section 9(1)(i), the legal position was that unless services are rendered in India, FTS would not be deemed to accrue or arise in India. Although Explanation 5 was inserted retrospectively, so far as withholding liability is concerned, it depends on the law as it existed at the point of time when payments are made. A Taxpayer is not expected to know how the law will change in future. While retrospective amendment in law does change the tax liability in respect of income with retrospective effect, it cannot change tax withholding liability, with retrospective effect.

When withholding obligations are to be discharged at the point of time when payment is made or credited, such obligations can only be discharged in light of the law as it then stands. Accordingly, taxpayer cannot be faulted for not withholding taxes. Thus, the primary issue whether services are in the nature of FTS and whether services are utilised in India was not discussed by the Tribunal.

P.S: Reason why the taxpayer was not seeking protection under the treaty is not clear.