BCAJ | Bombay Chartered Accountant Journal

Sections 68, 69A and 254(1) – Appeal to Appellate Tribunal – Jurisdiction and power – Cannot go beyond question in dispute – Subject matter of appeal in regard to addition made u/s. 68 – Tribunal holding addition u/s. 68 unjustifiable – Tribunal cannot travel beyond issue raised in appeal and make addition u/s. 69A – Order vitiated

21. Smt. Sarika Jain vs. CIT; 407 ITR
254 (All); Date of order: 18^th July,
2017 A. Y. 2001-02

Sections 68, 69A and 254(1) – Appeal to
Appellate Tribunal – Jurisdiction and power – Cannot go beyond question in
dispute – Subject matter of appeal in regard to addition made u/s. 68 –
Tribunal holding addition u/s. 68 unjustifiable – Tribunal cannot travel beyond
issue raised in appeal and make addition u/s. 69A – Order vitiated

In the A. Y. 2001-02, the
assessee had inducted capital in the firm in which she was a partner. During
reassessment proceedings u/s. 147 of the Income-tax Act, 1961, (hereinafter for
the sake of brevity referred to as the “Act”), the assessee explained
the source of the amounts received as gifts through banking channels and also
produced the gift deeds. The statements of the two donors were also recorded
u/s. 131. However, the Assessing Officer held that the gifts were not genuine
and added the amounts u/s. 68 of the Act as undisclosed income.

The Commissioner (Appeals)
affirmed the order and recorded findings that the documentation in respect of
the gifts was complete and that the assessee had established the identity of
the donors and their creditworthiness to make the gifts, but did not
acknowledge the gifts as genuine. The Tribunal held that the additions made by
the Assessing Officer u/s. 68 and sustained by the Commissioner (Appeals) could
not be sustained. Thereafter the Tribunal added the said amount as the income
of the assessee u/s. 69A.

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

“i) The use of the word “thereon” in section 254(1) of the Income-tax
Act, 1961 is important and it reflects that the Tribunal has to confine itself
to the questions which arise or are subject matter in the appeal and it cannot
travel beyond that. The power to pass such order as the Tribunal thinks fit can
be exercised only in relation to the matter that arises in the appeal and it is
not open to the Tribunal to adjudicate any other question or issue, which is
not in dispute and which is not the subject matter of the dispute in appeal.

ii) The Tribunal travelled beyond the scope of the appeal in making
the addition of the amounts of the gifts as income u/s. 69A. The subject matter
of the dispute all through before the Tribunal in the appeal was only with
respect to the addition, made u/s. 68, of the amounts received by the assessee
and not whether such addition could have been made u/s. 69A.

iii) The Tribunal had recorded a categorical finding that it was clear
that under the provisions of section 68, the addition made by the Assessing
Officer and sustained by the Commissioner (Appeals) could not be sustained
meaning thereby that the Tribunal was of the opinion that the Assessing Officer
and the Commissioner (Appeals) had committed an error in adding the amounts
u/s. 68 to the income of the assessee.

iv) When the amounts could not have been added u/s. 68, the Tribunal was
not competent to make the addition u/s. 69A. Therefore, the order of the
Tribunal was vitiated in law. Matter remanded to the Tribunal.”

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TRANSFER PRICING: WHAT HAS CHANGED IN OECD’S 2017 GUIDELINES? [PART 1]

Transfer prices are
significant for both taxpayers and tax administrations because they determine
in large part the income and expense and therefore taxable profits of
associated enterprises in different tax jurisdictions. With a view to minimise
the risk of double taxation and achieve international consensus on
determination of transfer prices on cross-border transactions, OECD¹ from time to time provides guidance in
relation to various transfer pricing issues.

In 2015, the OECD
came out with its Reports on the 15 Action items agreed as a part of the BEPS² agenda. These include Actions 8-10 (Aligning
Transfer Pricing Outcomes with Value Creation), Action 13 (Transfer Pricing
Documentation and Country by Country Reporting), and Action 14 (Making Dispute
Resolution Mechanisms More Effective). With a view to reflect the
clarifications and revisions agreed in 2015 BEPS Action Reports, the Transfer
Pricing guidelines were substantially revised and new Guidelines were issued in
2017 (2017 Guidelines).

This Article summarises the key additions
/ modifications made in the 2017 Guidelines (600
plus Pages) as compared to the earlier Guidelines.

These additions / modifications provide important new guidance to practically
look at different aspects of transfer pricing. From the perspective of the
taxpayers as well as tax practitioners, it is important to understand and
implement the new guidance to undertake, conceptually, a globally acceptable
transfer pricing analysis.

The first part
of the article deals with general guidance contained in Chapters 1 to 5 of the
2017 Guidelines. The second part of the article will deal with guidance
relating to specific transactions – Intangibles, Intra-Group Services, Cost
Contribution Agreements, and Business Restructuring.

This part of the
article summarises the following key changes in the 2017 Guidelines vis-à-vis
earlier guidelines:

1. Comparability Analysis

• Guidance on accurate delineation of
transactions between associated enterprises

• Functional analysis (including,
specifically, risk analysis) based on decision-making capabilities and
performance of decision-making functions

• Recognition / de-recognition of accurately
delineated transactions

• Additional comparability factors which may
warrant comparability adjustments

2. Application of CUP Method for analysing
transactions in commodities

3. New guidance on transfer pricing
documentation (three-layered documentation)

4. Administrative approaches to avoiding and
resolving transfer pricing disputes

Each of the above
aspects have been discussed in detail in subsequent paragraphs.

1. Comparability Analysis

The OECD Transfer
Pricing Guidelines advocate the arm’s length principle to determine transfer
prices between associated enterprises for tax purposes and consider
“Comparability Analysis” at the heart of the application of arm’s
length principle. The 2017 Guidelines provide detailed guidance on certain
aspects discussed below.

1.1 Accurate delineation of transactions as the starting point for
comparability analysis

The 2017 Guidelines
provide two key steps in comparability analysis:

Identification of
commercial or financial relations between associated enterprises and conditions
and economically relevant circumstances attaching to those relations in order
that the controlled transaction is accurately delineated;

Comparison of the
conditions and economically relevant circumstances of the controlled
transaction as accurately delineated with the conditions and the economically
relevant circumstances of comparable transactions between independent
enterprises.

______________________________________________________________

1 Organisation
for Economic Cooperation and Development

2 Base
Erosion and Profit Shifting

The 2017 Guidelines provide that the controlled transaction should be
accurately delineated. Further, for the purpose of accurate delineation of the
actual transaction(s) between associated enterprises, one needs to analyse the
commercial or financial relations between the parties and economically relevant
circumstances surrounding such relations. The process starts with a broad
understanding of the industry in which the MNE group operates, derived by an
understanding of the environment in which the MNE group operates and how it
responds to the environment, along with a detailed factual and functional
analysis of the MNE group. This information is likely to be documented in the
Master File of the MNE group. The process then narrows to identify how each entity
within the MNE group operates and provides analysis of what each entity does
and its commercial or financial relations with its associated enterprises.

This accurate
delineation is crucial since the application of the arm’s length principle
depends on determining the conditions that independent parties would have
agreed in comparable transactions in comparable circumstances. For applying the
arm’s length principle, it is not only the nature of goods or services
transacted or the consideration involved that is relevant; it is imperative for
taxpayers and practitioners to accurately delineate the underlying
characteristics of the relationship between the parties as expressed in the
controlled transaction.

The economically
relevant characteristics or comparability factors that need to be identified in
order to accurately delineate the actual transaction can be broadly categorised
as:

Contractual
terms

Functional analysis

Characteristics of property
or services

Economic circumstances,

Business strategies.

Information about these economically relevant characteristics is expected to be
documented in the local file of the taxpayer involved³.

__________________________

3 Refer
para 1.36 of 2017 Guidelines

1.2 Functional Analysis (Primarily, Risk Analysis)

The 2017 Guidelines
provide a detailed discussion on functional analysis, specifically on risk
analysis, as compared to earlier guidelines.

The focus of the
Guidelines with respect to functional analysis is on the actual conduct of the
parties, and their capabilities – including decision making about business
strategy and risks. The Guidelines also clarify that in a functional analysis,
the economic significance of the functions are important rather than the mere
number of functions performed by the parties to the transaction.

The 2017 Guidelines
provide detailed guidance on risks analysis as a part of functional analysis.
This is especially because the 2017 Guidelines have recognised the practical
difficulties presented by risks – risks in a transaction tend to be harder to
identify, and determination of the associated enterprise which bears the risk
can require careful analysis.

The Guidelines
stress on the need to identify risks relevant to a transfer pricing analysis
with specificity. The Guidelines provide for a 6-step process for analysing
risk in a controlled transaction, in order to accurately delineate the actual
transaction in respect to that risk. The process is outlined below:⁴

^{_______________________________________}

4 Refer
Para 1.60 of 2017 Guidelines

It is expected that
going forward, functional analysis in any transfer pricing evaluation will
specifically focus on the above framework to analyse risks.

A detailed
understanding of the risk management functions is necessary for a risk
analysis. Risk management comprises three elements:⁵

he capability to make
decisions to take on, lay off, or decline a risk bearing opportunity, together
with the actual performance of that decision-making function

The capability to make decisions
on whether and how to respond to the risk associated with the opportunity,
together with the actual performance of that decision-making function

The capability to mitigate
risk, that is the capability to take measures that affect risk outcomes, together
with the actual performance of such risk mitigation

The 2017 Guidelines
provide that the party assuming risk should exercise control over the risk and
also have the financial capacity to assume the risk. Control over risk involves
the first two elements of risk management relating to accepting or declining a
risk bearing opportunity, and responding to the risk bearing opportunity. In a
case where the third element, risk mitigation, is outsourced, control over the
risk would require capability to determine the objectives of the outsourced
activities, decision to hire risk mitigation service provider, assessment of
whether mitigation objectives are adequately met, decision on adapting or
terminating the services of the outsourced service provider etc. Financial
capability to assume the risk refers to access to funding required with respect
to the risk and to bear the consequences of the risk if the risk materialises.
Access to funding also takes into account the available assets and the options
realistically available to access additional liquidity, if needed.

As can be seen, the guidance gives weightage to decision-making
capability and actual performance of decision-making functions. The Guidelines
provide that decision makers should be competent and experienced in the area
which needs a decision regarding risks. They should also understand the impact
of their decisions on the business. Decision making needs to be in substance
and not just form. For instance, mere formalising of the outcome of
decision-making in the form of, say, minutes of board meetings and formal
signatures on documents would not normally qualify as exercise of decision
making function and would not be sufficient to demonstrate control over risks.
It is pertinent that these aspects are considered in particular when
undertaking a functional analysis – to identify the ‘control’ over decision
making of a particular function, rather than going by mere contractual terms or
other similar documents that evidence the ‘performance’ of the function.

________________________

5 Refer
Para 1.61 of 2017 Guidelines

The implication of
this detailed new guidance on functional analysis is that a party which under
these steps does not assume the risk, nor contributes to the control of the
risk will not be entitled to unanticipated profits / losses arising from that
risk.

The following
example illustrates application of 6 step process outlined in the 2017
guidelines in the context of risk analysis:⁶

____________________________-

6 Refer
Example 1 (Para 1.83) of the 2017 Guidelines

Company A seeks to
pursue a development opportunity and hires a specialist company, Company B to
perform part of the research on its behalf. Company A makes a number of
relevant decisions about whether and how to take on the development risk.
Company B has no capability to evaluate the development risk and does not make decisions
about Company A’s activities.

Step 1– Development risk is
identified as economically significant risk

Step 2–Company A assumes
contractual development risk

Step 3–Functional analysis
shows that Company A has capability and exercises authority in making decisions
about the development risk. Company B reports back to Company A at
pre-determined milestones and Company A assesses the progress of development
and whether its ongoing objectives are being met. Company A has the financial
capacity to assume the risk. Company B’s risk is mainly to ensure it performs
the research activities competently and it exercises its capability and
authority to control that risk through decision-making about the specifics of
the research undertaken – process, expertise, assets etc. However, this risk is
distinct from the development risk in the hands of Company A as identified in
Step 1.

Step 4–Company A and B
fulfil the obligations reflected in the contracts and exercise control over the
respective risks that they assume in the transaction, supported by financial
capacity.

Step 5–Since the conditions
specified in Step 4 are satisfied, Step 5 will not be applicable i.e. there is
no requirement of re-allocation of risk.

Step 6–Company A assumes and
controls development risk and therefore should bear the financial consequences
of failure and enjoy financial consequences of success of the development
opportunity. Company B should be appropriately rewarded for the carrying out of
its development services, incorporating the risk that it fails to do so
competently.

1.3 Recognition / De-recognition of accurately
delineated transaction

As discussed
earlier, one needs to identify the substance of the commercial or financial
relations between the parties and the actual transaction will have to be
accurately delineated by analysing the economically relevant characteristics.
For the purpose of this analysis, the 2017 Guidelines provide that in cases
where the economically significant characteristics of the transaction are inconsistent
with the written contract, the actual transaction will have to be delineated in
accordance with the characteristics of the transaction reflected in the actual
conduct of the parties.

The 2017 Guidelines
also provide for circumstances in which the transaction between the parties as
accurately delineated can be disregarded for transfer pricing purposes. Where
the actual transaction possesses the commercial rationality of arrangements
that would be agreed between unrelated parties under comparable economic
circumstances, such transactions must be respected even where such transactions
cannot be observed between independent parties. However, where the transaction
is commercially irrational, the transaction may be de-recognised.

1.4 Additional comparability factors which may
warrant comparability adjustments

While the
Guidelines discuss about the impact of losses, use of custom valuation, effect
of government policies in transfer pricing analysis, the 2017 Guidelines also
provide for some additional comparability factors that may warrant
comparability adjustments. In the past, in the absence of clear guidance by the
OECD, some of these factors (such as location savings) have led to litigation,
where the tax authorities have insisted on a separate compensation for the
existence of these factors, whereas, taxpayers have claimed these to be merely
comparability factors not necessitating any transfer pricing adjustments per
se. These factors are:

Location Savings:
The Guidelines provide the following considerations for transfer pricing
analysis of location savings: i) whether location savings exist; ii) the amount
of location savings; iii) the extent to which location savings are retained by
an MNE group member, or passed on to customers or suppliers; iv) manner in
which independent parties would allocate retained location savings.

Other Local Market
Features: These factors refer to other market features such as
characteristics of the market, purchasing power and product preferences of
households in the market, whether the market is expanding or contracting,
degree of competition in the market and other similar factors. These market
factors may create advantages or disadvantages, and appropriate comparability
adjustments should be made to account for these advantages or
disadvantages.

Assembled workforce:
The existence of a uniquely qualified or experienced employee group may affect
the arm’s length price of services provided by the group of the efficiency with
which services are provided or goods produced. In some other cases, assembled
workforce may create liabilities. Existence of an assembled workforce may
warrant comparability adjustments. Depending upon precise facts of the case,
similar adjustments may be warranted in case of transfer of an assembled
workforce from one associated enterprise to another.

MNE group synergies: Group
synergies may be positive or negative. Positive synergies may arise as a result
of combined purchasing power or economies of scale, integrated computer or
communication systems, integrated management, elimination of duplication,
increased borrowing capacity, etc. Negative synergies may be a result of
increased bureaucratic barriers, inefficient computer or networking systems
etc. Where such synergies are not a result of deliberate concerted group
actions, appropriate comparability adjustments may be warranted. However, when
such synergies are a result of concerted actions, only comparability
adjustments may not be adequate. In such situations, from a transfer pricing
perspective, it is necessary to determine: i) the nature of advantage or
disadvantage arising from the concerted action; ii) the amount of the benefit /
detriment; iii) how should the benefit or detriment be divided amongst the
group members (generally, in proportion to their contribution to the creation
of the synergy under consideration).

2. Application of CUP Method for analysing
transactions in commodities

The OECD Guidelines
provide that the selection of a transfer pricing method should always aim at
finding the most appropriate method for a particular case. The guidance
provides description of traditional transaction methods and transactional
profit methods. The 2017 Guidelines provide additional guidance in the context
of CUP method.

The 2017 Guidelines
provide that that CUP method would generally be an appropriate transfer pricing
method (subject to other factors) for establishing the arm’s length price for
the transfer of commodities between associated enterprises. The reference to
“commodities” shall be understood to encompass physical products for
which a quoted price is used as a reference by independent parties in the
industry to set prices in uncontrolled transactions. The term “quoted
price” refers to the price of the commodity in the relevant period
obtained in an international or domestic commodity exchange market. Quoted
price also includes prices obtained from recognised and transparent price
reporting or statistical agencies or from government price setting agencies,
where such indexes are used as a reference by unrelated parties to determine
prices in transactions between them.

Such quoted price
should be widely and routinely used in the ordinary course of business in the
industry to negotiate prices for comparable uncontrolled transactions.

Further, the
economically relevant characteristics of the transactions or arrangements
represented by the quoted price should be comparable. These characteristics
include physical features and quality of the commodity; as well as contractual
terms of the transaction such as volumes traded, period of arrangements, timing
and terms of delivery, transportation, insurance and currency terms. If such
characteristics are different between the quoted price and the controlled
transaction, reasonably accurate adjustments ought to be carried out to make
these characteristics comparable.

The Guidelines also
provide that the pricing date is an important element for making a reference to
the quoted price. Depending on the commodity involved, the pricing date could
refer to specific time, date or time period selected by parties to determine
the price of the commodity transactions. The price agreed at the pricing date
may be evidenced by relevant documents such as proposals and acceptances,
contracts, or other relevant documents. The Guidelines place the onus on the
taxpayer to maintain and provide reliable evidence of the pricing date agreed
by the associated enterprises. If reliable evidence is provided and it is
aligned with the conduct of the parties, the tax authorities should ordinarily
base their examination with reference to the pricing date. Otherwise, the tax
authorities may deem the pricing date based on documents available with them
(say, date of shipment as evident from the bill of lading).

Illustration:

An illustration of
how this guidance relating to the relevance of the pricing date is relevant, is
provided below.

Assume the case of a commodity the price of which fluctuates on a daily
basis. The commodity is available in the spot market. In some cases, the prices
are also agreed for a future date / period for future deliveries. A taxpayer in
India (ICo.) imports the commodity from its AEs, at prices agreed two months in
advance. For the sake of this example, assume that the future prices of the
commodity tend to be same / similar as the spot prices (with the possibility of
a small future premium of up to 0.10% in some cases). ICo also imports certain
quantities of the commodity on a spot basis from third parties – in order to
take advantage of a potential favourable price movement.

Some of the dates of transactions entered into by ICo, and the
corresponding prices are provided in the table below, along with comparable
uncontrolled prices for the exact same dates.

Transaction
Date

Transaction Price in INR per unit

CUP
Available in INR on Transaction Date

30^th June 2017

10,000

10,450

30^th September 2017

10,600

10,300

31^st December 2017

10,200

10,650

31^st March 2018

10,800

10,900

From a plain
reading of this table, which represents the approach of comparing the prices as
at the transaction date, it would appear that the import prices are at arm’s
length for the three purchases made in June 2017, December 2017 and March 2018.
However, for the purchases made in September, 2017, there is a comparable
transaction available with a lower price. Accordingly, it appears that a
transfer pricing adjustment for the difference (INR 10,600 – INR 10,300 = INR
300 per unit) is warranted in the instant case. In fact, based on similar data,
there could be a potential transfer pricing adjustment in the hands of the AE
of ICo for the months of June 2017, December 2017 and March 2018⁷.
Clearly, the above analysis does not represent the commercial reality of the
transactions – that the pricing of the transactions with the AE has been
decided much before the transaction has been entered into, and under the CUP
Method, the same cannot be compared with the spot prices paid for third party
imports.

_________________________________________

7 For
the purpose of this analysis, it is assumed that all relevant comparability
criteria for application of CUP Method are satisfied.

However, if ICo is
able to provide evidence of the dates on which the prices have been agreed with
its overseas AE, data pertaining to such dates may be considered even if there
is no comparable uncontrolled transaction entered into by ICo during such
dates. Now consider the additional evidence provided by ICo in the following
table (see highlighted columns).

As can be seen from
the table above, the transaction prices appear more closely aligned with the
quoted prices as at the PO date. These prices are, in fact, better indicators
of the real market scenario – since in the real world, in case prices are
determined in advance of the transaction taking place, the parties do not have
the benefit of hindsight, and would consider the prevailing quoted prices to
arrive at their transfer prices. ICo and the AE would yet need to demonstrate,
in their respective jurisdictions, that the difference between the quoted price
and the transaction price is representative of the arm’s length future premium,
however, this explanation should be a lot easier and involve far lesser tax
risk than starting from a relatively inaccurate starting point –prices agreed
at a different date.

Transaction Date

Purchase Order (PO) Date

Transaction Price in INR per unit

Quoted Price in INR on PO date

CUP Available in INR on Transaction Date

30^th June 2017

30^th April 2017

10,000

10,010

10,450

30^th September 2017

30^th July 2017

10,600

10,300

31^st December 2017

31^st October 2017

10,200

10,205

10,650

31^st March 2018

31^st January 2018

10,800

10,810

10,900

It is important for
the tax teams of MNEs to ensure that the procurement or sales teams (depending
on the nature of the transaction) document the correct period at which the
price was agreed (date or time, as the case may be – and depending on the
volatility of the price of the quoted product), and maintain evidence of the
quoted price of the commodity at the same period.

There appears to be
a direct correlation between the frequency and quantum of fluctuations in the
commodity prices, with the accuracy of the period of price setting that needs
to be evidenced.

3. New guidance on transfer pricing
documentation (three-tiered documentation)

The 2017 Guidelines
outline transfer pricing documentation rules with an overarching consideration
to balance the usefulness of the data to tax administration for transfer
pricing risk assessment and other purposes with any increased compliance
burdens placed on taxpayers. The purpose is also to ensure that transfer
pricing compliance is more straightforward and more consistent amongst
countries⁸.

Briefly, the three
fold objectives of transfer pricing documentation as outlined in 2017
Guidelines are (a) ensuring taxpayer’s assessment of its compliance with the
arm’s length principle (b) effective risk identification (c) provision of
useful information to tax administrations for thorough transfer pricing audit.

The 2017 Guidelines
suggest a three-tiered approach to transfer pricing documentation and insist on
countries adopting a standardised approach to transfer pricing documentation.
The elements of the suggested three-tiered documentation structure are
discussed below.

Master File – Master
File is intended to provide a high level overview to place MNE group’s transfer
pricing practices in their global economic, legal, financial and tax context.
The information required in the Master File provides a blueprint of MNE group
and contains relevant information that can be grouped in 5 categories (a) MNE
group’s organisational structure (b) a description of MNE’s business or
businesses (c) MNE’s intangibles (d) MNE’s intercompany financial activities
and (e) MNE’s financial and tax positions⁹. The Guidelines are not
rigid in prescribing the level of details which need to be provided as a part
of the Master File, and require that taxpayers should use prudent business
judgment in determining the appropriate level of detail for the information
supplied, keeping in mind the objective of the Master File to provide a high
level overview of the MNE’s global operations and policies.

_____________________________________

8 The earlier guidelines emphasised on the
greater level of co-operation between tax administrations and taxpayers in
addressing documentation issues. Those guidelines did not provide for a list of
documents to be included in transfer pricing documentation package nor did they
provide clear guidance with respect to link between process for documenting
transfer pricing, the administration of penalties and the burden of proof.

9 Refer
Para 5.19 of 2017 Guidelines

Local File – Local
file provides more detailed information relating to specific inter-company
transaction. The information required in local file supplements the master file
and helps to meet the objective of assuring that the taxpayer has complied with
the arm’s length principle in its material transfer pricing positions affecting
a specific jurisdiction. Information in the local file would include financial
information regarding transactions with associated enterprises, a comparability
analysis, and selection and application of the most appropriate method.

Country by Country
Reporting (CbCR) – The CbCR requires aggregate tax jurisdiction wide
information relating to the global allocation of the income, the taxes paid and
certain indicators of the location of economic activity among tax jurisdictions
in which the MNE group operates¹⁰. The Guidelines provide that CbCR
will be helpful for high level transfer pricing risk assessment purposes, for
evaluating other BEPS related risk (non-transfer pricing risks), and where
appropriate, for economic and statistical analysis¹¹. The Guidelines
provide that the CbCR should not be used as a substitute for a detailed
transfer pricing analysis based on a full functional analysis and comparability
analysis; and should also not be used by tax authorities to propose transfer
pricing adjustments based on a global formulary apportionment of income.

The Guidelines
provide (as agreed by countries participating in the BEPS Project) for the
following conditions underpinning the obtaining and the use of the CbCR:¹²

• Legal protection of the confidentiality of
the reported information

• Consistency with the template agreed under
the BEPS Project and provided as part of the Guidelines

• Appropriate use of the reported information
– for purposes highlighted above

Further, the 2017
Guidelines provide for ultimate parent entity of an MNE group to file CbCR in
its jurisdiction of residence and implementing arrangements by countries for
the automatic exchange of CbCR. The participating jurisdictions of the BEPS
project are encouraged to expand the coverage of their international agreements
for exchange of information.

Practically, this
three – tiered documentation is one of the most important transfer pricing
exercise which taxpayers and tax practitioners have been engaged in, over the
past more than a year– in aligning the three sets of documents, and ensuring
they provide consistent information.

______________________________________________-

10 The 2017 Guidelines recommend an exemption
for CbCR filing for MNE groups with annual consolidated group revenue in the
immediately preceding fiscal year of less than EUR 750 million or a near
equivalent amount in domestic currency as of January 2015. Refer Para 5.52.

11 Refer Para 5.25 of 2017 Guidelines

12 Refer Paras 5.56 to 5.59 of 2017 Guidelines

Detailed
discussion and analysis of the contents of Master File, Local File and CbCR
have been kept outside the purview of this Article. One may refer to Annex 1,
Annex II and Annex III to Chapter V of the 2017 Guidelines for the details of
contents of the Master File, Local file and CbCR respectively.

4. Administrative approaches
to avoiding and resolving transfer pricing disputes

The 2017 Guidelines
have provided administrative approaches to resolving transfer pricing disputes
caused by transfer pricing adjustments and for avoiding double taxation.
Differences in guidance as compared to the earlier guidance have been discussed
in this section.

MAP and Corresponding
Adjustments

The 2017 Guidelines
provide that procedure of Article 25 dealing with Mutual Agreement Procedure
(MAP) may be used to consider corresponding adjustments arising out of transfer
pricing adjustments.

The 2017 Guidelines
specifically discusses regarding the concern of taxpayers in relation to denial
of access to MAP in transfer pricing cases. The Guidelines make a reference to
the minimum standard agreed as a result of the BEPS Action 14 on ‘Making
Dispute Resolution Mechanisms More Effective’ and re-emphasise the commitment
on the part of countries to provide access to the MAP in transfer pricing
cases. The Guidelines also provide detailed guidance relating to time limits,
duration, taxpayer participation, publication of MAP programme guidance,
suspension of collection procedures during pendency of MAP etc. Overall, the
idea appears to be to make the MAP program more effective and meaningful for
taxpayers, and to enhance accountability of the tax administration in MAP
cases.

Safe Harbours

The 2017 Guidelines
highlight the following benefits of safe harbours:¹³

• Simplifying compliance

• Providing certainty to taxpayers

• Better utilisation of resources available
to tax administration

____________________________-

13
Refer Para 4.105 of 2017 Guidelines

The Guidelines also
highlight the following concerns relating to safe harbours:¹⁴

• Potential divergence from the arm’s length
principle

• Risk of double taxation or double non
taxation

• Potential opening of avenues for
inappropriate tax planning

• Issues of equity and uniformity

__________________________

14
Refer Para 4.110 of 2017 Guidelines

The 2017 Guidelines
provide that in cases involving small taxpayers or less complex transactions,
the benefits of safe harbours may outweigh the problems / concerns raised in
relation to safe harbours. The appropriateness of safe harbours can be expected
to be most apparent when they are directed at taxpayers and / or transactions
which involve low transfer pricing risks and when they are adopted on a
bilateral or multilateral basis. The Guidelines however provide that for more
complex and higher risk transfer pricing matters, it is unlikely that safe
harbours will provide a workable alternative to rigorous case by case
application of the arm’s length principle.

Concluding Remarks

The 2017 Guidelines
reflect the clarifications and revisions agreed in reports on BEPS Actions 8-10
(Aligning Transfer Pricing Outcomes with Value Creation), Action 13 (Transfer
Pricing Documentation and Country by Country Reporting), and Action 14 (Making
Dispute Resolution Mechanisms More Effective).

Evidently, the
focus areas of the 2017 Guidelines are substance, transparency and certainty.
Several practices and recommendations of the Indian tax administration do find
place in the BEPS Actions, and consequently, in the 2017 Guidelines also. India
is largely aligned with the 2017 Guidelines.

Even at the grass
root level, taxpayers and professionals are already experiencing the evolution
of transfer pricing analysis from a contractual terms based analysis to a more
deep rooted factual analysis considering several facts and circumstances
surrounding the transaction. Further, the way this analysis is documented is
also being transformed – from a jurisdiction specific documentation, to a
globally consistent, three-tiered documentation.

From the
perspective of the tax authorities, they now have the ‘big picture’ available
to them. This should enable them to undertake a comprehensive and more
business-like analysis of the MNE’s transfer pricing approaches.

shailesh.kwebmaker

TOP BOOKS ON PROFESSIONAL SERVICES MANAGEMENT

INTRODUCTION

When compared to
the study of business management, the study of professional services management
is of recent vintage. While business management education is most sought after
the world over, the knowledge and skills required for managing professional services
are usually acquired on the job,and many times through trial and error.
Professionals study technical subject, but often leave out the management
aspects, which impact their growth and profitability. It is therefore
imperative to keep in touch with the developing management thinking and best
practices about professional services.

David Maister, an
authority on this subject, emphasises that professional services involve a high
degree of customisation with a strong component of face-to-face interaction with
the client. A former Harvard Business School professor, Maister argues that
management principles and approaches from the industrial or mass consumer
sectors, which are based on standardisation, supervision and marketing of
repetitive tasks and products,are not only inapplicable to professional
services but may also be dangerously wrong.

Thankfully, there
are many books to study and learn the art and science of professional services
management. Some of the top books which also feature on several recommendation
lists are:

Title

Author(s)

The Trusted Advisor

David H. Maister, Charles H. Green and
Robert M. Galford

Managing the Professional Service Firm

David H. Maister

Flawless Consulting: A Guide to Getting
Your Expertise Used

Peter Block

Million Dollar Consulting: The
Professional’s Guide to Growing a Practice

Alan Weiss

The McKinsey Way

Ethan Rasiel

The Consultant with Pink Hair

Cal Harrison

This feature
attempts to summarise and highlight key learnings from some of the above books.
This article presents the summary of the first such book.

The Trusted
Advisor by David H. Maister, Charles H. Green and Robert M. Galford

THEME

The central theme
of this book revolves around the fact that the key to professional success is
not just technical mastery of one’s discipline, which is most essential, but
also the ability to work with clients in such a way as to earn trust and gain
their confidence.

At one time, being
a professional automatically carried prestige and easily win clients’ trust.
However, things have changed. The notion of embedded trust has been affected.
These days, professionals often find that they need more client access, more
ways to cross-sell and more opportunities to show the quality of their work
(beyond price considerations). Many clients now treat professionals as
untrustworthy, because they question the advisors’ motives or do not see them
as experts.

To break out of
these boundaries, one must become a “trusted advisor.” This requires
developing an ever-deepening relationship with each client. As such a
relationship evolves, the client will involve you in a broader range of
business issues. Along the way, you can progress from being a subject-matter
expert, to being an associate with expert knowledge and additional valuable
specialties. Moving from one level to the next is evolutionary, but once you
become a trusted advisor, your client will openly discuss both personal and
professional issues with you.

As an example of a
“trust-based relationship”, the book narrates the case of sports
agent David Falk and basketball star Michael Jordan. In 1977, Falk helped
negotiate Jordan’s $2.5 million endorsement deal with Nike. As Jordan’s career
progressed, Falk negotiated more endorsements. Eventually, Falk sold his agency
for $100 million, but he still collects 4% of Jordan’s earnings. Falk earned
Jordan’s trust and friendship by knowing what his client wanted, including
Jordan’s opinions about his fees. There were a few times when Falk waived his
fee without any discussion with Jordan because Falk knew Jordan might object to
the cost. He continues to work with Jordan today mainly due to the trust with
Jordan that Falk built.

With deep insights,
examples from real life and practical tips, the trust and behaviour framework
from this book has become a key element of management education for
consultants, and it has been helping a large number of professionals to pursue
the right approach and technique in their journey of being trusted advisors to
their clients.

PERSPECTIVES ON TRUST

Ambitious
professionals invest tremendous energy in improving their specific expertise
and gaining experience, but do not give adequate thought to creating and
strengthening the trust relationships with their clients. Many professionals do
not know how to think about or examine trust relationships. A useful framework
is provided to gauge the depth of the client relationship:

Depth of Relationship

Focus is on

Energy
spent on

Client receives

Indicators of success

Service Based

Answers, expertise, input

Explaining

Information

Timely, high quality delivery

Needs-based

Business problem

Problem Solving

Solutions

Problems resolved

Relationship-based

Client organisation

Providing insights

Ideas

Repeat business

Trust-based

Client as individual

Understanding the client

Safe haven for hard issues

Varied; e.g. creative pricing

The three basic
skills that a Trusted Advisor needs:

Earning Trust

Building Relationships

Giving Advice Effectively

Key characteristics
of trust are:

1. It grows instead of just appearing – it
results from accumulated experiences over time.

2. It is both rational and emotional – trust is
lot richer than logic alone and is a significant component of success.

3. It presumes a two-way relationship – between
two persons and is highly personal.

4. It is intrinsically about perceived risk –
creating trust entails taking some personal risks.

5. It is different for the client than it is for
the advisor – just because you can trust does not mean you can be trusted.
However, if you are incapable of trusting, you probably can’t be trusted.

6. It is personal–trust requires being understood
and having some capacity to act upon that understanding which can be performed
only by individuals and not institutions.

A sound advice
requires asking the following critical questions:

1. What options do we have for doing things
differently?

2. What advantages do you foresee for different
options?

3. How do you think relevant players would
react?

4. How do you suggest we deal with adverse
consequences of an action?

5. Other people have encountered difficulties
when they tried that. What can we do to prevent such things from occurring?

6. What benefits might arise if we tried a
different approach?

A good process for
the advisor to follow is:

1. To give them their options

2. To educate them about the options
(including enough discussion for them to consider each option in depth)

3. To give them a recommendation

4.To allow them flexibility to choose

Building a business relationship involves similar elements you would use
to build a personal relationship. You need to be sympathetic, understanding,
available, reinforcing and respectful. You need to understand the clients’
business and know what a decision involves. When you get to know a client, you
will often be able to tell when your advice is being sought and when it is not.
Both matter. Do not assume you can solve everything.Trusted advisors have
strong professional and personal relationships with clients.

A trusted advisor
must develop appropriate attitude or “mindsets”, the most important of which
are:

1. Client-focus — instead of “how this
reflects on me”, “solving my client’s problem”, make that
transition from the power of “technical competence” to the power of
“facilitating competence”.

2. Self-confidence — instead of worrying about
insecurity, focus on the problem at hand.

3. Ego-strength — instead of assigning
credit/blame, focus on bringing about the solution. “It’s amazing what you
can achieve when you are not wedded to who gets the credit”.

4. Curiosity — instead of “knowing”,
develop an attitude of inquiry.

5. Inclusive professionalism — seeing the client
as a peer and solving the problem together.

Sincerity is
crucial to both trust and relationships. If you have it and can show it, you
will do well. If you try to “fake it”, it will show up, making it not only
ineffective, but also creating an adverse reaction.

Getting into the
right mental frame of mind happens in two ways, simultaneously:

“from within” —
feeling a genuine interest/caring for the client and their success

“from without” —
acting in ways that express interest/caring for the client.

Sometimes you have
to start with one end or the other; “from without” is easier to initiate.
You can have genuine human contact without being a personal friend. In very
rare cases, you may not be able to work with someone. One of the most important
lessons to learn is that to earn trust, you must bet on the long term benefit
of the relationship. The hallmark of trusted advisors is that they don’t bail
out when the times get tough.

THE STRUCTURE OF TRUST BUILDING

The most critical
learning from this book is the ‘Trust Equation’. The authors suggest that there
are four primary components of trustworthiness, as shown below:

These components
have to do with the trustworthiness of words, actions, emotions, and motives,
as shown in below table:

Component

Realm

Trust behaviour

Trust failings

Credibility

Words

I can trust what he says about…

Windbags¹

Reliability

Actions

I can trust her to…

Irresponsible

Intimacy

Emotions

I feel comfortable discussing this…

Technicians

Self-orientation

Motives

I can trust that she cares about…

Devious

Credibility – The notion of credibility includes notion of both accuracy and
completeness. Accuracy, in the client-advisor world, is mostly rational.
Completeness, on the other hand, is frequently assessed more emotionally. While
most providers sell on the basis of technical competence, most buyers buy on
the basis of emotion. What we tend not to do is to enhance the emotional side
of credibility: to convey a sense of honesty, to allay any unconscious
suspicions of incompleteness. The best service professionals excel at two
things in conveying credibility: anticipating needs, and speaking about needs
that are commonly not articulated.

Reliability – It is one component of the trust equation that is action-oriented
and that distinguishes it from credibility. Reliability in the larger rational
sense is the repeated experience of links between promises and action. It also
has an emotional aspect, which is revealed when things are done in a manner
that clients prefer, or to which they are accustomed. In this emotional sense,
reliability is the repeated experience of expectations fulfilled.

Intimacy – The most common failure in building trust is the lack of
intimacy. Business can be intensely personal surrounded by obvious human
emotions related to issues at hand without involving private lives. It is the
extent to which a client can discuss difficult topics/agendas with you.

Self-orientation – There is no greater source of distrust than advisors who appear
to be more interested in themselves than in trying to be of service to the
client. The most egregious form is to be in it for the money – it extends
beyond greed and covers anything that keeps us focused on ourselves rather than
on our client.

DEVELOPMENT OF TRUST IN FIVE STAGES

It is important to
understand how trust-based relationships are developed; indeed, when examined
closely, you can see five essential stages that lead, consistently, to trusting
relationships.

__________________________________

1 a person who talks at length but says
little of any value

1. Engage – Give your clients and
prospects individual attention. Offer customisation. Make personal, timely,
topical connections with clients about their business challenges. Find out all
you can about new prospects. Seek opportunities to discuss activities of mutual
interest. Discuss more than factual content, because that can pigeonhole you as
a technician, instead of as an advisor.

2. Listen– Sometimes an advisor’s most
important job is to listen, sympathise, integrate and get involved. Listening
is an activity and not a passive process. When arranging a meeting, set an
agenda. That can help you prioritise various decisions, prompt a conclusion and
foster action. When clients share the agenda, they become involved in the
meeting and gain a vested interest in its outcome.

3. Frame – Once advisors can clearly
state their clients’ problems, they are more than half-way toward reaching a
solution. Framing a problem is challenging, but when you do it correctly, it is
very rewarding. You can frame problems in a rational or emotional context.
Rational framing breaks a problem down to its component parts. It works best
when it reveals a new perspective. Emotional framing uncovers any personal
feelings that may be linked to a decision. This can often be uncomfortable since
it involves saying things that have been left unsaid, often deliberately.

4. Envision – Articulating a possible new
reality opens a client’s imagination to new ways of doing things; it can spark
creativity or challenge the status quo. Envisioning, which is crucial to
problem solving, sets the stage for future actions.

5. Commit – Once you frame a problem,
shape a vision and determine a general course of action. Explain the
implementation details to your client. Covering all the pitfalls and barriers
is an essential part of getting the client to agree to future action. This
links the plan to the nuts-and-bolts of execution. Manage the client’s
expectations on what will happen. Restrain excess anticipation by clearly
stating what you plan to do and what the client should do. Give details to
avoid misunderstanding.

PUTTING TRUST TO WORK

The following behaviours can help a professional gain trust that would
have the highest impact, or fastest payback:

1. Listen to everything: Force yourself
to listen and paraphrase, in order to get what the client is trying to say.

2. Empathise (for real): Anyone who
understands us has earned the right to engage in discussion or even debate;
anyone who empathises with us has earned the right to disagree and still have
our respect. Listen to where the client is coming from, understand that
perspective and acknowledge that understanding.

3. Note what the client is feeling: Note
what clients say and do in your interactions with them. Make careful deductions
about what their feelings might be. Acknowledge your own feelings and voice
them as well, but carefully.

4. Build a shared agenda: Whether you are
in a large or informal meeting, share your ideas for an agenda and ask the
client to add their ideas as well. This creates buy-in and shows you have a
“we, not me” attitude.

5. Take a point of view: Go out on a limb
with an idea or perspective, even if you are not entirely sure of it. Such
articulation stimulates reactions and crystallises issues, serving as a
catalyst to draw ideas out of your client.

6. Take a personal risk: Put yourself
“out there” for your client — reveal something about yourself, even though such
revelations carry with them risks of personal loss, even ridicule.

7. Ask about a related area:
Advisors who notice and express interests outside their particular realm of
experience make an impression on their clients. They show that they care enough
about the client to not merely focus on the narrow realm of their professional
issues and interests, but to expand that focus to address a wide array of
client needs.

8. Ask great questions: Open-ended
questions allow you to probe the client’s needs without artificially framing
the client’s response or biasing them one way or another. The objective is to
hear what the speaker has to say, in the speaker’s own terms. By doing this,
you show the speaker respect by allowing him or her to set the frames of
reference, not contorting them to fit your viewpoint.

9. Give away ideas: Expertise is like
love — not only is it unlimited, but you can destroy it by not giving it away.
It cannot be scanned into a database; rather, it is the unique human ability to
redefine a problem and come up with creative solutions for solving it. It is
what a successful advisor brings to every situation, and it only gets better
with practice.

10. Return calls with unbelievable speed:
Getting back to the client, fast, could be the most trust-creating thing you
do. No one expects it, and it demonstrates how much you value your client.

11. Relax your mind: Critical meetings with
your client can be stress-inducing environments; it is crucial to rid your
mind, however temporarily, of internal distractions prior to entering into such
situations. Think about one saying or one question at a time. Write out your
feelings about the one you choose, or talk through it, aloud, prior to a client
meeting. Doing so will help cleanse your mind of distractions or internal
conflicts prior to heading into a potentially stressful situation.

SUMMING – UP

The experience
suggests that trusted advisors form a strong professional and personal bond
with their clients. They focus on their clients’ needs and believe that doing
the right thing has long-term benefits.

Trusted advisors
place the client relationship first and foremost, even if a current project
fails. This often means that the professional makes a substantial commitment to
the client even when there is no immediate prospect of a profit. Successful
trusted advisors continually explore new ways to help, define problems and work
on solutions.

In an organisational context, the
behavioural framework is also helpful to the subordinates in gaining greater
trust from their seniors.

shailesh.kwebmaker

AMENDMENTS IN COMPANIES ACT BY AN ORDINANCE

1.
Introduction

The Companies Act, 2013, (Act) came into force on 1.4.2014. There are 470 sections in this Act as
compared to more than 650 sections in the previous Companies Act, 1956. Various sections of the present Act were
brought into force in a phased manner.
This Act was amended by the Companies (Amendment) Act, 2015 and again by
the Companies (Amendment) Act, 2017.
These amendments were brought into force in a phased manner. Now, some important amendments are made in
the Act by the Companies (Amendment) Ordinance, 2018, which has been
promulgated by the Hon’ble President on 2^nd November, 2018. These amendments have come into force on 2^nd
November, 2018. Some of the important
amendments made by the Ordinance are discussed in this Article.

2. FINANCIAL YEAR – SECTION 2(41)

(i) The term “Financial Year” is
defined in section 2(41) of the Act. This section provides that the Financial
Year of a Company or a Body Corporate shall end on 31^st March, every
year. However, a company or a body a company which is holding, subsidiary or
associate of a Foreign Company which is required to prepare financial
statements with different Financial Year for submission of consolidated
accounts outside India, according to the law of that country, can have a
different Financial Year if the National Company Law Tribunal
(Tribunal), on application by such
company or body corporate, permits the same.
In this case such company or body corporate can have a different
financial year for the purpose of consolidation of accounts.

(ii) By amendment of this section it is now
provided that on and after 2.11.2018 such application will have to be made to
the Central Government in the prescribed form.
In other words, power to grant this permission is now transferred from
the Tribunal to the Central Government.
All pending applications as on 2.11.2018 before the Tribunal can be
disposed of by the Tribunal.

3. COMMENCEMENT OF BUSINESS BY A COMPANY – (NEW SECTION 10A AND SECTION 12)

(i) At present there is no provision for giving
intimation about commencement of
business by a company. A new section 10A
is now inserted to provide that a company incorporated on or after 2.11.2018
and having a share capital shall not commence any business or exercise any borrowing powers without complying with
the following procedure.

(a) A declaration in the prescribed form should be
filed by a Director of the company within 180 days of the date of incorporation
with the ROC. In this declaration it should be stated and verified that every
subscriber to the Memorandum of Association has paid the value of the shares
agreed to be taken by him on the date of making such declaration.

(b) Further, it is to be stated in the declaration
that the company has filed a verification of its Registered Office u/s. 12(2)
with the ROC.

(ii) If the above declaration is not filed, the
company will be liable to penalty of Rs. 50,000/-. Further, every officer who is in default will
be liable to pay penalty of Rs. 1,000/- per day during which the default continues
subject to a maximum of Rs. 1 Lakh.

(iii) Further, if the above declaration is not filed
within 180 days of the date of incorporation and the ROC is satisfied that the
company is not carrying on any business or operations, he can remove the name
of the company from the Register of
Companies as provided in Chapter XVIII of the Act.

(iv) It may be noted that s/s. (9) is added in
section 12 to provide that if the ROC is satisfied that a company is not
carrying on any business or operations, he can make physical verification of
the Registered Office of the Company in the prescribed manner. If the ROC is satisfied that no such
Registered Office is maintained by the company and no business or operations
are carried on by the company, he can remove the name of the company from the
Register of Companies as provided in the Chapter XVIII of the Act.

(v) It may be noted that consequential amendment
is made in section 248 dealing with power of ROC to remove the name of the
company from the Register of Companies.
It may further be noted that similar provision existed in this section
when enacted in 2013. However, this was omitted by the Companies (Amendment)
Act, 2015, w.e.f. 29.05.2015. The same provision is now brought back w.e.f.
2.11.2018 by amendment of section 248.
Further, this power to remove the name of the company for the above
default applies to a Private or a small company having share capital.

(vi) The above power appears to have been given to
the ROC to weed out some bogus or in operative companies which are formed by some
unscrupulous persons for money laundering and other anti-social activities.

4. CONVERSION OF PUBLIC COMPANY INTO PRIVATE COMPANY – (SECTION 14)

At present section
14(1) provides that a Public Company can be converted into a Private Company
with approval of the Tribunal. This
section is now amended to provide that such conversion can be made only after
approval by the Central Government. For
this purpose application should be made to the Central Government in the
prescribed form. It is also provided that all pending applications before the
Tribunal shall be disposed of by the Tribunal.

5. PROHIBITION ON ISSUE OF SHARES AT DISCOUNT – (SECTION 53)

(i) At present the punishment for non-compliance
with the section is fine between Rs. 1 Lakh to Rs. 5 Lakh payable by the
company and imprisonment of officer in default for a period upto six months or Fine
between Rs. 1 Lakh and Rs. 5 Lakh or with both.

(ii) This section is now amended to provide that
in the event of non-compliance with the
provisions of the section, the company and every officer in default shall be
liable to Penalty upto an amount equal to the amount raised through issue of shares at a discount or Rs.
5 Lakh whichever is less.

(iii) Further, the company will have to refund all
monies received from the persons who
have subscribed to such shares with
interest at the rate of 12% P. A. from the date of receipt to the date of
refund .

(iv) It may be noted that the
punishment by way of imprisonment of defaulting officers is now done away with.

6. NOTICE TO BE GIVEN TO ROC FOR ALTERATION OF SHARE CAPITAL – (SECTION 64)

Under the existing
section 64(2) the Company and every
officer in default has to pay Fine of Rs. 1,000/- per day during
which the default continues subject to maximum of Rs. 5 Lakh. The amendment to this section provides that
the amount shall be payable as Penalty for contravention of the
section.

7. DUTY TO REGISTER CHARGES – (SECTION 77)

(i) Section 77 provides that any charge created
by the company shall be registered with ROC within 30 days of such
creation. If this is not done, the
charge can be registered within 300 days of creation of the charge on payment
of the prescribed additional fees. If the
charge is not registered within this period of 300 days, the company can apply
for extension of time to the Central Government as provided in section 87.

(ii) This provision for extension of time beyond
30 days is now amended by amendment of
section 77 as under:

(a) The ROC may allow, on application by the
company, to register charges created before 2.11.2018 and the same can be filed
within 300 days of the date of creation, if not filed within 30 days, on
payment of prescribed additional fees

(b) If charge created before 2.11.2018 which has
not been filed within 300 days, the same can be filed within 6 months from
2.11.2018 on payment of such prescribed additional fees and different fees may
be prescribed for different classes of companies.

(c) The ROC may allow, on application by the
company, to register charges created on or after 2.11.2018, if not filed within
30 days, and the same can now be filed with 60 days of creation on payment of
the prescribed additional fees. It may
be noted that existing period of 300 days is now reduced to 60 days.

(d) In the case of a charge created on or after
2.11.2018, if the charge is not filed within 60 days, the ROC, on application
made by the company, may allow registration of charge within a further period
of 60 days after payment of such advalorem fees as may be
prescribed. This will mean that the fees
payable for the delay will be calculated as a percentage of the amount of the
charge.

(iii) Existing section 86 provides for punishment to
the company and its officers in default for contravention of sections 77 to
85. In addition to this punishment, this
section is now amended to provide that if any person willfully furnishes any
false or incorrect information or knowingly suppresses any material information
required to be registered u/s. 77, he shall be liable for action under section
447. U/s. 447 there is provision for levy of fine as well imprisonment of the
defaulting officer for specified period.

8. RECTIFICATION BY CENTRAL GOVERNMENT IN REGISTER OF CHARGES – (SECTION 87)

The existing
section 87 is replaced by a new section 87 which provides as under:

(i) The section provides for a situation in which
there is omission to give intimation to ROC of payment or satisfaction of a
charge within the stipulated time limit.
It also deals with the omission or misstatement of any particulars with
respect to any such charge or modification or with respect to any memorandum of
satisfaction or other entries made as provided u/s. 82 or 83.

(ii) With respect to the above, if the Central
Government is satisfied that such omission or misstatement was accidental or
due to inadvertence or some other sufficient cause or it is not prejudicial to
the position of creditors or shareholders, it may, give the following relief.

(a) Extend time for giving intimation of payment
or satisfaction of debt.

(b) Direct that the omission or misstatement be
rectified in the Register of Charges.

9. REGISTER OF SIGNIFICANT BENEFICIAL OWNERS IN A COMPANY – (SECTION 90)

(i) A very comprehensive new section 90 was
introduced by the Companies (Amendment) Act, 2017. Under this section a person having beneficial
interest of not less than 25% or, such percentage as may be prescribed in the
Shares of the Company or has right to exercise significant influence or control
as defined in section 2(27) has to give a declaration in the prescribed manner.
Section 90(9) provides that the company or the person aggrieved by the order of
the Tribunal passed u/s. 90(8) can make an application to the Tribunal for
relaxation or lifting of the restriction placed u/s. 90(8).

(ii) Section 90(9) has now been
amended to provide that the above application can be made within one year from
the date of the order u/s. 90(8).
Further, if no such application is made within one year, such shares as
referred to in section 90 shall be transferred to the authority constituted
u/s. 125(5), in such manner as may be prescribed. In other words, in the event
of delay in filing the declaration under
this section, the shares may be transferred to Investor Education and
Protection Fund set up u/s. 125.

(iii) Section 90(10) provides for punishment for
contravention of the provisions of section 90.
This section is amended to provide that
the person who fails to make the declaration of significant beneficial
ownership in the company u/s. 90 shall be punishable with imprisonment for a
term upto one year or with minimum fine of Rs. 1 Lakh which may extend to Rs.
10 Lakh or with both. If the default
continues, a further fine upto Rs. 1,000/- per day will be payable for the
period of default.

(iv) The above amendment appears to have been made
to deal with cases of benami shareholders in companies.

10. ANNUAL RETURN – (SECTION 92)

(i) The existing section 92(5) provides for
punishment for delay in filing Annual Return within the time specified in section
92(4). This punishment is by way of Fine
payable by the company and by way of imprisonment of officers in default or
with fine or both.

(ii) The above provision for punishment is now
modified by amendment of section 92(5) as under:

(a) The
company and every officer in default will be liable to pay penalty of Rs.
50,000/-.

(b) In case of continuing default, further penalty
of
Rs. 100/- per day subject to maximum of Rs. 5 Lakh is also payable.

It may be noted
that the provision for prosecution of the officer in default is now deleted.

11. STATEMENT TO BE ANNEXED TO SPECIAL NOTICE OF GENERAL MEETING – (SECTION 102) AND PROVISION FOR PROXIES – (SECTION 105)

In both the
sections 102 and 105 there is provision for punishment for contravention of the
provisions of the sections in the form of monetary payment by way of Fine. By amendment of these sections it is now
provided the same monetary amount shall be payable as Penalty.

12. RESOLUTIONS AND AGREEMENTS TO BE FILED WITH ROC – (SECTION 117)

The existing
section 117 (2) provides for levy of Fine if the specified
Resolutions and Agreements to be filed with ROC are not filed within the
specified time. The monetary limits of Fine is reduced and it is
now provided that the following Penalty shall be payable for the
default.

(i) The company shall be liable to pay penalty of
Rs. 1 Lakh and, in case of continuing default, further penalty of Rs. 500/- per
day of default, subject to maximum of Rs. 25 Lakh.

(ii) Further, every officer in default (including
the Liquidator, if any) shall be liable to pay Penalty of Rs. 50,000/- and, in
case of continuing default, he shall be liable to pay a further penalty of Rs.
500/- per day, subject to maximum of Rs. 5 Lakh.

13. REPORT ON AGM TO BE FILED WITH ROC – (SECTION 121)

U/s. 121 Report on
Annual General Meeting held by a listed public company is to be filed by such
company within the time provided in the section. U/s. 121(3) the company and
every officer in default is required to pay Fine for
non-compliance with the requirement of the section. This provision is now amended and it is
provided that Penalty for this default will be payable as under:

(i) The company will have to pay Penalty
of Rs. 1 Lakh and, in case of continuing
default, further penalty of Rs. 500/- per day of default subject to maximum of
Rs. 5 Lakh will be payable.

(ii) Further, every officer in default shall be
liable to pay penalty of Rs. 25,000/- and, in case of continuing default, a
further penalty of Rs. 500/- per day of default, subject to a maximum of Rs. 1
Lakh will be payable.

14. COPY OF FINANCIAL STATEMENTS TO BE FILED WITH ROC -(SECTION 137)

U/s. 137(3) the
company and the officers in default, as specified in the section, are liable to
pay fine of specified amount for non-compliance with the requirements of the
section. There is also provision for prosecution of the officers in
default. These provisions are amended
and it is now provided for payment of Penalty as under:

(i) The company shall be liable to pay Penalty of
Rs. 1,000/- per day during the period of default subject to a maximum of Rs. 10 Lakh.

(ii) Every officer in default, as specified in the
section, shall be liable to pay Penalty of Rs. 1 Lakh and, in case of continuing default, further
penalty of Rs. 100/- per day of default shall be payable subject to a maximum of Rs. 5 Lakhs. It may be noted
that the existing provision for imprisonment of the officer in default for a
specified period is now deleted from this section.

15. REMOVAL AND RESIGNATION OF AUDITOR – (SECTION 140)

Section 140 (2)
provides that an Auditor of a company has to file with ROC and the Company (C
& AG, if applicable) a Statement in the prescribed form (ADT-3) within 30
days about details of his resignation as Auditor. Section 140 (3) provides that
in the event of failure to comply with
this requirement the Auditor will have to pay Fine of Rs.
50,000/- which may extend to Rs. 5 Lakh.

Section 140(3) is
now amended to provide that the Auditor will have to pay for non-compliance
with the provisions of section 140(2) Penalty of Rs. 50,000/- or
an amount equal to his remuneration as Auditor, whichever is less. Further, in case of continuing default, a
further penalty of Rs. 500/- per day of default subject a maximum of Rs. 5 Lakh
will be payable.

16. COMPANY TO INFORM DIN TO ROC – (SECTION 157)

Section 157(1) provides for furnishing information about Director
Identification Number (DIN) to ROC and other prescribed authorities within the
specified time. In the event of default
in complying with this requirement the company and the officers in default have
to pay Fine as stated in section 157 (2). The provisions of
section 157(2) have now been amended to provide for payment of Penalty
as under:

(i) The Company shall be liable to pay penalty of
Rs. 25,000/-. Further, in case of continuing default, a
further penalty of Rs. 100/- per day of default subject to maximum of Rs. 1
Lakh shall be payable.

(ii) Further, every officer in default will be
liable to pay penalty of Rs. 25,000/- and a further penalty for continuing
default shall be payable at Rs. 100/- per day of default subject to a maximum
of Rs. 1 Lakh.

17. PUNISHMENT FOR CONTRAVENTION OF SECTIONS 152,155 AND 156 – (SECTION 159)

The existing
section 159 providing for payment of Fine as well imprisonment of
the individual or Director in default has been replaced by a new section 159.
This new section 159 removes the provision for imprisonment of the Individual
or Director in default and provides for levy of penalty as under:

(i) Penalty which may extend upto Rs. 50,000/-

(ii) In case of continuing default, a further
penalty which may extend upto Rs. 500/- per day during the period when the
default continues.

The wording of the
above section indicates that a penalty of less than Rs. 50,000/- or less than
Rs. 500/- per day may be levied at the discretion of the concerned authority.

18. DISQUALIFICATIONS FOR APPOINMENT OF DIRECTOR – (SECTION 164)

Section 164 gives a
list of circumstances under which a director may be disqualified for
appointment as Director in any other company.
The amendment of this section states that a person who has not complied
with the provisions of section 165(1) will now be disqualified for appointment
as Director of any other company. It may
be noted that section 165(1) provides that a person will not be entitled to
become director of more than specified number of Companies.

19. NUMBER OF DIRECTORSHIPS – (SECTION 165)

U/s. 165(6), if a
person accepts an appointment as a director in contravention of the specified
number of directorships stated in section 165(1), he is liable to pay Fine
of specified amount. This provision is now modified by amendment of section
165(6). It is now provided that such
person will be liable to pay Penalty of Rs. 5,000/- for each day
during which the default continues.

20. PAYMENT TO DIRECTOR FOR LOSS OF OFFICE – (SECTION 191)

U/s. 191(1) no
director can receive any compensation for loss of office under specified
circumstances. If there is contravention
of this provision, section 191(5) provides for payment of Fine by
such Director of Rs. 25,000/- which may extend to Rs. 1 Lakh. This section is
now amended to provide for payment of Penalty of Rs. 1 Lakh by such Director
for contravention of the provisions of section 191.

21. MAXIMUM REMUNERATION PAYABLE TO MANAGERIAL PERSONNEL – (SECTION 197)

(i) Section 197(7) provides that an Independent
Director shall not be entitled to receive any stock option from the
company. He can only receive sitting
fees, commission and reimbursement of expenses.
Now sub-section (7) of section 197 is omitted. Effect of this amendment will be that besides
sitting fees, commission etc., an Independent Director can enjoy the benefit of
Stock Option from the Company.

(ii) At present section 197(15) provides for
payment of Fine of specified amount by the person who contravenes
the provisions of this section. By
amendment of this section the Penalty of Rs. 1 Lakh can be levied
on the person who contravenes the provisions of section 197. Hitherto, no Fine was payable by the company.
By this amendment it is provided that if the company has contravened the
provisions of section 197, it will have to pay penalty of Rs. 5 Lakh.

22. APPOINTMENT OF KEY MANAGERIAL PERSONNEL – (SECTION 203)

The monetary limits
of Fine u/s. 203 (5) for non-compliance with section 203 have now
been modified by amendment of section 203(5) as under:

(i) The company will be liable to pay Penalty of
Rs. 5 Lakhs

(ii) Every Director and Key Managerial Personnel
who is in default shall be liable to pay penalty of Rs. 50,000/-.

(iii) In case of continuing default, further penalty
of Rs. 1,000/- per day of default subject to maximum of Rs. 5 Lakh shall also
be payable.

23. REGISTRATION OF OFFER OF SCHEMES INVOLVING TRANSFER OF SHARES – (SECTION 238)

U/s. 238(3) the
Director who is in default is liable to pay Fine between Rs.
25,000/- to Rs. 5 Lakh. This is now changed to Penalty of Rs. 1
Lakh by amendment of this section.

24. COMPOUNDING OF CERTAIN OFFENCES – (SECTION 441)

(i) At present section 441(1)(b) provides that an
offence punishable under the Act with
Fine only which does not exceed Rs. 5 Lakh can be compounded by the Regional
Director. By amendment of this section this limit of Rs. 5 Lakh is increased to
Rs. 25 Lakh. Therefore, the Regional Director can now compound any offence
where the Fine is below the limit of Rs. 25 Lakhs. U/s. on 441(1) (a) the
Tribunal has power to compound an offence where the amount of Fine leviable is
of any amount (i.e. even more than Rs. 25 Lakh).

(ii) Section 441(6) is now amended to provide that
any offence which is punishable under the Act with imprisonment only or with
imprisonment and also with Fine shall not be compoundable. In the existing section 441(6) it was provided
in specified cases it was possible to compound the offence with the permission
of Special Court. This concession is now
not available.

25. LESSER PENALTIES FOR ONE PERSON AND SMALLER COMPANIES – (SECTION 446B)

Section 446 B was
enacted by the Companies (Amendment) Act, 2017.
It came into force on 9.2.2018.
This section provided that if a One Person Company or a Small Company
fails to comply with provisions of section 92(5), 117(2) or 137(3), such
company or any officer in default shall be punishable with Fine or
Imprisonment, such Fine or Imprisonment shall not be more than half of the Fine
or half of the period of Imprisonment specified in the above sections. Now this section is amended to provide that,
if the company or the officer in default is liable to penalty, the same shall
not be more than half of the penalty specified in the above sections. This amendment is made as in the above
sections the punishment in the form of Fine and Imprisonment is now replaced by
the specified amount of penalty.

26. PUNISHMENT FOR FRAUD – (SECTION 447)

The second proviso
to section 447 provides that if fraud involves an amount of less than Rs. 10
Lakhs or one percent of the turnover of the company, whichever is less, and
does not involve public interest, such person may be awarded punishment by way
of imprisonment upto 5 years. Further,
fine upto Rs. 20 Lakh can be levied. By
amendment of this section the amount of the fine is now increased upto Rs. 50
Lakh.

27. ADJUDICATION OF PENALTIES – (SECTION 454)

Section 454
provides for appointment of adjudicating officer for adjudging penalty under
the provisions of the Act in such manner as may be prescribed. As per section 454(3) the adjudicating
officer may, by an order, impose a penalty on the company and the officer in
default. Now, s/s. (3) is substituted by
another s/s. (3) granting power to adjudicating officer to impose penalty on
any other person in addition to company and officer in default. Further, it is
also provided that adjudicating officer may direct such company or officer in
default or any other person to rectify the default wherever he considers fit.

28. PENALTY FOR REPEATED DEFAULT – (NEW SECTION 454 A)

This new section
provides for levy of Penalty for repeated defaults. It provides for levy of additional penalty on
the company, any officer in default or any other person in whose case any
penalty is levied under any provision of the Act, again commits such default
within 3 years from the date on which such penalty order is passed by the Adjudicating
Officer or the Regional Director. In
such a case for a second or subsequent default, the amount of the Penalty shall
be an amount equal to twice the amount of penalty provided for such default in
the relevant section. From the wording
of the section it appears that if penalty is once levied for non-compliance of
section 64, double the amount of penalty can be levied for subsequent default
for non-compliance of section 64 only and not for default under any other
section. This new section is on the same
lines as section 451 which provides for levy of double the amount of Fine for
second or subsequent default.

29. FINE VS. PENALTY

From some of the
amendments made by the above Ordinance it will be noticed that in some
sections, which provided for levy of Fine, the word “Fine” is replaced by the word “Penalty”. The distinction between the expression “Fine”
and “Penalty” can be explained as under;

(i) Chapter XXVIII (sections 435 to 446A) deals
with appointment of Special Courts and their powers. If we read these provisions it will be seem
that where the Act provides for punishment for contravention of any provision
by way of levy of Fine on the company or
levy of Fine and or Imprisonment of any defaulting officer, the same can be
done by the Special Court only. It is
also provided in section 441 that where only Fine can levied, the same can be
compounded by the Regional Director or the Tribunal. This is a time consuming procedure.

(ii) As compared to the above, where there is a
provision for levy of Penalty for default in complying with a particular
provision of Act, section 454 Provides that such Penalty can be levied by an
Adjudicating Officer appointed by the Central Government. By a separate Notification, some Registrars
of Companies (ROC) are appointed as Adjudication Officers. Thus, penalty leviable under different
sections can be levied by ROC. Any
company or officer in default aggrieved by levy of penalty by ROC can file
appeal before Regional Director u/s. 454(5).
This procedure will be less time consuming.

30. TO SUM UP

(i) The above amendments in the
Companies Act, 2013, have been made by an Ordinance promulgated by the Hon’ble
President on 02.11.2018 on the basis of the recommendations of the expert panel
appointed by the Ministry of Corporate Affairs.
This Panel was headed by the Corporate Affairs Secretary, Shri
Srinivas. The Ordinance covers only some
of the suggestions made by the Panel which the Government considered to be of
urgent nature. There are some more
recommendations by the Panel which are under consideration of the
Government. It appears that some more
amendments may be made in the Companies Act during the coming months.

(ii) It may be noticed from the amendments made in
some of the sections that punishment to officers in default by way of
imprisonment for specified period has been done away with. These sections deal with procedural
lapses. In some of the sections the
provision for Fine has been replaced by Penalty. Since the Fine can be levied by a Court and
Penalty can be levied by ROC, the administration of the provision for levy of
penalty will be less time consuming.

(iii) Some
of the amendments made by this Ordinance are of procedural nature. Taking an
overall view, the amendments by this Ordinance are Welcome. One area in which major amendments are
required relates to provisions applicable to private limited companies. As these Companies experience difficulties in
complying with some of the stringent provisions of the Act, which apply to all
companies, there is need to make relaxation in these provisions so that there
is ease of doing business for small and medium size industries and traders and
their compliance burden in reduced.

shailesh.kwebmaker

ANSWERS TO SOME IMPORTANT RERA QUESTIONS

REGISTRATION

Q.1. A developer
wants to develop a land admeasuring 500 sq. meters having 8 apartments. He is
advised by RERA expert that in view of section 3(2) he does not need to
register that project. The Developer wants to know whether his Project will be
totally outside the purview of RERA and none of the provisions of the Act will
be applicable to his project.

Issue regarding the
applicability of RERA in respect of the projects which should have been
registered but not registered by the Promoter for any reason, as also the
projects which are not required to be registered under the provisions of
section 3(2) of RERA, has been subject of varying views with different
Authorities taking different approach in the matter.

According to one
view the regulatory power is exercised on the basis of information furnished by
the promoter in the application for registration. In the absence of
registration of project, the Authority will not get the required information.
Hence, many provisions of RERA would become unworkable e.g. provisions based on
the sale agreement as per proforma,quantum of penalty, conveyance etc.

The other view is
that RERA nowhere restricts its application to registered projects. The
definition of ‘Real Estate Project’ is not confined to registered projects only.
Registration is only one of the obligations cast on the promoter, default in
respect of which visits with penalty under the Act. Non- compliance with one of
the obligation by the promoter, does not absolve him from all other obligations
which are cast on him for safeguarding the interest of the buyers which happens
to be primarily object and purpose of the legislation. It cannot be the
legislative intent to deprive the buyers of the protection provided under RERA
because of the self-serving default of the promoter.

MahaRERA had
consistently taken the view as mentioned in FAQs that it will entertain
complaint only in respect of registered projects. In a Writ Petition Mohmd
Zain Khan vs. MahaRERA & Others W.P. lodged under No. 908 of 2018
decided on 31.07.2018 the High Court of Bombay directed the Authority to
entertain complaints even in respect of unregistered projects and consequently
MahaRERA agreed to upgrade its software to record such complaints.
Consequently, the complaints in respect of unregistered projects also are being
registered by MahaRERA.

This settles the
controversy about the projects that are required to be registered but not
registered, The High Court order did not make it clear whether it will apply to
the projects which are exempted from registration by virtue of section 3(2) of
the Act. A view is possible to be taken that what applies to unregistered
projects, equally apply to unregisterable projects as well. Certain projects,
considered small, have been exempted from the requirement of registration for
ease of operation. It cannot be the legislative intent to deprive the
purchasers of apartments in real estate projects, the protection granted to the
purchasers under the Act. There is also no specific provision in the Act to
exclude these projects from the operation of RERA nor are they kept out of the
meaning of real estate project.

Q.2. As per
section 3(2)(b) the registration of the project will not be required if the
promoter has received completion certificate before 01.05.2017. This implies
that the relevance of O.C. is only for ongoing projects and not for those
projects which commence on or after 01.05.2017. Can a promoter start a new
project without advertising and without registering if he sells all the
apartments only after getting O.C.?

Section 3(1)
provides that w.e.f. 1^st May 2017 the Promoter can advertise and
sell the apartments only after registration of the project. As per section
3(2)(b), if promoter has received completion certificate before 1^st
May 2017 then registration is not required. This indicates that relevance of OC
is only in respect of the ongoing projects. However, as per the answer received
by us, MahaRERA has clarified that if a project is constructed, OC is obtained
and till the date of OC the promoter has not made any advertisement, then such
projects do not require registration. It means OC is relevant for new projects
also. If this view is adopted, the builder can avoid registration provided he
does not give advertisement and does not sell apartments till the date of OC.
This way he can save GST also.

The clarification,
however, has to be taken with a bit of caution. Any legislation needs to be
understood and interpreted in the context of the object and purposes it seeks
to serve. RERA is designed to introduce professionalism and transparency in the
sector and to ensure that the interest of the buyers are safeguarded against
the prevalent malpractices of the promoters. A question arises as to whether
the receipt of OC leaves the promoter with no scope for any other malpractice
against which remedies are provided under the Act.

Q.3. Suppose a
new project was registered on 15.05.2017 mentioning possession date as
30.08.2017. The Promoter could not complete construction. Hence, he got
extension of one year upto 30.08.2018. He obtained OC in August, 2018 but could
not sell all apartments upto 30.08.2018. Can he sell his unsold apartments
after 30.08.2018 when the registration certificate is not valid?

It has been
clarified by MahaRERA that after OC, registration is not required for a project
of a single building. Hence, sale of Apartments in building with OC does not
require MahaRERA registration.

The validity of
dispensing with the requirement of registration after issue of OC is a debatable
issue. In the facts of the case in the question, technically speaking, there
should not be any sale without registration. However, considering the
unavoidable hardship to the promoter, the Authorities may take a lenient view.

JOINT DEVELOPMENT PROJECT

Q.4. In
redevelopment arrangement where the landowner and the developer join to develop
a project, who is the promoter when-

(i) there is an arrangement of area sharing?

(ii) there is arrangement for revenue sharing?

RERA defines the
promoter as one who constructs or causes to be constructed apartments for sale.
The Explanation, however, provides that if the person constructing and the
person selling the apartments are different persons, both will be considered as
promoter and will be jointly liable in the project. Applying this provision, in
a redevelopment arrangement based on area sharing, both the landowner as well
as the developer will be treated as promoters as, while the construction will
be carried on by the developer, the sale of the share coming to the landowner,
will be made by the landowner.

The position in a
redevelopment arrangement based on revenue sharing, however, appears to be
different. MahaRERA in its clarification has been treating the area sharing and
revenue sharing arrangements at par and treating both as promoter. There is no
provision in the Act which makes the landowner sharing the revenue, as the
promoter when the entire work of construction and sale is carried out by the
developer alone.

Q.5. Whether a
cooperative Housing Society which enters into redevelopment arrangement in
consideration of part of additional constructed area to be allotted to existing
members, will be a promoter jointly liable with the developer. If so, whether
the Society will be responsible to the buyers of apartments sold by the
developer?

The issue is in the
realm of uncertainty. As per the definition of Promoter, the construction is to
be for the purpose of sale. In a redevelopment arrangement for development of
society land, the society, generally, gets the apartments from the builder, not
for sale, but for allotment to its members in lieu of the flats that they were
occupying pre-development. Strictly speaking, in such a case the society should
not be treated as promoter. MahaRERA, however, in its clarifications has been
taking different view and holding the society also as a promoter.

In a recent case of
Jaycee Homes Pvt. Ltd.,[7713] the Authority has taken the view that the
society is also a promoter and is also liable to the purchasers of the free
sale area made available to the developer. The order appears to have raised a
controversial issue. It needs to be read in the context in which the view was
taken by the Authority. Jaycee Homes Pvt. Ltd. executed development agreement
with Udayachal Goregaon CHS Ltd. The Developer constructed up to 11^th
floor out of 15 floors. It sold flats of his share. Meanwhile the society
terminated the agreements of the developer and refused to recognise the
purchasers of apartments from the developer. The purchasers filed a complaint
with MahaRERA and contended that their agreements are binding upon the society
as the society is also a promoter as per section 2(zk). Society relied upon the
judgement of Bombay High Court in the case of Vaidehi which held that as per MOFA,
the society is not a promoter. It was also contended that there was no privity
of contract between the society and the purchasers who purchased apartments
from the developer. But the Authority held that the society is a promoter and
liable to the purchasers.

In the facts of the
case above, the decision of the Authority seems to be influenced by the fact
that the development agreement having been terminated, the purchasers from the
developers were left in lurch and were without any remedy for no fault of
theirs. The society was brought within the meaning of ‘Promoter’ because of the
fact that by cancelling the development agreement of the developer and revoking
his power of attorney, the society regained the control and ownership of the
sales component. What the decision would have been, if the development of
building had gone in normal way without termination of the agreement, cannot be
said with any degree of certainty.

In our view, the
decision remains contentious. A cautious view is called for.

Q.6. Where the
person constructing and person selling are different, RERA makes both of them
promoters and make them jointly liable in respect of the project. In a
situation of redevelopment, on area sharing basis, whether it will be incumbent
on both to open separate specified bank accounts and deposit 70% of their
respective receipts in their accounts. If so, what will be the basis for the
landowner to withdraw from the bank account since no cost will be incurred by
him in the construction of the project and there will be no cost of land to the
project?

MahaRERA has taken
the stand that in such cases both the person being the promoter, should open
separate bank accounts and deposit 70% of their respective receipts in these
accounts. (Circular No. 12 ) In our view, the view needs reconsideration. The
law requires opening of the bank account for the project and not for the
promoter(s). In any case, the view leads to a position in which the landowner
having deposited 70% of the receipt from his share will not be able to withdraw
any amount as he will not be incurring any cost and as far as land owner is
concerned, there will be no land cost for the project. A view which results in
such situation of unintended hardship, can not be the legislative intent.

LEASE AGREEMENTS

Q.7. Lavasa
Corporation Ltd. is developing a township at Lavasa. It is executing agreements
for transfer of apartments by charging substantial premiums and Re. 1/- lease
rent per annum for 999 years. Lavasa Corporation Ltd. is of the view that the
purchasers are given apartments on rent. Hence, Lavasa Corporation Ltd. is not
a promoter but Landlord. Provisions of
RERA are not applicable to the lease of apartments by Lavasa Corporation Ltd.
What view can be taken in such matter?

A complaint was
filed before the Regulatory Authority against Lavasa Corporation Ltd. which was
dismissed by the Authority accepting the arguments of the promoter, for want of
jurisdiction. The learned member came to this conclusion on the basis of
definition of allottee given in section 2(d) of the Act. In the appeal filed by
the allottee before RERA Tribunal, it was held as under:

“10) The Respondent Lavasa
by its conduct of filing reply did not object to the point of jurisdiction and
also got its project registered with the RERA Authority is estopped in law in
terms of sec. 115 of the Evidence Act. The conduct of Lavasa naturally made it
believe to the customer / the Appellant that there was no bar to jurisdiction
with the MahaRERA Authority. Again when the registration was caused on 28^th
July 2017 in the Schedule, the property or the apartment, where the Appellant
has booked the flat is included. There is no exclusion at the time of
registration of specific property in the Hill Station – the township of Lavasa.
In the absence of such exclusion It is not open for Lavasa to canvass that the
point of jurisdiction raised before the Ld. Adjudicating Member was just.”

“Section 18 of the Act
contemplates as under: 18(1) if the promoter
fails to complete or is unable to give possession In accordance with terms of
Agreement for Sale or as the case maybe, duly completed by the date specified
therein. The term “as the case may be”, necessarily indicate to the
agreement which is subject of controversy. It means, depending on
circumstances. The statement in the Section equally applies to two or more
alternatives, Such Agreement in the situation cannot be by-passed or alleged to
be a Rent Agreement. This is supported by overall effect of Agreement,
referring Appellant to be a customer and not a tenant.”

“Sec. 105 of the Transfer
of Property Act contemplates a lease of immovable property to be a transfer of
right to enjoy immovable property for a certain time or in perpetuity in
consideration of price paid or promised, in the instant case, the terms are for
999 yrs. with an annual rental of Re. 1/-. The annual rental is of no
consequence as the Agreement itself provides a deposit of Rs.50,000/- by the
Appellant for meeting with exigencies. Consequently, there can’t be in
perpetuity any breach of any payment or deposit of rentals. The amt. of
Rs.43,77,600/- was accepted as premium naturally to provide freehold rights to
the Appellants to enjoy the property subject to restrictions under the Development
Control Authority or the Regulatory Authority of a township or the Hill Station
Rules. However, that by itself would not tantamount to squeezing the rights of
the Appellant to enjoy the property absolutely or to invoke the jurisdiction of
RERA.”

Although the
decision is on the facts of the case, it can be taken to be the view in all
such matters where the property is transferred on long term lease with
substantial amount by way of premium and a very nominal amount as rent to give
it the colour of a lease. Following several other cases cited by the appellant,
the Tribunal has held that the premium is to provide freehold rights to enjoy
the property subject to restrictions under the applicable Acts. The allottee
cannot be deprived of the benefits of RERA merely because a different
nomenclature is given to the transactions. The decision may be of help in all
such cases of long-term leases where the amount of premium forms a significant
part, almost equal to the price, forming in substance, a substitute of the
price of the property.

MOFA AND RERA

Q.8. The local
laws dealing with real estate promotion and development which prevailed when
RERA was introduced have not been repealed. As a result of which two
legislations dealing with the same subject are in operation simultaneously. In
such a situation, when RERA regulates ongoing projects also, how will the
defaults in delivery of possession in respect of agreements executed prior to
1.5.2017 will be dealt with in the matters of –

(i) Award of interest?

(ii) Award of compensation?

(iii) Quitting the project?

It was held by the
Tribunal in Aparna Arvind Singh vs. Nitin Chapekar (10448) that the
ongoing project bring with them the legacy of rights and liabilities created
under the statute of the land in general and MOFA in particular. Section 88
provides that its provisions shall be in addition to and not in derogation of
the provisions of any other law. MOFA has not been repealed.

MahaRERA in Order
No.4 dated 27.06.2017 clarified that ongoing projects in which agreements were
executed prior to 1^st May, 2017 shall be governed by the MOFA. Based
on this view, if the provisions of MOFA are applied, the position should be:-

Interest- Under MOFA, section 8 provides for payment of interest in case of
delay.at the rate of 9%. The Model agreement under MOFA also provides for
interest @ 9%. Hence, unless any other rate of interest is provided in the
agreement, that rate should be applied and in the absence of any rate, the rate
as per MOFA can be applied.

The question as to
whether the proposed date of completion should be as per the MOFA agreement or
the revised date informed under RERA. This question has been answered by the
Mumbai Tribunal in the case of Sea Princess Realty (0078) holding that
any extension of the date mentioned in the agreement is impermissible and the
promoter cannot give a go-by to solemn affirmation made at the time of
registration of the Agreement.

Compensation- There being no provision under MOFA for award of compensation in
case of default, award of compensation in accordance with RERA may not be
permissible.

Quitting the
Project- There being no provision under MOFA for
quitting the project, it is debatable whether an allottee can be permitted to
quit as per section 18 of RERA. Although, the Authority constituted under RERA
do allow the Allottees to quit and receive interest.

Section 88 of RERA
provides that the provision of this Act shall have effect, notwithstanding
anything inconsistent therewith contained in any other law for the time being
in force. With such a provision, in our view, it should not be impermissible to
decide the above issues in accordance with the provisions of the RERA and the
rules and regulations made thereunder.

ONGOING PROJECT

Q.9. Will a
project which was completed and occupied by the buyers but no OC was received
before 01.05.2017 qualify as an ongoing project required to be registered.
Also, whether the project which is completed with OC but the promised amenities
and facilities are yet to be provided, will qualify as ongoing?

MahaRERA in their
clarification through FAQs had taken the view that the projects which are
completed and occupied by the purchasers are not required to be registered as
ongoing projects, even if the OC has not been received. However, the Authority
in the decision, given by its Member Shri Kapadnis in Parag Pratap Mantri
vs. Green Space Developers has taken a different view holding that the
promoters of the buildings which are occupied by the residents without OC, must
register such projects with MahaRERA. The decision is of far reaching
consequence, at least in Mumbai where thousands of buildings are occupied but
are without the occupation certificate.

A view can be taken
that a project of a building with OC but without amenities like swimming pool
/office is not complete project. Such projects should be registered.

Q.10. If an
ongoing project is registered with MahaRERA, then will the Act be applicable
for the entire project or will it be applicable only to units sold after
registration?

Registration is of
the Project/Phase as a whole. The ongoing project is registered in its
entirety. Hence, the provisions of the Act are applicable to all units of the
Project/Phase irrespective of whether the agreement in respect of those
apartments was entered into prior to or post RERA.

REMEDIES U/S.18

Q.11. Does the
issue of OC debars the allottee to seek remedy u/s. 18 of RERA? Whether all the
provisions of RERA or certain provisions only, cease to apply after the receipt
of OC?

There is no
provision in the Act which takes away its jurisdiction in cases where OC is
received. The only exception is in respect of the project which were complete
before RERA came into force and OC was received. The object of the Act is to safeguard the
interest of the apartment buyers and protect them against the default committed
by the promoters/agents irrespective of whether the OC was received or not when
they entered into contract with the promoter. Non-receipt of OC is a violation
of the provision by the promoter for which he is subjected to penalty. The law
does not discriminate between the buyer who files complaints before receipt of
OC and one who files complaints for getting remedy u/s. 18 after OC. In the
absence of any provision to this effect, the protections under RERA are
available to both.

In a decision
MahaRERA has based the order on the premise that once the project is completed,
the rights of the buyers for remedy u/s. 18 cease. If the project is complete
and OC received, the buyer will cease to have remedy u/s. 18 even if the
possession was not delivered in time. The Authority has relied on the word “
is” used in section 18 which, according to it, rules out its application in
case of defaults if the project is complete and OC issued. In our view, the
Authority has misconstrued the import of the word ís’ and has failed to
appreciate that every word in the statute which needs to be construed in the
context in which it occurs.

In our view, the
only provision that ceases to be applicable, after the issue of OC, is the
provision to deposit 70% of the proceeds in the separate bank account. It is
because once the project is complete, the very purpose of the provision ceases
to exist. The Rules also provide that the money remaining in the bank account
can be withdrawn after the OC is issued. All other provisions of the Act
continue to be applicable even after the issue of OC.

Q.12. Whether
relief u/s. 18 can be claimed where no date of possession is mentioned in the
agreement of sale executed before the coming into force of RERA?

In Aparna Arvind
Singh vs. Nitin Chaphekar (10448) where the agreement was made under MOFA
and no date of possession was mentioned in the agreement, the Mumbai Tribunal
applied the provisions of section 4(1A) of MOFA and held that the promoter
committed breach of the provision by not mentioning the date of possession in
the agreement.

Going by the
cumulative effect of section 71(1), 72(d), 79 and 88 of RERA and the provisions
of MOFA, it was held that effect will have to be given in favour of the cause
propounded by the affected party. Beneficial legislation cannot be extended in
favour of a deceit against the docile flat purchaser/allottee.

Q.13. Is it
possible to claim relief u/s. 18 and other sections of RERA on the basis of
allotment letters?

In Ashish
RajkumarBubna vs. S R Shah Developer [0251] where there was specific
reference of flat number., its area, consideration, mode of payment, date of
possession and other necessary details given in the allotment letter itself,
the Mumbai Tribunal held that the parties were under an obligation to adhere to
the allotment letter.

Q.14. Whether
the refund of money envisaged u/s. 18 on failure of the promoter to complete
the project and deliver possession in time includes refund of service tax, VAT
charged from the allottee?

There are contrary
decisions of the Mumbai Tribunal on this issue. In Venkatesh Mangalwedhe vs.
D. S. Kulkarni [10409] the promoter was directed to refund the amount of
VAT and Tax charged from the purchaser. In the later decision in Ashutosh
Suresh Bag vs. MahaRERA [0120] , the Tribunal held that the refund of VAT
could not be given by the promoter as the tax amount is credited to the State
government in the name of the allottee. The promoter cannot be held responsible
to refund the VAT amount.

In this connection,
it may be relevant to refer to the provisions of section 72 which contains the
factors which the Adjucating Officer is required to take into account in
adjudging the quantum of compensation or interest. Clause (b) of the section
mentions ‘the amount of loss caused as a result of the default’. On
cancellation of Agreement VAT, GST paid by the purchaser is a loss to the
purchaser but not a gain for the promoter. Hence, final verdict will depend
upon the view taken by the High Court. .

CHANGES IN SANCTIONED LAYOUT

Q.15. Rule 4(4) 0f the Maharashtra Rules permit
inclusion of contiguous land parcel to the project land. Will it involve
obtaining written consent of at least two-third number of allottees and
revision of the original registration? Or, the contiguous land piece should be
registered as independent project or phase of the project even when the same is
dependent on the earlier project in certain matters including the right of way?

Since the rules
permit the amalgamation of a contiguous piece of land with the main project
land, there should be no legal necessity of obtaining the consent of at least
two-third of the number of allottees unless there will be changes in the
layout plan consequent to such amalgamation. The Rule permits separate
registration of the project either as independent project or as a phase of the
project.

Third proviso to Rule 4 states consent of 2/3^rd allottees may not be
necessary for implementation of proposed plan disclosed in the agreement prior
to registration and for changes which are required to be made by the promoter
in compliance of any direction or order by any Statutory Authority.

Q.16. If due to
a change in government policy, the promoter is entitled to additional FSI etc.,
can the promoter build additional floors in a registered ongoing project where
initially those floors were not planned?

Yes, but subject to
the approval of the Competent Authority and the consent of at least two- third
number of allottees as required u/s. 14 of RERA.

Q.17. Can the
promoter change the plans of subsequent phases after registration of the 1^stphase?

If a subsequent
phase has not been registered, the promoter can change the plans of the
subsequent phase without obtaining consent of the allottees from the allottees
of registered phase. However, if the subsequent phase is also registered,
consent of allottees, of the concerned phase, would be needed if the change in
the subsequent plan impacts the interest of the allottees of the registered
phase.

There are
situations where, when a project is divided in phases and registered
separately, the amenities and facilities in respect of all the phases are
concentrated in the last phase In such a case any change in the sanctioned plan
of the last phase will necessitate the consent of atleast two-third of the
number of allottees of all the earlier phases.

END USER VS. INVESTOR

Q.18. Whether
RERA differentiates between the end-user and the investor in matter of
application?

In PIL
developers vs. S R Shah [10411], the purchaser purchased 11 flats and a
plea was taken by the promoter that the purchaser was not an allottee under the
Act, but an Investor. The Mumbai Tribunal held that the Act nowhere makes a
distinction between the investor and actual user.

POSSESSION

Q.19. Whether
possession given for fit out is to be treated as possession given to the
allottee under the Act?

In BhavanaDuvey
vs. Teerth Realities [054] the Mumbai Tribunal held that Fit out possession
without occupancy certificate is not the contemplated possession under the Act.
Under RERA/MOFA the Act, possession can be given only after the issue of OC and
any possession given for whatever purpose before the issue of OC will not be in
accordance with the law.

PAYMENT BEFORE AGREEMENT

Q.20. Sometimes
buyer is ready and gives undertaking that he is okay with giving money beyond
10% but he does not want to register the agreement and pay stamp duty. Should
it be allowed?

No. Section 13(1)
of the Act prohibits the promoter from taking more than 10% of the cost of
apartment without entering into a written agreement for sale, duly registered.

CONVEYANCE

Q.21. If a phase is considered up to certain
floors as envisaged in the rules, then how & when will conveyance take
place. Assuming the next phase approvals for upper floors are not obtained in a
timely manner, what will be the position for effecting conveyance for the
floors constructed for which O.C. received?

Conveyance of the
structure (floors) contained in the phase is possible. As per section 17 the promoter
shall execute conveyance of the structure in favour of the Allottees and common
areas to the association of the Allottees. Thus, conveyance of the structure of
existing floors is possible as per section 17 of RERA.

In case the
amenities and facilities and other common area is tagged on and can be
determined only after the upper floors are constructed, the apartments in the
phase can be conveyed but conveyance of the common area to the Apex society
will wait till they are constructed.

VARIATIONS BETWEEN PROVISIONS OF RERA AND RULES

Q.22. What
should be the approach in matters where the rules framed by the State
Legislature are at variance with the provisions of RERA?

The States, in exercise of their rule making
power, have, in certain matters made rules which are at variance with the
substantive provisions of the Act. As a general principle, Rules are
subordinate legislation and a subordinate legislation cannot override the
substantive law. However, the Central Government is silent over it. As the variations
are generally benefiting the promoters, there is little possibility that these
rules will be challenged. One should, however, be aware of the possibility of
the rules being struck down
if, there is a challenge.

shailesh.kwebmaker

Is the word ‘Expert’ a misnomer?

The Ministry of Corporate Affairs constituted Committee of Experts (COE)
recently published a report¹ on regulating audit firms as directed
by the Supreme Court of India. Amongst other things, it concluded that
‘Multinational Accounting Firm’ (MAF) was a ‘misnomer’. The Supreme Court asked
them to revisit regulations to “regulate and discipline the MAFs” and lo and
behold – they have come up with a finding – there is no such thing as a MAF.
Let me walk you through some observations:

Constitution: The COE did not have any expert. The experts on
the committee are three bureaucrats with no skin in the game, no ground level
experience. Can such a committee even be considered as duly constituted as
envisaged by the highest court of India?

Selective Samples: The experts engaged 21 ‘stakeholder’² bodies. Notable amongst them were 4 trade
associations³ ; ONLY 7 CA firms (4 MAF⁴ who are accused
of violations + 2 affiliated to next tier international networks and ONLY 1
Delhi Firm) and 1 Delhi CA association. Authors of earlier reports mentioned by
the Supreme Court are disregarded. Can this be considered a representative
sample? If you look at the 11 points questionnaire circulated by the COE, you
can tell that it is superficial at best. One wonders if a more accurate
description of such stakeholders could have been ‘selectholders’.

While COE did propose some new ideas in their scholarly looking report,
they seem to have not considered the main point of the Supreme Court⁵
with the rigour expected of them. Additionally, a report relied upon (of Chawla
committee) is not even attached. Important fallacies doled out in the Report:

__________________________________________________________________

1 Finding and Recommendations on Regulating
Audit Firms and the Networks, October 2018

2 Page
204 of the COE Report

3 The
usual names who are not directly connected with the regulating audit firms, so
no skin in the game. Seemed like name lending.

4 One
of them enmeshed in one of the biggest fraud involving auditors in India and
those who were fined with about $1.5million by PCAOB for conducting “deficient
audits…”

5 Dated
23^rd February, 2018

1. Conflict of Interest: These
words define the biggest problems with MAF. The report collates some ‘best’
global practices (which have not stopped this menace in those jurisdictions)
and some legal provisions but lacks original thinking and way out. The problem
obviously is not legal or about the percentage of non-audit fees – it is real –
and some real answers are missing.

Conflict of interest is a complex problem. Audit firms and group
entities operate under the same brand, common ownership and/or management and
pose as ONE in the market, and sell audit and consulting services. Tell me –
can a judge advise on potential legal scheme that might come for scrutiny in
his court? The longest serving former SEC chairman⁶ has this to say:
“Consulting contracts were turning accounting firms into extensions of
management – even cheerleaders at times”. The expected rigour and
innovative suggestions are missing. Should a report sound like a nod or a wink?

2. Circuitous Entry &
Control: It is a sovereign right to allow or not to allow accounting services
under similar reciprocity with other countries. The MAFs circumvent this to
operate indirectly through ‘networks’ and entities that carry out accounting
and auditing in India to which India is yet to conclude under trade
negotiations. The effective management and/or control and significant influence
of MAF situated outside, are visible and identifiable. Here are some points
whose basis is disregarded in the report although mentioned in detail by the
Supreme Court:

a. Control and Influence: CEO
changes post-Satyam debacle and global CEO comes and meets a cabinet minister.
Recently, a CEO was changed to a person who is not even a partner of Indian
registered firm or any other Indian entity. A MAF website reads thus about the
change that seems to be carried out from overseas: “… Indian Board and ratified
by the Indian partners”.

__________________________________________________________________

6 Arthur Levitt

Another example⁷ : “All of the PwC Network Firms in India
share the same Territory – Senior Partner and Managing Partner…The PwC Network
Firms located in India share office space and telephone numbers. ..the Global
Engagement partner shall engage a senior audit professional from a PwC Network
Firm located outside India to oversee
and control the execution.

b. Business-Tests: Using brand,
marketing under the same name as MAF, cross-selling services, using
infrastructure, process, technology, people, strategy, marketing and
soliciting, influencing decisions, strategy, promotional materials, key
appointments, and other dependency etc., show that the MAFs operate in India
indirectly.

c. PCAOB Orders: If you
carefully study the reports of PCAOB they show MAFs operating in India through
LLP or Private Limited entities (not registered with ICAI) and use the Indian
ICAI registered firms for audit work. A response in respect of these audits is
signed by ‘Head of Audit’ on the letter head of such MAF. Many orders mention –
partners, locations, number of professional staff etc.

3. Chequered Legacy:
Professional malpractice, breach of contract, tax shelter fraud⁸ ..
are some of the words used by enforcement agencies. 2018 fallouts involving
MAF: Carillion⁹, Steinhoff, Colonial Bank & Federal Deposit
Insurance Corp¹⁰ , Quindell¹¹ , Ted Baker¹² ,
BHS and these stories of fines just don’t go away. Would you call such MAFs
‘reputed international brand name’¹³ ? A reasonable question that
arises is: why does the report refer to MAF as ‘potential indemnifier of
losses’ and their appointment ‘signalling a superior quality of audit’?

__________________________________________________________________

7 PCAOB Report Dated April 5, 2011 in the
matter of Pricewaterhouse

8 KPMG Tax Shelter Fraud – admitted charges of
criminal wrongdoing to help dodge $2.5 billion and agreed to pay $456 million
(about 2700 crore) involving partners, deputy chairman, and others with similar
titles.

9 Reported in UK newspapers and attributed
to UK MPs: KPMG (earning about £ 1.5 million/year) were rubber-stamping figures
that “misinterpreted the reality of business” … “in failing to exercise professional
skepticism…. KPMG was complicit in them”. The failure included “accounting for
revenue that had not even been agreed” [Some others used a more terrifying
language.]

A report, that in parts reads like a prospectus of MAFs, in praise and
even awe and seeks to wipe clean the past in disregard to the Supreme Court
directions is fit for rejection. One wonders why would a ministry report
disregard the obvious, discard the well reported and ignore what the Supreme
Court has said in such detail. After reading the conclusion given in the report
that ‘Multinational Accounting Firms’ is a misnomer, one wonders whether the
word ‘expert’ is a misnomer too!

Raman
Jokhakar

Editor

__________________________________________________________________

10 Federal Judge asked PwC to pay $625 million to
FDIC in one of the largest bank failure. Deloitte had earlier settled a claim
of $7 billion at an undisclosed amount in a fake mortgage case of TBW collapse
relating to the same matter. (www.marketwatch.com April 7, 2018)

11
KPMG fined £3.2 million after the
accounts were restated twice. This is a reduced fine as they chose to settle.

12 KPMG fined $3million by FRC for admission of
misconduct for providing expert witness services in breach of ethical standards.
(FRC website 20.8.2018)

13 Page 63

shailesh.kwebmaker

EGO – Edging God out

‘A
man wrapped up in himself makes a very
small bundle’

Benjamin
Franklin

The issues are: why is it said that if Ego is in, Ego edges God out and if so what
is Ego –what it does and how to manage it :

I believe that all success is based on Ego.
It is the one emotion which impels a person to achieve his goal. No one can
achieve anything in any field of operation without Ego. The conquerors of the
world – Alexander, Julius Ceaser, Napoleon, Ashoka and others had Ego. Ego is
the base of all activity – it is a great motivator. President Trump says:‘Show
me an individual without ego and I will show you a loser’. Let us not
forget that Gandhi’s ego was hurt when he was thrown out of the train in Africa
and it is this hurt that made him a leader. However, Gandhi knew how to manage
it and thereby became a Mahatma.

I also believe that both sinner and saint
have ego. Rishi Durvasa is known to have cursed Indra and Shakuntala
for having ignored him. Rishi Vishwamitra, giver of Gayatri,
created another heaven when his ego was hurt and hence remained a Rajarshi.
Vishwamitra became Brahmarshi only when he managed his ego. Let
us accept that a sinner commits murder because his ego is hurt. Nations
fight war when egos are hurt. No one is spared by Ego.

What does Ego do? Ego makes a person restless, capricious, dominating, self-centred,
selfish and above all, unconcerned about the impact his actions have on others.
An egoist is devoid of care and compassion and deprived of contentment despite
his success. In short, ego makes a person lonely and unhappy. An Egoist is a
seeker of success – to him `ends matter and means have no meaning’. He
deems trampling over others is his birthright. In short, Ego divides us –
breaks relationships, creates strife, destroys families and ruins businesses.
Divorces of every genre – whether in relationship or business – are based on
clash of egos.

Emerson says – ‘shadows of life are
caused by our standing in our own sunshine’. However, ego makes one a doer
and gives one an identity.

How does one
manage ego! Ashoka and
Gandhi have shown us the way. The way is : thoughts and action based on
and backed by principles, taken with care, concern and contemplation. Once an
egoist’s actions are based on these three ‘C’s the same are automatically based
on knowledge – the doer then becomes an instrument in the hands of God. Emperor
Ashoka is the finest example when after the battle of Kalinga he became an
instrument in the hands of God, developed humility and became a messenger of His
word.

The irony of Ego is that even when a person
is doing good, Ego raises its tetra head. The solution is : give up the concept
of doership–become an instrument in His hands. Do this, believe me, Ego stands
managed. This will bring peace, pleasure, happiness, success and above all
contentment which we all seek. In short :Befriend Ego.

I would conclude by quoting Dada Vaswani:

‘We
are restless until we find our rest in God’

Rest here means – surrender to God’s will.
Believe in and practice ‘let thy will be done’.

shailesh.kwebmaker

Beneficial/Benami Holdings In Companies – Disclosure Requirements Notified

Background

Section 90 and related provisions of the
Companies Act, 2013, have finally been brought into force on 13^thJune
2018 along with related Rules. They apply to all companies, with a small set of
specified exceptions. “Significant beneficial owners” of such companies are
required to make certain declarations. The intention appears to be that those
natural persons (i.e. individuals) who have significant ownership of or
influence in or control of a company need to come forward and disclose their
names. From the point of view of transparency, it would be known who really
controls/owns the company, even if the ownership/control is through holding
entities such as companies, LLPs, Trusts, etc. or through contracts,
arrangements etc. The other major intention and consequence may be that
benami holdings could be identified, or at least required to be.

However, as we will see, the wording not
just of the provisions in the Act but also of the Rules has ambiguities and
uncertainties. This is owing to poor drafting, undefined important terms, etc.
which could lead to problems in implementation. Indeed, it is even difficult to
be clear what is the real intention. For example, is the intention to target
only those cases where the real owners are behind the scenes through certain
structures? Or is the intention to require that all persons with significant
ownership/control be brought on record? If the latter is the intention, there
will be a one-time massive exercise since lakhs of companies will have to make
such disclosures.

This column had discussed earlier some
issues on section 90, at a time when the new provisions were made part of the
Act through the Companies Amendment Act 2017 but were not brought in force. Now
that they have been duly notified and brought into force and require action,
and that the detailed Rules/Forms too are also released, the provisions and
their implications deserve a fresh and closer study.

It may be added that several other
provisions of law such as those relating to money laundering, certain
securities laws, etc. already have provisions requiring disclosures
under certain circumstances. The Benami Transactions (Prohibition) Act, 1988,
too deals with comparable provisions.

Relevant provisions

The relevant provisions are section 90 of
the Companies Act, 2013, with a definition of a term in section 89(10), and the
Companies (Significant Beneficial Owners) Rules, 2018. While the sections give
the primary requirements, the Rules provide for further definitions, the
benchmark at which a shareholder would be treated as a significant beneficial
owner, the process to be followed when shareholders are companies, LLPs, etc.
and the forms, records, etc.

Definition of a “Beneficial Interest”

Section 89 deals with disclosures by persons
with beneficial interests in shares. A person whose name is entered in the
register of members as the holder of shares but who does not hold the
beneficial interest is required to make disclosures. The term “beneficial
interest” has been defined quite broadly in section 89(10) and reads as
follows:

“(10) For the purposes of this
section and section 90, beneficial interest in a share includes, directly or
indirectly, through any contract, arrangement or otherwise, the right or
entitlement of a person alone or together with any other person to—

(i) exercise or cause to be exercised any
or all of the rights attached to such share; or

(ii) receive or participate in any
dividend or other distribution in respect of such share.”

However, while Section 89 requires
disclosure for all cases of shareholding without beneficial interest, section
90 (read with Rules) requires disclosure where there is at least 10% beneficial
shareholding (which would make it a ‘significant beneficial holding’). Section
90 of course applies also to cases where a person has or exercises significant
influence or control.

Terms such as “through contract, arrangement
or otherwise” and “alone or together with any other person” are used but not
defined.

Requirements relating to disclosure

Section 90 (read with relevant Rules)
requires, to simplify a little, a “significant beneficial owner” to make
disclosure. This includes persons having at least 10% beneficial shareholding
or having the right to exercise or who actually exercises “significant
influence” or “control”.

The term “control” has been defined in
section 2(27). The term “significant influence” has not been defined in the Act
or Rules and hence there can be uncertainty. Interestingly, the definition of
the term “associate company” in section 2(6) does define this term, though for
purpose of that clause. It means having “control of at least twenty per cent of
total share capital, or of business decisions under an agreement”.

Holding in shares or other securities

While sections 89/90 refer to the beneficial
interest in shares, the Rules extend it also to global depository
receipts, compulsorily convertible preference shares and compulsorily
convertible debentures. However, no further details are given as to how these
will be applied.

Holding through companies, LLPs, etc.

The intention appears to be to ascertain
those natural persons (i.e., individuals) who are the real owners of a company
and who control it. If the shareholders are persons other than individuals, it
would be necessary to go behind these entities and find who are the significant
owners behind them. Hence, for this purpose, the Rules essentially require the
natural persons who have at least 10% interest in such entity. However, while
one can gauge the intention here, in practice, the wording does not seem to be
sufficient to unravel complex structure of holdings/control.

The method to determine significant
beneficial owners (SBO) in such cases has been specified as follows.

Where the member is itself a company, SBOs
would be the natural persons who directly or indirectly or alongwith other
natural persons or through other persons/trusts hold at least 10% of the share
capital or who exercise significant influence or control through other means.
Where the member is a partnership firm, the principle is the same except that
the holding may be in terms of capital or entitlement to the profits. In any of
these two cases, if the SBOs can still not be ascertained, then the natural
person who is the senior managing official would be deemed to be the SBO. If
the shareholder is a Trust, the persons to be disclosed are the Trustees, the
beneficiaries who have at least 10% interest in the Trust, and any other
natural person “exercising ultimate effective control over the trust through a
chain of control or ownership”.

Residence of significant beneficial owner

The significant beneficial owner or
intermediary entities may be in India or abroad.

When are disclosures to be made?

The required disclosures have to be made to
the Company within 90 days of the new law coming into force. The Company would
then have to make disclosures to the Registrar within 30 days of receipt of
such disclosures.

There is a one time requirement of making
disclosures and thereafter, disclosures have to be made for changes as well as
for acquisition by new acquirers.

Applicable to which companies?

The new provisions are applicable to all
types of companies, small or big, public or private. The Rules make exceptions
for shareholdings of certain SEBI regulated entities. Clearly, then, lakhs of
companies will have to examine whether these new requirements apply to them.

Do only significant beneficial owners who
are not legal owners have to make disclosures?

Section 89 requires disclosure by a person
who holds shares in his name, but does not have the beneficial holding in them.
Section 90 contains no such limitation. The question then is whether a person
who holds 10% or shares legally and beneficially, would also be required to
disclose? If yes, then practically each and every company will see such
disclosures. The Rules define the term “significant beneficial owner” as a
person specified in section 90(1) who holds at least 10% beneficial holding in
shares, but “whose name is not entered in the register of members of a company
as the holder of such shares”. However, section 90 has much wider scope and,
for example, includes persons having significant influence or control. Hence,
while the Rules may have intended to specify disclosure where there are
beneficial holders who are not legal holders, the wording does not seem to be
clear enough.

Disclosure by institutional shareholders

Though the language is not wholly clear, it
appears that shareholders who are pooled investments funds (regulated under the
SEBI Act), such as the following, do not have to make disclosures under these
provisions:

1. Mutual Funds

2. Alternative Investment Funds

3. Real Estate Investment Trusts

4. Infrastructure Investment Trust

Obligation on company to inquire
into/report

Obligation has also been placed on the
Company to require persons to make disclosures if it has reason to believe that
such persons are covered by these provisions. If such persons still do not make
a disclosure, the Company has to refer the matter to the National Company Law
Tribunal for directions that may include restrictions over such shares.

Implications for non-disclosures/false
disclosures

If the persons who are obligated to make
disclosures – i.e., the significant beneficial owner and the company – do not
make the prescribed disclosures, they will be subject to fines. False
disclosures may result in prosecution that can be stringent.

Benami transactions

The provisions will surely apply to
legitimate significant beneficial owners. There may be persons who have reason
to hold shares through companies, trusts, etc. or through other complex
structures. However, they could also apply even to persons holding shares
benami as specified in the Benami Transactions Prohibition Act, if the
requirements of that Act are attracted. Disclosure by such persons may result
in very stringent consequences under that Act.

Conclusion

There are several other laws that already
require disclosure of those persons who are the ‘real’ owners/controllers of a
company. The object of each of these laws may be different ranging from
prevention of money laundering, to protection of shareholders, to preventing
tax evasion/corruption, etc. Some such as the Takeover Regulations are
fairly elaborate and while they are complex, the specific nature of provisions
leaves lesser aspects to uncertainty. In other cases, the requirements broadly
describe what is to be ascertained in general terms and then give detailed
clarifications which generally help cover a large variety of situations. The
newly introduced provisions in the Act/Rules make certain well meaning and
significant requirements. However, there are ambiguities in several places that
raise concerns whether the objective would be achieved at all. In many cases,
the provisions may be simple to apply and persons may even err on the side of
caution (even though the disclosures carry the risk of inviting inquiries).

There will however be several situations
where the provisions may be difficult to apply on the facts. One hopes that
clarifications/FAQs with examples of several alternative situations are given
so that there is clarity for at least the vast majority of companies.

shailesh.kwebmaker

Property Tax

Introduction

The Municipal Corporation
of Greater Mumbai (“BMC”) has revised the Property Tax system applicable in the
city of Mumbai. Instead of the earlier rateable value system which was in
force, the property tax was quite low and remained constant for years together.
However, the BMC now has a Capital Value System for levying property tax which
levies tax on the basis of the Stamp Duty Ready Reckoner of the property. This
system is expected to garner substantial revenue for the BMC as it would link
the values to more realistic figures instead of the rent capitalisation values
which were quite low.

Capital Value based System

Under the new system,
property tax is computed as a percentage of the Stamp Duty Ready Reckoner Value
of the property. Currently, the Reckoner of 2015 is adopted as the basis for
this purpose. This value would be adopted for a period of 5 years starting from
1-4-2015. Hence, the capital value would remain unchanged for 5 years, i.e.,
till 2020. After 5 years, as per the present system the Reckoner Rates would be
increased. However, if a building is constructed after 2015, then the Reckoner
rate of the year in which it was constructed would be adopted and would remain
in force till 2020. The rates for levying tax on this capital value depends
upon the Category of the property and are as follows:

– Residential
with metered water supply in City and suburbs @ 0.359%

– Residential
with un-metered water supply in City @ 0.775%

– Residential
with un-metered water supply in suburbs @ 0.552%

– Shops
/ commercial / industrial with metered water supply in City and suburbs @
0.880%

– Shops
/ commercial / industrial with un-metered water supply in City @ 1.90%

– Shops
/ commercial / industrial with un-metered water supply in suburbs @ 1.280%

– Open
Land with metered water supply in City and suburbs @ 1.630%

– Open
Land with un-metered water supply in City @ 3.518%

– Open
Land with un-metered water supply in Suburbs @ 2.370%

In
addition, the BMC has exempted houses in the city with a carpet area up to 500
sq. ft. from property tax. The BMC is also considering passing a proposal for
concession in property tax for houses measuring between 500 sq. ft. and 700 sq.
ft.

The BMC has announced that
soon, personalised property tax bills will be issued, to the people who own
flats in those buildings that have Occupancy Certificates (OCs). However,
property tax of the unsold flats and common areas, will be paid by the builder.
Under the earlier system, the BMC issued a common property tax bill to a
housing society, which then collected the tax dues from the flat owners and
paid the amount to the BMC. The main problem with the earlier system, was that
if a member failed to pay the property tax, then, all the members were
penalised. Now, in the personalised property tax billing system, this will
stop.

Valuation Rules

Valuation of Open Land

Capital Value of open land,
i.e., land which does not have anything built upon it and which is not
appurtenant to a building is computed as follows: Value of open land under the
Reckoner * Weightage of user category * FSI permitted * Area of Land. The
weightage factor is given separately in Schedule A to the Rules for different
types of properties.

Valuation of Building / Flat

The Rules for valuing a
building / flat / premises for computing property tax are as follows:

(a) Capital Value of a Building / Flat is computed
as follows: Value of building under the
Stamp Duty Ready Reckoner * Weightage of user category (depending upon whether
the building falls under Part II, III or IV of Schedule A) * Weightage for Age
of Building * Weightage for Floor factor for Lift * Carpet Area of Building.
The weightage factors are given separately in Schedule A for different types of
properties.

There are eight major steps
to using the Stamp Duty Ready Reckoner which are as follows:

(i) Find out the Village Number and Village
Name in which the property is located;

(ii) Ascertain the Zone and the Sub-Zone;

(iii) Find out the CTS No. of the property;

(iv) Determine the type of property, e.g.,
Residential, Office, etc.;

(v) Calculate the Carpet Area of the Flat /
Office. Stamp Duty is paid on the basis of Built-up Area but for Property Tax
the Carpet Area is adopted;

(vi) Find out the Market Value for the type of
Property;

(vii) Ascertain if there are any Special Factors
as prescribed in the Reckoner;

(viii) The
Market Value of the Property for Stamp Duty purposes = Adjusted Fair Market
Value * Carpet Area of the Property

(b) The following are the weightages given while
valuing a building or a flat or office:

(i) User category

(ii) Nature and type of building~ weights have been
assigned for open terrace, dry balcony, porch, etc.

(iii) Age of building

(iv) Floor factor of building with Lift

For
instance, in the case of a residential building the Schedule provides some
weightages in the following manner:

User Category of Building weightage to reckoner
Rate (UC)

Nature and Type of Building weightage (NTB)

Weightage for Age Factor of Building (AF)

Weightage for Floor Factor (FF)

Residential
user 0.50

RCC
1.00

0-5
years 1.00

Car
Park basement 0.70

Five
Star Hotel 1.00

Pucca
Building 0.70

5-10
years 0.95

Ground
Floor 1.00

Factory
1.25

Semi
permanent Building 0.50

10-15
years 0.90

1^st
-10^th Floor 1.00

Shops
and Commercial 0.80

15-20
years 0.85

11^th-20^th Floor – 1.05

20-25
years+ 0.80

21^st
-30^th Floor – 1.10

31^st
– 50^th Floor – 1.15

CV = BV *
UC * NTB * AF * FF * CA

Where

CV = Capital Value of a
Building

BV = Base Value of the
building as per the Stamp Duty Ready Reckoner

UC = User category of
residential, shop, open land, etc.

NTB = Nature and Type of
Building, i.e., RCC, semi-pucca, etc.

AF = Age Factor
Depreciation

FF = Floor Factor
Adjustment for Building with Lift

CA = Carpet Area

(d) Some examples of computation of the capital
value of a property is as follows:

Illustration
-1: Carpet area of a Residential flat of 1000 sq.ft.on the 5^th
floor of a RCC constructed building at Colaba. The building is 40 years old and
as per the Reckoner of 2015, it falls in Zone 1/3 where the rate for
residential building is Rs. 497,500 per sq. mt. The weightages of various
factors would be as follows:

Particulars

Weightage

Base
Value as per Reckoner (BV)

497,500

—

Carpet
area (CA)

1000 sq. ft / 92.90 sq. mt

Weightage
for User Category (UC)

Flat

0.50

Weightage
for Nature and Type of Building (NTB)

RCC Building

1.00

Weightage
for Floor Factor (FF)

5^th -10^th Floor

1.05

Weightage
for Age of Building (AF)

35-40 years

0.65

Thus, the Capital Value of
the Flat would be worked out as under:

497,500 * 0.50
*1.00*1.05*0.65* 92.90 =Rs. 1,57,71,807

On this Capital Value, the
Property Tax for a Residential property @ 0.359% would be Rs. 56,620 per year
or Rs. 4,718 per month.

Illustration-2:
Carpet area of an Office is 10,000 sq.ft. and is located on the 15th floor of a
RCC constructed building at Bandra Kurla Complex. The building is more than 10
years old and as per the Reckoner of 2015 it falls in Zone 31/72 where the rate
for an Office is Rs. 155,300 per sq. mt. The weightages of various factors
would be as follows:

Particulars

Weightage

Base
Value as per Reckoner (BV)

Rs.155,300

—

Carpet
area (CA)

10,000 sq. ft / 929.02 sq. mt.

Weightage
for User Category (UC)

Office

0.80

Weightage
for Nature and Type of Building (NTB)

RCC Building

1.00

Weightage
for Floor Factor (FF)

11^th – 20^th Floor

1.10

Weightage
for Age of Building (AF)

10-15 years

0.90

Thus, the Capital Value of
the Flat would be worked out as under:

155,300 * 0.80
*1.00*1.10*0.90* 929.02 =Rs. 11,42,67,230

On this Capital Value, the
Property Tax for an office property @ 0.880% would be Rs. 10,05,551 per year or
Rs. 83,796 per month.

Conclusion

The Capital value based
Property Tax system is based on the Ready Reckoner and hence, suffers from the
same flaws which the Reckoner is infamous for. However, a good part is that for
residential properties, only 50% of the reckoner rate is adopted. Nevertheless,
double rates for the same property, non-consideration of various factors, such
as, differences in areas / properties, condition of flats, etc., would
all apply even to this system.

shailesh.kwebmaker

CONSOLIDATION OF CSR TRUSTS UNDER Ind AS

Background

Many Indian corporates have set up
Special Purpose Not-for-Profit Entities (NFP) to undertake corporate social
responsibility (CSR) activities as required u/s. 135 of the Companies Act,
2013. The CSR activities are either undertaken by the Company directly or
through a charitable trust under The Indian Trusts Act, 1882, section 8 company
under the Companies Act 2013 or a society under the Societies Registration Act,
1860. The sponsoring company will provide adequate funds or donations to the
trust, society or the section 8 company so that it can carry out the relevant
activities as required under the Companies Act, 2013. A question arises as to
whether such NFP should be consolidated under Ind AS 110, Consolidated
Financial Statements by the sponsoring company.

Under Ind AS 110, an investor
controls an investee and consequently consolidates it when it is exposed, or
has rights, to variable returns from its involvement with the investee and has
the ability to affect those returns through its power over the investee. Thus,
an investor controls an investee if and only if the investor has all the
following:

(a) Power
over the investee,

(b) Exposure,
or rights, to variable returns from its involvement with the investee, and

Arguments supporting consolidation of the
NFP

Following are the arguments
supporting consolidation:

Under Ind AS 110, variable returns are seen more broadly, and
will include exposure to loss or expenses from providing funds, donation,
credit or liquidity support and intangible benefits on reputation and image
from good governance practices. By hand-picking the members of the governing
body of the NFP, the sponsor of the NFP ensures that it has power over the NFP
either explicitly or implicitly. Using these powers, the sponsoring company
ensures that the NFP undertakes the desirable CSR activity, which meets its compliance
and other needs.

Ind AS 110 does not apply to
post-employment benefit plans or other long-term employee benefit plans to
which Ind AS 19, Employee Benefits, applies. However, there are no such
exemptions for NFPs. Moreover, the accounting for long term employee benefit
plans under Ind AS 19 effectively recognises the net assets and liabilities of
the Trust, i.e., the net defined benefit liability (asset) is determined after
taking into account the fair value of the plan assets and the relevant disclosures
are included in the separate financial statements and CFS of the company.

The NFP is controlled by the
sponsoring company for its own benefit and is not specifically exempted from
preparing CFS. Hence, an NFP should be consolidated.

CSR activities prior to the Companies Act, 2013 were undertaken
voluntarily. After the Companies Act, 2013, it has also become a
quasi-mandatory requirement. If a company does not spend on CSR, as required by
the Companies Act, 2013 it has to make appropriate disclosures in the
Director’s report. There are numerous activities a company has to undertake for
the purposes of complying with the various laws of the land. The cost of all
such compliance activities are included in the separate and consolidated
financial statements (CFS). Since CSR is a cost incurred to conduct business in
the country as required by legislation, it should be included and consolidated
in the financial statements. The NFP is merely an extension of the Company
created to ensure compliance with the Companies Act, 2013. A company that
undertakes CSR activities directly would have in any case included the CSR
spend in its separate financial statements and CFS. Whether the CSR activities
are under taken directly or through a trust, society or company, the outcome
with respect to financial statements should be the same.

Even in cases, where the CSR activity is not linked to compliance
but is undertaken for altruistic purposes, consolidation will still be
required. This is because in such cases, for reasons already described above,
the company has an exposure to variable returns in the form exposure to loss
from funding or providing liquidity support for running the CSR entity. In
addition, there will be intangible returns by way of enhancement or damage to
reputation and image.

Conclusion

The
author believes that the NFP created for CSR activities should be consolidated
in accordance with the requirements of Ind AS.

shailesh.kwebmaker

PENALTIES : TO ERR IS HUMAN – IS GST HUMAN?

Payment of taxes is considered a
civil obligation and breach of such obligation results in penal
consequences. The nuances of a duly
enacted statute provide the contours under which the taxes need to be
discharged and penal provisions accompany such legislations for its effective
enforcement. Yet, it is well known that
no statute is enacted with an object to impose penalties. Rather, they are
intended to operate as a deterrent to violating of any provision. Courts have
frequently held that penalty is imposed only in cases of contumacious conduct
by the tax payer. The GST enactment is no different and this resonates from the
Statement of objects and reasons placed before the Parliament while introducing
the Central Goods & Services Tax Bill, 2017:

“…. (i) To make provision for
penalties for contravention of the provisions of the proposed legislation … ”

Practical experiences depict a
contrasting picture. One would have experienced tax administrators (both Centre
and the State) applying the penal provisions mechanically without appreciating
the purpose and instances for which penal provisions are enacted. The following
statements are a common feature in show cause notices and adjudication orders:

“Assessee has intentionally
contravened the provisions of the Act and hence liable for penalty …;
suppressed this information from the revenue with an intention to evade tax
payment….; deliberately avoided the payment of taxes knowing fully well that
the transaction is taxable;….”

Not a single order goes without
imposition of penalty even in cases where the tax demand is under debate at
higher forums. All the tax payers are painted by a single brush leading to
undesirable litigation. Sometimes, administrative authorities do not even
consider it necessary to state that penalty is being imposed and one is
enlightened about the imposition only from the demand notice or computation at
the end of the order. There is a tendency to invoke and adjudicate the penalty
merely by a stroke of a pen, leaving the battle to be fought by the assessee.
Though, Courts have time and again held that penalty is not an ‘additional tax’
rather ‘an addition to the taxes collected’, this starking difference has been
ignored by tax administrators. With this foreward, we have examined the penal
provisions under the CGST law in the subsequent paragraphs:

General Principles of Penalty

Certain principles set down by Courts
while dealing with matters on penalty have been enlisted below:

– Penal
provisions should be strictly construed without much play. Yet, one should
ensure that the constructions fall within the contours of its Statute.

– There
has been considerable debate on whether mens–rea is an essential
requirement for imposition of penalty towards civil offences. While it is
certainly clear that mens–rea need not always be proved for
penalty, the statutory provisions should be examined to reconcile this debate:
(a) examine the statutory provisions for any express or implied requirement of
a guilty mind (such as use of the phrases like suppression, concealment, etc.
have an inbuilt requirement of mens-rea to be established); (b) identify
if the penalty has been intended to be a civil offence or a criminal offence
since the requirement of mens rea in civil offences is comparatively
lower than in criminal offences; and (c) once the requirements of the
provisions have been met, there is no discretion with the officer over the
quantum of penalty for such offence or referring back to the presence or
absence of mens-rea

– The
road to all assessments need not necessarily end with penalty. Though every tax
evasion arises out of non-payment, every non-payment should not be equated with
tax evasion. It has been famously cited that penalty should not be imposed
merely because one has been empowered to do so.

– The
onus is on Revenue to establish that the circumstances warrant imposition of
penalty. Only when this onus is effectively discharged that the tax payer is
required to defend his/her bonafide. Mere suspicion / surmises cannot form the
ground for penalty. Evidences and actions should be placed on record.

– Penalty
should be invoked under a specific clause/ provision and expressly stated out
in the notice/ order. The tax payer cannot be left to search for the provision
under which he/she has been penalised (Amrit Foods vs. CCE, UP 2005 190 ELT
433 (SC)).

– Penalty
invoked under clause (a) cannot be upheld under clause (b). The grounds of
invoking penalty and upholding the same would have to be reconcilable.

– Penalty
should be commensurate with the tax involved.

– Unequals
should not be treated as equals. A mala-fide tax payer and bonafide tax payer
cannot be saddled with same quantum of penalty merely on the ground of non-payment.

– Penalty
cannot be imposed for a future action on the theory of possibilities.

– One
cannot be penalised retrospectively, even in retrospective legislations. Penal
provisions prevailing on the date of offence should be applied.

– If
two reasonable views are possible or in cases of ambiguity, the lineal
construction should be adopted.

Statutorily recognised principles
of penalty (section 126)

The CGST / SGST law for the first
time has penned down certain disciplines for imposition of penalty. These are
principles from settled judicial decisions in the context of penalty:

– Minor
breaches (Tax effect < Rs. 5000) or omission in documentation without
fraudulent intent should not be subjected to penalty.

– Penalty
should be commensurate with the degree and severity of breach.

– Prior
notice and personal hearing should be granted prior to imposing penalty.

– Order
imposing penalty should be speaking about the nature of breach and the
applicable provision under which the penalty is being imposed.

– Voluntary
disclosure prior to discovery of breach of law should be dealt with leniency.

However, this section has given
limited applicability only to penal provisions where a fixed quantum or fixed
percentage has not been prescribed i.e. cases where discretion has been
bestowed upon the officer over the quantum of penalty.

Examination of legal provisions –
Scheme of Penalty under the GST law

The GST Law has elaborately spread
the provisions for penalty across various Chapters. Principally, penalties can
be classified into those which are imposed based on findings on the merits of
the issue in the course of adjudication proceedings (sections 73 and 74) and
those penalties which can be imposed by the proper officer independent of the
adjudication proceedings (broadly similar to that followed in Income tax) by
issuing a separate order i.e. once the ingredients of the respective penal
provisions are satisfied (section 127). There is also a third set of penalties
imposable in cases of goods in transit or evasive acts where goods are liable
for confiscation. On a reading of the entire set of penal provisions, there
appears to be a significant amount of overlap between provisions leading to
multiple touch points for an officer to invoke for imposing penalty.

The overall scheme of penalty has
been depicted in the following chart. In simplistic terms, section 127 r/w
section 73, 74 and 129/130 has carved out three broad pillars on the basis of
which penalty can be imposed.

General understanding of key
terminologies

Prior to examining the above scheme in detail, it is important to
examine the meaning of some terms used in these sections, to be applied
contextually under respective facts and circumstances only:

Term	Understanding as per Black’s law dictionary and other sources
Offence	A violation of the law; a crime, often a minor one.
Non-compliance	Failure or refusal to comply. Opposite – Compliance- The acting in accordance with a desire, condition etc.
Contravention	An act of violating a legal condition or obligation
Fraudulent/ Fraud	Fraud- A known misrepresentation or concealment of a material fact made to induce another to act to his or her detriment Fraudulent- Conduct involving bad faith, dishonesty, a lack of integrity, or moral turpitude Other legal sources Mere omission to give correct information is not suppression of facts unless it was deliberate to stop the payment of duty. Suppression means failure to disclose full information with the intent to evade payment of duty. When the facts are known to both the parties, omission by one party to do what he might have done would not render it suppression
Suppression	GST law – Explanation 2 to section 74 defines suppression as ‘non-declaration of facts or information which a taxable person is required to declare in the return, statement, report or any other document furnished under the Act or failure to furnish any information asked by the proper officer
False/Falsifying document	False – Untrue, Deceitful; lying. Not genuine, inauthentic Falsifying a record – The crime of making false entries or otherwise tampering with a public record with the intent to deceive or injure, or to conceal wrong doing Other Sources: “Erroneous, untrue, the opposite of correct, or true. The term does not necessarily involve turpitude of mind. In the more important uses in jurisprudence the word implies something more than a mere untruth; it is an untruth coupled with a lying intent, or an intent to deceive or to perpetrate some treachery or fraud.
	“In law, this word usually means something more than untrue; it means something designedly untrue and deceitful, and implies an intention to perpetrate some treachery or fraud”
Tampering/ destroying	Tampering– The act of altering a thing; esp., the act of illegally altering a document or product, such as written evidence or a consumer good. Destroying– To damage something so thoroughly as to make unusable, unrepairable or non-existent; to ruin.
Tax evaded	The willful attempt to defeat or circumvent the tax law in order to illegally reduce one’s tax liability.
Detention	The act or an instance of holding a person in custody; confinement or compulsory delay. Not allowing temporary access to the owner of the goods by a legal order/notice is called detention. However the ownership of goods still lies with the owner. It is issued when it is suspected that the goods are liable to confiscation.
Seizure	Seizure is taking over of actual possession of goods with right of disposal for recovery of dues by the department in case of perishable / highly depreciable goods. Seizure can be made only after inquiry/investigation that the goods contravened provisions of the Act. Title continues with the supplier-owner.
Confiscation	Confiscation of the goods is the ultimate act after proper adjudication. Once confiscation takes place, the ownership as well as the possession forcefully goes out of the hands of the original owner and into the hands of the Government Authority.

Term

Understanding
as per Black’s law dictionary and other sources

Offence

A violation of the law; a
crime, often a minor one.

Non-compliance

Failure or refusal to
comply.

Opposite – Compliance- The acting in accordance with a
desire, condition etc.

Contravention

An act of violating a legal
condition or obligation

Fraudulent/ Fraud

Fraud- A known misrepresentation or concealment of a
material fact made to induce another to act to his or her detriment

Fraudulent- Conduct involving bad faith, dishonesty, a lack
of integrity, or moral turpitude

Other legal sources

Mere omission to give
correct information is not suppression of facts unless it was deliberate to
stop the payment of duty. Suppression means failure to disclose full information
with the intent to evade payment of duty. When the facts are known to both
the parties, omission by one party to do what he might have done would not
render it suppression

Suppression

GST law – Explanation 2 to
section 74 defines suppression as ‘non-declaration of facts or information
which a taxable person is required to declare in the return, statement,
report or any other document furnished under the Act or failure to furnish
any information asked by the proper officer

False/Falsifying document

False – Untrue, Deceitful; lying. Not genuine,
inauthentic

Falsifying a record – The crime of making false entries or otherwise
tampering with a public record with the intent to deceive or injure, or to
conceal wrong doing

Other Sources:

“Erroneous, untrue, the
opposite of correct, or true. The term does not necessarily involve turpitude
of mind. In the more important uses in jurisprudence the word implies
something more than a mere untruth; it is an untruth coupled with a lying
intent, or an intent to deceive or to perpetrate some treachery or fraud.

“In law, this word usually
means something more than untrue; it means something designedly untrue and
deceitful, and implies an intention to perpetrate some treachery or fraud”

Tampering/ destroying

Tampering– The act of altering a thing; esp., the act of
illegally altering a document or product, such as written evidence or a
consumer good.

Destroying– To damage something so thoroughly as to make
unusable, unrepairable or non-existent; to ruin.

Tax evaded

The willful attempt to
defeat or circumvent the tax law in order to illegally reduce one’s tax
liability.

Detention

The act or an instance of
holding a person in custody; confinement or compulsory delay.

Not allowing temporary
access to the owner of the goods by a legal order/notice is called detention.
However the ownership of goods still lies with the owner. It is issued when
it is suspected that the goods are liable to confiscation.

Seizure

Seizure is taking over of
actual possession of goods with right of disposal for recovery of dues by the
department in case of perishable / highly depreciable goods. Seizure can be
made only after inquiry/investigation that the goods contravened provisions
of the Act. Title continues with the supplier-owner.

Confiscation

Confiscation of the goods is
the ultimate act after proper adjudication. Once confiscation takes place,
the ownership as well as the possession forcefully goes out of the hands of
the original owner and into the hands of the Government Authority.

A) Adjudication related
penalties (section 73 and 74)

Under the erstwhile scheme, penalty
(u/s 11AC of the Central Excise Act and 78 of the Finance Act) and extended
period of limitation emanated from a common trigger point i.e. fraud,
suppression, etc (prior to amendment by Finance Act, 2015). In cases where
extended period of limitation was dropped, penalty could not be imposed even in
respect of the normal period. In a particular case penalty was dropped even
though extended period of limitation was invoked against the assessee[1]. This
position was altered by Finance Act, 2015 where penalty was imposed even in
respect of cases not involving fraud, suppression, etc albeit at lower scale.
The amendment prescribed various scales of penalty for short payment depending
on the reasons for such non-payment. The GST law has toed the line prevalent
after the 2015 amendment and delinked both the concepts resulting in penalty
being imposable even for bonafide acts.

Section 73 (normal period
assessments) and 74 (extended period assessments) are parallel to the
adjudication provisions of section 73 of the Finance Act, 1994 and section 11A
of the Central Excise Act, 1944. The said provisions empower the proper officer
to initiate adjudication proceedings in cases of short payment/ non-payment,
irregular input tax credit and erroneous refund. During the course of such
proceedings, the proper officer would have an opportunity conclude on the
reasons for non-compliance by the tax payer and classify the cases on the basis
of intent.

The penalty would be imposed in the
order issued under the said section depending on the stage at which the tax
payer makes the payment of the taxes demanded. The important take aways from a
reading of the said provisions are:

1) Penalties
provided under the said section are absolute without much discretion being
granted to the proper officer on the quantum of penalty.

2) There
is no provision parallel to the erstwhile section 80 of the Finance act, 1994
wherein officers were granted powers to waive the penalty if ‘reasonable cause’
is shown by the tax payer.

3) Penalties
are directly linked to the alleged revenue loss to the respective Government.

4) Imposition
of penalties under these section are subject to an outer time limit of 3-5
years from the relevant date (due date of filing the annual return).

B) Non-adjudication related
penalties (section 122 to section 128)

Chapter XIX of the CGST/ SGST law –
‘Offences and penalties’ is a code for imposition of penalties in specific
cases. The said penal provisions u/s. 122 to 128 have been structured to lay
down the triggers for penalty in enlisted cases including detention and
confiscations. Under section 127, these penal provisions would apply only where
the proceedings of sections 62, 63, 64, 73, 74, 129 and 130 do not impose
penalty. The said provisions are as follows:

Section 122(1) – Specific Penalties

This section provides for 21
instances when penalty can be imposed on the tax payer. On a reading of certain
clauses, it appears that the law makers have targeted the issues at a micro
level in many cases. The section 122(1)
can be divided into two sub-parts for a better understanding:

– Part A : Enlists the
triggers for penalty; and

– Part B : Prescribes the
penalty for the enlisted circumstances as follows:

Ad-hoc penalty : 10,000 being the
bare minimum penalty;

(OR)

Proportionate penalty : 100%
penalty to tax evaded; tax not deducted/ collected; short-collected
or not paid; input tax credit availed or passed on or distributed
irregularly or refund claimed fraudulently whichever is higher.

A clause by clause analysis of
section 122(1) has been tabulated below. In the table the author has
categorised the possible reasons underlying a non-compliance into – (a)
clerical errors generally considered as bonafide; (b) interpretative in view of
ambiguity in law and deemed as bonafide; and (c) evasive where it is
intentional.

Clause	Trigger of penalty	Some examples	Attributable reasons	Possible Quantum
(i)	Supply without invoice or incorrect or false invoice	Clandestine removal	Evasive	10000 or 100% penalty
		Human error of not raising valid invoice	Clerical	10000
		Ambiguity in continuous supply of services/ goods	Interpretative	10000
(ii)	Invoice issued without supply of goods/ services	Bill Trading	Evasive	10000 or 100% penalty
		Invoice issued but goods not removed	Clerical	10000
(iii)	Collected any tax but fails to pay within 3 months[2]	Collected and failed to pay	Evasive	10000 or 100% penalty
		Failed to include in GST-3B/1 due to mistake though accounted liability in books of accounts	Clerical	10000
(iv)	Collection in contravention of the law coupled with failure to pay within 3 months	Tax collected on exempted goods and not recorded in accounts	Evasive	10000 or 100% penalty
(v) & (vi)	Fails to deduct or collect tax or after such deduction or collection failed to pay this entire amount	Tax collected on exempted goods and not recorded	Evasive	10000 or 100% penalty
(vii)	Takes or utilises input tax credit without actual receipt of goods/ services	Accommodation bills	Evasive	10000 or 100% penalty
(viii)	Fraudulently obtains refund	Falsifying ITC claims	Evasive	10000 or 100% penalty
(ix)	Takes or distributed input tax credit incorrectly	Falsifying ITC claims	Evasive	10000 or 100% penalty
	Incorrect distribution formula applied	Interpretative	10000
	Formula error	Clerical	10000
(x)	Falsifies or substitutes financial records with intent to evade taxes	Forgery	Evasive	10000 or 100% penalty
(xi)	Fails to obtain registration	Clandestine supplies	Evasive	10000 or 100% penalty
		Incorrectly ascertains the location of supplier	Interpretative	10000
(xii)	Furnishes false information in respect of registration	Fictitious address	Evasive	10000 or 100% penalty
(xiii)	Obstructs or prevents any officer	Fails to unlock a godown on demand	Considered evasive	10000 or 100% penalty
(xiv)	Transports without appropriate documentation	E-way bill not raised	Clerical	10000
		Clandestine supply	Evasive	10000 or 100% penalty
(xv)	Suppresses turnover	Clandestine supply	Evasive	10000 or 100% penalty
(xvi) & (xvii)	Fails to maintain appropriate records/ information or furnishes false information	Non-submission of inventory records	Clerical	10000
Non-maintenance	Clerical	10000
False data	Evasive	10000 or 100% penalty
(xviii)	Supplies, transports or stores any goods liable for confiscation	Clandestine goods	Evasive	10000 or 100% penalty
(xix)	Issues invoice by using another registered person’s number	Fraud	Evasive	10000 or 100% penalty
		Wrong GSTIN of same entity used	Clerical	10000
(xx)	Tamper material evidence	Fraud	Evasive	10000 or 100% penalty
(xxi)	Tampers with goods under detention	Fraud	Evasive	10000 or 100% penalty

Clause

Trigger
of penalty

Some
examples

Attributable reasons

Possible
Quantum

(i)

Supply without invoice or
incorrect or false invoice

Clandestine removal

Evasive

10000 or 100% penalty

Human error of not raising
valid invoice

Clerical

10000

Ambiguity in continuous
supply of services/ goods

Interpretative

10000

(ii)

Invoice issued without
supply of goods/ services

Bill Trading

Evasive

10000 or 100% penalty

Invoice issued but goods not
removed

Clerical

10000

(iii)

Collected any tax but fails
to pay within 3 months[2]

Collected and failed to pay

Evasive

10000 or 100% penalty

Failed to include in
GST-3B/1 due to mistake though accounted liability in books of accounts

Clerical

10000

(iv)

Collection in contravention
of the law coupled with failure to pay within 3 months

Tax collected on exempted
goods and not recorded in accounts

Evasive

10000 or 100% penalty

(v) & (vi)

Fails to deduct or collect
tax or after such deduction or collection failed to pay this entire amount

Tax collected on exempted
goods and not recorded

Evasive

10000 or 100% penalty

(vii)

Takes or utilises input tax
credit without actual receipt of goods/ services

Accommodation bills

Evasive

10000 or 100% penalty

(viii)

Fraudulently obtains refund

Falsifying ITC claims

Evasive

10000 or 100% penalty

(ix)

Takes or distributed input
tax credit incorrectly

Falsifying ITC claims

Evasive

10000 or 100% penalty

Incorrect distribution
formula applied

Interpretative

10000

Formula error

Clerical

10000

(x)

Falsifies or substitutes
financial records with intent to evade taxes

Forgery

Evasive

10000 or 100% penalty

(xi)

Fails to obtain registration

Clandestine supplies

Evasive

10000 or 100% penalty

Incorrectly ascertains the
location of supplier

Interpretative

10000

(xii)

Furnishes false information
in respect of registration

Fictitious address

Evasive

10000 or 100% penalty

(xiii)

Obstructs or prevents any
officer

Fails to unlock a godown on
demand

Considered evasive

10000 or 100% penalty

(xiv)

Transports without
appropriate documentation

E-way bill not raised

Clerical

10000

Clandestine supply

Evasive

10000 or 100% penalty

(xv)

Suppresses turnover

Clandestine supply

Evasive

10000 or 100% penalty

(xvi) & (xvii)

Fails to maintain
appropriate records/ information or furnishes false information

Non-submission of inventory
records

Clerical

10000

Non-maintenance

Clerical

10000

False data

Evasive

10000 or 100% penalty

(xviii)

Supplies, transports or
stores any goods liable for confiscation

Clandestine goods

Evasive

10000 or 100% penalty

(xix)

Issues invoice by using
another registered person’s number

Fraud

Evasive

10000 or 100% penalty

Wrong GSTIN of same entity
used

Clerical

10000

(xx)

Tamper material evidence

Fraud

Evasive

10000 or 100% penalty

(xxi)

Tampers with goods under detention

Fraud

Evasive

10000 or 100% penalty

The following observations emerge
from the above tabulation of examples:

1) Prima-facie,
the clauses seem to address all types of non-compliance and not just tax
evasion

2) Evasive
action is omnipresent in every clause, either impliedly or expressly

3) Interpretative
or clerical non-compliance seems to be missing in cases where phrases such as
fraudulent, tampering, falsification, etc are present

4) The
chapter title and section title use the phrase ‘Penalty for certain offences’
indicating that the section is addressing unacceptable defaults or defaults
having the ingredient of a gross violation which is non-curable resulting in
revenue law

5) In
certain cases, proportionate penalty on the basis of ‘tax evaded’ would not be
ascertainable resulting in a situation where there is no comparative to the
adhoc penalty of Rs. 10,000. This throws up two alternative theories:

(a) Section
122 only addresses actions involving tax evasion and not every non payment
(such interpretative / clerical cases); or

(b) Section
122 addresses both cases, but in cases where there is no evasive action, the
penalty imposable for any default is limited to Rs. 10,000

The questions emerging from the
above table are:

Q1 – Whether 21 clauses are
mutually exclusive to each other?

Section 122(1) contains cases which
could fall under more than one clause eg. supply without invoice (clause (i))
and suppression of turnover (clause (xv)). An assessee could be penalised under
either of the clauses – for example transport of goods without invoice would
trigger both clause (i) and (xiv). Though clauses are overlapping, the tax
payer can be imposed with penalty only under one of the clauses for the same offence.

Q2 – Does the prescription of
adhoc and proportionate penalty apply to each of the clauses or only to
specific clauses? In other words, does penalty proportionate to tax evasion, etc. apply to all cases of tax evasion
(express or implied) or only to cases where the clauses specifically use the
phrase ‘tax evaded’.

The provisions of section 122(1)
targets actions which are evasive impliedly and expressly. One argument could
be that the proportionate penalty applies only to cases where tax evasion is
specifically expressed in the clause (such as (x), (xv), etc.). Similar
phrases accompanying the proportionate penalty such as tax short deduction/
collection, input tax credit irregularly availed, refund fraudulently availed
are directly relatable to specific clauses. Since accompanying phrases are
directly relatable to a specific clause(s), the prescription of proportionate
penalty on tax evasion should also apply to specific clauses only.

However, the other argument would
be that once tax evasion has been established, proportionate penalty can be
imposed on the tax evaded irrespective of there being an express prescription
of tax evasion in the clause. Tax evasion is inbuilt in the manner in which the
clauses are worded (such as (i)). The above table depicts that every clause
seems to capture an evasive act even though the term tax evaded has not been
expressly spelt out. The intent of this provision is to address cases of tax
evasion with rigorous penalty equalling the amount of tax evaded. This is the
only way full force may be given to
section 122(1), else the said provision may become a toothless tiger.

Q3 – If the ingredients of tax
evasion have limited applicability, what would be the comparative figure to Rs.
10,000 in cases where the 100% penalty does not apply ?

For eg, if a tax payer issues an
incorrect invoice of Rs. 100,000 taxable @ 18% citing a wrong place of supply,
would one have to compare Rs. 10,000/- and Rs. 18,000 for imposition of penalty
or one can claim that there being no tax evasion, penalty of only Rs. 10,000/-
can be imposed? The answer to this question is dependent on the tax position
adopted on the scope of section 122(1). In cases where the scope of section
122(1) is considered as only addressing ‘offences’ and not all tax
non-compliance, no penalty can be imposed for clerical/ interpretative reasons
as cited in the above case. But where a stand is taken the section 122(1)
extends beyond cases of tax evasion, then a purposive effect to this stand can
be given as follows:

This chart implies that in non-tax
evasion cases, in the absence of a comparative figure, one should consider the
same as zero and then make a comparison leading to the inevitable conclusion
that Rs. 10,000/- would be the applicable penalty. Therefore, in case of a
wrong place of supply, the tax payer may be subjected to a maximum penalty of
only Rs. 10,000/-. This is the only
possible interpretation where penalty for substantive and procedural defaults
can be given effect to.

In summary, the reasonable
interpretation of section 122(1) would be it primarily addresses cases of tax
evasion / tax non-deduction etc. and every clause addresses cases of tax
evasion either expressly or impliedly. Hence, equal penalty can be imposed on
the tax payer irrespective of which clause the case falls under. Section 122(1)
does not have any applicability over procedural/ non-evasive defaults. But if
one were to still extend this provision to procedural defaults, the penalty
imposable would only be Rs. 10,000/-.

Section 122(2) – Tax liability/ refund related penalties

Section 122(2) – This section
provides for two levels of penalty depending on the reasons for non-payment.
The said section has recognised that mens-rea/ state of mind would
establish the gravity of the offence and hence the quantum of penalty. Unlike
section 122(1), the law makers have targeted the non-payment at a macro level
purely on the test of whether there is a short payment of tax to the exchequer
and have not listed down actions resulting in such short payment:

Any reason other than fraud

10,000 or 10% of the tax due whichever is higher

The clause specifically uses
the phrase tax due rather than tax evaded

Fraudulent reason

10,000 or 100% of the tax evaded
whichever is higher

Section 122(2) provides some
inferences as to interpretation of section 122(1) as well as 122(2):

1) Section
122(2) captures all cases of non-payment of tax and imposes a basic penalty of
10% of tax due which can jump to 100% in fraud cases.

2) Though
section 122(2) does not use the term ‘intent to evade’, it is implied by use of
the phrases – fraud, wilful misstatement, suppression, etc.: tax evasion
is always malafide and one cannot evade taxes without having the
intention to do so.

3) Use
of the expression ‘tax due’ in section 122(2) and tax evaded in section 122(1)
clearly establish the distinct domains that each of the clauses address.

4) Section
122(2) is general in its scope and presence of specific clauses in section
122(1) may exclude them outside the scope of section 122(2).

5) Proportionate
penalty u/s. 122(1) is at the same scale as that applicable to fraudulent
actions specified u/s. 122(2)(b). By this interpretation, the first theory over
section 122(1) is strengthened. The legislature would not have in its wisdom
treated non payment for clerical errors at par with those due to evasive acts
u/s. 122(1). It has therefore provided a reduced penalty of 10% or Rs. 10000
only to cases where the penalty is not on account of fraud, etc. and
section 122(1) does not extend its scope over clerical / interpretative
defaults.

Reconciling section 73/74 and
section 122(2)

Section 122(2) seems to be a close
replica of the penal provisions contained in section 73 and 74. Legal
provisions should not be out rightly held to be surplusage. The possible
reconciliation of this overlapping could be:

a. Section
122(2) provides an outer boundary / parameters under which penalty can be
imposed and section 73/74 operate within this confine.

b. Section
73(1) states that penalty would be imposed ‘under the provisions of this Act’,
possibly hinting at section 122(2). Section 73 and 74 grant concessions in
cases of early tax payment along with interest and penalty promoting dispute
resolutions and amicable settlement between the tax payer and the Government.

c. Section
127 which seems to be creating two separate branches is only a surrogate
section. Its role seems to empower the officer to play catch-up by imposing
penalty even if the same has not been imposed under adjudication proceedings;
this section by itself does not make section 122(2) mutually exclusive to
section 73/74.

Section 122(3) – Other Penalties

Section 122(3), provides for
ancillary circumstances or connected persons where penalty of Rs. 25,000 can be
imposed:

– Transporters,
employees, tax professionals, chartered accountants, purchaser of goods, tax
officials, etc. accompanying the assessee, who aid or abet an offence
could also be saddled with a penalty.

– Any
person who acquires or receives goods or services with knowledge that such
receipt is in contravention of provisions of the Act (for eg. procuring a
taxable services/ goods from an unregistered person for more than 20 lakhs in
aggregate in a financial year).

– Failure
to appear or issue invoice or account such invoice in book of accounts.

Section 122(3) also validates the
position that clerical actions which results in tax dues cannot be covered in
section 122(1) since clerical defaults have a fixed penalty of Rs. 25,000 only.

Section 125 – Miscellaneous penalty not specific elsewhere

Penalty of Rs. 25,000 in cases
where no penalty has been prescribed for a contravention of the act or the
rules.

Section 129 – Penalties in case of detention, seizure of goods in
transit

The GST law provides for imposition
of penalties for movement of goods which are in contravention of the statutory
provisions. The said provisions are non-obstante in nature. Two levels
of penalties are prescribed herein:

(a) Owner
comes forward for payment of tax and penalty: Penalty of 100% of the tax
payable or 2% of value of exempted goods or Rs. 25,000 whichever is less.

(b) Owner
does not come forward for payment of tax and penalty : Penalty of 50% of
taxable value of goods or
5% of value of exempted goods or Rs. 25,000 whichever is less.

Two primary ingredients are
required for invoking penalty under this section –(a) the goods should in
transit and are intercepted by the proper officer u/s. 68; and (b) the proper
officer should come to a conclusion that the movement of goods is in
contravention of the provisions of the Act.

It may be important to note that
this section is qua the goods under question and not the transaction
i.e. this section applies equally to transactions having the character of
‘supply of goods’ or ‘supply of services’ in terms of Schedule II to the law as
long as there are goods in movement, for eg. a works contractor engaged in
supply of services (exempted/ taxable) attempting movement of goods would still
fall under this section for production of delivery challan and e-way bills. The
possible areas of contravention could be:

Examples of cases involving
evasion

Examples of cases not
involving evasion

– Presence / validity e-way bill accompanying
the consignment

– Non-accompanying invoice/ delivery challan

– Variance in the physical and invoiced
quantity

– Prima-facie variance in description of physical goods and
that stated on invoice

– Clear diversion of goods to unreported
locations

– Non-reporting all details in e-way bill/
invoice/ delivery challan

– Failure to seek extension of e-way bill on
expiry

Incorrect reporting of details in e-way bill
eg. prima-facie
place of supply being in direct contradiction with address

– Supply of goods reported as supply of
services

Generally, the term ‘contravention’
is used in cases where severity of non-compliance is relatively high compared
to a procedural non compliance. For example, a person raising the e-way bill
fails to update the correct vehicle number on account of clerical reasons and a
person consciously conceals revealing details of the vehicle number ensure
multiple trucks use the same e-way bill. While both have failed to comply with
the law in letter, rationally the degree of the offence and the penalty should
be higher in the case of the latter rather than the former. The law cannot
treat unequals as equals. Given the quantum of penalty, it appears that this
section is only towards addressing revenue loss and not procedural/ clerical
defaults. Applying this intent, a person complying with the law but erring in
reporting the vehicle number should not be saddled with penalties of the
magnitude as prescribed in the section.

Further, the terms ‘detention’ or
‘seizure’ when used on conjunction imply severe cases of non-compliance. As
tabulated earlier, detention followed by seizure forcefully restricts the right
of possession of goods from its original owner. It breaches the right in rem
over the goods of its owner. In a welfare state, this is usually done where the
gravity of the offence is high and not otherwise. One can take a stand that
this section can be applied only to substantive offences where the owner of the
goods has escaped payment of taxes.

However, very recently, the Madhya
Pradesh High Court in Gati Kintetsu Express Pvt Ltd vs. CCT of MP
(2018-TIOL-68-HC-MP-GST) held that Part B of e-way bill is mandatory
and non-compliance of this requirement is amenable to penalty u/s. 129 of the
CGST/ SGST law. The court incorrectly distinguished an earlier favourable order
in VSL Alloys (India) Pvt Ltd vs. State of UP (2018) 67 NTN DX 1
which held that penalty cannot be imposed in case where Part-B of the eway bill
was
not completed.

This section also imposes penalties
on exempted goods with reference to its value upto a maximum of Rs. 25,000.
Impliedly, it equates the offence with a procedural violation since they do not
have any tax revenue impact. But ‘exempted goods’ should not be equated with
exempted supplies. The term exempted goods should be understood on a standalone
basis de-hors whether the transaction under question is enjoying any
benefit under Notification 12/2017-Central Tax (Rate).

Section 130 – Confiscation of goods/ conveyance

Section 130 are penal provisions
invoked as a consequence of either an inspection or interception activitiy. The
instances where this section can be invoked are enlisted below:

1) Undertakes
supply or receipt of goods in contravention of any legal provision with
malafide intent to evade tax – for eg. clandestine removal of goods from
premises or even receipt of goods by the fraudulent buyer.

2) Fails
to account for the goods which are liable for tax – unaccounted sales.

3) Supplies
goods without having any registration or even applying for the same.

4) Contravention
of any provision with intent of evasion of payment of tax.

5) Conveyances
used for illegal activities with connivance of the owner of such conveyance.

The provisions impose penalty or
fine (also called redemption fine) in lieu of confiscation (i.e. for release of
goods). However, in no case will the aggregate of penalty and fine be less than
the market value of goods. In case of confiscation of conveyance along with the
goods, the quantum of fine in respect of the conveyance would be equal to the
tax payable on the goods under transportation. This section applies without
prejudice to the imposition of tax, interest and penalties.

In summary, the possible comparatives between the three pillars
can be tabulated below:

Parameter	Section 73/74	Section 122-128	Section 129 & 130
Type	Transactional penalties	Behavioural penalties	Behavioural but specific to goods
Source	Books of accounts/ audit, etc.	External information	Interception/ Inspection
Timing of the proceeding	Post-mortem analysis	No specific timing	Real time while in possession of goods
Time Bar	3/5 years	No specific time bar	Until goods in transit/ possession
Waiver/ Discretion over quantum	No discretion once ingredients satisfied	No discretion once ingredients satisfied	Discretion over imposition but not quantum except in section 130 where there is a discretion on quantum
Exempted Transactions	NIL	Upto Rs. 10,000/- or 25,000/-	Rs. 10,000/-
Procedure	Part of adjudication proceedings	Independent of adjudication	Part of enforcement/ vigilance activities
Strength of Evidence	Medium	High	High
Onus	Revenue	Revenue	Revenue
Penalty type – Specific over general	Specific	Relatively general	Highly Specific
Independent appeal/ linked to adjudication	Part of adjudication	Independent	Independent
Impost on	Tax payer	Tax payer and accompanying persons	Owner/ Transporter

Parameter

Section
73/74

Section
122-128

Section
129 & 130

Type

Transactional penalties

Behavioural penalties

Behavioural but specific to
goods

Source

Books of accounts/ audit, etc.

External information

Interception/ Inspection

Timing of the proceeding

Post-mortem analysis

No specific timing

Real time while in
possession of goods

Time Bar

3/5 years

No specific time bar

Until goods in transit/
possession

Waiver/ Discretion over
quantum

No discretion once
ingredients satisfied

Discretion over imposition
but not quantum except in section 130 where there is a discretion on quantum

Exempted Transactions

NIL

Upto Rs. 10,000/- or
25,000/-

Rs. 10,000/-

Procedure

Part of adjudication
proceedings

Independent of adjudication

Part of enforcement/
vigilance activities

Strength of Evidence

Medium

High

Onus

Revenue

Penalty type – Specific over
general

Specific

Relatively general

Highly Specific

Independent appeal/ linked
to adjudication

Part of adjudication

Independent

Impost on

Tax payer

Tax payer and accompanying
persons

Owner/ Transporter

In a self-assessment scheme, the
onus of accurate tax computations, reporting and payments lie on the tax payer.
In an era where disclosures are of paramount importance, the tax payer is
expected to disclose as much detail as possible to its officers and establish
its bona fide before courts in subsequent proceedings. Ideally, disclosure to
the officer exercising administrative jurisdiction over the tax payer would be
regarded as sufficient proof of bona fide.

On the other side, tax
administrators should appreciate that unlike taxes, penalty provisions should
be studied on a factual basis rather by a strait jacket formula. Any
subjectivity would deliver adversarial results and everyone expects that the
current order undergoes a shift under the GST law.

[1] Sree Rayalaseema Hi-Strength Hypo
Ltd vs. CC Ex, Tirupathi, 2012 (278) ELT AP 167

[2] Twin condition of collection and 3
months from due date of payment should be compulsorily satisfied for this
clause to apply

shailesh.kwebmaker

PROVISIONS OF TDS UNDER SECTION 195 – AN UPDATE – PART II

In Part I of the Article we have
dealt with overview of the relevant provisions relating to TDS u/s. 195 and
other related sections, various aspects and issues relating to section 195(1),
section 94A and section 195A.

In this part of the Article we are
dealing with various other aspects and applicable sections.

1. Section
195(2) Application by the Payer

Section 195(2) of the Act reads as
under:

“195(2) Where
the person responsible for paying any such sum chargeable under this Act (other
than salary) to a non-resident considers
that the whole of such sum would not be income chargeable in the case of the
recipient, he may make an application to the Assessing Officer to
determine, by general or special order, the appropriate proportion of such sum so chargeable, and upon
such determination, tax shall be deducted under sub-Sec (1) only on that proportion
of the sum which is so chargeable.”

1.1 It is important to note that no specific
rule or form has been prescribed under the Income-tax Rules, 1962. The
application has to be made on a plain paper / letter head.

1.2 An issue often arises as to whether an
application can be made u/s. 195(2) for ‘nil’ withholding order.

The judicial opinion is divided on
the issue. In the following cases it has been held that an application can be
made u/s. 195(2) for ‘nil’ withholding order:

– Mangalore Refinery and Petrochemicals Ltd.
vs. DDIT 113 ITD 85 (Mum)

– Van Oord ACZ India (P.) Ltd. [2010] 323
ITR 130 (Del.)

However, a
contrary view has been taken in the following cases:

– GE India Technology Centre (P.) ltd.
[2010] 327 ITR 456 (SC)

– Czechoslovak Ocean Shipping International
Joint Stock Company vs. ITO 81 ITR 162 (Cal)

– Graphite Vicarb India Ltd. vs. ITO 28 TTJ
425 (Cal) (SB)

– Biocon Biopharmaceuticals (P.) Ltd. vs.
ITO IT 36 taxmann.com 291 (Bang).

It appears that in practice,
application u/s. 195(2) is used for both ‘nil’ as well as ‘lower’ TDS rate
order.

1.3 Another question arises as to in case a
work involves multiple phases, in such scenario, is it sufficient if order u/s.
195 is obtained for phase I of the work or whether order is to be obtained for
all the phases of the work. In Mangalore Refinery and Petrochemicals Ltd.
vs. DDIT 113 ITD 85 (Mum) it has been held that the payer should apply
fresh and obtain order for all phases of the work.

1.4 Whether order u/s. 195(2) of the Act is
subject to revision u/s. 263 by the PCIT or CIT. It has been in the case of BCCI
vs. DIT (Exemption) [2005] 96 ITD 263 (Mum) that order u/s. 195(2) of the
Act is subject to revision
u/s. 263.

1.5 An important point to be kept in mind is,
order u/s. 195(2) are not conclusive and the Assessing Officer (AO) can take a
contrary view in the assessment proceedings. This has been held by the Bombay
High Court in the case of CIT vs. Elbee Services Pvt. Ltd. 247 ITR 109 (Bom).

1.6 Section 195(2) does not
prescribe any time limit for passing order u/s. 195(2). The Citizens Charter
2014 prescribed that decision on application for no deduction of tax or
deduction of tax at lower rate should be taken in 1 month. However, in
practice, such orders take longer time.

1.7 It has to be noted that application u/s.
195(2) cannot be made for Salary payment.

1.8 Appeal under section 248

a) It is important to note that an order
u/s.195(2)/(3) is appealable, under a separate and specific section under the
Act.

b) Section 248 of the Act reads as follows:

“Appeal by a person denying
liability to deduct tax in certain cases.

248. Where under an agreement or other
arrangement, the tax deductible on any income, other than interest,
under section 195 is to be borne by the person by whom the income is payable,
and such person having paid such tax to the credit of the Central
Government, claims that no tax was required to be deducted on such income,
he may appeal to the Commissioner (Appeals) for a declaration that no
tax was deductible on such income.”

c) Section 248, as amended by the Finance Act,
2007 read with section 249(2)(a) provides for an appeal
u/s. 195, subject to fulfillment of following conditions:

i. The tax is deductible on any income other
than interest;

ii. Only if the tax is to be borne by the payer
under the agreement or arrangement. If tax is borne by the payee, a payer
cannot file an appeal u/s. 248 of the Act.

iii. The payer has to first pay the tax to the
credit of the Central Government;

iv. The appeal has to be filed within 30 days of
payment of tax [section 249(2)(a)].

d) It has been held that liability of TDS can be
appealed before CIT(A) u/s. 248 even without order from AO. CMS (India)
Operations & Maintenance Co. 38 taxmann.com 92 (Chennai).

2. Section
195(3), (4) and Section 197 – Application by Payee

2.1 Section 195(3), (4) and section 197 of the
Act apply in respect of application for lower or nil deduction of tax under
specific circumstances and on fulfillment of certain prescribed conditions. The
distinctive features of the aforementioned provisions are discussed below.

2.2 The text of the section 195(3), (4) and
section 197 is given for ready reference and better appreciation of the
distinct language and purposes of the said sections, which relates to
application by the payees for lower or nil deduction of tax at source.

Section 195(3) –
“Subject to rules made under sub-section (5), any person entitled to receive any interest or other sum
on which income-tax has to be deducted under
sub-section (1) may make an application in the prescribed form to the Assessing
Officer for the grant of a certificate authorising him to receive such interest
or other sum without deduction of tax under that sub-section, and where any
such certificate is granted, every person responsible for paying such interest
or other sum to the person to whom such certificate is granted shall, so long
as the certificate is in force, make payment of such interest or other sum
without deducting tax thereon under sub-section (1).”

Section 195(4) – “A
certificate granted under sub-section (3) shall remain in force till the
expiry of the period specified therein or, if it is cancelled by the
Assessing Officer before the expiry of such period, till such cancellation.”

Section 197(1) – “Subject
to rules made under sub-section (2A), where, in the case of any income of
any person or sum payable to any person, income-tax is required to
be deducted at the time of credit or, as the case may be, at the time of
payment at the rates in force under the provisions of sections 192, 193, 194,
194A, 194C, 194D, 194G, 194H, 194-I, 194J, 194K, 194LA, 194LBB, 194LBC and 195,
the Assessing Officer is satisfied that the total income of the recipient
justifies the deduction of income-tax at any lower rates or no deduction of
income tax, as the case may be, the Assessing Officer shall, on an
application made by the assessee in this behalf, give to him such certificate
as may be appropriate.”

2.3 Section 195(3) read with rule 29B and Forms
15C and 15D, in short, provides as follows:

Section 195(3) provides that a
payee entitled to receive interest or other sums liable to TDS and satisfying
certain conditions prescribed in rule 29B can make an application (Form 15C for
banking companies or Form 15D for non-banking companies) i.e.

a. Has been regularly filing tax returns and
assessed to Income-tax;

b. Not in default in respect of tax, interest,
penalty etc.

c. Additional conditions for non-banking
companies:

i. has been carrying on business or profession
in India through a branch for at least 5 years

ii. value of fixed assets in India exceeds Rs. 50
lakh.

d. Certificate issued by the AO valid for the
financial year mentioned therein unless cancelled before.

e. Application
for fresh certificate can be made after expiry of earlier certificate, or
within 3 months before expiry.

2.4 Section 197 read with rule 28AA and Form
13, in short, provides as follows:

a. Any payee can apply for no deduction or lower
rate of deduction

b. Prescribed form – Form 13

c. Prescribed conditions (Rule 28AA):

– Total income / existing
and estimated tax liability justifies lower deduction;

– Considerations for
existing and estimated tax liability justifying lower or nil TDS;

– Tax payable on estimated
income of previous year;

– Tax payable on assessed /
returned of last 3 previous years;

– Existing liability under
the Act;

– Details of advance tax,
TDS & TCS.

d.
AO to issue certificate indicating rate / rates of tax, whichever is
higher, of the following:

– Average rate determined
on the basis of advance tax; or

– Average of average rates
of tax paid by the taxpayer in last 3 years.

e.
Certificate issued by AO can be prospective only

f. Payment / credit made prior to the date of
the certificate is not covered. Circular No. 774 dated 17^th March
1999.

3. Lower
withholding – A Comparative Chart

The above discussion and the
comparative features of the aforesaid provisions are summarised in the table
given below.

Particulars	Section 195(2)	Section 195(3)	Section 197
Overview	Payer having a belief that portion (not the whole amount) of any sums payable by him to non-resident is not liable to tax in India, may make an application to AO to determine taxable portion.	Payee may make an application to AO for granting him a certificate to receive income without TDS.	Payee may make an application to AO for granting him certificate of ‘Nil’ or ‘lower’ withholding.
Application by	Payer	Non-resident Payee	Payee
Purpose	Determination of portion of such sum chargeable to tax.	No withholding	Lower / Nil withholding
Form	No Specific Format	Rule 29B – Form 15C and 15D	Rule 28 -Form 13
Outcome	AO to determine the appropriate proportion chargeable to tax and issue order accordingly.	Certificate issued by the AO subject to conditions specified in Rule 29B.	Certificate to be issued by AO subject to conditions specified in Rule 28AA.
Remedy	Order can be appealed u/s. 248.	uThere is no provision under Chapter XX of the Act, to appeal against the certificate issued. u Possible to pursue application u/s. 264. u Possible to explore writ jurisdiction – Diamond Services International (P.) Ltd. [2008] 169 Taxman 201 (Bom).

Particulars

Section 195(2)

Section 195(3)

Section 197

Overview

Payer having a belief that portion (not the whole amount) of any
sums payable by him to non-resident is not liable to tax in India, may make
an application to AO to determine taxable portion.

Payee may make an application to AO for granting him a
certificate to receive income without TDS.

Payee may make an application to AO for granting him certificate
of ‘Nil’ or ‘lower’ withholding.

Application by

Payer

Non-resident Payee

Payee

Purpose

Determination of portion of such sum chargeable to tax.

No withholding

Lower / Nil withholding

Form

No Specific Format

Rule 29B – Form 15C and 15D

Rule 28 -Form 13

Outcome

AO to determine the appropriate proportion chargeable to tax and
issue order accordingly.

Certificate issued by the AO subject to conditions specified in
Rule 29B.

Certificate to be issued by AO subject to conditions specified
in Rule 28AA.

Remedy

Order can be appealed
u/s. 248.

uThere is no provision under Chapter XX of the
Act, to appeal against the certificate issued.

u Possible to pursue application u/s. 264.

u Possible to explore writ jurisdiction – Diamond
Services International (P.) Ltd. [2008] 169 Taxman 201 (Bom).

In which cases and circumstances
one should make and application for lower or nil TDS u/s. 195(2) or 197, should
be determined keeping in view the above discussion.

4. Section
195 – Various situations

The various situations could be
faced by a payer as well as a payee has been very lucidly and succinctly
explained in the case of ITO IT vs. Prasad Production Ltd. [2010] 125 ITD
263 (Chennai)(SB), which is summarised as follows:

a) If the bona fide belief of the payer is
that no part of the payment has any portion chargeable to tax, he will submit
necessary information u/s. 195. However, if the department is of the view that
the payer ought to have deducted tax at source, it will have recourse u/s. 201.

b) If the payer believes that whole of the
payment is chargeable to tax and if he deducts and pays the tax, no problem
arises.

c) If the payer believes that only a part
of the payment is chargeable to tax, he can apply u/s. 195(2) for deduction at
appropriate rates and act accordingly.

d) If the payer believes that a part of
the payment is income chargeable to tax, and does not make an application u/s.
195(2), he will have to deduct tax from the entire payment.

e) If the payer believes that the entire
payment or a part of it is income chargeable to tax and fails to deduct tax at
source, he will face all the consequences under the Act. The consequences can
be the raising of demand u/s.201, disallowance u/s. 40(a)(i), penalty,
prosecution, etc.

f) If the payee wants to receive the
payment without deduction of tax, he can apply for a certificate to that effect
u/s. 195(3) and if he gets the certificate, no one is adversely affected.

g) If the payee fails to get the
certificate, he will have to receive payment net of tax.

5. Refund
of Tax withheld under section 195

A very important and practical
issue arises as to whether it is possible to obtain refund of tax withheld and
paid u/s. 195.

5.1 Circular No. 7/2007 dated 23-10-07 and
Circular No. 7/2011 dated 27-9-2011 prescribe various situations and conditions
under which refund can be obtained.

Conditions to be satisfied for
refund:

– Contract is cancelled and no
remittance is made to the NR

– Remittance is duly made to the NR, but the
contract is cancelled and the remitted amount has been returned to the
payee

– Contract is cancelled after partial
execution and no remittance is made to the NR for the non-executed part;

– Contract is cancelled after partial execution
and remittance related to non-executed part made to the NR has been returned
to the payee or no remittance is made but tax was deducted and deposited
when the amount was credited to the account of the NR;

– Remitted amount gets exempted from tax
either by amendment in law or by notification

– An order is passed u/s. 154 or 248 or 264
reducing the TDS liability of the payee;

– Deduction of tax twice by mistake from
the same income;

– Payment of tax on account of grossing up
which was not required

– Payment of tax at a higher rate under
the domestic law while a lower rate is prescribed in DTAA.

5.2 In the
following cases it has been held that pursuant to favorable appellate order
whether u/s. 248 or otherwise, refund of TDS has to be granted:

– Telco vs.
DCIT [2005] 92 ITD 111 (Mum);

– Samcor Glass
Ltd. vs. ACIT [2005] 94 ITD 202 (Del);

– Kotak
Mahindra Primus Ltd. vs. DDIT TDS [2007] 105 TTJ 578 (Mum).

5.3 In
the case of Tata Chemicals Ltd. [2014] 363 ITR 658 (SC), the apex
court has held that an assessee is entitled to interest on refund of excess
deduction or erroneous deduction of tax at source u/s. 195.

Pursuant to the aforementioned
decision of the SC, CBDT has issued Circular 11/2016 dated 26-4-16 and mentioned
that, ‘In view of the above judgment of the Apex Court it is settled that if a
resident deductor is entitled for the refund of tax deposited under section 195
of the Act, then it has to be refunded with interest under section 244A of the
Act, from the date of payment of such tax.’

6. Consequences
of non/short deduction/ reporting failures

6.1 The consequences of non-deduction, short
deduction as well as failure to report transactions have been summarised in the
Chart 1.

6.2 Disallowance
u/s. 40(a)(i) or section 58(1)(a)(ii)

A question often arises as to if
tax is deducted u/s. 195 though at incorrect rate, whether the disallowance
u/s. 40(a)(i) or section 58(1)(a)(ii) can be made.

In the following cases a favorable
view has been taken and it has been held that there should be no disallowance
if tax is deducted though at incorrect rate:

– Apollo Tyres
Ltd. vs. DCIT 35 taxmann.com 593 (Cochin)

– UE Trade
Corpn. (India) Ltd. vs. DCIT 28 taxmann.com 77 (Del)

– ITO vs.
Premier Medical Supplies & Stores 25 taxmann.com 171 (Kol)

– DCIT vs.
Chandabhoy & Jassobhoy 17 taxmann.com 158 (Mum)

– CIT vs. S.
K. Tekriwal [2014] 46 taxmann.com 444 (Calcutta).

However, in the case of CIT vs.
Beekaylon Synthetics Ltd. ITA No. 6506/M/08 (Mum) it has been held that in
such case there would be proportionate disallowance.

6.3 An issue arises for consideration is that
if the Indian company has not deducted tax at source u/s. 195, can the
Department proceed to recover the tax from both the Indian party as well as
foreign party?

In this regard, explanation to
section 191 provides as follows:

“Explanation.—For the removal of
doubts, it is hereby declared that if any person including the principal
officer of a company,—

(a) who
is required to deduct any sum in accordance with the provisions of this Act; or

(b) referred
to in sub-section (1A) of section 192, being an employer,

does not deduct, or after so
deducting fails to pay, or does not pay, the whole or any part of the tax, as
required by or under this Act, and where the assessee has also failed to pay
such tax directly, then, such person shall, without prejudice to any other
consequences which he may incur, be deemed to be an assessee in default within
the meaning of sub-section (1) of section 201, in respect of such tax.

Section 205 provides as follows:

“Bar against direct demand on
assessee.

205. Where tax is deductible
at the source under the foregoing provisions of this Chapter, the assessee
shall not be called upon to pay the tax himself to the extent to which tax
has been deducted from that income.”

A conjoint reading of the
Explanation to section 191 read with section 205 suggest that the department
cannot proceed to recover the tax from both the Indian party as well as foreign
party.

7. Tax
Residency Certificate and Implications of 206AA

7.1 Tax Residency
Certificate – Section 90(4)

– Finance Act,
2012 has introduced sub-section (4) to section 90 w.e.f. 1-4-2013 to provide
that a non-resident will not be entitled to claim benefits under the Treaty
unless he obtains a tax residency certificate from the Government of his
residence country/territory certifying that he is a tax resident of that
country.

– The
requirement applies to all Non-residents, whether Individuals, Companies, LLPs
etc., irrespective of the quantum of relief to be obtained.

– Furnishing
TRC is a mandatory requirement.

– Rule 21AB(1) mandates submission of following information
in Form 10F:

i. Status (individual, company, etc) of the
assessee;

ii. Nationality or country or specified territory
of incorporation or registration;

iii. Assessee’s tax identification number in the
country or specified territory of residence and in case there is no such
number, then, a unique number on the basis of which the person is identified by
the Government of the country or the specified territory of which the assessee
claims to be a resident;

iv. Period for which the residential status, as
mentioned in the certificate referred to in sub-section (4) of section 90 or
sub-section (4) of section 90A, is applicable; and

v. Address of the assessee in the country or
specified territory outside India, during the period for which the certificate,
as mentioned in (iv) above, is applicable.

– Declaration
not required, if TRC contains above particulars.

7.2 Skaps Industries India
(P.) Ltd. vs. ITO [2018] 94 taxmann.com 448 (Ahmedabad – Trib.)

This is an important decision in
the context of mandatory requirement of TRC u/s. 90(4). The ITAT after very
extensive discussion, held and observed as follows:

(i) The
ITAT states that as per the provisions of section 90(2) of the Act, the
provisions of the Act shall apply only to the extent they are more beneficial
to that the assessee and the same was often referred to as “treaty override”

(ii) The ITAT also observed that the provisions of section 90(4) do
not start with a non-obstante clause vis-à-vis section 90(2) of the Act. In the
absence of such non-obstante clause, the ITAT has held that section 90(4)
cannot be construed as limitation to the tax treaty superiority as stipulated
in section 90(2) of the Act. Accordingly, the Tribunal has held that even in
absence of a valid TRC, provisions of section 90(4) could not be invoked to
deny tax treaty benefits.

(iii) The Tribunal has, nevertheless, emphasised that though the
requirement to furnish TRC is not mandatory, the US Co. had to establish that
it was a USA tax resident. The onus was on the assessee to give sufficient
and reasonable evidence to satisfy the requirements of Article 4(1) of the tax
treaty, particularly when the same was called into question.

(iv) This decision lays down a very important proposition that that
the tax treaty benefits cannot be denied merely on the basis of
non-availability of TRC. Further it also lays down that, when a non-resident
assessee has substantiated its residential status by way of sufficient and
reasonable documentary evidence, the requirement of furnishing TRC would be
persuasive and not mandatory.

8. Section
206AA Requirement to furnish PAN

8.1 Section 206AA provides as follows:

“206AA (1) Notwithstanding
anything contained in any other provisions of this Act, any person
entitled to receive any sum or income or amount, on which tax is deductible
under Chapter XVIIB (hereafter referred to as deductee) shall furnish his
Permanent Account Number to the person responsible for deducting such tax
(hereafter referred to as deductor), failing which tax shall be deducted at the
higher of the following rates, namely:-

i. at the rate specified in the relevant provision
of this Act; or

ii. at the rate or rates in force; or

iii. at the rate of twenty per cent. ……….”

8.2 Section 206AA is very significant in the
context of TDS from payments to non-residents. It is pertinent to note that if
no tax deductible at source in view of the applicable provisions of the Act or
DTAA, provisions of section 206AA would not apply. There are various issues and
aspect relating to section 206AA are dealt with below.

8.3 Whether DTAA prevails over section 206AA

A very important question arises as
to whether section 206AA override provisions of section 90(2) and in cases of
payments made to non-residents, assessee can correctly apply rate of tax
prescribed under DTAAs and not as per section 206AA because provisions of DTAAs
are more beneficial.

Various benches of ITAT and Delhi
High Court have held that section 206AA does not override section 90(2) of the
Act and accordingly held that lower TDS as per favourable DTAA provisions is
applicable and not higher rate
u/s. 206AA. Some of the favourable decisions are as follows:

– DDIT vs. Serum
Institute of India Ltd. [2015] 68 SOT 254 (Pune)

– DCIT vs. Infosys BPO
Ltd. [2015] 154 ITD 816 (Bang.)

– Emmsons International
Ltd. vs. DCIT [2018] 93 taxmann.com 487 (Delhi – Trib.)

– Danisco India (P.) Ltd.
vs. UoI [2018] 90 taxmann.com 295 (Delhi)

– Nagarjuna Fertilizers
& Chemicals Ltd. vs. ACIT [2017] 78
taxmann.com 264 (Hyderabad-Trib.) (SB)

It is
pertinent to note that Article 51(c) of the Constitution states as follows:
“State shall endeavor to foster respect for international law and treaty
obligations in the dealings of organised peoples with one another; and
encourage settlement of international disputes by arbitration.”

The above decisions are in line
with the aforementioned constitutional mandate and spirit. Thus, in case
provisions of a DTAA is applicable, TDS would be at a lower rate as per the
DTAA even if non-resident deductee fails to furnish PAN.

8.4 Applicability of
surcharge or education cess on maximum rate of 20% as per section 206AA

It is pertinent to note that the
relevant clauses of the Finance Acts do not include section 206AA in their
ambit for the purpose of levy of surcharge or education cess.

The ITAT in the case of Computer
Sciences Corporation India (P.) Ltd. vs. ITO (IT) [2017] 77 taxmann.com 306
(Delhi-Trib.) after considering various aspects, held that there no
surcharge and education cess would be leviable on the rate of 20% prescribed
u/s. 206(1)(iii).

8.5 Whether it is
applicable to those who are exempt from obtaining PAN?

a) Section 139A(8)(d) provides
that the Board may make rules providing for class or classes of persons to whom
the provisions of section 139A shall not apply. Rule 114C (1) (c) (prior to its
substitution wef 1-1-2016) provided that the provisions of section 139A regarding
allotment PAN shall not apply to the non-residents referred to in section
2(30). Section 272B provides for a penalty for failure to comply with the
provisions of section 139A of Rs. 10,000/-.

b) In the case of Smt. A. Kowsalya Bai vs UoI
22 Taxmann.com 157 (Kar), the Karnataka High Court held that the assessees
having income below the taxable limit were not required to obtain Permanent
Account Numbers as per section 139A of the Act and still the provisions of
section 206AA were invoked to deduct tax at higher rate from the amount of
interest income paid to them as a result of their failure to furnish the
Permanent Account Numbers to the payers/deductors. Taking note of this
contradiction between the provisions of sections 139A and 206AA, Hon’ble
Karnataka High Court read down the overriding provisions of section 206AA and
made them inapplicable to the persons, who were not even required to obtain the
Permanent Account Numbers by virtue of section 139A.

c) In this regard, the Special bench of the
ITAT in the case of Nagarjuna Fertilizers & Chemicals Ltd. vs ACIT
[2017] 78 taxmann.com 264 (Hyderabad-Trib.) (SB) held that

“26. Although
the facts involved in the present case are slightly different, inasmuch as, the
non-resident payees in the present case were having taxable income in India,
the facts remain to be seen is that they were not obliged to obtain the
Permanent Account Numbers in view of section 139A(8) read with Rule 114C. There
is thus a clear contradiction between section 206AA and section 139A(8) read
with Rule 114C, as was prevailed in the case of Smt. A. Kowsalya Bai (supra)
and by applying the analogy of the said decision, we find merit in the
contention raised on behalf of the assessee that the provisions of section
206AA are required to be read down so as to make it inapplicable in the cases
of concerned non-residents payees who were not under an obligation to obtain
the Permanent Account Numbers.”

d) It is pertinent to note that Rule 114B and
114C have been substituted wef 1-1-16 and the rule relating to non-application
of provisions of section 139A regarding allotment PAN to the non-residents
referred to in section 2(30), is no more there except as provided in clause
(ii) of 3^rd proviso to substituted rule 114B(1).

8.6 Whether TDS deducted at higher rate on
account of section 206AA can be claimed as a refund by filing a return u/s. 139
by the non-resident?

Yes. A non-resident can claim
refund of TDS deducted at higher rate on account of section 206AA by filing
appropriate return of income after obtaining PAN.

8.7 Section 195A vis-à-vis
Section 206AA

a)
A very significant question arises in the context of application of
section 195A read with section 206AA, whether section 195A will apply in cases
where section 206AA is made applicable

There are different views possible
in this regard which are as follows:

i. View 1 – No grossing up required.

Neither
section 195A makes reference to section 206AA, nor section 206AA provides for
grossing up.

ii. View 2 – Grossing up required only
vis-à-vis clause (ii) of section 206AA(1), since section 195A refers to
grossing up is required where TDS is at the rates in force.

iii. View 3 – Grossing up is required in all
the three clauses (i) to (iii) of section 206AA(1).

In our view,
View 2 seems to be a better view.

b) Manner of grossing up

In cases
where rate in force is 10%* – Whether grossing up should be on 10% being rate
in force or on 20%?

The
different possible scenarios could be as under:

Particulars

Option 1

Option 2

Option 3

Option 4

Net of Tax Payment to non- resident

100

(+) Grossing up

11.11

21.11

Total

111.11

121.11

125

(-) TDS

11.11

22.22

21.11

Payment to be made to the non-resident

100

88.89

100

* Assuming a treaty rate of 10%

In Bosch Ltd. vs. ITO IT
[2012] 28 taxmann.com 228 (Bang) it was held that higher rate of
deduction at 20% under section 206AA is not applicable for tax grossing-up u/s.
195A, if TDS is borne by the Indian payer.

Higher TDS rate u/s. 206AA is
applicable only where non-resident recipient has income chargeable to
tax in India and does not furnish PAN.

In this regard, the ITAT observed
as follows:

“22. As regards
the grossing up u/s 195A of the Income-tax Act is concerned, we find that the
provision reads
as under:

“In a case other than that
referred to in subsection (1A) of sec. 192, where under an agreement] or other
arrangement, the tax chargeable on any income referred to in the foregoing
provisions of this Chapter is to be borne by the person by whom the income is
payable, then, for the purposes of deduction of tax under those provisions such
income shall be increased to such amount as would, after deduction of tax
thereon at the rates in force for the financial year in which such income is
payable, be equal to the net amount payable under such agreement or
arrangement.

23. Thus, it
can be seen that the income shall be increased to such amount as would after
deduction of tax thereto at the rate in force for the financial year in which
such income is payable, be equal to the net amount payable under such agreement
or arrangement. A literal reading of sec. implies that the income should be
increased at the rates in force for the financial years and not the rates at
which the tax is to be withheld by the assessee. The Hon’ble Apex Court in the
case of GE India Technology Center (P.) Ltd. (cited Supra) has held that
the meaning and effect has to be given to the expression used in the section
and while interpreting a section, one has to give weightage to every word used
in that section. In view of the same, we are of the opinion that the
grossing up of the amount is to be done at the rates in force for the financial
year in which such income is payable and not at 20% as specified u/s 206AA of
the Act.”

8.8 Section 206AA and Rule
37BC

a) As per section 206AA(7), the section shall
not apply to a non-resident/foreign company, in respect of:

– payment of
interest on long-term bonds referred to in section 194LC

– any other
payment subject to such conditions as may be prescribed.

b) Rule 37BC inserted wef 24-6-2016

Rule 37BC provides that section
206AA shall not apply on the following payments to non-resident deductees who
do not have PAN in India, subject to deductee furnishing the specified details
and documents to the deductor:

– Interest;

– Royalty;

– Fees
for Technical Services; and

– Payment
on transfer of any capital asset.

c) In respect of the above, the deductee shall
be required to furnish the following to the deductor:

– Name, e-mail
id, contact number

– Address in
the country outside India of which the deductee is a resident

– A certificate of his being resident from the Government of that country
if the law provides for issuance of such certificate

– Tax
Identification Number of the deductee/ a unique number on the basis of which
the deductee is identified by the Government.

d)
The interplay between provisions of a DTAA, section 206AA and section
90(4), in connection with TDS under section 195, is explained in the diagram
below.

9. Conclusion

In this part we have dealt with
some of the important procedural and other aspects relating to the TDS from
payments to non-residents. In the third and concluding part, we will deal with
some remaining aspects relating to TDS from payments to non-residents.

shailesh.kwebmaker

22. TS-274-ITAT-2018(Del) Daikin Industries Limited. v. DCIT A.Ys: 2006-07, Dated: 28th May, 2018

Article 5 of
India-Japan DTAA – marketing activities of Indian distributor constitutes
dependent agent PE (DAPE) for the Japanese parent in India; additional profits
were to be attributed to the DAPE by taking into account the functions and risks
that were not considered for TP analysis of the agent (distributor).

Facts

Taxpayer, a Japanese
company was engaged in the business of development, manufacture, assembly and
supply of air conditioning and refrigeration equipment. During the year, Taxpayer
sold air-conditioners in India directly to third party Indian customers (direct
sale) as well as to an Indian distributor, I Co who was the wholly owned
subsidiary of Taxpayer in India.

In addition to acting as
the distributor of Taxpayer’s products in India, I Co entered into a commission
agreement with the Taxpayer to act as a communication channel between the
Taxpayer and its customers in India. As per the agreement, I Co was responsible
for forwarding customer’s request to the Taxpayer as well as forwarding
Taxpayer’s quotations and contractual proposals to the customers in India. In
consideration of the said services, I Co charged a commission of 10% on direct
sales made by the Taxpayer in India.

As the Taxpayer failed to
produce the evidence showing its involvement in the marketing of products sold
by way of direct sales in India, AO held that the activities of identifying
customers, approaching, presentation, demonstration, price catalogue,
negotiation of prices and finalisation of prices etc. were carried on by I Co
on behalf of the Taxpayer in India, in addition to the activities set out in
commission agreement. Consequently, it was held that I Co constituted a DAPE of
the Taxpayer in India under India-Japan DTAA.

The CIT(A) upheld AO’s contention.
Aggrieved, the Taxpayer filed an appeal before the Tribunal.

Held

On DAPE

– The air-conditioning and refrigeration
industry in which the Taxpayer was involved was highly competitive and
tremendous efforts are required for effecting sales in such market. This is
also evident by the fact that I Co had to incur huge selling and distribution
expenses for selling the same products in its capacity as a distributor. It is
hard to comprehend that the Taxpayer managed to make direct contact with customers,
scattered all over India for effecting sales to them directly, without any
marketing efforts.

– The contents of the emails exchanged between
the Taxpayer and I Co demonstrate that the entire deal was negotiated and
finalised by Indian customers with I Co and the role of I Co was not confined
merely to a communication channel as contended by the Taxpayer.

– In absence of any evidence indicating direct
involvement of Taxpayer in marketing activities in relation to direct sales in
India and the emails indicating the involvement of I Co in finalising the deals
with customers in India, the inescapable conclusion is that the entire activity
starting from identification of customers, approaching them, negotiating prices
with them and finalisation of prices was done by I Co in India not only for the
products sold by them as distributor, but also for the direct sales made by the
Taxpayer.

– Although I Co did not have authority to
finalise the contract of direct sales in India, the substantial activities of any
sale transaction like the activities of negotiating and finalising the
contracts were performed by I Co.

– Thus I Co was habitually exercising an
authority to conclude contracts in India on behalf of the Taxpayer. The mere
fact that the Taxpayer was formally signing the contract of sale does not alter
this position in any manner.

– Also, I Co was securing orders in India
‘almost wholly’ for the Taxpayer as all the substantive parts of the key
activities in making sales were carried on by I Co in India.

– Exclusion of independent agent activities is
not applicable as the Taxpayer had not contested the dependent status of I Co.

On Attribution of profits
on determination of ALP

– Since the Taxpayer did not maintain TP
documentation nor did it furnish the TP report with respect to commission
payments to I Co, its contention that the payment of commission is at arm’s
length cannot be accepted.

– SC in the case of Morgan Stanley (292 ITR
416) held that, if the independent agent is remunerated at arm’s length by
taking account all the risk-taking functions of the enterprise, there can be no
further attribution to DAPE. SC further held that if the TP analysis does not
reflect the functions performed and risks assumed by the enterprise, then
additional profits are to be attributed to the PE by taking into account the
functions and risks that are not considered for TP analysis.

– The commission of 10% was paid to I Co only
towards the services rendered as per the commission agreement. However,
evidences in the form of emails correspondences between Taxpayer and I Co as
well as I Co and customer supported the contention of the revenue that the
functions performed by I Co were beyond the services covered by the commission
agreement and included all the activities in relation to negotiation and
finalisation of the price and other contractual terms of the customer
contracts.

– Hence, the determination of arm’s length
commission of 10% did not reflect the functions performed and the risks assumed
by the PE. Therefore, as held by SC in Morgan Stanley (292 ITR 416), additional
profits should be attributed to the DAPE (i.e., I Co) for the additional
functions undertaken by DAPE in India.

shailesh.kwebmaker

21. TS-330-ITAT-2018(Ahd) Skaps Industries India Pvt Ltd. vs. ITO A.Ys: 2013-14 & 2014-15, Dated: 21st June, 2018

Section 90(4),
90(2) of the Act- in the absence of a non-obstante clause u/s. 90(4), it
cannot limit treaty superiority contemplated u/s. 90(2)- mere non-furnishing of
the TRC cannot disentitle a taxpayer from claiming tax treaty benefits.

Facts

The
Taxpayer, an Indian company, made payments to a US entity for services in
relation to installation and commissioning of certain equipment purchased by
the Taxpayer. The Taxpayer did not withhold any taxes as it was not falling
within the ambit of fees for included services (FIS) under the DTAA.

The
AO was of the view that such payments were in the nature of FIS under the DTAA
and, thus, the Taxpayer was liable to appropriately withhold taxes. The CIT(A)
ruled in favour of the AO and also observed that, in the absence of a TRC, the
US entity was not entitled to protection under the DTAA.

Aggrieved,
the Taxpayer filed an appeal before the Tribunal.

Held

– Section 90(2) of the Act provides for an
unqualified treaty override wherein provision of the Act are applicable only to
the extent more beneficial to the Taxpayer. The only exception to the treaty
override principle is in case where the general anti-avoidance provisions
(GAAR) are invoked.

– The restriction on the application of tax
treaty benefits on failure to provide a TRC does not have an overriding effect
over section 90(2) (as opposed to GAAR).

– The requirement to furnish a TRC was
introduced so that the TRC is regarded as sufficient evidence for granting tax
treaty benefit and the AO is denuded of the powers to demand further details in
support of the tax treaty benefits claimed[1].
The TRC provision cannot be construed as a limitation to the superiority of the
tax treaty over the domestic law.

– Thus, mere non-furnishing of a TRC cannot be
a reason to deny tax treaty benefit. However, the Taxpayer should substantiate
its eligibility to claim tax treaty benefits by means other than a TRC.
Substantiating residential status by any other mode is far more onerous
compared to TRC, as the TRC can be easily obtained from the US authorities for
a modest user fee after filing a statutory form.

– A mere declaration by the US entity, without
any material to substantiate the basic facts set out in the declaration, cannot
be accepted as legally sustainable foundation for a finding of fact. Also, same
does not amount to certification by any authority and hence did not prove its
residential status.

– As the Taxpayer was earlier not asked to
submit evidence other than a TRC to prove residential status of the US entity,
the matter was remanded to the AO for fresh adjudication, with direction to
give the Taxpayer a fresh opportunity to furnish evidence not limited to, but
including, the TRC in support of the US entity’s entitlement to the tax treaty
benefits of the DTAA.

[1] Reliance was placed on an Authority
for Advance Rulings order in the case of Serco BPO Pvt. Ltd. [(2015) 379 ITR
256 (P&H)]

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20. TS-321-ITAT-2018 (Mum) DCIT v. D.B. International (Asia) Ltd A.Y: 2011-12, Dated: 20th June, 2018

Article 11, 23
of India-Singapore DTAA –relief from capital gains taxation in India cannot be
termed as ‘exemption’ – conditions for trigger of Limitation of Relief clause
not satisfied.

Facts

The Taxpayer, a tax
resident of Singapore, was carrying on its business operations including
trading in securities from Singapore. It did not have any PE in India. During
the year, Taxpayer earned capital gain on sale of shares, debt instruments and
derivatives (collectively referred to as “securities”) in India and claimed it
as non-taxable in India under the DTAA which provides exclusive taxation rights
on such gains to Singapore as resident country.

The AO contended that
since capital gains were not remitted/repatriated to Singapore, capital gain
benefit under the DTAA cannot be allowed. This resulted in non-satisfaction of
Limitation of Relief (LOR) article under the DTAA which restricts exemption in
source country (India) to the extent of repatriation of such income to resident
country (Singapore).

As against this, the
Taxpayer contended that the gains were not taxable in India because under
capital gains article, gains from sale of securities in India are taxable only
in Singapore. Once the entire worldwide income was assessed at Singapore, a
part of it cannot be taxed in India as it will amount to double taxation of the
same income. Thus, LOR provision is of no relevance in this case. In support of
its contention, the Taxpayer relied on Mumbai Tribunal ruling in the case of
Citicorp Investment Bank Singapore Ltd[1].

The Dispute Resolution
Panel (DRP), ruled in the favour of the Taxpayer. Aggrieved by this the AO
appealed before the Tribunal.

Held

u The LOR provision applies if income derived
from a source state is either exempt from tax or taxed at a reduced rate in
that source State. The above condition is not fulfilled in the present case as
capital gains derived by the Taxpayer from sale of Indian securities is taxable
only in the resident state, i.e., Singapore. The provision is clear and
unambiguous and expresses itself as not an exemption provision but it speaks of
taxability of particular income in a particular State by virtue of residence of

the Taxpayer.

u The expression “exempt” with reference to the
capital gain derived by the Taxpayer has been loosely used. Therefore, capital
gain which was not taxable in India due to allocation of exclusive taxation
rights to country of residence cannot be termed as an “exemption”. This is also
supported by Mumbai Tribunal ruling in the case of Citicorp Investment Bank
Singapore Ltd. as referred by the Taxpayer.

u LOR provisions are thus not applicable to the
facts of the case.

[1] 2017–EII–59–ITAT–MUM–INTL]

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19. TS-302-AAR-2018 Saudi Arabian Oil Company v. DCIT AAR No 25 of 2016 Dated: 31st May, 2018

Article 5 of
India-Saudi Arabia DTAA – setting up Indian subsidiary for providing business
support services and marketing support services does not create permanent
establishment in India

Facts

The Applicant, a tax
resident of Saudi Arabia, is a state owned Oil Company in the business of oil
exploration, production, refining, chemicals, distribution and marketing.
Applicant is the world’s largest crude oil exporter and is making offshore
crude oil sales to Indian refineries on Free on Board (FOB) basis such that the
title passes outside India and payment is also made outside India.

To expand its India
operations and for having a long term presence in India, Applicant established
a subsidiary company in India (I Co) and entered into a service agreement with
I Co to provide procurement support services. Directors of I Co are also
employees and part of high management team of the Applicant.

During the year under
consideration, an Addendum was proposed to the Service Agreement (Proposed
Addendum) under which I Co proposed to provide business support and marketing
support functions to the Applicant at an arm’s length price (ALP). Broadly, the
services agreed to be provided by I Co under the Proposed Addendum included
procurement, sourcing and Logistic Support, Quality Inspection Support,
Business support/marketing support function, plant audits for identified
manufacturers and suppliers, market research, ascertaining quality of crude
oil, promoting awareness etc.

Based on the nature of
activities proposed to be undertaken by I Co, AAR ruling was sought on the
issue whether I Co would create a PE of the Applicant under the India-Saudi
Arabia Tax Treaty.

Held

AAR relied on the
decisions in Formula One (394 ITR 80) and eFunds (86 taxmann.com 240) to state
that I Co, would not create a PE for the Applicant.

Subsidiary PE:

– I Co, as a subsidiary of Applicant, does not
automatically become PE of Applicant, unless specific tests of PE are
satisfied. I Co has its own board of directors and is/will carry out its own
business in India. As held in case of Vodafone Holdings International BV (2012)
341 ITR 1 (SC) and AB Holdings Mauritius II (AAR/ 1129 of 2011), companies are
separate legal and economic entities for tax purposes and therefore parent and
subsidiary are distinct taxpayers.

– It is unlikely that parent would not at all
be involved in the decision making of its subsidiary whose activities have to
be in consonance with the overall goals of the holding company. Similarly, it
cannot be expected that directors of subsidiary would act with such
independence that the overall objective of holding company gets compromised.

Fixed Place PE:

– I Co is utilising its establishment to carry
out its own business in India, i.e., to provide support services to the
Applicant. Applicant’s business is
carried on in and from Saudi Arabia and is monitored by the Saudi Arabian
Ministry of Petroleum and Mineral resources together with Supreme Council of
Petroleum and Minerals. Hence, the question of any main or core business
activities of Applicant being carried on at I Co’s establishment does not
arise.

– I Co’s establishment is not placed at
disposal of the Applicant. There is no material on record to indicate that the
I Co is or will be manned by employees or personnel of the Applicant.

– Services provided by I Co are support
services for which it is remunerated at ALP and such services do not constitute
main business of the Applicant which is exploration, production, refining, and
distribution of crude oil.

– Accordingly, I Co’s premises does not
constitute a fixed place PE for the Applicant in India. The fact that I Co is
remunerated at ALP does not have a bearing on evaluation of fixed PE.

Service PE

– Applicant is not rendering any services to
any customer in India, either directly or through I Co. It is I Co which is
providing support services, that too to Applicant and not to the customers of
Applicant.

– It is incorrect to say that entire control
and management of I Co is under the Applicant by virtue of its employees who
are also directors of I Co. Also period
of their stay in India is irrelevant since they would be discharging their
duties as directors of I Co and not for the Applicant. Further, the
relationship of such directors with Applicant in past years is also not
relevant.

– Applicant, therefore, does not have any Service
PE in India.

Agency PE

– Service Agreement requires the parties to
perform as an independent contractor and not as an agent. The Proposed Addendum
expressly prohibits I Co from representing itself as agent of Applicant or
negotiating any business terms or conditions on behalf of Applicant.

– Activities like allocations, claims,
communication of customers’ concerns, and maintaining business relationships
does not mean concluding contracts or habitually obtaining orders on behalf of
the foreign enterprise. Even as per the agreements, I Co cannot enter into any
agreement of a binding nature on behalf of the Applicant.

– Furthermore, Agency PE provision of the
treaty, relating to ‘obtaining orders’ covers obtaining orders for sales and
not for procurement/purchase[1] as in this case.

– Thus, I Co does not create any Agency PE for
Applicant.

Preparatory or auxiliary exemption

– PE exemption for preparatory or auxiliary
functions is irrelevant since there is no PE created in the first place.

– Nevertheless, I Co’s Services such as market
research, identifying new customers, etc. would be ‘preparatory’ in nature and
hence eligible for PE exclusion.

[1] It was contended by Applicant that
Agency PE provisions relate to sales contracts/orders. It excludes any activities
in relation to purchase orders

shailesh.kwebmaker

10. ACIT vs. Sameer Sudhakar Dighe Members : Mahavir Singh, JM and G. Manjunatha, AM ITA No. 1327/Mum/2016 Assessment Year: 2011-12. Decided on: 13th April, 2018. Counsel for revenue / assessee: V. Rajguru / None Section 56(2)(vii), CBDT circular no. 477 [F. No. 199/86-IT(A-1)], dated 22.1.1986 – Award received by a non-professional sportsman will not be chargeable to tax in his hands.

Section 56(2)(vii), CBDT circular no. 477
[F. No. 199/86-IT(A-1)], dated 22.1.1986 – Award received by a non-professional
sportsman will not be chargeable to tax in his hands.

FACTS

The assessee, retired from international cricket in the year
2002, was appointed as a cricket coach by BCCI to train the players at national
level. During the year under consideration,
a benefit match was arranged by BCCI for assessee. The assessee received net
proceeds of Rs. 50.44 lakh, which he treated as capital receipt. In the course
of assessment proceedings, the Assessing Officer (AO) asked the assessee to
explain why the amount under consideration should be treated as a capital
receipt. The assessee explained that the
benefit match is a game played for retired sportsmen to appreciate personal
talent and skill in sports and accordingly funds collected on behalf of benefit
match is a capital receipt. He placed
reliance on CBDT circular no. 477 [F. No. 199/86-IT(A-1)], dated
22.1.1986. The AO, treated the amount
received from benefit match as a revenue receipt and taxed it u/s. 56(2)(vii)
of the Act.

Aggrieved, the assessee preferred an appeal to CIT(A) who
considering the submissions made by the assessee and also the Board Circular
No. 477 (supra) decided the appeal in favour of the assessee.

Aggrieved, the revenue preferred an appeal to the Tribunal.

HELD

The assessee is a full time employee of Air India. The benefit match was conducted by BCCI,
which is a regulatory body for cricket in India to appreciate the personal
talent and skill in this sport because the assessee is a retired sportsman and
the proceeds arising out of this benefit match are in the nature of award. The Tribunal relying on the decision of the
Bangalore Bench of Tribunal in the case of G. R. Viswanath vs. ITO [(1989)
29 ITD 142 (Bang.)] held that there is no direct nexus between the payment
and assessee’s profession and these receipts being capital in nature cannot be
brought to tax.

The Tribunal also noted that the Delhi Bench of the Tribunal
has in the case of Abhinav Bindra vs. DCIT [(2013) 28 ITR (Trib.) 376 (Delhi)]
has considered the identical issue and also the provisions of section 56(2)(v)
and has held that if a sportsman who is not a professional sportsman has been
given awards/rewards/prizes then a liberal construction of Circular No. 447 is
required and amount of awards/rewards/prizes are held to be capital in nature.

The Tribunal held that the amount represents the gratitude
from the fans and followers by attending the benefit match conducted in honour
of the assessee who is a retired cricketer of international repute. This type of receipts are specifically
exempted by CBDT Circular No. 477 which states that the amount paid to amateur
sportsman who is not a professional will not be liable to tax in his hands as
it would not be in the nature of income.
The assessee was an amateur cricketer and his profession is employment
with Air India from where he is getting salary.
He played the game of cricket for India as his passion and the receipts
of the net proceeds from the benefit match was only in the nature of
appreciation of his personal achievements and talent and thus, cannot be
brought to tax by invoking the provisions of section 56(2)(vii)(a) of the
Act. These proceeds from the benefit
match received by the assessee are in appreciation of his past achievements in
International Cricket arena and such type of receipt cannot be taxed. The Tribunal upheld the order of the CIT(A).

The appeal filed by the Revenue was dismissed

shailesh.kwebmaker

9. DCIT vs. Saleem Mohd. Nazir Sheikh Members : Shamim Yahya, AM and Ram Lal Negi, JM ITA No. 5576/Mum/2015 Assessment Year: 2009-10. Decided on: 13th April, 2018. Counsel for revenue / assessee: Pooja Swarup / None

Section 271AAA
– If the search party does not put any question to the assessee about the
source of income, any adverse inference for the levy of penalty u/s. 271AAA
cannot be drawn.

FACTS

The assessee, in the course of search and seizure action on
Hitcons & Pranay group of cases, voluntarily declared amounts aggregating
to Rs. 70,03,525 as his undisclosed income.
In the return of income filed, he declared total income of Rs.
90,65,390. The Assessing Officer (AO)
passed order u/s. 143(3) assessing the total income of the assessee to be Rs.
1,11,28,815. Penalty proceedings under
section 271AAA were initiated for disclosure of Rs. 70,03,525.

The AO levied penalty under section 271AAA on the ground that
though the assessee had admitted undisclosed income of Rs. 70,03,525 in his
statement recorded u/s. 132(4) of the Act, he failed to specify as well as
substantiate the manner in which undisclosed income was derived.

Aggrieved, the assessee preferred an appeal to CIT(A) who
relying upon the judgment of the Allahabad High Court in the case of CIT vs.
Radha Kishan Goel [2005] 278 ITR 454 (Allahabad) and the decision of the
Gujarat High Court in the case of CIT vs. Mahendra C. Shah [2008] 299 ITR
305 (Guj.) as also the decision of the Nagpur Bench of the Tribunal in the
case of Concrete Developers v. ACIT [2013] 34 taxmann.com 62 (Nagpur-Trib.) allowed
the appeal filed by the assessee.

Aggrieved, revenue preferred an appeal to the Tribunal where it,
interalia, contended that the decision of Nagpur Bench of Tribunal,
relied upon by the CIT(A), has not been accepted by the Revenue and appeal has
been filed and admitted against the said decision of Nagpur Bench of Tribunal.

HELD

The Tribunal observed that the assessee has made a disclosure
of undisclosed income in the course of search and has shown such undisclosed
income in the return of income and has paid taxes thereon and the AO has
accepted the income returned and the source of the same. However, the AO has levied penalty u/s.
271AAA of the Act. The Tribunal observed
that CIT(A) relying on the ratio laid down in the decision of the Allahabad
High Court and the Gujarat High Court has elaborately considered the issue and
has passed an order deleting the levy of penalty. It observed that the ratio emanating out of
these two High Court decisions is that if the search party doesn’t put any
question to the assessee about the source of income, any adverse inference for
levy of penalty u/s. 271AAA cannot be drawn. The Tribunal also noticed that the
revenue has in the grounds mentioned about a decision of Nagpur Bench of the
Tribunal in favor of the assessee which has not been accepted by the revenue
but the department is in appeal before the High Court. The Tribunal observed that since no contrary
decision was pointed out by the Revenue, the Tribunal upheld the order passed
by CIT(A).

The appeal filed by the Revenue was dismissed.

shailesh.kwebmaker

7 Section 263 – Revision – Validity – Merger of assessee-company with another entity – Assessee-company non-existant on date of issue of notice and order u/s. 263 – Notice and order void ab initio

Principal
CIT vs. Kaizen Products (P) Ltd.; 406 ITR 311 (Del): Date of order: 25^th
July, 2017

A.
Y. 2009-10

There was
merger of the assessee with an entity V by an order of the Court dated
08/10/2010 and the merged entity was named A. For the A. Y. 2009-10, the
assessee filed the return of income on 19/09/2009. The Assessing Officer issued
a notice dated 09/04/2013 u/s. 148 of the Act and passed assessment order u/s.
147 on 23/07/2014 accepting the return filed by the assessee. The Principal
Commissioner issued a notice dated 23/03/2016 u/s. 263 and consequent thereto,
passed an order on 31/03/2016.

The
asessee contended before the Tribunal that the order u/s. 263 had been passed
against an entity which did not exist in the eye of law and therefore, the
proceedings were vitiated. The Department’s contention was that during the
proceedings u/s. 147, the assessee did not raise any objection on that ground
and therefore, it should not be permitted to raise the objection before the
Tribunal. The Tribunal held that the notice and order were both in the name of
a non-existent entity and therefore, void ab initio.

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

“The
assessee had ceased to exist as a result of the order of the Court approving
its merger with another company and the issuance of the notice u/s. 263 and the
consequent order were in respect of a non-existent entity and void ab initio.”

shailesh.kwebmaker

6 Section 263 – Revision – Powers of Commissioner u/s. 263 – Commissioner (Appeal) passed order in appeal – Assessment order merges in appellate order – Commissioner has no jurisdiction to set aside such order – Order passed by AO and Commissioner (Appeals) after due consideration – Commissioner cannot set aside such order

Principal
CIT vs. H. Nagraj; 406 ITR 242 (Karn): Date of order: 29^th May, 2018

A.
Y. 2008-09 and 2009-10

The
assessee firm was in the business of purchasing agricultural lands, converting
them for non-agricultural purposes and selling them. In the relevant years, the
assessee had claimed expenditure for developing lands. The assessee had
furnished names and addresses of parties to whom the amounts had been paid
along with permanent account numbers, bills and vouchers. Considering the
details furnished in support of the development expenses, the Assessing Officer
made addition of Rs. 2,38,16,700/- and Rs. 4,25,72,383/- for the A. Ys. 2008-09
and 2009-10 respectively. The Commissioner (Appeals) confirmed the additions to
the extent of Rs. 12,50,000/- for A. Y. 2008-09 and allowed the appeal in
respect of the balance. As regards A. Y. 2009-10, an addition of Rs. 2 crores
was confirmed and balance of Rs. 1,92,72,383/- was deleted.

By
exercising his powers of revision u/s. 263 of the Act, the Commissioner
proceeded to hold that the properties purchased by the assessee and the
subsequent sale made in favour of B did not tally in respect of both the
assessment orders and therefore, directed reconsideration of the entire
material. The Commissioner further found that the development expenses
consisting of labour charges and work-in-progress had to be added for the A. Y.
2008-09. Similarly, in respect of payment towards commission, the Commissioner
found that the cheque payments and the tax deducted at source made for claiming
expenditure had to be verified. The Tribunal set aside the order of the
Commissioner.

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

“i) The revisional authority cannot, by acting
u/s. 263, interfere and upset the order passed by the Appellate Commissioner.

ii) When the development expense as considered
by the Assessing Officer were the subject matter of appeal and the Commissioner
(Appeals) had found that for both the assessment years, the expenses incurred
had to be accepted disallowing the claim of Rs. 50 lakhs for the A. Y. 2008-09
and Rs. 2 crores for the A. Y. 2009-10, the question of the Commissioner
(Administration) exercising revisional jurisdiction u/s. 263 to once again
examine the very same issue so as to disallow the labour charges and
work-in-progress did not arise, as the order of assessment made by the
Assessing Officer merged with the order of the Appellate Commissioner.

iii) When the Assessing Officer scrutinised the
returns for the A. Ys. 2008-09 and 2009-10, he considered the purchase of lands
from villagers and thereafter sale of the same to B. He had dealt with the same
in the assessment order and had proceeded to arrive at a conclusion that for
the A. Y. 2008-09, there was unexplained income of Rs. 1,25,66,700/- and for
the A. Y. 2009-10, there was unexplained income in a sum of Rs. 1,92,72,383. He
had thus proceeded to treat these two items as undisclosed profit for the
respective years.

iv) The order passed by the Assessing Officer
merged with that of the Appellate Commissioner for both the assessment years.
Therefore, there was no scope for the Commissioner to exercise jurisdiction
u/s. 263 to reexamine the purchase made by the assessee in respect of the lands
in question. Similar was the factual matrix involved in respect of commission
expenses claimed by the assessee for the two assessment years. The assessee had
submitted full details regarding payment of commission. After considering the
material, the Assessing Officer chose not to make any addition on the item
pertaining to commission.

v) The Tribunal was right in holding that the
Commissioner was not justified in exercising the revisional powers u/s. 263 to
upset the order passed by the Assessing Officer which stood merged with the
order passed by the Commissioner (Appeals).”

shailesh.kwebmaker

5 Sections 10AA and 144C – Draft assessment order – Section 144C – Power of AO – Additions not proposed in draft assessment order cannot be made by AO in final order – AO making disallowance of deduction u/s. 10AA in final order not proposed in draft order – Breach of provisions of section 144C – Not permissible

Pr. CIT vs. WOCO Motherson Advanced
Rubber Technologies Ltd.; 406 ITR 375 (Guj):
Date of order: 20^th February, 2017

A. Y. 2011-12

The
assessee was a joint venture company of a company in Germany and another in
India. For the A. Y. 2011-12, in the draft assessment order issued by the
Assessing Officer u/s. 143(3) read with section 144C of the Act, the Assessing
Officer proposed only an arm’s length price adjustment of Rs. 1,48,43,000/- and
did not propose any disallowance in the draft assessment order. The draft
assessment order was carried before the Dispute Resolution Panel (DRP) but the
assessee did not succeed. Thereafter, while passing the final assessment order
the Assessing Officer not only made addition of the arm’s length price
adjustment of Rs. 1,48,43,000/-, but also disallowed 50% of the deduction
allowed u/s. 10AA on the ground that it was claimed in excess by the assessee.

The
Tribunal held that the disallowance made u/s. 10AA was in breach of section
144C and set aside the disallowance.

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

“i) Considering the entire scheme of section
144C, in conformity with the principals of natural justice, the assessee is
required to be given an opportunity to submit objections with respect to the
variations proposed in the income or loss returned. Therefore, while passing
the final assessment order, the Assessing Officer cannot go beyond what is
proposed in the draft assessment order.

ii) When the Assessing Officer forwarded a draft
of the proposed assessment order to the assessee, he had not proposed to make a
disallowance of Rs. 7,64,15,421/- u/s. 10AA of the Act. The Tribunal was right
in deleting the disallowance made by the Assessing Officer in respect of the
claim made by the assessee u/s. 10AA on the ground that the disallowance was in
breach of section 144C in as much as it was not proposed by the Assessing
officer in the draft assessment order.”

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4 Section 32 – Depreciation – Rate of depreciation – Computer – Printer part of computer – entitled to depreciation at 60%

CIT vs. Cactus Imaging India Pvt. Ltd.;
406 ITR 406 (Mad); Date of order: 16^th April, 2018

A. Ys. 2003-04 and 2004-05

For A. Ys.
2003-04 and 2004-05, the assessee had claimed depreciation at the rate of 60%
on its computers. The computers included printers. The Assessing Officer held
that the printers were not normal printers, but high value printers used for
printing banners and advertisement materials of large sizes and could not be
treated as a peripheral to a computer and the printer purchased by the assessee
could not perform any other function as performed by a normal computer.
Accordingly, the claim for depreciation at 60% was denied.

Before the
Commissioner (Appeals), a video demonstration was conducted and upon going
through the technical manual of the printers, he found that the printer could
not be used without the computer and concluded that it was a part of the
computer system. Accordingly, the appeals filed by the assessee were allowed.
These orders were affirmed by the Tribunal.

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

“i) Item III(5) of the old Appendix I to the
Income-tax Rules, 1962 stated “computers including computer software” and the
notes under the Appendix defined “computer software” in clause 7 to mean any
computer programme recorded in disc, tape, perforated media or other
information storage device. In the notes contained in the Appendix, the term
“computer” has not been defined.

ii) A printer cannot be used without a computer
and should be treated as part of the computer and an accessory to the computer.

iii) Since in respect of the very same machinery,
depreciation at the rate claimed had been permitted for the earlier years and
affirmed by the Division Bench, depreciation at the rate of 60% was allowable
on the printers.”

shailesh.kwebmaker

3 Section 32 – Depreciation – Additional depreciation – Condition precedent – Manufacture of article – Assessee need not be principally engaged in manufacture – Assessee entitled to additional depreciation on plant and machinery used in manufacture of ready mix concrete

Cherian Varkey Construction Co. (P) Ltd.
vs. UOI; 406 ITR 262 (Ker): Date of order:
19^th December, 2017

A.
Y. 2006-07

For the A.
Y. 2006-07, the assessee procured three vehicles, specifically for the
transport of ready mix concrete for use in the construction site, from its own
manufacturing unit. The procurement of the vehicles was in the relevant year.
The assessee claimed additional depreciation u/s. 32(1)(iia) of the Act to the
extent of 20% of the actual cost of such vehicles which, according to the
assessee qualified as plant and machinery used in manufacture. The claim was allowed
by the Assessing Officer, but later disallowed in reassessment u/s. 147/148 of
the Act.

The
Tribunal held that there was no manufacture involved in the making of ready mix
concrete and upheld the disallowance.

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

“i) It cannot be held on a reading of section
32(1)(iia) of the Act, that the additional depreciation permissible to the
extent of 20% of the actual cost of plant and machinery, would be permissible
only in the case of an assessee engaged principally in the business of
manufacturing or production. This would be doing violence to the provision
since then it would amount to introducing the word “principally” to read “ an
assessee engaged in the business principally of manufacture and production of
any article or thing; then a claim u/s. 32(1)(iia) would be permissible to the
extent allowed as depreciation.

ii) Considering the high degree of precision and
stringent quality control observed in the selection and processing of
ingredients as also the specific entry in the Central Excise Tariff First
Schedule, heading 3824 50 10 which deals with “Concrete ready to use known as
“Ready mix concrete”, though the ready mix concrete did not have a shelf-life,
the final mixture of stone, sand, cement and water in a semi-fluid state,
transported to the construction site to be poured into the structure and
allowed to set and harden into concrete was a thing or article manufactured.

iii) The assessee, though engaged principally in
the business of construction, was entitled to additional depreciation u/s.
32(1)(iia) for the plant and machinery used in the manufacturing activity being
the production of ready mix concrete.”

shailesh.kwebmaker

2 Section 68 – Cash credit (Shares, allotment of) – Where assessee allotted shares to a company in settlement of pre-existing liability of assessee to said company, since no cash was involved in transaction of said allotment of shares, conversion of these liabilities into share capital and share premium could not be treated as unexplained cash credits u/s. 68

V. R. Global Energy (P) Ltd. vs. ITO;
[2018] 96 taxmann.com 647 (Mad): Date of order:
6^th August, 2018 A. Y. 2012-13

The
assessee-company allotted 1,19,000 shares with face value of Rs. 10 at a
premium of Rs. 5400 to one VR and the allotment of shares by the assessee to VR
was in settlement of the pre-existing liability of the assessee to said VR. The
Assessing Officer added the share premium and the share capital for the fresh
allotment of shares and treated the same as unexplained cash credits u/s. 68 of
the Act, while holding that the method of valuation was not acceptable and that
the share premium of Rs. 5400 was unreasonable.

In appeal,
the Commissioner (Appeals) and the Tribunal upheld the decision of the
Assessing Officer.

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

“i) The cash credits towards share capital were
admittedly only by way of book adjustment and not actual receipts which could
not be substantiated as receipts towards share subscription money.

ii) The appeal is, thus, allowed and the
judgment and order of the Tribunal is set aside, for the reasons discussed
above. Additions u/s. 68 are also set aside.”

shailesh.kwebmaker

1. Section 2(28A) and 40 (a)(i) – Business expenditure – TDS – Disallowance u/s. 40(a)(i)

Principal CIT vs. West Bengal Housing
Infrastructure Development Corpn. Ltd.; [2018] 96 taxmann.com 610 (Cal):
Date of order: 9^th August, 2018

A. Y. 2005-06

Interest
(Compensation for belated allotment of plot) – As per agreement, under Housing
Scheme, for failure to make plots available to allottees within stipulated
time, assessee housing/infrastructure development corporation paid
damage/compensation on amount allottees paid at rate equivalent to SBI interest
rate of FDs – Payments so made would not make payment on interest as defined
u/s. 2(28A) since there was neither any borrowing of money nor was there
incurring of debt on part of assessee – Tax not deductible – No disallowance
u/s. 40(a)(i)

The
assessee, was engaged in development of land, housing and infrastructural
facilities. A sum of Rs. 9.71 crore was found debited in the profit and loss
account of the assessee. This sum was claimed as deduction in computing the
income of the assessee under the head ‘income from business‘. The nature
of this expenditure was explained by the assessee before the Assessing Officer
as ‘compensation for delay, delivery of plots‘. The explanation given
was that as per the offer of allotment of plot of land developed by the
assessee, the assessee was under an obligation to hand over physical possession
of the plot to the allottees on payment of the entire cost of the land. If
possession of handing over of the plot was delayed for more than six months
from the scheduled date of possession, the assessee had to pay interest on
installments already paid by the allottee during such extended period at the
prevailing fixed term deposit rates for similar period offered by the State
Bank of India. According to the assessee, the actual nature of payment was in
the nature of damages for delayed allotment of a plot and thus, the assessee
had no TDS obligation. The Assessing Officer viewed the payment to be in the
nature of payment of interest and held that by reason thereof, the assessee
should have deducted tax at source u/s. 194A of the Income tax Act, 1961
(hereinafter for the sake of brevity referred to as the “Act”) at the
time of payment or credit. The Assessing Officer further held that since the
assessee failed to deduct tax at source on the amount, the claim of the
assessee for deduction of the said sum cannot be allowed by reason of section
40(a)(ia).

The
Tribunal held that the amount in question cannot be characterised as interest
within the meaning of section 194A and hence, there was no obligation on the
part of the assessee to deduct tax at source and allowed the assessee’s claim.

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

“i) From the definition of interest as occurring
in section 2(28A), it appears that the term ‘interest’ has been made entirely
relatable to money borrowed or debt incurred and various gradations of rights
and obligations arising from either of the two. The parenthesis in the section
is in the nature of a qualification of the borrowing of money/incurring of debt
and what it includes.

ii) In CIT vs. H.P. Housing Board [2012] 18
taxmann.com 129/205 Taxman 1/340 ITR 388 (HP) the High Court held that the
money was paid on account of damages suffered by the allottee for delay in
completion of the flats.

iii) Reference may be made to the Apex
Court in Central India Spg. & Wvg. & Mfg. Co. Ltd. vs. Municipal
Committee, Wardha AIR 1958 SC 341. Besides agreeing with the reasons given
by the Himachal Pradesh High Court for holding that payment for delayed
allotment of flats cannot be brought u/s. 2(28A) the said decision is of a
co-ordinate Bench.

iv) The payment made by the assessee to the
allottee was in terms of the agreement entered between them where the liability
of the assessee would arise only if it failed to make the plots available
within the stipulated time. Hence, the payment made under the relevant clause
was purely contractual and as rightly held by the Tribunal, in the nature of
compensation or damages for the loss caused to the allottee in the interregnum
for being unable to utilise or possess the flat: The Flavour of compensation
becomes evident from the words used in the particular clause. The expression
‘interest’ used in the relevant clause of the Housing Scheme may be seen merely
as a quantification of the liability of the assessee in terms of the percentage
of interest payable by the State Bank of India. Since there is neither any
borrowing of money nor incurring of debt on the part of the assessee, in the
present factual scenario, interest as defined u/s. 2(28A) can have no application
to such payments. Consequently, there was no obligation on the part of the
assessee to deduct tax at source and consequently no disallowance could have
been made u/s. 40(a)(ia).

v) In view of the above, the decision of the
Tribunal is to be confirmed.”

shailesh.kwebmaker

One Nation One Reporting

Last few weeks of September are like last overs of a 20-20 match –
tension, exhilaration and victory. Many Chartered Accountants had serious
issues with the tax filing utilities. It seems that the “empty screen” virus
which attacked GSTN made its appearance on the “incometaxindiaefiling” portal
also. If not the departments, the portals are certainly in touch with each
other!

Throughout the month I received reminder messages to file my tax returns
on or before 30^th September 2018 or face penalty of Rs. 5000. Yet,
when I signed into the portal to upload, like thousands of others – the site
went blank – into an empty screen – perhaps representing the empty words of the
government.

From a high level, the Social Contract between the State and
Taxpaying Citizens is breaking down. One-word summary of its cause: Disregard.

Like many professionals, I wonder:

a. Has the Finance Ministry set
a new record of poor taxpayer services?

b. Have they breached their
obligation to make adequate arrangements to enable taxpayers to
discharge their obligations with ease¹ ?

c. What is the accountability
of Netacracy and Babucracy when compliance enabling mechanism does not
work?

d. Does tinkering Forms and
Utility (at random frequencies) corroborate the mission of the Department ²?

e. What should be the consequences
of not adhering to the stated Mission and Vision³ of Income Tax
Department?

I don’t know which emoji will come to your mind after reading Citizen’s
Charter, but many seem to have lost
the script.

________________________________________________________

1 Income Tax Department Mission, Point No 2: To
Make Compliance Easy

2 Income
Tax Department Mission, Point No 3: To be accountable and transparent

3 Income Tax Department Mission, Point No 4: To
deliver Quality Services

Design of Forms & Duplication: Income tax forms are a testimony to
design malfunction – in functionality and aesthetics, dated content, obsession
for excessive information, random placement of clauses, tinkering, focus on the
trivial and low sense of proportion.

Case in point: ITR to Form 29B to Form 3CD. Asking 8-10 registration
numbers in Form 3CD in Digital India – can I not put it in the master? MAT Form
29B asks for business code, which is already in ITR? Reproduction of details
from financials – when they could be attached or uploaded or picked up from MCA
(and let me tell you that when I incorporated a company in September I got
sales calls from five bankers before receiving certificate of incorporation –
how did they get that information?)? Asking for bifurcation of GST registered
and GST unregistered dealers – have GST returns stopped? 50 plus clauses/sub
clauses in a Tax Audit Report? … The only reason could be that someone didn’t
hear about ease of doing business!

In addition, multiple government agencies ask for same data for their
consumption although they are paid by the same taxpayers to talk to each other
and work in tandem. Can PF Department website not throw up a certificate to the
tax office about timely filings? What we need is – ONE NATION ONE REPORTING.
The State needs to get its act together and consolidate what it wants from
taxpayers and offer a single window to file everything! Instead of obfuscating,
blokes in North Block need to dumb down and utterly simplify everything.

How about:

1. Not seeing the nation as
‘largely tax non-compliant society⁴’ (effectively calling us tax
evaders) and treat them as partners in nation building!

_____________________________________________________________________________________

4 Finance
Minister Arun Jaitley in his Union Budget Speech, February 2017 – The same
minister who made political party funding opaque.

2. Not inflicting the taxpayers
with quagmire⁵ of compliances
and providing seamless ease of compliance (and this is not as easy as
sloganeering)!

3. A Ban on flip-flop law
tweaking and emphasis on discipline and care for taxpayers – it better be
demonstrable!

4. Ending multiplicity and
duplication of filings and have departments talk to each other! Taxpayers are
not government servants, it’s the other way round!

5. Justifying purpose, need and
quantum of reporting and why it cannot be served from fetching data from places
where it is already available! This means government has to be smarter and work
harder.

6. Not punishing people who
comply and support compliance with outright coercive and thankless
‘provisions’? Slash and burn large parts of the Act, that will be a good
act.

7. Inserting a new chapter in
every tax law on “Rights of Taxpayers”, “Government Obligation to Tax Payer
Services” and “Penalties for not serving the tax payers”.

8. Including the ‘public
servants’ under Consumer Protection Act or similar and report performance of
circles / wards on a quarterly basis – like we pay advance taxes – show us that
advance taxes are working to serve the
tax payer!

Most taxpayers risk a lot and some everything, to earn their livelihood
from which taxes are paid. Taxes should be like fees paid – governments owe one
to the people who do pay taxes. The Finance Ministry should be glad that people
are not studying the CAG Reports on the performance of the government/s’ in
spending their hard-earned taxes. Rather than using smoke and mirrors,
it is time to look in the mirror Mr Minister!

__________________________________________________________

5 The
word refers to a swamp, marsh, quicksand, complex, hazardous, muddled, mixed up
…

Raman Jokhakar

Editor

shailesh.kwebmaker

Scope of The Definition of The Term ‘Interest’ – Section 2(28a)

Issue for Consideration

The term ‘interest’ has been defined in section 2(28A) of the Income
tax Act as under:

“interest” means interest payable in
any manner in respect of any moneys borrowed or debt incurred (including a
deposit, claim or other similar right or obligation) and includes any service
fee or other charge in respect of the moneys borrowed or debt incurred or in
respect of any credit facility which has not been utilised.

The term has been exhaustively defined and in its scope it includes the
service fee or other charges in respect of the borrowings, debts and even
unutilized credit facilities. It not only includes interest, as understood
generally, which is payable on any kind of borrowing or debt, but also includes
payment on a deposit, claim or other similar right or obligation. This
extensive definition of ‘interest’ has been a subject matter of controversy,
more particularly from the point of view of the applicability of section 194A
to various types of payments for deduction of tax at source.

By applying the extensive definition, the Madras High Court considered
the payment of guaranteed return at a particular percentage to the investors,
under an investment scheme, to be an ‘interest’, though not captioned as
interest otherwise by the parties. On the other hand, the Calcutta High Court
took a view that the payment of an amount due to delay in delivering the plots,
though termed as interest in the letter of allotment, did not fall within the
ambit of the definition of ‘interest’. Though the facts of the cases before the
Madras High Court and the Calcutta High Court were materially different, the
issue arising therefrom was similar i.e. when does a payment made in respect of
a particular ‘obligation’ constitute interest.

Viswapriya Financial Services & Securities Ltd.’s case:

The issue regarding the interpretation of the definition of the term
‘interest’ first came up, before the Madras High Court, in the case of Viswapriya
Financial Services & Securities Ltd. vs. CIT 258 ITR 496.

In this case, the assessee had floated an innovative scheme of
investment which enabled individual investors to entrust their funds for
management to the assessee, with a guarantee from the assessee that it would so
manage the funds as to ensure a minimum return of 1.5 percent per month to the
investor. The salient features of the scheme operated by the assessee were as
follows:

– The offer memorandum was issued inviting the
investors to contribute and to entrust their money to the assessee for what had
been referred to as fund management. The offer memorandum formed the contract
between the investors and the assessee for the management on the investors’
behalf of the funds provided by the investors under the memorandum for
deployment in any investment.

– The investor, under that memorandum, was to
pay the amount to the assessee by cheques or drafts drawn in the name of
“Viswapriya Funds Management Account-Bank Guaranteed Investments”.
The investors’ money were not made part of the funds of the assessee-company’s
accounts but were kept in a separate account.

– A firm of chartered accountants had
been appointed to function as fiduciary and custodian of the scheme and the
accounts of that fund were also separately audited.

– The investments made in the course of the
management were fully secured and were backed by bank guarantees. However, the
money entrusted under the scheme was to be managed by the assessee, and the
investor was not required to be informed as to the specific investments made
from the fund and the particular investment in which the investor’s amount was
utilised.

– The investors were assured a guaranteed
return of 1.5 percent per month of the amount invested.

– The assessee was entitled to a management
fee of 6 percent per annum from all the funds invested on behalf of the
investors, but with a condition to forgo a part of that management fee if the
returns on the investment were insufficient to ensure the stipulated distribution
at the rate of 1.5 percent per month to the investors.

– If the return from the investments was in
excess of the amount of management fee and the minimum guaranteed return for
the investor, the assessee would become entitled to a performance incentive of
10 percent of such excess.

– The investor had been promised the return of
his investment at the end of the agreed period of three years.

– The investment made by the investor was
transferable. It was possible to be assigned or pledged with prior intimation
to the assessee. In the event of the death of the investor, the amount was to
be transferred to his nominee, if any, and in the absence of nomination, to his
legal heirs.

In the backdrop of these facts, for the assessment years 1993-94 and
1994-95, the assessing officer had passed an order u/s. 201(1) holding that the
assessee was liable to deduct tax at source u/s. 194A on the payments made to
the investors. The Tribunal upheld the order of the assessing officer and held
that the money received by the assessee from the investors created an
‘obligation’ and that the return on that investment at the guaranteed minimum
payment of 1.5 percent per month was covered by the definition of ‘interest’ as
provided in section 2(28A).

Before the High Court, on behalf of the assessee, it was submitted that
the income received by the assessee from the investments made by it did not
attract the liability for deduction of tax at source. Therefore, when the
amounts were distributed among the investors, no tax was deducted at source, as
the returns of the investments made from the fund were received by the
fiduciary and the custodian. It was also submitted that the scheme did not
bring about a relationship of debtor and creditor or borrower and lender and,
therefore, the definition of ‘interest’ in section 2(28A) did not apply to the
facts of the scheme.

The High Court held that the definition of interest, after referring to
the interest payable in any manner in respect of any money borrowed or debt
incurred, included the deposits, claims
and ‘other similar right or obligation’ and observed that the statutory
definition included amounts which might not otherwise be regarded as interest
for the purpose of the statute. Even amounts payable in transactions where
money had not been borrowed and debt had not been incurred were brought within
the scope of the definition, as in the case of a service fee paid in respect of
a credit facility which had not been utilised. Even in cases where there was no
relationship of debtor and creditor or borrower and lender, if payment was made
in any manner in respect of any money received as deposits or on money claims
or rights or obligations incurred in relation to money, such payment was, by
the statutory definition, regarded as interest.

The scheme operated by the assessee imposed an obligation on the
assessee to repay the investor at the end of the period of 36 months, and also
to ensure a monthly payment of 1.5 percent to the investor during that period.
This obligation to repay, in the opinion of the High Court, was an obligation
akin to a claim or a deposit, to which reference was made in the definition of
interest. The payment made by the assessee being a payment made in respect of
an obligation incurred under the terms of the offer memorandum, was regarded as
interest falling within the scope of section 2(28A). The fact that the assessee
did not choose to characterise such payment as interest was not considered as
relevant by the High Court.

West
Bengal Housing Infrastructure Development Corpn. Ltd.’s case

The issue of the interpretation of the definition of the term
‘interest’, in the contest of section 194A, again came up before the Calcutta
High Court in the case of Pr. CIT vs. West Bengal Housing Infrastructure
Development Corpn. Ltd. 96 taxmann.com 610.

The assessee was a
company engaged in the business of development of land, housing and
infrastructural facilities in New Town Projects, Kolkata. For assessment year
2005-06, it claimed a deduction of expenditure amounting to ` 9,71,17,977 which was in the nature of compensation for delay in
delivery of plots. As per the offer for allotment of plot of land developed by
the assessee, the assessee was under an obligation to hand over physical
possession of the plot to the allottees on payment of the entire cost of the
land and registration of sale deed.

If possession of
the plot was delayed for more than six months from the scheduled date of
possession, the assessee had to pay interest on installments already paid by
the allottee during such extended period, at the prevailing fixed term deposit
rates, for similar period offered by the State Bank of India. According to the
assessee, although the relevant clause of the allotment letter used the
expression “interest”, the actual nature of payment was in the nature
of damages for delayed allotment of a plot and not in the nature of interest.

Rejecting the explanation of the assessee, the assessing officer viewed
the payment to be in the nature of interest, and disallowed the expenditure
claimed by the assessee u/s. 40(a)(ia), on account of the failure of the
assessee to deduct tax at source u/s.194A. The CIT (A) confirmed the order of
the assessing officer. Upon further appeal, the Tribunal held that the amount
in question could not be characterised as interest within the meaning of
section 194A, and hence there was no obligation on the part of the assessee to
deduct tax at source. Accordingly, it deleted the disallowance made by the
assessing officer and confirmed by the CIT(A).

Before the High Court, on behalf of the revenue, it was argued that the
amount in question was covered by the definition of interest as provided in
section 2(28A). Reliance was placed on the decision of the Madras High Court in
the case of Viswapriya Financial Services & Securities Ltd. (supra). Reliance
was also placed on the decision in the case of CIT vs. Dr. Sham Lal Narula
50 ITR 513 (Punj), for the proposition that the amount paid in lieu of
delayed payment of compensation to which a person was entitled on the
acquisition of his land was in the nature of interest¹.

On behalf of the
assessee, it was argued that the amount payable by the assessee on account of
delay in delivering the plots was not interest within the meaning of section
2(28A), since the contract, in the instant case, was for sale of land by the
assessee to the allottee; the assessee did not borrow any money or incur any
debt; and no money was due by the assessee to the allottee. There was no
debtor-creditor relationship between the parties. The ‘right’ must be to a sum
of money and the ‘obligation’ must also be in respect of a sum of money. The
right of an allottee to obtain possession of land and the obligation of the
assessee to deliver possession therefore did not fall within the purview of the
definition. Reliance was also placed on the decision of the Himachal Pradesh
High Court in the case of CIT vs. H.P. Housing Board 340 ITR 388
wherein, on an almost identical set of facts, it was held that the amount paid
by the assessee (H.P. Housing Board, in that case) was not payment of interest,
but payment of damages to compensate the allottee for the delay in the
construction of his house and the harassment caused to him.

Additionally, the assessee also contended that taxing statutes must be
strictly construed and any doubt must be construed against the taxing
authorities and in favour of the taxpayer.

As far as the definition of ‘interest’ was concerned, the High Court
held that the term ‘interest’ had been made entirely relatable to money
borrowed or debt incurred, and various gradations of rights and obligations
arising from either of the two. The parenthesis in the section was in the
nature of a qualification of the borrowing of money/incurring of debt and what
it included.

On the facts of the case, the High Court held that the payment made by
the assessee to the allottee was in terms of the agreement entered between
them, where the liability of the assessee would arise only if it failed to make
the plots available within the stipulated time. Hence, the payment made under
the relevant clause of the letter of allotment was purely contractual and in
the nature of compensation or damages for the loss caused to the allottee in
the interregnum for being unable to utilise or possess the flat. It had the
flavour of compensation and the expression ‘interest’ used in the concerned
clause might be seen merely as a quantification of the liability of the
assessee in terms of the percentage of interest payable by the State Bank of
India. Since there was neither any borrowing of money nor incurring of debt on
the part of the assessee, it was held that the interest as defined u/s. 2(28A)
had no application to such payments.

__________________________________________________

1 Though the
revenue relied upon this decision and claimed that such amount paid in lieu of
delayed payment of compensation was regarded as interest, the High Court in
that case refrained itself from dealing with the question as to whether the
said amount was “interest” or “compensation”. The High Court in that case had
considered the essence of the transaction more than the nomenclature and dealt
with the issue as to whether the said amount was a “capital receipt” or
“revenue receipt”.

While holding so, the High Court preferred to rely upon the decision of
the Himachal Pradesh High Court in the case of H.P. Housing Board (supra) over
the decision of the Madras High Court in the case of Viswapriya Financial
Services & Securities Ltd (supra).

Observations

From the features of the scheme operated in Viswapriya’s case as
presented before the High Court, it appears that the scheme was similar to the
portfolio management scheme. In the case of portfolio management scheme, the
fund manager invests the funds of the investors and the gains generated by it
accrue to the investors. The fund manager receives the management fees for
managing the portfolio.

In Viswapriya’s case, the assessee had guaranteed a minimum
return with the condition that its management fees would get reduced to the extent
it failed to provide the guaranteed return. Therefore, as per the facts as
presented before the High Court, the only consequence of inability to provide
the guaranteed return was forgoing of the management fee to the extent of
shortfall and nothing more. Had it been the obligation of the assessee to
compensate the shortfall out of its own capital, then perhaps the view taken by
the High Court would have been justified.

In a similar case of chit funds, where the funds belong to the
contributors, various High Courts have taken a view that the bid discount and
dividend to contributors does not amount to interest. The logic is that bid
amount which is distributed among all the subscribers/members is not in respect
of any money borrowed by the chit fund company or any debt incurred by it.

Reference may be made to the following decisions in this regard:

CIT vs. Sahib Chits (Delhi) Pvt Ltd 328 ITR 342
(Del)

CIT vs. Avenue Super Chits (P) Ltd 375 ITR 76
(Kar)

CIT vs. Panchajanya Chits (P) Ltd 232 Taxman 592
(Kar)

The similar logic should have applied equally in Viswapriya’s
case. It appears that these cases have not been cited before the Madras High
Court nor the distinction between the interest, a definite liability, and the
return of gain to the one on whose behalf it was earned has been appropriately
highlighted.

A careful analysis of the definition of ‘interest’ as provided in
section 2(28A) reveals that, in order that a particular payment is regarded as
‘interest’ the following conditions should be satisfied –

1. The payment should be
interest, service fee or other charge.

2. It should be in respect of any
money borrowed or debt incurred including a deposit, claim or other similar
right or obligation and credit facility which has not been utilised.

3. It is payable in any manner.

Not all payments can be considered as ‘interest’, unless the payment
can be termed as the interest, service fee or other charge. The legislature in
its wisdom has used the words “interest” and not just “any amount”.
Therefore, an amount paid, which is not an interest in form and in substance,
cannot be brought into the definition of the term to deem it as interest. The
very fact that the definition, in its second limb, has specifically included
‘any service fee or other charge’ within its scope suggests that the ‘interest’
in its extended meaning includes service fee and other charge and nothing else.
If the first limb was capable of including any type of payment within its
scope, which is in respect of money borrowed or debt incurred, then the second
limb would become otiose. Such an interpretation is against the basic rule of
harmonious construction, whereby an interpretation which reduces one of the
provisions to a dead letter should be avoided. In short, unless the payment can
be classified as an ‘interest’ in its ordinary meaning of the term, it would
not be termed as ‘interest’ u/s. 2(28A) unless of course, the payment
represents the service fee or charge of the specified kind.

In the case of Viswapriya Financial Services & Securities Ltd.,
the amount paid by the assessee under the investment scheme floated by it can
also not be characteriSed as interest as per its general meaning. Interest is
something which is paid from one’s own income or capital. In the kind of
investment scheme operated by the assessee, the money was received from the
investors and retained by it in its fiduciary capacity. The assessee did not
become the owner of that money. The accumulated money was invested by the assessee
on behalf of the investors and the return earned by investing such money had
been distributed back to the investors who were entitled to it.

The Madras High Court was also swayed by the fact that the assessee had
guaranteed a certain percentage of return on investment made by the investors.
However, there may be several such arrangements under which the minimum return
has been guaranteed. For instance, a builder may assure a guaranteed repurchase
price to the investors. A life insurance policy may also have a minimum sum
assured on maturity to the policyholder. The differential amount in such cases
cannot be considered as an ‘interest’ merely because there is an obligation to
pay the amount with a pre-determined rate of return.

In the context of the certificates of deposit and the commercial paper
which are issued at a discount, the CBDT vide its Circular No. 647 dated
22-3-1993 has clarified that the difference between the issue price and the
face value is to be treated as ‘discount allowed’ and not as ‘interest paid’
and, therefore, the provisions of section 194A are not applicable to it. Thus,
the payment, even though in respect of the borrowing, has not been treated as
interest, as it is understood to be the discount and not the interest.

Guidance can be obtained from the decision of the High Court of Punjab
in the case of CIT vs. Sham Lal Nerula 50 ITR 513² for
understanding the general meaning of interest as quoted below:

“Interest” in general terms is the return or compensation
for the use or retention by one person of a sum of money belonging to or owed
to another. In its narrow sense, “interest” is understood to mean the
amount which one has contracted to pay for use of borrowed money.
“Interest” in this sense may be placed broadly in three categories.
The first kind is interest fixed by the parties to the bargain or contract,
that is, “interest'” ex pacto or ex contractu. The second kind of
“interest” is conventional interest, determined by the accepted
usage, prevalent in a trade or a mercantile community. This is also called ex
mora. In the third category may be placed the legal interest allowed by law or
where the court is empowered by the statute to grant interest generally or at a
fixed rate, that is, ex lege.

_______________________________________________

2 This decision is pertaining to the assessment
years prior to 1-6-1976 the date from which the definition of the term
‘interest’ was inserted in the Act.

The High Court of Punjab relied upon the decision of the House of Lords
in Westminster Bank Ltd. vs. Riches [1947] A.C. 390 / 28 Tax Cas. 159.
It was a case where a decree was passed against the Westminster Bank for £
36,255 as representing a debt due to Riches. In the exercise of its statutory
powers, the court also awarded a further sum of £ 10,028 as representing
interest due on the debt from the date when the cause of action arose. The
issue before the House of Lords was whether the additional sum of £ 10,028 was
taxable, being in the nature of income. The appellant contended that the
additional sum of £ 10,028, though awarded under a power to add interest to the
amount of the debt, and though called interest in the judgment, was not really
interest attracting income tax, but was damages.

In this context, Lord Wright observed:

“The appellant’s contention is in any case
artificial and is, in my opinion, erroneous, because the essence of interest is
that it is a payment which becomes due because the creditor has not had his
money at the due date. It may be regarded either as representing the profit he
might have made if he had had the use of the money, or conversely the loss he
suffered because he had not that use. The general idea is that he is entitled to
compensation for the deprivation. From that point of view it would seem
immaterial whether the money was due to him under a contract express or
implied, or a statute, or whether the money was due for any other reason in
law. In either case the money was due to him and was not paid or, in other
words, was with-held from him by the debtor after the time when payment should
have been made, in breach of his legal rights, and interest was a compensation,
whether the compensation was liquidated under an agreement or statute, as for
instance under section 57 of the Bills of Exchange Act, 1882, or was
unliquidated and claimable under the Act as in the present case. The essential
quality of the claim for compensation is the same, and the compensation is
properly described as interest.”

Though interest has been interpreted as including the damages or
compensation for deprivation in the aforesaid decision, it may not be true in
every case, in view of the subsequent insertion of the specific definition in
the Act. As per the definition, the interest should be one which is payable in
respect of –

– any moneys borrowed

– debt incurred

– deposit

– claim

– other similar right or obligation

– Credit facility, utilised or not.

Something which is not payable in respect of any of the above, cannot
be regarded as interest for the purpose of the Act, though can be regarded or
called as interest otherwise as per the principles laid down in the aforesaid
decisions.

The first item in the above list is borrowing of money, which is simple
to understand, and there cannot be any debate with regard to it. The second
item refers to the ‘debt incurred’ and the term ‘debt’, though not defined
further in this section, has been defined in section 94B as follows:

“debt” means any loan, financial instrument,
finance lease, financial derivative, or any arrangement that gives rise to
interest, discounts or other finance charges that are deductible in the
computation of income chargeable under the head “Profits and gains of
business or profession”.

The term ‘deposit’ is defined in section 269T as follows:

“loan or deposit” means any loan or
deposit of money which is repayable after notice or repayable after a period
and, in the case of a person other than a company, includes loan or deposit of
any nature.

Though both the above definitions have limited applicability to the
relevant Sections, it will have a persuasive value in order to understand their
meaning in the context of the definition of the term ‘interest’.

It can be seen that the common feature of all of the above items is
that there should be an involvement of money. As far as the borrowing is
concerned, the reference to ‘any moneys’ makes it clear that it cannot include
borrowing of non-monetary assets, for instance, borrowing of securities under
Securities Lending and Borrowing Scheme. As far as incurring of debt is
concerned, it can be a monetary debt or even a non-monetary debt. However, in
the context of this definition and considering the other preceding and
succeeding terms, it should be read in the narrow sense by applying the
principles laid down by the Supreme Court in the case of CIT vs. Bharti
Cellular Ltd. 330 ITR 239. In this case, the words “technical
services” have been interpreted in the narrower sense by applying the rule
of Noscitur a sociis, because the words “technical services”
in section 9(1)(vii) read with Explanation 2 comes in between the words
“managerial and consultancy services”. Therefore, incurring of a debt
not having monetary involvement should not be considered for the purpose of
interpreting the definition of the term ‘interest’.

Apart from borrowing of money and incurring of debt, the definition
also includes “deposit, claim or other similar right or obligation” in
parenthesis. As involvement of money is regarded as essential criteria, the
right must be to a sum of money and the obligation must also be in respect of a
sum of money. The Madras High Court has interpreted the term ‘obligation’ as
including the obligation to repay the money received. However, the definition
refers to a ‘similar’ right or obligation. Therefore, any and every obligation
in respect of money does not get covered unless it is similar to the borrowing
of money or incurring of debt. For instance, preference share capital cannot be
considered as a ‘similar obligation’.

Reference can also be made to CBDT’s Instruction O.P. No.
275/9/80-IT(B) dt. 25-1-1981 which dealt with the issue of applicability of
s/s. 94A to the hire purchase instalment paid by a hirer to the owner under a
hire purchase contract. The relevant portion of the circular is reproduced
below:

4. It has to be considered whether the payment of any instalment or
instalments under a hire purchase agreement can be said to be by way of
interest in respect of any moneys borrowed or debt incurred. In this context,
it has to be borne in mind that a hire purchase agreement is a composite
transaction made up of two elements bailment and sale. In such an agreement,
the hirer may not be bound to purchase the thing hired. It is a contract
whereby the owner delivers goods to another person upon terms on which the
hirer is to hire them at a fixed periodical rental. The hirer has also the
option purchasing the goods by paying the total amount of the agreed hire at
any time or of returning before the total amount is paid. What is involved in
the present reference is the real nature of the fixed periodical rental payable
under a hire purchase agreement.

5. It may be pointed out that part of the amount
of the hire purchase price is towards the hire and part towards the payment of
price. The agreed amount payable by the hirer in periodical instalments cannot
be characterised as interest payable in any manner within the meaning of
section 2(28A) of the Income-tax Act. It is in the nature of a fixed periodical
rental under which the hire purchase takes place.

6. It is true that the definition of the hire
purchase price in section 2(d) of the Hire Purchase Act, 1972, also refers to
any sum payable by the hirer under the hire purchase agreement by way of
deposit or other initial payment or credit or amounts to be credited to him
under such agreement on account of any such deposit or payment. But such
deposit or payment is not in respect of any money borrowed or debt incurred
within the meaning of section 2(28A) of the Income-tax Act.

7. In view of the above, it would appear that the
provisions of section 194A will not be attracted in the case of payment of
periodical instalments under a hire purchase agreement.

Thus, deposit not in the nature of
money borrowed or debt incurred has been considered to be not relevant for the
purpose of interpreting the definition of the term ‘interest’. It strengthens
the view that “deposit, claim or other similar right or obligation” in
parenthesis should also have the element of borrowing of money or incurring of
debt. Similarly, in the case of bill discounting and factoring, where the bill
or debt is assigned to the bank/financial entity, various High Courts have
taken the view that the discount or factoring charges in such cases does not
amount to interest, given that such transactions amount to assignment of the
bill or debt, and discounting or factoring charges paid were not in respect of
any debt incurred or money borrowed. Reference may be made to the following
cases:

CIT vs. MKJ Enterprises Ltd 228 Taxman 61
(Cal)(Mag)

Principal CIT vs. M Sons Gems N Jewellery (P.)
Ltd 69 taxmann.com 373 (Del)

CIT vs. Cargill Global Trading (P) Ltd 335 ITR 94
(Del) – affirmed by the Supreme Court in 21 taxmann.com 496

Attention is also invited to the decision of the Allahabad High Court
in the case of CIT vs. Oriental Insurance Co. Ltd. 211 Taxman 369. The
High Court was dealing with the applicability of section 194A on delayed
payment of compensation for accident under the Motor Vehicle Act. The relevant observations of the Court are
reproduced here:

37. The necessary ingredients of such interest are
that it should be in respect of any money borrowed or debt incurred. The award
under the Motor Vehicle Act is neither the money borrowed by the insurance
company nor the debt incurred upon the insurance company. As far as the word
“claim” is concerned, it should also be regarding a deposit or other
similar right or obligation. The definition of Section 2(28A) of the Income Tax
Act again repeats the words “monies borrowed or debt incurred” which
clearly shows the intention of the legislature is that if the assessee has
received any interest in respect of monies borrowed or debt incurred including
a deposit, claim or other similar right or obligation, or any service fee or
other charge in respect of monies borrowed or debt incurred has been received
then certainly it shall come within the definition of interest.

38. The word “claim” used in the
definition may relate to claims under contractual liability but certainly do
not cover the claims under the statutory liability. The claim under the Motor
Vehicle Act regarding compensation for death or injury is a statutory
liability.

In the case of West Bengal Housing Infrastructure Development Corpn.
Ltd. 96 taxmann.com 610, the Calcutta High Court was dealing with
altogether different facts as compared to Viswapriya’s case. The High
Court rightly held that the rights and obligation referred in the definition
should be arising either from borrowing of money or incurring of debt.
Therefore, the interest payable on account of failure to deliver a particular
asset on the scheduled date as per the agreed terms does not fall within the
definition of the term ‘interest’ under the Act. Though such compensatory
payment could have been regarded as interest as per the principles laid down in
the case of CIT vs. Sham Lal Nerula and Westminster Bank Ltd. vs. Riches,
the statutory definition does not recognise it as interest in the absence of
any borrowing of money, incurring of (monetary) debt or other such similar
arrangements having monetary involvement in respect of which the payment has
been made. Perhaps for similar reasons, the interest payable under the Real
Estate (Regulation and Development) Act, 2016 on account of the failure of the
promoter as envisaged in Section 18 of that Act may also not be regarded as
interest for the purpose of the Act.

This
analysis is restricted to the interpretation of the term ‘interest’ mainly from
the point of view of applicability of section 194A.

shailesh.kwebmaker

Rainmaking – In The Monsoon Of Our Time

In traditional parlance, a rainmaker has been a
term used to allude to the Native American practice of dancing to encourage
deities to bring forth the rain necessary for crops. In summertime during a
drought, for instance, the rainmaker would dance and sing songs on the plains,
and this activity was believed by others in the tribe to magically cause clouds
to come and bring the life-giving rain.

In today’s environment, a rainmaker is someone
with a Midas touch who ‘magically’ brings new business and clients to a firm or
generates more revenue from existing customers and donors, and rain is a
metaphor for money.

Having a rainmaker on your team can be a huge
asset, as well as a liability. As assets, there is the obvious: rainmakers can
bring in unprecedented amounts of revenue into your practice, making money flow
through your firm like actual rain in a Mumbai monsoon. Typically, they are
confident individuals whose optimism is infectious, making sure your firm is
constantly high on positivity. Because they are very good at positioning you in
front of clients, rainmakers can raise the image of your firm, and make sure
that they close deals.

Unfortunately, rainmakers have a downside as well:
they are typical good at doing the job, not so much as explaining how they got
it done, which makes them poor mentors and teachers. They can be high
maintenance and arrogant, and find it difficult to work with people in
authority. The biggest disadvantage of rainmakers however, is that they are
well aware of their own importance to the firm, and can hold it hostage, making
outrageous demands and throwing huge tantrums.

Rainmakers are outgoing, social and well-connected
individuals, always looking to make connections and open new avenues for fresh
business opportunities. While all of us may not be Harvey Specter (the
rainmaker on the popular Netflix show ‘Suits’), over 20 years in the profession
have taught me that we all need to ignite the rainmaker within us in order to
survive and stay relevant in today’s hyper-competitive market.

With the exponential growth of the Indian economy
in the past 20 years, there has been a corresponding increase in demand for
legal, accounting, trusteeship secretarial and administrative services. The
impact of this has been two-fold: on one hand, there has been a further
expansion of the Big 4 firms and their service offerings. Conversely, there has
been a break-away of the old guard and a mass migration of rainmaker
professionals who take with them, highly experienced leadership teams and go on
to set up boutique Indian firms (with a pan-India presence), and in some cases,
Indian tax advisory firms with global offices. This surge in entrepreneurship
has caused a huge disruption in the way in which larger, more established firms
attract new business and retain existing client relationships.

In the legal services market there has been
consolidation of some of the national legal firms with footprints across India.

Parallelly, the emergence of young entrepreneurial
firms, many of which are break-aways from old firms who start their independent
practices which offer a one-stop solution to their clients, has caused a
fragmentation in the market.

The traditional approach in business development
of professional services firms has had an unwritten rule: a strong aversion to any form of promotion, marketing or any other form of
solicitation of new clients or work.

In fact, the term ‘business’ was seldom used by
seasoned tax and legal professionals in the course of describing the nature of their work. Most professionals have held on to an image of being ‘service
providers’ who are sought after and approached by clients for their expertise
and advise.

The evolution of the legal and regulatory
landscape, along with increased transparency in procedures and initiatives by
the government resulting in “ease of doing business in India”, has impacted the
traditional sources of (bread and butter) work and revenue for
professionals.The professional services industry has also witnessed rapid
changes and development in the regulatory landscape with the introduction of a
new Companies Act and Good & Services Tax. New areas of practice such as
forensic accounting, competition law and trade law have developed, creating
additional opportunities for super-specialisation and novel service offerings
such as pre-emptive and strategic advice to clients. Artificial Intelligence
and technology have mechanised and caused the commoditisation of several
service offerings, forcing firms to cut fees and costs charged to clients.
There is innovate software available in the market that has automated the work
that was previously achieved by human effort. To further compound the
situation, the number of chartered accountants, lawyers and company secretaries
that have entered the profession over the past decade is also rising
exponentially, and all this while the pie of work has not grown proportionally.

The costs of doing business by professionals
(office rent and overheads, salaries, etc.) have also increased substantially.
The escalation in costs have well exceeded the growth of businesses and there
is a huge gap between the two. All these factors have resulted in a
hyper-competitive environment with price wars between firms and significant
undercutting of fees to capture market share and clients. There is no longer
any rationality between the fees that can be charged for a piece of work and the effort taken by the professional to perform the work.

Given the compounded effect of business disruption
by technology and automation, increase in competition and price wars amongst
professionals, it is imperative for professionals to adopt marketing strategies
to develop their practice, remain relevant and stay ahead of the curve.

This can be achieved in relatively simple ways and
with proper planning does not necessarily require significant time and effort.

Contribution of Articles: There is nothing as ego-boosting as a
by-line! The law and all legal matters have moved beyond the realm of purely
legal journals and sections dedicated to law and all things legal, and into the
regular broadsheets of almost all publications. Contributing articles and
opinion pieces to mainstream newspapers and magazines helps members of our
reticent community get into the public eye. The challenge is to make sure that
you avoid legalese and technical jargon, and write your pieces in a way that
appeal not just to your legal brethren but also to the public at large.

Quotes: A great way to make yourself visible is to
establish yourself as an ‘expert’ or ‘go-to’ person for journalists on legal
and tax issues and topics. All this would involve is the journalist calling or
emailing you for your comments on any issues that form the subject of your
article. It is a much simpler and more effective way of making yourself known,
with very little effort on your side. You would need to cultivate a few
journalists however, and make sure that you are available to them whenever they
need a quote.

Conducting Workshop for Clients: Clients look to you as experts who know
of the latest developments in the field. While the nitty-gritty of the legal
and tax world does not have to concern them, it is always useful to share basic
knowledge with your clients on these matters. When the Goods & Services Tax
was introduced across India in 2017, a number of professional services firms
organised workshops and seminars for their clients to explain the workings and
impact of this new tax regime to them. Most firms use these workshops as an
opportunity to network and touch base with clients, and hence they are invitee
events. A quicker, more cost-effective way to conduct such workshops is to host
webinars. All you need is a stable Internet connection, a webinar platform and
prior intimation to potential attendees.

Speaking at Conferences and Seminars: Speaking as opposed to attending
conferences and seminars, adds a lot more value to the brand equity of a
professional. This is one of the most effective, yet under-rated ways of
marketing oneself and ones’ services. Professionals who excel at this have got
their name on the speaker circuit and are often invited to prestigious events
as a keynote speaker or part of a panel, or even as moderator for a panel
discussion. Whichever role you get invited for, conferences and seminars are a
great way to get in the limelight and network with a large audience who could
translate into clients. The best way to organise this is to liase with event
organisers specialising in legal and tax conferences and seminars, and become
an indispensable part of their list of speakers.

Newsletter: Sending out a newsletter to clients is a great
way to be in regular touch with them. The newsletter needs to be attractively
presented, contain short snippets and articles and need not be more than 1-2
pages long. Alternatively, the newsletter could be a shorter update on recent
developments in the field or event alerts.

Change is the only constant in life, and as legal
and tax professionals, it is imperative that we let go of the old guard and
embrace new ways to networking and creating business for ourselves. ‘Those who
snooze, lose’, as the saying goes, so it is time we woke up, smell the coffee
and jumped on the marketing bandwagon so that we continue to stay relevant in
this dynamic and rapidly changing world.

shailesh.kwebmaker

Economic War

1. Preface

This is a simple
and short article explaining ‘what is an economic war’. The term: “Trade War”
has become current term. Earlier popular term was “Currency War”. Economic War
is a broader term covering all these smaller wars.

Some common queries
may be: “Why this War?” “What may be the impact of a global economic war on
India/ on global economy?” “Can we protect India from the ill effects of a war
amongst other nations?” “How is it that President Trump imposed sanctions on
Turkey (In August 2018) and Indian Rupee went down?”

This article
presents:

(i) Historical reasons leading to current
Trade War; and

(ii) A few probabilities as results of war. These are considered guesses.
I don’t know actually how future will unfold.

Global events like
Economic Wars are like “elephants”. Writers and observers are like “the
six blind men”. Everyone looks at one or two aspects. Warring parties
involved also create deliberate confusions. I am presenting my views. There are
several other views simultaneously prevalent. Some philosophical thoughts on
Wars are given in notes at the end of the article.

1.2 Definition: An
Economic War is fought mainly for economic benefits using economic instruments
as weapons. Its economic impact can be more devastating than a weapons war. And
yet, there may be no loss of life – at least directly due to war.

1.3 When the war is between a
giant like USA and a smaller country like Venezuela; the smaller nation may get
economically destroyed. When the war is between two giants like USA &
China, both may be damaged. If a full scale Economic World War erupts,
global economy can be seriously damaged. Whole world will be poorer.

Share markets should normally be the first victim. Yet, even now the market
indices have not fallen. This may be because: (i) the cartel of share market
giants may be convinced that all these “War Cries” are just Trump’s typical
style of negotiating. Once the declared opponents concede, there will be no
war. Or (ii) they may be offloading their stocks to the gullible retail
investors. Or (iii) the Cartel may have some other strategy.

1.4 Different economic
weapons are:

i) Currency exchange rate manipulation or
currency dumping (also called Currency War);

(ii) Globalisation & imposition of a particular
currency at the cost of others (Dollarisation);

(iii) Tariffs (Custom duties);

(iv) Import restrictions of the licensing type &
others;

(v) Nationalisation of assets & businesses
belonging to enemy Government and citizens of enemy country. US government has
done this repeatedly.

(vi) Sanctions; rhetoric & threats; etc.

(vii) Finally when
nothing works, weapons wars have been unleashed in the last few decades. The threat
of real weapons war makes rhetoric work. North Korean dictator Kim Jong-un knew
well that his fate will not be different from the fate of Iraq’s Saddam Hussein
and Libya’s Gaddafi. Hence, Kim came to the negotiating table.

1.5 Almost all wars
are fought for economic reasons (Greed of exploiting other nations’
resources for own benefit) and/or for ego issues. Even in today’s modern
world, large nations may go to war largely for ego. Generally many issues are
mixed up as the cause for a war. Mahabharat war was fought largely for
economics & ego. Duryodhan was greedy & egotist. He would not fulfil
his promise. War became necessary. Hitler started 2^nd world war for
redeeming the German pride & for economic reasons. USA has started current
trade war with China & several other countries mainly for economic reasons.

1.6 Many people are
greedy. This applies to individuals, societies, corporates and countries.
They want economic benefits at the cost of others. Generally they will start
with exploitations. If the exploited person, group, market does not
understand, fine. If, even after understanding, the exploited group cannot
fight back, there is apparent peace – which in economics may be called “Equilibrium”.
When someone resists, the equilibrium is disturbed. Systems are established
to frustrate resistance. When systems do not work and exploited people/
countries fight back; there may be a weapons war. Generally the exploited lobby
is further destroyed. Rarely the exploited sections win & exploiters lose the
war. Historians
praise victors.

Two illustrations
of economic exploitation within a country are given below: paragraphs 1.7 &
1.9.

1.7 Illustration 1: In
India the “Upper Caste” developed an entire caste system of exploiting the
“Lower Castes”. Religion & mythology have been used to confuse &
confound the poor people; and to establish & continue the exploitative
caste system. Similarly, religion & gender bias have been used by men to
exploit women. They (‘lower’ caste people & women) were deprived of even
education beyond their occupation by birth. It worked for thousands of years.
No amount of social reforms by several reformers including Gandhiji has
effectively removed Casteism from our society. (People living in big cities may
not have the idea of deep rooted caste prejudices in smaller towns &
villages.) Indian Constitution gave equal rights to women; and to every
individual irrespective of caste. Every Indian has a right to education. This
single step has maximum positive impact.

Indian Supreme
Court has now given equal rights to LGBT community & declared
individual freedom as corner stone of our constitution. But even these have
still not completely removed caste based prejudices and exploitations from our
society.

This is an
explosive subject & can provoke heated discussions on several issues.

1.8 My purposes for giving illustrations here are
to show that:

(a) Economic exploitation is all pervasive in
human life. Greed is almost like gravity – pulling every one down. Both
(Greed & Gravity) are not noticed in everyday life. Most people never
realise that they are: (i) exploiting others; and/or (ii) they are being
exploited. We Indians exploit others when we get opportunity. Exploitation is
not special to some people.

(b) At the same time, there can be NO
generalisations. Most social reformers have come from men and ‘upper
castes’.

(c) Exploitations have reversed also. As held by
Honourable SC in India, some backward caste people have abused the provisions
of The Scheduled Castes and Tribes (Prevention of Atrocities) Act, 1989. In
life there are several cross-currents.

1.9 Illustration 2: In USA, whole population is exploited
by business lobbies. Pharmaceutical Lobby and Insurance
lobby – to name two. For anyone in doubt, ask for costs of medicines and
medical services in USA; and compare with the costs in India. You will realise
how US residents are being exploited by Pharma lobby & Insurance lobby.

Banking Lobby

In the past, US
Government tightly regulated banks & financial institutions which
used public money. They were not allowed to indulge in speculation & in
derivatives with depositors’ money. The banking lobby got the regulations modified
and openly used public savings for dangerous speculation including derivatives.
Banks & Financial Institutions together brought about the Great American
Economic Crisis of the years 2007 & onwards. Economists of the world
know that ‘greed of banks and financial institutions’ was the primary cause for
the crisis. Nothing happened to bankers or to banking laws. Whole focus as
“Cause for Crisis” was shifted to tax planning; and BEPS programme was started
by G20 & OECD.

In USA, the weapons
lobby (Pentagon) is of course most powerful. Whole of USA is being
exploited for continuing wars and weapons productions. In fact, world has
financed American wars. This statement may look unbelievable. I have explained
it in some of my past articles. For a short statement, listen to CNBC interview
of Jack Ma – chairman of Alibaba at:

https://www.cnbc.com/video/2017/01/25/alibaba-chairman-jack-ma-on-meeting-donald-trump.html?__source=sharebar%7Cemail&par=sharebar

Current US initiated Trade War

2. Current
Trade War – started in July, 2018:

2.1 We come to current US
initiated Trade War. The Trade War has already started. So we are not
discussing empty theories. It is also possible that by the time, BCAS Journal
is printed and you read this article; a lot of developments would have taken
place.

2.2 To understand the
reason why Trump has started this trade war, we may consider several matters.

2.3 Trump’s theories: Trump claims that USA is the most liberal
country and rest of the world is taking undue advantage of USA. This is at the
cost of GDP, trade deficits and employment in USA. Since other countries are
not responding to his appeals; war is necessary. He also claims that USA is the
most powerful economy as well as army. So the war will be won by USA.

2.4 Trump has conveniently forgotten
past strategies implemented by USA. Today, when those strategies have
resulted in unemployment in USA, Trump loves to blame China & others. (See
Jack Ma’s interview on link given under paragraph 1.9 above and also see
paragraphs 5 & 6 below.)

2.5 War mongering: Every warrior – whether Individual or
Government – spreads several theories including incorrect theories that justify
the war. World has neither forgotten nor forgiven the campaign that US & UK
had spread when they decided to attack Iraq. They alleged after September 2001
(World Trade Centre attack by Al Qaeda) that Iraqi dictator Saddam Hussein had
accumulated “Weapons Of Mass Destruction” (WMD) which could be used
against..(?). It was known that Iraq neither had WMD nor the capability to
strike USA. It was later that the world realised that real purpose of attack
was – to punish Saddam Hussein – who defied US order to ‘sell oil only in US$’.
Saddam sold oil in Euro and got killed. Iraq got economically destroyed for not
obeying USA.

This is a clear
illustration of the hypothesis (Please see paragraph 1.6 above.) that: “when
economic exploitation is resisted, the victim is destroyed by weapons war”.
For eg., Saddam Hussein resisted US
Dollarisation of Iraqi crude oil exports. And Iraq was attacked by US. And
the world remained a silent spectator.

2.6 Even a strong army
may not open war on all fronts. But initially it seemed that Trump
opened up war on several fronts. He blamed almost all – (i) known adversaries
of USA as well as (ii) countries that considered themselves as strong allies of
USA. (Please see Note 1 below.) This second category includes Mexico, Canada,
UK & European Union (EU). After a lot of war rhetoric against EU; on 24^th
July, 2018, EU president Jean Claude Juncker met Trump and a temporary truce
has been signed. (Please see note No. 5 below.)

India has been
warned by Trump. But India is an insignificant trade partner of USA and hence
is on the low burner. (Don’t feel bad. We, Indians are still insignificant in
world economy.) There is also another equation of – using India to fight China.
So how USA behaves with India – is yet to be seen.

2.7 Some History: After 2^nd
world war, USA turned benevolent to all war victim countries including the
countries attacked by USA – Germany and Japan. To protect Western Lobby from
Russian threat, NATO was formed. Under NATO and similar other
agreements, the US army is present in every West European country and many
others. 72 years after the end of World War II, and 26 years after
dismemberment of USSR, US army is still present in Europe and several other
countries. Hence even Germany observes restrain while protesting against US
policies. Others have to simply toe the line.

2.8 Truth under the surface:
In USA, the President is most conspicuous person. He is the spokesman
for the whole Government. But his real power and impact may be far less than
apparent. There is an Establishment of think tanks, bureaucrats & lobbies
that works. They continue to work irrespective of the President for the time
being.

Illustration: When, in 1981, Ronald Reagan became the President, many
observers wrote him off as an ineffective failure from film industry. In 1982,
preparations for an Economic War against USSR started. (For some
details, see Note 2 below.) Reagan retired in 1988. The Economic attack on USSR
was made in the year 1992. Credit for the great event – destruction of USSR –
is being given to Reagan. However, who actually fought the war? The Establishment
which remains behind curtains fought the real economic war.

US policies (Paragraphs 3 to 6 below):

3. Super
Power No.1

3.1 It is US policy that US
should always remain Super Power No.1. All other countries should start from
No. 11 & onwards. If any country becomes so strong that it can challenge;
or does challenge US authority in some serious manner; it will be destroyed by
several alternatives available with USA. One of the alternatives is: Economic
War. Economic wars may take ten years preparations also.

3.2 I believe that an
action plan to hit China’s powers was already prepared long before Trump
decided to stand in election. Now that the Establishment has got a suitable
President, the war is started.

3.3 China has started
serious process to make Chinese Yuan a currency of international
trade. It has asked Russia, India and several countries to start their
bilateral trade in bilateral currencies. This is a challenge to the
Dollarisation of global trade.

China has started
serious endeavour to reduce its holding of US treasury bonds. China is
developing international foreign exchange markets in Yuan. This is a direct
challenge to Dollarisation of the international trade & investment.

China is today 2^nd
largest economy. Chinese military and mind-set are the only powers on
earth that can say “No” to USA. (Apart from President Putin of
Russia.) The “One Belt One Road”
project by China is an audacious plan to increase Chinese influence globally.
Expanding Chinese bases in South China Sea; building a chain of ports in
countries like Srilanka, Pakistan, Djibouti etc., is a threat to American ego
for its largest military presence all over the world.

These are more than
enough causes for USA to set in motion a plan to destroy China. The plan may or
may not be similar to the plan for USSR. The Establishment waited for
suitable opportunity and struck when suitable president was in chair. Further
plans will unfold as the days go by.

4. Dollarisation of Global Trade:

It is another
unwritten order that whole world should do its international trade in US $.
When this order is not obeyed, see what happens:

4.1 Iran & Venezuela are facing allegations of being
terrorist nations. Severe sanctions are imposed on them crippling common life.
Their offense: exporting crude oil in currencies other than US$.

4.2 South East Asian
countries – Indonesia, Thailand, South Korea, Malaysia, Philippines – went
insolvent in the year 1997 because they started exporting their goods to Japan
in Japanese Yen instead of US $. President Suharto of Indonesia committed
another offense of disobeying US order of allowing independence to East Timor.
(Population 12,00,000.) Suharto lost his power and Indonesia lost East Timor.

4.3 Iraq was attacked
and destroyed because it was selling oil in Euro. European Union understands
fully well that this is an indirect attack on EURO. However, EU can’t do much
except being a silent spectator.

4.4 EU launched Euro on 1^st
January, 1999. This was a challenge to Dollar
monopoly of international currency. Hence EURO suffered a massive
economic attack. Its exchange rate dropped from “1 Euro = $ 1.2” to “1 Euro = $
0.8”.

These are just some
illustrations of how US enforces Dollarisation of global trade &
investments – by fighting economic wars on the world.

4.5 Having Dollarised
global financial settlements, now US has Weaponised Dollar. She is using
$ as a weapon. If any nation, any bank or financial institution disobeys US
dictates, its international payments will be crippled. That entity’s international business will
almost be stopped.

5. Using World for
outsourcing labour:

Outsourcing is done
for many decades. Computer software outsourcing through the internet made it
famous. However, outsourcing manufacturing functions is far older tradition.

5.1 There was a time
when the US Establishment adopted a policy. “Reserve US manufacturing for high
tech products and for weapons. Even for high tech items US MNCs need to own
only the technology. Manufacturing was shifted abroad and commoditised. All low
value manufacturing should be outsourced.” First outsourcing started with Japan.
Then major supplier of labour was China. The Establishment’s theory was
as under. Manufacturing within USA has high labour cost. China can provide
cheap labour. So let China manufacture goods. US want only sales and
distribution of cheap goods from abroad. This way, US consumers would get goods
at cheaper prices. And MNCs will make higher profits. Around 1980, China was
‘advised’ to devalue its currency. Chinese currency was devalued from Two
Yuan per $ to Four Yuan per $. By the year 1993, Yuan depreciated to Eight
Yuan per Dollar.

5.2 A devaluation of Chinese
currency means: (i) US gets same goods for much less dollars. (ii) Chinese
individual exporter –who counts his profits in Yuan, feels that he is still
making good profits. (iii) China as a whole suffers massive losses. In fact
devaluation meant poor Chinese people subsidising rich Americans.

American MNCs would
go to China and set up factories there. China would feel happy as “foreign
direct investment” was flowing into the country bringing precious dollars.
However, all low value products and environmentally harmful production was
being shifted to China.

5.3 This was an
elaborate plan. Explaining it in easier terms would mean several pages of
article. I would end this second US strategy in short here.

6. Results of outsourcing were:

6.1 Americans were getting goods
at low prices. Inflation within USA was always under control.
American consumer was happy. American business made good profits in marketing
and distribution.

6.2 American labour
jobs were exported abroad. This was planned by US establishment. It was not
an unknown development. In a super capitalist country, it is a declared policy
that “there is no job security in USA.” Business creates several entry barriers
for competition and secures its safety. But as far as labour is concerned, it
has to simply hope. Simultaneously, even education is fully commercialised in USA.
It is very costly. Middle class and poor cannot afford higher education. Hence
supply of blue collar labour kept on increasing and employment opportunities
kept on going down.

6.3 This outsourcing
policy has gone on for a few decades. Whole generations of middle class have
become poorer than their parents. Trump realised this gap in US economic
system. He used it for his political advantage. Now, to fulfil his election
promise to bring jobs back to USA, he has to start a Trade War. This is what
the Establishment wants.

This is the
reason why USA has started a Trade War.

See preface
paragraph 1(i).

Summary so far: There is a serious challenge to USA’s Super Power status and
monopoly of Dollar. USA has started a pre-emptive strike before the challenge becomes
serious.

Note: US economic policies require decades of study to understand. It is
difficult to explain in one article. I have tried to simplify and summarise.
Another way of understanding real life economics is personal discussions at
BCAS study circle for International Economics.

7. Indian Government:

Very few Indians
give due importance to Economics Wars. Fewer still understand it. In these
chaotic and dangerous times we need a Government that fully understands the
risks to which whole world is now exposed; and implements plans to protect
Indian economy. In my humble submission our present Prime Minister understands
these matters far better than most other PMs. He has the will power and the
capability to protect Indian economy.

We may remember
that in 1992 & 1997 a cartel did attack primarily USSR and South East Asia.
Attacks on Indian economy were incidental. The 2007 American Economic Crisis
spread over almost entire globe. In all three instances, it was primarily GOI
and RBI which managed and protected Indian economy. Government bureaucracy
continues to be same – probably, now more competent and empowered. We should be
able to sail through.

Sadly, we do not
have any private sector think tanks that can help GOI.

8. Indian share market:

For a long period
Indian share market has behaved as if it has no connection with Indian economy.
In a war, such myths get exposed and destroyed. If the war is prolonged, Indian
share market can be badly affected.

9. Can we estimate how the Trade War will proceed
further?

What will be the
results for Global economy?

See preface
paragraph 1(ii).

The war can go any
which way. It is difficult to guess how it will go. And yet, there are people
with huge investments in global markets. Apart from investors in shares and
securities, there are large industrial investments that can be seriously
affected. They would want considered estimates of the consequences of the
current Trade War. Can anyone advise them? I cannot advise. But I am presenting
some extreme opposite probabilities.

Some probable
results:

9.1 Trump made all
kinds of noises, insults and threats against several countries. But he settled
without firing a single bullet – with North Korea and Mexico. There is a
compromise of sorts with EU. Canada may soon fall. It is possible that Trump
may win the “War on the World” simply by threats. Only China refuses to
succumb.

9.2 Past Economic Wars – Instruments used:

Some of the past
Economic Wars have shown that these wars are fought by US Government using
following instruments:

(i) media for
public mind manipulation; (ii) IMF, UN & World Bank; (iii) cartel of banks
& financial institutions (iv) American Think Tanks (v) fact that Dollar is
the global currency.

We may refer to all
these together as Economic War Group. Note that only USA has all these
war instruments.

Secrecy of their strategy is their strength. They will never tell “what” is
their target; and “how” and “when” they will try to achieve the target.

The issue of “When”
is answered as the Trade War with China has already started.

Let us assume that
Chinese Government is fully aware of this strategy of economic wars. To fight
this strategy, China needs similar group of international institutions under
its control; control over global media; global currency; and so on. It is well
known that no country other than USA has this strength. So, how can China win
the war? Make your own guess.

9.3 China’s possible alternative response:

In absence of a
comparable Economic War Group, what can China do? What can be the consequences?

Consider the war
background before proceeding.

1. USA is the largest debtor country.
Borrowing is now a compulsion. She needs to borrow every day $ 2 Bn. If the
world stops subscribing to US treasury bonds; US Government will stop
functioning.

2. Several countries around the world are fed
up of US hegemony. But “Who will bell the cat?” Who will throw the first
salvo? Once a nation strikes against US Economic war; many nations may join.

3. Trump is unpopular within and outside
USA. Long hand of law may catch up with Trump. Whether the next president will
be friendly with the “Establishment” or not; is an issue.

Possible
Response: Let us say, China takes following steps
& US responds step by step or at one stroke. (Note: This is pure
hypothesis. And yet, it is possible.) China owns largest quantity of US
treasury bonds and currency as its foreign exchange reserve.

CHINA

China dumps US
treasury bonds & currency worth one trillion Dollars in the market in
one day for cash settlement. Then China refuses to buy any further US treasury
bonds. China refuses to sell any goods to USA on credit or for $ payment. She
demands either gold or Yuan or commodities in payment for any export to USA.

USA

US Treasury bond
market can crash.

US Government &
Economic War Group can try to buy entire stock on the same day. This may not be
practical because China would demand cash payment. This would not be a
“futures” transaction. This would be sale by China “in Cash” for immediate
payment.

EU, Canada &
Mexico may follow China and refuse to sell goods on credit to US customers.

US need to borrow
every day. If the funds are not available, Government machinery will stop. It
has now happened several times that US Govt. could not pay its expenses &
non-essential services had to be stopped. Then the Govt. increased borrowing
limits & paid its expenses out of borrowings. Fiscal Cliff has been
discussed several times. It is a serious reality for which no American
Government has any solution. Real financial position of USA is weaker than what
is made out.

Now, if the world
stops lending to USA, what can US do? She will have to finance expenses by
simply printing notes. If there is no outside taker of US notes, deficit
financing will cause immediate and significant inflation. A country that
has not seen more than 2% inflation, will be shocked by 10% inflation.

More important, a
lot of commodities that US public takes for granted, will simply not
be available. US talks of shifting production from China to USA. Can it
start fresh factories in a short time? There can be huge uproar within USA
making US Government fall. So far, all wars have been fought beyond American
land. This war will be fought within USA. For the first time Americans
may suffer consequences of the war.

China’s response to
Economic War – by an attack on US $ – may work better if Japan, EU, Canada
& Mexico etc., join in the Economic World War. Normally US would succeed in
“divide & rule policy” & won’t allow all of them to join
together. However, the way Trump behaves, probability of a combined front
against USA has improved. Against a combined front USA is doomed. In absence of
a combined front, ‘who will win’ becomes uncertain. Only certainty will be –
world economy will be damaged.

9.4 How long the world will go
on fighting?

How can world
avoid all wars?

One solution
appears. If there were a World Government, all wars would be
unnecessary. We have a good experience also. In India, at some time, there were
more than seven hundred kingdoms. Huge amount of their resources were spent on
war & defence. Now India is one country. All Kingdoms have merged into one.
There is no war within India. Of course, there are differences and troubles.
But these can’t be compared with wars.

Another solution
may be: At the root of all wars, there are greed and ego. Consider –
hypothetically, a solution where greed and ego are replaced by love &
spirituality. There would simply be no wars of any kind. Not a single soul
would go without food, medical services, education & home. Then the form of
Government would be irrelevant.

May God Bless human
kind.

Notes:

Note 1. Allies: (See para No. 2.4) India, Pakistan, Britain or
any other country may consider itself to be a friend of USA. However, in
economics as in politics; no one is a permanent enemy and no one is a permanent
friend. Britain and European Union (EU) realised this fact when US cartel
attacked Euro on 1^st January, 1999 – the day of Euro’s launch.
Trump’s accusations against EU have made this fact abundantly clear.

Note 2. Outsourcing & Exchange Rates:
Japan:

In the year 1940,
Japanese Yen to US $ rate was 4 yen = $1. After 2^nd
world war defeat of Japan huge inflation took place in Japan. US occupied Japan
& controlled its economy. It is then that US outsourcing to Japan started.
Yen was depreciated to 360 Yen = $1.

After a few
decades, Japan grew in manufacturing strength. Japanese cars started winning
the competition with American cars. This is when Japan was asked to revalue its
currency. Eventually, it appreciated to 140 yen to a dollar in the year 1990.
And Japan went into deep recession. 1990s was called the lost decade for Japan.
By now rate has gone up to 112 yens per dollar.

US Strategy is: when a country is pure commodity supplier, its currency must be
down. When it starts competing with US manufacturers, its currency must
appreciate.

My observations: Japan is excellent in manufacturing and poor in international
economics. It followed the dictates of US Establishment in exchange rate policy
and suffers. China is refusing to obey the orders by the Establishment. Hence
the Trade War.

Note 3. An Illustration of past
Economic War: 1992 economic war on USSR.

In the year 1982
under president Reagan, US Establishment started preparations for economic war
against USSR. For the public & media consumption, “Star Wars” were started
to maintain US superiority in air war over USSR. Real strategy was – massive
expenditure in developing missiles and counter missiles made USSR insolvent, US
printed dollars & world grabbed dollars as $ was global currency. World
was financing US Star War. No one was buying USSR Rouble & hence no one
financed USSR in her Star War. Result was – USSR insolvency.

Reagan retired in
1989. In the year 1992 USSR was economically destabilised because of sudden
change from communist regime to democratic regime installed by President
Mikhail Gorbachev. KGB arrested Gorbachev and nation was thrown in chaos. At
that time the G4 – US, UK, France and Germany together with their cartel of
banks and financial institutions struck. USSR got divided into fifteen
countries and economically went insolvent. It got reduced from the position
of Super Power No. 2 to 11. USA won the Cold War without losing men or money.

Note 4. Strategies like outsourcing
may not be a Government of USA decision. Nor a one man decision. Initially,
businesses found it profitable to shift labour abroad. Then Government
supported it. Eventually it developed into a full national strategy.

Note 5. Trump’s negotiating
strategy is now famous. “First threaten the opponent with dire
consequences. When the opponent is mentally broken, negotiate on your own
terms.” This is what he did with North Korea and Mexico. This is how he
negotiated a temporary truce with European Union.

This truce has
given USA tremendous benefit. Consider the news that China was making overtures
with EU to make a joint attack on USA. EU was scared but was considering
joining hands with China. Now Trump has ensured that EU will stay with US.
China is the lonely warrior.

Note 6. More and more
nations are disillusioned about US hegemony. Finance Minister of Germany
– Mr. Heiko Maas came out with clear statement that – US is
using $ monopoly for suppressing other nations. Even the global Swift Payment
system based in Belgium is using US$ for settlements. EU must come out with its
own international settlement system independent of US $. Prime Minister Ms.
Merkel of Germany quickly contradicted. She said: US defence deal with Germany
is far more important. See the link –
https://www.politico.eu/article/angela-merkel-quashes-german-foreign-minister-heiko-maas-anti-american-dream/.

Soon French
President stated that US defence deal is no longer reliable. EU must not depend
exclusively on US for its defence.

Note 7. Ego: It is said: “Eleven Sadhus can stay in one
hut. But two Samrats cannot stay in one Samrajya”.

Note 8. Advait:

1. Indian philosophy of Advait has taught me
that “We are all one”. “?? ?? ?? ??” is a famous Indian slogan.

2. Hence no one is my enemy. When “We are all
one”; the concept of enemy is void ab initio.

3. We have to live in this practical Sansar
knowing the philosophy and yet being alert about people who, under the
influence of greed, are out to harm us. Protect ourselves. Protect the weak.
Hate none.

Note 9. Geeta:

Consider what Trump
representing US Government thinks: “I am the Super Power No. 1. I must get what
I demand. I can & will destroy all competition. Who can fight me?”

See here Geeta
chapter 16 shlok 14 as translated by Swami Chinmayanandji: (Without any
modification.)

“Businessmen in
the world, unknown to themselves, constantly chant this stanza in their heart
of hearts. “I destroyed one competitor in the market, and now I must destroy
the remaining competitors also.” …”In fact, what can those poor men do to stop
me from doing what I want?”… “Because there is none equal to me in any
respect…I am the Lord. I enjoy, I am the most successful man. I am strong in
influence, among political leaders, in my business connections, and in my bank
balance. I am strong and healthy….” This, in short, is the ego’s SONG OF
SUCCESS that is even hummed in the heart of a true materialist. Under the spell
of this Satanic lullaby, the higher instincts and the divine urges in man go
into a sleep of intoxication.

Most people keep
Geeta on one side while analysing commercial/ economic/ war matters. I
personally submit: Geeta is a way of life. Without incorporating principles of
Geeta in life, it (life) has no meaning at all. Consequences of a person’s
actions will be as projected in Geeta.

Nature has its own
way of dealing with any person (Individual, company or Government) who
continuously abuses others. Nature’s ways are unpredictable and beyond our
logic.

10. In my reading,
it is possible that the Trade wars started by USA – together will several other
factors; will bring about the downfall of USA. Then what? Some other greedy
people will exploit the world. Men have been fighting wars for thousands of
years. When will it stop?

Wars will stop when
people become free from forces of Maya – Greed and Ego. In other words, wars
will stop when people become spiritual.

shailesh.kwebmaker

Corporate Social Responsibility

1. Introduction

1.1 I
initiate the subject of Corporate Social Responsibility (CSR) with a sutra
written by Chanakya

Dharma – religion (ethics or commitment
to duty as a human being) is the nucleus of happiness. The core of dharma is
wealth or Artha. The stability of the state is the precondition for Artha
(wealth) in the state. The primary duty of the rulers/government is to be in
command over senses and emotions (perennially until they are ruling)

Corporate Social Responsibility (CSR)
is an evolving concept and represents the collective culmination of fundamental
desire of every human being to be happy and to direct the efforts of all to
make it happen.

1.2 General Aspects

Corporate Social Responsibility (CSR)
can be explained as the initiative of a company to assess and take
responsibility for the company’s effects on the environment and impact on
social welfare. The term, generally, applies to company’s efforts that go
beyond what may be required by regulators. Corporate social responsibility is a
form of corporate self-regulation integrated into a business model. CSR
functions as a built-in, self-regulating mechanism whereby a business monitors
and ensures its active compliance with the spirit of the law and its response
to societal needs.

1.3 The term
“corporate social responsibility” came into common use in the late
1960s and early 1970s after certain corporations formed the term stakeholder,
meaning those on whom an organisation’s activities have an impact. It was used
to describe corporate owners beyond shareholders.

1.4 A single
globally accepted definition of CSR does not exist. However, various
organisations have developed formal definitions of CSR, some of them are:

1.4.1 Corporate
Social Responsibility is the continuing commitment by business to behave
ethically and contribute to economic development while improving the quality of
life of the workforce and their families as well as of the local community and
society at large. – World Business Council for Sustainable Development.

1.4.2 Corporate
Social Responsibility is essentially a concept whereby companies decide
voluntarily to contribute to a better society and a cleaner environment. – European
Commission; Employment & Social Affairs.

1.5 Corporate
social responsibility offers manifold benefits both internally and externally
to the companies. Externally, it creates a positive image amongst the people
for its company and earns a special respect amongst its peers. Internally, it
cultivates a sense of loyalty and trust amongst the employees in the
organisational ethics. It can improve operational efficiency of the company and
can be accompanied by increase in quality and productivity.

1.6 The
essence of CSR comprises philanthropic, corporate, ethical, environmental and
legal as well as economic responsibility. In India, the evolution of CSR refers
to changes over time in cultural norms of corporations’ engagement and the way
businesses managed to develop positive impacts on communities, cultures,
societies, and environment in which those corporations operated.

1.7 In the
last decade, CSR has rapidly evolved in India with some companies focusing on
strategic CSR initiatives to contribute toward nation building. Gradually, the
companies in India started focusing on need-based initiatives aligned with the
national priorities such as public health, education, livelihoods, water
conservation and natural resource management.

2. CSR
in India – Legal Position

2.1 The
government introduced mandatory CSR requirements in Companies Act 2013. The
2013 Act mandates companies to spend on social and environmental welfare,
making India perhaps one of the very few countries in the world to have such a
requirement embedded in a corporate law. The CSR provision became effective
from 1^st April 2014. Significant amendments have been made to CSR
provisions through issuance of various notifications, clarifications (including
Frequently Asked Questions (FAQs)), Guidance Note on accounting for expenditure
on CSR (GN on CSR) by The Institute of Chartered Accountants of India.

2.2 As per
rule 2(c) of Companies (Corporate Social Responsibility Policy) Rules 2014 CSR
means and includes but it is not limited to –

i. Projects or programs relating to
activities specified in Schedule VII to the Act; or

ii. Projects or programs relating to
activities undertaken by the board of directors of a company in pursuance of recommendations
of the CSR committee of the Board as per declared CSR Policy of the Company
subject to the condition that such policy will cover subjects enumerated in
Schedule VII of the Act.

2.3 Applicable to certain companies

Section 135 (1) provides that every
Company having –

i. Net worth of rupees five hundred
crore or more; or

ii. Turnover of rupees one thousand
crore or more; or

iii. Net profit of rupees five crore or
moreduring the immediately¹ preceding financial year shall
constitute a Corporate Responsibility Committee of the Board.

As per rule 3 (1) of Companies
(Corporate Social Responsibility Policy) Rules 2014 every company including its
holding or subsidiary and a foreign company defined under clause (42) of
section 2 of the Act, having its branch office or project office in India which
fulfils the criteria specified in section 135(1) shall comply with the
provisions of section 135 of the Act and The Rules.

2.3.1 “Net
Worth” means the aggregate value of the paid-up share capital and all reserves
created out of the profits and securities premium account, after deducting the
aggregate value of the accumulated losses, deferred expenditure and
miscellaneous expenditure not written off, as per the audited balance sheet,
but does not include reserves created out of revaluation of assets, write-back
of depreciation and amalgamation.

2.3.2 “Turnover”
means the aggregate value of the realisation of amount made from the sale,
supply or distribution of goods or on account of services rendered, or both, by
the company during a financial year.

2.3.3 “Net Profit” means the net profit of a
company as per its financial statement calculated as per section 198 of the
Companies Act 2013, but shall not include the following: i. any profit arising
from any overseas branch or branches of the company whether operated as a
separate company or otherwise; and

ii. any dividend received from other
companies in India, which are covered under and complying with the provisions
of section 135 of the Act.

2.3.4 “average
net profits” shall be calculated in accordance with the provisions of
section 198 of the Companies Act 2013.

2.3.5 The net
worth, turnover or net profit of a foreign company shall be computed in
accordance with the balance sheet and profit and loss account of such company
prepared in accordance with the provisions of clause (a) of sub-section (I) of
section 381 and section 198 of the Act.

2.3.6 It has been provided that the net profits in
respect of a financial year for which the relevant financial statements were
prepared in accordance with he provisions of the Companies Act 1956, shall not
be required to recalculate the same in accordance with the provisions of
Companies Act 2013.

2.4 Constitution of the CSR Committee

2.4.1 Section
135 (1) provides that every Company covered by section 135(I) shall constitute
Corporate Social Responsibility committee with 3 or more directors, out of
which at least one director shall be independent director. In case where
company is not required to appoint an independent director under sub-section
(4) of section 149, it shall have in its CSR committee two or more directors.

A private company having only two
directors on its Board shall constitute its CSR Committee with two such
directors.

A foreign company shall constitute CSR
Committee comprising of atleast two persons of which one person should be
resident in India authorised to accept on behalf of the company service of
process any notices or other documents served on the company and another person
shall be nominated by the foreign company.

The composition of the Corporate Social
Responsibility Committee is required to be disclosed in the Board’s report
prepared under the Act.

2.4.2 The
2013 Act mandates that every company (including its holding or subsidiary, as
well as foreign companies having project office/branch in India) to undertake
CSR activities if they meet certain thresholds. One question which arises is
whether a holding or a subsidiary of a company (which fulfils the criteria for
CSR applicability under the 2013 Act) also has to comply with CSR provisions,
even if such holding or subsidiary itself does not fulfil those criteria. The
FAQs issued by the MCA clarify that a holding or a subsidiary of a company is
not required to comply with CSR provisions unless the holding or subsidiary
itself fulfils the CSR criteria.

2.4.3
It has also been clarified in the rules that every company which ceases
to satisfy the criteria mentioned above for three consecutive financial years
shall not be required to- a. constitute a CSR Committee; and

b. comply with the provisions contained
in section 135, till such time it meets the criteria specified in sub section
(1) of section 135.

2.5 Functions of CSR Committee

Section 135 (3) provides that the CSR
committee shall –

a. formulate and recommend to
the Board, a CSR Policy which shall indicate the activities to be undertaken by

the company as specified in Schedule VII; of Companies Act 2013

b. recommend
the amount of expenditure to be incurred on the CSR activities.

c. monitor
the Corporate Social Responsibility Policy of the company from time to time.

The Board shall take into account the
recommendations made by the CSR Committee and approve the CSR Policy of the
company.

2.6 CSR Policy and Report

Section 135 (4) provides that the Board
after taking into account the recommendations of CSR Committee, approve the CSR
policy for the Company and disclose the content of such policy on the Company’s
website.

The Board’s report to shareholders
pertaining to a financial year shall include an annual report of CSR containing
particulars specified in the Annexure to Companies (CSR Policy) Rules 2014.

2.7 Contribution under CSR

2.7.1 Section
135 (5) provides that every company referred in s/s. (1) shall ensure that the
company spends in every financial year at least 2% of the average net profits
of the Company made during the three immediately preceding financial years, in
pursuance of its Corporate Social Responsibility Policy.

If the Company fails to spend such
amount the Board shall in its report made under clause (o) of sub-section (3)
of section 134, specify the reasons for not spending the amount.

2.7.2 Contribution
of any amount directly or indirectly to any political party u/s.182 of the Act
shall not be considered as CSR activity.

3. CSR
ACTIVITIES

3.1 As per
rule 4 of Companies (Corporate Social Responsibility Policy) Rules 2014 CSR
activities includes activities undertaken by the Company as per its policy as
projects or programs either new or ongoing excluding activities undertaken in
pursuance of its normal course of business.

3.2 Activities which are included in CSR – As
per Schedule VII of Companies Act 2013

Activities relating to –

i.
eradicating hunger, poverty and malnutrition, promoting health care
including preventive health care and sanitation (including contribution to the
Swachh Bharat Kosh set up by the Central Government for the promotion of
sanitation) and making available safe drinking water;

ii.
promoting education, including special education and employment
enhancing vocation skills especially among children, women, elderly, and the
differently abled and livelihood enhancement projects;

iii.
promoting gender equality, empowering women, setting up homes and
hostels for women and orphans; setting up old age homes, day care centres and
such other facilities for senior citizens and measures for reducing
inequalities faced by socially and economically backward groups;

iv. ensuring environmental
sustainability, ecological balance, protection of flora and fauna, animal
welfare, agro forestry, conservation of natural resources and maintaining
quality of soil, air and water; (including contribution to the clean Ganga Fund
set up by the Central Government for rejuvenation of river Ganga)

v.
protection of national heritage, art and culture including restoration
of buildings and sites of historical importance and works of art; setting up
public libraries; promotion and development of traditional arts and
handicrafts;

vi.
measures for the benefit of armed forces veterans, war widows and their
dependents;

vii.
training to promote rural sports, nationally recognised sports, para
Olympic sports and Olympic sports;

viii.
contribution to the Prime Minister’s National Relief Fund or any other
fund set up by the Central Government for socio-economic development and relief
and welfare of the Scheduled Caste, the Scheduled Tribes, other backward
classes, minorities and women;

ix. contributions or funds provided to
technology incubators located within academic institutions which are approved
by the Central Government;

x.
rural development projects;

xi.
slum area development.

3.3 The CSR
projects or programmes or activities undertaken in India only shall amount to
CSR Expenditure. Companies should give preference to the local area and areas
around it where it operates, for spending the amount earmarked for CSR
activities. The MCA has also clarified that CSR activities enumerated in the
Schedule VII of the 2013 Act are broad-based and are intended to cover a wide
range of activities. Thus, these prescribed activities should be interpreted
liberally to capture
their essence.

3.4 Rule 4 of
the Companies (Corporate Social Responsibility Policy) Rules, 2014, requires
that the CSR activities that shall be undertaken by the companies for the
purpose of section 135 of the Act shall exclude activities undertaken in
pursuance of its ‘normal course of business’. The Rules also specify that CSR
projects or programmes or activities that benefit only the employees of the
company and their families shall not be considered as CSR activities in
accordance with the requirements of the Act. Such programmes or projects or
activities, that are carried out as a pre-condition for setting up a business,
or as part of a contractual obligation undertaken by the company or in
accordance with any other Act, or as a part of the requirement in this regard
by the relevant authorities cannot be considered as a CSR activity within the
meaning of the Act.

3.5 Similarly,
the requirements under relevant regulations or otherwise prescribed by the
concerned regulators as a necessary part of running of the business, would be
considered to be the activities undertaken in the ‘normal course of business’
of the company and, therefore, would not be considered CSR activities.

4. Implementing
CSR activities

4.1 A Company
can undertake CSR activities in one or more of the following ways:

i) The Company itself can do these activities
ii) A company established u/s. 8 of the
Act or a registered trust or a registered society, established by:-

a) the
company, or

b) the
company alongwith any other company, or

c) the
Central Government or State Government or any entity established under an act
of Parliament or a State legislature, or

d) Any
other person or persons, where such company or trust or society have an
established track record of three years in undertaking similar programs or
projects and the company has specified the projects or programs to be
undertaken, the modalities of utilisation of funds of such projects and
programs and the monitoring and reporting mechanism.

iii) A
company can collaborate with other companies for undertaking projects or programs
or CSR activities in such a manner that the CSR Committees of respective
companies are in a position to report separately on such projects or programs
in accordance with these rules.

4.2 Companies
may build CSR capacities of their own personnel as well as those of their
implementation agencies through Institutions with established track records of
atleast three financial years but such expenditure including expenditure on
administrative overheads shall not exceed five per cent of total CSR
expenditure of the company in one financial year.

5. CSR
– Accounting and related disclosures

5.1 The
Institute of Chartered Accountant of India has issued Guidance Note on
Accounting for expenditure on CSR activities which provides accounting
guideline for CSR expenditure.

5.2 The amount
of contribution made towards CSR would generally, be treated as an expense and
charged to the statement of profit and loss, unless it gives rise to an asset.
According to the Guidance Note on Accounting for CSR, an asset would be recognised
on the basis of an evaluation of control over the asset and accrual of future
economic benefits to the company.

5.3 Section
135 (5) of the Companies Act, 2013, requires that the Board of every eligible
company, “shall ensure that the company spends, in every financial year, at
least 2% of the average net profits of the company made during the three
immediately preceding financial years, in pursuance of its Corporate Social
Responsibility Policy”. A proviso to this Section states that “if the company
fails to spend such amount, the Board shall, in its report specify the reasons
for not spending the amount”.

Further, Rule 8(1) of the Companies
(Corporate Social Responsibility Policy) Rules, 2014, prescribes that the Board
Report of a company under these Rules shall include an Annual Report on CSR,
containing particulars specified in the Annexure to the said Rules, which
provide a format in this regard. The above provisions of the Act clearly lay
down that the expenditure on CSR activities is to be disclosed only in the
Board’s Report in accordance with the Rules made thereunder.

In view of above, no provision for the
amount which is not spent, i.e., any shortfall in the amount that was expected
to be spent as per the provisions of the Act on CSR activities as compared to
the amount actually spent at the end of a reporting period, may be made in the
financial statements.

The proviso to section 135 (5) of the
Act, makes it clear that if the specified amount is not spent by the company
during the year, the Directors’ Report should disclose the reasons for not
spending the amount.

However, if a company has already
undertaken certain CSR activity for which a liability has been incurred by
entering into a contractual obligation, then in accordance with the generally
accepted principles of accounting, a provision for the amount representing the
extent to which the CSR activity was completed during the year, needs to be
recognised in the financial statements.

Where a company spends more than that
required under law, a question arises as to whether the excess amount ‘spent’
can be carried forward to be adjusted against amounts to be spent on CSR
activities in future period. Since ‘2% of average net profits of immediately
preceding three years’ is the minimum amount which is required to be spent u/s.
135 (5) of the Act, the excess amount cannot be carried forward for set off
against the CSR expenditure required to be spent in future.

Further, the Board of Directors of the
Company are free to decide whether any unspent amount from the minimum required
CSR expenditure is to be carried forward to the next year. However, the carried
forward amount should be over and above the next year’s CSR allocation
equivalent to atleast 2% of the average net profit of the Company of the
immediately preceding three years.

Additionally, a company should also
disclose related party transactions e.g. contribution to a trust controlled by
the company in relation to CSR expenditure.

5.4 In some cases, a company may supply goods
manufactured by it or render services as CSR activities. In such cases, the
expenditure incurred should be recognised when the control on the goods
manufactured by it is transferred or the allowable services are rendered by the
employees. The goods manufactured by the company should be valued in accordance
with the principles prescribed in Accounting Standard (AS) 2, Valuation of
Inventories. The services rendered should be measured at cost. Indirect taxes
(like excise duty, service tax, VAT or other applicable taxes) on the goods and
services so contributed will also form part of the CSR expenditure.

Where a company receives a grant from
others for carrying out CSR activities, the CSR expenditure should be measured
net of the grant.

5.5 Item 5 (A)(k) of the General Instructions for
Preparation of Statement of Profit and Loss under Schedule III to the Companies
Act, 2013, requires that in case of companies covered u/s. 135, the amount of
expenditure incurred on ‘Corporate Social Responsibility Activities’ shall be
disclosed by way of a note to the statement of profit and loss. From the
perspective of better financial reporting and still be in line with the
requirements of Schedule III in this regard, it is generally recommended that
all expenditure on CSR activities, that qualify to be recognised as expense
should be recognised as a separate line item as ‘CSR expenditure’ in the
statement of profit and loss. Further, the relevant note should disclose the
break-up of various heads of expenses included in the line item ‘CSR
expenditure’.

5.6 In case a
contribution is made to a fund specified in Schedule VII to the Act, the same
would be treated as an expense for the year and charged to the statement of
profit and loss. In case the amount is spent through a registered trust or a
registered society or a company established u/s. 8 of the Act the same will be
treated as expense for the year by charging off to the statement of profit and
loss.

5.7 In cases,
where an expenditure of revenue nature is incurred on any of the activities
mentioned in Schedule VII to the Act by the company on its own, the same should
be charged as an expense to the statement of profit and loss. In case the
expenditure incurred by the company is of such nature which may give rise to an
‘asset’, a question may arise as to whether such an ‘asset’ should be
recognised by the company in its balance sheet. In this context, it would be
relevant to note the definition of the term ‘asset’ as per the Framework for
Preparation and Presentation of Financial Statements issued by the Institute of
Chartered Accountants of India. As per the Framework, an ‘asset’ is a “resource
controlled by an enterprise as a result of past events from which future
economic benefits are expected to flow to the enterprise”. Hence, in cases
where the control of the ‘asset’ is transferred by the company, e.g., a school
building is transferred to a Gram Panchayat for running and maintaining the
school, it should not be recognised as ‘asset’ in its books and such
expenditure would need to be charged to the statement of profit and loss as and
when incurred. In other cases, where the company retains the control of the
‘asset’ then it would need to be examined whether any future economic benefits
accrue to the company. Invariably future economic benefits from a ‘CSR asset’
would not flow to the company as any surplus from CSR cannot be included by the
company in business profits in view of Rule 6(2) of the Companies (Corporate
Social Responsibility Policy) Rules, 2014.

Where a company receives a grant from
others for carrying out CSR activities, the CSR expenditure should be measured
net of the grant.

5.8 Recognition of income earned from CSR
projects/programmes or during the course of conduct of CSR activities

Rule 6 (2) of the Companies (Corporate
Social Responsibility Policy) Rules, 2014, requires that “the surplus arising
out of the CSR projects or programs or activities shall not form part of the
business profit of a company”. Thus, in respect of a CSR project or programme
or activity, it needs to be determined whether any surplus is arising
therefrom. A question would arise as to whether such surplus should be
recognised in the statement of profit and loss of the company. It may be noted
that paragraph 5 of Accounting Standard (AS) 5, Net Profit or Loss for the
Period, Prior Period Items and Changes in Accounting Policies, inter alia,
requires that all items of income which are recognised in a period should be
included in the determination of net profit or loss for the period unless an
Accounting Standard requires or permits otherwise. As to whether the surplus
from CSR activities can be considered as ‘income’, the Framework for
Preparation and Presentation of Financial Statements issued by the Institute of
Chartered Accountants of India, defines ‘income’ as “increase in economic
benefits during the accounting period in the form of inflows or enhancements of
assets or decreases of liabilities that result in increases in equity, other
than those relating to contributions from equity participants”. Since the
surplus arising from CSR activities is not arising from a transaction with the
owners, it would be considered as ‘income’ for accounting purposes. In view of
the aforesaid requirement any surplus arising out of CSR project or programme
or activities shall be recognised in the statement of profit and loss and since
this surplus cannot be a part of business profits of the company, the same
should immediately be recognised as liability for CSR expenditure in the balance
sheet and recognised as a charge to the statement of profit and loss.
Accordingly, such surplus would not form part of the minimum 2% of the average
net profits of the company made during the three immediately preceding
financial years in pursuance of its Corporate Social Responsibility Policy.

5.9 Presentation and disclosure in financial statements

The General Instructions for
Preparation of Statement of Profit and Loss under Schedule III to the Companies
Act, 2013, requires that in case of companies covered u/s. 135, the amount of
expenditure incurred on ‘Corporate Social Responsibility Activities’ shall be
disclosed by way of a note to the statement of profit and loss.

The notes to accounts relating to CSR
expenditure should also contain the following:

a. Gross amount required to be spent by
the Company during the year;

b. Amount Spent during the year;

c. Details of related party
transactions eg; contribution to a trust controlled by the Company in relation
to CSR expenditure as per AS -18 – Related Party Disclosures;

d. Where provision is made in case of
CSR activity for which a liability has been incurred by entering into a
contractual obligation the same should be presented as per requirements of
Schedule III to the Companies Act, 2013. Further movements in the provisions
during the year should be shown separately.

6. CSR
– Tax implications

6.1 Before
Companies Act, 2013 and Finance Act, 2014, the expenditure on CSR was not
mandatory and there was no direct provision under Income Tax Act dealing with
CSR expenditure. Therefore, all the voluntary expenditures incurred on CSR were
claimed either u/s. 35(2AA) or 35AC or u/s. 80G of the Income Tax Act and in
most of the cases the CSR expenditures were claimed to be allowed u/s. 37(1) of
the Income Tax Act, 1961. However, after Companies Act 2013, CSR expenditure
became mandatory and the tax treatment of CSR spends became contingent upon the
Income Tax Act, 1961 and amendments thereof.

The Finance Act, 2014 had brought a
very radical and far reaching amendment, as far as CSR expenditures are
concerned. The Finance Act had proposed that CSR expenditure shall not be
allowed as expenditure u/s. 37 of Income Tax Act, 1961. However, any CSR
expenditure which is allowed as deduction under other sections such as section
30, 32, 35, 35AC, 80G etc., should be possible.

6.2 Historically
it is well established by various judicial pronouncement that the CSR
expenditures were allowed u/s. 37 (1) of the Income Tax Act, 1961, only on the
background that these expenditures were considered to be for the purpose of
business or for advancement of the business of the assessee. However, now Rule
4 of CSR Rule specifically provides that CSR activities will not include any
activities undertaken in pursuance of normal course of business and therefore,
to constitute a valid CSR expenditure, the expenditure cannot be in relation to
or for advancement of business of the company. Under this background, the
amendment in the Finance Act, 2014 seems to be clarificatory in nature as
expenditure can be allowed to be deducted u/s. 37(1) only when it is incurred
for the purpose of business.

6.2.1 If the
company directly undertakes CSR expenditures there will be no tax deduction and
therefore, the company cannot claim the tax benefits when it spends the amount
directly.

6.2.2 If the
company undertakes CSR expenditures through 80G registered NGOs (including its
own foundation) then the company can claim some tax benefit as such
contribution provide 50% tax benefit.

6.2.3 Further,
if a corporate undertakes CSR activities through Institutions registered u/s.
35CCA, 35AC, 35CCC, 35CCD of the Income Tax Act, 1961 or through funds like
Prime Minister Relief Fund, National Defence Fund having 100% tax benefit u/s.
80G then it will get 100% tax advantage.

6.2.4 Further, if
a corporate undertakes CSR activities through Institutions registered u/s. 35
for scientific research or social research then it may get 125% to 175% tax
advantage and will be most advantages for CSR, but the choice of activities will
be reduced and the money will go towards research and not towards direct field
level programmes.

6.2.5 Thus,
the present tax provisions of differential tax statement of CSR expenditure may
shift focus of the company to have a CSR policy on the basis of tax efficiency
also.

6.3 The present laws dealing with CSR, i.e.
Companies Act 2013 and Income Tax 1961, thus are going in 2 different
directors. The Companies Act requires a company to spend certain amount towards
C.S.R. and lays down elaborate mechanism in respect of the same. The Income Tax
Act very clearly states that the C.S.R. expenditure would not be allowed as
business expenditure. However, in case the company spends the amount of CSR
through a section 8 Company, Trust or Society, it can legitimately claim this
as a deduction under relevent provisions of the Income Tax Act. Thus, it
appears that there is a need to have a co-ordinated approach in these two laws,
in respect of CSR activities.

7. CSR
– Implementation issues

7.1 Certain
issues have been surfaced during the implementation of the CSR rules and they
can be addressed by setting up appropriate mechanisms. First, if a company has
to spend relatively large sums on CSR year after year, because its profits are
huge, it will face the challenge of identifying appropriate projects on a
sustained basis. It is important to realise that companies need to pump in 2
per cent of their net profits every year. This can put a strain on the
company’s management to search, select, implement and monitor new projects
every year. The task is likely to cumulatively build up both in terms of scale
and scope over time. For large companies the issue of identifying appropriate
projects on a sustained basis is even more challenging. Spending of such large
amounts may require large companies to have dedicated centres that identify,
implement, and monitor large scale projects or a large number of smaller
projects. This entails additional costs for a company that need to be factored
in. The Rules foresee this to some extent and allows companies to carry out
their CSR activities through registered trusts set up by the companies or
outside trusts with good track records; but the activities of these trusts
would in turn become challenging and will possibly need monitoring.

7.2 Another
issue relates to the treatment of CSR kind of expenditure that companies may
already be incurring. Would reclassifying them as CSR expenses meet the
requirements of law? For example, can companies that are operating educational
institutions or running major hospital facilities for their employees beyond
what the law requires, claim the excess facilities as CSR expenditure u/s. 135?

Will this be allowed if such facilities
are also open to nonemployees as well? Some questions have already been raised
as to whether certain types of expenditure which companies have been incurring
will qualify as items towards meeting the specified CSR target. In response to
this, the Ministry of Corporate Affairs issued a circular dated June 18^th,
2014 (MCA, 2014b) specifying that “the activities undertaken in pursuance of
the CSR policy must be relatable to Schedule VII of the Act and the activities
mentioned in the Schedule VII must be interpreted liberally capturing the
essence of the subjects enumerated therein.” As stated earlier, the circular
also lists certain specific types of expenditures that will count as CSR
expenditure for meeting the provisions of section 135 and those that will not.
More such explanations and clarifications are likely to be made over time.

7.3 Another
problem relates to coordination among companies in choosing their respective
CSR activities. This is a concern, particularly because the Rules recommend
that the companies give preference to local areas in their CSR spending. To
prevent duplication in particular types of CSR projects by companies within a
particular region, formal partnerships or consortiums can be set up to achieve
better coordination of CSR activities among companies within that region. In
instances where large investments are necessary, such as in hospitals and
schools, smaller companies may be better off by pooling their CSR resources
through such consortiums.

7.4 Many
companies give donation to Trust or Societies for the purpose of CSR and claim
it as CSR expenditure. In such cases, it is necessary for the company to obtain
a certificate from the Trust or Society that the requisite amount has been
actually spent for the purpose for which it was received by the Trust. The
Trust/ Society should produce some documentary evidence for the company to show
that the actual work is done and the amount is spent on such work.

7.5 The Trust
or Societies which receive money form companies towards CSR need to follow a
proper method of accounting whereby they should be able to show to the
companies that the money received is actually spent for the specified purpose.
The company may even ask for a certificate from the auditor of such
Trust/Society for this purpose and even ask for a copy of the financial
statement of the Trust/Society for its records.

7.6 Companies need support from Non-Profit
Organisations (NPO) in various area of CSR activities such as identification
implementation and perseverance in undertaking such activities. People need a
different mindset when they do social work. This is an area where people
working in social sector through NPO need to guide and support the people form
the corporate sector in respect of various skills required for doing such work.
The combination of perseverance of persons doing social work coupled with the
effective and efficient way of handling the matter can give better results from
CSR activities.

7.7 The
N.P.Os need to prepare proper project reports and present their ideas in an
organised manner before the corporates so that the Companies get the required
confidence before they commit their money and time for such projects. This is
one area which needs substantial improvement since a large number of N.P.Os do
not have the necessary expertise and skills to make proper presentation even
when they are actually doing good work at ground level.

7.8 There is a
need to carry out social audit of many of the CSR projects so as to identify
and measure the impact of such work on the various sections of the Society.
There is a need for more agencies who can do such work. Mere spending of money
is not sufficient for achieving the desired social results and this aspect
needs to be brought to the notice of the corporates in proper manner.

7.9 Registrar
of Companies has issued Notices to many companies to explain as to why the
companies have not spent the necessary amount towards CSR. There is no penalty
provided in the Companies Act 2013 for non-payment or less payment towards CSR.
However, the collection of such data and explanations form companies by
Registrar of Companies indicate that the Govt. might soon come out with some
more stringent provisions in this matter.

8. Way
Forward

8.1 CSR is a
social movement wherein the companies are contributing their money and time in
fulfilling certain social objectives which help the members of the society. It
would be more useful if the top management of the companies put their heart and
soul into it and spend some more time for these activities. This would achieve
better effective and efficient use of economic resources for the betterment of
the Society. This would be also a good step in the right direction to ensure
sustainability of the business of the company.

8.2 Corporate
Social Responsibility should now move on to Individual Social Responsibility
whereby each individual feels the necessity of doing something for the society
Of course doing your own job with full integrity and honesty itself is a
positive contribution to the Society. However, if every individual decides to
spend atleast 5% of his/her time for some social work, it will make great
difference to the society. Everyone can choose the area of work as per his
choice, but such commitment of time will make all the difference to the area of
work selected. This will support many good initiatives taken by N.P.Os since
the social work actually needs involvement of many people in addition to the
monetary contribution. Such social work will also enhance the work experience
and reputation of people doing it and make them more happy.

The purpose of this article would be
achieved if more readers decide to do something for others and move on to
fulfil Individual Social Responsibility.

shailesh.kwebmaker

17. [2018] 193 TTJ (Mumbai) 214 Asia Investments (P.) Ltd. vs. ACIT ITA NO. : 7539/MUM/2013 & 4779/Mum/2014 A. Y.: 2003-04 Dated: 23rd February, 2018

Section 271(1)(c) read with section 275
– Where once addition on which penalty
has been levied is set aside to Assessing Officer for fresh consideration, it
is as good as there is no addition for levy of penalty u/s. 271(1)(c)

FACTS

The assessee company filed return of income and the
assessment was completed u/s. 143(3) making certain additions. The assessee
carried the matter in appeal before the CIT(A) wherein the partial relief was
allowed by the CIT(A). The assessee filed appeal before Tribunal for the
additions sustained by the CIT(A). The Tribunal set aside the issue to the file
of the AO with a direction to examine the entire facts of the case.

The AO had initiated penalty proceedings u/s. 271(1)(c) and
after considering the submissions of the assesse, he passed order levying penalty
u/s. 271(1)(c).

Aggrieved by the penalty order, the assessee preferred an
appeal before the Ld. CIT(A) wherein the penalty was confirmed by the CIT(A).

HELD

The Tribunal stated that once the addition on which penalty
had been levied was set aside to the AO for fresh consideration, it was as good
as there was no addition for levy of penalty u/s. 271(1)(c) of the Act.

In present case, the AO had finalised penalty proceedings
before the Tribunal had set aside the issue of additions in the quantum appeal
to the file of the AO. The case was covered under the provisions of sub section
(1A) to section 275 of the Act where it is categorically stated that in a case
where the relevant assessment or the order is the subject matter of an appeal
before the appellate authorities or High Court and an order imposing or
enhancing or reducing or cancelling penalty or dropping the proceedings for the
imposition of penalty is passed before the order of the appellate authority is
received by the Commissioner then the order imposing or enhancing or reducing
or cancelling penalty or dropping the proceedings for the imposition of penalty
may be passed on the basis of assessment as revised by giving effect to such
order of the appellate authorities.

Therefore, the Tribunal set aside the issue to the file of
the AO directing him to reconsider the issue as per the provisions of section
275(1A) of the Act.

shailesh.kwebmaker

16. [2018] 193 TTJ (Mumbai)(UO) 36 ACIT vs. Zee Media Corporation Ltd ITA NO. : 2166/MUM/2016 A. Y. : 2011-12 Dated: 16th April, 2018

Section 4 read with section 133(6) – In the
absence of any material on record to show that the assessee has received amount
more than the income which had been declared by it in the P&L a/c, addition
cannot be made solely based on AIR information, especially when the assessee
requested the AO to examine the parties by issuing notice u/s. 133(6) but AO
failed to make any enquiry.

FACTS

The AO in the course of the assessment proceedings, on
perusal of the AIR data found that there was a discrepancy in income to the
extent of Rs.14,13,908 in Form 26AS and the books of account.

The assessee submitted that the transactions in respect of
the discrepancy did not happen and were not related to the assessee. The
assesse also filed before the AO a rectification application under section- 154
requesting for withdrawal of corresponding TDS credit.

It was submitted before the AO that these transactions did
not appear in the books of account of the assessee and the bank account also
did not reflect any receipts from these parties. The assessee requested the AO
to verify the books of account and also to examine the parties by issuing the
notices under section 133(6).

However, the AO treated the said amount as income of the
assessee for the reason that assessee claimed TDS on such transactions but
denied owning up of the said transactions.

Aggrieved by the assessment order, the assessee filed appeal
before CIT(A) but the addition was sustained by the CIT(A).

HELD

The Tribunal stated that in the absence of any material
brought by the revenue authorities that the assessee had received amount more
than the professional fees which had been declared by him in the P&L
account and when the professional income declared by the assessee far exceeded
the professional fees shown in the AIR information, the additions solely based
on the AIR information were not sustainable.

The AO also failed to make any enquiries with the parties as
requested by the assesse when the assessee had denied any transactions with
them. When the assessee had denied any transactions with the parties, the onus
was on the AO to verify the transactions with the parties and to establish that
the assesse indeed entered into any transactions with the said parties and had
received income from them. No such enquiries or effort was made by the AO.

The addition was made solely based on the AIR information
without bringing any cogent evidence on record to suggest that the assessee
received income from the said parties.

In the result, the Tribunal reversed the order of the CIT(A)
and directed the AO to delete the addition made on account of alleged
difference in income.

shailesh.kwebmaker

15. [2018] 194 TTJ (Mumbai) 122 All India Federation of Tax Practitioners vs. ITO ITA NO. : 7134/MUM/2017 A. Y.: 2013-14 Dated: 04th May, 2018

Section 249(1) read with rule 45 – Assessee
having filed the appeal in paper form, CIT(A) ought not to have dismissed the
same solely on the ground that the assessee has not filed the appeal
electronically as per the mandate of rule 45.

FACTS

The assessee was a trust and had filed its return of income
for A.Y.2013-14. Thereafter, assessment for the said year was completed by
order u/s. 143(3) on 17-2-2016.

Aggrieved by the order of the AO, the assessee preferred
appeal before CIT(A). The assessee filed appeal before CIT(A) in paper form as
prescribed under the provisions of IT Act, 1961 within the prescribed period of
limitation.

But the same was dismissed by CIT(A) by holding that the
assessee had not filed appeal through electronic form, which was mandatory as
per IT Rules, 1962. The CIT(A) passed the order without allowing hearing to
assessee merely on the basis of alleged default of not having appeal filed
electronically .

HELD

The Tribunal observed that the assessee had already filed the
appeal in paper form, however, only the e-filing of appeal had not been done by
the assessee which was only a technical consideration.

The Tribunal followed the ratio of the Hon’ble Supreme Court
decision in the case of State of Punjab vs. Shyamalal Murari & Ors. AIR
1976 SC 1177 wherein it was held that courts should not go strictly by the
rulebook to deny justice to the deserving litigant as it would lead to
miscarriage of justice and no party should ordinarily be denied the opportunity
of participating in the process of justice dispensation.

The Tribunal relying upon the judgement of Hon’ble Supreme
Court, held that the alleged compliances defaults were of a technical nature
and the same could not be a reason to deny an opportunity of appeal and
opportunity of justice in the deserving case.

In the result, the Tribunal set aside the CIT(A) order and
allowed the appeal. The Tribunal directed the assessee to file the appeal
electronically within 10 days from the date of receipt of ITAT order and
further directed the CIT(A) to consider the appeal filed by the assessee on
merits by passing a speaking order.

shailesh.kwebmaker

15. CIT(Exemption) vs. Indian Institute of Banking and Finance. [ITA No. 1368 of 2015 Dated: 28th March, 2018 (Bombay High Court)]. [ Affirmed ACIT vs. Indian Institute of Banking and Finance, dated 11/02/2015 ; Mum. ITAT ] Section 11 : Educational Institution – purpose of development of banking personnel for/in the banking industry – by holding courses and also disbursing knowledge by lectures, discussions, books, correspondence with public bodies and individuals or otherwise etc – Trust entitle to exemption.[Section 2(15)]

[ Affirmed ACIT vs. Indian
Institute of Banking and Finance, dated 11/02/2015 ; Mum. ITAT ]

Section 11 : Educational
Institution – purpose of development of banking personnel for/in the banking
industry – by holding courses and also disbursing knowledge by lectures,
discussions, books, correspondence with public bodies and individuals or
otherwise etc – Trust entitle to exemption.[Section 2(15)]

The assessee is a Company
registered u/s. 26 of the Indian Companies Act, 1913 as a non-profit making
Company. The principal objects of the assessee as per the Memorandum of
Association is to inter-alia conduct educational activities in respect
of the banking and finance subjects by holding courses and also disbursing
knowledge by lectures, discussions, books, correspondence with public bodies
and individuals or otherwise etc. It is an undisputed position that, assessee
is registered u/s. 12A of the Act.

During the course of assessment
proceedings, the assessee sought benefit of exemption u/s. 11 of the Act. The
A.O denied the same on the ground that the claim for exemption u/s. 10(22) of
the Act for the A.Y 1996-97 to 1998-99 which had been granted by the Tribunal was
pending in Appeal filed by the Revenue in High Court, as well as, application
u/s. 10(23C)(vi) of the Act was pending before the CIT. It was on the aforesaid
basis that the A.O held that the benefit u/s. 11 cannot be granted to the
petitioners. This without dealing with the petitioner’s primary contention that
they are entitled to exemption as they satisfy the definition of charitable
purpose as they are an educational institution.

On further Appeal, the Tribunal
allowed the assessee’s appeal. The Tribunal after examining the object clause
as given in the Memorandum of Association gave a finding that the assessee has
been created for the purpose of development of banking personnel for/in the
banking industry. The assessee company imparts education to the candidates who
are connected with the banking industry. It has library facility, organises
lectures, seminars and undertake examinations for promoting bank officers. In
the aforesaid context, the Tribunal concluded on facts which were before the
Revenue Authorities that it exists for advancement of learning in the field of
banking. Besides, on facts it found the fee structure of the institute for
these courses was not on the higher side. Further, the assessee company
reliance upon the decision of this Court in Director of Income-tax
(Exemption), Mumbai vs. Samudra Institute of Maritime Studies Trust, reported
in [2014] 49 taxmann.com 510 (Bombay) to inter-alia hold that the
activity which is carried out by the assessee company is educational in nature.
This is for the reason that it imparts education to the members of the banking
industry and prepares them to discharge their duties as bankers more
efficiently.

Further, with regard to the
objection of the A.O that as the benefit of the assessee company is restricted
only to the persons working in the banking industry, it is not available to the
public at large was negatived by placing reliance upon the decision of the Apex
Court in Ahmedabad Rana Caste Association vs. Commissioner of Income-Tax,
reported in 82 ITR 704. In the above case, it has been held that the object
beneficial to a section of the public is an object of general public utility
and to serve a charitable purpose it is not necessary that the object should be
to benefit the whole of mankind or all persons in a country or State. In the
above view, it was, held that the petitioners were an institute for a
charitable purpose as defined in section 2(15) of the Act.

Being aggrieved, Revenue filed
appeal before the High Court. The Revenue contented that the activity carried out by the assessee
is in the nature of running Coaching Classes or Center and therefore the
benefit of section 11 of the Act cannot be extended to the assessee company.

The Court observed that there is no
such objection taken before the authorities by the Revenue. Besides, nothing
has been shown to us why it should be considered as a coaching class. Further,
the Court found that the impugned order of the Tribunal has only applied the
decision of this Court in Samudra Institute of Maritime Studies Trust (supra)
to conclude that the activities which are run by the institute is an
educational activity and not in the nature of running a Coaching Center or a
Class. The grant or refusal to grant exemption u/s. 10(22) and/or (23C) of the Act cannot govern
the application of section 11 of the Act. In the above view, the Appeal was
dismissed.

shailesh.kwebmaker

14. CIT vs. Shankardas B. Pahajani [ITA No. 1432 of 2007 Dated : 24th April, 2018 (Bombay High Court)]. [Affirmed DCIT vs. Shankardas B. Pahajani [dated 13/09/2004 ; AY 1994-95 , Mum. ITAT] Section 147 : Reassessment – Audit objection- Reopening on basis of same set of facts available at time of original assessment – change of opinion – reassessment was held to be invalid

[Affirmed DCIT vs.
Shankardas B. Pahajani [dated 13/09/2004 ; AY 1994-95 , Mum. ITAT]

Section 147 : Reassessment
– Audit objection- Reopening on basis of same set of facts available at time of
original assessment – change of opinion – reassessment was held to be invalid

During the
course of assessment, detailed letters were filed by the assessee giving
complete details of the transactions relating to the purchase and sale of flats
in a building known as ‘Tanhee Heights’ resulting in capital gains. Thus, the
same was subject of consideration leading to assessment order u/s. 143(3) of
the Act. On 15^th May, 1998 a notice u/s. 148 of the Act was issued by the A.O seeking to reopen the assessment for
AY: 1994-95. The assessee objected to the re-opening of Assessment but the same
was not accepted. This resulted in assessment order passed u/s. 143(3) r/w section 147 of the Act and made addition.

On appeal, the CIT (A), allowed the
assessee’s appeal, holding that re-opening notice dated 15^th May,
1998 is without jurisdiction.

Being aggrieved, Revenue preferred
appeal before ITAT. The Tribunal held that the exercise of re-opening the
assessment is without jurisdiction. This on the ground that, the entire issue
of capital gains on which the reopening notice was issued was the subject
matter of consideration during the regular assessment proceedings u/s. 143(3)
of the Act. This is evident from the letters of the assessee disclosing all
facts during the regular assessment proceedings. Therefore, it held it to be a
case of change of opinion on the part of the A.O and therefore, absence of any
reason to believe that income chargeable to tax has escaped assessment.

The Tribunal concluded that there
was absence of application of mind by the A.O and the reopening notice was
issued on borrowed satisfaction i.e. on the basis of audit objection. Therefore
re-opening notice to be without jurisdiction.

The Revenue contended that the
reopening notice dated 15^th May, 1998 has been issued on account of
a recent decision of the Bombay High Court in Commissioner of Income-Tax vs.
Smt. Beena K. Jain, [1996] 217 ITR 363 (rendered on 23^rd November,
1993). Thus, it is submitted that the reopening notice is valid in law and
the appeal deserves to be admitted.

The High Court held that, the
assessee had furnished all information in respect of the issue of capital gains
by letters during assessment proceedings. Therefore, the A.O had applied his
mind to the facts and the law while passing the order of regular assessment.
The decision in the case of Beena K. Jain (supra) being relied
upon in support of the re-opening notice was available at the time when the regular
assessment order dated 12^thSeptember, 1996 u/s 143 of the Act was
passed. The reasons recorded in support of the impugned notice was merely on
the basis of borrowed satisfaction of the audit party. This also makes the
impugned notice bad. For the aforesaid reasons, the appeal was dismissed.

shailesh.kwebmaker

13. Jaison S. Panakkal vs. Pr. CIT. [ W.P no. 1122 of 2018, Dated : 26th April, 2018 (Bombay High Court)]. Section 179(1): Liability of director – Private company – show cause notice issued u/s. 179(1) did not indicate or give any particulars in respect of steps taken by department to recover tax dues from defaulting private company – Order set aside.

Section 179(1): Liability
of director – Private company – show cause notice issued u/s. 179(1) did not indicate or give any particulars in respect of steps taken
by department to recover tax dues from defaulting private company – Order set
aside.

The Assessing Officer vide order
dated 15/2/2018 passed u/s. 179(1) of the Act, held that the Petitioner was
liable to pay the tax dues of Rs.38.34 crores of M/s. Damasy Retail Jewellery
Pvt. Ltd. The Petitioner was a former Director of M/s. Damasy Retail Jewellery
Pvt. Ltd., having been a director during the period 29^th December,
2007 to 11^th November, 2009.

It was the case of the assessee
that the impugned order was not preceded by service of any show cause notice
upon him. Consequently, Petitioner had no opportunity to put forth his case
before passing of the impugned order.

The Revenue contended that the show
cause notice dated 26^th July, 2017 was attempted to be served by
Registered Post. However, same was received back with the postal remark “not
known”.

The Petitioner contended that the
show cause notice dated 26^th July, 2017 does not make any mentioning
of the Revenue’s attempt to recover the tax dues of M/s. Damasy Retail
Jewellery Pvt. Ltd. from it and the result thereof. In this circumstances, it is
submitted that the impugned proceedings, are completely, without jurisdiction.

The Hon’ble Court relied on the
decision in case of Madhavi Kerkar
vs. Asst CIT (Writ Petition No.567 of 2016) dt 5^th January, 2018 and
Mehul Jadavji Shah vs. Deputy CIT (Writ Petition No. 291 of 2018) dt : 5^th
April, 2018, wherein the High Court held that the jurisdiction to commence
proceedings against the Director of a delinquent company for a recovery of the
tax dues of the delinquent company, would require the notice to the Directors/
former Directors, itself, indicating what steps had been taken to recover the
dues from the delinquent company and the failure thereof. The show cause notice
should indicate to have satisfied the condition precedent for commencing
proceedings u/s. 179(1) of the Act.

As
the condition precedent for commencing proceedings u/s. 179(1) of the Act were
not satisfied the impugned order dated 15^th February, 2018 was
quashed and set aside.

shailesh.kwebmaker

44 Sections 9(1)vii), Expln 2 and 194J – TDS – Fees for technical services – Transmission of electricity – Payment made only for facility to use and maintenance of transmission lines – Not technical services – Mere involvement of technology does not bring something within ambit of technical services – Provisions of section 194J not applicable

The assessee was a licensee for
distribution and sale of electricity under the provisions of the Electricity
Act, 2003, by the Uttar Pradesh Electricity Regulatory Commission. The assessee
purchased power from Uttar Pradesh Power Corporation. For the A. Y. 2008-09,
the assessee made payments in terms of tariff issued by the Commission which
was bifurcated in two parts: (a) power supply tariff and (b) power transmission
tariff. The transmission charges were paid to the Uttar Pradesh Power
Transmission Company Ltd. (UPPTCL) and power supply charges were payable to the
Corporation. The Assessing Officer observed that payment made to the company
was not a payment of purchase or supply of power but payment of technical
charges for rendering “technical service” on monthly basis and consequently
held that the assessee was liable to deduct tax at source on charges paid for
transmission to the company and since it failed to do so, the amount of Rs.
1,65,32,88,040 was to be disallowed u/s. 40(a)(ia) of the Act.

The Commissioner (Appeals) and the
Tribunal accepted the assessee’s claim and cancelled the disallowance.

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

“i) Since
electricity was a commodity which could not be carried from one place to
another like other commodities, it had to flow through metal conductors which
were called “transmission lines” and therefore, transmission lines constituted
a facility for travelling of electricity from the point of generation to the
point of distribution. This flow of electricity in a conductor could not be
said to be any specialized, exclusive individual service rendered by the
company to the assessee because the grid was common and transmission lines were
used in general by respective distributor licensees. Only for the purpose of
facility to use and maintenance of transmission lines, charges were paid and
there was no “technical service”, as such, rendered by the company to the
assessee.

ii) Mere
involvement of technology would not bring something within the ambit of
“technical services” as defined in Explanation 2 to section 9(1)(vii) because
under the Act, the term “technical services” was defined in a different manner,
i.e., along with terms “managerial and consultancy services”. “Managerial and
consultancy services” by themselves did not include any technology but still
would be covered by the definition of “fees for technical services” in the Act.
Therefore, the term “technical services” was not dependent solely on whether or
not use of technology was involved.

iii) Moreover, the term “technical” had to be read applying the principle
of noscitur a sociis in the term “managerial and consultancy”. That
takes away normal and common meaning of “technical services” as was known in
common parlance and makes it totally different. Therefore, in transmission of
electricity, there was no human touch or effort and if the term “technical was
read applying the principle of noscitur a sociis with the term
“managerial or consultancy”, the provisions of section 194J were not
applicable.

iv) The
questions formulated are answered against the Revenue and in favour of the
assessee.”

shailesh.kwebmaker

43 Sections 10(38), 45 and 271(1)(c) – Penalty – Concealment of income – Capital gain – Exemption – Assessee claiming exemption u/s. 10(38) with a note that it reserved its right to carry forward loss – Bona fide belief of assessee that loss not required to be considered u/s. 10(38) – Penalty rightly cancelled by Tribunal

DIT
(International Taxation) vs. Nomura India Investment Fund Mother Fund.; 404 ITR
636 (Bom); Date of order : 15^th June, 2017 A. Y.: 2008-09

The
assessee earned long-term capital gain as well as long-term capital loss on
purchase and sale of shares. For the A. Y. 2008-09, while computing the total
income, it did not set off the long-term capital loss of Rs. 80.64 crores
against the long-term capital gain of Rs. 697.70 crores, which was exempted
u/s. 10(38) of the Act and in its return had put a note reserving the right to
carry forward the long-term capital loss. The Assessing Officer rejected the
claim of the assessee to carry forward the long-term capital loss and held that
it was not admissible and also levied penalty u/s. 271(1)(c) for concealment of income.

The
Tribunal cancelled the penalty.

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

“i) The provisions of section 271(1)(c) could only
be invoked upon satisfaction of the conditions laid down therein. The assessee
had claimed exemption u/s. 10(38) with a note that it reserved its right to
carry forward the loss of Rs. 80.64 crores, under the bona fide belief
that u/s. 10(38) the loss was not required to be considered. It could not be
stated that the act of the assessee in giving the note was with some ulterior
intention or concealment of income or giving inaccurate particulars.

ii) Therefore, the penalty was rightly cancelled
by the Tribunal. No question of law arose.”

shailesh.kwebmaker

42 Section 4 – Income – revenue or capital receipt – Where Government gave grant-in-aid to a company wholly-owned by Government, facing acute cash crunch, to keep company floating, even though large part of funds were applied by company for salary and provident funds, grant received was capital receipt

Pr.
CIT vs. State Fisheries Development Corporation Ltd.; [2018] 94 taxmann.com 466
(Cal); Date of order : 14^th May, 2018A. Y.: 2006-07:

The
assessee was a company wholly-owned by the State Government. The assessee was
engaged in business of pisciculture. The assessee received an amount as
grants-in-aid. Out of that, certain sum was received for payment of salary to
its employees, certain sum for payment of Provident Fund dues and certain sum
for the purpose of flood relief. The assessee claimed deduction of said sum
from its income on plea that same constituted capital receipt. The Assessing
Officer found that the fund was applied for items which were revenue in nature.
He recorded that such receipts were consistently treated in the past by the
assessee as revenue receipt. Thus, same could not be allowed for deduction as
capital receipt.

The
Tribunal did not solely rely on the nature of application of the funds received
through grant-in-aid. The Tribunal examined the character of the assessee as a
Government company as well as the character of grantor, being the State
Government itself, the financial status of the assessee and certain other
factors. The Tribunal accepted the assessee’s claim that grant-in-aid towards
provident fund dues constituted capital receipts.

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

“i) The fundamental principle for distinguishing
capital receipt from revenue receipt in relation to Government grant has been
laid down by the Supreme Court in the case of Sahney Steel & Press Works
Ltd. vs. CIT [1997] 94 Taxman 368/228 ITR 253. That was a case involving
government subsidy in the form of certain time bound incentives and facilities.
These incentives and facilities included refund of sales tax on raw materials,
machineries and finished goods. The Supreme Court found that the incentives and
facilities under a subsidy scheme to enable the assessee to acquire new plant
or machinery for expansion of manufacturing capacity or set up new industrial
undertaking could constitute capital receipt. In that case, however, the scheme
contemplated for refund of sales tax on purchase of machinery and raw
materials, subsidy or power consumption and certain other exemptions on
utilities consumed. The Supreme Court rejected the plea of the assessee for
treating such facilities and incentives as capital receipt on the reasoning
that such subsidy could only be treated as assistance given for the purpose of
carrying on the business of the assessee.

ii) So far as assessee’s case in this appeal is
concerned, Rs. 3.60 crores was received as grant-in-aid in the relevant
previous year towards salary and provident fund dues. On surface test, receipt
under these heads no doubt has the attributes of revenue receipt. But there are
two factors which distinguish the character of the grant-in-aid which the
assessee wants to be treated as capital receipt. Said sum was not on account of
any general subsidy scheme. Secondly, the sum was given by the State to a
wholly-owned company which was facing acute cash crunch. Financial status of
the company appears from the submission of the assessee’s representative
recorded in the order of the first Appellate Authority and there is no denial
of this fact in any of the materials placed.

iii) In the case of the assessee, though it is not
a grant from a parent company to a subsidiary company, the grant is from the
State Government, which was in effect, hundred per cent shareholder of the
assessee. Rs. 3.60 crores was meant for payment of staff salaries and provident
fund dues. As already observed, these item heads may bear the label of revenue
receipt on the surface, it is apparent that the actual intention of the State
was to keep the company, facing acute cash crunch, floating and protecting
employment in a public sector organization. There is no separate business
consideration on record between the grantor, that is the State Government and
the recipient thereof being the assessee. The principle of law as laid down in
the case of Siemens Public Communication Network (P.) Ltd. vs. CIT [2017] 77
taxmann.com 22/244 Taxman 188/390 ITR 1 (SC) is that voluntary payments
made by the parent company to its loss making Indian subsidiary can also be
understood to be payments made in order to protect the capital investment of
the assessee-company. Though the grant-in-aid in this case was received from
public funds, the State Government being 100 per cent shareholder, its position
would be similar to that of, or at par with a parent company making voluntary
payments to its loss making undertaking. No other specific business
consideration on the part of the State has been demonstrated in this appeal.
The assistance extended appears to be measures to keep the assessee-company
floating, the assessee being, for all practical purposes an extended arm of the
State. Though large part of the funds were applied for salary and provident
fund dues, the object of extension of assistance, to ensure survival of the
company.

iv) As regards the funds extended for flood
relief, the same cannot constitute revenue receipt. Flood relief does not
constitute part of business of the assessee.

v) Accordingly, the question is answered in
favour of the assessee and confirm the finding of the Tribunal.”

shailesh.kwebmaker

41 Section 4 – Income – Capital or revenue receipt – Real estate business – Seller of land not performing commitment under agreement to sell – Purpose of ultimate use of assessee’s land when acquired rendered irrelevant – Compensation received under arbitration award considered as capital receipt

Pr.
CIT vs. Aeren R Infrastructure Ltd.; 404 ITR 318 (Del): Date of Order : 25^th
April, 2018

The
assessee, engaged in the business of real estate, entered into a consortium
agreement with its associates which defined the role, rights and
responsibilities of the parties thereto. This consortium entered into an
agreement to sell with JMA, the seller, for purchase of 10 acres of land for a
consideration of Rs. 15 crores. The seller, JMA, defaulted in its commitment
within the prescribed and extended time limit. Ultimately, upon the parties
resorting to the arbitration, a settlement was arrived at and an award was made
based upon the parties eventual settlement. The amount received by the assessee
as a part of its entitlement as consortium was credited in its books of account
as a capital receipt. The Assessing Officer held that the amounts were revenue
in nature as the land would have been part of the stock-in-trade.

The
Tribunal held that the amount which was intended to be ultimately used as
stock-in-trade purposes was immobile and sterilized, rendered non-offerable and
therefore when received as part of the arbitration award, fell into the capital
stream. The Tribunal held that the only inference that can be drawn is that the
compensation received by way of reward due to non-supply of land by JMA under
the agreement was capital receipt.

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

“The
purpose of the ultimate use of the assessee’s land when acquired was rendered
irrelevant on account of the seller defaulting in its commitment. This rendered
the amount expended by the assessee immobile. The eventual receipt of the
amounts determined as compensation or damages, therefore, fell into the capital
stream and not revenue as was contended by the Revenue/appellant in this case.”

shailesh.kwebmaker

40 Section 43A – Foreign exchange fluctuation – Where assessee constructed a residential house and rental income earned therefrom was offered to tax as income from house property and not as business income, provisions of section 43A would not apply to apparent gain made by assessee as a consequence of foreign exchange fluctuation in respect of lift imported from abroad

CIT
vs. Bengal Intelligent Parks (P.) Ltd.; [2018] 94 taxmann.com 399 (Cal);

Date
of order: 10^th May, 2018

The
assessee was engaged in construction of houses for the purpose of letting them
out. The rental income was claimed as income from house property without the
expenses for constructing the house being claimed by way of deduction or the
individual items therefore being subjected to depreciation. In respect of a
particular elevator imported by the assessee for installation at one of its
buildings, the rise of the rupee compared to the relevant foreign currency
resulted in the cost of the equipment being effectively lowered by a sum in
excess of Rs. 6 lakh. The Assessing Officer added said amount to assessee’s
income.

The
assessee filed appeal contending that since the elevator was not used for the
purpose of its business and no deduction or depreciation or the like had been
claimed in respect thereof, the perceived additional income on account of
foreign exchange fluctuation could not be added back as an income in the hands
of the assessee. The Tribunal having accepted assessee’s contention, deleted
the addition made by the Assessing Officer.

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

“i) Section 43A deals with the variation of
expenses on account of the change in the rate of exchange of currency. Such
provision takes into account the additional expenses that may be incurred by an
assessee as a result of the fluctuation of foreign exchange rates or the gain
that may be made by an assessee on such account. However, such provision is
confined to assets acquired from a country outside India for the purpose of the
assessee’s business or profession. The Tribunal held in this case that since
the construction of the relevant house was not a part of the business of the
assessee, section 43A would not apply to the apparent gain made by the assessee
as a consequence of the foreign exchange fluctuation.

ii) On a plain reading of section 43A and the
fact that the assessee had not claimed any deduction or depreciation on account
of the lift or other construction material, it cannot be said that the Tribunal
committed any error or that there is any significant question of law that needs
to be looked into. In the result, revenue’s appeal is dismissed.”

shailesh.kwebmaker

Failure To Dispose Of Objections – Whether Renders Reassessment Void Or Defective And Curable?

Issue for
Consideration

Section 147 of the Income Tax Act, 1961
provides that if an Assessing Officer has reason to believe that any income
chargeable to tax has escaped assessment, he may assess or reassess such
income, subject to the provisions of sections 148 to 153 of the Act. Section
148 provides for issue of notice to an assessee, requiring him to furnish his
return of income in response to the notice, for the purposes of reassessment.
Section 148(2) requires an Assessing Officer to record his reasons for issue of
notice, before issuing any notice under this section. Courts have held that
recording of such reasons is mandatory, and issue of notice without recording
of such reasons is invalid.

The Supreme Court, in the case of GKN
Driveshafts (India) Ltd. vs. ITO 259 ITR 19, held that:

“when a notice under section 148 is
issued, the proper course of action for the noticee is to file return and if he
so desires, to seek reasons for issuing notice. The Assessing Officer is bound
to furnish reasons within a reasonable time. On receipt of reasons, the noticee
is entitled to file objections to issuance of notice and the Assessing Officer
is bound to dispose of the same by passing a speaking order. In the instant
case, as the reasons had been disclosed in the proceedings, the Assessing
Officer had to dispose of the objections, if filed, by passing a speaking
order, before proceeding with the assessment.”

Following this decision of the Supreme
Court, various cases have come up before different High Courts, requiring the
courts to consider the consequences in cases where the Assessing Officer passed
the reassessment order without disposing of the objections raised by the
assessee against the issue of notice for reassessment. The courts are of the
unanimous view that the reassessment order is not sustainable on account of
such lapse. The issue however has arisen in such cases as to whether the
reassessment proceedings are null and void, or whether the defect is curable by
providing a fresh innings to the AO for curing the defect by disposal of the
objections and pass a fresh order of reassessment after following the correct
procedure. While in some cases, the Gujarat, Bombay and Delhi High Courts have
quashed or set aside the reassessment order on the ground that the necessary
procedure had not been followed, effectively nullifying the order of
reassessment, in other cases, the Gujarat, Bombay, Delhi and Madras High
Courts, while setting aside the reassessment order, have restored the matter to
the Assessing Officer for disposing of the reasons and thereafter proceeding
with the reassessment.

MGM Exports’ case:

The issue came up before the Gujarat High
Court in the case of MGM Exports vs. DCIT 323 ITR 331.

In this case, for assessment year 2001-02,
the assessment was completed in September 2006 u/s. 143(3) read with section
254, after the original assessment order u/s. 143(3) was remanded back to the
Assessing Officer by the Tribunal. On 3^rdMarch 2008, the Assessing
Officer issued notice u/s. 148 proposing to reopen the completed assessment.
Vide communication dated 8^th March 2008, the assessee requested the
Assessing Officer to treat the original return of income as return of income
filed in response to notice u/s. 148 of the Act and also asked for a copy of
the reasons recorded by the Assessing Officer. The Assessing Officer supplied
the copy of the reasons recorded for reopening on 21^stOctober 2008.
On receipt of the reasons recorded, the assessee filed its objections, both on
jurisdiction and on the merits, vide communication dated 11^th
December, 2008. The Assessing Officer passed the reassessment order on 16^th
December, 2008.

The assessee filed a writ petition before
the Gujarat High Court. Before the High Court, it was argued on behalf of the
assessee that the Assessing Officer was under an obligation to first dispose of
the preliminary objections raised by the assessee, and could not have framed
the reassessment order. It was also submitted that until such speaking order
was passed, the Assessing Officer could not have undertaken reassessment.
Reliance was placed on the decisions of the Gujarat High Court in the cases of Arvind
Mills Ltd. vs. Asst. CWT (No. 1) 270 ITR 467, and Arvind Mills Ltd. vs. Asst.
CWT (No. 2) 270 ITR 469 for supporting the proposition.

On behalf of the Revenue, it was submitted
that the Assessing Officer had dealt with the objections in the reassessment
order itself, and hence, the same should be treated as sufficient compliance
with the directions and the procedure laid down by the Supreme Court in the
case of GKN Driveshafts (supra).

The Gujarat High Court considered the
decisions cited before it, and observed that the position in law was well
settled, and the Assessing Officer was accordingly required to decide the
preliminary objections and pass a speaking order disposing of the objections
raised by the assessee. Until such a speaking order was passed, the Assessing
Officer could not undertake reassessment.

Applying the settled legal position to the
facts of the case, the Court noted that it was apparent that the action of the
Assessing Officer in framing the reassessment order, without first disposing of
the preliminary objections raised by the assessee, could not be sustained.
Accordingly, it quashed and set aside the reassessment order. It however
directed the Assessing Officer to dispose of the preliminary objections by
passing a speaking order, and only thereafter proceed with the reassessment
proceedings in accordance with law.

A similar view was taken by the High Courts
in the following cases, where the reassessment order was quashed but the
Assessing Officer was directed to dispose of the objections and then proceed
with the reassessment:

Garden Finance Ltd. vs. Asstt. CIT 268
ITR 48 (Guj.)(FB)

IOT Infrastructure & Energy Services
Ltd. vs. ACIT 233 CTR 175 (Bom)

Rabo India Finance Ltd. vs. DCIT 346 ITR
81 (Bom)

SAK Industries (P) Ltd. vs. DCIT 19
taxmann.com 237 (Del)

Torrent Power SEC Ltd. vs. ACIT 231
Taxman 881 (Guj)

V. M. Salgaoncar Sales International vs.
ACIT 234 Taxman 325 (Bom)

Banaskantha District Oilseeds Growers
Co-op. Union Ltd. vs. ACIT 59 taxmann.com 328 (Guj)

Pr. CIT vs. Sagar Developers 72
taxmann.com 321 (Guj)

Simaben Vinodrai Ravani vs. ITO 394 ITR
778 (Guj)

In Home Founders Housing Ltd. vs. ITO 93
taxmann.com 371, the Madras High Court went a step further, and held that
non-compliance of the procedure indicated in the GKN Driveshafts (India)
case (supra) would not make the order void or non est, while
remitting the matter to the Assessing Officer for passing a fresh order, after
disposing of the objections. A Special Leave Petition against the said decision
has been rejected by the Supreme court.

Bayer Material Science’s case

The issue again came up before the Bombay
High Court in the case of Bayer Material Science (P) Ltd v DCIT 382 ITR 333.

In this case, relating to assessment year
2007-08, the assessee filed its return declaring certain taxable income. The
return was accepted by issuing intimation u/s. 143(1). On 6^th
February 2013, a notice u/s. 148 was issued seeking to reopen the assessment.
On 15^thMarch, 2013, the assessee filed its return of income, in response to the notice,
and sought a copy of the reasons recorded in support of the notice. The
Assessing Officer did not furnish the reasons recorded, in spite of the
assessee’s letters dated 15^thMarch, 2013 and 12^th
September, 2013 seeking the reasons recorded for issuing the notice. The
Assessing Officer finally furnished the copy of the reasons recorded for
issuing the notice to the assessee only on 19^th March, 2015.

On 25^th March, 2015, the assessee
filed its objections to the reasons recorded. The Assessing Officer, without
disposing of the assessee’s objections, issued a draft Assessment order,
required for a Transfer Pricing assessment, dated 30^thMarch, 2015.

The Bombay High Court noted that, as the
case involved transfer pricing issues, the period of limitation to dispose of
an Assessment consequent to reopening notice as per the 4th proviso to section
153(2) was two years from the end of the financial year in which the reopening
notice was served. The reopening notice was issued on 6^th February,
2013, and the reasons in support were supplied only on 19^th March,
2015 in spite of the fact that the
Revenue was aware at all times that the period to pass an order of reassessment
on the impugned reopening notice dated 6^th February 2013 would
expire on 31^st March, 2015.

The Bombay High Court observed that there
was no reason forthcoming on the part of the Revenue to satisfactorily explain
the delay. The only reason made out in the affidavit filed by the Assessing
Officer was that the issue was pending before the Transfer Pricing Officer
(TPO) and it was only after the TPO had passed his order on transfer pricing,
that the reasons for reopening were provided to the assessee. The Bombay High
Court expressed its surprise as to how the TPO could at all exercise
jurisdiction and enter upon enquiry on the reopening notice, before the notice
was upheld by an order of the Assessing Officer passed on objections. Besides,
the recording of reasons for issuing the reopening notice was to be on the
basis of the Assessing Officer’s reasons. The High Court observed that the
TPO’s reasons on merits, much after the issue of the reopening notice, did not
have any bearing on serving the reasons recorded upon the party whose
assessment was being sought to be reopened.

The Bombay High Court further noted that, in
the affidavit filed before it by the Department, it was stated that the
Assessing Officer was under a bonafide impression that the TPO would pass an
order in favour of the assessee. The Bombay High Court expressed its surprise
as to how the assessing officer could
then have any reason to believe that income chargeable to tax had escaped
assessment.

On 23^rd December 2015, when the
Department again sought more time from the High Court, the High Court indicated
that in view of the gross facts of the case, the Principal Commissioner of
Income Tax would take serious note of the above, and after examining the facts,
if necessary, take appropriate remedial action to ensure that an assessee was
not made to suffer for no fault on its part particularly so as almost the
entire period of two years from the end of the financial year in which the
notice was issued was consumed by the Assessing Officer in failing to give
reasons recorded in support of the notice.

When the matter again came up for hearing on
27^thJanuary 2016, the High Court was informed that, on 22^ndJanuary,
2016 the Principal Commissioner of Income Tax had passed an order u/s. 264, by
which he set aside the draft Assessment order dated 30^thMarch 2015,
and thereafter restored the matter to the Assessing Officer for passing order
after deciding the objections filed by the assessee. However, during the course
of hearing, the learned Additional Solicitor General, on instructions, stated
that the order dated 22^nd January, 2016 passed by the Principal
Commissioner of Income Tax was being withdrawn.

The Bombay High Court noted that the draft
Assessment order was passed on 30^thMarch, 2015 without having
disposed of the assessee’s objections to the reasons recorded in support of the
notice. The reasons were supplied to the assessee only on 19^th
March, 2015 and the assessee had filed the objections to the same on 25^thMarch,
2015. According to the Bombay High Court, thes passing of the draft Assessment
order without having disposed of the objections was in defiance of the Supreme
Court’s decision in GKN Driveshafts (India) (supra). Thus, the Bombay
High Court held that the draft Assessment order dated 30^th March,
2015 was not sustainable, being without jurisdiction, and set it asideas it had
been passed without disposing of the objections filed by the assessee to the
reasons recorded in support of the notice.

A similar view has been taken by the Gujarat
High Court in the case of Vishwanath Engineers vs. ACIT 352 ITR 549,
where, in spite of repeated reminders by the assessee even by pointing out the
law laid down by the Supreme Court, the Assessing Officer failed to dispose of
the said objections and instead of that, straightaway passed the order of
reassessment. In that case also, the Gujarat High Court, in the context of the
issue under consideration, held that AO was bound to disclose the reasons
within a reasonable time and on receipt of the reasons, the assesseee was
entitled to raise objections and if any such objections were filed, the
objections must be disposed of by a speaking order before proceeding to
reassess in terms of the notice earlier given.. The order of reassessment was
held to be not valid.

Similarly, in Ferrous Infrastructure (P)
Ltd. vs. DCIT 63 taxmann.com 201, the Delhi High Court considered a case
where the objections furnished by the petitioners to the section 148 notice had
not been disposed of by a separate speaking order prior to the reassessment
order. The Delhi High Court quashed the notice under section 148, the
proceedings pursuant to the notice and the reassessment order, on two grounds –
that the reasons had been recorded by the Assessing Officer after issue of the
notice u/s. 148, and that a separate speaking order had not been passed in
response to the objections, with the objections having been dealt with, if at
all, in the reassessment order itself.

Observations

The rationale for remanding the matter back
to the Assessing Officer, while quashing the reassessment order, has been
explained in detail by the Gujarat High Court, in the case of Sagar
Developers (supra):

“the question that arises is, whether if
the Assessing Officer defaults in disposing of the objections but proceeds to
frame the assessment without so doing, should the reassessment be terminated
permanently. In other words, the question is, should the assessment be placed
back at a stage where such defect is detected or should the Assessing Officer
for all times to come be prevented from carrying out his statutory duty and
functions.

It is by now well settled principle of
administrative law that whenever administrative action is found to be suffering
from breach of principles of natural justice, the decision making process
should be placed at a stage where the defect is detected rather than to
permanently annul the action of the authority.

Further it is also well settled that
whenever an administrative action is found to be tainted with defect in the
nature of breach of natural justice or the like, the Court would set aside the
order, place back the proceedings at the stage where the defect is detected and
leave the liberty to the competent authority to proceed further from such stage
after having the defect rectified. In other words, the breach of principle of
natural justice would ordinarily not result in terminating the proceedings
permanently.

The requirement of supplying the reasons
recorded by the Assessing Officer issuing notice for reopening and permitting
the assessee to raise objections and to decide the same by a speaking order are
not part of the statutory provisions contained in the Act. Such requirements
have been created under a judgment of the Supreme Court in the case of GKN
Driveshafts (India) Ltd. (supra). It is true that when the Assessing Officer
proceeds to pass the final order of assessment without disposing of the
objections raised by the assessee, he effectively deprives the assessee of an
opportunity to question the notice for reopening itself. However, the assessee
is not left without the remedy when the Assessing Officer proceeds further with
the assessment without disposing of the objections. Even before the final order
of assessment is passed, it would always be open for the assessee to make a
grievance before the High Court and to prevent the Assessing Officer from
finalizing the assessment without disposing of the objections.

The issue can be looked from slightly
different angle. Validity of the notice for reopening would depend on the
reasons recorded by the Assessing Officer for doing so. Similarly the order of
reassessment would stand failed on the merits of the order that the Assessing
Officer has passed. Neither the action of the Assessing Officer of supplying
reasons to the assessee nor his order disposing of the objections if raised by
the assessee would per se have a direct relation to the legality of the notice
of reopening or of the order of assessment. To declare the order of assessment
illegal and to permanently prevent the Assessing Officer from passing any fresh
order of assessment, merely on the ground that the Assessing Officer did not
dispose of the objections before passing the order of assessment, would be not
the correct reading of the judgment of Supreme Court in the case of GKN
Driveshafts (India) Ltd. (supra). In such judgment, it is neither so provided
nor one think the Supreme Court envisaged such an eventuality.”

Similarly, in Home Finders Housing’s case
(supra), the Madras High Court explained the rationale as under:

“It is not in dispute that there is no
statutory requirement to pass an order taking into account the statement of
objections filed by the assessee after receiving the reasons for invoking
section 147. The Supreme Court in GKN Driveshafts (India) Ltd. (supra) has
given a procedural safeguard to the assessee to avoid unnecessary harassment by
directing the Assessing Officer to pass a speaking order taking into account
the objections for reopening the assessment under section 147.

The forming of opinion to proceed further
by disposal of the objections need not be a detailed consideration of all the
facts and law applicable. It must show application of mind to the objections
raised by the noticee. In case the objections are such that it would require a
detailed examination of facts and application of legal provisions, taking into
account the assessment order sought to be reopened, the string of violations,
suppression of material particulars and transactions which would require considerable
time and would be in the nature of a detailed adjudicatory process, the
Assessing Officer can dispose of the objections, by giving his tentative
reasons for overruling the objections.

The disposal of objections is in the
value of a procedural requirement to appraise the assessee of the actual
grounds which made the Assessing Officer to arrive at a prima facie
satisfaction that there was escape of assessment warranting reopening the
assessment proceedings. The disposal of such objection must be before the date
of hearing and passing a fresh order of assessment. In case, on a consideration
of the objections submitted by the assessee, the Assessing Officer is of the
view that there is no ground made out to proceed, he can pass an order to wind
up the proceedings. It is only when a decision was taken to overrule the
objections, and to proceed further with the reassessment process, the Assessing
Officer is obliged to give disposal to the statement of objections submitted by
the assessee.

The core question is as to whether
non-compliance of a procedural provision would ipso facto make the assessment
order bad in law and non est. The further question is whether it would be
permissible to comply with the procedural requirement later and pass a fresh
order on merits.

In case an order is passed without
following a prescribed procedure, the entire proceedings would not be vitiated.
It would still be possible for the authority to proceed further after complying
with the particular procedure.

The enactments like the Land Acquisition
Act, 1894, contain mandatory provisions like section 5A, the non compliance of
which would vitiate the declaration under section 6 of the Act. Even after
quashing the declaration for non compliance of section 5A, the Court would permit
the conduct of enquiry and pass a fresh declaration within the period of
limitation.

Therefore, that non compliance of the
procedure indicated in the GKN Driveshafts (India) Ltd. case (supra) would not
make the order void or non est and such a violation in the matter of procedure
is only an irregularity which could be cured by remitting the matter to the
authority.”

Therefore, the High Courts which have held
in favour of remand, have relied on three aspects – one is that the
non-consideration of objections is a breach of principles of natural justice,
which can be remedied by restoring the matter to the earlier stage, secondly,
that the requirement is merely a procedural requirement, and thirdly, that this
is not a statutory requirement, but one laid down by the Supreme Court.

In Garden Finance’s case (supra), the
Full Bench of the Gujarat High Court analysed the logic of the Supreme Court
decision in GKN Driveshaft’s case (supra), as under:

“it appears that prior to the GKN’s case
(supra), the Courts would entertain the petition challenging a notice under
section 148 and permit the assessee to satisfy the Court that there was no
failure on the part of the assessee to disclose fully and truly all material
facts for assessment. Upon reaching such satisfaction, the Court would quash
the notice for reassessment. The question is why did the Court not require the
assessee to appear before the Assessing Officer.

Earlier when the Court required the
assessee to appear before the Assessing Officer, the Assessing Officer would
not pass any separate order dealing with the preliminary objections and much
less any speaking order, and the Assessing Officer would deal with all the
objections at the time of re-assessment. Hence, if the assessee was not
permitted to challenge the re-assessment notice under section 148 at the
initial stage, the assessee would thereafter have to challenge the
re-assessment itself entailing the cumbersome liability of paying taxes during
pendency of the appeal before the Commissioner (Appeals), second appeal before
the Income-tax Appellate Tribunal and then reference/tax appeal before the High
Court. It was in this context that the Constitution Bench had observed in
Calcutta Discount Co. Ltd.’s case (supra) that where an action of an executive
authority, acting without jurisdiction subjected, or was likely to subject, a
person to lengthy proceedings and unnecessary harassment, the High Courts would
issue appropriate orders or directions to prevent such consequences and,
therefore, the existence of such alternative remedies as appeals and reference
to the High Court was not always a sufficient reason for refusing a party quick
relief by a writ or order prohibiting an authority acting without jurisdiction
from continuing such action and that is why in a fit case it would become the
duty of the Courts to give such relief and the Courts would be failing to
perform their duty if reliefs were refused without adequate reasons.

What the Supreme Court has now done in
the GKN’s case (supra) is not to whittle down the principle laid down by the
Constitution Bench of the Apex Court in Calcutta Discount Co. Ltd.’s case
(supra) but to require the assessee first to lodge preliminary objection before
the Assessing Officer who is bound to decide the preliminary objections to
issuance of the re-assessment notice by passing a speaking order and,
therefore, if such order on the preliminary objections is still against the
assessee, the assessee will get an opportunity to challenge the same by filing
a writ petition so that he does not have to wait till completion of the
re-assessment proceed- ings which would have entailed the liability to pay tax
and interest on re- assessment and also to go through the gamut of appeal,
second appeal before Income-tax Appellate Tribunal and then reference/tax
appeal to the High Court. Viewed in this light, it appears that the rigour of
availing of the alternative remedy before the Assessing Officer for objecting
to the re-assessment notice under section 148 has been considerably softened by
the Apex Court in the GKN’s case (supra) in the year 2003. Therefore, the GKN’s
case (supra) does not run counter to the Calcutta Discount Co. Ltd.’s case
(supra) but it merely provides for challenge to the re-assessment notice in two
stages, that is: (i) raising preliminary objections before the Assessing
Officer and in case of failure before the Assessing Officer, and (ii )
challenging the speaking order of the Assessing Officer under section 148 of
the Act.”

From the above observations of the Courts,
it is clear that the requirement of disposal of objections by a speaking order
is not just a mere procedural formality, but a procedural safeguard introduced
by the Supreme Court, just as the recording of reasons by the Assessing Officer
is a procedural safeguard built in into the statute.

This safeguard, as analysed by the Gujarat
High Court Full Bench in Garden Finance’s case (supra), was to prevent
unnecessary harassment – to ensure that in cases where the issue of notice was
not justified, the assessee does not have to wait till completion of the
reassessment proceedings, which would entail the liability to pay tax and
interest on reassessment and also to go through the gamut of appeal, second
appeal before Income-tax Appellate Tribunal and then reference/tax appeal to
the High Court. The Supreme Court decision in GKN Driveshaft’s case (supra)
now provides for challenge to the reassessment notice in two stages, that is:
(i) raising preliminary objections before the Assessing Officer and (ii) in
case of failure before the Assessing Officer, challenging the speaking order of
the Assessing Officer u/s. 148. The requirement of disposal of objections is
therefore an additional level of protection granted to an assessee, and not
just a mere procedural requirement. This decision is delivered by the Full
Bench of the high court and shall, in any case, have a binding force over the
decisions of the division bench.

While disposing of the reasons, the
Assessing Officer has to pass a speaking order dealing with the objections, as
held by the Courts, and not just dispose of it mechanically without application
of mind, or in a standard format. The requirement of disposal of objections
cannot therefore be taken lightly.

It is at the same time important to appreciate
that in the matters of revenue laws, an order is to be conferred with a
finality at some point of time; an assessment cannot be kept open on one count
or another and certainly not for the lapses and latches of those in governance
and vested with power. Income tax Act, like many tax laws, is enshrined with
not one but various provisions that require the authorities and the tax payers
to carry out a task within the prescribed time limit; respecting these
statutory deadlines is not only essential for administration but also for the
dispensation of timely justice. ‘Satvar Nyay’, within the prescribed
time, is one of the promised objective of the tax laws.

An order of reassessment is required to be
necessarily passed within the time provided by section 153 of the Act and any
license even by the court to act beyond the prescribed time limit, will amount
to doing violence to the statutory law. In our considered view, a breach or a
lapse, in administration of a civil law or a procedure, should not be equated
with a breach in revenue laws and a breach here, should as a rule, be viewed as
fatal to the dispensation of justice. Significantly, one would find, not a few,
but hundreds of cases wherein the reassessment orders are routinely passed
without paying any heed to the need to dispose of objections by a speaking
order as mandated, under the law of the land, by the Supreme court; these
orders are passed with the knowledge of the law and, in most of the cases, are
passed in spite of being informed of the law. We are unable to side with a view
that seeks to provide a fresh innings to
an officer who consciously, knowingly has chosen to disrespect the law, even
where it is held to be administrative.

The fact that this safeguard has been
introduced by the Supreme Court and not incorporated in the statute itself,
should not make any difference – after all, what the Courts are doing is
interpreting the law as enacted. In the course of such interpretation, if a
view is taken by the Courts that a particular procedural safeguard is necessary
to avoid misuse of the provisions, such procedural safeguard should be regarded
as inherently built into the provisions itself.

Reassessment itself is a tool of harassment
of the assessee, as noted by the Gujarat High Court, in cases where it is not
justified. It is therefore a serious imposition on the taxpayer, for which
safeguards have been built in. If these safeguards are flouted by the Assessing
Officer, should the assessing Officer be given a second chance, is the moot question
that needs to be addressed.

Recording of reasons is the other safeguard
that has been built in. This is also a procedural safeguard. Almost all the
courts have been unanimous in their view that in a case where reasons have not
been recorded in writing before issue of notice u/s. 148, the reassessment
proceedings are invalid, and deserve to be quashed. Why should the same logic
not apply to the procedural safeguard of disposal of reasons before completion
of assessment?

Emphasising the need for such an order, the
Bombay High Court, in the case of Asian Paints Ltd. vs. DCIT 296 ITR 90,
recognised the importance of the safeguard of disposal of reasons, by holding
that if the Assessing Officer does not accept the objections filed to the
notice u/s. 148, he cannot proceed further in the matter for a period of four
weeks from the date of receipt of service of the order on the assessee,
disposing of objections with a view to enable the assessee to challenge the
order disposing of the objections, before the appropriate forum to prevent the
AO to proceed further with reassessment, if desired to do so.

Given the importance of this safeguard, and
the harassment that a reassessment causes to an assessee, the better view
therefore seems to be that in case these safeguards are not observed, the
Assessing Officer cannot be given a second chance to rectify his blatant
disregard of the safeguards put in place by the Supreme Court.

shailesh.kwebmaker

Emerging Technologies And Their Impact On Accounting And Assurance

Introduction

Emerging technologies such
as Robotic Process Automation (RPA), Cognitive & Artificial Intelligence,
Analytics and Blockchain present significant opportunities for both improving
our world and creating competitive advantage but they all bring with them new
risks that need to be understood, managed and assured.

The speed, ubiquity,
complexity and invisibility of technological change has driven holes through
and paths around our traditional three lines of defence. Without new approaches
to accounting and assurance, there is the danger of a breakdown in the
willingness of people to engage with technology and to share data — an erosion
of the ‘digital trust’ which is increasingly important to the success of
organisations, economies and societies.

Just as technology is
enabling business to do things they have never done before, so it is for
auditors. The basic premise of audit today remains what it has always been; to
give assurance to the capital markets that a company is correctly reporting its
financial results. Nevertheless, auditors are now using powerful technological
tools to deliver more comprehensive and even higher-quality audits.

These tools also save time
that can be spent focusing on complex areas of the audit and those that require
judgement. And because the tools enable the analysis of a complete data
population, they allow the auditor to add value by commenting on processes and
discussing related business issues with audit committees and company boards.

RPA:
Transforming audit delivery model

Robotic process automation
(RPA) – the automation of rule-based processes and routine tasks using software
applications known as “bots” – is one of the digital enablers of the
transformation of the audit. RPA is a fast, accurate and efficient way of
processing structured data from bank accounts and financial systems. It can be
used to perform general ledger analysis – for example, finding journal entries
that do not balance, are duplicated or are of a particularly high value – and
to create audit-ready work papers.

Benefits of RPA in audit
include global consistent quality, analytics driven approach, accelerated audit
start and reduced burden on audit team and client. Some of the audit activities
where RPA is being increasingly adopted by companies globally includes:

1. Data preparation:

– Automated
and streamlined data capture from multiple systems

– Data
mapping

– Reconciliation
of data

– Check
completeness of data

2. Audit procedures

– Analytical
review

– Sample
size calculation and selection

– Automation
of basic audit procedures

– Analysis
of trial balance, journal entries, application of agreed risk criteria and
materiality levels

– Audit
confirmations from vendors, financial institutions etc.

For example, in Australia,
over 50% of leading auditor’s bank audit confirmations for the recent 30 June
year-end were lodged by a robot. The robot submitted confirmation requests,
managed the process (including exceptions) and provided work papers back to the
audit team, along with the formal confirmation. This allowed the audit teams to
focus on judgmental areas rather than administration, accelerated and
identified issues earlier, reduced potential audit surprises, and improved
client service. Further solutions that employ RPA are now being developed.

AI:
Welcome to the machines

Artificial Intelligence
(AI) could be a game-changer for business generally, and professional services
in particular. With the rapid developments in machine learning, data mining and
cognitive computing, the next decade promises to see huge leaps forward.

While the excitement over
the potential applications of AI is understandable, there are some
misconceptions – and indeed fears – developing. Central to that is the fear
that AI will in fact replace humans in the value chain – doing the tasks we
currently do, but faster and more accurately, and thus rendering many of us
redundant.

We are currently at the
beginning of that journey. Following a lull in the pace of development, the
last three years have seen applications of AI becoming more mainstream across
professional services.

Take, for instance, the
issue of lease accounting. This is a hot topic, given the recent accounting
changes that demand that companies scrutinise their position with regard to
leases and recognise related liabilities.

Until now, analysis of
lease accounting has mainly been performed using human review. However, current
pilot programs indicate that AI tools may allow the analysis of a larger number
of lease documents in a much shorter timeframe. These pilots show that AI tools
would make it possible to review about 70%-80% of a simple lease’s contents
electronically, leaving the remainder to be considered by a human. With more
complex leases (in real estate, for instance), that figure would be more like
40%, but as the tools improve, and the machines learn, it is likely that more
complex contracts and data can be read, managed and analysed.

This illustrates some of
what narrow AI can deliver. It cannot, as yet, replace the judgement,
scepticism or experience that humans bring to their work. Making comparisons or
value judgements is not the function of this type of AI

But the real benefit we are
now beginning to see through this type of application is in its predictive
value. We recently used deep learning technologies to “learn” from seven years
of financial statements through six machine learning algorithms. This enabled
us to survey enough data to better evaluate where restatement risks lie. The
technologies make it possible to predict where future risks may occur and
enable audit teams to revisit and refine their approach. They also present intriguing
possibilities for the detection of fraud.

That predictive ability
marks the next step in the evolution of AI, and allows auditors to carry out
work like this more efficiently and with greater accuracy.

AI can do
a lot, but there’s also a lot it cannot do, and we cannot rely on it to deliver
scepticism and judgement.

Predictive
Analytics: Shortcut to tomorrow

Data analytics is being
increasingly applied to almost 100% of transactions at various stages in audit
by companies to bring enhanced insight and value. This includes planning,
interim as well as year-end audit procedures.

Data
analytics provides auditors with an enhanced ability to:

– Focus
on areas of risk

– Ask
better questions

– Detect
unusual items

– Strengthen
professional scepticism

Predictive analytics
combined with data visualisation and reporting is being applied in the
following audit activities using both structured as well as unstructured data:

1. Scoping

– Dashboard
reporting for stakeholders

– Repeatability
and audit trail

– Work-paper
generation

2. Interim
Financial Statement Review

– Flexible
period comparison

– Intelligence
on group operation

– Core
‘not significant’ BS and IS analysis

3. Single and
Multi-dimensional trending analysis of Key Performance Indicators/Key Risk
Indicators:

– Financial

– Non-financial

– Intra-component

– Inter-component

Blockchain:
Building blocks of the future

Blockchain may be best
known as the distributed ledger technology that underpins the digital currency
Bitcoin, but it could also be used for a host of other purposes that involve
transmitting data securely. These include payment processing, online voting,
executing contracts, signing documents digitally, creating verifiable audit
trails and registering digital assets such as stocks, bonds and land titles.
Its potential for application within the transaction-based financial services
industry is particularly vast, but it is relevant to organisations in every
sector.

Going a stage further,
blockchain could even overturn entire business models in certain sectors by
empowering the growth of “virtual organisations,” also known as decentralised
autonomous organisations (DAOs). DAOs operate through computer programs known
as “smart contracts” that carry out the wishes of human shareholders by automatically
executing the terms of a contract – for example, transferring money or assets.

In the future, finance
teams could make use of distributed ledgers – together with artificial
intelligence – to automate a range of processes, from payments through to
foreign exchange trades and the filing of tax returns. For greater efficiency,
finance functions could even outsource parts – if not all – of their routine
work to DAOs.

Finance teams could work
with blockchain in different ways, observes Professor Nigel Smart from the
department of computer science at the University of Bristol in the UK. “They
could have multiple distributed ledgers, each one doing something different. Or
they could have big distributed ledgers, with lots of different things going on
within one ledger. Some data may be visible to everybody, while other data may
be encrypted so that it is only visible to a small group of people.”

Since the data stored in
distributed ledgers is authenticated by multiple parties and continually
updated, it offers finance teams the possibility of both real-time reporting to
management and external auditors, and being able to work more effectively with
their external audit and tax providers.

It’s likely that auditing
will also be revolutionised by blockchain. Key to the technology is its record
of transactions, which enables something akin to real-time auditing by default.
Indeed, blockchain has been dubbed “digital era double-entry bookkeeping”
because of its similarity to old accountancy principles.

Blockchain might also be
able to replace random sampling by auditors, by making it easier and more
effective to check every single transaction using code. This would also make it
easier to investigate fraud, since real-time systems could highlight and investigate
anomalies.

Blockchain’s rise doesn’t
mean the end of the finance or audit team. Real-time auditing and reporting
will release CFOs and their teams from certain routine, time-consuming tasks so
that they can play more strategic, creative roles – and focus on new ways to
deliver future business value, rather than keeping track of past costs. And
human interpretation of data and transaction patterns will still be needed to
generate the new insights that can lead to business growth.

Blockchain’s
rise doesn’t mean the end of the finance or audit team.

Emerging
technology challenges for Assurance

There are four common
characteristics of emerging technology that have made designing appropriate
assurance techniques increasingly challenging:

1. Speed

The pace
at which new technologies such as Blockchain and AI are evolving drives three
main challenges:

– ‘Pilots’,
‘proof of concepts’, ‘agile’ and other quick ways of implementing emerging
technology means that it has often landed and is in use inside an organisation
before the assurance implications have been considered

– By
the time technical assurance training has been developed and rolled out (with
equally beautiful PowerPoint slides), the technology has often moved on.
Traditional methods for developing and delivering training haven’t kept pace
with the rate at which technology is evolving

– Regulators
and professional bodies have yet to develop frameworks and approaches for
guiding how these should be considered, implemented and assured

2. Ubiquity

The extent
of the potential, and in some cases actual, adoption of these technologies
creates a further challenge. Simply put both the likelihood and impact of
emerging technology risks are increasing:

– The
likelihood increases as the breadth of adoption increases. For example Gartner
predicts that AI will be in almost every new software product by 2020¹.

– The
impact increases as the depth of adoption increases. For example, IoT
technologies are increasingly used to control and protect national infrastructure
and AI is being used in healthcare both for diagnosis and recommendation of
treatment

3. Complexity

Emerging technologies
aren’t impacting organisations in nice bite-sized chunks:

– Convergence means these technologies interact (for example, there
is no reason you can’t use AI to process Blockchain transactions on IoT). The
ever increasing interactions between autonomous computer systems may lead to
unpredictable and potentially untraceable outcomes and as such technology
specific assurance approaches are of limited value

– Extended enterprises mean that these technologies are not
controlled exclusively by the organisation and are often adopted through the
use of third party services or dictated by the supply chain. Increasingly, the data
that is used by emerging technologies is shared between organisations

4. Invisibility

There is a danger that is
risks and therefore the need for assurance goes unnoticed:

– The
very existence of the emerging technology components may be unclear when it is embedded
into things we use. Software may include things such as machine learning and a
service maybe delivered using automation e.g. chat bots.

[1] https://www.gartner.com/newsroom/id/3763265

Even where
this use is clear, there is often no transparency around the level of assurance
that has been already been performed over it.

– The
need for assurance may be less visible to teams where the risks created by
emerging technology initially impact stakeholders outside of the organisation.
For example profiling based on observed data (collected through online activity
or cctv), derived or inferred data could cause significant unwarranted
reputational damage for an individual.

Key impacts of emerging technology on existing assurance approaches

Whilst
developing approaches to each emerging technology in turn can provide useful
guidelines for teams (where they land in isolation and this can be done quickly
enough) we believe there are three more fundamental shifts in assurance
approaches that need to be considered by assurance leaders:

1. From post to pre-assurance

Assurance after the event
is increasingly irrelevant. Whether its machine learning models that can’t be
retrospectively audited, the risk of almost instantaneously processing millions
of items incorrectly (but consistently) with RPA or the immutability of
Blockchain. The impact of not assuring emerging technologies before the event
will increase in line with the increase of the power and responsibility being
entrusted to them as they are embedded into safety critical, or decision
making, systems. Perhaps the most quoted example of this is a model used to
support criminal sentencing in the US by looking at the likelihood of
reoffending.

This significantly
under-predicted white males reoffending and over predicted black males based on
questions which introduced bias into the algorithm². Considering the
impact of this example then merely detecting discriminatory decisions after the
event will not be sufficient. Under the accountability provisions of
legislation such as GDPR organisations will need to find ways to build
discrimination detection into emerging technology to prevent such decisions
being made in the first place.

Assurance
after the event is increasingly irrelevant.

2. From timely to time limited assurance

Assurance teams spend a significant
amount of effort in providing comfort over processes, profits and projects
based on how well they are doing at a point in time and provide little comfort
as to how long into the future the assurance will remain valid— what is the
‘assurance decay’? If a continuously evolving model is working as expected now,
what assurance do we have that it won’t start producing erroneous decisions and
predictions going forward? While this may be an implicit gap in how assurance
is reported today, emerging technology will accelerate the need to address
this. To achieve this, the scope of assurance plans and reporting need to
evolve to address questions such as:

– What
are the things that we have assumed remain constant for the assurance to be
valid?

– What
ongoing monitoring controls are there that the assurance and these assumptions
remain valid?

– Are
there any specific triggers which would cause us to revisit or revise this
assurance as it would not be valid?

– What
assurance is there over controls which cover ongoing change management and
evolution of systems?

3. From data analytics to data dialectics

Over
the last decade assurance teams have increasingly attempted to use data
analytics to improve the way they scope, risk assess and deliver their work. Even
basic analytics have driven additional insight and comfort in areas ranging
from fraud (e.g. ghost employees) to commercial benefits (e.g. duplicate
payments). While many aspire to move towards more advanced analytics such as
continuous controls monitoring, emerging technology significantly increases a
challenge that has already slowed progress for teams in this area. Simply put:

– The
‘black boxes’ are getting darker. As we move into areas such as AI it is
becoming harder to understand how systems are processing things; and

[2] Angwin,
Julia. Make Algorithms Accountable. The New York Times, 1 August 2016

– The
‘data exhausts’ are getting bigger. Exponentially more data is being generated
by technologies such as IoT.

While
there will no doubt continue to be a role for traditional analytics moving
forward (including over emerging technologies such as RPA), we believe that
assurance teams should also develop a data dialectics approach — focusing less
on testing what the system has done and more on what it could and should have
done. To bring this to life:

Assurance
teams should also develop a data dialectics approach — focusing less on testing
what the system has done and more on what it could and should have done

– A
simple example of generating an independent expectation in practice has been to
predict store level revenue based on weather, footfall and advertising
campaigns and using this to highlight stores reporting revenue out of line with
central expectations.

– A
simple example of using an appropriate questioning approach is querying a
machine learning model to understand its sensitivity to changes in training
data and for specific outcomes understand which features are most heavily
driving this outcome and what would have to change to change the outcome. Even
where the underlying model is inscrutable a data dialectics approach provides a
step towards better algorithmic assurance.

Skills
auditors need & are CAs prepared for that?

This technology is already
impacting our organisations and this will only increase — we need to quickly
develop a plan that navigates a path between waiting (and potentially being too
late) or over focusing on this at the cost of other areas that require attention.
The reality is we have neither the luxury of doing nothing nor doing everything
we would want to. We suggest three steps to consider in developing a practical
response to assuring emerging technology risks.

1. Develop a rough map and
start skirmishes

Starting
work in this area is important both to address existing emerging technology
risks as well as developing capability and confidence to deal with this as it
increases in the future. In our work in this area we have found there are four
key corners to considering developing a rough map:

– Verifiability:
What are the consequences of doing nothing now on our ability to assure but
more importantly control this area in the future — will the horse already have
bolted?

– Visibility:
To what extent is the technology already understood with robust guidelines in
places to how it can be assured and controlled?

– Value
at risk: What is the likely impact in the future of risks not being addressed
in this area including the current direction of regulation (e.g. privacy)?

– Velocity:
What is the speed of likely adoption and impact of this technology in the
organisation in the future?

Having
developed a view of where we should focus our efforts, it is important to start
skirmishes early when we believe there will be an issue rather than when they
believe there will be an issue.

2. Train the troops

From our own experience in
developing approaches to assuring emerging technology we suggest three areas of
focus to enable our teams to build the right skills to remain relevant to their
organisations:

– Give
them first-hand experience: ‘The map is not the territory’ — teams can’t
prepare to deal with emerging technologies just by reading whitepapers (however
well written and informative they might be…), attending breakfast briefings or
webcasts. Training your entire team in becoming technical experts in data
science isn’t realistic either. To truly understand and be able to assure
emerging technologies the team needs to get hands-on with them — this means seeing
it in action, playing with it and gaining more than a superficial knowledge.

– Develop
effective communication and relationship skills: The shift to pre-assurance may
seem like a sensible step but for it to work involved up front. To do this they
need more than ever to be able to build the relationships that will allow them
to be invited to the table at the right time to stand shoulder-to-shoulder with
the rest of the business — relying on assurance dictates and stage gates alone
won’t be enough to achieve this. Therefore as the deployment of emerging
technologies increases so does the need for effective communication and
relationship building skills in assurance teams.

Relying on
assurance dictates and stage gates alone won’t be enough to achieve this

– Train for higher order
skills — the need to become more ‘human’: Ethics is an area where we have
clearly stated we need to collectively raise our game as an assurance
profession in terms of embedding this into our assurance plans and therefore
also in how we train our teams to understand and deal with this. However, we
believe developing other higher-order skills will enhance the team’s capability
for dealing with emerging technology — whether that’s in creativity (to help
them find new approaches) or perhaps most importantly in how to deal with
complexity. Even with today’s technology, complexity is a key area where
assurance often fails, for example gaps often occur in considering
technologies’ inter-relationship with other risks (e.g. master data, reports,
application controls, and interfaces). This will accelerate in the future and
as ‘simplicity does not precede complexity but follows it’ before our
teams deliver off the shelf work programs we need to encourage them to stand
back and to consider things such as these inter-relationships (between
technologies, suppliers, risks, data to name a few). Therefore training teams
to deal with and manage complexity (for example by training them in techniques
such as problem-structuring methods) in order to design appropriate assurance
will perhaps be the other key skill that makes a difference in the future.

3. Adapt

As technology and
organisations adapt we believe assurance functions must also move beyond the
‘iteration’ of the continuous improvement driven by measures such as
effectiveness reviews and audit committee demands if they are to appropriately
adapt. An approach we have applied to help assurance functions do this in
practice considers adaptation across an additional two dimensions:

– Iteration:
This is an area most assurance departments already focus on to drive ongoing
continuous improvement in existing processes by making them more efficient and
effective.

– Innovation:
Choosing a limited number of ‘big bets ‘where assurance teams can evolve or add
value by doing something totally different. For example emerging technologies
such as robotics have the potential for some more repetitive controls in
frameworks such as SOX to be automated to allow more focus on other areas which
require more judgement or are more complex.

– Integration:
It is difficult for assurance teams to have the resources to adapt alone and
collaboration is another dimension which can allow them to do this more
effectively. Working across the organisation and beyond (e.g. suppliers, peers)
to keep up to date and where appropriate to collaborate with other initiatives
and innovations can allow additional capabilities to be more quickly and
cheaply developed and delivered.

Conclusion

To conclude, following are
the two key messages which should serve as food for thought for all CA’s and audit professionals:

1.
Technology: The great leveller: The pace of technological
change is bringing with it unparalleled opportunities for companies to disrupt
themselves and enter new markets. The promise of greater productivity,
efficiencies and the elimination of human error is well documented. Less well
documented are the new risks that emerging technologies are creating for
organisations. The speed of adoption, complexity and ubiquity of these
technologies means that these risks are rapidly increasing in both likelihood
and impact and moreover often going unnoticed.

2. Get
ready: Current assurance approaches alone are insufficient to address
these risks. Assurance leaders urgently need to engage with their stakeholders
and the rest of the organisation to understand how emerging technologies impact
their organisation now, and in the future. Resulting changes to assurance
scopes and approaches require new skills and capabilities that assurance teams
need to start developing today to remain relevant for the future.

As part of this, ethical
assurance will be key to help ensure that in embracing these new technologies
organisations are confident that the way in which they are doing so is consistent
with their brand and culture allowing them to demonstrate integrity and build
essential digital trust.

shailesh.kwebmaker

Auditing: An Indic Framework

This article proposes
fundamental changes to the auditing framework in India seeking to move away
from the present Western framework, which has been blindly adopted, and lead to
dysfunction in our audit profession. There is more, but only a couple of
framework items, namely, marketing and constitutional status, are selected for
the present article. This ‘Indic Framework’ has the potential to drive changes
globally starting with India.

The Supreme Court has
directed on 23^rdFebruary 2018, in a landmark judgement against the
multinational audit firms operating in India, in the Sukumaran Case, that GoI
should come up with a new statutory framework. Identifying the root causes of
the problem sets the stage for a new framework. The auditor needs to be
constitutionally provided with a judges’ standing, in a fundamentally
re-thought new-framework, in so far as it concerns his role as an auditor.

Can the auditing system
work if the framework itself is broken and dysfunctional? Then why wonder as to
how come the auditing world has been raining scams and will continue to rain
scams? All we need to do is stop blindly following a defective framework
unthinkingly, because it comes from the West, or because some global firms,
powerful lobbies and governments support it.

The Auditor and The Judge – Marketing

For those who do not have a
clear picture that an auditor is seriously disrespected by the very framework
of the laws, and his position is compromised. The present western audit
framework is unsuitable for the quasi-judicial function of independent
financial statement auditing, should clearly visualise the following comparable
scenarios, and then introspect, if an auditor can still be independent, ethical
and respect worthy, no matter how honest he may actually be.

1 Imagine a judge pleading before the potential
litigants in his court –O Dear Potential Litigant in my Court, please give me
your case to stand in judgement over? please??! And the judge gets praised as
to what a fabulous marketing angel he is?!

2 Imagine a judge doing his brand marketing
exercise with a potential litigant in his court – I will give you my name on my
Order in your case, and, what a great name will be associated with the Order?
You simply cannot compare my name with any other? O Please, how can you go to a
smaller judge?!!

3 The judge then opens up his marketing
presentation and reveals high quality marketing collaterals, which leave his
litigants in a swoon – they can’t think of going to another “ordinary judge”…
It would be infra dig in my cocktail circuits to do that…hmmm..

4 Imagine a judge entering a remuneration
contract with a potential litigant in his court – these are my fees / salary /
consulting charges for issuing an order after I stand in judgement on your
litigation in my court!

5 Imagine a judge offering a bargain basement
“pricing offer” to a potential litigant in his court – I will undercut all the
other judges, I will give you 25 percent cut in my fees, you must appoint me!!

6 Imagine a judge sending snazzy
update-newsletters to the potential litigants in his own court, containing
scenarios of ‘advance rulings’ on what he would do as a judge in various
latest-situations, and telling the potential litigant. “Look at this, you will
not have problems, if your case gets heard in my court”!!

7 Imagine a judge telling the potential
litigants: this is not about me or who I am – this is not a service of my
personal skill and ability, it is not a conscience matter – it is all about the
vast empire of the Big N business of which I am partner and we have worldwide
strengths. What does it matter what is my capacity – after all it is not me, it
is ABCD, the largest “global judgment network” that is doing your work. How can
a lowly single honest judge be compared to ME?!! I am the most honest of all judges
ever!

8 Imagine a judge telling fellow judges in the
courts, you guys are incompetent and lack the capacity – you don’t employ as
many people as I, you don’t train them as well as I do, you don’t pay them as
well as I do. You are all nothing compared to what I AM. LoL. Litigants are not
fools to select me. ROFL.

9 Our judges network offers just about every
other service, doctoring, laundry, housekeeping, construction, what not? You
name it, we have it! Obviously, that makes us best judges. Don’t waste your
time with others! We come to ement delivered right there – don’t be ridiculous,
you don’t have to come to the Courts anymore. You’re the boss! And, ofcourse we
are truly the best in our global-village world – quality in everything we do,
always one step ahead. Cheers!

Constitutional
Authority

While the Judge enjoys
constitutional authority, the Auditor enjoys none. The case for the need to
make this change is identified here. There is indeed a very strong case for
this.

The
Auditor renders a very skillful job of delivering an opinion on the true and
fair view of the financial statements of the audited entity. There are multiple
points in the conduct of an audit where application of mind, involves very
experienced and deep judgment. On the one hand, there are the ‘facts’ of the
case. On the other hand, there are the laws and standards and ‘regulations’. An
application of the regulations to the facts, gives rise to numerous onerous
interpretations involving complex issues of law, probability, precedence,
intent, all supported by independence and ethics. This gives rise to multiple
set of interpretations and understandings of the same facts and regulations.
This is where judgment comes in. While the auditee’s management may argue along
one line, the independent directors, the promoter directors, the audit
engagement teams – at corporate office, and at other locations – and the
consulted subject matter experts, may all choose different lines. This is often
the case. Based on all this, the auditor (signing the financial statements) has
to make a final judgment call and his ‘order’ is contained in his Auditors
Report. It has been repeatedly said especially recently that an auditor’s
signature is relied upon by the whole nation, meaning to say that the role of
the auditor is crucial. Sadly, in all this, the company treats an auditor, who
plays such a crucial quasi-judicial role, like any other ‘vendor’: commercially
and there ends the matter.

This ostrich-like stance of
the western rules of auditing that is the basis of our present laws, defies the
facts of the situation, that in so far as the audit is concerned, the auditor
performs a quasi-judicial function based on exercise of both personal skill and
judgment, involving a conscience-based duty, delivering grass-root governance
to the entire economy in the form of assurance arising from his integrity, and
therefore the present structure is far from salubrious, just as making a judge
subservient to the litigants, denying him the standing, denying him the
privileges, and the financial independence, will all compromise and throw into
jeopardy the legal system.

The very same outdated
framework of laws, which fails to protect the standing and role of an auditor,
however, expects that the auditor should be independent of the auditee, without
providing any support for it. The auditor can be (and often is in present
times) hauled-up for misconduct for taking a stand in his audit opinion, which
need not match with those on the other side of the disciplinary process.

The disciplinary process is
often vitiated because decision-makers do not have a clue and/or have never
conducted a financial statement audit. Finding competent decision-makers to man
the disciplinary-process is akin to finding a needle in a haystack. An auditor
can be sued for defamation if he resigns for making explicit disclosures; and
really speaking it is not at all the auditor’s deliverable to make public
statements other than those he is formally reporting on. Vested interests in
our business world weaponize these legal provisions against the auditor and the
auditing firm in pursuit of their own goals, complicated by incompetence of
those who are given the powers to indict an auditor. Even a casual glance shows
that the classic systemic-failure of a ‘judge becoming subservient to the
litigants’, referred to above, has become the reality.This has jeopardised the
audit process – creating a dangerous environmentthat is now hanging by a thread
– one in which the big fish escape and nameless small issues gain a place of
importance.

The biggest loser of course
is the investor, and our capital markets. Ask well-experienced auditors, and
they will uniformly agree on these forces at work. As a further consequence of
our present defective foundation, the audit process over the years has turned
into an extreme-documentation-exercise rather than remain as one that is
focused on application of responsible professional judgement. The better
auditor is the better file-maker: one who is best able to fend off or absorb
professional liability. This in turn has created a secondary wave of
risks-and-failures. A cottage industry has emerged of ‘auditor shopping’:
good-documentation by presentation-savvyauditors is exploited by corporates, as
a substitute for good auditing. It is all too obvious that the process when
tested in situations will continue to fail, as it is inherently fraught with
inadequacies. No amount of SOX and governance rules, fresh auditing standards,
tweaks to listing rules, independent director training, higher regulatory
authorities, can fix the problem, and having tried it for a few years, we see
that audit failures still continue to happen. Why? Because the root cause of
the failure, namely the lack of standing and authority of an auditor as a
constitutional authority similar to a judge, has failed to be recognised.

It is essential to empower
the auditor and not keep him as a pawn in a commercial game. By keeping the
auditor as a pawn, all rules have already been compromised by interests whose
objective is that. Have we not said always that auditing is a noble profession?
Should there not be a framework to support it? Any disagreements of
stake-holders on an audit opinion, should vest as in the case of the order of a
judge, against the merits of the order itself, through an appeal to a senior
auditor on its content, rather than viciously crucify the auditor personally
and labeling him as guilty of misconduct, effectively destroying honest
professionals (even a single finding of guilt suffices in today’s evaluation
structure), professional firms, and finally de-railing the profession.

Grass
Roots “Good Governance” in National Interest

On a national scale, the
court system, interfaces with less than one percent of the population. The
legal system kicks in only when there is a complaint on a dispute. On the other
hand, nearly one hundred percent of the population is directly or indirectly,
subjected to an audit. Every business, and every charity, is audited. The
financial statement audit is nearly omnipresent and is a substratum of the
nation’s economy. The objective of our times is to bring in good-niti –
ethics, integrity, and good governance. Indeed this objective that is to
be fulfilled is in the motto– satyamevajayate. By re-positioning the
status of an auditor, the reach of integrity and good governance in society
will be almost pushed to one hundred percent.

This shows how vastly
favourable the impact on the population will be by a reform of this nature – in
fact so complete will be the roll out of the process of bringing an undercurrent
to all our affairs, that such a change will completely clean up the country’s
everyday standards of ethics at the grass root level. One can safely say that
this is in our national interest. Kautiliya believed that “greed clouds
the mind” implying that a greedy person could not figure out the consequences
of his/her actions. It is therefore essential that a premium is placed on
probity, and, the audit profession be rescued from the bad framework which
blindly ape the west, and the chartered accountant is given a constitutional
position similar to a judge in so far as his function as an independent auditor
of financial statements goes.

shailesh.kwebmaker

Forensic Audit: Adapting to Changing Environment

Expectations from Forensic
Auditors have sky rocketed after the revelation of many large value scandals,
which have rocked corporate India in the last decade. The latest one relating
to the LOU scam has crossed over Rs 11,000 crores! Not only the affected banks,
enforcement agencies, and the regulatory bodies, but even the hitherto
unaffected banks and even blue chip companies have started doing a lot of deep
diving exercises to ascertain whether they have been abused in any way. Thus,
experts in forensic accounting services are being sought out to perform this
massive task which is unprecedented in terms of size and scale.

In this backdrop, the
challenges to forensic auditors are huge. Perpetrators of financial crimes and
fraud have evolved with stronger capabilities and are armed with technology to
launch lethal attacks. This is further compounded by the growing complexities
in business operations. The nature of the business transactionssometimes are so
technical that they are not easy to comprehend for even technically qualified
experts, and to do a thorough forensic audit in such circumstances needs a huge
amount of patience and perseverance apart from the expertise. Therefore, to do
a good forensic audit in the days to come, forensic auditors will need to
adapt. In the theory of evolution, it is believed that the species which
survives the longest is not the one which is the strongest, nor that which is
the most intelligent, but that which is able to
adapt to the changing environment. Forensic auditors need to do exactly
that. They will have to adapt to the environment which poses such new
challenges.

The process of adapting
will be greatly facilitated if forensic auditors bring in creativity and
imaginative thinking. The following suggestions may facilitate a forensic auditor
to adapt better and perhaps bring in more penetrative results:

– Firstly, remove complete
reliance on standard checklists by customising them to the objectives of the
given situation. This can be better understood with a case study. In an
investigation assignment in a life insurance company, the forensic auditor had
to investigate and report on suspicious death claims based on data and
documents given to him for the last one year. He compiled a checklist, which
included selection of a test sample of transactions and applying routine
processes of vouching and verification of supporting claim documents like the
death certificates, crematorium receipts, doctors cause of death reports,
application form details, etc. The sample selection was done by using one of
the standard sampling methods like statistical sampling. The auditor’s entire
focus was on completing the work as per his checklist on a statistical sample,
and submitting his report. This procedure of applying a statistical sample and
then vouching and verifications of documents is certainly important, possibly
to gain confidence on the controls and procedures, but maynot be sufficient to
detect the possibility of fraud. One suggestion is to then reduce complete
reliance on standard sampling techniques and apply other kinds of focussed and
adapted sampling techniques additionally. The forensic auditor in this case
tried this approach. Since he had the full data dump of all the death claims on
an electronic spreadsheet, he started thinking about different ways of
extracting data samples which could possibly throw up any clues of fraud. That
was the key to his success. When one starts looking beyond the routine and
tries to visualise various possible ways of exposing a crook, amazing solutions
can come from such a thought process. In fact, it is said that a good
investigator is one who can think like a fraudster. The forensic auditor, in
this case, saw that in the data of death claims, there were many data fields
that were not addressed or checked by his audit check list. He realised that
fraudsters also realise what auditors check and what they generally don’t look
at. The forensic auditor spotted two data fields which caught his eye. Date of
birth of the deceased and date of birth of the beneficiary or the claimant.
These were not within the focus of the forensic audit at all. The forensic
auditor then decided to extract a new sample of data by filtering out those
claims paid where the date of birth of the
deceased and the date of birth of the claimant were the same. The
forensic auditor expected such instances to be nil or very miniscule. Except in
the rare situations where the claimantor beneficiary was a twin sibling of the
deceased, the date of birth of the beneficiary would be unlikely to be exactly
the same as that of the deceased. So out of 13,000 line items, he expected to
find no more than 4-5 such transactions where the date of birth of the deceased
and the beneficiary would be exactly the same. The data was filtered to those transactions
where the dates of birth were matching and to his surprise he found 82
transactions where the date of birth matched exactly for the deceased and the
beneficiary. Now the forensic auditor had a new direction of investigation and
he started examining them in greater detail. He made inquiries as regards which
branch offices had originated and paid these claims, who were the claims’
approving officers, which period during the year were these claims paid and
even how fast they were paid. He then grouped the sample data appropriately
branch wise, officer wise. The results were spectacular. 77 of the 82 claims
with the common dates of birth came from only one specific branch in North
Mumbai. A claims officer Mr. M. Thanvir was the common authorising claims
officer for all these claims. These claims were paid off 50 % faster (in number
of days after lodgement). Now the original checklist for document examination
was again used to vouch and verify in detail the claims of these 77 deaths. As
expected, solid evidence of falsified death certificates and other documents
was found and a major insurance fraud in the North Mumbai branch was exposed!
Thus customising the sampling technique, and applying appropriate additional
checks based on the revelations, did the trick. In other words adapting and
innovating was the key to the forensic auditor’s success.

– Secondly, the forensic
auditor must constantly do research and look for newer solutions and techniques
to address fraud in different situations. If the perpetrators of fraud can take
advantage of technology, so can the forensic auditors. A regular visit to
websites relating to latest fraud tools, techniques and approaches in fraud
investigations can enable a forensic auditor to meet the challenges of business
complexities and possibly gain from experiences of others. In one such
investigation assignment when a forensic auditor was stuck with limited
findings, he had come to a stage where he had to submit a report and close the
matter inconclusively stating there was lack of evidence. He had really worked
hard and found that all the documentary checks that he had applied were not
yielding any significant results, but there were plenty of warning bells and
other indicators which seemed to suggest that fraud existed. But he had no hard
core evidence. Of the many matters which were not resolved, he had one major
doubt in his mind that the credit card number that had been furnished as
evidence for payment was false, but he had no way to verify its correctness. He
did not give up hope and his patience and perseverance paid off. He surfed
through the internet looking for solutions for credit card frauds and with a
little effort he came across an algorithm called the Luhn’s algorithm. This
algorithm was able to ascertain whether a credit card number was a valid credit
card number. However, the algorithm in the form available on the internet was
difficult to use, so painstakingly the auditor prepared an electronic
spreadsheet incorporating the functions of algorithm and he was able to use it
to prove that the credit card number given as evidence of payment for an
expense was an invalid number. This forensic auditor was thus able to achieve
the objective only by doing research and adapting the forensic audit to the
needs of the situation.

While these two suggestions
stated above are possible approaches for solutions, there are other measures
too which not only forensic auditors, but all professionals should take. One,
do not allow ‘a stale procedures syndrome’ to set in. This stale procedures
syndrome is nothing but a term for ‘getting used to’, or ‘taking for granted’.
In our every day work we often get complacent when we do the same or similar
tasks again and again. There was a very interesting fraud investigation case
where an auditor was auditing the financial statements of a college for 2
decades. He was doing a reasonably good audit and generally the audit reports
issued were clean and unqualified. Unfortunately, he died and a new auditor was
appointed. The new auditor brought a fresh new wave of thought processes and he
started examining data with a completely new checklist, which was compiled
after a thorough understanding and evaluation of the activities and operations
of the college. One of the items in the financial statements which caught his
eye was the huge balance ofstudents deposits lying with the college. These were
amounts deposited by the students at the time of admission such as library
deposit, caution money deposit, etc. These deposits could be collected
by the students only when they left the college, which was usually about 4
years after their date of admission. Most students would forget to collect
these deposits for various reasons and consequently over a period of time the
college balance sheet disclosed a huge amount of unpaid students deposits. The earlier auditor never gave much attention
to this deposit amount since this was not a part of the college’s revenue and
it was merely an unclaimed liability payable only when requested for by the
students. Nevertheless, the new auditor painstakingly studied the deposit
collection and refund procedure and performed some checks on them as a part of
his new audit checklist. While he was examining the refund procedure, something
unusual caught his eye. The ledger account of deposit repayments showed
repayments for each date person wise, amount wise strangely in an
alphabetical order. To his surprise, he found that almost throughout the
entire year (barring some random exceptions) deposits were repaid to students
in an alphabetical order of their names.

This was not only queer but
also absurd. It was unthinkable that students would come to claim their deposit
refund in an alphabetical order. The new auditor called a few of the students
who had claimed their refund. All of them confirmed his suspicions that they
had not made any request for, nor had they got any refund. It was thus revealed
that the repayments were actually effected on forged refund applications
prepared and collected by the cashier himself. The cashier had adroitly taken
great care to ensure the forged application forms were prepared with all the
necessary supporting details and were attached to the cash payment vouchers,
but he made one fatal mistake. He got the names of students from the attendance
registers of the college, which were always in an alphabetical order.The
previous auditor also would have seen this ledger, but he had been auditing for
over two decades and his mind became ‘used to’ or `stale’ and he did not spot
this absurdity. The central lesson in this for all professionals is to combat
setting in of such a stale procedures syndrome by having more than a different
person to review the work, so as to bring in freshness and a greater alertness
to spot any warning bells of fraud.

Thus, in the foreseeable
future, forensic audits can increase their chances of success if they try to
innovate and adapt. The future holds opportunities for even the middle level
and smaller sized professional firms who want to do this kind of forensic
auditing work. Presently, that may appear to be difficult, but even smaller
firms can and will get a share of the pie. For this purpose, they will have to
adapt too by undergoing training and doing intense research. This will be the
fundamental need. Once the capability has been achieved, these firms can also
get empanelled with Police, Banks, Income Tax, PSUs etc. Very soon the
need will be so intense that all companies and potential clients may not wish
to go only to giant firms but also to small specialist firms where they would
have the benefits of both economical budgets and matching quality.

shailesh.kwebmaker

Accountants & Auditors: Ethics And Morality – A Fast Developing Story

Last week I met a few
friends from my accounting fraternity – and the discussions hovered around a
rather difficult recent phenomenon: Whether the audit-clients are becoming more
unethical nowadays? Or is it that the accounting community carrying out audits,
raising themselves from slumber and becoming stricter?

Just think of the scenario:
It is reported that during the five-month period January to May 2018, 32 firms
have resigned as auditors midterm from companies, compared to 36 auditor
resignations in the whole of 2017-18 and 18 in 2016-17. The numbers in earlier
years were all significantly lower. Fearing probable repercussions from
regulatory authorities on corporate governance standards, more auditing firms
are dropping their assignments like hot potatoes.

Deloitte resigned as
auditor of Manpasand Beverages, the producer of MangoSip – one of the largest
mango-drinks in India, after the auditee-company reportedly failed to share key
data. Price Waterhouse (PwC) quit as auditor for construction and infrastructure
company Atlanta Limited. Same happened at Vakrangee Ltd. where PwC quit, citing
concerns to the corporate affairs ministry about the books of accounts, mainly
related to its bullion and jewellery business.

Apart from the
resignations, the audit of many big names have come under stricter ‘audit
opinions’, with auditors flagging off some sticky issues. For instance, at Jet
Airways, L&T Shipbuilding and Reliance Naval and Engineering, auditors have
raised doubts whether these companies can continue as a “going
concern”.

And these are all bad news!

It may be noted that each
auditee, where auditor resignations have taken place, has since then denied any
irregularities, though their clarifications do not exactly answer the doubts
raised by the concerned audit firms.

The key
question is: have the environment changed and made auditors behave more
responsibly? Prima facie, the exodus of auditors
seem to be motivated by the fear of being pulled up by the market-regulator or
worse the company getting caught with their hands stuck in the hanky-panky
bowl.

Do
Corporates Cheat?

The vexed
question is: do businesses swindle? And if they do, then the auditors have a
lot to ponder, plan and perform.

A corporation is an
artificial legal entity – it can buy, sell, borrow, lend and produce – but can
it deceive and deceit? And if a company does cheat, then who should be held
responsible? Is it not the people within who cheat? If the employees of a
company cheat, can the responsibilities of the corporation be far behind?

Be it by choice or
compulsion, the corporate world has not been immune to cheating. Businesses are
a microcosm of our society and are made up of people like you and me. They have
the same strengths and weaknesses as
the people it consists of. Greed has been a major influencer for human
behaviour since long. No wonder, it has been said that many in the corporate
world have the feet of clay.

Auditors will therefore
have to be aware that cheating can and will take place. Some will try to cut
the corners, but many will not. It is the task of the auditors to sift through
the basket of eggs to find the ones which are either rotten or are in the
course of becoming decomposed.

Who is
responsible?

When a corporation commits
fraud, who should be held responsible – the management, the shareholders, the
finance managers or the auditors?

Time and again companies
have been penalised, taken to task and admonished for wrong doing. But the top
management, who would have masterminded the unlawful activity, generally have
got away rather lightly, if not scot-free. Take the example of Jeffrey
Skilling, the ex-CEO of Enron Corporation, who spearheaded one of the worst
accounting frauds in history and destroyed the company and trampled on the
lifelines of thousands of employees. But Skilling got away with a relatively
light punishment. Initially jailed in 2006 for 24 years, but his imprisonment
term was reduced by 10 years, only to walk away soon, a free man by 2019.

Are shareholders, the
ultimate owners of a joint-stock company, responsible for frauds if any? Let us
take a peep into a corporation, by lifting its corporate-veil. While in
theory the shareholders own a company, but in reality it is the directors and
the top management who run a corporation. They decide everything – how much
dividend to declare, how much bonus shares to issue and how much stock options
to be allotted to themselves. Shareholders in general, hardly possess the
ability or the wherewithal to influence corporate’s behavior – negatively or
otherwise, unless of course it’s the controlling shareholders.

Now comes the finance team,
the accountants and most importantly the CFO. Are they responsible? The CFO and
her team, have a lot of responsibility on good governance. When it comes to
doctoring the books of accounts, they would generally have the primary
responsibility. However, there could be frauds committed ‘on’ the corporation,
of which the finance team may not be aware. But for that purpose, a robust
internal control process with concomitant internal audit system needs to be put
into place.

According to the Companies
Act 2013, the introduction of Internal Financial Control (IFC) has ordained the
finance team to ensure orderly and efficient conduct of business, including
adherence to company policies, safeguarding of its assets, prevention and
detection of frauds and errors, accuracy and completeness of accounting records
and timely preparation of reliable financial information. These are all onerous
tasks. In addition, listed companies need to submit a certification from both
the CEO and CFO under Regulation 33 of the SEBI Listing Obligations &
Disclosure Requirements (LODR), 2015 has given an onerous task to the two top
guys. They will need to not only confirm that to their best of knowledge the
financial statements do not contain any materially untrue statements, no
transactions are fraudulent and illegal and they have communicated to the
auditors and the Audit Committee of instances of any significant frauds they
have been aware of.

There is another important
aspect the accounting team needs to consider. Most of the CFO team members
would be employees of an organisation. If the employer desires to carry out
hanky-panky, it is well neigh impossible for most employee-accountants to
negate the ulterior intent of their bosses. And this is the greatest conundrum
which faces most of the accounting community. What do you do when you know
things are not above board? Should you protest? Can you walk out or should you join
the bandwagon to save your skin with the job? Most literature would suggest
that ethics is the king, and being ethical is any accountants’ dharma. But when
the employer pulls the strings of poor governance, little in my view, are the
choices which can be made by the employees.

Now let us shift our
attention to the auditors. What is the level of their responsibility? Can they
take the sanctuary of the accounting reports and statements being ‘true and
fair’, and do not guarantee its complete ‘accuracy’? The primary responsibility
for prevention and detection of fraud lies with the management team. An auditor
do not guarantee that all material misstatements shall be detected. Auditors
opinion on the financial statements is based on the concept of obtaining
reasonable assurance from the documents, records and management team. In addition, if an auditor finds during the
course of audit that fraud has been committed by the company or its employees,
it must be reported immediately.

Let us look at the role of
the Auditors in some more detail.

Auditors
and Auditees

Auditors are the eyes and
ears of the shareholders and their boards. Their financial statements are
relied on by the outside world to take a view on a company’s state of affairs.
Auditors verify whether accounting information and reports have been prepared
appropriately (in fact, it should be prepared accurately subject to accounting
judgements wherever applicable). Auditors are looked upon as protectors of the
interest of the shareholders, creditors and the governments.

However, the trust reposed
on the auditors are sometimes belied and some of them miss out in doing their
duties fairly. And this the challenge the accounting fraternity is currently
fighting against.

Many a times, the auditors
fail to acknowledge that they have the responsibility of detecting impending
financial disaster in a corporation and highlight on ongoing fraud. Time and
again auditors tend to wash their hands off on the plea that they were led up
the garden path by the management, and they believed in what they were told and
showed. This basic tenet may get challenged sooner than later, not only by
public pressure but also by the accounting oversight boards set up by the
various Governments.

It is a fact that some
auditees would try to get a ‘better than actual’ picture certified. Not all
have this tendency but many have. And this is where the ethical standards of
auditors get tested. What does an auditor do when audit fees are at stake? A very
vexed question indeed, which the auditor and accounting community have been
grappling since time immemorial.

Rap on
the knuckles

Prime Minister Narendra
Modi gave Chartered Accountancy community a big jolt through his speech on
Chartered Accountants’ Day on July 1, 2017. The speech powerfully suggested at
CAs’ involvement in money-laundering and tax evasion. He also highlighted the
ICAI’s apparent poor record of disciplining its members. Used to being lauded
for its efforts in “nation-building”, the CA community was stunned by the Prime
Minister’s candor and the threat of severe action against errant CAs. This was
a clarion call to get the CA community on board with ethical practice.

Then came the unfortunate
Nirav Modi scandal at PNB. The Rs. 14,000-crore bank fraud perpetrated that
surfaced in February 2018 has raised fresh questions about the effectiveness of
auditing in banks. The public outcry gained ground when it came to the fore
that Public sector banks (PSBs) have a variety of audits done by CAs including
statutory, branch, concurrent, and stock audit. This development did not augur
well for the accounting fraternity. Unfortunately, the rising non-performing
assets of banks have also raised questions about the auditors’ failure to
review asset quality carefully and insist on provisions for bad loans.

In a significant move, the
Central Government in March 2018 approved setting up of the independent
regulator National Financial Reporting Authority (NFRA) that will have sweeping
powers to act against erring auditors and auditing firms. The PNB fraud became
the trigger point for this development. The CA community could not convince the
powers that be, especially the Ministry of Corporate Affairs, that the ICAI was
doing a good job in taking to task the recalcitrant auditors. And I tend to
agree with the general belief that ICAI could have done a much better job to
detect and punish the defaulting fellow members. The NFRA now becomes an
overarching watchdog for the auditing profession, with the powers of the ICAI
to act against erring chartered accountants getting now vested with the new
regulator.

Another development which
has made life a bit more difficult for the auditors is the Insolvency and
Bankruptcy Code 2016. Many defaulting borrowers failing to repay their
committed debt amounts, could be subject to forensic audit. Fingers can then
get pointed towards the auditors, if things are not found to be in order.

The appointment of NFRA and
instituting of bankruptcy proceedings, have definitely made things tough and
harsher for the auditors. No wonder that we are seeing more resignations of
auditors in the recent times. If any nation has to develop and flourish, it is
very important that the financial reports certified by the auditors, need to be
reliable. There is nothing wrong in making movement towards attainment of this
goal to make financial reporting more credible and dependable.

It may be also noted that
the Companies Act 2013 have granted legal status to Serious Fraud Investigation
Office (SFIO). This is a significant development exposing the accounting
fraternity to the vagaries of a third-party government controlled
investigations.

Let’s be
careful and team-up

While many businesses
prepare their accounting records to present the true picture of its health,
there are several who play ducks and drakes with numbers. Accounting fraud
usually begins small – by cutting some corners here and enhancing some revenue
there. However, it is like riding a tiger. Very difficult to disembark. Once
the mischief is done – the next quarter’s profits are never sufficient to undo
mistakes or mischiefs committed in the past.

Methodologies adopted by
the tricksters and fraudsters are numerous. And the reality is accounting
manipulations have been happening since the birth of accounting. Instances
exist where auditors have been hand in glove with their clients. There are also
numerous examples where auditors have not been able to detect wrongdoing in
their client companies.

As economy progresses and
information availability enhanced, the pressure on the auditors will only go
up. The CA community who conducts most of the audits and especially the
statutory audits, have to now come up to the expectations. There will continue
to be wayward clients bent upon taking short-cuts to meet their immediate
goals.

The moot point now is: the
auditing community which is mostly consisting of CAs, now needs to hold
themselves together against the unscrupulous in the business community. The
problem will be, if one auditor resigns and stands firm on ethics, others
should not give way. This is yet not happening. The resigning auditors’
positions are being taken by someone else. But if, we the CA community stand
firm on good governance, only we can be the winners – no doubt the economy and
the country will come out with flying colours under the banner of clean and
good governance.

The last
words

At the gathering when I and
my fellow CA fraternity members were debating what is in store for all of us,
the consensus was clearly that increasing premium will be placed on good
judgement, ability to distinguish the signal from the noise when it comes to
reporting and auditing. The audit profession will evolve significantly in the
next five years or so, changing more than what it has happened in the last
several decades.

Keeping pace with advancing
technology, discouraging immoral practices, sticking to ethics and acting
‘together’ against the black-sheep in the client-community, will become the fulcrum
for the accounting and auditing community’s continued relevance.

shailesh.kwebmaker

Substance Over Form

Background:

The principle of substance
over legal form is central to the faithful representation and reliability of
information contained in the financial statements. The responsibility on the
preparers of financial statements is to actively consider the economic reality
of transactions and events to be reflected in the financial statements. And
more importantly, account for them in a manner that does fairly reflect the
substance of the transaction (and situation). This is because, preparers
understand the commercial reality best and also the reason why the legal form
was considered appropriate to a particular set of transactions.

In the same way, it is
important for accountants and auditors whose responsibility it is to review
financial statements that they obtain the commercial reality and substance of
the transactions from the preparers to serve the overall objective of “faithful
representation” which represents one of the two ‘Fundamental Characteristics’
and components of the Conceptual Framework for financial reporting.

What is critical to both
the preparer and the reviewer is that ‘substance over form’ does not mean that
we ignore ‘Form’ …. in that case, the entire edifice on which Ind AS 115 on
Revenue Recognition where the contract with the customer is fundamental to
revenue recognition, would collapse! What is meant is, we focus on the
commercial substance and reality of the transaction(s) in its entirety.

Accordingly, this article
does not seek to judge the legality of transactions from the narrow prism of a
reviewer. Instead, it focuses on working together as preparers and reviewers to
reflect the substance of transactions in the financial statements.

1. Introduction:

1.1 We are all aware that an entity’s financial
statements should report the substance of the transactions that it has entered
into. Normally, transactions are such that the substance and form do not differ
and therefore, do not require any further inquiry. However, some of these would:

a. The
party that gains the principal benefits from the transaction is not the legal
owner of the asset;

b. There
are a set of transactions that we know are all inter-linked in such manner that
the commercial substance can be determined only by putting together all these
transactions, treating them as “interlinked”;

c. An
option is included on terms that make its exercise highly likely;

1.2 Let us
now look at a couple of transactions:

a. A
finance company buys a huge item of plant & machinery that it will not use
and plans to sell it to the previous owner? Is this a sale transaction or a
financing arrangement is what we may need to establish.

b. An auto
manufacturing company appoints dealers through whom it sells cars on the
condition that it will transfer the cars at a fixed price, will bear the cost
of price fluctuations and the risk of obsolescence… in effect, the auto maker
bears all the significant risks and this could be a significant indicator
whether the company needs to derecognise the asset.

2. Substance of transactions and the standard setters…

2.1 There has been a fair amount of understanding
and consensus among various authorities and accounting standard setters that
except for certain circumstances and reasons, “substance should follow
form“, although, it is not necessary that transactions should not
follow form.

2.2 Very
recently, Tax Authorities introduced General Anti Avoidance Regulations (GAAR)
to deal with certain set of transactions entered into by entities, with the
sole objective of reducing or shifting the tax base, etc to the detriment of
the Exchequer. The net effect of the GAAR provisions (to put them
simply) is to disregard the legal form of these transactions and look
only at the substance, that is the “Commercial Reality” and tax the entity
accordingly. Obviously, these relate to a specific set of transactions entered
into with the only significant objective of reducing tax liability.

2.3 Financial
markets have been developing products and solutions around financial
reengineering, segregating risks between parties and selling these products.
Lease financing, Securitisation, Derivative instruments, the creation of SPVs,
are part of innovative products that were developed to help finance companies.
Regulators and accounting bodies have been putting together their collective
wisdom and market knowledge to address these complexities.

Sale and Lease back arrangements were an accepted tax planning devise
until GAAR came in and so were financial leases on the basis of which an entire
industry came into being. Financial instruments became more complex with the
issue of complex derivative products, securitisation etc. The introduction of
convertible securities raised issues regarding the nature and classification of
capital and debt.

3. The response of the IASB

There is no
specific international financial standard that deals with the topic of
substance over form. Unless specifically governed by specific standards, the
terms of transactions will be scrutinised to determine how the transaction
should be recorded.

It was only
around 1985 that the Institute of England and Wales issued the first
authoritative document on Off Balance Sheet Financing with a view to
determining the accounting treatment of transactions and their economic
substance rather than their mere legal form.

The IASB
came up over a period of time with a fairly comprehensive Financial Reporting
Framework that formed the basis and context for standard setters across the
world. Notwithstanding that, substance over matter forms an all-pervading
aspect of financial accounting; its reference was omitted from the Framework
for the Preparation and Presentation of Financial Statements because it was
considered “redundant” to be presented as a separate component of “Faithful
Representation”. Except for FRS 5 which sets out the principles that
will apply to all transactions where we need to inquire into the basic
principles for identifying and recognising the substance of transactions,
none of the accounting bodies devote a separate standard to deal with the
complexities arising out of “substance over form”.

4. Let us look at some of the accounting
standards that specifically address the issue of substance over form in greater detail:

a. Ind AS 115 the new Revenue Recognition
Standard that replaces Ind AS 11: Construction Contracts and Ind AS 18:
Revenue specifically to deal with the complexities and changes that have been
taking place in the structuring of business transactions of various types and
in several sectors such as Information Technology, Infrastructure and Real
Estate, etc. by focusing on Revenue Recognition from the customer’s
point of view.

b. Ind AS 17
Leases where Operating Leases have also come within the ambit of the
Standard.

c. Ind AS 110 that deals
with Consolidated and Separate Financial Statements. The standard deals with
various scenario which emphasises on reflecting the substance in determination
of control such as de-facto control, assessment of participating rights
vs. protective rights, analysing the rights and obligation assumed by the
shareholders irrespective of their legal shareholding in the entity.

d. Ind AS 32 on Financial
Instruments: Presentation specifically deals with the classification of
debt instruments into debt and equity in certain cases, like for example
Convertible Debentures that are broken based on a fair valuation into equity
and debt. This standard also covers a situation where in a financial instrument
would classify as equity instruments but if the other members of the group
assumed any obligation or provided any guarantee to the holder of the
instrument, then such additional terms and conditions would need to be
considered for the determination such instrument as equity or financial
liability.

5. Illustrative “Principles” that could
apply to most transactions:

i. UK GAAP deals with the concept of
“substance over form” through FRS 5 that lays down the general principles that could apply to
transactions. It adopts a strictly Balance Sheet strategy namely, settle the
assets and liabilities and let the profit and loss entry emerge. One simple
governing principle is when determining the nature of transactions, one needs
to decide whether, as a result of the transaction, the reporting entity has
created new assets or liabilities or whether it has changed any of its assets
and liabilities. The Standard emphasises the need to focus on the commercial
logic of the (set of) transactions of the respective parties. And, if this does
not make sense, probably, all aspects of the transaction or all parties to the
transaction(s) have not been identified.

ii.
Complex transactions have certain common features that we need to look out for,
such as:

a. Where the legal title to an item is separated
from the ability to enjoy the principle benefits and exposure to the principle
risks associated with it; the main issue here is the identification of assets
and liabilities and tests to ascertain whether the asset or liability should be
recognised in the balance sheet

b. The tying up of all related transactions to
make sense of the commercial reality or substance;

c. The inclusion in the transaction of option
whose terms make it highly likely that the option will be exercised;

d.
Situations where the relationship between the two entities is that of parent
and subsidiary; the concept of ‘control’ becomes very critical here;

iii. The
identification and recognition of the substance of transaction is to identify
whether it has resulted in complete alienation of the asset or the liability or
whether, it has given rise to new assets or liabilities for the entity or
whether it has increased the existing assets or liabilities of the entity. The
transaction may result in the entity losing control over the future economic
benefits of the asset.

iv.
Transactions may result in the creation of new obligations where the entity is
unable to avoid the outflow of benefits. If that be so, the liability is
recognised!

v.
Complexities arise when there are subsequent transactions that result in
affecting these rights or obligations. Where the transaction does not
significantly alter the entity’s rights to benefits or its exposure to risks,
the entity should continue to maintain “status quo”. When significant
variations occur, it may be necessary to vary the valuation of the asset or the
liability. For example, through a series of transactions, an entity hands over
the economic benefits from a financial asset in part (one specific revenue
stream is parted with), there is no complete alienation, in which case, it may
be necessary to recognise the variation in the books.

In this
context, it may help revisit some of the key definitions to get to the
substance of the transactions and these are: Assets, Liabilities, Common Control, Options, etc.

6. Looking at Illustrative Case Studies to demystify some of the complexity:

A small
list of illustrations to better understand this principle….

A. Ind AS 115: Revenue Recognition

Consignment Sales:

This is a case of Principal vs
Agent. In this case, the Consignor sends goods to the consignee to the
specifications of the ultimate customer and is responsible for any deviations.
The Consignee sells the stock in the normal course and returns the unsold goods
to the Consignor.

Some of
the key or significant risks for consideration that would determine whose asset
or obligation it is would be:

… does
the Principal take primary responsibility for fulfilling the terms of the
contract on acceptability of the product and its specifications (that is,
meeting with customer specifications)

… who bears the Inventory risk:
this comprises of two components that is, whom bears the risk of slow moving
inventory and second, the risk of inventory after it reaches the customer (that
is, where the customer has the right of return)

… is the stock
transferred at a price fixed by the entity.

Comments:
The crucial tests are:

i. Consignment revenues are
not recognised when the goods are delivered to the consignee because control is
not transferred. Revenue is generally recognised on sale to the customer.

ii. Revenue recognition
upon transfer of ‘control’ is different from the ‘risk and rewards model’ under
Ind AS 18. Per Ind AS 115, ‘control of an asset refers to the ability to direct
the use of an obtaining substantially all of the remaining benefits from the
asset.

Sale & Repurchase:

A is a Developer in the
Real Estate business, he also possesses significant land banks. He enters into
an agreement with ABC Bank to sell some of the land based on:

i) Sale price on date of
sale will be decided by the seller who will appoint his own valuer;

ii) A gets the right to
develop the land during any time commencing within the next three years during
ABC’s ownership. Given A’s credentials in the sector, ABC will not unreasonably
withhold any of the development plans. However, ABC will bear all the outgoings
during this entire period including taxes etc. ABC will also charge an addition
fee of 10% of costs incurred that will cover its administration costs;

iii) The bank will maintain
a “Memorandum” account to which all costs incurred will be debited
and should A re-acquire the land, all these costs will be recovered including
interest calculated at the average of the last three years;

iv. The Bank grants A an
option to buy the land anytime within the next 5 years at the price that is
determined on the date of the repurchase, except that the Bank will deduct all
expenses it incurred during the period of its holding.

v. The Bank also has an option to sell the land
at the same price as determined in the Memorandum to any third party, except
that A will be given the first right of refusal. In the event of the land being
sold to a third party, all proceeds net of incidental costs including brokerage
etc. will be deducted by the bank and made good to A.

Comments:
The substance of the transaction appears clearly as a secured loan because, A
continues to control possession of the land, control’s its development, bearing
all costs and acknowledging all the obligations relating to ownership and use.
The right to first refusal virtually ensures that the return of the asset is
controlled fairly through the entire transaction.

Real
Estate Transactions: Performance obligation relating to the provision of common
amenities:

One area of significant
judgment is with regard to performance obligations made by the builder. It is
common, builders are able to sell individual apartments whereas common
facilities forming part of the performance obligations, remain incomplete.

1. Hypothetically, a builder had launched a
project of five buildings, out of which, he has completed three of them in
full. Under RERA, all the five buildings were considered as one project. The
builder has completed all necessary steps with regard to the individual
apartments sold, viz:

– The builder has a present
right for full payment from the respective owners

– Legal title has been
transferred for each of the apartments

– Physical possession has
been completed.

2. Significant risks and
rewards of ownership have been transferred to the individual owners and

– The owner has accepted
the apartment.

3. Common facilities such
as sports complex and social function halls;

4.These were all part of
the performance obligations of the builder.

The builder says that
Occupancy Certificate is pending and therefore, the builder’s contention is
that they do not propose to recognise any revenue on the completed units. The
alternate view is as under:

i. Revenue should be recognised
on the units actually sold; the amenities represent implicit obligations
because they are not ‘distinct’ from the project and real estate has been sold
without completion of these facilities;

ii. The individual units
are ready and the builder has actually been advised that they can apply for an
OC for the completed part because it is completed in every which way, however,
the builder has been postponing
this process.

Comments:
In the case above: This is an area of complexity and responses will differ upon
circumstances of the case:

i. There is a valid contract (whose attributes
meet with the conditions specified in Ind AS 115) that has been entered into
with the owners;

ii. Individual performance level obligations have
been met except that obligations that are implied such as sports complex and
function halls are yet valid expectations and therefore, obligations that
remain unfulfilled yet; however, the contract states that these areas are
scheduled to be complete by the time the other two buildings are completed.

iii. Given the fact that the three residential
buildings are complete in every which manner, the only question that remains
unanswered is whether the builder is in a position to apply for the OC
immediately; that would require him to confirm several matters including
mainly, an affirmation that all aspects of the three buildings have been
completed for survey by the Authorities. If the builder is in a position to do
so, Revenue should be recognised in respect of every apartment sold, which
meets the criteria set out in Ind AS 115 and para I above that is, there should
be a valid contract, individual (apartment) performance level obligations have
been met, legal title has been transferred for each of the apartments, physical
possession has been completed, significant risks and rewards of ownership have
been transferred to the individual owners and the owner has accepted the
apartment.

B. Ind AS 109: Financial
Instruments

Factoring of Debts:

Factoring is a common
practice to raise money’s especially in cases where a company wishes to remove
the factored debts from the balance sheet and preferably, show no liability for
payments made by the Factor.

Factoring: a Case Study:

A company with a poor
history of collections approaches a “Factor” because a stage has
arrived where the bankers have threatened not to increase working capital
limits to the extent of overdue debts. The company holds a portfolio of Rs.300
million. It enters into a “factoring” arrangement with a reputed
factor with the following key conditions:

i. The company will
transfer the portfolio through an assignment to the Factor for Rs. 275 million
of cash. All debts have been subject to a credit appraisal by an independent
agency to ensure that the portfolio transferred is, ab ignition, not a “troubled” debt. The Factor
will pay the cash of Rs. 275 million “upfront” to the company.

ii. The company will open a
separately nominated account into which it shall deposit all the collections it
makes from its debtors. The Factor will charge a collection fee and this will
be added up to the amounts collected by the company upon settlement and end of
agreement;

iii. Any collections
falling short of Rs.275 million will be to the company’s account and so will
any collections in excess of Rs.275 million: the company takes the upside too;

iv. Upon termination of the
agreement, all outstanding are agreed upon and settled in cash.

The substance of the
transaction is as under:

i. Under the agreement, the
maximum exposure that the company has is to the extent of Rs.275 million that
it has received from the Factor, upfront;

ii. It means, the company
has given a guarantee to the Factor to the extent of the entire Rs.275 million,
that is, for all credit losses;

iii. In addition, the
company is entitled to the upside too;

Comments:

i. This means, the company
has retained both the credit and late payment risks associated with the
portfolio; therefore, the entity has retained substantially all the risks and
rewards of ownership of the receivables and continues to recognise the
receivables.

ii. Such type of
transactions can be a very useful way of raising cash quickly and can be tricky
from accounting perspective. It involves analysing terms of arrangement to
establish the substance of the transaction. Key point here is, understanding
the “ownership” of the receivable in establishing the commercial substance of
the transaction.

iii The company will
therefore need to recognise the consideration received from the broker as a secured
borrowing.

C. Ind AS 110: Consolidation

Case Study: Control

The assessment whether an
investor has control over an investee depends whether the entity has all the
three elements of control over the investee, viz; power over the investee, exposure,
or rights to variable returns and the ability to use its power to influence the
investor’s returns.

It is a simple situation
where control of an investee is held through voting rights; however, it is not
clear whether control of the investee is through voting rights, a critical step
in assessing control is identifying the relevant activities of the investee,
and the way decisions about such activities are made. Relevant activities are
activities that significantly impact the investee’s returns. Power over an
investee is fairly established when an investor who does not have majority
voting rights has power to influence decision making with regard to the
relevant activities that significantly affect the investee’s returns.

Generally, decision making
is controlled by majority voting rights that also give rise to variable
returns. But in certain cases, the investor may be holding less than majority
of the voting rights, in which case, it may not be as straight forward. This is
particularly so in the case of a structured entity (SPV) that is used to
control an investee company and the investor does not have any dominant holding
in the structured entity and voting rights are not the dominant factor in
deciding who controls that structured entity. This is where all factors listed
above (power, exposure to variable returns and ability to use power over
investee) may all be need to be taken into consideration to determine the real
substance behind the structuring.

In cases cited above (that
is, where voting rights are not the dominant factor in deciding control over
the investee), an understanding of the purpose and design of the investee would
help to understand the reasons why the investor is involved with the investee,
what risks was the investee designed to be exposed and which are the key
parties exposed to those risks and variable returns. Such mapping of power with
the ability to use that power to influence the variable returns will be helpful
in determining who has the control.

In certain complex situations
where two or more investors control several relevant activities of the
investee, it is important to ascertain which investor controls the activities
with the most significant returns.

One may
conclude that the substance of the control can be determined by examining where
the decision-making powers resides i.e. seat of power.
To establish the decision making with complex legal structure, it is necessary
to look into framework for assessment of control i.e. i) Assessment of purpose
and design of the investee, ii) Its relevant activities, iii) and how decision
about these relevant activities are made. This involves complete
understanding of the lucidity behind the structure and role of each party.

7. Conclusion:

Given the complexities that
the financial markets are made of and also given the financial structuring
options that businesses have, it is necessary that the Financial Accounting and
Reporting Framework specifically may necessitate separate guidance that deals with ‘Substance
over Form’. While the specific standards such as Leasing, Revenue Recognition
and Consolidation have dealt with several of the complexities, the need for an
independent standard that builds the logic for accountants and auditors to
apply cannot be overemphasised.

shailesh.kwebmaker

View and Counterview: Fair Value: Should We Fear The Fair Value?

Fair Value
accounting is now strongly entrenched in the accounting cannons after centuries
of following historical cost convention. It is a shift from ENTRY perspective
to EXIT perspective. Historical cost convention was perhaps the premium for
stability and long-term prudence, to cover the business from volatility of
business and market forces. That idea of measure of value – based on original
cost – was replaced by a measure defined as exchange value (of an asset)
between knowledgeable and willing parties in an arm’s length transaction.

Does fair
value (FV) inform the user of financials better? Does it improve upon true and
fair consideration? Are users happy to pay the price of volatility to get the ‘real’
picture? REALITY, what actually happened, has been the central pillar
accounting for centuries. FV, in a lighter vein could be augmented or virtual
reality which only time will test.

This
fourth VIEW and COUNTERVIEW aims to tells the story of how fair the fair value
is and although it has had a bumpy ride in times of turbulence, it is now an
accepted norm of accounting.

VIEW: WHY FAIR
VALUE SHOULD NOT HAVE FEAR VALUE?

Dolphy D’souza

Chartered
Accountant

Fair value
accounting is an integral aspect of Ind AS and all other global standards, such
as IFRS or US GAAP. Since Ind AS has
been in use for more than two years now, a discussion on this topic is probably
only academic. Most entities reluctantly or otherwise have accepted this
concept, though the debate when it was first introduced was highly exacerbated.
Of course, in good times, everyone likes fair value accounting, however, in bad
times they will be complaining.

Some argue
that fair value accounting is procyclical and caused the credit crisis a few
years ago. However, subsequent research done by SEC indicates that financial
institutions collapsed because of credit losses on doubtful mortgages, caused
by sub-prime lending, and not fair value accounting. Fair value accounting was
rather useful in highlighting the inherent problem and weaknesses of entities.

Those
criticising fair value accounting do not seem to provide any credible
alternatives. Do we take a step back to historical cost accounting, wherein,
financial assets are stated at outdated values and hence not relevant or
reliable? Is there any better way of accounting for derivatives, other than
using fair value accounting? For example, in the case of
long-term foreign exchange forward contracts there may not be an active market.
For such contracts, entities obtain MTM quotes from banks. In practice,
significant differences have been observed between quotes from various banks.
Though fair value in this case is judgemental, is it still not a much better
alternative than not accounting or accounting at historical price?

Some years
ago, an exercise was conducted by a global accounting firm to determine
employee stock option charge. By making changes to the input variables, all
within the allowable parameters of IFRS, option expense as a percentage of
reported income was found to vary as much as 40% to 155%. However, since then
valuation guidance on fair value measurement has been issued by IASB and
International Valuation Standards Council (IVSC), and overtime subjectivity and
valuation spread reduced substantially.

The next
question is what kind of assets and liabilities lend themselves better to fair
value accounting. Whilst many non-financial assets under Ind AS are accounted
at historical cost, biological assets are accounted at fair value. Unfortunately,
many biological assets are simply not subject to reliable estimates of fair
value. Take for instance, a colt, which is kept as a potential breeding stock,
grows into a fine stallion. The stallion starts winning race events and is also
used in Bollywood films. The stallion earns substantial amount for its owner
from breeding and other services. The stallion gets older, his utility
decreases. Eventually, the stallion dies of old age and the carcass used as pet
food. At each stage in the life of the horse, the fair values would change
significantly, but estimating the fair values could be extremely subjective,
difficult and make earnings highly volatile. In many ways, the stallion reminds
one of fixed assets. Changes in fair value of fixed assets are not recognised
in the income statement, then why should the treatment be different in the case
of atleast some biological non-financial assets? Certainly, an invariable
application of fair valuation is not what the author recommends.

In India,
the debate on fair value has got confused because of lack of understanding of
Ind AS. For example, a common misunderstanding is that all assets and
liabilities are stated at fair value. However,
the truth is that under Ind AS many non-financial assets such as fixed assets
or intangible assets are stated at cost less depreciation (unless an entity
chooses to apply the revaluation model, subject to conditions being fulfilled).
The apprehension of using fair value accounting is driven by tax considerations
or legal legacy. However, one may note that Ind AS financial statements are
driven towards the needs of the investor and not of any regulator. Therefore,
the income-tax and other regulatory authorities should ensure that Ind AS is
tax or statute neutral.

Determining
fair value can be extremely excruciating in certain cases, such as biological
assets, contingent liabilities, unquoted equity shares, etc.
Notwithstanding the difficulty, determining fair value should not be an excuse
for abandoning the idea of fair valuation. Doing so would be throwing the baby
with the bath water. Fair valuation cannot be expected to provide, the same
result if different valuers were valuing it. This is because fair valuation is
not a science but an art and no guidance or methodology can ever make it a
science. IFRS 13 (Ind AS 113) and the IVSC valuation standards were certainly
helpful in bringing about clarity, consistency and in collapsing the valuation
spread between valuers.

In the
examples below, it is hard to imagine, a measurement basis other than fair
value.

S.No.	Particulars	Indian GAAP	Reason for fair value under Ind AS
1	Investment in equity and debt mutual funds	Long-term investments are carried at cost less provision for other than temporary decline in the value of investment, if any.	Under Ind AS 109, Investments in debt and equity mutual funds are measured at fair value with changes credited or debited to P&L (FVTPL). This makes absolute practical sense. Both retail and corporate investors evaluate their investment in equity and debt funds (other than FMPs) on the basis of its fair value and not historical cost. Even ordinary investors will consider historical cost as being an outdated measure.
2	Investment in equity shares (quoted and unquoted)	Long-term investments are carried at cost less provision for other than temporary decline in the value of investment, if any.	The reasons discussed in (1) above equally applies to investment in equity shares (quoted and unquoted). Some companies were against fair value in the case of investments in unquoted shares. However, Ind AS implementation has revealed that in many cases unquoted equity shares were either impaired or had a very high valuation. Accounting at fair value will reflect the real value of the shares and the entity that holds such shares. Such information is absolutely critical for any reader of financial statements, for making a sensible assessment of the true worth of an entity.
3	Investment in debt instruments	Carried at amortised cost by banks and financial institutions. Other entities carry Long-term investments at cost less provision for other than temporary decline in the value of investment, if any. Interest is recognised on accrual basis at contractual rate.	Such investments if they meet certain conditions are accounted on an amortised cost basis. However, the fair value disclosure with respect to such instruments is required. Factors such as change in interest rate, credit rating, inflation rate, etc. plays an important role in determination of fair value disclosure with respect to such instruments is required. Factors such as change in interest rate, credit rating, inflation rate, etc. plays an important role in determination of fair value.
			Consider an example on why fair value disclosure of loans given by a financial company is critical to understanding the financial position of the entity. Example: A finance company gives loan at competitive rates let say @ 8% and subsequently interest rate goes up; say 10%. Fair value of the loan is impacted significantly, resulting in a huge hair cut (but not under Indian GAAP). Further, an entity may have liability at floating rate, so there is clear mismatch between assets and liabilities, which will impact its future profitability and viability. This will get reflected under Ind AS but not under Indian GAAP.
4	Interest free loans between parent and subsidiary	Both parent and subsidiary recognise loan at amount paid/ received.	On day 1, the parent will recognize loan at fair value and debit the differential amount to investment in subsidiary. Subsequently, interest income is recognised in P&L at market rate. The subsidiary will also recognise loan at fair value and credit differential amount to capital reserve (investment by parent). This will result in interest expense recognition at market rate. Some may argue that this is notional accounting. However, this accounting will reveal the hidden cost in the group transactions. Further, it will eliminate transaction structuring by treating all loans whether interest bearing or non-interest bearing equally for accounting purposes. It will also bring transparency in related party transactions.
5	Redeemable and convertible instruments, for example, redeemable or convertible preference shares	Instrument is accounted for based on their legal form. Redeemable and convertible preference shares are presented as equity share capital	Redeemable preference share is treated as a liability. Convertible preference shares are split into equity and liability or derivative and liability. Fair value principles are applied in split accounting in case of convertible instruments and in determining the fair value of liability and interest expense. This, will fairly present the amount of liability and embedded equity/derivative.
6	Share based payment	Gives an option to account for ESOP expenses using either the fair value or the intrinsic value method over the vesting period.	It requires expenses of share based payment to be measured using the fair value method only. The fair value of an ESOP is estimated using an option pricing model like the Black Scholes Merton or a Binomial Model. Under Indian GAAP, very often the intrinsic method did not result in any ESOP cost for an entity. This is undesirable, since it makes a distinction between remuneration that is paid in cash vs that which is paid through an ESOP scheme. The form in which remuneration is paid should not determine the expense charge to the P&L.
7	Foreign Parent issues ESOP to employees of Indian subsidiary (there is no settlement obligation on subsidiary)	The parent generally recognizes ESOP expense and no expense is recognised by the subsidiary.	The expense will need to be recognised by subsidiary since its employees are receiving remuneration by way of ESOP. No expense can be recognised by the parent. Who provides the ESOP is not relevant to this assessment; rather, who receives the benefit is relevant. Fair value principles are applied in determining the ESOP cost.
8	Acquired contingent liabilities in business combination	Contingent liabilities do not form part of acquisition accounting.	The acquired contingent liabilities are recognised at the acquisition date at fair value, provided it can be measured reliably. By putting a value to contingent liabilities, the consequential goodwill amount is fairly reflected.
9	Sales Tax deferral/loan	Sales tax loan is accounted for at the undiscounted value.	Ind AS requires that on initial recognition, sales tax loan should be accounted for at fair value, i.e., present value of future cash flows. Difference between amount deferred and fair value of loan is correctly treated as government grant under Ind AS 20. Sales tax loan is a funding by the government to an entity. Ind AS accounting truly reflects that underlying substance.

S.No.

Particulars

Indian GAAP

Reason for fair value under Ind AS

Investment in equity and debt mutual funds

Long-term investments are carried at cost less provision for
other than temporary decline in the value of investment, if any.

Under Ind AS 109, Investments in debt and equity mutual funds
are measured at fair value with changes credited or debited to P&L
(FVTPL). This makes absolute practical sense.
Both retail and corporate investors evaluate their investment in
equity and debt funds (other than FMPs) on the basis of its fair value and
not historical cost. Even ordinary investors will consider historical cost as
being an outdated measure.

Investment in equity shares (quoted and unquoted)

Long-term investments are carried at cost less provision for
other than temporary decline in the value of investment, if any.

The reasons discussed in (1) above equally applies to investment
in equity shares (quoted and unquoted).
Some companies were against fair value in the case of investments in
unquoted shares. However, Ind AS
implementation has revealed that in many cases unquoted equity shares were
either impaired or had a very high valuation. Accounting at fair value will
reflect the real value of the shares and the entity that holds such
shares. Such information is absolutely
critical for any reader of financial statements, for making a sensible
assessment of the true worth of an entity.

Investment in debt instruments

Carried at amortised cost by banks and financial institutions.

Other entities carry Long-term investments at cost less
provision for other than temporary decline in the value of investment, if
any. Interest is recognised on accrual basis at contractual rate.

Such investments if they meet certain conditions are accounted
on an amortised cost basis. However,
the fair value disclosure with respect to such instruments is required. Factors such as change in interest rate,
credit rating, inflation rate, etc. plays an important role in
determination of fair value disclosure with respect to such instruments is
required. Factors such as change in
interest rate, credit rating, inflation rate, etc. plays an important
role in determination of fair value.

Consider an example on why fair value disclosure of loans given
by a financial company is critical to understanding the financial position of
the entity.

Example: A finance company gives loan at competitive rates let
say @ 8% and subsequently interest rate goes up; say 10%. Fair value of the
loan is impacted significantly, resulting in a huge hair cut (but not under
Indian GAAP). Further, an entity may
have liability at floating rate, so there is clear mismatch between assets
and liabilities, which will impact its future profitability and
viability. This will get reflected
under Ind AS but not under Indian GAAP.

Interest free loans between parent and subsidiary

Both parent and subsidiary recognise loan at amount paid/
received.

On day 1, the parent will recognize loan at fair value and debit
the differential amount to investment in subsidiary. Subsequently, interest
income is recognised in P&L at market rate. The subsidiary will also recognise loan at
fair value and credit differential amount to capital reserve (investment by
parent). This will result in interest expense recognition at market
rate. Some may argue that this is
notional accounting. However, this
accounting will reveal the hidden cost in the group transactions. Further, it will eliminate transaction
structuring by treating all loans whether interest bearing or non-interest
bearing equally for accounting purposes. It will also bring transparency in
related party transactions.

Redeemable and convertible instruments, for example, redeemable
or convertible preference shares

Instrument is accounted for based on their legal form. Redeemable and convertible preference
shares are presented as equity share capital

Redeemable preference share is treated as a liability. Convertible preference shares are split
into equity and liability or derivative and liability. Fair value principles
are applied in split accounting in case of convertible instruments and in
determining the fair value of liability and interest expense. This, will fairly present the amount of
liability and embedded equity/derivative.

Share based payment

Gives an option to account for ESOP expenses using either the
fair value or the intrinsic value method over the vesting period.

It requires expenses of share based payment to be measured using
the fair value method only. The fair
value of an ESOP is estimated using an option pricing model like the Black
Scholes Merton or a Binomial Model. Under Indian GAAP, very often the
intrinsic method did not result in any ESOP cost for an entity. This is undesirable, since it makes a
distinction between remuneration that is paid in cash vs that which is paid
through an ESOP scheme. The form in
which remuneration is paid should not determine the expense charge to the
P&L.

Foreign Parent issues ESOP to employees of Indian subsidiary
(there is no settlement obligation on subsidiary)

The parent generally recognizes ESOP expense and no expense is
recognised by the subsidiary.

The expense will need to be recognised by subsidiary since its
employees are receiving remuneration by way of ESOP. No expense can be
recognised by the parent. Who provides the ESOP is not relevant to this
assessment; rather, who receives the benefit is relevant. Fair value
principles are applied in determining the ESOP cost.

Acquired contingent liabilities in business combination

Contingent liabilities do not form part of acquisition
accounting.

The acquired contingent liabilities are recognised at the
acquisition date at fair value, provided it can be measured reliably. By
putting a value to contingent liabilities, the consequential goodwill amount
is fairly reflected.

Sales Tax deferral/loan

Sales tax loan is accounted for at the undiscounted value.

Ind AS requires that on initial recognition, sales tax loan
should be accounted for at fair value, i.e., present value of future cash
flows. Difference between amount deferred and fair value of loan is correctly
treated as government grant under Ind AS 20.
Sales tax loan is a funding by the government to an entity. Ind AS accounting truly reflects that
underlying substance.

In many
areas, fair valuation is simply inevitable. Fair value accounting does not
create good or bad news; rather it is an impartial messenger of the news.

counterview:
WHEREFORE FAIR VALUE?

Ashutosh Pednekar

Chartered
Accountant

A common misconception is
that wherefore means where; it is occasionally so used in
retellings of Romeo and Juliet — often for comedic effect. The meaning of “Wherefore
art thou Romeo?” is not “Where are you, Romeo?” but “Why are
you Romeo?” i.e. “Why did you have to be a Montague” ⁱ (the
family name of Romeo).

One may wonder, why in an
article that is meant to be defiant to current trends of accounting I am
quoting Shakespeare. Well, the fact remains that English as she is spoken is
not necessarily understood in the same manner by everyone. That is the bane with
Fair Value (FV) accounting too. My concept of FV could be different from your
concept. Hence, the users of financial statements could possibly, get different
perspective of financial statements. Accounting permits or requires (based on
specific conditions) different bases of measurement. The two main bases are
historical cost and current value, with current value having bases such as FV,
value in use for assets or fulfilment value for liabilities and current cost.
The IASB in March 2018 has issued the revised Conceptual Framework of
Financial Reporting. Chapter 6 describes various measurement bases and
discusses factors to be considered when selecting those. Our Indian Accounting
Standards (Ind AS) will need to follow this framework.

It is said that double
entry book keeping was first codified in a treatise 1494 in by Luca Pacioli.
Prior to that, there are records of double entry book keeping by Jews and
Koreans. The Bahi-Khata system of accounting in India was prevalent too. These
would have been times when traders of different regions and languages did
business with each other and to settle the trades needed a uniform language of
accounting acceptable to all. Double entry system of book keeping served the
purpose. Trade practices, technology and methods of transacting evolved but the
cardinal rules of accounting remained the same. Ever since Pacioli’s treatise
those rules (debit what comes in, credit what goes out, et al) have remained
consistent for more than 600 years!

_________________________________________________

i
https://en.wiktionary.org/wiki/wherefore#English

Twentieth century saw
multiplication of world trade; money becoming more fungible, businesses
regulated, stakes increasing, higher gains, deeper losses. This led the users
of financial statements question accounting and financial statements. The
persons who were making decisions of providing resources to an entity relied on
the financial information that was available and they realised that the
financial information was inadequate – if an entity had acquired an asset fifty
years ago and it was carried at historical cost less depreciation, then that
information was not relevant to the user who wanted to take a decision of
providing resources. These decisions were made on an elaborate combination of
what price a similar asset / business fetches in an open market and / or a
calculation of future cash flows, discounted at an appropriate rate reflecting
the risk of the entity i.e. at FV. However, accounting continued on historical
cost measurement basis.

Since 1980s there was a
demand to have the needs of resource providers addressed in the financial
statements. Consequently, the concept of FV gained prominence and eventually
accounting standards included it and the concept of exit price emerged.
Along with that came in the complex arithmetical computations, statistical
assumptions & probabilities requiring use of significant estimations.

India is in the process of
converging to IFRS since April 2016 in a phased manner. The entities that are
applying Ind AS are of different sizes and structures even amongst listed
entities The experience of two years of Ind AS of preparers and auditors has
been educating as well as exasperating. The questions that promoters and many
preparers ask of accountants and auditors are:-

– Why
my entity needs to be evaluated on an “exit price”.

– Am
I selling my entity as on the balance sheet date?

– What
has happened to the concept of going concern?

– My
balance sheet used to be prepared for me and my shareholders and my bankers and
my business partners and they know how healthy or otherwise I am.

– By
having my financial statements at an exit price am I telling the world that my
business is up for grabs at the values presented in the financial statements?

– I
do not want to and I have no intentions of selling my business, either in parts
or as a whole, then why should I increase my costs of compliance by undertaking
valuation exercises based on various inputs that standards themselves say can
be “unobservable” So, be definition they are abstract and unreal.

– So
am I placing a picture of my state of affairs based on presumptions, statistics
and estimations rather than at the values at which the transactions have taken
place?

Answers anyone?

The standard gives a three
level hierarchy for specific facts and circumstances. The hierarchy ranges from
simple to complex calculations. An entity is required to replicate the above at
each measurement date. If it is presenting financial results on quarterly
basis, then all these steps have to be done each quarter. The cost of
compliance with FV computations, recognition and measurement is indeed
significant. Not to mention the volatility that can enter the financial
statements. If the markets are erratic then it would get reflected in the
financial statements. Compare this with
the stability provided by historical cost measurement, where one is certain
that the amounts at which assets and liabilities are presented are the values
that are a result of transactions that have already occurred.

One typical example of the
complexity of FV accounting is the interest free or concessional interest loans
given to employees. An entity is required to determine the FV of such loans, by
discounting the cash flows at an appropriate rate of interest and documenting
the rationale of appropriateness and then presenting the difference between the
FV of the loan and the amount of loan as employee benefits and which would be
recycled over the tenor of the loan, making it PL neutral over multiple years.
When one explains this to business owner the reaction is flabbergasting. When
one explains the rationale of this charge, then there is a reluctant nodding of
head followed by, “but when I gave the loan, this was not my intention.
Sometimes the intent was to keep my employees satisfied and that cannot be an
accounting rule / requirement”. He
reacts by saying, “for me it is the amount of loan to employee that is
critical – on employee leaving the organization I will recover the absolute
amount and not its fair value.”

If a simple business transaction
of loan to employee causes such difficulties in FV accounting, one can only
imagine what could be the case in complex business transactions.

Some standards require
disclosure of FV of items that are carried at amortised cost! This defies logic
to some preparers as the business model permits those items to be carried at
amortised cost but disclosure requirements requires determining FV, implying
going through the grind of estimations & computations and justifying it to
all users of financial statements.

The user now has to read
the voluminous disclosures to understand the impact of the numbers in the
financial statements. Will they have the expertise of understanding the devil
in such detailed? Isn’t it fine that an entity provides such detailed information
on a need to know basis, sat, to a potential investor to whom “FV at exit
price” is more relevant rather than “historical cost”

The reaction of other
stakeholders & users of financial statements viz. bankers, lenders,
vendors, current & potential investors, tax authorities is awaited to be
seen in public domain. Reactions and responses of users of financial statements
and their impact on businesses will tell us whether FV accounting has achieved
what it had set out to; whether the benefits indeed exceeded the costs. Only
then, perhaps, we will know the answer to wherefore art thou fair value
accounting?

India is part of a global
business community and standards of performance have to be comparable. Hence,
India decided to converge with IFRS. But, is it fair that every Indian entity
that is not comparable with an international entity in terms of size and
structure is required to go through this grind of fair value and its
disclosures? Can one not look at a model of the IFRS for SMEs? For less complex
entities IFRS for SMEs give limited options w.r.t recognition & measurement
principles and disclosures are significantly less too. It would make the
financial statements more relevant and reliable.

It has taken the world six centuries to move
from historical cost measurement bases to FV measurement bases. We all
experience that lifecycle of new technologies is much short lived. Likewise,
can we equate FV as new technology prone for obsolescence a decade or five from now? And thereafter do we move to
a new technology or do we revert to historical cost.

An alternate proposition
would be that only those entities that frequently raise resources from local
and international markets, who have international investors, who have a mass
that matters or are comparable with the Fortune Global 500ⁱⁱ can be
required to have FV accounting. To understand where India stands, we have only
7 companies in this global list with the highest at 168th position. The 500^thcompany on the global list has revenues of US$ 21,609 Mnⁱⁱⁱ
(INR 1,44,780 Crore). It would be worthwhile to do an analysis around this
figure and determine what would be the right size for an entity to get involved
in determination of FV and recognizing it in its financial statements. For
others (excluding sectors such as banking, insurance & lending),
historical cost could continue. FV will be need-based information, not
necessarily part of financial statements.

One size fits all is a good
dictum. However, if the size of an average Indian business entity that applies
FV accounting is much smaller than the average size of a global entity that
applies FV accounting, aren’t we justified in having something simpler commensurate
with our size and nature of business?

This debate shall certainly
not end with this article but may at the least trigger a thought process, and
for that I would like to end with apologies to William Shakespeare by a bit
rephrasing of Marallus speaking to two rejoicing commoners in Julius Ceaser,
Act 1, Scene 1^iv :-

Wherefore
rejoice

What
conquest brings fair value home?

What
levels of hierarchy follows him to the statement of financial position to grace
in probability weighted estimates

You measurement
blocks, you recognition principles, you worse than senseless disclosure
requirements

Oh you
hard hearts, you cruel men of accounting

Knew you
not historical accounting.

________________________________________________

ii https://timesofindia.indiatimes.com/business/india-business/40-of-fortune-500-companies-asian-india-has-7-in-list/articleshow/59707630.cms

iii http://fortune.com/global500/list/

iv http://www.shakespeare-monologues.org/monologues/612

shailesh.kwebmaker

Accounting And Auditing In India – The Past, Present And Future

Evolution Of Accounting

1 Introduction

1.1 Financial
accounting and reporting remains the core tool of entities for communication
with its stakeholders. It is the semantics for such communication. Accounting
standards are the grammar of such language used by entities in such
communication. The separation of ownership and management in the growing
businesses and modern day complexities added the importance of timely and
accurate communications. The grammar (i.e. Accounting Standards) blends
uniformity in reporting and facilitation of unambiguous communication with the
variety of stakeholders including but not limited to owners/shareholders,
employees, regulators, trade/business relations, revenue authorities etc.

1.2 The subject of accountancy and its
importance has a long history in India e.g. a treatise on economics and
political science titled ‘Kautilya’s (also known as Chanakya) Arthshasthra’,
has elaborate prescriptions on accounting (and accountability) aspects for a
treasury and government which have features of universal utility. In line with
the evolution and changes in the scale and texture of economies and society,
financial reporting and accounting standards have also evolved and witnessed
path-breaking changes.

1.3 The earliest treatise on accounting is
generally thought to be Pacioli’s Summar of 1494. However, Bahi-khata (a
double-entry system of bookkeeping) predates the ‘Italian’ method by many
centuries. Its existence in India prior to the Greek and Roman empires suggests
that Indian traders took it with them to Italy, and from there the double-entry
system spread through Europe, which then evolved itself to accrual from cash
and gradually to present day modern reporting.

2 Evolution of accountancy in major jurisdictions

2.1 America:

After
the U.S. stock market crash in 1929, many investors and market participants
felt that insufficient and misleading accounting and reporting had inflated
stock prices that eventually crashed the stock market followed by the Great
Depression. Whether that perception was true or not is a separate debate, but
those feelings made accounting world more alert and agile about its role and
the continuing pressures on the accounting profession to establish accounting
standards prompted the American Institute of Accountants (now known as the
AICPA) and the New York Stock Exchange to review financial reporting
requirements.

2.2 A few years later, the Securities Act of
1933 and the Securities Exchange Act of 1934 were passed into law to restore
investor confidence, which set forth the accounting and disclosure requirements
for the initial offering of stocks and bonds and for secondary market offerings
respectively.

2.3 The 1934 Act also created the U.S.
Securities and Exchange Commission (SEC), which was mandated with standard
setting of financial accounting and reporting for publicly-traded companies.
However, the SEC while keeping the power to set standards chose to delegate its
rule-making responsibilities to the private sector. This means that if the SEC
did not conform to a specific standard issued by the private sector, it had the
authority to change that standard. Despite delegating its
rule-making responsibility, the SEC issued its own accounting pronouncements
called Financial Reporting Releases (FRRs).

2.4 The Committee on Accounting Procedure (CAP)
and American Institute of Accountants (now AICPA) were the very first
private-sector standard setting bodies. During 1938 to 1959, the CAP issued 51
Accounting Research Bulletins (ARBs). Since, it had not established a financial
accounting conceptual framework, its rule-making approach of dealing with
accounting and reporting problems and issues was subjected to severe criticism.

2.5 The CAP was then replaced by the Accounting
Principles Board (APB) set up under the recommendation of a special committee
appointed by AICPA which issued 31 Accounting Principles Board Opinions
(APBOs), 4 Statements and several interpretations during its tenure from 1959
to 1973. In contrast to its predecessor, it attempted to establish a conceptual
framework with its APB Statement No. 4 but failed. In addition to its
unsuccessful efforts to create a framework, it was also under fire for its
apparent lack of independence because its board members were supported by the
AICPA and other interest groups or stakeholders were not represented in its
rule-making process.

2.6 Emphasizing the significance of an
independent standard-setting structure, the APB was reorganized in 1973 into a
new body called the Financial Accounting Standards Board (FASB). As compared to
APB’s 18-21 part-time members who mostly represented public accounting firms,
the FASB has 7 full-time members representing the accounting profession,
industry and other various interest groups/stakeholders such as the government
and accounting educators.

2.7 In 1984, FASB formed the Emerging Issues
Task Force (EITF) with members of the FASB, auditing firms and industries with
the role of responding to emerging accounting and financial reporting issues
and publish its pronouncements in the form of EITF Issues – considered to form
part of US GAAP. The function of the EITF is important because it makes the
standard-setting process more efficient and allows the FASB to concentrate on
much broader and long-term problems.

3 UK/ Europe

3.1 Meanwhile, efforts in the UK and Europe to
create an international body to establish international accounting standards
were also gaining widespread support, which led to the creation of the
International Accounting Standards Committee (IASC) in mid-1973. Just like the
FASB’s EITF, the IASC established the Standing Interpretations Committee (SIC)
in 1997 to study accounting issues and problems that required authoritative
guidance.

3.2 In 1977, the International Federation of
Accountants (IFAC) came into existence as a result of an agreement signed by 63
accounting bodies representing 49 countries. The main objective of IFAC is ‘the
development and enhancement of a co-ordinated worldwide accountancy profession
with harmonized standards’. ICAI is a member of the IFAC since its
inception.

3.3 In 2001, the IASC reorganized itself to act
as an umbrella organisation to a new standard-setting body – the International
Accounting Standards Board (IASB). The accounting standards issued by the IASB
were designated as International Financial Reporting Standards (IFRS). The IASB
continued to adopt the 41 International Accounting Standards (IAS) issued by
the IASC between 1973 and 2002. It also adopted all SIC Interpretations which
were renamed as International Financial Reporting Interpretations Committee
(IFRIC).

3.4
IASB has no authority to enforce
compliance with IFRS and its adoption is entirely voluntary. In 2001, the
International Organization of Securities Commission (IOSCO) approved the use of
IAS/IFRS for cross-border offerings and listings and IFRS/IAS was also adopted
in 2005 by listed companies in the European Union. This adoption of IFRS/IAS by
EU companies gave a big filip for them to become gradually being adopted and
accepted across other jurisdictions.

3.5 Since October 2002, the IASB and FASB have
been working to remove differences between IFRS/IAS and US GAAP towards a
common set of high quality global accounting standards. Their commitment to the
convergence effort was embodied in a memorandum known as the Norwalk Agreement.

3.6 After 10 years of working together, some
notable convergence projects have been successfully completed. Major joint
projects completed include converged standards on Business Combinations,
Consolidation, Fair Value Measurement, Revenue Recognition and Leases.

3.7 Other projects were discontinued because
the two boards could not agree on some issues such as standards on
de-recognition, financial statement presentation, insurance contracts,
liabilities and equity, and post-employment benefits.

3.8 The major prevalent Accounting Practices in
the world today can be bifurcated to two broad categories:

i. International Financial Reporting Standards
(IFRS) issued by International Accounting Standards Board (IASB), which are
prevalent in more than 100 countries including European Union, Australia,
Canada etc.;

ii. US GAAP i.e. Generally Accepted Accounting
Principle followed in United States of America.

4 History & Evolution of Accounting and
Auditing in modern India

4.1 The evolution of India’s present-day
accounting system can be traced back to as early as the sixteenth century with
India’s trade links to Europe and central Asia through the historic silk route.
Earlier Indian accounting practices reflect its diversity as India has many
official languages and scores of dialects spread over numerous states.

1857:
The first ever Companies Act in India legislated.

1866:
Law relating to maintenance of accounts and audit thereof introduced. Formal
qualification as auditor was now required.

1913:
New Companies Act enacted. Books of accounts required to be maintained
specified. Formal qualifications to act as auditor were named and a Certificate
from the local government was required to act as an auditor – An unrestricted
Certificate to act as auditor throughout British India and a restricted
Certificate to act as auditor only within the Province concerned and in the
languages specified in the certificate.

1918:
Government Diploma in Accounting (GDA) was launched in Mumbai. On
completion of articleship of 3 years under an approved accountant and passing
of the Qualifying examination, the candidate would become eligible for the
grant of an Unrestricted Certificate.

1920:
The issue of Restricted Certificates discontinued.

1930:
Register of Accountants to be maintained by the Government of India to exercise
control over the members in practice. Those whose names found entry here were
called Registered Accountants (RA).

The
Governor General in Council replaced the local government as the statutory authority
to grant certificates to persons entitling them to act as auditors. Auditors
were allowed to practice throughout India.

1932:
First Accountancy Board was formed. The Board was to advise the Governor
General in Council on matters relating to accountancy and to assist him in
maintaining standards of qualification and conduct required of auditors.

1933:
First examination held by the Indian Accountancy Board. GDAs were exempted from
taking the test.

1935:
The first Final examination was held. GDAs were exempted from taking the test.

1943:
GDA was abolished.

1948:
Expert Committee formed to examine the scheme of an autonomous
association of accountants in India.

1949:
The Chartered Accountants Act, 1949 passed on 1^st May. The term
Chartered Accountant came to be used in place of Indian Registered Accountants.
The Chartered Accountants Act was brought into effect on 1st July and The
Institute of Chartered Accountants of India (ICAI) was born on 1^st
July 1949.

4.2
The ICAI, being the premier
standard-setting body in India, constituted Accounting Standard Board (the
‘ASB’) on April 21, 1977, with the objective to formulate Accounting Standards
to enable the Council of ICAI to establish a sound and robust financial
reporting standards framework in India.

The
ASB takes into consideration the Accounting Standards at the International
Level (IFRS/IAS) and sets National Standards based on those so that National
Standards are broadly aligned to Global Accounting Principles. ASB is
represented not merely by members of ICAI but also representatives from
Government including Revenue Departments, RBI, IRDA, MCA, Chambers of Commerce.

From
1977 to 1988, ICAI notified 11 Accounting Standards (‘AS’), made in
consultative manner by ASB, but these notified AS lacked statutory recognition.

4.3 The statutory recognition and legal force
was provided to Accounting Standards by amendment made in 1999 to the Companies
Act, 1956. New sub-sections (3A), (3B) and (3C) were inserted in section 211,
which required that every balance sheet and profit & loss account of the
Company complied with the accounting standards, prescribed by the Central Government
in consultation with the National Advisory Committee on Accounting Standards
(NACAS).

The
accrual method of accounting in India also gradually evolved with growth and
evolvement of the ‘Company’ form of business organisation and mandatory
requirement prescribed under the law [Section 209(3) of 1956 Act] for the
Companies to follow ‘accrual’ basis and according to double entry system of
accounting.

5 Accounting Standards

5.1 Accounting Standards are “written
documents, policies, procedures issued by expert accounting body or government
or other regulatory body covering the aspects of recognition, measurement,
treatment, presentation and disclosure of accounting transactions in the
financial statement”.

5.2 Objective of Accounting Standards:

– Standardise the diverse accounting policies.

– To eliminate non-comparability of financial
statements to the possible extent.

– Add to the reliability to the financial
statements.

– Help understand Accounting Treatment in
financial statements.

5.3 Advantages of Accounting Standards:

– Reduce or eliminate confusing variations in
the accounting treatments used to prepare the financial statements.

– Disclosures beyond that required by law.

– Facilitating comparison of financial
statements of across different companies.

– Uniformity of accounting treatment of
identical transactions

5.4 Procedure for issuing
Accounting Standards by ICAI:

The
following procedure is adopted for formulating the accounting standards:

– ASB constitutes Study Group to formulate
preliminary draft.

– ASB considers the preliminary draft and
issues Exposure draft (ED) for public comments. ED is also specifically sent
for comments to specified bodies such as industry associations, regulators,
stock exchanges and others.

– ASB considers comments received on ED and
finalises the draft AS for consideration of Council.

– Draft approved by council is recommended to
NACAS.

– NACAS recommends the Standard to the
Government of India (MCA) after its review and modifications, if any, in
consultation with ICAI.

– Government of India (MCA) notifies the AS on
acceptance of recommendations made by NACAS.

6 Important Milestones of Accounting
Standards in India

– 1979 – Preface to Statements of AS & AS
1 issued.

– 1987 – Mandatory status of AS 4 & AS 5.

– 1991 – Mandatory status of AS 1, AS 7, AS 8,
AS 9, AS 10 and AS 11 (Corporate Entities)

– 1993 – Mandatory status of AS 1, AS 7, AS 8,
AS 9, AS 10 and AS 11 (Non Corporate Entities)

– 1999
Legal recognition to ASs issued by ICAI under Companies Act, 1956.

– 2000-2003 – 12 AS were issued based on
IASs-major step towards convergence with IASs.

– 2002 – Insurance Regulatory and Development
Authority (IRDA) required Insurance Companies to comply with the Accounting
Standards issued by the ICAI.

– 2003 – Reserve Bank of India (RBI) issued
Guidelines on compliance with Accounting Standards (ASs) advising banks to
ensure strict compliance with the Accounting Standards issued by the ICAI.

– 2006 – MCA notified separate AS under Companies
(AS) Rules, 2006 which was based on work done by ASB of ICAI and approved by
NACAS. ASB decided to constitute a task force to develop a concept paper on
convergence with IFRS.

– 2007 – ASB and Council accepted
recommendations of Task Force for convergence with IFRS.

– 2010-11 Ind AS (IFRS Converged Standards)
prepared by ICAI, approved by NACAS and notified by MCA (Date not notified)

– 2015 – MCA issued the roadmap (dates of
implementation) for converged IFRS in phased manner & notified 39 Ind AS
formulated by ICAI and approved by NACAS.

– 2016 – MCA notified revised AS 2, AS 4, AS
10, AS 13, AS 14, AS 21, and AS 29 and Ind AS 11.

– 2018 – MCA notified Ind AS 115 replacing Ind
AS 11 and Ind AS 18.

7 Applicability
of Accounting Standards to Small and Medium Sized Enterprises (SMEs) and Small
and Medium-sized Companies (SMCs)

7.1 Under the Companies Act, 1956 Small and
Medium-Sized Company as defined in Clause 2(f) of the Companies (Accounting
Standards) Rules, 2006 were exempted from compliance of the Accounting
Standards AS 3 – Cash Flow Statement and AS 17 – Segment Reporting. Also AS 21
– Consolidated Financial Statements, AS 23 – Accounting for Investments in
Associates in Consolidated Financial Statements and AS 27 – Financial Reporting
of Interests in Joint Ventures (to the extent of requirements relating to
Consolidated Financial Statements were not applicable to SMCs since the
relevant Regulations did not require compliance with them. Relaxations in
respect to disclosures under certain Accounting Standards were also granted to
SMCs.

7.2 As per
‘Applicability of Accounting Standards’, issued by the ICAI (published in ‘The
Chartered Accountant’, November 2003), there are three levels of entities.
Level II entities and Level III entities are considered to be the small and
medium enterprises (SMEs). On the other hand, as per the Accounting Standards
notified by the Government, there are two levels, namely, SMCs as defined in
the Rules and companies other than SMCs. Non-SMCs are required to comply with
all the Accounting Standards in their entirety, while certain exemptions/
relaxations have been given to SMCs. Certain differences in the criteria for
classification of the levels were also noted.

Globalisation
of Accounting Standards

8.1 Globalisation of economies and evolution of
a highly interconnected world has had far reaching changes impact on economy
and the ‘accounting’ world also cannot remain unaffected there from. Since the
beginning 21^st century, there was renewed demand for global
harmonisation of accounting standards and to converge or adopt single set of
high quality standards that require transparent and comparable information in
the financial statements. There is also a significant transformation in the
fundamental accounting principles and concepts fair value measurements,
prominence to fair and faithful presentation, new components in financial
statements and so on gained acceptance.

8.2 Further, the direction of accounting
standard setting has shifted towards ‘Principles’ based standards rather
than ‘Prescriptive Rule’ based ones. There are two other major
developments also impacting standard-setting viz., the unprecedented global
financial crisis starting in 2007-08 and birth of integrated reporting
framework in 2010 having core objective of more effective communication with
stakeholders. Policy makers and Regulators are following the developments in
standard-setting area with keen interest. Therefore, accounting
standard-setting role has assumed greater responsibility and accountability.

8.3 International Financial Reporting Standards
(IFRS) area set of high quality principle-based standards and has become the
global financial reporting language with more than hundred countries accepting
or requiring IFRS based financial reporting. The U.S. Securities and Exchange
Commission has also allowed Foreign Private Issuers to file financials
statements prepared under IFRS without reconciliation to the US GAAP.

8.4 It is the primary duty of any company
irrespective of Indian company or foreign company to prepare financial
statements at the end of accounting period. While preparing financial
statements some accounting standards needs to be followed that is laid down by
Accounting Standard Board of the respective country. Subsidiary/Joint
Venture/Associate of a company located in another country need to prepare its
financial statements according to accounting standards of the country where it
is located, which leads to variation in profits. This variation in profits is
due to difference in accounting standards, which differs from country to
country. In order to remove these variation/difference in profits,
International Accounting Standard Board introduced International Financial
Reporting Standards called as IFRS. IFRS
are the common accounting standards followed by member countries of IASB in
preparing their financial statements. IFRS helps in arriving at similar profits
regardless of the location of an entity. Before any new IFRS are issued or
amendments are made in IFRS, IASB issues exposure drafts, discussion papers and
conducts out-reach events.

9 Advantages of convergence to IFRS

– Easy Comparison: Companies always
would like to compare their performance with other companies’ performance. IFRS
make this work easier because most companies are / will follow same accounting
standards in preparing their financial statements.

– One Accounting language company-wide:
Company with subsidiaries in foreign countries can use IFRS as common business
language in preparing its financial statements as most of the countries are
adopting / converging with IFRS.

– IFRS facilitates Cross border movement of
capital and cross border acquisitions, enables partnerships & alliance with
foreign entities.

– Availability of professionals
internationally: IFRS enhances the mobility of professionals internationally.

– IFRS provides more compatibility:
IFRS provide more compatibility among sectors, industry, & companies. This
would improve relationship with investors, suppliers, customers and other
stakeholders across the globe.

– Increased investment opportunities:
Common accounting standards help investors to understand available investment
opportunities better as opposed to financial statements prepared under
different set of national accounting standards.

– Lower cost of capital: Greater
willingness on the part of investors to invest across borders will enable
entities to have access to global capital markets which lowers the cost of
capital.

– Higher economic growth: Increased
investment opportunities lead to attraction of more investments which result in
higher economic growth.

– Better quality of financial reporting:
Convergence will place better quality of financial reporting due to consistent
application of accounting principles and reliability of financial statements.

10 Road to Indian Accounting Standards (Ind-AS i.e.
IFRS Converged Standards
in India)

10.1 The Leaders’ Statement at G-20 Summit held in
September 2009 attended by our Prime Minister Dr. Manmohan Singh at Pittsburgh
contained a commitment by the G-20 nations for convergence of accounting
standards globally.

10.2 In 2010-11, the ASB of ICAI after a
tirelessly effort came out with 35 Ind AS which, after NACAS consultation were
notified by Ministry of Corporate Affairs (MCA) in February 2011. However the
date of implementation which was scheduled to be 1^st April, 2011 was
not notified by the Government possibly, amongst other reasons, due to
tax-related concerns by corporates.

10.3 The current
government in its very first budget in July 2014 announced its intention of
implementing Ind AS from 2015 onwards. On 2^nd January 2015, the
Ministry of Corporate Affairs (MCA) issued a press release which laid down a
roadmap for adoption of Ind AS in India. 16^thFebruary 2015 marked
the dawn of new era in accounting standards in India when MCA notified the
final roadmap for adoption of new generation accounting standards, “Indian
Accounting Standards – Ind AS” based on the size of the companies and sectors
like Banking, NBFC & Insurance.

10.4 Between 2011, when MCA deferred the
implementation of Ind ASs and this notification, the International Financial
Reporting Standards (IFRSs) had gone through a significant rejig – the biggest
ones being the new accounting standards on Consolidation (IFRS 10, 11 and 12),
Fair Value Measurement (IFRS 13), Revenue (IFRS 15) and Financial Instruments
(IFRS 9). These developments have been incorporated in the standards notified
by the MCA based on the updation by ICAI with consultation of NACAS.

11 Indian Accounting Standards (Ind AS)

11.1 The key features of Ind-AS which are
principle-based IFRS converged standards include fair value measurement, use of
time value of money and reliance on robust disclosures. These Standards are
applicable for separate as well as consolidated financial statements.

11.2 The implementation of Ind-AS has led to
enhanced qualitative reporting due to additional information requirements and
more transparency. This will help the investors to better understand the risks
and rewards associated with the investment in an entity and, therefore, it
would make investment decisions easier.

11.3 Ind AS also require greater use of judgements
and estimates. Therefore, greater disclosure requirements are prescribed under
these Standards.

– For estimates: focus on the most difficult,
subjective and complex estimates including details of how the estimate was
derived, key assumptions involved, the process for reviewing and a sensitivity
analysis.

– For judgements: provide sufficient
background information on the judgement, explain how the judgement was made and
the conclusion reached.

– There is emphasis on substance over form
under these standards as they require us to look into the economic reality of a
transaction. Therefore, the substance of a financial instrument needs to be
looked into, rather that its legal form to determine its classification in the
balance sheet. For example, a compulsorily redeemable preference share is to be
classified as a financial liability under Ind AS while under Indian GAAP it was
classified as per its form i.e., it was classified as a part of equity.

11.4 Ind-AS thus, leads to more truthful
representation of transactions, e.g.

– Where goods are sold on extended credit
terms, i.e., extending the term beyond the normal credit period; then the
financing element built into the price is segregated and considered as
‘interest’ income. For example, goods that are normally sold at price of Rs.
100 for a credit period of 3 months. If, however, they are sold for Rs. 110 for
15 months credit then Rs. 10 will be considered as ‘interest’ (say @10%) income
under Ind AS. Similarly, fixed assets or inventories purchased on deferred
credit terms having financing element, namely ‘interest’ is also to be
segregated from the ‘purchase price’.

– Derivatives and hedge accounting was earlier
done on settlement-based approach rather than deferral approach. Ind-AS
requires fair value approach in case of these instruments.

– Accounting for time value of money, the true
position of financials closer to reality is depicted. There are many instances
where Ind-AS requires discounting of future amounts to arrive at the present
value. Some of these instances are discounting of long term provisions,
measurement of asset retirement obligations, measurement of liability in
defined benefit plans etc.

11.5 There are several fundamental changes that
the new standards bring in when compared to the earlier Standards. One key
fundamental change is the significant increase in focus on fair value
accounting. Ind AS requires application of fair value principles, which is
resulting in significant differences from financial information being presented
earlier. Complying with fair value principles of Ind AS will also require
assistance from professionals with valuation skills to arrive at reliable fair
value estimates.

The
following four Ind AS will have substantial impact with significant operational
and procedural changes specially for Banks, NBFCs and Insurance Companies:

– Ind AS 109, Financial Instruments which
provides the accounting and reporting norms for Financial Instruments.

Presently,
companies follow a provisioning matrix for impairment losses of financial
assets which is based on ‘incurred loss’ model wherein impairment losses were
recognised on occurrence of a credit risk trigger or event indicating objective
evidence of impairment. This could include a past due or default, significant
financial difficulty and so on.

After
Ind AS comes into place, the ‘expected loss’ model will be followed which is
based on estimating Credit Risk since initial recognition. Ind AS 109 requires
entities to recognise and measure a credit loss allowance or provision based on
an expected credit loss model.

The
new impairment model based on the expected credit losses as compared to
current percentage-based provisioning
requirements will have a significant impact on the entities’ estimation of the
probabilities of default.

– Ind AS 32, Financial Instruments:
Presentation which will change the presentation by the issuer of a financial
instrument as liability or equity based on principles of classification.

– Ind AS 113, Fair Value Measurement which
defines how fair value will be measured.

– Ind AS 115, Revenue from Contracts with
Customers which is effective from 1^stApril 2018, replacing Ind AS
11, Construction Contracts and Ind AS 18, Revenue.

11.6 Carve-Outs from IFRS: The Ind AS contain
some carve-outs as compared to IFRS as mentioned below. These carve-outs have
been made either due to conceptual issues or considering Indian economic
conditions and existing accounting practices being followed in the country.

– Events after the Reporting Period – Ind AS
10 vis-à-vis IAS 10As per IFRS, Rectification of any breach of a loan
agreement after the end of Reporting period is a non-adjusting event. Whereas,
as per Ind AS, if the lender, before the approval of Financials Statements for
issue, agrees to waive the breach, it shall be considered as an adjusting
event.

– Leases – Ind AS 17 vis-à-vis IAS 17:
As per IFRS, all leases rentals to be charged to statement of profit and loss
on straight-line basis. Whereas, as per Ind AS, no straight-lining for
escalation of lease rentals is to be done in line with expected general
inflation.

– Employee Benefit – Ind AS 19 vis-à-vis
IAS 19: As per IFRS, corporate bond rates are to be used as discount rate for
determining Actuarial Liabilities. Whereas, as per Ind AS, mandatory use of
government securities yields rate is to be done.

– The Effects of changes in Foreign Exchange
rates – Ind AS 21 vis-à-vis IAS 21: As per IFRS, recognition of exchange
rate fluctuations on long-term foreign currency monetary items is to be done in
the statement of profit and loss. Whereas, as per Ind AS, there is an Option to
defer exchange rate fluctuations on long-term foreign currency monetary items
existing as at the transition date.

– Investment in Associates and Joint Ventures
– Ind AS 28 vis-à-vis IAS 28: As per IFRS, for the purpose of applying
equity method of accounting in the preparation of investor’s financial
statements, uniform accounting policies should be used. In other words, if the
associate’s accounting policies are different from those of the investor, the
investor should change the financial statements of the associate by using same
accounting policies. Whereas, as per Ind AS, the phrase, ‘unless impracticable
to do so’ has been added in the relevant requirements.

– Financial Instruments: Presentation – Ind AS
32 vis-à-vis IAS 32: As per IFRS, equity conversion option in case of
foreign currency denominated convertible bonds is considered a derivative
liability, which is embedded in the bond. Gains or losses arising on account of
change in fair value of the derivative need to be recognised in the statement
of profit and loss as per IAS 32. Whereas, as per Ind AS, an exception has been
included to the definition of financial liability, whereby conversion option in
a convertible bond denominated in foreign currency to acquire a fixed number of
entity’s own equity instruments is classified as an equity instrument if the
exercise price is fixed in any currency.

– First time
Adoption – Ind AS 101 vis-à-vis IFRS 1: As per IFRS, on the date of
transition, either the items of Property, Plant and Equipment shall be
determined by applying IAS 16 ‘Property, Plant and Equipment’ retrospectively
or the same should be recorded at fair value. Whereas, as per Ind AS, an
additional option is given to use carrying values of all items of property,
plant and equipment on the date of transition in accordance with previous GAAP
as an acceptable starting point under Ind AS.

– Business Combinations – Ind AS 103 vis-à-vis
IFRS 3:

As
per IFRS, bargain purchase gain arising on business combination is to be
recognised in Statement of profit or loss as income, whereas, as per Ind AS, it
is to be recognised in Capital Reserve.

It
is proposed to minimise carve-outs in the future in course of time. In order to
minimise the carve-outs which are due to conceptual issues, ICAI is
continuously in dialogue with IASB and raising concerns at appropriate
international forums.

The
objective of carve-outs made due to Indian economic conditions and existing
accounting practices was to smoothen the transition to Ind AS and are proposed
to be removed over a period of time when Ind AS get stabilised in India and an
environment compatible with the requirements under IFRS is developed.

12 The way forward

12.1 Changes in Accountancy, due to change in
Technology: Globalization of national
economies and their interdependence had been strengthened by the internet,
which brings people living across the globe together in no time. This had an
impact on the working of the different professions and the profession of
accounting has not been left unaffected by this global revolution of
networking. New technologies spawn new applications and possibilities, which in
turn inspire changes to accounting methods and methodologies. The advent of
cloud-enabled computing has brought improvements to mobility and connectivity
for accountants. As a result, one is able to work with clients across the globe
from the comfort of one’s home, remotely access one’s data from a variety of
devices regardless of one’s location or the time, perform advanced computations
on the fly and retrieve real-time analytics. Technological changes to
accounting have automated many of the inputs and calculations that accountants
once had to perform manually. This allows one to play a more analytical and
consultative role in one’s interactions with clients. Of course, these advances
also require one to remain flexible, adaptable and perpetually learning in
order to keep up with the rapid pace. The evolving Block Chain technology and Artificial
Intelligence will also impact the way accounting is done, in times to come.
These are interesting times in the Accounting arena.

12.2 India has come a long way through evolving
the accounting rules towards better governance and globalization of its rapidly
growing economy. The couple of years of experience by several hundred Indian
companies ushering in IFRS converged accounting, to the say the least, is
encouraging. The existing Standards for SME/SMCs are also being upgraded to
make them compatible with Ind AS except for the complexities of Fair Value,
time value of money, etc. and this could be next era of big changes in
Indian context.

Origin
and Evolution of Auditing

13. Origin of Audit

13.1
The word audit comes from the word
“Audire” (means to hear). In general, it is a synonym to control, check,
inspect, and revise. In early days an auditor used to listen to the accounts
read over by an accountant in order to check them. Auditing is as old as
accounting. It was in use in all ancient countries such as Mesopotamia, Greece,
Egypt, Rome, U.K. and India. The Vedas contain reference to accounts and
auditing. Arthasashthra by Kautilya also detailed rules for accounting and
auditing of public finances.

13.2
In general, it is a synonym to control,
check, inspect, and revise. Auditing existed primarily as a method to maintain
governmental accountancy, and record-keeping was its mainstay. It wasn’t until
the advent of the Industrial Revolution, from 1750 to 1850, that auditing began
its evolution into a field of financial accountability. Checking clerks were
appointed in those days to check the public accounts and to find out whether
the receipts and payments are properly recorded by the person responsible.

13.3
As trade and commerce grew extensively
globally, the involvement of public money therein also increased manifold. This
in turn created a demand from the investors to have the accounts of the
business ventures examined by a person independent of the owners and management
of the business to ensure that they were correct and reliable. Such a demand
laid down the foundation for the profession of auditing.

13.4
Over the years, the extent of reliance
placed by the public on the auditors has increased so much with time that it
is, unreasonably, felt by the public that nothing can go wrong with an
organisation which has been audited. Though the fact that an audit has been
carried out is not a guarantee as to the future viability of an enterprise, it
is extremely important that the auditors carry out their assignments with
utmost professional care and sincerity, to uphold the faith posed by the public
in them.

13.5
Over the years, auditing has undergone
some critical developments. A change in audit approach from “verifying
transaction in the books” to “relying on system” also evolved due to the
increase in the number of transactions which resulted from the continued growth
in size and complexity of companies where it was unlikely for auditors to play
the role of verifying transactions. As a result, auditors started placing much
higher reliance on companies’ internal controls in their audit procedures.
Furthermore, auditors were required to ascertain and document the accounting
system with particular consideration to information flows and identification of
internal controls. When internal control of the company was effective, auditors reduced the level of detailed testing.

13.6
There was also a readjustment in auditors’ approaches where the assessment of
internal control systems was found to be an expensive process and so auditors
began to cut back their systems work and make greater use of analytical
procedures. An extension of this was the development during the mid-1980s of
Risk-Based Auditing (RBA). RBA is an audit approach where an auditor will focus
on those areas which are more likely to contain errors. To adopt the use of
RBA, auditors are required to gain a thorough understanding of their audit
clients in term of the organisation, key personnel, policies, and their
industries. The use of RBA places strong emphasis on examining audit evidence
derived from a wide variety of sources that is both internal and external
information for the audit client.This period also involved Introduction of
Computer Assisted Audit Techniques (CAATs) that facilitated data extraction,
sorting, and analysis procedures.

14. Advent of computerization and auditing

14.1
Before the advent of the computer, bookkeeping was done by actual bookkeepers.
The bookkeeper would record every financial transaction the company made in a
journal, the then book of primary entry. The transaction didn’t just need to be
entered into the journal but also copied to other ledgers, for example, the
company’s general ledger.

14.2
Prior to the advent of computers, to
ensure accounts were in balance, a ‘Trial Balance’ was used. If this internal
document revealed that the accounts were not balanced then the bookkeeper had
to undertake the arduous task of going through each transaction, check the
castings, carry-forwards, etc. until the root cause of the disparity was
located and rectified so that the accounts again balanced.

14.3
The advent of computerisation
dramatically changed the manner in which the business was conducted. It had
significant effect on organization control, flow of document information
processing and so on. Auditing in a Computerised environment however did not
change the fundamental nature of auditing, though it caused substantial change
in the method of evidence collection and evaluation. This also required auditors
to gain knowledge about computer environment (hardware, software, etc.)
and keep pace with rapidly changing technology, even to the extent of using
sophisticated Audit software.

14.4
Auditors generally followed an “auditing
around the computer” approach by comparing the machine’s input with its
output (parallel processing), just as he/she had compared the voucher files
with the ledger books in the early 1900s.

14.5
With the introduction of computers,
conventional accounting systems and methods using papers, pens, etc. underwent
drastic changes, therefore exerting a great impact on internal control and
audit trails in following audit procedures. Auditors could no longer depend on
visible records but only check the existence of adequate internal control
system to ensure accuracy of operations; the number of records which could be
read only when processed by computers increased while intermediary and legible
records which existed in conventional manual accounting processes decreased and
there were many cases in which audit trails were not available. Therefore,
audit procedures had to be revised to cope with
these problems.

14.6
With rapid changes in the business world, auditors only slowly realised they
needed to be technologically proficient and, perhaps, adopt new approaches. The
21^st Century forced auditors to rather “work through the computer”
in performing their functions as virtually all business transactions were
conducted via the information technology. Computer Assisted Audit Techniques
(CAATs) were developed for using technology to assist in the completion of an
audit. CAATs automated working papers and auditors used software to perform
audits. CAATs were very useful when
large amounts of data were involved or complex relationships of related data
were needed to be reviewed to gather appropriate audit evidence from the
aggregated data. It also increased the efficiency of the conclusions about data
analysis. Several CAATs were developed like Generalized Audit Software, Data
analysis software; Network security evaluation software/utilities; OS and DBMS
security evaluation software/utilities; Software and code testing tools”,
Interactive Data Extraction and Analysis, and Audit Command Language.

15. Auditing in future and use of technology
for audit

15.1
For the past two decades, auditors have
been seeking less and less audit evidence from detailed substantive testing.
Better accounting systems and the greater use of IT by clients has meant that
very few material transaction errors are being discovered by external auditors.
Therefore, audit emphasis is increasingly shifting from the detailed
examination of the routine transactions to the internal controls and the
potential of risk. These developments have to be viewed in terms of a change
from audit efficiency to audit effectiveness. There has been resurgence in the
emphasis on judgement regarding the assessment of risks and controls, judgement
regarding the interpretation of analytical reviews, and judgement in relation
to any testing (albeit on limited basis). The focus, by some firms, on the
high-level risks and controls, together with the justification of very limited
amounts of detailed substantive testing based on their risk analyses and
analytical reviews, has completely altered previous conceptions of the external
audit.

15.2
The functions of auditors have changed
over the years unlike its antecedent “accounting”. Much later in history, this
duty changed since auditors are not guarantors and there is no way they can
ascertain 100% that the financial statements prepared and presented are free
from fraud, therefore, the auditors were expected to give reasonable skill and
care in giving their opinion on whether the financial statements faithfully
represent the financial situation of the business. The roles of auditors were
seen to be changing due to changes in the world at large. Due to this, the
assertion in an audit report has changed from “True and correct” in the past to
the present concept of “True and Fair”.

15.3 Given the
recent advances in business technologies, the continuing emphasis on the
backward-looking or historical audit is now being seen as an outdated
philosophy. Instead, the thought is that real-time solutions are needed. As
such, it is felt that auditing firms that successfully experimented with the
CAATs should give eventual consideration to more advanced programs which
contain functionalities resembling the audit of the future and provide a higher
level of assurance. Furthermore, these programs may assist in optimizing the
audit function by analyzing all financial transactions as they occur. This has
also resulted in the evolution of different fields of audit viz., Statutory
Audit, Internal Audit, Management Audit, Systems Audit, Forensic Audit and so
on. Clearly, within the overall audit function, the scope and end result or the
reporting is different in the different types of audit.

15.4
The extent to which data, controls, and
processes are automated must be considered and discussed with the client, for
example a company that is overburdened by manual audit processes will need to
confront this issue at some point if the objective is to yield optimal benefits
from the audit. An enterprise that moves toward greater automation relative to
data, processes, controls, and monitoring tools begins to naturally structure
itself for the coming of the future audit. There are a variety of methodologies
like Embedded Audit Modules (EAM), Monitoring and Control Layer (MCL), Audit
Data Warehouse (ADW), and Audit Applications Approach that will need to
progressively adopted and used to meet the users’ expectations.

15.5 New technological
tools have the potential to enable the auditor to mine and analyze large
volumes of structured and unstructured data related to a company’s financial
information. This capability may allow auditors to test 100% of a company’s
transactions instead of only a sample of the population. Major accounting firms
have asserted that the use of these tools will enhance the audit by automating
time-consuming tasks, which are more manual and rote in nature. For example,
through the use of artificial intelligence, robotic systems could interface
with a client’s systems to transfer and compile data automatically, something
previously done manually by a junior auditor. Other areas where such
technologies may introduce efficiencies include processing of confirmation
responses or using drones for physical inventory observations.

15.6
As a result, the auditor should have
more time to carefully examine the more complex and higher risk areas that
require increased auditor judgement and contain high levels of estimation
uncertainty. Such tools, will also enable auditors to perform advanced
analytics which will provide them with greater awareness and deeper insights
into the company’s operations. Data analytics may also allow auditors to better
track and analyze their client’s trends and risks against industry or
geographical datasets, allowing them to make more informed decisions and
assessments throughout the audit process.

15.7
Further, through the power of big data,
auditors will be able to correlate disparate data information to develop
predictive indicators to better identify areas of higher risk, which in turn
could lead to early identification of fraud and operational risks. For example,
firms will have the ability to develop predictive models to forecast financial
distress in order to better assess the future financial viability of a company
or improve fraud detection by helping auditors assess the risk of fraud as part
of their risk assessment.

15.8
The use of these technological tools and
methods also raise certain challenges. For example, it is important that the
data being used is reliable, complete and accurate. That is true for general
ledger data, other financial and operating data, and data from outside the
company. Data security and quality control over these tools, whether developed
in-house or by vendors, are also factors for firms to consider. And ensuring
consistency of approaches across group audits may become difficult if such
tools are not readily available to, or used by, affiliate offices. Also,
auditors should take care that they are not over relying on data analytics. As
powerful as these tools are, or are expected to become, they nonetheless are
not substitutes for the auditor’s knowledge, judgement, and exercise of
professional scepticism.

16. Changing role of Auditors

In
the last two decades, rapid and vast development in corporate governance has
consolidated the auditor’s position as a watchdog. The perpetual accounting and
auditing failures like Enron, WorldCom, Paramalt, and more recently Satyam has
exposed serious lacuna in the auditing. India’s largest accounting fraud
“Satyam” has dented auditing profession and surfaced the inherent conflicting
position of auditors in the Indian business scenario. The recent ‘PNB’ scam and
the more recent resignation of auditors in several listed entities just before
the financial statements were to be adopted has also put the auditors; and
their role in the limelight.

16.1
According to IFAC, objective of an audit
is to enable the auditor to express an opinion on whether the financial
statement is prepared in all material respects, in accordance with an
identified financial reporting framework. The auditor’s opinion helps to
determine the true and fair financial position and operating results of an
enterprise. This is considered as most accepted role of the auditorsand
mandated so by the corporate laws of most countries of the world. In India
also, the auditor is cast with the responsibility of ensuring this aspect.

16.2
With development of stricter corporate
governance codes and new reporting standards both in accounting and auditing,
the auditor’s role has implicitly enhanced to a great extent as against the
traditional role of merely assessing the true and fair value of a corporation.
With financial reporting standards now focusing on concepts of ‘fair value’,
‘impairment’ and ‘going concern’, which involve a high level of judgement, the
role of auditors is becoming much more relevant than ever.

16.3
External auditors are the oldest
watchdogs, to protect the interest of the shareholders by verifying the
financial accounts and presenting their opinion on it. In India, in the recent
decade, capital markets have grown tremendously, open access of market has been
given to foreign nationals / investors, numerous corporate frauds (including
Satyam, Ricoh, and PNB) happened, and vast developments in the field of
corporate governance have taken place. All these increase theauditor’s
responsibilities and make them an integral part of corporate governance
framework. They are now professed to play different roles and responsibilities,
other than their statutory responsibilities in this contemporary business
environment. The corporate governancereforms by SEBI in the form of Clause 49
and the more recent LODR has improved the status of auditing and given much
needed significance to the role of auditors.

17. Standards on Auditing in India

17.1
In simplest possible terms, auditing standards represent a codification of the
best practices of the profession, which already exists. Auditing standards help
the members in proper and optimum discharge of their profession duties.
Auditing standards also promote uniformity in practice as also comparability.
Standards on Auditing help to:

– compensate for the lack of observability of
the audit outcome by focusing on the audit process;

– partially mitigate the information advantage
possessed by the auditor as a professional expert that might motivate the
auditor to under-audit;

– counter balance the diversity of demand
across multiple stakeholders that might drive the audit to the lowest common
denominator and create a market based on adverse selection; and

– provide a benchmark that facilitates the
calibration of an auditor’s legal liability in the event of a substandard
audit.

17.2
However, the Standards does not:

– discourage the use of judgement by auditors;

– limit the potential demand for alternative
levels of assurance;

– lead to excessive procedural routine or standardisation
in the conduct of the audit; or

– be set based on an enforcement agenda.

17.3
Since its establishment, the ICAI has
taken numerous steps to ensure that its members discharge their duties with due
professional care, competence and sincerity. One of the steps is the
establishment of the Auditing Practices Committee (APC) in September
1982. Representatives from the Reserve Bank of India, the Securities and
Exchange Board of India (SEBI) and industry were part of APC and had their say
before the ICAI formulated its guidance and statements on `Standard Auditing
Practices’. APC issued Statements on Standard Auditing Practices (SAPs) and
guidance notes without involving the public in the entire process.

17.4 In July 2002,
the central council of ICAI renamed the existing APC as Auditing and Assurance
Standards Board (AASB) to reflect the activities being undertaken by the
committee. To bring about more transparency in the auditing standards setting
process, the council also stipulated that the AASB would have four special
invitees.. Further, all exposure drafts issued by AASB are sent to specific
bodies such as the stock exchanges, Insurance Regulatory & Development
Authority (IRDA) and the Indian Banks’ Association (IBA) for their views and
comments.

17.5 The Standards
on Auditing (SAs) issued by ICAI are based on International Standards on
Auditing (ISAs) issued by IFAC.Since, ICAIis one of the founder members of
IFAC, the Standards issued by the AASB under the authority of the council of the
ICAI are in conformity with the corresponding International Standards issued by
the International Auditing and Assurance Standards Board (IAASB) established by
the IFAC. The only exception to this is SA 600 ‘Using the work of another
auditor’ which, looking to the Indian scenario where auditors can rely on
branch auditors or subsidiary auditors, is not converged with ISA 600.

Currently, the Standards on Auditing issued by the ICAI
are:

	Title
SQC-1	Quality control for Firms that perform audits and reviews of historical financial information and other assurance and related services engagement
Standards on Auditing (SA)
SA 100-199	Introductory Matters
SA 200-299	General Principles and Responsibilities
SA 300-499	Risk Assessment and Response to Assessed Risks
SA 500-599	Audit Evidence
SA 600-699	Using Work of Others
SA 700-799	Audit Conclusions and Reporting
800-899	Specialized Areas
Standards on Review Engagements (SREs)
SRE 2000 -2699
Standards on Assurance Engagements (SAEs)
SAE 3000-3699	Applicable to All Assurance Engagements
SAE3400-3699	Subject Specific Standards
Standards on Related Services (SRSs)
4000-4699	Standards on Related Services

Title

SQC-1

Quality control for Firms that perform audits and
reviews of historical financial information and other assurance and related
services engagement

Standards on Auditing (SA)

SA 100-199

Introductory Matters

SA 200-299

General Principles and Responsibilities

SA 300-499

Risk Assessment and Response to
Assessed Risks

SA 500-599

Audit Evidence

SA 600-699

Using Work of Others

SA 700-799

Audit Conclusions and Reporting

800-899

Specialized Areas

Standards on Review Engagements (SREs)

SRE 2000 -2699

Standards on Assurance Engagements (SAEs)

SAE 3000-3699

Applicable to All Assurance Engagements

SAE3400-3699

Subject Specific Standards

Standards on Related Services (SRSs)

4000-4699

Standards on Related Services

18. Revised Audit Reporting (Effective
for
periods beginning on or after 1^stApril 2018)

18.1
The ICAI has issued revised standards on audit reporting. The same are based on
the ISAs issued by IFAC in 2016. The reason stated by IFAC for issue of the
revised ISAs is as under:

– Continued relevance of audit

– Improve audit quality and
professional scepticism

– Enhance preparer focus on key
financial statement risk areas and disclosures

– Enhance communicative value to users

– Stimulate more robust auditor
interactions and user engagement

– Improve users’ understanding of what
an audit is and what the auditor does.

18.2
Key Audit Matters (KAM):

Mentioning
KAM in an audit report is one of the major changes brought about in audit
reporting from financial year 2018-19 onwards. KAM are defined as those matters
that, in the auditor’s professional judgement, were of most significance in the
audit of the financial statements of the current period. KAM are selected from
matters communicated with TCWG. KAM are required to be communicated for audits
of financial statements of all listed entities – however an auditor may also
voluntarily, or at the request of management communicate KAM. The following
considerations are used in determining matters of most significance:

– Importance
to intended users’ understanding of the FS

– Nature and extent of audit effort needed to
address

– Nature of the underlying accounting policy,
its complexity or subjectivity

– Nature and materiality, quantitatively or
qualitatively, of corrected and accumulated uncorrected misstatements due to
fraud or error (if any)

– Severity of any control deficiencies
identified relevant to the matter (if any)

– Nature and severity of difficulties in
applying audit procedures, evaluating the results of those procedures, and
obtaining relevant and reliable evidence

18.3
It is felt that the introduction of KAM
in the audit reports will usher in more transparency in disclosures and
improvement in audit quality.

conclusion

19.
Over the last decade, the users’
expectations from financial statements and audit report thereon have undergone
a sea-change. From a time where concise financial statements and crispaudit
reports were favoured, the trend now is clearly towards more disclosures and
transparency in financial statements and audit reports with more details. An
attempt has been in this article to discuss the evolution of accounting and
auditing to meet these ever-growing expectations.

shailesh.kwebmaker

Interview: Y. H. Malegam

In celebration of its 50th Volume – the BCAJ brings
a series of interviews with people of eminence, the
distinct ones we can look up to, as professionals. Those
people who have reached to the top of their chosen
sphere, people who have established a benchmark for
others to emulate.

This second interview is with Mr. Y. H. Malegam.
Mr.Yezdi Hirji Malegam is well known in the fraternity of
professionals – on both practitioners’ as well business
side. He served as president of the ICAI (1979-80), served
on the Board of the Reserve Bank of India (17 years),
and was awarded Padma Shri (2012). Academically, he
holds a particular distinction of passing both the Indian
Chartered Accountancy examination (stood first and won
a gold medal) and Society of Incorporated Accountants
examinations (stood first and won a gold medal).
Mr. Malegam was appointed on several committees/
commissions of significance. He also led one of India’s
oldest professional services firm for decades. However,
what surpasses his achievements and accolades is the
respect people have for Mr Malegam for his integrity,
clarity and the wealth of experience which is the true
hallmark of a professional.

In this interview, Mr Malegam talks to BCAJ Editor Raman
Jokhakar and BCAJ Past Editor Gautam Nayak about his
formative years, accounting and auditing aspects of the
profession, current issues before the profession, personal
anecdotes from his sixty plus years of career….

(Raman Jokhakar) Tell us a bit about yourself as a
young professional. What was it like growing up as a
fresher then?

After graduating as a B. Com, I started articles with
S. B. Billimoria & Co on 30thJune, 1952. I was 18 years
old. I spent the whole of my first year of articles at
Jamshedpur, where we were auditing Tata Iron & Steel
Co Ltd (Tata Steel) and Tata Engineering and Locomotive
Co Ltd (TELCO). It was a great learning experience.
These two companies had perhaps the best corporate
accounting systems, and they were amongst the few who
had started using the mainframe Punch-Card Hollerith
machines. It gave me the opportunity to audit a variety of
activities, including manufacturing, sales, iron ore mines,
collieries etc. This was the period when there was large
capital expenditure in Telco, and it was an opportunity
to understand how contractors’ bids and escalation
claims should be examined. It was also an opportunity
to appreciate how the use of accounting machines could
change the traditional audit programme. S. B. Billimoria
& Co were the main auditors of the Tata Group and the
Wadia Group as also Volkart Brothers, amongst a number
of business groups, and were auditors of the Reserve
Bank of India, the State Bank of India and almost all
the large Indian banks. Even while I was doing articles
for the Indian Institute, I was simultaneously doing byelaw
service for the Society of Incorporated Accountants,
London (which subsequently merged with the Institute
of Chartered Accountants in England and Wales). After I completed my articles in June 1955, I continued with the
firm for one year, during which time, I took charge of a
number of audits of the firm. I qualified in England in July
1957 and returned to India and rejoined S. B. Billimoria &
Co and became a partner on 1stJanuary, 1958.

I was immediately given some important and interesting
assignments. LIC had been formed with the amalgamation
of over 230 individual companies, and it was a gigantic
task to amalgamate the financial statements of the
companies. LIC had 12 auditors, but S. B. Billimoria & Co
was one of the four central auditors, and this task had to
be mainly done by me.

The Durgapur Steel Works were being constructed by
11 British firms under a contract with the Government of
India, whereby the individual firms sold the equipment
but formed a company (ISCON), which did the erection
on a cost plus basis. Price Waterhouse was appointed
by ISCON and we were appointed by the Government
to jointly certify the bills for construction. I was asked to
go to Calcutta to attend a meeting with ISCON and given
two large volumes of the contract, which I studied for the
first time on the long flight to Calcutta and thereafter, I
was in charge of this work. We had appointed Mr S. V.
Ayyar, a retired Chief Cost Officer of the Government
as our consultant, and he worked with me. I learnt a
lot from him as to how to audit construction invoices,
which stood me in great stead throughout my career.
For example, steel scrap had to be segregated between
structurals which were above a specified length, which
were sold as structurals, and which fetched a much
higher price as compared to those below this length,
which were sold as scrap. Similarly, for all construction
bills, it was necessary to examine the drawings and
ensure that the quantities billed were not in excess of
the quantities as per the drawings. On one occasion,
a sub-contract had a performance incentive, whereby
savings in cost was to be shared with the sub-contractor.
The incentive for which payment was made was a large
percentage of the estimated cost. I challenged this and
argued that obviously the estimates were understated.
This was disputed by the local office of ISCON, and
it was accepted only when, on a visit to UK, I met the
Company’s senior officials in the UK and convinced
them about my stand. Later, when examining the
fabrication bills for the capital expenditure at Telco, I
noticed that the escalation claims had been made and
accepted on the basis of the standard escalation claims
of the industry. I pointed out that the standard claim was
based on a standard percentage of the rate per ton of
fabrication, and it had been overlooked that there were
two rates which were applicable, namely one where steel
was supplied by Telco and second, where the steel was
supplied by the fabricator. The application of a common
percentage on both rates resulted in gross overpayment
where steel was supplied by the fabricator. This resulted
in substantial refunds from the fabricator for work already
done, and even more savings for work still to be done.

(R) What are the important parts of your daily
routine? Has it changed over the years?

From my student days, I always liked to start early in
the day. Even today, I wake up between 6 and 6.30 am,
take a morning walk and then start work by about 7.30
am. The best work, I feel, is done in the early part of the
morning, especially the work that involves thinking.

(R) What was your idea of success when you were
in your 20s? Did it change over the decades?

I am not a very ambitious person. I did not have a
concept of wanting to achieve something. However, I can
say that some incidents played an important role in shaping
my career.

In those days, there was no idea of increasing the business
by taking the work of someone else. We were the auditors
of RBI and of all its subsidiary corporations. I remember
that when the UTI was formed, we were closely involved in
its formation. You might still find some early documentation written in hand by me in formulating the regulations and Dr Pendharkar, the first CEO of UTI has acknowledged
this in his book. Since we were involved in its formation,
we expected that we would also be appointed as its first
auditors. However, after the formation, UTI appointed A
F Fergusson & Co. as auditors. After about two years,
the Chairman of UTI called Mr. Billimoria and said he
wanted to meet him. Mr. Billimoria asked for the reason
of the meeting. The Chairman said that they wanted to
appoint us as the auditors of UTI. Mr. Billimoria enquired
more about the matter, and the Chairman explained
that there were some differences with the auditors. Mr.
Billimoria asked the Chairman to give him the name of the
concerned partner, and told him that he (Mr. Billimoria)
would bring that partner of A F Ferguson & Co with him
to the UTI Chairman so that the matter can be sorted
out. These were the value systems, which have always
guided me.

(R) Who were your role models and mentors? How
did they shape your career?

My parents were my earliest mentors. My mother was
one of the first woman graduates and was a principal of
a school. Due to this, although she wanted me to study,
she insisted that after coming back from school, I should
go out and play and do school work later in the evenings.
This inculcated my interest in sports. I played cricket a lot,
both for my club and also my college, and represented my
Gymkhana in badminton and table tennis.

My father was a self-made man. He couldn’t complete his
studies in medicine due to financial difficulties, because
he lost his father when he was eight years old. He started
and ran a surgical equipments business, which he built
up successfully. He was more like a friend, and did not
impose things on me that I had to accept because he was
the father.

I was lucky to have good professors who took interest in
me in college and then of course there was Mr. Bhikaji
Billimoria. After the loss of my father, our relationship was
like father and son. He was a complete gentleman in all
respects. By his example, I learnt many things, including
how to behave with clients and colleagues, and most
importantly, never to compromise.

(R) What are the top lessons you learnt over
the past 8 decades that you wish to share with the
present generation?

i.To learn to ask questions and not be scared to show
my ignorance of a subject.
ii. Never to be patronising and to treat all persons
equally, irrespective of their social standing.
iii. Never be unwilling to admit mistakes and take
corrective action.

(R) Looking back, is there something you feel that
you could have done differently in your career?

I feel I should have given more time to understanding
information technology, where I am particularly deficient.
Earlier, I also used to practice income-tax and enjoy it.
Unfortunately, I could not devote enough time, as I got
more and more involved in the audit practice.

(Gautam Nayak) As a leader of a firm with stature
and long standing, what were the important pillars it
was built on – that new entrants could emulate?

i. We placed great emphasis on client acceptance and
retention. I had made a policy on acceptance or retention
of a client. Every partner, before taking a new client, had to
discuss it with me to ensure that the new client met those
criteria. Similarly, if a partner was unhappy with a client,
he was encouraged to discuss with me, the question of
whether the client should be retained.

ii. We never wanted to build a firm that was the largest or
the most profitable. The goal was to build a firm that was
most respected.

iii. Competence, fairness and integrity were the most
important aspects of the firm’s practice. Client’s
confidence in us was the most important aspect. Once we
felt that client confidence was not there, we would give up
the client. On one occasion, we had a different view with a
client group that constituted nearly 10% of our revenue. I
was the chairman of the Research Committee of the ICAI,
and a paper was presented at a Seminar in Mumbai which
suggested that customs duty need not be added as an
element of cost in the valuation of inventories. This paper
was sent to the Research Committee for consideration.
We thought that this was not a sound accounting practice,
and issued a guidance on that basis. One of the firm’s
clients, handled by another partner, had followed this
practice, as did many other companies after the Seminar.

Mr. Kuruvilla, CBDT Chairman, asked the CIT, Mumbai
to call me and discuss the whole issue of the accounting
practice. Since I was aware of the practice followed by
our client, I checked with the client if they would mind
me attending that meeting with the CIT to discuss the
matter. The client did agree. When I saw what the tax
department was intending to levy as additional tax on the
client, I told the department that the additional tax was
payable, but that the computation was excessive, which
the tax department accepted. However, the clients felt
that I should have defended their position, as they did
not want to change their stand. I told my partners that we
should not compromise, and that we should give up the
client. The client persuaded us not to do so, but within
a year, other issues arose, as the confidence had been
destroyed, and we gave up the group.

At the same time, it was necessary to demonstrate to the
client that we were willing to assist the client to act in any
way which was legal and permissible.

On one occasion, one of the Tata group entities suggested
an accounting adjustment, with which I did not agree.
However, on enquiry, I ascertained that they wanted to
give a dividend, but did not have enough profits to do so.
They had consistently given dividend, and wished to carry
on that practice. In those times, investment allowance
reserve was created in the accounts, which was meant
to be retained for seven years. Now that the seven years
had already passed, I suggested that this amount could
be brought back to the profit and loss account since it was
taken out from profit and loss account at the inception of the
reserve. The client took some time, and took an external
opinion, and came back saying that this was not possible.
They had taken an opinion of Fali Nariman. I asked the
client that I would like to meet Fali and discuss the matter.
After the meeting at the Oberoi, Fali Nariman agreed with
my view and even asked me to draft an opinion that he
could sign and give the client. This demonstrated to the
group that our approach to the audit was not negative and
encouraged the client to freely discuss with us all issues
with the confidence that we would permit everything which
was legal and acceptable, and at the same time not allow
anything which was not legal.

iv. When invited to speak on or contribute an article,
select a subject you do not know, rather than a subject
you are familiar with. This is the best form of learning, as
you prepare for the talk or article.

v. In building a professional practice, it is important to
attract talented individuals. In our firm, we did this by
identifying exceptional individuals at an early stage in
their career, giving them positions of responsibility and
empowering them and by having a policy of promoting
persons to partnership purely on merit, irrespective of
religion or caste or other considerations. In our firm, we
had partners of all communities, and no partner was
related to any other partner.

(G) Can you share your experience of the move from
heading a leading CA firm to being part of a Big N firm?

We had international affiliations for many years even
before I became a partner. However, this was mainly an
arrangement for mutual assistance. The international firms
referred clients to us and we allowed them to examine
our working papers to give them confidence about the
quality of our work. We also attended their international
conferences and built up personal relationships.

When we joined Deloitte Touche Tohmatsu in 2004, the
Indian firm consisted of S. B. Billimoria Co, C. C. Chokshi
Co and Fraser and Ross. N. V. Iyer and I became Co-
Chairmen of the firm. We shared a wonderful relationship,
as we were, and still remain, good friends. We both retired
in 2004, and A. F. Ferguson & Co. joined thereafter. The
Indian firm is, therefore, a combination of 4 large national firms. It is not controlled by an overseas entity. Only for
the purpose of technology or certain technical matters,
we had people from overseas. The benefits also flowed
the other way – when our Indian clients invested and
expanded overseas, Deloitte was appointed to do their
work in those countries.

One change that did happen. As the number of partners
increased, it became necessary to share profits on a
more results-based system and performance gradation
criteria became important for both partners and staff.
The international affiliation has greatly increased the
competence of the firm, as it had greater access to
technical inputs from overseas, as also the ability to refer
to international offices for guidance on specific issues.

(G) Worldwide, more and more reliance is being
placed on valuations and estimates, which are often
highly subjective, for the purpose of accounting.
Valuers are not as regulated as public accountants are.
Is the increasing role of valuation in accounting, more
specifically in relation to fair value measurements,
making the accounts more subjective and perhaps,
less reliable too?

The one area, other than audit, where I have done much
work, and to which I can claim expertise, is valuations.
When you do valuations, you have to have access to
information, which is otherwise not available in the public
domain. My view has always been that valuation based
approach should be applied to instruments listed in the
markets because the information is available. Valuation
based approach is also justified for associates and
subsidiaries, because the information is also available.
But applying fair value to unlisted entities does not seem
reasonable and practical since the information in the
public domain is often inadequate.

Fair value is largely applied to financial instruments, where
estimates are involved. Therefore, most other entities are
not significantly affected by fair value measurements.

(R) Is auditing becoming more a task of form over
substance? There is documentation and paperwork,
but auditor’s judgement could be missing. These
days, 60% or more time goes into documentation as
compared to actual testing and asking questions.
Is proving that procedures have been followed
becoming more important than the actual application
of mind? Is this desirable? Have the fundamentals of
audit changed?

One thing is that the auditor needs to be more
sceptical. In the olden days, you assumed that everyone
was a gentleman, and you accepted what they said. Now
you have to be sceptical of the people at the highest
level because all of these frauds take place. Not fraud in
terms of taking money out from the company, but fraud
in falsification of accounts for a number of purposes.
This is a grey line, at which things can be done without
your knowledge, so you have to be much more sceptical
during the audit.

I think you also need to realise that documentation is there
for your protection, but documentation alone does not add
to the value of audit. Except, of course, the very process
of creating documentation means that you do not leave
out some essential parts of the audit. To that extent, it is
useful, but it is not an excuse for not doing a good audit.

The other feeling is that when you had a lot of manual
work, which was being done earlier, accuracy of
accounting was one of the objectives. You had to balance
the trial balance, you had to take totals, you had to do
postings; now all that is gone – machines are doing all
that. Therefore, in the olden days, you needed a lot of
junior staff to do this work. Now that need does not arise.
Therefore, an audit cannot be done by junior staff. You
now need to do audits only with higher level of staff. And
therefore, the professional now has to think about this –
that can you afford to do auditing, when you rely upon
the work of juniors, when in effect the skills needed are of
a much higher level? That, I think, is affecting firms from
properly addressing the problem.

If I may take an example, if you are talking of concurrent
audit in banks – the whole purpose of the concurrent
audit was to prevent a malpractice before damage takes
place. And therefore it was nothing else, but equivalent
to internal audit, but internal audit done concurrently.
Therefore, you need much higher skills. And if you do not
do that, if you entrust that work to the articled clerks or the
people who have no maturity or the understanding of this,
you are not serving any purpose. In fact, you are creating
a worse situation, because you rely upon something, you
assume that is done, but there is no such control. That I
think is the big area, which you have to address.

And the other thing is, I think, increasingly now the
purpose of audit is changing. In the past, the purpose of
audit was to give some degree of reliability to the financial
information. Now, reliability by itself is not enough, with
increased computerisation, it is assumed that it will be
reliable. What is now needed is some assurance that
there is no mismanagement, that there is no fraud; some
assurance that you are able to provide to the reader. See
and answer the questions like – What is the future of this
company? Is this run as efficiently as it should be run?
This is where the changes are taking place.

(R) How do you see the audit profession developing
in the future? Would use of technology, such as
artificial intelligence, replace a significant part of the
audit process and audit judgement in the future? Or
would it only help in reducing test checks?

One of the things perhaps I was thinking about, is the
perception that the big firms are doing better audit. I think
one of the reasons perhaps is, that in the big firms there is
now specialisation. The Audit partner does only audit, the
tax partner does only tax. Now, in the smaller firms, the
same person is doing both audit and tax. I feel somehow,
that maybe you are not developing sufficient skills in either
area, in trying to do both. You may be an average auditor
and an average taxman, whereas if you specialise, you
would probably be a very good auditor and a very good tax
practitioner. Now this is the problem which is faced, and
therefore, what can the profession do? We are producing
a large number of members, and there is just not enough
work in the audit profession for them. Therefore, for those
areas which are more individual oriented, where you need
individual skills, there is no harm in having small firms, just
as you can have a lawyer who is appearing in the court as
an individual. He can have few support staff, and he can
have a huge practice. But you can’t have a solicitor’s firm
without having a large number of people specialising in
different areas. Now that is one of the basic issues in the
profession. If you want to go into the audit area, people
must get together and create larger entities; without that,
you cannot function, because you need larger staff, you
need more finances for systems, for machines and for
various other purposes.

The second is – that the skills have to be upgraded and I
don’t know whether we are doing that adequately. If you,
for example, find that people want more assurance than
there is available today, then obviously you will need to
have the skill to do that. What is needed is to understand
what is a good system of internal control, to know how
you detect fraud and what are the forensics skills that you
need. I think we are not doing enough of it in the training.
We keep on doing the same training over and over again.
I used to tell that even in the olden days to my staff – I
said “You are only looking at the paper. If someone gives
you a bill that he travelled by taxi, you will accept that bill.
You don’t know who has signed that receipt or if such a
person exists, but if a man tells you that he travelled by
taxi, you will not believe him. Now, perhaps you can be a
better judge to see whether that is a person, whose word
you can rely on, rather than a piece of paper”. Now that is
the skill which you have to develop, what is the relevant
evidence for checking the transaction, not just a piece of
paper. That is the whole point.

(R) Meaning, the amount of questioning or the type
of questioning and judgement?

Not just questioning. First is, that you are dealing with
people you must have the ability to assess, on whom you
can rely, and on whom you cannot rely. You have to be a
good judge of people, and you can find that out straight
away. There are some people whose honesty you do not
doubt. I am talking about intellectual honesty. Then there
are other people – you feel that maybe he is just trying to
tell you what you want to hear. So you have to understand
that you have to be polite, good but, at the same time,
sceptical. You have to put yourself in the shoes of that
person. If there is a company which is making losses, the
normal practice will be to try and reduce the loss, if it is
making profits, the practice will be to put some cushion
there, that sort of a thing.

(R) Few questions on the professional scene in
India: The Chartered Accountancy profession was
built on certain values and principles. People who
know you, hold you in the highest regard in terms of
abiding in and living those values. As you interact with
professionals – be it Directors, Auditors, Regulators
– do you feel that some of those fundamentals have
undergone a change?

I have personally not come across people for
whom I would say that I have some reservations about
them, but I have at the same time found the general
impression of others to be that standards have declined.
That is unfortunate.

I will give you a specific example. I was talking to some
bank people, the Managing Director of a bank, and I was
trying to work out how we can make better systems,
so I was making some suggestions, and I said, “If you
can get the borrower to submit audited certificates on
these aspects, then it will give you a better control.” And
I was shocked to find the response from that person,
when he said, “No, no, no, after all, all these auditors
certificates are fake certificates. We cannot rely upon any
of these auditors certificates”. And this, unfortunately, is
happening, because either the auditor or the person who
gives the certificate doesn’t understand the importance
of that certificate or he is too much indebted to that client
that he cannot afford not to do this.

Therefore, as far as the profession is concerned; we
have to have a zero tolerance practice. Again, I will
give you an illustration. When I was the president, there
was Mr. D’Souza who was the Commissioner of Income
tax. In the morning one day, I read in the newspaper a
report about some raid, and one Chartered Accountant
who was involved. So I went that morning to Mr. D’Souza
and I said, “Can you make a complaint against this
chartered accountant?” He was shocked, and he said,
as a President, he had expected me to protect the
member, and here I was asking him to make a complaint
against a member. I told him that “Sir, I am protecting
my members. By making a complaint and by punishing
this person, I will give the right message to the rest of
my profession. Whereas without that, it will be assumed
that the whole profession is of that type”. So that’s why I
am saying that we have to have zero tolerance. Anytime
something happens, you have to punish people who are
guilty because ultimately they are the custodians of a
brand. Chartered Accountancy is something which should
carry a lot of respect. The fact that you are a chartered
accountant must be synonymous with the fact that
you are a person of integrity. Now if that brand is
damaged, the whole profession gets damaged.

Unfortunately, our value systems have changed. You
admire a person who is very successful and how do you
measure success? You measure success by the fact that
he has got a large practice, or that is he making a lot of
money or that is he able to buy a large office. In our days,
we never looked at it in that fashion. We looked only at the
respect a person commanded, and the fact whether he
had a large practice or small practice didn’t matter.

(G) Related to this fact – Some people believe that
the distinction between business and professions,
such as the CA profession, has now blurred, and that
every profession has to function like a business to
grow and survive. What is your view?

See, I think there is some force in that. What has
happened is, that you have composite firms. You
have firms that do auditing, they do taxation, they do
management consultancy, they do advisory services etc.
So when that happens, naturally the people you take on
in the firm include non Chartered Accountants. In the old
days, you had one or two or a few of these people, now
a majority of the people are non Chartered Accountants.
They don’t have the same background, discipline etc.,-
they are result oriented. And when they are result
oriented, their whole value systems are different. Not that
they are dishonest, but for them getting work, making
larger profits, these all are more important. What is
happening, therefore, is that in these firms, the Chartered
Accountants are feeling the heat. Their performance
evaluation etc. is now being judged on the same lines
as the others. And therefore, there is a strong temptation
sometimes to cut corners. Even in the olden days, when you had people, in say a commercial organisation, you
had a chartered accountant and you had an MBA, and
the MBA seemed to be more progressive, more dynamic
and then the chartered accountant in order to survive, had
to become more dynamic – that sort of a thing. So there
is that risk, but ultimately this is what I feel – no individual
can use this as an excuse for rationalisation. The final test
for an individual is to be his own judge. If he believes that
what he is doing is ethical, his conduct is correct etc., then
it doesn’t matter whether the whole thing is becoming a
profession or not, or whether it is becoming a business.
Even within a business, you can act like a profession.

(R) About Work and Lifestyle that is changing these
days – Today in spite of technology, most people
around us are more stressed. There is more stress
and burnout amongst CAs. You worked during times
when there were no calculators, and everything had
to be done manually. What has changed?

The burnout is not because of technology, in fact,
technology helps you. This burnout is again because of
how you measure success. What do you want to achieve?
Contentment is a very difficult quality. Peer pressure is
there, and all of these situations lead to it.

[R] Having been a director of many companies,
what are your views on the overall quality of audit in
India and the independence of auditors?

Well, I have not had any occasion whereby I can say
that I have had any reservation about the quality of audit
or about the independence of the auditors. In fact, I would
say that the audit quality over the years is quite good and
it has improved. But I have been connected for auditing
with some big audits and big firms; I can’t really judge this
for smaller companies. But as I said, it’s only in some of
the financial institutions, where this feeling is there that
the reliance on the information which is provided, duly
audited, is not of the quality that one would have expected.

(G) With so many high-profile frauds becoming
public, auditors are being blamed. Is the criticism
justified? What are the real causes for this? You
mentioned about bank directors feeling a certain way.
Do you feel that the role of auditors needs to undergo
a change to match changing public expectations? Or
is a publicity initiative required to educate the public
(besides the Government) as to limitations of an
audit? What, in your opinion, is the long-term remedy
to meet this mismatch?

You see, it is very difficult at this stage to say, but
basically, you can have frauds which are facilitated by
a number of things. You can have a situation of a fraud
where there is collusion between the borrower and
the staff, or there is failure of the staff to perform their
functions. I don’t think external auditors can have a role
in this. You can have a problem, where the borrower and
the staff exploit the gap in the internal control system, and
that perhaps is an area where to some extent the external
auditor may have a responsibility.

And just to illustrate, this question of where you have
a letter of undertaking, which is not recorded in the
accounting system itself. Then, whether the system is
such that it should have been recorded – that system failure
is perhaps where the auditor has some responsibility.
You cannot expect an auditor to look at the failure of the
internal control regulation, or internal control procedures.
That the internal auditor has to do so. I would say thisto
the extent to which there is a fraud in the nature of
the falsification of financial information, I think the auditor
needs to be held responsible.

(R) Self-regulation is seen as a conflict of interest.
Why so? There are so many places where there is
similar apparent conflict of interest – legislators
passing laws to approve their own emoluments, a
tax officer becoming an appellate officer, or a lawyerfriendly
with fellow lawyers becoming a judge before
whom these fellow lawyers now appear. Do you
agree that self-regulation is a conflict of interest, or
that it has failed? Recently we have seen quite a bit
happening – how accountants can self-regulate is
being questioned.

I believe that all professions should have selfregulation,
but I also believe that there is no harm
in having an oversight. But it’s a question of what is
oversight. Oversight is not regulation – that is the big
difference which you have to make. The oversight is to
ensure that the system of self-regulation is functioning,
but the oversight does not take over the functions of the
self-regulator.

Having said that, it is also the responsibility of the selfregulator
to be able to demonstrate that the self-regulation
is effective, that you have sufficient independence, that
there are penalties for failures, and so on. If again, I may
give an example.You look at the Microfinance industry.
The Microfinance industry was in a shambles. Then,
when we made that report, we had made a number of
regulations about what a Microfinance company could
do, could not do, etc. And, at the Reserve Bank, I was
asked, who is going to monitor all this, and I said: “Our
recommendation is that you have a self-regulatory body.
Because the whole idea is that a regulator does not have
the resources to enforce regulation”.

Years ago, when I was asked to chair the committee on
the offer documents by SEBI or it’s predecessor. Before
every prospectus was to be cleared, it was examined by
the department. And it took 2 months to clear that. Then
I said that it was ridiculous, why should you do that? You
appoint an intermediary. The merchant banker is your
intermediary. He has to ensure that all the regulations
are complied with. And then you enforce discipline on
the Merchant Banker. If the Merchant Banker does
not function, you deregister him. Now, the threat of
deregistration is sufficient to ensure that he does his job.
Similarly, SEBI doesn’t regulate, the stock exchange is
the regulator. So, there also, you may have an oversight
body, but there must be a self-regulatory body, like the
Institute, which must ensure that the regulations are
followed.

(R) In this context, do you feel that NFRA, the way
it is constituted now, in its present form justified?
Given the qualifications required of NFRA members,
do you feel that they would be able to understand the
audit process, constraints and judgement calls taken
by an auditor?

I have not studied it in detail, but my general feeling is
that the oversight body has to see the functioning of the
self-regulator, but not take over its work.

(R): Right now they have powers to investigate,
they can enforce AS and SA and they can directly
reach auditors.

I feel, that perhaps is too much. That is not the correct
approach. But then you have to demonstrate that you
are doing your job adequately. Otherwise, the rationale
of doing this is because they feel it’s not being done
adequately.

[R] What is your view on rotation for public
interest entities, particularly given the international
experience showing that rotation leads to audit
concentration?

I have always been against rotation of audits, to be
quite honest. And I think the rationale for rotation, that
I pointed out repeatedly is, that if you imposed rotation,
you will be in fact destroying the second level firms. What
has happened is that a number of the companies grow,
and as they grow, they still want to retain the auditors with
whom they have grown. But when you impose rotation,
you give them an opportunity to change their auditor,
and when they have to change, they will go to a big 4
firm. So, in a sense, a lot of the work which is there with
the second level firms will flow into the big 4 firms. And I
don’t think, quite honestly, that rotation is the answer to
lack of independence. Whereas, the answer to that is the
restriction on exposure.

I mean, if you said, for example, that you cannot have
more than X percent of your work from a single group.
Because they say, at that level what will happen is, as
I said, that if I gave up 10% of my work I could afford to
give it up, but if it was 30% of my work, I would have had
second thoughts of giving up that work. So you must not
allow firms to get into the situation where they are overall
dependent on a particular client or a particular group.

(G) For that do you feel that the concept of joint
audit should be introduced in India, to encourage
the growth of medium-sized firms, and reduce audit
concentration?

I think quite honestly the whole motivation for joint audit
is wrong. You cannot impose regulation on audit to help
yourself. This is what has created a strong dislike of the
profession, especially in the case of banks. Every time,
our Institute has gone to the Reserve Bank of India to
say, give us branch audits, because if we don’t do branch
audits, then what will our members do, it has destroyed
it’s credibility.

Is it the responsibility of the client to provide work or
is it the responsibility of the profession to offer to the
client the service which the client needs? If you tell me that the joint audit is there and it helps because the
client is not dependent on a single auditor, and it helps
independence, I would agree with that view. But then, the
client must be free to appoint anyone as a joint auditor.
But, as soon as you go and tell the client that the law says
that you must appoint a joint auditor because it will help the
smaller auditor to get work, then that’s completely wrong.
And when the profession adopts or the Institute adopts
such an attitude, then you are creating a big damage to
your image.

(R) Sir, how do you view SEBI’s recent order against
Price Waterhouse? SEBI has sought to debar not just
a partner or two or not even just the firm involved, but
it has debarred the whole group. What is your view
on this? Secondly, SEBI also brought out a lower test
of ‘preponderance of probability’ as a sufficient test
in this specific matter instead of applying the test of
‘beyond reasonable doubt’.

I don’t know the details of this ‘preponderance of
probability’ which you are talking about, but I do feel that,
when you take action against a firm, and you take action
against an individual, the action against the individual
should be on the ground that the punishment for an
individual should be to debar him from doing the work
for a period of time or for all time, depending upon the
severity of his offence. The action against the firm should
only be a financial penalty, unless you can show that the
firm itself directed the individual, and the individual was
acting as an agent of the firm for the purpose of doing this.
That is the whole approach.

(R) Recently the ICAI made certain changes,
bringing the firm in, or the amendments in the
Companies Act, 2013 relating to the liability of the firm
– all of this is becoming more serious for auditors.

I feel it is virtually impossible, I mean it’s like saying
that every time the officer of the company commits an
offence, you can stop the company from doing business,
you can’t do this.

[R] Also Sir, what is your view on the Supreme
Court observations and directions on the operation of
Multinational Accounting Firms (MAF) in India? SC has
directed the Institute to take action against MAF who
are acting as surrogates of foreign accounting firms.

What is meant by surrogates?

[R] ICAI in their reports stated that some of firms
operating in India are in violation of foreign investment
norms. Accounting and auditing service is blocked
under GATS.

[G] Some firms have received subsidy from foreign
entities to acquire Indian firms – example was Price
Waterhouse – other example – there is a private
limited company where there is foreign investment,
you have Indian firm – Indian firm is regulated – but
office and staff are same – same visiting card, sharing
the same office, – on paper they are separate, but in
reality, acting as one entity.

No, I personally believe that if you have an Indian firm
and it is a part of the international membership, there is
no harm in a network arrangement, because it is like all
enterprises you work everywhere – work in cooperation,
collaboration, you get synergy out of this. If you do work
here for a foreign company, then you should do it on arm’s
length basis, then you should charge for it. But if a foreign
company or firm does something here indirectly, what it
cannot do directly, then obviously there is an offence.

(G) The Institute has issued letters to all firms who
are members of associations, not even networks.
Firms other than Big 4 – Indian firms who are members
of an association, have also been issued a letter.

I don’t see any difference in them. Having an
arrangement with an international firm, which gives
you access to technology, is no different from having a
company having a technical collaboration agreement with
someone. I do not see any particular reason if you are
paying a royalty to an international firm for using their
name. Then again, you have to see that there is a royalty
agreement which is in place. But if that International firm
has a network here, and you are doing that work on their
behalf, then it is a different situation. So you have to go
on the facts of each case – you cannot generalise the
situation.

(G) Indian Firms expanding overseas: Why has
the Indian accountancy profession not been able to
go global? What do you see as the biggest stumbling
blocks to Indian firms going global?

The question is like this – an Indian firm expanding
overseas would start off with the proposition that you are
an Indian group which is operating outside.
If you have, let’s say, a large number of Indian client
companies / groups having foreign subsidiaries, then
clearly you may need local firms to handle that work.
Suppose, for argument’s sake, you have a company, which
has a subsidiary in Spain. Now, you can either have a local
accountant there in Spain, or if you have a large number of
clients in Spain, you can have a firm there, which has an
affiliation with you, and that firm can do that work for you.

(G) The problem when you talk about collaboration
here is, the Institute does not allow sharing of fees
with non chartered accountants – typically, the ICAI
looks at it this way – a payment of fees to the foreign
firms is regarded as a violation of code of conduct.

I think, there is nothing which prevents you from
subcontracting work to a foreign firm. Sharing of fees
and paying for services are two entirely different things.
Sharing of fees means, the top line you are sharing.
Example, if you get work done from a solicitors firm, if
you get work done from a lawyer – why should you not get
work done from a chartered accountant or an accountant
there. If you are making payment for services rendered,
that is not sharing of fees.

[R] Constraints on Advertisement – Do you feel
that the constraints on advertisement and publicity
on Indian CA firms need to undergo a change, and
to what extent, especially when increasing number
of services can also be rendered by non-CA firms
– like GST or tax work or internal audit – who have
no restriction on advertisement? Do you feel that
such regulations in a competitive environment are
detrimental to the growth of the profession?

I think, perhaps the answer to that is, that you should
have a separate firm doing non-audit services. If you
have a separate firm which is doing non audit services,
then that firm because it is competing with non chartered
accountants should be allowed to advertise, but if you
have the same firm, then the question is that preferably
the names should be different – you cannot have indirectly,
a brand extension.

[R]: But then the ownership…

The ownership can remain the same. Same people
can be partners in both the firms.

[R] The role of ICAI has already been curtailed
significantly – disciplinary action and standard
setting going out. It is today left with education and
registration of members. What is happening and how
do you see its role going forward – will it remain with
these two functions?

See, in fact you have to go back, I don’t know enough
about the present situation. The Institute started as a
regulatory body and an examination body, that is how it
started. Then it developed, it setup a Coaching Board. So,
the core function of the Institute is still there.

Now, the question which arises is the standard setting.
Everywhere in the world, the standard setter is a separate
body. Now, there is no harm in the Institute being an
Accounting Standards Board, but the difficulty, which I
had always pointed out, was we set up an Accounting
Standards Board, and its composition was of the Council
Members plus a few outsiders. The authority of the
Accounting Standards Board was subservient to the
authority of the Council; the standards were issued not
by the Accounting Standards Board, but by the Council.
Now the question is, does the membership of the Council
have the competence to do this? The difficulty is that we
were not willing to shed power and responsibility. If you
had created an Accounting Standards Board, where you
have the right to appoint members for the Accounting
Standards Board, but with a composition which said that
majority of the members would be from outside, that the
chairman of Accounting Standards Board would be an
outside person, that the Board had the authority to issue
standards, and the Council was only concerned with the
procedural part and not the technical part, then you can
have it within; otherwise you can have it outside.That’s
your standard setting function. What happened with the
disciplinary action? The disciplinary action was, and
this again I had been pointing out for a long time; you
had to make a distinction between normal complaints
which were received and information received from the
regulatory bodies.

I will tell you in practice, the stand that we were taking,
in the Reserve Bank. We had a Board of Financial
Supervision, then there was a sub-committee of the
Board, which was called the Audit Committee. Now it’s no longer there. In my time, it was there. The function
of that Audit Committee really was to examine, whether
there was any lapse on the part of the auditor. When an
inspection report brought out that there was something
wrong, and that the NPAs were not properly disclosed,
we would insist on first sending a notice to the auditor, to
see what his explanation was. Then, as an independent
body, we would consider this. And if we were convinced
that there had been a failure, then we would go ahead
and make a complaint to the Institute or inform the
Institute. What does the Institute say- it said No! You
have to make a formal complaint, and if you are to make
a formal complaint, then your people must come and
give evidence, and you must do all that is required of a
complainant. Now, no regulator is willing to do that. After
we made a reference, no action was taken for years. So
what did we do finally? We decided that if we were prima
facie satisfied, we would take action on our own. We
don’t have to wait for the Institute. Now, this was when
the Institute didn’t make a distinction initially between the
matters of public interest, matters of internal obligation,
the independence of the disciplinary committee and its
functioning. These are not some things which happened
today or tomorrow. They happened over a period, and a
bad image was created. As a result of that, you gave an
excuse to the government to take away those functions.
Now you can’t blame the government for doing this.

(R) It is a result of things that have happened over
the years.

Yes.

(R) Do you feel at some point, we should have,
like in some countries, they have multiple Institutes,
meaning there is no one body that will give the
license.

There is only licensing, like that of the Board of Trade
in England, because there are separate Institutes which
exist. I don’t think that would probably come here.

(G): One aspect about image of Chartered
Accountants, which you mentioned. Amongst banks,
the image is quite negative. What do you think needs
to be done now? How does one arrest this problem
going forward? One is, of course zero tolerance
policy you mentioned. What needs to be done now
going forward?

I think it is a long drawn out process, but you have
to build up confidence. The important thing is that
for a profession, what you need, is not the brilliance
of the few, but the competence of the many. You are
holding out that as a member of the profession, your
members have a certain minimum level of competence.
You have to ensure that the competence is there; you
have to ensure that the work is taken by people who have
the ability to discharge that work. But if you are acting
like a politician, where you are trying to please your
voters and get more work for people without ensuring it’s
need or the competence, you are damaging the image of
the profession.

shailesh.kwebmaker

Needle Of Allegiance

July 2018 is a Special issue of the Journal.
However, this issue is a doubly special one as the BCAJ is in its Golden
Jubilee year. The issue is dedicated to Accountancy and Audit, which form the
core of our profession. I hope you enjoy the eight pieces of Golden Contents in the following pages.

Exclusivity and Trust

A profession normally has certain
exclusivity – legal and/or perceived. Such exclusivity commands an obligation
of trust. Competence and credibility herald this exclusivity. A Chartered Accountant’s
exclusivity generally lies in his capability to:

a. understand substance over form,

b. decipher and analyse the evidence
underlying such substance, and

c. finally arrive at a judgement over
financial reporting

The exclusive license given to CAs to attest¹
is a result of a lifelong commitment to a skill set and ethical orientation.
Skill and competence without values and ethics fail miserably. The exclusivity
to ‘attest’ financial reporting of millions of entities and billions in value
casts an obligation of trust. The numbers derive their full value from the
signature of an auditor. The IFAC code of ethics (2018) says it in this opening
line: “The distinguishing mark of the accountancy profession is its
acceptance of the responsibility to act in the public interest”. This
is the direction of an accountant’s compass, his True North.

Turbulence

The accountancy profession is undergoing
turbulence. Some of it is of its own making and some thrust upon it.
Expectation chasm, reporting frequency, measures of business performance, the
pace of change, complexity, corporate culture (unspoken behaviours, mindsets
and social patterns), thinning lines between evidence and substance, are some
challenges and even threats to the audit profession.

While accounting is more or less taken over
by technology, perhaps audit too will soon be done 100% and in real time by
machines. Human intervention in future could be close to nought.

Recent news about auditor resignations –
mid-term or days before results, SEBI Order banning a firm for wrongdoings of
partners, Audit Report changes, SEBI seeking powers on auditors, ministers
blaming auditors before investigations, putting auditors behind bars,overnight
activation of NFRA – these are all worrying trends.

Role vs. Expectation

As an intermediate student, I was taught
that an auditor was like a watchdog (meant to bark when they saw something
suspicious) and was not meant to be a bloodhound (seek the suspicious). Twenty
years later, there are several watchdogs watching the auditors, and some even
hounding them. The expectation from an auditor today is akin to a sniffer dog –
to look out for dangerous, suspicious, and explosive content that could
potentially endanger the auditee. Whether one agrees to the above re-characterization or not, there is an underlying
indication, however implicit it may be, to a dog’s life!

Auditors are blamed by some (who should be
forgiven for they have not learnt sampling and materiality) driven by rhetoric
and not reasoning, facts and objectivity. Nevertheless, over seven decades,
auditors have cumulatively endured in doing a commendable job in preventing
businesses from crossing the line.

Global Macros

I do not know of the statistics in India
post rotation, but the global audit scene is alarming: Big becoming bigger, to
an extent of ‘too big to fail’. This often drags others into failure. When a
part of the system begins to feel it is ‘the system’, it gives an impression of
infallibility and indispensability. Diversity and distribution mitigate the
risk for everyone and not the other way round. In spite of regulations and
regulators, armed with teeth and paws, corporate failures continue unabated.

[1] To bear out, to confirm, a declaration in support of a fact, a
testimony, to prove…

The recent
Carillion failure as reported widely in the UK is a case in point: A top audit
firm gave a clean bill of health for £ 29 m fees. Another firm ran the internal
audit and could not report ‘terminal failings’ or ‘too readily ignored them’.
Another firm led the restructuring of the failing giant for £ 13 m in fees
between July 2017 and January 2018 and took the last cheque of £ 2.5 m, a day
before the collapse. Directors prioritised senior executive bonus payouts and
dividends (before pension payments) as the firm neared collapse. FRC, the
regulator, did nothing, except commending the company for good accounting
practices months before it imploded. Pensioners’ £ 2.6 b will have to take a
‘haircut’ of some £ 900 m. SME Suppliers will wait for their £ 2 b of bills and
were informed that they could expect 1/100 of their outstanding. 19,000 plus in
the UK and 43,000 worldwide employees (and their families) face a question
mark. UK Parliamentary report said: ‘edifice of corporate governance is rotten
to the core’. A Labour MP in his report said “(the collapse) once again
highlighted the catastrophic failure and inadequacy of our regulatory
system”. The external audit firm was described as ‘complicit’ in the
company’s ‘questionable’ accounting practices and FRC as ‘timid’. The
liquidator firm (another top accounting firm) reported: ‘Unfortunately, as a
result of the liquidation appointments, there is no prospect of any return to
shareholders’. Lawmakers called four auditors involved as a ‘cosy club
incapable of providing the degree of independent challenge needed’. It all
sounds like a classic plot of a typical corporate and accounting failure. The
point is: auditors’ impact on the economy and society, and their sniffing,
barking and challenging, makes a big difference.

Root causes

The problems around audit and auditors are
multi-dimensional and systemic. The major part of the problems revolves around
the following:

a. Shareholder centric and shareholder wealth
maximisation business model

b. Definition of corporate performance and
performance linked executive pay

c. Regulations and Regulatory maze

d. Conflict of interest in case
of audit firms

I wish to leave you
with questions about audit and auditors that I feel require a fresh look:

1. Are auditors commercial entities like other
service providers or are they distinct?

2. Does client / shareholder / majority
shareholder interest supersede public interest as in the present model?

3. Can a ‘reasonable assurance’ be expected to
give ‘insurance’ on components of financial statements?

4. Should ‘scepticism’ be replaced by ‘suspicion’
in the audit lingo?

5. What is the real incentive that auditors have
to stand up and speak up to their clients?

6. Can those in audit practice claim to be
experts in every aspect of company business and provide services or have other
lucrative business relationship with audit clients?

7. How many times can a firm ‘settle’ with
regulators, shareholders, creditors? Does monetary payment wipe the slate
clean?

8. Can the same set of people, who design and
sell tax avoidance schemes with disregard to laws, be entrusted with audit in
public interest?

I was at an
academic seminar in Lucknow recently, where all others, except me, were from
academia – their names had the prefix ‘Dr’. On the last day, a professor from
Kashmir asked me if I considered myself a capitalist. He clearly saw me to be
one – a spoke in the wheel, he said. This was contrary to what I thought of my
work to be as an auditor – that I was protecting the larger public good.
Perhaps, many people do not see the audit profession that way any longer. As a
profession, we have to constantly check our compass and see if it continues to
point to its True North. Every professional will have to judge her needle of
allegiance – to ensure it has not swerved to the magnetic north – but it
continues to point towards the True North of public interest!

Raman Jokhakar

Editor

shailesh.kwebmaker

5 Section 133A – Returned income as against declared income during survey accepted.

5. Amod Shivlal Shah vs. ACIT

Members: G.S. Pannu (A. M.) and Pawan Singh (J. M.)

ITA No.: 795/MUM/2015

A.Y.: 2006-07

Dated: 23^rd February, 2018

Counsel for Assessee /
Revenue: Dr. K. Shivaram & Rahul Hakani / Rajesh Kumar Yadav

Section
133A – Returned income as against declared income during survey accepted.

FACTS

The
assessee was engaged in carrying out business activity as a builder and
developer. On 12.03.2007, a survey action u/s. 133A was carried out at the
business premises of the assessee. At the time of survey, it was noted that the
return of income for the assessment year under consideration as well as for
Assessment Years 2004-05 and 2005-06 were not filed. It was found that the
development work of residential building situated at Bandra, Mumbai was
complete in view of the Occupancy Certificate issued by the Municipal
Corporation on 31.10.2005. In the statement recorded, the assessee declared the
income of Rs. 1 crore based on the work-in-progress declared for Assessment
Year 2003-04 and in the answer at the time of survey, the working thereof was
also enumerated.

Subsequently,
the assessee filed a return of income for assessment year 2006-07 on 29.03.2007
declaring an income of Rs.25.36 lakh, which was accompanied by the audited
Balance-sheet and the Profit & Loss Account. The response of the assessee was that
subsequent to the survey, it compiled its accounts, which were got audited
and   it
showed    that
the    estimation     made
at Rs.1 crore was incorrect.
During the course of assessment, assessee also furnished the reconciliation
between income declared during survey and the returned income. In sum and substance, the stand of the
assessee was that the income declared at the time of survey was a rough
estimate, whereas the return of income was on the basis of audited accounts
compiled with reference to the corresponding evidences, material, etc.

The
AO did not accept the explanation furnished as according to him, the
declaration made at the time of survey was binding on the assessee and the same
could not be retracted. The CIT(A) also affirmed the addition made by the
AO.

Before
the Tribunal, the revenue supported the orders of the lower authorities and
relied upon the decision of the Mumbai Tribunal in the case of Hiralal
Maganlal and Co. vs. DCIT, (2005) 97 TTJ Mum 377.

HELD

The
Tribunal noted that the income declared during the survey was entirely based on
the estimation of the value of the WIP as appearing on 31.03.2003 and the
expenses estimated for Assessment Years 2004-05 to 2006-07. Thus, the income offered at the time of
survey was on an estimate basis. The
Tribunal also noted that the assessee had explained the basis on which the
income was drawn-up at the time of filing of return and the reasons for the
difference between the income offered at the time of survey and that declared
in the return of income.

To
a question, whether the AO was justified in making the addition merely for the
reason that assessee had offered a higher amount of income at the time of
survey – the Tribunal relied to the decision of the Supreme Court in the case
of Pullangode Rubber Produce Co. Ltd. vs. State of Kerala & Anr. (91 ITR
18) where the court had observed that the admission made on an anterior
date, which was not based on correct state of facts, was not conclusive to hold
the issue against the assessee.

According
to the Tribunal, the stand of the assessee was much more convincing since the
original declaration itself was not based on any books of account or supporting
documents, but was merely an estimate, whereas the return of income had been
filed on the basis of audited accounts and the principal areas of differences,
namely, the amount of sale proceeds and the expenditure were duly supported by
relevant documents.

As
regards reliance placed by the revenue on the decision of the Tribunal in the
case of Hiralal Maganlal and Co., the Tribunal noted that the said decision was
dealing with a statement recorded u/s. 132(4) of the Act at the time of search,
whereas the present case was dealing with a statement recorded u/s. 133A of the
Act at the time of survey. The Tribunal
pointed out that the Supreme Court in the case of CIT vs. S. Khader Khan
Sons, 352 ITR 480 had upheld the judgment of the Madras High Court in the
case reported in 300 ITR 157, wherein the difference between sections 133A and
132(4) of the Act was noted and it was held that the statement u/s. 133A of the
Act would not have any evidentiary value. The Tribunal also referred to the
CBDT Circular no. 286/2/2003 (Inv.) II dated 10.03.2003, wherein it has been
observed that the assessments ought not to be based merely on the confession
obtained at the time of search and seizure and survey operations, but should be
based on the evidences/material gathered during the course of search/survey
operations or thereafter, while framing the relevant assessments.

Accordingly,
the Tribunal set-aside the order of the CIT(A) and directed the AO to delete
the addition.

shailesh.kwebmaker

Section 115JB – For computing book profits u/s. 115JB, no adjustment can be made in respect of depreciation provided at a rate higher than that prescribed under Schedule XIV of Companies Act provided the assessee shows how and on what basis the specified period and the higher rate of depreciation was arrived at.

9. [2018] 93 taxmann.com 215
(Chennai)

Indus Finance Corporation Ltd
vs. DCIT

ITA No. : 1348/Chennai/2017

A.Y.: 2012-13

Dated: 03^rd May,
2018

Section 115JB – For computing book profits u/s. 115JB, no
adjustment can be made in respect of depreciation provided at a rate higher
than that prescribed under Schedule XIV of Companies Act provided the assessee
shows how and on what basis the specified period and the higher rate of
depreciation was arrived at.

FACTS

The
assessee, engaged in the business of providing non-banking financial services,
charged depreciation on wind mills at 80% as against 5.28% prescribed under
Schedule XIV of the Companies Act, 1956. The notes to the accounts mentioned
that depreciation on wind mill has been provided at the rates prescribed by the
Income-tax Act. For the purposes of computing book profits u/s. 115JB of the Act, the Assessing Officer (AO) sought to disallow the amount
of depreciation in excess of the amount computed by applying the rate
prescribed by Schedule XIV of the Companies Act, 1956. In the course of
assessment proceedings, it was submitted by the assessee that the rate of
depreciation given in Schedule XIV of the Companies Act was only the minimum
rate that had to be charged and the assessee was at a liberty to claim excess
depreciation when situation warranted. The AO, not being satisfied with the
contention of the assessee computed book profits by allowing depreciation on windmills
at the rate prescribed in Schedule XIV of the Companies Act, 1956.

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

Aggrieved,
the assessee preferred an appeal to the Tribunal where on behalf of the assessee
it was contended that the wind mills had not performed to the level expected
and therefore assessee was constrained to charge depreciation, above the rate
prescribed under Companies Act and reliance was placed on the decision of
co-ordinate bench in the case of DCIT vs. Indowind Energy Ltd, (ITA
No.1854/2015, dated 25.10.2016).

HELD

The
Tribunal noted that the assessee can, at its option, choose to provide
depreciation at a rate higher than that prescribed under Schedule of the
Companies Act. However, in doing so, the
assessee must justify that the depreciation so computed, is in accordance with
section 205(2)(b) of the Companies Act which provides that depreciation can be
provided by dividing ninety-five per cent of the original cost thereof to the
company by the specified period in respect of such asset. It observed that
except for the note in the annual accounts, nothing was brought on record to
show how and on what basis the specified period and the higher rate of
depreciation was arrived by the assessee. In absence of justification by the
assessee on the basis of depreciation arrived by it, the Tribunal held that,
for the purposes of computing book profits u/s. 115JB, lower authorities were
justified in allowing depreciation based on the rates prescribed in the
Schedule. The Tribunal distinguished the decision relied upon by the assessee
by holding that the said decision was based on realistic facts.

shailesh.kwebmaker

Section 37(1) – Premium paid on keyman insurance policy, under which in the event of death of the directors assured sum had to be received by the assessee, is allowable expenditure u/s. 37(1) of the Act.

8. [2018] 93 taxmann.com 188
(Mumbai)

Arcadia Share & Stock
Brokers (P.) Ltd. vs. ACIT

ITA Nos. : 5854 &
5855/Mum/2016

A.Ys.: 2011-12 &
2012-13

Dated: 25^thApril,
2018

Section
37(1) – Premium paid on keyman insurance policy, under which in the event of
death of the directors assured sum had to be received by the assessee, is
allowable expenditure u/s. 37(1) of the Act.

FACTS

The
assessee, a private limited company, engaged in the business of share and stock
broking, claimed deduction on account of premium paid towards keyman insurance
policy taken in the name of two of its directors. In course of assessment
proceedings, the Assessing Officer (AO) called upon the assessee to furnish
necessary details. After verifying the details furnished by the assessee and
referring to the characteristic of keyman insurance, the AO called upon the
assessee to justify the deduction claimed. The assessment order stated that the
assessee submitted some literatures of keyman insurance policy, but did not
furnish any document to prove that the policies taken are keyman insurance
policy. The AO held the premium paid to be on life insurance policy and not on
keyman insurance policy. Accordingly, he held that the premium paid by the
assessee cannot be allowed as business expenditure and disallowed the amount of
premia paid.

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

Aggrieved,
the assessee preferred an appeal to the Tribunal.

HELD

The
Tribunal noted that the assessee had claimed deduction of the premium paid in
respect of such Insurance policy in assessment years 2005-06, 2006-07 and
2007-08. While completing assessments for these years
u/s. 143(3) of the Act, the AO after examining assessee’s claim, allowed
deduction in respect of premium paid. The Tribunal held that when it is a fact
on record that the Insurance policies are continuing from the year 2004 and in
the preceding assessment years assessee’s claim of deduction in respect of
premium paid have been allowed by the AO in scrutiny assessments, in the
absence of any material change in facts the deduction claimed in respect of
premium paid cannot be disallowed in the impugned assessment year, as the rule
of consistency must be applied.

It
observed that except stating that in the preceding assessment years the AO has
not properly examined the issue no material change was pointed which could have
influenced the AO to take a different view in the impugned assessment year
departing from the view taken in the preceding assessment years.

The
Tribunal noted that the keyman insurance policies were taken in the name of
directors in pursuance to resolution dated 24^th February 2004 of
board of directors and the sum assured under the insurance policy as per the
terms and conditions will come back to the assessee on the death of policy
holders. Accordingly, the Tribunal allowed assessee’s claim of deduction of
premium paid in both the assessment years.

The appeals filed by
the assessee were allowed.

shailesh.kwebmaker

Section 254 (2) : Appellate Tribunal – Rectification of mistakes – Issue is debatable in view of contradictory judgements–order cannot be rectified

12. Procter & Gamble Home
Products Pvt. Ltd. vs. ITAT & Others. [Writ Petition no. 2738 of 2017 dated
: 09^th March, 2018 (Bombay High Court)].

[Procter & Gamble Home
Products Pvt. Ltd. vs. DCIT [ MA order
dt. 28/7/2017 (reversed) ; arising out of ITA No. 3531/Mum/2014; Bench : K ;
AY: Dated 06^thJune, 2016 ;
Mum. ITAT ]]

Section 254 (2) : Appellate
Tribunal – Rectification of mistakes – Issue is debatable in view of
contradictory judgements–order cannot be rectified

The
assessee had entered into an agreement with its sister concern for sharing of
certain common facilities and not for renting of the premises in favour of the
sister concern. However, the AO treated the amount received by assessee as
income from house property. The provision in the agreement for charge at Rs.90
per sq.ft. for the built-up area occupied from time to time was, in terms of the
understanding of the party, not implemented. Instead, as intended by the
parties all along, the cost of common facilities shared by the companies was
pooled and borne by the parties in the ratio of respective net sales. In terms
of this arrangement, the assessee in fact had paid Rs.7.63 crore to the said
sister concern such amount being net of the recoveries from such sister concern
in respect of its share of common expenses, full break-up of which was
furnished by the assessee during the assessment proceedings. Therefore, there
was no scope for arriving at any other artificial rent or any other amount
received/receivable by the assessee under the agreement. The impugned amount
considered taxable in the hands of the assessee has not been considered by the A.O
as an allowable expense in the hands of the sister concern in its assessment,
thereby resulting into double taxation of the said amount.

The Tribunal allowed the
Revenue appeal u/s. 254(1) of the Act by
holding that the amount received by it as rent/ compensation from its sister
concern for utilisation of a part of its premises is to be classified as ‘income
from other sources‘. This was after negative the alternate contention of
the assessee that rent/ compensation should be classifiable under the head ‘business
income‘ as also Revenue’s contention that it is classifiable under the head
‘income from the house property‘. The Tribunal did by following the
order of its coordinate bench (on identical facts) in the case of M/s. Procter
& Gamble Hygiene & Healthcare Ltd., (sister concern) for the Assessment
Years 1996-97 to 2000-01. In all the aforesaid cases, on identical facts it has
been held that the rent/compensation received has to be taxed under the head ‘income
from other sources’.

The Revenue had filed
Miscellaneous Application, seeking to rectify the order dated 6^thJune,
2016. This essentially on the following grounds:(a) the order dated 6^thJune,
2016 was passed without considering the written submission which were filed on
behalf of the Revenue; and (b) the order dated 6^th June, 2016 had
erred in relying upon the orders
passed in the sister concern case
for AY: 1996-97 to 2000-01 to allow the appeal.

This was in view of the fact
that all of them proceeded on a fundamentally wrong basis namely – that the
issue stands concluded by an order passed by the Tribunal for AY: 1995-96 in
respect of the sister concern. This was not so as in fact, as it did not
consider the claim of the Revenue that rent/ compensation is chargeable to tax
under the head ‘income from the house property‘ while holding it to the
taxable as ‘income from other sources‘.

The MA order of the Tribunal dated 28^thJuly,
2017 does recall its order dated 6^th June, 2016 only on the second
ground that the reliance by the Tribunal on its earlier order in respect of the
sister concern was not correct. As those orders in turn it relied upon an
earlier order for A.Y 1995-96 of the Tribunal which did not have any occasion
to deal with submission regarding the classification of the rent/compensation under the head ‘income
from house property’.

Being aggrieved, the assessee
filed an Writ petition to the High Court challenging the order passed in MA .
The High Court observed that the order of the Tribunal dated 6^thJune,
2016 while allowing Petitioner’s appeal, had relied upon the sister concern’s
order passed by the Tribunal in respect of A.Y 1996-97 to 2000-01. Admittedly,
all the orders of the Petitioner’s sister concern relied upon by the order
dated 6th June, 2016 had an issue with regard to the classification of
rent/compensation being received on letting of property under the head ‘income
from the house property’ or ‘income from other sources’. Therefore, it
followed the same. The order of the Tribunal in respect of its sister concern
for A.Y. 1995-96 was also before the Tribunal while passing the order dated 6^thJune, 2016. Therefore, the rectification application of the Revenue calls
upon the Court to reappreciate its understanding of the order passed by the
Tribunal in the case of its sister concern for A.Y 1996-97 to 2000-01. This was
on the ground that the earlier orders did not correctly understand/ interpret the
order passed by the Tribunal in respect of A.Y 1995-96 in the case of
Petitioner’s sister concern. This itself would in effect amount to Review.
Therefore, outside the scope of rectification. Besides, it seeks to sit in
appeal over order passed by its Coordinate Bench for Assessment Years 1996-97
to 2000-01. This was not permissible. Moreover, the Revenue has filed appeals
in the sister concern case for the A.Y. 1996-97 to 2000-01 u/s. 260A of the Act
to this Court. The question raised therein is on the issue of appropriate
classification of the rent/ compensation under the head ‘income from the
other sources‘ or under the head ‘income from the house property‘.
The aforesaid appeals have been admitted and are awaiting consideration for
final disposal. Till such time, as the orders of the Tribunal of its Coordinate
Bench in respect of the A.Y 1996-97 to 2000-01 are set aside or are stayed
pending the final disposal, its ratio would, prima facie, continue to be
binding. Therefore, even if the Revenue seek to contend to the contrary it
would be a debatable issue. This cannot be a subject matter of rectification.
Therefore, MA order dated 28^th July, 2017 of the Tribunal to the
extent it allowed the Revenue’s application for rectification of the order
dated 6th June, 2016 of the Tribunal was set aside. Accordingly, Petition was
allowed.

shailesh.kwebmaker

Section 43A : Foreign exchange fluctuation : on loan liability being notional as no actual payment was made – section 43A of the Act as amended w.e.f. 1st April, 2003 – would not require any adjustment in the cost of the fixed assets.

11. Pr.CIT vs. Spicer India Ltd. [ Income tax Appeal no.
1129 of 2015 dated: 18^th April, 2018 (Bombay High Court)]. [Affirmed DCIT vs. Spicer India Ltd. [ITA No.
1886/PN/2013; AY: 2003-04; Dated: 20^thOctober, 2014 ; Pune. ITAT]

Section
43A : Foreign exchange fluctuation : on loan liability being notional as no
actual payment was made – section 43A of
the Act as amended w.e.f. 1^st April, 2003 – would not require any
adjustment in the cost of the fixed assets.

The assessee is engaged in
manufacturing of axles and propeller shafts and assemblies. On 31^st
March, 2006, the assessment was completed u/s. 143(3) of the Act for the
A.Y.2003-04. Thereafter, the A.O reopened the assessment for the subject AY on
the ground that gain on foreign exchange conversion of loan liabilities, would
require corresponding change in the value of the fixed assets. This not having
been done, has resulted in the assessee claiming excess depreciation.

Consequent to the above
reopening, the A.O passed an order u/s.
143(3) of the Act r.w.s 147 of the Act, adding the excess depreciation
which has been disallowed to the assessee’s income.

Being aggrieved, the assessee
filed an appeal to the CIT(A). The CIT(A)
observed that section 43A of the Act deals with the increase or
reduction in the liability of the assessee as expressed in India currency on
account of changes in the rate of exchange of currency. Section 43A of the Act
has been amended w.e.f. 01.04.2013 i.e. from A.Y. 2003-04 to prescribe that the
adjustment of foreign currency fluctuations in respect of foreign currency
borrowings taken for acquiring fixed assets is to be made to the cost or the
WDV of fixed assets only at the time of making payment i.e. on cash basis and
not on accrual basis for the purposes of income tax. In the present case, the
impugned gain on foreign currency fluctuations is a notional gain in as much as
it has resulted on account of translation of foreign loan liability at the end
of the year on accrual basis.

The foreign exchange gain is
not as a result of actual payment made by the assessee. Therefore, the
aforesaid gain cannot be adjusted towards the cost of the fixed assets.
Accordingly, there is no justification for the A.O to have reduced the
depreciation allowance corresponding to the aforesaid exchange gains.

The Revenue being aggrieved, filed an appeal before the Tribunal.
The Tribunal by the dismissed the Revenue’s appeal by inter alia holding
on merits that in view of amended section 43A of the Act, the gain / loss in
the foreign exchange fluctuation on loan liability being notional as no actual
payment was made, section 43A of the Act as amended w.e.f. 1^st
April, 2003 would not require any adjustment in the cost of the fixed assets.
This is so as no actual payment has been made by the assessee during the
previous year relevant to the subject AY. Further, places reliance upon the
decision in Commissioner of Income Tax vs. Woodward Governor India P. India,
(2009) 312 ITR 254.

Being aggrieved, the Revenue
filed an appeal to the High Court. The High Court observed that no payment was
made during the previous year relevant to the subject AY. The Apex Court in Woodward Governor India
P. India, (supra) while dealing with the amended provisions of section 43A
of the Act has held that “…. with effect from 1^stApril, 2003 such
actual payment of the decreased/ enhanced liability is a condition precedent
for making adjustment in the carrying amount of the fixed asset.”

The aforesaid observation of
the Apex Court apply to the facts of the present case. Accordingly, the revenue
appeal was dismissed.

shailesh.kwebmaker

Section 147 : Reassessment – Reopening on basis of same set of facts – change of opinion – power not to correct mistakes – reassessment was held to be invalid [Section 148 ]

10. Pr. CIT vs. Century Textiles and Industries Ltd.

[ Income tax Appeal no 1367 of 2015 ; dated :
03^rd April, 2018 (Bombay High Court)]. [Affirmed DCIT vs. Century Textiles and
Industries Ltd. [ITA No.
2036/Mum/2013; Dated:
22^ndAugust, 2014 ; AY : 2007-08;
Mum. ITAT ]

Section 147 : Reassessment –
Reopening on basis of same set of facts – change of opinion – power not to
correct mistakes – reassessment was held to be invalid [Section 148 ]

Assessee is engaged in
manufacture of cotton piece goods, denim, yarn, caustic soda, salt, pulp and
paper, etc. The assessee had in its return of income claimed deduction
of Rs.33.67 crore u/s. 80IC of the Act in relation to its paper and pulp unit
on the basis of audit report in Form 10CCA.

During the scrutiny
proceedings, the A.O raised specific queries with regard to above claim u/s.
80IC of the Act which was responded. The A.O after considering the entire
material on record disallowed the assessee’s claim to the extent of Rs.11.49
crore out of total claim of Rs.33.67 crore u/s. 80IC of the Act while passing
assessment order u/s. 143(3).

Thereafter, a notice u/s. 148
of the Act was issued seeking to reopen assessment. Reasons in support of the
notice as communicated to the Assessee that “the income chargeable to tax to
the extent of Rs.4.99 crore has escaped assessment. Issue notice u/s. 148 for
A.Y.2007-08”

Assessee objected to the
reopening of the notice on the ground that the same amounts to change of
opinion and therefore without jurisdiction. However, the A.O rejected the
objection and proceeded to complete the assessment u/s. 143(3) r.w.s 147 of the
Act. The A.O disallowed the claim of deduction u/s. 80IC of the Act by further
amount of Rs.4.99 crore.

Being aggrieved, the assessee
carried the issue in appeal to the CIT(A). The CIT(A) rejected the assessee’s
appeal on the issue of reopening of assessment and confirmed the assessment
order.

Being aggrieved, the assessee
carried the issue in appeal to the ITAT. The Tribunal allowed the assessee’s
appeal, interalia holding that the assessee’s claim for deduction u/s. 80IC of the Act in respect of its paper and
pulp unit duly supported by audit report u/s. 10CCA of the Act was a subject
matter of enquiry by the A.O in the regular assessment proceedings. This is
evident from the fact that queries with regard to the claim of deduction
u/s. 80IC of the Act were specifically
raised by the A.O and the same were responded to by the assessee. Thus, the Tribunal
held that there was a view taken/opinion formed during the regular assessment
proceedings. Therefore, this is a case of change of opinion on the part of the
A.O in issuing notice and seeking to reopen assessment. The ITAT relied on the
decision of Supreme Court in CIT vs.
Kelvinator of India Ltd. [2010] 320 ITR 561 that “reasons to believe” do
not empower the A.O to reopen an assessment when there is change in opinion.
Power to reopen assessment as observed by the Supreme Court is only a power to
reassess not to review the order already passed.

Being aggrieved, the revenue
carried the issue in appeal to the High Court.
The Revenue in support of the appeal states that reopening notice was
not on account any change of opinion, as no opinion/view was taken in regular
assessment proceedings in respect of the receipts/income not derived directly
from the paper and pulp unit.

The Hon. High Court observed
that the reasons in support of the impugned notice is that during the regular
assessment proceedings on account of omission by the A.O the above income was
not excluded from the claim for deduction. This is different from non application
of mind to claim for deduction u/s. 80IC of the Act. As held by this Court in Hindustan
Lever vs. Wadkar (2004) 268 ITR 339, the reasons in support of the
reopening notice has to be read as it is. No additions and/or inferences are
permissible. Moreover, the power u/s. 147/148 of the Act is not to be exercised
to correct mistakes made during the regular assessment proceedings. In the
above facts, the view taken by the
Tribunal is a view in accordance with the decision of the Apex Court in
Kelvinator India (Supra).

The decision of this Court in
Export Credit Guarantee Corporation of India [2013] 350 ITR 651 relied by the Dept. was distinquished. It
was also found as a fact in the above case of Export Credit Guarantee
Corporation of India (Supra) that no query was raised during the course of
the regular assessment proceedings. Thus, the occasion for the A.O to apply his
mind to the claim by the assessee in that case, did not arise. Accordingly, the revenue Appeal was
dismissed.

shailesh.kwebmaker

Sections 226(3), 276B and 276BB – Recovery of tax – Garnishee proceedings – Assessee holding lease for settlement of sand ghats – Surrender of lease accepted by Government – Attachment of bank account of assessee thereafter for failure by Mining Office to collect tax from other settlees – No determination that settlement amount to Mines Department due against assessee – Liability was that of Mines Department – Attachment of assessee’s bank account not sustainable and revoked

18. Sainik Food Pvt. Ltd. vs.
Principal CCIT; 406 ITR 596 (Patna);

Date of order: 8^th
February, 2018

Sections 226(3), 276B and 276BB – Recovery of tax – Garnishee
proceedings – Assessee holding lease for settlement of sand ghats – Surrender
of lease accepted by Government – Attachment of bank account of assessee
thereafter for failure by Mining Office to collect tax from other settlees – No
determination that settlement amount to Mines Department due against assessee –
Liability was that of Mines Department – Attachment of assessee’s bank account
not sustainable and revoked

The assessee was the highest bidder
of the tender for settlement of sand ghats located in different districts in
the State of Bihar for the period of 2015-19. According to the notice inviting
tender the assessee was required to pay settlement amount in three instalments
with simultaneous payment of the required amount of tax to the Sales Tax
Department of the State, Income Tax Department and other statutory charges. The
assessee deposited the entire settlement amount with the Department of Mines
and Geology for the years 2015 and 2016. The assessee was required to deposit
the third and the last instalment of settlement amount in the month of
September, 2017.

In the mean while, the assessee
received a notice of demand dated 26/07/2017, issued by the ITO in purported
exercise of power u/s. 226(3) of the Income-tax Act, 1961 calling upon the
assessee to deposit the tax liability of the District Mining Office, Bhagalpur.
The assessee requested for grant of time so that the third instalment was paid
to the Department instead of to the District Mining Officer with settlement of
sand ghat. On 19/12/2017 the amount was deducted from the bank account of the
assessee by the Department which treated it to be an assesee u/s. 226(3)(x) and
dues payable by the District Mining Officer, Bhagalpur on account of default in
deducting tax collected at source from various brick kiln owners. The assessee
surrendered the lease on 14/10/2017 and was accepted by the State Government on
20/10/2017. The ITO (TDS) passed the order of recovery u/s. 226(3)(x) on
23/10/2017.

The assessee filed a writ petition
contending that the assessee was not a debtor of the Mines and Geology
Department after surrender of lease and its acceptance, that the action of the
Department in releasing the bank account of the Mining Department and
thereafter attaching the bank account of the assessee and recovery of tax
liability of the Mining Department from the bank account of the assessee was
not justified, and that not taking action against the Mining Department u/s.
276B and 276BB and attaching and recovering from the bank account of the
assessee was arbitrary exercise of power. The Patna High Court allowed the writ
petition and held as under:

“i) The
Department had not carried out any factual enquiry to examine whether or not
there was any liability to be paid by the assessee in connection with the
settlement of sand ghat. In the absence of factual enquiry, proceeding against
the assessee and treating it as debtor was not justified. The action of the
Department in treating the assesse as debtor and attaching its bank account and
recovering the tax liability of the Mines and the Geology Department from the
bank account of the assessee, without noticing the surrender of lease and its
acceptance by the State Government, was not proper.

ii) For
the lapse of the Mines Department the assessee could not be fastened with any
liability if no tax was due to be payable by the assessee against any head to
the Mines Department. In the absence of exclusive determination that the
settlement amount to the Mines Department was only due against the assessee, it
could not have been declared exclusive debtor. The counter-affidavit filed by
the Mines Department acknowledged the lapse of its officers. There was no
statement that the settlement or tax liability was exclusively due against the assessee
and not other settlees which was noticed from the fact that the assessee kept
on requesting the authorities in the matter of payment of tax u/s. 226(3)(x).

iii) The provisions of section 226(3)(x) did not confer such arbitrary
power to the Department to recover the amount from an innocent assessee after
surrender of settlement. The tax was the liability of the Mines and Geology
Department and instead of taking coercive action and adopting the means
available under the provisions of sections 276B and 276BB for recovery of the
liability from the Mines Department, attaching the bank account and directing
the tax due to be recovered from the account of the assessee was unreasonable
and unjustified. The attachment of the bank account was revoked.”

shailesh.kwebmaker

Sections 147, 148 and 151(2) – Reassessment – Notice u/s. 148 – Sanction for issuance of notice – Designated authority Additional Commissioner – Sanction by Commissioner – Notice not valid – Order of reassessment without jurisdiction and invalid

17. CIT vs. Aquatic Remedies
P. Ltd.; 406 ITR 545 (Bom):

Date of order: 25^th
July, 2018

A. Y. 2004-05

Sections 147, 148 and 151(2) – Reassessment – Notice u/s. 148 –
Sanction for issuance of notice – Designated authority Additional Commissioner
– Sanction by Commissioner – Notice not valid – Order of reassessment without
jurisdiction and invalid

The assessee was in the business of
trading in pharmaceutical product. The Assessing Officer issued a notice u/s.
148 of the Income-tax Act, 1961 to reopen the assessment for the A. Y. 2004-05.
The assessee contended that the issuance of the notice for reopening of the
assessment was without jurisdiction since the sanction for issuing the notice
had to be obtained from the Additional Commissioner according to section 151(2)
but the sanction had been obtained from the Commissioner which was in breach of
the sanction and therefore without jurisdiction. The Assessing Officer rejected
the claim and passed the assessment order u/s. 147.

The Tribunal allowed the appeal and
quashed the reassessment order passed by the Assessing Officer.

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

“i) U/s.
151(2) sanction to issue notice u/s. 148 has to be issued by the Additional
Commissioner. The Assessing Officer had not sought the approval of the
designated officer but the Commissioner which was evident from the form used to
obtain the sanction and the Additional Commissioner had not granted permission
to initiate reassessment proceedings against the assessee.

ii) The
view of the Additional Commissioner was subject to the approval of his superior
– the Commissioner. Thus, there was no final sanction granted by the Additional
Commissioner for issuing the notice u/s. 148 to reopen assessment. Further, it
was the Commissioner who had directed the issuance of the notice u/s. 148 to
the Assessing Officer.

iii) The order of the Tribunal in quashing the order u/s. 143(3)
r.w.s. 147 was correct. No question of law arose.”

shailesh.kwebmaker

Chapter X and Section 260A – International transactions – Determination of arm’s length price – Appeal to High Court – Power of High Court to interfere with such determination – Interference only if finding of Appellate Tribunal is perverse – Selection of comparables, short-listing them, applying of filters, fact finding exercises and final orders passed by the Tribunal binding on Department and High Court

16. Principal CIT vs.
Softbrands India P. Ltd.; 406 ITR 513 (Karn):

Date of order: 25^th
June, 2018

A. Y. 2006-07

Chapter X and Section 260A – International transactions –
Determination of arm’s length price – Appeal to High Court – Power of High
Court to interfere with such determination – Interference only if finding of
Appellate Tribunal is perverse – Selection of comparables, short-listing them,
applying of filters, fact finding exercises and final orders passed by the
Tribunal binding on Department and High Court

In the appeal filed by the Revenue
before the High Court against the order of the Tribunal the following questions
were raised:

“i) Whether
on the facts and in the circumstances of the case the Tribunal is right in law
in rejecting the comparables, namely, Kals Information Systems Ltd., Tata Elxsi
Ltd., M/s. Accel Information Systems Ltd., M/s. Bodhtree Consulting by
following its earlier order and without appreciating that the reasonings of the
Transfer Pricing Officer (TPO)/Assessing Officer (AO) for adopting the said
comparables which have been brought out in the TPO’s order and without
appreciating that TPO has chosen the same after application of mind and
materials on record?

ii) Whether
the Tribunal was justified in fixing the related party transaction (RPT) at 15
percent of total revenue and deleting Geomatric Software Ltd. (Seg) and
Megasoft Ltd. as comparables without going into specific facts in the case of
taxpayer and without adducing the basis for arriving at 15 percent cut off RPT
filter, in the case of taxpayer?”

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

“i) Income-tax
Act, 1961 contains special provisions relating to avoidance of tax in Chapter X
of the Act comprising sections 92 to 94B with regard to assessment to be done
for computation of income from international transactions on the principle of
“arm’s length price” and the relevant Rules for computation of such income
under the provisions of Chapter X are enacted in the form of rules 10A to 10E
in the Income-tax Rules 1962. The procedure for assessment under Chapter X
relating to international transactions is a lengthy one and involves multiple
authorities of the Department. A huge, cumbersome and tenacious exercise of
transfer pricing analysis has to be undertaken by corporate entities who have
to comply with the various provisions of the Act and Rules with huge data bank
and in the first instance they have to satisfy that the profits or the income
from transactions declared by them are at “arm’s length” which analysis is
invariably put to test and inquiry by the authorities of the Department through
the process of Transfer Pricing Officer and Dispute Resolution Penal and the
Tribunal at various stages, the assessee has a cumbersome task of compliance
and it has to satisfy the authorities that what has been declared by it is a
true and fair disclosure.

ii) The
pick of comparables, short-listing of them, applying of filters, etc., are all
fact finding exercises and therefore the final orders passed by the Tribunal
are binding on the lower authorities of the Department as well as the High
Court.

iii) The scheme of both section 260A in the Income-tax Act, 1961 and
section 100 read with section 103 of the Code of Civil Procedure, 1908 are in
pari materia and in the same terms. The existence of a substantial question of
law is a sine qua non for maintaining an appeal before the High Court. The High
Court may determine any issue which (a) has not been determined by the Tribunal
or (b) has been wrongly determined by the Tribunal, only if the High Court
comes to the conclusion that “by reason of the decision on substantial question
of law rendered by it”, such a determination of an issue of fact also would be
necessary and incidental to the answer given by it to the substantial question
of law arising and formulated by it.

iv) Sub-section
(6) of section 260A does not give any extended power, beyond the parameters of
the substantial question of law to the High Court to disturb the findings of
fact given by the Tribunal below. The insertion of sub-section (7) of section
260A does not give any new or extended powers to the High Court and the
pre-existing provisions from sub-section (1) to sub-section (6) in section 260A
of the Act already had all the trappings of section 100 and 103 of the Civil
Procedure Code.

v) The
Tribunal is expected to act fairly, reasonably and rationally and should
scrupulously avoid perversity in its orders. It should reflect due application
of mind when it assigns reasons for returning particular findings. The very
word “comparable” means that the group of entities should be in a homogeneous
group. They should not be wildly dissimilar or unlike or poles apart.

ii) From the perusal of the Tribunal’s order, it
was apparent that individual cases of such comparables had been considered,
analysed and discussed by the Tribunal and while some comparables were found to
be appropriate and really comparable to the facts of the assessee, some were
not. The Tribunal had given cogent reasons and detailed findings upon
discussing each case of comparable corporate properly. Whether or not the
comparables had been rightly picked up or filters for arriving at the correct
list of comparables had been rightly applied, did not give rise to any
substantial question of law.”

shailesh.kwebmaker

Sections 9 and 195 – Non-resident – Income deemed to accrue or arise in India – TDS – Effect of sections 9 and 195 – Non-resident liable to tax only on incomes attributable to operations in India – Commission paid for procuring abroad – Non-resident not liable to tax on commission – Tax not deductible at source on commission

15. Evolv Clothing Company Pvt.
Ltd. vs. ACIT; 407 ITR 72 (Mad):

Date of order: 14^th
June, 2018

A. Y. 2009-10

Sections 9 and 195 – Non-resident – Income deemed to accrue or
arise in India – TDS – Effect of sections 9 and 195 – Non-resident liable to
tax only on incomes attributable to operations in India – Commission paid for
procuring abroad – Non-resident not liable to tax on commission – Tax not
deductible at source on commission

The assessee carried on business of
export of garments and claimed to have entered into agency agreements with a
non-resident Italian agent for procuring export orders for the assessee at a
commission. In the A. Y. 2009-10, the assessee paid a sum of Rs. 3,74,09,773/-
as commission to the foreign agent. According to the assessee, since no amount
of agency commission was chargeable to tax in India, the assessee did not
deduct tax at source before payment of commission to the foreign agent.
According to the assessee, the foreign agent rendered service akin to the
service of a broker to the assessee, procuring orders upon market survey with
regard to demand for the products of the assessee in the foreign country. The
Assessing Officer passed the assessment order disallowing the entire commission
u/s. 40(a)(i), because tax had not been deducted at source. This was upheld by
the Tribunal.

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

“i) Explanation
1 to section 9(1)(i) of the Income-tax Act, 1961, would attract liability to
Indian tax for a non-resident with business connection in India, only in
respect of income attributable to his operations in India. The amendment with
retrospective effect from June 1, 1976, by insertion of Explanation to section
9(2) can only apply to income by way of interest, royalty and fees for
technical services and not to brokerage or job-wise commission on activities
incidental to procurement of orders.

ii) Section
195 attracts tax only on chargeable income, if any, paid to non-residents.
Where there is no liability, the question of tax deduction does not arise.
Where no part of income is chargeable in India, even clearance u/s. 195(2) or
(3) of the Act is not necessary. In Toshoku’s case (1980) 125 ITR 525, the
Supreme Court held that payments to agents for performance of services outside
India are not liable to be taxed in India.

iii) From the service agreements with the agents abroad, it was clear
that the service rendered was essentially brokerage service. The very first
clause of the agreement stated “to procure orders”. The reference to market
research abroad or co-ordination with the supplier or to ensure timely payment
or making available its office space for visit by the suppliers, were
ordinarily things which any agent or broker undertook incidental to brokerage
service. There was no finding that any of the commission agents had any place
of business in India.

iv) The
Assessing officer had in the assessment order, accepted that the assessee had
paid commission charges to oversees agents. It was not the case of the
Assessing Officer that any lump sum consideration had been paid for any
specific managerial, technical or consultancy services. The commission was not
taxable in India. The assessee was liable to deduct tax on such payment.

v) The
appeal is allowed and the questions framed are answered in favour of the
assessee and against the revenue”

shailesh.kwebmaker

Section 9 of the Act and Article 5 of DTAA–Income – Deemed to accrue or arise in India (Permanent establishment) – Where there were all relevant documentary evidence available on record to render finding whether assessee, a Netherland based company, had a permanent establishment in India and the Tribunal having referred to same in its order could not have remanded back matter to Assessing Officer for consideration afresh? – The Tribunal having referred to all factual details and crystallised issues could not have remanded back matter to Assessing officer for consideration afresh

14. Co-operative Centrale
Reiffeisen Boerenleenbank B. A. vs. Dy. DIT, (International Taxation); [2018] 97 taxmann.com 24 (Bom);

Date of order: 29^th
August, 2018:

A. Ys. 2002-03, 2003-04 and
2005-06

Section 9 of the Act and Article 5 of DTAA–Income – Deemed to
accrue or arise in India (Permanent establishment) – Where there were all
relevant documentary evidence available on record to render finding whether
assessee, a Netherland based company, had a permanent establishment in India
and the Tribunal having referred to same in its order could not have remanded
back matter to Assessing Officer for consideration afresh? – The Tribunal
having referred to all factual details and crystallised issues could not have
remanded back matter to Assessing officer for consideration afresh

The assessee was a tax resident of
Netherlands and was entitled to claim the benefit of the DTAA between India and
Netherlands. In fact the assessee was part and parcel of the Rabo bank group.
An Indian company, the Rabo India Finance Private Limited (RIFPL) was
registered as a non-banking financial company with the RBI. It provided wide
range of financial services such as credit facilities, investment banking,
strategic, financial and project advisory services. This company also belonged
to the Rabo group. It was claimed that both, the assessee and the said Indian
Company were independent entities but worked together on select assignments as
and when required. In the relevant years, the assessee claimed to have provided
assistance on principle to principle basis to the Indian company on a few
transactions and received fees and guarantee commission.

However, the amounts received under
the aforesaid category were not offered to tax in India on the ground that the
assessee did not have a permanent establishment in India within the meaning of
Article (5) of the DTAA. The Assessing Officer passed an order holding that the
Indian Company RIFPL was a permanent establishment of the assessee within the
meaning of Article 5 (5) of the DTAA. Hence, certain percentage of the sums
referred above were taken as profits attributable to the permanent
establishment. A further percentage from that was taken as profits chargeable
to tax in India. This resulted in the return depicting total income to Rs.
31.25 lakh.

On appeal, the
Commissioner(Appeals) came to the conclusion that the assessee neither had a
fixed place of business nor agency or any other form of permanent establishment
in India and consequently the income of the assessee was not taxable in India.
The Tribunal restored the matter back to the file of the Assessing Officer to
determine the issue afresh.

Thereafter, an application was
filed seeking rectification of order initially passed by the Tribunal. However,
the Tribunal concluded that the issue was rightly remitted to the Assessing
Officer by inter alia observing that the quantum of work done, services
rendered, the contract undertaken for outsiders would have to be examined to
determine whether RIFPL was an agent having independent status or was merely
working on behalf of assessee.

On appeal, the Bombay High Court
held as under:

“i) The
First Appellate Authority while deciding the Appeals of the assessee has passed
a fairly detailed order. The facts and the submissions have been noted in his
order. In fact, under separate heads, the details have been noted and
considered. The Appellate Authority concludes that all the agreements placed on
record would indicate that the RIFPL had procured the contract of provision of
services to the two parties.

However, with a view to meeting its
obligations, the RIFPL further entered into an agreement with the assessee
requiring the assessee to provide advisory services in Italy for a
consideration paid by the RIFPL. Based on these two contracts, the First
Appellate Authority concluded that it cannot be said that RIFPL is acting as an
agent of the assessee. On the contrary, the agreements point towards the said
Indian company obtaining independent contracts and subcontracting the part of
the work thereunder to the assessee. On each of the counts, namely, guarantee
commission and other services, the First Appellate Authority has held that the
Assessing Officer committed a mistake. The clear conclusion in this order is
that the business profits of the assessee are not taxable in India in absence
of any permanent establishment in India within the meaning of article 5 of the
DTAA.

ii) These
very materials could have been examined by the Tribunal and it would have
arrived at the satisfaction whether the Assessing Officer was correct or
whether the First Appellate Authority was right in reversing the order of the
Assessing Officer and holding as above in favour of the assessee. One does not
see why, when the Tribunal refers to all the factual matters in its order and
has in earlier paragraphs crystallised the issues, then, what was the occasion
for a remand. In the order under Appeal, the Tribunal notes that the assessee
preferred an Appeal before the First Appellate Authority and argued that the
concept of fixed place, permanent establishment requires the enterprises to
have their business or a place of management/branch in India or office in India
and the assessee had neither.

iii) The activities of the Indian company did not result in
constitution of any agency or permanent establishment of the assessee and that
the Indian company did not have any authority to conclude the contract on
behalf of the assesee, that it did not maintain any stock of any goods or
merchandise of the assessee nor did it secure any orders from the assessee that
it was economically and legally independent, that it was acting in ordinary
course of its business not dependent on the assessee. During the year under
Appeal, the Indian company had income from various sources amounting to Rs.
1386.70 Million. The assessee received professional income and guarantee
commission. There was also certain reimbursement of expenses by the Indian
company.

iv) In
the backdrop of all this, and further facts noted, a cryptic order has been
passed by the Tribunal. In fact, in the order under challenge in reference to
the Income Tax Appeal No. 4632 of 2006 for Assessment year 2002-2003, the
Tribunal says that the Indian company had made payment to the assessee for
providing the advisory services to it and under the Head ‘Guarantee Commission’
and that the Indian company was paying the assesee more than 30 per cent of its
income. That the basic issues are, as to whether the assesee had permanent
establishment in India or not and as to whether the services rendered by the
Indian company could be treated as the activities carried out by the assessee.
Yet, it says that there is nothing on record to prove that the provisions of
article 5(1) of the Agreement are applicable. That stipulates that the
permanent establishment for the purpose of convention meant a fixed business
through which the business of the enterprise was wholly or partly carried on.
The conclusion is that the assessee was not having fixed place of business in
India. Hence, the First Appellate Authority rightly held that the provisions of
article 5 (1) were inapplicable. It is in these circumstances, it is surprising
that the Tribunal still deems it fit and proper to remand the case. If there
was indeed no material on record, then, the above conclusion was impossible to
be reached.

v) Judicial
decisions have to be consistent and all the more there should be no confusion.
There ought to be some predictability and when given facts and circumstances
give rise to certain legal principles which parties assert are applicable,
then, as a last fact finding authority, the Tribunal could have summoned all
records and thereafter should have arrived at a categorical conclusion whether
the First Appellate Authority was right or the Assessing Officer. This having
admittedly not been done, it is opined that the Tribunal failed to act as a
last fact finding authority. It failed to discharge its duty and function
expected of it by the law.

vi) Thus,
the order of the Tribunal is set aside and revenue’s appeal is restored to the
file of the Tribunal for a decision afresh on merits and in accordance with
law.”

shailesh.kwebmaker

Sections 45 and 54(1) – Capital gain – Exemption u/s. 54 – Construction of residential house within stipulated time – Exemption in respect of cost of new residential house – Scope of section 54 – Does not exclude cost of land from cost of residential house

13. C.
Aryama Sundaram vs. CIT; 407 ITR 1 (Mad) :

Date of order: 6^th
August, 2018

A. Y. 2010-11

Sections 45 and 54(1) – Capital gain – Exemption u/s. 54 –
Construction of residential house within stipulated time – Exemption in
respect of cost of new residential house – Scope of section 54 – Does not
exclude cost of land from cost of residential house

The assessee
had sold a residential house property on 15/01/2010 for a total consideration
of Rs. 12,50,00,000/- and the total long term capital gains was Rs.
10,47,95,925/. On 14/05/2007, the assessee had purchased a property with a
superstructure thereon for a total consideration of Rs. 15,96,46,446/- and
after demolishing the existing structure, the assessee constructed a
residential house at a cost of Rs. 18,73,85,491/-. For the A. Y. 2010-11, the
assessee had claimed the entire long term capital gains as exempt from tax u/s.
54 of Act. The Assessing Officer held that only that part of the construction
expenditure that was incurred after the sale of the original asset was eligible
for exemption u/s. 54 and based on records held that the cost of construction
incurred after the sale of the original asset was Rs. 1,14,81,067/- and
accordingly allowed exemption of the same amount.

The Commissioner (Appeals) upheld the decision of the Assessing Officer. The
Tribunal held that section 54 was a beneficial provision and had to be
construed liberally on compliance with the conditions. It held that the
assessee had complied with the conditions of section 54 and remitted the matter
to the Assessing Officer to consider the deduction u/s. 54 for the construction
cost incurred by the assessee.

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

“i) Section
54(1) did not exclude the cost of land from the cost of the residential house.
According to the section the capital gains had to be adjusted against the cost
of the new residential house. What had to be adjusted or set off against the
capital gains was the cost of the residential house that was purchased or
constructed. Section 54(1) was specific and clear. It was the cost of the new
residential house and not just the cost of construction of the new residential
house, which was to be adjusted.

ii) The
cost of the new residential house would necessarily include the cost of the
land, material used in the construction, labour and any other cost relatable to
the acquisition or construction of the residential house. The condition
precedent for such adjustment was that the new residential house should have
been purchased within one year before or two years after the transfer of the
residential house, which resulted in the capital gains or alternatively, a new
residential house had been constructed in India, within three years from the
date of the transfer, which resulted in the capital gains.

iii) The new residential house had been
constructed within the time stipulated in section 54(1). It was not requisite
of section 54 that construction could not have been commenced prior to the date
of transfer of the asset that resulted in capital gains. If the amount of
capital gain is equal to or less than the cost of the new residential house,
including the land on which the residential house was constructed, the capital
gains were not to be charged u/s. 45.”

shailesh.kwebmaker

Sections 12A and 12AA(3)– Charitable purpose – Registration of trust – Cancellation of registration – Grounds for – Difference between objects of trust and management of trust – No change in objects of trust – Amendment in respect of appointment of chief trustee and manner of managing the trust – Not ground for cancelling registration of trust

12. CIT(Exemption) vs. Sadguru
Narendra Maharaj Sansthan; 407 ITR 12 (Bom):

Date of order: 28^th
February, 2018

Sections 12A and 12AA(3)– Charitable purpose – Registration of
trust – Cancellation of registration – Grounds for – Difference between objects
of trust and management of trust – No change in objects of trust – Amendment in
respect of appointment of chief trustee and manner of managing the trust – Not
ground for cancelling registration of trust

The assessee-trust amended its
trust deed. The Commissioner recorded that the amendment to the trust deed
devised a system by which the chief trustee would alone define his heir for the
post of the chief trustee and “adhishtata” and that the heir could not
take part in the management of the trust during the lifetime of the chief
trustee. The Commissioner exercised his power u/s. 12AA(3) of the Income tax
Act, 1961 (hereinafter for the sake of brevity referred to as the
“Act”) and cancelled the registration of the assessee on the ground
that the amendment violated the provisions of section 13(1)(c).

The Tribunal held that the
Commissioner had not appreciated the difference between the objects of the
trust and the powers/management of the trust; the amendment of the trust deed
dealt with the powers of the management of the trust rather than the objects of
the trust. The Tribunal set aside the order of the Commissioner cancelling the
registration of the trust.

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

“i) The
cancellation of registration u/s. 12AA(3) is only in two contingencies, one the
activities of the trust not being genuine or the activities of the trust not
being carried out in accordance with its objects.

ii) Cancellation
of the registration of the assessee-trust was not justified. The cancellation
was not on above two grounds. Section 13 applied while applying section 11. It
was in the domain of the Assessing Officer during the assessment proceedings
and not a basis for cancellation of registration.

iii) Besides, the amendment of the trust deed not being in the spirit
of charitable trust, could not be the basis of cancellation u/s. 12AA(3). The
term “spirit of a charitable trust” was not defined in the Act nor elaborated
in the order of the Commissioner. The amendment made in the trust deed did not
suggest any change or addition to the objects of the trust. It was only in
respect of the appointment of the chief trustee and the manner of managing the
trust. The Tribunal rightly held that the Commissioner had focused on change in
the future management of the trust rather than the objects of the trust to
cancel the registration. The appeal is dismissed.”

shailesh.kwebmaker

Section 37(1) – Business expenditure – Where assessee company had furnished names and PAN numbers of all vendors to whom it had paid repair and maintenance charges for their services, the Tribunal was justified in allowing expenditure on account of such repair and maintainence charges

11. Principal CIT vs. Rambagh
Palace Hotels (P.) Ltd.; [2018] 98 taxmann.com 167 (Delhi):

Date of order: 17^th
September, 2018

A. Y. 2005-06

Section 37(1) – Business expenditure – Where assessee company had
furnished names and PAN numbers of all vendors to whom it had paid repair and
maintenance charges for their services, the Tribunal was justified in allowing
expenditure on account of such repair and maintainence charges

During the year, i.e. A. Y.
2005-06, the assessee had claimed expenditure on account of repair and
maintenance charges paid by it to several parties. The Assessing Officer had
allowed repair and maintenance charges paid to four parties, who had appeared
before him and whose statements were recorded on oath. However, the balance
repair and maintenance expenditure was disallowed to the extent of 50 per cent,
on the ground of absence of supporting documents.

On appeal, the Commissioner
(Appeals) reduced the disallowance to 5 per cent. The Tribunal recorded that
the assessee had produced details of all vendors, including their PAN numbers,
invoices raised by them, etc., and held that the Commissioner (Appeals) was not
right in making disallowance of 5 per cent on the ground of mere suspicion and
accordingly allowed the full claim.

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

“i) The
finding of the Tribunal deleting disallowance of 50 per cent by the Assessing Officer
is primarily factual. One has quoted the reply filed by the respondent/assessee
before the first appellate authority. These documents and papers were relied
upon by the Tribunal and the Commissioner (Appeals). However, copies of the
said documents/papers have not been filed. There is nothing to show and
establish that the findings of the Commissioner (Appeals) and the Tribunal are
perverse and factually incorrect.

ii) Given
the aforesaid facts, there is no any substantial question of law arises for consideration.
The appeal is accordingly dismissed.”

shailesh.kwebmaker

TAXABILITY OF PROPORTIONATE DEEMED DIVIDEND IN CASE OF LOANS TO CONCERNS

Issue
for Consideration

“Dividend” is inclusively defined
u/s. 2(22) of the Income Tax Act, 1961. Clause (e) of that section provides for
taxation of of any payment by a company, not being a company in which public
are substantially interested, of any sum by way of advance or loan to a
shareholder, who is the beneficial owner of shares holding not less than 10% of
the voting power, or to any concern in which such shareholder is a member or a
partner and in which he has a substantial interest, to the extent to which the
company possesses accumulated profits. As per Explanation 3(b) of section
2(22), a person shall be deemed to have a substantial interest in a concern,
other than a company, if he is at any time during the previous year
beneficially entitled to not less than twenty per cent of the income of such
concern while in the case of a company, a person carrying not less than twenty
per cent of the voting power shall, by virtue of section 2(32) be considered to
be the person holding a substantial interest in the company.

In the case of loan or advance to a
concern in which a shareholder has a substantial interest, the Supreme Court in
the case of CIT vs. Madhur Housing & Development Co Ltd Ltd. 401 ITR 152,
has recently held that the taxation of deemed dividend would be
in the hands of the shareholder, and not in the hands of the recipient concern.
The ratio of this decision though has been doubted by the apex court in a later
decision in the case of National Travel Services vs. CIT, 401 ITR 154
and the issue therein has been referred to the larger bench of the court.

Whether in bringing to tax the
deemed dividend, in the hands of the shareholders, the amount of the loan
advanced to a concern, is to be apportioned in their hands or not is an issue
that requires consideration. If yes, what shall be the basis on which the
amount is to be apportioned is another issue that is open; in cases where more
than one shareholder holds more than 10% of the voting power in the lending
company, and also has a substantial interest in the recipient concern, in what
proportion would the amount of loan be taxed as deemed dividend amongst such
shareholders – in the proportion of their shareholding in the lending company
or in the proportion of their interest in the recipient concern.

While the Delhi bench of the
Tribunal has held that the taxation of deemed dividend would be in the
proportion of the interest in the recipient concern, the Hyderabad bench of the
Tribunal has taken a contrary view, that such taxation would be in the
proportion of the voting power in the lending company.

Puneet Bhagat’s case

The issue came up for consideration
before the Delhi SMC bench of the Tribunal in the case of Puneet Bhagat vs.
ITO 157 ITD 353.

The facts in this case were that
the assessee held 50% of shares in a company, in which his wife held the
remaining 50%. This company advanced a loan of Rs 10 lakh to another company,
in which the assessee held 53.85% shares, and his wife held 46.11%. At the
relevant point of time, the accumulated profits of the lending company were Rs
14.51 crore.

The assessing officer, following
the decision of the Delhi High Court in the case of CIT vs. Ankitech (P) Ltd
340 ITR 14, held that the deemed dividend had to be taxed in the hands of
the shareholders of the loan recipient company. Since both the assessee and his
wife were equal shareholders in the lending company, he taxed an equal amount
of Rs 5 lakh in the hands of each of the two shareholders.

The Commissioner (Appeals) rejected
the assessee’s appeal, confirming the addition made by the assessing officer.

Before the Tribunal, on behalf of
the assessee, it was argued that though, on the facts of the case, the amount
of loan liable for addition u/s. 2(22)(e) could not be apportioned amongst the
shareholders, both of whom had substantial interest in the concerns, in as much
as no mechanism had been provided in the Act for apportioning the amount of the
deemed dividend in the respective shareholders hands. The fact that there was a
different shareholding pattern of shareholdings in the two companies made the
thing all the more unworkable. Therefore, the computation provisions failed,
and, following the Supreme Court decision in the case of CIT v s. B C
Srinivasa Setty 128 ITR 294, the charging provisions would also fail.
Hence, it was argued that deemed dividend could not be taxed in the hands of
any or both the shareholders.

The Tribunal noted that there was
no dispute that the total amount of loan was taxable as deemed dividend in the
hands of the 2 shareholders, as the 2 shareholders held more than 20%
shareholding in both the lending company as well as the recipient company.
Referring to the argument that the charging sections would fail on account of
failure of the computation provisions, the Tribunal noted that for application
of section 2(22)(e), a loan to a ‘concern’ was also contemplated in the section
itself and therefore the charge could not have failed It also observed that it
would be too technical to hold that the legislature visualised only one
shareholder in the concern and therefore the better view would be to pin the
charge on all the qualified shareholders.

The Tribunal, having held so,
observed that the section clearly stated that the shareholder might be a member
of the concern or a partner thereof, which implied that the interest of the
shareholder in the concern was to be determined with reference to the
percentage of share in income or of the shareholding with the voting power in
the concern, of the qualified shareholder, that received the loan or advance.
According to the Tribunal, it was not necessary that in every case, the
detailed mechanism should be provided by the Act for computing the income. If by
reasonable construction of the section, the income could be deduced, then,
merely on the ground that a specific provision had not been provided, it could
not be held that the computation provisions failed. The Tribunal also observed
that it was well settled law that a construction which advanced the object of
legislation should be preferred to the one which defeated the same.

According to the Tribunal, the
percentage of shareholding in the concern to which the loan was given, was a
determining factor of the quantum of the deemed dividend to be taxed in case of
the shareholder. In the case before it, it noted that the assessee had 53.85%
shareholding with the voting power in the loan receiving company. Therefore,
according to the Tribunal, Rs. 5,38,500 should have been assessed as dividend
in his hands, and the balance Rs.4,61,100 should have been taxed as dividends
in the case of his wife. However, since in the assessee’s case, the AO had made
an addition of Rs. 5 lakh only, the Tribunal upheld the addition of Rs. 5 lakh.

G Indira Krishna Reddy’s case

Recently, the issue again came up
for consideration before the Hyderabad bench of the Tribunal in the cases of G
Indira Krishna Reddy vs. DyCIT (ITA Nos 1495-1497/Hyd/2014) and G V Krishna
Reddy vs. DyCIT (ITA Nos 1498-1500/Hyd/2014) dated 24^th May
2017.

In this case, the assessee and her
husband were both shareholders of a company, Caspian Capital & Finance P.
Ltd.holding more than 10% of the share capital of the company. This company
advanced amounts of Rs. 36.10 lakh and Rs. 15 lakh ostensibly by way of share
application money to 2 companies namely, Metro Architectures & Contractors
Pvt.Ltd. and Orbit Travels & Tours Pvt. Ltd. in which the assessee had shareholding of 20%
and 40% respectively, her husband also was holding more than 20% shareholding
in both the companies. The lending company Caspian Capital & Finance P.
Ltd. had accumulated profits exceeding the amounts of share application money
advanced at the relevant point of time.

The assessing officer, based on the
facts, held that such amounts advanced by Caspian Capital & Finance P. Ltd.
were unsecured loans, though termed as share application money. He therefore
added the entire share application money
of Rs. 51.10 lakh as income of the assessee by way of deemed dividend.

Before the Commissioner (Appeals),
on behalf of the assessee it was argued that the entire share application money
had been taxed as deemed dividend in the hands of the assessee as well has her
husband, which had led to double taxation. It was argued that the amount of the
deemed dividend, to be taxed in the asessee’s hands, should be restricted to
the percentage of the assessee’s shareholding in the recipient companies.

The Commissioner (Appeals), while
upholding the taxation of deemed dividend, directed the assessing officer to
apportion the entire advanced amounts between the assessee and her spouse as
per their shareholding pattern in the lending company and not in the recipient
company as was claimed by the assessee subject to the fact that it was taxed in
both hands of the assesseee and her husband. In case there was no taxation in
both hands, the Commissioner (Appeals) held that the question of apportionment
did not arise.

Before the Tribunal, it was argued inter
alia, that the share application money advanced to the recipient companies
should be taxed in proportion to the shareholding of the assessee and her
husband in the recipient company.

The Tribunal rejected the
assessee’s main contention that since the computation mechanism failed, no
addition of deemed dividend could be made. It observed that the entire advances
or loans, given to the concerns of the shareholders having substantial interest
were required to be taxed to the extent of accumulated profits. It observed
that dividend was always distributed to the shareholders of the company, and
the entire advances or loans given to such concerns of shareholders with
substantial interest should be brought to tax to prevent unauthorised
distribution of dividend to the controlling shareholders in the guise of loans
and advances.

On the issue under consideration
the Tribunal observed that there was no other shareholder who had substantial
interest in both the payer company and the recipient company, other than the
assessee and her husband. Therefore, the Tribunal held that the advances given
to the recipient companies were required to be taxed in the hands of both the
assessee and her husband. It however expressed its inability to follow the
decision of the Delhi tribunal in the case of Puneet Bhagat (supra),
wherein the Delhi Tribunal had held that the dividend would be assessable in
the hands of the shareholders in the proportion of the shareholding of the
shareholders in the recipient entity. The Hyderabad Tribunal observed that
dividend was always payable to the shareholders of the payer company, and
non-shareholders had no right in the dividend. Hence, according to the
Tribunal, the question of taxing the deemed dividend as per the proportion of
shareholding in the borrowing company did not arise.

The Hyderabad Tribunal, in holding
as above that the proportion should be in the ratio of the holding in the payer
company, relied upon the observations in the decision of the Mumbai bench of
the Tribunal in the case of ITO vs. Sahir Sami Khatib 57 taxmann.com 13,.
The Hyderabad Tribunal therefore expressed its inability to accept the
contention that the deemed dividend should be assessed in the hands of the
assessee in proportionto the assessee’s shareholding in the recipient company.

Observations

If one analyses the objective
behind section 2(22)(e), as noted by the Hyderabad Tribunal, it is to tax a
shareholder who is circumventing the taxation of dividend by taking the benefit
in a disguised form as a loan to another concern. That being the purpose, it is
no doubt true that the person who has got the benefit should be taxed to the
extent of the benefit that he has derived. However, when a loan is given to a
company or other concerns, one can perhaps say that the shareholders of the
borrowing company or the members of such concerns have received an indirect
benefit in the ratio of their shareholding in the borrowing company or in the
income sharing ratio of such concerns.

The argument on the other hand is
that normally, if the intention of shareholders of a company is to give a loan
to another entity instead of distributing dividend, they would have factored in
the shareholding of that other entity, to ensure that the shareholders of the
lending company get the benefit of the accumulated profits indirectly in the
ratio of their entitlements to such profits in the receiving company.

Given the fact that this is a
taxation of dividend, unless it can be demonstrated that the benefit has
actually flowed to the shareholders in a different ratio, the more appropriate
ratio to be adopted in such cases is the ratio of the shareholding of the
assessee in the lending company. The difference of opinion between
the Delhi and the Hyderabad benches of the Tribunal is limited to the adoption
of the proportion in which such loan is to be taxed; should the proportion be
determined w.r.t the shareholding pattern of the shareholders in a lending
company or should it be w.r.t such pattern in the receiving company or concern.

The decision of the Mumbai bench of
the Tribunal in the case of Sahir Sami Khatib vs. ITO(supra) relied upon
by the Hyderabad Tribunal has been upheld by the Bombay High Court, on the
facts of the case, in [ITA No 722 of 2015] vide its order dated 3^rd
October 2018 for reasons not relevant in deciding the issue under
consideration. The Bombay High Court observed in this case:

“Equally, we find that the
reasoning given by the ITAT that there cannot be any proportionate addition of
deemed dividend taking into consideration the percentage of the shareholding in
the borrowing company, does not give rise to any substantial question of law.
In the factual matrix before the ITAT, it held that Section 2(22)(e) of the I.
T. Act, 1961 does not postulate any such situation. This is especially the case
before us as there is only one shareholder that has a shareholding in the
lending company as well as in the borrowing company. This being the case and
purely factual in nature, we do not think that the ITAT was in any event
incorrect in rejecting this argument of the assessee. We may hasten to add that
different considerations may arise if two or more shareholders are shareholders
of the same lending company and the same borrowing company. In such a factual
position it could possibly be argued that the addition ought to be made on a
proportionate basis. However, we are not examining this issue in the present
case as the facts before us are completely different.

The last decision relied upon by Ms
Jagtiani was a decision of the Delhi ITAT wherein it appears that the Delhi
ITAT has allowed the proportionate allocation of deemed dividend on the basis
of the shareholding of the borrowing company. We find this Judgment to be
wholly inapplicable to the facts of the present case as in the facts of this
decision, both the shareholders were holding more than 10% in the lending
company and more than 46% in borrowing company. In fact, there were only two
shareholders of the lending company as well as of the borrowing company. It was
in these peculiar facts that the Delhi ITAT came to a conclusion that the
deemed dividend ought to be proportionately divided. In the facts before us,
and as mentioned earlier, the appellant – assessee is the only shareholder who
is the shareholder of the lending company as well as that of the borrowing
company. This being the case, the ratio of the Delhi ITAT is squarely not
applicable to the facts and circumstances of the present case.”

From these observations of the
Bombay High Court, it is clear that the decision of the Mumbai bench of the
Tribunal in Sahir Sami Khatib’s case was based on entirely
different facts, where there was only one shareholder who fulfilled the
conditions of being the beneficial owner of more than 10% of voting power in
the lending company, and more than 20% of the shareholding in the recipient
company. It was on these facts that both the Mumbai Tribunal and the Bombay
High Court held that there was no question of proportional taxation of deemed
dividend. Therefore, to that extent, the reliance of the Hyderabad bench of the
Tribunal on the decision of the Mumbai bench of the Tribunal was not justified.

Useful reference may be made to the
decision of the Pune bench of the Tribunal in the case of Kewalkumar Jain
vs. ACIT 144 ITD 672, though the issues in that case were slightly
different. In that case, loans were given directly to the four shareholders
holding more than 10% of the shares of the company (the total holding of such
shareholders being 100% of the company), and the aggregate value of such loans
amounting to Rs 3.81 crore exceeded the total accumulated profits of the
company, which amounted to Rs. 2 .61 crore. The assessee had a shareholding of
14%, and received a loan of 0.76 crore.

The assessing
officer had computed the assessee’s share of accumulated profits at 14% of 2.61
crore, amounting to Rs. 0.36 crore, added the assessee’s proportionate share of
the general reserve, and since such amount of Rs.0.42 crore was less than the
loan received by the assessee, had taxed such amount of Rs 0.42 crore as deemed
dividend in the hands of the assessee. In this case, the Commissioner exercised
his revisional powers u/s. 263, setting aside the assessment with a direction
to the assessing officer to arrive at the correct available accumulated profits
for considering the amount of deemed dividend assessable in the hands of the
assessee. According to the Commissioner, there was nothing in section 2(22)(e)
permitting or prescribing the restriction to the proportionate amount of
accumulated profits.

The Tribunal set aside the order of
the Commissioner u/s. 263, noting that the balance of the accumulated profits
had been taxed in the hands of the other shareholders, and hence there was no
error in taxing only the proportionate accumulated profits in the hands of the
assessee. This decision of the Pune Tribunal therefore does indicate that the
relevant ratio for the purpose of taxation of deemed dividend is the proportionate
shareholding in the lending company, where more than one shareholder is
chargeable to tax on the deemed dividend.

Fortunately or otherwise, with
effect from 1^st April 2018, this issue would no longer be relevant,
except perhaps for the disclosure by the shareholders of exempt income in their
returns of income, since such deemed dividend would also now be subject to
payment of dividend distribution tax at the rate of 30% u/s. 115-O by the
lending company, and would be exempt in the hands of the shareholders.

shailesh.kwebmaker

ROLE OF INDEPENDENT DIRECTORS

If there is
one institution that has been seen as a panacea for all ills in corporate
India, it is that of independent directors. The role of the independent
directors has come to mean different things to different people. Like the story
of the blind men and the elephant, it has come to mean different things
to different people. Some believe the independent director to be a strategic
guide; others want her to be a conscience-keeper; while yet others believe she
is a policewoman, who some believe is a watchdog and others believe must be a
bloodhound.

First, a word
on what exactly a director, or for that matter, the Board of Directors is meant
to do. Directors are those who direct the running of the company. The Board of
Directors comprises the individuals who direct the course of operations. The
management conducts the affairs of the company under the overall
superintendence, oversight and control by the Board of Directors. The
management of a company holds office at the pleasure of the Board of Directors.
Directors of a company hold office at the pleasure of the shareholders of the
company.

Once the Board
of Directors is appointed, the shareholders move out of the picture in relation
to the day-to-day oversight of the company. It is for the directors to govern
the company in terms of the Articles of Association. It is the directors who
are meant to provide strategic direction and guidance to the management of a
company. That is their main role. An attendant consequence is the role of being
policemen keeping vigil over the conduct of affairs by the management.

In this
context, sits the office of independent directors, which is now firmly codified
into the law. Making its debut in the Listing Agreement – a statutory agreement
between listed companies and stock exchanges – the concept has moved firmly
into Parliament-made company law, and indeed in the SEBI (Listing Obligations
and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”)
governing listing obligations that has replaced the listing agreement. With
each move in this regulatory waltz, the expectation, role and scope of what is
expected from an independent director has kept changing. Add to this rulings by
courts that have at the least laid down what cannot be ruled out from the role
of these directors.

Independence from?

Yet, to begin
with, one has to necessarily understand what the law expects from independent
directors in terms of independence – are they meant to be independent of
ownership or are they meant to be independent from management? As defined, the
independence is expected from both ownership and management. The definition
rules out independence of a director on both counts. An equity ownership
interest of two percent or more would result in a director being regarded as
non-independent. Likewise, senior executives of a company who become directors
would not be considered independent unless three years have passed since their
association with the company.

However, the
facet that skews the picture in any case is that all independent directors
would in any case rely on the vote of all shareholders to be appointed to the
Board of Directors – just as any other director would have to be voted into
office. In other words, every director, including the independent director,
holds office at the pleasure of the majority vote of the shareholders.

How
independent can the director therefore be, purely as a matter of political
science, from the shareholder? The answer perhaps does not lie in making the
majority owners, or controlling owners (under Indian law, “promoters”)
ineligible to vote for independent director appointments. The answer in fact lies in recognising that
independent directors cannot be totally independent of ownership and can indeed
lose their office by being voted out for being unpopular. Therefore,
strengthening the institution of the independent director, granting an
independent director protection of tenure, and providing conceptual clarity on
real role expectations is the way to go.

The very
concept of independent director is one that has developed as a matter of best
practice elsewhere in the world, but has been codified into the law here. Best
practices that evolved with the aim of minimising the risk of litigation
against those involved in governance of companies as a shield against
litigation, have become swords that directors need to defend themselves
against.

Role of
Independent Directors

The question
of whether a director is meant to represent the interests of the shareholders
has been well settled in case law.
Company law is quite clear that the role of every director on the Board
of Directors, whether independent or not, is to apply her mind to serving the
best interests of the company, and not of the shareholder who nominated her to
be appointed. Indian company law has been codified for long. However, what
standards a director must bring to bear, how she is supposed to conduct herself
in decision-making, and what is a realistic expectation from her was left
substantially to the sphere of judge-made law, laid down when dealing with
controversies and proceedings presented to them for resolution. India is a
common-law jurisdiction – gaps in the statute are filled in by judges,
providing meaning to ambiguities and inconsistencies based on the principles of
justice, equity and good conscience.

Some of these
principles are now codified into the Companies Act, 2013 (“the Act”), with
section 166¹ , which contains motherhood statements in the
expectations from directors in general, leaving the burden of establishing the
tests and standards to be applied when ruling on alleged violation of the
provision, to the courts – but more about that later. Once appointed, a
director has a fiduciary duty to discharge to the company and she is not a
servant of the shareholders who appoint her. The shareholders cannot impinge
upon the exercise of rights by a director in discharge of the fiduciary duties
of the director. Shareholders cannot dictate terms to directors except by
amendment of Articles of Association or by sacking the directors².

In the words
of the court, in the first-cited judgement in the footnote to the foregoing
paragraph:-

“The
shareholder….. is entitled to consider his own interests, without regard to
interests of other shareholders. However, Directors are fiduciaries of the
Company and the shareholders. It is their duty to do what they consider best in
the interests of the Company. They cannot abdicate their independent judgment
by entering into pooling agreements.”

_______________________________________________

1 References to Sections
by number are references to provisions of the Companies Act, 2013 while
references to Regulations by number are references to provisions of the SEBI
(Disclosure Obligations and Listing Requirements) Regulations, 2015.

2              All these principles are well
stated by a Division Bench of the Hon’ble Bombay High Court in the case of
Rolta India Ltd. & Another Vs. Venire Industries Ltd. & Others 2000
(100) Comp. Cas. 19 (Bom) and has been well analysed in other decisions
applying the principles found in this judgement, including Mrs. Madhu Ashok
Kapur & 3 Others Vs. Mr. Rana Kapoor & 8 Others – decision by Justice
Gautam Patel of the same court on June 4, 2015

“In our view,
the curtailment of the powers of Director by enforcement of such a clause would
not be permissible. Clause 8 would result in curtailment of the fiduciary
rights and duties of the Directors. The shareholders cannot infringe upon
the Directors’ fiduciary rights and duties. Even Directors cannot enter
into an agreement, thereby agreeing not to increase the number of Directors
when there is no such restriction in the Articles of Association. The shareholders
cannot dictate the terms to the Directors, except by amendment of Articles of
Association or by removal of Directors.”

[Emphasis
Supplied]

In the second
judgement referred to in the footnote to the foregoing paragraph, the court
rejected the attempt to cite the aforesaid judgment to support arguments
relating to the facts of the case before the court, but well reiterated the
same principle thus: –

“Or take a
nominee director, that is, a director of a company who is nominated by a
large shareholder to represent his interests. There is nothing wrong
in it. It is done every day. Nothing wrong, that is, so long as the director
is left free to exercise his best judgment in the interests of the company
which he serves. But if he is put upon terms that he is bound to act in
the affairs of the company in accordance with the directions of his patron, it
is beyond doubt unlawful, or if he agrees to subordinate the interests of
the company to the interests of his patron, it is conduct oppressive to the
other shareholders for which the patron can be brought to book .”

[Emphasis
Supplied]

The
codification of directors’ responsibilities in section 166, is a game-changer
in what company law means for directors.
For independent directors, the Code of Conduct stipulated u/s. 149 read
with Schedule IV, is another game changer. These are now explicit provisions of
the law that require directors to be mindful that their constituents are way
beyond shareholders alone. For all directors, the term used is “stakeholders”
u/s. 166 while for independent directors, there are specific obligations
imposed to be mindful of the interests of minority shareholders.

Therefore,
many of the past practices and comfort zones reached by corporate Boards of
Directors, are up for disruption. The impunity that has been demonstrated in
the past is no longer a light matter – indeed, companies are now actively
considering becoming private limited companies so that they are not bound by
the statutory obligation of maintaining the institution of independent
directors. A case in point is Tata Sons Ltd., which is a “systemically
important core investment company” and has sought to convert itself into a
private limited company amidst litigation over governance standards applied in
that company⁴.

What is clear
is that independent directors can now be litigated against as a matter of
codified legal standard, with principles-based law that forms part of statutory
obligations set out in Schedule IV of the Act.

Limitation of
Liability

Now, one facet
of the law that is not fully appreciated among Indian corporate boards yet, is
that while the limitation of liability for shareholders is limited,
increasingly, the limitation of liability for directors seems to not be so. The
Act has codified the obligation to have independent directors⁴; the qualifications of an independent director⁵;
the duties of independent directors⁶, with a specially stipulated
Code of Conduct for independent directors⁷. A fully codified robust
statutory framework for governance of companies in India is now formally in
place.

It is settled
law that every director of any company (including directors nominated by
specific shareholders) are meant to address and look after the interests of the
company and not the interests of the shareholders nominating them.

A director
indeed holds office at the pleasure of the shareholders, who can appoint,
remove or replace a director in compliance with other applicable law, by
passing an ordinary resolution. This is in fact the reason for the Takeover
Regulations to provide that a right to appoint a majority of the Board of
Directors constitutes “control” and it is the shareholder holding the majority
of a company who is deemed to be acquiring the voting rights in any listed
company, held by the company being acquired.

A ruling by
the Hon’ble Supreme Court just before the onset of the Act and the LODR
Regulations is instructive in appreciating this growing trend in this area of
jurisprudence. Upholding monetary
penalty imposed against directors of a company for a finding of market abuse by
a company, in the case of N. Narayanan vs. Adjudicating Officer, SEBI⁸
the Court actually ruled that the role of directors in listed companies is
meant to be a “particularly onerous” one, stating that “the Board of Directors
makes itself accountable for the performance of the company to shareholders and
also for the production of its accounts and financial statements especially when
the company is a listed company.”

_________________________________________________________________

3 Disclosure: The author is involved as an advocate
in the litigation and is interested in the intervention against Tata Sons Ltd.

4 Section 149(4)

5 Section 149(6)

6 Section 149(8) read with Schedule IV

7 Schedule IV to the Act

8 Civil
Appeals no. 4112 – 4113 of 2013 – available at:
http://judis.nic.in/supremecourt/imgs1.aspx?filename=40338

In the court’s
own words (paraphrasing would not do justice to the content): –

Responsibility
is cast on the Directors to prepare the annual records and reports and those
accounts should reflect ‘a true and fair view’. The over-riding obligation of
the Directors is to approve the accounts only if they are satisfied that they
give true and fair view of the profits or loss for the relevant period and the
correct financial position of the company. Company though a legal entity cannot
act by itself, it can act only through its Directors. They are expected to
exercise their power on behalf of the company with utmost care, skill and
diligence. This Court while describing what is the duty of a Director of a
company held in Official Liquidator vs. P.A. Tendolkar (1973) 1 SCC 602
that a Director may be shown to be placed and to have been so closely and so
long associated personally with the management of the company that he
will be deemed to be not merely cognizant of but liable for fraud in the
conduct of business of the company even though no specific act of dishonesty is
proved against him personally. He cannot shut his eyes to what must be
obvious to everyone who examines the affairs of the company even superficially.

The facts in
this case clearly reveal that the Directors of the company in question had
failed in their duty to exercise due care and diligence and allowed the company
to fabricate the figures and make false disclosures. Facts indicate that they have overlooked the numerous red flags in the
revenues, profits, receivables, deposits etc. which should not have escaped the
attention of a prudent person. For instance, profit as on quarter ending June
2007 was three times more than the preceding quarter, it doubled in the quarter
ending December 2007 over the preceding quarter. Further, there was
disproportionate increase in the security deposits i.e. Rs. 36.05 crore in
September 2007 to Rs. 270.38 crore in December 2007 as compared to increase in
the number of theatres during the same period. They have participated in
the board meetings and were privy to those commissions and omissions.

[Emphasis
Supplied]

All the
judgements and precedents cited above involved the law governing directors and
their role prior to the Act and the LODR Regulations coming into force. Now,
the codified law stipulates the standards to be followed and expectations from
directors. To take just the role of
independent directors, summarising and paraphrasing just some of their
obligations under Schedule IV, such directors must: –

a) act objectively, constructively and exercise
responsibilities in the interest of the company;

b) not allow extraneous considerations to vitiate
objective independent judgment in the paramount interest of the company as a
whole;

c) bring independent judgment to bear on the
Board’s deliberations especially on issues of strategy, performance, risk
management and resources;

d) safeguard the interests of all stakeholders,
particularly the minority shareholders;

e) balance conflicting interests of the
stakeholders;

f) moderate and arbitrate in the interest of the
company as a whole;

g) seek appropriate clarification or amplification
of information and, where necessary, take and follow appropriate professional
advice and opinion of outside experts at the expense of the company;

h) ensure that concerns about any proposed action
are addressed and, to the extent that they are not resolved, insist that their
concerns are recorded;

i) ensure adequate deliberations before
approving related party transactions and assure themselves that the same are in
the interest of the company; and

j) hold meetings of just the independent
directors at least once in a year, without the attendance of non-independent
directors and members of management.

Each of these
standards would necessarily entail mixed questions of fact and law in disputes
involving interpretation of Schedule IV. Section 166 is but a synopsis of these
tests and is made applicable to all directors, whether or not independent. The
LODR Regulations, which follow more of a check-the-box framework for
composition of the Board of Directors and of sub-committees of the Board of
Directors or listed companies, too have to be read with Section 166. It must be remembered that the provisions of
the SEBI Act, in particular, sections 11 and 11B, entitle SEBI to issue
directions “in the interests of the securities market”. Such directions may be
issued by SEBI of its own accord without having to convince any independent
judicial mind about the appropriateness of its intervention. The only check and balance is a post-facto
statutory appeal to the Securities Appellate Tribunal.

This poses
multiple nuanced threats to directors. Actions may be taken suo motu by
SEBI where it is convinced that a director must be taught a lesson. These may
take the form of restraint not to deal in securities or not to join the board
of directors of other listed companies or capital market intermediaries for
specified periods. Action by SEBI could
be triggered by a complaint by other regulatory agencies and tax authorities.
There is precedent of regulatory action triggered in such a manner. It is only a matter of time for the gravity
and creativity in the application of the law to reach the doorstep of
independent directors of companies that SEBI acts against.

Some independent directors are also prone to
getting carried away and get involved in the day-to-day functioning of the
company – at times with direct access to the employees whose line of reporting
is to the CEO. Whether a director has
been truly in charge of day-to-day operations or only relied on Board processes
for oversight of the company, will always be a mixed question of fact and law,
requiring tedious evidence.

Given the
scope for intervention by the securities regulator and indeed other regulators
who may be regulating the company in question, one must be very clear and have
very specific and formal processes for an independent director’s engagement
with the company.

Whether every director has then acted in the interests
of the company would become the question to ask. Derivative suits by shareholders in any civil
court present a serious threat to directors having to answer allegations about
their conduct. To summarise, if the general standard for directors of listed
companies as laid down by the Supreme Court in the Narayanan case (supra)
is to be followed under the newly-legislated framework set out in the Act and
the LODR Regulations, being a director, and more so, an independent director at
that, would not be an easy call.

shailesh.kwebmaker

INTERVIEW | ISHAAT HUSSAIN

In celebration of its 50th Volume, the BCAJ brings you a series of interviews with people of eminence, those whom we can look up to as outstanding professionals. These are persons who have reached the top of their chosen spheres, are leading lights of the profession and who have set high standards for others to emulate.

The fourth interview in this series features the indefatigable Mr. Ishaat Hussain. Originally from Patna, Bihar, he went to Delhi to study at St. Stephen’s College and then to England to pass Chartered Accountancy from ICAEW. He went through the rank and file at Tata Steel during one of the most fascinating times in the history of that company. He worked under four Chairmen at the Tata Sons, worked with stalwarts at the Tata Steel and played number of roles from financial management, tax, M&A, operations, banking, and so on. He served on Boards of several iconic and respected companies of India. Most notably, he served as Finance Director of Tata Steel, Board member at Tata Sons, chairman at Voltas and other group companies. 71 years old now, Mr. Hussain is a treasure trove. He tells his story, recalls anecdotes, shares his perspectives on life and work in this interview with BCAJ Editor Raman Jokhakar and Past Editor Gautam Nayak. Read on for his take on Fair Value Estimates, expectations from auditors, idea of success, conflicts of interest and what made him tick at the House of Tatas …

Raman Jokhakar: Can you tell us a little about your childhood, your formative years, what made you choose the Chartered Accountancy course and, if I may ask, why from the ICAEW? After that, how did you find your way to the Tata group?

I am from Patna. My father was a doctor and my mother’s family hailed from Lucknow. In those days, it was quite rare for a Bihari to marry in UP. I am 71 years old now; I did my initial schooling in Patna and then went to Doon School. I spent 5 years there, did my senior Cambridge and then went to St. Stephen’s for my BA with Honours in Economics. St. Stephen’s has probably produced 50% of the bureaucrats (and Ambassadors of India). One career option was to attempt to get into the IAS. The other choice was to do Chartered Accountancy. In retrospect I think it was the right decision not to go for the IAS. I have many friends in the IAS. They were all very bright – but they were quite frustrated at the end of their tenures!

I had a friend whose father was the Finance Director of Glaxo. He was going to do Chartered Accountancy. He put the idea of doing Chartered Accountancy in my head. I had lost my father when I was 15, so there was also a heavy emphasis on security. One thing that I have learnt about the Chartered Accountancy profession is that as a CA you will never starve. It is a “safe” profession.However, I knew that the pass rates were very low and it was very difficult to clear the exams. An elder cousin was in business and he was my mentor. When I mentioned Chartered Accountancy to him, he said it was an excellent idea. Besides, I had the aptitude. In school, I was reasonably good in maths. I did higher maths and got good grades. I also studied economics, which in retrospect was a good decision.

For a CA if you have a good knowledge of economics it helps you enormously in understanding finance. My cousin’s auditors were A F Ferguson & Co and I got articleship with them at Allahabad Bank Building in Bombay (Fort) right after my BA results. I was there for a year from July 1967.

GOING TO ENGLAND

However, almost all my college mates had gone to England to do their CA. I was a bit late on the draw. I was pretty comfortable here. But my friends kept saying – come here, come on, come over. So I finally started looking around for articleship in the UK. It meant that I would lose a year – but that was not bad because at Ferguson’s I got excellent training as an articled clerk. Finally, when I went to England, although I had lost a year, I was up to speed in accounting matters. My firm (in the UK) was very happy because of the experience I had (from the previous articleship). I was just 20 years old then, the world was opening up and it was thrilling to experience what was happening. India was a bit moribund at that time, not as advanced as it is today.

In the UK I joined a medium-sized firm. Doing small audits in the UK was a very different experience and a great learning in those days. In small firms you learnt a lot about accounting. Some of the clients could not put their final accounts together and you had to handle ‘incomplete records’. You won’t believe this, but once I had to prepare the accounts of some Pub. The proprietor came with a sack and left it on the table – that sack contained cheques, stubs, vouchers and all that you needed to piece his accounts together! Putting a set of accounts together from incomplete records provided tremendous learning. Even today, unless I am satisfied on the debits and credits I find it difficult to move ahead.

To return to my Chartered Accountancy, I passed my Inter with flying colours. I was in the top 5%. I got to my part 1 and then to part 2 and passed that also at the first attempt. That gave me terrific confidence in myself, plus I gained good experience, too. I used to do the largest audits for the firm.

And then, for personal reasons, I decided to come back to India. Very few amongst my contemporaries came back, Deepak Parekh was one of them, although I didn’t know him there. Keki Dadiseth was also a very dear friend and was also at Ferguson for a year. He, too, came back. I can count on my fingertips the number of people who came back.

BACK IN BOMBAY

On my return to India, I joined the ICI Group and was posted as the Financial Accountant to CAFI (Chemicals and Fibres of India) which used to make Terylene under the brand Terene. I joined them in Vashi where Reliance (ADAG) stands today. It was a great experience for me because I looked after all accounting, banking and insurance matters. As a front line manager, I also got to handle a large body of unionised staff. In those days, unions were very strong. Everything was a negotiation. Industrial relations in Bombay were not good and in CAFI, it was definitely bad. In fact, CAFI were just recovering from a two month old strike prior to my joining. This exposure to managing a large body of unionised staff has held me in very good stead throughout my career. That is why whenever I recruited accountants, I used to tell them while by and large all C.A.s have the requisite technical skills, they need to sharpen their people and inter-personal skills.

I was with CAFI for a year and a half; in ICI they used to transfer people around very quickly. I was transferred to ACCI (Alkali and Chemical Corporation of India) which used to make Dulux and Duco paints which was a very hot commodity in those days. I was with them in Bombay as the Regional Accountant. The Regional Accountant had much more to do than accounting, and the accounting was very simple, involving just branch accounting. But the godowns also reported to the Regional Accountant. All the contracts of the transporters used to be negotiated by me. Thus, I got considerable commercial experience.

LIAISING WITH BANK AND LENDERS

Since ACCI was headquartered in Calcutta and all the Financial Institutions such as IDBI, ICICI, LIC, the banks and RBI had headquarters in Bombay, a part of my job as the Regional Accountant was to liaise with these institutions. This was a unique and great experience and I was really lucky to get this exposure. One of the long-standing benefits of which was that many of those whom I dealt with in the 1970s had risen to the highest levels in these organisations which was of considerable value to me when I returned to Bombay in the ‘90s.

When I had completed five years, I felt I needed to step out and learn more about financing capital evaluation, project evaluation and so on. I mentioned this to my Finance Director and he said “fine, you come and work as my assistant”. I was transferred to Calcutta as Assistant to the Finance Director. There was a Finance Director, there was a Head of Finance and there was the Assistant (me). The three of us were a sort of think tank and I used to do all the legwork. In those days, there were no Excel spreadsheets.

While working on the financial part of the project evaluation, one had to start getting involved with the engineers to understand how the project cost was developed, talk to the commercial people about how they looked at the markets and assess the demand. One might have read all this in textbooks but I was now doing all this in practice. ICI was a very process oriented company. Both at CAFI and ACCI, the systems and procedures were well developed, though computers, thanks to the unions, were few and far between. Charts of authority along with delegation of powers, checks and counter balances and so on were in place and governance was of a high standard. ICI was also very sound in financial analysis and techniques. If you remember, in the early ‘80s, inflation was running at a very high level. In fact, there were proposals to dump “Historic cost Accounting” and to adopt “Inflation Accounting”. In ICI I was involved in “inflation accounting” which had been mandated by the ICAEW – it was a fascinating intellectual exercise.

I strongly believe that after one qualifies, one’s first job must be with a good company where one can get hands-on experience and exposure to good systems, procedures, governance and management.

Gautam Nayak: From heading financial functioning at a flagship entity to Tata Sons, how did that happen? Any memorable stops along the way?

My ex-boss at CAFI left the ICI Group to join Indian Oxygen. The Chairman of Indian Oxygen was Mr. Russi Mody. Mr. Mody told him that he was trying to modernise Tata Steel, particularly the finance and accounts department, which he felt was very archaic in its approach. He wanted to rejuvenate Tata Steel. He asked him whether he knew of any young guys who would consider joining Tata Steel. To cut a long story short, I agreed to meet Mr. Mody. We had an interview. He offered me two jobs – one was the number 2 man in accounts in Jamshedpur and the other was Finance Director in Indian Tube Company, which at that time was among the top 100 companies in India. I chose the latter.

THE SKY IS THE LIMIT

Indian Tube Company was 40 % owned by Tata Steel, 40 % by British Steel (which Tata Steel later acquired) and 20 % was held by the Indian public. It was not a listed company. British Steel was in trouble at that time and wanted to sell their shares and Tata Steel wanted to buy them out. Mr Mody told me that they were looking for a Finance Director, and he added that some day it would merge with Tata Steel and I would be back with him in Tata Steel. If I did well, then the sky was the limit for me. I said I would take my chance. I was only 30 or 31 then. That’s how I came in to Tatas.

In 1983, Indian Tube merged with Tata Steel. The Board continued because the merger was a contested merger and that was another experience that I had – how to deal with contested mergers. One of my jobs was to see the merger through. It went up to the MRTP (there was a hearing at MRTP). I made a presentation before them. I learned about share valuations and got a good understanding of M & A. It was a terrific learning experience. I continued to be on the Board because the company was not dissolved till two and a half years later but I, as an executive, was transferred to Tata Steel and became the Joint Director of Accounts, the no. 2 man – something that Mr. Mody had originally offered me.

Mr. Mody gave me two tasks at Tata Steel – to complete the merger and to go and “smell” Jamshedpur because what he had in mind for me was the position of Finance Director of Tata Steel. But he told me that in order to become the Finance Director it was necessary to go and live in Jamshedpur, to see what steel is about, imbibe the culture of Tata Steel and the Tatas.

OVER TO JAMSHEDPUR

I went to Jamshedpur as no. 2 but very unfortunately, the Director of Accounts (DOA) got a heart attack and took retirement. So I became the Director of Accounts. At that time, Mr. Mody was acquiring companies – Kumardhinbi Fire Clay, Metal Box Bearings Division, Dairy Ashmore. I dealt with all these three acquisitions, in addition to the ITC merger.

As Director of Accounts, I was truly overawed by the enormity of the job. The diversity of Tata Steel’s operations is best captured by the famous by-line “We also make Steel”. Furthermore, the Director of Accounts was not only responsible for accounting for such a diversified company, he was also responsible for despatches of all the steel from Jamshedpur. In other words, all the weighbridges came under the DOA’s charge.

Furthermore, the maintenance of attendance records, the Time Offices, which meant keeping a tab on some 45,000 people also came under the DOA’s jurisdiction. And you have to keep in mind this was in the ‘80s when there was very little computerisation. The departments reporting to me had a strength of 2000 people!

I often reflect on how I came through this “Baptism by fire”. As I said earlier that by and large, C.A.s have a high level of technical skills, but to manage a large body of people, one must have competence in inter-personal skills. I didn’t manage by sitting in my room. I was young then and I had boundless energy. I made it a point to be in touch with the troops, visit them informally and have some tea and pakoras with them. I would slap their backs, joke with them, motivate them – and I actually brought the overtime level down.

I treated my fellow professionals, about 150 of them, as equals and empowered them fully. I concentrated on doing things that I believed I could do better than anyone else and left the experts and specialists alone. However, I did not abdicate my responsibility and told them to come to me if they had a problem.

I was also very lucky with my choice of people. About two years into my tenure as DOA, I began a search for my successor. With the help of Mr. Mody, we selected Mr. R. Sankaran, from SAIL as the Joint Director of Accounts. Mr. Sankaran was an outstanding professional, some 15 years my senior and vastly more experienced than I was. I credit him for much of my success, not only when I was in Jamshedpur but later on when I moved to Bombay as Finance Director.

I truly believe that you must get people who are the best, even better than you, and if you have to work under them, then so be it. The organisation is more important than individuals. However, I have also learnt that what people value most is recognition and respect and who reports to whom is irrelevant. It is the team that matters.

Amongst the more significant impacts that I made as DOA in Jamshedpur was rationalising the manpower and setting the scene for the digital transformation which Tata Steel subsequently undertook.

With Mr. Sankaran in position and after completing four years in Jamshedpur, I told Mr. Mody I was ready for my next assignment.

MOVING TO BOMBAY HOUSE

I moved to Bombay House and became Finance Director. It was very interesting to work with Mr. Yezdi Malegam who was the Tata Steel Auditor and for whom I have the greatest respect. I think he is the finest accountant this country has ever had. I relied very heavily on him and he on me. We shared a very good relationship.

There was also Mr. Soonawala who was the Finance Director of Tata Sons. He was an outstanding man, a mentor in many ways. We all worked together as a team. We had only one objective – the good of the organisation. There were no personal agendas. This is where organisations fail and the culture you have to build is that of trust, a culture of respect. I did not give a damn about whether I was a Finance Director of Tata Sons or not. The respect, the treatment that I received, and gave, is what I value.

At Tata Steel, we did interesting things. We invented the SPN (Secured Premium Note). The financing of the entire modernisation programme of Tata Steel was an interesting challenge. I had Mr Tata and Mr Soonawala to advise and guide me. We worked collectively. Don’t be individualistic to seek credit. These are small things, but very vital in any organisation.

I attended Tata Steel Board meetings from 1984 when I became the Director of Accounts. Mr. JRD Tata was there – I saw him in action for 7 years. Mr. Nani Palkhivala was there, Mr. Keshub Mahindra was there. When I interacted with these people in the same boardroom, I was struck by their sense of decency. Although I was only 37 years old, they would listen to me, show me the courtesies. I developed confidence interacting with people like them.

TATA SKY IS DEAR TO MY HEART

In 1997-98, Mr. Tata was setting up his Group Executive Office. I had a very good relationship with him and had worked very closely with him. He was my Chairman. I used to meet him almost on a daily basis to report to him. So when he formed the Group Executive Office, he asked me to come and work with him. He said you can oversee Tata Steel as you know it so well now, get another man. So we brought in another person and I moved to Tata Sons as Executive Director with a clutch of companies to look after. And when Mr. Soonawala retired, I became Finance Director. I became Chairman of Voltas. I had earlier joined the Board of Titan in 1989 and was on the Board for 25 years! That was a terrific experience, tremendous breadth of businesses to be involved with – from steel to watches to jewellery and airconditioners. And when Tata Sky was formed, Mr. Tata told me to look after it. There was, of course, the telecom war, which was not a good story. I was also on the insurance companies for some time and eventually became chairman of two of them. In the meantime, there was the meltdown of Tata Finance. I became Chairman of Tata Finance, revived it and saved it. Tata Sons provided the money and there were a lot of people involved.

Tata Sky is very dear to my heart because I started it from scratch. I am so happy that it is likely to have an EBIDTA of over Rs.2,000 crores and a turnover of over Rs.6,500 crores. Its market valuation would probably be about $3 billion – it is an unquoted company.

It has been a very rewarding career. If I were to sum up, I would say that you have to do the right thing. Companies fail when they don’t do the right thing. Don’t get obstinate, don’t get arrogant, do the right thing. Do the right thing by people, build teams because it’s the people who deliver. People talk about strategy, I ask, what is strategy? Strategy for me is setting course. Once you have set your goal, go for it. You can strategise and decide what you want to do and how you want to do it. Once you have done that, then just execute.

This is what I have attempted to do in Tata Sky, in Voltas. When I took over Voltas, it was a Rs. 300 crore company (market cap), it used to make a profit of Rs. 40 to Rs.50 crores. By the time I left, it had a market cap of Rs. 20,000 crores. I was Chairman for 17 years and when I left it had cash of about Rs.1,800 crores and a pre-tax profit of Rs. 700 crores. People ask me, how did you do that? I say, I really don’t know. I just did my job. You just go to office and plunge into your job. My job was to set things right, get the teams in place. Just do the right thing, do it honestly, transparently and be execution-focussed.

(R): The big pillars of the Tata Group have stepped in and out; yet the culture continues. What is the secret behind keeping purpose and profit woven together in such a fine blend? Have these values ever taken precedence over business interests?

There is a certain ‘Tataness’. Where does it come from? I don’t know if I have the answer. There is a certain glue which keeps the group together. My feeling is that this comes from what the group stands for and that is what comes from the people must go back to the people. That is what Jamshetji Tata had said. The ownership structure of the Tata Group is such that we actually practice it – because whatever we do, eventually a large part of it goes back to the Trust, which it spends on charity. This, in my humble opinion, is the essence of it. That is how I felt. At the end of the day, kuch bhalaa kaam kiyaa. In the Tata Group, money is not an end; money is purely a means to an end. There is a certain-self actualisation and everybody across the group feels the same. Either they have thought through it, or they feel it. The Tata Trusts own 66 % of us, we are working for the trusts. The company is just a vehicle.

And we are very proud of our heritage. Of Jamshetji, Dorabji, JRD, Ratan Tata. Mr. Ratan Tata is an iconic figure. We have produced the only Bharat Ratna from the business world in this country. So many Padma Vibhushans, Padma Bhushans and Padma Shris have come from the Tata stable. Which organisation has achieved that? We are truly proud of this heritage. We feel proud of what we have given to the country. There is the TIFR (Tata Institute of Fundamental Research). The TISS (Tata Institute of Social Sciences). The Indian Institute of Science, Jamshedpur; Mithapur; Tata Motors in Pune; in Lucknow we have a huge plant. Wherever we have gone, we have served the community. Some human beings are driven just by money (I am not saying it is a bad thing). But many of us, after we reach a level of comfort, we want to give back. And that sense is very strong in the Tata Group.

When I spoke at the TISS the other day, I met a young lady who said she is doing work with the Tata Trusts. She said when she goes to talk to Tata Companies about CSR, she does not have to sell the concept of CSR to them. The connect is straightway. They know what CSR is. When she goes elsewhere, first of all people are really not interested. Secondly, she has to explain things to them. Thirdly, she doesn’t even know where she stands with them. So it all comes down to the Tata culture, our rich heritage with a very noble objective. And that is what I think keeps us together. We have had mishaps, but people forgive us.

(G): You worked with four group Chairmen. Can you share some stories about them, especially about JRD Tata!

In their own ways, they were all very exemplary people, exuding humility. The gap between me and Mr. JRD was very great. He was extremely courteous and correct. To give you an example…This was just after liberalisation in 1991. He was on the Board of Tata Steel but not Chairman (Mr. Mody was Chairman). Mr JRD was Chairman of Tata Sons. I was sitting in my room, my phone rang, it is not very often that he rang me up. He said this is ‘Jeh’ here (he called himself Jeh and we used to call him Mr. JRD). He said, are you busy? I said, not for you, Sir. He asked, are you sure? I said, absolutely sure. He said can you come up and have a cup of tea with me. I was perplexed! I went up to his office, very simple but elegant and classy. In fact, they have reconstructed his office in Pune.

When Mr. JRD used to sit in the chair in Tata Steel, he had 7 % of the vote, and although he was in charge and in control, he behaved as a person who only had a 7 % control. He would go round the table, he would speak very little, he would introduce the agenda, he would listen to everybody, forge a consensus. So that gives you a measure of the man and his transparency.

All the Chairmen I worked with were wonderful human beings, with a genuine heart for the less privileged. I have not seen that in many people – genuineness. They were all Deshbhakts. For them, anything that the group did, the question always asked was – is it good for the country. You look at our vision statements. It is all about the country. So that is what is remarkable about these people I have worked with – The Deshbhakts.

(R): How do the best Boards that you have been on deal with conflict of interest, particularly when promoters/groups control the Board? Any challenge you have come across as a Finance Director such as shared services, cross-charging, questionable transactions that need more probing – how did you deal with it as a Finance Director?

This is very easy to answer. No, I didn’t come across any challenge on this score. The problem of related-party transactions arises when people start having personal agendas.

(R): How does a large group like the Tatas handle the challenge of Related-Party Transactions?

As I said, the issue of related-party transactions and suspicion around them arises when people start having personal agendas. For us in the Tata Group, the culture discourages personal agendas and requires a high-level of integrity. We treat the independent Boards as truly independent Boards and all related-party transactions are entered into transparently, with an emphasis on substance over form.

(G): Conflict of Interest in respect of auditors – several firms have business entities with business relationship with audit clients. What are the best practices that Boards should follow from a legal and especially from an ethical point of view?

This is definitely an issue and a contentious one. While the Institute has laid down guidelines in this regard, I believe the accounting firms, particularly the Big 4, have to make a case for providing other services along with providing audit services. If providing just audit services is not a viable proposition, then it would appear to me that we do have a serious problem. To treat the audit as a loss leader, if that is so, is not an acceptable argument.

(R): From your long career as a Board member, have you seen expectations from auditors change – over the 80s to 90s to now – do Boards expect something different from what they used to?

No – it hasn’t remained static. I think what has really changed is the formation of Audit Committees. The formation of Audit Committees is a great innovation and a great force for good. Auditors now have a forum where they can strongly put their point of view across and they have time. It is up to the auditors now to make use of this forum to be much more forceful.

I think auditors must ask themselves – what does the man on the street expect from an auditor? How does he read an audit report? Is it true and fair, is it an opinion, or is it a certificate? The second point that I want to make is that the man on the street does not buy that the auditor is a watchdog, he wants the auditor to be a bloodhound. We were taught that the auditor is a watchdog and not a bloodhound. But now the ordinary man wants him to be a bloodhound.

(G): But from a practical perspective, considering the time limitations for an auditor, is it possible for him to be a bloodhound?

Given the technology that we have today, I think it is possible to be a bloodhound. Today everything is on the computer. Plug in your software and you can do a hundred percent check in 5 minutes. I think we have the technology to be a bloodhound.

(G): You feel an auditor should adopt technology better and work differently?

Of course. You can use it for fraud prevention. If I was the auditor, I would look at what the internal audit is doing; it should be the internal auditor’s duty to do checks on every transaction in real time. If they were not doing it, I would make an observation in the Auditor’s Report.

The other issue is – what do people really expect their Auditors to be signing off on? They are only giving a true and fair view. They are not giving the company a clean bill of health, right? But it should not be that you sign the accounts today and the company collapses tomorrow.

And this is why I believe Auditors must question the “going concern” assumption very closely before they sign off. The “going concern” assumption is that the business will be viable for the next 12 months. I strongly urge that Auditors should examine de novo the “going concern” assumption every year.

That brings me to my favourite topic – “cash profit” vs. “accounting profit”. As Chairman, I would start all my monthly, quarterly and annual accounts presentations by first looking at the cash flow statement. You start there and look at the key ratio of how much of your operating profit, how much of your PAT, is getting converted into cash. The cash flow should be the principle statement of account. It should not be item no. 3. It should be item no. 1. I don’t know if you studied the Carillion case…

(R): Yes. I have.

While they were reporting accounting profits, if you looked at their cash flows, there was clearly no case for declaring dividends for the last few years. It is the Directors who are charged with recommending payment of dividends, and given the cash situation, I am amazed how they could declare dividends while borrowings were rising alarmingly. Incidentally, the Auditors have come in for heavy criticism including for allowing the payment of dividends. This is clearly being unfair to the Auditors, but just goes to show peoples’ expectations from Auditors.

(R): Any views on Fair Value, Estimates and Judgements that now are a legitimate part of most financial statements – the shift from historical cost and prudence to market-linked approach?

The accounting that I learnt sought primarily to preserve the entity’s capital. From this grew the conventions of historic cost, prudence, accruals and going concern. If in any situation there was a conflict between prudence and the other conventions, then prudence would prevail. The historic cost convention has the advantage of verifiability. It is imperative that all the numbers in the financial statements are verifiable. While the argument for fair market value and mark to market are theoretically compelling, but in practice are very difficult to implement with any degree of certainty and objectivity.

The classic example of this difficulty was when options given by AIG to Goldman Sachs were valued and each party ended up with claims against the other party!

As I mentioned earlier, in ICI under instructions from the holding company we attempted inflation accounting in the ‘80s which tended to modify the historic cost convention. The idea was abandoned after a few trials because of the highly subjective nature of the assumptions that required to be made.

Therefore, to sum up, while I am sympathetic to the idea of fair value accounting, for the reasons explained earlier, I wouldn’t vote for it. However, even though my vote doesn’t count and Accounting Standards have accepted Fair Valuation Accounting, I would still urge that all unrealised gains arising from Fair Value Accounting should only be booked through other comprehensive income.

While “intangibles” are inherently difficult to value, and in many cases constitute a significant part of the balance sheet, one intangible in particular I would like to touch upon is goodwill arising on acquisition. Under extant accounting standards, goodwill is subject only to impairment testing. I have earlier spoken of my reservations about fair value accounting, and in the case of goodwill arising on acquisition, I strongly believe it should be amortised over a period of time. I’d like to draw your attention to a very interesting case I came across recently concerning Adidas in Germany. Adidas was carrying a large value for goodwill arising from an acquisition it made some 12 years ago. In Germany, they have a super regulator for financial reporting who disagreed on the value of goodwill being carried by Adidas, and the regulator forced Adidas to write down the value of goodwill.

(G): We saw some auditor resignations recently and some last-minute resignations. How do you see the role of auditors; any shortcomings you notice as a Board member?

Very good. I am wholly supportive of it. If they are not satisfied, and if the auditors take a stand, managements and boards can do nothing about it. I am not saying that they should become unreasonable. Be professional. Be what you were trained for. Be what you are taught in the classroom. Practice it. Don’t be unreasonable. I tell my friends who always knock auditors: I say to them, the auditor is a bit like the Reserve Bank of India. If the Reserve Bank of India says this bank is in trouble, there will be a run on the bank. If the auditor says that this company is not a going concern, there will be a run on it and it will pack up. This is a huge dilemma and I would advise auditors to make use of the regulators when they face this dilemma.

(G): SEBI has some regulations that if the auditor is qualifying, then the company can be forced to restate the accounts.

I am not aware of the regulation, but I don’t see any harm in it. In any case, the accounting standards do cover such eventualities.

(R): But isn’t it a matter of judgement where there is an element of subjectivity?

There you have to take materiality. If this judgement goes wrong, does this company go bankrupt? It depends on materiality.

(R): Has the idea of success changed over the years and how?

Yes, it has certainly evolved. I was very designation conscious at one point of time and I thought that that would be the measure of success. But that changed completely. Designations became irrelevant. At one point, money was important. But as I got better paid and I built up some assets – money became less important – how could I be helpful and useful? That became a great source of encouragement for me to continue.

(R): Some takeaways for the present generation!

Work hard, continuously widen your horizons, go beyond finance and accounting, go beyond business, have hobbies and you must play the game beyond the prize. Do your best. I can assure you that if you do your best, the results will come. I have not seen anybody who has tried and the result has not come.

You must have noticed I have stressed a lot on leadership and behavioural issues. I have done this for two reasons.
Firstly, while there is a lot of talk around this issue, I haven’t seen people really walking the talk. Secondly, peoples’ expectations of good Corporate behaviour is continuously increasing.Corporate behaviour and a company’s culture are strongly co-related. Hence, leadership and behavioural attitudes assume considerable significance.

shailesh.kwebmaker

Riding The Reset Button Constantly

Twelve
full moons have passed, and so have 360 sunrises as I write this. Holidays and
observances have gone by! Chartered Accountants are known to keep burning the
mid night oil to meet deadlines after deadlines. The year is over, Sir! It is
already Diwali.

Time
has flown by, to never return. Time is invisible, touching all there is. Time
is a temptress – every day looks like another day – but it really isn’t! The
Sanskrit word for time is Kaala. The word Kaala shares its root
with the Sanskrit words for death and black. Perhaps they all – time, black and
death – represent that which absorbs everything to a point of no return to its
original state. This Editorial therefore focuses on something to ponder around
the New Year.

Yuval
Noah Harai in his latest book – 21 Lessons for the 21^st Century
– writes about three threats staring at humans – Technology, Nuclear War and
Climate Change. A compelling new vision is not coming through in our fragmented
world order – from political, business or spiritual sides. How connected and
how evolved we are and yet how fragmented and shallow are some of our actions.
Take the recent Living Planet Report 2018. It tells a tale of what
humans have done so far to life around them. Homo sapiens have destroyed 95% of
all species that have ever come to this planet; since 1970, 60% of all wildlife
that existed then is extinct by manmade causes. Yet we are going on as if it is
business as usual. While we are focused on a $80 trillion world economy (or
whatever that number is), Nature gives us services worth $125 trillion per
year. Some of what humans do is not just cruel, but outright stupid too. No
other creature goes on a binge to destroy itself like humans. The word
Amazon brings an image of the online retail store these days, but 20% of the
real Amazon (forest) got wiped out in the last 20 years! Guess what –
consumption has played a big part in it. In other words: Amazons kill Amazon.
By Amazons, I mean the entire economic chain that entices us to consume. All
that we got and all that we need has its source in Nature. Just imagine the
pressure humans put on the planet – since circa 1800 the global population has
grown 7 times and Economic growth has been 444 times. Reading the report made
me wonder how misplaced our tools of measurement and epistemology of growth
are. We are moving fast but in the reverse gear!

On
the other hand there is good news. A new generation is re-shaping a messed up
planet – it does not want to own, does not need more and so it does not consume
like a maniac. This generation gets free news from the internet, sources free
books online¹, believes in solar and wind energy², they
are creating a sharing economy³. While the last generation bought
toys for their kids, this generation borrows toys from an online platform and
tells their children to take care of them, so that other children after them
will be able to play with them. This promise of change from ownership and
possession to sharing and circular economy – is a change in human thinking that
challenges present economic laws, legal structures, ideas of nations and rancid
belief systems. As one author writes, Geopolitics will be replaced with a
biosphere consciousness⁴. This silent transition will replace
consumerism by sustainability, capital by social capital, and being rich by
being valuable.

___________________________________

1 Even
the E Book share has nearly doubled in last 5 years to 25% of total book sales.

2 Germany’s
share of solar power is 7.5% of total consumption and India 2.2%. China has
added solar assets like never before – 43,530 MW in 2015 to 131,000 MW in
2017.

3 Statistics
say that sharing economy can eliminate 80% vehicles. Additionally, they will be
replaced by EV and perhaps driverless cars.

4 Refer ‘The Third Industrial Revolution’ by
Jeremy Rifkin.

Exclusivity
is substituted by inclusivity; a pyramid structure is giving way to open
source. People are realising that forest fires, floods, landslides have a
connection with hamburger and the beef⁵ in it. Simply speaking, many are finding out
that everything is interconnected and all that we do intimately affects someone
else and will boomerang back to us.

End
of 2016, I decided that through 2017 I won’t buy anything for myself (except
food) – like fasting on most forms of consumption. I could manage. As we march
into the New Year: let us consider to Refuse. Reduce. Reuse. Recycle. As
we begin the New Year let us consider offering back to the planet because if it
is not YOU then who and if is not NOW, then when?

New
Year means new beginnings – a cut-off to draw up a balance sheet of life and
revisit the reset button and stay at the beginning. As Jim Carrey puts it: “…Now
I am always at the beginning. I have a reset button. And I ride that button
constantly”. This festive season BCAJ wishes you and your family the very
best to ride that reset button whenever you need it all through a wonderful New
Year!

_________________________________________________________

5 The second biggest cause of climate change
supposedly is methane emissions from animals. Popular beef requires 28 times
more land than chicken and pork, 11 times more water, and results in 5 times
more climate warming emissions. Compared to potatoes, wheat and rice: impact of
beef per calorie is 160 times more land and 11 times more green house gases.

Raman Jokhakar

Editor

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shailesh.kwebmaker

39 Section 10B – Export oriented undertaking – Exemption u/s. 10B – Export from specified area of Iron ore excavated from specified area – Processing done outside specified area – Not relevant – Assessee entitled to exemption

Pr.
CIT(Appeals) vs. Lakshminarayan Mining Company.; 404 ITR 522 (Karn);

Date
of Order : 6^th April, 2018

A.
Ys.: 2009-10 to 2011-12

The
assessee was a firm in the business of mining and export of iron ore and was
granted a mining lease for an area of 105.2 hectors in Siddapura Village in
Bellary district. The assessee had entered into an operation and maintenance
agreement with NAPC, which operated the plant and machinery installed in the
export oriented unit and non-export oriented unit both belonging to the
assessee firm. The export oriented unit had started production on 23/09/2006
and accordingly the assessee claimed deduction u/s. 10B of the Act on the
profits derived from the production of iron ore from the export oriented unit
for the A. Ys. 2009-10 to 2011-12. The Assessing Officer disallowed the claim
with respect to production of iron ore said to have been outsourced by the
export oriented unit to the non-export oriented unit and restricted the claim
to the profits derived by the export oriented unit from its production.

The
Tribunal allowed the assessee’s claim.

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

“i) The processing of the iron ore
in a plant belonging to the assessee being in the nature of job work was not
prohibited and formed an integral part of the activity of the export oriented
unit; the mere fact that the plant was situated outside the bonded area was of
no legal significance as the benefit of customs bonding is only for the limited
purpose of granting benefit as regards customs and excise duty.

ii) The entitlement to deduction under the Act is
to be looked into independently and the benefit would stand or fall on the
applicability of section 10B. Hence the mere location of the plant outside the
export oriented unit and customs bonded area was not a disqualification to
claim deduction u/s. 10B. The assessee was entitled to exemption u/s. 10B.”

shailesh.kwebmaker

Section 68: Cash credits – Bogus loan – The proviso to section 68 inserted with effect from 01.04.2013, does not have retrospective effect – If the AO regards the loan as bogus, he has to assess the lender but cannot assess as unexplained cash credit

9. Pr.CIT – vs. Veedhata Tower Pvt. Ltd.

[Income tax Appeal no. 819 of 2015
dated: 17^th April , 2018 (Bombay High Court)]. [Affirmed Veedhata
Tower Pvt. Ltd vs. I.T.O-9(3)(3) [ITA No.7070/Mum/2014; Bench : H ; AY: 2010-11 ; Dated: 21^stJanuary,
2015 ; Mum. ITAT]

Section 68: Cash credits –
Bogus loan – The proviso to section 68 inserted with effect from 01.04.2013,
does not have retrospective effect – If the AO regards the loan as bogus, he
has to assess the lender but cannot assess as unexplained cash credit

The assessee had obtained a
loan from M/s. Lorraine Finance Pvt. Ltd (LFPL). The A.O. held that the
assessee was unable to establish the genuineness of the loan transaction
received in the name of LFPL nor able to prove the credit worthiness/the real
source of the fund. This led to the addition of the loan as unexplained cash
credit u/s. 68 of the Act.

In appeal, the view of the
A.O. was upheld by the CIT(A).

On further appeal, the
Tribunal while allowing the assessee’s appeal records on facts that, it is undisputed
that the loan was taken from LFPL. It is also undisputed that the lender had
confirmed giving of the loan through loan confirmations, personal appearance
and also attempted to explain the source of its funds. It also records the fact
that the sum of Rs.64.25 lakh had already been returned to LFPL through account
payee cheques and the balance outstanding was Rs.1 crore and 75 lakh. Besides,
it records that the source of source also stands explained by the fact that the
director of the creditor had accepted his giving a loan to the assessee’s
lender.

In view of the above fact, it
is the Revenue’s case that the source of source, the assessee is unable to
explain. The requirement of explaining the source of the source of receipts
came into the statute book by amendment to section 68 of the Act on 1^st
April, 2013 i.e. effective from A.Y. 2013-14 onwards. Therefore, during the
subject assessment year, there was no requirement to explain the source of the
source. The Tribunal held that the assessee had discharged the onus placed upon
it u/s. 68 of the Act by filing confirmation letters, the Affidavits, the full
address and pan numbers of the creditors. Therefore, the Revenue had all the
details available with it to proceed against the persons whose source of funds
were alleged to be not genuine as held by the Apex Court in CIT vs. Lovely
Exports (P.) Ltd. [2009] 319 ITR (St.) 5 (SC).

Being aggrieved, the
revenue filed an appeal to the High
Court. The grievance of the Revenue is that, even in the absence of the
amendment to section 68 of the Act, it is for the assessee to explain the
source of the source of the funds received by an assessee. It is submitted that
the assessee has not able to explain the source of the funds in the hands of
M/s. LFPL .

The High Court observed that
the Bombay Court in CIT vs. Gangadeep Infrastructure Pvt. Ltd, 394 ITR 680
has held that the proviso to section 68 of the Act has been introduced by the
Finance Act, 2012 w.e.f. 1^stApril, 2013 and therefore it would be
effective only from A.Y 2013-14 onwards and not for the earlier assessment
years. In the above decision, reliance was placed upon the decision of the Apex
Court in Lovely Exports (supra) in the context of the pre-amended
section 68 of the Act. In the above case, the Apex Court while dismissing the
Revenue’s Appeal from the Delhi High Court had observed that, where the Revenue
urges that the money has been received from bogus shareholders then it is for
the Revenue to proceed against them in accordance with law. This would not
entitle the Revenue to invoke section 68 of the Act while assessing the
assessee for not explaining the source of its source. In present case the
assessee had discharged the onus which is cast upon it in terms of the
pre-amended section 68 of the Act by filing the necessary confirmation letters
of the creditors, their Affidavits, their full address and their pan. In any
event, the question as proposed in law of the obligation to explain the source
of the source prior to 1^st April, 2013, A.Y 2013-14, stands
concluded against the Revenue by the decision of this Court in Gangadeep
Infrastructure (supra). Accordingly, the
revenue appeal is dismissed.

shailesh.kwebmaker

Desire a Defeat

India can boast of a very rich tradition of
‘Guru-Shishya-Parampara’ i.e. mentor-disciple relationship. In ancient India,
there was a Gurukul system where
the sages (gurus) stayed in their Ashrama (hermitage) in jungles. Pupils used to go to the Ashramas to stay
there for 12 long years to acquire knowledge. The Guru and his wife were
virtually the parents of the pupils. This helped to develop a strong bonding
between the Guru and Shishya. In today’s era of mass-education, this tradition
is practically extinct.

However, the remnants of this system can be found in present
times only in a few fields like art (music, dance) and our profession of CAs in
the form of mandatory articleship. Usually, when we come across a good singer,
we immediately ask – who is his Guru. Similarly, in the case of a bright CA, he
is asked about his principal during articleship.

There are certain principles which were observed in this
tradition in olden days.

First is ‘Acharya devo bhava’. People wrongly take the meaning of this
saying as ‘Guru is God’. Actually, it is not such a plain statement; but
it is in the imperative sense – meaning ‘you become the believer that Guru
is God’.

Secondly, there was a ban on Gurus not to impart the
knowledge to an ‘ashishya’ i.e. undeserving pupil. Only an ‘Adhikari’,
one who is endowed with the prerequisite virtues could be considered worthy of
receiving knowledge. If anybody undeserving receives knowledge, he is
considered as a sinner.

Thirdly, there is a popular shloka (verse):

People mistake it to be a mantra to be recited before meals (Bhojana-mantra).
They are under an impression that the mantra means ‘Let’s come together and
have meals’. Actually, it is a mantra –
which carries the essence of the relationship between teacher and student. Its
recitation is meant to remind the Guru and Shishya of this sacred bond in the
endeavour of learning. Its meaning is:

May both of us (Guru and Shishya) be protected by the
Divine,

May the Divine nourish both of us.

Let both of us together perform great tasks with great
energy and vigour,

May our study bring us purity and light;

May there never be any hostility Let us not hate or be
jealous of each other! Let us not act as rivals.

(Today we find strange relationships of jealousy or cheating
between a Ph.D guide and his student!)

Finally, the ultimate thought is –

One should always expect to win in all situations; but should
desire to get defeated (surpassed) by one’s son and pupil. Such principle was
implemented by many – the prominent examples being Guru Dronacharya and Arjun;
Shree Ramkrishna Paramahansa and Swami Vivekananda.

So, let us all CAs try to uphold this rich
tradition while dealing with our articled students!

shailesh.kwebmaker

8. ACIT vs. Jatin P. Mistry Members : C. N. Prasad, JM and Ramit Kochar, AM ITA No. 3404/Mum/2016 Assessment Year: 2008-09. Decided on: 13th April, 2018. Counsel for revenue / assessee: Abhijit Patankar / Fenil A. Bhatt

Section 40(a)(ia) – Amendment to section
40(a)(ia) made by the Finance Act, 2010 w.e.f. 1.4.2010 is retrospective in
operation and consequently disallowance
u/s. 40(a)(ia) is not called for in a case where there is late deposit of TDS
in Government Account when such delayed deposit is within the due date of
filing return of income.

FACTS

The Assessing Officer (AO) while passing order u/s. 143(3)
r.w.s. 263 of the Act noticed that amounts deducted by the assessee towards TDS
during the period from August 2007 to February 2008 were deposited in
Government Treasury after 30.4.2008 when these amounts should have been
deposited between 7.9.2007 to 7.3.2008.
Accordingly, the AO disallowed the payments by invoking provisions of
section 40(a)(ia) of the Act. He
rejected the contention of the assessee that the amounts were deposited before
due date of filing return of income and since the amendment of section
40(a)(ia) is retrospective, the disallowance should not be made.

Aggrieved, the assessee preferred an appeal to CIT(A) who
following the decision of the co-ordinate Bench in assessee’s own case and also
the decision of Delhi High Court in the case of CIT vs. Naresh Kumar
[262 CTR 389] and co-ordinate Bench of Mumbai Tribunal in Huda Construction
vs. ITO [ITA No. 816/Mum/2011 dated 15.4.2015] allowed the appeal.

Aggrieved, the revenue preferred an appeal to the Tribunal.

HELD:

The Tribunal noticed that the issue to be addressed is
whether there should be any disallowance u/s. 40(a)(ia) on account of late
remittance of TDS into government account when the assessee deposited such TDS
within due date for filing the return of income. Admittedly, there was a delay in deposit of
TDS by the assessee but the deposit was made before due date of filing return
of income.

The Tribunal noted that the issue is covered in favor of the
assessee, in its own case, by the decision of the co-ordinate Bench of the
Tribunal for assessment year 2009-2010.
The Tribunal also noted that the jurisdictional High Court has in the
case of CIT-II vs. Shraddha & S. S. Kale [ITA No. 1712 of 2014 dated
27.3.2017] decided the similar issue in favor of the assessee holding that the
amendment to section 40(a)(ia) by the Finance Act, 2010 w.e.f. 1.4.2010 is
retrospective. Following the decision of the jurisdictional High Court, the
Tribunal upheld the order of CIT(A) and rejected the ground of revenue.

The appeal filed by the revenue was dismissed.

shailesh.kwebmaker

From the Editorial – 1969

Reproduced from The Bombay Chartered Accountant
Journal

Volume 1, January 1969

We seem to have convinced ourselves that the following
sayings are all outdated: –

“Practice is better than precept”.

“Substance is
important than the form”.

“Knowledge is vital than the show of it”.

“Begin not with a programme but with a deed”.

We excuse the
deterioration in the Professional Standards on the plea that we are but a part
of Society, and the deteriorations in the Nation are bound to be reflected in
us.

The need of the
hour is that we professionals should withstand these forces. Our duty is to
make the people look to the future.

Our conscience must
be clear ; we should be of a ‘steel frame’; and must dispel the devils.

We must be
convinced that we have a role to play. We should not beat about the bush, but
turn the corner for the better.

The fountainhead of
our strength should be sound knowledge, which increases, when given. We should
avoid a show of knowledge, which is nothing but an exhibition of a weak mind.

We are the
guardians of the Nation’s finances, and with it the Nation’s morale. Our
actions and behavior should inspire the society at large to better themselves.

Let each of us
resolve to be the vanguard, and help and guide others to help themselves.

– Sham G. Argade

shailesh.kwebmaker

16 Return of income – Revised return – Due date u/s. 139(1) – Delay in filing return – Condonation of delay – Where assessee-company could not file return of income u/s. 139(1) before due date on account of some misunderstanding between erstwhile auditor and assessee and, assessee could not even obtain NOC from said erstwhile auditor immediately for appointment of an alternative auditor, in such circumstances, delay of 37 days in filing return of income alongwith audit report was to be condoned

REGEN
Powertech (P) Ltd. vs. CBDT; [2018] 91 taxmann.com 458 (Mad);

Date
of Order 28/03/2018: A. Y. 2014-15:

Sections
139(1) and 119(2)(b); Art. 226 of Constitution of India

For the A.
Y. 2014-15, the assessee-company could not file the return of income u/s.
139(1) of the Income-tax Act, 1961 before due date on account of some
misunderstanding between erstwhile auditor M/s. S. R.Batliboi & Associates,
Chartered Accountant and assesee and, the assessee could not even obtain NOC
from erstwhile auditor immediately for appointment of an alternative auditor.
The erstwhile auditors gave NOC on 15/12/2014. The new Auditor viz., M/s.CNGSN
Associates had completed the audit work and issued a Tax Audit Report dated
29/12/2014 and the petitioner Company, based on this, uploaded the Return Of
Income on 07/01/2015 along with the Tax Audit Report.

The
petitioner Company wished to file a revised return of income, after making
certain modifications to the earlier one, which is uploaded on 07/01/2015. Such
filing of the revised return is possible only if the original return had been
filed within the time prescribed u/s. 139 (1) of the Act. Therefore, the
petitioner company made an application to CBDT u/s. 119(2)(b) of the Act for
condonation of delay of 37 days in filing the return of income and accepting
the return of income filed on 07/01/2015 as filed u/s. 139(1). By an order
dated 01/06/2016, CBDT refused to condone the delay. The petitioner company
filed a writ petition before the Madras High Court and challenged the said
order of CBDT.

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

“i) It
is pertinent to note that without the Tax Audit Report u/s. 44 AB, the return
of income cannot be filed and the same will not be accepted by the System as a
correct return. According to the petitioner, the Auditors were delaying the
process of audit completion without proper reasons inspite of the petitioner
providing expert valuation report from other professional firm to satisfy their
concerns. The petitioner, left with no other alternative, but to look for an
alternative Auditor, after getting the NOC from M/s. S. R. Batliboi &
Associates. Thereafter, the petitioner Company appointed M/s.CNGSN Associates,
LLP, Chartered Accountant, Chennai as their Tax Auditor and requested them to
prepare the Tax Audit Report. The assignment was accepted by M/s. CNGSN
Associates on 29/11/2014, subject to NOC from the existing auditors viz.,
M/s.S.R.Batliboi & Associates. M/s.CNGSN Associates, by their letter dated
29/11/2014, also requested M/s. S. R. Batliboi & Associates to issue NOC.
However, no such NOC was given by the erstwhile Auditors. After repeated
requests made by the petitioner, M/s. S. R. Batliboi & Associates gave
their written communication dated 15/12/2014 expressing their inability to
carry out their audit and to issue a report.

ii) It is pertinent to note that the petitioner
cannot appoint an alternative Auditor without getting the written letter/NOC
from the existing Auditor. Thereafter, after getting NOC from the erstwhile
Auditor, the petitioner uploaded the return of income along with the Tax Audit
Report on 07/01/2015, hence, there was a delay of 37 days in filing the Return
Of Income. By delaying the submission of the return of income, the petitioner
did not stand to benefit in any manner whatsoever.

iii) When the petitioner had satisfactorily
explained the reasons for the delay in filing the return of income, the
approach of the 1st respondent should be justice oriented so as to advance the
cause of justice. The delay of 37 days in filing the return of income should
not defeat the claim of the petitioner. In the case of the petitioner failing
to explain the reasons for the delay in a proper manner, in such circumstances,
the delay should not be condoned. But, when the petitioner has satisfactorily
explained the reasons for the delay of 37 days in filing the return of income,
the delay should be condoned.

iv) Since the petitioner has satisfactorily
explained the reasons for the delay in a proper manner, I am of the considered
view that the 1^st respondent should have condoned the delay of 37
days in filing the Return Of Income along with the Audit Report.

v) In these circumstances, the impugned order
passed by the 1st respondent dated 01/06/2016 is liable to be set aside.
Accordingly, the same is set aside. The Writ Petition is allowed. No costs.”

shailesh.kwebmaker

15 Penalty – Concealment of income – Assessment u/s. 115JB – Assessment of income determined by legal fiction – Penalty for concealment of income cannot be imposed

Princ.
CIT vs. International Institute of Neuro Sciences and Oncology Ltd.; 402 ITR
188 (P&H); Date of Order: 23/10/2017:

A.
Y. 2005-06:

Sections
115JB and 271(1)(c)

The
assessee is a company. For the A. Y. 2005-06, the income of the assessee was
assessed u/s. 115JB of the Income-tax Act, 1961. The Assessing Officer also
imposed penalty u/s. 271(1)(c) of the Act for concealment of income.

The
Tribunal deleted the penalty holding that when the income is assessed u/s.
115JB penalty for concealment of income cannot be imposed.

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

“i) Under the scheme of the Income-tax Act, 1961,
the total income of the assessee is first computed under the normal provisions
of the Act and tax payable on such total income is computed with the prescribed
percentage of the book profits computed u/s. 115JB of the Act. The higher of
the two amounts is regarded as total income and tax payable with reference to
such total income. If the tax payable under the normal provisions is higher,
such amount is the total income of the assessee, otherwise the book profits are
deemed as the total income of the assessee in terms of section 115JB of the
Act.

ii) Where the income computed in accordance with
the normal procedure is less than the income determined by legal fiction namely
the book profits u/s. 115JB and income of the assessee is assessed u/s. 115JB
and not under the normal provision, the tax is paid on the income assessed u/s.
115JB of the Act, and concealment of income would have no role to play and
would not lead to tax evasion.

iii) Therefore, penalty cannot be imposed on the
basis of disallowance or additions made under the regular provisions. Appeal
stands dismissed.”

shailesh.kwebmaker

14 Princ. CIT vs. Swapna Enterprise; 401 ITR 488 (Guj); Date of Order: 22/01/2018: A. Y. 2011-12: Sections 132, 132(4) and 271AAA(2)(i), (ii), (iii)

Penalty – Presumption of
concealment in case of search – Condition precedent – Finding that statement
specified manner in which such income earned – No evidence to show that such
income earned from any other source – Payment of tax with interest before
assessment made – Conditions satisfied – Deletion of penalty justified

The
assessee-firm was in the business of development of housing projects. Search
and seizure operations were conducted, u/s. 132 of the Income-tax Act, 1961, at
the business and residential premises of the assessee. In the course of search,
a statement of one of the partners of the firm, AGK, was recorded u/s. 132(4)
wherein he had admitted Rs. 15 crore as undisclosed income. The said income was
offered in the return filed pursuant to search. The Assessing
Officer levied penalty,
u/s. 271AAA of Rs. 15
lakh at the rate of 10% of the admitted undisclosed income on the ground that
the assessee failed to substantiate the source of such undisclosed income.

The
Commissioner (Appeals) found that AGK, during the course of recording his
statement, had explained that the unaccounted income represented net taxable
income of the project undertaken by the assessee and that the details mentioned
in the seized diary represented the net taxable income for the projects and
during the course of assessment proceedings, the assessee had filed relevant
details in that regard. He also found that no evidence was found to show that
the assessee had earned the undisclosed income from any other source instead of
the project income. On the basis of such finding, he held that the first
condition as prescribed under clause (2)(i) of section 271AAA was fulfilled in
the case of the assessee. As regards second condition u/s. 271AAA(2)(ii), the
Commissioner (Appeals) found that the undisclosed income of Rs. 8.10 crore was
admitted by AGK in his statement u/s. 132(4), the basis of which was a diary
found and seized during the course of search. The diary contained the entries
of the unaccounted/undisclosed income of Rs. 8.10 crore belonging to the
assessee firm, which had been explained by AGK, while recording his statement.
Therefore, he held that the second condition also was satisfied since such
undisclosed income had been accepted by the Assessing Officer in the assessment
proceedings. As regards the third condition u/s. 271AAA(2)(iii) the
Commissioner (Appeals) noted that the tax together with interest, if any, in
respect of undisclosed income should have been paid by the assessee for getting
immunity from the penalty and the Assessing Officer had stated in the penalty
order itself that full tax including interest on the undisclosed income had
been paid by way of adjustment out of the seized cash or otherwise in response
to the notice of demand but before conclusion of the penalty proceedings. In
the light of the fact that the assessee had satisfied all the three conditions
set out in sub-section (2) of section 271AAA, the Commissioner (Appeals)
deleted the penalty. The Tribunal upheld the decision of the Commissioner
(Appeals).

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

“i) Both the Commissioner (Appeals) as well as
the Tribunal had recorded concurrent findings of fact that the partner of the
firm, AGK, during the course of recording of his statement at the time of the
search, had stated that the income was earned by accepting on-money in its
building project. Therefore, the manner in which income has been derived has
been clearly specified in his statement.

ii) It was not the case of the Department that
during the course of recording of the statement of AGK any specific questions
had been asked to substantiate the manner in which the income was derived. Thus
the findings recorded by the Commissioner (Appeals) and the Tribunal regarding
the satisfaction of clause (i) and (ii) of sub-section (2) of section 271AAA
did not suffer from any legal infirmity.

iii) In so far as the satisfaction of clause (iii)
of sub-section (2) of section 271AAA was concerned, the penalty order revealed
that the entire amount of tax and interest had been paid, prior to making the
assessment order.

iv) In the light of the above discussion, there
being no infirmity in the impugned order passed by the Tribunal, no question of
law, as proposed or otherwise, can be said to arise. The appeal, therefore,
fails and is, accordingly, summarily dismissed.”

shailesh.kwebmaker

13 Industrial undertaking – Deduction u/s. 80-IA can be claimed in return filed pursuant to notice u/s. 153A – Finding that assessee developer and not contractor – Assessee is eligible for deduction u/s. 80-IA(4)(i)

Princ. CIT vs. Vijay Infrastructure Ltd; 402
ITR 363 (All); Date of Order: 12/07/2017:

A.
Y. 2009-10:

Sections
80-IA and 153A

The
assessee was a developer eligible for deduction u/s. 80-IA(4)(i) of the
Income-tax Act, 1961. For the A. Y. 2009-10, the assessee claimed deduction
u/s. 80-IA in the return of income filed pursuant to notice u/s. 153A of the
Act. The Assessing Officer held that the assessee was a contractor and hence
was not eligible for deduction u/s. 80-IA(4)(i) of the Act.

The
Commissioner (Appeals) found that the assessee fulfilled all the criteria of a
developer in accordance with section 80-IA(4)(i) and by his works a new
infrastructure facility in the nature of road had come into existence and the
assessee was eligible for tax benefit u/s. 80-IA(4)(i) of the Act. The Tribunal
confirmed this. On the question whether the assessee is entitled to deduction
u/s. 80-IA(4)(i) when the claim is made in the return of income filed pursuant
to notice u/s. 153A of the Act, the Tribunal held that for the A. Y. 2009-10
and onwards, the time for filing revised return had not expired and therefore,
claim for deduction u/s. 80-IA if not made earlier could have been made in the
revised return. Once it could have been claimed in the revised return u/s.
139(1), it could have also been claimed u/s. 153A of the Act.

In appeal
by the Revenue, the following questions were raised before the Allahabad High
Court:

“i) Whether the Income-tax Appellate Tribunal was
justified in allowing the deduction u/s. 80-IA to the assessee on the basis of
a return filed after the issue of notice u/s. 153A of the Act?

ii) Whether the Income-tax Appellate Tribunal
was justified under the facts and circumstances of the case in confirming the
order of the Commissioner of Income-tax (Appeals) who has travelled beyond the
statutory provision of Chapter VI-A, u/s. 80-A(5) of the Income-tax Act, 1961
which clearly provides that if the assessee fails to make a claim in his return
of income of any deduction, no deduction shall be allowed to him thereunder?”

The
Allahabad High Court upheld the decision of the Tribunal and held as under:

“i) Sri Manish Misra, the learned counsel for the
appellant contended that the return u/s, 153A is not a revised return but it is
a original return. If that be so, then in our view, deduction u/s. 80-IA, if
otherwise admissible, always could have been claimed and we are not shown any
authority otherwise to take a different view. Therefore, in both ways,
deduction u/s. 80-IA, if otherwise admissible could have been claimed by the
assessee. Hence we answer both the aforesaid questions in favour of the
assessee and against the Revenue affirming the view taken by the Tribunal.

ii) It is next contended that there is another
substantial question of law that the assessee is not a “developer” but a
“contractor” and in this regard detailed finding has been recorded otherwise by
the Assessing Officer. The fact that the assessee was a “developer” and not a
“contractor” was a finding of fact concurrently recorded by the Commissioner
(Appeals) and the Appellate Tribunal, which was not shown to be perverse or
contrary to record. No substantial question of law arose.”

shailesh.kwebmaker

12 Company – Recovery of tax from director – There should be proper proceedings against the company for recovery of tax and only thereafter the balance outstanding can be recovered from directors u/s. 179 – Precondition for a valid notice u/s. 179(1) is that the notice indicate the steps taken to recover the tax dues from the company and its failure – The notice and order u/s. 179(1) quashed and set aside

Mehul
Jadavji Shah vs. Dy. CIT (Bom); W. P. No. 291 of 2018; Date of Order:
05/04/2018:

A.
Y. 2011-12:

Section
179(1) :

Art.
226 of Constitution of India

The
petitioner was a director of a private limited company viz., Shravan Developers
Pvt. Ltd. He had resigned from the company in the year 2013. The company had
failed to pay tax dues of Rs. 4.69 crore for the A. Y. 2011-12. On 06/02/2017,
the Assessing Officer of the company issued notice u/s. 179(1) of the
Income-tax Act, 1961 seeking to recover from the petitioner the tax dues of Rs.
4.69 crore of the company for the A. Y. 2011-12. The petitioner responded to
the notice and sought details of the notices issued to the company for recovery
of the tax dues. However, without responding to the particulars sought, the
Assessing Officer passed order u/s. 179(1) on 26/12/2017 making a demand of Rs.
4.69 crore upon the petitioner.

The
petitioner filed a writ petition before the Bombay High Court challenging the
validity of recovery proceedings u/s. 179(1) of the Act and the order u/s.
179(1) dated 26/12/2017. The Bombay High Court allowed the writ petition,
quashed the order dated 26/12/2017 passed u/s. 179(1) of the Act, and held as
under:

“i) It is clear that before the Assessing Officer
assumes jurisdiction u/s. 179(1) of the Act, efforts to recover the tax dues
from the delinquent Private Limited Company should have failed. This effort and
failure of recovery of the tax dues must find mention in the show cause notice
howsoever briefly. This would give an opportunity to the noticee to object to
the same on facts and if the Revenue finds merit in the objection, it can take
action to recover it from the delinquent Private Limited Company. This has to
be before any order u/s. 179(1) of the Act is passed adverse to the noticee.

ii) In this case, admittedly the show cause
notice itself does not indicate any particulars of the failed efforts to
recover the tax dues from the delinquent Private Limited Company. Thus, the
issue stands covered in favour of the petitioner by the order of this Court in Madhavi
Kerkar vs. ACIT; W. P. No. 567 of 2016 dated 05/01/2018.

iii) In the above circumstances, the impugned
order dated 26/12/2017 is quashed and set aside.”

shailesh.kwebmaker

11 Appeal to High Court – Delay – Condonation of delay – Period of limitation should not come as an hindrance to do substantial justice between parties – However, at same time, a party cannot sleep over its right ignoring statute of limitation and without giving sufficient and reasonable explanation for delay, expect its appeal to be entertained merely because it is a State – Delay of 318 days – No reasonable explanation – Delay not condoned

CIT(Exemption)
vs. Lata Mangeshkar Medical Foundation; [2018] 92 taxmann.com 80 (Bom); Date of
Order: 18/03/2018:

A.
Ys. 2008-09 and 2009-10:

Section
260A

For the A.
Ys. 2008-09 and 2009-10, the Department had filed appeal to the High Court u/s.
260A of the Income-tax Act, 1961 against the order of the Tribunal. There was
delay of 318 days in filing the appeals. An application was made for
condonation of delay. Sequence of events were narrated during the period of
delay. It was stated that the tax effect involved was over Rs. 6 crore for A.
Y. 2009-10 and over Rs. 3.4 crore for A. Y. 2008-09.

The Bombay
High Court refused to condone the delay and held as under:

“i) There is no proper explanation for the delay
on the part of the Commissioner. In fact, the affidavit, dated 16-9-2017 states
that, he handed over the papers to his subordinate i.e. the Deputy
Commissioner. This is also put in as one of the reasons for the delay. This
even though when they appear to be a part of the same office. In any case, the
date on which it was handed over to the Deputy Commissioner (Exemptions),
Circle, Pune is not indicated. Further, the affidavit dated 16-9-2017 also does
not explain the period of timse during which the proposal was pending before
the Chief Commissioner, Delhi for approval. The Chief Commissioner is also an
Officer of the department and there is no explanation offered by the Chief
Commissioner at Delhi or on his behalf, as to why such a long time was taken in
approving the proposal. In fact, there is even no attempt to explain the same.
The Commissioner being a Senior Officer of the revenue would undoubtedly be
conscious of the fact that the time to file the appeals was running against the
revenue and there must be averment in the application of the steps he was
taking to expedite the approval process.

Further,
there is no proper explanation for the delay after having received the approval
from the Chief Commissioner of Delhi on 29-5-2017. No explanation was offered
in the affidavits dated 16-9-2017 for having filed the appeal on 20-7-2017 i.e.
almost after two months. The additional affidavits also does not explain the
delay except stating that the Advocate to whom the papers were sent for
drafting asked for some document without giving particulars. Thus, the reasons
set out in the Affidavits and additional Affidavits in support were not
sufficient so as to condone the delay in filing the accompanying Appeal.

ii) The officers of the revenue were conscious
of the time for filing the appeal. This is particularly so as on an average
over 2000 appeals every year from the order of the Tribunal is filed by it
before this Court. Inspite of the above said callous delay. Thus, the delay
could not be condoned.

iii) The reasons that come out from the Affidavits
filed is, that the work takes time and, therefore, the period of limitation
imposed by the State should not be applied in case of revenue’s appeal where
the tax effect involved is substantial. Such a proposition could not be
accepted as it would be contrary to the law laid down by the Apex Court that
there is no different period of limitation for the State and the citizen.

iv) One more submission made on behalf of the
revenue is that, the assessee have been served and they have chosen not to
appear. Therefore, it must necessarily follow that they have no objection to
the delay being condoned and the appeal being entertained. Thus, it is
submitted that the delay be condoned and the appeal be heard on merits. This
submission ignores the fact that the object of the law of limitation is to
bring certainty and finality to litigation. This is based on the Maxim ‘interest
reipublicae sit finis litium’ i.e. for the general benefit of the community
at large, because the object is every legal remedy must be alive for a
legislatively fixed period of time. The object of law of limitation is to get
on with life, if you have failed to file an appeal within the period provided
by the Statute; it is for the general benefit of the entire community so as to
ensure that stale and old matters are not agitated and the party who is
aggrieved by an order can expeditiously move higher forum to challenge the
same, if he is aggrieved by it. As observed by the Apex Court in many cases,
the law assists those who are vigilant and not those who sleep over their
rights as found in the Maxim ‘Vigilantibus Non Dormientibus Jura Subveniunt’.
Therefore, merely because the assessee does not appear, it cannot follow that
the revenue is bestowed with a right to the delay being condoned.

v) The period of limitation should not come as a
hindrance to do substantial justice between the parties. However, at the same
time, a party cannot sleep over its right ignoring the statute of limitation
and without giving sufficient and reasonable explanation for the delay, expect
its appeal to be entertained merely because it is a State. Appeals filed beyond
a period of limitation have been entertained, where the delay has been sufficiently
explained such as in cases of bona fide mistake, mala fide action
of the Officer of the State etc; however, to seek that the period of
limitation provided in the statute be ignored in case of revenue’s appeals
cannot be accepted. The appeals which are filed by the revenue in this Court
u/s. 260A of the Act are very large in number and on an average over 2000 per
year from the orders of the Tribunal. Thus, the officers of the revenue should
be well aware of the statutory provisions and the period of limitation and
should pursue its remedies diligently and it cannot expect their appeals be
entertained, because they are after all the State, notwithstanding the fact
that delay is not sufficiently explained.”

shailesh.kwebmaker

Tax Planning/Evasion Transactions On Capital Markets And Securities Laws – Supreme Court Decides

Background

Carrying out
transactions on stock market to avoid tax is practiced. Using capital market
for tax evasion has recently been in news, for example, cases involving
long-term capital gains. A person may, for example, sell shares and book exempt
gains and soon thereafter buy such shares again from the market. At times, such
shares are sold within the family/group and therefore after some time,
transferred to the seller. In particular, what has also been alleged is that
transactions are carried not only with the sole purpose of generating capital
gain but also for manipulating volume and price on stock exchanges. The
question whether such transactions will get concessional tax treatment in tax
assessments is of course an important question. However, in this article, the
question is : how are such transactions treated under the Securities Laws?

Take a common
modus operandi to have been typically employed in the so-called long-term
capital gain transactions. A small listed company with low or non-existent
operations is used. A large quantity of shares is issued by way of preferential
allotment. The quantity of shares may be further increased through bonus issue.
During the period of one year for which such shares have to remain locked-in
(which is also the period of holding for availing of long term capital gains
benefits), the price of the shares is artificially inflated by a small group of
persons who trade within themselves at progressively higher prices. At the end
of this period, by which time the price of the shares is many times (often
50-100 times) more than the original price, the preferential allottees sell the
shares at such higher price. The initial buyer is alleged to have organised all
this. The preferential allottee thus obtains tax free long-term capital gains
(Finance Bill 2018 though seeks to charge 10% capital gains tax). However, in
the process, the capital market system is abused. Fake turnover at artificial
prices is recorded. If unchecked, this not only harms the credibility of the
capital markets but can also result in loss to investors. Several provisions of
Securities Laws specifically prohibit such artificial trading and manipulation.

There were
decisions of the Securities Appellate Tribunal that held, in effect, that the
mere fact that transactions were undertaken for purposes of obtaining tax
benefits, penal action will not necessarily follow. However, while such
decisions could be arguably held to be limited to their facts, it still leaves
an uneasy feeling.

Now, the
Supreme Court has given a detailed ruling. While we will consider the facts
before the Court and also what the Court said, it is important to note that the
Court did not specifically rule on the intent tax planning or even evasion in
such transactions. It did not consider the question whether the capital markets
can or cannot be used for such purposes. It, however, dealt with violation of
Securities Laws that often takes place in such cases and whether and when they
can be said to fall foul of Securities Laws. Hence, the decision has direct
relevance.

Facts of the
case

There were
several parties in the case before the Court but they fell in two broad
categories – the parties who carried out the transactions and the stock brokers
through whom such transactions were carried out.

The parties
entered into transactions that resulted in some persons making profits and
others making losses. This was said to have been done by entering into
transactions in the following manner. In the futures and options markets, one
party (or group) bought futures (or similar derivatives) from the other party
through the stock market mechanism at a particular price. These same parties
then entered into reverse transactions at a higher price, thus resulting in one
side earning profits while the other side was making losses. Take an example. A
transaction in futures of scrip X could be carried out by Mr. A purchasing 1000
futures at a price Rs. 100 each from Mr. B. This transaction would later be
reversed by selling such 1000 futures at a price or Rs. 140. Mr. A would earn a
profit of Rs. 40000 while Mr. B would make a loss of about the same amount.

These
transactions would be synchronised well and rarely, if at all, any other party
would – or even could – transact. Effectively, these persons would be almost
the only persons trading in such scrip.

SEBI found out
what was happening and penalised the parties and the brokers. The parties were
penalised for carrying out artificial trading and price manipulation. The stock
brokers, who are expected to act as gate keepers to the capital market and
exercise due diligence, were penalised for allowing such transactions to happen
through them.

The question
before the Supreme Court was whether such transactions violated the Securities
Laws and whether the parties and their stock brokers could be so punished ?

Ruling of
Court

The Supreme
Court had to deal with several aspects. The Court had to focus on how the
capital markets get affected by such transactions. Even if the purpose was
legitimate, the issue was whether the transactions contravened the Securities
Laws, if so, penal action would follow.

In particular,
it elaborately discussed the issue of synchronised trading. This is trading
where buyers and sellers match their transactions very closely in terms of
timing, volume and price. Thus, the net result is generally that, though the
market is open to all, the transactions get executed between connected parties.
The Court, discussed in detail certain decisions of SAT and ruled that
synchronised trading is not ipso facto illegal or violative of
Securities Laws.

However, it
noted that on the facts before it, the transactions were manipulative. The
price at which purchases and sales of futures and other derivatives was carried
out was not market driven but was pre-determined and therefore artificial. The
buying and selling price of such derivatives are usually related to the
underlying price of the shares/index with which they are linked. While of
course parties can buy at prices far away from such underlying price of the
scrip/index, if their judgement of the future tells them so, the Court found
that this was not so on the facts before it. The purchases and sales were
carried out at widely different prices on the same day and between the same
parties in a synchronised manner in terms of timing and volume. The conclusion
was only that the transactions for all practical purposes were bogus.

Interestingly,
a curious argument was advanced. Whether trading on the derivatives markets
could affect – and hence manipulate – the trading and price in the cash market?
For example, by manipulating say, the price of futures in Scrip X, can the
price of trading of Scrip X in the spot/cash market be affected? The SAT had
held that this was generally not possible in the type of transactions involved
in the present case. This was one of the reasons why SAT overturned the order
of Securities and Exchange Board of India. However, it is submitted the Supreme
Court, rightly pointed out that this was not the issue at all. It was not
SEBI’s case that the transactions in the derivatives markets were carried out
to manipulate the price in the spot/cash markets. SEBI’s case was that the
trading in the derivatives markets itself was artificial, bogus and
manipulative and this by itself was a violation of Securities Laws.

The Court also
rejected the argument that in case of futures, no delivery took place and hence
the transactions did not violate the provisions which prohibit dealing without
change of beneficial interest.

The Court
further described the meaning of unfair trade practices in securities particularly
in the context of the case. It stated, “Contextually
and in simple words, it means a practice which does not conform to the fair and
transparent principles of trades in the stock market. In the instant case, one
party booked gains and the other party booked a loss. Nobody intentionally
trades for loss. An intentional trading for loss per se, is not a
genuine dealing in securities. The platform of the stock exchange has been used
for a non- genuine trade. Trading is always with the aim to make profits. But
if one party consistently makes loss and that too in preplanned and rapid
reverse trades, it is not genuine; it is an unfair trade practice.”. The
Court pointedly noted that, “The non-genuineness of these transactions is
evident from the fact that there was no commercial basis to suddenly, within a
matter of minutes, reverse a transaction when the underlying value had not
undergone any significant change”. Once it held this, it was not difficult to
take the argument to the logical conclusion to hold that the trades were
violative of Securities Laws and uphold the penal action by SEBI.

The Court also
rejected the ruling of SAT that “only if there is market impact on account of
sham transactions, could there be violation of the PFUTP Regulations”. The
court held that fraudulent and unfair trade practices have no place whatsoever
in the capital market.

As far as the
stock brokers were concerned, the Court held that they could not be held liable
unless their own involvement could be demonstrated or it could be shown that
they acted negligently or in connivance with such traders.

Thus, the Court
upheld the penal actions against the traders but not against the stock brokers.

Tax
planning/avoidance/evasion through capital markets

The Court
steered clear of giving a specific and direct ruling on whether tax planning
through transactions in capital markets was by itself violative of Securities
Laws. However, it is submitted that it has given enough guidance on what the
approach should be. As discussed above, transactions that are manipulative or
fraudulent or apparently fake will by themselves be violative of Securities
Laws.

Conclusion

The decision
makes it clear that SEBI can examine transactions in light of how they are
carried out and whether they are violative of Securities Laws, irrespective of
whether or not the objective was tax planning, etc. Some tests are given on
whether such transactions would be held to be violative. The penal action under
Securities Laws will be in addition to any findings and consequences under tax
law.

shailesh.kwebmaker

Right to Information

PART A I DIRECTIONS OF SUPREME COURT

– Fee For RTI Application Should Not
Exceed Rs.50/, Rs. 5/- Per Page, Motive Need Not Be Disclosed

The Supreme
Court on March 20, 2018 capped the fee charged by high courts for responding to
queries filed under the RTI Act at Rs. 50 per application, bringing cheers to
activists seeking information under the transparency law.

The bench
comprising Justices A. K. Goel, R. F. Nariman and U. U. Lalit also asked the
high courts not to force applicants to disclose the reason for seeking
information under the Right to Information law.

On the fee: “We
are of the view that, as a normal Rule, the charge for the application should
not be more than Rs.50/- and for per page information should not be more than
Rs.5/-. However, exceptional situations may be dealt with differently. This
will not debar revision in future, if the situation so demands.”

On disclosure
of motive: With regard to the requirement of disclosure of motive for seeking
information, the Court ruled, “No motive needs to be disclosed in view of the
scheme of the Act.

On CJ’s
permission for disclosure of information: The Court noted that the requirement
of seeking permission of the Chief Justice or the concerned Judge for
disclosure of information “will be only in respect of information which is
exempted under the Scheme of Act.”

On transfer of
application to another public authority: The Court opined that while normally
the public authority should transfer the application to another public
authority if the information is not available, the mandate may not apply “where
the public authority dealing with the application is not aware as to which
other authority will be the appropriate authority”.

On disclosure
of information on matters pending adjudication: With regard to the Rules
debarring disclosure of information on matters pending adjudication, the Court
clarified that “the same may be read consistent with Section 8 of the Act, more
particularly sub-section (1) in Clause (J) thereof, bench passed the order on a
batch of petitions challenging the RTI rules of various high courts, and other
authorities like the Chhattisgarh Legislative Assembly, which imposed
exorbitant fees for application and photocopying.

Advocate
Prashant Bhushan, the counsel for NGO Common Cause, which was one of the
petitioners, said exorbitant fee was charged to disincentivise the general
public from seeking information. He also said the fee should not act as a
deterrent for information seekers.

The petition
filed by the NGO claimed that the Central Information Commission had repeatedly
asked the Allahabad High Court to modify its RTI rules, but its pleas were
ignored.

The Allahabad
High Court was charging Rs. 500 for a reply under the RTI Act, the petition
claimed.

A similar plea
was filed against the Chhattisgarh High Court which had dismissed a petition of
an applicant Dinesh Kumar Soni, and imposed a cost of Rs 10,000 on him for
seeking information.

In his
petition, Soni had challenged the Rule 5 and Rule 6(1) of the Chhattisgarh
Vidhan Sabha Secretariat Right to Information (Regulation of fees and costs)
Rules 2011, which require that a person making an application u/s. 6(1) of the
RTI Act was required to pay Rs. 300.

(Source: http://www.livelaw.in/fee-rti-application-not-exceed-rs-50-rs-5-per-pages-motive-need-not-disclosed-read-sc-directions-read-order/)

PART
B RTI ACT, 2005

– India’s
Right to Information in a mess

Over the years, the pendency of cases under
Right to Information (RTI) Act has shown an upward trend with close to two lakh
pending second appeal and complaint cases been reported under the Act across
the country.

According to the latest report “State of
Information Commissions and the Use of RTI Laws in India (Rapid Review 4.0)” by
Access to Information Programme, Commonwealth Human Rights Initiative (CHRI), a
New Delhi-based NGO, there were 1.93 lakh pending second appeal and complaint
cases in 19 Information Commissions at the beginning of this year as compared
to 1.10 lakh cases pending across 14 Information Commissions in 2015. The
report based on annual reports and websites of Information Commissions was
released at the Open Consultation on the Future of RTI: Challenges and
Opportunities held in New Delhi in the second week of March.

Maharashtra (41,537 cases), Uttar Pradesh
(40,248), Karnataka (29,291), Central Information Commission (23,989) and
Kerala (14,253) were the top five Information Commissions that accounted for 77
percent of the overall pendency. Pendency in Bihar, Jharkhand and Tamil Nadu
among others was not publicly known while Mizoram State Information Commission
(SIC) received and decided only one appeal case in 2016-17, said the report,
adding that SICs of Tripura, Nagaland and Meghalaya had no pendency at all. The
Central Information Commission and nine SICs (Gujarat, Haryana, Jammu &
Kashmir, Kerala, Maharashtra, Nagaland, Odisha, Uttarakhand and Uttar Pradesh)
displayed updated case pendency data on their websites.

Referring to RTI applications, the report
said that around 24.33 lakh RTI applications were filed across the Central and
14 state governments between 2015-17. The report mentioned that it was not
possible to get accurate figures in the absence of annual reports from several
Information Commissions. By a process of extrapolation it may be conservatively
estimated that up to 50 lakh RTI applications would have been submitted by
citizens during the same period, the report added.

About 24.77 lakh RTI applications were
reported in 2015 and it was based on data available for the years 2012-14
(where data was taken for the latest year for which an annual report was
available). The figure for 2015-17 appeared to be a little less but that might
be due to the absence of figures from several jurisdictions where RTI was used
more prolifically, added the report. Furthermore, around 2.14 crore RTI applications
were filed across the country since October, 2005, as per the data published in
the annual reports of Information Commissions accessible on their websites, the
report said, adding that if data was published by all Information Commissions
the figure might have touched 3 to 3.5 crores. Less than 0.5 percent of the
population seemed to have used RTI since its operationalisation, it further
added.

Despite the absence of their latest annual
reports, the Central Government (57.43 lakhs) and the state governments of
Maharashtra (54.95 lakhs) and Karnataka (20.73 lakhs million) continue to top
the list of jurisdictions receiving the most number of information requests.
Gujarat (9.86 lakhs) recorded more RTI applications than neighbouring Rajasthan
(8.55 lakhs) where the demand for an RTI law emerged from the grassroots.
Despite having much lower levels of literacy, Chhattisgarh (6.02 lakh) logged
more RTI applications than 100 percent literate Kerala (5.73 lakhs). Despite
being small states, Himachal Pradesh (4.24 lakhs), Punjab (3.60 lakhs) and
Haryana (3.32 lakhs) registered more RTI applications each than the
geographically bigger state of Odisha (2.85 lakhs). Manipur recorded the lowest
figures for RTI use at 1,425 information requests between 2005-2017. The SIC
did not publish any annual report between 2005 and 2011 and is yet to release
the report for 2016-17.

While the Central government, Andhra Pradesh
(undivided), Assam, Goa, Jammu & Kashmir, Kerala and Uttarakhand have
recorded an uninterrupted trend of increase in the number of RTI applications
received, Himachal Pradesh, Punjab, Sikkim, Nagaland and Tripura have reported
a decline in the number of RTI applications received in recent years and the
reasons for the drop in numbers, according to the report, requires urgent
probing. Arunachal Pradesh, Chhattisgarh, Haryana, Meghalaya, Gujarat, Mizoram,
Odisha and West Bengal have recorded a mixed trend where the RTI application
figures have fluctuated over the years. After seesawing in the initial years, Arunachal
Pradesh has reported a more than 82 percent decline in the number of RTI
applications received in 2015 against the peak reached in 2014. Mizoram also
showed a declining trend of 23 percent in 2016-17 after the peak scaled during
the previous year. West Bengal’s figures rose and dipped to less than 62
percent of the peak reached in 2010 but a rising trend was reported in 2015.

Referring to headless and non-existent SICs,
the report highlighted that there was no State Chief Information Commissioner
(SCIC) in Gujarat since mid-January 2018. While Maharashtra SIC was headed by
an acting SCIC since June 2017, there was no Information Commission in Andhra
Pradesh (after Telangana was carved out in June 2014). The State government had
assured the Hyderabad High Court that it would soon set up an SIC. More than 25
percent (109) of 146 posts in the Information Commissions were lying vacant.
Against 142 posts created in 2015, 111 Information Commissioners (including
Chief Information Commissioners) were working across the country. 47 percent of
the serving Chief Information Commissioners and ICs were situated in seven
states: Haryana (11), Karnataka, Punjab and Uttar Pradesh (9 each), Central
Information Commission, Maharashtra and Tamil Nadu (7 each). Six of these
Commissions were saddled with 72 percent of the pending appeals and complaints across the country.

The report further referred that 90 percent
of the Information Commissions were headed by retired civil servants and more
than 43 percent of the Information Commissioners were from civil services
background. This is the trend despite the Supreme Court’s directive in 2013 to
identify candidates in other fields of specialisation mentioned in the RTI Act
for appointment, argued the report. The report further mentioned that only 8.25
percent of the serving SCICs and ICs were women. Only 10 percent (8 out of 79)
of the Information Commissioners serving across the country were women. Three
of these women ICs were retired IAS officers while two were advocates and two
had a background in social service and education. One woman IC in Punjab had a
background in medicine.There were nine women ICs in 2015. The report said that
the websites of SICs of Madhya Pradesh and Bihar could not be detected on any
internet browser and the SICs of Madhya Pradesh and Uttar Pradesh had not
published any annual report so far. Jharkhand and Kerala SICs each had six
pending annual reports and Punjab had five while Andhra Pradesh had four
pending reports.

(Source: http://www.milligazette.com/news/16188-india-s-right-to-information-in-a-mess)

PART C INFORMATION
ON & AROUND

– Focus On
“Act Rightly” As Much As Right To Information Act, Says PM Modi

Twelve years after it was set up under the
Right To Information (RTI) Act, the Central Information Commission has a new
address — a five-storey environment friendly building in south Delhi, fitted
with information technology and video conference facilities. Earlier, the
highest appellate authority for RTI complaints used to function from two rented
accommodations.

“The greatest asset of a democracy is
an empowered citizen. Over the last 3.5 years we have created the right
environment that nurtures informed and empowered individuals,” said Prime
Minister Narendra Modi who inaugurated the new premises.

At a time when activists have accused the
government of holding back information, PM Modi said like the RTI Act, serious
attention should be paid to “Act Rightly”.

“Many times it has been seen that some
people misuse the rights given to the public for personal gains. The burden of
such wrong attempts is borne by the system”.

Activists say the government is yet to walk
the talk on transparency, and anti-corruption laws await proper implementation.

A Lokpal is yet to be appointed, four years
after the law was put in place. The chief information commissioner was
appointed by the present government after activists went to court. Of the 11
posts of information commissioner, four are vacant and four more retire this
year.

(Source:https://www.ndtv.com/india-news/focus-on-act-rightly-as-much-as-right-to-information-act-says-pm-modi-1821017)

u Ex-corporators
seek right to pursue RTI

Eight former corporators of the Thane
Municipal Corporation (TMC) have filed a criminal writ petition in the Bombay
high court seeking quashing of complaints registered against them by the Thane
police commissioner at the behest of the corporation and its commissioner. The
corporators have alleged that the complaint lodged against them was aimed at
discouraging them from seeking information under Right To Information (RTI) Act
about unauthorised and illegal construction being carried on in the municipal
limits of the corporation.

According to the petition filed by Sanjay
Ghadigaonkar and seven others, all of whom were former corporators in TMC, a
complaint was lodged against them by the Thane police as they had been seeking
information under RTI. The petition has alleged that they had been discouraged
by the corporation from seeking the information, but when it did not deter
them, the police complaints were lodged. The complaint has alleged that the
corporators were misusing the RTI Act for vested interests.

The petition also points to the fact that in
the recent session of the Vidhan Sabha, the chief minister Devendra Fadnavis
had clarified that there was no restriction on anyone from seeking information
under RTI and they cannot be prosecuted for seeking the information, but the
corporation had not heeded the same but had lodged complaints with the police
against them.

The petition while seeking an early hearing
has also prayed for restraining orders against the police from taking any
action against them as well as quashing of the complaints. The petition is
expected to come up for hearing in due course.

RTI shows Left leader’s murderer received
parole every month for 3 yrs.

A Right To Information (RTI) reply has
revealed that CPI(M) leader and murder convict P.K. Kunhanandan was given 15
days parole every month since 2015.

Kunhanandan, one of the convicts in the
murder case of slain leader T.P. Chandrasekharan, is serving a life-term for
the same.

The reply, sought by slain leader’s wife K.
K. Rema, also stated that barring two months (October and November 2017), the
convict had got parole repeatedly from 2015 to 2018.

Chandrasekharan, a local leader of CPI (M)
at Onchiyam in Kozhikode district, left the party in 2009 to form a new one,
Revolutionary Marxist Party (RMP); however, his political journey was cut
short, as he was brutally murdered on May 4, 2012, after his party won
considerable number of seats in a local body elections.

Fifteen CPI (M) workers were found guilty in
the case.

Rema is now reportedly considering legal
action against the state government.

(Source:http://www.business-standard.com/article/news-ani/kerala-rti-shows-left-leader-s-murderer-received-parole-every-month-for-3-yrs-118031900030_1.html)

– RTI being
strangled due to Maha’s neglect: Former CIC Gandhi

Former Central Information Commissioner
Shailesh Gandhi today said that the Right to Information Act was being
“strangled” due to the neglect of the state government.

Gandhi has written a letter to Chief
Minister Devendra Fadnavis asking him to fill the vacancies in the Information
Commission in the state.

“RTI is slowly being strangled in
Maharashtra by not appointing information commissioners. In Maharashtra, there
is vacancy of one Chief Information Commissioner and three commissioners. These
are not being filled despite repeated reminders,” Gandhi stated in his
letter to Fadnavis.

Gandhi said that the pendency at all the
commissions was now alarming and it was in turn killing the objective of the
Act which was transparency.

Sharing the figures of 31,474 pending cases
in four regions, Gandhi said, “Nashik region has 9,931 pending cases, Pune
has 8,647 cases, Amravati 8,026 cases and Mumbai(HQ) has 4,870 cases pending.
These cases are languishing for the want of information commissioners.”

His letter stated that it was a serious
matter and needed immediate attention and claimed that failure to do so would
allow the state to “succeed” in making the RTI Act
“redundant”.

“It will continue as a haven for
rewarding retired bureaucrats and other favourites. It will be an expense
account with no benefit to its citizens,” Gandhi wrote.

He said that Maharashtra was one of the
first states to enact the law when it came into effect in October, 2005 but the
state was now “reeling from the worst levels of pendency in years”.

(Source:http://www.business-standard.com/article/pti-stories/rti-being-strangled-due-to-maha-s-neglect-former-cic-gandhi-118031900500_1.html)

– Agents of
RTI justice, information commissions are its biggest bottleneck

A crippling staff shortage and vacancies in
crucial positions at the central and state information commissions is severely
undermining the Right to Information (RTI) Act, a study by NGOs Satark Nagrik
Sangathan (SNS) and Centre for Equity Studies (CES) has found.

According to the study, ‘Report Card on the
Performance of Information Commissions in India’, which looked at 29
information commissions, including the central information commission (CIC),
and is based on data gathered via 169 RTI pleas, the failure of the central and
state governments to proactively put out information in the public domain is
the second biggest bottleneck in the effective implementation of the Act.

The CIC and state information commissions
(SICs) are almost all functioning much below their sanctioned strength. The
CIC, for example, is four short of its sanctioned strength of 10 information
commissioners. Of these, four are set to retire this year.

Also, the Maharashtra, Nagaland and Gujarat
SICs are headless in the absence of a chief information commissioner. Kerala’s,
meanwhile, has only one information commissioner, out of a sanctioned strength
of five.

The information commissions serve the role
of watchdogs in the implementation of the RTI Act, approached by petitioners
when their pleas are either not accepted by a government agency, refused, or
elicit inadequate information.

According to the report, in 2016, the number
of appeals and complaints pending with 23 SICs stood at the “alarming figure of
1,81,852”, growing 9.5 per cent to 1,99,186 at the end of October 2017. The
Mizoram and Sikkim SICs had zero pendency as of October 2017, while information
wasn’t available for other states.

“The assessment found that several ICs were
non-functional or functioning at reduced capacity, as the posts of
commissioners, including that of the chief information commissioner, were
vacant during the period under review,” said the study, which covered the
period from January 2016 to October 2017.

According to the report, Telangana, Andhra
Pradesh and Sikkim had spells where the SICs didn’t function at all, while the
West Bengal SIC did not hear any complaints or appeals for nearly 12 months.
Not surprisingly, the date of resolution for a complaint/appeal filed with West
Bengal SIC in November 2017 was estimated at 43 years later by the NGOs (see
graphic).

Estimated time required for disposal of an
appeal/complaint filed on November 1, 2017.

In a situation of this kind, people have “no
recourse to the independent appellate mechanism prescribed under the RTI Act”,
the report pointed out.

“The transparency in public authorities
completely diminishes. They have no fear or accountability when this happens,”
said RTI activist Subhash Agrawal.

“The poorest of the poor use RTI for
information regarding basic entitlements such as ration cards. If it takes 5
years to get a response then what is the point? Justice delayed is justice
denied,” said Anjali Bhardwaj, co-convenor of the National Campaign for
People’s Right to Information and a founding member of the Satark Nagrik
Sangathan. There are outliers, of course. The SICs for Mizoram and Sikkim
disposed of appeals/complaints in less than a month.

The political side of it

State chief information commissioners, as is
the case with the central chief information commissioner, are appointed by the
government in consultation with the opposition. Agrawal said while not
appointing chiefs was often a government bid to dilute institutions, delayed
appointments resulted several times from a lack of coordination between the
chief minister and the leader of the opposition. “Mayawati and Mulayam Singh
didn’t see eye to eye, so it took a long time for the UP state commission to be
set up,” he added.

“Not having a chief (information
commissioner) is legally unsound. It is the commissioner who runs everything,
while everyone else is supposed to support him,” said Habibullah.

When the last resort crumbles:

The multitude of vacancies is a factor, of
course, but experts pointed out that it was the lack of transparency on the
part of the central and state governments that forced people to file RTI pleas
even for the most basic information.

“The government is not doing its job of suo
motu disclosure u/s. 4(1)(B) of the RTI Act, under which it has to update
information every 120 days,” said Wajahat Habibullah, the first chief
information commissioner.

Agrawal said
“more proactive disclosures by the government can cut the number of RTI pleas
filed by 70%”.

The ‘inexplicable’ overnight drop

The report pointed out how the CIC stated in
an RTI reply that the total number of appeals and complaints pending with it
stood at 28,502 as on 31 December 2016. However, according to its website, only
364 cases were pending with it on 1 January 2017, it added, terming the fall
“inexplicable”.

The returned complaints

Apart from the pendency, concerns have also
been raised about the high number of appeals and complaints returned to
petitioners, several for unspecified reasons, with many people wondering
whether this was a ploy to project lower pendency rates.

“This is extremely problematic as people,
especially the marginalised, reach the commissions after a great deal of
hardship and a long wait,” said the report.

“The number is so high that I suspect cases
were not rejected on solid grounds,” Habibullah added.

Bhardwaj said they had found instances where
cases were wrongfully returned.

She added that when the commissions returned
complaints, it “fails to perform its legal duty as a friend of the petitioner”.
“Many people are unlettered but they do have the right to information,” she
said.

The penalties, or the lack thereof

According to the RTI Act, the information
commissions can impose penalties of up to Rs 25,000 against public information
officers (PIOs) for violations of the RTI Act. However, according to the
report, penalties were rare.

The report added: “Penalties were imposed
in… only 4.1% of the cases where penalties were imposable!”

(Source:https://theprint.in/governance/agents-of-rti-justice-information-commissions-are-its-biggest-bottleneck/41229/)

– Govt
Orders Voluntary Info Disclosure Under RTI

With most of the departments and authorities
in the state yet to disclose voluntary information under Right to Information
(RTI) Act, the government on Friday directed all the concerned officials to
ensure the disclosures as per the transparency law within a week.

“With a view to maintaining conformity with
the provisions of Section 4 of J&K Right to Information Act, 2009, from
time to time, instructions have been issued, impressing upon all the
Administrative Secretaries, Heads of the Departments and Public Authorities of
the State to ensure effective implementation of the provisions of Section 4 of
the J&K RTI Act in letter and spirit by hosting all requisite information
on the official websites and updating them periodically,” reads a circular
issued by the government.

“However, it is being constantly observed
that some of departments are not implementing the provisions of Section 4 of
the Jammu & Kashmir Right to Information Act, 2009 and some of them have
yet not created their departmental websites.”

The J&K State Information Commission has
been persistently requesting for ensuring implementation of the provisions of
the J&K Right to Information Act, it said.

“Therefore all such departments as have not
so far created their own departmental websites are impressed upon to do so
within a fortnight and host the requisite material on the websites under the
provisions of Jammu & Kashmir Right to Information Act, 2009, on regular
basis. Further, all the Administrative Secretaries are enjoined upon to furnish
the status on this account to the General Administration Department as well as
State Information Commission within a week’s time positively.”

The CIC had shared details with the GAD about
the status of different departments regarding creation of websites, disclosure
u/s. 4 of the RTI Act, appointment of Public Information Officer and First
Appellate Authority.

The CIC has informed the GAD that many
departments were not disclosing the information as per the Act.

The CIC has also highlighted that the domain
name of GMC Jammu has expired on August 30 last year.

(Source:https://kashmirobserver.net/2018/local-news/govt-orders-voluntary-info-disclosure-under-rti-29164)

– Meghalaya
RTI Activist, Who Went After Cement Firms, Found Murdered

A right-to-information activist who was
working to expose alleged misuse of public funds in Meghalaya was found dead in
the northeast state, police said on Tuesday.

Poipynhun Majaw had been filing applications
under the Right to Information (RTI) Act to check alleged corruption in public
projects in Meghalaya’s Jaintia Hills Autonomous District Council.

His body was found near a bridge in
Khliehriat, the district headquarters of East Jaintia Hills, 120 kilometres
from state capital Shillong. He was also the president of Jaintia Youth
Federation.

Police said he was last seen riding a
motorcycle near the East Jaintia Hills deputy commissioner’s office on Monday
night.

“A wrench was found next to the body.
Preliminary inquest suggests the victim was hit on the head leading to his
death,” senior police officer AR Mawthoh said.

Recently, using replies he got from the
authorities under using the RTI route, he had alleged that cement firms have
been mining in the area without permission from the council.

(Source:https://www.ndtv.com/india-news/meghalaya-rti-activist-who-went-after-cement-firms-found-murdered-1826488)

– RBI: SMA details exempted from disclosure under
RTI

Contradicting its reply to an earlier right
to information (RTI) query, the Reserve Bank of India (RBI) has recently said
bank-wise information on special mention account (SMA) 1 and 2 is exempt from
disclosure u/s. 8 (1) (a) & (d) of the RTI Act. While SMA 1 refers to loans
where repayments are overdue between 31-60 days, SMA 2 loans are ones where
principal or interest is overdue between 61-90 days. Although these are
technically not non-performing assets (NPAs), but nonetheless indicate
‘incipient stress’. In April 2016, RBI had said in an RTI response that SMA 1
and 2 loans of all banks stood at Rs 6,24,119 crore at the end of December
2015, 9% higher than Rs 5,73,381 crore at the end of June 2015. It had further
said while SBI’s SMA-2 accounts stood at Rs 60,228 crore, or 5.17% of its total
advances, at PNB this exposure was approximately 6.31% of its total loan book
or Rs 24,824 crore. RBI’s executive director and appellate authority Uma
Shankar said on March 7, 2018, that there is no overriding public interest in
the disclosure of credit information. She added that section 45E of the RBI
Act, 1934, contains a specific bar against disclosure of credit information
collected by the central bank. “Though section 22 of the RTI Act, 2005, starts
with a non-obstante clause, the interpretation given to that section by CIC is
that it is not intended to override special enactments,” she said. She said SMA
data is collected by RBI solely for disseminating the information to other
banks having exposure to the accounts reported in SMA by banks.

(Source:http://www.financialexpress.com/industry/rbi-sma-details-exempted-from-disclosure-under-rti/1096387/)

RTI Clinic in April 2018: 2^nd, 3^rd,
4^th Saturday, i.e. 8^th, 15^th and 22^nd
11.00 to 13.00 at BCAS premises.

shailesh.kwebmaker

Hindu Succession Amendment Act– Poor Drafting Defeating Gender Equalisation?

Introduction

The Hindu Succession (Amendment) Act, 2005 (“2005
Amendment Act”) which was made operative from 9th September, 2005, was
a path-breaking Act which placed Hindu daughters on an equal footing with Hindu
sons in their father’s Hindu Undivided Family by amending the age-old Hindu
Succession Act, 1956 (‘the Act”).
However, while it ushered in great reforms it also left several
unanswered questions and ambiguities. Key amongst them was to which class of
daughters did this 2005 Amendment Act apply? The Supreme Court has answered
some of these questions which would help resolve a great deal of confusion.

The 2005 Amendment Act

The Hindu Succession (Amendment) Act, 2005
amended the Hindu Succession Act, 1956. The Hindu Succession Act, 1956, is one
of the few codified statutes under Hindu Law. It applies to all cases of
intestate succession by Hindus. The Act applies to Hindus, Jains, Sikhs,
Buddhists and to any person who is not a Muslim, Christian, Parsi or a Jew. Any
person who becomes a Hindu by conversion is also covered by the Act. The Act
overrides all Hindu customs, traditions and usages and specifies the heirs
entitled to such property and the order or preference among them. The Act also
deals with some important aspects pertaining to an HUF.

By the 2005 Amendment Act, the Parliament
amended section 6 of the Hindu Succession Act, 1956 and the amended section was
made operative from 9^thSeptember 2005. Section 6 of the Hindu
Succession Act, 1956 was totally revamped. The relevant portion of the amended
section 6 is as follows:

“6. Devolution of interest in coparcenary
property.?(1) On and from the commencement of the Hindu Succession (Amendment)
Act, 2005 (39 of 2005), in a Joint Hindu family governed by the Mitakshara law,
the daughter of a coparcener shall,?

(a) by birth become a coparcener in her
own right in the same manner as the son;

(b) have the same rights in the
coparcenery property as she would have had if she had been a son;

(c) be subject to the same liabilities in
respect of the said coparcenery property as that of a son, and any reference to
a Hindu Mitakshara coparcener shall be deemed to include a reference to a
daughter of a coparcener:

Provided that nothing contained in this
sub-section shall affect or invalidate any disposition or alienation including
any partition or testamentary disposition of property which had taken place
before the 20^th day of December, 2004.”

Thus, the amended section provides that a
daughter of a coparcener shall:

a) become, by birth a coparcener in her own
right in the same manner as the son;

b) have, the same rights in the coparcenary
property as she would have had if she had been a son; and

c) be subject to the same liabilities in respect
of the coparcenary property as that of a son.

Thus, the amendment equated all daughters
with sons and they would now become a coparcener in their father’s HUF by
virtue of being born in that family. She has all rights and obligations in
respect of the coparcenary property, including testamentary disposition. Not
only would she become a coparcener in her father’s HUF but she could also make
a will for the same. The Delhi High Court in Mrs. Sujata Sharma vs. Shri
Manu Gupta, CS (OS) 2011/2006 has held that a daughter who is the eldest
coparcener can become the karta of her father’s HUF.

Key Question

One issue which remained unresolved was
whether the application of the amended section 6 was prospective or
retrospective?

Section 1(2) of the Hindu Succession
(Amendment) Act, 2005, stated that it came into force from the date it was
notified by the Government in the Gazette, i.e., 9^th September,
2005. Thus, the amended section 6 was operative from this date. However, does
this mean that the amended section applied to:

(a) daughters born after this date;

(b) daughters married after this date; or

There was no clarity under the Act on this
point. The Maharashtra Amendment Act (similar to the Central Amendment) which
was enacted in June 1994 very clearly stated that it did not apply to female
Hindus who married before 22^nd June, 1994. In the case of the
Central Amendment, there was no such express provision.

Prospective Application upheld

The Supreme Court, albeit in the context of
a different context, clarified that the 2005 Amendment Act did not seek to
reopen vesting of a right where succession has already taken place. According
to the Supreme Court, “the operation of the Statute is no doubt prospective in
nature…. Although the 2005 Act is not retrospective its application is
prospective” – G. Sekar vs. Geetha (2009) 6 SCC 99.

The Supreme
Court has held in Sheela Devi vs. Lal Chand, (2007) 1 MLJ 797 (SC),
that if the succession was opened prior to the Hindu Succession (Amendment) Act,
2005, the provisions of the 2005 Amendment Act would have no application. Thus,
a daughter can be considered as a coparcener only if her father was a
coparcener at the time of the 2005 Amendment Act coming into force – Smt. Bhagirathi vs. S Manivanan AIR
2008 Mad 250. In that case, the Madras High Court observed that the
father of the daughter had expired in 1975. It held that the 2005 Amendment Act
was prospective in the sense that a daughter was being treated as a coparcener
on and from 9^thSeptember 2005. It was clear that if a Hindu male
died after the commencement of the 2005 Amendment Act, his interest in the
property devolved not by survivorship but by intestate succession as
contemplated in the Act. The death of the father having taken place in 1975,
succession itself opened in the year 1975 in accordance with the earlier
provisions of the Act. Retrospective effect cannot be given to the provisions
of the 2005 Amendment Act.

The Full Bench of the Bombay High Court in Badrinarayan
Shankar Bhandari vs. Omprakash Shankar Bhandari, AIR 2014 Bom 151 has
held that the legislative intent in enacting clause (a) of section 6 was
prospective i.e. daughter born on or after 9^thSeptember 2005 will
become a coparcener by birth, but the legislative intent in enacting clauses
(b) and (c) of section 6 was retroactive, because rights in the coparcenary
property were conferred by clause (b) on the daughter who was already born
before the amendment, and who was alive on the date of Amendment coming into
force. Hence, if a daughter of a coparcener died before 9^thSeptember
2005, since she would not have acquired any rights in the coparcenary property,
her heirs would have no right in the coparcenary property. Since section 6(1)
expressly conferred a right on daughter only on and with effect from the date
of coming into force of the 2005 Amendment Act, it was not possible to take a
view that heirs of such a deceased daughter could also claim benefits of the
amendment. The Court held that it was imperative that the daughter who sought
to exercise a right must herself be alive at the time when the 2005 Amendment
Act was brought into force. It would not matter whether the daughter concerned
was born before 1956 or after 1956. This was for the simple reason that the
Hindu Succession Act 1956 when it came into force applied to all Hindus in the
country irrespective of their date of birth. The date of birth was not a
criterion for application of the Principal Act. The only requirement was that
when the Act was being sought to be applied, the person concerned must be in
existence/ living. The Parliament had specifically used the word “on and
from the commencement of Hindu Succession (Amendment) Act, 2005” so as to
ensure that rights which were already settled were not disturbed by virtue of a
person claiming as an heir to a daughter who had passed away before the
Amendment Act came into force.

Finally, the matter was settled by the Apex
Court in its decision rendered in the case of Prakash vs. Phulavati,
(2016) 2 SCC 36. The Supreme Court examined the issue in detail and
held that the rights under the Hindu Succession Act Amendment are applicable to
living daughters of living coparceners (fathers) as on 9^th
September, 2005 irrespective of when such daughters were born. It further held
that any disposition or alienation including a partition of the HUF which may
have taken place before 20^th December, 2004 (the cut-off date
provided under the 2005 Amendment Act) as per law applicable prior to the said
date would remain unaffected.

Thus, as per the above Supreme Court
decision, in order to claim benefit, what is required is that the daughter
should be alive and her father should also be alive on the date of the
amendment, i.e., 9^th September, 2005. Once this condition was met,
it was immaterial whether the daughter was married or unmarried. The Court had
also clarified that it was immaterial when the daughter was born.

Further Controversy

Just when one thought that the controversy
had been settled by the Supreme Court, the fire was reignited. A new question
cropped up – would the 2005 Amendment Act apply to those daughters who were
born before the enactment of the Hindu Succession Act, 1956? Thus, could it be
said that since the daughter was born before the 1956 Act she could not be considered
as a coparcener? Hence, she would not be entitled to any share in the joint
family property? The Karnataka High Court in Pushpalata NV vs. V. Padma,
ILR 2010 KAR 1484 held that prior to the commencement of the 2005
Amendment, the legislature had no intention of conferring rights on a daughter
of a coparcener including a daughter. In the Act before the amendment the
daughter of a coparcener was not conferred the status of a coparcener. Such a
status was conferred only by the 2005 Amendment Act. After conferring such
status, right to coparcenary property was given from the date of her birth.
Therefore, it necessarily followed such a date of birth should be after the
Hindu Succession Act came into force, i.e., 17.06.1956. There was no intention
either under the unamended Hindu Succession Act or the Act after the amendment
to confer any such right on a daughter (of a coparcener) who was born prior to
17.06.1956. The status of a coparcener was conferred on a daughter of a
coparcener on and from the commencement of the 2005 Amendment Act. The right to
property was conferred from the date of birth. Both these rights were conferred
under the original Hindu Succession Act and, therefore, it necessarily followed
that the daughter who was born after the Act came into force alone would be
entitled to a right in the coparcenary property and not a daughter who was born
prior to 17.06.1956. The same view was taken again by the Karnataka High Court
in Smt Danamma and Others vs. Amar and Others, RFA NO. 322/2008 (Kar).

This 2^nd decision of the
Karnataka High Court was appealed in the Supreme Court and the Supreme Court
gave its verdict in the case of Danamma @ Suman Surpur and Others vs.
Amar and Others, CA Nos. 188-189 / 2018. The Apex Court observed that
section 6, as amended, stipulated that on and from the commencement of the 2005
Amendment Act, the daughter of a coparcener would by birth become a coparcener
in her own right in the same manner as a son. It was apparent that the status
conferred upon sons under the old section and the old Hindu Law was to treat
them as coparceners since birth.

The amended provision now statutorily
recognised the rights of coparceners of daughters as well since birth. The
section used the words ‘in the same manner as the son’. It was therefore
apparent that both the sons and the daughters of a coparcener had been
conferred the right of becoming coparceners by birth. It was the very factum
of birth in a coparcenary that created the coparcenary, therefore the sons
and daughters of a coparcener became coparceners by virtue of birth.

Devolution of coparcenary property was the
later stage of and a consequence of death of a coparcener. The firststage of a
coparcenary was obviously its creation. Hence, the Supreme Court upheld the
provisions of the 2005 Amendment Act granting rights even to those daughters
who were born before the commencement of the Hindu Succession Act, 1956, i.e.,
before 17.06.1956. Thus, the net effect of the decisions on the 2005 Amendment
Act is as follows:

(a) The amendment applies to living daughters of
living coparceners as on 09.09.2005.

(b) It does not matter whether the daughters are
married or unmarried.

(c) It does not matter when the daughters are
born. They may be born even prior to the enactment of the 1956 Act, i.e., even
prior to 17.06.1956.

(d) However, if the father / coparcener died prior
to 09.09.2005, then his daughter would have no rights under the 2005 Amendment
Act.

Conclusion

An extremely sorry state
that such an important gender equalisation move has been marred by a case of
poor drafting! One wonders why these issues cannot be expressly clarified
rather than leave them for the Courts. It has been 12 years since the 2005
Amendment Act but the issues refuse to die down. One can think of several more
questions, which are waiting in the wings, such as, would the daughter’s
children have a right in their maternal grandfather’s HUF? Clearly, this
coparceners amendment loves controversy.

shailesh.kwebmaker

Ind AS 115 – Revenue From Contracts With Customers

The impact
of revenue is all pervasive and encompasses all entities. The standard brings
about a fundamental change in how entities will envision, recognise and measure
revenue. In this article the author briefly discusses the date of applicability
of Ind AS 115, the fundamental changes from current practice, key impacts for
certain industries and disclosure and other business implications. Given the
pervasive and fundamental impact of the standard, entities that have not
already started, should waste no time in preparing for Ind AS 115.

When does Ind AS 115
apply?

The Exposure Draft (ED)
issued by the ICAI states that the standard would apply from accounting periods
commencing on or after 1^st April 2018.

However, it is not yet
notified by the Ministry of Corporate Affairs (MCA). In the past we have
observed instances where standards have been notified on the last day of the
financial year. Whilst there is no 100% guarantee that the standard would apply
from 1^stApril, 2018, companies should anticipate that it would be
notified by MCA before the end of the financial year, given the past
experience.

Whilst this is an unhappy
outcome, it may be noted that the ICAI had clarified the applicability date in
April 2017 and the ED was issued much earlier; providing enough opportunity to
prepare for implementation of the new standard. By the time this article is
published, it will be clear whether the standard has become applicable. It may
be noted that listed companies will have to churn out numbers under Ind AS 115
in the first quarter of 2018-19, and hence this is a highly onerous obligation,
than what may initially appear.

What are the fundamental
changes compared to the existing Ind AS 18 Revenue?

Ind AS 115 requires
perceiving revenue from the customer’s point of view; which is whether the
customer has received a stand-alone benefit from the goods or services it has
received. This is likely to impact accounting of connection, activation,
installation, admission, and similar revenue. This can be observed across
several industries, such as, telecom, power, cable television, education,
hospitality, etc. Consider for example, an electricity distribution
company installs an electric meter at the customer’s site. The meter certainly
benefits the customer, but it does not provide to the customer any independent
stand-alone benefit, because the meter is useless without the subsequent
transfer of power to the customer. Neither the customer can use the meter to
procure power from other distributors. Therefore, the customer has not received
any benefit from the meter on its own and consequently such connection income
is recognised overtime by the distribution company.

The other fundamental
change is that under Ind AS 115, an entity recognises revenue when control of
the underlying goods or services are transferred to the customer. This is
different from the current “risk and reward” model under Ind AS 18, where
revenue is recognised on transfer of risk and rewards to the customer. Consider
an entity transfers legal title and control of goods to a customer on free on
board (FOB) delivery terms. However, the entity reimburses the customer for any
damages or transit losses in accordance with its past practice. Under the Ind
AS 18, risk and reward model, some entities may have delayed recognition of
revenue till the time the customer has received and accepted the goods. This is
on the basis that the risk and rewards are transferred when the customer
receives and accepts the goods. Under the control model in Ind AS 115, revenue
will be recognised on shipment because control is transferred to customers at
shipment. As soon as the goods are boarded, the customer has legal title to the
goods, the customer can direct the goods wherever it wants and the customer can
decide how it wants to use those goods. In this situation, the entity will have
two performance obligations (1) sale of goods, and (2) reimbursing transit
losses. The total transaction price will be allocated between the goods and the
transit losses, and recognised when those respective performance obligations
are satisfied. However, in most situations, the performance obligation relating
to reimbursement of the transit losses may be insignificant, in which case it
may be ignored.

There are numerous other
changes that may not be fundamental, but still be very important. Take for
example, the discounting of retention monies. Currently under Ind AS 18 there
is debate on whether retention monies need to be discounted. This is because of
contradictory requirements in the standard. One view is that since revenue is
recognised at fair value, the retention monies need to be discounted to
determine the fair value of revenue. Ind AS 18 also states that “when the
arrangement effectively constitutes a financing transaction, the fair
value of the consideration is determined by discounting all future receipts
using an imputed rate of interest…………….The difference between the fair value
and the nominal amount of the consideration is recognised as interest revenue
in accordance with Ind AS 109.” This means that discounting is only required
when the arrangement contains a financing arrangement. Ind AS 18 was therefore
debatable.

On the other hand, Ind AS
115, is absolutely clear. Paragraph 62 states that “notwithstanding the
assessment in paragraph 61, a contract with a customer would not have a
significant financing component if any of the following factors exist: ………….(c)
the difference between the promised consideration and the cash selling price of
the good or service (as described in paragraph 61) arises for reasons other
than the provision of finance to either the customer or the entity, and the
difference between those amounts is proportional to the reason for the
difference. For example, the payment terms might provide the entity or the
customer with protection from the other party failing to adequately complete
some or all of its obligations under the contract.

Since retention monies are
held by customers as a measure of security to enforce contractual rights and
safeguard its interest, retention monies are not discounted under Ind AS 115.

Explain the five step model
in

Ind AS 115 and briefly
outline the impact on industry.

The model in the standard
is based on five steps, which are given below.

Step 1:
Identify the contract: A contract has to be enforceable and the transaction
price should be collectable on the day the contract is entered into. The
contract can be written or oral, but has to be enforceable. If the contract is
not enforceable revenue cannot be recognised.

Step 2:
Identify performance obligations: Within a contract there could be several
performance obligations. Performance obligations are basically distinct goods
and services within a contract from which the customer can benefit on its own.

Step 3: This
step requires determining the transaction price in the contract. Whilst in most
cases this would be fairly straight-forward, in certain contracts, it could be
complicated because of:

– Variable consideration (including application of the constraint)

– Significant financing component

– Consideration paid to a customer (for example, free mobile
offered to a customer that buys a telecom wireless package)

– Non-cash consideration

The standard deals in
detail on how to recognise, measure and disclose the above components.

Step 4: Allocate
the transaction price to the various performance obligations in the contract.

Step 5:
Recognise revenue when (or as) performance obligations are satisfied. This can
be at a point in time or over time.

The construct of the model
is very simple but when applied, can throw huge challenges and is very
different from current Ind AS 18. It may be noted, that there would be numerous
areas of differences and challenges for each industry. Below is a broad outline
of the impact of the standard and the interplay of the five steps on various
industries. It is a very brief summary of a few of the many issues, used only
for illustration purposes.

Real estate

Real estate entities offer
a 10:90 or similar schemes to customers. As per the scheme, the customer pays
10% of the contract value on signing the offer letter, followed by a 90%
payment when the unit is delivered to the customer. If real estate prices fall
significantly, the customer may simply decide not to take delivery, and allow
the 10% to be forfeited. In many jurisdictions, such contracts may not be
legally enforceable against the customer and when enforceable the legal system
could be a huge deterrent to recover the monies from the customer. If this is
the situation, there is no enforceable contract under Ind AS 115, and
consequently no revenue is recognised till such time the contract is enforceable
or the remaining 90% is received by the real estate entity.

Another hot topic for real
estate entities would be the method for recognition of revenue, i.e. whether
percentage of completion method (POCM) or completed contract method (CCM) would
apply when a building is constructed which has several units sold to different
customers. In this case, since the customer does not control the underlying
asset itself, as it is getting constructed, revenue is recognised only on
delivery of the real estate unit to the customer. This issue was discussed in
detail by IFRIC at a global level. IFRIC observed the following: although the
customer can resell or pledge its contractual right to the real estate unit
under construction, it is unable to sell the real estate unit itself without
holding legal title to the completed unit. Consequently, the real estate entity
is not eligible for overtime recognition of revenue. However, the standard
allows overtime recognition of revenue, in situations where the real estate entity
has the right to collect payments from the customer for work completed to date.
Such amounts should include cost and an appropriate margin. If the real estate
entity does not have such a right, in statute and contract, POCM recognition of
revenue is not allowed. In other words, revenue is recognised when the
completed unit is delivered to the customer. Real estate entities in India that
want to apply POCM should verify if the statute entitles them with such a
right. If such a right is provided in the statute, they should ensure that the
contract with the customer also provides such a right.

Pharmaceutical

Some Indian pharmaceutical
companies have sales in US, through a few large US distributors on a principal
to principal basis. However, the amount of revenue to be received from the US
distributors may be variable, as the contract may have a price capping
mechanism or provide an unlimited right of return to the US distributors. The
price capping mechanism ensures that if the entity sells the same products at a
lower price to other customers, the distributor would be entitled to a
proportionate refund.

The US distributors will
send a sales report containing quantity and value to the pharma company on a
quarterly basis. Under current standards, some pharmaceutical companies may not
recognise revenue on dispatch to the US distributor, but recognise revenue
based on reported sales at the end of each quarter; effectively treating the US
distributor as an agent. This is because the risks and rewards may not have
transferred to the US distributor who has an unlimited right of return and is
also entitled to the benefit from the price capping mechanism. Under Ind AS
115, the control of goods is transferred to the distributor on dispatch since
the US distributor has legal title and ownership of the goods.

The pharma company does not
have any rights to recover the products, except as a protective right in rare
situations. Consequently, the pharma company recognises revenue upfront when
the control of the goods is transferred to the distributor. Since revenue is
variable because of the price capping mechanism and the unlimited right of
return, the transaction price will need to be estimated in accordance with the
methodology prescribed in the standard.

Software Company

Many Indian software
companies applied the US GAAP accounting for Indian GAAP as well. Under US
GAAP, a software company needs to separately account for elements in a software
licensing arrangement only if Vendor Specific Objective Evidence (VSOE) of fair
value exists for the undelivered elements. An entity that does not have VSOE
for the undelivered elements generally must combine multiple elements in a
single unit of account and recognise revenue as the delivery of the last
element takes place. VSOE is not required under Ind AS 115. The standard
prescribes a methodology for determining and allocating the transaction price
to various elements, which uses VSOE but in its absence prescribes other
methods of determining the allocation of the transaction price to the various
elements.

Telecom

Telecom companies may offer
a free handset to customers along with a wireless telecom package (voice and
data). Currently, some telecom companies recognise the telecom package overtime
and the cost of the free handset is recognised as a sales promotion cost. Under
Ind AS 115, the total consideration will be split between the telecom package
and the handset, and recognised as those performance obligations are satisfied.
This would give a completely different revenue, cost and margin pattern
compared to current practice.

Engineering and
Construction

The standard contains a
detail set of requirements on how to account for contract modifications. For
example, an unpriced change order is common in construction contracts; wherein
the scope of work is changed by the customer but the price for the change is
not agreed. The standard would require that the revenue and cost estimates on
the contract are immediately updated, consequently percentage of completion
margins would change. The problem is that revenue from the change in scope is
variable and the standard requires caution in estimating the variable revenue,
whereas costs are fully estimated. Consequently, the initially estimated POCM
margins may decline.

Consumer products and other

industries

An entity may have sold
goods, but on request from the customer, would have held those goods in its
storage facility. This is often referred to as bill and hold sales and is
common across all industries. For example, some pharmaceutical companies may
have a stock pile program for vaccinations based on government directives or a
consumer goods company may hold goods sold at its storage location on request,
as the distributor may be short of storage space. Contrary to current practice,
under Ind AS 115, in many cases bill and hold sales may not qualify for revenue
recognition because the underlying goods are fungible. For example, the stock
pile program may not qualify for revenue recognition, if they are subject to rotation,
i.e., the entity can sell some from the pile to another customer and replace it
with fresh supplies. These arrangements do not meet the criterion for
recognition of revenue on bill and hold sales, though they may have fulfilled
the criterion under Ind AS 18.

Another common topic
relevant for a consumer goods and other companies is warranties. If the
warranties are sold separately, or warranty entails a service in addition to
assurance (such as an extended warranty period), they are accounted for as a
separate performance obligation, rather than as a cost accrual.

Currently, the entire
revenue is recognized upfront and estimated cost for warranty is provided.
Under Ind AS 115, revenue will be allocated between the goods and the warranty.
Revenue and cost of goods is recognised as soon as the goods are sold. Revenue
and cost on warranties is recognised overtime as the warranty service is
provided.

This will result in a
different revenue, cost and margin profile compared to current practice under
Ind AS 18. It may be noted, that if the warranties are assurance type
warranties, and not sold separately or contain extended terms, the accounting
under Ind AS 18 and Ind AS 115 is the same.

Which are the disclosure
requirements that are onerous?

There are numerous
disclosure requirements. Entities should not underestimate the disclosure
requirements. Here we discuss two key disclosure requirements.

1. Entities will be
required to provide disaggregated revenue information in the financial
statements. The standard requires such disclosure on the basis of major product
lines, geography, type of market or customer (government, non-government, etc.),
contract duration, sales channel, etc., whichever is the most
appropriate and relevant for the entity. The standard provides guidance on how
this disclosure is made, and suggests that existing information provided to the
CEO, board, analysts, etc. may be used, and one need not reinvent the wheel.

2. For contracts or orders
that require more than one year to execute, the standard requires disclosure of
(a) transaction price allocated to the unsatisfied or partially satisfied
performance obligations, and (b) time bands by which the obligations will be
fulfilled and revenue recognised. For the said purpose, quantitative or
qualitative measures can be used.

What are the business

implications of Ind AS 115?

Certainly when top line and
margins change compared to current accounting, it will have numerous
implications, such as on income-tax, bonuses that are dependent on
revenue/margins, revenue sharing arrangements, contract terms and conditions,
internal control over financial reporting, etc. For example, companies
may change the sales arrangement with their distributors, to provide them
control at the point of shipment, so that revenue can be recognised at
shipment, rather than when the customer accepts the goods.

Certain business implications may
not be immediately obvious. Some companies may accept onerous contracts, to
recover some portion of the fixed costs/capacity. The IFRIC is currently
discussing whether when providing for onerous contract full cost provision or
only incremental cost needs to be provided for. Now if full cost absorption is required,
more onerous losses get recognised earlier. This may be a deterrent for
companies to accept a contract that is onerous.

shailesh.kwebmaker

Perspectives On Fair Value Under Ind As (Part 2)

INTRODUCTION

Under Part 1 which was published in February 2018, we had discussed the broad principles underlying fair value measurement as enshrined in Ind AS 113- Fair Value Measurements. In this part, we would be broadly understanding the requirements for measurement and disclosure of fair value for various types of assets, liabilities and equity under various Ind ASs as indicated in Part 1, coupled with the benefits and perils of fair value accounting followed by certain practical considerations for first time adoption by Phase II entities based on the learnings gathered from the Phase I entities.

BROAD PRESCRIPTION ON FAIR VALUE UNDER CERTAIN Ind ASs:
As indicated earlier, the following are the main Standards which prescribe the use of fair value either for measurement, disclosure or assessment purposes.

Ind AS 36- Impairment of Assets:

The broad objectives of this Standard are as under:

a) To observe if there are any indicators of impairment of various assets.
b) To measure the recoverable amount and compare the same with the carrying value of the asset.
c) To impair the assets if the carrying value is greater than the recoverable amount.

The key consideration for assessing impairment is the determination of the recoverable amount which is defined as the higher of the “Value in Use” or “Fair value less Costs of Disposal”.

“Value in Use” for the purpose of the above assessment is determined by estimating the future cash flows that can be derived from the continuous use of the asset including its realisable value on ultimate disposal and discounting the same at an appropriate rate after considering the risk, premium or discount as applicable.The principles underlying the present value technique as per Ind AS 113 as discussed in Part 1 need to be kept in mind whilst estimating the future cash flows and the discount rate to be applied for arriving at the value in use.

The “Fair Value less Cost of Disposal” for the purpose of the above assessment refers to the amount arising from the sale of an asset or CGU in an arm’s length transaction less the cost of disposal. The costs of disposal includes legal costs, stamp duty and other similar levies, as applicable, cost of removing the asset and direct incremental costs to bring the asset into a selling condition. However, finance costs and income tax expenses need to be excluded whilst determining the cost of disposal. For determining the fair values, the principles as enunciated under Ind AS 113 as discussed in part 1 need to be kept in mind. However, there is no bar on the type of valuation technique to be used.

Apart from the other disclosures, Ind AS 36 requires the following specific disclosures dealing with fair value:

a) The basis used for determining the recoverable amount keeping in mind the fair value hierarchy as per Ind AS 113 discussed earlier.
b) The key assumptions and the discount rate considered for determining the value in use as defined above.

Ind AS 103- Business Combinations:

This Standard deals with the initial recognition of assets and liabilities in respect of business combinations which could be in the nature of acquisitions or amalgamation under common control transactions. In respect of business combinations accounted for under the “acquisition method”, the initial recognition of assets and liabilities is as under:

– Recognising and measuring all the identifiable assets, whether tangible or intangible, including those that are not previously recognised by the acquiree, and liabilities (including contingent liabilities) at fair value as determined as per Ind AS 113.

– Any contingent consideration which forms a part of the transaction also needs to be accounted at fair value in accordance with Ind AS 109 or 113, as applicable.

– Any goodwill resulting from the transaction needs to be tested annually for impairment in accordance with Ind AS 36 as discussed above.

This is one of the key Standards wherein extensive use of fair valuation is mandated. The broad principles governing fair valuation under Ind AS 113 would need to be kept in mind depending upon the nature of the assets and liabilities being acquired.

Further, apart from the other matters, the main challenge lies in identifying the intangible assets acquired as a part of the business combination which have not been recognised by the acquiree, but which meet the recognition and identifiability criteria and to allocate a fair value to them as a part of the overall consideration. This would require significant judgements based on the business rationale and other commercial considerations of the transaction. The broad principles governing the determination of fair value as discussed later, under Ind AS 38 – Intangible Assets would need to be kept in mind. The following are some of the broad categories related to intangible assets arising from acquisitions under business combination:
– Marketing
– Customer
– Artistic
– Contractual
– Technology

Ind AS 109- Financial Instruments:

This is another Standard which almost entirely rests on the premise of fair valuation. The underlying theme of the Standard is that all financial assets and liabilities should be initially measured at fair value as determined under Ind AS 113, which would normally be the transaction price, unless proved otherwise as discussed below.

Para B 5.1.2A of Ind AS 109 provides that the transaction price may need to be adjusted on initial recognition if there is a fair value as evidenced by a quoted price in an active market for an identical asset or liability (level 1) or based on a valuation technique that uses data only from observable markets (level 2).

The way the financial instruments are classified under Ind AS 109 drives their subsequent measurement.

Whilst the valuation of quoted financial instruments is quite straight forward, it is the valuation of unquoted and complex financial instruments, including derivatives, which poses various challenges given their hybrid nature and the difficulty in quantifying the associated risks. Whilst a detailed discussion of the valuation methods is beyond the scope of this study, the broad underlying principles are briefly touched upon hereunder.

For ease of understanding, financial instruments are classified into the following broad categories for valuation purposes:
a) Bonds and its variants
b) Forwards and futures
c) Call and put options
d) Equity Instruments

In respect of the instruments indicated in (a) to (c) above, determination of fair value needs to consider the various specific features like conversion options, put and call options, caps and floors and various other subjective assessments and judgements which are captured through various mathematical models. However, if such instruments are traded and quoted on a recognised stock exchange, the challenges in determining fair value are much less.

Equity Instruments:

The valuation of equity instruments is dependent on the underlying valuation of the company which has issued these instruments. For this purpose, the appropriate valuation methodology from amongst the various methods as discussed earlier would need to be considered dependent upon the nature of the business / industry and the purpose of the valuation whether on a going concern or liquidation basis etc.

A question which often arises in case of unquoted equity shares is the basis and frequency with which the fair value needs to be measured due to lack of credible recent information being available and consequently whether the cost can be considered as the fair value. In this context, para B 5.2.3 of Ind AS 109 provides that in limited circumstances, cost may be an appropriate estimate of fair value, especially in case if insufficient more recent information is available to measure fair value, or if there is a wide range of possible fair value measurements and cost represents the best estimate of fair value within that range. Further, para B5.2.4 of Ind AS 109 provides for a list of some of the following indicators, amongst others, where cost might not be representative of the fair value:

a) Significant change in the performance of the investee compared with budgets, plans or milestones.
b) Changes in expectation that the investee’s technical product milestones will be achieved.
c) Significant change in the market for the investee’s equity or its products or potential products.
d) Significant change in the global economy or the economic environment in which the investee operates.
e) Significant change in the performance of comparable entities, or in the valuations implied by the overall market.

Ind AS 28- Investments in Associates and Joint
Ventures:

The Standard provides that an investment in an associate or joint venture should be accounted by using the equity method under which the investment is initially recognised at acquisition cost. Subsequent to the acquisition, the difference between the cost of the investment and the investee’s share of the net fair value of the identifiable assets and liabilities, determined in accordance with Ind AS 113, is accounted as under:

– Goodwill – if the cost of the investment is greater than the investee’s share of the net fair value of the assets and liabilities. This goodwill is to be adjusted with the carrying value of the investment and is neither eligible for amortisation nor is it to be tested for impairment.

– Capital Reserve– if the investee’s share of the net fair value of the assets and liabilities is greater than the cost of the investment.

Further, such investments are to be tested for impairment in accordance with Ind AS 36 as a single asset.

Ind AS 38- Intangible Assets:

Any intangible asset which satisfies the recognition criteria as per the Standard shall be measured at cost. However, in the following situations, the intangible assets are required to be measured at fair value:

– Business Combinations – As discussed above, in such cases the cost shall be the fair value as on the acquisition date.

– Government Grants – In such cases, the entity shall recognise both the intangible asset and the grant initially at the fair value as per Ind AS 20 – Accounting for Government Grants and Disclosure of Government Assistance.

– Acquisition for non-monetary consideration– If any intangible asset is acquired in exchange of non-monetary considerations, the cost shall be the fair value of the asset given up or the fair value of the asset received which is more evident.

An entity has an option of choosing the revaluation model for subsequent measurement of intangible assets. However, for this purpose, the revaluations shall be done with sufficient regularity to ensure that the carrying value does not differ materiality from the fair value determined in accordance with Ind AS 113. Further, the entire class of intangible assets shall be subjected to revaluation. The frequency of revaluation depends upon the changes in the fair value of the intangible assets being revalued.

Whilst a detailed discussion of the valuation methods to be adopted for intangible assets is beyond the scope of this study, the broad underlying principles are briefly touched upon hereunder.

– Income Approach– As discussed earlier, this approach converts future cash flows to a single present value and discounting the same based on a rate or return that considers the relative risk of the cash flows. This approach is most commonly used to value technology and customer related intangibles, brands, trademarks and non-compete arrangements. The following variations to the income approach are also used to measure certain types of intangible assets:

a) Multi period excess earnings method as discussed earlier.

b) Relief from Royalty method– which is generally used for assets subject to licencing. The fair value of the asset under this method is the present value of the licence fee avoided by owning the asset (i.e. the savings in royalty).

c) With and without method – the value of the intangible asset in question is calculated by taking the difference between the business value estimated under two sets of cash flow projections for the whole business and without the intangible asset in question.

– Market Approach – This method is used for certain type of assets which trade as separate portfolios such as FMCG or pharmaceutical brands or licences.

– Cost Approach – This method is adopted for certain types of intangibles that are readily replicated or replaced such as software, assembled workforce etc.

Further, all intangible assets with a finite useful life need to be amortised and tested for impairment in accordance with Ind AS 36. Finally, all intangible assets with an indefinite useful life need to be tested annually for impairment.

Ind AS 102- Share Based Payments:

Ind AS 102 deals with the following types of share based payments:

– Equity settled share based payments
– Cash settled share based payments
– Share based payment transactions with alternatives

All transactions involving share based payments are recognised as expenses or assets over the underlying vesting period. Transactions with employees are measured on the date of grant and those with non-employees are measured when the goods or services are received.

In case of measurement of equity settled share based payment transactions, the goods or services received by an entity are directly measured at the fair value of such goods or services received. However, in case such fair value cannot be estimated reliably, the fair value is measured with reference to the fair value of the equity instruments granted.

In case of measurement of cash settled share based payment transactions, the goods or services received by an entity and the liability incurred will be measured at the fair value of the liability. This liability has to be re-measured at each reporting date, up to the date of settlement and changes in the fair value are to be recognised in the profit or loss for the period.

In case of transactions with employees, the fair value of the equity instrument must be used and if it is not possible, the intrinsic value may be used.

The term fair value is defined in the Standard as the amount for which an asset could be exchanged, a liability settled, or an equity instrument granted could be exchanged between knowledgeable, willing parties in an arm’s length transaction. This definition is different in some respects from the definition in Ind AS 113.

Ind AS 16– Property, Plant and Equipment:

Any item of property, plant or equipment which satisfies the recognition criteria as per the Standard shall be measured at acquisition cost.

An entity has an option of choosing the revaluation model for subsequent measurement of property, plant or equipment. However, for this purpose, the revaluations shall be done with sufficient regularity to ensure that the carrying value does not differ materiality from the fair value determined in accordance with Ind AS 113. Further, the entire class of property, plant or equipment shall be subjected to revaluation. The frequency of revaluation depends upon the changes in the fair value of the property, plant or equipment being revalued.

Whilst a detailed discussion of the valuation methods to be adopted for property, plant and equipment is beyond the scope of this study, the broad underlying principles are briefly touched upon hereunder.

– Market Value:– In case of real estate properties, the market approach is best suited by considering relevant information generated by market transactions for similar assets.

– Replacement Value:- In case of equipment, the replacement value is the most suitable method since that represents the price that an acquirer would pay after adjusting for obsolescence, physical wear and tear and other technological considerations.

Ind AS 40- Investment Property:
Any item of investment property which satisfies the recognition criteria as per the Standard shall be measured at acquisition cost.

Unlike in the case of property, plant and equipment and intangible assets, the subsequent measurement of investment property should be on the basis of the cost model. However, there is a mandatory requirement to disclose the fair value of investment property on the basis of a valuation by an independent valuer who holds a recognised and relevant professional qualification.
Whilst the fair value would need to be determined in accordance with the principles laid down in Ind AS 113, Ind AS 40 also lays down certain broad parameters, as under, for determining the fair value, which valuers would need to keep in mind.

– When measuring the fair value of investment property in accordance with Ind AS 113, an entity shall ensure that the fair value reflects, among other things, rental income from current leases and other assumptions that market participants would use when pricing investment property under current market conditions.

– There is a rebuttable presumption that an entity can reliably measure the fair value of an investment property on a continuing basis. However, in exceptional cases when the fair value of the investment property is not reliably measurable on a continuing basis (e.g. there are few recent transactions, price quotations are not current or observed transaction prices indicate that the seller was forced to sell) and alternative reliable measurements of fair value (for example, based on discounted cash flow projections) are not available, or if an entity determines that the fair value of an investment property under construction is not reliably measurable but expects the fair value of the property to be reliably measurable when construction is complete, it shall measure the fair value of that investment property either when its fair value becomes reliably measurable or construction is completed (whichever is earlier). In such cases, specific disclosures need to be given.

– If an entity has previously measured the fair value of an investment property, it shall continue to measure the fair value of that property until disposal (or until the property becomes owner-occupied property or the entity begins to develop the property for subsequent sale in the ordinary course of business) even if comparable market transactions become less frequent or market prices become less readily available.

Ind AS 41 – Agriculture:

This Standard applies to biological assets, agricultural produce at the point of harvest and government grants related to biological assets.

The fair value of biological assets and agricultural produce at the point of harvest shall be measured in accordance with Ind AS 113.

A biological asset needs to be measured on initial recognition as well as at the end of each reporting period at its fair value less cost to sell, unless the same cannot be determined in which case it needs to be measured at cost less accumulated depreciation and accumulated impairment losses.

Any agricultural produce harvested from an entity’s biological assets should also be measured at its fair value less the cost to sell at the point of harvest.

BENEFITS AND PERILS OF FAIR VALUE ACCOUNTING:
As is the case with any journey, the journey of fair value accounting under Ind AS also has a smooth ride and at the same time there are several roadblocks. Let us now briefly review its benefits as well as understand its perils and challenges.

Benefits of Fair Value Accounting:

Some of the major benefits of fair value accounting are discussed below:

– Realistic Financial Statements – Companies reporting under this method have financial statements that are more accurate than those not using this method. When assets and liabilities are reported for their actual value, it results in more realistic financial statements. When using this method, companies are required to disclose information regarding changes made on their financial statements. These disclosures are done in the form of footnotes. Companies have an opportunity for examining their financial statements with actual fair values, allowing them to make wise choices regarding future business operations.

– Benefit to Investors – Fair value accounting offers benefits for investors as well, since fair value accounting lists assets and liabilities for their actual value. Accordingly, financial statements reflect a clearer picture of the company’s health. This allows investors to make wiser decisions regarding their investment options with the company. The required footnote disclosures allow investors a way of examining the effects of the changes in statements due to fair values of the assets and liabilities.

– Timely Information – Since fair value accounting utilises information specific for the time and current market conditions, it attempts to provide the most relevant estimates possible. It has a great informative value for a firm itself and encourages prompt corrective actions.

– More data than historical cost – Fair value accounting enhances the informative power of the financial statements vis–a-vis the historical cost. Fair value accounting requires an entity to disclose extensive information about the methodology used, the assumptions made, risk exposure, related sensitivities and other issues that result in a more thorough financial statement.

– Mirrors Economic Reality – Proponents of fair-value accounting argue that using fair-value measurements is necessary for financial records to represent the economic reality of the business. Since conventional accounting only allows for asset values to be written down, book values tend to underestimate the value of assets. Fair-value accounting allows the value of investments as well as other assets (subject to choices being exercised) to be written up and down as market values change. Perils and Challenges of Fair Value Accounting:

Though there are several benefits in adopting fair value accounting, it is not without its fair share of perils and challenges, some of which are discussed hereunder:

– Frequent Changes – In times of volatility, values can change quite frequently which would lead to major swings in a company’s value and earnings. Publicly held companies find this difficult as investors may find it difficult to value the company when such swings take place. Additionally, the potential for inaccurate valuations can lead to audit problems, which are discussed separately.

– Less Reliable – Traditional accountants may find fair value accounting less reliable than historical costs. When an item has different values across different regions and entities, accountants must make a judgement call on valuing items on their books. If a company with similar assets or investments values items differently than another, issues may arise because of the differences in valuation methods.

–Inability to value certain Assets – Businesses with specialised assets may find it difficult to value these items on the open market. When no market information is available, accountants must make a professional judgement on the item’s value. Accountants must also make sure that all valuation methods used are viable and take into account all technical aspects of the item.

– Subjectivity – For assets that are not actively traded on a public exchange, fair-value measurements are subjectively determined. While the Accounting Standards provide a hierarchy of inputs for fair-value measurements, only level 1 inputs are unadjusted quoted market prices in active markets for identical items. If these are not available, the company either has to look to similar items in active markets, inactive markets for identical items, or unobservable company-provided estimates. These level 2 and level 3 estimates can also be a bone of contention between auditors and management.

Challenges for Auditors:

Whilst there are several challenges in adopting fair value accounting, by far the greatest challenge in implementing fair value accounting is faced by the auditors since they cannot abdicate their responsibilities on the ground that the fair values are determined by specialists and experts. In this context, SA-540 on Auditing Accounting Estimates, Including Fair Value Estimates, makes it clear that the auditors should identify and assess the risk of material misstatements and perform appropriate procedures to mitigate the same. However, several challenges are likely to be encountered by auditors in the course of their audit of the fair value estimates whether determined by the Management or the experts / specialists, due to the following factors:

– Fair value accounting estimates are expressed in terms of the value of a current transaction or financial statement item based on conditions prevalent at the measurement date;

-The need to incorporate judgements concerning significant assumptions that may be made by others such as experts employed or engaged by the entity or the auditor;

– The availability (or lack thereof) of information or evidence and its reliability;

– The choice and sophistication of acceptable valuation techniques and models;

– The need for appropriate disclosure in the financial statements about measurement methods and uncertainty, especially when relevant markets are illiquid; and

– The possibility of Management Bias in making estimates, selection of the method of valuation and finally the valuer itself (if there is a conflict of interest)!

SA-540 deals with the overarching requirement for the auditor to obtain sufficient appropriate audit evidence that fair value measurements and disclosures are in accordance with the entity’s applicable financial reporting framework. Within the SA, additional requirements tailor the requirements in other SAs to the audit of fair value; in particular, those dealing with the following matters:

– SA-315 – Understanding the entity and its environment and assessing the risks of material misstatement,
– SA-330 – Responding to assessed risks;
– SA-240 – Responsibilities relating to fraud;
– SA-570 – Going Concern;
– SA-620 – Using the work of an expert;
– SA-580 – Obtaining management representations; and
– SA-260 – Communicating with those charged with governance.

Thus it is imperative for the auditor to ensure that the requirements of the SAs are complied with by taking due care and exercising professional scepticism whilst auditing the fair value estimates and documenting the reasonableness of the management estimates and judgements regarding fair value, keeping in mind the principles laid down in Ind AS-113.

PRACTICAL CHALLENGES AND DECISIONS FOR IMPLEMENTATION BY PHASE II ENTITIES:

Key Learnings from Phase I Entities due to Adoption of Fair Value Accounting:

Some of the key learnings in the context of fair value accounting during the transition to Ind AS by phase I companies are of a net increase in the net worth of the top 100 listed entities due to adoption of fair value accounting in respect of investments (including in group companies) and property plant and equipment based on the options available on transition (which are discussed below) with a corresponding reduction in the Profit after Tax due to increased depreciation on property, plant and equipment as a result of fair value thereof.

Implementation Issues by Phase II Entities due to Adoption of Fair Value Accounting:

The transition to Ind AS by Phase II entities is already underway for the remaining listed entities and other entities having a net worth of more than Rs. 250 crores during the current financial year ending 31st March, 2018 and they would need to take certain decisions on the accounting choice from a fair value perspective keeping in mind the following matters, whilst transitioning to Ind AS.

Mandatory Fair Value Accounting:

In respect of the following areas fair value accounting would be mandatory, except that in certain cases an option has been given to adopt it either retrospectively or prospectively, as indicated there against, as provided for in Ind AS 101- First Time Adoption of Ind AS.

Area	Transition Applicability
Ind AS 109 – Financial Instruments	Retrospectively (optional)
Ind AS 102 – Share Based Payments	Retrospectively (optional)
Ind AS 103 – Business Combinations	Retrospectively (optional)

Area

Transition Applicability

Ind
AS 109 – Financial Instruments

Retrospectively
(optional)

Ind
AS 102 – Share Based Payments

Retrospectively
(optional)

Ind
AS 103 – Business Combinations

Retrospectively
(optional)

In respect of the first two items before taking any decision to adopt fair value retrospectively, the entity would need to take into account whether all the data and information is available to enable the computation of the fair value since origination, including but not limited to details of the cash flows and other data and assumptions required for valuation purposes. If the necessary data is not available or it is impractical and costly to reconstruct the same, the entity could adopt fair value prospectively from the date of transition. These decisions would accordingly have an impact on the net worth on the date of transition.

In respect of Ind AS 103, the entity has three options as under, to account for business combinations as per the acquisition method on a fair value basis, as provided in Ind AS 101:

a) To restate past business combinations retrospectively; or
b) To restate past business combinations from any other earlier date, in which case, all business combinations after that date would have to be restated; or
c) To apply Ind AS 103 prospectively.
This choice, like in the earlier two cases, would depend upon whether the necessary data and information is available as also the business rationale of the earlier acquisitions to enable fair values to be attributed to any intangibles especially against any goodwill which is accounted, whose amortisation would need to be reversed and it would need to be tested for impairment annually. Any such decisions could have a significant impact on the consolidated net worth.

Voluntary Fair Value Accounting:

The most significant decision for entities with regard to fair value on transition to Ind AS is whether to elect to measure an item of property, plant and equipment at the date of transition at its fair value and use that fair value as its deemed cost in accordance with para D5 of Ind AS 101.

Further, as per para D6 of Ind AS 101, a first-time adopter may elect to use a previous GAAP revaluation of an item of property, plant and equipment at, or before, the date of transition to Ind ASs as deemed cost at the date of the revaluation, if the revaluation was, at the date of the revaluation, broadly comparable to:

a) fair value; or
b) cost or depreciated cost in accordance with Ind ASs, adjusted to reflect, for example, changes in a general or specific price index.

The requirements discussed above also apply to intangible assets which meet the recognition and revaluation criteria as per Ind AS 38.

It needs to be noted that the above requirement is different from adopting the fair value model as laid down under Ind AS 16 and is a one-time decision to use the fair value as the new deemed cost which may have an immediate positive impact on the net worth but would impact the profitability on an ongoing basis if depreciation needs to be provided, unless the asset in question is land.

Finally, the above decisions on transition would have tax implications including under MAT, which have not been separately discussed but which would also need to be factored in before a final decision is taken.

CONCLUSION:
The above evaluation is just the tip of the ice-berg on a subject that is quite vast and complex. However, fair value accounting is here to stay and it would impact the way the financial statements are evaluated and also impact the auditors but prove to be a bonanza for valuation specialists who can laugh all the way to the bank!

shailesh.kwebmaker

5 Section 10A, proviso to Section 92C(4) – Section 92C(4) does not apply to income offered as part of voluntary transfer pricing (TP) adjustment. Voluntary TP adjustment being a notional income will not form part of turnover for computation of deduction u/s. 10A.

1. TS-116-ITAT-2018(PUN)

Approva Systems Pvt. Ltd vs. DCIT

ITA No.1051/PUN/2015

A.Y.: 2011-12

Date of Order: 12^thMarch,
2018

Facts

Taxpayer, an Indian company
was a 100% export oriented unit engaged in the business of providing software
development service to its US affiliate (FCo), as a captive service provider.
Taxpayer was also eligible to claim deduction u/s. 10A ^1.

For the relevant year under
consideration, Taxpayer voluntarily offered additional income to tax in respect
of its services to FCo, basis its transfer pricing (TP) documentation and claimed
a deduction u/s 10A on such additional income.

____________________________________________________________________________________________

1 There was litigation on the
issue of whether the Taxpayer was eligible to claim
deduction u/s 10A or 10B. The Tribunal in this decision held that the Taxpayer
was eligible to claim deduction u/s 10B.

AO contended that proviso
to section 92C(4) will apply to such income and no deduction can be allowed
u/s.10A. Without prejudice, since the Taxpayer failed to bring into India the
export proceeds in relation to the voluntary adjustment, it was not eligible to
claim deduction u/s. 10A in respect of such income.

Taxpayer contended that
such additional income represented the TP adjustment made to the profits of the
business and not the turnover and hence there was no requirement to realise the
same in convertible foreign exchange in India. Further Taxpayer contended that
the additional income was not determined by AO, but by itself on a voluntary
basis and hence proviso to section 92C(4) is not applicable in respect of such
income.

On appeal, the CIT(A) upheld
the order of AO. Aggrieved the Taxpayer appealed before the Tribunal.

Held

– The income which is
computed u/s. 92(1) in respect of an international transaction is a notional
income in the hands of Taxpayer.

– Section 92C(4) of the Act
requires the AO to compute the income of the Taxpayer as per the arm’s length
price (ALP) determined u/s. 92C(3). The proviso, to section 92C(4) further
provides that no deduction will be allowed to a Taxpayer u/s. 10A in respect of
such amount of income which is enhanced by AO having regard to the ALP u/s.
92C(3).

– In the present case, the
additional income was determined by the Taxpayer and not the AO. The Taxpayer
voluntarily offered an additional income to tax. Hence proviso to section 92C
(4) does not apply to such income. Reliance in this regard was placed on Austin
Medical Solutions Pvt. Ltd. vs. ITO (I.T. (TP) A. No.542/Bang/2012) and
IGate Global Solutions Ltd. vs. ACIT (2008) 24 SOT 3.

– As per section 10A
deduction is allowed on the profits derived from export of articles or things
or computer software upto an amount which bears to the profits of the Taxpayer,
the same proportion as the export turnover bears to the total turnover of the
Taxpayer. Once the additional notional income has been so offered to tax, it
forms part of profits of business.

Thus, the additional income notionally
computed u/s. 92(1) would form part of the profits of the Taxpayer for the
purpose of section 10A, however, such notional income does not qualify as
export turnover or total turnover. Hence there is no requirement to realis e
such income in the form of convertible foreign exchange in India. Hence
Taxpayer is eligible to claim deduction on such additional income.

shailesh.kwebmaker

4 S. 2(14), S. (47), S. 45, S. 92B of the Act; Exercise of right to nominate a person to exercise call option results in transfer of a capital asset. Since such exercise was as a result of an understanding or action in concert of various related parties, the transaction qualifies as a deemed international transaction.

TS-37-ITAT-2018 (Ahd-TP)
Vodafone India Services Pvt. Ltd. vs. DCIT
ITA No. 565/Ahd/17
A.Y: 2012-13;
Date of Order: 23rd January, 2018

FACTS
The Taxpayer, an Indian company, was an indirect wholly-owned subsidiary (WOS) of a Netherlands entity (BV Co) and was a part of a global group of companies (V Group). V Group carried on its telecommunication business in India through an operating company, I Co. All the shares of I Co were indirectly controlled by BV Co through a number of subsidiaries, AEs, call options and other financial arrangements. One such entity through which BV Co indirectly held interest in I Co was an Indian company, Omega Telecom Holding (Omega). Omega held around 5% shares in ICo.

Prior to the Taxpayer becoming a part of V Group, it was held by Hutchinson Group (H Group). H Group purchased the stake in I Co through various unrelated third parties owing to the regulatory restrictions on investment in the telecom sector.

SMMS investment Private Limited (SMMS) was one such Indian company through which H Group acquired interest in I Co. SMMS held around 62% shares in Omega (another Indian Company) which translated to an indirect interest of 3% stake in I Co. The acquisition of Omega by SMMS was funded through certain loans and capital (equity and preference share) contributed by third party investors (Investors). Investors, thus, became 100% shareholders of SMMS. The loans taken by SMMS were guaranteed by the ultimate parent entity of H Group.

It was as a result of transfer of certain intermediary companies by H Group to BV Co that Taxpayer became an indirect subsidiary of BV Co.

Taxpayer entered into a Framework agreement in June 2007 (FA 2007) with the investor. In terms of FA 2007, the Taxpayer had a call option to acquire entire equity capital of SMMS at nominal consideration of 4 Cr. (even when the value of SMMS could have been much higher than 1,500 Cr.). The taxpayer also had right to nominate some other person to exercise the available option right.

In November 2011, Termination Agreement and Shareholders Agreement were signed. In terms of TA, Taxpayer terminated the call option and paid a termination fee of INR 21 Crores to the investors. Post the termination of the call and put options, SMMS issued shares to another Indian company, India Hold Co, as agreed under SHA. Issue of shares resulted in India Hold Co holding 75% shares in SMMS. Further, as per the SHA, investors effectively exited from SMMS India on buyback of shares by SMMS and consequently India Hold Co. became 100% shareholder of SMMS.

Taxpayer contended that options that it held vis-à-vis investors in respect of shares of SMMS India were a contractual right and not a property right. Therefore it did not qualify as capital asset. Without prejudice, termination of option does not result in transfer. Further, since the transaction was between two residents, it did not qualify as an international transaction.

AO held that the Taxpayer had two rights by virtue of the call option viz., the right to exercise the option of purchasing the shares of SMMS and the right to assign the call option. On termination of the call option, such rights were extinguished and resulted in transfer of a capital asset by the Taxpayer. Further, AO held that, various agreements entered into by the parties indicate that the terms of the transaction were, in essence, decided by BV Co. Thus, such a transaction would qualify as a deemed international transaction.

Aggrieved, Taxpayer appealed before the Tribunal.

HELD
Whether call option is a capital asset and whether there was a transfer of no cost asset

– The two rights viz. the right to purchase shares of SMMS from the Investors and the right to sell shares of SMMS to the Taxpayer granted under FA 2007 are independent rights, in the sense that if one of the rights is exercised, the other right would become infructuous.

– In essence, the Taxpayer had a right to nominate who could acquire shares of SMMS at the agreed price.

– In the present case, the Taxpayer did not acquire the shares of SMMS, but exercised the right to nominate the person who could acquire the share of SMMS. Such right clearly falls within the expanded definition of capital asset under the ITL.

– Undisputedly, the facts before the SC in the Taxpayer’s case for earlier years did not involve nomination or assignment and, hence, the question of whether a right to nominate can be treated as a capital asset was never considered by the SC. Without prejudice, post the amendment to the ITL expanding the definition of capital asset u/s. 2(14), the SC’s decision stating that pending exercise, an option does not qualify as a capital asset, is no longer applicable.

– The Taxpayer had exercised the right of nomination under the call option. Once the right is exercised, its existence comes to an end. Hence, exercise of right to nominate results in transfer of a capital asset under the ITL.

– All the agreements entered into by the parties are to be read together to understand the actual transaction. The rights were acquired by paying consideration and hence it is not correct to suggest that options were no cost asset.

Whether there is an international transaction and whether the TP provisions apply in the absence of a consideration?

– The Scheme of Arrangement implemented effectively ensured that SMMS shares which could have been acquired and held by taxpayer in India came to be held by AE of the Taxpayer (India Hold Co). Hence the transaction qualifies as an international transaction.

– The Taxpayer had a valuable right to purchase shares of I Co at a nominal consideration of ~INR4crores. Such a right was given up by the Taxpayer for “zero” consideration.

– The TP provisions enable determination of the ALP for an international transaction and, hence, they have a role to play in computation of income. As long as a transaction is capable of producing an income, the TP provisions will apply to compute the income in accordance with ALP.

– The termination if implemented at ALP could have resulted in an income in the form of capital gains and such income has to be computed having regard to the ALP of the transaction. Even in case where there is zero income but application of the ALP results in a consideration being assigned, then the income i.e., capital gains in this case, is to be computed basis such ALP.

– The TP provisions cease to apply only when a transaction is inherently incapable of producing an income and is applicable in cases where income is not reported or if an income is not taken into account in computation of taxable income. Reliance in this regard was placed on a Special Bench decision in the case of Instrumentarium Corporation Ltd. (171 taxmann.com 193).

– The Bombay HC decision in the Taxpayer’s own case for earlier years was concerned with determination of the ALP of shares issued by the Taxpayer, which was admittedly a transaction on capital account. It is a settled proposition that capital receipts cannot be brought to tax in the absence of a specific enabling provision. In other words, the ALP adjustment was proposed in respect of an item of income which could never be brought to tax. Thus, the ratio of that decision is not applicable in the present facts of the case.

shailesh.kwebmaker

3 Article 5 and 7 of India-UAE DTAA – AAR’s decision indicating that a group concern has a PE in India, cannot be a basis for concluding that the Taxpayer has a PE in India. In absence of FTS article in the DTAA, income from provision of technical personnel is taxable as business income, provided that Taxpayer has a PE in India as per the relevant DTAA.

TS- 27-ITAT-2018 (Mum)
Booz & Company (ME) FZ-LLC vs. DDIT
I.T.A. No. 4063/Mum/2015
A.Y: 2011-12;
Date of Order: 19th January, 2018

Facts

Taxpayer, a company incorporated in UAE, was engaged in the business of
providing management and technical consultancy services. During the year, the
Taxpayer provided technical/professional personnel to its Indian associated
enterprise (ICo). The personnel were physically present in India for a period
of 156 days.

The Taxpayer contended that since DTAA does not have any specific
article on fees for technical services (FTS), the consideration received from
ICo is taxable as business income. However, in the absence of a PE in India,
the income received from ICo was not offered to tax by the Taxpayer.

AO observed that in respect of certain group companies including the
parent of the Taxpayer, AAR had given a common ruling that the said companies
had a PE in India. By placing reliance on AAR’s ruling, AO held that ICo
created a PE for the Taxpayer in India.

Aggrieved by the order of AO, Taxpayer appealed before the CIT(A) who
upheld the order of AO. Subsequently, Taxpayer appealed before the Tribunal.

Held

– The
ruling of the AAR in the case of group entities of the Taxpayer cannot be the
basis for determining the existence or otherwise of PE of the Taxpayer in
India, especially when AAR gave a common ruling without making any specific
reference to the provisions of the respective DTAA.

– ICo
did not earmark any specific or dedicated place for the personnel of the
Taxpayer, hence it cannot be said that the premises of ICo was under the
control or disposal of the Taxpayer. Thus ICo premises did not create a fixed
place PE for the Taxpayer in India.

– FCo
provided services to ICo and it is not a case where FCo was receiving any
services from ICo. Thus the question of dependent agent PE in India does not
arise.

– Since
the employees worked in India for an aggregate period of 156 solar days on all
projects taken together, the threshold for triggering Service PE clause is not
met.

– Thus
the income of the Taxpayer from provision of personnel is not taxable in India

shailesh.kwebmaker

Accounting For Uncertainty Over Income Tax Treatments

Background

IAS 12 (Ind AS 12) Income
Taxes specifies requirements for
current   and   deferred
tax   assets and
liabilities. However, there was no
clarity with respect to recognition and
measurement   of   uncertain
tax   treatments. An‘uncertain tax treatment’
is a tax treatment for which there is uncertainty over whether the relevant
taxation authority will accept the entity’s tax treatment under tax law. For
example,   an   entity’s
decision   not to include
particular income in taxable profit,
is an uncertain tax treatment if its acceptability   is
uncertain   under tax
law. IFRIC 23 Uncertainty over Income Tax
Treatments is an interpretation of IAS 12 that deals with recognition and
measurement of uncertain tax treatments. A corresponding interpretation is not
yet issued under Ind AS, but is expected shortly.

Uncertainty over Income Tax Treatments

In assessing whether
uncertainty over income tax treatments exists, an entity may consider a number
of indicators including, but not limited to, the following:

– Ambiguity in the drafting of relevant tax
laws and related guidelines (such as ordinances, circulars and letters) and
their interpretations

– Income tax practices that are generally
applied by the taxation authorities in specific jurisdictions and situations

– Results of past examinations by taxation
authorities on related issues

– Rulings and decisions from courts or other
relevant authorities in addressing matters with a similar fact pattern

– Tax memoranda prepared by qualified in-house
or external tax advisors

– The quality of available documentation to
support a particular income tax treatment.

Unit of Account

The Interpretation requires
an entity to determine whether to consider each uncertain tax treatment
separately or together with one or more other uncertain tax treatments. This
determination is based on which approach better predicts the resolution of the
uncertainty. In determining the approach that better predicts the resolution of
the uncertainty, an entity might consider, for example, (a) how it prepares its
income tax filings and supports tax treatments; or (b) how the entity expects
the taxation authority to make its examination and resolve issues that might
arise from that examination.

The author believes that
interdependent tax positions (i.e., where the outcomes of uncertain tax
treatments are mutually dependent) should be considered together. Significant
judgement may be required in the determination of the unit of account. In
making the judgement, entities would need to consider the approach expected to
be followed by the taxation authorities to resolve the uncertainty. The
judgement required in the selection of a unit of account may be particularly
challenging in groups of entities trading in various jurisdictions where the
relevant tax laws or taxation authority treat similar elements differently.

Example 1 – Unit of account

Entity A is part of a
multinational group and provides intra-group loans to affiliates. It is funded
through equity and deposits made by its parent. Whilst the entity can show that
its interest margin earned on many loans is at an appropriate market rate,
there are loans where the rate is open to challenge by the taxation
authorities. However, Entity A determines that, across the loan portfolio as a
whole, the existence of rates above and below a market comparator results in an
overall interest margin that is within a reasonable range accepted by the
taxation authorities.

Depending on the applicable
tax law and practice in a specific jurisdiction, a taxation authority may accept
a tax filing position on the basis of the overall interest margin if it is
within a reasonable range. However, there might be other taxation authorities
that would examine the interest rate separately for each loan receivable. In
considering whether uncertain tax treatments should be considered separately
for each loan receivable or combined with other loan receivables, Entity A
should adopt the approach that better reflects the way the taxation authority
would examine and resolve the issue.

Detection risk

The Interpretation requires
an entity to invariably assume that a taxation authority will examine amounts
it has a right to examine and have full knowledge of all related information
when making those examinations.

In some jurisdictions,
examination by taxation authorities is subject to a time limit, sometimes
referred to as a statute of limitations. In others, examination by taxation
authorities might not be subject to a statute of limitations, which means the
authorities can examine the amounts at any time in the future. Some respondents
to the draft Interpretation suggested in their comment letter that an
assessment of the probability of examination would be relevant in this latter
case. However, the IFRS Interpretation Committee (IC) decided not to change the
examination assumption, nor to create an exception to it, for circumstances in
which there is no time limit on the taxation authority’s right to examine
income tax filings.

The IC also noted that the
assumption of examination by the taxation authority, in isolation, would not
require an entity to reflect the effects of uncertainty. The threshold for
reflecting the effects of uncertainty is whether it is probable that the
taxation authority will accept an uncertain tax treatment. In other words, the
recognition of uncertainty is not determined based on whether a taxation
authority examines a tax treatment.

The Interpretation does not
explain what is meant by ‘results of examinations’. The examination procedures
vary by jurisdiction and, in some jurisdictions, an examination can have
multiple phases. In the author’s view, the communication between an entity and
the taxation authorities during the course of such examinations may provide
relevant information that could give rise to a change in facts and
circumstances before the actual ‘results’ of the examination are formally issued.

Example 2 – Detection risk

Entity A is based in
Country B. It is generally known that the taxation authorities in Country B
have limited resources. As a consequence, their examination procedures are
usually limited to a summary assessment of the income tax filings. Scrutiny tax
examinations are only performed in very rare circumstances and if there is a
clear indication of a tax fraud. Entity A has never been subjected to such a
scrutiny examination by the taxation authorities.

Prior to the application of
IFRIC 23, Entity A argued that it was unlikely that the taxation authorities
would identify any key income tax exposures not already identified through
their summary assessment, because they could be identified only by analysing
the underlying accounting records. Therefore, Entity A did not recognise any
uncertain tax treatments.

With the adoption of IFRIC
23, Entity A would need to consider underlying tax positions even though
scrutiny by the taxation authorities is unlikely. Entity A should assume that
the taxation authority can and will examine amounts it has a right to examine
and have full knowledge of all related information when making those
examinations.

Recognition and Measurement

Under IFRIC 23, the key
test is whether it’s probable that the taxation authority would accept the tax
treatment used or planned to be used by the entity in its income tax filings.
If yes, then the amount of taxes recognised in the financial statements would
be consistent with the entity’s income tax filings. Otherwise, the effect of
uncertainty should be estimated and reflected in the financial statements. This
would require the exercise of judgement by the entity. The recognition of
current and deferred taxes including uncertain tax treatments continues to be
on the underlying principle of “probability”. The measurement requirements in
IFRIC 23 do not distinguish between a probability of 51% and a probability of
100%. This is consistent with the objective of IAS 12 (Ind AS 12) that refers
to a probable threshold and with the Conceptual Framework for Financial
Reporting which refers to a probability threshold for the recognition of
assets and liabilities in general. It should be noted that deferred tax assets
on carry forward of losses can be recognised only if there is convincing
evidence that it will be utilised in future years.

Example 3 – Current and deferred tax impact

Entity C, constructs and
leases wooden chalet at hill stations, and claims 100% depreciation on the
basis that they are temporary structures. However, the tax laws may not
consider them as temporary structures and therefore there is a risk that the
100% depreciation claim may be disallowed. On application of IFRIC 23, Entity C
should reflect the impact of such uncertainties in the measurement of current
and deferred tax assets and liabilities as at the reporting date.

An entity may need to apply
judgement in concluding whether it is probable that a particular uncertain tax
treatment will be acceptable to the taxation authority. An entity may consider
the following:

– Past experience related to similar tax
treatments

– Legal advice or case law related to other
entities

– Practice guidelines published by the taxation
authorities

– The entity obtains a pre-clearance from the
taxation authority on an uncertain tax treatment.

In defining ‘uncertainty’,
the entity only needs to consider whether a particular tax treatment is probable,
rather than highly likely or certain, to be accepted by the taxation
authorities. If an entity concludes it is probable that the taxation authority
will accept an uncertain tax treatment, the entity shall determine the taxable
profit or loss, deferred taxes, unused tax losses, unused tax credits or tax
rates consistently with the tax treatment used or planned to be used in its
income tax filings. If an entity concludes it is not probable that the taxation
authority will accept an uncertain tax treatment, the entity shall reflect the
effect of uncertainty in determining the related taxable profit or loss,
deferred taxes, unused tax losses, unused tax credits or tax rates. An entity
shall reflect the effect of uncertainty for a unit of uncertain tax treatment
by using either of the following methods, depending on which method the entity
expects to better predict the resolution of the uncertainty:

a) the
most likely amount—the single most likely amount in a range of possible
outcomes. The most likely amount may better predict the resolution of the
uncertainty if the possible outcomes are binary or are concentrated on one
value.

b) the
expected value—the sum of the probability-weighted amounts in a range of
possible outcomes. The expected value may better predict the resolution of the
uncertainty if there is a range of possible outcomes that are neither binary
nor concentrated on one value.

If an uncertain tax
treatment affects current tax and deferred tax (for example, if it affects both
taxable profit used to determine current tax and tax bases used to determine
deferred tax), an entity shall make consistent judgements and estimates for
both current tax and deferred tax.

Example 4 – Application of Expected Value Method

– Entity A’s income tax filing in a
jurisdiction includes deductions related to transfer pricing. The taxation
authority may challenge those tax treatments.

– Entity A
notes that the taxation authority’s decision on one transfer pricing matter
would affect, or be affected by, the other transfer pricing matters. Entity A
concludes that considering the tax treatments of all transfer pricing matters
in the jurisdiction together better predicts the resolution of the uncertainty.
Entity A also concludes it is not probable that the taxation authority will
accept the tax treatments. Consequently, Entity A reflects the effect of the
uncertainty in determining its taxable profit.

– Entity A estimates the probabilities of the
possible additional amounts that might be added to its taxable profit, as
follows:

Estimated additional amount, INR

Probability, %

Estimate of expected value, INR

Outcome 1

–

15%

–

Outcome 2

200

Outcome 3

400

20%

Outcome 4

600

10%

Outcome 5

800

30%

240

Outcome 6

1,000

20%

200

100%

590

– Outcome 5 is the most likely outcome.
However, Entity A observes that there is a range of possible outcomes that are
neither binary nor concentrated on one value. Consequently, Entity A concludes
that the expected value of INR 590 better predicts the resolution of the
uncertainty.

– Accordingly, Entity A recognises and measures
its current tax liability that includes INR 650 to reflect the effect of the
uncertainty. The amount of INR 590 is in addition to the amount of taxable
profit reported in its income tax filing.

Example 5 – Application of the Most Likely Outcome Method

– Entity B acquires for INR 100 a separately
identifiable intangible asset that has an indefinite life and, therefore, is
not amortised applying IAS 38 (Ind AS 38) Intangible Assets. The tax law
specifies that the full cost of the intangible asset is deductible for tax
purposes, but the timing of deductibility is uncertain. Entity B concludes that
considering this tax treatment separately better predicts the resolution of the
uncertainty.

– Entity B deducts INR 100 (the cost of the
intangible asset) in calculating taxable profit for Year 1 in its income tax
filing. At the end of Year 1, Entity B concludes it is not probable that the
taxation authority will accept the tax treatment. Consequently, Entity B
reflects the effect of the uncertainty in determining its taxable profit and
the tax base of the intangible asset. Entity B concludes the most likely amount
that the taxation authority will accept as a deductible amount for Year 1 is
INR20 and that the most likely amount better predicts the resolution of the
uncertainty.

– Accordingly, in recognising and measuring its
deferred tax liability at the end of Year 1, Entity B calculates a taxable
temporary difference based on the most likely amount of the tax base of INR 80
(INR 100 – INR 20) to reflect the effect of the uncertainty, instead of the tax
base calculated based on Entity B’s income tax filing (INR 0).

– Entity B reflects the effect of the
uncertainty in determining taxable profit for Year 1 using judgements and
estimates that are consistent with those used to calculate the deferred tax
liability. Entity B recognises and measures its current tax liability based on
taxable profit that includes INR 80 (INR 100 – INR 20). The amount of INR80 is
in addition to the amount of taxable profit included in its income tax filing.
This is because Entity B deducted INR 100 in calculating taxable profit for
Year 1, whereas the most likely amount of the deduction is INR 20.

Changes in facts and circumstances

An entity shall reassess a
judgement or estimate required by this Interpretation, if the facts and circumstances
on which the judgement or estimate was based change or as a result of new
information that affects the judgement or estimate. For example, a change in
facts and circumstances might change an entity’s conclusions about the
acceptability of a tax treatment or the entity’s estimate of the effect of
uncertainty, or both. An entity shall reflect the effect of a change in facts
and circumstances or of new information as a change in accounting estimate
applying IAS 8 (Ind AS 8) Accounting Policies, Changes in Accounting
Estimates and Errors. An entity shall apply IAS 10 (Ind AS 10) Events
after the Reporting Period to determine whether a change that occurs after the
reporting period is an adjusting or non-adjusting event.

Examples of changes in
facts and circumstances or new information that, depending on the
circumstances, can result in the reassessment of a judgement or estimate
required by this Interpretation include, but are not limited to, the following:

(a) examinations
or actions by a taxation authority. For example:

(i) agreement
or disagreement by the taxation authority with the tax treatment or a similar
tax treatment used by the entity;

(ii) information
that the taxation authority has agreed or disagreed with a similar tax
treatment used by another entity; and

(iii) information
about the amount received or paid to settle a similar tax treatment.

(b) changes
in rules established by a taxation authority.

Example 6 – Change in facts and circumstances

Entity A claimed a
tax-deduction for a particular expense item. In the prior year, Entity A had
concluded that it was probable that the taxation authority would accept the tax
deduction. However, during the current year, Entity A is alerted by a similar
issue where a tax deduction was denied in a ruling by the Supreme Court. The
recent court ruling is considered a change in facts and circumstances. As a
result, Entity A has to reassess the uncertain tax treatment, taking into
account the recent Supreme Court decision.

Example 7 – Events after the reporting date

Scenario A

Entity C had claimed a tax
deduction for a particular expense item in its tax return related to the
financial year ending 31^stDecember 2018. However, for the purpose
of recognising current and deferred taxes in that year, Entity C had concluded
that it is not probable that the taxation authorities will accept the tax
deduction. Accordingly, Entity C had recognised an additional tax liability
relating to the uncertainty. In February 2020, before the approval of the
financial statements for the year ending 31^st December 2019, Entity
C receives the final tax assessment for 2018. The tax assessment confirms the
full deductibility of the expense item. The confirmation of tax deduction
received after the reporting period and prior to authorisation of the financial
statements for 2019 is considered as an adjusting event after the reporting
period. Accordingly, the additional tax liability that was recognised in 2018
relating to the uncertainty is released in the 2019 period.

Scenario B

Entity B claimed a
tax-deduction pertaining to interest expense on a loan granted by an affiliated
company, amounting to INR 500,000 in its tax return related to the financial
statements for the year ending 31^st December 2018. However, for the
purposes of recognising current and deferred taxes for that year, Entity B had
concluded that the taxation authorities will only accept a deduction of INR 100,000.
In March 2020, before the approval of the financial statements for the year
ending 31^st December 2019, Entity B learns from its tax advisor that
the taxation authorities have confirmed that they will accept, on a
retrospective basis, another method of determining interest rate at arm’s
length that would lead to a tax deduction of INR 300,000 in year 2018. In this
example, it appears that the taxation authorities have issued a new guideline
on deductibility of interest expenses relating to a loan from an affiliated
company. Accordingly, in contrast to Scenario A above, the information received
in March 2020 is considered as a non-adjusting event after the reporting period
for the 2019 financial statements.

Absence of an explicit
agreement or disagreement by the taxation authorities on its own is unlikely to
represent a change in facts and circumstances, or new information that affects
the judgements and estimates made. In such situations, an entity has to
consider other available facts and circumstances before concluding that a
reassessment of the judgements and estimates is required.

An uncertain tax treatment
is resolved when the treatment is accepted or rejected by the taxation
authorities. The Interpretation does not discuss the manner of acceptance
(i.e., implicit or explicit) of an uncertain tax treatment by the taxation
authorities. In practice, a taxation authority might accept a tax return
without commenting explicitly on any particular treatment in it. Alternatively,
it might raise some questions in an examination of a tax return. Unless such
clearance is provided explicitly, it is not always clear if a taxation
authority has accepted an uncertain tax treatment. An entity may consider the
following to determine whether a taxation authority has implicitly or
explicitly accepted an uncertain tax treatment:

– The tax treatment is explicitly mentioned in
a report issued by the taxation authorities following an examination

– The treatment was specifically discussed with
the taxation authorities (e.g., during an on-site examination) and the taxation
authorities verbally agreed with the approach; or

– The treatment was specifically highlighted in
the income tax filings, but not subsequently queried by the taxation
authorities in their examination.

Disclosures

There are no new disclosure
requirements in IFRIC 23. However, entities are reminded of the need to
disclose, in accordance with existing IFRS (Ind AS) standards. When there is
uncertainty over income tax treatments, an entity shall determine whether to
disclose: judgements made in determining taxable profit (tax loss), tax bases,
unused tax losses, unused tax credits and tax rates; and information about the
assumptions and estimates made in determining taxable profit (tax loss), tax
bases, unused tax losses, unused tax credits and tax rates under IAS 1 (Ind AS
1) Presentation of Financial Statements. If an entity concludes it is
probable that a taxation authority will accept an uncertain tax treatment, the
entity shall determine whether to disclose the potential effect of the
uncertainty as a tax-related contingency under IAS 12 (Ind AS 12).

Effective date and transition

IFRIC 23 applies to annual
reporting periods beginning on or after 1^st January 2019. Earlier
application is permitted. Entities can apply the Interpretation using either of
the following approaches:

– Full retrospective approach: this approach
can be used only if it is possible without the use of hindsight. The
application of the new Interpretation will be accounted for in accordance with
IAS 8, which means comparative information will have to be restated; or

– Modified retrospective approach: no
restatement of comparative information is required or permitted under this
approach. The cumulative effect of initially applying the Interpretation will
be recognised in opening equity at the date of initial application, being the
beginning of the annual reporting period in which an entity first applies the
Interpretation.

It
is not clear as to when this interpretation will apply under Ind AS. It is most
likely that this Interpretation may apply from annual reporting periods
beginning on or after 1^stApril 2019.

Key challenges

– Applying the Interpretation could be
challenging for entities, particularly those that operate in more complex
multinational tax environments.

– It would be challenging for entities to
estimate the income tax due with respect to tax inspections, when tax
authorities examine different types of taxes together and issue a report with a
single amount due therein.

– Entities may also need to evaluate whether
they have established appropriate processes and procedures to obtain
information, on a timely basis, that is necessary to apply the requirements in
the Interpretation and make the required disclosures.

– IFRIC 23 requires an entity to assume a
detection risk of 100%. An entity should not take any credit for the
possibility that uncertain tax treatments could be overlooked by the taxation
authority. This is a different approach compared to existing practice that may
lead to changes when the Interpretation is first applied. This could be a
challenging task in some cases.

Frequently Asked Questions

Will this
Interpretation apply to uncertain treatments of other taxes, for example GST?

Although uncertainty exists
in the determination of GST liability, IFRIC 23 is not applicable since GST is
not a tax on income and not in the scope of IAS 12 (Ind AS 12)/IFRIC 23. Rather
they would be covered under IAS 37 (Ind AS 37) Provisions, Contingent
Liabilities and Contingent Assets. It may be noted that whilst the
underlying principle for recognition in both standards is “probability”, the
measurement basis under the two standards are significantly different.

In a
particular jurisdiction, if tax is not deducted at source with respect to
royalty payments to non-resident the entity is subjected to penalty and also
disallowance of the royalty expenses in computation of taxable income. Is the
penalty and disallowance of the royalty expense covered under IFRIC 23?

Penalty is not a tax on
income and hence are not covered under IFRIC 23. Rather they would be covered
under IAS 37 (Ind AS 37) Provisions, Contingent Liabilities and Contingent
Assets. The disallowance of royalty expenses which is included in the
taxable income will be subjected to the requirements of IAS 12 (Ind AS 12) and
IFRIC 23.

Will
Interest and penalties levied by Income tax Authorities be covered under this
Interpretation?

IAS 12 (Ind AS 12) does not
explicitly refer to interest and penalties payable to, or receivable from, a
taxation authority, nor are they explicitly referred to in other IFRS
Standards. A number of respondents to the draft Interpretation suggested in
their comment letter that the Interpretation explicitly include interest and
penalties associated with uncertain tax treatments within its scope. Some said
that entities account for interest and penalties differently depending on
whether they apply IAS 12 (Ind AS 12) or IAS 37 (Ind AS 37) Provisions,
Contingent Liabilities and Contingent Assets to those amounts.

The IC decided not to add
to the Interpretation requirements relating to interest and penalties
associated with uncertain tax treatments. Rather, the IC noted that if an
entity considers a particular amount payable or receivable for interest and
penalties to be an income tax, then that amount is within the scope of IAS 12
and, when there is uncertainty, also within the scope of this Interpretation.
Conversely, if an entity does not apply IAS 12 to a particular amount payable
or receivable, then this Interpretation does not apply to that amount,
regardless of whether there is uncertainty.

An entity
determines that an uncertain tax treatment is not probable but is possible and
hence disclosure as contingent liability is required. Whether the contingent
liability disclosure will also include the consequential interest and penalty
amount?

Interest amount will be
included in the contingent liability amount if there is no or very little
likelihood of waiver. On the other hand, penalty amount may be waived by the
tax authorities. If it is probable that the penalties may be waived by the tax
authorities, they are not included in the contingent liability amount.

In evaluating
the detection risk, should an entity consider probability of detection by the
Income-tax authorities rather than assuming an examination will occur in all
cases?

The IC decided that an
entity should assume a taxation authority will examine amounts it has a right
to examine and have full knowledge of all related information. In making this
decision, the IC noted that IAS 12 (Ind
AS 12) requires an entity to measure tax assets and liabilities based on tax
laws that have been enacted or substantively enacted.

A few respondents to the
draft Interpretation suggested that an entity consider the probability of
examination, instead of assuming that an examination will occur. These
respondents said such a probability assessment would be particularly important
if there is no time limit on the taxation authority’s right to examine income
tax filings.

The IC decided not to
change the examination assumption, nor create an exception to it for
circumstances in which there is no time limit on the taxation authority’s right
to examine income tax filings. Almost all respondents to the draft
Interpretation supported the examination assumption. The IC also noted that the
assumption of examination by the taxation authority, in isolation, would not
require an entity to reflect the effects of uncertainty. The threshold for
reflecting the effects of uncertainty is whether it is probable that the
taxation authority will accept an uncertain tax treatment. In other words, the
recognition of uncertainty is not determined based on whether a taxation
authority examines a tax treatment.

Will the
principles of “virtual certainty” apply for recognition of current and deferred
tax assets in cases where there is uncertainty of tax treatments?

When the key test of the
Interpretation would result in the entity recognising tax assets (i.e. based on
the probability that the taxation authorities would accept the entity’s tax
treatment), the entity is not required to demonstrate the ‘virtual certainty’
of the tax authority accepting the entity’s tax treatment in order to recognise
such a tax asset. The underlying principle of “probability” will apply for
recognition of current and deferred tax asset arising from uncertain tax
treatments. Consider the example below.

Example 8 – Measurement of tax positions

The management of Entity B
decides to undertake a group-wide restructuring and records a restructuring
liability of INR 1,000,000. Entity B has tax loss carry-forwards of INR
1,200,000. Excluding the restructuring liability, taxable profit for the
current year is INR 2,000,000. Entity B is uncertain whether the local taxation
authorities will accept a deduction for the restructuring costs. However, it
analyses all available evidence and concludes that it is probable that the
taxation authorities will accept the deduction of the INR 1,000,000 in the year
when it is recorded.

Entity B therefore
estimates its taxable profit to be INR 1,000,000 and that this will be fully
offset with tax loss carry-forwards from the INR 1,200,000 available. As a
consequence, there is no current income tax charge in the period and Entity B
determines a remaining tax loss carry-forward balance of INR 200,000. As
management has convincing evidence that Entity B will realise sufficient
taxable profits in the future, it records a deferred tax asset for the unused
tax losses of INR 200,000. Though convincing evidence is required to record a
deferred tax asset on carry forward losses (INR 200,000), the acceptability of
uncertain tax treatments (INR 1,000,000) by the tax authorities is based on the
principle of “probability”.

Conclusion

For many large sized
entities or those with significant income tax litigations or complications,
this Interpretation may well be a significant change. Management and Audit
Committees should ensure that the Interpretation is properly understood and
complied with. Tax advisors too need to get upto speed on the standard, since
this standard may have significant impact on income tax computation and
assessments. _

shailesh.kwebmaker

Perspectives On Fair Value Under Ind As (Part 1)

INTRODUCTION
In line with the commitment made by our then Honourable Prime Minister, Shri Manmohan Singh at the G-20 summit nearly ten years back to adopt the International Financial Reporting Standards (IFRS), India has already begun its journey to converge with IFRS rather than adopt it. The roadmap by the Ministry of Corporate Affairs for adoption of International Financial IFRS converged Indian Accounting Standards (Ind AS) was announced in two phases for other than financial service entities, which is tabulated hereunder:

Phase

Entities Covered

Applicable Date

Entities
having net worth of more than Rs. 500 crores based on the audited Balance
Sheet as on 31^stMarch, 2014 or any subsequent date

Financial
Year ending 31^st March, 2017

All
other listed entities not covered in Phase I and unlisted entities having net
worth of more than Rs. 250 crores based on the audited Balance Sheet as on 31^st
March, 2014 or any subsequent date

Financial
Year ending 31^st March, 2018

The consolidated impact of the aforesaid convergence will result in significant differences in the preparation and presentation of financial statements thereby paving the way for greater transparency, enriched quality and enhanced comparability of the financial statements. Whilst there are several challenges consequent to adoption of Ind AS, the single most sweeping challenge would be a significant increase in the focus on fair value accounting which in turn is based on the principle of fair value measurement which is a fundamental concept and the underlying basis for the Ind AS framework. Keeping these factors in mind, this article aims to decipher the concept of fair value under Ind AS, its broad prescriptions, its benefits and perils coupled with certain practical challenges and decisions in its implementation especially on transition, for the Phase II entities tabulated above, keeping in mind the experience of the Phase I entities.

CONCEPT OF FAIR VALUE UNDER Ind AS
There are several Ind ASs as tabulated below, which permit or require entities to either measure or disclose the fair value of assets, liabilities or equity instruments.

Ind AS No.

Title

Impairment
of Assets

103

Business
Combinations

109

Financial
Instruments

Investments
in Associates and Joint Ventures

Intangible
Assets

102

Share
Based Payments

Property,
Plant and Equipment

Investment
Property

Agriculture

The primary purpose under Ind AS 113 is to increase the consistency and comparability of fair value measurement used in financial reporting and to provide a common framework whenever an Ind AS requires or permits fair value measurement irrespective of the type of asset, liability or the entity that holds the same. The basic objective of fair value measurement is to estimate the price at which an orderly transaction would take place between market participants under market conditions that exist at the measurement date. Let us now examine the key requirements of Ind AS 113 as well as each of the above Ind AS’s insofar as the fair value requirements are concerned.

Key Requirements of Ind AS 113:
Ind AS 113 addresses how to measure fair value but does not stipulate when fair value needs to be used which is determined by the other Ind ASs as indicated earlier. Further, Ind AS 113 applies to all fair value disclosures that are required or permitted by Ind AS, except for the following:

a)Share based payment transactions under Ind AS 102;
b)Leases under Ind AS 17; and
c)Measures that are similar to but are not fair value e.g. net realisable value under Ind AS 2,
Inventories, value in use under Ind AS 36, Impairment.

The disclosures required by this Standard are not required for the following:

a)Plan assets measured at fair value in accordance with Ind AS 19, Employee Benefits; and
b)Assets for which recoverable amount is fair value less costs of disposal in accordance with Ind AS 36, Impairment of Assets.

The fair value measurement framework described in this Standard applies to both initial and subsequent measurement, if fair value is required or permitted by other Ind ASs.

The basic objectives of Ind AS 113 are as under:

-To define the concept of fair value.
-To set out the framework for measuring the fair value.
-To lay down the disclosure requirements on fair value measurements.

Let us now proceed to briefly examine each of the above aspects.

Meaning of Fair Value:
IndAS 113 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”.

The basic premise which governs the determination and use of fair value is that it is always determined on a market based approach based on observable market prices or in its absence based on other appropriate valuation techniques which maximise the use of relevant observable inputs and minimise the use of unobservable inputs and is not entity specific. In other words, it means that the fair value has to be determined in accordance with use of the asset by market participants. A common example of such a situation is in the FMCG or Pharma industry when the acquirer acquires the business of a competitor with the objective of eliminating competing brands to promote his own brand. In such cases a fair value is attributed to the competing brand on the basis of its highest and best use (discussed later) by market participants, which principle is also laid down under Ind AS 103.

Before proceeding further, it is important to understand the concept of the term price in the context of fair value and also who are regarded as market participants since fair value is always to be determined on a market based approach.

The Price:
In keeping with its market based criteria as discussed earlier, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market at the measurement date under current market conditions (i.e. an exit price) regardless of whether that price is directly observable or estimated using another valuation technique.Thus, under normal circumstances, the fair value is the exit price.

However, when an asset is acquired or a liability is assumed in an exchange transaction for that asset or liability, the transaction price is the price paid to acquire the asset or received to assume the liability (referred to as an entry price). An example could be a company which has an old truck having a book value of Rs.2,50,000 which acquires a boat in exchange whose transaction price assumed on the basis of similar transactions on an arm’s length basis is Rs. 10,00,000 which could be construed as its fair value. Accordingly the boat will be accounted for at Rs.10,00,000 and a loss of Rs.7,50,000 (10,00,000-2,50,000) would be simultaneously recorded.

In most cases, the transaction price will equal the fair value (e.g. when on the transaction date the transaction to buy an asset takes place in the market in which the asset would be sold).Though in practice there may not be various situations where the transaction price may not represent the fair value, Ind AS-113 does recognise that the transaction price might not represent the fair value of an asset or a liability at initial recognition if any of the following conditions exist:

a)The transaction is between related parties, unless it can be demonstrated that the transactions are on an arm’s length basis. Keeping in mind the requirements under the Companies Act, 2013 most related party transactions in practice would pass the arm’s length test.

b)The transaction takes place under duress or the seller is forced to accept the price in the transaction e.g. if the seller is experiencing financial difficulty. Similarly in the recent past the insolvency proceedings under the Bankruptcy Code may force the sellers to accept certain prices arrived at through the resolution process whichmay not always be fair.

c)The unit of account represented by the transaction price is different from the unit of account for the asset or liability measured at fair value e.g. if the asset or liability measured at fair value is only one of the elements in the transaction in a business combination or the transaction includes unstated rights and privileges that are measured separately in accordance with another Ind AS or the transaction price includes transaction costs.

d)The market in which the transaction takes place is different from the principal market (or most advantageous market) e.g. those markets might be different if the entity is a dealer that enters into transactions with customers in the retail market, but the principal (or most advantageous) market for the exit transaction is with other dealers in the dealer market.

Market Participants:
They represent buyers and sellers in the principal (or most advantageous) market for the asset or liability that have all of the following characteristics:

a)They are independent of each other and are not related parties as defined in Ind AS-24.

b)They are knowledgeable and have a reasonable understanding about the asset or liability and the transaction using all available information that might be obtained through due diligence efforts that are usual and customary.
c)They are able and willing to enter into a transaction for the asset or liability.

Measurement Date:
It represents a clear and specific date for a particular transaction and the fair value needs to be computed as of that date rather than for a period.

After having understood the meaning of certain critical terms let us now proceed to gain some insights into the overall framework for measuring the fair value as laid down in Ind AS 113

Framework for Measuring the Fair Value:
The fair value measurement framework as laid down under Ind AS 113 broadly requires a determination of the following:

a.The asset or liability being measured.
b.The highest and best use for a non-financial asset.
c.The principal or most advantageous market.
d.The fair value hierarchy.
e.The valuation techniques to be adopted (including the inputs to be used).

a.The Asset or Liability being measured:

The asset or liability being measured at fair value could be either of the following:

a)A standalone asset or liability e.g. a financial instrument or a non-financial asset like land or equipment; or

b)A group of assets or liabilities e.g. a cash generating unit or valuation during the course of a business combination or restructuring transaction.

In either of the above situations, for the valuation under accounting depends on its unit of account, which is the level at which it is aggregated or disaggregated for accounting purposes.

When measuring fair value an entity shall take into account the following characteristics of the asset or liability which market participants would normally take into account when pricing the asset or liability at the measurement date.:

a) the condition and location of the asset (an example thereof could be a Company which owns a licence only for selling a product in India, the value of the intangible asset represented by the licence cannot be measured by assuming or factoring in the cash flows from the sale of the products outside India); and

b)restrictions, if any, on the sale or use of the asset (an example could be a Company which has a land parcel that can be used only for industrial purposes in which case, the value of the land needs to be measured based on the current conditions as well as keeping in mind the restrictions on use).

b.Highest and Best Use for a Non-Financial Asset:
As we have discussed above, to arrive at the fair value of an asset or liability, its value needs to be taken from the perspectives of the market participants in an orderly transaction for sale or exchange of an asset. However, many non-financial assets may not always be liquid enough nor have specific contractual terms which the financial assets would normally have.

Accordingly, the fair value measurement of a non-financial asset depends upon the following two factors:

a)The ability of the market participants to generate economic benefit by using the asset in its highest and best use. This is also referred to as the in exchange valuation premise. In such cases, the asset would provide maximum value to market participants primarily on a standalone basis. Thus, the fair value of the asset would be the price which would be received in a current transaction to sell the asset to market participants who would use the asset on a standalone basis. An example could be the estimated amount at which a particular piece and parcel of land adjacent to an existing factory (for a proposed expansion) could be exchanged on the date of valuation between a willing buyer and a willing seller wherein both the parties have acted knowledgeably, prudently and without compulsion.

b)The sale value to another market participant who will use the asset to its highest and best use. This is also referred to as the in use valuation premise. In such cases, it is presumed that an entity’s current use of a non-financial asset is its highest and best use unless market or other factors suggest that a different use by market participants would maximise the value of the non-financial asset. An example could be an FMCG company which acquires another similar entity but intends to discontinue the brands acquired pursuant to the acquisition. In such a situation, the fair value of the brands would nevertheless be computed assuming it from a market participant’s perspective even if the acquirer intends to kill the brand(s).

Keeping this in mind, the Standard also specifically provides that the fair value of non-financial assets should be measured based on its highest and best use.

The highest and best use refers to the use of an asset by market participants that would maximise the value of the asset or group of assets and liabilities by taking into account the use of the asset, considering the following factors:

Factors

Examples
of Evaluation Criteria

Physical
Possibility

– Size or location of the property

— Technical feasibility for applying the
asset for producing different goods

Legal
Permissibility

– Legal restrictions like zoning
restrictions

— Entry restriction sin certain markets

Financial
Feasibility

– Generation of
adequate cash flows to provide the desired return on investments to market participants to
put the asset to use

— The costs of converting the asset for
the desired use from a marketparticipants perspective

c.The Principal or Most Advantageous Market:

The basic premise under Ind AS 113 is that the fair value needs to be determined based on orderly transactions that would take place in the principal or in its absence the most advantageous market as defined earlier. Identifying these markets is one of the key considerations in the entire valuation process.

Ind AS-113 provides that an entity need not undertake an exhaustive search of all possible markets to identify the principal market or, in the absence thereof, the most advantageous market, but it shall take into account all information that is reasonably available. In the absence of evidence to the contrary, the market in which the entity would normally enter into a transaction to sell the asset or to transfer the liability is presumed to be the principal market or, in the absence of a principal market, the most advantageous market.

Whilst it is easier to determine the principal market based on the observed volume or level of activity. Example: a stock exchange having more frequent trading or volume for a listed company’s equity shares, to determine the most advantageous market, in other casesone needs to take into account the transaction costs and transportation costs in the manner discussed below.

Transaction Costs and Transportation Costs:
Ind AS-113 defines transaction costs as those costs which are incurred to sell an asset or transfer a liability in the principal (or most advantageous) market (discussed earlier) for the asset or liability that are directly attributable to the disposal of the asset or the transfer of the liability and meet both of the following criteria:

a)They result directly from and are essential to that transaction.

b)They would not have been incurred by the entity had the decision to sell the asset or transfer the liability not been made (similar to costs to sell, as defined in Ind AS 105).

Ind AS-113 defines transportation costs as those costs that would be incurred to transport an asset from its current location to its principal (or most advantageous) market.

As per para 25 of Ind AS-113, the price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs since they are not a characteristic of an asset or a liability but they are specific to a transaction and will differ depending on how an entity enters into a transaction for the asset or liability. Transaction costs shall be accounted for in accordance with other Ind ASs. Further, as per para 26 of Ind AS-113, transaction costs do not include transport costs. If location is a characteristic of the asset (e.g. for a commodity), the price in the principal (or most advantageous) market shall be adjusted for the costs, if any, that would be incurred to transport the asset from its current location to that market.

However, as we have seen earlier, both the transaction and transportation costs should be taken into account to determine the most advantageous market for an asset or a liability.
The above is explained with the help of an example to determine the most advantageous market based on the transaction and transportation cost.

Determination of the Most Advantageous Market – Facts of the case:
An entity holds an asset which can be sold in two markets situated in different locations with different prices. It enters into transactions in both the markets since there is no principal market for the asset. Certain other details are tabulated below:

Amount in Rs.

Market

Price

Transport Cost

Transaction Cost

Net Price

950

100

750

880

765

Determine the most advantageous market.

Solution:
Based on the net prices, the entity would maximise the net amount in market Y (Rs. 765) and hence it appears to be the most advantageous market.

However, on further analysis the fair value of market X and Y would be Rs. 850 and Rs. 805 after deducting the transportation cost as per the requirements of para 25 of Ind AS-113, discussed earlier, since location is a characteristic of the asset. However, even though the fair value of market X is greater, market Y remains most advantageous because of the overall greater net price. Accordingly, the fair value of the asset would be Rs. 805.

d.Fair Value Hierarchy:
The purpose of laying down a fair value hierarchy in the Standard is to increase consistency and comparability in the fair value measurements and disclosures. The basic premise of applying this hierarchy is to enable an entity to prioritise the observable inputs over those that are unobservable. Further, greater disclosures are mandated in respect of unobservable inputs adopted due to their inherent subjectivity.

The Standard establishes a fair value hierarchy that categorises into three levels, as discussed below, the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs).

Level 1 inputs:

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date and provides the most reliable evidence of fair value.

Level 1 inputs will be available for many financial assets and financial liabilities, some of which might be exchanged in multiple active markets (e.g. on different exchanges). Accordingly, the emphasis within Level 1 is on determining both of the following:

a)the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability; and
b)whether the entity can enter into a transaction for the asset or liability at the price in that market at the measurement date.

For example, if the equity shares are quoted on more than one exchange generally the price quoted on an exchange which has the maximum trading volume would be both the principal as well as the most advantageous market.

On the other hand, in respect of Government Securities, though they may be quoted, the market may not be very active or liquid and hence, the latest available quoted price may not be an appropriate level I input and may need to be adjusted.

Level 2 inputs:

Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable (those inputs that are developed using market data, such as publicly available information about actual events or transactions, and that reflect the assumptions that market participants would use when pricing the asset or liability) for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability.

Level 2 inputs include the following:

a)quoted prices for similar assets or liabilities in active markets.
b)quoted prices for identical or similar assets or liabilities in markets that are not active.
c)inputs other than quoted prices that are observable for the asset or liability, for example:
i) interest rates and yield curves observable at commonly quoted intervals;
ii) implied volatilities; and
iii) credit spreads.
d)market-corroborated inputs.

Adjustments to Level 2 inputs will vary depending on the factors specific to the asset or liability, which include the following:

a)The condition or location of the asset;
b)The extent to which inputs relate to items which are comparable to the asset or liability; and
c)The volume and level of activity in the markets within which the inputs are observed.

An adjustment to a Level 2 input that is significant to the entire measurement might result in a fair value measurement categorized within Level 3 of the fair value hierarchy, if the adjustment uses significant unobservable inputs.

Some of the common examples of Level 2 inputs used in valuation are:

a)Receive-fixed, pay-variable interest rate swap based on the Mumbai Interbank Offered Rate (MIBOR) swap rate.- A Level 2 input would be the MIBOR swap rate if that rate is observable at commonly quoted intervals for substantially the full term of the swap.

b)Licensing arrangement- For a licensing arrangement that is acquired in a business combination and was recently negotiated with an unrelated party by the acquired entity (the party to the licensing arrangement), a Level 2 input would be the royalty rate in the contract with the unrelated party at inception of the arrangement.

c)Finished goods inventory at a retail outlet – For finished goods inventory that is acquired in a business combination, a Level 2 input would be either a price to customers in a retail market or a price to retailers in a wholesale market, adjusted for differences between the condition and location of the inventory item and the comparable (i.e. similar) inventory items so that the fair value measurement reflects the price that would be received in a transaction to sell the inventory to another retailer that would complete the requisite selling efforts. Generally, the price that requires the least amount of subjective adjustments should be used for the fair value measurement.

d)Building held and used – A Level 2 input would be the price per square metre for the building (a valuation multiple) derived from observable market data, e.g. multiples derived from prices in observed transactions involving comparable (i.e. similar) buildings in similar locations.

e)Cash-generating unit- A Level 2 input would be a valuation multiple (e.g. a multiple of earnings or revenue or a similar performance measure) derived from observable market data (EV/ EBITDA multiple) e.g. multiples derived from prices in observed transactions involving comparable (i.e. similar) businesses, taking into account operational, market, financial and non-financial factors

Level 3 inputs:

Level 3 inputs are unobservable inputs (those inputs for which market data are not available and that are developed using the best information available about the assumptions that market participants would use when pricing the asset or liability) for the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that relevant observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. Accordingly, unobservable inputs shall reflect the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk.

An entity shall develop unobservable inputs using the best information available in the circumstances, which might include the entity’s own data. In developing unobservable inputs, an entity may begin with its own data, but it shall adjust those data if reasonably available information indicates that other market participants would use different data or there is something particular to the entity that is not available to other market participants (e.g. an entity-specific synergy). An entity need not undertake exhaustive efforts to obtain information about market participant assumptions. However, an entity shall take into account all information about market participant assumptions that is reasonably available. Unobservable inputs developed in the manner described above are considered market participant assumptions and meet the objective of a fair value measurement.

Some of the common examples of Level 3 inputs used in valuation are:

a)Long-dated currency swap – A Level 3 input would be an interest rate in a specified currency that is not observable and cannot be corroborated by observable market data at commonly quoted intervals or otherwise for substantially the full term of the currency swap. The interest rates in a currency swap are the swap rates calculated from the respective countries’ yield curves.

b)Three-year option on exchange-traded shares – A Level 3 input would be historical volatility, i.e. the volatility for the shares derived from the shares’ historical prices. Historical volatility typically does not represent current market participants’ expectations about future volatility, even if it is the only information available to price an option.

c)Interest rate swap- A Level 3 input would be an adjustment to a mid-market consensus (non-binding) price for the swap developed using data that are not directly observable and cannot otherwise be corroborated by observable market data.

d)Cash-generating unit – A Level 3 input would be a financial forecast (e.g. of cash flows or profit or loss) developed using the entity’s own data if there is no reasonably available information that indicates that market participants would use different assumptions.

e.Valuation Techniques:

After having understood the broad principles underlying fair valuation, an entity would need to determine the valuation techniques which are appropriate in the circumstances and for which sufficient data are available to measure the fair value, whereby there is maximum use of observable inputs and minimum use of unobservable inputs, keeping in mind the overall objective of the valuation exercise to estimate the price at which an orderly transaction to sell an asset or transfer a liability would take place between market participants under current market conditions.

There are three widely used valuation techniques which are prescribed in Ind AS 113 as under:

-Market approach
-Cost approach
-Income approach

Each of these are briefly analysed hereunder:

The Market Approach:

This approach uses prices and other relevant information generated by market transactions involving identical or comparable assets, liabilities or group of assets or liabilities. The valuation techniques consistent with the market approach often use market multiples derived from a set of comparable assets, liabilities or business, as applicable. Multiples might be in ranges with a different multiple for each comparable. The selection of the appropriate multiple within the range requires judgement, considering qualitative and quantitative factors specific to the measurement. Some of the commonly used market multiples are EV/ EBIDTA, revenue or matrix pricing involving comparison with benchmark securities.

The Cost Approach:

This approach reflects the amount that would be required currently to replace the service capacity of the asset, which is often referred to as the current replacement cost. From the perspective of a market participant seller, the price that would be received for the asset is based on the cost to a market participant buyer to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence (covering amongst others, physical deterioration, technological changes and changes economic conditions like interest rates, currency fluctuations), since a market participant buyer would not pay more for an asset than the amount for which it could replace the service capacity of that asset. For this purpose, the term obsolescence is much broader than depreciation which is provided for financial reporting or tax purposes.

The Income Approach:

This approach converts the future amounts comprising of cash flows, income or expenses to a single current (discounted) amount. The fair value measure so arrived at reflects the current market expectations of such future amounts. The following are the commonly used valuation techniques under this approach:

?????Present value technique
?Option pricing models
?Multi-period excess earnings method

Whilst a detailed discussion on each of these techniques is beyond the scope of this article, some broad principles underlying the same are covered hereunder.

Present Value Technique:
The present value technique is the most commonly used technique and is the only technique for which guidance is provided in Ind AS 113. This technique links the future estimates or amounts (e.g. cash flows or values) to a present amount using a discount rate. A fair value measurement of an asset or a liability using a present value technique captures all the following elements from the perspective of market participants at the measurement date:

a)An estimate of future cash flows for the asset or liability being measured.
b)Expectations about possible variations in the amount and timing of the cash flows representing the uncertainty inherent in the cash flows.
c)The time value of money, represented by the rate on risk-free monetary assets that have maturity dates or durations that coincide with the period covered by the cash flows and pose neither uncertainty in timing nor risk of default to the holder (i.e. a risk-free interest rate).
d)The price for bearing the uncertainty inherent in the cash flows (i.e.an illiquidity discount).
e)Any other factors that market participants would take into account in the circumstances.
f)For a liability, the non-performance risk relating to that liability, including the entity’s (i.e. the obligor’s) own credit risk.

Option Pricing Models:

These incorporate present value techniques and reflect both the intrinsic and time value of money of an option contract which represents a contract through which a seller gives a buyer the right, but not the obligation, to buy or sell a specified number of shares or other securities or commodities or foreign currency at a predetermined price within a set time period.Options are derivatives, which means that their value is derived from the value of an underlying investment or commodity or foreign currency, amongst others.

A further detailed discussion on the various option pricing models is beyond the scope of this article since it involves use of various statistical and other models, often quite complex, which are determined by valuation specialists taking into account various sophisticated models and tools.

Multi Period Excess Earnings Method:

The fundamental principle underlying this method is to isolate the net earnings attributable to the asset being measured. It is generally used to measure the fair value of intangible assets. Under this method, the estimate of an intangible assets fair value starts with an estimate of the expected net income of the enterprise or the group of assets. The other assets in the group are referred to as the contributory assets, which contribute to the realisation of the intangible assets value. Once the underlying value is determined, the contributory charges or economic rents, which represent the charges for the use of the assets based on their respective fair values, are deducted from the total net after tax cash flows projected from the combined group to obtain the “excess earnings” attributable to the intangible asset.

Use of Multiple Valuation Techniques:

If multiple valuation techniques are used to measure the fair value, the results thereof should be evaluated considering the reasonableness of the range of values. In such cases, the fair value is the point within the range that is most representative of the fair value in the given scenario.

Changes in Valuation Techniques:

As a general rule, valuation techniques shall be applied consistently. However, a change in the valuation technique or application of multiple valuation techniques is appropriate if the change results in a measurement that is equally or more representative of the fair value in the circumstances. Some examples of such circumstances are as under:

a)New markets develop or market conditions change.
b)New information is available.
c)Information previously used is no longer available.
d)The valuation techniques improve.

Inputs to Valuation Techniques:

General Principles:

As discussed above, valuation techniques used to measure fair value shall maximise the use of relevant observable inputs and minimise the use of unobservable inputs.

Inputs selected for fair value measurement shall be consistent with the characteristics of the asset or liability that market participants would take into account in a transaction for the asset or liability. In some cases those characteristics result in the application of an adjustment, such as a premium or discount (e.g. a control premium or non-controlling interest discount). When these characteristics reflect controlling shareholding, the share price would attract a premium and when it reflects a non-controlling interest, the share price would attract a discount.

In all cases, if there is a quoted price in an active market for an asset or a liability, an entity shall use that price without adjustment when measuring fair value, except in the following circumstances as specified in para 79 of Ind AS 113:

a)when an entity holds a large number of similar (but not identical) assets or liabilities (e.g. debt securities) that are measured at fair value and a quoted price in an active market is available but not readily accessible for each of those assets or liabilities individually. In such cases, as a practical expedient, an entity may measure fair value using an alternative pricing method that does not rely exclusively on quoted prices (e.g. matrix pricing). However, the use of an alternative pricing method would result in a fair value measurement categorised within a lower level of the fair value hierarchy.

b) when a quoted price in an active market does not represent fair value at the measurement date. For example, if significant events (such as transactions in a principal-to-principal market, trades in a brokered market or announcements) take place after the close of a market but before the measurement date. An entity shall establish and consistently apply a policy for identifying those events that might affect fair value measurements. However, if the quoted price is adjusted for new information, the adjustment results in a fair value measurement categorised within a lower level of the fair value hierarchy.

c)when measuring the fair value of a liability or an entity’s own equity instrument using the quoted price for the identical item traded as an asset in an active market and that price needs to be adjusted for factors specific to the item or the asset.

Inputs based on Bid and Ask Prices:

If an asset or a liability measured at fair value has a bid price and an ask price, the price within the bid-ask spread that is most representative of fair value in the circumstances shall be used to measure fair value regardless of where the input is categorised within the fair value hierarchy as discussed above. The use of bid prices for asset positions and ask prices for liability positions is permitted, but is not required mandatorily.

Ind AS 113 does not preclude the use of mid-market pricing or other pricing conventions that are used by market participants as a practical expedient for fair value measurements within a bid-ask spread.

Fair Value Disclosures:

The disclosures under Ind AS 113 aims to equip the users of financial statements with greater transparency in respect of the following matters:

a)The extent of usage of fair value in the valuation of assets and liabilities.
b)The valuation techniques, inputs and assumptions used in measuring fair value.
c)The impact of level 3 fair value measurements on the profit and loss account or other comprehensive income.

The Standard also lays down the broad disclosure objectives and has stipulated certain minimum disclosure requirements especially in respect of Level 3 fair value measurements, since there is greater subjectivity and judgement involved in using them.

The disclosures broadly cover the following aspects:

a)Reasons for non-recurring fair value measure-ments.
b)The fair value hierarchy adopted.
c)The reasons for transfer between the hierarchical levels for recurring fair value measurements.
d)The valuation techniques adopted,including any changes therein, for both recurring and non-recurring fair value measurements.
e)Quantitative information about significant unobservable inputs for recurring level 3 fair value measurements.
f)The amount of total gains and losses recognised in profit and loss and OCI, together withline items in which these are recognised, for recurring fair value measurements categorised within level 3 of the fair value hierarchy.
g)Sensitivity analysis, both narrative and with quantitative disclosures about the significant unobservable inputs. _
(to be continued)

shailesh.kwebmaker

22 Article 12 of India-Singapore DTAA; Section 9(1)(vii) of the Act – repeated performance of management support services leads to satisfaction of ‘make available’ condition

ITA
No. 1503/Del/2014 (Delhi)

Ceva Asia Pacific Holdings vs. DDIT

A.Ys: 2010-11, Date of Order: 8^th
January, 2018

Taxpayer, a non-resident company, operated
as a regional headquarter company providing management and support services to
its subsidiaries and related corporations in Asia pacific region. Taxpayer
entered into an administrative support agreement with its Indian affiliate
(ICo) to provide day-to-day administrative and management support services. As
per the agreement, Taxpayer rendered MIS and accounting support service,
information technology support service, marketing and advertising support as
well as treasury functions support services to ICo.

AO examined the nature of administrative
support services rendered to ICo, details of employees visiting India as well
as copies of the emails, bills, and ledger accounts with respect to such
services rendered. Based on these documents, AO noted that the services were
rendered by Taxpayer by working closely with employees of ICo in order to
customise its services as per the needs of ICo as well as to improve the
performance of ICo by employing the best practices and industry experience
possessed by Taxpayer in the functions of management, finance, accounts and IT.
AO held that Taxpayer made available administrative support services to ICo and
therefore, payment for such services qualifies as FTS under Article 12(4) of
the Indian-Singapore DTAA.

Taxpayer, however, contended that the
services did not satisfy the make available condition and hence did not qualify
as FIS as per Article 12 of India-Singapore DTAA. Hence, Taxpayer appealed
before the DRP who upheld AO’s order.

Aggrieved, the Taxpayer appealed before the
Tribunal.

Held

– “Make available? means that the person
receiving the service should become wiser on the subject of services. In other
words, service recipient should be able to perform the services on its own.

– While the documents produced by the Taxpayer
indicate that the nature of services rendered by the Taxpayer were preliminary,
basic, or simple support services; the nature of queries raised by ICo and the
nature of information that was transmitted by the Taxpayer to ICo indicated
that the services rendered by the Taxpayer are of such nature that, if they are
rendered for a long period of time, it would enable ICo to perform the services
on its own.

– One needs to however, examine various
correspondence between the Taxpayer and ICo, conduct of the Taxpayer and ICo as
well as the nature of services involved, to evaluate if services rendered by
the Taxpayer, in fact, satisfied the “make available” condition or not.

– Hence, the matter was remanded back to the
file of AO for deciding whether the services satisfy the “make Available?
criterion or not after taking into account all the relevant information and
documents. _

shailesh.kwebmaker

21 Section 9(1) (vi) of the Act; Article 12 of India-Ireland DTAA – payment towards supply of “off-the-shelf software does not qualify as ‘Royalty’ under the India-Ireland DTAA.

ITA NO.1535/MUM/2014

Intec Billing Ireland vs. ADIT

A.Y: 2010-11, Date of Order: 8^thJanuary,
2018

Taxpayer, a non-resident company, licensed
an ‘off-the-shelf’/’shrink wrapped’ billing software to an Indian company
(ICo). The software provided comprehensive business solution in transaction
management, billing and customer care issues related to telecom industry
players.

Taxpayer contended that the software
licensed to ICo was a standard product which was also licensed to various other
customers. Under the license agreement, ICo only acquired a right to use a copy
of the software for its business purposes. The right to make multiple copies
was also limited only for the internal business operations of ICo. ICo had no
right to resell the software or commercially exploit the software. The
Intellectual Property Rights (IPR) in the software was exclusively owned by the
Taxpayer. Hence, the payment made by ICo was for a “copyrighted article” and
not for use of “copyright”. Consequently, such payment does not qualify as
“royalty” under Article 12 of the India-Ireland DTAA.

AO held that the payment received by
Taxpayer for supply of ‘off-the-shelf’ software to ICo was for grant of ‘copyright’ and accordingly, the receipts
qualified as ‘Royalty’ u/s. 9(1)(vi) of the Act as well as Article 12 of
India-Ireland DTAA.

The Dispute Resolution Panel (DRP) accepted
the fact that the software was a shrink wrapped/ off-the-shelf software.
However, in light of the decisions in CIT vs. Samsung Electronics Co. Ltd.
(2012) 345 ITR 494 and DDIT vs. Reliance Infocom Ltd (2014) 159 TTJ 589,
DRP held that the payment made by ICo was for the use of or right to use
copyright and hence, the payment qualified as royalty within the meaning of
Article 12 of the DTAA.

Aggrieved, the Taxpayer appealed before the
Tribunal.

Held

– The terms
of the agreement clearly indicated that the IPR in the software was owned by
the Taxpayer and ICo was merely granted right to use a ‘copyrighted article’.

– Taxpayer merely granted right to use the
software to ICo for its own use in India, without any right to use the
copyright therein. Thus, the payment made by ICo did not qualify as royalty as
per Article 12 of the India Ireland DTAA.

– In various decisions¹, it has been held that grant of license of
shrink wrapped software does not amount to transfer of copyright and hence the
payment for such license does not qualify as royalty.

– The license agreement under consideration
and the software supplied by the Taxpayer to ICo was subject matter of
consideration before the co-ordinate bench of Tribunal wherein it was held that
sale of software to end-customer does not involve transfer of copyright and
hence payment for such license does not qualify as royalty.

– Though the decision of the co-ordinate bench
was in the context of India-USA DTAA, the definition of Royalty under the
applicable Indo-Ireland Tax DTAA being pari materia to Indo-US Tax DTAA,
payment for supply of software will not be taxable as royalty in the hands of
Taxpayer even under India-Ireland DTAA.

_________________________________________________________________

1 Illustratively, Halliburton Export Inc.
(ITA No. 3631 of 2016), Solid Works Corporation [2012] 51 SOT 34 (Mumbai)
Dassault Systems vs. DDIT (79 taxmann.com 205)

shailesh.kwebmaker

47 Charitable purpose – Charitable institution – Exemption u/s. 11 r.w.s. 2(15) – A. Ys. 2010-11 and 2011-12 – Society created by RBI to assist banks and financial institutions – Finding by Tribunal that assessee carried out an object of general public utility and was not engaged in trade – Assessee entitled to exemption

Principal CIT (Exemptions) vs. Institute of Development and Research in Banking Technology; 400 ITR 66 (T & AP):

The assessee was a society registered at the instance of the Reserve Bank of India (RBI) for the purpose of assisting banks and financial institutions, for the improvement of their performance. The assessee also offered M. Tech courses and Ph. D degrees in banking. It claimed exemption u/s. 11 of the Act, for the A. Ys. 2010-11 and 2011-12. The Assessing Officer rejected the claim. The Tribunal found that the assesee was carrying out an object of general public utility. It held that the assessee was not carrying on an activity in the nature of any trade, commerce or business. The Tribunal also pointed out that the charging of a fee by the assessee was not with profit motive and that therefore, merely because the assessee derived income it could not be held to be carrying on an activity in the nature of trade, commerce or business. It granted the exemption to the assessee. On appeal by the Revenue, the Telangana and Andhra Pradesh High Court upheld the decision of the Tribunal and held as under:

“i) The assessee was created by the Reserve Bank of India for the improvement of the performance of banks and the financial sector of the country, ultimately to have a bearing upon the economy of the country. Hence it was an institution established for an object of public utility.

ii) The Tribunal had found that it was not carrying on any activity in the nature of trade. It was therefore entitled to exemption u/s. 11 for the A. Ys. 2010-11 and 2011-12.”

shailesh.kwebmaker

46 Cash credit – Section 68 – A. Y. 2005-06 – Amount claimed to be long-term capital gains – Evidence of contract and payments through banks – Tribunal wrong in disregarding entire evidence and sustaining addition on sole basis of late recording on demat passbook – Addition u/s. 68 not justified

Ms. Amita Bansal vs. CIT; 400 ITR 324 (All):

Assessee is an individual. For the A. Y. an addition of Rs. 11,77,000 was made which according to the assessee was long term capital gain on sale of 11,000 share of a company. The Assessing Officer disbelieved the long term capital gain and made a corresponding addition of Rs. 11,77,000 u/s. 68 of the Income-tax Act, 1961(hereinafter for the sake of brevity referred to as the “Act”). On appeal, the assessee adduced evidence in the shape of contract notes/bill receipt, payments made through banking channels, contract notes and copies of pass book of its demat account in support of its claim and asserted its claim of long term capital gain as genuine and correct. The Commissioner (Appeals) after a detailed examination of the case of the assessee and evidence adduced by the assessee including the entries in the demat account passbook, the evidence of the broker firms through whom the transactions were made, and the contract note dated November 10, 2003, allowed the appeal. The Tribunal restored the addition on the sole ground of purchase of shares having been recorded late in the demat account of the assessee.

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

“i) An order recorded on a review of only a part of the evidence and ignoring the remaining evidence cannot be regarded as conclusively determining the question of fact raised before the Tribunal.

ii) Although the fact of the purchase transaction being recorded late in the demat passbook raised a doubt as to its genuineness and this evidence was relevant to the issue, there existed other evidence, adduced by the assessee in this case, in the shape of contract notes, bank transactions pertaining to payment for purchase and sale of shares and other material relied on by the Commissioner (Appeals). The Tribunal had also not specifically dealt with the findings recorded by the Commissioner (Appeals).

iii) In view of this, the finding of the Tribunal and the consequential order could not be sustained. The addition could not be made.”

shailesh.kwebmaker

Derived or not Derived From …….. ……

ISSUE FOR CONSIDERATION
In the annals of the Income-tax Act, no controversy is buried for ever. Like a hydra, it raises its head at the first available opportunity. One such controversy is about the eligibility for an incentive deduction of interest, received on deposits made in the course of an activity of an under taking or a business, the income of which is otherwise eligible for deduction. Whether such an interest is derived from the eligible activity or business and therefore, qualifies for a deduction or not is an issue which refuses to die down and comes up with regularity before the courts, in varied circumstances, with interesting facets.

At a time when the import of the issue has been fairly understood and addressed by the law makers and the practitioners and was believed to have been settled, it has resurfaced with beautiful facts. The recent decision of the Bombay High Court on the subject has revived the controversy with an immortal life span.

CYBER PEARL’S CASE
The issue recently came up for consideration in the case of Cyber Pearl IT Park Pvt. Ltd. vs. ITO, 399 ITR 310 before the Madras High Court in the context of section 80IAB for A.Y. 2009-10. The assessee in that case was engaged in the business of developing and leasing of Information Technology parks. For the assessment year 2009-10, the assessee claimed deduction u/s. 80-IAB of the Act to the extent of Rs. 4,20,59,087 which included a sum of Rs. 2,52,04,544 representing interest which the assessee had earned from security deposits from persons who had taken on lease the facilities set up in the parks. In form 10CCB filed by the assessee, the claim for deduction u/s. 80-IAB was restricted to a sum of Rs. 1,68,54,543. Based on this, the Assessing Officer passed an order u/s. 143(3) of the Act, restricting the deduction to a sum of Rs. 1,68,54,543 and treating the sum of Rs. 2,52,04,544, which was interest received by the assessee from security deposits given by the lessees as income from other sources. The CIT(A) confirmed the order of the AO and the Tribunal rejected the assessee’s claim for deduction qua the balance sum, i.e. Rs. 2,52,04,544 on two grounds: (a) that via auditor’s certificate issued in form 10CCB, the claim u/s. 80-IAB had been restricted to Rs. 1,68,54,543, (b) that the interest received from security deposit in the sum of Rs. 2,52,04,544 had “no direct nexus” with the industrial undertaking.

On further appeal to the High Court, the assessee contended the following:

–    the Tribunal did not appreciate the fact that in the income tax return filed by the assessee, the entire amount, of Rs. 4,20,59,087 was claimed as a deduction. The learned counsel submitted that because the mere fact that Form 10CCB restricted the claim to a sum of Rs. 1,68,54,543 could not be a ground for denying the deduction, which the assessee could otherwise claim as a matter of right u/s. 80-IAB.
–   the interest derived from the security deposit upon its investment in fixed deposits with the bank, was income, which was derived from business of developing a Special Economic Zone and therefore, was amenable to deduction u/s. 80-IAB.
–   the issue was settled in favour of deduction by the Bombay High Court in CIT vs. Jagdishprasad M. Joshi, 318 ITR 420 (Bom).

In response on the other hand, the Revenue made the following submissions.
–    for the interest earned from security deposits, to be amenable to deduction u/s. 80-IAB, it should have a “direct nexus” with the subject activity, which was, the business of developing a special economic zone.
–    only those profits and/or gains, which were derived by an undertaking or an enterprise from “any” business of developing a Special Economic Zone, would come within the purview of section 80-IAB.
–   in the following cases, the courts have held that the deduction was not eligible:

(i)   CIT vs. A.S. Nizar Ahmed and Co., 259 ITR 244 (Mad)
(ii)   CIT vs. Menon Impex P. Ltd., 259 ITR 403 (Mad)
(iii)   Pandian Chemicals Ltd. vs. CIT, 262 ITR 278 (SC)
(iv)   CIT vs. Shri Ram Honda Power Equip, 289 ITR 475 (Delhi)
(v)   Dollar Apparels vs. ITO, 294 ITR 484 (Mad)
(vi)   Sakthi Footwear vs. Asst. CIT(No.1), 317 ITR 194 (Mad)
(vii)   CIT vs. Mereena Creations, 330 ITR 199 (Delhi) and
(viii)   CIT vs. Tamil Nadu Dairy Development Corpo.Ltd., 216 ITR 535 (Mad).

The High Court, on an analysis of provisions of section 80-IAB, observed that an assessee was entitled to a deduction of the profits and gains derived by an undertaking or an enterprise from the business of developing a special economic zone. On examination of the decision of the Supreme Court in Pandian Chemicals Ltd.’s case (supra), and applying it to the case before it, the court observed as under;
– Pandian Chemicals Ltd. was a case for deduction u/s. 80-HH in respect of interest on deposits with Electricity Board for supply of electricity to industrial undertaking and the issue therein was whether such interest could be construed to be profits and gains ‘derived’ from an industrial undertaking and were eligible for deduction.
– the Supreme Court rejected the claim of the assessee by observing that the term ‘derived’ concerned itself with effective source of income only and did not embrace the income by way of interest on deposits made, which was a
secondary source.

–    only such income was eligible for deduction which had a direct or immediate nexus with the industrial undertaking.
–   the term ‘derived from’ had a narrower meaning than the term ‘attributable to’ and excluded from its scope the income with secondary or indirect source as was explained by various decisions of the apex court including in the cases of Cambay Electric Supply Industrial Co. Ltd., 113 ITR 84 (SC) and Raja Bahadur Kamakhaya Narain Singh, 16 ITR 325 (PC) and Sterling Foods, 237 ITR 579(SC).
–    the Madras High Court in the case of Menon Impex P. Ltd. 259 ITR 403 denied the deduction us. 10A by holding that interest on deposits made for obtaining letter of credit was not ‘derived from’ the undertaking carrying on the business of export.
–    the contention of the assessee that the decisions cited by the Revenue did not deal with the provisions of
section 80-IBA of the Act was to be rejected as the provisions of section 80-IBA were found to be para materia with the provisions dealt with in those cases, as all of them were concerned with the true meaning of the term ‘derived from’ whose width and amplitude was narrower in scope than the term “attributable to”.
–    once it was found that income was from a secondary source, it fell outside the purview of desired activity, which in the case before them was the business of developing a Special Economic Zone.

In deciding the case, in favour of the Revenue, the court was unable to persuade itself to agree with the decision of the Bombay High Court in the case of CIT vs. Jagdishprasad M. Joshi, 318 ITR 421 which had taken a contrary view on the subject of deduction of interest.

JAGDISHPRASAD JOSHI’S CASE
The issue had come up for consideration before the Bombay High Court in the case of CIT vs. Jagdishprasad M. Joshi, 318 ITR 421 in the context of section 80-IA for A.Y. 1997-98.

In that case, the court was asked to address the following substantial question of law; “Whether, on the facts and in the circumstances of the case and in law, the Tribunal was right in allowing the appeal of the assessee holding that the interest income earned by the assessee on fixed deposits with the bank and other interest income are eligible for deduction u/s. 80-IA of the Income-tax Act, 1961 ?”

On behalf of the Revenue, a strong reliance was placed upon the judgement of the Supreme Court in the case of Pandian Chemicals Ltd.(supra) and also the judgement of the Madras High Court in the same case reported in 233 ITR 497.

On behalf of the assessee, equally strong reliance was placed on the judgement of the Delhi High Court in the case of CIT vs. Eltek SGS P. Ltd.,300 ITR 6, wherein the Delhi High Court had considered the very same issue, and in the process examined the applicability of the judgement relied upon by the Revenue, and the court in Eltek’s case. The Delhi High Court had distinguished the language employed under sections 80-IB and 80-HH and had observed as under :
“ That apart s. 80-IB of the Act does not use the expression ‘profits and gains derived from an industrial undertaking’ as used in s. 80-HH of the Act but uses the expression ‘profits and gains derived from any business referred to in sub-section’..

A perusal of the above would show that there is a material difference between the language used in s. 80-HH of the Act and s. 80-IB of the Act. While s. 80-HH requires that the profits and gains should be derived from the industrial undertaking, s. 80-IB of the Act requires that the profits and gains should be derived from any business of the industrial undertaking. In other words, there need not necessarily be a direct nexus between the activity of an industrial undertaking and the profits and gains.

Learned counsel for the Revenue also drew our attention to Pandian Chemicals Ltd. vs. CIT, 262 ITR 278 (SC). However, on a reading of the judgement we find that also deals with s. 80-HH of the Act and does not lay down any principle different from Sterling Foods, 237 ITR 579 (SC). Reliance has been placed on Cambay Electric Supply Industrial Co. Ltd., 113 ITR 84 (SC) and the decision seems to suggest, as we have held above, that the expression ‘derived from an industrial undertaking’ is a step removed from the business of the industrial undertaking.”

The Bombay High Court dismissed the appeals, approving the decision of the Tribunal, holding that no substantial question of law arose in the appeal of the Revenue. The deduction allowed u/s. 80-IA to the assessee was upheld.

OBSERVATIONS
A few largely undisputed understandings, in the context of the issue under consideration, of the eligibility of an income from interest or any other receipt, are listed as under:
–   the term ‘attributable to’ is wider in its scope than the term ‘derived from’,
– the
term ‘attributable to’ is wider in its scope than the term ‘derived from’,
which has a limited scope of inclusion.
–    the term ‘attributable to’ usually includes in its scope, a secondary and indirect source of income, besides the primary and the derived source of income.
–    as against the above, the term ‘derived from’ means a direct source and may include a source which is intricately linked to the main activity which is eligible for deduction.
–    the difference between the two terms is fairly addressed to, explained and understood, not leaving much scope for assigning a new meaning.

It is also understood that the term ‘derived from’, is capable of encompassing within its scope, such income or receipts which can also be construed to be the primary source of the eligible activity or is found to be intricately and inseparably linked thereto.

Under the circumstances, whether a particular receipt or an income is derived from or not and is eligible for the deduction or not are always the questions of fact and no strait-jacket formula can be supplied for the same.

The legislature has from time to time enacted provisions for conferring incentives for promoting the preferred or the desired activities or businesses, over a period of almost a century. Obviously, the language employed in the multitude of sections and provisions varies and thereby, it has become extremely difficult to apply the ratio of one decision to the facts of another case, as a precedent. A little difference in the language employed by the legislature invites disputes, leading to a cleavage of judicial views as is seen by the present controversy under discussion. At times, it becomes very difficult to resolve an issue simply on the basis of the language alone, even where the provisions are otherwise required to be construed liberally, in favour of the tax payers.

An attempt has been made to list down a few of the examples of the language used in the different provisions of chapter VI-A and sections 10 A to 10 C of the Act.
–    Profits and gains derived from an industrial undertaking.
–    Profits and gains derived from the business of a hotel or a ship.
–    Profits and gains derived from a small scale industry.
–    Profits and gains derived from a business of …..
–   Profits and gains derived from execution of a Housing Project.
–    Profits and gains derived from exports.
–    Profits and gains derived from services.
–    Profits and gains derived from such business.
–    Profits and gains derived from an undertaking or an enterprise from any business of …..
–    100% of the profits.
–   Profits and gains derived by an undertaking from exports.

The list, though not exhaustive, highlights the possibility of supplying different meanings based on the difference in the language employed by the legislature. The major difference that has emerged in the recent years is between the following three terminologies:
–    Profits and gains derived from an undertaking .
–    Profits and gains derived from an undertaking or an enterprise from any business of …..
–   Profits and gains derived from a business of …..

The rules of interpretation provide that each word, or the omission thereof, should be assigned a specific meaning and should be believed to be inserted or omitted by the legislature with a purpose. Nothing should be believed to be meaningless. Applying this canon of interpretation, the Delhi High Court in the case of Eltek SGS P. Ltd. 300 ITR 006, in the context of section 80 IB, refused to follow the decisions in the cases of Cambay Electric Supply Industrial Co. Ltd. (supra), Sterling Foods (supra) and Pandian Chemicals Ltd. (supra) and Ritesh Industries, 274 ITR 324 (Delhi), by distinguishing the language used in sections 80 HH and 80 I from that used in section 80- IB of the Act. The High Court chose to strengthen its case by referring to the decision of the Gujarat High Court in the case of Indian Gelatin and Chemical Ltd. 275 ITR 284 (Guj). As noted earlier, in respect of income from interest, the Bombay High Court in Jagdishprasad’s case has followed the decision of the Delhi High Court in Eltek’s case in respect of duty drawback.

It is crucial to appreciate the difference in the language in section 80HH, section 80-I and section 80-IB of the Act. The language used in section 80-IB of the Act is a clear departure from the language used in section 80-HH and section 80-I of the Act. It is this choice of words that makes all the difference to the controversy that we are concerned with.

The court in Eltek’s case found it to be not necessary to go as far as the Gujarat High Court had done in coming to the conclusion that duty drawback was profit or gain derived from the business of an industrial undertaking. It was sufficient for the Court to stick to the language used in section 80-IB of the Act and come to the conclusion that duty drawback was profit or gain derived from the business of an industrial undertaking. The language used in section 80-IB of the Act, though not as broad as the expression ‘attributable to’ referred to by the Supreme Court in Sterling Foods and Cambay Electric’s cases is also not as narrow as the expression ‘derived from’. The expression “derived from the business of an industrial undertaking” is somewhere in between.

The distinction between the language employed in two different provisions has been noticed favourably by the courts in the judgements in the cases of Dharampal Premchand Ltd., 317 ITR 353 (Delhi) and Kashmir Tubes, 85 Taxmann.com 299 (J &K). In contrast, the Punjab & Haryana High Court following Liberty India, 317 ITR 258 (SC), has denied the deduction in spite of being informed about the difference in the language employed in the two provisions. [Raj Overseas, 317 ITR 215 and Jai Bharat Gums, 321 ITR 36].

A serious note needs to be taken of the decision of the Jammu & Kashmir High Court in the case of Asian Cement Industries, 261 CTR 561 wherein the court on a combined reading of section 80-IB(1) with section 80-IB(4), in the context of interest, held that nothing turned on the difference in language between the sections 80HH and 80IB and that the law laid down by the Supreme court in the cases of Sterling Foods (supra) and Pandian Chemicals Ltd. (supra) applied to section 80-IB as well. Similarly, the Uttarakhand High Court in the case of Conventional Fasteners, 88 Taxmann.com 163 held that the difference noted by the High Court in Eltek and Jagdishprasad’s cases was not of relevance and the ratio of the Supreme Court’s decisions continued to apply, in spite of the difference in language of the provisions.

Lastly, a careful reference may be made to the Supreme Court decision in the case of Meghalaya Steels, Ltd., 383 ITR 217 for a better understanding of the subject on hand. A duty drawback or refund of excise duty or receipt of an insurance claim or sale proceeds of scrap and such other receipts has obviously a better case for qualifying for deductions.

The better view appears to be that the use of different languages and terminologies in some of the provisions has the effect of expanding the scope of such provisions for including such incomes that may otherwise be derived from secondary source of the activity; more so, on account of the accepted position in law that an incentive provision should be construed in a manner that allows the benefit, than that denies the benefit. _

shailesh.kwebmaker

20 Section 9(1)(vii) of the Act; Article 12(4)(b) of India-US DTAA – Payment for MIS services does not make available any technical knowledge or skill and hence does not qualify as FIS under the DTAA; Reimbursement of payment made by a non-resident on behalf of a resident was not taxable as FTS in hands of non-resident.

TS-569-ITAT-2017(Kol)

The Timken Company vs. ITO

A.Ys: 2002-03 to 2007-08,

Date of Order: 29^th November,
2017

Facts 1

Taxpayer, a foreign company was engaged in
the business of manufacturing and sale of bearings. Taxpayer entered into an
agreement with its Indian subsidiary company (ICo), for rendering of management
information services (MIS) outside India. For instance, as part of the MIS
services, Taxpayer rendered product, process and tool design services, capital,
planning and inventory management services, quality assurance services, damage
and failure analysis, tax services and legal services etc. As per the
agreement, compensation payable by ICo to the Taxpayer would cover only
reimbursement towards the cost incurred by the Taxpayer without any profit
element or mark-up.

Taxpayer contended that the services
rendered by the Taxpayer to ICo did not make available any technical knowledge,
experience or skill and hence, the payments made by ICo for such services did
not constitute fees for included services (FIS) within the meaning of Article
12(4) of the Indo-US DTAA. It was further contended that income from such
services represents business profits, which, in absence of a PE, were not
taxable in India. Further, in absence of
a profit element, such business receipts were not taxable in India.

The AO held that payments made by ICo were
taxable in India as per Article 12 of Indo-USA DTAA. Aggrieved by the order of
A.O. Taxpayer appealed before CIT(A) who upheld the order of A.O.

Aggrieved, the Taxpayer appealed before the
Tribunal.

Held 1

– For a payment to qualify as FIS under
Article 12, following two conditions should be satisfied:

• Firstly, the payment
should be in consideration for rendering of technical or consultancy services.

• Secondly, the payment
should be in consideration of services which make available technical
knowledge, experience, skill, etc. to the person utilising the services.

– Services rendered by the Taxpayer to ICo
were purely advisory services and no technical knowledge or skill was made
available by the Taxpayer to ICo.

– The Tribunal referred to the example in the
MOU between India and USA, which supported the view that payment for advisory
services does not qualify as FIS under Article 12.

– Further, in absence of a PE in India, the
income form rendering services to ICo was not taxable in India.

Facts 2

During the relevant year, Taxpayer also
received payments from ICo as reimbursements towards payments made by the
Taxpayer to third parties for certain services rendered by third parties to
ICo.

Taxpayer contended that for a payment to
qualify as FIS, it should be made for rendering technical or consultancy
services. Since Taxpayer did not render any service to ICo, payments received
from ICo as cost reimbursement will not qualify as FIS. Further, the amount received from ICo was
purely in the nature of reimbursement of expenses incurred by Taxpayer on
behalf of ICo. Thus, such payments were not taxable in India.

However, AO contended that payment made by ICo
qualified as FIS under Article 12 of India-USA DTAA. On appeal, CIT(A) held
that the payments were in the nature of reimbursement and AO was not justified
in treating such payments as FIS. Aggrieved, AO appealed before the Tribunal.

Held 2

– The services were rendered by third parties
to ICo and Taxpayer merely paid on behalf of ICo. It is such amount which was
reimbursed by ICo to the Taxpayer.

– Taxpayer was not the ultimate beneficiary of
the payment made by ICo nor did it render any service to ICo. It was hence
incorrect for AO to treat such reimbursements as fee for technical services
(FTS).

– Assuming such payments are for services, in
absence of any evidence to show that such services made available technical
knowledge or skill, the payments could not be treated as FIS under the DTAA.

shailesh.kwebmaker

19 Article 13 of India-Germany DTAA; Section 9(1)(i) of the Act –Transfer of shares of foreign company which do not derive substantial value from the shares of ICo is not taxable in India, no withholding obligation in the absence of any tax liability in India.

GEA Refrigeration Technologies GmbH

AAR No. 1232 of 2012

Date of Order: 28^th November,
2017

The Taxpayer, a foreign company, acquired
100% shares of another foreign company (FCo1) from foreign shareholders
(Sellers). FCo1 was a family owned company having investments in many countries
including a wholly owned subsidiary in India (ICo). Pursuant to acquisition of
shares in FCo1 by the Taxpayer, there was an indirect change in ownership of
ICo.

From the valuation of the assets of FCo1
undertaken by an Independent valuer, it was found that ICo contributed in the
range of 5.23% to 5.57% to the value of total assets of FCo1.

Taxpayer as a buyer sought an advance ruling
to determine the taxability of transaction in the hands of the Sellers in terms
of indirect transfer provisions u/s. 9(1)(i) of the Act and India-Germany DTAA
and its consequential withholding
obligation.

The facts are pictorially reproduced as
follows:

Held:

– Under the Indirect transfer provisions of
the Act, gains arising from a transfer of a share or interest in a foreign
company/ entity that derives, directly or indirectly, its value substantially
from assets located in India is taxable in India. For this purpose, share/
interest is deemed to derive its value substantially from assets located in
India if the value of Indian assets: (a) exceeds INR 10Cr; and (b) the value
represents at least 50% of the value of all assets owned by the foreign
company/ entity.

– Where value contribution of ICo to the value
of total assets of FCo1 is minuscule as against the substantial value
requirement of at least 50% provided in the Act, then shares in FCo1 cannot be
said to derive substantial value from shares in ICo to trigger indirect
transfer provisions in India. Hence, income arising on account of transfer of
such shares in FCo1 cannot be taxed in India.

– As per India-Germany DTAA, gains derived
from transfer of shares of a company which is a resident of Germany may be
taxed in Germany. Further the capital gain article contains a residuary clause,
in terms of which the gains which other than the gains from transfer of assets
specified in the other clauses of capital gain article is taxable only in the
resident state.

– Since the income from transfer is not
taxable under the Act itself, the provisions of the DTAA becomes academic.

– Without prejudice, since the Taxpayer as
well as the Sellers were tax residents of Germany, transfer and payment for the
transaction was completed in Germany, capital gains arising from the transfer
of such shares by the shareholders of FCo1 would be taxable only in Germany as
per India-Germany DTAA.

– Even if one were to argue that transfer of
100% shares results in transfer of controlling interest, transfer of such
rights would be taxable only in the resident state i.e Germany in this case.
Since the transfer is not taxable in India, there will be no obligation on the
Taxpayer to withhold taxes.

shailesh.kwebmaker

18 Article 5 and 12 of India-Belgium DTAA; Explanation 2 to section 9(1)(vii) of the Act; Place provided in the stadium for storing lighting equipment under lock and continued presence required having regard to the nature of services rendered by the Taxpayer results in satisfaction of the disposal test.

TS-626-AAR-2017

Production Resource Group

Date of Order: 8^th November, 2017

Taxpayer, a non-resident company was engaged
in the business of providing technical equipment as well as services including
lighting, sound, video and LED technologies for various events. Taxpayer entered into a Service Agreement
with the Organizing Committee of the Commonwealth Games, India (OCCG), to
furnish lighting and searchlight services during the opening and closing
ceremonies of the Commonwealth Games India, 2010 on a turnkey basis.

As part of the arrangement, Taxpayer was
also required to undertake installation, maintenance, dismantling and removal
of the lighting equipment. Taxpayer was required to be available on call or in
person to service, rectify or repair any equipment supplied under the agreement.
Additionally, it was also required to undertake all related activities, such as
obtaining authorizations, permits and
licenses; engaging personnel with the requisite skills, ensuring their
availability; procure and/ or supply all necessary equipment; subcontracting;
and shipping and loading, insurance etc.

For carrying on the above activities,
Taxpayer was provided with an office space by OCCG. Taxpayer was also provided
an on-site space for storing its tools and equipment inside the Stadium where
the Games were held, under a lock. While
the agreement was entered into for a period of around 114 days, Taxpayer’s
employees and equipment are present in India only for a period of 66 days for
preparatory activities such as installation and dismantling of equipment.

Taxpayer sought an advance ruling on issue
of taxability of its income from OCCG under the DTAA.

Held

On the issue of Fixed place PE:

It was held that Taxpayer had a fixed PE in
India for the following reasons:

– The provision of lockable space for storing
the tools and equipment inside the Stadium implies that Taxpayer had access to
and control over such space to the exclusion of other service providers engaged
by OCCG including OCCG itself.

– Provision of empty workspace to the taxpayer
implies that such workspace is placed at the disposal and under access, control
of Taxpayer. Also, in the facts, the business had to be carried out on site.
For evaluating fixed place PE, it is immaterial if the place of business is
located in the business facilities of another enterprise.

– Given the expensive equipment, time lines,
precision and the highly technical nature of the work involved, it is
inconceivable that the space provided to taxpayer along with the required
security would not be at taxpayer’s disposal, with exclusive right to access
and control. Thus, the space is used not merely for storage alone, but having
regard to the nature of business of the Taxpayer, the usage is for carrying out the business itself.

– For a fixed PE to emerge, the fixed place
need not be enduring or permanent in the sense that it should be in its control
forever. The context in which a business is undertaken, is relevant. In the
present case, the duration for which the fixed place was at disposal of
Taxpayer was sufficient for the Taxpayer to carry on its business. Further,
there was a continuous effort by the taxpayer till the games were over. Hence,
permanence test was also satisfied. Reliance, in this regard, was placed on the
SC decision in the case of Formula One World Championship Ltd.
(TS-161-SC-2017).

– Additional factors of arrangement which
support that disposal test is satisfied are:

• Subcontracting of some
activities by the Taxpayer was indicative of the fact that the Taxpayer had an
address, an office, from which it could call for and award subcontracts.

• Without any premises under
its control, hiring and housing key technical and other personnel, who would
need regular and ongoing instructions during the entire period would be
difficult.

• Taxpayer entered into
various contracts for the purpose of its business in a contracting state, and
employed technical and other manpower for use at its site. The site was thus,
an extension of the foreign entity on Indian soil. Reference in this regard was
place on decision in the case of Vishakhapatnam Port Trust (1983) 144 ITR 146.

• Taxpayer Undertook
comprehensive insurance of its equipment. No insurance company would insure any
equipment, structures etc. against any risk of fire, damage or theft,
unless the place where the equipments are stored was safe, in exclusive custody
and at the disposal of the person who applies for the insurance. Goods are not
ordinarily insured when lying at a third person’s premises. This also suggests
that the place where the tools and equipment were stored was at the disposal of
the Taxpayer.

• It was mandatory for the
Taxpayer to acquire all authorisations, permits and licenses. This indicates
that Taxpayer had a definite place at its disposal, as it could otherwise not
be made liable for any default in the absence of the same.

• The act of carrying out
fabrication, maintenance and repair of equipments, and operating the same at
the opening and closing ceremonies would not have been possible if the premises
were not under Taxpayer’s control.

On the issue of Royalty

– There is a vital distinction between a
consideration received for assigning the rights for the use of the final
product on the one hand (i.e. equipment in this case) and the consideration for
assigning rights to use the IP i.e. the knowhow, technical experience, skill,
processes and methodology etc.

– It is usual for parties to assign exclusive
rights to the client to use the equipment, but to keep intact the element of
uniqueness and novelty in experiencing the lighting display. But how this
experience was created remains a trade secret with the creator of the same.

– In the present case, Taxpayer had merely
granted a right to use the equipment and not the right to use any IP in the
equipment, hence payment made by OCCG to the Taxpayer does not amount to
Royalty.

On the issue of FTS

– Services rendered by taxpayer were not
standard in nature since they were one of a kind and were customised for use by
a particular customer. Provision of services of lighting, search lights, LED
technology along with technical personnel to operate the same did not involve
mere pressing of a button and receiving the service but were complex activities
and could not be availed without the assistance of highly trained technical
personnel.

– Having regard to the MFN clause, the make
available condition in the FIS article of India Portugal DTAA will need to be
read into India-Belgium DTAA.

– Since the services rendered by the Taxpayer
to OCCG does not make available
technical knowledge or skill, payment for such services does not qualify as FTS
under the India-Belgium DTAA.

shailesh.kwebmaker

Transfer Pricing – Secondary Adjustments Under Section 92CE

1.0 Introduction

As the name suggests,
a Secondary Adjustment [SA] follows and is directly consequent upon a primary
transfer pricing adjustment to the taxpayer’s income. The purpose of a SA, as
articulated in the OECD Guidelines is “to make the actual allocation of
profits consistent with the primary transfer pricing adjustment.” SAs are imposed
by the same country imposing the primary adjustment and are based upon the
domestic tax law provisions of that country. Most often, a SA is expressed as a
constructive or deemed transaction (dividend, equity contribution or loan) and
is premised on the view that not only an underpayment or overpayment which must
be corrected and adjusted (primary adjustment), but also the benefit or use of
those funds must be recognized for tax purposes (the SA).

OECD’s Transfer
Pricing Guidelines for Multinational Enterprises and Tax Administrations (‘OECD
TP Guidelines’) defines the term ‘Secondary Adjustment’ as “a constructive
transaction that some countries will assert under their domestic legislation
after having proposed a primary adjustment in order to make the actual
allocation of profits consistent with the primary adjustment.” SA legislation
is already prevalent in many tax jurisdictions like Canada, United States,
South Africa, Korea, France etc. Whilst the approaches to SAs by
individual countries vary, they represent an internationally recognised method
to realign the economic benefit of the transaction with the arm’s length
position. It restores the financial situation of the relevant related parties
to that which would have existed, if the transactions had been conducted on an
arm’s length basis.

The underlying
economic premise for the SA is perhaps best expressed in the OECD TP
Guidelines, which state: “… secondary adjustments attempt to account for
the difference between the re-determined taxable profits and the originally
booked profits.”

OCED Model Convention
only deals with corresponding adjustment. It neither forbids nor requires tax
administrator to make SA. Relevant extract of commentary in OCED model
convention provides that “…nothing in paragraph 9(2) prevents such secondary
adjustments from being made where they are permitted under domestic law of the
contacting state.”

1.1 International
Approaches to SAs

Globally, the OECD
prescribes SA to take any form including constructive equity contribution, loan
or dividend.

A. Deemed Capital
Contribution Approach

B. Deemed Dividend Approach

C. Deemed Loan Approach.

1.2 Secondary Adjustment
– Global Scenario

Jurisdiction	Approach adopted for SA
Member State of European Union:
France, Austria, Bulgaria, Denmark, Germany, Luxembourg, Netherlands, Slovenia, Spain	Deemed profit distribution /Constructive dividend
USA	Deemed distributed income /Deemed capital contribution, as the case may be.
South Africa	Deemed dividend approach for Companies; Deemed donation approach for persons other than Companies.
UK	Deemed loan (Proposed)
Canada	Deemed dividend
South Korea	Deemed dividend / Deemed capital contribution, as the case may be.

Jurisdiction

Approach
adopted for SA

Member State of European Union:

France, Austria, Bulgaria, Denmark, Germany, Luxembourg,
Netherlands, Slovenia, Spain

Deemed profit distribution /Constructive dividend

USA

Deemed distributed income /Deemed capital contribution, as
the case may be.

South Africa

Deemed dividend approach for Companies; Deemed donation
approach for persons other than Companies.

Deemed loan (Proposed)

Canada

Deemed
dividend

South Korea

Deemed dividend / Deemed capital contribution, as the case
may be.

1.3 Secondary Adjustment
under the income-tax Act [the Act] – Section 92CE

India is considered as
one of the most aggressive Transfer Pricing (TP) jurisdictions in the world.
The scope of TP provisions in India is very wide compared to many countries and
the provisions are vigorously implemented resulting in huge adjustments,
demands and lot of litigations. A new provision called “Secondary Adjustment”
is introduced in the Indian TP regulations with insertion of section 92CE by
the Finance Act, 2017.

1.4 Meaning of the term
“Secondary Adjustment”

Secondary adjustment,
as defined u/s. 92CE(3)(v), means “an adjustment in the books of accounts of
the assessee and its associated enterprise to reflect that the actual
allocation of profits between the assessee and its associated enterprise are
consistent with the transfer price determined as a result of primary
adjustment, thereby removing the imbalance between cash account and actual
profit of the assessee.”

SA has been recognised
by the OECD and many other jurisdictions. As explained above, normally it may
take the form of characterisation of the excess money as constructive
dividends, constructive equity contributions or constructive loans. However,
section 92CE(2) considers such an adjustment as “deemed advance”.

1.5 Applicability of the
Provisions

Section 92CE (1)
provides that in the following cases, the tax payer shall make a SA:

where a primary
adjustment to transfer price (i) has been made suo motu by the assessee
in his return of income; (ii) made by the Assessing Officer has been accepted
by the assessee; (iii) is determined by an advance pricing agreement entered
into by the assessee u/s. 92CC; (iv) is made as per the safe harbour rules
framed u/s. 92CB; or (v) is arising as a result of resolution of an assessment
by way of the mutual agreement procedure under an agreement entered into u/s.
90 or section 90A for avoidance of double taxation.

It is provided that
the SA provisions will take effect from 1^stApril, 2018 and will,
accordingly, apply in relation to the assessment year 2018-19 and subsequent
years.

Proviso to section
92CE(1) further provides that provisions of SA would not apply in following
situations:

If, the amount of
primary adjustment made in the case of an assessee in any previous year does
not exceed one crore rupees and the
primary adjustment is made in respect of an assessment year commencing on or
before 1^st April, 2016 i.e. up to AY 2016-17.

1.6 Impact of the
Secondary Adjustment

Section 92CE(2)
provides that “Where, as a result of primary adjustment to the transfer
price, there is an increase in the total income or reduction in the loss, as
the case may be, of the assessee, the excess money which is available
with its associated enterprise, if not repatriated to India within the time as
may be prescribed, shall be deemed to be an advance made by the assessee
to such associated enterprise and the interest on such advance, shall be
computed in such manner as may be prescribed.” (Emphasis supplied)

Primary adjustment to
a transfer price has been defined u/s. 92CE(3)(iv) to mean the determination of
transfer price in accordance with the arm’s length principle resulting
in an increase in the total income or reduction in the loss, as the case may
be, of the assessee; (Emphasis supplied)

“Excess Money” has
been defined u/s. 92CE(3)(iii) to mean the difference between the arm’s length
price determined in primary adjustment and the price at which the international
transaction has actually been undertaken.

1.7 Example

(i) An Indian company “A” has
sold goods worth Rs. 10 crore to its overseas subsidiary “B”. The arm’s length
price is say Rs.15 crore.

(ii) The primary adjustment is
made by the AO by applying arm’s length principle amounting to Rs. 5 crore
(15-10).

(iii) Excess Money Rs. 5 crore.

(iv) “A” will have to debit the
account of “B” by Rs. 5 crore in its books of accounts.

(v) “A” will have to receive
Rs. 5 crore from “B” within the prescribed time provided in Rule 10CB(1).

(vi) If “A” fails to receive
the sum, then Rs. 5 crore will be deemed advance from “A” to “B” and the
interest on such advance shall be computed in the manner to be prescribed in
Rule 10CB(2).

1.8 Time Limit for
repatriation of excess money [Rule 10CB(1)]

CBDT vide Notification No. 52 /2017 dated 15
June 2017 inserted Rule 10CB providing for Computation of interest income
pursuant to secondary adjustments.

Transfer pricing Adjustments-Situations

Time Limit of 90 days for repatriation of excess money

If assessee makes suo moto primary adjustment in ROI.

From the due date of filing ROI u/s. 139(1) of the Act i.e.
30^th November.

If assessee enters in to an APA u/s. 92CD of the Act.

If assessee exercises option as Safe Harbour rules u/s 92CB
of the Act.

If agreement is made under MAP under DTAA u/s. 90 or 90A of
the Act.

If assessee accepts the primary adjustment made as per the
order of Assessing Officer (AO) / Appellate Authority.

From the date of order of AO/ Appellate Authority.

1.9 Rate of Interest for
computation of interest on excess money not repatriated within time limit [Rule
10CB(2)]

Denomination of International Transaction	Rate of Interest
INR	1 year Marginal Cost of Fund Lending Rate (MCLR) of SBI as on 1^st April of relevant previous year + 325 basis point
Foreign currency	6-month London Inter-Bank Offered Rate (LIBOR) as on 30th September of relevant previous year + 300 basis point

Denomination of International Transaction

Rate of Interest

INR

1 year Marginal Cost of Fund Lending Rate (MCLR) of SBI as on
1^st April of relevant previous year + 325 basis point

Foreign currency

6-month London Inter-Bank Offered Rate (LIBOR) as on 30th
September of relevant previous year + 300 basis point

The rate of interest is applicable on annual basis.

1.10 Analysis of section
92CE and Rule 10CB

a) Extra territorial
application – The foreign AE cannot be compelled to accept SA. Even if they pay
up interest, the home jurisdiction may not allow deduction of such interest.
The taxpayer in India will pay tax on such interest but corresponding deduction
may not be available to AE in its home jurisdiction. To that extent there could
be economic double taxation.

b) Taxpayer would be in a
precarious position if repatriation is not possible due to exchange control
regulation or some other difficulties in AE’s country.

c) It appears that there may
not be any additional tax consequences in case interest on deemed advance is
not repatriated to India.

1.11 Non-Discrimination –
Domestic Law and Tax Treaty

Whether the SA in
India may be challenged citing non-discrimination article in DTAA?

Article 24(5) of UN
Model:

“5. Enterprises of
a Contracting State, the capital of which is wholly or partly owned or
controlled, directly or indirectly, by one or more residents of the other
Contracting State, shall not be subjected in the first-mentioned State to any
taxation or any requirement connected therewith which is other or more
burdensome than the taxation and connected requirements to which other similar
enterprises of the first-mentioned State are or may be subjected.”

In the light of
Article 24(5), it may be observed that this paragraph forbids a Contracting
State to give less favorable treatment in terms of taxation or any requirement
connected therewith to an enterprise owned or controlled by residents of the
other Contracting State.

In India, there is no
provision for SA if an Indian company transacts with another Indian AE whereas
SA rule is applicable when an Indian company transacts with non-resident AE.

This may tantamount to
discrimination as per non-discrimination provisions in DTAA.

In this regard useful
reference could be made of the decision in case of Daimler Chrysler India
(P.) Ltd. vs. DCIT [2009] 29 SOT 202 (Pune).

1.12 Probable Issues

Several issues could
arise from the enactment of the above provisions. Some of them could be as
follows:

(i) SA in respect of
Transfer Price determined under a Mutual Agreement Procedure (MAP)

Combined reading of the
section 92CE(1) and the definition of the “primary adjustment” suggest that SA
can be made only when the primary adjustment has been made in accordance
with the arm’s length principle. However, in case of a MAP the price may
not be strictly determined based on arm’s length principles and may be a result
of negotiated price. In such a case, whether SA would sustain?

(ii) Adjustment by AO

Section 92CE(1)(ii)
provides for the SA where the assessee has accepted the primary adjustment made
by the AO. Thus, from the plain reading of the provision, it appears that if
the said adjustment is made by CIT(A), then provisions of SA may not be
applicable even if the assessee accepts the same. However, Rule 10CB(1)(ii)
provides that for the purposes of section 92CE(2), the time limit for
repatriation of excess money shall be on or before 90 days from the date of the
order of the AO or the appellate authority, as the case may be, if the primary
adjustments to the transfer price as determined in the aforesaid order has been
accepted by the assessee.

Further, if the order is
passed by the Dispute Resolution Panel (DRP) and accepted by the assessee, then
the SA would be applicable as in case of reference to DRP u/s. 144C, the
assessment is ultimately made by the AO only.

(iii) Increased Litigation

Section 92CE(1) lists
situations wherein the primary adjustment is accepted by the assessee. Thus,
acceptance of primary adjustment is a precondition for invoking provisions of
SA. Accordingly, till the time assessee has not exhausted his appellate
options, he cannot be compelled to accept primary adjustment and consequently
SA cannot be made.

Another related issue
will be whether SA would apply with prospective effect i.e. from the date of
final judicial determination or will it apply with reference to the date of the
original assessment order.

Hitherto, an assessee
could accept the primary adjustment by AO to buy the mental peace and avoid
long drawn litigation, but hence forth he will have to continue his fight to
avoid SA.

(iv) Computation of threshold
of Rs. 1 Crore

Proviso to section
92CE(1) provides that SA would not be applicable if, the amount of primary
adjustment made in the case of an assessee in any previous year does
not exceed one crore rupees.

It is not clear as to whether
this limit would be applicable to the aggregate of adjustments during a
previous year (qua previous year) or qua each transaction or
adjustment. To illustrate, if two adjustments are made each amounting to Rs. 65
lakh, then whether cumulative limit is to be considered or limit on a
standalone basis has to be considered. Also, it is not clear as to where the
primary adjustment in respect of one transaction is exceeding Rs. 1 crore and
the other is only for Rs. 10 lakh, whether the SA would be required for both
the transactions.

(v) Exceptions to the SA

Proviso to section 92CE
(1) reads as follows:

“ Provided that nothing
contained in this section shall apply, if,– (i) the amount of primary
adjustment made in any previous year does not exceed one crore rupees; and
(ii) the primary adjustment is made in respect of an assessment year commencing
on or before the 1st day of April, 2016.”

Use of the conjunction
“and” results in lot of confusion. The literal interpretation of the above
provision suggests that both the conditions need to be fulfilled to claim
exemption from SA. If that interpretation is adopted, then it would lead to
absurd results, such as SA would be required for each and every transaction
from AY 2016-17 (even for Re. 1 of the primary adjustment) and if the amount of
adjustment exceeds Rs. 1 crore then the SA would be required in respect of all
past transactions, may be from the start of the TP regulations.

The logical
interpretation should be to read both the conditions/situations separately. One
should read “or” as a conjunction in place of “and”. This interpretation draws
strength from the Notes on Clauses to the Finance Bill, 2017 where both the
conditions are mentioned separately.

(vi) Adjustment in the Books
of Accounts

The definition of the SA
provides for an adjustment in the books of the assessee and it’s AE.

The above provision
raises several issues:

How can an Indian TP
regulation provide for adjustments in the books of an AE which is situated in
some other sovereign jurisdiction? Any such adjustment would render the books
and audit procedure of the AE questionable.

It is also not provided
in which year’s books of accounts of the assessee such adjustments are to be
made, as by the time TP assessment is made the relevant year’s books must be
closed, audited and finalised. Thus, logically the adjustment has to be made in
the year of finalisation (acceptance) of the primary adjustment. Once assessee
makes SA, it may go against him as it will prove that the accounts of the year
in which the original transaction was effected was not recorded correctly and
therefore true and fair view of the accounts was impacted, (assuming the impact
of primary adjustment and SA are material). Transfer pricing is an art and not
an exact science and therefore to avoid such a situation it must be provided
that any such adjustment shall not affect the true and fair view of audited
accounts.

(vii) Transfer Pricing
Regulations in respect of SA

A question may arise as
to whether the SA could be regarded as a fresh “international transaction” as
it would be deemed to be an advance. However, it would be too farfetched; the
SA is result of international transaction and cannot be cause in itself. If we
interpret it otherwise, then we go into a loop. Accordingly, other requirements
pertaining to reporting, documentation etc. should not apply. However, a
clarification to this effect is highly desirable.

(viii) Computation of
Interest

It is provided that the
excess money would be regarded as deemed advance and interest on such advance
shall be computed in the manner prescribed in Rule 10CB(2). However, from the
computation mechanism provided in Rule 10CB(2), it is not clear as to from
which date one needs to compute the interest. Ideally, it should not be from
the date of individual transaction, to avoid complexity in case of multiple
transactions. Logically, it should be from the expiry of the time limit within
which the excess money is required to be repatriated to India.

(ix) Secondary Adjustment –
Double taxation

The provision of SA is a
unilateral one. The other country may or may not agree to it. Even primary
adjustment results in double taxation, the SA would only compound the problem
and put assessee to undue hardships. Whereas each country has a sovereign right
to protect its tax base, bilateral or multilateral treaties could help reduce
the rigours of double taxation.

(x) Repatriation of amount of
SA

Section 92CE(2) provides
that the excess money owing to SA must be repatriated to India within the
prescribed time period provided in Rule 10CB(1). However, where the SA is made
between an Indian PE of a foreign company and its subsidiary in India, then the
conditions of repatriation would be difficult to comply, unless the Head Office
of the PE remits the amount of SA on behalf of its Indian PE.

(xi) Implications of SA under
FEMA

Section 92CE(2) provides
that the excess money to be considered as deemed advance by an Indian
entity/company to its foreign AE. As per FEMA, an Indian entity can lend money
to its foreign AE only upon fulfilling certain conditions and subject to limits
and compliance procedure. Passing an entry in the books of account without
proper compliances could result in FEMA violations.

(xii) Deemed dividends u/s
2(22)(e) of the Act

Section 2(22)(e) of the
Act provides that payment by way of loan or advance by a company to a specified
shareholder (where the company is holding more than 10% of the voting power) or
to any concern in which he has a substantial interest shall be regarded as
deemed dividend.

A question arises as to
whether deemed advance due to SAs u/s. 92CE would be regarded as deemed
dividend u/s. 2(22)(e) in the event AE satisfies the conditions of requisite
shareholding or is considered as an interested concern?

Two views are possible
in this case:

According to one view,
once a sum is considered as an “advance” all logical consequences under the Act
would follow and accordingly it ought be regarded as advance for the purposes
of section 2(22)(e).

The other and more
plausible view is that section 2(22)(e) should not apply in such a situation
for various reasons. One of the important reason could be that the section
2(22)(e) refers to “any payment by a company….., of any sum… made.. by way of
advance…” and hence the emphasis on actual payment and not
deemed/constructive payment. Since advance arising out of SA are on deemed
basis, such deemed advance cannot be regarded as deemed dividends u/s. 2(22)(e)
of the Act.

(xiii) Other issues

a) Presently, there is no
specific provision to levy any penalty for non-compliances of SA.

b) Multiple transactions with
multiple AEs – How does an Indian entity allocate the amount of overall / lump
sum primary adjustment arising out of various transactions with many AEs in
order to comply the provisions of SA ?

c) Whether revised book
profit as a result of recording of SA will be subject to MAT, and if so, in
which year?

d) The AE may not be in a
position to repatriate the amount of SA because (a) it is incurring losses; or
(b) the country where it is located prohibits such remittance under its
exchange control regulations; or (c) the AE ceases to be AE before the SA is
made; or (d) the AE is not financially sound to repatriate the excess money.
Thus, if repatriation is not possible due to any of the foregoing reasons, will
the impact of SA be perpetual, is not clear.

e) Whether taxpayer can write
off this advance if it is not recoverable and claim deduction of write off as
there is no express provision to disallow such write off?

f) It is not clear whether taxpayer will be allowed to set off the amount
of deemed advance against the amount of loan to be repaid to its AE.

g) Foreign Tax Credit [FTC]:
Issues regarding FTC may arise as to (a) will FTC be available in India if
foreign withholding tax applies on repatriation of deemed advance to India; (b)
If yes, at what rate will such FTC be given; or (c) What would be the nature of
such receipts i.e. if the jurisdiction of the foreign AE treats the payment as
a dividend and accordingly applies withholding tax and will India still grant
FTC, in such cases?

h) Whether interest on deemed
advance chargeable to tax even if AE declines to accept this as its liability?

i) Whether SA needs to be
made in relation to deemed international transaction u/s. 92B(2)?

j) A further question may
arise as to whether SA of interest as recorded in the books of taxpayer will be
considered for the purpose of disallowance u/s. 94B.

For a satisfactory
resolution of the above issues, one hopes that the CBDT would issue the
necessary clarifications at the earliest to avoid cumbersome/repetitive / time
consuming and costly litigation which is already clogging the overburdened
judiciary.

1.13 Conclusion

It is true that the
concept of SA is prevalent in many developed jurisdictions. In that sense,
introduction of SAs rules in Indian transfer pricing regime is in conformity
with international practice. However, considering the level of maturity of
transfer pricing regime in India, it is debatable whether this is right time to
introduce SA rules in India. Indian revenue authorities are still striving to
cope up with many contentious issues arising out of transfer pricing disputes.
In the midst of such melee, introducing another dimension of transfer pricing
appears to be a pre-mature act. Debate may arise over whether SAs are
appropriate in the current global arena, where they are not consistently
applied and where various countries take different views on corresponding or
correlative relief. Provisions of SA are complex in nature and would result in
lot of hardships and increased litigation.

Further, in view of
various issues and complications, as discussed above, we wonder whether it
would not have been better if India also had adopted the deemed dividend
approach as adopted by many advanced tax jurisdictions rather than the deemed
loan approach, to obviate most of the probable issues arising due to the deemed
‘advance’ approach. _

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Action 13 – The Game Changer In Transfer Pricing Documentation

Backdrop – What is BEPS?
Base erosion and profit shifting (BEPS) refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. Under the inclusive framework, over 100 countries and jurisdictions are collaborating to implement the BEPS measures and tackle BEPS.

The OECD/G20 BEPS Project, set out 15 Action Plans along three key pillars: introducing coherence in the domestic rules that affect cross-border activities, reinforcing substance requirements in the existing international standards, and improving transparency as well as certainty.

These action plans will equip governments with domestic and international instruments to address tax avoidance, reduce double taxation and ensure that profits are taxed where economic activities generating the profits are performed and where value is created.

Action plan 13 – Transfer Pricing documentation and Country by Country Reporting

With the advent of globalisation, the integration of national economies and markets has increased substantially in recent years, putting a strain on the international tax rules which were designed more than a century ago. In this world of globalisation, companies can do significant tax planning through transfer pricing which may create opportunities for base erosion and profit shifting (BEPS).

The OECD introduced Action Plan 13 to enhance transparency for tax administration among various countries. These rules will provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid among countries according to a common template and ensure that profits are taxed where economic activities take place and value is created.
The Action Plan 13 has laid down a three-tiered standardised approach to transfer pricing documentation.

I.Country-by-Country Report (CbC)1

Large Multinational enterprises (MNEs) are required to file a Country-by-Country Report that will provide annually and for each tax jurisdiction in which they do business the amount of revenue, profit before income tax and income tax paid and accrued. It also requires MNEs to report their number of employees, stated capital, retained earnings and tangible assets in each tax jurisdiction. Finally, it requires MNEs to identify each entity within the group doing business in a particular tax jurisdiction and to provide an indication of the business activities each entity engages in.

II.Master File (MF)

The guidance on transfer pricing documentation requires multinational enterprises (MNEs) to provide tax administrations with high-level information regarding their global business operations and transfer pricing policies in a “master file” that is to be available to all relevant tax administrations.

III. Local File (LF)

A detailed transactional transfer pricing documentation has to be provided in a “local file” specific to each country, identifying material related party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations they have made with regard to those transactions.
______________________________________________________________________
1 Refer section 286 of Indian Income tax Act, 1961 read with Rule 10DB

Country-by-Country Reports are to be filed in the jurisdiction of tax residence of the ultimate parent entity. These reports can be shared between jurisdictions through automatic exchange of information, pursuant to government-to-government mechanisms such as the multilateral Convention on Mutual Administrative Assistance in Tax Matters, bilateral tax treaties or tax information exchange agreements (TIEAs). The Master file and the Local file have to be filed by MNEs directly to local tax administrations and should be compliant with local MF and LF regulations.

Taken together, these three documents will require taxpayers to articulate consistent transfer pricing positions and will provide tax administrations with useful information. This information will enable the tax authorities to gauge whether companies have used transfer pricing as means for profit shifting into low tax jurisdictions.

Action Plan 13 – India Perspective

On May 5, 2016, India introduced the concepts of Country-by-Country (“CbC”) reporting requirement and the concept of Master File in the Indian Income Tax Act, 1961 (“the Act”) through Finance Act 2016, effective from 1st April 2016. The Central Board of Direct Taxes (“CBDT”) on 31st October 2017 released the final rules on CbC reporting and Master File requirements in India (vide notification no. 92/2017).

I.Country-by-Country Report (CbC)

The Country-by-Country Report requires aggregate tax jurisdiction-wide information relating to the global allocation of the income, the taxes paid, and certain indicators of the location of economic activity among tax jurisdictions in which the MNE group operates. The report also requires a listing of all the Constituent Entities for which financial information is reported, including the tax jurisdiction of incorporation, where different from the tax jurisdiction of residence, as well as the nature of the main business activities carried out by that Constituent Entity. The format of the CbC report (Form No. 3CEAD available on department’s website) is aligned with the BEPS.

MNEs with annual consolidated group revenue equal to or exceeding INR 55,000 million (threshold of EUR 750 million as per OECD) are required to file the CbC. The due date for filing the CbC report in India continues to be the due date for filing the income-tax return i.e. 30 November following the financial year. However, for FY 2016-17, the due date is extended to 31st March 2018 (as per the CBDT Circular 26/2017 released on 25th October 2017).

The Country-by-Country Report will be helpful for high-level transfer pricing risk assessment purposes. It may also be used by tax administrations in evaluating other BEPS related risks and where appropriate for economic and statistical analysis.

CbC Notification – Further, every Indian constituent entity of an MNE headquartered outside India is required to file the CbC report notification in the prescribed format i.e. Form No. 3CEAC (available on department’s website). The CbC report notification is required to be filed atleast two months prior to the due date for filing the CbC report, that is aligned to the due date for filing the income-tax return of the Indian constituent entity. As mentioned above, the due date for filing the CbC report for FY 2016-17 has been extended to 31st March 2018 and accordingly, the due date for the first CbC report notification for FY 2016-17 has also been extended to 31st January 2018. However for subsequent years, the due date of filing the notification will be 30th September.

II.Master file

The Master file is a document which provides an overview of the MNE group business, including the nature of its global business operations, its overall transfer pricing policies, and its global allocation of income and economic activity in order to assist tax administrations in evaluating the presence of significant transfer pricing risk. In general, the master file is intended to provide a high-level overview in order to place the MNE group’s transferpricing practices in their global economic, legal, financial and tax context. The information in the master file provides a “blueprint” of the MNE groupand contains relevant information that can be grouped in five categories:

1.the group’s organisational structure;
2.a description of the group’s business;
3.the group’s intangibles;
4.the intercompany financial activities of the group; and
5.the financial and tax positions of the group.

The CBDT has prescribed that Master File has to be prepared as per the format given in Form 3CEAA (available on department’s website). The form comprises of two Parts i.e. Part A and Part B.

Part A of Master File – Part A comprises of basic information relating to the MNE and the constituent entities of the MNE operating in India (such as name, permanent account number and address). Part A of the Master File will be required to be filed by every constituent entity of an MNE, without applicability of any threshold;

Part B of Master File – Part B comprises of the main Master File information that provides a high level overview of the MNE’s global business operations and transfer pricing policies. Every constituent entity of an MNE that meets the following threshold will be required to file Part B of Master File:

-the consolidated group revenue for the accounting year exceeds INR 5,000 million; and
-for the accounting year, the aggregate value of international transactions exceeds INR 500 million, or aggregate value of intangible property related international transactions exceeds INR 100 million..

The Master File information required to be submitted as per Rule 10 DA of the Income tax Rules, 1962, is largely consistent with BEPS Action 13 requirements. However, few additional data requirements have been incorporated under Rule 10DA of the Income Tax Rules, 1962, requiring MNE to customise their Master File for India. The below table summarises the requirement as per OECD and Indian rules:
The Master File has to be furnished by the due date of filing the income-tax return i.e. 30th November following the financial year. However, for financial year 2016-17 (“FY 2016-17”), the due date is extended to 31st March 2018. MNEs with multiple constituent entities in India can designate one Indian constituent entity to file the Master File in India, provided an intimation to this effect is made in Form No. 3CEAB (available on department’s website), 30 days prior to the due date for filing the Master File in India i.e. March 1, 2018.

III.Local file

In contrast to the master file, which provides a high-level overview of the MNE group, the local file provides detailed pertaining to the intercompany transactions of the local entity. The local file supplements the master file and helps to meet the objective of assuring that the taxpayer has complied with the arm’s length principle in its material transfer pricing positions.

In India, the local file has to be maintained as prescribed under section 92D read with Rule 10 D of the Income Tax Act, 1961. No other specific requirements are prescribed for local file.

Practical Considerations

The CBDT has prescribed detailed rules on CbC reporting and Master File requirements in India however there are various aspects of the rules which will have practical considerations while implementing these rules. The ensuing paragraphs deal with some considerations that may come up while implementing the said rules.

Master file requirement	Summary of OECD BEPS Requirement	Additional requirements as per Indian final rules
IG’s intangible property	– IG’s strategy for ownership, development and exploitation of intangibles – List of important intangibles with ownership – Important agreements and corresponding transfer pricing policies in relation to R&D and intangibles	– Names and addresses of all entities of the IG engaged in development and management of intangible property – Addresses of entities legally owning important intangible property and entities involved in important transfers of interest in intangible property
IG’s intercompany financial activities	– Description of how the IG is financed, induding identification of important financing arrangements with unrelated lenders – Identification of entities performing central financing function including their place of operation and effective management	– Names and addresses of top ten unrelated lenders – Names and addresses of entities providing central financing functions including their place of operation and effective management

Master
file
requirement

Summary
of OECD BEPS Requirement

Additional
requirements as per Indian final rules

Organization
structure

– Chart illustrating
IG’s legal and ownership structure and
geographical location of operating
entities

Address
of all entities of the IG (draft rules had earlier only prescribed details
of all operating entities)

Description
of IG’s business

– Description of important drivers of
business profit

– Description of supply chain for the
specified category of products

– Functional analysis of the principal
contributors to value creation

– Description of important business
restructuring transactions,

acquisitions and divestments during the
reporting year

Functions,
assets and risk analysis of entities contributing at least 10% of the IG’s
revenue OR assets OR profits

IG’s
intangible property

– IG’s strategy for ownership, development
and exploitation of intangibles

– List of important intangibles with
ownership

– Important agreements and corresponding
transfer pricing policies in relation to R&D and intangibles

– Names and addresses of all entities of the
IG engaged in development and management of intangible property

– Addresses of entities legally owning
important intangible property and entities involved in important transfers of interest in intangible property

IG’s

intercompany

financial
activities

– Description of how the IG is financed,
induding identification of important financing arrangements with unrelated
lenders

– Identification of entities performing
central financing

function including their place of
operation and effective
management

– Names and addresses of top ten unrelated
lenders

– Names and addresses of entities providing
central financing functions including their place of operation and effective management

–Reporting year for CbC report: The requirement to file the CbC report is applicable to an MNE having consolidated group revenue exceeding the prescribed threshold in the immediately preceding financial year. Which means for Indian constituent entities of a foreign MNE where the ultimate parent entity has calendar year end i.e. 31st December, the CbC report is applicable for FY 2016-17 only if the prescribed consolidated group revenue threshold is exceeded for year ended 31st December 2016. In case of Indian constituent entities of an MNE headquartered in India where the ultimate parent entity has financial year end i.e. 31st March, the CbC report is applicable for FY 2016-17 only if the prescribed consolidated group revenue threshold is exceeded for year ended 31st March 2017.

–Accounting year that should be considered in case of CbC and Master File:The accounting year for CbC would be an annual accounting period, with respect to which the parent entity of the international group prepares its financial statements. However where a foreign MNE appoints an alternate reporting entity resident in India the CbC report would be required to be prepared and filed in India for the accounting year followed by the alternate reporting entity resident in India i.e. the previous year (April to March).

–Permanent establishment (PE): It is important to note that an Indian permanent establishment (PE) of a foreign MNEwill be said to be a “constituent entity resident in Indiafor the purpose of section 286 and Rule 10DB. Therefore, an Indian PE of a foreign entity should be treated as a constituent entity resident in India.
-Filing of CbC notification on behalf of other Indian Constituent entity: Where an MNE has more than one constituent entity in India, the rules currently do not prescribe to designate one constituent entity to file the CbC notification on behalf of other Indian Constituent entity. Therefore every constituent entity will have to file the CbC notification separately in Form 3CEAC.

–Filing of Part A of the Master File: Where there are more than one constituent entity in India, the designated entity can file the Part A of the Master File on behalf of its constituent entities.

–Threshold for filing the Part B of Master File:The Master file will be prepared for the group for the accounting year followed by the parent entity and therefore, the prescribed threshold for applicability of Part B of Master file should be determined based on the accounting year followed by the parent entity of the group. Accordingly, the threshold for determination of the consolidated group revenue and the aggregate value of international transactions ought to be considered using the period followed by the foreign parent as the Master File is being prepared for that period.

Penalties

The below table details the penalties in case of Non Compliance with the CbC and Master File requirements:

Sr. No	Particulars	Default	Penalty
CbC report	INR	Euro
1.	Non-furnishing of CbC report by Indian parent or the alternate reporting entity resident in India	Each day upto a month from due date	5,000 per day	65 per day
Beyond a month from due date	15,000 per day	200 per day
Continuing default beyond service of penalty order	50,000 per day	665 per day
2. 3.	Non-submission of information Provision of inaccurate information in CbC report	Beyond expiry of the period for furnishing information	5,000 per day	65 per day
Continuing default beyond service of penalty order	50,000 per day from date of service of penalty order	665 per day from date of service of penalty order
Knowledge of inaccuracy at time of furnishing the report but fails to inform the prescribed authority	500,000	6650
Inaccuracy discovered after filing and fails to inform and furnish correct report within fifteen days of such discovery
Furnishing of inaccurate information or document in response to notice issued
Master File
1.	Non-furnishing of information and documentation	Failure to furnish the information and document to the prescribed authority	500,000	6650

Sr. No

Particulars

Default

Penalty

CbC report

INR

Euro

Non-furnishing of CbC report by Indian parent or the alternate
reporting entity resident in India

Each day upto a month from due date

5,000 per day

65 per day

Beyond a month from due date

15,000 per day

200 per day

Continuing default beyond service of penalty order

50,000 per day

665 per day

Non-submission of information

Provision of inaccurate information in CbC report

Beyond expiry of the period for furnishing information

5,000 per day

65 per day

Continuing default beyond service of penalty order

50,000 per day from date of service of penalty order

665 per day from date of service of penalty order

Knowledge of inaccuracy at time of furnishing the report but
fails to inform the prescribed authority

500,000

6650

Inaccuracy discovered after filing and fails to inform and
furnish correct report within fifteen days of such discovery

Furnishing of inaccurate information or document in response to
notice issued

Master File

Non-furnishing of information and documentation

Failure to furnish the information and document to the
prescribed authority

500,000

6650

Conclusion

The below table summarises the various forms and deadlines for CbC and Master File Compliance

Particulars

Form No

Applicability as per Rules

Indian Timelines for
Compliance

Cbc Report

Form 3CEAD

Consolidated revenue >
INR 55,000 million

First Year – 31 March 2018

Subsequent Year – 30
November

CbC report notification

Form 3CEAC

Indian constituent entities
of MNE Group

First Year – 31 January 2018

Subsequent Year – 30
September

Filing of the Master File

Form 3CEAA

Part A : Every Constituent
Entity of MNE having international / specified domestic transaction

First Year – 31 March 2018

Subsequent Year – 30
November

Part B : Every Constituent
Entity of MNE meeting the prescribed threshold

Intimation of designated Indian
Constituent entity of a IG for filing Master File

Form 3CEAB

Indian Headquartered and
Foreign MNEs required to file Master File and having multiple constituent
entities resident in India

First Year – 1 March 2018

Subsequent Year – 31 October

Local Transfer Pricing Study
Report

As per section 92D read with
Rule 10D

Every Constituent Entity of
IG having international / specified domestic transaction

01-Nov-30

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