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Year: 2019

Section 5 of ITA, 1961 – Income – Accrual of income – Mercantile system of accounting – Bill raised for premature termination of contract and contracting company not accepting bill – Income did not accrue – Another bill of which small part received after four years – Theory of real income – Sum not taxable – Any claim of assessee by way of bad debts was to be adjusted

35.  CIT(IT) vs. Bechtel International Inc.; 414
ITR 558 (Bom.)

Date of order: 4th June,
2019

A.Y.: 2002-03

 

Section 5 of ITA, 1961 – Income –
Accrual of income – Mercantile system of accounting – Bill raised for premature
termination of contract and contracting company not accepting bill – Income did
not accrue – Another bill of which small part received after four years –
Theory of real income – Sum not taxable – Any claim of assessee by way of bad
debts was to be adjusted

 

The assessee was in the
construction business. It did not include in its return two sums of Rs. 26.47
crores and Rs. 59.51 crores, respectively, for which it had raised bills but
had not accounted for in its income. The AO rejected the assessee’s contention
that those amounts had not accrued to it and that even on the basis of the
mercantile system of accounting followed by it, the amounts need not be offered
to tax. But the AO was of the opinion that since the assessee had raised the
bills, whether the payments were made or not was irrelevant since the assessee
followed the mercantile system of accounting.

 

The
Commissioner (Appeals) held that the sum of Rs. 59.51 crores, for which the
assessee had raised the bill after the termination of the contract, could not
have been brought to tax since the bill pertained to the mobilisation and site
operation cost; but in respect of the sum of Rs. 26.47 crores, he did not grant
any relief on the ground that the bill pertained to the construction work that
had already been carried out before the termination of the contract. The
Tribunal found that in respect of the sum of Rs. 59.51 crores, the assessee was
awarded the contract of the project of the parent company of the contracting
company, that the parent company was in severe financial crises, that the
assessee raised the bill after the termination of contract, that the bill was
not even accepted by the contracting company and that the income never accrued
to the assessee. In respect of the amount of Rs. 26.47 crores, the Tribunal
found that due to the financial crises of the parent company of the contracting
company, the assessee could not receive any payment for a long time and could
recover only 8.58% of the total claim and, inter alia applying the
theory of real income, deleted the addition. The assessee had also in a later
year claimed the same amount by way of bad debts. The Tribunal while giving
relief to the assessee ensured that any such amount claimed by way of bad debts
was to be adjusted.

 

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

 

“(i)   The Tribunal did not err in holding that no real income accrued to
the assessee as only 8.58% of the total claim was received, applying the real
income theory, bill amount of Rs. 26.47 crores due to the financial crises of
the parent company of the contracting company, and in respect of the sum of Rs.
59.51 crores on the ground that the bill was raised after the termination of
the contract and the bill was not even accepted by the contracting party.

 

(ii)         The claim of Rs. 59.51 crores was for
damages for the premature termination of the contract. Any further examination
of the issue would be wholly academic since the assessee could have claimed the
amount by way of bad debts. In fact, such claim was allowed, but in view of the
further development, pursuant to the decision taken by the Tribunal, such claim
was ordered to be adjusted.”

Sections 2(24) and 4 of ITA, 1961 – Income – Meaning of – Assessee collecting value-added tax on behalf of State Government – Excess over expenditure deposited in State Government Treasury – No income accrued to assessee

34.  Principal CIT vs. H.P. Excise and Taxation
Technical Service Ltd.; 413 ITR 305 (HP)

Date of order: 7th
December, 2018

A.Ys.: 2007-08 to 2011-12 and
2013-14

 

Sections 2(24) and 4 of ITA, 1961 –
Income – Meaning of – Assessee collecting value-added tax on behalf of State
Government – Excess over expenditure deposited in State Government Treasury –
No income accrued to assessee

 

The assessee-society was registered
under the Societies Registration Act, 1860 on 27th August, 2002.
Under the objects of its formation the assessee was entrusted with the
responsibility of collection of value-added tax. The assessee maintained all
the multi-purpose barriers in the State of Himachal Pradesh from where all
goods entered or left the State in terms of section 4 of the Himachal Pradesh
Value-Added Tax Act, 2005. A form was to be issued to the person declaring the
goods at a cost of Rs. 5 per form till the levy was further enhanced to Rs. 10
w.e.f. 18th May, 2009. In terms of the bye-laws, the assessee used
to deposit Re. 1 per declaration  form
with the Government Treasury out of the Rs. 5 received till the year 2009; this
was later enhanced to Rs. 2 after the tax amount was increased from Rs. 5 to Rs
10 per declaration form. The assessee had been showing the surplus of income
over expenditure in its income-expenditure statements. The AO, therefore,
issued notices u/s 148 of the Income-tax Act, 1961 for taxing the excess of
income over expenditure. For the A.Y.s 2007-08 and 2010-11 the assessee
contested the notices stating that all the surplus income was payable to the
State Government and, therefore, it had earned no taxable income. The AO rejected
the assessee’s claim.

 

The Tribunal considered the
memorandum of association of the assessee as well as the details of its
background, functional requirements, operation and model, accounting structure
and ultimate payment to the exchequer of the Government. It also went into the
composition of the governing body, organisational structure, funds and
operation of the accounts of the assessee as enumerated in its bye-laws. It
held that the amount was not assessable in the hands of the assessee.

 

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

“(i)   The assessee neither created any source of income nor generated
any profit or gain out of such source. The assessee merely performed the
statutory functions under the 2005 Act and collected the tax amount for and on
behalf of the State and transferred such collection to the Government Treasury.
Even if the tax collection remained temporarily parked with the assessee for
some time, it could not be treated as ‘income’ generated by the assessee as the
amount did not belong to it.

 

(ii)   The Tribunal had rightly concluded that the surplus of income over
expenditure, as reflected in the entries or the returns filed by the assessee,
also belonged to the State Government and was duly deposited in the Government
Treasury. Hence, it did not partake of the character of ‘profit or gain’ earned
by the assessee.

 

(iii)        The non-registration of the assessee u/s
12AA of the Act was inconsequential.”

Section 14A of ITA, 1961 r.w.r. 8D(2)(iii) of ITR, 1962 – Exempt income – Disallowance of expenditure relating to exempt income – Voluntary disallowance by assessee of expenditure incurred to earn exempt income – AO cannot disallow expenditure far in excess of what has been disallowed by assessee

33.  Principal CIT vs. DSP Adiko Holdings Pvt.
Ltd.; 414 ITR 555 (Bom.)

Date of order: 3rd
June, 2019

A.Y.: 2009-10

 

Section 14A of ITA, 1961 r.w.r.
8D(2)(iii) of ITR, 1962 – Exempt income – Disallowance of expenditure relating
to exempt income – Voluntary disallowance by assessee of expenditure incurred
to earn exempt income – AO cannot disallow expenditure far in excess of what
has been disallowed by assessee

 

The assessee was in investment
business. It earned interest income from investment in mutual funds. It claimed
total expenses of Rs. 24.19 lakhs and voluntarily disallowed an amount of Rs.
7.79 lakhs as expenditure relatable to earning tax-free income u/s 14A of the
Income-tax Act, 1961. The AO rejected such working and applied Rule 8D(2)(iii)
of the Income-tax Rules, 1962 and made a disallowance of Rs. 2.19 crores.

 

The Commissioner (Appeals)
restricted the disallowance to Rs. 24.19 lakhs, the amount which was claimed as
total expenses. The Tribunal reduced it further to the assessee’s original
offer of Rs. 7.79 lakhs.

 

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

 

“(i)   The computation of the AO would lead to disallowance of
expenditure far in excess of what was claimed by the assessee itself. The
assessee’s entire claim of expenditure in relation to its business activity was
Rs. 24.19 lakhs out of which the assessee had voluntarily reduced the sum of
Rs. 7.79 lakhs in relation to income not forming part of the total income u/s
14A which was accepted by the Tribunal.

 

(ii)   Quite apart from the correctness of the approach of the Tribunal,
accepting the stand of the AO would lead to disallowance of expenditure far in
excess of what is claimed by the assessee itself. No question of law arose.”

Sections 37 and 43B(g) of ITA, 1961 – Business expenditure – Deduction only on actual payment – Assessee paying licence fee to Railways for use of land – Railways enhancing licence fee and damages with retrospective effect and disputes arising – Assessee making provision for sum payable to Railways – Nature of fee not within description of ‘duty’, ‘cess’, or ‘fee’ payable under law at relevant time – Sum payable under contract – Deduction allowable

32.  CIT vs. Jagdish Prasad Gupta; 414 ITR 396
(Del.)

Date of order: 25th
March, 2019

A.Y.: 2007-08

 

Sections 37 and 43B(g) of ITA, 1961
– Business expenditure – Deduction only on actual payment – Assessee paying
licence fee to Railways for use of land – Railways enhancing licence fee and
damages with retrospective effect and disputes arising – Assessee making
provision for sum payable to Railways – Nature of fee not within description of
‘duty’, ‘cess’, or ‘fee’ payable under law at relevant time – Sum payable under
contract – Deduction allowable

 

The assessee was allotted lands by
the Railways and the licence fee was collected for the use of the land. The
Railways revised the licence fee periodically and also claimed damages,
unilaterally, on retrospective basis applicable from anterior dates. These led
to disputes. Therefore, the assessee made provision for the amounts which were
deemed payable to the Railways but which were disputed by it and ultimately
became the subject matter of arbitration proceedings. For the A.Y. 2007-08, the
AO disallowed the claim for deduction of the amounts on the ground that it fell
within the purview of section 43B of the Income-tax Act, 1961 and that by
virtue of the conditions laid down in section 43B, especially (a) and (b), the
licence fee payable periodically and the damages as well could not have been
allowed as deduction since they were not paid within that year in accordance
with the provision.

 

The Tribunal allowed the assessee’s
claim.

 

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

 

“(i)   The reference to ‘fee’ in section 43B(a) had to be always read
along with the expression ‘law in force’. According to the documents placed on
record, the transaction between the parties was a commercial one, while the
land was allotted for a licence fee.

 

(ii)   The Notes on Clauses to the Bill which inserted section 43B(g)
stated that the amendment would take effect from 1st April, 2017 and would
accordingly apply only to the A.Y. 2017-18 and subsequent years. Thus, the
notion of clarificatory amendment would not be applicable. The contentions of
the Department with respect to applicability of section 43B were untenable.

 

(iii)        The assessee was entitled to deduction
on the enhanced licence fee in the year in which such enhancement had accrued
even though it was not paid in that year.”

Sections 48, 54F, 19 and 143 of ITA, 1961 – Assessment – Duty of Assessing Officer – It is a sine qua non for the AO to consider claims of deduction / exemption made by the assessee and thereafter to return the said claims if the assessee is not entitled to the same by assigning reasons

31.  Deepak Dhanaraj vs. ITO; [2019] 107
taxmann.com 76 (Karn.)

Date of order: 28th
May, 2019

A.Y.: 2016-17

 

Sections 48, 54F, 19 and 143 of
ITA, 1961 – Assessment – Duty of Assessing Officer – It is a sine qua non
for the AO to consider claims of deduction / exemption made by the assessee and
thereafter to return the said claims if the assessee is not entitled to the
same by assigning reasons

 

For the A.Y. 2016-17 the
petitioner-assessee had filed a return of income on 30th March, 2018
offering to tax the capital gains along with other sources of income. The said
return was held to be a defective return. The assessee thereafter filed a
revised return on 18th September, 2018 declaring long-term capital
gains and claiming deduction u/s 48 and exemption u/s 54F of the Income-tax
Act, 1961. The AO completed the assessment u/s 143(3) without considering the
return and the revised return and the claims for deduction / exemption u/ss 48
and 54F.

 

The assessee filed a writ petition
challenging the order. The Karnataka High Court allowed the writ petition and
held as under:

 

“(i)   Ordinarily, the Court would have relegated the petitioner-assessee
to avail the statutory remedy of appeal available under the Act provided the
principles of natural justice are adhered to. As could be seen from the order
impugned, the respondent has not whispered about the revised return filed by
the assessee except observing that the returns filed by the assessee were
invalidated being defective returns. If that being the position, no opportunity
was provided to the assessee u/s 139(9) to remove the defects in the returns
pointed out by the AO, nor was an opportunity provided to file a return
pursuant to the notice issued u/s 142(1). Even assuming the arguments of the
Revenue that no revised returns could be accepted enlarging the claim of
deduction / exemption beyond the time prescribed under the Act, it is a sine
qua non for the AO to consider the claims of deduction / exemption made by
the petitioner-assessee and thereafter to return the said claims if the
assessee is not entitled to the same by assigning the reasons. The impugned
assessment order prima facie establishes that the deduction claimed u/s
54F is not considered while computing the taxable turnover. This would
certainly indicate the non-application of mind by the respondent / Revenue.

 

(ii)   It is clear that recording of ‘reasons’ is a sine qua non
for arriving at a conclusion by the quasi-judicial authority and it is
essential to adopt, to subserve the purposes of the justice delivery system.
The reasons are the soul and heartbeat of the orders without which the order is
lifeless and void. Where the reasons are not recorded in the orders, it would
be difficult for the Courts to ascertain the minds of the authorities while
exercising the power of judicial review.

 

(iii)   It is a well-settled legal principle that there is no bar to
invoke the writ jurisdiction against a palpable illegal order passed by the
Assessing Authority in contravention of the principles of audi alteram
partem. On this ground alone, the order impugned cannot be approved. There
is no cavil with the arguments of the respondent placing reliance on the
judgement of the Apex Court in Goetze (India) Ltd. vs. CIT [2006] 157
Taxman 1/284 ITR 323 that no claim for deduction other than by filing a
revised return can be considered but not in the absence of the AO analysing,
adjudicating and arriving at a decision by recording the reasons. It is
apparent that no reasons are forthcoming for rejecting the revised returns as
well as the claims made u/s 54F. Such a perfunctory order passed by the AO
cannot be held to be justifiable.

 

(iv)  Hence, for the aforesaid reasons, without expressing any opinion on
the merits or demerits of the case, the order impugned and the consequent
demand notice issued u/s 156 as well as the recovery notice issued by the
respondent are quashed. The proceedings are restored to the file of the
respondent to reconsider the matter and to arrive at a decision after providing
an opportunity of hearing to the petitioner, assigning valid reasons as
aforementioned.”

SUPERIOR VOTING RIGHTS SHARES: A NEW INSTRUMENT FOR FUNDING

BACKGROUND

After a short
consultation process, the Ministry of Corporate Affairs and the Securities and
Exchange Board of India have, in quick succession, notified the new regime and regulatory
requirements relating to Superior Voting Rights equity shares (SRs).
Essentially, SRs are a special category of equity shares. They provide for
extra voting rights in comparison with ‘ordinary equity shares’.

 

Generally, all
equity shares are equal. They have the same right to dividends, the same rights
of voting and other features. To use the common Latin term, they are all pari
passu.

 

For private
companies, there was considerable flexibility to create several categories of
equity shares, each category having different rights. Typically, the
differences relate to voting and / or dividends. One category of equity shares,
for example, may have multiple voting rights as compared to others. This
enabled the holders to exercise far more control and say, compared to the
‘economic’ interest in the company.

 

Availability of
such flexibility helped companies and their founders / promoters to negotiate
with investors. Investors may be interested in economic returns while the
promoters / founders may be needed to be given assurance of control over the
running and management of the company.

 

However, while
this was well accepted in case of private companies, there was divergence of
views relating to listed companies and even unlisted public companies. On the
one hand, it was argued that such matters should be left for internal
negotiations and decisions of the company, its promoters and investors. If they
desire to have such a structure, the law should not meddle. This is, of course,
so long as there is adequate disclosure of the facts. On the other hand, there
was opposition to allowing any such instrument giving differential rights on
the ground that it would allow a small group of shareholders to control the
company even at the cost of shareholders holding otherwise majority of economic
value. It was argued that such instruments went against the principle of
corporate democracy and governance.

 

SEBI varied its
view over a period of time. It had allowed the issue of one category of such
instruments but there was an approval process that often took months. The
result was that there were barely 4-5 companies that issued such instruments.
Curiously, it was found that in most of the cases, such instruments traded at a
huge discount over the ‘ordinary equity shares’. There was far less trading,
too.

 

Recently,
however, the debate arose again particularly in case of startups that
extensively use technology (internet, digital, biotech, etc.). Such companies
need capital and flexibility and there has been a history of companies that
have seen very rapid growth. Such categories of companies need to be given a
freer hand and also their promoters given a share disproportionate to the
amount of money that they invest. SEBI had recently initiated a consultation
process wherein the current law and practice in India and abroad was
highlighted.

 

After debate
and consultation, the Ministry of Corporate Affairs (MCA) and SEBI have both
made changes in their respective regulations / rules to allow for certain types
of instruments. The features of these instruments are briefly discussed here.

 

What type of
instruments are allowed to be issued?

Equity shares
with extra voting rights than other ‘ordinary’ equity shares are allowed. These
rights are called superior rights and hence such instruments are referred to as
‘Superior Rights’ shares or SRs.

 

Which type of
companies are allowed to issue SRs?

All companies
are given such powers. The MCA has made generic rules applicable to all
companies. However, SEBI has made further regulations applicable to listed
companies.

 

WHAT
ARE SRs?

SRs are a
special category of equity shares with superior voting rights as compared to
other equity shares. No other differential, whether of dividends, share in
property, etc., is permitted. Thus, for example, the SRs – or ordinary equity
shares – cannot be given extra or lesser dividends. It is just that when it
comes to the matter of voting at general meetings, SRs would have extra voting
rights.

 

Note that the
MCA rules applicable to all companies generally provide for a wider category of
instruments not merely restricted to SRs. However, the focus of this article is
on SRs since SEBI has recognised and permitted only this class of instruments.

 

Shares with
‘inferior’ rights not allowed

Only shares
with superior voting rights are allowed to be issued. Thus, a company can have
a share with multiple voting rights or one voting right. It cannot have a share
with voting rights less than one vote per share. At present, companies have
issued shares with less voting rights. Such shares cannot be issued any more by
listed companies.

 

Shares with
other differential rights

Equity shares
with lesser or more dividend rights are not permitted to be issued by listed companies.
No other differential is also possible. The only differential permitted is
issue of shares with superior voting rights.

 

Who can be
issued SRs?

Unlisted
companies can issue SRs to any person. However, if the company wants to list
its shares on exchanges, the promoters / founders to whom SRs are issued should
be acting in an executive position in the company. Further, such SRs holders
should not be part of a promoter group whose collective net worth is more than
Rs. 500 crores.

 

How much extra
voting rights can be given to SRs?

SRs can be
given two to ten times extra voting rights as compared to ordinary equity
shares. At the minimum, thus, one SR can have twice the vote of an ordinary
equity share; and at the maximum, ten times. The multiple has to be in whole
numbers and not fractions (e.g., one cannot issue SRs with two and a half times
voting rights of ordinary equity shares).

What are the
procedures and approvals required for issue of SRs?

There are
several conditions for the issue of SRs. The articles of association should
permit such an issue. The companies’ rules require that an ordinary resolution
has to be passed approving such issue and for this purpose, certain disclosures
need to be made. However, the SEBI regulations require a special resolution
with certain further disclosure requirements. Earlier, there was a requirement
of having a three-year profit track record, but this requirement is now
dropped. As far as unlisted companies are concerned, any company can issue SRs.

 

Classes of SRs

The SEBI
regulations permit only one class of SRs.

 

‘Coat-tail’
provisions

These refer to
those situations where the SRs will have the same voting rights as ordinary
equity shares. In other words, SRs as well as ordinary equity shares will have
one vote per share. These requirements are prescribed for listed companies by
SEBI. Thus, in respect of the specified situations, which relate to important
matters or where there can be major conflict of interest, etc., the extra
voting rights on SRs are not available.

 

Sunset
provisions

Sunset in this context means the period of time after which the SRs
become ordinary equity shares. In other words, the extra voting rights of SRs
are removed. Unlisted companies are not mandatorily required to have sunset
provisions. However, listed companies need to provide that the SRs shall be
converted into ordinary equity shares by the fifth anniversary of listing of
the shares in the public issue of such a company. Such period can be extended
by another five years if a resolution is passed by the shareholders other than
SRs holders. The holders of SRs can, however, convert their SRs to ordinary
equity shares earlier.

 

There are also
mandatory sunset events where on the occurrence of such events the SRs get
converted into ordinary equity shares. These include, e.g., when the SR holder
resigns from the executive position, dies, etc.

 

Who can hold
SRs? What if they transfer the SRs?

Only those
promoters who have an executive position in the company can hold SRs. If the
holder dies, the person to whom such shares devolve will not have any superior
rights in respect of such shares. Generally, sale of SRs will result in the
superior voting rights lapsing and such shares becoming like other ordinary
equity shares.

Lock-in period

Under the SEBI
regulations, the SRs held by the promoters shall be locked in during the period
they are SRs, or for the period of lock-in in accordance with the ordinary
provisions relating to lock-in for minimum promoters’ contribution, whichever
is later.

 

Maximum
percentage of voting rights

The SRs cannot
have voting rights above 74% of the total voting rights. Thus, the ordinary
equity shares need to have at least 26% voting rights. For listed companies,
the ordinary equity shares held by SRs holders are also counted for the
purposes of this limit of 74%.

 

Special
requirements relating to corporate governance for listed companies

A company
having SRs is required to ensure that at least half of its board consists of
independent directors. Its Audit Committee should consist only of independent
directors. And its Nomination and Remuneration Committee, its
Risk Management Committee and its Stakeholders Committee should comprise of at
least two-thirds independent directors.

 

CONCLUDING
REMARKS

The positive
aspect of the new set of provisions is that now, particularly in case of listed
companies, SRs can be issued without formal approval of regulatory authorities
like SEBI. Approval of shareholders is generally enough. The discretion and
also the delay for such approval is thus eliminated.

 

However, it can
be seen that a very narrow type of instruments is permitted to be issued and
that, too, having a limited validity period. The superior rights are not
applicable under several situations. Importantly, though the wording is not
sufficiently clear, it appears that listed companies cannot make a fresh issue
of SRs (except as rights / bonus). Shares with inferior voting rights cannot in
any case be issued.

 

Thus, the
regulators have taken a very conservative position as regards the issue of SRs.
There is of course a worldwide debate on whether such shares with differential
rights be allowed and under what circumstances. While many countries do allow
(and many do not), some countries let companies and their shareholders /
investors decide. There is thus a good argument to allow flexibility to
companies and their investors to decide on what type of instruments can be
issued instead of a blanket ban or very narrow permissibility.

 

One of the
principal objections is that investors do not understand such instruments and
hence may end up acquiring them to their loss. Alternatively, they may simply
not invest. One would have, though, thought that after so many years of debate
on such instruments, there would be knowledge for those who want to make some
effort. After all, even equity investing is for informed investors, more so
when the focus of regulations these days is on more and more disclosures and
transparency.

 

Be that as it
may be, there is now a narrow but fairly clear type of instrument that can be
issued. Time will tell how successful it is with companies, their promoters /
founders and, above all, investors.  

 

POWER OF SILENCE

‘Maun’ in Sanskrit means silence. The
above is a Sanskrit proverb meaning everything can be achieved through silence.
It is a sign of control and tolerance. An underlying meaning of the proverb is
to exercise the wisdom to understand and comprehend when to speak and when to
be silent, given a particular situation.

 

When wisdom speaks, be silent. Do not
waste your candle when the sun is there – Anonymous

 

Mahatma Gandhi said silence has an effective
power to ignite the inner strength. According to him, the person who is on the
path of a continuous and effortful search for the truth follows the road-map of
silence. One of the basic and necessary foundations of Gandhiji’s principles of
Ahimsa could be silence.

 

Let silence be the art you practise

           

Many a time silence can speak volumes. A
well-known Hindi proverb Samajhnewale ko ishara kaafi hai has the
similar underlying interpretation – that a silent move can be more effective
than the spoken word. Silence has no limitations of communication. In the good
old days, movies used to be silent in the absence of technological advancement.
However, communication was complete and adequate.

 

The most important thing in communication
is what is not said – Peter Drucker

 

Silence is a form of meditation and
meditation without silence is almost impossible. Silence is more inner than
outer. It enables one to be calm and composed in the given situation. It has an
ability to increase one’s capacity to listen. It may not be a coincidence that
‘silent’ and ‘listen’ are spelt with the same letters! Silence can result in a
high level of concentration and high performance.

 

Work hard in silence; let your success
make the noise

In Hindu religion there is a concept of Maun
Vrat, meaning ‘Vow of Silence’. In the sixth month of the Hindu calendar,
viz. Bhadrapad, 16 days are set aside for those who wish to follow Maun
Vrat. Jain religion follows a particular day as Maun Ekadashi for
observing silence. It is a process of introspection and Maun Vrat could
have a scientific and medical justification too, so as to achieve conservation
of energy by remaining silent and its better utilisation. Exercising silence
enables one to hear the sounds of silence which are as healing as they are
enlightening.

 

If you want to make sense it has to come
from silence – Shri Shri Ravi Shankar

 

It is observed that in meetings and
discussions, the participants may speak when silence is expected and may remain
silent when speaking is necessary. It is said that smart people know what to
say, wise people know whether or not to say anything!

 

Be silent in two situations:

 

When you feel one can’t understand your
feelings from words, and

When one can understand without any words

 

In sports
activities such as tennis, silence is expected so that the players can
concentrate on the game. On the other hand, in cricket cheering the players and
creating a racket is usually expected! However, in a tense situation of winning
or losing, the spectators may observe silence on their own.

 

The quieter
you become, the more you can hear

 

In the context of the family scenario if the
members and life partners follow the proverb to its logical conclusion, the family life can become so peaceful.
The elders’ symbolic silence in place of harsh words in dealing with the
children in the family can many a time work wonders. Moreover, a legacy of
control and tolerance can be passed on its own and naturally to the next
generation.

Silence is one of the hardest arguments
to refute

 

However, the virtue of silence may have to
be set aside under the situation that one’s silence is interpreted as weakness
or ignorance. In case of a situation of injustice, one may have to make noise
or deal with it in protest with appropriate words. In above situations one’s
silence could be misjudged.

 

Fools multiply when wise men are silent

The Bhagavad Gita says: Contentment
of the mind, amiable temperament, silence, religious meditation and good
thoughts reflect austerity of the mind.

 

Let us follow the virtues of silence and
ignite the strength within. Let us strive for the maturity, wisdom and grace to
appreciate that silence can be far more powerful than having the last word.

 

Namaskaar!

THE ANCESTRAL PROPERTY CONUNDRUM RELOADED

Introduction

Under the Hindu
Law, the term ‘ancestral property’, as generally understood, means any property
inherited from three generations above of male lineage, i.e., from the father, grandfather,
great-grandfather. In August, 2019, this Feature had analysed the confusion
surrounding the issue of ancestral property, more specifically, whether
ancestral property received by a person can be transferred away?

 

This Feature
had then noted that, as regards ancestral property, two views were prevalent.

View-1: Ancestral property cannot be alienated. According to this view, if the
person inheriting it has sons, grandsons or great-grandsons, then it
automatically becomes joint family property in his hands and his lineal
descendants automatically become coparceners along with him. A corollary of
property becoming ancestral property is that it cannot be willed away or
alienated in any other manner by the person who inherits it.

View-2: Ancestral property becomes self-acquired property in the hands of the
person inheriting it. Thus, he can deal with it by Will, gift, transfer, etc.,
in any manner he pleases.

 

RECENT DEVELOPMENTS

Subsequent to
the publication of this Feature in August, 2019 the Supreme Court has once
again analysed the issue of ancestral property. What is interesting to note is
that on this burning issue two decisions of the Apex Court were delivered, both
of Co-ordinate Benches and both orders delivered on the same day (without reference
to one another)! These decisions appear divergent but ultimately due to the
facts, the conclusion reached is the same. Let us examine both these decisions.

 

Case-1:
Arshnoor Singh vs. Harpal Kaul, CA 5124/2019, order dated 1st July,
2019 (SC)

A person had
inherited property from his father who died in 1951 and which he, in turn, had
inherited from his father. This person tried to sell the property but his son
(the appellant before the Supreme Court) petitioned the Court against the same
on the grounds that the property was ancestral property and hence he could not
sell it on his own. Accordingly, the property was coparcenary / joint family
property in which the son had also acquired an interest by birth and hence his
father could not sell it as per his wish.

 

A two-member
Bench of the Supreme Court analysed various decisions, such as Yudhishter
vs. Ashok Kumar, 1987 AIR 558 on this subject (which were dealt with in
detail in the August, 2019 issue of the BCAJ under this Feature). It
held that after the Hindu Succession Act, 1956 came into force, the concept of
ancestral property has undergone a change. Post-1956, if a person inherited a
self-acquired property from his paternal ancestors, the said property became
his self-acquired property and did not remain coparcenary property.

 

However, the
Apex Court held that if the succession opened under the old Hindu law, i.e.,
prior to the commencement of the Hindu Succession Act, 1956, the parties would
be governed by Mitakshara law. The property inherited by a male Hindu
from his paternal male ancestor would be coparcenary property in his hands
vis-à-vis his male descendants up to three degrees below him. The nature of
property remained as coparcenary property even after the commencement of the
Hindu Succession Act, 1956. Incidentally, the comprehensive decision of the
Delhi High Court in the case of Surender Kumar vs. Dhani Ram, CS(OS) No.
1732/2012, dated 18th January, 2016 had taken the very same
view.

 

The Supreme
Court further analysed that in the case on hand, the first owner (i.e., the
great-grandfather of the appellant in that case) died intestate in 1951 and
hence the succession opened in 1951. This was a time when the Hindu Succession
Act was not in force. Hence, the nature of property inherited by the first
owner’s son was coparcenary property and thereafter, everyone claiming under
him inherited the same as ancestral property. The Court distinguished its
earlier ruling in the case of Uttam vs. Saubhag Singh, Civil Appeal
2360/2016, dated 2nd March, 2016 since that dealt with a
case where the succession was opened in 1973 (after the Hindu Succession Act,
1956 came into force), whereas the present case dealt with a situation where
the succession was opened in 1951.

 

The Supreme
Court reiterated its earlier decision in the case of Valliammai Achi vs.
Nagappa Chettiar, AIR 1967 SC 1153 that once a person obtains a share
in an ancestral property, then it is well settled that such share is ancestral
property for his male children. They become owners by virtue of their birth.
Accordingly, the Supreme Court did not allow the sale by the father to go
through since it affected his son’s rights in the property. Thus, the only
reason why the Supreme Court upheld the concept of ancestral property was
because the succession was opened prior to 1956.

 

Case-2: Doddamuniyappa vs. Muniswamy, CA No. 7141/2008, order dated 1st
July, 2019 (SC)

This decision of the Supreme Court also pertained to the very same
issue. The Supreme Court held that it was well settled and held by it in Smt.
Dipo vs. Wassan Singh 1983 (3) SCC 376, that the property inherited
from a father by his sons became joint family property in the hands of the
sons. Based on this principle, the Supreme Court concluded that property
inherited by a person from his grandfather would remain ancestral property and
hence, his father could not sell the same. In this case, neither did the
Supreme Court refer to its earlier decisions in Uttam vs. Saubhag Singh
(Supra) or Yudhishter vs. Ashok Kumar (Supra) nor did it go into the
issue of whether the succession was opened prior to 1951. It held as a matter
of principle that all ancestral property inherited by a person would continue
to be ancestral property for his heirs.

 

It is humbly
submitted that in the light of the above decisions, this view would not be
tenable after the enactment of the Hindu Succession Act, 1956. However, based
on the facts of the present case, one can ascertain that the first owner died
sometime before 1950 and hence it can be concluded that the succession opened
prior to 1956. If that be the case, as held in Arshnoor Singh vs. Harpal
Kaul (Supra), the property continues to be ancestral in the hands of
the heirs. Hence, while the principle of the decision in Doddamuniyappa’s case
seems untenable, the conclusion is correct!

 

AUTHOR’S (FINAL) VIEW

A conjoined
reading of the Hindu Succession Act, 1956 and the decisions of the Supreme
Court show that the customs and traditions of Hindu Law have been given a
decent burial by the codified Act of 1956. It is (once again) submitted that
the view expressed by the Delhi High Court in the case of Surender Kumar
(Supra) is the most comprehensive exposition on the subject of
ancestral property. To reiterate, the important principles laid down by the
Delhi High Court are that:

 

(i)   Inheritance of ancestral
property after 1956 does not create an HUF property and inheritance of
ancestral property after 1956 therefore does not result in creation of an HUF
property;

(ii)  Ancestral property can only
become an HUF property if inheritance is before 1956, and such HUF property
therefore which came into existence before 1956 continues as such even after
1956;

(iii) If a person dies after
passing of the Hindu Succession Act, 1956 and there is no HUF existing at the
time of the death of such a person, inheritance of an immovable property of
such a person by his heirs is no doubt inheritance of an ‘ancestral’ property
but the inheritance is as a self-acquired property in the hands of the legal
heir;

(iv) After passing of the Hindu
Succession Act, 1956 if a person inherits a property from his paternal
ancestors, the said property is not an HUF property in his hands and the
property is to be taken as a self-acquired property of the person who inherits
the same.

 

CONCLUSION

In recent
times, some newspapers have also joined the confusion bandwagon and have
started printing articles suggesting that ancestral property continues as ancestral
in the hands of the person inheriting the same. All of these help add fuel to
an already raging controversy.

 

Considering these latest Supreme Court decisions,
it is evident that the government needs to urgently amend the Hindu Succession
Act en masse and specifically address the burning issue of ancestral
property. A piecemeal approach to amendment should be avoided and the entire
Act should be replaced with a new one. The Act is over 60 years old and should
be substituted by a modern, comprehensive legislation which can prevent
litigation. Precious money and time would be saved by doing so. Till that time,
we will continue witnessing sequels to this puzzle known as ancestral property!

 

ATTRIBUTION OF PROFITS TO A PERMANENT ESTABLISHMENT IN A SOURCE STATE

The determination of income of a
Multi-National Enterprise (MNE) having operations in various jurisdictions
faces many challenges. It is not easy to attribute profits to various
constituents of an MNE spread over multiple jurisdictions. OECD has so far adopted
a separate entity approach and recommended determination of profits on the
Arm’s Length Principle (ALP) based on a FAR (Functions, Assets and Risks)
analysis. However, of late ALP based on FAR has been challenged by many
developing nations (including India) on the ground that it is more skewed
towards residence-based taxation and does not take into account the place of
value creation, i.e., the market. In a traditional approach, profits are taxed
in a source country only if there is a Permanent Establishment (PE). It is
easier for MNEs to plan their affairs in a manner so as to avoid the presence
of a PE in a source country. Further, in a digitalised economy, it is extremely
difficult to attribute profits to various jurisdictions based on the traditional
approach. Therefore, many countries worldwide have moved away from ALP and
resorted to either the Formulary Apportionment Method (FAM) or a Presumptive
Basis of Taxation. This article compares and contrasts the different methods of
profit attribution and provides a contextual study to understand the proposed
amendments in Rule 10 of the Income-tax Rules, 1962 (the Rules) in respect of
attribution of profits to the operations of an MNE in India.

 

PRESENT
SYSTEM OF PROFIT ATTRIBUTION

Article 5 of a tax treaty lays down norms
for determination of a PE in the state of source. Article 7 of a tax treaty
stipulates principles of determination of profits attributable to a PE. The
existence of a PE in a source state gives a right to that state to tax profits
which are attributable to its operations. As we know, a treaty only provides
for distributive rules for taxing jurisdictions, leaving detailed computation
of profits to the respective domestic tax laws. For example, once it is
established that there is a PE in India, computation of profits attributable to
that PE will be subject to provisions of the Income-tax Act, 1961 (the Act).
However, Article 7 does provide certain restrictions or guidelines thereof for
computation of profits. A moot issue is to determine how much profits are
attributable to a PE in the source state.

 

Provisions under the Income-tax Act, 1961

Section 9 of the Act deals with income
deemed to accrue or arise in India. It does provide certain source rules for
determination of such income. However, as far as business income is concerned,
section 9(1)(i) provides that all income accruing or arising whether directly
or indirectly through or from any business connection in India… shall be deemed
to accrue or arise in India. Clause (a) of Explanation 1 to section 9(1)(i)
further provides that in the case of a business of which all the operations are
not carried on in India, the income of the business under this clause deemed to
accrue or arise in India, shall be only such part of income as is reasonably
attributable to the operations carried on in India.

 

The provision in tax treaties is similar, in
that it provides that if the enterprise carries on business as aforesaid, the
profits of the enterprise may be taxed in the other state; but only to the extent
as are attributable to that PE. There is one exception, i.e., a tax treaty
which follows the UN Model Convention providing for the force of attraction
rule. According to this rule, when an enterprise has a PE in a source state,
then the entire revenue from the source state may get taxed in the hands of
that enterprise, whether or not it is attributable to that PE. Many Indian tax
treaties do have this Rule. However, the force of attraction is restricted to
the revenue derived from the same or similar activities as that of the PE.

 

Thus, determination of profits attributable
to a PE is crucial for its taxability in the source state. Ideally, the PE
should maintain books of accounts and financial statements in India (for that
matter, any source state) for determination of profit or loss from its business
operations, for it is so mandated in India. However, where such books of
accounts are not maintained (may be due to the head office’s view of
non-existence of PE or for any other reason) or where it is not possible to
ascertain the actual profits from such books of accounts, then the assessing
officer (AO) can invoke the provisions of Rule 10 which provide for
determination of profits as a percentage of the turnover, proportionate profits
or in any other manner as he may be deem appropriate. Thus, Rule 10 gives wide
discretionary powers to the AO in determination of profits attributable to a
PE.

 

Clauses (b) to (e) of Explanation 1 to
section 9(1)(i) of the Act provide various instances where income of a non-resident
from certain activities will not be deemed to accrue or arise in India.
However, Explanation 2 explicitly includes dependent agent within the scope of
business connection. Again, a question arises as to the role played by the
dependent agent and profits attributable to his activities in the dual
capacity: one, as an agent, and two, as a representative of the foreign
enterprise (as a PE).

 

Authorised OECD Approach (AOA)

At present, there are three versions of
Article 7 that feature in tax treaties worldwide, namely, (i) article 7 in the
OECD Model Convention (OECD MC) prior to 2010, (ii) article 7 in the revised
OECD Model Convention post-2010, and (iii) article 7 of the UN Model Convention
(UN MC). The distinguishing features of the above versions are given below.

 

Versions (i) and (iii) are similar in that
the pre-2010 OECD MC and the UN MC contain the provision of considering PE as a
separate and distinct enterprise. The PE, in this case, is considered as being
a separate and independent entity from its head office, such that it would
maximise its own profits. The PE, therefore, would be maintaining separate
books of accounts based on principles of accounting as applicable to a separate
and distinct entity. Klaus Vogel has referred to such a method as ‘separate
accounting’ or ‘direct method’. India supports this view and most of its tax
treaties are based on this principle.

 

However, in 2010, OECD changed its stance
and amended article 7 based on its report on the ‘Attribution of Profits to
Permanent Establishments’. In the said report and the new article 7 in its
model tax convention, OECD pronounced AOA as a preferred approach for
attribution of profits to a PE. AOA is also based on the ‘separate entity
approach’, though profits are to be determined based on Functions performed,
Assets employed and Risks assumed (FAR).

 

AOA provides
options for application of the new article 7 introduced in the OECD Model Tax
Convention in 2010 which requires that profits attributable to PE are in
accordance with the principles developed in the OECD Transfer Pricing
Guidelines wherein the PE is first hypothesised as a functionally separate
entity from the rest of the enterprise of which it is a part, and then profits
are determined by applying the comparability analysis and FAR approach.

 

The AOA recommends a two-step approach for
determination of profits attributable to a PE:

 

Step 1: A
functional and factual analysis of the PE, aligned with FAR analysis, as
recommended in transfer pricing guidelines;

Step 2: A
comparability analysis to determine the appropriate arm’s length return (price)
for the PE’s transactions on the basis of FAR analysis.

 

AOA is based on ALP, which in turn is
determined based on FAR analysis under transfer pricing, which essentially considers
the supply side of the transaction and ignores the demand side, i.e., the
market or sales; and, therefore, India has rejected the same.

 

There is one
more issue in the revised article 7 of the OECD MC. Its pre-2010 version
recognised and acknowledged that apportionment of profits based on one of the
criteria, namely, receipts (or sales revenue), expenses and working capital,
was a reasonable way of apportioning profits to the PE. This was based on
paragraph 4 of the pre-2010 version of the OECD MC which gave an option to
attribute profits by way of an apportionment if it was customary to do so in
the state of PE. However, the revised OECD MC dropped this paragraph. The
impact of this change is that even where accounts are not available or
reliable, one needs to attribute profits to a PE based on FAR without
considering the market or sales. India’s position is very clear in that it
would also take the demand side or sales into consideration for attribution of
profits to a PE.

 

Shortcomings of ALP

Section 92F(ii) defines the ‘Arm’s Length
Price’ as a price which is applied or proposed to be applied to a transaction
between persons other than associated enterprises, in uncontrolled conditions.

Thus, a transaction between two or more AEs
needs to be compared with a similar transaction between two unrelated parties,
for the same or similar product or service, in the same or similar
circumstances. These two unrelated parties, whose transactions are compared
with that of AEs, must have similar functions, assets or risks as that of the
AEs. It is practically impossible to find such comparable companies or
transactions.

 

Section 92C prescribes six methods to
determine the ALP. Pricing depends upon many factors other than FAR. ALP fails
to take into account all aspects of a business. One cannot easily find
comparables for many businesses that are engaged in specialised services or
businesses, especially specialised product-lines involving complex intangibles.

 

Moreover, availability of data in the public
domain at the time of entering into the transaction for comparison purposes is
a big challenge. Public data is available only in cases of commodity trading
through exchanges. Maintenance of contemporaneous documentation and valuation
thereof are another big challenge.

 

Profit Split Method

The Profit Split Method (PSM) is applicable
when transactions are so interrelated that it might not be logical or practical
to evaluate the same individually. Independent entities in such scenarios may
agree to pool their total profits and distribute them to each of the
participating entities based on an agreed ratio. Thus, PSM uses a logical basis
and divides profits among participating entities to a transaction similar to
what independent entities would have apportioned for arriving at such an
arrangement.

 

The PSM method first identifies the outcome
of the transaction (i.e., the net profit of the transaction) of the group. The
profit then is to be divided among the entities of the group on an economically
rational basis such that profits would have been distributed in an arm’s length
arrangement. The total profit may be the profit from the transactions or a
residual profit that cannot readily be assigned to any of the entities of the
group, e.g., profits arising from unique intangibles. The contribution of each
entity is based upon a functional analysis of each entity. Reliable external
market data, if available, is always given preference.

 

The PSM method, although a method under the
arm’s length approach, is in reality based on the principles which are used for
the purpose of ‘Formulary Apportionment’.

 

The positive aspect of every PSM approach is
that it examines the controlled transactions under review in a prudent manner
as it is a two-sided method where every MNE concerned is evaluated. Thus, the
PSM method will be beneficial if the underlying contribution involves
intangibles owned by two or more MNEs, as no transfer pricing method other than
PSM would be applicable. PSM offers flexibility because it considers the
specific facts and circumstances of MNEs which cannot be found in comparable
independent enterprises. Moreover, a real actual profit is being split which
generally does not leave any of the MNEs concerned with an unreasonably high
profit since each MNE is appraised. It also removes the possibility of double
taxation as the total profit is split and distributed to the various
constituent entities across jurisdictions.

 

Challenges of PSM – lack of availability
of data and functions

There are two fundamental disadvantages with
the PSM. First, the application of PSM usually includes a weak and sometimes
doubtful connection of external market data with the controlled transactions
under consideration, resulting in a comparison with a certain amount of
subjectivity. Moreover, there is the lack of availability of data; both
taxpayers and tax administrations might find it hard to obtain reliable
information from MNEs in foreign countries. This inconvenience might materially
affect the reliability of the method since the profit should be an economical
assessment based on each and every function undertaken by the MNE, preferably
using external comparables which can support the valuation. (Source: Markham,
Michelle – Transfer Pricing of Intangible Assets in the US, the OECD and Australia:
Are Profit Split Methodologies the Way Forward?)

 

FORMULARY APPORTIONMENT METHOD (FA)

The Meaning of FA

As the name suggests, it is the
apportionment of the profits / losses of a corporation based on some
predetermined formula, over its different units or group of companies operating
under common control, across different jurisdictions based on significant
economic presence.

 

Formulary Apportionment, popularly known as
unitary taxation, allocates profit earned (or loss incurred) by an MNE wherein
its entity has a taxable presence. It is an alternative to the separate entity
approach under which a branch or PE within a jurisdiction is reckoned as a
separate entity, requiring prices for transactions with other parts of a
corporation or a group thereof, according to ALP.

 

As opposed to this, FA assigns the group’s
total global profit (or loss) to each jurisdiction based on certain variables
such as the proportion of assets, sales or payroll in that particular
jurisdiction. It is thus akin to PSM in a sense.

 

Under this method, all entities of the group
are viewed as a single entity (unitary combination) and therefore the method is
also known as unitary taxation worldwide. This method requires combined
reporting of the group’s results.

 

Advantages of FA

A unitary approach would replace the
following major elements which create fundamental problems for taxation of MNEs
under the ALP:

 

(i)   The need for analysing arm’s length price,
that is, an analysis of internal accounts and transactions for determining the
appropriate arm’s length price;

(ii)   The need to deal with complex anti-avoidance
rules, such as thin capitalisation, controlled foreign corporations, limitation
of benefits et al to prevent base erosion and profit shifting;

(iii) Quantification of contribution of intangibles
in income generation;

(iv) Freedom from
litigation arising from source and residence attribution rules;

(v) Lesser compliance burden on MNEs.

 

The above would enable simplification of the
international tax system, which shall benefit both taxpayers and tax
administrations.

 

At present, a majority of the transfer
pricing disputes undergoing several rounds of litigation are generally decided
in favour of the taxpayer. This is so in the U.S., India and other countries.
This is bound to happen in the absence of clear guidance on transfer pricing
issues. Matters pertaining to selection of appropriate comparable(s), usage of
the most appropriate method for benchmarking the transaction, management fees,
cost allocation arrangements, royalty pay-outs, etc., have been and continue to
be under litigation.

 

On the other hand, the unitary taxation
method, if not totally, would at least reduce and significantly contribute in
settling disputes. Further, in many cases in countries where significant
economic activities are carried out, there may not be any significant
difference in corporate tax rates. Hence, in the absence of wide differences in
corporate tax rates, there may be no significant compulsion or reason to
minimise a firm’s global tax liability by relocating production activities.

 

Limitations of FA

There are two primary questions that need to
be addressed for successful implementation of FA.

 

Q1) How and what shall be the basis for
the apportionment formula?

 

Generally, an overwhelming consensus on the
determination of weights for the factors would be decided by negotiations and
trade-offs. Historical data provides that the factors have been generally given
equal weight, that is, one-third each (sales, labour and assets employed).

 

Approach of the United States of America

The water’s edge approach of the States in
the US has tilted the balance towards sales. This approach apportions income to
production and sale equally, i.e., 50% of income is apportioned based on sales
and 50% on production (assets and labour quantify production).

 

[Water’s edge election basically says that
you (as a business or entity) agree to be taxed within the jurisdiction for the
sales that occur within that state, but only within the parameters laid down by
that state.]

 

Approach of the European Union

On the other hand, in 2012 the EU amended
the proposal drafted by the EU Commission, from equal weights to the three
factors, to 10% for sales, 45% for assets and 45% for labour.

 

Differences in preferences

Countries where wage rates are higher would
favour payroll rather than headcount in respect of the labour factor. This
would tend to benefit from the inclusion of the assets factor with an equal
weight. Therefore, such countries can concede that the labour factor be based
on the number of employees.

 

Conversely, although countries which have
attracted large-scale manufacturing activities would benefit in terms of tax
revenues on account of the labour factor, they should also be willing to accept
a significant weightage for other factors. If the same has not been accepted,
there may be MNEs who would relocate their investments because of formula
over-weight tilt towards the labour factor. Therefore, it is essential that a
fine balance between factors of production and sales is achieved. This is
because some part of the income can be said to be attributable to (a) assets
employed for production, (b) number of employees on the payroll, and (c) the
sales function, of course.

 

Therefore, one may propose a ratio of 1
(assets employed): 1 (number of employees): and 2 (sales function). This is
because it gives equal importance to all factors of production as well as the
sales function. Further, equal importance is also given to the internal two (2)
factors of production as well, namely, capital and entrepreneurship.

 

Q2) 
Would it be appropriate to apply a general formula for all industries?

 

Evidently not. This issue has been debated
since the unitary approach was first mooted in the 1930s. The cause for concern
is that some types of industries do have special characteristics in need of a
special formula.

 

Examples

Transportation industries such as shipping,
aviation, etc., pose an issue because the assets which they are dependent upon
are mobile. In order to address the special nuance of this business, these
could be taxed based on the value of traffic between two contact (entry / exit)
points.

 

In the case of other nuanced industries,
such as extractive industries, the modern approach of ‘resource rent taxation’
is a more effective mode of taxation. Therefore, the interaction between
resource rent taxation and general corporate taxation would require a special
consideration.

 

However, for the purpose of achieving
neutrality, a general apportionment formula applied to most types of businesses
would be appropriate for allocating a general tax on income or profits.

 

Presumptive Taxation (PT)

As stated above, determination or
computation of profits in the source state is not an easy task and therefore there
is always an uncertainty about attribution of income and allowability of
expenses. Moreover, compliance burden is also high. In order to address these
issues, many countries give the option of presumptive taxation to
non-residents. Under this, irrespective of actual profit or loss, a certain
percentage of the gross receipts from the state of source is deemed to be
income and taxed therein. Once a taxpayer is covered by the presumptive tax
scheme, he would be relieved from the rigours of compliances.

 

The Income-tax Act, 1961 contains provisions
for taxing income of non-residents on presumptive basis. Some illustrative
provisions are given below:

 

Section

Types of assessees

Particulars of income

Tax rate

44BB

Any non-resident

Profits and gains in connection with or supplying
P&M on hire used, or to be used, in the prospecting for, or extraction or
production of mineral oils and natural gas in case of NR

10% of the gross receipts is deemed to be profits
and gains.

(Surcharge, health & education cess would be
extra)

44DA

Any non-resident

Royalties / FTS arising through a PE or fixed
place of profession in India

Taxable on net basis.

Basic rate 40%.

(Surcharge, health & education cess would be
extra)

44AE

Any assessee

Business of plying, leasing or hiring of goods
carriages owned by the assessee (not owning more than 10 goods carriages at
any time during the previous year)

Deemed profits @ Rs. 7,500 per vehicle, for every
month (or part thereof) or actual profits, whichever is higher.

In case of a heavy goods vehicle, profits are
deemed to be Rs. 1,000 per ton of gross vehicle weight or unladen weight as
the case may be, per vehicle for every month (or part thereof) or actual
earnings, whichever is higher

115A

Any non-residents and foreign company

Taxation in respect of income by way of dividend,
interest, royalty and technical service fee to non-residents and foreign
companies

(i) Interest income received by non- residents
(not being a company) or a foreign company – 20% plus applicable surcharge
and cess

(ii) Infra debt funds as specified u/s 10(47) –
5% plus applicable surcharge and cess

(iii) Dividend received by a non-resident or a
foreign company – 20% plus applicable surcharge and cess

(iv) Royalty or fees for technical services
income received by non-resident or foreign company – 10% plus applicable
surcharge and cess

115VA to V-O

Any company that owns at least one qualifying
ship and the main object of the company is to carry on the business of
operating ships

Computation of profits and gains from the
business of operating qualifying ships

(i) Qualifying ship having net tonnage up to
1,000 – Rs. 70 for each 100 tons

(ii) Qualifying ship having net tonnage up to
1,000 but not more than 10,000 – Rs. 700 plus Rs. 53 for each 100 tons
exceeding 1,000 tons

(iii) Qualifying ship having net tonnage up to
10,000 but not more than 25,000 – Rs. 5,470 plus Rs. 42 for each 100 tons
exceeding 10,000 tons

(iv) Qualifying ship having ship tonnage
exceeding 25,000 – Rs. 11,770 plus Rs. 29 for each 100 tons exceeding 25,000
tons

172

Any non-resident

Shipping business of non-residents

For the purpose of the levy and recovery of tax
in the case of any ship, belonging to or chartered by a non-resident, which
carries passengers, livestock, mail or goods shipped at a port in India –
7.5% of the amount paid or payable on account of such carriage to the owner
or charterer

Equalisation levy

Any non-resident

Charge of equalisation levy

Equalisation levy shall be charged @ 6% of the amount
of consideration payable, for any specified service received or receivable
from a non-resident, by –

i. A person resident in India carrying on any
business or profession; or

ii. A non-resident having permanent establishment
in India

 

 

Distinction between PSM / FA / PT

The stark difference between the Profit
Split Method (PSM), the Formulary Apportionment Method (FA) and the Presumptive
Taxation Method (PT) is the manner of calculation of profits.

 

Profit Spilt Method: In this method, total profits earned by related entities in
different jurisdictions is determined and then the same are attributed to each
one of them on a separate entity approach (following the arm’s length
principle), based on FAR analysis. In this case, usually the market or demand
side is overlooked or given less importance. This method is criticised in that
it is more skewed towards the country of residence of the enterprise.

Formulary Apportionment Method: Here, the actual profits of the MNE at the global level are
distributed to the participating entities. However, the distribution is based
on a predetermined formula with or without weightage. This method does take
care of demand side arising from ‘sales’, which is usually one of the factors
of profit allocation in the FA. This method considers all entities across the
globe under a single MNE as a single unit and consequently it is known as
‘Unitary Method’ as well.

 

Presumptive Taxation: This method rests on an altogether different footing. It does not
take into account the actual profit or loss of the business undertaking.
Instead, it presupposes a certain element of profit in the source state and
levies taxes based on a notional estimation. Normally, presumptive taxation is
given as an option to the taxpayer to have a tax certainty and reduce
litigation. If the actual profits are lower or there are losses, then the
taxpayer may opt for regular computational provisions along with related
compliances. Safe-harbour provisions under the TP Regulations are akin to
presumptive taxation.

 

PROPOSED PROFIT ATTRIBUTION RULE (COMBINATION
OF FA AND PT)

The CBDT Committee has recommended amendment
of Rule 10 of the Income-tax Rules to provide for detailed profit attribution
rules. It rejected the AOA for profit distribution, which is based on ALP
taking into account FAR analysis. It may be noted that AOA does not take into
account the demand side of a transaction.

 

The committee
suggested distribution of profits based on three factors carrying equal
weightage, namely, (a) sales (b) manpower and (c) assets. It is claimed that
the combination of these three factors would take into consideration both the
demand and the supply side of a transaction.

 

The draft report on Profit Attribution
outlines the formula for calculating ‘profits attributable to operations in
India’, giving due weightage to sales revenue, wages paid to employees and
assets deployed.

 

(Please refer to the July, 2019 issue of
the BCAJ for a detailed discussion on the proposed Profit Attribution Rules.)

 

CONCLUSION

Attribution of profits is a complex
exercise, more so when such attribution is related to complex intangibles or a
PE. The Arm’s Length Principle looks good in theory, but impracticable in real
ground situations. Therefore, even after decades of its existence, there are
litigations galore. Further, FAR analysis takes into account only the supply
side, giving less or no weightage to the demand side. On the other hand,
presumptive taxation, which uses estimation, may result in double taxation as
the residence country may deny the credit of taxes paid on presumptive basis.
The plausible solution seems to be a distribution of profits based on a
predetermined formula, i.e., the Formulary Apportionment Method.

 

However, unless there is a universal
consensus this method also is not practicable. Moreover, availability of data
at a global level or the willingness of a Multi-National Enterprise to share
such data could be a challenge. Difference in accounting treatment, difference
in taxable year, fluctuating exchange rates, changes in domestic tax laws, tax
incentives in different jurisdictions, etc., are all issues for which there are
no answers. This only proves that we are living in an imperfect world and that
we need to accept the imperfect tax system as the hard reality of life in an
era of cross-border transactions and the continuing emergence of giant
multinationals that rule the roost, with law-makers lagging far behind.

 

 

DETERMINING INCREMENTAL BORROWING RATE UNDER Ind AS 116

BACKGROUND

Ind AS 116 requires a
lessee to discount the lease liability using the interest rate implicit in the
lease if that rate can be readily determined. If the interest rate implicit in
the lease cannot be readily determined, then the lessee should use its incremental
borrowing rate. The interest rate implicit in the lease is likely to be similar
to the lessee’s incremental borrowing rate (IBR) in many cases. This is because
both rates, as they have been defined in Ind AS 116, take into account the
credit standing of the lessee, the length of the lease, the nature and quality
of the collateral provided and the economic environment in which the
transaction occurs. However, the interest rate implicit in the lease is
generally also affected by a lessor’s estimate of the residual value of the
underlying asset at the end of the lease and may be affected by taxes and other
factors known only to the lessor, such as any initial direct costs of the
lessor. It is likely to be difficult for lessees to determine the interest rate
implicit in the lease for many leases, particularly those for which the
underlying asset has a significant residual value at the end of the lease.
Consequently, the standard requires use of the IBR in these situations.

 

The lessee’s IBR is the rate that the lessee
would have incurred on debt obtained over a similar term for the specific
purpose of acquiring the leased asset. The lessee’s IBR may be equivalent to a
secured borrowing rate if that rate is determinable, reasonable and consistent
with the financing that would have been used in the particular circumstances.
The lessee’s IBR should reflect the effect of any compensating balances or
other requirements present in the lease that would affect the lessee’s
borrowing cost for similar debt. The IBR should also reflect the effect of any
third party guarantees of minimum lease payments obtained by the lessee, to the
extent that similar guarantees of debt payments would have affected the
borrowing costs. However, the lessee’s IBR should not include any component
related to the lessee’s cost of capital (i.e., the IBR should not reflect the
effect of lessee’s use of a combination of debt and equity to finance the
acquisition of the leased asset).

 

If the lessee’s financial condition is such
that third parties generally would be unwilling to provide debt financing, the
IBR of the lessee might not be readily determinable. In these rare cases, the
lessee should use the interest rate for the lowest grade of debt currently
available in the market place as its IBR.

 

Three steps are critical in determining the
IBR, namely: (a) the reference rate, (b) the financing spread adjustment, and
(c) lease-specific adjustment. These aspects are discussed below.

 

REFERENCE RATE

This will generally be the relevant
government bonds or currency swap rates (e.g., LIBOR) reflecting a risk-free
rate. The borrowings should be matched with the currency of the cash outflows
on the lease so that foreign exchange risk is removed. For example, lease cash
flows denominated in USD or GBP (or any other currency) should be matched with
the appropriate risk-free rates, such as those determined from US Treasury
Bills or UK Gilts.

 

The repayment profile should be considered
when aligning the term of the lease with the term for the source of the reference
rate. Risk-free rates exist for different durations. Therefore, the chosen rate
should be matched with the lease term, as defined by Ind AS 116. The relevant
duration of government bonds to consider is not the total lease term but a
weighted average lease term. While a risk-free rate determined from government
bonds or interest rate yield curves assumes repayment of the capital at
maturity, for an operating lease the repayments are typically spread over the
lease period.

 

Example: Foreign currency leases

Ez Co, an Indian airline company with INR
functional currency, leases aircrafts; the lease payments are specified in USD
and the interest rate implicit in the lease is not readily determinable. For
making the lease payments, Ez has borrowed in USD and taken a forward contract
to hedge against INR / USD exchange fluctuation risks. The USD loan interest
rate is 4% per annum and the hedge cost is 2% per annum. The currency in which
the lease is determined forms part of the economic environment for which the borrowing
rate is assessed. It is the US dollar incremental borrowing rate that has to be
determined. In this case, the IBR is 4% (subject to any further adjustments
required by the Standard) and not 6%.

 

FINANCING SPREAD ADJUSTMENT

For determining the spread, lessees should
use credit spreads from debt with the appropriate term. If the same is not
available, it will have to be estimated. The data available to entities to
determine their financing spread adjustment will depend on the type of company
and their financing structures.

 

Nature of debt financing

Type of entity

Data points available

Multiple debt financing arrangements

Large listed entities

Multiple data points

A bank loan

Small companies

Single data point

No significant debt financing arrangements

Cash surplus company

None

 

For entities with zero debt and / or net
cash balances, consideration should be given to both historical as well as
future debt facilities. The historical position may not be representative of
the current position of the company. It is incorrect to assume that companies
in this situation will have a zero spread, as Ind AS 116 requires the discount
rate to reflect the rate of interest the lessee would have to pay to borrow.
Companies with few data points on their credit spread should seek indicative
pricing from several banks or look to comparable data points available, such as
similar sized companies in a similar industry.

 

Ind AS 116 is very clear that the IBR is
lessee-specific. Therefore, it is important to evaluate what rate the lessee
would achieve on his own even if theoretically all funding would ultimately be
achieved through a group debt structure. Depending on who is the issuer, and
whether there are written guarantees from the group for the lease payments in
place, it may mean that in some cases a group credit spread that is applicable
to all lessees in a group may be more relevant. In determining an IBR, the
overall level of indebtedness of the entity (i.e., leverage) and whether the
value of the lease results in a change to the leverage ratio such that it
warrants a higher IBR, should be considered.

 

LEASE SPECIFIC ADJUSTMENT

The key requirement of Ind AS 116 is that the
IBR is directly linked to the asset itself, rather than being a general IBR. To
an extent, the lease is a secured lending arrangement as the lessor can reclaim
the underlying property. The security of the underlying asset should
potentially reduce the credit spread charged by a lender. If there are no data
points with respect to secured borrowing rates the lessee may consider asking
banks or lenders, or use valuation specialists. While all leases will reflect a
secured borrowing position, in practice certain assets may be more valuable to
a lessor and easier to redeploy. For example, the costs of repossessing an
asset of low value (e.g., a Xerox machine) or low duration relative to its cash
flow would be high. Consequently, the security would be largely irrelevant. On
the other hand, in larger value assets with a longer duration (e.g., office
space), the benefit of having security is more valuable because the lessor will
not be at a significant loss in the event of default by the lessee.

 

PROPERTY YIELDS

In the basis for conclusions of IFRS 16,
property yields are specifically identified as a potential data point for
companies to consider: ‘The IASB noted that, depending on the nature of the
underlying asset and the terms and conditions of the lease, a lessee may be
able to refer to a rate that is readily observable as a starting point when
determining its incremental borrowing rate for a lease (for example, the rate
that a lessee has paid, or would pay, to borrow money to purchase the type of
asset being leased, or the property yield when determining the discount rate to
apply to property leases). Nonetheless, a lessee should adjust such observable
rates as is needed to determine its incremental borrowing rate as defined in
IFRS 16.’

 

The valuation typically is determined by a
multiplier being applied to the rental income to be received, with the
multiplier representing 1/Yield. Using property yield is more suitable to
valuing commercial property where all likely buyers in the market view the
asset as an investment, for example, valuing
commercial properties. Using property yield is less suitable for owner-occupied
property (e.g., residential properties). Property yields are determined by
assessing the yield profile from recent, comparable sales of similar assets
with similar characteristics. The ‘equivalent yield’ reflected by comparable
sales represents the weighted average of current and future rental income,
smoothing out the effect of rent-free periods or vacancy. In determining the
property yield, the risk to be considered includes location, quality of
property, specification, future rental and capital growth prospects, the
tenants’ credit profile and local supply / demand dynamics. For companies
wanting to use property yields to help them determine lease specific
adjustments, the following assumptions are relevant:

 

(i)   The currency of property
lease cash flows is aligned with the currency in which the property is valued;

(ii)   The duration of the property
yield data points available are aligned to the weighted average term of the
lease; and

(iii)  The property yields are
aligned to the characteristics of the property lease being assessed (quality,
sector and location of the property).

 

Practical questions and answers

Query

Ind AS 116 defines the lessee’s incremental
borrowing rate as ‘The rate of interest that a lessee would have to pay to
borrow over a similar term, and with a similar security, the funds necessary to
obtain an asset of a similar value to the right-of-use asset in a similar
economic environment.’ What does ‘similar term’ mean in the context of a lease
with a non-cancellable period followed by one or more optional periods? Does
similar term imply:

 

(a)  A debt for a period equal to the
non-cancellable term?

(b) A debt for a period equal to the maximum term
(including the periods covered by the options to renew)?

(c)  A debt for a period equal to the
non-cancellable term with extension options?

(d) A debt for a period equal to the lease term as
determined in accordance with Ind AS 116 (i.e., taking into account whether or
not it is reasonably certain to exercise the option/s to renew).

 

Response

The discount rate should be consistent with
the cash flows that are to be discounted and since those cash flows take into
account only the rentals over the lease term as determined according to Ind AS
116, (d) is the right answer.

Query

Ind AS 116
defines the lessee’s incremental borrowing rate as ‘The rate of interest that a
lessee would have to pay to borrow over a similar term, and with a similar
security, the funds necessary to obtain an asset of a similar value to the
right-of-use asset in a similar economic environment.’ What does ‘similar
security’ mean in the context of a lease that grants to the lessee the
right-of-use (ROU) for the underlying asset for a period of time? Sometimes,
there could be some guarantees by the parent company or another company in the
group. Can the parent company’s IBR be used?

 

Response

If parent
provides guarantee on the subsidiary’s debt the pricing of the lease would be
more influenced by the credit risk associated with the parent. The rate used by
the subsidiary should reflect the IBR of the parent, unless the subsidiary is
able to obtain financing on a stand-alone basis without the parent or other
related entities guaranteeing the debt. If that is not the case, the parent’s
IBR would be a more appropriate rate to estimate.

 

However,
allowing a subsidiary to look up at the parent’s borrowing rate without looking
at anything else, such as the currency exchange rates, may not be appropriate.
Even with a guarantee from the parent company, there are other factors that
could influence the pricing (and the implicit rate) offered by the lessor (such
as tax and other local regulations for example). The lessee should always look
at its own borrowing rate and take into account the impact of any guarantees
provided by the parent company to the lessor. This could be done by soliciting
quotes from local lenders for similar conditions and guarantees. Corporate
borrowing rates may be used as a starting point. However, appropriate
adjustments are usually necessary to take into account specific facts and
circumstances of the lease. The inter-company rate on loans from the parent to
the subsidiary generally should not be used as the lessee’s incremental
borrowing rate.

 

Query

Ind AS 116
defines the lessee’s incremental borrowing rate as ‘The rate of interest that a
lessee would have to pay to borrow over a similar term, and with a similar
security, the funds necessary to obtain an asset of a similar value to the
right-of-use asset in a similar economic environment.’ What does ‘similar
value’ mean?

 

Response

The
right-of-use (ROU) asset rather than the underlying asset shall be considered
as a security with similar value. The value of the ROU
asset does not include payments that are not lease payments (e.g., variable
payments not based on an index or rate). Similarly, the lease payments relating
to optional periods that are not included in the lease term should also be
excluded.

 

Query

A company is able to estimate the IBR at
which it would borrow to buy a truck (10 years’ useful life) or property.
Whether the same IBR can be applied if the asset is not the truck but rather a
5-year right of use (ROU) or the asset is not property but an ROU of the
property, or say only two floors of a building are leased?

 

Response

Whilst there is a practical difficulty in
determining the IBR in the case of an ROU, it is necessary to do so and it will
not be the same as the IBR of the truck or the property.

 

A lessee should start with the rate it would
incur to purchase the underlying asset, but that rate would require adjustment
to reflect ‘an asset of similar value to the ROU asset’. Adjustments may be
both negative and positive depending on the type of asset and risks associated
with the residual value of the asset.  

 

ACIT-2(3) vs. M/s Tata Sons Ltd.; date of order: 9th December, 2015; [ITA. No. 1719/Mum/2012, A.Y.: 2004-05; Mum. ITAT]

3.      
The Pr. CIT-2 vs. M/s Tata Sons
Ltd. [Income tax Appeal No. 639 of 2017] Date of order: 19th August, 2019 (Bombay High Court)

 

ACIT-2(3) vs. M/s Tata Sons Ltd.; date of
order: 9th December, 2015; [ITA. No. 1719/Mum/2012, A.Y.: 2004-05;
Mum. ITAT]

 

Section 147 – Reassessment – The reopening
notice was issued before the reasons were recorded for reopening the assessment
– Reopening notice is bad in law [S. 148]

 

On 6th
March, 2009 the AO issued a notice u/s 148 of the Act seeking to re-open the
assessment. The assessee company contended that the reopening notice was issued
much before the reasons for doing so were recorded, thus the reopening notice
was without jurisdiction. However, the AO did not accept the assessee’s
contention and passed an order of assessment u/s 143(3) r/w/s 148 of the Act.

 

Being aggrieved with the order, the assessee
company carried the issue in appeal to the CIT(A). The CIT(A) held that the
reopening notice had been issued without having recorded the reasons which might
have led the AO to form a reasonable belief that income chargeable to tax had
escaped assessment. The reasons were recorded on 19th March, 2009
while the impugned notice issued is dated 6th March, 2009. The
CIT(A) held that the entire proceeding of reopening is vitiated as notice u/s
148 of the Act is bad in law.

 

Aggrieved with this, the Revenue filed an
appeal before the Tribunal. The Tribunal specifically asked the Revenue to
produce the assessment record so as to substantiate its case that the impugned
notice u/s 148 of the Act was issued only after recording the reasons for
reopening the assessment. The Revenue produced the record of assessment for
A.Y. 2004-05 before the Tribunal. The Tribunal on facts found from the entries
made in the assessment record produced an entry as regards issue of notice u/s
148 dated 6th March, 2009.

 

However, no
entries prior to 6th March, 2009 were produced before the Tribunal
so as to establish that the reasons were recorded prior to the issue of notice
dated 6th March, 2009 u/s148 of the Act. Thus, the Tribunal
concluded that there was nothing in the records which would indicate that any
reasons were recorded prior to the issue of notice. Therefore, the order of the
CIT(A) was upheld.

 

Still aggrieved, this time with the order of
the Tribunal, the Revenue carried the issue in appeal to the High Court. The
High Court held that both the CIT(A) and the Tribunal had concurrently come to
a finding of fact that no reasons were recorded by the AO prior to issuing the
reopening notice dated 6th March, 2009.

 

Further,
section 292B of the Act would have no application in the present facts as the
condition precedent for issuing of the reopening notice, namely, recording of
reasons, has not been satisfied by the AO. Thus, it is not a case of clerical
error but the substantial condition for a valid reopening notice, viz.,
recording of reasons to form a reasonable belief, is not satisfied. Accordingly
the appeal was dismissed.



Sandu Pharmaceuticals Ltd. vs. Asst. CIT-10(2); date of order: 23rd March, 2016; [ITA. No. 2087/Mum/2012; A.Y.: 2009-10; Mum. ITAT] Section 194H – Tax deduction at source – Manufacture the goods as per the specification – Discount vis-a-vis commission – No principal-agent relationship, hence not liable to deduct tax at source – Consistent view accepted over years

2.      
Pr. CIT-14 vs. Sandu
Pharmaceuticals Ltd. [ITA No. 953 of 2017] Date of order: 27th August, 2019 (Bombay High Court)

 

Sandu Pharmaceuticals Ltd. vs. Asst.
CIT-10(2); date of order: 23rd March, 2016; [ITA. No. 2087/Mum/2012;
A.Y.: 2009-10; Mum. ITAT]

 

Section 194H – Tax deduction at source –
Manufacture the goods as per the specification – Discount vis-a-vis commission
– No principal-agent relationship, hence not liable to deduct tax at source –
Consistent view accepted over years

 

The assessee company is engaged in the
manufacture of Ayurvedic medicines. During the assessment proceedings the AO
noted that on the sales turnover of Rs.14.25 crores, the assessee had given
discount of Rs. 7.27 crores. The AO called upon the assessee to furnish details
of the discount given. In response, the respondent pointed out that it was
selling its Ayurvedic medicines to a company called Sandu Brothers Private
Limited (SBPL) at a discount of 51%. This, after taking into account the cost
of distribution, field staff salary, travelling expenses, incentives,
marketing, etc. However, the AO held that 10% was on account of discount and
the balance 41% was the commission involved in selling its product through
SBPL. He therefore held that tax had to be deducted on the commission of Rs.
5.84 crores u/s 194H of the Act. This not being done, the entire amount of Rs.
5.84 crores being the commission at 41% was disallowed in terms of section
40(a)(ia) of the Act.

 

Being aggrieved, the assessee filed an
appeal before the CIT(A). But the CIT(A) dismissed the appeal.

 

Being aggrieved by the order, the assessee
filed an appeal to the Tribunal. The Tribunal observed that the assessee had
entered into an agreement with SBPL on 1st April, 1997 for the sale
of its products. As per clause 1 of the agreement, the assessee is to
manufacture and process certain Ayurvedic drugs and formulations by utilising
the secret formulation given by SBPL and pack them in bulk or in such other
packs as may be stipulated or specified by SBPL to enable them to market the
same by buying the said products on its account. Clause 11 of the agreement
stipulates that the sale of goods to SBPL is on principal-to-principal basis
and none of the parties to the agreement shall hold oneself as agent of the
other under any circumstances. It further stipulates that SBPL shall sell the
products on its own account only and not as an agent or on behalf of the
assessee.

 

Clause 10(a) of the agreement provides that
the assessee shall manufacture the goods as per the specifications of SBPL and
if the products are not in accordance with the standard, SBPL shall have the
right to reject the products. However, clause 10(b) provides that once SBPL
accepts certain products manufactured by the assessee, any loss suffered by
SBPL subsequently, due to handling, transportation of storage shall be borne by
SBPL itself. Thus, on overall consideration of the agreement between the
parties, it becomes clear that once certain goods are sold to SBPL after
certification by them, ownership of such goods is transferred from the assessee
and vests with SBPL. Thus, once the goods are certified by SBPL and sold to
them the contract of sale concludes as far as the assessee is concerned, as
goods cannot be returned back to the assessee. Therefore, examined in the
aforesaid perspective, it has to be concluded that it is a transaction of sale
between the assessee and SBPL on principal-to-principal basis and there is no
agency between them. Further, on a perusal of the invoices raised, it is clear
that the assessee has given a discount of 51% on the MRP of the goods sold.

 

These evidences clearly demonstrate that
there is no relationship of principal and agent between the assessee and SBPL.
The Departmental authorities have failed to demonstrate that SBPL was acting as
an agent on behalf of the assessee to satisfy the condition of section 194H. It
is also relevant to note, though, that the agreement with SBPL is subsisting
from the year 1997 and similar trade discount has been given to SBPL on sales
effected over the years; but the Department has not made any disallowance
either in the preceding assessment years or in the subsequent assessment years.
This fact is evident from the assessment orders passed for A.Ys. 2005-06 and
2006-07 u/s 143(3) of the Act. That being the case, when the Department is
following a consistent view by not treating the discount given in the nature of
commission over the years under identical facts and circumstances, a different
approach cannot be taken in the impugned A.Y.

 

Being aggrieved
by the order, the Revenue filed an appeal before the High Court. The Court
observed that the Tribunal has on facts come to the conclusion that the sale of
goods to Sandu Brothers Private Limited was on principal-to-principal basis and
not through an agent. Thus, no amount of the discount aggregating to Rs. 7.27
crores can be classified as commission. Therefore, section 194H of the Act
calling for deduction of tax of such a commission would have no application to
the present facts. The Revenue has not been able to show that the finding of
fact arrived at by it on the basis of the terms of the agreement is in any
manner perverse, or capable of a different interpretation. Therefore, the
department appeal was dismissed.

 

M/s Siemens Nixdorf Information Systemse GmbH vs. Dy. Dir. of Income Tax (Int’l Taxation) 2(1); [ITA No. 3833/M/2011; date of order: 31st March, 2016; A.Y.: 2002-03; Mum. ITAT] Section 2(14) – Capital asset – Advance given to subsidiary – Loss arising on sale of said asset was held to be treated as short-term capital loss [S. 2(47)]

1.      
The CIT (IT)-4 vs. M/s Siemens
Nixdorf Information Systemse GmbH [Income tax Appeal No. 1366 of 2017 Date of
order: 26th August, 2019 (Bombay
High Court)

 

M/s Siemens Nixdorf Information Systemse
GmbH vs. Dy. Dir. of Income Tax (Int’l Taxation) 2(1); [ITA No. 3833/M/2011;
date of order: 31st March, 2016; A.Y.: 2002-03; Mum. ITAT]

 

Section 2(14)
– Capital asset – Advance given to subsidiary – Loss arising on sale of said
asset was held to be treated as short-term capital loss [S. 2(47)]

 

The assessee company has a subsidiary by the
name Siemens Nixdorf Information Systems Limited (SNISL) to which it had lent
an amount of Euros 90 lakhs under an agreement dated 21st September,
2000. When SNISL ran into serious financial troubles and was likely to be wound
up, the assessee company sold this debt of Euros 90 lakhs to one Siemens AG.
This was done on the basis of the valuation carried out by M/s Infrastructure
and Leasing Finance Ltd. The assessee company claimed the difference in the
amount which was invested / lent to SNISL and the consideration received when
sold / assigned to Siemens AG as a short-term capital loss.

 

However, the AO disallowed the short-term
capital loss, pointing out that the amount lent by the assessee company to its
subsidiary was not a capital asset u/s 2(14) of the Act and also that no
transfer in terms of section 2(47) of the Act took place on the assignment of a
loss.

 

Being aggrieved, the assessee company
carried the issue in appeal to the CIT(A). But even the CIT(A) did not accept
the contention that the amount of Euros 90 lakhs lent to SNISL was a capital
asset and upheld the order of the AO. However, it also held that although the
assignment of a loss was a transfer u/s 2(47) of the Act, but it is of no avail
as the loan being assigned / transferred is not a capital asset.

 

On further appeal, the Tribunal held that
section 2(14) defines the term ‘capital asset’ as ‘property of any kind held by
an assessee, whether or not connected with his business or profession’, except
those which are specifically excluded in the said section. It further records
the exclusion is only for stock-in-trade, consumables or raw materials held for
purposes of business. It thereafter examined the meaning of the word ‘property’
to conclude that it has a wide connotation to include interest of any kind. It
placed reliance upon the decision of the Bombay High Court in the case of CWT
vs. Vidur V. Patel [1995] 215 ITR 30 rendered in the context of the
Wealth Tax Act, 1957 which, while considering the definition of ‘asset’, had
occasion to construe the meaning of the word ‘property’. It held the word
‘property’ to include interest of every kind. On the aforesaid basis, the
Tribunal held that in the absence of loan being specifically excluded from the
definition of capital assets under the Act, the loan of Euros 90 lakhs would
stand covered by the meaning of the word ‘capital asset’ as defined u/s 2(14)
of the Act. It also held that the transfer of the loan, i.e., capital asset,
will be covered by section 2(47) of the Act. The Revenue had not filed any
appeal on this issue, thus holding that the assessee company would be entitled
to claim loss on capital account while assigning / transferring the loan given
to SNISL to one to Siemens AG.

 

Being aggrieved with the order of the ITAT,
the Revenue carried the issue in appeal to the High Court. The Court observed
that section 2(14) of the Act defined the word ‘capital asset’ very widely to
mean property of any kind. However, it specifically excludes certain properties
from the definition of ‘capital asset’. The Revenue has not been able to point
out any of the exclusion clauses being applicable to an advancement of a loan.
It is also relevant to note that it is not the case of the Revenue that the
amount of Euros 90 lakhs was a loan / advance income of its trading activity.
The meaning of the word ‘property’ as given in the context of the definition of
asset in the Wealth Tax Act is that ‘property’ includes every interest which a
person can enjoy. This was extended by the Tribunal to understand the meaning
of the word ‘property’ as found in the context of capital asset u/s 2(14) of
the Act. The High Court in the case of Vidur Patel (Supra) has
observed
as under:

 

‘…So far as the meaning of “property” is
concerned, it is well settled that it is a term of widest import and, subject
to any limitation which the context may require, it signifies every possible
interest which a person can hold or enjoy. As observed by the Supreme Court
in Commissioner, Hindu Religious Endowments vs. Shri Lakshmirudra Tirtha Swami
of Sri Shirur Mutt (1954) SCR 1005, there is no reason why this word should
not be given a liberal or wide connotation and should not be extended to those
well-recognised types of interests which have the insignia or characteristic of
property right.’

 

The only objection of the Revenue to the
above decision being relied upon was that it was rendered under a different
Act. In this context, the Court relied on another decision in case of Bafna
Charitable Trust vs. CIT 230 ITR 846. In this case, the Court observed
as under:

 

‘Capital asset has been defined in clause
(14) of section 2 to mean property of any kind held by an assessee, whether or
not connected with his business or profession, except those specifically
excluded. The exclusions are stock-in-trade, consumable stores or raw materials
held for the business or profession, personal effects, agricultural land and
certain bonds. It is clear from the above definition that for the purposes of
this clause property is a word of widest import and signifies every possible
interest which a person can hold or enjoy except those specifically excluded.’

The Bombay High Court noted that the Revenue
had not been able to point out why the above decision of this Court rendered in
the context of capital assets as defined in section 2(14) of the Act was
inapplicable to the present facts; nor, why the loan given to SNISL would not,
in the present facts, be covered by the meaning of ‘capital asset’ as given u/s
2(14) of the Act. In the above view, as the issue raised herein stands
concluded by the decision of this Court in Bafna Charitable Trust (Supra),
and also by the self-evident position as found in section 2(14) of the Act, the
Revenue appeal accordingly stands dismissed.

Refund of tax wrongly paid – Income-tax authorities – Scope of power u/s 119 of ITA, 1961 – Tax paid by mistake – Application for revision u/s 264 not maintainable – Income-tax authorities should act u/s 119

8.      
Karur Vysya Bank Ltd. vs.
Principal CIT; [2019] 416 ITR 166 (Mad.) Date of order: 12th June, 2019 A.Y.: 2007-08

 

Refund of tax
wrongly paid – Income-tax authorities – Scope of power u/s 119 of ITA, 1961 –
Tax paid by mistake – Application for revision u/s 264 not maintainable –
Income-tax authorities should act u/s 119

The assessee is a
bank. For the A.Y. 2007-08, the assessee paid fringe benefits tax in respect of
contribution to an approved pension fund. For the A.Y. 2006-07, the Tribunal
held that fringe benefits tax was not payable on such contribution. Therefore, for
the A.Y. 2007-08, the assessee filed an application u/s 264 of the Income-tax
Act, 1961 for refund of the tax wrongly paid. The application was rejected on
the ground of delay.

 

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

 

‘(i) The Income-tax
Department represents the sovereign power of the State in matters of taxation.
Whether the Department had illegally collected the tax from the citizen or
whether the assessee mistakenly paid the tax to the Department, the consequence
is one and the same. If the assessee had mistakenly paid, it is a case of
illegal retention by the Department.

 

(ii) It is
well-settled principle of administrative law that if the authority otherwise
had the jurisdiction, mere non-quoting or misquoting of provision will not
vitiate the proceedings.

 

(iii)   Section 264 was clearly not applicable in
this case. But section 119 could have been invoked. The authority ought to have
posed only one question to himself, i.e., whether the assessee was liable to
pay the tax in question or not. If he was not liable to pay the tax in
question, the Department had no business to retain it even if it was wrongly
paid.

 

(iv)  In this view of the matter, the order impugned
in this writ petition is quashed and the respondent is directed to pass orders
afresh u/s 119 of the Act within a period of eight weeks from the date of
receipt of this order.’

Refund – Interest on refund – Section 244A of ITA, 1961 – Amount seized from assessee in search proceedings shown as advance tax in return – Return accepted and assessment made – Assessee entitled to interest u/s 244A on such amount

7.      
Agarwal Enterprises vs. Dy.
CIT; [2019] 415 ITR 225 (Bom.) Date of order: 24th January, 2019 A.Y.: 2015-16

 

Refund – Interest on refund – Section 244A
of ITA, 1961 – Amount seized from assessee in search proceedings shown as
advance tax in return – Return accepted and assessment made – Assessee entitled
to interest u/s 244A on such amount

 

In the course of
the search proceedings u/s 132 of the Income-tax Act, 1961 conducted in the
office premises of the assessee on 9th October, 2014 cash of Rs. 35
lakhs was seized. The assessee applied for release of the seized cash after
adjusting tax liability due on the amount but the same was not accepted by the
AO. The assessee filed its return of income for the A.Y. 2015-16, declaring
total income of Rs. 39.15 lakhs, which included the cash of Rs. 35 lakhs seized
during the course of the search. The assessee showed the seized cash of Rs. 35
lakhs as advance tax and claimed a refund of Rs. 27.50 lakhs. The AO passed an
assessment order u/s 143(3) of the Act including the said cash of Rs. 35 lakhs
in the total income. However, the amount of Rs. 35 lakhs which was shown as
advance tax was not accepted and an independent demand of Rs. 9.18 lakhs was
raised on the assessee u/s 156 of the Act. The demand was paid by the assessee.
Subsequently, on application for refund of seized cash of Rs. 35 lakhs, the AO
refunded Rs. 31.5 lakhs after deducting the outstanding penalty demand of Rs.
3.5 lakhs. However, the AO refused to pay interest on the refunded amount.

 

The assessee filed
a writ petition and challenged the order. The Bombay High Court allowed the
writ petition and held as under:

 

‘(i)   It was an undisputed position that Rs. 35
lakhs was seized when the officers of the Revenue searched the assessee’s
premises. It was also undisputed position that consequent to the seizure of Rs.
35 lakhs, the assessment was done not u/s 153A of the Act, but u/s 143(3) of
the Act in respect of the A.Y. 2015-16.

 

(ii) The assessee in its return of income filed on 22/09/2015 had shown
Rs. 35 lakhs being the seized cash, as advance tax. While passing the
assessment order, the Assessing Officer did not adjust the seized cash as
advance tax paid on behalf of the assessee. This non-adjustment by the
Assessing Officer of the amount being offered as advance tax by the assessee
was unjustified and without reasons. Under the circumstances, the character of
the seized cash underwent a change and became advance tax. This was more
particularly so as for the subject assessment year, it had been accepted as
income. Though the Revenue did not accept the declaration made by the assessee
in its return of advance tax, the fact was that the assessee claimed it to be
tax.

 

(iii) Therefore, on the date the demand notice u/s 156 of the Act was
issued, there was an excess amount with the Revenue which the assessee was
claiming to be tax. Therefore, in terms of the Explanation to section
244A(1)(b) the amount of Rs. 35 lakhs was excess tax (on change of its character
from seized amount to tax paid) and the assessee was entitled to interest on
Rs. 35 lakhs w.e.f. 16/12/2016 on the passing of the assessment order. The
Assessing Officer had to give interest at 6% per annum from 16/12/2016 up to
31/05/2017 on Rs. 35 lakhs (i.e. before the adjustment of penalty of Rs. 3.5
lakhs of Rs. 35 lakhs) and on Rs. 31.50 lakhs from 01/06/2017 to 07/03/2018
when the sum of Rs. 31.5 lakhs was paid to the assessee.’

Industrial undertaking – Deduction u/s 80-IB of ITA, 1961 – Condition precedent – Profit must be derived from industrial undertaking – Assessee manufacturing pig iron – Profit from sale of slag, a by-product in manufacture of pig iron – Profit entitled to deduction u/s 80-IB

6.      
Sesa Industries Ltd. vs. CIT;
[2019] 415 ITR 257 (Bom.) Date of order: 18th April, 2019 A.Y.: 2004-05

 

Industrial undertaking – Deduction u/s
80-IB of ITA, 1961 – Condition precedent – Profit must be derived from
industrial undertaking – Assessee manufacturing pig iron – Profit from sale of
slag, a by-product in manufacture of pig iron – Profit entitled to deduction
u/s 80-IB

 

For the A.Y.
2004-05, the assessee claimed deduction u/s 80-IB of the Income-tax Act, 1961
for one of its industrial undertakings which was engaged in the manufacture of
pig iron. The AO computed the deduction u/s 80-IB only on the profits arising
from the sale of pig iron, without considering the profits arising on sale of
‘slag’ which, according to the assessee, was a by-product in the manufacture of
pig iron.

 

The Commissioner
(Appeals) allowed the assessee’s claim. The Tribunal held that the Commissioner
(Appeals) had taken the correct view holding that profits from sale of slag
generated out of the manufacturing process were a part of the profits derived
from the industrial undertaking engaged in the manufacturing of pig iron, but
allowed the appeal of the Revenue.

 

The Bombay High
Court allowed the appeal filed by the assessee and held as under:

 

‘(i)   The conclusion drawn by the Tribunal was
contrary to the finding rendered by it and perverse. The slag generated during
the process of manufacturing activity of pig iron was part of the manufacturing
process and was a by-product of pig iron and an integral part of the
manufacturing activity conducted by the assessee and thus the profits earned
from the sale of such by-product would have to be considered as part of the
profits derived from the business of the industrial undertaking.

 

(ii)   The slag generated during the manufacturing activity
satisfied the test of first degree source and, thus, the assessee was eligible
to seek deduction u/s 80-IB for the profits earned out of the sale of slag, in
addition to the deduction already availed of by the assessee on the profits
earned on sale of pig iron.’

 

Capital gains – Exemption u/s 54F of ITA, 1961 – Agreement to sell land in August, 2010 and earnest money received – Sale deed executed in July, 2012 – Purchase of residential house in April, 2010 – Assessee entitled to benefit u/s 54F

20. Kishorbhai
Harjibhai Patel vs. ITO; [2019]
417 ITR 547 (Guj.) Date
of order: 8th July, 2019

A.Y.:
2013-14

 

Capital
gains – Exemption u/s 54F of ITA, 1961 – Agreement to sell land in August, 2010
and earnest money received – Sale deed executed in July, 2012 – Purchase of
residential house in April, 2010 – Assessee entitled to benefit u/s 54F

 

The
assessee entered into an agreement to sell agricultural land at Rs. 4 crores on
13th August, 2010. An amount of Rs. 10 lakhs towards the earnest
money was received by the assessee as part of the agreement. On 15th
October, 2011, possession of the land was handed over by the assessee to the
purchasers of the land. On 3rd July, 2012 the sale deed came to be
executed by the assessee in favour of the purchaser of the land. The assessee
had purchased a new residential house in April, 2010 and claimed exemption u/s
54F of the Income-tax Act, 1961. The AO denied the exemption on the ground that
the transfer of the land took place on 3rd July, 2012 and the
purchase of the residential house on 22nd April, 2010, thus it was beyond
the period of one year as required u/s 54F.

 

The
Tribunal upheld the decision of the AO.

 

The
Gujarat High Court allowed the appeal filed by the assessee and held as under:

‘(i)      The Act gives a precise definition to the
term “transfer”. Section 2(47)(ii) of the Act talks about extinguishment of
rights. The Supreme Court, in Sanjeev Lal vs. CIT (2014) 365 ITYR 389
(SC) is very clear that an agreement to sell would extinguish the
rights and this would amount to transfer within the meaning of section 2(47) of
the Act. This definition of transfer given in the Act is only for the purpose
of the income-tax.

 

(ii)      The assessee had purchased the new
residential house in April, 2010. The agreement to sell which had been executed
on 13th April, 2010 (and) could be considered as the date on
which the property, i.e., the agricultural land had been transferred. Hence,
the assessee was entitled to the benefit u/s 54F.’

Charitable purpose – Exemption u/s 11 of ITA, 1961 – Assessee entitled to allocate domain names providing basic services of domain name registration charging annual subscription fees and connectivity charges – Activity in nature of general public utility – Fees charged towards membership and connectivity charges – Incidental to main objects of assessee – Assessee entitled to exemption

19.  CIT vs. National Internet Exchange of India; [2019]
417 ITR 436 (Del.) Date
of order: 9th January, 2018 A.Y.:
2009-10

 

Charitable
purpose – Exemption u/s 11 of ITA, 1961 – Assessee entitled to allocate domain
names providing basic services of domain name registration charging annual
subscription fees and connectivity charges – Activity in nature of general
public utility – Fees charged towards membership and connectivity charges –
Incidental to main objects of assessee – Assessee entitled to exemption

 

The
assessee was granted registration u/s 12A of the Income-tax Act, 1961 from the
A.Y. 2004-05. The assessee was engaged in general public utility services. He
was the only nationally designated entity entitled to allocate domain names to
its applicants who sought it in India. It was also an affiliate national body
of the Internet Corporation for assigned names and numbers and authorised to
assign ‘.in’ registration and domain names according to the Central
Government’s letter dated 20th November, 2004. It provided basic
services by way of domain name registration for which it charged subscription
fee on annual basis and also collected connectivity charges.

 

The AO was
of the opinion that the subscription fee and the fee charged by the assessee
towards various services provided by it were in the nature of commercial
activity and fell outside the charitable objects for which it was established
and denied exemption u/s 11 of the Act.

 

The Commissioner (Appeals) held that the assessee had been incorporated
without any profit motive, that the nature of services provided by the assessee
were of general public utility and that the services provided were towards
membership and connectivity charges which were only incidental to the main
objects of the assessee. The Tribunal confirmed the order of the Commissioner
(Appeals).

 

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

 

‘(i)      The assessee had been incorporated without
any profit motive. The services provided by the assessee were of general public
utility and were towards membership and connectivity charges and were
incidental to its main objects. The assessee (though not a statutory body)
carried on regulatory work.

 

(ii)      Both the appellate authorities had
concluded that the assessee’s objects were charitable and that it provided
basic services by way of domain name registration for which it charged
subscription fee on an annual basis and also collected connectivity charges. No
question of law arose.’

 

Charitable institution – Registration u/s 12AA of ITA, 1961 – Cancellation of registration – No finding that activities of charitable institution were not genuine or that they were not carried out in accordance with its objects – Mere resolution of governing body to benefit followers of a particular religion – Cancellation of registration not justified

18. St.
Michaels Educational Association vs. CIT; [2019]
417 ITR 469 (Patna) Date
of order: 13th August, 2019

 

Charitable institution – Registration u/s 12AA of ITA,
1961 – Cancellation of registration – No finding that activities of charitable
institution were not genuine or that they were not carried out in accordance
with its objects – Mere resolution of governing body to benefit followers of a
particular religion – Cancellation of registration not justified

 

The
assessee was an educational institution running a high school and was granted
registration u/s 12AA of the Income-tax Act, 1961 in April, 1985. In August,
2011 the Commissioner issued a show-cause notice proposing to cancel
registration and cancelled the registration exercising powers u/s 12AA(3) of
the Act.

 

The
Tribunal upheld the order of the Commissioner cancelling the registration.

 

But the
Patna High Court allowed the appeal filed by the assessee and held as under:

 

‘(i)      A plain reading of the enabling power vested
in the Commissioner in section 12AA(3) would confirm that it is only in two
circumstances that such power can be exercised by the Principal Commissioner or
the Commissioner:

(a) if the
activities of such trust or institution are not found to be genuine; or (b) the
activities of such trust or institution are not being carried out in accordance
with the objects of the trust or institution. Where a statute provides an act
to be done in a particular manner it has to be done in that manner alone and every
other mode of discharge is clearly forbidden.

(ii)      The ground for cancellation of
registration is that in some of the subsequent governing body meetings some
resolutions were passed for the benefit of the Christian community. The order
of cancellation has been passed by the Commissioner without recording any
satisfaction, either on the issue of the activities of the school being not
genuine or that they were not being carried out in accordance with the objects
for which the institution had been set up. The order of cancellation of the
registration was not valid.’

 

Business expenditure – Section 37 of ITA, 1961 – Prior period expenses – Assessment of income of prior period – Prior period expenses deductible – No need to demonstrate that expenses relate to income

16. Principal
CIT vs. Dishman Pharmaceuticals and Chemicals Ltd.; [2019]
417 ITR 373 (Guj.) Date
of order: 24th June, 2019 A.Y.:
2006-07

 

Business expenditure – Section 37 of ITA, 1961 – Prior
period expenses – Assessment of income of prior period – Prior period expenses
deductible – No need to demonstrate that expenses relate to income

 

For the
A.Y. 2006-07, the AO found that the assessee had credited Rs. 3,39,534 as net
prior period income, i.e., prior period income of Rs. 46,50,648 minus prior
period expenses of Rs. 43,11,114. The AO took the view that ‘prior period
income’ was taxable, but the ‘prior period expenses’ were not allowable. Thus,
he made an addition of Rs. 46,50,648 as prior period income and denied the
set-off of the prior period expenses on the basis that a different set of rules
applied to such income and expenses.

 

The
Commissioner (Appeals) confirmed the addition and held that prior period expenses
cannot be adjusted against the prior period income in the absence of any
correlation or nexus. The Tribunal allowed the assessee’s claim and held that
once the assessee offers the prior period income, then the expenditure incurred
under the different heads should be given set-off against that income and only
the net income should be added.

 

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

 

‘(i)      The only requirement u/s 37 of the
Income-tax Act, 1961 is that the expenses should be incurred for the purposes
of the business or profession. There is no need to demonstrate that a certain
expense relates to a particular income in order to claim such expense.

 

(ii)      Once prior period income is held to be
taxable, prior period expenditure also should be allowed to be set off and the
assessee is not obliged in law to indicate any direct or indirect nexus between
the prior period income and prior period expenditure.’

 

DEMERGER TRANSACTION UNDER Ind AS

QUERY

  •      A has control over its100%
    subsidiary B.
  •      There are 5 investors
    (shareholders – X, X1, X2, X3 and X4) in A. No investor controls or jointly
    controls or has significant influence on A.
  •      A, B and all the investors in
    A follow Ind AS. All the investors measure their investment in A at FVTPL. A’s
    accounting policy is to measure investments in subsidiary and associates at
    cost in separate financial statements.
  •      Due to certain regulatory
    issues, A should not be controlling B.
  •      Consequently, B issues its
    shares to the investors in A without any consideration, which will reduce A’s
    shareholding in B to 40%. Accordingly, B becomes A’s associate.
  •      The number of shares which A
    held in B, pre and post the transaction has not changed, as shares have been
    distributed by B directly to the shareholders of A. However, A’s holding in B
    is reduced to 40%.
  •      Investor X, one of the 5
    investors, is holding 100 shares in A at fair value of INR 200. Investor X
    continues to hold 100 shares and has received shares of B for no consideration.
  •      All investors are treated
    equal in proportion to their shareholding.
  •      The decision to undertake the
    above transaction had the unanimous approval of the board of directors of B.

 

Pre- and post-restructuring shareholding pattern is depicted in the
diagram below:

How shall A, B and investor X account for this transaction in their Ind
AS separate financial statement (SFS)?

RESPONSE

Accounting
in SFS of investor X

View 1 – There is no change in X’s situation except that now X is directly
holding in B instead of through A. Consequently, X will simply split the fair
value of its holding in A into A’s share and B’s share on relative fair value
basis. Under this view, there is no P&L impact.

 

To support
this view, one may draw an analogy from ITFG 20 issue 4. In that fact pattern,
there is transfer of a business division from an associate to fellow associate.
ITFG concluded that there is no ‘exchange’ of investments. Investor continues
to hold the same number and proportion of equity shares in A Limited
(Transferor associate) after the demerger as it did before the demerger.
Therefore, applying this principle, the ‘cost’ of the new shares received in B
is represented by the amount derecognised by X Limited in respect of its
investment in A Limited. The accounting is presented below, with assumed
figures. However, one should be mindful that in ITFG’s case, investment is
carried at cost, whereas in the given case these investments are carried at
fair value. Consequently, if the fair value of shares in A pre-transaction is
less than the aggregate fair value of shares in A and B post-transaction, this
accounting may result in subsequent gains to investor X, which needs to be
recognised in the P&L.

 

In X’s SFS

Particulars

Dr. (INR)

Cr. (INR)

Investment in A (relative fair value)

Investment in B (relative fair value)

To investment in A (pre-receipt of B’s share)

80

120

 

 

200

 

 

View 2 – X is having investment in financial instrument, which are carried at
FVTPL. Post the transaction, X shall fair value its investment in A and B; if
there is any gain due to unlocking of value or other factors, gain should be
recognised in P&L immediately.

In X’s SFS

Particulars

Dr. (INR)

Cr. (INR)

Investment in B(@ fair value)      Dr

To Investment in A (change in fair value)

To gain on exchange – P&L (if any)

140

 

110

30

 

 

Note: Fair value of
investment in B and change in fair value of investment in A are hypothetical
and for illustrative purposes only. The gain of INR 30 reflects unlocking of
value in the hands of investors.

 

Accounting
in the SFS of A

View 1 – The number of shares which A held in B pre and post the transaction
has not changed. As the cost of investment for holding the same number of
shares has not changed and A has not received or distributed any shares, the
investments will continue to be recorded at the same cost, even though the
investment is now an associate. However, A will test the investment for
impairment as per Ind AS 36 and record the impairment charge to P&L, if
any. Analogy can be drawn from transactions wherein subsidiary issues shares to
outside unrelated shareholders and thereby the parent loses control and that investment
becomes as associate. In such a case, the common practice in SFS of parent is
that the investment continues to be recorded at cost (subject to impairment).

 

  •    Additionally, at the ultimate
    shareholders level per se nothing has changed. Therefore, it cannot be
    inferred that any dividend has been distributed to the shareholders by A. The
    decision is taken by the ultimate shareholders, and A does nothing substantial.
    At best, A is merely a pass through; that, too, indirectly rather than
    directly. Consequently, A is neither receiving any dividends nor distributing
    any dividends. However, due to the dilution, its investment in B will be tested
    for impairment.

 

  •    To support View 1, there can be
    multiple ways of looking at this transaction:

•   A is giving up the value of its
underlying investment in subsidiary B to its shareholders. A has not declared
and is not obliged to distribute any dividends (hence Ind AS 10 Appendix A Distribution
of Non-cash Assets to Owners does not apply). Neither is there a demerger
from A’s perspective. Consequently, A’s Investment in B will be credited at
fair value, book value, or brought to its post impaired value, with the
corresponding impact taken to equity.

•   This is merely a restructuring
arrangement where the subsidiary is now split between A and the ultimate
shareholders. There are no dividends received or paid. The decision of
splitting the shares is taken by ultimate shareholders, rather than A. A does
nothing. Consequently, A’s investment in B will be only tested for impairment.

 

In View 1, there is no credit to the P&L in the SFS of A.

 

View 2 – A
has not declared and is not obliged to distribute any dividends, but there is
an indirect distribution by A to its shareholders. In the absence of any
specific guidance to this unique fact pattern, and based on Ind AS 8
Paragraph10, A may draw analogy from Appendix A to Ind AS 10. Accordingly,
applying the guidance on distribution of non-cash assets to the owners, A shall
create a dividend payable liability out of its reserves, and then record the
distribution of non-cash asset (indirect receipt of shares of B) in its books
at fair value of the assets distributed, and the difference between dividend
payable (at fair value) and the investment in B (at proportionate cost of
deemed dilution) would be recorded as a gain in the P&L.

In SFS of A

Particulars

Dr. (INR)

Cr. (INR)

On creation of dividend
payable
liability at fair value

Equity Dr

To Dividend Payable

 

 

1000

 

 

 

1000

On distribution of dividend

Dividend payable (@ fair
value)

To Investment in B

(@Proportionate Cost)

To P&L (Gain) [Balancing
figure]

 

1000

 

 

900

 

100

 

Note: Fair value of dividend
payable and proportionate value of investment in B are hypothetical and for
illustrative purposes only.

 

Accounting
in the SFS of B

From B’s perspective, additional shares are being issued to ultimate
shareholders for which no consideration is received. Consequently, B will
credit share capital and debit equity. Essentially, the debit and credit is
reflected within the equity caption and there is no P&L impact.

 

CONCLUSION

Had A
directly distributed its investment in B to its shareholders, so that its
shareholding in B is reduced to 40%, the application of Ind AS 10 Appendix A
would result in View 2 only, from the perspective of SFS of A. However, in the
absence of any specific guidance under Ind AS with respect to SFS, the author
believes that different views have emerged. Moreover, it is unfair that a
restructuring transaction to comply with regulations should result in a P&L
gain. The ITFG may provide necessary clarifications.  

 

TAXATION OF GIFTS MADE TO NON-RESIDENTS

The Finance (No. 2) Act, 2019 has inserted
section 9(1)(viii) in the Income-tax Act, 1961 (the Act) regarding deemed
accrual in India of gift of money by a person resident in India to a
non-resident. In this article we discuss and explain the said provision in
detail.

 

INTRODUCTION

Taxation of gifts in India has a very long
and chequered history. Ideally, taxes are levied on income, either on its
accrual or receipt. However, with the object of expanding the tax base, the
Indian tax laws have evolved the concept of ‘deemed income’. Deemed income is a
taxable income where the law deems certain kinds of incomes to have accrued to
an assessee in India.

 

Similarly, the legislation in India uses the
concept of deemed income to tax gifts. The Gift Tax Act, 1958 was introduced
with effect from 1st April, 1958 and subsequently amended in the
year 1987. It was repealed w.e.f. 1st October, 1998. Till that date
(1st October, 1998), all gifts (including gifts to relatives)
barring a few exceptions were chargeable to gift tax in the hands of the donor.
The gifts were taxed at a flat rate of about 30% then, with a basic exemption limit
of Rs. 30,000.

 

With the
abolition of the Gift Tax Act, 1958 w.e.f. 1st October, 1998, gifts
were not only used for wealth and income distribution amongst family members /
HUFs, but also for conversion of money. With no gift tax and exemption from chargeability
under the Income-tax Act, gifts virtually remained untaxed until a donee-based
tax was introduced by inserting a deeming provision in clause (v) of section
56(2) by the Finance Act, 2004 w.e.f. 1st April, 2005 to provide
that any sum of money received by an assessee, being an individual or HUF,
exceeding Rs. 25,000 would be deemed to be income under the head ‘Income from
other sources’. Certain exceptions, like receipt of a gift from a relative or
on the occasion of marriage, etc., were provided.

 

The Act was amended w.e.f. 1st
April, 2007 and a new clause (vi) was inserted with an enhanced limit of Rs.
50,000. Another new clause (vii) was inserted by the Finance (No. 2) Act, 2009
w.e.f. 1st October, 2009 to further include under the deeming provision
regarding receipt of immovable property without consideration.

 

When the Act was amended vide Finance Act,
2010 w.e.f. 1st June, 2010, a new clause (viia) was inserted to also
tax (under the deeming provision) a receipt by a firm or company (not being a
company in which public are substantially interested) of shares of a company
(not being a company in which public are substantially interested) without
consideration or at less than fair market value.

 

Via the Finance Act, 2013, and w.e.f. 1st
April, 2013, another new clause (viib) was inserted for taxing premium on the
issue of shares in excess of the fair market value of such shares.

 

Yet another important amendment was made
vide the Finance Act, 2017 w.e.f. 1st April, 2017 suppressing all the
deeming provisions except clause (viib) and a new clause (x) was inserted.

 

At present, clause (viib) and clause (x) of
section 56(2) are in force and deem certain issue of shares or receipt of money
or property as income.

 

SECTION 56(2)(X) AND OTHER RELATED PROVISIONS

Section 56(2) provides that the incomes
specified therein shall be chargeable to income tax under the head ‘Income from
other sources’.

 

Section 56(2)(x) provides that w.e.f. 1st
April, 2017, subject to certain exemptions mentioned in the proviso thereto,
the following receipts by any person are taxable:

(a) any sum of money without consideration,
the aggregate value of which exceeds Rs. 50,000;

(b) any immovable property received without
consideration or for inadequate consideration as specified therein; and

(c) any specified property other than
immovable property (i.e., shares and securities, jewellery, archaeological
collections, drawings, paintings, sculptures, any work of art or bullion)
without consideration or for inadequate consideration, as specified therein.

 

It is important to note that the term
‘consideration’ is not defined under the Act and therefore it must have the
meaning assigned to it in section 2(d) of the Indian Contract Act, 1872.

 

The proviso to
section 56(2)(x) provides for exemption in certain genuine circumstances such
as receipt of any sum of money or any property from any relative, or on the
occasion of a marriage, or under a Will or inheritance, or in contemplation of
death, or between a holding company and its wholly-owned Indian subsidiary, or
between a subsidiary and its 100% Indian holding company, etc.

 

Section
2(24)(xviia) provides that any sum of money or value of property referred to in
section 56(2)(x) is regarded as income.

 

Section 5(2) provides that non-residents are
taxable in India in respect of income which accrues or arises in India, or is
deemed to accrue or arise in India, or is received in India, or is deemed to be
received in India.

 

SECTION 9(1)(VIII)

The Finance (No. 2) Act, 2019 inserted
section 9(1)(viii) w.e.f. A.Y. 2020-21 to provide that any sum of money
referred to in section 2(24)(xviia) arising outside India [which in turn refers
to section 56(2)(x)], paid on or after 5th July, 2019 by a person
resident in India to a non-resident, not being a company, or to a foreign
company, shall be deemed to accrue or arise in India.

 

Section 9(1)(viii) creates a deeming fiction
whereby ‘income arising outside India’ is deemed to ‘accrue or arise in India’.

 

Prior to the insertion of section
9(1)(viii), there was no provision in the Act which covered the gift of a sum
of money given to a non-resident outside India by a person resident in India if
it did not accrue or arise in India. Such gifts therefore escaped tax in India.
In order to avoid such non-taxation, section 9(1)(viii) was inserted.

 

Section 9
provides that certain incomes shall be deemed to accrue or arise in India. The
fiction embodied in the section operates only to shift the locale of accrual of
income.

The Hon’ble Supreme Court in GVK
Industries vs. Income Tax Officer (2015) 231 Taxman 18 (SC) while
adjudicating the issue pertaining to section 9(1)(vii) explored the ‘Source
Rule’ principle and laid down in the context of the situs of taxation,
that the Source State Taxation (SST) confers primacy and precedence to tax a
particular income on the foothold that the source of such receipt / income is
located therein and such principle is widely accepted in international tax
laws. The guiding principle emanating therefrom is that the country where the
source of income is situated possesses legitimate right to tax such source, as
inherently wealth is physically or economically generated from the country
possessing such an attribute.

 

Section 9(1)(viii) deems income arising
outside India to accrue or arise in India on fulfilment of certain conditions
embedded therein, i.e. (a) there is a sum of money (not any property) which is
paid on or after 5th July, 2019; (b) by a person resident in India
to a non-resident, not being a company or to a foreign company; and (c) such
payment of sum of money is referred to as income in section 2(24)(xviia) [which
in turn refers to section 56(2)(x)].

 

Section 9(1)(viii) being a deeming
provision, it has to be construed strictly and its scope cannot be expanded by
giving purposive interpretation beyond its language. The section will not
apply to payment by a non-resident to another non-resident.

 

It is to be noted that any sum of money paid
as gift by a person resident in India to a non-resident during the period 1st
April, 2019 to 4th July, 2019 shall not be treated as income deemed
to accrue or arise in India.

 

Exclusion of gift of property situated
in India:

Section 9(1)(viii) as proposed in the
Finance (No. 2) Bill, 2019 had covered income ‘…arising any sum of money
paid, or any property situate in India transferred…’

 

However, section 9(1)(viii) as enacted reads
as ‘income arising outside India, being any sum of money referred to in
sub-clause (xviia) of clause (24) of section 2, paid…’

 

For example, if a non-resident receives a
gift of a work of art situated outside India from a person resident in India,
then such gift is not covered within the ambit of section 9(1)(viii).

 

Thus, as compared to the proposed
section, the finally enacted section refers to only ‘sum of money’ and
therefore gift of property situated in India is not covered by section
9(1)(viii). It appears that the exclusion of the
property situated in India from the finally enacted section 9(1)(viii) could be
for the reason that such gift of property could be subjected to tax in India
under the existing provisions of section 5(2) where any income received or
deemed to be received in India by a non-resident or on his behalf is subject to
tax in India.

 

Non-application to receipts of gifts
by relatives and other items mentioned in proviso to section 56(2)(x):

As mentioned above, section 9(1)(viii) deems
any sum of money referred to in section 2(24)(xviia) to be income accruing or
arising in India, subject to fulfilment of conditions mentioned therein.

 

Section 2(24)(xviia) in turn refers to sum
of money referred in section 56(2)(x) and regards as income only final
computation u/s 56(2)(x) after considering exclusion of certain transactions
like gifts given to relatives or gift given on the occasion of marriage of the
individual, etc., as mentioned in the proviso to section 56(2)(x).

 

Thus, for example, if there is a gift of US$
10,000 from A who is a person resident in India, to his son S who is a resident
of USA, as per the provision of section 56(2)(x) read with Explanation
(e)(i)(E) of section 56(2)(vii), the same will not be treated as income u/s
9(1)(viii).

 

Therefore,
the insertion of section 9(1)(viii) does not change the position of non-taxability
of receipt of gift from relatives or on the occasion of the marriage of the
individual, etc. Similarly, the threshold limit of Rs. 50,000 mentioned in
section 56(2)(x) would continue to apply and such gift of money up to Rs.
50,000 in a financial year cannot be treated as income u/s 9(1)(viii).

 

It is important
to keep in mind that section 5 broadly narrates the scope of total income.
Section 9 provides that certain incomes mentioned therein shall be deemed to
accrue or arise in India. However, total income under the provisions of the Act
has to be computed as per the other provisions of the Act, and while doing so
benefits of the exemptions / deduction would have to be taken into account.

 

In this connection, the relevant portion of
the Explanatory Memorandum provides that ‘However, the existing provisions
for exempting gifts as provided in proviso to clause (x) of sub-section (2) of
section 56 will continue to apply for such gifts deemed to accrue or arise in
India.’

The Explanatory Memorandum, thus, clearly
provides for application of exemptions provided in proviso to section 56(2)(x).

 

Income arising outside India:

Section
9(1)(viii) uses the expression ‘income arising outside India’ and, keeping in
mind the judicial interpretation of the meaning of the term ‘arise’ or
‘arising’ (which generally means to come into existence), the income has to
come into existence outside India, i.e. the gift of money from a person
resident in India to a non-resident has to be received outside India by the
non-resident.

 

PERSON RESIDENT IN INDIA AND NON-RESIDENT

Person resident in India:

The expression ‘person resident in India’
has been used in section 9(1)(viii). The term ‘person’ has been defined in
section 2(31) of the Act and it includes individuals, HUFs, companies, firms,
LLPs, Association of Persons, etc.

 

The term ‘resident in India’ is used in
section 6 which contains the rules regarding determination of residence of
individuals, companies, etc.

 

It would be very important to minutely
examine the residential status as per the provisions of section 6 to determine
whether a person is resident in India as per the various criteria mentioned
therein, particularly in case of NRIs, expats, foreign companies, overseas
branches of Indian entities, for proper application of section 9(1)(viii).

 

Non-resident:

Section 2(30) of the Act defines the term
‘non-resident’ and provides that ‘non-resident’ means a person who is not a
‘resident’ and for the purposes of sections 92, 93 and 268 includes a person
who is not ordinarily resident within the meaning of clause (6) of section 6.

 

Therefore, for the purposes of section
9(1)(viii), a not ordinarily resident is not a ‘non-resident’.

 

It is to be noted that residential status
has to be determined as per provisions of the Income-tax Act, 1961 and not as
per FEMA.

 

Obligation to deduct tax at source:

Section 195 of the Act provides that any
person responsible for paying to a non-resident any sum chargeable to tax under
the provisions of the Act is obliged to deduct tax at source at the rates in
force. Accordingly, provisions of section 195 would be applicable in respect of
gift of any sum of money by a person resident in India to a non-resident, which
is chargeable to tax u/s 9(1)(viii) and the resident Indian gifting money to a
non-resident shall be responsible to withhold tax at source and deposit the
same in the government treasury within seven days from the end of the month in
which the tax is withheld.

 

The person resident in India shall be
required to obtain tax deduction account number (TAN) from the Indian tax
department, file withholding tax e-statements and issue the tax withholding
certificate to the non-resident. In case of a delay in deposit of withholding
tax / file e-statement / issue certificate, the resident would be subject to
interest / penalties / fines as prescribed under the Act.

 

Applicability of the provisions of
Double Taxation Avoidance Agreement (DTAA):

Section 90(2) of the Act provides that where
the Central Government has entered into a DTAA for granting relief of tax or,
as the case may be, avoidance of double taxation, then, in relation to the
assessee to whom such DTAA applies, the provisions of the Act shall apply to
the extent they are more beneficial to that assessee.

 

Therefore, the relief, if any, under a DTAA
would be available with respect to income chargeable to tax u/s 56(2)(viii).

 

The Explanatory Memorandum clarifies that
‘in a treaty situation, the relevant article of applicable DTAA shall continue
to apply for such gifts as well.’

 

A DTAA distributes taxing rights between the
two contracting states in respect of various specific categories of income
dealt therein. ‘Article 21, Other Income’, of both the OECD Model Convention
and the UN Model Convention, deals with those items of income the taxing rights
in respect of which are not distributed by the other Articles of a DTAA.

 

Therefore, if the recipient of the gift
is a resident of a country with which India has entered into a DTAA, then the
beneficial provisions of the relevant DTAA will govern the taxability of the
income referred to in section 9(1)(viii).

 

Article 21 of the OECD Model Convention,
2017 reads as follows:

Article 21, Other Income:

(i)   Items of income of a resident of a contracting
state, wherever arising, not dealt with in the foregoing Articles of this
Convention, shall be taxable only in that state;

(ii)   The provisions of paragraph 1 shall not apply
to income, other than income from immovable property as defined in paragraph 2
of Article 6, if the recipient of such income, being a resident of a
contracting state, carries on business in the other contracting state through a
permanent establishment situated therein and the right or property in
respect of which the income is paid is effectively connected with such permanent
establishment. In such case, the provisions of Article 7 shall apply.

 

Similarly, Article
21 of the UN Model Convention, 2017 reads as follows:

Article 21,
Other Income:

(1) Items of income
of a resident of a contracting state, wherever arising, not dealt with in the
foregoing Articles of this Convention shall be taxable only in that State;

(2) The provisions
of paragraph 1 shall not apply to income, other than income from immovable
property as defined in paragraph 2 of Article 6, if the recipient of such
income, being a resident of a contracting state, carries on business in the
other contracting state through a permanent establishment situated therein, or
performs in that other state independent personal services from a fixed base
situated therein, and the right or property in respect of which the income is
paid is effectively connected with such permanent establishment or fixed base.
In such a case the provisions of Article 7 or Article 14, as the case may be,
shall apply;

(3) Notwithstanding
the provisions of paragraphs 1 and 2, items of income of a resident of a
contracting state not dealt with in the foregoing Articles of this Convention
and arising in the other contracting
state may also be taxed in that other state.

 

On a comparison of the abovementioned Article 21 of the OECD and UN
Model Conventions, it is observed that Article 21(1) of the OECD Model
Convention provides taxing rights of other income to only a country of
residence.

 

However, Article 21
of the UN Model contains an additional para 3 which gives taxing rights of
other income to the source country also, if the relevant income ‘arises’ in a
contracting state.

 

DTAAs do not define
the term ‘arise’ or ‘arising’ and therefore in view of Article 3(2) of the
Model Conventions, the term not defined in a DTAA shall have the meaning that
it has at that time under the law of the state applying the DTAA.

 

India has currently
signed DTAAs with 94 countries. India’s DTAAs are based on both the OECD as
well as the UN Models. The distribution of taxation rights of other income /
income not expressly mentioned under Articles, corresponding to Article 21 of
the Model Conventions, in the Indian DTAAs can be categorised as under:

 

Sr. No.

Category

No. of countries

Remarks

1.

Exclusive right of taxation to residence state

5

Republic of Korea, Kuwait, Philippines,
Saudi Arabia, United Arab Emirates

2.

Exclusive right of taxation to residence state with limited
right to source state to tax income from lotteries, horse races, etc.

36

Albania, Croatia, Cyprus, Czech Republic,
Estonia, Ethiopia, Georgia, Germany, Jordan, Hungary, Iceland, Ireland,
Israel, Kazakhstan, Kyrgyz Republic, Latvia, Macedonia, Malta, Montenegro,
Morocco, Mozambique, Myanmar, Nepal, Portuguese Republic, Romania, Russia,
Serbia, Slovenia, Sudan, Sweden, Switzerland, Syria, Taipei, Tajikistan,
Tanzania, Uganda

3.

Source state permitted to tax other income

45

Armenia, Australia, Austria, Belarus,
Belgium, Bhutan, Botswana, Brazil, Bulgaria, Canada, China, Columbia, Slovak
Republic, Denmark, Fiji, Finland, France, Indonesia, Japan, Kenya, Lithuania,
Luxembourg, Malaysia, Mauritius, Mongolia, New Zealand, Norway, Oman,
Oriental Republic of Uruguay, Poland, Qatar, Spain, Sri Lanka, South Africa,
Thailand, Trinidad and Tobago, Turkey, Turkmenistan, Ukraine, United Kingdom,
United Mexican States, United States of America, Uzbekistan, Vietnam, Zambia

4.

In both the states, as per laws in force in each state

4

Bangladesh, Italy, Singapore, United Arab Republic (Egypt)

5.

Exclusive right to source state

1

Namibia

6.

No other income article

3

Greece, Libyan Arab Jamahiriya, Netherlands

 

Interestingly, in some of the DTAAs that
India has signed with countries where a large Indian diaspora is present, like
the US, Canada, UK, Australia, Singapore, New Zealand, etc., the taxation right
vests with India (as a source country). It is important that provisions of the
article relating to other income is analysed in detail to evaluate if any tax
is to be paid in the context of such gifts under the applicable DTAA.

 

In cases of countries covered in Sr. Nos.
1 and 2, due to exemption under the respective DTAAs, India would still not be
able to tax income u/s 9(1)(viii) arising to the residents of those countries.

 

IMPLICATIONS UNDER FEMA

Besides tax
laws, one should also evaluate the implications, if any, under the FEMA
regulations for gifts from a person resident in India to a non-resident. Thus,
one must act with caution to ensure compliance with law and mitigate
unnecessary disputes and litigation at a later date.

 

CONCLUDING REMARKS

The stated objective of section 9(1)(viii)
has been to plug the loophole for taxation of gifts of money from a person
resident in India to a non-resident. As the taxability is in the hands of the
non-resident donee, there would be a need for the donee / recipient to obtain
PAN and file an income tax return in India where there is a taxable income
(along with the gift amount that exceeds Rs. 2,50,000 in case of an
individual).

 

In conclusion, this is a welcome provision
providing certainty in the taxability of gifts to non-residents by a person
resident in India.  

 

 

IS IT FAIR TO INTERVENE WITH SEAMLESS FLOW OF INPUT CREDIT – RULE 36(4) OF CGST RULES?

BACKGROUND

GST has been rolled out in
India with one of its main features being bringing about a seamless flow of
input tax credit (ITC) across goods and services.

 

Provisions
of the Act related to ITC: The same are covered under
Chapter V of the Central Goods and Services Tax Act (CGST Act) and section 16
provides the criteria for eligibility and conditions for claiming the ITC which
are reproduced below:

 

‘(i)   he is in possession of a tax invoice or debit
note issued by a supplier registered under this Act, or such other tax-paying
documents as may be prescribed;

(ii)   he has received the goods or services, or both;

(iii)   subject to the provisions of section 41, the
tax charged in respect of such supply has been actually paid to the government,
either in cash or through utilisation of input tax credit admissible in respect
of the said supply; and

(iv) he has furnished the return u/s 39.’

 

Section 16 of the Act
entitles any registered person to claim ITC in respect of inward supply of
goods and services which are used or intended to be used in the course of business or
furtherance of business. Section 49 provides the manner in which ITC is to be
claimed. Section 49(2) provides that ITC as self-assessed in the return
of a registered person shall be credited to his electronic credit ledger in
accordance with section 41.

 

Further,
section 41(1) provides that every registered person shall, subject to such
restrictions and conditions as may be prescribed, be entitled to take credit of
ITC as self-assessed in the returns and such amount shall be credited on
provisional basis to his electronic credit ledger.

 

Section 42 provides for
matching, reversal and reclaiming of ITC by matching details of ITC furnished
in GSTR-2 with GSTR-1 of suppliers. It lays down the procedure for
communication of missed invoices with a facility for rectification of GSTR-1.

Due to technical limitations,
the process of filing GSTR-2 and 3 was suspended by the GST Council in its 22nd
and 23rd meetings. In the interim, the taxpayer was permitted to
avail ITC upon fulfilling the remaining conditions specified u/s 16, viz. valid
documents, actual receipt of supply, etc.

 

ISSUE

New Rule
36(4) inserted vide Notification No. 49/2019 with effect from 9th
October, 2019

The above-mentioned rule
relates to availment of input credit and was inserted in the CGST Rules
(reproduced below):

 

‘(4) Input
tax credit to be availed by a registered person in respect of invoices or debit
notes, the details of which have not been uploaded by the suppliers under sub-section
(1) of section 37, shall not exceed by 20 percent of the eligible credit
available in respect of invoices or debit notes the details of which have been
uploaded by the suppliers under sub-section (1) of section 37.’

 

As per the said rule, a
recipient of supply will be permitted to avail ITC only to the extent of valid
invoices uploaded by suppliers u/s 37(1) plus 20% thereof. In effect, the said
sub-rule provides restriction in availment of ITC in respect of invoices or debit notes, the details of which have not been uploaded
by the suppliers in accordance with section 37(1).

 

To clarify doubts, Circular
No. 123/42/2019-GST was issued on 11th November, 2019. It clarified
that the computation of the credit available as per the rule is required to be
done on a monthly basis, while computing the liability for the month and filing
GSTR-3B.

 

It was also clarified that
for the purpose of computation the auto-populate GSTR-2A as available on the
due date of filling of Form GSTR-1 should be considered and the balance credit
not appearing in the GSTR-2A can be claimed in succeeding months provided the
same appears in GSTR-2A

.

UNFAIRNESS

The registered persons who
have to file GSTR returns (GSTR-1) on a quarterly basis still need to make payment of taxes on monthly basis through Form GSTR-3B. GST, being a value-added
tax (VAT), a registered person is required to pay tax on his outward supplies after
taking credit of taxes paid on inward supplies. Thus, tax is payable on margin.
But the newly-inserted Rule requires the assessee to pay tax on outward
supplies and the ITC will be granted later on the basis of information uploaded
by the suppliers through their GSTR-1, which will be reflected in GSTR-2A.
Those who are filing GSTR-1 on quarterly basis, say for the months October, November
and December, 2019, the taxpayers will not have any credit and they will have
to make double payment of tax, i.e. once they have paid to the supplier and again they have to deposit with the government through GSTR-3B of
October, November and December, 2019. Although credit is not denied but it is
being postponed for three months. This is a huge drain on working capital for
all the taxpayers and more particularly on small and medium-sized businesses.

 

In the case of the SMEs and
MSMEs filing quarterly GSTR-1, the recipient would not be in a position to
claim ITC in respect of inward supply from them till return in GSTR-1 is filed
by them, although they are paying tax regularly every month. These enterprises
apprehend that because of this rule customers will prefer not to buy from them
and it will impact their existence and survival.

 

GSTR-2A is dynamic in
nature and is akin to moving the goalpost given the direct linkage to the
GSTR-1 filed by the supplier. The amount of ITC claimed vs. the amount reflected
in the ever-changing 2A with the books of accounts would result in a never-ending spiral of reconciliations.

 

GST returns are prone to
human error such as wrong punching of GSTIN, taxable amount, etc. for which the
amendment is required to be made in the following month’s GSTR-1 return. In
such cases, even if the claimant dealer has availed credit to the extent of the
amount reflected in the 2A on the due date of filing, a subsequent amendment by
the supplier can have severe consequences, even though the procedure was
followed correctly.

 

The Rule and the
clarification are silent on how they will operate vis-à-vis the invoices
pertaining to periods prior to October, 2019 which were uploaded by the
suppliers prior to October, 2019 but ITC on which is claimed post-October,
2019, and also vis-a-vis invoices between the 1st and the 8th
of October, 2019.

 

SOLUTION

Let the principle of
substance over form be followed. Let the GST return process be fully
implemented with all modules effective so that genuine credit is not denied.
Till then, Rule 36(4) be postponed and allow seamless credit flow.

 

CONCLUSION

IS IT FAIR?
In legal, commercial and compliance perspective

The present rules in
respect of ITC and furnishing details thereof in the return are not changed so
far. It is proposed to change new return provisions as contained in section 43A
from 1st April, 2020. The newly-inserted provisions of section 43A
provide for restriction of ITC maximum up to 20%. This provision is not yet put
into force and is proposed to be brought in from 1st  April, 2020.

 

Is it fair
on the part of the government to provide for restriction of ITC by 20% by
inserting sub-rule (4) in Rule 36?

 

As per law, currently there
is no requirement nor is there any facility to match invoices to claim ITC. So,
denying and restricting ITC by rule is contrary to the provisions of the Act,
particularly sections 38, 41 and 42.

 

GST law is stabilising, the
continuous tinkering with procedural aspects time and again creates confusion
and results in destabilisation.

 

Primarily, as per the new
section, ITC is available only for the entries appearing in GSTR-2A. For no
fault of genuine taxpayers, the ITC would be denied if it does not appear in GSTR-2A
which is out of his control and despite all valid documents on his records.

 

The government has not
appreciated the fact that a vast majority of the populace still has limited
access to technology and internet which are crucial for compliance. They are heavily
dependent on their consultants who are constantly battling with the frequent
changes in the compliance process; would they be able to cope with the
additional burden of matching credits?

 

Today businesses are
bleeding or working on paper-thin margins due to economic factors. How do they
survive if genuine credits are denied due to systemic issues?

How could ITC ever be
presumptive? What is the logic / basis of the 20% benchmark? Is it really
seamless flow of credit?

 

IS IT
FAIR? In broader perspective

India
recently moved to the 63rd ranking from 77th among 190
nations in the World Bank’s ‘Ease of Doing Business’ with a target to reach the
50th rank by 2020. Is it fair on the part of the law makers
to make frequent changes in the rules and compliances, small and sometimes
irrelevant, that cause a lot of stress to the business and professional
community, with escalating cost of compliances? Are we really on track to move
up to the 50th rank in ease of doing business?

IBC OR RERA? AND THE WINNER IS…!

INTRODUCTION

The Insolvency and
Bankruptcy Code, 2016 (‘the IBC’ or ‘the Code’) has probably seen the maximum
amount of litigation of all statutes that a three-year-old enactment can
witness. In addition to the disputes at the NCLT and the NCLAT level, the
Supreme Court has also delivered several landmark and innovative judgements
under the IBC. The Code deals with the insolvency resolution of stressed
corporate debtors and, where resolution is not possible, then their
liquidation. The government has also been very proactive in amending the Act to
take care of deficiencies, changing circumstances and situations.

 

It is interesting to note
that the maximum cases under the IBC have been from the real estate sector. As
of 30th June, 2019, 421 real estate cases were referred to the NCLT
under the IBC; of these, in 164 cases companies have been ordered to be
liquidated and 257 cases are still on. It is a well-known fact that most real
estate projects, especially those in the residential sector, are reeling under
debt stress. This has led to incomplete projects, prolonged delays in handing
over possession, etc. Aggrieved home buyers tried to avail the remedy of
seeking relief under the Code. There were several decisions which held that
home buyers could drag a realtor to proceedings under the Code.

 

Ultimately, the Code was
amended in 2018 to expressly provide that home buyers were financial creditors
under the Code and could trigger the Code. This was done by adding an
Explanation to section 5(8)(f) of the Code in the definition financial debt
– ‘any amount raised from an allottee under a real estate project shall be
deemed to be an amount having the commercial effect of a borrowing.’

 

It further provided that
representatives of home buyers could be appointed on the Committee of
Creditors. Thus, the 2018 Amendment empowered home buyers to a great extent.

Another remedy available to
home buyers was to seek relief under the provisions of the Real Estate
(Regulation and Development) Act, 2016 or RERA. Yet another remedy
available is to approach the consumer forums under the Consumer Protection
Act, 1986 since various judgements have held that a flat buyer is also a
consumer under that Act.

 

However, an interesting
issue which arises is whether these three Acts are at conflict with one
another? And in the event of a conflict, which Act would prevail? This
interesting issue was before the Supreme Court in Pioneer Urban Land
& Infrastructure Ltd. vs. UOI, [2019] 108 taxmann.com 147 (SC). Let
us dissect this judgement and some developments which have taken place pursuant
to the same.

 

PIONEER’S CASE

Challenge:
The real estate developers challenged the 2018 Amendment to the IBC on the
grounds that it was constitutionally invalid. Further, since there was a
specific enactment, RERA, which dealt with real estate, the IBC, which was a
general statute, could not override the same. Further, RERA also contained a non-obstante
clause and hence it must be given priority over the IBC.

 

Twin
non-obstante clauses: The IBC contains a non-obstante
clause in section 238 which provides that it overrides all other laws in force.
RERA also has a similar provision in section 89 but it also has section 88; and
section 88 provides that RERA shall be in addition to, and not in derogation
of, the provisions of any other law for the time being in force.

 

The Supreme Court negated
all pleas of the developers and upheld the supremacy of the IBC. It held that
the non-obstante clause of RERA came into force on 1st May,
2016 as opposed to the non-obstante clause of the Code which came into
force on 1st December, 2016. IBC had no provision similar to section
88 of RERA. It was clear that Parliament was aware of RERA when it amended the
Code in 2018. The fact that RERA was in addition to and not in derogation of
the provisions of any other law for the time being in force also made it clear
that the remedies under RERA to allottees were intended to be additional and
not exclusive remedies. The Code as amended, was later in point of time than
RERA, and must be given precedence over RERA, given section 88 of RERA.

 

Further, the Code and RERA
operated in completely different spheres. The Code dealt with a proceeding in
rem in which the focus is the rehabilitation of the corporate debtor by
taking over its management. On the other hand, RERA protects the interests of
the individual investor in real estate projects by requiring the promoter to
strictly adhere to its provisions. The object of RERA was to see that real
estate projects came to fruition within the stated period and that allottees
were not left in the lurch and were finally able to realise their dream of a
home, or be paid compensation if such dream was shattered, or at least get back
monies that they had advanced towards the project with interest. Given the
different spheres within which these two enactments operated, different
parallel remedies were given to allottees.

 

Wrong classification plea: Another challenge was that home buyers being classified as financial
creditors and not operational creditors, was constitutionally invalid. The
Court set aside this plea also. It held that real estate developers were a
unique case where the developer who was the supplier of the flat is the debtor
inasmuch as the home buyer / allottee funds his own apartment by paying amounts
in advance to the developer for construction. Another vital difference between
operational debt and allottees is that an operational creditor has no interest
in the corporate debtor, unlike the case of an allottee of a real estate
project who is vitally concerned with the financial health of the corporate
debtor. Further, in such an event no compensation, nor refund together with
interest, which is the other option, will be recoverable from the corporate
debtor. One other important distinction is that in an operational debt there is
no consideration for the time value of money – the consideration of the debt is
the goods or services that are either sold or availed of from the operational
creditor. Payments made in advance for goods and services are not made to fund
the manufacture of such goods or the provision of such services. In real estate
projects, money is raised from the flat allottee as instalments for flat
purchase. What is predominant, insofar as the real estate developer is
concerned, is the fact that such instalment payments are used as a means of
finance qua the real estate project.

It is
these fundamental differences between the real estate developer and the
supplier of goods and services that the legislature has focused upon and
included real estate developers as financial debtors. Hence, the Supreme Court
held it was clear that there cannot be said to be any infraction of equal
protection of the laws. Thus, even though flat allottees were unsecured
creditors, they were placed on the same pedestal as financial creditors like
banks and institutions. It held that the definition of the term ‘financial
debt’ u/s 5(8)(f) of the Code (‘any amount raised under other transaction,
including any forward sale or purchase agreement, having the commercial effect
of a borrowing’) would subsume within it amounts raised under transactions
which, however, are not necessarily loan transactions so long as they have the
commercial effect of a borrowing. It is not necessary that the transaction must
culminate in money being given back to the lender. The expression ‘borrow’ was
wide enough to include an advance given by the home buyers to a real estate
developer for ‘temporary use’, i.e. for use in the construction project so long
as it was intended by the agreement to give ‘something equivalent’ to the money
to the home buyers. That something was the flat in question.

 

Defeats
value maximisation: The Court also negated the
argument that classifying allottees as financial creditors was directly
contrary to the object of the Code in maximising the value of assets and
putting the corporate debtor back on its feet. It held that if the management
of the corporate debtor was strong and stable, nothing debarred it from
offering a resolution plan which may well be accepted by the Committee of Creditors.
It was wrong to assume that the moment the insolvency resolution process
started, liquidation would ensue. If the real estate project was otherwise
viable, bids from others would be accepted and the best of these would then
work in order to maximise the value of the assets of the corporate debtor.

 

Retrospective
nature: The Court held that this Amendment [insertion of Explanation to
section 5(8)(f) of the Code] was clarificatory in nature, and this was also made clear by the
Insolvency Committee Report which expressly used the word ‘clarify’, indicating
that the Insolvency Law Committee also thought that since there were differing
judgements and doubts raised on whether home buyers would or would not be
classified as financial creditors u/s 5(8)(f), it was best to set these doubts
at rest by explicitly stating that they would be so covered by adding an
Explanation to section 5(8)(f). Therefore, the Court held that home buyers were
included in the main provision, i.e. section 5(8)(f) with effect from the
inception of the Code, the Explanation being added in 2018 merely to clarify
doubts that had arisen.

 

Defence for developers: The Court also laid down the defence available to developers against
initiation of proceedings under the Code. The developer may point out that the
allottee himself was a defaulter and would, therefore, on a reading of the flat
agreement and the applicable RERA Rules and Regulations, not be entitled to any
relief including payment of compensation and / or refund, entailing a dismissal
of the said application. Under section 65 of the Code, the real estate
developer may also point out that the insolvency resolution process has been
invoked fraudulently, with malicious intent, or for any purpose other than the
resolution of insolvency. The Court gave instances of a speculative investor
and not a person who was genuinely interested in purchasing a flat / apartment.
Such persons could not claim relief. Developers may also point out that in a
falling real estate market, the allottee did not want to go ahead with its
obligation to take possession of the flat / apartment under RERA and, hence,
wanted to jump ship and really get back, by way of this coercive measure, the
monies already paid by it. Hence, there were enough safeguards available to
developers against false triggering of the Code.

 

Parallel
remedies: The Supreme Court held that another parallel
remedy is available and is recognised by RERA itself in the proviso to section
71(1), by which an allottee may continue with an application already filed
before the Consumer Protection Forum, he being given the choice to withdraw
such complaint and file an application before the adjudicating officer under
RERA.

 

Supremacy:
It therefore held that even by a process of harmonious construction, RERA and
the Code must be held to co-exist and, in the event of a clash, RERA must give
way to the Code. RERA, therefore, cannot be held to be a special statute which,
in the case of a conflict, would override the general statute, viz. the
Code.

 

SOME SUBSEQUENT DECISIONS

The NCLT Delhi applied the
above Pioneer case in Sunil Handa vs. Today Homes Noida
India Ltd. [2019] 108 taxmann.com 517 (NCLT – New Delhi). In this case,
home buyers stated that as per the flat agreement, the possession of the flat
had to be handed over latest by the year 2016. Despite having received almost
90% of the purchase value of the flats, the corporate debtor had till date
neither handed over the possession of the said units nor refunded the amount
paid by the financial creditors. Hence, they applied for corporate insolvency
resolution under the Code. The NCLT applied the decision in the Pioneer
case and held that in the event of a conflict between RERA and IBC, the IBC
would prevail. Hence, the petition was admitted.

 

Again, in Rachna
Singh vs. Umang Realtech (P) Ltd. LSI-598-NCLT-2019 (PB), the NCLT
Principal Bench took the same view and upheld insolvency proceedings against
the realtor.

 

However, a very interesting
decision was delivered in the case of Nandkishore Harikishan Attal vs.
Marvel Landmarks Pvt. Ltd. [LSI-617-NCLT-2019 (Mum.)].

 

In this case, the NCLT
observed that the intention of the petitioner was only to extract more
compensation from the realtor. He did not take steps for taking possession of
the flat by clearing his pending dues in spite of repeated reminders. Thus, the
defence laid down in the Pioneer case would come to the
developer’s rescue. The NCLT held that the petitioner was a speculative
investor who had purchased flats in a booming real estate market and now wanted
to escape his liability when the real estate market was facing bad times. It
held that ‘the Flat is ready for possession but the petitioner is adamant on
taking refund… The intention of the petitioner is only to extract more
compensation from the corporate debtor rather than the resolution of the
corporate debtor…’.

 

A very telling observation
by the NCLT was that ‘where hundreds of flat buyers are involved, when
compensation of this magnitude is acceded as demanded or CIRP is ordered, we
are afraid that it may lead to utter chaos in the real estate market in the
country and it will affect the real estate sector wholly and a situation may
arise that no investor will be forthcoming to invest in real estate sector.
This is not a case where many of the home buyers are duped or the corporate
debtor / developer had collected the money and done nothing.’

 

RERA in a
bind: Press reports indicate that RERA authorities across India are now
in a fix as to how they should approach all cases given the Supreme Court’s
decision in Pioneer. They fear that RERA’s authority would now be
diluted given the supremacy of IBC. What would happen if proceedings were
pending under RERA and one of the homebuyers moved a petition under the IBC?
Thus, even one flat buyer could stall RERA proceedings. Accordingly, the RERA
officials have approached the Ministry of Housing and Urban Affairs for clarity on this aspect.

 

In one
of the complaints before the MahaRERA in the case of Majestic Towers Flat
Owners Association vs. HDIL, Complaint No. CC006000000079415 a
complaint was pending before the MahaRERA. The developer contended that it has
been admitted for corporate insolvency resolution under the CIRP and, hence, a
moratorium u/s 14 of the Code applied to all pending legal proceedings.
Accordingly, the MahaRERA disposed of the complaint by stating that though the
complainant was entitled to reliefs under the provisions of RERA, the said
relief could not be granted at this juncture due to the pending IBC resolution
process. Of course, if the IBC resolution process ultimately does not survive,
then the proceedings under the RERA could be revived since the moratorium is
only for the duration of the process. More such cases would be seen in the
coming months as a fallout of the Pioneer decision.

 

PROPOSED LEGISLATIVE CHANGES

While the 2018 Amendment to
the IBC and the SC’s decision in Pioneer were meant to protect
home buyers, it also means that a single buyer (with a default of only Rs. 1
lakh) can drag a realtor to insolvency resolution, stall all proceedings under
RERA and thereby hold up all other flat buyers who could run into hundreds or
even thousands. Even if those other buyers do not wish to be a party, the
developer would have to endure the entire process under the IBC. This is a very
dangerous situation and one which the law-makers seem to be taking cognisance
of. Press reports indicate that the government is planning to amend the Code to
stipulate that the number of homebuyers required to file an insolvency case
must be at least 100, or they must collectively account for a minimum of 5% of
the outstanding debt of the realty developer, whichever is lower. However, they
will continue to enjoy the status of financial creditors. The planned amendment
is expected to be applicable only prospectively and will have no bearing on
those real estate cases that have already been admitted by the NCLT. The
government is also said to be mulling increasing the default limit to Rs. 10
lakhs.

 

CONCLUSION

Time and again the Supreme
Court has come to the rescue of the IBC by stating that it comes up trumps
against all other statutes – the Income-tax Act, RERA, labour laws, etc. While
it is a law meant to speed up recoveries and unclog the debt resolution system
in India, probably the time has come to consider whether it could actually
cause more harm than good. The proposals being considered by the government should
be implemented urgently. The real estate sector is already in a mess and needs
urgent salvation.  

 

THE OTHER SIDE

Every issue has three sides. One yours, one mine and the third, the
true one.

 

A common man ordinarily has single-track thinking. He knows things
only partially and believes that he has understood everything.

 

He forms a view based on his perception and sticks to that view. He
refuses to even imagine that there could be another side to a coin. Thus, he
develops a set pattern of thinking.

 

This is very dangerous for a professional. A chartered accountant,
for example, is expected to have the maturity to visualise different
situations, something beyond what is apparent on the face of it – be it a
transaction or be it a document.

 

It should at least occur to his mind that the reality may be
radically different from what is visible. This is true not only in assurance
function, but also in every aspect of our profession.

 

Especially in litigation, this kind of maturity is a must. One
should always be prepared for a counter-argument. Even in warfare, they develop
a strategy by artificially creating an ‘enemy group’ – just to ensure that
their strategy or plan becomes fool-proof.

 

Similarly, before arguing a complicated case in a court of law, a
good counsel always plays the role of a ‘devil’s’ advocate so that the likely
arguments coming from the opposite side are anticipated and taken care of.

Sometimes, such situations arise in real life and one is left
non-plussed. Occasionally, they also create some terrific humour.

 

Pandit Ramandas was a renowned classical singer. He always attracted
a jam-packed audience to his mehfils (concerts). They used to listen to
him in pin-drop silence and remained spellbound once he started singing. Even
the slightest disturbance would upset the Panditji as well as the audience.

 

Once, a concert was arranged in a small town where the hall was
neither ‘posh’ nor ‘modern’. It was a mediocre venue. On the first floor, near
the balcony, there was a carpenter doing some repair work.

 

As usual the concert started a little late – as per Indian Standard
Time (or Indian stretchable time)! Panditji adjusted his instruments and the
mike system and started singing.

 

The audience was all ears, waiting in anticipation. He started with
‘saa….aaa’, in his melodious voice. Alas! Just then, the carpenter hit a
nail with his hammer!

 

Panditji paused for a while. As soon as he resumed, the hammer hit
home once again. Panditji looked up and stopped singing. The audience was
irritated and started cursing the carpenter.

 

But the carpenter shouted from the top, ‘Panditji, aap ka chalne
dijiye, mujhe koi taqlif nahi ho rahi hai’! (Panditji, you please continue.
It is not disturbing me!)  

 

THE LIGHT ELEMENTS

Always India

Saffron, white and green,

What does it, to you, mean?

You must be proud,

Shout out aloud,

Ye Indians arise,

Let’s reach for the skies

All you gals
and guys! 

There will always be an India,

While there are village lanes,

Wherever there are grazing deer

Or noisy,
jam-packed trains!

There will always be an India,

While there’s a crowded street;

Wherever there’s a saint and seer

Or dirt and dust
and heat!

We shall, ere long, have an India,

Where all can read and write;

Let’s vow to lead them, now and here,

From darkness
into light!

Let’s look forward to an India,

Where drunkenness is past;

Gulp down your fruit-juice, not your beer

To break your
morning fast!

Very soon, we’ll have an India,

Where the people are well fed;

Bidding goodbye to yesteryear:

With none hungry
to bed!

There will, one day, be an India,

Where disease is abolished, and,

right from the womb to the bier,

its nationals
well nourished!

One day, we shall have an India,

Which is aglow with health,

Where no one has any idea

Of an untimely
death!

There will always be an India,

Her people well clad and shod;

In all their doings, most sincere

Protect them all,
dear God!

There will always be an India,

Where oppression is dead;

Where the people laugh, from ear to ear,

With a roof above their head!

Before long, we’ll have an India,

Where unemployment’s gone;

With factories working in top gear,

And fields
bursting with corn!

 

We’ll, very soon have an India,

Where discipline pervades;

There’s something in the atmosphere,

So that
lawlessness fades!

 

There will, one day, be an India,

Where lawbreaking’s outlawed;

No doubt, it does sound very queer,

So, help us all,
oh Lord!

 

There will always be an India,

Democratic to the core;

Of tolerance the pioneer

 And for all, an open door!

 

At all times, we’ll have an India,

Secular in each pore,

Outshouting the communal jeer

With an almighty
roar!

 

There will always be an India,

And India shall succeed;

With people, hailing from front and rear,

Of every caste
and creed!

 

There will always be an India,

United we’ll remain;

All communities will cohere

To seek their
common gain!

 

There will always be an India,

And harmony subsist;

No one can, at all, engineer

A conflict in its
midst!

 

There will always be an India,

Where amity shall reign;

Whether you are a mountaineer

Or living in the
plain!

 

There will always be, in India,

A pluralist structure,

From Kanyakumari to Kashmir

A well-blended culture!

There will always be, in India,

Different ethnic groups composed,

Ever ready to Volunteer

To Share Each other’s woes!

 

There will always be an India,

Cosmopolitan in mould;

But, all throughout, you’ll overhear:

“We’re one in the national goal!”

 

There will always be an India,

Non-violent we shall stay;

A quality we will revere

Along life’s crowded way!

 

May there, one day, be an India,

With poverty banished,

Where life has ceased, to be severe,

And destitution vanished!

 

There will always be an India,

And India shall progress,

If we resolve, this very year,

To ban all strife and stress!

 

There will always be an India,

And India shall flourish;

With peace and plenty, far and near,

As much as you can wish!

 

We shall shortly have an India,

Sweet-smelling as a rose;

That scene will, very often, appear,

Where milk and honey flows!

 

There will, one day, be an India,

Where hard work is the norm;

We’ll show the whole world that we are

A people that can perform!

 

There will always be an India,

Where good faith counts a lot;

In work, you can’t be insincere

But give it all you’ve got!

       

There shall, ere long, be an India,

With waste down to zero;

Where he, who leads the life austere,

Is the nation’s real hero!

 

There will one day, be an India,

Where dues are paid on time;

No sum remaining in arrear

Right to the smallest dime!

 

Ere long, we shall have an India,

Where corruption’s absent,

Where payments made are not 2-tier

And everything upfront!

There will always be an India,

Where charters we have signed

That, to principles, we shall adhere

To benefit
mankind!

 

There will always be an India,

Where truth shall hold its sway,

A land where you’ll constantly hear:

“Satyam eve
jayate”!

 

There will always be an India,

With honesty at heart,

And nothing causing it to veer

From the straight
and narrow path!

 

There will always be an India,

Its integrity unstained;

Our honour we shall ne’er besmear,

But keep it well
sustained!

 

There will always be an India,

Its people, so simple and kind;

No sophisticated veneer

 And with no axe to grind!

 

There will always be an India,

Hospitably inclined;

E’en the poorest keen to feed ya

Though they
themselves haven’t dined!

 

There will always be, in India,

People generous to a fault,

Who , like Santa Claus’s reindeer,

Give gifts at
every halt!

 

There will always be an India,

With goodwill everywhere;

No mud, another’s face to smear

Just genuine,
heartfelt care!

 

There will always be an India,

Where joyousness you’ll find;

Where misery is just a mere

Invention of the
mind!

 

There will always be an India,

Where merriment abounds;

Where the people couldn’t be happier

And smiles
outnumber frowns!

 

There will always be an India,

Where human rights rank high,

Where none may treat them with a sneer:

All must, with
them, comply!

 

Reproduced from BCAJ, 2001   

 

Capital gains – Exemption u/s 54EC of ITA, 1961 – Investment in notified bonds within time specified – Part of consideration for sale of shares placed in escrow account and released to assessee after end of litigation two years later – Amount taxable in year of receipt and invested in specified bonds in year of receipt – Investment within time specified and assessee entitled to exemption u/s 54EC

5.      
Principal CIT vs. Mahipinder
Singh Sandhu; [2019] 416 ITR 175 (P&H) Date of order: 12th March 2019 A.Y.: 2008-09

 

Capital gains – Exemption u/s 54EC of ITA,
1961 – Investment in notified bonds within time specified – Part of
consideration for sale of shares placed in escrow account and released to
assessee after end of litigation two years later – Amount taxable in year of
receipt and invested in specified bonds in year of receipt – Investment within
time specified and assessee entitled to exemption u/s 54EC

 

On 28th
November, 2007, the assessee sold certain shares and received a part of sale
consideration during the previous year relevant to the A.Y. 2010-11. The
assessee made investment in Rural Electrification Corporation bonds on 6th
August, 2010 and claimed exemption u/s 54EC of the Income-tax Act, 1961 in the
A.Y. 2010-11. The AO held that such income was to be taxed in the A.Y. 2008-09
and that since the assessee had made investment in REC bonds on 6th
August, 2010, i.e., after a period of six months from the date of transfer of
the shares, irrespective of when the whole or part of sale consideration was
actually received, the assessee was not entitled to deduction u/s 54EC of the
Act.

 

The Tribunal, inter
alia, held that the amount of Rs. 18 lakhs was deposited in an escrow
account as a security in respect of future liabilities of the company /
transferor, that since there was no certainty of the time of release of the
amount or part of the amount to either of the parties as dispute between the
parties had occurred and the litigation was going on, it could not be said that
the assessee had a vested right to receive the amount in question and that it
was only at the end of the litigation that the rights and liabilities of the
transferor and the transferee were ascertained and thereupon the share of the
assessee was passed on to the assessee for which the assessee had offered
capital gains in the immediate assessment year 2010-11. The Tribunal held that
the assessee was entitled to the benefit of exemption u/s 54EC as the amount
was invested by him in REC bonds in the year of receipt which was also the year
of taxability of the capital gains.

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

 

‘There was no error in the findings recorded by the Tribunal which
warranted interference. No question of law arose.’

 

Section 143 r.w.s. 131 and 133A – Assessing Officer could not make additions to income of the assessee company only on the basis of a sworn statement of its managing director recorded u/s. 131 in the course of a survey without support of any corroborative evidence

23  [2019] 199 TTJ (Coch) 758 ITO vs. Toms Enterprises ITA No. 442/Coch/2018 A.Y.: 2014-15 Date of order: 7th
February, 2019

 

Section
143 r.w.s. 131 and 133A – Assessing Officer could not make additions to income
of the assessee company only on the basis of a sworn statement of its managing
director recorded u/s. 131 in the course of a survey without support of any
corroborative evidence

 

FACTS

A survey action u/s. 133A was conducted in the business
premises of the assessee firm. During the course of survey, summons u/s. 131(1)
was issued by the AO to TCV, managing partner of the firm, and statement u/s.
131 was recorded in which he indicated the gross profit of the assessee at 15%.
On verification of the profit and loss, the AO found that the assessee had
shown gross profit at 10.55% instead of 15% as indicated by the managing
partner. The AO assessed the gross profit at 15% and made an addition to the
income returned.

 

Aggrieved by the assessment order, the assessee preferred
an appeal to the CIT(A). The CIT(A) observed that the statement of the managing
partner was not based on any books maintained by the assessee and, therefore,
no addition could be made based on such general statements.

 

Being aggrieved by the CIT(A) order, the Revenue filed an
appeal before the Tribunal.

 

HELD

The Tribunal held that u/s. 131 the income tax authority
was empowered to examine on oath. The power invested u/s. 131(1) was only to
make inquiries and investigations and not meant for voluntary disclosure or
surrender of concealed income. As per section 31 of the Indian Evidence Act,
1878 admissions were not conclusively proved as against admitted proof. The
burden to prove ‘admission’ as incorrect was on the maker and in case of
failure of the maker to prove that the earlier stated facts were wrong, these
earlier statements would suffice to conclude the matter. The authorities could
not conclude the matter on the basis of the earlier statements alone.

 

If the assessee proved that the statement recorded u/s.
131 was involuntary and it was made under coercion or during their admission,
the statement recorded u/s. 131 had no legal validity. From the CBDT Circular
in F. No. 286/98/2013-IT (Inv. II) dated 18th December, 2014 it was
amply clear that the CBDT had emphasised on its officers to focus on gathering
evidences during search / survey operations and strictly directed to avoid
obtaining admission of undisclosed income under coercion / under influence.

 

The uncorroborated statements collected by the AO could
not be the evidence for sustenance of the addition made by the AO. It had been
consistently held by various courts that a sworn statement could not be relied
upon for making any addition and must be corroborated by independent evidence
for the purposes of making assessments.

 

From the foregoing discussion, the following principles
could be culled out: Firstly, an admission was an extremely important piece of
evidence but it could not be said that it was conclusive and it was open to the
person who made the admission to show that it was incorrect and that the
assessee should be given a proper opportunity to show that the books of
accounts did not correctly disclose the correct state of facts. Secondly,
section 132(4) enabled the authorised officer to examine a person on oath and
any statement made by such person during such examination could also be used in
evidence under the Income-tax Act.

 

On the other hand,
whatever statement was recorded u/s. 133A could not be given any evidentiary
value for the obvious reason that the officer was not authorised to administer
oath and to take any sworn statement which alone had evidentiary value as
contemplated under law. Thirdly, the word ‘may’ used in section 133A(3)(iii),
viz., record the statement of any person which may be useful for, or relevant
to, any proceeding under this Act, made it clear that the materials collected
and the statement recorded during the survey u/s. 133A were not a conclusive
piece of evidence in themselves. Finally, the statement recorded by the AO u/s.
131 could not be the basis to sustain the addition since it was not supported
by corroborative material.

Section 115JAA r.w.s. 263 – Amalgamated company is entitled to claim set-off of MAT credit of the amalgamating company

7.  [2019]
111 taxmann.com 10 (Trib.) (Mum.) Ambuja Cements Ltd. vs. DCIT ITA No.: 3643/Mum/2018 A.Y.: 2007-08 Date of order: 5th September,
2019

 

Section 115JAA r.w.s. 263 – Amalgamated
company is entitled to claim set-off of MAT credit of the amalgamating company

 

FACTS

The assessee, engaged in the manufacture and
sale of cement, filed its return of income wherein a MAT credit of Rs. 20.12
crores was claimed. The AO, while completing the assessment, allowed MAT credit
of only Rs 6.99 crores instead of Rs 20.12 crores as claimed in the return of
income.

 

Aggrieved, the assessee preferred an appeal
to the CIT(A) on several grounds, one of which was that MAT credit was
short-granted. The CIT(A) directed the AO to grant MAT credit in accordance
with law. The AO passed an order giving effect to the order of CIT(A) wherein
he allowed MAT credit of Rs. 20.12 crores to the assessee.

 

The CIT was of
the opinion that the MAT credit allowed by the AO is excessive as the MAT
credit allowed includes Rs. 6.99 crores being MAT credit of ACEL, a company
which was amalgamated into the assessee company. She, accordingly, exercised
her powers u/s 263 of the Act and directed the AO not to grant MAT credit of
Rs. 6.99 crores because according to her the amalgamated company is not
entitled to MAT credit of the amalgamating company.

 

Aggrieved, the assessee preferred an appeal
to the Tribunal.

 

HELD

The Tribunal observed that there is no
restriction with regard to allowance of MAT credit of an amalgamating company
in the hands of the amalgamated company. According to the Tribunal, a plain
reading of the aforesaid provision reveals that MAT credit is allowed to be
carried forward for a specific period.

 

In the case of Skol Breweries Ltd.,
the Tribunal, Mumbai Bench, while deciding an identical issue, has held that
carried forward MAT credit of the amalgamating company can be claimed by the
amalgamated company. A similar view has been expressed by the Tribunal,
Ahmedabad Bench, in Adani Gas Ltd.. If we consider the issue in
the light of the ratio laid down in the aforesaid decisions, there
cannot be two views that the assessee is entitled to claim carried-forward MAT
credit of the amalgamating company Ambuja Cement Eastern Ltd. (ACEL).

 

The Tribunal also observed that while
completing the assessment in case of the amalgamating company ACEL in the A.Y.
2006-07, the AO has also concluded that carried-forward MAT credit of ACEL
would be available in the hands of the present assessee.

 

Keeping in view the assessment order passed
in case of the amalgamating company as well as the decisions referred to above,
the Tribunal held that the principle which emerges is that the carried-forward
MAT credit of the amalgamating company can be claimed by the amalgamated
company. Viewed in this perspective, the decision of the AO in allowing set-off
of carried forward MAT credit of Rs. 6,99,46,873 in the hands of the assessee
cannot be considered to be erroneous. Therefore, one of the conditions of
section 263 of the Act is not satisfied. That being the case, the exercise of
power u/s 263 of the Act to revise such an order is invalid.

 

The Tribunal quashed the impugned order
passed by the CIT.

 

This ground of appeal filed by the assessee
was allowed.

Section 43CA applies only when there is transfer of land or building or both – In a previous year, when an assessee engaged in the business of construction of a commercial project entered into agreements to sell flats / offices (which were under construction) and there was no transfer of any land or building or both in favour of buyers, provisions of section 43CA would not apply

1. [2019] 108
taxmann.com 195 (Mum. – Trib.) Shree Laxmi Estate (P.) Ltd. vs. ITO ITA No.:
798/Mum/2018 A.Y.: 2014-15 Date of order: 5th July, 2019

 

Section 43CA
applies only when there is transfer of land or building or both – In a previous
year, when an assessee engaged in the business of construction of a commercial
project entered into agreements to sell flats / offices (which were under
construction) and there was no transfer of any land or building or both in
favour of buyers, provisions of section 43CA would not apply

 

FACTS

The assessee,
engaged in the construction of a commercial project following the project
completion method of accounting, entered into seven agreements to sell flats /
offices. In each of these cases there was a huge difference between the
consideration as per the agreement entered into by the assessee and the stamp
duty value of the units agreed to be sold. Further, there were a further seven
agreements entered into during the previous year in respect of which the
allotments were made prior to 31st March, 2013. In these seven cases
also there was a huge difference between the agreement value and stamp duty
value.

 

The AO asked
the assessee to explain the difference between the agreement value and the
stamp duty value. In response, the assessee submitted that the two values were
different because (i) the stamp valuation authorities have charged stamp duty
by considering the project to be situated in an area different from the area
where the project is situated; (ii) in respect of seven agreements which were
registered during the year but the allotments were made in the earlier year,
the stamp duty value was greater because the allotments were made in an earlier
year whereas the stamp duty was levied on the basis of value prevailing on the
date of registration; (iii) the sale value of properties is based on various
market conditions, location, etc., whereas the stamp duty valuation is based on
thumb rule without taking into account various market conditions, location,
etc.

 

For these
reasons, the assessee pleaded, the agreement value is the correct value and the
buyers were not willing to make any payment over and above the amount stated in
the agreement. The assessee pleaded that in the alternative the provisions be
made applicable in A.Y. 2015-16 when, following the project completion method,
the assessee has offered profits for taxation. The AO added a sum of Rs.
3,41,41,270 being the difference between stamp duty value and the agreement
value of all the 14 flats to the total income of the assessee.

 

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

 

HELD

The Tribunal
noted that during the year under consideration the assessee had not reported
any sales of units since it was following the project completion method. The
project under consideration was completed and profits offered for taxation in
A.Y. 2015-16 by considering agreement value as sale consideration. The Tribunal
observed that it is not in dispute that the assessee had not sold any land or
building or both in respect of any of the units during the year under appeal.
The assessee had only registered the agreement during the year under appeal
wherein it is clearly stated that the subject mentioned property was still
under construction and that the ultimate flat owners shall allow the assessee
to enter upon the subject premises to complete the construction of the flats as
per the said agreement which was subject matter of registration with the stamp
duty authorities. The Tribunal held that what was registered was the ‘property
under construction’ and not the ‘property’ per se. Therefore, the question
was whether in these facts the provisions of section 43CA could at all be
applied.

 

Observing that the provisions of section 43CA are applicable only when
there is transfer of land or building or both, the Tribunal stated that in the
present case neither of these had happened pursuant to the registration of the
agreement. In respect of the seven allotments made prior to 31st March,
2013, the Tribunal observed that the assessee and the prospective purchaser had
specifically agreed that till such time as the agreement to sell is executed
and registered, no right is created in favour of the purchaser and that
allotment is only a confirmation of booking subject to execution of the
agreement which is to be drafted at a later point of time. The said allotment
letter also specifies that the relevant office has been allotted to the buyer
with the rights reserved to the assessee to amend the building plan as it may
deem fit and that the buyer is bound to accept unconditionally and confirm that
any kind of increase or decrease in the area of the said office or shift in the
position of the said office, due to amendment in plan, etc., and in case of
variation of the area, the value of the office shall be proportionately
adjusted.

 

The Tribunal
held that, during the previous year under consideration, the construction of
the property was not completed and that the registration of the agreement
resulted in a transfer of rights in the office (which is under construction)
and not the property per se. It held that there was no transfer of any
land or building or both by the assessee in favour of the flat buyers pursuant
to registration of the agreement in the year under appeal. The Tribunal held
that the provisions of section 43CA cannot be made applicable during the year
under consideration. The Tribunal supported its conclusion by placing reliance
on the decisions of the Tribunal in the case of ITO vs. Yasin Moosa Godil
[(2012) 20 taxmann.com 425 (Ahd. Trib.)] and Mrs. Rekha Agarwal
vs. ITO [(2017) 79 taxmann.com 290 (Jp. – Trib.)].

 

The Tribunal
allowed the appeal filed by the assessee.

 

 

Section 5(2), read with section 9, of the Act – Agency commission received by non resident outside India, for services rendered outside India, is not taxable in India.

2.      
TS-84-ITAT-2019 (Mum) Fox International
Channel Asia Pacific Ltd. vs. DCIT  A.Y.: 2010-11 Date of Order: 15th
February, 2019

 

Section 5(2), read with section 9, of the
Act – Agency commission received by non resident outside India, for services
rendered outside India, is not taxable in India.


FACTS

Taxpayer, a company resident in Hong Kong,
was a part of a group of companies, and was engaged in distribution of
satellite television channels and sale of advertisement air time for the
channel companies at global level.

 

During the year under consideration, Taxpayer
received income in the nature of agency commission for distribution of
television channels and sale of advertisement air time as an agent of the
channel companies. Having noted that the Taxpayer has entered into an
international transaction with its associated enterprises (AEs), AO made a
reference to the Transfer Pricing Officer (TPO) for the determination of the
arm’s length price (ALP).

 

The TPO while computing ALP noted that out
of the global commission received by the Taxpayer from the overseas channel
companies, commission fee received towards the services rendered outside India
was not offered to tax in India and only the commission fees for services
rendered within India was offered to tax in India. The TPO held that the entire
income including for services rendered outside India was taxable in India and
hence made transfer pricing adjustment to the total income of the Taxpayer. In
pursuance to the ALP determined by the TPO, the AO passed a draft assessment
order adding the transfer pricing adjustment to the income of the Taxpayer.

 

Aggrieved, Taxpayer appealed before the
Dispute Resolution Panel (DRP) and contended that agency commission received in
respect of services rendered outside India, and received outside India, is not
taxable in India u/s. 5 and 9 of the Act.

 

However, DRP rejected the Taxpayer’s
contention and held that by virtue of Explanation to section 9(2), entire
income is deemed to accrue or arise in India whether or not the non-resident
has a residence or place of business or business connection in India or the
non-resident has carried on business operations in India. Accordingly, DRP
upheld the adjustment made to the ALP by the TPO.

 

Aggrieved, Taxpayer appealed before the
Tribunal.

 

HELD

  •   The conclusion of the DRP
    that section 9 being a deeming provision can bring to tax any income which
    accrues or arises outside India, is incorrect.
  •   As per Explanation 1 to
    section 9(1)(i), a non-resident whose business operations are not exclusively
    carried out in India, only such part of the income as is reasonably
    attributable to the operations carried out in India, is deemed to accrue or
    arise in India. Thus, on a complete reading of the provisions of section 9 of
    the Act, only such income which has a territorial nexus is deemed to accrue or
    arise in India.
  •  Moreover, provisions of Explanation to section 9(2)1  of the Act, is not applicable to the agency
    commission earned by the Taxpayer.
  •   It is a well settled position
    of law that agency commission paid to non-resident agents outside India, for
    services rendered outside India, is not taxable in India. Thus, agency
    commission paid to Taxpayer outside India, for services rendered outside India,
    is not taxable in India.

 

C.A

PRINCIPLES OF NATURAL JUSTICE VIS-À-VIS ASSESSMENT UNDER MVAT/CST ACTS

INTRODUCTION

Assessment under taxation laws is considered to be
a quasi-judicial process. The Department authorities are expected to act in a
just and fair manner, including compliance with the principles of natural
justice.

 

Not calling records lying with department

There are a number of instances where the
investigation authorities may visit the place of business of an assessee.
Through such a visit, the Department may acquire possession of full / part
records of the assessee. The assessing authorities subsequently initiate
assessment proceedings. And the burden is on the assessee to produce records.
But strangely, no action is taken to call for the records lying with the
investigation authorities!

 

Often, adverse orders are passed based on reports
received from investigation authorities, or based on (their) own assumptions
without going into the actual records with the authorities.

 

Judgement of the Bombay High Court in the case of Insta Exhibitions Pvt. Ltd. (Writ Petition No. 6751
of 2019 dated 8th August, 2019)

One such case came before the Hon’ble Bombay High
Court recently. The facts narrated by the Court are as under:

 

‘3. The
grievance of the Petitioner is that both the impugned orders dated 14th
March, 2019 have been passed in breach of principles of natural justice
inasmuch as no sufficient opportunity to present their case was given to the
Petitioner. In particular, it is pointed out that the Petitioner had received a
notice for personal hearing from the Assessing Officer for the hearing
scheduled on 11th March, 2019. On that date, i.e. 11th
March, 2019, the Petitioner’s representative attended the office of the
Assessing Officer and filed a letter seeking an adjournment of eight days and
the respondents were requested to make available to the Petitioner its own
documents relevant for the assessment relating to financial year 2014-2015,
which were with the Assistant Commissioner of Sales Tax, Investigation Branch,
Bhayander (evidence in the form of receipt was also enclosed with the
Petitioner’s letter dated 11th March, 2019). The impugned orders do
record that the Petitioner’s representative was present at the hearing and the
filing of letter dated 11th March, 2019. It is submitted that the
assessment were (sic) finalised without giving the Petitioner the
documents in the possession of the Revenue. Thus, the Petitioner did not have
an opportunity to establish its case before the authority.’

 

The respondents opposed the writ petition on
grounds of alternative remedy and also on the ground that the submission of the
assessee is otherwise considered.

 

However, the Bombay High Court did not approve of
the action of the Department authorities and observed as under:

 

‘5. It is an undisputed position that the
Petitioner’s documents relating to the period 2014-2015 and necessary for the
Petitioner’s assessment, in particular to support its claim for branch transfer
and exhibition activity, were in the possession of the Department with effect
from 18th April, 2017. In spite of the Petitioner’s seeking copies
of the same, the same were not granted by the Assessing Officer as he did not
call for the necessary proceedings and papers from the Assistant Commissioner
of Sales Tax, Investigation Branch, Bhayander, who was in possession of the
papers relating to the assessment year 2014-15. In these circumstances, it was
impossible for the Petitioner to establish its claim for branch transfer as
also the exhibition activity as the documents relevant, according to the
Petitioner, in support of its aforesaid two claims, were amongst the documents
which were in the possession of the Assistant Commissioner of Sales Tax,
Investigation Branch, Bhayander. This non-giving of documents certainly
handicapped the Petitioner in the assessment proceedings. This certainly
amounts to a breach of principles of natural justice.

 

6. In the above view, there
is a flaw in the decision-making process which goes to the root of the matter.
Therefore, we set aside the impugned orders dated 14th March, 2019
passed under the MVAT Act and the CST Act. We restore the Petitioner’s
assessment proceedings to respondent No. 3 – Deputy Commissioner of State Tax –
for fresh consideration of the assessment for the period 2014-15 after
furnishing to the Petitioner all the documents relating to the assessment year
2014-15 which are in possession of the Assistant Commissioner of Sales Tax,
Investigation Branch, Bhayander, since 18th April, 2017.’

 

Thus, the Hon’ble High Court has remanded the
assessment for fresh orders after providing a proper opportunity to the
petitioner.

 

CONCLUSION

Compliance with the principles of natural justice
is a very important part of assessment. Non-compliance results in invalid
orders. However, the assessee is also required to be alert about his rights. It
is necessary that the issue about the requirement of following the principles
of natural justice is raised in due course. If not, then non-compliance will be
fatal to the validity of the orders passed. The above judgement will be useful
for reference in future proceedings.  

 

 

CALCUTTA CLUB CASE: PRINCIPLE OF MUTUALITY AND ITS RELEVANCE UNDER GST REGIME

INTRODUCTION

‘No man, in my
opinion, can trade with himself; he cannot, in my opinion, make, in what is its
true sense or meaning, taxable profit by dealing with himself ’.1

 

The principle of
mutuality is a concept borrowed from the ‘English decisions’ and has been adopted
and refined over a long period of time by the courts in India. The principle of
mutuality has been mainly held to be applicable in the context of levy of
income tax as well as the erstwhile sales tax regimes.

 

In a landmark
decision by the larger bench of the Supreme Court in the case of State of
West Bengal & Ors. vs. Calcutta Club Limited, Civil Appeal No. 4184 of 2009
[reported in 2019-TIOL-449-SC-ST-LB], it was held that the supply /
sale of goods or rendering of services by incorporated / unincorporated
associations or clubs to their members are not liable to sales tax / service
tax by application of the principle of mutuality even after the 46th
Amendment to the Constitution. Further, the Supreme Court also held that the
judgement in C.T.O. vs. Young Men’s Indian Association (1970) 1 SCC 462
which applied the doctrine of mutuality continues to hold the field even after
the 46th Amendment.

 

BACKGROUND: West Bengal & Ors. vs. Calcutta Club Limited (Supra)

The Assistant Commissioner of Commercial Taxes issued a notice to the
respondent club (assessee) proposing to demand sales tax on the sale of food
and drinks to the permanent members during the quarter ending 30th June,
2002. The demand was contested on the ground of principles of mutuality. The matter
was carried to the Tribunal which held that there is no supply or sale of goods
by the club to its members as members and the club are the same persons and
there is no exchange of consideration. The issue was contested before the High
Court by the Revenue. The High Court held that no sales tax could be imposed on
the supplies by clubs to their members.

 

On appeal, the
Division Bench of the Supreme Court in the State of West Bengal vs.
Calcutta Club Ltd. (2017) 5 SCC 356, considering the decision in C.T.O. vs.
Young Men’s Indian Association (1970) 1 SCC 462 and Fateh Maidan Club vs. CTO
(2017) 5 SCC 638 and Article 366(29A) of the Constitution, referred the
matter to a larger bench with the following questions:

 

(i)   Whether the doctrine of mutuality is still
applicable to incorporated clubs or any club after the 46th
amendment to Article 366(29A) of the Constitution of India?

(ii)   Whether the judgement of this Court in
Young Men’s Indian Association (Supra) still holds the field even after
the 46th Amendment; and whether the decisions in Cosmopolitan
Club (Supra) and Fateh Maidan Club (Supra) which remitted
the matter applying the doctrine of mutuality after the Constitutional
amendment can be treated to be stating the correct principle of law?

(iii) Whether the 46th Amendment by
deeming fiction provides that provision of food and beverages by incorporated
clubs to their permanent members constitutes sale, thereby holding the same to
be liable to sales tax?

 

Levy of
service tax on clubs or associations

In the meanwhile,
the High Court of Jharkhand in Ranchi Club Ltd. vs. Chief
Commissioner of Central Excise & ST, Ranchi Zone [2012 (26) STR 401
(Jhar.)] and the High Court of Gujarat in Sports Club of Gujarat
Ltd. vs. Union of India [2013 (31) STR 645 (Guj.)] held that no service
tax could be demanded on the services provided by clubs or associations to
their members by applying the doctrine of mutuality and by relying upon the
decision of the Supreme Court in Young Men’s Indian
Association (Supra).

 

Consequently,
departmental appeals were filed before the Supreme Court against the aforesaid
High Court decisions. In the light of reference to the larger bench of the
Supreme Court in State of West Bengal vs. Calcutta Club Ltd. (Supra),
the service tax matters were also placed before this bench.

SUBMISSIONS OF THE
PARTIES

The submissions
before the larger bench of the Supreme Court by the Revenue and the assessees
could be summarised as below:

 

Revenue:

(a) After the 46th amendment to the
Constitution which inserted Article 366(29A), more specifically clause (e), the
earlier decision holding that there cannot be levy of sales tax on supply of
goods by clubs or associations to their members would no more be applicable;

(b) The supply of food or drink by the clubs or
associations to their members could either be taxed under clause (e) of Article
366(9A) or under clause (f) thereof;

(c) The decisions of the Constitution Bench in the
case of Young Men’s Indian Association (Supra) is prior to the
amendment of the Constitution referred above and the amendment is to do away
the effect of the said decision;

(d) The phrase ‘unincorporated association or body
of persons’ in sub-clause (e) must be read disjunctively, and so read would
include incorporated persons such as companies, co-operative societies, etc.;

(e) The doctrine of mutuality has no application
when a members’ club is in the corporate form. Reliance was placed on the
decision in the case of Bacha F. Guzdar vs. Commissioner of Income Tax,
Bombay (1955)
1 SCR 876, wherein it was held that a shareholder is not the owner of
the assets of a company and, therefore, the aforesaid principle cannot possibly
apply to members’ clubs in corporate form.

 

Assessees:

(1) The 46th Amendment, which inserted
clause (29-A) into Article 366 of the Constitution, has not done away with the Young
Men’s Indian Association (Supra) as there cannot possibly be a supply
of goods by a person to himself; and that, therefore, the doctrine of agency /
trust / mutuality continues as before;

(2) Referring to the definition of consideration,
it was contended that the consideration should move from one person to another
and as there are no two persons involved in a transaction between a club and
its members, no consideration is involved and hence no sale is involved;

(3) Clauses (e) and (f) of Article 366(29A) are for
different purposes and the clause (f) cannot be used to tax the supply of food
or drink by the clubs or associations to their members;

(4) On the issue of levy of service tax on clubs or
associations it was submitted that:

(i)   The concept of mutuality as applicable to
supply of goods would equally be applicable to the provision of service by a
club to its members;

(ii)   The definition under ‘club and association
services’ specifically excludes incorporated entities;

(iii)  Similar to Article 366(29A)(e) of the
Constitution, there is no deeming fiction to treat services by clubs to their
members as service liable to tax; deemed fiction in respect of goods cannot be
applied to services, and reliance is placed on the decision in the case of Geo
Miller & Co. vs. State of M.P., (2004) 5 SCC 209;

(iv)  Where supply of food or drinks by clubs or
associations falls under clause (e) of Article 366(29A) in its entirety, there
cannot be any levy of service tax on such transactions as the Supreme Court in
the BSNL case (2006) 3 SCC 1 held that in Article
366(29A) only clause (b) relating to works contract and clause (f) relating to
catering contract can be vivisected into services
and goods;

(v)  Even if it is assumed that the decision of the
Supreme Court in Joint Commercial Tax Officer vs. The Young Men’s Indian
Association (Regd.), Madras, (1970) 1 SCC 462 has been overcome, that
would relate only to sale or purchase of goods and not to services. Therefore,
there is no deeming provision in the Constitution relating to entry 97 of List
I, where a deeming clause is present in respect of service.

 

ANALYSIS OF DECISION

Levy of sales
tax on the goods supplied by clubs or associations to members

The larger bench of
the Supreme Court on the issue of sale of goods by an incorporated or
unincorporated club or association to its members held as under:

 

  •   The doctrine of
    mutuality continues to be applicable to incorporated and unincorporated
    members’ clubs after the 46th Amendment adding Article 366(29A) to
    the Constitution of India;
  •   Young Men’s Indian
    Association     and other judgements which applied this doctrine continue to
    hold the field even after the 46th Amendment;
  •    Sub-clause (f) of
    Article 366(29-A) has no application to members’ clubs.

 

The reasoning for
the above view is summarised below:

(A) The 61st Law Commission Report,
which recommended the 46th Constitutional Amendment, was of the view
that the Constitution ought not to be amended so as to bring within the tax net
members’ clubs for the following reasons:

(1) The number of
such clubs and associations would not be very large;

(2) Taxation of
such transactions might discourage the co-operative movement;

(3) No serious
question of evasion of tax arises as a member of such clubs really takes his
own goods.

 

(B) Article 366(29A) was introduced by way of the
46th Amendment with a view to expand the scope of tax on sale in
respect of certain specified activities involving supply of goods or supply of
goods and services, which hitherto was held by the Supreme Court in various
decisions as not amounting to sale of goods. However, as regards clause (e) of Article
366(29A), relating to supply of goods by unincorporated associations to their
members, the Court ruled that the 46th Amendment did not overcome
the decision in the Young Men’s Indian Association case and the
doctrine of mutuality remains applicable even after the amendment.

 

It is interesting
to note that the Supreme Court placed reliance mainly on the decision in the
case of C.T.O. vs. Young Men’s Indian Association (1970) 1 SCC 462,
wherein the Association which is a society registered under the Societies
Registration Act, 1860 and the issue was whether supply of refreshments by the
society to its members would attract levy of sales tax. It should be noted that
in the said decision, members’ clubs were also a party. The Constitution Bench
of the Supreme Court in this connection, referring to the decisions of English
judgements in the cases Graff vs. Evans (1882) 8 Q.B. 373 and Trebanog
Working Men’s Club and Institute Ltd. vs. MacDonald (1940) 1 K.B. 576,
held that there cannot be sale between a club or association and its members
when refreshments are supplied. The Court further observed that the club, even
though a distinct entity, is acting as an agent in supplying various
preparations and the concept of transfer is completely absent.

 

Further, the Court
followed the principle laid out in Young Men’s Indian Association, in
Fateh Maidan Club [Fateh Maidan Club vs. CTO, (2008) 12 VST 598 (SC)] and
Cosmopolitan Club [Cosmopolitan Club vs. State of T.N., (2009) 19 VST 456
(SC)].

 

(C) The Supreme Court observed that the Statement
of Objects and Reasons for the 46th Amendment states that while sale
by a registered club or other association of persons (the club or association
of persons having corporate status) to its members is taxable, sales by an
unincorporated club or association of persons to its members is not taxable as
such club or association, in law, has no separate existence from that of the
members.

(D) The Supreme Court held that the Statement of
Objects and Reasons did not properly understand the decision of the Supreme
Court in the case of Young Men’s Indian Association and assumed
that sale of goods by members’ clubs in the corporate form were taxable. The
Court observed that in the Young Men’s Indian Association case,
it had held that sale of goods by an incorporated entity to its members is sale
to self and hence, does not amount to sale of goods for levy of sales tax. The
Court clearly stated that the Constitution Bench in Young Men’s Indian
Association placed reliance on two English decisions (Graff vs.
Evans & Trebanog Working Men’s Club and Institute Ltd. vs. MacDonald) which
pertained to incorporated clubs and hence the concept of mutuality would be
applicable to incorporated clubs or associations also.

 

(E) The Supreme Court further held that even in
case of sale / supply of goods by unincorporated associations or body of
persons to members, the requirement of consideration is not fulfilled since in
case of sale of goods to self, there exists no consideration as per the
provisions of the Contract Act, 1872.

 

(F) The Supreme Court also ruled out the contention
of the Revenue that the supply of food by clubs would fall under clause (f) of
Article 366(29A), if not under clause (e), and observed that clause (f) was
specifically brought in to tax supply of food by restaurants and that the
subject matter of sub-clause (f) is entirely different and distinct from that
of sub-clause (e) and it cannot be made applicable to members’ clubs.

 

(G) Unlike the specific provisions under the
Income-tax Act, 1961 such as section 2(24)(vii) or section 45, the absence of
such language in clause (e) to Article 366(29A) is also a pointer to the fact
that the doctrine of mutuality cannot be said to have been done away with by
the 46th Amendment.

 

Levy of service
tax on clubs or associations

The Supreme Court
held that the judgements of the Jharkhand High Court in Ranchi Club Ltd.
(Supra) and the Gujarat High Court in Sports Club of Gujarat
(Supra) are correct in their view of the law in Young Men’s
Indian Association (Supra). It was also held that with effect from 2005
no service tax could be levied on the services by clubs or associations to
their members in the incorporated form. Accordingly, the Supreme Court held
that show-cause notices, demand notices and other action taken to levy and
collect service tax from incorporated members’ clubs are declared to be void
and of no effect in law.

 

The judgement of
the Supreme Court is analysed as under:

(i)   The Court held that for the period prior to 1st
July, 2012, i.e.,  before the Negative
List regime, the definition of club or association as per section 65(2a)
of the Finance Act, 1994 specifically excluded incorporated entities. Thus, the
Court held that incorporated entities providing services to their members would
be outside the service tax net prior to 1st July, 2012.

 

(ii)   The Supreme Court held that companies and
co-operative societies registered under the respective Acts can certainly be
said to be constituted under those Acts.

 

(iii) For the period post-1st July, 2012, the Court,
referring to the definition of ‘services’ as per section 65B(44) of the Finance
Act, 1994 observed that to qualify as service the definition requires the
existence of two persons and the doctrine of mutuality, the doctrine of agency,
trust, as applicable to sales tax cases, would equally be applicable to the
definition of services. Accordingly, the Supreme Court held that services by an
incorporated club / association to its members would amount to service to self
and hence would not qualify as service as defined above. [Note: However, the
Supreme Court has not dealt with exclusion of deemed sale under Article
366(29A) from the definition of ‘service’ in section 65B(44) of the Finance
Act, 1994.]

 

(iv)  As regards the Explanation 3 to section
65B(44) of the Finance Act, 1994, the Court held that the said explanation
deeming associations and their members as distinct persons would not be
applicable to incorporated associations or clubs. Relying on the decision in the
case of I.C.T., Bombay North, Kutch and Saurashtra, Ahmedabad vs. Indira
Balkrishna (1960) 3 SCR 513, the Court further observed that the
expression ‘unincorporated associations’ would include persons who join
together in some common purpose or common action.

 

SUMMARY AND COMMENTS

In summary, the
supply of goods or services by incorporated / unincorporated clubs or
associations to their members would not be exigible to sales tax or service tax
on the basis of principles of mutuality. The larger bench of the Supreme Court
affirmed the judgement of Young Men’s Indian Association (Supra)
as regards the applicability of the doctrine of mutuality and held that it
continues to apply even after the 46th Amendment.

 

As regards the levy
of service tax on the services provided by the club to its members, the Supreme
Court held that the judgements of the Jharkhand High Court in Ranchi Club
Ltd. (Supra) and the High Court of Gujarat in Sports Club of
Gujarat (Supra) are correct.

 

Additional
points to be noted

In the context of
service tax levy on the services provided by clubs to their members, the larger
bench of the Supreme Court did not consider its categorical decision in Bharat
Sanchar Nigam Ltd. vs. UOI 2006 (2) STR 161 (SC) wherein it was held
that the 46th Amendment chose three specific situations: a works
contract, a hire- purchase contract and a catering contract, to bring the
services within the fiction of a deemed sale. Of these three, the first and the
third involve a kind of service and sale at the same time, hence apart from
these two cases where splitting of the service and supply has been
constitutionally permitted in clauses (b) and (f) of clause 29A of Article 366,
there is no other service which has been permitted to be so split.

 

Accordingly, under Article
366(29A) only ‘works contract’ in clause (b) and ‘catering contract’ in clause
(f) are divisible and split between services and goods and, therefore, there is
no question of splitting the deemed sale entry relating to sale or services
provided by the club to its members under clause (e) of Article 366(29A). This
aspect would have categorically ruled out any service tax levy for the period
up to 30th June, 2017. Even Explanation 3 found in the definition of
services u/s 65B(44) would have been restricted only to declared services u/s
66E(h) and (i) corresponding to clauses (b) and (f) of Article 366(29A) of the
Constitution as only those can be vivisected, and as clubs fall under Article
366(29A)(e), the said explanation would not apply as the transaction cannot be
vivisected.

 

Another aspect
which is to be noted from the above decision is that the concept of mutuality
would not be applicable to proprietary clubs. The Supreme Court in the case of Cosmopolitan
Club vs. State of T.N. (2009) 19 VST 456 (SC), referring to the English
decisions, brought in the distinction between members’ clubs and the
proprietary clubs as below:

 

7. The law in
England has always been that members’ clubs to which category the clubs in the
present case belong cannot be made subject to the provisions of the Licensing
Acts concerning sale because the members are joint owners of all the club
property including the excisable liquor. The supply of liquor to a member at a
fixed price by the club cannot be regarded to be a sale. If, however, liquor is
supplied to and paid for by a person who is not a bona
fide member of the club or his duly authorised agent, there would be a sale.
With regard to incorporated clubs a distinction has been drawn. Where such a
club has all the characteristics of a members’ club consistent with its
incorporation, that is to say, where every member is a shareholder and every
shareholder is a member, no licence need be taken out if liquor is supplied
only to the members. If some of the shareholders are not members or some of the
members are not shareholders that would be the case of a proprietary club and
would involve sale. Proprietary clubs stand on a different footing. The members
are not owners of or interested in the property of the club. The supply to them
of food or liquor though at a fixed tariff is a sale.

 

Therefore, in case
of proprietary clubs, the doctrine of mutuality would not be applicable
inasmuch as some of the shareholders may not be members of the club and vice
versa and outsiders could well use the club. In other words, the clear
mandate would be that the persons participating and persons enjoying should be
the same. If not, mutuality does not exist.

 

One other aspect to
be remembered is that although in the end portion of the judgement relating to
service tax the judgement seems to be confined to incorporated members’ club,
in our opinion it would apply to unincorporated members’ club also for three
specific reasons:

 

(1) The portion of
the judgement which answers the sales tax questions raised clearly covers both
type of members’ clubs and the Supreme Court refers to it when it discusses
service tax;

(2) If incorporated
members’ clubs or associations, where identity can be distinct, can still come
within the mutuality clause, there is no reason why unincorporated clubs or
associations cannot;

(3) Our observations relating to the BSNL case as to why the
transactions of clubs cannot be vivisected would rule out service tax
applicability. Further, the definition of services post-1st July,
2012 specifically excluded these transactions.

 

Whether above
decision is applicable in GST regime

With effect from 1st
July, 2012, GST is levied on the supply of goods or services or both in
terms of section 9 of the CGST Act, 2017. The term ‘supply’ is defined
elaborately in section 7 of the Act to include all forms of supply of goods or
services or both, such as sale, transfer, barter, exchange, licence, rental,
lease or disposal made or agreed to be made for a consideration by a
person in the course or furtherance of business.

 

 

It shall be noted
that the term ‘business’ that has been defined in section 2(17) of the CGST
Act, 2017 inter alia includes ‘provision by a club, association,
society, or any such body (for a subscription or any other consideration) of
the facilities or benefits to its members’.

 

Further, entry 7 of
Schedule II to CGST Act, 2017 reads as below:

 

‘7. Supply of
Goods

The following
shall be treated as supply of goods, namely:

 

Supply of goods
by any unincorporated association or body of persons to a member thereof for
cash, deferred payment or other valuable consideration.’

As per serial No. 7 of Schedule II, the supply of goods by any
unincorporated association or body of persons to its members shall be deemed to
be supply of goods. However, there is no such deeming fiction for ‘supply of
services’.

 

In terms of the
above referred provisions under the GST law, we are of the view that the
decision of the larger bench of the Supreme Court in Calcutta Club
(Supra) is applicable even under the GST regime for members’ clubs on
the basis of the following points:

 

(a) The doctrine of mutuality continues to apply
under GST law. In terms of section 7, the term ‘supply’ includes sale or
transfer or barter, etc., which requires two persons; further, the said supply
must be for consideration which necessarily involves two or more persons. As
there are no two persons involved in the provision of supply of goods or
services by the club or association to its members, there cannot be any
‘supply’ of goods or services. This is specifically so for members’ clubs.

 

(b) Though the definition of the term ‘business’
includes the provision of facilities or benefits by the club or association to
its members, there is no deeming fiction under the provisions of section 7
which defines the term ‘supply’ to include such transactions. As the supply of
goods or services by the club or association does not get covered under the
definition of supply u/s 7, there is no question of levying GST by referring to
the clause (e) of definition of ‘business’.

 

(c) In terms of section 7(1A) of the CGST Act, 2017
entries in schedule II are only for the purposes of classification and cannot
be read independently. Therefore, no tax could be levied on supply of goods or
services by incorporated or unincorporated associations to their members as the
main section does not cover it.

 

(d) Alternatively, as per serial No. 7 of Schedule
II, the supply of goods by an unincorporated association or body of persons
could be termed as ‘supply of goods’, hence incorporated clubs or associations
cannot be brought under this entry. Further, serial No. 7 of Schedule II only
covers ‘supply of goods’, hence the provision of service by the club or
association to its members remains outside the purview of GST.

 

(e) The ratio of the decision laid out in Young
Men’s Association (Supra) continues to hold the field that in a
members’ club, the club acts as merely an agent for the principal and would be
covered by the principle of mutuality.

 

In view of the above, the authors are sure
that the dispute would continue under the GST regime but are of the view that
the decision of the larger bench would apply to the GST regime also so as to
exclude members’ clubs from the purview of taxation.

RENEWED FOCUS ON ‘SUBSTANCE OVER FORM’ IN THE WORLD OF INTERNATIONAL TAX

At first instance,
the term ‘Double Irish Dutch Sandwich’ would appear to be an appetising snack.
However, in the world of international tax this has become an unappetising
proposition for multinational corporations (MNCs). This is because ‘Double
Irish Dutch Sandwich’ refers to the use of a combination of Irish and Dutch
companies by MNCs to shift profits to low or no tax jurisdictions.

 

This and other
similar aggressive tax strategies not only help MNCs reduce their effective tax
outgo, but also highlight the shift in mind-set of tax being a cost against
profit, rather than a duty towards society. Many countries have started
frowning upon such investment and operating ‘structures’ and are implementing
various measures both nationally and internationally to address the issue. The
general consensus amongst them is that MNCs should pay their fair share of
taxes in the countries where they actually operate and earn income. In this
context, the two important aspects identified by the world at large are that

(a) certain countries provide aggressive and preferential tax regimes to
MNCs to enable them to adopt aggressive tax strategies (including access to
favourable tax treaties); and (b) the operations of
MNCs in such countries do not have adequate economic or commercial substance to
justify the income allocated to them.

 

At the heart of
this fairly recent initiative is an age-old concept in tax laws, ‘substance
over form’ – whether the substance of the transaction is in fact different from
what its form is legally made out to be. This article aims to touch upon some
of the recent updates in the world of international tax which have a renewed
focus on ‘substance over form’ and the impact of some of the common structures
involving India.

 

(I)     Meaning of the terms ‘substance’ and ‘form’

‘Substance is
enduring, form is ephemeral’. These are the words
of Mr. Dee Hock (founder of VISA) which imply that while ‘substance’ is
long-lasting, ‘form’ is transitory. The term ‘substance over form’ is a
well-known,
age-old concept under accounting and tax laws not only in India but even
globally. In essence, the concept requires looking at the real purpose /
intention of the transaction rather than simply relying on the way the
transaction is presented legally and on paper (e.g. accounting entries, legal
agreements, etc.). Black’s Law Dictionary defines the terms ‘substance’ and
‘form’ as under:

(i)    Substance: ‘The essence of
something; the essential quality of something as opposed to its mere form’;

(ii)    Form: ‘The outer shape or structure
of something, as distinguished from its substance or matter’.

 

(II)   Landmark
judgements on substance over form

One of the earliest
landmark judgements in the world in the context of ‘substance over form’ is the
English Court judgement in the case of IRC vs. Duke of Westminster (1936)
AC 1 (HL). This judgement laid down certain important observations
which have subsequently been applied even by Indian courts. In this case, based
on professional advice, the Duke of Westminster paid his gardener an annuity
instead of wages and the same was claimed as tax-deductible expenditure. The argument
of the tax authorities was that the substance of the annuity payment was to in
fact pay wages, which were household expenses and not tax-deductible. The said
argument was, however, rejected by the House of Lords and Lord Tomlin observed
as under:

 

‘Every man is
entitled if he can to order his affairs so that the tax attaching under the
appropriate Acts is less than it otherwise would be. If he succeeds in ordering
them so as to secure this result, then, however unappreciative the
Commissioners of Inland Revenue or his fellow taxpayers may be of his
ingenuity, he cannot be compelled to pay an increased tax. This so-called
doctrine of “the substance” seems to me to be nothing more than an attempt to
make a man pay notwithstanding that he has so ordered his affairs that the
amount of tax sought from him is not legally claimable.’

 

The concept of ‘substance over form’ has also been discussed in Indian
judicial precedents since many years – for instance, the Supreme Court
judgement in the case of Mugneeram Bangur & Co.1  on facts of the case held that the sale of
the business of land development as a whole concern was a slump sale not liable
to tax, even though the Tribunal had factually held that the goodwill component
in the sale was the excess value / profit from stock in trade transferred with
the other assets. In a way, the Supreme Court had upheld the principle of form
over substance.

_____________________________________________________

1   [1965] 57 ITR 299 (SC)

2        [2012] 341 ITR 1 (SC)

 

However, in the
context of cross-border / international tax issues arising from ‘structures’,
the concept of ‘substance over form’ has recently gained more significance from
the judgement of the Supreme Court in the case of Vodafone International
Holdings B.V.2  The
judgement underlined the difference between adopting a ‘look-through’ approach
(substance) at the transaction, versus adopting a ‘look-at’ approach (form).
The Supreme Court observed that the following principles emerged from the
Westminster judgement:

1. A legislation is
to receive a strict or literal interpretation;

2. An arrangement
is to be looked at not by its economic or commercial substance but by its legal
form; and

3. An arrangement
is effective for tax purposes even if it has no business purpose and has been
entered into to avoid tax.

 

However, the
Supreme Court also noted that during the 1980s, the House of Lords began to
attach a ‘purposive interpretation approach’ and gradually began to place
emphasis on ‘economic substance doctrine’ as a question of statutory
interpretation. For example, in Inland Revenue Commissioner vs.
McCruckian (1997) BTC 346 the House of Lords held that the substance of
a transaction may be considered if it is a tax avoidance scheme. Lord Steyn
observed as follows:

 

‘While Lord
Tomlin’s observations in the Duke of Westminster
case [1936] A.C. 1 still point to a material
consideration, namely, the general liberty of the citizen to arrange his
financial affairs as he thinks fit, they have ceased to be canonical as to the
consequence of a tax avoidance scheme.’

 

In the light of
various judgements, the Supreme Court laid down the following rationale in the
context of substance over form:

(i)    The principle of the Westminster judgement is
that if a document or transaction is genuine, the court cannot go behind it to
some supposed underlying substance. Subsequent judgements of the English Court
have termed this as ‘the cardinal principle’.

(ii)    Courts have evolved doctrines like ‘substance
over form’ to enable taxation of underlying assets in cases of fraud, sham,
etc. However, genuine strategic tax planning is not ruled out.

(iii)   Tax authorities can invoke the ‘substance over
form’ principle (or ‘piercing the corporate veil’ test) only after establishing
on the basis of facts and circumstances that the transaction is a sham or tax
avoidant.

(iv)   For instance, in a case where the tax
authorities find that in an investment holding structure, an entity which has
no commercial / business substance has been interposed only to avoid tax, then
applying the test of fiscal nullity it would be open to the tax authorities to
discard such inter-positioning of that entity.

 

It is well-known
that the Supreme Court judgement in the Vodafone case was
significantly overridden through retrospective amendments made in the Indian
tax law in 2012. However, the retrospective amendments did not alter the
rationale that, unless there is conclusive evidence to suggest otherwise, once
a non-resident furnishes a tax residency certificate (TRC) from its home
country, benefits under the applicable tax treaty with India should not be
denied3 .

__________________________________________

3   This was also in line with an earlier Supreme
Court judgement in the case of Azadi Bachao Andolan and Another [2003] 263 ITR
706 (SC)

 

 

To address the
issue of ‘substance over form’, the General Anti-Avoidance Rule (GAAR) was
introduced in 2012 itself, although it became effective in India only from 1st
April, 2017. Subject to conditions, GAAR now permits tax authorities to deny
tax treaty benefit in India if the main purpose of undertaking the transaction
was to obtain a tax benefit under an impermissible avoidance arrangement in
India. GAAR also permits disregarding or re-characterising any step in the
impressible avoidance arrangement, including deeming connected persons to be
one person, relocating the situs of any asset or place of residence,
disregarding corporate structure or treating equity as debt or revenue item as
capital or vice versa, as deemed fit. Accordingly, the concept of
‘substance over form’ has now been codified under the Indian law with effect
from 1st April, 2017 through GAAR.

 

Further, with India
adopting the Place of Effective Management (PoEM) criteria from 1st
April, 2016 for determination of tax residency of foreign companies in India,
it can be said that Indian tax laws now have greater focus on the concept of
‘substance over form’. This is also the case under the Income Computation and
Disclosure Standard I relating to accounting policies which categorically
states that the treatment and presentation of transactions and events shall be
governed by their substance and not merely by the legal form.

 

(III)  Renewed international focus on substance over
form, i.e., tax planning vs. tax avoidance

In the past few
years, certain large MNCs were found to implement aggressive business /
investment structures (such as the ‘Double Irish Dutch Sandwich’) which shifted
profits to jurisdictions with low / NIL taxes. At times, while the structures
were legally valid, it was found that the economic activities in the
jurisdictions with lower / NIL taxes were not commensurate with the profits
allocated to such jurisdictions. With courts upholding the legal validity of
the structures in light of tax treaties and international tax law principles,
countries realised that tax treaties along with aggressive tax regimes in
certain countries were in fact the thin line that separated fair tax planning
from aggressive tax mitigation / planning.

 

To tackle this
issue, the OECD and G20 countries adopted a 15-point action plan in September,
2013 to address Base Erosion and Profit Shifting (BEPS). The BEPS Action Plan
identified 15 actions on the basis of three key pillars:

 

(a)   introducing coherence in the domestic rules
that affect cross-border activities;

(b)   reinforcing substance requirements in the
existing international standards; and

(c)   improving transparency as well as certainty.

 

While the concept
of ‘substance’ is one of the three key pillars of the overall BEPS project, it
is discussed in detail in BEPS Action 5: Countering Harmful
Tax Practices More Effectively, Taking into Account Transparency and Substance.
Further, the concept of ‘substance over form’ has been specifically discussed
in BEPS Action 6: Preventing the Granting of Treaty Benefits
in Inappropriate Circumstances.

 

The above-mentioned
15 actions have culminated in the formalisation and signing of the Multilateral
Instrument (MLI) which is a landmark development in the context of tax treaties
across the globe. The MLI seeks to modify thousands of existing bilateral tax
treaties through one instrument. It does not replace these bilateral tax
treaties but acts as an extended text to be read along with the covered
bilateral tax treaties for implementing specific BEPS measures.

 

India has deposited
the ratified MLI with the OECD on 25th June, 2019 and notified the
date of entry into force of the same as 1st October, 2019.
Accordingly, covered Indian tax treaties will be impacted from 1st
April, 2020 onwards. Hence, going forward it is imperative that any Indian
inbound or outbound cross-border structuring of investment / business
operations will have to factor BEPS and MLI aspects, if the structuring
involves availing tax treaty benefits.

 

(IV) Concept of ‘substance over from’ embedded in MLI

Part III of the
MLI, which deals with Treaty Abuse, includes two minimum standards / articles
which are sought to be introduced in the covered bilateral tax treaties. These
articles in essence require testing the substance of a transaction /
arrangement before granting tax treaty benefit. A summary of these articles is
as under:

 

1.    Article 6: Purpose of a Covered Tax
Agreement: This article seeks to act as a preamble to the covered bilateral
tax treaty and clarify that while the purpose of such treaty is to eliminate
double taxation of income, the same should not be used for creating
opportunities for non-taxation or reduced taxation through tax evasion or
avoidance. Specifically, it clarifies that cases of treaty-shopping for the
indirect benefit of residents of third jurisdictions would not be eligible for
tax treaty benefits.

 

2.    Article 7: Prevention of Treaty Abuse: This
article seeks to introduce the Principal Purpose Test (PPT) as a minimum
standard in the covered bilateral tax treaty. There is an option to supplement
the PPT with a Simplified Limitation of Benefits (SLOB) clause4.
Further, the PPT can be replaced altogether with a Detailed Limitation of
Benefits (DLOB) clause, if the same incorporates requisite BEPS standards. The
PPT mainly states that tax treaty benefit shall not be granted if it is
reasonable to conclude, having regard to all relevant facts and circumstances,
that obtaining that benefit was one of the principal purposes of any
arrangement or transaction that resulted directly or indirectly in that
benefit. The benefit would, however, be granted if the same is in accordance
with the object and purpose of the relevant provisions of the tax treaty.

From the above
articles it can be observed that wherever applicable, a transaction or
structure will need to have adequate economic substance in order to pass the
test laid down by the preamble or PPT article of the MLI.

_________________________________________________

4   India has adopted PPT along with SLOB with an
option to adopt an LOB in addition or replacement of PPT through bilateral
negotiation. However, various important tax treaty partners have only adopted
PPT which means that SLOB will not apply to those tax treaties

 

 

(V)    OECD’s focus on substance to tackle cases of
tax treaty abuse

BEPS Action 6 recognises that courts of some countries have developed various
interpretative tools such as economic substance, substance over form, etc.,
that effectively address various forms of domestic law and treaty abuses. There
is, however, an agreement that member countries should carefully observe the
specific obligations enshrined in the tax treaties to relieve double taxation
in the absence of clear evidence that the tax treaties are being abused.

 

BEPS Action 5 explains that the Forum on Harmful Tax Practices (FHTP) was
committed to improving transparency and requiring substantial activity for any
preferential tax regime in any country. FHTP was to take a holistic approach to
evaluate preferential tax regimes in the BEPS context and engage with non-OECD
members for modification to the existing framework, if required.

 

It has been
categorically explained that the work on harmful tax practices is not intended
to promote harmonisation of income taxes or tax structures generally within or
outside the OECD, nor to dictate to any country what should be the appropriate
level of tax rates. The intention mainly is to encourage an environment in
which free and fair tax competition can take place, i.e., a ‘level playing
field’ through agreement of common criteria that promote a co-operative
framework. The broad steps recognised by BEPS Action 5 are:

 

(i)    Enhanced requirement of having substantial
activity in jurisdictions with preferential tax regimes;

(ii)    Suitably checking the ‘nexus’ of actual
activity in such jurisdictions with the nature of income earned there;

(iii)   Improved transparency and addressing of BEPS
concerns through an agreed framework to exchange information pertaining to tax
provisions and rulings amongst countries;

(iv)   Need for amendments to preferential tax
regimes of countries in line with BEPS;

(v)   Ongoing engagement between FHTP and OECD and
non-OECD members to address BEPS.

The nature of core
income-generating activities, other than for IP activities, specifically
discussed in the BEPS Action 5 in the context of substantial
activity is as follows:

 

Nature of
activity

Illustrative core income-generating
activities

a. Headquarters regimes

Taking relevant management decisions;
incurring expenditures on behalf of group entities; and coordinating group
activities

b. Distribution and service centre
regimes

Transporting and storing goods; managing
the stocks and taking orders; and providing consulting or other administrative
services

c. Financing or leasing regimes

Agreeing on funding terms; identifying
and acquiring assets to be leased (in the case of leasing); setting the terms
and duration of any financing or leasing; monitoring and revising any
agreements; and managing any risks

d. Fund management regimes

Taking decisions on the holding and
selling of investments; calculating risks and reserves; taking decisions on
currency or interest fluctuations and hedging positions; and preparing
relevant regulatory or other reports for government authorities and investors

e. Banking and insurance regimes

Banking: Raising funds; managing risk, including credit, currency and
interest risk; taking hedging positions; providing loans, credit or other
financial services to customers; managing regulatory capital; and preparing
regulatory reports and returns

Insurance: Predicting and calculating risk; insuring or re-insuring
against risk; and providing client services

f. Shipping regimes

Managing the crew (including hiring,
paying and overseeing crew members); hauling and maintaining ships;
overseeing and tracking deliveries; determining what goods to order and when
to deliver them; and organising and overseeing voyages

g. Holding company regimes

Regimes providing benefits to companies
only holding equity in other companies should at a minimum require such
companies to adhere to all applicable corporate law filings and have the
substance necessary to engage in holding and managing equity participation.
For example, having both the people and premises necessary for these
activities to mitigate possibility of letterbox and brass plate companies
benefiting from such regimes

 

Subsequent to the Action
Report 5, the FHTP published its 2018 report on preferential regimes in
the context of harmful tax practices. An update to the same has been published
on 19th July, 2019. The report explains in detail the activity-wise
review of tax regimes in various jurisdictions and the FHTP’s view on the same.
Some of the key observations arising from the said report for the purpose of
this article are:

(a)   In the context of the first time review of the
substantial activities factor in ‘no or only nominal tax jurisdictions’, the
status of United Arab Emirates (UAE) was ‘in the process of being amended’,
while the status of others, including Bahrain, Bahamas, Bermuda, BVI, Cayman
Islands, Isle of Man, Jersey, etc., was held to be ‘not harmful’. The report
states that while economic substance requirements were introduced in all these
jurisdictions (in case of UAE from 30th April, 2019 onwards) and
domestic legal framework meets all aspects of the standard, there was ‘one
technical point’ in UAE that is outstanding. However, the UAE has committed to
addressing this issue as soon as possible. The technical point has, however,
not been discussed in the report.

(b)   Tax regimes in Mauritius such as ‘innovation
box’, ‘Global headquarters administration regime’, ‘Global treasury
activities’, ‘Captive insurance’, ‘investment banking’, ‘shipping regime’ and
the recently introduced ‘partial exemption system’ are all compliant and not
harmful. The report also recognised the abolition of the tax regime for Global
Business License 1 and 2 holders
in Mauritius.

 

(VI) Steps regarding
economic substance taken by UAE and Mauritius in light of the BEPS Project

It is well known
that UAE and Mauritius have favourable tax regimes (such as non-levy of
income-tax in UAE, non-levy of income-tax on foreign capital gains in
Mauritius, etc.) and tax treaties which allocate right of taxation of certain
income to these countries. This effectively results in double non-taxation.
Accordingly, to address BEPS concerns both UAE and Mauritius have recently
introduced substance norms. A summary of the substance regulations is provided
below:

 

UAE

With effect from 30th April,
2019 all persons licensed by authorities of UAE (including free zones) are
required to meet the economic substance criteria notified. Only commercial
companies with direct or indirect ownership by the government of UAE / its
emirate or a body under its ownership have been excluded from the
applicability of these provisions. The nature of businesses identified is
similar to the businesses explained above in the context of BEPS Action
5

 

It is important to note that all the
covered persons need to file a report on the economic substance requirements
with the regulatory authority (that has issued trade license to it) for each
financial year. Failure to meet the criteria entails administrative penalties
ranging from AED 10,000 to AED 300,000 depending on nature of default

 

It is crucial to understand that the
regulation grants

power to authorised personnel of the
regulatory

authority to enter the covered person’s
business premises and examine and take copies of business documents. The
regulation also permits exchange of

information from Regulatory Authority to
Ministry of Finance in UAE and further with designated foreign

 

authority in cases where either economic
substance test is not met, or in all cases of persons involved in high-risk
IP activities

 

UAE has also published a guidance
document on 12th September, 2019 to further explain the criteria
for meeting substance regulations

Mauritius

Earlier, Mauritius provided deemed
foreign tax credit of up to 80% for taxable foreign income, where creditable
foreign taxes were lower. This reduced the effective corporate tax on such
income from 15% to 3%. Further, a company incorporated in Mauritius was
considered as resident if its central management and control was exercised in
Mauritius, i.e., the test of residency was earlier not based on PoEM criteria

 

However, the Mauritius tax law has moved
from the deemed foreign tax credit regime to granting 80% exemption to
taxable foreign income from 1st January, 2019. No foreign tax credit would be
granted in Mauritius against the balance 20% taxable foreign income

 

Further, a company incorporated in
Mauritius shall be considered to be a non-resident if its PoEM is outside
Mauritius. The guidance provided by the Mauritius authorities states that in
order for a Mauritius company to be held to have its PoEM in Mauritius, its
strategic decisions relating to its core income-generating activities should
be taken in or from Mauritius. Further, majority of meetings of the Board of
Directors should be held in Mauritius or the executive management of the
company should be regularly exercised in Mauritius. The determination of PoEM
would be based on all relevant facts and circumstances considering the
business activities of the company

 

Detailed circulars have been issued by
the Mauritius tax authorities explaining the various criteria to be met by
different types of companies operating in Mauritius under the Global Business
License (GBL) regime (which permits obtaining TRC in Mauritius). Broadly
speaking, a Mauritius company operating under the GBL regime will now be
required to ensure that at all times it carries out core income-generating
activities in or from Mauritius by employing suitably qualified persons and
has minimum expenditure in line with its level of activities / operations

 

From the above table it can be observed that entities / businesses based
out of UAE and Mauritius are now required to meet the enhanced criteria of
economic substance in those jurisdictions to be considered as tax resident in
that jurisdiction and benefit from their tax regimes.

 

(VII)      Impact on
Indian inbound and outbound business / investment structures

In terms of Indian inbound and outbound structures, Mauritius and UAE
have been popular choices for businesses. Some of the common structures are
discussed below along with their impact on account of BEPS.

 

Structure 1: Indian outbound – use of UAE trading company

Facts: XYZ India has incorporated a
trading company, DUB, in one of the Free Trade Zones (FTZs) of UAE. XYZ India
undertakes import from, and export to, third parties through DUB. DUB maintains
a fairly good margin while dealing with XYZ India.

 

Tax advantage: Subject to Indian transfer pricing
regulations, profits earned by DUB are not liable to any tax in India provided
DUB is non-resident in India under the PoEM regulations and does not have a PE
in India. Since UAE does not levy tax on income of companies incorporated in
FTZs, the effective tax rate on profits of such UAE companies is NIL, unless
repatriated to India as dividend.

 

Impact of BEPS: As a distribution /
service centre company, under the UAE substance regulations DUB will be
expected to undertake the following activities in UAE:

1. Transporting and
storing goods;

2. Managing the
stocks;

3. Taking orders;

4. Providing
consulting or other administrative services.

 

Accordingly,
businesses adopting the above structure will now need to factor the substance requirements
in UAE.

 

Structure 2: Indian inbound – use of Mauritius as holding company

Facts: XYZ USA has incorporated a
company in Mauritius, MAU, as a holding company for investment in XYZ India
(made prior to 1st April, 2017). Income of MAU is either dividend
from XYZ India or capital gains from sale of shares of XYZ India.

 

Tax advantage: MAU will not be liable to pay any tax on capital gains earned from
sale of XYZ India since the same are not taxable in Mauritius and are also
grandfathered from taxation in India under the amended India-Mauritius tax
treaty. The dividend income of MAU, which is exempt from tax in India, will be
subject to an effective tax rate of 3%, which is low. Also, Mauritius has
various favourable tax treaties (especially with African countries) making it
an ideal jurisdiction for holding investments.

 

Impact of BEPS: Mauritius has not notified the tax treaty with India under MLI and
hence, the treaty is not currently impacted by MLI. However, the same is
expected to be bilaterally amended on the lines of BEPS and hence the
requirement of substance in the form of the preamble and PPT (or DLOB) is
expected in the future.

 

In the context of
inbound investment structures through Mauritius, past litigation with Indian
tax authorities has been mainly on the ground that the structures lack
commercial / economic substance and are artificially interposed to avail tax
treaty benefits in India. Now, under Mauritius law, MAU will be required to
have PoEM in Mauritius to be eligible for TRC. Further, as an investment
holding company, in compliance with circular letter CL1-121018 dated 12th
October, 2018 issued by the Financial Services Commission (FSC) of Mauritius,
the minimum expenditure to be incurred by MAU is USD 12,000 p.a. (although no
minimum employees are specified). The same will, however, be tested on a
case-to-case basis, as per facts. For instance, BEPS Action 5
states that in addition to undertaking all applicable corporate law filings,
holding companies are expected to have both the people and premises necessary
to ensure that letterbox and brass plate companies do not benefit from
preferable tax regimes. Whether this will impact the substance evaluation in
Mauritius needs to be seen in the future.

 

It may be noted
that the minimum expenditure in Mauritius will be required even though the
India-Mauritius tax treaty does not provide for any such expenditure under its
LOB clause for availing grandfathering benefit for capital gains.

 

Structures 3-6: Indian inbound structures involving UAE or Mauritius
(others)

 

Structure

Nature of income

from India

UAE

(India-UAE tax treaty is

amended by MLI)

Mauritius

(India-Mauritius tax treaty
is not amended by MLI as yet)

Foreign Direct Investment

Capital gains from sale of
partnership interest in an Indian LLP

Not taxable in India under
Article 13(5) of the India-UAE tax treaty. No tax in UAE as well

Not taxable in India under
Article 13(4) of the India-Mauritius tax treaty. No tax in Mauritius as well

Foreign Portfolio Investment

Capital gains from sale of Indian derivatives /
bonds / debentures

Not taxable in India under Article 13(5) of the
India-UAE tax treaty. No tax in UAE as well

Not taxable in India under Article 13(4) of the
India-Mauritius tax treaty. No tax in Mauritius as well

Structure

Nature of income

from India

UAE

(India-UAE tax treaty is

amended by MLI)

Mauritius

(India-Mauritius tax treaty is not amended by MLI
as yet)

Foreign Service companies providing onshore
services in India

Service income not in nature of fees for technical
services

No PE or tax in India unless presence in India of
9 months within any 12-month period. No tax in UAE
as well

No PE or tax in India unless presence in India of
90 days within any 12-month period. Low tax in Mauritius

Foreign Service companies mainly providing
offshore services

Service income in nature of fees for technical
services

FTS is not taxable in India under the India-UAE
tax treaty. No tax in UAE as well

Although FTS is now taxable in India under the
India-Mauritius tax treaty, the same is subject to a low tax rate
in Mauritius

 

Impact of
BEPS: The above structures seek to obtain tax
treaty benefits in India which may otherwise not be available under India’s tax
treaty with the country of headquarters of the business (say, USA or UK). Any
adverse impact on meeting substance requirements in the UAE or Mauritius could
adversely impact grant of tax treaty benefits in India – especially if TRC is
not granted to entities non-compliant with substance regulations.

 

Accordingly, businesses adopting the above
structures or any other structures involving use of an entity in a preferential
tax regime, in addition to PPT, should factor in the impact of substance
regulations in that country to ensure that the structure is compliant under
BEPS.

 

(VIII)     Parting
note

Considering the intention of the BEPS
project to tackle cases of tax avoidance and aggressive tax planning, it is not
surprising that India has been at the forefront of this landmark global
initiative. In addition to GAAR and PoEM, India has actively also incorporated
BEPS Actions into its domestic tax laws such as:

 

(i)    Country by country reporting (CbCR)

(ii)   Equalisation levy

(iii)
Commissionaire arrangements resulting in taxable presence

(iv) Significant
economic presence (SEP) constituting taxable presence for certain digital
businesses

(v) Limitation on
interest deduction for payments to associated enterprises

 

In fact, as a sign of things to come, the
recently-concluded protocol to the India-China tax treaty incorporated various
MLI provisions within the text of the tax treaty, including PPT (as a
result, India-China tax treaty is outside the purview of the MLI).

 

Accordingly, it is expected that BEPS
Actions and MLI will influence the approach of Indian tax authorities in the
future while granting tax treaty benefits in India. One of the key expected
areas of focus is to probe the economic substance of non-resident entities
under BEPS Action 5.

 

In light of the above, reference may be
made to another set of wise words from Mr. Dee Hock, which may be relevant in
the context of the future of international tax – ‘Preserve substance; modify
form; know the difference’.  

IMPORTANCE OF CYBER SECURITY FOR MID-SIZED ACCOUNTING FIRMS

INTRODUCTION

We live in a
world that is networked together; and network protection is no longer an option
but a prime necessity for small and mid-sized accounting firms that deal with
sensitive client data. It should be seamless and thorough, regardless of
business or organisational standing. We have our own set of measures in terms
of practices and policies (that we have enlisted here) which are essential for
the right amount of preparation vital for optimised security, damage control
and recovery from the consequences of any possible cyber breach episodes.

 

IMPORTANCE OF CYBER
SECURITY FOR SMALL AND MID-SIZED ACCOUNTING FIRMS

Cyber
security is among the top issues currently on the minds of managements and
boards in just about every company, large or small, public or private,
including the small and mid-sized accounting firms. It becomes especially
challenging because while dealing with clients’ sensitive data, there is no
scope for taking things leniently.

 

Cyber
attacks may result in:

(i)    regulatory actions;

(ii)   negligence claims;

(iii) inability to meet contractual obligations; and

(iv) a damaging loss of trust among clients and
stakeholders.

 

Consequently,
it may bring commercial losses, as also loss of reputation, disruption of
operations and sometimes even business closures. Small breaches, if not
addressed adequately, could lead to insurmountable problems. Therefore, it is
better to take preventive measures at the organisational level.

 

By
definition, accounting firms are trusted with some of the most intimate
personal and financial information of their clients. And hackers are
continually trying to get their hands on such critical, private information.
This is a challenge for them but not really too difficult; in fact, it is
extremely simple for them to hack into firms that don’t have appropriate cyber
security measures at the core level. This is the reason that accountants need
to be motivated even more and to be cautious about protecting their client
data.

 

Understanding
the basics of cyber security ensures not only the safety of client information,
but also the longevity of the firm. Accounting companies thrive on their
reputation for privacy, just as much as their ability to crunch numbers, and
cyber security is a vital part of this reputation.

 

As the owner
/ manager of a small accounting, bookkeeping or finance firm, you’ve probably
faced questions about your cyber security and whether your firm could get
hacked in the same way that any larger financial institution might have been
hacked. The short answer is, yes!

 

THE CHALLENGE FOR ACCOUNTING FIRMS

Cyber-criminals
usually target small and medium-sized accounting firms because such
organisations place relatively less emphasis on data security, controls and
risk evaluations; they are, therefore, more vulnerable than the big firms. In
many cases, such firms don’t have sufficient staff in the IT function and not
all staff has the ability to spot these issues, which can prompt further risks.
The senior partners are especially at risk since they are both effortlessly
identifiable on the web and are most likely to conduct online banking
transactions for their practices. Any savvy cyber-criminal knows the steps for
hijacking access to accounts, as well as the security features associated with
online banking.

 

WHY ACCOUNTING FIRMS ARE AT HIGH RISK FOR
CYBER ATTACKS

(a) They hold massive private data

Cyber
attackers understand that accounting firms have total information as privileged
data from HNI clients or organisations. In addition to tax documents, financial
records, PAN and direct-store data, accountants may also serve as sources for
years of private data. Actually, some accounting firms hold virtually the
complete individual accounts of their customers, transforming these practices
into important targets.

 

(b) They have productive corporate information

While
numerous accounting firms deal exclusively with tax documents and related
personal and business documents, different practices handle high-stake
corporate issues. Accounting firms that frequently deal with mergers,
acquisitions and corporate rebuilding hold data that might be of considerable
‘interest’ to cyber-criminals.

 

(c) Firms do not assess security risk

Unlike large
accounting businesses, small and medium accounting firms often do not implement
robust security measures. However, they are all vulnerable to a variety of
targeted security attacks regardless of size and location. Many cyber-criminals
today execute malware attacks by targeting small and medium accounting firms by
taking advantage of inadequate data security.

 

No
accounting firm can combat and prevent emerging security threats without
assessing its security risk on a regular basis. The security risk assessment in
the accounting firms will help them to check the nature of client data being
accessed by each employee and assess the effectiveness of the employee’s device
to prevent targeted security attacks. Besides, the risk assessment will help
the firm to evaluate and improve its security strategy according to the
security vulnerabilities.

 

(d) Small firms tend to have insufficient security

While one
may expect that big accounting firms have far more resources and also face the
maximum risk of cyber attacks, small and mid-sized firms are far more
vulnerable to cyber threats. Indeed, a few criminals target small accounting
firms since they would have installed far fewer security systems than needed.
Some hackers launch strong, sustained attacks on small, poorly secured firms to
the point that they breach the company’s restricted protections. When they get
access to an organisation’s system, cyber-criminals can regularly steal
virtually any type of documents, from financial records to emails.

 

(e) Small accounting firms may not recover from hacks

For small
accounting practices, recovery may prove fairly tough if not impossible to
achieve. Clients pay accountants for their skills; however, in return they
expect trust and tact. Once a firm has demonstrated that it can’t give
satisfactory information data security or guarantee customers’ protection, the
organisation may never have the capacity to return to its earlier level of
business.

 

ACTION PLAN TO PROTECT YOUR FIRM FROM CYBER
ATTACKS

1.       Know The
Applicable Laws

Any effort
to strengthen cyber security for accounting firms starts with an understanding
of the applicable laws. Every accounting firm is expected to protect its
clients’ Personally Identifiable Information (PII) or details which, if
disclosed, ‘could result in harm to the individual whose name or identity is
linked with this information.’ In such a case, the data can be stolen for
financial fraud and in some cases can cost you three times the damages.

 

The following is a list of your
clients’ PII that your firm could be in custody of: PAN; Aadhaar number / data;
digital signatures; bank account numbers; residential address; residential or
mobile phone numbers; date of birth; place of birth; mother’s maiden name;
financial records; and so on.

 

2.       Perform
Regular Risk Assessments

Prevention
is indeed better than cure. New threats emerge every day and you need to
re-adjust your safeguards to adapt to these new threats. For your firm an
annual risk assessment should be sufficient.

 

And at the
minimum your risk assessment should include the following:

(a)   A review of the client information your firm
is currently collecting, categorising which are regulated PII and sensitive
data;

(b)   Identification of new laws and the applicable
commitments and requirements that your firm needs to fulfil for compliance;

(c)   Partner with a Managed Services Provider to
make sure your risk is limited and make sure your systems are protected and
secure;

(d)  Any change in your firm’s practices concerning
the acquisition, storage and sharing of client data that could open new
loopholes for financial identity theft;

(e)   New developments in the regulatory and
business environment; and

(f)   New technologies that your firm could be
maximising.

 

3.       Create A Written Financial
Identity Protection Policy

It’s easier for your accountants
to follow cyber security protocols if it’s a formal memo, part of your
employees’ handbook, or clearly outlined in your standard operating procedures.
A written cyber security policy can also serve as your springboard in training
employees to be more cyber security savvy.

 

4.       Update The
Operating System

Whether you
run on Microsoft Windows or Apple Mac OS, the operating system requires
frequent or continuous updates for strengthened security. System updates are
especially significant for server operating systems where all patches and
updates require to be looked at and refreshed repeatedly. Regular updates of
OS, upgraded firewalls and anti-virus in your workstations can provide for more
reliable protection against threats.

 

5.       Email
Security

Many
accounting firms rely on email to communicate with clients, even to send tax
documents or personal data. As email hacks have become increasingly common, it
is crucial to secure professional email accounts, especially when transmitting
important documents. This has also raised the requirement for efficient
encryption software, which is hard to decrypt by an untrusted third party.

 

More than
90% of cyber attacks begin with a phishing email. A vast majority of people
open an email from an unknown individual’s name without browsing or verifying
the actual sender’s email address. Having your email shielded from unauthorised
access is of prime importance.

 

6.       Anti-Virus
Updates

Accounting
firms need to ensure that anti-malware applications are set to check for
updates frequently, scan the devices on a set schedule in a mechanised manner,
along with any media that is inserted
into any user computing terminal. In bigger firms, workstations must be
designed for reporting the status of the anti-virus updates to a unified
server, which can push out updates when released subsequently.

 

7.       Internet
Security

Browser downloads are another
leading method of cyber attacks. Internet searches can lead you to compromised
websites which infect your network with viruses and malware. To prevent this
type of attack, install all the latest security patches into your computers and
servers. Install a hardware firewall router with gateway anti-virus, gateway
anti-malware and intrusion protection system to stop the virus before it gets
into your private network. Routers provided by your Internet Service Provider
do not have this type of security. While these might be adequate for your home,
they are not designed for installation and application in any business
organisation.

 

8.       Protection
For Mobile Devices

As commerce
moves into the mobile space, so do hackers. Make sure that any employee that
uses mobile devices is encrypting data, password protecting the device (with a password
that is different from any other being used) and using the latest security apps
on the phone to ward off malicious third-party users.

 

9.       Protection
For Usb Devices

USB drives,
also known as pen drives, have become a popular form for storing and transporting
files from one computer to another. Their appeal lies in the fact that they are
small, readily available, inexpensive and extremely portable. However, these
same characteristics also make them attractive to attackers. And it’s not just
pen drives that are the culprits, any device that plugs into a USB port,
including electronic picture frames, iPods and cameras, can be used to spread
malware.

 

There are
numerous ways for attackers to use USB drives to infect computers. The most
common method is to install malicious code, or malware, on the device that can
detect when it is plugged into a computer. When the USB drive is plugged into a
computer, the malware infects that computer. Often, an organisation’s biggest
weakness might not be a malicious insider but rather an employee who simply
doesn’t understand the potential security risks of his / her actions.

 

There are
steps you can take to protect the data on your USB drive and on any computer
into which you might plug the drive:

 

(i)    Take advantage of security
features

Use
passwords and encryption on your USB drive to protect your data and make sure
that you have the information backed up in case your drive is lost.

(ii)   Keep personal and business
USB drives separate

Do not use
personal USB drives on company computers and do not plug USB drives containing
corporate information into your personal computer.

(iii) Use security software and
keep all software up to date

Use a
firewall, anti-virus software and anti-spyware software to make your computer less
vulnerable to attacks and make sure to keep the virus definitions current. It’s
also important to keep both the operating system and other software on your
computer up to date by applying any necessary patches.

(iv) Do not plug an unknown USB
drive into your computer

If you find
a USB drive, do not plug it into your computer to view the contents or to try
to identify the owner.

(v)   Disable Autorun

The Autorun
feature in Windows causes removable media such as CDs, DVDs and USB drives to
open automatically when they are inserted into a drive. By disabling Autorun,
you can prevent malicious code on an infected USB drive from opening
automatically.

(vi) Develop and enforce USB
drive-related policies

Make sure
employees are aware of the inherent dangers associated with USB drives and what
is your organisation policy on their proper use.

 

10.     Backing Up
Data Religiously

If all your
data is in one place, it is nowhere. Back up all of your most important data on
a regular basis. This may seem counter-intuitive to the concept of security as
you’re creating another copy of data that could be hacked. However, if the
backup is also stored securely over a proprietary or public network to an
off-site server, it drastically minimises chances of a breach or data loss.
There are additional fees associated with this type of backing up, but it’s
currently one of the best methods of security.

 

11.     Encrypt
Backup Data

Firms should
encrypt any backup media that leaves the workplace and also validate that the
backup is complete and usable. They should frequently review backup logs for
completion and restore files randomly to ensure that they will actually work
when required. Hiring an IT specialist is advisable to set up your firm’s
network and ensure your data is encrypted and secured. As a professional, your
responsibility is to ensure that data is secure when it’s in your custody.
Moreover, a backup is a definite must for any business.

 

12.     Educate
Employees

Most
breaches into accounting companies occur because of a backdoor innocuously left
open by an employee. Although hacking systems are becoming more sophisticated,
the majority of these systems are not able to force their way into a properly
managed security perimeter.

 

Security
education is a must and should be conducted once a year. In addition to looking
into the firm’s approaches, employees should be regularly instructed on current
cyber security attack techniques such as phishing and dangerous threats
including ransomware and social engineering used by hackers to gain access to a
user’s PC. Note: NEVER share your login, password or confidential
information over the phone with people whom you don’t know. Firms should review
IT / computer usage policies and provide reminder training to employees at
least once a year for all the new and updated policies.

 

13.     Wireless
Security

Secured
remote / wireless access into your network system should be planned, tested and
then implemented. Obviously, deploy a strong password policy, along with having
a guest network which should be set up for visitors (to your office network)
that need internet access via your wireless network system. This prevents any
guest user access to the system and resources on your network. This is
particularly required (to protect) in case one of the workstations or gadgets
used by the visitor is infected.

 

14.     Move Your
Data To The Cloud

Transporting
data using a USB drive is not secure. Data stored on the cloud has greater
protection than data stored on company servers. The move to such cloud services
can change business habits that help ensure a more secure accounting firm. For
example, if all company data is stored on the cloud, then there’s less need for
workers to email attachments to one another. When team members become less
reliant on email, it helps minimise the risk of falling victim to phishing
emails. Cloud accounting can make your business more efficient. It lets you
provide basic accounting services more easily – and in a cost-effective manner.

 

If you
haven’t moved your accounting practice to the cloud, you most likely believe it
is a complicated thing to do. But it’s not that hard to migrate your practice
to the cloud; it will improve your efficiency, save money and make your clients
feel safer than what they are feeling right now.

 

15.     Test
Security Measures

Hire security specialists for
proper configuration when implementing firewalls and security-related features
such as remote access and wireless routers. Chances are, your internal IT
people have not been exposed to ideal security training, or have no experience
with setting up a new device. External resources can likewise be called upon to
do penetration testing to recognise and lock down any system vulnerabilities.

 

16.     Byod Policies

The bring
your own device (BYOD) trend has seen rapid growth in offices throughout the
country. Since many accountants do get to access company and client data on
their personal devices, it is essential for firms to have policies with regard to
cyber security for such individual devices. Some accounting firms have decided
to completely prohibit the use of personal gadgets for organisation matters,
while others have imposed limitations to the data that can be accessed on them.
Furthermore, such devices can be easily targeted or exposed to cyber attacks by
hackers seeking confidential client data. Thus, it is in the best interest of
the accounting firms not to allow BYOD so that the data never leaves the
office.

 

17.     Remote
Working And Cyber Security

Large accounting firms deploy
resources for management of threats related to cyber security. They are well
equipped with infrastructure as well as manpower to keep such threats at bay.
But small and mid-sized firms may not enjoy similar privileges and could be
relatively more vulnerable to cyber threats.

 

Many firms
leverage cloud-based computing to enable employees to access accounting
software and client data remotely over the internet. The cloud-based services
and solutions even help accounting businesses to operate in distributed
environments. However, remote data access makes it easier for hackers to steal
and misuse sensitive financial data of clients.

 

Firms must
require employees to access the computers and business solutions over a secure
Virtual Private Network (VPN). A secure VPN will help the business to protect
data by avoiding the security risks.

 

Along with
that, it is recommended to use genuine and trusted software solutions, such as
Microsoft Remote Desktop, remote access. Apart from this, the firm must
implement multi-factor authentication to ensure that any unauthorised user does
not access the data stored in the cloud.

 

Recently, a
huge number of accounting firms have turned to remote staffing and hired such
staff to work for them. This could increase their anxiety about client data
even more as they won’t be able to monitor all the setups personally. In such
cases, the role of the remote staffing agency becomes all the more important.
Since the remote staff is actually working from their remote offices, these
need to be secured in terms of both policies as well as practices.

 

CONCLUSION

Isn’t
technology a crucial factor in cyber security for accounting firms? Some may
even go so far as to say that technology is at fault for all the modern-day
data espionage. However, you need to understand that it’s not technology per
se, but the poor implementation of the technology that is responsible.

 

One way that
accounting firms are jeopardising their own cyber security is by burdening
their employees with overseeing the implementation, management and maintenance
of these technologies. Between servicing your clients and fulfilling internal
administrative tasks, adding cyber security to your accountants’ long to-do
list is hitting a nail into your data-protection coffin. Something is bound to
fall through the cracks. It would be best to partner with a managed services
provider to take care of your cyber security and tech management needs.

 

All
professionals owe a duty to their clients, managers and other employees to
address digital security. Active contribution is the key to addressing the
risks of illegal cyber activities. Understand your data and focus efforts on
the most critical information, implement encryption, become compliant with
cyber security regulations, educate employees about mobile devices and devise a
basic set of desktop security policies. These steps are a good initial move,
but they do not completely cover the gamut of standards and protocols seen in a
high-quality Cyber Security Risk Management System.

 

Accounting firms
that also have teams working from remote locations need to select their vendors
after due research and assurance that the data shared would be as secure as
demanded by their clients.  

 



Sections 5 and 9 of the Act – As insurance compensation received by foreign parent company from foreign insurer was for protection of its financial interest in Indian subsidiary, it was not taxable in hands of the Indian subsidiary, although compensation was paid pursuant to fire damage to assets and stock of the Indian subsidiary

21. 
TS-439-ITAT-2019 (Del.) M/s. Adidas India Marketing vs. IT Officer
(P) Ltd. ITA No.: 1431/Del/2015 A.Y.: 2011-12 Date of order: 2nd July, 2019;

 

Sections 5 and 9 of the Act – As insurance
compensation received by foreign parent company from foreign insurer was for
protection of its financial interest in Indian subsidiary, it was not taxable
in hands of the Indian subsidiary, although compensation was paid pursuant to
fire damage to assets and stock of the Indian subsidiary

 

FACTS

The assessee was an Indian company engaged
in the business of sourcing, distribution and marketing of products in India
under a brand name owned by its overseas group company. A German company (F Co)
was the ultimate parent / holding company of the assessee. The assessee had
insured its fixed assets and stocks with an Indian insurer. F Co had insured
its financial interest in its worldwide subsidiary companies (including in
India) under a global insurance policy (GIP) with a foreign insurer. The
assessee had a fire incident against which it received compensation from the
Indian insurer during the relevant year. In respect of loss incurred by the
assessee, F Co also received insurance compensation under GIP in Germany from
the foreign insurer towards loss in economic value of its financial interest in
the assessee. The compensation received was reduced by the amount of
compensation received by the assessee from the Indian insurer. Further, F Co
had paid taxes in Germany on the compensation received under GIP.

 

The AO contended that the insurance
compensation received by F Co was in respect of loss of stock of the assessee
and that the email correspondence between the assessee and F Co indicated that
all receipts from insurance, relating to physical loss, business interruption
and mitigation cost, belonged to the assessee. Thus, overseas compensation
received by F Co had a direct business relationship with the business
activities of the assessee and hence the same should be taxed in India in the
hands of the assessee.

 

The DRP also
held that insurance compensation was taxable in the hands of the assessee as
the profit foregone on the lost stock and the loss suffered on other assets
were part and parcel of the business of the assessee in India.

 

The assessee had contended that

The insurance compensation received by the
assessee and F Co were under two separate and distinct contracts of insurance.
The contracts were with unrelated third-party insurers. The respective insured
persons (claimants) had separately paid the premium without any cross-charge.

 

While the insurance policy taken by the
assessee exclusively covered risk arising out of loss of stock and fixed assets
owned by it, the GIP exclusively covered the financial interest of F Co in the
assessee.

 

The privity of the insurance contract of the
Indian insurer was with the assessee and that of the foreign insurer was with F
Co. Further, the assessee was not a contracting party to the GIP.

 

Income ‘accrues’ to the assessee only when
the assessee acquires the right to receive it. Since there was no actual or
constructive receipt by the assessee, compensation could not be taxed in India
in its hands. Moreover, no income accrued to the assessee as the assessee had
not acquired any unconditional and absolute right to receive claim of
compensation under GIP.

 

F Co had undertaken the GIP with the foreign
insurer for all its investments worldwide, including in India.

 

HELD

Insurance policy between the assessee and
the Indian insurer was to secure stock-in-trade, which is a tangible asset.
However, GIP between F Co and foreign insurer was for securing investment made,
or financial interest, in subsidiaries which is an intangible asset. Thus, the
interest insured by the assessee and that by F Co were two different interests.

 

The insurance contracts entered by the
assessee and F Co were separate and independent since: (i) there were two
different claimants; (ii) claimants had separately paid the premium; (iii) no
part of the premium on GIP was allocated to the assessee; and (iv) the privity
of contract was with different parties.

 

As the assessee did not have any right or
obligation in the GIP and it was not a party to it, the assessee did not have
any right to receive the claim of insurance. The same was also not vested in
the assessee to be regarded as having accrued in the hands of the assessee.
Reliance was placed on the Supreme Court’s decision in the case of ED
Sassoon [26 ITR 27 (SC)].

 

The claim under GIP was in respect of
insured financial interest of F Co in its worldwide subsidiaries. The foreign
insurer had paid compensation for diminution in financial interest. Merely
because the computation of the claim was with reference to loss by fire of the
stock, or profit that could have been earned if such stock was sold, cannot be
construed to mean that the claim was in respect of loss of tangible property in
the form of stock of the assessee. The claim was in respect of the intangible
asset in the form of financial interest of F Co. Hence, the claim cannot be
said to have any ‘business connection’ in India.

 

The insured interest of F Co cannot be said
to be through or from any property in India or through or from any asset or
source of income in India. F Co had entered into a contract in Germany for
insuring the intangible assets in the form of financial interest in its
subsidiaries. This was quite distinct from the physical stock-in-trade of the
assessee that was lost in fire. Thus, the claim received by F Co could not be
treated as income deemed to accrue or arise in the hands of the assessee in
India.Further, the email correspondence was merely to explore the modes of
transfer of money from F Co to the assessee for restoring the financial
interest of F Co in the assessee. The same cannot determine the tax liability.
Such correspondence was related to application of money but did not indicate in
whose hands the money was taxable.

 

The GIP was taken to cover the contingent
losses that may or may not arise in future. Further, as F Co had actually paid
premium in respect of GIP from time to time and also paid tax in Germany in
relation to the insurance claim, there was no colourable device adopted by the
assessee for evading taxes in India.

 

Sections 5, 9, 40(a)(i) and 195 of the Act; Article 7 of India-USA DTAA – As services were rendered outside India and payment was also made outside India, receipts of the foreign company were not within the scope of ‘total income’ in section 5(2) – Fee received for merely referring and introducing clients is business income which, in absence of PE in India, would not be chargeable in India – Besides, the services were not in the nature of managerial, technical or consultancy services

20. 
[2019] 107 taxmann.com 363 (Mum – Trib.) Knight Frank (India) (P) Ltd. vs. ACIT ITA No.: 2842 (Mum.) of 2017 A.Y.: 2012-13 Date of order: 12th June, 2019;

 

Sections 5, 9, 40(a)(i) and 195 of the Act;
Article 7 of India-USA DTAA – As services were rendered outside India and
payment was also made outside India, receipts of the foreign company were not
within the scope of ‘total income’ in section 5(2) – Fee received for merely
referring and introducing clients is business income which, in absence of PE in
India, would not be chargeable in India – Besides, the services were not in the
nature of managerial, technical or consultancy services

 

FACTS

The assessee
was engaged in the business of rendering international real estate advisory and
property management services. During the course of the relevant year, the
assessee had paid referral fees to an American company (US Co) for introduction
of clients to the assessee. According to the assessee, the services rendered by
the US Co did not ‘make available’ any technical knowledge, experience, skill,
knowhow or processes to the assessee. Therefore, they were not in the nature of
‘Fees for included services’ in terms of Article 12 of the India-USA DTAA.
Since they were business profits of the US Co, in the absence of a PE in India
they could not be brought to tax in India.

 

However, the predecessor of the AO had, in
an earlier year, held that after retrospective amendment and insertion of
Explanation to section 9(2) of the Act, the income of a non-resident was deemed
to accrue or arise in India u/s 9(1)(v), (vi) or (vii)irrespective of whether
the non-resident had a place of business or business connection in India or
whether he had rendered services in India, and hence, the referral fee was taxable
in India. Following the order of his predecessor, the AO disallowed the fee u/s
40(a)(i) of the Act. The CIT(A) also followed the view held by his predecessor
CIT(A) and dismissed the appeal.

 

HELD

Sections 5 and 9 (post-2010 amendment)

Under section 5(2), income taxable in India
of a non-resident includes income received or deemed to be received in India
and income which has accrued or arisen, or is deemed to accrue or arise in
India.

 

Since the referral fee was paid outside
India, it was not received or deemed to be received in India. As regards
accrual, place of accrual would be relevant. Since the US Co had rendered the
services outside India, referral fee did not accrue or arise in India.

 

Section 9(1) in its clauses (i) to (vii)
deals with ‘income deemed to accrue or arise in India’. Clauses (ii) [salary
earned in India], (iii) [salary payable by government], and (iv) [dividend] are
not relevant in case of the US Co. Of the seven clauses, only the limb in
respect of ‘…directly or indirectly, through or from any business connection in
India…’ of clause (i) is relevant because the US Co had rendered services in
the course of its business. Explanation 1(a) to section 9(i) provides that if
all operations of a business are not carried out in India, only the income
reasonably attributable to the operations carried out in India shall be
taxable.

 

Since the US Co had rendered all its
services outside India, no part of referral fee could be attributed to any
operation in India. Hence, there was no income deemed to accrue or arise in
India. And, since the CIT(A) had based his conclusion on Explanation to section
9(2), which mentions clauses (v), (vi) and (vii), their applicability should be
examined. As clause (v) is in respect of ‘interest’, it is not relevant.
Similarly, clause (vi) deals with ‘royalty’, which is also not the case. Hence,
what needs to be examined is whether, in terms of clause (vii), the services
rendered were in the nature of managerial services, technical services or
consultancy services.

 

Managerial services

The US Co was referring or introducing
clients to the assessee. It did not provide any managerial advice or services.
Therefore, referral fee cannot be said to have been received for managerial
services.

 

Technical services

The US Co had not performed any services
which required special skills or knowledge relating to a technical field.
Therefore, referral fee cannot be said to have been received for technical
services.

 

Consultancy services

The US Co was using its skill and knowledge for
its own benefit and merely referring or introducing clients to the assessee. It
had not provided any consultation or advise to the assessee. Therefore,
referral fee cannot be said to have been received for consultancy services.

 

Make available

The service of referring or introducing a
client did not ‘make available’ any technical knowledge, experience, skill,
knowhow or processes to the assessee. Therefore, the receipt was not ‘Fees for
included services’ in terms of Article 12 of the India-USA DTAA.

 

Disallowance under section 40(a)(i)

As referral fee was business income of the
US Co, it was covered under Article 7 of the India-USA DTAA. And since the US
Co did not have a PE in India, referral fee was not chargeable to tax in India.
Hence, the assessee was not obligated to deduct tax at source u/s 195 from the
referral fee. Consequently, no disallowance u/s 40(a)(i) could be made.

 

Article 7, India-Malaysia DTAA; Article 7, India-UK DTAA – Compensation paid for contractual default, being business profit, was not taxable in India if recipient had no PE in India – Rebate given for quality issues effectively being discount in sale price, was not taxable; even otherwise, rebate being business profit, was not taxable in India if recipient had no PE in India

19. 
[2019] 108 taxmann.com 79 (Vizag. – Trib.) 3F Industries Ltd. vs. ACIT, Circle-1, Eluru ITA No.: 01 (Viz.) of 2015 A.Y.: 2007-08 Date of order: 17th July, 2019;

 

Article 7, India-Malaysia DTAA; Article 7,
India-UK DTAA – Compensation paid for contractual default, being business
profit, was not taxable in India if recipient had no PE in India – Rebate given
for quality issues effectively being discount in sale price, was not taxable;
even otherwise, rebate being business profit, was not taxable in India if
recipient had no PE in India

 

FACTS

The assessee was an Indian company engaged
in trading of certain products. The assessee procured the products from
suppliers in India and exported the same to foreign customers. Among others, it
had entered into export contracts with a Malaysian company (Malay Co) and a UK
company (UK Co). In respect of the contract with the Malay Co, as the price in
the Indian market was substantially higher the assessee could not procure the
products and did not fulfil the contract. Hence, the Malay Co claimed
compensation towards the losses suffered because of default by the assessee. To
maintain its business reputation and relationship with the Malay Co, the
assessee agreed upon the amount of compensation and paid up. In respect of its
contract with the UK Co, there were certain quality issues. Hence, the UK Co
claimed price rebate. Again, to maintain its business reputation and
relationship with the UK Co, the assessee agreed to a rebate.

 

The AO completed the assessment u/s 143(3)
of the Act. Subsequently, CIT undertook revision of the order u/s 263 and held
that as payment was made to a foreign company and no tax was deducted u/s 195
of the Act, the assessment was erroneous and prejudicial to the interest of the
Revenue. He directed the AO to examine disallowance u/s 40(a)(i) of the Act.
The AO proposed disallowance, which the DRP upheld.

 

HELD

Compensation for contractual default

The transaction of export was a business
transaction. Compensation was paid because of failure of the assessee to supply
the products. Thus, the payment was to compensate the Malay Co for the loss
suffered by it because of non-fulfilment of contract by the assessee.

 

Therefore, the receipt was business income
in the hands of the Malay Co. Further, the Malay Co did not have a PE in India.
In terms of Article 7 of the India-Malaysia DTAA, business income of the Malay
Co would be taxable only in Malaysia unless it had a PE in India. But since it
did not have a PE in India, the business income was not chargeable to tax in
India. Therefore, the question of disallowance u/s 40(a)(i) of the Act did not
arise.

 

Quality rebate

Quality rebate was given because of certain
quality issues. The perusal of the documents showed that the quality rebate
was, effectively, a discount in sale price. Hence, there was no question of
TDS.

 

Even otherwise, quality rebate was in the
nature of business profit for the UK Co. In terms of Article 7 of the India-UK
DTAA, the business income of the UK Co would be taxable only in the UK unless
it had a PE in India. But since it did not have a PE in India, the business
income was not chargeable to tax in India. Therefore, the question of
disallowance u/s 40(a)(i) of the Act did not arise.

 

Section 271(1)(c) – Imposition of penalty on account of inadvertent and bona fide error on the part of the assessee would be unwarranted

15. 
Rasai Properties Pvt. Ltd. vs. DCITITAT Mumbai: ShamimYahya (AM) and
Ravish Sood (JM) ITA No. 770/Mum./2018 A.Y.: 2013-14 Date of order: 28th June, 2019; Counsel for Assessee / Revenue: Nilesh Kumar
Bavaliya / D.G. Pansari

 

Section 271(1)(c) – Imposition of penalty
on account of inadvertent and bona fide error on the part of the
assessee would be unwarranted

 

FACTS

For the assessment year under consideration,
the assessee filed its return of income declaring total income of Rs.
80,19,650. In the schedule of Block of Assets, there was a disclosure of a sum
of Rs. 67,00,000 against caption ‘Deductions’ under immovable properties.

 

On being queried about the nature of the
aforesaid deduction, the assessee submitted that the same pertained to certain
properties which were sold during the year under consideration. The AO called
upon the assessee to explain why it had not offered the income from the sale of
the aforementioned properties under the head income from ‘Long-Term Capital
Gain’ (LTCG). In response, the assessee offered long-term capital gain of Rs.
19,45,176 and also made a disallowance of Rs. 93,453 towards excess claim of
municipal taxes.

 

In the assessment order, the AO initiated
penalty proceedings u/s 271(1)(c) for furnishing of inaccurate particulars of
income and concealment of income in the context of the aforesaid addition /
disallowance. Subsequently, the AO being of the view that the assessee had
filed inaccurate particulars of income within the meaning of 271(1)(c) r.w.
Explanation 1, imposed a penalty of Rs. 6,29,936.

 

Aggrieved, the assessee preferred an appeal
to the CIT(A) who deleted the penalty with reference to the disallowance of Rs.
93,453 but confirmed it with reference to addition of long-term capital gain
which was offered for taxation in the course of the assessment proceedings.

 

Aggrieved, the assessee preferred an appeal
to the Tribunal where it was contended that the LTCG on the sale of three shops
had, on account of a bona fide mistake on the part of the assessee, had
not been shown in the return of income.

 

The fact that the assessee had never
intended to withhold sale of the property under consideration could safely be
gathered from a perusal of the chart of the tangible fixed assets that formed
part of its balance sheet for the year under consideration, wherein a deduction
of Rs. 67,00,000 was disclosed by the assessee.

 

Besides, on learning of his mistake, the
assessee had immediately worked out the LTCG on the sale of the aforementioned
properties and had offered the same for tax in the course of the assessment
proceedings.

 

HELD

The Tribunal noted that while the assessee
had admittedly failed to offer the LTCG on the sale of three shops for tax in
its return of income for the year under consideration, at the same time, the
‘chart’ of the ‘block of assets’ of tangible fixed assets, forming part of the
balance sheet of the assessee as ‘Note No. 6’ to the financial statements for
the year ended 31st March, 2013 clearly reveals that the assessee
had duly disclosed the deduction of Rs. 67,00,000 from the block of fixed
assets. The Tribunal also found that the assessee in the course of the
assessment proceedings on learning about its aforesaid inadvertent omission and
not offering the LTCG on the sale of the aforesaid shops, had worked out its
income under the said head and offered the same for tax.

 

The Tribunal held that:

(a) when the assessee had disclosed the
deduction of Rs. 67,00,000 pertaining to sale of the aforesaid three shops from
the ‘block of assets’ in its balance sheet for the year under consideration,
therefore, there is substantial force in its claim that the failure to offer
LTCG on the sale of the said shops had inadvertently been omitted to be shown
in the return of income for the year under consideration;

(b) imposition of penalty u/s 271(1)(c)
would be unwarranted in a case where the assessee had committed an inadvertent
and bona fide error and had not intended or attempted to either conceal
its income or furnish inaccurate particulars;

(c) its aforesaid view is fortified by the
judgement of the Supreme Court in the case of PriceWaterHouse Coopers
Pvt. Ltd. vs. CIT(2012) 348 ITR 306;

(d) imposition of penalty u/s 271(1)(c)
would be unwarranted on account of the aforesaid inadvertent and bona fide
error on the part of the assessee.

 

The Tribunal set aside the order of the
CIT(A) and deleted the penalty imposed by the AO u/s 271(1)(c). The appeal
filed by the assessee was allowed.

 

Section 254(2) – If the appeal against the order of the Tribunal has already been admitted and a substantial question of law has been framed by the Hon’ble High Court, the Tribunal cannot proceed with the Miscellaneous Application u/s 254(2) of the Act

14. 
Ratanlal C. Bafna vs. JCIT ITAT Pune; Members: Anil Chaturvedi (AM) and
Vikas Awasthy (JM) MA No. 97/Pune/2018 in ITA No. 204/Pune/2012 A.Y.: 2008-09 Date of order: 15th March, 2019; Counsel for Assessee / Revenue: Sunil Ganoo
/ Ashok Babu

 

Section 254(2)
– If the appeal against the order of the Tribunal has already been admitted and
a substantial question of law has been framed by the Hon’ble High Court, the
Tribunal cannot proceed with the Miscellaneous Application u/s 254(2) of the
Act

 

FACTS

For the captioned assessment year, the
assessee preferred an application u/s 254(2) against the order of the Tribunal
in ITA No. 204/Pune/2012 for A.Y. 2008-09 on the ground that while adjudicating
the said appeal the Tribunal had not adjudicated ground No. 12 of the appeal,
although the same was argued before the Bench.

 

Aggrieved by the order of the Tribunal in
ITA No. 204/Pune/2012 for A.Y. 2008-09, the assessee had preferred an appeal to
the Bombay High Court which was admitted by the Court vide order dated 26th
November, 2018 (in ITA No. 471 and 475 of 2016) for consideration of
substantial question of law.


Since the present M.A. was the second M.A.
against the impugned order of the Tribunal, the Bench raised a query as to
whether a second M.A. is maintainable since the first M.A. against the same
order has been dismissed by the Tribunal. In response, the assessee submitted
that the second M.A. is maintainable because it is on an issue which was not a
subject matter of the first M.A. For this proposition, reliance was placed on
the decision of the Kerala High Court in CIT vs. Aiswarya Trading Company
(2011) 323 ITR 521, the decision of the Allahabad High Court in Hiralal
Suratwala vs. CIT 56 ITR Page 339 (All.) and the decision
of the Gujarat High Court in CIT vs. Smt. Vasantben H. Sheth (2015) 372
ITR 536 (Guj.).

 

At the time of hearing, the assessee relied
on the decision of the Bombay High Court in R.W. Promotions Private
Limited (W.P. No. 2238/2014) decided on 8th April, 2015 to
support its contention that even though the assessee has filed an appeal
against the order of the Tribunal, the Tribunal can still entertain an
application u/s 254(2) of the Act seeking rectification of the order passed by
it. Relying on this decision, it was contended that since ground No. 12 of the
appeal has not been adjudicated, the Tribunal can recall the order to decide
the said ground.

 

HELD

The Tribunal observed that it is a settled
law that the judgement must be read as a whole and the observations made in a
judgement are to be read in the context in which they are made; for this
proposition it relied on the decision of the Bombay High Court in Goa
Carbon Ltd. vs. CIT (2011) 332 ITR 209 (Bom.).

 

It observed
that the slightest change in the facts changes the factual scenario and makes
one case distinguishable from the other. It observed that the Kolkata Bench of
the Tribunal in Subhlakshmi Vanijya (P) Ltd. vs. CIT (2015) 60
taxmann.com 60 (Kolkata – Trib.) has noted as under:

 

‘13.d It is a well settled legal position
that every case depends on its own facts. Even a slightest change in the
factual scenario alters the entire conspectus of the matter and makes one case
distinguishable from another. The crux of the matter is that the ratio of any
judgement cannot be seen divorced from its facts.’

 

The Tribunal noted that in the case of R.W.
Promotions Pvt. Ltd. (Supra), the assessee had filed an appeal u/s 260A
of the Act before the High Court but the appeal was yet to be admitted. It was
in such a fact pattern that the Court held that the Tribunal has power to
entertain an application u/s 254(2) of the Act for rectification of mistake. In
the present case, however, it is not a case where the assessee has merely filed
an appeal before the High Court but it is a case where the High Court has
admitted the appeal for consideration after framing substantial question of
law.  On account of this difference in
the facts, the Tribunal held that the facts in the case of R.W.
Promotions (Supra) and the present case are distinguishable.

 

The Tribunal noted that the Gujarat High
Court in the case of CIT vs. Muni Seva Ashram (2013) 38 taxmann.com 110
(Guj.) has held that when an appeal has been filed before the High Court,
the appeal is admitted and substantial question of law has been framed in the
said appeal, then the Tribunal cannot recall the order.

 

The Tribunal held that since the appeal
against the order of the Tribunal has already been admitted and a substantial
question of law has been framed by the High Court, the Tribunal cannot proceed
with the miscellaneous application u/s 254(2) of the Act.

 

Hence, the Tribunal dismissed the
miscellaneous application u/s 254(2) of the Act seeking rectification in the
order of the Tribunal as being not maintainable.

 

Section 50C – Third proviso to section 50C inserted w.e.f. 1st April, 2019 providing for a safe harbour of 5%, is retrospective in operation and will apply since date of introduction of section 50C, i.e., w.e.f. 1st April, 2003, since the proviso is curative and removes an incongruity and avoids undue hardship to assessees

13. 
Chandra Prakash Jhunjhunwala vs. DCIT (Kol.) Members: A.T. Varkey (JM) and Dr. A.L. Saini
(AM) ITA No. 2351/Kol./2017 A.Y.: 2014-15 Date of order: 9th August, 2019; Counsel for Assesssee / Revenue: Manoj
Kataruka / Robin Chowdhury

 

Section 50C – Third proviso to section 50C
inserted w.e.f. 1st April, 2019 providing for a safe harbour of 5%,
is retrospective in operation and will apply since date of introduction of
section 50C, i.e., w.e.f. 1st April, 2003, since the proviso is
curative and removes an incongruity and avoids undue hardship to assessees

 

FACTS

The assessee in his return of income
declared total income to be Nil and claimed current year’s loss to be Rs. 1,19,46,383. In the course of assessment proceedings, the AO noticed that
the assessee had on 14th December, 2013 transferred his property at
Pretoria Street, Kolkata for a consideration of Rs. 3,15,00,000 and had
declared long-term capital gain of Rs. 1,22,63,576 on transfer thereof. The
stamp duty value (SDV) of this property was Rs. 3,27,01,950. In response to the
show cause notice issued by the AO as to why the SDV should not be adopted as
full value of consideration, the assessee asked the AO to make a reference to
the DVO to ascertain the fair market value of the property. Accordingly, the
reference was made but the DVO did not submit his report within the specified
time and the AO completed the assessment by adopting SDV to be the full value
of consideration.

 

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

 

HELD

The Tribunal observed that:

(i) the fundamental purpose of introducing
section 50C was to counter suppression of sale consideration on sale of
immovable properties, and this section was introduced in the light of the
widespread belief that sale transactions of land and buildings are often
undervalued resulting in leakage of legitimate tax revenues;

(ii) the variation between SDV and the sale
consideration arises because of many factors;

(iii) Stamp duty value and the sale
consideration, these two values represent the values at two different points
of time;

(iv) in order to minimise hardship in case
of genuine transactions in the real estate sector, it was proposed by the
Finance Act, 2018 that no adjustments shall be made in a case where the
variation between the SDV and the sale consideration is not more than 5% of the
sale consideration. This amendment is with effect from 1st April,
2019 and applies to assessment year 2019-20 and subsequent years;

(v) the co-ordinate Bench of the ITAT
Mumbai, in the case of John Fowler (India) Ltd. in ITA No.
7545/Mum./2014, for AY 2010-11, order dated 25.1.2017 held that if the
difference between valuation adopted by the Stamp Valuation Authority and
declared by the assessee is less than 10%, the same should be ignored and no
adjustments shall be made.

 

The Tribunal noted that the amendment made
by the Finance Act, 2018 is introduced only with prospective effect from 1st
April, 2019. It noted that the observations in the memorandum explaining the
provisions of the Finance Bill, 2018 make it abundantly clear that the
amendment is made to remove an incongruity, resulting in undue hardship to the
assessee. Relying on the decision of the Delhi High Court in the case of CIT
vs. Ansal Landmark Township (P) Ltd., the Tribunal held that once it is
not in dispute that a statutory amendment is made to remove an apparent
incongruity, such an amendment has to be treated as effective from the date on
which the law containing such an undue hardship or incongruity was introduced.

 

The Tribunal held that the insertion of the
third proviso to section 50C of the Act is declaratory and curative in nature.
The third proviso relates to computation of value of property and hence is not
a substantive amendment, it is only a procedural amendment and therefore the
co-ordinate Benches of ITAT used to ignore the variation of up to 10%, and
hence the said amendment should be retrospective. The third proviso to section
50C should be treated as curative in nature with retrospective effect from 1st
April, 2003,. i.e., the date from which section 50C was introduced.

 

Since the difference between the SDV and the
consideration was less than 5%, the Tribunal deleted the addition made by the
AO and confirmed by the CIT(A).

 

This ground of
the appeal filed by the assessee was allowed.

Section 56(2)(vii) – The amount received by the assessee from the HUF, being its member, is a capital receipt in his hands and is not exigible to income tax If the decisions passed by the higher authorities are not followed by the lower authorities, there will be chaos resulting in never-ending litigation and multiplication of cases

12. 
Pankil Garg vs. PCIT ITAT Chandigarh; Members: Sanjay Garg (JM)
and Ms Annapurna Gupta (AM) ITA No.: 773/Chd./2018 A.Y.: 2011-12 Date of order: 3rd August, 2019; Counsel for Assessee / Revenue: K.R. Chhabra
/ G.S. Phani Kishore

 

Section 56(2)(vii) – The amount received by
the assessee from the HUF, being its member, is a capital receipt in his hands
and is not exigible to income tax

 

If the decisions passed by the higher
authorities are not followed by the lower authorities, there will be chaos
resulting in never-ending litigation and multiplication of cases

 

FACTS

For the assessment year under consideration,
the AO completed the assessment of total income of the assessee u/s 143(3) of
the Act by accepting returned income of Rs. 14,32,982. Subsequently, the AO
issued a notice u/s 147 on the ground that the assessee has received a gift of
Rs. 5,90,000 from his HUF and since the amount of gift was in excess of Rs.
50,000, the same was taxable u/s 56(2)(vii) of the Act.

 

In the course of reassessment proceedings,
the assessee contended that the amount received by him from his HUF was not
taxable and relied upon the decision of the Rajkot Bench of the Tribunal in Vineetkumar
Raghavjibhai Bhalodia vs. ITO [(2011) 46 SOT 97 (Rajkot)] which was
followed by the Hyderabad Bench (SMC) of the Tribunal in Biravel I.
Bhaskar vs. ITO [ITA No. 398/Hyd./2015; A.Y. 2008-09; order dated 17th
June, 2015] wherein it has been held that HUF being a group of
relatives, a gift by it to an individual is nothing but a gift from a group of
relatives; and further, as per the exclusions provided in clause 56(2)(vii) of
the Act, a gift from a relative is not exigible to taxation; hence, the gift
received by the assessee from the HUF is not taxable. The AO accepted the
contention of the assessee and accepted the returned income in an order passed
u/s 147 r.w.s. 143(3) of the Act.

 

Subsequently, the Ld. PCIT, invoking
jurisdiction u/s 263 of the Act, set aside the AO’s order and held that the HUF
does not fall in the definition of relative in case of an individual as provided
in Explanation to clause (vii) to section 56(2) as substituted by the Finance
Act, 2012 with retrospective effect from 1st October, 2009. Though
the definition of a ‘relative’ in case of an HUF has been extended to include
any member of the HUF, yet, in the said extended definition, the converse case
is not included. In the case of an individual, the HUF has not been mentioned
in the list of relatives.

 

The PCIT, thus, formed a view that though a
gift from a member to the HUF was not exigible to taxation as per the
provisions of section 56(2)(vii) of the Act, a gift by the HUF to a member
exceeding a sum of Rs. 50,000 was taxable.

The PCIT also held that the decisions of the
Rajkot and the Hyderabad Benches of the Tribunal relied upon by the assessee were
not in consonance with the statutory provisions of sections 56(2)(vii) and
10(2) of the Act and, thus, the AO had made a mistake in not taking recourse to
the clear and unambiguous provisions of section 56(2)(vii) of the Act and in
unduly placing reliance on judicial decisions which were not in accordance with
the provisions of law.

 

The order passed by the AO was held by the
PCIT to be erroneous and prejudicial to the interest of Revenue and was set aside. The AO was directed to make assessment afresh.

 

Aggrieved, the assessee preferred an appeal
to the Tribunal.

 

HELD

The Tribunal noted that the AO had duly
applied his mind to the issue and followed the decisions of the co-ordinate
Benches of the Tribunal; hence, the order of the AO cannot be held to be
erroneous and, therefore, the PCIT wrongly exercised jurisdiction u/s 263 of
the Act and the same cannot be held to be justified and is liable to be set
aside on this score alone.

 

The Tribunal held that the PCIT neither had
any power nor any justification to say that the AO should not have placed
reliance on the judicial decisions of the Tribunal. The Tribunal held that if
such a course is allowed to subsist, then there will be no certainty and
finality to the litigation. If the decisions passed by the higher authorities
are not followed by the lower authorities, there will be chaos resulting in
never-ending litigation and multiplication of cases. The Tribunal held that the
impugned order of the PCIT is not sustainable as per law.

 

On merits, the Tribunal, after discussing
the concept of HUF and the provisions of sections 56(2)(vii) and 10(2), held
that any amount received by a member of the HUF, even out of the capital or
estate of the HUF cannot be said to be income of the member exigible to
taxation. Since a member has a pre-existing right in the property of the HUF,
it cannot be said to be a gift without consideration by the HUF or by other
members of the HUF to the recipient member. The Tribunal observed that
provisions of section 56(2)(vii) are not attracted when an individual member
receives any sum either during the subsistence of the HUF for his needs or on
partition of the HUF in lieu of his share in the joint family property.
However, the converse is not true, that is, in case an individual member throws
his self-acquired property into the common pool of an HUF. The HUF or its
members do not have any pre-existing right in the self-acquired property of a
member. If an individual member throws his own / self-acquired property in the
common pool, it will be an income of the HUF; however, the same will be exempt
from taxation as the individual members of an HUF have been included in the
meaning of relative as provided in the Explanation to section 56(2)(vii) of the
Act. It is because of this salient feature of the HUF that in case of an
individual the HUF has not been included in the definition of relative in
Explanation to section 56(2)(vii), whereas in the case of an HUF, members of
the HUF find mention in the definition of relative for the purpose of the said
section.

 

In view of the above discussion, the amount
received by the assessee from the HUF, being its member, is a capital receipt
in his hands and is not exigible to income tax.

 

The Tribunal allowed the appeal of the
assessee.

 

Section 194J, section 40(a)(ia) – Payment made by film exhibitor to distributor is neither royalty nor FTS and is not covered by section 194J and, consequently, does not attract disallowance u/s 40(a)(ia)

29. 
[2019] 71 ITR 332 (Ahd. – Trib.) ITO vs. Eyelex Films Pvt. Ltd. ITA No.: 1808 (Ahd.) of 2017 & 388
(Ahd.) of 2018 A.Ys.: 2013-14 and 2014-15 Date of order: 7th March, 2019;

 

Section 194J, section 40(a)(ia) – Payment
made by film exhibitor to distributor is neither royalty nor FTS and is not
covered by section 194J and, consequently, does not attract disallowance u/s
40(a)(ia)

 

FACTS

The assessee was an exhibitor of films. It
purchased cinematographic films from the distributors for exhibition in cinema
houses. The revenue earned from box office collections was shared with the
distributors as a consideration for purchase of films. The assessee had not
deducted tax at source on the said payments under the belief that the payment
does not fall under any of the provisions mandating TDS. However, the AO
categorised the said payments as royalty u/s 194J and, in turn, disallowed the
said payments u/s 40(a)(ia).

 

Aggrieved, the assessee preferred an appeal
to the CIT(A) who allowed the appeal. In turn, the aggrieved Revenue filed an
appeal before the Tribunal.

 

HELD

The Tribunal discussed the observations made
by the CIT(A) and concurred with its view which was as under:

 

Section 194J defines royalty in Explanation
2 to section 9(1)(vi). As per the said definition, the consideration for sale /
distribution or exhibition of cinematographic films has been excluded. The
payment made by the appellant could not be included under the definition of
royalty u/s 9 of the Act, and therefore the provisions of section 194J were not
applicable. Payments made by the assessee to the distributors were nothing but
the procurement charges, meaning purchases of the rights of exhibition for a
certain period as per the terms and conditions of the contract.

 

The CIT(A) had even discussed the
applicability of section 194C as well as section 9(1)(vii) of the Act and concluded that even section 194C was not applicable as the impugned
payment was not for carrying out any work.

 

CBDT circular dated 8th August, 2019 – The relaxation in monetary limits for departmental appeals vide CBDT circular dated 8th August, 2019 shall be applicable to the pending appeals in addition to the appeals to be filed henceforth

28. 
[2019] 108 taxmann.com 211 (Ahd. – Trib.) ITO vs. Dinesh Madhavlal Patel ITA No.: 1398/Ahd./2004 A.Y.: 1998-99 Date of order: 14th August, 2019;

 

CBDT circular dated 8th August,
2019 – The relaxation in monetary limits for departmental appeals vide CBDT
circular dated 8th August, 2019 shall be applicable to the pending
appeals in addition to the appeals to be filed henceforth

 

FACTS

The Tribunal vide its order disposed of the
present appeal and 627 other appeals filed by various AOs challenging the
correctness of the orders passed by CIT(A) and also cross-objections filed by
the assessees against the said appeals of the Revenue supporting the orders of
the CIT(A). The tax effect in each of these appeals is less than Rs. 50 lakhs.

 

The Tribunal noted that vide CBDT circular
dated 8th August, 2019 the income tax department has further
liberalised its policy for not filing appeals against the decisions of the
appellate authorities in favour of the taxpayers where the tax involved is
below certain threshold limits, and announced its policy decision not to file,
or press, the appeals before the Tribunal against appellate orders favourable
to the assessees – in cases in which the overall tax effect, excluding interest
except when interest itself is in dispute, is Rs. 50 lakhs or less.

 

Following the said circular, the Tribunal
sought to dismiss all the appeals. However, while dismissing the appeals, the
DR pointed out that the said circular is not clearly retrospective because in
para 4 it says, “(t)he said modifications shall come into effect from the
date of issue of this circular”. Relying on this, the argument sought to be
made was that the limits mentioned in the circular dated 8th August,
2019 will apply only to appeals to be filed after the date of the said
circular. The representatives of the assessees, however, argued that the
circular must be held to have retrospective application and must equally apply
to the pending appeals as well. It was submitted that the said circular is not
a standalone one but is required to be read with old circular No. 3 of 2018 which it seeks to modify.

 

HELD

The Tribunal did not have even the slightest
hesitation in holding that the concession extended by the CBDT not only applies
to the appeals to be filed in future but is also equally applicable to the
appeals pending disposal as of now. The Tribunal observed that the circular
dated 8th August, 2019 is not a standalone circular but has to be read
in conjunction with the CBDT circular No. 3 of 2018 (and subsequent amendment
thereto) and all it does is to replace paragraph Nos. 3 and 5 of the said
circular.

 

It observed that all other portions of the
circular No. 3 of 2018 have remained intact and that includes paragraph 13
thereof. Having noted the contents of paragraph 13 of the said circular No. 3
of 2018, the Tribunal held that the relaxation in monetary limits for
departmental appeals vide CBDT circular dated 8th August, 2019 shall
be applicable to the pending appeals in addition to the appeals to be filed
henceforth.

 

The Tribunal
dismissed all the appeals as withdrawn. As the appeals filed by the Revenue
were found to be non-maintainable and as all the related cross-objections of
the assessees arose only as a result of those appeals and merely supported the
order of the CIT(A), the cross-objections filed by them were also dismissed as
infructuous.


NEW RULES FOR INDEPENDENT DIRECTORS: HASTY, SLIPSHOD AND BURDENSOME

The new rules notified on 22nd October, 2019 by the Ministry
of Corporate Affairs under the Companies Act, 2013 require independent
directors to pass a test to demonstrate their knowledge and proficiency in
certain areas for board-level functioning in corporates. They need to score at
least 60% marks to qualify. They also need to enrol their names in a database
maintained for the purpose. The intention appears to be that companies should
choose independent directors from this databank. The above are the principal
requirements notified by the new rules.

 

BACKGROUND

It may be recalled that the Companies Act, 2013 requires listed
companies and certain large-sized public companies (in terms of specified net
worth, etc.) to have at least one-third of their boards peopled by independent
directors. SEBI has made similar requirements but with some differences (its
requirements apply to listed companies and provide for a higher proportion of
independent directors).

 

QUALITIES OF INDEPENDENT DIRECTORS

The qualities that make a person an ‘independent’ director have been
laid down in great detail in the law. However, these focus largely on their
independence from the company and its promoters but do not prescribe any
minimum knowledge, educational qualifications, etc., except when they are a
part of the Audit Committee. They occupy a high position in a company and are
expected to provide well-informed inputs on matters of governance, strategy and
so on to the company and its management. They are also expected to keep a
watchful eye on the finances, accounts and performance of the company by
exercising their skill and diligence. A failure on their part can be harmful to
the company and to themselves, too, since they may face liability and penal
action in many forms.

 

Against this background, the new requirement of minimum knowledge is
surely welcome. A designated institute (the Indian Institute of Corporate
Affairs) will publish the study material for directors to prepare for the test.
It will also conduct the prescribed test.

 

Often, independent directors have a background of law, accountancy,
etc., but there are also many directors chosen for their experience in a
relevant industry, for their technical knowledge and administrative expertise.
But such persons may not have knowledge and experience about how companies are
governed. It is possible that they may not even have rudimentary knowledge of
accounting. Such basic knowledge, duly confirmed by a test which they have to
pass, would help them and the company as well. This is particularly so since
the obligations placed on them are fairly comprehensive.

 

When do the new rules come into force?

The new rules come into force from 1st December, 2019 and are
spread over several notifications, one of which introduces a full set of rules,
another modifies an existing one and yet another notifies the institute that shall
oversee the teaching and the test. Three months’ time has been given to
independent directors to enrol their names in the databank and a period of one
year from enrolment to pass the test. Companies are required to ensure
compliance with this requirement and an independent director is also required
to confirm he is compliant in the filings made by him.

 

Who will administer the tests and maintain databank?

The new rules may be an attempt to provide a basic level of financial
and regulatory literacy. The institute notified (the Indian Institute of
Corporate Affairs) has to serve several functions. It has to release
educational material for independent directors that they can use to prepare for
the exams. It is also required to conduct the online test for them. (The scope
of the test covers areas such as company law, securities law, basic
accountancy, etc.) Apart from the qualifying exam, the institute is required to
conduct an optional advanced test for those who wish to take it.

 

The Institute is also required to maintain a databank of independent
directors containing detailed information of each such person. Companies
seeking to appoint independent directors can access such information on payment
of a fee to the institute. Interestingly, the institute is required to report daily
to the government all the additions, changes and removals from the databank.
This makes one wonder why would the government want to monitor this databank so
closely and so frequently.

 

To whom do these new requirements apply?

The requirement of enrolling in the database and passing the qualifying
test applies to existing as well as new independent directors. Existing
independent directors are given some time to enrol themselves in the database
and thereafter pass the qualifying test. New independent directors will have to
first enrol in the database.

 

Are any persons exempted from the requirements?

A person who has acted as an independent director or key managerial
personnel for at least ten years in a listed company or a public company with
at least Rs. 10 crores of paid-up capital, is exempted from the requirement of
passing the test. However, he would still have to enrol in the database.

 

Independent directors required to enrol in the database

Independent directors are required to enrol by providing the required
information and payment of a fee. Existing independent directors are required
to do this within three months, i.e., by 1st March, 2020. A person
seeking appointment as an independent director is required to enrol before
being appointed. He is required to pass the prescribed test with at least 60%
marks within one year of enrolment. The enrolment can be for one year, five
years or for a lifetime. The test has to be passed only once in a lifetime.
Directors, presumably, will update the knowledge of rapidly changing laws on
their own.

 

Companies are required to ensure and report compliance with these
requirements.

 

IMPLICATIONS OF THE NEW REQUIREMENTS

These new requirements will ensure that a person may be a top lawyer or
a chartered accountant with decades of experience, or a senior bureaucrat, or a
professor of a reputed college, yet he will have to pass this test with at
least 60% marks. Except for persons with ten years’ experience as specified
earlier, there is no exception provided.

 

GREY AREAS IN THE REQUIREMENTS

The law has some gaps and is ambiguous at a few places. Section 150 of
the Companies Act, 2013 pursuant to which these new requirements were
introduced was really for the maintenance of a database of independent
directors. This would help a company to search for such a director from the
database if it so chose. It did not make it mandatory that such a director must
be chosen from this database.

 

It is not clear whether existing directors will vacate their office if
they do not pass the test or if they do not enrol in the database. Will the
appointment of an independent director whose name does not appear in the
register be invalid, or will this be merely a violation of law? A similar
question can be raised for a person who has not passed the test with the
minimum percentage of marks. The intention appears to be that such persons
cannot be appointed; and in respect of existing independent directors, they may
have to vacate their office. However, this is not stated clearly in so many
words. Similarly, the wording of the law is ambiguous on whether a company has
to select an independent director only from the database. The purpose of the
database may get defeated if a company can appoint someone not enrolled, but
this is not specifically and clearly laid down.

 

BENEFITS AND BURDENS OF THE NEW REQUIREMENTS

The new requirements can be praised to the extent that independent
directors will now be required to have minimum relevant knowledge to do justice
to their roles. On the other hand, thanks to the constant tweaking of
requirements, the number of independent directors required is ever increasing.
Their obligations and potential liabilities are also enormous and continue to
increase. Their remuneration, however, is not guaranteed and can often be very
nominal with minimal sitting fees. The new requirements are not expected to be
costly. Even the fees payable to the institute for the enrolment are required
to be ‘reasonable’. It could be argued that the effort and the costs would pay
off in terms of knowledge. Nevertheless, no attempt has been made to increase
the powers of independent directors or ensure that they have at least such
minimum remuneration that makes doing their jobs worthwhile.

 

An independent director today, individually or even collectively, has
very few powers. He is often provided with some minimal information as
statutorily required for board meetings. Some directors can of course attempt
to use their personal and moral force to get their queries answered during
board meetings and sometimes in between, but success is not frequent. If he is
not happy, the eventual recourse he has is to resign. He may go public but he
risks legal action since usually he may not have adequate information and
documentation to back his claims. There is no institutional or legal process he
can take advantage of to express his views (preferably anonymously) and see that
wrongs are corrected. Independent directors may also often be treated with
contempt by managements and as an unavoidable nuisance. I would not be
surprised if the allegations (as yet unsubstantiated) in the Infosys case where
two independent directors are said to have been referred to as ‘madrasis’ and a
lady director as a ‘diva’ are true. Thus, neither from the remuneration point
of view, nor from the personal satisfaction point of view, is the office of
independent director worthwhile.

 

HASTY IMPLEMENTATION?

Then there is the issue regarding the fast-track implementation of these
provisions. As of now, even the institute and database or even the educational
material / test system does not seem to be fully ready for the new
requirements. While some time has been given for the transition, this would
still make it difficult for many to comply.

 

CONCLUSION

If the new rules are taken literally and narrowly, it is possible that
many independent directors would become disqualified and some may vacate their
office. Clearly, some clarification and relaxation both in terms of time and
requirements is needed. Generally, the office of independent directors also
needs a holistic relook, lest most of the cream of the crop quietly leave the
scene being underpaid, underpowered, under-respected and over-obligated.  

 

 

 

 

 

Timeless Words of Bapu

Government

Good government is no substitute for
self-government. Men often become what they believe themselves to be. If I
believe I cannot do something, it makes me incapable of doing it. But when I
believe I can, then I acquire the ability to do it even if I didn’t have it in
the beginning. Corruption and hypocrisy ought not to be inevitable products of
democracy, as they undoubtedly are today.

 

Finding yourself

The best way to find yourself is to lose
yourself in the service of others.

 

Action

It’s the action, not the fruit of the
action, that’s important. You have to do the right thing. It may not be in your
power, may not be in your time, that there’ll be any fruit. But that doesn’t
mean you stop doing the right thing. You may never know what results come from
your action. But if you do nothing, there will be no result.

 

Democracy

Democracy demands patient instruction on it
before legislation.

 

My notion of democracy is that under it the
weakest should have the same opportunity as the strongest.

 

People in a democracy should be satisfied
with drawing the government’s attention to a mistake, if any.

 

In true democracy every man and woman is
taught to think for himself or herself.

 

Happiness

Happiness is when what you think, what you
say, and what you do are in harmony.

 

Change

You must be the change you wish to see in
the world.

 

Non-violence

Non-violence is the greatest force at the
disposal of mankind. It is mightier than the mightiest weapon of destruction
devised by the ingenuity of man.

 

Whenever you are confronted with an
opponent, conquer him with love…Non-violence is a weapon of the strong…Strength
does not come from physical capacity. It comes from an indomitable will.

 

Schools

All our national schools ought to be
converted into factories of our national ammunition, namely, constructive work.

 

The Lawyer

I had learnt the true practice of law. I had
learnt to find out the better side of human nature and to enter men’s hearts. I
realized the true function of a lawyer was to unite parties riven asunder.

Renunciation

Again, let no one consider renunciation to
mean want of fruit for the renouncer. The Gita reading does not warrant such a
meaning. Renunciation means absence of hankering after fruit. As a matter of
fact, he who renounces reaps a thousandfold. The renunciation of the Gita is
the acid test of faith. He who is ever brooding over result often loses nerve
in the performance of his duty.

 

Swaraj

Swaraj of a
people means the sum total of the Swaraj (self-rule) of individuals.

It is Swaraj when we learn to rule
ourselves.

Conservation of national sanitation is Swaraj
work and it may not be postponed for a single day on any consideration
whatsoever.

The get rid of the infatuation for English
is one of the essentials of Swaraj.

 

Swadeshi

I must not serve a distant neighbour at the
expense of the nearest.

India must protect her primary industries
even as a mother protects her children against the whole world without being
hostile to it.

 

Success

A burning passion coupled with absolute
detachment is the key to all success.

First they ignore you, then they laugh at
you, then they fight you, then you win.

 

Triumph

Man’s triumph will consist in substituting
the struggle for existence by a struggle for mutual service.

 

State

The state is the sum total of the sacrifice,
on its behalf, of its members.

 

One of the last Notes left by Gandhiji in
1948

I will give you a talisman. Whenever you are
in doubt, or when the self becomes too much with you, apply the following test.
Recall the face of the poorest and the weakest man [woman] whom you may have
seen, and ask yourself, if the step you contemplate is going to be of any use
to him [her]. Will he [she] gain anything by it? Will it restore him [her] to a
control over his [her] own life and destiny? In other words, will it lead to swaraj
[freedom] for the hungry and spiritually starving millions? Then you will find
your doubts and your self melt away.

 

Journalism & Role of Newspaper

The newspaperman has become a walking
plague. He spreads the contagion of lies and calumnies.

 

One of the objects of a newspaper is to
understand popular feeling and to give expression to it; another is to arouse
among the people certain desirable sentiments; and the third is fearlessly to
expose popular defects.

 

Justice

Justice should become cheap and expeditious.
Today it is the luxury of the rich and the joy of the gambler.

 

Truth

Truth and untruth often co-exist; good and
evil often are found together.

 

Devotion to Truth is the sole justification
for our existence.

 

When you want to find Truth as God, the only
inevitable means is love, that is non-violence.

 

Ahimsa and
Truth are so intertwined that it is practically impossible to disentangle and
separate them.

INSIDER TRADING – LESSONS FROM A RECENT DECISION

BACKGROUND


SEBI had levied a penalty of Rs. 40 crores
for insider trading on the promoters against a profit of about Rs. 14 crores.
Recently, SAT confirmed this hefty penalty. The case proves how SEBI is able to
unravel facts to the last transaction and establish relations between several
parties involved in insider trading. The case also establishes SEBI’s intention
to act tough in such cases by levying stiff penalties on promoters acting
through associates. However, the case also has some grey areas. The issues are
as follows:

 

(i) When can price-sensitive information be
said to have arisen, particularly in case of complex transactions?

(ii) Whether purchase on negotiated terms of
a large quantity of shares from a person can be said to be a case of insider
trading?

(iii) How are the profits of insider trading
calculated – profits actually made, or should an attempt be made to quantify
the impact of price-sensitive information on the price?

(iv) Should profits made by insider trading
be disgorged and handed over to the party who may have suffered a loss?

 

The present case was about a tender with
electricity bodies where it may be difficult even for the management to be 100%
sure and whether initial success necessarily means ‘confirmed outcome’.

 

BASIC FACTS OF THE CASE

The case concerns dealings in the shares of
ICSA (India) Limited. The findings were that the promoters (consisting of
husband and wife and certain companies belonging to their group) purchased,
through certain persons, 15.86 lakh shares in February, 2009. These shares were
purchased when certain price-sensitive information was not made public.
According to SEBI’s order the price-sensitive information related to the
company being successful bidders to large contracts aggregating to Rs. 464.17
crores with various electricity bodies. The purchase price was approx. Rs. 75
per share. The shares were sold at a significant profit of about Rs. 14 crores.

 

The transactions were routed through persons
who could be described as ‘associates’. These associates were funded by the
promoters’ group for purchasing the shares. The shares so purchased were either
transferred to the promoter entities or sold in the market and the sale
proceeds transferred to the promoters.

 

SEBI’s penalty also included a penalty for
giving misleading information about the relations between the promoters and the associates and making misleading disclosures relating to
shares pledged by the promoters / associates.

 

The penalty of Rs. 40 crores levied for such
insider trading, etc., has been upheld by SAT.

 

SEBI’s order is dated 15th
October, 2015. The SAT order is dated 12th July, 2019 (Appeal No.
509 of 2015).

 

ALLEGATIONS

SEBI alleged
that there was price-sensitive information related to the company being
successful bidders of contracts with certain electricity bodies amounting to
Rs. 464 crores. Under the SEBI (Prohibition of Insider Trading) Regulations,
1992 (Insider Trading Regulations), insiders are prohibited from dealing in
shares of the company while having access to or being in possession of
unpublished price-sensitive information. The promoters and their group entities
were alleged to be aware of this price-sensitive information and indulged in
the purchase of a large quantity of shares before publishing this information.

 

The purchasers were funded by the promoter’s
group entities. The shares so acquired were either sold by the associates or
transferred to group companies. The profit made was also transferred to group
companies.

 

SEBI further alleged that incorrect
information was given about shares pledged by the group companies and associates.

 

DEFENCE BY THE PROMOTERS

The promoters denied that they had financed the
purchase of shares or that the various transactions through the associates
amounted to insider trading. They stated that only a preliminary outcome had
been received in respect of the bids when the shares were purchased and at that
stage one could not be certain that the contracts would be granted to the
company. They explained the whole process of grant of bids, including
preliminary acceptance and certain processes thereafter, and that until final
award took place, ‘price-sensitive information’ could not be said to
have arisen.

 

They also stated that a large foreign
shareholder had desired to sell the shares and that to avoid a negative impact
on the market his shares were purchased. It was also stated that the reason for
making purchases through the associates was that if the promoters had
themselves purchased the shares, a negative image would have been created
giving an impression of promoters increasing their holding in the company.

 

They also denied that they had given
misleading disclosures relating to promoters or of the relations between the
parties.

 

RULING BY SEBI

SEBI presented detailed facts of
transactions including how funds were transferred by group entities of the
promoters to the associates. It was also shown how shares were sold and monies
transferred or shares were simply transferred to the promoter entities.

 

SEBI also established how the promoter
himself was very closely involved with the contract bidding, and hence it was
clear that he was aware of the progress regarding receiving the contract.

 

On facts, too, from the data provided by the
promoters, it was shown that largely, once the preliminary bids were
successful, an eventual successful outcome was fairly certain. However, even
otherwise, the information at that stage was too price-sensitive.

 

The promoters were also held guilty of
providing misleading information of relations between the parties. Further,
SEBI held that the promoters had given misleading information relating to
pledging of shares by promoters.

Penalties were thus levied on various
entities involved. For ‘insider trading’, a penalty of Rs. 40 crores was levied
on the promoters and group entities / associates. For providing misleading
information, a penalty of Rs. 20 lakhs was levied on the promoters and one
associate. For giving misleading disclosure of promoter holdings, an aggregate
penalty of Rs. 38 lakhs was levied.

 

RULING BY SAT

The Securities Appellate Tribunal (SAT)
after extensively considering the arguments and the facts held that

 

(a) On the matter of price-sensitive
information, on facts, that is, after considering comparable cases and their
earlier rulings, the nature of bids and the awarding process, even the preliminary
outcome of a bid amounted to price-sensitive information and promoters’ dealing
in shares was in violation of the Insider Trading Regulations.

 

(b) On the amount of penalty, SAT noted that
SEBI had powers to levy penalty up to three times the gains made. Thus, the
penalty levied of Rs. 40 crores on profits on insider trading of Rs. 14 crores
was within the limit prescribed under law.

 

However, SAT reversed both the penalties
levied relating to providing of misleading information regarding associates’
pledging of shares.

 

OBSERVATIONS AND COMMENTS

The case presents some interesting aspects –
regarding how trades are done and how meticulous is SEBI’s investigation.
Despite there being some grey areas, the ruling should place promoters on guard
and about the dilemma they face whilst dealing in the shares of a company.

 

The manner in which trading was done was
curious and perhaps added to the complexity of the case. The promoters did not
themselves purchase the shares but provided finance to associates who acted (as
held by SEBI / SAT) more or less as a front / representatives. They used the
funds to buy the shares and then transferred the shares / sales proceeds to the
promoters. Hence, penalty was levied jointly and severally on all the concerned
parties. A side-effect of this was that even the associates, who may have been
parties of small means, were made liable to ensure payment of penalty.

 

The amount of penalty is fairly huge. The
profits made were Rs. 14 crores. The maximum possible penalty was Rs. 42
crores, i.e., three times the profits. Thus, by levying a penalty of Rs. 40
crores, the maximum limit of the penalty was almost touched. And SAT had no
hesitation in upholding it.

 

The grey area is about the time when
price-sensitive information can be said to have arisen. Both the SEBI and the
SAT orders deal with this aspect in detail. However, the dilemma remains as to
at what stage can a company and insiders be held to be confident that the
orders would be received. The matter becomes even more complex since companies
are required to share material information at the appropriate stage. The
dilemma is this: share too early and you may be held to be providing
misleading information if eventually the bid is rejected; share too late and
you may be accused of withholding and delaying release of price-sensitive /
material information. Considering that such analyses are always in hindsight,
the dilemma is compounded.

 

However, at least one aspect is clear – that
insiders should act with caution. Refraining from trading during this period
would be a wise decision because the Insider Trading Regulations themselves
provide for mandatory closure of the trading window for the period when such
information is ripening. For example, a long period of trading window closure
is mandated during the time when financial results of a company are being
finalised. Importantly, even preliminary success in bids is price-sensitive
information.

 

The next question is – should the person who
has suffered because of such insider trading be compensated? Insider trading is
often said to be a victimless crime. However, in some cases the victim may be
obvious. In the present case, can it be said that the foreign seller who sold a
large quantity of shares would not have sold the shares if he was aware that a
large order was virtually possible? In such a case, should not the profits made
by the promoters be disgorged and handed over to the seller?

 

This is the one question that often comes up
also in cases of frauds and price manipulation, etc. In the author’s view, this
is one area where both the law and practice lack clarity.

 

Finally, compliments are due to SEBI for the
meticulous gathering and analysis of information. White-collar violations are
often said to be sophisticated. Insider trading cases are even more notorious
for the sheer difficulty in proving guilt. In this case, though the
transactions were routed through associates, SEBI analysed the data and brought
out the whole linkages of relations and financial dealings between the parties.
This ought to serve as a lesson to promoters, especially in view of the hefty
penalty levied.  

 

CHALO KASHMIR

About eight to ten
days back I was on my morning walk when I saw a luxury bus standing near the
joggers’ park. To my surprise I saw a few CA friends in the bus      – Shah, Mehta,
Desai, Joshi, Kamat, Agarwal!

I wondered where all
of them were going together.

I asked: Are Ranchhodbhai, where are all of you going?

Shah: Kashmir!

I: Some seminar? Or RRC? But who has organised RRC in this tax and
audit season?

Shah: No RRC. No conference. Just on a visit.

I was even more
shocked. All CAs leaving in the month of August for a visit to Kashmir!?
Surely, they were crazy!

Q: You mean, there are all CAs in the bus?

A: No, only eight to ten of us.

Q: But what makes you visit Kashmir all of a sudden?

A: Now Article 370 is deleted.

Q: So what? How does it matter to us?

A: We are exploring business and professional opportunities there.

Q: (CAs becoming so proactive was another surprise to me!)

I said, but the
situation is not normal there. Terrorists are still active.

A: We are now not afraid of terrorists. We don’t mind fighting with
them!

I could not believe
what I was hearing! I checked up whether I was in a dream! A chartered
accountant – making such a bold and courageous statement? In my dictionary, the
antonym of CA was ‘a courageous person’.

Q: But why are you leaving the established things over here?

A: Kya settled hai?

Every year, New
Law! New Tax! New Regulation! New Accounting Standard! New Notice! New Penalty!
New Authority!

We felt the
terrorism by guns and bombs is much less disastrous than the tax and other
regulators’ terrorism over here!

Q: Oh! But life will be difficult there!

A: Idhar bhi kaunsa comfort hai? CA’s life is the most
miserable one! No one respects him. No one cares for him!

Q: Why? You have your own profession!

A: Own profession gaya paani mein! Kaun hamari sunata hai? We
have bosses everywhere and we are answerable to all. Ghar me biwi! In
office, our staff, our articles, clients – all are our bosses! You need to be
in their good books, always.

And in Government
Departments, the less said the better! As for the Government, you are only a
slave!

I saw considerable
truth in what they were saying. I wished I could join them; but as a typical CA
I lacked the courage to make up my mind!

I wished them good
luck, bid farewell to them and came back envying them.

 But just the day
before yesterday, I met Mr. Shah. He said they are now in a dilemma because the
first two buildings they saw there were the Income tax Office and the GST
office!

And the report was
that even the terrorists were afraid of attacking those two buildings!

 

CAN A GIFT BE TAKEN BACK?

Introduction

A gift is a transfer of
property, movable or immovable, made voluntarily and without consideration by a
donor to a donee. But can a gift which has been made be taken back by the
donor? In other words, can a gift be revoked? There have been several instances
where parents have gifted their house to their children and then the children
have not taken care of their parents or ill-treated them. In such cases, the parents
wonder whether they can take back the gift which they have made on grounds of
ill-treatment. The position in this respect is not so simple and the law is
very clear on when a gift can be revoked.

 

LAW ON GIFTS

The Transfer of Property
Act, 1882 deals with gifts of property, both immovable and movable. Section
122 of the Act defines a gift as the transfer of certain existing movable or
immovable property made voluntarily and without consideration by a donor to a
donee. The gift must be accepted by or on behalf of the donee during the
lifetime of the donor and while he is still capable of giving. If the donee
dies before acceptance, then the gift is void. In Asokan vs.
Lakshmikutty, CA 5942/2007 (SC), the Supreme Court held that in order
to constitute a valid gift, acceptance thereof is essential. The Act does not
prescribe any particular mode of acceptance. It is the circumstances of the
transaction which would be relevant for determining the question. There may be
various means to prove acceptance of a gift. The gift deed may be handed over
to a donee, which in a given situation may also amount to a valid acceptance.
The fact that possession had been given to the donee also raises a presumption
of acceptance.

 

This section is clear that
it applies to gifts of movable properties, too. A gift is also a transfer of
property and hence, all the provisions pertaining to transfer of property under
the Act are applicable to it. Further, the absence of consideration is the
hallmark of a gift. What is consideration has not been defined under this Act
and hence, one would have to refer to the Indian Contract Act, 1872. Section
2(d) of that Act defines ‘consideration’ as follows – when, at the desire of
one person, the other person has done or abstained from doing something, such
act or abstinence or promise is called a consideration for the promise.

 

HOW ARE GIFTS TO BE MADE?

Section 123 of the Act
answers this question in two parts. The first part deals with gifts of
immovable property, while the second deals with gifts of movable property.
Insofar as the gifts of immovable property are concerned, section 123 makes
transfer by a registered instrument mandatory. This is evident from the use of
the words ‘transfer must be effected’. However, the second part of
section 123 dealing with gifts of movable property, simply requires that a gift
of movable property may be effected either by a registered instrument signed as
aforesaid or ‘by delivery’.

 

The difference in the two
provisions lies in the fact that insofar as the transfer of movable property by
way of gift is concerned, the same can be effected by a registered instrument
or by delivery. Such transfer in the case of immovable property requires a
registered instrument but the provision does not make delivery of possession of
the immovable property gifted as an additional requirement for the gift to be
valid and effective. This view has been upheld by the Supreme Court in Renikuntla
Rajamma (D) By Lr. vs. K. Sarwanamma (2014) 9 SCC 456.

 

REVOCATION OF GIFTS

Section 126 of the Transfer
of Property Act provides that a gift may be revoked in certain circumstances.
The donor and the donee may agree that on the occurrence of a certain specified
event that does not depend on the will of the donor, the gift shall be revoked.
Further, it is necessary that the condition should be express and also
specified at the time of making the gift. A condition cannot be imposed
subsequent to giving the gift. In Asokan vs. Lakshmikutty (Supra),
the Supreme Court has held that once a gift is complete, the same cannot be
rescinded. For any reason whatsoever, the subsequent conduct of a donee cannot
be a ground for rescission of a valid gift.

 

However,
it is necessary that the event for revocation is not dependent upon the wishes
of the donor. Thus, revocation cannot be on the mere whims and fancies of the
donor. For instance, after gifting the donor cannot say that he made a mistake
and now he has had a change of mind and wants to revoke the gift. A gift is a
completed contract and hence unless there are specific conditions precedent
which have been expressly specified, there cannot be a revocation. It is quite
interesting to note that while a gift is a completed contract, there cannot be
a contract for making a gift since it would be void for absence of
consideration. For instance, a donor cannot enter into an agreement with a
donee under which he agrees to make a gift but he can execute a gift deed
stating that he has made a gift. The distinction is indeed fine! It needs to be
noted that a gift which has been obtained by fraud, misrepresentation,
coercion, duress, etc., would not be a gift since it is not a contract at all.
It is void ab initio.

 

DECISIONS ON THIS ISSUE

In Jagmeet
Kaur Pannu, Jammu vs. Ranjit Kaur Pannu AIR 2016 P&H 210, the
Punjab and Haryana High Court considered whether a mother could revoke a gift
of her house in favour of her daughter on the grounds of misbehaviour and
abusive language. The mother had filed a petition with the Tribunal under the
Maintenance and Welfare of Parents and Senior Citizens Act, 2007 which had set
aside the gift deed executed by the mother. It held that the deed was voidable
at the mother’s instance. The daughter appealed to the High Court which set
aside the Tribunal’s order. The High Court considered the gift deed which had
stated that the gift was made voluntarily, without any pressure and out of
natural love and affection which the mother bore towards the daughter. There
were no preconditions attached to the gift.

 

The
High Court held that the provisions of section 126 of the Transfer of Property
Act would apply since this was an important provision which laid down a rule of
public policy that a person who transferred a right to the property could not
set down his own volition as a basis for a revocation. If there was any
condition allowing for a document to be revoked or cancelled at the donor’s own
will, then that condition would be treated as void. The Court held that there
have been decisions of several courts which have held that if a gift deed was
clear and operated to transfer the right of property to another but it also
contained an expression of desire by the donor that the donee will maintain the
donor, then such expression in the gift deed must be treated as a pious wish of
the donor and the sheer fact that the donee did not fulfil the condition could
not vitiate the gift.

Again,
in the case of Syamala Raja Kumari vs. Alla Seetharavamma 2017 AIR (Hyd)
86 a similar issue before the High Court was whether a gift which was
made without any pre-conditions could be subsequently revoked. The donor
executed a gift deed in favour of his daughters out of love and affection. He
retained a life-interest benefit and after him, his wife retained a life-interest
under the said document. However, there were no conditions imposed by the donor
for gifting the property in favour of the donees. All it mentioned was that he
and his wife would have a life-interest benefit. Subsequently, the donor
executed a revocation deed stating that he wanted to cancel the gift since his
daughters were not taking care of him and his wife and were not even visiting
them. The Court set aside the revocation of the gift. It held that once a valid
unconditional gift was given by the donor and was accepted by the donees, the
same could not be revoked for any reason. The Court held that the donees would
get absolute rights in respect of the property. By executing the gift deed, the
donor had divested his right in the property and now he could not unilaterally
execute any revocation deed for revoking the gift deed executed by him in
favour of the plaintiffs.

 

Similarly,
in the case of Sheel Arora vs. Madan Mohan Bajaj, 2007 (6) Bom CR 633,
the donor executed a registered gift deed of a flat in favour of a donee.
Subsequently, the donor unilaterally executed a revocation deed cancelling the
gift. The Bombay High Court held that after lodging the duly executed gift deed
for registration, there was a unilateral attempt on the part of the donor to
revoke the said gift deed. Section 126 of the Transfer of Property Act provides
that the revocation of gift can be done only in cases specified under the
section and the same requires participation of the donee. In the case on  hand, there was no participation of the donee
in an effort on the part of the donor to revoke the said gift deed. On the
contrary, unilateral effort on the part of the donor by execution of a deed of
revocation itself disclosed that the donor had clearly accepted the legal consequences
which were to follow on account of the execution of a valid gift deed and
presentation of the same for registration.

 

However,
in the case of S. Sarojini Amma vs. Velayudhan Pillai Sreekumar 2018 (14)
SCALE 339, the Supreme Court considered a gift where, in expectation
that the donee would look after the donor and her husband, she executed a gift
deed. The gift deed clearly stated that the gift would take effect after the
death of the donor and her husband. Subsequently, the donor filed a deed of
cancellation of the gift deed. The Supreme Court observed that a conditional
gift became complete on the compliance of the conditions mentioned in the deed.
Hence, it allowed the revocation.

 

GIFTS MADE RESERVING INTEREST
FOR DONOR

One other mode of making a gift is a gift where the donor reserves an
interest for himself. For instance, a father may gift his flat to his son but
reserve a life-interest benefit for himself and his wife. Thus, although the
son would become the owner of the flat immediately, he would have an overriding
obligation to allow his parents to reside in the flat during their lifetime.
Thus, as long as they are alive, he would not be able to sell / lease or
otherwise transfer the flat or prevent them from staying in the flat. This issue
of whether a donor can reserve an interest for himself was a controversial one
and even the Supreme Court had opined for and against the same.

 

Ultimately,
a larger bench of the Supreme Court in Renikuntla Rajamma (D) By Lr. vs.
K. Sarwanamma (Supra) dealt with this matter. In this case, the issue
was that since the donor had retained to herself the right to use the property
and to receive rents during her lifetime whether such a reservation or
retention rendered the gift invalid? The Supreme Court upheld the validity of
such a gift and held that what was retained was only the right to use the
property during the lifetime of the donor which did not in any way affect the
transfer of ownership in favour of the donee by the donor. Thus, such a gift
reserving an interest could be a via media to making an absolute gift and then
being at the mercy of the donee. However, the gift deed should be drafted very
carefully else it would fail to serve the purpose.

 

CONCLUSION

‘Donor beware of how you gift, for a gift once given cannot be easily
revoked!’ If there are any
doubts or concerns in the mind of the donor then he should refrain from making
an absolute unconditional gift or consider whether to avoid the gift at all.
This is all the more true in the case of old parents who gift away their family
homes and then try to claim the same back since they are being ill-treated by
their children. They should be forewarned that it would not be easy to revoke
such a gift. In all matters of estate and succession planning, due thought must
be given to all possible and probable scenarios and playing safe is better than
being sorry!  

 

 

RECENT IMPORTANT DEVELOPMENTS – PART II

In Part I of the article published in July,
we covered some of the important developments in India relating to
International Tax. In this Part II of the article, we cover recent major
developments in the area of International Taxation and the work being done at
OECD and UN in various other related fields. It is in continuation of our
endeavour to update readers on major International Tax developments at regular
intervals. The news items included here come from various sources and the OECD
and UN websites.

 

(A) DEVELOPMENTS IN INDIA RELATING TO
INTERNATIONAL TAX

 

Ratification by India of the Multilateral
Convention to implement tax treaty-related measures to prevent Base Erosion and
Profit Shifting (Press release dated 2nd July, 2019 issued by CBDT,
Ministry of Finance)

 

India has ratified the Multilateral
Convention to implement tax treaty-related measures to prevent Base Erosion and
Profit Shifting (MLI), which was signed by the Hon’ble Finance Minister in
Paris on 7th June, 2017 along with representatives of more than 65
countries. On 25th June, 2019 India deposited the Instrument of
Ratification to OECD, Paris, along with its final position in terms of Covered
Tax Agreements (CTAs), reservations, options and notifications under the MLI,
as a result of which MLI will come into force for India on 1st
October, 2019 and its provisions will have effect on India’s DTAAs from FY
2020-21 onwards.

 

(B) OECD DEVELOPMENTS

 

(I) OECD
announces progress made in addressing harmful tax practices (BEPS Action 5)
(Source: OECD News Report dated 29th January, 2019)

 

The OECD has
released a new publication, Harmful Tax Practices – 2018 Progress Report on
Preferential Regimes, which contains results demonstrating that
jurisdictions have delivered on their commitment to comply with the standard on
harmful tax practices, including ensuring that preferential regimes align
taxation with substance.

 

The assessment of
preferential tax regimes is part of ongoing implementation of Action 5 under
the OECD/G20 BEPS Project. The assessments are conducted by the Forum on
Harmful Tax Practices (FHTP), comprising of the more than 120 member
jurisdictions of the Inclusive Framework. The latest assessment by the FHTP has
yielded new conclusions on 57 regimes, including:

 

  •    44 regimes where
    jurisdictions have delivered on their commitment to make legislative changes to
    abolish or amend the regime (Antigua and Barbuda, Barbados, Belize, Botswana, Costa
    Rica, Curaçao, France, Jordan, Macau (China), Malaysia, Panama, Saint Lucia,
    Saint Vincent and the Grenadines, the Seychelles, Spain, Thailand and Uruguay).
  •    As a result, all IP regimes
    that were identified in the 2015 BEPS Action 5 report are now ‘not harmful’ and
    consistent with the nexus approach, following the recent legislative amendments
    passed by France and Spain.
  •    Three new or replacement
    regimes were found ‘not harmful’ as they have been specifically designed to
    meet Action 5 standard (Barbados, Curaçao and Panama).
  •    Four other regimes have been
    found to be out of scope or not operational (Malaysia, the Seychelles and the
    two regimes of Thailand), and two further commitments were given to make
    legislative changes to abolish or amend a regime (Malaysia and Trinidad &
    Tobago).
  •    One regime has been found
    potentially harmful but not actually harmful (Montserrat).
  •    Three regimes have been
    found potentially harmful (Thailand).

 

The FHTP has
reviewed 255 regimes to date since the start of the BEPS Project, and the
cumulative picture of the Action 5 regime review process is as follows:

 

The report also
delivers on the Action 5 mandate for considering revisions or additions to the
FHTP framework, including updating the criteria and guidance used in assessing
preferential regimes and the resumption of application of the substantial
activities factor to no, or only nominal, tax jurisdictions. The report
concludes in setting out the next key steps for the FHTP in continuing to
address harmful tax practices.

 

(II) New
Beneficial Ownership Toolkit will help tax administrations tackle tax evasion
more effectively (Source: OECD News Report dated 20th March, 2019)

 

The first ever beneficial
ownership toolkit was released today in the context of the OECD’s
Global Integrity and Anti-Corruption Forum. The toolkit, prepared by the
Secretariat of the OECD’s Global Forum on Transparency and Exchange of
Information for Tax Purposes in partnership with the Inter-American
Development Bank, is intended to help governments implement the Global Forum’s
standards on ensuring that law enforcement officials have access to reliable
information on who the ultimate beneficial owners are behind a company or other
legal entity so that criminals can no longer hide their illicit activities
behind opaque legal structures.

 

The toolkit was
developed to support Global Forum members and in particular developing
countries because the current beneficial ownership standard does not provide a
specific method for implementing it. To assist policy makers in assessing
different implementation options, the toolkit contains policy considerations
that Global Forum members can use in implementing the legal and supervisory
frameworks to identify, collect and maintain the necessary beneficial ownership
information.

 

‘Transparency of
beneficial ownership information is essential to deterring, detecting and
disrupting tax evasion and other financial crimes. The Global Forum’s standard
on beneficial ownership offers jurisdictions flexibility in how they implement
the standard to take account of different legal systems and cultures. However,
that flexibility can pose challenges particularly to developing countries,’
said Pascal Saint-Amans, Head of the OECD’s Centre for Tax Policy and
Administration. ‘This new toolkit is an invaluable new resource to help
them find the best approach.’

 

The toolkit covers
a variety of important issues regarding beneficial ownership, including:

  •    the concepts of beneficial
    owners and ownership, the criteria used to identify them, the importance of the
    matter for transparency in the financial and non-financial sectors;
  •    technical aspects of
    beneficial ownership requirements, distinguishing between legal persons and
    legal arrangements (such as trusts) and measures being taken internationally to
    ensure the availability of information on beneficial ownership, (such as)
    a series of checklists that may be useful in pursuing a specific beneficial
    ownership framework;
  •    ways in which the principles
    on beneficial ownership can play out in practice in Global Forum EOIR peer
    reviews;
  •    why beneficial ownership
    information is also a crucial component of the automatic exchange of
    information regimes being adopted by jurisdictions around the world.

 

With 154 members, a
majority of whom are developing countries, the Global Forum has been heavily
engaged in providing technical assistance on the new beneficial ownership
requirements, often with the support of partner organisations including the
IDB. The Toolkit offers another means to further equip members to comply with
the international tax transparency standards.

 

The Toolkit is the
first practical guide freely available for countries implementing the
international tax transparency standards. It will be frequently updated to
incorporate new lessons learned from the second-round EOIR peer reviews
conducted by the Global Forum, as well as best practices seen and developed by
supporting organisations.

 

(III)
International community agrees on a road-map for resolving the tax challenges
arising from digitalisation of the economy (Source: OECD News Report dated 31st
May, 2019)

 

The international
community has agreed on a road-map for resolving the tax challenges arising
from the digitalisation of the economy, and committed to continue working
towards a consensus-based long-term solution by the end of 2020, the OECD
announced on 31st May, 2019

 

The 129 members of
the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS)
adopted a Programme of Work laying out a process for reaching a new global
agreement for taxing multinational enterprises.

 

The document, which
calls for intensifying international discussions around two main pillars, was
approved during the 28-29 May plenary meeting of the Inclusive Framework, which
brought together 289 delegates from 99 member countries and jurisdictions and
ten observer organisations. It was presented by OECD Secretary-General Angel
Gurría to G20 Finance Ministers for endorsement during their 8-9 June
ministerial meeting in Fukuoka, Japan.

 

Drawing on analysis
from a Policy Note published in January, 2019 and informed by a public
consultation held in March, 2019, the Programme of Work will explore the
technical issues to be resolved through the two main pillars. The first pillar
will explore potential solutions for determining where tax should be paid and
on what basis (‘nexus’), as well as what portion of profits could or should be
taxed in the jurisdictions where clients or users are located (‘profit
allocation’).

 

The second pillar
will explore the design of a system to ensure that multinational enterprises –
in the digital economy and beyond – pay a minimum level of tax. This pillar
would provide countries with a new tool to protect their tax base from profit
shifting to low / no-tax jurisdictions and is intended to address remaining
issues identified by the OECD/G20 BEPS initiative.

 

In 2015, the OECD
estimated revenue losses from BEPS of up to USD 240 billion, equivalent to 10% of
global corporate tax revenues, and created the Inclusive Forum to co-ordinate
international measures to fight BEPS and improve the international tax rules.

 

‘Important progress
has been made through the adoption of this new Programme of Work, but there is
still a tremendous amount of work to do as we seek to reach, by the end of
2020, a unified long-term solution to the tax challenges posed by
digitalisation of the economy,’ Mr Gurría said. ‘Today’s broad agreement on the
technical roadmap must be followed by strong political support towards a
solution that maintains, reinforces and improves the international tax system.
The health of all our economies depends on it.’

 

The Inclusive
Framework agreed that the technical work must be complemented by an impact
assessment of how the proposals will affect government revenue, growth and
investment. While countries have organised a series of working groups to
address the technical issues, they also recognise that political agreement on a
comprehensive and unified solution should be reached as soon as possible,
ideally before the year-end, to ensure adequate time for completion of the work
during 2020.

 

(IV)
Implementation of tax transparency initiative delivering concrete and
impressive results (Source: OECD News Report dated 7th June, 2019)

International
efforts to improve transparency via automatic exchange of information on
financial accounts are improving tax compliance and delivering concrete results
for governments worldwide, according to new data released on 7th
June, 2019 by the OECD.

 

More than 90
jurisdictions participating in a global transparency initiative under the
OECD’s Common Reporting Standard (CRS) since 2018 have now exchanged
information on 47 million offshore accounts, with a total value of around EUR
4.9 trillion. The Automatic Exchange of Information (AEOI) initiative –
activated through 4,500 bilateral relationships – marks the largest exchange of
tax information in history, as well as the culmination of more than two decades
of international efforts to counter tax evasion.

 

‘The international
community has brought about an unprecedented level of transparency in tax
matters which will bring concrete results for government revenues and services
in the years to come,’ according to OECD Secretary-General Angel Gurria,
unveiling the new data prior to a meeting of G20 finance ministers in Fukuoka,
Japan. ‘The transparency initiatives we have designed and implemented through
the G20 have uncovered a deep pool of offshore funds that can now be effectively
taxed by authorities worldwide. Continuing analysis of cross-border financial
activity is already demonstrating the extent that international standards on
automatic exchange of information have strengthened tax compliance and we
expect to see even stronger results moving forward,’ Mr Gurria said.

 

Voluntary
disclosure of offshore accounts, financial assets and income in the run-up to
full implementation of the AEOI initiative resulted in more than EUR 95 billion
in additional revenue (tax, interest and penalties) for OECD and G20 countries
over the 2009-2019 period. This cumulative amount is up by EUR 2 billion since
the last reporting by OECD in November, 2018.

 

Preliminary OECD
analysis drawing on a methodology used in previous studies shows the very substantial
impact AEOI is having on bank deposits in international financial centres
(IFCs). Deposits held by companies or individuals in more than 40 key IFCs
increased substantially over the 2000 to 2008 period, reaching a peak of USD
1.6 trillion by mid-2008.

 

These deposits have
fallen by 34% over the past ten years, representing a decline of USD 551
billion, as countries adhered to tighter transparency standards. A large part
of that decline is due to the onset of the AEOI initiative, which accounts for
about two-thirds of the decrease. Specifically, AEOI has led to a decline of 20
to 25% in the bank deposits in IFCs, according to preliminary data. The
complete study is expected to be published later this year.

 

‘These impressive
results are only the first stock-taking of our collective efforts,’ Mr Gurria
said. ‘Even more tax revenue is expected as countries continue to process the
information received through data-matching and other investigation tools. We
really are moving closer to a world where there is nowhere left to hide.’

 

(V) Money
Laundering and Terrorist Financing Awareness Handbook for Tax Examiners and Tax
Auditors

The OECD in June,
2019 released an update of its 2009 Money Laundering Awareness Handbook for
Tax Examiners and Tax Auditors. This update enhances the 2009 publication
with additional chapters such as ‘Indicators on Charities and Foreign Legal
Entities’ and ‘Indicators on Cryptocurrencies’ relating to money laundering. In
a separate chapter, the increasing threat
of terrorism is addressed by including indicators of terrorist financing.

 

The purpose of the Money
Laundering and Terrorist Financing Awareness Handbook for Tax Examiners and Tax
Auditors is to raise the awareness level of tax examiners and tax auditors
regarding money laundering and terrorist financing. As such, the primary
audience for this Handbook are tax examiners and tax auditors who may come
across indicators of unusual or suspicious transactions or activities in the
normal course of tax reviews or audits and report to an appropriate authority.
While this Handbook is not intended to detail criminal investigation methods,
it does describe the nature and context of money laundering and terrorist
financing activities, so that tax examiners and tax auditors, and by extension
tax administrations, are able to better understand how their contributions can
assist in the fight against serious crimes.

 

While the aim of
this Handbook is to raise the awareness of the tax examiners and tax auditors
about the possible implications of transactions or activities related to money
laundering and terrorist financing, the Handbook is not meant to replace
domestic policies or procedures. Tax examiners and tax auditors will need to
carry out their duties in accordance with the policies and procedures in force
in their country.

 

(VI)  G20 Osaka Leaders’ Declaration

The leaders of the
G20 met in Osaka, Japan on 28-29 June, 2019 to make united efforts to address
major global economic challenges. They stated in their declaration that they
will work together to foster global economic growth while harnessing the power
of technological innovation, in particular digitalisation, and its application
for the benefit of all.

 

In the declaration,
para 16, relating to tax, stated as follows:

 

‘16. We will
continue our co-operation for a globally fair, sustainable, and modern
international tax system, and welcome international co-operation to advance
pro-growth tax policies. We reaffirm the importance of the worldwide
implementation of the G20/OECD Base Erosion and Profit Shifting (BEPS) package
and enhanced tax certainty. We welcome the recent progress on addressing the
tax challenges arising from digitalisation and endorse the ambitious work
programme that consists of a two-pillar approach, developed by the Inclusive
Framework on BEPS. We will redouble our efforts for a consensus-based
solution with a final report by 2020. We welcome the recent achievements on tax
transparency, including the progress on automatic exchange of information for
tax purposes. We also welcome an updated list of jurisdictions that have not
satisfactorily implemented the internationally agreed tax transparency
standards. We look forward to a further update by the OECD of the list that
takes into account all of the strengthened criteria. Defensive measures will be
considered against listed jurisdictions. The 2015 OECD report inventories
available measures in this regard. We call on all jurisdictions to sign and
ratify the Multilateral Convention on Mutual Administrative Assistance in Tax
Matters. We reiterate our support for tax capacity building in developing
countries.’

 

(VII)  OECD expands transfer pricing country
profiles to cover 55 countries

 

The OECD has just
released new transfer pricing country profiles for Chile, Finland and Italy,
bringing the total number of countries covered to 55. In addition, the OECD has
updated the information contained in the country profiles for Colombia and
Israel.

 

These country
profiles reflect the current state of legislation and practice in each country
regarding the application of the arm’s-length principle and other key transfer
pricing aspects. They include information on the arm’s-length principle,
transfer pricing methods, comparability analysis, intangible property,
intra-group services, cost contribution agreements, transfer pricing
documentation, administrative approaches to avoiding and resolving disputes,
safe harbours and other implementation measures as well as to what extent the
specific national rules follow the OECD Transfer Pricing Guidelines.

 

The transfer
pricing country profiles are published to increase transparency in this area
and reflect the revisions to the Transfer Pricing Guidelines resulting from the
2015 Reports on Actions 8-10 Aligning Transfer Pricing Outcomes with Value
Creation and Action 13 Transfer Pricing Documentation and Country-by-Country
Reporting of the OECD/G20 Project on Base Erosion and Profit Shifting
(BEPS), in addition to changes incorporating the revised guidance on safe
harbours approved in 2013 and consistency changes made to the rest of the
OECD Transfer Pricing Guidelines.

 

A.    UN
DEVELOPMENTS

 

(VIII)     Manual
for the Negotiation of Bilateral Tax Treaties between Developed and Developing
Countries, 2019

 

The United Nations Manual for the Negotiation of Bilateral Tax Treaties
between Developed and Developing Countries (2019) is a compact training tool
for beginners with limited experience in tax-treaty negotiations. It seeks to
provide practical guidance to tax-treaty negotiators in developing countries,
in particular those who negotiate based on the United Nations Model Double
Taxation Convention between Developed and Developing Countries. It deals with
all the basic aspects of tax-treaty negotiations and it is focused on the
realities and stages of capacity development of developing countries.

 

The core of the Manual is contained in Section III which
introduces the different Articles of the United Nations Model Double Taxation
Convention between Developed and Developing Countries (United Nations Model
Convention). This section is not intended to replace the Commentaries thereon,
which remain the final authority on issues of interpretation, but rather to
provide a simple tool for familiarising less experienced negotiators with the
provisions of each Article.

 

We sincerely hope that the reader would find the above developments to
be interesting and useful.

 

 

UNINSTALLED MATERIALS AND IMPACT ON REVENUE RECOGNITION

BACKGROUND


Contract Co (CoCo) enters
into a contract with a customer to refurbish a 40-storey building and install
new lifts for a total consideration of INR 1,62,000. The promised refurbishment
service, including the installation of the lifts, is a single performance
obligation satisfied over time. The refurbishment will be performed over a three-year
period. The total revenue is expected to be as follows:

 

TOTAL EXPECTED REVENUE

 

 

INR

Transaction
price

1,62,000

Expected
costs

 

Lifts

81,000

Other
costs

54,000

Total
expected costs

1,35,000

Expected
gross margin

27,000

 

 

The contract costs incurred
over the three-year period are as follows:

 

CONTRACT COSTS OVER  THREE YEARS

           

 

Year 1

Year 2

Year 3

Total

 

INR

INR

INR

INR

Other
costs incurred

18,000

18,000

18,000

54,000

Cost
of lifts delivered to site but not yet installed at year-end

81,000

–

–

81,000

Total
costs incurred

99,000

18,000

18,000

1,35,000

 

At the end of Year 1,
included in the total costs of INR 99,000 are the costs incurred to purchase
the lifts worth INR 81,000. These lifts had been delivered at the site at the
end of Year 1 but had not yet been installed. The lifts were procured from a third-party
supplier and CoCo was not involved in either the designing or the manufacture
of the lifts. These lifts were installed at the end of Year 2. CoCo recognises
revenue over time, applying an input method based on costs incurred. Assume
that in arriving at the agreed transaction price, CoCo had applied the
following mark-up to its costs:

 

COST MARK-UP BY THE COMPANY

 

 

Cost

Mark-up

Transaction

Price

Gross Margin

 

INR

INR

INR

%

Cost
of lifts

81,000

7,200

88,200

8.2

Other
costs

54,000

19,800

73,800

26.8

Total

1,35,000

27,000

1,62,000

16.7

 

 

CoCo has determined that it
acts as a principal in accordance with Ind AS 115.B34-B38, because it obtains
control of the lifts before they are transferred to the customer.

 

QUERY 1

CoCo uses an input method
based on costs incurred. How should it determine the amount of revenue, profit
and gross margin to be recognised in its financial statements for Year 1, Year
2 and Year 3?

 

YEAR 1

The general principle of
over time revenue recognition in Ind AS 115 is that the pattern of revenue
recognition should reflect the entity’s performance in transferring control of
goods and services to the customer (see Ind AS 115.39). Paragraph B19 of Ind AS
115 notes that when an input method is used, an entity should exclude the
effects of any inputs that do not reflect the entity’s performance to date. It
specifically requires that revenue is only recognised to the extent of costs
incurred if:

 

(a) the goods are not
distinct; (b) the customer is expected to obtain control of the goods
significantly before receiving services relating to the goods; (c) the cost of
the transferred goods is significant relative to the total expected costs to
completely satisfy the performance obligation; and (d) the entity procures the
goods from a third party and is not significantly involved in designing and
manufacturing the same (but the entity is acting as a principal in accordance
with paragraphs B34-B38).

 

Therefore, CoCo excludes
the cost of the lifts from the cost-to-cost calculation in Year 1 because the
cost of the lifts is not proportionate to CoCo’s measure of progress towards
performing the refurbishment. Paragraph B19 is met because:

 

(i) The
lifts are not distinct. The refurbishment and installation of the lifts represents
one single performance obligation;

(ii) The
customer obtains control of the lifts when they arrive on its premises at the
end of Year 1, but installation of the lifts is only performed at the end of
Year 2;

(iii) The
costs of the lifts are significant relative to the total expected costs of the
refurbishment; and

(iv) The
lifts were procured from a third party and CoCo is not involved in designing or
manufacturing the lifts.

 

CoCo
therefore adjusts the measure of its progress towards completion and excludes
the uninstalled lifts from the costs incurred when determining the entity’s
performance to date:

 

 

DETERMINING THE ENTITY’S PERFORMANCE

       

 

INR

Total costs incurred to date:

99,000

Less: uninstalled lifts

(81,000)

 

18,000

 

CoCo then
calculates the percentage of performance completed to date:

 

INR 18,000
other costs (excluding lifts) / INR 54,000 total other costs (excluding lifts)
= 33.33% complete. CoCo recognises revenue to the extent of the adjusted costs
incurred and does not recognise a profit margin for the uninstalled lifts:

PROFIT MARGIN RECOGNISED

 

 

Year 1

 

INR

Total transaction price

1,62,000

Less: Cost of lifts

(81,000)

Adjusted revenue (excluding lifts)

81,000

% of performance completed to date

33%

Revenue for the period (excluding lifts)

27,000

Revenue recognised for cost of lifts

81,000

Total revenue for the period

1,08,000

Less: Costs for the period

(99,000)

Profit for the period

9,000

Profit margin (profit / total revenue)

8.33%

 

The above
accounting is clearly in accordance with Ind AS 115 and there are no
interpretation issues. However, the accounting in the following years is not
clear under Ind AS 115, which is the subject of this discussion.

 

YEARS 2 & 3

At the end
of Year 2 the lifts have been installed and an additional INR 18,000 of costs
has been incurred. Ind AS 115 does not contain specific guidance on the
accounting for the previously uninstalled materials that have now been
installed. Possible approaches for the accounting in the remaining years are:

 

View 1
– Continue to exclude the cost of the lifts from the cost-to-cost calculation
in the remaining periods of the contract;

View 2 –
Include the cost of the lifts in the cost-to-cost calculation once the lifts
have been installed and use a contract-wide profit margin;

View 3
– The cost-to-cost calculation would continue to exclude the cost of the lifts;
however, once the lifts have been installed, an applicable profit margin on the
lifts would be recognised as revenue;

View 4 – Since Ind  AS 115 is not specific in its requirements,
Views 1, 2 or 3 might be acceptable depending on the facts and circumstances.
It is necessary to consider whether the approach selected meets the overall
principle in Ind AS 115.39 that the amount of revenue should ‘depict an
entity’s performance in transferring control of goods or services promised to a
customer’. This principle once selected should be applied consistently.

 

View 1
– Continue to exclude the cost of the lifts from the cost-to-cost calculation
in the remaining periods of the contract;

Under this
approach, no profit margin would be recognised for the installed lift. The
profit margin derived from the lifts is instead shifted to the other services
in the contract as costs for those services are incurred.

 

COSTS INCURRED TO DATE

 

 

Year 1

Year 2

Year 3

 

INR

INR

INR

Total costs incurred to date

99,000

1,17,000

1,35,000

Less: Cost of lifts delivered but not installed at end of Year 1

(81,000)

(81,000)

(81,000)

Adjusted costs incurred to date (excl. lifts)

18,000

36,000

54,000

% of performance completed to date

33%

67%

100%

Revenue recognised to date (excl. lifts)

27,000

54,000

81,000

Revenue recognised for cost of lifts

81,000

81,000

81,000

Cumulative revenue recognised to date

1,08,000

1,35,000

1,62,000

 

 

REVENUE FOR THREE YEARS

 

 

Year 1

Year 2

Year 3

Total

 

INR

INR

INR

INR

Revenue for the period (excluding lifts)

27,000

27,000

27,000

81,000

Add: Revenue for cost of lifts

81,000

 

 

81,000

Revenue for the period

1,08,000

27,000

27,000

1,62,000

Less: Costs for the period

(99,000)

(18,000)

(18,000)

(1,35,000)

Profit for the period

9,000

9,000

9,000

27,000

Profit margin

8%

33%

33%

17%

 

Arguments for View 1:

 

Under B19(b)
only one accounting treatment applies to goods that meet the conditions set out
in B19(b). B19(b) does not distinguish goods that have been installed from
those that have not yet been installed. As per para B19(b), a faithful
depiction of an entity’s performance might be to recognise revenue at an amount
equal to the cost of goods used to satisfy a performance obligation if the
entity expects at contract inception that certain conditions are met.

The Basis
for Conclusions to IFRS 15 notes that the aim of the adjustment is to reflect
the same profit or loss and margin as if the customer had supplied those goods
themselves for the entity to install or use in the construction activity.
Paragraph BC172 of IFRS 15 notes: For goods that meet the conditions in paragraph
B19(b) of IFRS 15, recognising revenue to the extent of the costs of those
goods ensures that the depiction of the entity’s profit (or margin) in the
contract is similar to the profit (or margin) that the entity would recognise
if the customer had supplied those goods themselves for the entity to install
or use in the construction activity [IFRS 15.BC172]. If the customer had
supplied the lifts itself, then CoCo would not have recognised any profit or
margin on the lifts.

 

Per
paragraph IE98 from Illustrative Example 19, the adjustment to cost-to-cost can
be read to be applied throughout the entire life of the contract, in
accordance with paragraph B19 of Ind AS 115, the entity adjusts its measure of
progress to exclude the costs to procure the elevators from the measure of
costs incurred and from the transaction price. The entity recognises
revenue for the transfer of the elevators in an amount equal to the costs to
procure the elevators (i.e., at a zero margin).

 

Arguments against View 1:

 

View 1 does not reflect the
reality of the transaction as an entity would typically charge a margin for
procurement (the extent of the margin would likely depend on whether the item
is generic or of a specialised nature – a higher margin is likely to be applied
for items that are specialised in nature or that are harder to source), and
would not recognise a profit margin on the item when it is installed. Rather,
the margin is being shifted to the other services in the contract as costs for those
services are incurred. However, such margins may not be material when the
entity is procuring a generic item and is not involved in its design.

 

View 1 would
result in a different cumulative amount of revenue being recognised using the
same input method at the end of Year 2 when there has been a significant delay
between delivery and installation compared to when there is no delay – even
though the same amount of work has been performed at the end of Year 2. This is
because B19(b)(ii) would not be met because the customer does not obtain
control of the goods significantly before receiving the services.

 

View 2
– Include the cost of the lifts in the cost-to-cost calculation once the lifts
have been installed.

Under this approach, once the lifts have been installed, the cost of the
lifts would be included in cost-to-cost calculations.

 

COST-TO COST CALCULATIONS

 

 

Year 1

Year 2

Year 3

 

INR

INR

INR

Total costs incurred to date

99,000

1,17,000

1,35,000

Less: cost of lifts delivered but not yet installed

(81,000)

N/A

N/A

Costs incurred to date

18,000

1,17,000

1,35,000

% of POCM to date (rounded off)

33%

87%

100%

Revenue recognised to date

27,000

1,40,400

1,62,000

Revenue recognised for cost of lifts

81,000

N/A

N/A

Cumulative revenue recognised to date

1,08,000

1,40,400

1,62,000

                       

 

Year 1

Year 2

Year 3

Total

 

INR

INR

INR

INR

Revenue for the period

27,000

32,400

21,600

81,000

Add: Revenue for costs of lifts

81,000

N/A

N/A

81,000

Revenue for the period

1,08,000

32,400

21,600

1,62,000

Less: Costs for the period

(99,000)

(18,000)

(18,000)

(1,35,000)

Profit for the period

9,000

14,400

3,600

27,000

Profit margin

8%

44%

17%

17%

 

Arguments for View 2:

The
guidance in Illustrative Example 19 and the Basis for Conclusions to IFRS 15
focuses on the situation before the goods are installed, so the adjustment to
the cost-to-cost calculation only applies on goods that have been delivered but
not yet installed.

 

The
relevant extracts from the section for ‘Uninstalled materials’ in the Basis for
Conclusions are as follows:

 

BC171 of IFRS 15 states: The boards observed that if a customer
obtains control of the goods before they are installed by an entity… The boards
noted that recognising a contract-wide profit margin before the goods are
installed could overstate the measure of the entity’s performance and,
therefore, revenue would be overstated… [emphasis added].

BC172: The
boards noted that the adjustment to the cost-to-cost measure of progress for
uninstalled materials… (emphasis added).

 

BC174: …Although
the outcome of applying paragraph B19(b) of 1FRS 15 is that some goods or
services that are part of a single performance obligation attract a margin, while any uninstalled materials attract only a zero margin…

 

Arguments against View 2

When the
profit margin applicable to the procured item(s) is significantly different
from the profit margin attributable to other goods and services to be provided
in accordance with the contract, the application of a contract-wide profit
margin will overstate the amount of revenue and profit that is attributed to
the procured item(s). This is not consistent with the underlying principle in
Ind AS 115.39, which is that the amount of revenue recognised should ‘depict an
entity’s performance in transferring control of goods or services promised to a
customer’ (i.e., the satisfaction of an entity’s performance obligation).

 

As noted
in the analysis for Year 1 above, Ind AS 115.B19(b) includes guidance for
uninstalled material at the point at which control has passed to the customer.
This guidance is noted as being an example of ‘faithful depiction’ of an
entity’s performance. Consequently, when there are significantly different
profit margins attributable to procured item(s), it is necessary to adjust the
amount of revenue that is attributable to those procured item(s).

 

View 3
– Once the lifts have been installed, an applicable profit margin is recognised
for the lifts separately from the rest of the project:

 

APPLICABLE PROFIT MARGIN

       

 

Year 1

Year 2

Year 3

 

INR

INR

INR

Total costs incurred to date

99,000

1,17,000

1,35,000

Less: cost of lifts delivered but not yet installed

(81,000)

(81,000)

(81,000)

Adjusted costs incurred to date (excl. lifts)

18,000

36,000

54,000

% of performance completed to date

33%

67%

100%

Revenue recognised to date (excl. lifts)

24,600

49,200

73,800

Revenue recognised for lifts (mark-up included in Years 2 &
3)

81,000

88,200

88,200

Cumulative revenue recognised to date

1,05,600

1,37,400

1,62,000

 

       

 

Year 1

Year 2

Year 3

Total

 

INR

INR

INR

INR

Revenue for the period (excl. lifts)

24,600

24,600

24,600

73,800

Add: Revenue for lifts

81,000

7,200

0

88,200

Revenue for the period

1,05,600

31,800

24,600

1,62,000

Less: Costs for the period

(99,000)

(18,000)

(18,000)

(1,35,000)

Profit for the period

6,600

13,800

6,600

27,000

Profit margin

6%

43%

27%

17%

 

Arguments for View 3:

Same
arguments as for View 2, but it also addresses the downside of View 2 of
overstating profit margin once the materials are installed. Proponents of View
3 argue that this would most faithfully depict the economics of the transaction.

 

Arguments against View 3:

Mark-ups /
profit margins could be subject to management manipulation.

 

The
approach seems to have been considered but rejected by the boards as noted in
paragraph BC171 of IFRS 15. Alternatively, requiring an entity to estimate a
profit margin that is different from the contract-wide profit margin could be
complex and could effectively create a performance obligation for goods that
are not distinct (thus bypassing the requirements for identifying performance
obligations) [IFRS 15.BC171].

 

QUERY 2 –
assuming either View 2 or View 3 is followed for Question 1:

 

Where the
profit margins attributable to different components of a contract that is
accounted for as a single performance obligation are significantly different,
is it appropriate to use an input method as a measure of progress?

 

View 1

Yes. Although
different profit margins might arise from different parts of a contract, the
fact that the seller has a single performance obligation means that Ind AS 115
does not require those different components to be separately identified.
Proponents of this view note that IFRS 15.BC171 would appear to support this
approach: ‘Alternatively, requiring an entity to estimate a profit margin that
is different from the contract-wide profit margin could be complex and could
effectively create a performance obligation for goods that are not distinct
(thus bypassing the requirements for identifying performance obligations).’ It
is also noted that Example 19, which has different components that would
typically be expected to have different profit margins, is based on the vendor
using an input method to measure progress towards contract completion.

 

View 2

No. Ind AS
115.39 includes the objective that is required to be followed when measuring
progress where a performance obligation is satisfied over time, which is: ‘…The
objective when measuring progress is to depict an entity’s performance in
transferring control of goods or services promised to a customer (i.e., the
satisfaction of an entity’s performance obligation.’ Proponents of View 2
consider that, in the fact pattern set out above, the use of an input method,
with a single overall profit margin being allocated to costs incurred, would
result in an overstatement of performance for the transfer of the lifts and an
understatement of performance for the transfer of other services.

 

Supporters of View 2 also question whether the lifts are in fact part of
a single performance obligation. If the seller can procure the lifts
separately, then the customer could also procure the lifts, meaning that the
procurement of the lifts could be viewed as being a separate performance
obligation.

 

This
conclusion would also appear to be supported by IFRS 15.BC172, in that: ‘…For
goods that meet the conditions in paragraph B19(b) of IFRS15, recognising
revenue to the extent of the costs of those goods ensures that the depiction of
the entity’s profit (or margin) in the contract is similar to the profit (or
margin) that the entity would recognise if the customer had supplied those
goods themselves for the entity to install or use in the construction
activity.’

 

View 3

Ind AS115 is not specific in its requirements. Consequently, either View
1 or View 2 are acceptable as an accounting policy choice, to be applied
consistently to similar transactions.

 

AUTHOR’S VIEW AND
CONCLUSION

On Question
1,View 1 and View 2 are the two acceptable views, though on balance View 1 is
more preferred. View 3 and View 4 are not acceptable. View 1 practically makes
sense because it sticks with one approach throughout the period. This approach
is also consistent with Ind AS 115.B19 and meets the spirit of the requirement
in the Standard. View 2 may be accepted because Ind AS 115.B19 only applies to
uninstalled materials and once they are installed, then an entity goes back to
the general model for measuring progress.

 

On the
second question, View 1 is more appropriate. There is generally a better
alignment in margin using the input method, but not a guarantee of having a
consistent margin throughout in all cases.

 

The key
question is whether the use of the input method would be a faithful depiction
of the entity’s performance – and the response is in the affirmative. In any case, the standard
does not provide an option of applying input method, using different margins
for different components.  

 

DCIT CC-44 vs. M/s Shreya Life Sciences Pvt. Ltd. [ITA No. 2835/Mum./2014; Bench E; Date of order: 20th November, 2015] Penalty u/s 221(1) r/w/s 140A(3) of the Act – Default on payment of self-assessment tax – Acute financial constraints – Good and sufficient reasons – Penalty deleted

18.  The Pr.
CIT-Central-4 vs. M/s Shreya Life Sciences Pvt. Ltd. [Income tax Appeal No. 180
of 2017]; Date of order: 19th March, 2019; A.Y.: 2010-11

 

DCIT CC-44 vs. M/s Shreya Life Sciences Pvt. Ltd. [ITA No. 2835/Mum./2014;
Bench E; Date of order: 20th November, 2015]

 

Penalty u/s 221(1) r/w/s 140A(3) of the Act – Default on payment of
self-assessment tax – Acute financial constraints – Good and sufficient reasons
– Penalty deleted

 

The assessee is a pharmaceutical company manufacturing a wide range of
medicines and formulations. It filed its e-return on 15th October,
2010 and was liable to pay self-assessment tax of Rs. 2,61,19,300. But the
assessee did not pay the tax and merely uploaded the e-return. Asked the
reasons for not depositing the tax, it was submitted before the AO that the
assessee company was in great financial crisis.

 

However, the assessee’s contention was not accepted and the AO issued
notice u/s 221(1) r/w/s 140A(3) of the Act holding that the assessee had failed
to deposit self-assessment tax due to which a penalty was imposed u/s 221(1) of
the Act.

The CIT(A) deleted the penalty to the extent of Rs. 10 lakhs and upheld
the balance amount of Rs. 40 lakhs.

 

Both the assessee as well as the Department went in appeal before the
ITAT. The Tribunal, while deleting the penalty referred to relied upon the
further proviso to sub-section (1) of section 221 of the Act which provides
that where the assessee proves to the satisfaction of the AO that the default
was for good and sufficient reasons, no penalty shall be levied under the said
section.

 

The Tribunal accepted the assessee’s explanation that due to acute
financial constraints the tax could not be deposited. The assessee pointed out
that even the other dues such as provident fund, ESIC and bank interest could
not be paid. The assessee also could not deposit the government taxes such as
sales tax and service tax. In fact, the recoveries of the tax could be made only
upon adjustment of the bank accounts.

 

The financial crisis was because of non-receipt of proceeds for its
exports. Attention was drawn to the amount of outstanding receivables which had
increased from Rs. 291,96,24,000 to Rs. 362,54,82,000 during the year under
consideration.

 

On further appeal to the High Court, the Revenue appeal was dismissed.   

 

 

Dy. Commissioner of Income-tax, Circle-6(3) vs. M/s Graviss Foods Pvt. Ltd. [ITA No. 4863/Mum./2014] Pre-operative expense – New project unconnected with the existing business – Deductible u/s 37(1) of the Act

17.  The Pr. CIT-7 vs. M/s Graviss
Foods Pvt. Ltd. [Income tax Appeal No. 295 of 2017]; Date of order: 5th April, 2019; A.Y.: 2010-11

 

Dy. Commissioner of Income-tax, Circle-6(3) vs. M/s Graviss Foods Pvt.
Ltd. [ITA No. 4863/Mum./2014]

 

Pre-operative expense – New project unconnected with the existing
business – Deductible u/s 37(1) of the Act

 

The assessee is a private limited company engaged in the business of
manufacturing ice cream and other milk products. For the AY 2010-11 the
assessee had incurred an expenditure of Rs. 1.80 crores (rounded off) in the
process of setting up a factory for production of ‘mawa’, which project the
assessee was forced to abandon.

 

The AO was of the opinion that the expenditure was incurred for setting
up of a new industry. The expenditure was a pre-operative expenditure and could
not have been claimed as revenue expenditure.

 

The AO held that the assessee had entered a new field of business of
producing and supplying ‘mawa’ (or ‘khoa’) which is entirely different from the
business activity carried on by it. The AO completed the assessment and
disallowed the expenditure on the ground that it was incurred in connection
with starting a new project, that the expenditure was incurred for setting up a
new factory at Amritsar and thus not for the expansion and extension of the
existing business but for an altogether new business. The CIT(A) allowed the
appeal. The Tribunal relied upon its earlier decision for A.Y. 2009-10 and
confirmed the view of the CIT(A) and dismissed the Revenue’s appeal.

 

Before the Hon’ble High Court counsel for Revenue submitted that the
assessee was previously engaged in the business of manufacturing ice cream. The
assessee desired to set up a new plant at a distant place for production of
‘mawa’. This was, therefore, a clear case of setting up of a new industry.

The High Court observed that there was interlacing of the accounts,
management and control. The facts on record as culled out by the Tribunal are
that the assessee company was set up with the object to produce or cause to be
produced by process, grate, pack, store and sell milk products and ice cream.
In furtherance of such objects, the assessee had already set up an ice cream
producing unit. Using the same management control and accounts, the assessee
attempted to set up another unit for production of ‘mawa’, which is also a milk
product. The Tribunal, therefore, rightly held that the expenditure was
incurred for expansion of the existing business and it was not a case of
setting up of new industry, therefore it was allowable as revenue expenditure.

 

The High Court relied on the decision of the Supreme Court in the case
of Alembic Chemical Works Co. Ltd. vs. CIT, Gujarat, [1989] 177 ITR 377,
and the Bombay High Court decision in the case of CIT vs. Tata Chemicals
Ltd. (2002) 256 ITR 395 Bom.

 

The Department’s appeal was dismissed.

 

The DCIT vs. Mrs. Supriya Suhas Joshi [ITA No. 6565/Mum./2012; Bench: L; Date of order: 31st May, 2016; Mum. ITAT] Income from salary vis-a-vis income from contract of services – Dual control – Test of the extent of control and supervision

16.  The Pr. CIT-27 vs. Mrs.
Supriya Suhas Joshi [Income tax Appeal No. 382 of 2017]; Date of order: 12th April, 2019; A.Y.: 2009-10

 

The DCIT vs. Mrs. Supriya Suhas Joshi [ITA No. 6565/Mum./2012; Bench: L;
Date of order: 31st May, 2016; Mum. ITAT]

 

Income from salary vis-a-vis income from contract of services – Dual
control – Test of the extent of control and supervision

 

The assessee is the sole proprietor of M/s Radiant
Services, engaged in Manpower Consultancy and Recruitment Services in India and
overseas. The said Radiant Services had entered into an agreement with M/s
Arabi Enertech, a Kuwait-based company, in 2007-08 for providing manpower to it
as per its requirements. Individual contracts were executed for providing the
personnel. As per the contract, the Kuwait-based company paid a fixed sum out
of which the assessee would remunerate the employee.

 

The AO treated the payments made by the assessee to
the persons recruited abroad as not in the nature of salaries and applied the
provisions of section 195 r/w/s 40(a)(ia) and disallowed the same as no TDS was
done by the assessee. The AO concluded that there was no master and servant
relationship between the assessee and the recruited persons and therefore the
payments could not be held to be salaries. He did not accept the assessee’s
stand that the persons so employed worked in the employment of the assessee and
were only loaned to the Kuwait-based company for carrying out the work as per
the requirements of the said company. It is undisputed that in case of payment
to a non-resident towards salary, it would not come within the scope of section
195 of the Act, and hence this controversy. The assessee carried the matter in
appeal. The CIT(A) took note of the documents from the records, including the contract
between the assessee and the Kuwait-based company and the license granted by
the Union Government to enable the assessee to provide such a service. The
Commissioner was of the opinion that the assessee had employed the persons who
had discharged the duties for the Kuwait-based company. The assessee was,
therefore, in the process making payment of salary and, therefore, there was no
requirement of deducting tax at source u/s 195 of the Act.

 

The Tribunal confirmed the view of the CIT(A) upon
which an appeal was filed before the High Court.

 

The Hon’ble High Court observed that the contract
between the assessee and the Kuwait-based company was sufficiently clear,
giving all indications that the concerned person was the employee of the
assessee. The preamble to the contract itself provided that as per the contract
the assessee would supply the Commissioning Engineer to the said company on
deputation basis for its ongoing project. Such deputation would be on the terms
and conditions mutually discussed between the assessee and the said company.
The contract envisaged payment of deputation charges which were quantified at
US$ 5,500 per month. Such amount would be paid to the assessee out of which the
assessee would remunerate the employee. The mode of payment was also specified.
The same would be released upon the assessee submitting invoices. The record
suggested that the assessee after receiving the said sum from the Kuwait-based
company would regularly pay to the employee US$ 4,000 per month, retaining the
rest. In clear terms, thus, the concerned employee was in the employment of the
assessee and not of the Kuwait-based company, contrary to what the Department
contended.

 

The Department argued that looking to the
supervision and control of the Kuwait-based company over the employee, it must
be held that he was under the employment of the said company and not of the
assessee. In this regard, it placed heavy reliance on the decision of the
Supreme Court in the case of Ram Prashad vs. Commissioner of Income tax
(1972) 86 ITR 122 (SC). The Court observed that the test of the extent
of control and supervision of a person by the engaging agency was undoubtedly a
relevant factor while judging the question whether that person was an agent or
an employee. However, in a situation where the person employed by one employer
is either deputed to another or is sent on loan service, the question of dual
control would always arise. In such circumstances, the mere test of on-spot
control or supervision in order to decide the correct employer may not succeed.
It is inevitable that in a case such as the present one, the Kuwait-based
company would enjoy considerable supervising powers and control over the
employee as long as the employee is working for it.

Nevertheless, the assessee company continued to
enjoy the employer-employee relationship with the said person. For example, if
the work of such person was found to be wanting or if there was any complaint
against him, as per the agreement it would only be the assessee who could
terminate his services. Under the circumstances, no question of law arises. The
Department’s appeal was dismissed.

 

Sections 9(1)(vii)(b) and 195 of ITA 1961 – TDS – Income deemed to accrue or arise in India – Non-resident – TDS from payment to non-resident – Payment made to non-resident for agency services as global coordinator and lead manager to issue of global depository receipt – Services neither rendered nor utilised in India and income arising wholly outside India from commercial services rendered in course of carrying on business wholly outside India – Tax not deductible at source

46.  CIT(IT) vs. IndusInd Bank
Ltd.; [2019] 415 ITR 115 (Bom.) Date of order: 22nd April, 2019;

 

Sections 9(1)(vii)(b) and 195 of ITA 1961 – TDS – Income deemed to
accrue or arise in India – Non-resident – TDS from payment to non-resident –
Payment made to non-resident for agency services as global coordinator and lead
manager to issue of global depository receipt – Services neither rendered nor
utilised in India and income arising wholly outside India from commercial
services rendered in course of carrying on business wholly outside India – Tax
not deductible at source

The assessee was engaged in banking business. For
its need for capital, the bank decided to raise capital abroad through the
issuance of global depository receipts. The assessee engaged the A bank,
incorporated under the laws of the United Arab Emirates and carrying on
financial services, for providing services of obtaining global depository
receipts. The assessee bank raised USD 51,732,334 by way of the gross proceeds
of global depository receipts issued. The agency would be paid the agreed sum
of money which was later on renegotiated. The assessee paid a sum of USD
20,09,293 as agency charges which in terms of Indian currency came to Rs. 90.83
lakhs. The AO held that tax was deductible at source on such payment.

 

The Tribunal allowed the assessee’s claim that
there was no liability to deduct tax at source.

 

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

 

‘i)   The
assessee had engaged the A bank for certain financial services. The payment was
made for such financial services rendered by the A bank. The global depository
receipts were issued outside India. The services were rendered by the A bank
outside India for raising such funds outside India. It was, in this context,
that the Tribunal had come to the conclusion that the services rendered by the
A bank were neither rendered in India nor utilised in India and the character
of income arising out of such transaction was wholly outside India emanating
from commercial services rendered by the bank in the course of carrying on business wholly outside India.

ii)    The Tribunal
was, therefore, correctly of the opinion that such services could not be
included within the expression “technical services” in terms of
section 9(1)(vii)(b) read with Explanation to section 9. Tax was not deductible
at source from such payment.’

 

 

Sections 69, 132 and 158BC of ITA 1961 – Search and seizure – Block assessment – Undisclosed income – Search at premises of assessee’s father-in-law – Valuation of cost of construction of property called for pursuant to search – Addition to income of assessee as unexplained investment based on report of Departmental Valuer – Report available with Department prior to search of assessee’s premises – Addition unsustainable

45.  Babu
Manoharan vs. Dy. CIT; [2019] 415 ITR 83 (Mad.) Date of order: 4th
June, 2019; A.Ys.: B.P. from 1st April, 1989 to 31st March,
2000

 

Sections 69, 132 and 158BC of ITA 1961 – Search and seizure – Block
assessment – Undisclosed income – Search at premises of assessee’s
father-in-law – Valuation of cost of construction of property called for
pursuant to search – Addition to income of assessee as unexplained investment
based on report of Departmental Valuer – Report available with Department prior
to search of assessee’s premises – Addition unsustainable

 

During a search operation u/s 132 of the Income-tax
Act, 1961 conducted in the premises of the assessee’s father-in-law on 12th
August, 1999 it had been found that a house property was owned by the assessee
and his spouse equally and a valuation was called for from the assessee. After
the assessee submitted the valuation report, the Department appointed a valuer
who subsequently submitted his report in December, 1999. Thereafter, on 13th
January, 2000, a search and seizure operation was conducted in the premises of
the assessee. In the block assessment made u/s 158BC, the AO made an addition
to the income of the assessee on account of unexplained investment in the
construction of the house property.

Both the Commissioner (Appeals) and the Tribunal
upheld the addition.

 

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

 

‘i)   In the
absence of any material being found during the course of search in the premises
of the assessee with regard to the investment in the house property, the
assessee could not be penalised solely based on the valuation report provided
by the Department. The house property of the assessee was found during the
search conducted in the premises of the father-in-law of the assessee on 12th
August, 1999 and a valuation report was called for from the assessee as well as
the Departmental valuer. The valuation report was prepared much earlier to the
search conducted on 13th January, 2000 in the assessee’s premises.
Therefore, the valuation report was material which was available with the
Department before the search conducted in the assessee’s premises and it could
not have been the basis for holding that there had been an undisclosed
investment.

 

ii)    The
assessee had not been confronted with any incriminating material recovered
during the search. According to the valuation report submitted in the year
1999, it was only to determine the probable cost of construction and the valuer
in his report had stated that the construction was in progress at the time of
inspection on 12th August, 1999 on the date of search of the premises
of the assessee’s father-in-law. Therefore, the assessee could not be faulted
for not filing his return since he had time till September, 2001 to do so. The
order passed by the Tribunal holding that the investment in the house property
represented the undisclosed income of the assessee was set aside.’

 

Sections 69B, 132 and 153A of ITA 1961 – Search and seizure – Assessment – Undisclosed income – Burden of proof is on Revenue – No evidence found at search to suggest payment over and above consideration shown in registration deed – Addition solely on basis of photocopy of agreement between two other persons seized during search of other party – Not justified

44.  Principal CIT vs. Kulwinder
Singh; [2019] 415 ITR 49 (P&H) Date of order: 28th March, 2019;
A.Y.: 2009-10

 

Sections 69B, 132 and 153A of ITA 1961 – Search and seizure – Assessment
– Undisclosed income – Burden of proof is on Revenue – No evidence found at
search to suggest payment over and above consideration shown in registration
deed – Addition solely on basis of photocopy of agreement between two other
persons seized during search of other party – Not justified

 

In the A.Y. 2009-10, the assessee purchased a piece
of land for a consideration of Rs. 1 crore. Search and seizure operations u/s
132 of the Income-tax Act, 1961 were conducted at the premises of the seller
(PISCO) and the assessee. Further, during the course of the search conducted at
the residential premises of the accountant of PISCO, certain documents and an
agreement which showed the rate of the land at Rs. 11.05 crores per acre were
found. Since the land purchased by the assessee was part of the same (parcel
of) land, the AO was of the view that the assessee had understated his
investment in the land. He adopted the rate as shown in the agreement seized
during the search of the third party and made an addition to the income of the
assessee u/s 69B of the Act as undisclosed income.

 

The Commissioner (Appeals) held that the evidence
relied upon by the AO represented a photocopy of an agreement to sell between
two other persons in respect of a different piece of land on a different date,
that the AO had proceeded on an assumption without a finding that the assessee
had invested more than what was recorded in the books of accounts and deleted
the addition. The Tribunal found that the original copy of the agreement was
not seized; that the seller, buyer and the witnesses refused to identify it;
that the assessee was neither a party nor a witness to the agreement and was not
related to either party; that the assessee had purchased the land directly from
PISCO at the prevalent circle rate; and that in the purchase deed of the
assessee the rate was Rs. 4 crores per acre as against the purchase rate of Rs.
11.05 crores mentioned in the agreement seized. The Tribunal held that the
burden to prove understatement of sale consideration was not discharged by the
Department and that the presumption of the AO could not lead to a conclusion of
understatement of investment by the assessee and upheld the order passed by the
Commissioner (Appeals).

 

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

 

‘The Tribunal rightly upheld the findings recorded
by the Commissioner (Appeals). Learned Counsel for the appellant-Revenue has
not been able to point out any error or illegality therein.’

 

 

Electoral Bonds: Bonding Money and Power?

Politics is the gentle art of getting
votes from the poor and campaign funds from the rich, by promising to protect
each from the other – Oscar Ameringer

 

Election buzz is getting louder. A notable
change in this election from a financial perspective is that of funding of
elections via electoral bonds. The Finance Act, 2017 brought a far-reaching and
even questionable change that restricts citizens’ fundamental right to know
where the money comes from. The Finance Minister called it “substantial
improvement in transparency”. One can say this is a substantial example of
false equivalence.

 

Elections like everything else require
money. It is well known that power chases money and money seeks out power. One
of the greatest threats to democracy is money manipulating power. Electoral
Bonds (EB) compound these perennial problems manifold and even legitimise what
is fundamentally against the interest of citizens. Here is how the scheme
works:

 

a.  EB are as much or more opaque than earlier
systems:


i.   They are bearer instruments and a political
party does not have to disclose the name of the donors to anyone ever (as they
don’t even know it);


ii.   Companies are not required to disclose the
names of political parties to whom they give bonds; 


b.  The cap on corporate political funding of 7.5%
of last three years’ net profits was removed at the same time;


c.  F.Y. 2017-18 data shows1

i.   53% of all income (donations) of six
political parties came from Income from Unknown Sources2
 amounting to Rs. 689.44 crore
including 31% from EB (Rs. 215 crore) and Rs. 354.38 crore from voluntary
contributions below Rs. 20,000 where donor details are unknown (F.Y. 2017-18);


ii.   Six national political parties received 90%
of all donations from companies and 10% from 2,772 individual donors ;


iii.  The ruling party got 80% of its total income
from unknown sources.

As a wise citizen, you can connect the dots.
C K Prahalad3  gave an
interesting perspective a decade ago: “I cannot but assume that private funding
of elections of this magnitude is predicted on making an appropriate return.
Given the risky nature of the investment in elections, politicians as venture
capitalists, we can assume, will not settle for a less than ten-fold return.”

 

In the Indian context, it is hard to
understand why companies should fund important institutions and events of
democracy to this extent with anonymity? Why should corporates not disclose how
much and where the EB were given if they are only participating in the
democratic process? Why should political parties not disclose cash and non-cash
funding? Why should political parties not be audited by a panel approved by ECI
and CAG as proposed by an ADR report? Till this happens, I am not sure if
political parties really represent people and their interest!

 

Opaque funding through EB could easily be
legitimising corruption for favours granted by those in power in a way that can
never be known. While politicians are never known for matching words and
actions, one didn’t expect it from this government. Clean money without source
is akin to unclean money and is a slap on the face of ‘transparency’.

 

__________________________________________________

1   From Association of Democratic Reforms (ADR)
website/reports.

2     Unknown sources means – income declared in
tax returns but without giving sources of donations below Rs. 20,000 and
includes donation via electoral bonds, sale of coupons, etc.

 3   Seventh Nani Palkhivala Memorial Lecture,
January, 2010

 

 

Raman Jokhakar

Editor

Love – Hate

?Discover
the redemption power of love’

               Martin Luther King Jr.

 

Love and hate : both are very strong
emotions. They are actually two sides of the same coin. The irony is that at
times, with change in environment – the person we love is the person we hate.
Graham Greene says `I hate him for the very quality that once made me love him’.
The issue is: what is the difference between love and hate. Hate has been
defined as having strong feeling of hostility and / or antipathy. In my view –
love is giving without expectation and is based on the concept of `let go’
whereas `hate’ results from failure of expectations and is based on the concept
of `hold on’. Osho says : `love is happy when it gives something’ – whereas
hate is based on an unfulfilled demand / need expectation. Love expands and
grants space whereas hate contracts. Love accepts individuality – hate arises
because of failure of desire to control and change the other person. Love is a
mood reader. Hate is blind to the mood of the other person. Paul Coelho says :
`one is loved because one is loved. No reason is needed in loving’. Love is
always unconditional whereas `hate’ has a reason.

 

Love is the breath of life. Secret of basis
of lifelong love is understanding. Love is the essence of life – without love,
life is like an empty vessel. Love could be for a person, pet or place. It has
no boundary. Love need not be person-oriented. It could be love for nature, for
any of the performing arts, for a place. Love for books, and knowledge and
above all our unconditional love for God – our Creator.

 

The antidote to hate is forgiveness coupled
with other side of the coin ?love’.

 

?Forgiveness’ relieves and benefits both the
forgiver and the one who is forgiven. Gandhi says that forgiveness can only be
practised by the strong. The author has already expressed his view on a
previous writing on ?forgiveness’. I also believe that if one can forgive and
forget, it would make forgiveness divine. However, it is easy to forgive but
difficult to forget. One can only forget by the grace of God. Hence to really
get out of hate seek – nay crave His grace to forget. It would relieve you of
negativity and lead to love. Jesus said ?love thy enemy’. Even on the cross,
Jesus prayed for forgiveness of his tormentors when he prayed `Father, forgive
them’.

 

It is rightly said that ?a person who
truly loves one cannot but love all’. I believe that a person who loves God
cannot ever feel hate. In essence, he falls in love with himself and there
is no duality in love.

 

Thus ultimate of love is loving yourself.
This can happen only when you forgive yourself – stop repenting your mistakes
and ensure that you don’t repeat them. This happens when we are
mindfully-conscious of our actions and behaviour. Love for oneself is
the basis of loving others. Azim Jamal advises : ?If you yearn for love – be
loved, treat everyone you meet with love’.

 

I
would conclude by quoting Peter Usitnov :

?Love
is an endless act of forgiveness’.

THE FUGITIVE ECONOMIC OFFENDERS ACT, 2018 – AN OVERVIEW – PART 1

In the recent
past, there have been quite a few instances of big time offenders including
economic offenders (For example, Vijay Mallya, Lalit Modi, Nirav Modi, Mehul
Choksi, Deepak Talwar, Sanjay Bhandari, Jatin Mehta, Prateek Jindal etc.),
fleeing the country to escape the clutches of law. The Parliament has therefore
enacted a new law, to deal with such offenders by confiscating the assets of
such persons located in India until they submit to the jurisdiction of the
appropriate legal forum.

 

In this Part 1
of the article, we have attempted to give an overview of some of important
aspects of The Fugitive Economic Offenders Act, 2018 [the FEO Act or the Act].

 

1.  INTRODUCTION


The FEO Bill, 2018
was introduced in the Lok Sabha on 12th March, 2018 but the same
could not be passed both the houses of parliament were prorogued on 6th
April, 2018.  Hence, the FEO Ordinance,
2018 was promulgated on 21st April, 2018 which came into force
immediately. The FEO Bill, 2018 was passed by Parliament on 25th
July, 2018 and received the assent of the President on 31st July,
2018. Section 1(3) of the FEO Act provides that it is deemed to have come in to
force w.e.f. 21st April, 2018 and section 26(1) repeals the FEO
Ordinance, 2018.

 

2. 
NEED AND RATIONALE FOR FEO ACT


2.1  After approval of the proposal of the Ministry
of Finance to introduce the Fugitive Economic Offenders Bill, 2018 in
Parliament, the Press Release dated 1st March, 2018, issued by the
Ministry of Finance, Government of India, explained the background of the FEO
Bill, 2018, as follows:

 

“Background

There have been
several instances of economic offenders fleeing the jurisdiction of Indian
courts, anticipating the commencement, or during the pendency, of criminal
proceedings. The absence of such offenders from Indian courts has several
deleterious consequences – first, it hampers investigation in criminal cases;
second, it wastes precious time of courts of law, third, it undermines the rule
of law in India. Further, most such cases of economic offences involve
non-repayment of bank loans thereby worsening the financial health of the
banking sector in India. The existing civil and criminal provisions in law are
not entirely adequate to deal with the severity of the problem. It is,
therefore, felt necessary to provide an effective, expeditious and
constitutionally permissible deterrent to ensure that such actions are curbed.
It may be mentioned that the non-conviction-based asset confiscation for
corruption-related cases is enabled under provisions of United Nations
Convention against Corruption (ratified by India in 2011). The Bill adopts this
principle. In view of the above context, a Budget announcement was made by
the Government in the Budget 2017-18 that the Government was considering to introduce
legislative changes or even a new law to confiscate the assets of such
absconders till they submit to the jurisdiction of the appropriate legal
forum.”

 

2.2  The Statement of Objects and Reasons of the
FEO Bill, provides as follows:

 

“Statement of objects and reasons


There have been several instances of economic
offenders fleeing the jurisdiction of Indian courts anticipating the
commencement of criminal proceedings or sometimes during the pendency of such
proceedings. The absence of such offenders from Indian courts has several
deleterious consequences, such as, it obstructs investigation in criminal
cases, it wastes precious time of courts and it undermines the rule of law in
India. Further, most of such cases of economic offences involve non-repayment
of bank loans thereby worsening the financial health of the banking sector in
India. The existing civil and criminal provisions in law are inadequate to deal
with the severity of the problem.


2.    In order to address the said problem and
lay down measures to deter economic offenders from evading the process of
Indian law by remaining outside the jurisdiction of Indian courts, it is
proposed to enact a legislation, namely, the Fugitive Economic Offenders Bill,
2018 to ensure that fugitive economic offenders return to India to face the
action in accordance with law.


3.    The said Bill, inter alia, provides for:
(i) the definition of the fugitive economic offender as an individual who has
committed a scheduled offence or offences involving an amount of one hundred
crore rupees or more and has absconded from India or refused to come back to
India to avoid or face criminal prosecution in India; (ii) attachment of the
property of a fugitive economic offender and proceeds of crime; (iii) the
powers of Director relating to survey, search and seizure and search of
persons; (iv) confiscation of the property of a fugitive economic offender and
proceeds of crime; (v) disentitlement of the fugitive economic offender from
putting forward or defending any civil claim; (vi) appointment of an
Administrator for the purposes of the proposed legislation; (vii) appeal to the
High Court against the orders issued by the Special Court; and (viii) placing
the burden of proof for establishing that an individual is a fugitive economic
offender on the Director or the person authorised by the Director.

4.    The Bill seeks to achieve the above
objectives.”

 

2.3  Shri Piyush Goyal, then holding charge as
Finance Minister explained the rationale for the FEOA in the Rajya Sabha debate
on 25th July, 2018, as under:

 

“Sir, there have been many instances of economic
offenders in last several decades, fleeing from the jurisdiction of the Indian
Courts, sometimes in anticipation of commencement of proceedings or sometimes
during the pendency of proceedings. Sir, you are not able to impound of those
leaving the country, except through due process of law. The current laws as
they stand today, have its own limitations in stopping people who flee the
country in anticipation or during the pendency of the proceedings. The absence
of such offenders from the Indian courts has very deleterious consequences. The
existing civil and criminal laws do not allow us to adequately deal with the
severity of the problem, since they are not available or present.

 

Criminal law
does not allow us to push in for punishment, impound their properties and deal
with their properties. Therefore, it was felt necessary to provide an
effective, expeditious and constitutionally permissible deterrent to ensure
that such people do not runaway or, if they runaway, confiscate their
properties. In this context, in the Budget for
2017-18, the hon’ble Finance Minister had announced the intention of the
Government to introduce legislative changes or even a new law to confiscate
assets of such absconders till they submit themselves before the jurisdiction
of the appropriate legal forum. We are not only confiscating their assets but
we are also providing how the confiscated property will be managed and disposed
of, so that dues of Government of India, State Governments and banks, etc., can
be recovered from them.”

 

2.4  The Preamble to the FEO Act
provides as follows:

 

“An Act to
provide for measures to deter fugitive economic offenders from evading the
process of law in India by staying outside the jurisdiction of Indian courts,
to preserve the sanctity of the rule of law in India and for matters connected
therewith or incidental thereto.”

 

2.5  On 30th November, 2018 in the
meeting at Buenos Aires, India suggested following Nine Point Agenda to G-20
for action against Fugitive Economic Offences and Asset Recovery:

 

1.    “Strong and active cooperation across
G-20 countries to deal comprehensively and efficiently with the menace fugitive
economic offenders.

2.    Cooperation in the legal processes such
as effective freezing of the proceeds of crime; early return of the offenders
and efficient repatriation of the proceeds of crime should be enhanced and
streamlined.

3.    Joint effort by G-20 countries to form a
mechanism that denies entry and safe havens to all fugitive economic offenders.

4.    Principles of United Nations Convention
Against Corruption (UNCAC), United Nations Convention Against Transnational
Organized Crime (UNOTC), especially related to “International Cooperation”
should be fully and effectively implemented.

5.    FATF should be called upon to assign
priority and focus to establishing international co-operation that leads to
timely and comprehensive exchange of information between the competent
authorities and FIUs.

6.    FATF should be tasked to formulate a
standard definition of fugitive economic offenders.

7.    FATF should also develop a
set of commonly agreed and standardized procedures related to identification,
extradition and judicial proceedings for dealing with fugitive economic
offenders to provide guidance and assistance to G-20 countries, subject to
their domestic law.

8.    Common platform should be set up for
sharing experiences and best practices including successful cases of
extradition, gaps in existing systems of extradition and legal assistance, etc.

9.    G-20 Forum should consider initiating
work on locating properties of economic offenders who have a tax debt in the
country of their residence for its recovery.”

 

2.6  From the above, it is apparent that the
government is making all possible efforts to compel the FEOs to submit
themselves before the jurisdiction of the appropriate legal forum.

 

3.  OVERVIEW OF THE ACT AND THE RULES


3.1  The FEO Act is divided in three Chapters
containing 26 sections and one Schedule listing the sections and description of
various offences.

 

3.2  Various rules have been made by the Central
Government for various matters for carrying out the provisions of the FEO Act.
The present list of rules is as follows:

 

Sr. No.

Particulars of the Rules

Effective Date

1.

Fugitive Economic Offenders (Manner of Attachment of Property) Rules,
2018

(Issued in suppression of the Fugitive
Economic Offenders (Issuance of Attachment Order) Rules, 2018 dated 24th
April, 2018 and Fugitive Economic Offenders (Issuance of Provisional
Attachment Order) Rules, 2018 dated 24th April, 2018.)

24th August, 2018

2.

Declaration of Fugitive Economic Offenders (Forms and Manner of Filing
Application) Rules, 2018

(Issued in suppression of the Fugitive
Economic Offenders (Application for Declaration of Fugitive Economic
Offenders) Rules, 2018 dated 24th April, 2018.)

24th August, 2018

3.

Fugitive Economic Offenders (Procedure for sending Letter of Request
to Contracting State) Rules, 2018.

(Issued in suppression of the Fugitive
Economic Offenders (Procedure for sending Letter of Request to Contracting
State for Service of Notice and Execution of Order of the Special Court)
Rules, 2018 dated 24th April, 2018.)

24th August, 2018

4.

Fugitive Economic Offenders (Procedure for Conducting Search and
Seizure) Rules, 2018

(Issued in suppression of the Fugitive
Economic Offenders (Forms, Search and Seizure and the Manner of Forwarding
the Reasons and Material to the Special Court) Rules, 2018 dated 24th
April, 2018.)

24th August, 2018

5.

Fugitive Economic Offenders (Manner and Conditions for Receipt and
Management of Confiscated Properties) Rules, 2018.

(Issued in suppression of the Fugitive
Economic Offenders (Receipt and Management of Confiscated Properties) Rules,
2018 dated 24th April, 2018.)

24th August, 2018

 

 

3.3  Some
Salient Features of the FEO Act

a.  
The FEO Act is deemed to have come into force on 21st April
2018 i.e. the date of issuance of the FEO Ordinance, 2018.

b.  
The FEO Act extends to whole of India including Jammu and Kashmir.

c.  
The Act provides for measures to deter fugitive economic offenders from
evading the process of law in India by staying outside the jurisdiction of
Indian courts, to preserve the sanctity of the rule of law in India and for
matters connected therewith or incidental thereto.

d.   
Section 3 of the FEO Act provides that the provisions of the Act apply
to any individual who is, or becomes a Fugitive Economic Offender [FEO] on or
after the date of coming into force of the Act i.e. 21st April,
2018.

e.  
Section 4(3) provides that the authorities appointed for the purposes of
the Prevention of Money-laundering Act, 2002 shall be the Authorities for the
purposes of the Act.

f.  
Section 18 provides that no civil court shall have jurisdiction to
entertain any suit or proceeding in respect of any matter which the Special
Court is empowered by or under the Act to determine and no injunction shall be
granted by any court or other authority in respect of any action taken or to be
taken in pursuance of any power conferred by or under the Act.

 

4.    FUGITIVE ECONOMIC OFFENDER [FEO]


4.1  The term ‘Fugitive Economic Offender’ or FEO
is the main stay of the FEO Act, as the Act provides for action against FEOs
and the significance of the definition of FEO cannot be undermined. Section
2(1)(f) of the Act defines the term FEO, as follows:

“(f) “fugitive
economic offender” means any individual against whom a warrant for arrest in
relation to a Scheduled Offence has been issued by any Court in India, who –

(i)    has left India so as to avoid criminal prosecution;
or

(ii)   being abroad, refuses to return to India to
face criminal prosecution;”

 

Thus, a person is
considered to be a FEO, if he satisfies the following conditions:

a)    He is an individual;

b)    a warrant for arrest in relation to a
Scheduled Offence has been issued by any Court in India against him;

c)    he is a fugitive i.e. he (i) has left India
so as to avoid criminal prosecution; or (ii) being abroad, refuses to return to
India to face criminal prosecution.

 

4.2  Only
an Individual to be declared as FEO

From the definition
in section 2(1)(f) and provisions of section 3 (Application of Act), section
4(1) (Application for declaration of FEO and procedure therefore), section
10(1) (Notice), section 11 (Procedure for hearing application) and section 12(1)
(Declaration of FEO), makes it abundantly clear that only an individual can be
declared as a FEO.

 

Thus, prima
facie, the provisions of the FEO Act should not have application to a
company or Limited Liability Partnership [LLP] or partnership firm or other
association of persons.

 

However, as an
exception, section 14 dealing with ‘Power to disallow civil claims’ provides
that on declaration of an individual as a FEO, any Court or Tribunal in India
in any civil proceeding before it may, disallow any company or LLP (as defined
in section 2(1)(n) of the LLP Act, 2008) from putting forward or defending any
civil claim, if such an individual is (a) filing the claim on behalf of the
company or the LLP, or (b) promoter or key managerial personnel (as defined in
section 2(51) of the Companies Act, 2013) or majority shareholder of the
company or (c) having a controlling interest in the LLP.

 

Section 12(2) of
the FEO Act provides that on declaration of an individual as a FEO, the Special
court may order that any of the following properties stand confiscated to the
Central Government (a) the proceeds of crime in India or abroad, whether or not
such property is owned by the fugitive economic offender; and (b) any other
property or benami property in India or abroad, owned by the fugitive economic
offender. The assets owned by LLPs in which the FEO having controlling interest
or Companies in which the FEO is promoter or key managerial personnel or
majority shareholder, can be confiscated only if it is established that such
LLP or Company is benamidar of the FEO or the property held by the company or
LLP represents proceeds of crime. Further, it appears that the courts can lift
the corporate veil in appropriate cases and rule that the property standing in
the name of the company or LLP is actually the property of the Individual FEO
and the same is liable for confiscation.

 

4.3  Warrant
of Arrest

For an individual
to be declared as a FEO, it is necessary that (a) a warrant of arrest has been
issued against him by a Court in India; (b) such warrant is in relation to a
Scheduled Offence, whether committed before or after the date of coming in to
force of the FEO Act i.e. 21-04-18; (c) it is immaterial whether the warrant
was issued before, on or after 21-04-18 as long as the same is pending on the
date of declaration as FEO; and (d) if the warrant of arrest stands withdrawn
or quashed as of the date of declaration as FEO, then the individual cannot be
declared a FEO.

 

4.4 
Fugitive

The term ‘fugitive’
has not been defined in the FEO Act. Concise Oxford Dictionary defines a
‘fugitive’ as
a person who has escaped from the captivity or is in hiding. To be considered a
FEO the individual should
have (a) has left India so as to avoid criminal prosecution; or (b) being
abroad, refuses to return to India to face criminal prosecution.

 

Section 11(1) of
the Act provides that where any individual to whom notice has been issued under
sub-section (1) of section 10 appears in person at the place and time specified
in the notice, the Special Court may terminate the proceedings under the Act.
Thus, if the alleged FEO returns to India at any time during the course of
proceedings relating to the declaration as a FEO (prior to declaration) and
submits to the appropriate jurisdictional court, the proceedings under the FEO
Act cease by law.

 

4.5  Procedure
to declare an individual as FEO

The FEO Act, inter
alia, provides for the procedure to declare an individual as FEO, which is
as follows:

 

(i)    Application of mind by the Director or other
authorised office to the material in his possession as to whether he has reason
to believe that an individual is a FEO.

(ii)   Documentation of reason for belief in
writing.

(iii)   Provisional attachment (without Special
Court’s permission) by a written order of an individual’s property (a) for
which there is reason to believe that the property is proceeds of crime, or is
a property or benami property owned by an individual who is a FEO; and (b)
which is being or is likely to be dealt within a manner which may result in the
property being unavailable for confiscation. In cases of provisional
attachment, the Director or any other officer who provisionally attaches any
property under this section 5(2) is required to file an application u/s. 4
before the Special Court, within a period of thirty days from the date of such
attachment.

(iv)  Making an application before the special court
for declaration that an individual is a FEO (Section 4);

(v)   Attachment of the property of a FEO and
proceeds of crime (Section 5);

(vi)  Issue of a notice by the special court to the
individual alleged to be a FEO (Section 10);

(vii)  Where any individual to whom notice has been
issued appears in person at the place and time specified in the notice, the
special court may terminate the proceedings under the FEO Act. (Section 11(1))

(viii) Hearing of the application for declaration as
FEO by the Special Court (Section 11);

(ix)  Declaration as FEO by Special Court by a
speaking order (Section 12);

(x)   Confiscation of the property of an individual
declared as a FEO or even the proceeds of crime (Section 12);

(xi)  Supplementary application in the Special Court
seeking confiscation of any other property discovered or identified which
constitutes proceeds of crime or is property or benami property owned by
the individual in India or abroad who is a FEO, liable to be confiscated under
the FEO Act (Section 13)

(xii)  Disentitlement of a FEO from defending any
civil claim (Section 14); and

(xiii) Appointment of an Administrator to manage and
dispose of the confiscated property under the Act
(Section 15).

 

4.6  Manner
of Service of notice

Section 10 dealing
with Notice, provides for two alternative prescribed mode of service of notice
on the alleged FEO: (a) through the contracting state (s/s. (4) and (5); and
(b) e-service.

 

Notice through Contract State

Section 2(1)(c) of
the Act defines Contracting State as follows:

“Contracting
State” means any country or place outside India in respect of which
arrangements have been made by the Central Government with the Government of
such country through a treaty or otherwise;”

 

Section 10(4)
provides that a notice under s/s. (1) shall be forwarded to such authority, as
the Central Government may notify, for effecting service in a contracting
State.

 

Section 10(5)
provides that such authority shall make efforts to serve the notice within a
period of two weeks in such manner as may be prescribed.

 

Service of notice
through the contracting state is possible only when alleged FEO is suspected or
known to be in a contracting state with which India has necessary arrangements
through a treaty or otherwise.

 

E-service of Notice

Section 10(6)
provides that a notice under s/s. (1) may also be served to the
individual alleged to be a FEO by electronic means to:

 

(a)   his electronic mail address submitted in
connection with an application for allotment of Permanent Account Number u/s.
139A of the Income-tax Act, 1961;

(b)   his electronic mail address submitted in
connection with an application for enrolment u/s. 3 of the Aadhaar (Targeted
Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016; or

(c)   any other electronic account as may be
prescribed, belonging to the individual which is accessed by him over the
internet, subject to the satisfaction of the Special Court that such account
has been recently accessed by the individual and constitutes a reasonable
method for communication of the notice to the individual.

 

4.7  India’s
First Declared FEO

As per the news
report appearing in the New Indian Express dated 19th January, 2019,
Mr. Vijay Mallya is the first businessman to be declared an FEO under the FEO
Act. In absence of the copy of the court’s order being available in public
domain as yet, the key points of the special court’s order, as appearing in the
text of the new report, is given for reference.

 

“Businessman
Vijay Mallya’s claim that the Indian government’s efforts to extradite him were
a result of “political vendetta” was “mere fiction of his
imagination”, a special PMLA court observed in its order.

Mallya, accused
of defaulting on loans of over Rs 9,000 crore, was on January 5 declared a
fugitive economic offender (FEO) by special Judge M S Azmi of the Prevention of
Money Laundering Act (PMLA) court.

 

The judge, in
his order that was made available to media Saturday, said, “Mere statement
that the government of India had pursued a political vendetta against him and
initiated criminal investigations and proceeding against him cannot be ground
for his stay in UK.”

 

Besides these
bare statements, there is nothing to support as to how the government of India
initiated investigation and proceedings to pursue political vendetta, the judge
said in his order.

 

“Hence the
arguments in these regards are mere fiction of his imagination to pose himself
as law-abiding citizen,” he added.

 

The court said
the date of Mallya leaving India was March 2, 2016, and on that day admittedly
there was offence registered by the Central Bureau of Investigation (CBI) and
the Enforcement Directorate (ED).

 

Mallya laid much stress on the fact that he went
to attend a motorsports council meeting in Geneva on March 4, 2016.

 

“Had it
been the case that he went to attend a pre-schedule meeting and is a
law-abiding citizen, he would have immediately informed the authorities about
his schedule to return to India after attending his meeting and
commitment,” Azmi observed.

 

Therefore, in
spite of repeated summons and issuance of warrant of arrest, he had not given
any fix date of return, therefore it would be unsafe to accept his argument
that he departed India only to attend a pre-schedule meeting, he said.

 

The judge stated
that the ED application cannot be read in “piece meal” and must be
read as whole.

 

The satisfaction
or the reasons to believe by ED that Mallya was required to be declared as an
FEO appears to be based upon the foundation that despite repeated efforts, he
failed to join investigation and criminal prosecution.

 

Even the efforts
taken by way of declaring him as a proclaimed offender have not served the
desired purpose, he added.

 

Azmi said the
intention of the FEO Act is to preserve the sanctity of the rule of law and the
expression “reason to believe” has to be read in that context.

 

The reasons
supplied by the ED were the amount involved – Rs 9,990 crore, which is more
than Rs 100 crore which is the requirement of the Act.

 

As pointed out,
the summons issued were deliberately avoided, the passport was revoked,
non-bailable warrants were issued and he was also declared a proclaimed
offender, the judge said.

 

These appear to
be sufficient reasons to declare him an FEO, the judge observed.

 

Mallya is the first businessman to be declared an
FEO under the FEO Act which came into existence in August 2018.

 

The ED, which
had moved the special court for this purpose, requested the court that Mallya,
currently in the United Kingdom, be declared a fugitive and his properties be
confiscated and brought under the control of the Union government as provided
under the act.”

 

The various factors
considered by the court, as mentioned in the news report above, are important
for consideration. The special court has rejected the arguments of (a) that the
Indian government’s efforts to extradite him were a result of “political
vendetta”; (b) that he departed India only to attend a pre-schedule
meeting; (c) satisfaction or the reasons to believe by ED that Mallya was
required to be declared as an FEO appears to be based upon the foundation that
despite repeated efforts, he failed to join investigation and criminal
prosecution; and (d) since the proceedings of his extradition had begun in UK
and with those underway, Mallya cannot be declared a Fugitive.

 

In this connection,
it would be pertinent to mention that the Westminster’s Magistrates’ Court,
London, UK in the case of The Govt of India vs. Vijay Mallya, dated 10th
December, 2018 after detailed examination of various issues raised in
respect of Govt of India’s Extradition Request in its 74 page Judgement
available in public domain, found a prima facie case in relation to three
possible charges and has sent Dr. Vijay Mallya’s case to the Home Secretary of
State for a decision to be taken on whether to order his extradition.

 

4.8  Applications
in Other Cases

In a recent new
report in Hindustan Times, it is mentioned 
that the Enforcement Directorate [ED] has also submitted applications to
have Jewellers Nirav Modi and Mehul Choksi declared fugitives under the FEO Act
after they left India, where they are accused in a Rs. 14,000 scam at Punjab
National bank. These applications are likely to be heard by the same special
court.

 

4.9  Appeals

Section 17 of the Act provides that an appeal shall lie from any
judgment or order, not being an interlocutory order, of a Special Court to the
High Court both on facts and on law.

Every appeal u/s.
17 shall be preferred within a period of 30 days from the date of the judgment
or order appealed from. The High Court may entertain an appeal after the expiry
of the said period of 30 days, if it is satisfied that the appellant had sufficient
cause for not preferring the appeal within the period of 30 days. However, no
appeal shall be entertained after the expiry of period of 90 days. The Bombay
High Court in the case Vijay Vittal Mallya vs. State of Maharashtra
(Criminal Appeal No. 1407 of 2018) vide order dated 22nd
November, 2018, while dismissing the Mallya’s appeal for stay of the
proceedings u/s. 4 of the FEO Act, held that for an appeal to lie against an
order of the special court, the said order would have to determine some right
or issue.

 

5.     CONCLUDING REMARKS


The FEO Act is a
huge step towards creating a deterrent effect for economic offenders and would
certainly help the government bring alleged fraudsters such as Vijay Mallya,
Nirav Modi, Mehul Choksi and such other offenders  to justice.

 

In Part 2 of the
Article we will deal with remaining other important aspects of the FEO Act and
the Rules.

DETERMINING THE LEASE TERM FOR CANCELLABLE LEASES

FACT PATTERN


A lease contract of a
retail outlet in a shopping mall allows for the lease to continue until either
party gives notice to terminate the contract. The contract will continue
indefinitely until the lessee or the lessor elects to terminate it and includes
stated consideration required during any renewed periods (referred to as
“cancellable leases” in the rest of the document). Neither the lessor nor the
lessee will incur any contractual cash payment or penalty upon exercising the
termination right. The lessee constructs leasehold improvements, which cannot
be moved to another premise. Upon termination of the lease, these leasehold
improvements will need to be abandoned, or dismantled if the lessor so
requests.

 

QUESTION


Can the lease term go
beyond the date at which both parties can terminate the lease (inclusive of any notice period)?

 

TECHNICAL DISCUSSION


View 1:
No. The lease term cannot go beyond the date where the lessee can enforce a
right to use the underlying asset, i.e. the end of the notice period. The
existence of economic penalties (eg; cost of shifting) does not create
enforceable rights and obligations.

The definition of “lease
term” in Ind AS 116 refers to lessee’s rights and reads as follows:

 

The
non-cancellable period for which a lessee has the right to use an underlying
asset, together with both:

 

a)  Periods covered by an option to extend the
lease if the lessee is reasonably certain to exercise that option; and

b)  Periods covered by an option to
terminate the lease if the lessee is reasonably certain not to exercise that
option.

 

B34 of Ind AS 116 contains
further guidance and states:

 

In
determining the lease term and assessing the length of the non-cancellable
period of a lease, an entity shall apply the definition of a contract and
determine the period for which the contract is enforceable. A lease is no
longer enforceable when the lessee and the lessor each has the right to
terminate the lease without permission from the other party with no more than
an insignificant penalty.

 

Appendix A of Ind AS 116
clarifies that the word “contract” is defined in other standards and
used in Ind AS 116 with the same meaning, i.e. “an agreement between two or
more parties that creates enforceable rights and obligations”.

 

For example, paragraphs 10
and 11 of Ind AS 115 include the following more detailed guidance about “contracts”:

 

10. A contract is an
agreement between two or more parties that creates enforceable rights and
obligations. Enforceability of the rights and obligations in a contract is a
matter of law. Contracts can be written, oral or implied by an entity’s
customary business practices. The practices and processes for establishing
contracts with customers vary across legal jurisdictions, industries and
entities. In addition, they may vary within an entity (for example, they may
depend on the class of customer or the nature of the promised goods or
services). An entity shall consider those practices and processes in
determining whether and when an agreement with a customer creates enforceable
rights and obligations.

 

11. Some
contracts with customers may have no fixed duration and can be terminated or
modified by either party at any time. Other contracts may automatically renew
on a periodic basis that is specified in the contract. An entity shall apply
this Standard to the duration of the contract (ie the contractual period) in
which the parties to the contract have present enforceable rights and
obligations.

 

Both B34 and the definition
of a contract in Appendix A of Ind AS 116 is cross-referenced to BC127 in the
Basis of Conclusions of IFRS 16, specifically deals with “cancellable leases”
as follows:

 

Cancellable
leases

For the
purposes of defining the scope of IFRS 16, the IASB decided that a contract
would be considered to exist only when it creates rights and obligations that
are enforceable. Any non-cancellable period or
notice period in a lease would meet the definition of a contract and, thus,
would be included as part of the lease term. To be part of a contract, any
options to extend or terminate the lease that are included in the lease term
must also be enforceable; for example the lessee must be able to enforce its
right to extend the lease beyond the non-cancellable period. If optional
periods are not enforceable, for example, if the lessee cannot enforce the
extension of the lease without the agreement of the lessor, the lessee does not
have the right to use the asset beyond the non-cancellable period.
Consequently, by definition, there is no contract beyond the non-cancellable
period (plus any notice period) if there are no enforceable rights and
obligations existing between the lessee and lessor beyond that term. In
assessing the enforceability of a contract, an entity should consider whether
the lessor can refuse to agree to a request from the lessee to extend the
lease.

 

This conclusion is entirely
consistent with a “right-of-use model” based on recognising and measuring the
rights that the lessee controls and has had transferred to it by the lessor.
Including a renewal which the lessee cannot enforce without the agreement of
the lessor would unduly recognise in the right of use optional periods that do
not meet the definition of an asset. Even if the lessee has a significant economic
incentive to continue the lease, this does not turn a period subject to the
lessor’s approval into an asset because the lessee does not control the
lessor’s decision, unless the lessor’s termination right lacks substance. This
is a very high hurdle, which would be expected to be extremely rare and require
objective evidence.

 

View 2:
Yes, the lease term go beyond the date at which both parties can terminate the
lease.

 

Supporters of view 2
believe that an entity should evaluate the relevant guidance in the standard.
In considering the guidance in the standard, View 1 believes Ind AS 116 is
clear the lease term cannot be longer than the period in which the contract is
enforceable. However, Ind AS 116 is equally clear that a contract is
enforceable until both parties could terminate the contract with no more than
an insignificant penalty – which may be a period beyond the termination notice
period.

 

In the fact pattern above,
while the lease can be terminated early by either party after serving the
notice period, the enforceable rights in the contract (including the pricing
and terms and conditions) contemplate the contract can continue beyond the
stated termination date, inclusive of the notice period. In the fact pattern
above, there is an agreement which meets the definition of a contract (i.e., an
agreement between two or more parties that create enforceable rights and
obligations). However, the mere existence of mutual termination options does
not mean that the contract is automatically unenforceable at a point in time
when a potential termination could take effect.

 

Ind AS 116.B34 provides
explicit guidance on when a contract is no longer enforceable:

 

“A lease
is no longer enforceable when the lessee and the lessor each has the right to
terminate the lease without permission from the other party with no more than
an insignificant penalty.”

 

Therefore, when either
party has the right to terminate the contract with no more than insignificant
penalty there is no longer an enforceable contract. However, when one or both
parties would incur a more than insignificant penalty by exercising its right
to terminate – the contract continues to be enforceable. The penalties should
be interpreted broadly to include more than simply cash payments in the
contract. The wider interpretation considers economic disincentives.

 

While the IFRS16.BC127 does
not discuss the notion of “no more than insignificant penalty”, supporters of
View 2 believe that Ind AS116.B34 should be evaluated based on the wording in
the standard (i.e., taking into account the economic disincentives for the
parties). To the extent that the lessee has a more than insignificant economic
disincentives (e.g., significant leasehold investments) to early terminate the
lease, the 2nd sentence in B34 will not be applicable. However, on
the other hand, if one or both parties have only insignificant economic
disincentives to terminate, say, after five years, the lease is not considered
enforceable after five years and hence the lease term cannot exceed five years.
Ind AS116.B34 does not directly provide guidance as to how long the lease term
should be. Rather, it provides guidance as to when a contract is no longer
enforceable and thus no longer exists.

 

While Ind AS 116.B34 and
B35 provide guidance on evaluating the period in which a contract continues to
be enforceable and how to evaluate lessee and lessor termination options, they
do not address how to evaluate the lease term once the enforceable period of
the contract has been determined (i.e., at least until both parties no longer
have a more than insignificant penalty if they were to terminate the contract).
To determine the lease term, the parties would apply Ind AS 116.18-19 and
B37-40 (i.e., the reasonably certain threshold). “Reasonably certain” is a high
threshold and the assessment requires judgement. It also acknowledges the
guidance in Ind AS 116.B35 which indicates lessor termination options are
generally disregarded (“If only a lessor has the right to terminate a lease,
the non-cancellable period of the lease includes the period covered by the
option to terminate the lease.”)

Thus, in this fact pattern
above, it is possible that the lease term may exceed the notice period. The
lease term is the non-cancellable (notice) period together with the period
covered by the termination option that it is reasonably certain the lessee will
not exercise such termination option.

 

However, the lease term
cannot be no longer than the period the contract is enforceable (i.e., the
point in time in which either party may terminate the lease without permission
from the other with no more than an insignificant economic disincentive,
inclusive of any notice period). 

 

If the facts were different
and the contract had an end date but contemplates the lease might be extended
if both the lessee and lessor agree to new terms and conditions (including new
pricing) there may be no enforceable contract but rather an invitation to enter
into new negotiations.

 

In light of the compelling
arguments in both views, the author recommends that the Ind AS Transition
Facilitation Group (ITFG) should address this issue in consultation with the
IASB staff or IFRIC.

 

 

 

REOPENING CASES OF INTIMATION u/s. 143(1)

ISSUE FOR CONSIDERATION


Section 147 of the Income Tax Act, 1961
provides for reassessment of income which has escaped assessment for any
assessment year. The section reads as under:

 

“Income Escaping Assessment

If the Assessing Officer has reason to
believe that any income chargeable to tax has escaped assessment for any
assessment year, he may, subject to the provisions of sections 148 to 153,
assess or reassess such income and also any other income chargeable to tax
which has escaped assessment and which comes to his notice subsequently in the
course of the proceedings under this section, or recompute the loss or the
depreciation allowance or any other allowance, as the case may be, for the
assessment year concerned (hereafter in this section and in sections 148 to 153
referred to as the relevant assessment year) :

 

Provided that where an assessment under
sub-section (3) of section 143 or this section has been made for the relevant
assessment year, no action shall be taken under this section after the expiry
of four years from the end of the relevant assessment year, unless any income
chargeable to tax has escaped assessment for such assessment year by reason of
the failure on the part of the assessee to make a return under section 139 or
in response to a notice issued under sub-section (1) of section 142 or section
148 or to disclose fully and truly all material facts necessary for his
assessment, for that assessment year:”

 

The issue of applicability of the above
referred  proviso to section 147 has come
up before the courts in cases where no assessment has been made u/s. 143(3),
but merely an intimation has been issued u/s. 143(1). In other words, in cases
where more than 4 years have expired from the end of the relevant assessment
year, is the A.O. required to satisfy and establish that there was a failure on
the part of the assessee  to disclose
fully and truly all material facts necessary for the assessment for a valid
reopening of the case? While the Madras High Court has taken the view that
the  proviso applies even in cases of
intimation u/s. 143(1) and the A.O  is
required to establish that there was a failure to disclose material facts
before reopening a case, the Gujarat High Court has taken a contrary view that
the  proviso applies only in the case of
assessments u/s. 143(3). 

 

EL FORGE’S CASE


The issue came up before the Madras High
Court in the case of EL Forge Ltd vs. Dy CIT 45 taxmann.com 402.

 

In this case, an intimation was issued u/s.
143(1) on 31st December, 1991 for assessment year 1989-90. The
assessing officer thereafter noticed that the assessee had claimed deduction
u/s. 80HH and 80-I on the total income before set off of unabsorbed losses of
earlier years. Therefore, as the assessing officer was of the view that the
assessee was not entitled to deduction under chapter VI-A, reassessment proceedings
were initiated u/s. 147 and a notice was issued u/s. 148 on 15th
December, 1997.

 

The assessee objected to the reopening of
the assessment, contending that as the reopening was made after a lapse of 4
years from the end of the assessment year, and as there was no failure on the
part of the assessee to disclose all material facts necessary for making the
assessment, the reopening was not valid.

 

The Commissioner (Appeals) rejected the
assessee’s claim and dismissed the appeal, holding that the reopening of the
assessment by the assessing officer was perfectly in order. The Tribunal held
that the assessee did not disclose fully and truly all material facts, and
therefore agreed with the finding of the assessing officer as well as the
Commissioner (Appeals). It held that the reopening of the assessment was
justified, as it was well within the period provided for under the proviso to
section 147.

 

Before the Madras High Court, besides  pointing 
out on behalf of the assessee that the notice u/s. 147 did not give any
independent reasons for reopening of assessment u/s. 147,  it was argued that the details of the income
computation were very much before the assessing officer. The assessee therefore
claimed that the assessing officer had not shown that there was a failure to
disclose material facts necessary for assessment.

 

The Madras High Court observed that the
facts of the case showed that there was no denial of the fact that the assessee
had disclosed details of carry forward of the losses as well as the computation
of income, and that these details were very much before the assessing officer.
It observed that there was no denial of the fact that there was no failure on
the part of the assessee in disclosing the facts necessary for assessment, and
there was no allegation that the escapement of income was on account of failure
of the assessee to disclose fully and truly all material facts for assessment.

 

Applying the decision of the Supreme Court
in Kelvinator’s case, the Madras High Court accepted the argument of the
assessee that the assumption of jurisdiction beyond four years was hit by the
limitation provided under the proviso to section 147. The Madras High Court
therefore allowed the appeal of the assessee.

 

LAXMIRAJ DISTRIBUTORS’ CASE


The issue again came up before the Gujarat
High Court in the case of Pr CIT vs. Laxmiraj Distributors (P) Ltd 250
Taxman 455.

 

In this case, the assessee, a company, had
filed its return of income for assessment year 2009-10 on 13th
September, 2009. The return was accepted and an intimation was issued u/s.
143(1). Subsequently, a survey was carried out on the premises of the company.
During the course of such survey, several documents were seized and a statement
of a director of the company was recorded on 30th August, 2012.

 

The assessee also wrote a letter on 4th
September, 2012 to the assessing officer, in which it stated that the company
had verified its records for various years, that it might  not be possible to substantiate certain
issues and transactions recorded in the regular books of account as required by
law, as it would take a lot of time and effort, and that it would like to avoid
protracted litigation. To avoid litigation and penalty and to buy peace, the
company stated that it would voluntarily disclose an amount of Rs. 9 crore as
it’s undisclosed income, comprising of Rs. 7.52 crore for assessment year
2009-10 towards share capital reserves and Rs. 1.48 crore for assessment year
2013-14 towards estimated profit for the year of survey. In such letter,
details of the companies to which 7.52 lakh shares were allotted with premium
of Rs. 6.77 crore were given.

 

In spite of such letter, the company did not
offer such income to tax. The assessing officer therefore issued notice on 13th
February, 2013 u/s. 148, to reopen the assessment for assessment year 2009-10.
The reason recorded for such reassessment was that the income disclosed as a
result of survey at Rs. 7.52 crore was over and above the income of Rs. 78.47
lakh returned in the original return of income.

 

In reassessment proceedings, an addition of
Rs. 7.52 crore as bogus share capital was made. The Commissioner (Appeals)
rejected the assessee’s appeal.

 

The ground of
validity of the notice of reopening was raised before the Tribunal for the
first time. The Tribunal permitted raising of such ground, since it touched
upon the very jurisdiction of the assessing officer to reassess the income.

 

The Tribunal held that reopening of
assessment was bad in law, and therefore it did not enter into the question of
correctness of the additions. The Tribunal referred to the Supreme Court
decisions in the case of ITO vs. Lakhmani Mewal Das 103 ITR 437, and Asst
CIT vs. Rajesh Jhaveri Stock Brokers (P) Ltd 291 ITR 500, and the decision
of the Gujarat High Court in the case of Inductotherm (India) (P) Ltd vs. M
Gopalan, Dy CIT 356 ITR 481, and proceeded to annul the reassessment on the
ground that the formation of belief by the assessing officer that income
chargeable to tax had escaped assessment was erroneous  on account of the fact that there was no
corroborative evidence casting doubts on the assessee’s share capital received
up to the date of issue of the notice of reopening. According to the Tribunal, the
basic tenet of cause effect relationship between the reasons for reopening and
the taxable income having escaped assessment was not made out by the assessing
officer.

 

The Gujarat High Court observed that, in the
case of Rajesh Jhaveri Stock Brokers (P) Ltd (supra), the Supreme Court
highlighted a clear distinction between assessment under section 143(1) and
assessment made by the assessing officer after scrutiny u/s. 143(3). Such  distinction was noticed in the background of the
notice of reassessment where the return of the assessee was accepted u/s.
143(1). The Supreme Court had observed that, in the scheme of things, the
intimation u/s. 143 (1) could not be treated to be an order of assessment, and
that being the position, the question of change of opinion did not arise. The
Gujarat High Court further observed that the ratio of the decision was
reiterated in a later judgement of the Supreme Court in the case of Dy CIT
vs. Zuari Estate Development & Investment Co Ltd 373 ITR 661.

 

The Gujarat High Court also referred to its
decision in the case of Inductotherm (supra), where the court observed
that even in case of reopening of an assessment where the return was accepted
without scrutiny, the requirement that the assessing officer had reason to
believe that income chargeable to tax had escaped assessment, would apply.

 

The Gujarat High Court further referred to
the Supreme Court decision in the case of Lakhmani Mewal Das (supra),
where it had been held that the reasons for the formation of the belief contemplated
by section 147 for the reopening of an assessment must have a rational
connection or relevant bearing on the formation of the belief. Rational
connection postulated that there must be a direct nexus or live link between
the material coming to the notice of the assessing officer and the formation of
his belief that there had been escapement of the income of the assessee from
assessment.

 

Culling out the ratio of those decisions,
the Gujarat High Court stated that what broadly emerged was that there was a
vital distinction between the reopening of an assessment where the return of an
assessee had been accepted u/s. 143 (1) without scrutiny, and where the
scrutiny assessment had been  framed.
According to the Gujarat High Court, in the former case, the assessing officer
could not be stated to have formed any opinion, and therefore, unlike in the
latter case, the concept of change of opinion would have no applicability. The
common thread that would run through both sets of exercises of reopening of assessment
was that the assessing officer must have reason to believe that income
chargeable to tax had escaped assessment.

 

Looking at the facts of the case and the
observations of the Tribunal, the Gujarat High Court observed that the Tribunal
had evaluated the evidence on record in minutest detail, as if each limb of the
assessing officer’s reasons recorded for issuing notice of reassessment was in
the nature of an addition made in assessment order, which had either to be
upheld or reversed, which, according to the High Court, was simply
impermissible.

 

The Gujarat High Court referred to the
decision of the Delhi High Court in the case of Indu Lata Rangwala vs. Dy
CIT 384 ITR 337, where the Delhi High Court had taken the view that where
the return initially filed was processed u/s. 143(1), there was no occasion for
the assessing officer to form an opinion after examining the documents enclosed
with the return. In other words, the requirement in the first proviso to
section 147 of there having to be a failure on the part of the assessee “to
disclose fully and truly all material facts” did not at all apply whether the
initial return had been processed u/s. 143(1). In that case, the Delhi High
Court had taken the view that it was not necessary in such a case for the
assessing officer to come across some fresh tangible material to form reasons
to believe that income had escaped assessment.

 

The Gujarat
High Court thereafter considered the decision of the Madras High Court in the
case of EL Forge (supra) and expressed its inability to concur with the
view of the Madras High Court in the said case where it held that the condition
that there was a failure to disclose the material facts for the purposes of
assessment was required to be satisfied even in cases of intimation issued u/s.
143(1). According to the Gujarat High Court, the proviso to section 147 would
apply only in a case where  an assessment
had been framed after scrutiny. In a case where the return was accepted u/s.
143(1), the additional requirement that income chargeable to tax had escaped
assessment on account of the failure on the part of the assessee to disclose
truly and fully all material facts, would simply not apply. According to the
Gujarat High Court, the decision of the Supreme Court in Kelvinator’s
case did  not apply, to the facts of the
case before the court, as that was a case in which the original assessment was
framed after scrutiny.

 

The Gujarat High Court therefore allowed the
appeal of the revenue, quashing the conclusion of the Tribunal that the notice
of reopening of assessment was invalid.

 

OBSERVATIONS


Reading the proviso  in the manner, as is read by the  Gujarat High Court, would mean that in all
cases of the intimation u/s. 143(1) where other things are equal, the time
limit for reopening gets automatically extended to six years from the end of
the assessment year and that the requirement to satisfy the disclosure test has
to be met with only in cases of assessment u/s. 143(3) and is otherwise  dispensed with in  cases of intimation u/s. 143(1). On a reading
of the Proviso this does not appear to be the case and even on the touchstone
of common sense  there appears to be a
case that the requirement to satisfy the disclosure test should not be
restricted to section 143(3) cases only. A failure by the AO to initiate the
proceedings u/s. 143(2) and again under the main provisions of section 147,
within the time prescribed under the respective provisions can not be remedied
by resorting to the reading of the proviso in a convenient manner that
gives  a license to the AO to reopen a
case even after a lapse of a  long time
and deny the finality to the proceedings in cases where there otherwise is not
a failure to disclose the material on the part of the assessee. Such an
understanding is strongly supported by the overall scheme of the Income tax
Act.     

 

In cases where the assesssee has disclosed
the material facts and the AO has failed to have a prima facie look into
the facts, in time, and fails to pursue the matter appropriately, within the
prescribed time, it is reasonable to hold that his power to reopen a case comes
to an end irrespective of the fact that the assessment was not made u/s.
143(3).

 

Even otherwise, it is not unreasonable to
hold that in cases where the assessee has made an adequate disclosure of facts,
then the same are deemed to have been considered by the AO and therefore his
inaction, within the prescribed time, should be construed to be a case of a
change of opinion.  

 

It is difficult to appreciate that the
standards that are applicable to the cases covered by section 143(3) are not
applied to cases covered by section 143(1) for no fault of the assessee  more so when the assessee has no control over
the action or inaction of the AO. It is not the assessee who prevented the AO
from scrutinising the return of income. In fact, permitting the AO to have a
longer time than it is prescribed is giving him a premium for his inefficiency
of not having acted within the time when he should have.

 

The decision of the Gujarat High Court in Laxmiraj’s
case, is the one delivered on very peculiar facts involving an admission by the
assessee firm at the time of survey and not following it us with the offer for
tax in spite of admitted facts that were not denied by the assessee later on at
the time of even reassessment. The SLP file by the assessee against the
decision has been rejected by the Supreme Court 95 taxxmann.com
109(SC). 

 

The Madras High Court  in case of TANMAC India vs. Dy.CIT  78 taxmann.com 155 (Mad.)  held 
that if after issuing intimation u/s. 143(1) of the Act, the Assessing
Officer did not issue notice of scrutiny assessment u/s. 143(2) of the Act, it
would not be open for the Assessing Officer thereafter to resort to reopening
of the assessment. The High Court in deciding the case placed heavy reliance on
the decision of Delhi High Court in case of CIT vs. Orient Craft Ltd. 354
ITR 536 in which the distinction between scrutiny assessment and a
situation where return has been accepted u/s. 143(1) was narrowed down. The
Court had applied the concept of true and full disclosure even in case of
reopening assessment where return was accepted u/s. 143(1) of the Act.

 

It seems that the excessive reliance on the
ratio of the Supreme Court cases in Rajesh Jhaveri Stock Brokers’ case
(supra) and Zuari Estate & Investment Co.‘s  case (supra) requires a fresh
consideration and perhaps was uncalled for. The issue in those  cases has been about whether there could be a
change of opinion in a case where an intimation u/s. 143(1) was issued and
whether there was a  need to have the
reason to believe that income has escaped income in such cases of intimation
and whether an intimation was different form an order.  The issue under consideration, namely, the
application of the first proviso to section 147 was not an issue before
the  court in both the cases. It is
respectfully submitted that in the below quoted part of the decision, the
Supreme Court inter alia held that the condition of the First Proviso to
section 147 were required to be satisfied for a valid reopening of a case
involving even an intimation issued u/s. 143(1) of the Act.   

 

“The scope and effect of section
147 as substituted with effect from 1-4-1989, as also sections 148 to 152 are
substantially different from the provisions as they stood prior to such
substitution. Under the old provisions of section 147, separate clauses (a) and
(b) laid down the circumstances under which income escaping assessment for the
past assessment years could be assessed or reassessed. To confer jurisdiction
under section 147(a) two conditions were required to be satisfied firstly the
Assessing Officer must have reason to believe that income profits or gains
chargeable to income tax have escaped assessment, and secondly he must also
have reason to believe that such escapement has occurred by reason of
either  omission or failure on the part
of the assessee to disclose fully or truly all material facts necessary for his
assessment of that year. Both these conditions were conditions precedent to be
satisfied before the Assessing Officer could have jurisdiction to issue notice
under section 148 read with section 147(a). But under the substituted section
147 existence of only the first condition suffices. In other words if the
Assessing Officer for whatever reason has reason to believe that income has
escaped assessment it confers jurisdiction to reopen the assessment. It is
however to be noted that both the conditions must be fulfilled if the case
falls within the ambit of the proviso to section 147.”  The disclosure of
the material facts is a factor that can not be ignored even in the case of
intimation simply because the first proviso expressly refers only to the order
of assessment u/s. 143(3). It appears that the last word on the subject has yet
to be said and sooner the same is said by the Supreme Court, is better. 

 

Rectification of mistake – Debatable issue –Adjusting the business loss against capital gain in terms of provisions of section 71(1) of the Act –View once allowed by the AO could not be rectified by him if the issues is debatable. [Section 154]

1.     3.  
Pr.CIT-6 vs. Creative
Textile Mills Pvt. Ltd. [Income tax Appeal no 1570 of 2016 Dated: 13th February, 2019 (Bombay High Court)]


[Creative Textile Mills Pvt. Ltd vs.
ACIT-6(2); dated 28th October, 2015; ITA. No 7480/Mum/2013, AY : 2005-06,
Bench:C  Mum. ITAT]

 

Rectification
of mistake – Debatable issue –Adjusting the business loss against capital gain
in terms of provisions of section 71(1) of the Act –View once allowed by the AO
could not be rectified by him if the issues is debatable. [Section 154]

 

The
assessee is engaged in the business of Processing, Manufactures and Export of
Readymade Garments & Fabric, filed its return of income on 30.10.2005
declaring total loss of Rs. 4,37,23,576/-. The assessment order was passed on
31.12.2007 declaring total loss of Rs. 2,29,98,454/-. However, the AO made a
rectification of the assessment order u/s. 154 of the I.T. Act in its order on
the pretext that computation of loss has not been adjusted against the capital
gain and that excess loss has been allowed to the assessee and thus a sum of
Rs. 1,82,65,501/- was added on account of LTCG, against which an appeal was filed
before the CIT(A) on the ground, the order u/s. 154 was bad in law, void, ab
initio and was impermissible under the law.However, the ld. CIT(A) upheld
the order of AO.

 

Being aggrieved with the CIT(A) order, the assessee filed an appeal to
the ITAT. The Tribunal held that the assessee relied upon the judgment in case
of T.S.Balaram, ITO vs. Vokart Brothers & Others 82 ITR 50 (SC)
wherein it was held “that mistake apparent from the record must be an obvious
and patent mistake and not something which can be established by a long drawn
process and of reasoning on points on which there may be conceivably two
opinions. A decision on a debatable point of law is not a mistake apparent from
the record. The Ld AR further relied upon the cases of CIT vs. Victoria
Mills Ltd. [153 ITR 733], CIT vs. British Insulated Calender’s Ltd. [202
ITR 354], Addl. Second ITO vs. C.J. Shah [10 ITD 151 (TM)] and DCIT
vs. Shri Harshavardan Himatsingka [ITA No. 1333 to 1335/Kol/2012] (Bom. High
Court). In DCIT (Kol.) vs. Harshavardan Himatsingka, it was held
that the order passed by the AO u/s. 154 of the Act adjusting the business loss
against capital gain in terms of provisions of section 71(1) of the Act,
wherein assessee is entitled to carry forward the business loss without
adjusting the same from capital gain or the same is mandatory required to be
adjusted. It was further held by co-ordinate bench that this aspect of
provision of section 71(1) of the Act is also a subject matter of dispute and
there are case law both in favour and against the said proposition as
canvassed. Hence issue is debatable cannot be said that there was a mistake
apparent on record which could be rectified u/s. 154 of the Act, hence the
order passed by AO u/s. 154 of the Act is not sustainable. It was  further seen that in the regular assessment,
certain disallowance/additions were made by the AO which was deleted by ld.
CIT(A) in further appeal and the appeal filed by the department against the
order of CIT(A) has also been dismissed by the Tribunal and the case had
already travelled up to the ITAT till then no such interference was drawn at
the time of regular assessment or during the appellate stage. In view of the
above, ITAT held that  the order passed
by the AO u/s. 154 which was subsequently upheld by CIT(A) is void, ab
initio and the same is liable tobe set-aside and is not permissible under
the law.

 

Being aggrieved with the
ITAT order, the Revenue filed an appeal to the High Court. The Court held that
sub-section (1) of section 71 of the Act provides that where in respect of any
assessment year the net result of the computation under any head of income
other than “capital gains’ is a loss and the assessee has no income under the
head ‘capital gains’ he shall, subject to the provisions of this Chapter, be
entitled to have the amount of such loss set off against his income, if any,
assessable for that assessment year under any other head. This provision came
up for consideration before this Court in the case of Commissioner of Income
Tax vs. British Insulated Calendar’s Ltd. [202 ITR 354] in which it was
held that under sub-section (1) of section 71 of the Act the assessee has no
option in setting off the business loss against the heads of other income as
long as there was no capital gain during the year under consideration. The case
of the assessee does not fall under sub-section (1) of section 71 of the Act
since the assessee had declared capital gain. Such a situation would be covered
by subsection (2) of section 71 of the Act which reads as under;

“(2) Where in respect
of any assessment year, the net result of the computation under any head of
income, other than “Capital gains”, is a loss and the assessee has income
assessable under the head “Capital gains”, such loss may, subject to the
provisions of this Chapter, be set off against his income, if any, assessable
for that assessment year under any head of income including the head “Capital
gains” (whether relating to short-term capital assets or any other capital
assets)”.

 

In case of British
Insulated Calender’s (supra) this Court had in respect to sub-section 2 of
section 71 observed that “

in case of the assessee
declaring capital gain, he had an option to set off the business loss, whereas
no such option is given for sub-section (1)”. Before the High Court, of course,
the provision of sub-section 2 of section 71 of the Act was somewhat different
and the expression “ or, if the assessee so desires, shall be set off only
against his income, if any, assessable under any head of income other than
‘capital gains’” has since been deleted. Nevertheless, the question that would
arise is, whether even in the unamended form sub-section (2) of section 71 of
the Act mandates the assessee to set off its business loss against the capital
gains of the same year when this provision used an expression “may” as compared
to the expression “shall” used in s/s. (1).

 

In the present case, the Hon’ble Court was  not called upon to judge the correctness of
interpretation of either the revenue or the assessee. However the court
observed that issue  was far from being
clear. It was clearly debatable. In this position, the A.O, as per the settled
law, could not have exercised the rectification powers. The Income Tax Appeal
was dismissed.   

 

 

Section 45 – Capital gains – Non-compete clause – Transfer of business – Amount is liable to be bifurcated and apportioned – Attributed to the non- compete clause is revenue receipts and remaining was to be treated as the capital receipt taxable as capital gains.

1.    2.   
Pr CIT-17 vs. Lemuir Air
Express [ ITA no 1388 of 2016 Dated: 6th February, 2019 (Bombay High
Court)]

 

[ACIT-12(3)
vs. Lemuir Air Express; dated 9th October, 2015 ; ITA. No
3245/Mum/2008, AY : 2004-05 Bench: G 
Mum.  ITAT ]

 

Section
45 – Capital gains – Non-compete clause – Transfer  of 
business – Amount is liable to be bifurcated and apportioned –
Attributed to the non- compete clause is revenue receipts and remaining was to
be treated as the  capital receipt
taxable as capital gains.

 

The
assessee is a partnership firm. The assessee was engaged in the business as
custom house agent, as also an air cargo agent. The activities of the assessee
would involve assisting the clients in air freight, forwarding for export etc.
During the year, the assessee transferred its business of international cargo
to one DHL Danzar Lemuir Pvt Ltd (“DHL” for short) as a going concern
for consideration of Rs. 54.73 crore. The assessee offered such receipt to tax
as capital gain. The A O did not accept this stand of the assessee. He noticed
that in the deed of transfer of business, there was a clause that the assessee
would not involve into carrying on the same business. According to the A.O,
therefore, in view of such non-compete clause in the agreement, the receipt could
be the assessee’s income in terms of section 28(va) of the Act and
consequentially taxable under the head ‘Profits and Gains of Business and
Profession’.

 

The
assessee carried the matter in appeal. The CIT(A) was of the opinion that the
entire sum of Rs. 54.73 crore was not paid for non-compete agreement. He
apportioned the total consideration into two parts namely a sum of Rs. 4.5
crore was attributed to the non-compete clause, the rest i.e Rs. 50.23 crore
(after deducting costs) was treated as the assessee’s capital receipt taxable
as capital gains. On this apportionment, the CIT(A) arrived at after taking
into consideration the profit of the firm for last two years from said
business.

 

Revenue
carried the matter in appeal before the Tribunal. The Tribunal, by the impugned
judgment, upheld the view of the CIT(A) inter alia observing that the
assessee had under the agreement in question transferred the entire business
and the non-compete clause was merely consequent to the transfer of business.

 

Being aggrieved with the
ITAT order, the revenue filed an appeal to the High Court. The Court observed
that the entire sale consideration of Rs. 54.73 crore could never have been
attributed to the non-compete clause contained in such agreement. The CIT(A)
applied logical formula to arrive at the apportionment between the value for
the sale of business and of non-compete clause in the agreement. No perversity
is pointed out in this approach of the CIT(A). The assessee which was engaged
in highly specialised business, transferred the entire business for valuable
consideration. Non-compete clause in such agreement was merely a part of the
understanding between the parties. What purchaser received under such agreement
was entire business of the assessee along with non-compete assurance. We notice
that Clause (va) of section 28 pertains to any sum whether received or
receivable, in cash or kind, under an agreement, inter alia for not carrying
out any activity in relation to any business or profession. A non-compete agreement
would therefore fall in this clause. Proviso to said Clause (va), however,
provides that the said clause would not apply, to any sum whether received or
receivable, in cash or kind, on account of transfer of right to manufacture,
produce or process any article or thing or right to carry on any business or
profession which is chargeable under the head Capital Gains. The assessee’s
receipt attributable to the transfer of business was correctly taxed by the
CIT(A) as confirmed by the Tribunal as giving rise to capital gain. It was only
residual element of receipt relatable to the non-compete agreement which was
brought within fold of Clause (va) of section 28 of the Act. In the result, the
appeal was dismissed.

 

Section 68 – Cash credits – Share application money – Identity, genuineness of transaction and creditworthiness of persons from whom assessee received funds – Allegation by AO about evasion of tax without any supporting evidence, is not justified.

1.  1.    
The Pr. CIT-1 vs. Pushti
Consultants Pvt Ltd [Income tax Appeal no 1332 of 2016 Dated: 6th February, 2019 (Bombay High Court)]. 

 

[Pushti
Consultants Pvt Ltd vs. DCIT-1(2); dated 23rd March, 2015 ; ITA. No
4963/Mum/2012, AY 2008-09, Bench : C , Mum. 
ITAT ]

 

Section
68 – Cash credits – Share application money – Identity, genuineness of
transaction and creditworthiness of persons from whom assessee received funds –
Allegation by AO about evasion of  tax
without any supporting evidence, is not justified.

During
the course of the scrutiny proceedings, the A.O noticed that the assessee had
received share application money of Rs. 2.20 crore during the year under
assessment. The assessee substantiated its claim of share application money of
Rs. 2.20 crore received from Speed Trade Securities Pvt Ltd (“STSPL”
for short) by filing Board resolution and a letter from STSPL. The assessee
also filed details consequent to the summons issued u/s. 131 of the Act to the
director of STSPL. However, the A.O was not convinced with the same on the
ground that the board resolution of STSPL mentions that it will pay 50% of the
share application money i.e Rs. 2.20 crore and if the balance 50% of share
application money is not paid before 30.9.2008, the amount paid as share application
money will stand forfeited by the assessee. The A.O noted that STSPL has
sufficient funds to the extent of Rs. 14.33 crore available with it on
31.3.2009 (the extended period within which the balance amount of the share
application money has to be paid). In spite of having such huge funds at its
disposal, STSPL has allowed its investment to go in waste and claim loss in its
profit and loss account.

 

The A.O held that the
entire act of obtaining share application money and having it forfeited was an attempt
to evade tax. Thus, AO came to the conclusion that the share application money
was in fact the assessee’s own funds which were introduced under the garb of
share application money. Therefore,made an addition of Rs. 2.20 crore to
assessee’s income.

 

Being
aggrieved by the order of the A.O, the assessee filed an appeal to the CIT(A).
The CIT(A) dismissed the appeal upholding the view of the A.O and inter alia
placing reliance upon a decision of the Apex Court in the case of McDowell
& Co Ltd vs. Commercial Tax Officer1 (1985) 154 ITR 148 (SC) as being
applicable to the  facts of this case,
thus, dismissing the assessee’s appeal.

 

On
further appeal of the assessee, the Tribunal held that the evidence on record
established the identity, capacity and genuineness of the share application
money received from STSPL. This is on the basis of the fact that the amounts
were received through proper banking channels, the ledger accounts, bank
statement and audited annual accounts of STSPL were also submitted which
supported the case of the assessee. Further the valuation report/certificate of
a Chartered Accountant to the effect that the valuation of shares would be Rs.
20.83 per share and therefore, the receipt of share application money at the aggregate
price of Rs. 20 i.e Rs. 10 as face value and Rs. 10 as premium was perfectly in
order. It also recorded the fact that the application money had been paid by
STSPL by selling its own investments/shares in the stock exchange through its
broker Satco Securities and Financial Ltd (Satco) and had received the money
from Satco for sale of its investments/shares. The statement of Bank of Baroda,
the banker of Satco reflected the payments to STSPL for sale of its own
investments/shares of stock exchange was also produced. In the aforesaid view,
the impugned order held that the investment of Rs. 2.20 crore by STSPL on the
basis of evidence on record was established, as the identity, capacity and
genuineness stood proved. In the above view, the impugned order allowed the
assessee’s appeal.

 

Being
aggrieved with the ITAT order, the Revenue filed an appeal to the High Court.
The Court held that the assessee has gone beyond the requirement of the law as
existing in the subject assessment year 2008-09 by having explained the source
in terms of section 68 of the Act. Besides, the reliance by the CIT (A) on the
decision of McDowell (supra) is not applicable to the facts of the
present case. The Apex Court in decisions in the cases of Union of India
& Anr. vs. Azadi Bachao Andolan & 
Anr2 and Vodafone International Holdings 2 (2003) 263 ITR 706
(SC) B.V. vs. Union of India & Anr.3 also held that principles laid
down in the case of McDowell (supra) is not applicable across the board
to discard an act which is valid in law upon some hypothetical assessment of
the real motive of the assessee. Thus, imputing a plan on the part of the
assessee and STSPL to evade tax without any supporting evidence in the face of
the detailed facts recorded by the impugned order of the Tribunal, is not
justified. We find that the impugned order of the Tribunal being essentially a
finding of fact which is not shown to be perverse does not give rise to any
substantial of law. Hence, not entertained. Accordingly, the appeal is
dismissed.

 

Section 40A(2)(b) and 92BA – Specified domestic transactions – Determination of arm’s length price – Meaning of “specified domestic transactions” – Section 92BA applies to transactions between assessee and a person referred to in section 40A(2)(b) – Assessee having substantial interest in company with whom it has transactions – Beneficial ownership of shares does not include indirect shareholding – Amount paid to acquire asset – Not an expenditure covered by section 40A(2)(b)

6.      
HDFC Bank Ltd. vs. ACIT; 410
ITR 247 (Bom): Date of order: 20th December, 2018 A. Y.: 2014-15

 

Section
40A(2)(b) and 92BA – Specified domestic transactions – Determination of arm’s
length price – Meaning of “specified domestic transactions” – Section 92BA
applies to transactions between assessee and a person referred to in section
40A(2)(b) – Assessee having substantial interest in company with whom it has
transactions – Beneficial ownership of shares does not include indirect
shareholding – Amount paid to acquire asset – Not an expenditure covered by
section 40A(2)(b)

 

By an
order dated 29/12/2016, the Assessing Officer held that three transactions were
specific domestic transactions and referred the case to the Transfer Pricing
Officer for determining arms length price. The three transactions were, loans
of Rs. 5,164 crore purchased by the assessee from the promoters (HDFC) and
loans of Rs. 27.72 crore purchased from the subsidiaries, payment of Rs. 492.50
crore by the assessee to HBL for rendering services and payment of interest of
Rs. 4.41 crore by the assessee to HDB trust. The assessee filed a writ petition
and challenged the order.

 

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

 

“i)   The assessee purchased the
loans of HDFC of more than Rs. 5,000 crore. HDFC admittedly held 16.39% of the
shareholdings in the assessee. If one were to go merely by  this figure of 16.39% then, on a plain
reading of section 40A(2)(b)(iv) read with Explanation (a) thereto, HDFC would
not be a person who would have a substantial interest in the assessee. However,
the Revenue contended that the requirement of Explanation (a) of having more
than 20% of voting power is clearly established in the case because HDFC held
100% of the shareholding  in another
company which in turn held 6.25% of shareholding in the assesee. When one
clubbed the shareholding of HDFC of 16.39% with the shareholding of the other
company of 6.25%( and which was a wholly owned subsidiary of HDFC) the
threshold of 20% as required under Explanation (a) to section 40A(2)(b) was
clearly crossed.

ii)   HDFC on its own was not the
beneficial owner of shares carrying at least 20% of the voting power as
required under Explanation (a) to section 40A(2)(b). The Revenue was incorrect
in trying to club the shareholding of the subsidiary with the shareholding of
HDFC, in the assessee, to cross the threshold of 20% as required in Explanation
(a) to section 40A(2)(b). HDFC did not have a substantial interest in the
assesee, and therefore, was not a person contemplated u/s. 40A(2)(b)(iv) for
the present transaction to fall within the meaning of a specified domestic
transaction as set out in section 92BA(i).

iii)   Moreover the assessee had
purchased the loans of HDFC. This was  a
purchase of an asset.  This transaction
of purchase of loans by the assessee from HDFC would not fall within the
meaning of a specified domestic transaction.

iv)  As far as the second
transaction was concerned, the assessee held 29% of the shares in ADFC. In
turn, ADFC held 94% of the shares in HBL. The assessee held no shares in HBL.
The assessee could not be regarded as having a substantial interest in HBL.

v)   It was not the case of the
Revenue that the assessee was entitled to at least 20% of the profits of the
trust. The trust had been set up exclusively for the welfare of its employees
and there was no question of the assessee being entitled to 20% of the profits
of such trust. This being the case, this transaction clearly would not fall
within 40A(2)(b) read with Explanation (b) thereto to be a specific domestic
transaction as understood and covered by section 92BA(i).

vi)  None of the three
transactions that formed the subject matter of this petition fell within the
meaning of a specified domestic transaction as required u/s. 92BA(i) of the
Income-tax Act. This being the case, the Assessing Officer was clearly in error
in concluding that these transactions were specified domestic transactions and
therefore required to be disclosed by the assessee by filing form 3CEB. He
therefore could not have referred these transactions to the Transfer Pricing
Officer for determining the arms length price.”

 

 

 

Sections 69 and 147 – Reassessment – Where Assessing Officer issued a reopening notice on ground that assessee had made transactions of huge amount in national/multi commodity exchange but he had not filed his return of income and assessee filed an objection that he had earned no income out of trading in commodity exchange and he had actually suffered loss and, therefore, he had not filed return of income. Since, Assessing Officer had not looked into objections raised by assessee and proceeded ahead, impugned reassessment notice was unjustified

5.      
Mohanlal Champalal Jain vs.
ITO; [2019] 102 taxmann.com 293 (Bom): Date of order: 31st January, 2019 A.  Y.: 2011-12

 

Sections
69 and 147 – Reassessment – Where Assessing Officer issued a reopening notice
on ground that assessee had made transactions of huge amount in national/multi
commodity exchange but he had not filed his return of income and assessee filed
an objection that he had earned no income out of trading in commodity exchange
and he had actually suffered loss and, therefore, he had not filed return of
income. Since, Assessing Officer had not looked into objections raised by
assessee and proceeded ahead, impugned reassessment notice was unjustified

 

The
assessee, an individual was engaged in trading in commodity exchange. On the
premise that he had no taxable income, the assessee had not filed return of
income for the relevant assessment year. An information was received by the
Assessing Officer that as per NMS data and its details the assessee had made
transactions of Rs. 18.82 crore in national /multi commodity exchange. Further,
it was seen that the assessee had not filed his return of income. The Assessing
Officer concluded that profit/gain on commodity exchange remained unexplained
and also the source of investment in these transactions remains unexplained.
Therefore, the income chargeable to tax had escaped assessment within the
meaning of provisions of section 147 as no return of income has been filed by
the assessee.

 

The
assessee raised an objection that he had earned no income out of trading in
commodity exchange. He pointed out that the assessee’s sales turnover was Rs.
16.82 crore (rounded off) and he actually suffered a loss of Rs. 1.61 crore.
The Assessing Officer, however, rejected the objections. With respect to the
assessee’s contention of no taxable income, he stated that the same would be
subject to verification and further inquiry.

 

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

 

“i)   The Assessing Officer has
proceeded on wrong premise that even when called upon to state why the
petitioner had not filed return of income, he had not responded to the said
query. The petitioner did communicate to the department that he had no taxable
income and therefore, there was no requirement to file the return. The
Assessing Officer did not carry out any further inquiry before issuing the
impugned notice. In the reasons, one more error pointed out by the petitioner
is that the Assessing Officer referred to the sum of Rs. 18.82 crore as total
transaction in the commodities. In the petition as well as in the objections
raised before the Assessing Officer, the petitioner pointed out that his sales
were to the tune of Rs.16.82 crore against purchases of Rs. 16.84 crore and
thereby, he had actually suffered a loss.

ii)   The Assessing Officer has not
discarded these assertions. Importantly, if the Assessing Officer had access to
the petitioner’s sales in commodities, he could as well have gathered the
information of his purchases. Either on his own or by calling upon the
petitioner to provide such details, the Assessing Officer could and ought to
have verified at least prima facie that the income in the hands of the
petitioner chargeable to tax had escaped assessment. In the present case, what
the Assessing Officer aiming to do so is to carry out fishing inquiry. In fact,
even when the assessee brought such facts and figures to his notice, the
Assessing Officer refused to look into it.

iii)   In the result, the impugned
notice is quashed and set aside.”

Sections 12AA, 147 and 148 – Charitable Trust – Cancellation of registration – Section 12AA amended in 2004 enabling cancellation of registration is not retrospective – Cancellation cannot be made with retrospective effect Reassessment – Notice u/s. 148 consequent to cancellation of registration – No allegation of fraud – Notice not valid

4.      
Auro Lab vs. ITO; 411 ITR
308 (Mad): Date of order: 23rd January, 2019 A. Ys.: 2004-05 to 2007-08

 

Sections 12AA, 147 and 148 – Charitable Trust –
Cancellation of registration –  Section
12AA amended in 2004 enabling cancellation of registration is not retrospective
– Cancellation cannot be made with retrospective effect

 

Reassessment – Notice u/s. 148 consequent to cancellation
of registration – No allegation of fraud – Notice not valid

 

The
assessee, a charitable trust, was granted registration by the Commissioner u/s.
12A of the Income-tax Act, 1961, as it stood prior to the year 1996 with
medical relief as the main object of the trust. The returns of income were
assessed periodically by the Department and assessment orders passed year after
year until the  amendment to section 12AA
was introduced to specifically to empower the proper officer to cancel the
registration granted under the erstwhile section 12A of the Act. Subsequent to
the amendment, by an order dated 30/12/2010, the registration granted to the
assessee was cancelled on the allegation that the assessee failed to fulfil the
conditions required for enjoying the exemption available to the assessee
registered u/s. 12A. The Tribunal upheld the cancellation. Assessee preferred
appeal to the High Court which was pending. In the meanwhile, the Assessing
officer issued notices u/s. 148 of the Act and reopened the assessments for the
A. Ys. 2004-05 to 2007-08. The assessee’s objections were rejected. The
assessee filed writ petitions and challenged the validity of reopening.

 

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

 

“i)   Until 2004, when section 12AA of the
Income-tax act 1961 was amended, there was no power under the Act to the
Commissioner or any other authority to revoke or cancel the registration once
granted to charitable trusts. Later, on June 1, 2010, by the Finance Act, 2010,
section 12AA(3) was further amended to include specifically registration
granted under the erstwhile section 12A of the Act also within the ambit of
revocation or cancellation as contemplated u/s. 2004 amendment.

ii)   The powers of the Commissioner u/s. 12AA are
neither legislative nor executive but are essentially quasi-judicial in nature
and, therefore, section 21 of the General Clauses Act is not applicable to
orders passed by the Commissioner u/s. 12AA. Section 12AA(3) is prospective and
not retrospective in character. The cancellation of registration will take
effect only from the date of the order or notice of cancellation of
registration.

iii)   The cancellation of the registration would
operate only from the date of the cancellation order, that is December 30,
2010. In other words, the exemption u/s. 11 could not be denied to the assessee
for and upto the A. Y. 2010-11 on the sole ground of cancellation of the
certificate of the registration.

iv)  Unless the assessee had obtained registration
by fraud, collusion or concealment of any material fact, the registration
granted could never be alleged to be a nullity. It was evident that fact of the
cancellation of the registration triggered the reassessment proceedings and
evidently formed the preamble of each of the orders. And clearly, there was no
allegation of fraud or misdeclaration on the part of the assessee and the
Department was candid in confessing that the certificate was granted
erroneously. Therefore, reopening the assessment for the past years on account
of  the cancellation order dated December
30, 2010, in the case of the assessee by the Assessing Officer  was not permissible under the law and the
proceedings relating to the A. Ys. 2004-05 to 2007-08 were liable to be
quashed. Also, the assessment order relating to the A. Y. 2010-11 disallowing
exemption on the basis of cancellation order dated December 30, 2010, was
liable to be quashed.”

 

Section 68 – Cash credits – Capital gain or business income – Profits from sale of shares – Genuineness of purchase accepted by Department – Profits from sale cannot be treated as unexplained cash credits – Profit from sale of shares to be taxed as short/long term capital gains

3.      
Principal CIT vs. Ramniwas
Ramjivan Kasat; 410 ITR 540 (Guj):Date of order: 5th June, 2017 A. Y.: 2006-07

 

Section
68 – Cash credits – Capital gain or business income – Profits from sale of
shares – Genuineness of purchase accepted by Department – Profits from sale
cannot be treated as unexplained cash credits – Profit from sale of shares to
be taxed as short/long term capital gains

 

For the A.
Y. 2006-07, the Assessing Officer made additions to the income of the assessee
u/s. 68 of the Income-tax Act, 1961 on the ground that the assessee had sold
certain shares and the purchasers were found to be bogus. The second issue
was  in respect of the treatment of the
income earned by the assesse on the sale of shares. The assesse contended that
the shares were in the nature of his investment and the income earned to be
treated as long term capital gains. The Department contended that looking to
the pattern of holding the shares, the frequency of transactions and other
relevant considerations, the assessee was trading in shares and the income was
to be taxed as business income.

 

The
Commissioner (Appeals) dismissed the appeal filed by the assessee. The Tribunal
found that the purchase of the shares was made during the month of April, 2004
and they were sold in the months of May, June and July, 2005, that the
purchases thus made during the Financial Year 2004-05 had been accepted in the
relevant A. Y. 2005-06 and that in the assessment made u/s. 143(3) r.w.s. 147
the purchases of the shares were accepted as genuine. The Tribunal therefore
held that no additions could have been made u/s. 68 when the shares were in the
later years sold and deleted the addition. On the second issue, the Tribunal
took the relevant facts into consideration and referred to the circular dated
29/02/2016, of the CBDT and held that the income was to be taxed as capital
gains, be it long term or short term, as the case might be, and not as business
income.

 

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

 

“i)   Circular dated 29/02/2016, issued by the CBDT
provides that in respect of listed shares and securities held for a period of
more than 12 months immediately preceeding the date of their transfer, if the assessee
desires to treat the income arising from the transfer thereof as capital gains
that shall not be disputed by the Assessing Officer and the Department shall
not pursue the issue if the necessary ingredients are satisfied, the only rider
being that the stand taken by the assessee in a particular year would be
followed in the subsequent years also and the assessee would not be allowed to
adopt a contrary stand in such subsequent years.

ii)   The circular dated 29/02/2016 applied to the
assessee. The Tribunal was right in deleting the addition made u/s. 68 upon
sale of shares when the Department had accepted the purchases of the shares in
question as genuine and in holding that the share transaction as investment and
directing the Assessing Officer to treat the sum as short/long term capital
gains and not business income.”

 

Bank – Valuation of closing stock – Securities held to maturity – Constitute stock-in-trade – Valuation at lower of cost or market value – Proper – Classification in accordance with Reserve Bank of India guidelines – Not relevant for purposes of income chargeable to tax

2.      
Principal CIT vs. Bank of
Maharashtra; 410 ITR 413 (Bom): Date of order: 27th February, 2018 A. Y.: 2005-06

 

Bank – Valuation
of closing stock – Securities held to maturity – Constitute stock-in-trade –
Valuation at lower of cost or market value – Proper – Classification in
accordance with Reserve Bank of India guidelines – Not relevant for purposes of
income chargeable to tax

 

The
assessee claimed that the held-to-maturity securities constituted
stock-in-trade and were to be valued at cost or market value whichever was
less. The Assessing Officer disallowed the claim on the ground that the
assessee had shown the value at cost for earlier assessment years and therefore
it could not change the valuation. The Commissioner upheld the decision of the
Assessing Officer. The Tribunal held that irrespective of the basis adopted for
valuation in earlier years, the assessee had the option to change the method of
valuation of its closing stock to the lower of cost or market value provided
the change was bonafide and followed regularly thereafter, that the
held-to-maturity securities were held by the assessee as stock-in-trade and that
the receipts therefrom were business income.

 

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

 

“The order
of the Tribunal to the effect that the securities held to maturity were
stock-in-trade and the income on sales had been offered to tax as business
income, was correct. Merely because the Reserve Bank of India guidelines
directed a particular treatment to be given to a particular asset that would
not necessarily hold good for the purposes of income chargeable to tax.”

Section 260A – Appeal to High Court – Power of High Court to condone delay in filing appeal – Delay in filing appeal by Revenue – General principles – No reasonable explanation for delay – Delay cannot be condoned

1.   CIT vs. Lata Mangeshkar
Medical Foundation; 410 ITR 347 (Bom): Date of order: 1st
March, 2018 A. Ys.: 2008-09 and 2009-10

                                         

Section
260A – Appeal to High Court – Power of High Court to condone delay in filing
appeal – Delay in filing appeal by Revenue – General principles – No reasonable
explanation for delay – Delay cannot be condoned

 

Revenue
filed notice of motion for condonation of delay of 318 days in filing appeal.
The Bombay High Court dismissed the notice of motion and held as under:

 

“i)   Section 260A(2A) of the Income-tax Act, 1961
allows the Court to admit an appeal beyond the period of limitation, if it is
satisfied that there was sufficient cause for not filing the appeal in time. It
cannot be accepted that in appeal by the Revenue, the delay has to be condoned,
if large amounts are involved, on payment of costs. Each case for condonation
of delay would have to be decided on the basis of the explanation offered for
the delay, i.e., is it bona fide or not, concocted or not or does it evidence
negligence or not. The object of the law of limitation is to bring certainty
and finality to litigation. This is based on the maxim “interest reipublicae ut
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. Therefore, merely because the respondent does not appear,
it cannot follow that the applicant is bestowed with a right to the delay being
condoned. The officers of the Revenue should be well aware of the statutory
provisions and the period of limitation and should pursue its remedies
diligently.

ii)   There was no proper explanation for the delay
on the part of the applicant. In fact, the affidavit dated 16/09/2017 stated
that, the applicant handed over the papers to his subordinate, i.e., the Deputy
Commissioner. This was also put in as one of the reasons for the delay. This
even though they appeared to be a part of the same office. In any case, the
date on which it was handed over to the Deputy Commissioner was not indicated.
Further, the affidavit dated 16/09/2017 also did not explain the period of time
during which the proposal was pending before the Chief Commissioner of
Income-tax, Delhi for approval. The Chief Commissioner of Income-tax was also
an officer of the Department and there was 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 was no attempt to explain it. The
applicant being a senior officer of the Revenue would undoubtedly be conscious
of the fact that the time to file  the
appeal was running against the Revenue and there must be an averment in the application
of the steps he was taking to expedite the approval process. Further, there was
no proper explanation for the delay after having received the approval from the
Chief Commissioner at Delhi on May 29, 2017. No explanation was offered in the
affidavits dated 16/09/2017 and for having filed the appeal on July 20, 2017,
i.e., almost after two months. The delay could not be condoned.”

 

Article 7 of India-Singapore DTAA – No further profit attribution to an Indian agency PE where the commission is paid at arm’s length.

4.      
TS-74-ITAT-2019(Mum) Hempel Singapore
Pte Ltd. vs. DCIT A.Y.: 2014-15 Date of Order: 8th
February, 2019

 

Article 7 of India-Singapore DTAA – No
further profit attribution to an Indian agency PE where the commission is paid
at arm’s length.

 

FACTS


Taxpayer, a foreign company incorporated in
Singapore, was engaged in the business of selling protective coating/paints for
marine industry. Taxpayer had appointed its wholly owned subsidiary in India (I
Co) as a sales agent for rendering sales support services in India. For such
services I Co was remunerated at cost plus mark-up as commission on sales
effected in India. There was no dispute on the ground that I Co constituted
dependent agency PE (DAPE) for the Taxpayer in India under Article 5(4) of
India-Singapore DTAA.

 

Taxpayer contended that the cost plus mark
up to I Co was at arm’s length. Further, since the income attributable to the
DAPE in India was equal to the commission paid to I Co, the resultant income in
India was NIL.

 

AO, however computed an ad hoc amount
of 25 percent of sales in India as the income attributable to the DAPE in
India. Thus, the difference between such income and commission paid to ICo was
held as taxable in India.

 

The DRP affirmed the order of the AO.

 

Aggrieved, Taxpayer appealed before the
Tribunal.

 

HELD

  •    A foreign company is liable
    to be taxed in India on so much of its business profits as is attributable to
    its PE in India.
  •    The commission paid by the
    Taxpayer to I Co was accepted to be at arm’s length in the transfer pricing
    analysis of I Co for the relevant year.
  •    Further, once the commission
    is accepted to be at arm’s length in the hands of the agent, a different view
    cannot be taken in the case of non-resident principal who pays the commission
    to the agent. This principle has been enunciated by Delhi High Court in the
    case of DIT vs. BBC Worldwide Ltd.3
  •    If basis the transfer
    pricing analysis undertaken, the remuneration paid to the Indian agent is held
    to be at an arm’s length, there is no need to attribute further profits to the
    agency PE. The above principle has been confirmed by the Hon’ble Supreme Court
    in the case of Morgan Stanley & Co. Inc4  and the Hon’ble Bombay High Court in the case
    of SET Satellite Singapore Pte Ltd5. For this purpose, it is
    of no relevance if the transfer pricing analysis of the commission paid is done
    in the hands of the agent and not the principal.       

 

 

 

 

3.    ITA Nos. 1341 of
2010 & ors. dated 30.09.2011

4.  292 ITR 416

5.  (2008) 307 ITR 205

 

 

Section 2(15) r.w.s. 10(23C) – Where assessee was conducting various skill training programmes for students to get placement, activities would fall within definition of education u/s. 2(15), thus entitling it for exemption u/s. 10(23C)(iiiab)

22  [2019] 199 TTJ (Del) 922 Process-cum-Product
Development Centre vs. Additional CIT ITA No. 3401 to
3403/Del/2017 A.Y.s: 2010-11 to 2013-14 Date of order: 4th
February, 2019

 

Section 2(15) r.w.s.
10(23C) – Where assessee was conducting various skill training programmes for
students to get placement, activities would fall within definition of education
u/s. 2(15), thus entitling it for exemption u/s. 10(23C)(iiiab)

 

FACTS

The assessee society was engaged in imparting education
and in the same process trained students by sending them to sports industries,
etc. It conducted various short-duration training programmes of computer
training, training in Computer Accounting System, cricket bat manufacturing,
carom board manufacturing, training in R/P workshop, wood workshop, etc. The
assessee got raw material from industries and after manufacturing the goods
through its trainees, returned the finished goods after receiving its job charges.
The assessee claimed exemption u/s. 10(23C)(iiiab). The AO declined the
exemption on the ground that the assessee did not exist solely for educational
purposes.

 

Aggrieved, the assessee preferred an appeal to the CIT(A).
The CIT(A) also declined the exemption and recorded further in his order that
the issue of charitable activities of the assessee society being of charitable
nature was not relevant in the instant case as the assessee was yet to be
registered u/s. 12AA.

 

HELD

The Tribunal held that the main objects of the assessee
society were to be examined. The AO had relied upon the decision rendered by
the Supreme Court in the case of Sole Trustee Loka Shikshak Trust vs. CIT
[1975] 101 ITR 234 wherein the word ‘education’ as referred in section
2(15) was explained. The Supreme Court had categorically held that ‘education’
connoted the process of training and developing the knowledge, skill, mind and
character of students by normal schooling.

 

When the training imparted to the students was not to
produce goods of world standard by doing necessary marketing research and by
identifying products for domestic and export market, such training would be of
no use and the students who had been given training would not be in a position
to get placement. Examination of the audited income and expenditure account of
the assessee society showed that substantial income was from training courses
and there was a minuscule income from job receipts.

 

The
assessee society was admittedly getting raw material from various industries to
produce sport goods for them and the job charges paid by them were again used
for running the training institute, therefore it could not be said by any
stretch of the imagination that the assessee society was not being run for
educational / training purpose. The word ‘education’ was to be given wide
interpretation which included training and developing the knowledge, skill,
mind and character of the students by normal schooling. So, the assessee
society was engaged in imparting training to the students in manufacturing
sport goods and leisure equipments without any profit motive.

 

Further,
the exemption sought for by the assessee society u/s. 10(23C)(iiiab) was
independent of exemption being sought by the assessee u/s. 12AA. So, the
exemption u/s. 10(23C)(iiiab) could not be declined on the ground that
registration u/s. 12A had been rejected. The assessee society, substantially
financed by the Government of India, was engaged only in imparting
research-based education / skill training to the students in manufacturing of
sports goods and leisure equipments without any profit motive, to enable them
to get placement; this fell within the definition of education u/s. 2(15),
hence it was entitled for exemption u/s. 10(23C)(iiiab).

 

Section 148 – Mere reliance on information received from Investigation Wing without application of mind cannot be construed to be reasons for reopening assessment u/s. 148

21 [2019] 70 ITR (Trib.) 211
(Delhi) M/s. Key Components (P) Ltd.
vs. the Income Tax Officer ITA. No.366/Del./2016 A.Y.: 2005-2006 Date of order: 12th
February, 2019

 

Section 148 – Mere
reliance on information received from Investigation Wing without application of
mind cannot be construed to be reasons for reopening assessment u/s. 148

 

FACTS

The assessee’s case was reopened on the basis of
information received from the Investigation Wing of the Income-tax Department
that the assessee company has taken accommodation entries. The assessee
objected to the reopening; however, the AO completed the assessment after
making an addition of undisclosed income on account of issue of share capital.
The assessee challenged the reopening of the assessment as well as the addition
on merits before the Commissioner (Appeals). The CIT(A), however, dismissed the
appeal of the assessee on both grounds. Aggrieved, the assessee preferred an
appeal on the same grounds to the Tribunal.

 

HELD

The
Tribunal observed that in this case the AO has merely reproduced the
information which he received from the Investigation Wing, in the reasons
recorded u/s. 148 of the Act. He has neither gone through the details of the
information nor has he applied his mind and merely concluded that the
transaction SEEMS not to be genuine, which indicates that he has not recorded
his satisfaction. These reasons are, therefore, not in fact reasons but only
his conclusion, that, too, without any basis. The AO has not brought anything
on record on the basis of which any nexus could have been established between
the material and the escapement of income. The reasons fail to demonstrate the
link between the alleged tangible material and formation of the reason to
believe that income has escaped assessment, the very basis that enables an
officer to assume jurisdiction u/s. 147.

 

The
Tribunal remarked, “Who is the accommodation entry giver is not mentioned. How
can he be said to be ‘a known entry operator’ is even more mysterious.”

 

In
coming to the conclusion, the Tribunal discussed the following decisions at
length:

 

1.    Pr. CIT vs. Meenakshi Overseas Pvt. Ltd. [395
ITR 677] (Del.)

2.    Pr. CIT vs. G&G Pharma India Ltd. (2016)
[384 ITR 147] (Del.)

3.     Pr. CIT vs. RMG Polyvinyl (I) Ltd. (2017)
[396 ITR 5] (Del.)

4.    M/s. MRY Auto Components Ltd. vs. ITO – ITA.
No. 2418/Del./2014, dated 15.09.2017

5.    Signature Hotels Pvt. Ltd. vs. Income-tax
Officer Writ Petition (Civil) No. 8067/2010 (HC)

6.    CIT vs. Independent Media Pvt. Limited – ITA
No. 456/2011 (HC)

7.    Oriental Insurance Company Limited vs.
Commissioner of Income-tax [378 ITR 421] (Del.)

8.    Rustagi Engineering Udyog (P) Limited vs.
DCIT W.P. (C) 1293/1999 (HC)

9.    Agya Ram vs. CIT – ITA No. 290/2004 (Del.)

10.  Rajiv Agarwal vs. CIT W.P. (C) No. 9659 of
2015 (Del.)

 

Section 234E – In case of default in filing TDS statement for a period beyond 1st June, 2015, fees u/s. 234E cannot be levied for the period before 1st June, 2015

20 [2019] 70 ITR (Trib.) 188 (Jaipur) Shri Uttam Chand Gangwal vs.
The Asst. CIT, CPC (TDS), Ghaziabad ITA No. 764/JP/2017 A.Y.: 2015-16 Date of order: 23rd
January, 2019

 

Section
234E – In case of default in filing TDS statement for a period beyond 1st
June, 2015, fees u/s. 234E cannot be levied for the period before 1st
June, 2015

 

FACTS

The assessee filed TDS statement in Form 26Q for Q4 of
F.Y. 2014-15 on 22nd July, 2015 for which the due date was 15th
May, 2015. The TDS statement was processed and the ACIT, TDS issued an
intimation dated 30th July, 2015 u/s. 200A of the Act imposing a
late fee of Rs. 13,600 u/s. 234E of the Act for the delay in filing the TDS
statement. On appeal, the Learned CIT(A) confirmed the said levy. The assessee
therefore filed an appeal to the Tribunal.

 

HELD

The Tribunal observed that though the quarterly statement
pertains to the quarter ended 31st March, 2015, the fact remains
that there is a continuing default even after 1st June, 2015 and the
statement was actually filed on 22nd July, 2015. It further observed
that an assessee who belatedly filed the TDS statement even though pertaining
to the period prior to 1st June, 2015 cannot be absolved from levy
of late fee when there is a continuous default on his part even after that
date. The Tribunal, therefore, concluded that, irrespective of the period to
which the quarterly statement pertains, where the statement is filed after 1st
June, 2015, the AO can levy fee u/s. 234E of the Act.

 

At the same time, in terms of determining the period for
which fees can be levied, the only saving could be that for the period of delay
falling prior to 1st June, 2015, there could not be any levy of fees
as the assumption of jurisdiction to levy such fees has been held by the Courts
to be prospective in nature. However, where the delay continues beyond 1st
June, 2015, the AO is well within his jurisdiction to levy fees u/s. 234E for
the period starting 1st June, 2015 to the date of actual filing of
the TDS statement. In the result, the Tribunal partly allowed the assessee’s
appeal by deleting fees for the period prior to 1st June, 2015 and
confirmed the fees levied for the subsequent period.

Section 154 – Non-consideration of decision of Jurisdictional High Court or of the Supreme Court can be termed as ?mistake apparent from the record’ which can be the subject matter of rectification application u/s. 154 even if not claimed earlier by the assessee during assessment proceedings or appellate proceedings

19 [2019] 71 ITR (Trib.) 141 (Mumbai) Sharda Cropchem Limited vs.
Dy. Comm. of Income Tax ITA No. 7219/Mum/2017 A.Y.: 2012-2013 Date of order: 14th
February, 2019

 

Section 154 –
Non-consideration of decision of Jurisdictional High Court or of the Supreme
Court can be termed as ?mistake apparent from the record’ which can be the
subject matter of rectification application u/s. 154 even if not claimed
earlier by the assessee during assessment proceedings or appellate proceedings

 

FACTS

The assessee’s income was subject to assessment u/s. 143(3).
Additions were made u/s. 35D as also under other sections. The assessee did not
contest addition u/s. 35D but filed appeal against the other additions. In the
meanwhile, the assessee filed an application for rectification to allow the
expenditure on issue of bonus shares, in terms of decision of the Bombay High
Court in CIT vs. WMI Cranes Limited [326 ITR5 23] and the Supreme
Court in CIT vs. General Insurance Corporation [286 ITR 232].
However, the AO denied the rectification; consequently, the assessee appealed
to the Commissioner (Appeals) against the AO’s order rejecting his
rectification application. However, the assessee’s claim was rejected by the
Commissioner (Appeals) also. The assessee then filed an appeal to the Tribunal.

 

HELD

The Tribunal observed that the assessee moved
rectification petition u/s. 154 for the first time towards his claim u/s. 35D
relying upon the decision of the Hon’ble Supreme Court as well as the decision
of the jurisdictional High Court. The only basis on which the same was denied
by first appellate authority is the fact that there was no mistake apparent
from the record. The Tribunal considered the decision of the Supreme Court in ACIT
vs. Saurashtra Kutch Stock Exchange Ltd. [305 ITR 227]. It observed
that non-consideration of a decision of the Jurisdictional High Court or of the
Supreme Court could be termed as ‘mistake apparent from the record’.

 

The Tribunal also analysed the said facts from the angle
of constitutional authority – in terms of Article 265 of the Constitution of
India, no tax is to be levied or collected except by the authority of law. It
is trite law that true income is to be assessed and the Revenue could not
derive benefit out of the assessee’s ignorance or procedural defects. The
Tribunal finally allowed the appeal filed by the assessee considering the
principles of rectification pronounced in Saurashtra Kutch Stock Exchange
Ltd. (supra) and merits of the case as held in General Insurance
Corporation (supra).

 

Section 143 r.w.s. 148 – Failure to issue notice u/s. 143(2) of the Act after the assessee files the return of income renders the re-assessment order illegal and invalid

18 [2019] 105 taxmann.com 118
(Pune) ITO
(Exemptions) vs. S. M. Batha Education Trust ITA No. 2908/Pun/2016 A.Y.: 2012-13 Date of order: 4th
April, 2019

 

Section 143 r.w.s.
148 – Failure to issue notice u/s. 143(2) of the Act after the assessee files
the return of income renders the re-assessment order illegal and invalid

 

FACTS

The AO issued a notice u/s. 148 of the Act dated 29th
September, 2014 to the assessee, a trust engaged in educational
activities. The assessee neither replied to the notice nor filed its return of
income. Thereafter,
the AO issued two separate notices u/s. 143(2) of the Act on 29th
April, 2015 and 1st July, 2015. Subsequently, the assessee filed the
return of income on 21st October, 2015.

 

The AO completed the assessment and passed a reassessment
order. Aggrieved, the assessee preferred an appeal to the CIT(A).

 

Revenue also preferred an appeal to the Tribunal. The
assessee filed cross-objections challenging the re-assessment proceedings to be
bad in law since no statutory notice u/s. 143(2) was issued by the AO after the
assessee filed the return of income. The Tribunal decided this jurisdictional
issue.

HELD

The Tribunal held that the AO is required to issue
statutory notice u/s. 143(2) of the Act after the assessee files the return of
income in response to notice issued u/s. 148 of the Act. In the absence of such
a statutory notice after return of income is filed by the assessee, the
re-assessment order made by the AO was held to be invalid and illegal.

 

The Tribunal dismissed the appeal filed by Revenue and
allowed this ground raised by the assessee in its cross-objections.

Section 69 – No addition u/s 69 could be made in year under consideration in respect of investment in immovable property made in earlier year(s)

27. 
[2019] 200 TTJ (Del.) 375 Km. Preeti Singh vs. ITO ITA No. 6909/Del./2014 A.Y.: 2009-10 Date of order: 31st October,
2018;

 

Section 69 – No addition u/s 69 could be
made in year under consideration in respect of investment in immovable property
made in earlier year(s)

 

FACTS

The AO made an
addition of Rs. 55.39 lakhs while completing the assessment, being the entire
amount of investment in immovable property. The aforesaid amount of Rs. 55.39
lakhs consisted of cost of property of Rs. 51.86 lakhs and stamp duty of Rs.
3.53 lakhs. The investment made by the assessee during the year under
consideration was only Rs. 12.58 lakhs. The remaining amount of investment was
made in the earlier year(s) for which no addition could be made in the year
under consideration. The assessee 
submitted that the aforesaid investment of Rs. 12.58 lakhs during this
year included Rs. 6.05 lakhs by cheque out of the assessee’s bank account and a
payment of Rs. 6.53 lakhs made in cash. The assessee provided copies of the
accounts from the books of the builder from whom the property was purchased.
She also provided copies of statements of bank accounts. The assessee showed
that there were sufficient deposits in her bank accounts carried forward from
the earlier year to explain the source of the aforesaid cheques. The brought
forward opening balance at the beginning of the year in the bank accounts of
the assessee had accumulated over a period of time in the past few years.

 

On appeal, the CIT(A) upheld the addition of
Rs. 38.58 lakhs out of the aforesaid addition of Rs. 55.39 lakhs made by the
AO.

 

HELD

The Tribunal held that on perusal of section
4(1), it was obvious that in the year under consideration no addition could be
made in respect of investments in property made by the assessee in earlier
years or in respect of deposits in bank accounts of the assessee made in the
earlier year which was brought forward to this year for making cheque payments
of the aforesaid total amount of Rs. 6.05 lakhs. Moreover, certain amounts were
invested by the assessee and certain other amounts were deposited in the bank
account of the assessee in previous years relevant to earlier assessment years;
such investments or deposits could not possibly have been out of the income of
the previous year under consideration.

 

It is well settled that each year is a
separate and self-contained period. The income tax is annual in its structure
and organisation. Each ‘previous year’ is a distinct unit of time for the
purposes of assessment; further, the profits made and the liabilities of losses
made before or after the relevant previous year are immaterial in assessing the
income of a particular year. Even if certain income has escaped tax in the
relevant assessment year because of a devise adopted by the assessee or
otherwise, it does not entitle Revenue to assess the same as the income of any
subsequent year when the mistake becomes apparent.

 

In view of the
above, the AO was directed to delete the additions in respect of those amounts
which were invested by the assessee in earlier years, i.e., before previous
year 2008-09. Secondly, the AO was directed to delete the addition amounting to
Rs. 6.05 lakhs which was made by the assessee during the year under
consideration through cheque transactions from the bank account because, as
stated earlier, it was not disputed that the assessee had sufficient deposits
in her bank account at the beginning of the year to explain the source of the
aforesaid transactions by cheque. Thirdly, as far as investment aggregating to
Rs. 6.53 lakhs in cash was concerned, the matter was restored to the file of
the AO with the direction to pass a fresh order on merits on this limited issue
after considering the explanation of the assessee.

Special Deduction u/s 80-IA – Infrastructure facility – Transferee or contractor approved and recognised by authority and undertaking development of infrastructure facility or operating or maintaining it eligible for deduction – Assessee maintaining and operating railway siding under agreement with principal contractor who had entered into agreement with Railways and recognised by Railways as transferee – Assessee entitled to benefit of special deduction

43. CIT vs. Chettinad Lignite Transport Services Pvt. Ltd.; [2019] 415
ITR 107 (Mad.) Date of order: 12th March, 2019; A.Y.: 2006-07

 

Special Deduction u/s 80-IA – Infrastructure facility – Transferee or
contractor approved and recognised by authority and undertaking development of
infrastructure facility or operating or maintaining it eligible for deduction –
Assessee maintaining and operating railway siding under agreement with principal
contractor who had entered into agreement with Railways and recognised by
Railways as transferee – Assessee entitled to benefit of special deduction


For the A.Y. 2006-07, the AO denied the assessee
the benefit u/s 80-IA of the Income-tax Act, 1961 on the ground that the
assessee itself did not enter into a contract with the Railways or with the
Central Government and did not satisfy the requirement u/s 80-IA(4).

 

The Tribunal found that though the assessee had
only an agreement with the principal contractor who had entered into an
agreement with the Railway authorities to put up rail tracks, sidings, etc.,
the Railways had recognised the assessee as a contractor. The Tribunal held
that impliedly the Department had accepted the fact that the assessee had
provided ‘infrastructure facility’ to the specified authority, to maintain a
rail system by operating and maintaining such infrastructure facility as
defined, and that the assessee performed the contract according to the terms
agreed upon, that the services rendered by the assessee were an integral and
inseparable part of the operation and maintenance of a lignite transport
system, and that the assessee’s claim that it had complied with the requisite
condition specified under the proviso and was entitled to deduction u/s 80-IA
in terms of the proviso to sub-section (4) had to be accepted.

 

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

 

‘i)   The term
“infrastructure facility” has been defined in the Explanation to section 80-IA
and it includes a toll road, a bridge or a rail system, a highway project,
etc., which are big infrastructure facilities for which the enterprises have
entered into a contract with the Central Government or the State Government or
local authority. The proviso to section 80-IA(4) extends the benefit of such
deduction even to a transferee or a contractor who is approved and recognised
by the concerned authority and undertakes the work of development of the
infrastructure facility or only operating and maintaining it. The proviso to
sub-section (4) stipulates that subject to the fulfilment of the conditions,
the transferee will be entitled to such benefit, as if the transfer in question
had not taken place.

ii)    The
Tribunal had rightly applied the proviso to section 80-IA(4) and had held that
the assessee was recognised as a contractor for the railway sidings, which fell
under the definition of “infrastructure facility” and that it was entitled to
the benefit u/s 80-IA. It had also rightly held that the proviso did not
require that there should be a direct agreement between the transferee
enterprise and the specified authority to avail the benefit u/s 80-IA.

iii)   There
was no dispute that the assessee was duly recognised as a transferee or
assignee of the principal contractor and was duly so recognised by the Railways
to operate and maintain the railway sidings in the two railway stations. It has
been found by the AO himself that the assessee under an agreement with the
principal contractor had undertaken the work of development of the railway
sidings and had operated and maintained them.

iv)   The
findings of fact with regard to such position recorded by the Tribunal were
unassailable and that attracted the first proviso to section 80-IA(4). The
grounds on which the assessing authority had denied the benefit to the assessee
ignoring the effect of the proviso to section 80-IA(4) could not be sustained.’

 

 

Article 13(4)(c), Article 7 of India-UK DTAA – the development and supply of a technical plan or a technical design does not amount to ‘making available’ technical knowledge, experience, skill, knowhow or process to the service recipient; amount paid for such services does not qualify as FTS.

3.      
TS-76-ITAT-2019 (Mum) Buro Happold
Limited vs. DCIT A.Y.: 2012-13 Date of Order: 15th
February, 2019

 

Article
13(4)(c), Article 7 of India-UK DTAA – the development and supply of a
technical plan or a technical design does not amount to ‘making available’
technical knowledge, experience, skill, knowhow or process to the service
recipient; amount paid for such services does not qualify as FTS.

 

FACTS


Taxpayer, a company incorporated in the UK
was involved in the business of providing engineering design and consultancy
services. Taxpayer also rendered these services to its Indian affiliate, I Co.
During the year under consideration, I Co made payments to the Taxpayer towards
provision of consulting services as well as towards a cost recharge of common
expenses incurred by the Taxpayer on behalf of the group.

 

Taxpayer contended that the consultancy
services did not qualify as “Fee for included services (FIS)” under the treaty
in the absence of satisfaction of the ‘make available’ condition. Further, in
absence of a PE in India, such income is not taxable in India. Taxpayer also
contended that the amount received towards cost recharge is not taxable in India,
since such amount was a part of cost allocation made by the Taxpayer on a
cost-to-cost basis without any profit element. 

 

 

 

1.  Explanation to section 9(2) of the Act
provides that interest, royalty and FTS paid to a non-resident shall be deemed
to accrue or arise in India whether or not non-resident has a place of business
or business connection in India, and whether or not non-resident renders
services in India. The Tribunal appears to have not applied explanation to
section 9(2) on agency commission on the basis that it is business income and
not in the nature of interest, royalty or FTS.

 

 

AO observed that the services rendered by
the Taxpayer included supply of design/drawing. AO held that  as per Article 13(4)of the India–UK DTAA,
payment received for development and transfer of a technical plan or technical
design qualifies as FIS, irrespective of whether it also makes available
technical knowledge, experience, skill, knowhow, etc.  Further, the cost recharge expense which are
related to and are ancillary to the provision of consulting engineering
services held as FIS will bear same character as that of FIS and, hence,
taxable in India.

 

Aggrieved, the Taxpayer appealed before the
CIT(A) who upheld AO’s order. The CIT(A) concluded that provision of a specific
design and drawing requires application of mind by various technicians having
knowledge in the field of architectural, civil, electrical and electronic
engineering, and overseeing its implementation and execution at site in India
by the Taxpayer’s technical personnel, amounts to making available technical
services and hence the amount received would be in the nature of FIS.

 

Aggrieved, Taxpayer appealed before the
Tribunal.

 

HELD

  •    A careful reading of Article
    13 of the India-UK DTAA suggests that the words “development and transfer
    of a technical plan or technical design” is to be read in conjunction with
    “make available technical knowledge, experience, skill, knowhow or
    processes”. As per the rule of ejusdem generis, the words “or
    consists of the development and transfer of a technical plan or technical
    design” will take color from “make available technical knowledge,
    experience, skill, knowhow or processes”.

 

  •    The technical
    designs/drawings/plans supplied by the Taxpayer are project-specific and cannot
    be used by ICo in any other project in the future. Thus, the Taxpayer has not
    made available any technical knowledge, experience, skill, knowhow or processes
    while developing and supplying the technical drawings/designs/plans to I Co.

 

  •    Reliance was placed on the
    Pune Tribunal decision in the case of Gera Developments Pvt. Ltd.2,
    in the context of the FTS Article under the India-US DTAA. In Gera’s case it
    was held that mere passing of project-specific architectural drawings and
    designs with measurements does not amount to making available technical
    knowledge, experience, skill, knowhow or processes. The Tribunal also held that
    unless there is transfer of technical expertise skill or knowledge along with
    drawings and designs and unless the recipient can independently use the
    drawings and designs in any manner whatsoever for commercial purpose, the
    payment received cannot be treated as FTS.

 

2.   
[(2016) 160 ITD 439 (Pune)]

SECTION 115BAA AND 115BAB – AN ANALYSIS

INTRODUCTION

Finance Minister Nirmala Sitharaman presented her maiden Budget in the
backdrop of a significant economic slowdown which is now threatening to turn
into a recession. The Budget and the Finance Act passed thereafter did not
reduce the tax rates which many expected. In fact, the surcharge on individuals
was increased significantly, reversing the trend of a gradual reduction in
taxes in earlier Budgets. The increase was criticised and it was felt that the
high level of taxes would have a negative impact on the investment climate in
the country. Responding to the situation, the government issued the Taxation
Laws (Amendment) Ordinance, 2019 which seeks to give relief to corporates and a
fillip to the economy.

 

This article analyses the various issues in the two principal provisions
in the Ordinance. In writing this article I am using inputs from Bhadresh
Doshi, my professional colleague who spoke on the topic on the BCAS
platform a few days ago.

 

As I write this article, the Ordinance has been converted into a Bill. I
have considered the amendments made in the Bill while placing it before
Parliament. However, during its passage in Parliament, the said Bill may
further be amended. The article therefore should be read with this caveat.

 

SECTION 115BAA

The new provision 115BAA(1) provides that

(a) notwithstanding anything contained in the other provisions of the
Income-tax Act

(b)        income tax payable by

(c)        a domestic company

(d)       for A.Y. 2020-21 onwards

(e)        shall at the option of
the company

(f)        be computed at the rate
of 22% if conditions set out in sub-section (2) are satisfied

 

The proviso to this sub-section stipulates that in the event the company
opting for the lower rate violates any condition prescribed in sub-section (2),
the option shall become invalid for that previous year in which the condition
is violated and the provisions of the Act shall apply as if the option had not
been exercised for that year as well as subsequent years.

 

Sub-section (2) provides the following conditions:

(i)         the income of the
company is computed without deductions under sections 10AA, 32(1)(iia), 32AD,
33AB, 33ABA, 35(1)(ii)/(iia)/(iii), 35(2AA)/(2AB), 35CCC, 35CCD or any
deductions in respect of incomes set out in Part C of Chapter VIA other than a
deduction u/s 80JJAA;

(ii)        the company shall not
claim a set-off of any loss or depreciation carried forward from earlier
assessment years, if such loss or depreciation is attributable to the
provisions enumerated above;

(iii)       the company shall not
be entitled to set-off of any deemed unabsorbed loss or depreciation carried
forward by virtue of an amalgamation or demerger in terms of section 72A;

(iv) company shall claim depreciation u/s 32(1).

 

Sub-section (3) provides that the loss referred to in sub-section (2)
shall be treated as having been given effect to. The proviso, however, provides
that there would be an adjustment to the block of assets to the extent of the
depreciation that has remained unabsorbed for the years prior to assessment
year 2020-21.

 

Sub-section (4) provides that if the option is exercised by a company
having a unit in the International Financial Services Centre as referred to in
sub-section (1A) of section 80LA, the conditions contained in sub-section (2)
shall be modified to the extent that the deduction u/s 80LA shall be available
to such unit subject to compliance with the conditions contained in that
section.

 

Sub-section (5) provides that the section shall apply only if an option
is exercised by the company in the prescribed manner on or before the due date
specified under sub-section (1) of section 139 for any assessment year from
2020-21 onwards. The sub-section further provides that the option once
exercised cannot be withdrawn for the said year or future years.

The proviso provides that if an option exercised u/s 115BAB becomes
invalid on account of certain violations of the conditions set out in that
section, such a person may exercise the option under this section.

 

ANALYSIS

The new section grants an option to domestic companies to choose a lower
rate of tax @ 22% plus the applicable surcharge and cess and forgo the
deductions enumerated. It is fairly clear from the section that claim in an
anterior year attributable to the specified deductions which could not be
allowed on account of insufficiency of income cannot be set off in the year in
which an option under the section is exercised or future years.

 

The issue that may arise in this context is that except for the claim
u/s 35(1)(iv), the law does not contemplate a segregation of the business loss
into loss attributable to different sections. In fact, it is only in regard to
the loss arising on account of a capital expenditure u/s 35(1)(iv) that a
priority of set-off of losses is contemplated in section 72(2). Therefore, if
one is to give effect to section 115BAA(2), then the assessee company would
have to compute a breakup of a business loss which has been carried forward,
between various provisions to which it is attributable. Without such a
bifurcation the provision attributing loss to the enumerated deductions cannot
be given effect to. Even as far as depreciation is concerned, depreciation is
computed under sections 32(1)(i) and (iia). It is the aggregate of such depreciation
which is claimed as an allowance and a reduction from the written down value
(w.d.v.) of the block of assets. There is no specific provision requiring a
bifurcation between the two.

 

A harmonious interpretation would be that a company exercising the option
for the applicability of this section would have to give a breakup of the said
loss, attributing losses to the deductions referred to above and such
attribution would bind the Department, as the provisions for set-off do not
provide for an order of priority between general business loss and loss
attributable to the enumerated deductions.

 

The proviso
to sub-section (3) seeks to mitigate the double jeopardy to a person seeking to
exercise the option of the lower rate, namely, that set-off of unabsorbed
depreciation will not be allowed as well as the w.d.v. of the block would also
stand reduced. The proviso provides that if there is a depreciation allowance
in respect of a block of assets which has not been given full effect to, a
corresponding adjustment shall be made to the w.d.v. of the block. To
illustrate, if Rs. 1 lakh is unabsorbed depreciation in respect of a block of
assets for assessment year 2019-20, for computing the depreciation for the
block for assessment year 2020-21 the w.d.v. of the block shall stand increased
to that extent.

 

SECTION 115BAB

This section seeks to grant a substantial relief in terms of a reduced
tax rate to domestic manufacturing companies. The section provides that

(1)  a domestic company, subject
to conditions prescribed, would at its option be charged at a tax rate of 15%
from assessment year 2020-21 onwards;

(2)   it is, however, provided
that income which is neither derived from nor incidental to manufacturing or
production, and income in the nature of short-term capital gains arising from
transfer of non-depreciable assets, will be taxed at 22%. In regard to such
income, no deduction of expenditure would be allowed in computing it;

(3)   the income in excess of the
arm’s length price determined u/s 115BAB(6) will be taxed at 30%;

(4)     the conditions are:

 

(a)        the company is set up
and registered on or after 1st October, 2019 and commences
manufacture or production on or before the 31st day of March, 2023;

(b)        it is not formed by
splitting up or the reconstruction of a business already in existence (except
for re-establishment contemplated u/s 33B);

(c)        it does not use any
machinery or plant previously used for any purpose (except imported machinery
subject to certain conditions). Other than imported machinery, the condition
will be treated as having been fulfilled if the value of previously used
machinery or part thereof does not exceed 20% of the total value of machinery;

(d)       it does not use any
building previously used as a hotel or convention centre in respect of which a
deduction u/s 80-ID has been claimed and allowed;

(e)        the company is not
engaged in any business other than the business of manufacture or production of
any article or thing and research in relation to or distribution of such
article or thing manufactured or produced by it;

(f)        the explanation to
section 115BAB(2)(b) excludes development of computer software, mining,
conversion of multiple blocks or similar items into slabs, bottling of gas into
cylinders, printing of books or production of cinematograph film from the
definition of manufacture or production. The Central Government has also been
empowered to notify any other business in the list of excluded categories;

(g)        income of the company is
computed without  deductions under
sections 10AA, 32(1)(iia), 32AD, 33AB, 33ABA, 35(1)(ii)/(iia)/(iii),
35(2AA)/(2AB), 35CCC, 35CCD or any deductions in respect of incomes set out in
Part C of Chapter VIA other than a deduction u/s 80JJAA;

(h)        the company shall not be
entitled to set-off of any deemed unabsorbed loss or depreciation carried
forward by virtue of an amalgamation or demerger in terms of section 72A;

(i)         company shall claim
depreciation u/s 32(1).

 

Sub-section (3) provides that the loss referred to in sub-section (2)
shall be treated as having been given effect to.

 

Sub-section (4) empowers the CBDT, with the approval of the Central
Government, to remove any difficulty by prescribing guidelines in regard to the
fulfilment of the conditions regarding use of previously-used plant and
machinery or buildings, or the restrictive conditions in regard to the nature
of business.

 

Sub-section (5) provides that the guidelines issued shall be laid before
each House of Parliament and they shall bind the company as well as all income
tax authorities subordinate to the CBDT.

 

Sub-section (6) provides that if, in the opinion of the assessing
officer, on account of close connection between the company and another person,
the business is so arranged that it produces to the company more than ordinary
profits, he shall compute for the purposes of this section such profits as may
be reasonably deemed to have been derived from such business.

 

The proviso to the sub-section provides that if the aforesaid
arrangement involves a specified domestic transaction (SDT) as defined in
section 92BA, the profits from such transaction shall be determined having
regard to the arm’s length price as defined in section 92F.

 

The second proviso provides that the profits in excess of the arm’s
length price shall be deemed to be the income of the person.

 

Sub-section (7) provides that the section shall apply only if an option
is exercised by the company in the prescribed manner on or before the due date
specified under sub-section (1) of section 139 for any assessment year from
2020-21 onwards. The sub-section further provides that the option once
exercised cannot be withdrawn for the said year or future years.

 

The explanation to the section states that the expression ‘unabsorbed
depreciation’ shall have the meaning assigned to it in section 72A(7) for the
purposes of section 115BAB and 115BAA.

 

ANALYSIS

Unlike the provisions of section 115BAA, the provisions of this section
give rise to a number of issues, many of them arising on account of lacunae in
drafting which may be taken care of when the Taxation Laws (Amendment) Bill
becomes an Act. These are as under:

 

The threshold condition of eligibility is that the company is set up and
registered on or after 1st October, 2019 and commences manufacture
or production on or before the 31st day of March, 2023. It is not
clear as to whether the eligibility for the lower rate would be available to
the company after it is set up but before it commences manufacture or
production.

 

It needs to be pointed out that the situs of manufacturing unit
is not relevant. Therefore, manufacture outside India would also be entitled to
the lower rate of tax. Considering the tax cost in the country of manufacture,
this may not turn out to be tax effective, but such a situation is
theoretically possible.

 

If a company fails to meet the condition of commencement of manufacture
or production, the grant of the lower rate of tax would amount to a mistake
apparent from record amenable to a rectification u/s 154.

 

It is possible that in the interregnum between the setting up and
commencement of manufacture or production, the company may earn some income.
This is proposed to be taxed at 22% if it is not derived from or incidental to
manufacture or production. The term ‘incidental’ is likely to create some
controversy. While the higher rate of tax for such other income can be
understood, the condition that no deduction or expenditure would be allowed in
computing such income appears to be unjust. To illustrate, a company demolishes
an existing structure and disposes of the debris as scrap. The debris is
purchased by a person to whom it has to be transported and the company bears
the transport cost. On a literal interpretation of the section a deduction of
such expenditure will not be allowed. This aspect needs to be dealt with during
the passage of the Bill into an Act, or a suitable clarification needs to be
issued by
the CBDT.

 

Section 115ABA(2)(a)(i): This provides that the company is not formed by
splitting up or reconstruction of a business already in existence. As to what
constitutes splitting up or reconstruction of a business is already judicially
explained [Refer: Textile Machinery vs. CIT 107 ITR 195 (SC)].
There are several other decisions explaining the meaning of these terms. The
difference between this provision and all other incentive provisions is that in
those provisions (sections 80-I, 80-IA) this phrase was used in the context of
the business of an ’undertaking’. In this case the phrase is used in the
context of an assessee, namely, a domestic company. Therefore, an issue may
arise as to whether, after its formation, if a company acquires a business of
an existing entity (without acquiring its plant and machinery), the conditions
of this section would be vitiated. The words used are similar to those in other
incentive provisions, namely, ‘is not formed’. It therefore appears that a
subsequent acquisition of a business may not render a company ineligible for
claiming the lower rate of tax.

 

Section 115ABA(2)(a)(ii): This prescribes that the company does not ‘use’
any machinery or plant previously used for any purpose. While the explanation
grants some relaxation in regard to imported machinery, this condition is
extremely onerous. This is because hitherto the words used were ‘transferred to
a new business of machinery or plant’. Therefore, the undertaking had to be
entitled to some dominion and control over the old machinery for the condition
to be attracted. The provision as it is worded now will disentitle the company
to the relief if any old machinery is used. To illustrate, a company decides to
construct its own factory and the plant and machinery in the said factory is of
the value of Rs. 5 crores. During the course of construction, the company hires
for use a crane (which obviously has been used earlier), of the value of Rs. 2
crores. It would have, on a literal reading of the section, contravened one of
the eligibility conditions. It must be remembered that the condition is not
even connected with the business of manufacture but is attracted by ‘use’ of
the machinery by a company for any purpose.

 

Admittedly, this may not be the intention, but this condition needs to
be relaxed or amended to ensure that an overzealous tax authority does not deny
the rightful lower rate to a company which is otherwise eligible.

 

Section 115ABA(2)(a)(iii): This clause prescribes a condition that is even
more onerous. The company is not entitled to ‘use’ any building previously used
as a hotel or convention centre, in respect of which a deduction u/s 80-ID is
claimed. Here again the test is merely ‘user’ without there being any dominion
or control of the company over the building. Further, it is virtually
impossible for a company to ascertain whether the building in respect of which
it has obtained a right of temporary user has hitherto been used as a hotel or
convention centre, and whether deduction u/s 80-ID has been claimed by the
owner / assessee. To illustrate, a company decides to hold a one-month
exhibition of its manufactured goods and for that purpose obtains on leave and
licence 5,000 sq. ft. area in a commercial building. It holds its exhibition
and it later transpires that the said area was hitherto used as a convention
centre. On a literal reading of the section, the company would lose benefit of
the lower rate of tax. Clarity on this issue is required by way of issue of a
CBDT circular.

 

Section
115BAB(2)(b): The
last condition, which is distinct from the conditions prescribed in 115BAA, is
in regard to restricting the eligibility to those companies whose business is
of manufacture or production of articles and things, research in relation to
such goods as well as distribution thereof. The term manufacture is defined in
the Act in section 2(29B). The same is as follows: [(29BA) ‘manufacture’, with
its grammatical variations, means a change in a non-living physical object or
article or thing:

(a)
resulting in transformation of the object or article or thing into a new and
distinct object or article or thing having a different name, character and use;
or

(b) bringing
into existence of a new and distinct object or article or thing with a
different chemical composition or integral structure.]

 

These two terms have been judicially interpreted and are distinct from
each other, though the common man uses them interchangeably. Reference may be
made to the decisions of the Apex Court in CIT vs. N.C. Budharaja 204 ITR
412 (SC); CIT vs. Oracle Software India Ltd. 320 ITR 546(SC). The term
production is a wider term, while the term manufacture must ensure that there
is change in the form and substance of an article at least commercially. While
introducing the Bill, development of software in any form, mining and certain
other activities which could have fallen into the realm of manufacture or
production have been specifically excluded. Companies engaged in such business
will therefore not be entitled to the lower rate. It is also provided that the
Central Government is empowered to notify further businesses which will not be
entitled to the lower rate. It is hoped that any notification will be
prospective in nature, because if a company is registered and it incurs a cost
in setting up a manufacturing facility, a subsequent notification denying it
the lower rate will be unfair.

 

The
conditions prescribed in section 115BAB(2)(c) are identical to those of section
115BAA and the analysis in regard thereto will apply with equal force to this
section as well.

 

Sub-section (6) seeks to limit the operation of the section to income
which is derived from the business of the company computed at arm’s length. The
proviso further provides that if the arrangement between the company and the
related person (associated enterprise), involves a specified domestic
transaction, then the profits from the transaction will be computed based on
the arm’s length price as defined in 92F(ii).

 

Like in the case of section 115BAA, sub-section (7) provides that, in
order to avail of the benefit of the section, the company must exercise the
option on or before the due date prescribed in section 139, and once exercised
the option cannot be subsequently withdrawn for that or any previous year.

 

The explanation provides that the term ‘unabsorbed depreciation’ will
have the meaning assigned to it in clause (b) of sub-section (7) of section
72A. It is therefore clear that the denial of unabsorbed depreciation in
computing income will be restricted to such depreciation that is deemed to be
unabsorbed on account of an amalgamation or demerger. This appears to be in
keeping with the intent of the lawmakers.

 

CONCLUSION

Both the sections are clear on intent but seem to suffer from lacunae in
drafting, particularly in the case of section 115BAB. Let us hope that these
creases are ironed out before the Bill becomes an Act or if that does not
happen, then the Central Board of Direct Taxes (CBDT) issues circular/s
clarifying the legislative intent.

 

THE ART OF UNDERSTANDING & MANAGING STAKEHOLDER EXPECTATIONS – AN INTERNAL AUDITOR’S PERSPECTIVE

Internal Audit (IA) must recognise that it
exists to serve the needs of diverse stakeholder groups, that their
expectations are constantly evolving and may not be necessarily aligned.
Internal auditors, whether in-house or outsourced – irrespective of the size of
the organisation – who invest in managing the expectations of their various
stakeholders are more likely to create an IA function that remains successful
and relevant in the long term. Those who lose sight of this are at greater risk
of long-term failure.

 

THE STAKEHOLDERS

For IA, the stakeholders comprise:

(i)     The Audit Committee (AC) and the Board of
Directors (Board), to whom IA is supposed to report directly and functionally;

(ii)     The CEO (or head of the enterprise), to
whom IA usually reports administratively;

(iii)    The CFO, who is primarily responsible for the
internal control environment and who, therefore, may be IA’s perpetual ally;

(iv)    Other business heads of the organisation
(auditees);

(v)    Internal audit team (whether forming part of
the in-house team or members of professional services firms engaged on a
co-sourced basis);

(vi)    Statutory auditors and regulators;

(vii)   Other board committees and heads of support
functions, especially administration and HR; and

(viii) Professional network.

 

In well-established organisations, there
will also be potential collaborators such as the CIO (Chief Information
Officer), the CRO (Chief Risk Officer) and the Compliance Head who can jointly
drive the common governance agenda with the AC / Board and within the
organisation. Incidentally, the CIO can be the best catalyst and support for IA
as technology initiatives gain momentum to increase the effectiveness of IA.

 

IA needs to identify the key stakeholders
and categorise them in terms of influence and needs, craft engagement
strategies for each and build and maintain an effective working relationship
with them.

 

UNDERSTANDING STAKEHOLDER EXPECTATIONS

IA provides value to the organisation and
its stakeholders when it delivers objective and relevant assurance, and
contributes to the effectiveness and efficiency of governance, risk management
and control processes. To achieve this, the IA plan should reflect the issues
that are important to the stakeholders; it should address the challenges and
risks that stand in the way of the strategic and other key objectives of the
organisation. IA must invest sufficient time in talking to stakeholders to
identify and assess priorities. It should involve them in drafting the IA plan
and solicit inputs. Knowing what’s important to stakeholders is the
cornerstone of managing their expectations.

 

Keep your ear to the ground to ensure that
IA is in tune with current concerns and has a flexible plan. If need be, it
should review and update the plan at the half-year point or even quarterly if
circumstances so dictate. Design a process that brings information together;
share it within the IA team to ensure that the team is aware of the main
business drivers and risks; analyse it and make planning decisions
based on key risks and issues.

 

One of the most important aspects to think
about is the approach, frequency and content of communications for each
stakeholder so that it is easy and encourages them to get involved. Besides,
consider the balance and benefits of formal and informal protocol. Ensure that
the stakeholders understand your needs, relevance and the value of IA to the
organisation.

 

There are several key areas of IA work that
require good stakeholder understanding:

(a) The IA Charter, which defines its mission, role
and scope, should be a living document that helps to sustain IA’s value to the
organisation. The Charter must be up to date, clear, easily understood and
reflect the focus of IA. Stakeholders need to be aware of it and it could, for
example, be a key document on the IA intranet.

(b)        More and more internal auditors are
providing ratings at an engagement and overall level. IA should work with the
AC Chair and senior managers to devise a way of expressing ratings that help
them to understand where the business stands in relation to achieving its
objectives. Some ACs prefer narrative statements, others ‘traffic light’
systems or gradings. There is no right or wrong way of doing this. It does mean
talking through options, agreeing to a suitable format and applying it on a
consistent basis.

(c) Stakeholder feedback on individual engagements
and at the overall service level are important components to continuously
assessing the effectiveness of the service and how well it is providing value
to the organisation.

 

MANAGING STAKEHOLDER EXPECTATIONS – OVERVIEW

Having understood
the stakeholder expectations:

1.   Assess key stakeholder expectations, identify
gaps and implement a comprehensive strategy for improvement;

2.   Deploy quality resources for planning and
execution;

3.   Leverage technology to the full;

4.   Deploy a strategy for business knowledge
acquisition;

5.   Streamline IA processes and operations to
enhance value;

6.   Coordinate and collaborate with other risk,
control and compliance functions. In many organisations, some of these roles
are with IA or there may be an overlap. It is not unusual to find board members
looking at IA when issues of risk, control and compliance come up for review.

 

KEYS TO SUCCESS – HIGH-LEVEL INTER-PERSONAL SKILLS

Good oral, written
communications and presentation skills topped with soft skills will hold you
and your team in good stead.

 

Strong
collaboration with stakeholders calls for highly capable communicators who are
good not only at oral and written communications, but also good listeners who
are highly perceptive of body language and unspoken words. My experience over
the years is that there is scope for improvement for IA in effective
communication with stakeholders.

 

IA needs to
remember to communicate what is and what is not being audited and why. ACs need
clarity on this point. Further, the rule of sequence of observation, root
cause, risk and suggested mitigation presented objectively and with clarity
will reinforce your effectiveness.

 

And if you see a problem beyond your scope, either do something to fix
it, or bring it to the attention of those who can fix it. You will then be
perceived as a valuable partner to your stakeholders. Do not hesitate to
solicit feedback from stakeholders; ask them to identify areas for you to
improve.

 

To stay
relevant, always

*    Know your stakeholders’ expectations;

*    Set the right tone and culture for your team
– never stop short of demanding quality, agility and integrity;

*    Build
exceptional teams that deliver high-value assurance and advisory services to
the organisation / client.

 

STRIKING A BALANCE

To achieve the
right balance, IA may employ some of these approaches:

(i)   Engage stakeholders as a business leader, not
a technical auditor –

Assess the IA
team’s level of business acumen and, if necessary, develop a plan to spend time
and effort with those in the organisation who can help you think more like a
business leader and understand the risks related to its strategies and
businesses and the internal and external inter-dependencies. And align these
with functional knowledge of IA.

(ii) Coordinate with the second line of defence –

Understand clearly
the work done by functions in the second line of defence. Collaborate as much
as possible with these functions, work towards common views of risks and
compliance where possible. Once the rigour of their work is tested, IA may rely
on assurance work done by these functions.

(iii)        Balance competing demands –

Develop strong
relationships with stakeholders, including auditees at all levels. However,
stay grounded in your professional obligations and be firm when the situation
demands.

 

IA may also involve
itself in conducting proactive fraud audits to identify potentially fraudulent
acts; participating in fraud investigations under the direction of fraud
investigation professionals; and conducting post-investigation fraud audits to
identify control breakdowns and establish financial loss. Above all, just
watch for complacency!

    

Recent stakeholder
surveys suggest that whilst IA is keeping up with changes in business and is
communicating well with management and the Board by focussing on critical
areas, IA needs to demonstrate its capability for value-add. This is
best done by moving beyond its comfort zone to help organisations bring an IA
perspective to strategic initiatives and changes – digitalisation,
cyber-security, Internet-of-things and more. It needs to proactively flag
the new and emerging risks that organisations need to understand and
manage.

    

To successfully
manage auditees’ expectations, IA should become familiar with the most common
issues relating to their expectations. To understand them, find some time to
have one-on-one casual and unscripted conversations as often as possible. You
need to realise that stakeholders are not IA subject matter experts. They may
not understand the IA jargon or theory as well as you do. Take some time to
understand them and educate them when you know for sure that there are gaps in
their knowledge that should be filled. Keep it simple when communicating
with auditee stakeholders; in fact, use their language in your conversations
and you will instantly strike a chord!

    

Working with
stakeholders is a two-way process. Talking to and working with them is
fundamental to IA. It enables internal auditors to explain the value of IA
while getting to know stakeholder expectations. Regular face-to-face
meetings enable internal auditors to highlight the function’s role in good
governance and explain the value of the independent and objective assurance.
Stakeholders, on the other hand, have an opportunity to talk about IA
performance and flag risks or issues they would like to see in the IA plan.

 

Regular contact is
therefore beneficial to everyone, but it can be difficult to organise. Plan
ahead, especially as other assurance providers may be competing for your
stakeholders’ attention.

 

MANAGING STAKEHOLDER EXPECTATIONS

Let us now look at
how IA can manage its key stakeholders:

 

AC / Board,
CEO

  •     With the AC Chair as well
    as with the CEO, agree on the audit plan after presenting your draft and
    soliciting guidance to modify the same. That establishes your agreement that
    captures the stakeholder expectations. Thereafter, remain proactive; seek
    periodic meetings when you can share progress as also any challenges that could
    impede audit execution. Avoid surprises with all stakeholders, especially the
    AC Chair and the CEO. Reset expectations if necessary or seek support that may
    mitigate challenges.
  •     Talk to your stakeholders, particularly your
    AC Chair and CEO, perhaps also the CFO, and find out what they expect from IA.
    This not only includes the focus of the IA plan but also IA processes, such as
    expressing opinions, reporting styles, performance monitoring and quality
    assessment.
  •     Set up separate ‘audit
    planning days’ with the AC Chair / members outside the formal meeting schedule.
    Prepare monthly / quarterly activity reports or regular briefings for AC
    members requesting feedback. This might include a balanced scorecard or
    dashboard to show progress on a number of important activities. Meet informally
    or call your AC Chair between meetings. Meet the AC Chair before each meeting.
  •     AC Chair and CEOs often use
    IA as an informal sounding board with whom they can discuss risks and explore
    practical responses.

    

Auditees

  •     Organise formal, one-to-one
    internal audit planning discussions with business heads and heads of support
    functions.
  •     Find time for follow-up
    reviews with managers to understand changing risk profiles.
  •     Schedule informal, short
    ‘catch-up’ meetings or phone calls with managers to keep up with changes and
    developments in the organisation.

 

Your
collaborators

  •     Establish regular meetings
    with the CFO and risk management teams to maintain awareness of risk events and
    issues.
  •     Keep in touch with other
    assurance providers to share information.
  •     Collaborate with the
    compliance head and the IT head – both of them can be valuable supporters in
    your initiatives. IA can also work on creating a common resource pool with this
    set of collaborators.

 

Your team

  •     Arrange monthly team
    meetings for sharing experience during execution.
  •     Organise training for
    functional and soft skills. Hold ‘audit workshops’, for example, where the CEO,
    CFO or a business head may meet with a section of the audit team to discuss
    significant risks and issues.
  •     Recognise good performers.
    Ensure variety for team and focus on their development and rotation.
    Demonstrate how IA can be a pipeline for talent that is already groomed in
    process discipline.
  •     An annual two-day offsite for
    the IA team is ideal for brainstorming, introspection, assimilation of feedback
    and team-building. Try and get an external expert to address the team. The IA
    team is more often in the field and less often in office – life can be tough,
    so be sensitive to their hectic schedules and extend support to them.

 

External
stakeholders

  •     Schedule planning and
    update meetings with external stakeholders, e.g., external audit. It is
    necessary to share the audit plan and solicit inputs from the statutory
    auditors. Have at least quarterly meetings to exchange notes with them.
  •     Periodically engage with a
    professional network, which is a good source for sharing new initiatives,
    knowledge-sharing and also trying joint initiatives.
  •     Be a part of professional
    networking groups and occasionally host such meetings in your office. That also
    helps your team to get external exposure.

 

Over the years,
there is a reluctant acceptance that IA does not enjoy as much influence as it
could have enjoyed. There is a feeling that IA is not positioned properly
within the organisation to have the maximum possible impact. And often, IA is
reduced to a compliance function, unable to focus on the opportunities and
risks.

 

Often, IA teams do not have the right skills and capabilities to
undertake the kinds of activities to be relevant and impactful within the
organisation. In response to this challenge, more CAEs plan to use alternative
resourcing models in the coming three to five years to gain the kinds of skills
they need. Co-sourcing, for instance, is a popular option that helps access
specialised skills. Additional alternative resourcing models such as guest
auditor programmes and rotation programmes are also gaining acceptance.

 

Though many IA
teams are embracing analytics to drive deeper insight and provide greater
foresight, others are barely scratching the surface. CAEs are now attempting to
deploy advanced analytics and predictive tools that leading internal audit departments
are using to provide greater value, to provide deeper insight, and to provide
foresight to their stakeholders. Use of workflow-based audit planning and
execution software is helping IA in enhanced delivery.

 

STAKEHOLDER ENGAGEMENT
PLAN

Here are some
simple ideas that might form part of a Stakeholder Engagement Plan or a
component part of IA strategy:

(a) Develop an induction programme for new AC
members and business leaders / senior managers.

(b)        Organise separate management meetings and
earmark sessions during AC meetings to provide updates and relevant
information. This could include changes in legislation, regulation, risk
management and IA profession and how this might impact the organisation and
audit execution.

(c) Develop an intranet site that contains useful
and relevant information and ensure that it is kept up to date.

(d)        Prepare and circulate a brief note
containing information about IA activities. Use this channel to introduce your
team to a larger audience. Update this periodically to include highlights of
the achievements of IA during the year.

(e) Prepare short guides relating to the IA
process, IA involvement in projects such as systems implementation or new
business set-up, IA role with regard to risk management, etc. Auditees love to
see documented audit processes and terms of engagement with IA, including
service level agreements for flow of information, responses and action-taken
reports.

(f) Schedule periodic meetings with key
stakeholders, even when there is no direct engagement activity in their area,
to stay alive to business changes and the potential for new and emerging risks
that might call for a revision of the engagement plan.

(g)        Offer to second team
members for support or, better still, introduce the concept of guest auditor
for operational audits.

 

With support from
management, IA must help the organisation realise that there is one goal with
one common interest and that there is one team, not two, and each performs its
role in a different way – that would contribute significantly to harmonising
the work performance, increase effectiveness of IA and achieve stakeholders’
satisfaction.

 

DO STAKEHOLDERS MEET THE EXPECTATIONS OF INTERNAL AUDIT?

The question, how
IA can meet the expectations of stakeholders has often been discussed and
debated. Various questionnaires are used to measure the satisfaction of
stakeholders with the performance of IA and its role in achieving the
objectives of the organisation, improving its operations and enhancing the
control and risk management practices.

 

There is also a
need to address the subject from the other party’s perspective with the same
degree of interest – how can stakeholders meet the expectations of IA and be
supportive of IA? While it is the responsibility of the management to ensure
that IA is well accepted in the organisation, IA is well advised to take a
proactive approach and build bridges with various stakeholders through fair and
effective communication and finding opportunities to demonstrate the
contribution of IA on a regular, ongoing basis.

 

CONCLUSION

The frequent discussions about how IA meets the expectations of
stakeholders may perhaps give a wrong impression about internal audit in
comparison with other functions within the organisation. In some organisations,
IA is criticised for impacting the morale of business teams by raising
objections and concerns. In others, particularly those experiencing
cost-control measures, IA is often called upon to justify the reasons for its
existence and the importance of its work. These misconceptions can best be
erased by sustained investment in managing stakeholder expectations and
focusing on value-addition across the various areas addressed by Internal Auditors.

 

Though IA may not
be the most glamorous corporate activity, without it, many organisations would
fall foul of their numerous regulatory and compliance obligations. Indeed, IA
helps companies to establish and maintain solid cultures of compliance up and
down the corporate structure. Historically, IA has focused primarily on just
financial and compliance areas. More and more organisations are beginning to
see the strategic and operational benefits of utilising IA from an enterprise
risk angle. Compliance with ever-increasing regulations obviously remains a
core focus for IA teams; however, increases in social media usage as well as
the recent explosion in cybercrime and developments in the technological space
are posing more issues for internal auditors to address.

 

As IA encapsulates
a variety of business areas, boards, senior executives and auditors are
becoming increasingly aware of how companies can leverage IA as a strategic
business adviser, but it is up to companies to find the right balance. Happy
stakeholders will support IA adequately to ensure that the right resources are
available and influence the organisation culture to look at IA as a
collaborator.

 

Good business leaders should anticipate what their customers will
want in the days to come. Good IAs need to be alert to what their stakeholders
will expect from them, especially when there is so much turbulence in the
corporate world. Are you ready? 

 

SPORTS ASSOCIATIONS AND PROVISO TO SECTION 2(15)

ISSUE FOR
CONSIDERATION

A charitable
organisation is entitled to exemption from tax under sections 11 and 12 of the
Income-tax Act, 1961 in respect of income derived from property held under
trust for charitable purposes. The term ‘charitable purpose’ is defined in
section 2(15) as under:

 

‘“charitable purpose”
includes relief of the poor, education, yoga, medical relief, preservation of
environment (including watersheds, forests and wildlife) and preservation of
monuments or places or objects of artistic or historic interest, and the
advancement of any other object of general public utility:

 

Provided that
the advancement of any other object of general public utility shall not be a
charitable purpose, if it involves the carrying on of any activity in the
nature of trade, commerce or business, or any activity of rendering any service
in relation to any trade, commerce or business, for a cess or fee or any other
consideration, irrespective of the nature of use or application, or retention,
of the income from such activity, unless –

 

(a)   such activity is undertaken in the course of
actual carrying out of such advancement of any other object of general public
utility; and

 

(b)   the aggregate receipts from such activity or
activities during the previous year do not exceed twenty per cent of the total
receipts, of the trust or institution undertaking such activity or activities,
of that previous year;’

 

For the purposes of
income tax exemption, promotion of sports and games is regarded as a charitable
activity, as clarified by the CBDT vide its Circular No. 395 dated 14th
September, 1984. Many sports associations conduct tournaments where sizeable
revenues are generated from sale of tickets, sale of broadcasting and
telecasting rights, sponsorship, advertising rights, etc. resulting in earning
of a large surplus by such associations.

The issue has
arisen before the appellate authorities as to whether such sports associations
can be regarded as carrying on an activity in the nature of trade, commerce or
business and whether their activities of conducting tournaments cease to be
charitable activities by virtue of the proviso to section 2(15), leading to
consequent loss of exemption under sections 11 and 12. While the Jaipur,
Chennai, Ahmedabad and Ranchi Benches of the Tribunal have held that such
activity does not result in a loss of exemption, the Chandigarh Bench has
recently taken a contrary view, holding that the association loses its
exemption for the year due to such activity.

 

THE RAJASTHAN
CRICKET ASSOCIATION CASE

The issue came up
before the Jaipur Bench of the Tribunal in Rajasthan Cricket Association
vs. Addl. CIT, 164 ITD 212.

 

In this case, the
assessee was an association registered under the Rajasthan Sports
(Registration, Recognition and Regulation of Association) Act, 2005. It was
formed with the objective of promotion of the sport of cricket within the state
of Rajasthan. The main object of the association was to control, supervise,
regulate, or encourage the game of cricket in the areas under the jurisdiction
of the association on a ‘no profit-no loss’ basis. It was granted registration
u/s 12A. The assessee had filed its return claiming exemption u/s 11 for the
assessment year 2009-10.

 

During the course
of assessment proceedings, the AO observed that the assessee had earned
substantial income in the shape of subsidy from the Board of Control for
Cricket in India (BCCI), advertisement income, membership fees, etc. and
concluded that since the assessee was earning huge surplus, the same was not in
the nature of charitable purpose and was rather in the nature of business. The
AO, therefore, denied exemption u/s 11, computing the total income of the
association at Rs. 4,07,58,510, considering the same as an AOP. The
Commissioner (Appeals) upheld the order of the AO confirming the denial of exemption
u/s 11.

 

It was argued
before the Tribunal on behalf of the assessee that:

(i)    the term ‘any activity in the nature of
trade, commerce or business’ was not defined and thus the same had to be
understood in common parlance and, accordingly, the expression ‘trade, commerce
or business’ has to be understood as a regular and systematic activity carried
on with the primary motive to earn profit, whereas the assessee never acted as
a professional advertiser, TV producer, etc.;

(ii)   no matches of any game other than cricket or
no other events were organised to attract an audience, only cricket matches
were being organised, whether the same resulted in profit or loss. Further, not
all the cricket matches attracted an audience – the surplus had been earned
only from one cricket match;

(iii)   the Hon’ble Madras High Court in the case of Tamil
Nadu Cricket Association, 360 ITR 633 had held that volume should not
be the sole consideration to decide the activity of the society – rather, the
nature of activity vis-a-vis the predominant object was to be seen;

(iv) being registered under the Rajasthan Sports
(Registration, Recognition and Regulation of Association) Act, 2005, the
assessee was authorised as well as well-equipped for organising all the cricket
matches taking place in the state of Rajasthan.

(v)   all the payments in the shape of sponsorship,
advertisements, TV rights, etc. were received directly by BCCI which had later
shared such receipts with the assessee. Further, BCCI had delegated the task of
the organisation of matches to state associations and, in turn, state
associations were paid some funds for promotion and expansion of their
charitable activities;

 

(vi) a major benefit of organising the matches was
that the local teams, being trained by RCA, got an opportunity to learn from
the experience of coaches of international calibre assisting them during
practice matches and by witnessing the matches played by international players,
by spending time with them, etc. Ultimately, organising such matches resulted
in promotion of the sport of cricket and the surplus generated, if any, was purely
incidental in nature;

(vii) the assessee had been organising matches even
in the remote areas of Rajasthan where there few spectators and the assessee
association had to essentially incur losses in organising such matches;

(viii)  the surplus was the result of subsidies only
and not from the conducting of tournaments on a commercial basis. The subsidies
were a form of financial aid granted for promoting a specific cause, which was
ultimately for the overall benefit of a section of the public, but never for
the benefit of an individual organisation. The subsidy received was utilised in
the promotion and development of the sport of cricket in the state at each
level, i.e., from mofussil areas to big cities like Jaipur;

(ix) the renting of premises was done wholly and
exclusively for the purpose of cricket and no other activity of whatsoever
nature had been carried out, and neither was it engaged in the systematic
activity as a hotelier;

(x)   RCA was run by a committee which consisted of
members from different walks of life – such members were not professional
managers or businessmen. The agreement with the players was only to control and
monitor their activities, to ensure that the same was in accordance with the
objects;

 

(xi) The RCA was providing technical and financial
support to all the DCAs (District Cricket Associations), i.e., providing
equipments, nets, balls, etc. without any consideration. RCA was getting only
nominal affiliation fee from them and had provided grants of a substantial
amount to the DCAs;

(xii) RCA was organising various matches of national
level tournaments like Ranji Trophy, Irani Trophy, Duleep Trophy, Maharana
Bhagwat Singh Trophy, Salim Durrani Trophy, Laxman Singh Dungarpur Trophy,
Suryaveer Singh Trophy, matches for under-14s, u-15s, u-19s, u-22s, etc.,
without having any surplus. Rather, they were organised for the development of
the game of cricket at the national level and to identify the players who could
represent the country at the international level;

(xiii)  RCA was spending a large amount on the
training and coaching camps for which no fee was charged from the participants;

(xiv)  the assessee had organised several
championships in various interior towns and smaller cities of Rajasthan in
order to provide an opportunity and to create a competitive environment for the
talented youth, without any profit motive and with the sole intention to
promote the game of cricket;

(xv)       the surplus, if any, generated by the
assessee was merely incidental to the main object, i.e., promotion of the sport
of cricket and in no way by running the ‘business of cricket’.

 

Reliance was placed
on behalf of the assessee on the following decisions:

(a)   the Delhi High Court in the case of Institute
of Chartered Accountants of India vs. Director-General of Income Tax
(Exemptions) 358 ITR 91;

(b)   the Madras High Court in the case of Tamil
Nadu Cricket Association vs. DIT(E) 360 ITR 633;

(c)   the Delhi bench of the ITAT in Delhi
& District Cricket Association vs. DIT (Exemptions) 69 SOT 101 (URO); and

(d)   the Delhi bench of the ITAT in the case of DDIT
vs. All India Football Federation 43 ITR(T) 656.

 

On behalf of the
Revenue, it was argued that:

(1)   the entire argument of the assessee revolved
around the theory that grant of registration u/s 12A automatically entitled it
for exemption u/s 11. The case laws cited by the assessee in the case of the T.N.
Cricket Association and DDCA, etc., were in the context
of section 12A and were inapplicable;

(2)   the domain of registration u/s 12AA and
eligibility for exemption u/s 11 were totally independent and different. At the
time of registration, CIT was not empowered to look into the provisions of
section 2(15); these were required to be examined only by the AO at the time of
assessment;

(3)   once the first proviso to section 2(15) got
attracted, the assessee lost the benefit of exemption as per the provisions of
section 13(8) – therefore, the only question to be decided was whether the
assessee was engaged in commercial activity for a fee or other consideration;

(4)   the nature of receipt in the hands of the
assessee was by way of sharing of sponsorship and media rights with BCCI, as
well as match revenue for conducting various cricket matches. The assessee had earned
surplus of 75% out of the receipts in the shape of advertisement, canteen and
tickets, which amounted to super-normal profit. Therefore, the income of the
assessee from ‘subsidy’ was nothing but a percentage of the fee gathered from
the public for matches and a percentage of advertisement receipts while
conducting matches;

 

(5)   the nature of receipts in the hands of the
assessee certainly fell under ‘Trade & Commerce’ as understood in common
parlance. Once the receipts were commercial in nature and such receipts
exceeded the threshold of
Rs. 10 lakhs as the proviso then provided (both conditions satisfied in the
assessee’s case), the assessee would be hit by the proviso to section 2(15);

(6)   and once the proviso to 2(15) was attracted,
the assessee ceased to be a charitable organisation irrespective of whether it
was registered u/s 12A. Grant of registration u/s 12A did not preclude the AO
from examining the case of the assessee in the light of the said proviso and if
he found that the assessee was hit by the proviso, then the assessee ceased to
be a charitable organisation;

(7)   the receipts of ICAI were basically from
members (and not the public as in the case of the assessee) and did not exploit
any commercial / advertisement / TV rights as in the case of the assessee. One
test of the commercialism of receipt was whether receipts were at market rates
and were open to subscription by the general public as opposed to a select few
members;

(8)   and once the provisos to 2(15) were attracted,
the assessee lost the benefit of exemption u/s 11 as per section 13(8) and the
entire income became taxable.

 

The Tribunal noted
that the Revenue had not doubted that the assessee had conducted cricket
matches; the only suspicion with regard to the activity was that during the
One-Day International match played between India and Pakistan there was huge
surplus and the assessee had rented out rooms belonging to the association at a
very high rate. Therefore, according to the Tribunal, it could be inferred that
the AO was swayed by the volume of receipts. It noted that these identical
facts were also before the Hon’ble Madras High Court in the case of Tamil
Nadu Cricket Association vs. DIT (Exemptions) 360 ITR 633, wherein the
Court opined that from the volume of receipts an inference could not be drawn
that an activity was commercial and that those considerations were not germane
in considering the question whether the activities were genuine or carried on
in accordance with the objects of the association.

 

Further, it was not
in dispute that the TV subsidy, sale on advertisements, surplus from the ODI
between India and Pakistan, income from the RCA Cricket Academy were all
related to the conduct of cricket matches by the association. Without the
conduct of matches, such income could not have been derived. Therefore, the
incomes were related to the incidental activity of the association which
incomes could not accrue without the game of cricket.

 

The Tribunal, while
examining the facts from the perspective of volume of receipts and constant
increase in surplus, referred to the Supreme Court decision in the case of Commissioner
of Sales Tax vs. Sai Publication Fund [2002] 258 ITR 70, for holding
that where the activity was not independent of the main activity of the assessee,
in that event, such ancillary activity would not fall within the term
‘business’.

It added that the
objection of the AO was that the other activities overshadowed the main
activity, based upon the receipts of the assessee from the other activity. It,
however, noted that all those activities were dependent upon the conduct of the
match. Referring to various High Court decisions, the Tribunal was of the view
that the AO was swayed by the figures and the volume of receipts. It noted that
such receipts were intermittent and not regular and also were dependent on the
conduct of cricket matches. It was not the other way round, that the cricket
matches were dependent upon such activities. According to the Tribunal, the
facts demonstrated that the assessee had been predominantly engaged in the
activity of promoting cricket matches. The Tribunal, therefore, held that the
AO was not justified in declining the exemption.

 

A similar view has
also been taken by the Tribunal in the cases of Tamil Nadu Cricket
Association vs. DDIT(E) 42 ITR(T) 546 (Chen.); DCIT(E) vs. Tamil Nadu Cricket
Association 58 ITR(T) 431 (Chen.); Gujarat Cricket Association vs. JCIT(E) 101
taxmann.com 453 (Ahd.); Jharkhand State Cricket Association vs. DCIT(E) (Ran.);
Chhattisgarh State Cricket Sangh vs. DDIT(E) 177 ITD 393 (Rai.); and DDIT(E)
vs. All India Football Federation 43 ITR(T) 656 (Del).

 

THE PUNJAB CRICKET ASSOCIATION CASE

The issue again
came up before the Chandigarh Tribunal in the case of the Punjab Cricket
Association vs. ACIT 109 taxmann.com 219.

 

In this case, the
assessee cricket association was a society registered under the Societies
Registration Act, 1860. It was also registered u/s 12A of the Income Tax Act.
It filed its return of income claiming exemption u/s 11 for the assessment year
2010-11.

 

The AO observed
that the income of the assessee was inclusive of an amount of Rs. 8,10,43,200
from IPL­subvention from BCCI and Rs. 6,41,100 as service charges for IPL
(Net). The AO observed that the IPL event was a highly commercial event and the
assessee had generated income from the same by hosting matches of Punjab
franchisee ‘Kings XI, Punjab’ during the Indian Premier League through TV
rights subsidy, service charges from IPL and IPL-subvention, etc. Similarly,
the assessee had earned income from the facilities of swimming pool, banquet
hall, PCA chamber, etc., by hosting these facilities for the purpose of
recreation or one-time booking for parties, functions, etc., which activities
were commercial in nature, as the assessee was charging fees for providing the
facilities to its members. The assessee had also received income from M/s
Silver Services who provided catering services to Punjab Cricket Club and its
restaurant, which again was a commercial activity, as the assessee was earning
income from running of the restaurant which was not related to the aims and
objectives of the society. According to the AO, the activities of the assessee
were not for charitable purposes, and therefore, in view of the proviso to
section 2(15), he disallowed the claim of exemption u/s 11.

 

The Commissioner
(Appeals) dismissed the appeal of the assessee observing that:

(a)   it could not be disputed that the Indian
Premier League was a highly commercialised event in which huge revenue was
generated through TV rights, gate-money collection, merchandising and other
promotions;

(b)   the franchises had been sold to corporates
and individuals and in this process, the appellant had received a huge income
of Rs. 8,10,43,200 for IPL-subvention from BCCI, service charges (Net) of Rs.
6,41,100 and reimbursement of Rs. 1,86,64,990 from BCCI;

(c)   the argument of the appellant that all the
tickets of the IPL matches were sold by the BCCI or the franchisee team, and
the IPL players were sold in public auction for a huge amount, was all done by
the BCCI and the appellant had no role in conducting these matches, could not
be accepted, as huge revenue was generated in this commercial activity and
whether it was done by BCCI or by the appellant, the share of the income so generated
had been passed on to the appellant;

(d)   the Chennai Tribunal’s decision in the case
of Tamil Nadu Cricket Association (Supra) did not apply to the
appellant’s case as in that case the assessee had received funds from BCCI for
meeting the expenditure as the host, while in the case of the appellant it was
not only the reimbursement of expenses but over and above that a huge amount
had been passed on to the appellant;

(e)   the activity generating the income, whether
undertaken by BCCI or by the appellant, was purely a business activity of which
the appellant was a beneficiary.

 

It was argued before the Tribunal on behalf of the assessee that:

  •     the assessee was not involved in any manner
    in organising or commercially exploiting the IPL matches. The commercial
    exploitation, if any, was done by the BCCI;
  •     the only activity on the part of the
    assessee was the renting out of its stadium to BCCI for holding of IPL matches;
  •     ‘T-20’ or IPL was also a
    form of popular cricket. Since the main object of the assessee was the
    promotion of the game of cricket, considering the popularity of the IPL
    matches, the renting out of the stadium for the purpose of holding of IPL
    matches by the BCCI for a short period of 30 days in a year was an activity
    towards advancement of the objects of the assessee, of promotion of the game;
  •     in lieu of providing the
    stadium, the assessee got rental income for a short period and renting out the
    stadium was not a regular business of the assessee;
  •     the grant received from the
    BCCI during the year under consideration in the form of share of TV subsidy of
    Rs. 18,00,76,452 and IPL subvention of Rs. 8,10,43,200 was part of the largesse
    distributed by BCCI to its member associations at its discretion for promotion
    of the sport of cricket;

 

  •     BCCI was not obliged to
    distribute the earnings generated by it to state cricket associations and no
    such association could claim, as an integral right, any share in the earnings
    of BCCI;
  •     even if a member state
    association did not provide any assistance in holding of the IPL matches, or
    when the IPL match was not hosted or organised at the stadium of an
    association, yet the member cricket association got a grant out of the TV
    subsidy. However, if a match was staged or hosted at the ground of an
    association, the amount of subsidy was increased;
  •     whatever had been received
    from the BCCI on account of IPL subvention was a voluntary, unilateral donation
    given by BCCI to various cricket associations, including the assessee, to be
    expended for the charitable objects of promotion of the game of cricket and not
    in lieu of carrying out any activity for conducting of IPL;
  •     the assessee had no locus
    with respect to the promotion and conduct of IPL, except for the limited extent
    of providing its stadium and other allied services for holding of the matches.
    The question whether the conduct of IPL was a commercial activity or not might
    be relevant from BCCI’s standpoint, but not to the case of the assessee;
  •     the assessee’s income,
    including grants received from BCCI, was applied for attainment of the objects
    of the assessee society, i.e., mainly for promotion of the game of cricket;

 

  •     the assessee was running a
    regional coaching centre wherein gaming equipment / material was also provided
    such as cricket balls, cricket nets, etc. The assessee also distributed grants
    to the district cricket associations attached to it for the purpose of laying
    and maintenance of grounds, purchase of equipment, etc., as well as for holding
    of matches and for the purpose of promoting the game of cricket;
  •     the assessee conducted
    various tournaments for the member district cricket associations. On the basis
    of the inter-district tournaments, players were selected for the Punjab team
    who underwent training at various coaching camps and thereafter the teams were
    selected to participle in the national tournaments for different age groups. In
    addition, financial assistance had also been provided to the ex-Punjab players
    in the shape of monthly grants;
  •     the assessee was also
    maintaining an international cricket stadium, which gave needed practice and
    exposure to the cricketers. Even other sports facilities like swimming pool,
    billiards, lawn tennis, etc., were provided to the members as well as to the
    cricketers, which activities were also towards the achievement of the objects
    of the assessee society;
  •     the assessee had been
    spending substantial amounts towards development of the game at the grassroots
    level and also for the development and promotion of the game by holding
    international matches;
  •     the assessee was only
    conducting activities in pursuance of the objects, i.e., the promotion of the
    game of cricket in India and that merely because some revenue had been
    generated in pursuance of such activities, the same was not hit by the proviso
    to section 2(15);

 

  •     the Supreme Court had held
    in CIT vs. Distributors (Baroda) (P) Ltd. 83 ITR 377 that
    ‘business’ refers to real, substantial, organised course of activity for
    earning profits, as ‘profit motive’ is an essential requisite for conducting
    business;
  •     Delhi High Court in India
    Trade Promotion Organization vs. DIT(E) 371 ITR 333    , reading down the
    scope of the proviso to section 2(15), had held that an assessee could be said
    to be engaged in business, trade or commerce only where earning of profit was
    the predominant motive, purpose and object of the assessee and that mere
    surplus from incidental or ancillary activities did not disentitle claim of
    exemption u/s 11;
  •     Punjab & Haryana High
    Court in the cases of The Tribune Trust vs. CIT & CIT (Exemptions)
    vs. Improvement Trust, Moga 390 ITR 547     had approved the predominant
    object theory, i.e. if the predominant motive or act of the trust was to
    achieve its charitable objects, then merely because some incidental income was
    being generated that would not disentitle the trust to claim exemption u/s 11
    r.w.s. 2(15);
  •     all the incidental income /
    surplus so earned by the assessee in the course of advancement of its object of
    promotion of the game of cricket had been ploughed back for charitable
    purposes;
  •       profit-making was not the
    motive of the assessee and the only object was to promote the game of cricket.

 

It was argued on
behalf of the Revenue that:

(1)   in the annual report of BCCI, the concept of
IPL was described as merger of sport and business – the various IPL-related
activities described in the report indicated that the entire IPL show was a
huge money-spinner and had been rightly termed as ‘cricketainment’ by the BCCI;

(2)   the 38th Report of the Standing
Committee on Finance, dealing with Tax Assessment / Exemptions and related
matters concerning IPL / BCCI, mentioned that the income derived from media
rights and sponsorships was shared with the franchisees as envisaged in the
franchise agreement. The franchisees had to pay the BCCI an annual fee which
BCCI distributed to the associations as subvention. The report highlighted the
commercial character of IPL, which established that no charitable activity was
being promoted in organising the commercial venture called BCCI-IPL;

(3)   the Justice Lodha Committee, set up by the
Supreme Court, highlighted the unhealthy practices of match-fixing and betting.
Its report highlighted the indisputable fact that there was absolutely no
charitable work which was undertaken by the BCCI or its constituents while
organising the cricket, especially IPL, where the entire spectacle of
‘cricketainment’ was a glamorous money-spinner;

(4)   the Justice Mudgal IPL Probe Committee, set up
by the Supreme Court, highlighted the allegation of match / spot-fixing against
players. It further found that the measures undertaken by the BCCI in combating
sporting fraud were ineffective and insufficient. The facts demonstrated that
no charitable activity was undertaken in various matches conducted by BCCI-IPL.
The report highlighted the commercial character of the venture sans any
trace of charitable activity;

 

(5)   the Bombay High Court, in the case of Lalit
Kumar Modi vs. Special Director in WP No. 2803 of 2015, observed that
if the IPL had resulted in all being acquainted and familiar with phrases such
as ‘betting’, ‘fixing of matches’, then the RBI and the Central Government
should at least consider whether holding such tournaments served the interest
of a budding cricketer, the sport and the game itself;

(6)   the tripartite agreement / stadium agreement
proved that the assessee was intrinsically and intimately involved in
organising the commercial extravaganza of the IPL. It required the PCA to
provide all the necessary co-operation and support to the BCCI-IPL and the
franchisee. It mandated the PCA to provide adequate, sufficiently skilled and
trained personnel to BCCI-IPL at its own cost. The PCA was duty-bound to ensure
that TV production took place at the stadium according to the requirements of
TV producers. It required PCA to erect and install all the desired facilities,
structures and equipment required in connection with the exploitation of media
rights at its own cost. It was to use its best endeavour to make areas
surrounding the stadium available for exploitation of the commercial rights.
The PCA agreed to assist the BCCI-IPL with local trading standard department,
police, private security arrangements, with a view to minimising or eliminating
certain exigencies pertaining to matches, advertising / promotions,
unauthorised sale of tickets, etc. All costs of such services were to be borne
by the PCA;

(7)   the above clauses amply demonstrated that the
PCA, being the federal constituent and full member of BCCI, had taken various
steps / initiatives at its own cost to ensure that the BCCI-mandated IPL
matches were organised smoothly and were a huge commercial success;

(8)   no claim was made on behalf of the assessee
that the BCCI-IPL matches were charitable activities;

(9)   a perusal of the case laws cited on behalf of
the assessee revealed that the Hon’ble Courts therein were not presented with
public documents / Standing Committee Reports / facts wherefrom judicial notice
could be taken as per the Evidence Act.

 

Summons was issued
to the BCCI by the Tribunal for determination of the character of the amounts
paid by it to the assessee. BCCI clarified that there were two types of
payments made by it – reimbursements of expenditure which the state
associations had to incur for conduct of matches, and a share in the media
rights income earned by the BCCI. The claim of the BCCI was that these payments
were application of income for the purpose of computation of income u/s 11.
Since the tax authorities were denying BCCI the exemption u/s 11, strictly in
the alternative and without prejudice to its contention that the entire sum was
allowable as an application, BCCI had contended that the payments were
allowable as a deduction u/s 37(1).

 

The Tribunal observed that a perusal of the accounts of the BCCI revealed
that it had booked the above payments to the state associations as expenditure
out of the gross receipts. The BCCI had taken a clear and strong stand before
the tax authorities, including appellate authorities, that the payment to the
state associations was not at all an appropriation of profits. The Tribunal
noted certain appellate submissions made by the BCCI in its own case, which
seemed to indicate that it was organising the matches jointly with the state
associations.

 

In response to the
above observations, it was contended on behalf of the assessee that:

(a)   the primary plea / stand of the BCCI is that
the payments / grants made by it to the state associations is application of
income, hence it is only a voluntary grant given by the BCCI to the state
associations, including the assessee, for the purpose of the promotion of the
game of cricket, hence it cannot be treated as income of the assessee from IPL
matches;

(b)   the alternate stand of the BCCI that the
payments to the state associations be treated as expenditure in the hands of
the BCCI was opposite and mutually destructive to the primary stand of the BCCI
and thus could not be made the basis to decide the nature of receipts from BCCI
in the hands of the assessee;

(c)   the Revenue authorities, even otherwise, have
consistently rejected the aforesaid alternate contention of the BCCI and the
entire receipts from the IPL had been taxed in the hands of the BCCI;

(d)   if the BCCI was treated as an Association of
Persons (AOP) as per the plea of the Revenue, still, once the entire income
from IPL had been taxed in the hands of an AOP, further payment by BCCI to its
member associations could not be taxed as it would amount to double taxation of
the same amount.

 

The corresponding
submissions of the Revenue were:

(A)   the Punjab Cricket Association was absolutely
involved in the commercial venture of IPL;

(B)   BCCI had stated that it did not have the
infrastructure and the resources to conduct the matches by itself and was
dependent on the state associations to conduct them;

(C)   according to BCCI, the income from media
rights was dependent on the efforts of the state associations in conducting the
matches from which the media rights accrued;

(D) as per the BCCI, the state
associations were entitled by virtue of established practice to 70% of the
media rights fee. It was in expectation of the revenue that the various state
associations took an active part and co-operated in the conduct of the matches.
The payment was therefore made only with a view to earn income from the media
rights;

(E)   it was clear that the transaction between the
BCCI and the PCA was purely commercial in nature and the income / receipts
received by the PCA were in lieu of its services rendered to BCCI;

(F)   the share of revenue from BCCI out of sale of
media rights was not a grant – the various payments made by the BCCI ensured
that the state associations were ever ready with their stadia and other
infrastructure to ensure smooth execution of IPL matches.

 

On the basis of the
arguments, the Tribunal observed that the status of the BCCI was of an
Association of Persons (AOP) of which the state associations, including the
assessee, were members. It noted that the BCCI, in its consistent plea before
the tax authorities had claimed that the payments made to the state
associations were under an arrangement of sharing of revenues with them. BCCI
had pleaded that it had just acted as a facilitator for the sale of media
rights collectively on behalf of the state associations for the purpose of
maximising the profits, for which it retained 30% of the profits and the
remaining 70% belonged to the state associations. According to the Tribunal,
when the payer, i.e., BCCI, had not recognised the payments made by it to the
state associations as voluntary grant or donation, rather, the BCCI had
stressed that the payments had been made to the state associations under an
arrangement arrived at with them for sharing of the revenues from international
matches and the IPL, then the payee (the recipient associations) could not
claim the receipts as voluntary grants or donations at discretion from the
BCCI.

 

The Tribunal,
however, noted that the legal status as of that date was that BCCI was being
treated by the tax authorities as an AOP and the payments made to the state
associations as distribution of profits. The BCCI payments to the state
associations, including the appellant, having already been taxed in the hands
of BCCI, could not be taxed again in the hands of the member of the AOP, i.e.,
the state association, as it would amount to double taxation of the same
amount.

 

Further, it
observed that the state associations in their individual capacity were pleading
that the IPL might be the commercial venture of their constituent and apex
body, the BCCI, but that they were not involved in the conduct of the IPL.
However, these associations had collectively formed the apex association named
BCCI, got it registered under the Tamil Nadu Societies Registration Act and
thereby collectively engaged in the operation and conduct of the IPL through
their representatives in the name of BCCI. As per the Tribunal, PCA was
individually taking a totally opposite stand to the stand it had taken
collectively with other associations under the umbrella named as BCCI.

 

The Tribunal
observed that it was settled law that what could not be done directly, that
could not be done indirectly, too. If an institution claiming charitable status
being constituted for the advancement of other objects of public utility as per
the provisions of law was barred from involving in any commerce or business, it
could not do so indirectly also by forming a partnership firm or an AOP or a
society with some other persons and indulge in commercial activity. Any
contrary construction of such provisions of law in this respect would defeat
the very purpose of its enactment.

 

According to the
Tribunal, the assessee was a full member of BCCI, which was an AOP, which had
been held to be actively involved in a large-scale commercial venture by way of
organising IPL matches, and therefore the assessee could be said to have been
involved in a commercial venture as a member of the BCCI, irrespective of the
fact whether it received any payment from the BCCI or not, or whether such
receipts were applied for the objects of the assessee or not. However, once the
income was taxed in the hands of the AOP, the receipt of share of the income of
the AOP could not be taxed in the hands of the member of the AOP. For the sake
of ease of taxation, the AOP had been recognised as a separate entity; however,
actually, its status could not be held to be entirely distinct and separate
from its members and that was why the receipt of a share by a member from the
income of its AOP would not constitute taxable income in the hands of the
member.

 

The Tribunal
observed that even otherwise, PCA was involved in commercial activity in a
systemic and regular manner not only by offering its stadium and other services
for conduct of IPL matches, but by active involvement in the conduct of matches
and exploiting their rights commercially in an arrangement arrived at with the
BCCI. According to the Tribunal, there was no denial or rebuttal by the
appellant to the contention that the IPL was purely a large-scale commercial
venture involving huge stakes, hefty investments by the franchisees, auction of
players for huge amounts, exploiting to the maximum the popularity of the game
and the love and craze of the people of India for cricket matches. From a
reading of the tripartite agreement, the Tribunal was of the view that it
showed that the assessee was systematically involved in the conduct of IPL
matches and not just offering its stadium on rent to BCCI for the conduct of
the matches.

 

The Tribunal
further accepted the Department’s argument that the BCCI, which was constituted
of the assessee and other state associations, had acted in monopolising its
control over cricket and had also adopted a restrictive trade practice by not
allowing the other associations, who may pose competition to the BCCI, to hold
and conduct cricket matches for the sole purpose of controlling and exclusively
earning huge revenue by way of exploiting the popularity of cricket. PCA, being
a constituent member of the BCCI, had also adopted the same method and rules of
the BCCI for maintaining its monopoly and complete domain over the cricket in
the ‘area under its control’. Such an act of exclusion of others could not be
said to be purely towards the promotion of the game, rather, it was an act
towards the depression and regression of the game. Hence the claim of the
assessee that its activity was entirely and purely for the promotion of the
game was not accepted by the Tribunal. The Tribunal also did not accept the
assessee’s argument that the payment to it by the BCCI was a grant, holding
that it was a payment in an arrangement of sharing of revenue from commercial
exploitation of cricket and infrastructure thereof.

 

The Tribunal took
the view that the commercial exploitation of the popularity of cricket and its
infrastructure by the assessee was not incidental but was, inter alia,
one of the main activities of the assessee. It relied upon certain observations
of the Supreme Court in the case of Addl. CIT vs. Surat Art Silk Cloth
Manufacturers’ Association 121 ITR 1, to point out that there was a
differentiation between ‘if some surplus has been left out of incidental
commercial activity’ and ‘the activity is done for the generation of
surplus’ – the former would be charitable, the latter would not be
charitable. The Tribunal was of the view that despite having the object of
promotion of sports, the fact that the activity of the assessee was also
directed for generation of profits on commercial lines would exclude it from
the scope of charitable activity.

 

Even if it was
assumed that the commercial exploitation of cricket and infrastructure was
incidental to the main purpose of promotion of cricket, even then, in view of
the decision of the Chandigarh Bench of the Tribunal in the case of Chandigarh
Lawn Tennis Association vs. ITO 95 taxmann.com 308, as the income from
the incidental business activity was more than Rs. 10 lakhs [as the proviso to
section 2(15) then provided], the proviso to section 2(15) would apply,
resulting in loss of exemption.

Therefore, the
Tribunal held that the case of the assessee would not fall within the scope of
‘charitable purpose’ as defined in section 2(15), as the commercial
exploitation of the popularity of the game and the property / infrastructure held
by the assessee was not incidental to the main object but was apparently and inter
alia one of the primary motives of the assessee. Hence the assessee was not
entitled to exemption u/s 11.

 

The Tribunal
further noted that PCA had amended its objects to add the following object: ‘To
carry out any other activity which may seem to the PCA capable of being
conveniently carried on in connection with the above, or calculated directly or
indirectly to enhance the value or render profitable or generate better income
/ revenue, from any of the properties, assets and rights of the PCA;’

 

According to the
Tribunal, the amendment revealed that the assessee’s activities inter alia
were also directed for generation and augmentation of revenue by way of
exploitation of its rights and properties, and with the amended objects it
could exploit the infrastructure so created for commercial purposes which
supported the view taken by the Tribunal.

 

OBSERVATIONS

The Chandigarh
Tribunal seems to have gone into the various facts in far greater detail than
the Jaipur, Chennai, Ahmedabad and Ranchi Benches, having examined the stand
taken by the BCCI, in its accounts and before the tax authorities, as well as
examined the reports of various committees set up by the Supreme Court to look
into match-fixing and the management of the affairs of BCCI. It rightly
highlighted the observations of the Supreme Court in Surat Art Silk Cloth
Manufacturers Association (Supra), where it observed:

 

‘Take, for
example, a case where a trust or institution is established for promotion of
sports without setting out any specific mode by which this purpose is intended
to be achieved. Now obviously promotion of sports can be achieved by organising
cricket matches on free admission or no-profit-no-loss basis and equally it can
be achieved by organising cricket matches with the predominant object of
earning profit. Can it be said in such a case that the purpose of the trust or
institution does not involve the carrying on of an activity for profit, because
promotion of sports can be done without engaging in an activity for profit. If
this interpretation were correct, it would be the easiest thing for a trust or
institution not to mention in its constitution as to how the purpose for which
it is established shall be carried out and
then engage itself in an activity for profit in the course of actually carrying
out of such purpose and thereby avoid liability to tax. That would be too
narrow an interpretation which would defeat the object of introducing the words
“not involving the carrying on of any activity for profit”. We cannot
accept such a construction which emasculates these last concluding words and
renders them meaningless and ineffectual.’

 

The Tribunal
incorrectly interpreted this to apply to the facts of the assessee’s case,
since the Tribunal was of the view that the assessee was organising cricket
matches with a view to earn profit.

 

Besides holding
that PCA was carrying on a business activity of assisting BCCI in the conduct
of matches, one of the basis of the Chandigarh Tribunal decision was that since
BCCI was carrying on a commercial activity every member of BCCI (an AOP) should
also be regarded as carrying on a commercial activity through BCCI, which would
attract the proviso to section 2(15). In so doing, it seems to have ignored the
fact that under tax laws an AOP and its members are regarded as separate
entities and the activities carried on by each need to be evaluated independently.
For instance, if a charitable organisation invests in a mutual fund and its
share of income from the mutual fund is considered for taxation in the hands of
the charitable organisation, does it necessarily follow that the charitable
organisation is carrying on the business of purchase and sale of shares and
securities just because the mutual fund is doing so?

 

Secondly, the
Chandigarh Tribunal relied on the BCCI’s alternative contention that the
payments to the state associations should be treated as expenditure incurred by
it, ignoring BCCI’s main contention that it was a division of surplus amongst
the member associations. A division of surplus cannot be regarded as an income
from exploitation of assets, nor can it be regarded as a compensation for services
rendered.

 

Thirdly, the Tribunal relied on the then prevalent income tax appeal
status of BCCI, ignoring the fact that the appeals had not yet attained
finality; the conclusions in the appeals were therefore only a view of the
interim appellate authorities which may undergo a change on attaining finality.
Placing absolute reliance on such ratios of appeals of BCCI not yet finally
concluded, for deciding the case of PCA, was therefore not necessarily the
right approach.

The Chandigarh
Tribunal also seems to have taken the view that generating better returns from
use of properties, assets or rights amounts to commercialisation, vitiating the
charitable nature. That does not seem to be justified, as every person or
organisation, even though they may not carry on business, may seek to maximise
their income from assets. Can a charitable organisation be regarded as carrying
on business just because it invests in a bank which offers higher interest than
its existing bank? Would it amount to business if it lets out premises owned by
it to a person who offers to pay higher rent, rather than to an existing tenant
paying lower rent? Seeking maximisation of return from assets cannot be the
basis for determination of whether business is being carried on or not.

 

Can it be said that
merely because PCA was assisting BCCI in conducting the IPL matches at its
stadium it was engaged in a business activity? Such assistance may not
necessarily be from a profit-earning motive. It could be actuated by the motive
of popularising the game of cricket amongst the public, or by the desire to
ensure better utilisation of its stadium and to earn rent from its use. This
would not amount to carrying on of a business activity.

 

The question which
would really determine the matter is as to the nature of the amounts paid by
BCCI out of the telecast rights. Were such payments for the support provided by
the associations, for marketing of telecast rights by BCCI on behalf of the
state associations, a distribution of surplus by BCCI, or a grant by BCCI to
support the state associations?

 

If one examines the
submissions made by BCCI to the Tribunal in response to the summons issued to
it, it had clarified that payments towards participation subsidy, match and
staging subsidies were in the nature of reimbursements of expenditure which the
state associations have to incur for conduct of matches. This indicates that
the state associations incur the expenditure for the matches on behalf of BCCI,
which expenditure is reimbursed by BCCI. This indicates that the activity of
conduct of the tournament was that of BCCI.

 

In respect of the
second category of payments in regard to a share in the media rights income
earned by the BCCI, BCCI had clarified that these payments were application of
income for the purpose of computation of income u/s 11. Either donations /
grants or expenses incurred, both could qualify as application of income. In
the submissions to the Commissioner (Appeals) in its own case, BCCI had
clarified that such TV subvention represents payment of 70% of revenue from the
sale of media rights to state associations. These payments were made out of the
gross revenue from the media rights and not out of the surplus and were
therefore not a distribution of profit. Even if there were to be losses in any
year, TV subvention and subsidy would be payable to the state associations.

In its appeal
submissions, BCCI has stated that the state association is entitled to the
ticket revenue and ground sponsorship revenue. Expenses on account of security
for players and spectators, temporary stands, operation of floodlights, score
boards, management of crowds, insurance for the match, electricity charges,
catering, etc. are met by the state associations. On the other hand,
expenditure on transportation of players and other match officials, boarding
and lodging, expenses on food for players and officials, tour fee, match fee,
etc., are met by BCCI and the revenues from sponsorship belong to BCCI.

 

The submissions by
BCCI, in its appeal, further clarified that for a Test series or ODI series
conducted in multiple centres and organised by BCCI and multiple state
associations, it was found that if each state association were to negotiate the
sale of rights to events in its centre, its negotiating strength would be low.
It was, therefore, agreed that BCCI would negotiate the sale of media rights
for the entire country to optimise the income under this head. It was further
decided that out of the receipts from the sale of media rights, 70% of the
gross revenue, less production cost, would belong to the state associations.
Every year, BCCI has paid out 70% of its receipts from media rights (less
production cost) to the state associations. This amount has been utilised by
the respective associations to build infrastructure and promote cricket, making
the game more popular, nurturing and encouraging cricket talent and leading to
higher revenues from media rights.

 

From the above, it
is clear that while the conduct of matches may be physically done by the state
associations, it was BCCI which was responsible for the commercial aspects of
the IPL, such as sale of sponsorship rights, media rights, etc. BCCI pays 70%
of such revenues to the state associations for having permitted it to market
such rights. The state associations are conducting the matches as a part of
their object of promoting and popularising cricket. The conduct of matches was
quite distinct from marketing the rights to sponsor or telecast those matches.
Can the state associations be regarded as having carried on a commercial
activity, if they have granted the right to market such sponsorship and media
rights to the BCCI, with the consideration being a percentage of the revenues
earned by BCCI from such marketing?

 

A mere passive
receipt of income (though recurring and linked to gross revenues) for giving up
a valuable right may perhaps not constitute a business activity. An analogy can
be drawn from a situation where a business is given on lease to another entity
for running (or conducting). If such a lease is for a long period, various
Courts have taken the view that since the intention is not to carry on business
by the lessor, such lease rentals are not taxable as business profits of the
lessor. The mere fact that the lease rentals may be linked to the gross revenues
of the business carried on by the lessee would not change the character of the
income. It is only the lessee who is carrying on business and not the lessor.
On a similar basis, the carrying on of the business of marketing of rights by
BCCI would not change the character of matches conducted by the state
associations from a charitable activity carried on in furtherance of their
objects to a business activity, even if the state associations are entitled to
a certain part of the revenues for having given up the right to market such
rights.

 

In today’s times,
when watching of sport is a popular pastime resulting in large revenues for the
organisers, a mere seeking of maximising the revenue-earning potential of the
matches, in order to raise funds for furtherance of the cause of the sport,
cannot be said primarily to be the conduct of a business. The mere fact of the
quantum being large cannot change the character of an activity from a
charitable activity to a business activity, unless a clear profit-earning
motive to the exclusion of charity is established. This is particularly so when
all these state associations have been actively involved in encouraging sport
at the grassroots level in cities as well as smaller towns.

 

In a series of
decisions, the Supreme Court, the Madras, Gujarat and Bombay High Courts and
various benches of the Tribunal have held that the section 12A registration of
the state associations could not be cancelled merely on account of the fact
that they have conducted IPL matches. These decisions are:

 

DIT(E) vs.
Tamil Nadu Cricket Association 231 Taxman 225 (SC);

DIT(E) vs.
Gujarat Cricket Association R/Tax Appeal 268 of 2012 dated 27th
September, 2019 (Guj.);

Pr. CIT(E)
vs. Maharashtra Cricket Association 407 ITR 9 (Bom.);

Tamil Nadu
Cricket Association vs. DIT(E) 360 ITR 633 (Mad.);

Saurashtra
Cricket Association vs. CIT 148 ITD 58 (Rajkot ITAT);

Delhi &
District Cricket Association vs. DIT(E) 38 ITR(T) 326 (Del. ITAT);

Punjab
Cricket Association vs. CIT 157 ITD 227 (Chd. ITAT).

 

While most of these
decisions have been decided on the technical ground that applicability of the
proviso to section 2(15) cannot result in cancellation of registration u/s
12AA(3), in some of these decisions there has been a finding that the activity
of the conduct of the matches by the state associations is a charitable
activity in accordance with its objects.

 

Recently, in an
elaborate judgment of over 200 pages, the Gujarat High Court, hearing appeals
filed against the Tribunal orders in the case of Gujarat Cricket
Association (Supra), Baroda Cricket Association and Saurashtra
Cricket Association, in a series of appeals heard together (R/Tax
268 of 2012, 152 of 2019, 317 to 321 of 2019, 374 and 375 of 2019, 358 to 360
of 2019, 333 to 340 of 2019, 675 of 2019, and 123 of 2014, by its order dated
27th September, 2019), has decided the matter in favour of
the state associations. It noted from the resolution passed by BCCI that the
grants given by it were in the nature of corpus donations to the state
associations. After analysing the concept of ‘charitable purpose’, the
insertion of the proviso to section 2(15) and various case laws on the subject
of charity, the High Court held:

 

(i)    In carrying on the charitable activities,
certain surplus may ensue. However, earning of surplus, itself, should not be
construed as if the assessee existed for profit. The word ‘profit’ means that
the owners of the entity have a right to withdraw the surplus for any purpose,
including a personal purpose.

 

(ii)   It is not in dispute that the three
associations have not distributed any profits outside the organisation. The profits,
if any, are ploughed back into the very activities of promotion and development
of the sport of cricket and, therefore, the assessees cannot be termed to be
carrying out commercial activities in the nature of trade, commerce or
business.

 

(iii)   It is not correct to say
that as the assessees received a share of income from the BCCI, their
activities could be said to be the activities of the BCCI. Undoubtedly, the
activities of the BCCI are commercial in nature. The activities of the BCCI are
in the form of exhibition of sports and earning profit out of it. However, if
the associations host any international match once in a year or two at the
behest of the BCCI, then the income of the associations from the sale of tickets, etc., in such
circumstances would not portray their character as being of a commercial
nature.

 

(iv) The state cricket associations
and the BCCI are distinct taxable units and must be treated as such. It would
not be correct to say that a member body can be held liable for taxation on
account of the activities of the apex body.

 

(v)   Irrespective of the nature of
the activities of the BCCI (commercial or charitable), what is pertinent for
the purpose of determining the nature of the activities of the assessees is the
object and the activities of the assessees and not that of the BCCI. The nature
of the activities of the assessee cannot take its colour from the nature of the
activities of the donor.

The Gujarat High
Court has, therefore, squarely addressed all the points made by the Chandigarh
Tribunal while deciding the issue. It has emphatically held that the conduct of
the matches did not amount to carrying on of a business, particularly if the
surplus was merely on account of one or two matches. Further, the nature of
activity of BCCI cannot determine the nature of activity of the state
associations.

 

Therefore, as discussed in detail by
the Gujarat High Court, the better view seems to be that of the Jaipur,
Chennai, Ahmedabad, Delhi and Ranchi Benches of the Tribunal. But, given the
high stakes involved for the Revenue, it is highly likely that the matter will
continue to be agitated in the courts, until the issue is finally settled by
the Supreme Court.

 

RECORDS AND THEIR MAINTENANCE

Indirect tax being a transaction-based impost, it relies heavily on
transaction-level documentation for its implementation. The new millennium has
already completed a ‘graduation’ in statutory record maintenance – from preset
formats to content-based requirements. GST is a step in the same direction with
the added advantage of digitisation. This article lists some of the
documentation requirements under GST.

 

Persons liable to maintain records:

(a)        A person who is
registered (or liable to register) is required to maintain books of accounts
and records; distinct persons (such as branches, regional offices, etc.) of
such registered entities are required to maintain separate books of accounts
pertaining to their operations;

(b)        Certain designated
persons seeking registration for specific transactions (such as a deductor of
tax u/s 51; an e-commerce operator operating as a collector u/s 52; an input
service distributor) are required to maintain records for the purposes for
which they are designated;

(c)        The owner of a place of
storage of goods (such as a warehouse, godown, etc.) and transporters / C&F
agents are also required to maintain records of consignor, consignee and
specified details of goods. This requirement is placed even though the person
concerned does not have any ownership over the goods and their movement.
Independent enrolment forms have been prescribed (in Form ENR-01/02) for this
purpose. It is perceived that this provision is applicable only to person/s who
have possessory rights over the goods and should not be made applicable in
cases where the owner of the place of storage has merely leased out the
premises for storage without any control over the storage of goods.

(d)        Casual taxable person /
non-resident taxable person doing business temporarily in a state / country is
required to maintain books of accounts for its operational period in that state
/ country;

(e)        Agent (typically,
representative agent) is required to maintain accounts in respect of the
movement, inventory and tax paid on goods of each principal with the statement
of accounts of the principal;

(f) Reporting agencies (such as
state governments, registrars / sub-registrars, stock exchanges, the Goods and
Services Tax Network, electricity boards, etc.) are required to maintain and
report details of information specifically required to be reported in the
information return under GST;

(g)        A GST practitioner is
required to maintain records of the statements / returns being filed on behalf
of the registered persons.

 

List of records (section 35):

Section 35 of the CGST / SGST Acts provides for the maintenance of the
following records by registered persons at each place of business, e.g. each
stockyard would need to maintain a separate stock account of goods:

(i)     Production or manufacture
of goods,

(ii)    Inward and outward supply
of goods / services,

(iii)   Stock of goods,

(iv)   Input tax credit availed,

(v)    Output tax payable and paid,

(vi)   Any other requirement
specified.

 

In special circumstances, the Commissioner may on application prescribe
waiver over maintenance of specific documents, where the trade practice
warrants such waiver on account of difficulty in maintenance. Since this is a
discretionary power, the Commissioner can prescribe a conditional waiver (such
as subject to alternative document, etc.), too. Such records are required to be
audited by a chartered / cost accountant and submitted with the annual return
for the relevant year.

 

Specified Contents (Rule 56):

In addition to the above, the rules prescribe maintenance of the
following details:

 

(1) Stock registers should contain
quantitative details of:

(a) raw
material consumption,

(b)   details
of goods imported and exported,

(c)    production,
scrap / wastage, generation of by-products, loss / pilferage, gift / samples,
etc.

     Costing
records with standard conversion ratios can be maintained, especially in case
of standardised goods;

(2)  Transactions attracting
reverse charge with details of the inward supplies;

(3)  Register of prescribed
documents, i.e., tax invoice, debit / credit notes, receipts / payment / refund
vouchers, bills of supply and delivery challans;

(4)  Details of advance receipts,
payments and their adjustments.

 

Statutorily prescribed documents:

Tax invoices / debit notes / credit notes / e-way bills / receipt
vouchers etc. have been prescribed with their contents. These documents are not
permitted to be revised except where specified in the statute (such as issuance
of a revised invoice with attestation of the GSTIN number for a new registrant).

 

Tax invoices – These are required to be issued for
any taxable supply in accordance with the timings specified in section 31. It
not only proves supply of goods or services, but is also an essential document
for the recipient to avail Input Tax Credit. There are approximately 17
requirements and the said document is required to be issued in triplicate for
supply of goods and in duplicate for supply of services. Banking and insurance
companies have special instructions / waivers. An invoice document can be
signed with a digital signature of the supplier or its authorised
representative. An electronic invoice issued in terms of the Information
Technology Act, 2000 does not require a signature or digital signature. Persons
with a turnover above Rs. 1.5 crores and up to Rs. 5 crores and those above Rs.
5 crores should quote four-digit HSNs as against the eight-digit HSN in the
customs tariff.

 

Receipt / refund vouchers and payment
vouchers – These
documents are issued when there is flow of funds between the contracting
parties. This is a new prescription in comparison to the erstwhile laws and
aimed at documenting events occurring before the time of supply. Receipt
voucher is issued for any advance, refund vouchers are issued on refund of any
advance prior to issuance of tax invoice. Payment vouchers are issued by
recipients of supplies who are liable to tax under reverse charge provisions
signifying the date of payment and an affirmation to the supplier that he / she
would be making the payment under reverse charge provisions.

 

Debit / credit notes – Any upward / downward adjustment in
valuation after issuance of tax invoices can be undertaken only through debit /
credit notes. In the context of GST, these can only be issued in specific cases
u/s 34. But the section does not preclude any entity to issue debit / credit
notes in other circumstances in order to settle or adjust inter-party accounts.
In addition to the details specified in the tax invoice, the debit note and
credit note will also contain reference to the original invoice against which
it is being issued.

 

Bill of supply – This document is issued in case of an
exempt supply. In case where a taxpayer is making taxable and exempted supplies
(such as retailers), an invoice-cum-bill of supply can be issued containing the
required details.

 

Delivery challan – This document is required where
movement of goods takes place other than by way of supply, for job work, the
supply of liquid gas and other prescribed scenarios. It is also issued in case
of supply where the movement of goods takes place under completely /
semi-knocked-down condition in batches or lots. This should also be issued in
triplicate with the original document moving along with the goods in movement.

 

Business specific requirements:

(a)        Works contractors are
required to maintain details of receipt of goods / services and their
utilisation in respect of each works contract separately along with the other
details specified above. With effect from 1st April, 2019,
developers are required to maintain project-wise details of inputs, RCM and
books of accounts under the recently-issued real estate scheme;

(b)        While the principal is
principally liable to maintain records of its goods at job worker location, the
job worker is also required to maintain specific records in respect of each
principal’s goods, their consumption / output and their inward / outward
movement; and

(c)        Persons under the
composition scheme are required to maintain books of accounts and records with
specific waivers on the input tax credit front.

 

Electronic records – Rule 57:

Section 4 of the Information Technology Act, 2000 states that
maintenance of records in electronic form would meet statutory requirements
provided that the records should not be capable of being erased, effaced or
over-written and equipped with an audit trail, i.e., any amendment or deletion
of an incorrect entry should be under due authorisation and traceable with a
log of details. The electronic records [section 2(t) states that any data,
record or image or sound stored, received or sent in electronic form is an
electronic record] should be authenticated by means of digital signatures by
authorised agents of the registered person. The GST law also contains
provisions to this effect. Many accounting packages may not meet the
requirement of having an audit trail of data captured in the software and may
be staring at an unintended violation. Section 65B of the Indian Evidence Act,
1872 prescribed that an electronic record duly authenticated as per the IT Act
would serve as a documentary evidence in any proceeding and shall be admissible
in any proceedings without any further proof or production of the original
document.

 

Not only should the registered person maintain records of the respective
principal place and additional places, but should also take necessary steps for
recovery in case of data corruption or disaster recovery by maintaining
suitable back-ups of such records. In view of this specific prescription,
officers may be empowered to perform best judgement assessments even in cases
where records are irretrievable due to natural causes / accidents, etc., on
ground of non-maintenance of appropriate data recovery mechanisms.

 

Rule 56(15) requires electronic records to be authenticated with an
electronic signature. Interestingly, the IT Act considers an ‘electronic
signature’ secure and reliable only if the signature was created under the
exclusive control of the signatory and no other person. MSME managements
habitually handing over signatures to others for operational convenience are
finding this requirement to be an uphill task and an unknown risk.

 

Location / accessibility:

Records are required to be maintained at the principal place of business
specified for each state in which the registered person operates. In case of
additional places of business, location-specific records are required to be
maintained at the respective locations. In peculiar cases of un-manned
structures such as IT infrastructure, windmills, etc., constituting the place
of business, identification / sufficiency and accessibility of records would
become challenging. The documents should be readily accessible to the proper
officer and the taxpayer is duty-bound to assist the officer with all the
security systems in order to facilitate their verification.

 

Sufficiency in documentation:

GST places the onus on the taxpayer / Revenue to establish the presence
of a fact while invoking the provisions. The Indian Evidence Act, 1872 lays
down principles when evidence is sufficient to prove a fact, its probable
existence or non-existence. Under the Act, documentary evidences are segregated
into primary and secondary evidences and their implications as evidence have
been set out. In tax laws, the first resort to establish a fact is usually the
documentation maintained by the person. Normal accounting set-ups do not meet
all requirements prescribed in GST and information has to be sourced from the
operational set-up of the organisation. Some instances in the context of GST
are explained below:

 

(i) Time of
supply / raising tax invoice – One of the parameters used to ascertain the time of supply of
services is provision / completion of the service. Services are intangible in
nature and contracting parties usually do not document their start and end
point. An assessee operating under long-duration / phased contracts should
document milestones either with counter party (such as service completion
certificate, warranty certificates, etc.) or external certificates. This would
also assist the taxpayer to claim refund in case of excess payment arising on
cessation of contracts. The tax invoice should, apart from the mere description
of the service, also report the start and end date of the assignment with the
end deliverable in this time frame.

 

(ii) Input
tax credit claim –
Section 16(1)/(2) requires that the taxpayer establish use / intent to use and
receipt of services for establishing its right of input tax. The primary onus
is on the taxpayer for establishing this fact and once this is established it
would be the Revenue’s turn to establish this fact from records. Rule 57(13)
requires even service providers to establish utilisation of input services.
This becomes challenging and the authors’ view is that mere payment or debit in
the accounts of the assessee may not be sufficient to discharge the primary
onus. While there is no prescriptive list and it is highly fact-specific, the
taxpayer would have to establish the delivery of a service by the service
provider and its acceptance by the recipient, e.g. a company can furnish the
copy of the signed auditor’s report as proof of receipt of an audit service, an
IT company can furnish the repair and service report, etc. The recipient should
stamp the vendor tax invoice (electronic / physical) and map the same with
service completion report of the vendor’s counter signature to establish this
fact at a later date.

 

(iii) Possession of invoice vs. GTR-2A matching – Input tax credits are permissible on
the basis of invoices of the supplier. Vendors are also mandated to upload the
details of the invoices on the GST portal which can be matched by the recipient
at his / her end. Can this facility in the portal which has been designed to
act as a self-policing system for the Revenue also assist the taxpayer to
contend that the presence of the details on the portal is itself a recognised
invoice and a sufficient substitute to the requirement of possessing of the
original invoices? While one may argue that 2A reports do not capture all
details of an invoice (for testing eligibility, etc.), this is certainly a
plausible defence which taxpayers can resort to. Taxpayers can certainly
establish receipt of service by other collateral documents (such as contracts,
email trails, etc.) and these should ideally meet the requirements of officers
insisting on production of original invoices. The CBEC circular in the context
of refund has waived the requirement of submission of input invoices for
invoices appearing in the GTR-2A statement on the portal (No. 59/33/2018-GST,
dated 4th September, 2018).

 

(iv) Inventory in manufacturing and service
set-ups –
Manufacturers and service providers are required to maintain the stock of
consumption of goods. While the prescription is to maintain details of
consumption, it is advisable to map this with the costing records (standard
consumption ratios, etc.), bill of materials, shop floor registers, etc., in
order to produce the same before authorities in case of any allegation of
excessive wastage / clandestine removal, etc. The factory records should
contain the entire trail of consumption of raw materials right from the store
inwards up to the finished goods section. Batch records of inputs and their
journey to the particular batch of final products would be essential where raw
materials and finished goods do not have stable pricing. This also assists in computation
of any input tax reversal in case of ascertaining the input tax credit
component on destruction of goods such as by fire, etc. Service sector (without
a strong ERP) would face the challenge of establishing the consumption of
goods, especially where the unit of measurement of billing is different from
the UOM of the materials indented into the stock. In ‘Bill to Ship to
Movement’, the intermediate supplier should prove that the goods have been
received by the ‘end buyer’ in the transaction chain.

 

(v)        Valuation
under prescriptive rules, i.e., fair market value, rejection, cost plus, etc. – Valuation rules require to first
ascertain fair market value / open market value, non-monetary components, etc.
in case of fixing the taxable value. These values can be documented from market
databases, stock exchange details, regulatory publications, etc. Pricing of
like comparable transactions can be sought from third-party quotations;
purchase orders may be obtained and documented as a justification of the
valuation. In case cost-plus pricing is sought to be resorted to, documentation
of the rejections of other methodology and computation of costs through costing
records becomes essential.

 

(vi) Identification of inputs / input services /
capital and their usage in exclusive / common category – Rules 42/43 require tax credits to be
categorised in three baskets. The classification is driven by the end use of
the particular input. While the inventory records may record the issuance of
inputs to the particular goods / services, the end use of input services and
their exclusiveness to a particular class of supply (taxable, exempt,
zero-rated) should be documented through cost centres, project costing
documentations, etc.

 

(vii) Proving against unjust enrichment /
profiteering – Section
49(9) presumes that taxes paid by a person have been passed on to the recipient
of goods / services. Any claim of refund by such person would have to overcome
this burden of proof. As per the learning from erstwhile laws, one should
maintain affidavits, declarations from counter parties, price comparisons for
pre- and post the change in tax rates, costing / accounting records,
identification of end consumer, certifications, etc. for establishing against
unjust enrichment / profiteering.

 

(viii) Change in rate of goods / services and
cut-off date records: exemption to taxable vice-versa – In case of change in tax status for
goods / services, documentation over the criteria of supply of goods /
services, payment and invoicing should be maintained for all open transactions
on the said cut-off date. Apart from this, input tax credits of inputs in stock
or contained in unfinished / finished goods for availment / reversal should
also be maintained.

 

(ix) Maintenance of pre-GST documentation – Transitional provisions specify
certain conditions to be prevalent on 1st July, 2017 for availing benefits under the GST law. Moreover,
the status of certain unfinished transactions on this date (incomplete
services, partially billed services, advances, etc.) should have been
documented. For example, a dealer availing transition credit of stock available
from purchase prior to 1st July, 2017 should be in a position to map
the stock in hand to the invoice which should be within one year from the date
of introduction of GST.

 

(x)        Presence
/ absence of an intra-branch / registration activates – This is certainly a problem whose
solution is ‘elusive’ for all taxpayers having multi-locational presence. No
one, including the government administration, has a clue about this Pandora’s
Box. In a de-clustered environment, companies have started documenting internal
roles and responsibilities of offices and sharing of resources through
time-sheets and building invisible walls within the organisations. These are
passed at board meetings and maintained as per company records for future
production before officers. In clustered environments where the entire set-up
works so cohesively and partitions are impossible to be even envisioned and
documented, companies need to take a conservative approach and discharge the
taxes to protect themselves against any future cash loss.

 

(xi) Refund provisions require specific details – Refund procedures require certain
endorsements and proofs such as FIRCs / BIRCs for meeting the sanction
conditions. Currently, banks have refused to issue FIRCs on receipt of foreign
inward remittances citing a FEDAI circular. Some banks are issuing the same
only if a specific application has been made by the account holder. Being a
statutory requirement, as a last resort one should pursue this matter with the
banker and obtain alternative declarations which contain all the requirements
of the FIRC and make necessary submissions.

 

Other regulatory laws:

The Companies Act,
the Income-tax Act, banking / insurance regulation laws, etc. are also
governing organisations in record maintenance and GST requirements can be met
with the assistance of reports under other laws. Entities would of course have
to apply the more stringent provision in order to harmonise requirements across
laws. For example, the Companies Act requires that the books of accounts of the
company should be kept at the registered office except where the Board of
Directors adopts an alternative location with due information to the Registrar
of Companies. This conflict between GST and the Companies Act can be resolved
by the Board adopting a resolution to maintain accounts at distinct locations
to comply with GST laws. In any case, mere access to electronic records at a
particular location is also sufficient compliance with GST requirements in
terms of section 35 of the Act. The Companies Act also requires reporting the
Internet Service Provider credentials where details are maintained on a cloud
platform. The Income-tax Act requires maintenance of transfer pricing
documentation and this could serve as a ground for corroborating the valuation
approach of the taxpayer. Labour laws may require an establishment level
reporting of employees which may serve as deciding the salary costs of a
distinct person under GST. One would have to approach documentation with an
open mind to extract as much information as possible from available statutory reports rather than reinventing the
wheel and duplication of records.

 

Time limit for retention of records (section 36):

The prescribed records are required to be maintained for a minimum
period of six years from the due date of furnishing the annual return for the
relevant year. In case of any pending legal proceedings as at the end of six
years, the relevant documents pertaining to the subject-matter of dispute are
to be maintained for one year after the final disposal of the proceedings. With
the annual return due dates being extended to 31st December, 2019,
the due date of assessments and retention of records are also being extended
for the taxpayers concerned.

 

Implications for non-maintenance of records:

Non-maintenance of
records invites penalty u/s 122 to the extent of Rs. 10,000 or 100% of the tax
evasion, apart from the penalty imposable for non-payment of tax dues. Such
failure would invite best judgement assessment based on other data such as
electricity records, 2A reports, e-way bills, paper slips, past history, etc.
For the first time, the statute has introduced a fiction that non-accountal of
goods or services from records (shortage of goods on physical verification,
numerical variances, storage at unregistered places [rule 56(60)] etc.), would
invite show cause proceedings for recovery of tax on such goods. However, this
presumption is rebuttable with credible evidence, including the fact of
destruction, loss or otherwise of goods.

 

As one implements the
requirements, the trichotomy of materiality, practicality and technicality
would stare the taxpayer in the face. The dividing line of segregating
documents which are mandatory and those which are ancillary is very thin and
difficult for a taxpayer to decide upon. Law has prescribed the minimum
criteria and it is in the taxpayer’s own interest to implement the law and
maintain additional documents to substantiate his claims under the Act. It
takes less time to do things right than explain why you did it wrong – Henry
Wadsworth.

 

With
increased self-reporting over digital formats, there is also a high expectation
for the government to gear up its Information Technology capabilities. In a
bi-polar administration, it is very essential that the administration
streamline its documentation demands by avoiding parallel requests consuming
unnecessary time and economic resources. Governments should appreciate that
‘Compliance’ is just a subset of ‘Governance’ and not the other way round.

 

INDEPENDENT DIRECTORS

A recent notification mandates those who have been
independent directors (IDs) for not more than ten years to undergo a
proficiency test. We are told that India is the only country to start the
practice of proficiency tests.

Those desirous of appointment as IDs have to apply
online to include their names in a databank. Increase in the size of a
‘databank’ is good news, when many ‘commercial banks’ are kept afloat with
infusion of taxpayer money. One would hope that such tests will bring to the
databanks, and eventually to the Boards, IDs who will strengthen the
functioning of commercial banks.

Education is generally a welcome step when it is
in the field of one’s operation. Refreshing knowledge and remaining current is
imperative in the times of change and uncertainty.

The Indian education system historically and
chiefly focuses on technical aspects with little emphasis on the eventual
functionality of that knowledge. Knowledge without a clear and direct link to
practical use is futile. I remember a top tech company CEO speaking about how
they hire only seven of 100 engineers interviewed, as the rest were
unemployable in spite of being educated.

The directors’ proficiency tests cover three
specific areas, which are necessary without doubt, but not sufficient. The
areas specified are securities laws, accounting and company law. In addition,
there is a general residual category, ‘other areas necessary or relevant for
functioning as IDs’.

With so much happening in the area of corporate
governance, the role of the Board must be understood well. An institution like
SEBI could institute, on a periodic basis, studies on practices, processes,
challenges for IDs in the Indian context. Such empirical studies could aim to
bring clarity on attributes necessary for an ID in the Indian context.

An ID requires technical competence to even be
‘literate’ enough to decipher and ask questions to the management, and much
more to carry out the function of superintendence, direction and control. Obviously,
the curriculum and tests must match up to equip the ID for the role.

Experience and integrity top all other
qualifications. How to see through data, how to peel through layers by
questioning, how to get to the bottom of things, and how to look for
‘invisibles’ that are not in the routine reports, are some skills that come
from experience. Integrity related aspects include what it is to be
independent, how to see conflict of interest in related party transactions,
distinction between propriety and legal prescription. And then there are even
finer aspects such as the ability to see years ahead. These are attributes that
cannot be taught.

Two challenges before IDs are conflict of interest
and timely availability of reliable information. If the tests could build
capabilities in some of the above-mentioned areas, they would strengthen the
institution of the ID.

Tests may also be the beginning of systematic
regulation of IDs on the lines of other professions. Hearing about an
institute, marks, etc. indicates that eventually there could be CPE too.
Perhaps, ID resignations, like auditor resignations, will be questioned and
regulated.

Reports indicate that in 2018, 606 IDs resigned
(270 without citing any reasons) and 412 IDs have resigned between January and
22nd July, 2019 (107 without citing any reason). The gap between Liabilities
– Duties – Compensation remains a concern. Independence itself has not been
free from controversy, especially in promoter-controlled companies. Many laws
do not make a distinction between an ID and other directors. If the proficiency
test had questions related to statutory, civil, criminal and personal
liabilities, the outflow of IDs from Boards could be rapid in the times to
come.

After all, directors are meant to bring wisdom, counsel
and values, and bat for a strong sustainable foundation of a company. They are
there to look out for and speak up for the interests of non-promoter
shareholders. Let me end with a story I am reminded of while attending a Board
meeting as a young auditor. During the general discussions that often took
place around the fixed agenda, one of the Directors shared a story from a Board
meeting in which the legendary JRD Tata was present. When JRD found that many
dividend warrants were not encashed, he said they should be sent again, as they
used to be sent by post in those days. Management said that they had done what
was necessary as per law, and shareholders could come and claim their dividend.
JRD did not relent, and ultimately prevailed upon the company to do what was
right, and not just what was legally correct.

 

 

 

Raman Jokhakar

Editor

M/s Lokhandwala Construction Industries Pvt. Ltd. vs. DCIT-9(2); Date of order: 29th April, 2016; [ITA. No. 4403/Mum/2013; A.Y.: 2007-08; Bench: Mum. ITAT] Section 271(1)(c): Penalty – Inaccurate particulars of income – Method of accounting – Project completion method – Dispute is on the year of allowability of claim – Levy of penalty not justified

8.  CIT vs. M/s
Lokhandwala Construction Industries Pvt. Ltd. [Income tax Appeal No. 992 of
2017] Date of order: 17th September, 2019 (Bombay High Court)]

 

M/s Lokhandwala Construction Industries Pvt. Ltd. vs.
DCIT-9(2); Date of order: 29th April, 2016; [ITA. No. 4403/Mum/2013; A.Y.:
2007-08; Bench: Mum. ITAT]

 

Section 271(1)(c): Penalty – Inaccurate particulars of
income – Method of accounting – Project completion method – Dispute is on the
year of allowability of claim – Levy of penalty not justified

 

The
assessee is in the activity of building and construction. In filing the return
of income for the A.Y. 2007-2008, the assessee followed the Project Completion
Method. The AO by his assessment order dated 24th December, 2009,
disallowed the expenditure claimed towards advertisement and sales promotion on
the ground that the expenses would be claimed only in the year the project is
completed and income offered to tax. In penalty proceedings, the AO held that
the assessee was guilty of filing inaccurate particulars of income within the
meaning of section 271(1)(c) of the Act and levied penalty. The assessee filed
an appeal before the CIT(A) who dismissed the same.

 

Being
aggrieved by the order, the assessee filed an appeal to the Tribunal. The
Tribunal held that the claim was disallowed in the instant year on the ground
that such advertisement / sales promotion expenses should be allowed in the
year in which the sale of flats was undertaken in respect of which such
expenses were incurred. Pertinently, in A.Ys. 2009-10 and 2010-11 such expenses
were allowed following the methodology devised by the AO in the instant
assessment year. The aforesaid factual matrix goes to amply demonstrate that
the difference between the assessee and the Revenue does not hinge on
allowability or genuineness of expenditure but merely on the year of
allowability. In fact, the methodology devised by the AO in the A.Y. 2006-07
for the first time only seeks to postpone the allowability of expenses but does
not reflect any disagreement on the merit of the expenses claimed.

 

In the
years starting from A.Y. 1990-91 and up to 2005-06, the claim for deduction of
expenses has been allowed in the manner claimed by the assessee following the
‘project completion’ method of accounting. Therefore, if in a subsequent period
the AO re-visits an accepted position and makes a disallowance, the same would
not be construed as a deliberate attempt by the assessee to furnish inaccurate
particulars of income or concealment of particulars of his income. Therefore,
where the difference between the assessee and the Revenue is merely on account
of difference in the year of allowability of claim, and in the absence of any
finding or doubt with regard to the genuineness of the expenses claimed, the
penal provisions of section 271(1)(c) of the Act are not attracted. The penalty
levied u/s 271(1)(c) of the Act deserves to be deleted.

 

Being
aggrieved by the order, the Revenue filed an appeal to the High Court. The
Court observed that the AO adopted a methodology to postpone allowability of
claim for deduction of expenses in the year in which the income is offered to
tax. The question, therefore, is whether making such a claim on the basis of
accepted practice would amount to furnishing inaccurate particulars of income
within the meaning of section 271(1)(c) of the Act. In the case of CIT
vs. Reliance Petroproducts Pvt. Ltd. (2010) 322 ITR 158, the Supreme
Court observes that a mere making of a claim, which is not sustainable in law,
by itself will not amount to furnishing inaccurate particulars regarding the
income. Therefore, mere making of a claim which is disallowed in quantum
proceedings cannot by itself be a ground to impose penalty u/s 271(1)(c) of the
Act. The fact was that the assessee was following the above method since
1990-1991 till the subject assessment year and there was no dispute in respect
thereof save for the A.Y. 2006-07 and the subject assessment year. This fact
itself would militate against imposition of any penalty upon the assessee on
the ground of furnishing inaccurate particulars of income. Accordingly, the
Revenue appeal was dismissed.  

 

 

Section 147: Reassessment – Notice issued after four years – Original assessment u/s 143(3) – Reopening is based on change of opinion – Reassessment was held to be not valid

7.  Sutra Ventures
Private Limited vs. The Union of India and others [Writ Petition No. 2386 of
2019] Date of order: 9th October, 2019 (Bombay High Court)

 

Section 147: Reassessment – Notice issued after four
years – Original assessment u/s 143(3) – Reopening is based on change of
opinion – Reassessment was held to be not valid

 

The
assessee is a company engaged in the business of providing marketing support
services and consultancy in sports. For the A.Y. 2012-13, it filed a return of
income declaring total income of Rs. 6,44,390. The AO issued a notice for
scrutiny assessment. The assessee company replied to the queries; the scrutiny
proceedings were concluded and the assessment order was passed on 13th
March, 2015; the AO accepted the return of income filed by the assessee without
making any disallowance or additions.

 

After
the scrutiny assessment for the A.Y. 2012-13 was concluded, the Income Tax
Department conducted audit and certain objections were raised regarding purchases.
The assessee company filed its reply to the audit objections, submitting its
explanations. On 28th March, 2019 the assessee company received a
notice from the AO u/s 147 of the Act on the ground that there was reason to
believe that income chargeable to tax for the A.Y. 2012-13 had escaped
assessment. The AO provided the reasons to which the assessee company filed
objections. The objections raised by the assessee company were rejected by the
AO.

 

Being
aggrieved by the order of the AO, the assessee filed a Writ Petition before the
High Court. The Court held that in this case assessment is sought to be
reopened after a period of four years. The significance of the period of four
years is that if the assessment is sought to be reopened after a period of four
years from the end of the relevant assessment year, then as per section 147 of
the Act an additional requirement is necessary, that is, there should be
failure on the part of the assessee to fully and truly disclose material facts.
The reason of reopening was that the assessee company, in the profit and loss
account has shown sale of services at Rs. 1,87,56,347 under the head revenue
from operations and an amount of Rs. 20,46,260 was debited as purchase of
traded goods / stock-in-trade. The AO had opined that the goods were neither
shown as sales nor as closing stock because of which the income had escaped
assessment because of the omission on the part of the assessee.

 

The
Court observed that the assumption of jurisdiction on the basis of the reasons
given by the AO is entirely unfounded and unjustified. In the original
assessment the petitioner was called upon to produce documents in connection
with the A.Y. 2012-13, namely, acknowledgment of return, balance sheet, profit
and loss account, tax audit report, etc. The petitioner was also called upon to
submit the return of income of the directors along with other documents such as
shareholding pattern, bank account details, etc. The assessment order dated 13th
March, 2015 pursuant to the production of profit and loss account and other
documents referred to these documents. In the assessment order dated 13th
March, 2015 it is stated that the assessee company produced all the material
that was called for and it remained present through its chartered accountant to
submit the documents. The total income of the assessee company was computed
with reference to the profit and loss account. Therefore, the profit and loss
account was called for, was submitted by the assessee and was scrutinised.

 

Thus,
it cannot be said that there was any failure on the part of the assessee
company to produce all the material particulars. After considering the entire
material the assessment order was passed. The AO is now seeking to proceed on a
mere change of opinion. All these factors and the need for jurisdictional
requirement were brought to the notice of the AO by the assessee company. Yet,
the AO ignored the same and proceeded to dismiss the objections and reiterated
his decision to reopen the assessment. In these circumstances, the impugned
notice and the impugned order issued / passed by the AO were quashed and set
aside.

The Janalaxmi Co-operative Bank Ltd. vs. The Pr. CIT-1; date of order: 20th May, 2016; [ITA No. 1955/PN/2014; A.Y.: 2010-11; Bench: ‘B’ Pune ITAT] Section 263: Revision – Assessee filed detailed reply to the query raised by AO in respect of interest on NPA – Revision not possible if the AO had taken a view after due consideration of assessee’s submissions

6.  The Pr. CIT-1
vs. The Janalaxmi Co-operative Bank Ltd. [Income tax Appeal No. 683 of 2017] Date of order: 26th August, 2019 (Bombay High Court)

 

The Janalaxmi Co-operative Bank Ltd. vs. The Pr. CIT-1;
date of order: 20th May, 2016; [ITA No. 1955/PN/2014; A.Y.: 2010-11;
Bench: ‘B’ Pune ITAT]

 

Section 263: Revision – Assessee filed detailed reply to
the query raised by AO in respect of interest on NPA – Revision not possible if
the AO had taken a view after due consideration of assessee’s submissions

 

The
assessee is a co-operative society engaged in the banking business. It filed
its return of income for the A.Y. 2010-11 declaring Nil income. During the
course of scrutiny assessment, the AO issued a questionnaire to the assessee
who replied to the same. One of the queries was with respect to interest on
non-performing assets, Rs. 2,64,59,614, debited to profit and loss account. The
AO was satisfied with the reply of the assessee and did not make any addition
with regard to the interest on NPAs.

 

However,
the CIT issued a notice u/s 263 of the Act on the ground that no proper inquiry
/ verification was carried out by the AO in respect of interest expenses and
the NPAs claimed by the assessee. The CIT held that any provision towards any
unascertained liability is not an allowable deduction under the provisions of
the Act, therefore, the entire provision towards interest expenditure,
amounting to Rs. 2,64,59,614, needs to be disallowed. The CIT vide the impugned
order set aside the assessment order and directed the AO to pass fresh orders
after conducting proper inquiries / verification on the aforementioned issue.

 

Being
aggrieved by the order, the assessee filed an appeal to the Tribunal. The
assessee submitted that the issue relating to interest arising on NPAs has been
settled by the Supreme Court in the case of UCO Bank vs. CIT [154 CTR 88
(SC)]. The Bombay High Court had also, in the case of Deogiri
Nagari Sahakari Bank Ltd. in Income Tax Appeal No. 53 of 2014 on 22nd
January, 2015, decided the issue in favour of the assessee. The assessee
further submitted that the Co-ordinate Bench of the Tribunal, in the case of
similarly situated other assessees vide common order dated 4th
February, 2016, has deleted the addition made on account of interest accrued on
NPAs.

 

The
Tribunal held that a perusal of the submissions made by the assessee before
ACIT shows that during the course of assessment proceedings, the assessee has
given detailed reply to the query raised by the AO in respect of interest on
the NPAs. Therefore, once the issue has been considered by the AO in scrutiny
assessment proceedings, provisions of section 263 of the Act cannot be invoked
unless two conditions are satisfied, that is, (i) the assessment order is erroneous;
and (ii) it is prejudicial to the interest of Revenue. In the present case the
reason/s given by CIT to hold that the assessment order is erroneous is not
tenable.

 

Being
aggrieved by the order, the Revenue filed an appeal to the High Court. The Court
held that during the regular assessment proceedings leading to the assessment
order, specific queries with respect to interest for NPAs / sticky loans being
chargeable to tax were raised and the assessee had given detailed replies to
them. The AO, on consideration, did not make any addition with regard to it in
the return, i.e., on account of interest on sticky loans. In CIT vs. Fine
Jewellery (India) Ltd., 372 ITR 303 rendered in the context of section
263 of the Act, it was held that once inquiries are made during the assessment
proceedings and the assessee has responded to the queries, then non-mentioning
of the same in the assessment order would not lead to the conclusion that the
AO had not inquired into this aspect. In the result, the appeal of the Revenue
was dismissed.

Search and seizure – Assessment of third person – Sections 132, 132(4) and 153C of ITA, 1961 – Condition precedent – Amendment permitting notice where seized material pertained to assessee as against existing law that required Department to show that seized material belonged to assessee – Amendment applies prospectively – Where search took place prior to date of amendment, Department to prove seized documents belonged to assessee – Statement of search party containing information relating to assessee no document belonging to assessee – AO wrongly assumed jurisdiction u/s 153C

23. Principal
CIT vs. Dreamcity Buildwell P. Ltd.; [2019]
417 ITR 617 (Del.) Date
of order: 9th August, 2019 A.Y.:
2005-06

 

Search
and seizure – Assessment of third person – Sections 132, 132(4) and 153C of
ITA, 1961 – Condition precedent – Amendment permitting notice where seized
material pertained to assessee as against existing law that required Department
to show that seized material belonged to assessee – Amendment applies
prospectively – Where search took place prior to date of amendment, Department
to prove seized documents belonged to assessee – Statement of search party
containing information relating to assessee no document belonging to assessee –
AO wrongly assumed jurisdiction u/s 153C

 

For the
A.Y. 2005-06 the Tribunal set aside the assessment order passed by the AO u/s
153C of the Income-tax Act, 1961 holding that the assumption of jurisdiction
u/s 153C by the AO was not proper. The Tribunal found that two of the documents
referred to, viz., the licence issued to the assessee by the Director, Town and
Country Planning, and the permission granted to the assessee by him for
transferring the licence could not be said to be documents that constituted
incriminating evidence revealing any escapement of income.

 

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

 

‘(i)      Search and the issuance of notice u/s 153C
pertained to the period prior to 1st June, 2015 and section 153C as
it stood at that relevant time applied. The change brought about prospectively
w.e.f. 1st June, 2015 by the amended section 153C(1) did not apply.
Therefore, the onus was on the Department to show that the incriminating material
or documents recovered at the time of search belonged to the assessee. It was
not enough for the Department to show that the documents either pertained to
the assessee or contained information that related to the assessee.

 

(ii)      The Department had relied on three
documents to justify the assumption of jurisdiction u/s 153C against the
assessee. Two of them, viz., the licence issued to the assessee by the
Director, Town and Country Planning, and the letter issued by him permitting
the assessee to transfer such licence, had no relevance for the purpose of
determining escapement of income of the assessee for the A.Y. 2005-06.
Consequently, even if those two documents could be said to have belonged to the
assessee, they were not documents on the basis of which jurisdiction could be
assumed by the A O u/s 153C.

(iii)      The third document, the statement made by
the search party during the search and survey proceedings, was not a document
that “belonged” to the assessee. While it contained information that “related”
to the assessee, it could not be said to be a document that “belonged” to the
assessee. Therefore, the jurisdictional requirement of section 153C as it stood
at the relevant time was not met. No question of law arose.’

Revision – Section 264 of ITA, 1961 – Belated application – Merely because assessee filed application belatedly, revision application could not be rejected without considering cause of delay

 22. Aadil
Ashfaque & Co. (P) Ltd. vs. Principal CIT; [2019]
111 taxmann.com 29 (Mad.) Date
of order: 24th September, 2019 A.Y.:
2007-08

 

Revision
– Section 264 of ITA, 1961 – Belated application – Merely because assessee
filed application belatedly, revision application could not be rejected without
considering cause of delay

The
petitioner filed e-return on 29th October, 2007. Due to inadvertence
and by a mistake committed by an employee of the petitioner company, both the
gross total income and the total income were shown as Rs. 2.74 crores, instead
of total income being Rs. 56.91 lakh. Therefore, the petitioner filed its
revised return on 26th July, 2010 altering only the figures in gross
total income and total income without making any changes with respect to the
other columns and with income computation. While doing so, after five years of
filing the revised return, the petitioner company received a communication
dated 7th August, 2015 stating that there is outstanding tax demand
for the A.Y. 2007-08 of Rs. 87.26 lakhs. The petitioner was not aware of the
intimation issued u/s 143(1) till it was received by him on 23rd
September, 2015.

 

The
petitioner approached the first respondent and filed an application u/s 264 on
6th October, 2015. The same was rejected by the impugned order for
the reason that it was filed beyond the period of limitation.

 

The
assessee filed a writ petition and challenged the order. The Madras High Court
allowed the writ petition and held as under:

 

‘(i)      The petitioner claims that gross total
income shown in the original return filed on 29th October, 2007 as
Rs. 2.74 crores is a factual mistake; and, on the other hand, it is only a sum
of Rs. 56.91 lakh as the sum to be reflected as gross total income in all the
places. In order to rectify such mistake, it is seen that the petitioner has
filed a revised return on 26th July, 2010. By that time, it seems
that the intimation under section 143(1) raising the demand was issued on 20th
October, 2008 itself.

 

(ii)      According to the petitioner, they are not
aware of such intimation. On the other hand, it is contended by the Revenue
that such intimation was readily available in the e-filing portal of the
petitioner. No doubt, the petitioner has approached the first respondent and
filed application u/s. 264 to set right the dispute. However, the fact remains
that such application was filed on 6th October, 2015 with delay. The
first respondent has specifically pointed out that the petitioner has not filed
any application to condone the delay, specifically indicating the reasons for
such delay. It is also seen that the first respondent has chosen to reject the
application only on the ground that it was filed belatedly. Therefore, the ends
of justice would be met if the matter is remitted back to the first respondent
Commissioner for reconsidering the matter afresh if the petitioner is in a
position to satisfy the first respondent that the delay in filing such
application u/s 264 was neither wilful nor intentional.’

Hustling the Taxpayer

Almost every
government department is on a digital drive. Many of them ask for the same
information from a taxpayer to serve their individual needs. Many a times,
administrators seem to believe that good intentions can justify bad
implementation. Recent changes in ITR software is a case in point which was
justified by the CBDT as if 11th July was the most auspicious time
for tweaking the utility for a 31st July deadline! Such times make a
taxpayer and tax filer feel helpless and insignificant.

There is a
consistent and ceaseless endeavour on the part of the tax department to make
changes and tinker with ITRs and schema despite court orders against doing so.
Add to that changes in ITR itself – say, asking for directorship details.
Aren’t they available with MCA? Isn’t MCA part of the same government? Cannot a
Director based on PAN be matched with the tax data and serve the purpose of the
tax department? The talk of ease of doing business doesn’t seem consistent with
such actions. Many such actions send a message to the entrepreneur that there
are strong forces preventing him in his flight to success. To the habituated
and compliant taxpayer, it signals lack of care and respect by the authorities.

In all
fairness can a taxpayer ask – what do I get in return for my taxes? Taxes are
not a consideration, yet taxes are paid for a reason and ease of compliance and
clear outcome is the least a taxpayer can expect. The collector of taxes and
those who decide on spending them have an obligation directly towards a
taxpayer. Taxes are not a charge on taxpayer’s industriousness and patience.
Most middle class pays 20-30 per cent of earnings as direct taxes. Firms and
individuals have a surcharge (a sneaky and shaky way to collect more). On
dividend government taxes a risk-taking investor three times on his potential
gain – at company level, at dividend distribution level and then 10% if the
investor receives a sum greater than Rs. 10 lakhs. And if he wants to sell the
shares at profit he can do so up to Rs. 1 lakh without tax. And of course you
are not spared at the time of spending, with GST of 18%. Seems like the
taxpayer works, spends, invests and saves to pay taxes!

What is the
obligation of the collector of taxes towards a taxpayer? Government is under a
social contract to spend taxes well and for the benefit of the taxpayers too
and not just for its vote banks. One wonders how taxpayers feel about their tax
monies being spent and whether that spending has something in it for them, at least
in respect of a fair, just and timely tax administration.

As taxpayers,
many feel that their taxes don’t yield a bang for the buck. Someone said
that my taxes actually work against me, they end up as reservations in
education and work against my own children’s future. A taxpayer is not able to
perceive a clear and direct nexus between taxes paid and benefits received. Tax
payment is a service to the nation and the nation above all owes to the
taxpayer some service, too. Does a taxpayer receive a reasonable medicare? Or
dependable infrastructure? Or emergency services? Or access to a timely,
corruption-free and fair justice system? For many facilities the taxpayer pays
directly. Say airport charges or tolls or road tax. Add to that the taxpayer
money which covers up tax-free incomes of wealthy kisans who take even
say several crores of income tax free. Let’s not talk about mismanaged funds
like the NPAs of banks – an inefficiency or even mismanagement funded by taxpayer
monies.

A
pre-Independence mindset is deep-rooted with a very damaging perspective on
taxes. India is yet to develop its own taxation philosophy. The old and
imported socialist mindset looks at taxes as a wealth-distribution mechanism.
However, that is primitive, negative and a secondary approach which has failed.
The rich have found places to hide income and pay little taxes. And the
middle-income people get squashed and hustled. It is time that tax
administrators introspect more on questions such as these – how do I make a
taxpayer see her taxes as an investment which yields direct returns? What can
the government do to make the entire process feel smooth and easy? What will
make a taxpayer see her taxes as an investment in nation-building but also as a
contribution towards building her own future?

 

 

Raman Jokhakar

Editor

CONFLICT

Confrontation (conflict) will lead to losses on
both sides

—Xi Jinping, Chinese
President

 

How true. As a matter of fact, no one has ever won an
argument because in the end both winner and loser end up being miserable. Yet
the irony is that inherently an individual is always in conflict;
the issues are:

  •   a majority of us are in conflict; hence, is
    conflict a gift from God or is it His curse?
  •   can we humans convert conflict into a gift
    from God?!

 

I think we can if we accept the fact
that there is conflict. Most of us despite realising the existence of conflict
don’t accept, nay, don’t want to accept that there is conflict. The fact is
that when there is conflict in our mind and in our life we push it under the
carpet and pray that it will fade away rather than face the conflict and
attempt to solve it. This is the irony of being human.

 

Let us accept that conflict is a
part of human nature and exists everywhere, leading to stress, unhappiness and
a strained mind. Can we learn how to manage conflict? Let us examine a few
examples of how some have
managed conflict:

 

  •   Gandhi experienced conflict in his mind, body
    and soul when he was discriminated against because of his colour, creed and
    religion. He accepted the presence of discrimination in society and his
    solution was non-violence. Even when he was hit, he bore the pain and
    did not retaliate.
  •   President Kennedy accepted the presence of the
    Russian armada in the Pacific as conflict and his response was retaliation – a
    show of power. The result was that he won and the Russians retreated from the
    Pacific – the famous Cuba affair.
  •   Martin Luther King, Jr. accepted the
    discrimination that existed in American society despite the promise of equality
    in the Constitution and the assassination of President Lincoln. His response
    was Gandhian.
  •   Nelson Mandela accepted discrimination – he
    suffered pain and was jailed for years and won independence by following
    Gandhi.
  •   President Nixon created Watergate – he did not
    accept it and had to resign as President.
  •   Prime Minister Nehru never anticipated
    conflict with China (incursion or war) in 1962 or if he anticipated it, he
    ignored it. The result was that he died in 1964 a disappointed and disheartened
    man. His doctrine of panchsheel had failed.
  •   Me Too – The conflict is whether to
    accept or not to accept. Those who accept, resign; those who don’t, will face
    investigation and legal action.
  •   The patriarch and founder of the Birla Empire,
    Mr. G.D. Birla, foresaw and accepted a looming conflict in his business empire;
    his solution was division of the Birla assets between him and his brothers – a
    far-sighted action. The result is continuation of businesses yielding respect,
    prosperity and harmony in the Birla clan.

 

There are others who have avoided
conflict in the family by taking appropriate and timely action.

 

Firstly, to resolve or dissolve a
conflict we must accept that there is conflict; secondly, be at peace
with ourselves; thirdly, do not respond to conflict emotionally; and fourthly,
think clearly to seek a solution, a solution that brings harmony.

 

On the other hand, where conflict is
not accepted or after accepting it no attempt is made to resolve it, there is
disturbance and destruction resulting in loss of harmony, health and wealth.
Voltaire says “Conflict means that both parties are wrong”.

 

In society conflict results in
divorce, quarrels amongst siblings – even between parents and children and
amongst those who were once friends and colleagues. The legendary conflict
which resulted in the Mahabharata and the destruction of a clan was because of
Duryodhan who, after creating conflict and going back on his promise, refused
to accept a solution.

 

“To be or not to be” is the perennial Shakespearean
dilemma. Hence, let us accept that conflict exists in our daily existence. It
is rightly said – wherever there is choice there is conflict. We need to
accept the existence of conflict of choice and deal with it by choosing
with a clear and cool mind.

 

The paradox of conflict is
that conflict exists in every mind because of caste, creed and greed and the
result is confusion. These three give birth to conflict. Success lies in
managing these three. Conflict can be managed only by clarity. Clarity about
our objective and circumstances – understanding the reasons or the basis of
conflict; and, above all, –an intense desire to solve the conflict. It is then
and only then that conflict can be resolved. The solution lies in “accept
and act”. Stop fighting conflict because fighting only leads to more
conflict – it is like adding fuel to fire.

 

I will conclude by quoting William Hazlitt: “Nothing was
ever learnt by either side in a conflict”. And so I reiterate: Conciliation
or resolution with clear thinking is a gift from God. Both conflict and clarity
are also giftsfrom God.

 

 

 

BCAS – E-Learning Platform
(https://bcasonline.courseplay.co/)

Sr. No.

Course Name

Name of the BCAS
Committee

Course Fees (INR)**

Members

Non –
Members

1

Three Days Workshop on
Advanced Transfer Pricing

International Taxation
Committee

5550/-

6350/-

2

Four Day Orientation
Course on Foreign Exchange Management Act (FEMA)

International Taxation
Committee

7080/-

8260/-

3

Workshop on Provisions
& Issues – Export/ Import / Deemed Export/ SEZ Supplies

Indirect Taxation
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1180/-

1475/-

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7th
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Accounting & Auditing

Committee

2360/-

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5

Full Day Seminar on
Estate Planning, Wills and Family Settlements.

Corporate & Allied
Laws Committee

1180/-

1180/-

6

Workshop on “Foreign Tax
Credit”

International Taxation
Committee

1180/-

1475/-

7

Panel Discussion on
Analysis of PE Constitution – “Recent Judicial Pronouncements including
MasterCard, Nokia Networks and Formula One.”

International Taxation
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472/-

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8

12th
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Indirect Taxation
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5900/-

N. A.

9

Seminar on Tax Audit

Taxation Committee

2065/-

2596/-

10

Full Day Seminar on
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Corporate & Allied
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2301/-

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11

Long Duration Course on
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Indirect Taxation
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14,160/-

17,700/-

12

Half Day Workshop on GST
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Indirect Taxation
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1500/-

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Full Day Seminar on GAAR and Anti-avoidance Provisions

International Taxation Committee

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Seminar on Capital Gains and Income from Other Sources

Taxation Committee

2124/-

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Half Day Workshop on GST Annual Return 9

Indirect Taxation Committee

295/-

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16

BCAS Initiative – Educational Series on GST

Indirect Taxation Committee

Free

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GST Training Program for Trade, Industry and Profession

Indirect Taxation Committee

Free

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**Course Fee is inclusive of 18% GST.

For more details, please contact Javed Siddique at 022
– 61377607 or email to events@bcasonline.org

PERIOD OF INTEREST ON REFUND IN CASES OF DELAYED CLAIMS OF DEDUCTIONS

ISSUE FOR CONSIDERATION

Section 244A(1) provides for the grant of
simple interest in cases where refund is due to the assessee – simple interest
at the rates prescribed for different circumstances and for the periods
specified in the section. No interest is payable if the amount of refund is
less than 10% of the tax as determined u/s 143(1) or on regular assessment. In
a case where the return of income is not filed by the due date specified u/s
139(1), the interest is payable for the period commencing with the date of
filing the return. Ordinarily, interest is calculated at the rate of 0.5% for
every month or part of a month. Additional interest at the rate of 3% per annum
is granted in cases where the refund due as the result of appellate or
revisional orders is delayed beyond the period of the time allowed u/s 153(5)
of the Act. The amount of interest granted gets adjusted on account of
subsequent orders which have the effect of varying the amount of refund.

 

Where the proceedings resulting in the
refund are delayed for reasons attributable to the assessee, wholly or in part,
the period of the delay attributable to him is excluded from the period for
which interest is payable as per the provisions of sub-section (2) of section
244A. In deciding the question as to the period to be excluded, the decision of
the Commissioner shall be final.

 

Often, the refund arises or its amount
increases where a claim for deduction is made after filing the return of income
by filing a revised return, or placing the claim in the assessment or appellate
proceedings. In such cases, an interesting issue arises about deciding whether
the period for which the claim is deferred can be excluded for calculation of
the interest due to the assessee. Conflicting views of the courts are available
on the subject of excluding the period or otherwise. Gauhati and a few other
high courts have taken a view that the refund can be said to have been delayed
due to the failure of the assessee in claiming the deduction in time and the
period in question should be excluded while granting the interest on refund.
The Bombay, Gujarat and the other high courts have held that such situations of
deferred claims cannot be held to reduce the period for which the interest is
otherwise allowable to the assessee under
sub-section (1).

 

THE ASSAM ROOFING LTD. CASE

The issue came up for consideration in the
case of Assam Roofing Ltd. vs. CIT, 11 taxmann.com 279
(Gauhati). In that case the assessee filed its return of income on 31st
December, 1992 for the assessment year 1991-92, including the receipt of the
transport subsidy in the total income. In the note it was claimed to be a
capital receipt, though during the assessment proceedings completed on 16th
May, 1994 u/s 143(3) no separate representation was made by the assessee
claiming that subsidy was not taxable. An appeal was filed against the
assessment order for contesting the addition on account of the said subsidy
which was decided in its favour by the Commissioner (Appeals) by an order dated
27th October, 1994 directing that the transport subsidy amounting to
Rs. 98,79,266 be deleted from the total income. The AO passed an order dated 13th
December, 1994 to give effect to the appellate order, deleting transport
subsidy amounting to Rs. 98,79,266. He also allowed interest u/s 244A on the
amount of refund that was found due to the assessee as a result of the
appellate order for a period of 33 months, i.e., from 1st April,
1992 to 13th December, 1994.

 

Subsequently, in the rectification
proceedings, the AO held that the grant of refund was delayed for reasons
attributable to the assessee and, as a consequence, interest on refund was held
to be payable only for a period of eight months, that is, from 16th
May, 1994 (date of completion of assessment) to 13th December, 1994,
that is, the date of order giving effect to the appellate order. The appeal by
the assessee against the order reducing the interest was allowed by the
Commissioner (Appeals) and his order was confirmed by the Tribunal. The
following substantial question of law was raised: ‘Whether on the facts and
in the circumstances of the case, the Tribunal was justified and correct in
allowing interest u/s 244A of the Income-tax Act, 1961 to the assessee for the
period of delay in granting refund of tax where such delay is due to reasons
attributable to the assessee?’

 

The Revenue contended that the assessee had
voluntarily included the amount received on account of transport subsidy as
taxable income and on the said basis the assessment was made; at no point of
time in the course of the assessment proceedings had the assessee taken the
stand that the amount received on account of transport subsidy was not taxable;
the issue was raised by the assessee only in the appeal filed before the
Commissioner (Appeals) which was disposed of by the order dated 27th October,
1994; thereafter, on 13th December, 1994 the amount of transport
subsidy earlier included in the taxable income of the assessee was deleted and
orders were passed for the refund.

 

Relying on the provisions of section 244A(2)
of the Act, it was contended that the payment of refund was made at the
particular point of time only because of the conduct of the assessee in not
raising the said issue at any earlier point of time and the payment of refund, therefore,
got delayed for reasons attributable to the assessee; consequently, the
assessee was not entitled for interest for the period for which he was at
fault.

 

In reply the assessee contended that the
provisions of Chapter XIX of the Act made it abundantly clear that the grant of
refund was not contingent on any application of the assessee and such refund
u/s 240 of the Act was consequential to any order passed in an appeal or other
proceedings under the Act; no claim for refund was required to be lodged; the
provisions of section 244A(2) of the Act had no application to the case
inasmuch as the refund was consequential to the appellate order, no proceeding
for refund could be visualised so as to hold the assessee responsible for any
delay in finalisation of such a proceeding.

 

Relying on the decision in Sandvik
Asia Ltd. vs. CIT, 280 ITR 643, it was contended by the assessee that
there was a compensatory element in the interest that was awardable u/s 244A of
the Act and that such interest mitigates the hardship caused to the assessee on
account of wrongful levy and collection of tax. Reliance was also placed on the
decision of the Punjab and Haryana High Court in the case of National
Horticulture Board vs. Union of India, 253 ITR 12 to contend that interest
on refund was automatic and consequential and did not depend on initiation of a
proceeding for refund or on raising a claim for refund, as the case may be.

 

Section 244A of the Act, the Court observed,
contemplated grant of interest at the specified rate from the first day of
April of the assessment year to the date on which refund was granted in case of
payments of tax as contemplated by sub-clauses (a) and (b) of sub-section (1).
It further noted that under sub-section (2) of section 244A if the ‘proceedings
resulting in the refund’ were delayed for reasons attributable to the assessee,
no interest was to be awarded for the period of such delay for which the
assessee was responsible. Significantly, the Court took note of the expression ‘proceedings
resulting in revision (to be read as “refund”)’ appearing in sub-section
(2) of Section 244A to hold that the scope of section 244A(2) was not limited
to the cases of sections 238 and 239 but covered the cases of the refunds
arising on account of any order under the scheme of the Act; the expression
‘proceeding’ referred to in sub-section (2), more reasonably, would mean any
proceeding as a result of which refund had become due; viewed thus, the
expression ‘proceeding’ might take within its ambit an appeal proceeding
consequential to which refund had become due. The Court supported its decision
by relying on the decision of the Punjab and Haryana High Court in the
National Horticulture Board case (supra).

 

The Court in
deciding the issue noted the fact that the assessee itself declared the amount
of transport subsidy received by it to be taxable and voluntarily paid the tax
and no claim to the contrary was raised in the course of the assessment
proceeding; it was only in the appeal filed that the issue was raised and was
allowed by the Commissioner (Appeals) and a consequential refund was granted.

 

The Court ruled that in the above
circumstances, it could not but be held that the assessee was responsible for
the delay in grant of refund and it would be correct to hold that the interest
was payable only with effect
from 16th May, 1994 till the date of payment of the refundable amount.

 

The Gauhati High Court allowed the appeal of
the Revenue and reversed the order of the Tribunal by holding that the delay in
grant of refund was attributable to the assessee and as a consequence the
period for which interest on refund was to be granted required to be reduced.

MELSTAR INFORMATION TECHNOLOGIES LTD. CASE

The issue recently arose in the case of the CIT
vs. Melstar Information Technologies Ltd., 106 taxmann.com 142 (Bom.).
In this case, the assessee had not claimed certain expenditure before the AO
but raised such a claim before the Tribunal which remanded the proceedings to
the Commissioner (Appeals) who allowed the claim of expenditure. The deduction
so allowed resulted in a refund of taxes paid and it is at that juncture that
there arose the question u/s 244A of payment of interest on such refund.

 

It appears that there was a dispute about
the period for which the interest was to be granted to the assessee, or about
the eligibility of the assessee to interest. The AO seemed to be of the view
that no interest was payable to the assessee for the reason that the delay in
granting the refund was entirely attributable to the assessee inasmuch as he
had delayed the claim for deduction. The AO, while granting refund, seemed to
have denied the interest by relying on the provisions of section 244A(2) after
taking the approval of the Commissioner. The Tribunal, on an appeal by the
assessee, held that an appeal was maintainable against the order refusing the
interest on refund and further held that the delay could not be held to be
attributable to the assessee and, therefore, the Tribunal directed the payment
of interest.

 

The Revenue, aggrieved by the order of the
Tribunal had raised the following question for the Court’s consideration: ‘Whether
on the facts and circumstances of the case and in law, the ITAT has erred in
law in assuming jurisdiction to hear the appeal when no such appeal lies before
the ITAT or before CIT(A) because as per the provisions of Section 244A(2) of
the Income Tax Act, decision of CIT is final as held by Kerala High Court in
the case of Kerala Civil Supplies 185 taxman 1?’

 

The Court noted that the issue pertained to
interest payable to the assessee u/s 244A of the Act where the Revenue did not
dispute the assessee’s claim of refund and its eligibility to interest thereon
in ordinary circumstances. However, since the delay in the proceedings
resulting in the refund was attributable to the assessee, by virtue of
sub-section (2) of section 244A of the Act the assessee was not entitled to
such interest.

 

The Court observed that there was no
allegation or material on record to suggest that any of the proceedings were
delayed in any manner on account of reasons attributable to the assessee and
therefore the Tribunal was correct in allowing the interest to the assessee.

 

The Court, in deciding that there was no substantial
question of law involved in the appeal of the Revenue, relied on the decision
in the case of Ajanta Manufacturing Ltd. vs. Deputy CIT, 391 ITR 33
(Guj.) wherein a similar issue was considered. In that case, the
assessee had made a belated claim for deduction during assessment on filing a
revised return of income, and the Revenue had denied the interest by
attributing the delay in grant of refund to the assessee on applying the
provisions of sub-section (2) of section 244A of the Act. The Court noted with
approval the following observations of the said decision:

 

“16. We would also examine the order
of the Commissioner on merits. As noted, according to the Commissioner the
assessee had raised a belated claim during the course of the assessment proceedings
which resulted into delay in granting of refund and therefore, the assessee was
not entitled to interest for the entire period from the first date of
assessment year till the order giving effect to the appellate order was passed.
We cannot uphold the view of the Commissioner. First and foremost requirement
of sub-section (2) of Section 244A is that the proceedings resulting into
refund should have been delayed for the reasons attributable to the assessee,
whether wholly or in part. If such requirement is satisfied, to the extent of
the period of delay so attributable to the assessee, he would be disentitled to
claim interest on refund. The act of revising a return or raising a claim
during the course of the assessment proceedings cannot be said to be the
reasons for delaying the proceedings which can be attributable to the assessee.
(The) mere fact that the claim came to be granted by the Appellate Commissioner
would not change this position. In essence, what the Commissioner (Appeals) did
was to allow a claim which in law, in his opinion, was allowable by the
Assessing Officer. In other words, by passing order in appeal, he merely
recognised a legal position whereby the assessee was entitled to claim certain
benefits of reduced tax. Surely, the fact that the assessee had filed the
appeal which ultimately came to be allowed by the Commissioner, cannot be a
reason for delaying the proceedings which can be attributed to the assessee.

 

17. The Department does not contend that
the assessee had needlessly or frivolously delayed the assessment proceedings
at the original or appellate stage. In absence of any such foundation, (the)
mere fact that the assessee made a claim during the course of the assessment
proceedings which was allowed at the appellate stage would not ipso facto imply
that the assessee was responsible for causing the delay in the proceedings
resulting into refund. We may refer the decision of the Kerala High Court in
case of CIT vs. South Indian Bank Ltd., reported in (2012) 340 ITR 574 (Ker)
in which the assessee had raised a belated claim for deduction which was
allowed by the Commissioner (Appeals). The Revenue, therefore, contended that
for such delay, interest should be declined under Section 244A of the Act. In
the said case also, the assessee had not made any claim for deduction of
provision of bad debts in the original return. But before completion of the
assessment, the assessee had made such a claim which was rejected by the
Assessing Officer. The Commissioner allowed the claim and remanded the matter
to the Assessing Officer. Pursuant to which, the assessee became entitled to
refund. Revenue argued that the assessee would not be entitled to interest in
view of Section 244A(2). In this context, the Court held in Para. 6 as under
(page 578 of 340 ITR):

 

‘6.
Sub-section (2) of section 244A provides that the assessee shall not be
entitled to interest for the period of delay in issuing the proceedings leading
to the refund that is attributable to the assessee. In other words, if the
issue of the refund order is delayed for any period attributable to the
assessee, then the assessee shall not be entitled to interest for such period.
This is of course an exception to clauses (a) and (b) of section 244A(1) of the
Act. In other words, if the issue of the proceedings, that is, refund order, is
delayed for any period attributable to the assessee, then the assessee is not
entitled to interest for such period. Further, what is clear from sub-section
(2) is that, if the officer feels that delay in refund for any period is
attributable to the assessee, the matter should be referred to the Commissioner
or Chief Commissioner or any other notified person for deciding the issue and
ordering exclusion of such periods for the purpose of granting interest to the
assessee under section 244A(1) of the Act. In this case, there was no decision
by the Commissioner or Chief Commissioner on this issue and so much so, we do
not think the Assessing Officer made out the case of delay in refund for any
period attributable to the assessee disentitling for interest. So much so, in
our view, the officer has no escape from granting interest to the assessee in
terms of section 244A(1) (a) of the Act’.”

 

OBSERVATIONS

The issue under consideration revolves in a
narrow compass; whether the claim for deduction, made subsequent to the filing
of return of income, can be held to be attracting the provisions of sub-section
(2) of section 244A for excluding the period of delay in claiming the deduction
from the period for which interest is granted u/s 244A on the amount of refund
that has resulted or has increased due to the grant of deduction pursuant to
the delayed claim.

 

The relevant sub-section reads as under: (2)
If the proceedings resulting in the refund are delayed for reasons
attributable to the assessee, whether wholly or in part, the period of the
delay so attributable to him shall be excluded from the period for which
interest is payable under sub-sections (1) or (1A), and where any question
arises as to the period to be excluded, it shall be decided by the Principal
Chief Commissioner or Chief Commissioner or Principal Commissioner or
Commissioner whose decision thereon shall be final.

 

The requirement of sub-section (2) is that
the proceedings resulting into refund should have been delayed and the delay
should be for the reasons attributable to the assessee. Only where such
requirement is satisfied, the interest relating to the period of delay so
attributable to the assessee would be denied.

 

On a careful reading of the provision of
sub-section (2) it is gathered that the said provisions are attracted only in
cases where the twin conditions are cumulatively satisfied: the proceedings
resulting into refund have been delayed, and further that the delay is for
reasons that are attributable to the assessee. Non-satisfaction of any one of
the conditions would not disentitle the assessee from the claim of interest on
refund; for this purpose it may be essential to appreciate the contextual
meaning of the term ‘proceedings’. Can the acts of filing the revised return or
claiming the reliefs in assessment or appellant proceedings be construed to be
‘proceedings’ for attracting the provisions of sub-section (2)? May be not. The
proceedings referred to in sub-section (2) should, in our opinion, mean and
co-rate the proceedings in respect of assessment or adjudication of appeals and
it is here that the assessee should be found to have delayed such proceedings
in any manner for disentitling him from the claim of interest.

 

Revising the return or placing the claim
during such proceedings cannot be considered to be part of proceedings
resulting in refund. It is essential that the proceedings in question should
further result in refund. Only assessment, rectification, revision or appellate
proceedings can be considered to be proceedings that result in refund. It is
such proceedings that should have been delayed and not the claim of deduction
or refund, and further the delay in such proceedings should be attributable to
the assessee. It is for these reasons some of the Courts have given emphasis to
ascertain whether the assessee had contributed to delay the assessment
proceedings on frivolous grounds without placing their analysis of provisions
in so many words in the orders.

 

Our understanding is further strengthened by
the amendments of 2016 for insertion of clause “a” in sub-section (1) of
section 244A with effect from 1st June, 2016 to provide that the
interest would be paid for the period commencing from the date of filing of
return of income where such return is filed outside the due date prescribed u/s
139(1). In the absence of such an amendment, interest could not have been
denied to the assessee for the delay in filing the return of income as was held
by some of
the Courts.

 

The Court in the Assam Roofing Limited
case rightly held that the meaning of the term ‘proceedings resulting in
refund’ was not limited to cases of sections 238 and 239 of the Act but also
cover the other cases of refund and would include any proceedings resulting in
refund and such proceedings also included the appellate proceedings. Having
held that, the Court failed in appreciating that the assessee was not
responsible for delaying any of the proceedings that resulted in refund or said
to have been delayed. Instead, the Court held that the act of filing the claim
in the appellate proceedings was to be construed as an act of delaying the
proceedings that resulted in refund. It therefore held that putting a claim at
the appellate stage was responsible for delay in grant of refund and therefore
the interest for the period up to the date of putting the claim was not
allowable. It is respectfully submitted that this was a classic case of missing
the wood for the trees; the case where the Court was preoccupied with the delay
in placing the claim for deduction, overlooking the important fact that what
was relevant for the application of sub-section (2) was delay in the proceeding
and not the delay in grant of refund as a consequence of the delayed claim. It
might be that the assessee was responsible for making belated claim but
certainly not delaying
the proceedings.

 

It is required to be appreciated that the
interest is the consequence of payment of excess tax. Accordingly, once excess
tax is found to have been paid at whatever stage, the tax was required to be
refunded. And as a consequence interest was bound to be paid unless the
assessee is shown to be responsible for delaying the proceedings and not the
refund. Putting a delayed claim for the deduction, otherwise allowable under
the Act, under no circumstances could be construed as an act of delaying the
‘proceedings’, when it was otherwise the duty of the authorities to compute the
correct total income by allowing all deductions that were allowed under the Act
and simultaneously excluding all such receipts that were required to be
excluded. (Please see circular No. 26 dated 7th July, 1955.)

 

The act of revising a return or raising a
claim during the course of the assessment proceedings cannot be said to be part
of the proceedings for refund and cannot also be said to be the reasons for
delaying the proceedings which can be held to be attributable to the assessee.
This understanding will not change on account of the claim for deduction
outside the return of income. What happens on allowing the claim is something
which is otherwise required to be allowed as per the law by the AO. In other
words, by passing an order he merely recognises a legal position whereby the
assessee is entitled to claim certain benefits of reduced tax. Surely, the
claim in the proceedings ultimately resulting in refund cannot be construed as
an act of delaying the proceedings that can be attributed to the assessee. In
the absence of any finding that the assessee was responsible for delaying the
proceedings, the mere fact that the assessee made a claim during the course of
the assessment proceedings which was allowed at the appellate stage would not ipso
facto imply that the assessee was responsible for causing the delay in the
proceedings that resulted into refund.

 

In the case of Ajanta Manufacturing
Limited, 72 taxmann.com, 148 (Guj.), the assessee company had included
the receipt of subsidy in total income and paid tax thereon while filing the
return of income. During the course of assessment, a claim was made under a
letter for excluding the subsidy for receipt from income. The claim of the
assessee was allowed in appeal by the Commissioner (Appeals) and the reduction
in income resulted in refund. In deciding the period for which the interest
should be allowed for such refund, the High Court held that the disabling
provisions of sub-section 2 and section 244A were not attracted in the facts of
the case and the interest should be granted for the full period as per the
provisions of section 244(1) of the Act.

 

In the case of Sahara India Savings
& Investments Corporation Limited, 38 taxmann.com 192 (All.) the
refund was not granted for not filing TDS certificates with the return of
income. Subsequently, the refund became due on filing of the certificates;
while the refund was granted, the interest thereon was denied on the ground
that the refund was delayed due to non-filing of TDS certificates with the
return of income. The Allahabad High Court held that a delay in application for
refund could not be construed as a delay attributable to the assessee and the
provisions of sub-section (2) were not attracted in the facts of the case.

 

In the case of Larsen & Toubro,
330 ITR 340 (Bom.), again in the circumstances where the TDS
certificates were not filed with return of income, the Court upheld the order
of the Tribunal holding that interest u/s 244A could not be denied only on the
ground that certificates were not filed with the return of income.

 

The Supreme Court in the case of H.E.G.
Limited, 334 ITR 331 (SC), held that interest was payable to the
assessee u/s 244A for withholding of the refund by the AO on account of denial
of credit for TDS.

 

The Punjab and
Haryana High Court in the case of National Horticulture Board, 253 ITR 12
(P&H), held that the interest u/s 244A could not be denied on the
ground of the delayed application for refund of the taxes paid.

 

In the case of South Indian Bank
Limited, 340 ITR 574 (Ker.), the Commissioner (Appeals) had allowed the
related claim for deduction. The interest on resulting refund was denied by the
income tax authorities on the ground of the delayed claim for deduction which
was made, outside the return of income, in the assessment proceedings. The
Kerala High Court held that the AO had no escape from granting interest to the
assessee.

 

The Kerala High Court, in the case of Pala
Marketing Co-Op. Society Limited, 79 taxmann.com 438 (Ker.), however,
held that the assessee was not entitled to interest on refund where he had
delayed the filing of return of income even where such delay was condoned
following its own decision in the case of M. Ahammadkutty Haji, 288 ITR
304. However, the Rajasthan High Court in the case of Dariyavie
Singh Karnavat, 18 taxmann.com 180, held that the interest was payable
in similar circumstances ignoring the decision of the Kerala High Court in the M.
Ahammadkutty case cited before
the Court.

 

Interestingly, the Karnataka High Court in
the case of Dinakar Ullal, 323 ITR 452 (Kar.), ruled out the
application of circular No. 12 dated 30th October, 2003 and circular
No. 13 dated 22nd December, 2006 issued by CBDT. In granting the
interest on refund due on an application for condonation of delay in claiming
the refund of taxes paid, the said circulars provided that no interest on
refund should be granted in cases where the delay in application of refund was
favourably condoned.

 

Recently, the Bombay High Court in the case
of State Bank of India in ITA No. 1218 of 2016 held that interest
on refund could not be denied in a case where the refund arose on account of
the claim for deduction made during the assessment proceedings… following its
own decision in the case of Chetan M. Shah, 53 taxmann.com 18.

 

The better view appears to be the
one in favour of granting interest for the full period commencing from the
first day of the assessment year to the date of the grant of refund.

 

ASSESSMENT OF BUSINESS MODEL FOR NON-BANKING FINANCIAL COMPANIES (NBFCs)

INTRODUCTION


India Incorporated continues its journey
with the next phase of adoption of Ind As by Non-Banking Finance Companies
in two phases commencing from the accounting period beginning 1 April, 2018.
Whilst there are several implementation and transition challenges, assessment
of the business model is an important area which is likely to impact most
NBFCs.

 

The initial plan of the MCA was to implement
Ind AS for the entire gamut of financial service entities covering NBFCs, banks
and insurance entities, which has been deferred by a year for banks and by two
years for insurance companies. Accordingly, the discussion in this article is
restricted only to NBFCs.

 

It may be pertinent to note that the RBI
had constituted a Working Group to deal with the various issues relating
to Ind AS Implementation by Banks which had submitted a detailed
report in September, 2015 which may be equally important and
relevant to NBFCs since there is a fair degree of similarity in their business
models and the same would be also taken into account in the course of our
subsequent discussions.

 

BUSINESS MODEL ASSESSMENT FOR FINANCIAL
ASSETS (INCLUDING THE MEASUREMENT AND CLASSIFICATION)


Assessing the business model for holding
financial assets is the anchor on which the entire accounting for financial
assets rests. Before going into the assessment of the business model for
financial assets it is necessary to understand as to what constitutes a
financial asset, since for NBFCs it represents the single most important
component in the Balance Sheet and how its initial measurement is determined.

 

Meaning and Nature of Financial Assets Ind AS-32 defines a financial asset as any asset that is:

a)  Cash

b)  An equity instrument of another entity

c)  A contractual obligation to receive cash or
another financial asset from another entity or to exchange financial assets or
financial liabilities with another entity under conditions that are potentially
favourable to the entity.

 

As can be seen
above, an equity instrument needs to be evaluated from the perspective of an
issuer and the same is defined in Ind AS-32 as any contract that
evidences a residual interest in the assets of an entity after deducting all
its liabilities. Accordingly, from the point of view of the holder an
equity instrument is an asset / instrument in which the entity does not have a
right to receive a fixed contractual amount of principal or interest.

 

Accordingly, by
default any instrument which does not meet the definition of an equity
instrument from an issuer’s perspective would be regarded as a debt instrument
in which there is generally a contractual cash flow involved.

 

Initial Measurement of Financial Assets


As per Ind AS-109
an entity shall initially measure its financial assets at their
fair value plus or minus any transaction costs that are directly attributable
to the acquisition of the financial assets in case of those falling under the
FVTPL category (discussed later).

 

The best evidence of the fair value on initial
recognition is normally the transaction price. However, if the NBFC determines that the fair
value based on quoted prices in an active market for identical items, or
based on observable and unobservable inputs like interest rates, yields, credit
spreads etc., is different, the same shall be recognised as a day one gain or
loss. The common areas where such adjustments are required are staff and
related party loans and refundable premises deposits which carry preferential
interest rates or no interest rates.

 

Classification of Financial Assets


Under Ind AS-109,
understanding the business model under which financial assets are held is the
key criterion for determining their classification and subsequent measurement
and accounting. Ind AS-109 requires that all financial assets are required to
be classified under the following three categories for subsequent measurement
purposes:


a)  Amortised Cost

b)  Fair value through profit or loss (FVTPL)

c)  Fair value through other comprehensive income
(FVTOCI)

 

The classification
depends upon the following two criteria and options elected by the entity:

a)  The entity’s business model for
managing the financial assets, and

b)  The contractual cash flow characteristics
of the financial assets.

 

Further, there are separate
classification requirements for:

a)  Equity Instruments

b)  Debt Instruments

 

Equity
Instruments


Since equity instruments
do not involve the right to contractually receive fixed and determinable cash
flows whether through principal or interest, their classification is more dependent
upon the intention of whether it is “held for trading” (discussed
later). However, in situations in which the instruments are not held for
trading, the entity needs to exercise an irrevocable choice as to whether
it wants to elect the FVTOCI option. A tabulation of the choices
available is depicted hereunder:

 

 

 

Accordingly, all
equity instruments which are “held for trading” are required to be mandatorily
classified as FVTPL, whereas for all other instruments, the entity can make an
irrevocable option to classify the same as FVTOCI or elect the FVTPL option
(discussed later). The following are some of the key points which are
relevant regarding the FVTOCI classification of equity instruments:


a)  Classification as FVTOCI is not mandatory
though it cannot be used for equity instruments “held for trading”.


b)  The classification needs to be made on initial
recognition and is irrevocable.


c)  The election can be made on an instrument by
instrument basis and is not an accounting policy choice.


d)  If the entity elects this option then all fair
value changes on the particular instrument, excluding dividends, are recognised
through OCI and no recycling is permitted to Profit and Loss even on disposal,
though the cumulative gain or loss at the time of disposal may be transferred
within equity to retained earnings.


e)  There are no separate impairment requirements.


f)   Ind AS-101 gives the entity a choice to
designate the equity instruments on the basis of facts and circumstances that
exist on the date of transition to Ind AS.

 

Debt Instruments


The classification of debt instruments is dependent upon the business
model which refers to how an entity manages its financial assets so as to
generate cash flows i.e. whether the entity will collect the cash flows
by holding the financial asset till maturity or sell those assets or both.
A tabulation of the choices available is depicted hereunder:

 

 

The following are some of the key points which are relevant regarding
the FVTOCI classification of debt instruments:


a)  For debt instruments meeting
the above prescribed criteria, FVTOCI classification is mandatory, unless
FVTPL option is exercised as discussed below.


b)  For such debt instruments, interest income,
impairment and foreign exchange changes are recognised in profit and loss
whereas all other changes are recognised directly in OCI.

c)  On derecognition, cumulative
gains and losses previously recognised in OCI are reclassified from equity to
profit and loss.


d)  Ind
AS-101 gives the entity a choice to designate the debt instruments on the basis
of facts and circumstances that exist on the date of transition to Ind AS.

 

Option to Designate Financial Assets at FVTPL


Irrespective of the satisfaction of any of the above conditions for
amortised cost or FVTOCL designation, Ind AS-109 provides an option to
irrevocably designate a financial asset as measured at FVTPL if doing so eliminates
or significantly reduces a measurement mismatch, which is also referred to as
an ‘accounting mismatch’, which would otherwise arise if a different basis
is followed.
Though this is an accounting policy choice, it is not required to be applied
consistently for all similar transactions. Ind AS-109 provides the following
guiding principles to designate financial assets as measured at FVTPL:

 

a)  When the financial asset is
part of a hedging relationship.


b)  When the financial assets,
financial liabilities or both share a common risk such as interest rate risk
that gives rise to offsetting changes as part of the entity’s ALM policy.


c)  When a group of financial
assets is managed and performance is evaluated on a fair value basis such as
investment management, venture capital companies or stock broking companies.

 

Held for
Trading


Apart from the option to designate financial assets at FVTPL as
discussed above, another important consideration for FVTPL designation is
whether the financial assets are “held for trading” for which Ind AS-109 has
provided certain guiding principles which are briefly discussed hereunder:

 

a)  The financial assets are
acquired ‘principally’ for the purpose of selling in the near term e.g. stock
in trade held by a stock broker.


b)  The financial asset is part of a portfolio of
financial instruments that are managed together and for which there is evidence
of a recent actual pattern of short-term profit taking.


c)  ‘Trading’ generally reflects active and
frequent buying/selling with the objective of generating a profit from
short-term fluctuations in the price. However, churning of portfolio for risk
management purposes is not necessarily ‘trading’ activity.  

 

Business Model Assessment


Guiding
Principles


The following are some of the guiding principles laid down in Ind AS-109
which need to be considered whilst assessing and determining the business model
for managing financial assets, in the context of debt instruments, some of
which have also been reiterated in the RBI Working Group Report, referred to
earlier in the context of Banks which may also be pertinent to NBFCs:

 

a)  Assessing the entity’s business model for
managing financial assets is a matter of fact and not merely an assertion. It
has to be based on relevant and objective evidence including but not limited to
how the performance of the business model and the financial assets held within
the same are evaluated by the entity’s key management personnel, their risks and
how the personnel are compensated.


b)  The assessment is based on how groups of
financial assets are managed to achieve a particular business objective and is not
an instrument by instrument analysis, though at another level it is also not an
entity level assessment.

c)  A few exceptions against the stated portfolio
objectives may not necessitate a change in the business model e.g. a few sales
out of a portfolio which is on the “hold to collect” business model. In such
situations what needs to be considered are factors like the frequency, timing
and reasons for the sales and expectations of the future sales activity.


d)  Business model assessment is done based on
scenarios reasonably expected to occur and not on exceptional or extreme
situations such as ‘worst case scenario’ or ‘stress case scenario’.

 

Amortised Cost –
Business Model Test


Some of the key
features for assessing the business model test of holding on to a financial
asset for amortised cost determination areas are as under:


a)  To evaluate the entity’s business model to
hold financial assets to collect contractual cash flows, the frequency,
value and timing of sales in prior periods and the reasons for such sales have
to be analysed. Also, future expectations about such sales is required
to be analysed. It is important to bear in mind that higher or lower sales than
the previous expectations is not a prior period error.


b)  In real time business it is not always
practical to hold all the financial assets until their maturity, regardless of
the business model. Hence, some amount of selling/buying or so called ‘churning
of portfolio’ is expected and permitted. However, if more than infrequent
number of sales are made out of a portfolio or those sales are more than
insignificant in value, then there will be a need to assess and
validate how such sales are consistent with the business model whose objective
is to collect contractual cash flows.  

 

It would be useful
at this stage to analyse certain common situations where the business model
test of holding would not fail or fail from a practical perspective, before
getting into the assessment of the subsequent criteria of the contractual cash
flow test:

 

Circumstances when the business model test would not
necessarily fail

Circumstances when the business model test may generally fail

Infrequent  sales to meet unforeseen funding needs.

Holding
financial assets to meet everyday liquidity needs.

Purchases
of loan portfolio instead of originating loan portfolio, which may include
credit impaired loans.

Loans
originated with an intention to sell in the near future.

Sales
due to increase in credit risk of the financial assets which can be
demonstrated either with entity’s credit risk management policy or in some
other way. This could also include sales to manage credit concentration risk
regardless of the increase in credit risk.

Portfolio
of financial assets that meet the definition of ‘held for trading’ as
discussed above even if they are held for a long period.

Sales
effected closer to maturity where the proceeds approximately equal the
remaining contractual cash flows.

 

    

Amortised Cost –
Cash Flow Characteristics Test


Another equally
important test or criterion to be met for classification of financial assets as
subsequently measured at amortised cost is the characteristics of the cash
flows arising from the financial asset. Ind AS-109 provides that for this
purpose, the contractual terms of the financial asset should give rise on
specified dates to cash flows that are solely payment of principal and the
interest on the principal outstanding (SPPI).

 

Ind AS-109 defines
interest, for the purpose of the above assessment, as consideration for the
following:

 

a)  the time value of money.

b)  credit risk associated with the principal
amount outstanding during a particular period of time.

c)  other basic lending risks (such
as liquidity risk) and costs (such as administration for holding
the financial asset).

d)  profit margin.

 

Ind AS-109 defines
principal, for the purpose of the above assessment, as fair value of
the financial asset at the date of initial recognition. This initial amount may
change subsequently if there are repayments of the principal amount.   

 

For the purposes of
the above assessment, principal and interest payments should be in the currency
in which the financial asset is denominated. The following are some of the practical
considerations which are relevant for assessing the SPPI test:

 

a)  Modified (or imperfect) Time Value of Money
Element: This kind of situation arises when the financial asset’s interest
rate is reset periodically and the tenor of rate (benchmark rate) does not
match the tenor of interest period e.g. interest rate for a term loan is reset
monthly but rate is reset to one year rate. In such cases, entity will have to
assess whether the cash flows represent SPPI. This has to be demonstrated as
follows:


  • Compute (undiscounted) cash
    flows as if benchmark rate tenor matches interest period and compare it with
    cash flows (undiscounted) as per contractual terms (i.e. tenors do not match).

  • Above computation has to be
    done for entire period of the financial asset and hence consideration of facts
    that affect future interest rates and estimation would be required.
  • If the cash flows under
    above two scenarios are significantly different then the modified time value of
    money element does not represent SPPI.


b)  Rates set by Regulators: These shall be
considered as proxy for time value of money element, provided it is set by
broadly considering the passage of time element and does not introduce exposure
to risks and volatility inconsistent with basic lending arrangement.


c)  Pre-payment or extension options pass
the SPPI test, provided that the repayment amount substantially represents
unpaid principal and interest accrued as well as reasonable compensation for
early payment or extension of payment period.


d)  Floating or Variable Rates: Provisions
that change the timing or amount of payments of principal and interest fail the
SPPI test unless it is a variable interest rate that is a consideration for the
time value of money and credit risk and other basic lending risk associated
with the principal outstanding and the profit margin.

 

Key
Implementation and Transition Challenges


The current requirements for classification and accounting for
investments by NBFCs were quite simple and hence shifting over to an Ind AS
regime is expected to present a fair share of challenges both in initial
transition and on-going implementation. Further, though all Ind AS requirements
are required to be applied retrospectively on the date of transition, Ind
AS-101 provides certain exceptions thereto, one of them being that the entity
should assess the business model criteria on the basis
of facts and circumstances on the date of transition. Finally, the measurement
basis for all financial assets on initial recognition would henceforth be at
the fair value for which also Ind AS-101 provides for prospective application
on or after the date of transition to Ind AS. In spite of the aforesaid
exemptions from retrospective application, NBFCs are likely to face certain
transition and on-going implementation challenges, which are briefly discussed
hereunder:

 

a)  Treatment of existing
investments classified as current: As per the existing AS-13, all
investments that by their nature are readily realisable and are intended to be
held for not more than one year from the date on which they were made, are
regarded as current investments. Under Ind AS, all such investments may not
automatically meet the held for trading criteria especially in respect of
equity instruments, and especially if these are continuing for periods in
excess of one year on the date of transition. Accordingly, a fresh evaluation
of the purpose, nature and intention of such investments would need to be
undertaken to categorise them under the appropriate bucket. Also,
investments in mutual funds would generally fall under the FVTPL
category based on the “look through” test since there are no defined
contractual cash flows even in case of fixed maturity plans.

b)  Documentation and business
model assessment: – The classification requirements based on the criteria
discussed above may not be straitjacketed in all cases and would need to be
documented in a fair degree of detail based on the activity level and type of
business of the NBFC. The existing risk management and ALM policies especially
in case of smaller and unlisted entities would need to be recalibrated to
capture the various scenarios under Ind AS.


c)  Fair value determination:
The initial measurement of all financial assets at fair value would be a game
changer for many NBFCs. Whilst initially the transaction price would be the
fair value in many cases, this would need to be carefully evaluated in the case
of transactions with related parties, transactions not on an arm’s length basis
or transactions under duress, since in such cases the fair value at which other
market participants enter into the transactions would need to be considered which
would represent a day one gain or loss. Finally, the on-going assessment of the
fair value especially in case of financial assets which are not readily
tradeable or quoted on an active market would present challenges especially in
cases where there are not many observable inputs to determine the fair value,
since it could be based on significant judgements which more often than not
could be biased. This would make it inherently difficult for a comparison
between entities and also involve significant costs and efforts which may not
be always commensurate with the benefits.


d)  Link with liquidity crisis:
The current liquidity crisis which has engulfed many NBFCs may necessitate
selling of portfolios of financial assets the impact of which on the continued
assessment of the business portfolio would need a closer assessment requiring a
reclassification of debt instruments and loans from amortised cost to FVTOCI
for subsequent measurement.


e)  Judgements: Finally, the
assessment of the business model involves significant judgements and
assumptions which need to be constantly evaluated by the key management
personnel on several matters like determining the frequency and volume of sales
so as to rebut the business model of held to sale, whether interest rates reset
is on time value and the other criteria discussed earlier, the manner of
determining the pricing for financial assets and the inputs involved therein
since all of this would ultimately impact the business model assessment and the
consequential classification and measurement of financial assets. It may be
noted that the RBI working group has recommended the fixing of certain
thresholds to determine as to when the volume of sales could be considered frequent
so as to rebut the business model of “held to sale” criteria.

 

CONCLUSION


The above
evaluation is just the tip of the iceberg on a subject for which there may not
always be straitjacketed answers. However, the business model assessment is
here to stay and it would impact the way the financial statements are evaluated
and also impact the auditors and prove to be a bonanza for specialists to
develop fair values, who could laugh all the way to the bank!

 

 

Section 80-IA – Deduction u/s. 80-IA – Industrial undertaking – Generation of power – Assessee owning three units and claiming deduction in respect of one (eligible) unit – Losses of earlier years of other two units cannot be notionally brought forward and set off against profits of eligible unit – Unit entitled to deduction u/s. 80-IA to be treated as an independent unitSection 80-IA – Deduction u/s. 80-IA – Industrial undertaking – Generation of power – Assessee owning three units and claiming deduction in respect of one (eligible) unit – Losses of earlier years of other two units cannot be notionally brought forward and set off against profits of eligible unit – Unit entitled to deduction u/s. 80-IA to be treated as an independent unit

20

CIT vs. Bannari Amman Sugars Ltd.;
412 ITR 69 (Mad)

Date of order: 28th
January, 2019

A.Y.: 2004-05

 

Section
80-IA – Deduction u/s. 80-IA – Industrial undertaking – Generation of power –
Assessee owning three units and claiming deduction in respect of one (eligible)
unit – Losses of earlier years of other two units cannot be notionally brought
forward and set off against profits of eligible unit – Unit entitled to
deduction u/s. 80-IA to be treated as an independent unit

 

The
assessee manufactured and sold sugar. It operated three power generation units,
two in Karnataka and one in Tamil Nadu with a capacity of 16, 20 and 20
megawatts, respectively. For the A.Y. 2004-05, the assessee claimed deduction
u/s. 80-IA of the Income-tax Act, 1961 for the first time in respect of its 16
megawatts unit in Karnataka. The A.O. set off the losses suffered by the units
in Karnataka and Tamil Nadu against the profits earned by the eligible unit and
held that the assessee had no positive profits after such set-off and hence no
deduction was liable to be granted u/s. 80-IA.

 

The Tribunal found that independent power purchase
agreements were entered into by the assessee which contained different and
distinct terms and conditions. It held that the provisions of section 80-IA
were attracted only in the case of the specific unit which claimed deduction
and that consolidating the profit and loss of the three units of the assessee
by the lower authorities was untenable.

 

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

 

“i)   Section
80-IA(5) provides that in determining the quantum of deduction u/s. 80-IA, the
eligible business shall be treated as the only source of income of the assessee
during the previous year relevant to the initial assessment year and to every
subsequent assessment year up to and including the assessment year for which
the determination is to be made. Thus, each unit, including a captive power
plant, has to be seen independently as separate and distinct from each other
and as units for the purpose of grant of deduction u/s. 80-IA.

 

ii)   The mere
fact that a consolidated balance sheet and profit and loss account had been
prepared for the entire business would not disentitle the assessee to claim
deduction u/s. 80-IA in respect of only one undertaking of its choice. The
assessee had maintained separate statements and had filed before the
Commissioner (Appeals) detailing separate project cost and source of finance in
respect of each unit. The assessee had exercised its claim before the A.O. for
deduction u/s. 80-IA in respect of only the 16-megawatts unit at Karnataka.
Each unit, including a captive power plant, had to be seen independently as
separate and distinct from each other and as units for the purpose of grant of
deduction u/s. 80-IA.

 

iii)   In the light of the above discussion, the
questions of law are answered in favour of the assessee and against the Revenue
and the tax case (appeal) is dismissed.”

Section 119 – CBDT – Power to issue directions – Any directives by CBDT which give additional incentive for an order that Commissioner (Appeals) may pass having regard to its implication, necessarily transgresses on Commissioner’s exercise of discretionary quasi judicial powers. Interference or controlling of discretion of a statutory authority in exercise of powers from an outside agency or source, may even be superior authority, is wholly impermissible

19

Chamber of Tax Consultants vs. CBDT;
[2019] 104 taxmann.com 397 (Bom)

Date of order: 11th April,
2019

 

Section
119 – CBDT – Power to issue directions – Any directives by CBDT which give
additional incentive for an order that Commissioner (Appeals) may pass having
regard to its implication, necessarily transgresses on Commissioner’s exercise
of discretionary quasi judicial powers. Interference or controlling of
discretion of a statutory authority in exercise of powers from an outside
agency or source, may even be superior authority, is wholly impermissible

 

The
Chamber of Tax Consultants challenged a portion of the Central Action by the
CBDT which provided incentives to Commissioner (Appeals) for passing orders in
certain manner. The Bombay High Court allowed the writ petition and held as
under:

 

“i)   In terms of the provisions contained in
sub-section (1) of section 119, the Board may, from time to time, issue such
orders, instructions and directions to other income tax authorities as it may
deem fit for proper administration of the Act and such authorities shall
observe and follow the orders, instructions and directions of the Board. While
granting such wide powers to the CBDT under sub-section (1) of section 119, the
proviso thereto provides that no such orders, instructions or directions shall
be issued so as to require any income tax authority to make a particular assessment
or to dispose of a particular case in a particular manner.

ii)   When the CBDT guidelines provide greater
weightage for disposal of an appeal by the Appellate Commissioner in a
particular manner, this proviso of sub-section (1) of section 119, would surely
be breached.

 

iii)   Thus, the portion of the Central Action Plan
prepared by CBDT which gives higher weightage for disposal of appeals by
quality orders, i.e., where order passed by Commissioner (Appeals) is in favour
of Revenue, was to be set aside.”

Sections 2(47) and 45(4) – Capital gains – Where retiring partners were paid sums on reconstitution of assessee-partnership firm in proportion to their share in partnership business / asset, no transfer of assets having taken place, no capital gains would arise

18

Principal CIT vs. Electroplast
Engineers; [2019] 104 taxmann.com 444 (Bom)

Date of order: 26th March,
2019

A.Y.: 2010-11

 

Sections
2(47) and 45(4) – Capital gains – Where retiring partners were paid sums on
reconstitution of assessee-partnership firm in proportion to their share in
partnership business / asset, no transfer of assets having taken place, no
capital gains would arise

 

Under a
Deed of Retirement cum Reconstitution of the Partnership, the original two
partners retired from the firm and three new partners redistributed their
share. Goodwill was evaluated and the retiring partners were paid a certain sum
for their share of goodwill in proportion to their share in the partnership.
The assessee-partnership firm filed return of income. The A.O. was of the
opinion that the goodwill credited by the assessee-partnership firm to its
retiring partners was capital gain arising on distribution of the capital asset
by way of dissolution of the firm or otherwise. Thus, the assessee-partnership
firm had to pay short-term capital gain tax in terms of section 45(4) of the
Income-tax Act, 1961.

 

The
Commissioner (Appeals) agreed with the contention of the assessee-partnership
firm that there was neither dissolution of the firm nor was the firm
discontinued. He held that the rights and interests in the assets of the firm
were transferred to the new members and in this manner amounted to transfer of
capital asset. Thus, section 45(4) would apply. The Tribunal held that section
45(4) would apply only in a case where there has been dissolution of the firm
and, thus, the conditions required for applying section 45(4) were not
satisfied.

 

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

 

“i)   As per the provision of section 45(4),
profits or gains arising from transfer of capital asset by way of distribution
of capital asset on dissolution of firm or otherwise shall be chargeable to tax
as income of the firm. For the application of this provision, thus, transfer of
capital asset is necessary.

 

ii)   In the
case of CIT vs. Dynamic Enterprises [2014] 223 Taxman 331/[2013] 40
taxmann.com 318/359 ITR 83, the full bench of the Karnataka High Court
has held that after the retirement of the partners, the partnership continued
and the business was also carried on by the remaining partners. There was,
thus, no dissolution of the firm and there was no distribution of capital
asset. What was given to the retiring partners was money representing the value
of their share in the partnership. No capital asset was transferred on the date
of retirement. In the absence of distribution of capital asset and in the
absence of transfer of capital asset in favour of the retiring partners, no
profit or gain arose in the hands of the partnership firm.

 

iii)   In the instant case, admittedly, there was no
transfer of capital asset upon reconstitution of the firm. All that happened
was that the firm’s assets were evaluated and the retiring partners were paid
their share of the partnership asset. There was clearly no transfer of capital
asset.”

Section 37(1) – Business expenditure – Compensation paid by assessee developer to allottees of flats for surrendering their rights was to be allowed as business expenditure

17

Gopal Das Estates & Housing (P)
Ltd. vs. CIT; [2019] 103 taxmann.com 334 (Delhi)

Date of order: 20th March,
2019

 

Section
37(1) – Business expenditure – Compensation paid by assessee developer to
allottees of flats for surrendering their rights was to be allowed as business
expenditure

 

The
assessee was engaged in the business of construction and sale of commercial
space. The assessee developed a 17-storeyed building known as GDB in New Delhi.
It followed the Completed Contract Method (CCM) as compared to the Percentage
Completion Method (PCM). It booked flats to various persons after receiving
periodical amounts as advance. Some of the allottees of the flats refused to
take them for completion since the New Delhi Municipal Council (NDMC) changed
the usage of the Lower Ground Floor (LGF). The assessee then started
negotiating with the relevant flat buyers and persuaded them to surrender their
ownership and allotment letters. The assessee repaid advance money received
from these flat owners and also paid compensation in lieu of surrender
of their rights in the flats. This expenditure was claimed by the assessee as
‘revenue in nature’ and was charged to the profit and loss account (P&L
Account).

 

The A.O.
observed that the assessee had paid compensation amount ‘once and for all to
repurchase the property’ and this was ‘in fact a sale consideration and could
not be allowed as business expenditure.’ He observed further that flat owners
had shown the amount received from the assessee as capital gains in their books
of account as well as income tax returns after indexation of the cost of
acquisition. Accordingly, the payment of compensation towards ‘repurchase of
the flat’ was disallowed by holding that it was ‘a capital expenditure’. The
said amount was added back to the income of the assessee.

     

The
Commissioner (Appeals) directed that compensation paid to the allottees of the
flats for surrendering the rights therein be allowed as business expenditure of
the assessee. But the Tribunal set aside the order of the Commissioner
(Appeals) and restored the order of the A.O.

 

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

 

“i)   In the instant case, the assessee has a
plausible explanation for making such payment of compensation to protect its
‘business interests.’ While it is true that there was no ‘contractual obligation’
to make the payment, it is plain that the assessee was also looking to build
its own reputation in the real estate market.

 

ii)   Further, the mere fact that the recipients
treated the said payment as ‘capital gains’ in their hands in their returns
would not be relevant in deciding the issue whether the payment by the assessee
should be treated as ‘business expenditure.’ It is the point of view of the
payer which is relevant.

 

iii)   The payment made by the assessee to the
allottees of the flats for surrendering the rights therein should be allowed as
business expenditure of the assessee.”

Section 37(1) and Rule 9A of ITR 1962 – Business expenditure – Where assessee was engaged in business of production and distribution of films, cost of prints as well as publicity and advertisements incurred after production as well as their certification by Censor Board, the same would not be governed by Rule 9A, they would be allowable as business expenditure u/s. 37(1)

16

CIT vs. Dharma Productions Ltd.;
[2019] 104 taxmann.com 211 (Bom)

Date of order: 19th March,
2019

A.Y.s: 2006-07 and 2009-10

 

Section
37(1) and Rule 9A of ITR 1962 – Business expenditure – Where assessee was
engaged in business of production and distribution of films, cost of prints as
well as publicity and advertisements incurred after production as well as their
certification by Censor Board, the same would not be governed by Rule 9A, they
would be allowable as business expenditure u/s. 37(1)

 

The
assessee was engaged in the business of production and distribution of feature
films. The assessee claimed expenditure incurred for positive prints of feature
films and further expenditure on account of advertisements. The A.O. noticed
that these expenditures were incurred by the assessee after issuance of
certificate by the Censor Board and, hence, he disallowed the assessee’s claim
holding that such expenditure was not allowable deduction in terms of Rule 9A
and Rule 9B.

 

The Commissioner (Appeals), confirmed the
disallowance stating that any expenditure which was not allowable under Rule 9A
could not be granted in terms of section 37; thus, he held that the expenditure
on the prints and publicity expenses are neither allowable under Rule 9A nor
u/s. 37. However, the Tribunal allowed the assessee’s claim.

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

 

“i)   Sub-rule
(1) of rule 9A provides that in computing the profits and gains of the business
of production of feature films, the deduction in respect of the cost of
production of a feature film certified for release by the Board of Film Censors
in a previous year would be allowed in accordance with the provisions of
sub-rule (2) to sub-rule (4).

 

ii)   Clause (ii) of Explanation to sub-rule
(1) explains the term ‘cost of production’ in relation to a feature film as to
mean expenditure incurred for preparation of the film but excluding (a)
expenditure incurred in preparing positive prints, and (b) expenditure
incurred in connection with advertisement of the film after it is certified for
release by the Board of Film Censors. The sub-rules (2) to (4) of rule 9A make
special provisions for deduction in respect of profits and gains of the
business of production of feature films. For example, in terms of sub-rule (2)
of rule 9A, where a feature film is certified for release by the Board of Film
Censors in any previous year and in such previous year, the film producer sells
all rights of exhibition of the film, the entire cost of production of the film
shall be allowed as a deduction in computing the profits and gains of such
previous year. However, if the film producer either himself exhibits the film
on a commercial basis or sells the rights of exhibition of the film in respect
of some of the areas, or he himself exhibits the film in certain areas and sells
the rights in the rest and the film is released for exhibition at least 90 days
before the end of such previous year, the cost of production of the feature
film will be allowed as a deduction in computing the profits and gains of such
previous year. As per sub-rule (3) of rule 9A, if the feature film is not
released for exhibition on a commercial basis at least 90 days before the end
of previous year, a different formula for allowing the cost of production would
apply. These provisions thus make a special scheme for deduction for cost of
production in relation to the business of production of feature films. One
thing to be noted is that no part of the cost of production as defined in
clause (ii) of Explanation to sub-rule (1) is to be denied to the
assessee permanently. It is only to be deferred to the next assessment year
under certain circumstances.

 

iii)   All these provisions would necessarily be
applied in relation to the cost of production of a feature film. In other
words, if a certain expenditure is claimed by the assessee by way of business
expenditure, which does not form part of cost of production of a feature film,
rule 9A would have no applicability. In such a situation, the assessee’s claim
of expenditure would be governed by the provisions of the Act. If the assessee
satisfies the requirements of section 37, there is no reason why such
expenditure should not be allowed as business expenditure. To put it
differently, the expenditure that would be governed by rule 9A of the Rules
would only be that which is in respect of the production of the feature film.

 

iv)  In the instant case, the cost of the print and
the cost of publicity and advertisement (which was incurred after the
production and certification of the film by the Censor Board) are under consideration.
These costs fail to satisfy the description ‘expenditure in respect of cost of
production of feature film’. The term ‘cost of production’ defined for the
purpose of this rule specifically excludes the expenditure for positive print
and cost of advertisement incurred after certification by the Board of Film
Censors. What would, therefore, be governed by the formula provided under rule
9A is the cost of production minus these costs. The Legislature never intended
that those costs which are in the nature of business expenditure but are not
governed by rule 9A due to the definition of cost of production are not to be
granted as business expenditure. In other words, if the cost is cost of
production of the feature film, it would be governed by rule 9A. If it is not,
it would be governed by the provisions of the Act. The Commissioner was,
therefore, wholly wrong in holding that the expenditures in question were
covered under rule 9A and therefore not allowable. The Tribunal was correct in
coming to the conclusion that such expenditure did not fall within the purview
of rule 9A and, therefore, the assessee’s claim of deduction was governed by
section 37.”