BCAJ | Bombay Chartered Accountant Journal

Section 194H –Where assessee, engaged in business of providing DTH services, sold set top Box (STB) and recharge coupon vouchers to distributors at a discounted rate, discount so offered could not be considered as commission and, hence, not liable for deduction of tax at source under provisions of section 194H.

30. [2019] 197 TTJ 75 (Mumbai – Trib.) Tata Sky Ltd.
vs. ACIT ITA No.: 6923
to 6926/Mum/2012 A.Y: 2009-10 to
2012-13 Dated: 12^th
October, 2018

Section 194H
–Where assessee, engaged in business of providing DTH services, sold set top
Box (STB) and recharge coupon vouchers to distributors at a discounted rate,
discount so offered could not be considered as commission and, hence, not
liable for deduction of tax at source under provisions of section 194H.

FACTS

The
assessee-company was engaged in business of providing Direct to Home (DTH)
services in the brand name of Tata Sky. The provision of this service required
installation of set top box and dish antenna at the customer’s premises. The
assessee had entered into agreement with distributors for sale/distribution of
settop boxes, prepaid vouchers, recharge vouchers (RCVs) etc. As per the
agreements, STBs and RCVs were sold to distributors at a discounted price. The distributors/dealers
sold these items to customers/subscribers of the assessee-company at a price
not exceeding the MRP mentioned for the product.

The Assessing
Officer held that the assessee was liable to deduct tax at source in respect of
payments made to the distributors as discount for sale of STBs and recharge
coupons as same was ‘commission and brokerage’ and the same was income in the
hands of distributions for service relevant of assessee. He therefore, treated
the assessee to be in default as per the provisions of section 201(1).

Aggrieved by
the assessment order, the assessee preferred an appeal to the CIT(A). The
CIT(A) upheld the order of the Assessing officer.

HELD

The Tribunal
held that the assessee entered into agreement with the distributor for sale of
Set Top Box (STB) and recharge coupon vouchers. As per agreement products are
sold to distributor at discounted price, as agreed. The distributor/dealer
sells these items to customers/subscribers at a price not exceeding MRP on the
product. As per the agreement, payment of each order for the above items was to
be made by distributor either at the time of placing the order or at the time
of delivery. Apart from the above assessee also provided festival/seasonal
discounts to the distributors. For these discounts assessee did not make any
payment rather it issued credit notes and same was subsequently adjusted from
the payment due from the distributor, so in the financial statements the
discount amount was not reflected.

The Tribunal followed the ratio of the Bombay High
Court decisions in the case of CIT vs. Piramal Healthcare Ltd (2015) 230
Taxman 505 and CIT vs. Qatar Airways (2011) 332 ITR 253 wherein it
was held that the assessee should not be visited with the liability to deduct
TDS for non-deduction of tax at source u/s. 194H on the difference between the
discounted price at which it is sold to the distributors and the MRP upto which
they are permitted to sell. The difference between MRP and the price at which
item is sold to the distributor cannot be held to be commission or brokerage.
The distributors are customers of the assessee to whom sales are affected. The
discounts and credit notes credited cannot be considered to be commission
payment u/s. 194H and therefore, the assessee was not liable to deduct the tax at source on the impugned amounts in this case.

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Section 69 r.w.s.5 & 6 –Where additions were made to income of assessee, who was a non-resident since 25 years, since, no material was brought on record to show that funds were diverted by assessee from India to source deposits found in foreign bank account, impugned additions were unjustified.

29. [2019] 197 TTJ 161 (Mumbai – Trib.) DCIT (IT) vs.
Hemant Mansukhlal Pandya ITA No.: 4679
& 4680/Mum/2016 A.Y: 2006-07
& 2007-08 Dated: 16^th
November, 2018

Section 69
r.w.s.5 & 6 –Where additions were made to income of assessee, who was a
non-resident since 25 years, since, no material was brought on record to show
that funds were diverted by assessee from India to source deposits found in
foreign bank account, impugned additions were unjustified.

FACTS

The assessee
was a non-resident individual living in Japan on a business visa since 1990. He
had been a director in a company in Japan and had got permanent residency certificate
from Japan since 2001. The assessing officer had made addition towards amount
found credited in HSBC Bank account, Geneva on the ground that the assessee had
failed to explain and prove that deposit was not having any connection to
income derived in India and not sourced from India. The Assessing Officer had
made additions on the basis of a document called ‘base note’ received from
French Government, as per which the assessee was maintaining a bank account in
HSBC Bank, Geneva. Except this, the Assessing Officer had not conducted any
independent enquiry or applied his mind before coming to the conclusion that
whether the information contained in base note was verified or authenticated.

Aggrieved by
the assessment order, the assessee preferred an appeal to the CIT(A). The
CIT(A) deleted the addition of income as made by the Assessing Officer. Being
aggrieved by the CIT(A) order, the Revenue filed an appeal before the Tribunal.

HELD

The Tribunal
held that the Assessing Officer was not justified in placing the onus of
proving a negative that the deposits in foreign bank account were not sourced
from India on the assessee. The onus of proving that an amount falls within the
taxing ambit was on the department and it was incorrect to place the onus of proving
negative on the assessee. No material was brought on record to show that the
funds were diverted by the assessee from India to source the deposits found in
foreign bank account. Therefore, it is viewed that when the Assessing Officer
found that the assessee was a non-resident Indian, was incorrect in making
addition towards deposits found in foreign bank account maintained with HSBC
Bank, Geneva without establishing the fact that the said deposit was sourced
out of income derived in India. Hence, the findings of the CIT(A) were upheld
and the appeal filed by the revenue was dismissed.

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Section 68 – Mere non production of Director of Shareholder Company cannot justify adverse inference u/s. 68 of the Act.

28. (2018) 66 ITR (Trib.) 226
(Delhi) Gopal Forex Pvt. Ltd. vs. ITO ITA No.: 902/Del/2018 A.Y: 2008-09 Dated:
26^th June, 2018

Section 68 – Mere non production of Director of Shareholder Company
cannot justify adverse inference u/s. 68 of the Act.

FACTS

The assessee company filed its return of income. Subsequent to the
processing of return of income, information was received from the investigation
wing of Income tax about a search operation carried out in the case of Jain
Brothers who were involved in providing accommodation entries and bogus share
capital. The name of the assessee company was found in a list as one of the
beneficiaries.

Reassessment proceedings were initiated and additions were made by the
AO only on the basis of purported documents seized from the premises of Jain
Brothers. In the assessee’s case addition was sustained merely because the
director of shareholder company did not present himself physically before the
AO.

Important question raised before CIT(A) was whether adverse inference
u/s. 68 could be drawn by AO once assessee placed all the relevant documents in
its possession before AO to establish its burden u/s. 68, without discharging
secondary burden lying on the AO to point out defect in the assessee’s
submission.

HELD

Before the Hon’ble ITAT, heavy reliance was placed by the Hon’ble bench
on Moti Adhesives P. Ltd. ITA No. 3133/Del/2018 where it was held that
once assessee places all the reliable and trustworthy documentary evidences to
support the veracity of transactions u/s. 68, it is the duty of AO to
dispassionately consider the same with objective standards and to not make
additions solely on the basis of investigation wing’s report prepared at the
time of search. This discharges the assessee’s burden u/s. 68 & shifts the
secondary burden to the AO. To discharge his burden, the AO must bring credible
incriminating material on record to displace the detailed evidence filed by the
assessee. But in the present case, it was observed that AO merely reproduced
the investigation wing’s report in the reasons recorded, the show cause notice
issued & the final order passed. If reassessment & additions are based
upon the sole ground of prima facie opinions which are used to reopen
the case, this would frustrate the entire object of law. Besides, additions
made merely on basis of non-production of directors of Share Holder Company
disregarding all the other detailed evidences on record is unjustified.

The Hon’ble ITAT also relied on the following judgements:

i) Softline Creations
Pvt. Ltd. (387 ITR 636) [Delhi HC]

ii) CIT vs. Orissa
Corporation Pvt. Ltd. (Vol. 159 ITR 78) [SC]

iii) Crystal Networks Pvt.
Ltd. vs. CIT (353 ITR 171) [Calcutta HC]

iv) Crystal Networks Pvt.
Ltd. vs. CIT (353 ITR 171) [Calcutta HC]

v) CIT vs. Dataware Pvt.
Ltd. (ITAT No. 263 of 2011) [Calcutta HC]

vi) Rakam Money Matters Pvt.
Ltd. (ITA no. 778/2015) [Delhi HC]

vii) Orchid Industries Pvt.
Ltd. (397 ITR 136) [Bombay HC]

viii) Aksar Wire Products (P)
Ltd. (ITA no. 1167/Del/2015) [Delhi ITAT]

ix) CIT vs. Stellar
Investment Ltd. (Civil No. 7868 of 1996) [SC]

Thus, relying on the views expressed in a plethora of judgements, the
Hon’ble ITAT held that mere non production of Director of share holder company
ipso facto cannot justify straight adverse inference u/s. 68 dehors detailed
documentary evidences filed.

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Section 153A, Rule 27 – Any issues other than those relating to undisclosed income which come to the AO’s knowledge while conducting enquiries relating to Search shall not be considered by AO for making assessment u/s. 153A if normal assessment for such relevant assessment years had already been completed earlier. Rule 27 gives liberty to the respondent to raise any ground which had been decided against him by the first appellate authority.

27. (2018) 66 ITR (Trib.) 306 (Delhi) ACIT vs.
Meroform India Pvt Ltd. ITA No.:
4494/Del/2014 A.Y: 2011-12 Dated: 31^st
July, 2018

Section 153A,
Rule 27 – Any issues other than those relating to undisclosed income which come
to the AO’s knowledge while conducting enquiries relating to Search shall not
be considered by AO for making assessment u/s. 153A if normal assessment for
such relevant assessment years had already been completed earlier.

Rule 27 gives
liberty to the respondent to raise any ground which had been decided against
him by the first appellate authority.

FACTS

Assessment for six years was reopened u/s.
153A. Against these, the assessee filed appeals for all the six years. Out of
these, the department preferred appeals to the Hon’ble ITAT for three
assessment years. In these three appeals, the CIT(A) had dismissed the legal
contentions of the assessee but gave relief on merits. Therefore, assessee had
not filed any cross appeal or cross objection, but it raised a legal ground by
invoking Rule 27 of ITAT Rules, challenging the validity of additions made in
the impugned assessment orders on the ground that the same were beyond the
scope of section 153A. CIT(DR) objected to the admission of the petition made
under Rule 27 and submitted that the respondent assessee cannot be permitted to
raise a ground or an issue which was decided against it which could only be
done by filing of appeal.

The second
issue raised in the appeal was whether issues already considered in the
assessments completed earlier, which had attained finality, can be re-examined
u/s. 153A by the assessing officer?

HELD

The tribunal
allowed the ground raised under Rule 27 of the Income Tax Appellate Tribunal
rules, 1963 and held
as under:

Rule 27 gives
the liberty to the respondent to support the first appellate order on any of
the ground decided against him. The issue of scope of addition in assessment
completed u/s. 153A had been decided against the assessee and therefore, as a
respondent it can very well raise the defence in the appeal filed by the
revenue. The only limitation which can be inferred is that the respondent
cannot claim any fresh relief which had been denied to him by the first
appellate authority and also which is not part of the grounds so raised by the
revenue. In the given case, it was not a claim of any fresh relief denied to
the assessee and also it was a part of the ground raised by the revenue. The
respondent assessee got the favourable judgment on merits but there was an
adverse finding on the issue of scope of addition u/s. 153A; and therefore, the
assessee can very well raise such an issue under Rule 27.

In the second
issue, the ITAT held that in the case of assessments which have attained
finality and are non-abated assessments, no additions can be made over and
above the original assessed income unless some incriminating material has been
found during the course of search. This proposition had been well discussed in
the judgment of CIT vs. Kabul Chawla (2016) 380 ITR 573 (Delhi HC).
Further, section 153A does not say that additions should be strictly made on
the basis of evidence found in the course of the search. But this does not mean
that the assessment can be arbitrary or without any relevance or nexus with the
seized material. Thus, an assessment has to be made under this Section only on
the basis of seized material as laid down in Pr.CIT vs. Meeta Gutgutia 395
ITR 526 (Delhi HC).

Thus, in the
opinion of the ITAT all the additions made by the AO in the said three
assessment years were beyond the scope of assessment u/s. 153A, because
assessments for these assessments years had attained finality before the date
of search and no incriminating material was found relating to such additions.

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TRANSFER PRICING: WHAT HAS CHANGED IN OECD’S 2017 GUIDELINES? [PART 2]

This article summarises the key
additions/ modifications made in the 2017 Guidelines as compared to the earlier Guidelines. The first part of the
article, published in the December issue of the Journal, discussed about the
general guidance contained in Chapters I to V of the new Transfer Pricing
Guidelines issued in 2017 (2017 Guidelines). This part of the article deals
with guidance relating to specific transactions:

? Chapter VI – Special
Consideration for Intangibles

? Chapter VII – Special
Considerations for Intra-Group
Services,

? Chapter VIII – Cost
Contribution Agreements, and

? Chapter IX – Business
Restructurings

1. Chapter
VI – Special Considerations for Intangibles

The 2017 Guidelines
have broadened the concept of ‘intangibles’ for transfer pricing purposes, and
also provide detailed guidance on intangibles including several aspects of
intangibles not addressed in the earlier guidelines. The key differences are
discussed in this section.

1.1. Definition of
intangibles

The 2017 Guidelines
provide that the word ‘intangible’ is intended to address something which is not
a physical asset or a financial asset, which is capable of being
owned or controlled for use in commercial activities and whose
use or transfer would be compensated had it occurred in a transaction between
independent parties in comparable circumstances.¹ The 2017
Guidelines provide that intangibles that are important to consider for transfer
pricing are not always recognised as intangible assets for accounting purposes
and the accounting or legal definitions solely may not be relevant for transfer
pricing.

___________________________

1 Refer para 6.6 of 2017 Guidelines

The 2017 Guidelines discuss that distinctions are sometimes sought to be
made between (a) trade and marketing intangibles² (b) soft and hard
intangibles (c) routine and non-routine intangibles and between other classes
and categories of intangibles, but the approach to determine arm’s length price
does not depend on such categorisations.³ An illustrative list of
intangibles is also provided in the 2017 Guidelines. The Guidelines also
provide that factors such as group synergies and market specific
characteristics are not intangibles, since they cannot be owned or controlled
by any one entity in the group.

1.2. Framework for transfer
pricing analysis of transactions involving intangibles

Like any other transfer pricing matter, analysis of cases involving
intangibles should be in accordance with principles outlined under Chapter I to
III of the 2017 Guidelines. The Guidelines provide for a similar six-step
framework for analysing transactions involving intangibles.⁴

________________________________________________

2 Marketing Intangible and Trade Intangible
have also been defined in the 2017 Guidelines.

3 Refer para 6.15 of 2017 Guidelines

4 Refer para 6.34 of 2017 Guidelines

1.3. Intangible ownership and
contractual terms relating to intangibles

The 2017 Guidelines
specifically provide that legal ownership does not necessarily confer the right
to returns generated from the intangible. The Guidelines give an example of an
IP Holding Company which does not perform any relevant functions, does not
employ any relevant assets and does not assume any relevant risks. The
Guidelines provide that such party will be entitled to compensation, if any,
only for holding the title to the IP, and not in the returns otherwise
generated from the IP. The returns from the intangible, even though they accrue
initially to the legal owner of the intangible, will need to correspond to the
functions performed, assets employed and risks assumed by the different
entities in the group.

1.4. Functions, Assets and
Risks relating to Intangibles

1.4.1. Functions

The 2017 Guidelines
provide that determining the party controlling and performing functions
relating to DEMPE of intangibles is one of the key considerations in
determining arm’s length conditions for the controlled transactions.

In case some
functions are outsourced, if the legal owner neither performs nor controls the
outsourced functions relating to the DEMPE of intangible, it would not be
entitled to any ongoing benefit attributable to the outsourced functions.
Depending on the facts, the return for entities performing and controlling such
functions may comprise a share of the total return derived from exploitation of
the intangible.

1.4.2. Assets

The 2017 Guidelines
provide for considering important assets and specifically identify intangibles
used in research, development or marketing, physical assets and funding.

Unlike the earlier
guidelines, there is a detailed discussion in the 2017 Guidelines on funding,
and returns corresponding to funding. The Guidelines provide that funding
returns from intangibles would depend on the precise functions performed and
risks undertaken by the funder. An entity providing funding but not controlling
risks or performing functions relating to the funded activity would be entitled
to lesser returns than an entity which also performs and controls important
functions and controls important risks associated with the funded activity.

In the context of
funding, the Guidelines distinguish between financial risks (risks relating to
funding/ investments) and operational risks (risks relating to operational
activities for which the funding is used). If the investor controls the
financial risk associated with the provision of funding, without the assumption
of operational risks, it could generally expect only a risk-adjusted return on
its investments.

1.4.3. Risks

The 2017 Guidelines
specifically identify risks relating to transactions involving intangibles,
such as risks related to development of intangibles, risk of product
obsolescence, infringement risk, product liability risk, and exploitation risk.⁵
A detailed analysis of the assumption of these risks with respect to functions
relating to the DEMPE of intangibles is crucial.

The Guidelines also
provide that generally, the responsibility for the consequences of risks
materialising will have a direct correlation to the assumption of risks by the
parties to the transaction.

1.5. Actual (ex post)
Returns

The 2017 Guidelines
also discusses regarding sharing of profit/losses among group entities in case
of variation between actual (ex post) and anticipated (ex ante)
returns.

The 2017 Guidelines
provide that the entitlement of the group entity to the variation depends on
which party assumes the risks identified while delineating the actual
transaction. The entitlement also depends on performance of important functions
or contributing to control of economically significant risks, and for which an
arm’s length remuneration would include a profit-sharing element.

1.6. Illustration on
application of arm’s length principle in certain specific fact patterns

The 2017 Guidelines
identify specific commonly found fact patterns and provide useful guidance on
those and provide detailed guidance on these situations. These are briefly
discussed in this section.

1.6.1. Marketing intangibles

The 2017 Guidelines
discuss a common situation where a related entity performs marketing or sales
functions that benefit the legal owner of the trademark – through marketing
arrangements or distribution/marketing arrangements.⁶

___________________________

5 Refer para 6.65 of 2017 Guidelines

The Guidelines
provide that such cases require assessment of:

? Obligations
and rights implied by the legal registrations and agreements between the
parties;

? Functions
performed, assets employed and risks assumed by the parties;

? Intangible
value anticipated through the marketer/ distributor’s activities; and

? Compensation
provided to the marketer/distributor.

The Guidelines then
provide that any additional compensation for the marketer/distributor will
arise if it is not already adequately compensated for its functions through the
contractual arrangement.

1.6.2. Research, development and
process improvement arrangements

The 2017 Guidelines
provide that in cases involving contract research and development activities,
compensation on a cost plus modest mark-up basis may not reflect arm’s length
price in all cases. While determining the compensation, the Guidelines give
much weightage to the research team, i.e., including their skills and
experience, risks assumed by them, intangibles used by them, etc. Similarly,
analysis would be required in case of product or process improvements resulting
from the work of a manufacturing service provider.

1.6.3. Payment for use of company name

The 2017 Guidelines
provide that generally, no compensation should be paid to the owner of the
group name for simple recognition of group name, or to reflect the fact of
group membership. A payment would be due only if the use of the group name
provides a financial benefit to the entity using the group name. Similarly,
where an existing successful business is acquired by another business, and the
acquired business begins to use the group name, brand name, trademark, etc., of
the acquirer, there should be no automatic assumption that the acquired
business should start paying for such use of the group name and other
intangibles. In fact, in a case where the acquirer leverages the existing
positioning of the acquired business to expand to new markets, one should
evaluate whether the acquirer should pay a compensation to the acquired
business.

_________________________________

6
Refer para 6.76 of 2017 Guidelines

1.6.4. Other specific cases

The 2017 Guidelines
also provides guidance on various other specific fact patterns involving
intangibles such as transfer of all or limited rights, combination of
intangibles, transfer of intangibles with other business transactions, use of
intangibles in connection with sales of goods/ services.

1.7. Comparability factors

The 2017 Guidelines
provide detailed guidance on comparability factors relating to intangibles.
These factors should be considered in a comparability analysis especially under
the CUP Method (say, benchmarking analysis to find comparable royalty rates for
use of intangibles). The comparability factors specifically mentioned, although
not exhaustive, include exclusivity; extent and duration of legal protection;
geographic scope; useful life; stage of development; rights to enhancements,
revisions and updates; and expectation of future benefit.

Similarly, some key
risks that need to be analysed for a comparability analysis include risks
related to future development of the intangible, product obsolescence and
depreciation, infringement risks, product liability risks, etc.

1.8. Valuation of intangibles

The 2017 Guidelines
tend to favour the CUP Method and the transactional profit split method for
valuing intangibles. The Guidelines also recognise valuation techniques as
useful tools. One-sided methods including RPM and TNMM are generally not
considered reliable for directly valuing intangibles.

Use of cost-based
methods for valuing intangibles have also been largely discouraged, other than
in limited circumstances involving, say, development of intangibles for
internal business operations, especially when such intangibles are not unique
or valuable.

The Guidelines have
provided detailed guidance on the use of Discounted Cash Flow (DCF) Method or
other similar valuation methods for valuing intangibles. Having said that, the
Guidelines also caution that because of the heavy reliance on assumptions and
valuation parameters, all such assumptions and parameters must be appropriately
documented, along with the rationale for using the said assumptions or
parameters. The Guidelines also recommend taxpayers to present a sensitivity
analysis, with alternative assumptions and parameters, as part of their
transfer pricing documentation.

1.8.1. Intangibles having
uncertain valuations

In cases involving
intangibles the valuation of which is highly uncertain at the time of the
transaction, the 2017 Guidelines provide guidance on a much broader concept of
arm’s length behaviour. The Guidelines inter alia provide that in case
the valuation of the intangible is highly uncertain at the time of the
transaction, the parties to the transaction would potentially adopt short-term
agreements, include price-adjustment clauses, adopt a contingent pricing
arrangement, or even renegotiate the terms of the transaction in some cases.

1.8.2. Hard-to-Value Intangibles
(HTVI)

HTVIs include
intangibles for which, at the time of their transfer, (i) no reliable
comparables exist, and (ii) it is difficult to predict their level of success.

The 2017 Guidelines
make an exception regarding the use of ex post results, and provide that
in certain cases involving HTVIs, and subject to certain safeguards and
exemptions, ex post results can be considered as presumptive evidence
about the appropriateness of the ex ante pricing arrangements. The
Guidelines also provide a safe harbour of 20%, within which valuation based on ex
ante circumstances should not be questioned and replaced by valuation based
on ex post results.

2. Chapter
VII – Special Considerations for Intra-Group Services

In the analysis of
transfer pricing for intra-group services, one key issue is whether intra-group
services have in fact been provided, and the other issue is, what is the
intra-group charge for such services under the arm’s length principle. Detailed
guidance has been provided in the 2017 Guidelines on various aspects in the
context of intra-group services such as shareholders’ activities, on call
services, form of remuneration, determination of cost pools, documentation and
reporting, levy on withholding tax on provision of low value-added intra-group
services.

2.1. Low Value Adding
Intra-Group Services

The 2017 Guidelines
recommend an elective, simplified transfer pricing approach relating to
particular category of intra-group services referred to as low value adding
intra-group services. Under this approach, subject to fulfilment of certain
criteria, the arm’s length price of the services would be considered to be
justified without specific benchmarking and detailed documentation of the
benefit test by the recipient.

The guidance
provided in the 2017 Guidelines are summarised below.

3. Chapter
VIII – Cost Contribution Arrangements

The 2017 Guidelines
provide that a Cost Contribution Arrangement (CCA) is a contractual arrangement
among business enterprises to share the contributions and risks involved in the
joint development, production or the obtaining of intangibles, tangible assets
or services, with the understanding that such intangibles, tangible assets or
services are expected to create benefits for the individual businesses of each
of the participants.

Two types of CCAs
are commonly encountered: (1) Joint development, production or the procurement
of intangibles or tangible assets (“Development CCAs”); and (2) Procurement of
services (“services CCAs”).

With regard to
application of arm’s length principle, the general guidance provided in the
2017 Guidelines, including the risk analysis framework, also apply to CCAs. To
apply the arm’s length principle to a CCA, it is therefore a necessary
precondition that all the parties to the arrangement have a reasonable
expectation of benefit. The next step is to calculate the value of each
participant’s contribution to the joint activity, and finally to determine
whether the allocation of CCA contributions (as adjusted for any balancing
payments made among participants) accords with their respective share of
expected benefits.

The Guidelines also
provide that the guidance provided in Chapter VI relating to intangibles and
Chapter VII relating to intra-group services also apply to CCAs, to the extent
relevant.

Further, the
Guidelines provide specific additional guidance in the following areas:

3.1. Participants

A participant must
be assigned an interest or rights in the intangibles, tangible assets or
services that are the subject of the CCA and should have a reasonable
expectation of being able to benefit from that interest or those rights. The
Guidelines discuss in detail regarding determination of participants in CCAs.

3.2. Expected benefits

In determining the
participants’ share of expected benefits, the 2017 Guidelines encourage the use
of relevant allocation keys. The Guidelines also provide that the CCA should
provide for a periodic reassessment of allocation keys. Consequently, the
relevant allocation keys may change over a period of time, and this may lead to
prospective adjustments in the share of expected benefits of the participants.

3.3. Value of Contributions

The 2017 Guidelines
recommend distinguishing between pre-existing contributions and current
contributions for the purpose of valuing them. Any pre-existing contributions
(say, any existing patented technology) should generally be valued at arm’s
length based on the general guidance provided in the 2017 Guidelines, including
the use of valuation techniques. However, any current contributions (say,
ongoing R&D activities) should be valued based on the value of the
functions themselves, rather than the potential value of the future application
of such functions.

3.4. Documentation

The 2017 Guidelines
emphasise that taxpayers should provide detailed documentation relating to CCAs
as a part of the master file. Additionally, the local file should also contain
transactional information including a description of the transactions, amounts
of payments and receipts, identification of the associated enterprises
involved, copies of inter-company agreements, pricing information and
satisfaction of the arm’s length principle. The Guidelines also provide for an
additional disclosure of management and control of CCA activities and the
manner in which any future benefits from the CCA activities are expected to be
exploited.

4. Chapter
IX – Business Restructurings

The 2017 Guidelines
contain an elaborate discussion on transfer pricing aspects of business
restructurings. Business restructuring refers to the cross-border
reorganisation of the commercial or financial relations between associated
enterprises, including the termination or substantial renegotiation of existing
arrangements.

Business
restructurings may often involve the centralisation of intangibles, risks or
functions with profit potential attached to them.

As compared to the
earlier guidelines which included conversion of full-fledged distributors or
manufacturers to low risk ones and also included transfers of intangibles, the
2017 Guidelines also include concentration of functions in a regional or
central entity with corresponding reduction in scope or scale of functions carried
out locally, as a business restructuring transaction.

The Guidelines
address two aspects of a business restructuring – i) arm’s length compensation
for the restructuring itself, and ii) arm’s length pricing of
post-restructuring transactions.

Some key additional
guidance provided in these Guidelines is discussed in this section.

4.1. Arm’s length
compensation for the restructuring itself

4.1.1. Accurate delineation of the
restructuring transaction

The general
guidance relating to arm’s length principle is applicable also for business
restructuring. The 2017 Guidelines recommend performing accurate delineation of
transactions including detailed functional analysis in pre and
post-restructuring scenarios. In doing so, the Guidelines place special emphasis
on the risks transferred as a part of the restructuring, and importantly,
whether such risks are economically significant (i.e., whether they carry
significant profit potential and hence, may explain a significant reallocation
of profit potential).

Like earlier
guidelines, one needs to also analyse the business reasons for and expected
benefits from restructuring, and other options realistically available to the
parties.

4.1.2. Transfer of something of value

The 2017 Guidelines
provide that in case physical assets such as inventories are transferred
between foreign associated enterprises as a part of the restructuring, the
valuation of such assets is likely to be resolved as a part of the overall
terms of the restructuring. In practice, there may also be an inventory rundown
period before the restructuring becomes effective, to mitigate complications
relating to cross-border inventory transfers.

Similarly, in case intangibles
are transferred as a part of the restructuring, the Guidelines provide that the
valuation of such intangibles should be done in line with the guidelines
provided for valuation of intangibles, including guidance provided for valuing
HTVIs (Chapter VI).

In case of transfer
of an activity, the 2017 Guidelines are aligned with the earlier
guidelines and provide that the valuation of such an activity should be done as
a going concern of the entire activity, rather than individual assets.

4.1.3. Indemnification for termination or substantial
renegotiation of existing arrangements

Indemnification
means any type of compensation that may be paid for detriments suffered by the
restructured entity, whether in the form of an up-front payment, of a sharing
in restructuring costs, of lower (or higher) purchase (or sale) prices in the
context of the post-restructuring operations, or in any other form.

The 2017 Guidelines
provide for consideration of the following aspects in this regard:⁷

? Whether,
based on facts, the commercial law supports the right to indemnification for
the restructured entity

? Whether
the indemnification clause, or its absence, is at arm’s length

? Which
party should bear the indemnification costs

Each of the above
aspects has been discussed in detail in the OECD guidelines.

4.1.4. Documentation

The 2017 Guidelines
provide for documenting important business restructuring transactions in the
master file. Further, in the local file, taxpayers are required to indicate
whether the local entity has been involved in, or affected by, business
restructurings occurring in the past year, along with related details.

4.2. Arm’s Length
compensation for post- restructuring transactions

The 2017
Guidelines, like the earlier guidelines, provide that the arm’s length
principle should apply in the same manner to restructured transactions, as they
apply to transactions which were originally structured as such.

______________________________

7 Refer para 9.79 of 2017 Guidelines

Further, there
could be inter-linkages between the restructuring and the business arrangement
post-restructuring. In these situations, the compensation for the restructuring
and for the subsequent controlled transactions could be potentially dependent
on each other, and may need to be evaluated together from an arm’s length
perspective.

5. Concluding
Remarks

The 2017 Guidelines have addressed some key
challenges faced by taxpayers with respect to the specific
transactions/situations covered in this part of the article. In several
situations, the Guidelines provide for arm’s length behaviour in principle,
considering the overall scheme of things, and not merely evaluating the price
of isolated transactions

In the Indian
context, transfer pricing for transactions involving intangibles appears to be
a significant focus area for Indian tax authorities. Analysis of control of
functions and assumption of risks vis-à-vis provision of funding in
transactions relating to intangibles is extremely pertinent in the Indian
context given India’s leading position as a preferred destination for several
MNCs for intangible creation/upgradation in verticals such as technology,
engineering, pharma, etc.; and also given the huge marketing and promotional
spend incurred by many Indian distributors. The guidance also aligns, in
principle, with the approach of valuing intangible transfers using a DCF
approach, albeit with several safeguards relating to the assumptions and
other parameters used for valuations. Overall, the guidance provided in the
2017 Guidelines is largely being implemented by tax authorities, as evidenced
by the nature of queries and depth of discussions during APAs as well as
transfer pricing audits.

Guidance on low
value adding intra-group services has already been largely implemented in the
Indian safe harbour rules.

The 2017 Guidelines also provide several
examples relating to intangibles and CCAs in Annexes to Chapters VI and VIII,
respectively. Readers are encouraged to study the examples for a better understanding
of these concepts.

shailesh.kwebmaker

ARE PROFESSIONAL FIRMS HEADING TOWARDS EXTINCTION?

The Industrial Revolution 200 years back
completely transformed the way businesses were conducted. Work was standardised
into small repetitive steps which increased productivity not by 20% to 30% but
by a factor of hundreds. The technology revolution is today similarly poised to
transform the way in which professional practice is organised.The existing way
of conducting professional practice is undergoing a paradigm shift and
proactively managing these changes is not a matter of choice but a question of
survival. In this article an attempt has been made to articulate some of these
fundamental changes and how we need to respond to the challenges.

THE OLD WAY

Professionals as a class emerged in the
nineteenth century and today they are an indispensable part of society. They
are highly respected for their knowledge and expertise and the apex body (ICAI
in our case) under which they function has the responsibility to ensure that
those who are admitted into their fraternity are not just professionally
competent, but carry the profession with integrity.There is a tacit
understanding that in return for their specialised knowledge, the professionals
would be granted the right of self-governance in their field of expertise.

In 1939 the sociologist T.H. Marshall
remarked; “the professional man, it has been said, does not work in order to
be paid: he is paid in order that he may work.” So the core value of the
profession has been service and not profit. Some of our seniors remember with
nostalgia that we were in the profession of chartered accountancy
and not in the business of chartered accountancy.

The very foundation of the relationship
between a professional and a client is that of trust. Clients who seek the help
of professionals in matters of critical importance themselves lack the
requisite knowledge and expertise and would therefore follow implicitly the
advice of the professional. Similarly, the client would be in no position to
ascertain or even estimate what is the fair remuneration that must be paid for
such services. Indeed, the senior professionals would also reminisce about the
days when it was considered inappropriate to question a professional about his
fees.

The very basis of this relationship is now
under stress. The distinction between profession and business is getting
blurred and the concept that professionals will always put the interest of the
client above their own and act with utmost professional integrity is being
questioned. The very idea that certain tasks should be the exclusive domain of
professionals is also being questioned. Above all, technology is transforming
the manner in which professional services are rendered and professional firms
organised.

PROFESSIONAL AS THE GATEKEEPER

It is under this backdrop that one has to
try and understand the future of professionals, including Chartered
Accountants. The society expects us to be not just gatekeepers but conscious
keepers of the businesses we audit. We are expected to detect and flag off
financial impropriety and frauds; however, we continue to believe that this is
way beyond our scope of work. It has been ingrained in auditors that they are
watchdogs and not bloodhounds. However, this is a distinction that the world at
large does not understand. As John C. Coffee, Jr. asks in his book
Gatekeepers, “why did the watchdog not bark when Enron happened?”

Today, most professionals believe that
this so-called “expectation gap” needs to be bridged and that public awareness
needs to be created on the real role of the professional. However, may be we need to look at this issue from the perspective
of the public and the regulator, who expect us to detect frauds and other
financial misdemeanors. We are expected to raise an alarm well in advance when
the entity is going under. Is it possible to fulfill these expectations by
using technology, artificial intelligence (AI) and data analytics? If not,
there is a possibility that alternatives will emerge as that seems to be the
crying need of the times.

THE FEES MODEL

Also what will come under stress is the
age-old fees model that professionals have employed, where fees are
predominantly charged based on “time spent”. Clients seek professional advice
for solutions to problems that they have not fully comprehended. So
professionals don’t just help solve problems, but often also help in
articulating the problem itself with clarity. If this be the case, how can the
client even estimate the time that is expected to be spent by the professional
on a given assignment? It is hardly surprising that more and more clients want
to know the fees upfront or want a cap on the fees. Their argument is that as
professionals we have a better understanding of the problem and its intricacies
and hence are best placed to estimate the time. In other words, the risk of
time overrun (and conversely the advantage of efficiency) should be borne by
the professional.

Of course, time basis is still the only
effective and preferred fee determinant, but as professionals we must make a
conscious effort to move away from this model wherever possible for the
following reasons:

1. It is in the interest of the professional to
prolong the time, clearly leading to a conflict of interest situation.

2. The client has no means of judging the time
required or actually spent for the job. So there is an inherent reason for
heartburn that the time spent was padded up.

3. The system rewards the inefficient as those
who take more time are paid higher.

4. It stifles innovation and the need to bring
about efficiencies as there is no incentive to reduce time spent on the
assignment.

Fees charged on the basis of time spent
focuses on effort rather than results and professionals should consciously move
towards a fees model based on “value provided”.After all it is in our interest
to communicate to the client the value derived by him rather than time spent by
us.

TECHNOLOGY THE GAME CHANGER

But these are relatively minor challenges
confronting the profession. The elephant in the room is technology and
artificial intelligence that is encroaching upon all spheres of human
enterprise. According to research by Frey and Osborne cited in a 2014 article
by The Economist, Accountants and Auditors were the second highest
vocation that would be affected by technology. One of the jobs that was 10
years back believed to be immune from technology was that of a truck driver. It
was argued that driving required human skills and hence it could not be
automated. Google has now turned that argument on its head. In fact, it is not
inconceivable that children 30 years from now may be amused and amazed that
their parents actually physically drove their vehicles.

The initial efforts of using artificial
intelligence (AI) was based on trying to replicate the way the human mind
functions and these efforts only met with limited success. But today machines
have become much more adept by following a completely different path. As
Patrick Winston, a leading voice in AI stated, “there are lots of ways of
being smart that aren’t smart like us”. Chess for example was considered as
an epitome of human intelligence, intuitiveness and ingenuity. But the
programme “Deep Blue” beat the chess champion Gary Kasparov not by mimicking
the functioning of the human mind, but by applying brute computing power. The
machine lacked creativity or insights, but compensated by its ability to
analyse 200 million possible moves in seconds and winning with brute
number-crunching force.

In the light of these inevitable changes,
professionals will have to bring about transformative changes in the way they
conduct and organise their professional practice. A decade back it was common
to state that only those who will use technology effectively and integrate it
with their practice will survive. This meant the application of technology was
limited to automation and for incremental increase in efficiency and
productivity. This barely touched the tip of the proverbial iceberg in terms of
actual potential to bring about structural changes. The fact is that
technology today is no longer the enabler, it is the driver and it must be used
to bring about transformative changes. As professionals we must be prepared for
the future where judgement may be replaced by Big Data mining, experience by
analytical tools and intuition by computing logic.

BRUTE FORCE OF COMPUTING POWER

Moore’s Law predicted in 1996 that the
processing power of computers would double every two years. This sounded
improbable and certainly not sustainable, but the consensus today is that this
law will hold true for decades. Which means machines will be ever more
versatile and competent.

In the face of this, the argument often put
forth by professionals that however much one uses technology, the final
solution requires judgement and hence professionals will always be
indispensable, needs to be critically examined. The argument goes that routine,
repetitive work can be standardised and transferred to the machines, but tasks
requiring judgement and strategic inputs will still be the domain of humans.
However, the trend seems that machines with intelligent systems are bound to
become more and more sophisticated in making connections, identifying patterns,
forming correlations and finding solutions that may till now have been
considered well beyond human cognitive capabilities.

Already in a lot of areas, machines are
outperforming humans. By using their processing power, they are able to analyse
huge amounts of data to reach conclusions that are more accurate than those
reached by humans. As humans we make decisions emotionally/intuitively and then
justify them rationally. The ways of working of future machines are unlikely to
resemble the human way of working, but they will be effective and perhaps less
fallible. Deep Blue proved that human intuition and analytical capabilities are
no match for the brute computing and processing power of the computer.
Ominously, increasingly capable machines, using Big Data, AI or some other new
technology are poised to encroach upon more and more areas that were the
exclusive domain of human experts.

Audits can no longer be conducted behind the
shelter of test checks. 100% of the transactions can not only be verified, but
organised and analysed from different perspectives and this analysis can be on
real-time basis. Data can be drawn from varied sources, in different and even
unstructured formats. Analysis of this data collected both from within the
company and from other comparable businesses, may give remarkable insights into
the functioning of the auditee. At the core, Big Data is applying math to huge
quantities of data to infer probabilities and make increasingly accurate
predictions.

STANDARDISATION AND DELEGATION

Professionals also believe that their work
cannot be standardised beyond a point. It is highly intellectual and unlike
manufacturing work it cannot be spliced into small repetitive tasks. This
thinking is also under challenge and if one were to really break down the work
of a professional, a large portion can indeed be standardised and systematized.
Once that happens, it can easily be delegated to machines, and what’s more, it
can be digitised and be made available to be downloaded online. So tasks
considered as non-routine will increasingly be routinised and even genuinely
non-routine tasks may also be performed by smart machines of the future.

We have also seen that semi-qualified staff
with the aid of sophisticated technology are often as effective as highly
knowledgeable professionals. Paramedics with minimal training and good
equipment have transformed the health care in rural places. So it is not
difficult to visualise that a semi-qualified person with the help of
appropriate processes and systems will deliver the same end results as qualified
professionals. Technology-based companies could replace a lot of functions
performed by professionals with the help of semi-trained staff equipped with
the right technology support.

Would then professionals only be required to
tackle situations and problems where there are no clear-cut precedents? Without
precedents, the professionals would also be blind guessing and in such a
situation once again the computer would be better equipped to find solutions
through programmed simulation.

EXCLUSIVITY VS. COMPETITION

One big
protection for professionals is that they are insulated from competition. The
rationale is that professionals with intensive training alone can competently
handle complexities involved in a professional task. Opening out professional
tasks to non-professionals would expose the lay person to not just poor quality
of service, but to wrong and potentially damaging advice from quacks.

Surely, in
today’s knowledge world, it would be increasingly difficult to argue that
certain spheres of knowledge should be the exclusive domain of certain
professional bodies. Transparency ensures quality and as professional work is
standardised and streamlined, it is likely that in future customers will rely
more on peer review of fellow clients to decide the quality of the professional
service rather than a self-governing disciplinary mechanism.

So let’s not
be surprised if more and more tasks reserved for professionals are opened out
to others.

TO SUMMARISE

The present
form of professional practice is under threat from multiple forces:

1. AI through
brute computing and processing power is encroaching upon more and more areas of
professional practice and human endeavour.

2. Machines with Big Data
analytics are poised to produce consistently better results than those possible
by the best of professionals in ever-increasing areas.

3. Even intellectual work can be
defragmented into smaller tasks that can be standardised and hence be
machine-programmed.

4. Para professionals with
sophisticated access to databases and technology can do a large amount of work
that till now was the domain of qualified professionals.

5. The exclusivity protection to
professionals from regulators may be under threat and public opinion may compel
changes to allow many more service providers.

So the big
question: are professionals doomed to extinction? Probably not, but
professionals who are unwilling to transform their professional practice
in response to the above challenges may find it difficult to survive. Nobody
can predict the future. Yet, in a technology-driven world that premise is
nuanced as there may not be any future things that may have flourished for
centuries. As Peter Drucker put it, “the only thing we know about the
future for sure is that it will be different”.

Note: Some of the thoughts in this article
are inspired from the book “The Future of the Professions” by Richard Susskind
and Daniel Susskind.

shailesh.kwebmaker

PROSECUTION AND COMPOUNDING

PROSECUTION – The word Prosecution makes every person’s blood run cold. The
menace of black money, i.e., unaccounted money, and tax evasion have assumed
gigantic proportions. The need to control the menace resulted in taking of
drastic remedial measures by the Government. Prosecution and the resultant
terror of imprisonment serve as a powerful deterrent. Under the Income Tax
Act, 1961 there are various sections for Penalties and Provisions to
ensure/enforce tax compliance, but the best and most effective measure is
Prosecution. Assessment proceedings are civil proceedings while penalty
proceedings are quasi-criminal and prosecution proceedings are criminal in
nature. Prosecutions for offences committed by an assessee are tried by the
Magistrates in the Criminal Courts of the country and the procedure thereof is
governed by the provisions of the Indian Penal Code where attracted, as well as
the rules in the Code of Criminal Procedure and the Indian Evidence Act. In
simple words, we can say that the Income Tax Department has three ways to
punish the assessee, i.e. Levy Interest, Levy Penalties and Prosecution if he
does not follow provisions as prescribed by the Act. Monetary Punishment does
not have that impact on the assessee that Prosecution proceedings have.

The roots of
such harsh/rigorous provisions of Prosecution were found in the Wanchoo
Committee Report. The final report by the said Committee states as follows:

NEED FOR VIGOROUS PROSECUTION POLICY

In the
fight against tax evasion, monetary penalties are not enough. Many a
calculating tax dodger finds it a profitable proposition to carry on evading
taxes over the years if the only risk to which he is exposed is a monetary
penalty in the year in which he happens to be caught. The public in general
also tends to lose faith and confidence in tax administration once it knows
that even when a tax evader is caught, the administration lets him get away
lightly after paying only a monetary penalty, when money is no longer a major
consideration with him if it serves his business interests….

The Supreme
Court in Gujarat Travancore Agency vs. CIT (1989) 77 CTR (SC) 174: (1989)
177 ITR 455 (SC) observed that the creation of an offence by the statute
proceeds on the assumption that society suffers injury by the act of omission
of the defaulter and that a deterrent must be imposed to discourage the
repetition of the offence.

OFFENCES AND PROSECUTION UNDER INCOME TAX ACT, 1961

The term
“offence” is not defined under the Income Tax Act. Even the
Constitution does not define the term “offence” for the purpose of
Article 20. Section 3(37) of the General Clauses Act defines
“offence” to mean any act or omission made punishable by any law for
the time being in force. This definition would apply to ascertain whether or
not an offence had been committed and only if there is an offence committed the
offender would be prosecuted and would attract liability for punishment in
accordance with the law in force at the relevant time of the commission of the
offence. The term Prosecution is also not defined under the Income Tax Act;
however, Webster’s dictionary defines Prosecution as “The institution and
carrying on of a suit in a court of law or equity, to obtain some right, or to
redress and punish some wrong; the carrying on of a judicial proceeding on
behalf of a complaining party, as distinguished from the defence.”

CBDT recently
tabled its report[1]
on Performance Audit on Administration of Penalty and Prosecution before
Parliament wherein they pointed out various gaps in Administration of
Prosecution by the Department. They made some important recommendations; (a)
more robust mechanism to be employed for identifying cases for prosecution
which takes into account timelines, quantum of tax evasion and contemporary
impact, (b) posting of designated and experienced Nodal officer to handle
prosecution, (c) to identify the stage of pendency of all cases in the various
courts and follow it actively for resolution, (d) CBDT to consider compounding
offences before launching Prosecution so that revenues are collected, (e) CBDT
to deploy prosecution machinery for high-impact cases and avoid focusing on
low-impact cases.

Recently, it
has become a trend and it has been observed that notices for launching of
Prosecution are being issued in large numbers. The department went into
overdrive and issued show-cause notices en masse after CBDT released
Standard Operating Procedure to be followed for Prosecution in cases of the
TDS/TCS with a strict time frame to complete the entire process from
identification to passing order u/s. 279(1)/279(2) of the Act. Even for the
technical lapse, the department launched Prosecution or forced the assessee to go
for compounding. During FY 2017-18 (up to the end of November, 2017), the
Department filed Prosecution complaints about various offences in 2225 cases
compared to 784 for the corresponding period in the immediately preceding year,
marking an increase of 184%. Therefore, it has become very important to be
aware of the laws relating to Prosecutions under direct taxes.

KINDS OF OFFENCES

Income Tax
Act contains a Chapter XXII dealing with ‘offences and prosecution,’ i.e.
section 275A to section 280D of the Act, refer Appendix. Provisions of the
Criminal Procedure Code, 1973 are to be followed relating to all offences under
the Income Tax Act since the said Chapter XXII of the Act does not inter se
deal with the procedures regulating the prosecution. However, if the provisions
of the Code are contrary to what is specially provided for by the Act, then the
Act will prevail.

Recently,
Prosecutions have been initiated for various offences including wilful attempt
to evade tax or payment of any tax; wilful failure in filing returns of income;
false statement in verification; and failure to deposit the tax
deducted/collected at source or inordinate delay in doing so, among other
defaults.

For this
Article, sections 276B, 276C, 276CC and 277 of the Act are dealt hereunder
since most of the prosecution has been launched on the commission of offence
contained in these sections.

SECTION 276B – OFFENCE RELATED TO TAX DEDUCTION

Failure to
deduct tax is not an offence but having deducted but not paid to the Central
Government is an offence. If the accused wants to prove that he was prevented
by reasonable causes, the burden to prove is on the accused. The courts have
taken contrary positions with respect to Prosecution in the event the penalty
proceedings have been dropped. The Punjab and Haryana High Court held in Jag
Mohan Singh vs. ITO (1992) 196 ITR 473 (P&H) that the offence is
complete on the due date on which the amount should have been deposited but not
deposited and a late deposit will not absolve the accused; the fact that the
income-tax authorities charged interest on such deposit and did not impose
penalty will not absolve the accused from liability to Prosecution. However, in
Banwarilal Satyanarayan & Ors. vs. State of Bihar & Anr. (1989) 80 CTR
(Pat) 31: (1989) 179 ITR 387 (Pat), it has been held that when the
authority under the IT Act has dropped the penalty proceedings on finding that
assessee had furnished good and sufficient reasons for failure to deduct and/or
pay the tax, within time, the Prosecution for the same default is liable to be
discontinued.

SECTION 276C – WILFUL ATTEMPT TO EVADE TAX, ETC.

Section 276C
provides that if a person wilfully attempts to evade any tax, penalty or
interest chargeable or imposable under the Act, then without prejudice to any
penalty that may be imposable on him under any provisions of the Act, he will
be liable for prosecution. The Explanation inserted gives very wide coverage to
what constitutes ‘wilful attempt’. The Andhra Pradesh High Court in ITO vs.
Abdul Razaq (1990) 181 ITR 414 (AP) held that to spell out a wilful attempt
there must be an assessment on the return filed. The Rajasthan High Court in Gopal
Lal Dhamani vs. ITO (1988) 67 CTR (Raj) 175: (1988)172 ITR 456 (Raj) held
that what is contemplated is evasion before charging or imposing penalty or
interest; it may include wilful suppression in the returns before assessment
and completion; it is not necessary that an assessment must have been made
prior thereto and it is for the prosecution to prove the ingredients of the
offence before the
Criminal Court.

SECTION 276CC – FAILURE TO FURNISH A RETURN OF INCOME

With the
online return filings and various data at the disposal of the assessing
officer, it has become very easy to identify the assessees who despite having
taxable income have failed to file their tax return. This section opens with
the words “wilfully fails to furnish…return”. The word `wilful’
implies the existence of a particular guilty state of mind and it imports the
concept of mens rea. The Supreme Court (SC), in a recent ruling in the
case of Sasi Enterprises vs. ACIT [TS-43-SC-2014] has held that
prosecution proceedings u/s. 276CC of the Income Tax Act, 1961 (the Act) for
failure to file a return of income (ROI) could be initiated even while appellate
proceedings were pending. In deciding this case, the SC has placed reliance on
its earlier judgement in the case of Prakash Nath Khanna (Prakash Nath
Khanna vs. CIT [2004] 266 ITR 1 (SC)).

SECTION 277 – FALSE STATEMENT IN VERIFICATION, ETC.

This section punishes a person for providing the
Assessing Officer with information which he knows to be false or does not
believe to be true and thus induces him to make a wrong assessment resulting in
the levy of lower income-tax than is proper and due from the assessee. The
expression `person’ in this section is very wide and need not be restricted to
an assessee only. The Madras High Court in N.K. Mohnot vs. Chief CIT (1992)
195 ITR 72 (Mad) held Prosecution to be valid against the accused who in a
conspiracy with the other accused and certain employees in the race club
applied for duplicate tax deduction certificates in the names of winners,
forged the signatures of the original winners, made false documents and filed
returns containing false declarations and forged signatures and obtained tax
refund orders which were encashed by them.

SECTION 278E – ‘PRESUMPTION AS TO CULPABLE MENTAL STATE’

The burden of
proving the absence of mens rea is on the accused and provides that the
absence needs to be proved not only beyond ‘preponderance of probability’ but
also ‘beyond reasonable doubt[2]’.
He has to prove that he has no ‘culpable mental state’ which includes
intention, motive or knowledge of a fact or belief in, or reason to believe, a
fact. The Delhi High Court in V.P. Punj vs. Assistant Commissioner of Income
Tax & anr. (2002) 253 ITR 0369 held that in view of section 278E, the
absence of culpable mental state has to be proved by the accused in defence
beyond reasonable doubt — Otherwise the Court has to presume the existence of mens
rea.

SECTION 278B – OFFENCES BY COMPANIES / FIRMS/ ASSOCIATION OF PERSONS (AOP)

In case the
default is committed by a company/firm or AOP, the provisions of section 278B
of the IT Act prescribe that every person who was in charge of the company/firm
or AOP at the time of the commission of the offence will also be deemed to be
guilty and liable for Prosecution. Courts have held that a person in charge for
the purposes of section 278B means a person who is in overall control of the
day-to-day business of the company/firm/AOP.

Such person
will not be liable for prosecution if he proves the offence was committed
without his knowledge or that he exercised due diligence to prevent the
commission of such an offence. In case it comes to light that an offence has
been committed with the consent or connivance of or such offence is
attributable to some neglect on the part of a director, manager, secretary or
other officer of an entity, then such person will also be liable for
Prosecution.

SECTION 280 – ACCOUNTABILITY OF THE PUBLIC SERVANT

If a public
servant furnishes any information or produces any document in contravention of
the provisions of sub-section (2) of section 138, he would be punishable.
However, such Prosecution can be instituted only with the previous sanction of
the Central Government.

THE PROCEDURE FOLLOWED BY THE DEPARTMENT

The Income
Tax Act does not prescribe any specific procedure to be followed. However, the
Department follows its own Manual on Prosecution which lays down the various
rules and regulations for the launch of Prosecution and proceedings thereafter.
The Assessing Officer initiates the process and refers the matter to his
Commissioner with a report on the offence committed. The Commissioner, if
satisfied, will issue a notice to the assessee. If the assessee can prove
‘beyond doubt’ of no culpable mental state, then the Commissioner may direct
the AO not to file a complaint before the Court. It may be noted that if the
accused is aged 70 years or above, no prosecution is to be initiated in view of
instructions of the Board and judgment of Allahabad High Court in Kishan Lal
vs. Union of India (1989) 179 ITR 206 (All).

THE PROCEDURE FOLLOWED BY THE COURT

Once the
complaint is received, the Court summons the accused by sending the copy of the
complaint, and if the accused is not present on the day of summoning, then the
Court can issue a warrant against the accused, wherein he may be arrested and
produced before the Court.

After giving
the opportunity of hearing to the accused if the Court feels that there is no
apparent case, then the court will dismiss the complaint, whereas if there is
any primary evidence available, then the Court will frame a charge and the
Prosecution proceedings will be continued under Criminal Procedure Code. If the
trial results in a conviction, the appeal to the court will lie under the CPC
to be filed within 30 days of the date of order. Sanction for each of the
offence under which the accused is prosecuted is mandatory, otherwise the
entire proceedings will be void ab initio.

In the case
of Champalal Girdharlal vs. Emperior (1933) 1 ITR 384 (Nag) (HC), where
sanction was issued for an offence u/s. 277, however, the accused was found
guilty u/s. 277C, Therefore, it was held that the conviction was illegal.

When the
magistrate issues bailable or non-bailable warrant, necessary application for
seeking bail has to be made. If the bail application is rejected, an appeal
lies before the Session Judge and thereafter an application lies u/s. 482 of
the Criminal Procedure Code before the Hon’ble High Court.

PROOF OF ENTRIES IN RECORDS OR DOCUMENTS

By insertion
of section 279B of the Act by the Amending Act, 1989, the requirement to produce
a number of original records, documents, seized books of accounts, etc., before
the Courts for establishing the case have been dispensed with. It is now
possible for the Court to admit as evidence the entries on the records or other
documents in the custody of an income-tax authority and all such entries may be
proved either by the production of such records or other documents or by the
production of a copy of the entries certified by the income-tax authorities.

The question
is whether there is any mode of conciliation to avoid the rigours of
Prosecution; and the answer is compounding of offence.

COMPOUNDING OF OFFENCES

Section
279(2) of the Act provides that any offence under Chapter XXII of the Act may,
either before or after the institution of proceedings, be compounded by the
Chief Commissioner of Income Tax/Principal Chief Commissioner of Income Tax.
The CBDT has instructed that efforts should be made to convince the assessee to
go for compounding rather than face Prosecution. The Board has also instructed
that a prosecution should not ordinarily be compounded if prospects of success
are good. The number of complaints compounded by the Department during the
current FY (upto the end of November, 2017) stands at 1,052 as against 575 in
the corresponding period of the immediately preceding year, registering a rise
of 83%.

THE GENERAL MEANING OF COMPUNDING OF OFFENCES

Compoundable
offences are those which can be conciliated by the parties under dispute. The
permission of the Court is not required in such cases. When an offence is
compounded, the party, which has been distressed by the offence, is compensated
for his grievance.

A new set of
compounding guidelines are issued by the Income-tax Department vide
Notification F No. 185/35/2013 IT (Inv.V)/108 dated 23^rd December,
2014 (2015) 371 ITR 7 (St) w.e.f 1^st January, 2015.

The offences
under Chapter – XXII of the Act are classified into two parts (Category ‘A’ and
Category ‘B’) for the limited purpose of compounding of the offences, refer
Appendix. In case of an offence categorised in Category A, which are ‘less
grave’ offences, compounding is allowed only up to three occasions. Those
offences in Category B, or more serious offences, can be compounded only once.
The guidelines list down various other categories of persons who are not
eligible for compounding, for example: Offences committed by a person who was
convicted by a Court of law for an offence under any law, other than the Direct
Taxes laws, for which the prescribed punishment was imprisonment for two years
or more, with or without fine, and which has a bearing on the offence sought to
be compounded.

Notwithstanding
anything contained in the guidelines, the Finance Minister may relax
restrictions for compounding of an offence in a deserving case on consideration
of a report from the board on the petition of an appellant.

Procedure for
compounding

1. Compounding of an offence may be considered
only in those cases in which the assessee comes forward with a written request
for compounding of offence;

2. The amount of undisputed tax, interest and
penalties relating to the default should have been paid;

3. The assessee should express his willingness to
pay both the prescribed compounding fees as well as establishment expenses;

4. The assessee undertakes to
withdraw any appeal filed by him, if any, in case the same has a bearing on the
offence sought to be compounded. In case such appeal has mixed grounds, some of
which may not be related to the offence under consideration, the undertaking
may be taken for appropriate modification on grounds of such appeal;

5. On receipt of the application for compounding,
the same shall be processed by the Assessing Officer/Assistant or Deputy
Director concerned and submitted promptly alongwith a duly filled in
check-list, to the authority competent to compound, through the proper channel;

6. The competent authority shall duly consider
and dispose of every application for compounding through a speaking order in
the prescribed format within the time limit prescribed by the board from time
to time. In the absence of such a prescription, the application should be
disposed off within 180 days of its receipt. However, while passing orders on
the compounding applications, the period of time allowed to the assessee for
paying compounding charges shall be excluded from the limitation specified
above;

7. Where compounding application is found to be
acceptable, the competent authority shall intimate the amount of compounding
charges to the applicant requiring him to pay the same within 60 days of
receipt of such intimation. Under exceptional circumstances and on receipt of a
written request for further extension of time, the competent authority may
extend this period up to further period of 120 days. Extension beyond this
period shall not be permissible except with the previous approval of the Member
(Inv), CBDT on a proposal of the competent authority concerned;

8. However, wherever the compounding charges are
paid beyond 60 days as extended by the competent authority, the applicant shall
have to pay the additional compounding charge at the rate of 2% per month or
part of the month of the unpaid amount of compounding charges;

9. The competent authority shall pass the compounding
order within 30 days of payment of compounding charges. Where compounding
charge is not deposited within the time allowed, the compounding application
may be rejected after giving the applicant an opportunity of being heard. The
order of rejection shall be brought to the notice of the Court immediately
through prosecution counsel in the cases where the prosecution had been
instituted. The Division Bench of the Hon’ble High Court of Delhi in response
to the writ petition titled Vikram Singh vs. UOI (W.P.(C) 6825/2016)
held that the CBDT cannot insist on a “pre-deposit” of the compounding fee even
without considering the application for compounding. The CBDT instructions to
that extent is undoubtedly ultra vires section 279 of the Act.

CONCLUSION

Prosecution
is a serious offence. It is high time that the assessee realise the seriousness
with which the Department has started pursuing prosecution. It is in the
interest of the assessee to comply with the law; at the same time, it is the
responsibility of the CA fraternity to guide and advise their clients in not
violating any of the provisions of the Act. The Department should also take a
holistic view before launching Prosecution and be guided by the conduct of the
taxpayer and the gravity of the situation.

APPENDIX
– SUMMARY OF PROVISIONS UNDER THE INCOME TAX ACT, 1961

Sr. No.

Act or omission which constitutes an offence

Section under I.T. Act, 1961

Maximum Punishment (Rigorous imprisonment)

Minimum Punishment (Rigorous imprisonment)

Classification for Compounding Category

Contravention
of an order u/s. 132(3)

275A

Up
to two years and fine

As
decided by the Court

Failure
to comply with provisions of S.132(1)(iib)

275B

Up
to two years and fine

As
decided by the Court

Removal,
concealment, transfer or delivery of property to thwart tax recovery (w.e.f.
1-4-1989)

276

Up
to two years and fine

As
decided by the Court

Liquidator

(a)
Fails to give notice u/s. 178(1)

276A (i)

Up
to two years

Not less than six months unless special and
adequate reason given

(b)
Fails to set aside the amount u/s. 178(3)

276A (ii)

276A (iii)

Failure
to comply with the provisions of section 269UC about the transfer of property
without entering into an agreement as specified; failure to surrender or
deliver/possession of the property vested in the Central Government on the
presumptive purchase or contravening the provisions putting a restriction on
registration of documents.

276AB

Up
to two years

Not less than six months unless special and
adequate reason given

Failure
to pay the tax deducted at source within the specified period.

276B

Up
to seven years and fine

Three months and fine

Failure
to pay tax collected at source

276BB

Up
to seven years and fine

Three months and fine

a)
Wilful attempt to evade tax, penalty, interest, etc., chargeable or imposable
under the Act.

276C(1)

If
tax evaded is over Rs. 2,50,000/ – Seven years and fine

In
any other case two years and fine

Six months and fine

Three months and fine

b) Wilful attempt to evade payment of tax,
penalty or interest

276C(2)

Two
years and fine

Three months and fine

Wilful
failure to file a return of income u/s. 139(1) or return of fringe benefit
u/s. 115WD(1) or in response to notice u/s. 115WD(2), 115WH, 142(1), 148 or
153A of the Act

276CC

If
the amount of tax evaded is over Rs. 2,50,000/-, up to seven years and fine

Six
months and fine

In
any other case, Simple imprisonment for a term of two years and fine

Three
months and fine

Wilful
failure to furnish in due time return in response to notice u/s. 158BC.

276CCC

Simple
imprisonment for a term of three years and fine

Three
months and fine

Wilful
failure to produce accounts and documents or non-compliance with an order
u/s. 142(2A) to get accounts audited etc.

276D

Up
to one year with fine

Whenever
verification is required under Law, making a false verification or delivery
of a false account or statement.

277

If
the amount of tax evaded is more than Rs. 2,50,000/- –Up to 7 years and fine

Six
months and fine

Three months and fine

In
other cases, two years and fine

Falsification
of books of account or document, etc.

277A

Up
to two years and fine

Three
months and fine

Abetting
or inducing another person to make, deliver a false account, statement or
declaration relating to chargeable income, or to commit an offence u/s.
276C(1)

278

Amount
of tax, penalty or interest evaded more than Rs. 2,50,000/- – up to seven
years and fine

Six
months and fine

A
– Abetment of false return etc. with reference to Category ‘A’ Offences

Any
other case two years and fine

Three months and fine

Abetment
of false return etc. with
reference to Category ‘B’ offences

A
person once convicted, under any of the sections 276B, 276(1), 276CC, 276DD,
276E, 277 or 278 is again convicted of an offence under any of the aforesaid sections.

278A

Up
to 7 years and fine

Six
Months and fine

A
public servant furnishing any information or producing any document in
contravention of s. 138

280

Up
to six months and fine

As
decided by the Court

[1] Union Government
Department of Revenue – Direct Taxes Report No. 28 of 2013

[2] Circular No. 469
dt. 23-9-1986 (1986) 162 ITR 21(St) (39)

shailesh.kwebmaker

APPLICABILITY OF SECTION 14A – RELEVANCE OF ‘DOMINANT PURPOSE’ OF ACQUISITION OF SHARES/ SECURITIES – PART – II

Introduction

5. As
mentioned in para 1.3 of Part-I of this write-up [January, 2019 Issue of BCAJ],
the Apex Court dealt with the main issue of applicability of section 14A in
cases where the shares were purchased by the assessee for acquiring/retaining
controlling interest or as stock-in-trade and in the process, it has dealt with
some other issues in the context of these provisions. As further mentioned in
para 3 of Part-I of this write-up, the Delhi High Court in MaxOpp Investments
Ltd’s case for the Assessment Year 2002-2003 [(2012) -347 ITR 272] took
the view that for the purpose of determining the applicability of section 14A,
it is not relevant whether the assessee has made investments for the purpose of
acquiring/retaining controlling interest as the dividend income is exempt. As
such, according to the Delhi High Court, dominant purpose for acquiring shares
is not relevant in this context. On the other hand, as mentioned in para 4 of
Part-I of this write-up, the Punjab & Haryana High Court, in State Bank of
Patiala’s case for the Assessment Year 2008-2009 [(2017) – 391 ITR 218], took
the contrary view in a case where the shares/securities were held by the assessee
as stock-in-trade. The Apex Court in batch of cases [MaxOpp Investments Ltd
vs. CIT and other cases (2018) 402 ITR 640 (SC)] has brought out the facts,
observations and findings of the Delhi High Court in MaxOpp Investments Ltd’s
case and of the Punjab & Haryana High Court in State Bank of Patiala’s case
primarily to decide the main issue [Ref paras 3.1 to 3.3 and paras 4.1 to 4.3
of Part-I of this write-up].

Is dominant purpose relevant ?

6.1 After
noting the divergent views emerged from the High Courts on this issue and the
reasoning given by the High Courts in support of these conflicting opinions,
the Court proceeded to consider this main issue as to whether the purpose of
making investment yielding Exempt Income is relevant for the purpose of applying
the provisions of section 14A and arguments of both the sides in that respect.

6.2 The
Court, to begin with, referred to statutory scheme contained in the provisions
of section 14A and Rule 8D and noted that the same should be kept in mind to
examine the divergent views expressed in the judgments of the above referred
High Courts. Further, the Court also
referred to the views expressed by the Karnataka High Court in CCI Ltd’s
case and in both the judgments of the Calcutta High Court, in G.K.K. Capital’s
case and in Dhanuka & Sons’ case, referred to in para 4.4 of Part-I of this
write-up.

6.3 The
Court then briefly recapitulated the main
arguments canvassed on behalf of the Assessees that: the holdings of
investments in group companies representing controlling interest amounts to
carrying on business as held in various cases; the character of dividend income
from such investments in shares continues to be business income though, by
virtue of the mandatory prescription in section 56 of the Act, such dividend
income is assessable under the head ‘Income from Other Sources’; interest paid
on funds borrowed for such investments is for the purpose of business and not
for earning dividend income and conversely, interest paid on such borrowed
funds does not represent expenditure incurred for earning dividend income and
was not allowable u/s. 57(iii) (prior to introduction of section 14A).

6.3.1 Based
on the above principles, it was, inter–alia, contended on behalf
of the assessee that when the shares were acquired, as part of promoter
holding, for the purpose of acquiring controlling interest in the
investee-company, the dominant object is to keep the controlling interest and
not to earn dividend and even when the dividend is not declared, the Assessee would
not liquidate such shares. As such, no expenditure was incurred ‘in relation
to‘ Exempt Income as contemplated in section 14A as the mandate and requirement
of section 14A requires a direct and proximate nexus between the expenditure
and the Exempt income to attract section 14A. It was further contended that
even if contextual/ purposive interpretation is to be given, that also requires
direct and proximate connection between the expenditure and the Exempt Income.
The section requires that only expenditure actually incurred ‘in relation to’
Exempt Income is to be disallowed so as to remove the double benefit to the
assessee.

6.3.2 On
behalf of the Revenue, it was, inter-alia, contended that the view taken
by the Delhi High Court is correct and the objective behind these provisions
manifestly pointed out that the expenditure incurred in respect of Exempt
Income earned has to be disallowed. For this, the reliance was also placed on
the Apex Court’s judgment in Walfort’s case [referred to in para 3.3 of Part-I
of this write-up]. According to the counsel for the Revenue, otherwise the
assessee will get double benefit. Firstly,
in the form of exemption in respect of income and secondly, by getting
deduction of expenses against other taxable income as well. Therefore, the
expression ‘in relation to’ had to be given expansive meaning in order to
achieve the object of the provision. It was also pointed out that the literal
meaning of section 14A also indicates towards that and that was equally the
purpose of insertion of the provisions as brought out in Explanatory
Memorandum.

6.4 After
considering the contentions raised on behalf of both the sides, the Court
proceeded to consider the main issue and observed as under (pg 665):

“In the
first instance, it needs to be recognized that as per section 14A(1) of the
Act, deduction of that expenditure is not to be allowed which has been incurred
by the assessee “in relation to income which does not form part of the total
income under this Act”. Axiomatically, it is that expenditure alone which has
been incurred in relation to the income which is not includible in total income
that has to be disallowed. If an expenditure incurred has no causal connection
with the exempted income, then such an expenditure would obviously be treated
as not related to the income that is exempted from tax, and such expenditure
would be allowed as business expenditure. To put it differently, such
expenditure would then be considered as incurred in respect of other income
which is to be treated as part of the total income.”

6.4.1 After bringing out the effect of
section14A(1), the Court also stated that there is no quarrel in assigning the
above meaning to section 14A and , in fact, all the High Courts including the
Delhi High Court & Punjab & Haryana High Court have agreed on this
interpretation. Having observed this, the Court focused on the real issue with
regard to interpretation of the expression ‘in relation to’ and observed as
under (pg 665) :

“……The
entire dispute is as to what interpretations to be given to the words ”in
relation to” in the given scenario, viz., where the dividend income on the
shares is earned, though the dominant purpose for subscribing in those shares
of the investee-company was not to earn dividend. We have two scenarios in
these sets of appeals. In one group of cases the main purpose for investing in
shares was to gain control over the investee-company. Other cases are those
where the shares of investee-company were held by the assessees as
stock-in-trade (i.e. as a business activity) and not as investment to earn
dividends. In this context, it is to be examined as to whether the expenditure
was incurred, in respective scenarios, in relation to the dividend income or not. ”

6.5 After
bringing out the real issue on hand and by drawing support from the views
expressed by the Apex Court in Walfort’s case, the Court took the view that for
this purpose the dominant purpose test is not relevant and held as under (pgs
665/666):

“Having
clarified the aforesaid position, the first and foremost issue that falls for
consideration is as to whether the dominant purpose test, which is pressed into
service by the assessee would apply while interpreting section 14A of the Act
or we have to go by the theory of apportionment. We are of the opinion that the
dominant purpose for which the investment into shares is made by an assessee
may not be relevant. No doubt, the assessee like MaxOpp Investments Limited may
have made the investment in order to gain control of the investee-company.
However, that does not appear to be a relevant factor in determining the issue
at hand. The fact remains that such dividend income is non-taxable. In this
scenario, if expenditure is incurred on earning the dividend income, that much
of the expenditure which is attributable to the dividend income has to be
disallowed and cannot be treated as business expenditure. Keeping this objective behind section14A of
the Act in mind, the said provision has to be interpreted, particularly, the
words “in relation to” that does not form part of total income. Considered in
this hue, the principle of apportionment of expenses comes in to play as that
is the principle which is engrained in section 14A of
the Act…..”

6.5.1 In the above context, while disagreeing with
the view expressed by the Punjab & Haryana High Court in State Bank of
Patiala’s case, the Court agreed with the view taken by the Delhi High Court in
the MaxOpp Investments Ltd’s case and held as under (pg 666):

“The Delhi
High Court, therefore, correctly observed that prior to introduction of section
14A of the Act, the law was that when an assessee had a composite and
indivisible business which had elements of both taxable and non-taxable income,
the entire expenditure in respect of the said business was deductible and, in
such a case, the principle of apportionment of the expenditure relating to the
non-taxable did not apply. The principle of apportionment was made available
only where the business was divisible. It is to find a cure to the aforesaid
problem that the Legislature has not only inserted section 14A by the Finance
(Amendment) Act, 2001 but also made It retrospective, i.e., 1962 when the
Income-tax Act itself came into force. The aforesaid intent was expressed
loudly and clearly in the Memorandum Explaining the Provisions of the Finance
Bill, 2001.We, thus, agree with the view taken by the Delhi High Court, and are
not inclined to accept the opinion of the Punjab and Haryana High Court which
went by dominant purpose theory. The aforesaid reasoning would be applicable in
cases where shares are held as investment in the investee-company, may be for
the purpose of having controlling interest therein. On that reasoning, appeals
of MaxOpp Investment Limited as well as similar cases where shares were
purchased by the assessees to have controlling interest in the investee-company
have to fail and are, therefore, dismissed.”

6.6 The
Court then dealt with another aspect of the main issue that when the shares are
held as stock-in-trade. In this context the Court noted CBDT Circular No 18 dtd
2/11/2015 [referred to in para 4.3(a) of
Part-I of this write-up] wherein the Board has clarified that income from
investments made by a banking concern is attributable to business of banking
and is taxable as business income. In this Circular, the Board has gone by the
judgment of the Apex Court in the case of Nawanshahar’s case which was dealing
with the claim of the bank u/s. 80P
which was relied on by the Punjab &
Haryana High Court in State Bank of Patiala’s case. In this context, the Court
observed as under (pg 667):

“ Form this, the Punjab and Haryana High Court pointed out that this
circular carves out a distinction
between “stock-in-trade” and “ investment” and provides that if the motive
behind purchase and sale of shares is to earn profit, then the same would be
treated as trading profit and if the object is to derive income by way of
dividend then the profit would be said to have accrued from investment. To this
extent, the High court may be correct. At the same time, we do not agree with
the test of dominant intention applied by the Punjab and Haryana High Court,
which we have already discarded. In that event, the question is as to on what
basis those cases are to be decided where the shares of other
companies are purchased by the assessees as “ stock-in-trade” and not as
“investment”. We proceed to discuss this aspect hereinafter.”

6.6.1 While
finally deciding the above issue against the assessee to the effect that even
in such cases Sec. 14A will apply as the
purpose of acquisition of shares is not relevant, the Court held as under (pgs
667/668):

“ In those
cases, where shares are held as stock-in-trade, the main purpose is to trade in
those shares and earn profits therefrom. However, we are not concerned with
those profits which would naturally be treated as “income” under the head
“Profits and gains from business and profession”. What happens is that, in the
process, when the shares are held as “stock-in-trade”, certain dividend is also
earned, though incidentally, which is also an income. However, by virtue of
section 10(34) of the Act, this dividend income is not to be included in the
total income and is exempt from tax. This triggers the applicability of section
14A of the Act which is based on the theory of apportionment of expenditure
between taxable and non-taxable income as held in Walfort Share and Stock
Brokers P. Ltd. case. Therefore, to that extent, depending upon the facts of
each case, the expenditure incurred in acquiring those shares will have to be
apportioned.”

Other
Issues

7.1 The
Court then dealt with the facts emerging from State Bank of Patiala’s case
[referred to in para 4.2 of Part-I of this write-up] wherein the AO had
restricted the disallowance to the amount of Exempt Income [Rs.12.20 Crore] by
applying formula contained in Rule 8D and the CIT (A) had enhanced the amount
of disallowance to the entire amount of allocated expenditure [Rs.40.72 Crore]
beyond Exempt Income. In this context, the Court observed as under (pg 668):

“ … In spite of this exercise of apportionment of expenditure carried out
by the Assessing Officer, the Commissioner of Income-tax (Appeals) disallowed
the entire deduction of expenditure. That view of the Commissioner of
Income-tax (Appeals) was clearly untenable and rightly set aside by the
Income-tax Appellant Tribunal. Therefore, on facts, the Punjab and Haryana High
Court has arrived at a correct conclusion by affirming the view of the
Income-tax Appellate Tribunal, though we are not subscribing to the theory of
dominant intention applied by the High Court…”

7.1.1 While
disagreeing with the views of Punjab & Haryana High Court in State Bank of
Patiala’s case on the theory of dominant purpose test, the Court further stated
as under (pg 668):

”… It is
to be kept in mind that in those cases where shares are held as
stock-in-trade”, it becomes a business activity of the assessee to deal in
those shares as a business proposition. Whether dividend is earned or not
becomes immaterial. In fact, it would be a quirk of fate that when the
investee-company declared dividend, those shares are held by the assessee,
though the assessee has to ultimately trade those shares by selling them to
earn profits. The situation here is, therefore, different from the case like
MaxOpp Investment Ltd. where the assessee would continue to hold those shares
as it wants to retain control over the investee-company. In that case, whenever
dividend is declared by the investee-company that would necessarily be earned
by the assessee and the assessee alone. Therefore, even at the time of
investing into those shares, the assessee knows that it may generate dividend
income as well and as and when such dividend income is generated that would be
earned by the assessee. In contrast, where the shares are held as
stock-in-trade, this may not be necessarily a situation. The main purpose is to
liquidate those shares whenever the share price goes up in order to earn
profits. In the result, the appeals filed by the Revenue challenging the
judgment of the Punjab and Haryana High Court in State Bank of Patiala also
fail, though law in this respect has been clarified hereinabove. ”

7.2 The Court
then dealt with the effect of section 14A(2) and Rule 8D. In this context, it
may be noted that various the High Courts (including Delhi High Court in MaxOpp
Investments Ltd’s case) have taken a view that before applying Rule 8D to
determine the quantum of disallowance, the AO needs to record his satisfaction
with regard to incorrectness of the quantum of expenditure incurred in relation
to Exempt Income determined by the assessee. Effectively, section 14A(2)
provides that if the assessee has determined the amount of such expenditure
(which may be disallowed) then the AO cannot take resort to Rule 8D for
determination of such expenditure unless the AO, having regards to the accounts
of the assessee, is not satisfied about the quantum of disallowance determined
by the assessee and record reasons for the same. In short, the Rule 8D cannot
be regarded as mandatory for all cases attracting section 14A(1). In this
context, the following observations of the Court are relevant (pgs 668/669):

“…we also
make it clear that before applying the theory of apportionment, the Assessing
Officer needs to record satisfaction that having regard to the kind of the
assessee, suo motu disallowance under section 14A was not correct. It will be
in those cases where the assessee in his return has himself apportioned but the
Assessing Officer was not accepting the said apportionment. In that
eventuality, it will have to record its satisfaction to this effect. Further,
while recording such a satisfaction, the nature of the loan taken by the
assessee for purchasing the shares/making the investment in shares is to be
examined by the Assessing Officer.”

7.3 As
mentioned earlier, there were number of appeals before the Apex Court. One of
them was filed by Avon Cycles Ltd (Civil appeal No 1423 of 2015) in
which the issue was with regard to disallowance of interest under Rule
8D(2)(ii) in a case where mixed funds were utilised by the assessee for
investment in shares. In this context, the ITAT had held as under (pg 669):

“…Admittedly
the assessee had paid total interest of Rs. 2.92 crores out of which interest
paid on term loan raised for specific purpose totals of Rs. 1.70 crores and
balance interest paid by the assessee is Rs. 1.21 crores. The funds utilised by
the assessee being mixed funds and in view of the provisions of rule 8D(2)(ii)
of the Income-tax Rules the disallowance is confirmed at Rs. 10,49,851. We find
no merit in the ad hoc disallowance made by the Commissioner of Income-tax
(Appeals) at Rs. 5,00,000. Consequently, the ground of appeal raised by the
Revenue is partly allowed and the ground raised by the assessee in
cross-objection is allowed.”

7.3.1 The High Court had taken a view that the above
being finding other facts, no substantial question of
law arises.

7.3.2 This
appeal was dismissed by the Apex Court with following observations (pg 669):

“ After
going through the records and applying the principle of apportionment, which is
held to be applicable in such cases, we do not find any merit in Civil Appeal
No. 1423 of 2015, which is accordingly dismissed”

7.4 It may also be noted that in the Bombay
High Court judgment (Nagpur Bench) in the case of Jamnalal Sons Pvt. Ltd. [
(2018) 11 ITR –OL 385] , it appears that the Tribunal had deleted
disallowance of interest expenditure made u/s 14A read with Rule 8D on the
grounds that the assessee had interest free funds available which are far in
excess of the amount invested in shares on which dividend was earned [apart
from other fact that the interest income was also much more than the interest
expenditure]. For this, Tribunal had relied on the judgment of the Bombay High
Court in the case of Reliance Utilities & Power Ltd [(2009) 313 ITR 340]
wherein the Court has held that in such cases, it can be presumed that the
investments were made from the interest free funds. In this case [Jamnalal
& sons’ case], the Revenue had contended before the High Court that the
Punjab & Haryana High Court in Avon Cycles Ltd’s case [referred to in para
7.3 above] has taken a different view from the one taken in Reliance Utilities’
case and also pointed out that appeal of the assessee against this Punjab &
Haryana High Court judgment has been admitted by the Apex Court and is pending.
After considering this, the Bombay High Court has dismissed the appeal of the
Revenue and decided the issue in favour of the assessee for which it also noted
that in the case of HDFC Bank Ltd [(2014) 366 ITR 565], this Court has
reiterated the view taken in Reliance Utilities’ case. One of the appeals filed
before the Apex Court in the MaxOpp Investment Ltd’s case by the Revenue was
also against this Bombay High Court judgment in Jamnalal Sons Pvt Ltd’s case
[Civil Appeal No.2793 of 2018 – Diary No 41203 of 2017] and this appeal of the
Revenue is allowed by the Apex Court.

7.5 Few
appeals filed by the Revenue against the assessee involved the issue as to
retrospective applicability of Rule 8D. In this context, the Court stated that
the said Rule is prospective and will apply only from Assessment Year 2008-2009.
This has already been held by the Apex Court in the case of CIT vs. Essar
technologies Ltd. [(2018) 401 ITR 445]. This was also the view emerging
from the judgment of the Apex Court in the case of Godrej & Boyce
Manufacturing Ltd. (2017) 394 ITR 449 [Godrej’s case].

CONCLUSION

8.1 In
view of the above judgment of the Apex Court, now it is settled that for the
purpose of determining applicability of section 14A, the dominant purpose test
is not relevant. As such, irrespective of the purpose for which shares are
acquired [i.e. whether for acquiring controlling interest or even for business
activity(to be held as stock-in-trade), provisions of section 14A are
applicable. It is unfortunate that a very sound and rational distinction drawn
by the Punjab and Haryana High Court in the State Bank of Patiala’s case
[referred to in para 4.3 of Part-I of this write-up], in the context of shares
held as stock-in-trade, did not appeal the Apex Court in deciding this issue.

8.1.1 It
appears that in a case where shares are held as stock-in-trade and during the
relevant previous year, no dividend income (Exempt Income) is earned therefrom
by the Assessee, the provisions of section 14A should not apply. In this
context, the observations of the Apex Court referred to in paras 6.6, 6.6.1,
7.1, and 7.1.1 above may be useful.

8.1.2 Section
14A deals with disallowance of expenditure incurred in relation to Exempt
Income. Therefore, expenditure which is admittedly incurred in relation to
taxable Income [e.g. interest on Term Loan taken and utilised for acquiring
Plant & Machinery meant for manufacturing activity yielding profit which is
not exempt] should be kept outside the purview of disallowance u/s. 14A. As
such, the same should not be considered for the quantification of the amount of
such disallowance . For this, useful reference may be made to the observations
of the Apex Court referred to in para 6.4 above.

8.2 Once
the provisions of section 14A(1) are applicable and the quantum of expenditure
in relation to Exempt Income is required to be determined as provided in
section 14A(2), the method prescribed in Rule 8D for determining such quantum
may become relevant. However, if the assessee has suo motu determined the
amount of disallowance u/s 14A then in such cases, the AO cannot invoke Rule 8D
for determining the quantum of such expenditure without recording the reasoned
satisfaction [as contemplated in section14A (2)] that the amount of suo motu
disallowance made by the assessee is not correct. This was the view expressed
by various High Courts including Delhi High Court in MaxOpp Investment Ltd’s
case and Bombay High Court judgment in Ultra Tech Ltd [(2018) 407 ITR 560-
Special Leave Petition [SLP] dismissed (2018) 406 ITR (St) 12]. This view
also gets support from the observations in the judgment of the Apex Court in
Godrej’s case. This position now gets settled on account of the view expressed
by the Apex Court referred to in para 7.2 above. However, from the view
expressed by the Apex Court, this position may apply only in cases where assessee
in his Return of Income has suo motu apportioned some expenditure
towards the earning of Exempt Income but the AO is not satisfied with the same.
Therefore, practically, it is advisable for the assessees to suo motu
determine the quantum of such disallowance properly so as to avoid
applicability of Rule 8D when working under Rule 8D is adverse to the Assessee.
As such, the application of the Rule 8D is strictly not mandatory.

8.2.1 The
above view of the Apex Court, in practice, may raise some further issues,
especially where the Assessee has taken a stand that no such expenditure is
incurred as the observations of the Apex Court are in the context of section
14A(2) and there is no reference to section 14A(3) which refers to the claim of
Nil expenditure and provide that even in such cases, section 14A(2) applies. It
seems that, in such cases, the assessee has to first demonstrate that no such
expenditure is factually incurred.

8.3 Considering
the facts of State Bank of Patiala’s case and on account of the view expressed
by the Apex Court referred to in para 7.1 above, in cases where the AO has
restricted the amount of disallowance u/s 14A to the amount of Exempt Income
earned during the year while applying Rule 8D, it would not be possible for the
CIT(A) to enhance the amount of such disallowance beyond the amount of Exempt
Income. In this context, it is worth noting that in the case of the same
assessee (State Bank of Patiala), the Punjab & Haryana High Court [for
Assessment Year 2010-2011 – ITA No 359/2017 dated 14/11/17] appear to have
taken similar view [in the context of order passed by the AO as a result of
order of CIT u/s. 263] by relying on decision in case of same assessee for
other years [i.e Assesstment Year 2009-2010 (2017) 393 ITR 476 and the one
referred to in para 7.1 above]. This judgment of the Punjab & Haryana High
Court dated 14/11/17 in case of the same assessee also subsequently came-up
before the Apex Court in which the SLP is dismissed by the Apex Court by an
order dated 8/10/18 stating that ‘the SLP is dismissed both on the ground of
delay as well as on merits.’ We may clarify that the mere rejection of SLP by
non-speaking order of the Apex Court against the High Court judgment does not
by itself tantamount to confirmation of the judgment of the High Court and
declaration of law by the Apex Court on the issue involved. For implications of
dismissal of SLP, reference may be made to our analysis of the Apex Court
Judgment under the title ‘Impact of rejection of SLP’ in this column in
December, 2000 issue of this Journal.

8.3.1 In the above context, in cases where the AO
himself has not restricted the amount of disallowance, some further issues
could arise.

8.3.2 Currently,
a debate continues on the issue as to applicability of section 14A in cases
where no Exempt Income is earned by the assessee during the relevant previous
year. Decisions are available on both the sides. It is for consideration
whether the position with regard to restricting the amount of disallowance to
the Exempt Income referred to in para 8.3 above could support the case of the
assessee to contend that if there is no Exempt Income, the provisions of
section 14A should not apply. In this context, it may be noted that the Amritsar
Bench of Tribunal in the case of Lally Motors India Pvt. Ltd [(2018) 170 ITD
370] has taken adverse view after considering major decisions on both the
sides and also relying on the judgment of the Apex Court [but without
specifically referring to this point arising from the view expressed by the
Apex Court referred to in para 7.1 above] in MaxOpp Investments Ltd’s case. Of
course, if the shares are held as stock-in-trade, the issue should be governed
by the position mentioned in para 8.1.1 above.

8.4 Another
issue which is under debate on applicability of section 14A in cases where the
assessee has larger amount of owned funds as well as other interest-free funds
available as compared to the amount invested in shares etc., yielding Exempt
Income. In such a scenario, the courts have effectively confirmed a view that
if the interest-free funds available with an assessee are more than amount
invested in such shares etc. and at the same time, if the assessee has also
borrowed funds on interest, it can be presumed that the investments were made
from the available interest-free funds [Ref HDFC Bank Ltd (2014) 366 ITR 505
(Bom), Max India Ltd. (2017) 398 ITR 209 (P & H), Microlabs Ltd (2016) 383
ITR 490 [Kar HC], Gujarat State Fertilizers & Chemicals Ltd (2018) 409 ITR
378 (GHC), etc.] In this context, recently, in another case of Gujarat
State Financial Services Ltd [ITA Nos 1252/1253/1255 of 2018], the Revenue
contended that in view of the judgment of the Apex Court in MaxOpp Investments
Ltd’s case [considered in this write-up], the legal position is that whenever
the assessee has two sources of funds, interest bearing and non-interest
bearing and also has made investments yielding Exempt Income, disallowance u/s.
14A will have to be made if the issue is to be considered after introduction of
Rule 8D. According to the Revenue, one of the issues decided in MaxOpp
Investment Ltd’s case was this one while dealing with the appeal filed by Avon
Cycle Ltd [referred to in para 7.3 above] in which the issue was with regard to
disallowance under Rule 8D in a case where mixed funds were utilised by the
assessee for such investments.

8.4.1 The Gujarat High Court [vide order dtd
15/10/2018], while dealing with the above issue raised by the Revenue,
explained the effect of the judgment of Apex Court in MaxOpp Ltd’s case in this
respect and took the view that this judgment of the Apex Court does not lay
down a proposition that the requirement of Rule 8D(1) of the satisfaction to be
arrived at by the AO before applying the formula given in Rule 8D(2) is done
away with. In other words, according to Gujarat High Court, this judgment of
the Apex Court does not lay down a proposition that the moment it is
demonstrated that the assessee had availed of mixed funds [i.e. interest-free
as well interest bearing funds] and utilised them for making such investments,
the applicability of section 14A read with Rule 8D(2) would be automatic. This
may be useful in cases where Tribunal has given a finding by applying the
presumption of use of interest-free funds in making such investment. In this
context, it is worth noting that the fact of allowing appeal against the Bombay
High Court judgment by the Apex Court in case of Jamnalal & Sons Pvt Ltd.
[referred to in para 7.4 above] was not considered in this case.

8.4.2 As mentioned in para 1.1.1 of Part-I of this
write-up, the Rule 8D is amended and, under the amended Rule, the earlier
provisions contained in Rule 8D (2)(ii) providing for disallowance of
proportionate amount of interest expenditure in cases where the mixed funds are
used for making investments is deleted w. e. f 2/6/2016. Therefore, the issues
relating to applicability of that part of the Rule 8D and determining quantum
thereof under that portion of the Rule and large number of decisions dealing
with the same may not be relevant in the post amendment era for that purpose,
though, of course, the same should continue to be relevant for other purposes.

8.5 The position is now settled that Rule 8D is prospective as
mentioned in para 7.4 above. This should also apply to amendment in the Rule 8D
w. e. f 2/6/2016 referred to in para 8.4.2 above.

shailesh.kwebmaker

Section 56(2)(vii) – Provisions do not apply to rights shares offered on a proportionate basis even if the offer price is less than the FMV of the shares.

This is the first
and oldest monthly feature of the BCAJ. Even before the BCAJ started, when
there were no means to obtain ITAT judgments – BCAS sent important judgments as
‘bulletins’. In fact, BCAJ has its origins in Tribunal Judgments. The first
BCAJ of January, 1969 contained full text of three judgments.

We are told that the first convenor of
the journal committee, B C Parikh used to collect and select the decisions to
be published for first decade or so. Ashok Dhere, under his guidance compiled
it for nearly five years till he got transferred to a new column Excise Law
Corner. Jagdish D Shah started to contribute from 1983 and it read “condensed
by Jagdish D Shah” indicating that full text was compressed. Jagdish D Shah was
joined over the years by Shailesh Kamdar (for 11 years), Pranav Sayta (for 6
years) amongst others. Jagdish T Punjabi joined in 2008-09; Bhadresh Doshi in
2009-10 till 2018. Devendra Jain and Tejaswini Ghag started to contribute from
2018. Jagdish D Shah remains a contributor for more than thirty years now.

While Part A covered Reported Decisions,
Part B carried unreported decisions that came from various sources. Dhishat
Mehta and Geeta Jani joined in 2007-08 to pen Part C containing International
tax decisions.

The decisions earlier were sourced from
counsels and CAs that required follow up and regular contact. Special bench
decisions were published in full. The compiling of this feature starts with the
process of identifying tribunal decisions from a number of sources. Selection
of cases is done on a number of grounds: relevance to readers, case not
repeating a settled ratio, and the rationale adopted by the bench members.

What keeps the contributors going for so
many years: “Contributing monthly keeps our academic journey going. It keeps
our quest for knowledge alive”; “it is a joy to work as a team and contributing
to the profession” were some of the answers. No wonder that the features
section since inception of the BCAJ starts with the Tribunal News!

10.
Asst. CIT vs. Subhodh Menon (Mumbai) Members: R. C. Sharma (A. M.) and Ram Lal Negi (J. M.)
ITA No.: 676/Mum/2015 A. Y.: 2010-11. Dated: 7^th Decmber, 2018
Counsel for Revenue / Assessee: Tejveer
Singh and Abhijeet Deshmukh / S.E. Dastur

Section 56(2)(vii) –
Provisions do not apply to rights shares offered on a proportionate basis even
if the offer price is less than the FMV of the shares.

FACTS

The assessee was an executive director of
Dorf Ketal Chemicals India Pvt. Ltd. (“Dorf Ketal”). He filed his return of
income showing total income of Rs. 25.04 crore (revised). On 28.01.2010 the assessee acquired 20,94,032
shares in Dorf Ketal @ Rs.100/- per share i.e. @ face value for a consideration
of Rs.20.94 crore. According to the A.O., under Rule 11UA(c), the fair market
value of the share of Dorf Ketal was Rs.1,438.64. Therefore, the difference in
share value was brought to tax u/s. 56(2)(vii)(c) and the total income was
assessed at Rs. 326.32 crore. According to the AO, the assessee being a
salaried employee, the shares allotted to him could also be treated as
perquisite or profit in lieu of salary u/s. 17. Reliance was placed on the
ratio laid down by the Bombay High Court in the case of CIT vs D. R. Pathak (99
ITR 14). The CIT(A) on appeal, relying
on the decision of the Mumbai tribunal in the case of Sudhir Menon HUF vs.
Asst. CIT (I.T.A. No. 4887/Mum/2013 dated 12.03.2014) held in favour of the
assessee. Being aggrieved, the revenue
appealed before the Tribunal.

Before the Tribunal, the revenue justified
the order of the AO and contended that:

The assessee has not disputed the valuation of
the shares at Rs.1,538.64 per share as on 31,03.2009, which was in accordance
with the Rules. As regards argument of the assessee that after the date of the
issue of fresh shares, the valuation of the shares has been drastically reduced
with inclusion of the new contribution of share capital, according to the revenue, the share value of
the company has to be valued as on date of issue or prior to the issue date to
determine the fair market value;

The assessee was offered 21,78,204 shares at
face value of Rs. 100. However, he accepted only 20,94,032 shares. Thus,
according to the revenue, there has been disproportionate allotment in the case
of the assessee and thus the decision of the Mumbai Tribunal in the case of
Sudhir Menon HUF, relied on by the CIT(A), was distinguishable;

The provisions of section 56(2)(vii) are in the
nature of anti-abuse provisions and therefore should be interpreted strictly.
For the purpose, it relied on the Circular No. 1/2011 dated 6^th
April, 2011 and the decisions of the Hyderabad Tribunal in case of Rain Cement
Limited vs. DC IT (2017 1 NYPTTJ 362) and Kolkata Tribunal in the case of
Instrumentarium Corporation Ltd. (2016 (7) TMI 760 – ITAT Kolkata);

HELD

According to the Tribunal, the issue under
consideration was squarely covered by the order of the Mumbai Tribunal in the
case of Sudhir Menon HUF. As held under
the said decision, the Tribunal held that the provisions of section
56(2)(vii)(c) is not applicable to the facts and circumstances of the
appellant’s case.

As regards contention of
“disproportionate allotment” raised by the revenue, according to the
Tribunal, it is only when a higher than the proportionate allotment is received
by a shareholder, the provisions of section 56(2)(vii) get attracted. In the
instant case, the assessee applied for and was allotted a lesser than the
proportionate shares offered to him and his shareholding reduced from 34.57% to
33.30%.

The Tribunal further noted that the
transaction of issue of shares was carried out to comply with a covenant in the
loan agreement with the bank to fund the acquisition of the business by the subsidiary
in USA. Thus, the shares were issued by Dorf Ketal for a bonafide reason and as
a matter of business exigency. As per Circular No.1/2011 explaining the
provision of section 56(2)(vii) and relied on by the revenue, “the
intention was not to tax transactions carried out in the normal course of
business or trade, the profit of which are taxable under the specific
head of income”. Thus, the Circular supports the assessee’s case.

As regards the
alternated contention of the AO that the same should be considered for
taxability as perquisite u/s. 17, the tribunal held that the provisions of
section 17 do not apply to the shares allotted by Dorf Ketal to the assessee,
as the shares were not allotted to the assessee in his capacity of being an
employee of the company. The shares were offered and allotted to the assessee
by virtue of the assessee being a shareholder of the company. Therefore the
provisions of section 17 were not applicable. For the purpose, the Tribunal
referred to the Board Circular No. 710 dated 24^th July, 1995 which
provides that where shares are offered by a company to a shareholder, who
happens to be an employee of the company, at the same price as have been
offered to other shareholders or the general public, there will be no perquisite
in the shareholder’s hands. In the instant case, the Tribunal noted that the
shares were offered to the assessee and other shareholders at a uniform rate of
Rs. 100 and therefore, the difference between the fair market value and issue
price cannot be brought to tax as a perquisite u/s. 17.

In the result, the appeal filed by the
revenue was dismissed.

shailesh.kwebmaker

INSOLVENCY & BANKRUPTCY CODE, 2016 – SC’S BOOSTER SHOTS

It was started in September, 2002 with
Anup P Shah as its author. He continues to eloquently pen it every month since
then. BCAJ had several features on tax and accounting but very little of Law.
As auditors and advisors, CAs need to have a good working knowledge of laws
which impact business. Each article provided audit steps after covering the
legal aspects. The idea behind the feature is to educate CAs and even
businessmen about laws which impact a business and hence, the name “Laws &
Business”. Anup started writing on different laws and then moved on to
different legal issues. One notable change: When he started he was CA. Anup
Shah and now he is Dr. Anup P Shah.

You are about to read the 196^th
contribution. So far the column has covered 82 Laws and 164 legal issues. Two
editions of compilation of Laws and Business have been published by BCAS. When
we asked the author, what keeps him going after sixteen years of monthly
writing: “Writing crystallizes thinking – while readers may benefit from the
Feature, I get a larger benefit since before one can write on a subject, one
must study and analyse it thoroughly. In addition, the desire to learn new
legal issues and a zeal to write keeps the keyboard pounding!” Soon the feature will hit a double century!

Insolvency & Bankruptcy
Code, 2016 – SC’s Booster Shots

Introduction

Rarely has a law witnessed
as many legal challenges in its initial years as the Insolvency &
Bankruptcy Code, 2016 (“Code”) has! Although, the Code is less
than three years old, it has seen numerous battles not just at the NCLT level
but even at the Supreme Court. In addition, the Code itself has been amended
many times to address changing circumstances and in response to Court
decisions. Hence, it has been an evolving legislation. Promoters of companies
under insolvency resolution have tried resorting to judicial forums to prevent
losing control over their companies but Courts have been wary of allowing their
pleas. However, each time the Code has emerged stronger and more robust than
before. In the last few months, the Supreme Court has on three occasions,
delivered landmark decisions, which have helped uphold the validity of the
Code. Let us examine these decisions of the Apex Court in the context of the
Code.

Case-1: Swiss Ribbons (P.) Ltd. vs. UOI,
[2019] 101 taxmann.com 389 (SC)

The Supreme Court by its
Order dated 25^th January 2019, upheld the Insolvency and Bankruptcy
Code, 2016 in its entirety with some minor adjustments. This case was not fact
based since it involved a challenge to the Constitutional validity of the Code.
Some of the salient features of this path breaking decision are discussed
below. The main thrust of the petitioner’s argument was that the Code suffered
from various Constitutional infirmities and arbitrariness and hence, deserved
to be struck down. The Court held the primary focus of the legislation was to
ensure revival and continuation of the corporate debtor by protecting the
corporate debtor from its own management and from a corporate death by
liquidation. The Code was thus a beneficial legislation which put the corporate
debtor back on its feet and was not a mere recovery legislation for creditors.
The interests of the corporate debtor had, therefore, been bifurcated and
separated from that of its promoters / those who were in management. Thus, the
Corporate Insolvency Resolution Process (“CIRP”) was not
adversarial to the corporate debtor but, in fact, protective of its interests.

It observed that in the
working of the Code, the flow of financial resource to the commercial sector in
India had increased exponentially as a result of financial debts being repaid.
Approximately 3300 cases were disposed of by the NCLT based on out-of-court
settlements between corporate debtors and creditors which themselves involved
claims amounting to over Rs. 1,20,390 crore. The experiment conducted in
enacting the Code was proving to be largely successful.

Distinction between Operational and Financial
Creditors is Valid

It was argued that the
distinction between operational and financial creditors was Constitutionally
invalid and nowhere in the world was such an artificial bifurcation found. It
was quite likely that since operational creditors were often unsecured (e.g.,
creditors for goods and services) as compared to financial creditors (e.g.,
banks, NBFCs, etc.,) who may be secured, there might not be enough funds left
behind for the operational creditors after paying off the financial creditors.
Further, it was contended that operational creditors had no right to vote as
compared to financial creditors who alone could vote. Moreover, a financial
creditor could trigger a resolution application under the Code merely on a
default taking place. However, in the case of an operational creditor even if a
default takes place and an application is filed before the NCLT, the same would
be rejected if the debtor can prove that a dispute exists with the operational
creditor.

The Court noted that the
reason for differentiating between financial debts, which were secured, and
operational debts, which were unsecured, was in the relative importance of the
two types of debts when it comes to the objects sought to be achieved by the
Code. Giving priority to financial debts owed to banks and lenders would
increase the availability of finance, reduce the cost of capital, promote
entrepreneurship and lead to faster economic growth. The Government also will
be a beneficiary of this process as the economic growth will increase revenues.
Financial creditors from the very beginning are involved with assessing the
viability of the corporate debtor. They can, and therefore do, engage in
restructuring of the loan as well as reorganisation of the corporate debtor’s
business when there is financial stress, which are the things operational
creditors do not and cannot do. Financial creditors help in preserving the
corporate debtor as a going concern, while ensuring maximum recovery for all
creditors being the objective of the Code, and hence, are clearly different
from operational creditors and therefore, there is obviously an intelligible
differentia between the two which has a direct relation to the objects sought
to be achieved by the Code.

Further, the NCLAT has,
while looking into viability and feasibility of resolution plans that are
approved by the committee of creditors, always examined whether operational
creditors are given roughly the same treatment as financial creditors, and if
not, such plans are either rejected or modified so that the operational
creditors’ rights are safeguarded. Moreover, a resolution plan cannot pass
muster u/s. 30(2)(b) read with section 31 unless a minimum payment is made to
operational creditors, being not less than liquidation value.

The Regulations framed under
the Code have been amended to expressly provide that a resolution plan shall
now include a statement as to how it has dealt with the interests of all
stakeholders, including financial creditors and operational creditors, of the
corporate debtor. This further strengthens the rights of operational creditors
by statutorily incorporating the principle of fair and equitable dealing of
operational creditors’ rights, together with priority in payment over financial
creditors.

Hence,
the Court concluded that no discrimination resulted since it was demonstrated
that there was an intelligible differentia which separated the two kinds of
creditors.

Section12A withdrawal of CIRP

In the
past, there have been instances where on account of settlement between the
applicant creditor and the corporate debtor, judicial permission for withdrawal
of the CIRP was required. The Supreme Court, under Article 142 of the
Constitution, passed orders allowing withdrawal of applications after the
creditors’ applications had been admitted by the NCLT. Thus, without
approaching the Supreme Court, it was not possible to withdraw an application
even if both parties consented to the same – Lokhandwala Kataria
Construction P Ltd vs. Nisus Finance and Investment Managers LLP,
CA No. 9279/2017 (SC) and Mothers Pride Dairy P Ltd vs. Portrait
Advertising and Marketing P Ltd, CA No. 9286/2017 (SC).

To remedy this situation,
section 12A was inserted in the Code which allows for the withdrawal of an
insolvency petition filed against a corporate debtor if 90% of the Committee of
Creditors (CoC) approve such a withdrawal. It was argued that this section gave
unbridled and uncanalised power to the CoC to reject legitimate settlements
between creditors and corporate debtors. The Apex Court held that once the CIRP
was triggered, the proceeding became a proceeding in rem, i.e., a collective
proceeding, which could not be terminated by an individual creditor. All
financial creditors have to come together to allow such withdrawal as,
ordinarily, an omnibus settlement involving all creditors ought, ideally, to be
entered into. This explained why 90%, which was substantially all the financial
creditors, have to grant their approval to an individual withdrawal or
settlement. In any case, the figure of 90%, pertained to the domain of
legislative policy. The Court further pointed out that there was an additional
safeguard by way of section 60 of the Code, which provided that if the CoC
arbitrarily rejected a just settlement and/or withdrawal claim, the NCLT, and
thereafter, the NCLAT could always set aside such a decision. Thus, the Court
upheld section 12A of the Code.

Role of RP

The
Court did not find merit in the plea that the resolution professional was given
adjudicating powers under the Code. It held that he was given an administrative
role as opposed to quasi-judicial powers. The Court distinguished between the
role of a resolution professional who had an administrative role versus a
liquidator who had a quasi-judicial role. Thus, the resolution professional was
only a facilitator of the resolution process, whose administrative functions
were overseen by the CoC and ultimately by the NCLT.

Section 29A: Relief to ‘Related Party’

A multi-fold attack was
raised against section 29A which disentitled certain persons to act as
resolution applicants. Firstly, it was stated that the vested rights of
erstwhile promoters to participate in the recovery process of a corporate
debtor were impaired by a retrospective application of section 29A. It was
contended that section 29A was contrary to the object sought to be achieved by
the Code, in particular, speedy resolution process as it would inevitably lead
to challenges before the NCLT and NCLAT, which would slow down and delay the
CIRP. In particular, so far as section 29A(c) was concerned, a blanket ban on
participation of all promoters of corporate debtors, without any mechanism to
weed out those who are unscrupulous and have brought the company to the ground,
as against persons who are efficient managers, but who have not been able to
pay their debts due to various other reasons, would not only be manifestly
arbitrary, but also be treating unequals as equals. Also, maximisation of value
of assets was an important goal to be achieved in the resolution process and section 29A was contrary to such a goal since an
erstwhile promoter, who may outbid all other applicants and may have the best
resolution plan, would be kept, thereby impairing the object of maximisation of
value of assets. Another argument which was made was that under the Code, a
person’s account may be classified as an NPA in accordance with the guidelines
of the RBI, despite him not being a wilful defaulter. Lastly, persons who may
be related parties in the sense that they may be relatives of the erstwhile
promoters were also debarred, despite the fact that they may have no business
connection with the erstwhile promoters who have been rendered ineligible by
section 29A.

The Supreme Court held that
the Code was not retrospective in application and hence, it was clear that no
vested right of the promoters was taken away by the application of section 29A. The Court held that it must be borne in
mind that section 29A had been enacted in the larger public interest and to
facilitate effective corporate governance. The Parliament rectified a loophole
which allowed a back-door entry to erstwhile managements in the CIRP. Hence,
the Court upheld the validity of section 29A. However, it held that the mere
fact that somebody happened to be a relative of an ineligible person was not
good enough to oust such person from becoming a resolution applicant, if he was
otherwise qualified. In the absence of showing that such a person was connected
with the business activity of the ineligible resolution applicant, such a person
could not automatically be disqualified. Hence, the expressions related party
and relative contained in the Code would disqualify only those persons who were
connected with the business activity of the resolution applicant.

Ultimately, the Supreme Court
upheld the validity of the Code in its entirety with a minor tweak for
relatives / related parties!

Case-2: Arcelor Mittal India Private
Limited vs. Satish Kumar Gupta, (2018) 150 SCL 354 (SC)

This decision pertained to
the bid for Essar Steel India Ltd. 29A of the Code contains several
disqualifications for bidders, one of which is that a person would not be
eligible to submit a resolution plan, if such person, or one acting jointly or
in concert with such person was disqualified. In this case, there were two
bidders – the erstwhile promoters and another resolution applicant. It so
happened that both the promoters as well as the resolution applicant were
disqualified by virtue of the various clauses of section 29A. Hence, both of
them modified their shareholding structures and reapproached the NCLT. The
issue finally reached the Supreme Court as to whether both these bidders were
eligible to bid?

The Court adopted a
purposive interpretation of the section and held that the legislative intention
was to rope in all persons who may be acting in concert with the person
submitting a resolution plan. The opening lines of section 29A of the Code
referred to a de facto as opposed to a de jure position of the
persons mentioned therein. This was a typical instance of a “see through
provision”, so that one was able to arrive at persons who were actually in
“control”, whether jointly, or in concert, with other persons. A wooden,
literal, interpretation would obviously not permit a tearing of the corporate
veil when it came to the “person” whose eligibility was to be
considered. However, a purposeful and contextual interpretation was necessary.
While a shareholder is a separate legal entity from the company where he holds
shares, for verifying the resolution plan, it is imperative to lift the
corporate veil and ascertain the constituents who make up the Company. The
Court upheld the doctrine of piercing the corporate veil as enshrined in LIC
of India vs. Escorts Ltd (1986) 1 SCC 264 and distinguished the legal
personality concept of Soloman’s case. It observed that a slew of
judgments has held that where a statute itself lifts the corporate veil, or
where protection of public interest is of paramount importance, or where a
company has been formed to evade obligations imposed by the law, the court will
disregard the corporate veil.

The Court held that seen
from the wide language used in the section, any understanding, even if it is
informal, and even if it is to indirectly cooperate to exercise control over a
target company, is included in the definition of persons acting in concert and
it is not merely restricted to cases of formal joint venture agreements. The
stage at which ineligibility is to be examined is when the resolution plan was
submitted by a resolution applicant. So long as a person or persons acting in
concert, directly or indirectly, can positively influence, in any manner,
management or policy decisions, they could be said to be “in control”. The
expression “control”, in section 29A, denotes only positive control, which
means that the mere power to block special resolutions of a company cannot
amount to control. The Supreme Court also examined the decision of the SAT in the case of Shubhkam Ventures vs. SEBI (Appeal No. 8 of 2009
decided on15.1.2010) which had taken a similar view.

The Court held that since
section 29A is a see-through provision, great care must be taken to ensure that
persons who are in charge of the corporate debtor for whom such resolution plan
is made, do not come back in some other form to regain control of the company
without first paying off its debts. One of the persons mentioned in section 29A
who is ineligible to act as an resolution applicant is a person prohibited by
SEBI from either trading in securities or accessing the securities market. The
Court held that it was clear that it was clear that if a person was prohibited
by a regulator of the securities market in a foreign country from trading in
securities or accessing the securities market, the disability would equally
apply.

Lastly, the court dealt
with the timeline for completing a CIRP. The time limit for completion of the
CIRP as laid down in section 12 of the Code is a period of 180 days from the
date of admission of the application by the NCLT. This is extendable by a
maximum period of 90 days only if 66% of the CoC approve of the same and the
NCLT agrees to the same. If no resolution takes place within such period of 270
days, then the only option is to liquidate the corporate debtor. The Supreme
Court held that the timelines mentioned in the Code are mandatory and cannot be
extended. Nevertheless, the Court also relied on a legal maxim, Actus curiae
neminem gravabit – the act of the Court shall harm no man. Accordingly, it
held that where a resolution plan is upheld by the NCLAT, either by way of
allowing or dismissing an appeal before it, the period of time taken in
litigation ought to be excluded.

Ultimately, the Supreme
Court held that both the applicants were ineligible under the Code but
exercising its special powers under Article 142 it granted one more opportunity
to them to pay off the NPAs of their related parties and then resubmit their
bids.

Case-3: Brilliant Alloys P Ltd vs. S Rajagopal, SLP
No. 31557 / 2018, Order dated 14-12-2018

Section 12A of the Code
allows for the withdrawal of an insolvency petition filed against a corporate
debtor if 90% of the Committee of Creditors (CoC) approve such a withdrawal.
However, Reg. 30A of the Insolvency and Bankruptcy Board of India (Insolvency
Resolution Process for Corporate Persons) Regulations, 2016 provides that an
application for withdrawal u/s. 12A shall be submitted to the resolution
professional before the issue of invitation for expression of interest. Hence,
a question arises as to whether if the debtor and creditor agree to it, can the
petition be withdrawn even after the expression of interest has been issued?

The Supreme Court allowed
the withdrawal and held, that this Regulation has to be read along with the
main provision section 12A which contained no such stipulation. Accordingly,
this stipulation could only be construed as directory depending on the facts of
each case.

Conclusion

The
Supreme Court has time and again stepped in to protect and augment the Code. It
has endeavoured to preserve the basic fabric of the Code and to uphold its
provisions. However, at the same time it has made amendments where it felt a
change was required. The Code is a complicated and intricate legislation dealing
with an extremely complex subject and hence, such an evolution is expected.
However, it is heartening to note that the Apex Court has been up to the
challenge and has done it in a very timely manner. The Supreme Court decisions
have acted as a booster shot in the arm to the Code. The success of the Code
can be best summed up by the Supreme Court’s observations in Swiss Ribbons
(supra), “The defaulter’s paradise is lost. in its place, the economy’s
rightful position has been regained.”

shailesh.kwebmaker

IS IT FAIR TO DENY BENEFIT OF TAX DEDUCTED AT SOURCE (TDS) IN ABSENCE OF SUCH TDS IN FORM 26AS

BACKGROUND

Section 199(1) of the Income Tax Act 1961 permits
claim of Tax Deduction at Source (TDS) when such payment is made to credit of
the Central Government. However, instances have come to the notice of several
persons including tax authorities that in spite of the fact that

deductor has deducted tax at source and payment
thereof is not made to the credit of Central Government ( Consequently this
will not reflect in the TDS return of the deductor and as such will not further
reflect in 26AS of the deductee)

deductor has deducted tax at source and payment
thereof made to the credit of Central Government but such deductor has
defaulted in filing TDS Return ( Consequently this will not reflect in 26AS
of the deductee)

PROBLEM

Presently in either of the situations mentioned in
the preceding paragraph, deductee is denied benefit of TDS since in either case
such TDS does not reflect in 26AS of the deductee. With the electronic filing
of Income tax Returns being mandatory in respect of most of the assessees, deductee
( Assessee filing Return of Income) does not get credit of such TDS when return
of Income is processed by CPC . This results in

Either reduction in Refund Claimed in the
Return of Income

or results in a demand when Return was filed claiming
no refund.

UNFAIRNESS

1. Reduction
in the refund claimed or resulting demand, consequent upon non- granting of
credit of TDS (either not paid / return of TDS not filed) is unfair for the
deductee because such demand remains as outstanding demand on the CPC Website
and such demands get adjusted with future refunds due to the assessee
(Deductee).

2. In a
situation where Tax is deducted but not deposited, section 205 of the Income
Tax Act, 1961 comes to the rescue of the deductee. The said section reads as
under :

Head Note of the Section: Bar against direct demand on
assessee.

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

3. If we
paraphrase the above mentioned section, we can note that following ingredients
will emerge namely:

Tax is deductible from the deductee

Such Tax is deducted from the income

Assessee shall not be called upon to pay the
tax himself to the extent of such tax deduction

4. To
reiterate the rights of the Assessee in such situations, CBDT has issued
directions to the field officers vide reference number 275/29/2014-IT-(B) dated
01-06-2015. The relevant extracts are reproduced here:

Grievances have been received by the Board
from many taxpayers that in their cases the deductor has deducted tax at source
from payments made to them in accordance with the provisions of Chapter-XVII of
the Income-tax Act, 1961 (hereafter ‘the Act’) but has failed to deposit the
same into the Government account leading to denial of credit of such deduction
of tax to these taxpayers and consequent raising of demand.

As per section 199 of the Act credit of Tax
Deducted at Source is given to the person only if it is paid to the Central
Government Account. However, as per section 205 of the Act, the assessee shall
not be called upon to pay the tax to the extent the tax has been deducted from
his income where the tax is deductible at source under the provisions of
Chapter- XVII. Thus, the Act puts a bar on direct demand against the assessee
in such cases and the demand on account of tax credit mismatch cannot be
enforced coercively.

5. It
appears that above mentioned instruction was not observed by the field officers
(Reasons well known) and hence CBDT again has issued an office
memorandum on 11-03-2016 (OFFICE MEMORANDUM F.NO.275/29/2014-IT (B), DATED
11-3-2016). Relevant Extracts of the said Memorandum reads as under :

Vide letter of even number dated
1-6-2015, the Board had issued directions to the field officers that in case of
an assessee whose tax has been deducted at source but not deposited to the
Government’s account by the deductor, the deductee assessee shall not be called
upon to pay the demand to the extent tax has been deducted from his income. It
was further specified that section 205 of the Income-tax Act, 1961 puts a bar
on direct demand against the assessee in such cases and the demand on account
of tax credit mismatch in such situations cannot be enforced coercively.

However, instances have come to the notice of
the Board that these directions are not being strictly followed by the field
officers.

In view of the above, the Board hereby reiterates
the instructions contained in its letter dated 1-6-2015 and directs the
assessing officers not to enforce demands created on account of mismatch of
credit due to non-payment of TDS amount to the credit of the Government by the
deductor. These instructions may be brought to the notice of all assessing
officers in your Region for compliance.

CONCLUSION FROM
THE ABOVE

Thus, one will note from the above two
clarifications from CBDT that demand arising out of the situation of Tax
Deducted and not deposited, demand cannot be enforced from the assessee.

However, till date, the issue of TDS
being deducted, not deposited with central government by the deductor and
deductee ( Assessee) claiming such TDS and consequent refund in the return of
Income, is still not addressed by CBDT in spite of the fact that above
instruction/ office memorandum has been released .

SOLUTION

In the light of above, relevant rules should
authorise assessee to

Ask CPC to Block such demand from further
adjustment on the website and for the purpose a specific option be permitted to
be included in case of mismatch of TDS such as “TDS Mismatch since TDS
Deducted but not deposited by the deductor”

Assessee is permitted to send a proof of Tax
Deduction by the deductor (If Available) as a response to outstanding tax (TDS)
demand.

Besides relevant Rules should provide for a
proof of deduction to be submitted to the deductee on a Quarterly basis which
will substantiate a claim of the deductee that TDS is deducted since
entire hypothesis of the section 205 is based on the fact that “Tax is deducted”.
This is essential since deductor is an agent of Income Tax Department and as
such there is a privity between Tax department and the deductor which is
unfortunately lacking between deductor and deductee.

Lastly a deductee may be permitted
to lodge an online query when such deduction is not reflecting as a credit in
26AS against such deductors. A deductee will have to at least obtain a PAN and
TAN of the persons he deals with to lodge such queries.

shailesh.kwebmaker

APPLICABILITY OF MONEY LAUNDERING LAW TO SECURITIES LAWS VIOLATIONS

This was launched in April, 2006 by
Jayant Thakur. The aim of this column was to introduce Securities laws to the
readers. After covering the basics, the aim was changed to cover updates along
with analysis. Selection of topics and analysis is done on the basis of
relevance to accounting and tax aspects.
New laws, court and SAT decisions are covered in this space. Jayant
Thakur says: ”Writing this feature helps and even forces me to read each
development and analyse it for readers, thus adding to my knowledge too.” Well,
reading it gives the same effect too!

APPLICABILITY OF MONEY LAUNDERING LAW TO SECURITIES LAWS VIOLATIONS

There was a recent report in the media that
action against certain persons, who allegedly carried out price manipulation on
stock exchanges, was initiated under money laundering laws. If found guilty,
such persons would face additional and stringent punishment that could actually
be more than the punishment for even the original violation.

This is an eye
opener over how a few forgotten and dormant provisions can be used to levy fairly
serious criminal punishment in connection with violations of Securities Laws.
The parties face at least three years prison, and this is in addition to all
the action of penalty, debarment, prosecution, etc., they may face under
Securities Laws.

What can also be seen is that such action is
possible not just for price manipulation, but even for violation of several
other Securities Laws such as insider trading, takeovers, etc., and also for a
wide variety of corporate frauds under the Companies Act, 2013.

This raises several issues. What are these
provisions in money laundering laws that provide for punishment for such
securities and corporate laws? What type of such securities laws violations and
corporate frauds are covered? What is the additional criteria that makes such a
securities/corporate laws violation into a money laundering laws violation too?
Is it possible that the mere fact of indulging in such a violation will most
certainly result into violation of money laundering law? And thus, effectively,
result in double punishment?

WHAT IS ‘MONEY LAUNDERING’?

Money laundering is often confused with
laundering for tax purpose whereby money on which income-tax has not been paid
(‘black money’) is laundered and brought into books (ie converted into ‘white
money’). Money laundering, as defined and described under the Prevention of
Money Laundering Act, 2001 (“the Act”), is different. It is converting money
earned from certain serious crimes into money shown as earned in other manner.
For example, money earned through selling narcotic substances is shown as
monies earned from, say, sale of steel. The tainted money thus becomes
untainted. This camouflaging constitutes the offence of money laundering.
Interestingly, income-tax may be paid on such earnings. Just the source gets
camouflaged – or rather changed into a different colour. The punishment for such conversion – i.e., money
laundering – could be in the range of least 3 years prison upto 7 or even 10
years. This is apart from fine that may be levied.

WHAT ARE THE ‘CRIMES’ COVERED?

The Act lists certain crimes in respect of
which, the act of disguising the proceeds of such crimes is considered to be
the offence of money laundering. Hence, it is necessary to understand and list
what are such crimes.

Originally, the intention appears to list
only certain serious crimes such as drug dealing, terrorism, arms dealing, etc.
However, over the years, many more crimes have been added. Now the
offences/violations under various laws that are covered are in the hundreds.
Many of such crimes are what are referred to as white-collar crimes. In this
article, we will focus on four of them – insider trading, price
manipulation/fraud in securities markets, takeovers of companies and related
and corporate frauds. As we will see, these categories themselves have multiple
sub-categories.

Insider
trading

This
includes things like dealing in securities on the basis of unpublished price
sensitive information, sharing of such information, etc. The provisions
relating to insider trading are quite broadly defined. These include who are
‘insiders’, what is price sensitive information, what type of transactions or
actions deemed to be insider trading, etc.

Price
manipulation/fraud

Broadly stated, this includes manipulating
price of securities on stock exchanges, indulging in various types of unfair
practices, fraud, etc. These offences are defined generally and to add to that,
a long list of specific items has been listed which are deemed to fall under
this category.

Substantial
Acquisition of Shares and takeovers

The SEBI Takeover Regulations provide for
certain provisions to keep a check on change of control in a company. These are
broadly two. One is acquisition of shares or voting rights beyond a particular
limit without making an open offer. The second is acquiring shares beyond
certain specified limits without making disclosures.

Corporate
frauds

U/s. 447,
recently introduced vide the Companies Act, 2013, several types of acts/omissions
are deemed to be frauds and punishable under that provision quite strictly.
Once again, the main section 447 describes frauds very widely and generally. If
an act or omission falls under this description, it is fraud. However, there
are several other provisions under the Act that deem certain acts/omissions as
frauds u/s. 447.

Others

There are many
other white collar offences listed as specified offences for the purposes of
money laundering. It is possible that in many cases, corporate frauds or
securities related frauds may get covered in such other categories too.
However, this article focuses on the four items listed above.

THE SPECIFIED OFFENCE HAS TO BE PROVED FIRST

The first step has to be to prove the
original offence itself. For example, there has to be an offence of, say, price
manipulation. It is only when this offence is proved that there can be any
question of alleging that there was money laundering.

THERE HAS TO BE PROCEEDS OF SUCH OFFENCES

Money laundering obviously cannot exist without there
being some proceeds of such crime. In case of price manipulation, for example,
the profits made through such dealings is the proceeds of crime.

WHEN AND HOW WOULD SUCH OFFENCES ALSO RESULT IN MONEY LAUNDERING?

The offender may make some earnings from any
of the specified acts. If he shows these earnings as derived from a different
source, he would have committed the offence of money laundering.

PROVING THAT THERE HAS BEEN MONEY LAUNDERING

To determine whether the offence of money laundering has
taken place, a clear link would has to be established between the proceeds of
crime and the earnings/assets that were shown after such disguising.

DIFFICULTIES IN PROVING MONEY LAUNDERING IN CASE OF SECURITIES/ CORPORATE OFFENCES

It
is difficult enough to prove securities/corporate offences but let us say that
is done. The question, however, is how does one prove that (i) such person has
earned money from such offences (ii) he has disguised the proceeds of such
offences?

The difficulties are particularly compounded
in case of securities/corporate offences. In most of such cases, even if the
income is shown without any modification of source, proving money laundering
would be difficult. This is explained by several examples below.

Take a case, however, first of a case where
it may be possible to prove money laundering. Take a case of price manipulation
by the so-called ‘operator’. Such person may indulge in price manipulation in
shares. He enters into false transactions that result in rise of the price of
the shares. He is paid ‘fees’ for carrying out such activity. He records it as
fees for some other ‘consultancy’ or the like. Underlying papers show that he
did receive such fees and that it was disguised as having come from other
legitimate source. The offence of money laundering is thus proved.

However, take an example of a CFO who comes
to know that his employer company is going to declare good financial results.
He buys the shares at a particular price and then, after the news become public
and the price of the shares rise, he sells the shares at a higher price. The
offence of insider trading might be easily proved here. However, how does one
prove the offence of money laundering here? The CFO may have shown the income
as from capital gains in his books of accounts and tax returns. There is no
disguising involved here.

Similar is the case of price manipulation
where profits are made by buying shares at a low price, then indulging in price
manipulation/fraud, and then selling at a high price. Even if the offence of
price manipulation/fraud is proved, the income is still arising from gains on
sale of shares.

Violation of SEBI Takeover Regulations may
also have similar issues.

Then there is a
whole long list of frauds falling generally u/s. 447 and in many of such cases
too, such issues may arise.

WHAT IS THE PUNISHMENT?

The punishment
for money laundering is stringent. Generally stated, the punishment may range
from three years to seven years imprisonment. In effect, it calls for
punishment that is more strict than even the original offence.

CONCLUSION

It is possible
that the recent invoking of money laundering law in such white collar crimes is
to make an example in serious cases. This would create an added disincentive on
such people and also people who help them in disguising their earnings.
However, these white collar offences are large in number and varying in
intensity. In most cases, even the punishment for the original offence is
relatively mild. Often, a token penalty is levied. If the law relating to money
laundering is frequently used, then the consequences would be far more serious.
I submit that the list of offences covered here should be narrowed down only to
serious cases and there should be added conditions to be satisfied to invoke
the provisions relating to money laundering.

shailesh.kwebmaker

SEBI HOLDS AUDITORS LIABLE FOR NEGLIGENCE/ CONNIVANCE IN FRAUD – DEBARS THEM FOR 5 YEARS

BACKGROUND

Auditors have been the focus of several
regulators, each of whom seek independent and wide powers to take action
against them when they perceive that auditors have not discharged their duties
properly. SEBI has taken action against several auditors of listed companies
where SEBI felt that auditors were negligent, did not discharge duties mandated
by law and / or where there is connivance with the management in fraud, etc.

However,
whether and to what extent SEBI has powers to act directly against the
auditors has been controversial. There are several SEBI orders, a report of
consultation committee of SEBI, a detailed decision of the Bombay High Court,
etc., that have differing views. Some of the decisions of SEBI/SAT are under
appeal. SEBI has recently proposed amendments to regulations to prescribe
duties of auditors and the action SEBI can take in the event the prescribed
duties are not discharged. The powers SEBI is seeking may be questioned before
courts particularly on the issue whether the provisions SEBI Act are wide
enough to provide for powers merely by amending the Regulations. Thus, the
coming years will see several developments before a clearer picture emerges.

In the meantime, SEBI has passed yet another
order debarring a firm of auditors for 5 years from carrying out any
certification work for any listed company or any intermediary associated with
the capital markets. In the case of C. V. Pabari & Co., (“the Auditors”)
SEBI has passed order No : WTM/MPB/ISD-FAC/57/2018, dated 31^st
October 2018 relating to audit of Parekh Aluminex Limited. There are several
findings of erroneous accounting and presentation in financial statements, in
addition to diversion of funds, over valuation, etc., and violations of
provisions of the Companies Act.

The Order also debars for 5 years the
Wholetime Executive Director, who was also earlier the Chairman of Audit
Committee. However, this article focuses on the action taken against the
auditors, on the facts and the reasons provided by SEBI for debarring the
auditors for five years.

BROAD BACKGROUND AND SUMMARY OF THE ORDER.

Parekh Aluminex Limited was a company listed
on Bombay stock exchanges. During the period under question (FY 2009-10 to
2010-12), it was alleged that there was wrongful accounting and disclosure in
financial statements, diversion of funds, over valuation of certain assets,
etc. Some time after this period, the main promoter and Chairman/Managing
Director of the Company also passed away. The share price of the Company
plunged from some Rs. 300 to Rs. 10 and the shares were eventually delisted
from the Bombay Stock Exchange.

The Auditors who conducted audit of the
accounts during this period resigned. Other firms of auditors were appointed
who too resigned giving reasons such as non-availability of information. It
appears, however, they did submit some reports. A firm was also appointed to
conduct a forensic audit. Based on the interim forensic audit report and other
preliminary findings, SEBI passed an interim order and also served a show cause
notice to the Whole time Director and the Auditors. They were given a hearing
before passing the final order.

Let us consider some of the major
allegations made, the defenses given by the Auditors and the order of SEBI and
its reasons.

WHETHER SEBI HAS JURISDICTION TO ACT AGAINST THE AUDITORS?

An oft made defense by the auditors is that
SEBI does not have any jurisdiction to act against them in respect of their
services to a listed company. However, SEBI rightly cited the decision of the
Bombay High Court in case of Price Waterhouse & Co. vs. SEBI ((2010) 103
SCL 96 (Bom.)). The Court had held, under certain circumstances
particularly where it can be held that the auditors had connived with the
management in fraud, SEBI could take action against the auditors.

However, interestingly, SEBI observed that
even if the financial statements have not been drawn up in accordance with the
mandated accounting standards, SEBI could act against the auditors. It
observed, “…if the financial statements have been drawn up without following
the norms and standards of accounting, SEBI has jurisdiction to take regulatory
measures for protecting the investors interest by taking appropriate steps
against the Auditor.”. I submit that this view is not supported by the
decision of the Bombay High Court.

ALLEGATION – LOANS / ADVANCES WERE NETTED OFF AGAINST BORROWINGS

It was alleged that loans/advances given to
several persons were adjusted against bank loans in the financial statements.
This resulted in loans given and borrowings both being shown lower by more than
Rs. 1000 crores.

SEBI sought explanation from the Auditors as
to why such a disclosure was made and whether this was in consonance with
applicable accounting standards.

The answer of the Auditors was that the
adjustment and disclosure was made in the financial statements presented to the
Audit Committee and the Board and the final statements were approved by both
without any objections. The Auditor also pointed out that independent audits
were conducted by banks who had not objected to this adjustment. Further, the
banks extended additional loans. It appears, however, they could not provide
any explanation regarding compliance with accounting standards.

SEBI rejected the explanations. It stated
that auditors were expected to conduct an independent audit and could not rely
merely on approvals by Audit Committee/Board and ‘rubber stamp’ the accounts.
SEBI, reiterated that the Auditors could also not rely on bank audits as they
are mandated to conduct audit independent of other agencies. Further Auditors
failure to explain how such a practice was in compliance with accounting
standards was also noted.

DIVERSION OF FUNDS TO NON- CORE ACTIVITIES

The next allegation was that funds of the
company were diverted for non-core activities. It has been alleged that loans
and advances were given for the purposes of real estate which “…is a non-core
activity of the company”. Similarly, it was alleged that “…the company had
transferred money to companies trading in bullion which is diversion of fund as
the company is engaged in the manufacture of aluminum foil related products.”
Other similar diversion of funds was also alleged. In view of this, SEBI
concluded :

u that the company has
misrepresented its business operations to its shareholders and to the public in
general.”.

u that PAL has misstated its
accounts in respect of set off of such loans/advances and “diversion” of funds.
?

OBSERVATIONS OF SEBI ON ROLE OF AUDITORS

While dealing with the defenses offered by
the auditors and generally examining what had happened in the present case,
SEBI made several observations on role of auditors and what acts or omissions
can be held to be actionable:

(a) Auditors are experts in the field of accounts
and finance and should rely on their own expertise and judgment instead of
relying on and accepting accounting treatment by the management. Else, the
whole purpose of certification by them is defeated.

(b) The auditors could not present a due paper
trail for the work they claim to have done in respect of verifying the loan
documents. Hence, their defense on this aspect was rejected.

(c) Auditors should not merely be “rubber
stamping the accounts” and in doing this failed to follow the “minimum
standards of diligence and care as expected of a statutory auditor”.
Auditors thus showed “lack of professional skepticism in auditing the accounts
of the company”.

(d) Considering that in case of listed companies,
public at large, financial institutions (government and private), etc., rely on
report of auditors, “..the duty and obligation of being absolutely diligent
is multiplied manifold and the auditor cannot take such an obligation
casually”.

(e) The investing public relies on the financial
results to make informed decisions. False accounts have direct impact on
securities markets.

(f) Such alleged large-scale falsification,
following dubious accounting practices for manipulating financial results,
etc., could not happen without “…its statutory Auditor being part of the
manipulative and deceptive device. Even otherwise, by making representations in
a reckless and careless manner whether it is true or false, tantamount to
fraud”. ?

Making such observations, SEBI held that
there have been violations of the provisions of the Act and the Regulations
relating to fraud, manipulation etc., and accordingly gave various directions
as mentioned earlier against the auditors.

CONCLUSION AND WAY FORWARD

This is just one of several orders passed
against auditors for their alleged participation or connivance in fraud. Most
of the cases are about fraud, the observations and basis for passing of orders
vary and cover a wide area. It needs to be noted that where the auditors have
participated in or ignored fraud/falsification, the provisions in the SEBI
Act/Regulations relating to fraud would get attracted. This area is sought to
be extended to cover cases of negligence, failure to follow accounting
standards, or proper procedures of audit, and lack of professional skepticism.

The proposed Regulations by SEBI seeking to
prescribe extend the duties of auditors (and other specified professionals)
discussed earlier will thus need closer attention. These proposed amendments
require auditors to observe the proposed prescribed duties while rendering
services to listed companies and other specified entities associated with the
capital markets. Failure to do so would result in adverse action against them
by SEBI. Thus, SEBI would be able to, if these proposed amendments are made
law, take action against auditors even under situations even where there is no
fraud but there is lack of care, diligence, etc. The issue is : should auditors
face proceedings before multiple regulators and be subject to multiple and
overlapping consequences. It is time that a holistic assessment of the whole
issue is made and action against the auditors is through a single regulator,
under clear pre-defined and rational guidelines.

shailesh.kwebmaker

WE CHOOSE

‘Choice, not chance determines your destiny’

Aristotle

These words
mean a lot. There is substance in these words and the substance is Commitment.
We must reckon that choice and challenge are twins more like Siamese
twins not capable of being separated.

Every choice
comes with an opportunity and appended risks. Hence, every choice is a risk.
There is no success unless we choose. However, action based on choice backed by
commitment and effort achieves success, for example : Tilak and Gandhi’s call
for Swaraj backed by commitment and effort gave us Independence and John
Kennedy’s call to get man to moon in 1962 was not mere words or rhetoric but
was backed by national resources and national effort.

Let us consider
a few instances of choice :

As a nation we chose independence. We chose
partition. We chose secularism and then we chose Mandal which has led to the
division of society – instead of having a cohesive outlook we have divided
ourselves by caste, colour and creed. Ironically, this is not what the framers
of our Constitution and seekers of independence dreamt of. Their aim was to
create a cohesive society – whereas today we have a fractured society.
The present state is the result of what our leaders chose. Virtually every
section of society is seeking reservation for government jobs and educational
opportunities. There are protests; quite a few are violent which damage public
property. The issue is : can society choose to accept violence!

One’s choice to have harmony in a family is
to choose to sublimate individual ambition for achieving progress and happiness
of the family.

Business and organisation though based on an
individual’s (CEO or owners) vision is created through team work hence the
visionary chooses to create an institution which is guided by the visionary but
is not individual centred.

Prime Minister Modi’s vision of India based
on ?Sabka Saath Sabka Vikas’ is based on the choice of co-operation with
dissenting political parties.

One’s choice to become a chartered accountant
was based on one’s commitment to hard work, go through a period of training and
pass one of the toughest exams.

We chose to be chartered accountants because
we choose to serve stakeholders and provide the stakeholders with true and fair
financial statements. We have chosen to accept a social responsibility.

There are
choices we make in every aspect of our life. Every decision in our life is a
choice. The issue is : what is the base of our choice. In my view choice
should be based on discrimination, detachment and discussion. Decision based on
emotion can be wrong but decisions based on the three Ds are rational
and yield the desired results. Discussion could be with yourself, your mentor,
friend, relative or your team. I believe before discussing with others
discussion with one’s oneself or one’s own self is very relevant.

The issue is
: can we live – nay
exist without choice – I perceive that two times an individual does not have a
choice – is the time of birth and death. Choice is an integral part of our
existence. Metaphorically speaking it is rightly said : one can choose friends
but has no choice as to parents and siblings. It is one’s choice to enjoy them
or suffer them. Further, one has the choice of learning from one’s mistakes
rather than crib and wail over them. Above all one has the choice of
complaining and being dissatisfied or accepting the environment and being
satisfied and happy.

I would
conclude by quoting Byron Grant,

‘Being a man or woman is a matter
of birth.

Being a man or woman who makes a
difference

is a matter of choice‘

In short, it is only a happy person who can make a
difference.

shailesh.kwebmaker

FAMILY SETTLEMENTS – PART I

INTRODUCTION

Maximum disputes
take place within family members rather than among strangers! Family fights have been popular in India right from the times of
“the Mahabharata”. The fight between the Kauravas and the Pandavas is something
which several Indian families witness on a regular basis. As family businesses
grow, new generations join the business, new lines of thinking originate,
disputes originate between family members and gradually it gives rise to a
family settlement / arrangement.

Corporate India has
witnessed a spate of family feuds in almost all major corporate houses. A family arrangement is one of the oldest
alternative dispute resolution mechanisms which is known. The scope of a family
arrangement is extremely wide and is recognised even in ancient English Law.
This is because the world over, Courts lean in favour of peace and amity within
the family rather than family disputes.
In the last about 60 years, a good part of the law relating to Family
Arrangement / Settlement is well settled through numerous court decisions
including several decisions of the Supreme Court. It is ironic that in a
country where a substantial part of businesses are run and owned by joint
families, there is no legislation which governs or regulates such family
settlements or arrangements. Hence, the entire law in this respect is case-law
made.

WHAT IS A FAMILY SETTLEMENT / ARRANGEMENT?

It is important to
analyse the basic principles governing family settlement involving properties
held mainly by individuals. Various Courts, including the Supreme Court of
India, have laid down the basic principles relating to family arrangements. Halsbury’s
Laws of England also lays down some important principles in this respect:

“The agreement
may be implied from a long course of dealing, but it is more usual to embody or
to effectuate the agreement in a deed to which the term “family
arrangement” is applied. Family arrangements are governed by principles
which are not applicable to dealings between strangers.

When deciding
the rights of parties under a family arrangement or a claim to upset such an
arrangement the court considers what in the broadest view of the matter is most
in the interest of the family, and has regard to considerations which, in
dealing with transactions between persons not members of the same family, would
not be taken into account. Matters which would be fatal to the validity of
similar transactions between strangers are not objections to the binding effect
of family arrangements. …………”

CONCEPTS AND PRINCIPLES OF FAMILY ARRANGEMENTS / SETTLEMENT

From the analysis
of the numerous judgments, such as Maturi Pullaiah vs. Maturi Narasimham,
AIR 1966 SC 1836; Sahu Madho Das vs. Mukand Ram, AIR 1955 SC 481; Kale vs. Dy.
Director of Consolidation, (1976) AIR SC, 807; Hiran Bibi vs. Sohan Bibi, AIR
1914 PC 44; Hari Shankar Singhania vs. Gaur Hari Singhania (2006) 4 SCC 658,
etc., the concepts and principles of family arrangement are summarised
below :

(a) A
family arrangement is an agreement between members of the same family intended
to be generally and reasonably for the benefit of the family either by
compromising doubtful or disputed rights or by preserving the family property
or the peace and security of the family by avoiding litigation or by saving its
honour.

(b) If the arrangement of compromise is one
under which a person, having an absolute title to the property, transfers his
title in some of the items thereof to the others, the formalities presented by
law have to be complied with since, the transferees derive their respective
title through the transferor. If, on the other hand, the parties set up
competing titles and differences are resolved by the compromise, there is no
question of one deriving title from the other and, therefore, the arrangement
does not fall within the mischief of section 17 read with section 49 of the
Registration Act, as no interest in property is created or declared by the
document for the first time. It is assumed that the title had always resided in
him or her, so far as the property falling to his or her share is concerned,
and therefore, no conveyance is necessary.

(c) A
compromise or family arrangement is based on the assumption that there is an
antecedent title of some sort in the parties and the agreement acknowledges and
defines what that title is, each party relinquishing all claims to property
other than that falling to his share and recognising the right of the others,
as they had previously asserted it, to the portions allotted to them
respectively. That explains why no conveyance is required in these cases to
pass the title from one in whom it resides to the person receiving it under the
family arrangement. It is assumed that the title claimed by the person
receiving the property under the arrangement had always resided in him or her
so far as the property falling to his or her share is concerned and therefore
no conveyance is necessary.

It does not mean
that some title must exist as a fact in the persons entering into a family
arrangement. It simply means that it is to be assumed that the parties to the
arrangement had an antecedent title of some sort and that the agreement
clinches and defines what that title is.

(d) A compromise by way of family settlement is
in no sense an alienation by a limited owner of family property. Once it is
held that the transaction being a family settlement is not an alienation, it
cannot amount to the creation of an interest. For, in a family settlement each
party takes a share in the property by virtue of the independent title which is
admitted to that extent by the other parties.

(e) In the usual type of family arrangement,
unless any item of property which is admitted by all the parties to belong to
one of them is allotted to another, there is no ‘exchange’ or other transfer of
ownership.

(f) By virtue of a family settlement or
arrangement members of a family descending from a common ancestor or a near
relation seek to sink their differences and disputes, settle and resolve their
conflicting claims or disputed titles once for all in order to buy peace of
mind and bring about complete harmony and goodwill in the family. Family
arrangements are governed by a special equity peculiar to themselves, and will
be enforced if honestly made.

The object of the
arrangement is to protect the family from long-drawn out litigations or perpetual strifes which mar
the unity and solidarity of the family and create hatred and bad blood between
the various members of the family.

A family settlement
is a pious arrangement by all those who are concerned. A family settlement is
not within the exclusive purview of Hindus, but applies equally to various
other communities also, such as Parsis, Christians, Muslims, etc.

(g) The term “family” has to be
understood in a wider sense so as to include within its fold not only close
relations or legal heirs but even those persons who may have some sort of
antecedent title, a semblance of a claim.

It is not necessary
that the parties to the compromise should all belong to one family. The word
‘family’ in the context of a family arrangement is not to be understood in a narrow
sense of being a group or a group of persons who are recognised in law as
having a right of succession or having a claim to a share in the property in
dispute. If the dispute which is settled is one between near relations then the
settlement of such a dispute can be considered as a family arrangement.

Even illegitimate
and adopted children would be covered within the broader definition of the term
“family”. Thus, a settlement arrived at in relation to a dispute between
legitimate and illegitimate children would also be covered within the ambit of
a family settlement. Children yet to be born may also be covered.

(h) Courts have made every attempt to sustain a
family arrangement rather than to avoid it, having regard to the broadest
considerations of family peace and security. It is not necessary that every
party taking benefit under a family settlement must necessarily be shown to
have, under the law, a claim to a share in the property. All that is necessary
is that the parties must be related to one another in some way and have a
possible claim to the property or a claim or even a semblance of a claim on
some other ground as, say, affection.

(i) The said settlement must be voluntary and
should not be induced by fraud, coercion or undue influence.

(j) The family settlement must be a bona
fide one so as to resolve family disputes and rival claims by a fair and
equitable division or allotment of properties between the various members of
the family. The bona fides and propriety of a family arrangement have to
be judged by the circumstances prevailing at the time when such settlement was
made.

(k) Even if bona fide disputes, present
or possible, which may not involve legal claims are settled by a bona fide
family arrangement which is fair and equitable the family arrangement is final
and binding on the parties to the settlement.

(l) It
is not necessary that there must exist a dispute, actual or possible in the
future, in respect of each and every item of property and amongst all members
arrayed one against the other. It would be sufficient if it is shown that there
were actual or possible claims and counter-claims by parties in settlement
whereof the arrangement as a whole had been arrived at, thereby acknowledging
title in one to whom a particular property falls on the assumption (not actual
existence in law) that he had an anterior title therein.

(m) The consideration for such a settlement, if
one may put it that way, is the expectation that such a settlement will result
in establishing or ensuring amity and goodwill amongst persons bearing
relationship with one another.

(n) The family arrangement may be even oral.

(o) A family arrangement might be such as the
Court would uphold although there were no rights in dispute, and if sufficient
motive for the arrangement was proved, the Court would not consider the
adequacy of consideration.

(p) If in the interest of the family properties
or family peace the close relations settle their disputes amicably, the Court
will be reluctant to disturb the same. The Courts lean strongly in favour of
family arrangements that bring about harmony in a family and do justice to its
various members and avoid, in anticipation, future disputes which might ruin
them all.

(q) The essence of a family arrangement is an
agreement on some areas of dispute by the family members. The agreement is for
the benefit of all the members. The ultimate aim of the agreement is to
preserve amity and goodwill within the family and avoid bad blood. However,
every document cannot be styled as a family arrangement. For example, if the
patriarch of a family makes a will under which he divides his personal shares
in various businesses and family properties among his family members, then the
same cannot be called a family arrangement as it is merely a distribution of
the deceased’s estate as per his will. One of the key requirements for a family
arrangement is the existence of a dispute or a possible dispute. Under a will,
there is no consideration for the acceptance of arrangement.

(r) A family settlement is different from an
HUF partition. While an HUF partition must involve a joint Hindu family which
has been partitioned in accordance with the Hindu Law, a family arrangement is
a dispute resolution mechanism involving personal property of the members of a
family who are parties to the arrangement. A partition does not require the
existence of disputes which is the substratum for a valid family arrangement.
An HUF partition must always be a full partition unlike in a family settlement.

(s) The question of whether a Muslim family can
undergo a family settlement has been the subject matter of various judicial
decisions. All of these have upheld the validity of the same.

(t) If one of the family members voluntarily
gives up his share in the joint family property, i.e., he styles a gift deed as
a deed of family settlement, then it is not a case of a valid family
arrangement. Any settlement which does not envisage a dispute cannot be a
settlement.

(u) If the terms of the settlement are clear and
unambiguous and are not impossible to perform, then the plea of practical
inconvenience cannot be raised at the stage of implementation. That factor must
be considered at the stage of entering into the settlement and not later.

(v) Principles governing a family settlement are
different from commercial settlement. These are governed by a special equity
principle where the terms are fair and bona fide taking into
consideration the well-being of the family. Technical considerations like the
law of limitation should give way to peace and harmony in the enforcement of
settlements. The duty of the court is that such an arrangement and the terms
should be given effect to in letter and spirit.

(w) Consideration is one of the important
aspects of any contract. Under the Indian Contract Act, any contract without
consideration is null and void. In the case of a family settlement, the
consideration is the giving up of mutual claims and rights and love and
affection. In India, the Courts do not enquire into the adequacy of consideration
as in the case of USA.

EXAMPLES OF A VALID / INVALID FAMILY SETTLEMENT.

(a) A father has started a
business in which he is later on joined by his two sons. All the assets and
business interests are jointly owned by the family. After several years,
disputes arise between the two sons as to who is in command and who owns which
property. This leads to a lot of bad blood and ill-will within the family. In
order to buy peace and avoid unnecessary litigation, the father, the two sons
and their families effectuate a family settlement under which all the
businesses and properties are equally divided between the two brothers’
families. This is a valid family settlement and would be recognised in a court
of law.

(b) A father and son are joint in business. The
son has played an active role in the business and in creating the wealth. After
many years, the two develop a bitter dispute over various issues with the
result that the son wants to opt out of the business. The son gives up all his
rights and interest in the family properties and in return for the same the
father pays him some money. This is a valid family settlement.

(c) A family settlement is purported to have
been executed by all the family members of a particular family. However, the married
daughter has not signed the family settlement MOU. In such a case, it cannot be
said that the family settlement would bind the daughter – Sneh Gupta vs.
Devi Sawarup(2009) 6 SCC 194.

WHAT PROPERTIES CAN BE COVERED?

From the various
principles laid down regarding valid family arrangements, it is clear that
valid family arrangements can relate to self-acquired properties, or other
properties of the family. It is neither a pre-requisite nor even a necessary
condition that a valid family arrangement must relate to ancestral property
only. An analysis of the various Case Laws, such as, H. H. Vijayaba,
Dowager Maharani Saheb, 117 ITR, 784 (SC); Narayandas Gattani, 138 ITR 670
(Bom); Ziauddin Ahmed, 102 ITR 253 (Gau); Shanti Chandran, 241 ITR 371 (Mad),
etc., reveals that even where the property involved in the family settlement
was other than an ancestral property, and the family arrangements were held to
be valid:

(a) The property involved was that of the
relatives of the partners of a firm, which firm had mounting creditors. These relatives conveyed their properties for
the benefit of the creditors of the firm to discharge debts incurred by the
firm. It was held that the conveyance amounted to a valid family arrangement
and hence was not exigible to gift tax.

(b) An oral family arrangement, made by father,
during his lifetime, under which he directed a larger share to one son out of
his self-acquired non-ancestral property was held to be a valid family
arrangement.

(c) The property involved was certain joint
family land. Major part of the property
was apportioned to the sons of the Karta. It was held that the transaction was
a family settlement.

(d) Payments promised under a family arrangement
to be made to the assessee’s son out of the assessee’s private property, was
held to be a valid family arrangement.

(to be continued…..)

shailesh.kwebmaker

GLOBAL TAX DEVELOPMENTS – AN UPDATE

In recent years,
there has been a flurry of developments in the International Taxation field in
the arena of taxation of Digital Economy, Preventing Base Erosion & Profit
Shifting (BEPS), particularly after publication of BEPS Reports in October 2015
and signature of Multilateral Instruments by various Tax Jurisdictions.
Investigations are being conducted by various affected Tax Jurisdictions
particularly into tax evasion and tax avoidance through the use of Offshore UK
Jurisdictions and other Tax Havens. In this issue, we have attempted to capture
such major developments of particular interest to Indian Tax payers and their
tax Advisors.

1. GOOGLE, APPLE, FACEBOOK AND AMAZON (GAFA) TAX- FRANCE’S NEW DIGITAL TAX ON TECH GIANTS

The French
government’s GAFA tax is being introduced to combat attempts by the firms to
avoid paying what is considered a “fair share” of taxes in the
country, by taking advantage of European tax laws.

With efforts to
reform a European Union (EU) tax law not bringing the desired results, France
is going to introduce from 1^stJanuary 2019 a digital tax on
technology giants such as Google, Facebook, Apple and Amazon. The new tax
regime is expected to bring in an estimated 500 million euro ($570 million) to
the country’s coffers for 2019. Major technology companies have come under the
scrutiny of lawmakers in countries like France and Britain for allegedly
routing profits through operations in countries with extremely low tax rates or
other arrangements. Earlier this year, the European Commission published
proposals for a three per cent tax on the revenues of major tech companies with
global revenues above 750 million euro a year and taxable EU revenue above 50
million euro.

But to become law, EU tax reforms need the support of all member states. And
some countries, including Ireland, the Czech Republic, Sweden and Finland are
yet to come on board to bring the reforms.

2. EU’S EXPANDED TAX HAVEN BLACKLIST COULD APPLY TO US.

2.1 Black List

The European Union
plans to update its year-old blacklist of tax havens to include new criteria
and an expanded geographic reach—possibly all the way to the U.S. The bloc has
previously threatened that the U.S. could end up on the blacklist, along with
the likes of Guam and Trinidad and Tobago, unless it adopts stricter financial
reporting standards and agrees to share that information with other tax
authorities.

The 2019 blacklist
of tax havens will include those that haven’t adopted the Organisation for
Economic Cooperation and Development’s Common Reporting Standard, like the U.S.
The standard calls on countries to obtain information from their financial
institutions and automatically exchange it with other countries every year.

The EU’s goal is to
flag jurisdictions that have failed to make sufficient commitments to
increasing tax transparency and reducing preferential tax measures. Its overall
goal is to eliminate tax avoidance and fraud. Countries on the blacklist could
face sanctions—measures the EU has discussed include imposing withholding taxes
on any funds moved from the EU to a country on the list.

What started out as
a list of 17 countries in December 2017 is down to six. Besides the U.S. Virgin
Islands, the others, including Samoa, American Samoa, Guam and Trinidad and
Tobago have insignificant financial centers.

The new criteria
for the blacklist adopted for 2019 will require countries to apply the OECD’s
base erosion and profit shifting minimum standard—requiring companies with a
$750 million global turnover to report country-by-country tax and profits to
national tax authorities. The EU is also negotiating new rules to require
countries or independent territories to apply transparency standards to publish
the beneficial owners of companies. Most EU officials, tax experts and advocacy
groups expect 2019 to be crucial because the bloc must decide how to deal with
the U.S. There were several other tension points between the EU and the U.S. in
2018. The bloc accused the U.S. of violating trade rules through some of its
international tax reform provisions, and the U.S. opposed the bloc’s proposal
to tax digital companies.

Some EU politicians
and tax advocacy groups insist that the EU gets either a failing grade or an
“I” for incomplete in its tax haven blacklisting process. For others, the first
year of the EU tax haven process has made a mark as part of an overall trend
away from the use of offshore financing centers in places like the Channel
Islands or the Caribbean. There is a general pressure on companies using
offshore financial centers, driven by politics, popular media and multinational
organisations such as the OECD.

So far, the process
has been an overall failure because the process has been unfair or
inconsistent. When there are tax havens within the EU and they are not on the
list it makes, it hard to go after others outside the EU.

The EU Code of
Conduct Group for Business Taxation, made up of officials from EU member
nations, has the final say on which countries end up on the EU list. It
excludes members of the European Parliament. There is a situation where the
United States does not meet the transparency criteria but the EU member states
have decided to ignore that. This goes to show that the process is political.

2.2 Grey list

Although the
current EU tax haven blacklist only contains six countries and jurisdictions,
the EU member states agreed a year ago to establish a grey list. This is a
roster of countries, which include more than 50 countries, that currently don’t
comply with EU transparency and fair corporation criteria but made commitments
to do so by the end of 2018. EU member nations are due to decide by March 2019
whether the gray list countries have either met their commitments or should be
placed on the blacklist.

The gray list has
been positive in pushing countries to reform harmful tax practices and has for
the first time addressed the issue of zero tax regimes. Indeed one of the most
critical issues the EU must decide in the coming months is whether countries or
jurisdictions with zero corporate tax rates have substantial “economic
substance” on the ground to justify the multinational corporations using their
territory as a headquarters. The goal is to clamp down on letterbox companies.

2.3 Economic
Substance Requirements

The EU is
succeeding in the Channel Islands and in other territories as of 1^stJanuary
2019. Guernsey and Jersey are introducing substance requirements for tax
resident companies carrying out relevant activities.

The Cayman Islands,
one of the world’s largest offshore centers for fund management, is another
territory on the EU gray list. It has also recently adopted “economic substance”
requirements for any company that uses its territory for its headquarters.

2.4 The Isle of Man (IOM)

The IOM Parliament
has approved tax legislation that will allow the jurisdiction to avoid being
put on the European Union’s blacklist. This means that from January 2019,
companies engaging in “relevant activities” will have to demonstrate
that they meet specific substance requirements, to avoid sanctions.

Its focus will be
on business sectors identified by the EU including banking, insurance, shipping,
fund management, finance and leasing, headquartering, holding companies,
distribution and service centres and intangible property.

This Order follows
a comprehensive review that was carried out by the EU Code of Conduct Group on
Business Taxation (COCG) in order to assess over 90 jurisdictions, including
the IOM against standards of tax transparency, fair taxation and compliance
with anti-BEPS Reports.

The review process
took place in 2017 and although the COCG were satisfied that the IOM met the standards
for tax transparency and compliance with anti-BEPS measures, the COCG raised
concerns that the IOM, and other Crown Dependencies did not have “a legal
substance requirement for entities doing business in or through the
jurisdiction.”

The IOM is currently
on the EU’s greylist of jurisdictions that have committed to undertake specific
reforms to their tax practices before the end of the year. Without this Order
it would have been placed on a blacklist and faced sanctions as well as
reputational damage.

The legislation
will require companies that are tax resident in the IOM and which operate in
these business sectors to demonstrate a minimum level of substance here.
Substance requirements are set out in the legislation and some of the
requirements vary according to the business sector.

2.5 Economic Substance Legislation in Jersey

Jersey has tabled
new laws to address the EU’s concerns over ‘economic substance’, the degree of
real business activity carried out by companies registered in the Island.

The new proposed requirements for an economic substance test for Jersey
tax-resident entities have been published and are set to come into force on 1^stJanuary 2019 subject to States approval. The reforms include establish
new tests for certain tax resident companies carrying on “relevant activities”
in respect of demonstrating that they are “directed and managed” in Jersey, and
that their “core income generating activities” are undertaken here.

Last year the
Island avoided being placed on a new ‘blacklist’ of non-cooperative
jurisdictions drawn up by the EU Code of Conduct Group on business taxation,
but was among more than 40 regimes asked to reform their tax structures to
ensure compliance with standards, which was dubbed a ‘grey-list’ by some
commentators.

The EU wants Jersey
to show it has economic substance by ensuring the taxes it collects within the
financial services sector were generated through real economic activity in the
territory. In other words, proof that an offshore company is paying taxes in
Jersey because it largely does its work and earns its profits in/from Jersey.

The EU list, first
published in December 2017, was divided into three sections: i) cooperative
jurisdictions ii) non-cooperative jurisdictions and iii) jurisdictions that had
undertaken to modify their tax regimes to comply with the rules set by COCG.

Many of these ‘grey-listed’ jurisdictions operate tax transparency
regimes that are at least as good as the white-listed ‘cooperative’
jurisdictions, but fell foul of the COCG’s additional criterion that businesses
should only be granted tax residence in a jurisdiction once they demonstrate
they have adequate economic substance there.

The blacklist is to
be revised at the end of this year, and grey-listed jurisdictions such as Jersey
are at risk of being moved onto it if they do not act soon. Jurisdictions which
are blacklisted could face sanctions and risk reputational damage.

The other Crown
Dependencies, Guernsey and the Isle of Man, were also consulted and are due to
table similar draft laws soon. Affected companies should review outsourcing
arrangements (where relevant) in respect of Jersey tax-resident companies that
fall within the scope of the new law and whether the third-party service
provider agreements in place meet the tests set out therein.

3. OFFSHORE UK JURISDICTIONS REACT TO LATEST TAX AVOIDANCE INQUIRY

Officials from
Britain’s overseas territories and Crown Dependencies said they were prepared
to cooperate with the latest UK government investigation into tax evasion and
avoidance, but some expressed surprise that it was felt necessary. They pointed
to a raft of new regulations, including the Common Reporting Standard – an
automatic information exchange regime currently coming into force globally –
new and pending additional rules on beneficial ownership registers, and the
UK’s Retail Distribution Review, which they argue have transformed the
so-called offshore financial services industry over the last few years.

The UK Parliament’s
Treasury Sub-Committee has announced a “Tax Avoidance and Evasion inquiry” into
“what progress has been made in reducing the amount of tax lost to avoidance
and offshore evasion”, and whether HM Revenue & Customs (HMRC) currently
“has the resources, skills and powers needed to bring about real change in the
behaviour of tax dodgers, and those who profit by helping them”.

In his piece for The Guardian, John Mann, a Labour Party MP who
is Chairman of the Sub Committee overseeing it, noted that the British Virgin
Islands, Jersey, Guernsey, the Isle of Man, Bermuda and the Cayman “are on the
EU greylist of uncooperative tax jurisdictions”, and added: “We should regard
it as a matter of national shame that the crown dependencies and overseas
territories that fly our flag give shelter to the wealth of the world’s
financial elite.”

In a document
posted on Parliament’s website, the Sub-Committee investigating the tax haven
matters invites comment on six questions as follows:

i) To what extent has there been a shift in
tax avoidance and offshore evasion since 2010? Have HMRC efforts to reduce
avoidance and evasion been successful?

ii) Is HMRC adequately resourced and
sufficiently skilled to identify, challenge and counteract existing and new
avoidance schemes and ways of evading tax? What progress has it made since 2010
in promoting compliance in this area and preventing and responding to
non-compliance?

iii) What types of avoidance and evasion have
been stopped, and where do threats to the UK tax base remain?

iv) What part do the UK’s Crown Dependencies and
Overseas Territories play in the avoidance or evasion of tax? What more needs
to be done to address their use in tax avoidance or tax evasion?

v) How has the tax profession responded to
concerns about its role in aiding tax avoidance and evasion?

vi) Where does it [the tax profession] see the
boundary between acceptable and unacceptable practice lie?

3.1 Guernsey

The States of Guernsey’s
Policy & Resources Committee, noted in a statement that the EU Council of
Finance Ministers (ECOFIN) had reaffirmed that Guernsey “was a cooperative
jurisdiction in respect of taxation, following a screening against principles
of tax transparency, fair taxation and anti-base erosion and profit shifting”
and that it had also formally “committed to the OECD anti-BEPS initiative, and
in 2017 signed the multilateral convention”.

Guernsey had
committed to address certain outstanding ECOFIN concerns relating to “economic
substance requirements in respect of the analysis of fair taxation” this year,
but the OECD’s Global Forum had assessed the jurisdiction’s tax transparency
standards generally, and found them to “exceed the required standard”, the statement
added.

It is also claimed
that Guernsey also meets international standards in respect of the sharing of
beneficial ownership information…and in 2017 went further by establishing a
register of beneficial ownership and putting in place arrangements to share
this information with UK law enforcement authorities.

3.2 Jersey – No safe harbour for rogue operators

A spokesperson for
the States of Jersey said: “Jersey is not a safe harbour for rogue operators.
We run a professional, well-regulated international finance centre that expects
companies using our services to pay the tax that is due in the jurisdictions
where it is owed. Jersey does not want abusive tax avoidance schemes operating
in the island. Jersey is not on the EU Code Group’s blacklist, and was
confirmed as a cooperative jurisdiction. The Code Group is now working with the
island, to ensure that this position is maintained.

The government of
Jersey regularly engages with parliamentarians from across the House [of
Commons], including the Treasury Sub-Committee. We are happy to provide
information to the Sub-Committee on the island’s robust financial regulation
and cooperation with HMRC and the European Union.

3.3 British Virgin Islands (BVI) sets out measures
to counter EU tax ‘greylist’ concerns

BVI has outlined
its action plan detailing key steps the jurisdiction pledges to undertake in
order to allay EU concerns of harmful tax competition with the bloc. In the
EU’s assessment, a range of factors were taken into account including tax
transparency, fair taxation and a commitment to combat BEPS.

Any jurisdiction
judged by EU to be deficient within one or more of these areas is placed on
either a blacklist or an intermediary “greylist”. The EU classifies the
greylist as being for those countries where there is one area where concerns
remain but a commitment to address it has clearly been set out.

The BVI said that
it now meets its requirements relating to tax transparency and those in
relation to BEPS. However, the area which the EU has highlighted for the BVI is
referred to as “economic substance”, in other words the existence of a tax
regime without any real economic activity underpinning it.

The UK Overseas
Territories with financial centres, as well as Crown Dependencies, have all
been advised that they need to address this issue. The Premier is leading a
team to chart a way forward, and has committed to pass appropriate legislation
ahead of the December 2018 deadline set by the EU.

4. UNITED STATES – NEW BASE EROSION ANTI-ABUSE TAX (BEAT) REGULATIONS

US IRS and Treasury
officials on 14^th December 2018 discussed the proposed Base Erosion
Anti-Abuse Tax (BEAT) regulations at a Washington DC tax conference, explaining
the reasoning behind many positions taken by the government in the regulations.

A literal reading of the statutory language of the BEAT would result in
many payments that Congress intended to be base erosion payments to fall
outside the statute. To make the statute work as intended, the government
decided that, for purposes of defining applicable taxpayers, the regulations
should provide that the aggregate group is limited to domestic corporations
plus all foreign related parties that are subject to US net
basis tax.

4.1 Effectively Connected Income (eci) exception

Consistent with
this new aggregate group concept, the regulations add an exception to the
definition of a base erosion payment for amounts paid or accrued to a foreign
related party that are treated as ECI.

Kevin Nichols, Senior Counsel, (ITC) at the US Department of Treasury
said that, “When we define the aggregate group, we sort of draw a box around
all the US corporations as well as the foreign entities to the extent they are
subject to net US taxation. So, those transactions are all disregarded for
purposes of determining the base erosion percentage and determining if you are
an applicable taxpayer. And, once you are an applicable taxpayer, then that
same payment would technically meet the definition of a base erosion payment.
In order to create symmetry between the aggregate group concept and what a base
erosion payment is we linked those two so that there is this exception . . .
which says that payments subject to net taxation are an exception from the base
erosion payment definition”.

4.2 Non-cash payments, reorganisations, cost
sharing

The regulations make it clear that base erosion payments
do not need to be made in cash and can occur in the context of a tax-favoured
transaction. There is no logical basis to exclude non-cash consideration,
including payments of stock, from the defintion of base erosion payments or to
exclude a situation where the delivery of the noncash consideration is in
connection with a transaction that has special status under the code, such as a
reorganisation or a section 351 transaction. This rule, coupled with the Global
Intangible Low Taxed Income (GILTI) regulations, will make it more difficult
for taxpayers to move intellectual property from lower tax structures to the US
or to other jurisdictions. Base eroding payments from US participants to a
foreign related party can also be made in the context of a cost-sharing
arrangement.

4.3 Services Cost Method Mark-Up Exception

The proposed
regulations take the position that if you meet all the requirements of the
services cost method exclusion from the definition of base erosion payments,
the exclusion is available to the extent of the cost but not the to extent of
any markup.

While it has been
clear the exclusion would apply to US corporations that reimburse a foreign
related taxpayer for costs of services provided by the foreign party, there had
been controversy regarding whether and how the exclusion would apply if a
markup is added to the payment.

The regulations
clarification is welcome as companies have wondered if they need to forgo the
markup component to take advantage of services cost method exception and, if
they did forgo the markup, how the foreign jurisdiction would react.

4.4 Cost of Goods
Sold (cogs)
exception

Companies have been
spending significant resources trying to determine what costs can be properly
capitalised and thus considered reductions to gross receipts for purposes of
Cost Of Goods Sold (COGS) rather than as deductible payments subject to BEAT.
Companies that realise they have been deducting items that should have been
included in COGS now want to apply for a change in accounting method but are
concerned that the government may disregard a method change even if it is from
an improper method. Unlike the section 965 transition tax, the BEAT provisions
do not include a special anti-abuse rule aimed at changes in accounting
methods.

4.5 Banks, securities dealers, section 989 losses

The regulations add
taxpayer-favorable de minimis rules providing that if a small percentage
of a group’s activities include banking and securities dealer activities the
lower, 2 percent base erosion threshold applicable to banks will not apply.

Instead, the
general 3 percent threshold applies making it less likely that the group will
be subject to BEAT. The de minimus rule applies when the group’s gross receipts
from banking or securities dealer activities are 2 percent or less of total
receipts.

The regulations
clarify that that term “securities dealers” does not include brokers, as some
taxpayers had feared. The government decided to define the term by looking to
securities law.

The government,
after a lot of thought, decided to apply a neutral rule for section 988 losses,
noting that such payments can be very common. These losses are not treated as
base erosion payments and are also excluded from the denominator when computing
the base erosion percentage.

Note: The reader may visit the websites of the Revenue Authorities of
the concerned Tax Jurisdictions and download various draft reports / Tax
Legislations etc. referred to in this article for his study before rendering
any tax advice or undertaking any further action. If required, the taxpayers
and their tax advisors may consult tax specialists in the aforesaid tax
jurisdictions.

shailesh.kwebmaker

USEFUL LIFE UNDER IND AS 16 PROPERTY, PLANT AND EQUIPMENT AND LEASE TERM UNDER IND AS 116 LEASES

QUERY

A lessee enters into a lease for an office
property. The lease has a non-cancellable term of 5 years and contains an
option for the lessee to extend the lease for a further 5 years. The rentals
for the period under the extension option (i.e., years 6-10) are at market
rates. Upon commencement of the lease term, the lessee incurs cost constructing
immoveable leasehold improvements specific to the property. The useful life of
the leasehold improvement is 7 years. At the commencement date of the lease,
the lessee expects, but is not reasonably certain, to exercise the extension
option. The economic penalty of abandoning the leasehold improvement at the end
of the non-cancellable term of the lease is not so significant as to make
exercise of the renewal option reasonably certain. Over what period does the
lessee depreciate leasehold improvements?

RESPONSE

View 1 – The
useful life of the leasehold improvements is 5 years

Appendix A to Ind
AS 116 defines lease term as: “The non-cancellable period for which a lessee
has the right to use an underlying asset, together with both:

u (a) periods covered by an
option to extend the lease if the lessee is reasonably certain to exercise that
option; and…”

In this case, since
the lessee is not reasonably certain to exercise the option to extend the
lease, the lease term is 5 years for the purpose of Ind AS 116.

Ind AS 16 (56)
states that:

“…all the following
factors are considered in determining the useful life of an asset:

u (a) expected usage of the
asset. Usage is assessed by reference to the asset’s expected capacity or
physical output.

u (b) expected physical wear
and tear, which depends on operational factors such as the number of shifts for
which the asset is to be used and the repair and maintenance programme, and the
care and maintenance of the asset while idle.

u (c) technical or commercial
obsolescence arising from changes or improvements in production, or from a
change in the market demand for the product or service output of the asset…

u (d) legal or similar limits
on the use of the asset, such as the expiry dates of related leases.” (emphasis
added.)

Keeping in mind the
legal limits, the useful life of the leasehold improvements is 5 years.

View 2 – The
useful life of the leasehold improvements is 7 years

The useful life of
the leasehold improvement is based on its expected utility to the entity [Ind
AS 16(57)]. To determine the expected utility, the lessee would consider all
the factors in paragraph 56 of Ind AS 16. While paragraph 56(d) of 16 should be
considered, the factor regarding “expected usage of the asset” in paragraph
56(a) of Ind AS 16 is equally relevant in determining the useful life. The
condition contained in paragraph 56(d) of Ind AS 16 reflects the necessity to
consider the existence of legal or other externally imposed limitations on an
asset’s useful life. The ability to extend the lease term is within the control
of the lessee and is at market rates so there are no significant costs or
impediments to renewal. The term
“expected usage of the asset” for the determination of useful life of an asset
indicates a lower threshold than the “reasonably certain” threshold for
including the extension period in the lease term for Ind AS 116 purposes.

In accordance with
Ind AS 16 (51), if the assessment of useful life changes (for example, the
lessee no longer expects to exercise the lease renewal option) the change shall
be accounted for as a change in an accounting estimate. In such circumstances,
the entity may also need consider whether there is an impairment.

AUTHOR’S VIEW

The author believes
that there is greater merit in View 1, because it results in harmony between the way lease term
and useful life of the leasehold improvements are determined.

shailesh.kwebmaker

Article 13 (4) of India-France DTAA – Make available condition of India-UK DTAA to be read into India-France DTAA. Advisory services for review of strategic and mergers and acquisitions options, do not qualify as FIS in absence of satisfaction of make available condition.

22. TS-767-ITAT-2018 (Mum) Entertainment
Network (India) Ltd vs. JCIT Date of Order: 21^st December, 2018
A.Y.: 2011-12

Article 13 (4) of India-France DTAA – Make available
condition of India-UK DTAA to be read into India-France DTAA. Advisory services
for review of strategic and mergers and acquisitions options, do not qualify as
FIS in absence of satisfaction of make available condition.

FACTS

Taxpayer, an Indian company made payment to a French Company (FCo)
towards professional services³ rendered during the relevant year.
Taxpayer contended that services rendered by FCo were not technical services
and hence did not qualify as FTS. Without prejudice, by virtue of the Most
Favoured Nation clause (MFN clause) in the India-France DTAA, the make
available condition of India-UK DTAA had to be read into India-France DTAA. In
absence of make available condition being satisfied, payment made to FCo did
not qualify as Fee for included services (FIS). Further, in absence of a
permanent establishment of FCo in India, such income was not liable to tax in
India.

However, AO contended that the services rendered by FCo qualified as FTS
and hence in absence of any withholding, disallowed the payments made to FCo.

Aggrieved, Taxpayer appealed before the CIT(A) who upheld the decision
of AO.

Consequently, Taxpayer appealed before the Tribunal.

HELD

By
virtue of the MFN clause, make available condition had to be read into
India-France DTAA. The phrase “make available” means that the knowledge,
experience, skill, knowhow, etc should be passed on to the service
recipient such that the service recipient can carry out the services on
its own.

ICo
would have to go back to FCo if it wished to avail similar services from
FCo in future. Hence, the advisory services rendered by FCo, did not make
available any technical knowledge, experience, skill, etc., to ICo.

Hence,
services rendered by FCo did not qualify as FIS and hence there was no
requirement to withhold taxes on payments made to FCo in India⁴.

___________________________________________

3. FCo rendered advisory services by way of review of strategic and
mergers and acquisition options for ICo.

4. It appears that FCo did not have a PE in India.

shailesh.kwebmaker

PACKAGE SCHEME OF INCENTIVES – PROPORTIONATE INCENTIVES VIS-À-VIS RETROSPECTIVE EFFECT TO SECTION 93 OF THE MVAT ACT

This feature started as Sales Tax corner
in 1995-96. The first contributors to write it were Govind G Goyal and C B
Thakar. The feature was started with the intention to spread awareness about
Indirect Taxes, and more particularly sales tax as excise duty was covered by
another column titled Excise Duty Spectrum. Sales tax was replaced by VAT in
2005 and so the feature explained the new law initially. Later it was renamed
as VAT.

The
feature covers contemporary issues under VAT. It is an analytical feature where
a topic or an issue under it is selected and discussed in light of available
decisions from the highest court to the tribunals. Authors give a conclusion at
the end and offer their views. When we asked them what keeps them going they
said: “As we travel for speaking engagements across the country, we receive
positive feedback and that has been the major source of motivation for us”.
Talking about BCAJ@50, Govind Goyal said, “Its journey must continue with same
zeal, with same enthusiasm in pursuit of such a noble cause of sharing &
spreading knowledge.”

Package Scheme of Incentives –
Proportionate Incentives vis-à-vis retrospective effect to section 93 of the MVAT Act

Introduction

Under MVAT era there were
incentive schemes, for backward area units,
announced by the State Government from time to time, which were also
known as Package Scheme of Incentives (PSI). The incentives used to be given to
new units as well as for the expansion of the existing unit. The unit enjoying
original benefits under the PSI may have carried out expansion and therefore
may also become eligible for further PSI benefits by separate certificate for
expansion.

Under the 1993 PSI, the
units, who got the Entitlement Certificate for expansion, took benefit on the
whole production of the unit. While the Government was contemplating only
proportionate exemption i.e. in the ratio of production from exempted unit as
compared to total production.

However, the Hon. Bombay
High Court in case of Pee Vee Textile Ltd. (26 VST 281)(Bom)
ruled that once the unit holds Entitlement certificate even only for Expansion,
till the unit is entitled to take the benefit for total production and no pro
rata working is applicable.

Amendment in MVAT Act

Having above back ground,
Government of Maharashtra amended the MVAT Act, 2002 and inserted section 93
and 93A in the MVAT Act in 2009 with retrospective effect from 1^st
April 2005.

By the
above amendment, the Government prescribed the Scheme for pro rata
benefit in relation to Expansion. This amendment was retrospective and hence it
was challenged before the Bombay High Court. The Hon. Bombay High Court
delivered judgment in case of Jindal Poly Films Ltd. (63 VST 67)(Bom)
in which it was held that legislature has power to amend the position
retrospectively and hence the retrospective amendment was upheld. In view of
above it was general feeling that there are no chances to avoid pro rata
working of benefits from 1.4.2005.

However, recently there is
a judgment from the Hon. Bombay High Court in relation to above issue wherein
in spite of above position laid down earlier Hon. High Court has given
favorable judgment. The reference is to the judgment in case of Finolex
Industries Ltd. (MVAT A.No.61 of 2017 dt.29.10.2018).

Facts in above case

The facts, narrated by the
Hon. High Court in the judgment, may we read as follows:-

“3. The Appellant Company,
in the year 1994, has made a fixed capital investment of Rs.329.5 crore,
thereby creating a new manufacturing factory in Ratnagiri (hereinafter referred
to as “Ratnagiri Factory”) for manufacturing of PVC Resins and also PVC Pipes.
The said factory claimed the benefits of the Package Scheme of Incentives which
was prevailing at the relevant time, known as PSI 1988 and an eligibility
certificate under Part I of the 1988 Scheme was granted to the appellant by
SICOM qua its Ratnagiri unit. By virtue of the said eligibility
certificate, the appellant was held eligible for maximum entitlement of sales
tax incentives of Rs. 313,03,07,000/- by way of exemption. The said eligibility
certificate was valid for a period of 10 years from 4^th April 1994
to 30^th April 2004. On the basis of the said eligibility
certificate, the Sales Tax Department also issued an entitlement certificate on
25^th April 1994 to the appellant and both the certificates mentioned
the production capacity as 1,30,000 metric tonnes. The said eligibility
certificate expressly described the unit of the appellant as “Pioneer Unit”. In
the year 1993, a new Package Scheme of Incentives substituted the existing
Package Scheme of Incentives. The appellant made a further investment in its
Ratnagiri unit to the tune of Rs.208.89 crore in August 2002 and accordingly,
the existing capacity of PVC Resins and extruded products like pipes, flared up
from 1,30,000 metric tonnes to 2 lakh metric tonnes per annum. The appellant,
accordingly, made an application for availment of necessary incentives in terms
of 1993 Package Scheme of Incentives vide application dated 8^th
October 2002. Accordingly, on 10^th February 2003, a fresh
eligibility certificate was issued to the appellant in the capacity as Pioneer
Unit by SICOM. The said certificate issued on 11^th February 2003 was
valid for 106 months i.e. from 1^st August 2002 to 31^st
May 2011 and the eligibility certificate issued in favour of the appellant for
additional fixed capital investment of Rs. 20889.76 lakhs for village Ranpar,
District Ratnagiri was made subject to review/ monitoring every year. Certain
conditions were stipulated in the said eligibility certificate which included
the condition of automatic curtailment of the eligibility certificate from the point
of time when the total sales tax incentives admissible under the Scheme are
availed of, or exceed the limits as specific in the 1993 Package Scheme of
Incentives i.e. on attaining 69.93% of the gross value of Fixed Capital
Investment actually made subject to a ceiling of Rs. 20889.70 lakh i.e.
Rs.14,608.17 lakh or from the date from which the certificate of entitlement is
either cancelled or revoked, whichever event occurred earlier.

4. The certificate of
Entitlement issued in favour of the appellant on 21^st October 2002
by SICOM did not incorporate any condition whatsoever that availment of
incentives should be on proportionate basis of increase in production capacity
to the additional investment. The consequential certificate of entitlement
dated 10^th February 2003 issued by the Sales Tax Department,
according to the appellant, also does not in any condition stipulating that the
appellant should avail the incentives on a proportionate basis of increase in
production capacity of additional investment. It is the specific case of the
appellant that for the Financial Years 2005-06, 2006-07, 2007-08 and 2008-09
and in particular, for the Financial Year 2005-06 in respect of which the
present Appeal is filed, the appellant relied upon the eligibility certificate
and the Entitlement certificate issued in its favour and claimed complete
exemption from taxes for the entire turnover of sales made by it from Ratnagiri
unit. It is the case of the appellant that it fully satisfied all the
conditions of exemption imposed under the notification dated 1^st
April 2005 issued under the MVAT Act 2002 and necessary declarations were also
duly made on the invoice as required in the notification. As such, the
appellant exhausted the eligible quantum of benefit under the entitlement
certificate in the month of March 2009 itself. The appellant also claimed a
refund of tax paid on purchases in terms of Rule 78 of the MVAT Rules 2005 for
the period from 4^th February 2006 to 1^stMarch 2006 and
accordingly, the respondent granted provisional refund to the appellant
amounting to Rs. 5,65,39,588/.

Perusal of the chronology
of events would further reveal that on 22^nd February 2013, an
assessment order was passed by the Assessing Authority for the disputed period
2005-06.

In the assessment order,
the Assessing Authority applied the provisions of section 93 of the MVAT 2002
as retrospectively substituted by Maharashtra Act No.XXII of 2009 and only
allowed the exemption to the extent of prorate turnover of 35%. The assessing
authority rejected the claim of 100% exemption without applying prorate factor
on the ground that the dealer has not produced any books of accounts and has
not identified the goods manufactured by old and new units and there was no
identification of goods. Resultantly, the appellant was assessed to VAT Tax at
Rs. 6,07,82,694/- and the claim was verified and finally allowed at
Rs.10,30,85,904/and it was held that the assessment had resulted in excess
amount which was refunded to the dealer. For the remaining amount, a demand
notice was served on
the appellant.”

The
argument of the appellant was that since the benefits are already exhausted and
it has started paying tax subsequent to exhaustion and that there is no
periodicity available for taking benefit of modified working, the retrospective
amendment should not be made applicable to it.

On the part of Government
the argument was that the law should be applied as already upheld by the Hon.
Bombay High Court and only pro rata benefit should be granted,
irrespective of the consequences.

The Hon. Bombay High Court
has held that in the above specific circumstances the position should not be
disturbed. Hon. High Court concluded the position in following words.

“26. The findings recorded by the First
Appellate Authority as well as the Tribunal is amiss the legal position laid
down by the Hon’ble High Court in ACC Ltd Vs. State of Maharashtra (supra),
wherein it was categorically held that the expansion made by the existing
pioneer unit which specified conditions under para 3.12(b) will not be hit by
expansion under para 8.1(i)(c). The amendments made by Maharashtra Act No. XXII
of 2009 will not apply to units whose Cumulative Quantum of Benefits have been
fully utilized before expiry of the eligibility period even if the incentive is
computed in terms of amended Section 93 of the MVAT Act, 2002.

The amendment inserted by
Act No. XXII of 2009 would only govern those units where the Cumulative Quantum
of Benefits has not yet lapsed without full utilization and is in the process
of being availed. The eligibility availed under Section 93(1) is computed for a
particular year and if there is excess availment, then, the benefits can be
withdrawn. The challenge to the constitutional validity of Act No. XXII of 2009
was rejected by a Division Bench of this court in case of Jindal Poly Films
(supra) which is upheld by the Hon’ble Apex Court and thus, upholding the
retrospectively of the said amending enactment. The amendment of Section 93(1)
being retrospective in the sense would make the provision applicable to the
unit set up before the date of the said amendment, but in respect of sales
which are made by such unit on or after 27^th August 2009. Since the
appellant has already exhausted the benefits of exemption before 27^th
August 2009, the appellant cannot be deprived of the said benefits in light of
Section 93A which was inserted with effect from 27^th April 2009. The
amendment, thus would not apply to the sales already made between 1^st
April 2005 and 28^th August 2009. A retrospectively of a statute has
to be tested in the backdrop of its nature. A statute is not said to be
retrospective in operation merely because a part of the requisite for its
operation is drawn from a time antecedent to its passing. A situation which
takes away or impairs any vested right acquired under the existing law or which
creates a new obligation or imposes a new liability will be treated as
retrospective. If the amendment which is made on 27^thAugust 2009
applied to a unit to deprive it of all the exemptions of sale after 27^thAugust
2009, then, the amendment would affect such vested right and not merely a
future or contingent right and it would be retrospective in operation. The
industrial unit like the appellant which has been set up before 27^th
August 2009 and fulfilled all the requirements of the scheme, which was
prevailing, relating to enjoyment of certain sales tax benefits and if it had
fulfilled all the requirements of the scheme, then, a vested right is created
in favour of the unit to avail the exemption for a specified period and if on
the basis of an amendment which deprives the unit of all such benefits, it
would be retrospective in operation and would be against the spirit of a taxing
statute.”

Thus, favorable position is
available inspite of retrospective amendment.

Conclusion

The judgment gives much
required relief to the backward area units. In fact many units have suffered
financially due to retrospective amendment. This judgment will save many of
such units and they will not be affected by the retrospective amendment. This is
good judgment considering the basic intention of the Scheme. This judgment will
also be guiding judgment in relation to retrospective amendments, where
applicable and where not applicable.

shailesh.kwebmaker

BOOK-PROFIT FOR PAYMENTS TO PARTNERS – SECTION 40(B)

The column “Controversies” was started
in January, 1980, with Vilas K. Shah and Rajan R. Vora as the initial
contributors. Harish N Motiwalla took over from 1985-86 to 1993-94. Pradip
Kapasi contributed from May, 1992, and has not stopped rolling out controversy
after controversy till today. That is 27 years of monthly contributions. Gautam
S Nayak joined as co-author in April, 1996 and is now an experienced
‘controversialist’ for 23 years. Their unbeaten partnership is perhaps the
longest under BCAJ! The authors have been bringing out a new controversy every
month, month after month. So far, they would have brought out a record 275
controversies. Bhadresh Doshi joined them in June, 2018.

This is not a digesting feature, but an
ANALYTICAL FEATURE. The process starts with identifying a suitable controversy
where there are two conflicting views on a legal issue which are not settled by
the Supreme Court. Currently forum based or subject based issues are covered.
Pradip Kapasi says: “The authors, in the initial years used to ‘conclude’ the
issue, under consideration, in the end which practice for long has been
substituted with the authors offering their comments in the form of
‘observations’ leaving the debate open for readers.”

In the era of law driven by judgements,
the authors bring observations, record decisions, and also alternative
contentions that help resolve or reconcile controversies. In answer to the
question – what keeps them going – Pradipbhai said: “At an early age, the
feature taught that no view, even of the high court, is final and that there is
always another view which at times can be a better view.” Gautambhai answered
thus: “Writing this column is time consuming, but exhilarating, as one has to
consider all aspects of the issue thoroughly, while giving the observations.
After writing on an issue, one becomes completely aware of all the nuances of
the issue, as well as case laws on the subject, which definitely helps in one’s
practice, when one comes across similar issues.”

Book-Profit for payments to
partners –
Section 40(b)

ISSUE FOR CONSIDERATION

Section 40(b)
limits the deduction, in the hands of a firm, in respect of expenditure on
specified kinds of payments to partners. Clause(1) of section 40(b) prohibits
the deduction for payment of remuneration to a partner who is not a working
partner. Clause(2) provides that a deduction for payment of remuneration to a
working partner is allowed in accordance with the terms of the partnership
deed. Clause (5) has the effect of limiting the deduction for remuneration to
working partners, to the specified percentage of the “book-profit” of the firm.

“Remuneration”
includes any payment of salary, bonus, commission or remuneration by whatever
name called. The term “book-profit” is defined exhaustively by
Explanation 3 to section 40(b) which reads as under “Explanation 3-For the
purpose of this clause, ”book-profit” means the net profit, as shown in the
profit and loss account for the relevant previous year, computed in the manner
laid down in Chapter IV-D as increased by the aggregate amount of the
remuneration paid or payable to all the partners of the firm if such amount has
been deduced while computing the net profit”

‘Book-Profit’, as
per Explanation 3, means the net profit as per the profit and loss account of
the relevant year, computed in the manner laid down in Chapter IV-D. The
requirement to take net profit as shown in profit and loss account is quite
simple, but the requirement to compute the same in the manner laid down in
Chapter IV-D has been the subject matter of debate.

It is usual to
come across cases wherein the profit and loss account is credited with receipts
such as interest, rent, dividend, capital gains and such other income, which
may or may not have any relationship to the business of the firm. It is in such
cases that an issue arises while computing the Book-Profit of the firm, wherein
the firm is required to ascertain as to whether the interest and such other receipts
credited to profit and loss account are required to be excluded from the net
profit or not to arrive at the figure of the book-profit.

Conflicting
decisions of the high court are available on the subject of determination of
the book-profit for the purpose of section 40(b) of the Act. While the Calcutta
high court has favoured the acceptance of the net profit as per the profit and
loss account as representing the book-profit, the Rajasthan high court has
recently ordered for exclusion of such receipts from the net profit.

MD SERAJUDDIN
& Bros.’ CASE

The issue arose
before the Calcutta High Court in the case of
Md. Serajuddin & Bros. vs. CIT, 24 taxmann.com 46 (Cal.). In
that case, the assessee, a partnership firm, filed its return of income for the
relevant assessment years 1995-96 to 1998-99 by claiming deduction for
remuneration paid to partners which was calculated on the basis of the net
profit of the firm as per the profit & loss account of the year, which inter
alia included the credits for consultancy fees, interest on bank deposits,
profit on disposal of assets and interest on advance tax, which had been shown
as income under the head ‘other sources’. The returned income was accepted by
the Assessing Officer on issue of the intimation u/s. 143(1)(a). Subsequently,
the AO held that the income by way of consultancy fees, interest on bank
deposit, profit on disposal of assets and interest on advance tax, which had
been shown as income under the head ‘other sources’, could not be considered as
part of the book profit for the purpose of computation of allowable partners’
remuneration. He recomputed the deduction for remuneration by reworking the
book profit and disallowed the excess remuneration by applying the provisions
of section 40(b) of the Act. The Commissioner (Appeals) rejected the appeal of
the assessee. On further appeal, the Tribunal, without giving any reasonable
opportunity to the assessee, dismissed the appeal.

The High Court
admitted the appeals of the assessee firm on the following substantial question
of law on the issue under consideration, besides a few other aspects of the
issue not germane for the discussion :-

“Whether and
in any event, on a proper construction of the provisions of Section 40(b)(v)
and explanation 3 thereto, book profit comprises the entire net profit as shown
in the profit and loss account or only profit and gains of business assessed
under Chapter IV-D?”

On behalf of
the assessee firm, it was highlighted that for the purpose of Explanation 3 to
section 40(b)(v), the appellant had taken into consideration its net profit as
shown in the profit and loss account, which included consultancy fees, interest
on bank and company deposits, profit on disposal of cars used in the business
and interest on refund of advance tax paid and other items of incomes, which
were shown in the return under heading ‘income from other sources’. In support
of its action, it was submitted that;

the said Explanation 3 of section 40(b)(v)
provides for taking the net profit as shown in the profit and loss account and
not the profit computed under the head ‘profit and gains of business or
profession’;

unlike Explanation (baa) to section 80HHC
and section 33AB, both of which mentioned profit as computed under the head
‘profit and gains of business or profession’, Explanation 3 to Section 40(b)(v)
did not refer to any head of income and instead mentioned ‘net profit as shown
in the profit and loss account’;

had the intention been to restrict the
deduction only to the profit computed under the head ‘profits and gains of
business or profession’, the expression used in Explanation (baa) to section
80HHC and section 33AB would have also found place in Explanation 3 to section
40(b).

that none of the sections 30 to 43D, of part
IV –D, provided for exclusion of any item of income because it did not fall
under the head of ‘profits and gains of business or profession’.

the reasons for making the computation
provisions of Chapter IV-D applicable for computing the book profit was only to
ensure that all deductions had been allowed, as otherwise an assessee might
compute the book profit at a higher figure and thereby claim a higher amount by
way of remuneration for the purpose of deduction.

the quantum of deduction in computing income
under the head ‘profits and gains of business or profession’ ought be computed
with reference to the income falling under all the heads of income, including
the head ‘income from other sources’.

the decision of the Supreme Court in case of
Apollo Tyres Ltd. vs. CIT, 255 ITR 273 confirmed that the decision as to
which item of income should be taken into account for computing the quantum of
deduction, depended upon the language of the statutory provision allowing the
deduction.

The Revenue, in
response, contended that the assessee himself had offered the receipts in
question under the head ‘income from other sources’; that from a plain reading
of section 40(b)(v) r.w. Explanation 3 thereto, it was manifestly clear that
the term ‘book profit’ meant only that net profit which was computed in the
manner laid down in Chapter IV-D of the Act, which chapter dealt only with the
profit and gains of business or profession, and did not include profits
chargeable under Chapter IV-F under the head ‘income from other sources’; that
in a taxing statue, the words of the statue were to be interpreted strictly;
that section 40(b)(v), Explanation 3 made it abundantly clear that the net
profit had to be computed in the manner laid down in Chapter IV-D and such
profit did not include profit referred to in Chapter IV-F of the Act.

The Calcutta
High Court, on due consideration of the rival contentions, held that chapter
IV-D nowhere provided that the method of accounting for the purpose of
ascertaining net profit should consider the income from business alone and not
from other sources; section 29 provided for the manner of computing the income
from profits and gains of business or profession which had to be done as
provided u/s. 30 to 43D; by virtue of section 5 of the said Act, the total
income of any previous year, included all income from whatever source derived;
for the purpose of section 40(b)(v) read with Explanation there could not be
separate method of accounting for ascertaining net profit and/or book-profit;
the said section nowhere provided that the net profit as shown in the profit
and loss account should be the profit computed under the head profits and gains
of business or profession, only.

The Calcutta
High Court, citing the following paragraphs from the decision of the Supreme
court in the case of Apollo Tyres Ltd.(supra) , observed that the said
decision provided for an appropriate guidance on the point as to what should be
done in order to ascertain the net profit in case of the nature before the
court.

“Sub-section
(1A) of section 115J does not empower the Assessing Officer to embark upon a
fresh inquiry in regard to the entries made in the books of account of the
company. The said sub-section, as a matter of fact, mandates the company to
maintain its account in accordance with the requirements of the Companies Act
which mandate, according to us, is bodily lifted from the Companies Act into
the Income-tax Act for the limited purpose of making the said account so
maintained as a basis for computing the company’s income for levy of
income-tax. Beyond that, we do not think that the said sub-section empowers the
authority under the Income-tax Act to probe into the accounts accepted by the
authorities under the Companies Act. If the statute mandates that income
prepared in accordance with the Companies Act shall be deemed income for the
purpose of section 115J of the Act, then it should be that income which is
acceptable to the authorities under the Companies Act. There cannot be two
incomes one for the purpose of the Companies Act and another for the purpose of
income-tax both maintained under the same Act. If the Legislature intended the
Assessing Officer to reassess the company’s income, then it would have stated
in section 115J that “income of the company as accepted by the Assessing
Officer”. In the absence of the same and on the language of section 115J,
it will have to held that view taken by the Tribunal is correct and the High
Court has erred in reversing the said view of the Tribunal.”

“The fact that it is shown under a
different head of income would not deprive the company of its benefit under
section 32AB so long as it is held that the investment in the units of the UTI
by the assessee-company is in the course of its “eligible business”.
Therefore, in our opinion, the dividend income earned by the assessee-company
from its investment in the UTI should be included in computing the profits of
eligible business under section 32AB of
the Act.”

Relying heavily
on the findings of the apex court, the Calcutta High Court held that once the
income from other sources was included in the profit and loss account, to
ascertain the net profit qua book-profit for computation of the
remuneration of the partners, the same could not be discarded for the purposes
of computing the deductible amount of remuneration to partners. The appeal of
the assessee firm was thus allowed and the orders of the lower authorities were
set aside.

ALLEN CAREER INSTITUTE’S CASE

Recently, the
issue again arose before the Rajasthan High Court in the case of CIT vs.
Allen Career Institute. 94 taxmann.com 157. In this case, the Rajasthan
High Court, admitting the Revenue’s appeals, framed the following substantial
questions of law:

“Whether
in the facts and circumstances of the case the ITAT is justified in considering
the interest as part of the book profit in contravention of Section 40(b) i.e
as per Section 40(b) the book profit has to be computed in the manner laid down
in Chapter-IV D?”

“Whether
the Tribunal was legally justified in deleting the disallowance of
Rs.2,30,00,796/- made on account of remuneration to partners by taking the
interest earned on FDRs as part of book profit and business income under
Section 28 specifically when it was “Income from other sources” and
contrary to Section 40(b), Explanation 3 and Section 40(b) (v) (2)?”

On behalf of
the Revenue it was contended that Chapter IV-D, consisting of section 28 to 44,
provided for computation of the income under the head profits and gains of
business or profession; that the investment in the FDRs was not made as a
business necessity, without which the business of the assessee could not be
run, and, in fact, the FDRs were made out of the surplus funds available with
the assessee, and the income from bank FDRs could not be said to be business
income and was to be treated as income from other sources.

On behalf of
the assessee, it was contended that the interest income from the FDRs, credited
to the profit & loss account, should not be excluded from the net profit
for the purposes of determining the quantum of deduction in respect of the
payment of remuneration to the partners while applying the provisions of
section 40(b). Reliance was placed on the decisions in the case of CIT vs.
J.J. Industries, 358 ITR 531 (Guj.) and Md. Serajuddin & Bros. vs.
CIT, (supra) and Apollo Tyres Ltd. vs. CIT(supra). In addition, the
decision in the case of CIT vs. Hycron India Ltd. 308 ITR 251 (Raj.),
was relied upon to contend that the expression “profits and gains” as
used in section 2(24), had a wider expression, and was not confined to
“profits and gains of business or profession”. Further, the language
of section 10B, again, provides for exemption, with respect to any
“profits and gains” derived by the assessee, and was not confined to
“profits and gains of business and profession” as provided u/s. IV-D.
That ‘profit’ was an elastic and ambiguous word, often properly used in more
than one sense; its meaning in a written instrument was governed by the
intention of the parties appearing therein, but any accurate definition thereof
must always include, the element of gain. The meaning of word “gain”
has been given as acquisition, and has no other meaning. Gain was something
obtained or acquired, and was not limited to pecuniary gain. The word
“profit”, as ordinarily used, means the gain made upon any business
or investment. “Profits” is capable of numerous constructions, and
for any given use, its meaning must be derived from the context. In addition,
it was contended that had the intention been to limit the scope of the term
‘profit’ to the income determined under the head profits and gains of business
or profession, then it would have been so done as was done in the case of
section 115J of the Act.

The Rajasthan
High Court rejected the contentions of the assesse made in support of inclusion
of the income from interest and other sources for the purposes of computing the
quantum of the deduction in respect of the remuneration paid to partners,
holding that the interest and other income taxable under the head ‘income from
other sources’ was not to form part of the book profits for the purposes of section
40(b) of the Act, and was therefore required to be excluded from the net profit
as per the profit & loss account.

OBSERVATIONS

Section 14
requires the total income to be classified into five different heads of income
for the purpose of charge of income tax. Subject to such classification, the
total income of an assessee remains unchanged. The charge of the tax is on the
total income of the firm, and is not changed on account of its classification
into different heads of income.

There are
several provisions in the Income Tax Act, for grant of relief or otherwise,
where the legislature has used such language that expressly refers to the
income computed under the head ‘profits and gains from business and
profession’. For example, the benefit of deduction u/s. 10B is not restricted
to the income computed under the head ‘profits and gains from business and
profession’ but is allowed in respect of the ‘profits and gains’. Again,
section 115JB deals with the profit and loss account of an assessee in its entirety,
and covers the profit of the company as shown by the profit and loss account,
without restricting the same to the income of business. Explanation 3 also
employs a similar terminology while defining the term “book-profit” to mean the
net profit as shown in the profit and loss account for the relevant previous
year. In contrast, the provisions of section 33AB and section 80 HHC restrict
the relief to profits computed under the head ‘profits and gains of business or
profession’.

The use of the
words “computed in the manner laid down in Chapter IV-D” in Explanation
3 that follows the words ‘net profit, as per profit & loss account for
the relevant previous year’ may not presently change the amount of net
profit for the following reasons;

Unlike adjustments to book-profit required
to be made u/s. 115JB for MAT, no specific guidelines are provided in section
40(b) for adjusting the net profit. Reference may also be made to provisions of
section 33AB and section 80HHC, which expressly provide for restricting the
relief to profits computed under the head ‘profits and gains of business or
profession’ .

Chapter IV-D by itself cannot be considered
to provide any help in the matter of computation of book profit. Any attempt to
compute the book profit by applying all and sundry provisions of Chapter IV-D
would lead to a “book-profit” that would be devoid of any reality and may
result in allowing remuneration in excess of even the net profit of the firm.

Explanation 3 requires the net profit to be
increased by the amount of remuneration paid to partners of the firm. This
specific requirement is an example of an adjustment expressly provided by the
legislature to the net profit for quantification of the remuneration payable.

Needless to say that any attempt to exclude
certain receipts from net profit will have to be followed by the exclusion of
the expenditure incurred for earning such income. Such an exercise may be
extremely difficult and if attempted, may reflect inaccurate results.

None of the provisions for allowing deduction u/s.
30 to 43D of Chapter IV-D contains a provision that restricts the deduction
thereunder to the profits computed under the head ‘profits and gains of
business or profession’. There cannot be a separate method of accounting for
ascertaining net profit/book-profit and therefore, any income, if credited to
profit and loss account, should be eligible to be classified as book profit.

Ordinarily
unless otherwise provided, an income, even though computed under the different
heads of income, would not cease to be the income of the business more so where
the objective of the assessee such as a firm or company is to carry on business
for the entity.

The issue under
consideration has also been addressed by the Gujarat High Court in the case of CIT
vs. J.J.Industries, (supra), wherein the court allowed the deduction of
remuneration to partners calculated on net profit that included receipts of
interest and a few other items taxed under the head ‘ income from other
sources’.

The term
“profits and gains” used in section 2(24), clause(i) is wide enough to include
all the receipts of an assessee firm, and its scope need not be restricted to
the ‘profits and gains of business or profession’. Profit is an ambivalent and
multi-faceted term which connotes different meanings at different times and in
different contexts. The Supreme Court, in the case of Apollo Tyres Ltd.
(supra), clarified that the true meaning of the ‘profit’ should be gathered
with reference to the intention of the legislature in enacting the particular
provision. Any attempt to ascribe a general and all purpose meaning to the term
“profit” should be avoided and only such a meaning that fits into the context
should be supplied. The Rajasthan high court in fact, in the case of Hycron
India Ltd (supra), in a different context, has held that the term ‘profits
and gains’ need not necessarily be confined to ‘profits and gains of business
or profession’.

Attention is
invited to the decisions of the Jaipur bench of the tribunal in the case of S.P.
Equipment & Services 36 SOT 325, and Allen Career Institution 37 DTR 379
and the Madras High Court in the case of Sri Venkateshwara Photo Studio,
33 taxmann.com 360 and the Rajkot Bench in the case of Sheth
Brothers, 99 TTJ189 and the Mumbai Bench in the case of Suresh A. Shroff &
Co., 27 taxmann.com 291, all of which have held that, for the purpose of
computing the deduction for payment of remuneration to partners in the hands of
the firm, the items of income credited to the profit & loss account should
not be excluded, even where such items have otherwise been taxed under the head
‘income from other sources’.

The better view
therefore is the one propounded by the Calcutta & the Gujarat High Courts
that takes into consideration the larger meaning of the ‘profits & gains’
which fits into the context of section 40(b) and takes into consideration the
method of accounting employed by the firm for determining the net profit of the
firm.

The case for
inclusion of interest and such other receipts in the book profit is stronger in
cases where such receipts have been taxed under the head ‘profits and gains of
business or profession’. In such cases, there should not be any opposition from
the AO, who has otherwise accepted the character of such receipts as a business
income and assessed and brought to tax such receipts under the head ‘profits
and gains from business and profession’.

There is no
leakage or very little leakage of revenue in the whole exercise, in as much as
what is allowed in the hands of the firm is taxed in the hands of the partners.
Further what is disallowed in the hands of the firm is to be excluded from the
income of the partners. All of this is made clear by the express provisions of section28(v) of the Act.

shailesh.kwebmaker

Taxability of interest of NPAs in case of NBFCs

The column “Closements” commenced in
May, 1981, with Rajan Vora as the initial contributor who carried it till
1990-91. From August, 1988, Kishor Karia became a co-contributor to
“Closements”, and he continues to contribute 31 years later. R P Chitale had
joined in from 1990-91 to 2007-08. Atul Jasani joined the panel of contributors
from July 2008 and continues till date.

This
column covers a Supreme Court decision and provides an in-depth analysis and
implications.

Taxability of interest of NPAs in case of NBFCs

Introduction

1.1 In case of an assessee following Mercantile
System of Accounting [i.e. accrual basis of accounting], the taxability of
interest on ‘sticky loans’ or ‘doubtful advances’, not recognised as revenue in
the books of account , has been a matter of debate and litigation under the
Income-tax Act [ the Act] for a long time under different circumstances/
scenario.

1.2 In case of Banks, Non-Banking Financial
companies [NBFCs] etc., which are also engaged in the business of lending
money, the accounting treatment of Non-Performing Assets [NPAs] and interest
thereon is governed by the norms set by the Reserve Bank of India [RBI- RBI
norms]. Under such norms, such entities are required to make provisions for
NPAs and are also mandated to not to recognise the interest on such NPAs as
revenue in the accounts.

1.3 Subject to specific provisions in the Act,
the provision for such NPAs is not deductible in computing income under the
head “Profits and gains of business or profession’ [Business Income] in case of
such entities as held by the Apex Court in the case of Southern Technology
Ltd [(2010)- 320 ITR 577] – Southern Technology’s case. However, the
taxability of interest on such NPAs not recognised as revenue in the accounts
as per the RBI norms in case of NBFCs [which are not covered by section 43D]
has been a matter of debate and litigation as the same are not protected by the
provisions of section 43D of the Act
[applicable to Banks, Public Financial Institutions, Housing Finance Public
Companies etc] which effectively provides that such interest is taxable either
in the year of recognition in the accounts or in the year of actual receipt,
whichever is earlier. Co-operative Banks [ except in specified cases] are also
now covered within the scope of Sec 43D from assessment year 2018-19. The
Revenue, usually takes the view that such interest is taxable under the
Mercantile System of Accounting [Mercantile System] as income having accrued in
the relevant year on time basis, notwithstanding the fact that the principal
amount of loan itself is doubtful of recovery [i.e. NPA] and the NBFCs are
mandatorily required not to recognise such interest as revenue in the accounts
under the RBI norms. The Delhi High Court in the case of Vasisth Chay Vyapar
Ltd has taken a favourable view on this issue and similar view is also
taken in other cases by the High Courts [Mahila Seva Sahakari Bank Ltd
(2007) 395 ITR 324(Guj), Brahmaputra Capital & financial Services Ltd
(2011) 335 ITR 182 (Del), etc]. However, the Revenue is contesting this
view.

1.4 The issue referred to in para 1.3 above had
come-up before the Apex Court in the context of Delhi High Court judgment
referred to in para 1.3 above and other appeals filed by the Revenue involving
the similar issue and the issue is now decided by the Apex Court and therefore,
it is thought fit to consider the same in this column.

CIT
vs. Vasisth Chay Vyapar Ltd [(2011) 330 ITR 440 (Del)]

2.1 Before the Delhi High Court, various
appeals pertaining to different assessment years of the same assessee had
come-up involving common issue. In the above case, the assessee company was
NBFC and accordingly, was governed by the Directions of the RBI and was
required to follow the RBI norms.

2.2 In the above case, the brief facts were:
the assessee had advanced Inter Corporate Deposit (ICD) to Shaw Wallace Company
(SWC) and on account of default of the payment of interest by SWC, under the
RBI norms, the ICD had become NPA and was accordingly, treated as such by the
assessee. The interest income on the ICD was recognised on accrual basis and
offered to tax for the assessment years 1995-96, 1996-97. For the subsequent
years, the interest income on ICD was not recognised under the RBI norms and
the same was also not offered to tax. Factually, the interest on the ICD was
also not received until the assessment year 2006-07. The SWC was passing
through adverse financial crisis and winding up petitions were also pending
against the SWC in the court. As such, the recovery of the amount of ICD itself
was uncertain and substantially doubtful.

2.2.1 On the above facts, the Assessing Officer
(AO) took the view that the interest on ICD had accrued to the assessee under
the Mercantile System and accordingly, added to the income of the assessee. The
first Appellant Authority also affirmed the order of the AO. For this, the
Revenue held the view that: the provisions of the RBI Act, 1934 (RBI Act) read
with the NBFCs Prudential Norms. (Reserve Bank) Directions, 1998 (RBI norms)
can not override the provisions of the Act under which the amount of interest
was taxable as accrued under the Mercantile System and is accordingly, taxable
u/s. 5 of the Act; and as such, the interest in question is taxable in
respective years. When the matter came-up before the Tribunal, the view was
taken that the provisions of section 45Q of the RBI Act overrides the provisions of the Income-tax Act and
the action of the assessee not recognising income from ICD, following RBI
norms, was correct and in accordance with the law. Accordingly, the Tribunal held that in terms of section 145 of the
Act, no addition could be made in respect of such unrealised interest on the
ICD which was admittedly NPA.

2.3 Under the above mentioned circumstances,
the issue came-up before the Delhi High Court at the instance of the Revenue
viz. ‘whether the Tribunal erred in law and on the merits by deleting the
addition of income made as interest earned on the loan advanced to SWC by
considering the interest as doubtful and unrealisable.

2.3.1 On behalf of the Revenue, the views held by
the Revenue [referred to in para 2.2.1] was reiterated. It was also contended
that the liability under the Act is governed by the provisions of the Act and
merely because for accounting purposes, the assessee had to follow the RBI norms, it would not mean that the
assessee was not liable to show the interest income which had accrued to the
assessee under the Mercantile System and was exigible to tax under the Act. For
this, the reliance was placed on the judgment of the Apex Court in Southern
Technology’s case (supra) which, according to the Revenue, supports this
position.

2.3.2 On the other hand, on
behalf of the assessee, it was, inter-alia, contended that: as per the
provisions of section 45Q of the RBI Act
[which has non-obstante clause], interest income on such NPA is required to be
recognised as per the RBI norms and as held by the Apex Court in TRO vs
Custodian, Special Court Act. 1992 [(2007) 293 ITR 369] where an Act makes
provision with non-obstante clause that would override the provisions of all
other Acts; the chargeable Business Income has to be determined as per the
method of accounting consistently followed by the assessee; as per the relevant
provisions of Companies Act, as well as section 145 of the Act, it was incumbent upon the assessee to confirm to the
mandatory accounting method and follow those standards; the system of
accounting consistently followed by the assessee was in conformity with those
accounting standards which, inter-alia, provided not to recognise
interest on such NPA, in view of the uncertainty of ultimate collection due to
tight and precarious financial position of the borrower [i.e. SWC]. For this,
specific reference was also made to the Accounting Standard 9 [AS 9] issued by
the Institute of Chartered Accountants of India [ICAI]. Relying on certain
judgments of different High Courts [such as Elgi Finance Ltd [(2017) 293 ITR
357(Mad) etc], it was also further contended that the courts have held that
even under the Mercantile System, it is illusionary to take credit for interest
where the principal itself is doubtful of recovery. It is further contended
that the courts have also recognised the theory of ‘real income’ and held that
notwithstanding that the assessee may be following Mercantile System, the
assessee could only be taxed on ’real income’ and not on any
hypothetical/illusionary income. For this, reference was made to the judgments
of the Apex Court in the cases of UCO Bank [(1999) 237 ITR 889], Shoorji
Vallabhdas & Co [(1962) 46 ITR 144] and Godhra Electricity Co Ltd
[(1997) 225 ITR 746]. It was also pointed out that relying on this ‘real
income’ theory, the Delhi High Court has also held that interest on sticky
loans, where recovery of the principal was doubtful, could not be said to have
accrued even under the Mercantile System and accordingly, such notional
interest could not be taxed as income of the assessee. For this, reference was
made to the two judgments of the Delhi High Court viz. Goyal M. G, Gases (P)
Ltd [(2008) 303 ITR 159] and Eicher Ltd [(2010) 320 ITR 410]

2.4 After noting the facts of the case and
contentions raised on behalf of both the sides, the Court proceeded to decide
the issue. For this purpose, the Court first referred to the provisions of
section 45Q of the RBI Act [under the caption ‘Chapter III- B to override other
laws’] which effectively provides that the provisions of Chapter III-B shall
have effect notwithstanding anything inconsistent therewith contained in any
other law for the time being in force or any instrument having effect by virtue
of any such law. The Court then also noted as under (pg 448):

“It is not
in dispute that on the application of the aforesaid provisions of the RBI and
the directions, the ICD advanced to M/s. Shaw Wallace by the assessee herein
had become NPA. It is also not in dispute that the assessee–company being NBFC
is bound by the aforesaid provisions. Therefore, under the aforesaid provisions,
it was mandatory on the part of the assessee not to recognize the interest on
the ICD as income having regard to the recognized accounting principles. The
accounting principles which the assessee is indubitably bound to follow are
AS-9……”

2.4.1 The Court also noted the provisions of AS 9
contained in para 9 dealing with effect of uncertainty on revenue recognition.

2.4.2 The Court then noted that in the above
scenario, it has to examine the strength in the submission made on behalf of
the Revenue that whether it can still be held that the income in the form of
interest though not received had still accrued to the assessee under the
provisions of the Act and was therefore exigible to tax.

2.4.3 In the above background, the Court decided
to first consider the issue of taxability in the context of the Act and for
that purpose to examine whether, under the given circumstances, interest on ICD
has accrued to the assessee. In this context, after referring to the factual
position with regard to the ICD [referred to in para 2.2 above], the Court,
concluded as under (pg 449):

“…These
circumstances, led to an uncertainty in so far as recovery of interest was
concerned, as a result of the aforesaid precarious financial position of Shaw
Wallace. What to talk of interest, even the principal amount itself had become
doubtful to recover. In this scenario it was legitimate move to infer that
interest income thereupon has not “accrued”. We are in agreement with the
submission of Mr. Vohra on this count, supported by various decisions of
different High Courts including this court which has already been referred to
above.”

2.4.4 Having considered the position with regard
to accrual of interest under the Act as above, the Court further explained the
effect of RBI norms as under (pg 449):

” In the instant case, the assessee-company
being NBFC is governed by the provisions of the RBI Act. In such a case,
interest income cannot be said to have accrued to the assessee having regard to
the provisions of section 45Q of the RBI Act and Prudential Norms issued by the
RBI in exercise of its statutory powers. As per these norms, the ICD had become
NPA and on such NPA where the interest was not received and possibility of
recovery was almost nil, it could not be treated to have been accrued in favour
of the assessee.”

2.4.5 The
Court then noted the argument raised on behalf of the Revenue that the case of
the assessee was to be dealt with for the purpose of taxability under the
provisions of the Act and not under the RBI Act, which was concerned with the
accounting method that the assessee was supposed to follow and in that respect,
the reliance placed by the Revenue on the judgment of the Apex Court in Southern
Technology’s case (supra). In this context, the Court noted that, no doubt,
in the first blush, that judgment gives an indication that the Apex Court has
held that the RBI Act does not override the provisions of the Act. However, on
a closure examination in the context in which the issue had arisen before the
Apex Court and certain observations of the Apex Court in that case, shows that
this proposition advanced on behalf of the Revenue may not be entirely correct.
In that case, primarily the Apex Court was dealing with the issue of
deductibility of provisions for NPA as bad debt u/s. 37 (1)(vii) of the Act and
many of the observations of the Apex Court should be read in that context.
However, in that case itself, the Apex Court has made a distinction with regard
to ‘income recognition’ and held that income had to be recognized in terms of
RBI norms, even though the same deviated from Mercantile System and/or section
145 of the Act. In this context, the Court, inter-alia, noted the following
observations of the Apex Court in that case (pgs 451/452):

“At the
outset, we may state that the in essence RBI Directions 1998 are
prudential/provisioning norms issued by the RBI under Chapter III-B of the RBI
Act, 1934. These norms deal essentially with income recognition. They force the
NBFCs to disclose the amount of NPA in their financial accounts. They force the
NBFCs to reflect ‘true and correct’ profits. By virtue of section 45Q, an
overriding effect is given to the Directions 1998 vis-à-vis ‘income
recognition’ principles in the Companies Act, 1956. These Directions constitute
a code by itself. However, these Directions 1998 and the Income-tax Act operate
in different areas. These Directions 1998 have nothing to do with computation
of taxable income. These Directions cannot overrule the ‘permissible
deductions’ or ‘their exclusion’ under the Income-tax Act. The inconsistency
between these Directions and Companies Act is only in the matter of income
recognition and presentation of financial statements. The accounting policies
adopted by an NBFC cannot determine the taxable income. It is well settled that
the accounting policies followed by a company can be changed unless the
Assessing Officer comes to the conclusion that such change would result in
understatement of profits. However, here is the case where the Assessing
Officer has to follow the RBI Directions 1998 in view of section 45Q of the RBI
Act. Hence, as far as income recognition is concerned, section 145 of the
Income-tax Act has no role to play in the present dispute. “

2.4.6 After referring to the above referred
observations of the Apex Court in Southern Technology’s case (supra) and
deciding the issue in favour of the assessee, the Court further stated as under
(pg 452):

“We have also noticed the other line of cases wherein the Supreme Court
itself has held that when there is a provision in other enactment which
contains a non obstante clause, that would override the provisions of the
Income-tax Act. TRO v. Custodian, Special Court Act, 1992 [2007] 293 ITR 369
(SC) is one such case apart from other cases of different High Courts. When the
judgment of the Supreme Court in Southern Technology [2010] 320 ITR 577 is read in manner we have
read, it becomes easy to reconcile the ratio of Southern Technology with TRO v. Custodian, Special Court Act,
[1992] [2007] 293 ITR 369 (SC). Thus viewed from any angle, the decision of the
Tribunal appears to be correct in law. The question of law is thus decided
against the Revenue and in favour of the assessee. As a result, all these appeals are
dismissed.”

CIT vs. Vasistha Chay Vyapar Ltd – [(2019) 410 ITR
244 (SC)]

3.1 At the instance of the Revenue, the above
judgment of the Delhi High Court came up for consideration before the Apex
Court [being Civil Appeal No 5811 of 2012]. Many other appeals [such as appeal
in the Mahila Seva Sahakari Bank Ltd [(2017) 395 ITR 324 (Guj), Brahmaputra
Capital & Financial Services Ltd (2011)335 ITR 182 (Del), etc]
involving similar issue filed by the Revenue were also simultaneously dealt with by the Apex Court while deciding
this common issue.

3.2 Having considered the judgments under
appeal, the Apex Court, agreed with the same and held as under (pg 246):

” Having
gone through the impugned judgment in the aforesaid appeals, we are of the view
that the consideration of the question has been given a full and meaningful reasoning
and we agree with the same.

As a result, all the aforesaid appeals are
dismissed. . . .”

Conclusion.

4.1 In view of the above judgment of the
Apex Court, affirming the judgment of Delhi High Court referred to in para 2
above and other similar judgments involving the same issue, the position is now
settled that interest on NPAs not recognised in the accounts following the RBI
norms cannot be taxed on the ground that the assessee is following Mercantile
System of accounting. The judgment also clearly supports the view that under
such circumstances, interest of NPAs cannot be said to have accrued and
accordingly, can not taxed by invoking the provisions of section 5 of the Act.

4.1.1 Apart from this, the judgment of Delhi High
Court referred to in para 2 above having been affirmed and in that judgment,
relying on the observations of the Apex Court in Southern Technology’s case
[referred to in para 2.4.5 read with the observations referred to para 2.4.6],
the Delhi High Court has, effectively, expressed the view that the provisions
of section 45Q of the RBI Act and the RBI norms override the provisions of the
Act in this respect, and therefore also, such interest on NPA is not taxable
under the Act. In this context, the subsequent judgment of the Punjab &
Haryana High Court in the case of Ludhiana Central Co-op Bank Ltd [(2009)410
ITR 72] is also useful in which the High Court, after considering these
judgments, has clearly taken a view that section 45Q of the RBI Act has overriding effect and therefore,
such interest cannot be held to have accrued under the Act.

4.1.2 In
cases not governed by the RBI norms also, the observations in the Delhi High
Court judgment [referred to in para 2.4.3 above] should be useful in cases of interest on ‘sticky loans’ not
recognised in accounts, if the principle amount of loan itself is genuinely
doubtful of recovery, particularly due to precarious financial condition of the
borrower.

Effect of ICDS

4.2 From the Asst. Year. 2017-18, Business
income and ‘Income from Other Sources’ [Other Income] is required to be
computed in accordance with the provisions made in Income Computation and
Disclosure Standards [ICDS] notified u/s. 145 (2) of the Act. ICDS IV [Revenue
Recognition] also deals with recognition of interest as revenue in para 8. In
this context, answer to question no 13, given in Circular No 10/2017, dtd
23/3/2017 issued by the CBDT is worth
noting and the same is reproduced hereunder:

Question 13:
The condition of reasonable certainty of ultimate collection is not laid down
for taxation of interest, royalty and dividend. Whether the taxpayer is obliged
to account for such income even when the collection thereof is uncertain?

Answer: As
a principle, interest accrues on time basis and royalty accrues on the basis of
contractual terms. Subsequent non recovery in either cases can be claimed as
deduction in view of amendment to Section 36 (1) (vii). Further, the provision
of the Act (e.g. Section 43D) shall prevail over the provisions of ICDS.

4.2.1 The validity of some of the provisions of
different ICDS was challenged before the Delhi High Court in the case of Chamber
of Tax Consultants vs. UOI [(2018) 400 ITR 178 – CTC’s case]. Many of these
provisions of ICDS were held to be ultra vires the Act by the High
Court. Most of these invalidated provisions have been re-validated with
retrospective effect by various amendments made by the Finance Act, 2018 with
which we are not concerned in this write-up.

4.2.2 One
of the items under challenge before the Delhi Court in CTC’s case (supra)
was para 8.1 of the ICDS IV [Revenue Recognition] which provides that interest
shall accrue on time basis to be determined in the specified manner. The main
contention against this provisions was that in case of NBFCs also the interest
would become taxable on this accrual basis, even though such interest is not
recoverable [i.e. because of NPA status of the loan]. The deduction, if any, in
respect of the same can be claimed only u/s. 36(1)(vii) in respect of such
interest [which become the debt] as bad debt in the year in which the amount of
such debt or part thereof becomes irrecoverable without recording the same in
the books
of account.

4.2.3 In
the above context, the counter affidavit filed by the Revenue was as follows
(pgs 211/212):

“The
petitioners completely ignore the fact that this very provision of the ICDS
have been given approval by the highest legislative body, i.e., Parliament by
making an amendment to section 36(1)(vii) of the Act with effect from April 1,
2016 by Finance Act, 2015. The petitioners for furthering their point have
erroneously mentioned that the second proviso to section 36(1)(vii) casts an
additional burden on the assessee to prove that the debt is established to have
become due. In fact, a provision which is for the benefit of the assessees is
being projected to be a provision which is against the interests of
the assessee.

The ICDS
does not in any way wish to alter the well laid down principles of real income
by the Hon’ble Supreme Court, but is actually ensuring that there is a trace
available of the income which is foregone on this concept. Therefore, if there
is an interest income which is not likely to be realized is written off by the
assessee in the very same year immediately on its recognition (and even without
passing through its books), then it would be first recognised as revenue and
then allowed as a deduction under section 36(1)(vii) of the Act, including in
the case of NBFCs. However, in this process, the tax Department would have
information about the income which is so written off and keep a track of the
said sum then realised. Therefore, there is no enlargement of scope of income
or any deviation from the principles laid down by the hon’ble Supreme Court.”

4.2.4 In
view of the above, the Delhi High Court in CTC’s case (supra), while
rejecting the contention raised on behalf of the Petitioner, concluded as under
on this issue (pg 212) :

“Since
there is no challenge to section 36(1)(vii), para 8(1) of ICDS IV cannot be
held to be ultra vires the Act. This is to create a mechanism of tracking
unrecognized interest amounts for future taxability, if so accrued. In fact the
practice of moving debts which the bank or NBFC considers irrecoverable to a
suspense account is a practice which makes the organizations lose track of the
same. The justification by the respondent clearly demonstrates that this is a
matter of a larger policy and has the backing of Parliament with the enactment
of section 36(1)(vii). The reasoning given by the respondent stands to logic.
It has not been demonstrated by the petitioner that para 8(1) of ICDS IV is
contrary to any judgment of the Supreme Court, or any other court.”

4.2.5 Since the Delhi High Court in CTC’s case (supra) accepted the justification of the Revenue,
more so due to amendment made in the provisions of section 36(1)(vii), the High
Court took the view that para 8.1 of ICDS IV cannot be held to be ultra vires
the Act and it has not been demonstrated by the Petitioners that para 8.1 of
ICDS IV is contrary to any judgment of the Apex Court, or any other court. In
view of this, there is no amendment in the Act in this respect and accordingly,
interest income should continue to be governed by this provision of the ICDS.

4.2.6 In view of the judgment of
the Apex Court [referred to in para 3 above] affirming the judgment of the
Delhi High Court [referred to in para 2 above], it is worth exploring to raise
a contention that the said para 8.1 of ICDS is now contrary to the judgment of
the Apex Court. Apart from this, such interest on NPAs cannot be regarded as
accrued as held by the Apex Court and therefore, such interest cannot be
treated as accrued on time basis as contemplated in the ICDS and cannot be
taxed. Additionally, such interest, arguably, can not be taxed also on the
ground that the provisions of RBI Act[ read with RBI norms]overrides the
provisions of the Act as mentioned in para 4.1.1 above. Also due to the fact that the counter affidavit
of the Revenue before the Delhi High Court in CTC’s case (supra)
[referred to in para 4.2.3 above] specifically states that ICDS does not in any
way wish to alter the well laid down principles of real income by the Apex
Court, but is actually ensuring that there is a trace available of the income,
which is foregone in this concept, arguably, applying the real income theory,
such interest income should also not be considered as taxable. This contention should also be available to
the cases referred to in para 4.1.2 above.It may also be noted that, in cases
where interest income is assessable as Other Income, there is no specific
provision to claim deduction of income assessed under ICDS on time basis when
it becomes irrecoverable and this fact has not been considered by the Delhi
High Court in CTC’s case (supra) while dealing with the issue relating
to the said para 8.1 of ICDS IV.

shailesh.kwebmaker

Section 92C: Transfer pricing – Notional interest on Redemption of preference shares money paid to Associated enterprises- transfer pricing adjustments by re-characterising was held to be not legal Corporate guarantee commission – No comparison can be made between guarantees issued by commercial banks as against a corporate guarantee issued by a holding company for benefit of its AE

18.
CIT-6 vs. Aegis Limited [Income tax Appeal no 1248 of 2016 , Dated: 28^th
January, 2019 (Bombay High Court)].

[Aegis Limited vs. ACIT-5(1); dated
27/07/2015; ITA. No 1213/Mum/2014, AY: 2009-10; Bench : K, Mum. ITAT ]

Section 92C: Transfer pricing – Notional
interest on Redemption of preference shares
money paid to Associated enterprises- transfer pricing adjustments by
re-characterising was held to be not legal

Corporate guarantee commission – No
comparison can be made between guarantees issued by commercial banks as against
a corporate guarantee issued by a holding company for benefit of its AE

The assessee subscribed to redeemable
preference shares of its AE and also redeemed some of these shares at par. The
assessee’s case had been that subscription of preference shares does not impact
profit & loss account or taxable income or any corresponding expense
resulting into deduction in the hands of the assessee. Redemption of preference
shares at par represents an uncontrolled price for shares, based on a
comparison with such uncontrolled transaction price and, therefore, such
redemption of preference share should be considered at arms length from Indian
transfer pricing prospective.

During the course of transfer pricing
proceedings, the TPO observed that the preference shares are equivalent to
interest free loan and in an uncontrolled third party scenario, interest would
be charged on such an amount, as these are not in the nature of business
advances. After making reference to FINMMDA guidelines and conducting enquires
from CRISIL u/s. 133(6), he assumed the credit ratings of the AE to be BBB(-)
and on the basis of bond rate information obtained from CRISIL, he determined
the rate of interest at 15.41% and computed the adjustment of Rs. 59,90,19,794/.
The DRP agreed that the TPO’s re-characterisations approach into loan and
charging of interest thereon is correct. However, they did not agree with the
TPO’s approach of imputing the interest using credit rating and Indian bond
yield. They instead directed the Assessing Officer to charge interest rate as
charged by the assessee which was at 13.78% and thereby also directed to add
markup of 1.65%, for risks. They directed the adjustment to made
accordingly.

Being aggrieved
with the DRP order, the assessee filed an appeal to the ITAT. The Tribunal find
that the TPO /Assessing Officer cannot disregarded any apparent transaction and
substitute it, without any material of exception circumstance highlighting that
assessee has tried to conceal the real transaction or some sham transaction has
been unearthed. The TPO cannot question the commercial expediency of the
transaction entered into by the assessee unless there are evidence and
circumstances to doubt. Here it is a case of investment in shares and it cannot
be given different colour so as to expand the scope of transfer pricing
adjustments by re-characterising it as interest free loan. Now, whether in a
third party scenario, if an independent enterprise subscribes to a share, can
it be characterise as loan. If not, then this transaction also cannot be
inferred as loan. The Co-ordinate Benches of the Tribunal have been
consistently holding that subscription of shares cannot be characterises as
loan and therefore no interest should be imputed by treating it as a loan.
Accordingly, the adjustment of interest made by the A.O was deleted.

Being aggrieved
with the ITAT order, the revenue filed an appeal to the High Court. The Court
observed that, we are broadly in
agreement with the view of the Tribunal. The facts on record would suggest that
the assessee had entered into a transaction of purchase and sale of shares of
an AE. Nothing is brought on record by the Revenue to suggest that the transaction
was sham.

In absence of any
material on record, the TPO could not have treated such transaction as a loan
and charged interest thereon on notional basis. Accordingly this ground was
dismissed. Next Ground is adjustment made by TPO in connection with the
corporate guarantee given by the assessee in favour of its AE.

The Tribunal
restricted subject addition to 1% guarantee commission relying upon other
decisions of the Tribunal along similar lines. The TPO had, however, added 5%
by way of commission. Being aggrieved with
the ITAT order, the revenue filed an appeal to the High Court. The Court relied
on the judgment of this Court in the case of Commissioner of Income-tax,
Mumbai v. Everest Kento Cylinders Ltd. [2015] 58 taxmann.com 254 wherein it
has been held that there is a
substantial difference between a bank guarantee and a corporate guarantee.

The ITAT
observed that, the Tribunal applied a
lower percentage of commission in the present case considering that, what the
assessee had provided was a corporate guarantee and not a bank guarantee. The
Revenue appeal was dismissed.

shailesh.kwebmaker

Section 37(1) : Business expenditure–Capital or revenue-Non-compete fee –Allowable as revenue expenditure

17.
Pr CIT-3 vs. Six Sigma Gases India Pvt. Ltd [ ITA no 1259 of 2016 Dated:
28^th January, 2019 (Bombay High Court)].

[Six Sigma Gases India Pvt. Ltd vs..
ACIT-3(3); dated 09/09/2015 ; AY:
2006-07 ITA. No 3441/Mum/2012,
Bench : E ; Mum. ITAT ]

Section 37(1) : Business
expenditure–Capital or revenue-Non-compete fee –Allowable as revenue
expenditure

The assessee is a Private Limited
Company. During the year the assessee had entered into a non-compete agreement
with the original promoter of the Company under which in lieu of payment of
Rs.2.06 crore (rounded off), the promoter would not engage himself in the same
business for a period of five years. Incidentally, the business of the company
was of manufacture of oxygen gases.

The A.O did not
allow the entire expenditure as claimed by the assessee but treated it as
differed revenue expenditure to be spanned over five years period. By the
impugned order, the CIT(A) confirmed the action of the AO.

Being aggrieved
with the CIT (A) order, the assessee filed an appeal to the Tribunal. The
Tribunal by the impugned judgment held in favour of the assessee relying upon
and referring to the decision of this Court in the case of The CIT-1,
Mumbai vs. Everest Advertising Pvt. Ltd., Mumbai dated 14th December, 2012
rendered in Income Tax Appeal No. 6539 of 2010 wherein the Hon’ble
High Court has held that “…..the object of making payment was to derive an
advantage by eliminating the competition over a period of three years and the
said period cannot be considered as sufficiently long period so as to ward off
competition from Mr. Kapadia for a long time in future or forever so as to hold
that benefit of enduring nature is received from such payment. The Tribunal has
recorded a finding that exit of Mr. Kapadia would have immediate impact on the
business of the assessee-company and in order to protect the business interest
the assessee had paid the said amount to ward off the competition…..”

The Revenue
argued that, under the agreement, the assessee would avoid competition from the
erstwhile promoter for a period of five years. The assessee thus acquired an
enduring benefit. The expenditure should have been treated as a capital
expenditure.

The assessee submitted that, the
assessee did not receive any enduring benefit out of the agreement. Under the
non-compete agreement, the asssessee had received a immediate benefit by
avoiding the possible competition from the original promoters of the Company.

Being aggrieved with the ITAT order,
the revenue filed an appeal to the High Court. The Court find that the Madras
High Court in the case of Asianet Communications Ltd. vs. CIT, Chennai
reported in 257 Taxman 473 also treated the expenditure as revenue in
nature in a case where the non compete agreement was for a period of five yers
holding that the same did not result into any enduring benefit to the assessee.
Similar view was expressed by the same Court in the case of Carborandum
Universal Ltd. vs. Joint Commissioner of Income-tax, Special Range-I, Chennai,
reported in [2012] 26 taxmann.com 268. It can thus be seen that, looking to
the nature of non-compete agreement, as also the duration thereof, the Courts
have recognised such expenditure as Revenue expenditure. In the present case,
the assessee had subject agreement with the promoter of the Company to avoid
immediate competition. The business of the assessee company continue. No new
business was acquired. The benefit therefore was held by the Tribunal
instantaneous.

Accordingly appeal of revenue was
dismissed.

shailesh.kwebmaker

Section 263 : Commissioner- Revision – Book profit – only power vested upon the Revenue authorities is the power of examining whether the books of accounts are certified by the authorities under the Companies Act – Revision was not valid. [Section 115JB]

It
started in January, 1971 as “High Court News”. Dinesh Vyas, Advocate, started
it and it contained unreported decisions of Bombay High Court only. Between
January, 1976 and April, 1984, it was contributed by V H Patil, Advocate as “In
the Courts”. The baton was passed to Keshav B Bhujle in May, 1984 and he
carries it even today – and that’s 35 years of month on month contribution.
Ajay Singh joined in 2016-17 by penning Part B – Unreported Decisions.

16.
The Pr. CIT-1 vs. Family Investment Pvt. Ltd [ Income tax Appeal no:
1669 of 2016 Dated: 28^th January, 2019 (Bombay High
Court)].

[Family Investment Pvt. Ltd vs. The Pr.
CIT-9; dated 02/12/2015 ; ITA. No 1945/Mum/2015, AY:2010-11; Bench
F Mum. ITAT]

Section 263 : Commissioner- Revision – Book
profit – only power vested upon the Revenue authorities is the power of
examining whether the books of accounts are certified by the authorities under
the Companies Act – Revision was not valid. [Section 115JB]

The assessee-company is engaged in the
business of dealing in shares and securities under the Portfolio Management
Scheme. While framing the assessment order u/s. 143(3) of the Act, the A.O
observed that 15% of Book Profit is less than the tax payable on the income assessed
under the normal provision of the Act, provisions of section 115JB of the Act
will not apply. Hence, for the purpose of taxation, total income shall be taken
as per the normal provisions of the Act. This order did not find favour with
the Principal CIT who vide notice u/s. 263 of the Act dated 22^nd
September, 2014 sought to set aside the assessment order holding it to be
erroneous and prejudicial to the interest of the Revenue.

Being aggrieved
with the Pr.CIT order, the assessee filed an appeal to the Tribunal. The
Tribunal held that it can be seen that the only power vested upon the Revenue
authorities is the power of examining whether the books of accounts are
certified by the authorities under the Companies Act. It is not the case of the
Pr. CIT that the books of account have not been properly certified by the
authorities under the Companies Act, therefore the observations of the Pr. CIT
is not acceptable. The second contention of the Principal CIT is that the AO
has not examined this issue during the course of the assessment proceedings.

The Court observed that vide letter dated 7^th
December, 2012, the assessee has furnished (a) ledger account of donation u/s.
80G alongwith donation receipts (b) copy of acknowledgement of return of income
and balance sheet and profit and loss account of Shantilal Shanghvi Foundation
alongwith all its schedule. Thus, it can be seen that in response to a specific
query, the assessee has filed all the related details alongwith supporting
evidences. Therefore, it cannot be said that the AO has not examined this issue
during the course of assessment proceedings. The AO has thoroughly examined the
claim, therefore ITAT set aside the order of the Principal CIT.

Being aggrieved with the ITAT order,
the Revenue filed an appeal to the High Court. The Court observed that on
perusal of the documents on record with the assistance of the learned counsel
for the parties would show that the Tribunal proceeded to allow the appeal
principally on two grounds.

Apart from these observations of the
Tribunal, independently the court observed that during the year under
consideration the assessee had committed to a total donation of Rs.12.75 crore,
out of which Rs.10.25 crore was actually donated during the period relevant to
the assessment year in question. Out of the remaining Rs. 2.50 crore, Rs. 2
crore was donated in the next year, but even before the date of closing of the
account of the present year and remaining Rs.50 lakh was donated shortly after
that. In view of such facts, we do not see any reasons to interfere.

The court also took the note of the
fact that the decision of the Supreme Court in case of Apollo Tyres is referred
to larger bench. In the result, appeal is dismissed.

shailesh.kwebmaker

Section 194C and 194-I – TDS – Works contract/rent – Assessee refining crude oil and selling petroleum products – Agreement with another company for transportation of goods – Agreement stipulating proper maintenance of trucks – Not conclusive – Payment covered by section 194C and not section 194-I

58. CIT(TDS) vs. Indian Oil Corporation
Ltd.; 410 ITR 106 (Uttarakhand) Date of order: 6^th March, 2018

Section 194C and 194-I – TDS – Works
contract/rent – Assessee refining crude oil and selling petroleum products –
Agreement with another company for transportation of goods – Agreement
stipulating proper maintenance of trucks – Not conclusive – Payment covered by
section 194C and not section 194-I

The assessee-company was engaged in refining
crude oil and storing, distributing and selling the petroleum products and for
this purpose required tank trucks for road transportation of bulk petroleum
products from its various storage points to customers or other storage points.
For this purpose, it entered in to an agreement with another company which was
operating trucks. The assesse deducted tax at source u/s. 194C of the Act in
respect of payments to the said company.

The Commissioner (Appeals) held that the tax
was deductible u/s. 194C and not u/s. 194-I. The Tribunal upheld this. On
appeal by the Revenue, the Uttarakhand High Court upheld the decision of the
Tribunal and held as under:

“i) Modern transportation contracts are fairly
complex having regard to various requirements, which fall to be fulfilled by
the contracting parties. Conditions like maintaining the tank trucks in sound
mechanical condition and having all the fittings up to the standards laid down
by the company from time to time would not make it a contract for use.

ii) The tenor of the contract showed that the
parties to the contract understood the agreement as one where the carrier would
be paid transport charges and that too for the shortest route travelled by it
in the course of transporting the goods of the assessee from one point to
another. It unambiguously ruled out payment of idle charges. It also made it
clear that there was no entitlement in the carrier to any payment dehors the
actual transporting of the goods.

iii) The carrier under the contract was
undoubtedly obliged to maintain the requisite number of trucks of a particular
type subject to various restrictions and conditions, but it was under the
obligation to operate the trucks for the purpose of transporting the goods
belonging to the assesse. Therefore, use of the words “exclusive right to use
the truck” found in clause 1 and also in clause 6(e) would not by itself be
decisive of the matter. Even after the amendment to the Explanation u/s. 194-I,
the case would not fall within its scope as it was a case of a contract for
transport of goods and, therefore, a contract of work within the meaning of
section 194C and not one which fell within the Explanation to section 194-I,
namely use of plant by the assessee.”

shailesh.kwebmaker

Sections 9, 147 and 148 of ITA 1961 and Article 11 of DTAA between India and Mauritius – Reassessment – Income – Deemed to accrue or arise in India (Interest) – Where Assessing Officer, during assessment had accepted claim of assessee that it was entitled to benefit of India Mauritius DTAA, assessment could not have been reopened on ground that assessee did not carry out bona fide banking activities in Mauritius

57. HSBC Bank (Mauritius) Ltd. vs. Dy. CIT;
[2019] 101 taxmann.com 206 (Bom) Date of order: 14^th January, 2019 A. Y. 2011-12

Sections 9, 147 and 148 of ITA 1961 and
Article 11 of DTAA between India and Mauritius – Reassessment – Income – Deemed
to accrue or arise in India (Interest) – Where Assessing Officer, during
assessment had accepted claim of assessee that it was entitled to benefit of
India Mauritius DTAA, assessment could not have been reopened on ground that
assessee did not carry out bona fide banking activities in Mauritius

The assessee was a Banking Company
registered under the laws of Mauritius. For the A. Y. 2011-12, the assessee
filed its return of income declaring nil income. In the return, the assessee
had shown interest income of Rs. 238.01 crores and claimed the same to be
exempt from tax in India. This amount comprised of income on securities of Rs.
94.57 crore and interest income on External Commercial Borrowings (ECB) of Rs.
143.43 crore. According to the assessee, such income was not taxable in India
by virtue of DTAA between India and Mauritius. The Assessing Officer on
scrutiny, passed order u/s. 143(3) in which he added a sum of Rs.94.57 crore to
the total income of the assessee by rejecting the assessee’s claim of such
income on securities not being taxable in India. He however did not disturb the
assessee’s claim of interest income on ECB being not taxable. After four years,
the Assessing Officer issued notice to reopen assessment in case of assessee on
ground that banking activities carried out by assessee locally in Mauritius
were for namesake and assessee had failed to make true and full disclosure
regarding its beneficial ownership status. The assessee on being supplied
reasons for reopening assessment raised objections to the notice of reopening
of assessment. The Assessing Officer, however, rejected said objections.

The assessee filed writ petition and
challenged the validity of reopening. The Bombay High Court allowed the writ
petition filed by the assessee and held as under:

“i) The perusal of the reasons recorded by the
Assessing Officer would show that the only ground on which the notice of
reopening of assessment is issued was the assessee’s claim of exemption of
interest income which in turn was based on DTAA between India and Mauritius.
According to the Assessing Officer, the assessee had attempted to misuse the
DTAA since according to him, the assessee did not carry out banking business in
the said country.

ii) In this context, it is noted that the entire
claim had come up for consideration before the Assessing Officer during the
original scrutiny assessment. During such assessment, the Assessing Officer had
noted the assessee’s claim of exemption of interest on ECB made in the return
filed. In written query dated 21/10/2013, the Assessing Officer had asked the
assessee to explain several issues and called for documents.

iii) It was after detailed examination that the
Assessing Officer passed the order of assessment on 28/01/2016 in which he
disallowed the assessee’s claim of exempt interest of Rs. 94.57 crore which
related to interest on securities. He, however, did not tamper with the
assessee’s claim of exempt interest of Rs. 143.43 crore which was interest on ECB.
Thus, the entire issue was minutely examined by the Assessing Officer during
the original scrutiny assessment. To the extent, the Assessing Officer was not
satisfied with the assessee’s claim of exempt interest, the same was
disallowed. However, in the context of assessee’s claim of exempt interest of
Rs. 143.43 crore, by virtue of DTAA between India and Mauritius, the Assessing
Officer accepted the same.

iv) This very issue now the Assessing Officer
wants to re-examine during the process of reassessment. For multiple reasons,
same would be wholly impermissible. Firstly, as noted, the entire issue is a
scrutinised issue. This would be based on mere change of opinion and would be
impressible as held by series of judgments of the various Courts.

v) Quite apart, the impugned notice has been
issued beyond the period of four years from the end of relevant assessment
year. There is nothing in the reasons recorded to suggest that there was any
failure on the part of the assessee to disclose truly and fully all material
facts which led to the income chargeable to tax escaping assessment. In fact,
the perusal of the reasons would show that the Assessing Officer was merely
proceeding on the material already on record. Even on this ground, the impugned
notice should be set aside.

vi) In the result, the impugned notice is set
aside. Petition is allowed and disposed of accordingly.”

shailesh.kwebmaker

Section 144, 147 and 148 – Reassessment – Service of notice u/s. 148 – Notice sent to old address – Assessee’s returns for earlier years already on file and reflecting new address – Issue of notice at old address mechanically – Notice and order of reassessment and consequential attachment of bank accounts – Liable to be quashed

56. Veena Devi Karnani vs. ITO; 410 ITR 23
(Del) Date of order: 14^th September,
2018 A. Y. 2010-11

Section 144, 147 and 148 – Reassessment –
Service of notice u/s. 148 – Notice sent to old address – Assessee’s returns
for earlier years already on file and reflecting new address – Issue of notice
at old address mechanically – Notice and order of reassessment and
consequential attachment of bank accounts – Liable to be quashed

In the F. Y. 2010-11, the assessee shifted
her residence and filed returns of income under the same permanent account
number and e-mail ID. The returns disclosed the changed address. For the A. Y.
2010-11, the Assessing Officer sent a series of notices u/s. 148 of the Act for
reopening the assessment to the assessee’s old address. As there was no
response, the reassessment was completed on best judgment basis and an ex-parte
order was passed u/s. 144 read with 147. Upon issuance of an attachment order
to satisfy the demand raised in the reassessment order, the assessee filed a
writ petition contending that the reassessment proceedings were a nullity
because the notice was never served upon her and that the Assessing Officer did
not comply with the provisions of Rule 127 of the Income-tax Rules, 1962 which
stipulated examining the permanent account number database or the subsequent
years returns to ascertain the correct address of the assessee.

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

“i) Rule 127(2) states that the addresses to
which a notice or summons or requisition or order or any other communication
may be delivered or transmitted shall be either available in the permanent
account number database of the assesse or the address available in the
income-tax return to which the communication relates or the address available
in the last income-tax return filed by the assesse. All these options have to
be resorted to by the concerned authority, in this case the Assessing Officer.

ii) When the Assessing Officer issued the
reassessment notice on December 13, 2013, he was under a duty to access the
available permanent account number database of the addressee or the address
available in the income-tax return to which the communication related or the
address available in the last return filed by the addressee. The return for the
A. Ys. 2011-12 and 2012-13 had already been filed on 22/02/2012 and 13/12/2012
respectively, reflecting the changed address but with the same permanent
account number and before the same Assessing Officer.

iii) The Assessing Officer had omitted to access
the changed permanent account number database and had mechanically sent notices
to the old address of the assessee. The subsequent notices u/s. 142(1) were
also sent to the old address and the reassessment proceedings were completed on
best judgment basis. The Assessing Officer had mechanically proceeded on the
information supplied to him by the bank without following the correct procedure
in law and had failed to ensure that the reassessment notice was issued
properly and served at the correct address in the manner known to law.

iv) The reassessment notice issued u/s. 148, the
subsequent order u/s. 144 r.w.s. 147 and the consequential action of attachment
of the assessee’s bank accounts were quashed.”

shailesh.kwebmaker

Section 5 – Income – Accrual of income – Telecommunication service provider – Payments received on prepaid cards – Liability to be discharged at future date – To the extent of unutilised talk time payment did not accrue as income in year of sale – Unutilised amount is revenue receipt when talk time is actually used or in case of cards that lapsed on date when cards lapsed

55. CIT vs. Shyam Telelink Ltd.; 410 ITR 31
(Del) Date of order: 15^th November,
2018 A. Ys. 2003-04, 20004-05 and 2009-10

Section 5 – Income – Accrual of income –
Telecommunication service provider – Payments received on prepaid cards –
Liability to be discharged at future date – To the extent of unutilised talk
time payment did not accrue as income in year of sale – Unutilised amount is
revenue receipt when talk time is actually used or in case of cards that lapsed
on date when cards lapsed

The assessee provides basic
telecommunication services and had both prepaid and post paid subscribers. The
prepaid subscribers were billed on the basis of actual talk time. According to
the Department, in respect of the prepaid cards, the assessee was to account
for and include the entire amount paid on the date of purchase of the prepaid
cards by the subscribers and the date of purchase of the prepaid card was the
date when the income accrued to the assessee.

However, the assesse recognised the revenue
on prepaid cards on the basis of the actual usage and carried forward the
unutilised amount outstanding on the prepaid cards, if any, at the end of the
financial year to the next year. The unutilised amount was treated as advance
in the balance sheet and recognised as revenue in the subsequent year, when the
talk time was actually used or was exhausted when the cards lapsed on expiry of
stipulated time.

The Tribunal held that the amount received
on the sale of prepaid cards to the extent of unutilised talk time did not
accrue as income in the year of sale. On appeal by the Revenue, the Delhi High
Court upheld the decision of the Tribunal and held as under:

“i) The payments made on account of the prepaid
cards by the subscribers was an advance subject to the assesse providing basic
telecommunication services as promised, failing which the unutilised amount was
required to be refunded to the prepaid subscribers. The apportionment of the
prepaid amount was contingent upon the assessee performing its obligation and
rendering services to the prepaid customers as per the terms. If the assesse
failed to perform the services as promised, it was under an obligation to
refund the advance payment received under the ordinary law of contract or
special enactments, such as Consumer Protection Act, 1986.

ii) The Tribunal was right in
holding that the amount received on the sale of prepaid cards to the extent of
unutilised talk time did not accrue as income in the year of sale. In the case
of prepaid cards that lapsed, the unutilised amount had to be treated as income
or receipt of the assessee on the date when the cards had lapsed. The Assessing
Officer was to compute the assessees income accordingly while he gave effect to
the order of the Tribunal.”

shailesh.kwebmaker

Section 80P(1), (2)(a)(i) – Co-operative society – Co-operative bank – Deduction u/s. 80P(1), (2)(a)(i) – Income from sale of goods for public distribution system of State Government – Ancillary activity of credit society – Entitled to deduction

54. Kodumudi Growers Co-operative Bank Ltd.
vs. ITO; 410 ITR 218 (Mad) Date of order: 31^st October, 2018 A. Y. 2005-06: Ss. 80P(1), (2)(a)(i) of ITA 1961:

Section
80P(1), (2)(a)(i) – Co-operative
society – Co-operative bank – Deduction u/s. 80P(1), (2)(a)(i) – Income from
sale of goods for public distribution system of State Government – Ancillary
activity of credit society – Entitled to deduction

The assessee-society was in the business of
banking and provided credit facilities to its members. For the A. Y. 2005-06 it
filed Nil return. The Assessing Officer computed the assessee’s income at Rs.
22,16,211/- of which a sum of Rs. 2,55,118/- represented income on account of sale
of goods for the public distribution system of the Government of Tamil Nadu.
The Assessing Officer was of the view that such activity was not related to the
assessee’s banking activity and held that the income that arise therefrom was
not allowable as deduction u/s. 80P(2)(a) of the Income-tax Act, 1961
(hereinafter for the sake of brevity referred to as the “Act”) but
included such income for consideration in the overall deduction allowable u/s.
80P(2)(c)(ii) which amounted to Rs. 50,000/-.

The Commissioner (Appeals) and the Tribunal
upheld the decision of the Assessing Officer.

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

“i) The activity undertaken by the assesse was
not one which it was not authorized to do. The assessee was entitled to
distribute the items under the public distribution system. The bye-laws
themselves provided for such an activity as an ancillary activity by the
assesse. Furthermore, the assesse was bound by the directives issued by the
Government as well as the Registrar of Co-operative Societies. The fair price
shops were opened based on the directions opened by the Government as
communicated by the Registrar of Co-operative Societies and the District
Collector. Therefore, the activity done by the assesse could not be truncated
from the activity as a credit society and the authorities below had committed
an error in denying the special deduction.

ii) The assessee was entitled to the benefit of
deduction u/s. 80P(1) r.w.s. 80P(2)(a)(i).

iii) The tax appeal is allowed. The orders passed
by the authorities below are set aside and the substantial question of law is
answered in favour of the assessee. The Assessing Officer is directed to extend
the benefit of deduction u/s. 80P(1) r.w.s. 80P(2)(a)(i) to the
appellant/assessee.”

shailesh.kwebmaker

Business income or long-term capital gain – Income from shares and securities held for period beyond 12 months – Investments whether made from borrowed funds or own funds of assessee – No distinction made in circular issued by CBDT – Department bound by circular – Profit is long term capital gain

53. Principal CIT vs. Hardik Bharat Patel;
410 ITR 202 (Bom): Date of order: 19^th November,
2018 A. Y. 2008-09

Business income or long-term capital gain –
Income from shares and securities held for period beyond 12 months –
Investments whether made from borrowed funds or own funds of assessee – No
distinction made in circular issued by CBDT – Department bound by circular –
Profit is long term capital gain

For the A. Y. 2008-09, the Tribunal directed
the Assessing Officer to treat the profit of the assessee that arose out of the
frequent and voluminous transactions initiated with borrowed funds in shares as
“long term capital gains” instead of as business income following its order for
the earlier assessment year. The Department filed appeal before the High Court
and contended that the amount invested in shares by the assessee was out of
borrowed funds and therefore, the profit was to be treated as business income
and not as long-term capital gains. The Bombay High Court upheld the decision
of the Tribunal and held as under:

“i) According to Circular No. 6 of 2016 dated
February 29, 2016, issued by the CBDT, with regard to the taxability of surplus
on sale of shares and securities, whether as capital gains or business income
in the case of long term holding of shares and securities beyond 12 months, the
assessee has an option to treat the income from sale of listed shares and
securities as income arising under the head “Long-term capital gains”. However,
the stand once taken by the assessee would not be subject to change and
consistently the income on the sale of securities which are held as investment
would continue to be taxed as long-term capital gains or business income as
opted by the assessee. The circular makes no distinction whether the
investments made in shares were out of borrowed funds or out of its own funds.

ii) The Department was bound by Circular No. 6
of 2016 dated February 29, 2016 issued by the CBDT and the distinction which
had been sought to be made by the Department could not override the circular
which made no distinction whether the investments made in shares were out of
borrowed funds or out of the assessee’s own funds. No substantial question of
law. Hence not entertained.”

shailesh.kwebmaker

Section 37 (1) and 41 (1) – A. Business expenditure – Allowability of (Illegal payment) – Where assessee had purchased oil from Iraq and payments were made by an agent, there being no evidence to suggest that assessee had made any illegal commission payment to Oil Market Organisation of Iraqi Government as alleged in Volckar Committee Report, Tribunal’s order allowing payment for purchase of oil was to be upheld

52. CIT-LTU vs. Reliance Industries Ltd.;
[2019] 102 taxmann.com 142 (Bom) Date of order: 15^th January, 2019

Section 37 (1) and 41 (1) – A. Business expenditure – Allowability of
(Illegal payment) – Where assessee had purchased oil from Iraq and payments
were made by an agent, there being no evidence to suggest that assessee had
made any illegal commission payment to Oil Market Organisation of Iraqi
Government as alleged in Volckar Committee Report, Tribunal’s order allowing
payment for purchase of oil was to be upheld

The assessee claimed deduction towards the
payment for purchase of oil. The Assessing Officer’s case was that assessee had
paid illegal commission for purchase of such oil to State Oil Marketing
Organisation and therefore, such expenditure was not allowable.

The Commissioner (Appeals), while reversing
the disallowance made by the Assessing Officer, observed that there was no
evidence that the assessee had paid any such illegal commission. He noted that
except for the Volcker Committee Report, there was no other evidence for making
such addition. He noted that even in the said report, there was no finding that
the assessee had made illegal payment and it appeared that the payments were
made by an agent and there was no evidence to suggest that the assessee had
made any illegal commission payment to Iraq Government. The Tribunal confirmed
the view of Commissioner (Appeals).

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

“The entire issue is based on appreciation
of materials on record and is a factual issue. No question of law arises.”

B. Deemed income u/s. 41(1) – Remission or
cessation of trading liability (Claim for deduction) – Where on account of
attack on World Trade Centre, financial market, collapsed and market value of
bonds issued by assessee was brought down below their face value and, hence,
assessee purchased its own bonds and extinguished them, profit gained in
buy-back process could not be taxable u/s. 41(1) as assessee had not claimed
deduction of trading liability in any earlier year

The assessee had issued foreign currency
bonds in the years 1996 and 1997. On account of the attack on World Trade
Centre at USA on 11/09/2001, financial market collapsed and the investors of
debentures and bonds started selling them which in turn brought down the market
price of such bonds and debentures which were traded in the market at a value
less than the face value. The assessee purchased such bonds and extinguished
them. In the process of buy back, the assessee gained a sum of Rs. 38.80 crore.
The Assessing Officer treated such amount assessable to tax in terms of section
41(1).

The Commissioner (Appeals) and the Tribunal,
however, deleted the same. The Tribunal in its detail discussion came to the
conclusion that the liability arising out of the issuance of bonds was not a
trading liability and therefore, section 41(1) would have no applicability.

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

“i) There
is no error in the view taken by the Tribunal. Sub-section (1) of section 41 provides
that where an allowance or deduction has been made in the assessment for any
year in respect of loss, expenditure or trading liability incurred by the
assessee and subsequently, during any previous year, such liability ceases, the
same would be treated as the assessee’s income chargeable to tax as income for
previous year under which subject extinguishment took place. The foremost
requirement for applicability of sub-section (1) of section 41, therefore, is
that the assessee has claimed any allowance or deduction which has been granted
in any year in respect of any loss, expenditure or trading liability. In the
present case, the revenue has not established these basic facts. In other
words, it is not even the case of the revenue that in the process of issuing
the bonds, the assessee had claimed deduction of any trading liability in any
year. Any extinguishment of such liability would not give rise to applicability
of sub-section (1) to section 41.

ii) For
applicability of section 41(1), it is a sine qua non that there should
be an allowance or deduction claimed by the assessee in any assessment year in
respect of loss, expenditure or trading liability incurred by the assessee.
Then, subsequently, during any previous year, if the creditor remits or waives
any such liability, then the assessee is liable to pay tax under section 41.
This question, therefore, does not require any consideration.”

shailesh.kwebmaker

Section 194H – TDS – Commission – Definition – Manufacture and sale of woolen articles – Trade discounts allowed to agents who procured orders and sold goods on behalf of assessee – Not commission – Consistent trade practice followed by assessee – Concurrent finding by appellate authorities – No liability to deduct tax at source

40. CIT vs. OCM India Ltd.; 408 ITR 369
(P&H): Date of order: 9^th May, 2018 A. Y. 2008-09

Section 194H – TDS – Commission –
Definition – Manufacture and sale of woolen articles – Trade discounts allowed
to agents who procured orders and sold goods on behalf of assessee – Not
commission – Consistent trade practice followed by assessee – Concurrent
finding by appellate authorities – No liability to deduct tax at source

The assessee
manufactured and sold woolen articles. During inspection of the office records
of the assesee it was found that the assessee debited an amount of Rs.
4,57,52,494, to the account of trade turnover discounts which had been netted
out from the gross turnover and did not appear as an item of expense in the
profit and loss account. The assessee submitted before the Assessing Officer
that the commission or brokerage arose on account of agency transactions which
did not attract deduction of tax at source for the services rendered by the
third party. The Assessing officer held that the amount being turnover discount
was directly or indirectly for the services rendered according to the inclusive
definition of the Explanation to section 194H of the Act and that the assessee
was liable to deduct the tax at source. A demand of Rs. 47,12,507 on account of
TDS and a further amount of Rs. 6,59,751 on account of interest charged u/s.
201(1A) was raised.

The Commissioner
(Appeals) held that the assessee had been debiting commission which amounted to
Rs. 1.84 crore to its commission agents appointed territory-wise who acted and procured
orders or effected sales of the assessee’s products for and on its behalf and
got commission which varied from place to place and quality of the product to
product and therefore, the Assessing officer was not justified in invoking the
provisions of section 194H read with its Explanation to the trade discount
allowed by the assessee to its buyers, customers and direct trade dealers
without involvement of any intermediator or commission agents. Accordingly, he
held that the assessee was not liable under the provisions of section 194H read
with its Explanation and deleted the demand of Rs. 53,72,258. The findings were
affirmed by the Tribunal which held that there was no material on record before
the Assessing officer that such discount offer was a commission within the
meaning of section 194H.

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

“i) On a plain reading of section 194H, it is
clear that tax at source is to be deducted by a person responsible for paying
any income by way of “commission or brokerage”. The expression “commission or
brokerage” referred to in this section derives its meaning from the explanation
appended thereto. According to it, “commission or brokerage” includes any
payment received or receivable directly or indirectly by a person acting on
behalf of another person (a) for services rendered (not being professional
services), or (b) for any services in the course of buying or selling of goods,
or (c) in relation to any transaction relating to any asset, valuable article
or thing, not being securities. In order to examine whether Explanation (i) to
section 194H of the Act is attracted, necessarily, it is to be seen whether the
assessee has made any payment and, in case it is so, whether it is for services
rendered by the payee to the assessee.

ii) Since concurrent findings had been recorded
by the Commissioner (Appeals) and the Tribunal that the assessee had been
debiting trade discount allowed to its commission agents who were acting and
procuring orders or effecting sales of its products for and on its behalf, the
Assessing Officer was not justified to have invoked the provisions of the
Explanation to section 194H. The Department had not been able to show any error
or illegality therein.”

shailesh.kwebmaker

Section 45: Capital gains –Business income- Investment in shares- A company can have two portfolio – investor and a trader at the same time- Investment was held to be assessable as short term capital gains. [Section 28i)]

10. The Pr. CIT-12 vs. Business Match Services (I)
Pvt. Ltd [ Income tax Appeal no 699 of 2016 Dated: 27^th November, 2018 (Bombay High Court)].

[Business Match Services (I) Pvt. Ltd vs.
DCIT; dated 19/08/2015 ; ITA. No 7267/M/2010, AY: 2007-08 and 2008-09, Bench B,
Mum. ITAT ]

Section
45: Capital gains –Business income- Investment in shares- A company can have
two portfolio – investor and a trader at the same time- Investment was held to
be assessable as short term capital gains. [Section 28i)]

The assessee company is engaged in the business of providing
consultancy services in the field of private placement of shares to foreign
institutional investors, financial institutions.

During the two years under consideration, the assessee also dealt in
purchase and sale of shares. It declared a portion of profits arising on sale
of shares as Short term Capital Gain (STCG) and the remaining portion was offered
as its business income, i.e. the assessee has maintained separate portfolios
for investment and trading assets. In both the years under consideration, the
AO did not agree with the claim of STCG declared by the assessee and
accordingly assessed the same as business income.

The CIT(A) confirmed the view of the A.O, upon which, the issue
reached the Tribunal at the hands of the Assessee.

Being aggrieved with the order of the CIT(A), the assessee filed the
Appeal before ITAT. The Tribunal find that the AO has considered all the shares
together to take the view that the assessee has indulged in trading in shares.
However, the fact remains that the assessee itself has offered gains arising on
shares held as trading stock as its business income. The assessee has claimed
the gains arising on sale of Adani Enterprises Limited only as Short Term
Capital Gain with the claim that it has held the same as its investment. It is
now well settled proposition that a person is entitled to maintain two separate
portfolios, one for its investment and another one for its trading assets. For
this proposition, it relied on to the Circular No.4/2007 dated 15/06/2007
issued by the CBDT and also the decision rendered by Hon’ble High Court
in the case of Gopal Purohit (2010) (228 CTR 582). In the instant case,
the A.O has not disproved the claim of the assessee that it has maintained two
different portfolios as discussed above. Even though the Ld. CIT(A) has
observed that the question whether transactions were in the nature of trade or
otherwise is largely dependent upon the facts of each case, yet we are of the
view that the Ld CIT(A) has not properly appreciated the facts prevailing in
the instant case. The Tribunal held that the intention of the assessee at the
time of purchase of shares of Adani Enterprises Limited was to hold it as its
investments. The A.O has not brought any material on record to show the
contrary, which means that the AO has arrived at the adverse conclusion only on
surmises. Accordingly, the gains arising on its sale should be assessed as
Short term capital gains only. Accordingly, the gains arising on sale of shares
of Adani Enterprises Limited under the head “Income from Capital gains.” In the
earlier year also, Assessee had claimed capital gain out of its sale of shares.
Same was accepted by the A.O.

Being aggrieved with the order of the ITAT, the Revenue filed the
Appeal before High Court. The Court observed that the dispute pertains only to
one scrip namely the shares of M/s. Adani Enterprise Ltd., Assessee had
purchased the shares in installments and after holding them for some time, sold
them also in installments. Thus, there were no instances of repetitive purchase
and sale of shares. From the balance sheet, it could be gathered that the
Assessee had used its own funds or interest free funds, borrowed from the
Directors of the Company in order to purchase the shares. The Assessee had
taken physical delivery of the shares and in the books of account, treated the
same as an investment. Inter alia, on said grounds, Tribunal had ruled in
favour of the Assessee. Whether the purchase and sale of shares is in the
nature of investment or business venture, would depend on facts and
circumstances of each case. There are judicially laid down guidelines and parameters
to judge whether in a case, the sale of shares would give rise to business
income or capital gain. In the present case, the Tribunal has applied the
correct parameters to the facts, emerging from the record. The revenue appeal
was dismissed.

shailesh.kwebmaker

TAXABILITY OF LOAN WAIVER POST SC DECISION IN CASE OF MAHINDRA & MAHINDRA

Introduction

The decision
of the Supreme Court (SC) in the case of Commissioner vs. Mahindra &
Mahindra Ltd.¹
(Mahindra’s case) is a landmark ruling in the context of tax treatment
of loan waiver benefit obtained by a tax payer. The SC held that such waiver is
neither taxable as business perquisite u/s. 28(iv)² of the Income-tax Act 1961 (ITA), nor taxable
as remission of trading liability u/s. 41(1)³of the ITA.

The SC delivered the judgement after hearing a
batch of connected appeals with the lead case being that of Mahindra. In most
cases before the SC, the loan was utilised by the assessee for acquiring capital
assets (including in Mahindra’s case). But, there were also cases where the
loan was utilised by the assessee for working capital purposes. The SC has
delivered the judgment by analysing the fact pattern of Mahindra’s case as the
lead case.

To understand
the controversy in greater detail, it is worthwhile to revisit the history of
judicial development on this aspect.

OLD ENGLISH RULING ON NON – TAXABILITY OF REMISSION OF LIABILITY

As far back
as 1932, the House of Lords in the British Mexican Petroleum Company Limited
vs. The Commissioners of Inland Revenue⁴ (British case) dealt
with a case where the tax payer used to purchase raw material from a supplier
who was also the promoter of the company. At a later date, there was remission
or waiver of indebtedness (including indebtedness which arose due to supplies
effected during the year of remission). The release from liability was not
regarded as a ‘trading receipt’. The Court held “how on earth the
forgiveness in that year of a past indebtedness can add to those profits, I
cannot understand”.

_________________________________________

1 [2018]
404 ITR 1

2 Section
28(iv) of the ITA provides for taxation under the head ‘Profits and gains from
Business or Profession’ of value of any benefit or perquisite whether
convertible into money or not arising from business or profession

3 Section
41(1) of the ITA provides for business taxation of any loss, expenditure or
trading liability which is claimed in past years in the year of remission or
cessation of such loss, expenditure or trading liability.

4 (16
Tax Cases 570) (HL)

BRITISH CASE FOLLOWED BY INDIAN JUDICIARY

In the case
of Mohsin Rehman Penkar vs. CIT⁵ before the Bombay High Court
(HC), there was waiver of loan (including waiver of interest expense
component).Following the ratio of the British case, the Bombay HC held “it
is impossible to see how a mere remission which leads to the discharge of the
liability of the debtor can ever become income for the purposes of taxation”.

The ratio of these decisions was followed in the
following illustrative cases dealing with (a) waiver of a trading liability,
e.g. payable towards trading goods, or interest expense, allowed as deduction
from income, (b) waiver of a loan used for working capital purposes, and (c)
waiver of loan used for fixed capital.

Illustratively,
the following cases dealt with waiver of trading liability:

Agarchand Chunnilal vs.
CIT [1948] 16 ITR 430 (Nagpur HC) (A.Y. 1943-44)

C.I.T. vs. Kerala Estate
Moorlad Chalapuram [1986] 161 ITR 155(SC)(A.Y. 1964-65)

Further,
the following cases dealt with waiver of
loan used for trading purposes:

CIT vs. Phool Chand Jiwan
Ram [1995] 131 ITR 37 (Delhi)(A.Y. 1957-58)

Further, the
following cases dealt with waiver of loan used for fixed capital purposes:

Mahindra & Mahindra Ltd
vs. CIT [2003] 261 ITR 501(Bom HC) (A.Y. 1976-77);

Iskraemeco Regent Ltd vs.
CIT [2010] 331 ITR 317(Mad HC (A.Y. 2001-02).

5 [1948] 16 ITR
183

STATUTORY INTERVENTION TO OVERCOME THE RATIO OF BRITISH CASE RESTRICTED TO REMISSION OF TRADING LIABILITY

To overcome
the ratio of British case, a new s/s. (2A) was added in section 10 of the
Indian Income-tax Act 1922 (erstwhile ITA), whereby waiver of trading liability
was expressly made liable to tax by treating the waiver or remission as profits
and gains of business chargeable to tax as such.

Section 41(1)
of ITA is successor to section 10(2A) of the erstwhile ITA. Section 41(1)
fictionally treats any amount or benefit received by way of remission or
cessation in respect of loss, expenditure or trading liability allowed in any
past year as profits and gains of business or profession. The fiction is
attracted regardless of discontinuance of business in respect of which the
allowance or deduction was originally made.

The question
whether section 41(1) is wide enough to overrule decisions like Phool Chand (supra)
dealing with non-taxability of loan used for working capital became the subject
matter of debate which is discussed a little later in
this article.

JUDICIAL DEVELOPMENTS FAVOURING NON TAXABILITY OF WAIVER OF FIXED CAPITAL LOAN

The judicial
development in context of non-taxability of waiver of loan utilised for fixed
capital like plant and machinery has been quite consistent. The Courts
consistently held that such waiver is neither taxable u/s. 28(iv) of the ITA as
a business perquisite nor taxable u/s. 41(1) of the ITA. Refer, the following
illustrative cases:

Mahindra & Mahindra
Ltd vs. CIT (supra);

Narayan Chattiar Industries
vs. ITO [2007] 277 ITR 426(Mad HC);

CIT vs. Chetan Chemicals Pvt
Ltd [2004] 267 ITR 770(Guj HC) (A.Y. 1982-83);

Iskraemeco Regent Ltd vs. CIT
(supra);

An aberration
to this trend was the Madras HC ruling in the case of CIT vs. Ramaniyam
Homes⁶ which after
considering the earlier rulings including its own decision in the case of
Iskraemeco Regent (supra) held that waiver of loan has ‘monetary value’
and is, therefore, taxable u/s. 28(iv) of the ITA.

_________________________________

6 [2016] 384 ITR 530 (A.Y. 2006-07)

JUDICIAL DEVELOPMENTS FAVOURING NON TAXABILITY OF WAIVER OF WORKING CAPITAL LOAN

The Bangalore
Income-tax Appellate Tribunal (ITAT) in the case of Comfund Financial
Services (I) Ltd vs. DCIT⁷held
that section 41(1) of the ITA does not capture remission of a loan liability
used for working capital purposes.

In that case,
Deutsche Bank (DB) was one of the promoters of the tax payer company. It also
acted as banker to the tax payer company. DB had extended huge overdraft
facilities to the tax payer company. During the year under reference (A.Y.
1983-84), the outstanding on account of principal amount was Rs. 44.70 crore
and the outstanding on account of interest was Rs. 2.60 crore.

On account of huge losses suffered by the tax
payer company, DB decided to write off the above outstanding. In the assessment
of the tax payer, there was no dispute as regards taxability of write-back of
interest amount of Rs. 2.60 crore which was offered to tax u/s. 41(1) of the
ITA. The write-back of principal amount of Rs. 44.70 crore was not offered by
the tax payer to tax on the ground that section 41(1) of the ITA did not apply
to such write-back. However, the Tax Department’s contention was that the
overdraft facility was used to buy securities on trading account, and the cost
of security was allowed as deduction.

The ITAT did
not accept the contentions of the Tax Department and held that neither section
41(1) nor section 28(iv) of the ITA was applicable to the facts of the case.
The ITAT, drawing distinction between trading transactions of the tax payer
comprising of purchase of securities and the loan transactions with DB, held that
the remission of loan does not constitute revenue income in the hands of the
tax payer.

JUDICIAL DEVELOPMENTS FAVOURING TAXABILITY OF WAIVER OF WORKING CAPITAL LOAN

However, the
tide turned against the tax payer with the Bombay HC ruling in the case of Solid
Containers Ltd vs. DCIT⁸ which held that waiver of working
capital loan is taxable as income. The Bombay HC distinguished its earlier
ruling in the case of Mahindra & Mahindra Ltd. (supra) where waiver
of loan used for acquiring capital assets was held to be non-taxable u/s. 41(1)
or section 28(iv) of the ITA. The Bombay HC ruling was followed by the Delhi HC
in the case of Rollatainers Ltd. vs. CIT⁹ and Logitronics (P.) Ltd. vs. CIT¹⁰ where the Delhi HC distinguished between
waiver of loan used for acquiring fixed assets and loan used for working
capital purposes. The Delhi HC held that waiver of loan used for acquiring
fixed assets is not taxable, whereas waiver of loan used for working capital
purposes is taxable as income. While in the case of Solid Containers and
Rollatainers (supras), the taxability was confirmed u/s. 28(iv) of the
ITA, in the case of Logitronics (supra) it is not clear whether the
taxability was confirmed u/s. 41(1) or section 28(iv) of the ITA. None of the
decisions considered the amount to be a chargeable receipt w.r.t section 28(i)
of the ITA, and, with respect, correctly so.

__________________________________

7 [1998]
67 ITD 304 (A.Y. 1983-84)

8 [2009]
308 ITR 417

While
sustaining taxability, the Bombay and Delhi HCs relied on SC decisions in the
cases of CIT vs. T.V. Sundaram Iyengar & Sons Ltd.¹¹ and CIT
vs. Karamchand Thapar¹² for their conclusion on taxability of
waiver of working capital loan. Hence, it is necessary to understand the
purport of these SC rulings.

The SC in
Sundaram’s case (supra) held that if the amount is received as trading
transactions, even though it is not taxable in the year of receipt as being of
capital character, the amount changes its character when the amount becomes the
tax payer’s own money because of limitation or by any other statutory or
contractual right.

In the case
of Karamchand (supra), the tax payer was acting as a delcredre agent of
collieries and also as an agent for purchase of coal. Excess collections from
the customers for payment of railways remained unclaimed with the tax payer and
the Tax authority sought to tax the same as revenue income. In this case, the
SC upheld taxability on the reasoning that the initial receipt from the
customers was on trading account as a part of trading transaction. Excess
remaining with the tax payer was a normal feature of the regular business of
the tax payer. The SC held that “we do not see the case as a case of
transaction on capital account; it is a simple case where trading receipts were
more than expenditure”.

___________________________

9 [2011] 339 ITR 54

10 [2011] 333 ITR 386

11 [1996] 222 ITR 344

12[1996] 222 ITR 112

Having regard
to the context before the SC in the above rulings, with utmost respect, the
authors believe that reliance on these SC cases was not apt. These SC cases are
distinguishable from loan waiver case inasmuch as the SC in Sundaram’s case (supra)
and tax payer’s case was dealing with a receipt which always represented a
trading transaction, at point of receipt. The ratio, with respect, could not
have been extended to waiver of a loan receipt which was never, to begin with,
a trading receipt forming part of the regular trade transaction.

BUNCH OF APPEALS BEFORE SC IN MAHINDRA’S CASE INVOLVES BOTH WAIVER OF FIXED CAPITAL AND WORKING CAPITAL LOANS

The Tax
Department appealed to the SC against HC rulings holding that waiver of loan
used for acquiring fixed assets is on capital account and not taxable. The tax
payer in Rollatainer’s case (supra) appealed against the Delhi HC ruling
to the extent it held that waiver of loan used for working capital purposes is
taxable as revenue income¹³. The tax payer in Ramaniyam Homes (supra)
also appealed to the SC against the Madras HC ruling holding that remission of
loan is taxable as ‘monetary benefit’ u/s. 28(iv) of the ITA. The SC heard all
the appeals together in Mahindra’s case and disposed them under a common judgement.

AS A LEAD CASE, SC DECIDED MAHINDRA’S CASE, INVOLVING WAIVER OF FIXED CAPITAL LOAN, IN FAVOUR OF THE TAX PAYER

The SC explicitly dismissed the Tax Department’s
appeal in Mahindra’s case making it clear that waiver of loan used for
acquiring capital assets is neither taxable u/s. 28(iv) of the ITA nor taxable
u/s. 41(1) of the ITA. The SC held that the scope of section 28(iv) of the ITA
is restricted to non-monetary benefits received during the course of business,
whereas waiver of loan is akin to receipt of money.

Further, since the loan when borrowed
was not allowed as deduction, waiver thereof is not taxable as remission of
trading liability u/s. 41(1) of the ITA.

_________________________

13 Civil Appeal No. 1214 of 2012

SC ‘disposed’ off
other appeals involving both fixed capital and working capital loan cases

While
concluding and dealing with other appeals including tax payer’s appeal in
Rollatainer’s case (supra), the SC observed as follows:

“17. To
sum up, we are not inclined to interfere with the judgment and order passed by
the High Court in view of the following reasons:

(a) Section
28(iv) of the IT Act does not apply on the present case since the receipts of
Rs 57,74,064/- are in the nature of cash or money.

(b) Section
41(1) of the IT Act does not apply since waiver of loan does not amount to
cessation of trading liability. It is a matter of record that the respondent
has not claimed any deduction under section 36 (1) (iii) of the IT Act qua the
payment of interest in any previous year.

18. In
view of above discussion, we are of the considered view that these appeals are
devoid of merits and deserve to be dismissed. Accordingly, the appeals are
dismissed. All the other connected appeals are disposed off accordingly,
leaving parties to bear their own cost.”

Unfortunately,
the SC did not expressly comment on the aspect of distinction between loan used
for acquiring fixed assets and a loan used for working capital purposes.

SC RULING ARGUABLY SETTLES WAIVER OF WORKING CAPITAL LOAN CONTROVERSY

In the view
of the authors, the reasoning adopted by the SC at para 17 of the judgment for
upholding non-taxability was that: (a) section 28(iv) of the ITA does not apply
to a benefit in the nature of cash; and (b) section 41(1) of the ITA does not
apply since waiver of loan is not cessation of trading liability for which
respondent has claimed deduction. These reasonings are as applicable to a loan
for working capital as to a term loan. In fact, the basis on which some of the
decisions turned against the tax payer stands demolished by the SC conclusion
that section 28(iv) of the ITA is inapplicable to a case of loan receipt which
was received in the form of cash or money.

Further, it is also arguable that the SC used the
term ‘disposed’ while dealing with other connected appeals as distinguished
from ‘dismissed’ or ‘allowed’ since it was concerned with both the Tax
Department’s and the tax payer’s appeals.

Hence, the
authors believe that the ratio of the SC ruling in Mahindra’s case is equally
applicable to waiver of working capital loan.

WHETHER WAIVER OF LOAN CAN BE TAXED U/S. 56(2)(x) OF THE ITA?

In Mahindra’s
case, while dealing with non-applicability of section 28(iv) of the ITA to
waiver of loan, the SC observed, “Hence, waiver of loan by the creditor results
in the debtor having extra cash in his hand. It is receipt in the hands
of the debtor/assessee.” This observation raises concern whether a waiver of
loan granted by lender can be taxed as ‘Income from other sources’ u/s. 56(2)(x)
of the ITA.

Section
56(2)(x)¹⁴ of the ITA is an
‘anti-abuse’ provision. Section 56(2)(x) of the ITA provides that where any
person receives, in any previous year any sum of money, without
consideration, the aggregate value of which exceeds fifty thousand rupees,
the whole of the aggregate value of such sum shall be regarded as income
chargeable to tax. The provision has certain exceptions (like gifts from
relatives) which are not relevant for the purposes of current discussion.

The authors
believe that the context and language of section 56(2)(x) of the ITA would not
permit such interpretation. Firstly, in context, on a strict construction
basis, the section could apply only in a case where there is physical instead
of a hypothetical receipt, and the chargeability is examined at the stage of
receipt. Secondly, when the amount was received, it was not without
consideration. Thirdly, more often than not, the creditor will grant waiver in
lieu of some condition to be fulfilled by the borrower. For example, the banker
may grant waiver of a part of the amount, provided the balance part is agreed
to be paid within a given time frame. In any such scenario, the waiver is
backed up by consideration and cannot be said to be a grant ‘without
consideration’. Fourthly, in case of a distressed or insolvent company, it
would be a case of inability to recover rather than an intent to place cash in
the hands of the company. All in all, the context of a provision should be
limited to cases which tap the abuse for which the provision is introduced, and
is, arguably, very unlikely to extend to a case of waiver of loan.

______________________________

14 As also its predecessor provisions of s.
56(2)(v) / (vi) / (vii) / (viia) of the ITA

MINIMUM ALTERNATE TAX (MAT) LIABILITY IS GOVERNED BY BOOK TREATMENT

The entire
discussion in the earlier part of this article is in the context of computation under normal
provisions of the ITA. In contrast, section 115JB levies a MAT on ‘book profit’
of the company. The ‘book profit’ is largely governed by accounting treatment
adopted for recognition of gains and losses in Profit & Loss account
(P&L) as per applicable accounting standards. It is well settled by a
series of SC rulings starting with Apollo Tyres Ltd. vs. CIT¹⁵ that MAT requires strict construction and the
Tax Authority is not permitted to tinker with net profit shown in P&L
beyond what is expressly permitted by MAT provision itself.

Incidentally, the Expert Advisory Committee (EAC)
of the Institute of Chartered Accountants of India has opined that waiver of
loan should be credited to P&L¹⁶. Hence, if gain on account of
waiver of loan is credited to P&L, an issue arises whether such gain is
liable to MAT. This is a controversial issue which is not resolved by Mahindra’s
case since Mahindra’s case was concerned with normal tax treatment.

______________________________________

15 [2002]
255 ITR 273

16 Refer
EAC Opinion dated 24^th December 1998

Mahindra’s
case is helpful to the extent it holds that the benefit of waiver of loan is
not in the nature of ‘income’. The debate which arises is whether a benefit
which does not fall within the scope of charging provisions of sections 4 and 5
of the ITA can be taxed under MAT merely because it is credited to P&L.
This is a highly debatable issue on which there is sharp difference of opinion
within the judiciary, but this part of the controversy is best discussed as an
independent subject.

CONCLUSION

Since the
introduction of Insolvency and Bankruptcy Code, the waiver or re-calibration of
banking loans has been a matter of regular recurrence. The sacrifice made by
financial institutions plays a vital role in the rehabilitation of ailing
enterprises. The stamp of non-taxability on such waiver amount is perceived by
the tax payers as a substantial relief. The SC judgement is consistent with the
understanding that, but for a fictional provision in law, an income can only
accrue provided it originates from a source of income; the grace from a lender
is not reckoned to be a source from which income is expected to accrue to a man
in business. While the authors believe that the judgement is authentic enough
to urge for non-taxability of waiver of working capital loans, a clarification
to that effect from tax administration will go a long way in controlling
litigation in the years to follow.

shailesh.kwebmaker

IMPLEMENTATION OF EXPECTED CREDIT LOSS MODEL FOR NON-BANKING FINANCIAL COMPANIES

Introduction

India has already embarked on the journey
towards adoption of Indian Accounting Standards (IndAS) with effect from the
financial year ended 31^st March, 2017 in two phases for prescribed
classes of companies other than the financial service entities. This journey
continues with the next phase of adoption of Ind As by Non-Banking Finance
Companies (NBFC) in two phases commencing from the accounting period
beginning 1^st April, 2018. Whilst there are several implementation
and transition challenges, by far the biggest challenge for NBFCs lies in implementing and designing
an Expected Credit Loss model for making impairment provisions for financial
assets.

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. Apart from the said report there has been no
other regulatory guidance from the RBI or other sector specific regulators,
except from the National Housing Bank (NHB), which regulates Housing Finance
Companies, which is discussed subsequently.

DETERMINATION OF EXPECTED CREDIT LOSS (ECL)

NBFCs are currently mandated by the RBI to
follow a standardised rule based approach to determine the impairment of loans
in accordance with the prudential norms which requires classification of loans
into standard, sub-standard, doubtful and loss categories by prescribing the
minimum provisioning requirements under each category and hence the underlying
theme is the “incurred loss” model.

In contrast, Ind AS-109 dealing with
recognition and measurement of Financial Instruments has significantly modified
this approach for measuring and assessing impairment based on the entity’s assessment
of the expected credit loss over a 12 month period or for the entire duration
for all financial assets under amortised cost or FVTOCI category. However,
the RBI guidelines do mandate a minimum provision for different categories of
standard assets ranging from 0.4% to 2% which in a way is a form of an ECL
model, though the approach is quite different under Ind AS. This is expected to
be a game changer for all NBFCs and thus merits special attention in terms of
its approach as well as its implementation and transition challenges.

APPROACH TO DETERMINE THE ECL

As per Ind AS-109, ECL is required to be
computed on the basis of the probability weighted outcome as the present
value of the difference between the cash flows that are due to the entity in
accordance with the terms of the financial asset and the expected cash flows.
However, Ind AS -109 does not prescribe the methods or techniques for
computing the ECL and hence it is an area which is prone to a lot of subjectivity,
judgement and complexity for NBFCs.

It may be pertinent to note at this stage,
that in March 2012, the RBI had released a ‘Discussion Paper on Introduction
of Dynamic Loan Loss Provisioning Framework for Banks in India’ which provided a broad framework to compute
expected loss provisioning based on the industry average for some select asset
classes. Subsequently, vide its circular dated 7^thFebruary,
2014 the RBI advised banks to develop necessary capabilitiesto compute their
long term average annual expected loss for different asset classes, for
switching over to the dynamic provisioning framework.

Whilst these guidelines (which are still
to be implemented) are applicable to banks, NBFCs may find it useful atleast in
the initial stages to refer to these guidelines for developing their own models
based on the broad computational principles as discussed below.

Mathematically, ECL can be represented as under:

ECL = EAD*PD*LGD

Where:

EAD refers to
the Exposure at Default or the Credit Loss

PD refers to Probability
of Default

LGD refers to
Loss Given Default

It would be pertinent at this stage to
discuss the principles, implementation issues and challenges for each of
the above concepts.

Credit Loss

Ind AS-109 defines credit loss as the difference between all contractual cash flows that are
due to an entity in accordance with the contract and all the cash flows that
the entity expects to receive (i.e. all cash shortfalls), discounted at the
original effective interest rate(or credit-adjusted effective interest rate for
purchased or originated credit-impaired financial assets).

An entity shall estimate cash flows by
considering all contractual terms of the financial instrument (for example,
prepayment, extension, call and similar options) through the expected life of
that financial instrument. The cash flows that are considered shall also
include cash flows from the sale of collateral held or other credit
enhancements that are integral to the contractual terms. There is a
presumption that the expected life of a financial instrument can be estimated
reliably. However, in those rare cases when it is not possible to reliably
estimate the expected life of a financial instrument, the entity shall use the
remaining contractual term of the financial instrument.

Assessing the credit loss / EAD is likely to
present several implementation and transition challenges in the Indian context,
the main ones of which are indicated below:

a) Inadequate and inappropriate data: –
The existing guidelines for making provisions for NPAs are based on default
triggers based on time / due dates and may not always capture the estimated
cash flows from the facilities and related collaterals over the life of the
facility. It is thus imperative for NBFCs to evaluate their existing systems
and make suitable modifications and determine the additional data points
keeping in mind the time and cost constraints vis a-vis the benefits.

b) Individual versus collective assessment:-
Whilst for the small ticket and individual facilities it may not be possible,
feasible and cost effective to assess the EAD for each facility, entities would
still need to group these facilities based on shared / common characteristics
like type of facility, type of borrowers, regional and other similar
considerations. However for corporate and large ticket loans, the assessment
would need to be done individually for which appropriate triggers for
classification would need to be laid down based on assessment of various
factors some of which may involve subjectivity and judgements. An indicative
criteria can be the assessment criteria laid down by the RBI under the BASLE II
and III guidelines for retail and non- retail classification by Banks for
assessing capital adequacy, which though not strictly applicable could be a
useful guide and accordingly for all non-retail exposures, the individual
assessment needs to be done.

c) Cash flows from and realisability of
Collaterals:- This is likely to be by far the biggest challenge since
traditionally in our country enforcing of collaterals is a cumbersome legal
process which may in certain cases stretch upto a generation and beyond! These
and other similar factors would need to be assessed whilst evaluating the
present value of the cash flows. Also in many cases, fair value specialists
would need to be employed which would increase the costs and result in
significant judgements and potential bias which may vitiate the true picture.

Probability of Default (PD)

PD is an important constituent for computing
the ECL. However, the term is not specifically defined in the Ind As. It is a
financial term describing the likelihood of a default over a particular time
horizon. PD is the risk that the borrower will be unable or unwilling to repay
its debt in full or on time. The risk of default is derived by analysing the
borrower’s capacity to repay the debt in accordance with contractual terms. PD
is generally associated with financial characteristics such as inadequate cash
flow to service debt, declining revenues or operating margins, high leverage,
declining or marginal liquidity, and the inability to successfully implement a
business plan. In addition to these quantifiable factors, various qualitative
factors like the borrower’s willingness to repay along with factors like the
economic, business and industry factors relating to his area of operations also
must be evaluated.To summarise the PD is dependent on the overall credit
rating of the borrower which would factor in the above aspects, amongst
others.

Since it involves a fair degree of judgement
and estimation, entities would need to use appropriate internal statistical
models to assess the PD for various types of exposures over a 12 month
period or over the life of the exposure, as per the requirements laid down
under Ind AS discussed subsequently. This has also been reiterated by the RBI
in its Working Group Report. However, the report also refers to the Concept
Paper on Dynamic Provisioning, discussed earlier, which could be used as a
basis. The Paper has calculated the PD based on a study of data from 9 Banks
which represent approximately 40% of the total business under the following 4
categories of loans and worked out the PD. The only drawback in this
method is that it is calculated on the basis of the “percentage of
incremental NPAs during the year to the outstanding loans at the beginning of
the year”, whereas ideally the PD should be calculated based on the number of defaults
rather than the amount of default.

Weighted Average PD of Various Asset Classes

Type of Loans	PD
Corporate Loans	0.92
Retail Loans	3.16
Housing Loans	1.28
Other Loans	2.56
Total Loans	1.82

The above analysis though not entirely conclusive, fairly reflects the
differences in the PD based on the credit risks of the different types of
portfolio in the Indian scenario. However the same was based on a study which
is over five years old and the validity thereof, in the context of the current
economic and political environment, especially in case of corporate loans which
have a lower PD than retail remains questionable. Hence it is important for an
entity to have a dynamic and flexible statistical tracking mechanism.

Though the above discussion is in the
context of Banks, it may serve as a useful indicator / benchmark pending the
creation / generation of their own statistical models for NBFCs. However, NBFCs
are cautioned not to blindly use these without substantiating the same based on
data including, if required, taking the
help of experts.

Loss Given Default (LGD)

Like PD, LGD is
also an important constituent for computing the ECL. However, the term like in
case of PD is not specifically defined in the Ind As. LGD is the amount of
money a lender loses when a borrower defaults on a loan. The most frequently
used method to calculate this loss compares actual total losses to the total
amount of potential exposure sustained at the time that a loan goes into default.
In most cases, LGD is determined after a review of anentity’s entire portfolio,
using cumulative losses and exposure for the calculation. For secured
exposures, it involves assessing the realisable value and assessing the
foreclosure amount of the collaterals, which as we have seen earlier can be a
challenge in our environment. In simple terms, LGD represents the economic
or business loss rather than the accounting loss.

Since it involves a fair degree of judgement
and estimation, entities would need to analyse the defaults and the losses
at an overall portfolio level which as discussed earlier can represent a
significant challenge for many Indian entities. This has also been
reiterated by the RBI in its Working Group Report. However, the report also
refers to the Concept Paper on Dynamic Provisioning, discussed earlier,
together with the Internal Ratings Based Approach under BASLE II for
determining Capital Charge for Credit Risks vide its circular dated December,
2011 by the RBI, to be framed by Banks, which could be used as a basis. The
Concept Paper has calculated the LGD based on a study of data of a
pool of NPAs from 9 Banks which represent approximately 40% of the total
business under the following 4 categories of loans and worked out the same. Whilst
the method is not entirely fool proof and free from doubt, it is a good initial
indicator prior to design of appropriate statistical models by the NBFCs.

Average LGD Estimates of Various Asset
Classes

Type of Loans	Average LGD (%)
Corporate Loans	36.07
Retail Loans	33.36
Housing Loans	8.02
Other Loans	79.09
Total Loans	45.48

Like in the case of the PD, the above
analysis though not entirely conclusive, fairly reflects the differences in the
LGD based on the credit risks of the different types of portfolio in the Indian
scenario. However, the same was based on a study which is over five years old
and the validity thereof, in the context of the current economic and political
environment, remains questionable. Further, the lower LGD in the case of
Housing Loans appears to be primarily due to the collateral value of the
property financed, the recovery and enforcement thereof may present challenges.
Hence it is important for an entity to have a dynamic and flexible statistical
tracking mechanism

As is the case with the calculation of
PDs, though the above discussion is in the context of Banks, it may serve as a
useful indicator / benchmark pending the creation / generation of their own
statistical models for NBFCs. However, NBFCs are cautioned not to blindly use
these without substantiating the same based on data including, if
required, taking the help of experts.

STEPS TO CALCULATE THE ECL

The first step to calculate the ECL is to
classify the financial assets into different stages or buckets as tabulated
hereunder based on which the subsequent calculations for the extent of
impairment on ECL basis can be determined.

	Stage 1	Stage 2	Stage 3

Stage	Financial Asset is originated or purchased	*Credit Risk has increased significantly* in respect of the financial asset since initial recognition	The Financial Asset is *credit impaired*

ECL provision required	Twelve months ECL	Life time ECL	Life time ECL

Recognition of Interest Revenue (discussed in a subsequent section	EIR on gross carrying amount	EIR on gross carrying amount	EIR on amortised cost basis

As can be seen from the above, the following
are the key triggers for assessing impairment on the basis of life time
expected credit losses:

Assessment of increase
in the credit risk; and

Determining receivables
which are credit impaired.

Let us now proceed to briefly understand the
principles laid down in Ind AS-109 for assessing both these.

Increase in the Credit Risk

Whilst the assessment of increase in the
credit risk is qualitative and judgemental, IndAS-109 has laid down certain
principles which are summarised hereunder:

At each reporting date, an
entity shall assess whether the credit risk on a financial instrument has
increased significantly since initial recognition. When making the assessment,
an entity shall use the change in the risk of a default occurring over the
expected life of the financial instrument instead of the change in the amount
of expected credit losses. To make such assessment, an entity shall consider reasonable
and supportable information, that is available without undue cost or
effortthat is indicative of significant increases in credit risk since initial
recognition.

If reasonable and supportable
forward-looking information is available without undue cost or effort, an
entity cannot rely solely on past due information when determining
whether credit risk has increased significantly since initial recognition.

However, when information
that is more forward-looking than past due status (either on an individual
or a collective basis) is not available without undue cost or effort, an
entity may use past due information to determine whether there have been
significant increases in credit risk since initial recognition.

Regardless of
the way in which an entity assesses significant increases in credit risk, there
is a rebuttable presumption that the credit risk on a financial asset has
increased significantly since initial recognition when contractual payments are
more than 30 days past due.

Ind AS-109 has
provided a list of information / criteria which may be relevant
for assessing changes in credit risk. An illustrative list of the same is
provided below:

a) an actual
or expected significant change in the party’s external credit rating.

b) an actual
or expected significant change in the operating results of the party.

c)
significant changes in the value of the collateral supporting the obligation or
in the quality of third-party guarantees or credit enhancements, which are
expected to reduce the debtor’s economic incentive to make scheduled
contractual payments or to otherwise have an effect on the probability of a
default occurring.

Assessing Credit Impaired Financial
Asset:

For identifying receivables which are credit
impaired, Ind AS-109 defines a “credit impaired financial asset” as under:

“A financial asset is credit-impaired
when one or more events that have a detrimental impact on the estimated future
cash flows ofthat financial asset have occurred. Evidence that a financial
asset is credit-impaired include observable data about the following events:

(a) significant
financial difficulty of the issuer or the borrower;

(b) a breach of
contract, such as a default or past due event;

(c) the lender(s) of the
borrower, for economic or contractual reasons relating to the borrower’s
financial difficulty, having granted to the borrower a concession(s) that the
lender(s) would not otherwise consider;

(d) it is
becoming probable that the borrower will enter bankruptcy or other financial
reorganisation;

(e) the
disappearance of an active market for that financial asset because of financial
difficulties; or

f) the purchase
or origination of a financial asset at a deep discount that reflects the
incurred credit losses.

It may not be possible to identify a
single discrete event instead, the combined effect of several events may have
caused financial assets to become credit-impaired.”

One of the common criteria which is
practically applied in assessing credit impairment is to identify whether there
is a default or a past due event. In this context, Ind AS-109
provides that when defining default for the purposes of determining the risk of
a default occurring, an entity shall apply a default definition that is consistent
with the definition used for internal credit risk management purposesfor the
relevant financial instrument and consider qualitative indicators (for example,
financial covenants) when appropriate. However, there is a rebuttable
presumption that default does not occur later than when a financial asset is 90
days past due unless an entity has reasonable and supportable information to
demonstrate that a more lagging default criterion is more appropriate.

Accordingly, though the Ind AS
provides 30 and 90 day thresholds these are not sacrosanct like the existing
NPA guidelines and need to be evaluated in the context of other qualitative and
judgemental factors which need to be appropriately disclosed.

Accordingly, it is imperative for NBFCs to
establish their own internal credit risk rating models, subject
to cost and volume considerations for different categories of risks, rather
than blindly adopt the 30 and 90 days rebuttable presumptions indicated above.
Let us now proceed to briefly examine the implementation and transition
challenges

IMPLEMENTATION AND TRANSITION CHALLENGES

Framing Internal Credit Risk Rating
Models

Currently in the case of NBFCs, there are no
specific regulatory guidelines which provide for the establishment of credit
risk management policies on the lines as prescribed by the RBI under the BASLE
II and III framework for Banks, except the generic requirement under the
Companies Act, 2013 and the Listing Guidelines to frame Risk Management
Policies. Accordingly, the transition from a rule based regulator specified
criteria approach that largely ensures consistency of application across the
system to an ECL framework that is largely subjective based on management
judgement and being data intensive, necessitates fairly sophisticated credit
modelling skills and would represent an enormous challenge not only for the
NBFCs but also for auditors, regulators and supervisors, especially for the
small and medium sized as well as closely held entities.

Accordingly, NBFCs are advised and expected
to develop their own internal credit risk rating models as part of their
overall Credit Risk Management Policies under the Supervision of the Board with
implementation support from the Risk Management Committee. For this purpose the
broad steps which need to be followed are outlined below:

a) Framing an internal risk rating module for
different types of financial assistance and different types of financial
instruments, which evaluates each proposal for different types of risks,
security available, financial performance of the borrower etc.

b) Based on the scrutiny of the proposals
against the above parameters a scoring module is developed which assigns scores
on a range of 1-10, 1-100 etc., which in turn is linked to a grade. An
illustrative scoring grid is as under:

SCORE	GRADE
95-100	AAA
85-94	AA
75-84	A
55-74	B
25-54	C
1-25	D

Based on the above assessment any facility
granted to a borrower with a grading of C or D would represent increased credit
risk and hence would fall under stage 2 as discussed earlier thereby
necessitating a life time ECL calculation.

c) A comparison of the above internally assessed
ratings can be compared with the externally assigned ratings to the borrowers
by the recognised external credit rating agencies.

d) Periodic review of the above established
ratings through internal assessment coupled with audit assistance in certain
cases. For this purpose a review / assessment is undertaken of the servicing
and repayment of the facility, financial performance of the borrower, the
industry / business environment in which the borrower operates etc.

Normally, from a practical perspective, any rating down grade by more than
two notches would imply a default or credit impaired status necessitating the
movement of the exposure to stage 3 as discussed earlier, in addition to the
other specific qualitative parameters discussed.

The RBI working
group has discussed certain issues in the context of Banks pertaining to
identification of and the on-going assessment of increase in the credit risk as
under, which may be relevant and a useful indicator for NBFCs on initial transition,
subject to appropriate corroboration thereof with the existing data and the
peculiar nature of operations of each NBFC and pending any specific guidance
relating to NBFCs from the RBI:

a) The Group suggested that the RBI could
prescribe rule based indicative criteria for significant deterioration in
credit risk.

b) Whilst the group felt that the 30 days past
due scenario is quite common, Banks should take this opportunity to educate
their customers of making contractual payments within 30 days and also
simultaneously strengthen their credit monitoring mechanisms.

c) In the context of the 90 days default
criteria, the Group suggested that RBI may continue to define default for
consistency across the banking system keeping in view the Basel framework as
well as the Ind AS 109 prescriptions. Banks may be permitted the discretion to
formulate more stringent standards.

d) The Group also noted that Ind AS 109 envisages
other types of defaults, e.g., breach of covenants, which are not accompanied
by payment defaults. With respect to such defaults (not accompanied by payment
defaults), banks will need to build up adequate records to evidence the impact
of these events on the level of credit risk
and if these events constitute a significant increase in credit risk.

e) Finally, the Group also
noted that RBI vide its circular DBOD.No.BP.520/21.04.103/2002-03 dated
October 12, 2002 had issued a Guidance Note on Credit Risk Management that
inter-alia advised banks to adopt credit risk models depending on their size,
complexity, risk bearing capacity and risk appetite, etc. and accordingly
advised Banks to adopt the same, since based on which it is reasonably expected
that banks should be able to put in place at least some basic measures of expected credit losses.

Regulatory Challenges

The NHB vide its circular dated 16^th
April, 2018 has broadly laid down the following requirements:

a) In terms of the provisions of paragraph 24 of
the Housing Finance Companies (NHB) Directions, 2010 (“Directions”) on
Accounting Standards, in terms of which the Accounting Standards and Guidance
Notes issued by the Institute of Chartered Accountants of India shall be
followed in so far as they are not inconsistent with any of the Directions.

b) All Housing Finance Companies to follow the
extant directions on Prudential Norms, including on asset classification,
provisioning etc. issued by the NHB.

c) With regards to the implementation of Ind
AS, HFCs are advised to be guided by the extant provisions of Ind AS, including
the date of implementation.

A plain reading of
the aforesaid circular seems to suggest the following interpretation
alternatives:

a) HFCs should continue to follow the existing
directions including the prudential and asset classification norms whilst
determining their capital adequacy ratio, which seems to imply that the working
as per the existing NPA norms would continue. Thus it appears that a
separate set of regulatory accounts would need to be maintained.

b) For preparing the statutory accounts, the Ind
AS principles would need to be followed, which implies that the ECL model
should also be followed.

c) Companies should accordingly adopt the
ECL model and compare the provision as per the same with the existing NPA
provisioning guidelines and the higher of the two should be followed since the
intention of the NHB seems to ensure that the regulatory minimum provisions
should be maintained. This is also the recommended alternative as suggested by
the RBI working group in its report.

There is currently no similar circular
which has been issued by the RBI for application by the NBFCs other than HFCs,
thereby creating a lot of ambiguity and leaving the field open to varying
interpretations, which could involve substantial time, efforts and costs which
may not be commensurate with the benefits and expose the NBFCs to potential
regulatory scrutiny.It is strongly recommended that appropriate clarifications
are issued by the RBI in this regard.

CONCLUSION

The above evaluation is just the tip of the
ice-berg on a subject that is quite vast and complex. However, the ECL model 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 statistical models who could laugh all the way to the bank!

shailesh.kwebmaker

THE AUDITOR’S TRAGEDY

On
hearing Ram’s cries of help, Sita insisted that Lakshman go to his rescue.
Lakshman hesitated. If he went out to help Ram, who would protect Sita? He came
up with a solution: he drew a line around their grass hut. ‘Stay within!’ he
told his sister-in-law, ‘Within is culture, where you are safe. Without is the
forest, where no one is safe.’

This
story of Lakshman Rekha, the line drawn by Lakshman around Sita’s hut, comes to
us from regional Ramayanas like the Bengali Krittivasa Ramayana and the Telugu
Ranganatha Ramayana, written about seven hundred years ago. It is not found in
the old Sanskrit Ramayana of Valmiki, written two thousand years ago, or even
the oldest regional Ramayana, written in Tamil by Kamban, a thousand years ago.

How
do we view the Lakshman Rekha? A symbol of love, created by a young man to
protect his sister-in-law? Or as a symbol of oppression, created by a man to
control the movements of a woman. In the 21^stcentury, much of
feminist literature has conditioned us to see it as the latter. Lakshman, at
best, comes across as patronising patriarch. So it is in business.

Rules
are created to protect organisations. Some rules create efficiency while others
de-risk the company. Together they contribute to the prosperity and security of
the company. Together they ensure the organisation becomes controllable,
predictable, and manageable. Various technologies are created to ensure people
follow the rules. There are technologies to communicate the rules: the various
protocols, guidelines, regulations, procedures, and policies. There are
technologies to measure if the rules are being followed or violated. There are
technologies to flag repeat violations and escalate issues. Essentially, rules
help us domesticate and organise ourselves.

Then
come the auditors: the internal and external, who check if we have complied.
They go through our documents and our spending patterns and check if investor
wealth is safe, and if implementation aligns with agreed upon strategies and
tactics, and if the organisation fulfills its obligations of society by paying
taxes on time, and explaining all its costs and expenses that erode into
profit. The auditor is the Lakshman of the organisation, protecting the
institution for the Board of Directors and Investors.

The
analogy can upset many people for it equates Sita to the institution, and makes
her the property of Ram. It endorses patriarchy. Yet the relationship between
the Board of Directors and the institution is the same as Ram and Sita. Without
the institution (Sita), the Board of Directors (Ram) have no value or purpose,
or even meaning. Their entire existence depends on nourishing and protecting
the institution, and the institution in exchange makes them valuable, and
glamorous, worthy of respect, even worship.

It
is the auditor (Lakshman) who ensures that institution is safe. He ensures
rules are followed and even creates rules to ensure other rules are followed.
To the people in the organisation, he can seem like an oppressor. For his
actions limit movement. His demands take away freedom and agility. The larger
the company, the larger the investments, the more the rules, the more important
the auditor, the less nimble is the organisation. It takes away quick
decisions, and puts obstacles on the entrepreneurial spirit.

It is the auditor who is hauled up
when it turns out that the promoter has been misusing investor wealth to
increase personal wealth at the cost of the institution. In other words, when
the one who is supposed to be Ram turns into Ravana and gets the institution to
break rules for his own benefit. It is the auditor who has to prove his
honesty, and diligence, when there is a takeover. We often mock the auditor, or
the company secretary, as the oppressor who forces us to comply with rules we
don’t want to, who retards us, makes us inflexible and not very nimble,
especially when we are a large organisation. But he is Ram’s younger brother,
loyal and determined to protect all that his brother stands for.

(Source:
Devdutt.com, reproduced with permission)

shailesh.kwebmaker

INTERNATIONAL TAXATION AND FEMA KAL – AAJ – AUR – KAL

When I qualified as a Chartered Accountant way back in 1961, the words
‘International Taxation’ were not known to Chartered Accountants. The reason is
not difficult to find.

Our country had an acute shortage of foreign exchange. Hence the British
Government, who ruled our country before 1947, imposed exchange control
regulations as a temporary measure at the time of the Second World War through
the Defence of India Rules in 1939. Though it was meant to be a temporary
measure to fight the War, its continued need was felt and hence it was made
permanent by legislating the Foreign Exchange Regulation Act, 1947. It was a
very loose piece of legislation, not precise, leaving a lot to interpretations.

After the experience gained over 26 years, the 1947 Act was replaced by
the Foreign Exchange Regulation Act, 1973 (FERA) which came into force from 1^st
January, 1974.

Because of acute foreign exchange resources of the country, there were
very few inward foreign investments and hardly any outbound foreign investments
and that too, confined to a few high and mighty, the rich and the famous.

When I passed my final CA examination of November, 1960, the subject of
foreign exchange and/or international taxation was not on the CA curriculum.
Hence, there were hardly any tax professionals, aware of and practising
international taxation and foreign exchange regulations.

FERA, 1973 was a draconian, criminal law in which mens rea,
meaning guilty mind, was presumed. One was presumed to be guilty until one
proved oneself to be innocent – completely contrary to the established
principles of jurisprudence. For every need of foreign exchange, including for
legitimate foreign travel, one had to approach the Reserve Bank of India (RBI)
for release of foreign exchange. If one asked for release of foreign exchange
for five days, RBI would give sanction for three days. There were instances
when during a week of foreign travel, there was Saturday and Sunday in between;
in such cases RBI would rather want one to come back on Saturday morning and go
back on Monday morning and sanction foreign exchange accordingly! Coupled with
shortage of foreign exchange, there was what was known as requirement of ‘P’
form; meaning to get approval for booking your passage or ticket for going
abroad; and chances of getting that were better if one preferred to fly Air
India. Later, the foreign exchange quota was relaxed by allowing first a lump
sum of USD 100, later increased to USD 500 for a foreign trip, irrespective of
its duration. People used to book an excursion ticket by Air India, which was
valid for four months, avail of the sumptuous allowance of USD 500 and go
abroad. This was nothing but official invitation to contravene FERA as such
people used to make other arrangements for their requirement of foreign
exchange. The law was so impractical that the then Prime Minister had gone on
public record saying that offering a cup
of tea to a Non-Resident by a Resident would amount to contravention of FERA. Since then, we have come a long way.
Now, not only a cup of tea but complete hospitality to a non-resident is
permitted.

The real breakthrough came in July of 1991 when our foreign exchange
reserves were as low as approximately USD 1.1 million, hardly enough for
fifteen days’ imports. The country would have literally gone bankrupt but for
the timely action by the then Finance Minister, Dr. Manmohan Singh, who pledged
the country’s gold with IMF, announced sweeping reforms and saved the country
from international shame.

As a result of such reforms, foreign exchange reserves gradually
increased and both inbound and outbound foreign investments increased
gradually. This started the awareness about foreign exchange regulations,
double taxation avoidance agreements and international taxation amongst the tax
professionals. One saw a gradual increase in seminars and conferences with FERA
and International Taxation as subjects for discussions.

As per the experience gained over another 26 years, the Foreign Exchange
Regulations Act, 1973 (FERA) was completely replaced by the Foreign Exchange
Management Act, 1999 (FEMA) which came into force on 1^st June, 2000.
FEMA has been a civil law, which is more precise and comparatively easy to
understand and implement. Under FERA, all transactions in foreign exchange and
dealings with Non-Residents were prohibited unless permitted by RBI. Under
FEMA, all Current Account transactions are freely permitted under the automatic
route except for a very few requiring RBI permission but all Capital Account
transactions are prohibited unless permitted by RBI.

This opened up the floodgates of professional opportunities for tax
professionals and Foreign Direct Investments into India and India’s investments
overseas have considerably

increased, resulting in the present foreign exchange reserves of the
country in excess of USD 390 billion. Now the tax professionals have understood
the importance of International Taxation
and its potential for professional practice. The need is further strengthened
with the introduction of Transfer Pricing Regulations in our tax laws from
2001.

Since June, 2000, the law in force is Foreign Exchange Management Act,
1999 (FEMA). Hence the emphasis is more on management of foreign exchange
rather than regulation of foreign exchange. Hence, RBI has, since February,
2004, introduced the Liberalised Remittance Scheme (LRS) permitting residents
to access a certain amount of foreign exchange for their personal needs like
foreign travel, education, medical expenses, etc. The LRS scheme started with a
small quota of USD 25,000 to each resident to invest abroad, open a bank
account overseas etc. which gradually increased to USD 50,000, USD 100,000, USD
1,25,000 reduced to USD 75,000 for a short period and increased to USD 2,50,000 at which it has now
stabilised. Of course, the LRS scheme has brought in its wake new problems but
it is more or less successful.

Now the tax professionals have come to know the role of OECD in the realm
of International Taxation and
now we find
many such professionals
practising International Taxation and FEMA and also sharing their
knowledge at conferences and seminars. Study of international taxation, FEMA
and DTAA have opened up certain limited opportunities for international tax
planning but one has to do so very cautiously due to concepts and regulations
like GAAR, POEM, BEPS, MLI, TP, Permanent Establishment, etc. The matter has
become more complicated with the coming into play of FATCA and CRS which have
set into action, automatic exchange of information globally.

Over and above the Article for Exchange of Information contained in the
Double Taxation Avoidance Agreements (DTAA) that our country has entered into
with several countries, since many so-called tax haven countries were excluded
or were not inclined to enter into such agreements, now our Government has
proactively entered into Tax Information Exchange Agreements (TIEA) and also Multilateral
Convention on Mutual Administrative
Assistance in the matter of Taxation with many other countries.

These have resulted in our country being able to obtain tax information
from all these countries. Moreover, because of the Foreign Account Tax
Compliance Act (FATCA) of USA and the Common Reporting Standard (CRS) adopted
by many other countries resulting in automatic exchange of information, a lot
of information relating to beneficial owners of overseas assets and income has
started flowing in, resulting in Tax Department and Enforcement Directorate
initiating investigation against persons concerned. As a result of all these
steps, more and more persons have been adversely affected by the crackdown on
offshore tax havens.

All these, coupled with Black Money (Undisclosed Foreign Income and
Assets) And Imposition of Tax Act, 2015 (BMA), have opened up immense professional
opportunities and challenges for tax professionals provided
they have sharpened their skills in the fields
of international taxation and exchange control regulations. This may
also have implications of taxation in multiple countries requiring filing of
tax returns in other countries and paying taxes there. This will necessitate
the need to claim foreign tax credit in the country of residence in respect of
taxes paid in the source country. Many tax professionals must have already
experienced the impact of automatic exchange of information in respect of their
clients.

One important facility in International Taxation is the permission to
Chartered Accountants by CBDT and RBI to issue withholding tax certificate in
Form 15CB for making overseas remittances. This is very much appreciated by all
concerned as it, being prompt and
professional, saves time in making remittances.

However, one negative in the matter of International Taxation is the
attitude of Authorised Dealer Banks. RBI has delegated many powers to banks and
everything has to be routed through banks only. But their lack of knowledge hampers
and delays the process. Today, a professional who is able to advise clients in
the matter of International Taxation is much more respected than one who
confines to auditing and domestic taxation because of the opportunities thrown
open to corporates and entrepreneurs. Now it is no more confined to the high
and mighty, the rich and famous. The tax professionals are experiencing many
inquiries from common businessmen for advice on overseas structures and
regulations concerning the same.

The term, Base Erosion and Profit Shifting (BEPS) has now become an
important topic for discussions and consideration amongst tax professionals
globally and has made inroads into India also. The general tendency amongst
businessmen and industrialists is to look for low tax or no tax countries to
shift their activities. Hence, the existence of tax havens became very relevant
in the last few decades. The profits are artificially shifted to such low-tax
or no-tax jurisdictions. This brings out the issue of form over substance as
such activities do not have much substance. This, in short, is known as BEPS.

In recent times the world has become
more transparent in terms of commercial and economic activities. The tax havens
which had no Double Taxation Avoidance Agreement with any country have now
given up because of the fear of extinction and have signed tax information
treaties with all major countries. Frankly, tax haven has now become a dirty
word, as it immediately smells of tax evasion. Treaty abuse had become rampant
and to control the same, OECD formulated Multilateral Instruments (MLI) with a
view to modify bilateral tax treaties and arrest
treaty abuse.

Another avenue of international tax planning which had become very
popular was cross-border offshore Trusts for tax saving and estate planning. It
is always a fact that businessmen and entrepreneurs are very quick in
understanding and implementing such measures while the laws and tax authorities
are very slow in understanding such loopholes and catching up with legislation
to counter them. This leads to changes in domestic laws to make such
tax-planning measures very expensive and even useless. There was a time when
offshore Discretionary Trusts settled by Non-Resident relatives for the benefit
of their Resident relatives in India were very popular because any capital
distribution by such Trusts was exempt in the hands of such beneficiaries.
Moreover, the banking secrecy laws of jurisdictions like Switzerland, the
Channel Islands etc., helped proliferation of such Trusts. But now, with global
awareness about their abuse for tax planning, coupled with the KYC requirement
regarding the ultimate beneficial owner (UBO), has led to amendments in
domestic laws making such Trusts almost redundant.

Now that we Indians are allowed to own assets worldwide, the importance
of International Taxation has gained considerable importance. The issue of
Cross-Border Wills or Wills for overseas assets also opens up avenues for
international tax practice. One lesser known area is the GST impact on
cross-border transactions. Its impact on import and export of goods and
services, stock transfers, international trading, projects outside India etc.,
needs careful consideration as a part of International Taxation.

One important issue that seems to have escaped attention of the tax
professionals and the authorities concerned needs to be resolved. It is about the fact that when the
Enforcement Directorate (ED) concludes an investigation, even after
adjudicating process, no order is issued when it is in favour of the person
concerned but invariably an order is issued when the same is against the person
and a penalty is levied. It is well-known that under FEMA, there is no
limitation period prescribed but even then, there should be a regulation to
provide for a discipline of time limit within which an order, whether adverse
or favourable, must be issued by ED after completion of the hearing. We find this very common under all other laws
that an order is invariably issued, whether in favour or against, within a
reasonable time after the hearing is over. Even taking an example under FEMA,
the law provides that the hearing of a compounding application must be
completed within 180 days and thereafter an order is invariably issued within a
maximum of one month. Why shouldn’t the same be made applicable to the ED?

All these developments in the arena of International Taxation and FEMA
would mean that specialisation is the only way for tax professionals to
survive, succeed and prosper. The days
of Jack of All and Master of None are now over.
Now we have not only to look to the present but to think of the future
and equip ourselves to understand events happening globally in the fields of
economic activities, reforms and international taxation. However, the future
lies in complete removal of exchange control regulations. We have the examples
of England and Singapore and how they have progressed and flourished as
financial centres after abolishing exchange control regulations.

shailesh.kwebmaker

DEVELOPMENT OF TAX LAWS AND ADMINISTRATION IN INDIA – PAST, PRESENT AND FUTURE

In a brilliant introduction to his book, The
Law Book – 250 Milestones in the History of Law, Michael H. Roffer begins
with the statement: “The Law surrounds us. It affects the food we eat, the
water we drink, and the air we breathe. It travels with us. It defines our
relationships with the people with whom we live, work, and share space. It
affects our homes and schools, our offices and stores. The law touches every
aspect of our lives and even our deaths.” I am inclined to think, in a
lighter vein, that the author had the tax law in his mind more than any other
law, for the tax law (direct & indirect) touches every aspect of life which
he has listed! That is perhaps why Oliver Wendell Holmes Jr., made the famous
statement that “Taxes are the price we pay for civilization. I like to pay
my taxes”. But the question as to how the taxes are imposed and collected,
and upon whom they are levied, and in what manner and how they are quantified – these questions seem to
have always troubled the tax administrator, the tax payer, the tax lawyer and
ultimately the government.

Taxes have been looked upon, traditionally, as the government’s share in
the prosperity of the breadwinner. That is one of the main reasons why
income-tax paid is not allowed as a deductible expense; it has been held to be
the “Crown’s share in the profits”, there being other reasons, too. It would appear
that before the development of “money” as representing the purchasing power of
a person, the taxes were collected in kind, through commodities, even hard
work. Customs duty and taxes on owning of lands are said to be two of the
earliest taxes netting huge revenues for the countries. Only in the year 1798,
William Pitt the Younger, who was the Prime Minister of Great Britain those
days, first proposed a legislation to tax the citizens “upon all the leading
branches of income”. This law is generally believed to be the first formal
income-tax in history. This tax is believed to have been imposed to replenish
the treasury of that country which had been drained because of its war with
Napoleon Bonaparte. The tax was known as “The Triple Assessment” because
its measure was three times the expenditure which a person had incurred in the
preceding year. There is good reason to believe that the levy succeeded,
because it was followed up by a proposal that a general income-tax be charged
on all leading branches of income. This resulted in a tax legislated for the
first time in history in January, 1799, and it called for a progressive rate of
tax on annual income above 60 pounds; the rate began with 1% and went up to 10%
on incomes above 200 pounds. But it was a disaster, and the public protested
strongly and resisted payment. It was criticised as a “monstrous law” and “an
indiscriminate rapine”; experts claimed that the public received it with
nothing but “disdain and distrust”. Eventually the tax was repealed in 1802,
after a short life of just three years, but the trend had set in, and the law
had caught the eye of governments all over. In the very next year, England
enacted a new income-tax law and this law became the basis for all subsequent
enactments in that country and became the bedrock of that country’s fiscal
policy. Soon, Germany and America adapted the law, resulting in the passing of
several enactments for the levy and collection of income-tax.

In America, several short-lived attempts had been made in this behalf
and in the law passed in 1894, a tax of 2% was imposed on annual income over
4,000 dollars the object stated being “to address economic inequalities”. But
what happened was that in a decision of the Supreme Court of America, Pollock
vs. Farmers’ Loan & Trust Co., this levy was struck down as
unconstitutional; it was held that the taxes on real and personal property were
direct taxes and in the absence of apportionment among the states they were
unconstitutional. Chastened by this judgment, Howard Taft, the President of
America, wanted to levy income-tax in 1908 after an amendment to the
Constitution to expressly permit the levy. It was the sixteenth amendment and
after being passed by the Senate and the House of Representatives and the
required number of states, it became law in 1913. It was called the Revenue
Act, 1913 and it imposed tax on net income at rates ranging from 1% to 6%.

Beginning with William Pitt’s levy in 1798, taxes have been imposed to
recover monies lost on account of warfare, impliedly as a fee for protecting
the citizens against external aggression. In India, the Sepoy Mutiny in 1857
saw the British rulers imposing a tax in 1860 as a temporary measure for 5
years. In 1867, a licence tax on all trades and professions was imposed. In
1868, it became a ‘certificate tax’ and in both licence tax and certificate
tax, agricultural income was excluded. From 1869 to 1873, for a period of 4
years, there was an income-tax including agricultural income. The tax got
revived due to famine and other reasons in 1877, but it was the Act of 1886
which saw the first landmark of income-tax law of India. It remained in force
till 1918, in which year a comprehensive recasting of the income-tax law was
attempted with a measure of success. Inequalities and inconsistencies in the
earlier law were sought to be redressed. The heads of income such as property,
salaries, business earnings and professional income, other sources of income
were introduced in this law. It applied to income under these heads which arose
in British India.

The recommendations of the All India Tax Committee formed the basis of
the Indian Income-Tax Act, 1922 which tax lawyers of repute commend as a
well-drafted, precise legislation with about 60 sections. In this law, the tax
rates were not prescribed in a schedule as was done previously, and the rates
were left to be prescribed by the annual Finance Acts. This has endured till
now. Notable features of the Act were the adjustment of past losses and
inter-head and intra-head losses, liability of the successor to the business to
pay taxes of the predecessor, etc. The Act received wholesale amendments by the
1939 Amendment Act. Notable features of this amending Act were: introduction of
a category of “resident, but not ordinarily resident”, taxation of income
accruing outside British India even if it is not brought into British India,
introduction of provisions to prevent avoidance of tax by creating trusts,
transferring property to relatives (spouse, minor children),
dividend-stripping, bond-washing, introduction of closely-held companies to
avoid dividend income, etc.

The working of the 1922 Act led to certain situations which were thought
by the government to be not in the interests of the growth and development of
income-tax law in India, and a series of recommendations were sought with a
view to bringing about a legislation with more teeth and which was more
comprehensive. Substantial changes were made in the 1947 Taxation of Income
(Investigation Commission) Act, in 1952,
1953 and 1955 (Dr. John Mathai Committee). More importantly, the Act was
referred to the Law Commission in 1956 in order to make it “on logical lines
and to make it intelligible and simple, without at the same time affecting the
basic structure”. The recommendations of the Law Commission and the committee
headed by Mahavir Tyagi set up in the meantime formed the basis of the present
1961 Act.

The Income Tax Act, 1961 today is a maze no doubt, but to call it “a
national disgrace” (Nani Palkhivala, preface to the 8^th edition
of his treatise on income-tax law) would be unfair, in my humble opinion.
Government has the right to set right distortions practised by the tax payers
to “evade” (not avoid or mitigate or plan) income-tax, and it is also well
established that this can be done even retrospectively. This is particularly so
in modern days when multi-national enterprises indulge in multi-layering and
multi-structuring of the corporate entity, and locate them in different places
around the world and in different tax jurisdictions. The government of the day
must be conceded the right to combat such moves if it feels due taxes are not
being paid and the right to plug the loopholes, if necessary, by making the
amendments retrospective. It cannot be lost sight of that it is always a
running battle between the government and the tax payers, particularly the
multi-national juggernauts, and each side tries its best to outdo the other!
But to be fair to the tax payers, it must also be said that some of the
amendments in the recent past, say in about 10-12 years, have been startling,
upsetting the traditional and well-accepted notions of what is “income”. A
different concept of “taxation of benefits” has come to stay, where the
notional difference between the market value of an asset, movable or immovable,
and the price paid is roped in as income.

It is hard to believe that a provision in the Act which was read down to
make it workable, equitable and fair to both the citizen and the government, by
the Supreme Court in K.P. Varghese (131 ITR 597) (SC) has been
introduced through “the back door”, giving a go-by to the acclaimed principles
of taxation vis-à-vis the power under the Constitution of India explained
lucidly and forcefully, if I may say so with respect, in the judgment. There
are also recent instances of what is not income or even a receipt, being taxed
under some pretext or the other. We have all so far understood the pay-out of
dividend by a company as its expense (though not tax-deductible in the
company’s hands, being appropriation of profits), but we are now told that it
will be taxed as the income of the company, a proposition which is baffling.
The constitutional validity of this tax has undoubtedly been upheld by the
Supreme Court in the recent Tata Tea case and therefore the levy has come to
stay. But one shudders to think of the consequences that may follow in the
coming days. A citizen can be mulcted with taxes both on his income and his
expense, to put it crudely, taking umbrage under the ever-elastic Entry 82 of List
I (Union List) which permits the central government to levy “taxes on income
other than agricultural income”.

The power to tax income, and the general power to levy taxes, is
traceable to Article 246 of the Constitution of India which says that Parliament
has exclusive power to make laws with respect to any of the matters specified
in List I of the 7^th Schedule to the Constitution. It is also
necessary to note Article 248 which reiterates that Parliament has exclusive
power to make any law with respect to any matter not enumerated in the State
List or the Concurrent List and such power shall include the power to legislate
for the levy of tax not mentioned in either of these Lists. It is in this
background that we need to now look at Article 265, which occurs in the Chapter
titled “Finance, Property, Contracts and Suits”. It is a single-liner, and one
of the most powerful one-liners; one cannot also help noticing that the
marginal head of the article consists of 10 words, and the article itself
contains 12 words, only 2 more than the marginal head!

“ARTICLE 265. Taxes not to be imposed save by authority of law.—No tax
shall be levied or collected except by authority of law”.

The government therefore requires the authority of law not only to
“levy” taxes but also to “collect” them. The consequence is that a collection
machinery which is tyrannical or arbitrary or out of proportion with the
gravity of the situation or circumstances can also be held to be
unconstitutional, being in violation of the article. Since an entry includes
all subsidiary and ancillary matters, the power to tax would include the power
to enact law for the effective implementation and collection/recovery of the
tax levied. It can determine the procedure to collect the tax and provide for a
machinery and also make provision for evasion of taxation: Orient Paper
Mills Ltd. vs. State of Orissa (AIR 1961 SC 1438). It was, however, held
that the power to seize and confiscate the goods moving from one state to
another, which were not meant for sale, and also levy penalty was not
incidental to the power to levy tax under Article 265 (C.P. Officer vs. K.P.
Abdulla, (1970) 3 SCC 355).

In a federal set-up like ours, the inter-relationship between the
government at the centre and the state governments is very critical. According
to M.P. Jain, the author, inter-governmental financial relationship “touches
the very heart of modern federalism, as the way in which this relationship
functions affects the whole content and working of a federal polity”. Since
taxation is part – a very substantial and significant part – of the finances,
the allocation of the taxing powers is considered important in Constitutions.
The scheme of allocation of taxing powers is broadly based on the principle
that the taxes which are of a local nature are legislated upon by the states
and taxes which have a tax-base extending over more than one state, or which
should be taxed uniformly throughout India, or which can be more conveniently
collected by the centre, are allocated to the centre. The drawing up of a
Union List, State List and Concurrent List has by and large said to have
prevented the problem arising out of overlapping taxes being levied causing
hardship to citizens, though the Concurrent List has now and then caused some
problem or the other. There are some other federations in the world where this
problem (of overlapping taxes) has manifested itself more acutely.

I had earlier referred to the entries in the three Lists in the 7^th
Schedule to the Constitution being “elastic” and being the subject of a wide
interpretation. Here, there is a clear distinction between a tax entry and a
non-tax entry. A tax entry, it has been held in several judgments of the
Supreme Court, has to be construed or interpreted broadly and liberally. In Tata
Iron & Steel Co. vs. St. of Bihar (AIR 1958 SC 452), this principle of
broad and liberal interpretation of the tax-entries was extended to include the
power to tax retrospectively. An important principle in this context is the
doctrine of “pith and substance” which means this: the true character of the
legislation in question has to be ascertained by having regard to it as a
whole, to its objects and to the scope and effect of its provisions, and if
according to its “true nature and character” the law substantially relates to a
topic assigned to the legislature, which enacted it, then it is not invalid
merely because it incidentally trenches or encroaches on matters assigned to
another legislature. The fact of incidental encroachment does not affect the vires
of the law even as regards the area of encroachment; incidental encroachments
are not forbidden. The law in question has to be read as an organic whole and
not as a mere collection of sections; it should not be disintegrated into
pieces and each piece examined whether it fits into the Constitutional scheme
or division of legislative powers. The classic observations of the Supreme
Court in State of Bombay vs. Balsara (AIR 1951 SC 318) are these:

“It is well-settled that the validity of an Act is not affected if it
incidentally trenches on matters outside the authorised field and, therefore,
it is necessary to enquire in each case what is the pith and substance of the
Act impugned. If the Act, when so viewed, substantially falls within the powers
expressly conferred upon the legislature which enacted it, then it cannot be
held to be invalid merely because it incidentally encroaches on matters which
have been assigned to another legislature”.

Another aspect of Article 265 is that it is open to the legislature to
pass a validating Act to remove the infirmity in the law pointed out by the
judgment, and make the law effective from the date of its enactment and retain
the collections of the taxes under the law invalidated by the court. The
important condition, however, is that the government must have the power to
levy the tax, for in the absence of the power the tax must ever remain invalid:
M.P. Cement Manufacturers Association vs. State of M.P. (2004) 2 SCC 249.
The validation by a validating Act can however be done only by removing the
grounds of illegality (Rai Ramkrishna vs. State of Bihar) (AIR 1963
SC 1967), or by removing the basis of the decision and not merely by
disregarding or disobeying or “reversing” the judgment: Ahmedabad
Municipality vs. New Shorrock Spg. & Wvg. Co: (1970) 2 SCC 280.

Legislative competence (in addition to Constitutional validity) is the
deciding factor in examining the validity of a tax. In judging the legislative
competence – which has to be adjudicated at the threshold before any other
challenge is examined – the nature and character of the tax constitute a
significant element. The following aspects are irrelevant: (a) motive in imposing
the tax; (b) wrong reasons given in the statement of objects and reasons; (c)
the form and manner in which the power is exercised; (d) nomenclature of the
tax. In Jullundur Rubber Goods Manufacturers Association vs. UoI (1969) 2
SCC 280, it was held that so long as the doctrine of “pith and substance”
is satisfied and the “real nature and character of the levy” test is answered
in the affirmative, with reference to the taxable event and the incidence of
the levy, the law imposing tax cannot be invalidated. It cannot also be argued
that the tax under a particular entry shall be levied in a particular manner;
it is open to the legislature to adopt such method of levy as it chooses so
long as the character of the levy falls within the four corners of the particular
entry: Twyford Tea Co. vs. State of Kerala (1970) 1 SCC 189. The pithy
observations of the Supreme Court in Rai Ramkrishna (supra) are
noteworthy:

“The objects to be taxed, so long as they happen to be within the
legislative competence of the legislature can be taxed by the legislature
according to the exigencies of its needs. ……..the quantum of the tax levied by
the taxing statute, the condition subject to which it is levied, the manner in
which it is sought to be recovered are all matters within the competence of the
legislature”.

In Jain Bros. vs. UoI (1969) 3 SCC 311 and Avinder Singh vs.
State of Punjab (1979) 1 SCC 137, it was held that Art. 265 does not
prohibit double taxation of the same person twice over if the legislature
evinces a clear intention to do so and that the vice of double-taxation cannot
be spun out of the said article. But without an express provision in the law to
impose tax twice over on the same subject, there can be no double-taxation by
implication.

The question of sharing the revenues between the centre and the states
is crucial, not the least due to political reasons. In the USA, there is no
provision in their Constitution for sharing revenues between the centre and the
states, but in actual practice a system of conditional grants has come to be
under which the centre financially supports the states. Moreover, in that
country the power of the states to impose taxes is vast. The situation in
Australia and Canada is more or less the same, and there is a system of
tax-sharing. The Constitution of India also contains provisions to ensure
financial equilibrium in the distribution of collection by way of taxes. It may
be noted that most of the lucrative tax levies, such as corporation tax,
income-tax, goods and services tax, customs duty are within the domain of the
centre. On the other hand, the states require plenty of money for their welfare
and development schemes and they are mostly left with taxes by way of octroi,
entry tax, land revenues, etc. There are, however, political compulsions in
imposing land revenues, as well as considerations such as hardships to the
agriculturists to be taken note of. The makers of the Constitution did
recognise that the revenues of the states were thus inadequate to fulfill their
needs. In the Report of the Expert Committee on Financial Provisions, this was
highlighted. The Constitution therefore provided for sharing of the finances
between the centre and the states.

There are two major methods by which the finances are shared:
Tax-sharing and Grants-in-aid.There are detailed provisions in our Constitution
in Article 268 onwards and it is beyond the scope of this article to dive deep
into them. The most important aspect of tax-sharing is the establishment of a
Finance Commission which can devise its own formula for the splitting of the
revenues between the centre and the states in a flexible manner and without
being rigid. The Commission is a non-political body and consists of a president
and four members appointed by the President of India. Article 280 makes
elaborate provisions for the powers and functions of the Commission. The
functions include (a) the distribution between the Union and the States of the
taxes can be divided; (b) to lay down the principles to govern the
grants-in-aid of the revenues of the States out of the Consolidated Fund of
India; (c) to lay down the measures to augment the Consolidated Fund of the
States in order to supplement the resources of the panchayats on the basis of
the recommendations of the State Finance Commission; and (d) to lay down
measures to augment the State Consolidated Fund to supplement the resources of
the municipalities on the basis of the recommendations of the State Finance
Commission.

A burning question which has exercised the minds of tax experts,
economists, jurists, tax lawyers and persons of eminence is whether there
should be justice in taxation. N.T. Wright, an author who wrote several
books on religion, remarked: “A sense of justice comes with the kit of being
human. We know about it, as we say, in our bones”. John Rawls, in his book A
Theory of Justice says that the ultimate purpose of a State is justice.
James Madison, the celebrated President of the USA, said “Justice is the end
of government. It is the end of civil society. It ever has been and ever will
be pursued until it be obtained”. It is believed that taxation and economic
or fiscal policy, which are subsidiary features of a government, do aim to do
justice first and foremost. Thomas Piketty, in his book The Economics of
Inequality says that a primary factor for the persistence of economic
injustice in this world is tax and fiscal policy, though there may be other
reasons, too. Injustice in taxation has many facets, the main facet being
complexity due to lack of systematic theories which provide general guidance as
to how taxation does function in society, and the difficulty in reasoning it
out; according to David F. Bradford who wrote Untangling the Income Tax,
taxation “can be understood (if at all) by only a tiny priesthood of lawyers
and accountants”! Judge Learned Hand scathingly described tax law as a
“meaningless procession of cross-reference to cross-reference, exception upon
exception – couched in abstract terms that offer no handle to seize hold of….”.
Moreover, taxation or tax law takes note of and incorporates other disciplines
in it, such as economics, philosophy, at times even politics. In India, if one
has to understand the Income-Tax Act, one has to have more than a working
knowledge of other branches of law – Civil and Criminal Law, Partnership Law,
Hindu Law or Mohammedan Law, Company Law, Intellectual Property Law and so on.
This certainly makes the tax law more interesting, but also complex. In
contemporary tax jurisprudence, we often hear of horizontal and vertical
equity. Horizontal equity requires two persons similarly situated to be treated
similarly. Vertical equity requires two persons differently situated to be
treated differentially to a degree. These are probably different names given to
what is basically understood as fairness. Fairness in tax law, as presently
advised, seems to be a distant goal. Adam Smith must be turning in his grave!

Is there morality in taxation? This question has troubled many tax
jurists and lawyers over the years. We have a fascinating jurisprudence in
India on the subject. The debate will go on forever and jurists will keep on
saying that the two are poles apart, and that everything is fair in war, love
and taxation. The morality aspect is relevant not only in the means which the tax
payer adopts in “arranging his affairs in such a manner that he pays the least
amount of tax”, but it also applies to governments, particularly in the matter
of retrospective taxation. How moral is it to tax the results of a transaction
which, when it was put through, did not attract taxation but which has been
made subject to tax at a future point of time with back-effect? People may have
arranged their monetary affairs on the basis of the earlier law, and if they
are told after ten years that the earlier law is being withdrawn
retrospectively, it does cause enormous financial strain, mental agony and
leads to distrust or mistrust on the government of the day. Today’s world of
globalisation of business and inter-country commerce and investment suffers most
because of retrospective taxation, as we have seen recently in our country. The
debate will go on, and ways and means will be found to tide over such difficult
situations.

A stable tax policy may be a dream, but that should not prevent
governments from adopting a rational and informed view of taxation principles
to be adopted to serve the needs of the country. For a long time we did not
have a “tax policy unit” in the administration of the Income-Tax Act, and if
tax pundits are to be believed, this has resulted in several skewed situations
which benefit neither the government nor the tax payer. Fortunately, we now
have a Tax Policy Unit which carries out a lot of research, both of local and
overseas conditions, and keeps advising the government which can input the
advice to shape its fiscal policy.

The Indian government came out with proposals in 2016 to make use of
e-assessment procedures with the objective of transparency and speed, in
consonance with the “digital India” initiative. Measures are being taken to
showcase the Indian tax administration as an intelligent, sensitive and
non-combative system which will deal with overseas investors in India fairly
and honestly. The recent amendment to introduce a pilot-scheme where
assessments will be made without any interface between the tax officer and the
assessee is a step taken with the right intention and its success will drive
future amendments with a similar purpose. At the same time, the concern of the
tax payers about the unnecessarily aggressive and at times vengeful attitude of
the tax authorities cannot be said to be without basis and must be addressed.
It is very easy to make a deliberately excessive and high-pitched assessment,
create a demand and harass the assessees who will be forced to run from pillar
to post, spend huge amounts as legal expenses, suffer mental agony, run the
risk of assets and bank accounts being attached with consequent stoppage of
business, and so on and so forth. Tax compliance cannot be expected without
showing tax-sensitivity; to tax and to please is impossible, hence the need
today for a friendly and polite and at the same time objective approach, with
only the requirements of the law in mind. Collection of targeted amounts of tax
cannot be the sole objective and setting of targets must also be realistic;
assessments must be rooted to the law and should be in conformity with the
judicial precedents and not merely target-oriented. A target-oriented approach
tends to result in aggression and a flouting of the rule of law. Judicial
review of the assessments and decisions of the tax authorities should be viewed
as a corrective and not as criticism.
What is required from the tax administration is a broad-minded, professional
and impersonal approach. Computerisation has its place in the procedural
aspects of administering the law, but computers cannot be allowed to make
assessments!

Protracted and interminable tax disputes serve no purpose. The Act
provides for an excellent system of appellate and revisional remedies but of
late murmurs are being heard whether the appellate tiers, both the first and
the second, are discharging their duties impartially and without being
influenced by “oblique” considerations. There was a time when the Appellate
Assistant Commissioners used to write orders which were, quality and learning
wise, no less than those of judgments of High Courts or even the Supreme Court.
It is unfortunate that one does not get to see such orders these days. The tax
tribunal has always done an excellent job but of late one wonders if it can be
said to be immune to the “winds of change” sweeping the country and the mindset
of its people. Innovation and improvisation in the decision-making process is
welcome, but it should be within the framework of the judicial norms and discipline.
The decisions should be informed by objectivity and absence of bias – against
the Department of Income-Tax, against the tax payer and also against the
counsel! – and care should be taken to ensure that judicial adventurism does
not masquerade as judicial innovation or judicial creativity. I will say no
more.

A word about the emerging trends and issues in international taxation,
which has turned out to be a fascinating branch of the income-tax law. These
are mostly issues arising out of interpretation of tax treaties and
transfer-pricing issues. In both, the stakes are mind-boggling. The
jurisprudence is marvellous and provides excellent fodder for intellectual
acrobatics. The IRS has mastered these two branches of tax law; the tax
lawyers, with some unmatched original thinking, have made a huge contribution
to the growth of this branch of the tax law, supplemented by the learning
exhibited by the Tribunal in dealing with those issues. It is a matter of pride
for the profession that the highest number of decisions in this branch has
emerged from our country and it is believed that they are treated with great
respect in judicial forums across the world. This is a very good augury for the
tax administration of the country. It is further believed that this branch of
tax jurisprudence will govern the future tax litigation in our country.

To conclude, I can do no better than quote the learned author,
Padamchand Khincha, from his preface to the book Emerging issues in
International taxation: “Rightful tax is the price of social order. Tax
is that portion of a citizen’s property which he/she yields to the Government
in return for the benefits enjoyed from the society. Citizens feel that taxes
are (un)wantonly levied, that the pervasiveness of taxes is stifling.
Governments feel that the tax payers are short in discharging their
obligations……………..In this interaction of granting the benefits and demanding
the exaction, the equation is hardly ever balanced.” Well, very pithily
put. The goal of every tax administration is to find that ever-elusive balance!

JAI HIND!!!

shailesh.kwebmaker

Pelting Pessimism

Rudyard Kipling wrote: “Words are
the most powerful drug used by mankind.” The truth in those words shines bright
during election time. Just like ice cream or burger companies, the notable
limited period election flavours are linked to certain themes. One of them is
Pessimism.

Pessimism sells. The human mind is
wired for pessimism. Therefore, pessimism sticks – like Fevicol! A recent
article in GQ magazine[1] said: “When you look at pessimistic people,
probably the single [most-telling] hallmark is — they think that bad events
are permanent and that they’re unchangeable.” A lot of stuff in the media and
politics these days is akin to this.

Take the example of talking about
poverty and poisonous political rattling around this subject. Although India
has miles to go, millions of people have been brought out of abject poverty.
Yet politicos, and recently the winking and hugging parliamentarian, can’t stop
talking about poverty. Let’s do a fact check. There were 90.17 m people living
in extreme poverty in January, 2016 (6.8% of population). In January, 2019,
49.16 m people were reported to be living in extreme poverty (3.6% of
population) in India[2].
The current escape rate is 21.7 people/minute, whereas the target escape rate is
7.8 people/minute. Yet the narrative and discourse of pessimism is kept
consistent and incessant. The fact is that great good has happened and greater
good is yet to be done. It is important to acknowledge what is done and it is
imperative to focus on what needs to be done through ideas and action.

Business
Standard tweeted on January 22, 2019: “If everyone had decent
jobs… not very many would spare time for Kumbh”. What kind of “standard” is
this? Is this the way to talk about the faithful who visit the largest
congregation on the planet? Even if many were underemployed, is this the way to
look down upon millions of people by the media? Partisan, irresponsible,
agenda-driven, and biased seems to be a new standard and that too by a business
newspaper – this is appalling. On the other hand, a CII report said that the
fifty-day congregation – the Ardh Kumbh, will create jobs for 6 lakh workers
and generate revenue of Rs 1.2 lakh crore. Pessimism is often a false
projection to blur people’s perception by only flashing the doomsday prophesies
on the screen of the mind.

Beware!
False, pretentious, convenient facts abound! Pessimism is projected on an
oversized screen bigger than the falsehood it wants to project. Elections
involved rigging of some booths in earlier times. Elections today are about rigging
people’s perception on a scale not known before, one that is so immaculate
in design that you won’t even know. The upcoming 17^th national
election will have an electorate of nearly 900 million out of which 450 m have
access to internet, there are 270 m Facebook users and 200 m WhasApp users –
which is equal to more than any democracy in the world. We need to be watchful
of all this.

The President of India tweeted on 1^st
February about the cost of data – dropping from Rs. 250 per GB (2014) to Rs. 12
(2018). There are innumerable positive data points and there is an unfinished
agenda before the nation to overcome so many problems.

I recently read: “Life can only be
understood backwards; but it must be lived forwards.” We have to look ahead, to
look for the light. I hope we don’t succumb to pessimism. I hope we will look
through to see where the light is. Charlie Chaplin said: “You’ll never find
rainbows if you’re looking down”.

And yes the Supreme
Court will deliver its take about the fate of a prayer in schools which comes
from the civilizational soul of India. Strange as it is, some believe that
nation can be separated from the bedrock of its
civilization and the offshoots can poison the soil. The universality of those
words is as important and relevant as ever. Let me sign off with that same
aspiration: May all of us be led from untruth to truth, from darkness to
light, from death to immortality.

[1] 23^rd
September 2018

[2] https://worldpoverty.io
run by Vienna based NGO and funded by German Federal Ministry of Economic
Cooperation and Development. It gathers data available in public domain.

shailesh.kwebmaker

Eternal Vigilance

We are living in a war-like situation.
Technology is invading and virtually taking over our personal and professional
lives. It has become extremely difficult to maintain secrecy, confidentiality
and privacy. The invasion is probably with a vicious attitude and purpose. Our
bank account is vulnerable and our office and personal data is vulnerable.
Hence, we are vulnerable and are exposed to many risks. Everywhere, there is a
crisis of trust. In short there is a serious threat to security, an environment
of uneasiness and suspicion is prevailing.

In international politics, there is an often
quoted saying – “In international relations, there are no permanent
friends nor permanent enemies. There are only permanent interests!”
Unfortunately, this principle is becoming applicable even to our personal
relationships.

Actually, the use of technology was expected
to enhance our efficiency and make our living more creative and relaxed.
Unfortunately, the experience is exactly the opposite! Therefore, there is an
ever-increasing need for caution in every walk of life. The issue of privacy is
being discussed and debated internationally.

Sometimes, the damage occurs not necessarily
due to malicious intentions; but purely on account of negligence, lack of due
care or inadvertence. Nevertheless, the consequences are disastrous. As
chartered accountants, we expect that we should have independence and preserve
and practice client secrecy – privacy. One always should bear in mind that “eternal
vigilance is the cost of independence”.

Saint Samarth Ramdas has given a very
beautiful message for the conduct of our life in just four lines –

Not
only in the matters of spiritual but also in state-craft, unbroken alertness is
vital in every aspect.

“Harikatha”
stands for good and holy thoughts. All your actions should be motivated by some
constructive and positive thinking. One should aim at the larger good and not
at narrow selfishness. One should try to spread peace, well-being and
happiness. That is the Divine aspect of our life.

Second is “Raj-karan”. It does not
mean “politics” as we understand today. It indicates governance. One has to
conduct one’s affairs in a professional manner.

The third is “Savadhpan”
meaning vigilance. This is to keep away the negative powers from destroying a
good cause and lastly “Sarvavishayi” means in every walk of life.Actually, this was Samarth Ramdas’s message to Shivaji Maharaj; and
the latter followed it both in letter and spirit.

To conclude, I would say that despite the
present environment of distrust and being vulnerable, to have a peaceful life
one should act with truth, love and compassion at home, in business and in the
profession and in our dealing with society, whilst at the same time being
vigilant. In short, follow the dictate of Swami Ramdas.

shailesh.kwebmaker

DECODING GST – CLAUSE BY CLAUSE ANALYSIS OF GST FORM 9C

This article is oriented towards performing a clause by clause analysis
of GST Form-9C. GSTR-9C has been titled as a reconciliation statement driven
towards reconciliation of data as per books of accounts with the data reported
in the GSTR 9. Therefore, preparation of GSTR-9 has to be treated as being a
pre-cursor to the reconciliation statement to be prepared for GSTR-9C.

Foreword

We have all experienced multiple course corrections in the country-wide
GST implementation including the course correction in reporting front. For
instance, in April 2017, the ambitious plan of item level reporting (at output/
input level) in the form of GSTR-1/2/3 with GSTR-1A/2A was introduced. However,
in July 2017 GSTR-1/2/3 and its compliments have been suspended and replaced
with a surrogate return in the form of GSTR-3B condensed the information
requirement. The said form was meant to collect taxes and tide over the IT
preparedness in implementing this nation-wide law. There was a temporary shift
from item level reporting to aggregated level reporting in the returns.
Entities hence prepared internal workings (at item level) and only reported the
aggregate number in GSTR-3B. Then came October 2017 wherein the requirement to
file GSTR 1 was introduced.

The flip-flop in reporting formats and ambiguity in
law could have given scope for errors creeping into reporting or taxability.
The law permitted tax payers to rectify both these errors during the course of
the tax period with additional time granted until September 2018. Yet there
could be instances where errors remain unrectified. For such instances, GSTR-9
and 9C assume a higher significance for FY 2017-18. The Auditee should view the
exercise of GSTR 9 as an opportunity to review and rectify the ‘errors in
reporting’ and GSTR-9C as an opportunity to get an external view to taxability
and rectify ‘errors in taxability’.

Structure of Form 9C

Traditionally, scope of taxation under VAT/ Service tax/ Excise was
limited to business turnover. With advent of GST the gamut of taxation has
widened unimaginably – from financial / recorded transactions to
non-financial/unrecorded activities; from contractual events (written/ oral) to
non-contractual activities; from external transactions to internal events; from
revenue to capital / non-recurring items. The law has encompassed almost
everything one can imagine. We have in some sense transgressed from a
‘transaction based law’ to an ‘event based law’. The law drills deep into the
information mine of an organisation touching internal actions, behaviors and
movements. It is for this reason that 9C attempts to capture whole lot of
information which is beyond the trial balance/ balance sheet of an
organisation. The form has been structured as follows:

Part-I contains the basic details of registration. Part II, III, IV and
V are the reconciliation tables which are discussed below. It is pertinent to
note that any reconciliation is an examination of the presence/ absence of a
particular number in two comparatives. Therefore, prior to performing any
reconciliation, one needs to be clearly conscious of the composition of
starting point since all adjustments to be made to reach the other end are
based on the presence/ absence of that particular figure in the starting point.
All the clauses of Form-9C should be understood on the basis of this comparative.

Part II: Point No. 5: Reconciliation of turnover declared in audited
annual financial statements with turnover declared in Annual Return (GSTR-9)

This part reconciles the turnover level differences between audited data
and returned data. Conceptually, audited turnover would vary from returned
turnover on account of certain variances. While this part performs a two-way
reconciliation between audited accounts and GSTR-9, one would also have to
factor the background workings of GSTR-3B and make this a triangular
reconciliation to conclude on the tax level differences. The picture below
depicts the journey from BOA to GSTR-9 to GSTR-3B and back to BOA:

i. Timing variance
(TV): GST follows a monthly tax period and permits transactions to spill
over multiple months/ financial years but audited accounts freeze numbers
between two dates i.e. 01/04/XX to 31/03/XX. This spill-over effect creates
temporary differences in Y1 and reversing difference in a subsequent year (say
Y2). There could also be cases where the revenue recognition policy uses
different parameters in comparison to the GST time of supply provisions (eg. a
developer following percentage completion method of revenue recognition whereas
GST follows invoice/ receipt basis). Similarly, GST law requires the taxable
person to pay tax on advances received during the year though not recognised as
revenue, thus resulting in a timing difference between the BOA and returns.

ii. Accounting variance (Permanent variance) (AV): As mentioned
earlier, GST encompasses events which may not be reflected in the entity level
books of accounts (say internal stock transfers, internal cross charges, etc)
and thus creates a permanent variance between two numbers.

iii. Value variance
(Permanent variance) (VV): This represents variances arising on account
of difference in commercial value and GST value (section 15).

PART 5 & 6 – RECONCILIATION OF GROSS TURNOVER

This part reconciles the accounting turnover with the turnover reported
in GSTR-9. The GST turnover would be mapped from GSTR-9 (compilation of all
GSTR-1 returns) with subsequent year adjustments during the period April 2018
to September 2018 (such as rectification in errors in the amendment table,
etc.)

Clause Description

Intricacies

Auditor responsibility/ working Papers

Adjustments/ Illustrations

5A. Turnover as per audited financial statements
for the State/UT (for multi-GSTIN units under same PAN the turnover shall be
derived from the audited financial statement) – Starting Point

Report the revenue from operations of the entity
in the P&L for the financial year April 2017 to March 2018 (incl. the
non-GST period)

Financial year 2017-18 numbers are to be
adopted. For entities having multiple
registrations, the instruction of the form suggests that a GSTIN level
turnover should be extracted from the audited turnover at entity level.

Auditor should obtain the signed financial
statements. In case of multiple
registrations, auditor should obtain GSTIN level data which aggregates to the
audited figure under a representation letter.

Revenue excluding GST component should be adopted
from financial statements

No adjustment should be made to the financial
number and it should be directly planted into this clause. Any adjustments to
this number should be made only via form 9C.

This clause does not require a ‘State level
Trial Balance’ and the auditor can rely on any suitable methodology in the
company which extracts the registration level turnover from the revenue GL
(such as cost centre, location codes, etc).

Other income streams in separate schedules
should not be included here. Only those having GST implications should be
added as a separate line item.

All
subsequent clauses should also be applied at the GSTIN level only.

The auditor should check if the audit
adjustments on account of transfer pricing / IND-AS / provisions, etc., are
accounted for in the books at registration level / consolidated level and
accordingly, the registration level revenue should be arrived at.

Auditor may consider documenting/ reporting the
broad composition of the starting point as an observation in Part-B since all
subsequent adjustments are dependent on this composition.

5B. Unbilled revenue (UBR) at the beginning of the financial year(+)

5H. UBR at the end of the financial year (-)

UBR as reported in the Asset GL as on
01-04-2017and 31-03-2018 (+/-) to be taken at state level

The objective of this clause is to adjust
opening UBR which is billed during the GST period and eliminate fresh
recognition of UBR by reducing it from the audited revenue

It may be advisable to map the opening
composition of UBR with billing under Service tax/ GST period

Auditor to document the revenue recognition
policy and management’s view for its variance with the Time of Supply
provisions

Delay in billing beyond the contractual due
date may need to be analysed considering the provision of Time of Supply
under GST.

A MRL may be obtained with regards to details
of Unbilled Revenue provision of earlier period reversed during the period
under audit and fresh unbilled revenue provision created during the period of
audit

Some entities have taken a conservative stand
and considered UBR as their taxable turnover under Service tax (especially
export entities). In such case, a note
that UBR has not been reported since there is no timing variance between
revenue recognition and time of supply provisions could be provided.

5C. Unadjusted advances (UADV) at the beginning of the financial year
(-)

5I. UADV at the end of the financial year (+)

Report the UADV as on 31-03-2018 and 01-04-2017
as per BS/ location level accounts

Only taxable advances need to be included in
the opening/ closing values i.e. advances on which tax has been paid

In case of decentralised billing/ accounting
practiced during the service tax regime, it would be easy for the assessee to
ascertain the state level opening UADV

In case of service entities having centralised
registration under service tax, the adjustments towards opening UADV and the
service tax turnover may be recorded only in the Form 9C of the centralised
office of the tax payer

Verify opening UADV with the state level
billing in subsequent period to ensure accuracy of the data provided by the
assessee and ensure there is no cross adjustments between branches

If assessee has not offered advances to
taxation during the service tax/ GST period, this clause would become
redundant and an observation should be made in the certificate

Auditor to verify that tax has been paid and
turnover has been reported in GSTR-9 at the time of receipt of advances which
are comprised in the year end UADV

In certain cases tax payers have paid the tax
on advances based on an incorrect place of supply (i.e. IGST instead of
CGST+SGST), necessary adjustments may need to be made at the tax level if not
already adjusted in the returns. Refund of the incorrect tax may be sought by
the assessee through a separate process (refer tax level reconciliation)

5D. Deemed Supply under Schedule I

Transactions without considerations are to be
captured here such as Branch transfers/ intra-entity cross-charges; principal
agent supplies, etc

This should include activities which are deemed
to be supply under the GST law, i.e., covered under schedule I of the CGST
Act but not included in the financial statements/ state level turnover.

Auditor should identify all such cases which
might be covered under Schedule I of the CGST Act.

Auditor may consider reconciling the delivery
challans/ e-way bills generation data for completeness of the reporting.

Some entities have practiced departmental
accounting for state level registration and made consolidation adjustments at
the time of preparation of financial statements. One may verify whether the turnover in 5A
already includes this figure

In case where state level data has been
extracted from cost centres/ location codes, adjustments to the accounting
turnover becomes necessary.

Fixed asset and other inventory registers may
be examined to ascertain whether there are disposals/ write-off of business
assets on which input tax credit has been availed

For instance, branch transfer of goods can be
identified based on the examination of the inventory registers for
identification of inter-state stock movements and its reporting in GSTR-3B/1.
Similarly, deemed supply of service between distinct persons can be
identified by doing a revenue cost analysis for each registration and reviewing
the documented policy in this regard.

Auditor should conduct a review of all assets
and seek representation on the physical location/ presence within the
respective States to determine whether there is any permanent transfer/
disposal of assets

Auditors may consider caveating their report to
the extent that auditing methodologies only facilitate review of identified
branch transfers and that the certificate should not be construed as a
comprehensive identification of all such deemed supplies

In case of supply of goods, tax payers have
been exempted from payment of taxes at the time of receipt of advances. In such cases, closing unadjusted advances
for supply of goods would only comprise of receipts during July 2017 to Nov
2017.

5E. Credit notes issued after the end of the financial year but
reflected in the annual return (+) : apparent error in signage

Credit notes u/s. 35 are issued for cases
involving change in taxable value or on account of goods return or deficient
supplies

Credit notes raised by an entity could be those
which have a GST impact, i.e., satisfy the conditions prescribed u/s. 35 and
those which do not have a GST impact (for example, account settlement credit
notes or bad debts and so on). This
clause is meant to captures the former and that also only to the extent such
credit notes are issued during the subsequent financial year in relation to
supply made during the period under audit are reflected in the Annual return
filed for the period under audit

The auditor will have to review the GSTR 1
filed for the period from April to September of the next financial year and
determine credit notes which are issued in relation to supply made during the
period under audit and further analyse whether the same have been disclosed
in the Annual return or not.

There is lack of clarity on this clause and we
have to await an amendment to this clause.
Credit notes raised during 18-19 are logically not required to be
reported as part of the 17-18 reconciliation.
It is highly probable that this clause might be amended

5J. Credit Notes accounted for in the audited
financial statement but are not permissible under GST (-): apparent error in
signage

Credit notes u/s. 35 are issued for reduction of
taxable turnover (such as price re-negotiation, short shipment, incorrect tax
rate, etc)

This clause would capture all such credit
notes, where reduction in GST is not allowed u/s. 35 as discussed for the
earlier clause.

Identification of credit notes and reasons for
reduction sought in the taxable turnover should be documented as working
papers

Management may seek confirmations on reversal
of credit on the recipient end

5F. Trade Discounts accounted for in the audited
financial statements but not permissible under GST

Trade discounts u/s. 15(3) could be those granted
at the time of supply or post supply

Trade discount here should be understood to
include cash discounts, target discounts, incentives, etc. which do not
satisfy the conditions prescribed u/s. 15(3) for non-inclusion in the value
of taxable supply.

Auditor may consider conducting a sample
analysis of major contracts to identify whether discounts given during the
year on which section 15 (3) benefit has been claimed satisfy the parameters
prescribed therein

Gratuitous discount given by a company on 100^th
year celebration to its all India distributors may not be permissible under
this clause

5G. Turnover during April 2017-June 2017 (-)

Audited financial turnover at the location level
for the said period is to be reduced

The accounting turnover (net of all credit
notes/ debit notes and accounting adjustments) which was used to arrive at
the opening figure should be reduced to nullify the effect of pre-GST period
revenue during the FY.

Turnover in excise/ service tax/ VAT returns are irrelevant for reporting
here.

Auditor would need to understand the process of
ascertaining locational level turnover for April-June’17 especially under
service tax regime since many assessee might have opted for centralised
registration under service tax and would not have identified a turnover to a
specific location

A view with adequate disclosure may be given
that consolidated turnover for April-June’17 is to be tagged to the state
where service tax jurisdiction applies and the disclosure is not having any
adverse tax consequences

5K. Adjustments on account of supply of goods by
SEZ units to DTA units (-)

Report DTA sales by SEZ unit

‘Removals’ from SEZ units are liable to custom
duties as any other imported stock in the hands of the person who declares
himself as an importer on record (generally the DTA buyer). Since buyer discharges the customs duties
on the basis of bill of entry for home consumption, it is not considered as a
taxable supply by the SEZ unit even-though it is a turnover in the accounts

Where the SEZ unit declares itself as an importer on record, pays
the custom duties and also charges IGST on the stock transfer invoice to the
DTA unit, this would form part of the turnover of the SEZ unit and no
adjustments are required in this clause

The auditor may obtain a list of all DTA sales by the SEZ unit and
also obtain a copy of Bill of Entry filed by the customer as importer to
satisfy that the onus of discharging tax was not on the SEZ unit but on the
DTA unit buying the goods

DTA clearances of capital goods by SEZ
developers are not covered in this clause though principally similar implications
would apply (Section 30 of the SEZ Act
operates only for SEZ Unit)

5L. Turnover for the period under Composition (-)

Accounting turnover during the period under
Composition Scheme to be excluded

GSTR-4 data to be reconciled with accounting
turnover under the composition schemeand then excluded under this clause.

5M. Adjustments in turnover u/s. 15 and rules
made thereunder (+/-)

Variances in commercial value and GST value to be
aggregated and reported here

Section 15 and rules may require upward/
downward adjustment to taxable value (such as air travel agent invoices/
money-changer transactions, trading of used goods, admitted undervaluation in
related party transactions, admitted Free-of cost supplies with external
parties, etc)

Auditor can ascertain this figure by a invoice-wise comparison of
revenue GL and GST register (value column)

Auditor may study the upward/downward variance at a conceptual
level and aggregate the same but is not required to attest the said
quantification

Certain value exemption notifications (such as
sale of flats, sale of second hand pre-GST motor vehicles , etc) may also be
included here eventhough they are not part of section 15

5N. Adjustments in turnover due to foreign
exchange fluctuations (+/-)

Difference in valuation due to forex rates
adopted for revenue recognition / GST valuation

In respect of export of goods, the law requires
the customs notified rates to be adopted but commercially agreed currency/
forex rates may vary. Therefore, there will always be a difference in the
value of export of goods reported in the Annual Return vis-à-vis books of
accounts which will have to be reported here.

Auditor to examine the internal accounting policy in respect of
adoption of foreign exchange rates.

In addition, the auditors should obtain a statement of export of
goods during the year with both, the figures as per books of accounts as well
as the shipping bill plotted for verification and record purposes.

Certain accounting practices for companies who have hedged their
foreign exchange exposures on export revenue may be examined

Any variance in turnover due to difference in
foreign exchange rates at the time of receipt of advance and time of its
adjustments may need some reporting

5O. Adjustments in turnover due to reasons not
listed above (+/-)

Residual entry for all other adjustments

All case-specific adjustments may be carried
out here. If the web-portal does not
permit multiple sub-items, it may be advisable to maintain a internal working
and upload a scanned copy if permitted by the web-portal

Auditor to seek representation on this residual
adjustments and maintain working papers on the reasons for the adjustments
and its impact at the tax level. Missed reporting of outward supply should
not be reported here but reported as unreconciled difference

Expense recoveries which are debited to the
profit and loss account

High-sea sales/ drop shipments which are
excluded from GST

Sale of fixed assets, residual value of
destroyed goods, etc.

5R = 5Q-5P : Unreconciled difference between the Accounting
turnover (with adjustments) and the GSTR-9 turnover

Reasons for non-reconciliation to be provided
here

• It is absolutely essential to reconcile the two
turnovers to the last rupee to eliminate the possibility of compensating
reconciling items

Auditor cannot adopt a materiality test for this
unreconciled difference (eg. a Re 10 +ve and Re 9 –ve may result in Re 1
+ve). Auditor to identify every
difference

It is also essential to comment whether tax is
due on this difference and if yes, whether tax has been discharged and the
relevant tax period. If tax has not been discharged, auditor may consider
reporting the same as additional liability

PART 7& 8 – RECONCILIATION OF TAXABLE TURNOVER

This part aims at moving
from the reconciled total turnover as per accounts to the taxable turnover as
reported in GSTR-9. By this stage, the
accounting turnover has been brought to the level of total turnover as per
GSTR-9. Any difference arising in this reconciliation table would primarily
be on account of: (a) short-reporting of non-taxable turnover in GSTR-1 (say
interest income); or (b) short reporting of taxable turnover; (c) incorrect
reporting head. In the author’s view,
it may be advisable to rectify any short reporting of non-taxable turnover
and reporting errors of GSTR-1 in GSTR-9 itself so one is left only with
items having a final impact on the tax liability.

Clause Description

Intricacies

Auditor responsibility/ working Papers

Adjustments/ Illustrations

7A. Annual Turnover after (+/-) adjustments above

Turnover as per accounts with the +/- adjustments

This is an auto-filled data field

NIL

7B. Value of Exempted, Nil rates, Non-GST
supplies, No-Supply turnover (-)

Non taxable items comprised in GSTR-9 are
reported there

Exempted refers to supplies arising from
Notifications (Goods/ Services) u/s. 11 of the respective acts i.e. N-02/2017
and 12/2017

Documentation of the list of exemptions availed
and compliance of exemption conditions may be examined on sample basis

This turnover should be reported net of debit
notes/ credit notes as available from the books of accounts

Turnover having partial exemption such as rate
reduction of 18% to 5% or 0.1% or value reduction (in case of
developers) would not be reported here

Non-GST supplies imply supply of Non-GST
products (such as petroleum)

No-Supply implies turnover covered under
Schedule III i.e. sale of land, etc

Documentation
of the reasons provided by the assessee for treating the turnover as Non-GST/
No-Supply, etc.

7C. Zero-rated supplies without payment of tax
(-)

Export Supplies and Supplies to SEZ units/
developers

Export supplies of goods and services including
to SEZ units / developers from accounts is to be extracted and reported here

Auditor needs to maintain the LUT as part of
its working papers and broad parameters on which the assessee has treat the
transaction as export – a sampling may be undertaken for verification

Same as above

Tax type would be IGST even for same state SEZs

Sample verification of SEZ status of customers
may be carried out on the GSTN portal

7D. Supplies on which tax is to be paid on
reverse charge basis (-)

Turnover of suppliers under RCM

Supplies where the supplier records the
turnover but does not pay the tax are
to be reported here

Auditor needs to maintain the notification
under which the assessee has taken the stand that RCM is being discharged by
recipient

Sample invoices for RCM declaration may be
examined

Same as above

7G = 7F – 7E : Taxable turnover as computed above
and compared with the Turnover as per GSTR-9

There could be +ve/ -ve result

If everything has been captured above, 7G
should ideally be NIL

+ve implies GSTR-9 taxable turnover is greater
than accounting taxable turnover indicating tax refund

-ve implies GSTR-9 taxable turnover is lesser
than accounting taxable turnover resulting in indicating tax payable

Credible explanation should be provided at item
level for the difference

Auditor needs to ascertain all those cases
where there is admittedly a tax liability which is payable but the same has
not been considered by the assessee in its GST workings

Where the tax payer represents to have
discharged the tax liability in subsequent year GSTR-3B, a categorical
representation is important on this point.

There should not be any un-explainable difference
at this stage.

PART 9, 10 & 11 – RECONCILIATION OF RATE WISE LIABILITY AND AMOUNT
PAYABLE THEREON

This part aims at
reconciling the above adjusted taxable turnover at the rate level (as per
accounts) with the tax liability reported in GSTR-3B. Since the accounting turnover has undergone
changes prior to this level, one would have to perform a rate classification
(exempt, 6%, 12%, etc) even for the adjustments made until this point. Therefore, workings for the adjustments
should be maintained at an item level.
This part is also important to examine whether there is any excess
collection of taxes by the tax payer.
The tax GL of the tax payer is the primary source of data for this
clause.

Clause Description

Intricacies

Auditor responsibility/ working Papers

Adjustments/ Illustrations

9. Reconciliation of rate wise liability and amount payable thereon

Rate wise liability as per accounts to be
reported here

Account extracts computing the rate
wise liability at the CGST/SGST and IGST level would have to be aggregated
and reported here (Tax GL)

This should also include rate wise RCM
liability on inwards supplies of goods/ services

Back-up workings of GSTR-3B would have
to be examined with GSTR-9 to ascertain the differences at the tax level

Errors due to using incorrect rates
from HSN schedule could be reported here

Auditor to maintain working papers of
rate wise liability as per accounts vs. rate wise liability as per GSTR-9

To the extent the variance is because
of turnover level un-reconciled differences, as a consequence they may form
part of the un-reconciled tax amounts

Auditor can recommend any additional
liability under this clause

GSTR-3B is primary document for discharge
of tax liability and the back-up workings would provide insights into the
tax level differences beyond those arising due to turnover level

PART 12 & 13 – INPUT TAX CREDIT RECONCILIATION

This part performs an
analysis of the input tax credit availed as per accounts and that reported in
GSTR-3B. The tax administration
expects that accounts are the sole basis for credit availment and hence
difference in accounting and receipt of goods/ services could be the primary
reason for any variance in credits. Practically, multiple errors have been
performed during the GST implementation.
This exercise is a good opportunity to rectify clerical errors (such
as claiming excess credit in a particular head) as well as eligibility errors
(such as blocked credits, year-end mandatory credit reversals, etc). Importantly, this form should not be viewed
as a document to avail/ reclaim any missed credit or even adjust the same
with any output liability.

12A. ITC availed as per
audited financial statements for the state at GSTIN level

ITC ledger extracts for each GSTIN to be reported
here

Account extracts computing the aggregate of ITC as recorded in
accounts would be reported here. This figure should be net of any reversals
made in accounts on the input tax credit front.

Internal working should be made at the tax type level (CGST/ SGST or
IGST) though the reporting is required to be done at the aggregate level.

GSTR-2A reconciliation summary of the tax payer could be examined for
completeness.

Working papers of rate wise input tax credit as per accounts vs.
rate wise input tax credit used for GSTR-3B workings to be maintained.

Auditor to ascertain if input tax credit availed in a particular
state is mapped to another state in accounting systems.

ITC availed in accounts but not claimed in any of the transition/GST
returns may be written off/ ignored.

ISD credit availed in GSTR-3B but availed at a different location in
accounts may come up here.

12B. ITC booked in the earlier financial years
and claimed in current financial year (+)

Transition Credit of earlier financial years to
be reported here

Transition return workings
and the accounting treatment would have to be examined and reported here.

Cases of capital goods claiming credit in accounts during FY16-17
but reported in transition returns would also be covered.

Auditor to document basis of claim of
transition credit and the eligible duties/ taxes claimed u/s. 140.

Centralised Cenvat credit which is distributed
during transition may be adjusted appropriately.

12C. ITC booked in current financial year and
claimed in subsequent financial year (-)

ITC booked in accounts but availed in subsequent
financial year in returns

GSTR-3B workings and the ITC register as per accounts may be
reconciled on a line-item basis and the difference may be reported here.

This ITC register data may also be compared with
the ITC reported in GSTR-2A (Table 9 of GSTR-9).

Auditor need not propose any disallowance of
input tax credit availed in GSTR-3B merely on the ground of non-reporting of
invoice in GSTR-2A.

Auditor need not particularly verify conditions of section 16(2) for
reporting this figure.

All figures reported here should be net of any
reversals or vendor credit notes.

14. Reconciliation of ITC at description level

Ledger level break-up of ITC credit

This table appears to be a ledger-wise breakup
of the expenses and the corresponding ITC reported in 12A/12B/12C.

Auditor would need to obtain ledger level data
and extract the expenses under each ledger on which ITC has been availed.

Column 4 : Amount of eligible ITC availed represents
the actual ITC availed in accounts net of the adjustments in 12B/C at the
ledger level.

ITC from internal stock transfers which do not
appear at a GL level may also be reported as a separate line item

Prima facie examination of ledger
nomenclature / narrations may be adopted for checking eligibility

13 & 15. Reconciliation of ITC at ledger
level

Reasons for non-reconciliation to be provided
here

It is absolutely essential to reconcile the two
turnovers to the last rupee to eliminate the possibility of compensating
reconciling items

Auditor cannot adopt a materiality test for
this unreconciled difference (eg. a Re 10 +ve and Re 9 –ve may result in Re 1
+ve). Auditor to identify every
difference

Eg. Admitted reversals of input tax credit not
reversed in GSTR-3B; availment of credit without receipt/ accounting of
goods/ services; credit availed at the wrong GSTIN location

Reporting horizon of GSTR-9C

Books of accounts have an annual time horizon and the GST-1/3B work on
monthly periodicity with hard close only in September following the respective
financial year. This variance in period
poses a peculiar problem because of a lack of a revision option in GSTR-1/3B
and GSTN storing data based on reporting period rather than the document
date. Let’s take similar yet
contradictory examples (i) debit note raised in FY17-18 delayed reporting in GSTR-3B/1
of 18-19 (ii) debit notes raised in FY17-18 and delayed reporting only in
GSTR-1 in 18-19 (iii) debit notes raised in FY18-19 for enhancement of a price
agreed in FY 17-18 and reported in GSTR-3B/1 if 18-19? Let’s compare these example based on following
parameters

Parameter	Case – 1 : Delayed reporting in 3B & 1	Case – 2 : Delay in reporting only in 1	Case – 3 : delay in recognition
Original Invoice date	01-01-2018	01-01-2018	01-01-2018
Accrual of liability	January 2018	January 2018	January 2018 (*)
Debit note date/ Accounting entry	31-03-2018	31-03-2018	30-09-2018
Date of Reporting additional turnover in GSTR-9	Clause 10 certainly capture this amendment	Clause 10 would capture this amendment only at turnover level	Clause 10 would not capture this and treated as 18-19 transaction
Date of Reporting additional turnover in GSTR-1	This would be a reconciliation item at turnover and tax level for both 17-18 & 18-19	This will be a reconciliation item only at turnover level for both 17-18 and 18-19	Transaction of purely 18-19 though accrual of liability in 17-18

Whether reporting in 9C is anchored to tax liability accrued in FY 17-18
or anchored to accounting and/or reporting the base document? Section 9 r/w 12/13 provide the time of supply for the
‘transaction value’. Legally speaking,
all liabilities accrued in 17-18 (either through current year/ subsequent year
adjustments) should be reported as part of Form-9C irrespective of the date of
accounting and reporting in GSTR-3B/1.
Procedurally, section 35(4) and rule 59 require reporting based on date
of issuance of base document. Going by
this analogy, transactions accounted in 17-18 would form the basis and those
accounted subsequently (for any reasons) should not form part of 17-18. The author believes that this second approach
should be adopted keeping in mind the true spirit of reconciliation i.e.
balance two values based on its composition.

Part – B : General points for Audit observations/
Comments

Part-B is the Auditor’s report over the correctness of contents of the
reconciliation statement. The report
places an onus that the reconciling items are accurate having credible
reasoning. This said report could have
two forms – (a) where the certification is by the person who has also conducted
the statutory audit; and (b) where the certification is placing reliance on the
audited books of accounts examined by another statutory auditor. The prescribed format provides certain areas
where observations/ comment may be provided by the person certifying the
report. Other general points for
consideration during this exercise are:

GSTR-9 is a management document and auditor is not certifying the
contents of GSTR-9. Effectively implying
that auditor is not expected to certify the legal aspects such as
classification, place of supply, time of supply, eligibility of exemption/
zero-rated conditions, valuation. etc.

Compensating tax
adjustments cannot be netted off. Excess
payment can only be refunded by way of a refund application.

Observations should
emphasise that audit methodologies are expected to give a reasonable and NOT an
absolute assurance over the correctness of books of accounts and data reported
in the form.

Auditor’s recommendation
of the liability would generally be resorted for admitted tax liabilities,
numerical errors in reporting/ accounting, patent errors in taxability. In matters having multiple view points,
auditor may consider the management’s view under a representation.

Conclusion

From tax administration perspective, GSTR-9C is like an ‘appetizer’ in a
full course meal of assessments. In
other words, it addresses the limited question prior to any assessment ie. are
reported values are correct when compared to the accounting records. It gives a headstart of items included/
excluded from the returns and hence enables the officer to perform a Top-Down
analysis of the records of the entity.
Once this picture is laid out, the officer is equipped in examining the
nuts and bolts of each transaction (such as time of supply, place of supply,
valuation, rate of tax, eligibility/ ineligibility of credits, etc). Auditor is merely a facilitator and is not
expected to be a judge over the auditee’s decision.

shailesh.kwebmaker

BOOK PROFIT – WHETHER ADJUSTMENT REQUIRED FOR SHARE OF LOSS FROM PARTNERSHIP FIRM?

Issue for consideration

U/s. 115JB
of the Income Tax Act, 1961, a company is required to computateits book profits
and pay the Minimum Alternate Tax at 18.5% of such book profits. Explanation 1
to section 115JB provides that the term “book profit” means the ‘profit’ as
shown in the statement of profit and loss for the relevant previous year
prepared under s/s. (2), as increased or reduced by certain items specified
therein. One of the items of reduction contained in clause (ii) is –

(ii) – the
amount of income to which any of the provisions of section 10 (other than the
provisions contained in clause (38) thereof) or section 11 or section 12 apply,
if any such amount is credited to the statement of profit and loss.

There is
also a corresponding item of addition contained in clause (f) of the
explanation, which reads as under –

(f) the
amount or amounts of expenditure relatable to any income to which section 10
(other than the provisions contained in clause (38) thereof) or section 11 or
section 12 apply;

Section
10(2A) provides for an exemption in the case of a partner of a firm which is
separately assessed as such. The exemption is as under:

“in the
case of a person being a partner of firm which is separately assessed as such,
his share in the total income of the firm.

Explanation:
For the purposes of this clause, the share of a partner in the total income of
a firm separately assessed as such shall, notwithstanding anything contained in
any other law, be an amount which bears to the total income of the firm the
same proportion as the amount of share in the profits of the firm in accordance
with the partnership deed bears to such profits;

Therefore,
where a company is a partner in a partnership firm, which is taxed separately
as a partnership firm, and the company is entitled to a share of profits of the
partnership firm, such share of profit that the company is entitled to, is not
only exempt u/s. 10(2A) from income tax, but is also to be excluded from the
book profit, by reducing such share of profit credited to the statement of
profit and loss under Explanation 1(ii) of section 115JB and in so computing
any expenditure, incurred for earning such share of profit, is required to be
added back while computing the book profit.

The issue
has arisen before the Income tax Appellate Tribunal as to whether, in a case
where the share of the company in the income of the firm is a ‘loss’ which has
been debited to the statement of profit and loss of the company, whether such
loss is required to be added to the book profit of the company , in the same
manner as the share of profit is reduced from the profit as per the statement
of profit and loss. While the Chennai bench of the Tribunal has taken a view
that such share of loss from the partnership firm is to be added back while computing
the book profit, the Mumbai and Kolkata benches have taken the view that such
share of loss is not required to be added back while computing the book profit.

Metro Exporters Ltd’s case

The issue
first came up before the Mumbai bench of the tribunal in the case of DCIT
vs. Metro Exporters Ltd 10
SOT 647.

In this
case, relating to assessment year 1997-98, the provision then applicable was
section 115JA, which was almost identical to section 115JB in respect of the
issue under consideration. It provided for a reduction from the net profit as
shown in the profit and loss account for the relevant previous year of the
amount of income to which any of the provisions of Chapter III applied, if any
such amount was credited to the profit and loss account.

The assessee had debited its share of loss of Rs. 46.94 lakh from a
partnership firm to its profit and loss account. In the initial assessment, the
assessee’s computation of book profits, wherein it had not added back such
share of loss to the book profits, was accepted by the AO. However,
subsequently, reassessment proceedings were initiated u/s. 148 on the ground
that the income chargeable to tax was under assessed by way of omission to
increase the book profit by the share of loss in the partnership firm amounting
to Rs. 46.94 lakh debited to profit and loss account while computing the book
profit as per provisions of section
115 JA. Such share of loss was added to book profits by the AO in the
reassessment proceedings.

In first
appeal, the Commissioner(Appeals) deleted the addition made in the reassessment
proceedings, holding the reassessment proceedings as not being in accordance
with law, besides holding that the addition of Rs. 46.94 lakh of share of loss
from partnership firm could not be made to the book profits.

Before the
Tribunal, the Department contested both aspects – the decision against validity
of the reassessment proceedings, as well as the merits of the addition made to
book profits. Before the Tribunal, it was argued on behalf of the Department
that sub-clause (f) of the Explanation to section 115 JA, provided that for the
purposes of the section, the profit meant the net profit as shown in the profit
and loss account for the relevant previous year prepared under s/s. (2) as
increased by the amount or amounts of expenditure relatable to any income to
which any of the provisions of Chapter III applied and that the sub-clause
applied in the case of the assessee. It was further argued that the word
‘income’ included ‘loss’ also, and therefore sub-clause (ii) to Explanation to
section 115JA applied to the assessee.

On behalf
of the assessee, it was submitted that the addition was wrongly made as Chapter
XII-B was a special provision relating to certain companies, and therefore had
to be strictly construed. It was submitted that the proposition that the word
‘income’ included ‘loss’ was not applicable to assessment framed under Chapter
XII-B of the Act. Further, it was argued that the ‘loss’ was not an
‘expenditure’, and therefore did not fall within the purview of sub-clause (f)
to Explanation to section 115 JA. It was further submitted that sub-clause (ii)
to the Explanation to section 115 JA applied only “if any such amount is
credited to the profit and loss account”. In the case of the assessee, the
share of loss from the partnership firm was not credited to the profit and loss
account, but was debited to the profit and loss account, and therefore
sub-clause (ii) also did not apply to the case of the assessee.

The
Tribunal noted that the assessee had debited its share of loss from the
partnership firm to its profit and loss account. It observed that the
provisions of Chapter XII-B were special provisions relating to assessment of
certain companies, whereby the income of certain companies chargeable to tax
for the relevant previous year was deemed to be an amount equal to 30% of such
book profit. Being special provisions applicable to certain companies,
according to the Tribunal, they had to be strictly applied. The income of the
assessee had to be computed in accordance with book profit of the assessee, and
the working of the book profit had to be made as per the provisions of Chapter
XII-B.

The
Tribunal held that the proposition that the word “income” included “loss” was
not applicable while computing the profit in accordance with the provisions of
Chapter XII-B. The Tribunal further found that the provisions of sub-clause (f)
of the Explanation to section 115 JA applied to the amounts of “expenditure”
relatable to any income to which any of the provisions of Chapter III applied.
According to the Tribunal, the share of loss from a partnership firm was not
synonymous with the word “expenditure” used in that sub-clause.

The
Tribunal further noted that sub-clause (ii) of the Explanation to section 115
JA applied to income to which chapter III applied, if such amount was credited
to the profit and loss account of the assessee. In the case before it, the
tribunal noted that the share of the assessee from the partnership firm was
loss, and was therefore debited to the profit and loss account of the assessee,
and could not have been credited to the profit and loss account of the
assessee. Since it was not a case of share of profit from a firm credited to
the profit and loss account of the assessee, the tribunal held that no addition
for the purpose of computation of the book profit under section 115 JA could be
made with regard to share of loss of the assessee from a partnership firm.

The ratio
of this decision of the Mumbai bench of the Tribunal has been appllied by the
Kolkata bench of the Tribunal in the case of CD Equifinance Pvt Ltd vs.
DCIT, ITA No 577/Kol/2016 dated 9.2.2018 in the context of section 115JB
for Assessment Year 2012-13.

Fixit (P) Ltd’s case

The issue
again came up before the Chennai bench of the Tribunal in the case of DCIT
vs. Fixit (P) Ltd 95 taxmann.com 188.

In this
case,the assessee was a partner in two partnership firms, and its share of loss
from the two firms was Rs. 2,11,346 and Rs. 68,564, respectively. Such share of
loss was debited to the profit &loss account of the assessee, but was not
added back by the assessee to the net profit while computing book profit u/s.
115JB.

The
Assessing Officer was of the opinion that share income from a firm being exempt
under Chapter III, even if such share was a loss, it had to be added back for
computing the profit u/s. 115 JB. He therefore added the share of loss of the
two firms to the profits as per the profit & loss account and computed the
book profit for the purpose of levying tax u/s. 115 JB accordingly.

The
Commissioner (Appeals) decided the first appeal in favour of the assessee, on
the ground that the Explanation to section 115 JB spelt out the additions that
could be made to the profits shown in the audited profit & loss account.
Share of loss from a partnership firm could not be considered as an expenditure
relatable to exempt income, and therefore though such share of loss was debited
to the profit &loss account, such share of loss could not be added back
while computing the book profit u/s. 115 JB.

Before the
Tribunal, on behalf of the Department, it was argued that clause (ii) of the
Explanation to section
115JB clearly mandated deduction of any income to which any of the provisions
of section 10 applied, if such amount was credited to the profit & loss
account. It was argued that loss incurred by a firm was carried forward in the
hands of such firm. When share of profits from firms were to be reduced, loss,
being a negative income, had to be added back to profits shown in the profit
&loss account. That would be equivalent to an addition.

The
Tribunal analysed the provisions of section115 JB, in particular the
Explanation to that section. It also analysed the provisions of section 10
(2A). According to the Tribunal, what was excluded from the total income by
section 10 (2A) was the share of the partner in the total income of the firm.
Since share of loss in the firm was not an expenditure relatable to any exempt
income, in the opinion of the Tribunal, clause (f) of the explanation did not
apply.

However,
according to the Tribunal, it was clause (ii) of the Explanation which was
applicable. That was on account of the fact that in the opinion of the
Tribunal, share of loss was nothing but share of negative income. Clause (ii)
of the Explanation mandated reduction of income to which section 10 applied, if
such income was credited in the profit & loss account. According to the
Tribunal, when share of income from a firm was exempt and required to be
excluded u/s. 10 (2A), necessarily the share of loss was also to be excluded.
In the view of the Tribunal, what the assessing officer had done was that by
adding the loss from the two firms to the profits, he was effectively reducing
the negative profit, since loss was nothing but negative profit.

The
Tribunal therefore upheld the addition made by the assessing officer of share
of loss from the partnership firms to the book profit of the assessee.

Observations

The
controversy surrounds adjudicating upon two important facets; whether a ‘loss’
could be termed as an ‘expenditure’ and be added back to the book profit and
whether the right to reduce an ‘income’ from the book profit would oblige a
company to add back its losses. In effect, both the Mumbai and the Chennai
benches of the Tribunal have accepted the position that the provisions of
clause (f) to section 115 JB, providing for add back of the expenditure, do not
apply to the share of loss from a partnership firm, since such loss is not an expenditure
in relation to exempt income. Therefore, there is no dispute on the first
aspect of the controversy.

The
dispute is only as to whether clause (ii) of the Explanation to section 115JB
applies so as to require the company to exclude the loss in computing the book
profit or add back the loss, otherwise debited to the profit & loss
account, to the book profit. That Explanation applies to “amount of income
to which any of the provisions of section 10 apply”. The issue therefore
revolves around whether the proposition that “income” includes loss would apply
in this case i.

The
provisions of Chapter XII-B are special provisions that carry a fiction for
taxing an artificially computed income termed as book profit which is far
detached from the income or the real income on which tax is payable under the
original scheme of taxation of the Act. Computing the book profit is a
convoluted exercise that is removed from the concept of income and seeks to tax
an income that can in no sense be termed as an income. In the circumstances, it
is a futile exercise to apply the understanding otherwise derived in
interpreting the main provisions of the Act that deal with the income or the
real income.In the context of the income taxation, which seeks to tax the real
income of a person, It is true that the term ‘income’ includes ‘loss’ but it is
equally true to restrict the application of such an understanding to such an
income and not extend it to artificial income or fictional income. The Supreme
Court in J.H. Gotla’s case, 156 ITR 323 laid down the law while
explaining the ordinary concept of income to hold that it includes loss, as
well. Application of this analogy to an artificially conceived income should be
avoided at all costs.

There are
however two more arguments in favour of the proposition that such share of loss
is not to be added back in computing the book profits. The first is that the
share of loss is not credited to the profit and loss account, as required by
clause (ii), but is debited to the profit and loss account. Besides clause (ii)
falls under the items to be deducted while computing book profits, and not
under the additions to be made while computing book profits.

Secondly,
one may draw support from the decision of the Mumbai bench of the Tribunal in
the case of Raptakos Brett & Co Ltd 69 SOT 383 in the context
of exemption of capital losses on sale of listed shares u/s. 10(38). In that
case, while holding that only gains arising from the transfer of a long term
listed equity share was exempt, and not loss, the Tribunal interpreted the term
“income arising from the transfer of a long term capital asset”. It drew a
distinction between a situation where an entire source of income was exempt,
and a situation where only certain types of income from a source were exempt.
According to the Tribunal, if the entire source is exempt or is considered as
not to be included while computing the total income, then, in such a case, the
profit or loss resulting from such a source does not enter into the computation
at all. However, if a part of the source is exempt by virtue of particular
provision of the Act for providing benefit to the assessee, it cannot be held
that the entire source will not enter into the computation of total income.
According to the Tribunal, the concept of income including loss applies only
when the entire source is exempt, and not in the cases, where only one
particular stream of income falling within a source is falling within the
exemption provisions.

In the
case of a partner of a partnership firm, the partnership firm is the source of
income. Remuneration and interest from the partnership firm are taxable, with
only share of profit from the partnership firm being exempt from tax.
Therefore, only one stream of income from the source is exempt. That being the
case, following the rationale of Raptakos Brett’s decision, “income”
would not include loss, and share of profit would not include share of loss.
Therefore, the share of loss from a partnership firm, though may be covered by
section 10(2A), is not an income for the purposes of clause(ii) of section
115JB , and is further not credited to the profit and loss account. That being
the case, it is not required to be added back while computing book profits.

The better
view seems to be that no adjustment to the net profit is required to be made in
respect of the amount of share in loss debited to the statement of profit &
loss of the company while computing book
profit u/s. 115JB.

shailesh.kwebmaker

How to Sell a Mirror in a place full of Masks

As we cross into the New Year, we take a few days off to refresh,
rejuvenate and revive our mind, body and spirit. The day after 31^st
December seems so new and yet so much of it is still the same as it has been
for long. Taking time off allows us to reflect on all that is going on around
us and all that we are becoming as individuals and as a society.

Our founding fathers must have dreamt of this when we chose to be a
Republic. We are celebrating our 70^th Republic Day this month. Most
constitutions came from the divine rights theory based on an Anglo-Saxon system
where God who had all powers also gave all rights – to life, of speech etc. God
was substituted by the State for giving these rights through a constitution.
The caveat was: the State required the consent of its people. While God can do
no wrong, the State can. Therefore, the responsibility of people is even more.
This model asks us to own up what is happening, to discharge our responsibility
and then claim our rights. Often, people understand it in reverse order – claim
rights and hardly discharge duties.

The constitutional framework stands for and on the rule of law with a
dedicated judiciary to deal with conflict. We have come to a point where justice
is beyond the reach of most people. Can most citizens read or comprehend our
laws? Can a lay citizen knock at the door of the highest court and afford a
lawyer there? Are large parts of the judicial system impartial? Take an example
of ‘tribunals’–where although the judiciary is meant to be out of control of
the government, most tribunals are under direct control of the ministry which
is generally a party in the dispute before that very tribunal! And the time it
takes to close out a court case?

Such clear and visible problems limit the operation of law and impair
the Constitution of the State. In fact, many times the government is in
conflict with citizens for all the wrong reasons. At a recent tax hearing, an
officer mentioned that professionals are responsible for litigation. I asked
him then why does the department lose in most cases and at all levels? He just
said we could talk about this at length at another time!

India, like most oriental societies, is based on relationships, not on
individualism. Individual-based societies require more and more contracts for
everything. My roommate, a professor at UC Berkley, when I first went to the US
told me that all relationships in America were either contractual, functional
or legal. That is not so in our society. Therefore, more thrust on values,
rather than just (poorly drafted) laws, is critical.

Back then Dr. Ambedkar had said: “However good a Constitution may be,
if those who are implementing it are not good, it will prove to be bad. However
bad a Constitution may be, if those implementing it are good, it will prove to
be good.”

These days, many people make it sound as if all good emanates from the
Constitution alone. However, if you read Dr. Ambedkar’s words carefully –
culture, values and ethics are more important – for they make a person and then
whatever she handles will be driven by those values. We need as much or more of
manufacturing of this internal compass pointing towards true north in our
people, as we do for the creation of jobs.

At another proceeding, a tax officer was asking for every single
dividend counterfoil of a senior citizen. The assessee had no email and some
counterfoils were not received in the post. The officer said he would be
questioned and even considered corrupt for not taking every supporting evidence
although the bank statements in his possession mentioned the name of the payer
and amounts were rather small. Such kind of out-of-context excessive
technicalities in respect of an eighty-year-old homemaker assessee leads
nowhere; perhaps encourages some people to evade laws rather than struggle to
prove themselves to be on the right side.

A relationship-based society like India has survived and thrived on
values. I hope we can put much more thrust on building society and creating
social capital than focus on infrastructure, roads, economics alone. No doubt,
it is easier said than done – just as farm loan waiver does not correct the
root causes of the farmer problems, economics and laws without values won’t
solve a societal problem.

Friends, the word of the year declared by two prominent dictionaries
recently gives it away: Toxic¹ and Misinformation². Both
words articulate the stark realities of our times and what we need to fight and
overcome. I leave you with the deep thought that a poet articulates poignantly:

When there is so much falsehood in the world, how does one understand
what is true? How can one sell a mirror, in a marketplace full of (people
wearing) masks?

___________________________________

1 Oxford Dictionary for 2017

2 Dictionary.com for
2018

Happy New Year 2019!

Raman Jokhakar

Editor

shailesh.kwebmaker

APPLICABILITY OF SECTION 14A – RELEVANCE OF ‘DOMINANT PURPOSE’ OF ACQUISITION OF SHARES/ SECURITIES – PART – I

INTRODUCTION

1.1 The Finance Act, 2001 introduced the
provisions of section 14A in Chapter IV of the Income Tax Act,1961[the Act]
with retrospective effect from 1/4/1962 to provide restriction on deduction,
while computing the Total Income under the Act, of any expenditure incurred in
relation to income which does not form part of the Total Income [such
income is hereinafter referred to as Exempt Income]. Effectively, the section
provides for disallowance of expenditure incurred in relation to Exempt Income.

1.1.1 For the purpose of determining the quantum of
disallowance u/s. 14A, the Finance Act, 2006 introduced section 14A (2)/(3)
with effect from 1/4/2007. Section 14A (2) provides that the Assessing Officer
[AO] shall determine the amount of expenditure incurred in relation to Exempt
Income in accordance with the prescribed method, if the AO, having regards to
the accounts of the assessee, is not satisfied with the correctness of the
claim of the assessee in respect of such expenditure. section 14A (3) further
provides that the provisions of section 14A (2) shall also apply in cases where
the assessee has claimed that no such expenditure is incurred [i.e. such
expenditure is NIL]. The method of determining such expenditure is prescribed
under Rule 8D which was introduced with effect from 24/3/2008 and the same was
subsequently amended with effect from 2/6/2016

1.2 In the context of the provisions of section
14A, large number of issues have come-up for debate such as: applicability of
section 14A in cases where the shares [having potential of yielding Exempt
Income] are acquired /retained not for the purpose of earning dividend income
but for acquiring/retaining controlling interest; such shares are for trading
purpose and held as ‘stock-in trade’ where the dividend is incidentally earned;
whether section 14A can apply to cases where no Exempt Income [dividend] is
earned during the relevant previous year; etc. The issues have also come-up
with regard to quantification of amount of disallowance u/s. 14A under
different circumstances; whether the amount of disallowance should be limited
to the amount of Exempt Income earned during the year and also, whether for
this purpose, the application of Rule 8D is mandatory in all cases irrespective
of the fact that the assessee himself has determined the proper amount of such
disallowance while furnishing the Return of Income or has made a claim that no
such expenditure is incurred; etc. Large scale litigation is continued on
number of such issues in the context of the implications of section 14A.

1.3 Recently, the Apex Court, in MaxOpp
Investments Ltd and other cases, had an occasion to consider the major/main
issue of applicability of the provisions of section 14A under the circumstances
where the shares were purchased of a company for the purpose of gaining control
over the said company or were purchased as ‘stock-in-trade’. Since this
judgment settles this major issue and in the process,deals with some other
issues in the context of these provisions, it is thought fit to consider the
same in this column.

MAXOPP INVESTMENTS LTD Vs. CIT (2018) 402 ITR
640 (SC)

Background

2.1 In the above
case, various appeals [preferred by the assessees as well as the Revenue] had
come-up before the Apex Court involving the implications of section 14A.
Initially, the Court noted that, in these appeals, the question has arisen
under varied circumstances where the shares/stocks were purchased of a company
for the purpose of gaining control over the said company or as
‘stock-in-trade’. However, incidentally income was also generated in the form
of dividends as well which was exempt. On this basis, the Assessees contend
that the dominant intention for purchasing the share was not to earn dividends
income but control of the business in the company in whose shares investment
was made or for the purpose of trading in the shares as a business activity and
the shares are held as stock-in-trade. In this backdrop, the issue is as to
whether the expenditure incurred can be treated as expenditure ‘in relation to
income’ i.e. dividend income which does not form part of the total income. To
put it differently, is the dominant or main object would be a relevant
consideration in determining as to whether expenditure incurred is ‘in relation
to’ the dividend income. In most of the appeals, including in Civil Appeal Nos.
104-109 of 2015 [MaxOpp Investment Ltd], aforesaid is the scenario. Though, in
some other cases, there may be little difference in fact situation. However,
all these cases pertain to dividend income, where the investment was made in
order to retain controlling interest in a company or in group of companies or
the dominant purpose was to have it as stock-in-trade.

2.2 In the above context, the Court noted that
the Delhi High Court in MaxOpp Investments Ltd had taken a view that the
provisions of section 14A would apply regardless of the purpose behind making
the investment and consequently, proportionate disallowance of the expenditure
incurred by the assessee will be justified if the expenditure is incurred in
relation to Exempt Income. In this case, after deciding this major common
issues, the Delhi High Court also separately decided some other appeals on
their individual facts with which we are not concerned in this write-up. On the
other hand, the Court noted that the Punjab & Haryana High Court in State
Bank of Patiala has taken a view which runs contrary to the view taken by the
Delhi High Court.

2.3 For the purpose of deciding above referred
major issue, the Court preferred to deal with the findings given by the Delhi
High Court in the case of MaxOpp Investment ltd vs. CIT (2012) -347 ITR 272
[MaxOpp Investment Ltd’s case] and by the Punjab & Haryana High Court
in the case of Principal CIT vs.
State Bank of Patiala (2017) – 391 ITR 218 [State Bank of Patiala’s case]
in the context of facts of these cases.

MAXOPP INVESTMENT LTD’S CASE

3.1 In the background given in para 2 above, the
Court decided to briefly note the facts in the above case of Delhi High Court
(arising from Civil Nos104-109 of 2015) for better understanding of the issues
involved and relevant findings given by the High Court in that case.

3.2 In the above case, the Appellant company
[MaxOpp Investment Ltd- one of the appellants in set of appeals before Apex
Court] was engaged, inter alia, in the business of finance, investments
and dealing in shares and securities. The Appellant holds shares/securities in
two portfolios, viz. (a) as investment on capital account and (b) as trading
assets for the purpose of acquiring and retaining control over investee group
companies, particularly Max India Ltd., a widely held quoted public limited
company. Any profit/loss arising on sale of shares/securities held as
‘investment’ is returned as income under the head ‘capital gains’, whereas
profit/loss arising on sale of shares/securities held as ‘trading assets’ (i.e.
held, inter alia, with the intention of acquiring, exercising and
retaining control over investee group companies) has been regularly offered and
assessed to tax as business income under the head ‘profits and gains of
business or profession’ [Business Income].

3.2.1 Consistent
with the aforesaid treatment regularly followed, the Appellant filed return of
income for the previous year relevant to the Assessment Year 2002-03, declaring
income of Rs. 78,90,430/-. No part of the interest expenditure of Rs.
1,16,21,168/- debited to the profit and loss account, to the extent relatable
to investment in shares of Max India Limited, yielding tax free dividend
income, was considered disallowable u/s. 14A of the Act on the ground that
shares in the said company were acquired for the purposes of retaining
controlling interest and not with the motive of earning dividend. According to
the Appellant, the dominant purpose/intention of investment in shares of Max
India Ltd. was acquiring/retaining controlling interest therein and not earning
dividend and, therefore, dividend of Rs. 49,90,860/- earned on shares of Max
India Ltd. during the relevant previous year was only incidental to the holding
of such shares. The AO, while passing the assessment order dated August 27^th,
2004 u/s 143(3), worked out disallowance u/s. 14A at Rs. 67,74,175/- by
apportioning the interest expenditure of Rs. 1,16,21,168/- in the ratio of
investment in shares of Max India Ltd. (on which dividend was received) to the
total amount of unsecured loan. The AO, however, restricted disallowance under
that section to Rs. 49,90,860/-, being the amount of dividend received and
claimed exempt.

3.2.2 In appeal, the Commissioner of Income Tax
(Appeals) [CIT (A)] vide order dated January 12^th, 2005 upheld the
order of the AO. The Appellant herein carried the matter in further appeal to
the Income Tax Appellate Tribunal, New Delhi (ITAT). In view of the conflicting
decisions of various Benches by the ITAT with respect to the interpretation of
section 14A of the Act, a Special Bench was constituted in the matter of ITO
vs. Daga Capital Management (Private) Ltd. 312 ITR (AT) 1 [Daga Capital’s case].
The appeal of the Appellant was also tagged and heard by the aforesaid Special
Bench.

3.2.3 The Special
Bench of the ITAT in Daga Capital’s case, dismissing the appeal of the
Appellant, inter alia, held that investment in shares representing
controlling interest did not amount to carrying on of business and, therefore,
interest expenditure incurred for acquiring shares in group companies was hit
by the provisions of section14A of the Act. The Special Bench further held that
holding of shares with the intention of acquiring/retaining controlling
interest would normally be on capital account, i.e. as investment and not as
‘trading assets’. For that reason too, the Special Bench held that there
existed dominant connection between interest paid on loan utilized for
acquiring the aforesaid shares and earning of dividend income. Consequently,
the provisions of section 14A of the Act were held to be attracted on the facts
of the case.

3.2.4 On the
interpretation of the expression ‘in relation to’, the majority opinion of the
Special Bench was that the requirement of there being direct and proximate
connection between the expenditure incurred and Exempt Income earned could not
be read into the provision. According to the majority view, ‘what is relevant
is to work out the expenditure in relation to the Exempt Income and not to
examine whether the expenditure incurred by the Assessee has resulted into
Exempt Income or taxable income’. As per the minority view, however, the
existence of dominant and immediate connection between the expenditure incurred
and dividend income was a condition precedent for invoking the provisions of
section 14A of the Act. It was accordingly held, as per the minority, that mere
receipt of dividend income, incidental to the holding of shares, in the case of
a dealer in shares, would not be sufficient for invoking provisions of section
14A of the Act.

3.2.5 Against the
aforesaid order of the Special Bench, the Appellant preferred appeal u/s. 260A
of the Act to the High Court. The High Court of Delhi has, vide impugned
judgment dated November 18^th, 2011, held that the expression ‘in
relation to’ appearing in section 14A was synonymous with ‘in connection with’
or ‘pertaining to’, and, that the provisions of that section apply regardless
of the intention/motive behind making the investment. As a consequence,
proportionate disallowance of the expenditure incurred by the Assessee is
maintained.

3.2.6 While coming to the above conclusion, the
High Court also took into the account the law prevailing prior to insertion of
section 14A (Prior Law) and the object of insertion of section 14A. The Prior
Law was that when an assessee has a composite and indivisible business which
has elements of both taxable and non-taxable income, the entire business
expenditure was deductible and in such a case the principle of apportionment of
such expenditure relating to non-taxable income did not apply. However, where
the business was divisible, such principle of apportionment was applicable and
the expenditure apportioned to the Exempt Income was not eligible for deduction
[ref CIT vs. Indian Bank Ltd (1965)56 ITR 77 (SC), CIT vs. Maharashtra Sugar
Mills Ltd (1971)82 ITR 452(SC) and Rajasthan State Warehousing Cooperation vs.
CIT (2000) 242 ITR 452 (SC)]

3.3 The Apex Court considered the above
judgment and, inter alia, noted the following observations and findings
of the High Court:

a. The object behind the insertion of section 14A
in the said Act is apparent from the Memorandum explaining the provisions of
the Finance Bill, 2001 which is to the following effect:

‘Certain incomes
are not includable while computing the total income as these are exempt under
various provisions of the Act. There have been cases where deductions have been
claimed in respect of such Exempt Income. This in effect means that the tax
incentive given by way of exemptions to certain categories of income is being
used to reduce also the tax payable on the non-exempt income by debiting the
expenses incurred to earn the Exempt Income against taxable income. This is
against the basic principles of taxation whereby only the net income, i.e.,
gross income minus the expenditure is taxed. On the same analogy, the exemption
is also in respect of the net income. Expenses incurred can be allowed only to
the extent they are relatable to the earning of taxable income.

It is proposed to
insert a new Section 14A so as to clarify the intention of the Legislature
since the inception of the Income-tax Act, 1961,that no deduction shall be made
in respect of any expenditure incurred by the Assessee in relation to income
which does not form part of the total income under the Income-tax Act.

The proposed
amendment will take effect retrospectively from April 1, 1962 and will
accordingly, apply in relation to the assessment year 1962-63 and subsequent
assessment years.’

b. As observed by the Apex Court in the case of CIT
vs. Walfort Share and Stock Brokers P. Ltd. (2010) 326 ITR 1 (SC) [Walfort’s
case], the insertion of section 14A with retrospective effect reflects the
serious attempt on the part of Parliament not to allow deduction in respect of
any expenditure incurred by the assessee in relation Exempt Income against the
taxable income. The Apex Court in Walfort’s case further observed as under:

“…In other words,
Section 14A clarifies that expenses incurred can be allowed only to the extent
that they are relatable to the earning of taxable income. In many cases the
nature of expenses incurred by the Assessee may be relatable partly to the
exempt income and partly to the taxable income. In the absence of Section 14A,
the expenditure incurred in respect of exempt income was being claimed against
taxable income. The mandate of Section 14A is clear. It desires to curb the
practice to claim deduction of expenses incurred in relation to exempt income
against taxable income and at the same time avail of the tax incentive by way
of an exemption of exempt income without making any apportionment of expenses
incurred in relation to exempt income….

…Expenses allowed
can only be in respect of earning taxable income. This is the purport of
Section 14A. In Section 14A, the first phrase is “for the purposes of
computing the total income under this Chapter” which makes it clear that
various heads of income as prescribed in the Chapter IV would fall within
Section 14A. The next phrase is, “in relation to income which does not
form part of total income under the Act”. It means that if an income does
not form part of total income, then the related expenditure is outside the
ambit of the applicability of Section 14….”

The Apex Court in
Walfort’s case also clearly held that in the case of an income like dividend
income which does not form part of the total income, any expenditure/deduction
relatable to such (exempt or non-taxable) income, even if it is of the nature
specified in sections 15 to 59 of the Act, cannot be allowed against any other
income which is includable in the Total Income. The exact words used by the
Apex Court in that case are as under:

“Further, Section
14 specifies five heads of income which are chargeable to tax. In order to be
chargeable, an income has to be brought under one of the five heads. Sections
15 to 59 lay down the Rules for computing income for the purpose of
chargeability to tax under those heads. Sections 15 to 59 quantify the total
income chargeable to tax. The permissible deductions enumerated in Sections 15 to
59 are now to be allowed only with reference to income which is brought under
one of the above heads and is chargeable to tax. If an income like dividend
income is not a part of the total income, the expenditure/deduction though of
the nature specified in Sections 15 to 59 but related to the income not forming
part of the total income could not be allowed against other income includable
in the total income for the purpose of chargeability to tax. The theory of
apportionment of expenditure between taxable and non-taxable has, in principle,
been now widened Under Section 14A.”

c. Likewise, explaining the meaning of
‘expenditure incurred’, the High Court agreed that this expression would mean
incurring of actual expenditure and not to some imagined expenditure. At the
same time, observed the High Court, the ‘actual’ expenditure that is in
contemplation u/s. 14A (1) is the ‘actual’ expenditure in relation to or in
connection with or pertaining to Exempt Income. The corollary to this is that
if no expenditure is incurred in relation to the Exempt Income, no disallowance
can be made u/s. 14A.

STATE BANK OF PATIALA’S CASE.

4.1 In the above case, the Punjab and Haryana
High Court has taken a view which runs contrary to the aforesaid view taken by
the Delhi High Court. The Punjab and Haryana High Court followed the judgment
of the High Court of Karnataka in CCI Ltd. vs. Joint Commissioner of Income
Tax, (2012) 206 Taxman 563 [CCI Ltd’s case]. The Revenue has filed appeals
challenging the correctness of the said decision.

4.2 The Apex Court noted the brief facts of
this case and further noted that this case arose in the context where Exempt
Income was earned by the Bank from
securities held by it as its stock in trade. The Assessee filed its return
declaring an income of about Rs. 670 crores which was selected for scrutiny.
The return for the assessment year 2008-09 showed dividend income exempt u/s.
10(34) and (35) and net interest income exempt u/s. 10(15)(iv) (h). The total
Exempt Income claimed in the return of income was, Rs. 12,20 crore. The
Assessee while claiming the exemption contended that the investment in shares,
bonds, etc. constituted its stock-in-trade; that the investment had not been
made for earning tax free income; that the tax free income was only incidental
to the Assessee’s main business of sale and purchase of securities and,
therefore, no expenditure had been incurred for earning such Exempt Income; the
expenditure would have remained the same even if no dividend or interest income
had been earned by the Assessee from the said securities and that no
expenditure on proportionate basis could be allocated against Exempt Income.
The Assessee also contended that in any event it had acquired the securities
from its own funds and, therefore, section 14A was not applicable. The AO
restricted the disallowance to the amount of Rs. 12.20 crore which was claimed
as Exempt Income as against the expenditure of Rs. 40.72 crore allocated
towards Exempt Income by applying the formula contained in Rule 8D holding that
section 14A would be applicable. The CIT(A) issued notice of enhancement u/s.
251 of the Act and held that in view of section 14A, the Assessee was not to be
allowed any deduction in respect of expenditure incurred in relation to Exempt
Income. Therefore, he disallowed the entire expenditure of Rs. 40.72 crore
instead of restricting the disallowance to the amount which was claimed as
Exempt Income as done by the AO. The ITAT set aside the order of the AO as well
as CIT (A). It referred to a CBDT Circular No. 18/2015 dated 02.11.2015 which
states that income arising from such investment of a banking concern is
attributable to the business of banking which falls under the head
“Profits and gains of business and profession”. The circular states
that shares and stock held by the bank are ‘stock-in-trade’ and not
‘investment’. Referring to certain judgments and the earlier orders of the
Tribunal, it was held that if shares are held as stock-in-trade and not as
investment even the disallowance under Rule 8D would be nil as Rule 8D(2)(i)
would be confined to direct expenses for earning the tax Exempt Income. In this
factual backdrop, in appeal filed by the Revenue, the High Court noted that
following substantial question of law arose for consideration:

“Whether in the
facts and circumstances of the case, the Hon’ble ITAT is right in law in
deleting the addition made on account of disallowance Under Section 14A of the
Income Tax Act, 1961?”

4.3 The Apex Court then considered the above
judgment and, inter-alia, noted the following observations and findings
of the High Court:

(a) In its analysis, the High Court accepted the
contention of the counsel for the Assessee that the Assessee is engaged in the
purchase and sale of shares as a trader with the object of earning profit and
not with a view to earn interest or dividend. The Assessee does not have an
investment portfolio. The securities constitute the Assessee’s stock-in-trade.
The Department, in fact, rightly accepted, as a matter of fact, that the
dividend and interest earned was from the securities that constituted the
Assessee’s stock-in-trade. The same is, in any event, established. The Assessee
carried on the business of sale and purchase of securities. It was supported by
Circular No. 18, dated November 2^th, 2015, issued by the CBDT, which
reads as under:

“Subject: Interest
from Non-SLR securities of Banks – Reg.

It has been brought
to the notice of the Board that in the case of Banks, field officers are taking
a view that, “expenses relatable to investment in non-SLR securities need
to be disallowed Under Section 57(i) of the Act as interest on non-SLR
securities is income from other sources.

2. Clause (id) of
Sub-section (1) of Section 56 of the Act provides that income by way of
interest on securities shall be chargeable to income-tax under the head
“Income from Other Sources”, if, the income is not chargeable to
income-tax under the head “Profits and Gains of Business and
Profession”.

3. The matter has
been examined in light of the judicial decisions on this issue. In the case of CIT
vs. Nawanshahar Central Cooperative Bank Ltd. [2007] 160 TAXMAN 48 (SC),
the Apex Court held that the investments made by a banking concern are part of
the business of banking. Therefore, the income arising from such investments is
attributable to the business of banking falling under the head “Profits
and Gains of Business and Profession”.

3.2 Even though the
abovementioned decision was in the context of co-operative societies/Banks
claiming deduction u/s. 80P(2)(a)(i) of the Act, the principle is equally
applicable to all banks/commercial banks, to which Banking Regulation Act, 1949
applies.

4. In the light of
the Supreme Court’s decision in the matter, the issue is well settled.
Accordingly, the Board has decided that no appeals may henceforth be filed on
this ground by the officers of the Department and appeals already filed, if
any, on this ground before Courts/Tribunals may be withdrawn/not pressed upon.
This may be brought to the notice of all concerned.”

(b) The High Court pointed out that the Circular
carves out a distinction between stock-in-trade and investment and provides
that if the motive behind purchase and sale of shares is to earn profit then
the same would be treated as trading profit and if the object is to derive
income by way of dividend then the profit would be said to have accrued from
the investment. If the Assessee is found to have treated the shares and
securities as stock-in-trade, the income arising therefrom would be business
income. A loss would be a business loss. Thus, an Assessee may have two
portfolios, namely, investment portfolio and a trading portfolio. In the case
of the former, the securities are to be treated as capital assets and in the
latter as trading assets.

(c) Further, as a banking institution, the Assessee
was also statutorily required to place a part of its funds in approved
securities, as held in CIT vs. Nawanshahar Central Co-operative Bank Ltd.
MANU/SC/2707/2005 : (2007) 289 ITR 6 (SC) [Nawan shahar’s case]. Since, the
shares, bonds, debentures purchased by the Assessee constituted its
stock-in-trade, the provisions of section 14A were not applicable. Here, the
High Court noted distinction between stock-in-trade and investment and stated
that the object of earning profit from trading in securities is different from
the object of earning income, such as, dividend and interest arising therefrom.
The object of trading in securities does not constitute the activity of
investment where the object is to earn dividend or interest.

(d) The High Court then discussed in detail the
judgment of the Apex Court in Walfort’s case (supra) which related to
dividend stripping. After explaining the objective behind section 14A, the Apex
Court, in the facts of that case, had held that a payback does not constitute
an ‘expenditure incurred’ in terms of section 14A as it does not impact the
profit and loss account. This expenditure, in fact, is a payout.

(e) According to the High Court, what is to be
disallowed is the expenditure incurred to “earn” Exempt Income. The
words ‘in relation to’ in section 14A must be construed accordingly. Applying
that principle to the facts at hand, the High Court concluded as under:

“Now, the dividend
and interest are income. The question then is whether the Assessee can be said
to have incurred any expenditure at all or any part of the said expenditure in
respect of the exempt income viz. dividend and interest that arose out of the
securities that constituted the Assessee’s stock-in-trade. The answer must be in
the negative. The purpose of the purchase of the said securities was not to
earn income arising therefrom, namely, dividend and interest, but to earn
profits from trading in i.e. purchasing and selling the same. It is axiomatic,
therefore, that the entire expenditure including administrative costs was
incurred for the purchase and sale of the stock-in-trade and, therefore,
towards earning the business income from the trading activity of purchasing and
selling the securities. Irrespective of whether the securities yielded any
income arising therefrom, such as, dividend or interest, no expenditure was
incurred in relation to the same.”

4.4 The Court also noted that the Punjab and
Haryana High Court in the above case referred and concurred with the judgment
of Karnataka High Court in CCI Ltd’s case and considered the same. Apart from
this, the Court also felt it useful to refer and consider the judgment of
Calcutta High Court in the case of G.K. K. Capital Markets (P) Ltd [ (2017)
373 ITR 196 ] [G.K.K. Capital’s case] which had also agreed with the view
of the Karnataka High Court in CCI Ltd’s case. In this context, the Court also
mentioned that the earlier judgment of the Calcutta High Court in the case of Danuka
& Sons vs. CIT [(2011) 339 ITR 319} [Danuka & Sons’ case] was cited
by the Revenue in G.K.K. Capital’s case but that judgment was distinguished on
the ground that, in that case, there was no dispute that part of the income of
the assessee from its business was from dividend and the assessee was unable to
produce any material before the authorities below showing the source from which
the relevant shares were acquired.

[ to be
concluded]

Note: The judgment of the Apex Court in the
case of Rajasthan State Warehousing Corporation referred to in para 3.2.6
above dealing with the Prior Law was analysed in this column in the April, 2000
issue of this journal.

shailesh.kwebmaker

Section 147 : Reassessment – Beyond period of 4 years –Findings in case of another assessee – No failure to disclose material facts – Reassessment was held to be not valid. [Sections 80IB(10) ,148]

12. Pr.CIT
vs. Vaman Estate [ Income tax Appeal no 678 of 2016, Dated: 27^th November, 2018 (Bombay
High Court)].

[ACIT-21(2) vs. Vaman Estate; dated 15/07/2015 ;
ITA. No 5584/Mum/2012, AY: 2004-05 , Bench: F, Mum. ITAT ]

Section
147 : Reassessment – Beyond period of 4 years –Findings in case of another
assessee – No failure to disclose material facts – Reassessment was held to be
not valid. [Sections 80IB(10) ,148]

The assessee filed on 31.10.2004 declaring total income at Rs. Nil.
In the return of income filed by the assessee for the said assessment year, the
principal claim was of deduction u/s. 80IB(10) of the Act arising out of income
from development of a housing project. In the assessment carried out by the
A.O, he disallowed a part of the claim after detailed scrutiny. Such assessment
was reopened by the A.O by issuance of notice, which was done beyond the period
of four years from the end of relevant assessment year. In order to issue such
notice, the A.O had recorded the detailed reasons. The gist of his reason was
that a similar claim was lodged by one
Abode Builders for the same housing project. In the course of
examination of such claim of the said assessee, the A.O had detected certain
defects. The A.O had rejected the claim inter alia on the ground that
the development and construction of housing project had commenced prior to
01.10.1998 (which was the crucial date for claiming the benefits u/s. 80IB(10)
of the Act). The A.O of the present assessee, therefore, found that the
assessee was not entitled to the deduction since one of the essential
requirements of the provision was breached. He noted that these facts were not
disclosed by the assessee and not brought to the notice of the A.O during the
assessment. Therefore, there was failure on the part of the assessee to
disclose truly and fully all material facts necessary for assessment.

The CIT(A) observed that during the scrutiny assessment, there was
no failure on the part of the assessee to disclose truly and fully all material
facts. Even on merits, he was of the opinion that there was no evidence to
suggest that the development and construction of the housing project commenced
prior to 01.10.1998. On such grounds, the assessee’s appeal was allowed.

The Revenue carried the matter in further appeal before the
Tribunal. The Tribunal held that in absence of any failure on the part of the
assessee to disclose true facts, the reopening of assessment beyond the period
of four years was not permissible. It is undisputed that in the original
assessment, the A.O had examined the assessee’s claim of deduction u/s.
80IB(10) of the Act at some length. To the extent he was dissatisfied, the
claim was disallowed. Such assessment was sought to be reopened only on the
ground that in case of Abode Builders where similar claim was raised in
connection with the same housing project, the A. O had detected certain
breaches which disqualified the assessee from claiming deduction. Essentially,
according to the A.O, the development and construction of the housing project
had commenced prior to 01.10.1998. The CIT(A) in a detailed consideration of
all the relevant aspects of the matter came to the conclusion that there was no
material to suggest that the development and construction of the housing
project had commenced prior to 01.10.1998.

Being aggrieved with the order of the ITAT, the Revenue filed the
Appeal before High Court. The Court find that the assessee had made full
disclosure of all relevant facts during the original scrutiny assessment. As
noticed by the CIT(A), all necessary facts were before the A.O while deciding
the original assessment. During such assessment, the assessee’s claim of
deduction was also minutely examined by the A.O. Reopening of assessment beyond
the period of four years was, therefore, correctly disallowed by the CIT(A) and
the Tribunal. As noted, the only source available with the A.O to contend that
relevant material was not brought on record by the assessee was assessment in
case of Abode Builders. Here also, there is one vital defect in the logic
adopted by the A.O. We do not find any where any material to suggest that the
development and construction of the housing project commenced before
01.10.1998. Even in the reasons recorded, the A.O has not linked any material
in order to make this observation. He has mainly relied on the findings of the
A.O of Abode Builders. This conclusion was reversed by the CIT(A) noting that
in fact all along there was evidence suggesting that the commencement of
construction of the housing project was some time in the year 2002. It was
pointed out that the assessment order in case of M/s. Abode Builders was set
aside by the CIT(A) and the same was confirmed by the Tribunal. There was no
failure on the part of the assessee to disclose truly and fully all relevant
facts as correctly held by the CIT(A) and the Tribunal pursuant to the detailed
discussion. Therefore, no question of law arises. The appeal was dismissed
accordingly.

shailesh.kwebmaker

Business expenditure – Disallowance u/s. 40(a)(ia) – Payments liable to TDS – Effect of insertion of second proviso to section 40(a)(ia) – Declaratory and curative and applicable retrospectively w.e.f. 01/04/2005 – Payee offering to tax sum received in its return – Disallowance not attracted

42. Principal CIT
vs. Shivpal Singh Chaudhary; 409 ITR 87 (P&H) Date of order: 5^th July, 2018 A. Y. 2012-13 Sections 37, 40(a)(ia) and 201(1) of ITA 1961

Business expenditure – Disallowance u/s. 40(a)(ia) –
Payments liable to TDS – Effect of insertion of second proviso to section
40(a)(ia) – Declaratory and curative and applicable retrospectively w.e.f.
01/04/2005 – Payee offering to tax sum received in its return – Disallowance
not attracted

For the A. Y. 2012-13, the Assessing Officer had made certain
disallowance u/s. 40(a)(ia) of the Act being amount paid to a construction
company for job work on the ground that tax was not deducted at source. The
assessee had filed confirmation from the payee that the payment made by the
assesse to it had been shown in its return.

The Commissioner appeals held that the second proviso to section
40(a)(ia) is clarificatory and retrospective and deleted the addition. The
Tribunal upheld the decision of the Commissioner (Appeals).

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

“i) The second proviso to section
40(a)(ia) of the Act was inserted by the Finance Act, 2012 w.e.f. 01/04/2013.
According to the proviso, a fiction has been introduced where an assessee who
had failed to deduct tax in accordance with the provisions of Chapter XVII-B,
but is not deemed to be an assessee in default in terms of the first proviso to
sub-section (1) of section 201 it shall be deemed to have deducted and paid the
tax on such sum on the date of furnishing of return of income by the resident
payee referred to in the proviso.

ii) From the first proviso to
section 201(1) and the second proviso to section 40(a)(ia) it is discernible
that according to both the provisos, where the payee has filed the return
disclosing the payment received or receivable, and has also paid the tax on
such income, the assessee would not be treated to be a person in default and a
presumption would arise in his favour.

iii) The rationale behind the
insertion of the second proviso to section 40(a)(ia) was declaratory and
curative and thus, applicable retrospectively w.e.f. 01/04.2005. However, under
the first proviso to section 201(1) inserted w.e.f. 01/07/2012, an exception
had been carved out which showed the intention of the Legislature not to treat
the assessee as a person in default subject to fulfilment of the conditions as
stipulated thereunder. No different view could be taken regarding the
introduction of the second proviso to section 40(a)(ia), which was intended to
benefit the assessee, w.e.f. 01/04/2013 by creating a legal fiction in the
assessee’s favour and not to treat him in default of deducting tax at source
under certain contingencies and that it should be presumed that the assessee
had deducted and paid tax on such sum on the date of furnishing of the return
by the resident payee.

iv) In view of the above,
substantial question of law stands answered against the Revenue and in favour
of the assessee.”

shailesh.kwebmaker

Section 194L and 194LA – TDS – State Metropolitan Development Authority – Acquisition of land for projects paying sums to illegal squatters for their rehabilitation – Not a case of compulsory acquisition from owners of land for which compensation paid – No liability to deduct tax at source on payments to illegal squatters

39.
CIT vs. MMRDA; 408 ITR 111(Bom): Date of order: 6^th September,
2018 A. Ys. 2000-01 to 2009-10

Section 194L and 194LA – TDS – State Metropolitan Development
Authority – Acquisition of land for projects paying sums to illegal squatters
for their rehabilitation – Not a case of compulsory acquisition from owners of
land for which compensation paid – No liability to deduct tax at source on
payments to illegal squatters

For the purpose of
implementing the scheme of the Government relating to road widening near the
railway track, the assessee, the Mumbai Metropolitan Regional Development
Authority, evacuated illegal and unauthorised persons who were squatters and
hutment dwellers. The Assessing Officer was of the opinion that there was
acquisition of immovable property for various projects by the assessee, for
which the project affected persons were compensated under the Land Acquisition
Act, 1894, He treated the assessee as the assessee-in-default u/s. 201(1) of
the Act and liable to pay interest u/s. 201(1A) since the assessee had not
deducted tax at source u/s. 194L/194LA. Accordingly, he computed the payment of
tax u/s. 201(1) and interest u/s. 201(1A)

The Commissioner
(Appeals) allowed the appeal and deleted the demand. The Tribunal upheld the
order of the Commissioner (Appeals).

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

“i) The possession of those persons was
unauthorized and illegal and they were not the owners of the land on which they
had squatted or built their illegal hutments and were trespassers. Therefore,
there was no question of the land being acquired by the assessee.

ii) The Tribunal correctly came to the
conclusion that the land had always belonged to the State and it was encroached
upon, which encroachment was removed by the assessee and the encroaching
squatters or hutment dwellers were rehabilitated. There was no question of
there being any compulsory acquisition from them under any law either under the
1894 Act or any other enactments which permitted compulsory acquisition of
land. Hence section 194L or section 194LA had no application.”

shailesh.kwebmaker

Sections 115JB and 254 Rectification of mistake – Tribunal accepting that assessee’s book profits to be computed after giving effect to deduction u/s. 54EC – AO passing order giving effect to directions issued by Tribunal – Notice of rectification issued thereafter on ground that deduction u/s. 54EC wrongly allowed – Not permissible Notice quashed

38.
Meteor Satellite Pvt. Ltd. vs. ITO; 408 ITR 99 (Guj): Date of order: 16^thApril, 2018 A. Y. 2010-11

Sections 115JB and 254 Rectification of
mistake – Tribunal accepting that assessee’s book profits to be computed after
giving effect to deduction u/s. 54EC – AO passing order giving effect to
directions issued by Tribunal – Notice of rectification issued thereafter on
ground that deduction u/s. 54EC wrongly allowed – Not permissible Notice
quashed

For the A. Y.
2010-11, the Tribunal accepted the assessee’s contention and held that the
assessee’s profits ought to be computed u/s. 115JB of the Act after carrying
out deduction u/s. 54EC. The Assessing Officer gave effect to the order and
recomputed the assessee’s book profits according to the directions of the
Tribunal and passed an order. Subsequently, he issued a notice u/s. 154 of the Act
to rectify the order passed by him for giving effect to the order of the
Tribunal on the ground that the book profits of the assessee had been wrongly
computed by allowing deduction u/s. 54EC in contravention of the law for
determining the book profits and that rectification of the order was to be
carried out.

The assessee filed
a writ petition and challenged the validity of the notice. The Gujarat High
Court allowed the writ petition and held as under:

“i) There was no error in the Assessing
Officer’s order implementing the Tribunal’s directions. The Tribunal had
directed the Assessing Officer to compute the assessee’s book profits in a
particular manner which was correctly understood and given effect by him.

ii) He had proposed to rectify his order giving
effect to the Tribunal’s decision on the ground that there had been an apparent error. However, as long as the
order of the Tribunal stood, the assessment order was required to be
implemented. Further, having implemented the order, it was not open for him to
exercise power of rectification which was meant for correcting any error
apparent on record.”

shailesh.kwebmaker

Section 4 – Income – Chargeable as (Compensation) – Compensation awarded under Motor Vehicles Act or Employees’ Compensation Act in lieu of death of a person or bodily injury suffered in a vehicular accident, is a damage and not an income and cannot be treated as taxable income

37.
National Insurance Company Ltd. vs. Indra Devi; [2018] 100 taxmann.com
60 (HP): Date of order: 25^th October, 2018

Section 4 – Income – Chargeable as
(Compensation) – Compensation awarded under Motor Vehicles Act or Employees’
Compensation Act in lieu of death of a person or bodily injury suffered in a
vehicular accident, is a damage and not an income and cannot be treated as
taxable income

The respondent Nos.
1 and 2 had filed a claim petition being u/s. 3 of the Workmen Compensation Act
for compensation on account of death of ‘R’, who, while working as a
cleaner/conductor, died in an accident. The Commissioner allowed the petition
by awarding a sum of Rs. 3,94,135 along with 12 per cent interest. In pursuance
to the award, the petitioner-insurance company deposited a sum of Rs. 5,32,007,
in the Court of the Commissioner after deducting TDS on interest component
payable on the compensation amount, which was deducted by the
petitioner-insurance company in compliance of section 194A. The tax was
deposited with the respondent No. 3- ITO (TDS). In execution petition preferred
by the claimants/respondents for payment of balance amount of compensation, the
Commissioner, directed to attach movable property of petitioner-insurance
company herein for realisation of balance amount. The petitioner insurance
company filed a writ petition and challenged the said order. The Himachal
Pradesh High Court held as under:

“i) Section 194A clearly provides
that any person, not being an individual or a Hindu Undivided Family,
responsible for paying to a ‘resident’ any income by way of interest, other
than income by way of interest on securities, shall deduct tax on such income
at the time of payment thereof in cash or by issue of cheque or by any other
mode. Compensation awarded under Motor Vehicles Act or Employees’ Compensation
Act in lieu of death of a person or bodily injury suffered in a vehicular
accident, is a damage and not an income and cannot be treated as taxable
income.

ii) It is well settled that
interest awarded by the Motor Accident Claims Tribunal on a compensation is
also a part of compensation upon which tax is not chargeable.

iii) Therefore, in view of abovesaid
decision, deduction of tax by petitioner/Insurance Company on the awarded
compensation and interest accrued thereon is illegal and is contrary to the law
of land.

iv) In view of above discussion,
this petition is disposed of directing respondent No. 3 to refund the TDS to
the petitioner/Insurance Company.

v) The amount deposited with the
department after deduction at source is Rs. 34,468, whereas the impugned order
of realization passed by the Commissioner is Rs. 66,900. Therefore, it is made
clear that for payment of balance amount claimed in the execution petition
filed by the respondents No. 1 and 2, the petitioner/Insurance Company has to
satisfy the Court of Commissioner and in case any amount beyond Rs. 34,468 is
found payable to the D.H./Claimants/respondents, the Commissioner/Executing
Court shall be entitled to pass any order in accordance with law for failure of
the petitioner company to satisfy the award.”

shailesh.kwebmaker

Section 9 of the Act w.r.t. Article 12 of DTAA between India and Austria – Income – Deemed to accrue or arise in India (Royalty/Fees for technical services) – Assessee-company entered into a technical assistance agreement with a non-resident company in Austria for design of new 75CC, 3-valve cylinder head for moped application – Assessing Officer treated payment to Austrian company as royalty – Since engine had already been developed by assessee and scope of technical services agreement was only to design a new 3-valve cylinder head with a specified combustion system for considerable improvement of fuel efficiency, performance and meeting Indian emission standards and moreover all products, design of engines and vehicles were supplied by assessee, payment did not constitute royalty

36.
DIT vs. TVS Motors Co. Ltd.; [2018] 99 taxmann.com 40 (Mad): Date of the order: 24^th October,
2018 A. Y. 2002-03

Section 9 of
the Act w.r.t. Article 12 of DTAA between India and Austria – Income – Deemed to accrue or
arise in India (Royalty/Fees for technical services) – Assessee-company entered
into a technical assistance agreement with a non-resident company in Austria
for design of new 75CC, 3-valve cylinder head for moped application – Assessing
Officer treated payment to Austrian company as royalty – Since engine had
already been developed by assessee and scope of technical services agreement
was only to design a new 3-valve cylinder head with a specified combustion
system for considerable improvement of fuel efficiency, performance and meeting
Indian emission standards and moreover all products, design of engines and
vehicles were supplied by assessee, payment did not constitute royalty

The assessee
entered into a technical assistance agreement with a non-resident company in
Austria for design of new 75CC, 3-valve Cylinder head, the project which
commenced in January 2001 and was completed in October 2001. The assessee
during the assessment proceedings contended that the fees paid by them to the
Austrian company was only for technical services, as the entire work was done
in Austria and no part of the work was done in India and the entire income was
taxable only in Austria in terms of provision of the DTAA with Austria. The
Assessing Officer, on going through the technical assistance agreement held
that the Austrian company was providing the design of newly developed engine
for being used by the assessee and thus payment was taxable as ‘royalty’.

The Commissioner
(Appeals) allowed the assessee’s appeal and held that the payment did not
constitute royalty. The Tribunal dismissed the appeal filed by the revenue.

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

“i) The scope of the work was for design of a
new 3-valve cylinder head with AVL CCBR combustion system. This would have
considerable improvement of fuel efficiency, improved performance and Meeting
India 2004 Emission Limits under IDC test conditions. The agreement states that
the assessee has recently developed a new 75CC 4-stroke 2-valve air cooled
engine with single speed transmission for moped application. As the local
market, (India), is asking for better fuel economy, the Austrian company was
asked to design a new 3-valve cylinder head with a lean burn combustion system
with charge motion for rapid combustion. The whole work under the said
agreement was to be carried out in Austria. The assessee was to supply the
material with all design documentation, engines and components as required for
the project. The total price for the project work deliverables and services was
agreed at EURO 349.522.

ii) The engine has already been developed by the
assessee and scope of the technical services agreement was only to design a new
3-valve cylinder head with a specified combustion system for considerable
improvement of fuel efficiency, performance and meeting the Indian emission
standards. All products, design of the engines and vehicles are supplied by the
assessee. On completion all the drawings are also delivered by the Austrian
company to the assessee. The entire project was carried out in Austria and no
part of the project was performed in India. Thus, the Commissioner (Appeals)
rightly held that the payment does not constitute royalty.”

shailesh.kwebmaker

Section 10B – Export oriented undertaking – 10B(9)/(9A)) – Assessee firm was engaged in production and export of iron ore – It claimed deduction u/s. 10B – Assessing officer rejected assessee’s claim on ground that assessee’s sister concern got merged with assessee – assessee’s sister concern was also an EOU – Impugned order rejecting assessee’s claim was to be set aside

35.
CIT vs. Trident Minerals; [2018] 100 taxmann.com 161 (Karn): Date of order: 10^th October, 2018 A Y. 2009-10

Section 10B – Export oriented undertaking –
10B(9)/(9A)) – Assessee firm was engaged in production and export of iron ore –
It claimed deduction u/s. 10B – Assessing officer rejected assessee’s claim on
ground that assessee’s sister concern got merged with assessee – assessee’s
sister concern was also an EOU – Impugned order rejecting assessee’s claim was
to be set aside

The assessee-firm
was engaged in business of production, manufacture and export of iron ore. On
02/05/2008 the assessee’s sister concern namely KMMI Exports merged with
assessee. On 22/09/2009, return of income was filed u/s. 139(1) of the Act and
deduction u/s. 10B was claimed in respect of export income. The Assessing
Officer held that deduction u/s. 10B was not allowable on the ground that two
partnership firms had been merged and that assets of KMMI Exports had been
taken over by assessee.

The Commissioner
(Appeals) allowed the claim of the assessee.

The Tribunal upheld
the decision of the Commissioner (Appeals).

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

“i) The Commissioner (Appeals) recorded a
finding that the Circular of the Board issued u/s. 84 was not withdrawn and was
still in force. It is the Rule and also the practice of the Board to withdraw
the Circular once it is not relevant. Therefore, the Circular No. 15/5/63-IT(A1),
dated 13/12/1962 is in force and relevant in the present context, when the
clauses u/s. 80J and 10B are similar. It was also recorded by the appellate
authority that the observation made by the Assessing Officer, as per section
10B(7), only Indian company is eligible for amalgamation is not appropriate.

ii) As mentioned by the assessee in the written
submission that ‘the sub-sections (9) and (9A) which were omitted with effect
from 01/04/2004 clearly suggests that the transfer by any means will not entitle
the deduction under this section only up to 31/03/2003. In other words, the
transfer by any means is allowed with effect from 01/04/2004 by implication,
moreover, the firms merged are family concerns with same partners, with the
same sharing ratio and doing the same business and two firms are having 100 per
cent EOU recognised by the SEZ Authorities. Hence, the Commissioner held that
the claim of the assessee was justifiable and the same was allowed.

iii) On appeal filed by the revenue, Tribunal
recorded a finding that the unit of the assessee firm is a 100 per cent EOU
unit entitled for deduction u/s. 10B of the Act. It is also seen that Assessing
Officer has not disputed the EOU status of the unit KMMI Exports also. The
issue for consideration is after the merger of the firm KMMI exports with the
assessee-firm, whether the assessee-firm is entitled for deduction u/s. 10B of
the Act. Earlier, there was sub-section (9) to section 10B, which specifically
provided that the deduction cannot be allowed, if there was a transfer of
ownership or beneficial interest in the undertaking. The sub-section (9A) of
section 10B was omitted with effect from 01/04/2004. In this view of the
matter, the inevitable and appropriate conclusion is that the limitations
specified in sub-sections (9) and (9A) of section 10B Act do not exist from
01/04/2004 and, therefore, the conclusion of the Assessing Officer that
deduction u/s. 10B cannot be granted on the merger of firms is not correct.

iv) The Tribunal after considering a finding that
in view of the CBDT Circular No. 1 of 2013, dated 17/01/2013, it is clear that
deduction is granted to the undertaking. Therefore, it follows as long as the
undertakings remain eligible for deduction u/s. 10B, the deduction cannot be
denied merely on the ground that there has been a merger of the firms which own
the undertakings. The Assessing Officer has not rendered any finding that
either on the units, belonging to the assessee and the other belonging to the
firm that got merged, i.e., KMMI Exports, is not eligible for deduction u/s.
10B of the Act. The only reason adduced is that due to the merger of the two
units, the assessee is deploying assets already put to use by the merged firm
and hence the assessee cannot claim deduction u/s. 10B of the Act.

v) The Tribunal further recorded a finding that
both the units/undertakings of the assessee-firm and KMMI Exports are otherwise
eligible for deduction u/s. 10B and the deduction is towards undertaking as
long as undertakings are agreeable that section 10B which is not been disputed
by the Assessing Officer merger of the firm and KMMI Exports which is not
undertaking. In view of the above, the Tribunal upheld the order passed by the
Appellate Court allowing the deduction u/s. 10B.

vii) It is undisputed fact that the claim made by
the assessee for deduction u/s. 10B for the assessment year 2009-10 after the
merger of two firms with effect from 26/12/2011. It is also undisputed that in
view of the deletion of the provision of sub-section (9) of section 10B from
the statute with effect from 01/04/2004 the impugned order passed by the
Tribunal allowing the assessee’s claim for deduction u/s. 10B was to be
upheld.”

shailesh.kwebmaker

Section 10(23C)(iiiad) – Educational institution – Exemption u/s. 10(23C)(iiiad) – Assessee-trust was established predominantly with an object of providing education to all sections of society – Mere fact that it spent a meagre amount of its total income on some allied charitable activities such as providing food and clothing to relatives of poor students, would not stand in way of AO to deny benefit to it u/s. 10(23C)(iiiad)

34.
Sri Sai Educational Trust vs. CIT; [2018] 100 taxmann.com 50 (Mad): Date of order: 10^th October, 2018 A. Y. 2014-15

Section 10(23C)(iiiad) – Educational
institution – Exemption u/s. 10(23C)(iiiad) – Assessee-trust was established
predominantly with an object of providing education to all sections of society
– Mere fact that it spent a meagre amount of its total income on some allied
charitable activities such as providing food and clothing to relatives of poor
students, would not stand in way of AO to deny benefit to it u/s.
10(23C)(iiiad)

The assessee trust
was established predominantly with an object of providing school education to
all sections of society. The only activity of the assessee-trust was running of
an educational institution. The assessee-trust was granted registration u/s.
12A on 30/05/2016. The assessee filed its return for relevant year i.e. A. Y.
2014-15 claiming exemption of income. The assessee’s claim was based on plea
that in view of the registration granted u/s. 12AA of the Act, with effect from
01/04/2015 and in view of the first proviso to section 12A(2), effect of such
registration had to be applied retrospectively in respect of the subject year
i.e. A. Y. 2014-15 also and consequently, the Assessing Officer ought not to
have assessed the income to tax. The assessee’s alternative plea was that if
the exemption was not allowed with retrospective application of the
registration as contemplated u/s. 12A(2), it should have been granted the
benefit of exemption by applying section 10(23C)(iiiad). The Assessing Officer
rejected assessee’s claim of granting benefit of section 12A with retrospective
effect. He further held that since assessee was not existing solely for
educational purpose as it was carrying on some other charitable activities
also, exemption u/s. 10(23C)(iiiad) was also not allowable.

The assesee filed a
writ petition and challenged the order of the Assessing Officer. The Madras
High Court upheld the order of the Assessing Officer as regards section 12A.
The High Court allowed the writ petition and held that the assessee is entitled
to exemption u/s. 10(23C)(iiiad) and held as under:

“i) Perusal of the provision of section
10(23C)(iiiad) would show that any income received by any University or
educational institution existing solely for educational purposes and not for
purposes of profit, shall not be included in total income. In other words, such
income is not taxable and on the other hand, gets exempted from levy of tax. It
is the contention of the assessee that since the trust is existing solely for
educational purposes without having any purpose of profit, the respondent is
not entitled to bring the disputed income to tax.

ii) There is no dispute to the fact that the
assessee trust is running an educational institution for providing elementary
school education without distinction of caste and creed, from 1997. Though the
Trust Deed refers few other charitable activities such as providing medical
relief to the poor, relief to orphans, etc., the predominant object of the
trust is evidently seen as administering, establishing and maintaining schools
and other educational institutions to impart education to poor students without
any restriction as to caste, community or religion. This noble object of the
assessee trust cannot be looked into with magnifying glass to find out as to
whether any meagre expenditure spent by them on any allied charitable purpose,
so as to project, as though by doing such activity, the assessee-trust is not
existing solely for educational purposes. In this case, the objection of the
revenue relates to a sum of Rs.54,300/- spent by the petitioner for providing
sarees to mothers and grandmothers of the children studying in the school. This
free distribution of clothes to the mothers and grandmothers of the children is
considered by the revenue as the one not related to educational purposes.

iii) On the other hand, it is contended by the
assessee that such distribution was made only to encourage those mothers and
grandmothers to send their ward to the school without discontinuation. This
purpose is not doubted by the Revenue. Nor any contra material is available
before the Assessing Officer to draw adverse inference. Therefore, the main
object behind the distribution of the sarees to those persons is evidently for
ensuring the continuance of study at the petitioner School and not solely for
providing clothes to needy persons totally unconnected with the school.

iv) At this juncture, it is better to understand
the scope of Section 10(23C)(iiiad). The term “any university or
educational institution existing solely for educational purpose” used
under the above provision is heavily relied on by the Revenue to deny the
benefit of exemption to the petitioner on the sole ground that a portion of the
income spent on other charitable purpose, viz., distribution of sarees to the
mothers and grandmothers of the children studying in the school was not for
educational purpose. There is no dispute to the fact that the sum spent on such
purpose is very minimal, compared to the total income.

v) While the nature of existence of the
institution is to be derived only by considering the predominant activity of
the institution, the nature of spending the money so received by such
institution to its various activities, has to be ascertained and adjudged going
by the ultimate purpose for which it was spent. If the event of spending and
the purpose for which such event took place, have some nexus to achieve the
main object viz., the predominant activity of the institution, then such
spending on an allied activity cannot be looked in isolation from the main
object.

vi) An institution solely existing for
educational purposes, if indulges in certain allied charitable activities, such
as feeding and clothing poor, giving some medical aid to those people, etc.,
certainly, such activities cannot alter the predominant object of such
institution. While ‘the imparting education’ is like the water flowing in the
main channel, certain incidental other charitable activities done by such
institution, here and there, cannot be considered as major breach of the
channel, but as the reach of the ‘over flown’ water from the main channel to
the adjacent lands. So long as the desired destination of the channel (the
institution) is evidently existing and being achieved to reach the predominant
object and not disputed, the nature or character of the institution run by the
trust cannot be doubted, as it will always fit into the above term
“institution existing solely for educational purposes” and consequently,
is entitled to protection u/s. 10(23C)(iiiad).

vii) Further, strictly speaking, Section 10(23C)
contemplates and excludes any income “received by” and not “the
spending” of such money received u/s. 10(23C). At the same time, if the
spending is totally on a deviated object or an object, which is totally
opposite or opposed to the main object for which the trust is created,
certainly such spending cannot have any protection u/s.10(23C)(iiiad). Thus, the sole purpose of existence is to be gathered, derived
and construed based on overall predominant activity and not from certain
isolated activity, especially when such activity also happens to be charitable
in nature, more particularly, when a meagre sum is spent on such activity. At
the same time, proportionality of the money spent on such activity, other than
the predominant activity, also plays a major role in deciding the nature of
existence of the institution. If major portions of the money received by the
trust is spent on certain objects other than the predominant object, certainly
the sole purpose of the Trust for which it was created, can be doubted. On the
other hand, if such spending is meagre and does not shake the conscience of the
Assessing Officer, being the quasi judicial authority, is at liberty to bring
such expenditure also under the exemption clause.

viii) It is not established by the revenue that the
assessee is carrying on any other activities for profit other than running the
school. Therefore, when the only predominant activity is being carried on by
the assessee-trust, viz., the running of the school mere spending a meagre
amount, out of the total income derived by the trust, towards the distribution
of sarees to mothers and grandmothers of children studying in the school, could
not stand in the way of the Assessing Officer to deny the benefit u/s.
10(23C)(iiiad). Thus the respondents are not justified in rejecting the claim
of the petitioner u/s. 10(23C)(iiiad) of the Act.

ix) Accordingly, the writ petition is allowed and
the impugned order is set aside.”

shailesh.kwebmaker

Section 12A – Charitable or religious trust – Registration of (Cancellation of) – Where assessee educational society, set up with various aims and objects including improvement in standard of education of backward students of rural areas, was running a school and Commissioner had not doubted genuineness of aims and objects of assessee, application u/s. 12A could not be rejected merely on ground that secretary of society was getting lease rent for land given to society for running school or his wife who had requisite qualification was teaching in school and was being paid salary

33.
CIT (Exemption) vs. Ambala Public Educational Society; [2018] 100
taxmann.com 131 (P&H): Date of order: 29^th October, 2018

Section 12A – Charitable or religious trust
– Registration of (Cancellation of) – Where assessee educational society, set
up with various aims and objects including improvement in standard of education
of backward students of rural areas, was running a school and Commissioner had
not doubted genuineness of aims and objects of assessee, application u/s. 12A
could not be rejected merely on ground that secretary of society was getting
lease rent for land given to society for running school or his wife who had
requisite qualification was teaching in school and was being paid salary

The
assessee-society was a trust registered with the Registrar of Societies,
Haryana. The assessee-society was set up with various aims and objects
including improvement in the standard of education of the backward students of
rural areas. The assessee-society was running a school. It made an application
for registration u/s. 12A of the Act. During the proceedings, the Commissioner
was swayed by the fact that the secretary of the assessee-society was getting
lease rent of certain amount per annum for land given to society for running
school and wife of the secretary was teaching in school and getting salary from
the school. It was further stated that the assessee-society was not registered
under the New Haryana Registration & Regulation of Societies Registration
Act, 2012. Accordingly, the application was rejected.

On appeal, the
Tribunal ordered granting registration u/s. 12A to the society.

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

“i) The contentions raised by the revenue lacks
merit. There is no requirement u/s. 12A that the assessee-society is required
to be registered under the 2012 Act. Moreover, the assessee-society explained
before Tribunal that it had applied for registration under the 2012 Act but due
to back log, grant of registration was delayed. The certificate regarding
registration under 2012 Act was produced before the Tribunal.

ii) The application u/s. 12A cannot be rejected
merely on the ground that the secretary of the society was getting lease rent
for the land given to the society for running the school or his wife who had
requisite qualification was teaching in the school and was being paid the
salary. It is not the case set up by the revenue that the exorbitant amounts
had been paid by the assessee-society to the secretary or to his wife. No
dispute has been raised to the fact that the assessee-society is running a
school as per its aims and objects.

iii) The Commissioner while rejecting the
application has not doubted the genuineness of aims and objectives of the
assessee-society. On the other hand the Assessing Officer while finalising the
assessment for A. Y. 2010-11 u/s. 143(3) has specifically recorded the finding
that the income earned by the society has been utilised for educational
purposes.

iv) The order of the ITAT warrants no
interference. No error has been pointed out in the findings recorded by the
ITAT much less shown to be perverse. No substantial question of law arises. The
appeal is, accordingly, dismissed.”

shailesh.kwebmaker

Sections 40(a)(ia) and 194J – Business expenditure – Disallowance u/s. 40(a)(ia) – Payments liable to TDS – Third party administrator for insurance companies – Payments merely routed through assessee – Disallowance u/s. 40(a)(ia) not warranted

32.
CIT vs. Dedicated Healthcare Services (TPA) India Pvt. Ltd.; 408 ITR 36
(Bom): Date of order: 17^th September,
2018 A. Y. 2008-09

Sections
40(a)(ia) and 194J – Business expenditure – Disallowance u/s. 40(a)(ia) –
Payments liable to TDS – Third party administrator for insurance companies –
Payments merely routed through assessee – Disallowance u/s. 40(a)(ia) not
warranted

The assessee
carried on business as a third party administrator for insurance companies.
According to the Department, the insurance companies issued policies that were
serviced by the third party administrator who acted as a facilitator and
charged fees, provided services, such as hospitalisation, cashless access,
billing and call centre services, and all the claims payable by the insurance
companies for these services were routed through the third party administrator.

It was further
stated, that the receipts and disbursements were routed the bank account of the
assessee for which the assessee passed certain book entries, that on receipt of
the amount, the bank account was debited and the account of the insurance
company was credited and that on payment of claims to the hospital/insured, the
account of the insurance company was debited and the bank account was credited.

For the A. Y.
2008-09 it was found that the assessee had made payments to various hospitals
during the year without deducting the tax at source u/s. 194J of the Income-tax
Act, 1961 (hereinafter for the sake of brevity referred to as the
“Act”) which called for disallowance u/s. 40(a)(ia) of the Act.
Relying on the CBDT circular No. 8 of 2009, dated 24/11/2009, the Assessing
Officer held that the third party administrator was required to deduct tax at
source u/s. 194J from all such payments made to hospitals, etc.

The Commissioner
(Appeals) allowed the appeal filed by the assessee. The Tribunal upheld the
decision of the Commissioner (Appeals).

The Bombay High
Court upheld the decision of the Tribunal and held as under:

“i) The Tribunal had found that the assessee
only facilitated the payments by the insurer to the insured for availing of the
medical facilities. The assessee did not render any professional services to
the insurer or the insured and only collected the amount from the insurer and
passed it on to various hospitals which provided medical services to the
insured. It had found that for transactions there was no claim of expenses by
the assessee which was disallowed.

ii) The Department could not be permitted to
raise the same questions as had been earlier dealt with in the Division Bench
judgments and orders of the Court.”

shailesh.kwebmaker

EXTERNAL AUTHORITY FOR DISCIPLINARY ACTION AGAINST AUDITORS

1. Introduction

At present the Council of the Institute of
Chartered Accountants of India (ICAI) has power to ensure that its members
maintain discipline while discharging their professional and other duties.
Sections 21, 21A to 21D of the Chartered Accounts Act (CA Act) provide for
mechanism for conducting Disciplinary proceedings and for awarding punishment
to erring members of ICAI. Sections 22,22A to 22G of CA Act provide for filing
appeals before the Appellate Authority appointed u/s. 22. The First schedule to
the CA Act gives a list of Professional Misconduct by members in their dealings
with other members of ICAI or with the Institute. The Second Schedule to the
Act gives a list of Professional Misconduct by members in practice in their
dealings with their clients. Section 132
of the Companies Act, 2013 (Act), which has now come into force provides for
constitution of a “National Financial Reporting Authority” (NFRA). By a
Notification dated 21.03.2018 the Central Government has notified the
constitution of NFRA. U/s. 132 of the Act, NFRA is authorised to recommend to
the Central Government to notify Accounting and Auditing Standards as well as
to take disciplinary action against Auditors of some specified companies and
bodies corporate. This action can be taken against the Firms of Auditors as
well as against partners of the Firm. Thus an External Authority is now set up
to take disciplinary action against Auditors of specified entities. The existing powers of the Council of ICAI to
take disciplinary action against such Auditors is now taken away and entrusted
to the NFRA. However, ICAI will continue
to have powers regarding disciplinary matters in cases of Auditors of entities
other than specified entities.

The National Financial Reporting Authority Rules,
2018, have been notified on 13^th November, 2018. These Rules have
come into force on 14^th November, 2018. Significant changes have been made by section
132 of the Companies Act, 2013 and the above Rules in the matter of
disciplinary action against Auditors. In this article some of the important
provisions relating to disciplinary action that can be taken against Auditors
of specified entities by NFRA are discussed.

2. CONSTITUTION
OF NFRA

(i) Section
132(3) of the Act provides that NFRA shall consist of a Chairperson, who shall be a person of
eminence and having expertise in accountancy, auditing, finance or law and such
other members, not exceeding 15, consisting of part-time and full-time members
as may be prescribed.

(ii) NFRA
(Manner of Appointment and other Terms and Conditions of Service of Chairperson
and Members) Rules, 2018 notified on 21.03.2018 provide for various matters
relating to appointment, service conditions of Members of NFRA and other
matters. According to these Rules the Central Government has to appoint a
Chairperson, Three Full-Time Members and Nine Part-Time Members of NFRA. The
Rules provide for their qualifications, service conditions and other matters.

3. THE
POWERS OF NFRA

The powers which NFRA can exercise are listed in
section 132(4) as under:-

(i) Power
to investigate, either on its own or on a reference made by the Central Government, in case of
such class of bodies corporate or persons, as may be prescribed,
into the matters of professional or
other misconduct committed by a Chartered
Accountant or a Firm of Chartered Accountants. Once NFRA initiates this
investigation, ICAI or any other body will have no authority to initiate or
continue any proceedings in such matters of misconduct.

(ii) NFRA
shall have the same powers as vested in a Civil Court under Code of Civil
Procedure, 1908. In other words, it can issue summons, enforce attendance,
inspect books and other records, examine witnesses etc.

(iii) If
any professional or other misconduct is proved, NFRA can impose penalty as
under:

u
In the case of an individual CA, minimum penalty of Rs.1 lakh which may extend
to 5 times of the fees received by the individual.

u
In the case of a C.A. Firm, minimum penalty of Rs. 5 lakh which may extend to
10 times the fees received by the Firm.

u
NFRA can debar any Chartered Accountant or a CA Firm from practice for a
minimum period of six months or for such higher period not exceeding 10 years.

(iv) Any
person / firm aggrieved by any order of NFRA can file appeal before the
National Company Law Appellate Tribunal. This appeal can be made in such manner
and on payment of such fees as may be prescribed.

(v) The
above provisions of section 132 will override any provisions contained in any
other statute. This will mean that the Council of ICAI will not be able to
exercise its powers relating to disciplinary action against auditors of
specified entities. Even powers to formulate accounting and auditing standards,
ensure quality of audit etc., are now vested in NFRA. To this extent the autonomy conferred on ICAI
under the C.A. Act, 1949, is partially
taken away.

(vi) By a
Notification dated 13^th November, 2018, the Central Government has
issued the “National Financial Reporting Authority Rules, 2018” (NFRA Rules).
These Rules specify the class of companies and bodies corporate governed by
NFRA for taking disciplinary action against Auditors of these entities, the
functions and duties of NFRA and other related matters. The provisions of these
Rules are discussed below.

4. CLASS OF
ENTITIES GOVERNED BY NFRA – (RULE 3)

(i) Rule 3
of NFRA Rules gives power to NFRA to (a) monitor and enforce compliance with
the Accounting and Auditing Standards,
(b) Oversee the quality of Service of the Auditor u/s. 132 (2), and (c)
Undertake investigation u/s. 132 (4) of Auditors of the following class of
Companies and Bodies Corporate (Specified Entities).

(a) All
Companies which are listed on Stock Exchanges in India or outside India.

(b) Unlisted
Public Companies having (i) paid-up capital of Rs. 500 crore or more, (ii) Turnover of Rs.1,000 crore, or more, or (iii)
Aggregate outstanding Loans, Debentures and Deposits of Rs. 500 crore or more
as at 31^st March of the immediately preceding Financial Year.

(c) Insurance
Companies, Banking Companies, Companies engaged in Generation or Supply of
Electricity and Companies Governed by any Special Act or Bodies Corporate
incorporated by any Act in accordance with the provisions of section 1(4)(b) to
(f) of the Act.

(d) Any
Body Corporate or Company or person or any class of Bodies Corporate or
Companies or persons, on reference made to NFRA by the Central Government in
Public Interest. It may be noted that section 3 of the Limited Liability
Partnership Act, 2008 provides that an LLP registered under that Act is a Body
Corporate. Therefore, it appears that Auditors of any LLP, irrespective of its
capital, turnover or borrowings, will now be governed by the NFRA Rules if such
a case is referred to NFRA by the Government. Apparently, this does not appear
to be the intention of these Rules. We will have to wait for some clarification
from the Central Government in respect of this matter.

(e) A Body
Corporate incorporated or registered outside India which is a Subsidiary or
Associate Company of an Indian Company or a Body Corporate referred to in (a)
to (d) above, if the income or net worth of such subsidiary or Associate
Company exceeds 20% of the consolidated income or net worth of such Indian Company
or Body Corporate referred to in (a) to (d) above.

(ii) Auditors
of the above companies and bodies corporate have to file a return in the
prescribed form with NFRA on or before 30^th April of every year
under Rule 5.

(iii) A
Company or a Body Corporate, other than a Company Governed under this Rule, shall continue to be governed by NFRA
for a period of 3 years after it ceases
to be listed or its paid-up capital, turnover, or aggregate borrowing falls
below the limits stated in (i) (b) above.

5. REPORTING
OF AUDITORS APPOINTMENT

The above Rule provides for reporting about
Auditors’ particulars by a Body Corporate as under:

(i) Every
existing Body Corporate, other than a Company Governed by this Rule, has to
inform NFRA, within 30 days (i.e. on or before 14^th December, 2018),
particulars of Auditor holding office on 14^th November, 2018 in Form
NFRA-1.

(ii) Every
Body Corporate, other than a Company governed by this Rule shall, within 15
days of the appointment of its Auditor u/s. 139(1), inform NFRA about the
particulars of its Auditor in Form NFRA-1.

(iii) Every
Body Corporate incorporated or registered outside India (as referred to in Para
4(i) (e) above) has also to file the particulars of its Auditors in Form NFRA
-1 within the above time limit.

It may be noted that if the NFRA Rules apply to an
LLP, irrespective of its capital, turnover or borrowings, all small and big
LLPs will have to file particulars of their existing Auditors on or before
14.12.2018 in Form NFRA-1. This is going
to be a difficult task for an LLP.
Similarly, a Foreign Body Corporate to which Rule 3 is applicable will
have to file Form NFRA-1 within the above time limit. The above Rule states
that particulars of Auditors appointed u/s. 139(1) of the Act are to be given.
It may be noted that section 139(1) refers to appointment of Auditors of
Companies registered under the Companies Act, 2013. It does not refer to
appointment of Auditors by a Body Corporate.
Further, Form NFRA-1 requires the Body Corporate to state whether the
Auditor’s appointment is within the limit of 20 Audits provided in section
141(3)(g) of the Act. This limit applies to 20 Audits of Companies and not to
Bodies Corporate. To this extent, compliance with the reporting requirements of
Rule 3(3) will become difficult. It is difficult to understand why such onerous
duty is cast on all Bodies Corporate including LLP and Foreign Bodies
Corporate. Further, the time limit of
one month from the publication of Rules is too short as most of the bodies
corporate may not be aware of this requirement. It is not understood as to what
public interest is going to be served by bringing the Auditors of all LLPs
under NFRA when Auditors of all Private Companies and most of the Public
Unlisted Companies are kept outside the purview of NFRA.

6. FUNCTIONS
AND DUTIES OF NFRA (RULE 4)

Section 132 (2) of the Act read with Rule 4 of
NFRA Rules provides for functions and duties of NFRA as under:

(i) NFRA
shall protect the public interest and interest of investors, creditors and
others associated with Companies and Bodies Corporate, listed under Para 4(i)
(a) to (f) above, by establishing high quality standards of accounting and
auditing.

(ii) NFRA
will exercise effective oversight of accounting functions performed by the
above companies and bodies corporate and auditing functions performed by the
Auditors of the above entities.

(iii) Maintain
particulars of Auditors appointed by the above companies and bodies corporate.

(iv) Recommend
Accounting Standards and Auditing Standards for approval by the Central
Government. For this purpose NFRA shall
receive from ICAI recommendations for modification of existing accounting and
auditing standards or for issue of new standards before making recommendations
to the Central Government.

(v) Monitor
and enforce compliance with the Accounting and Auditing Standards notified by
the Central Government.

(vi) Oversee
the quality of service of Auditors associated with ensuring compliance with the
above standards and suggest measures for improvement in the quality of service.

(vii) Promote
awareness in relation to the compliance of the Accounting and Auditing standards. For this purpose it may
co-operate with National and International Organisations of Independent Audit
Regulators to establish and oversee adherence to these standards.

(viii) Perform
such other functions and duties as may be necessary or incidental to the above
functions and duties.

(ix) Discharge
such functions as may be entrusted by the Central Government by Notification.

7. MONITORING
AND ENFORCING COMPLIANCE WITH ACCOUNTING STANDARD (RULE 7)

For discharging this function, NFRA has the
following powers:

(i) It may
review the Financial Statements of the above specified entities and may issue a
notice to such Entity or its Auditor to provide further information or
explanation. It may also call for
production of the relevant documents for inspection.

(ii) It
may require personal presence of the officers of the Entity or its Auditor for
seeking additional information or explanation.

(iii) It
shall publish its findings relating to non-compliance by any such entity on its
website or in such other manner as it considers fit.

(iv) If, in
a particular case, NFRA finds that any Accounting Standard is not followed, it
can decide on the further course of investigation.

8. MONITORING
AND ENFORCING COMPLIANCE WITH AUDITING STANDARDS (RULE 8)

For discharging the above function, NFRA has the
following powers relating to the Auditors of the specified entitie:

(i) To
review the working papers of Auditors, including the Audit Plan and other Audit
Documents as well as any communication relating to the Audit.

(ii) To
evaluate the sufficiency of the quality control system of the Auditor and the
manner of documentation of the system by the Auditor.

(iii) To
perform such other testing of the audit, supervisory and quality control
procedures of the Auditor as may be considered necessary or appropriate.

(iv) It may
require the Auditor to report on its governance practices and internal
processes designed to promote audit quality, protect its reputation and reduce
risks, including risk of failure of the Auditor. It may take such action on this report as may
be necessary.

(v) NFRA
can require the Auditor to appear before it personally and obtain from him
additional information or explanation in connection with the conduct of the
Audit.

(vi) NFRA
shall publish its findings relating to non-compliance with the Auditing
Standards on its website or in such manner as it considers fit. In respect of proprietary or confidential
information, such publication will not be made but the same may be reported to
the Central Government.

(vii) In a
case where NFRA finds that any law or professional or other standard has been
violated by the Auditor, it may decide to conduct further investigation and
take action against the Auditor.

9. OVERSEEING
THE QUALITY OF SERVICE BY THE AUDITOR (RULE 9)

(i) On the
basis of the review made by NFRA, as stated above, it can direct the Auditor to
take measures for improvement of audit quality. This may include suggestions to
change the audit process, quality control and audit reports. It may also specify a detailed plan with time
limits.

(ii) It
shall be the duty of the Auditor to make the required improvements and send a
report to NFRA explaining as to how he has complied with the directions of
NFRA.

(iii) NFRA
shall monitor the improvements made by the Auditor and take such further
action, depending on the progress made by the Auditor, as it thinks fit.

(iv) NFRA
may refer, with regard to overseeing the quality of Auditors of the specified
entities, to the Quality Review Board (QRB) of ICAI and call for a report or
information in respect of such Auditors from QRB as it may deem appropriate.

10. INVESTIGATION
ABOUT PROFESSIONAL OR OTHER MISCONDUCT (RULE 10)

(i) NFRA
has power to investigate in the following circumstances.

(a) Where
any reference is received from the Central Government for investigation into
any matter of professional or other misconduct u/s. 132(4) as stated in Para 3
above.

(b) Where
NFRA decides to undertake investigation into any matter on the basis of its
compliance or oversight activities.

(c) Where
NFRA decides to undertake investigation suo motu in any matter of
professional or other misconduct by the Auditor of the specified entities

(ii) If
during the investigation, NFRA finds that any of the specified entities has not
complied with the Act or the Rules or which involves fraud amounting to Rs. 1
crore or more, it shall repot its finding to the Central Government.

(iii) On or
after 14^th November, 2018, the action in respect of cases of
professional or other misconduct against the Auditors of specified entities
shall be initiated by NFRA only. No
other Institute or Body can initiate such action against the Auditor. Further,
no other Institute or Body shall initiate or continue any proceedings in such
cases where NFRA has initiated an investigation as stated above. This will mean
that if any case against the Auditor of a specified entity is pending before
ICAI on 14.11.2018, the same will have
to be transferred to NFRA if NFRA decides to investigate in the same matter.

(iv) The
action in respect of cases of professional or other misconduct against Auditors
of companies and other entities (other than the specified entities) shall
continue to be investigated by ICAI as provided in the CA Act.

(v) For the
above purpose Explanation below section 132(4) provides that the expression
“Professional or other Misconduct” shall have the same meaning as assigned to
it u/s. 22 of the Chartered Accountants Act. Therefore, NFRA will have to
decide such cases of misconduct as
provided in section 22 and the First and Second Schedules of the C.A. Act.

(vi) It may
be noted that Rule 10 provides that NFRA shall initiate investigation against
the Auditors of specified entities u/s. 132(4) on a reference being made by the
Central Government. There is no provision
for investigation by NRFA on the basis of a compliant by a shareholder,
creditor or any other person who has a grievance against Auditors of the
specified entities. It is, therefore,
presumed that such complaints by shareholders, creditors etc., will have to be
investigated by ICAI under its Disciplinary Jurisdiction.

11. DISCIPLINARY
PROCEEDINGS (RULES 11 AND 12)

The procedure for conducting Disciplinary
Proceedings by NFRA against Auditors of specified entities is given in Rule 11
and 12. Briefly stated, this procedure
is as under:

(i) NFRA
can start disciplinary proceedings against Auditors of specified entities on
the basis of (a) a reference received from the Central Government, (b) finding
of its Monitoring, enforcement or oversight activities, or (c) material
otherwise available on record. If NFRA believes that sufficient cause exists to
take action against the Auditors u/s. 132(4), it shall refer the matter to its
concerned Division dealing with Disciplinary matters. This Division will then
issue show-cause notice to the Auditors.

(ii) Rule
11(2) and 11(3) specifies the various matters which will be stated in the
show-cause notice. Copies of documents relied upon by NFRA and extracts of
relevant portions from the Report of the Investigation and other records are to
be enclosed with the show-cause notice.
The procedure for service of show-cause notice is given in Rule 11(4).

(iii) Rule
11(5) states that the concerned Division shall dispose of the show-cause notice
within 90 days of the assignment through a summary procedure as may be
specified by NFRA. The concerned Division will pass a reasoned order in
adherence to the principles of natural justice.
For this purpose, where necessary or appropriate, opportunity of being
heard in person will be given. The concerned Division will also take into
consideration the submissions made by the Auditors and the relevant facts and
circumstances and material on record before passing the order. There is no
clarity whether the hearing will be given by a Bench of the members of NFRA and
whether the above order will be passed by such Bench. Again, it is not clear as
to how many members of NFRA will constitute such Bench.

(iv) The
above order passed by the concerned Division of NFRA shall specify that (a) No
further action is to be taken against the Auditors, (b) Caution the Auditors,
or (c) Punishment by levy of penalty and/or debarring the Auditors from
practice is awarded as specified in section 132(4). Such Penalty may be as
stated in Para 3(iii) above. The above
order shall not become effective for a period of 30 days from the date of issue
or for such other period as the order may specify for the reasons given in the
order.

v) The
above order has to be served on the Auditors and copies of the order have to be
sent by NFRA to (a) the Central
Government, (b) ICAI, (c) C & AG (if the case relates to Auditors of
a Government Company), (d) SEBI (if the
case relates to Auditors of a listed Company), (e) RBI (if the case relates to
Auditors of a Bank or NBFC), (f) IRDA (if the case relates to Auditors of an
Insurance Company), (g) Concerned regulator in
a foreign country (if the case relates to a Non-Resident Auditor). Further this order is to be published on the
Website of NFRA.

(vi) If the
above order imposes a monetary penalty on the Auditors the same is to be
deposited within 30 days of the date of the order. If appeal is filed against
the above order by the Auditor, he has to deposit 10% of the amount of the
penalty with the Appellate Tribunal. If within 30 days of the above order the
Auditor does not pay the penalty nor file appeal against the order, NFRA,
without prejudice to any other action, will inform the Company / Body Corporate
of which he was the Auditor. Upon receipt of such intimation the Company / Body
Corporate shall remove such Auditor in default and appoint any other Auditor in
accordance with the provisions of the Act.

(vii) If the
order imposes a penalty on the Auditor or debars the Auditor from practice,
NFRA will send copies of such order to all Companies / Bodies Corporate in
which the Auditor is functioning as Auditor. On receipt of such information,
all such Companies / Bodies Corporate shall remove that Auditor from his
position as Auditor and appoint another Auditor in accordance with the
provisions of the Act.

(viii) In all
the above cases where the order of NFRA is stayed or where penalty is to be
paid, the time limit of 30 days is from the date of the order. Since the time
given u/s. 421 for filing appeal to the Appellate Tribunal is 45 days from the
date of service of the order, Rule 11 and 12 should have given time to the
Auditor of 45 days for payment of penalty from the date of service of the order
of NFRA. Further, as stated in (vi) and
(vii) above, Rule 12 provides for intimation to be given to the specified
companies or bodies corporate about the order of NFRA awarding punishment by
way penalty or debarring the Auditor
from practice so that he is removed from his office as auditor in that company
/ body corporate. In the interest of justice, such intimation should not be
given by NFRA if the appeal filed by the Auditor before judicial authorities is
pending. Again, it may so happen that the action is taken by NFRA for
professional or other misconduct by an Individual who is one of the partners of
a Firm of Chartered Accountants. In such a case if the penalty is levied in the
case of that Individual or he is debarred from practice, the Firm of Chartered
Accounts which is the Auditor of the company / body Corporate should not be removed
from its office as Auditor of that company / body corporate. The provision in
Rule 12 to remove the Auditor from his position as Auditor of a company / body
corporate in a case where only penalty is levied by NFRA is very harsh and
needs to be modified.

12. OTHER
MATTERS

(i) Rule
13 provides that if any company or any officer of the company or an Auditor or
any other person contravenes any of the provisions of these Rules, such
company, its officer, Auditor or other person in default shall be punishable
under the provisions of section 450 of the Act. This section provides for levy
of Fine on the defaulting company, officer, Auditor or other person of an
amount upto Rs.10,000 and in case of continuing default, of a further Fine
which may extend to Rs.1,000 per day when the default continues.

(ii) Rules
14 to 19 provide for various matters such as (a) Role of the Chairperson and
full-time members of NFRA, (b) Constitution of advisory committees, study
groups, task force, (c) Measures to be taken for the promotion of awareness and
significance of Accounting and Auditing Standards, Auditor’s Responsibilities,
Audit Quality and such other matters through education, training, seminars,
workshops, conferences, publicity etc., (d) Maintenance of confidentiality and security of information, (e) Avoidance of
conflict of interest and (f) Association with International Associations and
securing International Assistance.

13. TO SUM UP

(i) NFRA
is established as an External Authority for taking Disciplinary Action against
Auditors by section 132 of the Companies Act, 2013. There was some resistance
by the CA profession and, therefore, this section was not brought into force
when the Companies Act, 2013 came into force on 1.4.2014. Section 132(3) and
(11) was brought into force on 21.03.2018. Section 132(1) and (12) came into
force on 01.10.2018 and section 132(2), (4), (5), (10) (13) (14) and (15) came
into force on 24.10.2018. S/s. (6) to
(9) were deleted w.e.f. 9.2.2018.

(ii) The
justification for creating such External Authority (NFRA) is given by the
Committee of Experts, appointed by the Ministry of Corporate Affairs, in their
Report dated 25.10.2018. In this Report they have stated as under:

“In the aftermath of Enron, the U.S. enacted
the Sarbanes Oxley Act, 2002. The Supreme Court in its judgment dated February
23, 2018 has referred to this statute to examine the need of an oversight
mechanism for the audit profession. This law inter alia provided for the
setting up of the Public Company Accounting Oversight Board (PCAOB) as an
independent audit regulator to oversee the audits of public companies.
Similarly, U.K. also has a two-tier structure, where the Financial Reporting
Council (FRC) is the independent regulator for the audit profession.

In the Indian context, the Satyam incident has
been a wake-up call for policy-makers. Pursuant to the global trend of shift
from Self-Regulatory Organisation (SRO) model to an independent regulatory
model for the audit profession, the Companies Act, 2013 provided for the setting
up of the National Financial Report Authority (NFRA).

However, the continued opposition to the
establishment of NFRA has delayed the implementation of this critical reform.
Consequently, although the Companies Act, 2013 was enacted in August 2013, the
section establishing NFRA was notified
only on March 21, 2018 along with the NFRA Chairperson and Members’
Appointment Rules, 2018. Once NFRA becomes fully operational, it will be
adequately equipped to handle the contemporary challenges in relation to
auditors, audit firms and networks operating in India.”

(iii) Reading
the provisions of section 132 of the Act and the above NFRA Rules framed by the
Central Government, it is evident that the autonomy of ICAI to issue Accounting
and Auditing Standards and taking disciplinary action in cases of erring
members is now curtailed. The function of ICAI will be restricted to only
recommending changes in the existing Accounting and Auditing Standards or
Suggesting new Standards. Whether to issue such Standards or not or in which
form they should be issued will be decided by NFRA and the Central Government.
Even the function of monitoring, enforcing, compliance, overseeing quality of
service rendered by the CA profession,
suggesting measures for improvement in quality of professional service,
promoting awareness in relation to the compliance of Accounting and Auditing
Standards which was hitherto in the domain of ICAI, has been transferred to
NFRA. Disciplinary jurisdiction which
was hitherto within the domain of ICAI has now been curtailed because NFRA is
now entrusted with the task of taking disciplinary action against the Auditors
of all listed companies, large unlisted Public Companies, Banks, Insurance
Companies Electricity Companies and Bodies Corporate. These provisions will
reduce the importance of ICAI as it is now left with the task of giving
education to students of CA Courses, conducting examinations and awarding
membership and Certificate of Practice to those who have passed the
examinations. Even the measures to be
taken for the promotion of awareness and significance of Accounting and
Auditing Standards, Auditors Responsibilities, Audit Quality and such other matters through education,
training, Seminars, Workshops, Conferences and Publicity which were in the
exclusive domain of ICAI, its Regional
Councils and Branches will now come under the domain of NFRA under Rule 16.

(iv) From
the above analysis of the provisions of section
132 of the Act and NFRA Rules it is evident that Auditors of the specified companies and bodies corporate will have to
be more vigilant while rendering their
professional services to these entities. Some questions of interpretations will
arise during the course of implementation of these Rules. Therefore, it is necessary that a strong
representation is made for modification of these Rules in respect of the
following matters:

(a) In Rule
3 it should be clarified that the expression “Body Corporate” shall not include
LLP. In fact no public interest is involved in the case of an LLP and,
therefore, Auditor of LLP should not be brought within the supervision of NFRA.

b) In Rule
3(2) it is provided that every existing body corporate should file Form NFRA-1
giving details of its Auditors within 30 days of publication of these Rules.
This time limit is too short and it should be extended up to 90 days from the
date of publication of the Rules (i.e. up to 14.02.2019).

(c) In Rule
10 it is necessary to clarify that the Investigation by NFRA about the
misconduct of the Auditors of any specified entity shall be only in respect of
their conduct relating to statutory audit of the entity. In this Rule the
expression used is “Professional or Other Misconduct”, which is very wide. It
includes conduct of an Auditor in his personal life as well as his conduct while rendering professional
services other than the Audit Service.

(d) In Rule
10 it is stated that the NFRA will start investigation against the Auditor of
specified entities on a reference being made by the Central Government or on its
own on the basis of the available records. It is essential that this Rule
should provide that any shareholder of a specified company or its creditor or
any other person can approach NFRA if there is a complaint against the Auditor
of a specified entity.

(e) In
Rules 11 and 12, for the reasons stated in Para 11 (viii) above, the period of
30 days should be increased to 45 days. Further, information about the order
passed by NFRA should not be given to specified entities if the Auditor has
filed appeal against the order of NFRA and the judicial proceedings are
pending.

(f) As
stated in Para 11(viii) above, if the order passed by NFRA is against the
conduct of an Individual who is a Partner of the Audit Firm and no punishment
is awarded to the Firm, the disqualification as auditor of the specified entity
should not extend to the Firm.

(g) Rule 11
deals with Disciplinary Proceedings to be followed by NFRA or making inquiry
against the Auditor of a specified entity. There is no clarity as to who will
give hearing to such Auditor. It is necessary to clarify that such hearing will
be given by a Bench of two or three Members of NFRA. It is also necessary to clarify that any
Authorised person or Advocate will be allowed to assist such Auditor at the
time of hearing.

(v) Establishment of NFRA with such wide
powers is a new experiment in India. As these provisions will have retroactive
application, in as much as matters relating to earlier years may also be
referred to NFRA, let us hope that NFRA takes into consideration the
limitations within which the Auditors have to discharge their Audit function
and adopts a sympathetic view while dealing with the disciplinary cases against
such Auditors.

shailesh.kwebmaker

INSOLVENCY RESOLUTION PROFESSIONAL – JOURNEY AND ACCOUNTING AND TAX ASPECTS

1. INTRODUCTION

1.1. The introduction of the Insolvency and
Bankruptcy Code, 2016 (“Code”) ushered in a new era in the distressed asset landscape
and was undoubtedly a significant reform. Prior to introduction of the Code,
multiple regulations, at times not in congruence, were leading to disputes and
defaults thus invariably delaying the entire process. The laws addressing the
revival and financial reconstruction were provided for under different Acts.
These different laws were implemented in different judicial forums, namely (i)
Provincial Insolvency Act, 1920 (ii) Presidential Towns Insolvency Act, 1909
(iii) Winding up provisions of the Companies Act, 1956 (iv) Sick Industrial
Companies (Special Provisions) Act, 1985 (v) Recovery of Debts Due to Banks and
Financial Institutions Act, 1993 and the (vi) Securitisation &
Reconstruction of Financial Assets, Enforcement of Security Interests Act, 2002
which often led to delay in achieving the end objective of
resolution/reconstruction.

1.2. The defining aspect of the Code is the strict
adherence to timelines, an aspect which was relatively absent in previous
legislations. The Code explicitly provides for a 180-day period of resolution
of the corporate debtor with an extension of 90 days. The lapse of 180/270 days
leads to the compulsory liquidation of the corporate debtor. The Code has
ushered in a change from the existing situation of “debtor in possession” to
“creditor in control”. This overhaul has empowered the creditors to take
decisions for the benefit of the corporate debtor and the creditors with
relatively less opposition from the promoters or the erstwhile directors of the
corporate debtor whose powers have been suspended during the period of
moratorium, which lasts during the period of the Corporate Insolvency
Resolution Process.

1.3. The Code has given significant headroom to
indebted companies reeling under pressure to meet their obligations and has
facilitated the lenders to expedite recovery and resolution of stressed assets.
The Code stipulates a strict 180-day window (extendable to 270 days) for
running and completing the Corporate Insolvency Resolution Process (CIRP). The
time-bound nature of the process is a unique feature that provides confidence
to the creditors and the appointment of an Independent Resolution Professional
to manage the process makes the entire ecosystem of resolution more sacrosanct.

2. IMPORTANCE OF INFORMATION

2.1. As an Interim Resolution
Professional/Resolution Professional (IRP/RP), one assumes the management
responsibilities of the company since the board of directors of the corporate
debtor stands suspended u/s. 17 of the Code.

2.2. While the IRP/RP is entrusted with the duty of
managing the company as a going concern during the CIRP and steer it towards a
successful resolution, he is required to comply with the provisions of various
regulations which govern the company undergoing CIRP.

2.3. As a process, the IRP/RP assumes the control
of the company once the CIRP is initiated and takes charge of the books of
accounts, financial information and records, assets and operations of the
company.

2.4. Various provisions of the Code require the
IRP/RP to take on record the financial information relating to the company for
present and past time period. For example, section 18 of the Code requires that
the IRP on assuming charge of the company has to collect all information
relating to the assets, finances and operations of the corporate debtor for
determining the financial position of the corporate debtor, including
information relating to, inter alia, financial and operational payments
for the previous two years and list of assets and liabilities as on the initiation
date.

2.5. In order to ensure a time-bound and speedy
mechanism, due care with appropriate safeguards needs to be incorporated so as
to ensure that the scales are balanced with regard to the speed, accuracy and
authenticity of the information, accompanied by its legality. In view thereof,
the Code has envisaged four pillars of institutional infrastructure. These
pillars include a new competitive industry of Information Utilities (IUs),
which has probably no parallel in India or abroad. These have been envisioned
with a view that they would store authentic and verified financial information
such as debt and default, assets and liabilities of corporates, partnerships
and individuals. Further, they shall hold a collection of information about all
corporate and individual entities at all times. Thus, when the Insolvency
Resolution Process would commence under the Code, within less than a day,
undisputed and complete information would become available to all stakeholders
involved in the process and thus address the source of delay in dissemination
of information.[1]
However, till date the IU pillar of the IBC has not been optimally developed
and is still in its nascent stage

2.6. Further, Regulation 36 of the Code requires
the Resolution Professional to prepare and submit an information memorandum
including, inter alia, the latest financial statements, the audited
financial statements of the corporate debtor for the last two financial years
and provisional financial statements for the current financial year made up to
a date not earlier than 14 days from the date of the application to CIRP.

2.7. Apart from this, the RP while undertaking his
duties under the Code requires that all the information pertaining to the
accounts of the company is kept up-to-date in order to ensure adequate
disclosures with respect to compliances, CIRP costs etc., during the CIRP as
and when required by IBBI.

2.8. Regular updating of accounting statements and
financial records is also required since the Code provides rights to the
Committee of Creditors of the Company to ask the RP for providing them with any
particular financial information during the process. Apart from this, the
Resolution Professional while dealing with prospective investors is also often
required to provide latest financial information which is required by the
investors for submission of the resolution plan.

2.9. The IBBI vide Circular dated 3^rdJanuary
2018 has directed all Insolvency Professionals to exercise reasonable care and
diligence and take all necessary steps to ensure that corporate persons
undergoing Insolvency Resolution Process, fast-track Insolvency Resolution
Process, liquidation process or voluntary liquidation process under the
Insolvency and Bankruptcy Code, 2016 comply with provisions of the applicable
laws (Acts, Rules and Regulations, Circulars, Guidelines, Orders, Directions,
etc.) during such process. For example, a corporate person undergoing
Insolvency Resolution Process, if listed on a stock exchange, needs to comply
with every provision of the Securities and Exchange Board of India (Listing
Obligations and Disclosure Requirements) Regulations, 2015, unless the provision
is specifically exempted by the competent authority or becomes inapplicable by
operation of law for the corporate person. This implies that it is the RP’s
responsibility to ensure that all the financial statements falling during the
CIRP are duly prepared and published as required under applicable laws and
regulations.

2.10. This aspect regarding compliance of various
laws during the CIRP process was also touched upon by the Mumbai NCLT Bench in
the case of Roofit Industries, where it noted that companies are governed by
various enactments, they have to run in compliance with the laws of this
country and it can’t be said that companies running under CIRP are free to
flout all other laws.

2.11. It is also to be noted that requirements
pertaining to their payment of tax or filing of returns during the CIRP would
be primarily the responsibility of the IRP/RP.

3. THE CHALLENGE

3.1. More often than not it is observed that the
IRP/RP’s face challenges in terms of availability of financial information,
various legacy non-compliances spilling over into the CIRP period, ongoing tax
appeals/litigations, lack of required data to finalise the books of accounts
and so on.

3.2. There are instances where it is found that
inadequate accounting procedures are followed by a company under CIRP and the
company may not have contemporaneous records pertaining to previous periods
maintained with it. This usually stems from the fact that there is usually a
brain-drain of key executives of the company undergoing CIRP, a possible case
of mismanagement in the past resulting in loss of records, loss of data during
handover by employees who have left the company, possible IT
infrastructure-related issues like server crashes, as also the various existing
non-compliances resulting in levy of penalties and interest.

3.3. Thus, the IRP/RP usually finds himself with a
myriad of challenges in meeting the ongoing compliances during the CIRP.
Although the Code u/s. 19 stipulates that the personnel of the corporate debtor
have to extend help to the Interim Resolution Professional in terms of running
the process and provide the necessary information, the primary responsibility
of compliance remains with the IRP/RP.

3.4. It is possible that the accounts of the
company for the year preceding the year in which the CIRP was initiated have
not been finalised and published as on the date of CIRP and with the board of
directors of the company now suspended, the RP has a task cut for him to ensure
the compliance of finalising the accounts. In such circumstances which are
usually also caused by lack of necessary co-operation from the previous
management of the company and lack of necessary information, the RP finds
himself in a challenging situation where he has to completely re-do the
financial statements to ensure their correctness and completeness.

3.5. This, in addition to possible non-availability
of past records, absence of adequate man-power within the company undergoing
CIRP and a legacy of past non-compliances poses a real challenge for the IRP/RP
in meeting the ongoing compliance.

3.6. As the auditor of the company is also required
to comment regarding the going concern status of the company in its audit
report, it becomes very difficult to harmonise the idea of going concern for a
company under CIRP to express an opinion.

3.7. The Resolution Professional is also required
to carry out a liquidation and fair valuation of the assets of the company
under CIRP. This also gives rise to various difficulties in integrating the
finding of the valuer appointed by the Resolution Professional which carries
out the liquidation and fair valuation within certain assumptions and a
framework, with the requirement to restate the financial statements as per the
applicable accounting standards for the company undergoing CIRP.

3.8. The matters pertaining to taxation also need
to be dealt with caution as there could be several ongoing cases that may
result into demands and penalties during the CIRP period. This requires the
IRP/RP to understand all the ongoing litigations to ensure that necessary steps
are taken to address the same. It is not quite possible to imagine a situation
where the bank accounts of the company under CIRP are attached u/s. 226 of the
Income Tax Act, 1961 for non-compliances before the CIRP. This leaves the
IRP/RP with a challenging situation where on the one hand he is duty-bound to maintain the
going concern status of the company, while on the other, the company’s bank
accounts are frozen affecting its ability to conduct day-to-day operations
smoothly.

3.9. This brings to the fore an important aspect of
overriding of legislations. Although section 238 of the Code is an over-riding
provision, it has been tested on various occasions as to its applicability and
operability given the evolving jurisprudence of the Code.

3.10. The problem of inadequate past financial
data bears an impact during the ongoing tax assessments as well. The company
usually reeling under financial stress finds itself in a difficult position to
meet the requirement for paying the appeal deposit or representing before the
tax authorities. This, however, does not absolve the RP of any compliances and
requires that he has to ensure that appropriate actions, be it appeal or
otherwise, are taken.

3.11. Section 80 of the Income Tax Act, 1961
provides that in the event a taxpayer fails to file return in accordance with
the provisions of section 139(3) of the Act, the carry-forward losses computed
in accordance with the sections specified therein would lapse. The RP often faces
some practical predicaments relating to filing of timely income tax returns
with inadequate available data, requirement of filing with respect to digital
signatures, changing of signatories for filing returns without support from the
previous signatories, etc. The direct implication of such non-compliance would
be to lose the benefit of carrying forward losses of the year.

3.12. Another set of challenges which may have an
implication on compliances is the mandatory applicability of Indian Accounting
Standards applicable to certain class of companies. Ind AS 8 deals with
Accounting Policies, Changes in Accounting Estimates and Errors. The said
standard mandates that any material prior period error is to be set right by
restating the financial statements of that year. A tax complication may arise
as to whether such error impacting the profit/loss of earlier years would be
allowed as an expenditure in the year of resolution or should be claimed for
the year when such error occured. Such claim would be possible only if the
timeline for revised return permits the same. In a nutshell, the claim in
respect of such error may not be available if one were to take the provision of
law and jurisprudence on the subject.

3.13. One other aspect of taxation is the claims
admission process, wherein the IRP/RP is required to deal with various claims
by the tax authorities including claims arising out of ongoing cases or cases
under appeal. The law is still evolving on the subject of determining the
amount of claim in case of liabilities which are not crystallised on the date
of submission of claim or are contingent on the happening/non-happening of
certain events in future.

3.14. Like the IBC, another reform that is still
in its sapling stages is GST. It is possible that the company under CIRP often
does not have adequate resources and manpower to ensure various GST compliances
including registration, transition from previous indirect tax regime to GST
regime or necessary infrastructure to implement GST.

3.15. A few other aspects that remain to be
tested are the possibility of waiver of existing tax demand on approval of a
Resolution Plan, tax liability of the period up to the date of approval of
Resolution Plan but crystallised afterwards, and waiver of tax liability arising
on implementation of the Resolution Plan given that a Resolution Plan may often
involve certain write-backs resulting in notional income for the company. The
order in the matter of J.R. Agro Industries Pvt. Limited vs. Swadisht Oils
Pvt. Limited, (Company Application No. 59 of 2018 in CP No. (IB) 13/ALD/2017)
may be referred to, wherein a company application was filed before the AA
(Allahabad Bench) by the RP u/s. 30(6) of the IBC for approval of the
resolution plan as approved by the Committee of Creditors. The AA observed that
“we cannot allow exemption of any liability arising in respect of income tax”.
The NCLT further noted that any statutory liability of the transferor company
shall be the liability of the transferee company and since the income tax
department was not a party to the proceedings, the resolution plan cannot be
approved without giving the department a hearing at this stage. Accordingly,
the resolution professional was asked to modify its resolution plan with a
direction that the same may be re-submitted after getting the plan approved
from the CoC. In this regard, numerous orders of the AA state that a waiver of
statutory dues, if any, can only be done by the appropriate authority by moving
an appropriate application before the statutory authorities.

3.16. IP is expected to
maintain robust documentation during the period he had acted in his role. This
would be more relevant because if there are certain challenges post his
completion of role, he would be expected to demonstrate that he acted in good
faith and with due diligence.

3.17. With the few relaxations and certain
decisions of the Hon’ble Supreme Court, it appears that the battle is only half
won with the complexities outpacing the challenges faced. The IBC has been a
landmark legislation and it will continue to evolve.

3.18. While some of the areas
listed above may need more thought and consideration, the issue that IBC deals
with is such that there will always be other unforeseen challenges.

4. ACCOUNTING CONSIDERATIONS

4.1. To begin with, when a company is under the
Resolution Process, if there is a reporting date and the company has to issue
its financial statements, the company will have to consider the following
issues:

4.1.1. Going Concern Assessment: Indian Accounting
Standard (“Ind AS”) 1 Presentation of Financial Statements, requires the
management to make an assessment of going concern while preparing the financial
statements. The company being admitted under the Code is an indicator of
accumulated losses and inability to pay its operational and/or its financial
creditors. Hence, the management of the company will have to carry out a going
concern assessment taking into consideration the stage of the Resolution
Process and its future prospects and decide on the accounting treatment
accordingly.

In cases where it
is likely that the company will be sent under liquidation or it has already
been referred for liquidation before the financial statements have been
approved for issue, the financial statements cannot be prepared using the going
concern assumption. Ind AS 1 does not prescribe the accounting treatment to be
followed in case financial statements are to be prepared on a basis other than
going concern basis. The management will have to decide on appropriate accounting
policies for preparing the accounts depending on the facts and circumstances
and provide detailed disclosures for the basis of preparation of the financial
statements and judgements made in selecting the accounting policies. There will
be a similar requirement under Accounting Standard (“AS”) 1 Disclosure of
Accounting Policies.

4.1.2. Impairment of Assets: AS 28 / Ind AS 36 Impairment
of Assets requires the management to test its tangible and intangible
assets for impairment in case any indicators are identified. When the company
is admitted under a Resolution Process under the Code, it is an indicator for
the management to calculate the recoverable amount for its tangible and
intangible assets and if it is below the carrying amount, an impairment loss will
have to be recognised in the profit and loss.

4.1.3. Additional Disclosures:
There may be several claims made by the creditors on the company which may or
may not match with the liabilities recognised in the financial statements.
Depending on the stage of the Resolution Process, the company will have to
provide detailed disclosures about such claims and also give the expected
financial effect of the same on the financial statement.

4.2. Once the Resolution Process has been approved,
the company under the Code will have to evaluate the following accounting
considerations:

4.2.1. Debt restructuring: There are several ways
in which the existing debt of the company may be restructured with the lenders
as part of the resolution. The accounting will be driven by the terms and
conditions of the agreed restructuring. In case of any full or partial waiver
of principal or interest amount by the lender, the gain on the reduction of the
liability for the company will be recognised in profit and loss as per Ind AS
109 Financial Instruments. There are some exceptions to this rule
provided under Appendix D to Ind AS 109 which the company may have to evaluate.

In case of novation
of the loan to the acquirer or a special purpose vehicle (SPV) formed for the
Resolution Process, the company will have to evaluate whether the same will
qualify for extinguishment of liability from original lender under Ind AS 109.

Ind AS 109 requires
that a substantial modification of the terms of an existing financial
liability, or a part of it, should be accounted for as an extinguishment of the
original financial liability and the recognition of a new financial liability.
A change in lender could significantly alter the future economic risk exposure
of the liability and could be regarded as representing a substantial change
which would lead to derecognition of the original liability.

In that case, the
company will derecognise the existing loan and recognise a new obligation to
the acquirer or the SPV at fair value of the loan with the revised term and the
difference between the carrying value of the extinguished liability and the
fair value of the new loan will have to be recognised in profit and loss.

This credit taken
to the profit and loss may have significant implications on the computation of
MAT.

4.2.2. Other aspects in the Resolution Process:
Depending on the other steps agreed as part of the resolution process, the
company may have to account for any additional equity / debt issued to the
acquirer. If a part of the business is being demerged, the company may have to
evaluate implications under Ind AS 105 non-current assets held for sale and
discontinued operations.

4.3. Depending on the structure finalised under the
Resolution Process, the acquirer will have to evaluate the following possible
accounting implications:

4.3.1. The acquirer will have to apply Ind AS 103 Business
Combinations and give effect to acquisition accounting at fair values of
the net assets acquired depending on the structure agreed – merger, demerger or
reverse merger. For the acquisition accounting, the company will also have to
undertake purchase price allocation of the net assets. This may entail several
accounting complexities as under, depending on the structure of the
transaction:

a. Are there any contingent liabilities of the
company which need to be fair valued?

b. While comparing the net assets acquired and
consideration transferred, normally there should not be a goodwill considering
the circumstances in which the transaction has taken place.

c. If there is a merger of the entities, the
acquirer to evaluate whether the values to be merged will be those appearing in
the standalone financial statements or consolidated financial statements of the
acquiree. There is guidance provided pertaining to this in the Ind AS Transition
Facilitation Group (ITFG) which the company will have to evaluate.

d. Due to fair valuation of
assets and liabilities, there will be changes in the book base and the company
will have to evaluate the consequent impacts on deferred tax balances.

In case the company
is following Indian GAAP, the acquirer will have to evaluate the accounting
treatment as per AS 14 Accounting for Amalgamations, whether pooling of
interest or purchase method will be used to account for the transaction.

4.3.2 Another important consideration is the
year in which this acquisition accounting needs to be done. Based on the
process under IBC and application of Ind AS 103, the same will be done in the
year in which the final approvals for the Resolution Plan have been received
from the NCLT. In case such approval is received after the reporting date, but
before the financial statements are approved for issue, appropriate disclosures
as per Ind AS 10 Events after the Reporting Date will have to be given.

Even after the Resolution Plan has been implemented, the acquirer
and the company will have to be mindful of some of the challenges as mentioned
hereunder:

a. In case the company becomes a subsidiary of
the acquirer, it will have to include the company’s financial statements in its
consolidated financial statements.

b. The acquirer will have to harmonise the
accounting policies, judgements and estimates of the company with its own
policies.

c. The acquirer will also have to evaluate the
Internal Controls over Financial Reporting (ICFR) for the company.

d. Finance function readiness will have to be
evaluated for quarterly and annual reporting, as applicable and compliance with
requirements of Accounting Standards, SEBI requirements and Companies Act.

e. A detailed investor communication will have
to be issued to manage the investor expectations.

Thus, it becomes
critical for both the acquirer and the company under the IBC to be mindful of
the various accounting implications while deciding the overall structure to
arrive at an effective resolution to revive the struggling company.

5. TAX CONSIDERATIONS

5.1. Prior to introduction of IBC,
the Sick Industrial Companies Act (SICA) was enacted to identify sick and
potentially sick companies owning industrial undertakings and for
implementation of suitable measures to revive such companies. Section 32 of the
SICA provided that the scheme made under the SICA would have overriding effect
over other laws in force and basis this provision, it was also possible for a
sick company to obtain customised tax concessions with the consent of the
income tax department through the BIFR scheme approved under SICA. However,
there is no similar provision in the Code. This led to recommendations from the
industry bodies and professional chambers for providing tax concessions under
the Income Tax Act, 1961 (ITA), for companies undergoing Resolution Process.

In deference to the
recommendations and to facilitate the effective implementation of IBC,
amendments were made in the ITA vide Finance Act, 2018 (FA 2018) to facilitate
the rehabilitation of companies undergoing Insolvency Resolution Process.

The following is a
snapshot of the amendments made by FA 2018:

1. Amendment of MAT provisions to provide for
deduction of aggregate of brought-forward book losses and unabsorbed
depreciation.

Provisions of section 115JB of ITA as they existed prior to amendment
by FA 2018 provided for deduction of an amount which is lower than
brought-forward loss and unabsorbed depreciation as per books in computing the
book profits for MAT purposes. FA 2018 inserted Clause (iih) in Explanation 1
to section 115JB(2) to provide a deduction of aggregate of
brought-forward losses and unabsorbed depreciation in case of a company against
whom an application for insolvency proceedings has been admitted under IBC.

2. Carry forward of losses of IBC companies
not to be impacted in case of change in shareholding pursuant to implementation
of Resolution Plan.

Section 79 of the ITA provides that carry forward and set-off of losses
in a closely-held company shall be allowed only if there is a continuity in the
beneficial owner of the shares carrying not less than 51% of the voting power,
on the last day of the year or years in which the loss was incurred.
Implementation of Resolution Plan under IBC for the revival of the insolvent
companies may involve restructuring in the form of mergers, acquisitions,
buy-outs, etc., thus resulting in a change in shareholding of the insolvent
company. Noting that application of section 79 in such cases may act as a
hurdle for the revival of the insolvent companies, FA 2018 amended section 79
to provide that the rigours of section 79 will not apply to change in
shareholding resulting from the implementation of the Resolution Plan under IBC[2].

3. Resolution professional authorised to
verify the return of income during the Resolution Process.

The return of income filed under the ITA is required to be verified
by the managing director/director of the company. Once an application for
insolvency resolution has been accepted under IBC, the powers of the board of
directors are suspended and the management of the affairs of the company is
handed over to the Resolution Professional. Section 140 of ITA was thus amended
to authorise the Resolution Professional to verify the return of income filed
by the company, in respect of whom an application for corporate insolvency
process has been admitted under IBC.

4. Section 178 – In addition, section 178 of
ITA dealing with responsibilities of a liquidator was amended by IBC (Section
247 of IBC read with the third schedule) to provide that the provisions of
section 178 will apply subject to the other provisions of IBC.

5.2. While the above amendments are welcome, the
following are certain aspects that need consideration/ suitable amendments to
truly enable the revival of insolvent companies.

1. The insertion of clause (iih) is intended
to provide relief to companies undergoing Insolvency Resolution Process by
allowing them full set-off of loss and depreciation instead of the lower of the
two. However, the interpretation of clause (iih) in conjunction with existing
clause (iii) raises number of interpretational issues:

u Which is the first year
in the lifecycle of corporate insolvency process in which clause (iih) will
become applicable?

u Once clause (iih) becomes
applicable, which is the year in which it shall cease to apply? This issue
becomes more crucial in cases where the Resolution Process extends beyond the
270 – day period prescribed under IBC due to litigations.

u If the amount of losses
and unabsorbed depreciation quantified under clause (iih) remains unutilised,
how would such losses and depreciation be carried forward and set off u/s.
115JB? Can both clause (iih) and clause (iii) be applied for a single year?

u A related issue that
arises is whether in case of the merger of an IBC company with another company
pursuant to a Resolution Plan, the amalgamated company can claim benefit of
clause (iih)?

2. MAT relief in respect of sick companies
covered under SICA was governed by clause (vii) of of Explanation 1 to section
115JB. Clause (vii) provides that any profits of a sick industrial company for
the period beginning from the assessment year in which the company qualifies as
a sick industrial company and ending with the assessment year in which the net
worth of the company becomes equal to or exceeds the accumulated losses, needs
to be reduced from ‘book profit’. In other words, profits of a company for the
period during which it qualifies as a sick industrial company under the SICA is
not to be considered for MAT purposes. Clause (vii) is now redundant with the
repeal of SICA.

It is very common for creditors of companies undergoing IBC to take
a haircut (waiver). Such waiver when credited to the profit and loss account is
likely to have a huge MAT impact for the IBC companies. This acts as a hurdle
for the revival of IBC companies. Clause (iih) providing relief to IBC
companies is not as wide in scope as clause (vii) and may not be able to
relieve the MAT impact of such waiver, especially in case of IBC who have
nominal or nil brought-forward losses. Clause (iih) may thus be of no help in
revival of such IBC companies.

3. Whether the benefit of
exclusion from section 79 applies only to change in shareholding of the IBC
company or whether it can apply even to the change in shareholding of
subsidiaries of the IBC company?

4. Whether the Resolution Professional who
verifies the return of income be visited with the consequences of a principal
officer under the Income Tax Act, such as penal consequences for failure in
withholding and payment of tax deducted at source (TDS), filing of TDS return,
etc.?

6. CONCLUSION

While it is
heartening to see that the government is keen to facilitate the implementation
of IBC, there are still many aspects as discussed above, which may need policy
consideration for the IBC to be effective in its true spirit.

Tax is and
continues to be a major factor that will impact and influence various
stakeholders in the IBC process. Despite IBC being hailed as an important
legislative reform to resolve the burgeoning NPA problem in the Indian economy,
if the tax laws are not amended appropriately, it may hinder the growth of the
Indian economy.

[1] BLRC Report

[2] This is subject to
affording a reasonable opportunity of being heard to the jurisdictional
principal commissioner or commissioner.

shailesh.kwebmaker

Section 37 (1) – Business expenditure – Rule of consistency – Expenditure claimed and allowed against professional income in earlier years and subsequent years – Allocation of expenditure between capital gains and professional business income in year in question – Not proper

51. Principal CIT vs. Quest Investment Advisors
Pvt. Ltd.; 409 ITR 545 (Bom) Date of order: 28^th
June, 2018 A. Y. 2008-10

Section
37 (1) – Business expenditure – Rule of consistency – Expenditure claimed and
allowed against professional income in earlier years and subsequent years –
Allocation of expenditure between capital gains and professional business
income in year in question – Not proper

For
the A. Y. 2008-09, the assesse filed return of income declaring professional
income of Rs. 1.31 crore and short term capital gains of Rs. 6 crore. As was
the practice for the earlier years and accepted by the Department, all the
expenses were set off against the professional business income. However, for
the relevant year, the Assessing Officer allocated the expenditure between
earnings of capital gains and professional income and disallowed an expenditure
of Rs. 88.05 lakh claimed by the assesse against professional income. The
Tribunal found that the authorities had consistently over the years for 10
years prior to the A. Ys. 2007-08 and 2008-09 and for the four subsequent
years, accepted the principle that all the expenses which had been incurred
were attributable entirely to earning professional income without allocation of
any amount to capital gains, and applying the principle of consistency the
Tribunal allowed the appeal filed by the assessee.

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

“i) For the earlier 10 years and 4
subsequent years the entire expenditure had been allowed against the business
income and no expenditure was allocated to capital gains. Once the principle
was accepted and consistently applied and followed, the Department was bound by
it. The basis for the change in practice should have been mentioned by the
Department, if it had wanted to change the practice without any change in law
or facts therein, either in its order or pointed out when the Tribunal passed
the order.

ii) Therefore, the Tribunal’s allowing the
assessee’s appeal on the principle of consistency could not be faulted as it
was in accord with the Supreme Court decision.”

shailesh.kwebmaker

Articles 5, 7 of India-Italy DTAA; Section 9 of IT Act – Where liaison office was involved in strategic business decision making in India including price negotiation and agreement finalisation, liaison office would constitute fixed place PE. Employees of a group entity in India carrying on core sale related activities, results in the emergence of a Dependent Agency PE in India

[2019] 101 taxmann.com 402 (Delhi – Trib.) 25.
ITA No: 6892 (Delhi) of 2017 GE Nuovo Pignone SPA vs. DCIT Date of Order: 1^st January, 2019 A.Y.: 2009-10

Articles 5, 7 of India-Italy DTAA; Section
9 of IT Act – Where liaison office was involved in strategic business decision
making in India including price negotiation and agreement finalisation, liaison
office would constitute fixed place PE. Employees of a group entity in India
carrying on core sale related activities, results in the emergence of a
Dependent Agency PE in India

FACTS

The Taxpayer, an
Italian company and part of an MNE (GE) group was engaged in the business of
supplying key equipment for oil and gas industry across the globe. One of the entities of the Taxpayer’s MNE
group (US Co) had set up a liaison office (LO) in India to act as a
communication channel with the customers in India. Further, the MNE group had
an Indian entity (ICo) which provided marketing support services to the group
companies including the Taxpayer in India. During
the relevant year, Taxpayer earned income from onshore services and as well as
offshore supply of spare parts and equipment to customers in India. However,
only income from onshore services was offered to tax as Fees for technical
services(FTS) in its return of income. Income from offshore supplies was not
offered to tax on the grounds that there was no business connection or PE in
India.

A survey was conducted at the premises of the LO of the group entity.
During the scrutiny proceedings, the AO relied on various documents and
correspondences found during the survey pertaining to the Taxpayer as well as
other entities of the MNE group. AO also made an enquiry about the sales made
by various entities of the Taxpayer group in India, employees/expatriates of
the group working from the LO premises and their roles and responsibilities.

From the material
collected during such survey and post survey enquiry, AO noted that various
expatriates of the group carried on overall business of the group, including
that of Taxpayer in India, Further the documents revealed that the employees of
ICo and expatriates in India had active involvement in conclusion of sale
contracts on behalf of the group entities of the MNE group including Taxpayer
in India

Based on this
evidence, AO held that Taxpayer had business connection in India with a fixed
place PE at the LO premises and Agency PE in the form of ICo. Aggrieved by the
draft assessment order, Taxpayer filed objections before the DRP.

The DRP upheld AO’s
order. Aggrieved, the Taxpayer appealed before the Tribunal.

HELD

Article 5 of India-Italy
DTAA describes a PE as a place which is used by a foreign enterprise for
carrying on business in India with some kind of regularity or permanence.

Basis the following facts,
Tribunal concluded that Taxpayer had a fixed place PE in India at LO’s
premises.

Taxpayer deputed an expatriate employee,
designated as ‘Oil and Gas, India Country Leader’ to India, who worked at the
LO premises along with active assistance of ICo’s employees in India.

The expatriate along with the support of
employees of ICo undertook activities like finalisation of contracts, strategic
decision making and negotiating sale prices with Indian customers from the
premises of LO. This fact was supported by the Tribunal decision² in
case of another member-company of the group. Thus, the role of the LO was not
limited merely to preparatory or auxiliary activities.Thus LO resulted in a
Fixed place PE in India.

Further, the Taxpayer did not make any off
the shelf sales to its customers in India. The sales were made on the basis of
prior contracts finalized in India. These contracts were negotiated and
finalized by the expatriates along with ICo’s employees in India.

Thus, the expatriates/ ICo created an agency
PE in terms of Article 5(4) of India-Italy DTAA for the Taxpayer in India.

________________________________

2. GE Energy Parts Inc vs. Addl DIT [2017] 78
taxmann.com 2 (Delhi-Trib)

shailesh.kwebmaker

Article 12 and Protocol to India-Belgium DTAA; Article 12, India-Portugal DTAA – due to MFN Clause in Protocol to India-Belgium DTAA, scope of FTS was to be restricted to that under India-Portugal DTAA and ‘make available’ condition was to be read into – as IT support services provided by a Belgian company did not ‘make available’ knowledge, experience, etc., the receipts were not in the nature of FTS.

24.
[2019] 101 taxmann.com 94 [Delhi – Trib] ITA No: 123 (Delhi) of 2015 Soregam SA vs. DDIT Date of Order: 30^th November, 2018 A.Ys.: 2011-12

Article 12 and
Protocol to India-Belgium DTAA; Article 12, India-Portugal DTAA – due to MFN
Clause in Protocol to India-Belgium DTAA, scope of FTS was to be restricted to
that under India-Portugal DTAA and ‘make available’ condition was to be read
into – as IT support services provided by a Belgian company did not ‘make
available’ knowledge, experience, etc., the receipts were not in the nature of
FTS.

FACTS

The Taxpayer a tax
resident of Belgium was engaged in the business of providing IT support
services to its group entities. The Taxpayer had provided such services to its
group entity in India and received consideration in respect thereof. The
Taxpayer furnished its return of income declaring NIL income and claimed refund
of tax withheld by the Indian group company.

The AO held that the entire income received by the Taxpayer for
providing IT support services was taxable in India as Fees for Technical
Services (FTS) under the DTAA.

Aggrieved, Taxpayer appealed before the DRP. The DRP held that having
regard to the Most Favoured Nation (MFN) clause in the protocol to
India-Belgium DTAA, the definition of FTS in Article 12 of India-Portugal DTAA
(which was restricted in scope) would apply. The DRP however, held that the
Taxpayer satisfied the ‘make available condition’ and hence, the receipt was
taxable as FTS in India. Aggrieved, the Taxpayer appealed before the Tribunal.

HELD

Article 12(3)(b) of
India-Belgium DTAA defines FTS. It includes payment for services of a
managerial, technical or consultancy nature. Protocol to India-Belgium DTAA
provides that if India enters into a treaty with an OECD country after 1^st
January, 1990 under which, it agrees to a lower rate of tax, or agrees to
restrict the scope of FTS, then, the same rate or scope shall also be
applicable under India-Belgium DTAA.

Subsequent to 01 January
1990, India entered into DTAA with Portugal, which is a member-country of OECD.
Under India-Portugal DTAA, scope of FTS is restricted by incorporating ‘make
available’ condition. Hence, in terms of Protocol to India-Belgium DTAA, this
restricted scope of FTS was to be read into definition of FTS under Article 12
of India-Belgium DTAA

The Taxpayer had provided
IT support services from outside India. No personnel of the Taxpayer had
visited India in connection with these services. The Taxpayer had not trained
any employee of Indian group company while providing these services. In the
order, neither the AO nor the DRP had specified how knowledge, experience, etc.
was made available nor did they mention how employees of India group company
could have utilised the experience gained by them.

Accordingly, IT support
services provided by the Taxpayer did not fall within the ambit of FTS under
Article 12 of India-Belgium DTAA, read with Article 12 of India-Portugal DTAA.

shailesh.kwebmaker

Article 23(3), India-Thailand DTAA – credit of tax that would have been payable on dividend paid by Thai subsidiary in Thailand, but for the exemption granted, could be claimed as credit against tax payable in India on the dividend.

23.
ITA Nos: 4347 to 4350/Del/2016 Polyplex Corporation Ltd vs. ACIT A.Ys.: 2010-11 to 2013-14, Date of Order: 24^th January, 2019

Article 23(3), India-Thailand DTAA – credit
of tax that would have been payable on dividend paid by Thai subsidiary in
Thailand, but for the exemption granted, could be claimed as credit against tax
payable in India on the dividend.

FACTS

The Taxpayer was an
Indian company, which had a wholly owned subsidiary in Thailand (“Thai Co”).
During the relevant years, Thai Co declared and paid dividend to the Taxpayer.
In terms of the Investment Promotion Act in Thailand, such dividend was not
laible to tax in Thailand..Taxpayer claimed tax sparing credit¹
against the taxes payable in India on the dividend income.

AO noted that the
dividend was exempt in Thailand in terms of Investment Promotion Act. As
provisions of a tax treaty provide tax benefit in respect of income which was
doubly taxed and not for tax which was not paid at all, it was concluded by AO
that the tax credit claimed could not be granted.

____________________________________

1. Article 23(3) provided that for the
purposes of foreign tax credit in India, “the term “Thai tax payable” shall be deemed
to include any amount which would have been payable as Thai tax for any year
but for an exemption or reduction of tax granted for that year”.

The CIT(A) upheld
the order of the AO.

HELD

The Tribunal observed that
tax sparing credit under Article 23(3) of India-Thailand DTAA could be availed
by the Taxpayer if dividend received by the Taxpayer was, in the first place,
taxable in the hands of the Taxpayer in Thailand, but was not taxed owing to an
exemption under the provisions of Investment Promotion Act or of the Revenue
Code of Thailand.

From perusal of Revenue
Code and Investment Promotion Act, it was noted that while the dividend would
have been otherwise taxable at 10%, it qualified for exemption under Investment
Promotion Act. Hence, tax sparing credit was allowable. However, any such
credit is further subject to limitation of ordinary credit, i.e. it cannot
exceed the amount of tax payable in India.

In the facts of the
case, the tax sparing credit of 10%
claimed by the Taxpayer was less than the tax payable in India on dividend at
30%. Acoordingly, whereas, the Taxpayer
was eligible for claiming such credit..

shailesh.kwebmaker

GOVERNMENT SUPPLIES UNDER GST

INTRODUCTION & POSITION UNDER PRE – GST REGIME

1. In
India, administration is divided into three tiers, namely Central Government,
State Government & Municipality/Local Authority. Each tier is entrusted
with specific powers & responsibility to carry out the various activities
and functions. In the said course, the said authority receives various
goods/services and at times, might even supply goods/services. Article 285
& 289 of the Constitution stipulates that the property of Union/ States is
exempted from taxes levied by the States/Union respectively. However, the same
does not apply to Indirect Taxes. The Supreme Court has held¹ that
indirect taxes levied by the Union/State shall be borne by the recipient
State/Union since the same would not be governed by immunity provided by the
Constitution vide Articles 285 & 289 respectively.

2. Therefore,
considering the above constitutional background, not only the Union/States were
liable to bear the indirect taxes levied, viz., VAT, Central Excise &
Service Tax, there was also a liability fastened to discharge service tax on
sale of goods/services provided by the Union/State. For instance, in the
context of sale of goods, under the VAT regime, certain class of person were
deemed to be a dealer with specific intention to tax specific sales, such as
sale of essential commodities at subsidised rates, auctions undertaken by the
Authorities, scrap, etc., carried out by such Government/Local Authority. This
included Customs Department, Department of Union Government/ any State
Government, Local Authorities, Port Trust, Public Charitable Trusts, Railways,
etc.

3. However,
in the context of services tax, the levy had to be analysed for two different
regimes, one being pre-negative list regime and second being the negative list
regime. Under the positive list regime, only selective services were being
taxed. Further, vide Circular No. 89/7/2006 – ST dated 18.12.2006, CBEC had
clarified that performance of statutory function could not be considered as
rendition of service. However, it was further clarified that “if such authority
performs a service which is not in the nature of statutory activity and the
same is undertaken for a consideration not in the nature of statutory fee/levy,
service tax would be leviable in such cases if the activity undertaken was
classifiable within the ambit of a taxable service”. In other words, the said
Circular prescribed tests to determine the applicability of service tax
vis-à-vis the nature of activity involved.

___________________________________________

1 Sea
Customs Act [AIR 1963 (SC)], Karya Palak Engineer, CPWD vs.
Rajasthan Taxation Board, Ajmer [2004 (171) ELT 3 (SC)]

4. However,
under the negative list regime, the definition of person specifically included
“Government” and provided that all services provided by the Government would be
covered under the negative list, except for following:

(a) Services
by Department of Posts by way of speed post, express parcel post, life
insurance and agency services provided to a person other than Government

(b) Services
in relation to an aircraft or a vessel, inside or outside the precincts of a
port or an airport

(d) Any²
services other than services covered above provided to business entities.

5. While
(a) to (c) above were covered under forward charge, i.e., the Government/Local
Authority providing the service would be required to collect and discharge
service tax, service under (d) were covered under reverse charge, i.e., the
business entity receiving the service would be required to discharge tax.
However, upto 31.03.2016, clause (d) covered only support services which was
defined to mean infrastructural, operational, administrative, logistic,
marketing or any other support of any kind comprising functions that entities
carry out in ordinary course of operations themselves but may obtain as
services by outsourcing from others for any reason whatsoever and shall include
advertisement and promotion, construction or works contract, renting of
immovable property, security, testing and analysis.

_____________________________________

2 Substituted
for “Support services” w.e.f 01.04.2016

6. Further,
the Education Guide had also clarified that services which are provided by
government in terms of their sovereign right to business entities, and which
are not substitutable in any manner by any private entity, are not support
services e.g. grant of mining or licensing rights or audit of government
entities established by a special law, which are required to be audited by CAG
u/s. 18 of the Comptroller and Auditor-General’s (Duties, Powers and Conditions
of Service) Act, 1971 (such services are performed by CAG under the statue and
cannot be performed by the business entity themselves and thus do not
constitute support services.)

7. The
above position was amended w.e.f 01.04.2016 to provide that any service
provided by Government to business entities would be excluded from the scope of
negative list. Further, CBEC vide Circular 192/02/2016 dated 13.04.2016
clarified that whether or not any activity is carried out as statutory function,
the same would be liable to service tax (subject to specific exemptions) so
long as payment is being made for getting a service in return. However, it was
clarified that fines and penalty chargeable by Authority were not leviable to
service tax.

LEGAL POSITION UNDER THE GST REGIME

8. The
charging section for levy of GST provides for levy of tax on all supplies of
goods, except alcoholic liquor for human consumption on the value determined
u/s. 15 and at such rates as may be notified and collected in such manner as
may be prescribed and paid by the taxable person

9. The
term “taxable person” has been defined u/s 2 (107) to mean a person
who is registered or liable to be registered u/s. 22 or 24. Section 2
(84) defines the term “person” to include, among others a local authority;
Central Government or a State Government. Section 22 provides that every
supplier shall be liable to be registered in the state from where he makes
taxable supplies. Therefore, the issue that would need consideration is whether
the Government (Central/State) or Local Authority can be said to be engaged in
making taxable supplies, either of goods or services? To answer the said
question, one needs to determine whether the activities undertaken by the
Government or Local Authority can be classifiable as supply or not. For the
same, reference to section 7 becomes necessary. Section 7 (1) which defines the
scope of supply to include all forms of supply of goods or services or both
such as sale, transfer, barter, exchange, license, rental, lease or disposal
made or agreed to be made for a consideration by a person in the course or
furtherance of business.

10. Section
2 (17), which defines the term business provides that business shall include any
activity or transaction undertaken by the Central Government, a State
Government or any local authority in which they are engaged as public
authorities. In other words, the activities or transactions undertaken by
the Government or Local Authority are deemed to be business and therefore as
long as there is supply of goods/service by such Government/ Local Authority,
they would be classifiable as supply.

TAXABILITY UNDER GST REGIME

11. Therefore,
the question that would need consideration is whether all activities/functions
undertaken by Government/Local Authority has to be treated as supply of goods
or services or not? This question may not be relevant in the context of goods;
however, it would be very relevant in the context of services. This is because
though service has been defined in a very wide manner to mean anything other
than goods, section 7 (1), which defines supply, pre-necessitates the existence
of a contract for treating an activity/transaction as supply. The same is
evident from the fact that section 7 (1) uses the phrase made or agreed to
be made. This would necessarily require the presence of quid pro quo
for any activity undertaken by the Government/ Local Authority, i.e., the
person making the payment should receive something in return. Some instances
where quid pro quo exists in the activities undertaken by Government/
Local Authority include:

companies
engaged in telecommunication sector have to pay license fee to the Department
of Telecommunication for spectrum allocation

builders
are required to pay various charges to the Local Authority in the form of
permission charges, lease premium, staircase allowance, etc., for undertaking
construction activities. Such transactions may amount to service

companies
making payment to ROC in the form of filing fees, fees for increasing
authorised share capital, etc., thus enabling them to comply with the
provisions of the law

12. However,
there can be instances where the element of quid pro quo may not exist.
For instance, in Gupta Modern Breweries vs. State of Jammu & Kashmir
[(2007) 6 SCC 317], the Court was required to decide whether the fees
recovered for audit conducted by Excise Authorities on the records of assessee
were in the nature of a fee or tax? In the said case, the Court held that there
was no quid pro quo between the taxpayer and the Government/Authority
and therefore the amounts were in the nature of tax and not fee. Therefore, if
such amounts recovered by the Government are treated as tax and not fees, the
same would not amount to a service to the licensee by the Government. That
being the case, such payments to the Government may not attract GST.

13. With
regard to taxes levied by Government/Local Authorities under other statutes,
such as property tax, stamp duty, etc., they cannot be treated as being consideration
for any service provided. This view was also expressed by the CBEC in its’
Circular 192/02/2016. One important fact to support this view is perhaps that
tax is a compulsory exaction of funds, not involving any quid pro quo
and no specific performance can be enforced upon payment of the same from the
Government or Local Authority.

14. Similarly,
penalties or fines levied for violation of any statute, bye-laws, rules or
regulations will also not amount to a service. This would be for the reason that
the penalty or fine would not be paid by the recipient for receiving any
specific service, but are infact in the nature of compulsory payments imposed
on him. For instance, car towing charges collected by the State Government for
a car parked in No-Parking Zone. Even if the owner of car would be paying for
the said charges, yet, the same should not be treated as service supplied by
Government since there was no agreement to receive the said service.

15. To
support the above view, one may refer to the Judgment by the New Zealand
Tribunal in Case S65 (1996) 17 NZTC 7408 wherein a taxpayer, who was a
solicitor, was the subject of a disciplinary hearing by the New Zealand Law
Practitioners Disciplinary Tribunal. The taxpayer argued that the costs he was
ordered to pay were a supply of goods or services to him by the Law Societies.

In the said case, it was held that
costs imposed by a disciplinary tribunal were not subject to GST because there
was no “supply”. The costs of prosecuting an allegedly defaulting solicitor
could not be described as the supply of a service; and in the context of the
Goods and Services Tax Act, “services” are generally considered to be some
activity which helps or benefits the recipient. In other words, penalties,
fines, etc., imposed by the Government/ Local Authorities cannot be treated as
consideration for service provided and hence should not attract GST.

LIABILITY TO PAY GST

16. In
a manner similar to the service tax regime, substantial services provided by
the Government/Local Authority to business entities have been covered under
reverse charge mechanism, except for following specific services where the
respective Government/Local Authority is liable to collect and discharge the
tax liability:

Renting of
immovable property services³

Services
by the Department of Posts by way of speed post, express parcel post, life
insurance, and agency services provided to a person other than the Central
Government, State Government, Union territory

Services
in relation to an aircraft or a vessel, inside or outside the precincts of a
port or an airport;

Transport
of goods or passengers

17. In
all other cases of services provided by Government to business entities, the
liability to pay service tax has been fastened on the recipient of service.
While the term business entity has not been defined under GST law, the same
will have to be understood as a person carrying on any business, whether or not
liable to pay GST. For instance, a person dealing in non-GST goods, say
alcohol, is required to obtain liquor licenses for dealing in license. Since
such a person would be a business entity, even though there is no GST
applicable on his outward supplies, he would be required to obtain registration
under GST and discharge the applicable tax thereon. This would also require
such a person to comply with the various provisions of the GST law as well.

18. In
addition to the above, notification 12/ 2017 Central Tax (Rate) also provides
exemption for various other services provided to/by Government/Local
Authorities. Some of the relevant exemptions for services provided by
Government/Local Authorities are listed below:

(a) Services
by Central Government, State Government, Union territory, local authority or
governmental authority by way of any activity in relation to any function
entrusted to a municipality under Article 243 W of the Constitution
[Entry 4]

(b) Services
by a governmental authority by way of any activity in relation to any function
entrusted to a Panchayat under Article 243G of the Constitution [Entry 5]

(c) Services
by the Central Government, State Government, Union territory or local authority
excluding the following services—

(i) services by the Department of Posts
by way of speed post, express parcel post, life insurance, and agency services
provided to a person other than the Central Government, State Government, Union
territory;

(ii) services in relation to an
aircraft or a vessel, inside or outside the precincts of a port or an airport;

(iii) transport of goods or passengers;
or

(iv) any service, other than services
covered under entries (a) to (c) above, provided to business entities [Entry 6]

(d) Services
provided by the Central Government, State Government, Union territory or local
authority to a business entity with an aggregate turnover of up to twenty lakh
rupees (ten lakh rupees in case of a special category state) in the preceding financial
year. However, the same is not applicable to services covered under (i) to
(iii) in (d) above as well as in case of renting of immovable property services
[Entry 7]

(e) Services
provided by the Central Government, State Government, Union territory or local
authority to a business entity where consideration does not exceed Rs. 5000.
However, this exemption is not available in case of services covered under (i)
to (iii) above and in case the services are in the nature of continuous supply
of services and the total consideration payable for the supply during the year
exceeds Rs. 5000. [Entry 9]

(f) Services
provided by the Central Government, State Government, Union territory or local
authority by way of allowing a business entity to operate as a telecom service
provider or use radio frequency spectrum during the period prior to the 1^st
April, 2016, on payment of license fee or spectrum user charges, as the case
may be. [Entry 42]

(g) Services
provided by the Central Government, State Government, Union territory or local
authority by way of-

(i) registration required under any law
for the time being
in force;

_________________________________________________________________________________________________

3 Vide notification 3/2018 dated 25.01.2018, services
of renting of immovable property supplied by Central Government, State
Government, Union territory or local authority to a person registered under the
Central Goods and Services Tax Act, 2017 have been brought within the purview
of reverse charge.

(ii) testing, calibration, safety check
or certification relating to protection or safety of workers, consumers or
public at large, including fire license, required under any law for the time
being in force [Entry 47]

(h) Services
provided by the Central Government, State Government, Union territory or local
authority by way of issuance of passport, visa, driving license, birth
certificate or death certificate [Entry 61]

(i) Services
provided by the Central Government, State Government, Union territory or local
authority by way of tolerating non-performance of a contract for which
consideration in the form of fines or liquidated damages is payable to the
Central Government, State Government, Union territory or local authority under
such contract.
[Entry 62]

(j) Services
provided by the Central Government, State Government, Union territory or local
authority by way of assignment of right to use natural resources to an
individual farmer for cultivation of plants and rearing of all life forms of
animals, except the rearing of horses, for food, fibre, fuel, raw material or
other similar products. [Entry 63]

(k) Services
provided by the Central Government, State Government, Union territory or local
authority by way of assignment of right to use any natural resource where such
right to use was assigned by the Central Government, State Government, Union
territory or local authority before the 1^st April, 2016. [Entry 64]

(l) Services
provided by the Central Government, State Government, Union territory by way of
deputing officers after office hours or on holidays for inspection or container
stuffing or such other duties in relation to import export cargo on payment of
Merchant Overtime charges
[Entry 65]

(m) Services
supplied by a State Government to Excess Royalty Collection Contractor (ERCC)
by way of assigning the right to collect royalty on behalf of the State
Government on the mineral dispatched by the mining lease holders.

19. Similarly,
following services provided to Government/ Local Authority have been exempted:

(a) Pure
services (excluding works contract service or other composite supplies
involving supply of any goods) provided to the Central Government, State
Government or Union territory or local authority or a Governmental authority by
way of any activity in relation to any function entrusted to a Panchayat under
Article 243G of the Constitution or in relation to any function entrusted to a
Municipality under Article 243W of the Constitution [Entry 3]

(b) Composite
supply of goods and services in which the value of supply of goods constitutes
not more than 25 % of the value of the said composite supply provided to the
Central Government, State Government or Union territory or local authority or a
Governmental authority or a Government Entity by way of any activity in
relation to any function entrusted to a Panchayat under Article 243G of the
Constitution or in relation to any function entrusted to a Municipality under
Article 243W of the Constitution
[Entry 3A]

(c) Supply
of service by a Government Entity to Central Government, State Government,
Union territory, local authority or any person specified by Central Government,
State Government, Union territory or local authority against consideration
received from Central Government, State Government, Union territory or local
authority, in the form of grants. [Entry 9C]

(d) Services
by an old age home run by Central Government, State Government or by an entity
registered u/s. 12AA of the Income-tax Act, 1961 (43 of 1961) to its residents
(aged 60 years or more) against consideration upto twenty five thousand rupees
per month per member, provided that the consideration charged is inclusive of
charges for boarding, lodging and maintenance [Entry 9D]

(e) Service
provided by Fair Price Shops to Central Government by way of sale of wheat,
rice and coarse grains under Public Distribution System (PDS) and to State
Governments or Union territories by way of sale of kerosene, sugar, edible oil,
etc., under Public Distribution System (PDS) against consideration in the form
of commission or margin [Entry 11A/ 11B]

(f) Services
provided to the Central Government, State Government, Union territory
administration under any training programme for which total expenditure is
borne by the Central Government, State Government, Union territory
administration [Entry 72]

CERTAIN ISSUES & RULINGS

20. What
will be the scope of functions entrusted to a municipality under Article 243W?

One
particular function performed by the Municipality is to provide permission to
various utility service providers (electricity, gas, etc.,) to carryout
excavation work to laydown underground wire, pipe-lines, etc., for which
charges in the form of access charges & reinstatement charges are levied by
the Municipality.

An
application for Advance Ruling was made before the Authority in Maharashtra by
Reliance Infrastructure Limited [2018 (013) GSTL 0449 (AAR)] as to
whether the above charges would be covered under functions entrusted to a
Municipality under Article 243W or not? The Authority in the said case held as
under:

This restoration work would not result
in performing of the sovereign function. The sovereign function has already
been performed by constructing the road or undertaking maintenance works of the
roads. The restoration work can be equated neither to construction work nor to
maintenance work as suo motu undertaken by the Municipal Authorities. The
restoration charges are also not in the nature that the Municipal Authorities
are performing any job of construction for the applicant. The street or pavement
or road that is dug up is a general road. In view of all above, we are of the
firm view that it should not be disputed that the recovering of charges for
restoring the patches which have been dug up by business entities of the nature
as the applicant cannot be equated to performing a sovereign function as
envisaged under Article 243W of the Constitution.

However,
the Authority in the above case has while appreciating the fact that the
function of construction and maintenance of road is entrusted to the
Municipality under Article 243W, erred in not appreciating the fact that the
reinstatement charges recovered from the utility service providers is merely to
meet the cost incurred for undertaking the functions entrusted to it under
Article 243W, i.e., to maintain the roads. This is done by the Municipality by
appointing contractors, who undertake the activity and charge the Municipality
for the same. The role of Municipality is to ensure that the said function
relating to construction and maintenance of road is properly performed, which
is performed by collecting the said charges from such public utility companies.
In fact, one can say that in case of access & reinstatement charges
collected by the Municipality, it is infact a case of service to self rather
than service to public utility companies as it helps the Municipality to
perform the function entrusted to it under Article 243W.

Interesting
aspect to note in the above case is that there were two different charges
collected by the Municipality, namely reinstatement charges and access charges.
In the case of access charges, the Authority has arrived at a prima facie
conclusion that tax would be payable. However, it has failed to appreciate the
fact that in case of access charges, the Municipality has recovered GST from
the Applicant. The question that therefore would need analysis is whether there
would be double taxation, i.e., the supplier of service also charges GST and
the recipient also discharges GST on the same under reverse charge?

Further,
in another Ruling in the case of VPSSR Facilities [2018 (013) GSTL 0116
(AAR)], the Authority held that cleaning services provided to the Northern
Railways, classifiable as Central Government would not be eligible for
exemption under Entry 3 since the Railways do not carry out any function
entrusted to a Municipality under Article 243W. The Authority further held that
the Municipality was entrusted with functions only in relation to urban areas
and not in relation to railway properties. If this view is accepted, exemption
will not be available in case of services provided by Central/State Government
in relation to carrying out any function entrusted to a Municipality under
Article 243W.

21. Whether
exemption under Entry 6 will extend to other services provided by Department of
Posts?

On going
through the website of Department of Posts, there are three different
categories of service provided, as under:

Premium

Domestic

International

Speed Post

Letter

Express Parcel

Book Packet

EMS Speed Post

Business Parcel

Registered Newspaper

Air Parcel

Logistics Post

Parcel

International Tracked Packets

The
services relating to speed post & express parcel post are explicitly
covered under forward charge. However, other services provided to business
entities by Department of Posts will be covered under clause (d) of Entry 6 of
notification 12/ 2017 and therefore be liable to tax under reverse charge
mechanism.

This
would be important in the case of business delivering goods through posts,
companies mailing annual reports/notices under normal post, magazines posted on
license to post without pre-payment, etc., Off-course, one can claim the exemption
of Rs. 5000 but the same would need to be analysed on a case to case basis.

22. In
case of exemption under Entry 72, can exemption be denied on the grounds that
only cost is borne by the Government and no service is received by the
Government?

Entry 72
provides for exemption to services provided to Government under any training
programme for which total expenditure is borne by them. In such cases, there
are programmes where the service provider is required to identify candidates
for providing training and upon completion of training or as per agreed terms,
the Government makes the payment for such training to the service provider,
i.e., the service is not provided to the Government but only the cost is borne
by the Government.

In such
a case, can the exemption be denied on the grounds that since service is not
provided to Government but the candidate, the exemption is not available.

The
answer to the same would be in negative in view of the fact that the definition
of recipient of service u/s. 2 (93) provides that recipient of supply in case
where consideration is payable for supply shall be the person liable to pay the
service and not the person consuming the service. Therefore, since the claim
for payment for the service is to be made before the Government conducting the
programme, the payment can be enforced only from the Government and therefore,
in view of section 2 (93), it is the Government who is the recipient of
service.

TAX DEDUCTED AT SOURCE

23. Vide
notification 50/2018 – CT (Rate) dated
13.09.2018, in addition to specified class of people referred to in clause (a)
to (c) of section 51, i.e., Department/Establishment of Central Government or
State Government, local authority or Government agencies, following class of
people have been made liable to deduct tax at source on payments to be made on
various supplies received by them:

(a) an
authority or a board or any other body, –

(i) set
up by an Act of Parliament or a State Legislature; or

(ii) established
by any Government,

with 51 % or more participation by way
of equity or control, to carry out any function;

(b) Society
established by the Central Government or the State Government or a Local
Authority under the Societies Registration Act, 1860 (21 of 1860);

24. The rate of TDS
applicable on such payments would be 2%, being 1% CGST and 1% SGST/UTGST in
case of intrastate supplies and 2% IGST in case of interstate supplies.

CONCLUSION

25. To
summarise, under the GST regime, while making payment for any activity or
function undertaken by Government or Local Authority, one will need to analyse
the GST implications on multiple fronts, such as :

whether
the activity undertaken by the Government or Local Authority partakes the
character of a service or not?

Whether
the activity is classifiable under the exemption list or not?

26. The
above exercise will need to be followed rigorously by a business not entitled
for full credit as payment of tax under reverse charge, even on a conservative
basis will have to be taken as cost, which may not be necessary. Off course, a
business eligible to claim full input tax credit might take a conservative view
and not go in to the above hassles by discharging tax on all payments since
there may not be any cash flow issues or unnecessary tax costs.

27. More care needs to be exercised in
case of services provided to Government/Local Authority in view of the fact
that claiming a wrong exemption can have significant repercussions involving
payment of tax out of pocket saddled with consequential interest and penalties.
One further needs to ensure that in each case, the exemption be analysed on
their own rather than depending on the recipients’ claim of exemption, since
the same may not be always correct.

shailesh.kwebmaker

THE INSOLVENCY & BANKRUPTCY CODE, 2016

Two years ago,
India was accorded number 130 in the World Bank’s Ease of Doing Business 2017
rankings[1],
with the average time for resolution standing at 4.3 years. Low recovery rates
had led to a dip in the number of high-risk high-return ventures, as investment
returns could not be guaranteed to investors’ satisfaction. However, with the
onset of the Insolvency and Bankruptcy Code, 2016 (“IBC”), there has been a sea
change in the restructuring space, leading to an increasingly diligent business
environment and a quicker turnaround on account of resolution plans being
completed within a year of the commencement of the IBC in several cases. India
displayed rapid progress as per the Ease of Doing Business 2018 rankings,[2] as it rose thirty ranks, and has
proceeded to further improve by twenty three ranks and jumped to number 77 in
the recently published Ease of Doing Business 2019 Rankings.[3]

LEGAL CHANGES

Committee of Creditors

The IBC has undergone
a substantial amount of changes from its inception, evolving gradually based on
the needs of all the stakeholders involved. The commercial wisdom of the
committee of creditors (“CoC”) comprising of financial creditors has
been given utmost weightage, which can be deduced in a number of cases. The
voting threshold for major decisions to be undertaken by the CoC has been
reduced from 75 % to 66 %, whilst routine decisions can now be taken with the
approval of 51 % of the CoC, which was 75 % prior to the latest amendment.
Further, withdrawal of an application is now only permitted if 90 % of the CoC
approve the same.

Section 29A of the IBC

Section 29A of the IBC, which pertains to the eligibility criteria of
resolution applicants, has inspired intense debate from its inception. The
section has now been substantially amended in order to widen the scope of
ineligible resolution applicants, so as to protect the interests of the company
as a going concern and ensuring maximisation of the value of the assets. The
most notable case in this regard has been the ongoing resolution process of
Essar Steel Limited, wherein ArcelorMittal and Numetal Limited have been
engaged in a competitive bid process in order to acquire Essar Steel Limited.
This case has been instrumental in setting out the eligibility criteria
applicable to resolution applicants under the IBC.

Subsequent amendments have resulted in increasingly stringent conditions
being applied to defaulting promoters and their connected parties in order to
prevent them from finding loopholes to regain their companies after leading
them to financial distress. The exception to this rule is the MSME industry,
whose promoters are currently exempt from the restrictions applicable u/s. 29A
of the IBC.

Cross-Border Insolvency
Laws

With a number of creditors and assets located across the globe,
regulating the recovery and involvement of foreign assets and creditors has
gained an increasing urgency in order to address the interests of all
stakeholders. This has led to lawmakers initiating the process of aligning
domestic cross-border insolvency laws with existing international laws under
UNCITRAL. While the draft chapter, which is currently undergoing an extensive
review, deals with the laws pertaining to corporate debtors only, eventually
the focus will also include personal cross-border insolvency laws.

Impact of IBC across
all spheres of law

In order to
facilitate the smooth implementation of the IBC, a number of significant
changes have been introduced across several spheres of law, in the form of
amendments to the Income Tax Act, 1961, the Companies Act, 2013, multiple
Securities and Exchange Board of India (“SEBI”) regulations and the Real
Estate Regulations and Developments Act, 2016 (“RERA”).

a) Relaxations under Income Tax Act

With regard to
income tax, there have been two relevant changes in the form of amendments to
the Finance Act, 2018. Section 79 of the Finance Act, 2018 has been amended to
provide that business losses shall not lapse in respect of a company, whose
resolution plan has already been approved by the National Company Law Tribunal
(“NCLT”). However, the amendment has a caveat in the form of an
opportunity to appeal to higher authorities.

Moreover, section 115JB has been amended to provide that in the case of
companies whose application is admitted by the NCLT under the IBC, the amount
of total loss brought forward (which is inclusive of unabsorbed depreciation)
would be allowed to be reduced from the book profit for the purpose of levying
minimum alternate tax.

Additionally, a
reference could also be made to the Monnet Ispat & Energy Limited judgment,
which has rendered further clarity on the priority of the ranking provided to
the Income Tax Department under the waterfall mechanism provided u/s. 53 of the
IBC.

b) Exemptions under Companies Act, 2013

Under the Companies
Act, 2013, if a resolution plan has already been approved by the NCLT, then the
consent of shareholders of the corporate debtor (which is generally required
for significant corporate actions such as reduction of capital, disposal of
material assets and preferential allotment of shares), is not necessary for the
resolution plan to take effect.

c) SEBI
(Delisting of Equity Shares) Regulations, 2009

Delisting of
securities from stock exchanges generally requires compliance with stringent
pricing norms and appropriate shareholder consent. However, if delisting is
proposed under a resolution plan under the IBC, then exemptions from the
elaborate delisting requirements are available, provided, the resolution plan
under the IBC grants an exit option to the existing public shareholders at a
price not less than their liquidation value and the price provided to promoters
and/or other shareholders. Further, an application for listing of shares
delisted pursuant to a resolution plan under the IBC can now be made without
adhering to the cooling-off period prescribed under the delisting regulations.

d) Exemptions under SEBI (Listing Obligations
and Disclosure Requirements) Regulations, 2015

Shareholder consent
is no longer required if certain actions are undertaken pursuant to an approved
resolution plan under the IBC. These include undertaking material related party
transactions, divesting control in a material subsidiary and selling more than
20 % of the assets of a material subsidiary. Relaxations have also been
provided for undertaking the actions listed herewith pursuant to an approved
resolution plan under the IBC such as change of promoter, a company procuring
professional management, and a reclassification of promoter(s) or promoter
group as public shareholder.

e) Exemptions under SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011

Companies which
have an approved plan under the IBC have also been exempted from the
requirement of making an open offer. Further, successful acquirers under a
resolution plan are now permitted to hold more than
75 % of the shares in a listed company, which would have otherwise breached the
requirement for a minimum public shareholding of 25 %.

f) Exemptions under SEBI (Issue of Capital and
Disclosure Requirement) Regulations, 2011

Preferential
allotment of shares can be made by companies if the preferential allotment
takes place as the result of a resolution plan under the IBC. Further
exemptions include relaxation from the multiple pricing requirements and
requirement of shareholder consents for allotment of equity shares and
convertible securities.

g) Real Estate Regulations and Developments
Act, 2016

With the Jaiprakash Associates Limited – Jaypee Infractech Limited case gaining
an exceptional amount of traction, it became essential to address the concerns
of home buyers as significant financial creditors. With the ordinance on 6^th
June, 2018 and subsequently the amendment of 17^thAugust, 2018
coming into effect, allottees under the Real Estate Regulations and
Developments Act, 2016 are now included as financial creditor(s) in keeping
with the amendment to the definition of financial debt.

The amendment and the outcome of the Jaypee Infratech Limited
matter has shown the efforts made by lawmakers to secure and protect the
interests of homebuyers who did not have any representation in the CoC despite
their substantial investment.

STRUCTURAL AND CULTURAL
CHANGES

The architects of
the IBC drafted the law with an endeavour to ensure that the company remains a
going concern. The IBC has provided the economy a medium to ensure commercial
stability. The IBC has now gained traction as a means of ensuring the
maximisation of the value of assets in a time-bound manner and preventing the
obliteration of the value of the assets of the company on account of corporate
distress.

In the course of
the last two years, a system comprising of experienced professionals and
organisations such as Insolvency Professionals (“IP”), Information
Utility (“IU”), Insolvency Professional Entities (“IPE”),
Insolvency and Bankruptcy Board of India (“IBBI”) in collation with the
adjudicatory authorities has managed to create an efficient ecosystem. The
combined efforts and experience of the aforementioned parties in dealing with
stressed assets can be credited for the significant turnaround the market has
undergone.

The IBBI has taken
up the mantle of regulating the aforementioned parties with multiple
regulations, guidelines and circulars, in order to help these parties to
smoothly navigate through these problematic situations. The adjudicatory
authorities have provided further clarity with regard to the laws applicable
and have adopted alternate approaches occasionally to ensure that the interests
of all stakeholders are not compromised.

The culture of
creditors consistently having to pursue debtors to ensure recovery has
gradually evolved into a culture wherein the promoters are viewing debt
repayment as an obligation, and not as an option, leading to speedier
resolution and recovery for the creditors. With promoters being held
accountable under the IBC, promoters have begun to take proactive steps to
ensure that defaults do not occur or are engaged in offering out-of-court
settlements for existing debts to their creditors.

The change has
percolated beyond debtors and creditors, and has led to a significant and
expedited improvement in the overall economic culture prevalent in the market,
with corporates opting to take quicker action with regard to deployment of
resources and smoother functioning in terms of timely payments in order to
reduce any possibilities of being involved in insolvency proceedings.

RBI Circular dated 12^th
February, 2018 on Stressed Assets

Reporting
requirements have become increasingly stringent especially on account of the
RBI 12^th February, 2018 circular (“Circular”), which in addition to
the multiple amendments to the law, has led to significant improvements in the
prevalent debt culture, with lenders exercising more caution by using
feasibility and viability as the determinants for future projects.

The IBC has
increasingly become more inclusive and creditor-friendly by providing for
mitigation of risk not only for financial creditors but also for operational
creditors. With regard to financial creditors, home buyers are also considered
as a class of financial creditors, a step which has provided substantial relief
to the common population in addition to corporate organisations.

The circular has also led to an improvement in ensuring post-credit
disbursement discipline, in addition to future lenders increasing their
diligence and prudence while determining the viability of a project which they
intend to fund.

It must be noted,
however, that the ensuing litigation filed by a number of power companies has
led to a halt to the ongoing process of bringing to task a number of defaulting
companies as banks refrain from reporting them as non-performing assets.

Project Sashakt

In addition to the
Circular, Project Sashakt has also been largely responsible for introducing a
structural change in the business environment by increasing transparency and
investor confidence with regard to the financials of a bank. Early resolution
is key to the preservation of organisational capital and to ensuring a quicker
turnaround with regard to the resolution process.

The committee
headed by Mr. Sunil Mehta suggested a five-pronged approach, which would result
in bad loans amounting to up to Rs. 50 crore being managed at the bank level,
within a stipulated deadline of 90 days, whilst bad loans between Rs. 50 crore
to Rs. 500 crore would require banks to enter into an intercreditor agreement,
which would authorise the elected lead bank to implement a resolution plan in
180 days or make reference of the asset to the NCLT. As a part of Project
Sashakt, the government is currently looking into instituting an Asset
Reconstruction Company (“ARC”) and an Asset Management Company (“AMC”)
and is on the lookout for possible investors who would be willing to fund the
AMC.

A collation of the
ideas and implementation respectively for Project Sashakt and the Circular is
expected to bring in substantial improvement with regard to debt recovery in
compliance with expedited timelines.

CASES WHICH HAVE MADE
AN IMPACT

a) Bhushan Steel Limited

Bhushan Steel Limited (the company has been renamed as Tata Steel BSL
Limited) and Bhushan Power and Steel Limited have been a significant part of
the resolution process under the IBC. Bhushan Steel Limited was one of the
first major companies to achieve resolution and was acquired by Tata Steel
Limited. Bhushan Power and Steel Limited is currently undergoing the resolution
process, with its three bidders – Tata Steel Limited, JSW Steel Limited and
Liberty House. Bhushan Power and Steel Limited has undergone two rounds of
bidding. In the first round of bidding, Liberty House submitted its bid after
the proposed deadline, and filed before NCLT an application seeking consideration
of its bid. The NCLT subsequently directed the CoC to consider Liberty House’s
bid, resulting in Tata Steel Limited appealing before the NCLAT to discount
Liberty House’s bid from being considered on account of non-adherence to the
procedure.

The NCLAT, however,
asked the CoC to reconsider Liberty House’s bid. With a number of appeals filed
by both Liberty House and Tata Steel Limited based on several issues,
eventually the NCLAT asked lenders to consider the three bids submitted by Tata
Steel Limited, Liberty House and JSW Steel Limited in a second round of
bidding. Reports state that currently JSW Steel Limited is the H1 bidder for
Bhushan Power and Steel Limited after Tata Steel Limited refrained from
revising its bid.

b) Essar Steel Limited

The ongoing
resolution process of Essar Steel Limited has significantly led to the
developments which have taken place in section 29A which sets out the
ineligibility criteria of resolution applicants. ArcelorMittal and Numetal
Limited have been engaged in a competitive bidding process for more than a year
in order to procure one of the largest steel companies in India.

This led to the
eligibility of both the companies to be re-examined in light of the amendment,
with the Resolution Professional declaring both the prospective resolution
applicants as ineligible. A number of applications were filed by both the
companies pertaining to the ineligibility of the other company on account of
their association with non-performing assets. The orders passed by the courts
in this matter have dealt in detail with issues concerning management and
control in addition to lifting of the corporate and several other aspects of
section 29A. Subsequently, both
companies were asked to clear their non-performing assets (“NPA”) within
two weeks from the order passed by the Supreme Court on 4^th
October,2018.

ArcelorMittal has offered to pay Rs. 42,000 crore for Essar Steel
Limited. ArcelorMittal has already made a payment of Rs. 7,469 crore in order
to clear the outstanding liabilities on account of NPAs, Uttam Galva Steels
Limited and KSS Petron Limited in keeping with the order of the Supreme Court.
However, in a last attempt to save their flagship company, the promoters of
Essar have offered to pay back all dues, amounting to Rs. 54,000 crores. Even
though ArcelorMittal has been declared as the H1 bidder, a number of creditors
have challenged the decision before the adjudicatory authorities claiming that
the plan does not address the interest of all stakeholders sufficiently. The
outcome of this case will play a significant role in determining the future of
a number of NPAs.

c) Jaypee Infratech Limited – Jaiprakash
Associates Limited

The case concerning Jaypee Infratech Limited – Jaiprakash Associates
Limited has been instrumental in helping home buyers to secure their rights as
financial creditors in the CoC, and participate in the resolution process.

The courts have
gone out of their way to ensure that the rights of home-buyers are not
compromised as far as possible and have accorded home-buyers the status of
financial creditors in order to render them a voice with regard to major
decisions to be undertaken by the CoC.

Jaypee Infratech
Limited provided an upstream guarantee to its parent company, Jaiprakash
Associates Limited. However, subsequently both companies have become NPAs.
During the first attempt for resolution, the CoC for Jaypee Infratech Limited
had decided to liquidate the asset on account of unviable proposals. However,
the liquidation proceedings were stayed by the Supreme Court, whilst NCLT asked
Jaiprakash Associates Limited to return 760 acres of land to Jaypee Infratech
Limited on account of the transaction being deemed undervalued and fraudulent.
Through subsequent court hearings, the Supreme Court asked Jaiprakash
Associates Limited to pay Rs. 1,000 crore, which was subsequently reduced to
Rs. 650 crore.Since liquidation would not
serve the purpose of recovering the dues of the creditors, the Supreme Court
opted to restart the resolution process and included home buyers as a class of
financial creditors in the CoC. The insolvency process for Jaypee Infratech
Limited has commenced, with the home-buyers voicing their opinions with regard
to the selection of the resolution professional already.

CONCLUSION

In a short span of two years, the IBC has managed to stabilise the
economy to a considerable extent. By establishing an efficient ecosystem of
dedicated organisations and individuals with experience in the field of
insolvency and bankruptcy, the market has witnessed a turnaround with regard to
NPAs in multiple sectors. Credit must be given to the lawmakers and
adjudicatory authorities for the efforts they have made to address the best
interests of all stakeholders to the best of their capacities.

It must also be
duly noted that with defaulters being held accountable for their financial
irresponsibility under the IBC, the managements responsible for companies, such
as promoters, are proactively engaged in ensuring that their companies do not
convert into NPAs.

In cases where
companies have defaulted, attempts are being made to convince their creditors
to accept out-of-court settlements. Alternatively, by means of IBC, distressed
asset fund investors are being provided with multiple opportunities for
investment and to ensure the turnaround of NPAs. This is gradually reflecting
positively on the fiscal health of the economy. In the course of another year,
the impact that IBC has made as a path-breaking law will be clearly evident as
a number of approved resolution plans will be implemented to a substantial
extent.

[1] Ease of Doing
Business 2017, World Bank http://www.doingbusiness.org/en/rankings

[2] http://www.worldbank.org/en/news/press-release/2017/10/31/india-jumpsdoing-business-rankings-with-sustained-reform-focus

[3] Ease of Doing
Business 2019, World Bank http://www.doingbusiness.org/en/rankings

shailesh.kwebmaker

Section 9 of the Act; Articles 7, 5 and 12 of India-Philippines DTAA – In absence of FTS Article in DTAA, and in absence of PE in India, receipt of Philippines company from Indian company, being in the nature of business profit, were not chargeable to tax in India.

17. [2018] 100 taxmann.com 230 (Bangalore –
Trib.) DCIT vs. IBM India
(P.) Ltd IT (IT)ANos.: 1288,
1291, 1294, 1297, 1300, 1303 & 1306 (Bang.) of 2017 A.Ys.: 2009-10 to
2015-16 Date of Order: 16^th
November, 2011

Section
9 of the Act; Articles 7, 5 and 12 of India-Philippines DTAA – In absence of
FTS Article in DTAA, and in absence of PE in India, receipt of Philippines
company from Indian company, being in the nature of business profit, were not
chargeable to tax in India.

FACTS

The Taxpayer was an Indian
member-company of a global group. The Taxpayer was engaged in the business of
selling computers, software and lease financing of its products. The group had
a policy of deputing employees of one group company to another group company,
as may be required for certain business projects. For this purpose, the two
respective group companies entered into a standard expatriate agreement. During
this period, the employer of the deputed employee paid salary of deputed
employee in the home country. Thus, Philippines Group Company, (“FCo”) of the
Taxpayer had deputed its employee to the Taxpayer in India. The Taxpayer
reimbursed the amount equivalent to the salary to FCo. Further, the Taxpayer
had withheld tax on the salary of the employee and deposited the same with
Government of India. The Taxpayer did not withhold tax from the reimbursed
amount.

According to the tax authority,
FCo continued to be the employer of the deputed employees and also paid their
salaries. The Taxpayer only reimbursed salary to FCo but did not directly pay
salary to deputed employee. Therefore, the reimbursed amount was covered within
the definition of FTS under the Act as well as under India-Philippines DTAA.
Since the Taxpayer had not withheld tax from reimbursed amount, it was held
‘assessee-in-default’.

In appeal before CIT(A) the
Taxpayer also contended that in absence of FTS article in India-Philippines
DTAA, the receipt was ‘business profit’ and since FCo did not have a PE in
India, the receipt could not be chargeable to tax in India. CIT(A) held that
even if reimbursement by the Taxpayer to FCo was regarded as FTS, the payment
would not be chargeable to tax in India in absence of FTS article in
India-Philippines DTAA.

______________________________________________________

2. Apparently,
the disallowance was u/s. 40(a)(i) of the Act though the decision does not
mention the relevant provision

HELD

In
an earlier decision in the case of the Taxpayer, the Tribunal has held that
when India-Philippines DTAA does not provide for taxing of FTS, it is not
chargeable to tax.

There
is no specific clause in India-Philippines DTAA regarding income in the nature
of FTS. Article 23 does not apply to items of income which can be classified
under any other article, whether or not the income is taxable. A payment would
be covered by Article 23(1) [‘Other Income’ Article] if the payment was not
covered within any other Article.

FCo
received payment in the course of its business. FCo did not have any PE in
India. Hence, the receipt, though business profit, cannot be brought to tax
under Article 7. Therefore, it was not chargeable to tax in India.

shailesh.kwebmaker

Section 9 of the Act; Article 12 of India-Japan DTAA – payments received by Japanese company in respect of deputation of high-level technical executives to Indian subsidiary were FTS, particularly because technical knowledge was made available; in absence of reconciliation of receipts with actual payments, the receipts could not be treated as reimbursement of cost.

16. [2018] 99 taxmann.com 183 (Chennai – Trib.) Panasonic
Corporation vs. DCIT ITA No.: 1483
(Chny) of 2017 A.Y. 2013-14 Date of Order: 2^nd
August, 2018

Section
9 of the Act; Article 12 of India-Japan DTAA – payments received by Japanese
company in respect of deputation of high-level technical executives to Indian
subsidiary were FTS, particularly because technical knowledge was made
available; in absence of reconciliation of receipts with actual payments, the
receipts could not be treated as reimbursement of cost.

FACTS

The Taxpayer was a company
incorporated in Japan. (“FCo”). FCo was engaged in the business of electrical
and electronic products and systems. FCo had a subsidiary in India (“ICo”). In
the course of its business, FCo deputed certain high-level technical executives
to ICo for providing highly technical services to ICo. ICo reimbursed the
salaries of the deputed employees to FCo.

According to ICo, since it was a
case of mere reimbursement of expenses, the receipts by FCo could not be construed
as income of FCo. Further, the objective of secondment was to support ICo and
there was no economic benefit to FCo.

According to the AO, ICo was
required to withhold tax from the payment. Since ICo had not withheld the tax,
the AO disallowed² the
deduction while passing draft assessment order. The DRP directed FCo to
reconcile receipts from ICo with actual payments. FCo could not reconcile the
same. DRP observed that routing salary through FCo was with the twin objectives
of having absolute control over seconded employees and not letting the customer
know about the margin retained by FCo over the actual salary. DRP further
observed that services rendered by employees of FCo made technology available
to ICo which was apparent since subsequently there was no requirement for
deputation of employees again.

Relying on decision in Food
World Supermarkets Ltd vs. DDIT [2015] 63 taxmann.com 43, DRP conducted
that irrespective of whether amount was received with mark-up or on
cost-to-cost basis, it had to be considered as FTS. Since FCo could not
reconcile the receipts with actual payments, it could not be treated as
reimbursement of expenses.

HELD

The
AO disallowed claim of FCo on the ground that it received FTS. The AO and DRP
also found that the technical knowledge was made available to ICo. FCo also
could not reconcile the receipts and the actual payments, before DRP as well as
the Tribunal.

The
deputed personal were all holding senior technical/managerial positions with
ICo and reported to the top management of FCo. They were working under
direction, control and supervision of FCo.

The
deputed personal were rendering highly technical services. Further, the
services resulted in technology being made available to ICo, which obviated the
necessity of employees to be deputed again. Accordingly, order of the AO and
DRP was confirmed.

shailesh.kwebmaker

Section 5 of the Act – salary for services rendered outside India but received in India is not taxable in India in absence of TRC if the Taxpayer furnishes evidence in support of accrual of salary outside India.

15. IT A No.:2407/Bang/2018 Maya C. Nair vs.
ITO A.Y.: 2013-14 Date of Order: 31^st
October, 2018

Section 5 of the Act – salary for services rendered
outside India but received in India is not taxable in India in absence of TRC
if the Taxpayer furnishes evidence in support of accrual of salary outside
India.

FACTS

The Taxpayer
was an individual employed in India. During the relevant year, she was deputed
by her employer to USA. During the deputation period, her entire remuneration
was credited by her employer to her bank account in India. As her stay in India
was less than one hundred and eighty-two days, she qualified as non-resident in
terms of section 6(1) of the Act. In her return of income, the Taxpayer
disclosed remuneration for services rendered in India as taxable and claimed
remuneration for the deputation period outside India as exempt. For the period
of her deputation in USA, the Taxpayer had furnished return of income in USA
and had also duly paid taxes in USA.

However, for the following reasons,
the AO concluded that the Taxpayer was not entitled to exemption of income
earned on deputation in USA and accordingly charged tax thereon.

(i) The Taxpayer had not provided confirmation of her employer in India
or in USA to establish that she was working in USA.

(ii) The receipt of salary in India by the Taxpayer suggested that
she had rendered services in India, unless the Taxpayer proved otherwise¹.

(iii) To claim benefit in terms of India-USA DTAA, the Taxpayer was
required to provide Tax Residency Certificate (“TRC”), which she had failed to
provide.

The Taxpayer preferred an appeal
before CIT(A)-12. By her order dated 31-10-2017, and relying on certain
judicial decisions, CIT(A)-12 deleted the addition made by the AO in respect of
the exempt income. Subsequently, by a departmental administrative order, CCIT
transferred the appeal for that particular year to CIT (A)-10. Hence, CIT(A)-10
passed ex-parte order dated 28-02-2018. In his order, CIT(A)-10 upheld
the order of the AO treating income that had accrued in USA as taxable in
India.

__________________________________________

1. It may be
noted that section 5(2) of the Act provides that income received in India by a
non-resident is chargeable to tax in India.

HELD

When
CIT(A)-10 passed the order, order of CIT(A)-12 was in existence. It was solely
the mistake of the department, for which, the Taxpayer should not be made to
suffer hardship and harassment.

CIT(A)-12
could not have invalidated her order as ‘rectification’ u/s. 154 of the Act. Section
154 merely provides for correction of mistake apparent from the records but
does not confer power to recall or invalidate an order.

As
there cannot be two appellate orders of two different CIT(A)s for the same
assessment year, order of CIT(A)-10, being later, was not a valid order under
law and was liable to be quashed as non-maintainable.

It
is not the case of revenue that the order of CIT(A)-12 was perverse or was made
on wrong factual or legal premise. CIT(A)-12 had passed a reasoned order and
had relied on decisions of jurisdictional High Court and the Tribunal.
Therefore, remanding the matter to CIT(A)-10 would, rather than serving a
useful purpose, will cause hardship to the Taxpayer.

In
ITO vs. Bholanath Pal [2012] 23 taxmann.com 177 (Bangalore), it was held
that salary accrues where the services under the employment are rendered. The
facts of the Taxpayer are similar to the facts in the said decision. Absence of
TRC cannot be a ground for denying DTAA benefit. A taxpayer is required to
provide evidence in support of exemption claimed. The Taxpayer had furnished
evidence of her stay outside India and since the salary for services rendered
outside India did not accrue in India, it was not taxable in India.

shailesh.kwebmaker

Article 12 of India-USA DTAA; Explanation 2 to section 9(1)(vi), payment made towards web hosting charges not taxable as royalty under the Act as well as the DTAA

14. TS-623-ITAT-2018 (Pune) EPRSS Prepaid
Recharge Services India P. Ltd. vs. ITO Date of Order: 24^th
October, 2018 A.Y.: 2010-11

Article
12 of India-USA DTAA; Explanation 2 to section 9(1)(vi), payment made towards
web hosting charges not taxable as royalty under the Act as well as the DTAA

Facts

The Taxpayer is a private Indian
company engaged in distribution and sale of recharge pens of various DTH
providers via online network. In order to run its business, the Taxpayer required
access to servers. Instead of purchasing servers and incurring expenditure on
its maintenance, Taxpayer hired server space under a web hosting agreement from
a foreign company (“FCo”).

The Taxpayer did not withhold
taxes while making payment to FCo for such services on the contention that
payment for web hosting services did not qualify as royalty or FTS.

AO, however, held that the
payments were made for the use of servers which amounted to use of commercial
equipment. Hence, they qualified as royalty u/s.9(1)(vi) of the Act. Aggrieved,
the Taxpayer appealed before CIT(A), who upheld the order of AO.

The Taxpayer appealed before the
Tribunal.

HELD

As
per the terms of the agreement, the Taxpayer had made payments for use of
technology driven services of FCo and not for use of any IPR or rights owned by
FCo. The fact that payments made to FCo varied with the use of technology also
supported the fact that the payments were for availing services. Accordingly,
the payments made for web hosting services did not qualify as royalty.

Further
while using the technology services provided by FCo, the Taxpayer did not use
or acquire any right to use any industrial, commercial or scientific equipment.
Hence, the payments made by Taxpayer cannot be said to be covered under clause
(iva) to Explanation 2 of section 9(1)(vi) of the Act. Reliance was placed on
the decision of Madras HC in Skycell Communications Ltd. & Anr
(TS-18-HC-2001).

Thus,
the Taxpayer was not liable to withhold taxes on web hosting charges paid to
FCo.

Without
prejudice, the definition of royalty, which was retrospectively amended to
include use of, or right to use, an equipment cannot be applied in respect of
the tax years which have elapsed before the amendment came into force.

In
any case, since payments were made by the Taxpayer to FCo before the
retrospective amendment came into force, the Taxpayer cannot be held to be in
default for failure to withhold taxes on the basis of retrospective amendment.

Also, retrospective
amendment to the Act cannot amend the DTAA. Thus, amended definition of
‘royalty’ under the Act cannot be read into the DTAA. Since the Taxpayer had no
control over the servers of FCo, payment for such services did not qualify as
royalty under the DTAA as well.

shailesh.kwebmaker

Section 2(47) – Reduction of share capital, even where there is no change in the face value of the share or the shareholding pattern, results in extinguishment of right in the shares amounting to transfer of shares.

8. Jupiter Capital Pvt. Ltd. vs. Assistant
Commissioner of Income Tax (Bangalore) Members: Sunil Kumar Yadav (J. M.) and Arun Kumar
Garodia (A. M.) ITA
No.:445/Bang/2018 A.Y.: 2014-15. Dated: 29^th
November, 2018 Counsel for
Assessee / Revenue: S. Parthasarathi /
D. Sudhakara Rao

Section
2(47) – Reduction of share capital, even where there is no change in the face
value of the share or the shareholding pattern,
results in extinguishment of right in the shares amounting to transfer
of shares.

FACTS

The
assessee had invested in 15,33,40,900 equity shares at face value of Rs. 10 on
different dates in its subsidiary company, Asianet News Network Private Limited
(‘ANNPL’). The total number of shares of ANNPL was 15,35,05,750 out of which
the assessee’s share was 99.89%. As a result of the Order of High Court of
Bombay, there was a reduction in share capital of ANNPL to 10,000 nos., and
consequently the share of the assessee was reduced proportionately to 9,988
nos. The Court also ordered for payment of Rs. 3.18 crore as a consideration
for reduction in share capital. The face value of the shares remained the same
at Rs. 10 after the reduction.

The assessee claimed Rs. 164.49 crore as Long Term
Capital loss. According to the assesse, this loss had accrued on account of
reduction in share capital of ANNPL. According to the AO, the reduction in
shares of ANNPL did not result in transfer of capital asset as envisaged u/s.
2(47). The AO came to this conclusion, in light of the finding that, even though
the number of shares had reduced, the face value of Rs. 10 as well as the
percentage of assessee’s share at 99.89% remained at the same level as it was
before the reduction of share capital. He didn’t agree with the assessee that
there was real transfer of asset, as the scheme resulted in
extinguishment/relinquishment of part of the assessee’s rights in the shares of
ANNPL and therefore, the transaction fell within the purview of section
2(47). The AO held that the decision of
the Supreme court in the case of Kartikeya V. Sarabhai vs. CIT (228 ITR 163) relied on by the assessee
cannot be applied as the facts of the case are contrary to the case as there
was no reduction in the face value of the shares in the case of the
assessee. On appeal, the CIT(A) agreed
with the AO and upheld her order.

HELD

The Tribunal noted
that in the case of the assessee, on account of reduction in number of shares
in ANNPL, the assessee extinguished its right of 15,33,40,900 shares and in
lieu thereof, it received 9,988 shares at Rs. 10/- each along with an amount of
Rs. 3.18 crore. According to the
tribunal, the basis adopted by the CIT(A) to hold that the judgment of the
Supreme Court in the case of Kartikeya V. Sarabhai was not applicable in
the present case was not proper as the Supreme court had not made any reference
to the percentage of shareholding prior to reduction of share capital and after
reduction of share capital. According to
the tribunal, the judgment of the Apex Court was squarely applicable to the
case of the assessee, therefore, following the same the Tribunal held that the
assessee’s claim for capital loss on account of reduction in share capital in
ANNPL was allowable.

shailesh.kwebmaker

Section 194-1A – Four persons who purchased immovable property of Rs. 1.5 crore jointly not liable to deduct tax at source since purchase consideration for each person was Rs. 37.5 lakh which was less than the threshold limit of Rs. 50 lakh prescribed in the provisions.

7. Vinod Soni vs. ITO (Delhi) Members: H.S. Sidhu (J. M.) Ando.P. Kant (A. M.) ITA
No. 2736/Del/2015 A.Y.:
2014-15. Dated:
10^th December, 2018 Counsel
for Assessee / Revenue: Raj Kumar / B.S.
Rajpurohit

Section
194-1A – Four persons who purchased immovable property of Rs. 1.5 crore jointly
not liable to deduct tax at source since purchase consideration for each person
was Rs. 37.5 lakh which was less than the threshold limit of Rs. 50 lakh
prescribed in the provisions.

FACTS

The
assesse and three of his family members each purchased 1/4^th
undivided equal shares in an immovable property vide single sale deed for Rs.
1.5 crore. The purchase consideration for each person was Rs. 37.5 lakh.
According to the AO, since the value of the property purchased under single
sale deed exceeded Rs. 50 lakh, as per section 194 IA(2), the assessee was
required to deduct tax at source @1%. For his failure, the AO held the assessee
as defaulter u/s. 201(1) and levied a penalty of Rs. 1.5 lakh. The levy was
confirmed by the CIT(A).

HELD

The
Tribunal noted that as per the purchase deed each of the vendees had become the
absolute and undisputed owner of the said plot in equal share. It also noted from details of party wise
payment furnished that each of the vendee had made payment from their own bank
account / loan account. Further, the
tribunal also noted that the provisions of section 194-IA do not apply where
the consideration for transfer of immovable property was less than Rs. 50 lakh.
According to the Tribunal, since the said provisions apply to a person being a
transferee, the provision would apply only w.r.t. the amount related to each transferee
and not with reference to the amount as per a sale deed. In the instant case, there were four separate
transferees and the sale consideration w.r.t. each transferee was Rs. 37.5
lakh, i.e. less than Rs. 50 lakh each. Each transferee was a separate income
tax entity therefore, it observed that the law has to be applied with reference
to each transferee as an individual transferee/person. Accordingly, it was held
that the provisions of section 194-IA were not applicable and allowed the
appeal of the assesse.

shailesh.kwebmaker

Sections 28, 40A(2)(b) – If the assessee derives income from developing properties and leasing them out, income is chargeable to tax as ‘business income’ following the concept of consistency. No disallowance u/s. 40A(2)(b) can be sustained if the AO fails to specifically bring the actual fair market value on record on basis of corroborative evidences.

25. (2018) 66 ITR (Trib.) 116 (Mumbai) ACIT vs. Grew
Industries Pvt. Ltd. ITA No.:
5427/Mum/2016 A.Y.: 2011-12 Dated: 9^th May, 2018

Sections
28, 40A(2)(b) – If the assessee derives income from developing properties and
leasing them out, income is chargeable to tax as ‘business income’ following
the concept of consistency.

No
disallowance u/s. 40A(2)(b) can be sustained if the AO fails to specifically
bring the actual fair market value on record on basis of corroborative
evidences.

FACTS

Briefly,
facts were that the assessee – a company, was engaged in the business of
development of commercial properties including I.T. Parks, offices etc., and
given them on lease. The Assessing Officer (AO) intended to treat the lease
rent as ‘Income from house property’ as against ‘Business income’ as offered by
the assessee. Upon this, the assessee explained that the I.T. Park was
developed by Salarpuria Properties Pvt Ltd (SPPL) on the land belonging to the
assessee. That the assessee developed the property to be used as I.T. Park in
Bangalore keeping the need of I.T Sector in Bangalore and office premises of
several I.T Companies were located in the I.T. Park. Also, the development and
maintenance of I.T. Park was a very complex commercial activity, which required
continuous and considerable efforts so as to provide services round the clock.
It was submitted, as per section 80 IA of the Act, development and maintenance
of I.T. Park was regarded as a business activity. It was submitted by the
assessee that in A.Y. 2006-07 to A.Y.2010-11, the income received from I.T.
Park was offered as ‘Business income’ and the department had also accepted it.
Therefore, it was submitted that the income offered by the assessee should not
be assessed as ‘Income from House Property’. Disregarding the assessee’s
submissions, the AO held the income to be ‘Income from house property’. This
was later reversed by the first appellate authority.

During
the course of assessment proceedings, the Assessing Officer noticed that the
assessee had claimed deduction on account of payment of salaries of Rs.
1,11,000/- and Directors remuneration of Rs. 2,20,00,000/. The AO found that no
such remuneration was paid in the earlier assessment years. He, therefore,
called upon the assessee to justify the reasonableness of payment made to them.
The assessee justified the payment made to the Directors, however, the
Assessing Officer was of the view that there was no justification of payment to
the Directors and also observed that the assessee failed to establish the
reasonableness of commission paid to the Directors. Accordingly, he disallowed
the payment made u/s. 40A(2)(b) of the Act. The CIT(A) after considering the
submissions of the assessee, allowed assessee’s claim. The CIT(A) appealed to
the ITAT.

HELD

The
learned DR relying on the observations of the Assessing Officer submitted that
the lease rentals were received by the assessee merely as an owner of the property.
Therefore, the income derived from lease rental had to be assessed as ‘Income
from House Property’. The learned AR submitted that the assessee had also
demonstrated with documentary evidence that it was operating and maintaining
the I.T. Park. The learned AR submitted that the assessee was in the business
of developing and leasing out commercial properties, I.T. Parks etc. Therefore,
the income derived from such activities had to be treated as ‘Business income’.

The
Tribunal pointed out that the Assessing Officer himself had accepted the fact
that the assessee owns number of properties and had leased them out. Though
principle of res judicata is not strictly applicable to income tax
proceedings, each assessment year being an independent unit, rule of
consistency cannot also be ignored. Considering all the facts on record, the
ITAT held that the object of the assessee was to derive income from developing
properties and leasing them out. Further following the principle of
consistency, as per earlier years the income of the concerned year should also
be considered to be ‘business income’.

As
regards the payment made to the Directors, the Assessing Officer had disallowed
them primarily for two reasons – firstly, the assessee had not carried out any
business activities and secondly, the payment made was unreasonable. The first
reasoning of the Assessing Officer had lost its force considering the fact that
the income derived by the assessee had been held to be business income. Even
otherwise also, besides leasing out of properties, the assessee had other
business activities also. That being the case, the disallowance of expenditure
on the ground of no business activity was totally wrong. As regards the
applicability of section 40A(2)(b) of the Act is concerned, the ITAT observed
that the Assessing Officer had not established on record what was the fair
market value of the services rendered by the assessee. The Assessing Officer
merely made a vague statement that the remuneration paid by the assessee to the
Directors was unreasonable, without bringing any corroborative evidence on
record. Neither did he establish the actual fair market value of the services
rendered. Hence, the ITAT held that the disallowance was merely on the basis of
conjectures and surmises and could not be sustained.

shailesh.kwebmaker

Section 234E – Assessing Officer cannot make any adjustment by levying fee u/s. 234E prior to 01.06.2015

24. [2018] 66 ITR (Trib.) 69 (Chennai) A.R.R. Charitable
Trust vs. ACIT ITA No.:
1307/Chny/2017 & 238, 239, 240 & 241/Chny/2018 A.Y.s: 2013-14 to
2015-16 Dated: 24^th July, 2018

Section
234E – Assessing Officer cannot make any adjustment by levying fee u/s. 234E
prior to 01.06.2015

FACTS

Prior
to 01.06.2015, there was no enabling provision in section 200A of the Act for
making adjustment in respect of the statement filed by the assessee with regard
to tax deducted at source by levying fee u/s. 234E of the Act. The Parliament
for the first time enabled the Assessing Officer to make adjustment by levying
fee u/s.234E of the Act with effect from 01.06.2015. Therefore while processing
statement u/s. 200A of the Act, the Assessing Officer cannot make any
adjustment by levying fee u/s. 234E prior to 01.06.2015.

Thus
the legal position prior to 01.06.2015, as per various precedents was that, the
Assessing Officer had no authority to levy fee while issuing intimation u/s.
200A of the Act. In the present case, the Ld. CIT(A) in his order, stated that
intimation u/s. 200A of the Act was issued on 31.07.2015. However the Ld. AR
pointed out referring to the intimations issued u/s. 200A of the Act, that all
the intimations u/s. 200A of the Act were issued before 01.06.2015, therefore,
the CIT(Appeals) was not justified in confirming the levy of fee.

HELD

The Tribunal on careful examination of facts held that the
intimations were issued for all the years before 01.06.2015. Therefore, the
CIT(Appeals) was not correct in saying that the intimations were issued on
31.07.2015. When the intimations were issued before 01.06.2015, this Tribunal
was of the considered opinion that the Assessing Officer had no jurisdiction to
levy fee u/s. 234E of the Act. The amendment to section 200(3) of the Act was
made only with effect from 01.06.2015.

Relying
on its own decision in Smt. G. Indhirani the Tribunal in I.T.A. Nos.238 to
241/Chny/18, held that while processing statement u/s. 200A of the Act, the
Assessing Officer cannot make any adjustment by levying fee u/s. 234E prior to
01.06.2015. Thus the fee levied u/s. 234E of the Act was deleted.

shailesh.kwebmaker

Sections 11, 12 – Tax exemption u/s. 11/12 cannot be denied merely for receiving sponsorship from a corporate business entity.

23. (2018) 66 ITR (Trib.) 82 (Delhi) D.C.I.T. vs. India
Olympic Association ITA No.:
1130/DEL/2016 A.Y.: 2011-12 Dated: 19^th July, 2018

Sections
11, 12 – Tax exemption u/s. 11/12 cannot be denied merely for receiving
sponsorship from a corporate business entity.

FACTS

The
assessee-society was an Apex sports body for selecting athletes to represent
India at Olympic Games, Asian Games and other international athlete meets at
these events. It was registered u/s. 12A of the Act. The assessee received an
income from sponsorship amounting to Rs. 86 lakh received from Samsung India
Electronics Pvt. Ltd for 2010 Asian Games and 2010 Youth Olympic Games.
Therefore, the Assessing Officer (AO) formed an opinion that the assessee had carried
out the activities for the purposes of general public utility in the nature of
trade, commerce or business. The AO further formed a belief that this
transaction of the assessee was in the nature of rendering services in relation
to business of Samsung in lieu of consideration from Samsung India Electronics
Pvt. Ltd. The AO was convinced that
proviso to section 2(15) of the Act squarely applies and hence the assessee
does not fall within the category of ‘charitable organisation’. Accordingly,
benefit u/s. 11/12 of the Act was denied to the assessee. Being aggrieved, the
assessee carried the matter before the first appellate authority and reiterated
that the proviso to section 2(15) of the Act does not apply in the case of the
assessee and the AO had wrongly denied claim of exemption u/s. 11/12 of the
Act.

HELD

The
Tribunal allowed the assessee’s appeal and held as under:

1. On drawing support from the speech of the Finance Minister and
subsequent clarification issued by the CBDT within the framework of amended
provisions of section 2(15) of the Act, the Tribunal was of the view that an
object of public utility need not be an object in which the whole of the public
is interested. It is sufficient if well defined section of the public benefits
by the objects which means that the expression “object of general public
utility” is not restricted to objects beneficial to the whole mankind.

2. Receiving sponsorship is not a part of any business carried out by
the appellant. Merely receiving sponsorship from a business entity cannot
tantamount to a conclusion that the assessee has entered into a business
activity with such sponsorer.

3. The Hon’ble ITAT relied on the following decisions:

(a) CIT vs. Swastik Trading Co. Ltd. (113 ITR 852) wherein it was
held that establishing and maintaining Gaushalas and Panjrapole constitutes
charitable purpose.

(b) ICAI vs. Director General of Income Tax (Exem) (347 ITR 99)
where ICAI which was denied exemption u/s. 10(23C)(iv) of the Act because in
the opinion of the DGIT (Exem.) the institute was holding coaching classes and
therefore was not an educational institution. The Hon’ble Delhi High Court held
that the order denying the exemption was not valid.

Thus, in the Tribunal’s opinion, there was no material
which may suggest that the assessee association was conducting its affairs
solely on commercial lines with the motive to earn profit. There was also no
material which could suggest that the assessee association had deviated from
its objects which it had been pursuing since past many decades. The proviso to
section 2(15) of the Act was not applicable to the facts of the case and the
assessee-association deserved benefit u/s. 11/12 of the Act.

shailesh.kwebmaker

Section 234A – When the taxes have been deposited before the original due date of filing of return of income even though the return has been filed within the extended due date so notified by the CBDT, there would not be any levy of interest u/s. 234A where the returned income has been accepted or where the taxes deposited are higher than the taxes finally determined by the AO.

22. [2018] 196 TTJ 768 (JP – Trib.) Rajasthan State
Mines & Minerals Ltd vs. ACIT ITA No.: 47/Jp/2018
A.Y.: 2014-15.Dated: 24^th October, 2018

Section
234A – When the taxes have been deposited before the original due date of
filing of return of income even though the return has been filed within the
extended due date so notified by the CBDT, there would not be any levy of
interest u/s. 234A where the returned income has been accepted or where the
taxes deposited are higher than the taxes finally determined by the AO.

FACTS

The
due date of filing of return of income for A.Y.2014-15 was extended by the CBDT
vide its order u/s. 119 from 30.9.2014 to 30.11.2014. The assessee filed the
return on 28.11.2014. The assessee had paid self-assessment tax well before the
original due date of filing return of income. The AO while working out the
interest u/s. 234A had not given credit of self-assessment tax paid by the assessee.
Aggrieved by the assessment order, the assessee preferred an appeal to the
CIT(A). The CIT(A) confirmed the same.

HELD

The
Tribunal followed the ratio of the Hon’ble Supreme Court decision in the case
of CIT vs. Pranoy Roy & Anr. (2009) 222 CTR (SC) 6 wherein it was
held that the interest u/s. 234A of the Act on default in furnishing return of
income shall be payable only on the amount of tax that has not been deposited
before the due date of filing of the IT return for the relevant assessment
year. The Tribunal relying upon the judgement of Hon’ble Supreme Court, held
that where the taxes deposited before filing the return of income were more
than the taxes finally determined on regular assessment, the interest u/s. 234A
was held not leviable.

shailesh.kwebmaker

Section 271AAA r.w.s 132 and 153C – Where no search and seizure operation u/s. 132(1) was carried out in assessee’s case, initiation of penalty proceeding u/s. 271AAA by Assessing Officer was invalid.

21. [2018] 196 TTJ 812 (Mumbai – Trib.) DCIT vs. Velji
Rupshi Faria ITA No.:
1849/Mum/2017 A.Y.: 2008-09 Dated: 31^st August, 2018

Section
271AAA r.w.s 132 and 153C – Where no search and seizure operation u/s. 132(1)
was carried out in assessee’s case, initiation of penalty proceeding u/s.
271AAA by Assessing Officer was invalid.

FACTS

The assessee was
an individual and stated to be the key person pursuant to a search and seizure
operation u/s. 132(1) of the Act in certain business concerns. The Assessing
Officer (AO) initiated proceedings u/s. 153C of the Act against the assessee.
Pursuant to the notice issued u/s. 153C of the Act, the assessee filed its
return of income. During the assessment proceedings, the AO referring to the
incriminating material found in course of search and seizure operation made a
number of additions. While completing the assessment, the AO also initiated
proceedings for imposition of penalty u/s. 271AAA of the Act. And then passed
an order on 13^th March 2014.

Aggrieved
by the assessment order, the assessee preferred an appeal to the CIT(A). The
CIT(A) after considering the submissions of the assessee and having found that
search and seizure operation u/s. 132(1) of the Act was not carried out in case
of the assessee, followed the decision of the Tribunal, Ahmedabad Bench, in
case of Dy. CIT vs. K.G. Developers, ITA No.1139/Ahd./ 2012, dated 13^th
September 2013, and deleted the penalty imposed.

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

HELD

The
Tribunal held that only in case of a person in whose case search and seizure
operation u/s. 132(1) of the Act was carried out on or after 1^st Day
of 2007 but before the 1^st Day of July 2010, penalty proceedings
u/s. 271AAA of the Act could be initiated. The primary condition for initiating
penalty proceeding was, a person concerned must have been subjected to a search
and seizure operation u/s. 132(1) of the Act. In present case, no search and
seizure operation u/s. 132(1) of the Act was carried out. Thus, the primary
condition of section 271AAA of the Act remained unsatisfied. Even otherwise
also, if penalty proceedings u/s. 271AAA of the Act was initiated against a
person who was not subjected to search action u/s. 132(1) of the Act, the
provision itself became unworkable as no declaration u/s. 132(4) of the Act was
possible from any person other than the person against whom the search and
seizure u/s. 132(1) was carried out. In the end, the Tribunal upheld CIT(A)
order.

NOTE:
Section 271AAA was applicable for searches u/s. 132(1) initiated prior to the 1^st
day of July, 2012. For searches initiated on or after the 1^st day of
July, 2012, section 271AAB shall be applicable.

shailesh.kwebmaker

INTERVIEW – N. R. NARAYANA MURTHY

In celebration of its 50th Volume, the BCAJ has brought a series of interviews with people of eminence, those whom we can look up to as outstanding professionals.

The fifth interview in this series features Mr N. R. Narayana Murthy, co-founder of Infosys, one of the top ten Indian companies by market capitalisation. Mr Murthy is known for his entrepreneurial journey of setting up a hugely successful IT company in the times of anti-business government controls. He is perhaps better known as a fine human being and someone who brings ideas that India needs the most. He guides several companies as Board member and numerous educational and philanthropic institutions such as INSEAD, Cornell University, etc. He is well known for a committee he headed on Corporate Governance. Integrity, character, simplicity and discipline are some of the values his life exemplifies. He was awarded Padma Vibhushan, the second highest civilian award for ‘exceptional and distinguished service’. He continues to inspire professionals, entrepreneurs and youth. Considering his time constraints, BCAJ sent him five questions to receive written answers from him. We hope you enjoy these pearls from this oyster of a man.

Values in Business: If you can tell us about the factors that helped build a strong value system personally and at Infosys. Were there instances in your formative years that left a strong impression? What steps did you take to ensure that it stayed deep and strong?

A community makes the desired economic progress with equity and dignity for all only when every member of the community follows a certain code of conduct agreed upon after detailed consultation with experts in a society. Such a set of norms for behaviour is what is termed a value system. Such a set of norms enhances the trust and confidence of each member of the community in every other member of the community and in the value system. When there are lacunae in this set of norms, it is the duty of the elite, the rich, the powerful and the influential people to fight and change the norms. This task cannot be taken up by the weak, the poor and the marginal people.

When confidence and trust are high in the set of norms in a community, then such a community faces no bottlenecks to progress like corruption, nepotism, and inefficiency. Therefore, progress is likely to be fast in such a community.

There were several events which taught us, at Infosys, the importance of values. We learned from each instance and bettered ourselves.

The best instrument a leader has to instill a good value system is leadership by example, walking the talk and practising the precept. Employees are watching a leader every minute they are in contact with him or her. They want to imitate him or her since he or she is a powerful role model for them. It is very important for our corporate leaders to demonstrate their compliance with the agreed upon values in every transaction. It is also necessary for the leaders of capitalism in India to practice self-restraint in arrogating for themselves a disproportionate percentage of the fruits of labour in a corporation.

Fairness, transparency and accountability in senior management compensation are a must. They have to lead an austere life shunning vulgar display of wealth and power if they want capitalism to become strong in India.

The leaders have to tell stories from their own company where they ensured that good values indeed succeeded and how they made sacrifices to overcome huge problems they faced using the right methods.

Financial Figures: As a leader of Infosys – you would have to deal with numbers all the time – what was it that you always looked at from what may seem like a maze – your tools and rules?

Being an engineer, I have been a numbers man all my life. I am also comfortable in connecting the 50,000 feet bird’s eye view of the world with the ground level worm’s eye view of the world. In other words, I am comfortable both with strategy formulation and overseeing a detailed execution plan to achieve the strategy. That is why our annual strategy conference has been called (right from the early days) as STRAP (Strategy and Action Plan). Strategy takes a week to formulate but implementing that strategy successfully takes 3 years.

This country has made a science of lack of integrity, nepotism, ignoring meritocracy, poor work ethic, lack of discipline, corruption, putting the interest of an individual ahead of the country, and not caring for the commons. Unless a leader like Mahatma Gandhi emerges to lead cultural transformation, I do not see India can redeem her pledge to the founding fathers.

Therefore, in running a company, it is first important to decide what your strategy is. My strategy has always been to bring innovation in every function of the organisation to differentiate ourselves from our competitors to provide a better value to our customers, charge 20% to 25% higher prices, and obtain industry-leading operating margins (this was true as long as I was the Executive Chairman of the company till 2011; I do not know what it is now). Every business has about 5 to 7 levers that you can tweak to achieve your objectives. I focused my attention only on the US GAAP figures since our revenue was 98% from abroad. Some of the parameters I looked at were: revenue growth (on-site and off-shore), utilisation of professionals (on-site and off-shore), ratios of the number of senior, middle and junior people on-site and off-shore, spend on sub-contractors, gross margins (on-site and off-shore), cost of business enabler functions as a percentage of revenue, per-capita revenue productivity, per-capita after-tax dollars added, number of innovations added, cost per innovation and ratio of after-tax dollars to cost in dollars of such innovation, attrition, brand and compliance.

Corporate Governance: You headed the SEBI committee. In light of all that is going on (IL&FS, ICICI, NPA mess, economic offenders getting away) – How do you see the state of Corporate Governance in India today? More specifically the role of Executive Directors, Independent Directors and Auditors in particular – what are we still missing?

While SEBI has done a good job in attempting to improve corporate governance standards in India, the Indian culture has not allowed their efforts to succeed as much as they would want. The primary requirement for sustainable Indian economic growth to ensure that the poorest child in the remotest part of the country has decent access to education, healthcare, nutrition and opportunity for betterment is the cultural transformation of the country. This country has made a science of lack of integrity, nepotism, ignoring meritocracy, poor work ethic, lack of discipline, corruption, putting the interest of an individual ahead of the country, and not caring for the commons. Unless a leader like Mahatma Gandhi emerges to lead cultural transformation, I do not see India can redeem her pledge to the founding fathers.

The value of independent directors and success of governance depends on a courageous, value-based, tough, intelligent, detail-oriented and hard-working chairman who leads by example. Such people are rare in this country. Unless there is a non-executive chairman who has the attributes that I spoke about earlier and whose stature is high enough that the CEO operates under his or her governance instructions, governance is unlikely to succeed. The companies where the board is subservient to the CEO will sooner or later fail as we have seen what happened in many well-known companies in India.

How do we improve the quality of independent directors? There must be a school established by SEBI to teach the basics of governance and business (various sectors of the economy) to those who want to be independent directors. Only those who obtain 80% marks in an examination conducted by an international professional body should be given licence to practice as independent directors. This certification should be valid for just five years and the independent directors should be recertified once in five years. When there is an issue of misgovernance in a company, the certificates of all the independent directors including the chairman should be withdrawn for ten years and they should be punished very severely. Those directors who are found not guilty should get recertified.

Success: How do you define and see success? Has it changed over the years and how?

Success to me is the ability to bring a smile onto the face of people when you enter a room. They smile not because you are rich, powerful, beautiful but because you are for them. I follow the following words of Ralph Waldo Emerson :

“To laugh often and much; to win the respect of intelligent people and the affection of children; to earn the appreciation of honest critics and endure the betrayal of false friends; to appreciate beauty; to find the best in others; to leave the world a bit better, whether by a healthy child, a garden patch, or a redeemed social condition; to know even one life has breathed easier because you have lived. This is to have succeeded.”

If one were to find you on a nice and easy day – what would you be doing at home, Sir?

I would be reading a book on mathematics or physics or computer science and listening to music – Western classical, Carnatic classical, Hindi and Kannada film songs.

shailesh.kwebmaker

BCA JOURNAL @50 – HISTORY OF THE LAST 10 YEARS

The
Bombay Chartered Accountant Journal (BCAJ) is the only offering of the the
Bombay Chartered Accountants’ Society (BCAS) that reaches members and
subscribers every month. Contributed entirely by volunteers, it has been doing
so for the past fifty years. From the days of cyclostyled bulletins in 1950 to
bi-monthly printed bulletins as a source of Tribunal decisions in 1962 to the
first printed and bound Journal in 1969 of 40 pages at a subscription of Rs.
18/year, the BCAJ has blazed the trail over these fifty years.

History
of the first forty years of the BCAJ was published in the July 2009 (40^th
Year of the BCAJ) by the then Editor Gautam Nayak. In the same vein, this piece
seeks to give a snapshot of the last ten years.

THE FIFTH DECADE
(2009-10 TO 2018-19)

This
decade saw four Editors – Gautam Nayak (till July, 2010), Sanjeev R. Pandit
(2010-11 to 2012-13) Anil J. Sathe (2013-14 to 2016-17) and this writer since July, 2017.

This
decade saw numerous and frequent changes. It saw amendments to company law in
the aftermath of Satyam fraud, settling down of VAT regimes across India and
end of State Sales Tax, XBRL, Citizens Charter by the tax department,
establishing of Income tax Ombudsman, strengthening of RTI, proliferation of
ERPs, Vodafone dispute and retrospective amendments, thrust on Corporate
Governance, FCRA amendments, increasing size of service tax law, Digital
Certification, Cloud Computing, focus on family-managed companies in a
globalising economy, Stock Options, Companies Act revamp and a new 2013 Act,
Transfer Pricing, CAs practising under LLP, Competition Law, FATCA and CRS,
BEPS, NCAS, AAR, GAAR, CSR, Ind AS, IBC, GST, NFRA and such other changes.

New features

New
features that were started in this decade included Risk containing case
studies by Dr. Vishnu Kanhere from May, 2009. It contained practical content,
as risk management was the buzz word. SAP and Fraud was written by
Chetan Dalal from October, 2009, which was an extension of his earlier series
on fraud detection. This was to arm the CAs with tools to use in an ERP
environment. Auditing Standards by Bhavesh Dhupelia and Shabbir
Readymadewala highlighted important points of the revised standards on auditing
and their practical impact. In 2009-10, BCAJ started a feature called Indirect
Taxes – Recent Decisions penned by Bakul Modi and Puloma Dalal. In
2012-13 – Ethics and You penned by C. N. Vaze was started to address the
need to keep the focus on ethics in a light yet effective manner. A new feature
Student Forum with a view to encourage the next generation was started
with contributions from students. With opening up of the economy, more global
reporting and the imminence of IFRS coming to India – Jamil Khatri and Akeel
Master wrote regularly in a feature titled IFRS. A column to cover
building blocks of the evolving GST law was started under the title Decoding
GST by Sunil B. Gabhawalla, Rishabh Sanghvi and Parth Shah. Statistically
Speaking was introduced to draw attention to some key indicators with Parth
Shah and Akshata Kapadia as first compilers. In July, 2018, a bi-monthly series
Tech Mantra was started with Yazdi Tantra as its contributor. FEMA
Focus was started in October, 2018 to bring out brief analysis of changes
in foreign exchange law including compounding orders authored by Bhaumik Goda
and Saumya Sheth. All other features such as Tribunal News, In the High Courts,
From Published Accounts, VAT and others continued as usual.

Articles

The
articles that appeared showcased burning issues of the times. Rotation of
Auditors in the aftermath of Satyam fraud by P. N. Shah; articles on Female
Rights in HUF by M. L. Bhakta; articles on IPR laws by Aditya Thakkar are few
of the examples. A series of six articles on M&A was contributed by Krishna
Chaturvedi and Vijay Iyer as M&A was the flavour of the time. A series on
Transfer Pricing was also carried out considering its increasing importance.
Family-managed companies going the professional way and double-dip recession by
Rajaram Ajgaonkar; Lawyers Duties and Accountability by Senior Advocate S. E.
Dastur brought about matters beyond the regular tax and audit subjects.
Articles by Sriraman Parthasarthy on audit were especially noteworthy, as they
covered contemporary issues with usable content. N. M. Ranka wrote a series
articles titled Rules of Interpretation of Tax Statutes. Building the Firm of
the Future by Dr. Lee Fredericksen was an especially admired article giving
numerous graphical data points.

The
young Shantanu Gawade, age 14 years, spoke at BCAS and his talk on “Ethical
Hacking and Cybercrimes” was published in the form of a report in the December,
2011 issue.

Editorials and Other Content

Editorials
continued to speak objectively, emphatically, and fearlessly. A number of
cartoons were brought out during this decade too – depicting what words couldn’t
have. Every feature writer and President – whether writing their monthly page
or digesting cases or giving commentary on cases or laws – did so with purpose
and passion, some summarising, others detailing or analysing – each one doing
it with exactitude and calibre.

Digital Push: BCAJONLINE.ORG

Reading
a professional journal in print format has remained in vogue. However, a
digital platform has its own benefits. A CD containing Journals from 2000 to
2011 was brought out earlier. A web version was thought imperative. The Journal
got its dedicated website in April, 2014, containing full text of all journals
published since the year 2000. This facilitated search of the Journals for
specific topics or authors or articles. A flip book version was also started in
April, 2017.

Printer

BCAJ
was printed since 1970 by Vijay Mudran run by Madhav Kanitkar, who after 40
years of association with the BCAS was not only a well wisher but also
complemented the editor with his observations. He would make numerous
suggestions and took great care of the BCAJ. In February, 2010 BCAJ switched to
Spenta Multimedia when Vijay Mudran suddenly discontinued their operations.
Along with the change of the printer BCAJ reviewed its font size, cover page,
and structure to ensure that these were contemporary and more reader friendly.

Interviews

The
July, 2010 Annual Special Issue carried an interview of Justice Ajit P. Shah
pertaining to law and the legal system and challenges before the judiciary such
as judicial appointments, tribunalisation, arbitration and mediation, RTI, and
the criminal justice system. The July, 2012 Annual Special Issue covered an
interview of film star Anupam Kher, who shared his professional journey and
lessons learnt along the way. The golden jubilee year 2018-19 saw six
interviews described later.

GST

As the
advent of GST was becoming imminent, numerous articles around model GST law to
GST/VAT in other countries were brought out. Welcome GST articles carried the
theme to bring readers abreast with the grandest tax change India was to see.

July,
2017 marked the arrival of Goods and Services Tax. BCAJ decided to carry its
Annual July Special Issue containing 21 Articles on GST without any of the
regular features. This was perhaps done only once earlier in 1993. More than
19,000 copies (including normal subscription) of this Special Issue were
printed and several subscribers booked additional copies in advance. The issue
was released at the hands of the Hon. Union Cabinet Minister Piyush Goyal, a Chartered
Accountant. This was the highest circulation number of the Journal.

Surveys

A
survey on Practice Management was conducted in October, 2015, on a number of
data points of fee scales, billable hours, gross fees, profit per partner,
etc., comparing these with similar figures in the USA. This was perhaps the
first one of its kind in the Journal. Another survey was conducted on Practice
Management in August, 2018 and the results printed in September, 2018. BCAJ
also carried out a Survey on BCAJ itself, to obtain data points on reader
expectations in January, 2018. 95% of respondents answered YES to the question
on satisfaction with overall coverage of topics. 50.5% respondents spent more
than two hours reading the journal every month. Heartening indeed!

Subscription

The
BCAJ cover price has remained the same in all the 10 years: Rs. 1200 per year
or Rs. 100 per copy. This was nothing short of remarkable. This is possible
solely because of consistent voluntary contributions by several professionals
over the years. Members and readers have always remained the centre point and
focus of the Journal.

Losses

In
these ten years, BCAJ lost its biggest supporters: past editor Bhupendra V.
Dalal (2014), publisher Narayan K. Varma (2015) and contributor to 50 plus
Namaskaars Pradeep A. Shah (2017).

Books developed from BCAJ
content

The
BCAJ churns out vast amounts of content. Four books took shape out of the BCAJ
articles series – “Laws and Business” (by Anup P. Shah), “Novel and
Conventional Methods of Audit, Investigation and Fraud Detection” (by Chetan
Dalal), Namaskaar ki Bhet (in two parts in 2011 and 2015) and an E book “Rules
of Interpretation of Tax Statutes” (by N. M. Ranka).

Annual special issues, best article & best feature awards

Year	Theme of Annual Special Issue	Best Article and Awardee/s	Best Feature and Awardee/s
2009	40^th Year of the BCAJ	Kirit S. Sanghvi for “Simplicity and Complexity”	Jayant M. Thakur for “Securities Laws”
2010	Profession the way forward	H. Padamchand Khincha & B.R. Sudheendra for “Carry forward and set off of MAT Credit u/s.115JAA- Allowability in the hands of the amalgamated company- A Case Study”	Jamil Khatri & Akeel Master for “IFRS”
2011	Family managed businesses	Atiff Khan for “ Understanding Islamic Finance”	Pradip Kapasi & Gautam Nayak for “Controversies”
2012	Professionals	Ajit Korde CIT for “What does Settlement mean”	Govind Goyal & C.B. Thakkar for “VAT”
2013	Accountability of Professions	Sriraman Parthasarathy for “Auditor Dilemma”	Bakul Mody and Puloma D. Dalal for “Service Tax”
2014	Future of India –perspectives of the youth	Ankit V. Shah & Tarunkumar Singhal for “Power of the tribunal to stay demand beyond 365 days”.	Bhavesh Dhupelia, Shabbir Readymadewala & Vijay Mathur for “Auditing standards”.
2015	Ethics	Yogesh Thar & Anjali Agarwal for “Domestic Transfer Pricing”	C.N. Vaze for “Ethics and You”
2016	Expectations	Aditya Thakkar for “Territorial jurisdiction Infringement of Copyright and/or trademark”	Keshav Bhujle for “In the High Courts”
2017	GST	Gautam Nayak & Pradip N. Kapasi for “Demonetisation-Some Tax issues”	Anup P. Shah for “Laws and Business”
2018	Audit & Assurance	Akeel Master and Rupali Adhikari Sawant for “Artificial Intelligence Embracing Technology – New Age Audit Approach”	Sunil Gabhawalla, Rishabh Singhvi & Parth Shah for “Decoding GST”

Year

Theme of Annual Special Issue

Best Article and Awardee/s

Best Feature and Awardee/s

2009

40^th
Year of the BCAJ

Kirit S. Sanghvi for “Simplicity and Complexity”

Jayant
M. Thakur for “Securities Laws”

2010

Profession
the way forward

H.
Padamchand Khincha & B.R. Sudheendra for “Carry forward and set off of
MAT Credit u/s.115JAA- Allowability in the hands of the amalgamated company-
A Case Study”

Jamil
Khatri & Akeel Master for “IFRS”

2011

Family
managed businesses

Atiff
Khan for “ Understanding Islamic Finance”

Pradip
Kapasi & Gautam Nayak for “Controversies”

2012

Professionals

Ajit
Korde CIT for “What does Settlement mean”

Govind
Goyal & C.B. Thakkar for “VAT”

2013

Accountability
of Professions

Sriraman Parthasarathy for “Auditor Dilemma”

Bakul
Mody and Puloma D. Dalal for
“Service Tax”

2014

Future
of India –perspectives of the youth

Ankit
V. Shah & Tarunkumar Singhal for “Power of the tribunal to stay demand
beyond 365 days”.

Bhavesh
Dhupelia, Shabbir Readymadewala & Vijay Mathur for “Auditing
standards”.

2015

Ethics

Yogesh
Thar & Anjali Agarwal for “Domestic Transfer Pricing”

C.N.
Vaze for “Ethics and You”

2016

Expectations

Aditya
Thakkar for “Territorial jurisdiction Infringement of Copyright and/or
trademark”

Keshav
Bhujle for “In the High Courts”

2017

GST

Gautam
Nayak & Pradip N. Kapasi for “Demonetisation-Some Tax issues”

Anup
P. Shah for “Laws and Business”

2018

Audit
& Assurance

Akeel
Master and Rupali Adhikari Sawant for “Artificial Intelligence Embracing
Technology – New Age Audit Approach”

Sunil
Gabhawalla, Rishabh Singhvi & Parth Shah for “Decoding GST”

Golden year – 2018-19

Unlike
in the past, special content was featured all through the year as GOLDEN
CONTENTS. BCAJ interviewed eminent professionals Y. H. Malegam and Zia Mody;
investor Rakesh Jhunjhunwala; Tata Group Director Ishaat Hussain, tech
entrepreneur N. R. Narayana Murthy and the leadership of Institute of Internal
Auditors, Naohiro Mouri and Richard Chambers. Volume 50 carried 6 interviews,
31 Special Articles, 6 View and Counterview, a survey, Kaleidoscope on CAs,
Spoof, Blast from the Past and this article on history under the Golden
Contents. Articles ranged from Succession, Audit, Investments, Insolvency Law,
GST, CSR, musings, to auditor resignations amongst others. The Survey on
Practice Management ranked key challenges faced by practitioners. View and
Counterviews brought out two sides of current topics such as NFRA, Fair Value
Accounting, etc.

BCAJ
will publish a Digital version of the entire Golden Contents in the free access
section of the website – to commemorate the fabulous fifty years.

Spirit of BCAJ: Volunteering

The
Journal is run on a pro bono basis by professionals committed to the
cause of BCAS by volunteering to share their knowledge with their fraternity.
The Journal Committee is the only committee of the BCAS that meets every month
to review the Journal and to brainstorm and review the content. The Editorial
Board meets quarterly or more to review policies and larger themes. The yearly
Marathon Meeting of all feature writers of the Journal is generally held in
January to review yearly statistics and analysis and to give a critique on the year
gone by. As you will read in the following pages, people have been contributors
for 10-15-20 to over 30 years sharing knowledge and giving time, month on
month, year on year. We salute them all!

shailesh.kwebmaker

MAY THE GOLDEN GLOW GROW

The 50^th Volume is culminating
with this issue, but another extraordinary journey of the BCA Journal starts
next month. The task of the BCAJ will never end. Golden content will end with
this issue, but the glow must continue. Some things have no end – time, service
to fellow humans and quest for knowledge. Hope you will enjoy reading the
special content this issue carries.

As I was preparing and compiling material
contained in the following pages I was overwhelmed by the volunteers, who have
contributed month on month for years on end. Only one thing stands out –
commitment. I got to speak to several of the feature writers, and their central
objective was – how to benefit the readers! Just as this Sanskrit poetry says

Let
us always remember,

Let
us repeatedly speak out:

Our
duty is to do good to humanity.

The
Journal through its work of spreading knowledge serves the nation. Each one can
only serve a part, and that part is part of the whole. That way we serve the
whole. Do read the poem Jal Dastur, wrote in 2001 titled Always India in 43
verses. Our endeavour should be to build and serve the nation which is still
young but stands on the bedrock of the oldest living civilisation.

Our BCA
Journal in these fifty years has created a vast Vaangmay (a body of content/knowledge). It has presented Vichaar (thought, counsel, consideration of mater), Vishleshan (Analysis),
Vivechan (examining deeply, critical evaluation), Vaktavya (a statement fit for saying), Vistaar (elaboration and
detailing), Vitaran (Transference or distribution of knowledge), provided Vikalpa (alternatives), shown
a Vidhi (process,
of how to go about), which has resulted in
Vardhan (foster, increase) of
capabilities of the readers. This has led to Vidvatta , Vitta and Vinay (Scholarship, wealth and humility).

Thank
you, contributors! BCAJ is an example of owners working and workers owning. As
you will read below each column, contributors have truly owned their column and
therefore the journal, and have worked so hard year after year, month on month pro
bono.

The
difference between past and future is that future is not known and yet it is
arriving for sure. Future is coming faster than we are going towards it. What
will BCAJ be like at 75? Will BCAJ have AI as its editor? Perhaps one might be
able to take a capsule of the journal and it will transfer and register all of
the content in a reader’s brain! Or we might have a wearable and we will be
able to see and simulate various propositions given in the Journal simply by
thinking about it! It’s more likely that domains will be embedded in technology
and not otherwise. Perhaps there will be BCAJ Alexa whom you can speak to and
ask what you want? Who knows? But one thing is for sure that the essence of the
Journal will always be to share and serve. No matter what is in store for us,
we will cross every challenge and cover the distance:

Everything we have learnt will surely become
less useful with time. We will have to learn more but that learning will last
for lesser and lesser time. The ratio of relearning will be based on unlearning
/ past accumulation. Professionals will then be transformational officers –
transforming themselves faster and certainly more than transforming
others. That way of growing will be the
real golden glow! May it continue to grow!

Raman Jokhakar

Editor

shailesh.kwebmaker

FRIENDSHIP

It was launched in January, 2003, with a
purpose to express the need for balance in a CA’s life. It is meant to cover
topics that are strictly non technical and non professional but high on deeper
aspects of life such as values and spirituality. The first Namaskar was written
by Narayan Varma and since then countless people belonging to a wide spectrum
of backgrounds have written Namaskaars.

Two compilations of Namaskaars titled
Namaskar ki Bhet were published in 2011 and 2015 respectively. BCAJ owes a shaashtang
namaskar (full prostration) to Pradip A Shah who has written more than fifty
Namaskars. K C Narang has been reviewing them for a long time. To the
contributors – past, present and future – our Namaskaars!

FRIENDSHIP

Sukha ke saba saathi, Dukha me na koy goes a popular Hindi song meaning – All give you company in your
happiness but in your adversity, all shun away!

The English proverb – ‘A friend in need
is a friend indeed’ is often quoted. But this ‘friendship’ has got another
angle in today’s materialistic world of competition, ego and one-upmanship.

About three to four generations back, the
intellectual middle-class lacked resources. They were struggling to settle in
cities after coming from villages and small towns. Most of the successful people
today in industry, films, performing arts or even in civil or corporate
services, have come from average financial background. They struggled together
to come up in life. They willingly shared their difficulties, doubts and
anxieties. They helped each other and there was an unwritten bond between them.
They suffered and rejoiced together.

Many of the business fields and professional
careers were virgin or untapped. Therefore, everybody had a scope to grow as
virtually there was no competition. The author believes that even today
opportunities are available to everyone as the cake is growing. However, some
of us perceive differently.

However, in last two or three decades,
middle-class has arrived at a different level. By and large, they are
resourceful. There is competition in every sphere of operation. In addition due
to technology, people have become isolated like islands. Now the ‘friendship’
is mainly on social media.

Ego, envy, jealousy and competition have
replaced love, affection and understanding. Competition is fierce. The real
questions are :

Whether one rejoices in the
success and achievements of another person?

Does one really feel happy
when one learns about another’s progress?

For example :

There was a group of poets who were very
close to each other. One of them got nominated for a national award. The other
members of the group virtually abandoned him. As luck would have it, he did not
receive the award (as some other nominee got it!) all the members of the group
again joined him!

In another instance three friends and
colleagues working under a not-so-good boss helped each other in work and in
solving issues. However, when one of them got promoted, the other two were
upset! They stopped helping him. Is this friendship!

This has become a common occurrence.
Although in public, we praise a winner or achiever, in private, we often
criticise him or comment on his defects. We may even express surprise as to how
he succeeded although, he did not deserve it!

Today’s scene is so vitiated that doubts are
always expressed about the sanctity of success. When an award or honour is
conferred, people feel ‘it is managed?’ They believe that it is
more attributable to factors other than merit.

There are instances where even a mentor is jealous
about his disciple’s success; and even father is jealous of his son. Sibling
rivalry has always existed and is more pronounced today.

In this situation, it is difficult to find a
person who stands by you in difficulty and shares your pain and pleasure – a
real `well-wisher’.

In Sanskrit Subhashit, one of the
attributes of a good friend is the one who really rejoices in your success!
Hence in the author’s view one is blessed to have a friend and one must always
reckon and remember the good old saying :

‘to
have a friend be a friend’

shailesh.kwebmaker

Section 194IA – The limit of Rs. 50 lakh in section 194-IA(2) is qua the transferee and not qua the amount as per sale deed. Each transferee is a separate income-tax entity and the law has to be applied with reference to each transferee as an individual transferee/person.

26. [2018] 101 taxmann.com 190 (Delhi-Trib.) Pradeep Kumar
Soni vs. ITO (TDS) (Delhi) ITA No.:
2739/Del./2015 A.Y.:
2014-15.Dated: 10^th
December, 2018

Section 194IA
– The limit of Rs. 50 lakh in section
194-IA(2) is qua the transferee and not qua the amount as per
sale deed. Each transferee is a separate
income-tax entity and the law has to be applied with reference to each transferee
as an individual transferee/person.

FACTS

The Assessing
Officer (AO) received information from the Sub-registrar that vide an agreement
registered on 3^rd July, 2013, the assessee along with 3 other
persons has purchased an immovable property for a consideration of Rs. 1.50
crore.

The AO observed
that the assessee was required to deduct tax u/s. 194-IA @ 1% and deposit the
same to the credit of the Central Government. He, accordingly, called for
information u/s. 133(6) of the Act. In response, the assessee submitted that
each of the four transferees have jointly purchased the property and the share
of every co-owner is Rs. 37.50 lakh which is less than Rs. 50 lakh and
therefore, the provisions of section 194-IA are not applicable. The AO held
that since the consideration for the transfer of immovable property is Rs. 1.50
crore, i.e. more than Rs. 50 lakh, and the same is executed through a single
deed and registered the provisions of section 194-IA are applicable. He passed
an order u/s. 201(1) and 201(1A) of the Act holding the assessee and three
other transferees to be jointly and severally responsible for payment of
taxes.

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

Aggrieved, the
assessee preferred an appeal to the Tribunal.

HELD

The Tribunal
noted that the sale deed inter alia provided that “the Vendees have
become the absolute and undisputed owner of the above said plot in equal
share.” It also noted that section 194-IA(2) provides that section 194-IA(1)
will not apply where the consideration for transfer of immovable property is
less than Rs. 50 lakh. It observed that section 194-IA(1) is application to any
person being a transferee, so section 194-IA(2) is also, obviously, applicable
only with respect to the amount related to each transferee and not with
reference to the amount as per sale deed. It noted that in the instant case,
there are four separate transferees and the sale consideration w.r.t. each
transferee is Rs. 37.50 lakh, hence, less than Rs. 50 lakh each.

It held that
each transferee is a separate income-tax entity therefore, the law has to be
applied with reference to each transferee as an individual transferee/person.
The law cannot be interpreted and applied differently for the same transaction,
if carried out in different ways. The point to be made is that, the law cannot be
read as that in case of four separate purchase deed for four persons
separately, section 194-IA was not applicable, and in case of a single purchase
deed for four persons section 194-IA will be applicable.

The Tribunal
noted that AO has passed a common order for all four transferees u/s. 201(1).
The Tribunal stated that this was to justify his action since in case of
separate orders for each transferee separately, apparently, provisions of
section 194-IA could not have been made applicable since in each case purchase
consideration is only Rs. 37.50 lakh. This action of the AO shows that he was
clear in his mind that with reference to each transferee, section 194-IA was
not applicable.

The Tribunal
held that the addition made by the AO and confirmed by CIT(A) to be not
sustainable in the eyes of law and deleted the same.

The appeal
filed by the assessee was allowed.

shailesh.kwebmaker

FAMILY SETTLEMENTS – PART II

We
continue with our analysis of family settlements….

Capital Gains Tax liability

Taxation
is always a key consideration in any transaction more so in a family settlement
which involves properties / assets changing hands. Under the Income-tax Act,
any profits or gains arising from the transfer of a capital asset are
chargeable to capital gains tax. Thus, the primary condition for levy of
capital gains tax is that there must be a “transfer” as
defined in section 2(47) of the I.T. Act. This primary condition must be
satisfied before a tax levy on a capital gain may come in (C.A. Natarajan
vs. CIT, 92 ITR 347 (Mad)). A family arrangement, in the interest of
settlement, may involve movement of property or payment of money from one
person to another. Several judgments have held that there is no “transfer”
involved in a family arrangement. Therefore, there is no question of capital
gains tax incidence under a family arrangement.

The
following principles emerge from various cases:

(a) The transaction of a family settlement entered
into by the parties bona fide for the purpose of putting an end to the dispute
among family members, does not amount to a “transfer”. It is not also
the creation of an interest.

(b) The assumption underlying the family arrangement is that the
parties had antecedent rights in all the assets and this proposition of law
leads to the legal inference that the same does not amount to any transfer of
title. Section 47 of the Income-tax Act excludes certain transfers and since
the family arrangement is not held to be a transfer, it would not require to be
listed in section 47 unlike a partition which is a transfer and had to be
specifically excluded from section 45. Since section 45 can apply only to
capital gains arising from transfers, family arrangements fall outside the
scope of section 45, in view of the legal position that a family arrangement is
not a transfer at all.

(c) In a family settlement, the consideration for
assets received is the mutual relinquishment of the rights in joint property
and hence, cost of assets received on settlement is the cost to the previous
owner.

(d) Even a married daughter can be made a
party to a family settlement between her paternal family members – State
of AP vs. M. Krishnaveni (2006) 7 SCC 365. If she surrenders shares
held by her pursuant to a family arrangement, then it would not be a taxable
transfer – P. Sheela, 308 ITR (AT) 350 (Bangl).

(e) In B.A. Mohota Textiles Traders (P.) Ltd.
[TS-234-HC-2017(BOM)], the Bombay High Court held that any transfer of
shares by a company would not be the same as transfer by its members even if
the transfer was pursuant to a family arrangement between the family members.

While
on the subject of income-tax, one should also bear in mind the applicability of
the provisions of section 56(2)(x) of the Income-tax Act, 1961, which treats
the value of certain property received without consideration / adequate
consideration by an individual donee as his income. The section applies to any
gift of cash, immovable property and certain types of movable property, such
as, shares, jewellery, arts and paintings, etc. While a gift between
specifiedrelatives is exempt, gifts received from other relatives is taxable.
Here an issue which arises is that whether an asset received from a non-defined
relative under a family settlement could be taxed under this section? Is not
the settlement of disputes a valid consideration for the receipt of the asset?
In this respect, the decisions in the case of DCIT vs. Paras D Gundecha,
(2015) 155 ITD 180 (Mum) andSKM Shree Shivkumar vs. ACIT(2014) 65 SOT 232
(Chen) have held that property received on family settlement is not
taxable u/s. 56(2).

Whether Registration and Stamp Duty is required?

One
of the main issues under a family settlement is that whether the instrument
which records the family arrangement between the family members requires
registration under the Registration Act, if it affects the rights or interests
in immovable properties. A natural corollary of registration is the payment of
stamp duty. Stamp duty is leviable as on rates as applicable on a conveyance.
In most states in India, the stamp duty rates on a conveyance are the highest
rates. For instance, in the State of Maharashtra, the rate of conveyance on
immovable properties is 5%. As with all principles which involve a family
settlement, the law relating to registration of family settlement instruments
have been laid down by various Supreme Court and High Court decisions. There
are no express decisions on the issue of whether stamp duty is leviable.
However, the decisions rendered in the context of the Registration Act are
equally applicable. The principles laid down by some important cases, such as, Ram
Charan Das vs. Girja Nandini Devi (1955) 2 SCWR 837; Tek Bahadur Bhujil vs.
Debi Singh Bhujil, (1966) 2 SCJ 290; K. V. Narayanan vs. K. V. Ranganadhan, AIR
1976 SC 1715; Chief Controlling Revenue Authority vs. Shri Abdul Karim Ebrahim
Balwa, (2000) 102 BOMLR 290, etc., are as under:

(a) If a person has an absolute title to the
property and he transfers the same to some other person, then it is treated as
a transfer of interest and hence, registration would be required.

(b) A family arrangement may be even oral in
which case no registration is necessary. The registration may be necessary only
if the terms of the family arrangement are reduced to writing. Here also, a
distinction should be made between a document containing the terms and recitals
of a family arrangement made under the document and a mere memorandum prepared
after the family arrangement has already been made either for the purpose of
the record or for information of the Court for making necessary mutation. In
such a case, the memorandum itself does not create or extinguish any rights in
immovable properties and is, therefore, not compulsorily registerable.

(c) A family arrangement, the terms of which may be
recorded in a memorandum, need not be prepared for the purpose of being used as
a document on which future title of the parties are founded. When a document is
nothing but a memorandum of what had taken place, it is not a document which
would otherwise require compulsory registration.

(d) A family arrangement as such can be
arrived at orally. Its terms may be
recorded in writing as a memorandum of what had been agreed upon between the
parties. The memorandum need not be prepared for the purpose of being used as a
document on which future title of the parties be founded. It is usually
prepared as a record of what had been agreed upon so that there be no hazy
notions about it in future. It is only when the parties reduce the family
arrangement to writing with the purpose of using that writing as a proof of
what they had arranged and, where the arrangement is brought about by the
document as such, that the document would require registration as it is then
that it would be a document of title declaring for future what rights in what
properties the parties possess.

(e) If a document would serve the purpose of proof
or evidence of what had been decided between the family members and it was not
the basis of their rights in any form over the property which each member had
agreed to enjoy to the exclusion of the others, then in substance it only
records what has already been decided by the parties. Thus, it is nothing but a
memorandum of what had taken place and therefore, is not a document which would require compulsory registration u/s. 17 of the Registration Act.

(f) Registration is
necessary for a document recording a family arrangement regarding properties to
which the parties had no prior title. In one case, one of the parties claimed
the entire property and such claim was admitted by the others and the first one
obtained the property from that recognised owner by way of a gift or by way of
a conveyance. On these facts, the Court held that the person derived a title to
the property from the recognised owners and hence such a document would have to
satisfy the various formalities of law about the passing of title by transfer.

(g) If the document itself creates an interest
in an immovable property, the fact that it contemplates the execution of
another document will not exempt it from registration u/s. 17(2)(v) of the
Registration Act.

(h) If the family arrangement agreement is required
to be registered and it is not so registered, then the same is not admissible
as an evidence under the Registration Act in proof of the arrangement or under
the Evidence Act. However, the same document is admissible as a corroborative
of another evidence or as admission of the transaction, etc.

(i) The essence of the matter is whether the deed
is a part of the partition transaction or merely contains an incidental recital
of a previously completed transaction.

Reorganisation of Companies and Family Settlement

Very
often a Family Arrangement also seeks to make the family controlled companies
(whether public or private) as parties thereto so as to make the arrangement
(so far as it relates to family shareholdings in such companies) to be
effective and binding. The moot point here is, when there is a family
settlement which involves reorganisation of some of the properties of one or
more companies in the Group, whether the principles of family settlement would
be applicable even to such reorganisation?
In other words, when there is a transfer of a property from a company to
another company or to an individual as a part of a family settlement, whether
it would be correct to say that there is no transfer of the property, and
therefore direct and indirect taxes would not apply? There is not much support
on this aspect.

The
decision of Sea Rock Investment Ltd., 317 ITR 253 (Karn), dealt
with the case of a company owned by the family members which was made a party
to the family arrangement and which transferred shares held by it to various
family members. The company claimed an exemption from capital gains by stating
that it was pursuant to a family arrangement. The High Court disallowed this
stand by holding that a Company was a separate legal entity distinct from the
family members and hence, it was liable to pay tax on this ground.

In
the case of Reliance Natural Resources Ltd vs. Reliance Industries Ltd,
(2010) 7 SCC 1, the Supreme Court held that a Family Settlement MOU,
signed by the key management personnel of a listed company, did not fall within
the corporate domain. It was neither approved by the shareholders nor was it
attached to the demerger scheme which demerged various undertakings from the
listed company. The Court held that technically, the MOU was not legally
binding on the listed companies.

It
is true that a company is a separate legal entity and has an existence
independent from its shareholders and therefore, in normal circumstances, the
property of a company cannot be treated as that of its shareholders. However,
as pointed out above in various Court judgments, Courts make every attempt to
sustain a family arrangement rather than to avoid it, having regard to the
broadest considerations of family peace, honour and security. If the principles
of family settlement are confined only to the properties owned by individuals
and not to those owned through corporate entities, then it would not be
possible to use the instrument of family settlement for settling disputes between
the members of the family and it would be necessary to go through the
litigations. It is submitted that a relook may be needed at the above decisions
or else we could have a plethora of family disputes clogging the legal system.

STAMP DUTY ON OTHER INSTRUMENTS

Sometimes,
the parties to a family settlement may implement it through other modes, such
as a Release Deed, a Gift Deed, etc. Although these are not family settlement
awards in the strict sense of the term, but in the commercial sense they would
also be a part and parcel of the family settlement. Hence, the stamp duty
leviable on such instruments is also covered below.

Release Deed

A
release deed is a document by which a person relinquishes his share or interest
in a property in favour of another person. Under Article 55 of the Indian Stamp
Act, a release attracts duty at Rs. 5. However, various states have enacted
their own amendments to this Article. Earlier, a release deed attracted only
Rs. 200. For instance, in the state of Andhra Pradesh it is 3% of the
consideration or market value whichever is higher.

The
Bombay High Court, in the case of Asha Krishnalal Bajaj, 2001(2) Bom CR
(PB) 629 held that a Release Deed is not a conveyance and only
attracted stamp duty as on a release deed. In the case of Shailesh
Harilal Poonatar, 2004 (4) All MR 479, the Bombay High Court held that
a release deed without consideration under which one co-owner released his
share in favour of another in respect of a property received under a will, was
not a conveyance. Accordingly, it was liable to be stamped not as a conveyance
but as a release deed.

To
plug this loophole, in 2005 the duty in the State of Maharashtra was increased
on such instruments to Rs. 5 for every Rs. 500 of market value of the property.
The 2006 Amendment Act has once again made an amendment in Maharashtra to
provide that if the release is without consideration; in respect of ancestral
property and is executed by or in favour of the renouncer’s spouse, siblings,
parents, children, children of predeceased son, or the legal heirs of these
relatives, then the stamp duty would only be Rs. 200. In case of any other
Release Deed, the duty is equal to a conveyance. Thus, for immovable
properties, it would be @ 5% on the market value of the property. What is an
ancestral property becomes an important issue. E.g., if a son releases his
share in a property acquired by his deceased father, so that his mother can
become the sole owner, it would not be a release of an ancestral property.

Similar
provisions are found under the Karnataka Stamp Act. The duty on a release deed
between family members, i.e., spouse, children, parents, siblings, wife of a
predeceased son or children of a predeceased child, is Rs. 1,000.

Gift Deed

Section
2(la) of the Maharashtra Stamp Act defines an “instrument of gift” to include,
in a case where the gift is not in writing, any instrument recording whether by
way of declaration or otherwise the making or acceptance of such oral gift. The
gift could be of movable or immovable property. The term gift has not been
defined and hence, one has to refer to the definition given u/s.122 of the
Transfer of Property Act, which is “a transfer of certain existing movable or
immovable property made voluntarily and without consideration.”

An
instrument of gift not being a Settlement or a Will or a Transfer attracts duty
under Article 34 of Schedule-I to the Maharashtra Stamp Act. A gift deed
attracts duty at the same rate as applicable to a Conveyance (under Article 25)
on the Market Value of the Property which is the subject matter of the
gift. Almost all States whether under
the Indian Stamp Act or under their respective State Acts levy duty at the same
rate as applicable to a Conveyance on the Market Value of the Property which is
the subject matter of the gift.

The
Maharashtra Stamp Act provides for a concession to gifts within the
family. Any gift of property to a family member (i.e., a spouse, sibling,
lineal ascendant / descendant) of the donor, shall attract duty @ 3% or as
specified above, whichever is less. However, if the gift is of a residential
house or an agricultural property and is to a spouse / child or a grandchild,
then the duty is a concessional sum of Rs. 200. In such a case, the
registration fees are also Rs. 200. Thus, there is a very large concession for
a gift of two types of properties, viz, a residential house or an agricultural
land made to six relatives. Both these conditions must be satisfied for the Rs.
200 concessional duty. For a gift of any other property made to any family
member, including these six relatives or for a gift of these two properties
made to any relative other than these six relatives, the concessional duty is
3% of the market value.

One
misconception often faced is the coverage of lineal ascendants – are females
covered? Can a grandmother, mother and son be treated as a lineal line? The
answer is yes, there is no requirement that lineal ascendancy or descendancy is
limited only to male members or to the same gender. All that is required is
relatives in a straight line. The definition under the Maharashtra Stamp Act is
not as wide as u/s. 56(2) of the Income Tax Act. The relatives covered u/s. 56
of the Income-tax Act but not under the Stamp Act are spouses of siblings;
uncles and aunts; spouses of one’s lineal ascendant / Descendant; lineal
ascendant /descendant of spouse and their spouses.

The
Karnataka Stamp Act, 1957 also provides for a concession for gifts
within the family of the donor. The duty is only a flat sum of Rs. 1,000 to Rs.
5,000 depending upon where the property is located. The definition of family
for this purpose means father, mother, husband, wife, son, daughter,
daughter-in-law, brothers, sisters and grandchildren of the donor.

The
Rajasthan Stamp Act, 1998 provides a concessional rate of 2.5% for gifts
in favour of father, mother, son, brother, sister, daughter-in-law, husband,
son’s son, daughter’s son, son’s daughter, daughter’s daughter. Further, in
case of gifts in favour of wife or daughter the stamp duty is only 1% or Rs. 1
lakh, whichever is less. stamp duty for a gift in favour of widow by her
deceased husband’s mother, father, brother, or sister or by her own mother,
father, brother, sister, son or daughter is Nil.

Epilogue

From
the above discussion, it would be obvious that our present laws relating to
income-tax, stamp duty, registration, etc., are inadequate to deal with family
settlement and, in fact, instead of facilitating the family settlement, they
may hamper it. This is all the more strange given the fact that a large number
of businesses and assets are family owned in India and hence, the possibility
of there being a family dispute is quite high! Hence, it is necessary to make
suitable amendments in various laws so as to facilitate family settlement.

shailesh.kwebmaker

ELECTORAL AND POLITICAL REFORMS

Elections are fundamental to democracy. Elections in India are in dire
need for reforms. In this article, the author, a professor at IIM, Bangalore
and Chairman of the Association of Democratic Reforms (ADR) shares his views.
The electoral system has many shortcomings and urgent reforms are the need of
the hour. To commemorate our 70^thRepublic Day, BCAJ requested him
to write for the Journal so that professionals can be better aware citizens.

ABSTRACT

We discuss as far as
possible the root causes of various problems in elections and democracy. The
different objectives of voters and parties is one such reason. Competitive
politics and the increasing role of money and crime is another. One section of voters
seems to vote on “identity” – caste, religion, language and so on. This makes
campaigns divisive. Some implications of the system beyond elections into the
financial sector are also discussed, and a small link established between
various economic and financial crises and the kind of elections and parties we
have. We propose a solution. The key is not the solution itself, but the
objective: reduce competition among parties, make things transparent, create a
system that unites the country, its citizens and politicians. After all, we all
belong to the same country.

In true democracy every man and woman is taught to think for himself
or herself.

– Mahatma Gandhi

The need for electoral reforms is felt by everyone. This includes
citizens, the Supreme Court, the Election Commission, government, media and
many well-meaning politicians. There is a long list of features that are good
about our democracy and an equally long list of things that need improvement.
Once in a while, it is important to step back and look at some basic issues and
discuss how these can be sorted out. What are the root causes of what we see in
elections and politics? We try to show that these basic issues lead to the
myriad problems we see during elections, the scams, problems in governance and
so on.

At the outset, we
need to recognise that we need elections and political parties. Without them,
democracy cannot function. In the Indian context, there are a few significant
stakeholders. First and foremost are the citizens or voters themselves. Second,
we have the politicians and political parties. To regulate them and conduct
elections, we have the Election Commission. Once in a while, the courts also
step in. They are required to see that the laws of the country are upheld. As a
check and balance, we have the media. Most important, to finance the elections
we have various funders.

We need to accept
and recognise two basic issues. One is that political parties and candidates
are committed to winning elections. That is a legitimate pursuit. The second
fact that we ignore is that elections cost money. We are not talking of the
money spent by the Election Commission. Candidates and political parties need
funds to contest elections. Merely pointing out scams and irregularities is not
enough. We need to ask a basic question: what is the root cause of these
problems?

One fundamental
issue is the basic divergence in the goals and expectations of two stakeholders
– the citizens and the political system. Citizens ultimately want good
governance. They want that the money they pay as taxes is properly utilised and
develops the country and the people. This includes a long list like education,
health, roads, water, garbage disposal, rural development, poverty eradication
and so on. ADR’s periodic national surveys reinforce this. One of the top
priorities of the people of India, for instance, is employment.

Political parties,
on the other hand, have one basic motivation – to win elections and be in
power. This is not the same as wanting to develop the country. There are no
doubt well-meaning politicians who want to do that. But the critical question
is: if development requires long-term work, but the next election is round the
corner, what would they do? Invariably, they choose “winnability” over all other
factors. For instance, creating employment for hundreds of millions is not easy
and would take a long time. It is easier to make promises and give various
subsidies and loan waivers.

Let us also look at
it from the politician’s point of view. An honest politician feels overwhelmed
by the competition. There is a huge amount of spending during elections by
other candidates, and all sorts of promises are made. He feels compelled to
compete with others on the same lines. It is said “spending money does not ensure
victory, but not spending any money ensures defeat”.

Of late the role of
money in elections has risen dramatically. This is similar to other democracies
around the world. There are some rules and regulations regarding this – limit
on the amount being spent is the principal rule under the law. But as everyone
knows, this is not followed. For instance, two former Chief Election
Commissioners have gone on record during their term in office to say that over
Rs.10,000 crores of cash was pumped into one State election alone.

No doubt voters have
become aware and take funds from many candidates and vote for the candidate of
their choice. But we miss the key question: whoever wins, has spent a lot of
money. So will he work for good governance or for recovering the funds spent?
Where will he recover it from?

In summary, the
political system is beholden to big money. We have had a series of corporate
scams recently. Not all are linked to political funding, but some are.

Let us look at the
other side – the voters. They have to choose between parties and candidates
presented to them. What do they do if they don’t like anyone? Recently, one
Trump appointee was embarrassed by a statement he had made attacking the
candidate Trump. He now says he had to choose him because he thought the
alternative was worse. This is often the predicament of the ordinary voters in
India. They have to vote for someone. Election after election shows that voters
vote out one party and in the next election vote out another party. Rarely do
we see the same party getting re-elected either at the State or even the
national level. In many States, they always change the party in power in every
election.

There are other
issues with “mass” voters as well. There are endless discussions on the caste
and religious factor in elections. In short, the identity-based voting and
politics. This has nothing to with India or the developing countries.
Identity-based voting happens all over the world, especially when there are
problems like joblessness, immigration and so on. The recent elections in the
US and the Brexit vote are more or less an outcome of lack of jobs and
immigration. The groups that feel they have lost out are usually based on one
race or language or social class even in the US and the UK. We do not comment
on whether this is right or not. Given the identity-based politics, it is but
natural that political parties will use it during campaigns. In India
particularly, the rhetoric on identity-based politics has steadily increased,
and the level of political debate gone down. The media channels and social
media are having a great time highlighting what one politician said about
another. Rarely do we see a seasoned discussion on the development of a
constituency, State or country. Why does this happen? Politicians feel that to
win they don’t have to do a great job – they simply have to defeat the other
candidates. If voters are moved by identity-based politics, so be it, they seem
to say. Another issue with voters is the accusation that they are also
short-term thinkers like the politicians. Some civil society voter awareness
campaigns say: A buffalo costs Rs. 35,000. Why do you sell your vote for Rs.
5,000? To be fair to voters, they choose between the lesser of many evils (not
to say that politicians are evil). They are also somewhat cynical because they
don’t see the kind of development they expect and feel that no matter who wins,
things will remain more or less the same. So why bother?

On the other hand,
there are a large number of well-to-do educated voters. In India as in other
countries, the voting percentage here is very low. India perhaps still does
better than other so-called advanced countries in terms of voting percentage.
The principal reason is that their own life is hardly affected no matter who
wins the elections. So why bother to vote? Also the feeling that my one vote
hardly makes a difference.

To summarise this
aspect: the fundamental difference in motivation and expectation between voters
and politicians has over time led to an increasing “distance” or cynicism. One
wants power, the other wants good governance. Power needs money and money has
its own logic. Those who fund elections expect returns from the winner, and
politicians who spend money expect to recover the funds they have spent.

A closely related
issue is transparency in funding. Till 2008, Income tax returns of political
parties were not publicly available. It took several years of struggle by ADR
to get these in the public domain. Next, the source of funding is still not
known. The accounting systems of political parties are not up to the standard
of a professionally-run company. Many in fact use the single entry cash-based
system – not a double entry accrual system. The accounts are not properly
audited. Once some degree of transparency was coming in, the doors were shut by
the Electoral Bond system. Now no one can find out who gave how much money to
which candidate or party. In other countries, this is public information. The
flaws of the Electoral Bond system require a separate lengthy discussion. It
has been challenged in the Supreme Court.

Along with money
power, there is the issue of crime in politics. Various Supreme Court judgments
and media coverage is ignored. Parties continue to field people with criminal
records. The Table below for the current Lok Sabha elected in 2014 shows that a
combination of crime and money increases the chances of getting elected. The
columns represent the politicians with a serious criminal record, those with
serious criminal record and assets of between Rs. 1 crore and Rs. 5 crore and
so on.

LS 2014	Total	Serious Crime	Ser Cr + 1cr	Ser Cr + 5cr	Ser Cr + 10cr
Winners	543	112	93	52	32
Candidates	8163	889	397	176	107
%	6.70%	12.60%	23.40%	29.50%	29.90%

As shown, the percentage of candidates who win increases steadily as the
crime and money combination increases. There are three key questions: can we
expect good governance when we have such MPs in Parliament? They belong to all
the various major political parties and their leadership knowingly gives
tickets to them. The second question is why do they give tickets to them? The
third question is why do voters elect them? This requires a lot of research.
Preliminary data show that parties field such candidates because of their
“winnability”. Voters are either unaware of the facts or have to choose between
the lesser of evils. Since political parties continue to indulge in the game of
money and muscle power without transparency, there is a need for political
party reforms. A citizen’s initiative led by a former Chief Justice of India
drafted such a Bill but no party is interested in passing it as of now.

Before we come to
possible solutions, let us look at the system that we have. No doubt it is a
democracy. But there are broadly four types of democracies with many variations
and permutations and combinations. One is the first-past-the-post system like
we have in India with a British Parliamentary way of electing a Chief Minister
or Prime Minister. The party or coalition with a majority elects their leader.
Second, we have the US Presidential system where the President and the Governor
of each State is directly elected by the voters. In India, we vote for the
local candidate, not for the CM or PM. The elected MLAs and MPs, in turn, elect
them. Third, we have the list or proportional representation system. Here each
voter in effect has two votes – one for a candidate and another for a party.
While candidates are directly elected as in other countries, the votes obtained
by a political party nationwide are then converted by a formula into additional
seats. For instance, in India, we increasingly see that the vote difference
between two parties is very small, but the seat difference is huge. In a few
cases, a party with more votes has even lost a State election (in Karnataka it
happened twice). The proportional representation system tries to correct this.
Fourth, we have the French system of run-off elections. They say anyone with
less than 50% of the votes cast is not a people’s representative. So the top
two candidates have a run-off election in the second round.

Each system has its
pros and cons. The Indian-British system is easy to understand for the ordinary
voter. But it has many negatives. The CM in almost every State has to placate
various interests within his or her own party (unless the CM is a mega
politician who single-handedly brings in all the votes). So we see Cabinet
reshuffles and many disgruntled MLAs. It has also contributed to the large
number of political parties that we have. Over 34 parties have at least one MP
in Parliament. While this can be taken positively as celebrating diversity,
winning elections at a local level means getting far less than 50% of the votes
cast. Over 200 MPs have less than 40% of the votes cast and many have won with
less than 30% votes. That is because there are so many parties and candidates
in each constituency. Even at the level of political parties, the winning party
usually gets between 25% and 32% of the national vote in Parliament. The votes
are greatly split, but power is not shared – it is with the ruling party or
coalition. This raises a fundamental question: whom does the Government
represent?

The US system of
direct elections is attractive to many groups. However, many others, including
the Constitutional Review Committee headed by a former Chief Justice of India,
and one former President and another Vice President have cautioned against it.
While it brings stability, it gives unbridled power to one individual with no
doubt some checks, and balances like between the Congress, the Senate and the
President in the US. The problem in India is that we are the most diverse
nation in the world. Dozens of languages, hundreds of dialects, hundreds of
castes, all the major religions in the world and so on. Each group wants some
representation. A via media may be to have this at the State level rather than
at the national level. But a lot more foresight about all the implications is
required before we change our system.

Many other groups
recommend the proportional representation (PR) system. In particular, the
Dalits, Muslims and the urban educated want this. For instance, BSP got nearly
15% votes in the 2014 national election but got 0 seats. With the PR system,
they would get between 30 and 70 seats depending on the formula used.
Similarly, the Muslim representation will go up and so on. Given our
heterogeneous country, each group will form a pan-India political party over
time and claim seats in Parliament and the State Assemblies.

The French system
was endorsed by a minority of commissions and thinkers. Some former CEC’s have
also said that it is easy to implement. The main argument in favour of it is
that no one can buy 50% of the votes and that too twice. The nature of
campaigns and politics has to become more inclusive as a result. The divisive
politics that we see today will come down. The downside according to some is
that it achieves nothing as the winner in the first round usually wins in the
second round as well. That may be true in France, but it remains to be seen how
it works out here.

Before we propose
any solution, one important aspect needs to be re-emphasised. We have nearly
2,000 registered political parties, and most States are governed by a regional
party. The voter is often faced with over a dozen candidates in the polling
booth, many of whom are Independents. The political calculation is then simple.
The candidate knows how many are on his side (committed) and how many are never
going to vote for him. He can concentrate on the swing voters. They can be
bought over, or promises made to win them over with freebies, subsidies,
distribution of mobiles, free rations, loan waivers and so on. He can attack
other candidates in increasingly vulgar terms. He can raise communal and caste
issues openly. But we need to understand that he is not really abusing others,
he is really appealing to his own voter base. Thankfully, the role of muscle
power and booth capturing is no longer there thanks to the Election Commission.
But there are other tricks routinely used. Voter lists are tampered with
wherever possible. In one case, over 10,000 voter IDs were found of a
particular religious group in one flat. You can also buy people’s voter IDs to
ensure they do not vote. In some areas, there is a threat of post-poll violence
and people are told to simply not vote. Since the margins of victory in many
constituencies are very low, these tactics can make the difference between
victory and defeat. We have perhaps the youngest voters in the world. To what
extent they are interested in thinking through various issues before voting is
not known. But we cannot blame the youth – the elders also sometimes vote based
on identity or various other factors.

While voters are
increasingly giving clear mandates, the era of coalition Governments is not
over. This may be good in some ways as it acts as a check to excesses by a
ruling party. But it also leads to instability, and behind-the-scenes
bargaining for the fishes and loaves of office. Many times a minor party gets
into power within a coalition. At other times the minor parties have a lot of
bargaining power.

What is the
collateral damage? To what extent do those in power work for the people and to
what extent do they work for those who fund them? One bare-bones method of
fundraising is something like this. A bold entrepreneur or business house goes
to someone in power and says, give me so much land or other public resources.
He says he will set up a plant and create so many jobs. If he is able to
persuade those in power, he then uses the public resources or land to leverage
large loans, preferably from public sector banks. Naturally, those in power
need some consideration to help them fight elections. Meanwhile, bad loans keep
rising. There are many clever ways of making money and helping those in power.
A book can perhaps be written on that. Politics of the type we have can affect
the financial sector in the long run.

On the social front,
we have State after State with huge deficit financing. This is growing and
sometimes seems irreversible. The politics of buying votes from the public
exchequer by giving freebies has led to this.

So where are we? We
have a highly competitive political system with over 2,000 parties, of which at
least 50 if not more are serious contenders for winning seats either at the
national or State level. We have a very diverse and heterogeneous population
divided on caste, religion, language and so on. We have an increasing role of
money power. (There are all sorts of interesting stories about how this is used
and practically every Indian has one story to tell). There are all sorts of
tricks being used to win elections – from campaign strategies to media management,
social media, fake news, paid news and what not. This is bound to happen given
the structure we operate in. We have a lot of collateral damage to the banking
sector and the State finances.

What can we do? We
propose one possible solution. It may or may not be workable but it addresses
the problems outlined earlier. We need to solve some basic problems – reduce
the role of money power and crime, reduce divisive politics and the politics of
hatred and appeasement. One way is to reduce the competition in politics. The
Japanese have an interesting multi-member constituency. Each is a large domain
and several members can be elected from the same constituency. This was true in
a few constituencies in India also for one or two elections after Independence.

What do we then
propose? We need to balance between what is practical and what is ideal. If at
most two candidates can be elected from each constituency, it would mean for
instance that anyone with say 35% or more votes is elected. We can then have at
most two candidates. How does this help? If a popular candidate knows he or she
is very likely to get past 35% of the votes polled, he need not spend so much
money, he need not abuse the other candidates and political parties. It is also
in line perhaps with the Indian ethos where co-operation and consensus is the
social norm, not competition. The winner takes all democracy that we have seen
is largely in the Western framework of competition and individualism. Our joint
family system, the notion of biradri, is more about living together
without animosity to others. Another thing we need to fix is transparency in
funding. Thirdly, we need ordinary people to fund their favourite candidate and
party with small amounts. Instead of selling their votes people need to support
politics. If they want a good government, they should pay for it, even if it is
a small amount.

There are many other
issues like which of the four systems of government we need. Or whether we need
an intelligent combination of some of those systems. The media needs to be
regulated. The Election Commission has a long list of recommendations that the
government is not acting on. There have been at least half a dozen major
Commissions that have gone into the issues of Electoral Reforms. Again, the government
has not acted – it is a long-term issue and elections are short-term. The hope
is that as more and more people think about these issues and become active
citizens, change will eventually come.

Finally, what about
the coming elections? The idea of active citizens who campaign not for a
candidate or for a party, but for good governance is needed. Social media in
various languages has increased the reach. ADR itself carries out a campaign
saying no votes for crime and for bribes. Voters need to understand that
selling their vote is not only demeaning but also harmful in the long run. The
more such non-partisan groups who carry out such campaigns, especially in
regional languages, the better.

shailesh.kwebmaker

DIFFERENTIAL VOTING RIGHTS SHARES – AN INSTRUMENT WHOSE TIME HAS COME?

Differential Voting Rights
Shares (DVRS) are in the news again as SEBI has set up a committee to review
the law relating to them. It appears that SEBI may be considering removal of
some of the severe restrictions on them so as to make their issue easier. This
could bring life into this instrument that otherwise is more or less a dead
instrument due to regulatory constraints.

This proposal has
surprisingly seen severe resistance even at this stage when the Committee is
merely set up. Opposition is of near paranoiac proportion. I submit that the
instrument by itself is useful and should be allowed with reasonable
conditions. It is of course not an instrument for all. It is not even anybody’s
case that this instrument will be very popular amongst corporate and/or
investors. But for many – companies, promoters and investors – it could work
well.

Let us first briefly
consider what DVRS are, what is broadly the current legal position, what are
the issues and opposition points and their possible answers and what could be
the way forward.

What
are DVRS?

DVRS are a variant of equity
shares. In other words, DVRS are equity shares. However, DVRS depart from
the usual equal-vote, equal-dividend features of ordinary equity shares.
Instead, they give differential voting and/or dividend rights. DVRS may thus
carry more – or less – voting rights than ordinary equity shares. Thus, for
example, one DVRS may carry just 1/10th voting right. 10 such DVRS would thus
carry one vote, compared to ordinary equity share which has one vote one share.
Or DVRS could carry more voting rights as for example, one DVRS having 10
votes.

Similarly DVRS could carry
more (or less) dividends than ordinary equity shares. DVRS could, for example,
be entitled to, say, 5% more dividends than ordinary equity shares. This helps
to compensate for lesser voting rights.Otherwise, such DVRS may carry all the
other features as ordinary equity shares. They may, for example, carry the same
rights on liquidation. There could be variants other than the normal
voting/dividends right however, this article focuses on variants of voting
rights and dividend rights only particularly in listed companies.

Legal provisions relating to DVRS

DVRS have always been
possible for private companies. However, flexible requirements for
public/listed companies have been a relatively recent phenomena. The provisions
relating to DVRS are contained in the Companies Act, 2013, rules made
thereunder, SEBI Regulations, circulars, etc. These have evolved over time.
Hence, the regulations are scattered and are cumbersome and time consuming.
Some features of the law can be summarised, albeit in a simplified manner.

Issue of DVRS would
generally require approval of shareholders by an ordinary resolution through
postal ballot. It generally would also require approval by SEBI. DVRS would
have to be offered to all shareholders proportionately – thus, DVRS would have
to be either in the form of right shares or as bonus shares. DVRS cannot be
more than 26% of the equity share capital. Existing equity shares cannot be
converted into DVRS.

Importantly, DVRS that have
right to a higher dividend or more voting rights than existing equity shares
cannot be issued. This restriction is obviously for protection of existing
shareholders whose rights would get diluted if new shares having more
dividends/voting rights are issued. These requirements end up being
restrictive, time consuming and even finally uncertain. This may also be one of
the major reasons why DVRS did not pick up in India and that the existing ones
are not successful. Even otherwise, the regulations for issue of DVRS are half
hearted. Most other provisions of law refer and provide for ordinary equity
shares and not DVRS. Thus, there is a legislative vacuum in respect of DVRS.
The Committee considering DVRS will thus need to recommend extensive amendments
to several laws.

DVRS
issued

Barely 5 companies have
issued DVRS in India. Except one, the other DVRS trade at prices that are at a
huge discount over the price of the corresponding ordinary equity shares. Tata
Motors DVRS, for example, trade at nearly 50% discount over the price of their
equity shares.

Future Enterprises Limited,
however, has its ordinary equity shares and DVRS trading at very small
differential. Part of this may be ascribed to the fact that their DVRS carry
25% less voting rights with right to 2% more dividends, as compared to ordinary
equity shares. The market liquidity of such DVRS is also generally poor.

Opposition
to DVRS and some possible responses

There has been severe
opposition to DVRS amongst certain circles, which is strong almost to the level
of being paranoiac/irrational. I submit that much of this opposition is
unjustified and can be refuted.

Much
of the fears and concerns can be dealt with if the DVRS are seen as just
another instrument whose value can be determined by informed parties using
relevant valuation models. Higher or lower dividend or voting rights would be
factored in the valuation. A company desiring to give lower voting rights can
compensate this loss by offering a lower issue price and/or with sweetener of
higher dividend rights. The point is that the market would generally take care
of the handicaps/advantages of differential rights by valuing the DVRS. Hence,
the opposition to DVRS would have to be considered in this light.

The core opposition to DVRS
is that it would help entrench existing management without their investing
money proportionate to their rights. Promoters and management would thus invest
lesser amount, take lesser risk and yet get higher control. This is
misconceived. Higher votes would result in higher price for such shares that
the promoters have to pay and lower price for the equity shares (DVRS) issued
to other shareholders. If investors consider the right to remove management as
very important to them, they will either pay a very low price for such shares
with lower rights or may not buy them altogether. So long as transparency is
maintained of the rights and disabilities on DVRS, the parties should be free
to work out the value amongst themselves either directly or through response to
public issue or through open markets.

It has been said that very
few companies have issued DVRS and these DVRS except 1 have badly performed.
The explanation for this can be several. One is educating the investors of this
instrument. Second is that the regulations themselves are complex and near
prohibitive. Finally, once again, the markets can be expected to take care of
the situation. If investors perceive that such instruments will give them
lesser return or have lower value, they will value them accordingly in the
market, as they would any other security. Banning or creating near prohibitive
conditions is not the answer.

Safeguards of corporate Governance and other provisions

Much has changed since the
time when the provisions relating to DVRS were introduced. We have extensive
corporate governance requirements and other new requirements that provide for
transparency and protection of various stakeholders. We have requirements
relating to a certain number of independent directors. The law provides for
extensive regulations relating to related party transactions. There are various
committees including Audit Committee, Nomination and Remuneration Committee,
etc. which look into certain issues. Shareholders earlier could rarely vote
because they could not attend general meetings physically since such meetings
were often held at remote or far off places. Postal ballot and electronic
voting has changed this situation a lot. Thus, there are many safeguards that
keep some check on majoritarian control.

Suggestions

As stated earlier, so long
as transparency is maintained and certain basic conditions are complied with,
DVRS should be allowed to be issued.

Rights on existing
instruments should not be changed without the approval of the holders. Take an
example. Presently a company has Rs. 10 crore of ordinary equity shares (1
crore equity shares of Rs. 10 each face value). Now, let us say the promoters
of the company hold 20 lakh ordinary equity shares of promoters. Thus, they are
entitled to 1/5th of the voting rights. If these 20 lakh ordinary equity shares
are converted into 20 lakh DVRS with each DVRS having 10 votes, the result
would be as follows. Total votes would be 280 lakh (200 lakh votes now held by
the promoters and 80 lakh votes by the others). The promoters would have 200
lakh votes which would be about 71%. Thus, their voting share jumped from 20%
to 71%. This results in loss of voting rights and thus value of the other
shareholders. This should not be permitted and the existing law does not permit
it.

In case of fresh issue, the
new shares should be offered to all. If it is proposed that the fresh issue is
to a special group, the issue should be transparently valued and the issue
price should not be lower than such price. SEBI could consider providing
formulae for this. The objective is that the value of existing shareholders
should not suffer because of such issue.

In the interim, till more
experience is gained, a cap can be placed on the number of DVRS. However,
unlike the present poorly drafted law that provides a cap on the maximum amount
of DVRS as a percentage of total capital, the cap should be on the maximum
voting rights that such DVRS carry. The cap of 26% of the capital could be
considered. The objective would be that the promoters/management, even if they
allot all the DVRS with higher voting rights to themselves, would be able to
hold only a certain maximum of voting rights through such DVRS.

Provisions could be made
whereby certain major decisions require approval by a higher majority. This
would give adequate say to a significant majority of shareholders. This will
help ensure that those in control with DVRS are not able to take such major
decisions that could affect the value of shareholders without their say. Like
certain preference shares, if there is no dividend paid for, say, 3 years, the
DVRS could be made entitled to voting rights.

Conclusion

Clearly, then, DVRS are an
instrument whose time has come. One hopes that, firstly, the Committee
wholeheartedly endorses this instrument. Further, it should propose extensive
rehaul of the various laws that deal with issue of securities and ensure that DVRS
are also provided for. They may also provide for conditions to ensure fair
play. In particular, there should be transparency and also education of
investors. Thereafter, the parties – companies, promoters and shareholders –
should be permitted to structure instruments as per their needs and desires and
at a value they mutually decide.

shailesh.kwebmaker

Appeal to Commissioner (Appeals) – Revision – Power of Commissioner(Appeals) – Application for revision and withdrawal of appeal to Commissioner(Appeals) – Order passed in revision granting relief – Commissioner(Appeals) has no power to decide appeal

41. Assessing
Officer vs. Dharmendra Vishnubhai Patel; 409 ITR 276 (Guj) Date of order: 5^th February, 2018 Sections 246A and 264 of ITA 1961

Appeal to Commissioner (Appeals) – Revision – Power of
Commissioner(Appeals) – Application for revision and withdrawal of appeal to
Commissioner(Appeals) – Order passed in revision granting relief –
Commissioner(Appeals) has no power to decide appeal

In this case assessment was made and penalty was levied on the assesse.
On 24/09/2016, the assesse filed an appeal against the order of penalty before
the Commissioner(Appeals). On 16/02/2017, the assessee filed a revision
petition u/s. 264 of the Income-tax Act, 1961 (hereinafter
for the sake of brevity referred to as the “Act”) against the
order of penalty before the Commissioner. On the same day he also made a
communication to the Commissioner (Appeals) before whom his appeal was pending,
in which, he conveyed his intention to withdraw the appeal. In exercise of his
revisional powers u/s. 264, the Commissioner set aside the order of penalty.
Despite this the Commissioner (Appeals) proceeded to decide the appeal on the
merits and by an order dated 25/09/2017 dismissed the appeal. The assesse filed
writ petition and challenged the validity of the order of the Commissioner
(Appeals).

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

“i) In terms of clause (a) of
sub-section (4) of section 264, revisional powers would not be exercised, inter
alia, in a case where the period of limitation for filing appeals has not
expired and the assesse has not waived the right of appeal. This is essentially
to ensure that in the case of the same assesse a single issue does not receive
consideration at the hands of the two separate and independent authorities, one
exercising appellate jurisdiction and the other revisional jurisdiction.

ii) The assessee had clearly made
a choice to persuade the Commissioner to exercise his revisional powers u/s.
264 and not pursue his appeal before the Appellate Commissioner. The revisional
authority therefore correctly proceeded to decide the revision petition of the
assesse and on the facts correctly allowed it. It was thereafter not open for
the Commissioner (Appeals) to still examine the merits of such an order.”

shailesh.kwebmaker

Counsel for Assessee/Revenue: Lalchand Choudhary/Vijay Kumar Soni Section 24(a) – Rental income earned by a co-operative society for letting out the building terrace is assessable under the head ‘Income from House Property’ and is entitled to deduction u/s. 24(a).

11.
Citi Centre Premises Co-Op. Society Ltd.
vs. Income Tax Officer (Mumbai) Member:
A.K. Garodia (A. M.) ITA No.: 3029 and 3030 / Mum / 18 A.Y.:
2013-14 and 2014-15 Dated: 1^st February, 2019

Counsel for Assessee/Revenue: Lalchand
Choudhary/Vijay Kumar Soni Section 24(a) – Rental income earned by a
co-operative society for letting out the building terrace is
assessable under the head ‘Income from House Property’ and is entitled to
deduction u/s. 24(a).

FACTS

The contention of the assessee before the
Tribunal was that rental income earned by a co-operative society, the assessee,
for letting out the building terrace and permitting erection and installing of
cell phone towers thereon in the building owned by it was assessable under the
head ‘Income from House Property’ and not as ‘Income from other sources’ as
assessed by the AO. Therefore, the assesse claimed, it was entitled to
deduction u/s. 24(a).

According to the AO, for assessing an income
earned in respect of a property as an income from house property, the property
in question should be fit for habitation.
According to him an open plot/ terrace cannot be termed as house
property as it is the common amenity for use of members of the assessee society
and cannot be used for habitation.

HELD

According to
the Tribunal, the facts in the case of the assessee were identical with the
facts in the case of Matru Ashish Co-operative Housing Society Ltd., vs. ITO
[27 taxmann.com 169] before the Mumbai Tribunal. As held in the said case, the tribunal held
that income from letting out of the terrace was to be assessed under the head
‘income from house property’ subject to deduction u/s. 24, as against income
from other sources, as assessed by the AO.

In the result the appeal filed by the assessee
was allowed.

shailesh.kwebmaker

Section 68 – Additions made to income of assessee, who was a non-resident since 25 years, were unjustified since no material was brought on record to show that funds were diverted by assessee from India to source deposits found in foreign bank account.

20. [2018] 100 taxmann.com 280 (Mumbai-Trib) DCIT(IT) vs. Hemant
Mansukhlal Pandya ITA Nos.: 4679
& 4680 (Mum) of 2016 and C.O. 58
& 159 of 2018 A.Y.s: 2006-07
& 2007-08 Dated: 16^th November, 2018

Section
68 – Additions made to income of assessee, who was a non-resident since 25
years, were unjustified since no material was brought on record to show that
funds were diverted by assessee from India to source deposits found in foreign
bank account.

FACTS

The
assessee, a non-resident since financial year 1995-96, is a director in a
company in Japan and living in Japan on business visa since 1990. He got permanent residency certificate from
Japan in 2001. The assessee has filed
his return of income for AY 2006-07 declaring total income of Rs.
5,51,667. Subsequent to processing of
the return, the assessment was reopened u/s. 147 of the Act for the reasons
recorded as per which information was received by Government of India from the
French Government under DTAA that some Indian nationals and residents have
foreign bank accounts in HSBC Private Bank (Swisse SA, Geneva) which were
undisclosed to the Indian Income-tax department. This information was received
in the form of a document (hereinafter referred to as ‘base note’) was processed
with that of the assessee’s Indian income-tax return and found that the details
contained in base note were matching with the information provided by the
assessee in his income-tax return. Accordingly, the DDIT(Inv), Unit VII(4),
Mumbai sent information to the concerned AO for further action. The AO, after
recording reasons, issued notice u/s. 148 of the Act for reopening of the
assessment.

In
the course of assessment proceedings the AO called for various details
including details of bank accounts maintained in HSBC, Geneva in original CD
and other details. In response to notice, the assessee, stated that he is a
non-resident for more than 25 years and being a non-resident, he is not under
obligation to declare his foreign assets and foreign income to the Indian
Income-tax Authorities; hence, the question of submitting the CD of the HSBC
Bank account or the consent waiver form does not arise. The AO, issued notice and asked the assessee
to file necessary details in support of HSBC Bank account maintained in Geneva
and also show cause as to why assessment shall not be framed u/s. 144 of the
Act, based on material available on record.

In
response, the assessee filed an affidavit and stated that his foreign bank
accounts and foreign assets have no connection with India or any Indian
business. No amounts from India have been transferred to any of his foreign
accounts directly or indirectly. The assessee
challenged the authenticity and correctness of the base note and contended that
no addition can be made merely on assumptions or presumptions. The assessee
further submitted that the bank account maintained in HSBC, Geneva is having no
connection with India and accordingly question of furnishing details of bank
accounts and foreign assets does not arise. He further stated that he has filed
his income-tax return regularly in India in the status of Non-resident
declaring whatever income accrued or deemed to accrue in India and such returns
have been accepted by the department. In the absence of any provisions to
declare foreign bank accounts and assets by non-residents to Indian Income-tax
department, the question of disclosing those accounts to Indian Income-tax
department does not arise and consequently, the amount lying in HSBC Geneva
account cannot be taxed in India.

The
AO added the peak balance in HSBC account, amounting to Rs. 48,95,304 (Rs.
45.52 per USD) by holding that since the assessee had not produced any
evidences to prove that the money deposited in his foreign bank account does
not have any source from India. He held
that since the assessee did not produce any documentary evidence to prove that
prior to 2001 he was permitted to have business/profession or work in Japan or
any other country the only conclusion that can be drawn is that prior to this
date, the assessee cannot be engaged in any business, profession or employment
in Japan. He also held that there is a prima
facie presumption of amounts in the said account being undisclosed and
sourced from India. The circumstances of the case point to only one thing with
regard to source of deposits in HSBC, Geneva accounts; that the deposits were
made by the assessee in his HSBC, Geneva account from sources in India which
have not been disclosed in his return of income.

Aggrieved,
the assessee preferred an appeal to CIT(A) who deleted the addition made by the
AO.

Aggrieved,
the revenue preferred an appeal to the Tribunal.

HELD

The
Tribunal noted that the assessee had only one bank account in India of which
the bank statements from 1998 to 2008 were furnished by the assessee. On
perusal of the said bank statements it could be seen that no amounts have been
transferred by the assessee from this bank account in India to any of the other
bank accounts including HSBC Geneva. It
also noted that the balance maintained in this Indian Bank Account is so less
that it cannot fund an amount of Rs. 4.28 crore which has been added by the AO
to assessee’s income. The Tribunal
observed that the AO sought to put the onus of proving a negative that the
deposits in foreign bank accounts are not sourced from India, on the
assessee. It held that the AO is not
justified in placing the onus of proving a negative on the assessee. In fact, only a positive assertion can be
proved and not a negative one. The onus
of proving that an amount false within the taxing ambit is on the department
and it is incorrect to place the onus of proving negative on the assessee. The
Tribunal held that when the AO found that the assessee is a non-resident
Indian, he was incorrect in making addition towards deposits found in foreign
bank account maintained with HSBC Bank, Geneva without establishing the fact
that the said deposit is sourced out of income derived in India, when the
assessee has filed necessary evidence to prove that he is a non-resident since
25 years and his foreign bank account and assets did not have any connection
with India and that the same have been acquired/sourced out of foreign income
which has not accrued/arisen in India.

The Tribunal then proceeded to examine whether the government/
legislature intended to tax foreign accounts of non-residents. Having noted the clarifications of Minister
of State for Finance on the floor of the Loksabha and also the provisions of
the Black Money Act and the FAQs issued to the Black Money Act it held that the
AO, without understanding these facts and also without answering the
jurisdictional issue of whether the non-resident assessee was liable to tax in
India in respect of deposits in his foreign bank account, when he had proved
that the source of deposit was not from India, went on to make addition on
wrong footing only on the basis of information in the form of base note which
is unverified and unauthenticated. It
held that no material was brought on record to show that the funds were
diverted by the assessee from India to source the deposits found in foreign
bank account. The suspicion, however
strong, cannot take place of proof and no addition could be made on presumption
and assumption. The Tribunal held that
the AO had not proved that impugned addition could be made within the ambit of
section 5(2) r.w.s. 68/69 of the Act.

The
Tribunal also noted that the co-ordinate Bench of ITAT has in the case of Dy.
CIT vs. Dipendu Bapalal Shah [(2018) 171 ITD 602 (Mum.-Trib.)] decided an
identical issue in respect of foreign bank accounts and held that when the AO
failed to prove the nexus between deposits found in foreign bank accounts and
source of income derived from India, erred in making addition towards deposit
u/s. 68/69 of the Act.

As
regards reliance of the revenue on the decision of the Mumbai Bench of ITAT in
the case of Rahul Rajnikant Parikh [IT Appeal No. 5889 (Mum) 2016] the
Tribunal held that the said case has no application to the facts of the case as
in the said case, the Tribunal has not laid down any ratio. The matter was set aside to the file of the
AO. It is settled law that a
judgment/order delivered by consent has no precedential value.

The
Tribunal held that the AO erred in making addition towards deposit found in
HSBC Bank Account, Geneva u/s. 69 of the Act.
It held that the CIT(A) has rightly deleted the addition made by the AO.
The appeal filed by the revenue was dismissed.

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Section 153A: Assessment – Search- Approval to the assessment order granted by the Addl. CIT in a casual and mechanical manner and without application of mind renders the assessment order void. [Section 153D].

11. Pr CIT
vs. Smt. Shreelekha Damani [ ITA no 668 of 2016 Dated: 27^th November, 2018 (Bombay High
Court)].

[Shreelekha
Damani vs. DCIT(OSD-1)CR-7; dated 19/08/2015; ITA. No 4061/Mum/2012, AY:
2007-08 Bench: F Mum. ITAT ]

Section
153A: Assessment – Search- Approval to the assessment order granted by the
Addl. CIT in a casual and mechanical manner and without application of mind
renders the assessment order void. [Section 153D].

A search and seizure action u/s. 132 of the Act was carried out on
16.10.2008 on Simplex Group of Companies and its Associates. The
Office/residential premises of the company and its Directors/connected persons
were also covered. Simplex Group is engaged in the business of Reality, paper,
Textile and Finance. On the basis of the incriminating documents/books of
account found during the course of search and seizure operation, assessment was
made u/s. 143(3) of the Act r.w.s 153A and as per the endorsement on page-11 of
the assessment order this order is passed with the prior approval of the ACIT,
Central Range-7, Mumbai.

The assessee before the Tribunal raised a additional ground against
the assessment order that the A.O has not complied with the provisions of
section 153D and hence the assessment made u/s. 153A of the Act is bad in law.

The Revenue furnished the copy of the approval given by Addl. CIT,
Central Range-7, Mumbai which is also filed by the assessee in the paper book .
The assessee vehemently submitted that the so called approval brought on record
cannot be considered as an approval within the frame work of the provisions of
Sec. 153D of the Act. The approval granted by the Addl CIT is devoid of
application of mind and by any stretch of imagination the order made u/s.
143(3) r.w.s 153A of the Act cannot be said to be made after receiving the
approval as per the provisions of section 153D of the Act.

The Tribunal held that the contents of this approval are “res
ipsa Loquiter” in as much as the language is speaking for itself. The Addl
CIT says that the draft order was placed before him on 31.12.2010. He further
says that there was no much time left to analyse the issue of draft order on
merit, therefore, the said order is approved as it is.

The legislature wanted the assessments/reassessments of search and
seizure cases should be made with the prior approval of superior authorities
which also means that the superior authorities should apply their minds on the
materials on the basis of which the officer is making the assessment and after
due application of mind and on the basis of seized materials, the superior
authorities have to approve the assessment order.

The approval granted by the Addl. Commissioner is devoid of any
application of mind, is mechanical and without considering the materials on
record. In our considered opinion, the power vested in the Joint
Commissioner/Addl Commissioner to grant or not to grant approval is coupled
with a duty. The Addl Commissioner/Joint Commissioner is required to apply his
mind to the proposals put up to him for approval in the light of the material
relied upon by the AO. The said power cannot be exercised casually and in a
routine manner. The Tribunal observed that in the present case, there has been
no application of mind by the Addl. Commissioner before granting the approval.
Therefore, the assessment order made u/s. 143(3) of the Act r.w.s. 153A of the
Act is bad in law and deserves to be annulled.

Being aggrieved with the order of the ITAT, the Revenue filed the
Appeal before High Court. The Court observed
that in plain terms, the Additional CIT recorded that the draft order
for approval u/s. 153D of the Act was submitted only on 31^st
December, 2010. Hence, there was not enough time left to analyse the issues of
draft order on merit. Therefore, the order was approved as it was submitted.
Clearly, therefore, the Additional CIT for want of time could not examine the
issues arising out of the draft order. His action of granting the approval was
thus, a mere mechanical exercise accepting the draft order as it is without any
independent application of mind on his part. The Tribunal is, therefore,
perfectly justified in coming to the conclusion that the approval was invalid
in eye of law. We are conscious that the statute does not provide for any
format in which the approval must be granted or the approval granted must be
recorded. Nevertheless, when the Additional CIT while granting the approval
recorded that he did not have enough time to analyse the issues arising out of
the draft order, clearly this was a case in which the higher Authority had
granted the approval without consideration of relevant issues. Question of
validity of the approval goes to the root of the matter and could have been
raised at any time. In the result, no question of law arises. Accordingly, the
Reveune Appeal was dismissed.

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